Rating Errors Costly to Insurers |
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Written by U.S. Insurance News
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Friday, 06 October 2006 |
A new Premium Rating Error report by Quality Planning Corporation finds that $16.2 billion worth of premium revenues were lost in 2005 by auto insurers that used faulty rating information as a basis for calculating policy premiums.
There are costly mistakes, and then there are really costly mistakes.
A new Premium Rating Error report by Quality Planning Corporation finds that $16.2 billion worth of premium revenues were lost in 2005 by auto insurers that used faulty rating information as a basis for calculating policy premiums.
The amount of loss roughly equals 10% of the $163 billion in premiums generated by personal auto insurance policies in the United States last year. Premium “leakage” in 2005 was about the same as that in 2004, meaning insurers have not corrected the problems causing the massive loss in premium revenue.
“For the average auto insurer, each percent of rating error loss translates into a 20 percent reduction in profitability,” said Dr. Daniel Finnegan, founder and president of QPC. “An insurer that reins in these losses through stringent data integrity measures can increase profits significantly.”
The good news for insurers is that identifying the source of the problem and correcting it, at least partially, is achievable. The Premium Rating Error report breaks down the rating errors into driver rating errors and vehicle rating errors. Driving rating errors, such as inaccuracies in driving records and driving experience, accounted for $8.7 billion in premium loss in 2005, up from $8.5 billion in 2004. Vehicle rating errors include miscalculations in commute distances, annual mileage, and vehicle usage.
For instance, though 17% of cars are driven more than 20,000 miles annually, only 4% are rated in this category. The report concludes, “Failure to identify these higher risk vehicles and rate them accordingly represents a major source of unmanaged loss costs.”
Finnegan said that these “can be controlled and reduced by insurers willing to adhere to fundamental principals of solid underwriting—that is by gathering, validating and maintaining accurate rating data.”
The Premium Rating Error report takes into consideration premium audit reviews of more than 18 million private passenger auto policies issued by 20 major auto insurers.
Finnegan acknowledges that change is a constant during the life of an auto insurance policy. Policy holders switch jobs, buy and sell vehicles, and watch their kids get driver’s licenses.
“On average, 52 percent of existing policies have a change in driver or vehicle every year, and 50 percent of the remaining policies have some other meaningful change,” Finnegan said. “It is difficult for auto insurers to keep up with these changes.”
Unfortunately, underwriting will never be a flawless process. Premium loss is inevitable because policy holders fabricate facts or make honest mistakes in giving their insurance agent information needed to write a policy. Insurers compensate for this by inflating premiums a bit for all policy holders, to the detriment of the honest ones.
“Rating error introduces significant inequalities into auto insurance,” Finnegan said.
Honest people subsidize the dishonest, low-risk drivers subsidize high-risk drivers, low-mileage drivers subsidize high-mileage drivers.”
One way insurers can overcome flawed data is to create and use graduated rating plans. The report shows that insurers who use those plans gain a competitive advantage over insurers who use flat rating plans.
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