1. ONE YEAR EXECUTIVE POST GRADUATE PROGRAMME 2009-10
Pricing in Insurance Industry
Submitted By: Group II
 Rachit Bhagat
Instructor : Prof. Vinaysingh Chawan
 Rajendra Inani
 Shashank Bhansali
 Vishal Sharma

2. Table of Contents
1 Current Scenario in Insurance Pricing ............................................................................................. 3
2 Perceptions about Health Insurance in India .................................................................................. 4
2.1 Ease of claims disbursement................................................................................................... 4
2.2 Increased hospital network coverage ..................................................................................... 4
2.3 Product Innovation ................................................................................................................. 4
2.3.1 Long term policies ........................................................................................................... 4
2.3.2 Simple policy documents ................................................................................................ 4
2.4 Pricing Innovation ................................................................................................................... 4
2.5 Regular benefits to insurance holders .................................................................................... 4
3 Pricing Strategies in the industry .................................................................................................... 5
3.1 Applicable Principles in Costing Process ................................................................................. 5
3.2 Risks considered in Costing of Insurance Policies ................................................................... 5
3.3 Product Development and Costing Process ............................................................................ 6
4 The Pricing Models – The building blocks of price optimization .................................................... 7
4.1 Claim Propensity Models ........................................................................................................ 7
4.2 Market Situation Models ........................................................................................................ 8
4.3 Customer Behaviour Models .................................................................................................. 9
5 The Revolution in Insurance ........................................................................................................... 9
6 Recommendations and Conclusion .............................................................................................. 10
7 Appendix ....................................................................................................................................... 11
7.1 Current price Rates of Insurance policies and Industry ........................................................ 11
7.2 Comparison of Price Rates in Industry .................................................................................. 12
7.3 Market Segments and what customers are looking for in insurance ................................... 12
7.4 Predictive Models Support Price Optimization..................................................................... 13
7.5 Elasticity of Demand in Insurance — Measuring Renewals by Price Changes ..................... 13
7.6 Measuring the Impact of Discounts in Insurance Industry ................................................... 14
8 References .................................................................................................................................... 14
PRM – Group Assignment P a g e |2

3. 1 Current Scenario in Insurance Pricing
The evolution of insurance pricing began in the 1950s, when property/casualty insurers first started
differentiating between customers based on their geography or personal characteristics. By the mid-
1970s, most auto insurers were using over 160 different rating classifications to reflect differences in
vehicle use and driver characteristics. Similar refinements were introduced in homeowners‘ coverage
and commercial lines products. Mainframe computers afforded insurers the ability to manipulate
exposure and claim data at a new level of granularity. During the 1980s and 1990s, several innovative
pioneers began collecting a significant amount of customer data and analyzing various customers
attributes in combination to predict each customer‘s claim propensity more accurately. These
innovations originated in auto insurance, where the volume of data and market opportunity were the
greatest. In the U.S., the predictive power of credit data was a seminal insight. Over time, the ranks of
innovators have grown. A number of insurers in Europe, the U.K. and the U.S. have been using
advanced statistical modelling techniques to improve their risk assessment and selection by
integrating various characteristics that differentiate their customers into rating and underwriting
models. Using predictive models that relate a broad set of customer attributes to claim propensity, the
most innovative companies have been able to :
 Identify customers with below-average claim propensity in a given rating class and target their
marketing toward those customers
 Implement preferred underwriting program tiers that offer partial discounts to those with
below-average claim propensity
 Implement nonstandard underwriting programs that offer coverage ―at the right price‖ to
customers who would otherwise be deemed uninsurable.
Healthcare expenditure in India in FY 2006 was approximately 5 percent of GDP compared to
Japan (7.9 percent of GDP), UK (8.4 percent of GDP) and Brazil (7.5 percent of GDP). Public sector
expenditure on healthcare has progressively decreased over the years from about 26 percent in 1995
to under 20 percent of the total healthcare spending in FY 2006. Consequently, the private sector has
played a dominant role in financing of healthcare expenditure, with households accounting for a
disproportionate 76 percent of the total healthcare expenditure, increasing from 67 percent in 1995.
Households spend nearly 5 to 6 percent of their total expenditure and 11 percent of their non-food
consumption expenditure on health, as per consumer expenditure data of the various rounds of the
National Sample Survey Organization. Data also shows an increasing growth rate of 14 percent per
annum in household health spending since FY 1995-96.
In terms of health insurance coverage, statistics in India have not been very encouraging. Several
different types of insurance cover are available – Government schemes such as the Employees‘ State
Insurance Scheme and Central Government Health Scheme, employer cover in PSUs and the Indian
Railways, and finally private insurance schemes. It has been estimated that around 15 percent of the
population was covered under some pre-paid scheme in India in 2007, with less than 2 percent share
of private health insurance. What are the implications of limited public spending on healthcare and
low coverage in India? In countries like India and a number of other developing countries, which still
rely mostly on out-of-pocket payments, universal access to healthcare is elusive.
A significant proportion of the population, who suffers a hand-to-mouth existence, is forced to make
direct payments, often with a heavy burden of debt, to access healthcare from the market because
the public provision is grossly inadequate or non-existent. High reliance on out-of-pocket spending is
likely to pose health policy challenges related to financial risk protection in future years. Risk pooling
insures people against such risks by transferring the costs of covering the sick to a large number of
healthy people who need to pay only a small premium. India needs to focus on the potential ways to
pool risk and reduce out of pocket expenditure, for which other sources of healthcare funding need to
be stepped up.
PRM – Group Assignment P a g e |3

