Final answer:
The method used to estimate the financial needs of a family after a policyholder's death is called a needs-based analysis. Actuarially fair premiums have to be calculated based on the risk presented by different groups, and charging a uniform premium risks adverse selection, which can disrupt the insurance market balance.
Step-by-step explanation:
The approach that calculates the amount of money a family needs immediately upon the death of the insured to pay for their expenses and basic necessities is known as a needs-based analysis in life insurance. This analysis considers immediate expenses such as funeral costs, debts, and regular living expenses that the family will incur. It's important to factor in not just immediate expenses, but also future needs such as education costs for children, retirement for the surviving spouse, and any other long-term financial goals.
When determining premiums for life insurance, actuarial fairness comes into play. Here's how it applies to our example regarding 50-year-old men, with and without a family history of cancer:
- The actuarially fair premium for the group with a family history of cancer, with a higher risk of death, would naturally be higher than for the lower risk group.
- Calculating an actuarially fair premium for the entire group involves averaging the risk, which might not accurately reflect the individual risk levels.
- If the insurance company tries to charge a uniform actuarially fair premium, those at higher risk might be more inclined to buy the insurance, while those at lower risk might opt out, leading to an imbalance known as adverse selection.
Essentially, an insurance company must account for the cost of claims, operational expenses, and its profit margin to remain sustainable while also setting fair premiums for its policyholders.