California Life and Health Insurance Practice Exam

Adverse selection refers to the tendency of high-risk individuals to seek more insurance coverage compared to low-risk individuals. This phenomenon occurs because those who perceive themselves as more likely to experience a loss—typically due to health conditions or risky behaviors—are more inclined to purchase insurance, often leading to an imbalance in the risk pool.

When a larger proportion of high-risk individuals are insured while low-risk individuals opt out, it can result in higher claim payouts for the insurance company than anticipated, potentially leading to increased premiums for all policyholders or even financial instability for the insurer. This is a critical concept in insurance as it highlights the importance of accurate risk assessment and pricing strategies to maintain a balanced and sustainable insurance model.

The other alternatives presented do not accurately capture the essence of adverse selection, which specifically involves the behavior of various risk levels within the insured population rather than obligations, underwriting processes, or coverage levels driven by low-risk individuals.