Digitized by the Internet Archive in 2007 with funding from IVIicrosoft Corporation http://www.archive.org/details/elementsoflifeinOOdawsrich MILES MENANDER DAWSON, ELEMENTS LIFE INSURANCE, MILES MENANDER DAWSON. V New York : THE SPECTATOR COMPANY. 1896. <^ Copyright, 1892, BY Miles M. Dawson. GENERAL ELEMENTS bF LIFE INSURANCE. INSURANCE IN GENERAL. Insurance is the equalization of fortune. By its pro- visions, a large number of men arrange to lose small sums in order that none of them may lose a great sum in a specified way. Thus it is the alhance of prudent men against misfortune, the most important because the most vital invention of civilization. In so far as insurance is applied — and its field grows wider day by day — it transfers the burden of ill for- tune from the shoulders of the individual to society, thus serving to protect the whole. Freed from the dread of disaster, the individual finds broader oppor- tunities, and dares accept them. This beneficent alliance has been brought about, not bj^ an appeal to sentiment, but by a direct appeal to business men in a business way. The fundamental idea is indemnity, the replacing, in whole or in part, in kind or in equivalent, that which is lost. To give more than the amount lost subverts the very princi- . pies of insurance, in that it no longer merely protects the individual from disaster, but places before him the hope of gain. Insurance undertakes to warrant to a man the continued possession of that which he has; it is contrary to its purpose to cause him to wish to lose what he has in order to possess himself of the proceeds of the insurance. Originally men insured only against those disasters which were least understood and most dreaded, such 100794 as loss of ships at sea, of life on a long journey or Yoyage, of limb or time by railway accident. The common, e very-day risks were beheld with indiffer- ence, even if such misfortune were not met with equa- nimity. A single exception was that of insurance against fire, a not unusual occurence, but one pecul- iarly feared. Particularly where conflagrations might ensue ^were the disasters because of fire dreaded, and in conseqvience ^was fire insurance in demand. The fixing of premium rates for insurance was at first largely a matter of guesswork; but the principle was that of averages, and in due time the rules of average applied. As statistics were compiled, classi- fications of hazard took place, and rates were more accurately calculated. In almost all sorts of insurance the hazard on a given subject may vary at different times and for various reasons. The risk of fire upon a building may vary because of new or changed exposures, because of alterations or new occupancies in the building itself. The risk of accident to an individual may vary because of change of occupation. But in neither of these does there occur a constant change of hazard characteristic of the subject of insurance. In that respect as in many others, two sorts of in- surance form a class, the insurance of individuals against death and against illness. The latter is as yet in its infancy, and is besides foreign to the subject in hand. But in common with life insurance, it cov- ers a hazard which varies regularly, because of the inherent character of physical man. In life insurance, a gradual but increasing tendency to greater hazard appears as the person insured grows older, resulting, finallj', in a certainty of death. Really there can be no such thing as insurance against death without any modification. A man would be accounted a fool who would wager a thou- sand dollars that another would never die. Insurance against immediate death or against premature death is another matter; and, in fact, that is all that any company really furnishes, notwithstanding appearances. For the rest, a ''self-assurance fund" or reserve is accumulated to pay the loss if the insured life survive until the time when death is accounted certain. The usual life policy, therefore, provides, first, for an insurance in the ev^ent of premature death, and, second, for an estate certain accumulated from the insured's own savings in event of death in the full- ness of years. Owing to these peculiar considerations, the study, of the science of life insurance has been attended b}^ greater difficulties than the study of other branches of insurance. Fortunately the statistics of hazards of lives are more complete than any other statistics employed in insurance. Without complete and tolerably accurate vital statistics, it w^ould be a dangerous speculation to attempt to estimate the hazards of lives. Another consideration would add not a little to this perplexity. In the nature of things it would not do to permit a life insurance company to cancel at will a contract entered into by it; nor is it commonly deemed wise to leave the company free to renew the same or not at pleasure. Since these rights, comn on to all other forms of insurance, are b^^ the vt^ry nature of life insurance denied the insurers, it behooves them to be very careful, indeed, as to what contracts they give. For the same reasons the insurers of lives are com- pelled to be cautious in granting such insurance, and to require evidence that the life to be insured is at least up to the average in apparent chance to reach old age. To this end an examination by a physician is required, and a large and not yet fully digested mass of statistics has been collated, bearing on the importance of the various answers recorded concern- ing the applicant's present physical condition, and personal and family history. The tendency in this country, owing largely to the mutual or participat- ing system, has been to discriminate more and more closely. In England the current has set the other way, even to the point of accepting risks without ex- pert examination at all. There is danger in both extremes, for insurance should not be lightly denied the average man, conscious of no ill health and equal to his responsibilities; to refuse insurance to such is to defeat its purpose. On the contrary, men fully equal to the average in health and strength, will be found unwilling to pay beyond the measure of their own hazard; and a company requiring no examina- tion is likely to find itself with impaired lives only upon its books. A thorough overhauling of the more or less crude statistics now attainable would perhaps result in a classification of risks which would admit a larger number to the benefits of life insurance, while at the same time giving to the better risks the full advan- tage due them. Various plans have been already devised for this purpose and one plan of dividing surplus, known as tontine, automatically discrimi- nates in favor of those of superior vitality. The principle of indemnity must not belost sight of in life insurance. The beneficiary in a life policy should have an interest in the life insured. Else the contract is a speculation, a form of gambling and utterly opposed to true insurance, which is meant to defeat the spirit of taking chances, not to foster it. For the same reason the amount of the insurance should be within the financial value of the life to the beneficiary. This question, because of the overesti- mate placed upon a life by those who love the man as husband and father, as well as because few men ex- ceed or even approach their actual value in insurance, has not received the attention given to it in other lines of insurance. Yet it is of paramount importance, because of public policy. One case is now in the courts (and others have been), in which murder for the amount of the insurance is charged. Standards whereby to measure the value of a human life are not lacking in life insurance offices; and eventually, doubtless, more attention will be demanded by this phase of the problem. Meanwhile, the natural course of a life policy (and still more of a limited payment life or endowment) is to reduce the amount of insur- ance as the insured grows older, and to a minimum , in old age. Thus a gradual and natural decrease takes place, adjusting the insurance to the diminish- ing value of the life. This is accomplished by the ac- cumulation of the reserve for the estate-certain, which reduces by its whole sum the actual insurance car- ried. VITAL STATISTICS. To know what statistics show to be the average risk of fire on a certain class of property during the previous year is enough for the fire underwriter. His contract covers but one year ahead or, if a longer period, he has at all times the right to cancel when- ever in his judgment the risk has increased. If he were by the nature of the contract and, in fact, of the business required to warrant a price for the insurance indefinitely and practically without the right to can- cel before a loss or contest after one, it is probable that he would require much more definite information about the risk he was assuming. In very few cases, indeed, would a man accept alife insurance policy about the renewal of which the com- pany should reserve a choice. Even an option of fixing a new rate according to the hazard would make a life policy undesirable. So firm is the public demand for a closed contract that even to dispute a claim for fraud, if death has actually taken place, is an unpopular move. No one would even consider a policy which reserved the right to cancel at will. When the rate is not a level one for life, Hie public requires a definite limit to be placed upon future pre- miums. The only apparent exception is assess- ment insurance, and even then the company has not the right to arbitrarily fix the rate. Men usually en- ter such societies for cheap, temporary insurance ; if they expect permanent insurance, they have been led to believe that the cost cannot exceed a certain figure. In any case, all regular companies are by the nature of things required to guarantee their rates through- out the term of the policj- — commonly for life. If life insurance companies could at their option refuse to renew their policies each year, even waiving the right of cancellation during the year, the rates for insurance could be greatly reduced. In that case the stud^^ of vital statistics would be simplified into the mere question of in what ratio men begin- ning the year in perfect health die before its expira- tion. The deeper and more intricate problem of the average risks of average lives, the course of a gener- ation of men succumbing to disease and thinning out as the years proceed until the last old patriarch is in his grave, would not call for solution. But the life insurance company must provide in its calculations not onty for the inevitable increase of cost because of increasing age, but also for the change from healthy conditions proven by exami- nation to the average condition of mankind. While the matter is not yet considered definitely settled, the actuaries have brought forward figures to show that the benefit of selection is lost in about five years; or, in other words, that in five jears the men this year admitted into the company after strict examinations will not be better risks than the average of men at their then ages. In any case it is certain that, aside from discrimination because of ancestry, the benefit of selection is very soon lost; and therefore is it that no company dares base its calculations on the assump- tion that it will have a better experience than the ordinary. It would not do for a company to base its rate for ten years hence for a policj^ taken at age 40 10 upon its present experience on new policies taken out at age 50. In short, insurance companies must expect a death rate approximating the average death rate of a similar lot of people taken at random from the popu- lation. If there be any gain after the bloom of fresh selection is over, it v^ill be because of freedom from hereditary taint or tendency to disease. But such companies must not make their calculations upon statistics materially more favorable than the general mortuary experience of the country. In order then to insure a single person for his whole life, whether on level premium, limited payment or natural premium plan, it is necessary for a company to fix in advance the rate for each succeeding j^ear; and, to accomplish that, the company must have accurate information as to the hazard at each succeed- ing age until the ultimate limit of life. To obtain such information tables must be made from statistics covering a very large number of lives. These tables will show the actual percentage of hazard at each succeeding age; or, if more convenient for the calcula- tion, v^ill show the actual cost, had each life been insured. A year's statistics of the mortality of this nation would exhibit all ages and would enable one to construct a table showing in what order the lives of a generation now setting out would fail. The gathering and classification of such statistics are no light undertaking even now in this age of statistics. In the infancy of life insurance, the undertaking was indeed an heroic one. August Meitzer in his excellent work on ''The History, Theory and Technique of Statistics " gives a 11 full though concise account of the genesis of mortality tables. The baptismal and death records, begun to be kept in London about the beginning of the seven- teenth century, served as the basis for the first calcu- lations made by John Graunt in 1662. Meitzer says: * 'He calculates that of 100 persons born, 36 die in the next 6 years, 24 in the next decade, 15 in that follow- ing, and then 9, 0, 5, 4, 2 and 1." This would place the ultimate limit of life at 86, considerably below the age now used in any table. More complete tables were constructed by Edmund Halley, in 1693, from the statistics of the city of Breslau. This work also comprised what the author called *' an attempt to ascertain the price of annuities on lives." He calculated approximately the average expectation of life at each age; for the * 'expectation" was originally the basis for premium computations. Insurance of lives from the dangers of distant and hazardous journeys and voyages was already well known. Some men, more daring than others, had also undertaken to insure lives for the term of life. Premiums were crudely constructed from the premise: ''He's good for ten jxars yet," orthe like. ^"Expecta- tion" was regarded the matter of prirhe importance J In 1742, after several life insurance companies haa already begun operations, Johann Peter Siissmilch gathered together in a comprehensive review all the valuable vital statistics then available. At the initiative of the philosopher Menander, Sweden the preceding year had begun the registration of births, marriages and deaths, thus becoming the pioneer in national statistics of that sort. In 1765 the Equi- table Life Insurance Institution was founded at Lon- don, the first to operate on the mutual or participa- ting principle. During all this time, and in fact until after the beginning of the present century, the com- panies made their rates from the fragmentary data furnished by Siissmilch. Wide differences therefore occured in the rates of the companies, even where intelligent management prevailed. Elsewhere the fatuity which again presented itself a few years ago in assessment concerns, and is even now prevalent in endowment bond swindles, led scores of institutions into bankruptcy. To avoid such perils, it was found necessary to obtain definite statistics showing what the average death rate is at each age, so that, when one under- took an insurance upon a life, it could be demon- strated whether the present resources and future premiums balanced the risk. For this purpose, about 1815, Milne tabulated the mortality of Carlisle city from 1779 to 1787 and from it framed the ''Carhsle Tables," which became very popular. The "Actuaries' or Combined Experience Tables" w^ere at a later date deduced from the experience of seventeen English companies and in most quarters supplanted the Car- lisle. "The American Experience Tables" are the w^ork of Shephard Homans, then the actuary of the Mutual Life Insurance Company of New York, and were deduced from the experience of that company. These two latter tables have been made authoritative in this country. Nearly all the States employ the actuaries' tables; the State of New York uses the American. In England the "Carlisle Tables" still divide the honors with the "Combined Experience." There is no very great variance between the three. 13 The widest difference arises from the placing of the ultimate limit of life at age 95 in the American tables; the other tables place the limit at age 100. This is really arbitrary, however, and by no means signifies that the limit of life in America is lower than in England. The figures given at the older ages — from 75 on— are in all tables rather the result of logic than calculation. Complete and full statistics at those ages are wanting; and the best that the actuaries have yet been able to do is to arrive at such figures in the tables by an abstruse geometrical calculation, w^orkingfrom what is known as the curve ofmortality, the sweep and direction of which is easily demon- strated by the facts known concerning mortality at younger ages. The ultimate or extreme limit of life, taken together with the sweep of this curve, deter- mines the speed or slowness with which the remain- ing lives fail. The experiences of nearly all the American com- panies were combined a few years ago to form -a new set of tables, one for male lives and one for female. Various statistics dealing with mortality by States and even counties, and also v^ith the various causes of death, w^ere carefully collated. Only a small part of the information thus brought to light has as jet been utilized; the classification of hazards is yet in its infancy, despite the clearest demonstration of the differences caused by sex, locality and heredity. The analysis of the statistics of female risks showed that a higher death-rate was to be expected from age 20 to age 40 than among male lives, and a much lower death rate from age 40 to age 65. This indicated that a special rate and a special reserve should be 14 made for female lives. This has not been done. Some companies charge women $3 or $5 per $1,000 more than men up to age 45; others charge both sexes tl;ie same. But none charges less after age 40 and none has attempted to construct scientifically ad- justed rates for female lives, although Mr. Meech, who compiled the statistics referred to, has made it easy to make the adjustment. The same is true concerning each and every other item in this valuable compilation. In example, the more conservative companies limit their operations to States in which the mortality v^as found favorable; the others write freely, making a distinction, if any, in dividends only. Nothing approaching scientific discrimination in rates has been tried, even in the matter of lives in the Arkansas swamps, where an old person is rarely seen. Doubtless many of the companies were deterred from making any discrimination in rates by the fact that all the States were rapidly coming to imitate Massachusets in adopting the arbitrary standard of the actuaries' tables for estimating reserve liabilities. The honored actuary, Elizur Wright, who had urged the adoption of this standard, considered it by no means a final one, but, instead, only the most reliable then at hand. It was in no sense his purpose to make companies technically insolvent which were not genuinely insolvent; and far less ^was it in is mind to prevent companies from making a rate commensu- rate with the actual hazard. He was on the outlook for definite information relating to the mortality experience of American companies, and he expected American companies to conform their rates to Amer- ican experience. In his report of 1864 to the Massa- 15 chusetts legislature, Mr. Wright gives the compar- ative experience of American companies as reported to him, and in commenting upon the figures he says: **It seems to us, after a careful consideration of the experience of the companies which we have observed for the last five years, as well as that of several of the larger American companies prior to that time, that premiums might be considerably reduced with safety on policies not extending beyond the age of 70." In his report of the following year, Mr. Wright gave a further illustration of the favorable experience of American companies and said: *'0f course this favorable difference of experience cannot be perma- nently held by companies whose business is chiefly whole-life policies; for if the death rate is slower on the earlier ages, it must be faster on the later, the limit of human life being pretty certainly fixed." Mr. Wright clearly had no intention of creating hard and fast lines which should fix once for all the rates to be charged for life insurance; and the State supervision which refuses to take into the account more recent statistics resembles what Elizur Wright did about as Pharasaism resembled the religion of Job. At the same time, Mr. Wright was at one with the others in the idea that ^' the limit of human life is pretty certainly fixed." In consequence of that, to his view, later mortality almost balances present saving; the fewer deaths now, the more hereafter and before the limit fixed in our calculations. Such a view seems natural, but is nevertheless fallacious; for the same vitality which means longer lives in the aggre- gate means a longer life to the oldest survivor as well. The two are but different expressions of the same 16 fundamental fact, the superior vital energy of the race; and the existence of one necessarily implies the other. The gain in mortality is therefore an absolute gain, not to be neutralized by an augmented death rate beyond 70. This statement does not rest upon logic alone^ but is supported b3^ facts. The mortality of the Presby- terian Ministers' Fund, the oldest American company, shows a heavy saving over the actuaries' tables, which saving is quite as apparent at older as at younger ages. This is not an exceptional case in this regard, for the New England, the Mutual Benefit and the Connecticut Mutual, all of which are old companies and have done a whole-life business prin- cipally, now make heavy gains from mortality each year. Reports of longevity beyond the limit set by the tables have been frequent and in many cases abso- lutely indisputable. It would almost be safe to say that the facts justify puttingthe limit at 110, or pos- sibly 120 instead of C5 or 100. The fact that the tables compiled by Mr Meech followed the old assumption as to the limit of life probably had not a little to do with their want of influence upon the practice of companies. The varia- tion from the actuaries' and American experience tables did not seem wide enough to render the use of the old tables ridiculous; and so long as the old tables continued the arbitrary standards of State depart- ments, the companies could not well undertake any serious departure in rates. One company did under- take, not a discriminating adjustment, but a general reduction of rates to accord with its actual experience. 