Sexual Discrimination or Risk-based Pricing

Just when you thought you’d seen the height of political stupidity, another politician opens their mouth and out comes absolute drivel. We’re not referring to Mike Huckabee’s recent “misspeak” when he said the President Obama grew up in Kenya. Nor do mean the Texas immigration bill introduced by Representative Debbie Riddle that would make it a crime to employ an illegal alien with punishments up to two years in jail and a $10,000 fine – unless, of course, that illegal alien is cooking, cleaning, minding the children or cutting the lawn of those wealthy Texans that can afford domestic help. (click here for article) And, no, we are not even including the proposed law in the State of Georgia that would make a miscarriage punishable by death. (click here if you don’t believe us)*

As silly as these are, the Europeans have decided that insurance companies that charge men more for life and automobile insurance than they do for women are practicing sexual discrimination. The price differential has nothing to do with women having statistically lower accident rates, or that women have statistically longer life expectancies. Women pay lower insurance rates because they are women, and that cannot be permitted in an enlightened society. (Click here for article)

Fairly priced insurance is based on the probabilities of a certain event happening within a certain time period. Individuals that are risk averse (those with diminishing marginal utility of consumption) will always choose to buy fairly priced insurance, and will often purchase insurance that is not fairly priced. An insurance company can estimate risk based on historical data and observable traits. For example, smokers pay higher premiums than non-smokers because, statistically, they die sooner. An insurer with many clients can rely on the law of large numbers to predict probabilities for the “average” client in a certain demographic subset. In Europe, apparently, women are not to be treated as an identifiable demographic subset.

What the European law makers are hoping for, no doubt, is that men and women will pay the same premiums based on the average of what they pay now. Sorry, not going to happen. One insurance company may try this, but a second would come along and realize that women are being over charged. They could create a policy that would be cheaper and attractive only to women. Women would then ‘self-select’ into that policy. When they do, the single priced policy would only be sold to men, and since the price is less than the risk for men, that company would go bankrupt. The men would then flock to the only other policy available, and the price of that policy is below the pooled risk, and that company also goes bankrupt. The result; no insurance market.

This is not a new idea. It comes from a paper written in 1976 by Michael Rothschild and Joseph Stiglitz: Equilibrium in Competitive Insurance Markets: An Essay on the Economics of Imperfect Information, The Quarterly Journal of Economics Vol. 90 No. 4 pp. 629-649

Clearly, insurance executives have read this paper, and politicians have not. The insurance industry has been notably silent on the issue because, in the short term, the only solution to non-discrimination is to increase the price women pay for insurance so it is the same as the premium that men pay. Women will be subsidizing the profits of the insurance company, but that is not discriminatory.

As we have previously tried to explain, markets are terribly efficient. We believe that insurance companies will create a mechanism that is not deemed discriminatory and that allows individuals to self-select into policies at the price they are currently paying. For example, insurance contracts are filled with exclusions – events under which the policy will not pay. (Terrorism, war etc.) We can propose a specific set of exclusions that will allow people to self-select into life insurance policies. Policy “A” has a low premium but does not pay out in the event of death from prostrate cancer. Policy “B” has a high premium and will not pay out in the event of breast cancer. Since there is no mention of the insured’s sex, these policies are not discriminatory. We will leave it up to the reader to figure out who buys which policy.

*Thanks to Graeme for drawing this one to our attention.