Final answer:
Reduced paid-up insurance is not a dividend option; it's a non-forfeiture option that allows a policyholder to stop paying premiums and get a reduced amount of coverage. If an insurance company charges an actuarially fair premium to a group as a whole rather than individually, it risks adverse selection, where low-risk members may opt out. Coinsurance involves policyholders paying a percentage of a claim while the insurer pays the rest.
Step-by-step explanation:
The phrase 'reduced paid-up insurance' implies an option for policyholders who no longer want to pay premiums on their insurance but still want to retain some coverage. In this case, the 'reduced paid-up' is not a 'dividend option' but rather a non-forfeiture option that allows the policyholder to use the accumulated cash value of an insurance policy to purchase a paid-up policy with a reduced face amount, ensuring they still have some level of coverage without paying additional premiums.
Discussing actuarially fair premiums and how they are calculated, if an insurance company charges the actuarially fair premium to the group as a whole, merging high-risk and low-risk individuals, the company may face adverse selection. The lower-risk individuals may choose not to participate because they are being charged more than their fair share to subsidize the higher-risk members, potentially leading to a riskier and more expensive insured pool. This can erode profits or even lead to financial instability for the insurance company if not carefully managed.
Coinsurance is a concept where the insurance policyholder pays a percentage of a loss, and the insurance company pays the remaining cost. This structures the insurance policy so that the risk is shared between the insurer and the insured, often leading to more cautious behavior from the insured as they are financially involved in the potential losses.