Price Optimization White Paper
As adopted by EX Committee 4/6/16
NAIC to Consider Adopting Price Optimization White Paper
March 2016, CIPR Newsletter
The Use of Price Optimization in Insurance Ratemaking
August 2015, CIPR Newsletter
Big Data and Insurance
August 2015, CIPR Newsletter
Price Optimization in Auto Insurance Markets: Actuarial, Economic and Regulatory Considerations
July 2015, Insurance Information Institute Presentation
Price Optimization Overview
November 2014, Casualty Actuarial Society Presentation to CASTF
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Issue: The recent use of "price optimization" tools in determining the premium to be charged to policyholders is an emerging and evolving issue that recently drew increased attention and discussion among state insurance regulators, industry and consumer advocacy groups. Some argue the use of price optimization to determine premiums may result in rates that are unfairly discriminatory.
State insurance regulators around the country continue to actively monitoring the issue. State insurance regulators are concerned that price optimization may be a departure from traditional cost-based ratemaking and toward ratemaking based in part on consumers' price sensitivity. A number of states issued bulletins prohibiting or restricting the use of price optimization, or the concept of rating based on price elasticity, in personal lines ratemaking, while others states issued requests for information. As of August 31, 2016, 20 jurisdictions took public action with respect to price optimization. The list of states and their bulletins are available on the NAIC Casualty Actuarial and Statistical (C) Task Force webpage.
The NAIC Casualty Actuarial and Statistical (C) Task Force began drafting a Price Optimization White Paper in early 2015, which analyzes price optimization and its use in insurance ratemaking, with a primary focus on personal lines. The White Paper was finalized in November 2015 and provides guidance and regulatory recommendations to states. The Executive (EX) Committee and Plenary adopted the Price Optimization White Paper at the 2016 Spring National Meeting.
Overview: Price optimization is a practice that has been used in many industries for years, most commonly in the retail and travel industries. Many companies have embraced price optimization tools to help determine what price they will charge for their products or services. Vendors have developed commercially available software that allows companies to perform price optimization.
While price optimization is not a new concept, there is no widely accepted method or common definition, particularly with respect to how it's being employed in the insurance industry. There are a wide variety of existing definitions used by different stakeholders to describe a range of practices. Some stakeholders refer to price optimization as relying on predictive modeling and "big data," while others refer to the term to mean using information about customers' price sensitivity as a rating factor.
In the NAIC Price Optimization White Paper price optimization is referred to as "the process of maximizing or minimizing a business metric using sophisticated tools and models to quantify business considerations. Examples of business metrics include marketing goals, profitability and policyholder retention."
Consumer advocacy groups have expressed concern about insurers' use of price optimization, contending it is a practice where premiums are "set based on the maximum amount a consumer is willing to pay, rather than the traditionally accepted methods of calculating premiums based on projected costs, such as claims, overhead and profit." They argue price optimization is being used by insurance companies to increase profits by raising premiums on individuals who are unlikely to shop around to find a better price. They also assert the practice discriminates against low-income consumers who tend to shop around less frequently than wealthier consumers.
Proponents of price optimization argue however, that price optimization is used widely in many or most markets, and in fact represents innovation in pricing models that ultimately benefits consumers, regulators and insurers. Trade groups representing the property and casualty industry maintain prices charged to consumers using the technique are legal and meet regulatory standards, as optimization stems from ranges of price estimates that are actuarially sound.
State insurance regulators are concerned some property and casualty insurers have been relying upon price optimization to help determine the premiums they will charge to policyholders. Consequently, a number of states have taken preemptive action to ban the practice. Several states issued bulletins stating price optimization results in rates that are unfairly discriminatory. Some of these states are also requiring insurers to remove price optimization factors from rate filings.
Status: The issues and concerns about the use of price optimization remain a key priority for state insurance regulators. The NAIC Casualty Actuarial and Statistical (C) Task Force began drafting the Price Optimization White Paper in early 2015 after the issue of price optimization was referred to them from the NAIC Auto Insurance (C/D) Study Group. The White Paper was adopted by the NAIC Property and Casualty Insurance (C) Committee on November 21, 2015 and the Executive (EX) Committee and Plenary adopted the White Paper at the 2016 Spring National Meeting. The White Paper provides background information on state rating law, actuarial principles, and price optimization, including an overview of various definitions of price optimization used by stakeholders. Potential benefits and drawbacks of price optimization are also identified, which includes the concerns raised by consumer advocacy groups.
A section discussing regulatory responses to price optimization rating schemes is also included, which discusses the concerns raised by state insurance regulators. The White Paper also includes recommended wording in Appendix A for states to consider when issuing a letter or bulletin to personal insurance companies. The final section of the draft White Paper outlines regulatory recommendations and next steps.