Rules of the road: predictive modeling can help commercial insurers set premiums.
The time has come for commercial auto insurance to benefit from the same predictive modeling techniques and strategies that have been a boon Boon
A general term that refers to a benefit or improvement for investors. This can include such things as increased dividends, a stock market rally and stock buybacks.
Notes: to personal-line insurance products.
Personal auto insurance rating has been revolutionized by decades of enhancements, such as independent vehicle symbols, liability symbols, ZIP code zip code
System of postal-zone codes (zip stands for “zone improvement plan”) introduced in the U.S. in 1963 to improve mail delivery and exploit electronic reading and sorting capabilities. territory rating, motor vehicle record scoring and credit scoring Credit scoring
A statistical technique that combines several financial characteristics to form a single score to represent a customer's creditworthiness. . Now, commercial auto rating plans can enjoy greater predictive risk accuracy as well.
Insurers already pursuing such sophisticated rating plans are realizing the advantages. By taking a closer look at the risks themselves, insurers are able to determine more accurate "walk-away" prices and more detailed price points. One national commercial insurer, for instance, began using vehicle identification numbers to improve commercial auto classification, much as it does for personal auto.
The insurer implemented this new policy after discovering that Peterbilt tractor-trailers were being misclassified as light trucks. Pricing was adjusted accordingly.
Another company found that commercial auto policies charged between 25% and 40% of personal auto rates when it compared commercial auto rates for private passenger-type vehicles to personal auto rates for similar drivers and vehicles. The percentage differences were mainly due to the personal auto rating plan's pricing of vehicle characteristics, such as luxury and sports cars, as well as driver age and moving violations A moving violation is any violation of the law, committed by the driver of a vehicle, while it is in motion. The term "motion" distinguishes it from parking violations. While parking violations are charged against a vehicle (which will be towed if violations go unpaid or are .
Building a Better Plan
An actuarially sound rate is required to be "not excessive, not inadequate, and not unfairly discriminatory dis·crim·i·na·to·ry
1. Marked by or showing prejudice; biased.
2. Making distinctions.
dis·crim ." Classification plays an important role in commercial auto rating because it is the primary means of measuring differences in expected losses between risks based on "fair" criteria. Desirable rating characteristics are:
* objective--they aren't subject to personal judgment
* verifiable--they can be validated from a reliable source
* cost effective--they are accessible at an economically viable cost
* predictive--they accurately differentiate loss potential
The problem is that several commercial auto rating factors do not fully satisfy these criteria. For example, vehicle use can be quite subjective. Vehicle weights, ages, purchase price and radius of operations frequently are not verified. It can be cost-prohibitive to acquire driver motor vehicle records.
The most abused elements of most commercial auto rating plans are the vehicle use and industry classification codes assigned. An ISO-based rating has three vehicle use categories: service (drive to job site only); retail (delivery to homes); and commercial (all other).
These categories create at least two problems.
For starters, since they are not verifiable, these risks are rated as "service" when more competitive pricing is needed and "commercial" when premiums are increasing. Secondly, they are not homogeneous The same. Contrast with heterogeneous.
homogeneous - (Or "homogenous") Of uniform nature, similar in kind.
1. In the context of distributed systems, middleware makes heterogeneous systems appear as a homogeneous entity. For example see: interoperable network. . "Commercial," for example, contains so many different underlying uses that it does not effectively differentiate risk. And while secondary classification codes do show differences by insured industry, they are often underutilized because secondary class often is not verified, resulting in higher rates.
There are alternatives. Standard Industrial Classification (SIC) and North American North American
named after North America.
North American blastomycosis
see North American blastomycosis.
North American cattle tick
see boophilusannulatus. Industry Classification System (NAICS NAICS North American Industry Classification System ) codes offer readily available and verifiable solutions to both vehicle use and secondary classification. Every U.S. company is assigned a single, verifiable SIC and NAICS code. Commercial auto analyses suggest materially different loss expectations by industry class. (See "Illustrative il·lus·tra·tive
Acting or serving as an illustration.
