Not all financial products attempt to turn a sum of money today into a larger one tomorrow. Even retail banking grew more out of a desire to protect what one had rather than to acquire more. However, the need for protection features more prominently in the story of insurance than of almost any other financial innovation, for perfectly obvious reasons. This is illustrated surprisingly well through the history of marine insurance. As large and risky ventures menaced by everything from storms to pirates, the business of shipping goods by sea has for centuries been supported by sophisticated insurance products.
Indeed, maritime insurance is among the oldest forms of insurance still in existence. It has, however, evolved noticeably over the centuries. Curiously enough, early forms of insurance for sea voyages were intertwined with attempts to circumvent medieval prohibitions on usury, or the lending of money at interest. In time, sophisticated insurance companies and marketplaces would form, underwriting policies around the world. Though commercial shipping is just one sector served by the global insurance industry today, it was a particularly large market in the early days of modern insurance.
Early Maritime Insurance
Insurance is essentially about transferring individual risks into pools that are more predictable and manageable, a concept closely related to diversification. A merchant with a single sea-going vessel is at much greater risk of being ruined by a storm than a merchant with an entire fleet; insurance helps the merchant by transferring that risk to another party. Indeed, in medieval Europe, merchants regularly sold shares in their voyages’ profits to other merchants. This was a source of financing, but by transferring risk, it also served as a form of insurance. In the coastal Italian city states where this kind of agreement was common, it was called a ‘commenda.’
Along with the ‘commenda,’ another form of early marine insurance was the sea loan, also called a ‘foenus nauticum’. These were loans to merchants shipping goods by sea and were also a feature of commercial life in medieval Italian port cities like Genoa and Venice. Of course, the credit risk of a loan to such a merchant is strongly tied to the safe arrival of his ship at its destination. If the borrower is shipwrecked, the lender is likely facing a loss. Naturally, the lender would demand compensation for taking on this risk but lending at interest was prohibited by the religious authorities in medieval Italy.
Circumventing this prohibition is where insurance came in. The sea loans worked around usury laws by bundling lending with insurance with the effect that the obligation to repay the loans was explicitly waived in the event of a wreckage. Because the lender was out his principal if the ship was lost, sea loans were a form of ‘loan-like’ insurance similar to the catastrophe bonds of today. Authorities investigating accusations of usury would be unable to distinguish the interest rate implicit in the contract from an insurance premium.
The sea loan was a boring product perhaps but it was also one subject to substantial financial innovation. The end for sea loans came when they started being lent to borrowers who had no financial interest in the ships in question. Borrowers would take out sea loans where the ship referenced in the contract was of no interest to them; to these borrowers, the sea loans were sources of financing, not insurance. The experimentation went even farther; some sea loans were made contingent on the safe arrival of any one of a set of ships. This innovation made these sea loans just like any regular loan as the chance of the covered event occurring was incredibly remote.
From there, it was not long until the religious authorities caught on and sea loans were condemned as usurious in 1236 by Pope Gregory IX. Of course, the need for marine insurance remained and as such it began to diverge from the lending it often attempted to obscure. Another consequence of the crackdown was that the epicenter of innovation in the marine insurance industry moved north to Britain where many Italian merchants carried on this trade. Indeed, even in the late-16th century, many of the underwriters’ names found on English insurance contracts were Italian.
The First Insurance Companies
Innovations in insurance in Britain weren’t limited to maritime insurance. For example, the oldest recorded life insurance policy was written in Britain for a man named William Gibbons in June 1583. The death benefit of that contract was about £4800, a fairly astronomical sum for that era. The premium paid was 8% for twelve months of coverage and the risk was split among sixteen underwriters. It was not smooth sailing though as Gibbons died a few days before the policy lapsed and the underwriters tried to get out of paying the claim by arguing over the exact meaning of ‘twelve months’.
Even simple marine insurance had been written in other countries before this point. The oldest known basic marine insurance contract was written in Palermo in Italy in the mid-14th century. The contract had an indemnity of 300 florins, payable following the loss of cargo, for which the insured party paid a premium of 54 florins, or 18%. These contracts were made through brokers who would pair the party seeking insurance with enough underwriters willing to take on the risk, a laborious process. Knowledge of shipping would have been necessary to adequately price the risk being transferred and therefore many of these underwriters were merchants themselves.
