What is meant by the spread of risk?

The concept of the spread of risk refers to the practice of distributing policies across a wide range of individuals, businesses, or geographical locations in order to minimize potential catastrophic losses. By spreading risk, an insurer can mitigate the impact of any single loss instance on its overall portfolio. This diversification means that not all insured parties are likely to experience losses at the same time, which helps maintain the financial stability and solvency of the insurance company.

For instance, if an insurer only sells policies in a high-risk area, such as a flood-prone region, a natural disaster could lead to a large number of claims simultaneously, resulting in significant financial strain. Conversely, spreading risk across various demographics, geographic regions, and risk levels allows the insurer to absorb losses more effectively and provide more consistent coverage for its policyholders. This strategy is fundamental in the insurance industry, as it enhances resilience against losses that could threaten its ability to pay claims.

The other choices focus on risk concentration or reducing the number of policies, which could actually increase financial vulnerability and do not contribute to effective risk management.