Popular Science Monthly/Volume 19/August 1881/Origin and History of Life Insurance I
By THEODORE WEHLE.
LIFE insurance is based upon the theory that there is a law of mortality governing life; that is to say, that at all ages from birth to the utmost limits of life a certain proportion of individuals will die during fixed periods. Not that the precise duration of an individual life can be predicted, but that the ratio of deaths out of large gates will remain the same under similar conditions. This conception, so self-evident to-day, was slow to dawn upon the human mind. Ancient pagan belief, various forms of superstition, as well as theology, all assumed life to be under the special control of a mysterious and arbitrary power. The conviction that it is subject to laws, as unalterable as those that govern the physical universe, has only gained ground within a comparatively recent period. Nor could such a view assert itself until mathematics and statistics had reached a certain degree of perfection; for, previous to that, the law of averages and probabilities, as applicable to social problems, could not be understood.
Even after science had taken the initiative, and formulated the law upon such data as were accessible, a long period elapsed before steps were taken to apply its principles to practical ends. The conditions of society were as yet too unsettled, property and life too insecure, to permit such experiments. Not until after the middle of the eighteenth century did the desire to provide for widows, orphans, and other dependents, become so general as to lead to the establishment of a life-insurance society in London.
Since then the system has been steadily perfected, and has grown to considerable dimensions all over the civilized world. At present more than 600,000 lives are insured in the United States alone; and the usefulness of the institution is only beginning to be properly appreciated. In view of this fact, and of the general interest that cooperative enterprises are attracting just now, it may be well to point out that life insurance must be reckoned among the grandest and most successful efforts ever attempted in that direction. It has, moreover, a century's experience to attest the strictly scientific principles upon which it rests. Such an institution well deserves to be better and more generally understood; but, however large the number directly interested, it is strange how few have correct notions about it. This is probably attributable to the character of the literature on the subject, which, addressed to specialists, employs many technical terms, or, intended for soliciting agents, contains mere platitudes. Thus the impression prevails that it is either too dry or veiled in too much mystery to deserve the attention of even the educated classes.
It will be the aim of these articles, while giving an outline of the origin and history of mortality-tables, the results attained, and an explanation of the practical working of the whole system, to present it in so plain and popular a manner as to be readily understood by every intelligent reader.
I. Origin and History.—Among the nations of antiquity, the Romans were the first to make an effort to arrive at a law of mortality. To this they were led indirectly by their highly developed system of jurisprudence. It became necessary at times to fix the value of life-estates, i. e., property owned during lifetime only, without the right of alienation or bequest, and to do so the probability of life had to be estimated. It appears that the method in common use was about equivalent to assuming that all persons who attain the age of thirty would certainly live to the age of sixty, and then certainly die. This purely arbitrary assumption was probably accepted by jurists as the simple solution of a difficult problem.
A great improvement was introduced by the Prætorian Prefect Ulpianus, one of the most eminent of Roman jurists. He published a table of mortality, in which a distinction was made between the different ages, and the probable number of years of life for each given. The rate of mortality assumed for the middle ages approximates to that probably prevalent previous to the seventeenth century. Whether this table was based upon actual observation or was purely speculative is not settled; but, if its estimates were correct, the chances of life above sixty years were very poor indeed among the Romans. However, these early efforts do not seem to have exercised any influence toward a proper investigation of the subject, and, having been forgotten, they only possess a passing interest for us.
The real germs from which life insurance ultimately developed were life-annuities and tontine annuities. These latter derived their name from a Neapolitan adventurer, Tonti, who came to Paris in 1653, in the reign of Louis XIV. He formed associations based upon the agreement that members should pay a certain sum of money into a fund, which was to be managed by him or other founders. The interest on this capital was annually divided among the surviving members, and, as their number grew smaller, their income became larger from time to time, until eventually the last survivor enjoyed the whole annual proceeds, which often were considerable. An instance is given of a widow who died in France in 1726, at the age of ninety-six, as the last survivor of a tontine society, having an income of 79,000 francs; her husband had been a surgeon, and had paid 300 francs for her membership in the association.
Such schemes were naturally attractive, and spread rapidly over Europe. Various modifications were introduced, adapting them to changing circumstances. Even governments had recourse to them as a means of raising money, when credit was low. The English Government made a tontine loan in 1693, comprising 1,002 members, the last of whom died in 1783. The other, known as the Great English Tontine, was started in 1789 for £1,000,000, embracing about 3,500 lives.