4. 2 Perceptions about Health Insurance in India
2.1 Ease of claims disbursement
Currently, consumers find the claims disbursement process to be vague, fraught with problems and
with no surety of reimbursement of claims. Instead, they wish to have a hassle free claims and a
disbursement process, in which the insurance agent is present at the hospital to take care of the
formalities during an emergency. Use of medical cards that are like credit cards, which can be swiped
at hospitals, may prove to be an innovative and hassle-free process.
2.2 Increased hospital network coverage
Consumers prefer that their insurance policy to cover a greater number of hospitals and certain
Doctors, particularly ‗Family Doctors‘ in their network.
2.3 Product Innovation
Coverage of incidental costs and more diseases: While hospitalization forms a substantial cost in
medical care, pre-hospitalization entails visits to specialists, diagnostic tests etc., and post-
hospitalization care also entail high costs. Therefore, coverage of these expenses is desirable.
Consumers also expect coverage of diabetes, blood sugar, dental ailments, surgeries such as eye
surgeries, root canal etc that do not require hospitalization, and specialized coverage for women to be
part of their ‘Model Health Insurance offerings‘
2.3.1 Long term policies
Consumers wish to take longer-term health insurance policies compared to the existing one-year
policies. Consumers also mentioned a need for bundling health insurance with life insurance
2.3.2 Simple policy documents
Small pointers such as printing policy documents in local languages can be very useful in helping
consumers understand their health insurance policy better. Consumers also want the policy document
to be simple and easy to understand
2.4 Pricing Innovation
Currently for most policies, the frequency of payment of premium is yearly. However, several
consumers have suggested an alternative possibility of a one-time premium with life-long coverage.
This is especially preferred by self-employed people who could have a spurt in earnings during a
particular year, which can be invested in a policy as a onetime investment. Another alternative is the
payment of a one-time large premium, followed by yearly top-ups to cover a family for a long period
2.5 Regular benefits to insurance holders
Apart from the coverage benefit to the insured, consumers also demanded regular benefits. Annual
health checkups, substantial reduction in premium for a ‗no claim‘ year etc, were some examples
where consumers felt that they could gain some benefit from their association with the health
insurance company.
PRM – Group Assignment P a g e |4

