Price Optimization Flashcards
Define “Cost based” rate:
Estimate of the future cost associated with individual risk transfer. This is based on expected claims, claim handling expenses, underwriting expenses, policy acquisition expenses, reasonable profit, investment income, and other risk transfer costs
Define “Rating cell”:
Combination of rating variables from a rating plan
Define “Risk profile”:
Set of characteristics listed in the insurer’s rating plan required to calculate the premium. People with the same risk profile should have the same expected risk, loss & expenses.
Define “Unfairly discriminatory rates”:
Unfair discrimination exists if, after allowing for practical limitations, price differentials fail to reflect equitably the differences in expected losses and expenses.
Defines “price optimization”:
The process of maximizing or minimizing a business metric using sophisticated tools and models to quantify business considerations.
Examples of business metrics that are maximized via price optimization:
Marketing goals, profitability and policyholder retention.
3 types of optimization used in ratemaking:
- Ratebook Optimization: cost and demand models are utilized to adjust the factors in an existing structure.
- Individual Price Optimization: creates a price based on cost & demand models at the individual policy level.
- Hybrid Optimization: create a new rate factor based on a demand model that supplements a cost based rating algorithm.
Factors incorporated in Hybrid Optimization models:
- expected retention
- profitability
- rate of change from the current premium to the proposed premium
- premium volume
- expense
Compare price optimization and the traditional ratemaking approach:
1) Traditional Approach
2) Price Optimization Approach
Rating Plan Development:
1, 2) Base rate (loss cost) × adjustment factor
Adjustment factors (for auto insurance) are based on... 1, 2) Age, gender, territory, make & model year, ect
Adjustment to rates based on market, regulatory and other considerations are based on…
1) Qualitative assessment
2) Qualitative and quantitative assessments informed by analysis of risk related and non risk related data
Basis for adjustment to rates is…
1) Insurer judgement
2) Automatic, systematic analysis (modeling)
Price optimization poses several problems to regulators:
- Because price optimization impacts the selections as opposed to the cost based indications, regulators may be challenged when reviewing the insurer’s rates, as it may not be clear how exactly optimization influenced the selections.
- There is a large amount of information related to the price optimization process to consider.
- Regulators must rely on the insurers to provide accurate and complete information on the rates, as well as the adjustments required to produce those rates.
- Regulators currently do not have the necessary data for an independent evaluation of a large portion of the insurer’s modeling & calculations.
List some criticisms against price optimization:
- penalizes customers, as it involves insurers attempting to charge the highest possible price without causing the consumer to switch.
- can result in unfairly discriminatory rates
- Insurers may raise prices of those who are less likely to shop around, many of whom are low income and minority consumers.
- It can result in drivers of the same risk being charged different rates
List some ways in which different regulators have responded to price optimization:
- Many states defined price optimization and prohibited the defined practice
- Some state regulators believe that the existing state laws are sufficient to cover price optimization. No bulletin/ public announcement specific to optimization is necessary
- Many states have not yet received a filing that mentioned that price optimization was used in the rating process
List some options for potential regulatory responses to price optimized rating schemes that were recommended by the Price Optimization Task Force:
- Determine which price optimization practices, if any, are allowed in the state
- Define any constraints on the price optimization process & outcomes.
- Develop regulatory guidance on statutory rate requirements,
to ensure that the rates are not excessive, inadequate, or unfairly discriminatory
- Enhance filing requirements
- Require explanation/ reasoning to support any proposed rate that deviates from the actuarially indicated rate
- Change the filing laws to require more transparency (after considering state laws on confidentiality)
List examples of constraints that regulators can apply to optimization:
- limit the price adjustment to be between the current rate and actuarially indicated rate, and always move towards the actuarial indicated rate
- require that the rating factors selected be: between the current and actuarial indicated factors; or within a confidence interval around the current/ indicated factors; or directionally consistent with the current factors
- limit the variables that can be used in defining a risk class
- only allow price optimization to be applied to classes of at least a certain size
- price optimization adjustment to rating factors must produce rates that maintain cost based differences
Describe how filing requirements can be enhanced to accommodate price optimization:
- consider whether the actuarial indication is the point estimate, or any selected value within the confidence interval around the point estimate
- consider whether to require actuarial certification that the indications in the rate filing are based exclusively on the cost considerations, and are not otherwise adjusted
- consider requiring disclosure of any adjustments to rates that are not based on expected costs
- consider disallowing non cost based adjustments to selected rates or rating factors
