Insurance companies determine risk exposure by which of the following?

• A. Law of large numbers and risk pooling
• B. Small sample size and guesswork
• C. Guaranteed future performance
• D. Market volatility

Answer: (A)

The main idea is how insurers estimate and manage risk across many policyholders. As the number of independent exposures grows, the actual losses tend to align with the expected losses. This is the law of large numbers. It gives insurers a reliable basis to predict total claims and set premiums that cover those expected losses.

Risk pooling is the other piece: spreading risk across a large group means individual losses become less volatile for the insurer as a whole. The combination of many similar risks and the law of large numbers lets an insurer estimate expected losses more accurately and price policies accordingly, while also stabilizing results.

The other concepts don’t fit because a small sample size and guesswork would lead to highly uncertain predictions; guarantees about future performance aren’t possible in insurance, since losses are not guaranteed; and market volatility relates more to investment results than to the fundamental method of estimating risk exposure for underwriting.