Dynamic insurance pricing
A recent development in personal lines underwriting and young drivers car insurance has been the use of dynamic pricing. An insurer may decide to increase its rates to improve overall profitability. As a result insurers have developed approaches to pricing that model the renewal behaviour of policyholders.
Advances in technology have allowed insurers to analyse new data elements and to detect correlations through multi-variate as opposed to single-variable analysis. By using information on the elasticity of demand to estimate policyholder retention, it is possible to determine rate structures that produce the optimal combination of growth in policy numbers and profitability.
Insurers will typically try to estimate the likelihood of customers shopping around for an alternative quote, relating this to the size of premium increase and the likelihood of their switching on a similar basis. The probability of switching may differ according to whether the case is intermediated or direct, or due to a range of risk, customer loyalty or even socioeconomic factors.
The probabilities of both shopping around and switching are the most difficult elements of the dynamic pricing model to apply parameters to. Insurers might look at industry studies of the relationship between customer loyalty and price, surveys of policyholders and their own commercial experiences. Some common factors affecting the likelihood of retention include:
- holding other policies with the same insurer
- the length of time a policy has been held with an insurer
- whether a policy is held through a broker or directly with the insurer
- the level of rate increase
- the insurer's competitive position.
Insurers need to be constantly mindful of competition law when sharing data and pricing and risk assessment techniques. In 2010, an enquiry by the OFT into the use of "What if" software led to the withdrawal of this software from insurers who were able to interrogate competitors' rating structures.
Released On 5th Jul 2011