Final answer:
The Waiver of Premium Rider allows an insurance company to waive premiums if the insured becomes disabled. Charging an actuarially fair premium to all instead of segmenting by risk can lead to adverse selection, with higher-risk members buying insurance and low-risk members opting out, potentially causing financial losses.
Step-by-step explanation:
The life policy rider that allows the insurance company to forgo collecting the premium if the insured becomes disabled is known as the Waiver of Premium Rider. This rider is an additional feature that can be attached to a life insurance policy, providing the benefit that if the policyholder becomes chronically ill or disabled and is unable to pay premiums, the insurance company waives the premium payments, keeping the policy active without financial strain on the insured.
This is beneficial for both the insured, who maintains life insurance coverage during a difficult time, and the insurer, who retains the policyholder without risking payment defaults or policy lapses. In a scenario where an insurance company attempts to charge the same actuarially fair premium to a group as a whole instead of to each risk group separately, the company may face a problem known as adverse selection.
The higher-risk members of the group become more likely to buy insurance while those at low risk may opt out, leading the pool to have more high-risk individuals and potentially resulting in financial losses for the insurance company. To combat this, insurance companies may either thoroughly segment customers into risk groups and charge accordingly or require that even low-risk members buy insurance at a rate that might be above their actuarially fair amount.