Vermont Issues Bulletin on Price Optimization in Personal Lines Ratemaking

Vermont regulators issued a bulletin last week addressing the issue of “price optimization” in personal lines ratemaking.

The Vermont Department of Financial Regulation (DFR) noted in the bulletin that some property/casualty insurers have been relying upon the practice of price optimization to help determine the premiums that they will charge to policyholders.

But DFR warned property/casualty insurers that adjustments to rates may not be based on non-risk-related factors and that going forward, all personal lines rate filings must disclose whether the company uses non-risk-related factors such as “price elasticity of demand.”

The DFR Insurance Bulletin No. 186 was issued on June 24 and is applicable for all property/casualty insurers issuing personal lines policies in Vermont.

DFR also noted that the National Association of Insurance Commissioners’ (NAIC) Casualty Actuarial and Statistical (C) Task Force is currently in the process of drafting a “white paper” analyzing price optimization and its use in insurance ratemaking.

“While there is no universally-accepted definition of price optimization, the practice, in some of its applications, involves the judgmental use of factors not specifically related to a policyholder’s risk profile to help determine or adjust his or her insurance premium,” the bulletin said.

“An example would be using an individual policyholder’s response to previous premium increases to determine how much of a premium increase the policyholder will tolerate at renewal before engaging in comparison shopping or switching to a different insurer,” the bulletin said. “This practice can result in two policyholders receiving different premium increases even though they have the same loss history and risk profile.”

DFR reminded property/casualty insurers doing business in Vermont that all ratemaking must conform to the statutory requirements contained in Chapter 128 of Title 8 V.S.A.

“Specifically, insurers are reminded that, under Section 4685(d) of Title 8, unfair discrimination is considered to exist if price differentials ‘fail to reflect equitably the differences in expected losses and expenses’ for different classes of policyholders,” the bulletin noted. “In classifying policyholder risks for ratemaking purposes, insurers are allowed to use rating plans ‘which provide for recognition of probable variations in hazards, expenses, or both.'”

DFR pointed out that both base rates and rating classes must be based on factors specifically related to an insurer’s expected losses and expenses.

And while insurers may employ judgment in setting their rates, judgmental adjustments to a rate may not be based on non-risk-related factors such as price elasticity of demand, which seek to predict how much of a price hike a policyholder will tolerate before switching to a different insurer, DFR noted.

“The use of such factors not only unfairly discriminates between policyholders of the same risk profile, but is also directly in conflict with the statutory principles that underlie Vermont’s ‘open and competitive’ property and casualty marketplace,” the bulletin said.

DFR said it recognizes that not all insurers have adopted the practice of price optimization. DFR also said that to help identify the possible use of inappropriate rating factors, insurers are directed that henceforth all personal lines rate filings must disclose on the SERFF general information page whether the company uses non-risk-related factors such as price elasticity of demand to help determine the insured’s final premium.

Rate filings currently under review by DFR should be amended to disclose this information, the bulletin said. The authority for this requirement is contained in 8 V.S.A. ยง 4688(a)’s language that “every insurer shall file with the commissioner all rates and supplementary rate information, and supporting information which are to be used in this state.”

Several other states including Florida, Maryland, Ohio and California have addressed the practice of price optimization in recent months.

Consumer advocacy groups the Consumer Federation of America (CFA) and the Center for Economic Justice (CEJ) issued a statement Thursday applauding Vermont DFR Commissioner Susan L. Donegan for the action and called on all insurance commissioners around the country to prohibit price optimization.

“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,” said J. Robert Hunter, director of insurance for CFA and former Texas insurance commissioner. “It is the obligation of insurance commissioners to protect consumers from this kind of price gouging, and we applaud Commissioner Donegan for her action.”