Skimming from the Bottom: Empirical Evidence of Adverse Selection When Poaching Customers

This paper studies implications of competitive customer poaching in markets with heterogeneous and privately known costs to serve. Using individual-level driving records from a large car insurer in Portugal, we show that poached customers generate a 21% higher cost to serve than observationally equivalent own customers. Screening on all available consumer characteristics and behavioral variables, with the exception of switching behavior, can alleviate only 50% of adverse selection. We develop and estimate an empirical framework based on a dynamic churn model that rationalizes this adverse selection. Our estimates imply that risky customers have more incentive to search and switch, and that the population of switchers is itself heterogeneous in riskiness. We propose a new consumer lifetime value measure that accounts for switchers’ risk endogeneity. We apply this measure to study actuarial pricing and insurance contract design.