Discussion on “The Discriminating (Pricing) Actuary,” by Edward W. (Jed) Frees and Fei Huang

I congratulate the authors on this enjoyable and timely article, which touches on several of my interests. I would like to offer some comments on nonrisk price discrimination, that is, individual price variations that do not reflect expected costs (sometimes described as “price optimization”).

Nonrisk price discrimination has been common in personal lines insurance for at least 15 years in Europe, and more recently in the United States. It therefore seems remarkable that the topic has been almost completely ignored in both actuarial science and insurance economics literature. There are books on price and revenue optimization in general (Phillips 2005) and a case study of price optimization from the perspective of a single insurer (Krikler et al. 2004). However, neither of these considers the distinctive features of insurance (adverse selection, moral hazard, etc), or how nonrisk price discrimination affects overall market outcomes.

My paper Thomas (2012), which Frees and Huang kindly cited, made the following main points:

1. Aggregate industry profits are likely to be increased where all insurers practise nonrisk price discrimination against the same groups (best-response symmetry), but decreased where different insurers discriminate against different groups (best-response asymmetry).

2. In particular, inertia pricing (i.e., higher markups for renewing customers, compared with risk-equivalent new customers) is likely to reduce aggregate industry profits, because it involves best-response asymmetry: Every insurer offers a discount to persuade the customers of other insurers to switch.

3. While inertia pricing may benefit customers in aggregate, not all customers are better off, and the distributional effects may be unattractive (e.g., the customers who do not switch regularly, and so are made worse off, are probably less sophisticated or less informed). Furthermore, the high level of switching generated by inertia pricing is inefficient for society as a whole: It arises purely as an artifact of market structure, and does not reflect changing customer needs or preferences.

Nonrisk price discrimination is now a topic of active regulatory interest and intervention in many jurisdictions. In the United Kingdom, the regulator has banned higher pricing for insurance renewals compared with risk-identical new customers with effect from January 1, 2022, and predicts that this will save customers money in the aggregate (Financial Conduct Authority 2020; 2021). Although this prediction is contrary to the conclusions of Thomas (2012) summarized in the preceding, I acknowledge it may well turn out to be correct. In particular, my analysis was predicated on wholly rational switching decisions by all insureds. Once one allows for behavioral effects such as inattention and cognitive limitations to affect switching decisions, different conclusions are possible.

Given the extent of regulatory intervention around nonrisk price discrimination, the lack of academic interest seems surprising. A lack of access to data might explain the lack of empirical work, but not the lack of theory. By engaging with the topic, Frees and Huang have taken a step toward rectifying this omission. So I congratulate them once again for this, and for the other contributions of their article.

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