Adverse selection is a problem in economics.
It can happen when one side of a deal knows more than the other side. Economists call this information asymmetry. The person with more information may know something important about the risk or quality of the deal.
Adverse selection can make a market work less well. People or goods with greater risk may be more likely to enter the market. People or goods with lower risk may leave it.
Adverse selection is common in insurance. A person often knows more about their own risk than the insurance company does.
For example, a driver may know that they often drive in a dangerous way. The insurance company may not know this. A high-risk driver may be more likely to buy a large amount of insurance than a low-risk driver.
If an insurance company cannot tell which customers have high risk, it may charge the same price to many people. This price may seem too high to people with low risk. Some of them may decide not to buy insurance. The people who remain may then have a higher average risk.
Adverse selection can also happen when people buy and sell used cars. A seller usually knows more about the quality of the car than a buyer does.
If buyers cannot tell good cars from bad cars, they may not want to pay a high price. Owners of good cars may then decide not to sell them. This can leave more low-quality cars in the market.
Economist George Akerlof used the used-car market as a famous example of this problem. Bad cars in this example are often called "lemons".
Adverse selection is related to moral hazard, but they are different problems.
Adverse selection is usually about information that is hidden before a deal is made. Moral hazard is usually about actions after a deal is made. For example, a person may take more risks after getting insurance.
Both problems are studied in information economics. They can cause a market failure.