The gap between MSRPs (manufacturer's suggested retail price) for cars and their book value is creating difficulties for auto insurers setting rates, according to Martin Ellingsworth, president of Salt Creek Analytics, a data analysis advisory firm.
More recently, cars have been selling for more than MSRP and cars with many added options, which raise prices above MSRPs (which are the same as "sticker prices," but without taxes and fees), were also selling above MSRP, Ellingsworth explained. At the same time, used cars rose in value and held value for longer.
This gap, he said, "created a total insurance value exposure times 15 million cars a year coming off the line brand new, plus the prior six or eight years of production that also held their value differently. So you might have 100 million cars holding $1,000 to $10,000 more value than you expected."
The gaps between total and actual price could be anywhere from 40 to 60%, according to Elllingsworth. Other factors can compound this gap, like valuation errors. Too high of a valuation raises the premium and too low a valuation means the coverage is underpriced, meaning the auto owner ends up underinsured.
The consequences of this gap include drivers dropping insurance and therefore violating the law when they drive, drivers who are underinsured or deductibles being raised. Raising deductibles can reduce the number of claims, but that will give a false picture of what's really happening in an insurance pool or market.
The overall result is that insurers and underwriters end up charging more, in varying ways, whether that's correct and appropriate or not, Ellingsworth explains.
"If the base rate used to be 100, and now it's 120, everybody got a 20% increase at the base rate level," he said. "If you have a 15 to 25 year old car, that's almost worth nothing, that's being carried at a high rate, you got a 20% increase. If you've got a brand new car fully loaded with options that's worth $75,000, but you're only being charged for $50,000 [in value], you got a 20% increase. So even with a 20% increase, your rate might not be adequate on that brand new car."
Conversely, Ellingsworth gave an example of a 20-year-old used car being covered at 40% of its original sale price of $20,000. The coverage would set the value at $8,000, even though such an old car would likely only fetch $800 if sold. The insurer could give a better (and lower) coverage rate, based on the actual value at risk, he said.
Therefore, charging a rate that is commensurate with the value at risk is a simple solution for this converge gap, Ellingsworth stated.
"But what does it mean to change base rate methodology?" he asked. "If you've done it one way for 50 months, 50 quarters or 50 years, changing it to something a little bit more dynamic in a risk-averse industry, you'll want to study that."
Raising rates out of an inability to price is not a good answer to the value gap problem. "The industry owes the consumer a better answer than 'here's your bill,'" he said.
Using the total MSRP is an easy measure for insurers to adopt, according to Ellingsworth. "If a car's MSRP was set at $50,000, but the total price and value is $72,000, they can plug it in at that."
