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"'Nick Szabo's Papers and Concise Tutorials
The Birth of Insurance
Copyright (c) 2005 by Nick Szabo
(Here's an excerpt from a history of commercial institutions that I am writing.)

Northern Italy responded to the crises of the 14th century in a remarkable way -- with further innovation. In short succession Genoa developed insurance, insurance pools secured by landed estates, and reinsurance. Exchanges sprang up for trading public debt, commodity futures, and other commercial paper. Bankruptcy law and the settlement of international trade disputes reached new levels of sophistication. Accounting became widespread and double-entry bookkeeping was born. As a result of their cumulative breakthroughs in institutions and technology, Europeans became the first merchants to travel and trade around the entire globe.

The earliest risk-pooling insurance contracts were structured similarly to, and enforced under the same legal principals as, loans. Indeed they bundled a loan from the combined investor/insurer with an insurance clause -- in the event that the ship was wrecked, the loan need not be paid back. In 14th century Genoa, we see the separation of the investor from the insurer, via a contract with its conditional clause but requiring no initial loan. Investment contracts became separate entities and could be contracted with different parties, greatly improving the spreading of risk for these ventures. Such improved risk management was crucial for the explosion of overseas trade that Europe initiated over the succeeding centuries.

The following contract illustrates a insurance pool -- one of the earliest insurance pools. The pool consists of many counterparties, each pledging his entire property as security. Often these were feudal lords with large landholdings, so the value that could be brought to bear to back these insurance contracts was vast. This is how Lloyds Names still work today. Since several Names back a single contract (e.g. covering a single shipment of goods, as here), each Name puts only a tiny fraction of their estate at risk in that voyage. An insurance exchange like Lloyds allows the agents of goods owners, shippers, and Names to meet and mass-produce these kinds of contracts. Such occurred, albeit in a more sporadic and awkward way, in 15th century Genoa. Here we see an early contract that is still structured legally as a loan, by the neat trick of simply making the initial loan a fictional payment.

...Geri, [son] of the late Ser Lapo of Florence, Simone Guascone, [9 more Names listed], each of them [liable] for the amount written below, have acknowledged and in truth have declared to me, notary undersigned, as a public official [holding] a public office, making the stipulation and receiving in the name and stead of Federico Vivaldi, citizen of Genoa, that they have bought, have had, and have received from him a certain amount of goods of the said Frederico...And for these goods and in consideration of their price each of them has promised to give and to pay to said Frederico or to his accredited messenger: [from] the said Geri,150 gold florins, the said Simone, 50 florins, [100 florins each from the other Names] within the next five months from now. Otherwise they have promised to give and to pay to the said Frederico the penalty of the double of it and of the entire amount to which and to the extent of which [this agreement] is violated or is not observed as above, together with restitution of all losses, unrealized profits, and expenses which might be incurred because of it in court or outside -- the aforesaid remaining as settled, and under hypothecation and pledge of their goods and [the goods] of any one of them, existing and future.

[The above is binding] with the exception and special reservation that if the amount of goods, property, and merchandise which was loaded or is to be loaded by Frederico Imperiale or by another in his behalf for the account of the said Frederico Vivaldi in Aigues-Mortes -- to be transported to Ayassoluk and Rhodes or to either of these two localities in a certain ship...and which departed from Aigues-Mortes or is about to depart in order to sail to aforesaid regions -- is brought and unloaded in the said location of Ayasoluk and Rhodes or in either of them, in safety, then and in such a case the present instrument is canceled, void, and of no value and pro rata. And be it understood that such a risk begins when the said ship departs and sets sail from Aigues-Mortes, and it remains and lasts, while the captain goes, stays [in port], sails, loads and unloads, from the said locality of Aigues-Mortres up to the said localities of Ayassoluk and Rhodes, in whatever manner and way he wishes, until said amount of goods, property,and merchandise has been brought and unloaded in Ayassoluk and Rhodes or in either of these two localities in safety, and pro rata. Let the present instrument also be canceled if the said Frederico refrains from asking payments of the aforesaid amounts of money for the space of one year after the time or the time limit has elapsed for asking or obtaining their payment....Done as above, September 15th, around nones. [1393 A.D.]

Frederico's forebears were pioneers in exploring, and perhaps trading with, the west coast of Africa, as far as the southern hemisphere, in the 13th century.

