Which insurance product is most susceptible to adverse selection?

• A. Health insurance
• B. Flood insurance
• C. Terrorism insurance
• D. Auto insurance

Answer: (A)

Adverse selection happens when one side of a deal has better information about risk than the other, so high-risk individuals are more likely to buy the product. In health insurance, people know their own health status and future medical needs, while insurers can’t perfectly price that private risk up front. If premiums reflect average risk, those with high expected medical costs are strongly motivated to enroll, and healthier individuals may opt out or wait, shrinking the pool of low-cost customers. That makes costs rise and can push more healthy members out, creating a cycle that undermines the market. Other types of insurance—like flood, terrorism, or auto—rely more on observable factors (location, usage history, or policy specifics) and often have mitigating features or government involvement that reduce the degree of adverse selection. Health insurance is therefore the most susceptible.