Page 293 - IC38 GENERAL INSURANCE

This becomes possible because of a principle known as the “Law of large
numbers”. It states that the larger the size of the pool of risks, the actual
average of losses would be closer to the estimated or expected average loss.

Example

To give a simple illustration, the probability of getting heads on a toss of the
coin is ½. But how sure can you be that you will actually get 2 heads if you toss
the coin four times?

Only when the number of tosses gets very large and closer to infinity, the
chance of getting heads once for every two tosses will become closer to one.

It follows that insurers can be sure of their ground only when they have been
able to insure a large number of insured. An insurer who has insured only a few
hundred houses, likely would be worse affected than one who has insured
several thousand houses.

Important

Conditions for insuring a risk

When does it make sense to insure a risk from the insurer‟s point of view?

Six broad requirements for a risk to be considered insurable are given in the box
below.

i. A sufficiently large number of homogenous [similar] exposure units to
make the losses reasonably predictable. This follows from the law of large
numbers. Without this it would be difficult to make predictions.

ii. Loss produced by the risk must be definite and measurable. It is difficult
to decide the compensation if one cannot say for sure that a loss has
occurred and how much it is.

iii. Loss must be fortuitous or accidental. It must be the result of an event
that may or may not happen. The event must be beyond the control of
insured. No insurer would cover a loss that is intentionally caused by the
insured.

iv. Sharing of losses of the few by many can work only if a small percentage of
the insured group suffers loss at any given period of time.

v. Economic feasibility: The cost of insurance must not be high in relation to
the possible loss; otherwise the insurance would be economically unviable.

vi. Public policy: Finally the contract should not be contrary to public policy
and morality.

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