Recent comments from the Consumer Federation of America (CFA) accuse a bulk of U.S. auto insurers of using what it calls a relatively new, discriminatory pricing practice that distances the industry from traditional pricing models based on the likelihood a driver files a claim.
Robert Hartwig, president of the Insurance Information Institute (III), responded to the CFA’s claims that “price optimization” allows car insurers to reject “actuarial standards for the sake of increased profits” by calling the comments “patently false and absurd.”
According to a 2008 report from Towers Perrin, price optimization integrates a customer’s willingness to pay into an overall pricing strategy.
So in addition to pricing a policy based on how likely a driver is to file a claim, the use of price optimization further adjust the price based on the price that the consumer is willing to tolerate.
Hartwig said price optimization is a part of the popular wave of “big data” analytics that helps consumers find a range of car coverage options in the market, and car insurers further break down pricing of their applicants and policyholders and consumers.
However, according to the CFA, price optimization can produce discriminatory prices for consumers when combined with commonly used models based on price elasticity, a term used in economics to describe the availability of goods compared to their prices, because lower-income drivers typically compare car insurance prices less often than other socioeconomic groups.
“By using price elasticity models, an insurer can raise the price of auto insurance for some segments of the population who are unlikely to change insurers if the premium price goes up above the cost-based level through application of price optimization,” the CFA stated in letters sent to insurance regulators.
CFA Appeals to State Commissioners to Look into Discrimination
In a letter sent to commissioners of the nation’s state insurance regulatory departments, the CFA said that industry experts have already acknowledged that price optimization walks the line of legality.
The CFA noted several panels and events on the topic of price optimization, including an October 2012 event of the Casualty Actuarial Society (CAS), where a webinar was presented titled “Price Optimization vs. Actuarial Standards.”
The webinar’s title further signifies the industry’s attempt to move into more murky pricing territory by changing the actuarial models it has historically employed to calculate the risk that a driver will file an auto coverage claim, according to J. Robert Hunter, the CFA’s director of insurance.
“Some of the panelists admitted that there is a tension between the CAS Standards and the use of price optimization,” Hunter’s letter read. “One said that the CAS must revisit the standards to ‘get up to date.’ When asked if the actuarial Standards had to be changed so price optimization could comply, one panelist answered, ‘Yes. The tension is there and must be relieved. We need a safe harbor.’”
The CFA officially opposed such changes in May in letters to industry groups like the CAS and National Association of Insurance Commissioners.
Hunter told Online Auto Insurance News (OAIN) that the CFA’s public stance against incorporation of price optimization into actuarial standards has “at least slowed [changes] down,” but added that it is up to regulators to fully stop the practice.
“You must act to stop the use of PO in your state since it is both actuarially unsound under current CAS Principles and produces rates that clearly are unfairly discriminatory,” Hunter said in his letter to regulators.
Survey: Price Optimization Common Among Major Insurers
Hunter highlighted findings from the Earnix survey, saying its findings show the alarming rate that the North America’s largest insurers use price optimization practices.
The survey found that 45 percent of insurers that have more than $1 billion in annual premiums use price optimization, while 29 percent plan to do so in the near future. More importantly, according to Hunter, is that a slim 3 percent of those large insurers responded that they had no plans for price optimization.
The survey culled responses from executives and “pricing analysts or managers,” according to Earnix.
“They start with risk-based rates and then adjust upward based on PO,” Hunter told OAIN.
Hartwig called the CFA’s claims “patently false and absurd.” He said the Earnix’s survey was “informal” and conducted by a firm that was “looking to sell its services.”
“[The CFA] is bizarrely basing all kinds of wild accusations on some marketing materials that are coming out of one firm,” Hartwig told OAIN. He added that regulators “already review rates before they come to market in all states” to ensure legality and fairness to consumers.
In the survey, Earnix defines price optimization as a practice that helps achieve financial goals “while maintaining regulatory compliance.”
The firm did not return a request for comment.
According to Hunter, the importance of the survey’s findings aren’t diminished because they originate from a consulting firm.
“[Earnix] is trying to sell its PO products for sure but they would not fake such a survey,” he told OAIN.
III: More Options Available than Ever
Hartwig denied CFA’s claims, telling OAIN that a move away from “non-actuarial practices makes no sense.”
“Price is based on risk and absolutely nothing else,” he said. “It can make no sense for insurers to move off of anything other than risk. How can you reasonably price a policy if you move away from risk-based models?”
He defined price optimization as “not an actuarial term,” but part of a movement across the U.S. where industries use “big data” and advanced analytics to further polish the way they view people who buy their products. For the car insurance industry, Hartwig said, big-data analytics has helped companies better define risk.
“Insurers can now store and analyze ever-larger amounts of data to ascertain the risk associated with an individual applying or a policyholder already on the books,” he told OAIN. “So insurers aren’t abandoning actuarial standards, they are refining it.”
Dubbing big-data usage over the last decade as a “quantum leap,” Hartwig also said that insurers aren’t the only beneficiaries of refined pricing methods.
“More so than ever in the past, the price charged to a policyholder is more closely associated with risk that the policyholder presents,” he said. “This benefits everyone, especially the policyholder.”
Advanced analytics have also produced more options for consumers as private companies are founded to meet specialized needs, according to Hartwig.
“I think most regulators would say analytics have produced more options for a range of consumers and depopulated the traditional [state-sponsored] last-resort markets that high-risk drivers have had to go to,” he said. “Now, almost every driver is able to find a policy on the market today, irrespective of where they live, what they drive and the risk-based background they present. There’s a policy available to them all.”
To that end, Hunter said he still believes that the use of advanced analytics is being abused when it comes to lower-income and disadvantaged motorists who pose the same claims-related risks as richer drivers.
“Big data [meaning] fairer rates [is] fine,” he told OAIN. “But here it is the opposite, classic unfair discrimination, which is defined as charging the same-risk persons different prices.”
He said that he has received five responses from regulatory offices to his letters and all said that they are “going to look into it.”
“Regulators must be vigilant in stopping unfair practices,” he told OAIN.