Unfair Discrimination in Rating: Price Optimization

(b) canceling a policy before the expiration of the policy term; and (c) failing to renew a policy at the renewal of the policy term. Maryland Law Applied to Price Optimization In General Section 27-212(e)(1) of the Insurance Article provides that: An insurer may not make or allow unfair discrimination between insureds or properties having like insuring or risk characteristics in: (i) the premium or rates charged for insurance; (ii) the dividends or other benefits payable on the insurance; and (iii) any of the other terms or conditions of insurance. For purposes of the Insurance Article, the Court of Appeals has defined unfair discrimination as “discrimination among insureds of the same class based on something other than actuarial risk.” Insurance Commissioner v. Engelman, 345 Md. 402, 413 (1997). By its nature, price optimization involves discriminating among policyholders of the same class based on factors other than actuarial risk. The purpose of price optimization is to move away from traditional cost-based rating to take advantage of price elasticity in the market by charging the most that the market will bear without losing business. One of the ways that insurers use price optimization is to analyze patterns of behavior of policyholders to try to predict whether a policyholder is likely to switch to another insurer if the insurer increases premiums. This may involve the use of a “retention model.” If an insurer’s analysis indicates that a policyholder is likely to switch to another insurer, that policyholder will be charged a lower premium than a policyholder who is considered unlikely to switch to another insurer. By way of example, one developer of price optimization models indicated that one of the characteristics it would consider is whether a policyholder has complained to the insurer.1 If a policyholder has complained, this would indicate that the policyholder is unsatisfied and not likely to accept a premium increase. As a result, all other things being equal, this policyholder would be charged a lower premium than a policyholder who has not complained to the insurer. This means that policyholders would be charged higher premiums simply because they have not complained to the insurer, regardless of whether these policyholders pose any more risk of loss than policyholders who have complained. One advocate of price optimization explained its use as follows: 1 Presentation of Towers Watson to the NAIC Auto Insurance (C/D) Study Group on July 28, 2014. Microeconomic theory teaches us that thoughtful selection of prices, or price discrimination, is a key to maximizing revenue and profit. Our research, in fact, reveals that if P/C insurers adopt advanced pricing strategies that consider customer elasticity differences, they can boost their revenue by roughly 3 percent and returns-on-equity by 1 percent, on average. Price elasticity of demand (PED) essentially refers to the responsiveness – elasticity – of a customer in terms of the quantity of a product that he or she will buy when the price of that product changes. … Assume that through careful study of an insurer’s data, we can determine that females of a certain age exhibit less price elasticity than male drivers of the same age or females in adjacent age categories. Without being overly prescriptive, we could tweak the established rating relativity variables – within their accepted confidence levels – to arrive at a different rate for those drivers.2 As this explanation indicates, price optimization involves varying rates based on factors that are unrelated to risk of loss, such as price elasticity or the willingness of an insured to accept a premium increase. Consequently, the use of price optimization may result in two insureds with like risk characteristics being charged different premiums, which is a violation of §27-212(e)(1) of the Insurance Article. Corrective Action Plan The MIA requires every insurer that currently utilizes price optimization to rate insurance policies in Maryland to file a corrective action plan with the Maryland Insurance Administration no later than January 1, 2015. An insurer should include in the corrective action plan:  the lines of business for which the insurer is using price optimization, a description of the manner in which the insurer is using price optimization, and the SERFF filing numbers of any rate and/or rule filings that contain price optimization;  a description of the company’s proposed corrective action;  a target date for making corrective rate and/or rule filings; and  a target date for implementing the corrective rate and /or rule filings. Corrective action plans may be mailed, emailed, or faxed to the following: Geoffrey Cabin Director, P&C Rates and Forms 200 St. Paul Place, Suite 2700 Baltimore, MD 21202 Email: geoffrey.cabin@maryland.gov Fax: 410-468-2307 2 “Predictive Analytics: Bringing Price Elasticity Concepts to P/C Insurance”; published by Carrier Management; September 3, 2013; www.fractalanalytics.com/news/predictive-analytics-bringing-price-elasticity-concepts-pcinsurance (Copyright 2014, All rights reserved. Fractal Analytics, Inc.) Failure to submit a corrective action plan and to re-file rates/rules that are compliant with Maryland law may result in administrative action. Any questions or comments regarding this bulletin should be addressed to Geoffrey Cabin, Director of P & C Rates and Forms at Geoffrey.cabin@maryland.gov or at 410-468-2310. Therese M. Goldsmith Insurance Commissioner By: Sandra Castagna Associate Commissioner Property and Casualty Signature on original