In insurance terminology, what does the term "adverse selection" specifically relate to?

The term "adverse selection" in insurance refers to the tendency of those who perceive themselves as being at higher risk to seek out insurance coverage more frequently than those who consider themselves at lower risk. As a result, insurers may end up with a disproportionate number of high-risk policyholders, which can lead to higher claim payouts and potential financial losses for the insurance company.

Insurers prefer low-risk insureds because they balance the risk pool and reduce the likelihood of high claims. By selecting clients who are less likely to make claims, insurers maintain profitability and sustainability in their operations. This underscores the importance of effectively assessing risk in the underwriting process. Recognizing and managing adverse selection is crucial for insurance companies to ensure a stable and healthy risk pool.