Adverse Selection in Term Life Insurance Purchasing Due to the BRCA1/2 Genetic Test and Elastic Demand

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ABSTRACT

Consumer groups fear that the use of genetic testing information in insurance underwriting might lead to the creation of an underclass of individuals who cannot obtain insurance; thus, these groups want to ban insurance companies from accessing genetic test results. Insurers contend that such a ban might lead to adverse selection that could threaten their financial solvency. To investigate the potential effect of adverse selection in a term life insurance market, a discrete-time, discrete-state, Markov chain is used to track the evolution of twelve closed cohorts of women, differentiated by family history of breast and ovarian cancer and age at issue of a 20-year annually renewable term life insurance policy. The insurance demand behavior of these women is tracked, incorporating elastic demand for insurance. During the 20-year period, women may get tested for BRCA1/2 mutations. Each year, the insurer calculates the expected premiums and expected future benefit payouts which determine the following year's premium schedule. At the end of each policy year, women can change their life insurance benefit, influenced by their testing status and premium changes. Adverse selection could result from (i) differentiated benefits following test results; (ii) differentiated lapse rates according to test results; and (iii) differentiated reactions to price increases. It is concluded that with realistic estimates of behavioral parameters, adverse selection could be a manageable problem for insurers.

INTRODUCTION

The initial phase of the human genome project was completed in 2003, with the sequencing of the human genome. Researchers hope that this sequencing will allow them to develop new drugs and therapies and to identify genetic risk factors for a variety of conditions. At the same time, many fear that the human genome map may open a new frontier for potential discrimination, particularly in insurance. Senators James Jeffords and Tom Daschle stated that "misuse of genetic testing could create a new underclass: the genetically less fortunate" (Jeffords and Daschle, 2001). In many countries, an intense legislative and lobbying activity, reminiscent of the debate over access to HIV tests in the 1980s, is taking place that could shape the environment of underwriting in life and health insurance. Consumer groups, fearing discrimination and the creation of a class of uninsurable individuals, want insurers and employers prevented from gaining access to medical information obtained through genetic testing.

In opposition to these views, insurance companies point to the risk of adverse selection. With over 1,000 genetic tests offered, they fear that policyholders may gain a financial advantage through insurance purchase decisions, from genetic information known to them but not revealed to insurers. (1) Insurers claim that without a level playing field, a death spiral of increasing premiums and decreasing portfolio size may threaten their financial solvency. They emphasize the positive implications of DNA testing for annuitants and the benefits of early diagnosis. They discuss the ethics and inconsistency of prohibiting the use of genetic tests, while allowing other medical tests and family history to be used for underwriting purposes. Both sides, consumer groups and the insurance industry, recognize that the predictive information obtained from genetic tests could be relevant to the actuarial calculations used by insurers in establishing policies and premiums. The issue is whether the use of such information by insurers in underwriting is justified on economic and market grounds to overcome social concerns. Actuaries in the United States voice their concerns through bodies such as the American Academy of Actuaries; by means of Issue Briefs (American Academy of Actuaries, 1998, 2002), articles, and Capitol Hill briefings. Congress is urged to proceed with extreme caution when it considers legislation aimed at preventing genetic discrimination in insurance. …