How does an insurer fulfill claims according to the principle of spreading risk?

The principle of spreading risk is fundamental to the insurance industry and revolves around the idea that insurers pool the premiums collected from many policyholders to create a financial buffer. This pooled fund is then used to pay for individual claims that occur, allowing the insurer to manage risk across a broad spectrum of insured individuals.

By utilizing pooled premiums, the insurer is essentially distributing the financial risk among all policyholders. This means that while not all policyholders will file claims at the same time, the collective contributions from everyone can cover the costs incurred from those who do. This system reduces the financial impact on any single policyholder and promotes stability within the insurance company. It’s a fundamental mechanism that enables insurance to function effectively, ensuring that funds are available when claims arise.

The other options do not accurately represent how insurers manage risk. Investing in high-reward securities carries its own risks and does not directly relate to the spreading of risk principle. Charging high premiums typically addresses underwriting risk but does not effectively spread risk across the pool of policyholders. Transferring risk to a reinsurance company is a strategy for managing risk but does not primarily involve the mechanism of pooled premiums used to pay for claims.