Getting the price right: savvy personal lines writers are slicing the market into segments to price risk more accurately. (Property/Casualty: Pricing).

Property/casualty insurers that excel at turning underwriting profits have one thing in common: they accurately price risk.

Claims management also is key, but it can only do so much to reverse underpriced business. Companies use different methods to get the price right, but no matter what their approach, the ultimate result is profitable business.

Whether it's looking for a single, specific type of risk, or looking to place similar risks together, many insurers use segmentation--the process of slicing the market into segments--to underwrite business successfully.

Judging the Risks

Insurance has traditionally operated by pooling similar risks, which allows the insurer to bet that the premiums produced by the pool will be greater than claims paid to that group. Segmentation allows companies to create more categories and better define the risk pool. If done correctly, the business written will be more profitable--because the company can more accurately predict future losses--as well as save many consumers money, because they'll be paying for the appropriate risk, not paying higher premiums because they've been lumped in with the risk of a larger group.

"With investments returns down, companies are more cognizant of their underwriting results," said John Andre, vice president in the property/casualty division at A.M. Best Co. "Many are using stricter segmentation to more accurately price business."

A simple example of segmentation is to look at a driver's age, said John Blodnick, a vice president and director of Safeco's auto product. "Everybody knows a 16-year-old driver is a higher risk than a 20-year-old driver. If you group all of these ages into one group at the same price, you are undercharging the 16-year-old and overcharging the 20-year-old. Break them down into different groups, and you can have an appropriate rate for both," Blodnick said. If you don't divide them into different groups, "you're putting your company at risk of getting all of the 16-year-olds and none of the 20-year-olds."

Seattle-based Safeco, the 14th-largest auto writer in the United States, is in the process of rolling out a new segmented auto product. Under the new product, Safeco has expanded its rating structure from three to five tiers covering just preferred and standard auto to 10 to 16 tiers covering preferred, standard and nonstandard auto, said Kim Garland, vice president and director of Safeco's auto product.

Safeco has three main rating levels now: the product level--preferred, standard or nonstandard; the characteristic level--age, gender, marital status, territory, etc.; and the tier level-- which includes other underwriting factors such as credit-based insurance scoring.

In the past, Safeco wouldn't accept nonstandard business. One of Safeco's goals in adapting the new rating structure was to better match the rate to the individual risk, which would allow the company to write more business and be more profitable doing it, said Garland.

"Under the old system, we accepted just 40% to 50% of the risks, and rejected the rest," Garland said. "Now we have a price for these people. The price is higher, but nonstandard business can be profitable if you price it accurately."

While companies, including Safeco, are reluctant to reveal too much about their rating structures, Garland said Safeco uses 30 to 40 different factors or characteristics to set an individual's rate. "There are billions of possible variations," he said.

"The important thing to understand is that the actual factors are not a set number," Blodnick said. "They can vary depending on state results, laws and regulation."

By crunching Safeco's own data, as well as looking at industry trends, Safeco takes into account what the loss experience is for a particular risk factor. For 2001, Safeco had an adjusted loss ratio of 66.3 on $2.16 billion in direct written premiums, according to A.M. Best Co. data. Adjusted loss ratio is direct losses incurred divided by the difference between direct premiums earned and dividends paid to policyholders. The company expects even better results with the new rate structure, which was launched in the first states eight months ago.

Safeco is "very pleased with the results," Garland said. Even though the company has raised rates by an average of 5% across the board, new business is up 50% to 70% in some states.

And while overall rates went up 5%, Garland said some people saw rates decrease while others rose 15% to 20%. "We've targeted rate increases to people whose experience has justified it," Garland said.

Even though Safeco said it's too early to judge how profitable the business is, Blodnick said the company's goal is to produce a 96 combined ratio; that is, to pay out just 96 cents in claims and expenses for every $1 of premium received.

"The important part of segmentation and price tiering is you can still get a preferred customer and identify them, but not all preferred customers are the same. Some are better than others. We identify the very preferred to the just preferred. Not all nonstandard policyholders are the same; some are better than others. We had to establish which risks were better and what risks were worse," Garland said.

