Credit scoring will heat up competition: U.S. analytics expert

Predictive modelling, including credit scoring, played a major role in heating up the competition in the United States auto insurance market, according to a U.S. researcher of insurance analytics.
David Cummings, vice president of research at ISO Innovative Analytics, a unit of Insurance Services Office Ltd. (ISO), made the observation during his presentation on ‘Actuarial Predictive Modeling’ at the Canadian Insurance Financial Forum (CIFF) in Toronto on May 19.
“The [U.S.] auto rate plan, prior to the introduction [of credit scoring], had been a fairly static entity… for decades,” Cummings said. “But then the introduction of credit really revolutionized the way that companies looked at their risks.
“It changed the way that they segmented them and created a substantial increase in competition. That continues today when you see all of those auto insurance ads on TV in the United States.
“There’s plenty of competition going on today.”
Cummings linked Progressive’s rapid increase in U.S. market share with the company’s aggressive use of credit scoring.
In his presentation, Cummings showed an example of how competition is stoked through companies being selected against.
For example, Company A does not use credit scoring. It has three policies – a $600 policy, an $800 policy and a $1,000 policy – for a total revenue of $2,400.
Because the Company A does not use credit scoring, it offers an average $800 rate to all three policyholders.
Company B uses credit scoring to more accurately price the risk. It offers $600 to Company A’s $600 policyholder (who is paying the average $800 premium to Company A, causing the policyholder to switch to Company B.
Company A now has two policyholders, an $800 customer and a $1,000 customer, and offers an average premium of $900 to both.
Again, Company B uses credit scoring to segment its pricing and offers a rate of $800 to the $800 policyholder of Company A, causing him or her to switch.
Company A is now left with only one policyholder, worth a total revenue of $1,000, less than half of what it formerly had.
“The early adopters were really able to take off with [credit scoring], because of that ability to price accurately,” Cummings noted of the U.S. market. “There were lower-cost risks and they were able to steal them out from under the slower actors, some of whom were much larger than they were.
“So it created a real opportunity for that profitable growth earlier on. Which as soon as everybody realized that that’s what got Progressive to move so quickly up to the top of the ranks – they were one of the early adopters – then that got everybody’s attention. They said, ‘Hey, I’d like to do that, too’.”