Gambling and insurance are similar in that most people who gamble or buy insurance on average lose money. But as the graphs illustrate the outcome is quite different in one key respect. Insurance narrows the range of outcomes, while gambling widens it.

05 November 2019

The distinction between investment, insurance and gambling is an essential one for policymakers and regulators. At the most basic level it is easy to see the differences between these products. But is it possible to extend the theoretical distinctions to more complex products and so give consumers clearer guidance?

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Gambling intentionally puts up a stake that the gambler is willing to lose. Insurance collects payments against replacing, repairing, or recovering property that an owner is unwilling to lose. Gambling is the intentional and willful exposure of one’s self or assets to the risk of loss.
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.
Motoring offenses: You cannot obtain an insurance policy against expected fines for offenses committed while on wheels. However, it should be noted that there is no clear distinction between insurable and non-insurable risks. Theoretically, an insurance company should be ready to insure anything if a sufficiently high premium would be paid.
The concept requires that the insured have a 'stake' in the loss or damage to the life or property insured. What that 'stake' is will be determined by the kind of insurance involved and the nature of the property ownership or relationship between the persons. The requirement of an insurable interest is what distinguishes insurance from gambling.

Professionals in financial markets are used to the sneers – ‘It’s all just gambling’. It may be an unfair smear (mostly) and often it is easy to distinguish between a flutter and an investment or even an insurance policy.

But while it may be easy in practice to distinguish between gambling and certain financial transactions it is far harder to do in theory. And in this case, theory matters, for whether an activity is classified as buying a financial product or as gambling will determine it status in law and in regulation and is sure to influence the attitudes of consumers who are considering whether or not to hand over their money.

The solution may lie in trying to make these distinctions, not by trying to define the product, but by considering the typical outcomes.

Rather than asking what is this product supposed to be, we could ask: what happens to people who buy these things?

Let us start by looking at three relatively pure examples of investing, insurance and gambling.

Buying £100 worth of a FTSE 100 tracker fund is clearly investing. Buying a betting slip for £100 from a bookmaker, with the pay-out dependent on Spring Beauty finishing first in the 2.30pm handicap stakes at Chepstow, is clearly gambling. And paying £100 to an insurance company that pays out the cost of accidental or criminal damage to your property is clearly buying insurance.

So far, so easy

But while intuitively very different, all three of these have core features in common. Play for fun poker sites. All three involve making a payment of £100 right now, for a product that may deliver pay-out in the future, subject to certain conditions being met. (The value of the FTSE 100 in the future; the results of a horse-race; and the occurrence of theft or fire at your house.)

At the time the purchase is made, it is not known for certain what the pay-out will be or whether a pay-out will be made at all.

So what are the differences?

The differences are clearest, indeed they are utterly stark, when we look at the outcome distributions – what happens to people when they buy these products.

The outcomes distributions for these basic products can be theoretically modelled showing the outcomes for 100 typical consumers who spend £100 on each product and comparing it to another 100 people who don’t buy the product and simply keep their cash under the mattress. (The detailed assumptions used for these models can be found at the bottom of this article. They are, I hope, uncontroversial.)

If we can present these models graphically, looking at the distribution of outcomes and also the average outcomes, then the differences between investment, insurance and gambling are glaring.

Investment

Gambling

Insurance
Note: The average outcome without purchase and the outcome with purchase are very close
together in this example

The two key metrics here are the average outcome for buying or not buying the product, and the majority outcome – what happens to most people who either do or do not buy.

For investment products, the vast majority of those who buy the product (invest) do better than those who don’t. And the average outcome for those who invest is also better than for those who don’t.

For both insurance and gambling, those who do buy the products (those who do bet and who do take out insurance) on average lose money in comparison with those who don’t. The crucial phrase here, of course, is on average.

This creates a clean distinction in typical outcomes between investment on the one hand and insurance and gambling on the other.

Gambling and insurance are similar in that most people who gamble or buy insurance on average lose money. But as the graphs illustrate the outcome is quite different in one key respect.

Insurance narrows the range of outcomes, while gambling widens it.

For insurance products, most people are better-off if they do not buy insurance - they save the premium, and their house does not burn down. But a small number of these uninsured people are catastrophically worse off - their house burns down and they have no insurance cover. So, among the uninsured we have a wide range of outcomes.

The effect of buying insurance is to narrow this range. Most insurance buyers suffer a small cost (paying the premium), but no-one who has bought insurance suffers a catastrophic loss.

Now consider gambling.

All those who refrain from gambling have exactly the same outcome, they lose nothing and they gain nothing. This is the ultimate narrow range of outcomes.

The effect of gambling is to widen the outcomes. Among those who place a bet the vast majority are worse off (they lose their stake), but a very small number make a big profit as their horse romps home.

Of course, insurance premiums are not a pure loss as the payer does gain peace of mind in return. Similarly, the gambler may argue that while they typically lose, the activity of gambling still gives them pleasure. However, neither of these points alters the significance of the outcome distribution model which captures financial outcomes of these products.

With these metrics in mind for investment, insurance and gambling in their purest forms, we can construct a table.

Product	Average return	Widen or narrow the range of outcomes?
Investment	Positive	Widen
Insurance	Negative	Narrow
Gambling	Negative	Widen

So far, I have considered investment, insurance and gambling in quite pure forms – a FTSE tracker, general insurance and a flutter on the horses. And, of course the outcome distribution model I have described has in these cases served only to confirm what we already intuitively knew – investment, insurance and gambling are very different things.

But having established this perspective I would suggest that any real or proposed financial product can a

10 Difference Between Insurance And Gambling