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Fido vs. Gecko

I noticed recently that Progressive is offering customers free insurance for their dogs if they sign up for auto insurance with the company. The insurance I imagine pertains only to injuries that dogs might sustain while in the car of their owners. Why might Progressive offer this benefit to their customers?

Insurance markets are characterized by two major features: regulation and market segmentation.

Auto insurers are regulated at the state level, which means that someone living in Massachusetts is not free to purchase insurance products regulated and approved for sale outside of Massachusetts. One of the many problems caused by regulation is that prices tend to be higher than what would prevail in a less regulated market. So, Progressive offering free coverage of pets to their auto policy holders might be indicative of the fact that auto insurers are earning excessive rents from being in a regulated market (i.e. competitors cannot freely come in and bid down prices). I don’t buy this story too much as the auto insurance market in many states has become less regulated, and it seems a bit irrational to “give away” profits like this for no apparent reason. The question for me will be better answered when we see (or not) other companies following similar policies.

This brings us to the second major feature of insurance markets – segmentation. And this, I suspect, is really behind Progressive’s policy. Insurers go to extraordinarily great lengths to figure out what (potential) customers are likely to file claims. We know teenage boys are more likely to get into accidents than soccer moms (all else equal); we know that owners of Honda Civics in the city are more likely to have their cars broken into than owners of Ford Pintos in the suburbs; and so on. In a market without interference, insurance companies would charge premiums to these different groups of people that reflect the expected losses from insuring each group. In other words, if teenagers are going to get in more accidents, then companies will have to pay out more in claims for teenagers than for other drivers, and therefore teenage drivers should pay a higher premium for their insurance coverage.

However, insurance companies are not allowed to segment their markets in any way that their actuaries tell them makes sense. And that is because it is illegal for companies to charge certain groups of people different prices, just as it is illegal for retailers to charge certain groups of customers different prices based on some observable characteristics. For instance, airlines cannot charge heavier passangers higher fares despite the fact that weight contributes to higher fuel costs and also can be an inconvenience to nearby passengers. The Civil Rights Act ensures that things like weight cannot be used to discriminate, even if it makes economic sense to do so. Similarly, I do not believe that insurance companies are able to charge premiums that vary with income, or a whole host of other factors that are probably related to the probability of a person from that group filing a claim. So, like supermarkets printing coupons in the Sunday paper (thereby allowing them to charge higher prices to the people who do not think it worth their time to clip coupons), insurance companies have an incentive to find creative ways to segment their customer base into those that are unlikely to file a claim and those more likely to file a claim, but in ways that are not inconsistent with existing legal statutes. Some companies give families an insurance discount when students from those families get high grades in school. That seems to be a way to charge different prices based on location and income (and perhaps some unobservable attributes) that might otherwise be illegal if stated explicitly.

So too with dog insurance. It would not be beyond imagination that actuaries have found that families that have dogs, or that travel with dogs, are less likely to file a claim than those that do not have dogs (although I would have guessed just the opposite). Why? Because owners of dogs are also the people that have characteristics that auto insurance companies look favorably upon, but that they cannot legally use to charge differential prices.

Of course, it might simply be the case that Progressive is using dog insurance as a simple advertising tool (and expense). It might be the case that the expected value of what they would have to pay out in dog claims is so small that whether or not they insure dogs will have little impact on Progressive’s bottom line. In any event, I doubt that providing insurance to canines will make dog owners more likely to ride in their cars with their pets, nor do I expect that it will encourage more aggressive driving among dog owners. Providing dog insurance will have little impact on costs, but can have a potentially large impact on the number of customers Progressive has. At base, offering free dog insurance is a way for Progressive to distinguish their product from that of their competitors, something that all firms aggressively pursue in markets that are not tainted by restrictions on competition from non-market forces, much to the benefit of existing and future customers.

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