Question

1) Why do insurance companies charge different rates based on age, sex, marital status, where people live, how much they drive, whether they smoke, driving record, etc?

2) Asymmetric information and how to deal with it?

3) Why is price discrimination more prevalent for services than goods?

Need help with these 3 homework questions.

Answer 1

1)

Auto insurance rates vary from one insurance company to another because each uses its own unique formula to assess risk and determine how much you pay. All insurance companies will base your rate on the following variables, but no two companies will have the same exact end result:

• How much risk you present to an insurance company
• What it costs your insurer to conduct business
• How much money your insurance carrier estimates it will need to pay all claims during the year

Assessing your risk

Weighting different factors about you

Insurance companies assess a number factors to determine your likelihood of experiencing an accident or loss, or how much of a risk you pose. Not all companies consider the same factors. Additionally, some companies attach more significance to certain factors than others. That means your rates will vary from one insurance company to another depending upon the rating factors each insurer uses and the weight they place on the different factors.

The following factors influence car insurance rates as they are commonly used by insurers to assess if you are a high-risk driver or not:

• Your age
• The make and model of your car
• Your driving record
• Where you drive and keep (garage) your car
• Your claims history
• Your credit rating

Using statistics to help assess risk

Auto insurance companies analyze statistical information about millions of drivers. They then use it to identify characteristics of drivers who are more likely to file claims that the company would have to pay. The statistical information that insurance companies collect regarding driver types and so on can differ, so that as well can make insurance rates differ.

When calculating how much you pay, insurance carriers also usually group you together with other people whose age, sex, occupation and experience are similar to yours. If you fall in a group considered low risk, you are likely to pay less for coverage than if you are put in a group considered high-risk.

Planning for future claims costs

The amount needed by the insurer to cover the costs of accidents or losses that may happen in the future also plays a role in determining your rate, and also varies by company. Since insurance companies can’t see into the future, they must use past claims history and experiences to help determine future losses that they will have to pay out on. Because each company has had different claims experiences with the groups of people they insure, the rates charged by different companies are never identical.

The cost of doing business

There is also the varying cost of doing business as an insurance provider that is taken into account when rates are set. Each company's cost of doing business (how much they pay to sell and service policies), along with their financial goals, is different, resulting in different prices being charged.

Comparing rates is the smartest way to save on car insurance

Car insurance premiums can vary widely between insurance companies due to the rating factors they use, the statistical information they look at, their own claims experience and the cost of doing business. That’s why to get the best rates you need to do a car insurance comparison, and see which companies have the lowest rates for the coverage you want. Enter your ZIP code and in the tool below, and you’ll see average car insurance rates for the coverage level selected. You’ll also see the highest and lowest rate fielded from up to six major insurers – for the same policy. This shows you how much you can save by comparison shopping.

2)

What is 'Asymmetric Information'

Asymmetric information, also known as information failure, occurs when one party to an economic transaction possesses greater material knowledge than the other party. This normally manifests when the seller of a good or service has greater knowledge than the buyer, although the reverse is possible. Almost all economic transactions involve information asymmetries.

BREAKING DOWN 'Asymmetric Information'

Asymmetric information is the specialization and division of knowledge in society as applied to economic trade. For example, medical doctors typically know more about medical practice than their patients. After all, through extensive education and training, doctors specialize in medicine, whereas most patients do not. The same principle applies to architects, teachers, police officers, attorneys, engineers, fitness instructors, and other specially trained professionals.

Economic Advantages of Asymmetric Information

Growing asymmetrical information is a desired outcome of a market economy. As workers specialize and become more productive in their fields, they can provide greater value to workers in other fields. For example, a stockbroker’s services are less valuable to customers who know enough to buy and sell their own stocks with confidence.

One alternative to ever-expanding asymmetric information is for workers to study in all fields, rather than specialize in fields where they can provide the most value. Associated with this alternative are large opportunity costs and possibly a lower aggregate output, which would lower standards of living.

Another alternative is to make information abundantly available and inexpensive, such as through the internet. It is important to note that this does not replace asymmetric information. It only has the effect of moving information asymmetries away from simpler areas and into more complex areas.

Disadvantages of Asymmetric Information

In certain circumstances, asymmetric information may lead to adverse selection or moral hazard. These are situations where individual economic decisions are hypothetically worse than they would have been had all parties possessed more symmetrical information. Most of the time, the solutions to adverse selection and moral hazard are not complicated.

