Which statement about risk pooling is true?

Which statement about risk pooling is true?

• A. Increasing pool size increases insurer risk.
• B. A homogeneous pool cannot achieve equal premiums.
• C. Risk pooling reduces risk to the insurer due to the law of large numbers.
• D. Moral hazard is not affected by pooling.

Answer: (C)

Risk pooling reduces the insurer’s risk by spreading it over a large group. As the pool grows, the total claims tend to reflect the average expected claims, and the fluctuations of individual outcomes cancel each other out. This is the law of large numbers in action, which lowers the insurer’s risk exposure. So increasing pool size doesn’t raise risk; it tends to lower it. A homogeneous pool can indeed support equal premiums because members share similar risk, so the statement that such a pool cannot achieve equal premiums isn’t correct. Moral hazard, a behavioral issue where insured individuals change their behavior because they are protected by insurance, isn’t addressed directly by pooling alone; pooling does not eliminate or guarantee the protection against such behavioral changes, and insurance design often uses deductibles or copays to manage it. Therefore, the true statement is that risk pooling reduces risk to the insurer due to the law of large numbers.

Risk pooling reduces the insurer’s risk by spreading it over a large group. As the pool grows, the total claims tend to reflect the average expected claims, and the fluctuations of individual outcomes cancel each other out. This is the law of large numbers in action, which lowers the insurer’s risk exposure.

So increasing pool size doesn’t raise risk; it tends to lower it. A homogeneous pool can indeed support equal premiums because members share similar risk, so the statement that such a pool cannot achieve equal premiums isn’t correct. Moral hazard, a behavioral issue where insured individuals change their behavior because they are protected by insurance, isn’t addressed directly by pooling alone; pooling does not eliminate or guarantee the protection against such behavioral changes, and insurance design often uses deductibles or copays to manage it. Therefore, the true statement is that risk pooling reduces risk to the insurer due to the law of large numbers.