As a reminder, please be aware this conference call is being recorded. Now I'd like to introduce your host for today's program, Mr. Mark Nogal, Head of Investor Relations. Please go ahead, sir.
Thank you, Jonathan. Good morning. Welcome to Allstate's 4th special topic investor call. You'll remember we instituted these instead of having an Investor Day. This morning, we will discuss our property liability claim settlement process and reserving practices. After prepared remarks, we will have a question-and-answer session. Our management team is here to provide perspective on this topic. We'll not be covering 4th quarter operating results. Please hold those questions until the 4th quarter earnings call in early February. The slide presentation and webcast can be found on our website at allstateinvestors.com. As noted on the 1st slide of the presentation, our discussion will contain non-GAAP measures and forward-looking statements about Allstate's operations. Allstate's results may differ materially from these statements. Please refer to our 10-K for 2021 and other public documents for information on potential risks.
We are recording this call and a replay will be available following its conclusion. I'll be available to answer any follow-up questions you may have after the call. Now I'll turn it over to Tom.
Good morning. Thank you for joining us today. Let's start on slide 2, which highlights Allstate's strategy. You'll remember our strategy has 2 components, increase personal profit liability market share and expand protection solutions that are shown in the 2 ovals on the left. The right-hand panel lays out the key messages of today's calls. Allstate's claim capabilities are key to our ability to generate attractive returns from personal auto and homeowners insurance. We have a highly effective and efficient claim organization. It leverages scale, technology, operating precision, and people to deliver a great customer experience. Our loss estimates and reserve liabilities use consistent practices, multiple analytical methods, and external reviews to ensure reserve adequacy. These processes led us to increase the reserve liability for prior years in 2022 by amounts that are larger than has been the case in recent years.
This is primarily due to subrogation payments made to other insurance companies and higher projected losses for bodily injury claims from third parties. To go through these three points, Mario Rizzo, who of course leads our property liability operations, is gonna put the importance of claims into perspective and provide an overview of our operations. Eric Brandt, our Chief Claims Officer, will describe how we settle three types of claims, auto physical damage losses, third-party bodily injury claims, and homeowners' losses. Jess will use that construct to describe how we set reserves and discuss the increases to prior year reserves that we made this year. Now I'll turn it over to Mario.
Thanks, Tom. Let's start on slide 3 and discuss how claims practices are key to value creation. The table on the page breaks down our adjusted net income by business over both a longer time period and through the first nine months of 2022. As you can see from the first column, over the 5 years prior to the pandemic, we generated approximately 2/3 of our income from insurance underwriting. Claims practices are key to value creation, as roughly 70% of auto insurance and 64% of homeowners' insurance premiums were paid to customers through claim costs, as you can see in the third column. In 2022, however, this ratio increased, particularly for auto insurance, largely driven by rising costs and prior year reserve strengthening.
Moving to slide 4, let's break down our incurred losses and net reserve balances by line of business and coverage, excluding runoff liabilities. Auto physical damage losses represent the biggest component of loss costs on the income statement, but bodily injury claims represent the largest component of the reserve liability on the balance sheet. Starting with the left chart, we have incurred $26.7 billion in losses through the first nine months of 2022. The majority is related to Allstate brand auto insurance at $16.4 billion, with physical damage losses representing 55% of this total, which is shown in light blue. While physical damage makes up the largest component of losses, it represents a much smaller proportion of net reserves, as you can see from the chart on the right, since 75% of losses are paid within three months.
When it comes to our net reserve balance of $25.4 billion, the largest amount is for Allstate brand bodily injury claims, which are recorded at $8.9 billion or approximately 35% of the total. This is because these claims take much longer to settle, as Eric will discuss in a couple of minutes. Let's turn to slide 5 and discuss the size and scope of the claims organization to show how we support the settlement of claims. Allstate has a long history of delivering enterprise value through our claims handling by leveraging global operations to execute highly effective processes while utilizing advanced technology and making strategic investments to operate at scale.
On the left, you can see we are able to process large volumes of claims across each of our lines, including more than 6 million auto and homeowners insurance claims annually with a high degree of customer satisfaction. In fact, Allstate ranked above all major competitors in J.D. Power's 2022 U.S. Auto Claim Satisfaction Study. These claims range in complexity from a cracked windshield, which we handle almost exclusively via straight-through claims processing, all the way up to the most complex loss types, such as severe injuries or total losses on auto or home policies.
As you can see from the chart on the right, our claims expense ratio, excluding catastrophes, has consistently improved since 2018 by leveraging technology and innovations such as QuickFoto Claim and Virtual Assist. We expect to continue to drive down our claims expense ratio over time as part of our goal of reducing our adjusted expense ratio. I'll turn it over to Eric Brandt, Chief Claims Officer, to discuss how our claims organization manages the claims process from start to finish and capabilities that ensure fast and fair resolution.
Thanks, Mario. Let's begin on slide 6, where you can see how our auto physical damage claims process is designed for effectiveness and efficiency. The high-level process map on the top half of the page illustrates the claims journey for first-party collision or comprehensive claims and third-party property damage claims. This journey starts with the first notice of loss following an accident. It continues through investigation of the accident to determine if there is liability, a damage assessment by our adjusters, a repair or total loss determination, and ultimately resolution through payment. As you can see in the first bullet, physical damage loss costs account for more than half of our total auto losses. Total loss claims account for approximately 45% of first-party collision costs. As a result, the increase in used car prices since 2019 has significantly reduced underwriting profit.
