The Efficiency Effects of Categorical Discrimination in the Insurance Industry

Recent public policy debate has focused concern on the equity dimensions 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 categorization always enhances efficiency. When categorization entails a non-negligible resource cost, however, no unambiguous efficiency ranking of informational regimes is possible. When categorization is costless, we demonstrate that government, having no better information than market participants, can effect redistribution without assuming 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.