Data Science in the Insurance Industry
By Kat Campise, Data Scientist, Ph.D.
Data science as applied within the insurance industry is currently in an emerging stage. While actuarial scientists utilize statistical methods for their risk calculations, and predictive analytic techniques are used within the industry, insurance companies haven’t embraced data science as quickly as other industries. But, why?
The short answer is regulation. Although insurance companies are privately owned and operated, their decisions have a widespread impact on the public. Health insurance is a prime example of the public and private intermingling despite the insurance policy being a private contract between the policyholder and the insurance company. Policyholders pay X amount monthly and/or agree to meet a premium payment amount to, ideally, have a safety net in case a drastic event occurs, such as needing heart surgery. Moreover, there may be thousands, tens of thousands or hundreds of thousands of policyholders who rely on the insurance company’s decisions.
If the insurance company fails to meet the agreed-upon financial obligation — and they’ve devised massive legal documents that state what they will and will not cover, and when — then a ripple effect is generated. Should the policyholder have a heart attack, they are not going to merely wait for death. No, instead they’ll be rushed to the hospital and treated. However, if they cannot pay, then the hospital now has the responsibility to recoup the money from elsewhere. Depending on the U.S. state, either the state remits payment or the cost is passed on to existing and future patients. If the state pays, then the money is replenished through taxes. As much as many may believe that medical services should be free, doctors, nurses, and other health care providers also need to be paid, as do the vendors of the medical equipment and pharmaceutical companies.
So, everyone has skin in the game when it comes to insurance: all policyholders, the hospital, the physicians and nurses, the insurance company, and non-policy holders who are residents of the particular U.S. state. Consequently, insurance companies are regulated at the state level which includes licensing, overseeing financial durability, and monitoring the insurance company’s actions to ensure fair and reasonable market practices.
Also, keep in mind that insurance companies need a larger population of policyholders that don’t generate frequent claims, whether large or small. In the case of health insurance, for the insurance company to remain financially viable and meet its obligations to all of its policyholders, the healthy population paying into the monetary pool must be greater than the policyholders who are more likely to need ongoing medical treatment. As such, policy pricing is based on statistical assessments of policyholder risk. Smokers with a history of heart disease present a higher risk of financial demands on other policyholders, which in turn can increase the costs of insurance and medical care for everyone else. Calculating these factors is the realm of the actuary.
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