Catalog of clever ideas: Insurance

Socialism for capitalists

 

Life has its ups and downs. You win some, you lose some. Your ship comes in, your ship goes down.

It was this last prospect that caused merchants in medieval Venice to band together to pool their resources and risks. Their enterprises included lengthy and sometimes perilous voyages to the Indies. If a voyage was successful, bringing back spices and silks that commanded high prices in the Adriatic entrepot, the owners of that ship made a financial killing. But if the ship fell victim to storms or pirates, the financial fatality could be to the owners. To prevent such an outcome, merchants joined forces, each taking a small part in several sailings. This smoothed out the highs and lows for the participants. No single success was as profitable for any one merchant as before, but no failure bankrupted any.

The system worked only because the average return on the voyages was positive. Five ships arrived safely for every one that didn’t, or some such reckoning. If the average had been negative, instead of ensuring a profit to all the system would have ensured their failure.

This is a standard feature of insurance schemes. Whatever activity they insure has to produce a surplus. And this is why poor countries don’t have elaborate social welfare programs, which are essentially insurance schemes. Spreading the risk is the inverse of spreading the wealth. If there’s no wealth to spread, the project never gets off the ground.

Yet even poor societies apply the collectivist principle. The hunters of a village agree to share whatever they bring home. A bad day for one hunter doesn’t cause his family to go hungry. The concept of noblesse oblige is a variant. In this case the noble insures commoners against starvation and himself against revolt.

Modern corporations arose out of the Venetian joint ventures. In time they gained various legal attributes, but at base they are insurance schemes. The many thousands of shareholders in companies like Meta jointly participate in the profits when things go well, as they have for the most part since Facebook went public in 2012. And they jointly share the losses when things go badly, as in 2022 when the company lost three-quarters of its value.

Government got into the insurance business in the nineteenth century. Otto von Bismarck of Germany devised the first modern social-security program, utilizing the surplus created by Germany’s industrialization to weave a safety net under workers. The Iron Chancellor was no bleeding heart. He wanted to steal the thunder of the growing socialist movement in Europe, which likewise sought a better deal for workers but by a more radical reform of the political economy.

Dozens of countries had followed Bismarck’s lead by the time America joined the movement in the 1930s. Individualism is the enemy of insurance, and the ethos of individualism runs strong in the American psyche. But eventually Americans accepted government-run insurance programs to protect against ruin occasioned by old age, unemployment and ill health.

If Congress was behind the world curve on insurance, American courts were at the cutting edge. Product liability goes back to the code of Hammurabi, which held manufacturers liable for injuries caused by defects in what they produced. It had to compete with the concept of caveat emptor—let the buyer beware—in the early industrial revolution. But in America after World War II a broad interpretation of product liability took hold in the courts. Negligence was no longer required for a manufacturer to be held liable. If a product proved dangerous, the manufacturer could be compelled to pay damages to the injured. The underlying thinking was that in a wealthy country like America, the risks consequent to innovation ought to be spread. The costs of paying the claims would raise prices to consumers, but these were the equivalent of insurance premiums.

Silicon Valley adapted the Venetian model in a peculiar way. The venture capital firms that funded the tech boom of the late twentieth century accepted risk ratios much greater than had been the norm in American business. Ten VC bets might go bust—or twenty or thirty—for each bet that won. But the winner would pay for all the failures and still make the VC partners rich.

Insurance has become more ubiquitous than ever. Auto insurance, boat insurance, casualty insurance, death insurance, employment insurance, fire insurance—hardly a letter of the alphabet lacks its insurance. The idea is always the same: Don’t face risk alone. It’s a good idea. Always has been.