Final answer:
An insurance company charging an actuarially fair premium to a group as a whole faces adverse selection, which can lead to losses. To avoid this, they typically segment customers into risk groups and charge accordingly or rely on government mandates requiring the purchase of insurance.
Step-by-step explanation:
When an insurance company attempts to charge an actuarially fair premium to a group as a whole, instead of to individual groups based on risk, it faces the challenge of adverse selection. Adverse selection occurs when there is an imbalance in the risk profile of the insured, potentially leading to higher-risk individuals being more likely to purchase insurance, while lower-risk individuals opt out. This can result in losses for the insurer as they may end up paying more in claims than they receive in premiums.
To mitigate this issue, insurance companies may employ several strategies. One such strategy involves separating insurance buyers into different risk groups and charging premiums accordingly. This way, those at higher risk may be charged a premium that reflects their greater likelihood of filing a claim. Conversely, low-risk individuals can be offered lower premiums, reducing the chance of policyholders with low risks opting out. Additionally, government laws and regulations may require that all individuals, regardless of risk, purchase insurance to prevent market failure due to adverse selection.