Thursday, 1 December 2011

Is Insurance like Gambling?

Many of my clients who often compared life insurance purchase to gambling. Their rationale is that by paying premiums to cover an insured event, we are betting against the insurance company. Since insurance is an expense and one effectively loses the “bet” if the insured event such as death, disability or critical illness does not befall upon us. It seems to have the same effect of placing a bet on a table game in a casino and hoping for a favourable 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)


Let’s explore the 2 options in detail.

Possible outcome 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 accept 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. 

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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 a very 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.


Summary

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.


Activity
Type of Risk
When does the risk exist?
How to eliminate the risk?
Gambling
Speculative risk
Only when one gambles
Cannot be eliminated
Insurance
Covers Pure risk
Present from the onset
Can be managed with proper insurance planning







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. Do contact me at 8183 2979 for a simple insurance review now!



Read my related articles:  1. The psychology of Gambling and its impact on Insurance planning
                                       2. Are young people investing or gambling?
                                       3. Why Singaporeans fail financially?

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