These claims settle relatively quickly, with 85% of first-party claims fully settled within 3 months of the first notice of loss. Third-party claims take longer to settle because many of these are handled by another insurance company, so that after 90 days, only about half of the ultimate amounts have been paid. Jess will discuss how this impacted prior year reserve changes this year. We use advanced technology and analytics to enhance our customer service and control costs. For example, QuickFoto Claim enables us to settle a claim with a customer who sends us pictures of damage through their cell phone, enabling us to avoid sending an adjuster out. This not only lowers costs, it enables us to settle claims in hours rather than weeks.
Predictive modeling starts at first notice of loss, where close to 50% of customers choose to report their claim digitally. Our rules-based system intelligently routes the customer to set them up for the best path forward. Predictive modeling also distinguishes likely total losses from repairable vehicles, enabling us to expedite settlements and salvage sale to reduce cost. Leveraging scale and strategic partnerships shows up in the Good Hands Repair network of more than 4,300 shops and our proprietary parts network, both of which enable us to get priority for our customers and access to parts discounts, which result in advantage in both cycle time and cost management. Let's shift to slide 7 to discuss bodily injury claims. This process exhibit illustrates the importance of exposure recognition, segmentation, and risk management.
A third-party bodily injury claims are complicated and they account for more than a quarter of auto losses. Again, starting at first notice of loss, for every auto accident, we need to determine whether anyone was injured. Bodily injury exposures are detected through claim reporting, predictive modeling, and external reporting databases. Now, if there's no injury, we settle the physical damage claim as we just discussed. If an Allstate customer is injured, the claim is covered by first-party medical coverages in the auto policy where appropriate. If a third party is injured and the customer is at fault, then we're also responsible for medical costs and damages. In this case, the claim gets medical treatment, which varies based on the severity of the accident. Our claim professional gets involved early in these cases. We assess the severity of injury, the facts of the accident, and make an initial liability assessment.
This enables us to help the claimant with the right resource based on the complexity of the claim. Some claimants choose to work with us directly. Others have an attorney represent them. We didn't show these steps sequentially in the exhibit since they overlap in timing. Some simple injuries are settled in months. More severe injuries could require years of medical treatment and complicated liability determinations, which may change as more facts become known. As a result, it takes about four years to have 80% of the ultimate liability for these claims to be paid. This is why the reserve balance that Mario discussed is such a large percentage of the overall reserves. To ensure fast and fair resolution of claims, we utilize in-house experts, including staff medical doctors, to provide a clinical review of complex medical records.
We have fraud indicators to flag and prioritize claims for further investigation. If claim settlements are litigated, we utilize our expert staff legal organization to ensure the amounts we pay on behalf of our customers are appropriate. Let's move to slide 8, and we'll cover homeowners' claims processes. This process exhibit splits claims between catastrophe and non-catastrophe, there are many ways to segment claims, such as fire losses, water damage, or liability, all of which use different settlement practices. In all cases, we leverage technology, analytics, and scale to provide great service while appropriately remediating losses. In fact, more than half of our Allstate brand-reported homeowners claims are a direct result of a catastrophic event. The journey starts with the first notice of loss following homeowners damage.
We then quickly work to remediate further damage through actions such as tarping a roof or removing standing water or preventing access to a home. We then investigate the loss, determining what has to be remediated and making payments to the customer to repair damage or replace contents, and in some cases, cover additional living expenses. In severe catastrophe events, we also may recover amounts from reinsurance. The bottom half of the slide highlights our advanced claim capabilities. We use advanced technology such as satellite imagery and fixed-wing aircraft to assess damage. We leverage Virtual Assist to enable video collaboration between adjusters, contractors, and customers to resolve low touch claims quickly and accurately. Leveraging weather data, we estimate claim volume and type to deploy people to the right locations, and in some cases, we get to the customers' houses before they file a claim.
Our predictive models and estimating platform supports our experts by determining the best method of inspection, decisions on repair versus replace, material grade selection, quantity, and available discounts. Our scale enables strategic partnerships with an expansive supplier network that includes loss mitigation experts, restoration contractors, and material suppliers, which can meaningfully impact loss cost and provide customer experience benefits. With knowledge of where these events may occur, we mobilize our operational response units, such as our mobile claim centers, to ensure we have adjusters on the ground ready to assist. Using Hurricane Ian as an example, we had about 4,000 dedicated people available to help customers, within 48 hours of landfall, we had 12 local claim centers operational. I'll turn it over to Jess to discuss our reserving practices.
Thank you, Eric, and good morning. I'll begin on slide 9 with an overview of our reserving process. Reserving is an iterative process with strong governance and oversight. We use consistent practices, multiple analytical methods, and external reviews to ensure reserve adequacy. The diagram on this page shows that the claims reserving process begins with the first notice of loss in the claim department. As the claim develops over time, the claim department updates its assessment of the costs associated with each claim. In some cases, the claims are settled so fast that this timeframe is days, so the file is opened and closed at one amount. In other cases, such as bodily injuries, the claims department has a standard process through which it updates the claim file over multiple years. Financial operating analysis is extensive in order to assess profitability, pricing needs, and claim operational effectiveness.
The actual setting of reserve amounts is done by reserving actuaries who rely on strong collaboration with the claims department, but independently establish the reserve levels. A loss committee of senior leaders reviews the reserving actuary's conclusions before we publish quarterly financial results. While it's important to work closely with other business units, the reserving department remains independent. We balance strong partnership with independence in developing our estimates of ultimate loss. External reviews are also completed by Deloitte, our independent auditors, and KPMG, which is the external appointed actuary. All of this work is guided by professional standards set by the Casualty Actuarial Society and American Academy of Actuaries, extensive data and analytics, and management oversight. Slide 10 provides historical context on the impacts of claim prior year reserve liability changes.
