The efficiency of voluntary risk classification in insurance markets

Keith J. Crocker and Nan Zhu

Journal of Risk & Insurance, 2021, vol. 88, issue 2, 325-350

Abstract: It has been established that categorical discrimination based on observable characteristics such as gender, age, or ethnicity enhances efficiency. We consider a different form of risk classification when there exists a costless yet imperfectly informative test of risk type, with the test outcome unknown to the agents ex ante. We show that a voluntary risk classification in which agents are given the option to take the test always increases efficiency compared with no risk classification. Moreover, voluntary risk classification also Pareto dominates a regime of compulsory risk classification in which all agents are required to take the test.

Date: 2021
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