Why would Warren Buffett, known the world over for his brilliant, if prudent, insights into investing, put his money into what looks like a trickster’s game?
That’s exactly what he seems to be doing when his flagship company Berkshire Hathaway Inc. agreed to insure a promotional gimmick by US home mortgage lender Quicken Loans in what is aptly called March Madness.
Under the Billion Dollar Bracket Challenge, Quicken will give US$1 billion to whoever correctly predicts the winner in each of the 63 games in the National Collegiate Athletic Association’s men’s basketball tournament next month. It will also award US$100,000 each for the 20 entries that give the most accurate brackets. So that’s US$2 million that the mortgage lender has to shell out, whether or not anyone is able to bag the US$1 billion jackpot.
Now, the problem for Berkshire is that it will charge an insurance premium based on the probability of someone winning the prize. So how exactly should such probability be computed? What is the risk of Buffett, who ranks fourth in the Forbes’ list of the world’s richest men with an estimated worth of US$53 billion, losing the equivalent of nearly 2 percent of his personal fortune to this apparent insanity?
That is the question the Hong Kong Economic Journal’s investor diary column tries to answer.
With the number of contestants limited to the first 10 million people who are able to register for the game, the risk incurred in insuring the bracket challenge basically depends on the probability of someone making the correct guess.
At least three scholars have tried to crunch the numbers. Jeffrey Bergen of DePaul University puts the probability of guessing correctly all the 63 game results at one in 9,223,372,036,854,775,808. That’s 9.2 quintillion! The other two pundits give much higher chances of winning for skilled players of the bracket challenge. Jay Berger, also from DePaul University, says the figure is no more than one in 128 billion, while Ezra Miller with Duke University believes it’s one in 1 billion.
Even using Miller’s number, which is very optimistic indeed, it’s way below the chance of winning Hong Kong’s Mark Six lottery, which is about one in 14 million. So calling Buffett’s bluff is like hoping to be hit by lightning a thousand times during one’s lifetime — and surviving them all to claim the prize.
That being the case, according to the column, the premium that can be charged based on the three probability figures, in descending order, would be US$10 million, US$78,000 or much less.
But as in any game of chance, what if someone wins?
Shareholders of Berkshire Hathaway probably wish the Oracle of Omaha would stop making such weird and wacky bets — or they might start entertaining the idea that it’s time for a change of leadership in the highly respected insurer.
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