Insurers Adding Sophistication To Underwriting

By Steve Tuckey

NU Online News Service, Feb. 23, 11:25 a.m. EST?Insurers, in a quest to refine their personal lines underwriting, are upgrading their systems with a variety of new data that gives them a sophisticated, individualized picture of each customer’s risk, according to industry professionals.[@@]

The new underwriting methods are not without their critics, who maintain companies can use them to skirt the normal regulatory approval process for rate changes.

But, experts in the field said insurers who don’t adopt the new technique may be doomed. They named Progressive as the pioneer in this underwriting methodology. Among the latest companies to revamp its underwriting is Chubb Corp., which said it is in the process of implementing a new tiered underwriting system.

The Warren, N.J.-based carrier has already set in motion the system for underwriting personal homeowner renewals, and over the next year will implement it for new homeowners business and new and renewal business for personal auto coverage.

Prudential analyst Jay Gelb, in a note to investors, said the new plan “could lead to faster than expected growth” for the company.

Chubb spokesman Mark Schussel confirmed the company was undertaking an effort to “better match price to risk,” but did not want to go into details for competitive reasons.

Instead of simply categorizing risks as sub-standard and standard, carriers have set numerous categories within the standard realm based on criteria that go beyond age and driving record, and are including such new standards as credit scores and previous liability limits.

But not all carriers are created equal in regard to their ability to, in the words of InsurQuote vice president Kelly Whaley, “paint a picture of the consumer’s potential for loss.”

“Every company does not paint the same picture,” Mr. Whaley said. “In fact, while some companies are painting a Mona Lisa, others are still finger-painting.”

A report put out last year by McKinsey & Company consultants with InsurQuote, the analytic software firm, ranked Cleveland area-based Progressive first in such underwriting sophistication. It cited the fact that Progressive produced 7,776 different quotes for a group of customers. That group all received the same quote from Nationwide, the carrier ranked last and tenth in the study.

With personal lines accounting for only 25 percent of its business, Chubb was not ranked in that study.

In a report last year, then Lehman Bros. analyst Chris Winans noted that late adapters to this new underwriting technology “are largely doomed to an extended purgatory as they scramble to catch up.”

“Those that do not try will see the quality of their books continue to deteriorate at the hands of those insurers that started three years ago or longer and today are continually introducing increasingly accurate versions of their pricing models,” Mr. Winans said.

But some industry critics fear that these new and more stratified tiering schemes are ways of getting new prices through the underwriting process as opposed to the rating process, which is more highly regulated.

Birny Birnbaum, director of the Austin, Texas-based Center for Economic Justice, explained official scrutiny of such pricing is avoided because, “historically, regulators have not reviewed underwriting practices.”

Terry Tyrpin, senior vice president for the Chicago area-based Property Casualty Insurers Association of America, views the new segmentation tools as “enablers” that allow drivers who may not have been insurable in the past to be able get coverage.

“It is an enabler rather than a circumnavigation of any underwriting or rating rules. Those rating standards still exist, and they can’t be bypassed simply because you are using a more segmented or sophisticated rating system,” Mr. Tyrpin.

Mr. Whaley said the sophistication of any company’s rating plan can be judged on four characteristics: granularity?the number of distinct premiums for a selected group of policyholders; dispersion?the ability of a rating plan to differentiate the risk potential of policyholders over the range of their rating plan; interaction effects?a plan’s use of combinations of variables to explain more than the variables can explain individually; and advanced variables?using new variables not yet incorporated into mainstream rating plans.

Mr. Tyrpin said the plethora of sources now available to insurance companies allows them greater latitude in pricing.

“Insurance companies no longer have to depend solely on motor vehicle departments for driving records. In fact, they found the quality and accuracy and completeness of information on driving record alone is not as good as it should be so therefore there was automatically a quest to try to improve the quality of underwriting by looking for alternative sources of information.”

In addition to credit scores, companies now have access to more complete collision data from third party vendors, especially crucial in those states where it is not a part of the driving record, Mr. Tyrpin said.

New variables are constantly being looked at in an attempt to paint that masterpiece. While credit may be considered an “emerging variable,” according to the McKinsey-InsurQuote study, “innovative” ones include prior bodily injury claims, occupation and education.

“It stands to reason that all variables were at some point ?new’ variables,” Mr. Whaley said. “The companies that find them and incorporate them into their rating plans have a competitive advantage, although temporary, over their competition. And as time goes on, these companies begin to develop an expertise in finding and using other new variables in pricing that other companies don’t have.”

Particularly in the early stages of development, carriers must not only perfect the new models but also adapt corporate cultures to fit the new underwriting philosophy, Mr. Whaley said.

“Through change companies are getting better at developing sophisticated rating plans,” he said. “Change is not easy for any company. But it is required. The only other option is to whither away through many cycles of adverse selection and eventually cease to exist as a business entity.”