The Emergence and Development of Fidelity Insurance in 19th-Century Britain

The Geneva Papers on Risk and Insurance Vol. 29 No. 2 (April 2004) The Emergence and Development of Fidelity Insurance in 19th-Century Britain by Greg Anderson* Dost thou still retain thine integrity
of 13
All materials on our website are shared by users. If you have any questions about copyright issues, please report us to resolve them. We are always happy to assist you.
Related Documents
The Geneva Papers on Risk and Insurance Vol. 29 No. 2 (April 2004) The Emergence and Development of Fidelity Insurance in 19th-Century Britain by Greg Anderson* Dost thou still retain thine integrity 1 1. Introduction This article deals with the emergence of insurance in one of the most sensitive areas of human behaviour: employee honesty in the workplace. Employers have always shown concern for the honesty and integrity of employees, especially those occupying positions of trust. Historically clerks often filled this role. Up to the middle of the 19th century clerks were employed in relatively small numbers as trusted lieutenants to their employers. However, as the British economy shifted towards a more complex corporate structure, the number of clerks increased rapidly. The managerial control of this growing workforce required new methods. The traditional arrangements for monitoring the performance and honesty of clerks consisted of surety bonds and apprenticeship. Clerks posted bonds as a form of security and entered apprenticeship contracts which deferred compensation until they had proved their worth. These arrangements suited the interests of both parties. Employer interests were safeguarded by clerks binding themselves closely to firms which offered the prospect, if not the promise, of security and upward mobility. Agency theory, even when used in a static way, can help explain the use of such bonding schemes. 2 A common example of agency theory is the relationship between the owner of a firm (principal) and his employee (agent). The agency problem lies in the methods used by the employer to motivate the employee to act on his behalf rather than follow self-interest. Although neither 19th-century clerks nor their employers thought in terms of agency theory, the uncertainty surrounding dishonesty in the workplace at that time was and remains a classic principal-agent problem. Agency theory can also help to explain the potential weaknesses in such personal bonding schemes and the need for more effective monitoring arrangements. Weaknesses became apparent in traditional bonding schemes during the course of the 19th century. As suretyship and apprenticeship became costly to monitor and enforce, employers and clerks tried alternative arrangements. Fidelity insurance companies were established which were able to reduce such costs by offering guarantees against acts of employee dishonesty. These * Senior Lecturer, School of Accounting, Economics and Management Science, University of Salford, U.K. 1 The quotation is from the London Guarantee Society Report (date uncertain, probably c.1930). 2 For various applications of agency theory and the range of possible principal-agent problems see Hendrikse (2003). There are very few historical applications of agency theory but see S. Jacoby (1983) for the use of performance bonds to deter employees from joining trade unions and D. Jacoby (1991) for the use of agency theory to explain changes in the control of industrial apprenticeship. Both studies refer to the U.S. I am grateful to the comments by an anonymous referee on the use made of agency theory in this paper. Published by Blackwell Publishing Ltd, 9600 Garsington Road, Oxford OX4 2DQ, UK. THE EMERGENCE AND DEVELOPMENT OF FIDELITY INSURANCE IN 19TH-CENTURY BRITAIN 235 companies filled an important role in the transition from a traditional paternalistic system of employer control to the structures and systems associated with modern firms. 2. Background: counting-house capitalism In the first half of the 19th century most clerks worked in the counting-houses of individual enterprises. Only later in the century, and especially after 1900, did the bureaucratic conditions associated with large-scale corporate employment become more common. Within the counting-house clerks were employed in small numbers as part of a tightly-knit personal system strongly characterized by mutual trust between them and their employers. 3 The relationship between employers and clerks had similarities to the vertical friendship between patrons and clients that permeated pre-industrial England. The resulting social nexus, it has been argued, was more personal and comprehensive than the contractual employment relationships associated with capitalism. 