Adj. 1. SIC Rate Relativities," left.)
It Ain't Heavy, It's Extra-Heavy
Other rating factors are being refined as well. Consideration of vehicle weight can be improved for the level of refinement and verifiability. ISO's class plan has four vehicle weight classes: light, medium, heavy and extra-heavy. Alternatively, the Interstate Commerce Commission Interstate Commerce Commission (ICC), former independent agency of the U.S. government, established in 1887; it was charged with regulating the economics and services of specified carriers engaged in transportation between states. developed eight weight classes that do a much better job of grouping similar vehicles that are readily verifiable using vehicle identification numbers.
This verifiable approach to vehicle weight also addresses popular misconceptions Misconceptions is an American sitcom television series for The WB Network for the 2005-2006 season that never aired. It features Jane Leeves, formerly of Frasier, and French Stewart, formerly of 3rd Rock From the Sun. regarding specific vehicle types. The most common misperception mis·per·ceive
tr.v. mis·per·ceived, mis·per·ceiv·ing, mis·per·ceives
To perceive incorrectly; misunderstand.
mis is that all pickup trucks are "light." In truth, most large pickup trucks have gross vehicle weights well in excess of the "light" limit of 10,000 pounds.
VIN VIN Vulvar intraepithelial neoplasm, see there decoding de·code
tr.v. de·cod·ed, de·cod·ing, de·codes
1. To convert from code into plain text.
2. To convert from a scrambled electronic signal into an interpretable one.
3. software for commercial autos can validate VINs and provide correct ICC ICC
See: International Chamber of Commerce weight class. VIN decoding also provides verifiable vehicle age and original price estimates. VIN-based pricing estimates, however, do not include vehicle modifications made post-production, such as cranes, mobile equipment, refrigeration refrigeration, process for drawing heat from substances to lower their temperature, often for purposes of preservation. Refrigeration in its modern, portable form also depends on insulating materials that are thin yet effective. or specialized spe·cial·ize
v. spe·cial·ized, spe·cial·iz·ing, spe·cial·iz·es
1. To pursue a special activity, occupation, or field of study.
For private passenger vehicles, characteristics can be better reflected by using personal auto insurance product vehicle symbol relativities or simplified vehicle characteristic factors. These factors include: model year; vehicle segment such as compact, midsize, full size or luxury; high performance surcharges; and protective device credits.
The radius of operations rating characteristic often presents difficult challenges. First, radius is as hard to verify in commercial auto as personal auto. Second, ISO's price breaks at 50 and 200 miles appear arbitrary and do not suit all states equally well. Is driving within a 50-mile radius in Rhode Island Rhode Island, island, United States
Rhode Island, island, 15 mi (24 km) long and 5 mi (8 km) wide, S R.I., at the entrance to Narragansett Bay. It is the largest island in the state, with steep cliffs and excellent beaches. comparable to the same radius of operations in Montana?
For insureds specializing in trucking, data on miles driven annually may present a replacement that is actually available and verifiable. Unfortunately, a broadly applicable, readily available and verifiable tool to improve radius-of-operations ratings does not exist yet.
Another challenge in commercial auto rating is reflecting differences in premium due to the number of insured vehicles. In most states, "fleet" is defined as insureds with five or more powered units. Smaller risks are "nonfleet." While differences in expected loss costs between small and large risks are intuitive, why make a distinction only at five vehicles? It seems to be a somewhat arbitrary and simplistic sim·plism
The tendency to oversimplify an issue or a problem by ignoring complexities or complications.
[French simplisme, from simple, simple, from Old French; see simple approximation approximation /ap·prox·i·ma·tion/ (ah-prok?si-ma´shun)
1. the act or process of bringing into proximity or apposition.
2. a numerical value of limited accuracy. of a more complex relationship. Predictive modeling results suggest a more sophisticated approach (see "Commercial Auto Pure Premium Relativities by Fleet Size," page 54).
