Delaware Bans Use of Price Optimization in Insurance Pricing

October 6, 2015

Delaware has issued a bulletin prohibiting the use of price optimization in insurance pricing.

The Delaware Department of Insurance said in its Bulletin No. 78 on Oct. 1 that “while price optimization has no universally accepted definition, it generally refers to an insurer’s practice of varying rates based on factors other than the risk of loss” in order to charge each insured the highest price that they will tolerate without shopping for alternative coverage.

These non-risk factors would include the likelihood that policyholders will renew their policies and the willingness of certain policyholders to pay higher premiums than other policyholders.

The bulletin was addressed to all property/casualty insurers writing personal lines policies in Delaware, rating organizations, and the Delaware Insurance Guaranty Association.

The bulletin said that insurers use sophisticated analytics that cover not only risk of loss, but such things as how happy an individual is with their insurance company. The practice can result in two policyholders receiving different premium increases even though they have the same loss history and risk profile.

Delaware insurance law prohibits charging unfairly discriminatory rates, requires that the rates be based upon risk, and requires differences among risks to have a demonstrable probable effect on losses or expenses, according to the Delaware Department of Insurance.

While risk classification is widely accepted as a legitimate insurance actuarial principle, and Delaware insurance laws permit insurers to classify certain risks, the fundamental factor underlying insurance rates is that they reflect a risk of loss and the associated expenses of servicing and maintaining a policy, the bulletin said.

The bulletin points out that 18 Del. C. §2503(a)(2) specifies “Rates shall not be excessive, inadequate, or unfairly discriminatory.” According to the Delaware Department of Insurance, a rate will be considered unfairly discriminatory if price differentials fail to reflect equitably the differences in expected losses and expenses for different classes of policyholders.

“To the extent that price optimization involves gathering and analyzing data related to numerous characteristics specific to a particular policyholder and unrelated to risk of loss or expense, insurers may not use price optimization to rate policies in Delaware,” the bulletin advised.

The Delaware Department of Insurance said any insurer currently utilizing price optimization in a manner described in the bulletin to rate policies in Delaware must submit a SERFF filing that is compliant with the bulletin no later than Dec. 15, 2015 — with proposed effective dates no later than April 1, 2016, for new business and July 1, 2016, for renewal business.

The filing submission must identify the SERFF tracking number of the filing that is being replaced or corrected. Failure to submit the filing in compliance with the bulletin may result in administrative action, the Department of Insurance said.

The department also explained that it does not intend to prohibit or restrict such practices as capping or transitional pricing when applied on a group basis.

“Insurers should group individual policyholders into justifiable, supportable, risk-based classifications and treat similarly situated policyholders the same with respect to insurance pricing,” the department said. “Likewise, the use of sophisticated data analysis to develop finely tuned methodologies with a multiplicity of possible rating cells is not, in and of itself, necessarily a violation of rating laws as long as the classifications are based strictly on expected losses, expenses, or other justifiable, supportable risk characteristics.”

Delaware joins a growing number of states and jurisdictions including California, District of Columbia, Florida, Maine, Maryland, Ohio, Pennsylvania, Rhode Island and Vermont that are prohibiting the use of non-risk based features of price optimization in insurance pricing.

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