A memorandum released last week by Florida Insurance Commissioner Kevin McCarty warning insurers in the state not to use price optimization in rating has gotten cheers from a consumer advocate group and jeers from an insurance industry trade association that says the definition of the practice used is too vague.
The memo, released May 14 by the Florida Office of Insurance Regulation (OIR), was addressed to all property/casualty insurers authorized to do business in Florida to “emphasize the requirements of the Florida Insurance Code in connection with insurers’ use or potential use of price optimization in determining policyholder premiums.”
McCarty cited Florida insurance statutes that says OIR is required to review a rate filing to determine if a rate is excessive, inadequate, or unfairly discriminatory in accordance with “generally accepted and reasonable actuarial techniques.”
Further, McCarty wrote, the law also provides that a rate shall be deemed unfairly discriminatory as to a risk or group of risks if the application of premium discounts, credits, or surcharges among such risks does not bear a reasonable relationship to the expected loss and expense experience among the various risks.
Price optimization introduces information such as supply and demand or competition into the rating of policyholders. The practice took center stage late last year when the Consumer Federation of America (CFA) charged that insurance giant Allstate was basing auto insurance premiums on the “marketplace considerations” factor.
The CFA stated at the time that it had “clear evidence” that Allstate and other insurers were using the practice to increase profits by raising premiums on individuals who are unlikely to shop around to find a better price. CFA said that price optimization is “unrelated to risk to set rate for a particular insured.”
The topic has become a controversial one in the months since CFA’s report. So much so that the National Association of Insurance Commissioners’ (NAIC) Casualty Actuarial and Statistical Task Force began to examine the practice and is currently working on a white paper on the subject.
“Insurers that have used price optimization in the determination of rates filed and currently in effect should submit a filing to eliminate that use,” wrote Florida Commissioner McCarty in the May 14 memo. “Insurers should ensure that any filings subsequent to the date of this memorandum do not utilize price optimization in any manner.”
The problem with McCarty’s warning, says Alex Hageli, director of Personal Lines Policy for the Property Casualty Insurers Association of America (PCI), is Florida’s definition of price optimization isn’t clear, and, as such, the regulator’s assessment could be unnecessarily punitive to insurers and policyholders in the state.
“We are concerned that [the definition] is vague and very broad and may implicate some rating practices that are beneficial to policyholders,” he said.
McCarty acknowledged in the memo that price optimization does not have a universally recognized definition, but offered Florida’s definition:
“In a regulated insurance context and for the purpose of this informational memorandum, price optimization is a process for modifying the insurance premium that would otherwise be charged to an insured or class of insureds in order to maximize insurer retention, profitability, written premium, market share, or any combination of these while remaining within real world constraints. Price optimization utilizes the economic concept of ‘price elasticity of demand,’ which is a measure of the responsiveness of the quantity of a good or service purchased to a change in its price.”
Hageli said that the vagueness of the memo may cause some insurers to limit their use of other pricing practices that benefit consumers, such as price tempering, in which insurers gradually implement substantial but actuarially justified rate increases in order to mitigate the impact on policyholders, which he says is often times at the behest of regulators.
Based on the memo’s definition of price optimization, this practice could be impacted Hageli said. “The industry defines price optimization rather broadly whereas regulators seem primarily concerned about price elasticity. We share their concerns in that regard, but just worry that the language they are using does not fully account for how the industry defines price optimization.”