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The foundations of our great insurance industry

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“The risks that businesses face depend on a multitude of factors, from political (in) stability and growing regulations to climate change and macroeconomic shifts. Will a post-pandemic world accentuate these global business risks even further, or will something entirely new rear its head?”

– Iman Ghosh, Visual Capitalist

Starting this week’s monthly re/insurance feature with a history snippet.

Insurance, starting with the oldest-known marine Insurance as we know it today, evolved from sophisticated societies in existence thousands of years ago. Yes!

According to Encyclopaedia Britannica, a bottomry contract around 3000-4000 BC was normal practice for Babylonians, Greeks, and other advanced civilisations. Such a maritime contract (now almost obsolete), by which the owner of a ship borrows money for equipping, cargo, repairing the vessel and, for a definite term, pledges the ship as security – stipulated that if the ship be lost in the specified voyage or period, by any of the perils enumerated, the lender shall lose his money. Certain types of insurance pools also existed, depending upon the time in history, place of jurisdiction and the like.

Catherine Duffy: recipient of the Fred Reiss Lifetime Achievement Award

Marine and commercial law legislation then was formulated, evolving into another professional specialty, since contracts between the insurer and the insured had to clearly delineate each parties’ responsibilities in the event of a risk failure.

Insurable risk

Any event with an uncertain outcome is considered a risk; so, it may be thought that for a certain price anything can be insured.

However, not every risk is considered an insurable risk.

Insurer language may refer to risk, perils, hazards; while often linked together, there is a clear delineation between these terms.

Risks may or may not be quantifiable to degree, likelihood, pure, speculative, subjective, exposure, systemic, fundamental, dynamic, static, severity, probability and more.

A peril is a potential event that can cause a loss.

A hazard is a factor or activity that may cause or exacerbate a loss, essentially upping the ante for a peril to occur.

Insurance contracts have become highly precise, clearly defining risks and perils; then, more specifically stating what perils would be covered, insured at what amount, for how long, replacement value, etc.

Performance on the contract may also include some type of “maintenance of the value” clause pertaining to say, the property, product, service, and even in certain situations, health and life, of the client.

For example, read your property and casualty, or a mortgage insurance policy. Generally, there is a clause stating that the owner will maintain the property to a certain standard – the result if not adequate may mean less reimbursement in the event of loss, or absolute cancellation of the policy.

Risk management and company strategy

As insurers refined processes and products, around 1950, it became clear that merely insuring under a contract could be more cost efficient for both provider and purchaser of insurance by not just selling a policy, but managing the risks defined by that policy.

Insurers could control costs for their clients as well as controlling risk outcomes better by developing risk management processes. Further, the client business model could retain some of the risk by implementing loss prevention procedures, a major change to the entire insurance process. Today, most companies include a Head of Risk Management position.

So many different situations, representing so many different exposures to risk; an investing risk is different from a physical health risk, a cybersecurity risk, different again from a property risk, investment risk, political or defamation risk, war and population catastrophe, etc.

What is an established certainty; individuals and businesses have spent, or will spend significant amounts over life cycles to insure against the risks, while the global insurance business today is estimated at $6 trillion.

Congratulations to Catherine R (Swan) Duffy, recipient of the Fred Reiss Lifetime Achievement Award. A wonderful award, so well-deserved.

We continue with featured excerpts from her marvellous book, Held Captive: The History of International Insurance in Bermuda. Chapter 2, page 7-8.

The California earthquake of April 18 1906 was one of the worst natural catastrophes to strike North America in modern times. Three thousand lives were lost, a quarter of a million people were rendered homeless and the city of San Francisco was almost destroyed. Munich Re Group called it an “acid test” with property damage estimated at unimaginable levels of $500 million, equivalent to $80 billion in today’s money.

As a result of this tragedy, the insurance industry worldwide realised that there could be no such thing as boundaries or borders between the varying countries that provided services to each other.

The members of the industry quickly learnt that without mutual assistance, the whole insurance philosophy would fall into ruins. It was this tragedy that removed the concept of borders from the insurance industry for ever and that led to the opening of the global insurance market as it is known today.

The crisis also changed the scope of reinsurance purchasing, which would later undermine a fundamental concept of insurance – that of spreading the risk among many insurers, beginning with the introduction of the concept of excess of loss reinsurance by Cuthbert Heath, a member of Lloyd’s of London syndicates that had heavy exposure to the disaster.

The problem at the time was that some policies covered fire only, others earthquake only, others covered fire caused by earthquake, while many insurers disputed claims on the grounds that they originated from causes not covered.

Mr Heath’s innovative solution was excess of loss cover. A direct Insurer would pay reinsurance premiums only for losses above an agreed figure, up to an upper limit. Thus, the loss was spread both “horizontally” among different underwriters and “vertically”, so that neither the direct insurer nor any reinsurer was exposed to too great a loss.

Shocking disaster: the San Francisco earthquake of 1906 led to fundamental changes in the insurance industry

Meanwhile, the people of Bermuda were continuing to experience major changes to their way of living

•Belco began to feed electricity to the island

•Bermuda got our own coat of arms in 1910

•The Elbow Beach Hotel opened in 1912

•The Bermuda Trade Development Board, was formed in 1913

•1913 construction began on Bermuda's King Edward VII Memorial Hospital

•The First World War broke out and several men from Bermuda went to fight in a war that was not their own.

Next: the large of law numbers, dispersion ratios

References

“Visualising the Biggest Business Risks 2021”, ZeroHedge, https://tinyurl.com/jz9s8rr7

“The Biggest Business Risks in 2021“ Visual Capitalist Iman Ghosh 2021jun14. https://tinyurl.com/yf7mbk8k

Encyclopaedia Britannica, https://tinyurl.com/yd8p8ktm

Martha Harris Myron, CPA JSM, a native Bermudian, is the author of The Bermuda Islander Financial Planning Primers, international financial consultant to the Olderhood Group International, and financial columnist to The Royal Gazette. All proceeds from these articles are donated by The Royal Gazette to the Salvation Army, Bermuda. Contact: martha@pondstraddler.com

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Published July 03, 2021 at 8:00 am (Updated July 05, 2021 at 8:01 am)

The foundations of our great insurance industry

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