Can adverse selection increase social welfare?

Abstract

This talk will focus on the effects 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 the case of 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. Empirical evidence suggests that these conditions may be realistic for some insurance markets