Domestic Distortions and the Early Emergence of the International Trade in Fire Insurance from the UK

Domestic Distortions and the Early Emergence of the International Trade in Fire Insurance from the UK
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   The World Economy  (2006)doi: 10.1111/j.1467-9701.2006.00859.x  © 2006 The Author Journal compilation © 2006 Blackwell Publishing Ltd, 9600 Garsington Road,Oxford, OX4 2DQ, UK and 350 Main St, Malden, MA, 02148, USA  1629  Blackwell Publishing LtdOxford, UKTWECWorld Economy0378-5920 © 2006 Blackwell Publishers Ltd (a Blackwell Publishing Company)November 20062911Original ArticleINTERNATIONAL TRADE IN UK FIRE INSURANCEOLIVER M.WESTALL  Domestic Distortions and the Early Emergence of the International Trade in Fire Insurance from the UK  Oliver M. Westall   Lancaster University Management School In the second half of the nineteenth century, British fire insurance exports grew rapidly to more than half of the revenue accepted by British fire insurance companies.It has been suggested by some, including Michael Porter, that this expansion was based on a comparative advantage created in large part by a highly competitive domestic insurance market.Yet the existence of strongand sophisticated cartels in theBritish insurance market is well known.The paper argues that in fact the chief motive for the drive to develop business abroadcame from the existence of the cartel, whose increasing power prompted the creation of a number of new well-supported companies.The circumstances of the insurance business forced them to develop a large and diversified business and this required them to join the cartel.Thismembership deprived them of the price weapon to develop their business in the domestic market.They were thus forced to develop innovative strategies to grow.One of these was to deploy innovative marketing policies at home.The other was to expand abroad.By contrast, most of the older companies that had created the cartel developed foreign business later and on a far smaller scale.  1. THE ARGUMENT  O  NE of the earliest of Professor Bhagwati’s many important contributions tothe literature has been to emphasise the importance of the interactionbetween activity in the domestic and international economy, especially in relationto the distortions in domestic markets and their implications for the gains fromtrade. In these discussions, he has concentrated on the welfare and policy aspectsof that relationship (Bhagwati and Ramaswami, 1963). But by illuminating itsimportance he has, as he always does, opened up new avenues for research.Similarly, in later work, he refined our analysis and understanding of the specialconsiderations that apply to the trade in services. This has helped us to appreciatebetter its increasing role in the international economy over recent decades asinformation and communication technology and the international mobility of human capital have transformed the possibilities for international services trade,and provided one of the fundamental building blocs of globalisation (Bhagwati,1984 and 1987).This paper picks up these two Bhagwati themes and explores them specula-tively in a historical context: that of the growth of fire insurance exports fromBritain in the nineteenth century. The second half of that century saw an initialphase of globalisation with remarkable trade and factor flows across the world.The City of London was at the heart of that development as the major entrepôt for trade, and the financial market that managed international interest rates, supportedthe world’s trade credit, and sent investment pulsing out to create additionalcapacity across the world (Kynaston, 1994; and Michie, 1992). Insurance inter-penetrated the City’s activities. The Lloyd’s market was the world centre of marine insurance, and British insurance companies, mostly based in the City andcertainly all with close City links, provided networks of offices and agencies   1630OLIVER M. WESTALL  © 2006 The Author Journal compilation © Blackwell Publishing Ltd. 2006  stretched across the world, that provided one of the many institutional linkagesthat made the City of London an essentially cosmopolitan economic centre.In addition to the direct provision of insurance to clients requiring fire, acci-dent and marine cover across the world, British insurance companies were oftenestablished and operated by mercantile financial groups, so that the trading andinvestment activity that drove the international economy forward was oftenclosely linked in their boardrooms. Insurers followed their British policyholders’business interests across the world. Furthermore, insurers’ reserve funds formedan increasingly important element in financial markets, in the City and elsewhere.This should not be exaggerated. They did not invest in equities or significantlydirectly in property in the nineteenth century. But they were very large holdersof bonds and mortgages, not just in London, but also in many other internationalfinancial markets. Large financial deposits were required by most governmentsto secure policyholders, create barriers to entry to raise the local profitability of underwriting, and – not entirely incidentally – to help fund governments whootherwise had some difficulty raising money at modest cost. This internationalportfolio provided yet another form of integration for the world’s financialmarkets (Michie, 1992, pp. 150–74).This paper focuses on the fire insurance business that was almost entirelytransacted by companies until the closing decades of the nineteenth century whenthe Lloyd’s market began to accept a fire business that was to grow substantiallyin the next century. The argument explored in