Not What, But Who
Commercial auto pricing also can be improved by using underwriting Underwriting
1. The process by which investment bankers raise investment capital from investors on behalf of corporations and governments that are issuing securities (both equity and debt).
2. The process of issuing insurance policies. scorecards that focus on "who" the insured is, and not "what" is being insured. Using this approach, both driver and owner characteristics are being incorporated into these plans.
Commercial auto pricing for driver characteristics has borrowed liberally from personal auto rating refinements, such as driver age and driving record. Reflecting these characteristics in commercial auto can present challenges such as:
* Drivers vs. vehicles: Commercial auto risks often have more drivers than vehicles.
* Periodic vs. dedicated drivers: Motor vehicle records of dedicated drivers are more predictive than those of occasional drivers.
* MVR MVR
In currencies, this is the abbreviation for the Maldive Rufiyaa.
The currency market, also known as the Foreign Exchange market, is the largest financial market in the world, with a daily average volume of over US $1 trillion. ordering criteria: Annual record searches on all drivers may be cost prohibitive pro·hib·i·tive also pro·hib·i·to·ry
1. Prohibiting; forbidding: took prohibitive measures.
A common approach to the driver/ vehicle mismatch mismatch
1. in blood transfusions and transplantation immunology, an incompatibility between potential donor and recipient.
2. one or more nucleotides in one of the double strands in a nucleic acid molecule without complementary nucleotides in the same position on the other considers overall driver averages (see "Average Driver Age Pure Premium Relativities" on page 54.)
Predictive models also can help with developing MVR reordering re·or·der
v. re·or·dered, re·or·der·ing, re·or·ders
1. To order (the same goods) again.
2. To straighten out or put in order again.
3. To rearrange.
v. criteria based on driver age (for example, all drivers under 25); current score (perhaps all drivers with more than 2 points against their licenses); and/or tenure (ordering MVRs on all new drivers). These criteria can enhance cost-effectiveness without materially impacting accuracy.
Credit scoring is another approach from personal lines insurers that is being successfully adopted by commercial auto insurers. Applying credit to commercial auto insurance faced several challenges. Initially, getting a high enough "hit rate" of credit scores for small-business commercial auto policies was challenging. Vendors have significantly reduced the number of small business "no hit" and "thin" files by blending commercial credit data with personal credit scores of small-business owners. This approach works well when a business has a small number of primary owners (see "Credit Scoring as Part of an Underwriting Scorecard," page 52).
Using scores that blend personal and commercial data introduces additional regulatory scrutiny. As a result, some commercial-lines insurers are using an alternative approach that incorporates specific credit information, rather than a score, into their underwriting scorecards. Examples include: number of transactions; total balance overdue OVERDUE. A bill, note, bond or other contract, for the payment of money at a particular day, when not paid upon the day, is overdue.
2. The indorsement of a note or bill overdue, is equivalent to drawing a new bill payable at sight. 2 Conn. 419; 18 Pick. ; number of public records/collections; average number of days in which balances are overdue; and number of inquiries.
Insurers are finding that internal financial information captured over the course of an insured relationship can be used on renewal policies. Internal data, such as premium financing Premium Financing involves the lending of funds to a person or company to cover the cost of an insurance premium. Premium finance loans are often provided by third party finance entity known as a "Premium Financing Company"; however insurance companies and brokerages occasionally experience, which can range from late payments to payment "in full" at inception, and difficulty recovering deductibles all have potential as rating characteristics.
"Who" characteristics beyond driving record, driver age and credit are being incorporated in commercial auto rating plans. Factors such as years of risk, years in business, hours of operation, on-site ownership, mandatory drug screening and employee turnover rates have been included in analyses.
