What is the principle of risk pooling in insurance?

The principle of risk pooling is fundamentally based on the idea of spreading risk across a large group of individuals or entities. This diversification allows insurance companies to collect premiums from many policyholders, which helps to cover the costs associated with claims made by a relatively smaller number of insured individuals. By having a large pool of policyholders, the insurer can average out the risks, leading to a more stable and predictable financial environment.

Lowering premiums is a significant benefit of risk pooling, as it enables insurers to keep costs manageable for policyholders. When risk is spread over a larger number of people, the likelihood of any single individual making a claim in any given time period decreases, thereby allowing the insurer to offer lower premiums to policyholders. This concept is central to the operation of insurance as it allows for affordability and accessibility of coverage.

In contrast to the correct choice, other options do not accurately reflect the core idea of risk pooling. The focus on increasing potential profits from high-risk policies does not encapsulate the primary aim of making insurance more affordable and accessible through risk distribution. Minimizing the number of insured events is contrary to the objective of insurance, which is to cover risks. Targeting only high-value assets would limit the pool to those able to afford high-value premiums