Consider adverse selection in life insurance or fire insurance. High-risk customers, such as smokers, the elderly, or those living in dry environments, may be more likely to purchase insurance. This could raise insurance premiums for all customers, forcing the healthy to withdraw. The solution is to perform actuarial work and insurance screening and then charge different premiums to customers based on their associated potential risks.

How to deal with it?

Asymmetric information is inherent in most, if not all, markets. To take a basic example, a patient admitted to a hospital probably has less information about illness and recovery options than the doctor does. Markets compensate for this by developing agency relationships where both parties are incentivized to produce an efficient outcome.

In the hospital case, the doctor has an incentive to diagnose accurately and prescribe treatments correctly, or else he might be sued for malpractice or otherwise have his reputation suffer. Since it is likely that doctors and patients have repeat relationships, the law of repeat dealings also shows that both actors are better off in the long run if they deal fairly with one another.

According to economic theory, asymmetric information is most problematic when it leads to adverse selection in a market. Consider life insurance: A customer might have information about his risk that the insurance company cannot easily obtain.

To compensate for a lack of information, the insurance company might increase all premiums to offset the risk of uncertainty. This means that the riskiest individuals (who ostensibly value insurance most highly) effectively price out some of the less risky individuals (who aren't willing to pay as much).

(a). Professional qualifications

In undergoverned LMICs the quality of health care offered to poor and even middle-income patients is very often seriously deficient (Das, Hammer, & Leonard, 2008)??and this problem has been documented in the other, professional service sectors as well (Leonard, 1977)?. This problem often is traceable to lack of knowledge. For example, teachers cannot transmit information they do not have and health practitioners cannot diagnose diseases or perform procedures of which they have no understanding. Thus the institutions that provide professional qualifications, train to refresh and upgrade knowledge, and regularly supervise practice are all critical components of the quality of a service. In this regard it is unsurprising that in rural Tanzania the quality of care offered by a clinic was associated with the presence of an MD (Mliga, 2000)?, and MDs in Delhi demonstrate superior competence to those with lesser qualifications in both the public and private sectors (Das & Hammer, 2007)?. Cameroonian villagers who feared they had a serious ailment bypassed cheap clinics to reach much more expensive ones known for their special competence (Leonard, 2009)? and Ugandan dairy producers who would not pay the higher fees of a fully qualified veterinarian for routine care were willing to do so when surgery was required (Koma, 2000)?. As we will see below, however, the management necessary to turn higher competence into more effective service is not always provided. (For example, Das et al., 2012? found only small differences in clinical quality between the trained and untrained in rural India.)

(b). Professional accreditation

Certification of qualifications at the point of entry to a profession is one of the few areas in which effective regulation in LMICs is common and institutionalized (Patouillard, Goodman, Hanson, & Mills, 2007)^?? (Ensor & Weinzierl, 2007)??(Kumaranayake, Lake, Mujinja, Hongoro, & Mpembeni, 2000)?. This is broadly true across the professions—for physicians, veterinarians, teachers, etc—particularly when they are employed in government-supported settings (Rose, 2006)??. In many countries, however, differences in qualifications are signaled to the public more by the organizational setting in which practice is taking place and less well for differences between the individuals within them—a point to which we will return later.

(c). Regulation of practice/malpractice

In the undergoverned LMICs on which we are focusing, the regulation of competence and effectiveness in day-to-day practice generally is weak or non-existent (Rose, 2006)??. Hence, the strength of a state’s formal institutions is closely related to the health status of its population (Knowles & Owen, 2010)?. For example, corruption is negatively correlated with health indicators and is a serious concern in the procurement of pharmaceuticals (Kohler & Baghdadi-Sabeti, 2011)??. Regulatory weaknesses are more likely in undergoverned states and are an important part of the institutional context within which their health and development services operate. In many countries most rural private pharmacies have no staff with any kind of professional qualification on the premises, despite formal regulations requiring their presence (Bloom et al., 2009)?? (Bett, Machila, Gathura, McDermottd, & Eisler, 2004; Ensor & Weinzierl, 2007)?. Use of the law to control medical malpractice in India is judged ineffective (Peters & Muraleedharan, 2008)? although it is more evident in China.

