What does adverse selection lead to in the context of insurance?

Adverse selection refers to a situation where individuals with a higher risk of requiring insurance are more likely to purchase insurance, while those at lower risk tend to opt out. This phenomenon can lead to a concentration of higher-risk policyholders within an insurer's pool, meaning that the insurer is more likely to face a higher frequency and severity of claims than anticipated.

As a direct consequence of adverse selection, insurers may experience a risk of higher losses. This happens because the insurer must pay out more in claims than anticipated based on the information they had while setting premiums. To compensate for this risk, insurance companies might raise premiums overall, leading to a cycle where low-risk individuals leave, further exacerbating the problem.

Considering the context, the correct answer highlights that the primary issue presented by adverse selection is the increased risk of financial loss for insurers due to the skewed risk pool. The other options do not accurately capture the implications of adverse selection in the insurance market context. Lower premiums for low-risk individuals would be unlikely due to the need to raise premiums to cover losses. Standardization of policy terms and more comprehensive coverage options may not directly relate to the effects of adverse selection and are more about policy structure rather than the risk profile of the insured pool.