Image for Adverse selection

Adverse selection

Adverse selection occurs when one party in a transaction has more information than the other, leading to an imbalance. This is common in insurance markets, where those who know they are at higher risk are more likely to purchase insurance, while healthier individuals may opt out. As a result, insurers may face higher costs and may raise premiums, further driving away low-risk customers. This cycle can lead to a market failure, where only high-risk individuals remain, making it challenging for insurers to provide affordable coverage.

Additional Insights

  • Image for Adverse selection

    Adverse selection is a situation in markets where one party has more information than the other, leading to imbalances. For example, in insurance, individuals who know they are high-risk (like those with health issues) are more likely to seek insurance, while low-risk individuals might avoid it. This can result in insurers facing higher claims than expected, raising costs for everyone. Essentially, adverse selection occurs when crucial information is unevenly distributed, causing inefficiencies and potential losses in various markets.