During the last decade websites used for comparing auto insurance rates such as onlineautoinsurance.com and insurance.com as well insurance firms’ own websites have become a popular way for consumers to shop for insurance. By 2005 it was estimated that nearly 70% of insurance shoppers used the internet to obtain price quotes[1]. Naturally, this kind of ready access to price comparisons has lead to a more price competitive market and commoditization. I sat down with John Lucker, a Principal at Deloitte Consulting LLP, to discuss the auto insurance industry and how firms can creatively package and price insurance to overcome any commoditization of their product.

To most customers who rarely, if ever, need to make a claim, auto insurance is simply an unavoidable recurring expense with little tangible benefit. As Mr. Lucker points out, “Technically from a legal perspective you’re consuming the product, but you don’t feel like you’re consuming anything, because you’re not getting anything back.” For those customers, the quality of an insurance policy might be difficult to observe, and decisions are made based on price.

If auto insurance were truly a commodity, insurance companies would have no control over price. In order to gain pricing power, a firm would first need to differentiate itself from its competitors. Fortunately for auto insurers, their offerings aren’t identical. The challenge is making customers aware of the quality differences among insurers in terms of, for example, customer service and claims handling. However, with slogans like, “15 minutes could save you 15%,” “Drivers who switched saved an average of $396,” and, “Discounts up to 40%,” auto insurers draw the customer’s attention to price rather than to the desirable attributes of their products that might otherwise differentiate themselves.

Even if the commoditization of the auto industry is inevitable, there are ways that firms could add to their bottom lines through innovative pricing strategies or by bundling value-added products with the main auto or home insurance policy. As Mr. Lucker reasoned, “It’s a lot cheaper and easier to sell more to customers you already have than to get new customers.”

One interesting avenue for profit growth could be through offering warranties on consumer goods as add-ons to existing home or auto insurance policies. Retailers of electronics and home appliances in particular offer warranties at the point of sale that yield notoriously high margins. Insurance companies might be able to offer a similar product to existing policyholders. For example, a customer would have the option to add a warranty for a computer, a television, a cell phone, or an e-book reader to their home or auto insurance policy.

It’s not immediately obvious what pricing strategy would be appropriate for the insurer in this case. Apple, for example, might be able to demand a premium for its Apple Care warranty because of the technical support they can provide the customer. Retailers might have a competitive advantage in customer acquisition since they interact with the customer at the point of sale. An insurance company, however, might offer a greater value proposition by consolidating all a customer’s policies into one bundled policy. A definitive answer is beyond the scope of this article; however, if done correctly, warranties represent an opportunity to better price discriminate by allowing a customer to purchase a basic policy and then add whatever they feel is necessary.

Another interesting and potentially lucrative avenue for profit growth would be to offer expedited claims and VIP repairs service for a higher price, either on a recurring basis, or as a one-time extra charge at the time a claim is made.

An existing example of creative pricing in the insurance industry is a little used auto insurance product called PAYD (pay as you drive). This strategy is used by Texas insurer MileMeter and was once used by Norwich Union in the UK (Norwich Union has since discontinued PAYD partly due to privacy concerns).  The idea of PAYD is self-explanatory; a customer is charged based on how many miles he drives. In the case of Norwich Union, a GPS was installed in the consumer’s vehicle to monitor where, when, and how he drove. Per-mile insurance rates varied based on vehicle speed and on the time of day (young adults, for example, were charged a higher rate between the hours of 11pm and 6am because the probability of a collision was higher during this time).

MileMeter’s method of tracking the amount of miles a consumer drives is a little less formal. When a driver buys an insurance plan they submit a digital photo of their odometer. Each six-month policy covers multiples of 1,000 miles with a 1,000-mile minimum. Once the six-month policy is up, the driver sends another digital shot of the odometer and they are charged for going over the mileage they purchased or credited the dollar value of the miles they did not use, with the exception of the first 1,000 miles. This strategy is similar to a two-part tariff. The purchase of the first 1,000 miles is basically the entrance charge and additional miles carry an incremental cost to the driver.

Although PAYD is creative, Mr Lucker suggests that it might actually hurt an insurance company. A per-mile charge could encourage drivers to use their cars less, thereby lowering revenue and profit. However, the incremental cost is probably small enough, particularly compared to the cost of gas and wear-and-tear, to be largely irrelevant when deciding whether to drive or use alternative transportation for a particular trip.

Finding innovative ways to price discriminate based on value is critical to remaining profitable in a market that is undergoing commoditization. The ideas discussed above illustrate the need for the insurance industry to find creative ways to price and package their services to avoid price wars and the resulting commoditization of their products.

- Jared Mulholland, M.B.A., Class of 2010

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[1] Family Finance: Consumers Increasingly Use Internet to Price Auto Insurance, Jeff D. Opdyke. Wall Street Journal (Eastern edition). New York, N.Y.: May 25, 2005. p. D.2