In risk-based pricing—common in marketplaces for home, car, or other insurance—consumers are offered different prices based on the risk presented. This allows insurers to set prices based on the risk they assume and to tailor policies, and prices, to potential customers.
Holly Bakke, a former commissioner of the New Jersey Department of Banking and Insurance and currently principal at Strategic Initiatives Management Group, recently sat down with the Chamber to discuss her experience overseeing the insurance market in New Jersey. Along the way, we discussed what risk-based pricing is, how it benefits consumers, and expands the availability of insurance. We also discussed why changes to the law would increase the cost of insurance.
During her time as commissioner, New Jersey overhauled its auto insurance laws, causing major national insurers to decide to return to the state, resulting in more competition and, ultimately, lower insurance rates and fewer uninsured drivers.
Q: What is risk-based pricing in insurance?
A: Risk-based pricing bases the cost of insurance on the risk presented. It can be auto or home insurance, but there are risks associated with each. For example, the age and condition of the home, or the type of car and the driver’s traffic record.
Q: Why do insurance companies use risk-based pricing?
A: Insurers use risk-based pricing to be as competitive as possible in the insurance marketplace. The better job they do assessing risk, the lower the premiums they can offer to good drivers. Insurance companies don’t want to overcharge or undercharge consumers, they want the premium they charge to reflect an individual’s risk.
Q: One of the unique attributes of insurance products, as opposed to some other consumer goods that use uniform pricing, is that they are individually priced based on the risk characteristics of the policyholder. How does risk-based pricing help expand the “risk pool” and allow insurance to be sold to more people?
A: If risk-based pricing is put aside and a more uniform insurance risk pool is used, policyholders will be paying an average premium for the pool—not what they should be paying as individuals. We learned in New Jersey that without risk-based pricing, the 80% of the policyholders who were good drivers were subsidizing the 20% who were bad drivers. So, it’s not so much about expanding the pool as it is about expanding pricing options where people pay based on their risk—that’s the goal.
Q: If we eliminate risk-based pricing for auto insurance (or other forms of insurance) what sort of effect would that have on insurance pricing and availability?
A: In New Jersey, prior to the introduction of reforms, national insurers were either leaving the state or had never entered. This left New Jersey without a competitive market where consumers had a choice of company, cost and coverage. Risk-based tools were an essential part of the reforms as both national and domestic insurers wanted to compete effectively for drivers. Once we made changes, national insurance companies entered the state while some domestic insurers changed their ratings, and pricing and premiums went down. It was amazing to watch how, in a very short period of time, a competitive marketplace took hold and consumers benefited.
Q: What would you say to those who would assert that risk-based pricing is inherently unfair?
A: I have not found that to be the case. The assumption that certain groups of people are poor credit risks is simply not fair. Insurance is blind to race, ethnicity, religion—and that’s appropriate. It is not one size fits all. A competitive marketplace gives consumers choices—of companies that use credit, make credit an option, or don’t use credit al all—and to deny them that choice puts them in a position where they don’t have access to a tool that could lower their rates.
Learn More About Risk-Based Pricing:
The Center for Capital Markets Competitiveness at the U.S. Chamber of Commerce recently released a report, “The Economic Benefits of Risk-Based Pricing for Historically Underserved Consumers in the United States,” that explores this topic in greater detail.
In addition, Bakke recently published a piece on the subject titled “This change would hike car insurance in New Jersey.”