The new "who" characteristics are often implemented using an underwriting scorecard. These scorecards are either filed as an addition to the rating plan or treated as tiering criteria within underwriting guidelines guidelines,
n.pl a set of standards, criteria, or specifications to be used or followed in the performance of certain tasks. . This second approach takes advantage of the flexibility created by multiple company rating tiers and schedule rating plans. Typically, this results in a recommended tier (e.g.-15% deviation company) and a suggested schedule rating modification (e.g.-10%).
Underwriting scorecards have several advantages. They consider multiple factors at once. Implementation of a scorecard within underwriting guidelines allows a company to preserve its competitive advantage longer. Scorecards serve as the basis for a feedback loop to underwriters, agents and insureds, providing information on the basis for the pricing decision.
For example, it might be communicated by the insurer that average driver age and MVR points resulted in a higher premium. This can increase underwriter underwriter n. a company or person which/who underwrites an insurance policy, issue of corporate securities, business, or project. (See: underwrite)
UNDERWRITER, insurances. One who signs a policy of insurance, by which he becomes an insurer. and agent confidence in the scorecard and provide insureds with characteristics they can control to reduce future premiums. For example, they might exclude drivers with poor driving records.
Predictive modeling applications for commercial auto insurance allow insurers to take advantage of the innovations developed by Progressive Corp. anal other personal auto insurers. But this is only the beginning. Insurers that incorporate a variety of vehicle, driver and owner characteristics into rating plans significantly improve their understanding of expected losses.
Underwriters who use new objective information and more accurate manual premiums will be empowered to determine better risk selection and final pricing for their companies.
* The News: Commercial auto insurers gain a competitive edge by adopting the underwriting techniques used by personal lines writers.
* The Background: Commercial auto pricing has been based on factors that are arbitrary or difficult to verify.
* The Payoff: With new, objective information, underwriters can better determine risk selection pricing.
Contributor Robert J. Walling is a principal and consultant with Pinnacle pinnacle (pĭn`ĭkəl), minor architectural motif of vertical tapering shape, usually crowning a pier, buttress, or gable. Although sometimes it appears in Renaissance design, as in the Certosa di Pavia, it is almost exclusively a medieval Actuarial ac·tu·ar·y
n. pl. ac·tu·ar·ies
A statistician who computes insurance risks and premiums.
[Latin Resources Inc, in Bloomington, Ill. He can be reached at firstname.lastname@example.org.
Illustrative SIC Rate Relativities [ILLUSTRATION OMITTED] Data shown is for illustrative purposes only. Results have been modified to preserve client confidentiality. Essential details of SIC relativities from commercial auto predictive modeling applications also have been modified or hidden. SIC Factors Descriptions 171X 1.10 Plumbing/HVAC 173X 0.85 Electrical Contractors 175X 1.00 Carpentry 179X 0.95 Misc. Contractors 27XX 0.85 Printing/Publishing 35XX 0.90 Industrial Machinery 507X 0.95 Hardware Wholesaler 514X 1.10 Grocery Wholesaler 571X 0.85 Home Furnishings 581X 0.95 Restaurants 59XX 1.10 Misc. Retail 64XX 0.85 Insurance Agents 65XX 1.05 Real Estate 721X 1.25 Laundry/Dry Cleaning 734X 1.20 Building Services 737X 1.10 Computer Services 76XX 1.05 Misc. Repair Services 80XX 1.00 Health Services 87XX 0.90 Eng. & Mgt. Services Source: Robert J. Walling Credit Scoring as Part of an Underwriting Scorecard How five bands of credit scores could be incorporated into a predictive model to develop rating relativities. In this example, the indicated relativities have been scaled so they can be included in an underwriting scorecard. Indicated On Balance Score Credit Score Exposure Relativity Indicated Points Adequate 503,000 1.000 1.002 49 Borderline 215,000 1.060 1.062 11 No Score 127,000 1.030 1.032 19 Preferred 149,000 0.850 0.852 74 Deficient 37,000 1.100 1.102 0 1,031,000 0.998 1.000 Source: Robert J. walling [ILLUSTRATION OMITTED]