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Report Says U.S. Insurance Industry Loses More than $16B in 2004 on Auto Premium Rating Error

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Quality Planning Corporation (QPC), the Rating Integrity Solutions Company, has released its annual Premium Rating Error report. The report concludes that premium rating errors continue to lower the overall profits of auto insurance companies.

QPC estimates that $16 billion of premium revenues were foregone in 2004 due to inaccuracies in rating information – an increase of $800 million over 2003. The report can be found online at: http://www.qualityplanning.com/research.html .

To put this $16 billion premium rating error into perspective, it represents about 9.8% of the $163 billion revenue recognized by personal auto insurance premiums industry-wide.

Dr. Daniel Finnegan, founder and CEO of QPC, noted, “For the average auto insurer, each one percent of rating error losses translates into an 20 percent reduction in profitability.”

QPC’s Premium Rating Error report presents the results of premium audit reviews of more than 16 million private passenger auto policies from 18 major carriers. The report highlights how different categories of rating errors contribute to the overall premium rating error, and distinguishes between vehicle rating errors (mileage, usage, type of vehicle and location) and driver rating errors (who actually drives the vehicle, driving experience and driving record).

In 2003, it was driver rating factors that contributed the most to rating error. In 2004, vehicle rating factors proved the most problematic for auto insurers, rising from $6.1 billion to $7 billion. The report indicates that flaws in rated commute distance, annual mileage, vehicle usage and rated territory were the primary contributors to the $900 million increase. All of these rating errors offer the potential to be reduced if an auto insurer focuses underwriting activities on gathering, validating and maintaining accurate rating data.

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. On average, 52% of existing policies have a change in driver or vehicle every year, and 50% of the remaining policies have some other meaningful change. It is reportedly difficult for auto insurers to keep up with these changes.

And it is reportedly an accepted insurance industry fact that there is some level of premium ‘leakage’ – premium revenue that is lost due to misrepresentation of facts, lifestyle changes or outright fraud by policyholders. Insurance companies reportedly know that not all consumers are entirely forthcoming with accurate rating information, intentionally or not, when they apply for insurance, so they build this risk into their calculations when they determine premium pricing. The numbers in the report show that auto insurers could better analyze rating data to identify and correct this incorrect information.

Finnegan noted 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.”

Vehicle garaging errors represent one area where better analysis can reportedly help control risks. Quality Planning Corporation has reportedly identified thousands of examples where young drivers keep their vehicles registered at their parent’s homes long after they have moved to large cities such as New York or Los Angeles.

A similar problem reportedly 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 percent higher than those vehicles driven 16,000 to 20,000 miles. Failure to identify these higher risk vehicles and rate them accordingly reportedly represents a major source of unmanaged loss costs.

QPC’s research reportedly shows that carriers that build and maintain finely graduated rating plans can expect to enjoy significant competitive advantages over carriers with flat rating plans.

Finnegan added, “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.”


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