Risk-based pricing of property and liability insurance

Abstract

Policymakers currently show renewed interest in restricting the use of certain accurate ratemaking variables in personal lines (automobile and homeowners) insurance. Policymakers are considering, and in some states enacting, laws that would exclude gender, education, occupation and credit-based insurance scoring (CBIS) as insurance rating variables. The author argues that excluding accurate rating variables from the insurance pricing process has negative consequences. The accuracy of insurance prices decreases, creating cross-subsidies where lower-risk insureds pay higher premiums and higher-risk insureds pay lower premiums. In addition to being objectively unfair, cross-subsidies increase the overall cost of insurance and distort policyholder incentives to take appropriate precautions. The end result is higher prices, more property damage, more injuries and more fatalities. The author also address arguments put forth by opponents of these rating variables and demonstrate the high level of competition in insurance markets.