Voluntary associations for specific purposes were also quite frequent. One of a later date, originating in this city, may be mentioned by way of illustration. The Tontine Association of New York, established in 1794 by prominent merchants, upon 203 shares, applied its fund of about $40,000 to the erection of a coffee-house at the corner of Wall and Water Streets. There was an agreement that, when the nominees (mostly young children of the originators) should be reduced to seven, the association should come to an end. Accordingly, in 1870, the requisite number being reached, steps were taken to have the property (which was then valued at $200,000) divided.
The advantages the tontines seemed to offer made them very enticing. The larger the number of deaths a prospectus would promise, the greater the expected gain to the survivors. No reliable calculation or precise prediction of the mortality was necessary, since they were to be guided by the actual experience only. But the very ease with which they could be formed tended to make them deteriorate into little better than mere lottery schemes, used by designing men to plunder the credulous.
At present the tontine principle does not enlist our sympathy, being too selfish for our times, but it probably answered a good purpose in its day. Life and property were insecure, the investment of small sums difficult, the usury laws stringent: how natural for men to look to immediate enjoyment, when provision for the future was surrounded by so many uncertainties!
Nor is it likely that Tonti was the real originator of the idea. There is reason to assume that similar customs had taken root in Italian cities long before his time. Probably the same conditions and needs of society also led to the practice of purchasing life-annuities. It seems to have been a favorite mode of raising money, among the flourishing towns of the Netherlands, since the early part of the sixteenth century. On the payment of a certain sum to the party granting the life-annuity, a fixed annual income could be secured during lifetime.
Two other methods of making loans were also known to these old communities, namely, terminable and perpetual annuities.
Terminable annuities are such as are redeemable after a fixed number of years, and bear interest until maturity. That is the usual mode of investing funds at present.
Perpetual annuities are those that bear interest for ever, while the principal never becomes payable. Many European governments have funded their debts upon that principle, the most noted being the French rentes and the English consols.
The people of the Netherlands, that so early displayed commercial and political activity, continued to grow in importance until, by the middle of the seventeenth century, they ranked among the foremost nations of Europe. The freedom they enjoyed fostered material prosperity and encouraged the arts and sciences. Their statesmen and officials were often men of the highest attainments.
One of the greatest among these was Jan de Witt, Grand Pensionary of Holland and West Friesland, a disciple of Descartes, and author of a mathematical work of note.
About contemporary with him, the eminent French thinker, Pascal, had laid down the first principles of the doctrine of chances. The celebrated Christian Huygens enlarged upon these inquiries in a treatise written in Dutch. When, in 1671, the States-General applied to De Witt to elaborate the best plan for raising a loan, he was the first to apply the principles of the science to a practical subject. In a memorable report he states that, for reasons given, it is better to negotiate funds by life-annuities, which by their nature are terminable, than to resort to either perpetual or terminable annuities. He shows that it had long been the practice in Holland to grant life-annuities at double the rate of interest current. That is to say, if four per cent, was customary, a loan of one hundred florins would bring four florins per annum, while one hundred florins applied to the purchase of a life-annuity would yield an income of eight florins. He goes on to prove that the practice of making no distinction between the ages, the selling a life-annuity on the same terms to the young and the old, was based on a fallacy. He then applies the doctrine of chances to data, most likely deduced from former annuity experiences, and proceeds to construct a mortality-table. This table, though erroneous in many respects, is still the first application of mathematical principles to questions of this kind, and, as such, deserves the highest consideration.
The report was never acted upon, and was lost before De Witt's contemporaries had become acquainted with it.
Toward the end of the seventeenth century, the subject of calculating a table of mortality began to create interest in scientific circles in England; but the difficulty was, to obtain reliable statistics. A few registers had been kept since 1538, and by 1600 they had been introduced into probably one half the parishes of England. Unfortunately, only births or baptisms had been entered. During the plague, the government was induced to publish mortality bills, showing the number of deaths; but here, also, the ages were not stated. The Royal Society, finding no data at home, turned to the Continent of Europe.
The city of Breslau, in Silesia, had kept an exact register of births and deaths for some time, and reliable copies for the five years from 1687 to 1691 were obtained. These were intrusted to the Astronomer Royal, the celebrated Dr. Halley, renowned for having calculated the orbit of a comet, which has been named after him. He published a treatise, which appeared in the "Philosophical Transactions" in 1693, giving the following mortality-table, the first that had ever been constructed on exact scientific principles:
Considering the disadvantages under which he labored, it was a wonderful production. He had no record of the whole population, and only 6,193 births and 5,869 deaths of all ages from which to draw his deductions.
