Saturday, September 5, 2009

A not so happy fairy tale, part I.

Once upon a time, a land far across the sea was plagued by pirates (and we don't mean last month in Somalia).  The rich men who were losing vessels and cargo were losing money, while those whose ships made it back made lots of money.  As they whinged around the fireplace at Lloyd's coffee house, an enterprising soul offered up a fresh idea.  He would arrange a consortium by which everyone would pay into a common pot out of which those who lost vessels would be compensated.  And thus, the almost modern idea of insurance was born.

It quickly became clear that while the ships were out at sea, there was a lot of money just sitting around, and the insurer could make some money by investing it in other markets.  The idea is pretty simple - you take in $1000 in insurance premiums, out of which you pay yourself $30 or $40 to cover your bar tab, and plan on using the rest to pay off on losses - you know there will be losses because there be pirates out there.  However, until the losses come in you get to invest the premiums.  A shrewd investor might may 10% or 15% on the premiums, pocketing another $100 to $150 by the time the ships came back (or didn't) and he had to pay off on losses.

Of course, sometime investors lose money.  When that happened, the unlucky investor/insurer found himself destitute.  The insurer had to pledge all his assets in surety for the premiums.  After all, who in their right mind would hand a big stack of money to someone if you knew very well that they could spend the money on gambling and horses then declare bankruptcy.

This system worked well for several hundred years.  The thought of losing everything and ending up in debtors prison kept the Lloyd's insurers conservative and honest (or relatively so).  Then, an evil witch invented the limited liability corporation.

To be continued...

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