ELI5: adverse selection

// eli5

What is adverse selection?

Adverse selection is when one person in a deal knows more information than the other person, and uses that advantage to get a better deal. [1][2] It's like if you were selling your toy and the person buying it didn't know it was broken, so you could sell it for more money.

Why does it happen?

It happens because people have secrets or know things about themselves that the other person doesn't know. [3] For example, someone buying insurance might know they're sick, but the insurance company doesn't know that yet.

What does it feel like?

For the person being tricked, it feels like buying a lemon—you think you're getting something good, but it turns out to be bad. [2] For the person with the secret, they feel like they won the game because they knew something the other person didn't.

How do you fix it?

People can ask more questions, get more information, or use tests to make sure both sides know the same things. [1][2] Insurance companies might ask health questions to find out if someone is sick before selling them insurance.