California Personal Auto Rating Plans
The Good, The Bad and The Ugly
Kelleen Arquette
November 2006
© 2006 Towers Perrin
Agenda
 California Private Passenger Automobile Regulations
 Background – Proposition 103
 New Regulations
 Market Impact
— Pumping and Tempering
— Market Studies
— Industry Comments
— Lessons from Other States
 What Can Companies Do?
 Other Regulations
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Background – Proposition 103
 Enacted in 1988
 Requires premiums based on certain variables in a certain order
 Three Mandatory Factors
— Driving Safety Record
— Annual Mileage
— Years of Driving Experience
 Optional Rating Factors
— Some can be combined with Years of Driving Experience
— Only approved list allowed
 Mandatory rate decrease
 Average weight of optional factors below third mandatory factor
 Requires rating plan factors to be developed using sequential
analysis
 Territorial Restrictions
 10 frequency bands and 10 severity bands
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New Regulations
 Enacted July 14, 2006
 Required each insurer to cap the amount of spread an insurer can
use for territorial rating
 20 frequency bands and 20 severity bands
 Although more bands allowed, restriction on weight limits
territorial dispersion
 Required each insurer to file an updated rate level indication
 Weight of each optional factor below third mandatory factor
 Two phases
 First filing within 30 days – move part way towards full
compliance, including rate filing
 Second and subsequent filings – achieve full compliance within
two years
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Implementation – Phase One
 First filing required to correct for any non-compliance
by 15%
 For any factor with weight above the third
mandatory factor, decrease the weight by 15%
 Initial filings did not accomplish full compliance for
factor weights
 Frequency and severity bands
 Gender and marital status in some cases
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Implementation – Phase One (continued)
 Auto Club (Interinsurance Exchange of the Auto Club)
 First to file
 7.0% decrease
 Weights for multi-car, gender for a few coverages,
frequency bands and severity bands still above third
mandatory factor
 Retained current frequency and severity band
definitions
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Implementation – Phase One (continued)
 USAA
 Second to file
 5.1% decrease
 Weight for frequency band factors still above weight
of third mandatory factor
 Retained current frequency and severity band
definitions
 Reduced weight of frequency band factors by
lowering the relativities for the highest rated bands
and increasing the relativities for lowest rated
bands, instead of tempering
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Implementation – Phase One (Continued)
California Market Share
Pending Rate Changes
State Farm
Rest of
Industry
Mercury
GEICO
State Farm: -8%

Mercury: +4.5%

Auto Club: -7%

Farmers: 0%

Allstate: 0%
Interins Exch
of Auto Club
USAA
Progressive
Farmers
CA State Auto
AIG
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Allstate
AIG: -5%

California State Auto: -5%

Progressive: -2%

USAA: -5%

GEICO: -5%
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Implementation – Phase Two
 Full compliance with proposed regulations must be
achieved by July 14, 2008
 Requires at least one filing – rate and class plan
 Redefine territory definitions to 20 territories
 Number of filings will depend on
 Customer rate impact
 Customer retention
 Rate indication
 Competition
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Pumping and Tempering
 Factor weight
 Weighted average of the absolute difference of the relativities
from the mean
 Measure of dispersion
 Temper – lessens dispersion, decreases factor weight
 Pump – increase dispersion, increases factor weight
 Example
 Driving Safety Record
 Annual Mileage
 Years of Driving Experience
 Frequency Band
10
9
8
13
 Possible solutions
 Select different relativities to align weights
 Temper frequency band relativities
 Pump years of driving experience, annual mileage and driving
safety record
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Pumping and Tempering (continued)
 Cross-subsidies
 Pumping Driving Safety Record – Drivers with accidents and
convictions pay too much, high surcharges may create incentive
for unreported minor accidents
 Pumping Annual Mileage – Long annual mileage drivers subsidize
short annual mileage drivers, incentive for policyholder to
underestimate annual mileage
 Pumping Years of Driving Experience
 Higher rates for new drivers increases likelihood of
undisclosed drivers
 Increase uninsured population of new drivers (<9 years driving
experience) and experienced drivers (59+ years of driving
experience)
 Temper Cost and Frequency Bands – Urban rates subsidized by
suburban and rural rates
 Temper Gender/Marital Status – Rates for inexperienced single
male drivers subsidized by other drivers
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Pumping and Tempering (continued)

