Transportation Operations LINCS Practice Exam

Which mathematical law serves as the foundation of the insurance industry?

1. Pythagorean Theorem

2. Central Limit Theorem

3. The Law of Large Numbers

4. Transaction Cost Theory

The correct answer is: The Law of Large Numbers

The Law of Large Numbers is fundamental to the insurance industry because it provides the statistical basis for predicting the likelihood of certain events occurring over time. This law states that as the size of a sample increases, the average of the sample will get closer to the expected value of the population. In the context of insurance, this means that when an insurance company has a large number of policyholders, it can accurately estimate the probability of claims based on historical data. By pooling many similar risks, insurers can predict the total number of claims and the average amount that will be paid out, allowing them to set premiums appropriately. This principle helps stabilize the financial performance of the insurance company and enables it to fulfill its obligations to policyholders. While other concepts like the Central Limit Theorem provide important insights into probability distributions, they do not directly underpin the operations and financial models of the insurance sector in the same way the Law of Large Numbers does. The Pythagorean Theorem deals with geometric relationships and is unrelated to risk assessment, and Transaction Cost Theory centers on economic decisions and market exchanges, which are also not core to insurance principles.