The Business of Risk Part One: The History of Risk Management
The idea that humans can manage risk has not always been accepted. In ancient Greece, it was widely held that people face the consequences of a risk because it was the will of Zeus. In other words, the outcome of a risk was not something that humans had the ability to control, it was something determined solely by the whims of the gods.
Our modern understanding of risk is rooted in the Hindu-Arabic numbering system, which reached the West around eight hundred years ago. In a book called Liber Abaci (1202), the Renaissance thinker, Leonardo Pisano, made people aware of the ways numbers could be substituted for Hebrew, Greek, and Roman systems which used letters for counting and calculations. The book was filled with practical examples of how measurement could be used to mitigate risk which revolutionised commercial bookkeeping, making it possible to calculate profit margins and interest payments.
The use of numbers to quantify risk picked up during the Enlightenment. The French thinkers Chevalier de Mere, Pierre de Fermat, and Blaise Pascal contributed to the development of probability theory – the mathematical underpinnings of the concept of risk. This made it possible to measure probability in terms of numbers, instead of making decisions based on degrees of belief.
This shift in attitudes towards risk was, to quote the financial historian Peter L. Bernstein, a way that humans turned “Against the Gods” by taking control of their destiny, rather than being passive victims of nature.
It did not take long for humans to start making money off this new-found belief in the ability to predict and control future events. In seventeenth-century England, thousands of ships carrying cargo travelling out on the Thames from London, creating demand for information on weather patterns and risks in unfamiliar seas. In the absence of mass media, coffee houses emerged as the primary source of news and information on the maritime industry. These coffee houses were essentially the first insurance markets in England.
In 1688, the English merchant Edward Lloyd opened a coffee house near the Thames on Tower Street. It became such a popular venue for seafarers seeking information on maritime risks, that Lloyd moved to a larger and more luxurious building on Lombard Street in 1691. He launched the Lloyd’s List a few years later, which contained information on arrivals and departures of ships, and intelligence on conditions abroad – the first official edition was published by Thomas Jemson in 1734.
By this point Lloyd’s was an established and reliable brand. Shipowners seeking insurance would go to a broker, who would then take this risk to the coffee house to find an individual risk-taker who would agree to cover the loss, in return for a specified premium, by writing their name under the terms of the contract – these one-man insurance operators soon became known as “underwriters”.
In 1771, nearly a hundred years after Edward Lloyd opened his coffee house on Tower Street, a group of seventy-nine unincorporated underwriters operating under a self-regulated code of conduct came together to form the Society of Lloyd’s. They committed all their worldly possessions and financial capital to secure their promise to make good on their customers’ losses. These were the original Members of Lloyd’s – they later became known as the “Names”.
The Members of Lloyd’s made significant social contributions over the coming century. A strong relationship was forged between Lloyd’s and the Admiralty – Lloyd’s provided information on ship activity overseas in exchange for protection from the Admiralty. In 1798, following the Battle of the Nile and the destruction of Napoleon’s fleet, the Lloyd’s Committee raised £38,000 to help the wounded and bereaved. These social contributions led to a formal recognition of the importance of the insurance industry in 1871, with the signing of the first Lloyd’s Act, which established a detailed constitution that made it illegal for anyone not recognised as a Lloyd’s underwriting member to sign a Lloyd’s policy.
In the late nineteenth century, the insurance industry began expanding coverage to include non-maritime risks. The reputed underwriter, Cuthbert Heath, wrote the first burglary policy, and the first hurricane and earthquake policies in 1887. The first motor car was invented in 1885; Lloyd’s underwriters were the first to offer car insurance in 1904, describing the cars as a “ship navigating on land”. The same methods being used to evaluate the risk of a ship being lost at sea, were now being applied to evaluate the risk of a car crashing on the road.
Humanity has come a long way since ancient Greece. It is now widely accepted that humans are both willing and able to manage a whole range of risks in ways that are both socially and economically beneficial. In its pure form, insurance is an essential component of a well-functioning society because it distributes risk in ways that promote the common good. It does this in two keyways.
The first is that insurance protects the most vulnerable by offering a safety net when things go wrong. During the Covid lockdown, for example, thousands of small businesses received payments from business interruption insurance policies which helped them remain solvent during a global health crisis. More recently, insurance companies are funding the reconstruction of the bridge in Baltimore which collapsed in March 2024.
The second is that insurance encourages entrepreneurship and innovation. In 1965, Lloyd’s syndicates provided the first space satellite insurance policy covering physical damage to the Intelsat I. More recently, insurance companies are providing coverage to satellite manufacturers and operators in India. This encourages the privatisation of space launches by reducing the risk entrepreneurs face when developing innovative technologies.
Entrepreneurs face an array of risks which stunt innovation. Without insurance, several risks simply would not be worth taking and society would miss out on the gains which innovation brings.