#1202 How does promotion insurance work?

How does promotion insurance work? It is basic insurance that covers businesses that offer promotions or competitions that are basically a publicity stunt.

Promotion insurance, like all types of insurance, is a form of risk management. The idea of risk management has been around for thousands of years because disasters have always happened. Archaeologists discovered evidence of an insurance policy dating from 1750 BC. It was for a merchant ship, and it stated that the merchant only had to repay the principal of the loan (without interest) in the event of the loss of the contents of the ship due to an act of god. Risk management was furthered by the Romans, who came up with the principle of general averages. This was a rule whereby all shareholders in a ship (or everyone that had cargo on it) would share in losses if some of the cargo was lost or jettisoned to save the ship and the rest of the cargo. For example, if a ship carries cargo from companies A to Z and there is a storm, the crew might have to jettison cargo from companies A and B to save the ship. A and B have lost their cargo, but the rule is that all companies from A to Z will divide the losses between them. The idea of risk management slowly involved into the current system of insurance and the first insurance company was The Insurance Office, which was established in London in 1667. This was a direct result of the losses in the Great Fire of London.

The idea behind insurance is that you pay a company a sum of money every month on the understanding that if something happens, they will pay for you. The amount you pay every month depends on the final cost the company will incur if that thing happens and the likelihood of it happening. To do this, insurance companies have to be able to work out the probability of something happening. Insurance companies employ people called actuaries and their job is literally to work out the probabilities. For example, if you are buying car insurance, the insurance company needs to know your age (people in their 20s and again in their 70s are more likely to crash), where you live (more crime), how far you drive every year (more driving = more chance of crashing), and a host of other things. Then they need to know how much your car costs. They do complex calculations and work out the monthly fee you will have to pay. If you don’t crash, the insurance company keeps your money. If you do crash, they buy you a new car. They are gambling but with the odds as controlled as possible. With life insurance, they can look at death tables, but they also need to know your level of health, where you live, lifestyle, and things like that to work out your chance of dying. Insurance companies hope the thing they are insuring you against won’t happen, but that is not how they make money. When you pay an insurance company, they know that if the event they are insuring you against does happen, it will be fairly far in the future, so they invest the money you are giving them. That is where they get their enormous profits from.

Promotion insurance is the same as any other kind of insurance. A lot of companies offer promotions to sell more products, or to get their name in the news. If a company is offering two for the price of three, or a free bag of potato chips to every 100^th customer, they are not going to lose a lot of money, but they are also not going to get into the news. Some companies offer crazy promotions to get their name out there. For example, a lot of professional sports teams have halftime shows where they might have a competition. Basketball games have a lot where a spectator can try to make a long shot, or shots from several different distances. If they make it, they win a substantial amount of money. Ice hockey has one where a member of the audience has to hit a puck and try to get it through a space barely wider than the puck at the other end of the court, to win money. There are lots of these. The thing about all of them is that they are incredibly hard to do, but not impossible. This is where promotion insurance comes in. The sports team, or the stadium, or whoever is in charge of paying out if the spectator makes the shot, will take out promotion insurance. The actuaries at the insurance company will analyze all of the specifics of the shot to work out the odds of the spectator making it and them having to pay out the million dollars. They will make complex calculations and quote the stadium a monthly fee. If there are odds of 10,000 to 1, and five games a week, the insurance company know that the shot might be made once every 38 years, roughly. That gives them a long time to invest the stadium’s money so that if they have to pay out, they will have made far more than a million dollars in profit. And that is what I learned today.

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