A traveling salesman sells Peter an insurance policy to protect his home against a volcano eruption. He convinces Peter “a volcano is coming this way” despite the fact that Peter lives in Rhode Island, far away from any active volcanoes. He convinces Peter to purchase the policy by using the gambler’s fallacy and convincing Peter that Rhode is “due for one.”

If this were actually true, the premiums associated with this policy would be extremely high and likely be the same as the cost that an actual volcano would inflict on the town. Insurance markets function on the interaction between uncertainty, risk aversion in consumers, and risk neutrality for firms. If some horrible event were guaranteed to occur imminently, there would be little incentive to sell insurance.

Thanks to Alex Marsella for the clip submission and most of the summary!