What is Adverse Selection in the context of insurance?

Adverse selection refers to the tendency of individuals who are at higher risk of experiencing a loss to seek insurance more aggressively than those who are at lower risk. This leads to a disproportionate number of high-risk individuals in the insurance pool, which can drive up costs for insurers. Consequently, insurers may find themselves covering more claims than anticipated, as those most likely to file a claim are the ones who purchase insurance policies, making the overall risk profile of the pool less favorable.

In this context, the correct answer highlights that people are more inclined to seek coverage for situations where they perceive a higher risk—in other words, they are more aware of their own vulnerabilities and are more motivated to protect themselves against potential losses. This behavior can skew the risk pool and poses challenges for insurers in terms of pricing and managing risk effectively.