What is adverse selection?

In life insurance, adverse selection refers to the fact that someone with health concerns is more likely to apply for a policy, increasing the overall risk to insurers.

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Amanda Shih

Amanda Shih

Editor & Licensed Life Insurance Expert

Amanda Shih is a licensed life, disability, and health insurance expert and a former editor at Policygenius, where she covered life insurance and disability insurance. Her expertise has appeared in Slate, Lifehacker, Little Spoon, and J.D. Power.

Updated|3 min read

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When you apply for life insurance, you’ll answer many questions about your health and lifestyle and may undergo a medical exam during underwriting. Underwriting helps insurers set their rates and protects them from something called adverse selection.

For life insurers, adverse selection happens if they insure a much higher number of people with high-risk health conditions than relatively healthy people. Here’s how adverse selection applies to life insurance and how it can impact your policy and your beneficiaries.

Key takeaways

  • Adverse selection is when one person in a contract or negotiation has information that the others don’t.

  • In insurance, it occurs when many more high-risk people seek coverage than medium- and low-risk people.

  • Insurance providers try to prevent this by charging high-risk applicants higher premiums.

What is adverse selection in life insurance?

Adverse selection occurs when one of the parties in a contract or negotiation knows information that the others don’t, giving them an advantage. In life insurance, people with more medical conditions are more likely to shop for a policy than someone who is relatively healthy.

If a provider insures too many high-risk individuals, it may have difficulty keeping up with claims, leading to higher costs for customers.

Examples of adverse selection in life insurance

Life insurance underwriting measures your provider’s risk by how likely you are to die while your policy is active. Adverse selection in life insurance involves people who would receive higher premiums based on medical history or lifestyle risks like:

Someone who falls into any of the above categories may feel more compelled to look for life insurance than a healthy non-smoker with no risky hobbies or complex medical history, leaving insurers with a less varied pool of policy applicants.

Insurers compensate for the higher risk of these applicants by charging them higher rates or declining applications in some cases.

How adverse selection impacts life insurance companies

Insurance companies need to be able to accurately predict your risk so they can reliably pay out insurance claims to all of their customers. 

Based on the company’s calculations, the premiums paid over the life of your policy should be able to fund your death benefit. If too many policyholders die sooner than the insurer anticipates, it's more difficult for the company to pay benefits for all of its policyholders.

A higher-risk person who hides details from their insurer might die sooner than predicted while paying lower premiums than they should have been, leaving a gap between what they’ve paid and the death benefit the insurer owes. If the insurer has to fill that gap from their cash reserves, then it loses money.

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How adverse selection affects your life insurance policy

In the worst case, too many instances of adverse selection mean higher life insurance rates for all of an insurer’s customers. But insurance providers already have processes in place to protect against adverse selection, so you’re unlikely to feel a personal impact.

The effect is clearest during underwriting, when you’ll be asked extensively about your lifestyle and health and the underwriter will conduct a thorough review of records including:

  • Attending Physician Statement (APS) from your doctor

  • Financial information

  • Medical Information Bureau (MIB) reports of your previous insurance applications

  • Motor vehicle report 

  • Prescription history 

What happens if you’re dishonest when buying life insurance?

If you contribute to adverse selection by withholding information from your insurer, then you won’t just cause issues for the insurance company, but yourself as well. Intentionally concealing or misrepresenting details on your application is considered insurance fraud, and your insurer can cancel your policy or deny your application.

If your application is declined because you lied, it’ll go on your MIB report and can make it harder for you to be approved for another policy. If you manage to be approved and a lie is discovered later, your provider can deny or reduce the payout to your loved ones.

Be totally honest when applying for a life insurance policy. Otherwise, you could contribute to adverse selection and jeopardize your family’s financial protection.

Frequently asked questions

What does adverse selection mean?

Adverse selection is when one party in a negotiation or contract has more information than the others, giving them an advantage.

How does adverse selection apply to life insurance?

If an insurer covers too many high-risk people or offers them lower rates than it should, it will be harder to pay benefits to every policyholder.

Why does adverse selection matter for life insurance shoppers?

Too much adverse selection might lead to higher insurance rates. If you try to hide information from your insurer, your loved ones could be denied a payout when you die.