The ‘switch-and-save’ insurance model is dead!

Switching insurance providers is painful. The process normally involves long forms, hours waiting on the phone, and having to recall numerous trivial details about your life. Customers are unlikely to think about insurance again once a policy is signed unless an issue arises before renewing the contract.  

Economics research has long recorded that consumers in various markets stick to products they have previously purchased and prefer to buy brands they are familiar with even when cheaper alternatives of similar quality are available. This stasis is rooted in switching costs, inattention due to information costs, risk aversion, and quality uncertainty1. Moreover, the more options presented to subjects, the more likely they are to stick to defaults or follow the “path of least resistance”2

Because nobody derives joy from shopping around for insurance and most people are willing to pay a premium to stay put, something has to actively nudge an insured to switch.

Most of the time, this nudge comes in the form of advertising trying to convince customers to switch insurers. As the graphs below show, leaders in the auto insurance market are big spenders on advertising, but with results that scarcely seem to justify the cost.

Source: S&P Global Market Intelligence

Switch-and-Save Models

All ‘switch-and-save’ insurance models engage customers at the bottom of the funnel and compete for the same limited pool of insureds. As a result, insurance providers heavily invest in advertising to convince potential clients to ditch their current insurance provider and switch.

This investment in advertisement translates to higher costs and ultimately higher premiums paid by insureds. This shift of the average cost curve shrinks the total market for insurance: the higher premium surpasses some customers’ reservation price, and they are forced to self-insure (or, in the case of auto insurance, buy less than they otherwise would have done).

This strategy is damaging to the insurer and loyal customers who do not choose to switch. To offer a ‘switch-and-save’ scheme to one class of insured people, the rates for riskier insureds or loyal lower-risk insureds who decide not to switch must inevitably rise. 

As John Campbell highlighted in his Presidential Address to the American Finance Association in the US mortgage market, customers consistently pay the price for failing to renegotiate their contracts.

Additionally, even in a hypothetical world where there may be zero cost to switching, and every customer saves money by changing providers at the end of their contract, ‘switch-and-save’ would still be a zero-sum game. Insurers would still have to compete over the same limited pool of customers.

Our next article will show how making insurance more convenient for customers to get significantly increases demand and can easily increase consumer welfare by over 150% of a typical insurance premium.

 

Contributing Authors from Oxford University:
Jacqueline Dai, Laura Fritsch, James Hall, and Mungo Wilson

1. Klemperer, P., 1995. Competition when consumers have switching costs: An overview with applications to industrial organization, macroeconomics, and international trade. The review of economic studies, 62(4), pp.515-539.; Erdem, T. and Sun, B., 2001. Testing for choice dynamics in panel data. Journal of Business & Economic Statistics, 19(2), pp.142-152.; Dubé, J.P., Hitsch, G.J. and Rossi, P.E., 2009. Do switching costs make markets less competitive?. Journal of Marketing research, 46(4), pp.435-445.; Shcherbakov, O., 2016. Measuring consumer switching costs in the television industry. The RAND Journal of Economics, 47(2), pp.366-393.

2. Agnew, J. and Szykman, L., 2011. Annuities, financial literacy and information overload. Financial Literacy: Implications for Retirement Security and the Financial Marketplace, pp.158-178.