Which insurance products are listed as having adverse selection issues?

• A. Health insurance
• B. Flood insurance
• C. Terrorism insurance
• D. All of the above

Answer: (D)

Adverse selection happens when the person buying insurance knows more about their own risk than the insurer, so higher‑risk individuals are more likely to buy coverage or to buy more of it. This skews the insured pool toward riskier cases and can push prices up or even undermine the market if not managed.

Health insurance is a classic example: individuals have private information about their health and future risk, so sicker people often seek coverage more eagerly and may use more benefits. If premiums don’t accurately reflect individual risk, the pool becomes riskier on average, driving up costs and sometimes prompting healthier people to drop out.

Flood insurance faces the same dynamic. Homeowners in flood-prone areas know their true exposure, and unless premiums perfectly reflect that risk or subsidies distort pricing, the high-risk segment tends to enroll at higher rates, concentrating losses in the pool and raising expected costs for everyone.

Terrorism insurance also exhibits adverse selection. Entities with greater exposure to terrorism risk—due to location, industry, or activities—are more motivated to secure coverage. If pricing can’t precisely differentiate risk, the insurer’s pool can become disproportionately riskier, challenging profitability and pricing.

Because adverse selection can arise across these different insurance lines, the option that includes all of them best represents where adverse selection issues can occur.