What if everything they ever taught you about risk waswrong?

And I’m not talking “wrong” in the sense that Galileantransformation inaccurately describes motion compared to modernrelativistic formulae. The difference between those two approachescan be measured in digits well to the right of the decimalpoint.

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I’m referring to a wrong that, quite possibly, might be moreakin to those Seven Deadly “wrongs” mentioned in a certainwell-read book popularly used by preachers and SundaySchool-marms.

The misuse of “risk” is actually less of an ethics question andmore of an applied science question (see “The Folly of Risk and the 401k Fiduciary,”FiduciaryNews.com, July 11, 2017). To understand this, weneed to understand the difference between how an actuary views riskversus how a casino operator views risk. Both individuals work inindustries ruled by the law of large numbers. Both use statisticsdetermine how to optimally price their products. Both sell theirproducts to a vast swath of the population, where race, color,creed, as well as income status, mean nothing.

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The difference between an actuary and a casino operator lies notin the back-end of their operations, but in the front-end. It’s inhow they position their product and the marketing strategies theyuse to sell their product to the mass market.

These different approaches, in turn, cause their consumers toview their products through different lenses. Insurance,fundamentally, is a business proposition based on the amorality ofmathematics. Gambling is nothing more than a leisure activity, itsonly redeeming value being it relieves someone from the horror ofsitting through yet another remake/sequel/reboot of some nearlycentury-old comic book superhero.

This becomes clearer when we consider how customers “play theodds” (aka “manage risk”) in both industries.

You buy insurance to protect your downside. You agree to pay alittle bit of money to stave off losing a lot of money. In the end,you actually prefer to lose that little bit of money rather than gothrough the agony of losing and then replacing what ever asset youhappen to be insuring.

Think about it. Sure, the insurance company will replace yourcar, but do you really want to go through the trouble of breakingin a new car? You really like that car you’re driving. The lastthing you want to do is replace it. Still, from a purelymathematical perspective, it makes too much sense not to getinsurance (besides, most states require you have auto insurance).It’s a form of sound risk management.

Consider, on the other hand, the point of view of the Black Jackplayer. He sits there counting cards (until the casino finds out,that is), trying to determine the most likely next play from thedealer’s hand. Here “risk management” doesn’t mean preventinglosses (although it does hope to reduce losses), it’s meant toanswer the question on whether the bet makes sense. In other words,are you more likely to win rather than lose. For those that doubtthis intention, recall all those gags about a bookie plying his“sure thing” tip.

No insurance agent ever tells someone buying a policy is a “surething” to make money. It might be a “sure thing” to make yourselfwhole again, but it’s definitely not something that produces adramatic return on your premium payment.

Therein lies the difference between and insurance company and ariverboat gambler. One emphasizes loss prevention. The other seeksinordinate gains.

In an era of market-topping closes, which of these do you mostrepresent?