History of Finance - The multi billion dollar insurance market

How should we deal with risk and uncertainties of the future? Should we be able to rely on the voluntarily charity of our fellow human beings when calamity strikes, or should we able to count on the state i.e the compulsory contributions of our tax payers to bail us out when the flood comes?

The short way of asking the above question is “Are you insured”?

The most basic financial impulse of all is to save for a rainy day because as we have been painfully reminded by the past financial turmoil’s that the world really can be a dangerous place. The struggle to overcome risk has been a constant theme of the history of money, from the invention of life insurance by two Scott clergymen, to the explosive growth of hedge funds and their multi billionaire owners. At the core of our struggle with risk is an insoluble conflict, we want to be financially secure and so we yearn for a predictable world. But the future always seems to come up with new and unpleasant ways to take us by surprise. We want calculable risk; we are stuck with random uncertainty.

Its two Church of Scotland ministers who deserve the credit for inventing the first true insurance fund back in 1744, and fathering a multibillion-dollar industry. Robert Wallace, and his friend Alexander Webster, were hard drinkers and mathematical prodigies. They were unhappy at the way the women and children of their fellow clergymen were treated, if the men of the households were no more. Left at the mercy of the fellow ministers, they were often homeless and without money. The ministers were responsible for paying out some money collectively to the widow and the orphans. Wallace and Webster came up with an ingenious plan to curtail this problem, now recognized as the first true insurance fund in history. They ran their numbers over and over again making careful assumptions of the maximum number of widows and orphans that would have to be provided for in the future. They key point was that the ministers from now on would just not pay money only when the grave reaper struck one of their own, rather they would pay premiums that would be used to create a fund. The fund would then be invested for profitable purposes. The widows and orphans hence forth would be paid out of the returns on that money, leaving the premiums to accumulate. All that was required for the scheme to work was an accurate projection of how many widows and orphans there would likely be in the future, a calculation that the couple of ministers made with extraordinary precision. The creation of the Scottish Minister Widow Fund, was a milestone in financial history, for it provided a model not just for clergy man but for everyone who aspired to provide for life’s eventuality.

By 1815 the principle of insurance was sufficiently widespread to be adopted by the widows of men who lost their lives in wars. The Scott Ministers grew into the world famous Scottish Widows. Even novelists, not renowned for their financial prudence were allowed to join. Sir Walter Scot, a historical novelist, playwright, and poet took out a policy in 1826 to assure his creditors that they would be paid in the event of his death. By the mid 19th century being insured for much was now as a badge of respectability and a much desired status symbol.

What no one anticipated back in 1744, was that the careful actuarial calculation of two ministers would grow into today's huge insurance industry. Robert Wallace understood the importance of size and volume in insurance schemes. The larger the number of people paying into the fund, the easier it become by law of averages to predict how much would be paid out each year. In simple words, insurance is about trying to cope with the risk of the future. No matter how many private funds are set up, there are still a lot of people who are still not insured in today's world. The welfare system adopted by most of the developed economies to provide for the poor still remains a challenge and threat all over the world.