The chart on the left shows the absolute dollar impact in a calendar year of prior year reserve changes on underwriting income, excluding catastrophe losses and the runoff operations. As you can see, prior year reserve releases have had a positive impact of $190 million on average each year from 2012 to 2021. The current year has obviously deviated from this with $1.3 billion of reserve increases for prior years through the first nine months of the year. The chart on the right shows these changes related to the reported combined ratio as a percentage of the net reserve liability.
Given the size of our net reserve balance and the amount of premium we earn each year, prior year reserve changes have historically represented approximately 1 percentage point change on our combined ratio and had a similar impact on the net reserve balance. In the current year, this has increased to approximately 4% and 5 points respectively. Now let's shift to slide 11 and discuss the reserving process for physical damage claims in the context of the same process flow diagram that Eric utilized earlier. When physical damage claims are first reported, we open up a notice count. This establishes a developmental reserve based on our best estimate of the average claim severity as determined from historical data and recent severity trends. Through the life cycle of a claim, estimates of ultimate loss are updated to incorporate the potential for subrogation and the likelihood and magnitude of third-party demands.
This entire process happens quickly for first-party physical damage claims, with 85% paid within three months. Third-party claims take longer, with only 50% of ultimate losses paid within three months. Slide 12 highlights how physical damage loss cost has been impacted by rising inflation and our corresponding increases to severity levels for claims reported in 2022. The left side of the slide indexes inflation to year-end 2018 for the main inputs to physical damage severity. Used car values, shown in the light blue, are up substantially. While they're now below the recent peak, they continue to run at more than 50% above pre-pandemic levels. Conversely, labor rates and part prices continue to accelerate, putting upward pressure on severities. The chart on the right highlights the revisions to our current report year ultimate severity increases relative to the full prior year by quarter.
We originally booked collision severity at an increase of 14% as of the first quarter compared to the prior report year. Given the cost trends on the left, this has increased to 17% as of the end of the third quarter. In property damage, we increased the year-over-year change from 11% in the first quarter to 17% in the third quarter. This reflects increased costs in third-party carrier subrogation demands. We continue to monitor these inflationary trends and their impacts on our paid severity to determine the best estimate for loss severity. Now let's move to slide 13 and discuss the increase in physical damage reserves for prior years. The chart on this slide depicts gross paid losses for physical damage coverages for the 9 months after the end of the calendar year.
Our expectation was that payments on 2021 claims would be $1.33 billion for the nine months ended September, as represented by the dark blue dashed line. You can see this exceeded previous report years at the comparable ages of development by approximately 40%. At the end of the third quarter, however, the actual paid losses for 2021 claims were $1.63 billion, which exceeded our estimates by $300 million. This is why we increased prior year property damage reserves, most of which was done in the first half of 2022, with only minimal upward development in the third quarter. Let's move to slide 14 and discuss the reserving process for bodily injury claims. Similar to physical damage, when bodily injury claims are first reported, we open up a notice count at first notice of loss.
At this point, the assigned adjuster to the claim sets up a case reserve based on the information known at the time. Additionally, a developmental reserve and an estimate for incurred but not reported claims is established. As we work through the life of a claim from left to right, both case and supplemental reserves are continuously evaluated as new information is provided and trends develop. Throughout this process, we make payments to claimants and adjust reserves accordingly, which may take years to resolve, resulting in higher statistical variability. We use multiple actuarial methods to determine the reserve balance, since only 15% of ultimate losses are paid during the year in which they are reported. Moving now to slide 15, let's discuss prior year reserve strengthening that occurred in bodily injury, primarily during the third quarter.
The pie chart on the left breaks down the $675 million of Allstate brand bodily injury prior year reserve strengthening recorded in 2022 by report year. As you can see, the bulk of the increase was related to report years 2019 and 2020, with additional contributions from report years 2018 and prior. The reserve strengthening was responsive to adverse development we've experienced for those report years, reflecting more severe accidents, higher medical costs, and litigation costs. As part of our actuarial processes, we consider multiple reserving methodologies, five of which are listed on the right table. Each method has strengths and weaknesses, and actuarial judgment is required to select the appropriate reserve balance. These methods use a wide range of statistics, some of which we've listed in the far right column.
We are proactively responding to trends in these results using sophisticated analytical tools to establish the reserve liability for open claims. In the second quarter of the year, we increased reserves for bodily injury claims by approximately $140 million. In the third quarter, the analysis indicated the cost would be higher than that estimate. The reserve liability for prior years was increased by another approximately $480 million. At the end of each quarter, we follow the robust process I discussed on slide nine to estimate reserves by year, by reserve segment, and record the appropriate balance. Turning to slide 16, let's end by setting some historical context before we move into your questions. Claims capabilities are undoubtedly key to Allstate's historical profitability in auto and home insurance.
These capabilities, combined with our pricing, underwriting, and expense management, lead to a differentiated performance over time, as you can see by the two charts. Allstate's auto insurance combined ratio has outperformed the industry average from 2017 to 2021 by approximately 6.5 points. On the right, the homeowners combined ratio has been about 12 points better than the industry over that same period. As we've discussed, we have a comprehensive plan to return to auto profitability and return it to the mid-90s. When combined with strong homeowners results, this will generate adjusted net income return on equity in our long-term target range of 14%-17%. With that context, we'd like to open it up for your questions.
Certainly. As a reminder, ladies and gentlemen, if you do have a question at this time, please press star one one on your telephone. Our first question comes from the line of Paul Newsome from Piper. Your question, please.
