1. Risk Pooling
Rather than face the risk of totaling our car and being required to replace
it out of current income, we enter a pool, joining others for a known affordable
fee, thus sharing the risk with other pool members. This concept of transferring
the individual's risk to the pool is as old as mankind first banding into
tribes.
2. Law of Large Numbers
If the pool is small, there is the risk of Adverse Selection meaning that there
are too few members in the pool to make accurate predictions of the frequency
of an occurrence.
For example, if I take one die from a pair of dice and roll it 10 times, I
might well have 4 fives turn up out of the 10 rolls. However, if it is rolled
100 times, 1000 times, 10,000 times, or 200,000 times, the sides will come
up equally to 3 or 4 decimal points. Thus, it becomes predictable. When the
frequency of the occurrence is accurately established, losses can be predicted
and the amount needed (premium) from each member of the pool will be known.
The following questions are a review of the content
on this page. Answer them and then click below to check your response.
What is the danger if the risk pool
is small? A
S
.
Basic principles of insurance include: The P
of
risks,and the Law of L
N
Click here to check your answers
What is the danger if the risk pool is small? _________ _________.
Ans. Adverse Selection.
The law of large numbers does not work with a small number of risk takers.
Basic principles of insurance include: The __________of risk and the law
of _______.
Ans. pooling
of risks (loss sharing) , & The law of large numbers.
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