Two months ago we held Insurance Partners’ seminars in three locations around the state. My brief message was that state after state had seen fit to ban price-optimization. I predicted Minnesota would soon follow suit. It appears I was right. However, I wonder if in making their ruling the regulators in Minnesota have reacted to a genuine need and have a plan of enforcement going forward.
Price-optimization is known by other names, such as “predictive-modeling.” It was defined in a recent bulletin by the State of Minnesota as “any method of taking into account an individual’s or class’s willingness to pay a higher premium relative to other individuals or classes.” The State of Minnesota went on to say this practice includes “varying rates and premiums in order to maximize insurer retention, profitability, written premium, market share or some combination of these.”
An example of this practice would be an insurer charging an attractive initial rate that over time they would increase. In order to be actuarially sound in this practice they insurer needed to have a good idea how long the insured would stay with them and how much rate increase tolerance the insured would have. That is where the complex algorithms for predicting consumer behavior come in. If a person is deemed to be a potential long-term client, not easily swayed by rate change, they’re offered a favorable initial rate.
According to the State of Minnesota our current statutes demand that rates must be an accurate estimation based on expected loss, expense, and degree of risk. On that basis they have demanded that all companies currently engaged in “price-optimization” shall immediately cease this practice.
Agents sell an intangible that often is hard to explain to our customers, and price-optimization can result in a loss of face. A good agent is never uncomfortable explaining a justifiable rate increase. However, the argument is often over before the conversation has begun. If the agent initiated the conversation to discuss a premium increase and possible alternatives, the customer response will normally be favorable. If the agent sits back and waits until the customer reaches a pain threshold that prompts the customer to contact the agent, the battle is probably lost before it started.
Obviously, when a rate is set below market, with a five- or six-year plan to become profitable “over time,” the agent is faced with repetitive rate increases that are hard to explain. Often, because of electronic funds transfer, or payment through escrow, the customer isn’t sensitive to smaller increases.
Over the last two decades, I’ve watched one particular company use this practice to carve out a huge market share in Minnesota and across the nation. Other companies have followed suit. Given the success of the initial company those other companies had no choice.
While I accurately saw this ban coming and believe the State of Minnesota basically got it right in their bulletin, I have some misgivings.
- Given black box underwriting how will the Commerce Department enforce this ruling? With millions of dollars of written premium knowingly underpriced on the books, how will companies comply with changed pricing in the sixty days demanded by the State’s bulletin? Are they expected to simply take a huge fiscal loss?
- Just because I don’t like this practice, doesn’t make it wrong. Just because fourteen other states have banned this practice, doesn’t make it wrong. Our laws are based on charging a fair, non-discriminatory price for a product. Our laws specifically ban predatory pricing. I believe a very valid argument can be made that “price-optimization” is a lawful practice within the statutes cited in that it is both fair and non-discriminatory.
- As I’ve seen “price-optimization” used I’ve not seen any evidence of “price gouging” which is the rallying cry that caused this practice to be banned in the other states. In some of the other states the ban resulted from legislative action with people like always-misinformed consumerist Robert Hunter crying “wolf.” For example; a person’s annual premium for auto insurance would be $1,000 a year, but for price-optimization and periodic premium pricing adjustments. Using characteristics primarily taken from credit history and buying habits the insurer believe the insured will stay with them for six years through several rate increases. The insured is charged $900 the first year, $940 the second year, $980 the third year, $1,020 the fourth year, $1,060 the fifth year and $1,100 the sixth year and thereafter. Under either system the insured pays $6,000 for six years of identical coverage. The insurance company is assuming the risk that the insured will stay with them through the six years. The insured has not experienced a disruptive (more than five percent) increase in premium, so has not shopped their insurance. Since the net is the same to the consumer, how is that price-gouging? Agents will act in the customer’s best interest and will move policies to other companies when rates become too far out of line.
It will be interesting to see how this plays out. I believe this bulletin could be positive for independent agents as it will prevent direct writers from creating undue disruption in the market by using overly-aggressive “teaser” rates. On the other hand, price-optimization has created opportunity for agile agencies. They’ve managed to maintain agency retention ratios in the nineties, while individual companies have struggled to keep above eighty.
Overall I think independent agents will do slightly better without price-optimization. Direct writers will have substantially worse retention as this has been a great pricing advantage for them. Captives will also do slightly better as price-optimization has been disruptive for them when their agents lacked alternatives for their customers.
The cynic in me believes that several large direct-writing markets will continue to price their product using price-optimization tools, but will be artful in how their filings reflect this practice.
I don’t like price-optimization, but in matters of pricing I’m very skeptical when government thinks they can do a better job of consumer protection than the free market. I fail to see the harm in allowing a customer to think they’re getting a better deal. If a consumer doesn’t use an agent to help them negotiate the insurance world I have little sympathy for their ensuing economic loss. Agents will work to retain clients through smooth pricing. Most agencies have agency management systems set to alert them of irregular increases. I think that in an environment where we see customers move their insurance from one company to another for very little advantage it is highly unlikely any pricing scheme can result in “gouging.”