The History of Insurance

If risk is like a smoldering coal that may spark a fire at any moment, insurance is our fire extinguisher.

Countries and their citizens need something to spread risk among large numbers of people and to move risk to entities that can handle it. This is how insurance emerged. Read on to learn how insurance evolved and how it can work to protect you from being burned by risk.

The main concept of insurance—that of spreading risk among many—has been around as long as human existence. Whether it was hunting giant elk in a group to spread the risk of being the one gored to death or shipping cargo in several different caravans to avoid losing the whole shipment to a marauding tribe, people have always been wary of risk.

The first written insurance policy appeared in ancient times on a Babylonian obelisk monument with the code of King Hammurabi carved into it. The Hammurabi Code was one of the first forms of written laws. These ancient laws were extreme in most respects, but one offered basic insurance in that a debtor didn't have to pay back his loans if some personal catastrophe made it impossible (disability, death, flooding, etc.).

In the Dark and Middle Ages, most craftsmen were trained through the guild system. Apprentices spent their childhoods working for masters for little or no pay. Once they became masters themselves, they paid dues to the guild and trained their own apprentices. The wealthier guilds had large coffers that acted as a type of insurance fund. If a master's practice burned down—a common occurrence in the wooden hovels of medieval Europe—the guild would rebuild it using money from its coffers. If a master were robbed, the guild would cover his obligations until money started to flow in again. If a master were suddenly disabled or killed, the guild would support him or his widow and family.

This safety net encouraged more and more people to leave farming and take up trades. As a result, the amount of goods available for trade increased, as did the range of goods and services available. The style of insurance used by guilds is still around today in the form of group coverage. (For related reading, see: Individual vs. Group Health Insurance: What's the Difference?)

The practice of underwriting emerged in the same London coffeehouses that operated as the unofficial stock exchange for the British Empire. In the late 1600s, shipping was just beginning between the New World and the old as colonies were being established and exotic goods were ferried back. A coffeehouse owned by Edward Lloyd, later of Lloyd's of London, was the primary meeting place for merchants, ship owners and others seeking insurance.

A basic system for funding voyages to the New World was established. In the first stage, merchants and companies would seek funding from venture capitalists. The venture capitalists would help find people who wanted to be colonists, usually those from the more desperate areas of London, and would purchase provisions for the voyage. In exchange, the venture capitalists would be guaranteed some of the returns from the goods the colonists would produce or find in the Americas. It was widely believed you couldn't take two left turns in America without finding a deposit of gold or other precious metals. When it turned out this wasn't exactly true, venture capitalists still funded voyages for a share of the new bumper crop: tobacco. 

After the voyage was secured by venture capitalists, the merchants and ship owners would go to Lloyd's and hand over a copy of the ship's cargo to be read to the investors and underwriters who gathered there. The people interested in taking on the risk for a set premium would sign at the bottom of the manifest beneath the figure indicating what share of the cargo they were taking responsibility for (hence, underwriting). In this way, a single voyage would have multiple underwriters who would try to spread their own risk by taking shares in several different voyages.

By 1654, Blaise Pascal, the Frenchman who gave us the first calculator, and his countryman, Pierre de Fermat, discovered a way to express probabilities and, thereby, understand levels of risk. Pascal's triangle led to the first actuary tables that were, and still are, used when calculating insurance rates. These formalized the practice of underwriting and made insurance more affordable. (For related reading, see: How is my insurance premium calculated?)

In 1666, the great fire of London destroyed around 14,000 buildings. London was still recovering from the plague that ravaged it a year earlier, and many survivors found themselves without homes. As a response to the chaos and outrage that followed the burning of London, groups of underwriters who had dealt exclusively in marine insurance formed insurance companies that offered fire insurance.

Armed with Pascal's triangle, these companies quickly expanded their range of business. By 1693, the first mortality table was created using Pascal's triangle and life insurance soon followed. (For related reading, see: Five Insurance Policies Everyone Should Have.)

Insurance companies thrived in Europe, especially after the Industrial Revolution. In America, the story was very different. Colonists' lives were fraught with dangers that no insurance company would touch. As a result of lack of food, wars with indigenous people, and disease, almost three out of every four colonists died in the first 40 years of settlement. It took more than 100 years for insurance to establish itself in America. When it finally did, it brought the maturity in both practice and policies developed during that same period of time in Europe. (For related reading, see: The History of Insurance in America.)