From American Affairs Journal, May 2022:
REVIEW ESSAY
Underwriters of the United States:
How Insurance Shaped the American Founding
by Hannah Farber
University of North Carolina Press, 2021, 352 pages
Property insurance is everywhere, but it is rarely prominent in the public mind. Its internal workings are obscure, full of technical language, esoteric customs, and mind-numbing legalese. Most people give it little thought beyond what is absolutely necessary. Nonetheless, as Hannah Farber’s Underwriters of the United States makes clear, property insurance is a powerful social force in any complex economy. And surprisingly, this excellent academic analysis of underwriting in the American shipping industry, up until 1860, has much to say about America today. Most of all, it makes us consider how corporate entities, and more generally concentrations of private wealth and power, can and should interact, and be permitted to interact, with the rest of the nation.
Shipping goods has always been risky, as wrecks littering the floor of the seven seas attest. For colonial American seafaring merchants, insurance crucially aided their business, while enriching insurers. And as Farber narrates, insurers returned the favor, using their profits to support and strengthen their own society, first their cities, then their states, and finally their new country. This double role is reflected in the two meanings of the book’s title. In insurance parlance, an underwriter is simply the insurer. But Farber focuses more on a second, broader meaning—anyone who takes risks in order to help another entity succeed. In business, most often that help is getting access to needed capital, for which service the underwriter himself profits. Early insurance companies took risks to help the United States raise both financial and social capital, becoming a key element of the nation’s rapid growth in the nineteenth century.
The Lex Mercatoria
Every business with a single owner, or a small group of owners, revolves around a continuous balancing of existential risk and reward. This is something not viscerally understood by most people, but it is the central truth for owners. An employee does not really care about the risks facing a business, aside from not losing his job if the firm fails. Nor does he really care about business-level rewards—outsize success—because, after all, in that case the employee typically does not share, or share much, in the rewards. An owner cares about both a great deal, because he can easily be ruined by risk materializing, or he can be made rich by success. Thus, for an owner, mitigating risk at a reasonable cost is highly desirable. Only an expert in risk can do that, which is why property insurance exists.
Using fascinating original research into a variety of primary sources, Farber focuses on maritime insurance (with occasional compare-and-contrast discussion of fire insurance). This was no simple business. We think of business complexity as a modern phenomenon, and to some extent that is true, but colonial-era shipping involved a nearly infinite set of permutations on the core image we have from movies, of a ship with some bales of goods loaded into the hold in one place and unloaded in another. Multiple owners; multiple responsible parties; variations (many that could not be forecast) in cargo, destination, and ports of call; ongoing conflicts and wars; and much more made it very difficult to precisely tailor an insurance policy to any given maritime venture. Without some way of simplifying analysis, writing insurance would merely have become gambling, or more likely would not have been done at all.
The solution was for all parties to rely on, and to draft insurance contracts incorporating by reference, a massive compendium of pseudo-law: the lex mercatoria, the law of merchants. This was a lengthy set of rules, set down by this point in a few different print editions, that purported to embody the timeless and invariable laws governing shipping. It did no such thing; some of the rules were simply made up by the editors of the print editions, and the universal applicability of the laws, even before nation-states came fully of age, was exaggerated. Yet it worked, and in practice the widespread acceptance, even by courts in different countries, of the lex mercatoria acted as a collective, common suspension of disbelief, somewhat similar to how the Germans fixed their hyperinflation problem in 1923—by pretending a new currency, the rentenmark, had value. You can accomplish a lot if everyone agrees to believe in something that is notional and, most importantly, agrees to take the resulting bad with the good. That’s how the law of merchants worked in practice. An important element of this was evenhandedeness: the lex mercatoria imposed stiff obligations on both insurers and insured. A system designed to favor one party over another would never have lasted.
That the lex mercatoria wasn’t based in statute law, that is, a law passed by a legislature, doesn’t mean it was not effectively law. Mostly, it was based on, and a generally accurate representation of, custom—what is called today “course of dealing.” Today, when the common law is dead and statute law is, even for the educated, viewed as the only type of “real law,” it makes it very difficult to understand a great deal of history if we do not grasp that custom was, until quite recently, effectively the supreme law of all Anglo-Saxon law, and of much continental law as well. William Murray, Lord Mansfield, perhaps the greatest expositor of the common law, explicitly viewed the lex mercatoria as part of the common law—that is, something to be applied by judges to individual cases in accordance with other custom and precedent, the spine and skeleton of the common law. In effect, the custom of acceptance by private parties created the law by which other private parties were bound, a type of bootstrapping that, on average, benefited everyone. (Lawyers will recognize that the lex mercatoria is a predecessor of today’s Uniform Commercial Code, a set of uniform laws created by academics and then passed by state legislatures to create broad default provisions for contracts, which allows parties to contract without endlessly complex negotiation.)
For maritime law, the key fact making the lex mercatoria truly useful was that it was viewed by insurance companies, and by seamen and their backers, as a transnational law, which could be cited in a French, Spanish, or English court as easily as in an American one. Yet as nation-states consolidated and centralized power in this time period, and projected that power beyond the nation’s borders, they cared less and less about a supposedly transnational set of laws, eroding the ability of merchants and insurance companies to rely on the lex mercatoria. Still, the law of the sea, whether ultimately governed by a transnational or national source, was necessarily largely international. Moreover, it had to, and did, contain provisions for many practices we find strange, such as a privateer who seized an enemy ship being able to take it to a neutral port and obtain a judgment from a local court awarding him ownership of the ship and its cargo—which all other courts, including those of the country of the original owner, would acknowledge.
The biggest spur for the ultimate sidelining of the lex mercatoria was the Napoleonic Wars, and in particular the English strategy to strangle Napoleon through complete control of the seas. In practice, this meant that the English took any action on the high seas they regarded as necessary to harm Napoleon, regardless of what the lex mercatoria might say—although they did provide that aggrieved foreigners could travel to London, or hire London lawyers, to attempt to recover ships and goods seized, or be remunerated for those destroyed. Those who went through the process were successful surprisingly often—but it was an English process, governed by English law, if sometimes informed by earlier custom. Throughout the nineteenth century, larger states, including Spain and France, also increasingly rejected the lex mercatoria as governing law. Quite often, they incorporated some of its principles into their own maritime laws, and in modern times, elements of the lex mercatoria have become part of international maritime law established by treaties, such as the United Nations Convention on the Law of the Sea. So in a sense, the lex mercatoria lives on.
Brokerage
But back to colonial times. This was an era before regulators, beyond a few very specific areas such as customs duties, and so insurance products in England, and then in America, developed organically—it was a natural evolution, tied to increasing complexity of trade. The original structure of property insurance was “brokerage,” meaning that a person or group of people held himself or themselves out as willing to insure risks. In practice, they usually did not do so only by themselves, but further spread the risk by syndicating it—that is, by assembling a group of men who collectively shared the risk under a contractual instrument. A brokerage is not a corporation, or what was originally called a “chartered joint-stock company,” but rather a type of partnership, typically a close-knit form of legal entity, with the risk concentrated in partners known to each other, not spread out among stockholders with no other connection.....
....MUCH MORE
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