6 reasons why you should not stick to transparent insurance pricing

“Our pricing must be transparent”, “we need to be able to explain our pricing”, “our management wants to understand our rates”, “we need to be able to justify a premium presented to any individual or a quotation provided to an agent”.

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I hear such statements frequently from numerous insurers of literally any size, regardless of the market they operate in and the products they offer. Obviously, these are fair points to consider, as transparency gives comfort and a feeling of being in control to the interested parties - either management, agents, or customers. Additionally, it’s often a regulatory requirement, or at least is believed to be one.  

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However, at the same time, in the same markets, there are insurers that walk away from the focus on transparency and instead prioritize performance, personalisation, and business results. Based on several cases of insurers I came across from markets such as the UK, Poland or Greece, I can tell such a strategy proved to be highly beneficial for them, having a reflection in lower loss and combined ratios. Apparently, it also turned out to be appealing to policyholders as market shares of those insurers kept on growing way above market average consistently for several years.

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Those observations sparked a reflection that turned into this article. An article that aims to discuss a few of the most common and important reasons for easing up on pricing transparency and instead focusing on the sophistication, accuracy, and business performance of pricing models.  

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Needless to say, the intention of this blog post is not to undermine the need to stay compliant with local regulations or to follow fair and non-discriminatory practices – these are key principles that must be adhered to whether we intend to keep pricing fully transparent or not.

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Reason 1 – Avoiding a transparency trap  

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Paraphrasing a well-known saying that “no one got fired for selecting IBM as IT vendor”, I believe the same goes for building a better pricing model. One of the main responsibilities of a pricing actuary is a proper risk evaluation and reflecting that risk in a premium to ensure a profitable portfolio and an adequate price for the risk taken. Using a limited number of explanatory variables or restraining from using more sophisticated approaches purely for the sake of maintaining transparency is basically against those principles.  

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As our study shows, implementing more advanced approaches including ML models and price optimisation algorithm results in 2-4 p.p. combined ratio improvement as well as portfolio GWP increase of up to 9,4%. Those results are aligned with market benchmarks included in McKinsey report¹ that quantifies impact of price sophistication on portfolio performance.  

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Figure 1. Potential gains from increased pricing sophistication.¹

Naturally, the details may differ from one company to another, so everyone needs to test find their own sweet spot and balance.

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Knowing that – from the perspective of business performance and portfolio profitability, the most accurate models should be applied, even if they are not fully transparent. Of course, provided they produce reasonable and time-consistent results.

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Reason 2 – Agents do not need to understand how the premium is calculated

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There is a common belief that agents, brokers or other intermediaries need to be able to explain the price to the end customer. But is that really the case? Do agents truly need to be able to understand and explain details of the premium calculation to the client or is it just a matter of well-established habit? And where the explainability really ends? Even if we provide a set of factors and coefficients to an agent to explain offered premium, there may always be a follow-up question about how were those factors and coefficients calculated. That brings up a question if we can’t have a 100% explainable model, should we strive to explain it at all?

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I believe that if you have a solid pricing model and you know how you want to price the risk, you do not need to explain yourself either to an agent or to a client. In my opinion, it is a matter of smart communication and education of agents to be able to explain to a client in a polite and professional manner that the premium has been calculated according to the evaluation of risk performed by the insurer, based on the provided information, taking into account the policyholder’s data, insured object data and claims history.

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There are a number of examples of successful transitions from transparent, yet basic pricing, to a more advanced and less explainable approach.  

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Naturally, it required some time and consistency to train agents to operate in a new way, trust the provided quotations and answer to customers request to explain a price with confidence. Companies that decided to go down that route managed to obtain a buy-in from agents and are now widely used with tremendous business outcomes.

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Ultimately, it’s up to every insurer’s decision and strategy to balance benefits of both approaches and decide which way to proceed.  

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Reason 3 – Insurers need results to thrive, not price transparency  

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Insurers, at least the stock companies, are commercial institutions that operate to generate returns for their shareholders. They also need to deliver strong financial results to stay in the game and be a stable partner providing safety to their policyholders. If less transparent pricing will result in better business results, then I believe it’s in the best interest of the company to compromise on price transparency.  

