Insurance Loss Coverage Under Restricted Risk Classification: The Case of Iso-elastic Demand

MingJie Hao, Angus Smith Macdonald, Pradip Tapadar, R Guy Thomas

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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.
Original languageEnglish
Pages (from-to)265-291
Number of pages27
JournalASTIN Bulletin: The Journal of the IAA
Issue number2
Early online date16 Feb 2016
Publication statusPublished - May 2016


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