What does the concept of "risk pooling" allow insurers to do?

The concept of "risk pooling" is fundamental to the insurance industry as it allows insurers to combine the risks of multiple policyholders. By pooling together a large group of individuals or entities, insurers can distribute the financial risk of claims across all participants. This collective approach helps in managing and mitigating losses because not all policyholders will experience a loss at the same time, and the premiums collected from the entire pool provide the funds necessary to pay out claims when they do occur.

This mechanism stabilizes the insurer's finances, enabling them to predict and model future claims more accurately, which ultimately supports the sustainability of the insurance model. The effectiveness of risk pooling lies in the principle of large numbers, which means that as the size of the pool increases, the risk becomes more predictable. Consequently, this leads to more stable premiums for policyholders, who benefit from sharing the risk.