4 Certainly the high trust culture associated with gentlemanly capitalism enabled employers to make a number of assumptions about the behaviour of their clerks. The idea of the gentleman represented a particularly powerful and effective set of values both in and outside the workplace. Gentlemanly behaviour could go a long way in determining clerks loyalty and trustworthiness and to some extent their efficiency and enthusiasm as well. It might also help to shape the personal characteristics of these men which could impinge on their working lives in very direct ways. Therefore gentlemen might be expected to avoid inappropriate behaviour and exhibit strong moral attitudes. One way of predicting the gentlemanly behaviour of their clerks was for employers to recruit them from the same family, social, business and religious networks as themselves. This process of selfrecruitment not only helped to reinforce gentlemanly behaviour but also to guarantee a future supply of entrepreneurial talent. In the heyday of family capitalism clerks were seen as a key source for the supply of senior employees and partners. Indeed a common contemporary criticism of clerical work was that well-placed young men used patronage and family influence as a way of monopolizing the best positions. 5 By their close guardianship of trade secrets and valuable information clerks had a key role in the life of the business. They were responsible for record-keeping, including the writing of business letters, maintenance of financial records, and basic book-keeping. The best clerks exhibited good general educational skills which were then shaped into firmspecific ones through gradual acquaintance with their particular employment. The obvious moral hazard associated with clerical work was reduced by the mutual trust between clerk and employer often expressed in the form of unwritten tacit expectations of conduct. 6 This form of gentlemen s agreement was similar in many respects to those which existed between employers in which the gentleman s word was his bond. While the average size of the workforce was small, and as long as partners and 3 There is ample information on the work conditions of the 19th-century counting-house. See Lockwood (1958) and Anderson (1976). The size of the counting-house workforce was small and the division of labour slight and intimate (Lockwood, 1958, p. 19). One reliable contemporary observer estimated the average number of clerks in commercial offices in the 1870s was four. See B. G. Orchard (1871), p Perkin (1969). 5 The values associated with gentlemanliness and their impact on 19th-century clerks are discussed by Lockwood (1958). 6 Ibid. 236 ANDERSON proprietors closely monitored counting-house procedures, the personal system of control appears to have worked effectively. In addition by the first half of the 19th century two mechanisms were in place which were intended to resolve potential weaknesses inherent in the personal system. The commercial apprenticeship was widespread, particularly in the private sector, and clerks were rarely allowed to assume a full clerkship before first serving one. Although the length and legal standing of an apprenticeship varied, it was not unusual for clerks to serve between three and five years and to be bound to their firm through legal indentures. In important respects the commercial apprenticeship was more akin to those operating in the old skilled trades with clerks having learned the mystery of their craft hopeful of career progression. The prospects inherent in clerking at this time meant that competition for the best positions was intense, with nominations keenly sought and waiting lists commonplace. Because the apprenticeship contained both training and screening elements it was a useful instrument for solving monitoring problems. The legal indentures could be written in such a way that they proscribed patterns of behaviour associated with high risks for employers, e.g. gambling, drinking, stock market speculation and indebtedness. 7 As part of their employment contract clerks also had to find surety. The use of personal suretyship among private individuals was an age-old practice which had become commonplace by the 19th century among employees, like clerks, who occupied positions of trust. The traditional method was to get an employee to deposit a sum of money, the size of which varied with the responsibilities involved. However, since many young men may have faced personal liquidity problems there were practical objections to the widespread use of personal deposits. The solution lay in the use of private suretyship, in which the surety or sureties agreed to make good any loss which the employer might sustain through the actions of the individual employee. Most people who became personal sureties did so as a favour to friends or relatives. The system was a natural outgrowth of counting-house capitalism by which socially well-placed young men were able to gain positions in the best business houses. In the absence of external audits and since no system of book keeping could by itself prevent embezzlement, employers relied heavily on these bonding mechanisms. The apprenticeship successfully monitored employees before they were offered long-term employment while suretyship contained an element of moral security a feeling that an employee would be less likely to default if it meant letting down a friend or relative. Defaults were costly monetarily and interpersonally. Friends and relatives could become bitter enemies Weakness of suretyship: emergence of agency problems Private suretyship appears to have worked effectively when the demand for clerks and others to fill positions of trust could be met from an adequate supply of socially well-placed young men. However, pressures began to build in the system. Firstly the demand for clerical 7 Although much less is known about the commercial apprenticeship than its industrial counterpart it was widespread in commerce, banking and insurance in the first two-thirds of the 19th century. See Anderson (1975), (1976), Orchard (1871) and Lockwood (1958). 