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.