On the 1st March the European Court of Justice (Case C-236/09) handed down its judgment prohibiting insurers from using gender as a factor in rating insurance products. The prohibition comes into effect from 21st December 2012. The judgment will have far reaching consequences. For example the Guardian estimates that in some cases young men may see their motor premiums decrease by 25 per cent and some young women may see their premiums increase by 60 per cent. The judgment is of course not binding in South Africa.
The issue of gender rating and discrimination is not new, not even in Europe, nor is this the first time that this matter has been before courts. For example in the Canadian case of Zurich Insurance Company v Ontario (Human Rights Commission) 1992 93 DLR 4th 346 SC a single twenty year old male complained that he was discriminated against because he had to pay insurance rates which exceeded the rates paid by women. He alleged he was discriminated against on the basis of age, gender and marital status. The Court by a majority of five judges to two ruled in favour or the insurance company. There is no discrimination where rates are set according to objective statistical evidence. This was also the position in Europe in terms of Article 5 of Directive 2004/113, especially 5(2). It is this directive which the European Court of Justice declared to be invalid when it expires on the 21st December 2012. The Article may not be re-promulgated.
The problem with this new European Court position is that lawyers have a very childlike understanding of discrimination. To them merely to charge different premiums to boys and girls is discrimination. This is neither insightful nor profound. To them justice is achieved by treating everyone equally, a very Marxist proposition. Like almost all Marxist propositions it is clearly flawed. As far back at the Greeks it was pointed out injustice results when unequals are treated as equals. Forcing the same premiums causes injustice.
For a clearer understanding of the matter it is to the economists we must turn. The childlike view of lawyers is of little assistance.
Adam Smith’s lowest price for insurance (1776)
The father of modern economics was Adam Smith. In his famous book the Wealth of Nations (1776), he pointed out that the person who pays no more than the cost of claims and expenses of handling insurance ‘pays no more than the real value of the risk, or the lowest price at which he can reasonably expect to insure it’. Adam Smith over two hundred years ago correctly articulated the fundamental principle of insurance pricing.
Rothschild and Stiglitz information theory of insurance (1976)
How then is insurance arranged to achieve Adam Smith’s lowest price; that each person pays for their own real value of risk and no more? The answer to that question had to wait 200 years. It was answered in 1976 by two economists Rothschild and Stiglitz. Stiglitz subsequently received the Nobel Prize in economics. The lowest price is achieved when insurance is sold in the free market. Start with the assumption that unequal risks, men and women motorists, are insured in a single risk pool. In this event women will be subsidizing men and to a very significant extent, in some cases by paying 60 per cent more for insurance. This is a state of inequality. Insurers which have access to the statistics will realize that women are overcharged and see in this a business opportunity. A new insurance product will evolve in the free market offering women the correct price, Adam Smith’s lowest price. The women who are overcharged will then leave the combined pool and move to the correctly rated, risk segregated pool. Without the cross-subsidization from women, the premiums of the combined pool will rise to its correct level and in the end two correctly priced pools will exist. The free market costlessly correctly prices insurance products. By the same token if men are in fact being overcharged, a product will evolve offering them a reduced price. Neither men nor women can be overcharged in a free market. If men are paying higher premiums it is because of their claims history. Individuals within each pool also pay different premiums because of the no-claim bonus system.
In South Africa we have seen the market segregation phenomenon work a number of times. This is very interesting because when I lecture this aspect of the theory it is useful to show how theory and practice complement each other. Insurance for women has evolved as predicted because of women’s lower claims experience. It will be recalled, as another example, when AIDS first made its appearance insurers wished to correctly rate the risk and once again a lobby arose attempting to force cross-subsidization (ie inequality). They tried to force this inequality by prohibiting testing for AIDS. The market then evolved so that those who did not have AIDS were happy to reveal their status and thus be correctly rated.
Gary Becker’s economics of discrimination
Gary Becker, another Nobel Prize winner did a great deal of work on the economics of discrimination. Discrimination like other economic phenomena can be measured and expressed in monetary terms. A person is discriminated against when that person is paying a price in excess of what that person should be paying. The measure of discrimination is the difference in the price. The price of insurance should be Adam Smith’s price. This is the price set by the free competitive market. Girls, if forced to pay the same price as boys, are thus subject to discrimination, to the extent of 60 per cent of the price. Thus discrimination does not occur merely because boys and girls pay different premiums. It occurs when someone is forced to pay more than they should. The consequence of the European judgment is not to abolish discrimination but to introduce it.
Masakhane Tax
The additional amount that women will be forced to pay, can, like all forced payments be seen to be for what it is. It is a tax. Once it is realized what is happening, it should be clear that it is becoming common to use state power to impose additional amounts on some to subsidize others. This has become so common in South Africa, that I decided this form of tax needed a name. I have named it the Masakhane Tax. It will be recalled that while the ANC was angling for power it encouraged and enforced a boycott against the payment of service fees to local authorities. Once it got into power if of course wanted money and tried to get the resumption of payment of service fees. To achieve this it launched Operation Masakhane with was a failure. But the ANC still needed the money, so it increased the fees of those who do pay to cover the costs of services used by those who do not pay. The paying consumers paid additional amounts to cover the cost of those who did not pay. This additional amount is what I have called the Masakhane Tax. The failure of Operation Masakhane gave birth to the Masakhane Tax. It will be recalled right at the beginning the local government rates and taxes in some areas were increased by 400 per cent to produce an income to pay for areas which were not paying. The Masakhane Tax can be substantial, far in excess of VAT.
