Differentiation and insurance – Why actuaries still think that sex is important?
1
Background
The European Court of Justice ruled recently that it will no longer be possible to use gender as
a risk factor in insurance for pricing purposes. The industry and also actuaries found this odd as
it is so clear that using gender as a risk factor is actually good for everybody. In the discussions
over the years it has been clear that what actuaries find self-evident is not at all self-evident
generally.
This article tries to give some understanding to the difficulty of communicating the case for
gender differentiation. It starts by showing the trivial issue that differentiation as such makes
economic sense.
It continues with presenting two ethical standpoints, utilitarianism and Kantian ethics.
Utilitarianism is one of the ethical theories saying that what is good can be decided by looking at
the consequences – utilitarianism is thus a form of teleological ethics. Kantian ethics, on the
other hand, is a deontological ethical theory: what is good can be decided a priori, without
looking at the consequences.
It seems that actuaries generally express their logic taking some form of utilitarianism as
granted. It seems then that this logic is not easily acceptable to someone starting from a
different ethical background.
The meaning of the article is not to say that those who find using gender as a risk factor
unacceptable are Kantian. Neither has it intended to say that all actuaries are utilitarian. It only
tries to make it understandable that actuaries generally tend to use utilitarian argumentation
which might not be easily welcomed by those who happen to subscribe to some non-utilitarian
ethical theory. It does this by using Kantian ethics as an example.
The article does not solve any problem or give guidance on how to formulate one’s
argumentation to make it more widely accepted. It only tries to make it easier to understand why
something one person finds self-evident is not at all evident to another person.
It might also be interesting to note that actuaries are often quite conservative. We now think that
gender differences are so evident that they must always have been used for pricing. It appears
however that at least Finland has a very short history of using gender as a risk factor in life
insurance. Different tables for men and women were introduced in Finland in 1973. This
happened on the initiative of a certain actuary who had to spend many years to convince the
industry and his fellow actuaries that this makes sense.
2
Logic of insurance
Harper1 expressess the core of insurance principle as:
“Insurance is based on the complementary principles of solidarity and equity in the face of
uncertain risks. Solidarity implies the sharing by the population, as a whole or in broad groups,
of the responsibility and the benefits in terms of costs, while equity means that the contribution
of an individual should be roughly in line with his or her known level of risk.”
It is usually understood that insurance has started when a community has decided to share
risks among themselves. This has resulted in different kinds of organisations operating on the
principle of mutuality. Usually the scope of mutuality has only gradually extended to larger
spheres. There seems to have always been hesitancy over spreading risk sharing too wide in
the fear that others might try to benefit from the arrangement in an inappropriate manner.
Earlier mutual arrangements have gradually developed into more and more sophisticated
structures and the operation has become increasingly business-like. Insurance is still today
operated to a fairly large extent in the form of mutual companies even though limited companies
have gained more and more share.
Both types of companies operate to a large extent in a similar manner although certainly mutual
companies have retained much more the idea of individuals agreeing internally to pool their
risks. Both types of companies can also be thought as service providers that sell their products
to the general public.
Insurance talks always of pooling of risks, i.e. there exists always solidarity between the
insured. This solidarity exists both in mutual insurance companies as well as in limited
companies.
There are different forms of solidarity. These can be expressed2 in the following way:
“Risk solidarity is a consequence of risk sharing, and it implies that ex post the lucky support
the unlucky. Subsidizing solidarity involves ex ante value transfers from one group to
1
2
Harper Peter S, Insurance and genetic testing, Lancet. 1993 Jan 23;341(8839):224-7
Franziska Tausch, Jan Potters,Arno Riedl, Preferences for Redistribution and Pensions: What Can We Learn from
Experiments?, RM/10/044
another—as is the case, for example, when longevity risk is expected to be larger for one group
(women) than for another (men). Income solidarity usually implies that income is redistributed
from the rich to the poor”
Insurance business can thus be thought of in two ways:
-
individuals subject to a certain risk agree to pool their risks by forming an organisation, an
insurer, that carries the risk by collecting premiums (and sometimes doing retroactive
collecting if premiums ex ante turn out to be insufficient), or
-
an insurance company, using the capital provided by its owners, offers pooling of risks to the
general public by selling them insurance products.
In both arrangements one needs to discuss the question whether the insurer should be able to
use differentiation when covering the risks. In the first case one can ask whether a certain group
of individuals should be allowed to exclude others from the population covered. In the second
case the question is whether a service provider is allowed to exclude certain individuals from its
clients.