Integrating the Process

Allstate, the second-largest auto writer in the United States, uses segmentation for both rate plan development and product design as well as underwriting and marketing, said Fred Cripe, vice president of policy and pricing for Allstate.

About three years ago, Allstate increased its underwriting divisions to provide generally seven tiers for standard auto and 11 tiers for nonstandard, although the structure varies from state to state. Rating factors include age, gender, marital status, make, model and year of vehicle, specific safety features, where the auto is garaged, the amounts of coverage purchased, deductibles, policy limits, length of time the driver was with the prior carrier, types of coverage purchased with the prior carrier, driving record and some measure of financial stability--often credit-based insurance scoring.

"Generally, the highest tiers have the highest claims frequency and the highest costs," Cripe said. "Lower tiers have lower frequency, and are priced accordingly."

Cripe said Allstate has been pleased with the structure, in both the company's ability to analyze the data and accurately price the business.

"We are particularly proud of the way in which we've been able to take our historic loss experience, look at factors that may have not been traditionally used in rate making, and incorporate those factors in our rate structure and overall rate level," Cripe said.

Allstate, Northbrook, Ill., had an adjusted loss ratio of 64.9 in 2001 on direct premiums written of $15.2 billion, a sign that it is getting the price right.

Cripe said years ago, Allstate was like many personal-lines companies that had actuaries to develop prices, underwriters to develop underwriting criteria, policy writers who drafted the language, and marketing personnel who got the product Out. Each department may have believed it was doing the right thing, but if the end policy wasn't profitable, it was difficult to pinpoint why.

"Now it's integrated," Cripe said. "Product managers provide an integrated view working with all the functional departments--rates, marketing, risk management and product design. We really focused on integration and accountability for results."

Small, but Mighty

Segmentation works not only for large insurers, but also for small, regional companies that have honed the strategy to make niche markets more profitable.

With $239.6 million direct premiums written in 2001, Safeway Insurance Group, Westmont, Ill., was the 73rd-largest auto writer in the United States, but had one of the most enviable adjusted loss ratios in the industry: 55.6 in 2001, well below the top 25 carriers' adjusted loss ratio of 73.6.

"I hate to use the term, but I think we take a simple approach," said Richard Ward, director of business development for Safeway. "Credit scoring is a hot topic out there, but we do not use it. Being a nonstandard writer, we expect our policyholders to have relatively poor credit."

Safeway has segmented the market down to a niche, where it specializes in writing nonstandard auto in urban areas. Then, it's segmented even that niche; the company re-engineered its rating structure to 27 classifications from nine. It uses traditional factors such as age, marital status, and gender, as well as geographic territory.

The key to the company's success is keeping close tabs on how those classes are performing in the eight states where Safeway writes business Ward said. "When you take an across-the-board rate increase, it affects every-one equally But we determine where we are profitable, and where we are not profitable, and let the profitable business stay--just fix the unprofitable business."

Safeway uses a two-step approach, Ward said. First, the company looks at what its rates are, then where those rates fit in the marketplace. And it's a marketplace that Safeway knows well. It only writes business in urban areas. "We write in Illinois, but only in Chicago; we don't write in Springfield," Ward said.

What drives its policyholders in purchasing insurance is not just price, it's the payment options, Ward said. "Most of insureds who buy nonstandard coverage from independent agents look at what is it going to cost me today to start the policy, not how much will it cost in the long term."

Even though nonstandard policies have a higher cancellation rate than standard policies, Safeway has an edge over its competitors by giving the customer a longer grace period to submit the payment before the policy is cancelled, Ward said.

The Producer Factor

As companies become more concerned with turning an underwriting profit, many have begun to reward agents for producing profitable business.

Most companies have built-in contingent commission structures which put agents more at risk for unprofitable business, said Andre of A.M. Best.

When the market is hard and companies are more focused on profitability, they tend to look at agents and profitability more, said Todd Bault, an equity analyst with Sanford C. Bernstein & Co. "But it's a good idea. Agents should be responsible to some degree for their book of business."

