Car Wars.

Competition is intense in the auto insurance market. To hold the line, insurers are cutting rates, becoming more customer-focused and changing how they sell.

The battle for market share in the auto insurance industry is heating up. Fast-moving Progressive and Geico have established a foothold and continue to gain ground, capturing chunks of the market from industry behemoth State Farm.

The top three auto insurers--State Farm, Allstate and Farmers--have lost market share over the last three years, while No. 4 Progressive and No. 6 Geico, part of Berkshire Hathaway, have doubled the number of policies each has written, according to A.M. Best Co. data. State Farm, the No. 1 writer of private-passenger auto in the United States, has seen its 21.6% slice of business in 1995 drop to 18.9% in 1999. In comparison, Progressive grew from 2.6% of the market in 1995 to 4.8% in 1999, and Geico has grown from 2.5% in 1995 to 4.1% last year.

Direct-selling channels, such as toll-free phone numbers, are the weapons of choice for Progressive and Geico. Industry experts say the phenomenon of consumers buying direct and the transformation of auto insurance into a commodity explains the drain from the top three writers' market shares.

With the advent of online aggregators, such as Quotesmith.com, and company Web sites that provide quotes, more consumers are opting for lower prices over brand loyalty. "The ease in which the consumer can comparison shop their auto policy, either on the Internet or through 800 numbers, has increased the commodity nature of the auto marketplace. The increased number of advertisements with claims of sizable savings have enticed many consumers to obtain multiple quotes rather than just renewing their policy," said Anthony Diodato, an A.M. Best Co. property/casualty analyst.

Price Matters

Companies using direct marketing to sell auto insurance are experiencing sales increases of 10% to 12%, while those using traditional distribution lines, such as agents, have seen nominal growth, said Mark Lane, an equity analyst for William Blair & Co. Consumers are using the direct channel to shop around and compare prices, because price is important to them. J.D. Power & Associates, a marketing information firm, recently reported that the most important consideration when consumers weigh their happiness with insurers is the price of the auto policy. Many top insurers, such as Allstate, Geico and Progressive, are making buying direct more comfortable for the consumer.

The top two private-passenger auto writers are taking divergent paths in direct selling.

Allstate--ranked second in direct premiums written--shifted its focus to direct selling last November when it announced its new Web-based personal computer network business model--the Good Hands Network. The strategy blends the Internet and toll-free-number service with Allstate's agent force. Allstate has four new call centers in three states, and its redesigned Web site can issue quotes and sell policies 24 hours a day. The call centers help to sell policies, service existing policies and respond to online customers who request more information through the Allstate Web site.

State Farm's call centers are available for policyholders to file claims after hours, and consumers in 42 states can receive rate quotes on auto insurance online. Gary Grant, vice president of State Farm's actuarial department, said State Farm still has an advantage over direct sellers. "We have the State Farm agents for those who need advice. That's an advantage in the electronic world," he said.

Something Extra

In addition to giving consumers method-of-purchase choices, insurers also are catering to policyholders' needs. Increasingly, insurers are adding services like access to car loans or discounts on policies to boost customer retention. "Instead of a rate war, we see a value war. We're working on how to add value to customers," said Kevin Kelso, vice president of Farmers auto product management. Farmers Auto Buying Service provides policyholders with prices on new and used cars and has established prearranged pricing at more than 5,000 dealers nationwide: The Los Angeles-based insurer also makes auto loans available and even markets vacation packages. "We want to meet people's needs every day; that's what's driving day-to-day life, not rate wars," Kelso said.

Erie Insurance Group, a regional auto insurer based in Erie, Pa., said that in addition to lowering its rates moderately this year--about 1% to 2%--it also is offering targeted rate decreases for preferred drivers. Its Pioneer Experience Rating Credit is a discount that rewards long-term policyholders for their safe-driving records. Those who have been with Erie for at least three years and who have the best claims records--that's 70% of its policyholders--are eligible for a discount. The amount of the discounts vary. Married drivers also enjoy discounts from Erie, which writes in 10 states, mostly in the Mid-Atlantic region. Assigned drivers that are married, age 45 through 69, receive a 7.5% decrease on select coverages, and those age 50 to 64 receive a 15% rate discount. "We wanted to target our decreases and reward good drivers. It's also good customer service," said Ross Fonticella, vice president and associate actuary of the property/casualty department of Erie.

Most insurers are trying to retain business by changing the ways they sell policies and by offering value-added services. But State Farm and Geico are breaking away from the pack and setting their own courses to gain and retain business. For State Farm, that means cutting rates in California, the largest auto insurance marketplace in the United States.

When State Farm cut rates 5% in California in July, it sent a shock wave throughout the industry. Other insurers already had announced rate hikes. "We were aware of State Farm's move but our policy is not to sacrifice profit for rates," said Mary Beth McDade, a spokeswoman for Progressive. The Mayfield Village, Ohio-based insurer raised rates 6.5% in the first six months of 2000 in the 48 states in which it conducts business.

Stephen J. Leaman, president of Farmers Personal Lines, said he understands that State Farm is faced with challenges in terms of market share and is doing something about it. "They have lots of surplus, and they intend to use it to save market share," he said. "I think that's bad for customers in the long term, and I think that's bad for the business. But do they have the horses to do it? They sure do." Leaman said Farmers will not react to "irrational pricing, so we're going to do what we think we should for our book of business. There may be a rate war, but it's not going to be with us."

