Understanding insurance

As documented in Niall Ferguson’s The Ascent of Money, the origins of insurance lie in seventeenth century Edinburgh, Scotland. This was after the Calvinist reformation.

Widows of the Calvinist ministers needed some form of income protection after the death of the said ministers. So, two clergymen: Robert Wallace and Alexander Webster, who were drinking buddies, came up with the idea of providing some form of insurance to these widows.

Using the mathematical ideas of their fellow Scotsman, Colin Maclaurin, they collected the life expectancy tables of typical Scottish clergymen. Thus, they originated actuarial science.

Their formula was to:

  1. Collect premiums for insurance policies from a large number of ministers so that the total amount collected is quite large
  2. Invest the sum in some way (mostly they used it to give out loans to younger ministers and made money off the interest)
  3. In case of the minister’s demise, the widows would be paid the value of the insurance policy in the form of an annuity

This way, they built up large sums of money collected from the insurance premiums. Wallace and Webster accurately calculated the life expectancies and the growth of the money pool.

The two century-old Scottish Widows company (acquired by Lloyd’s in the 1990s) still maintains the reputation of being very well-trusted by the British public.

Today, insurance companies hold some of the biggest assets in the finance world. They are major institutional investors.

There is another interesting angle to this story which comes in the form of the welfare state. This has its origins in the ideas of the German conservative, Otto Von Bismarck. He figured out that a good way to squelch the noises being made by the socialists of his time was to implement a social insurance scheme, which would mandate a retirement at age 65. In one stroke, he made all his aging socialist enemies retire and provided the people a government program which, he foresaw, would reduce public dissatisfaction with the government.

The program of social insurance and the welfare state was carried out to a great extent earliest by the Japanese, who were prone to facing numerous natural calamities, like earthquakes and tsunamis. The Japanese government also got involved in many wars in the early part of the twentieth century, eventually ending in 1945 with the tragedies at Hiroshima and Nagasaki. Hence the need to provide coverage insured by the state, instead of relying on private insurance providers.

Similar welfare programs arose in the anglospheric West for the first three quarters of the twentieth century until the rise of stagflation (stands for economic stagnation combined with high inflation). This arose as a consequence of excessive government spending and a lack of economic growth. This phenomenon gave the impetus to economists like Milton Friedman to advocate the roll back of the welfare programs.

Today, the United States government is deeply in debt. It seems possible that the programs of social security etc. may not have sufficient funds in the near future to fulfill their promises of insuring the public.