When is utilitarian welfare higher under insurance risk pooling?

Indradeb Chatterjee, Angus Smith Macdonald, Pradip Tapadar, R. Guy Thomas

Research output: Contribution to journalArticlepeer-review

Abstract

This paper considers the effect 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 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. Using the concept of arc elasticity of demand, we extend the results to a form applicable to more general demand functions. Empirical evidence suggests that the required elasticity conditions for social welfare to be increased by a ban may be realistic for some insurance markets.
Original languageEnglish
JournalInsurance: Mathematics and Economics
Early online date16 Aug 2021
DOIs
Publication statusE-pub ahead of print - 16 Aug 2021

Keywords

  • Arc elasticity of demand
  • Elasticity of demand
  • Insurance risk classification
  • Insurance risk pooling
  • Relative utilitarianism
  • Social welfare

ASJC Scopus subject areas

  • Statistics and Probability
  • Economics and Econometrics
  • Statistics, Probability and Uncertainty

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