Why do people gamble on the lottery but insure their car?
When you gamble, in the long run, you lose money. Let us say, the payouts are 50% of the amount you pay in. Therefore, gambling in the long term makes no rational economic sense. Over time, the odds will even out and you will have lost 50% of what you spent.
Yet, taking out insurance means that in the long run, on average, you will receive less than what you pay in.
If you wanted to maximise your welfare – why not gamble on not getting your car stolen. If you win (and car doesn’t get stolen) then you save the insurance premium. It is a better bet than going to the bookmakers.
There are many reasons why we insure some things and gamble on others.
Risk Averse. We don’t mind paying £200 a year insurance premium, but, we do mind having to find £10,000 to buy a new car. The chance of losing our car is very slim, but, we can’t afford risk of having to pay out a huge sum. However, it is relatively easy to budget for paying £200 insurance premiums.
Gambling is Fun. Worrying over losing an expensive car isn’t
People say football or horse racing is more exciting if we have a monetary stake. The worry of not insuring a big item like car disturbs our peace of mind.
Diminishing Marginal Utility of Money.
If your income is £20,000. Then an extra £200 income gives less benefit compared to getting an extra £200 on a salary of £5,000. The first £5,000 you earn is essential for the basics of life – food, rent e.t.c. However, if you have a high income extra money has less impact on increasing your living standards. Your third car gives less satisfaction than getting your first car.
Therefore, if we spend £200 a year on insurance our income may go down from £20,000 to £19,800. This is only a small decrease in living standards – we don’t really miss that extra £200. However, if our car got stolen or our house burnt down, we would miss that money