“The purpose of price optimization is to extract as much profit as possible from policyholders, who are often required to purchase insurance policies,” according to a February 2015 press release from the Consumer Federation of America.
Executive SummaryOpinion: 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 3, he explains that what is being maximized is retention, not price, as he brings together concepts explained in Part 1 and Part 2 of this article series. 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 3 of a three-part article series.
Is that what Allstate is doing with its Complementary Group Rating?
We’ve spent more than 4,000 words in Part 1 and Part 2 of this article series learning how Allstate’s plan operates. We followed the reasoning of actuary Irene Bass, a former Casualty Actuarial Society president and a former member of the American Academy of Actuaries’ board of directors. Let’s put that effort to good use.
First, the CGR plan does not maximize profits. It maximizes retention. Remember all those paragraphs ago (in Part 1) when I asked you to remember that the standard actuarial model assumes that all risks renew no matter how much their rates go up? And if all risks renewed, the model indicated that the company would achieve a certain profit level. And that profit level was the return on equity approved by the regulator.
Allstate’s rating method does something more sophisticated. It understands that some risks will not renew after a rate change. It looks at several sets of rating plans, all of which promulgate fair rates. It tries to figure out which set will give the highest level of retention. In other words, it determines which plan is most like the 100 percent retention assumed by the actuarial model.
The overall profit that results is disclosed in the rate filing. If that profit is too high, the regulator will reject the filing. The only way the insurer can make excessive profits is if the regulator approves the filing. Saying that insurers are maximizing profits or price-gouging, in this case, is akin to saying regulators aren’t doing their jobs. There is no evidence that is happening.
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