I've uploaded a class problem with solutions on the topic of insurance death spirals at http://fin4335.garven.com/spring2024/insurancedeathspiral.pdf. Please read this concise 2-page document before watching the video to enhance your understanding of how unchecked adverse selection can lead to a so-called insurance death spiral, demonstrated via a numerical example.

In this example, a flawed insurance regulation mandating uniform premiums for all consumers triggers the insurance death spiral. This one-size-fits-all approach is problematic because consumers have varying accident probabilities. Consequently, low-risk individuals pay disproportionately high premiums, while high-risk individuals pay too little. This discrepancy encourages low-risk consumers to leave the insurance market in favor of self-insurance. Their departure leaves behind a pool that is riskier and costlier to insure, prompting insurers to raise premiums. As premiums climb, more of the remaining lower-risk consumers opt out, further escalating costs. This vicious cycle of increasing premiums and the loss of low-risk insureds can significantly destabilize the market, potentially leading to prohibitively high premiums for the highest-risk consumers and, ultimately, market failure in the sense that insurance becomes unavailable at any price.