§ 5. Insurance viewed as a wager. Insurance, without question a highly useful thing, appears, paradoxically, to be in its outer form a bet. The large merchant with many ves sels used in many kinds of business had in the days before marine insurance an advantage in distributing his losses over a number of voyages. Antonio, the wealthy merchant, is made thus to express his security: "MV ventures are not in one bottom trusted Nor to one place; nor is my whole estate Upon the fortune of the present year. Therefore my merchandise makes me not sad." In its early form marine insurance was the attempt of smaller ship-owners to distribute their losses (as could the wealthy merchant) over a number of undertakings, lucky and unlucky. It became customary for a ship-owner to bet with a wealthy man that the ship would not return. If it did come back, the owner could afford to pay the bet; if it did not, he won his bet and thus recovered a part of his loss. Gradually there came about a specialization of risk-taking by the men most able to bear it. They could tell by ex perience about what was the degree of uncertainty, and could lay their wagers accordingly. When several insurers were in the same business, competition forced them to insure the ves sel and cargo of the ordinary trader for something near the percentage of risk involved. The insurance thus tended to become a mutual protection to the ship-owners; what had to be paid in premiums to cover risk came to be counted as part of the cost of carrying on that business.
Every legitimate form of insurance exhibits the character istics that it reduces loss at the margin where it is felt most keenly. The difference between insurance and gambling, thus, primarily in the purpose of insurance, which is not to increase artificially the risk that the insured runs, but to neutralize or offset an already existing chance. The insurance bet is what is called a "hedge." § 6. Insurance as mutual protection. The difference be tween gambling and insurance lies further in the collective method of insurance, which combines the chances scattered among a number of persons. Insurance does not increase the total of risks and of losses, but merely combines, averages, and distributes them equally among all the insured. This eliminates the chance element to the individual by converting it into a regular cost to all members of the group. Modern insurance is conducted either by enterprisers for profit, or by mutual companies; but in any case in large measure the losses in insurance are mutually shared, as the premiums (plus interest earned) equal the total losses plus operating expenses and profit, if any is made. Each insured gets a contract of indemnity for the payment of a sum that will help cover the losses of others. Such an exchange is mutually beneficial. The premium comes from marginal income; the loss, if it occurs, would fall upon the parts of income having higher value to the insured. The less urgent needs of the present are sacrificed in order to protect the income that gratifies the more urgent needs of the future. In insurance each party gives a smaller value for a greater ; each makes a gain. The greater security in business stimulates effort.
This effect is quite the opposite of that of gambling.
§ 7. Conditions of sound insurance. To be economically sound, insurance must have to do with real productive agents, and with a group of occurrences that, as a whole, are ap proximately ascertainable in advance—however irregularly they may fall upon individuals. The insured must be numer ous enough, and the objects insured so distributed in space and in time, that the "law of large numbers," or of statis tical averages, applies. This means that in any one year the cost will not vary greatly from the average; otherwise the security is weakened.
The beneficiary must have an insurable interest in the property or person insured, that is, the beneficiary must actually suffer a loss by the occurrence insured against, and the amount of the indemnity must not be greater than the loss incurred. Some of the greatest difficulties in insurance arise from the absence of these essential conditions. When there is no insurable interest, or when the indemnity is greater than the loss that may be incurred, the beneficiary may and sometimes does find it to his interest to bring about the socially injurious event insured against. He artificially in creases the loss against which insurance was taken. When the insured sets fire to his own buildings, or drives his auto mobile more carelessly than he otherwise would, he makes an illegitimate use of insurance. Constant efforts are made by insurance companies to guard against these "moral risks," the least calculable of any. Merchants whose stocks have been mysteriously burned two or three times find difficulty in getting further insurance. Formerly insurance was not paid in case of death by suicide; but now usually no such limitation is contained in a policy after a period of one or more years. As men rarely plan suicide years in advance, death by one's own hand some years after taking life insur ance is regarded as coming under the ordinary rules of chance. Yet it is to be feared that this liberal policy serves as a temptation at times to crime and to self-destruction.
§ 8. Farmers' mutual insurance. Property insurance may be viewed as an aspect of enterpriser's but may also, as may any insurance, be considered a form of saving. The premium paid each year may be looked upon as a sum prudently saved and laid aside to repair or rebuild the house when later it burns. Let us suppose that the chance of any one house being destroyed by fire in any one year is 1 in 500 ; then, on the average, the owner of each house would in 499 of the years have no loss from fire and the other year would lose the whole house. If the loss could be mathematically distributed over 500 houses, each house would burn down 1/500 each year, never more nor less, and fire loss would be a regular cost of repair. If no provision is made for this, the actual income of each owner in his lucky years would be .2 per cent greater (estimated on the cap italization) than, on the average, is the net income of the whole group of owners. A prudent owner of one house, 2 See Vol. I, pp. 365 and 374.