Marine Insurance

Origins and Institutions, 1300-1850

Adrian Leonard, Adrian Leonard

• Publisher: Palgrave Macmillan
• Year: 2016
• ISBN:
  9781137411389
• Topic: Economia
• Subtopic: Storia economica

Since its invention in Italy in the fourteenth century, marine insurance has provided merchants with capital protection in times of crisis, thus oiling the gears of trade and commerce. With a focus on customs, laws, and organisational structures, this book reveals the Italian origins of marine insurance, and tracks the spread of underwriting practices and institutions in Europe and America through the early modern era. With contributions from eleven leading researchers from seven countries, the book examines key institutional developments in the history of marine insurance. The authors discuss its invention in Italy, and its evolution from private to corporate structures, assessing the causes and impacts of various state interventions. Amsterdam and Antwerp are analysed as one-time key centres of underwriting, as is the emergence and maturity of marine insurance in London. The book evaluates an experiment in corporate underwriting in Cadiz, and the development of insurance institutionsin the United States, before applying the metrics of underwriting to discuss commerce raiding in the Atlantic up to the nineteenth century.

1

Introduction: the Nature and Study of Marine Insurance

A.B. Leonard

In the words of a twenty-first-century Lloyd’s underwriter, ‘insurance is the mortar between the bricks of commerce’. It provides contingent capital which is transformed into cash in times of crisis, allowing entrepreneurs and companies to trade with smaller quantities of conventional capital than are prudently necessary in their particular, perilous trading environments. In so doing, insurance transforms many of the uncertainties of capitalism into fixed costs.¹ Further, it does so remarkably efficiently, a fact confirmed by its surprising resilience, and by the steadiness of its structure. As this volume shows, the basic instrument of premium-based marine insurance remained almost identical over the entire four-century period covered by the contributors, beginning about four hundred years before Lloyd’s emerged as a distinct, branded insurance market in 1769.² Today underwriters there, elsewhere in London, and in the other marine insurance centres of the world trade in a financial product which continues basically unchanged from that which was used centuries before, right down to the wording of the contract, called a policy.

Although the basic marine insurance structure has been in use ‘time out of mind’, as Francis Bacon acknowledged in 1601, the institutions which surround it have evolved significantly. Steady and progressive change characterises the communities of merchants that bought and sold insurance, the rules adopted to govern the way the business operated, the mechanisms established to enforce those rules (whether informal or statutory), the nature and depth of the organisations erected to provide and catalyse marine insurance, and the relationships between insurers and states. This volume outlines some of those institutional changes, which themselves illustrate the significant parallels which have cut across and through the temporal and geophysical stages of the development of marine insurance.

The underlying marine insurance instrument is elegantly simple. The buyer, or insured, selects the amount of contingent capital he or she wishes to receive after an unforeseen insured loss has occurred. This ‘sum insured’ under an individual policy will reflect all or some of the value of a vessel or cargo during a specified voyage (but not more). In exchange for their promise to pay their share of the ‘indemnity’ if a valid claim is presented, the insurers receive, in advance, a ‘premium’ expressed as a percentage of the sum insured. Thus, the type of risk transfer discussed in this book is often referred to as ‘premium insurance’. Each insurer commits to pay only his own share of the total sum insured, since typically during the period explored in this book multiple men (they were always men) each assumed only a portion of the risk transferred under a single policy. They showed this willingness by signing their names at the bottom of the document, under the main policy wording, making them ‘underwriters’ or ‘subscribers’.

The simplicity of this age-old financial instrument was and is bedevilled by details, however. Many points of potential contention may arise between insurers and their insureds which are not directly clarified by the policy language. Coverage is the main one. While the broad list of perils insured under the standard policy appears to cover any and all losses arising from the threats of nature (maris, the seas) and the acts of men (gentium), insurers in practice were renowned for attempting to wriggle out of claims, by arguing that losses were caused by the manifestation of an uninsured peril. Of course, denying claims entirely was not the norm. If it had been, the market would have withered centuries ago. Instead, it flourished.

Policy language has remained unchanged for so long precisely because of its ambiguity. As will be shown in this volume, disputes were typically settled by disinterested merchants from within the trading community. Sometimes, inevitably, courts and other outside tribunals with diverse levels of competence were called in to pass judgement. Each decision made by the arbiters of the merchant community added a new layer to the accepted interpretation of the contract wording within that community. Litigation outcomes also put paid to questions of coverage (although future adherence to third-party interpretations of the contracting parties’ intents as to the limits of coverage was sometimes rejected). Changing the words of the contract reopened the potential for dispute, and was avoided by retaining tested contractual language. Over the centuries this approach reduced the possible points of contention. So too did the harmonisation of the rules of disparate insuring communities.

