The History of Insurance

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Podcast Transcript

Insurance seems like a pretty modern concept. There are insurance commercials on television, and insurance companies sponsor major sports teams. 

Most of us have to buy insurance, or we are at least under someone else’s insurance policy.

However, insurance is far from a modern concept. It is actually one of the oldest financial arrangements in human history.

Learn more about insurance, how it was created, and how it works on this episode of Everything Everywhere Daily.

Insurance is usually considered a pretty boring subject. It is often very technical, and most importantly, it deals with something that we don’t want to think about. 

So, before we get too far into it, what exactly is insurance?

The common definition of insurance is that insurance is a contract in which a policyholder receives financial reimbursement against losses from an insurance company if a predetermined event should occur.

Basically, insurance is a form of risk mitigation. If something should happen with a negative financial consequence, an insurance company would pay a policy policyholder based on the terms of their contract. 

You can, if you really want, get an insurance policy for almost anything. More on that in a bit.

In reality, there are a small number of categories that most people buy insurance for. 

Auto insurance is probably one of the most popular forms of insurance worldwide. Getting in a car accident is a low-probability event. However, if you should get into a car accident, it will cost you a lot of money. 

You might need repairs to your car, you might even need to entirely replace your car. If the accident was severe, you might need to pay for medical treatment, or you might have to pay for someone else’s medical treatment if you were at fault.

You can buy insurance policies for homes, cars, farm crops, natural disasters, shipping products, apartments, airplane flights, and even your life. 

So where did the idea for insurance come from? 

The earliest evidence of insurance dates back over 3,000 years. 

In 1902 archeologists discovered a large two-and-a-quarter meter stone tablet with 4,130 lines of cuneiform writing which dated back to the First Babylonian Empire, 3,750 years ago. This stone, known as the Code of Hammurabi, was a list of the laws issued by the king which governed the land. I’ve previously done an episode on the subject. 

Many of the laws listed in the Code of Hammurabi directly or tangentially dealt with the subject of insurance. 

There were laws dealing with liability, insurance fraud, and Acts of God. 

Here I should note that in insurance terms, Acts of God don’t refer to anything religious. An act of god refers to any sort of natural event which is beyond human control.  A hurricane, tsunami, tornado, flood, and some fires, can be considered acts of god. 

An act of god might be exempted from a contract, or it might be the very thing that you are trying to insure. 

The Code of Hammurabi is the earliest evidence we’ve found of some sort of insurance in the ancient world. Already 3,750 years ago, it seems that insurance had become quite sophisticated. That means that insurance of some sort probably dates back even further. 

What appears to have initiated the development of insurance was long-distance trade. When you live in a village and you trade with those people around you, insurance isn’t really necessary. If something bad happens, it will probably happen to everyone.

However, when you trade with people who lived further away, there was a risk that your ship could sink, resulting in a total economic loss. 

The idea of financially protecting yourself from risk appears to have been one which arose in different parts of the world independently.  There are several ancient Indian Sanskrit texts which deal with the subject of insurance. 

As early as 1000 BC, the island of Rhodes had developed a system of rules for sea transportation which said that if a crew had to throw cargo overboard to save a ship, then the losses would be shared equally with everyone who had cargo and with the ship owners. 

Ancient Athens had an insurance-like system where shippers would take out a loan that would be repaid when a voyage was complete. In the event that a ship and its cargo were lost, then they didn’t have to repay the loan. It is sort of the opposite of how insurance policies work today. These were known as ‘sea loans.’

Instead of paying in a little and getting out a lot in the event of a disaster, you took out a loan for a lot and didn’t repay it if something happened.

There is evidence dating back to ancient Egypt and Rome for early forms of life insurance. Common people back then could pay into a burial society which would then cover their funeral expenses. These mutual aid societies were a form of insurance that, in some forms, still remain popular today. 

During the Middle Ages, insurance never went away, but it did change. In 1236, Pope Gregory IX declared sea loans to be usury and hence a sin. 

This resulted in a change in risk mitigation strategies. In particular, in Italy, it resulted in a new type of contract called a commenda. The commenda was an early form of legal partnership where investors would share profits and losses. 

In Portugal, they took a different approach. In 1293, King Denis created the Bolsa de Comércio, which was basically the first organization to offer marine insurance. You pay in a regular amount and get a payout upon some event. 

Marine insurance contracts began appearing in Italy in the 14th century, and by the 15th century, the wording and terms for marine insurance contracts had become standardized. 

By the 16th century, special courts started to appear that specialized in marine insurance. 

While the vast majority of insurance in the middle ages was marine insurance to protect shipping, it wasn’t long before the idea expanded to other areas, and insurance became a proper business. 

The beginning of the modern insurance business can be traced back to late 17th century London to a place known as Lloyd’s Coffee House, owned by Edward Lloyd. 

Lloyd’s Coffee House became a go-to place for sailors, ship owners, and merchants who wanted the latest news on the shipping industry. People would go there to talk and exchange information. 

They also began taking bets on what ships would be lost at sea. 

This coffeehouse eventually evolved into the modern company known as Lloyd’s of London. Technically speaking, Lloyd’s of London is not an insurance company. It is a marketplace where companies and wealthy people can come together to underwrite policies. 

