What principle explains why larger groups yield more predictable insurance outcomes?

The law of large numbers is the principle that explains why larger groups yield more predictable insurance outcomes. This statistical concept states that as the size of a sample increases, the sample mean will get closer to the expected value, or population mean.

In the context of insurance, when a larger group of similar risks is pooled together, the variability of the outcomes can be reduced. This means the insurer can predict losses and set premiums more accurately. For example, if an insurance company insures a small group of policyholders, the costs of claims can vary significantly year to year due to random occurrences. However, with a larger group, the average losses will tend to stabilize around the expected amount, leading to more predictable and manageable overall results.

This principle is essential for insurance companies, as it allows them to calculate risk more effectively and establish rates that reflect the true nature of the risk being insured. It ultimately supports the sustainability and profitability of the insurance enterprise.