Autosource-Whitepaper-Final

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Contents

Summary 3

Purpose 3

Research Design 5

Research Findings 6

Data Analytics 6

Literature Research 8

Interpretaion & Analysis 9

Conclusion 13

BY COLIN WRIGHT

Audatex is the world leader in the development and implementation ofsoftware and services for the automobile and insurance claims processing industry.As part of the Solera group of companies,we draw on our broad global claims marketexperience to identify and implement thebest-practice processes that drive continuous improvement for our local customers and their trading partners.

Autosource Macroeconomic Analysis: Understanding Recent Trends in ACVs

Copyright © 2016 Audatex Canada. All rights reserved.

Audatex, Autosource, and Audatex Estimating,are trademarks orregistered trademarks of Audatex. All other trademarks used are the property of their respective owners.

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SummaryIn terms of perspective, this white paper provides more of a ‘birds-eye’ view rather than a granular, case-by-case analysis of actual cash value (ACV) estimations. Some useful insights are made available. Principal among these are that macroeconomic factors are the key determinants for the supply of, and demand for, used vehicles, and of used vehicle pricing in aggregate. It is also apparent that Autosource ACV trends are reliable proxies for used vehicle market price trends. Although not explored in detail, it is clear that used vehicle markets in Canada and the U.S. are fundamentally alike, but the timing and scale of any response to marketplace events may be affected by other factors unique to each country.

PurposeMany of Canada’s leading insurers rely on used vehicle valuations generated by Autosource, Audatex Canada’s valuation tool, to help them settle total loss claims. Autosource captures data from across the Canadian marketplace, finds vehicles that are both geographically proximate and comparable to the loss vehicle, and then uses a proprietary algorithm built using literally millions of data points to calculate a valuation amount.

Autosource is a robust, time-tested product. Its outputs are critical to ensuring that the promise of indemnity, i.e., that the claimant will be restored to the position they were in prior to their loss, is met, and that the settlement process is equitable for both policyholder and insurer alike.

Over the past 18-24 months, aggregate analyses suggested that actual cash value amounts were trending upward (See Figure 1.) during a period when inflation was negligible and other economic factors such as GDP growth, the price of oil, employment, and the value of the Canadian dollar were either soft or declining. In an environment where most indicators suggest that prices should hold steady or perhaps even decline, the trend in ACV seems counterintuitive.

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From a client perspective, confidence in ACV is critical. They need to know that the data used is both representative and that the calculations used weight key factors appropriately. For Audatex, generating valuations is not a static process, but more an evolutionary one that necessitates continual re-evaluation of data, methods, assumptions and external factors that may be impactful.

This study was undertaken to identify key drivers of recent trends and to confirm that generated valuations continue to accurately reflect the marketplace and are not artefacts of an imperfect methodology.

FIGURE 1

For Audatex, generating valuations is not a static process, but more an

evolutionary one.


Research DesignThe research design for this study comprises two components: a statistical analysis of 2015 ACV data; and a literature search focused primarily on reports generated by government agencies and commercial market research firms.

Autosource data were extracted for 20151 and various data mining techniques were applied, including a cluster analysis, the construction of a linear regression model, a correlation analysis of expected vs. observed outcomes, and profiling of the identified clusters.

The dataset included latest ACV values aggregated by month, province, region of origin, make, and vehicle category as well as vehicle age and mileage. Only data from typical instant, i.e., system-generated, valuations were included. A linear regression model built off the dataset also incorporated additional variables such as the value of the Canadian dollar over time. Part of the dataset from the first half of the year was used to “train” or fine tune the model while the remainder was reserved to test its predictive ability against observed results.

Valuable insights were gained from a variety of sources accessed during the literature search conducted for the study. Because vehicle markets develop over multi-year, or even longer, timescales the search was not limited to only the most recent published material but also included analyses of economic events and trends stretching back for the better part of the last decade.

