What does "risk pooling" mean in insurance terminology?

"Risk pooling" refers to the process of combining multiple individuals or entities into a collective group to share the potential financial losses that may arise from uncertain events. In insurance, this concept is fundamental because it allows the insurer to manage risk more effectively by spreading it among a larger number of insured parties. When losses occur within this pooled group, the financial burden is not placed solely on one individual but is instead distributed across all members, making it more manageable for everyone involved.

This method lowers the likelihood of significant financial strain on any one member and promotes stability in the insurance system. By pooling risks, insurers can predict losses more accurately and set premiums that reflect the collective risk, thereby ensuring financial sustainability and affordability for policyholders. This highlights the crucial role of risk pooling in maintaining the overall functionality and purpose of insurance.