17 The arbitrary tests of the old tables soon made its surplus seem pitiably small and even threatened to wipe out that margin in time. So the attempt was given over after a somewhat stubborn struggle, and a return to the old standards w^as inaugurated In consequence of these things, the actuaries' and American tables, though known to be too unfavorable and also to be opposed to proper classification of hazards, yet remain the standards both for govern- mental examinations of life insurance companies and for the making of rates and dividend calculations and adjustments within the companies themselves. Since the actuaries' tables are standard in nearly every State, they will be referred to hereafter in the illustrations given in this work. The tables are here given, together with the rate per cent of mortality and the expectation of life at each age from 10 to 100. ACTUARIES ' TABLE OF MORTALITY. Number Deaths Per cent, of Expecta- AGE. living. each year. deaths to the living. tion of life. 10 100,000 676 .006760 48.36 11 99,324 674 .006786 47.68 12 98,650 672 .006812 47.01 13 97,978 671 .006848 46.33 14 97,307 671 .006896 45.64 15 96,636 671 .006944 44.96 16 95,965 672 .007003 44.27 17 95,293 673 .007062 43.58 18 94,620 675 .007134 42.88 19 93,945 677 .007206 42.19 18 Actuaries' Table of Mortality.— Continued. Nnmber Deaths Per cent, of Expecta- AGE. living. each year. deaths to the living. tion of life. 20 93,268 680 .007291 41.49 21 92,588 683 .007377 40.79 22 91,905 686 .007464 40.09 23 91,219 690 .007564 39.39 24 90,529 694 .007666 38.68 25 89,835 698 .007770 37.98 26 89,137 703 .007887 37.27 27 88,434 708 .008006 36.56 28 87,726 714 .008139 35.86 29 87,012 720 .008275 35.15 ,/ 30 86,292 727 .008425 34.43 ^ 31 85,565 734 .008578 33.72 32 84,831 742 .008747 33.01 33 84,089 750 .008919 32.30 34 83,339 758 .009095 31.58 35 82,581 767 .009288 30.87 36 81,814 776 .009485 30.15 37 81,038 785 .009687 29.44 38 80,253 795 .009906 28.72 39 79,458 805 .010131 28.00 40 78,653 815 .010362 27.28 41 77,838 826 .010612 26.56 42 77,012 839 .010894 25.84 43 76,173 857 .011251 25.12 44 75,316 881 .011697 24.40 45 74,435 909 .012212 23.69 46 73,526 944 .012839 22.97 47 72,582 981 .013517 22.27 48 71,601 1,021 .014260 21.56 49 70,580 1,063 .015061 20.87 50 69,517 1,108 .015939 20.18 51 68,409 1,156 -016898 19.50 H h 19 Actuaries' Table of Mortality. — Continued. Number Deaths Per cent, of Expecta- AGE. Hving. each year. deaths to the living. tion of life. 52 67,253 1,207 .017947 i 18.82 53 66,046 1,261 .019093 18.16 54 64,785 1,316 .020313 17.50 55 63,469 1,375 .021664 16.86 56 62,094 1,436 .023126 16.22 57 60,658 1,497 .024679 15.59 58 59,161 1,561 .026386 14.97 59 57,600 1,627 .028247 14.37 60 55,973 1,698 .030336 13.77 61 54,275 1,770 .032612 13.18 62 52,505 1,844 .035120 12.61 63 50,661 1,917 .037840 12.05 64 48,744 1,990 .040826 11.51 65 46,754 2,061 .044082 10.97 66 44,693 2,128 .047614 10.46 67 42,565 2,191 .051474 9.96 68 40,374 2,246 .055630 9.47 69 38,128 2,291 .060087 9.00 ^ 70 35,837 2,327 .064933 8.54 "^ 71 33,510 2,351 .070158 8.10 72 31,159 2,362 .075805 7.67 73 28,797 2,358 .081884 7,26 74 26,439 2,339 .088468 6.86 75 24,100 2,303 .095560 6.48 76 21,797 2,249 .103179 6.11 77 19,548 2,179 .111469 5.76 78 17,369 2,092 .120444 5.42 79 15,277 1.987 .130065 5.09 80 13,290 1,866 .140406 4.78 81 11,424 1,730 .151436 4.48 82 9,694 1,582 .163194 4.18 83 I 8,112 1,427 .175912 3.90 6 5. 1'/^ 20 Actuaries' Table of Mortality.— Concluded. Number Deaths Per cent, of Expecta- AGE. living. each year. deaths to the living. tion of life. 84 6,685 1,268 .189678 3.63 85 5,417 1,111 .205095 3.36 86 4,306 958 .222480 3.10 87 3,348 811 .242234 2.84 88 2,537 673 .265274 2.59 89 1,864 545 .292382 2.35 90 1,319 427 .323730 2.11 91 892 322 .360987 1.89 92 570 231 .405263 1.67 93 339 155 .457227 1.47 94 184 99 .516304 1.28 95 89 52 .584270 1.12 96 37 24 648640 .99 97 13 9 .692308 .89 98 4 3 .750000 .75 99 1 1 1.000000 .50 21 RATEMAKING— TERM AND NATURAL PREMIUM. The simplest method of apportioning the contribu- tions for life insurance is the annual renewable term or natural premium plan. This plan provides for rates increasing as the insured's age increases, each year taking care of itself. To ascertain the net rate at any age for $1,000 in- surance, assume that you have insured the numbe? living at that age according to the tables. Then by reference to the tables at that age you will find the number dying; that number multiplied by $1,000, slip.ws the total expected loss for the year. All actu- aries assume that these losses are to be paid at the close of the yesiv ; hence to ascertain what should be collected at the beginning of the year to cover them the amount should be discounted at 4 per cent simple discount. As that sum is what the whole number living at the age named should pay, it is only neces- sary to divide it by the number living to find what each should pay. The quotient is the net natural premium of that age. At the close of that one year the insured renews if at all at the premium for one year's assurance at the next higher age. And so on, indefinitely, the cost finalh^ becoming prohibitory. Doubtless, if mortality tables of a complete and ac- curate character had preceded the assuring lives in point of time, the natural premium tables would have been early discovered. But mortality tables only 22 came into existence in answer to a call by actuaries for safer and fuller data from which to work on plans covering the whole period of life in insurance and annuities. These plans were already in existence and high in popular favor. Scientific exploitation of statistics is supposed to set forth the simpler deriva- tions first; but the practical business world often adopts the complex before science has examined the data at all. Natural premium insurance, therefore, while by far the simplest form, came latest into the arena, rather tardily endeavoring to satisfy the public's demand for pure insurance at a low price. The popular de- sire had voiced itself in a swarm of hastily organ- ized and improperly managed associations and or- ders before actuaries and managers could be made to see that it was possible to sell life insurance from year to year at its current value. Even now the lesson is but half learned, and the term natural pre- mium is used to cover a multitude of frauds and thefts, simply because it is yet a mystery t^ many. A very large proportion of the worlc^s insurance will alw^ays be of the character known* as *' tempo- . rary," that is, will be intended only to cover for a limited , even if indefinite, period of time. Regular com- ' ■'panics have been more or less averse Jo undertaking to supply this want, because among actuaries it was a grave question whether there was not so great an opening for adverse selections, or the departure of healthy lives, that no company could hold up under it. Therefore, except when united with a heavy in- vestment, thus affording something to be forfeited in event of discontinuance, the regular companies 23 were for a long time unwilling to make a practice of issuing renewable term policies. Only during the last decade has this form of insur- ance been popularized, largely through the deter- mined efforts of SheppardHomans, the renowned Nes- tor of American actuaries. For the purpose of push- ing this cheap and useful form of insurance before the public, Mr. Homans caused the organization of a new company and devoted the later and maturer years of his life to advancing the cause of natural premium insurance. In the construction of rates Mr. Homans made an addition of one- third to the net rates to form a special reserve or guarantee fund. To the whole rate thus made up he added just $4 per $1,000 insurance for expenses. The addition of the percentage for a guarantee fund seems to have been for the purpose of preventing adverse selection during the earlier years. It was Mr. Homans' original idea to distribute this fund to reduce the premiums after ten years. This plan has since been almost abandoned however; and so much as is necessary to keep the rate level at the age of entry is used each year for that purpose, the remainder being carried forward with interest. The original intention, therefore, was to have the cost advance gradually as the actual hazard increased; but now the rate is kept level as long as possible and then the rate recoils to a high figure when the artifi- cial reduction ceases for want of funds. This is prac- tically a surrender of the principles of natural premium insurance, and an imitation of level premium. The rates for terms longer than one year are made in the same manner as rates for one year's insurance. 24 For instance, if a person were set to construct a pre- mium to be paid in advance in one sum for term in-" surance for two years, lie would discount the sum of the losses for the first year at 4 per cent simple dis- count for one year, and the sum of the losses for the second year at 4 percent compound discount for two 3^ears. These sums he would add together and divide the total by the number living at the beginning of the year. The quotient would be the single premium for term insurance for two years at the^e specified. ^ If a single premium for three years insurance were- required, it would only be necessary to add to the sum of the discounted losses of the first and second years the present value of the losses of the third year, calculated at 4 per cent compound discount for three" years. Then divide by the number living at the orig- inal age as before. A similar process will reduce the net single premiums at every age and for any term of years. The single premium of a one-year term policy is the annual premium for a natural premium policy for the current year. ^ But where a level annual premium is required the 'Case is somewhat different. In that cape the first and subsequent annual premiums must be equivalent to the net single premium for the same term. To ascer- tain what^annual premium will be equivalent to the single premium, it is first necessary to find out what is the present or discounted value of one dollar in hand and one dollar promised to be paid annually during the term if the insured is living. In other words, the promise of the insured to pay a dollar 25 each year must be dealt with as an annuity upon his life, but in the company's favor. To ascertain the present value of one dollar a year from now, the payment conditioned upon the in- sured now at a certain age then being alive,, it is first necessary to discount the dollar at 4 per cent simple discount, and then to multiply the same by the frac- "^ tion formed by dividing the number living at the end of the year by the number living at the beginning. That fraction represents the probability of one's be- ing yet alive to pay at the close of the year ; and the result of multiplying the present value of one dollar by it is to find the present value of the dollar subject to the contingency of death during the year. This sum added to the one dollar to be • paid in advance the first year gives the total present value of a prom- ise to pay a dollar annually in advance for two A^ears if living. If the present value of an annual premium of one dollar for two years be ascertained, then to ascertain the number of dollars in an annual premium equal in value to the single premium for term insurance for two years, divide the single premium by the present value of the annuity of one dollar. The quotient will ^ be the annual premium corresponding to the single premium. If the annual premium for a three-year term were required, it would only be necessary to add to the present value of an annuity of one dollar for two years the present value of a third dollar to be paid at the beginning of the third year, conditioned upon surviving the first and second 3^ears. To find that value multiply the present value of one dollar at 4 per 26 cent compound discount for two years by the frac- tion formed by dividing the number living at the be- ginning of the third year by the number living at the beginning of the first year, according to the tables, This fraction represents the probability of surviving until the beginning of the third year and the result of the multiplication expresses the present value of one dollar payable two years hence if living. Adding this value to the pr-esent value of a two-year annuity of one dollar already ascertained, the present value of a three-year annuity of one dollar is found. By dividing the net single premium for three years' term insurance by the present value of an annuity of one dollar for three years, the number of dollars neces- sary to be paid annually to equal the single premium or, in other words, the corresponding annual pre- mium, is arrived at. A continuation and elaboration of this process will yield the net annual premium at any age for term in- surance for any number of years. The loading or margin for expenses and contingen- cies on the annual renewable term or natural pre- mium rates is commonly $4.00 per $1,000 insurance in addition to the thirty-three and a third percent of the net premium added thereto to form a special re- serve fund. The loading on single-premium term policies, and on annual-premium term policies as well, is com- monly thirty-three and a third per cent of the net premium. 27 RATEMAKING— WHOLE LIFE. Death is not a mere chance, but, on the contrary, the most certain of human events. In the nature of things, it would be folly to bet against its occurrence without hedging; and therein consists the fatuity of assessmentism. Any insurance intended to cover the whole period of life must be calculated on the basis of paying a certain claim. If a pool were formed and it were gravely proposed to put in money enough to leave each member's widow one thousand dollars at his death, the deposit re- quired from each one would be easily estimated, and would be the same regardless of the then ages. It requires one thousand dollars to create an estate of one thousand dollars; if none were to pay more than that, none could pay less. The onh^ modification arises from the fact that, while death is certain, the time of its occurrence is very uncertain. Even that would make no difference in the proposed deposits if it were not for the fact of interest. The possibility of earning interest upon such deposits, until they are gradually paid out in death-claims, puts a new face on the aifair. Then the element of time assumes importance and It is necessary to endeavor to discover at what time at the earliest the various payments would be required because of death. For this purpose were " carefully constructed and conservative mortality tables found requisite. For mere term insurance much 28 more crude and careless estimates would have an- swered. But where certain loss stares one in the face, not to be escaped and for which one must without fail prepare, it is essential to know when it is to be expected. Forewarned is forearmed. Suppose, therefore, that, armed with mortality ta- bles, a man was set to calculate: \ (1) When the amounts of the insurance on the lives of 1,319 persons now aged 90 would have to be paid; (2) what gross amount he would need to have in hand now to meet such payments as they fall due, assuming that he could earn 4 per cent, on sums in his hands^ (3) what sum each of the 1,319 would have to pay in as a single premium to make up the necessary fund; (4) what is the present value of one dollar in hand plus a promivSe of a man now 90 to pay one dollar each year until his death; (5) what annual premium in advance is equivalent to the single premium at age 90. Referring to the actuaries' tables it is found that the 1,319 living at age 90 die in the following order: The first year 427 The sixth year 52 '' second'* 322 ''seventh'* 24 " third " 231 " eighth " 9 " fourth " 155 '' ninth " 3 " fifth " 95 " tenth " 1 Therefore if each be insured for $1,000, payable at the close of the year in which he died, the insurance would have to be paid— $427,000 in one year, etc., ending with $1,000 in ten years. If a man owe $1,000, due in one year, and money will earn 4 per cent., he holds the equivalent of his debt when he possesses $1,000, discounted at 4 per cent., or about $961.54. Therefore, if he owes $427,- 29 000 due in one year, he should possess 427x$961.54^ in order to be solvent at the present moment. The equivalent of $1,000 due in two years, reckoning in- terest at 4 per cent., is about $924.56; therefore the amount required to be in hand to pay $322,000 of losses the second year is 322 x $924.56. In the same way all the death claims can be discounted and cal- culated at their present values. The sum of such present values is $1,192,897.65 and constitutes the gross present fund which will enable him to meet all mortuary claims as the same fall due. If it is the intent that these 1,319 old men shall de- posit each the same amount, the whole to be suffi- cient to pay the family of each $1,000 at his death, it will be necessary for each to deposit l-1319th part of $1,192,897.65, or about $904.40. This amount, therefore, is the net single premium at age 90. If these 1,319 men are to pay each his quota in equal annual payments so long as he lives, it is evi- dent that the number paying will each year be de- creased by the number dying during the previous year. For instance, if each were to pay $1.00 at the beginning of each year during life, $1,319.00 would be received the first year. But before the second pay- ment would fall due, 427 would be dead, and only l,319less 427,or892,would remain to meetpayments. The amount collected, therefore, would be but $892, which being discounted at 4 per cent, is equivalent to $857.69 in hand. The equivalents of the amounts which the payments each succeeding year will yield is determined in the same manner; and when these are added to the $1,319 in hand the immediate value oi the promises of 1,319 30 men aged 90 to pay $1.00 each annually in ad- vance is obtained. The value of such promises is about $3,278.24; and expressed in fractions the aver- age value of each man's promise or in other words of a life annuity at age 90 is $2.485398. If the present v^orth of the 1,319 men's promises to pay $1.00 annually in advance throughout their lives is $3,278.24 and the immediate fund necessary to pay the estate of each $1,000 at his death is $1,192,- 897.65, it is evident that the annual premium charged these men must be as many times $1.00 as $3,278.24 is contained in $1,192,897.65, or about $363.89 net. The same conclusion will be arrived at if the net single premium for insurance be divided by the net present value of an annuity of $1.00. That, indeed, is the usual course when making this illustra- tion. For actuarial and accounting purposes all these operations are simplified (in a mathematical sense- only) and short methods are employed to reach re- sults required. The mass of figures is codified into commutation tables, and they are then expressed in logarithms in large part, which makes it possible for divisions and multiplications to be performed by sub- traction or addition. It is these arrangements for mathematical convenience which give to, the science of insurance an appearance of mystery. The actual operations are simple enough, but cumbersome. All net single and annual premiums for whole life insurance are arrived at in the same manner as the foregoing. To such net premiums a loading of from 25 to 40 per cent is commonly added to cover all contingencies and expenses. 