Hao, M., Macdonald, A., Tapadar, P. and Thomas, R. (2019). Insurance loss coverage and social welfare. Scandinavian Actuarial Journal [Online] 2019:113-128. Available at: https://doi.org/10.1080/03461238.2018.1513865.
Restrictions on insurance risk classification may induce adverse selection, which is usually perceived as a bad outcome, both for insurers and for society. However, a social benefit of modest adverse selection is that it can lead to an increase in `loss coverage', defined as expected losses compensated by insurance for the whole population. We reconcile the concept of loss coverage to a utilitarian concept of social welfare commonly found in economic literature on risk classification. For iso-elastic insurance demand, ranking risk classification schemes by (observable) loss coverage always gives the same ordering as ranking by (unobservable) social welfare.
Thomas, R. (2018). Why insurers are wrong about adverse selection. Laws [Online]. Available at: http://dx.doi.org/10.3390/laws7020013.
Insurers typically argue that regulatory limits on their ability to use genetic tests will induce ‘adverse selection’; they say that this has disadvantages not just for insurers, but also for society as a whole. I argue that, even on its own terms, this argument is often flawed. From the viewpoint of society as a whole, not all adverse selection is adverse. Limits on genetic discrimination that induce the right amount of adverse selection (but not too much adverse selection) can increase ‘loss coverage’, and so make insurance work better for society as a whole.
Hao, M., Macdonald, A., Tapadar, P. and Thomas, R. (2018). Insurance loss coverage and demand elasticities. Insurance: Mathematics and Economics [Online] 79:15-25. Available at: https://doi.org/10.1016/j.insmatheco.2017.12.002.
Restrictions on insurance risk classification may induce adverse selection, which is usually perceived as a bad outcome. We suggest a counter-argument to this perception in circumstances where modest levels of adverse selection lead to an increase in `loss coverage', defined as expected losses compensated by insurance for the whole population. This happens if the shift in coverage towards higher risks under adverse selection more than offsets the fall in number of individuals insured. The possibility of this outcome depends on insurance demand elasticities for higher and lower risks. We state elasticity conditions which ensure that for any downward-sloping insurance demand functions, loss coverage when all risks are pooled at a common price is higher than under fully risk-differentiated prices. Empirical evidence suggests that these conditions may be realistic for some insurance markets.
Tapadar, P. and Thomas, R. (2017). Why insurance works better with some adverse selection. The Actuary India [Online] 9:17-17. Available at: http://www.actuariesindia.org/downloads/souvenir/2017/ActuaryIndiaJuly2017.pdf.
Tapadar, P. and Thomas, R. (2017). Appetite for selection. The Actuary - The magazine of the Institute & Faculty of Actuaries [Online]:18-19. Available at: http://www.theactuary.com/features/2017/05/appetite-for-adverse-selection/.
Hao, M., Macdonald, A., Tapadar, P. and Thomas, R. (2016). Insurance loss coverage under restricted risk classification: The case of iso-elastic demand. ASTIN Bulletin [Online] 46:265-291. Available at: http://dx.doi.org/10.1017/asb.2016.6.
This paper investigates equilibrium in an insurance market where risk classification is restricted. Insurance demand is characterised by an iso-elastic function with a single elasticity parameter. We characterise the equilibrium by three quantities: equilibrium premium; level of adverse selection (in the economist’s sense); and “loss coverage”, defined as the expected population losses compensated by insurance. We consider both equal elasticities for high and low risk-groups, and then different elasticities. In the equal elasticities case, adverse selection is always higher under pooling than under risk-differentiated premiums, while loss coverage first increases and then decreases with demand elasticity. We argue that loss coverage represents the efficacy of insurance for the whole population; and therefore that if demand elasticity is sufficiently low, adverse selection is not always a bad thing.
Thomas, R. (2012). Non-risk price discrimination in insurance: market outcomes and public policy. Geneva Papers on Risk and Insurance - Issues and Practice [Online] 37:27-46. Available at: http://dx.doi.org/10.1057/gpp.2011.32.
