Academic journal article Journal of Risk and Insurance

Consumer Information and Decisions to Switch Insurers

Academic journal article Journal of Risk and Insurance

Consumer Information and Decisions to Switch Insurers

Article excerpt

Introduction

Undoubtedly, there is no other product for which consumer ignorance is so prevalent. Many consumers are unaware that there are price differences among insurance companies.... Comparative price shopping is very difficult since price differences for comparable coverages are not available in printed form.... Asking |the fellow in the next office~ about his insurance is of little value since he is in a different risk class, lives in a different community, and drives a different kind of car (Joskow, 1973, p. 404).

Many markets are characterized by substantial differences in price, even though the good being sold is considered to be fairly homogeneous. One such market is that for automobile insurance. In many instances, identical policies issued to the same individual by different insurers will sell for dramatically different premiums. The reasons for this are mainly informational. As Joskow's quote above indicates, information is not easy to obtain in insurance markets. This article investigates the role of information in the decision to purchase insurance from a particular firm, paying special attention to the decision to switch companies. Our main contention is that consumers not only must incur search costs to obtain price information, but that they also must obtain information on product quality, which can be obtained only through experience. Furthermore, once an insurer is chosen, there exists a switching cost for changing companies, which reduces the propensity to switch. Consumer survey information from the Federal Republic of Germany is used in this article to support these contentions.

The fact that insurance contracts are identical does not necessarily mean that the insurance product is homogeneous among suppliers. Indeed, the quality of the company, its reputation, solvency characteristics, marketing methods, claims handling procedures, and so on make the insurance product different from firm to firm. Furthermore, much of the information about the insurance product's quality and other attributes is not available to the consumer at the time of purchase. For example, a consumer might need to wait until an accident occurs and a claim is filed before he or she has sufficient information on a particular insurer's claims service. This example highlights the "experience-good" nature of insurance, whereby many product attributes are learned only after the product has been purchased and "used."

Even if we ignore product differences, consumers typically must incur search costs if they wish to compare prices of insurers. Indeed, Joskow's quote is underscored by results of a 1973 U.S. survey (Cummins et al., 1974) which revealed that about one-half of all U.S. consumers surveyed had never compared prices for their automobile insurance policies. Several authors have expanded Stigler's (1961) explanation of costly search as a cause of price dispersion. Dahlby and West (1986) used data for compulsory third-party automobile liability insurance in the province of Alberta (Canada) and found empirical support for the "costly-search" argument in explaining price dispersion in this market. The notion of "switching costs," or what Weizsacker (1984) calls the "costs of substitution," recently has received a fair amount of attention in the literature, especially with regard to its effects on market structure (see, for example, Klemperer, 1987, and Farrell and Shapiro, 1988). The key idea is that buyers incur real costs for switching from one supplier (in this case, an insurer) to another, as explained by Williamson (1979). These costs enable the original supplier to exert some monopoly power over established customers. Thus, consumers have a reservation-price differential equal to the switching costs and will not switch to a new supplier unless the quality-adjusted price reduction exceeds this switching cost.

The purpose of this article is to examine the interaction of these components in the consumer's insurance purchasing decision. …

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