Final answer:
Paying insurance premiums more frequently can lead to higher overall costs due to administrative fees. When premiums reflect an individual's risk (actuarially fair), high-risk individuals might opt out of insurance due to high costs, while raised premiums to cover high-risk losses could deter low-risk customers.
Step-by-step explanation:
Paying insurance premiums on a more frequent basis typically leads to a higher total annual cost for the policyholder. Insurance companies often charge extra fees for the administrative costs associated with processing multiple payments.
Therefore, choosing a monthly payment plan over an annual one, for example, might lead to higher overall costs due to these additional fees.
If insurance companies try to set premiums that accurately reflect the risk of claim (actuarially fair levels), high-risk individuals may face prohibitively high costs. As a consequence, this could deter them from purchasing insurance altogether.
Furthermore, in trying to balance the risk pool and cover losses from high-risk individuals, an insurance company may raise premiums, which could discourage low-risk customers from maintaining their insurance policies, creating an imbalance in the insurance market.