5. 3 Pricing Strategies in the industry
There exist five key principles that would apply to any costing process. It is understood that insurance
costing does not occur in isolation but, rather, is heavily influenced by a robust, competitive
marketplace. This fact will naturally impact certain aspects of the overall costing process; however,
the principles articulated below would always apply.
3.1 Applicable Principles in Costing Process
 Unbiased – Insurance costing would provide the user with an unbiased estimate of future
costs, benefits, and risks.
 Comprehensive – Insurance costing would be performed with integrity and include an
analysis of all relevant risks to the insurer. These include both financial and non-financial
risks. To the extent that the potential impact or the volatility of the risk is greater, more
extensive testing and analysis would be performed.
 Documented – The costing exercise would be documented. This documentation includes the
development of the models and assumptions used as well as overall results and sensitivity
testing. It would be recognized that the future outcomes of insurance products are uncertain.
Therefore, if possible, the documentation would include a range of possible outcomes with
associated probabilities. Clearly written analysis of the results would be included.
 Communicated – The results of the costing exercise would be clearly communicated in a
manner understandable to the key decision-makers.
 Review/Approval Process – The costing exercise would be subject to a review and approval
process that is appropriate for the risks undertaken. This includes a peer review process to
ensure data and model integrity, as well as a review to ensure that risks have been
adequately analyzed. The individual(s) who approve and sign off on the costing exercise
would be at a level of authority that is commensurate with the risks undertaken.
 Risk Definition- Key part of insurance product pricing - Insurance companies face a
multitude of risks on a daily basis. The company‘s exposure to these risks is influenced by the
design of the policies sold. In costing an insurance product, the actuary would be aware of the
following risk categories and consider if they have the potential to impact the profitability of
the product. Where the impact has the potential to be material, the actuary would document
and measure them.
3.2 Risks considered in Costing of Insurance Policies
The following is a list of risks that would be considered in the costing of insurance policies:
Risk Definition Examples
Competitive The inability to build or maintain a Competitor actions may cause shifts
Risk sustainable, competitive advantage in a in the distribution of sales resulting in
given market or markets. different profit levels.
Regulatory Risk that legislative actions, tax change, Changes in tax laws may result in
Risk court decisions or regulatory rulings will changes to policyholder behaviour
alter market or competitive abilities. changing the profitability levels of the
product; Favourable treatment of a
product for valuation, capital or tax
purpose may cease to exist.
Reputational The risk that negative publicity, whether Complicated policy features not
Risk true or not, causes a decline in the understood by policyholders may
customer base, costly litigation and/or result in potential negative impact to a
PRM – Group Assignment P a g e |5

6. Risk Definition Examples
revenue reduction. company‘s image leading to extra-
contractual benefits. Adjustment to
policy features may not be utilized due
to potential impact on reputation.
Credit Risk Credit risk is the risk of default and change Credit quality and level of
in the credit quality of issuers of securities, diversification within the investment
counter-parties and intermediaries to whom portfolios backing the product as well
the company has an exposure. as the reinsured ceded.
Market Risk Market risk arises from the level or volatility Adverse movement in assumed equity
of market prices. Market risk involves the returns, currency rates or interest
following: rates; ―in-the-money‖ interest rate
 exposure to movements in the level of guarantees.
financial variables;
 exposure of options to movements in the
underlying asset price;
 exposure to other unanticipated movements
in financial variables;
 exposure to movements in the actual or
implied volatility of asset prices and options.
Liquidity Liquidity Risk is the exposure to a loss in Product designs requiring the use of
Risk the event that insufficient liquid assets will illiquid assets to meet pricing targets.
be available, from the assets supporting the
policy obligations, to meet the cash flow
requirements of the policyholder obligations
when they are due, or assets may be
available but only at excessive cost.
Underwriting Underwriting is the specific insurance risk Mortality, morbidity, lapse,
Risk arising from the underwriting of insurance policyholder anti-selection.
contracts. The risks within the underwriting
risk category are associated with both the
perils covered by the specific line of
insurance and with the specific processes
associated with the conduct of the
insurance business.
Operational Operational risk is defined as the risk of Inability to execute a hedging strategy
Risk loss resulting from inadequate or failed on a timely basis; administration,
internal processes, people, and systems or illustration and pricing systems
from external events. calculating values differently; errors in
pricing system.
3.3 Product Development and Costing Process
The product development and costing process can be applied to both new products and those that
are being re-priced. The process includes the following stages:
1. Discovery
1.1. Channelling of product concepts through a cross functional team.
1.2. Initial review of ideas and decision to commit resources to further study.
PRM – Group Assignment P a g e |6

