Insurance risk pooling, loss coverage and social welfare: When is adverse selection not adverse?

Restrictions on insurance risk classification may induce adverse selection, which is usually perceived as a bad outcome, 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 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. We also reconcile the concept of loss coverage to a utilitarian concept of social welfare commonly found in economic literature. For iso-elastic insurance demand, ranking risk classification schemes by (observable) loss coverage always gives the same ordering as ranking by (unobservable) social welfare.