31 RATEMAKING— LIMITED-PAYMENT AND EN- DOWMENT. Endowment is the antithesis of life insurance; that is to say, an endowment is conditional upon a man's living, while life insurance is pa^^able only at death. A simple or pure endowment, therefore, is synony- mous with the original idea of tontine, each being in- tended to benefit survivors only. This idea was early adopted as a corrective of the apparent tendency of life insurance to be too expen- sive to those who live long, and it was expected to induce many to insure, by the hope of gain, who, confiding in perfect health and constitutions, might otherwise have refused to act. By combining the advantages of insurance in event of death and of cer- tain endowment in event of survival, it was hoped that the best lives might be attracted. Recent inves- tigations set forth in Dr. Emory McClintock's essay ''On the Effects of Selection," seem to indicate that this hope has not proved groundless. Although in practice the endowment is very rarely seen except connected with life insurance, yet in fact the two things are very different and essentially dis- tinct. So far as any real gain is concerned, the two operations might as well be in separate institutions. In the calculation of rates, therefore, it is necessary to take up the two elements separately, one being the cost of the endowment and the other the cost of the insurance — one the providing for a certain payment 32 to those who do not die, the other providing a cer- tain payment for thope who do die. The company which agrees to pay each of 100,000 men now aged 10 $1,000, if he survives to age 30, must have a total of $86,292,000.00 on hand 20 years later, according to the actuaries* table, for there will be 86,292 people A^et living to demand the fulfill- ment of that contract. The lower the death rate has( been the more will Ha^c to demand the payment; the higher the rate has been, the less will be required to meet all demands. Assuming the experience of the table, to find the amount required to be on hand now to meet such obligations it would only be necessary to discount this gross amount at a rate of compound discount, such as may be assumed to be certain to be secured. Assuming 4 per cent as such a rate, it is found that the present value of $1,000 due in 20 years is $456,387, It follows that the present value of $86,292,000 will be $456.387X$36,292, or $39,- 382,547.00. Now if the original 100,000 boys were required to put into the pool sufficient to pay each survivor $1,000 at age 30, each would have to pay in 1-100,- 000 that amount or, approximately, $393.82, which is the net single premium at age 10 for a pure endow- ment due in 20 years. The net annual premium may be arrived at by dividing this single premium by the present value of a 20 year annuity of $1.00 at age 10. Endowment life insurance provides not only for the payment of endowments tJ the survivors, but of life insurance to those that die. The net single premium for the latter can be founa by the calculations for term insurance rates for the endowment period. 33 This net single premium for $1,000 at age 10 for a term of 20 years according to the actuaries' table at 4 per cent is $92.75. This premium covers the con- tingency of dying before the completion of theendowr- ment period; the simple endowment premium covers the contingenc3^ of surviving. The two combined cover all contingencies and provide for the payment of a certain claim, due at the end of 20 3'ears or at prior death. The net single premium therefore at age 10 for a 20 year endowment life insurance of $1,000 is $393.82+$92.75 or $486.57 in all. To find the net annual premium, this sum should be divided by the present value of an annuity of $1.00 for 20 years from age 10. In the case of semi-endowment policies, the amount of the endowment is not the same as the amount of insurance, being but one-half as much. Other pro- portions are occasionally used under a similar name, but inaccurately. In such case, the single premium for the amount of the endowment and the single premium for the amount of insurance should be added together as before, and the annuity similarly applied -as a divisor. In the case of limited-payment life policies', the intent is to provide insurance for those who die before the completion of the premium-pay- ing period and also a fund sufhcient to furnish paid-up insurance to all who survive the same period. This is equivalent to a partial endow- ment life insurance, the endowment being for an amount equal to the net single premium at the age attained upon completion of period; for such single premium is the net amount necessary to sustain a, 34 paid-up insurance at that age. Therefore, to calcu- late the net single premium for a limited-payment life policy, find the net single premium for term insurance for the amount of the policy to cover the premium- paying period; then find the net single premium for a simple endowment equal to net single premium for insurance at age attained at the close of the period. The sum of these two is the net single premium for a limited-payment life policy. To find the net annual premium proceed as before to divide the single pre- mium by the present value of a temporary annuity of $1.00 for the premium-paying period. The annual premium may be ascertained directly from the single premium for a whole life insurance by the same process; for it will be found that the single premium obtained by the foregoing process and the single premium obtained by process described in the previous paper are identical. As has been said before, the higher the death rate has been, the fewer remain to draw an endowment; consequently a pure endowment contract is the more profitable to a company, the higher the death rate has been. On the contrary, the other component part of an endowment life insurance premium, the term in- surance element, 3''ields the more profit the lower the death rate has been, since fewer persons have by dy- ing caused outlay for death claims. In endowment life insurance, the claim against the company is a certain one, the only question being as to time of payment, during the endowment period in case of death. Hence the gain because of one death fewer in any year is not the amount which would have been paid, but only the interest on the same to the ma- 35 turity of the endowment period. The gains of supe- rior mortality on endowment policies are therefore small, and less on short term endowments than on others. While, as has been said, the endowment and life in- surance transactions are essentially distinct, and in fact complementarj^ to each other, and while they could as well be carried on in different companies, it must not be understood, as some misguided men have thought and said, that it is equivalent to an endow- ment life insurance to carry term insurance and invest in usual channels. The endowment portion of a life insurance premium is not that sum which paid an- nually in advance and improved at a certain rate of interest compounded will equal the promised sum at the close of the period. It is that smaller amount which will be sufficient on the average to pay the promised sum only to all who survive. In instance, the annual payment in advance which produces $1,000 when compounded at 4 per cent in- terest is about $32.29. The net annual premium for a 20 year endowment life insurance at age 20 is $36.97, according to the actuaries' table at 4 percent interest. By the same table the net 20 year term rate at age 20 is $8.24. Deducting this from the endow- ment life insurance premium, we have not $32.29, but $28.73 as the net premium for a simple endowment. A loading for contingencies and expenses is added to the net premiums, such loading commonly vary- ing from a minimum of 20 per cent on the net pre- miums to a maximum of 40 per cent. The question of "loading," its purpose and misuse, will be consid- ered hereafter under a separate heading. OF 36 RATEMAKING— SPECIAL AND UNUSUAL CONTRACTS. One of the most common of the dep artures from what is considered regular in life insurance, is to make the premiums payable otherwise than annually. Pre- miums payable semi-annually, quarterly, bi-monthly and even monthly are too common to excite remark, and in industrial insurance weekly premiums are the rule rather than the exception. The treatment of these departures is for the most part unscientific and purely arbitrary. Almost all offices, for the convenience of their book-keepers, choose to consider all policies (unless paid for a longer period) annual premium policies, and all deferred premiums practically as credits granted. This is car- ried to the point of deducting all such deferred premiums from the face of the policy upon the death of the insured. Such is even now the practice of al- most all companies. There appears to be no good reason why proper rates should not be established for such methods of payment which would not place the policyholder in the unenviable attitude of debtor. The extra charge usually exacted for th^ privilege ofsmaller and more frequent payments is ample to cover the added risk— that of paying a few dollars more in proportion to cash received. In order to pay quarterly or semi-annually in the least arbitrary companies, one is called upon to pay 3 per cent more than the annual rate; in many companies the in- creased cost is nearer 5 per cent. This charge 37 amounts to a very high interest upon the deferred amount and no advantage accrues other than that of time of payment. Of course these are small mat- ters, only worthy the time spent upon them because the day is at hand when insurers \y^ll demand a why and wherefore for all such requirements. In the matter of monthly payments, however, the overcharge approaches extortion, the less excusable because it is visited upon those ^vho are less able to bear it, the ^N^age workers. The method of adjusting such premiums is commonly to divide the annual rate by ten, thus exacting during the year 20 per cent more than the annual premium. As these premiums are usually paid like others, into the office, the pleacf great additional expense hardly bears examination. In the case of ^^eekly premiums there is more justi- fication for a considerable increase of cost, because such premiums are usually collected from house to house, and in very small sums. Yet, even in such cases, the percentage paid for collecting rarely exceeds 15 per cent and as the loading on whole life policies is nearly always more than 30 per cent of the gross premium, it ^would seem that a very moderate in- crease might answer after aU. One of the most common variations is the introduc- tion of the return premium feature into policies. The effect of this feature upon the unsophisticated is that of bewilderment; yet the method by which this is ac- complished is by no means difficult of explanation. In all problems jQt presented, v^^e have had to deal only with the payment of a definite equal sum upon the death of each insured. Suppose instead that the agreement was to insure the lives of 1,319 people now 38 aged 90 years as follows: To pay $100 each to the heirs of all who died the first year, $200 for all who died the secondyear, etc., at arithmetical progression, and ending in $1,000 to the heirs of the onemanwho died at age 100. By calculating the gross amounts which would be paid out each year for death losses in this manner, then reducing such amounts by com- pound discount to their present values and adding the same together, we arrive at the total amount it would be necessary to have on hand if one undertook these insurances without expecting any further premiums. That gross amount divided by the number insured, (1,319) will yield the net single premium required from each to effect such an insurance. By dividing this single pre- mium by the present value of an annuity of $1 in advance, the net annual premium for such an insur- ance is found. Suppose, now, that it be required to find the extra premium to be charged for a contract to return a premium of $100 at death. It is evident that the transaction is separate and distinct from the original insurance and is in fact identical with the contract already described. That the extra premium is to be returned as well as the original premium only appears to complicate the matter, for it is easy to approxi- mate by ordinary arithmetical means the actual premium required. Algebraic means while really more simple and direct, are not within the scope of the present book. Another form of insurance, now becoming more common and popular, is that by which the principal amount is payable in deferred installments after 39 death, and in some cases after maturity, as an endow- ment. This sort of poHcy is Yariously known as an installment contract, an annuity contract, a trust certificate, and a ^* special " contract. The rates are apparently somewhat lower than those of other pol- icies but, as in so many other things, appearances are here deceitful. The only mystery about these contracts is the actual insurance carried, which is not the princi- pal amount named in the policy but merely the pres- ent value of the installments. By proceeding with that fractional amount as the principal sum, in the beaten path of previous calculations, it w^ill not be found difficult to make rates for these policies. Another late candidate for popular favor is the ** Guaranteed Interest Bond," by w^hich, after pay- ments cease, the insured may leave the principal sum as a paid-up policy and draw a certain interest an- nually thereon. In some cases, ivhere the interest does not exceed 4 per cent, there is no extra charge for this feature, the interest being just what it seems. The New York companies in general, however, and many others have not thought it best to assume so high a rate of interest in their calculations. That fact makes the determination of proper rates a fresh and somew^hat unique problem, for it is reallj^to raise a phantasm of what is not. For the usual style of contract, w^here the income and paid-up insurance continue for the life of the assured, the rate may be arrived at either (1) by combining the rate for a lim- ited payment life policy with the rate for a deferred annuity equal to the desired income, or (2) by com- bining the rate for an endowment with the rate for a deferred annuity equal to the difference between the 40 actual interest they are ready to guarantee and the income promised. Where, after a certain further num- ber of years, the company agrees to pay the principal over, a combination of the rates for limited-payment endowment and for an annuity equal to desired in- come should be used instead of first combination just given. In all cases where the company is not in fact willing to pay as an interest the promised income, the reserve value at the beginning of income-paying period is larger than the principal sum of the policy. The latest departure is the continuous instalment policy, providing, first, for a definite instalment for a term of years and, second, for a continuation of the instalment throughout the beneficiary's life if he or she survives the term. This covers the usual specious objection to a survivorship annuitj^, that the bene- ficiary might die after receiving but one payment and so a considerable sum be lost; and it also covers the more substantial objection to an ordinary instal- ment policy, that it may not provide an income for the life of the beneficiary. A rate for this policy is made either by increasing the rate for an ordinary instalment policy by a premium covering the value of the contingent annuity beyond the term of the in- stalment; or, more simply, by adding to the rate for a survivorship annuity the difference between the premiums for a term annuity-certain and a term annuity contingent upon life. 41 RATEMAKING-THE LOADING. What has been said in preceding papers on the general subject of ratemaking has concerned only net rates or the premiums which will be sufficient, assum- ing a certain rate of interest and a death rate accord- ing to the tables, to cover all demands. Possible errors in these premises are not taken into account. The possibilities of losses on investments, of reduced interest earnings, of augmented death losses, are not provided for; and no provision is made in the net rate for any expense whatsoever. It is not so many years since a life insurance pre- mium was first divided into its component parts; and a much shorter time has it been since insurance men became unanimous about the necessity for loading. Among the first of the many altercations into which Elizur Wright's love of justice led him, was one with a then reputable English company which was ready to prove itself solvent on the basis that it would hereafter have no expenses but death losses, no ex- cessive mortality, no interest earnings lower than the rate assumed, and no losses on investments. In other words, in the judgment of their actuary, no loading was required. That view was supported by no less an authority than F. G. P. Neison, then the leading actuary of England with a string of academic titles following his name, and in this country it was en- dorsed by the then professor of mathematics at Yale. Of course both were disposed to scoff at this untitled 42 interloper, who won the day, nevertheless, and be- came heir to the name, '' Father of Life Insurance." The position which he declared untenable was that future premiums will not be required to cover future exigencies, and that it is safe to spend more than the loading now and recoup from future savings. Any such charge or mortgage against future premiums was in Mr. Wright's view a reduction of the premium from the start and an impairment of the company's resources which deserved attention. The outstand- ing brokerage renewal contracts of many companies — that is, contracts to pay renewals as part compen- sation for services already rendered in obtaining insurances — would doubtless be regarded by the old actuary, were he living, as legitimate matters to be considered in calculating their reserve liabilities and assets. All of which goes to shov^ that the views of insur- ance managers as to the proper offices of the loading on premiums are yet hazy and by no means unani- mous. For the most part loading is added to net premiums by a method of gross percentage without regard to the purposes for which the same is collected. Much of the calculation must of necessity be crude; but it seems clear that some of the items ought easily to be treated in a more scientific manner. The only effort in this direction of which we are aware is that of Sheppard Homans, who divides the loading on natural premium pohcies into two parts, one being for expense purposes and one for all the other various purposes for which loading is collected, but mainly for possible excessive mortality. Mr. 43 Homans was the chief defender of Mr. Wright in the contest before mentioned; and he carried the division of premiums into their component parts to its legiti- mate conclusion when he introduced the plan of apportioning dividends known as the "contribution plan." In his new method of fixing the loading on premiums, he calculates the part for expense pur- poses at a level amount per $1,000 of insurance and the part for other purposes at a certain percentage of the net premium. As in all branches of insurance, commissions use to be paid on the basis of a percentage of the pre- mium, the partition of the loading does not seem very happy in that regard. Mr. Homans has indeed found it possible to work that plan only at a commission of so much per $1,000; but even to do that he has been compelled to wipe out the distinction for the first year of insurance between one part of the loading and another. On all other forms of insurance, this method has proved altogether impracticable and the partition of the loading has accordingly been aban- doned except as to natural premium policies. The method by which loading for other purposes is calculated is more to be commended. It must be remembered that the interest factor is absent from natural premium calculations; no provision therefore is required for decreasing interest or losses on invest- ments. No other way to figure a margin on estima- ted death-loss requirements seems so sensible as to add a reasonable percentage. In addition to the reasonable appearance of this feature, the fact that every dollar of this part of the loading must be used for its own purpose and no other, or returned to the 44 insured, would form a curb on the disposition of some insurance officials to boo»t expenses. Such would seem salutary and beneficial to policyholders. It may fairly be assumed that the expense element should be a percentage of the gross premium; that the element to cover excessive mortality may v^ell be a percentage of the net premium on whole life policies since all the net premium is eventually expended for mortality; and that the interests of policyholders demand that these two items be kept separate and distinct. Provision for decrease in interest can only be prop- erly made by assuming a rate certainly low enough at the outset of net premium calculations. Losses on investments must in the nature of things be met from surplus already accumulated and not from future premiums. Therefore it seems clear that that item can safely be eliminated from the calculation. In any case no method of approximating a proper loading for contingencies of that kind has been suggested. Such loading, if necessary at all, would be required to a greater degree on endowment than on other policies; and might make good the difference between the loading required to cover possible excessive mor- tality on such policies and on life policies. For it must be borne in mind that the mortality element in an endowment policy is only the net term premium for the amount and for the term of the policies, if indeed it can fairly be considered so much. On the other hand, of course, the factor for expense must be much larger owing to the usages in the mat- ter of commissions, whatever may be the effect upon the desirability of endowments as investments. 