The form of the table has been substantially retained to the present day. It begins with 1,000 children, in the first year of life, of whom 145 die in the course of the year. At the beginning of the second year there are 855 living, of whom 66 die in the course of that year; and so the table continues until, at the age of 90, the last one of the original number will die. The probability of dying in any one year of life is readily ascertained. For instance, in the first year of life, 145 die out of 1,000. Therefore, the probability of dying is 1000=·145. In the second year 66 die out of 855, which makes the probability 855=·077. That is to say, according to Halley's table, 142 per cent. of all newly-born children will die in the first year of life, and about 74 per cent. in the second year. Another interesting deduction pointed out by him is what a modern actuary has called the equation of life. It will be observed that, out of 1,000 at age 1, 499 will survive at 34, which indicates that the chances of dying or living to age 34 are about equal for a child at birth. It may be applied to any other age. At 19 the table shows 604 living, while at 54 there are 302; therefore, a youth at 19 has, to age 54, an equal chance of living or dying.
Whether Halley's table is a correct exposition of the mortality of the time it is difficult to say, since his data may have been insufficient; but the reasoning on which it was based and the conclusions drawn were strictly scientific.
But, while Halley's treatise must have been highly appreciated by mathematicians, the public at large seemed to have remained ignorant of its value. Life-annuities continued to be sold on mere conjecture. Even the English Government made no distinction between different ages in the early part of the eighteenth century. A child at ten years could obtain a life annuity of £100 for £714, while it was probably worth over £1,300 at that time.
It is not within the province of this article to trace in detail the progress made in the science of life contingencies. Nearly every mathematician of note contributed to the perfection of the theory, while it was left almost exclusively to England to apply it in practice.
Passing over minor writers, Thomas Simpson, a self-taught mathematician, a mind of great originality, next deserves notice. In 1742 he enlarged upon the theory of Halley, De Moivre, and others, and, deeming the Breslau table not applicable to English conditions, he compiled and computed a mortality-table from the London mortality bills from 1728 to 1737. For a number of years he published pamphlets and delivered lectures on the subject, attracting the attention of the public at large.
Shortly thereafter James Dodson, also a very able mathematician, employed Simpson's tables, and made many valuable additions and suggestions thereto. He contributed a number of able papers to the "Philosophical Transactions," and was the first to point out, in 1755, how mortality-tables might be applied to the calculation of life-insurance premiums.
Up to this time, it will be noticed, life insurance in the modern sense was unknown. Both tontines and annuities had the very opposite object in view, sacrificing the whole capital for an increased income during lifetime. The reasons that made tontines popular have been briefly touched upon. Similar causes applied to life-annuities; besides, they provided a convenient way of evading the usury laws, and were often resorted to for that purpose. It was impossible to discriminate what part of the high rate of interest paid was for the use of money, and what percentage was due to the chance of death.
But, while life insurance as a system is of recent date, the practice of effecting temporary insurance on lives had its origin with the rise of marine insurance, probably as early as the fourteenth century. It was no more, however, than a mere bet, not based upon any experience or estimate, and led to many immoral devices. On that ground it was declared unlawful, and prohibited in the Netherlands, Spain, and Italy, together with other wager contracts, as far back as the fourteenth and fifteenth centuries. In England, however, there was no restriction, and, in the eighteenth century, betting on the lives of prominent men was carried on regularly at Lloyd's and other coffee-houses in London.
The spirit of gambling, that set in with the South-Sea bubble in 1720, continued to ebb and flow until the statute against wager contracts was enacted in 1773. It gave rise to a large number of wild insurance schemes, most of which were ridiculous, while many were intentional frauds. The failures that necessarily followed created distrust and retarded the efforts that were just beginning to be made to introduce legitimate life insurance.
