Final answer:
Risk-averse consumers prefer actuarially fair but less comprehensive insurance, as they pay a premium matching expected losses. Risk-loving individuals may favor full coverage regardless of actuarial fairness, valuing protection over cost. Real-world factors like diverse risk groups and moral hazard complicate this dynamic.
Step-by-step explanation:
The question pertains to whether risk-averse consumers always prefer actuarially fair but not fully comprehensive insurance over full insurance that is actuarially unfair, and if the opposite is true for risk-loving consumers. Insurance is essentially a method of sharing risk among a group, allowing people to pay premiums in exchange for compensation should an unpleasant event occur. The concept of actuarial fairness refers to a scenario where the premiums paid by a person equal the expected payout for their risk group. On the other hand, full but actuarially unfair insurance might have higher premiums than the expected payout, which accommodates the costs of running an insurance company and its profit.
Risk-averse individuals, who prefer certainty over uncertainty, will likely prefer an actuarially fair policy even if it does not cover all possible losses, since they are paying a premium that is in line with their expected losses. This provides them with a sense of security knowing that they are not overpaying for their coverage. Conversely, risk-loving consumers, who prefer taking on more risk, might opt for full coverage even if it costs more than the fair actuarial value because they value the additional protection from potential high losses above the financial cost of the higher premium.
It is worth noting that in real-world scenarios, factors such as investment income, administrative costs, and diverse risk groups complicate this picture. Furthermore, insurance can create a moral hazard because insured individuals might take fewer precautions to avoid risks, knowing they are covered. This behavior can cause the cost of insurance to rise for everyone within the risk group.