Insurance business in the US has historically been more advanced in the field of risk pricing than Continental Europe. The US also tends to regulate pricing of personal lines at state level, and insurance rates must be published (even if not discernible without some complexity). Within Europe the most competitive personal lines market is probably the UK; in the rest of Europe price comparison websites and online sales do not have the same level of penetration.
Everyone knows pricing is integral to insurance risk. Take two insurers operating in the same market (A and B). If business A's view on pricing is not as accurate as B's view on pricing, the risk is that A ends up writing the business that B (and others) are avoiding by pricing more accurately. Therefore A looses money by writing the worse risks and someone else makes money by writing the better risks. This is known as adverse (or anti) selection. It is not rocket science. If a business has much higher loss ratios than its competitors, the competition must be doing something better. That may include better pricing and risk selection. Whether it is in the financial markets or in insurance, every transaction has a right and wrong price and where there is a price mismatch in the markets it creates an opportunity for someone to make money at the expense of someone else. Those who are better at risk selection are also able to charge less for the risks that they select. If competitors cannot keep up, then they risk losing good business whilst keeping and/or acquiring bad business.
The pricing of insurance products clearly rely on information, including what information the insurer has about the policyholder to assess the likelihood of a claim arising. There are lots of factors that influence risk. The typical ones are the personal characteristics of the individual, such as occupation, age, sex and marital status. There are less obvious ones; for example, a person's credit history tends to be an accurate proxy for risk. Risk can also be assessed by external factors, such as the price of petrol, weather or economic conditions. In insurance terms the greater the likelihood of a claim the higher the premium that the insurer should be charging if it wants to underwrite that business profitably. The lesser the risk, the larger the discount it should be giving the customer to reflect that. Against this backdrop, technology has now created a treasure trove of data for insurers. Traditionally, insurers have relied almost exclusively on internal sources of information, in particular information provided by policyholders and their own databases. In recent years the industry has started to look at increasing numbers of external data-sets and using this as an important pricing tool, with growing recognition as to its value. More importantly, with modern technology there is the potential for far more interaction between an insurer and its customers, enabling them to charge a premium based on the continuous flow of information about customer behaviour (e.g. in motor insurance the use of telematics or black boxes fitted in the vehicle).
In the US especially, underwriting entails extensive use of both internal and external data. This allows more accurate testing of potential new opportunities; in other words, removing unprofitable segments of risks underwritten, writing new and profitable business segments, more of other segments and/or better pricing of renewal business. It is all about risk selection (i.e. accuracy of pricing) whilst at the same time providing a fairer price to the customer. There is also a growing acceptance that big data provides a clear opportunity to improve loss ratios. To put it another way, if all insurers had access to and used the same information to inform their pricing decisions, no insurer would have a competitive underwriting advantage over any other.
There is a quiet revolution taking place in the insurance world when it comes to digital technology and big data. Insurers in the not too distant future will base their decisions on pricing with incredible accuracy drawing from the predictive and actual behaviour of their customers. The insurance industry can become the laboratory for technology that will change the way companies interact with consumers in the future. We are already seeing this but it is only the beginning. Those that crack the code will create huge shareholder value and corporate wealth. The stakes could not be higher and the equivalent of an arms race in the field of data is now on.
Nigel Feetham is a partner at Hassans (a Gibraltar law firm) and Visiting Professor at Nottingham Law School, Nottingham Trent University. Nigel is also the author and co-author of a number of books.
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