Examkin

Question

Difficulty: EasyLaw of Large Numbers

An insurance company wants to utilize the Law of Large Numbers to improve the accuracy of its predicted aggregate losses for the upcoming year. Which action best demonstrates the correct application of this principle?

  1. Insuring a greater number of similar exposure units to accurately predict total group losses, even though individual losses remain unpredictable.Answer
  2. B
    Offering new policies that insure businesses against market unprofitability to balance the portfolio.
  3. C
    Avoiding the risk entirely by retaining the funds and choosing to self-insure the existing portfolio.
  4. D
    Stabilizing the insurer's loss ratio by having a reinsurer directly handle and pay all individual policyholder claims.

Answer

Insuring a greater number of similar exposure units to accurately predict total group losses, even though individual losses remain unpredictable.
The correct answer accurately captures the essence of the Law of Large Numbers. By pooling a large number of homogeneous exposure units, the insurer can statistically predict the total number of losses for the entire group with greater accuracy. This statistical predictability applies only to the aggregate group and cannot determine exactly which individual policyholder will experience a loss.

Step-by-Step Solution

1
Identify the core principle of the Law of Large Numbers.
The principle states that a larger pool of similar (homogeneous) exposure units leads to more accurate predictions of expected losses.
Knowing the definition is necessary to identify its correct application.
2
Analyze the options to see which one aligns with the requirement for homogeneous exposure units and aggregate loss predictability.
Only the option describing an increase in similar exposure units to forecast total group losses matches the principle.
The correct answer must demonstrate pooling of pure risks for statistical predictability.

Key Concept

Law of Large Numbers
Rate this question

Topics

Law of Large Numbers

More questions from this topic