In this paper we present one of the main results of collective risk theory in non-life insurance mathematics, which says that for small claims the ruin probability decreases exponentially fast. The discussion is made in the context of the classical Cram\u00b4er-Lundberg model using the martingale technique.

Like most areas of mathematics, probability theory emerged from the need to deal with real-life problems. Besides its use in games of chance and astronomical data analysis, the \ufb01eld experienced a great impetus in the 19th century from applications in the social sciences: statistics, demography, economics, insurance and even law. It is then not totally surprising, though still remarkable, that the pioneering work on the most sophisticated branch of modern probability theory, that of continuous-time stochastic processes, were also related to social science applications.1

Brownian motion is used to describe price \ufb02uctuations at the Paris stock exchange. Written under the supervision of none other than Henri Poincar\u00b4e, it antedated Ein- stein\u2019s work (1905) on the physical explanation of Brownian motion and Wiener\u2019s (1923) rigorous mathematical construction, namely of Wiener process (with con- tinuous nowhere di\ufb00erentiable sample paths). It antedated as well the now almost

and Boltzmann was in part inspired by statistics as applied to social sciences. It seems that the \ufb01rst evolution equation for a probability density ever written was Boltzmann\u2019s integro-di\ufb00erential equation in 1872.

universally accepted axiomatization of probability theory laid down in 1933 by An- drei Kolmogorov (who was critical of Bachelier\u2019s lack or rigor but acknowledged his in\ufb02uence in his work on continuous-time Markov processes), not to mention It\u02c6

As is well known, this work was almost forgotten (partly due to its novelty and partly to its lack of rigor) until it was rediscovered in the 1950\u2019s and early 60\u2019s by mathematicians, physicists and economists. It gained renewed signi\ufb01cance dur- ing the intense academic work on \ufb01nancial mathematics in the wake of the deep structural changes in the global \ufb01nancial markets of the seventies (and the con- comitant computer and telecommunications revolution), a work that culminated in the Nobel-winning (1997) Black-Scholes-Merton model. By that time, the the- ory of martingales, developed in the \ufb01fties by Doob (having Wiener process as the quintessential example) and It\u02c6

tool of the modern theoretical and applied \ufb01nance specialist and the importance of Bachelier\u2019s work was internationally recognised through the celebration of the First World Congress of the Bachelier Finance Society held in Paris (2000). [14]

What is perhaps less well known is that almost at the same time as Bachelier\u2019s thesis, another pioneering work, this turn in the \ufb01eld of actuarial science, was done by the Swede Filip Lundberg. In his 1903 Uppsala thesis he uses yet another important example of stochastic process, to wit, Poisson process (with discontinuous sample paths), in modelling theruin problem for an insurance company. Extended and rigorized by Harald Cram\u00b4er in the thirties, the so-calledCram\u00b4er-Lundberg model is still a landmark of insurance mathematics (non-life branch). It wouldn\u2019t be unfair to say that it has a similar role in actuarial science as the Black-Scholes-Merton model in \ufb01nance. [12]

It is fascinating to realize that from such applications in \ufb01nance and insurance, developed almost simultaneously, the two most important examples of stochastic processes came to life.2 Interestingly, actuarial/insurance mathematics was also important in the quest for the foundations of probability theory. In fact, David Hilbert, in his famous address at 1900 International Congress of Mathematics held in Paris, included the axiomatization of probability theory as part his 6th problem (on the axiomatization of physics of which probability was thought to be a part). He makes reference to a lecture on the subject by insurance mathematician Georg Bohlmann (published in 1900) in the context of life-insurance problems (who, in turn, cites Poincar\u00b4e\u2019s 1896 textbook on probability as a main source!). [7]

amer-Lundberg model, in particular the use of martingale methods to derive the Cram\u00b4er-Lundberg estimate. The paper is structured as follows. We \ufb01rst discuss the central but subtle concept of risk in \ufb01nance and insurance and the role of the actuary as a risk manager. We then describe the classical Cram\u00b4er-Lundberg model and the related ruin problem for insurance risk. Finally we derive the Cram\u00b4er-Lundberg estimate, after which we make some concluding remarks.

Everyone agrees that the concept ofrisk is central to the disciplines of \ufb01nance and actuarial science. Ironically, however, there is no consensus on what it precisely means. It generally has the negative connotation of a \u201closs\u201d3 usually measured in monetary units. And the fact is that it may have di\ufb00erent meanings to di\ufb00erent people in di\ufb00erent situations. Thus one speaks of various \u201crisk factors\u201d in a given context. These factors are usually interconnected in complex ways and one tries to devise associated \u201crisk measures\u201d in order to obtain some quantitative estimate (and hopefully some control) of one\u2019s vulnerability to such factors.4

Risk is also commonly associated withuncertainty, a psychological category, which in turn manifests itself due to theunpredictability of certain future events. This is a typical situation in \ufb01nance and insurance, as various transactions and exchanges are contingent on the occurrence or not of certain future events, generating uncertainty regarding what could happen in-between. Consider for example therisk

(a) Ignorance, lack of information or poor/partial knowledge about the laws and mechanisms that rule this phenomenon. This is an unavoidable fact of the hu- man condition. It can in principle be mitigated with improved and continuous research; so in a sense, science can be viewed as a collective e\ufb00ort to curb such human limitations. But for an individual, incomplete information is the rule.

(b) It might be the case that even knowing in detail the laws and mechanisms involved, still the process or system dealt with has some intrinsic instability; for example, it could display sensitivity to small perturbations causing an ampli\ufb01cation of errors, leading to a disruption of any long-time predictability. This is thought to be the case of so-called \u201cchaotic dynamical systems\u201d (e.g., in meteorology).

(c) It could also happen that the system is stochastic by nature. Of course, that doesn\u2019t mean that the system\u2019s behaviour is arbitrary; quite the opposite, it means that its behaviour (or some aspects of it) is governed by the (very stringent) laws of probability.

All of the items above (and others) can of course happen simultaneously in a given situation. However, item (c), that we may call \u201cstochastic hypothesis\u201d, is very popular in many models in \ufb01nance and actuarial science. So much so that in these models \u201crisk\u201d is simply de\ufb01ned as a certain random variable (or some parameter linked to it, like standard deviation) representing an uncertain future payment/liability. In other words, for the sake of mathematical modelling, one avoids discussing the origin of randomness and justidenti\ufb01es it to risk. Thus, in \ufb01nance models all the complexities of market price determination are reduced to