Good morning, and thank you for the call. I wanna ask about how the business mix shift with the acquisitions plus just the shift in the emphasis of your distribution towards direct and independent agents may have changed the nature of the claims that you're settling. If it both and I guess it's two-part. First question, does it change the nature of the claims? The second part is, does it change the nature of the subrogation? Are you dealing with different, you know, companies when you're doing subrogation?
Let me set a little context, and then Mario and Eric can jump in and give their perspective. First, thank you, Paul. Good morning. We, when you look at, I really look at it by brand more than method of distribution. In the Allstate brand, the pricing plans are the same, the targeting is the same. Sometimes you get different people that come through direct than come through the agents, but we're getting a lot better, and the customers are getting better at making sure we get the full swath of people that come through, so high risk, low risk, short-term, long-term, lifetime value in all of those.
All of our pricing plans and our marketing and our allowable acquisition costs are based on making sure we get the right profitability for our customer no matter which channel, which way they come to us in the Allstate brand. The National General book of business, as you know, is more what we would call non-standard or higher risk drivers. That tends to have lower limits than some of the Allstate branded business. With that context, I may get Mario and Eric to jump in.
Yeah. Thanks, Paul, for the question. I think National General, again, just given the nature of the non-standard business it writes, it's gonna write less full coverage, more liability only, lower limits. Those claims are different. Then just non-standard auto claim handling, which, you know, Eric can talk a little bit about by its very nature is a different process. I think that I think looking at it by brand, as Tom mentioned, is the appropriate way to look at it. Certainly, the National General mix of business from a standard/non-standard mix perspective is different. But I think within the Allstate brand, you kind of poked at direct versus agency-driven business. I don't think...
You know, we're still writing standard and preferred risks in the Allstate brand, regardless of the channel it's coming through. At this point, direct is continues to aggregate to be, you know, a much smaller percentage of the total. I don't think it's had much, if any, impact on the, the mix of types of claims and so on because it's still the same risk segment we're writing, just they happen to be coming through different distribution channels. I don't know, Eric, if you wanna add anything to that.
Yeah. Thanks, Mario. Paul, it's Eric. The one thing that, just keying off of brand and channel, I think I heard in your question, does channel give rise to instances where we may be subrogating against other insurance companies? Short answer is no. Good question. We're finding regardless of channel that we're interacting, you know, broadly with the market. Our collections are, you know, quite healthy this year, and they've been performing quite well. There's nothing about distribution that causes us to have interactions with different carriers.
I guess as a follow-on, are the carriers that you're, you know, negotiating with changing their stance? You know, we obviously are in a quite a changing market both in auto and home, and I wonder if part of the issue here is that there's little less cooperation amongst the competitors.
I mean, I don't know there's really cooperation ever. Like we wanna get back as much of our customers' money as is due to them if somebody bashed into their car. We always fight hard for that. I'll let Eric talk about the change in our processes and their processes. I guess I would say, though, Paul, you know, when there's more money at stake, people get more focused on it and, you know, particularly in... It's not that we weren't or other people weren't paying attention to it, but as those costs escalate, you really double down. Eric, maybe you wanna talk about our processes 'cause we can't really speak to what other people are doing.
Yeah. I'll just pull back the curtain a little bit. It's a business-to-business interaction. First I'll start with our process. Our process is this goes back to investments in data and analytics, dedicated specialists in how we interact in the system to recover those collision paid loss dollars, you know, that we're seeking. Again, we're quite pleased with subrogation receivables this year. You know, we hit some records this year that we're comfortable with. The thing I would say in terms of industry cooperation or carrier-to-carrier interaction, look, we put a number on the file, and we seek to get that maximum recovery on a per unit basis. We know about, you know, carrier-to-carrier practices, and we ensure that we max out that return to the best of our abilities.
If you're talking about cooperation, there's remedies, you know, for if a carrier disagrees with the number that we've put on it, you can go to arbitration, intercompany arbitration, that would dispose of the matter. We believe that our position is the right position more often than not. We can either come to an agreement or we can take it to that intercompany arbitration. In extreme instances, we may even have to litigate. The net on the whole system is that we're quite comfortable with those recoveries, and they're showing up in our net paid severities for collision.
Great. Thank you very much for all the help. Much appreciated.
Yep.
Thank you. One moment for our next question. Our next question comes from the line of Alex Scott from Goldman Sachs. Your question please.
Hi. Good morning. First one I had for you is just, you know, high level on how you include inflation assumptions into the reserving. You know, I see the different methodologies, particularly on page 15 that you're laying out there. I mean, such a critical component of it right now is, you know, how you're funneling in sort of your assumptions around where inflation will go and so forth into those methodologies. I'd just be interested in, you know, if you could comment on that at all.
you know, if there's anything you could tell us about how paid losses are running relative to your estimates when you kinda compare it versus different vintages over time and so forth, that would give us some comfort that even, you know, with the rise in inflation over the past, you know, year that you're in the right spot.
Alex, thank you. I'll let Jess answer the question on inflation, but I don't want you to come away thinking like we have like an inflation pick. That's some number that we suddenly changed. Inflation is implicitly embedded in it. On your question on paid, did you have a specific segment of claims that you're thinking about in terms of paid versus reserved? Or like, because we segment this in so many different levels. As we talked about, you know, physical damage is different than bodily injury. Did you have one segment in particular?
