Massachusetts Life Producer Practice Exam

How does an insurer utilize the law of large numbers in their business practice?

1. To increase risk rates

2. To deny claims

3. To better predict incurred losses

4. To obfuscate liability terms

The correct answer is: To better predict incurred losses

Insurers utilize the law of large numbers to better predict incurred losses by analyzing data from a larger pool of insured individuals over time. This principle posits that as the number of exposures (or insured risks) increases, the actual results will more closely approximate the expected results. In simpler terms, the more data and experiences an insurer collects, the more accurately they can assess the likelihood and frequency of certain risks, leading to more precise predictions of losses. By relying on large datasets, insurers can identify patterns and trends, such as the average cost of claims and the likelihood of claims being filed. This knowledge allows them to set appropriate premiums, manage risk effectively, and ensure that their reserves are adequate to cover future claims. Overall, the law of large numbers fosters a more stable and predictable insurance environment, ultimately contributing to the financial health of the insurer.