Discrimination

Insurance companies often discriminate on the basis of age, sex, health, and other observable characteristics. If insurance companies didn’t discriminate, then most of their market would disappear. To see this, consider a very simple example of health insurance in which two people want to buy health insurance, a healthy person and a sick person.

Table 7: Insurance

Person’s Health	Most Person Is Willing to Pay for Insurance	Cost of Insurance to Insurance Company
Healthy	$500	$400
Sick	$2,000	$1,900

This table shows how much it would cost to insure the people and what they would be willing to pay for insurance. First, notice that the insurance company should be able to make money from both customers, who are willing to pay $100 more than it would cost the insurance company to provide them with coverage. Consider what happens, however, if the insurance company can’t discriminate. If it wanted to sell to both people, it would have to charge at most $500 because that is all a healthy person would be willing to pay. If, however, the insurance company charges $500 to both, it would obviously lose money since its expenses would be far greater than $500. Consequently, the insurance company can’t profitably sell to both at the same price. If it sells at too low a price, it will lose money, and if it sells at too high a price, the healthy person won’t buy any insurance. The only way in this example that the insurance company can sell to everyone is if it discriminates and charges the sick person more.

Governments don’t like the sound of the word “discrimination,” so they often place restrictions on insurance companies’ ability to discriminate. To preserve their markets, however, insurance companies have strong incentives to get around antidiscrimination laws. Health insurance companies naturally attract the sickest people, whereas they want to sell to the healthiest. To repel sick people, insurance companies try to exclude those with preexisting conditions.