2003 study ranked importance of rating variables

Three most important factors connected to loss propensity do not align with
California’s Three Mandatory Factors

Insurance score is not an optional factor in California

Years of driving experience used in California instead of age
Coverage
Factor 1
Factor 2
Factor 3
Bodily Injury
Liability
Age/Gender
Insurance Score
Geography
Property
Damage Liability
Age/Gender
Insurance Score
Geography
Medical
Payments
Insurance Score
Limit
Age/Gender
Comprehensive
Model Year
Age/Gender
Insurance Score
Collision
Model Year
Age/Gender
Insurance Score
Source: The Relationship of Credit-Based Insurance Scores to Private Passenger Automobile Insurance Loss
Propensity, Michael Miller, FCAS and Richard Smith, FCAS, Epic Actuaries, June 2003
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Market Studies – Robert Downer Study
 Study commissioned by Personal Insurance Federation of
California (PIFC) and Association of California Insurance
Companies (ACIC)
 Study performed by Robert Downer of ARM Consultants, Inc.
 Data from four large auto insurers
 Study focused on rate changes for individual drivers rather than
rates relative to indicated costs
 Study assumed revenue neutral changes
 Study shows
 Over 60% of all drivers will receive a rate increase
 Nearly 75% of drivers with 34 years driving experience (50+
years old) will receive rate increases
 Over 60% of California Good Drivers will receive rate
increases
 Over 55% of drivers not considered California Good Drivers
will receive rate decreases
Source: Personal Insurance Federation of California Reference Book, “Impact of petition to modify use of Optional
Rating Factors”, Robert Downer
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Market Studies – Mercer Oliver Wyman Study

California Department of Insurance commissioned study by Mercer Oliver Wyman

Participation from several companies

Three instruction sets completed by participating companies, data provided to
Mercer Oliver and Wyman for analysis

Study focused on rate changes for individual drivers rather than rates relative to
indicated costs

Study assumed revenue neutral changes

Study shows
 Rate increases for 52 of 58 counties
 Approximately 60% of California drivers would receive a rate increase
 27% of all drivers will get a rate increase of over 10%
 Rural drivers subsidize urban drivers
 Magnitude of cross-subsidies range from $344 million to $742 million

Two studies show same results – New regulations will result in rate changes for
drivers across the state

Rate changes not considered in either study
Source: California Farm Bureau Federation Fact Sheet, “Proposed Amendment of Title 10 California Code of Regulations, Section 2632.8 –
Optional Automobile Insurance Rating Factors”
Californians to Stop Unfair Rate Increases, “Two Different Studies – Same Conclusion, Department of Insurance Proposal Will Result In
Higher Auto Insurance Rates for More Drivers?”
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Industry Comments – 45 Day Comment Period
 Insurer comments during 45 day comment period prior to passage
of new regulations
 Rates should be cost-based and substantially related to the
risk of loss
 A driver’s location (zip code) should be a critical factor in
calculating insurance rates
 Drivers in rural regions of the state should not be forced to
subsidize the rates for drivers in urban regions of the state
 The proposed regulations will result in arbitrary rates because
of the act of pumping and tempering and the resulting crosssubsidies. Pumping and tempering move rate relativities in
opposite direction of indicated
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Lessons from other states - Michigan
 Michigan Essential Insurance Act
 Take-all-comers provision
 Territory restrictions
— 20 territories
— Maximum 10% rate differential between adjacent territories
— Restrictions on maximum rate differential between highest and
lowest rated territories (lowest rated not less than 45% of highest
rated)
 Market Impact
 Urban territories subsidized by suburban and rural territories
 Insurers specialized in urban or rural areas, with rates that reflected
their market area
 Coverage availability problems in Detroit
 Increase in the involuntary market, especially in Detroit
 Similarities to California Regulations
 Territory restrictions that create a subsidy for urban drivers
 CA insurers must accept all California Good Drivers
Source: Mackinac Center for Public Policy, www.mackinac.org, “The Essential Insurance Act”
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Lessons from other states - Massachusetts
 State-mandated rates
 Territories
 Territory definitions are re-defined every two years
 Urban territories subsidized by rural territories
 27 territories
 Age, gender and marital status prohibited
 Mandatory Offer Rule
 Tempering and capping
 Exit restrictions
 Reallocation of premiums across insurers based on
loss experience
Source: Chapter 2 “Automobile Insurance Regulation: The Massachusetts Experience” Sharon Tennyson, Mary A.
Weiss, Laureen Regen
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Lessons from other states – Massachusetts
(continued)
 Market Impact
 Cross-subsidies – urban territories subsidized by rural territories,







