In underwriting, what does 'information asymmetry' mean?

Information asymmetry in underwriting refers to a situation where one party has more or better information than the other party involved in a transaction. In this context, it means that the insurer (the party providing coverage) has less information about the applicant (the person seeking insurance coverage) than the applicant does about their own risk profile. This disparity can create challenges for the insurer in accurately assessing risk and determining appropriate premium levels.

Due to information asymmetry, applicants may have a more comprehensive understanding of their health, lifestyle, or other risk factors that can affect their premiums, which the insurer may not fully comprehend. Consequently, this can lead to issues such as adverse selection, where individuals with higher risks are more likely to seek insurance, thereby impacting the overall risk pool and profitability for the insurer. Understanding this concept is vital for underwriters as it highlights the importance of collecting sufficient and relevant information during the underwriting process to make informed decisions.