Self-driving cars are a danger to IAG and Suncorp

If you're keen to have a personal chauffeur, you're probably excited by the self-driving car revolution that seems to be just around the corner. If you're an investor in our large auto insurers, however, it's time to temper your enthusiasm.

Suncorp (ASX: SUN) and Insurance Australia Group (ASX: IAG) own AAMI and NRMA, respectively. Together, they account for around 70% of the auto insurance market and insure some 12 million cars in Australia. It's a cozy duopoly, which offers some protection, but driverless vehicles are still likely to curb earnings growth in the long term.

At first, that statement may seem counter-intuitive. By far, an auto insurer's largest cost is the settled claims paid out to policyholders when they're in accidents or their cars are damaged.

The main pitch by car manufacturers working on autonomous vehicles – such as Tesla, General Motors, and BMW – is that these cars are safer than regular drivers. Complex algorithms can assess countless road conditions and monitor the car's surroundings in a way that ordinary drivers could never achieve – and, consequently, these cars are less likely to be in accidents.

Fewer accidents mean fewer insurance claims, so Suncorp and IAG's costs should come down. Hurrah! It's easy to look at their income statements and say ‘right, if revenue is this, and driverless cars cut claims to this, then net profit should grow'. Unfortunately, reality doesn't work like that.

From pocket to hand

Auto insurance is largely a ‘commodity product', meaning that there is little to differentiate one policy from another. Customers tend to focus on price and that makes the industry extremely competitive. If self-driving cars reduce the number of crashes and bring down claims, the insurers are likely to engage in a battle of one-upmanship to lower prices so that they can maintain market share.

IAG and Suncorp's net profit is a function of two things: premium revenue and the margin they earn on that revenue. Given the competitive backdrop, there's no reason to think that margins will change, so lower premium revenue will drag down net profit. We expect most of the savings associated with autonomous vehicles to wind up in the hands of customers, not the pockets of shareholders.

It's likely to be a drawn-out effect. Despite billions being spent on research and development, driverless cars are still in their infancy and there are many regulatory hurdles to cross, not to mention people will probably need some convincing before they hand control to a computer.

Nonetheless, NRMA's own estimate is for one million driverless cars to be on Australian roads by 2035. That's only around a 5% penetration rate, so the decline in profitability is likely to be minor – probably imperceptible for 20 years – but change is coming. When a significant proportion of owners have made the switch to autonomous vehicles, drivers may be safer, but shareholders had better buckle up.