Why risk pooling

The insurance industry basically runs on the concept of risk pooling. The earliest references to insurance policies and risk pooling can be found some years back. Traders and merchants pooled their resources and shared the common risk of damage or loss of goods.

That covered the merchants from sudden damage or loss of goods by relatively paying less amount for the recovery. The insurance industry has now grown into a major business which plays a significant role in shaping the Economy. More and more people are seeking to transfer their risks to the companies as a part of the Insurance pool.

Different types of Insurance cover different aspects of life and living, but the basic principle of risk pooling remains the same. Actuaries - professionals in finance - work for the Insurance companies and calculate the probability and severity of the risk. Accordingly, they calculate the cost of pooling one's risk with that of others through the Insurance company. While calculating, some limits are put to covering a certain entity even if it is at high-risk.

For eg. Insurance companies use the actuarial data to calculate the risk of an individual considering their profile and demographic group.

So, as the risk related to the individual increases, the cost of insurance also increases. There are numerous practical difficulties in making integration operational, so the report offers some guidance on implementation, noting that optimal design of risk pooling arrangements depends heavily on local circumstances.

It concludes with suggestions for a number of measures of health system performance that can offer indications of the success of risk pool integration. Skip to main navigation.

But by pooling their resources, these ancient businessmen were able to spread the risks more evenly among their numbers, so each paid a relatively small amount.

Under the Babylonians, those receiving a loan to fund a shipment would pay an additional amount in exchange for a rider cancelling the loan if a shipment should be lost at sea. The insurance industry grew enormously, as individuals and businesses sought to protect themselves from economic catastrophe by transferring their risks to an insurance pool. We still have commercial shipping insurance — just as we did in the ancient world — and we also insure against such diverse risks as fires, floods, theft, auto accidents, kidnap and ransom schemes, defaults on the part of our debtors, lawsuits and judgments, dying too early and even against the risk of living too long.

A class of professional experts in finance and probability, called actuaries, work for insurance companies to attempt to predict the probability and severity of risk. They also take lapse rates and interest rates or other expected rates of return on investment assets into account, with the goal of setting acceptable premiums.

The premium is the cost of pooling one's own risk with that of others via an insurance company and includes the insured's share of expected claims costs, administrative expenses, sales and marketing expenses, and a profit for the insurer.

If a premium payer is affected by a covered risk, the insurance company, and not the insured, takes the hit. If claims are higher than expected, however, the insurance company may have to raise rates on policy holders across the board.

About Marsh Leadership Media Careers. The success of some larger captive pools, along with the increasing number of captives forming to take advantage of the Section b election under the Internal Revenue Code has led to rapid growth in the establishment of small captive pooling facilities. Of most concern to the IRS is whether the pooling arrangement actually provides members with sufficient risk shifting and distribution and whether lines insured in the facility represent true insurance risks.

Despite greater IRS scrutiny, continued growth is expected in well-structured pooling arrangements for captives of all sizes given the inherent benefits of third-party premium, risk diversification, and underwriting stabilization. By sharing its individual loss experience with other pool members, a captive participating in a risk pool can experience some or all of the following benefits: Diversification of its underwriting portfolio.

Reduction in the variability of retained captive losses by trading its own losses for a smaller portion of a large pool of more diversified losses. Stabilization of cash flow. Most Common Concerns With Risk Pooling One drawback of risk pooling is that members have no control over the underlying loss control and claims management of other pool members from whom they are assuming losses.