Is Insurance a Form of Gambling?
Many
of my clients often compare buying life insurance to gambling. Their
rationale is that by paying premiums to cover an insured event, we are
betting against the insurance company, as insurance is an expense and
one effectively loses the “bet” if the insured event such as death,
disability or critical illness does not befall us.
It feels similar to placing a bet on a table game in a casino and hoping for a favorable outcome.
So is insurance truly like gambling? Let us tackle this question from a risk management perspective. We understand that when it comes to risk financing, there are two options:
Let’s explore the 2 options in detail.
Figure 1 – Possible outcomes from being uninsured/under insured
Financially, there are 3 possible scenarios that can happen to an individual who chooses not to buy life insurance and accepts any risks along the way. The optimal scenario for the individual is to lead a healthy, accident free life and save money on premiums. The worst case scenario is immense financial burden on self and family, should a crisis strike.
Figure 2 – Possible outcomes from being insured
It is a different picture for an individual who chooses to buy life insurance and transfer this risk to an insurance company. In this scenario, the individual accepts a small and guaranteed loss by paying premiums, in exchange for eliminating the possibility of a much larger financial burden should the insured event occurs.
Two of the three possible scenarios are thus eliminated. Whether or not anything unfortunate were to happen to the individual, nothing would happen to him financially as he is well protected. (Depending on the type of policy purchased, his financial loss is either indemnified or there is a lump sum payout to cover that loss)
As one can see, insurance is an effective risk transfer tool. In a personal financial plan, insurance planning is probably the second most important aspect after one’s cash flow is properly managed. The purpose of insurance planning is to remove all uncertainty first before embarking on other aspects of personal finance.
The fundamental difference between gambling and insurance
It is important to understand the fundamental difference between gambling and insurance. Gambling is what we call speculative risk. Speculative risk can result in a win, status quo or loss scenario. When one gambles, he is creating a risk that is not there in the first place. One will not lose money if he simply refuses to gamble. Insurance on the other hand, covers pure risk, which can result in only two scenarios, status quo (nothing happens to me) or loss (Death, disability, critical illness). This risk exists even when there is inaction from an individual.
Figure 3 – Differences between gambling and insurance
Insurance is not gambling. Ironically, not getting insurance is gambling with the financial futures of ourselves and our loved ones. Given the little insurance planning most Singaporeans have embarked on, many people may be at “gambling” without realizing it.
By Gary Tay, who blogs at Reflections of an Independent Adviser.
Source>>
It feels similar to placing a bet on a table game in a casino and hoping for a favorable outcome.
So is insurance truly like gambling? Let us tackle this question from a risk management perspective. We understand that when it comes to risk financing, there are two options:
1) Risk Acceptance (Not buying Insurance)
2) Risk Transfer (Buying Insurance)
2) Risk Transfer (Buying Insurance)
Let’s explore the 2 options in detail.
Figure 1 – Possible outcomes from being uninsured/under insured
Financially, there are 3 possible scenarios that can happen to an individual who chooses not to buy life insurance and accepts any risks along the way. The optimal scenario for the individual is to lead a healthy, accident free life and save money on premiums. The worst case scenario is immense financial burden on self and family, should a crisis strike.
Figure 2 – Possible outcomes from being insured
It is a different picture for an individual who chooses to buy life insurance and transfer this risk to an insurance company. In this scenario, the individual accepts a small and guaranteed loss by paying premiums, in exchange for eliminating the possibility of a much larger financial burden should the insured event occurs.
Two of the three possible scenarios are thus eliminated. Whether or not anything unfortunate were to happen to the individual, nothing would happen to him financially as he is well protected. (Depending on the type of policy purchased, his financial loss is either indemnified or there is a lump sum payout to cover that loss)
As one can see, insurance is an effective risk transfer tool. In a personal financial plan, insurance planning is probably the second most important aspect after one’s cash flow is properly managed. The purpose of insurance planning is to remove all uncertainty first before embarking on other aspects of personal finance.
The fundamental difference between gambling and insurance
It is important to understand the fundamental difference between gambling and insurance. Gambling is what we call speculative risk. Speculative risk can result in a win, status quo or loss scenario. When one gambles, he is creating a risk that is not there in the first place. One will not lose money if he simply refuses to gamble. Insurance on the other hand, covers pure risk, which can result in only two scenarios, status quo (nothing happens to me) or loss (Death, disability, critical illness). This risk exists even when there is inaction from an individual.
Figure 3 – Differences between gambling and insurance
Insurance is not gambling. Ironically, not getting insurance is gambling with the financial futures of ourselves and our loved ones. Given the little insurance planning most Singaporeans have embarked on, many people may be at “gambling” without realizing it.
By Gary Tay, who blogs at Reflections of an Independent Adviser.
Source>>
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