Auto Insurer Rating Errors, Fraud Cost $16.1 Billion Last Year

Fraud and insurers’ inability to track insureds resulted in premium rating errors that cost carriers $16.1 billion in revenues last year, according to San Francisco-based Quality Planning.

The company, a subsidiary of Insurance Services Office in Jersey City, N.J., validates policyholder information for auto insurers.

According to the Quality Planning annual premium rating error report, the latest figure is slightly down from the 2006 figure of $16.6 billion—but still almost 10 percent of the total $162 billion in personal auto premium written.

The firm identifies two primary reasons for rating error: consumer fraud and the inability of insurers to keep track of key lifestyle and driving habits of their customers.

Titled "Auto Insurance Industry Continues to Hemorrhage Cash," the report is online at http://tinyurl.com/6mtf3c.

Raj Bhat, president of Quality Planning, said, "The year 2007 saw the first decrease in auto premium leakage since Quality Planning began issuing this industry report five years ago. We believe this is likely the cumulative effect of several large insurers eliminating the mileage component from their rating plans."

"Seldom is there debate over whether or not people who drive more miles should pay higher premiums, yet over the past several years some companies have elected to forgo the use of annual mileage as a critical rating factor—simply because it was difficult to validate," said Mr. Bhat adding, "Their decision may prove costly."

The report aggregates and summarizes audit results of more than 4 million policies from 16 major carriers. The sample includes substandard to preferred books of business, all distribution channels, and national and regional carriers. Sample results were weighted to reflect the total national private passenger auto line.

In this year's report, Quality Planning noted a small upward trend in the misreporting of garaging addresses and of youthful drivers.

The trend was found to be most striking in large urban areas where vehicle garaging location can dramatically affect premium. Nationwide, 1 to 2 percent of all policies written include an unrated operator, who is most often a high-premium younger driver. Policies that contain such rating errors account for more than $2 billion of annual premium leakage.

"The insurance industry can combat premium leakage by applying appropriate analytic tools," said Mr. Bhat. "Some policyholders misrepresent facts, and others don't report lifestyle changes. Others boldly commit fraud. Underwriting doesn't have to accept those trends as a cost of doing business or, worse, as justification to counterbalance leakage by inflating premiums for all policyholders."

The 2007 report includes a detailed analysis that shows how different categories of rating error contribute to overall premium rating error and distinguishes between vehicle rating errors (mileage, usage, type of vehicle, and location) and driver rating errors (driving experience and driving record).

Quality Planning said it recommends auto insurers better analyze policyholder rating data to identify and correct flawed information—steps which could have a positive effect on profitability.

The firm puts auto insurance companies' books of policyholders through a battery of more than 150 proprietary tests, cross-reference checking, and pattern-matching algorithms to identify errors and discrepancies that might suggest customer fraud.

Quality Planning also provides insurers with additional services, such as policyholder phone interviews to discover missing drivers, verify garaging addresses, determining annual mileage, and other key rating information.