Common Mistakes When Pricing Long-Term Contracts
- Written By Michael Covert
Developing pricing for long term contracts, specifically auto warranty, poses a tricky challenge for insurers. Determining rates for losses that will not occur until three, five, or seven years into the future requires balancing multiple factors to help ensure profitability and appropriate matching of premium earnings and future losses.
Auto warranties, supplemental tire and wheel coverage, guaranteed auto protection (“GAP”), and other long-term contracts require careful actuarial analysis of multiple variables. Mistakes can be costly – and won’t become apparent until well into the future.
Luckily, by avoiding some of these common mistakes, you can develop pricing for long term contracts that protects your customers and keeps you in the black.
Best in class rating manual structure / pricing flexibility
The long-term contract space, specifically for auto warranty, is much more competitive than ever before, as many insurers and InsurTech companies create brand new programs to corner a piece of this market. Therefore, in order to remain competitive and profitable, insurers must achieve as much flexibility on rating plans as possible. Greater flexibility means you have a higher chance of achieving profitability from the get-go without having to continually refile your rating plans to adjust rates.
Working with actuarial experts who apply expertise with long-term contracts across multiple states can dramatically enhance your pricing process. Actuarial consulting experts can develop a factor-based manual that makes it significantly easier to understand the base rates, rating factors and the impact of rate changes on future policyholders. Determining actual relativities for the main rating variables, along with associated base rates, can turn those old school 500-page “rate cards” into concise rating plans, lessening the time drain on your staff for review and understanding of the material as well as reducing the likelihood of erroneous price quotes and premium reversals.
Misjudging your competition
Competitive analysis provides both a starting point and a point of comparison for your rating plans. It’s a valuable component of the big picture. In addition to jurisdictional and coverage plan comparison, there are two lesser-known areas where you may not be obtaining a true sense of how your pricing stacks up against the competition for auto warranty business.
Less experienced folks in this space may compare rates and factors without thoroughly examining the class plan (actual vehicles) to which these factors are assigned. Not everyone assigns auto classes the same way, so it’s crucial to confirm that you’re looking at comparable plans.
Differences in individual components covered in vehicle service contracts can also throw off the accuracy of your competitive analysis. In order to achieve a true apples-to-apples comparison, you must drill down into individual components of each vehicle service contract to make sure that coverages align.
Incorrect profitability analysis
While you may see your market share rise quickly in this space from a balance sheet perspective, in order to understand profitability, you must earn premium appropriately over the life of the long-term contract. Too much upfront premium earnings may lead you to believe that your loss ratio is strong, but when earned premiums start to slow and losses begin to stack up – there is little that can be done to course-correct at that point. It’s imperative to track your earning patterns alongside your loss development to maintain a consistent loss ratio over time.
Rate level indication inaccuracies
Relying solely on an overall rate level indication can paint an incorrect picture. For example, development of losses will vary considerably on whether a vehicle is new versus used. Similarly, with comparing new cars with say 0-10,000 initial miles versus “new” vehicles with 24,000 to 36,000 initial miles. The rate level indications are generally very different for numerous combinations of new/used, term/length of the contract and initial mileage of the vehicle. It’s important to understand how to best break out each one in order to achieve accurate rate level indications as well as balancing homogeneity and credibility in your data.
Not peer-reviewing your work
If you’re not already writing business in this space, much of the above is likely not apparent. As a result, you may inadvertently begin writing a significant amount of “bad” business while other insurers are steering clear. Even if you have been writing certain types of extended service contracts, it’s easy to fall into oversights that could result in leaving money on the table. Experienced actuarial consulting partners can provide an unbiased, fresh perspective on your work, taking into account product expertise, state-by-state knowledge and a deep understanding of rating plans and rate flexibility to ensure that your rates are reasonable for the associated risk.
As competition in this space rises, insurers are rushing headlong into product offerings that might end up costing them dearly down the line. The old saying, “You can’t fix old business” has never been more applicable than to long-term contracts, because the bottom line is: you’re on the hook until the end of the contract. However, by carefully analyzing each element in your rating and working with an experienced actuarial team comprised of subject matter experts, you can sidestep the mistakes outlined above and develop a proven, competitive and profitable product.
