Marine Insurance in Britain and America,
1720–1844: A Comparative Institutional
Analysis
CHRISTOPHER KINGSTON
This article examines how the marine insurance industry evolved in Britain and
America during its critical formative period, focusing on the information asymmetries and agency problems that were inherent to the technology of overseas
trade at the time, and on the path-dependent manner in which the institutions
that addressed these problems evolved. I argue that the market was characterized
by multiple equilibria because of a potential lemons problem. Exogenous shocks
and endogenous institutional development combined to bring about a bifurcation
of institutional structure, the effects of which persist to the present day.
M
arine insurance played a vital role in facilitating the expansion of
trade during the eighteenth and early nineteenth centuries, but the
industry developed in different ways in different countries. By the midnineteenth century, the British marine insurance market was dominated
by Lloyd’s of London, a marketplace where private individuals risked
their personal fortunes by insuring vessels and cargoes with unlimited
liability. In contrast, in the United States, private underwriting had virtually disappeared, and marine insurance was predominantly carried out
by joint-stock corporations. To account for the success of private underwriting in Britain and its demise in the United States, I focus on the
information asymmetries and agency problems that were inherent to the
technology of overseas trade at the time, how institutions arose to address these problems, and how exogenous and endogenous changes in
the political, legal, and economic environment affected the evolution of
these institutions over time.
Broadly, the argument is as follows. In Britain, the Bubble Act of
1720 temporarily limited the development of marine insurance corporations, thereby enabling Lloyd’s coffee house to develop as a center
where individual private underwriting could flourish. Lloyd’s became a
The Journal of Economic History, Vol. 67, No. 2 (June 2007). © The Economic History
Association. All rights reserved. ISSN 0022-0507.
Chris Kingston is Assistant Professor, Department of Economics, Amherst College, Amherst
MA 01002. E-mail: [email protected].
I am grateful to Masahiko Aoki, Jeremy Atack, Daniel Barbezat, Daniel Bogart, Ann Carlos,
Avner Greif, Douglass North, John Nye, Robin Pearson, Gary Richardson, Beth Yarbrough,
George Zanjani, two anonymous referees, and seminar participants at the Economic History Society, the Risk Theory Society, the Business History Conference, the Association of Business
Historians, Washington University in St. Louis, the University of Connecticut, The University
of California at Irvine, and Stanford University for helpful comments and discussions.
379
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Kingston
hub for information about ships and their crews, political and economic
developments, and the many other factors affecting the risk of a voyage,
and also for information about the reputations of market participants.
Over time, Lloyd’s role gradually evolved in the shadow of the Bubble Act as a variety of informal and later formal organizations, laws,
specialized roles, and mechanisms for sharing information became
adapted to a market dominated by private underwriting. In particular,
the extended period of heightened risk during the Revolutionary and
Napoleonic wars (1793–1815) led to boom years in marine insurance,
and a period of accelerated institutional development at Lloyd’s. By the
time the relevant sections of the Bubble Act were repealed in 1824, exposing Lloyd’s underwriters to competition from an influx of new jointstock corporations, Lloyd’s had gained an institutional sophistication
that enabled it to survive.
In contrast, although private underwriting had been developing rapidly in the American colonies, it never reached the level of complexity
of Lloyd’s. Instead, independence freed the U.S. marine insurance market from the Bubble Act’s restrictions before the start of the Revolutionary wars, and private underwriting was rapidly extinguished as marine insurance corporations developed during the wars.
I argue that the market was characterized by multiple equilibria. In
Britain, the existence of well-developed institutions for private underwriting ultimately meant that corporations had inferior access to the information needed to assess risks, and as a result, faced a “lemons” problem (explained in what follows) that hindered their expansion. This was
not the case in the United States, where private underwriting was less
well developed. Furthermore, the timing of exogenous changes including American independence and the Revolutionary and Napoleonic
wars, together with the endogenous development of Lloyd’s and its legal environment, drove the process of equilibrium selection and gave
rise to a path-dependent bifurcation of institutional structure between
Britain and the rest of the world.
TRANSACTION CHARACTERISTICS
In a marine insurance contract, an insurer (“underwriter”) assumes
some of the maritime risks on a vessel or cargo, or both, in exchange for
a premium. The risks covered may include a variety of risks at sea or in
port, for a particular voyage or for a period of time. Marine insurance
originated in the Italian city states in the middle ages. By the start of the
eighteenth century it had become a familiar practice and, because of the
hazardous nature of maritime commerce, a crucial input for trade. How-
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ever, insurers had to contend with numerous sources of uncertainty and
complex information asymmetries that created agency problems for
both the insurer and the insured. These can be separated into three main
categories.
First, the probability of a ship or its cargo being lost or damaged (and
therefore, the appropriate premium) depended on numerous risk factors
including the route, the season, the age and seaworthiness of the ship, and
the quality of its crew and armament, as well as, in wartime, the danger
of capture by enemy naval vessels and privateers, and the possibility of
seizure in a foreign port. Some of these factors could be taken into account by the underwriter when determining the premium. Often, however, merchants had better information than underwriters about various
aspects of the risk. Thus, one underwriter complained that “with the
keenest penetration and judgement, it will rarely happen that [the underwriter] is on an equal footing, as he ought to be, with the insured.”1
Second, there were many opportunities for moral hazard on the part
of the insured. These ranged from excessive risk-taking, such as sending
unseaworthy ships to sea or attempting to carry goods into a blockaded
port; to outright frauds, such as deliberately sinking an insured ship,
misrepresenting the value of the goods, insuring the same goods multiple times, or seeking to insure a ship already known to have been lost.
For example, it was perfectly legal, and not uncommon, for merchants to insure the same goods with multiple policies. Legally, the
merchant could not recover in total more than the value lost.2 Legislation passed in 1746 sought to control moral hazard and gambling by
making it illegal to insure without an insurable interest, and banned reinsurance (except in special circumstances) because there had been instances in which underwriters had fraudulently sought to reinsure their
interest after receiving private information of a loss.3 However, the possibility of fraudulent overinsurance and deliberate shipwreck remained a
serious concern for underwriters. In 1816, for example, a merchant took
1
Weskett, Complete Digest, p. 297, emphasis in original. Merchants often tried to convince
underwriters of the quality of the vessel and crew. The problem, of course, was to convey this
information credibly. For example, in 1749, New York merchant Gerard Beekman, requesting
his London agents to get insurance for a slaving voyage, wrote: “I am Concerned in a fine Brigantine prim[e] Sailors Saild 2 Days ago for the Coast of Africa with a fair wind the Captain Extreamly well acquainted have bin several Voiages there. hes a Sober honist and Industerous man
the vessell mounts 6 Carrage guns 4 pounder . . . am in hopes of the Vessell is so good and well
found etc. that it may Save me one or two per Cent on the Premium . . . I hope youl git done at
the Cheapest rate and Lett the underwritters be good” (Beekman to Shaw and Snell, 20 January
1749) [White, Beekman Mercantile Papers, p. 73].
2
In the event of inadvertent overinsurance (for example, if the value of the cargo had been
overestimated), only whichever insurance had been made first was effective, and the premiums
on the remaining policies were returned net of a small deduction. Weskett, Complete Digest.
3
Weskett, Complete Digest, p. 457; and Raynes, “History,” pp. 162–63.
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Kingston
out eight policies with brokers in London, Hull, Glasgow, and Dundee
to insure a ship and goods worth about £1,850 for a total of £5,405, and
then deliberately scuttled the ship after secretly removing some of the
cargo. By chance, the fraud was discovered, and the culprit narrowly
escaped a death sentence.4
Third, the financial stability of the underwriters was a major concern
for those buying insurance. Private underwriters might become bankrupt, die, emigrate, or abscond before a claim could be made, and their
financial stability was frequently uncertain, especially in wartime, when
the increased risks both to ships at sea and to the fortunes of the underwriters made private underwriting more precarious. In addition, because
both the timing and route of voyages in wind-driven vessels were inevitably unpredictable, and because assembling witnesses and documentary proof to support a claim in court could be a slow and costly process, underwriters had frequent opportunities to contest claims or delay
payment. As a result, merchants preferred to insure with underwriters
they perceived as nonlitigious and financially secure.
