Pricing Optimization in Commercial Insurance: An Interview with John Lucker, Deloitte Consulting LLP

JohnLuckerJohn Lucker leads Deloitte’s Actuarial and Insurance Solutions data mining and predictive modeling practice known as Advanced Quantitative Solutions (AQS). He provides leading insurance carriers with end-to-end business, operational, and technical consulting services. Mr. Lucker has helped numerous commercial and personal insurance carriers develop innovative methods and solutions, and is a co-inventor of three predictive modeling patents which are pending.

Mr. Lucker is a frequent speaker at national insurance and risk management trade association conferences and has been published and quoted in numerous trade journals and professional publications. He holds a BA and an MBA from the University of Rochester.

In a recent conversation, John was kind enough to share with us his observations and insight into the challenges and opportunities related to pricing optimization in commercial insurance.

Q: What challenges do you see at the top of the list for insurers these days?

JOHN LUCKER: Recently, regulatory issues have become front and center, but I believe these will play out at their own pace. At the core of many of the issues faced by insurers is the need to grow, and growth is tough because the P&C marketplace is relatively mature. There is some organic growth, but the commonly used method for growth is to win business away from other insurers, which makes the marketplace somewhat of a zero-sum game. Clearly product innovation can help generate organic growth but this is a more strategic and evolutionary process for insurers.

Whether a carrier can retain customers and cause customers to defect from other carriers depends on a number of factors, including the ability to optimize pricing, handle claims more effectively, provide superior customer service, recruit and retain new distributors and employees, know the customer better than the competition, have deep competitive and market intelligence, and build a culture of innovation and product dynamism. We see companies coming up with new products and coverages such as identity theft insurance, Pay-As-You-Drive insurance, specific valuable articles coverage, expanded homeowners coverage, and a variety of new commercial products to allow insurers to expand the market beyond the zero-sum game.

Another challenge insurers face is the need to maximize profits. With the return on investments down and costs of repairs, medical, and other expenses going up, insurers must find ways to maintain or enhance profitability.

Q: How are you helping the insurers you work with address these challenges?

JOHN LUCKER: At the center of almost all of these challenges is the need for insurers to do a better job making decisions based on data and objective science rather than via more traditional subjective processes. That’s where advanced analytics becomes very important and it’s where we help insurers in their efforts to develop and implement end-to-end analytic solutions. We help them think through and execute better ways to apply analytics to pragmatic real world solutions. We don’t just focus on the technical aspect of the analytics, but also help them determine how to make them come alive in the company through technology implementation and integration, business implementation, organizational change management, regulatory compliance, etc.

We have been engaged by many personal and commercial lines carriers over the years. Personal Lines analytics has evolved with credit based insurance predictive models and class plan optimization at the core of the movement, but commercial lines had not developed an analogous affinity for analytics until recently. In recent years, however, commercial carriers have been focusing on increasing analytic competency, and have developed more hunger for innovation in underwriting, claims, loss control, premium audit, distribution management, hard and soft fraud fighting, and other core areas.

Q: How long have you been involved in pricing optimization projects? How have the pricing practices and our understanding of those changed over this period?

JOHN LUCKER: Pricing optimization is a relatively new field in the US insurance industry. Deloitte has been providing various forms of pricing optimization related services for about 5 years, and we have been heavily focused on it for the past 3 years.

When I look at pricing I see three levels of what companies are doing:

  • Tier 1 is what actuaries have been doing for many, many years, which is risk-based, loss cost pricing that goes into a filed rating plan.
  • Tier 2 is what Deloitte has been focusing on for the past decade. In personal lines, it’s about analytic models for enhanced underwriting. In commercial insurance, it is an analytical way to create objective price points for tiering and debits/credits for underwriting actions versus the subjective approach that underwriters traditionally take.
  • Tier 3 is price optimization for new business acquisition and renewal retention. It sits on top of Tier-1 and Tier-2, analyzing market and agent behavior as well as propensities for retention or defection and factoring these into the Tier-1 rating and Tier-2 underwriting indications.

Q: How does competition figure into this process?

JOHN LUCKER: Underwriters have always had to react to the competition, but much of it has been based on intuition, especially in commercial insurance. Although intuition may be directionally correct, in most cases, it is neither as precise nor as consistent as it needs to be to come up with an optimal price. What pricing optimization provides is an objective set of numerical guidelines that can steer the underwriter to the right price while maintaining sensitivity to risk and market factors.

