Part One: Program Structure

From The Original Insurance Wiki

Part One: Program Structure

At the most basic level, there are two methods of underwriting PPA:

[edit] Risk Qualification

This type of underwriting, usually associated with highly preferred programs--those with the lowest prices and best coverage options, involves establishing a set of qualifying characteristics, then evaluating applicants against those criteria. Product managers and actuaries usually develop the criteria (or Underwriting Guidelines), based on historical data, to reflect the characteristics of those risks least likely to incur a loss.

Example:

A hypothetical carrier, Acme Insurance, has conducted an extensive analysis of its historical loss patterns for PPA. Based on this analysis, an Ultra-Preferred program offering a 30% discount from Acme’s standard rate has been developed and is offered for any risk meeting all of the following criteria:

The risk must be multi-car.

• All cars must have full coverage (liability and physical damage).

• At least one of the vehicles must be a four-door sedan, a station wagon, or a mini-van.

• All drivers on the policy must be at least 32 years old.

• No more than one moving violation per driver can have occurred during the last 3 years.

• No driver can have been involved in an accident during the last 3 years.

• The applicants can have submitted no comprehensive claims during the last 3 years.

The task for Acme’s agents and in-house underwriters is straightforward. They must gather the information required for each applicant and evaluate that information against the guidelines. If the risk meets all established criteria, the policy is accepted and receives the Ultra-Preferred discount of 30%. (Discussion of what happens to those risks not meeting the criteria is deferred to a later section).

[edit] “Price to the Risk”

The second type of underwriting for PPA is encapsulated in the phrase “there is no bad risk, only a bad price”. This type of underwriting is generally associated with the opposite end of the risk spectrum from preferred risks, commonly referred to as non-standard automobile.

The underwriting task here is more complex than in risk qualification. No absolute standard exists for comparison. Instead, the process involves gathering numerous pieces of data and using them to determine a price and limits at which Acme is willing to insure the risk. The types of information used include the following:

• Age, sex, and marital status of all drivers on the policy.

• Complete driving records (MVRs) for all drivers.

• A report on claims history from a third-party information provider.

• A credit score for at least the named insured from a third-party information provider.

• Information about the vehicles to be insured—make, year, model, engine size, ABS, passive restraints, anti-theft devices, etc.

• The types of coverages applied for and the limits for each.

• Information about previous insurance purchased by the applicant.

All of this information is evaluated to determine the combination of limits and prices Acme is willing to offer, on an applicant-by-applicant basis. Acme might cap the BI/PD coverage it is willing to offer a specific client to 50/100, and offer only certain deductibles on physical damage coverage, based on the combination of these factors.

It is beyond the scope of this paper to discuss the development of the rating algorithms used to develop “price to the risk” programs. Which criteria are important and their relative importance vary from carrier to carrier, and in fact constitute trade secrets for most of them. For the our purposes, we need only to understand that such criteria do exist, the general types of criteria in common use, and how we can evaluate them.

A Corollary to the two methods of underwriting PPA—“Offensive Pricing”

It is important to bear in mind that PPA is regulated, and usually marketed, at the state level (more on this in the next section). Competition is intense, and carriers are very aware of and sensitive to the actions of others in the various local marketplaces. In this highly competitive environment, companies frequently engage in what can be referred to as “offensive pricing”. The purpose of underwriting and risk selection is not only to get the risks a carrier wants, but also to make sure a certain competitor gets the one it doesn’t want.

For example…

• Acme Insurance has studied actuarial data relating the credit score of an applicant to their likelihood of filing a future claim against an auto insurance policy. Acme now gathers credit scores at the point of sale as part of its underwriting process, prior to quoting a price for any policy.

Acme’s primary competitor, “Brand X”, does not order credit scores.

• For selected risks known by Acme to be extremely likely to file claims based on their credit score, the product manager has made sure that Acme is priced well above Brand X.

• Given the price sensitivity of the PPA market, Brand X writes those policies in virtually every case. Acme has priced offensively against Brand X to the latter’s financial detriment.