Question

William, age 67, has owned his life insurance policy for the past 15 years and has mailed his monthly premiums to his life insurance company. Last month he failed to mail the monthly payment on his premium due date as well as during his policy's grace period. As a result, which of the following scenarios will MOST likely occur?

Answer 1

If an insurance company charges an actuarially fair premium to a mixed risk group as a whole rather than to each risk-specific subgroup, adverse selection may lead to financial losses due to a higher proportion of high-risk individuals purchasing the insurance.

Step-by-step explanation:

The question pertains to an insurance company that is selling life insurance policies to 50-year-old men who are divided into two groups based on their family history of cancer.

In scenario (c), if the insurance company charges an actuarially fair premium to the entire group as a whole rather than to each group separately, they will likely face a situation known as adverse selection.

Adverse selection occurs when those who are at a higher risk are more likely to purchase insurance at a rate that is meant to reflect an average risk.

In this case, those with a family history of cancer would be more motivated to buy the insurance since the premium would be lower than what would be charged if their specific risk factor were taken into account.

Conversely, the healthier group may opt out as the premium would be higher than their actual risk, leaving the insurance company with a larger proportion of high-risk individuals.

This could lead to financial losses for the company as they may pay out more in claims than what they collect in premiums.