By Raj Bhat
In 2010, rating error reduced premium revenue in the private passenger auto insurance industry by $15.4 billion. The reduced revenue was essentially a multibillion-dollar industry "donation" handed directly to policyholders. Premium rating error represents 9.4 percent of a total $164.1 billion in personal auto written premium. Without action, insurers will continue to lose billions more over the coming years — all because of premium leakage that could be stemmed if appropriate steps are taken.
The year 2010 saw a slight decrease in auto premium leakage compared with 2008. While ample evidence shows that people, on average, drove somewhat more in 2010, the overall mileage increase in driving obscures the fact that a segment of the population drove appreciably less because of job losses and tough economic times. Inaccurate mileage assessment is one of many factors that cause premium leakage. Addressing premium leakage across all rating factors can make a considerable difference — in many cases reducing the auto underwriting ratio by as much as three percentage points.
For individual carriers, reducing rating error is a significant opportunity for profit gains. A reduction in auto rating error directly affects the bottom line. In a small-margin business where an individual carrier might have average profits of 5 percent of premium in a good year, adding 1 or 2 percent of loss-free premium can make a substantial difference to an auto writer's combined ratio.
Conversely, unchecked rating error leads to failures in risk management. As an example, policies with unrated 16-year-old male drivers in the household experience an average loss ratio of more than 200 percent.
All stages of the underwriting cycle are susceptible to rating error: sales, risk analysis, policy servicing, and renewal. While significant error occurs at initial application, analysis shows that most rating errors — and massive premium leakage — arise from changes in rating data for a policyholder over time.
How to Reduce Premium Leakage
On average, after initial policy screening, 82 percent of audits uncover policies lacking enough premium to cover the intended risk. By effectively identifying errors in rating data, carriers can take the steps necessary to correct costly errors and restore profitability to their book of auto policies.
Auto insurers can prevent premium leakage by leveraging data and advances in analytic and decision-support methodologies. Those tools address the new dynamics of America — changes in jobs, location, life circumstances, and so forth. Through accurate rating, insurers can reduce premium leakage and increase profits. The following steps show how.
Step 1: Get it right at the point of sale
To ensure rating integrity and limit premium leakage, insurers need to employ available technologies and conduct sophisticated data analyses. All new business should undergo this process, in real time, from an agent's or customer service representative's desktop. Numerous rating variables also require new-business audit checks to identify potential rating errors.
Audit checks should verify:
With additional analytic tools such as pattern analysis and statistical algorithms, insurers can flag questionable policyholder information for a variety of findings, including:
Step 2: Get it right at renewal
Even if a policy undergoes careful analysis at initial application, there is a significant likelihood that changes in everyday life will create a different risk profile over time. Changes in marital status, job changes, new cars, new houses, and "new" 16-year-olds all create very different risks. Annual review of renewal policies can keep insurers on top of those changes.
The renewal process is similar to the new-business review but should be more in-depth. Intelligent reviews would identify only those policies that have a high likelihood of changes to rating elements. Once those policies are identified, insurers should employ an efficient and effective validation program.
The policyholder contact strategy should be comfortable yet comprehensive. To achieve optimal household contact, today's active policyholders also need multiple response options, most important of which is the Internet. With this strategy, it's possible to achieve customer contact rates of more than 80 percent.
Contact is important not only for securing customer acknowledgment of rating variable changes but also for improving the overall customer insurance experience. Far too often, a policyholder's only contact with his or her insurance company is the annual or semiannual invoice. An annual "checkup" call or contact goes a long way toward maintaining a positive — and long-term — company-policyholder relationship.
Step 3: Develop a long-term approach
Once an insurer has completed steps one and two — and cleaned up its auto book of business — a baseline of accurate information exists to enable regular maintenance of a premium leakage program. The baseline will help enable affordable rating integrity effectiveness for the future. The key is to avoid lapses that could allow rating error to creep back in. Studies show that changes made during reunderwriting have an average life span of two to three years. That means there is substantial lifetime value in a rating integrity program that goes far beyond the first-year cost of execution.
The bottom line is that a great deal of time and effort goes into a one-year cleanup. However, significantly less time and effort are required to keep an auto book clean. Smart companies realize the advantages and have integrated rating integrity into their policy renewal process.
Dr. Raj Bhat is president of Quality Planning, which provides tools and services that help auto insurers identify rating errors, recover lost premium, and minimize future losses.