What does the law of large numbers enable an insurer to do?

The law of large numbers is a fundamental principle in the field of insurance that allows insurers to predict losses with greater accuracy. This concept states that as the number of similar but independent risks increases, the actual results will come closer to the expected outcomes. In practical terms, when an insurer collects data from a large number of similar policies, they can use this historical data to estimate future claims and losses more reliably.

By pooling a large number of similar risks, insurers can smooth out the variations in individual claims, making it easier to predict costs and set appropriate premiums. This statistical approach helps insurers maintain financial stability and ensures that they have enough reserves to cover future claims. Therefore, the law of large numbers is crucial for insurers in their risk assessment and financial planning processes, enabling them to operate effectively within the insurance market while fulfilling their obligations to policyholders.