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State of the Assigned Risk Market

During 2006, application volumes were down in nearly all states by 30-45% relative to 2005. This trend continues in 2007, as application counts in the largest AIP markets through April are down an additional 35-55% relative to the same period one year ago. The following table displays application count trends through April 2007:

New Application Count Trends by State

	2005	2006	Change	2006 thru Apr	2007 thru Apr	Change
NY PP	178,654	123,295	-31.0%	51,285	33,803	-34.0%
NY OTPP	11,657	8,166	-30.0%	3,084	2,176	-29.4%
NJ	85,770	50,502	-41.1%	23,341	10,816	-53.7%
TX	29,187	21,824	-25.2%	9,156	6,098	-33.4%
PA*	42,247	28,662	-32.2%	9,642	5,588	-42.0%
CA PP	15,870	8,850	-44.2%	3,504	2,180	-37.8%
CA LC	5,991	6,126	-2.2%	1,968	3,097	+57.4%

* - PA app counts through March 2007

Not only are new applications down significantly, but renewal retention in all states is being impacted by voluntary market conditions. Several factors are contributing to the rapid decline in AIP application volume, which have now reached all-time historical low points in many states. These factors include the following:

Aggressive voluntary market competition
Pricing segmentation
An increase in quoting options in the voluntary market

Aggressive voluntary market competition

Industry private passenger combined ratios are at historical lows, with several large carriers reporting combined ratios less than 90 over the past year. Because of the recent profitable results for personal auto, carriers are getting more aggressive, seeking to maintain or increase market share.

With 10 or more points of margin to play with, rate cutting has officially begun. Already this year in New York, six of seven rate filings from major companies writing private passenger auto have contained significant rate decreases. In addition, standard and preferred writers are 'dipping down' into non-standard tiers to supplement volume. This is having a direct and significant impact on both new and renewal assigned risk volumes.

Major carriers are also opening up writings in the Five Boroughs of New York, for risks with liability-only coverage and even for minimum limit customers. These are the very risks that have traditionally been the sole property of the New York Plan. With strong profits continuing, it will likely take some time before the rate cutting and aggressive underwriting gets to the point where the personal auto tide turns into an underwriting loss.

Until then, carriers will be satisfied with stable or increasing volume albeit at lower, but still sufficient, profit margins. At this point we do not envision a sharp turn in the cycle, but some leading indicators point to a flattening in the curve over the next 1-2 years.

Pricing segmentation

Pricing segmentation is having an impact on the assigned risk cycle. Sophisticated pricing models with literally millions of price points make it possible for voluntary market carriers to more appropriately 'cherry-pick' risks from the plan and write them in their voluntary programs at adequate rate levels that are typically below the plan.

Because the assigned risk rating algorithm is not tiered based on credit (insurance) score, prior insurance, chargeable incidents, or many other factors, the voluntary markets can appropriately write many risks that formerly went to the plan at adequate rate levels. Of course, this should leave the plan with much smaller volume but with a significantly worse underwriting result. Due to the lack of credibility within many of these new pricing cells, it may take longer than in the past for carriers to fully understand whether and where they have attracted clients that are performing well and where they may be inadequately priced.

We believe this will lead to a longer 'down' cycle in the assigned risks plans than we have seen historically, and when the cycle does begin to turn it will likely not turn as abruptly as we have seen previously as multi variate rate plans allow for more precise changes in lieu of large scale changes to underwriting eligibility guidelines.

Increase in quoting options in the voluntary market

The AIP is no longer the only available option for certain risks, as it has been in the past. With segmented pricing, many carriers have a rate for nearly every risk combination. With many more quoting options available, agents now find that the AIP is no longer the lowest rate option in the market, as has been the case at some points in the past.

Although the AIP rates themselves are becoming more inadequate than ever, this is more because the mix of business remaining in the plan is much different than it was several years ago, rather than the fact that underlying cells within the AIP plan are performing worse than they have in the past. In addition, direct and online writers are taking more market share away from non-standard agents that previously sent a certain portion of their risks into the plan. Some of these risks (especially younger, inexperienced operators) are now bypassing the agency distribution channel altogether, and moving directly into the voluntary market without first spending some time in the AIP.

State of New York AIP risks

Contrary to the opinion of some observers, we do not believe NYAIP risks are going to Pennsylvania in droves of rate evasion. Although this may be happening to some extent in the voluntary market, there is no evidence that the PA Plan is growing as the NYAIP shrinks.

Another theory is that risks are going uninsured – UM frequency does not support this theory either as it continues to remain flat or decline in the NYAIP. The main driver of the depopulation is that the voluntary market has become so profitable and so competitive that many drivers who live in the five boroughs of New York are no longer going into the plan. Instead they are being driven by aggressive advertising to direct writers. It appears these carriers are more than willing to write these risks at a somewhat lower profit margin in order to maintain or grow market share.

