- Asymmetric information
- Asymmetric information is a situation in which the two parties to an economic transaction have unequal information, so one knows much more than the other.
- Imperfect information
- Imperfect information is a situation in which buyers, sellers or both lack the information they need to make an informed decision about a product's price or quality.
Problems of asymmetric information in insurance
Can you name the two problems of asymmetric information in insurance?
An insurer knows less than its customers in two ways: about who they are before the deal, and about what they do after it.
Adverse selection is the problem in which insurance buyers know more about whether they are high-risk or low-risk than the insurance company does.
Can you think of an example?
Of 100 drivers, 60 will have £100 of damage in a year, 30 will have £1,000 and 10 will have £15,000. A premium covering the average is £1,860, so the low and medium risks decline it and only the £15,000 drivers buy.
Moral hazard is the case when people engage in riskier behaviour with insurance than they would if they did not have insurance.
Can you think of an example?
A driver whose policy pays for every dent stops taking care when parking in tight spaces, because the insurer, not the driver, now pays for the damage.