History, Theory & Meaning of Insurance, The history books point to the beginnings of an organised industry in the seventeenth century. Shipping merchants, gathering in Edward Lloyd’s coffee shop in Lime St, London would speculate on whether each other’s ships would successfully reach their destination – with the kitty going to those unfortunates whose ship didn’t make it.
Lloyd’s of London remains the world’s biggest insurance market and still sits on the site of Edward Lloyd’s coffee shop. The modern insurance industry evolved out of something else, however. When Karl Marx predicted that Britain would become the first communist country, he wasn’t paying a compliment.
Marx was referring to the ongoing carnage caused by the industrial revolution. This would lead workers to rise up, he thought, and take over the Forces of Production.
The underlying’ idea’ – that the misfortunes of the few fall light on the many, runs deep in societies of all kinds, across all cultures and creeds. Indeed, the word ‘insurance’ is so inculcated in our culture, it is easy to forget how pivotal it is to our civilization and society in the round.
Early History: The Coffee Shop
‘Insurance’ existed in a recognisable form in pre- historic Minoan and other ancient civilisations but also spontaneously developed around the London shipping market about 350 years ago, in Edward Lloyd’s coffee Shop, in Lime Street, London which remains the site of the world’s largest insurance market, Lloyd’s of London – it still bears his name.
The shipping merchants would gather in Lloyds, drink coffee and speculate on the outcome of their maritime adventures, with the kitty going to the owner whose vessel didn’t survive the voyage. The first Marine and Life Assurance Acts would describe the function of insurance as a mechanism to ‘mitigate the consequences of misfortune’. These days, inelegant management-speak calls it ‘a risk transfer mechanism’.
The backbone of what is now the modern insurance industry developed during the industrial revolution. The Victorians were visionaries with amazing confidence and ambition. Invention and innovation were second nature, they believed anything was possible.
They transformed innate human compassion into an organized industry, which promoted social good, cohesion and underwrote the spirit of their age – progress. However, progress came at a high cost. When Karl Marx predicted that Britain would become the first communist country he wasn’t referring to our collective intellectual genius, he was referring to the ongoing carnage of the industrial revolution, which would result in the workers rising up to take control of the Forces of Production.
The Marxist revolution was stymied in the UK by the first Workers Compensation Acts, industrial welfare and mutual societies and the rise of social insurance. In time these all turned into companies and in turn the companies all merged into global capital reinsurance giants.
It is ironic that this most ‘socialist’ of concepts is now run by global capitalists and is one of the pivots on which Western society operates and functions. Our ability to transfer risk and financially ameliorate ‘acts of god’ has allowed progress across society as a whole, making risk taking, innovation and product development commonplace.
21st Century Insurance
The range of covers available has constantly widened;- everything from the destruction of your property to the breakdown of your washing machine, or even against the prospect of paying prize money for a “hole in one” in a golf match, or against your racehorse being kidnapped.
If all this sounds like an exaggerated form of gambling, then there are some important distinctions about insurance policies that separate them from the local bookmaker.
You can only insure property and circumstances in which you have a personal financial interest – known as insurable interest. Ownership is the principal criteria but there are other circumstances where you may suffer financially albeit you do not own the property in question. Moreover, insurance is about putting you back “where you were”, not making you better off. This is called indemnity even if some settlements are “new for old”.
An insurance policy is a contract listing clearly defined risks covered (called perils i.e. – fire). It is not a maintenance contract for your business.
Insurance is responsible, in part, for the great technological progress mankind has made over the last century. It covers everything from shoelaces to skyscrapers to satellites floating about in space. It’s contribution to society is immeasurable.
If we couldn’t get insurance cover would we attempt to put hundreds of millions of pounds worth of hardware in space, or in the North Sea? Would banks lend money to business to invest in buildings and equipment if their security was at risk from fire? Would we experiment and try new medicines, technologies, building methods if we couldn’t transfer the risk of it going wrong.
It really does happen
And indeed in spite of, (or perhaps because of) all the advances mankind has made, inhabiting the planet remains a hazardous affair.
Natural phenomena (fires, storms etc) are bad enough but our own mistakes continue unabated with disastrous results.
Ferry boats tip over, aeroplanes fall out of the sky, crushes happen in football stadiums, motor cars crash, oil platforms explode, factories collapse and helicopters crash into pubs. Accidents abound. And that’s before you take account of deliberate malicious activity, mugging, murder, burglary, arson, terrorism and then, of course, there’s a new medical condition emergent every year.
It’s endless. Just where would we be without it?
Traditionally, the commercial insurance market would take about seven years to move from ‘hard’ (high premiums) to ‘soft’ (low premiums) through the claims cycle. The abandonment of the tariff in 1984 set off a wave of competition interrupted only by the solvency and capacity crisis following the World Trade Centre attacks of 2001.
