InsuranceRescue Publications

Automobile Insurance Price Optimization

back to Publications Summary

This month’s article focuses on a controversial and technical topic in the auto insurance world - Price Optimization. The reason it’s important is because price optimization will impact the average cost of car insurance for consumers. How, you ask, will this affect my car insurance price? Perhaps before I tell you how, I’ll focus on why.

Automobile insurance has become just another commodity. Some will argue this point, but that is this writer’s opinion. I also believe that a well-qualified insurance agent remains a smart insurance buyer’s best resource to navigate this complex and important purchase. But many insurance consumers are simply searching and buying their policies online. And why is that?

Insurance companies spend billions of dollars annually to get you to switch to their company simply because they want you to believe their average car insurance rate is lower than what you’re paying today. Company A says they’ll save you $500 a year. Company B says they will save you $375 per year. And so on. How can this be?

First, there are car insurance cost savings – on average – for each of these companies. But you and I have no idea what data were used to come up with these amazing statistics. Understanding that each company is different and is generally honest, I do believe their quoted statistics are accurate. But remember, as this quote attributed to several writers states, “Statistics are used much like a drunk uses a lamppost: for support, not illumination.”

Some of us will save money by changing insurers. Just make sure you compare apples to apples (limits, deductibles, etc.). Also, you may want to ask how your new insurance company’s renewal pricing works. For example, if you don’t have any claims or changes, will your premium remain the same, get better (lower), or could it rise? If it could increase, what factors cause that.

Something new for auto insurance pricing?

Price optimization has been used in retail sales for years, but it is relatively new in the insurance marketplace. So perhaps the best place to start is with a formal definition, relative to insurance. If it was only that simple.

What I discovered in my research were way too many definitions from way too many sources. Robert Hartwig, in a recent presentation1 at the National Conference of Insurance Legislators (NCOIL), said there are “At least 7 definitions from states; as well as other definitions from regulators and from vendors.” I won’t list each of these definitions given their length and complexity. Instead I’ve done my best to provide a reasonably simple description.

Price optimization is the use of available consumer behavior data, in analytical models, to assess customer (consumer) response to varying prices for a product (automobile insurance), while helping to maximize the company’s operating profits.

Dandy (or ugh). So what the heck does this mean and why would an insurance company want to use price optimization? There are many reasons, not the least of which is making a greater profit from a business (auto insurance) that has had historically poor profit margins.

Historically, the longer a customer remains with their insurance company, the more profitable that customer becomes. You’ll occasionally hear this called lifetime value. Insurance companies aggressively compete to retain their “good” clients. But what if the insurance company didn’t need to price all auto insurance clients quite so aggressively?  For example, we know that certain types of clients shop less than others.

  • What if a company could assess which customers shop often and which customers hardly ever shop?
  • And what if the insurer could charge a higher price for that non-shopping client, knowing they would still stay?

Hmmm. Interesting questions that lead to the heart of “price optimization.” So from the oft asked Google Search question, “How much is car insurance, anyway?” we find the answer may be dependent on what the insurer knows about your shopping habits.

Car insurance costs (average auto insurance rates) are determined through the process of ratemaking. Typically an insurance company’s actuaries manage much of the ratemaking process. The Casualty Actuarial Society’s (CAS) Statement of Principles Regarding Property and Casualty Insurance Ratemaking focuses on four ratemaking principals.2

  • Principle 1: A rate is an estimate of the expected value of future costs.
  • Principle 2: A rate provides for all costs associated with the transfer of risk (jgf: moving the exposure from the consumer/buyer to the insurance company).
  • Principle 3: A rate provides for the costs associated with an individual risk transfer.
  • Principle 4: A rate is reasonable and not excessive, inadequate or unfairly discriminatory if it is an actuarially sound estimate of the expected value of all future costs associated with an individual risk transfer.
  • In addition to the four principles above, it must be noted that “judgment” elements also come into play during automobile insurance pricing activities.

And herein lies the controversy. Should some of the judgment portion of ratemaking include marketplace considerations? For example:

  • If internal or external data indicate that married 30-year old drivers with no children shop their insurance more often than married 30 year old drivers with one child, should an insurance company be allowed to charge the non-shopper a higher rate even though these two drivers have identical loss experience?
  • If an insurance company knows you are an insurance shopper (FYI: when you go to an insurance site your information and activities are generally tracked unless you use a browser in private mode), should your insurer be able to charge you less because they know that you are predisposed to shopping when your rate is raised?

Some state insurance regulators are beginning to say “No” because they do not consider marketplace considerations as a risk factor. These regulators believe that price optimization is a pricing practice that may cause a rate that is unreasonable, excessive, and unfairly discriminatory.

As a seasoned insurance guy, with many years of pricing experience, I do understand why an insurer would want to use any and all available data to price their auto insurance business for a maximum profit. But as a consumer, I believe price optimization can (will; does) appear to be extremely unfair, especially to those of us who always assumed that our allegiance and loyalty would be “rewarded” with a better rates, rather than a higher price previously charged to a less loyal customer.

This is a truly complex topic and there are voluminous reports and studies available to read. The National Association of Insurance Commissioners (NAIC) will be releasing recommendations very soon. For automobile insurance buyers (just about all of us) it would be wise to ask your insurance company if they use price optimization. If they do, then perhaps it is time to shop and compare products and prices.

  1. Source: “Price Optimization in Auto Insurance Markets; Actuarial, Economic and Regulatory Considerations”; NCOIL Conference, 7/17/2015. Robert P. Hartwig, Ph.D., CPCU, President & Economist, Insurance Information Institute
  2. Source: NAIC Casualty Actuarial and Statistical (C) Task Force; Price Optimization While Paper. May 19, 2015.

Jonathan Farris is a retired insurance executive and president of InsuranceRescue Services, LLC, a property & casualty insurance consulting firm based in Madison, Wisconsin. Mr. Farris can be reached at