In insurance, what is a primary concern with adverse selection?

Adverse selection refers to a situation in insurance where there is an imbalance of information between the insurer and the insured. Specifically, it occurs when individuals who perceive themselves to be at higher risk are more likely to seek insurance coverage than those who see themselves as lower risk. This leads to a pool of insured individuals that consists primarily of those who are more likely to file claims, ultimately increasing the insurer's overall risk.

The correct choice highlights that insurers may not be fully aware of the higher risks among applicants. If insurers cannot accurately assess the risk levels of each applicant, they may inadvertently offer policies to high-risk individuals without appropriately adjusting the premium to reflect that risk. This can lead to financial instability for the insurer if the claims exceed the premiums collected.

Understanding this concept is essential for effective risk management in the insurance industry, as it prompts insurers to develop strategies to better assess risks and to design premium structures that can help mitigate the financial impact of adverse selection.