The possibility of differentiation seems to depend also on the type of the product. We might
have different rules when we are talking of products for the masses that are necessary for
everyday life, compared to products that might be considered luxury. As an example it might be
impossible to rent a home or get a mortgage without insurance cover. Then it might be thought
that such insurance cover must be accessible to everybody with terms that are understood to be
fair. If however we are dealing with a luxury product (e.g. a huge life insurance policy) there
might be more possibilities of allowing differentiation.
One criterion might also be whether the insured can by his or her own actions influence to which
category he or she belongs to. Gender and health are in this sense independent of the actions
of the insured whereas for example smoking or other things related to habits is chosen by the
insured. Age might be thought differently from gender and health as each individual basically
goes through all ages.
In private insurance it is usually thought that only risk solidarity (or probabilistic solidarity, as it is
sometimes called) is possible3:
“That lucky policyholders pay for the damages caused by less fortunate insureds is the essence
of insurance (probabilistic solidarity). But in private insurance, solidarity should not lead to
3
Rob Kaas, Marc Goovaerts, Jan Dhaene, Michel Denuit, Modern Actuarial Risk Theory, Springer 2008
inherently good risks paying for bad ones. An insurer trying to impose such subsidizing
solidarity on its customers will see his good risks take their business elsewhere, leaving him
with the bad risks. This may occur in the automobile insurance market when there are regionally
operating insurers. Charging the same premiums nationwide will cause the regional risks, which
for automobile insurance tend to be good risks because traffic is not so heavy there, to go to the
regional insurer, who with mainly good risks in his portfolio can afford to charge lower
premiums”.
As noted above, the logic of differentiation of risks is at least in some areas more and more
under criticism and even legal constraints are imposed. We need to ask why this is so.
3
Different justifications
In sociology there are analyses on why different individuals can make different decisions when
presented the same problem. The problem there is why people knowingly or unknowingly justify
their decisions in different ways. This issue has been discussed under the theory of justification.
Maybe the most widely known theory of justification is created by the French sociologists Luc
Boltanski and Laurent Thévenot4. Boltanski and Thévenot argue that justifications fall into six
main logics exemplified by six authors:
-
civic (Rousseau),
-
market (Adam Smith),
-
industrial (Saint-Simon),
-
domestic (Bossuet),
-
inspiration (Augustine), and
-
fame (Hobbes).
Later research has added further logics but for our problem these logics are sufficient. Boltanski
and Thévenot argue that the logics or justifications conflict as people compete to legitimize their
views of a situation. Boltanski and Thévenot show that these justifications can easily point to
different conclusions:
“Each of the different worlds refers to a particular prudence that is expressed in particular in the
economics of the business organization. In the inspired world it is creativity. In the domestic
world it is the logic of good human relations. In the world of opinion it is fame, marketing and
4
Luc Boltanski, Laurent Thévenot, On Justification, Princeton University Press, 2006 (Luc
Boltanski et Laurant Thévenot : De la justification. Les economies de la grandeur , Paris:
Gallimard 1991)
good public relations. In the civic world it is the logic of the social contracts and citizenship
rights. In the market world it is the logic of money, management and business strategy that is
important. In the industrial world it is the logic of productivity. In the modern enterprise that is the
paradigmatic rationality”.
It seems that the actuarial or the industry logic is based on the industrial world. I have however
only used the theory of Boltanski and Thévenot to illustrate how easy it is to come to different
conclusions on an issue. We are going to look at next at the economic case of differentiation
and then look at the issues from an ethical point of view.
4
Economic case
It is of course trivial issue to show that differentiation generally makes economic sense. But
maybe it helps to look at this more carefully.
Let’s look at two cases of groups A and B (number of insured in each group nA and nB,
respectively)
-
in the first case compensation C is the same for both groups but the groups have different
probabilities pA and pB for the payment (e.g. death benefit for two age groups).
-
in the second case different compensation CA and CB for the groups but probabilities (p) are
the same (e.g. capital value of old age pension for men and women – omitting the fact that
reaching the pensionable age has different probabilities).
It is easier to think of this in a deterministic environment as, at least in the first approximation,
stochastics probably does not change things materially. Also, the situation is easier to
understand with a lighter mathematical back bag.
4.1
Same compensation – different probabilities
As stochastics can be disregarded, we can look just at net premiums. Each insured would pay a
premium of pAC (respectively pBC) that would cover the claim amount nApAC (respectively
nBpBC).
If we combine the groups, the expected claims will be (nApA+nBpB)C. If the requirement is that
premiums cannot discriminate, then the individual premium will be (nApA+nBpB)C / (nA+nB). If
pA<pB ,then clearly pAC = (nApA+nBpA)C / (nA+nB) < (nApA+nBpB)C / (nA+nB) < (nApB+nBpB)C /
(nA+nB) = pBC.
In principle all is well here – but we will return to this in the connection of adverse selection.
