Final answer:
Pooling risks in the insurance company helps spread potential losses across a large group of policyholders. Classifying policyholders into risk groups and charging premiums based on expected losses can help ensure fairness in cost distribution.
Step-by-step explanation:
Pooling risks is a concept used in the insurance industry to mitigate the financial impact of high-risk individuals. When an insurance company pools the risks of its policyholders, it spreads the potential losses across a large group, which reduces the overall risk for the company. However, if the insurance company raises premiums to cover the losses of high-risk individuals, it may discourage low or medium-risk individuals from buying insurance.
One way to address this issue is to classify policyholders into risk groups based on their likelihood of experiencing an adverse event. The insurance company can then charge each group according to their expected losses. This approach, known as actuarial fairness, ensures that the premiums paid by a person in a risk group are equal to the amount they would receive in insurance payments on average. By doing so, the insurance company can ensure a fair distribution of costs among policyholders.
In summary, pooling risks in an insurance company helps spread the potential losses across a large group of policyholders. However, the company needs to balance the need to cover high-risk individuals' losses without discouraging low or medium-risk individuals from buying insurance. Classifying policyholders into risk groups and charging premiums based on expected losses can help achieve a fair distribution of costs.