What is Adverse Selection in Life Insurance?

Adverse selection is a problem that every life insurance company has to deal with in one way or another. Here are the basics of adverse selection and how it can impact life insurance.

Adverse Selection

The term adverse selection refers to the situation when a life insurance company is negatively affected by having different information than their customers. When insurance companies do not have all of the facts, they may not be able to make the best decisions when it comes to writing life insurance policies. Because of this, it can cut down on profits for the insurance company and it can negatively impact all of the individuals that are insured with the company.

Example

Everyone knows that if you engage in certain risky behaviors, you are more likely to die than someone that does not take risks. Because of this, if the insurance company knows that you engage in these behaviors, they are going to charge you more for your insurance policy. However, at the same time, individuals that take these risks might be more likely to purchase insurance. Because of this, the company might bring in too many customers that engage in these practices. Because of this, they might end up paying more money in claims than they bring in.

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