6 | Emphasis 2008/1
OVERCOMING THE CHALLENGES OF CMA
Taking a sophisticated approach to assessing competitive position is becoming less of an
option and more of a business necessity in personal lines, despite the costs and other hurdles.
By Christopher W. Hurst and Kelleen D. Arquette
In the last decade, a revolution has occurred EXHIBIT 1
in the personal automobile and homeowners Competitive Landscape — Personal Auto
insurance marketplace. As insurers began
to leverage data mining and multivariate
pricing techniques to make better use of GEICO
the vast amount of information that is
available about their policyholders, they USAA
implemented more and more sophisticated Allstate
rating plans. Today’s leading insurers Travelers
typically have rating plans with several
thousand individual price points. These Rest of U.S. Farmers
insurers are continuing to push the envelope
with innovative rating plan segmentation Nationwide State Farm
and more complex statistical models that
are not fully disclosed in rate filings.
THE CHALLENGE Note: Size of bubble represents 2006 market share.
Leading insurers will continue to use data
mining as a tool to establish niche pricing that have an effective way of measuring cal and current rate-level changes of the
that will attract better-performing risks competitive position can incorporate this insurers’ selected competitors. While the
and send other risks to their competitors. information into price-setting processes, internal costs of maintaining such an
Exhibit 1 compares the sophistication along with cost-based pricing analysis, as approach are minimal, this approach does
(measured by number of price points and they attempt to maximize profitability not provide competitive position by segment
complexity of the rating structure) of across the spectrum of risks. The question since most companies do not disclose
leading personal auto insurers’ rating is how to best measure their competitive average rate-level changes by individual
plans with their performance over the last position by segment. segment of business. In addition, this is a
three years. (Performance measures a relative approach to understanding competi-
combination of market-share growth and MEASURING COMPETITIVE POSITION tive position. That is, monitoring competitor
combined ratio relative to the industry.) Insurers differ in their approaches to com- rate changes tells nothing of the competitive-
While some companies, like USAA and petitive analysis, ranging from simple to ness of the insurers’ rates being charged;
GEICO, have leveraged unique competi- very complex. Exhibit 2 on page 8 lists five it only provides insight as to how their
tive advantages gained through advertising possible approaches along with relative competitive position changes over time.
or niche marketing to achieve stronger costs, data sources, strengths and disad- For example, if the insurer discovers that
performance, those insurers with the most vantages. On the low end of the sophisti- competitor X has implemented a 5.0%
advanced rating plans typically have also cation spectrum are the approaches based rate-level increase, the insurer is still not
enjoyed the best results. on competitors’ rate changes and company able to make a direct comparison of average
statistics, while competitive market analy- premiums being charged.
In this complex and rapidly changing sis (CMA) is the most advanced.
environment, companies need to monitor Some insurers monitor competitive position
their competitive position by segment to Competitive Rate Changes and using their own company statistics. By
avoid adverse selection and negative com- Company Statistics monitoring figures such as close rates (the
pany profit performance, and to capitalize The approach based on competitors’ rate percentage of quotes converted to policies),
on price advantages. Further, insurers changes entails a simple review of histori- retention rates, new business production
Emphasis 2008/1 | 7
Christopher W. Hurst is a consultant with Towers Kelleen D. Arquette is a consultant with Towers
Perrin in St. Louis. He specializes in ratemaking, Perrin in Bloomington, Illinois. She specializes
rating plan design, competitive market analysis, in competitive market analysis, ratemaking,
and pricing strategy for personal and commercial reserving and predictive modeling for personal
lines, as well as reserving for warranty lines of lines. Mrs. Arquette is a Fellow of the Casualty
business. Mr. Hurst is a graduate of Northwestern Actuarial Society and a graduate of the
University and a Fellow of the Casualty Actuarial University of Idaho. She also has an M.S.
Society. in mathematics from Eastern Washington
and number of quotes over time, the insurer However, using a method with a handful Competitive Market Analysis
attempts to draw conclusions about changes of risk profiles has several limitations: CMA is the most direct and thorough
in its competitive position. The cost of such I It can be difficult to amalgamate the approach to measuring competitive position
an approach is generally low, assuming results to effectively assess competitive (see Emphasis 2007/2, “Competitive Market
that the insurer already has the data avail- position across the entire spectrum of the Analysis in Personal Lines”). Now in use
able. In fact, many do not, particularly by insurer’s target market. among a handful of leading companies, it
segment. involves using a batch-rating tool to calculate
I It restricts the insurer’s ability to identify rates for an insurer and selected competitors
Like the approach focusing on competitors’ emerging adverse selection or competitive for all current policies in a particular state.
rate changes, the use of company statistics price advantages. Alternatively, it can perform calculations
is a relative approach to measuring competi- I As the number of price variations for a significant number of target risks.
