South Carolina Personal Lines Practice Exam

What law is utilized for statistical prediction of loss in calculating insurance rates?

1. Law of averages

2. Law of large numbers

3. Law of diminishing returns

4. Law of probability

The correct answer is: Law of large numbers

The law that is utilized for statistical prediction of loss in calculating insurance rates is the law of large numbers. This principle states that as the number of exposure units increases, the actual loss experience will converge towards the expected loss experience. In the context of insurance, the more policies an insurer underwrites, the more predictable the overall losses become. This allows insurers to set premiums more accurately based on the statistical analysis of large datasets, leading to more reliable forecasting of future claims. By relying on this law, insurers can spread the risk across a larger group of policyholders, which stabilizes their financial outcomes and ensures they can meet future claims. The law of large numbers is fundamental to the insurance industry, enabling actuaries and underwriters to establish rates that are both competitive and sufficient to cover the anticipated losses. The other laws mentioned, while relevant in different contexts, do not specifically help in calculating insurance rates. The law of averages is a more general concept that doesn't necessarily apply specifically to the statistical basis of insurance. The law of diminishing returns relates to the output of production and its relationship to input factors, which is outside the realm of statistical predictions for insurance. The law of probability deals with the likelihood of events occurring but does not directly imply the consequences for large groups