Final answer:
If an insurance company charges an actuarially fair premium to the entire group rather than accounting for different risk groups, it risks financial instability due to adverse selection, where low-risk individuals may opt out and high-risk individuals pay too little, potentially leading to unsustainable losses.
Step-by-step explanation:
When an insurance company charges an actuarially fair premium to the entire group instead of each risk group separately, it may encounter several issues. If a single premium is set for all groups, individuals in lower-risk categories may find they are paying too much relative to their actual risk level. This can lead to a situation known as adverse selection: lower-risk individuals decide to opt out of the insurance pool because they don't feel they're getting a fair rate. Conversely, high-risk individuals would be paying a premium that's too low for the level of risk they bring into the pool, resulting in a potential shortfall in funds for the insurance company when large claims are made.
Over time, the imbalance can become unsustainable, causing the company to incur losses, raise premiums, or potentially go out of business. The fundamental law of insurance requires that premiums collected must cover claims, operational costs, and allow for some profit. Hence, without proper risk-based pricing, the financial stability of the insurance company could be compromised.