Final answer:
The most common type of life insurance for group plans is term life insurance. The actuarially fair premium for life insurance varies by risk group. An insurance company must carefully calculate premiums to reflect the blended risk of all members, considering factors such as the likelihood of claims and operational costs for it to be sustainable.
Step-by-step explanation:
The type of life insurance most commonly used for group plans is typically term life insurance, which provides coverage for a specified period and is often provided by employers as part of a benefits package. Actuarially fair premiums depend on the risk assessment of each insured group.
Risk Groups and Actuarial Fairness
Risk groups are defined as clusters of individuals who share similar risks of experiencing a specific event, such as death, in life insurance contexts. When an insurance company calculates premiums, it assesses the risks based on factors like personal habits or family medical history. The premium is calculated to cover the claims, operational costs of the company, and allow for profits.
Calculating Actuarially Fair Premiums
If an insurance company were offering life insurance to different risk groups separately, the actuarially fair premium would vary. For instance, with a 1 in 50 chance of dying in the next year, the fair premium for the group with a family history of cancer would be (1/50) x $100,000, equals $2,000. Conversely, for the group without a family history of cancer and a 1 in 200 chance of dying, the premium would be (1/200) x $100,000, equals $500.
If the insurance company cannot discern family cancer histories and instead provides insurance to the whole group, calculating a single actuarially fair premium becomes complex. They would need to consider the blended risk of both groups. This situation could lead to adverse selection if the premium does not accurately reflect the risk of a particular subgroup within the larger group.