Anti-selection describes a rise in the possibility that a person may cancel their pre-existing contract because they are confident that demands and needs exceed what the service provider has included in the package.
An example would be when a person has a preexisting condition, and the insurance is far lower than what would be required to cover the condition.
Since sick individuals are more likely to join in insurance, the company is forced to raise prices to pay the claims, ultimately driving healthier people away.
Adverse selection is an example of asymmetric information, which refers to a situation where one party has lesser knowledge than the other.
Consequently, the party with less knowledge has a higher chance of ending up at a loss.
In insurance, adverse selection applies both ways. If the buyer decides not to disclose full information about their health, they can end up being in profit, putting the company at a loss and vice versa.
Key Takeaways
- Anti-selection refers to individuals with higher risks or undisclosed information seeking insurance coverage, leading to higher claims and financial strain on insurers.
- Adverse selection is a market failure resulting from information asymmetry, where one party has more information about a transaction than the other, leading to undesirable outcomes.
- Both concepts highlight the importance of accurate risk assessment and information sharing in insurance and other markets.
Comparison Table
| Parameters of comparison | Anti-selection | Adverse selection |
|---|---|---|
| Definition | Behavior change after the agreement | Lack of symmetry in information before the subscription of the contract |
| Legal consequence | One of the parties could face legal consequences | No legal consequences |
| Nature | Effect | Cause |
What is Adverse Selection?
Adverse selection refers to a situation where either the seller or buyer has more information than the other. They can use that information for their benefit, eventually putting the other party at a loss.
There are two situations in this scenario. Adverse selection is at play when those in high-risk or risky activities purchase life insurance.
Here, the customer has better health knowledge and may benefit from this by withholding particular information.
In the same way, if the company decides to withhold some information, that can be a disadvantage to the consumer.
When an insurance company sells premiums at a greater cost than is reasonable based on the incentives they are giving to uninformed clients.
The buyer ultimately buys the package much higher than the actual cost.
Another example of adverse selection is a current global issue where insurance companies extract the genetic information of a client.
They then decide whether that person is illegible to be insured or not based on the genetic information.
On the other hand, there are individuals who use their genetic information to get insurance.
What is Anti-Selection?
Anti-selection is when a person decides to withdraw their insurance contract because it is evident to them that the illness they have is far more serious than what the insurance company is offering them in their package.
That person is sure that due to this, he will be at a loss rather than benefit because of the insurance and hence decides to withdraw from their subscription.
As a result of this, the insurance company is forced to increase their package so that sick people would sign up.
This consequently pushes away those who are in healthier conditions.
A shortage of healthy people might also affect the overall amount of premiums received by the insurance company.
As a result, the insurance company is forced to raise health insurance prices to make up for the shortfall.
However, because of rising healthcare expenses, more healthy people may quit their policies.
Main Differences Between Anti-Selection and Adverse Selection
- Anti-selection is the change in a consumer’s behaviour after purchasing a deal. The consumer feels that the current plan he acquires is not sufficient for his needs and, as a result, decides to opt-out. While the adverse selection is the asymmetry of information on either side of the deal between two parties
- In some cases of anti-selection, the parties might face consequences for terminating the contract however, that is not the case in adverse selection.
- Adverse selection is the cause, while anti-selection is the result of adverse selection.
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