8 On the operation of private suretyship in the 19th century see Anderson (1975), Hannah (1986), Dinsdale (1927), Fitzgerald et al. (1991) and Munn (1988). THE EMERGENCE AND DEVELOPMENT OF FIDELITY INSURANCE IN 19TH-CENTURY BRITAIN 237 labour increased rapidly during the 19th century. Transaction costs increased as employers faced with the cost of searching for respectable labour became encumbered by personal bonding arrangements which restricted the supply of labour since it excluded recruits who were otherwise perfectly acceptable but who could not find sureties to act on their behalf. 9 At the same time, problems began to appear within private suretyship and were given widespread publicity. The growth of trade, the increase in financial transactions and the promotion of new companies increased the opportunities for embezzlement among employees. As banks, insurance companies, railways, shipping and trading firms rose in numbers and size the demand for security became intense. Within these firms the first outlines of vertical career hierarchies developed and as the salaries of senior employees increased so the guarantees required became larger and more difficult to attract. Defects in private suretyship became more openly discussed. An underlying fear was that the employers protection implicit in suretyship was more nominal than real. Concern grew about the potential search and exposure costs. The surety might die without the employers knowledge or be difficult to trace. How could the continuing solvency of the surety be properly checked? The surety s financial position might change over time even without the knowledge of his closest friends. These problems came to a height in the 1830s and 1840s. Firstly it was noted that embezzlement occurred in the collection of taxes since collectors were often small private retailers who needed capital but could not find private suretyship and who borrowed from taxes in the hope of replacing the money from sales in the short term. More worryingly, a series of frauds in the Port of London exposed serious weaknesses in the system since port officials who engaged in the fraud were required to name two sureties while an annual report into their continued existence and solvency was required. It transpired that not a single case was found of a surety being rejected by the Board of Customs for many years, while in one case surety was accepted by a man with a history of fraud and imprisonment. 10 While it seemed that neither employer nor public protection could be guaranteed by private suretyship the risks for those who acted as surety were also more openly discussed. In a system based on trust and good will the surety was forced to make assumptions about the bonded individual s behaviour. Gentlemen s agreements were effective between trustworthy individuals but since there was no risk-sharing a delinquent individual could impose heavy costs on the surety without any corresponding costs to himself. One contemporary observer concluded that security bonds failed to reinforce even the common integrity implied by their covenants. 11 It should be noted that the prosecution of a dishonest employee by either his surety or his employer was both difficult in law (since embezzlement was such a difficult crime to prove) and unlikely since it was enormously destructive of the gentlemanly system because of public exposure of family and friends. 12 In addition, the surety might be exposed by an unscrupulous employer intent on proving a claim outside the terms of the bond, 9 The argument that personal bonding schemes disappeared in the late 19th century as the nature of clerical work changed and the size of the clerical workforce increased is in Hannah (1986), p By the 1840s the defects in private suretyship were well known. Much publicity was generated in a pamphlet by C. Sanderson, Surety-ship: The Dangers and Defects of Private Surety and their Remedies (1844) which was already in its 15th edition. The Customs House frauds caused particular alarm and were the subject of a government enquiry in From A Plea for the Prevention of Embezzlement. (1850) p. 5 (anonymous). 12 The weaknesses of the law in relationship to embezzlement are discussed later in this article. For reference to the impact of embezzlement on family and friends see Anderson (1975). 