45 In practice at present, companies load life and limited-payment life rates from 33i/^ per cent to 40 per cent, making 25 per cent to 33% per cent of the gross premiums; and endowment rates from 20 per cent to 25 per cent, making from 16% per cent to 20 per cent of the gross premiums, unless for very long terms, when the loadingisthe sam^ as on life policies. This loading is considered in all life insurance calcu- lations as a single component of the premium and all of it may be used for expense purposes at the option of the management. 46 PREMIUMS— THEIR COMPONENT PARTvS. The premium on a term policy, a life policy, a lim- ited-payment life policy, or in fact any policy involv- ing no 'other payment than at death, consists ot two parts, the loading for expenses and contingen- cies, and the net premium solely for mortality purposes. Not only is all the net premium required for mortali+y purposes ; but it would be insufficient, were it not supplemented by interest on the sums re- maining unexpended from year to year. That it commonly requires somewhat less money is owing, not primarily to the size of the net premium, but to the fact that death has in many cases been deferred aifew months or years longer, and to the further fact that abetter interest has been earned than it would be safe to count on. If no interest were earned upon the funds carried over from year to year, the net premiums would be insufficient to cover the death losses even upon a much more favorable experience than has yet been known, or in fact on any possible experience involv- ing the final death of all. Especial emphasis upon this point is proper, as cer- tain misleading analyses of premiums have been put forth by many assessment companies and even by some regular companies seeking to do a natural premium business. These analyses have the air of scientific precision and are the more dangerous be- 47 cause they are half-truths and deceive many who have a smattering of sound learning. By these the net premium is divided into two parts, known as the mortuary and the reserve element. The first of these is described as the part really re- quired for insurance, and the second is variously ex- plained as a ''self-insurance, "in vestment portion, etc. The inference meant to be drawn from this analysis is that no necessity exists for any charge above, the mortality element with a small addition as a pre- cautionary safeguard. The half-truth is that the net premium is necessa- rily composed of money to be expended today and money to meet tomorrow's engagements. The amount of money to be expended this year is, how- ever, not the same as the amount to be expended next year; and, as the whole net premium remains the same, it follows that the amount available for future engagements will vary in inverse ratio. In scientific phraseology a net premium is a fixed sum composed of two complementary variables. The line separating the two elements of the premium moves every year and never resumes its former posi- tion. But the distinction between the two is merely a matter of convenience; both parts are for the same purpose, namely: to pay death losses. Reference to the papers upon rate-making will show that in the calculation of the net premium no provision is made for any other purpose; the calculation was merely to find the amount of premium necessary to pay losses. The only distinction between the so-called elements of the premium is that of present and future re- 48 quirements; and the part which is called the mortu- ary element in such analyses is the portion which a mortality exactly corresponding to the table would require to be at once expended, while the part called the reserve element is an advance against future claims sure to come. The folly of such analyses is more fully seen when the single premium is examined. In that case the mortuary element is very small, compared with the reserve; because the reserve element comprises all future mortuary demands, discounted. In the same way the reserve element in limited-payment life pre- miums is an installment toward caring for mortuary d«.mands after the close of the premium-paying period . In the same way again the reserve element in a whole life premium is, with its interest, to cover the defi- ciencj' of future premiums in meeting future mortuary demands. A precisely similar office is performed by the part left unexpended from a natural or annual renewable term premium ; it is expected of it that it will pay the losses until the next premium is paid in. In the case of a term policy for more than one year, the office of the money left unexpended is soon made clear, since the whole premium would not be suffi- cient to meet the mortuary demands in the later years of the term if not aided by the accumulation made. During those years the reserve element of the premium is less than nothing. By the close of the term all the reserve is expended in payment of death claims. The same is true also of all life policies, the term being the whole life of the holder. The long term of 49 the policy confuses many because the accnmtilation in- creases for so many years before the current mortuary demands exceed the net premium. Even then the de- ficit is made good from the interest, of which some- thing remains to swell the accumulation. In fact, the growth of the fund only ceases at the death of the insured; and if he reaches what is assumed to be the ultimate limit of life, the reserve amounts to the face of his policy. This is why the reserve in whole-life premiums is called by some the self-insurance fund, as indeed it is, in the sense that after contributing to meet other mortuary demands it also makes sure of meeting its own. Who would be content to carry a policy which would be sure to provide for all death claims but his own ? But the reserve element is not self-insurance in the sense that is commonly intended, that it serves no purpose except to accumulate against the day of certain death. Its interest earnings are part and parcel of itself, impossible if it were not; and for nianj^ of the later years, even in a whole-life policy, such interest is called upon to make good the defi- ciencies of the regular premium in meeting current mortuary demands. A whole-life premium, like an endowment premium, must cover not merely risk but certainty as well; must meet the demands of claims that may come and the demand of a claim that v^ill come. It therefore con- sists of two essential elements not touched upon in the puerile analyses referred to, which are in fact only book-keeping conveniences; these two elements are term insurance to the assumed lirnit of life and a pure endowment due at that time. The term element cov- 50 ers the danger of dying, the endowment element the possibility of living. Pure endowment provides for a sum to be paid if the insured lives to age 100 : term insurance for a sum to be paid if he dies before that time. To see how small a part of the whole the en- dowment element is, it is only necessary to make these calculations separately, as, for instance, by the actuaries' table and 4 per cent interest at age 50. Term or others' insurance element $37 77 Endowment or self insurance element 01 The total $37 78 In other words, 1 cent a year from all men now living at age 50 will supply $1,000 for each of them who survives to age 100. Of course, like all other components, the endowment element is much larger if the insurance is taken late in life. At ages under 50 it is less than 1 cent per $1,000 insurance. The deposit for reserve, varying from year to year, com- prises both the deposit for reserve on the term element and the whole of the pure endowment element. For the practical purposes of accounting, it is not neces- sary to make such a distinction; and tables of the cur- rent cost of insurance, the so-called mortuary portion of the premium, answer all purposes. The cost of in- surance on all plans is found each year by calculating by the mortality of the tables the cost, not of the in- surance named in the policy, but of that insurance less any reserve accumulations. To avoid constant cal- culations these items are made up into tables, and the various amounts, which taken together with these equal the level net premium, are denominated deposits for reserve. 51 As has been more than hinted in the foregoing, an endowment premium consists primarily of t\70 essen- tial elements, a term insurance and a pure endow- ment element. From year to year there will be re- served not merely the whole endowment element, which is merely intended to pay off the insured at the close of the endowment period, but during the earlier years the deposit for reserve on the term in- surance as well. In the later years, when the cost of insurance, the so-called mortuary element, is larger than the term element, the reserve on the term insur- ance is gradually v/iped out. The cost of insurance as a mortuary element be- comes peculiarly ridiculous in term insurance when it comes to exceed the net term premium, of which it is supposed to be a part. 52 RE-INSURANCE RESERVES. The reserve of a life insurance company is that sum of money which it would have to pay another com- pany to assume its insurances. In former times how much this reserve should be was left to the judgment of the managers of the various companies; it was expected that the intelligence of the public and the natural caution of the shareholders would be ample protection against too small reserves. This was found to be erroneous. The ordinary rules of business, which are meant to govern cases where the entire assets are the property of the mana- gers, will not apply where the larger part of the funds is in the nature of a trust, the beneficial ownership being in others. In an ordinary business, capital is active, and it is evident enough that to withdraw it will cripple the business and thus react to the propri- etor's disadvantage. In insurance corporations cap- ital simply accumulates so long as the company is pushing its business; the purpose for which it is accumulating is not always clear; and to a share- holder it would seem a plain matter that all above what is absolutely required for safet3' should swell his dividends. Naturally too he would view the amount required through a reversed telescope, especially as it will not be needed for many years. Such dangers are not imaginary, as may be seen by looking over the history of life insurance. 53 In England, governmental interference has been but partial and largely advisory. Great latitude is allowed in the matter of mortality tables to be em- ployed, and a little freedom is granted in the matter of interest rate assumed. Too wide departure from the common standards, however, would not be per- mitted. A company might easily make itself ridicu- lous by too favorable assumptions — a fact which it could not conceal since a valuation b^^ a competent actuary must be made at frequent intervals and the bases of the calculations given in his reports. The latitude given is broad enough, however, to admit of considerable variations in premiums charged; though it is,of course, considered amark of superior strength to be able to qualify under the most severe stand- ards. If companies undertook to be reckless concerning reserves in England, it may well be said that they felt sure of freedom in that regard in America. Thanks are mainly due one man, the late Elizur Wright, of Massachusetts, for those governmental precautions v^hich have held in check the marked tendencies toward recklessness on the part of American compan- ies. When he began his work, under a statute calling for an early compliance with tht reserve requirements of the actuaries' tables and four per cent interest, a then popular company in Hartford reported that its re-insurance reserve was a certain sum because another company was willing to take over its busi- ness for that sum. Another company, this time an importation from Great Britain, figured out a surplus exceeding its entire assets by assuming that old busi- ness could be cared for without expense. This plea 54 had the support of F. G. P. Nelson, then regarded the highest actuarial authority in England, and he was seconded by the professor of mathematics in Yale. To both of these gentlemen the mathematical result was conclusive, regardless of business common sense. Fortunately for the security of the insuring public, such tactics were not successful against the sturdy sense of Elizur Wright, who not merely knew what he knew, but— rarest of all accomplishments— knew how to make others know it. The reasonable test of solvency proposed by him was generally adopted and enforced. The position of Dr. Wright was, that it should not be assumed that any company would insure the risks of another at a less premium than the latter com- pany exacts, nor at less premium than the net premium (actuaries' four per cent) even if the latter company did business that way. To assume that one company would take over the business of another at less than the premiums charged would be to assume that the premiums charged were exorbitant. To assume that any company could afford to take over the risks at less than net premiums (actuaries' four per cent) would involve the absurdity of believ- ing that an average company had an experience better than the average; for to be safe the re-insur- ance reserve must be not what would re-insure the business in a particular company, but what would probably re-insure it in any well-regulated company. A company may be justified in assuming that it can do better than the average in carrying on its own business; it cannot be justified in assuming that it can at will find others able and willing to do so in its 55 stead. It may sell insurance at whatsoever premiums it will, but it must show itself to be at all times able to pay others for re-insurance at the lowest average rates they could afford to accept. For instance, the usual rate at age 30 for a one year term policy is $15.00 a year for $1,000 insurance; the net premium (actuaries' four per cent) is $7.78. Now, if a company charged the former premium, it should be estopped by that fact from claiming that it could re-insure a risk with six months to run at the latter rate, for it would thus convict itself of extortion. On the contrary, if a company reported its premium as $5.00 a year, it should not be permitted to use that figure in calculating its reserves, since it is clear that no company would be likely to accept the re-insur- ance at a less premium than is required by average experience. Since, then, a company is not permitted to use its own large premiums as an argument for a lower re- serve-thereby confessing their exorbitance— it follows that in practice it is as well to use net premiums to calculate reserves. The problem is a simple one in the case of one-year term policies; a part of the year's premium proportionate to the unexpired term is charged. Equally simple is the problem in the case of a paid-up life policy; it would be necessary to pay over the net single premium at the age of the in- sured at date of re-insurance. In the case of whole-life policies with annual pre- miums, a new feature is introduced, which at first sightxomplicates matters. The new company would, of course, charge a man now 50 the rate at age 50, while, if he has been insured for 20 years, the old 56 company is receiving only the rate at age 30. The contract with the insured will not admit of a larger demand upon him than the specified premium. It follows therefore that in order to effect this re-insur- ance the old company must each year during the life of the insured, pay the difference between the rates at age 30 and at age 50. It may avoid that by paying the discounted value of such differences or, in other words, the present value or net single premium of an annuity on the insured's life equal to the difference in premiums. Therefore such is also the present value of the company's liability on the policy and the proper reserve. Where the actual premium is lower than the net premium assumed, the difference is treated as an additional liability and the present value of an annuity of like amount is added as a spe- cial reserye. The method of ascertaining the reserve on limited- payment life and endowment policies is substantially the same. If it is proposed to re-insure a twenty- payment life policy, issued at age 30, and which has run five years, it is evident that the new company must in some way get the equivalent of the premiums on a fifteen-payment life issued at age 35. From the insured it can collect but the premiums specified in the policy; it follows, therefore, that it must demand from the old company the equivalent of an annuity of the difference between the two premiums. This annuity differs from the annuity mentioned in whole- life reserve calculations, in that the former is a term annuity payable for fifteen years if the insured* sur- vive, while the latter is a life annuity payable as long as the insured survives. 57 The calculation of endowment reserves proceeds upon precisely similar lines; indeed, a limited-pay- ment life policy is in effect an endowment for an amount equal to a net single premium for life insur- ance at the age attained at close of premium -tDaying period. The usual practice regarding policies on which pre- miums less than annual are payable is to calculate reserve liability as if paid by annual premiums and then count deferred premiums as part of the re- sources. This is because such deferred premiums are regarded as temporary credits to be deducted in any settlement of the policy. 