Within the last 15 years there have been significant innovations in the pricing of personal and commercial insurance. Three quick examples come to mind:
- The use of more powerful pricing models, often based on Generalized Linear Models (GLMs)
- The use of personal and business credit histories
- The advent of Usage Based Insurance (UBI)
These innovations allow for more sophisticated pricing, based on the premise that they can be used to more accurately predict an insured’s risk.
Such innovation is welcome, but it does come with a price. Ten to fifteen years ago, one could easily pick up an insurance company’s rating manual and, with good old fashioned pencil and paper, figure out what rate you would be charged. Fast-forward to today, and that situation has changed. Many insurance companies have invested significant time and resources to develop complex underwriting and pricing models that almost always incorporate “credit scores” or “insurance scores” generated by third party vendors. The results of these models and their underlying classifications are often filed with insurance departments under the auspices of being a “Trade Secret.” As such, a portion of the rating manual is not made public. The new rating process has the outward appearance of a “black box,” as an insured’s rate cannot be calculated from the publicly available manual. This is complicated by the fact that there is seemingly only one accurate source for a given insurance company’s actual rates…the insurance company itself.
Enter UBI. Now your auto insurance premium can be determined based on information transmitted electronically from a “black box” in your vehicle. As new types and massive quantities of information become available from insureds, insurers will surely protect this data and any modeled results based on it under the auspices of being a “Trade Secret.” Even now, some insurers are offering discounts to their insureds so they can begin collecting telemetric vehicle data. Ultimately data generated from a “black box” may be modeled through another “black box” before determining your insurance premium. UBI also represents another departure from traditional personal insurance pricing in that your insurance premium may not even be known in advance, which presents a whole new set of questions.
How comforting is all this? Are we ready for pricing innovations like UBI now or is it the wave of the more distant future? Tell us what you think.