Economists Do It With Models

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Truth In Advertising, Selection Bias Edition…

March 6th, 2009 · 5 Comments
Advertising · Markets

Okay, I am well aware that it is Friday night, but sometimes an econ girl just can’t help herself. I am sitting here with my dog and watching TV (you will notice a theme in posts along this general line), and along comes yet another of those car insurance commercials that boasts about how much money drivers that switched to Company X saved over their previous policies. (I am guessing that I see more of these ads than others because I live in Massachusetts, which recently changed regulation on auto insurance so as to allow price competition among insurers.)

For example, this is the one I just saw from Allstate:
“If you think GEICO is the cheap insurance company, then you’re really going to be confused when you hear this: drivers who switched from GEICO to Allstate saved an average of $518 a year. Confused? Don’t be.”
(On a side note, this wording doesn’t even make sense- how can you tell me to not be confused when all you’ve done is give me information that confuses me more? But I digress.)

I am guessing that if I watch TV for another half hour or so (meaning that I don’t get enticed by Guitar Hero or the Wii Fit) I will see a commercial for GEICO stating roughly the same fact, perhaps even with the woman with the big tricked out name tag (I think her name is Flo, and I am strangely fascinated by her). So what is going on? Is one (or both) of the companies lying? Probably not, and some simple logic can show why.

The important part of the wording is “of the customers that switch”. So let’s think for a second…what on earth could possibly cause a customer to switch insurance providers? I suppose you can make some arguments about coverage and customer service and such, but I’m an economist, so clearly my main explanation is that the switches are due to the almighty dollar. So you get a type of selection bias that results, since the people that choose to switch are by and large those who would save money by doing so. Is it any surprise then that customers that switch from one provider to another save money?

Furthermore, switching insurance providers is kind of a pain in the rear end, so people probably aren’t going to switch to save $1, or even $5, $10, etc. Let’s take an extreme hypothesis- suppose people wouldn’t switch unless they were going to save at least $500? Then it’s not at all surprising that of the people who switch, the average savings was $518. There just might not be that many people who count in that average! But that has no connection as to whether YOU would save money by switching, so understanding the selection bias principle can help you be a smart consumer in deciding whether it is worth your time to shop around for auto insurance!

A follow up question: How can multiple companies make these cost savings claims? That one’s easy- you can have consumers switching in multiple directions if different companies have different pricing models, which by and large they do. In fact, the pricing models are seen as one of the companies’ most important assets and are usually kept under about 12 layers of security.

(In case you are curious, here is an overview of the FTC’s Truth in Advertising guidelines. The claims referred to above are certainly in the grey area of acceptability, in my opinion. I am now curious as to how much the “reasonable consumer” understands about selection bias!)

Tags: Advertising · Markets

5 responses so far ↓

  • 1 Neesh // Mar 7, 2009 at 7:19 pm

    So, super ironic- there’s a GEICO advertisement in the side column to this comment form.
    As for your rant, it made so much sense when you actually thought about it. Anyone who looks at the facts already handed to them through the internet can figure out how they’re being duped. Unfortunately, not many people understand that every advertisement has an angle and is trying to pull some kind of wool over their eyes.
    Ha, I’m basically trying to say nice observation.
    =)

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