Having known that information asymmetry is compounded by adverse selection and m

Question

Having known that information asymmetry is compounded by adverse selection and moral hazard, as an insurance analyst for a car insurance company, you need to set up a premiumdeductible structure that will help identify the type of customers that are likely to make frequent claims. Speak directly to your employees and explain how you would set up the two-tier pricing model.

a. Indicate to your employees how you would set up this structure with a specific example.

b. Would it be ethical to charge potential “frequent abusers” a higher fee structure? Please justify your reasoning based on ethical perspectives.

c. Explain to your employees the process you would follow and how this would affect the financial bottom line of the company.

Explanation / Answer

a. The frequent claimants should be identified through a comprehensive and systematic observation and analysis exercise. It should be identified on their previous records and critically examining the circumstance prevalant at that time. As this will surely offend the customer in case, the company should be ready to bear the risk of losing this customer. An example is an offender on an e commerce site who orders expensive garments for fun and returns them after few days, taking advantage of company's return policies. He /she can be observed minutely to come to a conclusion that the behaviour relates to the mindset of the customer and not related to the facts like quality, unsuitability, difference from the description or any such other factors responsible for return. Similarly,a person who has been booked for rash driving on several occasions is morelikely to be involved in an accident and hence should be charged more

2. The discrimination between customers is not an ethical practice,as there may be genuine reasons behind their behavior, which can be given the benefit of doubt. However, the incidents where the customer's behavior is too risky to prevent him /her from being damages and subsequent claims are sure and certain, imposition of differential premium is essential for feasibility of operations.

3 The differential charging may cause the loss of few customers, causing loss of business in some cases, but in majority of cases, the higher premium will make for the higher probability of claims by such vulnerable groups and improve the bottom line of the company.

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