Principles of Risk Management and Insurance, 13th Edition

Adverse Selection and Insurance

When insurance is sold, insurers must deal with the problem of adverse selection. Adverse selection is the tendency of persons with a higher-than-average chance of loss to seek insurance at standard (average) rates, which, if not controlled by underwriting, results in higher-than-expected loss levels. For example, adverse selection can result from high-risk drivers who seek auto insurance at standard rates, from persons with serious health problems who seek life or health insurance at standard rates, and from business firms that have been repeatedly robbed or burglarized and seek crime insurance at standard rates. If the applicants for insurance with a higher-than-average chance of loss succeed in obtaining the ...