What Is the Law of Large Numbers in Insurance Theory?

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The Law of Large Numbers in insurance theory is based on the idea that larger numbers of policies written result in more accurate predictions of incidents resulting in loss. This prediction also enables companies to estimate how many policies they need to write to cover the expected annual losses.

For example, if experience indicates that one out of every 75 car insurance policies results in a claim each year and the company insures 150 people, the company reasonably expects two claims per year. If the company only insures 15 people, it is harder to predict if one of those 15 is likely to be involved in an accident.