14 March 2016 | CIPR Newsle er

NAIC C A P O W P

By Kris DeFrain, NAIC Director of Research and Actuarial Department I State insurance regulators are evalua ng “price op miza-

on” tools and whether they should be used by property and casualty insurers in their ratemaking processes.1 The use of price op miza on is specifically being evaluated in light of the statutory standards in most states that rates shall not be “inadequate, excessive, or unfairly discriminatory.” The NAIC Casualty Actuarial and Sta s cal (C) Task Force began dra ing a price op miza on white paper in early 2015 analyzing price op miza on and its use in personal lines insurance ratemaking. At the 2015 Fall Na onal Mee ng, the Property and Casualty Insurance (C) Com-mi ee adopted the Task Force’s Price Op miza on White Paper (white paper). The white paper provides background informa on on price op miza on, iden fies poten al bene-fits and drawbacks of using price op miza on, and presents op ons for state regulatory responses regarding the use of price op miza on in personal lines insurance ratemaking. The NAIC’s full membership will consider adop ng the white paper at the upcoming Spring Na onal Mee ng in New Orleans. This ar cle will summarize the Task Force’s white paper, including the proposed state regulatory ac ons and the policy recommenda ons for regulators to consider. P S R A R Under most states’ laws, insurance personal lines’ “rates shall not be inadequate, excessive or unfairly discriminato-ry.” While accep ng some ra ng devia ons from indicated rates and ra ng factors, state regulators are concerned the use of sophis cated methods of price op miza on could deviate from tradi onal ratemaking, extending beyond ac-ceptable levels of adjustment to cost-based rates and re-sul ng in prices that vary unfairly by policyholder. Because of these concerns, the Task Force proposed state regulators consider taking the following ac ons: 1. Consider issuing a bulle n to address insurers’ use of

methods that may result in non-cost based rates. (A dra bulle n for considera on is included in the white paper.)

2. Consider enhancing requirements for personal lines rate filings to improve disclosure and transparency around rates, rate indica ons and rate selec ons.

(Ideas for poten al requirements for rate filings are included in the white paper.)

3. Analyze models used by insurers in ratemaking to en-sure the model adheres to state law and actuarial prin-ciples. (A list of possible ques ons to assist the regula-tory analysis is provided in the white paper.)

In the white paper, the Task Force made recommenda ons regarding rates and the regulatory rate review for personal lines insurance, summarized as follows: 1. Under any defini on of price op miza on, states

should address the requirement in their state ra ng laws that “rates shall not be excessive, inadequate or unfairly discriminatory.”

2. Ra ng plans should be derived from sound actuarial analysis and be cost-based. The proposed rates devel-oped from an actuarial analysis need to comply with state laws. They should also be consistent with the ac-tuarial principles derived from a professional actuarial body and the actuarial standards of prac ce established by the Actuarial Standards Board (ASB).

3. Two insurance customers having the same risk profile should be charged the same premium for the same cov-erage. Some temporary devia ons in premiums might exist between new and renewal customers with the same risk profile because of capping or premium transi-

on rules.

4. Not all rates and ra ng plans accepted or approved strictly adhere to the actuarial indica ons. While actu-arial indica ons are largely preferred over pure judg-ment, regulators acknowledge the actuarial indica ons are only an es mate of the cost to transfer risk and some insurer judgment will inevitably enter the rate se ng process. The Task Force recommends states al-low flexibility reflec ng insurance loss and expense costs in the selec on of ra ng factors. Some addi onal recommenda ons regarding the acceptance of devia-

ons from the actuarial indica ons are as follows:

a. The Task Force recommends the selec on of a pro-posed rate between the currently approved rate and the actuarially indicated rate be allowed if based on reasonable considera ons adhering to state law and consistent with actuarial principles and Standards of Prac ce reflec ng expected insur-ance loss and expense costs.

(Continued on page 15) 1 For more on price op miza on, visit: www.naic.org/cipr_topics/

topic_price_op miza on.htm.

March 2016 | CIPR Newsle er 15

NAIC C A P O W P (C )

b. The Task Force recommends a selected rate out-side the range defined by the current and indicated rate may be acceptable provided it is disclosed, complies with state law and is shown to be con-sistent with actuarial ratemaking principles and Standards of Prac ce.

c. The Task Force acknowledges capping and transi-onal rules can be in the public’s best interest but

recommends regulators consider the extent to which they will allow capping and transi onal ra ng. Considera on should be given to the length of me over which premium changes will be lim-ited before they reach the approved rate level, the size and reasonableness of capping upper and low-er bounds, and the extent to which capping of one rate might affect rates charged to others.