inexperienced drivers subsidized by experienced drivers
Massachusetts auto insurance market less profitable than the
U.S. auto insurance market overall
Increase in residual market
Fewer firms in the market compared to other states
Shift to Massachusetts-only firms
Cross-subsidies distort consumer behavior
— Insurance premiums charged do not reflect true cost of
providing insurance
— Greater relative participation of high risk drivers in the driving
and insuring population, increasing average expected costs
Companies specialize in urban or rural markets
Regulations lead to higher insurance costs
Source: Chapter 2 “Automobile Insurance Regulation: The Massachusetts Experience” Sharon Tennyson, Mary A.
Weiss, Laureen Regen
National Association of Mutual Insurance Companies press release, “Study supports NAMIC Position That
Massachusetts Over-Regulation Leads to Higher Insurance Costs”, April 30, 2004
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Lessons from other states – Massachusetts
(continued)
 Proposed legislation in 2006 to revise auto system.
Although not passed, work is ongoing to build support
 Similarities to California market
 Territorial restrictions
 CA insurers must accept all CA Good Drivers
 Pumping and tempering
 Complex system of cross-subsidies
 Difference from the California market
 No mechanism for reallocation of premium
Source: Chapter 2 “Automobile Insurance Regulation: The Massachusetts Experience” Sharon Tennyson, Mary A.
Weiss, Laureen Regen
National Association of Mutual Insurance Companies press release, “Study supports NAMIC Position That
Massachusetts Over-Regulation Leads to Higher Insurance Costs”, April 30, 2004
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Conclusions
 Cross-subsidies
 Reduce incentive for companies to write subsidized drivers
 Insurance premiums charged do not reflect true cost of providing
insurance
 Greater relative participation of high risk drivers in the driving and
insuring population, increasing average expected costs
 Companies specialize in rural or urban markets
 Higher insurance costs
 Auto insurance market less profitable than U.S. auto insurance
market
 Rate increases for rural and suburban drivers
 Rate changes across the state
 Consumer shopping
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What can companies do?
 Diligent data collection for accurate rating
 MVR reports – must balance with cost of MVR ($ )
 Annual mileage
 Undisclosed drivers
 Misclassification lowers factor weights
 Underestimation of annual miles lowers the factor
weight for annual mileage annual mileage
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What can companies do? (continued)
 Redefine cost and frequency bands – geographic
clustering
 As major competitors make class plan filings, include
competitive review and make adjustments to proposed
class plan
 Maximize use of optional rating factors
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What can companies do? (continued)

Optional Rating Factors
 Type of vehicle
 Vehicle performance capabilities (including alterations)
 Type of use of vehicle (pleasure, business, commute, etc.)
 Percentage use of the vehicle by the rated driver
 Multi-vehicle households
 Academic standing (Good Student Discount)
 Driver training or defensive driving courses
 Vehicle characteristics (protective devices, theft deterrent devices)
 Gender
 Marital status
 Persistency (renewal discount)
 Non-smoker
 Secondary driver characteristics (safety record, years licensed, gender, marital
status, driver training, academic standing for drivers not assigned as primary
or secondary drivers on another vehicle)
 Multi-policy discount
 Relative claims frequency
 Relative claims severity
Source: California Insurance Regulations, Title 10, Chapter 5, Subchapter 4.7, Section 2632.5
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What can companies do? (continued)
 Years of driving experience can be combined with
 Percent use
 Academic standing
 Gender
 Marital status
 Driver training
 Analyze rating factors used by competitors
 Household Composition Factor (Allstate)
 Liability Symbol (Allstate)
 Model year for liability coverages in addition to liability symbol




