What phenomenon is illustrated when high-risk individuals are more prone to purchasing insurance within the insurance sector ?
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Answer: C. adverse selection
Explanation
Adverse selection occurs when individuals with higher than average risks disproportionately seek out insurance coverage. Asymmetric information allows high-risk buyers to purchase policies without insurance companies knowing their true risk profile. This market distortion happens before the insurance contract is signed, unlike post-contract behavioral changes. Information asymmetry arises when one party in a financial transaction possesses more information than the other. Insurance markets rely on pooling risks across diverse populations to maintain financial stability and profitability. Market failure can occur in insurance sectors if adverse selection drives healthy customers out of the pool.
Moral hazard refers to insured individuals taking greater risks after purchasing protection because they are shielded. Risk aversion describes a consumer's psychological preference for avoiding uncertainty and financial loss. A poor gamble is an informal term for an unfavorable bet rather than a specific market failure concept.
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