The need for insurance and pension arrangements comes from personal risk and uncertainty.

If you go on a journey or voyage, there is the risk of losing any goods entrusted to you, or your own possessions, or even your life. Your house may catch fire and leave you and your family without a roof over your heads. If you are a breadwinner, you run the risk of dying too soon and leaving your family to starve. You may be unable to get a loan, if the lender is worried about repayment in the event of your death. Alternatively, you may live too long after retirement, so that your savings become exhausted.

Early history

These risks existed from the earliest times, when the usual method of relieving poverty was by charity. Destitute people used to beg on the streets. Nearby monasteries might have provided them with left-over food and drink, or the monks' cast-off clothing. However, charity was never very satisfactory, because it provided inadequate and uncertain relief, with a social stigma.

Hence people tried to protect themselves financially against the risks of life and death. They developed elementary insurance-type arrangements, which often failed because of a lack of knowledge and understanding. Pensions were granted even in ancient Greece, and burial societies were formed in both Greece and Rome to meet members' funeral expenses. In England in the Middle Ages it was sometimes possible to pay a lump sum to a monastery and receive board and lodging (known as a ‘corrody’) there for the rest of your life. However, not all corrodians were compatible with the religious life. An unsuitable person could breed much discontent, as when a lady residing at Langley priory had twelve dogs who used to follow her into church and made a great uproar!

Theories of interest and probability

The seventeenth century began to see personal risk placed on a more scientific basis. Compound interest was studied, which was important later in establishing how much investment income could be earned by the assets of insurance and pension funds. Probability theory emerged with a publication in 1657 by the Dutch mathematician, Christian Huygens. He showed that, in order to have p chances of obtaining a sum of money A and q chances of obtaining a sum of money B, it is worth paying a sum equal to (pA+qB) divided by (p+q).

The Bills of Mortality

Another important advance came in 1662 from a surprising source, a London draper called John Graunt. His great achievement was to show the regularities of the patterns of life and death in a group of people, despite uncertainty about the future lifetime of only one person. He had the original idea of making a statistical analysis of the London Bills of Mortality. These had been published for many years, week by week, to warn wealthy householders when the plague was increasing, so that they could leave London in time.

Graunt’s life table

Although the age at death was not recorded in the Bills Graunt analysed, every Bill did record the number of people dying from each cause of death. Since some causes of death applied mainly to young children, he deduced that about 36% of the total number of deaths related to children dying before age six. This was the starting point for his famous ‘life table’, which showed how many of every 100 babies survived until ages 6, 16, 26, 36, 46, ... etc. Unfortunately the table did not give a realistic representation of true survival rates, because the figures for ages after 6 had to be guessed. Graunt also estimated the population of London, which was often said to run into millions, as 384,000. This is thought nowadays to have been quite accurate – another remarkable achievement.

Creation of actuarial science

It now became possible for the first time to envisage setting up an insurance scheme providing life assurance or pensions for a group of people, where it could be worked out how much money each person in the group should contribute to a common fund assumed to earn a fixed rate of interest.

The first person to demonstrate publicly how this could be done was Edmond Halley, the famous mathematician and astronomer, after whom the comet is named. The Royal Society in London asked Halley to analyse some data collected by Caspar Neumann, a clergyman of Breslau in Germany, relating to the births and deaths in that city between 1687 and 1691. Unlike the London data, the Breslau data were classified by age, and this enabled more accurate survival rates at each age to be obtained. Halley used the data in 1693 to construct his own life table (for individual ages, not just age groups), which was found to give a reasonably accurate picture of survival and became well known throughout Europe.

Most important, however, was the method which Halley demonstrated of using his life table to work out how much money someone of a given age should pay to purchase a life-annuity. Halley examined each future annual instalment of the annuity separately and used his life table to estimate the probability that the person would survive to receive that instalment. The resulting probability was multiplied by the sum (obtained from a compound interest table at a specified rate of interest) which would need to be invested now in order to pay for that instalment if one were certain to receive it. Halley then went on to do likewise for the next instalment, and so on. Summing these present values for all future instalments up to the end of life then gave the value of the whole annuity. Actuarial science had been created.

The Equitable

The first life assurance company to use premium rates which were calculated scientifically for long-term life policies was The Equitable, founded in 1762. The techniques used to calculate these premiums were developed from Halley's method by James Dodson, a London mathematician. The company still exists, though it has run into difficulties recently. Many other life assurance companies and pension funds were created over the following 200 years.

Actuaries

It was The Equitable which first used the term 'actuary' for its chief executive officer in 1762. Previously the use of the term had been restricted to an official who recorded the decisions, or ‘acts’, of ecclesiastical courts!

The Institute of Actuaries

In 1848 the actuaries of a number of life assurance companies established the Institute of Actuaries. Its objects were stated to be the development and improvement of the mathematical theories upon which the practice of life insurance is based, and the collection and arrangement of data connected with the subjects of duration of life, health and finance. Another object was the improvement and diffusion of knowledge, and the establishment of correct principles relating to subjects involving monetary considerations and probability. Thus even so long ago, the Institute's objectives were by no means confined to life assurance. It was clearly envisaged that actuarial science would have wider applications, as has proved to be the case.

The Faculty of Actuaries

In 1856 the Scots in the Institute decided to form the Faculty of Actuaries in Scotland and that body remains the Scottish counterpart of the Institute to this day. The Faculty was, in fact, first to receive the honour of being incorporated by Royal Charter in 1868; the Institute became a chartered body in 1884. For many years, however, the two legally separate bodies have worked as one supporting the UK actuarial profession.

Adapted from an article in 'Inside Careers 2003-2004' by Chris Lewin

• More actuarial history
• Reading list on the history of the actuarial profession [pdf, 119 kb]
• Archive of Equitable Life Assurance Society