What is adverse selection?

Adverse selection refers to a situation in which sellers have information that buyers do not have, or vice versa. This asymmetric information can then be exploited. Asymmetric information, also called information failure, occurs when one party to a transaction has greater material knowledge than the other, typically about product quality.

What is the difference between adverse selection and moral hazard?

Like adverse selection, moral hazard occurs when there is asymmetric information between two parties. However, adverse selection occurs when there's a lack of symmetric information prior to a deal between a buyer and a seller, and moral hazard occurs after a deal is struck.

How do insurance companies fight adverse selection?

To fight adverse selection, insurance companies reduce exposure to large claims by limiting coverage or raising premiums. Adverse selection is when sellers have information that buyers do not have, or vice versa, about some aspect of product quality.