Adverse selection in insurance primarily leads to which type of financial issue?

Adverse selection occurs when there is an imbalance of information between the insurer and the insured. Specifically, it refers to a situation where individuals with a higher likelihood of filing a claim are more likely to seek insurance, while those who are healthier or pose lower risks may opt out. This results in insurers attracting a riskier pool of clients.

The key financial issue that arises from adverse selection is disproportionate losses. Because the insurer has insured a higher-than-expected number of high-risk individuals, claims payouts can exceed the premiums collected, leading to financial strain. This can result in the insurance company having to increase premiums further, potentially driving away the lower-risk customers, and creating a cycle that exacerbates the issue.

On the other hand, the other options do not directly relate to the core financial challenges posed by adverse selection. For instance, homogeneous exposure units refer to having similar risk profiles among insured units, which is the opposite of what happens in adverse selection. Materiality typically pertains to the significance of information in the context of claims or underwriting but doesn't directly encompass the broader financial implications of adverse selection. A fixed amount does not directly tie into the additional loss problems that arise from adverse selection scenarios. Therefore, the primary risk tied to adverse selection is indeed the potential