Imagine a new casino opens in your street. For curiosity's sake, one afternoon, you check it out.
After having adjusted to the usual smoky atmosphere, you discover that this casino offers just one single game. To take part you pay a monthly fee of 10 €. Next, you choose a number between zero and one million.
For as long as you pay the monthly fee, every weekend, a giant roulette disk is turned to determine a random number. If your number shows up you win as much money as your current house is worth. Despicable gambling?
Yes, but now imagine that whenever this number shows up (and only then) your house burns down. Now it's an insurance.
Gambling and insurance do share some characteristics, notably based on probabilistic outcomes and the casino and insurance company's reliance on the Law of Large Numbers to determine profit. However, there are at least two significant differences between gambling and insurance.
ReplyDeleteFirst, in insurance the random event can happen to you even if you do not put down a stake. In your example above, whether or not you pay your $10, you still get a number on the roulette wheel. Even if you don't buy fire insurance, your house can still burn down.
Second, in the event that your number comes up, in gambling your payoff is a large positive number. In insurance, the payoff is close to zero. Indeed, many times the outcome is the same whether your number comes up or does not come up.
In your example above, if your number comes up, your payoff is:
Payoff = Insurance Payout - Value of Lost House - Premiums.
If Insurance Payout = Value of Lost House, then this simplifies to Payoff = - Premiums.
If your number doesn't come up:
Payoff = - Premiums.
The net outcome is the same in both cases. This is a very significant difference from what we normally think of as gambling.
I think those to differences are strong enough to render the similarities between gambling and insurance superficial.
Every weekend, a giant roulette dish is turned to determine a random number. If your number shows up you lose as much money as your current house is worth. For a small monthly fee, you can avoid playing this game.
ReplyDelete"Small" monthly fee? It's more like every time your number doesn't come up, whatever number the ball landed on is how much the monthly fee increased by, in percent.
ReplyDeleteOh, sorry, I was thinking about health insurance.
Heh, as Kleps puts it, not buying insurance is gambling.
ReplyDeleteDepending on what is insured, I actually agree.
DeleteThe big problem we have today is that people want to get reimbursed for the loss even if they never put their money down. Be it bailouts, flodding relief, medical care.
ReplyDeleteAs a libertarian/conservative I support the right not to place your money on the wheel. But then I say tough luck if your number came up. You shouldn't automatically get reimbursed but you might be if the rest of us feel it in our hearts to do so.
However, that is at most a one time event. In the US you have people living in a flood plain and lose their house with no insurance. The government reimburses them and they still don't get the flood insurance, or move. If they are too stupid or stubborn to learn from the first time they deserve no bailouts for the second loss.