In life insurance, what does anti-selection refer to?

Anti-selection, also known as adverse selection, occurs in the context of life insurance when individuals who are more likely to make a claim (those in poorer health) are more inclined to seek insurance than healthier individuals. This phenomenon can happen because those in poor health have a higher perceived likelihood of dying sooner, making them more motivated to secure insurance coverage, often at the same rate as healthier individuals.

Consequently, if an insurance company does not accurately assess and price for this additional risk, it could lead to a situation where the insurer collects premiums primarily from individuals who are more likely to file claims, resulting in financial loss for the insurer. This is why understanding and managing anti-selection is crucial for insurance companies in order to maintain a balanced and sustainable risk pool.

Healthy individuals generally have a lower claim probability and thus don't seek out life insurance as aggressively, which is why they are not a focus of anti-selection. Random selection of policyholders and basing premiums on group averages are strategies implemented by insurers to mitigate the impacts of anti-selection.