Final answer:
If the insured understate their age on a life policy application, the insurer will adjust the death benefit to reflect the correct age and corresponding premiums. This ensures that the benefit paid aligns with what would have been the actuarially fair amount had the insured provided accurate information at the outset.
Step-by-step explanation:
When a death claim is submitted and the insurer discovers that the insured understated her age on the application for a life policy, the insurer will typically adjust the benefit payout according to the correct age. The premium rates for life insurance are calculated based on the age of the insured, as age is a critical factor in assessing the risk of death. Understating age may lead to lower premiums than what is actuarially fair for the actual age group.
If the insured had stated the correct age, the premiums would have been higher; therefore, the insurer will recalculate the premiums based on the correct age and adjust the death benefit accordingly. This often results in a reduced benefit amount paid out to the beneficiaries to compensate for the underpaid premiums.
Using an example involving family history of cancer and actuarial fairness, it is clear that people sometimes have more information about their risk factors, such as driving habits or health history, than insurers can easily access. Actuarially fair premiums take into account the probability of an insured event occurring; understating age disrupts this assessment, leading to an unfair advantage for the insured and potential losses for the insurer.