5S SURPLUS-WHENCE DERIVED. In the conduct of a life insurance business a gain may be made in all or either of three directions. The two simpler sources of profit are the realization of higher interest than was counted on and the saving of a portion of the loading charged to cover expenses and exigencies. In the management of the business of nearly all companies a profit is certain to arise from a higher interest experience than was assumed in making rates. If there were not a profit from this source, it would be evident that the assumed interest w^as too high, and the rates based thereon danger- ously low. The object of rate computations and of laws fixing the interest factor to be used in reserve calculations is to avoid thepossibility of dangerously low rates; and to accomplish that purpose a lower interest than the current rate is alw^ays used. In consequence, as has been said, a profit is practically certain to arise from this source, since no company now-a-days dares to disregard the plain requirements of a conservative business. Such has not always been the case, however. When Elizur Wright began his crusade against reckless methods in life insurance, a then popular Connecticut company reported that its reserves were on a 6 per cent basis. It was not solvent even on that basis; but, had it been possible for it to continue until the present, it would now be 59 an exception to the rule mentioned, for it certainly would not realize any profit from excess interest. Gains from the margin or loading, proving more than suflScient to cover the expenses and contingen- cies for which it is 'collected, should be reasonably constant and stable. Conservatism requires also that the addition to the net premium be ample pi o- vision for the expenses and possible losses other than death-claims. Every argument in favor of caution in other respects is equally applicable in favor of sufficient loading, though the legislatures have not yet mediatel3^ or immediately compelled such action. The facts indicate that some such interference would not be improper, since the percentage of premium re- ceipts used for expenses and other purposes for which the loading is collected varied in 1891 from 17.2 to 41.9 in the companies of the United States. The companies experiencing the largest expense outlay w^ere not the companies doing the largest new busi- ness. The average percentage in all companies for ten years past is 22.7, which seems to indicate that no very large gain is to be expected from the loading, which usually varies from 20 to 33^2 per cent of the whole premium, averaging perhaps a little over. 25 per cent. Companies which habitually expend more than the whole loading are practically nullifying the conservative limitations of the State and defjangthe laws of probability. For any excess of expenditure over the loading must be made good from the gains from other sources, and to proceed to such expendi- ture is to assume that the net premium is more than equal to its offices and will yield a profit at least sufficient to offset the excess of expenditure. In 60 any case, a company having such an expense ratio not merely gains nothing on its loading but is com- pelled to recoup its loss in that regard from the gains from other sources. In the case of limited-payment and more especially single-payment policies, it certainly should not be considered that there is a gain upon the loading just because the immediate expenses and contingent losses do not equal the loading. For in such cases the loading is not merely a provision for this year's expenses and other contingencies, but for the same in future years, as well, v^hen no premiums are to be paid. To assert that no such provision is necessary or desirable is to deny the very premises of the argu- ment for loading. Of the other source of profit, the saving on death- loss estimates, less explanation is usually thought necessarj^ than of either of the foregoing. Notwith- standing this, the subject requires much closer inves- tigation and is much moie complex than either of the others; for into it enters that fact, so often lost sight of, that death is not a chance but a certainty and that the only chance is in regard to the time of death. In respect to all policies covering the entire period of life, therefore, it is not the case that the company whose actual loss experience is but one million dollars against an expected loss of a million and a half has gained from that source one-half mill- ion dollars, for every one of the claims which did not fall due this year is certain to fall due some time. In the premiums there is not made any provision for paying these claims at another time, but instead only a provision for meeting the demands of other 61 policies^ It follows, therefore, that the real gain will be the interest actually earned on this half million before it is needed, plus the premiums and interest on the same which those who did not die as expected pay in before they do die. Of course the original rate- calculations were not made with an expectation that these men pay premiums after they die)Ahere- fore any premiums that they pay after their expected deaths constitute an element of gain. It is perhaps clear from all this that the subject of gains on mor- tality is in a degree involved and difficult. To arrive at the proper method of computing such gains it is necessary to consider what would be re- quired to reinsure these persistent survivors. Since they have not died, it is evident that the only ob- jection to counting the face of their policies as profit is the fact that they must still be insured at the old premium. Whatever then wrill reinsure them, the new company to receive only the old premiums thereafter, is clearly the measure of what is to be de- ducted from the apparent gain to get at the real gain. For if they are reinsured, there is no longer any offset of the gain. Of course the company can itself well afford to take the risk but only on the same terms, that is, for a consideration of the present reserves and all future premiums. In recapitulation, upon all policies running for the whole period of life a less mortality than is expected results in a gain of the amount not expended plus all future premiums, less the cost of carrying on the in- surance, which is the present net reserves plus all future premiums. Eliminating the element of future premiums common to both, the statement becomes 62 simply: the gain is the whole amount not expended less the present net reserves on the equivalent insur- ance. The same is clearly the case in endowment insur- ance also. For if Jones does not die this year as was expected, the company will certainly pay out the amount saved thereby either before the expiration of the term as a death-loss or at its expiration as an endowment. To get rid of this necessity the com- pany must reinsure the policy, which will require the entire reserve and all future premiums. Therefore the real saving is the apparent gain less such re- serve. In term insurance for longer than one year, the same applies; for if the insured does not die as ex- pected, it is necessary to provide him with insurance as per contract, which will require the present reserve and all future premiums. In annual term or natural premium insurance, it is otherwise, as each year's insurance is a separate transaction. Even when renewable by their terms, such policies are supposed to be reinsurable at the close of their policy -years without other considera- tion than the transfer of future premiums. That this could be done in practice is doubtful; but the rate is each year supposed to be sufficient to cover the risk and the objections to such reinsurance are ob- jections to the plan, not to the price. The apparent gain therefore on such policies is the actual gain. Thus in general it is true that the apparent gain at the expiration of the terms of all sorts of policies is the actual gain; and that apparent gains previous to that time must be diminished by the cost of the in- 63 surance which is to be carried on account of the per- sons who refuse to die at the proper time. What has been said does not furnish a formula for ascertaining the surplus earnings of a company. It will be found of greater importance in apportioning the profits. The simplest method of determining the actual surplus of the year is by the balance sheet, which on one side shows the assets brought forward from the previous year plus, the receipts of the year, and* on the other the actual expenditures plus the re- insurance reserve at the end of the year and the sur- plus brought forward from the previous year. The difference between these totals will be the profit on the year's business. 64 SURPLUS— HOW APPORTIONED. In purely stock companies the problem of appor- tioning surplus offers no special difficulties, since all profits belong to the proprietary stock. But it is peculiar to life insurance that it seems to demand a mutual system by requiring heavy margins in all directions in order to insure safety. Since one must either insure for life or a long term or run the risk of being without insurance and uninsurable, it follows that the permanence and security of the institution is of the greatest moment. That can only be assured by paying premiums adequate beyond a question; for such and so rapid is the accumulation of assets that a capital however large becomes insignificant by comparison. Adequate premiums mean more for the strength and soliditj of the company than would capital stock, which might soon fall into designing hands were the premiums inadequate. The desire of men for the best bargain naturally tends to reduce rates to the lowest possible basis, without reference to the effect upon the security of the company; for men cannot be expected to act counter to what appears to be self interest. There- fore, the logic of the situation requires the introduc- tion of a system which will make men willing to pay adequate premiums and thus divert competition to some other direction. By adopting the mutual system this is accomplished, as both all possible 65 guarantees of safety are thus obtained and insurance is furnished at the lowest possible cost notwith- standing. This system transfers competition from price to cost, which is an important change, inas- much as it means care and caution on the part of the companj^ furnishing insurance at the lowest cost, in- stead of daring or desperation on the part of the company bidding lowest for insurance in the market. In consequence of these things, the mutual system has become well nigh universal, and some method for properly apportioning the profits among the mem- bers is required. At different times and with different companies, various methods have been in vogue; and even in this country and at this day at least one large company employs a formula which is a mystery to all actuaries and which produces very singular and seemingly contradictory results. The original method was to divide the surplus into bonuses in proportion to the premiums paid; in some cases in proportion to the current premiums, in others in pro- portion to the sum-totals. This was a sort of rough justice, reminding one of the administration of law on the frontier. The inequities of the prevailing systems became ap- parent as the business developed; and in the office of the Mutual Life Insurance Company, of New York, a new system was first adopted which has since be- come almost universal in this country. It is known as the contribution plan and was discovered by Sheppard Homans and David Parks Fackler, then actuaries of the Mutual. The central thought of the plan was, as the name implies, to distribute the profits pro rata as they had been contributed. Aq- 66 cording to this, gain from the loading would be dis- tributed in proportion to the amount each person paid in for loading purposes. In the same way the gain from excess interest would be distributed in pro- portion to the amounts of the policy accumulations earning interest. At the time this plan was adopted this meant the reserves only, because accumulated surplus plans were not then in use. At the present day, when such plans are more common than any other, the share of the company's assets contributed by the policy and comprising both reserve and sur- plus should be this factor in proportionate distribu- tion of surplus. The gain from mortuary sources is also distributed according to amounts contributed to pay mortuary losses; or, rather, according to the amounts which were thought to be required to pay current mortu- ary losses. For it must not be lost sight of that the entire net premiums on all policies for the whole period of life are contributed to pay mortuary losses. It is in this connection that the partition of pre- miums into so called expense, mortality and deposit for reserve elements comes into play as a book- keeping convenience. Of course, in order to calculate the proper apportionment of gains from loading, it is necessary to know the amount of the loading. It is also necessary to know the amount of the reserve in order to calculate its due share of surplus interest, although simpler methods might be adopted in the case of accumulated surplus policies. To know the amount of current deposits for reserve is in no sense requisite and, in fact, such amounts are determined iust because the separation of the other two elements leaves them already determined. 67 The so-called mortality element, or, more accu- rately, the current cost of insurance, is a very mis- leading item to many. In the paper next preceding this, it was shown that the survival of a man or so more than was expected in a given year does not imply the gain of the amount of their policies, since they must still be insured, which requires the present reserves upon their policies and all future premiums. There is in such cases no great gain without some small loss. That rule is reversed when death does occur, for then the compan3^ is freed from the obligation to continue the insurance. It loses the amounts of the policies but gains the reserves; or, in other words, its net loss is the amounts of the policies less their reserves. It fol- lows, therefore, that its net risk is the sum of all its policies less the sum of all its reserves, and that its risk on any policy for any year is the amount of the policy less its then reserve. It follows also that the table cost of insurance on that policy for the current year will be a net natural premium, not for the amount of the policy, but instead for the net amount at risk. Since the cost of insurance is an annual term premium, it is possible to calculate upon it a gain without a deduction for re-insurance. Now it is plain that the actual cost of insurance will bear the same ratio to the tabular cost as the actual death losses of the year do to the death losses ex- pected. Therefore, the total actual gain will be the same percentage of the aggregate tabular cost as the total apparent gain is of the expected loss. That same percentage applied to the tabular cost of insur- ance on each policy will show how much each policy contributed to that gain. At least, that is the assumption which governs this method of distribu- tion and it is for the most part justifiable, though open to some objections, as will be shown hereafter. For annual or frequent distributions of surplus it is almost beyond question that the contribution plan does each person exact justice, and any departure from it properly excites suspicion of discrimination. 69 SURPLUS— HOW AND WHEN DISTRIBUTED. The manner in which the surplus earnings should be distributed and applied has been from the begin- ning a question engaging the attention of the ablest actuaries. In early times, and even until our own, the current of practice if not of theory was toward reversionary additions to the policy, or the furnish- ing of as much more permanent insurance as the sur- plus would justify. This course seemed to be borne out by the fact that the insured evidently intended to apply his money to the purchase of insurance and that, consequently, the office of the premium was to furnish as large an insurance as possible. Springing from the practice, and especially from that line of reasoning, came the plan of applying the surplus to the purchase of temporary insurance, thus increasing the immediate protection to the largest possible amount. This plan, just to the extent of the temporary insurance thus furnished, became a com- petitor of short term and assessment plans in point of cheapness. Unfortunately, just to the same ex- tent, it was subject to the objections to assessment insurance, being an increasing cost contract. It was not found satisfactory. The application of surplus in the form of reversion- ary additions of a permanent character of course in- creased the reserve values of the policies, or the amount that would be required to reinsure them. To This is clear, since the new company would have to assume a larger risk at the former premium. For a time companies did not report the values of these paid-up additions as a liability, but this was insisted upon later and is now the custom. Probably one reason, if not the principal one, for the absence of these items from the reserve calcula- tions was the fact that originally, although fully paid for, such paid-up additions were forfeited with the original policy upon non-payment. Therefore it was not thought fair to consider the same paid-up insurance, which of course it would be a contradic- tion to talk of lapsing. It did not follow because of that, to be sure, that no account should be taken of such insurance in calculating reserves, since insurance which may be lost is not on that score already out of existence. But it did follow that such paid-up additions should not be forfeited with the original policy, and that became clear to every one. A recognition of the insured's rights in this surplus accumulation as something already earned and not contingent upon future action carried with it almost as a corollary the eventual recognition of his right to dictate what was to be done with it. It soon be- came the custom to permit the conversion of such reversions into their net cash values, either by a selection of cash dividends once for all, or by the priv- ilege of an option when the surplus was declared, or, in more liberal companies, by the continual privilege of conversion at any time. So that in effect the in- sured became absolute arbiter over the manner in which the surplus was to be applied. On the part of actuaries, so long as reversions only 71 were allowed, there was little objection to the plan; but with the privilege of conversion a new situation was created. The presumption was that healthy persons would take cash dividends and persons in impaired health would prefer to increase their insur- ance, thus creating a selection of risks adverse to the company. This presumption, though backed up by no statistics, seemed unassailable and stubbornly continues until this day, because apparently in line with common sense. To assume that common sense will govern is, however, perhaps too bold an assumption, and doubtless therein lies the ex- planation of the discrepancy between theory and statistics. In any event, the result of this actuarial theory was to cause a complete revulsion of practice from reversions with the privilege of cash conversions to cash dividends with the privilege of dividend addi- tions instead, but subject to proof of good health in most cases. Such became the almost universal prac- tice, the cash dividends being commonly used in re- duction of premiums and only payable in case the new premium is paid, although such dividend is al- ready earned and in fact a direct outgrowth of pre- miums already paid. Other methods of applying the surplus were as short term and permanent reductions of the premium. The latter amounted to the purchase of single premium annuity for life with the net cash surplus, such an- nuity available only in payment of future premiums. The absolute title to the reserve value of such annui- ties was not conceded to the policyholder, the same being forfeited upon non-payment of premiums, as 72 was originally true of reversionary additions. This method never became in any sense popular in this country. Some companies, which divided surplus at periods longer than one year, hit upon the idea of distribut- ing its payment over the succeeding period, thus making a level premium for the period and also pre- venting sudden depletion of the funds of the com- pany. Like all other methods, this had plausible features; but the companies practicing it usually" treated the surplus as something only earned as it was paid and forfeitable at any time upon non-pay- ment of premium. It is difficult to see wherein it diftered except in name from annual dividends de- ferred the same number of years. The practice of deferring the payment of dividends for several years after the beginning of the policy was an early one and justified by better reasons than are usually put forth in defense of life insurance pro- cedure. The theory of surplus division is, and the practice ought to be, that all profits are di- vided without reservation. But if such a division is to be made after the first year, it is evident that the company will have no considerable margin between itself and insolvency. The fairer and better course, whereby to avoid this undesirable condition, would seem to be to withhold for a certain time the pay- ment of dividends from every policy, thus compelling each in turn to contribute to the general surplus. This would only defer the payment of the entire ^ut^ plus, which would all be accounted for at or after the termination of the policy. It is perhaps unnecessary to say that many companies forgot to thus account 73 for it, some even in event of termination by death or maturity and nearly all in event of termination by lapse or surrender. The shortening of the time during which |the pay- ment of dividends was deferred was not occasioned so much by any of these cogent considerations as by the clamor for lower premiums on the part of the public. In order to avoid granting the popular de- mand many companies preferred to put forth a par- tial loan plan, whereby the insured could from the start avoid paying the whole premium. Such loans were made for a proportion of the premiums fully equal to the expected dividends and it was repre- sented that the dividends would soon wipe them out. This plan had indeed the opposite effect to that of the former systems, inasmuch as the person who availed himself of the loan and soon discontin- ued had the benefit of the reduction, while he who paid full premiums and discontinued had no corre- sponding advantage. Taking to such expedients did not stem the tide of the public demand, which was at last Janswered by reducing the term during which the payment of divi- dends was delayed to not longer than two years. In most companies, in fact, the term was shortened to one year, a dividend being given as soon as earned and determined. In order to carry a current