What's New in Cybertalk?

by Jean Gora 

December 1999

Note: CyberTalk is a column that appears monthly in LOMA's Resource, the magazine for insurance and financial services management. To see more contents of the magazine and to see how to subscribe, click on Resource.

Going, Going, Gone: Insurance on the Auction Block

Auctions are proliferating on the Internet, and they are invading areas of commerce that have not traditionally held auctions. To what degree is the auction model relevant to insurance distribution on the Internet? This month’s CyberTalk examines this issue. It focuses particular attention on the new online insurance mall, Ebix.com, which comes closer than other insurance malls to the auction model. To understand this issue, one needs some understanding of auctions in general. This article first describes some of the major types of auctions. It then shows how various players have adapted these types to the Internet. Finally, it examines how the insurance industry is beginning to make use of the auction model.

Traditionally, auctions emerge whenever "competitive market prices do not exist, but the object sold is of particular uniqueness and size…or when the resource in question does not have a price other than the terms of trade which are revealed through strategic interaction of traders, such as financial assets like stock, options, corporate or government bonds."¹

Types of Auctions

Auctions vary depending on whether they involve single or multiple bidders (buyers) and bid-takers (sellers) and the degree to which they control their market via monopoly or monopsony. A monopsony exists when there is only a single buyer but multiple sellers of a particular good or service.

Traditional auctions typically involve a monopolistic seller or single bid-taker and come in various flavors. When most people think of an auction, they think of a particular type of auction called an English auction. In such an auction, the auctioneer offers a product for sale and may name the reserve price (the minimum price the seller will accept). Potential buyers try to win it by bidding up the price. The sale occurs when there are no more bids. The highest bidder wins the object. This type of auction has long been used in the sale of rare items, such as fine art and antiques, which appeal to a very limited group of potential buyers. Announced well in advance of its occurrence, the auction attracts interested buyers to a single location.

The Dutch auction is a variant of the traditional auction. However, instead of starting the bidding at a low price, the auctioneer starts it at a high price and progressively lowers the price until someone makes a bid. Dutch auctions are often used in situations where the seller wants to dispose of multiple identical items. Each bidder can bid for the entire lot or for partial lots. The high bidder gets the quantity he wants at the high bid price. Bids continue until the entire lot is disposed of. Major banks use Dutch auctions to establish interest rates on various securities such as preferred stock, municipal bonds, and other bonds. The term "Dutch auction" derives from the practices of Dutch sellers of flowers in the 17^th century.

Double auctions involve multiple buyers making bids and multiple sellers making offers. Stock markets operate a continuous double auction; both buyers and sellers submit the shares they wish to trade and specify either a specific price or the market price. All bidders can become bid-takers and vice versa. Trades take place when matching occurs between the shares and prices offered by buyers and sellers.

Reverse auctions typically involve a single or monopsonic buyer who wants something offered by a number of different sellers. In such auctions, the buyer indicates what he is willing to buy. Potential sellers make competitive offers for his business. In some reverse auctions, the buyer also indicates how much he is willing to pay. Sellers have the option of meeting that price or of offering different prices. Those who offer higher prices bet that a buyer who receives no offers at the desired price will decide to accept the lowest of those higher prices. If the buyer receives no offers at or below his desired price, he has the option of not buying. Reverse auctions have traditionally been used in awarding large, complex procurement contracts such as contracts for major construction projects. They are sometimes called procurement auctions.

Bidding

Auctions can also vary on the basis of whether the bidding is open or closed and whether bidders are allowed to make multiple bids. If the bidding is open, each bidder sees the bids of competitors. The most common forms of traditional auctions have open bidding. Financial markets that operate double auctions do as well. Bidders may not see the bids of competitors directly. Instead, they see how the price of the instrument is altered by other bids. When bidding is open, the behavior of individual bidders is influenced by the actual behavior of other bidders.

Some types of auctions allow bidders to make only one bid each; others allow bidders to make multiple bids. Some types of reverse auctions used for procurement purposes allow each bidder only a single bid. Typically bids are sealed so that each bidder cannot know how his competitors are bidding. The auctioneer does not open any of the bids until all bids are received. Because the number of bidders on a procurement contract may be small, there is the desire to prevent collusion among bidders.

Impact of the Internet

The Internet makes all forms of auctions dramatically more attractive by automating the matching process, increasing the number of participants in a particular auction, and lowering the costs of participation. These benefits are interrelated. Automation of the matching process makes auctions a cost-effective distribution mechanism for items that were previously too trivial to be worth auctioning. At the same time, it also makes the auctioning of complex products attractive because it reduces the work associated with product comparisons. Because Internet is in operation around the clock, it is well suited to the disposition of highly perishable items.

