What is adverse selection in the context of insurance?

Adverse selection refers to a situation in the insurance industry where individuals with a higher risk of needing insurance are more likely to purchase it or opt for more comprehensive coverage than those with a lower risk. This can skew the risk pool, leading to a higher likelihood of claims being made than the insurer had anticipated.

In the context of health insurance, when someone buys coverage while being aware that they are likely to incur significant costs due to pre-existing health issues, this behavior is an example of adverse selection. It indicates that the insured knows their health status may lead to more frequent or costly claims than what is representative of the average policyholder. This can ultimately result in higher premiums for all policyholders, as insurers adjust their pricing to account for the risks associated with their actual pool of insured individuals.

The other options present different scenarios but do not correctly define adverse selection. For instance, purchasing insurance to mitigate business losses does not inherently reflect risk awareness in the same sense as adverse selection. Filing a claim without prior coverage would not contribute to adverse selection, as it implies that no insurance was in place to begin with. Not purchasing insurance due to low risk also does not align with adverse selection, as it involves individuals choosing not to insure themselves based on their assessment of