Well, I think physical damage is probably where you'd see it most acutely. I mean, is there anything you can tell us about, you know, how paid relative to, you know, the ultimate incurred losses that you're expecting? I would think that that percentage would be, you know, should be running lower than a normal time because of the increasing inflation over the past year. I'm just trying to get my arms around that in particular and where we are now.
Maybe let me take a shot at it, Jess, like, 'cause I'm trying to make sure I understand the question. On physical damage, those are paid pretty quickly, so inflation doesn't really impact it. The paid got stretched out a little bit because it took longer to get to a body shop, longer to get parts. People took it in, didn't get all fixed, they had to take it back, so it got stretched out some. I wouldn't say that it has a dramatic impact on the preserving practices because it's still kind of settled within the year, except for the point that Jess made, which is, as those amounts from subrogation from other carriers came in later and at bigger numbers than we had originally estimated, that paid drove it up, if that's right.
Jess, do you wanna add to that and...
Well, I mean, certainly. I mean, I think it's, you know, what you're driving at is, you know, some of the things that you probably observed. I, you know, I saw a note that you put out, Alex. I think the way that I would think about it is we're always fine-tuning our estimates of total loss for specific accident years as data emerges. You know, we continue to do that. You know, we consider all the different nuance around paid and incurred, you know, which includes settlement rates, changes in business, and inflation. You know, I think that, you know, as Tom said, it's something that we're keeping an eye on. As it relates to your earlier question, though, on how we factor in inflation, I think Tom hit the nail on the head.
It's inherent in the estimation process of reserves, right? We're not making specific picks. What we're looking at is data and information to make judgment, and that's incorporated in the reserves. The inflation is coming through actual paid losses as we refine reserve estimates, and we incorporate that into our viewpoint.
Got it. Maybe if I could sneak one quick one in. In terms of the rideshare, I know you guys, this isn't a huge business for you, but, it, you know, I saw recently you decided to exit the non-telematics piece of what you were doing. Just curious, you know, just because I think, you know, appears had some issues with estimating reserves there. Is there anything nuanced that you have to do around reserves? Anything you can tell us about those reserves that would give us confidence that, that won't happen for you guys?
Well, Jess can talk about the reserve changes we've made in that business. Let me maybe just tell the complete story on it. We were early in that business. We've probably written over $1 billion of premium in that business with the big transportation network companies, some of the home-sharing companies. It's not meeting our profitability targets, so we're essentially exiting the business unless those carriers wanna use telematics, which to date we've not had one use. We think it would be a good idea to use because we think it's better, it's more accurate. You could get the individual driver pricing right, and that would help you account for the higher liability limits that exist in those policies.
You know, the most transportation network companies have $1 million liability coverage versus, you know, maybe it's $100 or $300 in personal product liability, and that leads to increased amounts of litigation, to be honest, and therefore higher costs. What our position has been with the transportation network companies, like, we need to make money. We're here to help you. We got a great claim operation, as Eric talked about. We can do a lot to take care of your customers, and those hurt by your customers, but we're not gonna do it for free. We think the best way to do that is using telematics. We're trying to encourage them to use telematics. Far none are, and if they don't, we won't be selling any of the business.
Jess, you wanna talk about the reserve changes we've made on ABI?
Yeah. I think that the reserve changes are affected by all the same factors we talk about on other bodily injury claims. The difference that Tom highlighted is you have higher limits. I don't know that there's any unique secret sauce to how you reserve. You just have to understand the nature of the underlying contract, and then it's gonna be impacted by the same factors. We did do some strengthening, as you know, in Q3. We think we put up the right number. We always think we put up the right number. You know, the underlying, you know, methods and assumptions really rely on the, you know, looking at the same type of data, understanding the different limits, and then making adjustments as needed. As I said, we did do some strengthening.
We feel good about the reserve that's up. We'll continue to look at the data as it rolls in for actual claims in the quarter.
Thank you.
Thank you. One moment for our next question. Our next question comes from the line of Greg Peters from Raymond James. Your question, please.
Good morning, everyone. I'd like to zero in on slide 14 and specifically the line at the bottom about the reserving process, where you mention how the adjuster establishes a case reserve, and then you talk about the adjuster continuously reviewing the case reserve throughout the process. What I'm ultimately trying to do is reconcile that, this continual review process, with the violence of the total reserve addition that you've reported year-to-date. If the things are being constantly reviewed and updated, I'd be surprised that you'd have such a violent correction that happened this year. Maybe you can spend a minute.
Has something changed in your process this year considering your experience, or are you changing the inputs on how these case reserves are being established so this doesn't happen again?
Well, there's a couple of words there, Greg, I might take exception to about violent. Lots of it-
Sorry about that. Well,
Reserve changes aren't really violent. With that said, let me just talk about, you know, it's really, I think, what Jess said on page 15. I'll maybe just mention that, then Jess, you can provide some context. Scott or Eric, Scott Downey, who is our Chief Reserving Actuary, is here with us. May wanna talk about the process, and Eric, maybe you wanna talk about what you're doing in litigation. We use all these methods to look at it, and each method gives you a different answer. It's each method's right at some point in time, and it's wrong at some other point in time.
You have to kind of look at all of those in total, and decide what are the trends telling you. As Jess said, in the second quarter, we said, "Look, these trends aren't looking that good on prior years for auto bodily injury." We added money to reserves based on that. You know, as a year develops, you get more and more certain. As more and more cases are paid out, you get more and more certain. We looked at it again as we always do, it's continuously. In the third quarter, we said, "You know, we should put up some more money." Now, there have been some underlying things that have changed in there, that you remember the courts were closed for 2 years.
