Which statement best describes the characteristics of an effective risk pool?

• A. Large and homogeneous
• B. Small and diverse
• C. Large and heterogeneous
• D. Small and homogeneous

Answer: (A)

The key idea is that pooling works best when you have many similar risks. When a pool is large, the law of large numbers kicks in, so the average loss per participant becomes very close to the expected value, making total losses more predictable and funding more stable. If the pool is small, random fluctuations dominate and outcomes can swing widely, undermining reliability.

Keeping the pool homogeneous means the risks are similar, so the variability around that average loss stays low. This makes pricing and contributions fair and predictable. A heterogeneous mix mixes very different risk levels, which can distort the average, complicate pricing, and undermine the smoothing effect pooling is meant to achieve.

So, an effective risk pool combines a large size with similar risk profiles, maximizing predictability and stable funding.