Insurance industry history

Insurance is a means of spreading risk across a large group of people. The uncertain risk—such as loss of life, property, or employment—is replaced by the predictable cost of an insurance premium. The two basic categories of insurance are the property and casualty industry and the life and health industry. The property and casualty industry comprises numerous different insurance lines, including automobile, homeowners’ (a “multiple peril” type of insurance that covers fire, weather, and accidents), commercial multiple peril, general liability (to protect companies or professionals from damage claims), medical malpractice, fire, reinsurance (the selling of a portion of large policies to other insurance companies), ocean and inland marine, and surety (for professionals who require bonding). Additionally, state and federal governments offer various types of insurance not fully provided by the private sector, including protection for bank deposits, crops, property in flood-prone areas, and workers’ compensation.

Although most 19th-century companies already specialized in one line of insurance, in 1865 New York specifically banned the provision of more than one line by the same company. After the Chicago fire of 1871 and the Boston fire of 1873, most other states similarly prohibited multiple-line insurance companies and continued to do so until the late 1940s. Due to space constraints, this article will cover only marine, fire, automobile, life, and health insurance.

The first form of insurance in the United States was on seagoing vessels and their cargo. As early as 1682, ships trading between England and the colonies were often protected against the hazards of the voyage by British insurance companies. During the 18th century, wealthy individuals or partnerships in Philadelphia and New York began establishing offices to underwrite marine risks, but English firms continued to dominate this field. The first American corporation to sell marine insurance was the Insurance Company of North America, chartered by Pennsylvania in 1794. The stability and longevity of incorporated insurance firms quickly spread to cities throughout the eastern seaboard including New York, Boston, New Haven, and Charleston, where numerous marine companies received charters over the next decade.

Despite their initial success, marine companies encountered a series of obstacles to their growth during the 19th century. Beginning in 1803 with the Napoleonic Wars between Britain and France, neutral American ships were continuously harassed by the two warring nations. While this hostile seagoing environment increased demand for marine insurance, the conditions of war likewise increased the risk of loss, placing the companies in a precarious financial condition. Between 1803 and 1812, the secretary of state reported 1,600 American vessels captured by the British, French, Neapolitans, or Danes. In contrast, the Embargo Act of 1807 brought all American trade to a virtual standstill and eliminated the business of marine insurance companies during most of 1808.

With the restoration of peace in 1815, marine insurance companies proliferated rapidly. The industry entered a period of intense competition during which rate wars forced many companies into BANKRUPTCY. A rash of fraudulent insurance claims during the 1820s further weakened the industry. One early historian estimated that one-third of all marine insurance claims from 1820 to 1840 were dishonest. The industry finally reached a period of stability and prosperity during the 1840s and 1850s, only to be disrupted again by the Civil War. The suspension of the cotton trade, heavy marine losses, and high wartime taxes all proved disastrous to the industry. Foreign competitors— the British in particular—capitalized on this weakened condition to regain dominance in both shipping and marine insurance. By the 1920s, only three major American marine companies were active in New York compared with 15 foreign companies. By the year 2000, only 3 percent of property and casualty premiums were for marine insurance.

Modern fire insurance originated as a direct result of the great London fire of 1666. In the colonies, attempts were made during the early 18th century to regulate the construction of buildings and to form organizations to extinguish fires. America’s first fire company, the Friendly Society of Mutual Insuring of Homes Against Fire, was established in Charleston, South Carolina, in 1735, but a major fire in 1741 put the association out of business. It would be more than a decade before the next company, the Philadelphia Contributorship for Insuring Houses from Loss by Fire, opened in 1752. The first known New York company—the Mutual Insurance Company (renamed the Knickerbocker Fire in 1846)—was not chartered until 1787. During the late 18th and early 19th centuries, marine insurance companies also commonly underwrote fire risks, but marine insurance remained the main focus of these early firms.

