Marine Insurance in Philadelphia During the Quasi-War with France,

Transcription

1 Marine Insurance in Philadelphia During the Quasi-War with France, CHRISTOPHER KINGSTON Until the 1790s marine insurance in the United States was organized by brokers and underwritten by private individuals. Beginning in 1792, however, the private underwriters had to compete with newly formed marine insurance corporations. Each organizational form had advantages and disadvantages. This article uses archival data from a private underwriter and a corporation to study how the competition between these different organizational forms was affected by a powerful exogenous shock which substantially increased the risks to American merchant shipping in the late 1790s: the Quasi-War between the United States and France. A round 20 June 1797 the Philadelphian merchant George Latimer visited the insurance brokerage of Isaac Wharton and David Lewis to insure goods he was shipping to Hispaniola (Haiti) on the snow Boston. A policy was drawn up specifying the details of the risk and the premium rate was tentatively agreed at 15 percent, reflecting the danger of capture by French privateers then active in the Caribbean. The brokers then offered the policy to their underwriters. A few days later, William and Samuel Keith insured twelve hogsheads of claret that they were shipping on the same vessel for $480, likewise paying a premium of 15 percent. 1 However, instead of going to a broker, the Keiths obtained their insurance from the Insurance Company of North America (INA), a joint stock marine insurance corporation. At this time, France and Britain were at war. Therefore, as was usual, the insured in all cases warranted that the vessel carried the documents required to establish that the goods were American (neutral) property under U.S. law. Nevertheless, the Boston was captured on 25 July by the French privateer Fine, and carried into Jean-Rabel, where she was The Journal of Economic History, Vol. 71, No. 1 (March 2011). The Economic History Association. All rights reserved. doi: /s Christopher Kingston is Associate Professor, Department of Economics, Amherst College, 314 Converse Hall, Amherst, MA cgkingston@amherst.edu. I thank ACE Group and the ACE Group corporate archivist, Joan Lowe, for access to the INA archive; and Price Fishback, Gillian Hadfield, Daniel Klerman, Walter Nicholson, Robert Wright, two anonymous referees, and seminar participants at Union College, Wesleyan University, the Insurance and Society Group, BHC, ISNIE, the NBER Summer Institute, Georgia State University, George Mason University, and the Center in Law, Economics, and Organization at USC for helpful comments and discussions. Anoop Menon provided excellent research assistance. 1 NARA, Collector of Customs at Philadelphia, Outward foreign entries, E1059B, Box 1689, 13 June 1797; and INA Marine Blotter, ACE Group Archives. 162

2 Marine Insurance in Philadelphia 163 condemned by a prize court for intending to trade with the English. 2 This was unfortunate, but not unusual. During the late 1790s hundreds of American merchant vessels suffered similar fates. 3 Brokerages for individual underwriting had been operating in Philadelphia since the 1740s, but the first American marine insurance corporation had been formed only in Then in the late 1790s, during the pivotal period when private underwriters and newly formed corporations existed side by side, Philadelphia s marine insurance industry was buffeted by a massive exogenous shock, the Quasi-War between America and France. This article uses archival data from a private underwriter and a marine insurance corporation to study how the Quasi-War affected the institutional structure of Philadelphia s marine insurance industry. THE FORMATION OF AMERICAN MARINE INSURANCE CORPORATIONS While the basic contractual form of marine insurance policies was quite standardized by the eighteenth century, the exact details of particular policies varied considerably. Goods and vessels were usually insured in separate policies. Some policies covered simple one-way trips, but others covered more complicated voyages to multiple ports. The insured risks varied from sea risk dangers of wind and weather to broader coverage including the possibility of enemy capture. Policies sometimes allowed some flexibility as to route and cargo, including specified adjustments to the premium in various contingencies. It was also common for the parties to add idiosyncratic clauses and conditions to the policy reflecting the nature of the proposed voyage and the information available at the time of contracting. Before 1792 transactions were generally organized by brokers who gathered names for each policy. By limiting their exposure on any single risk and spreading their underwriting judiciously across a variety of voyages, the private underwriters many of them merchants themselves attempted to make a profit while minimizing the likelihood of heavy losses. Although this system enabled merchants to share risk, it had some drawbacks. In addition to the transactions costs of finding a new set of underwriters for each policy, the security of the policy depended on the financial security of the individual underwriters. 2 ACE Group Archives, INA ledger labelled, French Captures ; and Bonnel, Guerre de Course, p On 2 November 1797 the INA paid a total loss. Presumably, the private underwriters did also.

3 164 Kingston A natural way to try to overcome some of these difficulties was to form insurance partnerships or other associations. Britain s Bubble Act of 1720 had made the formation of marine insurance partnerships or corporations illegal in the American colonies, but independence freed Americans from this constraint. The first American joint stock marine insurance corporation, the Insurance Company of North America (INA) was formed in Philadelphia in 1792, and obtained a charter from the state legislature in Many more marine insurance corporations were formed in Philadelphia and other U.S. cities over the following decade, part of a set of institutional innovations that Richard Sylla has called the U.S. Financial Revolution. 4 What were the advantages of corporations compared to the existing system of private underwriting? The most frequently cited advantage associated with the corporate form is the limitation of stockholders liability to the value of their stock. Limited liability facilitates the delegation of control of capital by large numbers of investors to those with the specialist managerial skills needed to employ the capital productively. 5 In particular, a key advantage of limited liability corporations in comparison with joint liability partnerships is the protection they afford to shareholders with deep pockets in case the firm should become insolvent. This is crucial if shares are to be freely transferable. Without limited liability, both creditors and other shareholders would need to monitor each shareholder s solvency in order to protect their own position, and in particular, they would want to ensure that shares were not transferred to asset-poor individuals. 6 However, joint liability partnerships had never been observed in British or American marine insurance. Instead, the most salient organizational alternative was private individual underwriting, either through stable syndicates or more usually through ad hoc syndicates organized by brokers on a policy-by-policy basis. In either case, there was no joint liability. Each private underwriter was liable only for the amount he had underwritten or for his share of the syndicate, so the deep pockets problem did not arise. Furthermore, while some of the early American marine insurance corporations obtained charters with clear limited liability provisions, others did not, and many of the charters were more ambiguous or avoided the question. The charter granted to the INA in April 1794 was silent on the question of limited liability, but its founders were keen to 4 Sylla, Political Economy. 5 For example, see Easterbrook and Fischel, Limited Liability. 6 Woodward, Limited Liability. See, however, Acheson, Hickson, and Turner, Does Limited Liability Matter? for evidence against this argument.

