Final answer:
In insurance, the payout can far exceed the premiums paid by the insured due to the spreading of risk across many policy holders. Charging actuarially fair premiums across the board may lead to adverse selection and financial instability for insurers. Insurers offer different policies with varying co-pays and premiums to cater to different risk profiles and preferences.
Step-by-step explanation:
The subject matter at hand is the principle of insurance and actuarial fairness. In the hypothetical scenario involving Damon's illness, it is indeed plausible that the payment received from the insurance company could far exceed the cumulative premiums paid by Damon's family. This is owing to the nature of insurance, which is designed to spread the financial risk of an event (such as an illness) across a larger pool of individuals who contribute premiums.
Concerning the question on actuarially fair premiums, when an insurance company charges a premium reflective of the average risk of the entire group rather than segmenting it into groups based on individual risks, they risk attracting a larger proportion of high-risk individuals. This phenomenon is known as adverse selection. Ideally, to maintain solvency and profitability, an insurance company must balance premiums such that they cover the expected payouts without over-disincentivizing low-risk individuals from acquiring or keeping their insurance plans.
Insurance companies often tailor policies with different co-pays and premiums depending on the risk-profile and preferences of their customers. A policy with a high co-pay is typically offered to individuals who prefer lower monthly premiums and are willing to pay more out of pocket in the event they need medical services. Conversely, a policy with a high premium but lower co-pay might appeal to those who expect to frequently use medical services and prefer to pay more upfront to reduce the cost of each service or procedure.
When high-risk individuals incur significant costs that are not adequately covered by their premiums, the insurance company faces a financial loss. In an attempt to recover these losses by increasing premiums, the insurer may inadvertently drive away the lower-risk customers who no longer see the value in the insurance, due to the higher prices. This can further worsen the risk pool and financial stability of the company.