Asymmetric Information and Adverse selection:

Asymmetric Information: it is a situation in which one party has more information compared to the other. It often occur when the seller knows more than the buyer, and vice versa. This could be seen as a potential problem, as one party can take advantage of the other party’s lack of knowledge. Asymmetric information is seen as two basics, Moral Hazards and Adverse selection. 

The video below is from MRUniversity, it explains the basics of Adverse Selection.

Thus Adverse selection can be defined as a phenomenon where the insurer is confronted with the probability of loss, due to a risk that wasn't factored in at the time of sale. This occurs when the insured people deliberately hide certain pertinent information from the insurer. The information may be of critical nature as these help in ascertaining the risk profile of the insured and accordingly help in determining the correct premiums. 

However, non disclosure of the information which impacts the life of the insured can lead to faulty determination of premiums and may lead to loss of the insurance company as the insurer will find it difficult to do a prudent asset liability management owing to payment of more claims compared to the receipt of premiums.

The uneven knowledge between the buyers and sellers causes the price and quantity of the goods or services in a market to shift. This results in "bad" products or services being selected. For example, if a bank set one price for all of its checking account customers it runs the risk of being adversely affected by its low-balance and high activity customers. The individual price would generate a low profit for the bank.

The Death Spiral of Adverse Selection:

Methods to reduce the problem of Adverse Selection:

Government Policies- Private insurance companies usually protect themselves against adverse selection by offering a range of policies where the lower the cost of the insurance, the higher the out-of-pocket payments. 

This offers people choice, so that those who have a low risk of getting sick can buy a low-cost policy with higher out-of-pocket payments , while higher-cost policies with lower out-of-pocket payments can be selected by people who believe that they have a higher risk of getting sick.

To avoid adverse selection, firms need to try and identify different groups of people. This is why there are health insurance premiums for people who smoke and obese people.Insurance firms will charge different rates to consumers depending on factors, such as age.This means that those who are at most risk will likely have higher premium rates.

Tax- Another way for governments to deal with the problem of adverse selection is through tax funded social health care services. Although this may seem as a partial solution, it faces a potential problem in controlling the costs of providing health care and puts a huge burden on the government regarding the budget.

Citations:

"Asymmetric Information Definition | Investopedia." Investopedia. N.p., 19 Nov. 2003.  Retrieved 8 Jan. 2016

“Asymmetric Information: Adverse Selection and Moral Hazard.” Boundless Economics. Boundless, 21 Jul. 2015. Retrieved 9 Jan. 2016

Pettinger, Tjvan. "Adverse Selection Explained." Economics Help. N.p., 28 Nov. 2014.  Retrieved 8 Jan. 2016

Freidman, Ari. “Understanding The Individual Mandate’s SCOTUS Pivot Points.” Understanding The Affordable Care Act.” Nora Becker. Retrieved 9 Jan. 2016