INSURANCE AND REINSURANCE; A HISTORICAL CHRONOLOGY: Risk Tradition to Trading, From Conjecture to Calculation & Birth of Modern Insurance

THE PROMISE INSURANCE SHOW PRESENTATION ON MAKING A CASE FOR INSURANCE AND REINSURANCE; A HISTORICAL CHRONOLOGY

Introduction: The Insurance Story since 18^th Century

A total of USD 4,613 billion was spent globally on insurance in 2012.

Modern life can hardly be imagined without this form of risk protection. And yet, comparatively little is known about the history of the industry, although it has played a major part in shaping today’s society and culture. Industrialization, welfare, innovation, economic development, or modernization per se would not have been the same without private insurance.

Since the 18th century, building insurance on solidarity, business acumen, and the logic of calculation has proved an almost unbeatable business idea. It was to conquer the world over the next centuries.

Trade and emigration became the two most important enablers for creating a global insurance safety network.

As every history, that of insurance has been exposed to challenges. Many were inherent to the industry. Some large catastrophes proved too big to deal with for some companies. 

From the San Francisco Earthquake in 1906 to Hurricane Betsy in 1965 or the attack on the World Trade Center in 2001, the industry had to cope with unexpected enormous losses.

But challenges also came from the economy and its recurring crises which at times caused bigger losses than the worst insured catastrophes. Also monetary issues caused difficulties with floating exchange rates and fluctuating interest rates.

But overall the insurance industry has proved remarkably resilient to all these challenges. Even in the recent crisis, insurance was less affected than other industries. A long history of prudent reserving and risk awareness had taught insurers to act cautiously.

In antiquity, risk was often seen through the lens of fate and met with acceptance rather than defiance. Protecting against misfortunes was perceived as tantamount to interfering with divine providence.

For millennia, prayers, pilgrimages and donations outperformed insurance premiums.

Indeed, as late as the 19^th century, insuring against death was likely to arouse controversy among clerics.

But there were acceptable ways of alleviating losses, such as sharing risks within social and business communities.

Risk mitigation based on solidarity was widespread among guilds, trade associations and village communities.

Most seafaring nations distributed cargo onto different ships to hedge against storms and pirates while fraternal organizations provided ex-post, and thus morally acceptable, forms of solidarity.

Spreading risk in such a way had its limits, however, and as a business model it faced many difficulties. Ship owners sailing the same route would often experience accumulated losses, as would certain communities, such as mine-workers.

A single disaster could far exceed the capacities of a burial club (Kwezika, Harambee, munno-mukabi, Twezimbe, etc. as referred in African setting.)

Also, early forms of mutual insurance, whereby premiums were paid ex-ante, lacked the sophistication of modern enterprises. Operating costs had to be financed out of members’ contributions and hardly any such societies had ways to invest the capital professionally. For modern insurance, spreading risk and managing finances was to become vital.

One more element, however, was to be at least as influential.

In 1654, the French nobleman Chevalier de Mere was vexed by uncertainties in his gambling pastime. He wanted to know what the chances were of rolling a six in a certain sequence. The mathematicians Blaise Pascal and Pierre de Fermat used an old pyramid of numbers and eventually were able to prove that a mathematical probability could be determined.

This triggered a revolution in the development of probability theories and mathematicians all over Europe cooperated and applied their findings to calculate life expectancy.

This attempt at predicting the future was in direct opposition to Church doctrine but, ironically, it was the Church whose mortality tables provided some of the input used in those early probability calculations.

Mortality tables were often the work of clerics who wanted to discover the role and plans of a divine creator and prove the clear regularities and divine order behind the apparent randomness of mortality.

Life insurance was slow to adopt the new science. Various forms of annuities prevailed, resembling gambling more than assurance. For some time so-called “tontine” schemes, named after their creator Lorenzo Tonti, had enjoyed great success, especially in Italy and France.

Subscribers could buy a share in a kind of life annuity based on the mortality of an appointed nominee. With nominees grouped by age range, interest was shared out and paid to subscribers annually.

When a nominee died, the associated subscriber’s share in the annuity became void, and the remaining subscribers within the age range received an increased share of the interest.

Many tontines were fraudulent or badly under-subscribed and eventually were turned into simple life annuities.

It was only later in the 18th century that life insurance was put on a healthier footing. James Dodson, a 45-year-old English mathematician, was refused insurance because of his advanced age.

This annoyed him so much that he searched for a mathematical solution in order to form a more equitable base upon which to calculate premiums as a percentage of life expectancy.

This principle was to be adopted by the English Equitable Life Assurance Society in 1766. On this basis, the Welshman Richard Price later developed a cost and accounting model.

In 1774 he calculated profitability in life insurance or the Equitable Life based on current and expected mortality, so that the current state of the operations could be assessed more precisely.

From then on, life insurance no longer relied on speculation.

Friendly or benevolent societies, also called fraternal organizations, have a long tradition in many European countries. Before modern insurance such organizations would provide insurance, often for people with a similar working background. With the advent of modern insurance and the welfare state many of these mutual organizations went out of business.

Members of fire societies were obliged to help each other to secure goods from burning houses of fellow members. The societies had their own fire-fighting equipment. Some of them gradually started collecting money for those affected by a fire and eventually turned into mutual fire insurance companies.

