Principles of Microeconomics / Unit 15 MIC 1409 worked example, 60 to 90 seconds
The Adverse-Selection Spiral
The idea
From the risk table, offer the pooled premium; groups paying more than their expected loss leave. Recompute the pool from those remaining: claims against premiums give the insurer's loss. Raise the premium to cover the new pool and ask who leaves next, until only the worst risks remain at their own fair premium. Then show what a mandate does: everyone stays, the pooled premium holds, and the low-risk subsidize the high-risk.
In practice
Worked example: at the pooled premium of one thousand seven hundred forty, the seventy drivers whose expected loss is two hundred leave. Thirty remain: their claims are one hundred sixty thousand and their premiums fifty-two thousand two hundred, a loss of one hundred seven thousand eight hundred. The premium must rise to five thousand three hundred thirty-three, and now the twenty with two-thousand-dollar risk leave. Ten remain at twelve thousand each, insuring only those certain to claim. A mandate keeps all one hundred in at one thousand seven hundred forty, and the seventy safe drivers pay one hundred seven thousand eight hundred toward the others' claims.
Where people slip
The spiral turns on buyers knowing their own group; if the insurer could classify, it would price each group fairly and the safe would stay. And the mandate does not make coverage cheap; it decides who pays for the risky, which is why it is contested.
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