Massachusetts Life Producer Practice Exam

According to the law of large numbers, how would losses be affected if the number of similar insured units increases?

1. Predictability of losses will be improved

2. Losses will decrease significantly

3. Insurance premiums will be higher

4. Risk becomes unmanageable

The correct answer is: Predictability of losses will be improved

The law of large numbers is a fundamental principle in insurance and probability that states that as the number of similar insured units increases, the actual losses will become closer to the expected losses. This principle allows insurers to predict with greater accuracy the total amount of losses they might incur. When the number of similar insured units increases, the predictability of losses improves because the variability, or risk, spreads over a larger group. This means that the insurer can use historical data more effectively to estimate future claims. With a larger pool of insureds, random fluctuations in losses tend to average out, leading to more stable and predictable outcomes. This improved predictability is essential for insurers to establish accurate premium rates and maintain financial stability. It helps them determine how much to charge in premiums while still being able to cover claims, thereby ensuring the company’s viability in the long term. The other options do not align with the principles of the law of large numbers. For example, simply increasing the number of insureds does not inherently decrease losses or make risk unmanageable; rather, it makes losses more predictable. Additionally, while premiums could change as a result of improved predictability, they wouldn’t necessarily be higher just because there are more insured units. Thus, the correct answer highlights