Nonetheless, individual underwriters have trouble controlling risk. After all, insurance works best when risk is pooled but individuals often lack the capital necessary to adequately diversify their exposures. This is also to say nothing of the institutional knowledge required to be successful in insurance where information on historical losses often forms the basis for pricing the transfer of future risks. Thus, one would think selling insurance is better suited for a company combining the knowledge and resources of several underwriters and this is exactly what happened in Britain, where limited liability was another benefit of incorporation.
In Britain, the formation of the oldest insurance companies coincided with the South Sea Bubble, an early-18th century speculative boom in the shares of many of the world’s first joint-stock companies, some of which were these early insurance firms. In fact, crucial to the creation of these insurance companies was the ‘Bubble Act,’ which was passed by the British Parliament in 1720, while the South Sea Bubble was still inflating. This act restricted the operations of companies to the missions set out in their charters and limited the formation of new companies. However, the Bubble Act did grant charters to two new firms specializing in insurance.
These companies were the Royal Exchange Assurance Company and the London Assurance Company, the first two insurance firms in Britain with limited liability. The entrepreneurs behind these companies petitioned King George I and Parliament for a charter; one couldn’t just incorporate a business themselves in 18th century Britain. The independent unchartered underwriters who were the mainstays of the insurance industry up to then fought against it. If it isn’t clear why, in the midst of the South Sea Bubble, the government would allow these stock companies just as it was cracking down on others, consider that these companies together promised to pay the government £600,000 for the charter. This offer was accepted as the British government was in considerable debt at the time. In fact, attempts to restructure the large state debt were responsible for the South Sea Bubble then underway.
In the case of the London Assurance Company, the firm was chartered to sell marine insurance in 1720 and was licensed to offer fire and life insurance in 1721. An initial capitalization of £1,500,000 was authorized, of which under £900,000 was actually subscribed. The company had a modest start; it was founded in a London pub called Rising Sun, which still exists in central London today. Despite the humble origins, the company was floated in the year of the South Sea Bubble; shares spiked to £160 before quickly falling to £12. A clever historian later said it was a stormy start for this marine insurer.
Nonetheless, in its first year, the company made a £9,740 profit from selling maritime insurance. It was a much bigger business than the fire and life insurance operations, which netted £570 and £170 respectively in 1721, when those operations were authorized. Institutionalization of insurance in the form of these companies was followed by early insurance regulations. In Britain, the Marine Insurance Act of 1745 required that the insurance buyer have an actual financial interest in the property being covered by the policy, an early measure designed to prevent insurance fraud.
Lloyd’s of London
Despite the success of these early insurance companies, underwriting by individuals did not die off in Britain. In fact, it survives to this day in the form of Lloyd’s of London. Lloyd’s is an insurance market composed of private individuals and syndicates underwriting insurance contracts, including marine insurance, which was its first major business line. Lloyd’s started as a club for marine insurers in the late-17th century. Such a club served a crucial purpose since, as was mentioned earlier, syndicating risk among numerous individuals was laborious and sharing knowledge was critical.
As a private marketplace where individual underwriters could write insurance contracts, it served as a substitute to the insurance companies. In a way, it benefited from the Bubble Act which, although it granted charters to two competitors, also restricted the formation of new companies. This insulated Lloyd’s from competition and meant that when the insurance market was opened up to new firms in the early-1800s, the market had already gained a level of sophistication that enabled them to compete with new firms. Even today, the underwriters at Lloyd’s still write billions of pounds of insurance contacts including in marine insurance. The marketplace’s publication, Lloyd’s List, still focuses on shipping and marine insurance news, albeit serving a market far larger and perhaps more advanced than that of medieval Italy or early-modern Britain.
Marine insurance makes the seas safe for trade, not by diminishing any gale or blocking a single wave but by reducing their potential to ruin merchants. Various different financial products and firms have filled this role over the centuries and not just in the business of maritime insurance. Both property and casualty insurance and life insurance are products that have existed for longer than most other financial innovations. This fact, along with the story of marine insurance, illustrates the vital role finance in general, and insurance in particular, plays in protecting peoples’ livelihoods. It is not just the insured party that benefits from this protection but all those who do business with him.
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2. Kingston, Christopher. “Marine Insurance in Britain and America, 1720–1844: A Comparative Institutional Analysis.” The Journal of Economic History, vol. 67, no. 02, 2007.
3. Kohn, Meir G. “Risk Instruments in the Medieval and Early Modern Economy.” SSRN Electronic Journal, Feb. 1999.
4. Leonard, A. B. The Pricing Revolution in Marine Insurance. Economic History Association.
5. Street, George Slythe. London Assuance: 1720-1920. Williams & Norgate, 1920.