It is said that the basis of insurance is the spread of risk. How is this achieved?
Select one:
a.
Take the risks of the few and spread them amongst the many, i.e. reinsurance.
b.
Financers underwrite a portion of the risk.
c.
Place the risk at Lloyds.
d.
Insurers underwrite only a portion of the risk.
Expert Answer
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The correct option is a. Take the risks of the few and spread them amongst the many, i.e. reinsurance.
The basis of insurance is the concept of risk pooling. This means that the insurance company takes the risks of a large number of people and spreads them out over a large population. This way, if one person makes a claim, the cost is not borne by that individual alone, but by all of the people in the pool.
Reinsurance is a form of risk pooling that allows insurance companies to spread their risk even further. In reinsurance, an insurance company (the reinsurer) agrees to take on a portion of the risk from another insurance company (the ceding company). This allows the ceding company to reduce its own risk exposure and to make its premiums more affordable.
The other options are incorrect because:
Option b is not the basis of insurance. Financers do not underwrite risks.
Option c is not the basis of insurance. Lloyd’s is a specific insurance market, not a general concept.
Option d is not the basis of insurance. Insurers do not underwrite only a portion of the risk. They underwrite all of the risk, but they may transfer some of that risk to reinsurers.
So, the answer is a.
Conclusion:
Insurance is based on the principle of risk pooling. This means that the insurance company takes the risks of a large number of people and spreads them out over a large population. This way, the cost of any one claim is not borne by a single individual, but by everyone in the pool.
Reinsurance is a form of risk pooling that allows insurance companies to spread their risk even further. This can help to make insurance premiums more affordable and to ensure that insurance companies are able to remain solvent even if a large number of claims are made.