A property insurance company insures tens of thousands of similar single-family homes across a large geographic area. According to the Law of Large Numbers, what is the primary benefit the insurer achieves by pooling this massive number of homogeneous exposure units?
- AIt transforms the underlying exposures from pure risks into speculative risks, guaranteeing a financial return.
- BIt functions as a form of risk retention, allowing the homeowners to self-insure against property damage.
- It allows the insurer to more accurately predict the expected aggregate losses for the entire pool of homes.Answer
- DIt shifts the primary legal responsibility for paying all claims directly to a reinsurer.
Answer
The correct answer is the option stating that it allows the insurer to more accurately predict the expected aggregate losses for the entire pool of homes.
The Law of Large Numbers states that as the number of similar exposure units increases, the actual losses will more closely approach the mathematically expected losses. This statistical principle is the foundation of insurance, as it allows insurers to accurately predict aggregate claims and charge appropriate premiums for the entire pool.
Step-by-Step Solution
Key Concept
The Law of Large Numbers
Estimated Time:45s