What does "risk pooling" refer to in insurance?

Risk pooling refers to the practice of grouping multiple policyholders together to share the financial risk associated with insurable events. By gathering a larger number of individuals or entities, the insurance provider can predict and distribute the costs associated with claims more effectively. This concept is fundamental to how insurance works, as it enables the insurer to charge lower premiums based on the collective risk of the pool rather than assessing each policyholder individually. It helps create stability in the insurance market, ensuring that there are sufficient funds available to pay out claims while also allowing for a more efficient and equitable way of managing risk across a diverse group of individuals.

The other concepts presented, while related to insurance, do not accurately define risk pooling. Underwriting focuses on evaluating the risks of insuring specific individuals; reducing premium costs may be a benefit of risk pooling but is not the definition itself; and investment strategies relate to how funds are managed rather than the pooling of risk among policyholders.