Final answer:
An automatic premium loan occurs when a policyholder misses a premium payment. It uses the policy's cash value to cover the payment, keeping the policy active.
Step-by-step explanation:
An automatic premium loan is generated when a policyholder misses a premium payment (Option B). In a life insurance policy, if the policyholder does not pay the premium on time, the insurance company can prevent the policy from lapsing by automatically taking out a loan against the policy's cash value. The amount of the loan is used to cover the unpaid premium, ensuring that the policy remains in effect.
This mechanism is predefined in the terms of the policy and does not require the policyholder's request, cancellation of the policy or reaching a specific cash value threshold. It is important for policyholders to understand this feature as it can decrease the cash value of their policy and accrue interest on the loaned amount.
If an insurance company attempts to charge an actuarially fair premium to the entire group rather than to each subgroup separately, it may face issues with adverse selection. This approach could lead to losses if higher risk individuals are undercharged, while lower risk individuals may be overcharged and choose not to purchase insurance from that company. This could result in a disproportionately high-risk pool, and potentially, financial instability for the insurance company.