182
Unit 3 Nature of the Industry
Terms
law of large numbers
underwriting
adverse selection
smart systems
inspection report
Medical Information
Bureau
credit score
insurance score
actuary
ratings bureau
reinsurance
Section 10.2
How Insurers Manage Risk
Objectives
After completing this section, you will be able to:
¶ Dwok‘hmsgdk‘vnek‘qfdmtladqr-
¶ Cdehmdsgdqnkdnetmcdqvqhshmfhmhmrtq‘mbd-
¶ Cdrbqhadgnvqdhmrtq‘mbdvnqjr-
Law of Large Numbers
Insurance allows individuals and businesses to protect themselves
from financial loss by transferring risk to the insurance company. But,
what does the insurance company do to manage the risks it assumes?
The insurer must pay claims whenever a policyholder experiences
a covered loss. An important way insurance companies manage the
risks they take on is through the law of large numbers. The law of
large numbers holds that the accuracy of a statistic increases with a
greater sample size.
Insurance companies pool risk. That is, they cover a group made
up of a large number of policyholders. The probability is that only
a small number of the policyholders will experience a loss. So, the
money coming in from premiums will likely be more than the money
going out to pay covered losses.
A larger statistical
sample creates the
expected outcome of a
coin landing heads-up
50% of the time.
Source: Shutterstock (jcjgphotography)