But a new era had begun in the history of the English people. The cessation of internal strife, the settlement of fundamental, constitutional questions, the increase of material prosperity, the greater power and intelligence of the people, and the growth of large towns, particularly London, had completely changed the conditions of society as compared with previous centuries. Selfishness and brutality gradually yielded to more forethought and refined feeling; family ties grew warmer and more generous. Comforts were greater, life and property more secure, and everything tended to a more vivid desire in thoughtful men to provide for their families in the contingency of their own death. The feeling was most pronounced among the clergy and other professional classes, and associations began to form to accomplish that purpose. The conditions on which they were based were somewhat similar to those even now in vogue, with benevolent institutions having the same object in view. On the death of a member, his heirs would receive a certain contribution from the surviving members.
Such arrangements, when a mere subordinate feature of benevolent societies, may work well for a time, but they can not serve as substitutes for life-insurance companies. These can only be founded on scientific principles, and all other devices must be futile and short-lived, as a century's experience has amply shown. The difficulties to be encountered were clearly foreseen and explained by the mathematicians of the day, and their labors did not prove in vain. In 1761 a number of gentlemen petitioned Parliament for a charter for a life-insurance association. They met with opposition, on the ground that the undertaking was purely speculative, devoid of any merit, and sure to fail. The charter not being granted, they organized in 1765, as a mutual insurance company, under the title of "The Equitable Society."
They were the first to issue policies for life, for a fixed amount, and at premiums not merely conjectural. Still, for a number of years their progress was very slow. But the public mind was agitated on the subject, and many men of superior ability were absorbed by it. Most prominent among these was Dr. Price, an unsuccessful Unitarian preacher, who had contributed many excellent papers to the "Philosophical Transactions," and published treatises on annuity values. He was consulted by one of the many insurance societies then forming, all of which he found started on a basis sure to lead to ruin. As he expressed it, "All London seems to be entering societies of this sort," and he determined to examine the subject thoroughly. What appeared an easy task proved the arduous labor of many years. The London mortality bills could not serve as a proper basis for insurance calculations. The large and fluctuating population of a city like London, with its extremes of social conditions, could not be deemed a fair exponent of the value of healthy lives of the whole country. Dr. Price set to work to collect data from which trustworthy tables might be computed. He constructed quite a number of them, among which, one based on thirty years' mortality of Norwich, and another on ten years' observation at Chester, attracted considerable notice. He also applied such French, Dutch, and Swedish statistics as were available. But most important of all, and the one on which his fame chiefly rests, was the Northampton table, taken from thirty years' mortality observations of the town of Northampton. At the time of its publication, Dr. Price's numerous works had become widely known and his reputation was well established. In 1780 the Equitable Society, which had commenced with Dodson's London tables, concluded to adopt the Northampton table, and Dr. Price became the Society's consulting actuary. The directors generally followed his suggestions, and within a year he made 20,000 computations for them. The Society, now basing the reserves on the Northampton table, which showed a lower rate of mortality than Dodson's, found the surplus to accumulate rapidly, and large and frequent dividend additions were made to the old policies. With the reduction of the premiums the business increased steadily, and numbers of new companies were started in competition, whose fate we need not follow. Life insurance had become a practical system, established on a scientific basis.
The directors of the Equitable Society were intelligent and enterprising but very careful men. They had selected the Northampton table, from the different new tables presented, because among these it showed the highest rate of mortality. It proved to be based on a peculiar error of reasoning. An enumeration of the whole population could not be obtained, and the parish registers only gave a record of the christenings and deaths. But the town contained great numbers of Baptists, who repudiate infant baptism; and Dr. Price overlooked the fact that births and christenings were not identical, and assumed a much higher proportion of deaths to births than had actually occurred. The Northampton table came into general use, however, and the English Government, that had adopted it as a basis for annuity values, lost about £2,000,000 before its inaccuracy was discovered.
The next step of importance was the publication of a new mortality table, known as the Carlisle table, by an eminent actuary, Mr. Joshua Milne, in 1816. It was deduced from data obtained from the town of Carlisle, a very healthy and prosperous place, growing both by immigration and natural increase. During the eight years from 1779 to 1787 the population had risen from 7,077 to 8,677 inhabitants, being just 1,000, and the deaths recorded were 1,840. While the number under observation was very small, the advantage of having enumerations of the whole population was considerable. For the first time it was possible, not only to compare births and deaths, but also to determine their proportion to the living. With the exception of the very young and old ages, where the numbers had been too few to make it reliable, the excellence of the Carlisle table was so pronounced that it quickly superseded the Northampton table, and remained in use until within a very recent period. With its adoption, premiums were again lowered, and the business increased largely. It outgrew the experimental stage, and, until then confined to England, began to extend to the Continent of Europe.