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INSURANCE LOSS COVERAGE UNDER RESTRICTED RISK CLASSIFICATION: THE CASE OF ISO-ELASTIC DEMAND

  • MingJie Hao (a1), Angus S. Macdonald (a2), Pradip Tapadar (a3) and R. Guy Thomas (a4)

Abstract

This paper investigates equilibrium in an insurance market where risk classification is restricted. Insurance demand is characterised by an iso-elastic function with a single elasticity parameter. We characterise the equilibrium by three quantities: equilibrium premium; level of adverse selection (in the economist's sense); and “loss coverage”, defined as the expected population losses compensated by insurance. We consider both equal elasticities for high and low risk-groups, and then different elasticities. In the equal elasticities case, adverse selection is always higher under pooling than under risk-differentiated premiums, while loss coverage first increases and then decreases with demand elasticity. We argue that loss coverage represents the efficacy of insurance for the whole population; and therefore that if demand elasticity is sufficiently low, adverse selection is not always a bad thing.

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Keywords

INSURANCE LOSS COVERAGE UNDER RESTRICTED RISK CLASSIFICATION: THE CASE OF ISO-ELASTIC DEMAND

  • MingJie Hao (a1), Angus S. Macdonald (a2), Pradip Tapadar (a3) and R. Guy Thomas (a4)

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