Price Optimization

Question 1

What is the main focus of this paper?

Answer 1

personal lines pricing
- IDs pros and cons of PO

Question 2

Actuarial Judgement vs Price Optimization

Answer 2

-these are distinct concepts
-PO takes a data-based approach to judgements actuaries have always been making but now apply them @ more granular level (individual vs class)

Question 3

Why does the CFA say PO generates unfairly discriminatory rates?

Answer 3

o Unfairly discriminatory because often low demand elasticity consumers are low-income
 Also can charge identical risks different rates

Question 4

What does “unfairly discriminatory” mean exactly?

Answer 4

“They exist if after allowing for practical limitations, price differentials fail to equitably reflect the differences in expected losses and expenses”

Question 5

Briefly describe the four principles of ratemaking as defined by the CAS.

Answer 5

o (1) – A rate is an estimate of the expected value of future costs.
o (2) – A rate provides for all costs associated with the transfer of risk.
o (3) – A rate provides for the costs associated with an individual risk transfer.
o (4) – A rate is reasonable and not excessive, inadequate, or unfairly discriminatory if it is an actuarially sound estimate of the expected value of all future costs associated with an individual risk transfer.

Question 6

Briefly describe the three forms of price optimization.

Answer 6

o Ratebook Optimization – adjust current factors
o Individual Optimization – model based on cost and demand
o Hybrid Optimization – create new factors based on demand model

Question 7

Briefly describe the key differences between price optimization and traditional ratemaking.

Answer 7

o Adjustments are qualitative vs qualitative and quantitative
o Basis for adjustments is insurer judgement vs automatic, systematic analysis (modeling)

Question 8

What have been some regulatory responses to PO?

Answer 8

• Constraints may be needed even if requirements are met
• Some regulators have defined PO and issued bulletins prohibiting it
• Some believe state laws are sufficient and issue no bulletin
• Some states have never received a filing including PO usage

Question 9

Describe constraints regulators can impose on price optimization.

Answer 9

 Might require rate be between current and indicated rate
 Might require selected rating factors to be within current and indicated, or within a certain confidence interval, or directionally consistent
 Might limit certain variables
 Might require only apply to a class at least size x
 Might require adjustments to rating factors must produce rates that maintain cost-based differences

Question 10

How can regulators enhance the filing requirements of PO?

Answer 10

 Is it a point estimate or confidence interval?
 Consider requiring disclosure of non-cost based rate adjustments
 Is PO used?
 Disclosures of differences in prices with identical risk profiles
 Report showing distribution of ELRs under current vs proposed (histogram with 2 series)
- If proposed distribution is wider, could be additional subsidies
 Disclose all data sources, rating factors, models, risk classifications
 Disclosures of what factors are affected by PO, size of impact, cumulative impact of PO across all rating factors
 Actuary certifies all non-cost based considerations are documented

Question 11

According to the CASTF, what pieces of PO violate the not unfairly discriminatory requirement?

Answer 11

 Price elasticity of demand
 Propensity to shop around
 Retention adjustment @ individual level
 Policyholders’ propensity to ask qs / file complaints

Question 12

Final 3 recommendations of the CASTF

Answer 12

 Consider issuing bulletin for non-cost based methods
 Consider enhancing filing requirements
 Analyze models filed to ensure they comply with state law and ASOPs