You're not settling as many of those litigated cases. When Scott's trying to see, you know, what are the pays on represented cases, when you get to during the pandemic, there weren't as many 'cause there was no place to go to settle it. That has changed, and we've changed our practices around that. Jess, how would you add to that? And we can get Scott and Eric in the conversation.
What I would add is there's a granularity component to what you're asking about, Greg, which is an adjuster's looking at a case, and they're making an estimate, right? When we start to think about the way that we establish reserves in, you know, when you're in Scott's role, and when we look at the aggregate, you're looking at all the data and information that's rolling in on far more cases, right? We have the benefit of perspective on how cases are settling. The way that I think about it is we haven't, you know, made changes to process, but what we do is we have the benefit as we establish the overall reserve of seeing the landscape more broadly based on all the data and information that's rolling in to help forecast how those claims will ultimately settle, right?
It doesn't mean to imply that the adjusters aren't continuously looking or that the adjusters aren't necessarily putting up what they believe is the right reserve. Scott has the benefit of data and methods that help project out what that ultimate claim is gonna settle at, that's broader and more comprehensive than an individual adjuster. That's how I would think about that question. I don't know, Scott, if you had specific as the guy who gets to make the estimates?
Yeah.
Thanks, Jess and Tom. I think you pretty thoroughly covered it. I think the one nuance within the question that I would comment on is maybe there was an assumption that the case reserves are 100% accurate at all times. What we've seen historically is that the case reserves are made based on known facts at the time, then the actuaries come behind the scenes on that and put an additional provision on to estimate the full likelihood of the claim. While Eric's team, and he can comment on that more, is continuously evaluating that case reserve, there will still be development upward in the case reserve, upward in the pays, and that is what we were looking at in our trends and our methodologies when we're making those projections.
Yeah, that's an excellent point. That's the third. If you go to the page you were on page 14, that's the third row on the bottom part of the page.
Yeah, got it. That's a thorough answer. Tom, it was a poor word choice. I guess the second question.
It's fine, Greg. You're a friend. We own it. I think it'd be useful for Eric to talk about what we've been doing to manage litigation costs in the face of what I described on the courts being closed. It's not like we just sit around and say, "Oh geez, like, let's hope this opens up." We're pretty proactive. Eric, maybe you wanna talk about that.
Yeah. Thanks, Tom. I'll just take a step back and just refer to our continuous improvement culture. We're always iterating on improvements in cost, quality, efficiency, service levels. As we've discussed on this call and previous special topic with regard to auto, we've made some well-placed bets in investments in capabilities, whether it be technical, medical, legal, data scientists, and so on. I think tapping into those is something that we've been doing in an accelerated way. What I'm getting at is when COVID resulted in widespread shutdowns, we scanned the external operating environment and said, "Well, what new risk could this present?" One of the items we identified was increased legal risks, which is a component of social inflation.
An increased legal risk could be manifesting in record level court backlogs, and record level court backlogs could mask some adverse development. We organized around this possible risk, tapped into those investments, and we've been accelerating the disposal of matters that we've determined to have some risk of adverse development while simultaneously maintaining our rigor on defending matters as necessary. If we choose to go all the way to trial, we still win far more often than not by multiples. For those matters that present some risk as identified by those investments and those capabilities, we've been accelerating that disposition. That's resulted in significant reductions in open outstanding inventory, specifically as it relates to litigation. While you're reading about or we're reading about, you know, record levels of court backlogs, our litigated inventories currently sits significantly below pre-pandemic levels.
We think that we've been taking advantage of those insights and feeding those back into the entire system.
Just a point of clarification on that. To what extent are you using technology and artificial intelligence in the litigation process? Maybe you can just give us some color on that.
Yeah. I'll anchor back to the special topic call on auto, where we had a brief double click into claims. In that call, we referred specifically to increased investments in data science. Our portfolio of models that is specifically geared towards managing tort liability matters is robust, and I won't call out each model. Broadly speaking, they center around, injury exposure detection, potential attorney involvement, potential for litigation, and potential for volatility. These are kind of broad categories of our portfolio of models. That is fed into not just the decision as a decision support tool for our claim professional, but it's integrated in our legal team. The whole thing comes together for us to be able to get out ahead of unnecessary adverse developments.
It plays a significant role, I think, is the bottom line. The future in as far as, we're concerned, and it's the reason why we've highlighted that as one of our well-placed bets and a place where we make strategic investments while continuing to reduce overall operating costs.
Got it. Then I'm gonna pivot back to National General as my second question, which is-
Hey, Greg, could I ask you to hold that? We still got a pretty big list of people.
Oh, sure. Yes, absolutely. Fine.
So
Okay. All right. All right. Fair enough.
Thanks. You can follow up with Mark. He's around all day.
Thank you. One moment for our next question. Our next question comes from the line of Elyse Greenspan from Wells Fargo. Your question please.
Hi. Thanks. you know, my question, you know, kind of goes back to, you know, slide 15 where you guys went through, the bodily injury adverse development that you guys have seen this year. you know, it just feels like we've seen a lengthening of the tail right on auto, which is typically been a short tail line, especially since you guys, you know, there's a big portion of the reserve development right from 2018 and prior. I was hoping that you can comment on that. There wasn't a lot of movement in 2021, yet we saw movement in years prior. If we can just get, you know, some color on there, you know, as part of the, you know, reserve strengthening you saw for BI so far this year.
