How does the Law of Large Numbers benefit insurers?

The Law of Large Numbers is a fundamental principle in insurance that helps insurers manage risk more effectively. This principle states that as the number of exposure units (e.g., policies or insured events) increases, the actual loss experience will more closely approximate the expected loss.

By spreading risk across more policies, insurers can rely on the predictability of losses. With a larger pool of policyholders, the variability of individual claims is minimized, leading to a more stable and predictable financial outcome for the insurer. This allows for better forecasting of costs and premiums, enabling the insurer to set rates that are fair and sufficient to cover the expected claims.

This principle is critical to the insurance business model, as it allows insurers to offer coverage and manage their solvency while ensuring that they can pay claims when they arise. Therefore, the option referencing the spreading of risk across more policies accurately reflects how the Law of Large Numbers operates to benefit insurance companies.