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When is utilitarian welfare higher under insurance risk pooling?

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  • Chatterjee, Indradeb
  • Macdonald, Angus S.
  • Tapadar, Pradip
  • Thomas, R. Guy

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.

Suggested Citation

  • Chatterjee, Indradeb & Macdonald, Angus S. & Tapadar, Pradip & Thomas, R. Guy, 2021. "When is utilitarian welfare higher under insurance risk pooling?," Insurance: Mathematics and Economics, Elsevier, vol. 101(PB), pages 289-301.
    • Handle: RePEc:eee:insuma:v:101:y:2021:i:pb:p:289-301
    DOI: 10.1016/j.insmatheco.2021.08.006
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    References listed on IDEAS

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    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies

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