It is a time-honored practice in insurance ratemaking forinsurers to study their competitors' rates. And, because of rateregulation, competitors' price information is a matter of publicrecord.

By maintaining awareness of rateactivity, an insurer can identify opportunities to achievecompetitive advantage by balancing the actuarial component of itsrates with knowledge of the market position. For many companies,the filings of leading insurers provide a view of pricinginnovations and more-sophisticated rate structures.

Since the early 1990s, when new data and analytical-ratemakingtechniques were introduced to personal-lines insurance, increasedpricing sophistication among leading carriers has created a growingdivide between the technological “haves” and “have nots.” Manylagging insurers are trying to bridge the gap by copying the ratestructures of leading carriers, resulting in an explosion ofcopycat ratemaking.

It's easy to understand why an insurer with a less-sophisticatedrate structure might see imitation ratemaking as a convenientsolution. To develop its own pricing enhancements, a companyrequires significant resources, including data sources andanalytical expertise that the insurer may not have.

By emulating a leading carrier, the insurer seems assured of acompetitive pricing position without committing the upfrontresources needed to develop and implement a new rate plan. Butimitation ratemaking has many costs and considerable businessrisks.

The Costs Of Copying

Rate filings are publicly available, but that does not meanthey're free. When an insurer decides to emulate rates, it iscommitting substantial capital to build a copyinginfrastructure.

There are costs involved in obtaining rate filings andmonitoring filings for updates. But the most significant costs comefrom interpreting the filings and compiling them in a form that thecopycat company can use.

The leading carriers are fully aware of copycats, so they dowhat they can to make it difficult to assemble a fully operationalrate plan from their filings. These days, they don't even need totry very hard because rating plans are becoming increasinglycomplex.

As a result, it takes considerable effort to import, assembleand restructure the elements of a rate plan so it is operational inan imitation-rating system. This time and effort must be expendedfor each state in which the insurer writes. In the end, theemulating insurer must devote many people and systems to makecopying possible.

Incomplete Info

But even if successful in cracking the code and accuratelyassembling the information from the filing, some elements are oftenmissed. Several aspects of the leading competitor's rate plan maybe confidential and not available to the public.

For example, the details of tiering plans and company-placementguidelines are not filed or made public in many states. The laws incertain states specifically protect proprietary credit-basedinsurance scores from public disclosure.

A filing may show how much the leading carrier will charge arisk with an insurance score of 750, but the copycat has noinformation about why the risk has that score. By substitutinganother insurance score, the copycat may be forcing a square peginto a round hole.

The imitation strategy can also create an incomplete view of theinsurer's market position. When a company decides to copy, itinherently narrows its focus to one competitor.

That means it may not be aware of what other carriers are doing.Even in the most concentrated markets, multiple leading carriersstruggle against each other to gain market share. Chasing only oneof those carriers can leave the emulating insurer vulnerable.

Invitation For Pricing Risk

Imitating another insurer's rates exposes the copycat to one ofthe most deadly business risks in insurance: namely, pricingrisk—the risk that rates do not match the costs to provideinsurance coverage. By replicating rates, the copycat implicitlyassumes that its cost structure will also mimic the costs assumedin those rates.

A former underwriting executive told me of a time he waspressured to simply copy a leading carrier's rates. He responded,“Are we also going to copy that carrier's claims-handlinginfrastructure, their claim-settlement practices, theirunderwriting costs, their agency-compensation plan and their targetmarkets? If not, then it doesn't make sense to copy theirrates.”

As the statement illustrates, costs between two companies maydiffer significantly in a variety of ways. It's almost impossiblefor an outsider to know enough about a competitor's cost structureto make adequate comparisons. By adopting a competitor's rate plan,the copycat may not be collecting enough premium to cover actualcosts.

Besides, a carrier's rates reflect much more than coststructure. They also represent numerous market-based decisionsrelating to issues as diverse as target marketing, agencyrelationships, and the balance between attracting new customers andretaining existing customers.

By adopting the competitor's rates, the copycat implicitlyadopts a host of strategic business decisions without participatingin the decision-making process at all. If the copycat's strategiesdon't line up with what the competitor had in mind, the result maybe an even greater mismatch between revenue and costs. It's a riskybet.

Breaking the Critical Feedback Cycle

The ratemaking process provides an essential feedback loop for acompany to examine both its costs and its revenues.

As actuaries review rates, they can examine how claims andoperating costs are trending and provide important information tocompany management.

But if a company uses imitation ratemaking, its actuaries mayspend more time trying to understand the competitor's rates thandetermining the company's own costs. The flow of cost-trendinformation may lessen or slow, weakening management's ability tomonitor development of adverse trends.

The Alternative: A Cost-Based Focus

The way to mitigate pricing risk is to be constantly aware ofcosts and how premiums relate to them.

Insurers cannot afford to let competitive pressures divert focusfrom understanding their costs and managing both expenses andrevenues to accomplish strategic goals.

Companies increasingly have better access to data and analysisthat can bring sharper insight concerning cost and revenue drivers.Data marts and reporting tools provide important information aboutinternal operating costs.

Companies can supplement their own analyses of loss experiencewith sophisticated new predictive analyses of industry loss data togain better understanding of loss costs and enhanced ratesegmentation—without exposing themselves to the costs and risks ofcopycat ratemaking.