Price Optimization Overview Casualty Actuarial Society Committee on Ratemaking Price Optimization Working Party November

Summary Introduction Historical Practice Current Practice Points of consideration 2

Introduction 3 Ratemaking Process –Actuarial Cost Estimates –Goals –Resource limitations –External Environment Regulatory Competitive –Brand/Reputation –Target customers Price Optimization helps quantify pieces of the ratemaking process.

Introduction Definition of Price Optimization –The supplementation of traditional actuarial loss cost models to include quantitative customer demand models for use in determining customer prices. –The end result is a set of proposed adjustments to the cost models by customer segment for actuarial risk classes. 4

Evolution of P&C Pricing Progression follows advances in science and technology Since GLM’s, analytic efforts have gone beyond customer costs. 1900’s 2000’s 2010’s Overall Rate Indication One-way Segment Analysis GLM’s Customer Lifetime Value Price Optimization HISTORICAL RECENT CURRENT Customer Demand Analysis 5

Historical Practices Making adjustments to the actuarially indicated rates is not a new practice. Often described as actuarial judgment. Process was not objective or quantified SegmentExposure % Actuarial IndicationSelected Mono-Line42.78% Mulit-Line57.22% ? SimplificationConsistencyCompetitiveDisruptionMarketingRegulation 6

Current Practice Key similarities –Adjustments are made directly to filed and approved actuarial risk classes; and, –Adjustments are made with user-defined business goals in mind. Key differences from historical practice –Market demand and customer behavior are quantified instead of being subjectively determined; and –The effect of the rate deviation from the loss cost on business metrics is mathematically measured. 7

Current Practice Optimization Engine Actuarial Loss Cost Models Reasonable Profit and Growth Goals Regulatory Considerations Market Considerations / Competition Adjusted Actuarial Models 8

Current Practice 9 Cost-based prices Optimized prices Goals determine which direction you want to go Regulations determine how objectives can be achieved. Market considerations connect profit and quantity Optimization engine finds the prices that best achieve your goals.

Points of Consideration Historical methods of assessing impact of a rate change assume overall distribution of risks will remain unchanged. –Significant asymmetry regarding which customers will accept the new pricing and which customers will choose to leave. –New customers will not always have the same profile as customers lost. –In the interests of actuaries to anticipate these changes. Low-income customers –Price optimization works at a rating factor level and income is not a rating factor. –Low income customers do not all have the same price sensitivity. –For a given company, price sensitivity exhibited by customers to that company is heavily dependent on that company’s prices, which can vary widely. Enables companies to measure multi-year customer costs. 10

Price Optimization Working Party –Morgan Bugbee, FCAS, MAAA, Chair –Bob Matthews, FCAS, –Sandra Callanan, FCAS, MAAA –John Ewert, FCAS, MAAA, CPCU, ARM, ARe –Serhat Guven, FCAS, MAAA –LeRoy Boison, FCAS, MAAA –Christine Liao, FCAS, MAAA 11