Setting insurance prices based on the risk taken seems like a straightforward concept. If insurance companies were forced to come up with a single price for coverage without taking into account specific risk factors—including the likelihood of having to file a claim—insurance would become prohibitively expensive for everyone, with the lowest risk takers subsidizing the riskiest.
Risk-based pricing enables insurers to offer the lowest possible premiums to policyholders with the most favorable risk factors, enabling them to take out a wider range of policies, improving both the availability and affordability of cover.
Complications arise when actuarially sound rating factors intersect with other attributes in ways that could be perceived as unfairly discriminatory. For example, concerns have been raised about the use of credit-based insurance scores, geography, home ownership and motor vehicle records in determining home and auto insurance premiums. Critics say this could lead to “proxy discrimination,” where people of color in urban areas are sometimes charged more than their suburban neighbors for the same coverage. Concerns have also been expressed about using gender as a rating factor.
Triple-I has published a new Issues Brief that succinctly explains how risk-based pricing works, the predictive value of rating factors and their importance in keeping insurance affordable while enabling insurers to retain the funds needed to deliver on their promises to the policyholders. Integral to fair pricing and reserving are the teams of actuaries and data scientists that insurers employ to quantify and differentiate between a range of risk variables while avoiding unfair discrimination.
“There is no place in today’s insurance market for unfair discrimination,” the letter says. “Besides being illegal, discrimination based on any factor that does not directly affect the insured risk would be bad business in today’s diverse society.”
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