Law of Large Numbers in Insurance

Author - Webner

Law of Large Numbers is the basis for successfully running Insurance Business. If historical data is collected for several years for life insurance for example and the information like how many people died during the policy, how many claims were made etc is available then it can be deduced that on average what is the percentage of claims that will possibly be made for an insurance policy (with certain deviation of course). Law of Large NumbersOn this basis cost can be calculated and premium amount can be decided. This same concept applies to Car insurance, property insurance, health and other types of insurance. This is called Law of Large Numbers. Note that for Law of Large Numbers to work sample data must be very large. The larger the data the higher the accuracy of calculations since it will cover majority of the possible cases and average will be closure to actual practical value. Data must of similar type of risks or exposure units. Here Exposure Unit means the number of units in the insured item or person (like if $1000 of a car is 1 exposure unit then a $10000 car has 10 exposure units – more on this will be explained in upcoming lessons). Mathematical Experts who collect all this data, play with stats and come up with conclusions are called as Actuaries.

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