7. 2. Scoping
2.1. Preliminary feasibility study to assess technical, administrative, financial and regulatory
requirements.
2.2. Market research study and competitive analysis.
3. Business Case and Development
3.1. Further refine product idea and develop business case with initial pricing, costs and sales
projections.
3.2. Translate the product definition into reality through product, process and other related
support. Project team develops final pricing, systems, marketing and launch plan.
4. Testing and Validation
5. Documentation and Approval
6. Launch
6.1. Deliver to market a complete and serviceable product.
7. Post-Launch
7.1. Tracking, reporting and assessment of product and performance for future refinement.
4 The Pricing Models – The building blocks of price optimization
In essence, price optimization is about getting to know your customers and your market better. Price
optimization integrates claim propensity, market situation and customer behavior models to predict
the impact of price changes on volume and identify the best price changes for a given financial
objective and constraints. Price optimization ultimately seeks to provide a company with the tools
necessary to maximize a particular strategic objective — for example, either volume or profitability —
and to allow for flexibility to adapt to changing business circumstances. The power of price
optimization is that it allows the company to gather demographic and market data ranging from
person‘s age and to competitor pricing, to customer likelihood to purchase insurance at specific times
of the day — the list is limited only by the insurer‘s needs and then, to use them, singly or in
combination, to set rates. There are basically three methods used in the industry and are widely
considered to be the standard:
4.1 Claim Propensity Models
These models express how customer attributes are predictive of their inclination to report a claim.
These models are used to develop new rating plans or customer scoring systems for underwriting.
Sophisticated claim propensity models can integrate a variety of qualitative customer attributes with
traditional quantitative rating risk factors to more accurately predict both the likelihood that a
policyholder may experience a claim in the future and the probability of the claim being above or
below average claim costs for any given class. These models can be used for targeted marketing,
underwriting segmentation and more accurate pricing.
PRM – Group Assignment P a g e |7

8. Insurers face several challenges in moving from underwriting alone to a greater use of more accurate
risk assessment and pricing. First is the challenge of gathering accurate data and scrubbing them so
they‘re useful. Second is conducting statistical analyses and extracting usable insights from them.
Finally, more accurate risk assessment and pricing entails a fundamental shift in an insurer‘s culture.
Claim propensity models almost always reveal some surprising, non-intuitive results that challenge
long-held beliefs, and the insurer‘s staff must learn to trust the data that come out of them.
Implementing claim propensity models is expensive, and if the staff ignores the results or the
company doesn‘t act on them, it will make no sense to incur the costs.
4.2 Market Situation Models
These models express how the company‘s competitive position and the market‘s competitive intensity
vary by segment or niche within the market. Traditionally, companies have analyzed the
competitiveness of its rating plan based on a relatively small sample of representative hypothetical
customers by comparing the company‘s prices against key competitors. While this approach gives the
company a general sense of its relative price position, insights from such an analysis are limited by
the small sample size. Innovative companies have substantially expanded the extent of these price
comparisons and have found new ways to make use of the richer market information they provide. By
populating a market situation model with price comparisons for virtually every possible customer (i.e.,
every combination of customer attributes) across a broader array of competitors, companies can
identify customer population segments and niches where their competitive position is weak or strong.
More importantly, the large volumes of price comparisons facilitate a more complete analysis of the
competitive intensity of particular market segments, enabling the company to make tactical decisions
about which segments to attack and which segments to retreat from.
Competitive market analysis using market situation models is used: to help identify segments where
the company‘s prices are low or high relative to the market to understand the competitive intensity
in each segment and support strategic decisions regarding product deployment in different
competitive segments to understand the potential scope for price changes and what impact such
changes would have on market positioning. Until now, techniques employing market situation models
have been applied predominantly to auto insurance because it is such a significant business for
personal lines carriers in many countries. However, the same concept can be applied to other
personal lines products, such as health or homeowners (householder) insurance, with the
understanding that these insurers will face similar hurdles in gathering competitor information,
verifying accuracy and scrubbing the data for analysis. Market situation models provide potential
pricing strategies by combining both univariate and multivariate analyses. Univariate analysis
assesses company positioning one variable at a time and is used to present comparisons among a
peer group of competitors in a format that is easy to interpret. Univariate analysis also provides price
analysis against market average.
Multivariate analysis involves measuring the intensity of competition — in other words, how hard are
insurers fighting to win market share in particular segments. The intensity is determined by looking at
how closely prices cluster together within a segment. The closer prices are to each other, the greater
the intensity of competition. Conversely, the more dispersed prices are in a given segment, the lower
the competition. It is also necessary to assess the price position of the company against its
competitors by risk profile. By combining the results of univariate and multivariate analyses, an insurer
is presented with potential pricing strategies for each customer in each market segment, as well as
input to rating actions.
PRM – Group Assignment P a g e |8

