A new paper from Triple-I says that risk-based pricing allows insurers to offer the lowest premiums to policyholders with the most-favourable risk factors.
The paper, Trends and Insights: Risk-Based Pricing of Insurance, states that risk-based pricing also allows insurers to offer higher premiums for less-favourable risks. Triple-I said in the report that while such a model seems ‘a fundamental concept’, misunderstandings ‘regularly sow confusion’.
It wrote: “This concept becomes complicated when actuarially sound rating factors intersect with other attributes in ways that can be perceived as unfairly discriminatory. For example, concerns have been raised about the use of credit-based insurance scores, geography, home ownership, and motor vehicle records in setting home and car insurance premium rates. Critics say this can lead to ‘proxy discrimination’, with people of colour in urban neighbourhoods sometimes charged more than their suburban neighbours for the same coverage.”
The paper refers to the US state of New Jersey, which implemented risk-based pricing. It says, in 2002, that four of the six largest insurers did not do business in the state, with the country’s largest insurer saying it was leaving. Alongside this, it says that 80% of drivers subsidised bad drivers.
Holly Bakke, the former banking and insurance commissioner for New Jersey, is quoted as writing last year: “The Legislature replaced an outdated system with a competitive one that protected consumers. In short order, over $170m was returned to drivers in the form of refunds and price reductions. Today, there are over 70 auto insurers competing for New Jersey drivers, and the percentage of uninsured drivers is the lowest in the country.”
Now, Triple-I is saying that risk-based pricing has many benefits, including the accurate reflection of risk, aligning the premiums paid with risk assumed, expanding the availability of coverage, and promoting a competitive marketplace.
It added: “The risk-based pricing concept also incorporates actuarially sound rating factors such as credit-based insurance scores, geography, home ownership and motor vehicle records. These variables improve the accuracy of insurance prices for auto and homeowners insurance.”
The Brief also addressed concerns regarding the use of gender as a rating factor. Six states currently ban insurers from using gender as a factor when pricing personal auto insurance. Gender and age have long been reliable predictors of the likelihood a prospective policyholder will file an auto insurance claim. Denying insurers access to actuarially sound rating tools would force them to price risk less precisely, causing lower-risk drivers to subsidize the riskiest ones, Triple-I noted.
Dale Porfilio, chief insurance officer of Triple-I, said: “There is no place in today’s insurance market for unfair discrimination. In addition to being illegal, discrimination based on any factor that doesn’t directly affect the insured risk would be bad business in today’s diverse society.”
