California Property & Casualty Broker-AgentGeneral InsuranceEasy
An insurance company uses a statistical model to predict the likelihood of future claims based on historical data. This process relies on which fundamental insurance principle?
- ALaw of Large Numbers
- BPrinciple of Utmost Good Faith
- CPrinciple of Subrogation
- DPrinciple of Indemnity
Show answer & explanationAnswer & explanation
Correct answer: A. Law of Large Numbers
The Law of Large Numbers states that as the number of exposure units (insured risks) increases, the more closely the actual losses sustained will approach the probable losses expected. This principle makes statistical prediction and accurate pricing of insurance possible.
Why the other options are wrong
- B. Utmost Good Faith requires honesty and full disclosure from both parties in an insurance contract.
- C. Subrogation allows the insurer to recover payment from a third party responsible for the loss.
- D. Indemnity ensures the insured is restored to their pre-loss condition, without profiting.
Law of Large Numbers
A fundamental principle of insurance stating that as the number of similar exposure units increases, the more accurately actual losses will reflect the statistically expected losses, allowing insurers to make reliable predictions and set accurate premiums.
- Foundation of actuarial science.
- Enables accurate loss prediction.
- Requires a large number of similar exposures.
- Reduces uncertainty for insurers.
Memory trick: S.I.L.U. for Subrogation, Indemnity, Large Numbers, Utmost Good Faith.