surplus under this plan it was necessary to resort to the plan of not dividing the total actual earnings, but only so much thereof as seemed judicious to the managers — a most dangerous custom, as both theory and facts abundantly attest. Singularly enough, the changes which take place in 74 almost all businesses do not appear to be otherwise than adventitious and accidental. Yet beneath the surface it is possible to trace a slow evolution directed by causes unknown to the persons who seem to be the leaders in the new methods. This has been pecu- liarly true of life insurance, which has advanced in most cases along unexpected lines and not only with- out the aid of the great actuaries, but even against their earnest opposition. The most striking excep- tion to this general statement is the work of the re- nowned Elizur Wright, who combined in himself the skill of a mathematician and the hard sense of a man of affairs. But conforming to the usual trend, the change which has of late years taken place in the matter of dividend periods was occasioned by something en- tirely foreign to that which has made it popular. The fall of dividends below the expectations of the insured had previous to 1870 prepared the public for a change to a plan where the net annual expenditure would not vary. Non-forfeiture was yet too new to be appreciated and by many was considered a prime cause of the low dividends. The time was ripe for a change from old methods and the tontine plan of dividends deferred for long terms was launched. The crisis, and the attendant falling off of the insurance in force because of lapse and surrender, served to bring the so-called profit from lapses into undue prominence — undue because the lapse experience was totally abnormal and, it is to be hoped, not soon to be experienced again. Such should not have been the case and, from the recent popularity of non-forfeiture plans, it is clear 75 that such was not the real cause of the general favor for the new plans. The true secret of their success was the long dividend period, which at the same time silenced the demand for immediate cheapness and aroused expectations of eventual gain. The mere length of the dividend period was the real point of attraction; the other features were merely accidental and transitional and are already in process of rapid elimination. Traditions of the past and its methods are 3^et too strong to be fully shaken oflf and in conse- quence there is yet talk of "lapse-profits" and — most comical of all things — "loss-profits." But the current has set in for sim pier and more straight-forward meth- ods, less involved in mystery. Of all the features once considered essential to tontine but one seems likely to last and that is the long dividend period, which, had it been unaccompanied with taking features when proposed, would have had a hard road to travel to reach popular favor. The hardships of forfeiture, once enforced against policyholders under this plan, have long ago been avoided. Of course, as no dividend is declared until the close of the period, no dividend is given to policies surrendered before that time. But even that appar- ent hardship is now-a-days mitigated by a larger surrender value in many companies than would otherwise be deemed safe and proper. The tide of progress is set in that direction in answer to an un- mistakable public demand. No such demand exists for the relaxation of the forfeiture of claims to surplus upon the death of the insured. The impression seems to prevail that insur- ance is cheap enough to those who die soon and that the true problem is to make it cheap to those who live long. The absence of any such protest is signifi- cant, determining in fact the central idea and work- ing principle of a long dividend period, namely: That to survivors only belong the surplus, for they only have contributed it. The same logic which has made the contribution plan of apportioning surplus the only possible one is relentlessly comiDclling the adoption of long surplus periods. The traditional methods of calculating surplus and the considering tontine surplus a mere accumulation of annual dividends obscure the matter somewhat. But the true tontine plan involves the following: The accumulation of the actual premiums at the actual interest rate of the company, deducting from time to time the policy's share of expenses and gross losses and adding its share of any offsets, such as the funds accumulated upon policies matured by death or the actual surrender charges against the funds of policies surrendered. A proper method of book-keeping should show the account clearly from year to year and would contrast sharply with the cumbrous and involved methods now in use. As the tendency of the times is toward longer divi- dend periods, so is it also in the direction of greater freedom for the policyholder in the matter of the ap- plication of surplus. As the periods do not frequently recur, the actuaries do not seem to have the same fear of adverse selection as in the case of annual divi- dend policies. Consequently, the greatest latitude is permitted in optional disposition of the surplus, with the exception that in case the amount at risk is increased a new examination is usually required. 77 Certain improvements, scarcely yet begun, may soon be expected in this direction; for it has been the usage of companies to treat tontine policyholders quite dif- ferently from some others in the matter of the single premiums charged at the close of dividend periods for life insurance or life annuities. If the insured chose to apply his fund to the purchase of paid-up in- surance, it has been the custom to exact for a non- participating policy the premium a new applicant v^ould pay for a participating policy. Indeed, the rates of single premiums were raised at a time suspi- ciously near the termination of the first tontine periods. Quite contrary to this is the treatment accorded the holders of limited-payment life policies, whose contracts really consist of, first, a partial en- dowment equal to the net single premium of a life policy at the age attained at the close of premium- paying period, and, second, the purchase of a paid- up life polic3^ with the proceeds of that endowment. That life policy is sold at the net premium, and yet participates, while from the proceeds of a tontine policy a loaded premium is exacted without partici- pation. This is manifestly unfair and out of place in a mutual system. The same condition of affairs is found in the case of an annuity, except as to partici- pation. A deferred annuity contract consists of two separable contracts, namely: a partial endowment for an amount equal to the net single premium of the desired annuity at the age attained at the close of the premium-paying period, and the purchase with the proceeds of such endowment of an annuity at the net single premium then required. Contrariwise, a loaded premium is charged when the proceeds of a tontine policy is the purchasing medium. 78 In justification of these unjust distinctions the dan- ger of higher reserve requirements is often urged and seemingly with some cogency. But in the first place the same argument would apply with even greater force to limited payment life and deferred annuity policies; for not only is the net rate used, but the table and interest on which that rate is computed is settled in advance and, dividends being payable an- nually, there would be no apparent means of making good any deficit in reserves. There seems to be no just reason why the single premiums should not be fixed at figures unquestionably safe and then em- ployed in both and in all cases, except, perhaps, the purchase of new insurance under new policies. Long dividend periods render companies safer by the accumulation of a large surplus; avoid the neces- sity of leaving a portion of the surplus contributed by a policy undeclared from year to year in order to make a vsrorking surplus; avoid the possibility of paying a dividend which future experience will show never to have been earned; avoid the payment of profits to persons who by early death contribute a loss and not a profit; enable a company to contract for more liberal and definite surrender values with- out prejudice to other interests; enable a company tQ meet the increased reserves under any future regula- tion from one's own fund instead of a mysterious "general surplus"; render to each of the actual con- tributors of surplus and reserve his exact share of the whole, and make it possible for a wide liberty of choice to be granted the insured in the use of his fund without danger to the company or damage to others. 79 EXPENSES-HOW ASSESSED. Little effort has been made by actuaries to place the assessment of expenses upon a scientific and therefore just basis. The office of actuary, in this country at least, has been to furnish a safe estimate of net rates required and leave the rest to business managers. English actuaries have usually had a broader field of activity, being in fact the responsi- ble managers as well. But in both countries few endeavors to adjust the expense charges on a scien- tific basis have been made. On the contrary, as has been mentioned in earlier papers of this book, the actuary then in highest esteem in England as late as 1860 gravely tested the solvency of a company on the assumption that it would have no expenses whatever and that therefore its gross premiums would be available without deduction to pay losses. In such an assumption he had the support of a learned pro- fessor in Yale and other great mathematicians. In the light of that so recent occurrence it is not singu- lar that no very determined attempt to solve the problem of assessing expenses has been made. The entire subject was until of late considered beneath the notice of scientific men. The custom came to be to reckon the expenses in proportion to the premium as the most convenient method, making no distinction as to kinds of policies. This practice, modified in most companies 'because of 80 the necessity of furnishing endowment insurance art a rate within reason, prevails to this day. Of course any variation, however, compels a surrender of the rule of percentage upon the premiums. The varia- tions are all accommodated by a method which is not a wide departure from the premium-percentage system. This method starts by considering the load- ing as an ** expense element" according to the phraseology of some or, in other words, all available for expense purposes. Accordingly the sum of the margins of '' loading '^ is considered the assumed ex- pense and forms a fund. The amount remaining in this fund at the close of the fiscal year is rebated to the policies in proportion to their contribution to the fund. In effect, this is charging the actual expenses as a percentage of the loading, which, when the load- ing bears the same proportion to the premium, what- ever be the form of policy, is exactly equivalent to the premium-percentage method, but not otherwise. It has already been pointed out in a previous paper that the loading is not an ' 'expense element" but a provision for any and all contingencies. Among the exigencies it is meant to meet are the decline of inter- est and consequent increased reserve requirements, unexpected shrinkage in value of assets, financial losses and excessive mortality experience. The first of these contingencies has already come to all our companies once at least and each of the others to some company. If the whole loading is to be availa- ble for expenses, it follows that no provision is made for any of these contingencies. What is to bethought of those sadly numerous cases where the actual ex- pense exceeds the so-called expense fund is a question. 81 The attention of actuaries has of late been called to the subject of expense apportionment by the pressure of companies upon the expense funds in their race for new business. The brokerage system, which means the outlay of much more than the loading on a first premium to secure the same, has involved the prob- lem, inasmuch as there seemed to be a manifest unfairness when other and older policies were called on to meet the deficit. Schemes to overcome this difficulty have been much discussed, but it is probable, judging from events, that the problem will disappear with the brokerage system itself. The impossibility of indefinitely extending business under that system, and especially of launching a new company with prospects for immediate success, has impelled many to search earnestly for some means to circumvent this stumbling-block. The collection of a larger amount for expenses at higher than at lower ages, thus emphasizing the dis- advantage of age, was some time ago recognized as a wrong. Sheppard Homan, the eminent actuary, discarded that method in the construction of his peculiar yearly-term rates. He added a loading for other purposes to the net premium by a percentage plan, but made his expense charge a definite sum per thousand of insurance at all ages. The same rule was not applied by him to other plans, I believe, and even on that plan does not apply to the first year's pre- mium, in which all above the net premium is considered available for expenses. His method has lately been adopted, I understand, by the New England Mutual and by it applied to all policies of whatsoever form, so far at least as first-year's commissions are con- ^ OF THE UNIVERSITY cerned. No alteration of the loading has been an- nounced, however, and it is by no means certain that a radical change in that regard is intended. It is in any case an error to suppose that such is the most important reform in the matter of expense assessment. It is not clear that there is any real in- justice in charging a larger expense against a large premium than a small one, especially when the whole premium is intended for mortality purposes. If such is unjust, the injustice is common to all commission businesses and to all forms of insurance. So far as pure insurance is concerned, there seems to be no argument of convincing force against the system of premium-percentage. It is worthy of remark, how- ever, in this connection that no good reason appears for assessing expenses other than initial commissions and other expenditure of that nature against a new single premium and at the same time absolving an old one from all contribution. Just how the ex- penses of a company whose policies were all pai'd-up would be met is, indeed, an enigma. But while it is not probable that a percentage con- tribution would be any more objectionable on a purely life premium than on a fire or accident pre- mium, experience has clearly shown that there is a strenuous though not often conscious objection to the application of that system to the premiums of policies which are largely investmeiit in character. The fact of such objection was provocative of the variation from the percentage system already men- tioned, and the failure of the popularity originally expected for endowment insurance can be largely traced to the popular impression that the premiums 83 are too high. This is only another way of saying that too large a portion of the premium is to be ex- pended, for otherwise the maturity value would be the greater for the big premium. Men will pay a reasonable sum for life insurance expenses when they desire insurance, even as they pay a sum not always reasonable for expenses when they purchase other insurance. But few men would know- ingly pay twenty-five dollars per annum for the privilege ot investing seventy-five. When they do it without knowing it, they not infrequently feel that they have been duped, and many look with suspicion upon the mysterious unwillingness to guarantee much. In instance, the loading on a life premium at age 30 is in many companies $7.09 per $1,000 of insurance. The loading on a limited payment life policy is not proportionately so large, for which departure no good reason can be given. The method in vogue for assessing expenses against this policy is, however, to treat the entire loading as an assumed ''expense ele- ment" for current use and to hold no margin for expenses after the policy becomes full-paid. So long as this is the case, no tears need be shed over the apparent inequality. The loading in the same com- panies on a twenty-year endowment premium is $11.86 per $1,000 of insurance, although the pre- mium provides only for term insurance, upon vrhich the loading would usually be about $4.00. All above that amount the policyholder is paying, not for expense in taking care of insurance, but for ex- pense in taking care of money. In the total premium he is paying more by far for expenses and mortality 84 than the holder of a life policy, taking into account the reserve value of both policies at the end of twenty years. This operates as a handicap to his investment and makes it to his interest to purchase insurance on life plans and invest elsewhere. Such should not be the case, as the life insurance company has a distinct advantage over other channels of investment in the fact that it becomes a hedge against the chances of death and that, as survivors only receive the investment, the desired amount may be accumulated at less annual outlay than by other means. As was explained in the papers on rate-making, the net en- dowment premium consists, not of a term premium and an installment sufficient to amount at 4 per cent to the face of the policy, but of a term premium and an installment considerably smaller than the other, being a net simple endowment premium. The advan- tage of endowment insurance over term insurance combined with other investments is that a smaller installment is required. That advantage is more than equalized by the larger amount of expenses taxed against endowment premiums. The endowment premiums of one large company are lower than those of many others; and that fact in connection with a puzzling method of dividend ap- portionment leads me to conclude that the company has adopted a more intelligent treatment of expense 'distribution. What it is the company has not seen fit to make public. It is clear, however, that the proper thing would be to make a very sharp distinc- tion between premiums intended for actual insurance and premiums intended for investment in pure en- dowments. Whether paid in one premium or many, 85 life policies should bear their due proportion of ex- penses; and, while not strictly equal, it is not greatly- amiss that the contribution should be proportionate to net premium. But provision should be made in the part of the loading intended for expenses, not merely for present outlay but for future demands as well; and present extravagance should thus be curbed. Endowment policies should not be charged for insurance expenses more at most than is exacted from a life policy for equal amount taken at same age. Endowment or pure investment expenses, which should be very low, can best be provided for by making the interest and mortality calculations low enough to leave a sure margin. SURRENDER VALUES.