Material from government entities such as the Financial Consumer Agency of Canada and Statistics Canada, as well as from the research arms of major financial institutions such as Scotiabank, was reviewed. Reports from specialist automotive research companies on both sides of the border, such as the U.S.-based National Automobile Dealers Association (NADA) and DesRosiers Automotive Consultants in Canada, were also examined. Business news reports published by mainstream media outlets such as The Globe & Mail or The Financial Post provided additional, relevant information.

As a starting point for the research and subsequent analytical activity, it was hypothesized that ACVs are proxies for used vehicle market prices and that any long-term movement or identifiable trend in ACVs will mirror real-world events, price movements, and trends in those markets. As such, the drivers of the used vehicle market will also drive ACVs.

1 Obtaining current data for the used car market in Canada can be challenging. For example, there is a two-three-month lag for Statistics Canada price data and seasonal adjustments are made to prior entries with each new entry. Volume data are not readily accessible except in year-end summaries. The ability to provide an “up to the minute” snapshot of the market is, therefore, constrained.


A strong correlation between changes to ACVs and changes in $CAD/$USD exchange rate is a suprising find.

Research Findings

Data AnalyticsThrough the initial data analysis, fourteen clusters were defined. Each cluster contained vehicle makes and models that share similar characteristics. A multiple linear regression model was developed and trained with a subset of the data as planned. The model was then used to forecast results for the remainder of the dataset. Actual ACVs for the latter half of the year were then compared with the forecast ACVs, exceeding them by an average of $674 at year-end.

Two of the fourteen clusters defined were weakly correlated with overall ACV and two others, clusters 4 and 8, were negatively correlated, meaning that the actual results for these clusters moved in the opposite direction to what the model predicted. Clusters 4 and 8 accounted for 36% of the valuations in the dataset which suggests that they strongly influenced the difference between actual and model results.

Examining the composition of these clusters revealed that 50% of the vehicles in Cluster 4 are classified as “Economy-Domestic” while an additional 14% are “Economy-Import”. In terms of vehicle makes, Cluster 4 contains a disproportionate number of vehicles from defunct brands; Pontiac, Saturn, and Oldsmobile account for 42%, 11% and 8% of the cars in the cluster, respectively. These brands are overrepresented in the cluster relative to their distribution within the dataset overall.

Within Cluster 8, “Economy-Import” at 47%, and “Mid-Foreign” at 27% are the predominant categories, and Toyota, Honda, Nissan and Volkswagen are notable brands (See Figure 2.). At shares of 29%, 13%, 10% and 9%, respectively, these makes account for nearly two thirds of the vehicles in the cluster.

FIGURE 2


A strong correlation discovered between changes to ACVs and changes in the $CAD/$USD exchange rate is a somewhat surprising finding. Although the U.S. is Canada’s largest trading partner, there is no obvious reason that the value of the dollar should correlate with, or have any influence upon Canadian used vehicle prices as these are domestic assets being bought and sold in the domestic market with domestic currency.

A separate analysis was conducted comparing ACVs for both cars and light trucks for 2014 through the first quarter of 2016 with the Consumer Price Index (CPI)1 over the same period. The following charts (Figures 3. & 4.) illustrate a generally positive correlation, particularly for cars, with overall price inflation in the Canadian economy.

1 Source for CPI data: www.statcan.gc.ca

FIGURE 3

FIGURE 4


Literature ResearchThe purpose of the literature search was twofold: identify current marketplace trends and the key macroeconomic factors that drive them; and provide historical context by reviewing and analyzing recent, relevant economic events.Notable findings:

Over the 2012-2015 time frame, the total value of used car sales in Canada increased 18%, while the average price increased 20%1 and total unit volume declined 2%2 (Figure 5).