this paper is that the growth of British fire insurance exports cannot be understood outside the context of thestructure and behaviour of the domestic insurance market. On the face of it, thisis profoundly uncontentious, and often implicitly assumed. Indeed Michael Porter has made the case more explicitly as the central explanation of the success of British overseas insurance in The Competitive Advantage of Nations  . There hesuggests that British success in insurance exports was due to the light-touchregulation British insurance regime, in comparison with the tight regulatorycontrol in national markets in Europe and local state control in the US (Porter,1990, p. 664). This, he assumes, along with many others, created a highly competi-tive market that drove down premium rates and allowed a far more energeticapproach to product and process innovation. A platform was thus created for expansion into less privileged foreign markets, whose far tighter regulation reducedcompetitive pressures, allowed higher profitability and inhibited innovation. Britishcompanies thus enjoyed an important international comparative advantage basedon the benefits of competition at home that allowed them to exploit particularlysuccessfully the closely controlled markets that were characteristic of most other countries with significant insurance markets.This paper attempts to turn that argument on its head – and for one simplereason. While British government regulation of insurance was always light untilthe 1970s, this certainly did not guarantee competitive behaviour. Indeed, British   INTERNATIONAL TRADE IN UK FIRE INSURANCE1631  © 2006 The Author Journal compilation © Blackwell Publishing Ltd. 2006  insurance has a reasonable claim to have been one of the most successfullycollusive markets in British economic history. Its companies have demonstratedan extraordinary capacity to control competition in intrinsically fragmented andfissiparous business in a highly disciplined way for long periods.This process can be quickly sketched. In the eighteenth century the dominationof the fire insurance market by two large companies – the Sun and the REA – allowedcollusion to remain largely implicit (Supple, 1970, pp. 88–92; and Dickson, 1960,p. 84). With the later entry of the Phoenix, conversations began between the com-panies, but explicit formal control was unnecessary (Supple, 1970, pp. 91–95; Dickson,1960, pp. 87–95; and Trebilcock, 1985, pp. 441–50). Market expansion duringindustrialisation after 1790 encouraged the entry of many new companies creatingnew problems for control. Smaller companies could cut rates without provokinga response from the established companies with more revenue to lose from lower premium rates. When market growth slowed in the 1820s, established Londoncompanies used their financial strength to try to drive newer concerns out. Butnew entrants could always recreate competition. From the 1830s, therefore, thelarger companies began to create more formal market control. This involvedtariffs specifying the premium rates and policy terms on which business shouldbe written. This led eventually to the creation of a market organisation establishedin 1868 as the Fire Offices Committee (FOC), with the support of nearly all significantinsurance companies (Dickson, 1960, pp. 154–59; and Supple, 1970, pp. 127–30).By restricting reinsurance facilities and tariff information to members, itencouraged all companies who sought to grow to a significant scale, to join.While never establishing absolute market control, it was an overwhelminglyimportant price leader across the market for a century. When fire insurancecompanies entered accident insurance, creating the modern ‘composite’ insurer,market control engrossed that market as well. However, it was never as effectivein that market. This reacted back on fire insurance, for successful entry intoaccident insurance provided a platform for cross-entry into fire. In some accidentinsurance markets, the independent companies’ share became substantial andtariff control came under pressure, especially after 1950. Market control in accidentinsurance collapsed in 1968. Under pressure from the Monopolies Commission,some aspects of collusion in fire insurance were voluntarily withdrawn in theearly 1970s. But it required Margaret Thatcher’s indignation and strength of willto insist on the final disbandment of formal collusion in fire insurance in 1985,although the EU has continued to watch the market carefully (Westall, 1991).Competitive control was thus maintained, broadly speaking, from the lateeighteenth century until the 1980s. A far more credible interpretation of the light-touch regulatory regime was that tougher controls were not necessary to protectconsumers from the risk of company collapse when the cartels operated success-fully. And governments especially, and consumers probably, placed greater importance on protection from the risk of the collapse and loss of cover, than the   1632OLIVER M. WESTALL  © 2006 The Author Journal compilation © Blackwell Publishing Ltd. 2006  steady but less obvious consumer loss through higher margins and premiums(Westall, 1991).So the competitive market argument will scarcely wash – as is obvious whenone studies the profoundly conservative and sluggish behaviour of most Britishinsurance companies throughout the history of the business. However, this is notto say that market structure and behaviour do not matter. To the contrary, theargument of this paper is that the international expansion was a direct result of effective collusion.The story may have a more general relevance. There are many parallels withBritish banking, where collusive markets also prevailed alongside