What is the main purpose of the Law of Large Numbers in insurance?

The main purpose of the Law of Large Numbers in insurance is to predict and manage risk by increasing sample size. This statistical principle states that as the number of exposures increases, the actual loss experience will approach the expected loss. In the context of insurance, this means that as an insurer covers more policies or insured events, the insurer can more accurately predict the amount of claims it will face.

With a larger sample size, the insurer reduces the potential for variability in loss experience, leading to more reliable forecasts of future claims. This is crucial for setting appropriate premiums and ensuring the solvency of the insurance pool. By effectively managing risk and understanding loss probabilities, insurers can make informed decisions on policy underwriting and pricing, which ultimately contributes to the financial stability of the insurance operation.

This principle does not directly influence the premiums assigned to high-risk clients, eliminate fraud, or define adverse selection, which are separate concepts that address different aspects of insurance operations and risk management.