INSURANCE AND GAMBLING
INSURANCE AND
GAMBLING
G
ambling works as follows:
you pay a sum of money to
the “house.” Then a random
event occurs such as a roll of
the dice, a spin of the wheel,
or the outcome of a sports event. The
important thing is that neither you nor the
house controls or influences the outcome.
Before the event, you and the house have
agreed that if the event turns out one way,
the house keeps your money, and if the
event turns out the other way, the house
pays you according to an agreed formula.
Now consider the “house” as an insurance
company. The money you pay is a
“premium.” The event—which neither you
nor the insurance company controls—is
the passage of time (usually a year), and the
two possible outcomes are fire damaging
your home or no fire. If there’s no fire, the
insurance company keeps your premium. If
there is a fire, the insurance company pays
you the amount of the damage.
On the surface, insurance and gambling
look alike. They both involve risks, they
are both contracts, and payments are made
from a pool of funds. They both fall in the
aleatory (from the French word, alea, for
a game of dice) category of contracts. By
definition, aleatory contracts are those
“contracts in which the performance of
one or both parties is contingent on a
particular event.” They are both contingent
on “something happening.”
There are two very different ways to decide
whether to gamble or not, and whether to
buy insurance or not. One is arithmetic
and the other is psychology. Sometimes
the two methods give different answers. To
decide whether to gamble using arithmetic,
compare the amount you might win times
the probability of winning against the
amount you might lose and that probability.
If the probable winning amount exceeds
the probable loss amount, then you should
gamble. And vice versa; if the probable
winning amount is less than the probable
loss amount, then you should not gamble.
If the two are equal, then arithmetic does
not tell you whether to gamble or not.
Should you buy insurance? Using
arithmetic, calculating the probabilities
yourself is difficult. The insurance
companies have already done their
calculations. Based on the numbers, they
have developed a premium that ensures a
good deal for them. Just the fact that they
make a profit tells you that it is not a good
deal for you.
Then, other than regulatory requirements,
why do smart people take the gamble of
insurance? Because of the psychological
term called risk aversion. A bookmaker
gives you the chance to get ahead. An
insurer gives you the chance to not fall
behind. We buy insurance against bad
events. Arithmetically, it makes the same
sense to link the insurance payout to a
good event as to a bad event. You could
buy insurance against having a fire-free
year, however, insurance companies prefer
linking the payout to a loss. This allows
them to say they are helping you in your
time of need rather than admit that they
are paying you a gambling debt.
One important difference between
gambling and insurance is that while the
former simply provides entertainment,
the latter performs a valuable societal
function of spreading risk. Although
most policyholders will end up paying
more to their insurance company than
the company will pay to them, they are
still getting a good deal in that they are
shielded from the threat of a potential
bankruptcy resulting from a catastrophic
event. For a risk-averse person (i.e., most
of us), buying insurance maximizes their
peace of mind, even if they are overpaying
for it.
BY: ERIC P. WOKAS, CSP ARM
RISK CONTROL CONSULTANT
JGS INSURANCE
Eric Wokas has over 25 years of experience
as a risk management consultant working
for various major property/casualty
insurance carriers including Continental,
Zurich and Gerling as well as Aon an
international insurance brokerage firm.
At JGS Insurance Mr. Wokas continues
to assist clients in development and
implementation of practical solutions in
reducing risk.
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