Thus, items that were never previously auctioned—like empty airline seats and hotel rooms—are now sold via auction on the Internet. Prior to the Internet, there was no cost-effective way for an airline with large blocks of unbooked seats to dispose of these seats shortly before scheduled flight times. Many potential sellers avoided selling because of the cost and effort associated with creating a distribution channel. Internet auctions offer a ready-made, low-cost distribution channel for virtually anything. A seller can use it at the drop of a hat—literally.

It is no coincidence that the stock market, the most noteworthy example of a double auction, has flourished in this environment, attracting millions of investors into online trading.

Popular Auction Sites

Auctions of all sorts have proliferated on the Internet. EBay.com, the most famous of them, uses variations of both the English and Dutch auction forms. In its English auction, called a "reserve" auction, eBay engages in proxy bidding. "Bidder A" specifies the maximum amount he is willing to bid. That amount is kept secret and called the proxy bid. As the auction proceeds, the system acts as a proxy for Bidder A and casts bids on his behalf, raising the bids only enough to outbid other bidders. If another bidder outbids Bidder A, the system immediately ups A’s bid. This continues until the price exceeds Bidder A’s maximum proxy bid, or the auction ends, or Bidder A wins the auction. The system also operates proxy bids on behalf of Bidders B, C, etc. All bidders are able to monitor the current bid. If the amount being bid surpasses Bidder A’s proxy amount, he has the option of entering a new higher bid. The other bidders can do so also. After the close of the auction, the buyer and seller deal directly with one another to arrange payment and shipment.

As noted above, eBay also uses a version of the Dutch auction to allow sellers to dispose of multiple identical items. Some sectors of the financial industry have already begun offering Dutch auctions on the Internet. USABancshares.com offers daily Dutch auctions on U.S.-government-insured bank certificates of deposits through a site called CDenergy.

Priceline.com, another Internet auction site, uses a variation of the reverse auction form. Priceline calls it a demand collection system. The bidder names the price he is willing to pay for an item and guarantees that bid with a credit card. Priceline holds the bid open for a specific period of time and communicates it to sellers or their databases, which can then make offers. Once they have done so, they cannot cancel them. Buyers are required to be flexible regarding brands, sellers, and product features. Priceline is not truly monopsonic; for everything sold through Priceline, there may be more than one potential buyer. Nevertheless, it may appear monopsonic to the buyer because he does not see the other buyers.

Credit products are among the many products one can buy through Priceline, which offers home mortgages, home equity loans, and home refinancings through Lending Tree, Inc., which also operates a site under its own brand. The Lending Tree is a network of 80 lenders. It processes $65 million in loan applications per day through its site.

Corporate procurement auctions on the Internet also represent reverse auctions. These auctions are flourishing. A recent issue of Prism, an Arthur D. Little periodical, suggests why: "In the last two years, broadly available, real-time reverse auctions have captured the imaginations of purchasing managers, who are now able to orchestrate microcosmic buyers’ markets. Each auction features a number of competing suppliers dynamically pricing their wares. Buyers can see all the competing bids simultaneously on a viewing screen and watch them plummet as the auction progresses. For buyers, this forum represents a quantum leap forward from the static sealed bids of old."²

Changing Transaction Models

An auction’s appeal depends in part on the number of participants. The price of a good depends on the demand for it in relation to the available supply. The more participants in an auction, the more likely its prices will be viewed as the prices that the market in general will bear. An Internet auction site with heavy traffic has greater appeal than one with light traffic. Its prices are more likely to be viewed as the market’s prices.

But even an Internet auction attracting heavy traffic is far from attracting all Internet users. At the end of the second quarter of 1999, eBay.com had 5.6 million registered users, a fraction of total Web users, and had facilitated $622 million in sales. New sites appearing on the Internet now promise to allow users to make bids and offers on all Internet auction sites simultaneously. (eBay.com wants to bar such services from its site.) Thus, anyone buying or selling anything on the Internet becomes a potential auction participant, dramatically increasing the degree to which prices set on the Internet can be viewed as the prices the market will bear.

