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Gambling Insurance

Life, in many ways, is a carnival, a broad array of games of chance with varying stakes. The difference is that the decision whether to play some of these games– whether to undertake the risk of loss for a chance at reward– is not voluntary. Being involved in a car crash comes to mind, although the drivers and passengers did make the choice to get into a car that day. Losing property to theft or fire is another example, although owners can take preventative measures to protect against loss by those means. Contraction of a genetic disease may be a better example, as we do not have much choice of whether or to whom to be born, as far as I recall.

To deal with risk over which we believe we have less control, we spread it across a population that shares resources for the purpose of compensating those who actually suffer a loss. This is the insurance principle, the idea of pooling resources to be paid out to the subset that suffers bad outcomes. The members of the pool know that there is a chance that they will have a bad outcome, but not all of them actually will. Because they cannot know beforehand who will suffer the harm, they all pay in advance to compensate the ones who actually do, possibly themselves.

Insurance companies often advertise their services as providing the support of “a good neighbor,” the security of being “in good hands,” or the assurance of “peace of mind.” Does the purchase of an insurance policy really reduce risk, though, or does it merely trade one type of risk for another? Many people in a risk pool will never suffer the bad outcome that triggers payment, instead spending their whole lives (or whatever length of time they continue to participate) paying into the pool, in some sense, for nothing. Ex post, after the fact, all they did was give their money away to what could most kindly be described as an inefficient charity fund. Of course, no one can know ex ante, before the fact, whether he or she will suffer the harm, which is why so many people buy insurance. What is less obvious is that the decision whether to buy insurance itself carries risk.

I am resistant to the notion of living one’s life through the constant lens of economic analysis. The concept of opportunity cost, in general terms, is a valid and meaningful consideration, however, and even if we shy away from a conscious weighing of the financial costs and benefits of everything in our lives, we undertake a subconscious experiential opportunity cost analysis all the time. Despite the advances in transportation technology and our supposed ability to multitask, we can only be in one place at one time, doing (for the most part) one thing at one time. The limitations of our reality force us to make choices. The choice to do one thing necessarily forecloses other options.

Is there a meaningful difference between a legitimate gambling house and a fraudulent one?

Like it or not, the stability and security so many seek may be elusive in a world of opportunity costs. No matter how you toss the dice, we are all gambling men and women, constantly betting on one alternative over another with the choices we make. Even in an area ostensibly about security and comfort– insurance– both sides are gambling: policyholders are betting that they will suffer the insured-against harm, and the issuers are betting that they won’t.

Some readers may find themselves dismissive of this account, unsurprised about and cognizant of the risky nature of the world. With every rambling step through life another wager made with imperfect information, though, is it better to press on, attempting to gain a complete set of information; surrender to the flow, in full acknowledgement of the unattainability of omniscience; or take some middle or alternate path?

From ancient Egypt to modern America, people have been struggling to work out an approach to this life of uncertainty:

Since it cost a lot to win
and even more to lose,
You and me bound to spend some time
wondering what to choose.

Goes to show you don’t ever know,
Watch each card you play
and play it slow.
Wait until your deal comes round,
Don’t you let that deal go down.

Robert Hunter, Jerry Garcia & Bill Kreutzmann, Deal, Garcia (Jan. 1972).

How are you holding your cards?

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Categories: Incentives, Information
  1. AD
    June 11, 2010 at 8:18 am

    A classic professional gamble comes in the decision to spend time in professional training. One must try to weigh the time and financial costs of the training against the likelihood that there will be a relevant job for the trainee upon completion of the program. This week, a Law School Transparency co-founder participated in an ABA podcast entitled “Lowering the Stakes: How Law Schools Can Help Next Gen Lawyers Take Gamble Out of Hefty Tuition.” Listen or read the transcript at http://www.abajournal.com/weekly/article/lowering_the_stakes.

  2. AD
    July 7, 2010 at 11:59 pm

    During a recent travel delay, I decided to start reading Nudge, the popular political theory text by Richard Thaler and Cass Sunstein in which the authors present their libertarian paternalism thesis. I plan to write more about the book once I finish reading it, but for now, I will offer a quotation from the early pages that presents some of the challenges of insurance in a more eloquent and concise way than I did above:

    “Notice first that many insurance products have all of the fraught features that we have sketched. The benefits from holding the insurance are delayed, the probability of having a claim is hard to analyze, consumers do not get useful feedback on whether they are getting a good return on their insurance purchases, and the mapping from what they are buying to what they are getting can be ambiguous.” Richard H. Thaler & Cass R. Sunstein, Nudge: Improving Decisions About Health, Wealth, and Happiness 79 (Penguin Books 2009) (2008).

    Being in the business of selling insurance policies, insurance providers have an incentive to prey upon potential customers’ informational weaknesses.

