R. Guy Thomas

Loss Coverage as a Public Policy Objective for Risk Classification Schemes

This article suggests that from a public policy perspective, some degree of adverse selection may be desirable in some insurance markets. The article suggests that a public policymaker should consider the criterion of “loss coverage,” and that in some markets a policymaker may wish to regulate risk classification with a view to increasing loss coverage. Either too much or too little risk classification may reduce loss coverage. The concept is explored by means of examples and formulaic and graphical interpretations. An application to the UK life insurance market is considered.

Demand Elasticity, Risk Classification and Loss Coverage: When Can Community Rating Work?

This paper investigates the effects of high or low fair-premium demand elasticity in an insurance market where risk classification is restricted. High fair-premium demand elasticity leads to a collapse in loss coverage, with an equilibrium premium close to the risk of the higher risk population. Low fair-premium demand elasticity leads to an equilibrium premium close to the risk of the lower risk population, and high loss coverage – possibly higher than under more complete risk classification. The elasticity parameters which are required to generate a collapse in coverage in the model in this paper appear higher than the values for demand elasticity which have been estimated in several empirical studies of various insurance markets. This offers a possible explanation of why some insurance markets appear to operate reasonably well under community rating, without the collapse in coverage which insurance folklore suggests.

Indemnities for long‐term price risk in the UK housing market

Discusses the features which distinguish the market for residential property from the markets for other assets. Proposes that financial institutions should offer house‐buyers indemnity policies which pay out an amount related to any fall in the level of a general index of house prices, on the sale of the house at a loss at any time during the mortgage term. To facilitate hedging the risk of a portfolio of such policies (and therefore, the pricing of the policies), a market in “perpetual futures” on indices of housing assets is proposed. Discusses possible users of these contracts and outlines further research.

Non-Risk Price Discrimination in Insurance: Market Outcomes and Public Policy

This paper considers price discrimination in insurance, defined as systematic price variations based on individual customer data but unrelated to those customers’ expected losses or other marginal costs (sometimes characterised as “price optimisation”). An analysis is given of one type of price discrimination, “inertia pricing”, where renewal prices are higher than prices for risk-equivalent new customers. The analysis suggests that the practice intensifies competition, leading to lower aggregate industry profits; customers in aggregate pay lower prices, but not all customers are better off; and the high level of switching between insurers is inefficient for society as a whole. Other forms of price discrimination may be more likely to increase aggregate industry profits. Some public policy issues relating to price discrimination in insurance are outlined, and possible policy responses by regulators are considered. It is suggested that competition will tend to lead to increased price discrimination over time, and that this may undermine public acceptance of traditional justifications for risk-related pricing.

Insurance loss coverage and social welfare

ABSTRACT Restrictions on insurance risk classification may induce adverse selection, which is usually perceived as a bad outcome, both for insurers and for society. However, a social benefit of modest adverse selection is that it can lead to an increase in ‘loss coverage’, defined as expected losses compensated by insurance for the whole population. We reconcile the concept of loss coverage to a utilitarian concept of social welfare commonly found in the economic literature on risk classification. For iso-elastic insurance demand, ranking risk classification schemes by (observable) loss coverage always give the same ordering as ranking by (unobservable) social welfare.

When Is Utilitarian Welfare Higher Under Insurance Risk Pooling

This paper focuses on the effects of bans on insurance risk classification on utilitarian social welfare. We consider two regimes: full risk classification, where insurers charge the actuarially fair premium for each risk, and pooling, where risk classification is banned and for institutional or regulatory reasons, insurers do not attempt to separate risk classes, but charge a common premium for all risks. For the case of iso-elastic insurance demand, we derive sufficient conditions on higher and lower risks’ demand elasticities which ensure that utilitarian social welfare is higher under pooling than under full risk classification. Empirical evidence suggests that these conditions may be realistic for some insurance markets.