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The Efficiency of Categorical Discrimination in Insurance Markets

Authors


  • The author can be contacted via e-mail: crothsch@middlebury.edu. Thanks to Abhijit Banerjee, Peter Diamond, Amy Finkelstein, Mikhail Golosov, James Poterba, Ivan Werning, and Muhamet Yildiz for useful discussions; Keith Crocker (the editor) and two anonymous referees for superb advice; and the National Science Foundation for financial support.

Abstract

Crocker and Snow (1986) show that banning categorization based on risk-related characteristics such as gender or race in pricing insurance policies is inefficient whenever categorization is costless. Their analysis, by contrast, suggests ambiguous welfare effects of banning costly categorization. I show that this latter conclusion is incorrect: categorical pricing bans are inefficient even when categorization is costly. Whenever the ban-imposing government can instead provide breakeven partial social insurance, it can remove its ban in such a way that the insurance market will choose to employ the categorizing technology only when doing so is Pareto improving.

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