LAW OF Large numbers
Overall, we’re a pretty safe group of people. Everyone doesn’t have a loss
all the time. For this reason, by predicting the number of losses that will occur, an insurance company can provide large amounts of insurance for relatively little money. To help them predict their losses accurately so they can charge the proper premiums needed to accumulate adequate funds, insurance companies rely on the law of large numbers.
The law of large numbers says that the more examples used to develop any statistic, the more reliable the statistic will be.
Consider these statistics.
- Four out of five homes have defective wiring. To determine this, 15 homes were checked.
- Three out of four automobiles will suffer some form of tire damage each year. Five million auto owners were surveyed.
- The law of large numbers tells us that the tire statistic will be more accurate than the wiring statistic in predicting what will happen in the future because the tire statistic is based on many more examples.