238 ANDERSON for losses caused not by dishonesty but by inefficiency. Without insider knowledge of the firm s accounts and routine the surety lacked the means to carry out an investigation Fidelity insurance: company formation The hazards and costs associated with private suretyship attracted so much attention that a committee was set up in 1839 to investigate the possibility of corporate suretyship. The success of Britain s growing insurance market provided a benchmark for what might be achieved. In a number of areas insurance contracts had come to depend upon firms rather than individuals. In particular, the success since the 18th century of fire, life and marine insurance companies encouraged the spread of insurance into other areas. 14 The 1839 Committee included leading members of London s commercial and financial establishment (Bank of England and London Stock Exchange) and it set about collecting data from banks, insurance companies, breweries, railway companies and commercial firms. 15 The official records of embezzlement were also examined and actuaries consulted. Coincidentally, the application of basic mathematical principles to fidelity insurance was being considered, for the first time, in a formal and testable way. Professor A. De Morgan argued that: If a thousand banker s clerks were to club together to indemnify their securities, by the payment of one pound a year be tolerably well ascertained that (given) the instances of dishonesty (yearly) among such persons... this club would continue to exist, subject to being in debt in a bad year to an amount which it would be able to discharge in the good ones. 16 Following the 1839 Committee s deliberations, the London Guarantee Society (L.G.S.), generally acknowledged as the world s first fidelity insurance company, was established in It counted among its clients some of the country s best known firms and institutions including the East India Company, the City of London and other corporations as well as banks and private firms. Following the L.G.S. more companies entered the field and by 1890 there were nearly 30 operating, some like the L.G.S. provided cover across the whole economy, some at first combined fidelity with life insurance, while a small number specialized in particular risks. 17 There were difficulties associated with the first phase of company development. It is generally accepted that for an insurance industry to flourish it requires statistical predictability as a precondition of insurability. In the early years the actuarial information available to the companies for particular classes of risk was only partly developed and understood. At 13 Such unscrupulous firms would incur considerable reputational damage (if it was discovered). However in theory there are incentives for firms to collect bonds (or the equivalent e.g. employment fees) by stating falsely that workers were dishonest or shirked: see Katz (1986), p An acute contemporary observer like Sanderson (1844) was conscious of the danger. 14 For the background on the history of British insurance see Rayner (1964). 15 Dinsdale (1927), p D. A. Morgan, Dublin Review, August In the history of British insurance, fidelity insurance is generally regarded as the oldest class of accident insurance. Established in 1840 with the London Guarantee Society it predated personal accident insurance which was started for railway passengers in 1848: Dinsdale (1927), p. 79. THE EMERGENCE AND DEVELOPMENT OF FIDELITY INSURANCE IN 19TH-CENTURY BRITAIN 239 first the claims made in the L.G.S. were not excessive and the business grew steadily but in 1850 the claims of the previous year amounted to 10,000 against premiums of 11,500 which forced a restructuring of the business and a reduction of costs. 18 Another fidelity company, the British Guarantee Association formed in 1845 declared in its annual report for 1856 that some bonds would not be renewed because they belonged to a class of risks which experience had proved to be of too hazardous a character. 19 When guarantees were extended by the fidelity companies to government officials the British government and especially the Treasury expressed particular concern about the viability of the fidelity companies. In an Act of Parliament in 1867 it set out general conditions which had to be met before the guarantee of a particular company was accepted. 20 These concerns were well-founded since a number of companies, for example the British Surety Company (1842), the West of Scotland Guarantee Association ( ) and the Fidelity Guarantee Society (1845), either failed to mature or were wound up after a few years The development of the insurance contract The chequered history of the early fidelity companies did little to reassure public scepticism about corporate suretyship. Despite the agency problems associated with private suretyship some observers felt that the moral security associated with the old system was still superior. Interestingly similar objections were made to life insurance when it was first introduced, i.e. that it would attract only needy and desperate men seeking to mend their ruined fortunes. 22 Much of the hostility emanated from the Treasury
Similar documents
View more...
Related Search
We Need Your Support
Thank you for visiting our website and your interest in our free products and services. We are nonprofit website to share and download documents. To the running of this website, we need your help to support us.

Thanks to everyone for your continued support.

No, Thanks