Question

What is meant by the insurance concept that risks are pooled or shared? How does each business benefit from pooling risks? Are there any disadvantages to a business from pooling its risks with others?

Answer 1

Risk pooling, in terms of insurance, means spreading the risk (due to unplanned incidence/catastrophe) evenly among a large population of contributors. Risks normally mean a financial risk, that may be huge for a single individual or entity and transferred to a larger consortium in exchange for a premium. In simplistic terms, each contributor, pays a premium (much lower than the risk) and sum total of all premiums is used to pay the any of the contributor who actually faces the unfortunate incidence. Normally higher the risks associated, higher are the premiums.

Each business benefits as it is able to protect its interest in event of unfortunate incident only for a small sum of premium. Thus, mitigating the risk and its effects. Thus, business are able to plan their resources better and use them optimally for growth and operations.

The disadvantages of risk pooling could be

1) in case the unfortunate event does not occur the premium amount is lost (in pure insurances)

2) in case there are too many claims then the insurance provider may not be able to pay all the dues to all the parties (usually a result of poor risk assessment)