California Life and Health Insurance Practice Exam

“Risk pooling” in insurance refers to the concept of grouping multiple policyholders together to share the costs associated with risk. This principle is foundational to how insurance operates. By pooling their risks, policyholders essentially create a common fund that is used to pay for the losses incurred by a few members of the group.

In this model, the collective contributions made by all members help mitigate the financial impact of individual losses. Since not everyone in the group will experience a loss at the same time, the costs are distributed across many participants, which makes insurance more affordable and sustainable for everyone involved. It allows insurers to stabilize their pricing structures and provide coverage to individuals who might otherwise find insurance prohibitively expensive or unavailable.

This concept helps to explain why insurance is effective, as it leverages the law of large numbers—where the more individuals are included in the risk pool, the more predictable and manageable the overall risk becomes.