What is meant by "adverse selection" in the context of insurance?

"Adverse selection" refers to a situation in the insurance market where individuals who are at a higher risk of making a claim are more likely to seek insurance coverage than those at lower risk. This phenomenon occurs because those who anticipate needing insurance—due to health issues, risky lifestyles, or other factors—are more motivated to purchase policies, while healthier individuals may choose to forgo insurance since they perceive less personal risk.

When high-risk individuals overwhelmingly make up the insurance pool, it can lead to increased claims and, consequently, financial losses for the insurance provider. This can result in higher premiums for everyone or even a situation where the insurer may decide to limit coverage options or exit the market altogether, as they can't sustainably operate under an imbalanced risk pool.

In contrast, the other choices reflect different aspects of insurance but do not accurately describe adverse selection. Choice A, for instance, speaks about insurers favoring low-risk individuals, which would be the opposite of adverse selection. Choice C refers to wellness incentives, which aim to encourage healthy behavior among policyholders rather than addressing risk selection. Lastly, choice D mentions catastrophic coverage, which does not relate to the nuances of risk selection.