Price-Optimization Ban Might Result in Market Disruption

Price-Optimization Ban Might Result in Market Disruption

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.”

James Holm

Usage-Based Insurance Could Become a Problem for Your Agency

Unfortunately, usage-based insurance (UBI) could become a problem for your agency.

You can always tell the pioneers because they’re the ones with the arrows in their backs. When insurance companies wander into uncharted grounds, they often drag agencies along with them.

If you have a company who is involved in UBI using telemetrics to collect their data, you could become a party to future lawsuits. UBI is also known as pay as you drive (PAYD) or (more commonly) pay how you drive (PHYD). The data is collected and reported to the carrier through a telemetrics device.

A few weeks ago Wired published an article about a hacker remotely high-jacking the controls of a Jeep Cherokee. When I read that article, I wondered if this had implications regarding the telemetrics dongle used by companies like Hartford and Progressive to field-test a driver’s actions, such as braking.

A subsequent article in Business Insurance seems to suggest my concerns were well-grounded. Researchers at UC San Diego used the dongle for Metromile to take over some controls on a Corvette. Metromile is a new, west coast company that is charging for auto insurance based on actual miles driven.

Should one of your customers experience a loss due to a hacker, your agency could be named in a suit, claiming you advised your customer to install the dongle.

You should:

1.)   Consider advising your customers NOT to use the UBI telemetrics based on hackers.

2.)   Consider contacting your customers who are using the dongle, to tell them about the potential for hacking.

3.)   Consider contacting your companies to see if they’re willing to provide a hold-harmless for your agency.

Usage-based insurance isn’t going to go away. Your agency doesn’t need to suffer the slings and arrows of a pioneer.

Killing a Sacred Cow

Killing a Sacred Cow

Sacred cows make the tastiest hamburger.” Abbie Hoffman

Abbie Hoffman was a counter-culture revolutionist of the 1960s with a strange sense of humor, yet his attitude toward scared cows rang true.

Sacred cows are those ideas that, though unreasonable, are held to be above criticism.

There is one sacred cow that I would like to see finally exposed.

“Agents Are Only as Good as the Loss Ratios They Produce. . ..”

Insurance companies have a right — and a duty to their shareholders — to do what is necessary to make a profit. That is true, but they can only do what is legal and ethical in the pursuit of maximized profits.

It is common for insurance companies to restrict access to certain programs, or terminate contracts, based on their poor loss ratios with an agency. Contractual changes seemingly occur most often with personal lines insurance companies and their agencies.

Yet, most personal lines agents don’t place enough business with a single company to amass a volume that is actuarially creditable. I’m not an actuary, but in my opinion, most premium volumes under $1,000,000 lack legitimacy when applying the Law of Large Numbers.

Agents don’t have access to the black box algorithms used by companies to match a risk with proper premium levels. My years at an underwriting desk lead me to believe that without the ability to price and classify risk, most underwriters would fail to develop a profitable book.

Insurance laws, like those in Minnesota, prohibit agents from declining a risk. Since agents are statutorily prohibited to decline a risk and have no ability to set a price, aren’t agents being held accountable for outcomes over which they have little control?

Insurance companies occupy shaky ethical grounds when their actions to maximize profits are based on decisions that will create economic troubles for their contracted agents. This is especially true when companies act despite a weak nexus between agency loss ratios and the quality of representation provided by the agency.

My agency has housed two operations during the last three decades. One side of the office contained a traditional general agency that provided outsourced underwriting to specialty companies. The other side housed the administrative arm of an agency aggregation. The management of both operations was identical and grounded in the same intense desire to produce positive results for our companies.

The general agency side of our operation, the side that had pricing, classification, and risk selection capabilities, consistently produced award-winning profits for our companies. We were the most profitable agent in the nation for one of our general agency’s companies for two different years and near the top many other times.

The agency aggregation operation produced highly varied loss ratio results despite our diligent efforts to follow our companies’ marketing wishes.

It is my belief that loss ratio is an improper gauge of performance. Profitability is mainly the function of the company and NOT the agency. My five decades in this industry have led me to believe that an agent’s job is to provide an insurance company with a strong flow of business that closely matches that company’s underwriting appetite.

That’s a job description I can accept. It doesn’t frame the agent as a target when an adverse loss ratio is developed. It clearly defines what the agent must do to satisfy the relationship with the carrier. All that is needed is a meeting of the minds on quantifiable goals.

I’ve been an underwriter, the top executive for a small insurance company, and an agent. I believe most insurance programs develop loss problems because of poor execution, or planning, at the company level.

A poor loss ratio might be an indication of a risk characteristics problem within an agency’s book of business, and possibly brought on by faulty marketing. Agents do, from time to time, find company errors. Company actuaries make mistakes and often create soft spots in their company’s underbelly. If agents diligently exploit those weaknesses, they could be developing books of business that are horribly flawed and don’t represent a strong flow of business that closely matches the company’s appetite.

