Making Economic Sense Out of Unisex Life Insurance (or the Difference between Cost and Value and Why it Matters to Real People)

In this piece, I take issue with one of the fundamental tenets of law and economics as it has been used to justify gender discrimination in the pricing of life insurance and annuities, namely, that individuals should bear their own identifiable costs so as to avoid misallocation of society's resources. Most scholars of the law and economics persuasion have argued that unisex pricing of life insurance products is a bad idea because on the average women live longer than men. They argue that it costs more to insure the life of a man because the payoff comes sooner and the present value is greater. Thus, to charge men and women the same price for life insurance would constitute a subsidy running from women (who would pay too much) to men (who would pay too little). As a result, men would buy too much insurance and women would buy too little. Using a simple example, I show here that gender-based pricing results in radically different outcomes for male and female consumers if one focuses on income rather than present value. Gender-based pricing means that a man must set aside more from his pay during life in order to secure the same insurance benefits as a woman. And a woman who uses the proceeds to buy an annuity must suffer lower benefits for a longer time than a man. In short, if one looks either at the periodic outlay by the insured or at the income available to the beneficiary under an annuity, gender-based pricing appears to be quite at odds with the reasons why people buy insurance and how much they buy. Perhaps more important, in the absence of market failure, men and women would bargain around gender-based rates (and in many cases they effectively do so), which suggests that it is gender-based rates that result in the misallocation of resources. The problem with gender-based rates lies in two unstated premises: (1) that the present value of lump sum insurance benefits is an accurate measure of value to a consumer, and (2) that unisex pricing will cause consumers to buy more or less insurance or annuities than under gender-based pricing. Most people buy insurance with a view to the income it will generate for the beneficiary. Clearly, people buy annuities to provide themselves income. In both cases, the value of the product inheres in the periodic income it generates and not the length of time over which that income will be received. Indeed, the very existence of annuities proves the point. Annuities exist only because many people are willing to trade a lump sum for an assured income. In other words, the essential idea behind an annuity is that people care more about income than about lump sum values. Thus, even though the present value of a man's death benefit is higher than a woman's death benefit because it will likely be paid sooner, what matters most to the consumer is the income it will generate for the beneficiary. This difference in perspectives is critical. Insurance companies live forever. People do not. Hence, although the cost of writing insurance and annuities quite rightly concerns the insurance company, it has nothing to do with the value perceived by the insured. Thus, because it is value and not cost that motivates someone to buy something, the idea that there is a subsidy implicit in unisex insurance rates is mistaken. For the consumer, the purpose of life insurance and annuities is to hedge against the risk that one will die early or late. The present value of the benefits is irrelevant. In addition, the most important factor that determines the amount of insurance one will buy is the amount one can spend up to the point of adequate coverage. Thereafter, it is unlikely that cheaper insurance will induce people to buy more. Insurance is a hedge, not a bet. And it makes no sense to hedge more risk than you have.