What is the potential consequence of adverse selection for insurance companies?

Adverse selection refers to a situation where there is an imbalance in the risk pool of an insurance company, often resulting from the asymmetry of information between buyers and sellers. In this scenario, individuals who are at a higher risk of making a claim are more likely to seek insurance, while individuals at a lower risk tend to avoid purchasing it.

The consequence of this is that the insurance company may end up with a disproportionate number of high-risk policyholders. As a result, the likelihood of loss increases because the claims made by these higher-risk individuals will usually exceed the premiums collected from them, leading to financial instability for the insurer. This could ultimately impact the company's ability to provide coverage at reasonable rates for all policyholders, as premiums might need to be increased to cover the higher-than-expected claims.

In summary, the correct answer highlights that adverse selection increases the likelihood of financial loss for insurance companies due to the concentration of higher-risk individuals in their insured population.