Some Novel Perspectives on Risk Classification

This paper considers a number of novel perspectives on risk classification, primarily in the context of life and critical illness insurance. I suggest that the terminology of “adverse selection” is often misleading, because from a public policy viewpoint, adverse selection may not always be adverse. I suggest that public policymakers should consider the criterion of “loss coverage”, and that in many markets a socially optimal level of adverse selection is that which maximises loss coverage. A review of empirical studies suggests that adverse selection is often difficult to observe in practice; this leads to the concept of propitious selection, and various psychological perspectives on risk classification. I suggest that competition between insurers in risk classification can sometimes be characterised as a malevolent invisible hand, and that public policy should direct competition towards areas that are more clearly beneficial to all insurance customers. I also consider the perspectives of risk classification as blame, the conflict between risk classification and human rights, and the fallacy of the one-shot gambler. The Geneva Papers (2007) 32, 105–132. doi:10.1057/palgrave.gpp.2510118