On its own, without looking for supporting reasons, an agency’s poor loss ratio is almost meaningless. Sometimes a poor loss ratio is merely a result of events. Bad things happen, and people buy insurance to protect assets otherwise lost when those incidents occur. Without a certain amount of loss activity, insurance loses its purpose.

Given today’s data-mining capabilities, pruning agency representation based on loss ratio alone is highly unethical. If an agent has selected against his company, placing only those risks that are highly advantages to his customers and detrimental to his company, he should be educated. Then, if necessary, that agency should be reprimanded and remedial actions taken. If he persists in presenting a flow of the wrong kind of business, the agency contract should be terminated, as the agents needs do not match the appetite of the carrier.

As a general agent who specialized in small, commercial, hard-to-place risks, I felt I had a good read on an agency’s principles by the fourth or fifth application we received from them. If their applications were incomplete or seemingly misleading, we would ask for more information. A rogue agent would rarely respond, knowing that we would decline the risk.

It would seem that insurance companies could easily create a matrix for risk characteristics that would allow a much more revealing “ratio” to be calculated. That ratio would compare the percentage of high-profit potential business to the percentage of acceptable business that has much less potential for profit. That ratio would be much more meaningful.

It is a time-honored tradition within insurance companies to review risks that have incurred large losses. The first question is normally, would we have written this risk had our underwriting standards at the time been properly imposed? The second question normally would be, is there anything about this risk that should have alerted us to its large loss potential? Instead of wrongly fixating on loss ratios, companies need to become much better at quantifying desired risk characteristics (prior to loss) and holding agencies responsible for delivering a desired flow.

Prior to the advent of the black box, agency loss ratio was a more accurate measurement of performance. With today’s technology using an agency loss ratio as a litmus test is a sacred cow past its prime that should be shipped to McDonald’s.

James Holm is a five-decade veteran of the insurance industry. Despite the tone of this article, his agency had one of its best years in 2014 in regards to the amount of profit-sharing income received. His remarks are reflective of overall trends in the industry rather than entirely personal circumstances. You can read more of his blogs at http://www.enhancedinsurance.com/

Ethics and Insurance

I started my career in 1970 in a management trainee program for the Continental Insurance Company of New York. The two-year course included classroom instruction in the Chicago office from the corporation’s top management in the various departments.

Continental Insurance logo

As I recall, even though the course went into great detail with subject matter that ranged from a full day tour of Underwriter’s Laboratories to actual hands on boiler inspections, the material presented barely touched on ethics.

The education manager did tell us that our corporate objective was to meet the reasonable assumption for coverage by the insured. Of course, that was the legal theory in practice at that time and still is to some degree.

The education manager railed against Mayor Daly’s actions when the McCormick Place burned. According to him the huge convention center should have been a partial loss of about 10%. He said the Mayor condemned it based on political reasons and rolled the bulldozers before objections could be launched. He said it very quietly, because such words criticizing “Hizzoner” were considered treason in Chicago in the early 1970’s.

The VP of underwriting for farm, who was the head of underwriting for the nation, spoke to us for over an hour about the ethical considerations of farm underwriting. He said that when a fire occurred the difference between a small fire and a total loss often came down to whether the farmer walked or ran to his phone to call for help. He said that if the farm was prosperous he would likely run.

He never once spoke to the ethics of the underwriters on his own staff. He seemingly just assumed they would “do the right thing”.

It seemed like ethics were considered a given, at that time.

Shortly after we went through the course, I heard about an underwriter in the Chicago office who “issued” a phony policy to one of the large downtown Chicago hotels. The underwriter, and a small number of co-conspirators collected and pocketed the “premium”. They had written the policy on the $30 million hotel with a $100,000 deductible and assumed there would be no losses. Unfortunately for them, a $3 million fire occurred.

That was the first time that I realized that insurance employees did bad things.

About that same time a theatre burned to the ground in a small town in southern Minnesota. The agent in that town wrote nearly every large business in his town with The Continental. The Continental was the largest fire company in the U.S. at that time. The agent had “bound” the business verbally the day before the fire. I was traveling with the Special Agent (field rep) for that territory as the last lap of my training. We were working out of the Minneapolis branch.

About ten people in the branch, the manager, production superintendent, several key underwriters, the claim manager and several field people met after hours and constructed an underwriting file to send to the home office. The file was duly date stamped to make it appear it had been handled properly, and in a timely fashion, so that the $250,000 loss could be paid without fail.

I didn’t feel right about what was done that evening. I did understand that The Continental was the “logical carrier” and probably would be held for coverage by a court of law. But in my mind, the agent’s E&O should have responded. I was told the E&O carrier would subrogate against The Continental, so what we were doing was merely avoiding a lot of red tape and embarrassment for a good agent.