Elyse, maybe let me talk a little about tail. Jess can talk about 2021. I think what we're seeing in there are more severe accidents now. More severe accidents just take longer to resolve. When Eric talked about the slide, he said, "You know, you get medical treatment, and then we do injury evaluation." You know, sometimes it takes, you know, a year to figure out exactly what's wrong with somebody and then what the protocols are. With more severe accidents, you are seeing that go through our severity picks and auto profitability. If you said, really, does it take, you know, what's a short tail line in total and make it a long tail line, I mean, I guess it would depend what your measure is, but I think it's still relatively short.
Eric talked about the things he's doing to speed up some of that litigation settlement. We don't manage it for a specific amount of time, but I don't think it fundamentally changes the nature of what's a short tail business to a long tail business. Jess, do you wanna talk about 2021?
Yeah. I would start by saying, you know, obviously, accident year 21 is the least mature. It's something that we have an eye on. I think you have to go up, and always just kind of remember, we book a total reserve for all accident years, current and prior, in aggregate. There's a lot of granularity underneath that you have to look at. While this zeros in on BI, you have to keep in mind that we're looking at coverages across accident years, lines of business, and there's a significant amount of segmentation within the overall reserve process to get to that just over $25 billion. You know, like I said, accident year 21 is one that we're focused on.
Also, you know, keep in mind we're looking at it in the. Across coverages in relation to an overall balance, Elyse. We feel good about that we put up the right number for 21. We continue to feel that way as it relates to the overall reserve balance. That's kind of the way that we're thinking about it.
Elyse, you don't see underneath. I mean, Jess was talking about the segmentation. We put up a reserve balance that we think is for all claims that are outstanding for all prior years, all coverages, BI, PD, PIP, uninsured motorists. We do it by state, so we do, you know, big states like New York, Texas. When Scott's doing his work, he's always looking at all of those segments and trying to decide what does he think the right amount is for that segment, and then what's the right amount in total. We often move money around between prior years and different coverages in different states. You just don't see it because our goal is to get the total number right. In this case, in the third quarter, we didn't think the total number was right.
That's why I put up the additional money. There's lots of granularity down below there.
Also, I guess, in the third quarter, you guys saw like the intra-year adverse development, was that mostly, right, also for, bodily injury related adjustments, right?
I'm sorry. You cut out on the beginning part of the question.
I was saying in the third quarter, right, you guys saw, you know, some intra-year adverse development, right, you know, for the other quarters of 2022 in the third quarter. Was that also mostly, you know, for bodily injury-related adjustments?
Well, I actually go to slide. Where's Jess' slide? If you go to slide 12, we did make intra-year adjustments for PD in the third quarter for the prior year. We raised, for example, property damage to 17% for the whole year, which-- And we had only had it at 12% for the whole year at the end of the second quarter. That five-point difference went into all three quarters. You're right on that. I don't remember, Jess. Did you make changes on bodily injury for the whole year, too?
Bodily injury started. If you had a similar chart, Elyse, for bodily injury, it was at 8% Q1 up to 9% in Q2, and then we booked bodily injury at 12% at the end of Q3. We have been taking current, taking the trend, the observations into the current accident year as well and increasing the year-over-year change on BI.
Okay. Thank you.
Mm-hmm.
Thank you. One moment for our next question. Our next question comes from the line of Tracy Benguigui from Barclays. Your question, please.
Thank you. Good morning. Turning to bodily injury, I'm just thinking about the third-party claims that are coming in with more medium tail risk. To what extent in your more recent reserving actions did you raise the proportion of IBNR reserve for bodily injury than you have in the past, and if you could share those statistics?
I mean, we look at it in total, Tracy. IBNR would be incurred but not reported. Nobody's called us. Typically people don't call you all the first notice of loss, not all at the right time. We estimate, they'll call us later. That's a part of it. The developmental reserves that Scott talked about are, we're not sure we've got all the facts available in the case stuff. We don't ask the claim adjuster to just make it up. They put down what they see. Scott has to look at that case reserve and say, "You know, it's almost always goes up." There's two parts of those supplemental reserves.
I think the I don't think any change in IBNR in the math we do would be really substantive related to, is there a trend related to profitability of auto insurance? I think, I mean, Scott changes it all the time. But again, he does it by coverage, by state. Like, he's got it split a whole bunch of ways.
We haven't changed any process, Tracy, as it relates to that. As Tom said, it's part of the normal process. We certainly don't disclose any statistics as it relates to IBNR that we would be sharing. I would just take away that we do it consistently with the way that we've done it, and it incorporates observations, you know, by accident year.
Okay. Can you discuss your actual versus expected process? I'm just wondering how responsive you are in real time, actual versus expected. Do you sit back and wait for more time to transpire to validate those anomalies to your historical trends?
What's A versus?
actual versus expected. Yeah.
I'm like, wow, we have a lot of acronyms, Tracy. I love getting stumped on. Jess, do you wanna take that or Scott?
I think Scott is best able probably to talk through the way that we think about it, Tracy. I mean, I think, you know, I keep going back to, we put up the reserve in aggregate that's right, and that includes expectations and actual results on a quarterly basis. Scott, I think, can dive in maybe a little bit on your question more specifically.
Yes, sir. Hi, Tracy. Thanks for the question. you know, from a actual versus expected standpoint in the actuarial world, that is a kind of a monitoring statistic that is looked at. I would go back to what Jess says. We rely generally on the commonly common actuarial methods that were listed on the slide. those tend to give a good signal. When you think about actual versus
The, the signal that that sends, we generally see our methodologies track fairly well to that kind of output since we are a large company and have a significant amount of data.
You also have to keep in mind, Tracy, that we use a count versus severity method. You know, obviously that makes the actual versus expected comparison that Scott's doing, different than someone that's, you know, looking at accident year loss ratio picks.
