Final answer:
The insured typically cancels the policy when the unearned premium is calculated on a short rate basis. If an insurance company charges an actuarially fair premium to a whole group rather than individually, it might suffer from adverse selection and possible financial losses. The correct option is A.
Step-by-step explanation:
When a policy is terminated and the unearned premium is calculated on a short rate basis, it typically implies that the policy was cancelled by the insured themselves rather than the insurance company. Short-rate cancellation is a way for insurers to recoup the costs associated with the early termination of a policy.
Therefore, when a short rate basis is used for the calculation of the unearned premium, the correct answer to who cancelled the policy is (a) The insured.
If an insurance company tries to charge the actuarially fair premium to the group as a whole rather than to each group separately, the company may face the risk of adverse selection.
This is because lower risk members may find the premiums disproportionately high compared to their risk and may choose not to purchase insurance, leaving the insurance company with a pool of higher risk members, which could ultimately lead to financial losses for the company.