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IAI Actuarial Core Principles · Business Economics · Pricing strategies in the financial services sector

A life insurer has moved from a single community rate to premiums that vary finely with each applicant's genetic test results, which applicants can choose to take or not disclose. Which statement is the most accurate economic assessment?

The most accurate view is that asymmetry persists when applicants can withhold results. Fine classification only works on information the insurer can observe, so people with private bad news may still buy more cover and adverse selection can remain, despite risk-based pricing.

  1. AFiner risk classification always improves welfare because it removes all information asymmetry
  2. BIf applicants can withhold test results while the insurer cannot require them, asymmetry persists, and high-risk people may buy more cover, so adverse selection can remainCorrect
  3. CRisk-based pricing eliminates moral hazard but increases adverse selection by definition
  4. DRisk-based pricing raises premiums for all customers equally
  5. Risk classification has no effect on the demand of low-risk customers

Explanation

Risk-based pricing only helps to the extent information is observable. If applicants can keep private knowledge hidden, they can still choose cover based on it, so adverse selection persists. Classification also does not remove moral hazard or raise all premiums equally.

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