Philadelphia Reflections

Rise and Fall of Life Insurance

Hammurabi Code

While it is possible to see traces of the origin of insurance all the way back to ancient Mesopotamia, insurance of a currently recognizable form began around 1500, with maritime insurance creating risk pools for ships at sea. Eventually, insuring the life of a ship and ensuring the life of a person did not seem greatly different in principle; sooner or later everyone dies, but in those days sooner or later most ships sank. From the records of such pooling efforts, we can see that a sailor in colonial times had a 40% chance of not returning from a typical voyage. Learning this, some of the plots of Shakespeare's Merchant of Venice becomes more understandable, and the enormous wealth of successful sea captains, privateers, whalers and ship owners seems more justified by the risks they were taking. In retrospect, it seems hard to understand why anyone at all went to sea, thus why it took so long to discover America. Selling maritime insurance was a way to gamble on these risks. You might not get wet, but you were still taking big risks with your money.

Life insurance was a comparatively late arrival on the insurance scene and grew out of the experience with maritime risk pooling. The first life insurance company was the Presbyterian Ministers Fund, a Philadelphia institution if there ever was one. In essence, the church had undertaken to support the widows of ministers. Insurance tailored to the life of each minister, when pooled together, approximated the church's collective widow-support risk. Only ministers were insured by this fund, however. The Insurance Company of North America (now Cigna) seems to have been the first company to sell life insurance to all comers. That's definitely an improvement; limiting the risks to a particular occupation amounts to "adverse risk de-selection", unintentionally excluding, for example, women and blacks. On the other hand, the concept was totally new; no insurance at all would have been attempted if it had been initially impossible to limit the risk.

Insurance has since spread to many other topics, but it remains true that life insurance has one central unique feature. It is absolutely certain the customer will die, the policy will be cashed in. The uncertainty is when it will happen. After a while, it became evident that premiums would be collected until the final date, and could be invested until it happens. When the pool of customers gets large enough, there is almost perfect predictability about the average age at death, so the bigger the company the safer it should be.

There is one great potential weakness in this system, lying in the fact that the person who buys the policy and receives the assurances will not be around to complain about failures of those assurances at the time the policy is cashed in. It takes many years before public trust in such promises overcomes skepticism. The growth of life insurance was therefore slow until the Civil War suddenly demonstrated there were unpredictable risks around. Unfortunately, abuses of the system by fly-by-night companies in the last half of the Nineteenth Century led to heavy government regulation of the industry. Philadelphia's reputation for integrity rapidly expanded its dominance of insurance, but could not prevent the heavy hand of regulation from holding it down, or local taxes from driving it into other jurisdictions. State Insurance commissioners were originally charged with guarding against an insurance company going bankrupt by using unrealistic low prices to attract business. The public interest was redefined to mean low premiums, by the obscure but effective method of legally shifting the debts of a bankrupt insurer onto its surviving competitors -- neither the public nor the Legislature had to worry about it any further. In the insurance capital of the country, stockholder returns and executive salaries gradually went from too fat to too thin. Insurance companies, one by one, moved to other states or at least to other counties. It is now possible to wander through the abandoned executive suites on the top floors of the former insurance palaces and feel as though you were at Luxor, wandering through the abandoned Egyptian temples of Karnak.

To be fair about it, it is also possible to have a real estate agent take you through the former estates of life insurance entrepreneurs whose business practices amply justified some regulatory over-reaction. Plenty of old retired lawyers will be glad to tell you of the times they wrote new insurance laws for their insurance client, who just forwarded them to Harrisburg for enactment -- before the Second World War. But the destruction of this industry does no one any good, and it is surely fair to argue that excessive profits were the lesser of the two evils.

Setting the regulatory risk to one side, the life expectancy of Americans has dramatically lengthened in the past century, nearly eight years in the past fifty years. Such unpredictable reduction of risk ought to lead to increased profitability for the insurer, but it also leads the public to shift to less profitable term insurance. The young buyer can see a period of several decades of dependent children, followed by a long period of life when the death of the breadwinner is less tragic. I needed, living too long becomes a modern new concern, the outliving of accumulated savings. When the investment manager of the insurance e company is faced with a choice of more investment safety or greater investment return, he must produce a combination of both, an impossible assignment. And so, insurance business drops off as clients wander away toward more glowing promises, or at least toward promises unconstrained by the growls of a consumer-driven insurance commissioner. During the Great Depression of the 1930s, only two life insurance companies went bankrupt, so at least the old way of running these companies produced safety. The 1930s now seem a long time ago.

Originally published: Thursday, June 10, 1993; most-recently modified: Tuesday, June 04, 2019