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

A life insurer offers a term plan at a lower premium to non-smokers and a higher premium to smokers. From an economics viewpoint, which statement best describes this practice?

This is third-degree price discrimination, because customers are split into observable groups and charged different prices. In insurance the gap also mirrors different expected claim costs, so it is risk-based segmentation rather than purely capturing consumer surplus.

  1. APerfect first-degree price discrimination, since each customer pays their own reservation price
  2. BThird-degree price discrimination based on observable group characteristics, which also reflects differences in costCorrect
  3. CSecond-degree discrimination, where customers self-select through quantity discounts
  4. DPredatory pricing aimed at excluding rival insurers
  5. Peak-load pricing based on time of purchase

Explanation

Charging distinct groups different prices based on an observable trait is third-degree discrimination. Here the difference mainly reflects expected claim costs, so it is risk-based pricing rather than pure exploitation of willingness to pay. First-degree would need individual reservation prices, and second-degree relies on self-selection.

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