In the context of these information asymmetries and agency problems, information was critical. Underwriters needed access to prompt
and accurate intelligence on the movements and condition of particular
ships, the “character” of the merchant being insured and the captain of
the vessel, and on political developments at home and abroad, as well as
the experience to weigh this information correctly to determine premiums. In the words of one contemporary underwriter,
An insurer ought to be constantly casting about for the earliest, the best, and the
most circumstantial intelligence:—he ought to have a quick perception of the
circumstances of the risque, and be able to reason well and instantly thereupon,
in order to guard against concealments and misrepresentations . . . it is far more
material to him to regard the quality than the quantity of the risques which he
undertakes.5
Information, however, traveled slowly in the eighteenth century. The
latest news from foreign ports was frequently months old. Ships sometimes disappeared without a trace, and if a ship was lost or damaged, it
was frequently costly, and sometimes impossible, to verify or disprove
events that had occurred in distant ports or at sea. It could also be difficult for merchants to accurately judge a prospective underwriters’ prudence and financial solidity, or for an underwriter to learn about a merchant’s “character”; personal connections and the “trust” embodied
therein were a valuable asset for any businessman.
4
5
Jackson, “Marine Insurance Frauds,” p. 316.
Weskett, Compete Digest, p. 295, emphasis in original.
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383
Despite all these difficulties, marine insurance provided crucial support for the expansion of trade throughout the eighteenth and nineteenth
centuries. The market was able to function because institutions were
created to mitigate the information asymmetries and agency problems
inherent to marine insurance at the time. What were the important characteristics of these institutions, and how did they arise?
MARINE INSURANCE IN BRITAIN, 1720–1844
At the start of the eighteenth century, marine insurance in Britain was
carried out entirely by private individuals.6 Many underwriters were
merchants who wrote insurance on the side, but any wealthy individual
willing to dabble could underwrite a policy. A merchant wishing to insure generally employed a broker to draw up a policy and present it to
private underwriters for their signature. If they considered the premium
acceptable, the underwriters wrote their name on the policy, along with
the amount they were willing to insure.7 Risks were usually shared
among several underwriters. Although there was as yet no single center
for underwriting, merchants and underwriters generally frequented several coffee houses around the Royal Exchange and near the Thames,
where they exchanged news and gossip, and transacted marine business
including ship auctions and marine insurance.8
During the stock market boom that culminated in the “South Sea
Bubble” of 1720, several groups of merchants and speculators began
petitioning to obtain charters for joint-stock marine insurance corporations.9 The promoters of the proposed corporations argued that they
would provide cheaper and more secure insurance than the existing system of private underwriters. Private underwriters had unlimited liability
for losses, but there had been instances of failures, especially in wartime. In contrast, the proposed corporations would be backed by a large
capital fund, and in the event of a claim, the merchant could more easily
6
On the early history of marine insurance, see Barbour, “Marine Risks”; and de Roover,
“Early Examples.” For British insurance generally, see Cockerell and Green, British Insurance
Business; Raynes, History; and Martin, History. On Lloyd’s, see Gibb, Lloyd’s of London; and
Wright and Fayle, History. Supple, Royal Exchange Assurance; and John, “London Assurance
Company” discuss the history of the chartered corporations. Weskett, Complete Digest, and the
evidence given to the Select Committee on Marine Insurance, “Report,” are the most comprehensive contemporary guides.
7
If the premium offered was too low, the merchant could increase it or go without cover. For
example, In 1704, merchant Michael Mitford “offered 8 pct but noe body will underwrite it on
any account the ship having been so long missing however the policy lies by us in the office if
any will subscribe tis well” (Guildhall Library MS 11892A, 21 October 1704).
8
See “The Internet in a Cup,” The Economist, 20 December 2003, for a discussion of the role
of the coffee houses as centers of business information in the eighteenth century.
9
Supple, Royal Exchange Assurance, chap. 2.
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recover his losses from a corporation than from many individual underwriters separately. In addition, corporations would expand the pool of
capital available for underwriting by enabling those without specialist
knowledge of marine risks, or with relatively modest amounts of capital,
to act as insurers by entrusting their underwriting decisions to experts.10
The proposed charters were opposed by merchants and private underwriters in London and Bristol, who claimed that the existing system
was adequate, and that a monopoly would harm trade. It was widely assumed on both sides that if charters were granted, the proposed corporations would rapidly drive the private underwriters out of the market.11
The argument was settled when the two main groups of promoters offered the King £600,000 (to pay off the debt on the Civil List) in exchange for charters. Two joint stock corporations (the Royal Exchange
Assurance and the London Assurance) were subsequently incorporated as
part of what later became known as the “Bubble Act” of 1720. The Bubble Act made it illegal for joint-stock companies to operate without a corporate charter. In all industries except marine insurance, however, other
kinds of unincorporated companies, including partnerships and trusts,
were still allowed, and businessmen were later able to use these devices
to create (highly imperfect) substitutes for the joint-stock business corporation.12 However, marine insurance received special treatment: all firms
and partnerships, apart from the two corporations chartered by the Bubble
Act, were barred from writing marine insurance (crucially, however, private underwriting by individuals was still allowed).
The Bubble Act had a tremendous impact on the development of marine insurance in Britain until the relevant clauses were repealed in
1824, but its ultimate effect was neither foreseen nor intended in 1720.13
Contrary to expectations, private underwriting not only survived, but
flourished. In 1810, it was estimated that “both [corporations] added together would not exceed what two of the most considerable individual
underwriters would write in one year.”14
10
Harris, “Formation,” argues that the innovation of the chartered joint-stock corporation as
an institutional form during the seventeenth century was motivated by the need to overcome
commitment problems resulting from asymmetric information between “insiders” and uninformed “outsiders,” so as to encourage the latter to invest.
11
Supple, Royal Exchange Assurance, p. 186.
12
Harris, Industrializing English Law.
13
Harris, Industrializing English Law, p. 211.
14
Select Committee on Marine Insurance, “Report.” One indirect measure of the corporations’ market share comes from the revenue generated by Stamp Duty on marine insurance policies. By that measure, between 1800 and 1823, their share of the London market averaged 6.0
percent, varying from a low of 2.2 percent (in 1821) to a high of 18.4 percent (in 1811) (based
on Martin, History, p. 246; and “Account of Sums Received by Commissioners of Stamps on
Marine Policies, 1810–23,” Parliamentary papers 1824 (316) XVII.501).
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385
Why, despite their advantages, did the two chartered corporations fail
to dominate the British marine insurance market? In the remainder of
this section, I describe how the market developed. Later, I argue that the
way in which the market developed—in particular, the way in which the
private underwriters managed to overcome the information asymmetries
and agency problems described in the previous section—meant that the
two chartered corporations faced a lemons problem that hindered their
expansion.
Edward Lloyd’s coffee house opened for business in the mid-1680s,
and by the turn of the century, had become a center for ships news and
other activity connected with shipping.15 By the 1720s, it had emerged as
a focal meeting place for marine insurance. Merchants and brokers could
get policies underwritten there quickly and conveniently because of the
number of underwriters in attendance, and underwriters in turn were
lured by the prospect of plentiful opportunities to underwrite. In this way,
long before it gave rise to any formal association, Lloyd’s coffee house
became the center of the marine insurance market in London.16
In order to compete with the corporations, the private underwriters
had to overcome the three kinds of information asymmetries and agency
problems discussed previously: collecting and interpreting the information needed to determine the correct premium; overcoming moral hazard problems such as fraud on the part of the insured; and generating
confidence in the good faith and financial security of the underwriter.
Business practices at Lloyd’s, which emerged and evolved gradually
over an extended period of time, managed to partially overcome each of
these difficulties.
First, to meet his customer’s needs for shipping news, Lloyd made a
systematic effort to gather and disseminate the most accurate and up-todate information on ship movements, political developments, and any
other relevant information. Some of the news came from the customers
themselves; but Lloyd also employed runners who went along the docks
picking up news of arrivals, departures, losses, and other relevant gossip,
and relaying this information to the coffee house. He began to build up a
network of correspondents who were paid to send him shipping informa15
Dawson, “London Coffee-Houses.”
