What Does Adverse Selection Mean?
Adverse selection, in the context of insurance, occurs when an insurance company accepts only applicants who they believe will incur a low probability of loss. Consequently, there is adverse selection when buyers become more eager to purchase an insurance policy in the belief that they highly need to make a claim.
Adverse selection is also known as anti-selection.
Insuranceopedia Explains Adverse Selection
Adverse selection has a negative effect in the insurance business because the parties to the contract tend not to gain equal benefits. To resolve this issue, insurance companies offer premiums proportional to the risk based on the person’s condition. For example, a person who smokes will have higher health and life insurance premiums than a non-smoker. Similarly, a person who has been convicted guilty of DUI would have to pay higher premiums than a person without a record of drunk driving.