My first year in the field I was asked by one of my largest agents to help him back date coverage to cover a claim. I refused. He went around me to my superior who also refused. In the end, the agent cut back sharply on the business he placed through our company. In hindsight doing less business with an unscrupulous agent wasn’t a bad thing.

A few months later another agent asked me to fulfill the promise of an exclusive sales territory that my predecessor had “promised” to him. The agent was a bank president whose agency placed a great deal of crop/hail through our company. He wanted me to make him the only agent who could write crop/hail through us in his county. My predecessor had retired but stopped in our office quite often for coffee. He told me that not only had he not offered an exclusive, the subject had never come up.

I kick myself even to this day for not closing that agency for my company, because two years later that banker/agent handed us a $2 million loss under the bankers’ blanket bond. It seemed his dishonesty went beyond fabricating conversations.

Perhaps the first instance of corporate ethics that hit home for me was on the last day of our training. We were having a few congratulatory beers when one of the home office people asked me what I thought of the education manager. I can remember telling him that I thought the manager was quite sharp, maybe too sharp for the position he held. It was explained to me that he had recently been demoted from a fast track to the CEO office. His son had broken into a draft board and burned records. His corporate career was essentially over. I’ve often wondered about that home office decision.

Over the years I’ve seen dozens of occasions when ethics were challenged and found wanting. So much so that it appears that maybe we all should take a moment to think about how we make ethical determinations.

Years ago I was introduced to a process for determining whether or not a considered action passed the test of ethics.

  1. Define the problem. If you can’t reduce the problem to a one-sentence statement, perhaps it is more about unresolved personal issues than a real business problem.
  1. Consider alternatives. Once you have a comprehensive list, you might be able to eliminate those alternatives that present ethical problems immediately. Make sure your alternatives are legal and meet the standards and rules you work under.
  1. Establish a list of the stakeholders, who will be impacted by your actions.
  1. Determine how each stakeholder will be impacted by your action and assign a score for each stakeholder on a scale of one to ten with one being very poor and ten being excellent.
  1. If your average score is less than seven you need to consider other alternative actions.

If all else fails use the “mom” test. Many people say if you would not be embarrassed to have your mother read about your actions in the local paper, it probably is ethical.

James Holm

The Federal Insurance Office (FIO)

Word came out of Washington this week that the Federal Insurance Office (FIO) is looking to establish the government’s definition of “affordability” of private passenger auto insurance. The Dodd-Frank Law gave the government authority to bark up this tree.

When I hear “government” and “insurance” in the same sentence my warning bells go off.

I don’t have a firm position on whether the federal government would be a better regulator than individual states. It would seem the opportunity for stupidity would be just as pervasive on either level.

The FIO stated that auto liability is mandatory in all states except New Hampshire, and that owning an automobile is likely associated with a higher probability of employment and other factors associated with economic wellbeing.

They went on to say that, “personal auto insurance may be interpreted as affordable if it is actually purchased by individuals and/or families.”

It might be that the FIO is looking for an issue in order to assert that there’s “trouble, trouble, trouble” that only federal regulation can fix.

Or, even worse, it could be the FIO is looking to start down the road toward a federal private passenger auto insurance program.

They have a ready partner in consumer lobbyist Bob Hunter who has made a career out of misinterpreting numbers in order to be the Professor Harold Hill of our industry. His latest quote is a gem.

“With millions of low- and moderate-income Americans struggling to afford state-required auto insurance and insurers constantly adding new highly questionable factors like education, occupation and elasticity of demand that drive up the cost to those least able to afford coverage, FIO’s interest is not only necessary, it is urgent.”

It’s safe to say that Mr. Hunter has yet to meet a free enterprise driven market that he likes. “Insurance” might not rhyme with “T” but our nation’s capitol is looking for “trouble” and Mr. Hunter would seemingly like to be at the front of that parade.

I’ll agree that education might not be the strongest proxy variable for a responsible insured, but I’ll defend forever an insurance company’s right to decide under what circumstances they will establish their rates and underwriting criteria.

I would love to ask Mr. Hunter, at one of those hearings he loves to populate, what percentage of the current 14% uninsured autos would buy insurance if their rate were cut in half. My guess would be under 25% would buy the reduced-cost coverage, leaving the uninsured number still north of 10%.

I would love to ask him if he thought maybe stronger enforcement of the laws requiring auto insurance might not be a better first step?

Did you ever have an upset stomach sending you the false message that if you would just eat more your pains would go away? I wonder if D.C. isn’t going through something like that. Could it be they think the answer to the Obamacare-rollout cramps is another hardy meal of boondoogle?

James Holm