Selling Error

You see the TV ads all the time, "People who switch to Company X save on average $480!"  This sounds great, and if you can find a deal like that you should take it if you think it's a good value.  There are a couple reasons this claim is distorted, though, and I'm not talking about the "on average" part--you probably got that already, and it's not that big of a deal anyway.  No, I'm talking about two subtle stories about that magical savings number.

First, is the phrase "people who switch."  I don't know the exact number, so I'll just guess that about 15% of policies are switched a year.  It doesn't matter what the number is, just that it is low.  These switchers will only switch to a company when the quote is good enough.  It could even be a bad quote, but on average the quotes that are accepted will be better.  Each shopper will also probably reject a handful of bad quotes from several companies.  So, that savings number?  Well, it's not the average difference in quotes between Company X and its competitors, it's the average difference of quotes that were accepted (the 15%).  Have you noticed that the savings numbers for different insurance companies are about the same?  That's because these numbers are approximations of the switching price of insurance consumers, which is about the same across the market.  Insurance policies are priced based on actuarial models which contain many inputs, which the "average savings" number averages out, discarding all that detail and leaving the difference at which most people switch.  Not a compelling sales pitch.

The second story involves error, which enters the picture through actuarial models.  An actuarial model is a model that predicts the likelihood of an event through time.  For example, your chance of death rises over time, teenagers are more likely to wreck a car, and so on.  Of course, the model doesn't predict exactly when you will die or which teenager is going to wreck, and the difference between what the model said and what actually happened is called prediction error, or just error.  Insurance companies use this information as an input into their pricing.

Each company has a team of actuaries building models, each making a different prediction about risk, and each setting a different price.  So, when you pop up four rate quotes, you are getting rates set from four different risk models, each with its own errors, higher and low, about how risky you are.  Granted, companies have pricing strategies for certain situations, and some are more discount or full-service, but in general the highly-paid statisticians that work in the industry come to very similar results for individual cases.  However, their drive for individualization can lead to different predictions for the same individual at times.

So how do all these people get all these deals?  Well, there are a large number of people who get quotes and then don't take them.  These transactions are not included in the switcher average.  That leaves the people who did see an offer that was good enough to switch.  This happens because the company is offering a directed discount (new customer, bundling, senior, etc.), or because one company's model made an error and under-priced the situation relative to all the other models.  Think of it as one of the companies making a bad bet and you taking advantage of them.  I don't know how much actual price competition is going on versus variance in model predictions, but I'd wager that many deals are the result of model error.  So, the "average savings" number reflects not only how much of a discount it takes to get people to switch, but also the average difference between your current rate and the lowest prediction by the set of quotes (models) that you got.

If you got a good deal and switched companies, you probably purchased one of these model errors.  You may have gotten an intentional rebate, but you were probably also on the low end of the risk predictions.  That is perfectly fine, and I'm not implying that you or the company you got the policy from are doing anything wrong, or even unusual.

When you see a commercial like this, you should think, "I wonder if I could find a company to give me an accidentally low quote that I could switch to?"  Check out quotes periodically, and you'll probably find that they are a lot closer than on the TV ads, and then remain a non-switcher.  Or snag the occasional great rate.  We use an insurance broker to do this for us, for free.

When I see a commercial like this, I think that it a poor advertising strategy to keep pushing the same overall average number that applies to everyone in the industry.  It's annoying.

Happy error hunting.