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An Overview of the Use of PriceOptimization for Private PassengerAutomobile InsuranceWill Davis FCAS MAAASERA ConferenceCharleston Harbor Resort & MarinaApril 30, 2015
Introduction Definitions “Fer It, Or Agin’ It?” Conclusions
My Background My Role at the SC DOI My Topic My Opinions
Price Optimization, is it: best pricing strategy ? incorporation of demand models ? revenue management ? anticipation of consumer behavior ?Or, is it: subjective pricing ? industry profit lever ? unfairly discriminatory tool ? THE DEVIL ?
Is the PPA Insurance Market Competitive?Why do we care? Sellers can’t exert “Market Power”Products sold at the Marginal CostCharacteristics Many buyers & sellers that are price takers? LargelyUndifferentiated & homogeneous products? LargelyEasy entry/exit of firms? YesPerfect information about price and availability? NoHence, we regulate, to overcome this asymmetry
Oversimplified PPA Liability Example: Current prices only differ by type of car – FastAverageSlow- 200- 150- 100
What is Price Optimization? Vendors – “systematic process suggestingadjustments to cost-based prices to fit thecompetitive market and business objectives” CAS – “the supplementation of traditionalactuarial loss cost models to includequantitative customer demand models for usein determining customer prices; result is a setof proposed adjustments to the cost models bycustomer segment for actuarial risk classes”
What is Price Optimization (continued)? Regulators – “varying premiums for factorsunrelated to risk to charge the highest pricethat can be sold ” Consumer Groups – “charging the most acustomer is willing to pay, rather than a pricethat’s related to projected costs”
Three Main Variations:1. Ratebook Optimization – incorporating costand demand models in an existing class plan2. Individual Optimization – rate engine thatbuilds individual price based on cost anddemand (ie – no traditional class plan)3. Hybrid Optimization – add a new rate factorto the cost-based class plan, based on demandmodels
Back to Our Oversimplified Example:Current Cost-BasedTypePricePriceFastAverageSlow 200150100 240180120Avg of All 150 180Price Opt VarietiesPrice 1 Price 2 Price 3
Back to Our Oversimplified Example:Current Cost-BasedPrice Opt VarietiesTypePricePricePrice 1 Price 2 Price 3FastAverageSlow 200150100 240180120 230170110Avg of All 150 180 170
Back to Our Oversimplified Example:Current Cost-BasedPrice Opt VarietiesTypePricePricePrice 1 Price 2 Price 3FastAverageSlow 200150100 240180120 230170110 30021090Avg of All 150 180 170 200
Back to Our Oversimplified Example:Current Cost-BasedPrice Opt VarietiesTypePricePricePrice 1 Price 2 Price 3FastAverageSlow 200150100 240180120 230170110 300 28021019090100Avg of All 150 180 170 200 190Note: There is information asymmetry
Pro’s From the Carriers’ Perspective: Takes advantage of technology/less “hands on”May provide more insight into future resultsMay increase stability of renewals, reducingexpenses/increasing profitsCon’s Requires investment in technology“Learning curve”Regulatory “risk”
Pro’s From Society’s Perspective: Perceived “shoppers” could get favorable pricingIf expenses reduced, premiums may fallReduced uncertainty for insurers could increase thesupply of coverage offeredCon’s Prices may be higher than the cost-based estimate forthose with less ability or inclination to shopInsurers have access to more/superior informationIncreased distrust of the industry and regulators
Pro’s From an Actuarial Perspective: So-called “Ratebook Optimization” can be a moresystematic (and hence possibly superior) way ofdoing what pricing actuaries and analysts already doCon’s The “Individual Optimization” form seems to clearlyviolate the Statement of Principles on RatemakingThe “Hybrid” form may do so as well, dependingupon how it’s usedCredibility is a concern
Pro’s From a Regulatory Perspective: Could reduce customer defection, which mighttranslate into reduced system costsCon’s State laws, including this state, require that rates benot excessive, inadequate, or unfairly discriminatoryRates that are not cost-based would be excessive forsome, inadequate for some, and unfairlydiscriminatory to those with less informationOur code also requires that rates be “reasonable;” isit reasonable to charge more because you can?
Conclusions
Three Main Variations: 1. Ratebook Optimization - incorporating cost and demand models in an existing class plan 2. Individual Optimization - rate engine that builds individual price based on cost and demand (ie - no traditional class plan) 3. Hybrid Optimization - add a new rate factor to the cost-based class plan, based on demand models
