Segueing into segments: certain marketplace realities of pricing, if ignored, could run a micro-segmentation juggernaut aground.

A shift in the pricing aspect of the private-passenger auto operating model is sparking great interest. This phenomenon, called micro-segmentation, involves radical expansion of price points for a market basket of policyholders based on predictive modeling applications and external databases. For example, a carrier that previously had 100 different rates for a certain set of policyholders may today have as many as 400 to 500 different rates for the same group.

From an actuarial viewpoint, expansion of price points creates a better match between risk and price as predictive models refine traditional rating plans for previously unaddressed differences in policyholder risks. From the consumer's viewpoint, it means that insurers will compete harder (lowering prices) for better risks.

Once the bastion of a few hard-nosed competitors, micro-segmentation is not a new concept. What's new is that its use has become widespread. In recent years, most of the top 20 carriers have rolled out new pricing plans based on micro-segmentation, leading many industry commentators to suggest that this proliferation in price points will be the strategic battleground for personal lines carriers over the near term. While that is true, certain marketplace realities, if ignored, could run a micro-segmentation juggernaut aground.

The Buying Decision: The first reality is that many factors besides pricing enter into consumer decisions to buy auto insurance, including:

* Tradition. "My parents used Company X and I do the same." "My parents relied on Agent Smith, and that's good enough for me." (This obviously plays better for insurers with captive agents.)

* Convenience. "Agent Smith is around the corner." I can pay my bill over the Internet." "I can take care of everything when I cash my check."

* Experience. "They have always been responsive to my inquiries." "They provide excellent service." "They were fair in settling my claims."

* Reputation. "My buddy saved $50." "My neighbor said their service was excellent/horrible."

* Brand. "I know they'll be there when I need them." "They have a known brand, so they must be good."

* Loyalty. "I've been with Company X for 20 years and see no reason to change now."

* Sales effectiveness. Whether driven by company mission or higher commissions, this attribute captures the relative effectiveness of the sales force.

This list, though not exhaustive, speaks to the complexity of understanding any given consumer's decisionmaking process. A segment of the driving population will base its buying decisions solely on price. But for the vast majority of consumers, price will be only one of several factors. Focusing on implementing micro-segmentation without considering the impact of these other factors could prove to be a major misstep for carriers.

Marketplace Conditions. Trends in the marketplace also affect the purchase decision. Several recent studies indicate that more consumers today are shopping around for auto insurance. This shift in buying patterns is supported by the price transparency facilitated by the Internet and the heavy advertising by a tranche of competitors emphasizing the availability of lower prices.

But while it's true that the number of consumers who shop around for auto insurance has increased over the past three years, this trend is influenced by the spate of rate increases that is facilitating today's profitable results. Shopping patterns should be reexamined during a period of stable or falling rates to see whether this trend holds up.

Macro Trends Favoring Customer Retention. The first trend is the ever-increasing "busyness" of our lives. The second is our growing addiction to positive buying experiences. The third is the impact of electronic commerce on our bill-paying activities.

The first two trends conspire to drive consumers to spend as little time as possible considering their auto insurance purchase decision. The last--paying bills online-allows us to fulfill this obligation in mere seconds.

Many insurers undervalue the power of this last trend. The typical policyholder's window to consider shopping for a different insurance price lasts from the time they receive a bill to the time they mail their payment. The power of reducing this window to mere seconds should not be overlooked.

So what can we take away from these marketplace realities? First, price is critical, and micro-segmentation is now table stakes. Second, the current industry focus on micro-segmentation often overlooks other critical issues. And finally, winning insurers need to sift through the confusion and tailor their offerings to their customers. [BR]

Chris McShea is director of Property/ Casualty Services in Ernst & Young's Insurance Actuarial and Advisory Services practice. He can be reached at [e-mail].