What does pooling of risk refer to?

Pooling of risk refers to the practice where a large group of individuals or entities come together to contribute to a shared fund that is used to cover potential losses that may occur within that group. This concept is fundamental to insurance and risk management because it allows participants to mitigate the financial impact of risks that may affect any one of them. The idea is that while individual losses may be unpredictable, the collective pattern of losses can be more easily anticipated and managed through shared contributions.

When pooling occurs, each member pays into a common fund—often through premiums—creating a sizeable resource that can be utilized to cover losses experienced by any member of the pool. This distribution of risk reduces the burden on individuals since no single person or entity carries the full weight of the potential loss. The larger the pool, the more stable and effective the risk protection becomes, as the principle of large numbers helps to predict total expected losses accurately.

In contrast, insuring only high-value assets would focus solely on specific, expensive items without considering the benefits of risk sharing. Grouping beneficiaries together for risk coverage can be part of pooling but doesn't fully encapsulate the financial contribution aspect and the collective fund dynamic. Dividing risks among insurance companies refers to reinsurance and the sharing of risks at an organizational