Step 1
Work It Out
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You must read each slide, and complete any questions on the slide, in sequence.
In a private insurance market, there are two different kinds of people: some who are more likely to require expensive medical treatment and some who are less likely to require medical treatment and who, if they do, require less expensive treatment. One health insurance policy is offered, tailored to the average person’s health care needs: the premium is equal to the average person’s medical expenses (plus the insurer’s expenses and normal profit).
The insurance policy is unlikely to be feasible because those people who are less likely to require expensive treatment generally know that they are less likely to need health insurance. And since the insurance premium is based on the average person’s medical expenses, those who are less likely to require treatment will find this policy too expensive. So many of these individuals will not purchase this one-size-fits-all policy. However, the policy is generally a good deal for those who know they are likely to require a lot of—and very expensive—medical treatment,and those individuals will want to buy the policy. So the insurer will be left with an adverse selection of mostly high-risk individuals and, in order to avoid losing money on selling the policy, will have to increase the premium. These are the first steps in what is known as the adverse selection death spiral.
The insurance policy is unlikely to be feasible because those people who are less likely to require expensive treatment generally know that they are less likely to need health insurance. And since the insurance premium is based on the average person’s medical expenses, those who are less likely to require treatment will find this policy too expensive. So many of these individuals will not purchase this one-size-fits-all policy. However, the policy is generally a good deal for those who know they are likely to require a lot of—and very expensive—medical treatment,and those individuals will want to buy the policy. So the insurer will be left with an adverse selection of mostly high-risk individuals and, in order to avoid losing money on selling the policy, will have to increase the premium. These are the first steps in what is known as the adverse selection death spiral.