The business of selling insurance is based on probability and the law of large n

Question

The business of selling insurance is based on probability and the law of large numbers. Consumers buy insurance because we al face risks that are unlikely but carry high cost. Think of a fire destroying your home. So we form a group to share the risk: we all pay a small amount, and the insurance policy pays a large amount to those few of us whose homes burn down. The insurance company sells many policies, so it can rely on the law of large numbers. An insurance company looks at the records for millions of homeowners and sees that the mean loss from fire in a year is = $300 per person. (Most of us have no loss, but a few lose their homes. The $300 s the average loss) The company plans to sell fire insurance for $300 plus enough to cover its costs and profit. Explain clearly why it would be stupid to sel only 10 policies The probability of having to pay for a total loss for one or more of the 10 policies is very small, but if it were to happen, it would be financially disastrous. According to the law of large numbers, the company must sell at least 300 policies to make a profit. The probability of a house fire is high, so the company would pay for a total loss for most of the 10 policies According to the law of large numbers, the company must sell at least 1,000 policies to make a profit Explain why selling thousands of such policies is a safe business. The law of large numbers says that the company will make $300 for every policy sold The law of large numbers says that the average claim on every policy will be close to $3,000, so the insurance company will collect enough to cover the claims. The company would make a profit, even if it had to pay for a total loss for most of the policies The company only has to pay $300 per policy The law of large numbers says that the average claim on many policies will be close to $300, so the insurance company will collect enough to cover the claims

Explanation / Answer

1) option A is correct: the probability of having to pay for a total loss for one or more of the 10 policies is very small, but if it were to happen it would be financially disastrous.

2) option E)

the law of large number says that the average claim on many policies will be close to $ 300 . so the insuarnace company will collect enought o cover the claims

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