Commercial motoring has had a tough decade, and with third party litigation funding on the rise, the industry needs advice on how to move forward.
Commercial auto is currently a struggling segment of the property and casualty insurance market.
Insurance companies have struggled to turn a profit in recent years, and they continue to struggle to control soaring claims costs. Poor underwriting results from 2014 to 2019 led to significant rate increases. However, many industry experts question whether the steep rate increases since 2018 are enough to deal with exploding claims costs.
Reinforcing this general sentiment, AM Best placed a negative outlook on the commercial auto market in 2022, and Fitch Ratings Services said the somewhat favorable trend in 2021 and 2022 may be unsustainable in 2023 and beyond.
We agree with these assessments and believe that it will be difficult for commercial auto insurers to be profitable in the near future, for several reasons.
First, there has been an explosion in the severity of liability claims and associated legal costs (both have increased at about the same rate).
Verisk’s Stephanie Fox said the average verdict for claims with verdicts over $1 million increased tenfold between 2010 and 2018. We believe the presence of third-party funders (TPLFs) is a significant factor contributing to these trends. .
Second, today’s inflation rate is as high as it has been in 40 years. In addition to normal Consumer Price Index (CPI) inflation, automakers and body shops continue to face supply chain shortages that are hampering their ability to obtain parts and repair cars.
Third, the trucking industry faces a shortage of drivers and struggles to recruit new drivers into the profession.
This shortage has increased driver turnover and put additional pressure on delivery times. Inexperienced and significantly older drivers make up a large portion of the workforce, and historical experience shows that these drivers tend to have a higher accident frequency.
Finally, insurance companies are faced with an unfavorable evolution of reserves from previous years and a lower reinsurance capacity.
All of these factors have a negative impact on insurers’ net income.
High commercial auto loss rates
It is well known in the insurance industry that commercial auto insurance companies have struggled over the past decade.
Defense expense and cost containment (DCCE) loss and expense ratios for commercial motor vehicle liability (CAL) have been significantly worse than the overall P&C insurance industry loss ratios since 2012, as shown in the figure 1.
While the outlook for commercial auto has generally been pessimistic, perhaps one point of optimism is that the spread between CAL and P&C loss ratios has reached its lowest point in nearly a decade, with a difference of 7.4% in 2021.
To get a better idea of where the commercial automobile is headed, we looked at recently published material from the 10-Q company for top commercial automobile writers.
Progressive is seeing an increase in claims severity in its commercial auto business, which is partially offset by a higher average premium per vehicle due to rate increases.
Allstate also notes unfavorable reserve reestimates for its commercial automotive book. However, Allstate attributes this supply development primarily to written shared economy activities in the states that Allstate left.
Conversely, Travelers and Old Republic show favorable loss trends in their commercial automotive books for the past accident years, as shown in their second-quarter 10-Q reports.
While those 10-Q statements seem to be sending mixed signals, it’s promising to see a favorable development for Travelers and Old Republic, which have historically had more exposure to long-haul trucking on their books than Progressive and Allstate.
As Allstate noted in its 10-Q, losses were significantly worse in some states, with six states posting five-year losses and DCCE ratios above 85%.
Figure 2 shows five years of loss experience for the seven worst performing states based on our analysis of industry data.
Various factors influence these results, such as the litigation environment, high exposure to trucking, and a higher prevalence of nuclear verdicts.
Premium growth higher than that of the P&C industry
One would assume that consistently observed adverse outcomes would eventually be corrected as carriers increase their rates. In fact, commercial auto insurers have increased their rates several times in recent years, with many even implementing significant increases in consecutive years.
Figure 3 shows that the year-over-year change in direct written premiums has been approximately double that of the P&C industry as a whole in three of the past four years.
The lower premium growth seen for commercial auto liability in 2020 is likely a function of reduced exposure, fewer rate increases and premium refunds or policyholder dividends due to pandemic.
The impact of pandemic refunds and dividends is difficult to measure, as their impact could be reflected in various accounting measures, including premium reductions, underwriting costs or policyholder dividends.
Stronger premium growth in 2021 appears to have offset reduced premium growth in 2020 as exposure has returned to pre-pandemic levels and many carriers have resumed (or continued) accepting rate increases.
Background to Third-Party Litigation Funding
The increase in large verdicts in commercial automotive cases is partly attributable to social inflation and increased third-party litigation funding.
Social inflation is generally described as a change in claims costs due to the perception that certain parties are better placed to bear the cost of an accident. Many believe that social inflation is caused at least in part by a deterioration in sentiment towards big business after the global financial crisis of 2007-2010.
The public’s growing aversion to big business over the past decade is thought to be influencing juries looking for someone they think they can afford to pay in the event of an accident resulting in serious injury.
Research by the Insurance Information Institute and the Casualty Actuarial Society indicated that between 2010 and 2019, social inflation increased claims for commercial auto liability insurance by more than $20 billion.
The emergence of third-party funders in recent years is also an important factor that insurers should be aware of, given the potential impact on litigation costs, resolution strategy, potential exposure of the insured and ultimately the bottom line of the insurance industry. TPLFs provide upfront funding for often costly and drawn-out litigation in exchange for a percentage of the proceeds of the case, if successful. The TPLF sector has grown into a massive industry in recent years, and major players now invest billions of dollars each year in litigation.
TPLFs first appeared in personal injury suits and provided plaintiffs who could not afford an attorney or find an attorney to work unscheduled with a way to “get through their day in court.” However, many TPLFs no longer provide funding for personal injury actions. Instead, the TPLFs have focused on commercial litigation and class action lawsuits in an effort to seek much larger recoveries.
The commercial automotive industry has been one of the main targets of TPLFs in recent years.
What was once described as a business focused on assisting Davids against Goliaths – with Goliaths being championed by larger insurers – third-party litigation funding has grown rapidly and reversed this dynamic. As a result, the TPLFs have pushed up settlements, along with legal costs and awards, and petty plaintiffs are now on a par with, if not superior to, the Goliaths.
The TPLF phenomenon is somewhat amorphous as TPLFs often lurk in the background and defendants are often not even aware that a third party is funding a plaintiff’s case.
TPLFs generally agree to fund litigation fees and expenses without any guarantee that they will receive a return on their investment. Interestingly, most TPLFs were founded and continue to be controlled by former litigants who left the courtroom for a boardroom. Before investing in a case, TPLFs must weigh the cost of litigation against the expected award or settlement. Ultimately, any proceeds are first used to pay attorneys’ fees, and then the TPLFs take a large chunk of the recovery, often leaving the plaintiff with less than half of the settlement or award.
At the same time, some of these cases would never have made it to court without the involvement of the TPLF, as a plaintiff’s attorney may not be willing to bear all the risks (and significant costs) involved. in handling the case. Thus, the assumption of litigation risk by TPLFs generally increases the number of litigations. And the increase in litigation – both the number of lawsuits filed and the increased duration of the case – is impacting insurance companies, as well as the entire legal system.
So what is the influence of TPLFs on the bottom line? Find out in Part 2, as these Milliman actuaries dig deeper into commercial auto and third-party litigation funding. &
Brian is a senior actuary and consultant for Milliman Inc., where his areas of expertise are property and casualty insurance. Christopher Fredericks is a partner at Mendes & Mount LLP. Drew is an Associate Actuary for Milliman Inc. with expertise in pricing, reserving and predictive analytics for various P&C exposures. Katie is a consulting actuary for Milliman Inc. and has expertise in pricing, predictive analytics and claims reserve analysis.