4 Marine Insurance in Philadelphia 165 limit their liability if possible, and they attempted to do so by changing the wording of the policy. 7 Subsequent charters in Pennsylvania and New York were similarly silent on the question. In December 1803, the Articles of Association of the Phoenix Insurance Co. made clear the founders intention that the members of this association shall not be liable to any loss, damage, or responsibility, in their persons, or property, other than the property which they have respectively invested in the capital and funds of the company. 8 Although the charter they obtained two months later adopted most of the provisions of their Articles of Association verbatim, the section on limited liability was conspicuously omitted. 9 It was not until 1810 that Pennsylvania granted a charter with a clear statement of limited liability. 10 Massachusetts, Connecticut, Rhode Island, and Washington DC all chartered marine insurance corporations with limited liability. 11 In 7 Insurance Company of North America charter: Early American Imprints (EAI), 2nd series, no The standard form of policy used by private underwriters included the clause, And so we the Assurers are contented and do hereby promise and bind ourselves, each one for his own part, our Heirs Executors and Goods, to the Assured.... A similar clause appears in privately underwritten policies from Britain and America throughout the eighteenth century (see, e.g., HSP collection 1552, box 6/8). At first, the INA also used this form, but in May 1794, shortly after incorporation, it changed the wording to And so we the Assurers are contented, and do hereby bind the Capital Stock, and other common Property of the President and Directors of the Insurance Company of North America to the Assured. This might be read as an attempt to highlight the security of the policy; but more likely, its intent was to explicitly restrict any claims to the common property of the corporation as opposed to the private property of the shareholders (Montgomery, History, pp. 17, 49 50). 8 Articles of Association: EAI, 2nd series, no. 4867; charter (6 Feb 1804): EAI, 2nd series, no Again, it is hard to be sure whether this was because limited liability was rejected or taken as a given. In any case, the Phoenix adopted a policy wording similar to that of the INA, as did the Union, which was also chartered in See Phoenix policies in HSP MS 1552 box 8b; Constitution of the Union Insurance Company, July 1803 (EAI, 2nd series, no. 5192); and an 1804 policy reproduced in Fowler, History, p. 70. See also the Philadelphia Insurance Company Articles of Association (1803), which specified limited liability (EAI, 2nd series, no. 4863); and its 1804 charter, which was silent on the issue (EAI, 2nd series, no ). Like the Philadelphia corporations, both the New York Insurance Company and the United Insurance Company (also chartered in 1798 in New York) placed clauses in their policies stating that only the joint stock property of the company would be liable to pay losses. The New York Insurance Company s Articles of Association (1796) included a clear limited liability provision; but its Act of Incorporation (1798) omitted these sections and instead stipulated that if the corporation were dissolved, its members would be responsible for its debts in their individual and private capacity to the extent of their respective shares, and no further (Articles of Association: EAI, 1st series, no ; charter: EAI, 1st series, no ). See also Goebel, Law Practice, pp The charter of the United States Insurance Company specified that losses would be paid out of the joint funds of the company exclusively. Charter: EAI, 2nd series, no See charters of the New Haven (1797), Hartford (1803), Middletown (1803), Norwich (1803), and Union (1805) in Connecticut, Statute Laws; for the Connecticut corporations, however, note that only a fraction (from 10 to 40 percent) of the nominal value of the capital stock was actually to be paid in; the rest was secured by promissory notes from the shareholders, making them in effect liable for further payments on demand up to the nominal value of their

