Final answer:
Life and health insurance contracts are considered contracts of adhesion because they don't allow negotiation of terms and insured must adhere to the insurers' terms. Adverse selection in these markets leads to higher-risk individuals purchasing more insurance, presenting challenges for insurance companies. The Affordable Care Act attempts to mitigate this by mixing high-risk and low-risk individuals in health insurance pools.
Step-by-step explanation:
Life and health insurance contracts are often referred to as contracts of adhesion because they are presented on a "take it or leave it" basis by the insurer to the insured, without giving the latter a chance to negotiate the terms. The insured must adhere to the set terms if they want the insurance coverage. This is largely due to the phenomenon known as adverse selection, where individuals with greater health risks are more likely to apply for and purchase insurance, while those with lower risks might opt out, potentially leaving insurers with a higher proportion of high-risk individuals. As a consequence, insurance companies face the challenge of pricing policies to ensure that they do not suffer losses due to a disproportionate number of high-risk insurees overwhelming their risk pool.
The adverse selection issue is mitigated in the health insurance market by selling insurance through employer groups or state-sponsored exchange markets under The Affordable Care Act, thereby mixing high-risk and low-risk individuals. However, this problem remains a challenge for small companies that are often unable to provide health insurance to their employees. The market distortion, that adverse selection brings about, poses a significant challenge in the pricing and provision of insurance, one that affects both the insurer and the insured.