Adverse Selection

Adverse selection is the proclivity of those with higher risk to purchase insurance in greater amounts than those with lower risk. Much of insurance law and practice is designed to control adverse selection. This simulates how the distribution of risk versus risk aversion levels among the members of the pool interacts with the classification criterion used by the insurer to produce different levels of adverse selection. You can adjust the characteristics of the pool using the sliders and adjust the criterion used to separate the pool into "low-risk" (blue) and "high-risk" (yellow) by dragging the red line to the left or right. Darker and larger points show insureds who purchase insurance; lighter and smaller points show potential insureds who decline to purchase insurance. With the graphics complexity control set to medium or higher, dashed lines show the equilibrium premiums for insurance. With the graphics complexity control set to high, arrows show the increase in premium prices due to adverse selection.