In an adverse selection death spiral, why do premiums rise?

In an adverse selection death spiral, why do premiums rise?

• A. Because the risk pool is not homogeneous; higher-risk members stay while lower-risk leave
• B. Because everyone pays the same price
• C. Because the government caps prices
• D. Because insurers introduce random pricing

Answer: (A)

Adverse selection happens when those with higher expected costs are more likely to buy or stay in insurance as prices rise, while healthier, lower-cost individuals drop out. In an adverse selection death spiral, premiums climb because the risk pool becomes increasingly skewed toward higher-risk members. With more high-risk people in the pool, the insurer expects higher claims, so it raises premiums to cover those costs. As premiums rise, even more low-risk individuals opt out, leaving an even riskier pool and pushing premiums higher still. This self-reinforcing cycle can continue until the market becomes unaffordable or unsustainable. So the rise in premiums is driven by the changing composition of the pool toward higher risk.

Adverse selection happens when those with higher expected costs are more likely to buy or stay in insurance as prices rise, while healthier, lower-cost individuals drop out. In an adverse selection death spiral, premiums climb because the risk pool becomes increasingly skewed toward higher-risk members. With more high-risk people in the pool, the insurer expects higher claims, so it raises premiums to cover those costs. As premiums rise, even more low-risk individuals opt out, leaving an even riskier pool and pushing premiums higher still. This self-reinforcing cycle can continue until the market becomes unaffordable or unsustainable. So the rise in premiums is driven by the changing composition of the pool toward higher risk.