Differences of understanding or custom between communities were another common source of dispute. A clear example lies in the parallel development of European and Indian insurance custom. Premium insurance appears to have been invented independently by both the merchants of Italy and those of India, and was in active use in the latter region by, at latest, the mid-seventeenth century. In both traditions, contingent capital was promised to cover actual losses, in exchange for a fee paid in advance, calculated against the value of the goods insured and the route of transport. The European practice of sharing individual risks between multiple underwriters seems to have been absent in India, however, leading to ‘considerable capital and cash flow problems’ for the insurance of very big consignments (a common complaint levelled against private underwriters in European markets). Further, customary practices had been worked out differently in Europe and India, as the articles of co-partnership of the Ganges Insurance Company, launched in India by Europeans in 1791, illustrate. The company’s founders stated that the insurance business was ‘almost entirely in the Hands of the NATIVE BANKERS, who are guided solely by Caprice and Custom, without any knowledge of the true principles of assuring as practised in European Governments’.³ European underwriters were equally governed by custom, if not always caprice, and, needless to say, their practices, and specifically those of London, soon displaced those of India. Nonetheless, the parallels of the underlying risk transfer instrument, and the adoption of customary rules to govern its use, are clear.

European insurers in India had recourse to local courts when they felt prevailing custom did not match their expectations, and, as in Europe, those authorities sometimes referred such actions to panels of business leaders. In Europe, arbitration was the preferred course of action. However, what Bacon’s insurance act of 1601 referred to as ‘the arbitrary course’ did not in all cases prove sufficient to satisfy disputing parties. States and their judiciaries were often called upon to intervene, although they were typically ill-equipped to do so since, with practice governed by customs rather than legal codes, state adjudication was unpredictable and typically time-consuming. Still, state authorities were generally supportive of the practice of marine insurance because it was recognised as an important catalyst of trade, which was respected by states as a lucrative source of revenue. As such, state tinkering with the operation of markets or enforcement mechanisms tended to be carried out with the intention, at least, of improving the insurance market (protectionist measures notwithstanding). However, as this volume shows, such efforts sometimes fell short of their mark. While they could be effective at easing the resolution of disputes and reducing transaction costs and fraud (while facilitating the taxation of premiums), they could, unless carefully crafted, interfere with the operation and peculiar flexibility of the insurance markets they sought to assist.

Insurance in its earliest incarnations in all the markets discussed in this volume began as a mutually beneficial system of finance, and was traded between members of a merchant community as a ‘club-good’ (or perhaps a club-service) which they used to improve the commercial experience of all participants. Buchanan defines club-goods as those which fill the ‘gap between the purely private and the purely public good … the consumption of which involves some “publicness”, where the optimal sharing group is more than one person or family, but smaller than an infinitely large number.’⁴ Merchant-insurers, as underwriters were known in England since at least the seventeenth century, used their club-good to make more secure the trade both of individuals and of the community, despite commercial rivalries. In a theoretical perfect underwriting environment, all merchants would share in the losses of the community proportionally to the risks which they brought to its risk pool. In practice, when underwriting was profitable, some of the cost was defrayed, but loss-costs ultimately had to be covered. Insurance made paying more manageable.

This club-good nature of marine insurance provided the strengths of the underwriting system when it remained within close communities of merchants. However, when the optimal size and nature of the group sharing the club-good were exceeded, problems could and did emerge, as in the example of the differing customs of European and Indian insurers. As insurance markets grew, the entry of new participants, who may be cast as outsiders, often upset customary balances that had been achieved within markets of insurers trading the instrument as a club-good, since understandings of the status quo and expectations of outcomes may not be shared by newcomers. As Rossi argues, ‘While a relatively low number of new players may be easily absorbed, the swift entry of a large number creates serious difficulties to the preservation of the system. The best way to maintain it is to adopt dispute resolution mechanisms which preserve the cohesion of the weakened system.’⁵

A theoretical conception of the division between established merchant-insurers and another group of outsiders can be drawn from Braudel, who describes a two-tiered system of commerce. The lower tier, he proposes, comprises the ‘market economy’. It is characterised by routine transactions of transparent but competitive exchange governed by a set of rules, and which involve only the buyer, the seller, and sometimes an intermediary. Such were the original insurance markets of merchant-insurers. Braudel’s higher tier is the ‘capitalist sphere’, in which transparency, control, and the rules which limit profitability are avoided, or are not enforced. Different mechanisms and agents govern the capitalist sphere and the market economy.⁶ It is apparent in all of the marine insurance centres studied in this volume that, as they grew and matured, higher-level insurance markets of the Braudellian capitalist sphere collided with those of the merchant-insurers. Established institutions were shown to be inadequate to meet challenges posed by outsiders. Disputes could not always be managed within the framework of custom. External mechanisms, principally those of the state, were often found wanting.

