Beruflich Dokumente
Kultur Dokumente
Alessandro Santoni
Francisco Gmez Alvado
Gmez
March 2007
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2008 Towers Perrin
Contents
Case study
Conclusion
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The next frontier in pricing management
competition
provides a thorough understanding of the elasticity of
market place in which a company is operating are
h demand
ets
k
Customer price elasticity models which ar
reflect market competition and customer m
behaviour so as to predict the volume of new
business and renewal acceptances at various
prices for different types of customers
profi economic
tabil
Optimization techniques which integrate it y cost
these models to predict the profit/volume
impact of price changes, and to identify the
best price changes for a given financial
objective and constraints
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Why Price Optimization?
The personal lines insurance industry is highly competitive and maintaining
Opportunities for improving profitability though efficiency and cost reduction are
Pricing management presents the best opportunity for a company to improve its
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Progessive: growing volume while maintaining
profitability through price segmentation
16.0 14.8
14.3
13.8
14.0
T otal R ev enues (in $ M ill)
11.9
12.0
10.0 9.3
7.5
8.0 6.8
6.1
6.0 5.3
4.6
4.0
2.0
0.0
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99
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Contents
Case study
Conclusion
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The Price Optimization equation
Profit models
Profit per customer
Price
Expected Profit
Claims plus other costs
0
X
Elasticity models
0 Price
Demand d
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CLIENT
Optimization Project focused on better CASE
STUDY
Context Objectives
The company was providing quotes for renewal Improve the renewal process.
considering only profitability, past claims Forecast the impact of different strategies on
experience and previous premium. profitability and premium volume.
The market entered a price war. Maximize retention and expected profit.
Case study is based on a European company - rate regulations are different in the US
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Illustrative example
Initial project workshop to further understand the companys strategy and financial
objectives for the Price Optimization process.
Establish:
Maximization/minimization function: Maximize Expected Profits
Time horizon (One year)
Business constraints:
Global (Target retention rate: 85.0%)
Individual (Base on individual policy profiles):
Number of claims in the previous years (0, 1, 2, >2)
Non claims discount (<55%; => 55%)
Tenure (< 4 years; >= 4 years)
Historical loss ratio (<55%; >= 55%)
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Gap analysis Step 2
Understand how much of the information and analysis is already available through
previous work
Use existing company pure pricing models based on expected cost of claims as an
input to the Optimization process. This is a fundamental part of the process and
one which will have a significant impact on profitability
Understand the current rating structure and what enhancements and additional
flexibility might be required to meet the objectives
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10
Competitive Market Analysis (CMA) Step 3
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Renewal analysis Step 4
What is it?
The renewal rate is defined as a customer (who has been offered renewal) staying with
the company 12 weeks after expiring date
How is it used?
Assess how variable the renewal rate is across the portfolio and identify segments of the
business that have higher/lower than average rates
Combine with the CMA to assess how good a predictor the competitiveness measure is
of retention - by customer segment and over time
Provide initial insight into customer elasticity e.g. what happened to retention rates when
previous price changes were implemented?
Assess how retention rate varies as a function of price change at renewal
Data used for the statistical estimation of customer renewal demand:
All car policies renewed between May 2007 and July 2007.
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Illustrative example
Low
Competitiveness Position
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Customer price elasticity
Summary of models Step 5
GLM
Final Models
Note: in Europe, agencies are given discretionary budgets to offer discounts to insureds sometimes
referred to as commercial discounts
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Customer price elasticity
Possible explanatory variables Step 5
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Illustrative example
Customer price elasticity
Base profile Step 5
Intercept 0.15
Lapse probability=
Xb/(1+(Xb)) 13.4%
Renewal probability=
1-Xb/(1+(Xb)) 86.6%
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Illustrative example
Customer price elasticity
Results Elasticity curve Step 5
% PREMIUM CHANGE
140,000 25%
120,000
Num of Policies
20%
Lapse rate
100,000
80,000 15%
60,000 10%
40,000
5%
20,000
0 0%
<-8% -8% - -6% -6% - -4% -4% - -2% -2% - 0% 0% - 2% 2% - 4% 4% - 6% 6% - 8% >=8%
Policies Probability Lower C.I Upper C.I.
PREMIUM OFFERED
70,000 35%
60,000 30%
Num of Policies
lapse rate
50,000 25%
40,000 20%
30,000 15%
20,000 10%
10,000 5%
0 0%
0-100 100-150 150-200 200-250 250-300 300-350 350-400 400-600 600-800 800- 1000- >1200
1000 1200
Policies Probability Lower C.I. Upper C.I.
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Illustrative example
Customer price elasticity
Results Distribution Channel Step 5
DISTRIBUTION CHANNEL
200,000 30%
180,000
25%
160,000
Num. of policies
140,000
20%
lapse rate
120,000
100,000 15%
80,000
10%
60,000
40,000
5%
20,000
0 0%
Traditional Direct Bancassurance
Policies Probability Lower C.I. Upper C.I.
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Illustrative example
Optimization Step 6
This step involves combining the cost models (claims and expenses) and the
customer price elasticity models derived in previous steps in order to determine
the optimal profit loading by customer type
The optimal price will be the one that satisfies the companys objectives and
constraints maximising profitability subject to a certain volume of business
17 EF with restrictions
EF without restrictions
15
Company Strategy
Optimal Strategy
13
11
7
70 75 80 85 90 95
Retention (%)
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Optimization Step 6
Comparison of company and optimized pricing schemes
Price Strategy Comparison
120,000 100%
90%
100,000
80%
Number of policies (in Th.)
70%
80,000
% of renewals
60%
60,000 50%
40%
40,000
30%
20%
20,000
10%
0 0%
<-8% -8% - -6% -6% - -4% -4% - -2% -2% - 0% 0% - 2% 2% - 4% 4% - 6% 6% - 8% >=8%
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Illustrative example
Optimization Step 6
Average
Premium Retention Expected
Distribution of premium changes Change Rate Profit (million)
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Implementation Step 7
a) An algorithm that calculates the optimised price per individual customer based
on their particular rating attributes. The algorithm can be built into the rating
structure and operate in real-time
b) A set of optimized premium rates that would fit into a tabular rating structure
Given the IT investment, lead time, and other operational considerations that need to
be made for option (a), our current recommended approach for the company is (b)
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Contents
Case study
Conclusion
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Price Optimization: The next challenge
though efficiency and cost reduction are more difficult, pricing management
presents the best opportunity for a company to improve its profitability and
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Conclusions
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