Price Wars

• Bonnie Brewer Cavanaugh
• October 2005
• 

When auto underwriting giant State Farm announced in May that it would offer private-passenger auto policy pricing based on segmentation, no one was really surprised. After all, three of the top five auto writers already offered it; State Farm was due.

Yet now that the market leader has jumped into the fray, its competitors are readying for another pricing war -- tiered pricing, that is -- because even though the pricing wars subsided over the past couple of years, the auto insurance market remains highly competitive.

"All the major competitors are looking for a way to distinguish themselves to attract and retain high-value customers," said Anthony Diodato of the A.M. Best Co. Property/Casualty Ratings Division. "For example, Allstate introduced the Auto Choice Program, while Progressive offers concierge service for its customers."

Allstate's Auto Choice is a pricing mechanism that lets customers customize their coverage; they can opt for everything available -- all the "bells and whistles" -- to just the bare bones needed to comply with individual state regulations. The Northbrook, Ill.-based firm, the nation's second-largest auto writer, also prides itself on customer service and pricing.

Progressive of Mayfield Village, Ohio, the third-largest U.S. auto insurer, developed Concierge Service, a one-stop accident claim, repair and car rental service in which insured drivers can file a claim, rent a loaner car, and get vehicle repairs through one of the company's 22 service centers in 18 markets nationwide.

Track Record

Segmentation, the practice of slicing the auto insurance market into multiple segments to allow a company to create more categories and better define the risk pool, has been working well for State Farm's competitors. Progressive, which pioneered segmented pricing in the 1990s, has grown markedly in the past several years. It was the fifth largest private-passenger auto insurer in 1998; the third largest in 2002; and remains the third largest today, with a 7.3% share of the market for 2004. The company saw a 6.7% market share for 2003, up from 5.8% in 2002.

Allstate, which implemented tiered auto insurance pricing during 1999 and 2000, saw 10.4% of the private- passenger auto market share for 2004, up from 10.2% in 2003 (which was a slide from its 10.6% market share in 2002). And Geico, a Berkshire Hathaway company based in Washington, D.C., and the fourth-largest private-passenger auto insurer, also saw a market share hike -- to 5.6% for 2004, up from 5.1% in 2003 and 4.7% in 2002 -- since it began offering tiered pricing. Geico was sixth largest private-passenger auto insurer in 1998 and the fifth largest in 2002.

State Farm had a 19.3% share of the private-passenger auto insurance market in 2002, followed by a slide in 2003 to 19.0%, and another dip in 2004 to 18.2%. Of the top five private-passenger auto carriers, only Farmers Insurance Group of Los Angeles joined State Farm in taking a dip: Its current market share of 5% for 2004 is down from 5.1% in 2003 and 5.4% in 2002.

State Farm offered no direct explanation for why it succumbed to segmented pricing, and others in the industry could only speculate.

"What prompts us to do anything like this is a desire our company has had since it was founded by George J. Mecherle in 1922 to match price to risk, to price our products fairly," State Farm spokesman Dick Luedke said. The company is embracing segmentation as a means to attract new customers, he added.

Fred Cripe, Allstate's group vice president of policy and pricing, could only guess why State Farm would wait until now to offer a tiered pricing plan: "If they always wanted to do this, why did it take them so long?"

"For State Farm, it's a natural progression to introduce a tiered rating program as a defensive measure against its competitors," Diodato said. "It will give them more pricing flexibility to retain its high-quality customer."

In State Farm's 2004 Annual Report, Chairman and Chief Executive Edward B. Rust Jr. expressed disappointment in the company's performance and vowed to recharge its auto division. "Although we wrote 5.6 million auto applications and added more than 375,000 policies and accounts to our total book of business, we fell short of our growth goals in our core auto business. Our toughest competitors increased their share of the auto market -- we did not," Rust stated.

State Farm's auto insurance business makes up some 65% of the property/casualty company's net written premium. Yet the company said its foray into segmented pricing has little to do with performance.

"Whether we're growing like wildfire, or losing customers, I don't think it would change our desire to price accurately," Luedke explained.

The company does seem braced for competition, however. As Rust noted in the 2004 Annual Report, "We'll learn, adapt and change." And with a little hard work, "2005 will become the year where State Farm returns to profitable growth in auto."

State Farm still has a large market share, and its competitors have a long road to travel to catch up. The company has an additional edge just by the sheer volume of material at hand. "When one considers the amount of customer information retained, State Farm has the data to develop a multiple variable approach that could enhance the way it underwrites its business," Diodato said.

Currently State Farm groups its customers by age, location, type of vehicle, length of commute, vehicle usage and driving record, Luedke said. He did not reveal how those groups would be further segmented, nor what effort or technological advancements the company would need to accommodate multiple tiers.

Technology's Role

New technology was a major player in bringing tiered pricing to Allstate. "It took a substantial amount of resources on the business side and the technology side to implement this," Cripe said.

The only thing more difficult than building the model for tiered pricing was actually implementing it, said Mike LaRocco, president of product underwriting and claims for Seattle-based Safeco. "It's a very significant work effort. We needed a much more sophisticated system to support issuing and serving policies," LaRocco said. "The way we price and assess risk changed significantly. The system to support and change those policies has to change along with it."

