Washington, D.C. – Delaware law, like that of almost every other state, requires that insurance rates be cost-based and prohibits rating based on non-risk factors, such as a consumers’ web browsing activity or likelihood to shop in the face of a rate increase. Insurers have recently started to utilize such non-risk factors in setting consumers’ insurance premiums with a statistical tool called “price optimization.” Price optimization mines non-insurance personal consumer information to maximize the premium an insurer might charge and is promoted by vendors as a way to increase insurer profitability. In the past year, a dozen state insurance departments have notified insurers state law requires rates to be cost-based and use of price optimization based on non-risk factors is illegal.
Delaware Insurance Commissioner Karen Weldin Stewart issued an official bulletin to insurance companies to disclose any use of so-called “price optimization” and highlighted the state’s prohibition on any use of pricing techniques unrelated to risk, such as price elasticity of demand. Commissioner Weldin Stewart stated clearly that price optimization is illegal. The bulletin states:
To the extent that price optimization involves gathering and analyzing data related to numerous characteristics specific to a particular policyholder and unrelated to risk of loss or expense, insurers may not use price optimization to rate policies in Delaware.
Delaware is the 13th jurisdiction to notify insurers that price optimization violates state insurance statutes that require cost-based pricing and prohibit unfair discrimination in setting insurance premiums. Montana, Rhode Island, Washington, D.C., Maine, Indiana, Washington, Florida, Maryland, Ohio, California, Vermont and Pennsylvania have previously issued notices to insurers with the same message as the Delaware bulletin: utilizing non-risk related consumer characteristics to set insurance prices is illegal.
The Consumer Federation of America (CFA) and the Center for Economic Justice (CEJ) applaud Commissioner Stewart for recognizing that price optimization is illegal price-gouging, but called on her to close loopholes in her bulletin.
Commissioner Weldin-Stewart’s bulletin states insurers may continue such illegal practices based on non-risk factors until July 1, 2016 and fails to require refunds to consumers who were illegally over-charged. In addition, her bulletin creates a loophole for insurers when it states:
The Department does not intend this Bulletin to prohibit or restrict such practices as capping or transitional pricing when applied on a group basis. . . . Likewise, the use of sophisticated data analysis to develop finely tuned methodologies with a multiplicity of possible rating cells is not, in and of itself, necessarily a violation of rating laws as long as the classifications are based strictly on expected losses, expenses, or other justifiable, supportable risk characteristics.
The consumer groups explained that “Capping” and “Transitional Pricing” within the “finely-tuned methodologies with a multiplicity of possible rating cells” are simply other terms for illegal price optimization. While an insurer might take a lower-than-cost-indicated rate for a broad class of policyholders – such as all drivers in Dover – it is illegal for the insurer to pay for that rate cut with a higher-than-cost-indicated rate in the remainder of the state. Without specific guidance to insurers that an insurer decision to use a lower-than-indicated rate for one group may not be paid for with a higher-than-indicated rate for another group, Commissioner Weldin’s guidance on capping, transition pricing and overly-detailed risk classes is in conflict with her guidance on price optimization. Further, an insurer appears authorized, under terms of the bulletin, to even cap an indicated rate reduction, requiring consumers to pay more than the risk-based rate.
State law requires insurance rates to be cost-based because insurance is different from other consumer products. It is a complex legal document and purchase is required by the state. The Commissioner has the authority and responsibility to stop the use of non-risk factors, but she does not have the authority to permit deviations from cost-based pricing.
In recent years, insurance companies have begun to use “price optimization” to raise customers’ premiums based on individual shopping habits and perceived “price elasticity of demand,” which is a measurement of a consumer’s tolerance for price changes and can also reflect their level of access to other choices. Price optimization aims to determine how much insurers can increase rates for each individual customer beyond what is appropriate based on his or her risk profile.
“Most Americans are required by law to buy auto insurance and by their mortgage company to buy homeowners insurance, and it is terribly unfair and entirely illegal for insurance companies to vary premiums based on whether or not they are statistically likely to shop around,” said J. Robert Hunter, Director of Insurance for CFA and former Texas Insurance Commissioner. “It is the obligation of Insurance Commissioners to protect consumers from this kind of price gouging. We applaud Commissioner Stewart for her action but request she amend her Bulletin so that deviations from cost-based pricing are stopped in Delaware immediately.”
According to the consumer groups, price optimization marks a radical departure from the actuarial practice of pricing insurance premiums according to the risk of loss posed by the policyholder. The purpose of price optimization is to extract as much profit as possible from policyholders who are often required to purchase insurance policies.
“Price optimization by insurers is Big Data run amok and simply price gouging by a fancy name. Consumers are being punished for activities and circumstances unrelated to risk and without any disclosure or transparency by insurers,” said Birny Birnbaum, Executive Director of CEJ. “The actions by 12 state insurance commissioners and the insurance commissioner of the District of Columbia are the first steps in returning insurance practices to the foundation of pricing insurance based on risk of loss.”
The Consumer Federation of America is a national organization of more than 250 nonprofit consumer groups that was founded in 1968 to advance the consumer interest through research, advocacy, and education.
The Center for Economic Justice is a non-profit organization that works to increase the availability, affordability and accessibility of insurance, credit, utilities, and other economic goods and services for low income and minority consumers.