In Part 1 of this article series, I described cost-based pricing used by actuaries, which includes business judgment—introducing differences between the technical price indication for a book of business and final “street prices” filed with regulators.
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 2, he explains classification plans that introduce individual surcharges and discounts to overall pricing indications for different groups of customers and how Allstate introduced an enhancement to this step—designed to solve “the reversal problem.”
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 2 of a three-part article series.
But pricing actuaries do much more than estimate how much rates should change on an entire book of business. They must estimate the various discounts and surcharges that different groups of customers must pay.
A company might charge $300 on average for collision coverage in a state. But hardly anyone would pay exactly that amount. Male drivers would pay more in most states. Middle-aged drivers would usually enjoy a discount.