Insurance Pricing Models – Building a Better Insurance Pricing Process 📊
Today’s insurance pricing models are no longer a cost-plus game. Insurance companies must learn to adapt to new technological, market, and consumer complexities with better, more dynamic pricing if they want to maintain a competitive advantage in the industry.
In this article, we will discuss the 6 steps that insurers can take to improve both insurance pricing strategy and price realisation. We call these actions the six processes to pricing power in insurance.
But, before we jump into the process, let’s take a little look at how insurance pricing works and what it actually is.
What is unit pricing in insurance?
Rate making, or insurance pricing, is the rate of charges or premiums set by the insurance companies. The benefit of rate making is to ensure a fair and adequate premium for the clients, given the stiff competition in the insurance sector.
A rate is a price per unit of insurance for each exposure unit, which is the unit of measurement used in insurance pricing, whereas in pure premium, it refers to that portion of that rate needed to pay losses and loss-adjustment expenses.
Loading is the amount needed to cover other expenses like sale expenses and allows room for profit.
Technology disruptors revising insurance pricing strategy
As you know, technology has already disrupted many industries; the same is true for insurers’ pricing strategies, the insurance pricing models, profit realisations, and ability to compete. Other examples are the ever-changing collection of price and feature-comparing websites available to us now. All of which empower us to compare and review hundreds of insurance products by price, value, and benefits. Or, you can also include the Solvency II imposed recently by the government to ensure insurers maintain higher capital levels without decreasing overall returns. To do that, they must either reduce costs or increase pricing.
In addition, the internet and new insurance platforms provide us with an insight on how to effectively match a product choice with our unique needs and willingness to pay; we are the new insurance broker.
Insurance pricing is now more effective and value-transparent. Though technology consumers have become much more informed and price-savvy, they are more receptive to new price policies, offers as well as aware of security, mobility, and different types of coverage. All of these learnings, innovations and policies have in turn created the need for new price policies and dynamic pricing structures.
6 steps to building a better Insurance Pricing Process
Fortunately, there are steps that insurers can take to improve both pricing strategy and price realisation in a changing technology-driven world. We call these actions the six processes to pricing power in insurance.
1. Upgrading portfolio price management.
In order to maximise retention to the most profitable clients – and to improve the profitability of low-value clients – insurers must achieve a deeper understanding of one’s own client base. There is now a trend for big insurers to develop more granular customer and price segmentation. Generating deep client insight from comprehensive data collection is essential for adding higher-margin auxiliary coverage alongside principal policies.
2. Polishing new business pricing.
Initially, insurers tended to offer deep discounts to clients in the hope that this would ease the pain of the inevitable price increase at renewal time. But, this method has been proven to be ineffective. The industry has learned from the data gathered not only from their own customer base but also from buying habits from other insurance buyers other from their own. As a result, some big insurers now are optimising their pricing of new business. This includes reinforcing better risk management practices so they don’t get financially crippled by clients who decide not to renew their insurance policy.
3. Controlling the difference between list and customer invoice prices.
Insurance sales agents have the tendency to give huge discounts to meet their quotas. This has led to distorted overall pricing structure and a generation of unprofitable portfolios. Removing the discrepancies in the RRP, rating structure, and actual customer invoice price is essential. Especially, if it is for a business whose profitability is driven by agents and brokers. Controlling discounts and linking it to the agent’s overall performance will improve the sustainability of the insurance firm.
4. Harmonising distribution objectives with company-wide goals and pricing strategy.
Many insurance firms place the insurers’ incentives with performance. But, most evaluations are based on recruiting new clients rather than policy renewals. This results in a lack of focus on retention rather than long-term profitability. The industry needs to re-evaluate its incentives on the bottom line (loss ratio) as well as on the top line. This includes: giving agents additional options such as alternatives to monetary discounts (including higher deductibles, free supplementary coverage, and vouchers for future renewals), training staff on how to use first-rate customer-relationship-management systems to retain their best customers and regular updates on how to provide the best possible sales experience.
