Principals of Life Insurance

Life insurance is based on two basic principles risk pooling (or loss sharing) and the law of large numbers.

Risk Pooling (or Loss Sharing)

Basically risk pooling or loss sharing allows that the financial loss experienced from one person's death, that would normally be catastrophic to that person's family, if spread over a large group would be very minimal. So if a group of 1,000 persons agreed to pay $10,000 to the family of anyone in the group that died, it would only cost each member $10 a year to cover the death of one individual per year. But how can you predict how many persons may die in a particular year?

The Law of Large Numbers

While one cannot predict exactly how many individuals will die in any given year, the larger the number of individual risks in a group the more certainty there is as to the amount of loss to be expected in that group. Insurance companies are uniquely qualified to predict mortality since they have been tracking mortality statistics for hundreds of thousands of people for hundreds of years. For more information on the history of life insurance see the article "The Oldest Life Insurance Company in the U.S.".