Final answer:
Charging an actuarially fair premium to an entire group rather than to specific risk segments may lead to adverse selection, potentially causing financial losses for the insurance company as high-risk individuals will be more inclined to buy insurance. The situation can also result in market distortion and an imbalanced portfolio. Addressing this issue might require government intervention or better market segmentation.
Step-by-step explanation:
Impact of Charging Actuarially Fair Premiums to a Group as a Whole
If an insurance company decides to charge the actuarially fair premium to a group as a whole rather than assessing each subgroup separately, the company risks encountering a situation known as adverse selection. In such a case, individuals with high risks are more likely to purchase insurance compared to those with low risks, because the premiums do not accurately reflect their individual risk levels. Consequently, the insurance company may face financial losses as the premiums collected will not suffice to cover the high number of claims.
Moreover, the insurance company may be tempted not to sell insurance to those perceived as high risks or, alternatively, fail to draw in low-risk customers who feel that they should not pay more than what is fair for their specific risk group. Both scenarios can lead to market distortion and an imbalanced insurance portfolio with an unhealthy ratio of high-risk to low-risk insured parties.
The company could resort to government laws and regulations to require individuals to buy insurance, or it could segment the market more accurately. These measures might help retain the low-risk customers and ensure the viability of the insurance market.