What can lead to higher insurance premiums in a market influenced by adverse selection?

In a market influenced by adverse selection, higher claims due to uncalculated risks is a significant factor that can lead to increased insurance premiums. Adverse selection occurs when there is an imbalance in information between the insurer and potential policyholders. Typically, higher-risk individuals are more likely to seek insurance coverage because they know they are more likely to need it.

When these higher-risk individuals purchase insurance, they tend to file more claims, causing insurers to incur higher payouts than anticipated. This situation can lead to a cycle where the insurer raises premiums to cover the costs associated with these claims. As premiums rise, it could further dissuade lower-risk individuals from purchasing insurance, exacerbating the adverse selection issue and resulting in even higher claims from the remaining higher-risk pool.

The other factors mentioned, such as increased competition, reduction in policyholders, and lack of diversification of insured risks, may influence premiums but do so in a different context. Increased competition generally leads to lower premiums, while a reduction in policyholders might not directly correlate with increased claims. Lack of diversification can have implications for risk management but does not directly lead to higher claims in the same way adverse selection does. Thus, focusing on the impact of uncalculated risks and claims effectively highlights the