Adverse selection primarily occurs when?

Adverse selection occurs when there is an imbalance in the risk levels among those who choose to purchase insurance. The correct answer indicates that those with higher risk are more likely to seek insurance coverage, leading to a concentration of high-risk individuals within the insurance pool. This situation arises because high-risk individuals are more aware of their likelihood of needing insurance benefits, while low-risk individuals may feel they do not need insurance or are less likely to purchase it, thinking that they will not benefit from it. As a result, insurance companies end up insuring more individuals who are likely to require claims, which can lead to increased costs and potentially create financial instability for the insurer due to the higher frequency of claims.

In contrast, the other options outline scenarios that do not align with the concept of adverse selection. If lower-risk individuals avoid purchasing insurance, it doesn't directly describe the phenomenon itself but rather highlights a symptom of adverse selection. When random selection of applicants is conducted, the risks are balanced, and when all risk levels are adequately represented, it leads to a stable insurance pool without the struggles associated with adverse selection.