Some private underwriting also occurred in regional ports (see, for example, Jackson, “Marine Insurance Frauds” and Hull; and the Association of Underwriters and Insurance Brokers in
Glasgow, Glasgow City archives, TD 103/1/1). Regional underwriters mainly insured local vessels, because of their greater familiarity with the vessels and individuals involved. By insuring
locally, merchants could avoid having to use agents, and recover claims more easily. On the
other hand, regional markets were unable to handle large risks, and found it harder to spread risk
effectively. In 1807, for example, Hull underwriters suffered unusually heavy losses as a result
of the “Danish captures” (Jackson, Hull, p. 152).
16
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tion from domestic and foreign ports, and cultivated a special relationship
with the post office (which had its headquarters near the coffee house): in
exchange for an annual fee, letters addressed to Lloyd’s were carried free
of postage, sorted specially and held for collection by a Lloyd’s messenger. The combined effect of these efforts was to give Lloyd’s a “practical
monopoly of complete and up-to-date shipping intelligence.”17
As the news was brought in, it was announced publicly from a pulpit
built for the purpose. From 1692, Lloyd also published a weekly newspaper of shipping news (which later became Lloyd’s List).18 In the early
1760s, a committee of Lloyd’s underwriters began employing surveyors
to assess the condition of ships, and compiling this information in a register of ships that became known as Lloyd’s Register.
Because interpreting all this information to determine premiums involved weighing numerous factors, underwriting was ultimately a matter of individual judgment, requiring experience and familiarity with the
routes, vessels, people, and circumstances involved. Lloyd’s attracted a
wide variety of underwriters, many of whom were active or retired merchants, and whose specialist knowledge of particular kinds of risks enabled them to make these kind of judgments. This was particularly important in evaluating cross risks (voyages between two foreign ports).
As one broker explained:
. . . if I have a cross risk to make, if it is from America, I go to a box where there
are Americans to give me information; . . . and so it is from the Baltic, or any
other part . . . for they are the people who can begin the policy for me better than
others, and I by that means get it done; for it is of no use applying to a Baltic
merchant [to underwrite] on an American risk, he knows nothing at all about it
. . . . There are so many people frequent the coffee-house, if an underwriter does
not himself understand it, he soon gets information, and makes me master of the
subject at the same time.19
Once a policy had been begun by a respectable “lead” underwriter with
the appropriate expertise, other underwriters, despite lacking specific
knowledge of the risk, were often willing to “follow the lead” and underwrite at the same premium.
Second, there was the problem of moral hazard on the part of the insured. The concentration of business at Lloyd’s may have helped to
control some kinds of fraud, including fraudulent overinsurance, by
raising the probability of detection. In addition, contemporary accounts
suggest that the trust generated through repeated interaction between
merchants and brokers, and between brokers and underwriters, was key
17
Wright and Fayle, History, p. 75.
McCusker, “Early History.”
19
Select Committee on Marine Insurance, “Report,” evidence of J. J. Angerstein.
18
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387
in helping to control (though not eliminate) many kinds of fraud. Here,
the broker’s role was crucial.20 A reputable broker, such as J. J.
Angerstein, was “very careful with whom I open accounts,” and stated
that “other brokers as well as myself refuse business continually” from
those he did not consider “respectable.”21
Underwriters would therefore underwrite policies more readily, and
at a lower premium, for a reputable broker than for someone they did
not know or trust, and endeavored to maintain a reputation for honest
and open dealing, so as not to risk losing the business the broker had to
offer by underwriting imprudently or appearing overly “litigious.” They
were even often willing to pay claims in cases where an unanticipated
change in the voyage or a mistake on the policy might have rendered
the policy technically invalid.22 Again, however, the broker’s role was
key. Angerstein noted that “the private underwriters will settle the loss
for a man of character, where they will not for a man whom they suspect.”23 Another broker, who had occasion to settle heavy losses in
1809, stated that “it was settled on the letters only of the different merchants, and on the confidence the underwriters placed in me.”24
Because reputable brokers could get policies underwritten more
quickly, at lower premiums, and with better underwriters than the merchants could achieve independently, merchants also valued their relationships with good brokers, and had an incentive to avoid suspicious
dealings lest they jeopardize these relationships. Thus, all market participants had an incentive to refrain from opportunistic behavior and
maintain a reputation for prudence, fair dealing, and respectability.
There remained the problem of the underwriter’s security. Although
private underwriters did sometimes fail, such failures were surprisingly
rare, even during the Napoleonic wars, when several calamitous events
produced large claims. The reputation mechanism played a role here:
20
Kingston, “Intermediation,” provides a model and a fuller discussion of the central role of
brokers in this market.
21
Select Committee on Marine Insurance, “Report,” evidence of J. J. Angerstein.
22
For example, in 1759, Glasgow merchant James Lawson procured insurance in London on
the Bettsey from Glasgow to Maryland. Subsequently, complications arose because of a change
of plan: rather than going north around Ireland as planned, the Bettsey sailed in company with a
warship that Lawson feared might take the south channel, perhaps invalidating the policy. Yet
the underwriters not only accepted the alteration on the policy but voluntarily provided a 2 percent abatement of the premium for sailing in convoy (Glasgow City Archives, TD 172/1, 19
February 1759, 2 April 1759, 4 May 1759, 1 October 1759). In 1755, the London-based German
merchant Nicolas Magens observed that “It is notorious to all the Mercantile World that as the
English Insurers pay more readily and generously than any others, most Insurances are done in
England” (John, “London Assurance Company,” p. 127).
23
Select Committee on Marine Insurance, “Report,” evidence of J. J. Angerstein.
24
Select Committee on Marine Insurance, “Report,” evidence of Moses Getting. Emphasis
added.
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Kingston
A broker will tell his merchant, that he cannot complete his insurance with good
men, unless he will give a higher premium. The answer frequently is . . . get the
best names you can; and thus the merchant frequently sets the advantage to be
gained by the reduction of premium, against the risk to be run from the want of
solidity in the underwriters. No merchant who offers a fair premium, and whose
business is transacted by brokers of respectability, is ever under the necessity of
taking a doubtful name on his policy.25
The terms of credit granted to brokers in the collection of premiums
also helped to ensure the underwriters’ security. Underwriters granted
brokers generous terms of credit, often over a year, to pay premiums.26
This meant that at any time the private underwriters had, in effect, two
sources of capital: their own private fortune, with full unlimited liability;
and a fund of premiums owed to them by the brokers for policies they
had already underwritten. In turn, the brokers often allowed credit to the
merchants, so that in effect, the premium was often not actually paid until
after the risk had been run. Even if an underwriter became insolvent,
there were generally sufficient outstanding premiums due from the brokers to pay off any claims that might arise on outstanding policies.27
Thus, by the late eighteenth century, business practices that emerged
at Lloyd’s had managed to partially overcome each of the three kinds of
information asymmetries and agency problems described previously by
collecting and making efficient use of shipping information, while (imperfectly) protecting underwriters against fraud, and merchants against
insolvency and opportunism on the part of the underwriters. Remarkably, these practices emerged despite virtually no conscious collective efforts to design new rules or change old ones. Rather, Lloyd’s was “a
striking example of evolution as distinguished from creation. Conditions have been made, rules instituted not in preparation for new factors
and developments, but to systematise a practice which had already been
adopted to meet the requirements of commerce as they arose.”28 Yet the
system worked so well that Lloyd’s became the most important center
of marine insurance in Europe.
The evolving legal environment both reflected and reinforced the
dominance of Lloyd’s. Until the mid-eighteenth century, insurance
cases had been decided for the most part in an unsystematic, ad hoc
25
Hansard, Parliamentary Debates, XV (1810), pp. 408–09. Speech by Joseph Marryat.
The underwriters were willing to grant such lenient terms of credit because of the brokers’
customary system of remuneration: brokers got 5 percent of the premium income, plus 12 percent of any net profits made by the underwriter on the account at the time accounts were settled.
Therefore, it was in the underwriter’s interest to maintain a credit balance with the broker, so
that if any losses should occur, in effect, 12 percent of the burden would fall on the broker.
27
This system is described by several witnesses to Select Committee on Marine Insurance,
“Report.” See also Weskett, Complete Digest; and Marryat, “Observations.”
28
Wright and Fayle, History, p. 2.
