Regulatory Adverse Selection in the Life Insurance Market

Abstract

This paper is concerned with the effects of regulations that prohibit the use of information to risk-rate premiums in a life insurance market. In particular, new information derived from genetic tests is likely to become very relevant in the near to medium term future. Many governments have prohibited the use of this information in ratemaking, thereby generating regulatory adverse selection. In our model, individuals early in their lives neither know their desired level of life insurance later in life nor their mortality risk, but learn both over time. We obtain both positive and normative results which differ qualitatively from those obtained in standard, static models. In particular, we show that legislation prohibiting the use of results from genetic screening tests for ratemaking purposes in the life insurance market may increase welfare.