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Risk Classification in Insurance Contracting

51 Pages Posted: 12 Nov 2011 Last revised: 22 Aug 2012

Georges Dionne

HEC Montreal - Department of Finance

Casey Rothschild

Wellesley College

Date Written: April 24, 2012

Abstract

Risk classification refers to the use of observable characteristics by insurers to group individuals with similar expected claims, compute the corresponding premiums, and thereby reduce asymmetric information. Risk classification can be used to mitigate adverse selection and improve insurance market efficiency, but it may have undesirable equity or efficiency consequences. We employ a canonical screening model of insurance contracting to study these trade-offs in a range of informational environments, and to understand when efficiency or equity concerns are likely to be particularly important. We also review empirical studies on risk classification and residual asymmetric information.

Keywords: Adverse selection, Classification risk, Diagnostic test, Empirical test of asymmetric information, Financial equity, Insurance rating, Insurance pricing, Moral hazard, Risk classification, Risk characteristic, Risk pooling, Risk separation, Social equity

JEL Classification: D80, D82, D86, G22, I11, I18

Suggested Citation

Dionne, Georges and Rothschild, Casey, Risk Classification in Insurance Contracting (April 24, 2012). Available at SSRN: https://ssrn.com/abstract=1958176 or http://dx.doi.org/10.2139/ssrn.1958176

Georges Dionne (Contact Author)

HEC Montreal - Department of Finance ( email )

3000 Chemin de la Cote-Sainte-Catherine
Montreal, Quebec H3T 2A7
Canada
514-340-6596 (Phone)
514-340-5019 (Fax)

HOME PAGE: http://www.hec.ca/gestiondesrisques/

Casey Rothschild

Wellesley College ( email )

106 Central St.
Wellesley, MA 02181
United States

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