Adverse selection is a situation where people with higher risk are more likely to buy insurance, while lower-risk peoplechoose not to.

This creates an imbalance. The insurer ends up covering more high-risk individuals, which leads to higher claims and can push premiums up for everyone.

In simple terms, the people who most need insurance are the ones most likely to buy it — and that can make the system more expensive.

This happens mainly because of information imbalance. Individuals know more about their own risk (health, lifestyle, habits) than the insurer does.

As a result:
• High-risk individuals are more willing to buy or keep insurance
• Low-risk individuals may feel premiums are too high and opt out

Over time, this can lead to rising premiums and, in extreme cases, make insurance products unsustainable.

To manage adverse selection, insurers take steps like:
• Medical tests and background checks (underwriting)
• Waiting periods and exclusions
• Pricing policies based on risk levels
• Offering group insurance (like employer policies) to spread risk

Adverse selection happens when people who are more likely to make a claim are more likely to buy insurance than those with lower risk.

In India’s health insurance market, individuals with existing health issues often buy policies soon after diagnosis, while healthier people delay or avoid buying insurance. This results in a pool of higher-risk policyholders, leading to increased claim payouts for insurers.

To manage this, insurers in India, such as HDFC Ergo and Star Health, use measures like waiting periods for pre-existing diseases and medical check-ups before issuing certain policies. These steps help ensure a more balanced risk pool and support the financial stability of the insurer.

information asymmetry theory
George Akerlof
insurance, lending, and financial markets