From Chapter 5, Insurance As Gambling
Suppose that you walk into your bookie's “office” and ask: “What are the odds that I will die of a cause other than suicide in the next 12 months?” The bookie knows you to be fairly young and healthy, and he knows that you have no diseases that you're hiding. He stares at the ceiling for a while and/or consults his crystal ball and replies: “99 to 1 odds against it ”.1 Let's assume that the bookie is willing to take this bet: You give him $1,000. He give you his marker, which is a note that says something like “If you die for any reason (other than suicide) within 12 months of today I will give$100,000 to you – actually to your family, considering the nature of the bet. In either case, I keep the $1,000.”
Most of us really do handle things this way, we just change the names of the items and the title of our bookie. The more common scenario is for you to walk into your insurance broker's office and ask: “What are the odds that I will die in the next 12 months?” Your insurance broker asks you to fill out some forms, possibly to get a physical examination. He then stares at his Actuarial, or Life, Tables for a while and replies “99 to 1 odds against it.”
Once again, we'll assume that he is willing to take the bet that is to write you a policy. You give him $1,000. 2 He give you his marker, which in this case is labeled “Term Life Insurance olicy.” The insurance policy, boiled down to its simplest terms, says something like “If you die for any reason other than suicide with 12 months of today, I will give $100,000 to you – actually to people name as your beneficiaries – considering the nature of the policy. Whether you die during this period or not, the insurance company keeps the $1,000.
When looked at this way, it becomes clear that both gambling casinos and insurance companies are in the same business – taking long odds bets from people who come through the door. Gambling casinos usually deal with slot machine kinds of bets while insurance companies usually deal with insurance kinds of bets, but they both have very sophisticated sets of tables telling them the odds on every bet that they might take. In the case of the gambling casino, these tables take the form of probabilities based on the mechanisms of the slot slot machines and the numbers layout of the roulette wheels; in the case of the insurance company, these tables take the form of average life expectancies, and so on. Since terms such as betting and gambling tend to make people nervous, whereas having insurance tends to make people feel warm and secure, insurance companies have their own language and are careful to minimize any references to betting and odds. From the point of view of the casino and the insurance company the difference between the two different types of bets is, of course, totally cosmetic.
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Should we conclude that there's absolutely no difference between placing a gambling casino bet and buying an insurance policy? No. There is one very big difference which is implicit in the discussion above. When you put money into a slot machine, you're hoping to win the bet. When you pay a year's premium on a life insurance policy, you're hoping to lose the bet but cannot accept the consequences of winning the bet unless you have placed a big enough bet. In other words, you're hoping you don't die during the next 12 months, but just in case you do die, you want to make sure you have enough life insurance that your heirs are left economically secure. This simple but very important difference makes gambling a frivolous and sometimes painful entertainment, while prudent insurance purchases are an important part of personal and family financial security and health planning.
1: 99 to 1 odds against you dying means that the probability of you dying is 1/(99 + 1) = 1/100 = 0.01.
2: In this simple example we create no profits or losses for the insurance company.