Final answer:
An insurance company sets life insurance premiums based on risk assessment, with premiums varying for individuals or averaging out for a group without detailed family health information.
Step-by-step explanation:
An insurance company must calculate premiums based on the level of risk associated with providing coverage to particular individuals or groups. Concerning life insurance, two scenarios challenge this risk assessment:
- If the insurance company were selling life insurance separately to each group, considering their family cancer histories, the actuarially fair premium would be personalized. Premiums would differ based on the group's level of risk due to genetic predispositions to cancer.
- If the insurance company were offering life insurance to the entire group without knowledge of family cancer histories, they would calculate the actuarially fair premium for the group as a whole. This would mean averaging out the risk across all members, irrespective of their family health history.
Such assessments prove challenging when the insured knows more about their potential risks, like the family's health history in life insurance or their driving habits in car insurance, than the insurer. This concept is known as information asymmetry. Therefore, insurers must carefully consider this when setting premiums to manage potential losses from high-risk individuals within a group.