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The Giant Hole in Actuarial Models

Eye of the Storm: Natural disasters, the insurtech market, and other musings from Bob Frady, CEO of HazardHub


The insurance industry is run on actuarial models -- models that take a lot of data and science to properly price an insurance policy. Actuaries have to undergo rigorous training. Actuaries are the true pulse of insurance.

As Sean Harper of Kin Insurance pointed out to us, there is one problem with actuarial models --one giant hole that, in many cases, renders the models obsolete.

The giant hole? The fact that human input is required to fulfill the actuarial model.

Actuarial models are based upon “perfect world” data, where all of the data elements are known. The problem is, you have to collect those known elements from the insured, the agent, and/or the broker. It's what we like to call a “thief amongst the jewels” problem. Or – as Sean puts it, “garbage in, garbage out (GIGO)”.

Here's an example. I talked to an agent today who said, “I don't know why carriers always ask me when the plumbing has been replaced in the building. I know that if I say ‘30 years,’ they’re not going to write the policy. So, whether or not the plumbing has been replaced in the last 10 years, I always say, ‘Less than 10 years.’”

This sort of “I know the wrong answer will sell the policy” approach to answering questions is a real-world manifestation of the giant hole in actuarial models. It happens every day -- especially with “edgy” policies that might not otherwise get placed with a competitive rate.

The solution is a painful one: rebuild your actuarial models using data that you can pre-populate with little to no input from the insured, the agent, or the broker.

Bill Budde of CGI once told me, “There are old actuaries. There are bold actuaries. But there are no old, bold actuaries.” The problem is that many actuaries in leadership positions don’t want to rebuild their actuarial models. They will live with the imperfect data because overall their companies do OK. Until, of course, they don't.

This is one place where insurtech-based carriers and MGUs have a significant advantage over more traditional carriers. They are data first. They live and breathe data. They build systems that integrate APIs and consistently question their own actuarial approaches. They live by the champion/challenger process. As one head of underwriting told me, “Give me the reported data from multiple independent third parties any day over the word of insured's agents or brokers. That's a bet I'll take all day long.”

We love to work with these forward-thinking organizations because we know that mastering data provides a significant competitive advantage in three meaningful ways – including the following:

  1. It saves everyone time by eliminating the need for so much manual input of data. The carrier has done the work to put together the data that will accurately feed their actuarial models.
  2. It can allow for much faster policy quoting because the time spent gathering data is eliminated.
  3. Coupled with a strong user experience, it makes the process of buying insurance much less painful for the insureds. A less painful process will lead to a more engaged – and loyal – customer.

Companies that want to successfully compete in a fast-changing market need to become data-first organizations – without relying on the vagaries of human error.

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