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HOW TO SUCCESSFULLY MANAGE THE PRICING DECISION PROCESS Michael J.

Miller

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HOW TO SUCCESSFULLY MANAGE THE PRICING DECISION PROCESS BY MICHAEL J. MILLER

Biography: Mr. Miller is a management and actuarial consultant with Tillinghast in its Bloomington, Illinois office. Prior to joining Tillinghast, he was an actuary with State Farm Insurance. He graduated from Illinois State University in 1968, became a Member of the American Academy of Actuaries in 1975 and a Fellow of the CAS in 1981. Abstract: Determining insurance prices certainly has actuarial implications, but it's too important to be left solely to actuaries. Insurers which successfully manage the pricing decision process all recognize pricing as an integral part of the annual operational planning process. Good pricing decisions are designed to produce the planned financial results by coordinating actuarial, underwriting, marketing and claim considerations. This paper discusses both the common characteristics of well-managed pricing decisions and the characteristics of pricing decision processes which have often been unsuccessful. The roles which an actuary can, and should, play in the pricing decision process are also identified.

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INTRODUCTION

In the property/casualty that is of of to an actuarial insurance determine

insurance nature. prices those

business, Indeed, and actuaries expected the

the term "pricing" expected are costs

implies are an

something important uniquely often costs. cause cost. it may

foundation qualified reflects Underwriting, the price

recognized But

as being pricing expected

costs.

insurance of

considerations marketing, charged

beyond legal

determination business

and other

considerations determined

may all expected

to be different
insurance

than the actuarially pricing involves which actuarial

This means that not be restricted

while

considerations, actuarial in nature.

to considerations

are purely

If

one accepts

the notion

that

pricing expected

goes beyond costs, all of

the sole

domain of the actuary for management then into pricing important to price to a

and the

actuarially

indicted

the question the affected

becomes how to coordinate rational decision decisions its and effective process is

and integrate pricing decision. because

disciplines an effective the most

Establishing pricing is one of

important

made by management. then it

If management does not have the expertise follows that it

own product, its

logically plan

does not have the ability own business. then it In short, not

prepare if

own operating is

or effectively to price its

manage its own product,

an insurer

not prepared

should

be

licensed

by the regulator

to do business.

Over the years their pricing

this

author

has been requested

by a number of insurers of these studies

to evaluate

decision pricing

processes. decisions, were but

The emphasis rather

has seldom been were made, what team was

on specific information

on how the decisions and who on the

and factors

considered

management

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involved.

These consulting information

studies

have typically as well

involved

a complete

assessment of have making both

of the management the actuarial, been conducted

system, marketing large and

as the operational functions. for

procedures The studies

underwriting, for both

and claims small


insurers,

both

those and for

independent those with

pricfng actuaries

decisions and those actually

and those with

relying

on rate Having

bureaus, observed

no actuaries. used by insurers of both successful

and studied decisions, pricing a

the different number decision of

procedures

in make pricing

common characteristics processes

and unsuccessful

have been identified.

CHARACTERISTICS OF UNSUCCESSFUL PRICING DECISION PROCESSES

Distrust

of Data

Historically, to consolidate that such

the U.S. property/casualty data and promulgate are for

insurance benchmark rates

has relied or loss many

heavily costs. It have at

on bureaus is argued data the of risk data

benchmarks credibility level. stretched or loss

necessary ratemaking

because

insurers especially need for

insufficient classification base is often rates its

purposes,

Unfortunately, in an attempt costs. Every of future Without

the justifiable
to

an industry

rationalize has,

the unjustified or should that have,

need for the expertise is based the plan,

benchmark to develop entirely insurer effective

insurer costs,

own projection data. its

even if

projection

on industrywide cannot develop

the expertise plan.

to project Without

the future,

own operating
occur.

a meaningful

management

cannot

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This

widely

held

trust

in industry discredit

consolidated their

data and projected own data. Some insurers information even exposure

costs

has led

some insurers bother data

to completely important lacks

do not even because data the

to produce supposedly

management

and ratemaking cases,

credibility. large all or

In extreme small,

is not its

available. product that readily

No insurer, without knowing has

can effectively its time.

manage and price book of business The failure demonstrates

there or loss is

is to know about changing, over

and how to have

business available

changed, premium,

and exposure

information and a complete

a naive of

understanding the concept

of the concept of partial

of credibility

misunderstanding

credibility.

No Actuarial

Analysis

Actuarial do not influence follow is

rate reflect

change indications the competitive Insurers with with rate

are based on a projection and legal considerations decision change

of expected which processes indications. of effort

costs also

and often

pricing.

weak regard

pricing to rate

typically Either it

one of two approaches actuarial

assumed that

change

indications

are a waste

and no

attempt change

is made to project indications It is is difficult to

losses adjusted

and expenses, to produce

or the calculation rates which are

of the rate deemed is worse. fail planning will to be Both to

competitive. of these

to know which pricing are totally

of the two approaches market an integral charge driven part

approaches that rate

and both of the

recognize process. allow,

change

indications is that that

are

The underlying so any actuarial

premise indication

"we can only differs

what the market rate

from the market

is useless."