Given the potential price-setting power of Internet auctions, what could happen to prices charged by sellers who do not participate in them? "A major concern of the suppliers is that it will be difficult to isolate auctions from other sales channels because consumers will adapt their buying behavior. As a result, an increasing price pressure not only on the auctioned products but also as a side effect on those products that have not been singled out for auctions is feared."³

The proliferation of auctions and reverse auctions for all kinds of goods is creating a situation in which the double auction model applies to more and more commercial transactions. Everyone is both a potential buyer and a potential seller. Within this context, a single Internet auction site cannot operate as a monopolistic seller because there are so many other auction sites. A single buyer cannot operate as a monopsonic buyer in a reverse auction because there are so many potential buyers. For all buyers, there is competition; for all sellers, there is competition as well.

Auctions and Insurance

Is the auction model likely to invade the insurance industry? It has already done so and will do so more in the future.

Insurance brokers have always employed a limited form of reverse auction by presenting the same case to multiple carriers and asking them to make offers on it. Essentially the broker operates as an auctioneer. The various Internet insurance markets such as InsureMarket and InsWeb employ a similar model but make it more efficient by allowing potential buyers of insurance to request offers directly from the carriers.

The Internet insurance malls differ in several key ways from some of the most popular Internet auction models. They do not:

Invite the prospective buyer to indicate a price at which he would buy insurance.

Extend over time and allow interested carriers to see how the purchase price is changing based on the offers of their competitors.

Allow carriers to adjust their initial offers based on offers made by their competitors. Thus, if five insurers initially offer premium quotations ranging between $100 and $500 for the same business, the one with the high offer has no opportunity to enter a new, lower offer to increase its chances of winning the business.

Allow buyers to see the offers being made by the sellers for the business of other prospective buyers.

InsureMarket operates with a relatively closed universe of sellers. It has an agency relationship to its carriers and has only 10-15 of them. InsWeb, which is compensated as a service bureau on a transaction basis, continues to add additional carriers aggressively and now has more than 50. Nevertheless, participation in InsureMarket and InsWeb requires significant cooperation on the part of carriers. Both of them are, therefore, seller-controlled markets to a significant degree. The fact that they are seller-controlled explains in part why they have not adopted the auction model more aggressively. Auctions tend to depress the prices sellers can get for their wares.

Although large corporations with complex insurance needs may at times operate as monopsonic buyers of insurance, individual consumers almost never can. Their numbers are too great and their requirements too conventional. In insurer does not lose much if it refuses to make an offer on one individual’s business because the terms are unattractive. Thus, it is very difficult for the individual to force these carriers to make aggressive offers for his business. However, if a large number of individuals buyers request offers, the penalty for the carriers that refuse to participate in the reverse auction grows.

Enter ebix.mall

Now a new Internet mall, called ebix.mall, has begun to test whether it can force carriers to participate in an online insurance mall that operates under an auction model that transfers far more power to the buyers than is available to them through InsWeb and InsureMarket. It operates the first Internet auction in insurance using the Priceline reverse auction model.

The name "ebix.mall" is an acronym for electronic brokers and insurers express. It is accessible through the ebix.com Web site. At this mall, the prospective buyer selects the type of insurance he wishes to buy and enters personal details on an online application in ACORD format. In addition, he can also enter the amount of the monthly premium he wishes to pay. Agents, brokers, and insurers are invited to make offers on this business. Both prospective buyers and sellers can see summary personal details of all potential buyers and the high and low offers all sellers have made for their business.

Any licensed agent, broker, or insurer can register with ebix.mall and make offers. The site is free to prospective insurance buyers. Sellers pay a $100 annual registration fee. If an agent provides a quote, the agency is charged $0.50. If the consumer decides to make the purchase, he enters his social security number, which is sent to the agent, which is then charged another $10. The agent is then responsible for contacting the buyer to close the sale.

From Delphi to Ebix

The operator of ebix.com, formerly called Delphi Information Systems, now does business under the ebix.com name. This company has long been a provider of agency management software with a focus on the property/casualty industry. It is one of many traditional software companies that are retooling their traditional businesses around the Internet and adopting "dotcom" corporate names in the process. One objective is to take advantage of investor willingness to give high valuations to Internet stocks.

It now offers a product called ebix.link that allows insurance agents to submit potential business to carriers over the Internet. An agency must pay $20 for each carrier submission and the carrier itself has to pay $20 to receive the submission.

When potential buyers enter information on the premiums they wish to pay, they are likely to enter low amounts. If multiple agents/brokers/carriers bid on their business and really want that business, their bids will over time come closer and closer to the amount entered by the potential buyer. Thus, this kind of auction will tend to depress prices.

