Final answer:
Insurance companies assign premiums based on risk categories, with higher risks leading to higher premiums. State insurance regulators' efforts to mandate low premiums can lead to insurance companies avoiding high-risk clients or withdrawing from the market. An example includes auto insurance scenarios in New Jersey and State Farm's withdrawal from the Florida property insurance market.
Step-by-step explanation:
How Minimum Insurance Works
Insurance companies frequently categorize individuals into risk groups to assign insurance premiums appropriately. Individuals presenting a lower risk are assigned lower premiums, while those with higher risks tend to pay more for their insurance coverage. For example, in automobile insurance, if 60 drivers incur minor damages of $100 each, 30 drivers face medium damages of $1,000, and 10 have major accidents costing $15,000 apiece, and all these 100 drivers are charged the same premium of $1,860, it implies that drivers with minor damages are essentially subsidizing the costs for those who have experienced major accidents. This homogenization goes against the fundamental risk assessment principle in insurance.
On the governmental side, state insurance regulators may enforce regulations to cap premiums at a low level. However, this can conflict with the basic tenet of insurance where the average payout cannot surpass what is collected in premiums. When premiums are forced to remain low, insurance providers might opt out of offering coverage to high or medium-risk clients or even withdraw from the market entirely, as seen when several companies halted operations in New Jersey, or when State Farm stopped offering property insurance in Florida.