Category: Uncategorized

Drawing from George Akerlof’s groundbreaking paper on “The Market for Lemons,” adverse selection emerges as a problem that happens before contracts are signed, when buyers and sellers possess different levels of information about what’s being exchanged, specifically, how risky the potential policyholder is.

The heart of the issue? People or companies with higher-than-normal risk tend to seek insurance coverage more aggressively, especially when insurers can’t accurately tell different risk levels apart and must charge rates based on the group’s average risk. This pattern takes hold under particular circumstances: when the insured knows things about their own risk that the insurer doesn’t, when people’s decision to buy insurance depends heavily on price, and when there’s a clear link between how risky someone is and how much coverage they want.

The fallout can be dramatic – premiums might climb so high that safer customers walk away, shrinking the market to an inefficient size or even causing certain coverage types to vanish entirely. For insurers, this phenomenon restricts their ability to cover risks where private information plays a major role and risk classification proves tricky.

While health and life insurance often provide the textbook examples, marine insurance isn’t immune. Adverse selection lurks wherever shipowners hide information about how seaworthy their vessels truly are, what maintenance practices they follow, how fragile their cargo might be, or what kind of safety culture exists within their operation.

Insurance markets face an ongoing struggle with information asymmetry. This occurs when one party knows substantially more than the other in a transaction. For marine insurance, this typically means that shipowners or cargo owners understand their specific risks better than the insurers who cover them.

This knowledge gap creates two major problems:

First, there’s adverse selection, which happens before contracts are signed. Since insurers can’t perfectly differentiate high-risk clients from low-risk ones, they often set premiums at a middle ground. These middle-of-the-road rates tend to drive away safer clients while attracting riskier ones. Over time, this skews the client pool toward higher risks, pushing premiums up and potentially drying up coverage for certain segments. When insurers can’t effectively sort diverse risks, especially when offering one-size-fits-all premiums, they leave themselves vulnerable.

Second comes moral hazard, which emerges after insurance is in place. People change their behaviour when they know they’re protected. They might put less effort into preventing losses (ex-ante moral hazard) or become more likely to file claims or inflate them (ex-post moral hazard). In shipping, this might show up as skimping on vessel maintenance or navigating less carefully, while afterward, it could involve submitting claims for damages that barely qualify for coverage. Both types drive up costs for insurers and ultimately for everyone with a policy. The challenge of monitoring precautions or verifying claims only makes this worse.

The marine insurance world faces particularly tough information asymmetry challenges due to several factors: operations spread across the globe, huge differences between vessels and voyages, complex and potentially devastating maritime risks (including long-term liabilities like pollution), and the involvement of numerous parties (owners, charterers, managers, crew) whose actions can all affect risk levels.