Looking out on the horizon, we believe that volume in the NYAIP will continue to drop during 2007 as voluntary market competition continues to intensify. Our current estimate for 2007 is for volume of approximately $150M-$175M. This would represent an 80% decline since the last annual peak volume of $938M in 2002. This would also be the smallest annual NYAIP volume in many decades. On an inforce vehicle basis, the decline in NYAIP is even more dramatic, since average premium per vehicle is significantly higher today than it was at previous low points in the assigned risk cycle.

There is a -3.5% rate change pending with the Insurance Department which likely will not go into effect until at least Third Quarter. If this change gets approved, we do not see it having a material impact on plan volume for 2007, and we expect minimal if any impact on application counts occurring after the change goes into effect.

Capsule information from other markets

New Jersey

Premium and application volume began to fall off the cliff in the second half of 2007, after showing steady declines over the past several years. The emergence of new entrants like GEICO, Progressive, and others to the state is causing acceleration in the depopulation of the NJ Plan, which is even more dramatic than in other states.

New Jersey is now 'the place to grow' for many personal auto writers. 2006 NJ PAIP volume came in at $138M, a 44% decline from 2005, and it is likely that New Jersey plan volume will decline to near or less than $100M for 2007. Current rate indications are relatively flat, and it is unlikely that a rate change will be made in the near future. There has been a mix shift towards a higher percentage of basic policies (minimum coverage, BI optional) in the plan over the last year.

Pennsylvania

Application volume is declining rapidly, down 42% relative to last year for the first quarter. Again, this is likely driven by increased voluntary market competition dipping down into the non-standard and assigned risk segments. Although this is still the third largest assigned risk market in which LAD services are offered, we project written premium volume for 2007 will decline to less than $17M in 2007 (the PA Plan reported $22M in volume for 2006).

Texas

AutoOne is the largest writer of TX AIP policies at the present time, with a quota of 34.4%. The proposed rules requiring electronic insurance verification are scheduled to be implemented in June, and carriers need to be in full compliance by 2008. At this time, we do not see this having a large impact on plan volume in the near-term.

By the time the rules are fully in place in 2008, we may begin to see a flattening of plan volume. Any increase in volume due to this rule change will likely continue to be offset by increasing voluntary market competition. We currently project 2007 plan volume will come in at less than $10M, compared to volume of $11.5M in 2006.

California

The Low Cost program is the only major LAD program where 2007 volume is increasing. In fact, application counts are up dramatically through April relative to 2006. Although the program has expanded to several new counties, much of the growth is related to a DMV letter campaign that is now advising drivers that if they cannot provide evidence of insurance that their plates will be suspended.

The volume increase in CA Low Cost is being spurred by drivers in this situation seeking to obtain basic insurance for the lowest cost possible, and being referred to CA Low Cost by the DMV. For the first time, CA ARP applications are now lower on a monthly basis than those for CA Low Cost business. AutoOne is the largest writer of both CA ARP and CA Low Cost policies, handling over 26% of all CA ARP assignments and over 41% of all CA Low Cost assignments.

The CA Advisory Committee has now approved a rule change that would allow all carriers to buyout via LAD when plan volume drops below $10M (previously those with market shares above 5% needed to seek exemption to enter a LAD contract). It is very likely that 2008 plan volume will come in at less than $10M for both CA ARP and Low Cost, making the LAD alternative an attractive option even for the largest carriers in the state.

What does this all mean for LAD Rates?

Rapidly declining plan volumes generally foreshadow dramatic increases in loss and combined ratio of the risks that remain in the plan. This is likely even more true during this low point in the cycle, as insurers should be better able to 'cherry pick' the good risks from the plan through improved pricing segmentation.

What will be left in the plan should be even worse than what we had seen at previous cycle low points (the loss+ALE ratio in New York exceeded 200% during the last low point in 2001). We have observed some significant deterioration in the mix of business and combined ratio on new AIP business written in 2006 relative to 2005, and expect the deterioration to continue into 2008 as plan volume continues to decline rapidly.

Any rate decreases in the plan will further exacerbate the issue of increasing combined ratios. All of this should portend continued increases in LAD rates to offset deteriorating results.

Although we expect LAD rates in most states to increase or remain stable in 2008 relative to 2007, the good news is that overall AIP cost may decline due to the continued rapid year-over-year depopulation in the assigned risk plans countrywide.

In 2008, we plan to continue to offer takeout credit solutions in New York as a way to further manage companies' AIP obligations even if LAD is not a viable option. In upcoming newsletters, we will detail why this year is the perfect time to consider a LAD or Takeout option, if your company is not doing so already.

Thus far, there is still no end in sight to the decline in AIP plans countrywide. Adjusting to this differential and planning ahead is the best solution. For further information, contact AutoOne at 631-547-2000 or visit http://www.autooneins.com.

Ben Walden,
VP & Chief Actuary

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