What is the meaning of Adverse Selection?

Adverse selection is a situation where one party in a transaction has more information than the other. The information is generally highly useful about some aspect of the transaction like about the quality of the product. The asymmetry in information raises the probability of risk for the insurer as the risk is not included in at the time of sale.

This usually occurs when the insured party hides vital information from the insurance provider. The latter information is considered important for correctly assessing the risk profile of the insured and thereby determining the accurate premiums. Thus, to avoid this, insurance companies lessen exposure to such huge claims by either putting limits on coverage or raising premiums.