• Following near-record new car sales in 2012, record sales were seen in 2013, 2014 and 2015

• There are still approximately ten million cars ten years old or older on Canadian roads – replacement demand continues to fuel a very active new car market in 2016

• Consumer preference has shifted to light trucks and crossovers – sales of subcompact and compact cars have declined

• Low fuel prices plus favourable purchase financing and leasing options contribute to changing preferences

• While the overall value of used cars sold in Canada has risen over the past few years the number of units sold has declined slightly meaning that average values have increased

1 Statistics Canada, CANSIM 080-0020, 2016

2 DesRosiers Automotive Consultants Inc., 2016

FIGURE 5


• There is a used car shortage that is putting upward pressure on prices – particularly within specific categories

• Industry-watchers expect the shortage to ease as the effects of multiple factors, e.g., changing consumer preferences or changes in financing, impact supply

• Used vehicle sales from Canada to the U.S. have soared as the value of the Canadian dollar has declined

• The recession in 2008-09 profoundly impacted auto sales on both sides of the border• Post-recession, new vehicle financing changed significantly1 • In 2007 in Canada, leasing had a 42.4% share of new vehicle financing – this collapsed

to a 7.1% share in 2009• Leasing has been rebounding steadily – in 2015, 28.8% of new cars in Canada were

financed with leases• During the recession, some automakers, notably GM Corp. and Chrysler LLC, suspended

leasing altogether while others limited its availability to certain market segments• Chrysler did not offer leasing in Canada from 2008 until 2013, and GM from 2008

until 2011• To maintain affordability, the market shifted to extended-term loans (ETLs) – average

terms have increased by two months annually since 2010 reaching 74 months in 2015• 84- and 96-month ETLs are now commonplace• There is increasing concern about an “auto bubble” – ETLs and broader availability of

leasing options contribute to ever-higher levels of consumer debt – the frothy new car market of recent years could contract sharply under certain scenarios which would have an impact on used car markets a few years down the road

Interpretaion & AnalysisThe results of the data analytics and literature search point in the same direction. Recent increases in ACVs mirror a rise in average used car prices that is driven by multiple factors. Principal among these is a shortage in supply that has its roots in the recession of 2008-09.

Off-lease vehicles are an important source of supply to the used car market. Lease financing terms are typically 36-60 months in length meaning that many late-model used cars are lease returns. The cessation or sharp curtailing of leasing by major manufacturers during the recession directly affected used car supply 3-5 years later.

As noted by the Financial Consumer Agency of Canada, consumer purchase decisions hinge on affordability, or more correctly, on the regular payment amount needed to finance the vehicle2. In fact, much vehicle advertising highlights the payment amount while burying the full retail price and other payment terms in fine print.

1 For the purposes of this document, loans, leases and cash are all considered as different forms of purchase financing.

2 Auto Finance: Market Trends, Financial Consumer Agency of Canada, March 2016

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In order to continue to provide car shoppers with attractive, “affordable” financing options in the absence of leasing programs, manufacturers turned to extended term loans, low interest rates and more frequent payments. Previously, typical car loans had 36-48 month terms paid monthly. Post-recession, ETLs became the norm with terms of 60, 72, 84, and, more recently, 96 months. In addition, bi-weekly, or even weekly repayment schedules have become commonplace. Advertising focused on the payment amount and the low, or even 0% interest rates being offered.

Consumer choice has also been affected by ETL financing. Purchasers who focus on the regular payment rather than on the total cost of financing have a tendency to buy up and purchase “more car”, or possibly a different type of vehicle such as a crossover or compact SUV (Figure 6).

The increasing prevalence of ETLs has played a part in shifting consumer preference away from conventional passenger cars toward light trucks. In an expanding market over the period 2011–2015 where the total number of units sold has risen from 1,585,519 to 1,898,485, the passenger car share of market has slipped from 43.8% to 37.7% while the light truck share of market has grown from 56.2% to 62.3%1. Many consumers find themselves in a negative equity position because of ETLs – they owe more than their car is worth for much of the loan term – the average amount of ETL negative equity is -$6,7002. For some car owners, being in a negative equity position is a disincentive to sell or trade their vehicle before they have finished paying for it which effectively delays the addition of these vehicles to the used vehicle market.

