Compound Probability

AAA

DEFINITION of 'Compound Probability'

A mathematical term relating to the likeliness of two independent events occurring. The compound probability is equal to the probability of the first event multiplied by the probability of the second event. Compound probabilities are used by insurance underwriters to assess risks and assign premiums to various insurance products.

INVESTOPEDIA EXPLAINS 'Compound Probability'

The most basic example of compound probability is flipping a coin twice. If the probability of getting heads is 50% (.50), then the chances of getting heads twice in a row would be (.50 X .50), or .25 (25%).


As it relates to insurance, underwriters may wish to know, for example, if both members of a married couple will reach the age of 75, given their independent probabilities. Or, the underwriter may want to know the odds that two major hurricanes hit a given geographical region within a certain time frame. The results of their math will determine how much to charge for insuring people or property.

RELATED TERMS
  1. Insurance Underwriter

    A financial professional that evaluates the risks of insuring ...
  2. Conditional Probability

    Probability of an event or outcome based on the occurrence of ...
  3. Premium

    1. The total cost of an option. 2. The difference between the ...
  4. Actuary

    A professional statistician working for an insurance company. ...
  5. Casualty Insurance

    A broad category of coverage against loss of property, damage ...
  6. Priori Loss Estimates

    A technique used by insurance companies to calculate loss reserves.
RELATED FAQS
  1. What is the difference between moral hazard and adverse selection?

    Adverse selection occurs when there's a lack of symmetric information prior to a deal between a buyer and a seller, whereas ... Read Full Answer >>
  2. What is the difference between a simple random sample and a stratified random sample?

    Simple random samples and stratified random samples differ in how the sample is drawn from the overall population of data. ... Read Full Answer >>
  3. What are the advantages and disadvantages of using systematic sampling?

    As a statistical sampling method, systematic sampling is simpler and more straightforward than random sampling. It can also ... Read Full Answer >>
  4. What is the difference between the standard error of means and standard deviation?

    The standard deviation, or SD, measures the amount of variability or dispersion for a subject set of data from the mean, ... Read Full Answer >>
  5. What is the theory of asymmetric information in economics?

    The theory of asymmetric information was developed in the 1970s and 1980s as a plausible explanation for common phenomena ... Read Full Answer >>
  6. What is the difference between the loss ratio and combined ratio?

    The loss ratio and combined ratio are two ratios used to measure the profitability of an insurance company. The loss ratio ... Read Full Answer >>
Related Articles
  1. Fundamental Analysis

    Find The Right Fit With Probability Distributions

    Discover a few of the most popular probability distributions and how to calculate them.
  2. Insurance

    Is Insurance Underwriting Right For You?

    If you have excellent analytical skills and an eye for detail, this may be your calling.
  3. Home & Auto

    Selecting The Right Mix Of Insurance Benefits

    Choosing employee benefits involves weighing the probability you will need them against taxes and cost.
  4. Active Trading Fundamentals

    Bet Smarter With The Monte Carlo Simulation

    This technique can reduce uncertainty in estimating future outcomes.
  5. Fundamental Analysis

    What is Quantitative Analysis?

    Quantitative analysis refers to the use of mathematical computations to analyze markets and investments.
  6. Fundamental Analysis

    Understanding the Simple Random Sample

    A simple random sample is a subset of a statistical population in which each member of the subset has an equal probability of being chosen.
  7. Economics

    What is Systematic Sampling?

    Systematic sampling is similar to random sampling, but it uses a pattern for the selection of the sample.
  8. Economics

    What is Adverse Selection?

    Adverse selection occurs when one party in a transaction has more information than the other, especially in insurance and finance-related activities.
  9. Fundamental Analysis

    Explaining Expected Return

    The expected return is a tool used to determine whether or not an investment has a positive or negative average net outcome.
  10. Fundamental Analysis

    Explaining the Geometric Mean

    The average of a set of products, the calculation of which is commonly used to determine the performance results of an investment or portfolio.

You May Also Like

Hot Definitions
  1. Fiduciary

    1. A person legally appointed and authorized to hold assets in trust for another person. The fiduciary manages the assets ...
  2. Expected Return

    The amount one would anticipate receiving on an investment that has various known or expected rates of return. For example, ...
  3. Carrying Value

    An accounting measure of value, where the value of an asset or a company is based on the figures in the company's balance ...
  4. Capital Account

    A national account that shows the net change in asset ownership for a nation. The capital account is the net result of public ...
  5. Brand Equity

    The value premium that a company realizes from a product with a recognizable name as compared to its generic equivalent. ...
Trading Center