26
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389
way. However, Lord Mansfield, who was Chief Justice of the Court of
King’s Bench from 1756–1788, took major steps towards rationalizing
and setting out legal principles of insurance. The principles and precedents that Mansfield established were generally derived from mercantile
practice and custom, including the principle of “utmost good faith,” according to which any misrepresentation or concealment of facts by the
insured, or deviations from the planned voyage without reasonable
cause, would void a policy. Mansfield also simplified legal procedure,
in particular, by eliminating the necessity for an insured party to bring
legal actions against each underwriter separately in the event of a disputed claim (the “Consolidation Rule”). This strengthened private underwriting by removing one of the corporations’ major advantages.29
The Revolutionary and Napoleonic wars (1793–1815) substantially
disrupted trade and increased the risks of international commerce.30 The
risk of capture increased the demand for marine insurance and drove up
premiums.31 On average, the high wartime premiums more than compensated underwriters for the increased losses, and although some underwriters failed, many others made a fortune. The marine insurance
market expanded rapidly as a result. The number of subscribers to the
society of Lloyd’s grew from 179 in 1775 to more than 2,000 by 1801.32
The two chartered corporations also prospered as their premium income
grew (see Figure 1), but the market remained overwhelmingly concentrated at Lloyd’s.
This growth in business greatly accelerated the process of formal institutional development at Lloyd’s. An ad hoc committee had been
meeting sporadically since 1769, mainly to deal with leasing and furnishing suitable premises, but beginning in 1794, the committee’s role
expanded to encompass communications with the Admiralty and other
branches of government regarding naval developments, convoys, and
stamp duty, as well as prosecuting several instances of fraud. In 1796, it
began to hold regular meetings and to issue an annual report. Since the
1770s, the committee had been making sporadic efforts to coerce those
frequenting the coffee house to pay a subscription fee, but in April
29
Oldham, Mansfield Manuscripts.
See O’Rourke, “Worldwide Economic Impact,” for a quantitative assessment of the economic impact of the wars.
31
The total number of ships on the Register of the British Empire on 30 September 1792 was
16,329. During the first nine years of the war (to April 1802), a total of 3,919 British ships were
captured by the enemy, of which 799 were recaptured. During the same period, approximately
3,700 more were lost by marine risks (Wright and Fayle, History, pp. 183, 451). Of course, British underwriters also insured many foreign (neutral) vessels. Insurance of enemy vessels, which
had been common in earlier wars, was banned in 1793 (John, “London Assurance Company,”
p. 136).
32
Gibb, Lloyd’s of London, p. 61.
30
Kingston
390
350,000
Premia
300,000
Profit/Loss, 3 year lag
250,000
200,000
150,000
100,000
50,000
0
1840
1830
1820
1810
1800
1790
1780
1770
1760
1750
1740
1730
1720
-50,000
FIGURE 1
PROFITS AND AGGREGATE PREMIUM INCOME OF THE LONDON ASSURANCE
CORPORATION’S MARINE ACCOUNT
Notes: It is assumed that profits carried to account in a given year correspond to underwriting
from three years earlier. Profits are averaged over 1808–1810 and 1811–1816, when a single
underwriting account was kept open for several years.
Source: Guildhall Library, MS 8749A
1800, in response to overcrowding, they finally took effective measures
to enforce the exclusion of nonsubscribers from the subscribers rooms.33
In wartime, circumstances often changed rapidly, so prompt and accurate shipping, political, and military news was more important than
ever. All the correspondence had previously been handled by the coffee
house masters, but as the volume of correspondence grew, this arrangement became unsatisfactory, so in 1804 a secretary was appointed
to manage it. The secretary further developed and extended Lloyd’s’ intelligence-gathering apparatus, for example, by appointing new correspondents abroad and subscribing to foreign newspapers. In 1792,
Lloyd’s had 32 correspondents in 28 ports. By 1820, the system had
been formalized, and 269 “agents” had been appointed.34
33
34
Guildhall Library MS 31571.
Wright and Fayle, History, pp. 75, 383.
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391
In 1811, a dispute arose over losses in the Baltic, and it became clear
that the lack of clear regulations governing the operations of the committee and the use of information were the root cause of the problem. In
response, a Trust Deed was drawn up that formalized the committee’s
responsibilities, including the supervision of the intelligence system, the
appointment of agents, and the election of subscribers, and empowered
the committee to act on behalf of the underwriters as a group.35
Thus, in response to temporary needs caused by the increased demand for marine insurance during the Revolutionary and Napoleonic
wars, Lloyd’s had developed a formal governance structure and membership, and had formalized and strengthened its mechanisms for information gathering and self-regulation (however, underwriting remained
strictly on an individual basis, and there was as yet no formal attempt to
ensure the financial security of underwriters).
In 1824 the relevant sections of the Bubble Act were repealed, paving
the way for an influx of new joint-stock corporations. As in 1720, it was
widely expected that this would mean the end of private underwriting.
One contemporary underwriter, for example, believed that “if companies are sanctioned, individual underwriting must cease, as has been
proved by the example of all other countries, more particularly by the
recent example of America.”36 By the 1820s, however, the boom years
were over, premiums were low, and the number of subscribers at
Lloyd’s was in decline. The average annual premium income on marine
policies at the London Assurance, for example, was over £216,000 between 1810 and 1814, but less than one-tenth as much in 1820–1824
(Figure 1).37 The Royal Exchange fared even worse: premium income
plunged from £545,290 in 1814 to £14,562 in 1824, and whereas it had
made average annual profits of £32,500 in 1793–1813, it lost an average
of over £20,000 in 1814–1834.38 In this inhospitable environment, many
of the new companies failed, though several survived and made substantial inroads into Lloyd’s share of the market, capturing as much as
half the market by 1844.39
In 1844 the Joint Stock Companies Registration and Regulation Act
enabled companies to obtain all the privileges of incorporation by registering and meeting various legislative requirements, leading to a second
large influx of new corporations.40 Again, many of the new companies
35
Guildhall Library MS 31571, June/July 1811.
Marryat, “Observations,” p. 265.
37
Based on Guildhall Library MS 8749A.
38
Supple, Royal Exchange Assurance, p. 201.
39
Palmer, “Indemnity,” pp. 76–77.
40
Limited Liability was not a general feature of British corporations until 1855. However, all
insurance companies had limited liability clauses in their policies (Shannon, “Coming,” p. 282).
36
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failed. Lloyd’s dominant position in the market continued to come under threat from the companies, particularly during the 1870s, forcing it
to evolve in significant ways. However, in the late nineteenth century,
the flexible, market-based institutional structure of Lloyd’s proved more
adept than the companies at identifying and exploiting new underwriting opportunities, and it moved significantly into fire and accident insurance while remaining a major force in the marine insurance market.41
MARINE INSURANCE IN AMERICA, 1720–1844
In the United States, as in Britain, the Revolutionary and Napoleonic
wars had a decisive and lasting effect on the development of the marine
insurance industry; but unlike Britain, private underwriting in the
United States had virtually disappeared by 1815, and the business was
carried on almost entirely by joint-stock corporations.42
In the early eighteenth century, American merchants generally obtained insurance in London, although the distance created considerable
uncertainty and inconvenience. For example, orders for insurance on
voyages to Britain were often sent ahead on ships expected to arrive before the ship being insured. If the ship made a fast passage and arrived
before the orders for insurance, then the premium was sometimes saved,
but this could also be precarious, as illustrated by the case of an agent in
London who received instructions to insure a consignment of tobacco
only an hour before the news of the ship’s loss arrived, leaving the tobacco uninsured.43
As the trade of the colonies expanded, an increasing amount of insurance was obtained locally. By the 1740s insurance brokers were operating in Boston and Philadelphia.44 Local underwriters had better information on local risks, and their proximity enabled quick payment in
case of loss, facilitated resolution of disputes, and avoided the necessity
for merchants to rely on agents to represent their interests.
For example, in the early 1740s, Boston merchant Benjamin Dolbeare regularly obtained insurance in London on voyages between Boston and the West Indies. However, when the sloop Tryall was captured
by the Spanish in 1739 on a voyage from Curacao to Boston, it took
over a year to obtain payment from London. In 1742, he wrote for insurance on the Friendship, which was to sail to Antigua and then, if a
41
Wright and Fayle, History; and Westall, “Invisible, Visible and ‘Direct’ Hands.”
