Global supply-chain disruption and higher repair costs will likely amplify commercial auto insurers' losses in the short run. As the U.S. economic outlook brightens, set to grow at its fastest pace since 1984 fueled by consumers eager to spend, pent-up demand is outpacing available supply. This has resulted in shortages and driven up prices for many items from car parts to anchovies. Supply-chain problems and higher freight demand have led to shortages of drivers and vehicles, which has created unique capacity imbalances in the trucking industry. Indeed, S&P Global Ratings thinks these factors will likely have a spillover effect on the commercial auto insurance sector. As the confluence of risk factors (such as shortage of experienced drivers, more miles driven, and rising litigation costs) intensifies, we believe underwriting profits for commercial auto insurers will likely remain elusive as the economy opens back up.

As the U.S. economy reopens, we expect road accidents are returning to historical levels. Americans drove less in 2020 due to COVID-19 restrictions (decreased by about 430.2 billion miles, or 13.2%, from 2019). With much lower average traffic congestion and fewer cars on the road, the U.S. Dept. of Transportation's National Highway Traffic Safety Administration showed accident fatalities involving large trucks and buses fell nearly 13% to 4,565 fatalities and nonfatal crashes by roughly 14% to 156,707. However, to put that number in perspective, a study by the Federal Motor Carrier Safety Administration (FMCSA) study found the number of fatal crashes involving large trucks and buses had grown 57% between 2009 and 2019. Most truck accidents are generally caused by critical driver error, such as failure to follow speed limits, improper surveillance of surroundings, distracted driving, fatigue (mostly caused by not adhering to rest-time regulations), coupled with poor road conditions (e.g., fog and snow) and mechanical failures. In an average year, about 500,000 truck-related accidents occur in the U.S., including those involving physical damage only (see table 1 for those including fatalities and personal injuries).

Table 1

For the past several years, we have been monitoring commercial auto insurance, which protects motor vehicles owned by businesses against financial loss stemming from legal liability for related injuries, damage, or accidents arising out of the ownership, maintenance, and control of a motor vehicle. We have observed a common thread attributed to year-over-year losses--generally an influx of inexperienced drivers and rising defense and settlement costs have led to underwriting losses (above 100% in the combined ratio) in the commercial auto insurance industry. Not only have the risk variables not lessened over that time, the current shortage of auto parts has led to higher repair costs, and a higher number of older vehicles driving more miles leading to more accidents could amplify loss frequency and severity, at least in the short run.

Commercial Auto 101: The Trucking Business And The Underlying Insurance

The trucking business

Trucking accounts for nearly 6% of all U.S. full-time employment according to the Bureau of Labor Statistics (BLS); the U.S. trucking industry employs about 7.4 million workers that support the $800 billion sector. For years, industry experts have warned of a looming trucker shortage, particularly for long-haul drivers delivering across state lines and among the older ages of experienced drivers. Its labor force is fluid, with a very high attrition rate, as it competes with industries such as warehouses and construction. This, along with time away from home, health issues, and stagnant wages for many truckers are the predominant reasons behind the persistently low retention and shortage of drivers. The American Trucking Assn. estimates the shortage may swell to 160,000 truckers by 2028 from 60,00 at year-end 2019.

According to FreightWaves, a third-party U.S.-based supply-chain and logistics freight data analytic firm, insurance expenses, as percentage of total revenue for the trucking industry, climbed to 4.8% as of first-quarter 2021, up from 3.4% at year-end 2016 due to rising costs of insurance as insurance carriers pushed rate increases over the past four years to offset losses from a rising number of accidents and higher settlement costs.

One factor cited by the trucking industry has been the sharp increase in the number and value of so-called "nuclear" verdicts. A study conducted by the American Transportation Research Institute (ATRI) showed that these large verdicts against trucking fleets are increasing both in number and in size of awards. Of the 451 cases compiled by ATRI in 2006-2019, it found 265 cases with verdicts exceeding $1 million from 2012-2019 compared with 79 cases from 2005-2011. ATRI's research also shows the average verdict award spiked dramatically in 2018 by a factor of nearly 5x from less than $5 million in 2017 to $22.3 million in 2018. Longer term, the average verdict grew 32.8% annually (rising to $22.3 million from $2.3 million) while the Consumer Price Index (CPI) grew about 2.0% and health-care costs at 5.4% annually between 2010 and 2018, highlighting how social inflationary pressures have led to ever more severe verdicts.

