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Rejda Rmi Ppt02a

The document discusses basic statistics and probability distributions including mean, variance and standard deviation. It also covers the law of large numbers which is important for insurance and how risk does not increase proportionately as the sample size increases for insurers.

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walidabdo274
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54 views9 pages

Rejda Rmi Ppt02a

The document discusses basic statistics and probability distributions including mean, variance and standard deviation. It also covers the law of large numbers which is important for insurance and how risk does not increase proportionately as the sample size increases for insurers.

Uploaded by

walidabdo274
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPT, PDF, TXT or read online on Scribd
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Chapter 2

Appendix

Basic Statistics
and the Law of
Large Numbers

Copyright © 2017 Pearson Education, Inc. All rights reserved.


Probability and Statistics
• The probability of an event is the long-run
relative frequency of the event, given an
infinite number of trials with no changes in
the underlying conditions.
• Probabilities can be summarized through a
probability distribution
– Distributions may be discrete or continuous
• A probability distribution is characterized by:
– A mean, or measure of central tendency
– A variance, or measure of dispersion

Copyright © 2017 Pearson Education, Inc. All rights reserved.


2A-2
Probability and Statistics (Continued)

• The mean ( ) or expected value = X P i i

• For example,
Amount Probabil XiPi
of Loss ity of
(Xi) Loss
(Pi)
$ 0 X 0.30 = $ 0
$360 X 0.50 = $180
$600 X  X i Pi
0.20 = $120
2A-3
Copyright © 2017 Pearson Education, Inc. All rights reserved.
= $300
Probability and Statistics (Continued)

• The variance of a probability distribution is:


   Pi  X i  EV 
2 2

• For the previous loss distribution,


 2  0.30(0  300) 2  0.50(360  300) 2
0.20(600  300) 2
 27,000  1,800  1,800
 46,800

Copyright © 2017 Pearson Education, Inc. All rights reserved.


2A-4
Probability and Statistics (Continued)

• The standard deviation =  2    216.33


• Higher standard deviations, relative to the
mean, are associated with greater
uncertainty of loss; therefore, the risk is
greater

Copyright © 2017 Pearson Education, Inc. All rights reserved.


2A-5
Law of Large Numbers

• The law of large numbers is the


mathematical foundation of insurance.
• Average losses for a random sample of n
exposure units will follow a normal
distribution because of the Central Limit
Theorem.
– Regardless of the population distribution, the
distribution of sample means will approach the
normal distribution as the sample size increases.
– The standard error of the sampling distribution
can be reduced by increasing the sample size
Copyright © 2017 Pearson Education, Inc. All rights reserved.
2A-6
Exhibit A2.1 Sampling Distribution
Versus Sample Size

Copyright © 2017 Pearson Education, Inc. All rights reserved.


2A-7
Exhibit A2.2 Standard Error of the Sampling
Distribution Versus Sample Size

Copyright © 2017 Pearson Education, Inc. All rights reserved.


2A-8
Law of Large Numbers (Continued)

• When an insurer increases the size of the


sample of insureds:
– Underwriting risk increases, because more
insured units could suffer a loss.
– But, underwriting risk does not increase
proportionately. It increases by the square root
of the increase in the sample size.
– There is “safety in numbers” for insurers!

Copyright © 2017 Pearson Education, Inc. All rights reserved.


2A-9

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