ACTUARIES AT PLAY!
NAIC publishes a white paper that outlines pretenses of rate review
The paper provides 55 pages of
“best practices” for the … “reviewer” who
wants to appear to understand what he or she
is about to rubber stamp.
Public Policy Analysis & Opinion
By Kevin P. Hennosy
In late October 2021, The National Association of Insurance Commissioners (NAIC) published a white paper that discusses regulatory “review” of insurers’ use of “predictive analytics along with big data.” The white paper writers opine that these actions by carriers have “significant potential benefits to both consumers and insurers.”
At least, that is what the carriers’ lobbyists told them, and who are state officials to challenge the formers’ opinion? Or, in the words of The Mighty Oz, “Pay no attention to the man behind the curtain!”
The white paper makes clear that state insurance departments lack “the necessary tools to effectively review insurers’ use of predictive models in insurance applications.” The paper provides 55 pages of “best practices” for the insurance regulator, or “reviewer,” who wants to appear to understand what he or she is about to rubber stamp. It recommends the following principles that promote a comprehensive and coordinated review of predictive models across the states:
- State insurance regulators will maintain their current rate regulatory authority and autonomy.
- State insurance regulators will be able to share information to aid companies in getting insurance products to market more quickly across the states.
- State insurance regulators will share expertise and discuss technical issues regarding predictive models to make the review process in any state more effective and efficient.
- State insurance regulators will maintain confidentiality, in accordance with state law, regarding predictive models.
Beyond the inherent sexiness of the topic matter, the actuarial white paper revives memories of my misspent youth. In the late 1980s, I worked in the regulatory affairs office of Nationwide Insurance Companies. I know I have mentioned this fact in several recent editions of this column, but as a child the nuns beat into me a belief that confession is good for the soul.
Part of my job at Nationwide consisted of serving as a member of a group who attended NAIC meetings. It was an age before shoe-bombers and rampant pandemics in the United States, so one could still enjoy travel.
Unlike many NAIC meeting attendees from insurance companies, trade associations, and law firms, we did not lobby the regulators on issues. Only on rare occasions did the company ask us to deliver a comment letter, or seek a change in policy recommendations, before an NAIC session.
Our group gathered information and initiated relationships. The information ended up in a report to the company officers published about 10 days after each NAIC convention. The company’s regulatory compliance personnel often called upon the office to use its relationships to quietly address issues with state insurance departments before the issue resulted in some legal tussle.
Nationwide’s founder, Murray Danforth Lincoln, created the office of regulatory affairs and hired former Ohio Chief Insurance Examiner Lynn McCall to run it. In Lincoln’s autobiography, Vice President in Charge of Revolution, he recounts how the confrontational practices of his lawyers toward state regulators damaged the policyholders’ interests. Lincoln charged McCall with avoiding confrontation when discussing the company’s perspective to regulators—never legislators.
Whether one described McCall’s role as “facilitator” or “fixer” was a matter of opinion. The approach worked much better than repeatedly going to court.
Working in the office of regulatory affairs provided a powerful introduction to insurance issues, as did NAIC meeting attendance. Just about any aspect of the companies’ operations could come under the purview of regulatory affairs. The work experience proved quite interesting.
When I was the newest team member, I received the assignment to cover the deliberations of the Casualty Actuarial and Life and Health Actuarial Task Forces. At that time, the actuaries met at the end of the quarterly meetings of the NAIC, when most attendees had already left for home.
As my boss announced the assignment prior to my first NAIC meeting, the rest of the staff found it difficult to repress the urge to giggle. My fellow staff members assured me that the actuarial task force meetings would provide me with legendary levels of excitement, such as watching the car rust, watching grass grow, or watching paint dry.
What I learned was that the actuaries established their own definition of an action-packed meeting agenda. By action packed, I mean the presentation of spirited and scintillating debates over whether an agenda item should receive the priority “16a” or “18c.” This was the stuff of trial by combat among the actuaries. Factions formed, friendships ended, and at times madness ensued.
