adverse selection

Definitions

noun the theory that bad quality goods will be more likely to be sold than good, because some traders want to get rid of products and buyers are not capable of judging if the quality or price is too low. This applies in many commercial spheres, such as the stock market or insurance, as well as in general trading. Three factors come into play: (i) the variable quality of similar products on the market; (ii) the fact that buyers and sellers do not possess the same information about the product (usually the seller knows more than the buyer); (iii) sellers are more likely to want to get rid of bad quality products than good quality products.

(written as Adverse Selection)
Insurers tend to set their premiums in relation to the average experience of a population. If members of subsets of the population have different probabilities of illness (or at any rate they believe they have different probabilities) then those with low probabilities (or low perceived ones) may not buy insurance and those with high probabilities (or perceptions) may eagerly seize their opportunity. If this happens, insurers end up with clients who are likely to prove costlier than expected; premiums will have to rise. High-risk individuals tend to 'drive out' low-risk individuals.

2 definitions in context