Evolution of Property/casualty (pc) Insurance Industry

Evolution of Property/Casualty (PC) Insurance Industry and Contract Standardization (Auto/Homeowners) in the U.S.

Fire Insurance Origins: London Fire of 1666; Philadelphia Contributorship in 1752 (Benjamin Franklin): we discussed these during last class

But, they had no reliable statistics on the probability of loss from fire, and they didn’t know what to charge for fire insurance.

Result: absence of loss data + forces of competition + human nature = price wars, which led to insurer insolvencies, company failures, and policyholders who got no payments to cover their losses

(Modern solution to above, we saw in Regulation discussion, was solvency regulation and guaranty fund creation, but it would be many decades before these regulations developed)

In meantime, insurers discovered a way to address these problems on their own, and which still exists today

To deal with the absence of data on loss probabilities, fire insurers began to pool data on their claims experience

The more data on loss characteristics and claims, the more accurate their forecasts of losses were, and the more confident they could be of premiums that should be charged

Pooled data was meaningful only if it was about the same thing (fire by lightning, or fire by defective chimneys, not both in the same data pool): “homogeneous data”

This led to promises of fire insurers to pay its policyholders on essentially the same terms…i.e., a standardized contract

This was the beginning of the standard insurance contract: all insurers had to sell the same standard form coverage to capture the benefits of data pooling, but each insurer could compete on price and reliability of service, but not on the terms of coverage

For a century, this practice continued…not without problems requiring regulation: renegades charging prices too low leading to insolvency, shady insurers who defrauded policyholders with low premiums with no intent of staying around, and so on.

Fire insurers set up organizations to receive and pool the data by individual insurers and to prepare standard fire insurance policies to be used by the insurers

To guard against price wars, the insurers who controlled these organizations (also called “rate bureaus”, had them supply rates to be charged by all of the member insurers that were set at above-competitive levels

Insolvencies were avoided this way by the insurers, but at the cost of “price fixing” (U.S. vs. Southeastern, 1944, which we just discussed in the Regulation lecture)

New liability insurers after 1880 and into the 20th century followed