Insurance is big business and is load-bearing for many industries. It has gained popular acceptance. Prediction markets have not. This is despite clear similarities between the two domains.
One can list similarities:
You are trading financial contracts about the odds of real world events.
The market price of a policy elicits and aggregates information about the forecasts of professional traders and this price can inform the publics’ view of risk.
Insurance is a tax on BS (If one underwriter says to you “that policy you wrote, its a steal, that boat’s never gonna sink” you can say “wanna bet?” and let them reinsure you.)
Or you can consider this extract from an official history of Lloyd’s of London[1]:
It was possible to get a policy—which is a dignified way of saying a bet—on almost anything. You could get a policy on whether there would be a war with France or Spain, whether John Wilkes would be arrested or die in jail, or whether some Parliamentary candidate would be elected. Underwriters offered premiums of 25 per cent on George II’s safe return from Dettingen; there were policies on whether this or that mistress of Louis XV would continue in favour or not.
One particularly grisly form of speculation, quoted by Thomas Mortimer in a book published in 1781 and engagingly entitled The Mystery and Iniquity of Stock Jobbing, was this:
> A practice likewise prevailed of insuring the lives of well-known personages as soon as a paragraph appeared in the newspapers, announcing them to be dangerously ill. The insurance rose in proportion as intelligence could be procured from the servants, or from any of the faculty attending, that the patient was in grave danger. This inhuman sport affected the minds of men depressed by long sickness; for when such persons, casting an eye over a newspaper for amusement, saw that their lives had been insured in the Alley at 90 per cent, they despaired of all hopes; and thus their dissolution was hastened.
It is possible that at Lloyd’s such activities where limited to a few. Even so the reputation of the coffee house was endangered.
So, given the many and obvious similarities between insurance markets and prediction markets, why have insurance markets succeeded where prediction markets have not?
- ^
Taken from pages 26-28 of Hazard Unlimited by Anthony Brown.
A much higher fraction of the benefits of prediction markets are public goods.
Most forms of insurance did took a good deal of time and effort before they were widely accepted. It’s unclear whether there’s a dramatic difference in the rate of adoption of prediction markets compared to insurance.
Insurance exists for a specific reason. People buy insurance contracts because they want to hedge some kind of risk. Insurance companies can diversify this risk across many uncorrelated bets. With prediction markets neither of these is necessarily true, so you are not guaranteed to have positive-sum trades. Even when there are theoretically trades to be made, pricing contracts on random propositions with poor reference classes is much more difficult than forecasting the probability of death, earthquakes, a golf hole-in-one, etc., so it may not be worthwhile.
If people enjoy gambling on random propositions like the fate of the king’s mistresses, that’s an entirely different business model.
And specifically, the risk they hedge against is usually some major risk to themselves. So insurance is similar to a social safety net in some sense. If there’s a (totally made up) 1⁄100 lifetime chance of each person being severely injured in a car crash, and such an injury would both cost me a lot of money and a lot of earning power, then of course I’d want to insure against it. Even though the insurance company takes a cut, I’d much rather lose money on this insurance contract than collect on it. And we hope that market competition prevents the insurers from taking too big of a cut, because the insurers compete on rates. Prediction markets just don’t serve this function at all.
People in this thread are focusing too much, I think, on bespoke kinds of insurance (which is most kinds of insurance), and not enough on normal everyday insurance (which is most actual insurance contracts).
Insurance is very different from a prediction market. There are competitive aspects, but the wager is between a professional oddsmaker and a consumer. Price (aka probability) discovery in insurance is performed by experts, not by buyers of the insurance.
So, from certain cynical perspective, that it is okay for a professional to bet against laymen and make lots of money in the process (and perhaps use a part of that for lobbying), but it would be highly irresponsible to let two laymen bet against each other.
Less cynically speaking, insurance mostly creates stability, other forms of betting mostly create instability. If the professional makes a wrong decision and loses a lot of money—either he can take the cost because he made a lot of money from other bets, or he goes bankrupt.
The layman’s losses from a wrong bet against the professional are limited to monthly payments of an insurance that was worthless in the first place. But that cost is known in advance, and most insurance contracts can be cancelled when you realize you are running out of money.
Laymen betting against each other often comes with an attitude “I believe that I am right, therefore I do not think much about the consequences of being wrong… oops, now my family can’t eat because I lost my entire salary”. Negative externalities for everyone around.
Perhaps we could make a safe version of a prediction market by not letting idiots bet (by somehow credentialing the players e.g. based on their income) but that would mean losing a lot of fuel that was supposed to power the market.
I have no clue what “it is okay” means, so I can’t comment on that framing. From a legal (in most places) and from a common social-approval perspective, gambling is never good, but is an acceptable vice when it’s taxed and controlled at scale, or so small as to be unnoticeable.
Insurance bypasses this by framing it as “shared risk”, and generally prevents insuring things for significantly more than the loss those things bring. It’s not a free, arbitrary wager, it’s a very restricted and controlled wager that can be explained as making an adverse (to the buyer) event somewhat less painful.
In any case, the key insight behind prediction markets is crowdsourcing of probability beliefs (aka price discovery). This is a thing that insurance markets do not do. Thus, the question is answered (“because they are not comparable things”).
Prediction markets, if they ever become popularized, would practically be redistributing wealth from the below average to the above average.
So it’s a critical disadvantage compared to insurance markets.
But that’s also why it sounds so highly appealing.
i.e. Trying to collectively outsmart the bottom sounds like it has better prospects than trying to outsmart the top.
Insurance markets also effectively redistribute wealth from the financially illiterate (people who buy financial products such as endowment life insurance) towards insurance salesmen and owners of the insurance companies.
But this pattern-matches “customers buying products from companies”, which is a context where it is normal that the money goes from the customers to the companies, so no one objects.
But more importantly to the reasons people actually buy insurance, they redistribute comparatively small amounts from the (most people) lucky to pay large amounts to the (few) unlucky. Which, behind the veil of ignorance, you would want, to ensure (insure) that your life is not ruined by bad luck.
I wrote about exactly this recently- https://www.lesswrong.com/posts/zLnHk9udC28D34GBB/prediction-markets-aren-t-magic