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Price Optimization or Gouging? 18 States Call Out Insurers for Unfair Practice

Think your car insurance company should give you a discount for being a loyal customer? In some cases, the exact opposite is true.

Many insurers use something called “price optimization” to evaluate how likely customers are to shop around, and then charge more or less based on the results. Consumer advocates have complained loudly about the practice -- which they often refer to as "price gouging" -- during the past few years.

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Regulators in 18 states -- plus the District of Columbia -- have said the practice is illegal with Virginia being the latest earlier this year.

Industry representatives argue that concerns about price optimization are overblown, but agree that consumers should regularly shop for car insurance to ensure they get the best deal.

How price optimization affects auto insurance rates

Price optimization means using big data to adjust rates based on factors such as indicators of whether an increase would cause a specific customer to shop around for a better deal.

A company might raise rates for some customers, but leave them the same for people who have switched insurers in the past, have credit checks from insurers on their credit reports, complain about their coverage or ask lots of questions, reports Robert Hunter, insurance director for the Consumer Federation of America. As the National Association of Insurance Commissioners Casualty Actuarial and Statistical Task Force put in in a white paper on the subject: “By measuring and using price elasticity of demand, an insurer can ‘optimize’ prices to charge the greatest price without causing the consumer to switch to another insurer.”

In a 2013 survey of 73 executives and pricing professionals representing companies that sell auto coverage in the United States and Canada, 55 percent reported using customer price elasticity when setting rates. Representatives at 45 percent of large insurers (gross written premiums more than $1 billion) reported using price optimization and another 29 percent said they planned to do so in the near future.

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States require car insurers to base rates on factors related to expenses and risk, and not discriminate among customers.

“Charging two people with the same characteristics a different rate is unfair discrimination,” Hunter says. It’s also immoral, he adds, because states generally require drivers to buy insurance.

Price optimization can have an outsized impact on poorer drivers, who might not have as much access to the internet (which makes comparison shopping easy) or might not be as savvy about shopping around, Hunter says.

The NAIC task force recommended that, under state requirements that rates not be unfairly discriminatory, regulators should not allow pricing that accounts for: price elasticity of demand; propensity to shop for insurance; retention adjustment at an individual level; or a policyholder’s propensity to ask questions or file complaints.

Virginia Insurance Commissioner Jacqueline Cunningham recently spoke about practice, issuing a notice on April 15 saying “any rate differentials for the same coverage must be based on differences between expected losses and/or expenses,” adding that this does include “price optimization techniques intended to maximize overall retention, profitability, written premium or market share based on how much of a premium increase an individual policyholder is likely to tolerate before seeking coverage with other carriers.”

Industry: Price optimization is a normal practice

James Lynch, chief actuary for the Insurance Information Institute, says insurers who use price optimization see it as no different from how they’ve always refined rates, albeit higher-tech.

Models often churn out rates that are not competitive, so companies tweak them using various factors, he says, adding that two customers may end up paying different amounts, but both rates are reasonable and fair. 

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Also, rating formulas have gotten so complicated that it’s virtually impossible for two drivers to have identical risk profiles, meaning you can’t attribute price differences to any one factor, or say that two drivers with the exact same profiles are paying different amounts, Lynch says.

“There are more combinations of rates than there are drivers, so in essence everybody ends up in a different bucket.”

As for the idea that price optimization unfairly affects poorer customers, the III points to its 2014 survey, which found people making less than $35,000 a year were more likely to shop around for a policy than those at other income levels.

Shopping for insurance can lower rates

One point of agreement among consumer advocates and industry representatives is the importance of shopping around for the best rate on car insurance.

Each company has its own way of factoring variables into its rates, so no one company will provide the lowest price in every circumstance.

“They don’t all have the same data, and they don’t all interpret it the same way, and they don’t model it the same way,” Lynch says.

One insurer can easily charge twice or three times as much as another for the exact same customer, Hunter reports.

It’s particularly important to get new rate quotes after a big change, such as getting married, moving or buying a new car. The insurer that provided the lowest quote in your old circumstance may no longer give you the best deal.

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