On the history of marine insurance in America, see Huebner, “Development”; Ruwell,
Eighteenth-Century Capitalism; Gillingham, Marine Insurance; Fowler, History; and Montgomery, History.
43
Joshua Johnson’s letterbook, 19 Febuary 1774 (Price, Joshua Johnson’s Letterbook).
44
Gillingham, Marine Insurance, pp. 18, 109.
42
Marine Insurance
393
war with France had not broken out, to Guadeloupe, and otherwise, to
the English or Dutch Leeward Islands, and if markets there were unfavorable, to Jamaica, before returning to Boston. In the event, however,
the vessel went no farther than Antigua and Dolbeare spent the next two
years trying to prove this in order to obtain a partial return of premium,
apparently without success. In March 1745 he settled his account with
his London agent and subsequently rarely obtained insurance in London
except on transatlantic voyages. Most likely, he had begun to insure his
West Indies ventures locally.45
Other merchants remained suspicious of local insurance and continued to insure in London, where insurance was generally cheaper, and
the underwriters were regarded as more financially secure. In 1743,
writing to his London correspondent for insurance, Philadelphia merchant William Till observed:
I do not know but the Insurers in London may be unwilling on some Occasions
to underwrite, as we have an Insurance Office here and imagine the most dangerous Policys may fall to their share, but for my Part I have always looked on
the Thing as a Novelty . . . [and] shall constantly write to London for Common
and honest Insurances.46
Although colonial America had nothing that could compare with
Lloyd’s, several active centers for private underwriting emerged. In
Philadelphia, underwriters frequented the London Coffee House in the
1760s, and made several, apparently abortive attempts at organization.47
In 1787, the broker Benjamin Fuller was able to obtain 34 underwriters
on a large policy, “All the underwriters in the City (except 2 or 3) having Subscrib’d.”48 Similarly, there were two coffee houses that functioned as meeting places for marine business in New York.49
The Revolutionary and Napoleonic wars created enormous risks and
opportunities for American merchants.50 Britain’s naval superiority effectively closed off direct communications between France and its
colonies, so at the outbreak of war, the French opened their colonies to
trade with American vessels. Under the “Rule of 1756,” Britain refused
to recognize the neutrality of vessels trading directly between France
and its colonies, but American vessels were able to carry on the trade
45
46
B. Dolbeare letterbook, Massachusetts Historical Society, MS N-201.
William Till to Lawrence Williams, 5 August 1743. Historical Society of Pennsylvania MS
660.
47
Gillingham, Marine Insurance, pp. 32–37.
Benjamin Fuller papers, Historical Society of Pennsylvania MS AMB 3485, 9 August
1787.
49
Harrington, New York Merchant, p. 154.
50
On the American position during the wars, see Clauder, “American Commerce”; and Phillips and Reede, Neutrality.
48
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394
Exports
120
Re-exports
Net Freight Earnings
100
80
60
40
20
1815
1810
1805
1800
1795
1790
0
FIGURE 2
VALUE OF EXPORTS AND RE-EXPORTS FROM THE US, AND NET FREIGHT
EARNINGS OF US SHIPPING, 1790-1819
(millions of dollars)
Source: North, “United States Balance of Payments,” tables A-1, A-2, A-3, pp. 590–95.
indirectly by importing goods from French, Spanish, and Dutch colonies to the United States, where they paid customs duties, thereby conferring neutral status on the goods so that they could be re-exported to
France and the continent; while in the reverse direction, European
goods flowed indirectly to the colonies.
As a result of these new opportunities, and of protective tariffs and
regulations that had been introduced by Congress in 1789, American
trade volumes and shipping tonnage grew rapidly (Figure 2). In the
words of one contemporary American observer:
The affairs of Europe are certainly of less and less consequence to us in a political point of view; in a commercial, they rain riches upon us; and it is as much as
we can do to find dishes to catch the golden shower.51
At the same time, however, this growing trade was subject to considerable risk. Although America was neutral, both belligerents employed
their navies and commissioned privateers to seize food bound from
51
The Columbian Centinel, 5 November 1796, quoted by Smith and Cole, Fluctuations,
p. 15.
Marine Insurance
395
America for the other, and to seize enemy property carried in American
vessels. The decrees regarding neutrality issued by the belligerents
changed with sometimes extraordinary frequency, and in any case were
not always carefully observed.52 Six hundred American vessels were
seized or detained in British ports between 6 November 1793 and
28 March 1794 alone, and crucially, British insurers could not be held
legally liable for losses on neutral vessels captured by British ships.53 In
1796–1797, when the French began to capture American vessels in the
Caribbean in retaliation for Jay’s treaty between the United States and
Britain, the premium on one-way voyages to the West Indies rose from
a range of 3–6 percent in the fall of 1796 to as much as 15–20 percent in
the summer of 1797 and reached 25 percent in 1798, before American
naval victories in 1799 and 1800 brought rates back down.54
The growth in trade during the 1790s, coupled with its uncertainty,
created the conditions for a rapid expansion of the American marine insurance market but placed considerable strain on the existing loosely
organized system of private underwriting through brokers. However,
independence had freed Americans from the Bubble Act’s restrictions
on the formation of joint-stock corporations, and after a period of political debate and uncertainty, the newly independent American states had
begun to charter corporations for various purposes with increasing frequency during the late 1780s and early 1790s.55 Thus, conditions were
ideal for market entry by corporations.
The first American marine insurance corporation, the Insurance Company of North America (ICNA), was formed in Philadelphia in 1792
and chartered in 1794. The President and Directors were all leading underwriters, and most of the board were Philadelphia merchants. In contrast to Britain, where the two chartered corporations held a monopoly,
no monopoly was sought in America. Philadelphia’s remaining private
52
To give an extreme example, on 9 May 1793 the French issued a decree authorizing their
vessels to arrest any vessels laden with provisions for an enemy port. On 23 May they exempted
American vessels from this decree. On 28 May they suspended this exemption, but reversed this
suspension on 1 July. Finally, on 27 July they reversed their position again by repealing the decree of 23 May (Clauder, “American Commerce,” p. 11).
53
Huebner, “Development,” p. 436.
54
See, for example, Wharton and Lewis, “Account of Policies Underwritten”, Historical Society of Pennsylvania MS AMB 95591. In March 1797, the Insurance Company of the State of
Pennsylvania usually charged 2.5 or 3 percent to cover the sea risk only on one-way voyages to
the West Indies, but 15 percent for all risks on voyages to British ports and 7–8 percent to
French and Spanish ports though “it is to be remarked that Circumstances varying as they do
We are obliged to vary premiums very often” (ICSP letterbook, Historical Society of Pennsylvania MS 2001, 11 March 1797).
55
Until 1799, virtually all business incorporation was by special act of state legislatures. The
total number of charters to business corporations grew from 33 in 1781–1790 to 295 in 1791–
1800 (Davis, Essays, vol. 2, pp. 17, 22–25).
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underwriters initially opposed the INCA charter, but having observed its
early success, they founded the rival Insurance Company of the State of
Pennsylvania, which was also chartered in 1794.
Boosted by high wartime premiums, the Philadelphia corporations
quickly proved highly profitable, and this in turn encouraged the formation of incorporated companies elsewhere: in Maryland in 1795, in
Connecticut in 1797, in New York and Virginia in 1798, in Massachusetts and Rhode Island in 1799, and in Maine in 1800.56 By 1810 private
underwriting had virtually disappeared in the United States, and it was
reported that “in every part of America the Insurances are done by incorporate companies,” including seven in Boston, eight in Philadelphia,
five in Baltimore, and six in New York.57 At the same time, the volume
of American business insured in London fell sharply; in 1810, one
American merchant in London estimated that “nineteen twentieths” of
his consignments from America were insured in America.58
The subsequent development of the American corporations was uneven. As their number increased, competition reduced their profitability.
