Regulation – the beginning of the modern era

In recounting the history of insurance regulation, we have seen thus far that in the Elizabethan era the state intervened to decide which court had jurisdiction over insurance disputes. This was not done in the public’s interest but to further the interests of the President of the Court, Dr David Lewis.

This was followed by the South Sea Bubble where the state intervened once again, passing the South Sea Bubble Act of 1720 banning the formation of new companies. This was in an attempt to shore up the share price of the South Sea Company. However, it had the opposite effect causing the collapse of the South Sea Company.

The intervention was once again not in the public’s interest but in the interest of the existing shareholders. In those days, the two insurers, the Royal Exchange Assurance and the London Assurance, were left untouched by the Bubble Act and thus remained as the only insurance companies.

The South Sea Bubble Act was only repealed in 1825. With this repeal companies could still not be formed since no legislation existed allowing for the formation and registration of any companies. Legislation allowing the formation of companies was only passed in 1844, 124 years after the South Sea saga.

The commercial age

When we think of companies we tend to think of limited liability, that is, shareholders cannot be sued by creditors. The corporate veil protects the shareholders. Their liability is limited to their investment in the company. Limited liability did not come with the formation of companies in 1844 but was introduced later in 1855 with the passing of tentative legislation, which was soon repealed and replaced with comprehensive company legislation. With that we can say that the modern commercial age was born.

Of course, and this is the important point insofar as regulation is concerned, without companies there was nothing to regulate. Therefore, concerning insurance regulation, 1844 can be seen as the start of modern insurance market regulation.

It would be incorrect to believe that between 1720 and 1844 no “corporate” entities existed. The Bubble Act did not prevent individuals from trading or forming associations and trading. So, in the insurance field, the Bubble Act did not prevent societies such as Lloyd’s from trading and flourishing and indeed being able to set the pattern, regulation and otherwise, for that age.

The start of something big

It will be recalled that in 1688, before the South Sea fiasco, Edward Lloyd owned a coffee shop. Before the age of the office block, London coffee shops were famous and took the place of the modern office. People who wished to arrange insurance, usually for a marine adventure, knew the place to go was Lloyd’s Coffee Shop. At the coffee shop they could find someone, a wealthy person, a merchant, who for a price would be prepared to accept a portion of the risk, say five percent. So the person seeking insurance would have to do the rounds until 100 percent cover was secured, or as it was said then and now, the ‘slip was filled’.

Each person who was prepared to accept a portion of the risk would sign at the bottom of the slip, below the descriptive writing. Since their signatures appeared below the writing those who accepted the risk were called “the underwriters”, a term which exists to this day signifying the person who decides to take the risk. As time passed, the system evolved. The underwriters moved from Lloyd’s Coffee Shop but retained the name Lloyd’s.

Lloyd’s continued in the tradition of Edward Lloyd, providing facilities but never accepting the risks itself, that remained the responsibly of the various underwriters. The underwriters became professional insurance carriers and began to group into syndicates.

No longer was it necessary to find each individual underwriter. It became possible to speak to the manager of the syndicate, and increasingly risk takers became more remote, becoming Names. As the syndicates grew, so did the number of Names, and Lloyd’s evolved into a market. Lloyd’s itself (now the Society of Lloyd’s) never formally accepted any risk, but now became the regulator of the Lloyd’s market. This is how the UK self-regulation system evolved. An interesting feature of Lloyd’s is that no underwriter or Name initially put down any capital. Only if they were called upon, they paid out of their capital to cover the loss.

First company legislation

Outside of Lloyd’s, and probably based on the Lloyd’s model, similar developments were taking place, especially within the insurance market. Many of the UK’s most famous Victorian insurers were formed before 1844, that is, before it was legally possible to form companies. They were individuals trading as “companies” being established in terms of a Deeds of Settlement.

The Rock Life Assurance Company for example, was established in 1806, the Crown Life in 1825. These eventually became the Law Union and Rock which operated in South Africa. The Liverpool & London & Globe, known simply as the Globe, was formed in 1836, operating in South Africa from that year onwards.

South Africa’s first insurance “company” was formed in 1831, before the company legislation was passed. Even after the company legislation was passed these “companies” still operated. So in 1883, there was the famous court case of Castellain versus Preston involving the Globe. The litigation was not in the name of the “company” but in the name of the Chairman of the company. So when it was decided to pass the first company legislation, there was a well-developed market of “companies” probably modelled on the syndicate structure of Lloyd’s but unlike Lloyd’s, there was no market regulator.

Looking backwards, a very surprising feature of early companies becomes apparent. As in the case of Lloyd’s there was no obligation whatsoever on the part of shareholders to pay over any capital to the companies and as a rule they did not pay over any capital. Investors subscribed to shares and only paid in when called to do so, to meet the needs of the company. In some cases shareholders could pay a deposit. The South Sea Bubble seemed to cast a long shadow over corporate operations; no capital paid over. So the modern idea of Basal I, II, III or Solvency II or Solvency Asset Management (SAM) prudential management via capital is quite strange looking backwards.

The path of regulation

The graph below shows, in red, the capital of London & Lancashire from its inception in 1862. Shortly after its formation it suffered massive losses and was technically insolvent until 1872. Yet it traded itself out of insolvency. Even in the face of technical insolvency, the Board of Directors refused to issue a call to the shareholders to make their shares paid-up. In our modern times something similar happened with AIG. It suffered massive losses when it insured toxic assets and was bailed out by the US Government. But within a short period of time it paid off the assistance. Without any assistance it would have traded itself out of technically insolvency but because of regulator intervention it would not have been permitted to do so.

The question now becomes, with the establishment of companies, not having any capital at all or very little, what was the path of regulation? We continue with this story in subsequent editions.