Section G Regulation of Insurance: Price Optimization

Question 1

Define “Cost based” rate:

Answer 1

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.

Question 2

Define “Rating cell”:

Answer 2

Combination of rating variables from a rating plan

Question 3

Define “Risk profile”:

Answer 3

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 and expenses.

Question 4

Define “Unfairly discriminatory rates”:

Answer 4

Unfair discrimination exists if, after allowing for practical limitations, price differentials fail to reflect equitably the differences in expected losses and expenses.

Question 5

Define “price optimization”:

Answer 5

The process of maximizing or minimizing a business metric using sophisticated tools and models to quantify business considerations.

Question 6

Examples of business metrics that are maximized via price optimization:

Answer 6

Marketing goals, profitability and policyholder retention.

Question 7

Three types of optimization used in ratemaking:

Answer 7

1. Ratebook Optimization: cost and demand models are utilized to adjust the factors in an existing structure.
2. Individual Price Optimization: creates a price based on cost and demand models at the individual policy level.
3. Hybrid Optimization: create a new rate factor based on a demand model that supplements a cost based rating algorithm.

Question 8

Factors incorporated in Hybrid Optimization models:

Answer 8

• expected retention
• profitability
• rate of change from the current premium to the proposed premium
• premium volume
• expense

Question 9

Compares price optimization and the traditional ratemaking approach

Answer 9

Question 10

Price optimization poses several challenges to regulators

Answer 10

💩 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 and calculations

Question 11

List come criticisms against price optimization

Answer 11

🔹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 customers.

Question 12

List some ways in which different regulators have responded to price optimization

Answer 12

▪️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.

Question 13

List some options for potential regulatory responses to price optimized rating schemes that were recommended by the Price Optimization Task Force

Answer 13

▫️ Determine which price optimization practices, if any, are allowed in the state

▫️ Define any constraints on the price optimization process and 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)

Question 14

List examples of constraints that regulators can apply to optimization

Answer 14

♟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

Question 15

Describe how filing rates can be enhanced to accommodate price optimization

Answer 15

🔹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

Question 16

List ways in which regulators can ensure that optimization is more transparent

Answer 16

▫️ disclosure of whether price optimization is used

▫️ disclosure of differences in proposed prices for the existing and new customers that have the same risk profile

▫️ file a report to show the distribution of the expected loss ratios under both the current and proposed prices

▫️ disclosure of all date sources, models and risk classifications used by the insurer to calculate the premium

▫️ disclosure of which rating factors are impacted by the price optimization for all existing and new applications for insurance

▫️ require a certification by an actuary that all non cost based considerations impacting the proposed rates and rating factors are documented in the filing

Question 17

Recommended criteria in which a selected rate that is not between the current and indicated rate may be acceptable if:

Answer 17

🔹 it is disclosed

🔹 it complies with state law

🔹 it is demonstrated to be consistent with actuarial ratemaking principles and Standards of Practice

Question 18

List examples of factors that regulators should prohibit be used in price optimization

Answer 18

▫️ price elasticity of demand

▫️ propensity to shop for insurance

▫️ retention adjustment (at the individual level)

▫️ propensity to ask questions or file complaints

Question 19

List 3 recommendations of the Task Force for the states:

Answer 19

🔹 Consider issuing a bulletin to discuss insurer’s use of methods that may produce non cost based rates

🔹 Consider enhancing requirements for personal lines filings to increase disclosure and transparency around rates/rate indications/rate selections

🔹 Analyze models used by insurers in ratemaking to ensure that the model meets state law and confirms to actuarial principles