Pooling Arrangements and Diversification of Risk

  Pooling arrangement means sharing loss and risks equally or split evenly any accident costs. As a result pooling arrangements reduce risks (standard deviation) for each participant. In pooling arrangements the average loss is paid by each person.   

The probability distribution of accident costs facing each person is reduced by pooling arrangements. The pooling arrangement decreases the probabilities of the extreme outcomes. In pooling arrangements each person’s risk is reduced but each person’s expected accident cost is unchanged. 

  The pooling arrangement reduces risks through diversification. In pooling arrangements, the cost has become more predictable. Normally the average loss is much more predictable than each individual’s loss.    

Pooling arrangement also decreases the additional risks by adding people. By adding more people the probability distribution of each person accident cost will continue to be changed. In all the factors being held constant the risk that can be reduced through pooling arrangement increases as the number of participant’s increases. In this case the pooling arrangement decreases risk for each participant. The probability distribution would become more and more bell shaped if more participants are added.