South Carolina Life Insurance Practice Exam

What is the primary purpose of the Law of Large Numbers in insurance?

1. To define the premiums

2. To predict loss statistically

3. To manage claims effectively

4. To establish policy limits

The correct answer is: To predict loss statistically

The primary purpose of the Law of Large Numbers in insurance is to predict loss statistically. This principle states that as the number of exposure units increases, the actual loss experience will more closely approximate the expected loss, allowing insurers to make more accurate predictions about future claims based on historical data. This statistical foundation is crucial for insurers as it helps them to calculate premiums, reserve funds, and manage the overall risk involved in providing insurance coverage. As a result, the Law of Large Numbers plays a fundamental role in underwriting processes and the establishment of rates, ensuring that they are set based on reliable data and trends rather than random occurrences. In contrast, while defining premiums, managing claims, and establishing policy limits are important aspects of the insurance business, they rely on the predictive power provided by the Law of Large Numbers rather than serving as its primary purpose.