5. Under the requirement “rates shall not be … unfairly discriminatory,” insurance ra ng prac ces that adjust the current or actuarially indicated rates or the premi-ums, whether included or not included in the insurer’s ra ng plan, should not be allowed when the prac ce cannot be shown to be cost-based or comply with the state’s ra ng law. With due considera on as to wheth-er prac ces are cost-based or in compliance with state ra ng law, the Task Force believes the following prac-

ces, at a minimum, are inconsistent with statutory requirements that “rates shall not be … unfairly dis-criminatory”:

a. Price elas city of demand.

b. Propensity to shop for insurance.

c. Reten on adjustment at an individual level.

d. A policyholder’s propensity to ask ques ons or file complaints.

6. Ra ng plans in which insureds are grouped into homo-geneous ra ng classes should not be so granular that resul ng ra ng classes have li le actuarial or sta s cal reliability. The use of sophis cated data analysis to de-velop finely tuned methodologies with a mul plicity of possible ra ng cells is not, in and of itself, a viola on of ra ng laws as long as the ra ng classes and ra ng fac-tors are cost-based.

C The issues and concerns about the use of price op miza-

on remain a key priority for state insurance regulators. As of March 1, 2016, 18 jurisdic ons2 have taken public ac on with respect to price op miza on. Many of the ac ons have been to issue bulle ns restric ng the use of price op miza on under the defini on in each bulle n. A copy of the white paper, as well as a list of the jurisdic ons that have taken public ac on, along with their regulatory bulle-

ns, is available on the Casualty Actuarial and Sta s cal (C) Task Force Web page.3 Other states are awai ng adop-

on of the NAIC white paper by the full membership or believe their current state law is sufficient and no addi on-al ac on is necessary.

2 California Bulle n (Feb. 2015), Connec cut (Dec. 2015), District of Columbia (Aug. 2015), Delaware (Oct. 2015), Florida (May, 2015), Indiana (July 2015), Maine (Aug. 2015), Maryland (Oct. 2014), Minnesota (Nov. 2015), Missouri (Jan. 2016), Mon-tana (Sept. 2015), New York (March 2015), Ohio (Jan. 2015), Pennsylvania (Sept. 2015), Rhode Island (Sept. 2015), Vermont (June 2015), Virginia (July 2015) and Washington (July 2015).

3 www.naic.org/commi ees_c_ca .htm.

A A

Kris DeFrain is the NAIC Director of the Re-search and Actuarial Department. She is cur-rently charged as primary NAIC staff for the Principle-Based Reserving and the Casualty Actuarial and Sta s cal Task Forces. Ms. DeFrain manages a staff of actuaries, sta-

s cal analysts, insurance contract experts, and research analysts working on regulatory solvency- and market-related issues, provid-ing regulatory services, and conduc ng research for the Center for Insurance Policy and Research. Ms. DeFrain received her bachelor’s degree in finance/actuarial science from the University of Nebraska in 1989. She received her FCAS designa on from the Casualty Actuarial Society (CAS), where she previously served as Vice President—Interna onal. Ms. DeFrain is a member of the American Academy of Actuaries and a Char-tered Property & Casualty Underwriter.

March 2016 | CIPR Newsle er 29

© Copyright 2016 Na onal Associa on of Insurance Commissioners, all rights reserved. The Na onal Associa on of Insurance Commissioners (NAIC) is the U.S. standard-se ng and regulatory support organiza on created and gov-erned by the chief insurance regulators from the 50 states, the District of Columbia and five U.S. territories. Through the NAIC, state insurance regulators establish standards and best prac ces, conduct peer review, and coordinate their regulatory oversight. NAIC staff supports these efforts and represents the collec ve views of state regulators domes cally and interna onally. NAIC members, together with the central re-sources of the NAIC, form the na onal system of state-based insurance regula on in the U.S. For more informa on, visit www.naic.org. The views expressed in this publica on do not necessarily represent the views of NAIC, its officers or members. All informa on contained in this document is obtained from sources believed by the NAIC to be accurate and reliable. Because of the possibility of human or mechanical error as well as other factors, however, such informa on is provided “as is” without warranty of any kind. NO WARRANTY IS MADE, EXPRESS OR IM-PLIED, AS TO THE ACCURACY, TIMELINESS, COMPLETENESS, MERCHANTABILITY OR FITNESS FOR ANY PARTICULAR PURPOSE OF ANY OPINION OR INFORMATION GIVEN OR MADE IN THIS PUBLICATION. This publica on is provided solely to subscribers and then solely in connec on with and in furtherance of the regulatory purposes and objec ves of the NAIC and state insurance regula on. Data or informa on discussed or shown may be confiden al and or proprietary. Further distribu on of this publica on by the recipient to anyone is strictly prohibited. Anyone desiring to become a subscriber should contact the Center for Insur-ance Policy and Research Department directly.

NAIC Central Office Center for Insurance Policy and Research 1100 Walnut Street, Suite 1500 Kansas City, MO 64106-2197 Phone: 816-842-3600 Fax: 816-783-8175

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