Homework Help

Why does the assumption of independence of risks matter in the examples of insurance?

user profile pic

anniesautos | Student, Undergraduate | (Level 1) Salutatorian

Posted May 10, 2012 at 2:46 PM via web

dislike 1 like

Why does the assumption of independence of risks matter in the examples of insurance?

2 Answers | Add Yours

Top Answer

user profile pic

pohnpei397 | College Teacher | (Level 3) Distinguished Educator

Posted May 10, 2012 at 3:11 PM (Answer #1)

dislike 2 like

This matters because it allows insurance companies to spread risks out over large pools of customers.  

The assumption of independence of risks holds that there will not be clustering of a certain kind of risk.  In other words, there will not be clusters of houses that are more likely to burn down than others or clusters of people who are more likely to die young.  This is important because it allows the spreading of risk.  If there is independence of risks, then the insurers can get a large pool of customers who are not likely to all have the same problem occur.  Because of this, the companies can get enough premiums to pay off any claims that are made.

user profile pic

belinda2378 | Student, Undergraduate | (Level 1) eNoter

Posted May 17, 2012 at 11:42 PM (Answer #2)

dislike 0 like

It matters because it presents benefits for both the insurance company as well as the insuror. It speads the risks out making it feasible to pay off claims for the insurance companies and the cutomers premiums to help themselves and possibles claims.

Join to answer this question

Join a community of thousands of dedicated teachers and students.

Join eNotes