This paper considers price discrimination in insurance, defined as systematic price variations based on individual customer data but unrelated to those customers’ expected losses or other marginal costs (sometimes characterised as “price optimisation”). An analysis is given of one type of price discrimination, “inertia pricing,” where renewal prices are higher than prices for risk-equivalent new customers. The analysis suggests that the practice intensifies competition, leading to lower aggregate industry profits; customers in aggregate pay lower prices, but not all customers are better off; and the high level of switching between insurers is inefficient for society as a whole. Other forms of price discrimination may be more likely to increase aggregate industry profits. Some public policy issues relating to price discrimination in insurance are outlined, and possible policy responses by regulators are considered. It is suggested that competition will tend to lead to increased price discrimination over time, and that this may undermine public acceptance of traditional justifications for risk-related pricing.
Thomas, R. (2012). Genetics and insurance in the United Kingdom 1995-2010: the rise and fall of scientific discrimination. New Genetics and Society [Online] 31:203-222. Available at: http://dx.doi.org/10.1080/14636778.2012.662046.
Around the millennium there was extensive debate in the United Kingdom of the possible use of predictive genetic tests by insurance companies. Many insurance experts, geneticists and public policymakers appeared to believe that genetic test results would soon become widely used by the insurance industry. This expectation has not been borne out. This article outlines the history of exaggerated perceptions of the significance of genetic test results to insurance, with particular reference to the United Kingdom, suggesting reasons why they arose and also why they have declined. The article concludes with some speculation about how policy on genetics and insurance might develop in future.
Thomas, R. (2009). Demand elasticity, risk classification and loss coverage: when can community rating work?. ASTIN Bulletin [Online] 39:403-428. Available at: http://dx.doi.org/10.2143/AST.39.2.2044641.
This paper investigates the effects of high or low fair-premium demand elasticity in an insurance market where risk classification is restricted. High fair-premium demand elasticity leads to a collapse in loss coverage, with an equilibrium premium close to the risk of the higher risk population. Low fair-premium demand elasticity leads to an equilibrium premium close to the risk of the lower risk population, and high loss coverage – possibly higher than under more complete risk classification. The elasticity parameters which are required to generate a collapse in coverage in the model in this paper appear higher than the values for demand elasticity which have been estimated in several empirical studies of various insurance markets. This offers a possible explanation of why some insurance markets appear to operate reasonably well under community rating, without the collapse in coverage which insurance folklore suggests.
Thomas, R. (2008). Loss Coverage as a Public Policy Objective for Risk Classification Schemes. Journal of Risk and Insurance [Online] 75:997-1018. Available at: http://dx.doi.org/10.1111/j.1539-6975.2008.00294.x.
This article suggests that from a public policy perspective, some degree of adverse selection may be desirable in some insurance markets. The article suggests that a public policymaker should consider the criterion of "loss coverage," and that in some markets a policymaker may wish to regulate risk classification with a view to increasing loss coverage. Either too much or too little risk classification may reduce loss coverage. The concept is explored by means of examples and formulaic and graphical interpretations. An application to the UK life insurance market is considered.
Thomas, R. (2008). Taxable and tax-advantaged portfolio management for UK personal investors. British Tax Review 2008:34-55.
This article makes some observations on the interaction of UK taxation and portfolio decisions by a personal investor managing his own investments in quoted company shares. Three holding vehicles are considered: two types of tax-advantaged account (ISAs and SIPPs), and taxable holdings registered directly in the investor’s own name or a nominee (personal account). Some observations are made on ways in which portfolio management of a taxable account differs from management of a tax-advantaged account. Simple models are used to illustrate the dif?culty of producing post-tax out-performance from active management of a taxable account. Guidelines are suggested for the type of investment to be allocated to each type of account, for turnover in each type of account, and for decisions on switching between investments held in a taxable account.
