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Which principle asserts that as the number of insured individuals increases, the actual loss experience becomes more predictable?

  1. Law of averages

  2. Law of large numbers

  3. Law of diminishing returns

  4. Law of risk reduction

The correct answer is: Law of large numbers

The principle that asserts that as the number of insured individuals increases, the actual loss experience becomes more predictable is the Law of Large Numbers. This statistical concept is fundamental in insurance because it demonstrates that with a larger population of insured entities, the variations and fluctuations in loss experiences become less pronounced. As more individual risks are pooled together, the overall risk becomes more stable and predictable. This is because extreme individual losses are averaged out across a larger group, leading to a more accurate estimation of future losses. Insurers rely on this principle to set premiums and reserve sufficient funds to pay claims, ensuring they can cover the losses of all policyholders effectively. In contrast, the Law of Averages suggests a misinterpretation of probability where outcomes are expected to balance out over a short term, which is not the foundation upon which insurance operates. The Law of Diminishing Returns typically relates to production inputs and outputs rather than risk assessment in insurance. The Law of Risk Reduction is not a recognized principle in this context. Thus, the Law of Large Numbers accurately captures the essence of predictability in insurance as the number of insured individuals grows.