The term "adverse selection" in the health insurance industry refers to the potential for health care plans to attract buyers that demand more care than the insurance company expected, resulting in higher costs.
When a health insurance company makes an insurance plan, they typically estimate how much health care the average person covered by the plan will demand; if the true average exceeds the estimate, it is sometimes called adverse selection.
Adverse selection can increase the cost of health care. If people demand more health care than insurance companies expect, they will have to adjust their estimate to compensate for the discrepancy.
Insurance companies may attempt to prevent underestimating costs by charging different rates for high risk groups such as smokers or drug users.
The higher health care costs become, the more likely healthy people are to drop or reduce coverage, which can increase adverse selection.
Adverse selection essentially means disproportionately attracting high risk or sick people that are expensive to insure.