Car prices are on the rise. This could be a problem for car insurers.

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JD Power data shows an increase of more than 50% in the cost of used vehicles on average.

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About the Author: Marty Ellingsworth is Executive Managing Director of Global Insurance Intelligence at JD Power.

Nearly two years after the start of a global toll of supply chain, inflation and prices for new and used vehicles, auto insurers are tackling a big problem. All analytical models built with historical data to determine repair and replacement costs now need to be updated. Each current vehicle claim could be much more expensive than the assumed models. And auto policy portfolios may need to address their capital issues given the forward-looking nature of this inverted depreciation curve.

Depending on how insurers handle this challenge, they could face a toxic combination of inadequate premiums and pressure to raise rates. For those who fully understand the new valuation formula, however, this evolution presents an opportunity to generate more accurate estimates than ever before, while providing clients with hyper-personalized plans. The key is to access more granular, vehicle-specific data sets.

Understand the pricing problem

Before finding solutions, it is important to understand exactly how the market has evolved over the past two years to create this problem. The supply chain disruption that caused a shortage of new vehicles and OEM parts had far-reaching effects. As an example, let’s say you walked into a fender bender while holiday shopping and your vehicle needs a replacement right rear panel. Chances are good right now that the manufacturer won’t have this panel in stock for weeks or months. If you happen to find the part in stock at a local auto body shop, you shouldn’t be surprised to pay a 30-50% markup depending on supply and demand. So the $800 share you need becomes a $1,200 share. Insurers who have not taken this phenomenon into account are left behind.

It’s even worse in a total loss scenario. Traditionally, cars take their first big hit of depreciation once they’re driven off the lot, then gradually decline over a decade on the road, before finally falling below a threshold where the cost of repair would exceed the cost to pay on the value of the vehicle.

But as the value of used vehicles has skyrocketed – JD Power data shows a more than 50% increase in the cost of used vehicles on average – that changes the equation. When an adjuster is looking for a comparable value on, say, a 2015 sedan with $10,000 in damage, a total loss is much harder to rationalize if that sedan retained an abnormally high value.

Processes throughout the insurance value chain have always been built on trend data that has rarely seen dramatic changes over a period of a few years. But unique economic events since 2020 mean they need to be completely redesigned. New data sources that provide a granular understanding of what exactly is on each vehicle chassis must be introduced to replace the old assumption-based model.

A new era of personalization

As these new conditions force insurers to create more precise and personalized pricing, the ripple effects will be considerable. At JD Power, we expect the current surge in used vehicle values ​​to move away from the recent peak of 70% above the norm over the past decade, but the new plateau in values ​​could be 50 % higher on an ongoing basis. But insurers can’t just add a 50% increase to all current and future loss reserves for auto property damage.

Instead, they must develop risk assessment and pricing engines capable of creating personalized insurance rates that take into account a deeper understanding of vehicle attributes and values, as well as an underwriting monitoring and risk pricing using observational data such as mileage, routes traveled and driver behavior. These new custom valuation methods can create market values ​​per vehicle based on an individual vehicle identification number, which outperforms a single depreciation curve, as the curve is now inverted.

This can be difficult for legacy system insurers to manage, but new processes driven by data, AI, and cloud can remove the burden of running legacy operations and apply enterprise-ready processes. API to organize similar ongoing appraisals for both new and used vehicles on an ongoing basis.

From the customer’s perspective, this creates a double-edged sword. As their cars are worth more than their loans and past expected values, leaving some upside down in their vehicles, replacement and repair costs rise, meaning cost-based insurance rates losses are likely to find a new higher balance. However, by tailoring policies to the individual, based on more granular, VIN- and driver-specific data attributes, it will be possible for insurers to offer customers more personalized plans than ever before. This, in turn, has the potential to create the kind of personalized customer experience that builds loyalty and long-term promotion.

Stay one step ahead

This is an inflection point in the industry. The unpredictable conditions presented new challenges and opportunities. Near real-time pricing will improve pricing, billing, underwriting, risk management and claims for businesses, while making the value of risk-based pricing more transparent and desirable for consumers.

Even the most optimistic forecasts do not foresee a recovery in used car prices until next fall, which means that insurers will have to adapt on the fly over the coming year. Those who can find ways to accommodate this volatility will not only reap the short-term benefits, but put in place the infrastructure to help weather the next crisis.

Guest comments like this are written by writers outside of Barron’s and MarketWatch newsroom. They reflect the views and opinions of the authors. Submit comment proposals and other feedback to ideas@barrons.com.

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