Insurance Origins

Insurance companies help CEOs and others manage some of their risks. In exchange for a constant stream of premiums, insurance companies offer to pay the organization a sum of money when a predetermined event happens such as a natural catastrophe, a fire, or a data breach.

More broadly put, an insurance company creates value by pooling and redistributing various types of risk. It does this by collecting liabilities (i.e. premiums) from all the companies that it insures and then paying them out to the few that actually need them. The insurance company can then effectively redistribute those liabilities to entities faced with some sort of event-driven crisis, where they will need more cash than they currently have on hand. As not everyone within the pool will actually suffer an event requiring the total use of all of their premiums, this pooling and redistribution function lowers the total cost of risk management for everyone in the pool.

Insurance companies theoretically make money in two ways:

1. By charging enough premiums to cover the expected payouts that they will have to cover over the life of the policy
2. By earning investment returns ("the float") using the collected premiums

In actual practice, many insurance companies pay out almost all of their premiums in order to attract larger customer volumes and liabilities. Chief earnings focus is thus placed on investment returns.

Insurance has been around in Asia for a long time. Methods for risk transfer were practiced by Chinese traders as long ago as the 3rd millennium BC. Chinese merchants traveling treacherous river rapids would redistribute their wares across many vessels to limit the loss due to any single vessel's capsizing.

By 1750 BC Babylonian sailing merchants would pay their lenders an additional sum in exchange for the lender's guarantee to cancel the loan should the shipment be stolen or lost at sea. In Rhodes in the first millennium, groups of merchants created a ‘general average’ to ensure their goods being shipped together and the premiums would be used to reimburse any merchant whose goods were jettisoned during transport, whether to storm or sinkage.

Separate insurance contracts (i.e., insurance policies not bundled with loans or other kinds of contracts) were invented in Genoa in the 14th century, as were insurance pools backed by pledges of landed estates. The first known marine insurance contract dates from Genoa in 1347.

In our next newsletter, we come right up to date and explain why insurance is important to the modern CEO.?