The Problem of and Solution to Asymmetric Information in Markets

 by Tareef Ahmed

As UK citizens, we are lucky enough to be blessed with the National Health Service (NHS) which provides free at the point of delivery healthcare for anyone who requires it no matter your social identity or beliefs. However,  there are many countries across the world that do not have universal healthcare. The most obvious example of a first-world country without this free healthcare would be the United States of America. Instead, they have a private system relying on citizens purchasing health insurance: this however is a very flawed system as we will explore.

We assume humans are rational economic beings and make rational decisions that are the most efficient to them - nobody would willingly spend extra money on something that provides no utility to them. This is the fundamentals of demand which is the quantity of a good or service that a consumer would purchase at a given price. So how much would a person pay for insurance on the basis that they may possibly need to use a hospital and pay extortionate prices? The simple answer is, people that know they are likely to need medical assistance in the future are more likely to purchase health insurance as it prevents them from being piled up with healthcare bills.

This means that on average, the health of people buying insurance will be lower than the average health of the population due to those with poor health being more likely to purchase insurance. If we class this information as asymmetric (where one party knows something relevant to the transaction that the other party doesn’t) due to people being unwilling to share their medical information and history, there is a major issue. The insurance companies would not be able to differentiate between different individuals due to no information on these ill-healthed individuals so would have to set a flat rate for everyone. As these firms have more ill-health consumers, their operating costs will be higher due to them having to payout more. We know that firms aim for maximising their profits and to do this, they will have to charge higher prices for everyone. These higher prices however will discourage people with good health to purchase an insurance plan. But due to the firm losing out on all those customers, they will aim to cover their losses by further increasing their prices. 

Now, those with minor health conditions may not purchase insurance policies due to them not thinking it will be worthwhile thus perpetuating the issue to the point where many people now can no longer justify purchasing insurance and would rather take the risk of living uninsured. This is a market failure as the market is not working efficiently at all due to the misallocation of goods - those who would like to purchase health insurance at a reasonable price can not.

Fortunately, this issue has mostly been solved due to information becoming more transparent so that firms are now able to differentiate between individuals and provide them a quote that is more fitting for them - depending whether they’re high risk and are more likely to need to claim insurance or if they have very little risk so are not likely to accumulate a costly bill. As people apply for any sort of insurance, they need to provide their details to the insurer and provide information about factors that may affect their likelihood of claiming insurance - we can see this when applying for car insurance: we are asked information about where the vehicle would be parked as a garage is a safer place to store a vehicle than on a road (however a driveway would usually provide the lowest insurance due to the large number of accidents that occur whilst trying to parking in garages). To prevent people from providing false information to lower the cost of their policy, it is illegal (Insurance Fraud) to provide wrong information and will not only invalidate the policy but can also lead to fines.

So when applying for insurance of any sort, be sure to double check the information you are providing is correct - even if it means paying more.