Chart 1

As of June 30, 2021, outbound tender volumes have risen sharply since the start of 2020; we surmise more trucks and private passenger cars on the road will likely translate to more accidents. A tender is a load offer sent electronically from a shipper to a trucking company. An index of tender volumes created in March 2018 by FreightWaves, which started with a baseline of 10,000, showed that U.S. outbound tender volumes climbed above 15,000 as of July 31, 2021, up from 10,000 in 2019. This implies outbound tender volumes so far for 2021 are 50% above 2018 and 2019 levels. Outbound tender volume is expected to rise for the rest of the year while capacity will remain tight, according to the company.

The pandemic-induced hangover has also prompted vehicle manufacturers to cut production due to chip and auto part shortages with new truck orders facing shipping delays of nine months or more. A semiconductor chip shortage may likely persist all the way to 2023 according to IHS Markit. Even if it's not yet obvious as to how that would lead to an increase in road accidents, considering that older fleets are susceptible to mechanical failures (one of leading factors for truck accidents), higher repair costs would likely exacerbate insured losses.

The insurance

Commercial auto insurance (liability and physical damage) constituted about 6.25% (about $45 billion) of the property/casualty industry's total direct premium written in 2020. The largest writers include Progressive Corp., Travelers Corp., Old Republic Insurance Co., Liberty Mutual Insurance Co., Nationwide Mutual Insurance Co., Zurich American Insurance Co., and Berkshire Hathaway Inc. The top 10 underwriters account for nearly 43% of total market share, but most have yet to realize an underwriting profit. Commercial auto insurance became problematic in 2011. This uptick in losses, interestingly, coincides with the rising number of cases with verdicts above $1 million at the same time.

Chart 2

Chart 3

Looking at the components that measure underwriting losses, we observed defense and cost-containment expense (DCCE), a proxy for defense and litigation costs for insurers, remains elevated despite many years of rate increases. Accordingly, insurers incurred an average of $9.40 of defense cost per $100 premium written (DPW) between 2016 and 2020 on commercial auto policy, up from $9.30 per $100 DPW between 2010 and 2015. This compares with $6.80 for all other casualty lines between 2016 and 2020, down from $7.70 between 2010 and 2015. Despite the cumulative rate-on-rate increases of nearly 40% from 2016-2020, commercial auto policies remain expensive to defend and settle relative to other casualty policies.

Chart 4

While it may look as though commercial auto is finally making substantial progress, generating a 102% combined ratio in 2020 (versus 109% in 2019), we think court closures coupled with fewer miles driven and less-congested roads have contributed to a temporary relief. With businesses and courts reopening and people reverting to old driving habits along with other unresolved structural challenges (inexperienced drivers and rising litigation costs), we believe the industry is still posting inadequate reserves for recent accident years. In 2020, the industry strengthened reserves by about $2.1 billion for commercial auto (mostly coming from 2016-2019)--the ninth consecutive year of adverse development. We anticipate further price increases as necessary to catch up with rising health-care costs and unabating litigation expenses.

Chart 5

What Lies Down The Road For Commercial Auto Insurers

Commercial auto insurance will likely remain a loss leader as the economy reopens, but we also see insurers remaining vigilant by taking preemptive actions in pricing at the product level, as well as account level (such as achieving adequate underwriting profits from other lines written within the account) to justify writing this business. Insurers are also boosting the use of technology (such as dash cams, electronic logs, and telematics) and risk sharing in addition to remaining watchful on actuarial loss picks, reserving discipline, and exposure management to limit run-away losses. Over the years, we have seen insurers intensifying their monitoring of contributing loss factors such as more-aggressive personal injury attorneys, distracted driving, and a shortage of experienced drivers to mitigate the rising number of claims counts and adverse loss frequency/severity trends. With top commercial auto insurers generally being highly diversified and strongly capitalized, we see limited rating pressure, although underwriting performance from commercial auto insurance will remain a drag on the industry's profitability. We note that the better performing companies (notably, Progressive Corp.) are growing the fastest, while those that have consistently underperformed have scaled back over the past 10 years.

Table 2

Table 3

Table 4