9. 4.3 Customer Behaviour Models
These models express how the customer‘s attributes and the market‘s situation are predictive of the
customer‘s behaviour, for example, response rate or lapse rate. Developing accurate customer
behaviour models is the final building block in price optimization. Successful customer behaviour
models help companies understand how current customers will react to price changes for retention
and how price levels will affect new business development. By developing models of customer
responses to discounting, marketing campaigns, competitive activity and other pricing or service
events, insurers can gain a comprehensive picture of customers‘ demand preferences at different
price points. Because this analysis enters new territory for most insurers, it requires a shift in mindset
on the part of management, followed by careful project planning to be sure the analysis results will be
usable.
The price elasticity function takes into account different variables that have not been widely analyzed,
including the history of price variations, brand strength and awareness, distribution channel and other
significant factors. The result of this modelling produces a scoring algorithm to predict conversion
and/or retention rates for price relative to price changes and to the competition.
The most effective way to generate a price elasticity of demand curve is to vary prices and measure
the impact on volume. Insurers can use controlled testing of rates to generate demand curves. By
replicating the rate structure and marketing to one group of customers through parallel testing of
multiple sets of rates, the insurers can measure the impact on volumes as prices change. This kind of
testing helps measure conversion and retention rates by price.
The aim of price optimization is to set prices across an insurer‘s portfolio that maximize a predefined
measure of customer value over a given time period and align pricing with the company‘s strategic
objectives. Effective price optimization allows a property/casualty insurer to increase and decrease
premium prices based on a combination of marketplace variables, including, but not limited to,
product demand, certain customer characteristics and the competitive landscape. It also takes into
account the implications of price differentials, including customer retention, profitability and lifetime
value.
5 The Revolution in Insurance
Health insurers are entering a new world where individuals, not groups, are the decision makers. In
essence US health care is going retail, from the growing interest in health savings accounts (HSA) to
the proliferation of minute clinics and other convenient settings for delivering care. Yet many insurers
are ignoring the transformation of their industry and the opportunities and challenges it presents.
The challenge is manifesting itself in many ways. Traditionally, employers selected health care
products for their employees and paid for most of the services and other costs. Increasingly, however,
those costs are being passed on to individuals, who now decide what products to buy, as well as,
where, when, and how to buy them. Individual consumers are also demanding first-rate service from
their payers – service in line with what they expect from other consumer industries, such as banking
or retailing – along with near 100% accuracy and the convenience of interacting at any time through a
number of channels. And given the complexity of health insurance products and of the health care
system, consumers want more advice and support than ever.
But health care insurers, or payers, have grown up as wholesale enterprises, and their competencies,
organizational structures, and mind-sets are largely directed at serving groups, not individuals. As that
dynamic changes, payers will need much sharper insights about the consumer, along with better
PRM – Group Assignment P a g e |9