Hingham Mutual is one company that credits its agents for its success, said Brian Wilkin, president of the Hingham, Mass-based company.

While the largest 25 homeowners writers posted an adjusted loss ratio of 79.3 in 2001, Hingham Mutual, the 98th-largest company, had an impressive adjusted loss ratio of 46.9 on $33.3 million in direct premiums written. Agents play a big part in its underwriting success, Wilkin said.

Agents can earn up to an additional 8% commission on profitable business. "We look at where we want to be, where we want to write, and what areas we don't want to write," Wilkin said. For instance, faced with fairly high catastrophic cover, Hingham avoids writing coastal properties.

"We have an edge in knowing where the high-risk properties are," Wilkin said. Several agencies have represented the company since it was founded in 1826. "Having agents that have represented you for 170 years is a pretty good thing, "Wilkin said.

Hingham divides its homeowners business not only into different segments, but different companies, Wilkin said. Hingham Mutual Fire Co. targets older housing stock, and Danbury Insurance Co., the company's stock insurer, targets the newer properties.

Like Safeway, Hingham does not use credit-based insurance scoring.

"We think we have a pretty good handle on the business we have, where to write and what risks to choose," Wilkin said.

Being physically close to the business it writes also gives Penn National an edge, its leaders said.

Harrisburg, Pa.-based Penn National boasted an adjusted loss ratio of 58.8 in 2001 for its auto insurance and 50.3 for its homeowners multiperil insurance. The company, the 100th-largest homeowners writer and the 84thlargest auto personal-lines insurer, writes business in six states and offers standard, preferred and preferred advantage--a "super-preferred--programs, said Ralph Leventhal, director of personal lines for the company.

"Our rate decisions are based on a combination of using traditional actuarial information and factoring in underwriting and agency-management initiatives. It's something that is a little unique," Leventhal said.

"We reward agents for profitability," said Lee Freeman, Penn National's marketing manager. "We want to be the company of choice for agents, rather than the company of last resort."

The agents play an underwriting role even before the business is submitted. "They know their territory and they know their markets. They give us business that fits our strategy," Leventhal said.

Agents and underwriters are in touch daily, and every state has territory managers overseeing it all. To keep its staff closer to the business being written, there are two personal lines underwriting offices, one in Harrisburg, Pa., for Pennsylvania, Maryland and New Jersey and a second office in Greensboro, N.C., for business written in Virginia, North Carolina and Tennessee.

"Our underwriters are each assigned to specific agencies," Leventhai said.

Depending on the agent makes sense, Freeman said. "Your agents know you and your area. Because we are not a large, national company--we are regional and smaller in scope--we keep very focused on every state we do business in. We are absolutely committed to the states we do business in."

Penn National strives to be consistent, so while other companies have dramatic rate increases, or stop writing business altogether, Penn National tries to be steady, Freeman said. "Agents can rely on us, know that we are not changing," he said.

Penn National uses insurance scores where allowed, but also uses traditional underwriting criteria, such as past driving record. The company aims to have each program profitable, not using one or two to offset the unprofitable performance of another. "Some companies are returning to the basics. Our strategy is to continue with the basics. We never took the philosophy of growing for growth's sake and we'll fix it later," Leventhal said.

Reinsurance Savings

A company with a history of accurately pricing business is not only more profitable on that business, but may see favorable reinsurance rates, said Tim Carroll, president and chief executive officer of GE ERC, a member of GE Global Insurance Holdings, the fourth-largest global reinsurer.

"The more credibility, the more stability in the data we get from the primary writer, the easier it is for us to price," Carroll said. "If we have to use heavier weight on just exposure, because we can't rely on the client's experience, we'll have a greater margin for error and that will have to be reflected in the price."

Reinsurers also are counting more on clients to provide actual data, rather than promises of future performance, Carroll said.

"What is different is we are asking our clients to provide a far greater depth of data than we ever did before," Carroll said. "We're spending a lot more time with them, sending our actuaries out to them. In the past, clients would have given reinsurers data once a year, around renewal time. Now we get updates throughout the year."