impressiveoverseas expansion (Jones, 1991). And it is perfectly possible that the relation-ship between market behaviour and export growth will be as important withincontemporary preferential trading areas, as it was within national economiesduring the nineteenth century. The European insurance market has seen extra-ordinary structural change over the last decade. On the one hand we have seen theemergence of large cross-European corporations, often created by the purchaseof relatively small British companies still shaped by the collusive market fromwhich they emerged in the 1980s, by very large European companies whose sizehad been inflated by their relaxed regulatory environment. On the other, newtechnology has encouraged the emergence – especially in Britain – of directcompanies using phone and web marketing linked to powerful interactive data-bases. Paradoxically, for the first time in insurance history, this has given privateconsumers access to a highly competitive insurance market, relative to businesspurchasers. In the latter market, we may expect implicit collusion to remainimportant, and this may have important implications for the drive to operate outsidethe trading area, if trade liberalisation in services is not effective in practice.  2. BRITISH FIRE INSURANCE EXPORTS IN THE NINETEENTH CENTURY  The focus on the export of fire insurance is first because life assurance hasremained largely a domestic business. Policyholders prefer the security of a localinsurer when policies have such a long life from first premium to death. Lifeinsurers have always been apprehensive about assuming long-term obligations inforeign currencies and remain so even now, with globalised financial markets andmore sophisticated opportunities for hedging. That is not to say that there wasno international trade in life assurance in the nineteenth century. Americancompanies mounted an aggressive marketing campaign in Britain in its closingdecades, and British companies sold to expatriates throughout the Empire, but thescale involved was insignificant (Wilkins, 1970, pp. 103–7). Accident insuranceremained a tiny, marginal business at home and abroad until the advent of themotorcar led to such rapid and substantial growth that British international  INTERNATIONAL TRADE IN UK FIRE INSURANCE1633  © 2006 The Author Journal compilation © Blackwell Publishing Ltd. 2006  accident insurance business overhauled fire insurance exports during the yearsbetween the two world wars of the last century (Westall, 1988).Marine insurance is a different issue. It is by its very nature international inits activities, but that creates immediate problems of classification. Businesscame to the London marine insurance market by many routes. Companies andunderwriters did not – perhaps often could not – record whether they were sellinga marine policy on a ship sailing the oceans to a British or foreign owner. Moreparticularly, the structure of the marine insurance market is quite different. Thehighly specific nature of the risk for each cargo or voyage has not encouragedthe same standardised approach to underwriting that has been so successful inthe fire business. The Lloyd’s market has remained important. That is not to saythat it was as competitive as many assert. Dense networks of underwriters inter-penetrated the Lloyd’s market and premium rates were usually set by one or other leading underwriter that others followed. And for much of the nineteenthcentury Lloyd’s underwriting syndicates were on the back foot, resisting strongcompetitive pressure from marine insurance companies that could cover far larger risk acceptances. Indeed, many in mid-century would have argued that Lloyd’swas an example of business archaeology from the early eighteenth century thatwould soon disappear. The institution only pulled itself back into the mainstreamin the 1880s and 1890s. It changed its organisation to accept far larger marineinsurance risks that allowed its brokers to compete with the companies. And itbegan to accept non-marine – fire and accident – business for the first time andbecame the research and development department of British insurance, develop-ing a wide portfolio of new and highly innovative insurance products. Its profilehas always been higher than its reality. The story of marine insurance is quitedifferent from the fire insurance that is our focus (Westall, 1997).Fire insurance was therefore a company business for almost all the nineteenthcentury and it was within this structure that overseas expansion took place. We cannotmeasure this in any sort of detail yet. Company published accounts did not revealgeographical divisions of business, and even now insurers resist any obligationto provide such information. It is only available from internal accounts, and the taskof collating this data for the nineteenth century is only just beginning. But the broadpicture is clear. At the start of the century there was very little foreign insurancetransacted by any company, apart from the Phoenix, for reasons we will explorelater. Even by mid-century, as Table 1 shows, of the three oldest companies: theSun, the REA and the Phoenix; only the latter had a substantial share of foreigninsurance, and the one new company that had moved into the top four, the NorwichUnion, had an even smaller share of foreign business than the Sun and the REA.After 1850, the position changed quickly. Rapid growth took place in fireinsurance exports to Europe, the British colonies in the Caribbean, Australia andCanada and above all in the United States. By the end of the century, overseasbusiness had become larger than domestic. A widely accepted estimate suggests
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