Final answer:
Risk pooling in the insurance industry is essential as it allows for the spread of risk across many insured individuals, ensuring that the premiums collected are adequate to cover the claims, expenses, and profits of the insurance company. It also requires a balance of risk among insured members to maintain market stability. Therefore the correct answer is b. Risk pooling creates large groups to spread the risk level out while maximizing the amount of premiums that can be collected
Step-by-step explanation:
Risk pooling is essential for the insurance industry to exist because it spreads out the level of risk across a large group of people. When an insurance company pools the risks, it effectively ensures that the collected premiums from many are available to cover the losses of the few who need to file claims. This practice is critical to maintaining the financial stability of the insurance system. The pooling of risks enables insurance companies to collect enough in premiums to cover the unpredictable claims which might exceed the premiums paid by any individual, while also covering the administrative costs and generating a profit for the company.
Not all individuals or firms face the same level of risk, and therefore, they are often classified into different risk groups. These groups help in understanding the probability of a claim and in pricing the insurance premiums accordingly. It is important for a healthy balance to be maintained in risk pools—too many high-risk individuals can lead to higher costs for everyone and potentially result in insurance market instabilities.