(Auto Club)
New Vehicle Discount (USAA)
Multiple Policy Discount (State Farm)
Garaging location for comprehensive coverage (Auto Club)
Persistency Discount (several insurers)
Source: California Insurance Regulations, Title 10, Chapter 5, Subchapter 4.7, Section 2632.5
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What can companies do? (continued)
 Sequential Analysis
 Order of optional factor
— Driving Safety Record (first), Annual Mileage
(second), Years of Driving Experience (third)
— Cost and Frequency Bands (last)
 Multivariate analysis to compare proposed to
indicated
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Other Regulations
 Regulations on the Horizon
 Annual Mileage Regulations
 Prior Approval Regulations
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Regulations on the horizon – Annual Mileage
 Proposed regulations
 Estimated annual mileage (new business or added vehicles)
— Based on policyholder estimate
— May use reasonable estimate if policyholder’s estimate is
not available
 Calculation
— Distance to/from work, number of days driven to work
— Difference between estimate and prior 12 months
 Verification (renewal business)
— Odometer reading from insured
— Service records (insurer can’t require)
— Technological devices provided by insurer
— Smog check odometer readings
 New business – cannot request annual mileage from prior
carrier
Source: CDI Proposed Regulation Text, Mileage Verification, Section 2632.5
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Regulations on the horizon –
Annual Mileage (continued)
 Association of California Insurance Companies’
response to proposed annual mileage regulation
 Insurers should be allowed more flexibility in
estimating annual mileage
 Annual mileage verification should be allowed on
new business
 High potential costs to insurers as regulations may
require collection of annual mileage information
from current book
Source: Statement of the Association of California Insurance Companies on “Proposed Amendments of Section 2632.5”,
June 2006
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Regulations on the horizon –
Annual Mileage (continued)
 “Black Box” rating (telematics)
 Potentially provides information to car makers (and
insurers) through on-board sensors, Global
Positioning Units (GPS) units and mobile phone
technology
 GM announced telematics will be standard on all
GM vehicles by 2007 (and has been standard for
Mercedes-Benz and BMW)
 If cost and potential legislative barriers are
overcome, could provide exact annual mileage
 Progressive has been piloting a system in Minnesota
since 2004 and Texas since 1998
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Regulations on the horizon –
Prior Approval Insurance Regulations
 Prior Approval Regulations
 Specifies methodology for developing rate indication
— Loss Development – dollar-weighted average of last three
link ratios, no tail factor
— Trend – company’s latest 12 quarters of calendar year paid
claim cost and frequency data, developed using
exponential curve of best fit
— Efficiency Standard – maximum allowable expense ratio
set by insurance commissioner, three-year average
expense ratio
— Leverage Factors and Surplus – allocation based on loss
and unearned premium reserves
— Credibility – current rate plus a trend
— Catastrophes – historical experience only, no external data
 Limited scope for variance requests
Source: Proposed Regulation Text 2642.4 – 2648.4
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Regulations on the horizon –
Prior Approval Insurance Regulations (continued)
 Association of California Insurance Companies – “Comments on
Proposed California Prior Approval Insurance Regulations”,
Michael A. Walters
 Unprecedented degree of prescription – no ratemaking
methodology is appropriate in all cases
 Removes actuarial judgment
— Methodology
— Input
 Result – cause operating losses or inadequate returns for
insurers and lines constricted by simplistic rate indication
approach
 Recommendation – proposed procedures guideline for
simplistic approach, identify filings that need more attention
Source: Michael A. Walters, Tillinghast report to the Association of California Insurance Companies,
September 13, 2006
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Questions?
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