  3. AD
    July 15, 2010 at 5:20 pm

    In response to a question about life insurance, a friend said that he never wanted to be worth more dead to someone than he was while alive. All of us will cease life processes on this planet, though. It is just a matter of time.

    In 2010, that matter of time has become a matter of financial significance, however, due to the impending reinstatement of the federal estate tax (sometimes called the “death tax”). Absent congressional action, the estate tax will be reinstated in 2011 after the Senate allowed it to lapse at the end of 2009.

    While many saw the estate tax as adding financial insult to fatal injury, the one-year, tax-free window has made 2010 a (financially) good year in which to die. By closing that window, as the Wall Street Journal notes, Congress is incentivizing death. If the estate tax returns in 2011, as the Journal suggests it probably will, it “will come roaring back”:

    “Not only will the top rate jump to 55%, but the exemption will shrink from $3.5 million per individual in 2009 to just $1 million in 2011, potentially affecting eight times as many taxpayers. The math is ugly: On a $5 million estate, the tax consequence of dying a minute after midnight on Jan. 1, 2011 rather than two minutes earlier could be more than $2 million; on a $15 million estate, the difference could be about $8 million.”

    According to a tax historian, the top rate increase would be “the largest increase in a major tax” ever.

    The arrangement presents incentives for individuals and their heirs that are, if not perverse, at least awkward. While the moral and economic incentives for those near death at the end of 2009 aligned (bracketing right-to-die scenarios) to encourage them to live into 2010, moral and economic incentives are at best misaligned as we find ourselves on the downslope of 2010. Setting aside the more (melo?)dramatic voices, all probably would enjoy some modicum of predictability, something that may be wanting as congressional midterm elections approach.

    The full story is available at http://online.wsj.com/article/SB10001424052748703609004575355572928371574.html?mod=WSJ_hps_sections_personalfinance

  4. Mrs. Anti-Virus
    August 15, 2010 at 2:13 pm

    I bet you wish george bush was still president now

  5. AD
    October 4, 2010 at 4:37 pm

    The Volokh Conspiracy’s Orin Kerr today highlights a story out of Tennessee about what happens when people come to regret their decision not to participate in an insurance pool.

    “[Obion County, Tennessee] does not have its own fire department, and instead relies on the fire protection services of the nearby City of Fulton. But there’s a catch: The City of Fulton does not automatically serve residents of the county. If Obion County residents want to be protected by the City of Fulton Fire Department, they need to pay a $75 fee to the City.

    “Obion County resident Gene Cranick decided not to pay the $75 fee, and then he set a fire in his backyard in two large barrels. The fire began to spread, and he called 911. The 911 operator told him that because he hadn’t paid the fee, the fire department would not respond. Cranick’s wife told the 911 operator that she would be willing to pay “whatever the cost” to hire the Fire Department to put out the fire, but was told that this was not an option. The Fire Department did not come out until the fire spread to a neighbor’s yard — the neighbor had paid the fee — and the firemen put out the neighbor’s fire but not Cranick’s.”

    Kerr’s full post, including his discussion of the community’s reaction (outrage) and his own thoughts on this classic insurance scenario is available at http://volokh.com/2010/10/04/county-resident-declines-to-pay-for-fire-protection-and-then-his-house-catches-on-fire

  6. AD
    January 4, 2011 at 12:01 pm

    The secondary market for life insurance is getting some coverage this week at the Wall Street Journal and Volokh Conspiracy. The VC’s Kenneth Anderson calls it “death-bet insurance”: “A person tak[es] out life insurance, and then turn[s] around and sell[s] the policy to a stranger — a hedge fund, for example, via intermediaries — who pays the premiums and collects after the insured’s death.”

    The secondary market raises a question once thought to have an obvious answer: whom is the beneficiary of a life insurance policy? Typically, the decedent’s surviving family members are the intended beneficiaries. Lacking the support of the deceased and bearing end-of-life costs, they collect on the policy in his or her stead. With the availability of a secondary market, however, the person whose life is insured is able to get cash now, while forfeiting posthumous payouts. (On the other side, the investor bears the risk of prolonged life of the insured: “If the insured person does not die on schedule, then the investor has the double-whammy of having to wait for payout and pay premiums in the meantime or lose the payout.”)

    This apparently has created a storm of litigation. “Insurance companies have been suing the third party investors, the investors have been countersuing the insurance companies, and in some cases, relatives of the deceased insured have been suing to claim that the insurance proceeds really belong to them.”

    Anderson’s VC post, with links to WSJ coverage, is available at http://volokh.com/2011/01/03/death-bet-insurance.

  7. Angila Wrench
    February 19, 2013 at 4:46 pm

    I want to start a blog written by a fictitious character commenting on politics, current events, news etc..How?

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