Premium rating errors lowered the overall profits of auto insurance companies by an estimated $15.2 billion in 2003 due to inaccuracies in rating information, according to a new report.
Quality Planning Corporation, in its annual Premium Rating Error report, put this $15.2 billion premium rating error into perspective, by noting it represents about 9.7 percent of the $157 billion revenue recognized by personal auto insurance premiums industry-wide.
Dr. Daniel Finnegan, founder and chief executive officer of QPC, noted: “Our research shows that if an auto insurance company can cut its rating error by 50 percent, it is likely that the company can more than double its profits.”
QPC’s Premium Rating Error report presents the results of premium audit reviews of more than 14 million private passenger auto policies from 16 carriers and reveals how different categories of rating errors contribute to the overall premium rating error.
The report finds that it is the rating factors over which insurance companies have little control that contribute the most to rating error: unrated drivers (1.6%) and commute/annual mileage (1.9%).
QPC advises that in the life of an auto policy, change is a constant. Household composition fluctuates: policyholders change jobs, cars are acquired and sold, kids grow up and get their driver licenses. “It’s difficult for auto insurers to keep up with these changes,” said Finnegan.
Insurers must also contend with insurance fraud. “It’s an accepted insurance industry fact that there is some premium ‘leakage.’ Insurance companies know that not all consumers are entirely forthcoming with the facts, intentionally or not, when they apply for insurance, so they build this risk into their calculations when they determine premium pricing. But do they do enough analysis?” he asked.
Finnegan notes that the problem of rating error extends beyond just industry profits: “Rating error introduces significant inequalities into auto insurance; honest people subsidize the dishonest, low risk drivers subsidize high risk drivers, those that rarely use their vehicles subsidize high-mileage drivers.”
Unrated drivers are one area where better analysis would reduce claim costs, QRC maintains. Policies with unrated (that is, unknown to the insurance company) 16-year-old male drivers in the household exhibit total claim losses more than twice the national average.
A similar problem exists with annual mileage — the miles drivers state they will drive when they apply for coverage. Many carriers, aware of the high error in these mileage data, rate in only two categories such as zero to 7,500 miles, and over 7,500 miles. QPC’s analysis of the loss-histories of vehicles driven more than 30,000 miles found loss frequencies that were 31 per cent higher than those vehicles driven 16,000 to 20,000 miles. Failure to identify these higher risk vehicles and rate them accordingly represents a major source of unmanaged loss costs.
QPC’s research shows that carriers that build and maintain finely graduated rating plans can expect to enjoy significant competitive advantages over carriers with flat rating plans.
QPC assists auto insurers in their efforts to minimize rating error. Typically, QPC takes an auto insurance company’s book of policyholders and runs it through a battery of proprietary tests, cross-references and pattern-matching algorithms to identify likely rating error. QPC also provides insurers with additional services such as the development of tailored scripts for call centers and non-confrontational interviews of policyholders to verify critical facts used to rate them.
“Policy data provides key inputs to marketing, sales, business segmentation, financial planning, corporate planning and staff/agent compensation. So rating error directly impacts, in a negative way, the overall health of an insurance company,” Finnegan adds.
Quality Planning Corporation (QPC) was founded in 1985 and is headquartered in San Francisco. It is a member of the Insurance Services Office family of companies. For more information, visit www.qualityplanning.com. The report can be found online at: http://www.qualityplanning.com/research.html.