Misrepresentation, Non-Disclosure and Breach ... - Law Commission

Section 3 Economic incentives in insurance markets
3 Economic incentives in insurance
markets
Before presenting information on the size and coverage of various insurance
markets and the incidence of claims remaining unpaid for reasons of nondisclosure
and misrepresentation, it is important to understand some of the
economic incentives that consumers and firms may face. We present some
information and illustrative examples of how markets may operate when
non-disclosure and misrepresentation occur (in a stylized or theoretical sense)
and the potential remedies that might be available.
3.1 Comparing different remedies: an
illustration
To illustrate the effect of different remedies it may be helpful to provide a
simple example with some alternative scenarios to illustrate alternative
outcomes. The aim is to find the remedy that would most satisfactorily
compensate the insurer for any loss it has suffered as a result of a consumer’s
failure to give accurate pre-contractual information.
3.1.1 Baseline Case
Insurer A issues life insurance policies to 1,000 people. It has good claims
data, and is able to assess accurately the risks and payments involved. Of the
1,000 people insured, 800 are in normal health while the remaining 200 have
high blood pressure. The insurance company knows that among its
population of insureds, the risk of death for those with normal health is 2 in
100.
From this group of individuals, the insurance company therefore anticipates
receiving two claims for every hundred policies. If we assume that each claim
involves a payment of £10,000 and that the underwriting costs exactly cover
the expected claims to be paid, this implies that the cost to the consumer of
each policy is £200 3.
Insurer A also knows that 20% of its pool of individuals suffers from high
blood pressure. For this group, the risk of death is double that of a person
with normal health – at 4 in 100. As the cost per claim is the same (£10,000),
the appropriate underwriting premium for this group of policyholders is £400
each.
If the outcomes of the insured are as expected, and the insurer knew who
suffered from high blood pressure and who did not, the profile of its 1,000
policies will be represented in the Table overleaf:
3 The insurer also adds a mark-up for sales, administration, and profit, but for the purposes of this
illustration, we are only concerned with the premium necessary to cover the anticipated claims.
London Economics
June 2007 8