• Vermont Department of Financial Regulation Addresses Price Optimization In Property and Casualty Ratemaking
  • July 10, 2015 | Author: G. Donovan Brown
  • Law Firm: Colodny Fass, P.A. - Tallahassee Office
  • In Bulletin 186 issued last week, the Vermont Department of Financial Regulation ("VDFR") addressed the issue of "price optimization" by reminding all property and casualty insurers issuing personal lines policies in Vermont that all ratemaking must conform to statutory requirements in Chapter 128 of Title 8 V.S.A. relating to property and casualty insurance rate regulation.

    Noting that some property and casualty insurers may been relying on the practice of price optimization to help determine premiums charged to policyholders, the VDFR specified that, under Section 4685(d) of Title 8, unfair discrimination is considered to exist if price differentials "fail to reflect equitably the differences in expected losses and expenses" for different classes of policyholders.

    The VDFR explained that, in classifying policyholder risks for ratemaking purposes, insurers are allowed to use rating plans "which provide for recognition of probable variations in hazards, expenses, or both." See 8 V.S.A. § 4686(2).

    As these sections make clear, the VDFR added, both base rates and rating classes must be based on factors specifically related to an insurer's expected losses and expenses. While insurers may employ judgment in setting their rates, judgmental adjustments to a rate may not be based on non-risk-related factors such as "price elasticity of demand" which seek to predict how much of a price increase a policyholder will tolerate before switching to a different insurer, the VDFR said.

    The use of such factors not only unfairly discriminates between policyholders of the same risk profile, but is also directly in conflict with the statutory principles that underlie Vermont's "open and competitive" property and casualty marketplace¸ the VDFR emphasized.

    The VDFR acknowledged that not all insurers have adopted the practice of price optimization. To help regulators identify the possible use of inappropriate rating factors, insurers are directed that, henceforth, all personal lines rate filings must disclose on the SERFF General Information page whether the company uses non-risk-related factors such as "price elasticity of demand" (as defined above) to help determine the insured's final premium.

    Rate filings currently under review by the VDFR should be amended to disclose this information. The authority for this requirement is contained in 8 V.S.A. § 4688(a)'s language that "every insurer shall file with the Commissioner all rates and supplementary rate information, and supporting information which are to be used in this State."

    According to the VDFR, statutory definitions of "supplementary rate information" and "supporting information" make it clear that these terms include all factors that are used to help determine a policyholder's final premium. See 8 V.S.A. § 4683 (18) and (19).

    A failure to comply with this directive shall be considered a violation of Section 4688(a).

    The National Association of Insurance Commissioners' Casualty Actuarial and Statistical Task Force is currently in process of drafting a "white paper" analyzing price optimization and its use in insurance ratemaking. While there is no universally-accepted definition of "price optimization," the practice--in some of its applications--involves the judgmental use of factors not specifically related to a policyholder's risk profile to help determine or adjust his or her insurance premium.

    An example would be using an individual policyholder's response to previous premium increases to determine how much of a premium increase the policyholder will tolerate at renewal before engaging in comparison shopping or switching to a different insurer. This practice can result in two policyholders receiving different premium increases even though they have the same loss history and risk profile.