Insurance Efficiency and Insurance Equity

Ethical values are involved in the differential treatment received by the insured due to their disabilities. Now, normative arguments are being considered for and against the different treatment of some persons related with other by the insurers. We look at these arguments in the context of insurance efficiency and insurance equity.

Insurance Efficiency

Imagine a society with only has two group of individual: A and B. Both are identical aside from the fact that A has disability that are related to one of four chances or being not able to work (disability). On the other hand, B’s source of income are stable, whereas A is not stable. In this society, would B agrees to a contribute part of A’s risk by paying a sum of money in the event that he develops the incapacity? Rationally, the answer is depend on what motivates B. Leaving aside the question of selflessness on one side for the moment, both individuals have mutual interest to negotiate an agreement that some of the risks of failure in B will be covered in exchange for a payment of A.

This concept of mutually beneficial exchange leads to a normative principle which is closely related with utilitarianism where the society as a whole will be better if mutually beneficial gains from trade are used. A broader definition of the insurance efficiency shall apply if the distribution of risks is carried out without the payment from A

In this example, it is tempting to read the structure of an insurance contract between A and B. In such scenario, B is become an insurer party who offered contingent benefits to A as a substitute for a contribution in the form of a premium. If B then decides to offer an insurance contract that is purchased by many of A individuals, consequently B will have lot of income just from premiums. He also will incur liabilities only to those As who are incompetent of work in that particular year. As a result of pooling the benefits of a large number, the scope for insurance efficiency trade between insurers and individuals facing risk is considerably enhanced.

Now take a moment to extend the example above by including individuals C. C is person that have one in two possibility chances or being not able to work (disability). Presuming that the insurer has a way of finding the difference between A and C, then it will has two options. It could work out what premium would be needed to charge for cover to both A and C in order that its income and liabilities should balance in any given year. This is a pooling insurance contract involving a degree of cross-subsidization from the low risk insurance (A) to the high risk insurance (C).

While this arrangement could be seen as equitable, in that both A and C pay the same premium, we will argue that it is inefficient. Instead, the insurer could work out what distinct premiums could be charged to As and Cs separately so that the income from each risk type as a group balances the liabilities from each risk type as a group: that is, the insurer would avoid cross-subsidization between risk types by using separating insurance contracts (or premium discrimination). As far as insurance efficiency is referred, it can be shown that an insurance market in which everybody pays a per unit premium equal to his or her expected loss is one in which all potential gains from trade have been exhausted.

Some ethical issues in relation to disability and insurance base from this differentiation between pooling and separating insurance contracts. There is often a confusion among the insurer’s role in pooling risks over time (that is, the law of large numbers), and the desirability of pooling across individuals who face different risks. It is often not fully understood that an insurer is quite capable in principle of charging a separate and distinct premium to every individual while still carrying out the pooling function associated with insurance.

Insurance Equity

So what are the ethical problems with the separation of the insurance contracts? Why should insurers be questioned from moral reasons due to distinguish between the insured because of their disability? First, you could argue that disability is a fundamental characteristic of human beings, such as gender and race, to which they have no control. Therefore it is somehow not fair for people with disabilities to be treated differently than people without one. In this context, the argument that the differentiation may in some cases is being used as vehicle for uninformed prejudice. There was only a few support for the differentiation on the basis of factors over which the insured had some little control. Insurance equity in this sense is referred with the protection covering of fundamental rights to non- discriminatory treatment.

One could argue that there is a preference for the society of the partial redistribution of the low risk insurance to those bearing the high risk insurance through no fault of their own egalitarian values are defined, if in terms of expected wealth. For instance, people with a disability such as born with cerebral may unable to work for any length of time. For this reason they may have relatively little wealth and uncertain future. If a low risk, high wealth individuals cross-subsidies such individuals through pooling contracts, it might be seen as a fair outcome by many people. This is closer to the economist’s usual use of the term ‘equity’, in the sense of distributive justice.

In both imaginary society above, one could argue that the discriminatory premiums that will benefit to the able-bodied physical conditions are unfair. But then again, we should asking if the insurers are indeed acting as moral agents when differentiating between risk groups (high risk insurance and low risk insurance).