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IAI Actuarial Core Principles · Economic Modelling · Role of insurance in reducing or removing risk

Which feature most directly limits the ability of an insurer to transfer risk effectively through pooling of many policyholders' risks?

Highly positively correlated risks, such as a cyclone damaging many insured properties together, limit pooling. Diversification works by independence, so with correlated losses the variance of average loss per policy does not fall as the pool grows, and the insurer keeps systematic risk.

  1. ARisks that are independent of each other across policyholders
  2. BRisks that are highly positively correlated, such as a cyclone hitting all insured properties in one coastal districtCorrect
  3. CLarge numbers of policies of similar size
  4. DPolicyholders having symmetric information with the insurer
  5. Losses that are accidental and measurable

Explanation

Pooling reduces the variance per policy only when risks are diversifiable, i.e. not strongly correlated. Correlated losses mean the variance of the average does not fall as n rises. The other options all support pooling.

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