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Sector Spotlight: Will the Automobile Industry Remain in Cruise Control?

Why recent gains may not translate into long-term sustainability for insurers.

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The landscape for automobile insurance stocks has been quite favorable this year. Companies in the industry have benefited from rising profits tied to higher premiums, mostly as a result of rising fatalities on US roadways, due primarily to distracted drivers. While markets clearly approve of the short-term profits of auto insurers, we believe that this industry catalyst is not sustainable over the long term. The industry faces several potential headwinds that could lead to structural declines in insurance premiums, including a reduction in auto accidents and fatalities and fewer drivers on the road due to ride sharing and self-driving cars, as well as advances in auto safety technology and better price transparency for drivers.


Driving fatalities rising in the short term

Technological advances in automobiles, such as anti-lock brakes and power steering, led to a 30-year decline in motor vehicle fatalities. That trend, however, was disrupted recently when driving deaths started to rise (as shown in Exhibit 1) due to increased driver distraction, including texting and other in-car diversions.

mfse_autoins_blog_ex1

While we believe this trend could continue in the short term, the probability that it will persist over time is relatively low, as technological and transportation advancements are likely to mitigate much of the risks being taken during the average roadway experience.


The ride-sharing generation: Teens prefer to be driven

We expect ride-sharing services such as Uber, along with self-driving/autonomous vehicles, will decrease the demand for personal vehicles and thus insurance. This situation is similar to that of mall retailers. Although malls aren't going away, total sales traffic has slowed and will likely continue to deteriorate over time.


It is also relevant that the percentage of US high school seniors with driver's licenses has fallen 11% from just a decade ago (as shown in Exhibit 2). Many millennials appear to be avoiding the hassle of getting a license and maintaining a car, preferring instead the ease of ride sharing. So, while auto insurers are currently getting a cash flow lift from various industry trends, what happens to the long-term value of the industry when ride sharing services such as Uber — whose drivers buy commercial insurance separately — and autonomous vehicles — whose owners are also likely to purchase insurance from commercial auto underwriters —  become fully integrated? We believe these trends raise concerns over the sustainability of auto insurance cash flows and profits, which translates into reduced expectations for the stocks of these companies over the long term.

mfse_autoins_blog_ex2

Further headwinds: Telematics and aggregators

The introduction of more technological advances in the field is also clouding the sustainability of the auto insurance industry. We believe auto insurers will tap into automobile data to price your exact driving behavior, a platform known as "telematics." This technology is designed to monitor your driving by tracking how hard you brake, how fast you drive, how far you drive and when you drive. Based on your behavior, auto insurers will re-price your risk. If you're a better driver, you'll get a discount, and if you're not driving well, you'll theoretically pay a premium. The technology is still new and a device needs to be plugged into your car. However, more original equipment manufacturers will be embedding telematics into new vehicles.


Aggregators such as travel sites that search for the best air travel, hotel and car rental deals have become commonplace, but this type of service is not readily available for automobile insurance, at least not in the United States. One of the main reasons it's difficult to aggregate in the US is because auto insurance is regulated on a state-by-state basis. If insurers want to implement a price increase, they have to go to state regulators to justify the need. Companies can't increase premiums just because a competitor is raising prices or because it wants to increase profit. Overall, price transparency is bad for profitability, especially for levered business models such as auto insurers with high premium-to-equity ratios. We believe that despite current challenges the industry will become more transparent over time, and this should lead to lower premiums and ultimately lower cash flows for insurers.


Conclusion

Short-term gain might not translate into long-term sustainability for the auto insurance industry. In our view, the recent surge of accidents and fatalities, mainly due to in-car distractions, is not a sustainable trend due to auto vehicle and trip innovation. Thus, while the industry might be attractive in the short term, long-term investors should be aware that short-term trends can often be misleading and unsustainable.
To learn a more about this topic, please watch our new videos about the auto insurance industry, which feature Robert M. Almeida, investment officer, and Jeff Cho, research analyst.

 

The material is provided for general and educational purposes only. The views expressed are those of the authors and are subject to change at any time. These views should not be relied upon as investment advice, as securities recommendations, or as an indication of trading intent on behalf of any other MFS investment product.

 

This content is directed at investment professionals only.

 

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