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Adverse selection

Adverse selection Definition

Adverse selection or anti-selection is a term used in economics and insurance. It was originally used in insurance to describe a situation where the people who take out insurance are more likely to make a claim than the population of people used by the insurer to set their rates. For example, when setting rates for a life insurance contract, a life insurer may look at death rates among people of a certain age in a certain area. Now suppose that there are two groups among the population, smokers and non smokers, and the insurer can't tell which is which so they each pay the same premiums. Non smokers know that they are less likely to die than average and that they are cross subsidising smokers, so will be reluctant to insure themselves, while smokers will have a higher likelihood of claiming so will be more likely to buy insurance. The insurance company ends up with people with higher average mortality rates than allowed for when setting premiums.




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