Another useful categorisation can be drawn from Janeway’s characterisation of participants in what he dubs the ‘three-player game’ of enterprise. In it, the sovereign state strives constantly over resources with the market economy (defined as the institutions enabling production), while financial capitalism exploits discontinuities that may arise.⁷ The distinction is useful since it neatly bisects the mechanisms of the market from speculations. Merchant-insurers, underwriting primarily to share risk, are part of the nuts and bolts of the market economy. Those underwriting purely for profit, or investing passively in insurance companies, are credit-providing financial capitalists. Thus they constitute another type of market outsider, distinguished by their financial motivation, rather than their desire for mutual risk-sharing. Others, who may be categorised as outsiders due to financial motivations, are those who sought to defraud the merchant-insurers. They were simply criminals.

The tensions arising from the participation of groups of outsiders, as both buyers and sellers, in expanded markets required institutional interventions into the otherwise obscure operation of the merchant-insurers’ systems. Institutional changes arising from these interventions were implemented either by the merchant-insurers themselves, or by states at their behest. When they were effective, interventions served to reinforce the established practices of the merchant-insurers. It is characteristic of the origins and development of marine insurance markets that custom was reintroduced or reinvigorated by interventions, including state interventions. Such reaffirmations of merchant practice furnished certainty, the quest for which characterises institution-building in insurance markets. As they expanded from their founding circle of merchant-insurers who traded based on trust and mutual interest to encompass broader groups of seaborne adventurers and those primarily seeking profits, the delivery of certainty became increasingly important.

Old systems worked when they were perceived to deliver certainty of outcomes. Because such systems were based on custom, uncodified law, and, in cases of dispute, judgements which could be enforced only through honour on the part of the participants and ostracism on the part of the community, they were unable to deliver certainty when markets began to grow beyond small communities. It was uncertain which courts would hear cases, or what judgements they would make. It was uncertain if the security of institutions was sufficient to withstand large-scale losses, or if an alternative structure would be more robust. It was uncertain if measures to prevent abuses of the system were adequate, or if strengthened defensive systems would limit markets’ flexibility sufficiently to render them uneconomic. All that appears to have been certain to contemporaries was that marine insurance was essential to trade, and that trade was critical to the common good.

Law and lawmaking are central to the discussion. Merchant-insurers embraced the Law Merchant, but some of the handful of historians who have explored marine insurance in detail, and also some contemporary commentators, have argued that the business lacked necessary regulatory structures. Bindoff, for example, claims that ‘its unsystematic character is something to wonder at … it developed … with a minimum of control and was riddled with abuse and fraud.’⁸ Outsiders sometimes challenged the merchant-insurers’ system in this way, but the Law Merchant was typically up to the job of governing routine market transactions, and even most exceptional cases. Despite this, incorporating customary merchant practice into the formal law which governed state courts, and thus conferring appropriate exogenous enforcement authority onto insurance markets, proved a long and difficult challenge. The deterrent and punishment of fraudsters, for example, should have been addressed with relative simplicity through statute. However, dealing with this subset of the outsiders was complicated by the arcane nature of marine insurance contracts. It was sometimes very difficult for nonspecialists to know if a criminal act had actually occurred. Questions related to the limits of coverage were even more difficult for third-party judges to resolve. This has made the challenges surrounding the provision of judicial teeth to the customs which governed practice, while retaining the flexibility which contributed significantly to the usefulness of insurance, a constant theme within the history of marine insurance. One way in which these challenges were overcome was the involvement by state institution-builders of merchants in the design and execution of new institutions, another theme which often appears in the chapters which follow.

A theoretical model

The framework of ‘New Institutional Economics’ (NIE) provides a useful set of tools for the analysis of the development of insurance markets. NIE places the interplay between market forces and institutional (as opposed to organisational) evolution at its centre, and focuses especially on factors such as transaction costs, contracts and rules, the social influences which impact upon the evolution of institutions, and property rights. The costs of enforcement and information-sharing are usually pivotal. Game theory is sometimes applied to identify optimal outcomes.⁹

NIE proposes a theoretical set of institutional developments which, when present, lead to increasingly profitable commerce, and thus to the growth of trade. North and others have a...