What is risk pooling and how does it benefit low-probability high-cost events?

• A. Spreading risk across many individuals; subsidies high-cost individuals through the group.
• B. Spreading risk across a single individual.
• C. Reducing premiums to zero for all insured.
• D. Substituting individual risk with government risk.

Answer: (D)

Risk pooling means spreading the chance of a very costly event across a large group so no one person bears the full burden. When many people contribute to a common pool, the rare, high-cost claims can be paid out from the pool’s funds, making the cost to any individual more affordable and stable. Within the pool, costs can be cross-subsidized so those with higher anticipated costs aren’t faced with prohibitive bills on their own. Substituting all individual risk with government risk describes a different setup (social insurance administered by the government), not the typical insurance idea of a shared pool among individuals. The essence is that shared contributions cover the expensive events for many, not that costs disappear, or that risk is handed over entirely to the government.