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Trading and Investment Terms

Adverse selection

It refers generally to a situation in which sellers have information that buyers do not have or vice versa.

  • In the common scenario, in the insurance sector those in dangerous jobs or high-risk lifestyles to purchase products like life insurance.
  • In these cases, it is the buyer who has more knowledge
  • To fight adverse selection, insurance companies reduce exposure to large claims by limiting coverage or raising premiums.
  • For example, A life insurance company charges higher premiums for race car drivers. 
  • A car insurance company charges more for customers living in high crime areas.
  • A health insurance company charges higher premiums for customers who smoke.

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