When Everyone Claims at Once
Written by Studio AM.
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Insurance combines the risks of many policyholders. When losses are largely independent, a large pool can make the total cost more predictable than any one household's experience. One damaged house need not mean thousands of others will claim at the same time.
A flood or earthquake creates a different pattern. Many properties in the affected area may suffer together. These losses are correlated: knowing that one property was damaged can tell an insurer something about the risk to its neighbors. Adding more customers in the same exposed area may increase the size of a disaster loss without providing much diversification.
Insurers respond in several ways. They hold capital for severe events, limit concentrations of risk, and buy reinsurance, which transfers part of their exposure to other insurers. A reinsurer can combine different regions and types of risk so that one local disaster represents a smaller share of its total business.
Diversification has limits when events affect many regions or when several disasters occur close together. Pricing, coverage limits, and the resources available to pay claims therefore matter alongside the number of policyholders. Pooling remains useful, but a large pool must be examined for shared exposures, not merely counted.
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Questions
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Question 1 of 4
The passage mainly explains
The answer is C: Why correlated losses require insurers to manage shared exposure as well as pool risks.
The passage contrasts independent risks with common-event losses and explains several ways insurers manage the latter.
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Question 2 of 4
Why can combining risks from different regions help a reinsurer?
The answer is D: A single local disaster may affect a smaller share of its business.
Regional diversity reduces concentration in one event; it does not require all distant disasters to happen in different years.
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Question 3 of 4
As used here, losses that are 'correlated' are losses that
The answer is B: are related, so one can provide information about another
The neighbor example explains that losses can share a cause and therefore be related.
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Question 4 of 4
Which response to correlated losses is named in the passage?
The answer is A: Holding capital, limiting concentrations, and buying reinsurance.
The third paragraph lists these three responses.
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