Final answer:
The nonforfeiture option allows a life insurance policy to continue beyond the grace period when a premium is overdue. It offers reduced coverage in various forms without requiring further premiums. Charging a single actuarially fair premium for a diverse risk group can lead to adverse selection and financial instability for the insurer.
Step-by-step explanation:
In the context of life insurance policies, the provision that allows a policy to continue beyond the grace period when a premium is overdue and not paid is known as the nonforfeiture option. The nonforfeiture option ensures that even if the policyholder fails to pay the premium within the grace period, they will still have some form of coverage. This could come in the form of reduced paid-up insurance, extended-term insurance, or a cash surrender value. The purpose of nonforfeiture options is to provide the policyholder with a certain level of protection and value, taking into account the premiums already paid, even if they can no longer continue with the original policy terms.
In terms of actuarially fair premiums, if an insurance company cannot differentiate between groups based on risk factors such as family cancer histories, they may end up charging a single actuarially fair premium to the entire group. This combined premium would likely be higher than the fair premium for low-risk groups and lower than the fair premium for high-risk groups. This could result in adverse selection, where higher-risk individuals are more likely to purchase insurance, potentially making the insurance pool less healthy on average and leading to financial instability for the insurance company over time.