10. product management, retailer distribution, customer service, risk management, and consumer-
oriented medical management. What‘s more, as the industry becomes more retail oriented, payers
face severe competitive threats. Analogous changes in other industries have reshaped the landscape,
putting incumbents on the defensive and rewarding entrants. The same thing could happen in health
insurance. The transition will be difficult, for insurers will have to develop retail capabilities while
managing the traditional wholesale business.
6 Recommendations and Conclusion
As the economic slowdown continues, insurance companies continue to worry about how to retain
their most profitable customers. Customers who continue their business relationships with the insurer
are more than revenue generators. Satisfied customers are, indeed, a company's brand
ambassadors. They spread the word about positive experiences they have had with their insurer to
others they come in contact with. This word-of-mouth marketing is valuable for a company, especially
in these tough times.
As companies evaluate how to retain their best customers, many are considering implementing price
optimization. For most customers, price connotes real value. Understanding price and what it means
to a customer is an important aspect of understanding the person's lifetime value to a company. In
fact, according to one estimate, 30 percent of insurance buyers are price-motivated or ‗serial
shoppers‘, without brand loyalty.
Price optimization is a strategy with which a company, after getting to know how sensitive its existing
clients are to changes in product prices, will arrive at how much business it can obtain within defined
profitability levels. Optimal pricing is necessary if a company wants to link its business volume with
profits and more importantly, if it wants to increase profits by keeping the same levels of customer
retention.
A U.K.-based insurer, for example, opted to implement price optimization. The insurer, with an
estimated USD 637 billion in assets, implemented pricing optimization through advanced analytics in
its underwriting division. The analytics helped the insurance giant identify customer segments with a
higher probability of cancellation. The company then prepared a plan of action to retain these clients.
Price optimization has become increasingly important because sales of personal lines of business
have become very competitive. Many insurers are also looking at launching new products, some of
which are in niche customer segments. In this context, getting the price right is all the more imperative
or a company may lose valuable clientele to its competitors.
Price optimization is an important component of overall price management which is crucial to
profitability. In fact, it is the next frontier of insurance policy management. Understanding pricing at a
finite level is a prerequisite to understanding the sensitivity of price changes. It is one of many
variables that can be used to estimate the elasticity of demand for each life insurance policyholder's
risk profile. When all these variables are analyzed, it is possible to identify the cluster of policyholders
that are more price-elastic.
So what are the components of an effective price optimization model require?
 Cost models - These predict the net claims and other costs for customers
 Competitive management analysis - This provides an analysis of the market in which the
company operates
PRM – Group Assignment P a g e | 10

11.  Customer elasticity models - These reflect market competition and customer behavior in order
to predict volume of new business and renewal rates for customers at different rates
 Optimization techniques - These integrate models to predict volume and price, identify the
best prices, and the impact of price changes.
Price optimization is not a one-time event but rather a key part of a revenue strategy. Ideally, this
should be a continuous process, allowing a company to refine its assumptions as new data becomes
available.
The winners in this arena will find they have powerful tools to help them manage the swings of the
insurance cycle. When prices in the market are falling, those with a stronger knowledge of the
profitability characteristics of their customers, as well as their price elasticity of demand, will be in a
much better position to manage through the downturn. Indeed, as the gap between winners and
losers opens, expertise in price optimization will become a core competency of all insurers in the
market.
7 Appendix
7.1 Current price Rates of Insurance policies and Industry
PRM – Group Assignment P a g e | 11

12. 7.2 Comparison of Price Rates in Industry
7.3 Market Segments and what customers are looking for in insurance
PRM – Group Assignment P a g e | 12

13. 7.4 Predictive Models Support Price Optimization
7.5 Elasticity of Demand in Insurance — Measuring Renewals by Price
Changes
PRM – Group Assignment P a g e | 13

14. 7.6 Measuring the Impact of Discounts in Insurance Industry
8 References
 Report on Health Insurance Summit 2008
 Price Optimization: A Potent Weapon for Innovative Insurers
 http://entrepreneurs.about.com
 http://www.celent.com
PRM – Group Assignment P a g e | 14