— PAID-UP INSURANCE. In the beginning, and for a very long time, the in- sured was held to divest himself of all rights under his contract by failure to pay premiums when due. This regulation was strictly enforced, leaving the insured even without the privilege of reinstatement, especially if in impaired health. If readmitted to the benefits of his policy, it was considered a matter of grace and not of right. All pleas for consideration were dismissed with the retort '*It is all your own fault," unless it was clearly to the advantage of the company to permit a reinstatement. This was not thought so great a hardship in the days when ordin- ary life insurance was practically the only form in use. The nature of a whole life policy was not at all under- stood outside of strictly actuarial circles. It was by no means generally known that a life policy neces- sarily involved the accumulation of money from the premiums. It was easy to reason by analogy from fire and marine insurance that of course no insurance could be given unless premiums were paid. The large assets of life companies were thought to be unneces- sary and of the nature of surplus. Although a certain degree of reason was conceded to govern the practice of charging an older man more than a younger one, the fact that the premiums did not in- crease with age seemed mysterious and in fact ren- dered the first assertion dubious. Even to this day 87 the life insurance reserve is a riddle to many men if not to most men. The doubt occasioned by so many apparently conflicting things flowered eventually in the roseate schemes of assessmentism. So long as whole life contracts were uppermost in the public mind, the chief complaint against compa- nies in the matter of default in payment of premium was caused by their refusals to accept the premiums though overdue. Aside from the comparatively rare cases when the insured v^as nigh unto death, it was thought unfair that the insured should, though yet in good health, be compelled to pay a higher premium than before because of advanced age. This damage because of the forfeiture condition was measured therefore by the diflerence between the premium he was paying before and the premium required at the new age. This, even though his health conditions admitted of his obtaining new insurance. In a dull way men came to realize that they were wronged, feeling a sense of injury but not altogether compre- hending it, nor v^hat the company gained by inflict- ing it, which was in fact the value of an annuity upon the insured life equal to the difference mentioned. The mutual S3^stem marked the beginning of a concession of rights to the insured after he had parted with his premiums. But although it seemed easy for men to understand that they had an interest ill whatever v/as left of their premiums after providing for all things necessary to safe insurance, or, in other words, in the surplus, it was still diflRcult for them to realize what their rights were in the matter of re- serve. Upon surrender, in fact, the companies held the insured to have forfeited his right to any interest 88 whatever, even to surplus already earned and appor- tioned. Such indifference to men's plain rights natur- ally indicated but little hope of a wider recognition of their claims in matters less clearly understood. Events, apparently entirely disconnected, forced upon the companies a departure from the system of forfeiture. First, in the order of time and primary importance as well, was the introduction of limited- payment life and endowment policies. These policies by their very names and natures implied a some time cessation of payments and apaid-up ownership.. To be evicted entirely from this ownership upon failure to pay later premiums was too evident an injustice to pass unchallenged. No analogy could exist between such contracts and fire insurance; they resembled the purchase of property on partial payments instead. The demand for fair treatment became too pro- nounced to overlook and had to be met in some way. It became, in short, a question between giving up the new and most popular plans or conceding some- thing to the general call for fair treatment. In fact, at about that time a general blaze of dis- satisfaction sprang up in all parts of this country and England as well. Abroad the outrageous disre- gard of common honesty on the part of insurance managers called forth one of Charles Dickens' most severe satires. There it resulted in legislation to regulate the various companies and societies of the realm. In this country it fortunately culminated in more severe and careful examination, particularly in the State of Massachusetts and under the direction of Elizur Wright. One result of this investigation was legislation upon this and many correlated sub- 89 jects in several States; but a more important result was the general understanding of the people that they had rights and interests. This was in the end tantamount to the granting of their demands or the failure of insurance forever. The compulsion of law, in itself but an expression of the people's desire, has not proven so efficacious as the demand itself. Theodore M. Banta, who has since obtained wide celebrity because of his courageous exposure of the maladministration of William H. Beers, president of his company, is credited with having moved the New York lyife Insurance Company to adopt non-forfeiture provisions in the ten-payment life policies then issued by the company, thus becoming the pioneer in that respect. After two or more payments had been made, these policies could be exchanged for paid-up policies for as many tenths the original amount as annual premiums actually paid. The initiative was shortly followed by nearly all companies and compe- tition in that regard raged for several years. This competition was checked by the reactionary tontine movement, which received a great impetus by the number of lapses from 1873 to 1878, the dread of extinction on the part of companies, and the hope of gain on the part of insurers. The check was but temporary, however, and partial; by 1882 the cur- rent was again flowing uninterruptedly in the other direction, tontine giving way to semi-tontine with non-forfeiture conditions. There was great variety in the methods of meeting the popular demand. In the case of limited-payment life and endowment insurance, the course indicated by the New York Life was generally followed. While 90 not really exact justice, there was an apparent fair- ness about the method which satisfied the public for the time at least. But the problem was more complex in the case of other policies, and ordinary life policies were by no means least troublesome. The simplest and certainly the fairest course would have been to apply the net difference between the premium of the policy and the premium which would be charged at the present age to purchase frac- tional insurance at the premium at the present age. In instance, the paid-up insurance granted at age 40 on a policy issued at 30 would be determined as follows: Premium at age 40, $32.20; at age 30, $23.30; the difference $8.90 a year, which at $32.20 per $1,000 insurance will pur- chase about $276.40 insurance. The same result will be reached by applying the difference between the net premiums to purchase insurance at the net pre- mium at the present age, or by the circumlocutory method of finding the present value of an annuity equal to the difference between the premiums and applying it as a net single premium to the purchase of insurance. These methods are equivalent and give the same results, but the last and most involved of the three is the one in common use. Perhaps its use is explained by the altogether too common custom of applying the present value of an an- nuity equal to the difference between the net premiums to purchase insurance at ''the pub- lished rates of the company" or the gross single pre- mium at the age attained. This is equivalent to. using the difference between the net premiums to pur- chase insurance at the gross premium. In instance, 91 the net premium at age 40 (actuaries 4 per cent) is $23.68;at age 30, $16.97; the difference being$6.71 a year instead of $8.90. This applied to purchase in- surance at the rate of $32.20 a year gives about $208.40. This is manifestly unfair as compared with policies becoming paid-up in the usual way, at any rate; but many companies, not content with this, make the paid-up insurance non-participating though purchased at a participating rate, thus inflicting further injustice. Many companies also condition the giving of paid-up insurance upon the surrender of the policy within a specified time, as if it were still a grace instead of a right. So stubbornly do tradi- tional wrongs cling to life. The exact and correct method for calculating paid- up values for limited-payment policies is to apply the net reserve as a net single premium to the purchase of insurance at the age attained. This will give less insurance in the earlier years of the policy and much more in later years; but it is exact justice at all times. In a modified form this method is in use among some companies, but most frequently the insurance is charged for at the gross premium rates. Similarly, the proper mode of determining paid-up endowment values is to apply the reserve to purchase a paid-up endowment running through the unexpired term at the net single premium required for such an endowment. This process will 'likewise give a smallerpolicy in the earlier j^ears and a larger in the later years than the formula in common use. In the use of the term ''net single premium" every- where in the foregoing, such amount is meant as is 92 considered an adequate reserve upon a paid-up policy of like character when that age is attained. That no provision should be made for expenses in such a pre- mium is not intended; but that no more ample provision is required than in the case of policies already paid-up and presenting similar liabilities for the company is axiomatic. The practice of making such paid up policies non- participating or without rights to future surplus is well-nigh universal, except' where statutory enact- ments supervene to prevent. It admits of no defense, when the premiums exacted are such^ as would be charged a new applicant for a participating policy, which is ordinarilv the case. 93 SURRENDER VALUES— EXTENDED INSURANCE. The reserve on a policy is of the nature of a fund to help out future premiums. It was but natural, therefore, that there should be proposed a method of accomplishing that end upon the failure of premiums by default. The purpose of the insured in paying premiums was assumed to be to carry the amount of insurance specified in the policy; and that design was furthered, upon non-payment of premiums, by apply- ing the reserve of the policy to continue the insur- ance. The simplest of these extensions, though almost the latest in order of adoption, is the giving of a specified grace in payment of premiums, charging therefor at customary rates of interest. This re- lieves insurance of its harsh character and gives a reasonable opportunity for reaching and advising the policyholder before he has lost his rights. A lit- tle leniency in this regard is certainly desirable both in the interest of insured and company, as insurance should not be a snap-judgment affair and cannot af- ford to take upon itself such semblance. The only objection urged against this plan in practice is that, when the public has become used to it, all will take advantage of the time and thereby any real advan- tage will be lost. That is altogether erroneous, as companies practicing the system will readily attest. As much might likewise be assumed from the fact 9i that no one cares to pay interest unless obliged to do so. Some companies not regularly allowing grace put such a provision in their policies upon request, thus discriminating between policyholders in a very rep- rehensible manner. Many companies which dis- avow all privileges of this sort privately instruct their agents to grant grace at discretion and permit them to hold back reports in consequence, a prac- tice which has frequently been the cover if not the cause of embezzlement. One company at leas t grants an extension in the payment of premium for a period to suit the exigency upon request and at the discre- tion of its actuary, who is supposed to take into ac- count the policy's reserve value in his consideration of the matter. Such favors must be asked for, how- ever, before lapse by non-payment, or, if afterward, can be granted only upon proof of continued health. As the possibility of such extension is usually un- known to the insured, and as it is human nature to expect to be able to pay until the day is at hand, this system of grace can hardly be considered gener- ally useful. The foregoing relates to the cases of men who in- tend to continue their policies by the payment of pre- miums. The application of the reserve to carry on the insurance when the policy has been intentionally lapsed by non-payment presents other and quite dif- ferent features. In many such cases it would be erroneous to assume that the insured desired to have his reserve applied to continue his policy. The actual facts disprove the theory. In any case, to use the reserve to pay premiums on the original policy— unless 95 the increase of the reserve by such payment be taken into the account — would be a spoliation under the masque of justice. Yet such was originally the prac- tice of the institutions which then most loudly de- fended the extension system. Such a miserable pretense of fair treatment is even to this writing found in the policy of one company, the conditions reading as follows: '* Continue in force for such time as one annual premium on this policy is contained in its reserve value according to the American four per cent table of mortality, at the end of which time this contract shall cease." Such a policy becomes non- participating, although the premium charged is the full participating rate. Not content with so enor mous an overcharge, the company stipulates for a deduction, in the event of the insured's decease, of all forborne premiums with six per cent interest thereon. Yet even this is a great improvement over a former policy in which the six per cent reserve was used as a basis and the dear public hoodwinked into think- ing it better than a four. If such practices can be successful at this late day, it can easily be imagined what deception was em- ployed when life insurance was new. One con sequence of the prevailing indisposition to do any thing like justice in his day was the effort of Elizur Wright to secure equity for the insured by legislation. Upon his initiative, laws were enacted in Massachu- setts compelling companies organized under its laws to continue the insurance in force for a time deter- mined by the amount of the reserve, less a small surrender charge, taken as a single term premium. That there might be no excuse for delay because of 96 incomplete actuarial calculations, the brave old man caused a complete table of single premiums for all terms and at all ages above 10 to be prepared and printed in the State reports. That table alone would render the reports valuable documents. At the time this legislation was made there were few policies other than life; endowments were just coming into use. Consequently Mr. Wright was justified in assuming that the sole object for which men paid premiums was to secure insurance. His efforts were, therefore, directed toward obtaining for them the fulfillment of the desired ends. Modern insurance presents precisely contrary features to those familiar to him at that day, being for the most part investment in character and looking toward the ultimate payment of cash during the lifetime of the insured. Therefore the old rule will not so well apply, and the legislation has been found in most cases useless and in some cases harmful. Massachu- setts long ago revised her laws to accommodate the new features, and placed greater emphasis upon a cash surrender allowance, also insisted upon by Mr. Wright. New York permitted her laws to become optional instead of compulsory, and in the matter of extensions Missouri stands alone in compelHng surrender privileges of that nature. Companies favoring the extended insurance sur- render system have accommodated the change of base from protection only to' combined protection and in- vestment by causing only so much of the reserve as is necessary to carry term insurance for the amount of the policy through the remainder of its term to be applied to that purpose. The remaining portion of 97 the reserve is then used as a single premium for the purchase of a diminished endowment due at the expi- ration of the original term. All of the companies granting extended insurance make the policies non-participating from the date of default in premium, most of them forfeiting the last dividend earned as well. None of the various laws relating to extensions require the companies to con- tinue the policies as participating contracts. Actuaries have not urged many objections to ex- tended insurances except when it is optional with the policyholder whether he takes paid-up insurance or extended insurance upon surrender. It has been all but unanimously held b^^ American actuaries in the past that there is grave danger of adverse selection of risks when such is the case. There seems to be justification in reason for the view that a man who has great confidence in his vitality would select paid- up insurance, while another, conscious of impending death, would prefer extended insurance. This has been thought especially true where an additional cash option was offered. Perhaps the defect in this reasoning lies in the assumption that a man who knows himself to be near his death will sustain his policy at all hazards. More probably, however, men do not act reasonably at all. A case recently came to the writer's attention of a man who despite danger- ous illness not only failed to meet a premium, though he had the money, but even- neglected to apply for the paid-up insurance to which he was entitled. This with the full concurrence of his wife, the beneficiary, and after advising with his banker. Such may be an extreme case; but in any event statistics have 98 proven the adverse selection theory a chimerical bug- a-boo. The leading Australian company, as old and as large as most of the American companies, makes a practice of allowing a grace on all premiums, of applying dividends as reversionary additions v^ith privileges of cash conversion at will, of extending the insurance upon non-payment of premium by charg- ing the premiums against the original policy as loans until the entire reserve including all dividends is exhausted, permitting payment of premiums with- out health conditions at any time during such extension, and permitting surrender for cash or paid- up insurance at any time. Despite all these privileges, considered so conducive of adverse selection, and many other freedoms avoided by most American companies, the company contrives to pay divi- dends far in excess of any American company. Its interest does not average a higher rate than some American companies experience. 99 SURRENDER VALUES—CASH.. Until recent years, cash was not usually given as a surrender value even upon urgent request, cer- tainly not as a matter of course or of right. Life in- surance began as a proprietary business, and even the first mutual companies were essentially proprie- tary without the safeguard of a stock interest. Even to this day, such is often the case. Consequently the attitude of companies when requested to redeem their promises to pay before maturity was that of the greedy note-shaver of a country town. Covering themselves behind the mystery of a mortality table, and often by a sanctimonious concern for the victim's family, pretending to wish to discourage the Hghtly surrendering of the protection of widows and or- phans, company managers have filched large sums from persons who by immediate distress were compelled to realize on all possible resources at what- soever sacrifice. Such profiting by the need of others was reprehensible enough when it resulted in a direct gain to the managers. Now, when any such profit is supposed to inure to other members, who may each in turn be thus despoiled, no excuse can be offered; unless the charges in relation to perquisites of managers from surrender charges are true. So long as there was no definite understanding of what constituted a proper reserve on a policy, it was perhaps unavoidable that there should be a wide variance in the estimate of its cash value. In mutual 100 insurance there would seem, however, to be no ques- tion whatever as to what should be allowed upon surrender. In such companies the insured should not part from the ownership of his money because he in- trusts its possession to the company. The company has no right to appropriate more of it than is neces- sary- to cover the policy's just share of death losses and expenses. Whatever remains should be consid- ered the property of the policyholder, and is either surplus or a fund to help out future premiums. If the former, the title may be doubtful, as such sur- plus may by the very essence of the contract be the property of survivors only. But the reserve will not be called on to meet future premiums upon the in- sured's life if he carries no insurance, and there is no good reason why all should not be returned to him, if any. The indisposition of most companies to do any- thing near justice in this regard moved Elizur Wright to get before the Massachusetts' legislature a bill requiring all Massachusetts' companies to pay a cash value for any policy surrendered upon its an- niversary. This cash value was to be determined by deducting from the 4 per cent actuaries' reserve a moderate surrender charge. This surrender charge was a percentage of the present value of future * 'costs of insurance" or net insurance value, such percentage being sufficient to cover any ad- verse selection caused by the withdrawal of the life. Radically this plan was the outgrowth of proprietary ideas; and the surrender charge was not so much to counterbalance a loss as a future profit expected to be made. It was essentially 101 adapted to life policies only and to companies ex- pecting to reap a profit for stockholders from the premiums. Upon endowments the surrender charge was not merely less than on life policies but less than on term policies also. The objection to allow- ing ample cash values because of possible adverse selection may be dismissed as bosh; all statistics prove the contrary. Any possible gain made by such ill treatment of patrons has been much more than counterbalanced by the increased cost and difficulty of obtaining business. The average sensible person nowadays refuses to take an insurance "until I can see my way clear," knowing full well that he will be despoiled if he falls on the way. Consequently, he is either altogether deterred from entering or is brought to do so only after much soliciting. He must think not merely of this year's outlay but of his ability to meet future premiums. The gratuitous concern for others' families put forth in the pretense of discour- aging lapses would be ludicrous were the subject not so serious. Nothing is so sure to make one lapse without delay in most cases as the discovery that he will not be fairly treated . Nothing is so likely to encourage him to continue as the confidence that whatever befall he will get good value for his money. Men can be led but not be driven. The last argument against regular cash values, and one commonly conceded to have more force than all others, is the possible danger of embarrassment to the companies because of a general demand dur- ing panicky times. There is doubtless some cogency in this position as it is found to obtain in banks, and the similitude between life companies and banks 102 becomes greater the more investment insurance is urged. It might be inconvenient, if not disastrous, to be compelled to market long-time securities in a crisis; and such is certainly to be avoided. Banks of deposit are, by the laws of most States, prohibited from holding such securities if they accept demand deposits. Policies made surrenderable for cash at the option of the holder are in effect demand certifi- cates. As has already been said, however, the Mass- achusetts law requires cash values only at anniver- saries of the policy and is therefore not subject to this objection. That life companies are embarrassed by this phase of the matter is their own fault. Had they been dis- posed to act fairly there would have been no public demand for such conditions in the policy and a com- pany could refuse cash payment for surrendered poli- cies whenever it was necessary in order to avoid dis- aster. But under no circumstances is a company justifiable in refusing to pay the full reserve when it pays anything; * 'discouraging surrenders" is a piti- able subterfuge unworthy of men vested with so great a trust. That the public believe a company insincere in its profession of desire to do equity in the matter of surrender values is btcause of the public's bitter experience in that regard. Until that experi- ence fades away and is reversed by new experience of a contrary character, the public will demand definite agreements in the contract and will not be satisfied with excuses of whatsoever character. Meanwhile, many companies seek to avoid possi- ble dangers of the sort just described by stipulating for notice a number of months in advance or for sur- 103 render only upon the anniversai'y of the policy. In so far as these conditions are intended only to ^Yoid the possibility of a run upon the company and, con- sequently, in so far as they are enforced only when necessary, they are unobjectionable. If, as is often true, they are made use of in times of no financial stress as an excuse for an absolutely indefensible dis- count from the cash values pretended to be given, they are utterly disgraceful. 