For a year and a half, I sat through those task force meetings trying to take notes. I do not remember a single debate concerning a policy recommendation. There were times when I assumed that the meetings of the task forces were an elaborate ruse that actuaries perpetuated on the NAIC to secure another hotel night or two. Maybe the task forces were a cover story for a secret marathon game of Dungeons & Dragons in an unnumbered suite of the hotel.
So, when I noticed that the NAIC published a 55-page white paper on casualty actuarial issues, I was intrigued. I must admit that I am weird that way.
The report carefully avoids establishing regulatory tenets of the kind assumed by the drafters of the McCarran-Ferguson Act. That statute, which lends authority over insurance to the states to the extent that each state regulates insurance, does not use the term “review.”
In addition, the white paper makes clear that the predictive models that underlay today’s insurance products “are difficult to explain to someone (e.g., a consumer) who has little to no expertise in modeling techniques.”
What the white paper fails to note is that, in such a situation, the insurance markets cannot be described as competitive, because of the lack of informed consumer choice. This absence of informed consumer choice in the market for insurance is why Congress deemed that the business of insurance should be regulated—long before the use of today’s predictive models and big data analytics.
The NAIC white paper places emphasis on the carriers’ wide acceptance of a Generalized Linear Model (GLM) for predictive analytics. Perhaps the best description of the GLM is “the letters printed on the outside of a proverbial black box.”
According to the NAIC white paper, “GLMs introduce significant improvements over univariate-based rating plans by automatically adjusting for correlations among input variables. However, it is not always easy to understand the complex predictive model output’s relationship to cost.”
For example, the NAIC describes GLMs as consisting of three elements, which follow:
- A target variable, Y, which is a random variable that is independent and is assumed to follow a probability distribution from the exponential family, defined by a selected variance function and dispersion parameter.
- A linear predictor, η = Xß.
- A link function g, such that E(Y) = µ = g−1( ).
Certainly, even old-school actuarial calculations appeared daunting to those who lacked a significant background in statistics, but the GLM introduces new concerns: “To further complicate the regulatory review of models in the future, modeling methods are evolving rapidly and are not limited just to GLMs. As computing power grows exponentially, it is opening the modeling world to more sophisticated forms of data acquisition and data analysis,” according to the white paper.
Even if state jurisdictions decided to affirmatively regulate this insurance rating activity, state governments lack the resources necessary to do the job required under an originalist reading of McCarran-Ferguson.
In the absence of actual regulation, the NAIC long ago shifted to discussing the pretense of regulation. This white paper does not stray from that habit.
Most of the white paper consists of tables containing suggested “best practices” to address the question, “How can regulators determine whether predictive models, as used in rate filings, are compliant with state laws and/or regulations?” (When state officials do not have a clue as to what the insurer presented for “review.”)
The white paper makes clear that the establishment of best practices is not an effort to establish a national standard for rate review. “Rather, best practices will assist the states in identifying the model elements they should be looking for in a filing that will aid the regulator in understanding why the company believes that the filed predictive model improves the company’s rating plan and, therefore, makes that rating plan fairer to all consumers in the marketplace.”
Instead of establishing a standard, the white paper seeks to improve regulators’ understanding of insurers’ use of predictive models. In addition, best practices could address the problems related to scorecard models and the model algorithm. In these latter two examples, the paper observes, “There is often not sufficient support for relative weight, parameter values, or scores of each variable.”
(As most readers have probably always suspected.)
The NAIC limited the scope of the white paper to private passenger auto and homeowners insurance. However, the paper notes: “The identified best practices should be readily transferrable when the review involves other predictive models applied to other lines of business or for an insurance purpose other than rating.”
The document may prove interesting to insurance compliance personnel, who hold responsibility for rate filings. After all, people enjoy kabuki dancing, too. Readers may obtain a copy free of charge from the NAIC website, in the “Resources” section.
Kevin P. Hennosy is an insurance writer who specializes in the history and politics of insurance regulation. He began his insurance career in the regulatory compliance office of Nationwide and then served as public affairs manager for the National Association of Insurance Commissioners (NAIC). Since leaving the NAIC staff, he has written extensively on insurance regulation and testified before the NAIC as a consumer advocate.