What is the main concern of adverse selection in insurance?

The main concern of adverse selection in insurance is that individuals who are at a higher risk of claiming are more likely to purchase insurance. This arises because those who know they are unhealthy or have greater risks are more inclined to seek out insurance coverage, resulting in a pool of policyholders that is made up disproportionately of high-risk individuals.

When the insurance pool consists mainly of those who are more likely to file claims, it can lead to higher costs for the insurer, which can subsequently lead to increased premiums for all policyholders. This situation creates an imbalance where the insurer holds a higher potential for loss, which can impact their ability to provide coverage effectively and sustainably. Adverse selection is a fundamental concept in insurance that highlights the necessity for insurers to accurately assess individual risk to maintain a balanced policyholder base.

Healthy individuals might opt out of purchasing insurance if they fear that they will be charged the same as higher-risk individuals, which further exacerbates the issue. The implications of adverse selection emphasize the importance of underwriting and risk assessment processes in insurance practices.