What does the law of large numbers seek to achieve in insurance?

The law of large numbers is a fundamental principle in insurance, which states that as the number of exposure units (such as policies or insured items) increases, the actual loss experience will tend to approach the expected loss experience. This principle allows insurers to better predict and manage the risks they are underwriting.

When a large number of similar policies are written, the insurer can collect more data on loss patterns and trends. This abundance of data helps in accurately estimating potential losses and setting premiums accordingly. It reduces unpredictability and increases the reliability of statistics used for making informed decisions about pricing and risk management.

In contrast, if fewer policies are written, the variability in the potential losses tends to be much greater, making it more challenging to predict outcomes with confidence. This is why a greater volume of written policies enhances an insurer's ability to approximate loss expectations effectively.