One person’s house fire is a catastrophe; a thousand independent houses share the cost more easily. Risk pooling is the practice of combining many similar exposure units so that the average loss becomes predictable and the impact on any single participant is reduced.

Insurance companies exist largely to organize these pools. Premiums from the many pay the losses of the few. The law of large numbers makes the aggregate result more stable as the pool grows, provided the risks remain reasonably independent and homogeneous.

Adverse selection and moral hazard can undermine a pool if higher-risk members join disproportionately or if insureds take less care. Underwriting, pricing differentials, and contract design keep the pool balanced. Effective pooling is what turns individual uncertainty into a manageable business proposition.

• Combining many risks to stabilize average loss
• Core economic function of insurance
• Relies on the law of large numbers
• Threatened by adverse selection and moral hazard