Abstract
We defend, from a contractarian perspective, that the fair price of an insurance policy is the amount that the contracting parties agree when they are both equally uncertain about the insured event. Drawing on the approach developed by R. Sugden in The Community of Advantage, we answer two standard objections raised against contractarianism in the actuarial sciences: (1) people are not wise enough to assess their actuarial risks; (2) they are not rational enough to decide which insurance policy suits them better. We show under which circumstances people can make fair actuarial agreements, without presupposing any objective risk or rationality benchmarks.
This is a preview of subscription content, log in via an institution to check access.
Similar content being viewed by others
Data availability
Not applicable.
Notes
See Heras et al. (2020) for a discussion of the origins and justification of the standard account of actuarial fairness. Throughout this paper we will speak of actuarial fairness in a broad sense that we introduce there, not to be confused with the textbook definition presented above.
For recent debates see the objections and responses compiled in the Journal of Economic Methodology (28.4, 2021) and the International Review of Economics (68.1, 2021).
We are not debating here how actuarial estimates track real risks: we think they do, but not in the same way that physics track the probability of a nucleus decay. Landes’ objection hinges about the asymmetry of knowledge between actuaries and customers, independently of whether this knowledge is based on objective risks or socially regulated models.
From a probabilistic standpoint, insurance customers would be naturally modelled as Bayesian agents forming subjective probabilities about actuarial risks. However, as we will argue below in more detail, there are few occasions for updating since customers just sign a few contracts throughout their life and rarely have access to other people’s claims. For the same reason, it is difficult to construct money pumps against their interests, so deviating from Savage axioms may not put them at excessive risk.
For an introductory overview of Domat’s work see (Iglesias, 2009). Domat’s principle is an instantiation of the doctrine of uberrima fides in Anglo-Saxon insurance law, “the customers duty to disclose facts which are material to the risk and which enable the insurer to form a rational decision whether to accept the risk and, if so, at what premium” (Achampong, 1987, p. 329).
Skogh (1999) provides a decision theoretic analysis of RPS showing that mutually beneficial risk-sharing is, indeed, possible without the assignment of a probability. If the partners assume that the risks they are confronting have the same probability, whatever it may be, they will have the right incentive to pool those risks.
Now, assuming there will be fraud, companies may protect themselves against it, raising ex ante the probability of the insured event. “Innocent” customers will pay for these overestimated risks: wouldn’t this be unfair? The problem is that it might be impossible for companies to control for the possibility of fraud in a more efficient way. Screenings or more exhaustive fraud investigation will equally raise the price. Hence, to the extent that the possibility of fraud is generally acknowledged, the overestimation of risks may be legitimate.
See https://www.nytimes.com/2020/02/21/business/medicare-advantage-retirement.html (Accessed on May 16, 2023).
For the current US debate on how to regulate this problem see: https://www.nytimes.com/2022/11/03/upshot/private-medicare-misleading-marketing.html (Accessed on May 16, 2023).
For an updated survey see: https://www.kff.org/medicare/report/beneficiary-experience-affordability-utilization-and-quality-in-medicare-advantage-and-traditional-medicare-a-review-of-the-literature/ (Accessed on May 16, 2023).
References
Ayuso, M., Guillen, M., & Nielsen, J. P. (2019). Improving automobile insurance ratemaking using telematics: Incorporating mileage and driver behaviour data. Transportation, 46(3), 735–752.
Baker, T. (1993). Constructing the insurance relationship: Sales stories, claims stories, and insurance contract damages. Texas Law Review, 72, 1395.
Baker, T. (2011). Health insurance, risk, and responsibility after the Patient Protection and Affordable Care Act. University of Pennsylvania Law Review, 159(6), 1577–1622.
Cronk, L., & Aktipis, A. (2021). Design principles for risk-pooling systems. Nature Human Behaviour, 5(7), 825–833.
Cronk, L., Berbesque, C., Conte, T., Gervais, M., Iyer, P., McCarthy, B., et al. (2019). Managing risk through cooperation: Need-based transfers and risk pooling among the societies of the Human Generosity Project. In Global perspectives on long term community resource management (pp. 41–75). Springer.
Dold, M. F., & Rizzo, M. J. (2021). The limits of opportunity-only: Context-dependence and agency in behavioral welfare economics. Journal of Economic Methodology, 28(4), 364–373.
Dong, X., Milholland, B., & Vijg, J. (2016). Evidence for a limit to human lifespan. Nature, 538(7624), 257–259.