This insurance contract was still, legally speaking, a loan. This had at least two interesting consequences on what we now call the insurance premium. Firstly, the premium was treated as goods purchased by the insurer on credit. Secondly, even at this late date, contracts were coy about the actual value of such goods. Leaving the value of those goods unspecified made usury difficult to prove in this "loan", and as usual the Genoese courts were happy to ignore usury as long as the merchants were being reasonably discrete about it. In the case of insurance, the Church was quick to recognize that what was being paid for here was a real risk, and therefore not usury.

Conceptually, insurance contracts were a big step in the abstraction of risk. Their similarity to gambling would become apparent. The first book on insurance, On Insurance and Merchant's Bets, makes the connection. It was written by the Portuguese lawyer Santera, in 1488, at a time when the Portuguese, financed by Genoese investors, were starting to make many dangerous trading voyages down the west coast of Africa. Santera summarized the insurance contract as follows -- "I undertake the peril, for your giving me money, as is the understanding of Baldus." Santera argues that the good intentions of the contracting parties must be presumed, even though insurance and betting could be a cloak for usury. Since life is full of uncertain events, everybody by necessity makes bets. A lawyer must for a variety of reasons be able to determine what the just price (the modern "fair value") of an insurance contract is. For example, a lawyer must determine whether there was consideration in the contract (under the most common understanding and stemming from Roman law, consideration had to be at least half the just price). In computing damages, the value of the insurance contract is also often relevant. Franklin [ref] gives the following example from Santera -- "If someone charges 16 percent in circumstances for which 8 percent is usual, it may be inferred [as a rebuttable presumption] that the insurance was intended to cover a second voyage. If a ship's master defers sailing until a more dangerous time of year, a price previously just may become unjust."

By 1488 the Genoese already had a very sophisticated insurance industry, and the Portuguese were making use of it on risky trading voyages down the west coast of Africa. Genoese investors and commercial practices played a leading role not only in the African trade, but in the colonization of the Atlantic Islands (Azores, Canaries, and Madeiras). The Genoese and Portuguese established sugar plantations and vineyards on these islands; by 1465 Madeieras sugar could be bought in London.

In the decade after of Santera penned his book on insurance, the Portuguese and Genoese would be putting European innovations to even more spectacular use. Their ships were financed by sophisticated investment and insurance schemes, brimmed with European cannon (mostly made in Germany, Hungary, and Northern Italy), used a compass new to Europe, measured velocity for dead reckoning with the help of the sand glass, and measured location with newly printed navigation tables and ephemerides. In 1492 the Genoese navigator Christopher Columbus, seeking Asian spices by a westward route, discovered America. Columbus from early in his career was an agent for Genoese investors in the Madeira islands. The Madeiras were an early Atlantic conquest of the Portuguese crown and Genoese investors. Columbus' voyage to find a westward route to the Indies was backed by a consortium of Castilian and Genoese investors. The Genoese also plaid a substantial role in funding the subsequent Spanish colonization of the Americas by Columbus and his successors.

In 1498 the Portuguese Vasco Da Gama, following up on previous Portuguese exploration and trading voyages down the coast of Africa to the southern hemisphere, pioneered the sea route to the Orient from the Atlantic shores of Europe, via the Cape of Good Hope (South Africa). There followed large numbers of commercial spice fleets, funded by Genoese, Venetian, and German merchants among others. The Portuguese royal fleet and privateers, both often financed by loans from these same investors, conquered or purchased Hormuz, Malacca (near modern Singapore), Goa, and Macau, gaining control of the vast wealth of the Southeast Asian sea trade, and trading spices and other Oriental wealth to Western Europe for silver, a commodity quite scarce in Southeast Asia but highly useful for oiling the transactions of Southeast Asian trade.

Chinese and Arabs, by contrast, despite having been more advanced than Europe in navigation and shipping for so many centuries, had not even come close to pioneering the route around Africa in the opposite direction or discovering for the world the unknown continents of North and South America. The Portuguese' cleverly capitalized and insured ships carried out silver from Europe and gold from West Africa, and returned a variety of goods such as spices that Europe craved. That such a small society could put so much money into such very risky enterprises -- and reap vast profits in the process -- was completely unprecedented. The Portuguese, a century before just a tiny little country of sleepy fishing villages in an obscure corner of the world, in short order conquered the strategic points of Chinese, Indian, and Arab trading routes and became masters of the Oriental sea trade. It was the most shocking development in world history to date, and pioneered the way for other Europeans to follow.

References
Medieval Trade in the Mediterranean World: Illustrative Documents, Translated by Robert S. Lopez & Irving W. Raymond

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