What does the pooling of risks refer to in insurance?

Pooling of risks in insurance refers to the practice where a group of individuals or entities come together to share the financial consequences of risks they face. By contributing to a collective fund, they can cover potential losses that could affect any one member of the group. This mechanism allows the costs associated with losses to be distributed among all members, reducing the financial burden on any single individual.

When a group pools their risks, their total contributions (or premiums) create a fund that is used to pay for claims made by any member of the group who suffers a covered loss. This method is a fundamental aspect of how insurance works, as it helps ensure that everyone has access to financial support in the event of unforeseen circumstances, such as accidents, natural disasters, or health issues. This concept underlies the collaborative nature of insurance, assisting individuals in managing risks that might otherwise be financially devastating on their own.