4.2
Same probabilities – different compensation
Again we can just look at net premiums. The premium would be pCA (respectively pCB) and the
claim amount would be nApCA (respectively nBpCB).
If we combine the groups, the expected claims will be p(nACA+ nBCB). If we cannot discriminate
in premiums, the premium would be p(nACA+ nBCB)./ (nA+ nB). If CA<CB then, as in 1.1, clearly
pCA < p(nACA+ nBCB)./ (nA+ nB). < pCB.
Again, in principle all is well here – but there is a need to return to this in the connection of
adverse selection.
5
Adverse selection
It is evident that individuals in group A will feel deceived, the more so if the combined tariff is
much higher than the actual tariff for group A would have been. It is somewhat difficult to judge
how high the difference needs to be before individuals start to react. Anyway, if we start from
the economists’ hypothesis of complete markets, this should happen immediately as the price
differs between the groups.
This would, when we talk of voluntary insurance, result into a situation where some individuals
think they are better off by not taking insurance. This leads to a phenomenon actuaries call
adverse selection.
When adverse selection occurs, the premiums are insufficient. Therefore, anticipating adverse
selection, premiums need to be loaded. This will result in more individuals not insuring which
would again result in a higher loading. Ultimately the premium would be set at pBC or pCB. In
this situation only those belonging to group B would buy insurance. Clearly this would be suboptimal when you look at the whole.
Actuarial logic says that to cover as efficiently as possible the largest amount of insureds one
would need to differentiate between groups A and B. Referring to theory of justification this
would clearly apply the industrial logic. One can easily see that differentiation based on
industrial logic would run into difficulties when trying to make decision makers applying another
logic to accept this. As the issue is extensively analysed elsewhere5,6 I am not going to spend
more time on this here but look at the ethical case.
Jyri Liukko, Solidaarisuuskone – elämän vakuuttaminen ja vastuuajattelun muutos, Gaudeamus
Helsinki University Press, 2013
5
Traditional insurance has tried to apply easily verified and objective criteria for differentiation.
Additionally a desirable characteristic of a criterion is that the insured cannot have direct
influence on it. Criteria like gender and age are thus easily applicable and observed. Some
insurers use criteria like smoking which is much more difficult as the insured can tell he is nonsmoker and still continue smoking.
With the choice of criteria modern technology is increasingly offering new methods of
differentiation. Genetic testing has given rise to much discussion on differentiation although
currently this testing has delivered fairly limited actual techniques for insurance (and using
genetic testing in underwriting is forbidden in many jurisdictions). It is however evident that
medical technology in different forms, i.e. not only in genetic testing, will create more and more
sophisticated methods to differentiate between different risks.
6
Moral case
It is clear from the analysis above that actuaries can easily say that all differentiation in
premiums is beneficial for the society from an economical point of view.
On the other hand this would in many cases mean discrimination that would not be morally
acceptable. For example, in most cultures people would hardly be content if insurance would be
allowed to discriminate according to ethnic background.
Gender has however been an issue where differentiation has not been thought to mean
discrimination. Now its use has been prohibited in the European Union. We will look at two
ethical theories and show that based on these one can make different conclusions of the
acceptability of gender differentiation. These ethical theories are presented here only very
briefly but there are good texts available elsewhere. For a good condensed treatment the reader
6 Jyri
Liukko, Genetic discrimination, insurance, and solidarity: an analysis of the argumentation
for fair risk classification, New Genetics and Society Volume 29, Issue 4, 2010 Special
Issue: SOLIDARITY MATTERS: EMBEDDING GENETIC TECHNOLOGIES IN PRIVATE AND
SOCIAL INSURANCE ARRANGEMENTS
could consult a basic textbook7. Utilitarism has good separate treatments8,9 and also Kantian
ethics is treated extensively elsewhere10,11.
6.1
Utilitarianism
Utilitarianism is a form of consequential ethics. The general definition of consequentialism is “Of
all the things a person might do at any given moment, the morally right action is the one with the
best overall consequences”12.
Consequentialism is based on two principles:
-
Whether an act is right or wrong depends only on the results of that act
-
The more good consequences an act produces, the better or more right that act.
There are different forms of consequential ethics. The one that seems to correspond actuarial
thinking is utilitarianism. Utilitarianism states that people should maximize human welfare or
well-being.
There are utilitarian thoughts also earlier but utilitarianism as a clearly identified logic is thought
to start with Jeremy Bentham (1748 – 1832) after whom it was elaborated by John Stuart Mill
(1806-1873). In its classical form utilitarianism says that no act is inherently wrong as everything
depends on the consequences of the act. For example lying or even murder can be accepted if
the result can be thought to be beneficial. There are other problems with utilitarianism that have
resulted in other theories for example by John Rawls (1921-2002).