5 166 Kingston contrast, Maryland explicitly rejected limited liability. The charter of the Maryland Insurance Company, passed on 24 Dec 1795, stipulated: That if at any time the funds of the corporation should not be competent to pay and satisfy the just demands of the assured, that nothing herein contained shall be construed to discharge the stockholders from being liable for their respective proportions of said losses, according to the number of shares they may hold therein, but no stockholder shall be liable for more than his own proportion of losses as aforesaid, or to answer for the failure or deficiency of others. 12 Since the security of the policy therefore depended upon the solvency of the members, the charter also stipulated that any transfers of shares had to be approved by the directors. An unincorporated association formed in Baltimore in 1799 and two further corporations chartered in January 1805 adopted similar rules. 13 The Maryland corporations were therefore essentially similar to large stable syndicates of private underwriters. The difference was mainly in their size, the ease with which shares could be transferred, and the raising of a capital fund as an initial bulwark against losses. In summary, while it appears that the corporations founders were in general keen to limit their liability if possible, it seems unlikely that limited liability was their primary objective. In all cases, either by the charters, or by clauses inserted in the policies, wealthy shareholders were insulated from joint liability in the event that other shareholders proved insolvent. But this cannot be viewed as the key motive for incorporation, since there had been no joint liability under the existing system of private underwriting either. This accords with Edwin Perkins view that from a de jure standpoint, the historical evidence regarding whether stockholders in the late eighteenth and early nineteenth century had limited or unlimited personal liability for a firm s potential losses is inconclusive. However, they probably enjoyed de facto limited liability, shares. For Rhode Island: see charters of the Newport (1799), Providence (1799), Warren (1800), Washington (1800), and Hope (1804), EAI, 1st series, nos , 36182, 38980, 38344; 2nd series, no While the 22 marine insurance corporations chartered in Massachusetts between 1797 and 1805 appeared to limit shareholders liability (the phrasing varied and was in some cases somewhat ambiguous), they also made the president and directors jointly and severally liable for all losses incurred on policies underwritten after they knew of losses in excess of the capital stock. See charters ( ) in Massachusetts, Private and Special Statutes, vols. 2 and 3. See also Dodd, American Business, p In Washington DC, the U.S. Senate granted the Columbia General Insurance Company a limited liability charter in February 1803 (EAI, 2nd series, no. 5201). 12 Laws of Maryland, Session Laws, 1795 (Maryland State Archives online, vol. 647, p. 54). 13 Whereas it is contemplated to establish an office or society for insurance, in the city of Baltimore, under the name and stile of the Marine Insurance Office, EAI, 1st series, no ; Charters of the Marine Insurance Co. and the Union Insurance Co., Laws of Maryland, Session Laws, 1804 (Maryland State Archives online, vol. 562, pp , 49 51).

6 Marine Insurance in Philadelphia 167 which later became formalized as the American common law developed in the early nineteenth century. Given this ambiguity, he argues that in the early republic we may safely conclude that the prospect of limited liability does not appear to have been among the inducements attracting investors to place their funds in the shares of commercial banks and other corporate ventures. 14 If not limited liability, what were the advantages of the corporate form? In support of their petition for a charter, the INA s founders argued that whereas individual underwriters frequently failed, a corporation would improve the security of the policy by holding a capital fund large enough to cover all but a catastrophic run of bad luck. 15 The security of the policy was of paramount concern for merchants, so this gave the corporations an important advantage on the demand side. In addition, if a loss occurred, the insured would find it easier to recover from a corporation than from many private underwriters individually. Equally important, however, the corporations had an advantage in the supply of insurance services because of their sheer scale. As Eugene Fama and Michael Jensen note, stock companies enable risk to be spread across many residual claimants who individually choose the extent to which they bear risk and who can diversify their holdings. 16 Thus, the INA s founders argued that a corporation could draw on a larger stock of capital than could be accessed through the existing system of private underwriters, whereas under the existing system, for want of a sufficient number of underwriters of responsibility large sums of money were drained from the country as many American merchants continued to obtain insurance abroad, principally in London. From this perspective, the key advantage of the corporate form was to facilitate the organization of enormous yet flexible underwriting syndicates, which vastly reduced the transactions costs of spreading risk among a large number of people and obviated the need to find a new group of underwriters for each policy. In particular, the corporate form expanded the pool of available capital for underwriting by enabling wealthy individuals who were not merchants or were not physically located in Philadelphia to act as underwriters by 14 Perkins, American Public Finance, pp. 117, 373. Similarly, Edwin Dodd was unaware of any substantial evidence on the question whether, at the turn of the century, informed opinion in Massachusetts did or did not regard incorporation as implying limitation of liability, and argued that limited liability only became clear through court cases in 1808/09 (Dodd, American Business, pp. 370, 372). See also Handlin and Handlin, Origins; and Forbes, Limited Liability. 15 INA petition to the Pennsylvania legislature, 18 December 1792, reprinted in Montgomery, History, pp Fama and Jensen, Agency Problems.

7 168 Kingston entrusting their underwriting decisions to experts. 17 At the same time it gave these investors the flexibility to withdraw their capital by selling their shares. 18 Opponents of the petition argued that these advantages could equally be provided by an unincorporated company, and the founders of the INA indicated that they were willing to proceed without a corporate charter if necessary. 19 Nevertheless, they vigorously sought a charter in the face of considerable opposition. Competition among states probably eased their path. When their initial petition for a charter ran into opposition, they briefly threatened to seek a charter in Delaware. 20 Given their important advantages in financial security and riskspreading, it may appear that corporations were simply a superior organizational form to the preexisting institutions of private underwriting. But the story is not so simple. In Britain, Lloyd s of London had developed into a sophisticated marine insurance marketplace based on private underwriting, and successive waves of entry by corporations in the nineteenth century failed to dislodge Lloyd s from its dominant position or to drive Britain s private underwriters out of business. 21 So, what disadvantages, if any, did the corporations have relative to private underwriting? The key disadvantage of the corporate form identified by Fama and Jensen is that agency problems, arising from the separation between control by decision makers within the firm and the owners who bear the residual risk, create a need for costly internal governance structures. Even with such mechanisms in place, the agency problems are unlikely to be completely overcome. 22 Timothy Guinnane, Ron Harris, Naomi Lamoreaux, and Jean-Laurent Rosenthal argue that such agency problems make the corporate form inferior to other organizational forms for many kinds of business activity. 23 For example, Eric Hilt 17 Along similar lines, Harris, Formation, argues that the corporate form enabled informed insiders to commit not to abuse the rights of less-informed outsiders and thereby attract investment in the East India Company during the seventeenth century. Hilt, Incentives in Corporations, p. 204, argues that corporations formal governance structure helped to induce small investors with no knowledge of whaling to invest in whaling voyages in the 1830s. 18 This would explain why corporations rather than partnerships were introduced. 19 See Thoughts on Insurance Corporations, &c. by An Enemy to Unnecessary Corporations, United States and Evening Advertiser, 1 Jan 1794, reproduced in Fowler, History, pp Montgomery, History, pp Kingston, Marine Insurance in Britain and America. 22 Fama and Jensen, Separation of Ownership and Control and Agency Problems. 23 Guinnane et al., Putting the Corporation in Its Place.

