Which of the following best defines 'adverse selection' in insurance?

Adverse selection refers to the phenomenon where individuals with a higher risk of filing claims, such as those with pre-existing health conditions or higher likelihood of needing medical care, seek insurance coverage more often than those who are considered low risk.

Option B accurately captures this concept, as it highlights the focus on insuring individuals with known high risks. When a disproportionate number of high-risk individuals purchase insurance, it can lead to increased costs for the insurer. This situation causes the insurer to potentially face financial losses because they may have to pay out more in claims than they collect in premiums.

In contrast, the other options do not align with the definition of adverse selection. Policies sold to businesses pertain to a different aspect of insurance distribution, while offering lower premiums for healthy individuals typically seeks to balance risk rather than exacerbate it. Recovering costs through premiums is a general practice in insurance but doesn’t specifically illustrate the adverse selection phenomenon. Thus, understanding adverse selection is crucial for insurance providers to develop strategies that mitigate this effect, ensuring a balanced risk pool and sustainable premium pricing.