Final answer:
Being an underwriter is important due to the need to manage asymmetric information when evaluating policyholders’ risks and setting appropriate premiums.
Step-by-step explanation:
The role of an underwriter is critical in the insurance industry, primarily due to the issue of asymmetric information, where the policyholder often knows more about the risks being insured against than the insurer. This information gap can lead to problems like adverse selection, where high-risk individuals are more likely to buy insurance, and moral hazard, where the existence of insurance can lead some to take greater risks. Underwriters assess the risk of potential clients, decide on the terms of coverage, and calculate an appropriate insurance premium that is both competitive and sufficient to cover the risks. They utilize tools and knowledge to mitigate these risks, for example by setting terms that discourage risky behavior or by requiring higher premiums from high-risk policyholders.
An actuarially fair insurance policy is one where the premium matches the expected payout, taking into account the probability and cost of the insured event. However, in reality, insurance premiums must also cover administrative expenses and potential profits for the insurer, which means premiums are often higher than the expected payout. The benefits received by individuals in an insurance pool can vary widely; some may receive much more, while others receive little or nothing, but across the pool, the average benefits should align with the average premiums, minus the insurer's expenses.
For individuals and entities alike, good underwriting can make the difference when it comes to financial stability and risk management. For instance, a life insurance company not only pays out claims but also has a financial role, often lending money or allowing policy owners to borrow against their policies. The efficiency of underwriters in collecting and analyzing data on policyholders ensures the viability and competitiveness of an insurance company while protecting its financial health and the welfare of the clients.