capitalist may adopt measures for preventing the origin and spread of fire; or he may decide to carry the risk himself, and as a consequence pay a higher rate of interest on the capital he borrows and puts into the business; or he may buy insurance, and for a definite sum, called the premium, transfer the risk to some other person, or group of persons, called the insurer.

All three of these methods are used by the capitalist of to-day, and the cost of each enters into the cost of production. The extent to which each is used will depend chiefly upon its relative cost. Statistics, however, show that during each succeeding decade a larger proportion of the country's wealth, subject to the uncertainty of loss through fire or marine perils, has been protected by insurance placed with corporations.

3

Extent of Fire and Marine Insurance Business.-The fire and marine insurance business of the country, and for that matter insurance along all important lines, has had a most remarkable development during the last twenty-five years. Less and less of the total risk is borne by the capital in the industry, and more and more reliance is placed upon insurance and fire prevention. Competent estimates place the value of property in the United States protected by fire insurance in excess of $100,000,000,000. About ninety per cent of the insurance written in the United States, it is estimated, is reported to the Insurance Department of the State of New York, and at the close of 1918 this business was distributed approximately as follows: American stock companies, $58,000,000,000, foreign stock companies, $21,000,000,000, and mutual companies (all classes) $6,000,000,000. It is also estimated that at the close of 1918 the

'Report of Special Committee on Fire Waste and Insurance to the Chamber of Commerce of the United States, 1918.

factory mutuals of the country carried risks aggregating approximately $5,000,000,000, and farmers' mutuals about $6,000,000,000. A special Committee on Fire Waste and Insurance recently reported to the Chamber of Commerce of the United States that "the total cost of the fire hazard in the United States cannot be far from $750,000,000 a year." Of this total the value of property burned per year averages approximately $300,000,000, whereas in years of catastrophe the total rises to $500,000,000. But to this actual loss there must be added another quarter of a billion dollars to cover the expense of operating the insurance business in all its forms. There must also be added the heavy costs involved in the equipment and maintenance of fire departments and other similar agencies. To quote the Committee's report: "In 1918 one hundred forty-six of the two hundred twenty-seven cities of the United States exceeding thirty thousand in population spent $52,000,000 for operation of fire departments alone, or more than one-fourth of the sum they spent for schools. Sixty-nine of these cities had, in addition to $115,000,000 invested in buildings and equipment for fire departments, $1,200,000,000 invested in watersupply systems, a portion of which (perhaps one-fourth) should be chargeable to fire fighting."

Marine risks written and renewed during 1918 by all companies, domestic and foreign admitted, operating within the United States, exceeded $66,000,000,000. Of this total, branch offices of admitted foreign companies wrote or renewed 58.4 per cent, American companies controlled abroad through stock ownership, 5 per cent, and American companies, 36.6 per cent. These figures, however, do not reflect the total marine insurance originating in the United States. Competent underwriters estimate that at least 20 per cent of all marine insurance originating in this country is exported directly abroad by brokers

and others to be placed with non-admitted underwriters or with the home offices of admitted foreign companies.* Benefits Derived from Fire and Marine Insurance."Substitution of certain for uncertain loss.”—Viewed from the standpoint of society in general, as contrasted with the individual property owner, the economic value of fire and marine insurance is indirect rather than direct in character. It is apparent that the insurance of property does not in the least reduce the amount of fire waste. During the last fifteen years, 1906 to 1920 inclusive, over $3,680,000,000 worth of property, representing an average annual loss of $245,000,000, was destroyed by fire in the United States. This enormous amount of property, wasted annually by fire, is gone forever. It is not replaced by insurance, since the insurance company has merely collected premiums from the many whose property is not destroyed, in order to indemnify the unfortunate owners whose property is lost.

If insurance, therefore, does not prevent the destruction of property, and does not directly increase the wealth of the community, to what shall we attribute its principal value? The answer is that the real gain derived from insurance is due to the combination of a large number of separate risks into a group, thus making possible the "substitution of certain for uncertain loss." The larger the number of separate risks combined in a group, the less uncertainty will there be as to the amount of loss, since the law of average will apply with greater precision; and the less uncertainty of loss, the smaller is the accumulation of money necessary from the many to meet the losses of the few. In fact, if the aggregate of risks combined in a group were so large as to make the application of the

For a detailed discussion of the volume of marine insurance written see S. S. Huebner: "Report on Status of Marine Insurance in the United States," Washington, 1920.

law of average perfect, and thus remove all uncertainty as to the amount of loss that will be experienced during a given period of time, the accumulation of money through premiums from property owners (leaving out of account the expenses and reasonable profits of the insurer) would be limited to the exact amount of the expected loss.

It is in the application of this principle that the nature of the gain to society from the institution of insurance becomes apparent. Thus, let us assume that there are five thousand owners, owning five thousand houses, valued at $10,000 each, and alike in all respects. Let us also assume that the average annual loss, as shown over a considerable number of years, amounts to 1/2 of 1 per cent of the value, although for individual years the loss varies from a minimum of 14 of 1 per cent to a maximum of 1 per cent. Now, were there no system of insurance, it is apparent that these five thousand owners, if they wish to eliminate the element of gamble, would have to make a liberal addition to the rental in order to cover the uncertainty of loss by fire, to which each is exposed. How much each would add, is a matter of conjecture, but it is conservative to assume that each would demand at least an extra 5 per cent on his investment, or $500 per year, or $2,500,000 for the entire group, because of the risk assumed. But even at this extra rate of 5 per cent, these house owners would be making a gamble at odds of 1 to 20.

But let us now assume that these five thousand owners combine their risks into one group. It must be clear that by doing this they have substituted for the great uncertainty of loss which confronted them as individuals, a certain and definitely known loss, amounting on the average to 12 of 1 per cent, or $50 per house, and only $250,000 for the group. Without the aid of insurance all these owners would be obliged to increase their rentals by at least ten times the amount needed to cover their losses,

and at the end of the year the great majority of them, since they had suffered no losses, would have the entire sum as a net gain, while the unfortunate few would be losers to many times the extra sum charged. In each case the charge for the risk was shifted to the tenant, and he had to pay considerably more each year than he would have been called upon to pay if the uncertainty of loss had been removed by a system of insurance. "The risk that an insurance company carries is far less than the sum of the risks of the insured, and as the size of the company increases the disproportion becomes greater."

Just as the rent payer is benefited, so it can be shown that insurance benefits all consumers, since it reduces the cost of practically all commodities by diminishing that part of the cost of production which the manufacturer must necessarily set aside as a fund for protection against risk. Were there no system of insurance, it is apparent that the owner of a vessel, if obliged to carry the risk himself, would naturally want as a precautionary measure to increase his freight charges by at least 10 or 20 per cent. And even then he would be gambling at heavy odds since an early loss, before his self insurance fund had reached an appreciable amount, would largely wipe out his equity. Under arine insurance, however, this vessel owner can substitute for the great uncertainty, confronting him as an individual, a certain and definite loss (the premium) probably amounting on the average to not more than one-tenth of the allowance considered necessary under a non-insurance system. The burden of the consumer is limited to this smaller premium whereas in the absence of insurance it would be increased substantially. By thus eliminating uncertainty, marine insurance greatly reduces the margin of profit wanted in commercial transactions.

Allan H. Willett, "The Economic Theory of Risk and Insurance, New York, 1901, p. 108.