California joined Maryland and Ohio in recent weeks in take action against a pricing technique that has come under fire from consumer advocate groups.
More than 750 insurers operating in the state were notified that they must stop using so-called “price optimization” tactics—the practice of basing pricing on a customer’s “willingness to pay a higher premium relative to other individuals or classes,” according to insurance commissioner Dave Jones.
“Price optimization represents a fundamental threat to fairness in rating,” Jones said.
Insurance companies have long said such techniques are business decisions designed to increase their relative competitiveness and, as such, do not qualify as “rating.” Consumer advocacy groups, however, have been watching the practice with concern for the last 10 years.
“What you get [when you use price optimization] is sort of the opposite of insurance,” Birny Birnbaum, executive director of the Center for Economic Justice, told Insurance Business. “The idea of insurance is that you transfer the risk of a catastrophic event to an insurance company, which will diversify and spread the risk across all insurers.
“But with this ultra-refined rating, they’ve spread the distance between the least desirable risk and the most desirable, and the least are charged higher and higher rates the more insurers refine their rating plan.”
It is unclear how many insurance companies in the state use price optimization, as insurers are not required to report it to the commissioner’s office.
This has made it difficult to track the practice. However, a Towers Watson report suggests that as many as 50% of property/casualty insurance companies employ price optimization in their businesses.
For agents, the use of price optimization by insurers puts them in a “tough position,” said Birnbaum.
“It’s just like when credit scoring was introduced. Companies didn’t tell consumers what was going on, so agents were stuck in this position where someone would say, ‘I’ve got a new, higher price’ and the agent was forced to explain that it was because of their credit,” he said. “With price optimization, you’ve got the same thing—you get an indication for a rate increase but agents are not in a position to help out.”
The new action against price optimization was issued at the end of February. Because insurers do not disclose it as part of their rating methodology, it is difficult to judge how the action will affect rating for auto insurance customers.
