Insurance Ratemaking and a Gini Index

Abstract

AbstractWelfare economics uses Lorenz curves to display skewed income distributions and Gini indices to summarize the skewness. This article extends the Lorenz curve and Gini index by ordering insurance risks; the ordering variable is a risk‐based score relative to price, known as a relativity. The new relativity‐based measures can cope with adverse selection and quantify potential profit. Specifically, we show that the Gini index is proportional to a correlation between the relativity and an out‐of‐sample profit (price in excess of loss). A detailed example using homeowners insurance demonstrates the utility of these new measures.