What it means
Suppose a car dealer offers a $50,000 car to anyone who sinks a basketball shot from the centre of the court. The chance of winning is tiny, but if someone does, the dealer faces a large cost that was not budgeted for.
An insurer takes on that risk in return for a premium. The price depends on the size of the prize, the probability of someone winning, and the insurer's own costs and profit margin.
Insurers set the probability using statistics and data on past contests, together with the rules of the event. They may require independent witnesses, measured distances and fixed entry rules, because these reduce the chance of disputes.
The premium is usually small compared with the prize, often well under 1% of the amount covered. For a business that runs a promotion once, buying the cover turns an uncertain possible loss into a certain and known cost, which makes budgeting far easier.
There are limits. Insurers will not cover contests where the outcome can be influenced by the organiser or entrants, and they rely on strict conditions about how the event is run.
The business should read the policy carefully, because a mistake in the way the contest is run can mean a claim is refused. Prize indemnity cover is not a way of making an unfair contest legitimate.
The organiser must still follow laws about advertising, gambling and lotteries in each place where the promotion runs.
In practice
Real-world examples.
Example
A golf club runs a hole-in-one contest with a $100,000 prize at its charity day. It buys prize indemnity insurance for a few hundred dollars. The charity can run the contest without risking its funds. The cost of the cover is far lower than the money it could raise from entry fees on the day.
Example
A supermarket launches a promotion where one shopper in a draw can win $250,000. The marketing team buys cover so that the cost of the prize does not hit profit if the winner is drawn. The finance team treats the premium as a marketing expense. If no one wins, the premium is simply the price of having been protected.
Example
A radio station runs a call-in contest with a $20,000 jackpot that grows each week. The station buys cover for each week's jackpot. The insurer asks for logs of calls and independent witnesses to confirm the result. Each week the cover is renewed for the new jackpot size, so the premium rises as the prize grows.
Formula
Calculation
Premium = prize amount x probability of a win x (1 + insurer loading)
The insurer loading is the percentage added to cover expenses, risk and profit.
Suppose a retailer offers a $1,000,000 prize for a perfect score in a skills contest. The insurer estimates that the chance of a win is 1 in 5,000, which is 0.0002.
Expected cost = 1,000,000 x 0.0002 = $200.
If the insurer adds a loading of 50%, the premium is 200 x 1.50 = $300.
For $300 the retailer protects itself against a $1,000,000 payout. If the retailer instead ran 20 such contests, the premiums would total 20 x 300 = $6,000.Case study
Seen in the real world.
Summit Motors is an illustrative, fictional car dealership that held a launch weekend with a contest: any visitor who kicked a football through a small target from 40 metres would win a $30,000 car. The marketing manager assumed that nobody would succeed.
The finance manager asked what would happen if someone did. The loss would be $30,000, which was more than the weekend's entire marketing budget of $20,000.
She bought prize indemnity insurance for a premium of $450, and the insurer required a marked distance and an independent referee. In this illustrative story, a visitor hit the target on the second afternoon, the insurer paid out $30,000 and the dealership handed over the car without any loss to its budget.
Watch out
Common mistakes.
- Running a contest without cover because the odds of winning seem small, when a single win can wipe out the budget.
- Ignoring the insurer's conditions on witnesses, measurements and records, which can lead to a refused claim.
- Treating the premium as a prize cost, when it is the cost of transferring the risk and should be recorded as a marketing or event expense, with any claim proceeds matched against the prize that is paid.
Questions
People also ask.
How is the premium worked out?
The insurer multiplies the prize by the chance of a win and adds a loading for costs and profit, so bigger prizes and higher odds mean higher premiums.
Is this insurance the same as gambling?
No, the business is protecting itself against a large cost, and it does not make money from the outcome of the contest, whereas gambling involves staking money in the hope of a gain.
Can the cover be bought after the event has started?
Usually not, because insurers want to assess the risk before the contest begins and do not insure an event once the result is known.
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