Funding the X-Prize

by on August 30, 2007 at 7:18 am in Economics | Permalink

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).

1 michael vassar August 30, 2007 at 8:37 am

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.

2 spencer August 30, 2007 at 9:35 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.

3 Eric G August 30, 2007 at 10:58 am

Perhaps a prediction market would have done a better job. Were the “experts” at Boeing and McDonnell-Douglas institutionally biased?

4 Andromeda August 30, 2007 at 1:27 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.

5 sa August 30, 2007 at 3:29 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.

6 Brian Courts August 30, 2007 at 5:40 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.

7 Gordon Mohr August 31, 2007 at 2:16 am

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.

8 R.J. Lehmann August 31, 2007 at 9:56 pm

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.

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