The Insurance Industry: A Really Big Casino

The basic definition of insurance is an agreement to suffer a definite small loss (the premium) in order to avoid the potential of an unknown large loss (a claim). People buy insurance to avoid volatility. Insurance companies accept premiums from a large and diverse group of clients.  On some policies, they “win” (the premium exceeds the claims) and others, they “lose” (the claims exceed the premium).  The insurance company doesn’t really care who wins and who loses, as long as the winners compensate for the losers. 

A casino provides an environment where people can come and make bets. The casino essentially reallocates the losses of some to the winnings of others (and uses statistics and probability to accurately set pay-outs). It makes an override for creating the environment. The more people placing bets, the better. A casino spends considerable sums attracting people to its environment through marketing, fancy hotels, glamour, etc. 

The insurance industry is not unlike a casino. The industry reallocates money between losers and winners, and charges an override for doing so. It too spends significant sums attracting and retaining customers. The larger the overall insurance industry, the more insurance carriers can make (in an absolute sense). Like a casino, the insurance industry doesn’t actually “create” anything—all funds paid out are just funds paid in by someone else in the system. The insurance industry is essentially a large income redistribution system.

A group captive is therefore akin to a group of employers creating their own casino. They determine who gets in and the payouts. They keep the override typically charged by the industry. In addition, they often reduce expenses by eliminating the equivalent of the fountain outside the Bellagio.