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Rate

change

indications expected know if


target

should costs. the rates KetUKnS. place If

be viewed an insurer dictated

as a quantitative

diagnostic true rate

tool

for

determining then it its

does not know its

needs,

cannot
OK

by the market

are sufficient
are

to produce informed If the (e.g. are part of

planned

Once fUtUKe expectations

determined, expectations. other claims

discussions market changes necessary the rate

can take prices

as to how to respond an
inSUKeK

to those

dictated in

are too low, rules,

mustknowwhat emphasis results.


OK

actions handling) all


OK

underwriting in order

marketing the planned

to produce

Implementing for management

change

indication

is just

one alternative

to consider.

Incomplete

Competitive

Analvsis

Insurers analyzing important, for

with

weak pricing

decision market.

processes Anecdotal

tend

to

spend

too

little force

time is

the competitive but

information picture. or relying

from the sales Comparing entirely

does not provide classes

a complete of business, to identify of the

a few base rates on a comparison and risk rules

one or two selected rates,

of average classification which create

does not begin definitions

the mismatches special

in territory and rating

and all problems.

discounts

competitive

Another is limited should are very strategy

frequent

shortcoming

of some insurers companies. at least

is

that

the competitive can be helpful, in the analysis it is not

analysis but one which

to a few "peer" to include

Such a comparison one or two insurers As in most businesses, of struggling the winners,

be careful successful

in the market. in a subgroup with group.

a winning

to be the best

competitors. even if they

In the long-run, are not presently

one must find considered

ways to compete

to be in the peer

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No Awareness

of COKDOKata Profit

Requirements

Many insurers underwriting

have profit

historically provision,

calculated

rates
OK

utilizing 5.0%.

some predetermine Such a pricing provision return stratef in th

such as OX, 2.5% if, and only targeted

can be successful rates has a logical

in the long-run relationship

if,

the profit corporate

to the

on equity.

Insurers corporate pKOCess. heirlooms profit

with profit

weak pricing goals to

decision those

processes personnel

often involved

do not in the

communicate pricing are

thei

decisio typicall: those

The profit from the past

provisions

used

in

the

Kate

CalcUlations to directly corporate

and no one has made an effort return in the current

relate plan.

provisions

to the target

Operating

Plan

Not Activelv

Used As A Management

Tool

Insurers prepare it until

with

poorly

managed pricing plan

decisions

either

have no operating year

plan

ox

an operating

at the beginning Prices

of the fiscal

and then disregarc to last year's

the end of the year. results

are established market may also conditions

to respond

underwriting from tighten invented are not operating there

or to meet current department. rules, There OK perhaps

and appease

complaints attempt risks tc is

the marketing underwriting with unified plan.

be some Unquantified for "preferred"

a new program edge.

the hope of regaining in the sense If the actual scramble will

a competitive

Typically, impact

these

actions

of quantifying profits to fix

the expected

on the current the targets, declarations

at the end of the year things next quickly yeaK.

miss

is a collective results

and the usual

are made that

be better

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It

is possible the

to manage the financial cycles of hard and soft

results markets.

of a property/casualty But successful are tightly solely

insurer, management intertwined. of

despite results If

requires

a recognitionthatpricing prevent achieving

and planning profit goals

market

conditions

through and/or

pricing

activities, The type of

then some adjustment adjustment if

must be made in underwriting of the adjustment are off

marketing. and is

and extent

can be coordinated the mark and an attempt and marketing

managed only

one knows how far the expected

the prices

made to quantify

impact

of the underwriting

changes,

Pricing

Decision

Delesated

Too Far Down In The Oreanization

It

is

an axiom

that

achievement

of profit underwriting, decision

targets

requires marketing often

the coordination and claims functions.

of

the viewpoints The insurers of the four is

of the actuarial, with weak pricing

processes

have allowed

one or two this senior in the

functions to have

to dominate the final

the decision. decision

The only

way to prevent by a

imbalance executive, development impact losses)

on pricing executive
but

reviewed

preferably of the

the CEO. The senior details of rate the proposal, action

need not be involved should be informed the expected

as to the profits (or

of the contemplated arising


to

on the customers,

from the new rates, bring


the

and any necessary results in line

adjustments with

in underwriting plan.

and marketing

expected

the operating

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CHARACTERISTICS OF SUCCESSNL PRICING DECISION PROCESSES

Information.