Ten years ago, few companies used segmentation to slice the market into smaller and more accurate tiers, but technology and competition have helped many companies to price more carefully, Bault said. As technology and data collecting continue to improve, insurers are likely to become more skilled at accurately pricing risk.

Adjusted Loss Ratio, Top Auto Writers--2001

A good way to judge if a company has priced its product accurately is to
look at its underwriting profitability. One measure of underwriting
profitability is adjusted loss ratio, which is direct losses incurred
divided by the difference between direct premiums earned and dividends
paid to policyholders. The following companies are among the top 100
auto writers, based on direct premiums written in 2001, but have been
sorted by lowest adjusted loss ratio.

($ Thousands)

                                            2001 Direct
                                               Premiums
Rank  Group                         AMB#        Written  2001

 1    Ace INA Group                 18498      $190,679  47.5
 2    American Modern Ins Group     04086       303,605  50.0
 3    Canal Group                   03930       233,874  53.9
 4    Safeway Ins Group             00459       239,587  55.6
 5    Kingsway America Group        18442       337,422  56.5

 6    Motorists Ins Group           18236       230,146  58.1
 7    Penn National Ins             00766       204,357  58.8
 8    Progressive Group             00780     7,222,716  59.7
 9    Alfa Ins Group                18412       421,758  60.3
10    W R Berkley Group             04655       414,948  60.9

11    Mercury General Group         04524     1,337,963  61.1
12    Westfield Group               00730       485,886  61.8
13    Pemco Ins Cos                 00790       214,896  62.3
14    Chubb Group of Ins Cos        00012       661,606  62.7
15    Assurant Group                18499       192,827  63.2

16    Grange Mutual Casualty Group  03917       490,744  63.4
17    Commerce Group Inc            02966     1,041,844  63.6
18    Kemper Ins Cos                04427       926,211  64.6
19    Ohio Casualty Group           00726       650,972  64.6
20    Allstate Ins Group            00008    15,200,422  64.9
      Total U.S. P/C Cos.                  $154,222,820  73.4

                                      Adjusted             % of
                                    Loss Ratios         Company
Rank  Group                             2000     1999  Premiums

 1    Ace INA Group                     56.0     99.6       5.1
 2    American Modern Ins Group         46.2     54.1      64.2
 3    Canal Group                       72.6     60.1      82.1
 4    Safeway Ins Group                 57.7     52.4      97.3
 5    Kingsway America Group            52.4     55.6      93.2

 6    Motorists Ins Group               53.7     53.2      60.5
 7    Penn National Ins                 68.5     66.4      43.3
 8    Progressive Group                 69.9     62.9      97.9
 9    Alfa Ins Group                    63.5     63.4      64.2
10    W R Berkley Group                 72.7     81.3      24.7

11    Mercury General Group             59.3     55.5      92.7
12    Westfield Group                   71.6     71.2      41.9
13    Pemco Ins Cos                     58.0     58.6      77.0
14    Chubb Group of Ins Cos            74.5     70.1      10.8
15    Assurant Group                    57.8     63.7       9.6

16    Grange Mutual Casualty Group      67.6     57.6      69.5
17    Commerce Group Inc                59.9     63.8      90.4
18    Kemper Ins Cos                    69.0     62.6      19.6
19    Ohio Casualty Group               72.5     69.6      42.0
20    Allstate Ins Group                65.4     58.7      74.1
      Total U.S. P/C Cos.               73.1     67.7      43.6

Source: A.M. Best Co. state/line product, as of June 28, 2002

Adjusted Loss Ratio, Top Homeowners Writers--2001

A good way to judge if a company has priced its product accurately is to
look at its underwriting profitability. One measure of underwriting
profitability is adjusted loss rtio, which is direct losses incurred
divided by the difference between direct premiums earned and dividends
paid to policyholders. The following companies are among the top 100
homeowners writers, based on direct premiums written in 2001, but have
been sorted by lowest adjusted loss ratio.

