Final answer:
Charging an actuarially fair premium to a group as a whole without accounting for different risk profiles can lead to adverse selection and financial instability for an insurance company, as premiums may not adequately cover claims and costs for each subgroup.
Step-by-step explanation:
If an insurance company charges an actuarially fair premium to the group as a whole rather than to each group separately, it may face issues. This is because not all insured parties face the same level of risk. Charging a uniform premium across different risk groups can lead to adverse selection, with lower-risk individuals potentially leaving for cheaper options, and higher-risk individuals remaining. This may result in the premiums collected being insufficient to cover the claims, operational costs, and desired profits of the company.
Risk groups are fundamental to actuarial science and insurance pricing. Assigning proper premiums based on individual group risk ensures that the total premiums collected adequately reflect the costs associated with providing the insurance. Without this differentiation, the insurance company could encounter financial instability and potential losses.
The concept of actuarial fairness implies that premiums should be set so they are proportional to the risk presented by the insured, accounting for the need to cover claims, operational costs, and profits. Charging the same premium to groups with differing risks jeopardizes the financial balance required for an insurance company to operate sustainably.