According to the Large Loss Principle, which statement is true?

According to the Large Loss Principle, which statement is true?

• A. The maximum possible loss must be insured, even for small losses
• B. Small losses should be paid with savings rather than insurance
• C. Insurance should cover only large losses, ignoring small losses
• D. Premiums should be set based on average losses

Answer: (B)

Under the Large Loss Principle, risk financing is designed so that insurance protects against large, potentially ruinous losses, while small, frequent losses are absorbed from internal resources. This keeps insurance costs from being dominated by many minor risks and preserves capacity for the big events. Hence, small losses should be paid from savings rather than insured, aligning with paying minor hits out of pocket and using insurance for the truly substantial losses. The other ideas push insurance coverage for small losses, ignore the need to fund small losses, or price premiums purely on averages, which don’t reflect the focus on limiting exposure to large, damaging events.

Under the Large Loss Principle, risk financing is designed so that insurance protects against large, potentially ruinous losses, while small, frequent losses are absorbed from internal resources. This keeps insurance costs from being dominated by many minor risks and preserves capacity for the big events. Hence, small losses should be paid from savings rather than insured, aligning with paying minor hits out of pocket and using insurance for the truly substantial losses. The other ideas push insurance coverage for small losses, ignore the need to fund small losses, or price premiums purely on averages, which don’t reflect the focus on limiting exposure to large, damaging events.