How do insurance companies benefit from the law of large numbers?

Insurance companies benefit from the law of large numbers because it enhances their ability to predict future claims with greater accuracy. This principle states that as the number of exposure units increases, the actual loss experience will more closely approximate the expected loss. Essentially, when insurers have a larger pool of policyholders, they can analyze historical data and trends to anticipate the frequency and severity of claims.

By accurately predicting future claims, insurance companies are better positioned to set appropriate premium rates, reserve sufficient funds for claims payouts, and maintain overall financial stability. This predictive capability is fundamental for effective risk management within the industry. Hence, the law of large numbers enables insurers to calculate risks more efficiently and develop strategies that align their resources with expected obligations.