The Age of Reason or Enlightenment of the 17th and 18th centuries provided the grounds for accepting actuarial science as a rational means to conduct better business. Insurance, and especially life insurance, resonated with the search for laws, the statistical recording of natural events and the calculation of future developments. Behind this innovation was the conviction that the world and its possible future states could be predicted and computed.

Pascal’s triangle was used by the Swiss mathematician Jacob Bernoulli who contributed the law of large numbers to actuarial science. This was to become the axiom from which life insurers could calculate expected losses.

Insurance was thus an ideal laboratory for enlightened business ideas.

The process of collecting different types of institutional and personal information and using underwriting to transform it into quantifiable costs was important.

It created a vital counterbalance to the new and potentially destabilizing forces that were transforming the division of labour, urbanization, and the economics of trade.

Insurance also helped money become the means of communication within the economy and contributed to more and more problems being expressed in terms of costs and time.

Not all cultures adopted such thinking from the start. In Southern Europe, it took a catastrophe to change the perception of risk and the views on destiny.

The Great Lisbon Earthquake in 1755 challenged the traditional interpretation of divine omnipotence.

Almost the entire city was destroyed, including churches and municipal buildings, but, much to the concern of many survivors, the red-light district was left intact.

How could a benevolent God allow this, and why did an all-powerful God not prevent it?

Was mankind really meant to take destiny into its own hands?

Rational thinkers were increasingly seen to be on the winning side of the argument, and although the Earthquake did not immediately boost the idea of insurance in the South, it gave rise to modern seismology.

Blaise Pascal as a twelve year old boy. Together with Pierre de Fermat he later developed the basis for probability calculations which were to have a lasting impact on life insurance.

In England it was the Great Fire of London in 1666 which had changed public opinion. Hardly any of the 70,000 destroyed homes were insured.

One Londoner, Nicholas Barbon, made a fortune out of rebuilding the city and then turned to insuring the houses.

His main motive was not solidarity but business, pure and simple. His rational approach and his experience as a banker and mortgage provider made him realize that his insurance company needed to be built on a different financial foundation, and so, in 1681, he created the first known joint stock insurance company.

Shareholding was to become essential for modern insurance as it allowed the separation of operating capital from risk capital and provided funds to expand business into new lines and beyond the home market.

The Old Sugar House in Hull had been set up to compete with London refineries but was abandoned in the 1840s. In 1868 it collapsed killing eight men and boys. Sugar had become an important catalyst for industrial growth in England. Refining of the raw sugar at plants in Europe was associated with a considerable fire risk. In the second half of the eighteenth century, fires at sugar refineries accounted for a large proportion of all bankruptcies in England.

Only two of the fire insurance companies at the time also insured sugar refineries, albeit at inflated rates and with meager policy limits. In 1782, eighty-four sugar refinery owners in London founded a joint-stock insurance company, the Phoenix. They were the first ones to specialize in insuring large industrial risks and, on the trail of sugar, to deliberately export this modern form of insurance.

The immediate success of such joint stock corporations was, however, dealt a significant blow as it led to speculation and subsequently ruin, as happened in the South Sea Bubble in 1720. 

The rational business ideas of the Enlightenment also tempted many investors to abuse the sound concepts of insurance to bet on the most unlikely risks, such as the outcome of wars, the danger of dying from excessive consumption of gin, or the date of birth of heirs to empires. 

The government subsequently banned some forms of insurance. A ban on reinsurance had already come into force in 1746. Still, it seemed there was an inevitable logic in developing insurance further. 

The economist Adam Smith praised it as a rational invention and even a moral obligation. Not to insure oneself he considered a “thoughtless rashness and presumptuous contempt of the risk”

The Great Fire swept through London from 2 to 5 September in 1666. It destroyed over 70,000 homes, although only six deaths were recorded. It did not take long for the first fire insurance company to be established after the catastrophe.

The Phoenix emblem with the Monument to the Great Fire of London in the background. The Phoenix managers were the first to venture out beyond the borders of their own country with agencies. Along with the new joint-stock marine insurance companies and Lloyd’s of London, they were among the first to respond to the rapid increase in the interdependence of the global economy that had been under way since the middle of the eighteenth century.

The industrial revolution and the growth of the Empire called for insurance solutions. 

Towards the end of the 18th century the first truly modern and global insurance company, the Phoenix, as founded by an association of sugar refinery owners in London. Soon after its foundation, it insured risks in distant countries and it was the first insurer to establish offices abroad. 

And so it was from Britain that property and life insurance started colonizing the world, based on modern science, new forms of capitalization, and the possibility to spread risks across the globe.

Altogether, this was to prove a virtually unbeatable business model.

The Amsterdam Stock Exchange, engraving by Francois van Bleyswyck, 1743. The Verenigde Oostindische Compagnie (Dutch East India Company) in Amsterdam established the oldest known stock exchange in 1602. For insurance, shareholding was to become an ideal way to raise operating capital which allowed them to expand their business.

The 1755 Lisbon earthquake and tsunami.

Yours truly 

Emmanuel Sanyu Safali

The founder and host of

The Promise-Insurance Show on YouTube and TV

emma.safali@gmail.com

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