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Predictive Analytics White Paper Predictive Analytics White Paper Charles Nyce, PhD, CPCU, API Senior Director of Knowledge Resources American Institute for CPCU/ Insurance Institute of America Copyright AICPCU/IIA and subject to all copyright laws. Copyright AICPCU/IIA and subject to all copyright laws. PREDICTIVE ANALYTICS WHITE PAPER Charles Nyce, PhD, CPCU, API Senior Director of Knowledge Resources American Institute for CPCU • Insurance Institute of America 720 Providence Road • Suite 100 • Malvern, PA 19355-3433 Phone (610) 644-2100, ext. 7245 • Fax (610) 644-7387 www.aicpcu.org Copyright AICPCU/IIA and subject to all copyright laws. © 2007 American Institute for Chartered Property Casualty Underwriters/Insurance Institute of America All rights reserved. This paper or any part thereof may not be reproduced without the written permission of the copyright holder. Unless otherwise apparent, examples used in AICPCU/IIA materials related to this paper are based on hypothetical situations and are for educational purposes only. The characters, persons, products, services, and organizations described in these examples are fictional. Any similarity or resemblance to any other character, person, product, services, or organization is merely coincidental. AICPCU/IIA is not responsible for such coincidental or accidental resemblances. This material may contain Internet Web site links external to AICPCU/IIA. AICPCU/IIA neither approves nor endorses any information, products, or services to which any external Web sites Copyright AICPCU/IIA and subject to all copyright laws. refer. Nor does AICPCU/IIA control these Web sites’ content or the procedures for Web site content development. AICPCU/IIA specifically disclaims any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials. AICPCU/IIA materials related to this paper are provided with the understanding that AICPCU/IIA is not engaged in rendering legal, accounting, or other professional service. Nor is AICPCU/IIA explicitly or implicitly stating that any of the processes, procedures, or policies described in the materials are the only appropriate ones to use. The advice and strategies contained herein may not be suitable for every situation. ii Contents Introduction .......................................................................................................................................................................... 1 Overview of Predictive Analytics ....................................................................................................................................... 1 Drivers of Insurers’ Use of Predictive Analytics ............................................................................................................... 2 Technological Advances ........................................................................................................................................2 Data Availability.....................................................................................................................................................2 Insurers’ Desire for Growth In Slow-growth Markets ............................................................................................2 Insurers’ Search for Competitive Advantage .........................................................................................................3 Insurers’ Use of Predictive Analytics ................................................................................................................................. 4 Marketing ...............................................................................................................................................................4 Hit Ratio ............................................................................................................................................................4 Retention Ratio .................................................................................................................................................5 Underwriting ..........................................................................................................................................................5 Claims .....................................................................................................................................................................5 Identifying Potentially Fraudulent Claims ........................................................................................................5 Prioritizing Claims .............................................................................................................................................7 The Predictive Analytic Process ......................................................................................................................................... 7 Data Mining ............................................................................................................................................................9 Model Development ...............................................................................................................................................9 Regression Models .............................................................................................................................................9 Advanced Models ............................................................................................................................................11 Model Validation ..................................................................................................................................................11 Predictive Analytics’ Advantages for Insurers ...............................................................................................................11 Predictive Analytics’ Disadvantages for Insurers .........................................................................................................12 Frequently Asked Questions Regarding Widespread Insurer Use of Predictive Analytic Techniques ............................................................................................................................14 Copyright AICPCU/IIA and subject to all copyright laws. iii Copyright AICPCU/IIA and subject to all copyright laws. Foreword The American Institute for Chartered Property Casualty Underwriters and the Insurance Institute of America (the Institutes) are independent, not-for-profit organizations committed to expanding the knowledge of professionals in risk management, insurance, financial services, and related fields through education and research. In accordance with our belief that professionalism is grounded in education, experience, and ethical behavior, the Institutes provide a wide range of educational programs designed to meet the needs of individuals working in risk management and property-casualty insurance. The American Institute offers the Chartered Property Casualty Underwriter (CPCU®) professional designation, designed to provide a broad understanding of the property- casualty insurance industry. CPCU students may select either a commercial or a personal risk management and insurance focus, depending on their professional needs. The Insurance Institute of America (IIA) offers designations and certificate programs in a variety of disciplines, including the following: • Claims • Management • Commercial underwriting • Marine insurance • Fidelity and surety bonding • Personal insurance • General insurance • Premium auditing • Insurance accounting and finance • Quality insurance services • Insurance information technology • Reinsurance • Insurance production and • Risk management agency management • Surplus lines • Insurance regulation and compliance Copyright AICPCU/IIA and subject to all copyright laws. You may choose to take a single course to fill a knowledge gap, complete a program leading to a designation, or take multiple courses and programs throughout your career. No matter which approach you choose, you will gain practical knowledge and skills that will contribute to your professional growth and enhance your education and qualifications in the expanding insurance market. In addition, many CPCU and IIA courses qualify for credits toward certain associate, bachelor’s, and master’s degrees at several prestigious colleges and universities, and all CPCU and IIA courses carry college credit recommendations from the American Council on Education. The American Institute for CPCU was founded in 1942 through a collab- orative effort between industry professionals and academics, led by faculty members at The Wharton School of the University of Pennsylvania. In 1953, the American Institute for CPCU merged with the Insurance Institute of America, which was founded in 1909 and which remains the oldest continu- ously functioning national organization offering educational programs for the property-casualty insurance business. The Insurance Research Council (IRC), founded in 1977, helps the Institutes fulfill the research aspect of their mission. A division of the Institutes, the IRC is supported by industry members. This not-for-profit research organiza- tion examines public policy issues of interest to property-casualty insurers, insurance customers, and the general public. IRC research reports are distrib- uted widely to insurance-related organizations, public policy authorities, and the media. The Institutes strive to provide
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