What does "risk pooling" mean in the context of insurance?

Risk pooling in the context of insurance refers to the practice of grouping individuals together to spread financial risk among them. This concept is fundamental to how insurance operates, as it allows the costs of potential losses to be shared across a larger group. When individuals pay premiums into a common fund, those funds are used to cover claims from those who experience losses, such as illnesses or accidents. By pooling risks, insurance companies can stabilize the cost of premiums, reducing the financial burden on any single individual who may face high costs due to unexpected events. This collective approach decreases the likelihood that the insurance provider will face large claims that it cannot cover, thereby promoting financial viability for the insurer and providing a safety net for the insured.

Options that discuss the distribution of agents or forecast claims do not capture the essence of risk pooling, as they relate more to the operational aspects of insurance rather than the fundamental principle of sharing risk among a group. The mention of pooling resources to form new insurance companies also deviates from the essence of risk pooling, which fundamentally concerns the sharing of existing financial risks, rather than the creation of new entities.