Final answer:
A 10-year life insurance policy for a 20-year-old male is cheaper than for a 50-year-old male due to the lower risk of death. Actuarially fair premiums are determined by risk, meaning higher risk groups pay more, which can influence their decision to purchase insurance.
Step-by-step explanation:
A 10-year, $200,000 term life insurance policy for a 20-year-old male would have a lower premium than the same insurance policy for a 50-year-old male because younger individuals are generally at lower risk for mortality and health problems. Insurance premiums are calculated based on the risk of the insured event occurring; in this case, the event is the death of the policyholder. Younger people are statistically less likely to die within the term of the policy, thereby presenting a lower risk to the insurance company.
For actuarially fair premiums, consider these examples:
20% of a group of 1,000 50-year-old men have a family history of cancer with a 1 in 50 chance of dying in the next year. For this group, an actuarially fair premium would take into account the higher risk associated with their family history.
The other 80% have a 1 in 200 chance of dying in the next year, resulting in a lower actuarially fair premium due to their lower risk.
If the entire group were charged a single premium without differentiating the risk, it could lead to adverse selection where the higher risk individuals are more likely to purchase the insurance, potentially making it unprofitable for the insurer. Additionally, high-risk groups may find themselves charged so heavily that they may opt out of buying insurance at all.