South Africa has long since exceeded its maximum taxing capacity so the Masakhane Tax increasing is being used. Take schools. The government says everyone has a constitutional right to be educated. Therefore pupils may not be expelled from schools for non-payment of fees. The government does nothing about students who cannot afford the fees. The net practical result is that parents who are paying for their children are forced to pay an additional amount for those who cannot afford to pay. This additional amount is the Masakhane Tax. The same approach was used with the provision of free water. The government did not subsidize the free water. Those who pay for water pay an additional amount, the Masakhane Tax for those who get the free water. It is easy to show that the same thing is happening with medical aid schemes. The same thing is happening with municipal costs such as electricity and water. Every year billions are written of for those who do not pay. The additional cost on those who do pay is yet another example of the Masakhane Tax. Municipal fees increase with usage. This is contrary to reality. Average costs decrease with usage. The higher increasing price is to fund the Masakhane Tax.
It should be clear that in South Africa the Masakhane Tax is widespread. It is also a great money-spinner for the government. Vat is charged on the price including the additional amounts. So it produces an increased income stream for the government. Vat is also charged after income tax is subtracted so the government gets two tax bites of the Masakhane Tax cherry. One can understand why in South Africa it has become so popular. There is another reason. The Masakhane Tax does not appear in the governments accounts. It is more than a stealth tax, it is an invisible tax.
Other economic consequences
There are a host of other consequences attached to forcing equal rates in insurance. I am not going to look at all of them. The law of supply and demand notes that as the price increases to the quantity decreases. So if women are forced to pay 60 per cent more, far fewer women will be able to afford insurance. Some women thus, who could afford insurance will face ruin because they did not buy insurance which would have saved them from ruin. In many instances women will not be able to purchase motor vehicles because banks will insist that they purchase insurance when they purchase the vehicle. Since at the increased cost they cannot afford insurance they will be deprived of the right to own a motor vehicle. The converse is also true. Many males who could not afford insurance will now, thanks to the subsidy provided by women be able to purchase insurance. The reason why males are paying the higher premiums is because of their higher claims experience. So more accidents can be expected. The Association of Police Officers in the UK pointed out that the biggest killer of young women in Britain is their boyfriends’ driving.
Correctly priced insurance does not result in cross-subsidization. If equal premiums are forced girls will subsidize boys. Rothschild and Stigliz pointed out attempts to pool unequal risks can in some cases result in no market at all. The males could be worse off; no insurance at all. So for example if an insurer knows that it is offering insurance to males at a rate which will produce a loss insurers may well decide not to offer insurance at all to certain males and if this is prohibited not to offer insurance at all. Something similar happened in the USA. State regulators insisted insurance be sold at the same price in all geographical areas. The claims experience in some areas were excessive and at the approved price insurers would suffer losses if they provided insurance. So they did not. They took city maps and drew red boarders round the areas in which they would not sell insurance at all, giving rise to the now notorious redlining concept. In these areas even those who wanted to pay the correct premium could not purchase insurance. Insurers may well decide not to offer any insurance to certain age groups.
Forced prices have other consequences. It inhibits innovation. Insurance for Women is an innovation. It and dozens of other innovations would never occur if equal premiums are forced. Forced prices are by definition above the market price. Being able to set prices above market prices leads to corruption. Someone, not the market is setting the price. This leads to the problem of regulatory capture. It usually turns out that when prices are not set by the market, prices rise above the market price and the increased prices are the benefit of the price setters, not the consumers. When this happens regulatory capture has occurred. George Stigler another Nobel prize winner examined most of the regulations passed in America and found almost always regulatory capture had occurred. I was involved in writing a history of a pharmaceutical company. At one time (long before the current time that is) medicines were subject to price controls. While discussing this period with the managing director who served during that period I expressed the view that that must have been a difficult time to manage a company. He disagreed. In a price control system the price can be set which is easier than in a free market where the market sets the price. He found the free market more difficult to deal with than a system where the prices can be set.
Rule by lawyers, not parliament not government
The case also demonstrates a growing problem; the rise of rule by lawyers and the demise of parliamentary law and government of the people by the people according to the rule of law. There is an increasing loss of freedom. The first person, I know who clearly understood and expressed this was Raoul Berger (1977) in his book Government by Judiciary. Forced equal premiums in Europe will be the product of a judicial decision, not the decision of the UK Parliament or the action of the UK government. The UK and Europe is increasingly being ruled from outside and not by the elected, persons accountable to the voters. The UK is being ruled by childlike lawyers.
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