Pooling and diversification of risks
Risk pooling is the principle according to which all policyholders pay premiums so that those among them who experience a claim are reimbursed. This principle goes further, by pooling the various risks among themselves within the insurance company (diversification), and by pooling them between insurers (insurance pools) and with reinsurers (see the article by Patrick Thourot in this issue).
Diversification allows an insurer to ease constraints on the use of its capital. An insurance company must absolutely guarantee the reimbursement of all claims it covers. In each country, national or regional regulators define precise regulatory constraints. Part of the capital is thus blocked for the constitution of reserves: the company must invest these sums in a liquid and non-risky way (in particular in Treasury bills), to be available for repayments.
The amount of this total is strategic because it determines not only the total amount of commitments the company can make but also the sums it can invest in a riskier but more profitable way. Diversification between independent risks is one way to alleviate this constraint. The probability of having to deal with disasters of totally different natures at the same time, such as a flood in the United States, a plane crash in Europe and a factory explosion in China, etc., is so low that it it is not necessary to make provisions each year for all the risks covered.
However, the real independence of risks is difficult to determine. On the one hand, two distinct risks can be linked to the same cause. Thus, a climatic phenomenon of the El Niño type could have contrasting consequences on rainfall in different parts of the globe (drought on one continent, floods on another, or hurricanes on a third). On the other hand, one disaster can lead to others. For example, flooding in one country can cause a breakdown in the supply chain on the one hand (such as the floods in Thailand in 2011) and the resurgence of an epidemic on the other.
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