Insurance is a complicated product. Period.
No debate used to exist relative to whether insurance was a complicated product. Complication was (is) obvious given the length of the policies, legal terminology, excessive use of prepositions and the aspects that get insurance nerds excited: inclusions within exclusions and exclusions within inclusions.
Moreover, no one wants to buy insurance. 2+2=4. That is simple, and the simple part is that, when complexity is combined with massive reluctance and resentment to purchase, this equals consumer misery.
One solution for mitigating consumer misery is to make insurance seem simple. “15 minutes will save 15%” makes insurance seem exceedingly simple. “The average consumer saves $X when switching to…” makes insurance seem simple.
The “commoditization” of insurance that has received so much press is really a misnomer. Insurance is not a commodity. A complex good, because it is complex, generally cannot be a commodity. A true commodity is a product that is always identical. Red winter wheat from one farm is the same as red winter wheat on another farm. With GMO (genetically modified organism) seeds, the product is literally identical. Silver is silver once processed.
Insurance policies and claim practices between companies are not nearly the same. This is why agents actually still need to read the policies they are selling to avoid E&O claims. This is why it matters if a policy is an ISO policy versus a non-ISO policy. Policies are not identical and, therefore, fail the test for commoditization. Is the goal the same? Yes, but the means and values are different. Therefore, the product is not a commodity, even in personal auto.
Instead, insurance is more easily sold by a certain kind of company/agent if that company/agent can convince the public that all policies are the same, and, therefore, the only difference is price. In other words, these vendors need to convince the public that insurance is indeed a commodity, even though it is not. And they are pretty good at doing this.
Rather than commoditization, the result is really better described by the economist Carl Shapiro in his fantastic study, “Consumer Information, Product Quality and Seller Reputation” (Bell Journal of Economics 13, no. 1 (1982): 20-35). He describes how, when a product is complex from the consumer’s perspective, mediocre vendors will always take advantage of the consumer and vendors providing higher-quality services/products.
The mediocre vendors do this by causing consumers to think they are getting the same product for a lower price. They may do this in a number of ways and, often in the financial world, will reduce a quality decision to one number. This number may be a rating, such as a rating company’s rating of an insurance company. The vendors know that insurance agents and consumers and regulators look at one number/letter. Then they work backwards to figure out how to get to that number with a product/service that really does not deserve that rating but that will qualify because they manage to check all the boxes. This may have happened many times in the credit crisis and was arguably a leading cause of the credit crisis.
I think this may be happening with some insurance companies today, but that is for another article. Relative to commoditization, the “one” number is a price. The silent message is that all insurance is the same, and the consumer should not spend any time considering the coverage differences or claims practices. Then the vendors go one step further and truly abuse the proper use of statistics because they only cite quotes that save money. For example, take the $300 saved when switching. The statistic may be correct, and statistics do not lie. The pictures people paint with statistics can mislead, though. If 100 people get quotes from this company, and 95 quotes result in premiums higher than they are already paying, but five do save money, then technically the tag line is correct because it includes the word “switch.” If instead, all quotes were included, I am guessing the average savings would be less, and the average savings of all quotes is a rather important point.
Another example is the focus on new business quotes vs. renewal pricing. This is a rather interesting point because so many companies jack renewal rates. Therefore, new business quotes vs. renewal pricing is really an apples-to-oranges comparison. Theoretically, with true actuarial based pricing, this difference should not exist. Consumers inherently get this, but the companies play to their advantage in two fascinating ways.
The first is that by advertising that the consumer is saving $X on new business, vendors cause consumers to think that new and renewal pricing are the same. The difference creates an opportunity to gain new business on price.
The second interesting play is that companies are not exclusively, and maybe not primarily, using actuarial-based pricing on either the new or the renewal. Instead, what they do at renewal is increase the price based on their price elasticity curve. A few insurance company people actually learned economics in college. They increase the renewal pricing knowing that they’ll lose a percentage of clients (to other companies encouraging insureds to switch for $X savings on average switch). The damage, if the pricing is designed well, is negligible because the extra money made with those who stay more than makes up the difference for those that are lost. Then they create stickiness in the initial sale because the initial saving is so great that consumers are likely to think they are always saving more with this company and will not shop as often, resulting in paying more than if they shopped all the time.
These companies that focus the consumer on one number and the concept that all coverages and claims practices are the same are smart. As Shapiro stated, companies that focus on causing consumers to think they are getting more quality than they really are is an inevitable outcome of a free economy.
What are the rules for successfully selling a non-commodity financial product as a commodity?
- The right kind of advertising is crucial. This means keeping it simple. Avoid all indication of complexity or differences between products.
- Barely mention “insurance.”
- Use bad humor employed by cartoonish actors/animated characters.
- Repeat, repeat, repeat, repeat, repeat, repeat, repeat, repeat, repeat. According to a report by Coverager, Oct. 16, 2018, Geico averaged 9.83 views per household of just one of their television commercials. To create enough sales and existing consumer brand knowledge, every household had to see that one advertisement almost 10 times.
- Spend huge amounts of money on advertising. According to the same Coverager report, citing Alphonso & Statista (TV advertising data companies), Geico spent $232 million on television advertising alone (not including online advertising) in the last quarter of 2017. It is estimated in the article that Geico spends another 20% or so online. Call it $250 million plus per quarter, which extrapolates to $1 billion plus per year. According to A.M. Best, the Geico subgroup rating unit (002933) writes approximately $30 billion in DWP annually. Advertising expense then is only between 3% and 4%. Advertising for Geico then is incredibly affordable.
(Note: I am using Geico because I have access to these data points and because the company has a successful strategy. I am not picking on them, and I am not advocating for them. With the data available, I can more easily explain the market using their data vs. other carriers, although those carriers may be more aggressive, less aggressive, better/worse, more expensive/less expensive, use all the strategies described or none. I also do not know with certainty if Geico uses the strategies described, and I do not mean to imply they do by including their specific results.)
See also: How to Resuscitate Life Insurance
Barring a few billion dollars available, and remember those billions have to be used on high-quality adverting and corporate leadership, competing directly is not a wise decision. How then does an agent/company win with true quality and care for the consumer?
In Shapiro’s analysis, the masses are lost in these situations involving complex products. Marketing is about the masses. So the solution involves selling. Selling is about the individual. Selling is about treating people as individuals. Selling is about taking the opportunity to tailor coverage for each individual. Selling is about identifying clients who care about the right coverages (the masses are lost) and converting those who would care if someone took the time to explain why they, the consumers, should care. Selling is about matching consumers’ needs and budget with a policy that best fits their needs. Selling, in this environment at least, is about having the knowledge required to create a custom policy. The producer who does not know the coverages is like a tailor who cannot measure. The suit may not be off the rack and may technically be “custom,” but it is mostly worthless.
You can find this article originally published here.