8 Marine Insurance in Philadelphia 169 has shown that because of internal agency problems, corporations performed significantly worse than unincorporated partnerships at managing complex whaling voyages in the 1830s. 24 The private underwriters, in contrast, faced no such internal agency problems because they underwrote on their own account. The riskbearers and decision makers were the same people. This also gave them another important advantage, the leeway to be flexible. Because of the inherent uncertainties of eighteenth century trade, it was common, and often unavoidable, for vessels to deviate from their planned voyages and thereby technically void the policy. As a result, marine insurance contracts were necessarily incomplete and it was important for merchants to be able to trust the underwriter to act in good faith. In 1806 a broker informed a correspondent that: The insurance on the Orestes, as you desired, was wholly effected by incorporated Companies, and you need never consider an apology necessary for giving them the preference when you wish it done...(but) I can assure you, in regard to solvency, there are not perhaps two [private underwriters] who write that I would hesitate in laying an India risk of my own before: And many persons in this City are giving a preference to Individual Underwriters, from experience that they may meet with a greater spirit of accommodation from them, in case of Loss, than they can always expect from the Directors of an Office, who must consult the Interest of the Stockholders, and may not conceive it consistent with their Duty to be liberal. 25 The private underwriters may also have had an advantage in overcoming agency problems between the underwriter and the insured. While the system of private underwriting was based on direct, hard-nosed market transactions, it also relied on repeated interaction, reputation, and trust among merchants who were deeply knowledgeable about their business, and who dealt with each other in long-lived, multifaceted business, social and religious relationships. Thus, underwriting on each other s voyages became part of the complex web of trusting personal interactions that characterized the eighteenth century business world Hilt, Incentives in Corporations. 25 Robert Hobart to Benjamin Mumford, 23 January 1806, Campbell-Mumford papers, NYHS. 26 Although the system of private underwriting as practiced by brokers, such as Wharton & Lewis, was quite different from mutual insurance (a consumer cooperative), there are some intriguing parallels. The mutual form, when feasible, has the advantage of not requiring a large initial outlay of capital. Zanjani, Regulation, found that in the early-twentieth-century United States, entrepreneurs in the life insurance industry tended to opt for the mutual form when statelevel regulations regarding initial capital requirements were sufficiently permissive to make it feasible to do so. As discussed by Hansmann, Organization of Insurance Companies, mutuals frequently also do better in overcoming moral hazard and adverse selection problems between the firm and the insured.

9 170 Kingston Finally, as Oliver Westall notes, the optimal choice of organizational structure in insurance depends in part on the ability to transmit and process information about risks. 27 In the course of their business as merchants involved in trade, the private underwriters constantly gathered information about the goods, vessels, captains, and routes on which they underwrote and the people with whom they dealt. Embedded within their business and social networks, they were well placed to obtain and process the information necessary to evaluate risks and to overcome moral hazard and adverse selection problems. 28 THE QUASI-WAR WITH FRANCE In the eighteenth century, it was common during wartime for belligerent nations to commission private vessels to prey on enemy commerce. Privateering provided a free, straightforward, and incentivecompatible way for the state to increase its naval strength and harass the enemy. It should not be confused with piracy. At least in theory, privateers were subject to strict rules governing the treatment of both enemy and neutral vessels. If the captured vessels or goods were legally condemned in prize courts, they became property of the captor. If, on the other hand, the privateers were unable to show that the vessel or goods were legitimate captures ( good prize ), they were released, sometimes with payment of compensation. In practice, however, nations differed over the conditions governing the neutrality of vessels and cargoes, and inevitably, because a lot of money was at stake, the system was sometimes abused. The corporations founded in the United States in the 1790s came into being at a turbulent time. Britain and France were at war. Although the United States remained officially neutral (until 1812), it almost went to war on several occasions. In 1794 the British captured hundreds of American vessels trading with French colonies in the West Indies, and war for a time seemed imminent, but it was averted by the signing of Jay s Treaty in November of that year. The treaty put an end to British captures, but to obtain peace the Americans made several concessions that were unfavorable to France. France retaliated by issuing a series of increasingly restrictive decrees governing the neutrality of American vessels. During the next few years, hundreds of 27 Westall, Invisible, Visible, and Direct Hands. 28 Because of the small scale of the market, and because many of those involved in corporations were merchants, the Philadelphian corporations disadvantage was likely much less severe than the lemons problem that Kingston, Marine Insurance in Britain and America, argues inhibited the growth of British marine insurance corporations.

