Which of the following is a consequence of adverse selection?

Adverse selection occurs when there is an imbalance in the market caused by information asymmetry, where individuals with a higher risk of making a claim are more likely to purchase insurance than those with a lower risk. This phenomenon can lead to increased expenses for insurance companies because they end up insuring a larger proportion of high-risk policyholders. Consequently, insurers may face greater claim payouts than anticipated. This necessitates increased reserves and can lead to higher operational costs as insurers must adjust their business models to account for the increased likelihood of claims.

The other options do not accurately describe the consequences of adverse selection. While it might seem that premiums for all policyholders could lower, in reality, the presence of higher-risk individuals leads insurers to raise premiums overall to balance the risk they are assuming. Adverse selection does not inherently decrease competition among insurance providers; rather, it may drive some companies out of the market if they are unable to manage the risk effectively. Lastly, while risk assessment models can improve with more data, adverse selection typically indicates that the existing models are failing to properly account for the high-risk individuals entering the pool.