Risk Pooling

In insurance, the term "risk pooling" refers to the spreading of financial risks evenly among a large number of contributors to the program. Insurance is the transference of risks from individuals or corporations who cannot bear a possible unplanned financial catastrophe to the capital markets, which can bear them easily -- at least in theory. The capital markets, meanwhile, are generally happy to take on risk from individuals and corporations -- in exchange for a premium they believe is sufficient to cover the risk.

             

                                           Risk pooling is essential to the concept of insurance. The earliest known insurance policies were written some 5,000 years ago, to protect shippers against the loss of their cargo and crews at sea. Any one of them would be devastated by the loss of a ship. But by pooling their resources, these ancient businessmen were able to spread the risks more evenly among their numbers, so each paid a relatively small amount. Under the Babylonians, those receiving a loan to fund a shipment would pay an additional amount in exchange for a rider cancelling the loan if a shipment should be lost at sea.