($ Thousands)

                                               2001 Direct
                                                  Premiums
Rank  Group                             AMB #      Written  2001

   1  QualSure Ins Corp                 12379      $38,174  27.7
   2  Philadelphia Ins Cos              00476       64,791  34.6
   3  Poe Financial Group               18554       49,618  37.5
   4  Regency Ins Co (NC)               10600       42,289  38.3
   5  American Strategic Group          18538       36,994  39.3

   6  HDI US Group                      18492      337,917  39.4
   7  Assurant Group                    18499      106,418  39.8
   8  Axa Corporate Solutions US Group  18557       44,822  43.7
   9  Selective Ins Group Inc           03926       47,852  45.0
  10  Preferred Mutual Ins Co           00774       38,826  46.7

  11  Hingham Mutual Group              18284       33,299  46.9
  12  Commerce Group Inc                02966       88,426  49.4
  13  North Carolina FB Group           18279      117,159  49.5
  14  Bankers Ins Group Inc             18379       38,406  49.5
  15  Penn National Ins                 00766       32,566  50.3

  16  Donegal Group                     03168       45,234  50.9
  17  Royal & SunAlliance USA           18371      149,974  53.5
  18  Quincy Mutual Group               18437       89,983  53.6
  19  American Intern Group Inc         18540      197,155  53.9
  20  Century-National Ins Co           03090       65,359  54.3

      Total U.S. P/C Cos.                      $37,290,386  77.6

                                          Adjusted              % of
                                        Loss Ratios          Company
Rank  Group                                 2000      1999  Premiums

   1  QualSure Ins Corp                     20.4         0        77
   2  Philadelphia Ins Cos                  26.4      53.3      13.8
   3  Poe Financial Group                   34.4      43.9      56.2
   4  Regency Ins Co (NC)                   23.5      44.5      94.9
   5  American Strategic Group              46.9      32.1      72.1

   6  HDI US Group                          28.1      29.7      16.1
   7  Assurant Group                        40.9      40.3       5.3
   8  Axa Corporate Solutions US Group      25.4     -99.9      21.9
   9  Selective Ins Group Inc               57.9      47.7       4.7
  10  Preferred Mutual Ins Co               51.9      46.1      33.5

  11  Hingham Mutual Group                  49.3      40.1      75.6
  12  Commerce Group Inc                    40.1      25.7       7.7
  13  North Carolina FB Group               62.0     114.7      21.4
  14  Bankers Ins Group Inc                 41.9      36.3      12.1
  15  Penn National Ins                     59.6      66.9       6.9

  16  Donegal Group                         61.0      60.8      17.6
  17  Royal & SunAlliance USA               66.7      63.6       3.2
  18  Quincy Mutual Group                   51.0      46.7      36.6
  19  American Intern Group Inc             67.7      21.0       1.3
  20  Century-National Ins Co               38.4      42.9      44.5

      Total U.S. P/C Cos.                   66.7        64      10.5

Source: A.M. Best Co. state/line product, as of June 28, 2002

RELATED ARTICLE: Progressive Pioneered Segmentation

When it comes to getting the price right, few companies are as highly praised as Progressive. "I'd have to put Progressive at the top of the heap," said Todd Bault, an equity analyst with Sanford C. Bernstein & Co. "Over the last decade, the whole science of personal-lines pricing has improved a lot. Whereas a decade or more ago, Progressive might have been one of the few companies using credit scoring, now most are using credit scoring. I don't think Progressive has quite the arbitrage it had in the early 1990s and late 1980s, but it still does a better job of managing data and finding new things to look at."

Even competitors admire how Progressive sets rates.

"When I was doing the price piece of it, I always kept an eye on what Progressive is doing," said Richard Ward, Director of business development for Safeway Insurance Group. "They get the price right."

With $7.22 billion in direct premiums written at yearend 2001, Progressive is the fourth-largest writer of total auto in the United States and at the top of the pack when it comes to keeping its adjusted loss ratio low. Progressive had an adjusted loss ratio of 59.7 for year-end 2001, the lowest among the top 10 largest writers and well below the average adjusted loss ratio of 93.1 of the largest 100 companies, according to A.M. Best Co. data.

