Definition
Law of Large Numbers
The law of large numbers is the statistical principle that the larger the number of similar risks pooled, the more predictable the average loss becomes.
Insurers cannot predict whether a specific individual will fall ill or crash a car, but across a large pool of similar lives the proportion of claims becomes stable and forecastable. This predictability lets actuaries set premiums that, in aggregate, cover expected claims plus expenses and margin.
The law underpins why insurance needs scale: a small pool can be derailed by a few unexpected claims, whereas a large pool's actual experience converges on the expected. It is the mathematical foundation that makes pooling of risk commercially viable.
Related terms
- ActuaryAn actuary is a professional who applies mathematics, statistics and financial theory to price insurance, value liabilities and assess long-term risk.
- Mortality TableA mortality table shows the probability of death at each age, used by actuaries to price life insurance and value liabilities.
- Pooling of RiskPooling of risk is the core insurance mechanism whereby premiums from many insured parties are pooled to pay the losses of the unfortunate few.
Plain-English explainer from The Dispatch Investors Encyclopedia. General information, not financial advice.