05/14/2012 05:02 pm ET Updated Jul 14, 2012

Are High Gas Prices a Boon to Auto Insurers?

In principle, one would expect personal lines automobile insurance companies (State Farm, Allstate, Berkshire Hathaway, etc.) to realize a modest windfall from recent increases in gasoline prices. After all, higher gas prices should cause a decrease in miles driven by insured motorists, leading to fewer personal injury and physical damage claims... all else remaining the same. However, I think it's fair to say that "not all's the same 'twixt the pump and the claim" -- not even the same as it used to be.

Three basic premises underlie the notion that auto insurers benefit from higher gas prices: (1) higher prices cause motorists to drive less; (2) fewer miles driven mean fewer collisions; and (3) competitive and/or regulatory forces are insufficient to compel insurers to pass along cost savings to policyholders. This last item is consistent with the conventional consumerist wisdom that insurance prices are upwardly "sticky"; that is, premiums tend to rise quickly to account for increases in underlying costs, but rarely decline as rapidly to reflect cost decreases.

A brief comparison of the Bureau of Labor Statistics' gasoline and motor vehicle insurance CPIs offers some support for the combined effect of the above three premises. In particular, the insurance index plateaued while gas prices rose during both the periods from 1998 to 2001 and from 2004 to 2008. However, the continued rise in the insurance CPI through the beginning of the global financial crisis to the present -- at a time when the gasoline CPI experienced extreme volatility followed by a fairly steady upward climb -- hints at an underlying structural change that doesn't bode well for auto insurers or their customers.

Naturally, it's difficult to determine which, if any, of the above premises have changed in the recent past. Certainly, it's possible that the financial crisis itself is the dispositive factor, perhaps because both insurance companies and their regulators found price increases helpful for addressing solvency concerns during that period. However, recent analysis of the price elasticity of demand for gasoline -- that is, the degree to which motorists respond to increasing gas prices by adjusting the amount of fuel purchased -- suggests that higher gas prices may no longer provide the deterrent to driving they once did.

Although long-term effects of increasing gas prices are difficult to investigate (because prices tend to fluctuate up and down over time, preventing the simple analysis of a single, upward trend), researchers have found that short-term price elasticity has declined signficantly in absolute value in recent decades. Today, this quantity is believed to be somewhat lower than 0.1, meaning that a 10 percent increase in the price of gas implies less than a 1 percent decrease in the amount of gas consumed.

The decline in price elasticity is a complex phenomenon with numerous underlying factors. Likely causes include: an increasing need for people to drive cars as city dwellers relocate to the suburbs; a decreasing marginal benefit of additional fuel-efficiency measures as vehicles incorporate more enhanced technology; and perhaps even growing consumer habituation to higher -- and more volatile -- gas prices. (Importantly, increasing overall wealth doesn't appear to be a factor, because the poorest drivers tend to manifest the least elasticity.)

Regardless of its causes, the decrease in price elasticity offers one simple warning for auto insurers and their investors in the coming years: higher gas prices are no longer the dependable boon they once were. For auto insurance consumers, the message is equally clear: expect no future premium relief in return for today's high gas prices.