Final answer:
Ed is interested in buying a cash-value life insurance policy with flexible premium choices, a death benefit, and a tailored cash value accumulation. The actuarially fair premiums for individuals with or without a family history of cancer will differ, and if undifferentiated, may lead to adverse selection.
Step-by-step explanation:
The question pertains to an individual, Ed, who is interested in purchasing a cash-value life insurance policy that offers three key elements: a flexible premium, a death benefit, and the option to choose how the cash value accumulates to fit the policyholder's needs. A cash-value life insurance policy combines a death benefit with a savings component, allowing the policyholder to build cash value over time, which can then be used during their lifetime.
Actuarially Fair Premiums
An actuarially fair premium is one that is proportionate to the expected loss and the level of risk involved. In the case of individuals with or without a family history of cancer, the premiums would be set differently for each group due to the variations in mortality risk.
a. For those with a history of cancer (20% risk): The actuarially fair premium would be calculated based on a 1 in 50 chance of death within a year for this higher risk group. b. For those without a family history of cancer (80% risk): The actuarially fair premium would be lower, reflective of a 1 in 200 chance of death.
If the insurance company is unable to differentiate the risk due to family cancer history and thus offers a single premium to all, the policy might be underpriced for higher risk individuals and overpriced for lower risk individuals, eventually leading to adverse selection.