Most early fire companies were set up as assessment companies serving one town, city, county, or neighborhood, where members would pay a fee only when another member suffered a property loss. During a period when fire-fighting equipment was inadequate and buildings were highly flammable, small fires quickly spread; this exposed a small group of people to a high risk of heavy loss, and many fire insurance companies were wiped out by a single conflagration. For example, the disastrous 1835 fire in New York bankrupted 23 of that city’s 26 companies. As a result, mutual companies—in which members paid a regular fee with any annual surplus being redistributed to the policyholders—gained in popularity.

In 1837, Massachusetts began requiring fire insurers to maintain a reserve fund for the purpose of paying higher-than-predicted claims. New York enacted the nation’s first comprehensive insurance code in 1849, followed four years later with its own reserve requirement for fire companies. In response to revelations of insolvency and fraudulent organization among several fire insurance companies, state insurance departments were created to supervise all types of insurance. Beginning with New Hampshire in 1851, Massachusetts in 1855, and New York in 1859, most other states followed suit with their own supervisory departments during the postbellum period.

During the 1850s and 1860s, many states enacted protectionist legislation in order to promote local business interests or to raise revenues. Out-of-state companies in all lines of insurance were often charged higher taxes, required to invest in local bonds as a security deposit, and forced to purchase various state, county, and municipal licenses for their agents. The industry orchestrated a test case to challenge the constitutionality of these state regulations when a fire insurance agent representing several New York firms refused to pay a Virginia licensing fee. Unfortunately for the insurance industry, the Supreme Court ruled in the 1869 case of Paul v. Virginia that insurance polices were not commerce and therefore fell outside of federal jurisdiction as defined by the Constitution.

One of the biggest problems faced by fire insurance companies during the 19th and early 20th centuries was rate-cutting. Low barriers to entry allowed numerous companies to flood the market, frequently setting low rates in order to undercut the existing competition. These rates often proved inadequate in the event of a fire, resulting in company insolvency and high loss rates for policyholders. For example, threequarters of the involved companies were bankrupted by the 1871 Chicago fire and 1873 Boston fire. In response, companies banded together into organizations of fire underwriters for the purpose of setting industry rates. Ironically, fire companies would come to rely on the Paul decision to argue that since they were not engaged in interstate commerce, this rate-setting activity was not in violation of the Sherman Antitrust Act of 1890 or the CLAYTON ACT of 1914.

The San Francisco earthquake of 1906 again forced many companies into bankruptcy and the remainder to raise rates. In 1910, New York established the Merritt Committee to investigate the practice of rate-setting among fire insurance companies. The committee uncovered numerous abuses committed by the industry, including charging discriminatory rates, boycotting customers, and challenging claims without due cause. In the aftermath of the investigation, many states mandated the establishment of rating bureaus to pool company data and determine ideal rates. State-sanctioned rate-setting, free from the restraints of antitrust legislation, was perceived to be the only viable means of ensuring the solvency of fire insurance companies.

The 1869 Paul v. Virginia decision was finally overruled in the 1944 case of United States v. South-Eastern Underwriters Association. The case involved a group of multistate fire insurance underwriting bureaus that were charged with conspiring to fix prices and limit competition— in violation of the Sherman and Clayton Antitrust Acts—by bribing insurance commissioners. In a 4 to 3 decision, the Supreme Court ruled that multistate insurance companies did indeed engage in interstate commerce and that insurance companies could therefore be prosecuted under the antitrust acts. In response, Congress passed the McCarran-Ferguson Act of 1945, declaring state regulation and taxation of the insurance industry to be in the public’s best interest. It also placed the industry specifically outside the purview of the SHERMAN ACT, the Clayton Act, and the FEDERAL TRADE COMMISSION Act as long as such business was regulated by state law. Congress recognized that the sharing of information actually facilitated competition and solvency. By the year 2000, only 3 percent of property and casualty premiums were for fire insurance.

