Maryland Insurers Using ‘Price Optimization’ Ordered to File Corrective Action Plan

The Maryland Insurance Administration (MIA) issued a bulletin alerting insurers that the use of “price optimization” in Maryland is in violation of §27-212(e)(1) of the state’s Insurance Article.

MIA said it is requiring insurers that currently utilize price optimization to rate insurance policies in Maryland to file a corrective action plan with MIA by no later than Jan. 1, 2015.

MIA told Insurance Journal that “although the MIA is aware that at least some carriers’ rate filings have incorporated price optimization, we do not yet know the full extent of the practice.”

“Personal auto and homeowners appear to be the lines where the practice is most prevalent,” MIA said in a statement. “The practice also has been noted in some commercial property filings. The MIA will continue to scrutinize rate filings for unfairly discriminatory practices, including the use of price optimization.”

MIA has issued Bulletin 14-23 (Re: Unfair Discrimination in Rating: Price Optimization) on Oct. 31 to all property/casualty insurance companies in Maryland, rating organizations, Joint Insurance Association and the Maryland Automobile Insurance Fund.

“It has come to the attention of the Maryland Insurance Administration that some insurers are using ‘price optimization’ to rate insurance policies in Maryland,” the bulletin stated.

According to the bulletin, price optimization refers to the practice of varying rates based on factors other than the risk of loss — such as the likelihood that policyholders will renew their policies and the willingness of certain policyholders to pay higher premiums than other policyholders.

“The MIA has determined that the use of price optimization results in rates that are unfairly discriminatory in violation of the §27-212(e)(1) of the Insurance Article,” the bulletin stated. “As a result, insurers may not use price optimization to rate policies in Maryland.”

For purposes of the state’s Insurance Article, the Court of Appeals has defined unfair discrimination as “discrimination among insureds of the same class based on something other than actuarial risk, (Insurance Commissioner v. Engelman, 345 Md. 402, 413 – 1997),” according to the bulletin.

The purpose of price optimization is to move away from traditional cost-based rating to take advantage of consumers’ “price elasticity” in the market by charging the most that the market will bear without losing business.

“One of the ways that insurers use price optimization is to analyze patterns of behavior of policyholders to try to predict whether a policyholder is likely to switch to another insurer if the insurer increases premiums,” the bulletin stated.

“This may involve the use of a ‘retention model.’ If an insurer’s analysis indicates that a policyholder is likely to switch to another insurer, that policyholder will be charged a lower premium than a policyholder who is considered unlikely to switch to another insurer.”

The bulletin stated that, by way of example, one developer of price optimization models indicated that one of the characteristics it considers is “whether a policyholder has complained to the insurer.” If a policyholder has complained, this would indicate that the policyholder is unsatisfied and not likely to accept a premium increase. As a result — all other things being equal — this policyholder would be charged a lower premium than a policyholder who has not complained to the insurer.

This means that policyholders would be charged higher premiums simply because they have not complained to the insurer, regardless of whether these policyholders pose any more risk of loss than policyholders who have complained, according to the bulletin.

The bulletin cites one advocate of price optimization who said the research shows if P/C insurers adopt advanced pricing strategies that consider customer elasticity differences, they can boost their revenue by roughly 3 percent and returns-on-equity by 1 percent, on average.

Price optimization involves varying rates based on factors that are unrelated to risk of loss, such as price elasticity or the willingness of an insured to accept a premium increase, according to the bulletin, and “consequently, the use of price optimization may result in two insureds with like risk characteristics being charged different premiums, which is a violation of §27-212(e)(1) of the Insurance Article.”

Corrective Action Plan
The MIA said in the bulletin that it is requiring every insurer that currently utilizes price optimization to rate insurance policies in Maryland to file a corrective action plan with the MIA by no later than Jan. 1, 2015. An insurer should include in the corrective action plan the following information:

• the lines of business for which the insurer is using price optimization, a description of the manner in which the insurer is using price optimization, and the SERFF filing numbers of any rate and/or rule filings that contain price optimization;
• a description of the company’s proposed corrective action;
• a target date for making corrective rate and/or rule filings; and
• a target date for implementing the corrective rate and /or rule filings.

Source: The Maryland Insurance Administration