Vermont Regulators Issue Bulletin on Price Optimization

Vermont regulators recently issued a bulletin addressing the issue of price optimization in personal lines ratemaking, warning insurers that adjustments to rates may not be based on non-risk-related factors.

The Vermont Department of Financial Regulation (DFR) Insurance Bulletin No. 186 (“Price Optimization in Personal Lines Ratemaking”) was issued on June 24 and is applicable for all property/casualty insurers issuing personal lines policies in Vermont.

In the bulletin, DFR noted that some property/casualty insurers have been “relying upon the practice of price optimization” to help determine the rates that they would charge to policyholders.

DFR said the National Association of Insurance Commissioners’ (NAIC) Casualty Actuarial and Statistical (C) Task Force is currently in the process of drafting a “white paper” analyzing price optimization and its use in insurance ratemaking.

And while there is no universally-accepted definition of price optimization, the practice, in some of its applications, involves “the judgmental use of factors not specifically related to a policyholder’s risk profile to help determine or adjust his or her insurance premium,” DFR said.

An example would be examining a policyholder’s response to previous rate increases to determine how much of a rate hike the policyholder would tolerate at renewal before engaging in comparison shopping or switching to a different insurer.

This practice can result in two policyholders receiving different rate hikes even though they may have the same loss history and risk profile, DFR explained.

DFR reminded P/C insurers doing business in Vermont that all ratemaking must conform to the statutory requirements contained in Chapter 128 of Title 8 V.S.A.

“Specifically, insurers are reminded that, under Section 4685(d) of Title 8, unfair discrimination is considered to exist if price differentials ‘fail to reflect equitably the differences in expected losses and expenses’ for different classes of policyholders,” the bulletin noted. “In classifying policyholder risks for ratemaking purposes, insurers are allowed to use rating plans ‘which provide for recognition of probable variations in hazards, expenses, or both.'”

DFR pointed out that both base rates and rating classes must be based on factors specifically related to an insurer’s expected losses and expenses.

And while insurers may employ judgment in setting their rates, judgmental adjustments to a rate may not be based on non-risk-related factors such as price elasticity of demand, which seek to predict how much of a price hike a policyholder will tolerate before switching to a different insurer, DFR noted.

“The use of such factors not only unfairly discriminates between policyholders of the same risk profile, but is also directly in conflict with the statutory principles that underlie Vermont’s ‘open and competitive’ property and casualty marketplace,” the bulletin said.

DFR said that to help identify the possible use of inappropriate rating factors, henceforth all personal lines rate filings must disclose on the SERFF general information page whether the company uses non-risk-related factors such as price elasticity of demand to help determine the insured’s final premium.

However, when asked if DFR is specifically prohibiting price optimization in personal lines insurance, a DFR spokesperson told Insurance Journal that the department “has not banned the use of price optimization” and that the bulletin “focuses narrowly on a pricing strategy called price elasticity of demand, which uses data to predict how much of a price increase a policyholder will tolerate before switching to a different insurer.”

“This practice not only unfairly discriminates between policyholders with the same risk profile, but also inhibits price competition between insurance companies,” the spokesperson said.

Consumer advocacy groups the Consumer Federation of America (CFA) and the Center for Economic Justice (CEJ) said in a statement that Vermont is the fifth state to formally address price optimization, following Florida, Maryland, Ohio and California, all of which have taken the further step of explicitly banning the practice within the past year.

“Most Americans are required by law to buy auto insurance and by their mortgage company to buy homeowners insurance, and it is terribly unfair and entirely illegal for insurance companies to vary premiums based on whether or not they are statistically likely to shop around,” the two groups stated.

The groups also urged regulators around the country to stop insurers from using price optimization.