When GM and Chrysler went into bankruptcy protection in 2008 they suspended their leasing programs. This action would have had the effect of limiting the supply of vehicles from these manufacturers to the used vehicle marketplace in the short- to medium-term, as purchasers would have been forced to migrate to longer-term ETLs for affordable financing.

The recession also impacted new vehicle sales overall (see Figure 7, below). Total sales volume for new passenger cars and light trucks collapsed from about 1.69 million units in 2007 to 1.48 million in 20093. The market has steadily rebounded since, achieving successive new records in the past three years.

These changes in sales volume, financing and consumer preference affect the market


2 Financial Consumer Agency of Canada, March 2016

3 Statistics Canada, CANSIM 079-0003, 2016

FIGURE 6

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unevenly, i.e., by region, vehicle type, make and model, but the overall effect post-recession was a slow erosion of the supply of used vehicles to the Canadian market.

Figure 8., below, maps the changes in finance options against overall unit sales. It shows that leasing peaked in 2005 and then suffered a 38% drop in share of finance by the end of 20091. Unit sales of used vehicles, rose for four years until 2011, after which they began to decline, suggesting, first, an increase in supply between 2005 and 2011, and then a subsequent tightening of supply. Three years later, used sales were again on the rise, fueled by steadily increasing supplies of off-lease vehicles as leasing rebounded over the intervening years, plus the addition of vehicles purchased post-recession using conventional financing.


FIGURE 7

…leasing peaked in 2005 and then suffered a 38%

drop in share of finance by the end of 2009.

In the broadest terms, the expected response to a reduction in supply is upward pressure on pricing. The cluster analysis provides support for this. As discussed in the Data Analytics section earlier, cluster 8 accounted for 30% of the valuations in the dataset. The largest vehicle categories in the cluster are“Economy-Import” at 47%, “Mid-Foreign” at 27%, “Minivans” at 11%, and “Economy-Domestic” at 8%. On a brand basis, Toyota, Honda, and Nissan account for 29%, 13%, and 10% of the vehicles in the clusterwhile Ford, Dodge and Volkswagen have 9%each. Notably, Toyota and Volkswagen wereoverrepresented in the cluster relative to theirdistribution within the dataset overall.


Cluster 8 ACVs are negatively correlated with model predictions meaning that they are higher than projected. Taking into account the various factors influencing supply, it is reasonable to posit that fewer domestic vehicles would have been added to the used vehicle market as lease returns dried up. This would have a twofold impact on pricing as the limited supply of domestic vehicles would lend buoyancy to prices for those vehicles and, in turn, consumers looking for domestics but finding fewer to choose from would look for substitutes, i.e., similar imported vehicles. The increased demand for a limited supply of imported, foreign vehicles would put price pressure on those vehicles. A reduction in supply of one category leads to increased demand for a substitute category and both categories experience upward price pressure.

Recent changes in the $CAD/$USD exchange rate only served to exacerbate the problem. As noted previously, the rise in ACVs is also negatively correlated with the decline in the value of the Canadian dollar versus the US dollar. In 2015, Americans bought 200,000 used vehicles in Canada and exported them to the U.S. - 7% of the total number of used vehicles sold in Canada1. The favourable exchange rate makes Canadian used autos very attractive to U.S. buyers; dealers are reported to be paying asking prices at auction and shipping truckloads of vehicles south. The impact on the Canadian market is a reduction in the supply of late model used vehicles contributing to increased retail prices. Exports from every province climbed in 2015, but Ontario was the dominant supplier suggesting that impacts might be experienced differently by region2.

Looking forward, the ongoing resurgence of leasing post-recession bodes well for used car buyers. Analyses of the U.S. market suggest that as these vehicles start to come off-lease in 2016-2018 buyers will have greater choice and the increased supply is expected to exert downward pressure on prices3. These expectations appear to be coming to fruition.

