Loss Coverage: Why Insurance Works Better with Some Adverse Selection

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.