By David Cummings
As predictive analytics continues to reshape property/casualty insurance ratemaking, the pricing sophistication among leading carriers has created a growing divide between the “haves” and “have nots.” Increasingly, many lagging insurers are trying to bridge the gap by parroting the rate structures of industry leaders.
While imitation is the sincerest form of flattery, it’s also easy to understand why an insurer with a less sophisticated rate structure might see parroting as a quick and easy way to improve its competitive position. After all, because of rate regulation, competitors’ price information is a matter of public record. To develop its own pricing enhancements, a lagging insurer would have to invest significant resources, including data and analytical expertise that it might not have.
By emulating a leading carrier, the insurer seems assured of a competitive pricing position without committing the up-front resources needed to develop and implement a new rate plan. But there are significant costs and considerable business risks to adopting a rate-copying strategy.
Rate filings may be publicly available, but that doesn’t mean they’re free. An insurer that decides to emulate rates will need to build a copying infrastructure and incur many costs to do so. There are expenses involved in obtaining rate filings and monitoring them for updates. But the most significant costs come from interpreting the filings and compiling them in a form that the copying carrier can use.
Even in the most concentrated markets, multiple leading carriers struggle against each other to gain market share. Mimicking only one can leave the copying carrier vulnerable.
The leading carriers are fully aware that parrots are out there, but they certainly aren’t interested in making their filings easy to use. These days, they don’t even have to try very hard to make things difficult because rating plans are becoming increasingly complex. As a result, it takes considerable effort to import, assemble, and restructure the elements of a rate plan for it to be operational in a copied rating system. The copying insurer must expend considerable time and effort for each state the insurer writes in. In the end, many people and systems are required to make parroting possible.
Even if a company successfully cracks the code and accurately assembles information from the filing, it will often miss some elements. Pieces of the leading competitor’s rate plan may be considered confidential and not available to the public. For example, the details of tiering plans and company placement guidelines are not filed or made public in many states. The laws in certain states specifically protect proprietary credit-based insurance scores from public disclosure. A filing may show how much the leading carrier will charge a risk with an insurance score of 750, but the copying carrier has no information about why the risk has that score. That makes it difficult, if not impossible, to replicate that portion of the rating plan.
The price-parroting strategy can also create an incomplete view of the insurer’s market position. When a company decides to copy, it inherently narrows its focus to one competitor. The costs are simply too high to focus on multiple competitors. That means the copying carrier may not be aware of what other carriers are doing. Even in the most concentrated markets, multiple leading carriers struggle against each other to gain market share. Mimicking only one can leave the copying carrier vulnerable.
A former underwriting executive told me of a time he was pressured to simply copy a leading carrier’s rates. He responded, “Are we also going to copy that carrier’s claims handling infrastructure, their claim settlement practices, their underwriting costs, their agency compensation plan, and their target markets? If not, then it doesn’t make sense to copy their rates.” This executive recognized that the copying strategy would have exposed his company to one of the most deadly business risks in insurance, namely, pricing risk — the risk that rates do not match the costs to provide insurance coverage.
Insurers cannot afford to let competitive pressures divert focus from understanding their own costs and managing both expenses and revenues to accomplish strategic goals.
By replicating rates, the copying carrier implicitly infers that its cost structure will mimic the costs assumed in those rates. However, costs between two companies may differ significantly in a variety of ways. It’s almost impossible for an outsider to know enough about a competitor’s cost structure to make adequate comparisons. As a result, by adopting a competitor’s rate plan, the copying carrier may not be collecting enough premium to cover its actual costs.
Besides, a carrier’s rates reflect much more than cost structure. They also represent numerous market-based decisions relating to issues as diverse as target marketing, agency relationships, and the balance between attracting new customers and retaining existing customers. By adopting a competitor’s rates, the copying carrier adopts a host of strategic business decisions without participating in the decision-making process at all. If the copying carrier’s strategies don’t line up with what the competitor had in mind, the result may be an even greater mismatch between revenue and costs. It’s a risky bet.
The ratemaking process provides an essential feedback loop for a company to examine both its costs and its revenues. As actuaries review rates, they can examine how claims and operating costs are trending and provide important information to company management. But if a company adopts a parroting strategy, its actuaries may spend more time understanding the competitor’s rates than examining the company’s own costs. The flow of cost trend information may lessen or slow, weakening management’s ability to monitor development of adverse trends.
The way to mitigate pricing risk is to be constantly aware of costs and how premiums relate to them. Insurers cannot afford to let competitive pressures divert focus from understanding their own costs and managing both expenses and revenues to accomplish strategic goals. Companies increasingly have better access to data and analysis that can bring sharper insight concerning cost and revenue drivers. Many companies have already invested in improving their data marts and the reporting tools that provide critical information about internal operating costs, but those tools may still be underused.
When it comes to predictive modeling, companies can supplement their own analyses of loss experience with sophisticated new predictive analyses of industry loss data. In doing so, they gain better understanding of loss costs and enhanced rate segmentation — without exposing themselves to the costs and risks of a price parroting strategy. Polly may want a cracker, but without a way to find it, that parrot may wind up only with crumbs.
David Cummings, FCAS, CPCU, is senior vice president of Personal Lines and Analytics at ISO.