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Personally, I can’t imagine a situation where anyone in charge of the insurance company and its results would give up on business performance for the sake of transparency unless it’s truly required to stay compliant.  

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Nowadays, insurers in many markets operate on a very thin margin and are desperately looking for ways to differentiate themselves, evaluate risks better and attract the customer segments that will yield higher margins. If that doesn’t go on par with transparency, then the decision what to compromise on should be fairly straightforward.

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Reason 4 – Why help competitors to figure out your pricing strategies?

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Transparent pricing models are not transparent just for you. They are also transparent for your competitors, who can easily figure out your algorithms and replicate them.

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For basic pricing models with a few variables split into a handful of categories, it just takes a limited number of requests to observe how each variable change impacts the final price. Why would you make your competitors’ lives so easy and benefit from your pricing efforts?

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On the other hand, when you implement a complex pricing model with data enrichment and apply non-linear algorithms on top, then replicating that won’t be so easy. Anyone willing to do so would need to gather much more data points and put exponentially more effort into figuring out how to properly mimic your pricing.  

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If you add to it a reasonable dynamics of price changes, it would be hardly possible for any competitor to be in a position to figure out how your pricing algorithm actually works at any given point in time.

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Reason 5 – No need to make fraudsters life easier

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Insurers are losing over $300 billion in the US alone² due to insurance fraud. A lot of it comes from application fraud, which is basically manipulation of the data provided for quotation in order to obtain a lower premium for insurance product.  

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Simple and transparent pricing is just like an invitation for fraudsters saying – come and take advantage of me, here are the parameters, just play with them for a few minutes and you’ll easily guess what values you need to provide to get a better price.  

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Such an approach inevitably leads to an increased scale of abuse, which would in many cases qualify as insurance application fraud. Obviously, that’s something none of the insurers would like to experience for their portfolio. Yet anyone having a basic pricing, which is prone to data manipulation, is definitely more exposed to such practices than the others.

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Reason 6 – Sophistication can go on par with compliance  

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Probably the hardest nut to crack. In some markets, regulators are stricter than in others with respect to the transparency and filing of insurance pricing. And even within jurisdictions subject to a pretty strict regulations, there are ways to stay compliant while driving pricing sophistication.  

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Naturally, this post is not legal or compliance advice but rather refers to observations and conclusions based on market practices. Those seem to suggest that in a majority of cases, there is a space for increasing sophistication while staying perfectly compliant.  

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There may be several ways to achieve that, for example implementing necessary technologies, adding new skills to the team or redesigning the process, to unlock new pricing capabilities while maintaining regulatory compliance. For example, insurers implementing price optimization and associated demand models may still fulfill required transparency requirements by providing a range of premiums offered for a specific risk profile instead of a fixed rate. Such an approach is no less transparent than a premium based only on risk factors adjusted by discretionary sales discounts on top. It is much more data-driven and proves to deliver better results, though.

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As a result, companies that take a bit more aggressive strategy and comply with regulations following a more advanced and sophisticated approach may gain a huge competitive advantage over the ones that are more conservative and stick to the legacy compliance processes.

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Conclusions

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In summary, although there are multiple reasons and rationales for maintaining a fully transparent pricing structures, there are also several compelling reasons for giving up on transparency for the sake of higher model accuracy, better results, increased profitability and more personalized offering.  

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Overall, it is part of each insurer’s strategy to decide how they want to position themselves in the market and whether their priorities are on the transparency or performance side.  

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As for me, given all of the reasons provided in the blog post, the benefits of sacrificing transparency for the sake of building a better-performing business are simply too vivid to ignore.

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Whether you agree or disagree with the presented point of view, if you’d be interested in having a chat, sharing your thoughts or discussing your current challenges concerning insurance pricing please contact me at: mat@quantee.ai.

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References:

¹ https://www.mckinsey.com/industries/financial-services/our-insights/the-post-covid-19-pricing-imperative-for-p-and-c-insurers

² https://insurancefraud.org/fraud-stats/