Automobile insurance began early in the history of the AUTOMOTIVE INDUSTRY, but the first compulsory law was not passed until 1927 by Massachusetts. Since then, most states have passed laws requiring some minimum level of insurance for all automobiles. As with other types of liability insurance, the person claiming injuries or damage as the result of an automobile accident had to prove that the other party was at fault. Consequently, the process itself was long and inefficient, with legal fees consuming approximately one-quarter of all insurance premiums. During the 1960s, states began considering no-fault insurance in which property and injury claims would be paid by each person’s own insurance company, regardless of who was at fault. By the early 1970s, several major insurance companies joined consumer groups in announcing their support for no-fault policies, believing that the change would result in considerable cost savings. Massachusetts first adopted no-fault in 1971, followed by 23 other states by 1976. On several occasions during the 1970s, the federal government even considered mandating no-fault insurance across the country.

The drive for nationwide no-fault insurance had died quickly by the late 1970s. In most states, trial lawyers managed to win concessions from legislatures that weakened the laws. For example, several states offered no-fault insurance while still permitting damage lawsuits. Other states allowed drivers to sue for damages above a stipulated amount. Only in New York, Michigan, and Pennsylvania was a relatively pure form of no-fault insurance attempted. During the 1980s and 1990s, several states repealed some or all of their no-fault provisions due to rising insurance costs. The prudence of no-fault insurance continues to be debated in the remaining states. In the year 2000 automotive insurance was the largest line within property and casualty insurance, accounting for 46 percent of premium income.

The first American life insurance enterprises can be traced back to the late colonial period. The Presbyterian Synods in Philadelphia and New York set up the Corporation for Relief of Poor and Distressed Widows and Children of Presbyterian Ministers in 1759; the Episcopalian ministers organized a similar fund in 1769. In the half-century from 1787 to 1837, 26 companies offering life insurance to the general public opened their doors, but they rarely survived more than a couple of years and sold few policies. The only early companies to experience any success in this line of business were the Pennsylvania Company for Insurances on Lives and Granting Annuities (chartered 1812), the Massachusetts Hospital Life (1818), the Baltimore Life (1830), the New York Life and Trust (1830), and the Girard Life, Annuity and Trust of Pennsylvania (1836).

Despite this tentative start, life insurance did make some significant strides beginning in the 1830s. Life insurance in force (the total death benefit payable on all existing policies) grew steadily from about $600,000 in 1830 to just under $5 million a decade later. By 1850, just under $100 million of life insurance was spread among 48 companies. The top three companies— the Mutual Life of New York (1842), the Mutual Benefit Life of New Jersey (1845), and the Connecticut Mutual Life (1846)—accounted for more than half of this amount. The passage of laws permitting women to purchase life insurance on the lives of their husbands—free from the claims of creditors—and a change in the corporate structure of firms from stock to mutual companies accounts for much of the success during the 1840s.

The major boom period in life insurance sales occurred during and after the Civil War. Although the industry had no experience with mortality during war—particularly a war on American soil—and most policies contained clauses that forbade military service, almost all companies agreed to ensure war risks for an additional premium rate of from 2 percent to 5 percent. The goodwill and publicity engendered with the payment of each death claim, combined with a generally heightened awareness of mortality, greatly increased interest in life insurance. Whereas only 43 companies existed on the eve of the war, the newfound popularity of life insurance resulted in the establishment of 107 new companies between 1865 and 1870.

The success and profitability of life insurance companies bred stiff competition during the 1860s; the resulting market saturation and a general economic downtown combined to push the industry into a severe depression during the 1870s. For many postbellum companies, innovation into markets previously ignored by the larger life insurance organizations was the only means of avoiding failure. Beginning in the mid- 1870s, companies such as the John Hancock (1862), the Metropolitan Life (1868), and the Prudential of America (1875) began issuing industrial life insurance. First sold in England in the late 1840s, industrial insurance targeted lower-income families by providing policies in amounts as small as $100. Premiums ranging from $0.05 to $0.65 were collected on a weekly basis, often by agents coming door to door. Additionally, medical examinations were often not required, and policies could be written to cover all members of the family instead of just the main breadwinner. Industrial insurance remained only one-sixth of the amount of life insurance in force through 1929, but the number of policies written had skyrocketed to just under 90 million. By the eve of the Great Depression there existed more than 120 million ordinary and industrial life insurance policies—approximately equivalent to one policy for every American man, woman, and child.