Information,

Information

It

is

an

old that

cliche, the

but three

insurers most

with

strong elements

pricing of

decision

processes insurance seem to even a new their

understand operation understand or a very product

important

a successful These insurers

are information, that small knowing all

information there

and information.

is to know about gives

a book of business,

book of business, their

them a competitive

edge in pricing

and managing

business.

Contrary have price of

to conventional

wisdom, information All

it

is not just systems (large if

the giants

of the industry to

which

good management their product. pricing

and the

confidence

independently are capable system data No

insurers their product

and small,

new and old)

independently

a good management expertise publicly its first to utilize available policy like the

information the internal information. until allowing hospital a

is in place in conjunction insurer information to perform install room.

and the staff with be industry

has sufficient data to

and other issue

should

permitted is operative.

complete a doctor failed to

system major

To do otherwise later learning

is a bit that

surgery

and then

the equipment

necessary

to adequately

monitor

the patient

in the recovery

Obiective

Actuarial

Analysis

All

good pricing Sometimes

decisions the rates

begin

with

an objective by the actuarial

actuarial

projection cannot

of future be charged

costs.

indicated

analysis

202

in a competitive regulator. shade the

marketplace,

nor

can they it

be expected is important

to be approved that

by the not

But no matter indicated rates.

how bad the news, just to

the actuary or politically

rates

produce

competitively important cost

"acceptable" effectively team.

To do so is

to withhold

information

and

take a crucial

management decision

out of the hands of the management

There available the

is a great

amount of competitive capability

information to digest are all

and market of the data. to rely

intelligence The insurers on identify it

data with

and a limited pricing to not

best

decision only For monitor example,

processes

learning rates,

new computer profitable possible to

technology market identify niches overlapping demographic

competitor's the computer

but also

niches. profitable arise risk data. by

technology for personal rating

makes insurance.

marketing identifying classification

opportunities out-dated definitions

These market and available

territory

definitions publicly

and analyzing

Profit

Obiective

Discinlines

Manaeement

Financial

theorists

and model-builders insurance income, lines

can convincingly anunderwriting and reasonable

prove loss, total is In

that

for

many

property/casualty with investment with

of business a fair is that

when combined return. given an The to the

can produce theories of loss

problem

many financial in the

no consideration company.

human factor operation where

management

an insurance is considered

insurance management

an underwriting

to be acceptable,

203

discipline otherwise corrected two.

is reject

always

diminished.

A marginal or an unprofitable manager

risk

which

an underwriter

would

is now accepted

agency which is tolerated for

would have been another month or

immediately

by the marketing

The best

managed insurers culture. offices

have

a clearly

stated state of total goals

profit the profit profits, in terms

objective goals for

which

is part

of the corporate divisions

Some insurers in terms

the operating the goals profits. Some goals in

and branch

some state of underwriting

terms of operating But however may view is this stated,

profits

and some state is always

the objective semantics,

described

with

the word profit. in the corporate

as only word

but reference

to a "lose."

the wrong

choice.

Insurers stated division successfully which which stated in

exhibiting terms of

a high

degree

of management profits because Operating

discipline that profit is

tend the targets

to have that

goals the used

underwriting managers

result

and branch

can control. but

are also

by some insurers,

such targets

do involve

an investment Profit tend impact

return targets to be because income offices. there and

is out of the control are the least

of the division in instilling Total

and branch

managers. discipline

successful returns.

management returns have

in terms

of total

the least

such targets to individual

depend on an arbitrary lines of insurance,

allocation operating

of surplus divisions

and investment and/or branch

When the performance is a tendency for

of a line the manager formulae

manager to spend for

is judged too

on a total trying rather

return

basis,

much time advantage,

to understand than concentrating

change the allocation on managing

personal

the business.

204

In

a well-managed

pricing

decision

process, tend

all

the

players division rates if

have

a sense

of

accountability. managers to charge the

The successful less than

insurers

to allow

and/or

branch

the actuarially such as tightening

indicated

they have a plan growth. the new to

to make-up The marketing quality of

difference, manager

underwriting rates will

or slowing tend to certain the

who claims of business, cause at least

that or the

lower

improve that leeway

the

book

underwriter is generally

who is given

underwriting implement judgments the only

rules

will

improvement once. But

program,

these

concessions for

to professional the actual results.

make sense if

the managers

are accountable

Accountability information monitor to live there

can system

only

exist

if

two

conditions

are

met. results

The

management to

must be designed of the decisions decisions.

to provide

the actual

necessary long explain

the effect with appears their

and the managers The accountability insurers staff.

must be in place factor may well

enough why

to be a correlationbetween with a stable

with

a history

of good pricing

decisions

and insurers

Accountability indicated implemented. both verified delightful wrong, actuaries from rates

is

also

important

in

the

determination arising from

of

the

actuarially to be sound, be easily This is a

and the projection Tliere

of profits

the new rates are logically but cannot

are a number of ratemaking and a financial for for accuracy theory by actual theorist for

models which viewpoint, financial

an actuarial retroactively situation

results. never

the actuarial situation

who can probably insurance

be proven Even

but an unacceptable are held

a well-managed insurance

company.

accountable

in well-managed

companies.