1 Auto Remarketing Canada, 2016

2 Scotiabank, 2015

3 National Automobile Dealers Association, NADA Used Car Guide, under licence by J.D. Power and Associates, 2016

FIGURE 8

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The NADA Used Car Guide for August and September report consecutive declines in the Used Vehicle Price Index of 1.1% and 0.4% respectively1. Similar easing is expected for Canada as well, and a decline was evident in August when average used car prices declined month-over-month by 0.3%2 (see Figure 9.). With increasing supply south of the border, exports of used vehicles to the U.S. may also decline which might further ease pressure on pricing.

ConclusionAn obvious endpoint for this analysis is that the impressions of industry participants are confirmed; ACVs have been rising and this rise is counterintuitive when considered in the context of how a number of widely reported economic indicators such as inflation, the price of oil, and rates of employment have behaved. In fact, the story is more complex. Although there may be a tendency to view the used car market as static, with a steady supply of vehicles becoming available as the fleet inexorably turns over, it is anything but. The research conducted for this paper reveals that current availability is largely determined by the economic conditions that prevailed several years ago and by the response of the marketplace to those conditions.

1 NADA Used Car Guide, August, September, 2016

2 Auto Remarketing Canada, September, 2016

FIGURE 9


The recession of ’08-’09 dealt a serious blow to overall sales. It also had a dramatic impact on car companies and financing institutions in terms of how they assessed and managed risk. Leasing collapsed and with it a major source of supply to the used car market. To maintain affordability, ETLs became commonplace.

These events and the responses to them impacted both short- and longer-term supply. The disequilibrium between the supply and demand of used vehicles in both Canada and the U.S. is a major driver of the recent rise in ACV values; the resurgence in leasing and record sales of new vehicles is expected to reverse that trend in the near-term.If nothing else, this analysis highlights the complexities of new and used vehicle markets and the multiplicity of variables that drive volumes and pricing. A good example is the impact that a declining dollar has had. When the Canadian dollar was at or near par with the U.S. dollar Canadians turned to the U.S. and purchased new vehicles because, even with import costs, lower MSRPs south of the border made it attractive to do so. Now the tables have turned and used Canadian vehicles are seen as bargains by American buyers. Used vehicle exports help ease supply issues in the importing country but exacerbate them in the source country.

The challenge this complexity presents for market watchers and forecasters is significant. It is reasonable to broadly predict future trends but exceedingly difficult to determine the delta of marketplace changes with any accuracy. The analysis also highlights that Autosource, which uses current marketplace prices obtained from multiple sources, is an excellent proxy for the market. The cluster analysis reveals how changes in supply and changing consumer preferences impact pricing - Autosource valuations effectively track these changes.

There are some emerging trends that are likely to have an impact going forward. New vehicle sales in Canada softened somewhat beginning in July and continuing through August and September, but still remain at historically high levels and in aggregate are up by 3.2% year-over-year1. The consumer shift away from passenger cars to sport utilities and crossovers continues unabated. Also noteworthy is the long-term trend toward greater negative equity. This will affect the ability of consumers to take on additional debt meaning that some will retain their vehicles longer and others will be pushed into different vehicle and financing choices when they fail to meet the underwriting criteria of lending institutions for the purchase of new vehicles. How these trends will affect the future supply and pricing of used vehicles will only be apparent through continued monitoring and analysis.

1 DesRosiers Automotive Consultants Inc.

The disequilibrium between the supply and demand of used vehicles is a major driver of

the recent rise in ACV values.

Audatex Canada1210 Sheppard Avenue East, Suite 204North York, OntarioM2K [email protected]

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Copyright © 2016 Audatex Canada, All rights reserved.

The information contained in this document represents the current view of Audatex on the issue discussed as of the date of publication. Because Audatex must respond to changing market conditions, it should not be interpreted to be a commitment on the part of Audatex, and Audatex cannot guarantee the accuracy of any information presented after the date of publication.

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