In the context of insurance, what does "adverse selection" lead to?

Adverse selection occurs in the insurance industry when individuals with higher risks are more likely to seek insurance or are more willing to purchase it than those who are at lower risk. This typically leads to a situation where the pool of insured individuals is not balanced, as it is skewed towards those who are more likely to make claims.

As a result, insurers may experience higher costs because they must pay out more claims than expected when the pool consists of individuals who are more likely to suffer losses. To counteract these increased risks, insurance companies may increase premiums across the board. This ultimately leads to higher costs for all policyholders, regardless of their individual risk levels, as the insurer adjusts to the overall heightened risk presented by the pool of insured individuals.

In summary, adverse selection disturbs the equilibrium of risk in an insurance pool, leading to increased costs for everyone involved.