Thomas, R. (2007). Some novel perspectives on risk classification. Geneva Papers on Risk and Insurance - Issues and Practice [Online] 32:105-132. Available at: http://dx.doi.org/10.1057/palgrave.gpp.2510118.
This paper considers a number of novel perspectives on risk classification, primarily in the context of life and critical illness insurance. I suggest that the terminology of "adverse selection" is often misleading, because from a public policy viewpoint, adverse selection may not always be adverse. I suggest that public policymakers should consider the criterion of "loss coverage", and that in many markets a socially optimal level of adverse selection is that which maximises loss coverage. A review of empirical studies suggests that adverse selection is often difficult to observe in practice; this leads to the concept of propitious selection, and various psychological perspectives on risk classification. I suggest that competition between insurers in risk classification can sometimes be characterised as a malevolent invisible hand, and that public policy should direct competition towards areas that are more clearly beneficial to all insurance customers. I also consider the perspectives of risk classification as blame, the conflict between risk classification and human rights, and the fallacy of the one-shot gambler.
Whitten, S. and Thomas, R. (1999). A non-linear stochastic asset model for actuarial use. British Actuarial Journal [Online] 5:919-953. Available at: http://dx.doi.org/10.1017/S1357321700000751.
This paper reviews the stochastic asset model described in Wilkie (1995) and previous work on refining this model. The paper then considers the application of non-linear modelling to investment series, considering both ARCH techniques and threshold modelling. The paper suggests a threshold autoregressive (TAR) system as a useful progression from the Wilkie (1995) model. The authors are making available (by email, on request) a collection of spreadsheets, which they have used to simulate the stochastic asset models which are considered in this paper.
Thomas, R. and Smith, A. (1998). Positive theory and actuarial practice. The Actuary [Online] 1998:16-17. Available at: http://www.theactuary.com.
In recent months, the actuarial profession has seen a debate about how financial theory
ought to be developed and applied. This has been essentially a normative, philosophical
exercise, imposing a view of how actuarial practice should progress. In this article we
outline an alternative approach to understanding and explaining actuarial practice. The
approach is positive rather than normative: it observes actuarial practice and the theories
on which it is based and seeks to explain why these practices and theories prevail, rather
than offering prescriptions for theories which should prevail.
Moultrie, T. and Thomas, R. (1997). The right to underwrite? An actuarial perspective with a difference. Journal of Actuarial Practice [Online] 5:125-146. Available at: http://www.jofap.org/documents/vol5/v5_moultrie.pdf.
For a very long time, underwriting has formed part of the actuarial canon. With increasing frequency, challenges are being issued against the right of insurance companies to underwrite their applications for new business, arguing that certain aspects of the practice are undesirably discriminatory. This paper explores the role of the actuary in the underwriting process, and the challenges that are being set for the profession (as opposed to the life insurance industry) as a result of this role.
Thomas, R. (1996). Indemnities for long-term price risk in the UK housing market. Journal of Property Finance [Online] 7:38-52. Available at: http://dx.doi.org/10.1108/09588689610127145.
Discusses the features which distinguish the market for residential property from the markets for other assets. Proposes that financial institutions should offer house buyers indemnity policies which pay out an amount related to any fall in the level of a general index of house prices, on the sale of the house at a loss at any time during the mortgage term. To facilitate hedging the risk of a portfolio of such policies (and therefore, the pricing of the policies), a market in 'perpetual futures' on indices of housing assets is proposed. Discuss possible users of these contracts, and outlines further research.
Thomas, R. (1994). Untitled. Statistician 43:595-596.
Tapadar, P. and Thomas, R. (2018). Why insurance works better with some adverse selection. In: International Congress of Actuaries.
