Question

Explain the concepts of risk pooling and the insurance principle. What does the insurance principle tell investors? In the same context, explain the concept and message of risk sharing. Finally, what is the implication of risk pooling and risk sharing for longer-term investing? Does risk fade in the longer run? Explain.

Answer 1

Risk pooling is the practice of bringing together risk from different insurance companies to form a pool.

Insurance principle states that the insurance contract is between the insured and the insurer. It follows principle of utmost good faith, insurable interest, principles of indemnity, contribution and subrogation. The point is that the risk willl be shared among a large group of people in which each person will pay a minimal amount of money. This money will be accumulated together and the this will form the total contribution. If any one of the insured persons faces any damage due to the risk then the money from the contribution will be given to him or her. Thus, by risk pooling or risk sharing, the insurance company will be able to reduce the risk per head and so the money that each person will have to contribute will also be less. If the practice of risk pooling and sharing is practiced over a period of time then the risk factor reduces and fades away.