Texas Property and Casualty License Practice Exam

What is the law of large numbers in the context of insurance?

1. It describes the likelihood of multiple events occurring

2. It states that as the number of similar loss exposures increases, predictions about claims become more accurate

3. It involves the analysis of individual risk factors

4. It shows that larger groups are less predictable

The correct answer is: It states that as the number of similar loss exposures increases, predictions about claims become more accurate

The law of large numbers is a fundamental principle in the field of insurance that asserts that as the number of similar loss exposures increases, the predictions regarding claims become more accurate. This concept relies on the idea that individual variation in loss experience diminishes when viewed at a larger scale. Essentially, when insurers pool a large number of similar risk exposures, the average loss can be predicted with greater certainty because the random fluctuations of individual claims tend to average out. This allows insurance companies to set premiums more accurately and manage risk effectively. The other options explore related concepts but do not capture the essence of the law of large numbers. While the likelihood of multiple events occurring is pertinent to the insurance realm, it does not address the main idea of accuracy in predictions as the size of the dataset increases. Individual risk factors are important in underwriting but are secondary to the overarching principle that with more exposure data, predictions become more reliable. Lastly, the notion that larger groups are less predictable directly contradicts the law of large numbers, which emphasizes that larger groups, contrary to unpredictability, actually lead to better predictability in loss outcomes.