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Demand Elasticity, Risk Classification and Loss Coverage: When Can Community Rating Work?

Published online by Cambridge University Press:  09 August 2013

R. Guy Thomas
R. Guy Thomas*
Affiliation:
School of Mathematics, Statistics & Actuarial Science, University of Kent, Canterbury CT2 7NF, United Kingdom, E-mail: r.g.thomas@kent.ac.uk
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Abstract

This paper investigates the effects of high or low fair-premium demand elasticity in an insurance market where risk classification is restricted. The effects are represented by the equilibrium premium, and the risk-weighted insurance demand or “loss coverage”. High fair-premium demand elasticity leads to a collapse in loss coverage, with an equilibrium premium close to the risk of the higher-risk population. Low fair-premium demand elasticity leads to an equilibrium premium close to the risk of the lower-risk population, and high loss coverage – possibly higher than under more complete risk classification. The demand elasticity parameters which are required to generate a collapse in coverage in the model in this paper appear higher than the values for demand elasticity which have been estimated in several empirical studies of various insurance markets. This offers a possible explanation of why some insurance markets appear to operate reasonably well under community rating, without the collapse in coverage which insurance folklore suggests.

Keywords

Adverse selectionloss coveragerisk classificationdemand elasticitycommunity rating
Type
Research Article
Information
ASTIN Bulletin: The Journal of the IAA , Volume 39 , Issue 2 , November 2009 , pp. 403 - 428
Copyright
Copyright © International Actuarial Association 2009

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