Regulatory restrictions on insurance risk classification are a common feature of personal insurance markets. Whilst such
restrictions appear motivated by social objectives, they may also induce adverse selection. This is usually perceived as a
disadvantage, both for insurers and for society. We suggest a counter-argument to this perception in circumstances where
modest levels of adverse selection lead to an increase in ‘loss coverage’, defined as expected losses compensated by
insurance for society as a whole. This happens if the shift in coverage towards higher risks more than offsets the fall in
number of individuals insured.
The possibility of this outcome depends on insurance demand elasticities for higher and lower risks. We state elasticity
conditions which ensure that for any downward-sloping insurance demand functions, loss coverage when all risks are pooled
at a common price is higher than under fully risk-differentiated prices. We also discuss some empirical evidence on
insurance demand elasticities, and some limitations of the loss coverage concept. For a more discursive treatment, see our
recent book Thomas (2017) and papers (Hao et al. (2016, 2016a, 2016b)).
Thomas, R. (2017). Loss Coverage: Why Insurance Works Better with Some Adverse Selection. In: Actuarial Teachers and Researchers Conference. Available at: https://blogs.kent.ac.uk/atrc/files/2017/07/1.10-Guy.pdf.
Insurers typically argue that regulatory limits on risk classification will induce ‘adverse selection’; they say that this has disadvantages not just for insurers, but also for society as a whole. I argue that even on its own terms, this argument is often flawed. From the viewpoint of society as a whole, not all adverse selection is adverse. Limits on risk classification which induce the right amount of adverse selection (but not too much adverse selection) can increase ‘loss coverage’, and so make insurance work better for society as a whole.
Hao, M., Tapadar, P. and Thomas, R. (2015). Loss coverage in insurance markets: why adverse selection is not always a bad thing. In: International Actuarial Association Colloquium. Available at: http://www.actuaries.org/oslo2015/papers/IAALS-Hao&Tapadar&Thomas.pdf.
This paper investigates equilibrium in an insurance market where risk classification is restricted. Insurance demand is characterised by an iso-elastic function with a single elasticity
parameter. We characterise the equilibrium by three quantities: equilibrium premium; level of adverse selection; and “loss coverage”, defined as the expected population losses compensated
by insurance. We find that equilibrium premium and adverse selection increase monotonically with demand elasticity, but loss coverage first increases and then decreases. We argue that
loss coverage represents the efficacy of insurance for the whole population; and therefore, if demand elasticity is sufficiently low, adverse selection is not always a bad thing.
Thomas, R. (2001). Genetics and insurance: an actuarial perspective with a difference. In: 27th International Congress of Actuaries. Available at: https://www.actuaires.org/EVENTS/Congresses/Cancun/ica2002_subject/life/life_89_thomas.pdf.
This paper is based on a submission which I made to a public consultation by the Human Genetics Commission in the United Kingdom in 2001. Many individuals organisations. Many individuals or organisations capable of commenting technically on insurance discrimination have a commercial interest in promoting such discrimination. Technical expertise is therefore directed to the promotion of discrimination for commercial ends, but little technical expertise is applied to counteract it. This paper to the Human Genetics Commission attempts to redress the balance. Its central section comprises a point-by-point rebuttal of some of the myths and half-truths which are promulgated by those wishing to legitimise insurers' access to genetic test results.
Thomas, R. (1998). Actuarial values. In: 26th International Congress of Actuaries. Glasgow, UK: Institute and Faculty of Actuaries, pp. 95-110.
This paper seeks to identify the characteristic values implicit in contemporary actuarial
thought and practice. ‘Values’ is used here to mean fundamental concepts which we
use, largely intuitively, to guide our patterns of thought and behaviour. We consider to
what extent these values are characteristic simply because actuarial work attracts
individuals who already subscribe to them, and to what extent these values may be
inculcated by actuarial training. We then consider whether the characteristic values we
have identified are congruent with the changing values of wider society, and whether
they are likely to be conducive to the continuing success of the profession in the 21st
Thomas, R. (2017). Loss Coverage: Why Insurance Works Better With Some Adverse Selection. [Online]. Cambridge, UK: Cambridge University Press. Available at: https://doi.org/10.1017/9781316178843.