Okay. It doesn't sound like a lot has changed. You're saying when you saw these adverse loss trends, your actual versus expected, you were responsive or you waited for it, you know, because you have years of data that you're mentioning that may contrast versus what you're seeing.
I would just say, you know, our process has been consistent. We don't wait or accelerate. We just put up the money when we think we need to put it up based on all the analysis. Our external advisors, we're in the same place we were at the end of the second quarter and the same place we are in the end of the third quarter. We feel good about the processes and the holistic governance over it.
Thank you.
Thank you. One moment for our next question. Our next question comes from the line of David Motemaden from Evercore ISI. Your question please.
Hi. Thanks. Good morning. Jeff, I just wanted to just talk about some of the bodily injury reserves, specifically that you set up for 2021. It sounds like you guys are keeping track of this fairly real time. I guess, how have the assumptions you made last quarter to reserves been holding up, relative to your actual experience here in the fourth quarter?
David, while I appreciate the question, that's not something that we talk about. What's going on in the fourth quarter is for the fourth quarter call, which we'll have in February.
Okay. Okay. That's fair enough. Just another one. You know, if I look at BI incurred severity across some of your peers like GEICO and Progressive, they've increased their BI accident year severity around 8%-9% annually over the last four years. You know, just looking back to, you know, 2018. I'm wondering, after all the changes you've made, you know, where does your severity increase look, you know, relative to that 8%-9% that some of your peers are assuming on an annual basis? I think you talked about 5% for 2021 was your assumption.
I don't think you've made many changes to that just based on the $41 million of increases you've made September year to date, and I think 12% now for 2022. Just trying to get some sense, you know, for what you're assuming on severity just to help us get some comfort that, you know, the charges are behind us.
David, let me start with the end and then go to the beginning. We've established the reserves at what we think is appropriate based on all the claims that are out there, all the facts we have, all the different methodologies going, and we feel good about that. I can understand why you're like, well, geez, why did all of a sudden you figure it out in the third quarter? We said, you know, we made changes in the second quarter. When the numbers change, then you have to make sure you get it right. And we feel good about where we're at. I think in terms of competitors, it's really hard. You know, like, we obviously also look at competitors and see where are they and what are their picks.
You know, one of the problems is it all depends where you start. You know, if as you pointed out, you gave a four-year run of it, and if you do a five-year run, you'll get a different number. If you do a two-year run, you get a different number. It's a little hard, and other people do their reserves differently. We described a very, what I would say, ground up, granular, case-based reserving. I can't speak to how everybody else does their reserving. You know, some people use target loss ratio picks. They say, "My loss ratio is gonna be 70%," and that's what they book to. They have lots of statistics under that to prove it or not prove it, and includes many of the same statistics we have.
You're kind of coming at it from different angles, so it's really hard to tell. All I can know is we feel good about the number we have up at this point, and we think that the balance in total is right. The balance in any given year will change as we go forward. Money might move from 2019 to 2018 or 2018 to 2021. We feel like the gross amount of the reserves that are on the balance sheet and then the net that's available is the right amount.
Thank you.
Thank you. One moment for our next question. Our next question comes from the line of Michael Zaremski from BMO. Your question please.
Hey, morning. Appreciate the call, and I'll just stick to one question. I guess going back to the conversation you were having with Elyse about the tail and, you know, more severe claims take longer to resolve. I guess, you know, if we look at the shape of the tail for, you know, let's just say on the private passenger auto casualty only. I mean, the shape in year one and two has been elongating for, I thought it was like a secular trend for, I think, you know, since 2015, 2016, 2017, you guys have talked about, right, the paid ultimate ratio declining, you know, from the 40s, you know, down into the 30s.
I thought there was, you know, more of a secular trend there that wasn't, you know, just due to more severe accidents, what I thought was a more recent phenomenon. I don't know if anything you can touch on there on what's been driving ultimately the ultimate paid claim ratio to fall in, you know, the 12 and 24 month category. I thought litigation was, you know, more litigation was one of the reasons, that's my one question. Thank you.
Thank you, Mike. Yeah, I'll wrap up after this answer. Let me go way up for a second, then I'll come down. One reason we started the presentation up top is bodily injury represents about 27% of our total loss cost. When you're talking about lengthening out that component of it, remember, you're still paying out a whole bunch of other client cases long before that. In terms of its weighted average on the duration of the line, it doesn't have a huge impact. You are right, with more both the court delay that Eric talked about, which we've tried to mitigate, but also just more severe accidents, like people are driving faster or getting in more severe accidents.
People are getting hurt more, so that just in and of itself takes more medical treatment, more time to figure out how we're gonna get the person back to where they were. More severe cases attract more attorneys because they are more severe, and that takes time. You're correct in that there are, you know, there is some lengthening of it, but I don't think it changes the overall economics of auto insurance. It doesn't really change what we're in terms of our economic returns on auto insurance. Because remember, as those claims stretch out, there is obviously risk associated with those claims extending, and it makes it harder to estimate what those claims will cost you, but you're also getting investment income along the way.
I don't think it's fundamentally changed the attractiveness of the auto insurance business. Let me just close by saying, you know, kind of where we started. Our claim capability is core to making sure we get really attractive returns from personal auto and home insurance. We expect to be back there with our comprehensive profit improvement plan, and that's in large part driven by a really highly effective and efficient claim operation that leverages scale and technology and operating precision and people. We hope that we gave you a look into that world today, which is a core component of why we expect to be able to do 14%-17% when we get auto profitability back to the mid-90s.
Thank you all for joining us today, and we'll talk to you after fourth quarter results.
Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.