What is a Death Spiral?

In the insurance industry, a death spiral is a sequence of events that result in making health insurance unaffordable, driving people out of the health insurance market. There are a number of contributing factors to the development of death spirals, but the key cause is adverse selection; people tend to avoid buying health insurance until they need it, and drop health insurance when they don't have a need anymore. This drives up the costs of providing a health insurance plan, resulting in higher premiums, copays, and deductibles, and can create a death spiral.

The formation of a death spiral usually starts when people with high medical expenses find themselves limited in terms of the plans they can select. This can be the result of denied coverage or inadequate benefits under most other plans. As people with high health expenses join an insurance plan, the cost of administering the plan rises for the insurer, because it is paying out more money.

This results in adjustments to premiums and other terms associated with the plan. Healthy people withdraw from the plan because they do not think the high costs are worth the coverage, leaving sick people who need insurance coverage behind. Without payments from relatively healthy individuals who rarely file claims to support it, the plan becomes even more costly to run and the insurance company keeps raising the prices. The result can be a situation where people are priced out of insurance policies even if they need and want insurance.

Critics of the insurance industry have argued that in addition to being fed by adverse selection, the death spiral can also be driven by running insurance on a for-profit model. Companies feeling threats to their profits will take steps to protect their income, and these steps can include raising premiums when it is not strictly necessary to continue administering a plan. This may be a factor in some cases, but it is undeniable that insurance works most effectively when it contains a blend of people who need it and people who don't.

Insurance companies argue that the best way to prevent death spirals is to develop a mandate requiring people to buy insurance. This would prevent healthy people from leaving insurance plans or never signing up in the first place, providing a pool of funds to pay benefits to people who need them. Mandates to address problems like the insurance death spiral are controversial in some regions of the world and there are a number of arguments for and against.