With computer technology advancing by leaps and bounds, it’s no surprise that insurance companies have started using sophisticated software to help them determine what rates to charge their customers. While the insurance industry calls the process “price optimization”, consumer advocates call it biased and believe that they are using it to avoid insuring high risk customers, something that borders on being illegal.
In fact they call it “unfair and discriminatory” and, speaking for the Consumer Federation of America and Center for Economic Justice, say that they want this new process banned.
Price optimization is a “data mining” process that allows insurance companies to determine which customers are more likely to accept price increases and, conversely, which of them will shop around for a new policy if there’s a price increase, according to Robert Hunter of the CFA.
Formerly an insurance commissioner in Texas, Hunter says that the data mining allows insurers to see if they could “get away” with increasing rates on low income customers who, because of their financial situation, have fewer choices, and uses factors like their social economic status and financial literacy to make their determinations.
“What we’re seeing here is a way to take advantage of the fact that some people don’t shop for insurance and that’s wrong.” Hunter said. “It produces unfairly discriminatory rates which are illegal.”
Hunter says that, if two people have exactly the same risk factors, then they should also have the same insurance rate but, using price optimization, the least likely customer to switch carriers will be “tagged” for an insurance hike.
“It’s wrong, because it unfairly discriminates,” he said.
An executive for the Center for Economic Justice, Birny Birnbaum, says that price optimization is simply “a euphemism for price gouging,” and added that “It’s unfair because it has nothing to do with your cost to the system—your likelihood of a claim—and everything to do with your market power or lack of market power.”
On the other side of the fence the insurance industry is insisting that there is nothing illegal or immoral about their new price optimization system. They say that they are now able, using “big data”, to make predictions about consumer behavior. The scores that they use to make these predictions are not regulated and hidden from consumers and, in many cases, can be filled with inaccuracies, according to Herb Weisbaum from CNBC.
The president of the Insurance Information Institute, Robert Hartwig, disagrees and says that the new process does not discriminate or abandon the core principles of risk-based pricing that insurance companies have always used. In his opinion it simply provides “more precision in the process associated with pricing and allows insurers in an analytical way to deal with what-if scenarios.”
Hartwig goes on to say that “I take issue with the notion that somehow there’s something going on here that disadvantages consumers, when in fact consumers have more information at their fingertips than they ever had before in the history of the insurance industry,” He added that “The notion that poor people are somehow disadvantaged by this is equally absurd.”
The biggest problem is simply that there is no way for consumer to know which insurance company is using price optimization and which companies aren’t because, as they’re not obligated to inform state regulators of this information, most don’t.
Earnix, one of the global leaders in price optimization, performed a survey of the marketplace in 2013 and found that over 25% of automobile insurance companies, and approximately 45% of larger insurance companies in North America, are currently using the price optimization process. Their survey also found that 36% of insurance companies have plans to incorporate it into their pricing structure in the very near future.
So, while data mining and price optimization seem to stand on shaky moral ground, you can expect that in the next few years most insurance companies will be adopting the new process in determining what to charge their customers.