When the better-informed side self-selects, the pool worsens and prices must rise, worsening it further.
Health insurance is the textbook case: as premiums rise, the healthy drop out, the remaining pool is sicker, premiums rise again. This is why mandates and open-enrolment windows exist.
In practice
- A repair warranty priced for the average appliance attracts owners of the worst ones, so claims rise, so the price rises, so the careful owners drop out.
- An open salary band set at the market average recruits the people who cannot get more elsewhere.
- Further reading
- Wikipedia
- Subject
- Economics & Incentives
- Essay
- The theories behind every argument about money