From comical legalities and a mix of ethics & math, a bedrock industry emerged
by Norton Reamer and Jesse DowningNorton Reamer and Jesse Downing are the authors of Investment: A History [www.investmentahistory.com] (Columbia Business School Publishing, February 2016).
– Mr. Reamer is the former chief investment officer and CEO of Putnam Investments. He founded and for twenty years ran United Asset management. In 2003, he founded and led Asset Management Finance. Each firm was a leader in its investment approach and organizational structure. He now lives and works in Boston.
– Mr. Downing is a graduate of Harvard College, where he studied economics and mathematics. He currently works at an investment management firm in Boston.
Today we consider life insurance part of the bedrock of families’ financial security in the United States. But where did it come from, how did it grow into the industry we know it as today, and what’s next for insurers and insureds?
It may surprise some – even those in the industry – to learn that the history of insurance is one of comical legal strategies, clever actuarial mathematics, progressive policy action, and grappling with the ethics of betting on death. But what lies ahead is a tougher question to answer.
Life Insurance Pioneers
One of the earliest records of a life insurance contract dates to 16th century England, when several acquaintances of a man named William Gibbons took out a policy on him. The policy’s duration was 12 months, and the premium was a small fraction of the death benefit, with a payout ratio of 25 to 2. When Gibbons died twenty days before the end of the twelfth month, the purchasers of the contract expected a windfall.
But the insurers attempted some legal trickery to avoid paying the claim. Since the policy was for 12 months, they argued, and the shortest month of the year is 28 days, the contract was really for 336 days – not the 365 days of the calendar year. Thus, they concluded, they were not responsible for the claim. Ultimately, the court recognized the absurdity of the insurers’ argument and held them liable.
Almost two hundred years after the episode with Gibbons and his insurers, whole life insurance came into existence. In 1756, an English mathematician and Fellow of the Royal Society named James Dodson applied for life insurance coverage from the Amicable Society but was declined due to his old age. The Amicable Society, a group offering insurance chartered by Queen Anne in 1706, was only willing to extend life insurance coverage for younger individuals.
Dodson demonstrated that an insurer could charge a yearly premium to a customer, regardless of the customer’s age, if it properly reflected the individual’s mortality risk to the insurer. Later, an English scholar named Edward Rowe Mores put Dodson’s ideas into action by founding the Equitable Life Assurance Society in 1762. Though Dodson would not live to see its charter, his innovative take on life insurance spawned what is today the oldest mutual insurer in the world.
While life insurance was quick to catch on in Great Britain, it was not so speedy elsewhere. Enthusiasm for insurance was tempered somewhat by religious considerations, and the belief that betting on death was absolutely inappropriate. Many people believed that the timing of death was God’s domain and beyond human speculation, and some religious leaders spoke out against the practice entirely.
This initial religious fervor, hundreds of years ago, actually has vestigial influence in life insurance today. Many jurisdictions have laws requiring the beneficiary to have “insurable interest” – or a legitimate benefit conferred by the survival of the insured – upon formation of a new policy. In other words, you can’t take out a life insurance policy on a perfect stranger.
Regulations like this, which exist to deter sheer betting on death and to prevent malfeasance, are certainly positive. And even though few people are excited by the idea of broad wagering on the timing of an individual death, over time we have come to recognize the importance of risk transfer around death.
The 1840s to Today
As we can see, life insurance has grown in popularity and variety over the last few centuries. But it was really in the 1840s that the life insurance industry hit an inflection point and really took off in the United States. Two structural changes led to monumental growth in life insurance coverage between 1840 and the end of the Civil War and, ultimately, its full integration in the American economy.
First, starting in the mid-19th century, it became legal for women to be the beneficiaries of policies in which their husbands were the insureds. Before 1840, many married women were not permitted to sign insurance contracts themselves or to be a direct beneficiary of their husband’s policy. Stunningly, the justification was that the relationship of marriage was not seen at the time as necessarily constituting an insurable interest.
Instead of the going to the wife, the death benefit would be payable to the husband’s estate, and thus accessible to creditors before the widow. This changed when insurers joined forces with women’s rights activists to promote the passage of laws like the Married Women’s Property Acts, passed by a number of states starting in 1839 and 1840.
The second structural change the industry experienced in the 1840s was the growth of mutual life insurance companies, or firms whose profits went not to shareholders but, rather, to the policyholders themselves. Mutual life insurers had greater access to capital markets in the wake of the 1837 financial panic, because they required significantly less seed capital.
Life Insurance Today
Over the last 150 years, life insurance in the United States has grown tremendously. According to a LIMRA market research study, 70% of American families owned a life insurance policy in 2010. An industry that represents trillions of dollars of insured events, it is truly a part of the bedrock of American financial security in the 21st century.
In order to meet liabilities, life insurers invest their assets – historically in fixed income securities, like government bonds, but increasingly in mortgage-backed securities and corporate debt as well. Over time, insurance companies have moved toward public equities as well, with these allocations growing at a 5% annual clip from 2000 to 2010.
The Democratization of Investment – The Big Picture
The establishment and growth of insurance companies as investment vehicles is directly linked to the vast expansion of individuals who are part of the world of investing. In fact, it is just one of many steps in the long process of the democratization of investing: a broad diversification of investment opportunities and steadily increasing levels of savings in the hands of everyday people, allowing them to take advantage of those opportunities.
For thousands of years, the only people who qualified as “investors” were wealthy and politically connected landowners. Investment opportunities were few and accessible only to the elite.
Yet in the blink of an eye, historically speaking, that world has been replaced by one full of investment opportunities for common people, from stocks and bonds, to mutual funds, to pension plans, to real estate, to many other vehicles for investment. And life insurance was one of the earliest and simplest investment vehicles that sought to meet the needs of the non-elite individual for financial security, accumulation, and management.
Investment’s democratization is a project that should and will continue. Life insurance will remain a staple of the democratic investment landscape, as families seek to shift the mortality risk of the breadwinner(s) onto a common capital base managed by the life insurer.
But there are hurdles ahead. For insurers and investment professionals, the design and management of creative, superior vehicles that achieve adequate returns without unacceptable risk continues to be the challenge. ◊