Risk Classification and Health Insurance

Risk classification refers to the use of observable characteristics by insurers to group individuals with similar expected claims, compute the corresponding premiums, and thereby reduce asymmetric information. With perfect risk classification, premiums fully reflect the expected cost associated with each class of risk characteristics and yield efficient outcomes. In the health sector, risk classification is also subject to concerns about social equity and potential discrimination. We present an analytical framework that illustrates the potential trade-off between efficient insurance provision and social equity. We also review empirical studies on risk classification and residual asymmetric information that inform this trade-off.