Final answer:
Adverse selection in insurance markets leads to a predominance of high-risk individuals as policyholders, raising premiums and potentially destabilizing the market. Insurers counter this by segregating customers by risk or through government interventions like the Affordable Care Act.
Step-by-step explanation:
Adverse selection can make it difficult for an insurance market to operate effectively by attracting individuals who are at higher risk of making insurance claims while dissuading lower-risk individuals from purchasing insurance. This imbalance can raise costs, as insurers may increase premiums to compensate for the higher risk pool, which can further discourage low-risk individuals from buying insurance, exacerbating the problem.
In order to manage adverse selection, insurers may attempt to separate potential clients into different risk categories and adjust premiums accordingly. Another method to counteract adverse selection is through government legislation, as seen with The Affordable Care Act, which mandates health insurance for all and prevents insurers from denying coverage based on pre-existing conditions, aiding in the distribution of risk across a wider population.