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Funding the X-Prize
Yesterday, Tyler and I met with Tom Vander Ark, the president of the X-Prize Foundation, to discuss and debate the future of prizes. One interesting bit of trivia that Tom mentioned was that the X-Prize was funded with an insurance contract. The funders paid the premium and the insurance company agreed to pay if the prize conditions were met.
To figure out how to price the contract the insurance company called "the experts" at Boeing and McDonnell-Douglas. According to the experts the conditions for the X-Prize to be won (carrying three people to 100 kilometers above the earth's surface, twice within two weeks) were so unrealistic as to be basically impossible within any reasonable time frame. Thus, the funders got lucky. The insurance company offered the contract at a very low premium and the rest is history!
The X-Prize Foundation is doing exciting work. They are building on the huge success of the Ansari X-Prize to launch many more prizes. Prizes in auto technology and genomics have already been announced and the foundation will be funding many more prizes in the future (You can suggest a prize here).
Posted by Alex Tabarrok on August 30, 2007 at 07:18 AM in Economics | Permalink
Comments
It's not good luck for your technical judgment to be more accurate than someone else's, nor for other people to be wildly over-confident. Getting the suckers to actually put their money where their mouth is takes some skill, but not so much luck either.
Posted by: michael vassar at Aug 30, 2007 8:37:30 AM
I knew that the X-Prize was funded by insurance but was still very curious how the premium was calculated. Now I know! That's a great story. As Michael notes, it's not luck.
The question though is will the insurers get it wrong a second time?
Posted by: Sameer Parekh at Aug 30, 2007 8:52:30 AM
The insurance company gets odds on how likely something is using consensus approaches. But the odds are extremely high that the individual that wins the price will use an unconventional approach -- that is basically the main reasons prizes are attractive as an incentive.
Posted by: spencer at Aug 30, 2007 9:35:01 AM
If you read Warren Buffet's annual stockholder's letter, you would have seen a result such as this as almost inevitable. Buffet talks about this sort of thing almost every year. The insurance company could have mitigated some of their loss by taking credit for paying out on the prize and advertisng their willingness to take unusual risks of this order. Turn the event into free or reduced cost advertising.
Posted by: Murphy at Aug 30, 2007 9:38:37 AM
Perhaps a prediction market would have done a better job. Were the "experts" at Boeing and McDonnell-Douglas institutionally biased?
Posted by: Eric G at Aug 30, 2007 10:58:17 AM
OMG an insurance company wrote a contract and took a loss on it.
If only there were some approach to this issue based on markets. Then we wouldn't have to rely on so-called "experts"!
Posted by: Barbar at Aug 30, 2007 12:27:32 PM
Jordan's, a wacky Boston-area furniture company, will reimburse everyone who bought furniture from them in the early part of this season if the Red Sox win the World Series. It's funded by insurance. I am awfully curious how those odds were calculated.
Posted by: Andromeda at Aug 30, 2007 1:27:43 PM
Jordan's Furniture is owned by Warren Buffett...
Posted by: mc at Aug 30, 2007 3:23:23 PM
spencer above makes an awesome point. i never thought about it that way. insurance payouts do a good job of solving the hardest problems and the incentives of the prize sponsor and the participants are aligend in the same direction.
Posted by: sa at Aug 30, 2007 3:29:31 PM
Check out http://www.prize4life.org/. Trying to do the same thing with research for ALS. Some friends of mine from business school started this, it's doing pretty well already.
Posted by: Dave at Aug 30, 2007 4:12:23 PM
carrying three people to 100 kilometers above the earth's surface, twice within two weeks
Just a minor correction - the prize was awarded for carrying one person into space twice within two weeks.
Posted by: Brian Courts at Aug 30, 2007 5:40:08 PM
Actually Brian neither of us is quite correct. The prize was awarded for a spaceship *capable* of carrying three people but in the actual flights you are correct it carried one.
Alex
Posted by: Alex Tabarrok at Aug 30, 2007 6:29:00 PM
Perhaps the experts at Boeing and MD also (consciously or subconsciously) biased their findings in favor of enabling a larger prize. Experts in spaceflight are also fans of spaceflight.
Posted by: Gordon Mohr at Aug 31, 2007 2:16:50 AM
In this case it is difficult for me to understand the difference between insurance and gambling. In my life, gambling does have a negative connotation but typically insurance does not. I'm reconsidering my position - maybe insurance is indeed nothing more than legalized gambling? What information should I consider which might pursuade me otherwise?
Posted by: Penelope at Aug 31, 2007 3:46:06 AM
The typical industry-apologist response is that gambling creates risk, whereas insurance is a transfer of some pre-existing risk. Another way to state is that insurance represents the insured's trading of some certain, definable loss (premiums payments) for some other uncertain but potential catastrophic one. (In which case, it's always seemed clear to me, insurance certainly is gambling from the perspective of the insurer.)
But this area of "promotion insurance," as it is called in the business, is gambling, plain and simple. And it's actually not permitted in most U.S. states. The glaring exception is Texas, which has a robust surplus lines market (that is, companies that operate, much like Lloyds syndicates, free of most of the usual regulatory restrictions of form and rate that govern so-called "admitted" insurers.) There are a variety of promotion insurance products, but most of them fall under the broad headings of prize indemnity or coupon over-redemption.
Surplus lines markets operate in every state, and are a key part of the commercial property/casualty market, but promotion insurance is one particular branch of surplus lines I've yet to see take root anywhere other than Texas. At least, in the U.S. market. In the U.K., the rules are far less restrictive, which is how Lloyds underwriters can be so much more creative.
Posted by: R.J. Lehmann at Aug 31, 2007 9:56:12 PM
"In this case it is difficult for me to understand the difference between insurance and gambling. In my life, gambling does have a negative connotation but typically insurance does not. I'm reconsidering my position - maybe insurance is indeed nothing more than legalized gambling? What information should I consider which might pursuade me otherwise?"
To make Lehmann's arguement more clear: in gambling, the risk only exists if you choose to play. You aren't going to lose your shirt on the races if you don't actually bet on the races. The people who operate gambling are actively creating *NEW* risk which wouldn't exist otherwise for the customer.
However, your house isn't safe from fire because you choose not to purchase insurance. The risk to the customer exists with or without your willful participation in an insurance plan.
Of course, that is the explaination in theory. In reality, gambling is "bad" for the same reason drugs, prostitution, and other victimless crimes are bad - because it is fun! There is nothing an uptight busybody hates more than people having fun!
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