What is "adverse selection" in the context of health insurance?

Adverse selection refers to a situation in the health insurance market where individuals who are at higher risk of needing medical care are more likely to purchase health insurance compared to healthier individuals. This occurs because those who anticipate higher medical expenses recognize the value of insurance coverage, making them more inclined to seek it out. Consequently, if a significant number of high-risk individuals enroll while healthier individuals opt out, the overall risk pool becomes skewed.

This dynamic can lead to a range of problems for insurers, including increased costs and the potential for higher premiums as the insurers attempt to cover the higher expenses associated with a riskier population. In contrast, if healthier individuals choose not to purchase insurance, the insurer is left with a disproportionate number of claims, which can destabilize the insurance market.

Understanding adverse selection is crucial for insurance companies, as they must design products and pricing strategies that mitigate this phenomenon, ensuring a balanced risk pool that includes both healthy and less healthy individuals. This ensures the sustainability of insurance plans and keeps premiums affordable for everyone involved.