(d). Paraprofessionals

The rural poor and especially those who live in remote areas have particular difficulty obtaining services because the better educated providers are reluctant to live there and when they do so are frequently absent from their posts (Banerjee & Duflo, 2006)^??. Professionals also often are culturally distant from the rural poor, which detracts further from their motivation to serve them well. Even veterinarians, who are much more attracted to rural life than teachers or physicians, are reluctant to live with pastoralists. As a result, the posting to remote areas of fee-charging staff with only basic but expert-provided external training can lead to substantial improvements in service delivery, because they may be culturally better attuned with their clients than highly qualified professionals and provide them with better real access to assistance for relatively simple but serious and endemic problems. Such was the logic underlying the “bare-foot doctors” initiative of China’s Cultural Revolution and the community health workers proposed in WHO’s Alma Ata Declaration of 1978. Initially many of these workers were community-supported rather than fee charging, but over time they have evolved toward the latter. The reduction in livestock mortality rates of African pastoralists through the deployment of fee-charging Community Animal Health Workers with limited training is particularly clear (Catley et al., 2004; Peeling & Holden, 2004)??. Similar success with community (human) health workers has been reported for a range of tasks in LMICs (Chopra, Munro, Lavis, Vist, & Bennett, 2008)^?? (Tendler, 1997)?.

The problem with the use of minimally trained service staff is not with the staff themselves, for they can be highly effective at preventive and simple curative human and veterinary medicine as well as at agricultural extension. Private schools whose staff lack teaching certificates also often out-perform government ones whose teachers have better formal qualifications, even when serving the poor (Patrinos, Barrera-Osorio, & Guáqueta, 2009)^?? (Rose, 2006)??. Nor is the problem that they or their organizations are charging for their services and that they therefore are in the market. The issue instead is that the training they receive must be well done and they must continue to receive effective support, supervision, and updating throughout their service lives. In other words they must be backed by institutionalized “organizational intelligence” (Goodman et al., 2007; Patrinos et al., 2009; Peters, El-Saharty, Siadat, Janovsky, & Vujicic, 2009; Shah, Brieger, & Peters, 2010)^?? (Catley et al., 2004; Peeling & Holden, 2004)?? (Leonard, 1977; Ly, 2000)?. If these staff succeed in being absorbed into the regular civil service—as frequently is their ambition—and their management is neglected, their effectiveness can drop significantly (Leonard, 1977, 1991)?. On the other hand, when they remain in the private voluntary sector and are subject to strong management—as often has been the case with missions in Africa—they can outperform government facilities with better trained staff (Ly, 2000; Mliga, 2000)?. However if they drift away from the organizations that trained them and become wholly autonomous, as has occurred in many countries, they can become no better than untutored drug sellers, cut off from professional support and supervision and with documented problems with safety, effectiveness of treatment, and costs (Basu et al., 2012)^?? (Bloom et al., 2008)??.

(e). Visible training and supervision

When strong management is visible to the consuming public it reduces information asymmetry by “signalling” the quality of the work actually done by the minimally-qualified staff and thereby increases clients’ willingness to pay for more of the service they provide. Thus in Senegal pastoralists were willing to buy more preventive animal health measures from the Community Animal Health Workers of a Lutheran mission that provided strong support and supervision than they were from a similar government service in a neighboring area (Ly, 2000)?. Similarly, a study in Cameroun demonstrated that even the poor were willing to pay more for quality medical service when they believed they had a condition that justified it (Leonard, 2000a, 2009)?. In a variety of professions there is a demonstrated willingness to pay for more of the services provided by well-supported and supervised, minimally-qualified providers, when the quality they are offering is relevant to the purchaser’s needs (Tooley & Dixon, 2006)?? (Koma, 2000)?.

3)

Introduction

Price discrimination is a pricing strategy that charges customers different prices for identical goods or services according to certain criteria. In pure price discrimination, the seller/provider will charge each customer the maximum price they are willing to pay. In more common forms of price discrimination, the seller places customers in groups based on certain attributes and charges each group a different price.

Industries that commonly use price discrimination include the travel industry, pharmaceuticals, leisure and telecom industries. Examples of forms of price discrimination include coupons, age discounts, occupational discounts, retail incentives and gender based pricing.

There are three types of price discrimination:

1. First degree - the seller must know the absolute maximum price that every consumer is willing to pay.
2. Second degree - the price of the product or service varies according to the quantity demanded.
3. Third degree - the price of the product or service varies by attributes such as location, age, sex, and economic status.

The purpose of price discrimination is to capture the market's consumer surplus. Price discrimination allows the seller to generate the most revenue possible for a product or service.

FIRST-DEGREE PRICE DISCRIMINATION

First-degree price discrimination means exploring/judging what your customers are willing to pay for an item and selling it at that price. Car dealers may exercise first degree price discrimination by looking at how a potential car buyer is dressed. A potential customer who has the latest version of a phone and wears expensive clothes is more likely to be able to pay a premium for a new car – or that's what the dealer will surmise! This strategy can also require a business to profile its customers and offer personalized prices based on previous purchases, particularly online. Merchants who use a customer's purchase history and data on comparison shopping behaviour to determine prices could however be vulnerable to possible consumer alienation.

