What might be a consequence of adverse selection for insurance companies?

Adverse selection occurs when there is an imbalance within the insurance market, where those most likely to require insurance—typically higher-risk individuals—are more inclined to purchase coverage, while lower-risk individuals opt out. This self-selection leads to an insurance pool that is skewed towards individuals who are more likely to file claims, resulting in higher costs for the insurer.

In this context, the correct choice highlights that the consequence of adverse selection is an elevated cost structure for insurance companies. This arises because the risk pool comprises a disproportionate number of high-risk individuals. As a result, claims costs increase significantly, forcing insurers to raise premiums to offset these higher payouts. If insurers do not adjust their premiums accordingly, they can face financial instability or even insolvency due to mounting claims. Thus, the presence of adverse selection compels insurance companies to navigate a more challenging environment marked by increased financial risk.