Actuaries occupy a quiet, arcane world, their debates obscure: Loss development factors: weighted vs. straight? Premium impact: parallelogram vs. extension of exposures? Reserve methods: chain ladder vs. Bornhuetter-Ferguson.

Executive Summary

Opinion: Allstate's rating process made price optimization the biggest controversy in P/C insurance. But it might not be what it seems, according to James Lynch, chief actuary of the Insurance Information Institute. In this three-part series of articles, Lynch explains what he calls the ultimate irony—that "the Allstate plan that kicked off the brouhaha might not even be price optimization." Here, in Part 1, he explains what price optimization is—value-based pricing—and how that differs from the cost-based pricing methods that actuaries use to estimate how much rates should change on an entire book of business. Lynch was asked by Allstate officials to review and write about the plan, but he independently chose Carrier Management to publish his article. The article is based on his review of a report by another actuary, information from Allstate and knowledge he has gained from his study of price optimization over a two-year period. Part 1 of a three-part article series.

So Allstate’s Complementary Group Rating process—CGR for short—is one for the books.

The early filings of the company’s CGR plan launched the price optimization controversy in the public eye. The plan, according to its detractors, let Allstate gouge consumers on price, charging the maximum amount each customer would be willing to pay.

“This is a watershed moment in the history of insurance consumer protection,” said Robert Hunter in a press release in late 2014. Hunter is director of insurance at the Consumer Federation of America (CFA), a consumer advocacy group that often finds fault with insurer practices.

“If regulators don’t block this scheme immediately, American consumers will pay a huge price. While we are forced by law to buy these companies’ insurance products in order to drive, there seems to be nothing stopping them from targeting millions of unsuspecting customers with unnecessary and unjustified price hikes.”

The media noticed, particularly after the CFA started calling the practice a “loyalty penalty.” NPR’s headline said, “Being a Loyal Auto Insurance Customer Can Cost You.” Consumer Reports called price optimization a “schmo tax,” as if to say you are a sucker if you don’t shop for insurance and your insurer will jack up your rates unless you do.

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