How does the law of large numbers assist insurers?

The law of large numbers is a fundamental principle in insurance that allows insurers to predict outcomes more accurately as the number of events (or exposures) increases. This principle states that as the size of a sample increases, the actual results will more closely approximate the expected results.

When it comes to claims payments, insurers benefit from this concept because it allows them to estimate the total expected losses within a given period more reliably. By collecting data across a large pool of insured individuals or entities, insurers can identify trends and probabilities associated with future claims. This predictive capability is crucial for setting premiums at levels that adequately cover expected claims, ensuring the financial stability of the insurer.

As a result, being able to reliably predict claims payments helps avoid significant discrepancies between anticipated and actual payouts, allowing insurers to manage risk and maintain solvency effectively.