Price Optimization

Question 1

NAIC paper applies to personal or commercial lines

Answer 1

Personal lines

Question 2

Actuarial judgements traditionally applied at individual or rate class level

Answer 2

rate class level

Question 3

Does price optimization allow deviations from indicated rates at MORE or LESS granular level than traditional ratemaking

Answer 3

price optimization allows for deviations on more granular level

Question 4

Items used in price optimization process

Answer 4

• big data (data mining of insurance and non-insurance personal info where permitted by law)
• advanced statistical modeling (often GLMs)

Question 5

define price optimization

Answer 5

• process of maximizing or minimizing a business metric
• uses sophisticated tools and models to quantify business considerations

Question 6

define cost-based rate

Answer 6

traditional actuarially derived rate based on loss costs, LAE, and other expenses

Question 7

define price elasticity of demand

Answer 7

change in quantity demanded vs price
- high = consumers will shop around if prices go up a little
- low = price doesn’t have much effect on demand

Question 8

define ratebook optimization

Answer 8

adjust factors in a cost-based rating structure using a demand model

Question 9

define individual price optimization

Answer 9

build a pricing structure based on both cost and demand

Question 10

define hybrid structure

Answer 10

insert new rate factor based on demand model (into existing cost-based rate structure)

Question 11

define constrained optimization

Answer 11

setting min and max limits on a model’s output

Question 12

Differences between price optimization and traditional ratemaking (5)

Answer 12

Traditional:
- applied at class level
- used cost-based pricing
- deviations from indicated rates are subjective
- will assign same price to identical risks
- generally accepted by regulators

Price Optimization
- can be applied to individual polices
- incorporates non-cost-based considerations like propensity to shop around
- deviations from indicated rates are based on quantitative models
- may assign different prices to identical risks
- may not be acceptable to regulators

Question 13

3 things a rate filing CAN’T be

Answer 13

inadequate, excessive, unfairly discriminatory

Question 14

Benefits of price optimization

Answer 14

• doesn’t unfairly discriminate (low-income customers more likely to shop around)
• provides more accurate pricing (neither inadequate nor excessive)
• if optimization applied at ratebook level, not unfairly discriminatory

Question 15

Drawbacks of price optimization

Answer 15

• regulators don’t have data to independently verify rates based on price optimization
• models (often GLMs) can produce large individual rate swings
• no evidence of improved stability from using price optimization
• concern that ratemaking ASOPs may be violated (if rates are unfairly discriminatory)

Question 16

Regulator responses to price optimization rating plans

Answer 16

• determine permissibility with respect to state laws
• define regulatory constraints (min/max rate swings, require that methods are applied only to rate classes of at least a certain size)
• transparency: full explanation of DAM (data, assumptions, methods), rate differences btwn customers with identical risk profiles (if any)

Question 17

Disclosures a regulator may require when price optimization is used in rating

Answer 17

• rate adjustments that are not cost based
• whether price optimization was used
• which rating factors affected and quantitative impact
• whether customers with same risk profile have different rates
• data sources and models that affected the rate charged in any way

Question 18

Recommendations by Task Force regarding pricing methodology

Answer 18

• rates should be cost-based
• rates should comply with state law
• customers with identical risk profiles should be charged the same rate (aside from temporary differences like transition rules)

Question 19

Rating considerations Task Force believes are unfairly discriminatory

Answer 19

• price elasticity of demand
• propensity to shop for insurance
• retention adjustment at individual level
• policyholder’s propensity to ask questions or file complaints

Question 20

Recommendations by Task Force regarding state regulatory practices

Answer 20

• issue bulletin addressing use of non-cost based methods
• enhance disclosure requirements for rate filings
• ensure compliance with state laws and actuarial principles by analyzing insurers’ rating models