Since then, massive premium hikes have stabilised and premiums levels have been uncontroversial, except in industries with specific issues, like solicitors PI or liability for entertainment risks.
Even major natural disasters (Asian and Japanese Tsunamis, New Orleans Flooding) or man-made disasters (Professional Indemnity losses on WorldCom, Enron, Parmalat) have not much interrupted solvency, capacity or premium stability.
More recently, the banking and financial crisis of 2008, which should have increased premiums as interest rates collapsed, forcing a return to underwriting for profit, made little impact as insurers tried to secure cash flow through lowered premiums.
Market Stability Factors
Other factors which influence the stability of the market going forward are:
The elastic supply of capital introducing new entrants.
The variable cost of Re-insurance.
Relentless increases in court awards.
The activities of ‘no win- no fee’ claims companies.
New industrial diseases (like vibration white finger) from ‘old’ industries.
New industrial diseases (like RSI) from ‘new technologies.
Increasingly unpredictable weather patterns, flash flooding.
Attempted use of IT to lower expense ratios.
Loss of investment income through minimal interest rates.
Toughened E.U. accounting and solvency rules
Overall volume of claims in the short term.
2014/2015: Flood & Liability Insurance Hikes in Licensed and Entertainment Premises.
The flooding of the Summerset flats in 2014 brought the flood map out the drawer once more, with both premium hikes and restrictions on cover in flood sensitive areas.
The cost of liability insurance has been gradually increasing overall to reflect the claims culture of modern society. The costs of ever escalating court awards and costs of litigation have had to be reflected in premiums. It is unlikely to reduce. Parity will be an achievement going into 2015.
The has been heightened in the area of Food, Drink and Entertainment and this has been accentuated where security doormen are employed,even on an agency basis.
One insurer has two £5million pound claims where a doorman’s behavior has left a customer very seriously injured, permanently incapacitated and wheelchair bound.
The liability insurance issue has been exacerbated following the “Luminar Leisure” case which concluded there was no protection afforded by sub-contracting to ‘agency doormen/security” rather than conventional staff – the issue hinges on ‘control’ rather than ‘status’.
Therefore, although the premium drift is upwards to deal with rising settlements, city-centre pubs with doormen, nightclubs and entertainment venues are experiencing very severe premium hikes at this time.
If you would like more information or like to discuss commercial Insurance please contact us.
The Tariff and the Effect of Competition
Until the mid 1980’s, commercial insurance premiums were routinely stable. This stability was inculcated into the system by tariffs which applied throughout the entire market.
It made little difference whether you bought your commercial insurance from Commercial Union or General Accident.
In the 1970’s, increased competition from American insurers and a developing government view that the tariff system was anti-competitive led to it being formally abolished in 1984.
This freed insurers to charge what they thought was the correct rate for the risk and as demonstration that they are frequently wrong, neither of the above mentioned companies now exist.
Since the abolition of the tariff, over fifty composite insurers have collapsed or been rescued by merger and acquisition.
The reason this has happened and the reason the commercial insurance market remains dangerously unstable is best explained by comparing it to a more conventional business.
Value Chain Analysis
IN A MANUFACTURING BUSINESS, FOR EXAMPLE, THE VALUE CHAIN COMPRISES OF ROUGHLY:
Raw materials + labour + equipment + logistics = cost + profit %
FOR AN INSURANCE UNDERWRITER, THE COST OF CLAIMS IS SIMILAR TO THE COST OF RAW MATERIALS:
Claims? + labour + equipment + marketing = cost + profit?
Uncertainty and Instability
Since the cost of claims is not known at the time the premium is put forward, in effect, the insurance company sells the product, policy by policy, without knowing how much it cost to make.
It is this uncertainty about the results of the underwriting process that has produced such instability over the last twenty years.
This is, of course, a simplistic view of a very complex market which is also affected by other factors, such as interest rates, the supply of capital, reinsurance and so on, but the fundamental problem remains as described above.
The range of catastrophes, natural and man-made, twinned with the ever widening range of illness, accident and compensation culture, have all contributed to make premiums fluctuate wildly.
Although all sorts of devises and risk management models are studied to predict the future, these have proved futile – no one foresaw the World Trade Centre attacks, for example.
Despite the industry’s best endeavours to achieve stability, this is unlikely to be forthcoming in the present structure and premiums will continue to fluctuate.
At the Business Insurance Bureau, we understand this market and guide our clientele through it’s peaks and troughs, whilst maintaining their cover with insurers who can deliver their promises.
We have a true passion for reducing risk and ensuring the success of every business we work with, we pride our self on it, so please, pick up the phone today.