Adverse selection

Refers to a situation in which sellers have relevant information that buyers lack (or vice versa) about some aspect of product quality.

Adverse Selection

A sociological phenomenon in which those persons with the most dangerous lifestyles or careers are the most likely to buy life insurance policies. Adverse selection may also occur if those persons conceal or falsify relevant information when they apply for the insurance policy. This has the potential of economic hardship for life insurance companies because those most likely to receive a death benefit are the ones buying policies. This reduces profit potential. Life insurance companies attempt to counteract adverse selection by limiting coverage and/or raising premiums. Adverse selection is also called antiselection.

adverse selection

the tendency for people to enter into CONTRACTS in which they can use their private information to their own advantage and to the disadvantage of the less informed party to the contract. For example, an insurance company may charge health insurance premiums based upon the average risk of people falling ill, but people with poorer than average health will be keener to take out health insurance while people with better than average health will tend not to take out such health insurance, so that the insurance company loses money because the high risk part of the population is over-represented among its clients. Adverse selection results directly from ASYMMETRY OF INFORMATION available to the parties to a contract or TRANSACTION. Where there is hidden information that is private and unobservable to other parties to a transaction, the presence of hidden information or even the suspicion of hidden information may be sufficient to hinder parties from entering into transactions.