Life & Health Insurance Practice Exam 2026 - Free Practice Questions and Study Guide

Adverse selection occurs in insurance markets when there is an imbalance in the information that buyers and sellers have about the risk of loss. Specifically, it refers to a situation where individuals who are at a higher risk of requiring insurance benefits are more likely to purchase insurance, while those at lower risk may opt not to buy it.

The correct answer highlights that individuals in poor health are more likely to seek and maintain insurance coverage. This behavior increases the likelihood that the insurer will face higher-than-expected claims, as those who expect to incur higher medical costs are incentivized to purchase insurance. This creates a pool of insured individuals that is riskier than the general population, ultimately leading to higher premiums or potential losses for the insurance company.

In this context, the presence of healthy individuals buying insurance would not lead to adverse selection; in fact, it would help balance the risk pool. Uncertain risks associated with premiums can lead to pricing adjustments but do not directly contribute to adverse selection. Lastly, while government regulations can influence insurance markets, they do not inherently cause adverse selection. The phenomenon is fundamentally rooted in the behavioral tendencies of individuals based on their perceived or known health status.