Price comparison websites offer great advantages to insurers and customers But bidding in a crowded market also has its risks. Here we help you to sort the curse from the cure and get the right price for your product.
The ‘winner’s curse’ describes the result of an auction, where the highest bidder tends to overpay.
The term was first coined by three petroleum engineers in 1971. Capen, Clapp & Campbell were trying to understand the poor financial returns gathered by oil companies drilling in the Gulf of Mexico.
Leases to drill in the Gulf are acquired by auction. Each would-be leaseholder estimates the value of a given area and bids accordingly. The highest bidder gets to drill. Capen, Clapp & Campbell observed that poor returns were a consequence of the bidding process:
“If it is true, as common sense tells us, that a lease winner tends to be the bidder who most overestimates reserves potential, it follows that the ‘successful’ bidders may not have been so successful after all.”
Insurers can fall prey to a kind of winner’s curse when selling through comparison websites – a method that encourages underselling. Strategies for combating the curse include: understanding your pricing models and biases, trusting the price that you’re quoting, and knowing when to step away.
A CROWDED MARKET
Comparison websites have emerged as a valuable tool for consumers, with 85% of people now using this method when shopping for insurance. Go Compare and Money Supermarket reportedly saved consumers a combined total of over £3.2 billion in 2017.
The consumer can compare hundreds of quotes with just a few clicks. Insurance quotes have become ultra-competitive, and price is the main consideration for customers. The competition to offer the lowest price has therefore never been hotter. So how do insurance providers avoid quoting a price they can’t afford?
BREAKING THE CURSE
Insurers have several tools they can use to defend against the winner’s curse.
Above all, pricing models need to be reliable and accurate. This involves getting the most out of the accessible data. Understanding your data and how to enrich what you already have is fundamental in developing accurate models. The next step in an ever-changing market is to be able to update and progress these models effectively and regularly as new data becomes available. This shouldn’t be just an annual activity, but something which you can monitor frequently with real-time dashboards.
Another option is bid shading – where you add margin into your models in order to allow for unmodelled risk. This will inevitably lead to fewer policies bound, and selection bias may occur where policies bound contain risk characteristics that you haven’t considered. However, if done well it can allow a new market entrant to gain brand recognition and grow their exposure in a controlled way.
The likelihood of the winner’s curse increases as the competition rises, so a third option is to try to avoid overcrowded marketplaces entirely. Take Direct Line for instance, who choose to not be on price comparison websites. They instead focus on quality customer relationships, independent marketing campaigns and reputation – which has seen them win awards for being Britain’s most trusted insurance provider. Although this is an expensive strategy to start with, it offers some protection against dangerous market winds.
It will be easy to see after the fact, when you’ve overpaid or undersold and fallen victim to the winner’s curse. The ease with which consumers can browse multiple deals for the best price is increasing year on year, so don’t leave it too late before fixing an ineffective model.
Whether you’re drilling for oil or pricing insurance premiums, it’s important to accurately value your product and be careful of the auction environment.