Wednesday, 30 March 2011

Car insurance and the arbitrary quality of egalitarian justice

Mark Pennington writes on a recent judgement from the European Court of Justice. Pennington says,
Classical liberals claim that theories of justice must be judged by their practical capacity to facilitate positive sum games in society and to eliminate scope for the exercise of inconsistent and arbitrary political power. Unfortunately, as one of the recent rulings by the European Court of Justice reveals few people in today’s legal and political elites are willing to conceive justice in this regard. Three weeks ago the European Court ruled that it was inadmissible for car insurance providers to take into account sex-specific differences for risk assessment and actuarial purposes on the grounds that this breached the fundamental ‘right to equal treatment’ for men and women. As a consequence, European women will no longer be able to benefit from cheaper driving insurance resulting from their lesser likelihood of involvement in automobile accidents than men of equivalent age and experience. It is difficult to see how this decision is compatible with a positive sum view of society. Men will not be made any better off by the decision as their insurance premiums will at best remain unchanged and women will be made worse off as their previously cheaper premiums will now be equalised upwards in line with those of men.
The European Court could have made a better decision had they bothered to read a paper by an old (yes, I really did mean to emphasis the "old" in this sentence) teacher of mine, Alan Woodfield. Back in 2000 Alan published a paper in New Zealand Economic Papers on "Preventing Insurance Markets from Separating into Gender-Dominated Price-Coverage Combinations". (New Zealand Economic Papers, 34(2),  2000, 243-268). The abstract reads:
This article first examines the extant literature on regulatory attempts to prohibit gender-based risk categorization in insurance markets as adopted in a number of countries and proposed in New Zealand's Human Rights Bill 1992 (but not subsequently enacted). The literature suggests that regulators' aspirations and expected outcomes may not materialize. Stronger regulations that effectively impose unisex pricing requirements at either the level of the individual firm or the market level, and which attempt to prevent markets separating into price-coverage combinations dominated by one or other gender, are then evaluated. While these raise the likelihood that targeted gender groups or the majority of their members are made better off via access to pooling contracts, the desired results are still not guaranteed. A variety of outcomes are possible, including pooling contracts that make no insured person better off and separating contracts that make targeted groups better off. Outcomes are sensitive to various parameters and also to the concepts of equilibrium deemed appropriate to the problem.
In conclusion Alan writes,
This article has examined the nature of contracts and welfare implications of interventions in competitive insurance markets which attempt to compensate for gender-based differences in risk. Although these interventions fail to enhance efficiency, they might be expected to raise the welfare levels of those agents allegedly suffering discrimination in insurance markets. For the case where females, for example, are uniformly riskier than males, it is shown that females may not necessarily be better off as a result of regulation, although they will be so in a number of situations, whereas males are always worse off. Where females are riskier on average, but some females are low-risk types and some males are high-risk types, it is shown that if the information required to assign individuals to the correct risk class is prohibitively costly for insurers to obtain, then while high-risk females are typically better off as a result of regulation, they need not be so, and can even be worse off, compounding the inefficiencies associated with adverse selection. The welfare effects for low-risk females are extremely variable, and are critically dependent on the specific form of the regulation, the underlying parameters of the problem, and the choice among alternative myopic (Nash) and non-myopic (Riley, Wilson, Spence-Miyazaki) concepts of equilibrium. Further, equilibrium will not always be characterized by pooling rather than separating contracts even when unisex insurance prices prevail everywhere, and where pooling contracts do prevail, regulators cannot be assured that all members of a disadvantaged gender group will be made better off by regulation.
I'm guessing that the European Court of Justice did not think the issue through. The set of possible outcomes is more complex that the court seems to think. And the outcome they did pick looks like one of the worst.

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