What circumstances could violate the assumption of independence of the policies? Choose the correct answer.

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BlackTom AI · Accepted Answer

Question restatement: What circumstances could violate the assumption of independence of the policies? Choose the correct answer.

Option A: A major catastrophe occurs, with many policies in an area.

Analysis of Option A: A major catastrophe affecting many policies in a shared area creates correlated losses. When multiple policies experience claims simultaneously due to the same event (e.g., earthquake, flood, hurricane), the outcomes are no longer independent—claims are linked by the common event. This directly violates the independence assumption used in many actuarial models and risk pooling, which relies on the idea that one policy's claim does not predict another's.

Why this option is correct: Independence assumes that the occurrence and size of losses on one policy are not systematically related to losses on other policies. A catastrophe introduces a common cause and heavy tail in the joint distribution of losses, creating dependence between policies. In practice, insurers model such events with catastrophe modeling and reinsurance because the independence assumption fails under extreme, area-wide events.

Why other options would be incorrect: There are no additional options provided to evaluate, so this section cannot compare alternatives. In general, incorrect alternatives would typically suggest scenarios where losses stay unrelated or where dependence is not introduced; such statements would fail to recognize how a shared exposure or common risk factor (like a catastrophe) creates correlation among claims. However, given the provided option, the catastrophe scenario is the one that clearly breaks independence by introducing a common cause across multiple policies.

BUSI_V 291 202 2024W2 Ch 06 Quiz Level 2

What circumstances could violate the assumption of independence of the policies? Choose the correct answer.

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