SECOND-DEGREE PRICE DISCRIMINATION

Second-degree price discrimination refers to special deals and prices offered to customers who meet certain conditions or who are seeking certain special qualities. Buy-two-get-one-free offers, special prices for bulk purchases and premium packages are examples of second-degree promotions. Customers typically appreciate these opportunities as long as the rewards are obtainable and they are not accompanied with price increases to compensate. This form of price discrimination allows your business to provide savings to customers who value "deals," to reward loyal customers with frequent purchase cards and to increase your margin on rare or premium items. Communications companies usually offer a packaged deal for Internet, phone and TV services at a discount to what consumers would pay for all three services separately.

THIRD-DEGREE PRICE DISCRIMINATION

Third-degree pricing offers special discounts to members of certain groups, such as students, OAPs, or children. These discounts are frequently reflected in restaurant offers, bus/rail fares and admission prices, but can also apply to retail prices on production of ID. Students and pensioners are given discounts because they exhibit high price sensitivity.

Third-degree price discrimination gives you the opportunity to expand your market by selling to a group that might not buy otherwise. It is rare to encounter resentment among customers who do not fall into the discounted group as long as you have not raised prices in general to compensate for the discounts.

Methods of Price Discrimination

Methods of Price Discrimination include:

• Coupons: coupons are used to distinguish consumers by their reserve price. Companies increase the price of a product and individuals who are not price sensitive will pay the higher price. Coupons allow price sensitive consumers to receive a discount. The seller is still making a profit.

• Age discounts: the price of a good or admission to an event is based on age. Age discounts are usually broken down by child, student, adult, and OAP. In some cases, children under a certain age are given free admission or eat for free. Examples of places where age discounts are given include restaurants, cinemas, and other forms of entertainment.

• Occupational discounts: price discrimination is present when individuals receive certain discounts based on their occupation. One example would be for members of the armed services.

• Retail incentives: this includes rebates, discount coupons, bulk and quantity pricing, seasonal discounts, and frequent buyer discounts.

• Gender based prices: in certain markets prices are set based on gender. A Ladies Night at a bar or club is a form of price discrimination.

EXAMPLES OF PRICE DISCRIMINATION

PRICE DISCRIMINATION IN THE TRAVEL INDUSTRY

The travel industy conducts a substantial portion of their business using price discrimination. Travel products and services are marketed to specific social segments. Airlines usually assign specific capacity to various booking classes. Also, prices fluctuate based on time of travel (time of day, day of the week, time of year).

If you are looking for a bargain flight with a low-cost airline, booking early with carriers such as EasyJet or RyanAir will normally mean lower prices. This gives the airline the advantage of knowing how full their flights are likely to be and is a source of cash flow prior to the flight time.

Closer to the time of a flight with most airlines the fare rises, on the justification that a consumer’s demand for a flight becomes inelastic. People who book late often regard travel to their intended destination as a necessity and they are likely to be willing and able to pay a much higher price.

PEAK AND OFF-PEAK PRICING

Peak and off-peak pricing is common in the telecommunications industry, leisure retailing and with utility companies. For example, telephone and electricity companies separate markets by time - there are usually three rates for telephone calls: a daytime peak rate, an off peak evening rate and a cheaper weekend rate. Electricity suppliers also offer cheaper off-peak electricity during the night. The reason for this price discrimination is that at off-peak times there is plenty of spare capacity whereas at peak times when demand is high the supplier may experience capacity constraints. Leisure Centres on the other hand will often charge more for evening and weekend attendances because this is when the majority of the public want to use the facilities. They want to encourage more users to attend during weekdays by charging less for admission during off-peak times.

Conclusion

Price discrimination may enable a business to turn a loss into a small profit - or a business activity can keep going, rather than close down. This is obviously beneficial for consumers because it increases their choice of goods and services. One example of this might be rail travel. Without off peak and peak prices train companies would make a bigger loss and may have to discontinue their service.

Price discrimination means that firms have an incentive to cut prices for groups of consumers who are sensitive to prices (elastic demand). These groups often have less disposable income than the average consumer. The downside is that some consumers will face higher prices.

Price discrimination is one way to manage demand. For instance, if there was no price discrimination morning rush hour trains would be even more overcrowded and it can be used to give an incentive for some people to go later in the day. This should mean that those who have to travel at rush hour benefit from less congestion.