It is a time-honored practice in insurance ratemaking for insurers to study their competitors' rates. And, because of rate regulation, competitors' price information is a matter of public record.

By maintaining awareness of rate activity, an insurer can identify opportunities to achieve competitive advantage by balancing the actuarial component of its rates with knowledge of the market position. For many companies, the filings of leading insurers provide a view of pricing innovations and more-sophisticated rate structures.

Since the early 1990s, when new data and analytical-ratemaking techniques were introduced to personal-lines insurance, increased pricing sophistication among leading carriers has created a growing divide between the technological “haves” and “have nots.” Many lagging insurers are trying to bridge the gap by copying the rate structures of leading carriers, resulting in an explosion of copycat ratemaking.

It's easy to understand why an insurer with a less-sophisticated rate structure might see imitation ratemaking as a convenient solution. To develop its own pricing enhancements, a company requires significant resources, including data sources and analytical expertise that the insurer may not have.

By emulating a leading carrier, the insurer seems assured of a competitive pricing position without committing the upfront resources needed to develop and implement a new rate plan. But imitation ratemaking has many costs and considerable business risks.

The Costs Of Copying

Rate filings are publicly available, but that does not mean they're free. When an insurer decides to emulate rates, it is committing substantial capital to build a copying infrastructure.

There are costs involved in obtaining rate filings and monitoring filings for updates. But the most significant costs come from interpreting the filings and compiling them in a form that the copycat company can use.

The leading carriers are fully aware of copycats, so they do what they can to make it difficult to assemble a fully operational rate plan from their filings. These days, they don't even need to try very hard because rating plans are becoming increasingly complex.

As a result, it takes considerable effort to import, assemble and restructure the elements of a rate plan so it is operational in an imitation-rating system. This time and effort must be expended for each state in which the insurer writes. In the end, the emulating insurer must devote many people and systems to make copying possible.

Incomplete Info

But even if successful in cracking the code and accurately assembling the information from the filing, some elements are often missed. Several aspects of the leading competitor's rate plan may be confidential and not available to the public.

For example, the details of tiering plans and company-placement guidelines are not filed or made public in many states. The laws in certain states specifically protect proprietary credit-based insurance scores from public disclosure.

A filing may show how much the leading carrier will charge a risk with an insurance score of 750, but the copycat has no information about why the risk has that score. By substituting another insurance score, the copycat may be forcing a square peg into a round hole.

The imitation strategy can also create an incomplete view of the insurer's market position. When a company decides to copy, it inherently 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 carriers struggle against each other to gain market share. Chasing only one of those carriers can leave the emulating insurer vulnerable.

Invitation For Pricing Risk

Imitating another insurer's rates exposes the copycat to one of the most deadly business risks in insurance: namely, pricing risk—the risk that rates do not match the costs to provide insurance coverage. By replicating rates, the copycat implicitly assumes that its cost structure will also mimic the costs assumed in those rates.

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

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

Besides, a carrier's rates reflect much more than cost structure. They also represent numerous market-based decisions relating to issues as diverse as target marketing, agency relationships, and the balance between attracting new customers and retaining existing customers.

By adopting the competitor's rates, the copycat implicitly adopts a host of strategic business decisions without participating in the decision-making process at all. If the copycat's strategies don't line up with what the competitor had in mind, the result may be an even greater mismatch between revenue and costs. It's a risky bet.

Breaking the Critical Feedback Cycle

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

As actuaries review rates, they can examine how claims and operating costs are trending and provide important information to company management.

But if a company uses imitation ratemaking, its actuaries may spend more time trying to understand the competitor's rates than determining the company's own costs. The flow of cost-trend information may lessen or slow, weakening management's ability to monitor development of adverse trends.

The Alternative: A Cost-Based Focus

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

Insurers cannot afford to let competitive pressures divert focus from understanding their costs and managing both expenses and revenues to accomplish strategic goals.

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

Companies can supplement their own analyses of loss experience with sophisticated new predictive analyses of industry loss data to gain better understanding of loss costs and enhanced rate segmentation—without exposing themselves to the costs and risks of copycat ratemaking.

Special Reports /

The Perils Of Copycat Ratemaking

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