In the context of insurance, should covered losses be independent?

In the context of insurance, covered losses are generally not required to be independent. This concept stems from the nature of risk pooling, which is fundamental to insurance. Insurers operate on the principle that they can predict and manage losses based on large numbers of similar risks. When losses are dependent—meaning that the occurrence of one loss might increase the likelihood of another—the insurer must account for this correlation in their pricing and risk assessment.

For example, if a catastrophic event occurs, such as a flood, several policyholders in the same geographic area may all file claims simultaneously. If these claims were completely independent, the insurer would not face a concentrated risk, making the situation manageable. However, when losses are dependent, the potential for cumulative losses is greater, impacting the insurer's ability to fulfill claims, manage their reserves, and maintain overall financial stability.

Thus, the notion that losses should be independent is not aligned with how insurance operates in practice. While insurers can manage risk through various techniques, including diversification and reinsurance, losses in real-world scenarios often exhibit dependencies that can influence pricing and overall risk exposure. This idea reflects the complexity of risk assessment in the insurance industry.