Dowd, K., Blake, D., & Cairns, A. J. (2010). Facing up to uncertain life expectancy: The longevity fan charts. Demography, 47(1), 67–78.
Einav, L., Finkelstein, A., & Fisman, R. (2023). Risky business: Why insurance markets fail and what to do about it. Yale University Press.
Ferreira, J., Jr., & Minikel, E. (2012). Measuring per mile risk for pay-as-you-drive automobile insurance. Transportation Research Record, 2297(1), 97–103.
Guala, F. (2021). Behavioural politics: Social insurance and mutual benefit in Robert Sugden’s The Community of Advantage. International Review of Economics, 68(1), 89–100.
Hacking, I. (2001). An introduction to probability and inductive logic. Cambridge University Press.
Heras, A. J., Pradier, P.-C., & Teira, D. (2020). What was fair in actuarial fairness? History of the Human Sciences, 33(2), 91–114. https://doi.org/10.1177/0952695119856292
Kelly, M., & Nielson, N. (2006). Age as a variable in insurance pricing and risk classification. The Geneva Papers on Risk and Insurance: Issues and Practice, 31(2), 212–232.
Kiviat, B. (2019). The moral limits of predictive practices: The case of credit-based insurance scores. American Sociological Review, 84(6), 1134–1158.
Kiviat, B. (2021). Which data fairly differentiate? American views on the use of personal data in two market settings. Sociological Science, 8, 26–47.
Kvalnes, Ø. (2011). Blurred Promises: Ethical Consequences of Fine Print Policies in Insurance. Journal of Business Ethics, 103 (Suppl 1), 77–86. https://doi.org/10.1007/s10551-012-1224-7
Landes, X. (2015). How fair is actuarial fairness? Journal of Business Ethics, 128(3), 519–533. https://doi.org/10.1007/s10551-014-2120-0
Lee, R. D., & Carter, L. R. (1992). Modeling and forecasting US mortality. Journal of the American Statistical Association, 87(419), 659–671.
Lemaire, J., Park, S. C., & Wang, K. C. (2016). The use of annual mileage as a rating variable. ASTIN Bulletin: THe Journal of the IAA, 46(1), 39–69.
Lesch, W.C., Brinkmann, J. (2011). Consumer Insurance Fraud/Abuse as Co-creation and Co-responsibility: A New Paradigm. Journal of Business Ethics, 103 (Suppl 1), 17–32. https://doi.org/10.1007/s10551-012-1226-5
Skogh, G. (1999). Risk-sharing institutions for unpredictable losses. Journal of Institutional and Theoretical Economics/zeitschrift Für Die Gesamte Staatswissenschaft, 155(3), 505–515.
Sugden, R. (2018). The community of advantage. Oxford University Press.
Sugden, R. (2021). Normative economics without preferences. International Review of Economics, 68(1), 5–19.
Vaupel, J. W., Villavicencio, F., & Bergeron-Boucher, M.-P. (2021). Demographic perspectives on the rise of longevity. Proceedings of the National Academy of Sciences of USA, 118(9), e2019536118.
Acknowledgements
We are thankful to Bob Sugden for his initial encouragement, to several anonymous reviewers for their comments and to Susana Monsó and Violeta Ruiz Cuenca for helping us editing the manuscript. Teira’s research has been funded by Spanish Ministry of Science and Innovation Grants (RTI2018-097709-B-I00 and PID2021-128835NB-I00).
Author information
Authors and Affiliations
Corresponding author
Ethics declarations
Conflict of interest
No conflict of interest to report.
Ethical Approval
No human/animal research involved.
Informed Consent
No informed consent form necessary.
Additional information
Publisher's Note
Springer Nature remains neutral with regard to jurisdictional claims in published maps and institutional affiliations.
Rights and permissions
Springer Nature or its licensor (e.g. a society or other partner) holds exclusive rights to this article under a publishing agreement with the author(s) or other rightsholder(s); author self-archiving of the accepted manuscript version of this article is solely governed by the terms of such publishing agreement and applicable law.
About this article
Cite this article
Heras, A.J., Pradier, PC. & Teira, D. A Contractarian Approach to Actuarial Fairness. J Bus Ethics (2024). https://doi.org/10.1007/s10551-023-05602-x
Received:
Accepted:
Published:
DOI: https://doi.org/10.1007/s10551-023-05602-x