Where ignorance is bliss: the “dark corner” of risk classification

Abstract

PurposeThe paper aims to explore a risk‐finance context in which less information may be preferable to more information.Design/methodology/approachInsurance companies collect a variety of information on potential policyholders to support two fundamental components of risk classification: underwriting (the determination of whether or not to offer an insurance contract to a particular individual or firm) and rating (the calculation of a policyholder's premium level once a contract has been offered). Although risk classification is necessary in voluntary markets to ensure that most individuals or firms will be able to purchase insurance, it is not necessary when the purchase of insurance is required by government. The paper explores the usefulness of risk‐classification‐related information in the context of government‐mandated insurance.FindingsIn the case of government‐mandated insurance, it is shown that risk classification may be more or less useful, depending upon the degree to which policyholders are able to obtain substantial premium reductions for risk control efforts. When such reductions are not available, then risk classification is not only “less useful,” but in fact particularly unjust to certain policyholders.Originality/valueThe paper describes an insurance context in which less information is preferable to more information.