Early Mover Advantages: Evidence From the Long‐Term Care Insurance Market

ABSTRACT Researchers frequently question whether financial firms benefit by developing new products because barriers to entry common to other industries generally do not exist. Studies of early mover advantages for new financial products provide mixed evidence at best. We find evidence of early mover advantages in the relatively young market for long-term care insurance (LTCI) using data that allow broad testing of financial performance. Product differentiation, individual lines exposure, firm size, and traditional health insurance experience also affect financial performance. INTRODUCTION The extant literature contains a wealth of conceptual and theoretical analyses of financial market innovation, but relatively little empirical evidence (Frame and White, 2004). The core issue of whether financial firms actually gain from innovation is particularly intriguing because these firms generally do not benefit from the barriers to entry that can make such behavior profitable in nonfinancial industries. For instance, a pharmaceutical or technology firm can develop a profitable new product that cannot be imitated for many years because of patent laws. Other potential barriers can stem from switching costs, proprietary learning, and economies of scale and scope (Rumelt, 1987). Financial firms are not as sheltered as others because entry into the industry is relatively easy, patents typically are not available, and public disclosure of new product structures and terms generally is required by regulators (Tufano, 1989; Berger and Dick, 2007). Despite these barrier-reducing factors, financial firms continue to develop new products, services, production processes, and organizational forms (see, e.g., Frame and White, 2004). While theoretical researchers continue to develop rationales for innovation by financial firms when imitation by competitors is so easy and inexpensive, relatively few empirical researchers have explored whether early movers gain competitive advantages in new product markets. Further, the evidence that does exist is mixed at best. Some researchers find that early movers into new financial products gain greater market share, at least in the short run, and suggest that they may benefit from lower costs because of economies of scale or proprietary information. Lower costs for new financial products have been implied, rather than directly observed, in these studies, however. Some researchers also find evidence that financial innovators are able to charge relatively high prices, but others claim that imitators are able to leverage favorable reputations to mitigate any early mover advantages. Researchers have not been able to verify higher market or book returns to financial firms that innovate with new products, however. Our study fits within this vein of empirical research into financial product innovation as we empirically examine whether insurers have benefited by moving relatively rapidly into the market for long-term care insurance (LTCI) that emerged in recent decades. Product-specific data unique to LTCI allow rigorous examination of market share, profits, and pricing that is not possible for other financial products. We first analyze innovations introduced in LTCI products. Then we empirically examine potential early-mover advantages using our unique set of financial performance measures and price estimates. We find that early movers in the LTCI market gained relatively greater market share than later entrants, which is consistent with prior research. This evidence is not enough to demonstrate early mover advantage because insurers potentially could "buy" market share merely by operating unprofitably. We therefore explore LTCI profitability and pricing. We find that early movers into the LTCI line generally are more profitable but are not charging higher premiums for LTCI policies. Although like previous researchers we cannot observe product-specific costs, we argue that early movers into LTCI have cost advantages because of their larger market shares and profits in the face of apparently competitive pricing. …