Insurance and the Limits of Rational Discrimination

Abstract:     
In recent years, the insurance industry has come under attack for engaging in "discriminatory" practices against minorities. Critics assert that black applicants for insurance are often charged higher rates than white applicants, or are even denied certain kinds of insurance altogether. In response, insurance companies offer the following defense: any difference in rates between racial groups simply reflects the underlying riskiness of the average white and black applicant in society. In other words, insurance companies suggest that they have a perfectly rational reason to discriminate against minorities. On average, minorities are more expensive to insure.

The profit-making objective of this kind of "rational discrimination" distinguishes it from bigotry or "irrational discrimination." While bigotry is generally symptomatic of racial animus, rational discrimination is motivated only by financial concerns. Hence, it is difficult to incorporate any element of fault, or malevolent intent, into an analysis of rational discrimination.

Policy makers and academics have reached little consensus about how to address the implications of rational discrimination. This Current Topic argues that rational discrimination should not be viewed simply as a question of profitability or financial interests, but must also be approached from a moral perspective. Part One examines the underlying cause of rational discrimination in one particular insurance market, locating its ultimate source in the historical injustices perpetrated against Blacks. This section condemns rational discrimination for perpetuating and even exacerbating social inequalities. The analysis suggests that our society will not fully succeed in reducing economic asymmetries between Blacks and Whites unless it confronts rational, as well as irrational, discrimination.

Parts Two and Three examine two alternative methods of interfering with rational discrimination in insurance: prohibiting the practice altogether or compensating for its deleterious effects through a subsidy. While either approach will reduce the correlation between race and risk, this analysis suggests that a subsidy offers significant moral and practical advantages over a prohibition.

Number of Pages in PDF File: 23

Keywords: Discrimination, Law and Economics, Insurance

JEL Classification: D63, G22, J15, J71, J78, K19

Accepted Paper Series