tive position. Additional discussion and included in the rating plans of leading
analysis would be necessary to determine insurers grows, it becomes even harder The result is a complete picture of the
the company’s internal targets for these to identify necessary pricing actions. effectiveness of a competitive pricing
figures and compare them to actual results position, down to each individual rating
over time. Further, a change in any of Qualitative Analysis segment. In addition, the output of a full
these statistics may not necessarily mean Some insurers opt for a qualitative analysis CMA (the insurer’s current premium and
that the company’s competitive pricing approach. This approach compares aspects the competitors’ premiums by segment)
position has worsened or improved. For of individual rating variables (number of can be effectively incorporated into a price
instance, a drop in retention rates may price points, interaction of the variable with optimization approach that balances com-
result from a change in claim settlement other variables, range of rating factors, petitive position, cost-based pricing and
practices or from negative publicity about etc.) of several selected competitors with expected customer retention (see “Price
the insurer. those of their own. An example summary of Optimization for Innovative Insurers” in
such an approach for the personal auto tier this issue).
Market Basket Approach variable is shown in Exhibit 3 on page 9.
A more sophisticated approach to compet- CHALLENGES IN MEASURING
itive analysis is the market basket approach. This approach allows the insurer to acquire COMPETITIVE POSITION
Many insurers use this method, which the most information about its competitive Although the most comprehensive and
worked well before the explosion in rating position without calculating premiums. It most effective, numerous challenges have
plan sophistication. In this method, insur- can identify strengths and weaknesses of to be overcome to develop a reliable CMA.
ers select a handful of target risk profiles the insurer’s rating plan in relation to select Some of these obstacles also apply to any
and then use either internal or external competitors. While it does not provide any approach to measuring competitive position.
comparative rater tools that will calculate insight into the effectiveness of the com-
competitor premiums by coverage. Some petitor’s rating plan, qualitative analysis Company Selection
comparative rater tools also allow an option can identify the conditions under which In an effort to minimize customer disrup-
to vary the target risk profiles across certain possible adverse selection may occur, tion, many insurers have closed existing
variables (e.g., ZIP code) to increase the indicating a need to act. The most signifi- companies to new business and implemented
number of rate variations being compared. cant challenge is the potential difficulty their next-generation rating plans in a new
This approach provides the benefit of in obtaining the information necessary to company. When an insurer has business
being an absolute measure of competitive do a complete analysis (e.g., details about in multiple companies, it becomes more
position by isolating the analysis to the competitor credit-scoring or tiering models). difficult to determine which companies
current rates being charged. to include in the competitive analysis.
8 | Emphasis 2008/1
Approaches to Competitive Analysis
Level of Sophistication
LOW MEDIUM HIGH
Competitor Company Market Qualitative Competitive
Rate Changes Statistics Basket Analysis Market Analysis
Cost(s) $ $ – $$$ $$ $$$ $$$$
Data Competitive filings Retention rates Competitor manuals Competitor manuals Comparative rating tool
sources Agent feedback Production Agent/employee and filings Company data
DOI Web sites Conversion rates feedback DOI Web sites Competitor manuals and
Industry publications Comparative rating tool filings
(for development of DOI Web sites
Benefits Data relatively Data may already Provides competitive Complete view of rating Comprehensive view of
easy to acquire be available position for selected plan segmentation competitive position by
Easy to reproduce risks Provides additional each rating segment
on a regular basis Isolates the competitive direction for internal Output can be incorporated
price position pricing analysis into pricing strategy to
Disadvan- Relative measure Need to determine Limited view of Ignores effectiveness Accuracy of comparative
tages Lack of information target measures current position of rating plan raters
by segment Other influences Requires application Competitor information Need to develop tiering
may impact statistics of judgment may not be easily alignment strategy
Ignores emerging available Must develop distribution
adverse selection assumptions for unused
Input Data selected competitors are programmed into tier for one insurer aligns to the highest-
With the CMA or market basket approaches, the vendor’s software. Does the software rated tier for another insurer. For example,
a database of policies needs to be created, support batch rating thousands of policies if Company A has 10 tiers, with Tier 10
with information on either hypothetical or in a timely fashion? Does the platform being the highest rated, and Company B
actual risks written by the insurer. Using accurately perform various aspects of rating has 20 tiers, with Tier 20 being the high-
actual written policies introduces a bias such as driver assignment, territory assign- est rated, then Company A’s Tier 10 is
to the analysis as, presumably, the insurer ment and tier alignment? What processes aligned with Company B’s Tiers 19 and 20.
