Understanding the main drivers of Value creation is essential to manage efficiently any business. While P&C insurers are used to monitoring their activity according to short term goals, the purpose of our paper is to determine the optimal prospecting and pricing strategy an insurer must adopt to maximize the Value of his business. More precisely, we focus on two questions:

  - How to select the most profitable customer segments at a given period

  - How the optimal pricing and prospecting strategy varies with respect to insurance cycle.

Our model relies on a Customer-Value metric, defined as the sum of a current policyholder or a future New Business’s economic cash-flows, generated over the remaining lifetime of the policy. We assume that the insurer’s quotes number depends on marketing investment, and that policyholders’ conversion and retention rates depend on the relative premium (the ratio of the insurer’s price to the market’s price). Thus, the insurer's objective function is the sum of the value of his in-force portfolio and his future New Business generations. Our approach differs from Taylor (1986) and Emms (2007) in two ways: (a) pricing optimisation accounts simultaneously for Customer Value and Insurance cycles (b) and marketing spending is considered as a decision variable of the optimization program.

Using a logit demand function, we find a closed-form solution to the optimization program and analyze how the optimal policy varies with respect to customers’ price elasticity, the market price and the current state of the insurance cycle. We also consider the case where the renewal rate depends on price evolution as well as the premium relative to market. A numerical example illustrates the behaviour of the optimal pricing policy in this case.

Furthermore, we provide a case study based on car insurance data, showing the practical uses of our framework: assessing the insurer's Value and building his strategic planning, improving the trade-off between short-term profitability and long-term value creation, as well as identifying customer segments with high value in order to optimize the insurer's marketing and pricing policy.

Reference

Taylor, G. C. (1986). Underwriting strategy in a competitive insurance environment. Insurance: Mathematics and Economics , 5(1), 59-77.

Emms, P., Haberman, S., & Savoulli, I. (2007). Optimal strategies for pricing general insurance. Insurance: Mathematics and Economics , 40 (1), pp. 15-34.