Ebix.mall also allows the potential buyer to enter a future time—between one and three days—at which the auction of his business will end. The site shows the time remaining in each auction. These deadlines serve as a catalyst to bids because carriers know that when the auction ends, the potential customer relationship disappears completely.

The ebix.mall current activity screen describes the potential buyer’s chief underwriting characteristics, his target monthly premium, the deadline for that particular auction, the number of bids for that business, the lowest and highest bids received, the status of the auction, and the state where the buyer is located.

Power to the Consumer

In general, ebix.mall places more power in the hands of consumers than InsWeb, InsureMarket, and the various Internet insurance price quotation services. Its relative openness makes it easy for a larger number of sellers or their agents to make offers for their business. It gives the individual greater ability to influence the price at which he or she obtains coverage. As more sellers participate, policy prices should drop. If they drop a lot, agents will be priced out of the market, and carriers will have to make offers directly. The question then is why agents, brokers, and carriers would choose to participate in an auction format that will, if successful, depress insurance prices and possibly their income.

They have little incentive to participate as long as the number of potential buyers inviting offers on their business is small. The cost of nonparticipation is negligible. However, as the number of potential buyers goes up, so does the cost of nonparticipation; too much business would go elsewhere. A visit to the site on October 25, 1999, suggests that the number of potential buyers remains small, and the number of sellers even smaller. This is not surprising since the site only went live on September 8, 1999. The life section showed 18 prospective buyers of life insurance, only eight of whom had received offers for their business. Of these eight, only two had received more than one bid each. Of them, one received a low offer of $44.61 per month and a high offer of $61.47 per month. The other, who had input a target monthly premium of $20 per month, received two lower offers, one for $1.06 and the other for $13.73.

The auto insurance section of the site was the busiest, with 57 potential buyers. Other sections of the site show 18 potential buyers of homeowners insurance and 34 for health insurance.

Although ebix.mall accepts quotations directly from insurance companies, it is at this time primarily targeted at agents and brokers. As the company’s traditional business is providing agency management systems, this focus is not surprising. However, the firm’s traditional business appears to have been in some trouble. Company revenues for the quarter ending June 30, 1999, were $3.8 million, compared to $6.2 million in the same quarter of 1998. As a result of these losses, the company slashed operating expenses by $3 million. Although the company blamed this decline on Y2K problems in its traditional customer base, the problems may also have come from pressure on the traditional agency system from a variety of sources, including the Internet.

An HP Partnership

One interesting aspect of the ebix.com site is that it carries the Hewlett-Packard brand as well as the ebix.com brand. HP is providing hardware, software, and consulting to ebix.com and in return will share revenue and could eventually own 9.4 percent of the site. Thus, HP has assumed a share of risk for the success of the venture.

HP wants to be an integrated provider of Internet services for vertical industry portals. Hewlett-Packard’s interest in vertical portals and its willingness to accept back-end pricing (revenue sharing) are widely shared by players in the Internet industry. HP’s traditional hardware business is under constant price pressure, and by providing the services to support vertical portals, it taps a new and different revenue source. Given the fact that any revenue generated by ebix.mall is small at this time, success for it from the venture will hinge on the willingness of consumers and insurance industry players to overturn traditional ways of doing business.

Features and Challenges

The ebix.com site has many of the features offered by other industry portals; the ability to personalize the welcome page, access to industry news, online bulletin boards, links to insurance associations, and other similar features. It also conducts weekly polls, which have no scientific validity but generate interest. Its poll in the last week of October 1999 asked whether the respondent had ever read his or her insurance policy. Of 96 respondents, only 44 percent said they had done so.

The main challenge for ebix.com will be to attract consumer traffic to the site. Both InsWeb and InsureMarket face a similar challenge and have resolved it by entering dozens of alliances with other Web sites that generate traffic. Ebix.com is following a similar approach and already has an alliance with InfoSeek. One has to wonder, however, whether other malls have effectively locked it out of many alliances. Of course, many of these alliances depend on the willingness of one site to pay another for traffic. Hewlett-Packard has the resources to pay ebix.com’s allies handsomely.

Ebix.com is conducting an experiment in insurance distribution and pricing that is far more daring than any others conducted to date. Few carriers and even fewer agents and brokers are yet prepared for an environment in which they have to make real time offers on individual business and then update those offers within minutes as the effects of competitors’ offers become apparent. It will be interesting to see what happens. A site called DealAssist, based in Germany, has entered the reverse auction business on a global basis. Insurance is one of the products it offers to auction.

Notes: