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

Section 3 Economic incentives in insurance markets
Table 1: Illustrative working of an insurance market with no misrepresentation
1. Standard policy 2. Policy for people
with high blood
pressure.
Number of policies written 800 200
Premium per policy £200 £400
Income from pool of policies £160,000 £80,000
Expected number of claims 2% = 16 4% = 8
Actual number of claims 2% = 16 4% = 8
Cost per claim £10,000 £10,000
Cost of claims for pool £160,000 £80,000
Economic Profit £0 £0
3.1.2 Scenario 1: Charging the full premium
However, some people fill out insurance application forms inaccurately,
despite the clear warnings of the possible consequences of doing so. Suppose
that the insurance company writes 150 for people with high blood pressure,
instead of writing 200. The shortfall is accounted for the fact that the
insurance company insures 50 people who have high blood pressure who
have misrepresented their condition. These individuals should have been
charged £400, but instead have been charged the standard policy rate of only
£200 each.
Suppose that the various categories of policy holder suffer a critical illness in
line with expectations. From the normal population, there will be 16 claims
(as before) while from the group of individuals that has disclosed high blood
pressure, there will be 6 claims. In the case of the group of individuals who
have not disclosed their existing condition of high blood pressure, there are 2
claims.
Clearly, in the absence of any legal remedy, the insurer would be forced to
pay claims from 2 individuals that should have represented or disclosed
themselves to be suffering from high blood pressure. The impact of this
would be that the insurer has suffered a significant economic loss of £10,000.
London Economics
June 2007 9