In health insurance, what does "adverse selection" refer to?

Adverse selection is a fundamental concept in health insurance that describes a scenario where individuals who are at a higher risk of needing medical care are more likely to seek health insurance coverage compared to those who are healthier and potentially at lower risk. This phenomenon occurs because those who anticipate higher healthcare needs want to protect themselves financially, leading to a disproportionate number of high-risk individuals in insurance pools.

When this happens, insurers may face challenges in managing costs, as the risk pool may contain more individuals who will utilize health services extensively, thereby increasing the overall claims and causing insurers to raise premiums for all policyholders. This can also lead to a situation where healthier individuals opt out of insurance altogether, further inflating the risk within the insurance pool.

In contrast to the correct choice, the other options present behaviors or practices that do not correctly capture the essence of adverse selection. For example, charging higher premiums based on age is a standard practice that reflects demographic risk but doesn’t define adverse selection itself. The idea of healthier individuals avoiding insurance aligns with notion of risk avoidance, but it is not the definitive characteristic of adverse selection. Lastly, requiring applicants to pass health assessments is a process aimed at assessing risk, rather than a description of adverse selection.