10 Marine Insurance in Philadelphia 171 American merchantmen were captured by French privateers for alleged violations of these decrees. 29 By 1798 the situation in the West Indies was described by a Frenchman as, A system of piracy almost general, sustained by a commercial tribunal which condemns without reserve and without exception neutral and allied ships on the most frivolous pretexts. 30 The United States government responded to these attacks by building a navy that began to patrol sea routes and capture French privateers. However, the United States did not declare war on France. Its navy was authorized to attack vessels that posed a threat to American shipping, but not to attack unarmed French merchant vessels or to attack the French on land. Because war constantly threatened to erupt during this period, but was never officially declared or fully engaged, the conflict placed the Adams administration and the American people in a state of almost perpetual crisis. 31 It is therefore referred to as a Quasi-War. Following Napoleon Bonaparte s coup d état in 1799, it became clear that the new French government wanted peace, and the Quasi-War was brought to an end by a peace agreement (the Mortefontaine Convention) signed in September EFFECTS OF THE QUASI-WAR War created both problems and opportunities for merchants and underwriters. For merchants, the interruption of regular channels of commerce could make wartime trade highly profitable. Yet, rapidly changing political and military circumstances and the slow speed of communication meant that unskillful or unlucky merchants could easily find themselves facing ruin. For underwriters, high premium rates meant that wartime underwriting could be highly profitable if carried out judiciously, but it could prove disastrous if an unexpected political or military development caused a string of losses. The Quasi-War caused substantial fluctuations in insurance rates as rumors of war and reports of privateering activity waxed and waned. The secretary of one of the corporations remarked in 1797, Circumstances varying as they do, We are obliged to vary premiums very often. 32 There was some trepidation about French intentions as early as October of 1795, when the INA board sent a deputation to the Secretary of State 29 On the Quasi-War generally, see DeConde, Quasi-War; Allen, Our Naval War; Clauder, American Commerce ; and Phillips and Reede, Neutrality. 30 Quoted by Palmer, Quasi-War, p DeConde, Quasi-War, p HSP MS 2001 (Insurance Company of the State of Pennsylvania letterbook), 11 Mar 1797.

11 172 Kingston to inform him that a Report prevails that the French cruisers have orders to Capture all vessels bound to British ports and request him to apply to the French minister to know whether this is so or not. 33 French captures began early in By late 1796 American newspapers carried lists of captured vessels and the usual rate of premium on a one-way voyage to the West Indies was 5 to 6 percent, already well above the usual peacetime rate of 2½ to 3 percent. By early 1797 it had risen to 10 to 15 percent, and 25 percent and more was paid in 1798, when New York merchant David Gelston lamented: It is said England has issued orders to take all Neutral Vessels bound to any French, Dutch, or Spanish ports either in Europe or America the French declare against all English ports the United States against all French ports where is a Vessel to be sent? 34 By 1799 the successful actions of the U.S. Navy had begun to bring premiums down, and they declined further in 1800/01 as the number of French privateers diminished and the two countries moved toward peace. This article uses two manuscript sources to study the Quasi-War s effects on premium rates and the institutional structure of the marine insurance industry. The first is a record of 1,068 policies insured by a private underwriter through Wharton & Lewis s brokerage, easily the most established insurance brokerage in Philadelphia at the time, between April 1795 and March The amounts recorded do not reflect the total sums insured on these vessels, and some voyages that were insured through Wharton & Lewis s office do not appear in this record, so the record appears to reflect the underwriting of a single substantial underwriter or possibly some kind of syndicate. 36 Therefore, the Wharton & Lewis register of policies is an incomplete, but substantial record of the most important locus of private underwriting activity in Philadelphia during this period. In what follows, it is also assumed to be a representative record, both in terms of the premiums charged and the overall number of policies underwritten Montgomery, History, p David Gelston to S. Tinker, 29 June Gelston letterbook, NYHS. 35 Account of Policies Underwrote at Wharton & Lewis s Ins ce Office, HSP MS AMB In December 1795, for example, the prominent Philadelphia merchant Stephen Girard insured $10,000 through Wharton & Lewis on the ship Voltaire from Philadelphia to Hamburg and back (Gillingham, Marine Insurance, p. 100). However, the entry in the Wharton and Lewis record records a sum insured of only $ In the vast majority of cases, all the private underwriters who subscribed a policy were paid the same premium, so the Quasi-War s effect on the premiums charged by this underwriter should be reflective of its effect on other underwriters also. The assumption that the volume

12 Marine Insurance in Philadelphia 173 FIGURE 1 NUMBER OF POLICIES UNDERWRITTEN EACH MONTH BY THE PRIVATE UNDERWRITER THROUGH WHARTON AND LEWIS (RIGHT SCALE) AND BY THE INSURANCE COMPANY OF NORTH AMERICA (LEFT SCALE), APRIL 1795 MARCH 1801 Sources: HSP MS AMB 95591; INA Marine Blotters; and (for 1798/9) Journals, ACE INA Archives. These data are compared with records of policies insured during the same period by the Insurance Company of North America (INA), one of the two corporations active in the market. 38 Note that one INA blotter, covering the period from April 1798 March 1799, is missing, so there is a gap in the INA data covering this period. Figure 1 shows how the volume of business done by the private underwriter and the corporation was affected by the Quasi-War. Of course, there were perhaps 50 private underwriters and two corporations active in the market, so it is not possible to gauge market share precisely. However, the Quasi-War clearly coincided with a striking shift of the marine insurance business out of the hands of private underwriters and of business transacted by this underwriter reflects changes in the overall quantity of private underwriting is more problematic, but seems necessary given the lack of records of other private underwriters. 38 INA Marine Blotters, ACE Group Archive, Philadelphia. The other insurance company active in Philadelphia was the Insurance Company of the State of Pennsylvania, which was also chartered in 1794.

