Question

3. Discuss adverse selection in the context of health insurance and its relation to the eventual ending of a health care policy as describe by the “death spiral” scenario.

A. Describe the “death spiral” scenario.

B. What asymmetric information problem is the main cause of the “death spiral” scenario?

Answer 1

Death spiral is a condition where the structure of insurance plans leads to premiums rapidly increasing as a result of changes in the covered population. It is the result of adverse selection in insurance policies in which lower risk policy holders choose to change policies or be uninsured. The result is that costs supposedly covered by insurance are pushed back onto the insured. Adverse selection in health insurance happens when sicker people, or those who present a higher risk to the insured, by health insurance while healthier people don't buy it.

In simply we can say that ,A death spiral is the worst case scenario for an insurance market ,and it results in the collapse or near-collapse of the market .

Asymmetric information is the most problematic when it leads to adverse selection in a market. To compensate for a lack of information ,the insurance company might increase all premiums to offset the risk of uncertainty .