5. Adding customer value drivers and competitor insights into pricing.
Most insurers set their cost-oriented pricing structures on claims experience. To improve their pricing strategy, they must incorporate client price sensitivity and prevailing market prices (those of competitors) into their own pricing too. Some would complain that regulations prevent them from allowing demand-based pricing or that their agents do not like it. However, there are already insurance organisations finding innovative ways to work within the regulatory structure, giving them an earning return of up to 5 per cent of gross written premiums.
6. Reinforcing the organisation’s infrastructure.
That means the needs for a strong actuarial team, as well as a sharp managerial oversight capable of translating the business strategy into a disciplined pricing strategy. Insurers need a revision in pricing processes, including a better dialogue among the management team to truly understand, monitor, and critique the work of the insurance agents. Updating their pricing systems requires boldness and willingness to try new systems, conduct pricing tests, and stretch boundaries in terms of common practices.
Technological disruptors like Big Data, the Internet of Things, and predictive data analysis tools are giving the insurance industry the means to design usage-based and other innovative pricing models.
These new insurance pricing models and strategy gather data from new, external sources and estimate insurance pricing risk or consumer willingness to pay, buy, or churn more accurately. And during the underwriting phase, will identify precisely fraudulent applicants.
The problem for some insurance companies it seems has been based on antiquated systems and misaligned operations. The problem is in the analogue world where the insurance rates are hard to precisely fit the individual’s demands. So, setting the right insurance policy for the client is basically speculating what kind of insurance the client needs.
Larger insurance companies have actuarial departments that maintain their own databases. That is to estimate the frequency and the dollar amount of losses for each underwriting class. But, smaller companies rely on advisory organisations or actuarial consulting firms for loss information.
The new insurance pricing models can cater to demand more precisely so that customers are no longer obliged to buy the other insurance options they do not need. This unbundling makes companies exposed to disruption, specifically if they cross-subsidise parts of their offering, as insurers do, with direct sales channels.
Most insurance companies only until recently have upgraded to a level sophisticated enough that would deliver their intended pricing strategy.
Customers are also increasingly discerning and price-sensitive when they buy insurance products. The entry of new players and price aggregators has further driven the price down. This has led to customers looking for cheaper and cheaper deals. Now, the insurance market is facing a whole scale cycle of commoditisation.
Tips on starting a new pricing strategy
Before insurance firms implement a new pricing strategy, they should ask the following questions:
- Is our pricing strategy giving us all the advantages it should?
- Do we really understand the dynamics of consumers’ responses to price changes?
- Do we have the organisational abilities to bring about a pricing step change; one that will it give us a remarkable edge over our rivals?
- What investments should we create so that we can close any gaps in our pricing capabilities?
Insurers that can answer these questions honestly will very likely find themselves benefiting from their efforts. They will be on the same level with their customers and will be able to react accordingly with pricing moves. In addition, they will also know which actions will give them the best result. On the other hand, insurers that do not take the necessary action will end up playing a guessing game that will decrease their pricing power moving forward.
- Customers are increasingly informative and price sensitive. Insurers must find other pricing methods that are aligned to digital.
- The entry of direct players and price aggregators has meant greater transparency. This means that it has enabled customers to choose the least expensive deal on their own terms.
- Many insurers are still tempted to attract clients with initial deep discounts. They are, after all, hoping for a higher insurance renewal price when renewing the policy. But, this strategy is proving increasingly ineffective.
In this article, we discussed insurers that take the initiative to address the many pricing-related challenges. Only some insurer demonstrating good value-based pricing examples will reap their rewards in the years to come.
We believe that insurers that fail to take action may end up playing a guessing game; one that will diminish their pricing power going forward.
Insurers with the best teams and systems to generate comprehensible data from a deep client insight will lead the market. This is particular to identifying prospects for cross-selling and/or adding higher-margin auxiliary coverage alongside principal policies.
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