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Price Optimization Overview

Casualty Actuarial Society

Committee on Ratemaking

Price Optimization Working Party

November 2014

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Summary

Introduction

Historical Practice

Current Practice

Points of consideration

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Introduction

Ratemaking Process– Actuarial Cost Estimates– Goals– Resource limitations– External Environment

• Regulatory• Competitive

– Brand/Reputation– Target customers

Price Optimization helps quantify pieces of the ratemaking process.

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Introduction

Definition of Price Optimization– The supplementation of traditional actuarial

loss cost models to include quantitative customer demand models for use in determining customer prices.

– The end result is a set of proposed adjustments to the cost models by customer segment for actuarial risk classes.

Evolution of P&C Pricing

Progression follows advances in science and technology

Since GLM’s, analytic efforts have gone beyond customer

costs.

1900’s

2000’s2010’s

Overall Rate Indication

One-way Segment Analysis

GLM’s

Customer Lifetime

Value

Price Optimization

HISTORICAL

RECENT

CURRENT

Customer Demand Analysis

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Historical Practices

Making adjustments to the actuarially indicated rates is not a new practice. Often described as actuarial judgment.

Process was not objective or quantified

Segment Exposure %Actuarial Indication Selected

Mono-Line 42.78% 1.0000 1.0000

Mulit-Line 57.22% 0.9151 ?

Simplification

Consistency

Competitive

Disruption

Marketing

Regulation

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Current Practice

Key similarities– Adjustments are made directly to filed and

approved actuarial risk classes; and,– Adjustments are made with user-defined

business goals in mind.

Key differences from historical practice– Market demand and customer behavior are

quantified instead of being subjectively determined; and

– The effect of the rate deviation from the loss cost on business metrics is mathematically measured.

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Current Practice

Optimization Engine

Actuarial Loss Cost Models

Reasonable Profit and

Growth Goals

Regulatory Considerations

Market Considerations / Competition

Adjusted Actuarial Models

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Current Practice

Quantity

Pro

fit

• Cost-based prices

Optimized prices

Goals determine which direction you want to go

Regulations determine how objectives can be achieved.

Market considerations connect profit and quantity

Optimization engine finds the prices that best achieve your goals.

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Points of Consideration

Historical methods of assessing impact of a rate change assume overall distribution of risks will remain unchanged.– Significant asymmetry regarding which customers will accept the new pricing

and which customers will choose to leave.– New customers will not always have the same profile as customers lost.– In the interests of actuaries to anticipate these changes.

Low-income customers– Price optimization works at a rating factor level and income is not a rating

factor.– Low income customers do not all have the same price sensitivity.– For a given company, price sensitivity exhibited by customers to that company

is heavily dependent on that company’s prices, which can vary widely.

Enables companies to measure multi-year customer costs.

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Price Optimization Working Party– Morgan Bugbee, FCAS, MAAA, Chair– Bob Matthews, FCAS, – Sandra Callanan, FCAS, MAAA– John Ewert, FCAS, MAAA, CPCU, ARM, ARe– Serhat Guven, FCAS, MAAA– LeRoy Boison, FCAS, MAAA– Christine Liao, FCAS, MAAA