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Broad

Role

For the Actuarv

The actuary initial and

plays

a key role of the historic the indicated

in the pricing data,

decision

process a projection

by conducting of future But insurers

the costs with

analysis calculating pricing role.

developing rate

cost-based

action. their

successful broader

decision

processes

tend to utilize

actuaries

in an even

Actuaries ascertain Sometimes shifting market

should

be working

closely

with but also

the

marketing

people

to market

not

only

the competitive loss marketing analysis power ratios

situation, can be

identify

profitable increases

niches. simply

improved

and rate

avoided

by

emphasis

from one market solely

to another.

Too often with

in the past, sufficient Actuaries profitability analysis and

has consisted live qualified to identify

of identifying an agent

where people in that

purchasing are uniquely

and then placing

neighborhood. data with

to
markets

combine favorable

demographic for

expectations

expansion. is equally

Much of this available

can be based on data small insurers.

in the public

domain which

to large

Actuaries good pricing policy

and underwriters decisions. or rules, a or

should The effect change the in

also

be working ratios retention of

closely

together

to arrive in the rate a change are

at of in all

on loss policy

from a change levels, or

growth,

underwriting quantifiable. rather target. then

introduction

a new insurance to quantify their

program those

The best rely

managed insurers in an effort

do attempt to keep

changes, results on

on hunches,

financial

206

Finally, calculation This results projection, is

no pricing

decision

is

complete

unless expected for

there

has been

an explicit implemented. financial this the

and communication critical are management

of the profit information The actuary

from the rates if

an insurer

planned

to be achieved. but in so doing affect

is uniquely

qualified

to prepare going on within

must be aware of all results,


not

the changes just

company which

the financial

the rate

change.

FINAL NOTES TO THE CEO

The Good.

The Bad and The Satisfied

There

are

some insurers pricing decision

which

exhibit and

all for

of

the them

characteristics the potential which

of for exhibit

a wellfurther nearly The trouble

managed

process There of

improvement all the

is marginal.

is also

a group

of insurers decisions

characteristics which quickly is possess and then, with

poorly

managed pricing

procedures. into

insurers fairly challenge survive excellence.

most of the bad characteristics thankfully, group of take corrective that

tend to get action. do enough

The more serious things right to

a large

insurers wrong is

comfortably This considers will never

and enough group the of

things

to prevent with

the achievement its results. may be

of true Until possible,

insurers possibility

satisfied that

management excellence

improvements

be achieved.

Expense

Budpet

versus

Ooeratinrr

Plan

Throughout actual annual

this

paper

there results with

has been frequent to an operating varying degrees

reference plan. of success plan. Most

to the need to compare insurers implement expenses. plan an

and expected expense budget not all

in controlling

Surprisingly,

insurers

have an operating

A good operating

207

is stated expenses, projected unless

on a market but profits. there is also

segment basis projected No pricing

and includes writings, process plan.

not only

the expected claim

operating losses and

premium decision operating potential,

projected

can be consistently The operating management requirements, apparent from plan

successful provides the can be

a complete which all

benchmark judged. against because

against With

alternate capital

decisions

the advent plan

of risk-based will

the need to manage to many insurers the regulator.

an operating the alternative

become increasingly be unwelcome

may well

assistance

Inter-Disciuline

Conflict

Pricing claims between natural

decisions considerations. these friction would four

involve

a balancing While

of actuarial,

underwriting, degree of it

marketing of conflict affairs, appears could "big drop

and

the existence is a healthy to

of a reasonable and natural manage. if state

functions can be

this that its

frustrating

Sometimes each discipline of the

management narrow

be easfer

and more efficient a better

provincialism

and adopt

understanding

picture."

All

insurers

tend

to exhibit

these

inter-discipline no effective

frictions, way of balancing management and the final

but

those

with

weak pricing inputs. lines able

decisionmanagementhave with best

the different to have good is

The insurers of communication to properly

pricing
the

decision

tend

between

disciplines, viewpoints.

decision-maker

balance

the various

As tempting conflicts actuary tries pricing

as it

may be, one does not want to eliminate the guess management the marketing team. It

these becomes

inter-disciplinary dangerous when an person to the views

and homogenize tries to think decision. will to second like

manager,

and the marketing input is important the competing

an underwriter. The trick produce

Each discipline's

is in coordinating the budgeted results.

or balancing

in a way that

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