What is insurance?

 - July 30, 2008, 5:14 AM

To better understand insurance it helps to understand what it really is. The historical foundation of insurance is that disaster can strike anyone, at any time. The concept of insurance is the good fortune of many helping provide for the bad fortune of a few.

Insurance dates to 2100 BC and the days of Babylonia. Traders took loans to finance long-distance trips across deserts and through mountains to acquire and sell goods. They would pay back the loan, plus interest, from the profits of their trip. The Phoenicians and Greeks had a similar system to finance their ocean-going trade efforts. It is not difficult to imagine the vast assortment of potential problems that beleaguered those early traders, causing many to lose everything.

Witnessing the effect of financial loss, the early Romans came up with the idea of burial clubs. They were essentially a form of life insurance in which everyone paid a premium to ensure they would have a noble burial and their families would be given some money afterwards. About that time, trade in Europe was growing, as were European cities. Medieval guilds expanded on the Roman idea of insurance to include ways of protecting guild members from fire loss, a common disaster and shipwreck. The earliest known formal insurance contract was signed in Genoa in 1347; it was a marine policy against loss by shipwreck. The idea quickly spread throughout Europe.

In London in 1688, merchants, ship owners and insurance underwriters frequented a coffeehouse down by the docks to do business. Until 1693 life insurance was sold at one price for everyone regardless of age, but that year Edmond Halley, an astronomer, had developed the first mortality table based on statistical laws of mortality and compound interest. From that time on insurers could adjust the premium for a specific age.

By the end of the 18th century, that common gathering place– Lloyd’s Coffee House–had morphed into the first modern insurance company, covering everything from life insurance to maritime. Over the next 200 years new insurance products developed rapidly and became commonplace in business and among the wealthy.

Before the concept of corporations, the business of writing insurance was actually done by a number of wealthy individuals who would financially back the policy. These individuals, who signed their names under the actual insurance proposal indicating the percentage of the total risk they were accepting, became known as underwriters.

In 1735 the first American colonial insurance company was formed in Charleston, S.C. Other companies quickly formed throughout the colonies and the practice became firmly rooted in America. The Great New York Fire of 1835 underscored the requirement for having adequate cash reserves to meet unanticipated large losses and, as a result, states began requiring insurers to maintain appropriate reserves.

Though the airplane had been around for a number of years, it wasn’t until 1925 that the idea of aviation insurance surfaced. According to a paper published in 1944 by Reed Chambers, then president of the United States Aviation Underwriters, a highly speculative, fledgling airline called Florida Airways experienced its first accident even before the airline opened for business.

One of the company’s Ford-Stout aircraft taxied between two others damaging both wingtips and one wingtip on each of the other two aircraft. Taking a loss even before the first revenue dollar was generated put a significant chill on investors, and
Chambers instantly saw the necessity for insuring aircraft. As if that weren’t bad enough, a few months later a hurricane hit Miami and completely destroyed another company aircraft, and not long after that yet another crashed, killing both passengers and the pilot.

According to Chambers, “They were, as a result, faced with damage suits that would completely bankrupt the corporation. Thereupon, the stockholders decided to liquidate the company and reorganize it, which was later done, and it became a part of the great Pan American World Airways System, which was in the process of getting started.” While aviation insurance existed in Europe, there was no such thing in the U.S., so Chambers and a friend, Dave Beebe, who was at that time in the Marine department of the insurance company Marsh and McLennan, decided to study the European aviation insurance business. Finally, in July 1928 the two were able to convince four casualty companies and four fire companies to join together in the founding of the United States Aircraft Insurance Group.