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.

BREAKING DOWN '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. Addition Rule For Probabilities

    A statistical property that states the probability of one and/or ...
  2. Joint Probability

    A joint probability is a statistical measure where the likelihood ...
  3. Continuous Compounding

    The process of earning interest on top of interest. The interest ...
  4. Insurance Underwriter

    A financial professional that evaluates the risks of insuring ...
  5. Discrete Compounding

    Discrete compounding refers to the method by which interest is ...
  6. Posterior Probability

    The revised probability of an event occurring after taking into ...
Related Articles
  1. Investing

    Financial Forecasting: The Bayesian Method

    This method can help refine probability estimates using an intuitive process.
  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. Investing

    Accelerating Returns With Continuous Compounding

    Investopedia explains the natural log and exponential functions used to calculate this value.
  4. Investing

    Understanding the Power of Compound Interest

    Understanding compound interest is important for both investing and borrowing money.
  5. Investing

    Overcoming Compounding's Dark Side

    Understanding how money is made and lost over time can help you improve your returns.
  6. Insurance

    Behind the Law of Large Numbers in the Insurance Industry

    Discover how the law of large numbers helps insurance companies cope with risk, and why the theory does not always live up to reality.
  7. Insurance

    Bundle Your Insurance For Big Savings

    Bundling your insurance can save you money and time. Read on to see how get the most out of multiline insurance discounts.
  8. Personal Finance

    APR and APY: Why Your Bank Hopes You Can't Tell The Difference

    Banks use these rates to entice borrowers and investors. Find out what you're really getting.
  9. Investing

    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. Retirement

    Using Compounding to Boost Retirement Savings

    Allowing growth on your investments to compound over time gives you immense returns when saving for retirement.
RELATED FAQS
  1. What formula can I use to calculate interest on interest?

    Find out more about compounding interest, what it measures and how to calculate the amount of compound interest accrued using ... Read Answer >>
  2. What are examples of risks for all underwriter types?

    Learn about the risks faced by different types of underwriting activity. Explore specific examples of risks faced by insurance ... Read Answer >>
  3. What is the difference between underwriting and investment income for an insurance ...

    Learn more about insurance companies' investment and underwriting incomes. Read about how investment incomes and underwriting ... Read Answer >>
  4. How to calculate compound loan interest in Excel?

    Find out about compound interest and how to use the compounding interest formula in Microsoft Excel to calculate the compound ... Read Answer >>
Hot Definitions
  1. Net Present Value - NPV

    Net Present Value (NPV) is the difference between the present values of cash inflows and outflows. Used in capital budgeting ...
  2. Return On Equity - ROE

    The amount of net income returned as a percentage of shareholders equity. Return on equity measures a corporation's profitability ...
  3. Bond

    A bond is a fixed income investment in which an investor loans money to an entity (corporate or governmental) that borrows ...
  4. Whole Life Insurance Policy

    A life insurance contract with level premiums that has both an insurance and an investment component. The insurance component ...
  5. Compound Annual Growth Rate - CAGR

    The Compound Annual Growth Rate (CAGR) is the mean annual growth rate of an investment over a specified period of time longer ...
  6. Capital Asset Pricing Model - CAPM

    A model that describes the relationship between risk and expected return and that is used in the pricing of risky securities. ...
Trading Center