has a general competitive price advantage does the vendor have in place to ensure More often than not, an insurer’s actual
on those policies it has already written. accurate results? What types of training and tier distribution is far from uniform. A
A basket of all risks that have obtained a support services does the vendor provide? uniform approach to tier alignment also
quote from the insurer may better represent does not consider the target market of
the target market of the insurer. However, Insurance Score/Tier Alignment each insurer. If Company A only targets
the insurer may not collect information As insurers have started to use credit char- preferred risks and Company B writes
about quotes not converted into new busi- acteristics in pricing, how they use tiers has policies on a spectrum of risks, then
ness policies. The insurer may then need often become difficult to replicate. In addi- the tier alignment is further lacking in
to develop a set of theoretical risks such tion, the industry uses a wide variety of credibility.
that the resulting database represents the credit-based insurance scoring models.
target market. Generally, vendors providing comparative In today’s environment, tier alignment is
rating software have taken a simplified usually the greatest challenge in competi-
Comparative Rater approach to determining which tiers from tive analysis. Without a reasonable tier
Premiums may be generated using an in- various insurers are comparable when rating alignment strategy, the analysis will likely
house comparative rating system or by a particular policy. This leaves the option of yield misleading results. If a market basket
purchasing a tool from an external vendor. more complex tier alignment to the user. or CMA approach is selected, an alterna-
In selecting an external vendor, the insurer tive to simple vendor alignment strategies
must determine whether the rates for the Some vendors assume not only that the should be considered.
distribution by tier is uniform for each
competitor, but also that the highest-rated
Emphasis 2008/1 | 9
Qualitative Analysis — Personal Auto Tier
Tier XYZ Company Competitor A Competitor B Competitor C
Underwriting tier variables Age of driver, at-fault and Number of years Prior bodily injury limits, Not-at-fault accidents,
not-at-fault accidents, with prior carrier, number of years minor violations, historical
minor violations home ownership with prior carrier lapse in coverage
Number of underwriting tiers 4 10 22 12
Credit-based insurance External vendor Company-developed External vendor External vendor
score model model #1 model model #1 model #2
Number of credit tiers 6 22 30 25
Total number of tiers 10 32 52 37
Number of unique tier
10 12 40 31
Tier factor spread* 2.00 8.63 1.50 4.25
Writing in multiple
Yes Yes No No
*Highest tier factor divided by lowest tier factor
Missing Internal Data on MANAGING INTERNAL COSTS WHY TAKE THE CHALLENGE?
Key Rating Variables ASSOCIATED WITH COMPETITIVE The benefits of a more rigorous approach
Tier will likely not be the only rating ANALYSIS to competitive analysis are numerous.
variable for which a creative approach is Moving from a simple approach to a Profitability can be maximized by including
needed. With the introduction of new and more comprehensive competitive analysis competitor prices, along with loss-cost
innovative rating variables by competitors, requires additional resources and time. In indications and expected retention in set-
there may be variables for which data are addition, incorporating the results of a ting prices by segment. Insurers can also
currently not collected. Further, internal CMA into a price optimization framework better prioritize the implementation of
data may be available, but not accurate. requires skills in advanced statistical needed rating plan changes and be more
What assumptions about expected risk analysis and predictive modeling that may informed when communicating with their
distributions can be made so that a specific not be available in pricing departments. sales force.
competitor’s rating variable is applied in
a reasonable way? Perhaps a combination Beyond the costs of attracting and retain- Those insurers that are first to adopt a
of existing variables can serve as a proxy ing the necessary talent, there are costs cost-effective and comprehensive approach
for the new variable. External sources of for subscriptions to comparative rating to CMA and incorporate it into their pric-
information may be helpful in deciding software or for continual maintenance of ing strategy will improve their chances
when to apply the variable. an internally developed comparative rater. of realizing market-leading, profitable
Competitor manuals must be obtained growth. It is only a matter of time before
Validation of Generated Premiums and programmed. However, costs can be other companies begin to adopt similar
Validation of results should be a key part managed by focusing initial CMA efforts approaches. It pays to get ahead and stay
of any competitive analysis, particularly in a few key states or by limiting the ahead with this important analytical tool.
one that relies on output from an external analysis to selected competitors.
comparative rater. From a detailed view For comments or questions, call or e-mail
of the software output, premiums for indi- As competitors leverage the insight gained Christopher W. Hurst at 1-314-719-5846,
vidual policies may be hand-rated to ensure from a more sophisticated competitive firstname.lastname@example.org or
accuracy of the rating tool and appropri- analysis, those left behind risk additional Kelleen D. Arquette at 1-309-828-8351,
ateness of the input data. Additionally, adverse selection, deteriorating profitability, email@example.com.
external competitor information can be and decreased retention. Compared to the
gathered to verify that the results generated costs of not pursuing an effective compet-
by the software are reasonable. itive pricing strategy, the expense of
establishing and maintaining a CMA is