Final answer:
Charging an actuarially fair premium to an entire group rather than to each risk group separately may lead to a financial loss for the insurance company due to adverse selection. Higher-risk individuals would be undercharged, while lower-risk individuals may find premiums too high and opt-out, leading the company to lose money or potentially increase premiums, which could further reduce their customer base.
Step-by-step explanation:
Impact on Insurance Company Charging Actuarially Fair Premium to Entire Group
If an insurance company tries to charge the actuarially fair premium to an entire group rather than adjusting it for separate risk groups, it may face certain financial repercussions. Specifically, in the scenario described where one group has a higher probability of dying within the next year due to a family history of cancer, the premium, if not adjusted for this risk, will be inaccurately low for higher-risk individuals and too high for lower-risk individuals. Charging a single actuarially fair premium to the whole group may lead those with lower risk to seek insurance elsewhere or opt not to purchase insurance, deeming it too expensive for their level of risk.
This imbalance can cause the insurance company to lose money because the collected premiums will not adequately cover the higher number of claims coming from the higher-risk individuals. Moreover, if the company decides to increase premiums to cover these potential losses, it risks losing customers with lower risk, adding further strain on the company's finances. This concept reflects the insurance principle known as adverse selection, where insurance pricing does not adequately reflect the level of risk, leading to a loss of low-risk customers and an overrepresentation of high-risk customers.
To maintain solvency and profitability, an insurance company must adjust premiums to accurately reflect the risk of each insured individual or group. Failing to do this and charging a blanket actuarially fair premium can lead to financial instability for the insurer.