13 174 Kingston into those of the corporations beginning in 1796, at around the time that French captures began, and lasting until the threat receded around The private underwriter insured a total of 286 voyages in 1796, which collapsed to only 69 in 1798 before recovering somewhat to 186 in 1800 as the danger diminished. The number of vessels entering Philadelphia from foreign ports, which may be taken as a rough barometer of the size of the market, also fell somewhat during the war, from 817 in 1796 to 487 in 1798, and 565 in The number of policies insured by the INA, however, actually increased from 1148 in 1796 to 1547 in 1798, and was 1459 in EXPLAINING THE QUASI-WAR S EFFECTS It seems clear that the corporations were far more successful than private underwriters in taking advantage of the tremendous opportunities presented by the Quasi-War. Why? First, the security of a privately underwritten policy was always a concern for merchants. Even in peacetime, those seeking insurance spared no effort to find good men to cover their risks, and those who insured on behalf of correspondents in other ports constantly reassured them that the names on their policies were safe. However, in wartime it became even more difficult than usual to form reliable judgments about the solvency of other merchants, because of the increased danger of losses from both trade and underwriting. The Quasi-War, like earlier wars, coincided with numerous failures. In April 1797 it was reported that: The underwriters that are substantial will not take a risk to the West Indies and back under 33½ to 40 percent against all risks. I say substantial because many of our underwriters circumstances are such [that they are experiencing financial difficulties]. 41 In May 1799 the Oliver brothers, merchants in Baltimore, warned that [t]he Times are so critical that there is but little security in any foreign expedition and we don t feel anxious to engage in them. Others were less cautious however, leading to numerous bankruptcies in Baltimore in 39 The goods on a single vessel, and the vessel itself, might be covered by several policies; and Philadelphia s underwriters insured both inbound and outbound voyages both to Philadelphia and other American ports, and occasionally, cross risks between two foreign ports. Also, see Dun, What Avenues. 40 The private underwriter s total premium income fell slightly from $14,642 in 1796 to $13,251 in 1797 (the higher premiums almost compensating for the falling volume of business), before collapsing to $7,007 in In contrast, the INA s total premium income rose from $467,122 in 1796 to $1,225,790 in 1797 and $1,304,219 in David Spears, quoted by Ruwell, Eighteenth-Century Capitalism, p. 89.

14 Marine Insurance in Philadelphia , and the Olivers believed that Philad[elphia] will soon be in the same situation. 42 Thus, one merchant advised a correspondent that although the private underwriters might be slightly cheaper, he should insure with a corporation because It being of a long duration before the Voyage is completed, Deaths and other accidents may (and does too often) happen to Individuals. 43 In contrast, as their founders had anticipated, the corporations were widely perceived as financially secure. The INA s capital, unlike that of a private underwriter, was dedicated solely to the payment of insurance losses, and was large enough to cover all but a catastrophic run of bad luck. 44 Moreover, its charter stipulated that its funds were to be invested in relatively safe investments such as government debt and the stocks of public corporations, such as banks, canal and turnpike companies, as well as a small amount of real estate sufficient to house the company s offices. It was specifically forbidden to trade in goods or to engage in banking. Accordingly, as the financial security of private underwriters became more suspect, merchants seeking reliable insurance naturally gravitated to the corporations. In September 1799, for example, Daniel Coxe insured $8,000 worth of goods with the INA, noting in the policy that a portion of the goods insured, having been underwrote in New York by Bankrupts, is to be considered as not having been underwrote there. 45 The upshot is that, while the war naturally drove up the actuarially fair rates of premium on all voyages, it also caused an additional relative increase in demand for insurance by corporations and a decrease in the demand for private underwriting services because of the corporations greater perceived financial security. Given the relative decline in the demand for private underwriting, the private underwriters would have needed to lower their premiums relative to those of the corporations to maintain their market share. However, they could not afford to compete too aggressively on price, as several factors conspired to encourage a fall in the supply of private underwriting services during the war. First, war changed the nature of the risks insured against in a way that undermined the value of merchants human capital for assessing risks. In 42 Bruchey, Robert Oliver, pp. 193, David and Philip Grim to Watson and Paul, 4 February 1799, quoted by Wright, First Wall Street, p The INA s capital stock was $600,000. Total marine premiums paid (the other branches of the business were negligible) were $303,129 in 1795, $467,122 in 1796, $1,225,790 in 1797, $1,304,219 in 1798, $830,976 in 1799, and $912,511 in Given that most of the risks were run off within a few weeks or months, the company certainly had a comfortable reserve against outstanding risks throughout this period. 45 Policy No. 8243, INA Marine Blotters, 20 September 1799 (the risk was from New Orleans to Philadelphia).

15 176 Kingston peacetime, the private underwriters familiarity with captains, cargoes, vessels and routes made them good judges of the risks they insured. But war reduced the relative value of this idiosyncratic knowledge about individual risks, overwhelming it with systemic risks that affected all vessels relatively more equally, such as the risk of an unexpected increase in privateering activity. Furthermore, although wartime premiums presented private underwriters with opportunities for high expected returns if they underwrote judiciously, it also became harder for them to diversify their risks. An unexpected political or military development, such as a change of policy regarding neutral rights leading to the capture of a large number of merchantmen, might impact a merchant-underwriter s trade income and at the same time cause multiple underwriting claims against him. Thus, as a mechanism used to spread risk among the community of merchants, the system of private underwriting was better suited to insuring against idiosyncratic peacetime hazards that would affect some merchants but not others, such as accidents at sea, than to dealing with systematic wartime dangers which could strike many merchants simultaneously. In the first case, the lucky could compensate the unlucky; but if all were unlucky together, the risk-sharing function of insurance would fail. A final reason for merchants to be cautious in their wartime underwriting was that in an age when virtually all trade was conducted on credit, it was crucial to safeguard a reputation for financial prudence. A merchant who was seen to be underwriting at excessively low premium rates would not only earn reduced underwriting profits, but might also risk damaging his perceived creditworthiness within the merchant community, which could be calamitous. Thus, to preserve both their capital and their good name, the private underwriters had ample cause for caution. For most of them, after all, underwriting was a sideline to their main business as merchants, and if it became too risky, they could shift their attention to other activities. Of course, the corporations also faced increased risks during wartime, but because their stockholders could diversify their assets in other ways, corporations could spread risk more widely and could therefore afford to be less risk-averse than individual underwriters. The implication, then, is that the war temporarily gave corporations an advantage on the supply side. Both kinds of underwriters would naturally increase premiums during wartime to compensate for the heightened risks, but private underwriters caution would be reflected in an additional leftward shift of the supply curve for private underwriting services during wartime.

