Rating Errors Cost U.S. Auto Insurers $13.7 Billion, Says Consultant
Whether it be an honest mistake or outright fraud, inaccurate data on vehicles and drivers is costing the U.S. auto insurance industry dearly, according to a San Francisco-based consultant.
According to Quality Planning Corporation, an estimated $13.7 billion in premium revenues was left on the table by auto insurers in 2003 due to rating errors that diminished income. Changes that affect auto insurance premiumsincluding household composition, switching jobs, adding or deleting vehicles, and adding new driversare all subject to faulty and/or fraudulent reporting, the consultant noted.
"Its an accepted fact that there is some premium leakage," said a QPC press announcement. "Insurance companies know that not all consumers are entirely forthcoming with the facts, overtly or covertly, when they complete an insurance policy application. Consequently, insurers must build this risk into their calculations when they determine premium pricing."
QPC said it conducts premium audits for private passenger auto policies, and that its 2003 report summarizes results of more than 13 million such policies from "10 major carriers." Results are weighted to reflect "the total national private passenger auto line."
The $13.7 billion premium rating error represents 9.6 percent of personal auto insurance premium revenues nationwide, QPC claimed. The biggest contributors to that figure are unrated drivers (1.7 percent) and commute/annual mileage (1.5 percent), the consultant added.
In any single sample of 100 policies QPC audits, 85 will result in a recommendation to raise the premium, the company said. Another 5 policies will need to have premium reduced, while the remaining 10 should remain the same, although some information may still be inaccurate.
The $13.7 billion figure, however, does not take into account an estimated $100 million being overcharged in premium on that 5 percent of policies, said Bob Uren, vice president of underwriting at QPC.
According to Raj Bhat, vice president of technology at QPC, the overcharges are relatively low, because they are generally for "smaller items," such as when a driver moves or retiresas opposed to factors with larger impacts, such as unlisted drivers.
In estimating rating error, QPC said it compares the "expected distribution" of rating factors to the rated distribution. Where annual mileage is considered, the expected distribution of factors is the distribution, "given the characteristics of policies written." QPC noted that it "expect[s] the average new Ferrari to be driven an average of 3,500 miles per year, and the average new Chevy cargo van to be driven more than 20,000 miles."
The figures are based on numerous studies of vehicle use patterns, the consultant said. Actual odometer readings from more than 30 million vehicles were also used in developing the statistical models.
In addition, QPC utilizes direct measurement. "For over a million vehicles in the sample, we had data for multiple odometer readings to evaluate actual annual mileage," the company noted. QPC said it also interviewed more than one million insureds concerning their vehicle usage patterns and annual miles driven. These results were used to help refine and validate the statistical models.
Asked why insureds would not misrepresent mileage to QPC researchers, assuming they had done so with their carriers, Mr. Bhat pointed out that QPC has external databases against which it can check individual cases before asking questions. Odometer readings, he pointed out, may be taken during an oil change or a smog check, or as part of the claims process.
According to Mr. Bhat, when QPC questioners mention mileage from such benchmarks, "it prevents [policyholders] from giving you really bad data."
"It takes a pretty sophisticated liar to follow the deception [on odometer readings] all the way through," Mr. Uren said, adding that QPCs researchers are never confrontational with policyholders.
The 2003 report, based on data from 2002, revealed that an increasing number of auto insurers are surveying policyholders to update rating information, said QPC. "In the surveys, carriers were more likely to require policyholder response as a condition of renewal," the report noted. The surveys are estimated to have reduced total rating error slightly in two rating categories, annual mileage and unlisted operators.
Another trend identified by QPC was an increase in rating error due to mis-reporting of a vehicles garage address. "In total, we estimate that 0.6 percent of premium is lost due to territory mis-reporting for a dollar loss of approximately $840 million," said QPC.
According to Daniel Finnegan, founder and CEO of QPC, "Our latest research shows that if an auto insurance company can cut its rating error by 50 percent, it is likely that the company can more than double its profits."
With such an obvious value proposition, why havent insurers made more efforts to cut rating errors? "Its very difficult for insurers to validate this information," explains Mr. Uren. Both he and Mr. Bhat suggested that QPC has access to more sophisticated statistical models and databases. For insurers to go after each policy rating error "one at a time" would be "really expensive," Mr. Uren noted.
"We can do it for less than they can," Mr. Bhat stated.
"Companies have leaked as much as 15 percent [in lost premiums]," said Mr. Uren. "We can collect 50 to 60 percent of that in the first year."
To do such an audit, QPC charges range from $8 to $10 per policy, but the company cautions that many variables can affect that rate. "[Customers] will get more than four times [the money] they put in," Mr. Bhat stated.
Reproduced from National Underwriter Property & Casualty/Risk & Benefits Management Edition, July 28, 2003. Copyright 2003 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.
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