In response to a series of newspaper articles during 1905 that portrayed extravagant spending and political payoffs by executives of the Equitable Life Assurance Society, the New York state legislature convened the Armstrong Committee to examine the conduct of all life insurance companies operating within the state. Among the abuses uncovered were interlocking directorates, the use of proxy voting to frustrate policyholder control of mutual companies, inappropriate investments, unlimited company expenses, rebating (the practice of returning to a new client a portion of the first premium payment as an incentive to take out a policy), policy forms that were biased against policyholders, the encouragement of policy lapses, and the condoning of “twisting” (a practice whereby agents misrepresented and libeled rival firms in order to convince a policyholder to sacrifice her existing policy and replace it with one from that agent). The legislature responded by enacting a wide array of reform measures, including strict regulations regarding acceptable investments, limitations on lobbying practices and campaign contributions, the elimination of proxy voting, standardization of policy forms, and a ban on rebating and twisting by agents. Eventually 19 other states followed New York’s lead in adopting similar legislation.

Throughout the 20th century, life insurance has been the second-largest financial intermediary in the country. In the year 2000, there were 369 million life policies worth $16 trillion.

Although health insurance existed as early as 1847, it remained an extremely minor insurance line until the late 1920s, when the cost and demand for medical care began to rapidly increase. In 1929, a group of Dallas teachers entered into a prepaid hospitalization plan with Baylor University Hospital. As incomes fell during the Great Depression, prepaid hospital plans began to spread among employee groups. In order to control competition between hospitals, the American Hospital Association eventually affiliated these plans under the name Blue Cross. Believing that such plans were in the public’s best interest, states passed special legislation designating the Blue Cross plans as nonprofit corporations free from state insurance regulations. This nonprofit status required that they charge uniform rates regardless of health status.

As the popularity of Blue Cross plans spread, physicians began to fear that hospitals would use these plans to restrict their services. Additionally, the federal government began to consider the creation of national compulsory health insurance. In order to thwart these threats, in 1934 the American Medical Association began developing plans for prepaid insurance for physician’s services, using Blue Cross as their model. The first such plan went into effect in California in 1939. By 1946, these plans affiliated under the name of Blue Shield.

With the success of Blue Cross and Blue Shield, for-profit insurance companies began entering the field. The major advantage enjoyed by the commercial companies was their ability to charge differential rates based on health status, enabling them to attract the healthiest groups away from the Blues with lower rates. Health insurance gained a further boost during World War II. As WAGE AND PRICE CONTROLS went into effect, companies began competing for scarce labor resources by providing better health benefit packages.

Although 75 percent of Americans were enrolled in some type of health insurance plan by the end of the 1950s, many groups were still excluded from this coverage. In 1965, Congress created Medicare to provide compulsory hospital insurance and supplementary medical insurance to Americans 65 and over. Additionally, Medicaid was established to provide federally supported, state-level coverage for the poorest Americans. In the year 2000, with medical costs skyrocketing and 17 percent of people under the age of 65 lacking health coverage—including 12 percent of children under 18—politicians and consumer groups continue to debate the plausibility of establishing a national health insurance plan.

Further reading

• Grant, H. Roger. Insurance Reform: Consumer Action in the Progressive Era. Ames: Iowa State University Press, 1979. 
• Meier, Kenneth J. The Political Economy of Regulation: The Case of Insurance. Albany: State University of New York Press, 1988. 
• Zartman, Lester W., and William H. Price. Yale Readings in Insurance: Property Insurance—Marine and Fire. New Haven, Conn.: Yale University Press, 1926. 

Sharon Ann Murphy