Don’t Trust the Black Box

Don’t Trust the Black box!

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You know what I mean.  The secret sauce insurance companies cook up to rate and price their products.  The secret tiers, the magic variables, the rating alchemy.  No one but the initiated traveling the path of Ivy League MBAs and Actuarial Secret Societies have gazed upon these models.
In the early 2000s, these pricing models, especially in auto, came into vogue.  No one was more successful at developing these sophisticated systems than Progressive.  And they worked.  Profits rolled in, and the rest of the industry was quick to follow.
Multivariate pricing was the name of the game.  Identify as many variables that could reliably be used to identify a customer, and price on each of these factors.  None of these would have been possible before the advent of sophisticated desktop computer power.  It could never have happened in the days of manual rating.  I remember back in my Progressive days when these models were first being launched, one particular DOI (I think VA) questioned the accuracy of the rating.  They actually asked someone from the company to come to the DOI and demonstrate the ability to manually rate several policies.  Because the rating was done through computer algorithms, and not real people, the company had to find someone with a math degree to demonstrate the problem to the DOI.  In my mind’s eye, I imagine a disheveled college professor spending hours calculating on a giant blackboard, filling it with numbers, square roots, squiggles, and Greek letters.
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Credit was the backbone of this type of rating.  This upset and confused many agents and regulators.  Customers were mystified.  But as time went on, it proved itself a predictor of loss and behavior.
 It’s probably been 15+ years since the industry has been unprofitable in auto. Several years ago, I caught myself saying, “Auto profitability is reliable.  The only thing we really have to worry about anymore is property, and that is only because of weather.”  Then 2016 hit.  No one made money.  The big dog of insurance, State Farm, lost $30 Million in auto.
What happened?
Industry experts tell us it is multiple things: cost of repair, increased cars on the roads, distracted driving.
I’d put my money on distracted driving. Credit underwriting and multivariate pricing models struggle to identify this risk.
Unfortunately, this is not only impacting company profitable and increasing pricing for your customers, it is impacting your ability to generate profit-sharing and contingency dollars.  If it continues, it could even jeopardize contracts inside your agency.
What to do?
1.  Trust but Verify.  You remember Ronald Reagan, and his relationship with the Soviets.  In his negotations, he often said he trusted them, but verified their statements on the back end, just to be sure.  This has to be an agent’s attitude toward the pricing black box.  Trust it but verify it.  Carriers claim they can price for everything and have a price for every risk. Use it but don’t rely on it.  Don’t rely on them to DNR customers that become serial claimants.  You need to step in and ask for that non-renewal.  Resources are thinner at companies than they used to be, and humans aren’t monitoring individual accounts.  I’ve done this exercise with agents and have found examples of a customer with multiple claims (11) continuing to renew year after year, and continuing to cost everyone money.  Review your books of business with your carriers and take action.

2.  Oldschool Underwrite.  You know how to do this, but if you have staff that has come into your agency since 2005, they may not.  Even if a company advertises, “Price for every risk” or “Let the system do the underwriting”, don’t!  Have everyone ask 2 questions for every new customer:

“Will this customer make our agency and companies money long-term?” and “Will this customer attract good or bad business?”  

You might have to sit down and actually explain what good business looks like to some staff.  We’ve all become so reliant on the rating system to determine profitable customers. The mantra has become “If it takes it, we write it.”

Unprofitable books don’t help anyone, and the industry loses in the process.
It’s time to go back to basics.  Trust the tools, but don’t rely on the black box to make you money.

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