Page 131 - DCOM309_INSURANCE_LAWS_AND_PRACTICES

Insurance Laws and Practices

Notes 2. The Law of Large Numbers: The principle of risk sharing only works when the law of large
numbers is operational. Under this scientific principle, the larger the group, the lesser
impact the death of one member has on the group as a whole. A group with just a hundred
or a thousand members would not work. The base would be too fragile, too susceptible to
mortality due to situations and events that lead to unexpected mass deaths (such as an
epidemic or an earthquake that would take away thousands of lives in a certain geographic
location. This is one reason why groups and individuals today transfer the risk to insurance
companies, in effect forming groups consisting of hundreds of thousands, very often
millions, of members. Hence, larger groups make insurance successful.
3. Predictable Mortality: The third principle of life insurance is predictable nature of
mortality. It is not possible to tell when a person will die. But as more than a century has
passed for the insurers recording data about health, lifestyle and mortality trends, insurers
can project life expectancies. This data is recorded in mortality tables.

Did u know? A mortality table summarizes the life span of a large number of people.
Specifically, it tells about (1) the number of deaths that will occur per 1,000 individuals at
a given age and (2) the life expectancy of an individual at any age. It charts a representative
sample of 10 million lives and follows them to age 100, when for insurance purposes, the
last person is presumed to have died.
Once the insurance company can reasonably predict how many people of a given age will
die in a given year, insurer can then project costs and premium rates. More the life
expectancy, the lesser is the cost of life insurance.
4. Investments: It may be years before a claim is made against the policy, premiums collected
minus the claims paid during the year and the other expenses of insurance company are
invested. Also, a percentage of assets is set aside as company reserves to meet the claims
as they arise.

Figure 8.1: Life Insurance: A Scientific Approach

Risk Sharing The law of large numbers

Reasons of Life Insurance being Scientific

Predictable Mortality Investments Fair and Accurate Risk Selection

5. Fair and Accurate Risk Selection: A life insurance contract is an aleatory contract. It is
based on the possibility of a chance occurrence and, in all likelihood, one side will benefit
more than the other. Fair and accurate risk assessment should be done.

Notes Especially with individual insurance policies, coverage is issued based on the
assumption of reasonable risk.

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