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PART ONE

FIRE INSURANCE

CHAPTER I

THE FUNCTIONS OF FIRE INSURANCE

FIRE insurance has been defined as "that social device for making accumulations to meet uncertain losses of capital through fire, which is carried out through the transfer of the risks of many individuals to one person or a group of persons.

2

All industry involving the ownership of combustible property is more or less subject to risk of loss through fire and the elements, and in all business enterprises it is the desire of the capitalist to eliminate this risk as far as possible. Three methods of elimination may be used: either the 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 commonly used by the capi

'The best treatment of this subject is found in Allan H. Willett's "The Economic Theory of Risk and Insurance." Excellent brief discussions are also found in F. C. Moore's introductory chapter to his work on "Fire Insurance and How to Build," and in Richard M. Bissels's lecture on the "Place of Fire Insurance in the Financial World." These sources, especially the first two, have been drawn on to a considerable extent in this chapter.

2 Allan H. Willett, "The Economic Theory of Risk and Insurance," Macmillan Co., New York, 1901, p. 106.

talist of to-day, and the cost of each enters into the cost of production. The extent to which each is used by the capitalist will depend chiefly upon its relative cost. Statistics, however, conclusively show that during each succeeding decade a larger proportion of the country's wealth, subject to the uncertainty of loss through fire, has been protected by insurance carried by companies. The fire-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.

1. Viewed from the standpoint of society in general, as contrasted with the individual property owner, the economic value of fire 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 over $2,633,226,175 worth of property, representing an average annual loss of $175,548,411, has been destroyed by fire in the United States. This enormous amount of property is wasted annually by fire, and i̇s 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 can be applied with greater precision; and the less uncertainty of loss,

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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 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 capitalists, 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, amounted to of 1 per cent of the value, although for individual years the loss varied from a minimum of 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 capitalists, if they wished 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 1 per cent on his investment, or $100 per year, or $500,000 for the entire group, because of the risk assumed. But even at this extra. rate of 1 per cent, these house owners would be making. a gamble at odds of 1 to 100. The chances are that, if obliged to assume a risk of such great odds, they would demand much more than the extra 1 per cent.

But let us now assume that these five thousand capitalists 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 defi

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