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How insurers can give their pricing models an added ‘sheen’

Why an insurance pricing model without a decision framework is like a half-painted room

Casualty|Insurance Consulting and Technology|Personal Lines|Property
Risk Culture

By Kiki Wang | April 27, 2021

More sophisticated models are only a part of an effective pricing strategy for personal lines insurers.

Most if not all leaders in personal lines insurance have realized the importance of analytics in determining the appropriate price for a risk. What has happened though, as Jeff Hay, chief underwriting officer at the Donegal Insurance Group, and I, recently explained to delegates at the Casualty Actuarial Society’s Ratemaking, Product and Modeling (RPM) virtual seminar, is that the race for pricing effectiveness in the marketplace has largely become a race for the most sophisticated pricing model.

What’s wrong with that? It’s not bad, but it is incomplete. An insightful model is only the primer for an effective pricing strategy. We’d equate it to only putting one coat of paint on a wall when it would really benefit from two.

Our contention is that, in today’s market, really sprucing up pricing practices also involves developing a complete and robust decision-making framework that supports making pricing modifications that align with product and underwriting strategies and current market conditions.

As we see it, such a framework starts with setting the right goals:

Understand costs

Insurance is unique in that the true cost of the product sold is unknown at the point of sale. Because insurance is a promise to compensate a policyholder in the event of an unknown insurable loss, it’s an analytical exercise to understand potential true costs.

That analytical exercise should be pure and unconstrained by business goals or regulation. The knowledge of the true cost to an individual carrier of providing the insurance product needs to be separate from, but sensitive to, other factors and judgments that may ultimately dictate price. For example, the potential ban on using credit scores in pricing personal lines insurance in some U.S. states doesn’t alter the fact that insurers’ costs vary by credit scores. Delegate polling found the market is split equally between those that do and don’t use unconstrained cost models.

Align with business strategy

With true costs estimated as accurately as possible, it’s time to consider business strategy and determine how rate changes or new rating plans will help deliver that strategy. For example, a growth strategy might require dramatically undercutting the competition, doing more business in a target market segment, reversing under-performance or, more likely, blending growth with profit improvement. Achieving a balance between growth and profit strategies relies on understanding relative performance at a granular level so that companies can recognize changes shift on a dime in targeted segments of the market.

Leverage key performance indicators (KPIs)

Leveraging KPIs helps to measure success objectively. Key points to address will include setting some starting benchmarks, monitoring performance as specifically as possible against the strategy (maybe growth based on conversion rate, for example), and determining a tolerance range for performance variance before action is needed.

Turning insights into action

Starting with the goals, the chart below summarizes our view of the components needed for a complete decision-making framework. It incorporates analytics to inform decisions throughout the entire pricing, product development and implementation process. Additionally, getting through implementation is not an end, but the start of actively monitoring how decisions impact the business and feeding relevant information to the next round of modeling and scenario testing. In fact, it is not about how sophisticated and complex the models are, but how to leverage the sophistication behind analytics to provide actionable insights and inform decisions.

Critically, turning analysis into meaningful and strategic action will also need consideration about how the operating model might need to be adjusted and how people are empowered to make decisions, the associated governance and the change management needed to create the right, supportive culture.

Decision-making framework for pricing strategy
Decision-making framework for pricing strategy
The typical insurer’s product strategy starts with modeling then involves scenario testing ultimately leading to market implementation and performance monitoring, which may loop back to the first step.

Bringing it all together

Clear objectives, business and analytics strategies that inform decision making, strong and relevant metrics, and an effective operating model on top of a decision framework – in today’s market these are attributes that should give an insurer’s pricing an added sheen.

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