Risk, and therefore premiums, remained high throughout the Napoleonic Wars; between 1803 and 1812, as many as 1,600 American vessels
were captured by various European powers.59 After 1815, premiums fell
to low peacetime rates, but fierce competition persisted and profits remained low until the 1840s, when the expansion of American shipping
created a “golden period,” which lasted until the American Civil War.60
Throughout, although there were apparently unsuccessful attempts to
re-establish private underwriting, American marine insurance remained
almost entirely in the hands of corporations.61 After the Civil War, as
shipping technology shifted from wood and wind power to iron and
steam, and the invention of the telegraph revolutionized information
flows, the American shipping industry went into decline and the British
companies and Lloyd’s successfully re-invaded the American market;
but that is another story.
56
See Roelker and Collins, One Hundred Fifty Years, on Rhode Island; Fowler, “Marine Insurance,” on Massachusetts; Woodward, Insurance, on Connecticut; Crothers, “Commercial
Risk,” on Virginia; and Davis, Essays, on New York and Maryland.
57
Quoted in Select Committee on Marine Insurance, “Report.”
58
Select Committee on Marine Insurance, “Report,” evidence of S. Williams.
59
Huebner, “Development,” p. 436.
60
Huebner, “Development,” p. 438.
61
John Bennett, the Secretary of Lloyd’s, reported an American newspaper advertisement regarding one such attempt in evidence given to the Select Committee on Marine Insurance in
1810. Huebner (“Development,” p. 432) states that “the Lloyd’s system of underwriting,
through often tried . . . never obtained a prominent foothold in [the United States],” but he may
have been referring mainly to the colonial period.
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397
HYPOTHESIS: A “LEMONS” PROBLEM
Given their advantages, why did the chartered corporations fail to
dominate British marine insurance after 1720? Conversely, if private
underwriting was somehow more efficient, then why did a Lloyd’s-like
institution for private underwriting not develop in the United States?
After all, American underwriters and merchants were very familiar with
Lloyd’s.
One might hypothesize that the British corporations chartered in 1720
simply had an insufficient capital stock to capture the market. However,
although their charters gave them the right to increase their capital stock
to £1.5 million, neither ever did so.62 The nominal capital of the Royal
Exchange was only £508,329 during most of the eighteenth century, and
the capital available for underwriting was even less.63 Even in comparison with this capital stock, their underwriting was very modest. In
1761–1765, for example, annual premiums (also a rough measure of the
expected value of losses) averaged only £36,600 at the REA, yielding
average profits of about £6,100; the London Assurance averaged premiums of £43,300 and profits of £7,300.64 Furthermore, both corporations
were able to substantially increase their underwriting activity when the
opportunity arose during the Napoleonic wars (Figure 1), and even then,
were eager to extend their business further.65 Finally, capital constraints
would not explain the corporations’ failure to drive Lloyd’s out of business after 1824.
One factor contributing to the corporations’ small share of the market, noted by both A. H. John and Barry Supple, is that underwriting
was a “gaining trade,” so that it was to the mutual advantage of merchants to insure each other.66 This can certainly explain some private
underwriting, but would only apply to the minority of merchants who
62
In 1720, while welcoming the proposal for a new corporation, the Attorney General stated
that “the Ends of Trade will, I think, be sufficiently served by a far less Joint Stock than is . . .
proposed” (quoted by Supple, Royal Exchange Assurance, p. 29).
63
Supple, Royal Exchange Assurance, p. 71. According to one of the directors of the Royal
Exchange Co., that company had a nominal capital of £680,000 in 1810, but had the right to call
up to £1.5 million from its shareholders (Select Committee on Marine Insurance, 1810, evidence
of P. Grenfell). He also asserted that the stockholders in the corporation did not enjoy limited liability.
64
On the REA, see Supple, Royal Exchange Assurance, p. 62. On the London Assurance, see
Guildhall Library MS 8749A. During the same years, William Braund, “a steady but by no
means a great underwriter” at Lloyd’s made average annual profits of about £1,700 on premium
income of between £4,000 and £9,000 (Sutherland, London Merchant, pp. 65, 69, 74–77).
65
Select Committee on Marine Insurance, “Report,” evidence of J. Holland and T. Greathead.
See also “The Case of the London Assurance Corporation and their objections to the Repeal of
the Statute of 6 Geo I,” in Guildhall Library MS 18833.
66
John, “London Assurance Company,” p. 133; and Supple, Royal Exchange Assurance,
p. 189.
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were also active brokers and underwriters (and as the American experience showed, the corporate form could equally be used as an institutional device for such risk-sharing).67
In this section, I argue that the marine insurance market was characterized by multiple equilibria, and that the survival of private underwriters in Britain hinged on their superior access to the information needed
to assess risks, which created a lemons problem for the comparatively
less-well-informed underwriters at the corporations. In the next section,
I argue that the timing of historical events influenced equilibrium selection, giving rise to a divergence in institutional structure between Britain and the United States.
The greater security and convenience offered by corporations was the
key argument for the chartering of corporations in both Britain in 1720
and America in the 1790s. From merchants’ correspondence and other
contemporary records, it is clear that these were perceived as their main
advantages, particularly in wartime. In 1748, one merchant wrote:
I Wrote thee lately that Divers Insurers were become Bankrupts, and that more
we looked upon as doubtful, It appears our Suspicions were too well founded for
more are in the same Situation, who were men of large Capitals, Tis very Difficult to know Who to Accept of, and We think it unsafe at present to Apply to
Any of the Policy Brokers, but to get our Business done either at the Royal Exchange, or London Assurance Office, tho’ the premiums may sometimes be
rather higher, Yet the safety in Our Opinion will more than answer the difference.68
On a level playing field, therefore, corporations ought to drive private
underwriters out of business. However, as emphasized previously,
asymmetric information was a pervasive feature of marine insurance
contracts in the eighteenth century (much more so than in the case of
fire or life insurance). Information traveled slowly and was frequently
incomplete, and merchants had strong incentives to conceal information
that, if known, would raise the premium and to represent other facts so
as to reduce the premium. The corporations’ advantage in security
might therefore be overturned if they were at a disadvantage in assessing risks.
In Britain, this is precisely what happened. As Lloyd’s developed as a
center for sharing information, the corporations found themselves increasingly at a disadvantage in evaluating risks. The business practices
that evolved at Lloyd’s—the reputation mechanism, the system of lead
underwriters, the web of credit relationships—all tended to undermine
67
68
Select Committee on Marine Insurance, “Report,” evidence of George Browne.
Gillingham, Marine Insurance, p. 19.
Marine Insurance
399
the corporations’ advantage in security while putting them at a disadvantage in evaluating risks.
To see how the lemons problem might develop, imagine a variety of
merchants with differing degrees of private information about the voyages they propose to insure, and suppose that the private underwriters
have access to some of this private information, while (for simplicity)
the corporations observe none of the private information. Then the
“best” risks—those merchants whose vessels are unusually seaworthy,
for example—might prefer to insure with the private underwriters, despite the corporations’ greater financial security, because the private
underwriters, being better informed, are likely to charge them lower
premiums. But then, the corporations will be left with a disproportionately poor selection of risks, forcing them to raise their premiums. This
in turn will induce more of the better risks to apply to private underwriters; and so on, until the corporations are left with only the very
worst risks. Thus, an equilibrium might develop in which the better
risks are insured by private underwriters at low premiums, while the
corporations charge high premiums and receive business only from the
worst risks.
There is a further twist to this lemons problem. Basic insurance theory suggests that, at a given premium, good risks would wish to purchase a lower quantity of insurance than bad risks.69 The historical record confirms that merchants frequently underinsured, particularly if
they had a relatively small amount of merchandise traveling on a
“good” ship.70 Thus, not only will the less-informed underwriters (in
this case, the corporations) get the worst risks, but the worse the risks
are, the more insurance they will buy.
Of course, the information available to the private underwriters depends on the volume of business they transact. If we begin with the assumption that the private underwriters have no informational advantage,
then given the insecurity of private underwriting, all merchants would
indeed prefer to insure with the corporations, and the lemons problem
would not develop. Thus, there is an alternative equilibrium in which all
merchants choose corporate underwriters.
The lemons hypothesis can explain why the British corporations
failed to dominate the British marine insurance market. Although they
were not excluded from Lloyd’s news service, the corporations could
69
See, for example, Rothschild and Stiglitz, “Equilibrium.”
