Theory of Probability

Definition - What does Theory of Probability mean?

The theory of probability (also known as probability theory or theoretical probability) is a statistical method used to predict the likelihood of a future outcome. This method is used by insurance companies as a basis for crafting a policy or arriving at a premium rate.

Insuranceopedia explains Theory of Probability

The theory of probability aims to establish patterns for the occurrence of various types of events by using mathematical or statistical methods.

Insurance companies use this approach to draft and price policies. When issuing health insurance, for instance, the policy given to a smoker is likely more expensive than the one issued to a non-smoker. Statistical figures show a stronger association with a variety of health risks for habitual smokers or those with a history of smoking. Insuring a smoker, then, is a greater financial risk given their higher probability of serious illness and, hence, of filing a claim.

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