Most academic and policy commentary represents adverse selection as a severe problem in insurance, which should always be deprecated, avoided or minimised. This book gives a contrary view. It details the exaggeration of adverse selection in insurers' rhetoric and insurance economics, and presents evidence that in many insurance markets, adverse selection is weaker than most commentators suggest. A novel arithmetical argument shows that from a public policy perspective, 'weak' adverse selection can be a good thing. This is because a degree of adverse selection is needed to maximise 'loss coverage', the expected fraction of the population's losses which is compensated by insurance.
This book will be valuable for those interested in public policy arguments about insurance and discrimination: academics (in economics, law and social policy), policymakers, actuaries, underwriters, disability activists, geneticists and other medical professionals.
Thomas, R. (2012). Hur Tolv Privata Investerare Blivit Rika På Aktier. Stockholm: Lind & Co.
Många drömmer om att bli rika på aktier men få lyckas. Vad är hemligheten?
I den här boken porträtteras tolv personer som alla skapat sig en betydande förmögenhet på aktiemarknaden. Gemensamt för samtliga är att de en gång haft en vanlig anställning men vid något tillfälle bestämt sig för att på heltid ägna sig åt privata investeringar. Övriga förutsättningar har skiftat - några av de tolv har akademisk examen och erfarenhet av finansvärlden, andra lämnade skolan tidigt och är helt självlärda. Några har drömt om att bli professionella investerare, för andra har arbetslöshet och sjukdom lett in dem på aktieaffärer. Men alla tolv har lyckats.
Boken tar även upp andra, mer kända aktieinvesterare, bland andra politikern John Lee som varit minister i Margaret Thatchers regering och den svenske finansmannen Peter Gyllenhammar.
Som läsare bjuds man bland annat på insikter om olika investeringsstrategier. Vissa lägger större delen av sitt kapital i ett mindre antal bolag och behåller innehaven under många år, medans andra omsätter sitt kapital flera gångar om dagen. Några investerare är nätverkare som går på bolagsstämmor och håller nära kontakt med de företag de köper aktier i, andra fattar sina beslut utifrån tekniska analyser eller allmän finansinformation.
Även om boken innehåller en del avancerade resonemang och tips är det inte någon tekniskt komplicerad text. Den förmedlar insikter och avslöjar praktiska kunskaper som kan inspirera såväl nybörjare som luttrade finanshajar.
Thomas, R. (2011). Free Capital: How 12 Private Investors Made Millions in the Stock Market. [Online]. Harriman House. Available at: http://www.harriman-house.com/products/books/450474/investing/free-capital.
Wouldn't life be better if you were free of the daily grind - the conventional job and boss - and instead succeeded or failed purely on the merits of your own investment choices? Free Capital is a window into this world.
Based on a series of interviews, it outlines the investing strategies, wisdom and lifestyles of 12 highly successful private investors. Each of them has accumulated £1m or more - in most cases considerably more - mainly from stock market investment. Six are 'ISA millionaires' who have £1m or more in a tax-free ISA, a result which is arithmetically impossible without exceptional investment returns.
Some have several academic degrees or strong City backgrounds; others left school with few qualifications and are entirely self-taught as investors. Some invest most of their money in very few shares and hold them for years at a time; others make dozens of trades every day, and hold them for at most a few hours. Some are inveterate networkers, who spend their day talking to managers at companies in which they invest; for others a share is just a symbol on a screen, and a price chart shows most of what they need to know to make their trading decisions.
Free capital - money surplus to immediate living expenses - is the raw material with which these investors work. It can also be thought of as their psychological habitat, free from the petty tribulations of office politics. Lastly, free capital describes the footloose nature of their assets, which can be quickly redirected towards any type of investment anywhere in the world, without the constraints which institutional investors often face.
