Final answer:
The actuarially fair premiums for life insurance vary when calculated for groups with differing risks. When charging a single premium for a mixed-risk group, insurance companies risk adverse selection. Deductibles, copayments, and coinsurance are employed to mitigate moral hazard and align costs with behavior.
Step-by-step explanation:
Understanding Insurance Premiums and Moral Hazard
In the scenario involving a division of 50-year-old men into two groups based on family cancer histories, if an insurance company were to sell life insurance separately to each group, the actuarially fair premium would reflect the distinct risk each group represents. For those with a family history of cancer who have a 1 in 50 chance of dying within the next year, and those without such history who have a 1 in 200 chance, the premiums would be calculated based on these probabilities and the $100,000 payout upon death.
However, if life insurance is sold to the entire group without differentiating based on family cancer histories, the insurance company would need to calculate a single premium that averages out the risk across the entire group. Charging an actuarially fair premium for the group as a whole could lead to adverse selection, wherein individuals with higher risk are more likely to purchase insurance, potentially resulting in losses for the insurance company.
Insurance systems often employ tools like deductibles, copayments, and coinsurance to mitigate the problem of moral hazard, where policyholders may engage in riskier behavior or over-utilize services because they are not fully bearing the cost of their actions. These tools lessen the disconnect between the premiums paid and the benefits received, encouraging more responsible behavior from policyholders.