California Life-Only & Accident and Health AgentGeneral InsuranceMedium
A group of 100,000 individuals, all aged 35 and non-smokers, are observed for mortality rates over a year. Actuaries predict, based on historical data for this demographic, that approximately 100 of them will die. This prediction relies on the principle of:
- AAdverse Selection
- BInsurable Interest
- CLaw of Large Numbers
- DRisk Pooling
Show answer & explanationAnswer & explanation
Correct answer: C. Law of Large Numbers
The Law of Large Numbers states that as the number of exposure units increases, the more closely the actual loss experience will approximate the expected loss experience. By observing 100,000 similar individuals, actuaries can make a highly accurate prediction of deaths based on historical averages.
Why the other options are wrong
- A. Adverse selection is the tendency of poorer risks to seek or continue insurance.
- B. Insurable interest is the financial stake in the subject of insurance.
- D. Risk pooling is the sharing of risks by a large number of people or entities.
Law of Large Numbers
The Law of Large Numbers states that as the number of similar exposure units increases, the more closely the actual loss results will approach the probable loss results predicted by probability theory.
- Foundation of insurance pricing and underwriting.
- Requires a large number of similar exposures.
- Increases predictability of future losses.
- Allows insurers to estimate future claims accurately.
Memory trick: Insurance relies on Large Numbers, Adverse Selection avoidance, and Insurable Interest.