Although it presents many advanced insights and valuable investment hints, this is not an overly technical book. It offers practical ideas and inspiration, with revealing detail and minimal jargon, making it an indispensable read for novice and experienced investors alike.
Hao, M. (2017). Insurance Loss Coverage under Restricted Risk Classification.
Insurers hope to make profit through pooling policies from a large number of individuals. Unless the risk in question is similar for all potential customers, an insurer is exposed to the possibility of adverse selection by attracting only high-risk individuals. To counter this, insurers have traditionally employed underwriting principles, identifying suitable risk factors to subdivide their potential customers into homogeneous risk groups, based on which risk-related premiums can be charged.
In reality, however, insurers may not have all the information reflecting individuals' risks due to information asymmetry or restrictions on using certain risk factors by regulators. In either case, conventional wisdom suggests that the absence of risk classification in an insurance market is likely to lead to a vicious circle: increasing premium with the prime aim to recover losses from over-subscription by high risks would lead to more low risks dropping out of the market; and eventually leading to a collapse of the whole insurance system, i.e. an adverse selection spiral. However, this concept is difficult to reconcile with the successful operation of many insurance markets, even in the presence of some restrictions on risk classification by regulators.
Theoretical analysis of polices under asymmetric information began in the 1960s and 1970s (Arrow (1963), Pauly (1974), Rothschild & Stiglitz (1976)), by which time the adverse consequences of information asymmetry had already been widely accepted. However, empirical test results of its presence are mixed and varied by markets.
Arguably from society's viewpoint, the high risks are those who most need insurance. That is, if the social purpose of insurance is to compensate the population's losses, then insuring high risks contributes more to this purpose than insuring low risks. In this case, restriction on risk classification may be reasonable, otherwise premium for high risks would be too high to be affordable. Thus, the traditional insurers' risk classification practices might be considered as contrary to this social purpose.
To highlight this issue, ''loss coverage'' was introduced in Thomas (2008) as the expected population losses compensated by insurance. A higher loss coverage indicates that a higher proportion of the population's expected losses can be compensated by insurance. This might be a good result for the population as a whole. A corollary of this concept is that, from a public policy perspective, adverse selection might not always be a bad thing. The author argued that a moderate degree of adverse selection could be negated by the positive influence of loss coverage. Therefore, when analysing the impact of restricting insurance risk classification, loss coverage might be a better measure than adverse selection.
In this thesis, we model the outcome in an insurance market where a pooled premium is charged as a result of an absence of risk-classification. The outcome is characterised by four quantities: equilibrium premium, adverse selection, loss coverage and social welfare. Social welfare is defined as the total expected utility of individuals (including those who buy insurance and those who do not buy insurance) at a given premium. Using a general family of demand functions (of which iso-elastic demand and negative-exponential demand are examples) with a non-decreasing demand elasticity function with respect to premium, we first analyse the case when low and high risk-groups have the same constant demand elasticity. Then we generalise the results to the case where demand elasticities could be different.
In general, equilibrium premium and adverse selection increase monotonically with demand elasticity, but loss coverage first increases and then decreases. The results are consistent with the ideas proposed by Thomas (2008, 2009) that loss coverage will be increased if a moderate degree of adverse selection is tolerated. Furthermore, we are able to show that, for iso-elastic demand with equal demand elasticities for high and low risks, social welfare moves in the same direction as loss coverage, i.e. social welfare at pooled premium is higher than at risk-differentiated premiums, when demand elasticity is less than 1. Therefore, we argue that loss coverage may be a better measure than adverse selection to quantify the impact of risk classification scheme being restricted. Moreover, (observable) loss coverage could also be a useful proxy for social welfare, which depends on unobservable utility functions. Therefore, adverse election is not always a bad thing, if demand elasticity is sufficiently low.
The research findings should add to the wider public policy debate on these issues and provide necessary research insights for informed decision making by actuaries, regulators, policyholders, insurers, policy-makers, capital providers and other stakeholders.