6 | Emphasis 2008/1




PROPERTY/CASUALTY INSURANCE

OVERCOMING THE CHALLENGES OF CMA

Taking a sophisticated approach to ...
Emphasis 2008/1 | 7




                        Christopher W. Hurst is a consultant with Towers                          ...
8 | Emphasis 2008/1




 EXHIBIT 2
 Approaches to Competitive Analysis
                                                   ...
Emphasis 2008/1 | 9




 EXHIBIT 3
 Qualitative Analysis — Personal Auto Tier
                                            ...
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Competitive Market Analysis

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Competitive Market Analysis

  1. 1. 6 | Emphasis 2008/1 PROPERTY/CASUALTY INSURANCE 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 Performance Progressive 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 AIG insurers are continuing to push the envelope with innovative rating plan segmentation Nationwide State Farm Liberty Mutual and more complex statistical models that are not fully disclosed in rate filings. Rating Sophistication 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
  2. 2. 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 University. 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.
  3. 3. 8 | Emphasis 2008/1 EXHIBIT 2 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 target rates) 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 maximize company profitability 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 variables 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
  4. 4. Emphasis 2008/1 | 9 EXHIBIT 3 Qualitative Analysis — Personal Auto Tier Company 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 price points Tier factor spread* 2.00 8.63 1.50 4.25 Writing in multiple Yes Yes No No companies? *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 chris.hurst@towersperrin.com 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, kelleen.arquette@towersperrin.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 minimal.

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