Managing Risk Effectively Through Changing Times

For the 15 years leading up to the pandemic, risk pricing was relatively stable.  Severity for most Asian imports and domestic vehicles traded consistently in the $700 to $800 range per occurrence. 

Frequency was the primary variable, with most Asian models in the 20% to 35% range and most domestics between 40% and60%. For many administrators and agents, this created a false sense of confidence about what to expect in the future.

Pandemic Domino Effect

The long period of relative stability was upended after the global pandemic that started in 2020. The following circumstances are the primary factors in changing loss emergence patterns:

• Chip shortages slowed production and decreased availability of desired vehicles and options.
• Plant closures due to illness decreased the output and efficacy of the facilities.
• This led to a shortage of new vehicles, which decreased supply at new-car dealerships.
• The lack of supply led many dealers to sell vehicles at large markups over manufacturer’s suggested retail price and caused a run on used-car inventories.
• Used-car prices consequently rose due to lack of supply, and more dealerships were competing for each unit at auction.
• This led to many dealers lowering their standards for used-car inventory, and higher mileage cars that would once have been wholesaled became retail inventory.
• The overall product mix shifted to higher risk.

The long-lasting consequences for our industry were significant, the results of which we are still experiencing, and I would opine we are likely to continue to experience for quite a while longer.   

A few primary consequences come to mind:

• Higher-mileage used vehicles represented a greater share of vehicle service contract sales than in the past, while dealers sold fewer new cars and new VSCs. This skewed the risk mix in favor of used and in particular in favor of higher mileage and higher risk vehicles. When you consider that consumers have been keeping their cars longer due to persistently inflated costs, more of these less desirable VSCs are going all the way to term and not getting cancelled out. This has impacted VSC risk pricing in a material way.
• All the vehicles sold for well over MSRP have led to higher than typical GAP severities for our industry. This factor affects virtually all makes. Beyond this, many EVs have experienced significant depreciation, which further degrades GAP underwriting experience for the vehicles. While the worst years are behind us, many administrators have several ugly claims years on their books, with significant risk still in force.   

A New ‘Normal’

Then we got through Covid, or at least we entered a sense of a new “normal.” 2022 arrived, and Russia invaded Ukraine, leading to a spike in interest rates. The U.S. federal government injected a significant amount of liquidity into the economy between direct stimulus and other mechanisms, such as Paycheck Protection Program loans. Inflation started to increase, and in March 2022, the Federal Reserve raised the federal funds above 0%. As the Fed raised interest rates, banks responded and increased their interest rates on money lent. Despite this, inflation persisted and led to more interest rate increases. Rinse and repeat. In June 2023, inflation peaked at 9.1% over the previous year, then slowly decreased. Despite the decrease in inflation, prices continued to go up, though at a slower pace than previously.

OK, at this point you may be wondering – why the economics lesson, Hanlon? When are you going to get to the point about what we do now? Soon, grasshopper, soon.

As all this inflation made its way through our economy, everyone was affected. That $10 cheeseburger from several years ago now costs $15 or $17. The person that cuts your hair probably raised their prices in the past five years. Same with the person who mows your lawn, cleans your pool or walks your dog. Attorneys, accountants, plumbers and electricians, everyone raised their prices to cover increased costs. High inflation is a harmful flywheel for us all.

As the cost of parts increased along with everything else, and as dealers raised their labor rates, VSC loss costs significantly increased. Additionally, the complexity of vehicles continued to rise. In some cases, this requires more time to complete repairs, combined with the higher labor cost. Windshield repairs, for instance, now require precise calibration due to their heads-up displays. In other cases, parts complexity has increased – think Tesla. This may create efficiencies on the front end but add meaningful cost to the repair once the vehicle is in service and has a claim.

The result of all of this is an increase in the rate of change within both frequency and severity across the entire book. Risk pricing fundamentally changed, and yet many administrators were slow to implement premium increases.

All the talk in 2022 about inflation being “transient” led to many administrators neglecting to prioritize proactive premium increases, and consequently many reinsurance positions became effectively under-reserved. 

Many reinsurance books are mature and have enjoyed a favorable inception-to-date earned loss ratio for many years. The belief that inflation would soon pass carried on for some over the following couple of years. It eventually became clear that there was a real problem, and one that could not be easily resolved.

Some administrators who were behind the premium increase curve attempted a series of small increases over time to play catch-up. This approach can work, but it takes time. Others chose to take their medicine all at once and implemented significant premium bumps. While more immediate in impact, this approach can shock the client, often leading to attrition and potential underwriting losses as dealers move to other carriers to start over.

Righting the Ship

Here are proactive tips I would consider adopting as we navigate this new reality of managing dealer risk:

1. Focus on emerging trends more than historical results. Your best indicators, in order, are your trailing three months, trailing six months, trailing 12 months and trailing 24 months results. One quarter is a data point. At two quarters, begin to establish a trend.
2. Make premium increases part of your reinsurance-management culture with clients. Costs go up over time, and premiums must adjust accordingly.  It’s far easier to raise premiums if you implement consistent, incremental increases over time.
3. Seek to identify anomalies. Benchmark dealers against similar books of business. When one dealer is an outlier in claims experience, dig into why. Don’t just throw premium at every problem.
4. Look at the other levers you can pull beyond premium. Review losses by make, age, miles, drivetrain, etc. Sometimes one tranche of business causes an outsize amount of claims for a client. For example, if a dealer is reinsuring everything up to 100,000 miles and most losses occur over 90,000, it’s easy to cut eligibility a bit to improve the performance of the book.

A Case Study to Learn From

To share a few practical examples of these principles being deployed in real time, I would offer a few high-level specifics as guidance for your dealer clients’ own approach:

• We recommend dealers implement a series of increases along the way to minimize pushback at a dealership level.
• We suggest dealers make eligibility adjustments within individual client book as warranted. Our risk team identified claim spikes early, and we took proactive measures to mitigate those areas of risk.
• Dealers should focus on trailing three-, six-, 12- and 24-month risk patterns and largely look past legacy book performance. Protective had proactive, sometimes difficult conversations as new trends emerged, and our clients came to appreciate that transparency.
• Where eligibility is reduced, dealers should provide credible secondary solutions to handle higher-risk business in a manner that doesn’t compete with the dealer’s interests or reinsurance position.
• Protective’s average VSC reserve is 18% higher than it was three years ago.
• Our average GAP reserve is 14% higher than it was three years ago.
• Our average reserve for lifetime-type products is more than 50% higher than it was three years ago.

The end result of all these proactive maneuvers at Protective is that the spike we saw from pandemic-related risk changes has largely subsided, trailing loss ratios have substantially decreased, and we remain ahead of the risk curve.

I hope this experience proves helpful to you all as we seek to serve our clients and effectively manage risk.

Ryan Hanlon served as chief sales officer for Portfolio until its January 2026 acquisition by Protective Asset Protection division. He serves Protective as vice president, distribution and is formulating with other senior leadership the go-to-market strategy of the newly combined Protective APD business unit.