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.
- Research Centres and Themes, Genetics and Insurance Research Centre - Professor
- Research Centres and Themes, Centre for Finance & Investment - Professor
- School of Mathematical & Computer Sciences - Professor
- School of Mathematical & Computer Sciences, Actuarial Mathematics & Statistics - Professor
Person: Academic (Research & Teaching)