SPEAKER_00: Amazing, fascinating stories of inventions, ideas and innovations. Yes, this is the podcast about the things that have helped to shape our lives. Podcasts from the BBC World Service are supported by advertising.
SPEAKER_02: 50 things that made the modern economy with Tim Harford. How can I help you?
SPEAKER_01: I wanted to place a bet that I, Tim Harford, was going to die in the next year. Can you give me odds on that?
SPEAKER_02: Right. Can I take a bet on my own death?
SPEAKER_02: I'm not too sure. Just hold the line for a moment please, thank you.
SPEAKER_00: Hello Mr Harford? Hello.
SPEAKER_00: Sorry to keep you waiting there. OK, no, basically we're doing bets on death because
SPEAKER_02: it's a negative bet, you see.
SPEAKER_01: That was me, almost a decade ago, trying to take a bet on my own life with one of the UK's leading betting shops. William Hill should have taken the bet. After all, I'm still alive. But they won't gamble on life and death. A life insurance company, by contrast, does little else. Legally and culturally, there's a clear distinction between gambling and insurance. Economically, the difference is not so easy to see. Both the gambler and the insurer are agreeing that money will change hands, depending on what transpires in some unknowable future. Gambling tools such as dice date back millennia, perhaps 5,000 years in Egypt. Insurance may be equally old. The Code of Hammurabi, a law code from Babylon in what is now Iraq, is nearly 4,000 years old. It includes 282 clauses devoted to the topic of bottomry, which is a kind of maritime insurance bundled together with a business loan. A merchant would borrow money to fund a ship's voyage, but if the ship sank, the loan didn't have to be repaid. Around the same time, Chinese merchants were spreading their risks by swapping goods between ships. If any one ship went down, it would contain a mix of goods from many different merchants. But all that physical shuffling around is a fuss. It's more efficient to structure insurance as a financial contract instead. A couple of millennia later, that's what the Romans did with an active marine insurance market. Later still, Italian city states such as Genoa and Venice continued the practice, developing increasingly sophisticated ways to ensure the ships of the Mediterranean. Then in 1687, a coffee house opened on Tower Street near the London Docks. It was comfortable and spacious and business-booned. Patrons enjoyed the fire, tea, coffee and sherbet, and of course, the gossip. The inhabitants of this coffee house loved to gossip about ships, what was sailing from where, with what cargo and whether it would arrive safely or not. And where there was gossip, there was an opportunity for a wager. The patrons loved to bet. They bet, for example, on whether Admiral John Bing would be shot for his incompetence in a naval battle with the French. He was. The gentleman of this coffee house would have had no qualms about taking my bet on my own life. The proprietor saw that his customers were as thirsty for information to fuel their bets and gossip as they were for coffee. And so he began to assemble a network of informants and a newsletter full of information about foreign ports, tides, and the comings and goings of ships. His name was Edward Lloyd. His newsletter became known as Lloyd's List. Lloyd's coffee house hosted ship auctions and gatherings of sea captains who would share stories. And if someone wished to insure a ship, that could be done too. A contract would be drawn up and the insurer would sign his name underneath, hence the term underwriter. It became hard to say quite where coffee house gambling ended and formal insurance began. Eight decades after Lloyd had established his coffee house, a group of underwriters who hung out there formed the Society of Lloyd's. Today, Lloyd's of London is one of the most famous names in insurance. But not all modern insurers have their roots in gambling. Another form of insurance developed not in the ports, but in the mountains. And rather than casino capitalism, this was community capitalism. Alpine farmers organised mutual aid societies in the early 16th century, agreeing to look after each other if a cow got sick or perhaps a child. While the underwriters of Lloyd's viewed risk as something to be analysed and traded, the mutual assurance societies of the Alps viewed risk as something to be shared. Risk sharing mutual aid societies are now among the largest and best funded organisations on the planet. We call them governments. Governments initially got into the insurance business as a way of making money, typically to fight some war or other in the turmoil of Europe in the 1600s and 1700s. Instead of selling ordinary bonds, which paid in regular instalments until they expired, governments sold annuities, which paid in regular instalments until the recipient expired. Annuities were popular products because they, too, are a form of insurance. They insure an individual against the risk of living so long that all her money runs out. Providing insurance is no longer a mere money spinner for governments. It's regarded as one of their core priorities to help citizens manage some of life's biggest risks. Unemployment, illness, disability and ageing. Faced with these deep pools of risk, private insurers often merely paddle. At least citizens in richer economies expect insurance from their governments. In poorer countries, governments aren't much help against life-altering risks such as crop failure or illness. And private insurers don't take much of an interest either. The stakes are too low and the costs too high. That's a shame. The evidence is growing that insurance doesn't just provide peace of mind, but is a vital element of a healthy economy. For example, a recent study in Lesotho showed that highly productive farmers were being held back from specialising and expanding by the risk of drought, a risk against which they couldn't insure themselves. When researchers created an insurance company and started selling crop insurance, the farmers bought the product and expanded their businesses. Today, the biggest insurance market of all blurs the line between insuring and gambling, the market in financial derivatives. Derivatives are contracts that let two parties bet on something else, perhaps exchange rate fluctuations or whether a debt will be repaid or not. They can be a form of insurance. An exporter hedges against a rise in the exchange rate. A wheat farming company covers itself by betting the price of wheat will fall. For these companies, the ability to buy derivatives frees them up to specialise in a particular market. Otherwise they'd have to diversify, like the Chinese merchants four millennia ago who didn't want all their goods in one ship. And the more an economy specialises, the more it tends to produce. But unlike boring old regular insurance, for derivatives you don't need to find someone with a risk they need to protect themselves against. You just need to find someone willing to take a gamble on any uncertain event anywhere in the world. It's a simple matter to double the stakes or multiply them by 100. As the profits increase, all that's needed is the appetite to take risks. Before the international banking crisis broke in 2007, the total face value of outstanding derivatives contracts was many times larger than the world economy itself. The real economy became the sideshow. The side bets became the main event. That story didn't end well.
SPEAKER_02: An excellent history of risk and insurance is Peter Bernstein's book, Against the Gods. For a full list of our sources, please see bbcworldservice.com slash 50 things.
SPEAKER_01: If you like this podcast, don't forget you can download all the other episodes and you also might like to try The Inquiry. One pressing question from the news, four expert witnesses and some challenging answers.