16 Marine Insurance in Philadelphia 177 To evaluate these arguments, it is instructive to compare the premiums charged during the Quasi-War by the INA and the private underwriter on one-way and round-trip voyages between the United States and 13 major categories of destination: Asia, 46 Cuba, 47 Hispaniola, 48 Jamaica, 49 France, 50 Northern Europe, 51 Southern Europe, 52 the Mediterranean, 53 the United Kingdom and Ireland, 54 the Spanish Main, 55 Martinique and Guadeloupe, other ports in the Lesser Antilles, 56 and New Orleans. 57 The premiums are estimated as p irt rt t WL irt irt r 1 t 1 where p irt is the rate of premium on policy i, travelling on route r in time period t, the rt are fixed effects for voyages on each of the 26 routes r (one-way and return voyages are treated separately) during each of the ten six-month time periods between 1 April March 1798 and 1 April March 1801 (making 260 voyage-year combinations in all, 21 of which were omitted due to a lack of data). 58 WL irt is a dummy variable which identifies whether policy i was underwritten by the private underwriter; and irt is an error term. The coefficient of interest is t, the estimated additional premium charged by (or paid to) a private underwriter in period t. 10 t 1 46 Canton, Calcutta, Batavia, Madras, etc. 47 Mostly Havana and Santiago. 48 Port au Prince, Jeremie, Gonaives, Cape St. Nichola Mole, Cape Francois, Aux Cayes, etc. 49 Kingston, Savanna le Mar, Montego Bay, etc. 50 Excluding the Mediterranean: Bordeaux, Le Havre, Nantes, etc. 51 Amsterdam, Rotterdam, Hamburg, Bremen, etc. 52 Gibraltar, Cadiz, Lisbon, Madeira, St. Sebastian, Oporto, etc. 53 Barcelona, Marseilles, Leghorn, Malaga, Genoa, Naples, etc. 54 London, Liverpool, Bristol, Dublin, Cork, Londonderry, Glasgow, etc. 55 Curacao, La Guaira, Surinam, Cayenne, Demerara, etc. 56 St. Croix, St. Kitts, St. Thomas, St. Bartholemews, Barbados, Antigua, etc., including Puerto Rico. 57 The private underwriter (WL) insured 1,068 policies between 1 April 1795 and 31 March 1801 and the INA insured 8,359. Peace risks were excluded, as were voyages outside the categories described above (such as a handful of voyages to the River Plate and Peru), risks between two U.S. ports, and voyages not originating or terminating in the United States, such as from the West Indies to Europe or between two European or West Indian ports. One INA ledger, containing 1,569 policies in 1798/99, is missing. Although it is possible to reconstruct a handful of data points for this period from other sources, there is insufficient data to enable a meaningful comparison of premiums in this period, so any policies between April 1798 and March 1799 were excluded. 58 For example, no return voyages to France were insured between October 1799 and March 1801; no return voyages to the Mediterranean between October 1795 and March 1796; and so on.

17 178 Kingston TABLE 1 ESTIMATED PREMIUM DIFFERENCES BETWEEN PRIVATE AND CORPORATE UNDERWRITERS Number of Policies Period t t-stat INA WL April 1795 September ( 4.66) Oct 1795 March ( 1.46) April 1796 September ( 0.82) Oct 1796 March (0.53) April 1797 September (1.10) Oct 1797 March (4.13) April 1799 September ( 1.49) Oct 1799 March (1.26) April 1800 September (0.61) Oct 1800 March ( 1.43) N 6,077 5, Adjusted R Notes: White heteroskedastic-consistent t-statistics in parentheses. Not reported: coefficients for 239 voyage-time period dummy variables. The Number of Policies columns count only those policies included in the regression. Table 1 reports the results of this regression. The key finding is that controlling for route, in the summer of 1795 the private underwriter was charging, on average, 1.28 percent less than the corporation, but by the winter of 1797/98, at the height of the Quasi-War, he was charging 2.83 percent more. The differences are both statistically significant and large enough to substantially affect merchants incentives, so it is not surprising that the table also shows that the relative volume of business shifted dramatically in favor of the corporation. Table 2 illustrates this pattern by comparing the average premiums charged by the private underwriter and the corporation and the volume of business they underwrote on major routes. The increase in the relative premiums charged by private underwriters and the fall in the volume of business are consistent with the interpretation that the Quasi-War caused a fall in the supply of private underwriting services. As a result, the private underwriters share of the market collapsed and their premiums increased even further than the corporations premiums did during the war. The fall in the

