Final answer:
If an insurance company charges an actuarially fair premium to the group as a whole, it may face adverse selection. Low-risk individuals might opt-out leading to a riskier pool and higher claims. Over time, this could financially hurt the insurance company. (TRUE)
Step-by-step explanation:
When an insurance company charges an actuarially fair premium to the group as a whole rather than to each risk group separately, it may face the issue of adverse selection. Different individuals or entities face varying risks due to factors like genetics, personal habits, or geographical location. Therefore, risk groups are formed based on the shared risks of an adverse event occurring within those groups. Charging a uniform premium fails to account for the stratification of risk, which can lead to undercharging high-risk groups and overcharging low-risk groups.
This could result in low-risk individuals choosing to opt-out of the insurance pool since they might not see the value in paying a higher premium for their low risk, while high-risk individuals would have more incentive to stay in, recognizing their higher probability of filing a claim. Over time, this can lead to a pool that is skewed towards higher-risk individuals, driving the insurance company to raise premiums in order to cover the larger number of claims. Eventually, this can create a cycle that forces even more low-risk individuals out, potentially resulting in the insurance company suffering financially due to an unsustainable insurance pool.