And he should know: Prior to arriving at Safeco, LaRocco helped develop tiered pricing programs at Geico and Progressive.

Tiered pricing has been a real boon for Safeco, LaRocco said: "It's been terrific, and we think the results pretty much validate that we've been able to grow our market share significantly over the last three years, while achieving and exceeding our underwriting profit goals. It has been a really solid success."

The 13th-largest auto insurer with a 1.6% private-passenger auto market share for 2004, Safeco implemented tiered pricing in May 2002 and has since seen a rise in market share (to 1.5% in 2003 from 1.4% in 2002). The company increased its risk segments from five tiers to up to 16 tiers, and is using numerous determining factors to assess its customers. The number of characteristics in the underwriting model is about 15, while the rating model tiers are more multifaceted.

Reaping the Rewards

Allstate also has seen a "very positive" impact on its business since implementing tiered pricing. "We certainly can attribute some of our growth and policies in force to the existence of this program," Cripe said. "The quality of the business that we've been writing improved, and that's impacted both our profitability and our retention."

And Allstate is seeing a shift toward higher lifetime value customer segments. "It means that we end up attracting more customers who are likely to have better loss experiences, stay with the company longer and buy more products from us," Cripe added. The company now also uses a tiered pricing structure for its homeowners business and for such specialty lines as renters insurance, condominiums, boats and motorcycles.

Safeco is using tiered pricing for its homeowners and commercial lines.

LaRocco sees State Farm's entry into tiered pricing as an advantage. "Quite frankly, I think it's good for the industry. I think the more sophisticated we become as an industry, the better it is -- the better we get at matching rates to risk, the better we get at being consistent suppliers of a price," he said.

State Farm's entry into segmentation also signals the opportunity for other, more progressive companies to join as well. "It's important to note that only two or three companies are really doing it at the level of sophistication that we are," LaRocco said. "There's a big difference between companies that are talking about it, and ones that have really excelled at it."

Although he foresees a future in which the entire auto-writing industry will eventually go the way of segmented pricing, smaller carriers would have to contend with three major factors:

-- Dealing with the amount of data that has to be validated while having to rely on industry data, which is not as good as proprietary data;

-- A huge financial commitment from a technology standpoint;

-- Finding the right human talent to pull off the job.

"While there are data drive models, really, really smart people have to analyze the data and ultimately make the decisions," LaRocco said. "It's a huge human resources investment as well as a technology investment. Those resources are tough to come by, by all accounts; for small companies, it's an uphill battle."

LaRocco also foresees a massive effort ahead of State Farm.

"For such a large company, implementing this in such a huge book of business is going to create a huge challenge for them. I applaud them for the effort," he said. State Farm will likely implement its new pricing across the board on a step-by-step basis in order to protect their assets, he added.

Improvements to Safeco's pricing tiers have been ongoing. "These models are never static at Safeco," LaRocco said. "They are dynamic models, and the biggest change is going on right now: the next evolution of our auto product that's been rolled out now in 12 states, a more sophisticated approach to pricing. We charge a different liability rate by vehicle with our new product."

Allstate also plans to initiate an even more segmented pricing structure: Strategic Risk Management 4, an improved pricing platform that has been in development for about two years. Allstate launched SRM4 in a couple of states in December, with a national rollout scheduled into 2006. It follows SRM3, which is in use in some areas of the country, and SRM2, the current national tiered pricing model. And while SRM2 contains seven pricing tiers, SRM4 will have the capacity of 384 tiers and some 1,500 price levels.

Safeco has three rating levels, representing literally thousands of price points: the Product Level for preferred, standard and nonstandard accounts; the Characteristic Level, segmented according to age, gender, marital status and territory, etc.; and the Tier Level, which includes credit-based insurance scoring.

"We have a very complete multivariate underwriting model, which helps us select risks into one of those tiers, then a multirating model that puts them into any number of thousands of price points within each of the rating tiers," LaRocco explained.

State Farm's new pricing format already has been implemented in a handful of states, with a national rollout to take place through 2006.

As for the competition, they likely will watch State Farm closely. "As the market leader, State Farm's actions have a ripple effect throughout the personal lines sector," Diodato said. "However, the impact of its tiered pricing program is uncertain and will depend on how aggressive it implements rate changes."

Allstate has not yet felt the impact of State Farm's pricing move. "We've tracked pretty carefully the states where they've got tiered pricing in," Cripe said. They include Kentucky, Tennessee, Florida and Iowa. "So far we haven't seen any significant impact. But it's early."

see "U.S. Private-Passenger Auto Market Share"

Learn More

State Farm Group

A.M. Best Company # 00088

Distribution: Exclusive agencies

Allstate Insurance Group

A.M. Best Company # 00008

Distribution: Exclusive agencies

Progressive Insurance Group

A.M. Best Company # 02407 (Progressive Casualty Insurance Co.)

Distribution: Independent agents, direct

Berkshire Hathaway Insurance Group

A.M. Best Company # 01737 (Geico Casualty Co.)

Distribution: Direct

Safeco Insurance Cos.

A.M. Best Company # 00078

Distribution: Independent agents

For ratings and other financial strength information about these companies, visit www.ambest.com.

By Bonnie Brewer Cavanaugh, Bonnie.Cavanaugh@ambest.com