Gambling & Insurance Policies

Summary
Taking risks is part of everyday life. For the most part, people are good at dealing with risks with which they are familiar. Certain types of risks, however, when "intuitively" processed, lead to suboptimal behaviors.

(Photo: Wikimedia)

Commentary
Schneier writes about risk a lot: our intuitions about, overreactions to, and essential need for risk. The most common failures of our risk intuition stem from cognitive biases related to rare, unknown, or voluntary risks.

In general, we tend to think that people are risk averse. But sometimes people seem to seek out risks-- such as playing the lottery. Why? A possible explanation is the framing effect. Consider the following case. You can have one of the following applied to your order:

• A $5 discount, or
• A $5 fee waived.

Which did you choose? The first sounds like you're getting a good deal; the second sounds meh. But they result in the same price!

Now imagine there's probability thrown in for good measure. Which of the following sounds like a better insurance sales pitch:

• There's a pretty good chance you won't loose anything.
• There's a small chance you'll loose a lot.

Now compare that with a lottery sales pitch:

• There's a pretty good chance you won't win anything.
• There's a small chance you'll win a lot.

In the first case (insurance), avoiding the loss sounds better. In the second case (lottery), the large gains seem attractive. In each case, the way the situation is framed changes which options seems better.

More on this later.