What is the key advantage of pooling risks for insurers?

Pooling risks allows insurers to manage uncertainty and predictability within the insurance framework effectively. By gathering a large number of risks into a single pool, insurers benefit from the Law of Large Numbers, which states that as the size of the sample increases, the actual results will more closely approximate the expected results.

This means that the number of claims that arise from the pooled risks is more likely to align with the underlying probability of those claims occurring. When risks are pooled, the insurer can spread the risk over many policyholders and have a clearer statistical understanding of potential losses. This enhances their ability to set premiums accurately and maintain financial stability.

While increased attraction of risks, limiting losses, or providing guarantees against higher-than-expected losses are elements related to risk management, they do not encapsulate the primary operational benefit of pooling risks, which fundamentally hinges on the statistical predictability stemming from a larger sample size. Thus, understanding that the number of claims corresponds closely to the predicted probabilities is essential in the functioning of insurance as a risk management tool.