Final answer:
Insurers must evaluate exposures to ensure that premiums are set according to the risk level of policyholders. Charging higher premiums for high-risk individuals, such as those with diabetes, is necessary to cover potential claims but must be balanced to avoid discouraging low-risk individuals from purchasing insurance.
Step-by-step explanation:
Because insurers need to evaluate exposures according to expected losses, a person with diabetes would likely be categorized as a higher risk compared to someone without a pre-existing condition. Insurers have to carefully assess the risk level of each policyholder to determine the appropriate premium. If the risk is predicted to be high, insurers may charge a higher premium to cover the potential costs of claims. This process is essential to maintain a sustainable insurance model, wherein the collected premiums should cover the payouts for losses.
In situations where high-risk individuals, like those with diabetes, are charged appropriate premiums, the insurance company can avoid significant financial losses. However, this creates a balancing act, because if premiums are set too high for high-risk policyholders, it could unreasonably increase the overall cost of insurance. As a consequence, this can drive away lower-risk individuals, who may find the cost of insurance less justifiable, thereby disrupting the insurance pool.