Combination of Many Risks into a Group Is Necessary to Make the Law of Average Apply

Our definition of life insurance, it will be recalled, involved "the transfer of risks of many individuals to one person or a group of persons". Such a combination of risks is absolutely essential if the business is to be established on a basis other than speculation or gambling. To eliminate the speculative factor it is necessary to proceed on the theory that the larger the number of separate risks of a like nature combined into one group, the less uncertainty will there be as to the amount of loss that will be incurred.

To insure a single life for $1,000 during a given year, it is clear, is in the nature of a gamble, because the individual must either die or survive that period, with the result that there is either a 100 percent, loss or gain. If the number of persons insured is increased to one hundred the element of uncertainty will still be present to a large extent, although the variations in the number dying or surviving the year will be much less than that noted in the preceding case. But if 500,000 lives of similar physical condition are combined in the same group, and more than that number of lives are now insured in each of several American companies, the fluctuation in the rate of death from year to year will vary only by the smallest fraction of 1 percent, with the result that the company will be able to determine in advance the amount of its death claims and thus to place its business upon a non-speculative basis. In fact, if the number of lives insured by a company were so large as to make the application of the law of average perfect, practically all uncertainty as to the amount of loss that would be experienced during a given period would be removed. As has been well said:

When the insurance is furnished by a company with capital or surplus which answers as a given guarantee of stability, it becomes a business, instead of a speculation, the distinction being that while an individual who assumes a single risk either loses or gains thereby the whole amount involved, the company which takes many, by means of the aggregate business reduces the possible variations to narrow limits and really makes of insurance a business attended with less peril than almost any other. . . . During a given year an individual either dies or he survives the year; the result is a 100 percent loss or a 100 percent gain, if one wagers upon the one life. But make one hundred thousand of these bets upon persons of the same age and like physical condition and the variation in the result will not be 2 percent, usually, instead of 200 percent. There is nothing more uncertain than life and nothing more certain than life insurance.