Lead Foot

On the other hand, Geico's plan is to increase advertising spending this year by 45% to about $350 million--an unprecedented amount in the insurance world. Because the personal-lines insurance market is so concentrated--60% of the market is controlled by the top 10 companies--any major moves by the top companies affect the remaining auto writers, most of which lack the size and sophistication to compete with the top. State Farm's and Geico's marketing strategies are like cannon balls rolling loose on a ship's deck--no one knows how they will affect the competition, said Michael A. Smith, an equity analyst for Bear, Stearns.

In his annual letter to Berkshire Hathaway shareholders, Chief Executive Officer Warren Buffet announced his intention to continue aggressively competing in the auto insurance marketplace. Saying he will keep Geico's foot on the advertising pedal, Buffet wants to achieve significant growth and sear the Geico brand into U.S. consumers' minds. He intends to spend a lot of money to do that, 66% more than the $110 million Allstate spent last year. Buffet boasts that he would happily spend $1 billion annually on marketing, "if we knew we could handle the business smoothly." The $350 million being spent this year puts Geico in the ad-spending stratosphere of American Express, which spent $329 million in 1999.

Tortoise, Not a Hare 

State Farm's mutual business structure makes it easier for the company to react to the current business climate. Because a mutual doesn't have to answer to stockholders, it can take a long-term view and is not beholden to quarterly statements, the company said. "We don't knee-jerk as much, we have a more steady philosophy and don't try to grow 20% in one year. We're a tortoise, not a hare," Grant said.

A.M. Best's Diodato agreed, saying that public companies have the dual responsibility of satisfying their policyholders with low insurance rates while appeasing their shareholders, who are looking for higher returns on their investments. Conversely, nonpublic companies, for the most part, only have to satisfy policyholders. For example, due to its superior financial strength, State Farm Mutual was able to dividend a $1 billion in profit back to its policyholders and reduce rates in specific marketplaces without concern for the reaction of Wall Street, Diodato said.

Blair Sanford, an equity analyst for Cochran, Caronia & Co., predicted that State Farm will "make hay" of the fact it is lowering rates and will be able to increase market share, particularly in California.

In the last five years, State Farm's market share in California has fallen from 19.48% in 1995 to 13.91% in 1999, according to A.M. Best Co. data. State Farm insures about 3 million cars in the Golden State. "As other carriers in California are taking prices up, it's a bit of a divergence to reduce rates, definitely a move to increase market share," Sanford said. In fact, the rate cut stands out against other companies' moves. "You just don't see decreases anymore," Farmers' Kelso said.

State Farm also can benefit simply because of its size. State Farm's $23 billion in direct premiums is almost double No. 2 Allstate's total and is nearly four times larger than those written by Farmers, Progressive or Nationwide. "Because of their large capital base and geographic spread, State Farm can afford to be competitive," said Lucio Lefante, an A.M. Best Co. property/casualty analyst. And California is not the only state where State Farm is cutting rates. As of June 30, the Bloomington, Ill.-based company issued rate reductions in 21 jurisdictions, states, provinces and the District of Columbia, as well as 15 price hikes.

Kelso said the rate decrease is like a gauntlet thrown down to online carriers, as well as Progressive and Geico. Both companies have more than doubled their market share in California in the last five years. Ranked No. 9 five years ago, Progressive moved from a 0.95% share of business in private-passenger auto insurance business in 1995 to garnering 2.45% of market share in 1999. No. 10 Geico had 0.86% of the California market five years ago and grew to 2.1% in 1999.

"State Farm is saying, 'If you're selling directly and think you're going to come in and steal customers, you better bring your checkbooks,'" Kelso said.

Rate War?

It's unlikely that a rate war will develop because of State Farm's move, experts say, pointing to the major hurdle of rising claim costs.

"I don't expect a rate war. The rest of the industry is experiencing rising loss costs, insurers won't be able to maintain a roll for an extended period of time," Sanford said. Insurers are dealing with rising medical costs and paying more to fix cars, too. The strong economy is partly to blame, because the higher incomes are putting more drivers on the road who are driving newer and more expensive cars.

Leaman points to insurers' returns on investable assets as the reason for a probable absence of a rate war. Insurers' investment returns and the performance of the bond market aren't enough to fund a rate war. "I think if this were last year at this time and people saw 15%, 17% or 20% return on equities for that portion of their portfolio, they would be saying to themselves, 'Well, maybe we can tough this out a little longer.' So the returns we count on in the investment side are much more normal than they have been," Leaman said.

"A rate war makes me think of the poster, 'What if they held a war and nobody came?'" Kelso said. Farmers is raising rates in some areas and lowering them in others, but the net effect is rates are going up, he said. Farmers is especially concerned about the rising cost of auto parts. The widespread use of unibody car design and airbags has made repairs more costly. "Since the State Farm verdict on non-[original equipment manufacturer] parts, there's been some muscle flexing on the part of auto-parts companies, raising prices 3% to 10% on a broad sample of parts," Kelso said.

Progressive has other things on its mind and has washed its hands of a rate war.

"Our focus is on getting to a 96 combined ratio," McDade said. And Progressive believes it has time on its side. "We raised rates before others and we will be able to grow when others are raising rates, because we will be stabilized," McDade said.

Grant of State Farm said he is unsure where the rates will end up. "Other companies have to deal with the presence of stockholders. Can they hang with us? I don't know; it may be difficult," he said.