Adverse selection in insurance describes what situation?

Adverse selection in insurance refers to the situation where one party takes advantage of having more information than the other party, particularly regarding risk. In the context of insurance, this typically means that individuals who are at a higher risk of filing a claim are more likely to seek insurance than those who are at lower risk.

This imbalance occurs because high-risk individuals are often aware of their likelihood of needing insurance, while insurers may not have the same level of insight into each applicant's actual risk profile. As a result, if insurers do not adequately quantify and price this risk, they may find themselves insuring a disproportionately high number of high-risk individuals, leading to increased claims and financial losses.

Understanding adverse selection is critical for insurers as it impacts their underwriting processes, pricing strategies, and overall business viability. To mitigate adverse selection, insurers may implement measures to gather more information about applicants, adjust premiums based on risk factors, or employ underwriting guidelines that can help balance the risk pool.