How you gather new information and adjust these numbers to account for how the market is changing is exactly the challenge. A big part of what we help insurers with is putting in place the process to collect market information and then help them use it as part of the optimization. For example, if an underwriter negotiates a price with an agent, one approach is to capture the marketplace negotiation in a systematic way that enables the optimization of future prices. In many cases this data already exists but it may be on paper, so an insurer needs to convert the information into an electronic format that can be used by a pricing optimization system. There is a cost to this process, but generally the benefits far outweigh the cost. This is only one mechanism to capture and store data proxies for marketplace pricing behavior and trends.

Q: How much of it is process versus technology?

JOHN LUCKER: Much of it is technology but a lot relies on applying a sound business process and executing on it. A major concern in the implementation of pricing optimization is ‘lopsided execution’. It is easy for an underwriter to take the pricing optimization recommendation when it calls for a lower price. Crediting off of a base price is always an easy sell in the marketplace. But sometimes you need to raise the price, which can create a difficult situation with the customer. That’s something people don’t like doing. Given the choice, a debit discussion is often avoided. It’s a pain versus pleasure human condition, and in insurance it can cost a carrier a lot of money.

If the process is not in place to ensure correct execution, the result of selective implementation of pricing optimization can be worse than not doing anything, since you end up just lowering prices for some customers without getting higher prices from other customers to offset those lower ones. Pricing equity needs to work both ways, with customers paying appropriately for the risk they pose to a carrier and the value they receive from the products and relationship.

Q: To what degree are insurers aware of the latest developments in pricing optimization?

JOHN LUCKER: I don’t think pricing optimization has a broad awareness yet in insurance companies, especially in the US. I think many people learned about efficient horizons and theoretical price optimization for retail industries in college or elsewhere, but probably have not learned how such concepts can be applied in the US insurance business. Common practice tends to be more subjective, particularly on the commercial side. Price optimization is especially a green field area for commercial lines, and this is something that Deloitte is leading the charge on, as we did for Tier 2 underwriting predictive analytics.

Q: What are some of the things that are standing in the way of pricing optimization? How do you help insurers overcome these obstacles?

JOHN LUCKER: Some insurers seem somewhat concerned when thinking about pricing optimization due to regulatory issues. They worry that pricing optimization factors in market behavior, because that has not been part of the formal or explicit pricing process until now. Companies should recognize that underwriters have been doing the same thing all along, they just do it in their heads, and not in a very systematic way. This is what has always been driving market cycles. Once a company takes a deeper dive thinking about pricing optimization they tend to see that it is fair, equitable, and reflects underlying risk and the value carriers and their products and services provide to customers.

Q: How does a solution like Earnix Optimizer fit into the work you are doing with your clients?

JOHN LUCKER: Earnix offers a foundational framework that enables a company to optimize pricing. It handles both the Tier-1 (risk cost) and the Tier-3 (market-based) pricing. It enables a company to monitor the various offers and counteroffers that underwriters make, and it then makes recommendations on how to adjust their approach moving forward based on how the market reacts to these offers. It provides a platform that supports the rigorous analytics required to do that in close to real-time to enable a company to react more quickly to changing market conditions.

Q: Based on your experience, what are the keys for an insurance organization to be successful in implementing pricing optimization?

JOHN LUCKER: Pricing optimization has been getting a lot of interest from actuaries and people who deal with the technical aspects of pricing. What has been missing is the understanding of the business approach that is required to make pricing optimization a success within an organization. You can spend years trying to perfect the technical model by a fraction of a percent, but what I always tell my clients is that by the end of the day, a marginal improvement through heroic efforts isn’t always worth the time and expense.. The model is never going to be perfect. The important thing is to get it better than it was before and then put in place the process to execute on it better than the competition. As some wise men have said, “80 or 90 percent of something is better than 100 percent of nothing” and “don’t confuse effort with results”.

The details of this work are very intriguing to many technical insurance professionals, but at the end of the day, if you only deal with price optimization as a technical or actuarial issue, you risk missing some of the critical business issues that need consideration. To help our clients with their price optimization activities, we end up spending much more time working with them on their business process, cultural issues, and organizational change management than we do on the technical modeling. They have to get all of their stakeholders to buy into the adoption of price optimization, including actuarial, underwriting, regulatory, distribution, marketing, and IT. This usually means that they have to get senior management to lead the charge.

Q: How do you help them get senior management to do that?

JOHN LUCKER: We have a methodology to show them how their actions will translate into quantifiable business benefits (ROI) and how to be better positioned to compete in the marketplace, get more new customers, and right-price all customers. This is something they have to buy into before they can be successful with pricing optimization. These projects must be driven from the top levels of an organization for true success to be realized.

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