Auto Premium Rating Error Cost U.S. Auto Insurers More Than $16 Billion

San Francisco-based Quality Planning Corp., the rating integrity solutions company, today released its annual Premium Rating Error report, showing premium rating errors remain a drag on auto insurer profitability. QPC estimates $16.2 billion of premium revenues were foregone in 2005 by insurers that use inaccurate rating information to calculate premiums.

The industry’s combined $16.2 billion premium rating error represents nearly 10 percent of the $163 billion revenue recognized by personal auto insurance premiums industrywide. Losses were essentially unchanged from the previous year and indicate insurance companies are still missing opportunities to capture this significant source of revenue, according to the QPC report.

Dr. Daniel Finnegan, founder and president of QPC, noted, “For the average auto insurer, each percent of rating error loss translates into a 20 percent reduction in profitability. An insurer that reins in these losses through stringent data integrity measures can increase profits significantly.”

QPC’s Premium Rating Error report is based on premium audit reviews of more than 18 million private passenger auto policies from 20 major carriers. The report shows how different categories of rating errors contribute to overall premium rating error, and distinguishes between vehicle rating errors (mileage, usage, type of vehicle and location) and driver rating errors, driving experience and driving record).

In 2005, driver rating errors rose to $8.7 billion from $8.5 billion in 2004, largely because of an increase in unrated operators. The report reveals that flaws in vehicle rating factors such as rated commute distance, annual mileage, vehicle usage and rated territory were also major contributors to the nearly $1 billion increase over the 2004 figures. “All of these rating errors can be controlled and reduced by insurers willing to adhere to fundamental principals of solid underwriting — that is by gathering, validating and maintaining accurate rating data,” Finnegan said.

“In the life of an auto policy change is a constant,” said Finnegan. “Household composition fluctuates: policyholders change jobs, cars are acquired and sold, kids get their driver licenses and start to use the family car.”

“On average, 52 percent of existing policies have a change in driver or vehicle every year, and 50 percent of the remaining policies have some other meaningful change. It is difficult for auto insurers to keep up with these changes,” said QPC’s president.

Finnegan noted it is an accepted insurance industry fact that premium “leakage” occurs in the underwriting process. That is, premium revenue is lost because of misrepresentation of facts, lifestyle changes or outright fraud by policyholders. Because not all consumers provide accurate rating information, intentionally or not, insurers build in factors to cover leakage in their pricing, inflating premiums for all policyholders. The QPC report shows how auto insurers could better analyze rating data to identify and correct flawed information.

“The rating error extends beyond just industry profits,” noted Finnegan. “Rating error introduces significant inequalities into auto insurance. Honest people subsidize the dishonest, low-risk drivers subsidize high-risk drivers, low-mileage drivers subsidize high-mileage drivers,” he said.

Vehicle-garaging errors represent one area where better analysis can help control risks. QPC has identified thousands of examples where young drivers keep their vehicles registered at their parents’ homes long after they have moved to large cities such as New York or Los Angeles, where coverage costs tend to be higher.

Another significant cause of leakage is under-reporting the number of miles driven. The QPC report noted mileage under-reporting can occur because of “mileage bands” or groupings that rate many policyholders at lower mileage levels than they actually drive. Additionally, while 17 percent of vehicles are driven more than 20,000 miles per year, only 4 percent are actually rated in this category. “Failure to identify these higher risk vehicles and rate them accordingly represents a major source of unmanaged loss costs,” the report says.

QPC’s research shows that by building and maintaining finely graduated rating plans, insurers achieve a significant competitive advantage over carriers with flat rating plans.

QPC helps auto insurers minimize rating error. QPC processes auto insurance companies’ book of policyholders through a battery of more than 150 proprietary tests, cross-reference checking and pattern-matching algorithms to identify errors and discrepancies that might suggest customer fraud.

The report can be found online at: http://www.qualityplanning.com/.

Source: QPC