Extending the Theory to Meet the Practice of Insurance
David M. Cutler and Richard Zeckhauser
Harvard University and NBER
We are grateful to Anda Bordean and Anna Joo for research assistance, and to
Dan Gilbert for helpful conversations.
Doth not the wise merchant in every adventure of danger give part to have the rest assured?
Nicholas Bacon, to the Opening of Parliament, 1559
Formal insurance arrangements date back at least to ancient Greece. Marine loans
in that era advanced money on a ship or cargo. It would be repaid with substantial
interest if the voyaged succeeded, but forfeited if the ship was lost, much like the
structure of contemporary catastrophe bonds. The interest rate covered both the cost of
capital and risk of loss.1 Direct insurance of sea risks, using premiums, probably started
around 1300 in Belgium. The first known life insurance policy was written in 1583. By
the end of the 17th century, sea risk insurance had evolved to a competitive process
between underwriters evaluating risks and meeting at Lloyd’s coffee house, the precursor
to Lloyds of London.
Today, insurance is a major industry established throughout the world. It moves
progressively into new fields. For example, health insurance was virtually unknown in
the United States prior to 1929 and now pays for more than 10 percent of the US GDP.
Risks ranging from a Camcorder breaking down to being sued for sexual harassment are
all insurable events.
In recent decades, economic attention has caught up with the remarkable
burgeoning of the insurance industry. This is largely attributable to the explosion in
1 Such arrangements are known as bottomry or respondentia bonds. Early insurance arrangements reflected
poor understanding of insurance theory. For exa