Final answer:
An automobile insurance scenario with 100 drivers shows how premiums are calculated to cover total damage costs from accidents. Drivers pay a yearly premium, creating a pool of money used to distribute the financial risk of accidents.
Step-by-step explanation:
The given question can be explained using a simplified example of automobile insurance, which is a fundamental concept in business studies, particularly in the insurance sector. In this scenario, 100 drivers are split into groups based on the severity of the accidents they might incur. With no way to distinguish between low-risk, medium-risk, or high-risk drivers at the start of the year, here's how the costs break down:
60 drivers have minor incidents costing $100 each.
30 drivers have medium-sized accidents costing $1,000 each.
10 drivers have large accidents costing $15,000 each.
Without insurance, each individual facing large accidents would have to bear a significant financial burden. However, if each of the 100 drivers pays an annual insurance premium of $1,860, the total collected amount by the insurance company will be $186,000. This pool of money is then used to cover the total damage costs from all accidents, effectively distributing the risk among all the policyholders.