The Efficiency Effects of Categorical Discrimination in the Insurance Industry

Abstract

Recent public policy debate has focused concern on the equity di- mensions of categorical discrimination based on sex, age, or race in insurance and similar markets. We consider the efficiency effects of such discrimination and establish that costless imperfect categoriza- tion always enhances efficiency. When categorization entails a non- negligible resource cost, however, no unambiguous efficiency rank- ing of informational regimes is possible. When categorization is costless, we demonstrate that government, having no better informa- tion than market participants, can effect redistribution without as- suming dictatorial control of the market, implying that a market equilibrium with costless categorization is potentially Pareto superior to one without it. When categorization is costly, however, the market may categorize when Pareto improvements are not possible.