"What we are trying to do is accurately and as finely as possible identify as many segments as we can; that is, identify as many groups of policyholders for whom we predict the same average loss costs," said John Barbagallo, Progressive's director of product research and development. "If we can do that successfully, we'll have more price points, and be priced more accurately in the long run and produce a better loss ratio."

Progressive approaches pricing differently from other companies, Barbagallo said. While many carriers use underwriting to define what risks are acceptable at a given price, and then try to attract customers that fit their underwriting, Progressive looks more at individual risks.

"We started out writing nonstandard business that was cancelled or rejected by other companies," Barbagallo said. "We looked at every risk that came in, and tried to figure Out what it would cost to insure the different risk profiles profitability. We might have a $300 and a $600 and a $900 level, for instance. The more segmentation you have, the more price points you'll have to fit those customers."

Progressive has a wider range of available rates than its competitors, Barbagallo said, although he added he couldn't say if it has 10, 100, or 1,000 rates.

"We have 4.5 million personal auto customers, and a lot of customers share a common rate. We' don't have an individual rate for each customer, but many rates for groups of people that share common characteristics and predicted loss costs," Barbagallo said.

In addition to looking at traditional underwriting factors, such as age, gender and driving history, Progressive was one of the first to use credit-based insurance scoring to factor in a driver's financial record.

While some companies use credit scores to decide which customers it won't accept, Progressive views the credit score as "a continuum from A to Z with many different rates. We use it in conjunction with many other factors to make a range of prices," Barbagallo said, "And we never use credit to reject, cancel or non-renew a policy."

Also, Progressive goes a step further and bases its rates on a combination of those individual factors. For instance, by looking at points on a driver's license in conjunction with the driver's age, Progressive views the points to be most predictive of risk on older drivers, less predictive on middle-aged drivers, and predictive again on younger drivers--although not quite as predictive as older drivers.

"We don't use a lot of unique things; it's how we use them and how we model them," Barbagallo said. "We try to give everyone a rate. There are some unacceptable risks, but we try to keep that list as short as possible."

That philosophy has worked for Progressive, which has grown rapidly and has always had a five-year loss ratio that outperformed the industry, he said.

In fact, Progressive is so sure that it has set the price right, it is happy to direct consumers to competitors who offer a policy cheaper. The company routinely quotes its competitors' prices to customers, in addition to offering a Progressive quote. Progressive launched the practice of giving competitors' quotes as a marketing tool, but it has brought other benefits.

"Sure, no system is perfect, but we're confident enough in our ability to price a risk accurately that we have no problem providing comparison rates to show our customers what is available to them from other companies," Barbagallo said. "In the short term, we may lose some business, but in the long term, we feel good that we're able to use our unique pricing abilities to provide an important tool for customers to make better decisions."

Progressive also prides itself on having "more decision makers closer to the market."

For most states, Progressive has a product manager responsible for that state, instead of a national underwriting manager or actuary who works at corporate headquarters. That helps the company to be quicker to catch a loss trend or pricing opportunity, Barbagallo said.

"We are able to respond quickly to changes and trends, and the frequency of change and adjustment is higher," he said.

The company reviews rates for each state quarterly, and if need be, moves quickly to adjust them. For instance, in 2000, when the industry was confronting a rapid spike in loss costs, Progressive completed 113 auto rate revisions in 45 states.

"I think what we are most proud of is that we've been able to grow our business at a very high level, over many years, and still deliver profitable results," Barbagallo said. "At the same time we did that, we broadened our reach to more customers."

Profitability Analysis, Progressive Casualty Pool

Progressive's strong underwriting results have helped it outperform its
competitors.

Period                 Company  Industry Composite
Ending          Combined Ratio      Combined Ratio

1997                      94.8                97.5
1998                      92.9                98.6
1999                      99.4               101.9
2000                     106.6               105.5
2001                      96.4               101.1
5-Year Average            98.5               101.2
09/2001                   96.5               101.1
09/2002                   91.9

Source: A.M. Best Co. Company Report