Why should losses not be catastrophic to the insurer?

Why should losses not be catastrophic to the insurer?

• A. One event with one claim is not a problem for insurers
• B. One event with many claims can threaten solvency
• C. Catastrophic losses are easier to price
• D. Catastrophic events can't occur

Answer: (B)

The key idea is concentration risk and solvency. Insurance works by spreading risk across many policies so that the total claims stay manageable. When a single catastrophic event triggers a large number of claims at once, the insurer faces a huge spike in liabilities that can overwhelm reserves and capital, threatening the company’s ability to pay all claims. That’s why losses should not be catastrophic: the financial cushion provided by premiums, investment income, capital, and reinsurance must be large enough to absorb such a surge. To manage this, insurers diversify across products and regions and buy reinsurance or catastrophe protection to cap the maximum impact of any one event. This protection isn’t perfect, but it helps keep solvency safer in extreme scenarios. The other statements don’t fit because a catastrophe involves many claims from one event (not just one claim), pricing such extreme losses is difficult due to tail risk, and catastrophic events can and do occur.

The key idea is concentration risk and solvency. Insurance works by spreading risk across many policies so that the total claims stay manageable. When a single catastrophic event triggers a large number of claims at once, the insurer faces a huge spike in liabilities that can overwhelm reserves and capital, threatening the company’s ability to pay all claims. That’s why losses should not be catastrophic: the financial cushion provided by premiums, investment income, capital, and reinsurance must be large enough to absorb such a surge. To manage this, insurers diversify across products and regions and buy reinsurance or catastrophe protection to cap the maximum impact of any one event. This protection isn’t perfect, but it helps keep solvency safer in extreme scenarios. The other statements don’t fit because a catastrophe involves many claims from one event (not just one claim), pricing such extreme losses is difficult due to tail risk, and catastrophic events can and do occur.