A memorandum released last week by Florida Insurance Commissioner Kevin McCarty warning insurers in the state not to use price optimization in rating has gotten cheers from a consumer advocate group and jeers from an insurance industry trade association that says the definition of the practice used is too vague.
The memo, released May 14 by the Florida Office of Insurance Regulation (OIR), was addressed to all property/casualty insurers authorized to do business in Florida to “emphasize the requirements of the Florida Insurance Code in connection with insurers’ use or potential use of price optimization in determining policyholder premiums.”
McCarty cited Florida insurance statutes that says OIR is required to review a rate filing to determine if a rate is excessive, inadequate, or unfairly discriminatory in accordance with “generally accepted and reasonable actuarial techniques.”
Further, McCarty wrote, the law also provides that a rate shall be deemed unfairly discriminatory as to a risk or group of risks if the application of premium discounts, credits, or surcharges among such risks does not bear a reasonable relationship to the expected loss and expense experience among the various risks.
Price optimization introduces information such as supply and demand or competition into the rating of policyholders. The practice took center stage late last year when the Consumer Federation of America (CFA) charged that insurance giant Allstate was basing auto insurance premiums on the “marketplace considerations” factor.
The CFA stated at the time that it had “clear evidence” that Allstate and other insurers were using the practice to increase profits by raising premiums on individuals who are unlikely to shop around to find a better price. CFA said that price optimization is “unrelated to risk to set rate for a particular insured.”
The topic has become a controversial one in the months since CFA’s report. So much so that the National Association of Insurance Commissioners’ (NAIC) Casualty Actuarial and Statistical Task Force began to examine the practice and is currently working on a white paper on the subject.
“Insurers that have used price optimization in the determination of rates filed and currently in effect should submit a filing to eliminate that use,” wrote Florida Commissioner McCarty in the May 14 memo. “Insurers should ensure that any filings subsequent to the date of this memorandum do not utilize price optimization in any manner.”
The problem with McCarty’s warning, says Alex Hageli, director of Personal Lines Policy for the Property Casualty Insurers Association of America (PCI), is Florida’s definition of price optimization isn’t clear, and, as such, the regulator’s assessment could be unnecessarily punitive to insurers and policyholders in the state.
“We are concerned that [the definition] is vague and very broad and may implicate some rating practices that are beneficial to policyholders,” he said.
McCarty acknowledged in the memo that price optimization does not have a universally recognized definition, but offered Florida’s definition:
“In a regulated insurance context and for the purpose of this informational memorandum, price optimization is a process for modifying the insurance premium that would otherwise be charged to an insured or class of insureds in order to maximize insurer retention, profitability, written premium, market share, or any combination of these while remaining within real world constraints. Price optimization utilizes the economic concept of ‘price elasticity of demand,’ which is a measure of the responsiveness of the quantity of a good or service purchased to a change in its price.”
Hageli said that the vagueness of the memo may cause some insurers to limit their use of other pricing practices that benefit consumers, such as price tempering, in which insurers gradually implement substantial but actuarially justified rate increases in order to mitigate the impact on policyholders, which he says is often times at the behest of regulators.
Based on the memo’s definition of price optimization, this practice could be impacted Hageli said. “The industry defines price optimization rather broadly whereas regulators seem primarily concerned about price elasticity. We share their concerns in that regard, but just worry that the language they are using does not fully account for how the industry defines price optimization.”
However, CFA Director of Insurance and former Texas Insurance Commissioner J. Robert Hunter applauded McCarty’s action and called on insurance commissioners around the country to follow his and the three other states’ lead.
“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,” Hunter said. “It is the obligation of Insurance Commissioners to protect consumers from this kind of price gouging, and we applaud Commissioner McCarty for his action.”
Hageli said CFA’s claims about the practice are much ado about nothing.
“It all goes back to the question of how you define [price optimization]. There is a gray area of what do these bulletins mean and where is there overlap,” he said. “And that is our overriding concern. What do you mean when you say ‘price optimization’ and what do you mean when you say ‘maximizing profit?'”
Hageli says PCI hopes to sit down with McCarty to get clarification on what exactly the OIR is classifying as the practice, what maximizing profit means and if the definition applies to all lines or just personal or commercial lines.
He said the worry in the industry is that what carriers think is vagueness in the rules could put them out of compliance without them realizing it.
“Companies are going to want to be in compliance and in my opinion that won’t be an issue… but it is a question of what compliance is with this,” he said. “It would be helpful if they did release better specificity on what they intend and if we sit down with them that’s what we will ask.”
Hunter said insurance commissioners could fine insurers for refusing legitimate orders and have a “full set of options beyond that if an insurer ignores the order, up to and including lifting the license to do business of a recalcitrant insurer.”
The OIR says it is required to initiate proceedings to disapprove a rate that it finds on a preliminary basis may be excessive, inadequate or unfairly discriminatory.
FLOIR had no further comment on the memo and would not respond to a request by Insurance Journal on what punishments or actions could be taken against insurers in the state of Florida that do not comply.
CFA and the Center for Economic Justice (CEJ) have written letters to state insurance commissioners and presented to the NAIC over the past two years calling for pro-active and pre-emptive efforts to protect consumers from “big data” and other non-risk related strategies for rating drivers and homeowners and raising prices, the CFA said in a statement.
Additional states may not be far behind Florida in issuing warnings. Hunter said New York has issued a call for information and he said his group is aware of other states that are considering action.
“Price optimization by insurers is big data run amok. Consumers are being punished for activities and circumstances without any disclosure or transparency by insurers,” said Birny Birnbaum, executive director of CEJ. “The state actions by four insurance commissioners are the first steps in returning insurance practices to the foundation of pricing insurance based on risk of loss.”