As a result, Lloyd’s of London has issued policies for a host of things that no other company would touch. This includes the bodies of professional wrestlers like Ric Flair, the vocal cords of singers like Celine Dion, the legs of Betty Grable, and even the taste buds of a food critic. 

Property insurance began in earnest after the Great Fire of London in 1666. Companies offered fire insurance and also created their own fire departments, now having a vested interest in their client’s homes not burning to the ground. 

However, they would let buildings burn which weren’t insured, which caused a problem because fires spread. The insurance companies eventually pooled their assets to create municipal fire departments, which would fight all fires in a community.

Because of the aftermath of the Great London Fire and the rise of Lloyd’s of London in marine insurance, London became the center of the insurance industry. 

In the early 18th century, the Amicable Society for a Perpetual Assurance Office in London offered the first true life insurance policy.  Men could buy shares each year, and then at the end of the year, shares were paid out to widows and children of those who died—people who otherwise would have been left destitute.

With the growth of the insurance industry in the 17th and 18th centuries, it became necessary to put the business on a firmer mathematical footing. If you were betting against a ship sinking, a home burning down, or someone dying, you had to know exactly what the odds were of such an event occurring. 

This was the start of actuarial science. In 1693, Sir Edmund Halley, the same person for whom the comet is named, created the first life table, which determined the odds that someone would die at a given age. 

Statistical techniques improved in the 18th century, and in 1762, the Society for Equitable Assurances on Lives and Survivorship was founded. The first insurance company based on actuarial science, where premiums were paid based on your age. 

It was also the first mutual insurance company. You’ve probably heard the term ‘mutual’ used in reference to insurance companies before. A mutual insurance company is a type of co-op where the company is owned by the policy holders. 

The 19th century saw the development of accident insurance, the forerunner of modern auto insurance. The first accident policies were created for the railroad industry, which suffered frequent accidents during its early years. 

The entire insurance industry is based on the premise of distributed risk. Taken in large numbers, the number of people dying, homes that burn, or ships that sink behaves somewhat normally over time. By spreading the risk across a large number of policyholders, it is possible to pay someone when an unpredictable event occurs. 

But what happens when there is an event which strikes a large number of people all at once, or there is just a statistical quirk where a large number of insurance claims are made all at once?

Such an event could bankrupt an insurance company. What does an insurance company do to protect themselves from such an unlikely event?

They do the exact same thing that their policyholders do. The insurnace companies take out insurance.

The companies that insure insurance companies are called reinsurance companies.  

Some companies specalize in reinsurance and some companies do both insurance and reinsurance. It is basically another way to spread risk around. 

Reinsurance has been around since at least the middle ages, but the importance of it became evident after the 1906 San Francisco Earthquake. At the time, most insurance companies were local and issued policies to people in the same community. That in and of itself is a risk.

After the San Francisco Earthquake 12 American insurance companies went bankrupt as well as one in Germany and one in Austria. 

The first independent reinsurance company was Cologne Re which was founded in 1846 after the Great Fire of Hamburg in 1842. 

The 20th century also saw the rise of social insurance. This is where the government acts as the insurance company.  You pay into a fund and then get money back when you are older or are infirmed. 

The original principals involved were similar to that of the insurance industry. Risk was distributed over the entire population with benefits paid out to specific individuals. 

The primary difference between private and social insurance is the mathematics behind it. Social insurance is dependent on the demographics of the country that issues it.  In particular, the two biggest factors are population growth and life expectancy. 

When most social insurance programs were started, it was during an era of both high population growth and low life expectancy. You had many people paying into the system and few people taking money out of the system. 

Over time, however, life expectancies have gone up, and population growth has gone down. The result is less money coming in and more money going out. 

This is a subject for a future episode, but almost every developed economy in the world is dealing with this problem right now. The recent protests in France over raising the retirement age from 62 to 64 is just one manifestation of this problem. 

Insurance really is an important part of the world’s economy. The ability to distribute risk has allowed economies and societies to flourish by avoiding debilitating events that would otherwise cause everything to come to a halt. 

It really isn’t a stretch to say that insurance is one of the cornerstones of the modern world. 

The Executive Producer of Everything Everywhere Daily is Charles Daniel.

The associate producers are Thor Thomsen and Peter Bennett.

Today’s review comes from listener Eduardo Cano over on Twitter. He writes:

Hi Gary, I hope you’re having a fantastic day wherever you are. I have been listening to your podcast religiously, and I wanted to take this opportunity to thank you for gracing my mornings with your knowledge and wisdom. I am passionate about history and traveling and love the way you narrate your stories which makes it easy for the brain to retain that information and very enjoyable. Sending you a massive hug straight from Honduras. Eduardo.

He also added:

I listened to your episode on the Football War and was so happy to learn so many facts about my country I didn’t know. You should make an episode about Central America!

Thanks, Eduardo! I think there is a lot to be said about Central America, both individual countries and the region as a whole. I previously did an episode on why the West Indies weren’t a single country but rather a collection of small independent countries.

I think the same question could be asked of Central America. Why is a group of small, contiguous countries that speak the same language and were colonized by the same country separate countries today? And, of course, why did they become so different?

Remember, if you leave a review or send me a boostagram, you too can have it read on the show.