6.2
Kantian ethics
Kantian ethics is the result of the work of Immanuel Kant (1724-1804). It is one form of dutybased or deontological ethics. In deontological ethics some actions are wrong or right in
themselves, regardless of the consequences. Deontological ethics is sometimes called nonconsequentialist ethics just because you cannot justify an action by showing that it produces
good consequences.
7
Julia Driver, Ethics, the Fundamentals, Blackwell Publishing, 2007
Alexander, Larry and Moore, Michael, "Deontological Ethics", The Stanford Encyclopedia of
Philosophy (Winter 2012 Edition), Edward N. Zalta (ed.), URL =
<http://plato.stanford.edu/archives/win2012/entries/ethics-deontological/>
9 http://www.bbc.co.uk/ethics/introduction/consequentialism_1.shtml
10 Johnson, Robert, "Kant's Moral Philosophy", The Stanford Encyclopedia of Philosophy (Winter
2013 Edition), Edward N. Zalta (ed.), URL =
<http://plato.stanford.edu/archives/win2013/entries/kant-moral/>
11 http://www.bbc.co.uk/ethics/introduction/duty_1.shtml#top
12 Internet Encyclopedia of Philosophy, http://www.iep.utm.edu/conseque/
8
Kant thought that it is possible to develop a consistent moral system by using reason. Kant
created the so-called categorical imperative that is the core of Kantian ethics and can be
expressed in two formulations (Kant stressed that these versions are different ways of
expressing the same rule):
-
always act in such a way that you can also will that the maxim of your action should become
a universal law, and
-
act so that you treat humanity, both in your own person and that of the another, always as
an end and never merely as a means.
The first formulation can be simplified to say that always act in such a way that you would be
willing for it to become a general law that everyone else should do the same in the same
situation.
Like utilitarianism also Kantian ethics creates paradoxes but these are not essential to what
follows.
6.3
What can happen when a utilitarian discusses with a person who subscribes to Kantian ethics
One can reach different judgments based on moral assumptions. Two examples of this are in
the following.
If we start from utilitarianism (or Bentham) then our goal is the maximum of total benefit. Of a
smaller concern here is who gets the benefit. We could easily say that full differentiation in
insurance always increases the overall (financial) utility and should thus be allowed. This is so
because the maximum amount of those needing insurance cover could be actually covered with
the lowest cost. This would certainly mean that quite a few people actually needing cover
(maybe in fact those most in need) would either be excluded from the insurance pool or they
would have to pay premiums they cannot afford.
If however we start from Kantian ethics we might reach another conclusion. From Kantian ethics
we would say that all actions should be proposed as universal laws (categorical imperative).
If we can choose with our individual choices to which group, A or B, we belong, we could
conclude that discrimination is fair. If, however (as is usually the case with gender), we would
not be able to belong to both groups, our view would be different. We could not, generally and in
Kantian ethics, say to an individual in group A that he/she should accept a higher premium
because this individual could never belong to group B. Of course we could think that educated
people should accept this but it seems that already this is something we cannot generally
require.
It seems actuaries have the tendency of motivating things knowingly or unknowingly using
utilitarian ethics as the starting point (and this might not only apply to actuaries but to the whole
insurance industry motivating its existence through utilitarianism or, using the thoughts of
Boltanski and Thévenot, the industrial logic as the mode of justification). What we have seen
above is that there are other ways of looking at a single situation.
Actuaries often find it hard to understand why their logic is not accepted. Why for example such
a trivial fact is not understood that differentiation of risks is always to the benefit of everybody.
Maybe actuaries should however learn to think that utilitarianism is not the only way of looking
at things and there are valid ways of looking at things from another viewpoint. Probably that
would not make it easier for actuaries to win support to their arguments but it would at least
make the world more easily understandable.
Not all risk factors are the same. In the European Union there is now under discussion a
directive on age and disability. One can say that age is an interesting risk factor in Kantian
ethics. We can say that everyone goes through all ages so according to Kantian ethics
differentiation might still be possible. Another way of looking at this is to say that actually using
age as a risk factor is not differentiation or discrimination. This conclusion can be reached by
starting from the fact that, at least in principle, everybody as an individual goes through all
states, all ages. In this sense one can say that using age does not mean a decision of dividing
individuals to different categories. Instead, using age is just stating the fact.
We see from statistics that longevity is strongly correlated with gender. We see however also
that longevity is strongly dependent on socioeconomic factors. Socioeconomic factors have in
themselves a factor that very strongly increases mortality. This risk factor is smoking. Maybe
actuaries could find it easier to say that they think sex is important but smoking is more
important than sex. But in any case actuaries do these both things knowingly or unknowingly
subscribing to the ideas of utilitarianism.