Final answer:
Adverse selection refers to the set of conditions that affect an insurer's ability to collect premiums commensurate with the level of risk incurred. It can result in higher costs for the insurance company and may be influenced by government laws and regulations. Insurers can mitigate adverse selection by separating insurance buyers into risk groups and imposing eligibility criteria, or by mandating the purchase of insurance.
Step-by-step explanation:
The set of legal or regulatory conditions that affect an insurer's ability to collect premiums commensurate with the level of risk incurred is called adverse selection. Adverse selection occurs when insurance buyers who pose a higher risk are more likely to purchase insurance, while those who pose a lower risk are less inclined to buy insurance. This can lead to higher costs for the insurance company, as they may have to cover the losses of the high-risk individuals without being able to collect higher premiums.
Insurance companies may face adverse selection due to government laws and regulations that influence the insurance industry. For example, if regulators impose restrictions on the amount insurers can charge for premiums, it may prevent the insurer from adequately pricing the risk. As a result, the insurance company may choose not to sell insurance in that particular market to avoid adverse selection.
To address adverse selection, insurers may try to separate insurance buyers into risk groups and charge them accordingly. This can involve screening individuals or imposing specific criteria for eligibility. Additionally, laws mandating that people be required to purchase insurance can also help mitigate adverse selection by ensuring a broader pool of insured individuals.