User:Conor Kenny/Financial glossary

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  • Adverse selection:
    • "ADVERSE SELECTION: When you do business with people you would be better off avoiding. This is one of two main sorts of MARKET FAILURE often associated with insurance. The other is MORAL HAZARD. Adverse selection can be a problem when there is ASYMMETRIC INFORMATION between the seller of INSURANCE and the buyer; in particular, insurance will often not be profitable when buyers have better information about their risk of claiming than does the seller. Ideally, insurance premiums should be set according to the risk of a randomly selected person in the insured slice of the population (55-year-old male smokers, say). In practice, this means the AVERAGE RISK of that group. When there is adverse selection, people who know they have a higher risk of claiming than the average of the group will buy the insurance, whereas those who have a below-average risk may decide it is too expensive to be worth buying. In this case, premiums set according to the average risk will not be sufficient to cover the claims that eventually arise, because among the people who have bought the policy more will have above-average risk than below-average risk. Putting up the premium will not solve this problem, for as the premium rises the insurance policy will become unattractive to more of the people who know they have a lower risk of claiming. One way to reduce adverse selection is to make the purchase of insurance compulsory, so that those for whom insurance priced for average risk is unattractive are not able to opt out."[1]
    • Investopedia: "What Does Adverse Selection Mean?
      1. The tendency of those in dangerous jobs or high risk lifestyles to get life insurance.
      2. A situation where sellers have information that buyers don't (or vice versa) about some aspect of product quality.
      Investopedia explains Adverse Selection: In order to fight adverse selection, insurance companies try to reduce exposure to large claims by limiting coverage or raising premiums."[2]
    • Wikipedia: "Adverse selection, anti-selection, or negative selection is a term used in economics, insurance, statistics, and risk management. It refers to a market process in which "bad" results occur when buyers and sellers have asymmetric information (i.e. access to different information): the "bad" products or customers are more likely to be selected. A bank that sets one price for all its checking account customers runs the risk of being adversely selected against by its low-balance, high-activity (and hence least profitable) customers. Two ways to model adverse selection are with signaling games and screening games."[3]

General resources