For example, American merchant Henry Laurens instructed his agents in London that when
his goods were shipped “by a good vessel and master” they should leave values below £100 uninsured, and only insure three-fourths of the value of larger shipments (Laurens to Bridgen and
Waller, 7 January 1786 [Hamer, Papers]).
70
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not match the collective expertise and local knowledge of the private
underwriters.71 Neither could they write “lines” on a Lloyd’s policy;
they issued separate policies, with their own terms and conditions, according to their own rules. A bylaw implemented at Lloyd’s in 1834
formalized the existing rule that all underwriting had to be strictly personal: “no subscriber shall underwrite risks for the account, benefit or
advantage, either direct or indirect, of any public company.”72
Consistent with the lemons hypothesis, as the eighteenth century
wore on, the corporations became increasingly conservative and restrictive in their underwriting. This was manifested in several ways. On
regular risks, their premiums were generally 20–30 percent higher than
at Lloyd’s. After experiencing numerous instances of fraud in the early
eighteenth century, they became increasingly reluctant to insure cross
risks, and refused to cover the risk of seizure in a foreign port—both
risks for which a specialist knowledge of local circumstances was of vital importance, and the corporations disadvantage was therefore particularly acute.73 They also limited the amount they would insure on a single voyage, and placed stringent restrictions on deviations from the
planned voyage. For many merchants, it was this restrictiveness, even
more than the high premiums, that induced them to insure at Lloyd’s instead. One stated that
If I could do all my business at the public offices I should undoubtedly prefer
doing it with them . . . In all risks that they will take, they in my opinion are
preferable to Lloyd’s coffee-house; in the first place, I feel myself perfectly insured, I feel that my property is safely insured . . . I do not think that I can state
properly that they are of little service on account of the difference of premiums;
I think it is in the amount that they take . . . instead of having a sum that they
will do on one risk, it is three, four or five times as much as they will take.74
Another merchant, having insured with the London Assurance Company, warned his correspondent that in case of accident, he should have
71
It has been asserted (Supple, Royal Exchange Assurance, p. 199) that the corporations were
only granted the right to purchase Lloyd’s intelligence beginning in 1814. But in fact, as early as
1727, clerks of the London Assurance Corporation regularly attended Lloyd’s to gather shipping
news, and by 1737, a clerk was tasked to attend Lloyd’s twice a day to collect news and to find
out what he could about movements in premiums. In 1748, the corporation began making regular annual payments to the coffee-house masters for access to shipping intelligence and (from
1749) for Lloyd’s List, and from 1766 it also subscribed to “a register of shipping,” the forerunner of Lloyd’s Register. Both corporations also subscribed to the Committee of Lloyd’s
sometime before 1800, which would have given them access to the subscriber’s rooms (Guildhall Library MS 8728/2, 10 May 1727; MS 8728/4, 14 September 1737; MS 8741/1, July 1748
and May 1749; MS 8728/8, 29 January 1766; MS 31571).
72
Wright and Fayle, History, p. 317.
73
John, “London Assurance Company,” p. 133.
74
Select Committee on Marine Insurance, “Report,” evidence of Alexander Glennie.
Marine Insurance
401
the documents relating to the claim “well arranged authenticated and
sent by two conveyances” because “these Gentlemen or rather this
Company are rather particular in respect to vouchers either for an average or loss.”75 They were too particular for one American merchant,
resident in London, who explained to his partners in Maryland:
I have not made it [insurance] in a public office [ie., a corporation]. The reason
why I did not was their particularity; they must know who you are and a deal of
that; then again you are plagued more than little enough before you can get the
money after a loss and everybody prefer making theirs at Lloyd’s for that reason.76
Both Supple and John also treat the corporations “lack of vigor” in
underwriting as the major proximate cause of their modest growth, but
neither explains this conservatism satisfactorily.77 John hypothesizes
that the private underwriters were “better able, and more willing, to accept all kinds of risks, simply because they could be spread over a large
number of persons.”78 Yet, the corporations had hundreds of shareholders, so if anything, they should have had an advantage in this regard.
Supple suggests that the companies’ caution may be attributable in part
to restrictions on the freedom of action of their underwriter, though he
does not explain the motivation for any such restrictions.79
The key to understanding the corporations’ cautious approach to underwriting is the lemons problem, which resulted from their disadvantage in evaluating risks. For example, in 1810, the chief clerk in the marine insurance department of the Royal Exchange Assurance Co.,
explained to a Parliamentary Select Committee that the company’s
practice was to underwrite a maximum of £5,000–10,000 on any one
ship in the West India or Baltic fleets, because it was usually only offered the opportunity to insure about one-tenth of the ships in the fleet.
If it could insure all the ships in the fleet, he claimed, it would “have no
hesitation” in insuring £20,000–25,000 on each ship, “because it would
be playing a more equal game.”80 Furthermore, it was the existence of
Lloyd’s that created this lemons problem:
The two public offices . . . confine themselves to what are called regular risks
. . . It would be absurd to expect any public office to act on any other system; for
it is impossible that the acting director or secretary of a public office, should
75
Francis Rotch to Christopher Champlin, 9 October 1786 [Massachusetts Historical Society
1915].
76
Joshua Johnson’s letterbook, 26 July 1771 (Price, Joshua Johnson’s Letterbook, p. 8).
77
Supple, Royal Exchange Assurance, chap. 9; and John, “London Assurance Company.”
78
John, “London Assurance Company,” p. 133.
79
Supple, Royal Exchange Assurance, p. 200.
80
Select Committee on Marine Insurance, “Report,” evidence of J. Holland.
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possess the same knowledge, as to the nature and extent of every new description of risk, . . . as 1,500 underwriters, mostly men of commercial habits, and
consequently commercial knowledge, daily collected together for the purpose of
communicating and receiving intelligence . . . who concentrate the scattered rays
of information, as it were, into one focus at Lloyd’s. On this conviction the public offices, very wisely, refuse to take what they do not understand.81
The corporations were also at a disadvantage in learning about the
“character” of market participants. Although the Royal Exchange company would have liked to expand its business, it often refused to insure
merchants whom it did not know well because their insurances were not
“tendered fairly.”82 Probably because of their disadvantage in evaluating the “character” of applicants for insurance, a good deal of the corporations’ business was restricted to merchants and brokers who were also
directors or shareholders in the corporation.83
INSTITUTIONAL CHANGE AND EQUILIBRIUM SELECTION
Transactions cost economics suggests that market institutions have an
advantage in governing transactions where information is dispersed and
where transmitting information is costly. So, for example, “marine
risks, with a wide variety of complicated risk factors generating a large
premium, might be better handled individually,” as at Lloyd’s.84 However, as Oliver Westall notes, the transactions cost approach does not
address the process of institutional change. In particular, it cannot explain why Britain and America, which were in close commercial contact
and shared essentially the same technology and knowledge, developed
different institutions to govern apparently similar marine insurance
transactions.
The argument in the preceding section suggests the potential for multiple equilibria in the marine insurance market, which can account for
both the success of marine insurance corporations in the United States
after 1792, and the persistence of private underwriting in Britain after
1720 and 1824. But why did different equilibria emerge?
In both Britain and the United States, the corporations began brightly.
In Britain, in the period before it obtained its charter (1718–1720), the
company that became the Royal Exchange Assurance corporation was
initially very successful, did a large amount of business, and was even
accused of undercutting the market in order to drive private underwrit81
Hansard, Parliamentary Debates, XV (1810), pp. 407–08. Speech by Joseph Marryat.
Select Committee on Marine Insurance, “Report,” evidence of J. Holland.
83
John, “London Assurance Company,” p. 134; and Supple, Royal Exchange Assurance,
pp. 77–79.
84
Westall, “Invisible, Visible and ‘Direct’ Hands,” pp. 45–46.
