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What is a Risk Pool?

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  • Written By: Ken Black
  • Edited By: Andrew Jones
  • Last Modified Date: 03 November 2016
  • Copyright Protected:
    2003-2016
    Conjecture Corporation
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A risk pool is a risk management strategy employed by insurance companies, and some governments, to ensure that the losses from claims do not become catastrophic. In the pool, everyone shares the risk evenly, making it unlikely that even a large-scale event would affect everyone in the same way. Therefore, the risk pool is seen as a way to provide protection to the individual, while also protecting those who are providing the insurance.

Generally speaking, the safest risk pool is one that has a large number of people involved. Just as in a science or statistics experiment, the law of large numbers indicates that more consistent results will be produced by a vast sample size; the same is true with a large risk pool. As more people are added to the pool, the more predictable the income and expenses for the entity as a whole become. This offers protection not only for the companies involved, but also for the policyholders because premiums remain more stable.

In fact, if the risk pool is managed properly, the only increase in premiums should be when providers increase their fees. It is not the occasional large claim that affects premiums as much as consistent increases across the entire system. The only thing that will really affect the bottom line is a systemic increase in fees charged by providers offering services to the pool.

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There are cases, however, when a larger risk pool can be a dangerous situation. For example, during major natural disasters in localized areas, such as hurricanes, large floods, and large earthquakes, many claims may result at once, even from a very large pool. When that happens, the larger the pool within the affected area, the more liability there is for the company or companies involved. This has the potential to turn what is supposed to be a stabilizing strategy into a very destabilizing situation.

Risk pools may form in several different ways. One employer could have enough employees that pooling them together becomes a large enough pool to satisfy an insurance provider. Smaller providers may pull resources together by buying portions of other company's policies in a process known as reinsurance. This provides a method for companies with limited resources to find some protection in a larger pool. Governments sometimes bring individuals together in insurance cooperatives.

In some situations, a risk pool strategy may not work. If insurance is voluntary rather than compulsory, some policyholders may feel the risk is too great if certain clients are allowed in. Those individuals could look for another provider, or start a pool on their own in hopes that they can minimize financial risk. This leaves the original pool with nothing but high-risk clients.

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