Final answer:
Insurance is less viable for loss exposures involving small or highly probable losses due to administrative inefficiencies and adverse selection, which lead to unbalanced risk pools and potentially significant financial losses for insurers.
Step-by-step explanation:
Loss exposures involving only small losses or a high probability of loss are often considered uninsurable because they conflict with the basic principles of insurability and the operational model of insurance companies. Small losses may not be insurable due to administrative costs related to underwriting and processing claims, making it financially inefficient for insurers to cover them. When these minor losses are frequent, ensuring them would require high premiums relative to the benefit gained which can seem uneconomical for policyholders.
Similarly, loss exposures with a high probability of loss are challenging to insure because they can lead to adverse selection, wherein only those likely to file a claim would purchase insurance. This results in an imbalanced pool with not enough low-risk individuals to offset the high risks. As a consequence, the insurance company may have to raise premiums to cover the anticipated losses, which would discourage those with lower risk from buying insurance, further destabilizing the risk pool and causing significant financial losses to the insurer.
All insurance is based on sharing risk among many policyholders. When risks are not shared, or when information is not perfect, the system is at peril. Insurance operates on the balance between the probability of an event and the severity of its consequences, which is disrupted in scenarios with high risk frequency or low financial impact.