82
Marine Insurance
403
ers out of business.85 However, “The deflation of the South Sea bubble
quickly undermined the financial basis of the Royal Exchange Assurance,” and the value of its stock, which had risen from less than £20 per
share in January 1720 to over £200 in August, fell below £10 by the end
of the year.86 Both of the newly chartered corporations had difficulty
raising the capital needed to pay their debts to the King’s Civil List
(half of which was eventually written off), primarily because many of
their subscribers, who had paid in only a fraction of the nominal value
of their stock, were themselves in financial trouble; repeated efforts to
attract new subscribers were largely unsuccessful. The London Assurance suffered heavy losses as a result of a storm that sank 12 Jamaica
ships in October 1720, and was forced to borrow money to survive.87
“. . . [T]he Companies’ difficulty was the underwriters’ opportunity,”
and within a few years the corporations were doing only a small proportion of the total marine insurance business.88
As discussed previously, the institutional structures and intelligencegathering apparatus that enabled private underwriters at Lloyd’s to deal
with the information asymmetries and agency problems inherent in marine insurance took time to evolve. In particular, the quarter century of
warfare from 1793–1815 provided a sustained stimulus leading to substantial institutional change at Lloyd’s. By 1824 Lloyd’s was well developed, and the new influx of corporations were unable to dislodge the
existing equilibrium dominated by private underwriting.
In contrast, in America, the formation of joint-stock corporations became possible at a time when private underwriting was still at a comparatively early stage of development, and at a highly favorable time for
marine underwriting. Because many of the most prominent merchants
and brokers were instrumental in founding the corporations, they probably suffered little or no informational disadvantage relative to private
underwriters, and therefore no lemons problem.89 Like the British corporations before them, they began brightly and were accused of under-
85
Supple, Royal Exchange Assurance, p. 20.
Supple, Royal Exchange Assurance, pp. 36–38.
87
Postlethwayt, Universal Dictionary, article on “Actions.”
88
Wright and Fayle, History, p. 63.
89
It may be that the development of the American marine insurance market put Lloyd’s underwriters at a disadvantage in evaluating American risks. One merchant noted that between
1792 and 1802, on cross-voyages he had insured between American and the West Indies,
Lloyd’s underwriters had, on average, paid out in losses almost 10 percent more than he had
paid them in premiums (Select Committee on Marine Insurance, 1810, evidence of G. Shedden).
In contrast, during the same period, the ICNA in Philadelphia, which insured many similar voyages, made an aggregate underwriting profit equivalent to almost 10 percent of premiums
(Montgomery, History, p. 58).
86
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Kingston
cutting the market in a deliberate attempt to drive private underwriters
out of business.90 Unlike the British corporations, they succeeded.
Could a private underwriting institution such as Lloyd’s have survived, once established, in the United States? One might argue that such
a development would have been hindered by the lack of a “London” in
America: America had several major ports and numerous minor ports,
so that the marine insurance market was really a fragmented collection
of local markets. However, merchants corresponded freely all along the
east coast, engaged in joint ventures, and insured each other’s voyages.
New York merchant Gerard Beekman, for example, frequently brokered
policies for Rhode Island merchants in New York in the 1750s, and in
turn he sometimes insured his own voyages in Philadelphia, where he
found the premiums lower than in New York.91 So, it is at least plausible that the several existing centers for private underwriting might have
evolved into more developed institutions, given time.92
As a major component of the nineteenth-century expansion of trade,
the development of marine insurance is of interest in its own right.
However, the development of the industry also illustrates the interplay
between design and evolution in the creation of institutions and the potential for path-dependent institutional change.
Masahiko Aoki argues that institutional change frequently involves
short, turbulent periods of deliberate institutional innovation and experimentation, interspersed with longer periods during which these experiments are gradually weeded out.93 The development of the marine
insurance business in the eighteenth century appears to fit this pattern.94
Exogenous events provided an impetus for deliberate institutional innovation at particular points in time, such as the efforts to obtain charters
for the British corporations during the South Sea Bubble in 1719–1720;
90
Montgomery, History, p. 40.
Gerard Beekman to Townsend White, 6 October 1754 (White, Beekman Mercantile Papers).
92
In this regard, it is interesting to note the many parallels between the development of
Lloyd’s and the London Stock exchange. Both originated in early-eighteenth-century coffee
houses, and gradually developed mechanisms to deal with the increasing complexity of business
as the century progressed. Both businesses relied crucially on timely information and trust
among the market participants. Whereas Lloyd’s disseminated this information through Lloyd’s
List, the Stock Exchange had the Course of the Exchange. Like Lloyd’s, the Stock Exchange received a huge impetus from the Revolutionary and Napoleonic Wars (because of the increase in
the size and turnover of the National Debt), so that “by the end of the Napoleonic Wars in 1815,
the Stock Exchange had become an accepted part of financial life displaying many features
quite recognizable today” (Hennessy, Coffee-House, p. 32). In America, the New York Stock
Exchange also developed from informal coffee-house origins into a formal centralized market
for stocks and government debt (Banner, “Origin”), but there was no parallel development of an
American marine insurance marketplace.
93
Aoki, Towards a Comparative Institutional Analysis, p. 243.
94
Caballero and Kingston, “Comparing Theories,” survey theories of institutional change.
91
Marine Insurance
405
the chartering of the American corporations in the 1790s in response to
the new opportunities created by American Independence; and the development of a formal structure at Lloyd’s in response to the growth of
business during the Napoleonic wars. In many ways, however, it was
the evolutionary changes, which occurred between these episodes of deliberate innovation, that ultimately shaped the direction of overall institutional change. In particular, the twin evolution of business practices at
Lloyd’s and British insurance law during the eighteenth century gradually generated relatively effective institutions, despite a lack of centralized direction or deliberate institution building, as merchants, underwriters, and coffee sellers gradually altered their perceptions and
behavior in response to a gradually changing environment.
CONCLUSION
In Britain, the Bubble Act of 1720 prohibited the provision of marine
insurance by partnerships or companies, other than the two chartered
corporations. This enabled Lloyd’s to develop as a center where private
underwriters gathered and shared information. This article has argued
that this information gave rise to a lemons problem, which prevented
the corporations from taking over the market. The Revolutionary and
Napoleonic Wars strengthened the system of private underwriting at
Lloyd’s, enabling it to survive even after the repeal of the Bubble Act.
In the United States, in contrast, where the protection provided by the
Bubble Act had been removed by American independence prior to the
wars, private underwriting was quickly extinguished by competition
from joint-stock corporations.
Because Britain and America evolved quite different marine insurance institutions, one might wonder whether one set of institutions was
more efficient than the other. This would be all the more surprising because both countries were in close commercial contact and had a long
history of “institutional transplants.” It is not clear, however, that either
arrangement was more efficient in any meaningful sense. Both had
drawbacks: under the Lloyd’s system, even careful underwriters might
be unable to meet their obligations if they suffered a run of bad luck.
The corporate system as it developed in the United States, however,
lacked Lloyd’s ability to gather and efficiently use underwriters’ idiosyncratic information about risks.
Over time, both systems attempted to resolve these defects. In the
1860s Lloyd’s began to accept deposits from underwriters as a guarantee of security to the assured, and in 1871, it was incorporated as a Society with the power to make bylaws to regulate itself as a marine insur-
406
Kingston
ance marketplace. In the late nineteenth century underwriters gradually
began to form syndicates in which a single individual wrote on behalf of
several underwriters. This further increased the security of policies by
reducing the transactions costs of spreading risk more widely.95
Some American corporations employed their own foreign correspondents, but they had nothing like the advanced information-gathering apparatus of Lloyd’s. However, beginning in the 1830s and 40s, associations of marine insurers were formed in New York and Philadelphia to
unify practices and counter fraud, and in 1881, in response to renewed
competition from British insurers, a national association of marine underwriters was formed to unify practices and maintain a single network
of correspondents worldwide.96
There are a number of promising avenues for further research. This
article has focused on the adverse selection (lemons) aspect of the
agency problem between merchants and underwriters; but there were
also important moral hazard problems involved. I believe that reputation
mechanisms helped to mitigate these problems, and that the brokers
played an important role in these mechanisms; but this has not been sufficiently explored here. More research is also necessary to flesh out the
American side of the story; in particular, to understand what drove the
rapid transition from private to corporate underwriting in America during the 1790s. Finally, further study of the internal organization of the
British corporations would help us to understand their comparative advantages and disadvantages relative to private underwriting.
95
Gibb, Lloyd’s of London, pp. 177–78.
On the New York and Philadelphia associations, see Fowler, History, pp. 150, 198; and
Mitchell, Premium, p. 11. On the national association, see Mitchell, Premium, p. 28.
96
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