What is meant by "adverse selection" in insurance?

Adverse selection refers to the phenomenon where individuals who are at a higher risk of making a claim are more likely to seek insurance than those who are at lower risk. This behavior leads to an imbalance in the insurance pool, as the insurer may end up with a disproportionately high number of high-risk policyholders. Since insurance pricing and underwriting often rely on accurate risk assessment, adverse selection can result in increased claims and financial losses for insurers if not managed properly. This is why underwriting practices are crucial; they aim to assess risk fairly and ensure that premiums are aligned with the actual risk presented by applicants.

The other options do not accurately capture the essence of adverse selection. Providing equal coverage to both high and low-risk applicants would negate the concept of risk differentiation necessary in insurance. Evaluating all applicants as low-risk disregards the foundational principle of underwriting, which is to assess risk accurately. Lastly, ignoring past loss experiences would undermine the insurer's ability to make informed decisions about the risks they are taking on.