18 Marine Insurance in Philadelphia 179 TABLE 2 AVERAGE PREMIUM RATES AND VOLUME OF BUSINESS ON MAJOR ROUTES 4/1795 3/96 4/1796 3/97 4/1797 3/98 4/1799 3/00 4/1800 3/01 INA WL INA WL INA WL INA WL INA WL Hispaniola (one-way) 7.05 (72) 4.82 (30) 7.99 (210) 9.71 (31) (326) (15) 9.99 (106) 8.62 (8) 9.83 (205) (21) Hispaniola (roundtrip) 9.29 (47) 7.6 (34) (151) (18) (168) (4) (38) (3) (67) (3) Cuba (one-way) 4.10 (25) 3.70 (5) 5.09 (41) 4.44 (8) (79) (9) (125) (12) (184) (24) Asia (one-way) 7.5 (2) 7.62 (8) 9.67 (14) 7.83 (9) (48) (9) 13.3 (25) 12.5 (1) (10) (7) N. Europe (one-way) 4.99 (53) 4.53 (44) 5.19 (86) 4.43 (36) 8.64 (145) 9.75 (16) (57) (10) 9.46 (67) 9.06 (24) UK (one-way) 4.81 (16) 4.04 (14) 5.08 (56) 5.00 (11) 10.2 (71) (2) (67) (6) 8.82 (41) 7.48 (21) Notes: The first number in each cell is the average rate of premium (in percent) on voyages (in either direction) between the corresponding category of destinations and ports in the United States (mostly Philadelphia) during the specified period. The number in parentheses is the corresponding number of policies. volume of private underwriting was likely exacerbated by an additional fall in demand for private underwriting as merchants sought the perceived security of policies issued by the corporations. The resulting increase in relative demand for corporate underwriting explains the tremendous growth in the INA s volume of business during the Quasi-War. A caveat is in order here: this comparison of premium rates relies on an implicit assumption that the types of voyages insured by the corporation and the private underwriter do not differ systematically in terms of the hidden characteristics of the captain, vessel, and crew that is, that there is no unobserved selection bias. This assumption is potentially problematic. One might hypothesize, for example, that merchants may have tried to insure the best risks privately among themselves, leaving the worst risks to the corporations. Conversely, it could be that merchants tended to insure with private underwriters only if they were turned down by the corporations, so that private underwriters got a disproportionate share of the worst risks.

19 180 Kingston We are also assuming that there are no systematic differences in the contractual details of the risks. The INA record reveals a rich variety of policy conditions. A typical entry, for example, reads in part: at & from Norfolk to Cape Nichola Mole & at & from thence to Port au Prince, with a convoy, if not, to proceed from the Mole to Jeremie, or a French port in the Bite of Leogane or any other port in the Island of Hispaniola & at & from thence back to Norfolk on the Schooner Nelly, James Brown master, Goods, Drs 15pCt whereof if no Loss happens three percent is to be returned if she does not go into the Bite of Leogane or to more than one Port besides Cape Nichola Mole. 59 Many of the INA policies contained idiosyncratic conditions of this sort. For example, many policies gave the vessel liberty to touch and trade at particular ports, with returns of premium if those ports were not visited. Others granted returns of premium if the vessel sailed in convoy or before or after a certain date. Most policies included a warranty that the goods insured were American property, but some did not. Some of these were declared to be carrying false papers in an effort to pass as neutral. Premiums were considerably higher on vessels declared to be carrying contraband, a profitable but hazardous business. If it was uncertain on which vessel goods would be shipped, they might be covered (for a slightly higher premium) on any good American vessel. Voyages to Hamburg or Amsterdam usually specified a return of premium if the vessel went north about to avoid the English Channel. An important source of variation arose from the fact that insurance might be purchased at any time from before a vessel sailed to when it was expected to arrive. Some vessels were even insured when they were already considered overdue, and naturally these paid a higher premium, which might also be affected by rumors about storms, enemy activity, and so on. Unfortunately, the Wharton & Lewis record does not specify all the policy conditions, and therefore the possibility of either adverse selection in the choice of insurer or of systematic unobserved differences in the policy conditions adopted by the private and corporate underwriters cannot be entirely ruled out. Note, however, that the qualitative argument remains valid unless any such selection biases changed significantly during the course of the war. Three other developments are worthy of mention. First, the success of the two pioneering corporations in Philadelphia led within a few years to similar incorporations in other American states. Increased competition from other corporations, particularly in New York and Maryland, may 59 Policy no. 3818, 9 December 1796, INA Blotters, ACE Group Archive.

20 Marine Insurance in Philadelphia 181 help to account for the leveling off in the INA s volume of business seen in Figure 1 despite a growth in the volume of trade after the end of the Quasi-War. 60 Second, as a result of both the increased capacity of the American marine insurance industry and the intermittent political problems and uncertainties between the United States and Britain, the volume of American business insured in London fell sharply. One American merchant in London argued that the increased security afforded by corporations in America had led to a sharp decrease in the amount of insurance done in London by American merchants, so by 1810, nineteen twentieths of his consignments from America were insured in America. 61 In particular, American underwriters generally had better and more recent information about the important West Indian routes, and this advantage became particularly important in wartime, when premiums could fluctuate rapidly. 62 Finally, yellow fever outbreaks clearly disrupted the private underwriting networks, as seen in Figure 1. In September October 1797, the WL record contains only a single entry: the ship Sickness, captain Disease, on a voyage from Earth to Heaven with a cargo of 1,500 souls, a reference to the outbreak of Yellow Fever during which many Philadelphia residents left the city. During the yellow fever outbreaks in 1797 and 1798, both the INA offices and Wharton & Lewis s office were temporarily moved. 63 However, while the secretary of the corporation continued to issue policies during these outbreaks, the private brokers would have found it difficult to fill policies if most of their underwriters had fled to the countryside. CONCLUSION Both organizational forms corporate and private underwriting had advantages and disadvantages. Private underwriting was a longestablished and flexible market-based mechanism for sharing risk among a community of merchants. The corporate form increased the security of the policy and expanded the pool of available capital beyond the merchant community, but it may have suffered disadvantages in dealing with asymmetric information and agency problems. Indeed, many of the 60 Further market entry in Philadelphia came a little later with the chartering of four new corporations in February and March 1804 (Fowler, History, p. 69). 61 Select Committee on Marine Insurance, Report, evidence of S. Williams. 62 Kingston, A Broker and His Network, argues that the early growth of Philadelphia s marine insurance industry (based on private underwriting) in the late 1750s was partly driven by the disruption of regular channels of communication with London during the Seven Years War. 63 Montgomery, History, p. 83; and Fowler, History, p. 60.