104 PREMIUM AND OTHER LOANS. The recognition of the policyholder's right to the value of his policy carried with it the privilege of using it as a collateral security for a loan. The fact that no safer or better securities than their own policies could be found was recognized by companies at an early day, and, had it not been involved with the disputed matter of cash surrender values, it is probable that the privilege of a loan not exceeding the reserve value would long ago have been granted by all companies. For the actuarial objection of ad- verse selection could hardly apply, since by this means men who would otherwise surrender their policies would be induced, and enabled as well, to continue them. Likewise, it cannot be argued that such a convenience would result in men lightly sur- rendering the protection of their families, which possibility so troubles the truly good among insur- ance managers. Instead, men v^ould thus find in their life policies the friends in need who are friends indeed, a means of relief during the extremity of misfortune and an unfailing resource of their families after their death. Surely, anything which will make life insurance more efficacious should be fostered. The purposes for which it is purchased nowadays are two, the protec- tion of families against the loss of support and the accumulation of a fund for **a rainy day." It cannot 105 be successfully denied that both these ends are sub- served by permitting the fund to be drawn against when an exigency arises. This is particularly true in the case of policies in which the investment element predominates. Such policies are of the nature of bonds and it is often of the highest importance that they should be availa- ble as collateral. Any one familiar with soliciting in the life insurance business must be convinced that to make the hypothecation of policies free as possible would greatly widen the scope of insurance and facil- itate soliciting. I^ife insurance policies will con- tinue to be regarded by the public as low-class in- vestments so long as companies deliberately discredit their own promises to pay by refusing to recognize them as desirable security for their investments. A general reformation in this regard would result in the common acceptance of such policies as collateral all over the countr^^ and at all financial institutions, and would correspondingly relieve the pressure upon life insurance agents for accommodation loans, at the same time rendering the sale of insurance much easier. The objection urged against cash surrender values because of the possibility of a sudden and united call for money necessitating a sale of securities would seem to have little appositeness in the case of loans; although the same fatuity which caused the compa- nies to act insincerely about cash values, until the people no longer believed anything not written in the contract, has brought about a similar situation in the matter of loans. It would be common sense, were the people's confidence in the rectitude of in- 106 surance management such as it should be, first, that companies would gladly loan up to the full value of policies at current rates of interest, and, second, that no one would expect such a loan were there no loan- able funds in the treasury. Such would be the reasonable expectation of a man who held a time de- posit certificate in a bank— just that and no more. But the perverse action of insurance managers has led men to expect anything but what one would expect in anything else; and this well-grounded suspicion will not be quieted by less than definite promises in the contract itself, and capable, therefore, of legal enforce- ment. To such a pass has the folly and stupidity of the past brought insurance that companies are now about to be compelled by popular distrust of their pretenses to promise such loans in a definite manner without reference to the company's con- venience. There is no shadow of reason in refusing to loan the full reserve, if any loan is to be made. To talk of margins where one's own promise to pay is the col- lateral is worse than ridiculous; and the remnant of that ancient pretense of fatherly solicitude for the assured 's family and assumed guardianship over him and them, which is put forth as a sometimes excuse for loaning but one-half or two-thirds the reserves, is sillier still. It is better to loan a man the full reserve and keep his patronage than to pay it to him and lose his patronage. In a bank it would be far better to loan a man the face value with accrued interest of a 3 per cent time certificate, the loan to bear 6 per cent, than to cash his certificate and let him go his way. Bankers are already familiar with the same 107 principle; they decide as to discounts, taking into account tlie customer's balance, thus augmenting the average actual interest. Certain companies have made a distinction be- tween loans against policies when the loans are to pay premiums and loans for other purposes. Loans of the former kind are defended as praiseworthy and loans of the latter sort condemned as tending to re- duce the value of the insurance to the beneficiary. Premium loans have been made in several ways. A very common form, which raged for a number of years, was known by the generic name of ''premium loan or part-note plan." It consisted of accepting notes for a definite fraction of the premium from the start, such notes usually payable from proceeds of the policy only. The percentage of premiums for which notes w^ere given v^as supposed to be fixed to accord with the current annual dividends, and in practice agents were instructed to assert that the dividends would take care of notes and interest, a prophecy or estimate which rarely proved reliable. As such policies were bought for their supposed cheapness, and as the increasing indebtedness against them resulted in increasing cost with decreasing in- surance, they proved very unsatisfactory and were lapsed in large numbers. The experience of compa- nies under such contracts has been repeatedly quoted as the strongest possible argument against all forms of loans — an argument more plausible than forcible. This form of premium loans is now, happily, almost obsolete; it was never demanded by the public, but w^as foisted upon it under a misapprehension of the subject. 108 Another form of premium loan is the loaning of a full premium upon request. This does not wideh^ differ from ordinary loans, except in the insufferable endeavor to dictate what the policyholder shall do with his money. A few years ago, a leading company adopted this idea in a policy which, by other less agreeable features, attracted widespread notice. It agreed, after a certain number of years, to loan any or all premiums through a second term of years, thus securing the policyholder against loss of his pol- icy through inability to meet premiums. Its initia- tive has been followed by some other companies and seems to have had some effect upon the practices of many companies. At present there is the widest diversity in the mat- ter of loan privileges. Several companies agree to loan a percentage of the reserve, varying from 50 per cent to 90 per cent. Some of these impose conditions as to time for application; others do not. One company which in all other particulars prides itself upon treat- ing all policyholders, old and new, without discrim- ination, grants premium loans to ordinary policy- holders on request but denies them to holders of ac- cumulated-surplus policies— a preference not defensi- ble on any ground, since the latter policies are the better security and the loss of them a severer one to the holder, resulting in the total forfeiture of the sur- plus. But one company has as yet made arrange- ments to loan the full reserve, and it does so only at periods five years separated, the amount loaned at intervening times being the same as at the close of the last period. 109 POLICY CONTRACTS.— THE APPLICATION. In reading modern life insurance policies, one is met at the very outset by a reference to another in- strument, or other instruments, supposed to have been executed by the insured. In various and often studied phrases such writings are stated to have been accepted as warranties, to be the basis of the contract, to be partial consideration for the con- tract, to be part of the contract itself, etc. Upon reference to these papers they are found to consist of certain declarations and promises made by the in- sured and recorded either by the company's agent or medical examiner or partly by each. The declara- tions cover the personal and family history of the applicant, both by general and detailed statements, his present condition in all regards, and his inten- tions in many regards. His promises are commonly merely assent to stipulations printed on the sheet and often imperfectly understood by him. The effect of incorporating such paper or papers into the contract is intended to be the placing of all statements contained therein upon the footing of warranties instead of representations. This distinc- tion is of a purely legal character, not generally un- derstood, yet of the highest importance. If no refer- < ence were made to such writings, or if they were re- ferred to as mere representations, the construction of a court would be that such statements must be true 110 to the best of the insured's knowledge and belief, if at all material to the eontract. Thus, to avoid such a contract, a company would be compelled to prove, first, that the information withheld would probably have caused the rejection of the life proposed, and, second, that the insured knew the facts. Such proof would raise a strong presumption of fraud, which might be confirmed by other evidence, but which, though unconfirmed, would nevertheless seem well- nigh incontrovertible. The two propositions named are, however, both very difficult to prove in ordinary cases and it is to escape from that difficulty that a resort to the war- ranty system was hit upon. A warranty is a solemn declaration of the absolute truth of statements, coup- led v^ith a consent that the contract shall fail if they are found false in any particular. This is accomplished by making such statements not merely representations in order to obtain insurance, but statements offered as a basis and part consideration for the contract. The failure of any part of the application is, therefore, a failure of the foundation involving the downfall of the superstructure, or, to change the metaphor, a failure of the consideration voiding the contract ab initio. It is no longer neces- sary to prove that the error is material, that it was made with full knowledge of the fact, that it was by inference at least intentional and therefore fraudulent. The only thing required to be proved in order to avoid the contract is that any statement is not strictly true or any promise not exactly fulfilled. Such is the law, and that it is not enforced in all its stringency is because there has arisen a series of legal restrictions which interfere with its application, and furthermore, and more particular^, because petit juries blindly do justice in defiance of law. The courts, recognizing the iniquity of the system, seize every opportunity to render all warranty stipula- tions nugatory. The application being constructed by the company and the statements therein recorded by its agent or representative, it is a legal maxim to construe it strictly as to the company and liberally as to the insured . The same applies to the policy itself with even greater force. Means of getting evi- dence as to materiality of the statements, the igno- rance of the insured concerning the facts, and the absence of fraudulent intent are usually to be found; and, when such evidence of a convincing character is presented, juries soon do what is right between the parties, without regard to legal hair-splitting. That such is the case does not in the least relieve in- surance companies of the odium of keeping up this vile system. The oft-repeated assertion that claims are not contested unless believed to be fraudulent is no excuse; the only possible proof of such honest pur- pose would be to throw away all defenses except against fraud. If a company cannot prove fraud to a jury, it has no right to expect the public to believe that there is fraud or to shield corporate greed and oppression under the name of justice. At the best, unless companies intend to enforce warranty stipu- lations to the letter, they are retaining an anti- quated weapon of defense which they either dare not use at all or only upon occasion, which means the vilest discrimination — a discrimination between ben- eficiaries. 112 To make plain the enormity of this offense against equity, the error of a year in the age of a grand- parent at death, although it were a year too young, would avail to set aside a policy under a strict con- struction of the warranty law. The existence of a secret malady unknown to every one at the time of contract, including the applicant, but v^hich must have existed in latent form, is another reason of avoidance; such evidence was seriously brought forth in a cause celebre a few years ago. Many of the in- quiries of the application are concerning things of which in most cases the insured can have but hear- say information and could not by any possibility know of his own knowledge, so that his testimony thereto would be competent in a court of law. Many other questions call for professional skill in diagnosis of diseases not possessed by all practition- ers and by few others. Other inquiries are so broad in their scope and general in character as to seem to cover mere matters of opinion. Yet the answers to each of these must be the exact truth in order to ful- fill the requirements of a warranty. Both in the wording of contracts and in disposi- tion to contest, using trivial defenses under the cover of warranty, assessment and fraternal societies are even greater sinners than regular companies, as wit- ness their involved and misleading certificates and their frequent resort to the courts. In a vague and indefinite way the people have for a long time been sensible of the wrong. This sentiment has shown itself in strong resentment against companies guilty of any illiberality toward claimants and a marked preference for companies establishing a contrary 113 reputation. That no more has been demanded of the co-operatives is only another proof of how little is expected from them anyhow. Popular indignation has resulted in decisions palliating the severity of the law, incurious special legislation on the subject here and there, in the incorporation of a copy of the in- sured's declarations in his policy in many cases, and latterly in the adoption of incontestability provis- ions after a short interval. Thus, in order to preserve the right to contest when no fraud can be proved, companies have been willing to agree after a short time not to refuse to be defrauded. To so singular a position has the wrong-headed determination to conserve foolish and antiquated provisions brought the companies. In fire insurance the application with its warranties has already been practically discarded. Because the application was in the manner de- scribed made a part of the contract, it v^as found a convenient receptacle for many stipulations and con- ditions, which were too objectionable in- the policy proper. This has been carried to a ridiculous point by certain companies, which advertise policies free from conditions and use applications one side of which (usually not seen by the applicant) is wholly made up of printed conditions. Even then an over- flow appears on the other side of the application, which is in toto a warranty and a consideration for the insurance. One of these companies causes a man to warrant that within a certain time he will not kill himself; it could easily have him warrant that he will not die at all, so far as his knowledge of sign- ing any such agreement is concerned. Several com- panics insert in their applications an agreement concerning the division of surplus which utterly de- stroys the mutuality of the contract and surrenders the insured's interests wholly into the hands of the company's managers. Many applications yet con- tain clauses waiving rights given by special statutory law, although the decision of the supreme court of the nation is that such waivers are absolutely void unless provided for by the law itself. Very obnoxious stipulations, seeking to absolve companies from all responsibility for the frauds of their agents, are fre- quently inserted. Provisions that the contract shall be considered to be made at the home office of the com- pany or shall be construed according to the laws of a certain State are not infrequent. Such pro visions have never been upheld in any of the higher courts and are repugnant alike to law and common sense. A further condition limiting the time within which suit may be brought against the company is sometimes inserted; such a provision might be held legal, judging from a decision of .a national court upon a case in which, however, the provision was by legislative enactment. Similar provisions are sometimes made concerning the making of proofs of death. The endeavor to turn a life insurance company into a temperance society appears in some applications as well as in some policies, in a promise never to become an inebri- ate, coupled w^ith a concession of the right of cancel- lation if such agreement be broken. Nowadays, when drunkeness is pretty generally believed to be a disease, such stipulations are singular reading. Other conditions, which are utterly foreign to the real character of a proposal for insurance, might be 115 quoted; but enough has been said to awaken the reader to the fact that the average application should receive a close examination before a signa- ture. Anything beyond the proper statements of fact and intention of the applicant is really out of place. 116 POLICY CONTRACTS.— THE PROMISE TO PAY. The form upon which a life policy is modeled is that of a simple contract, best typed by an ordinary promissory note. It is not in any sense identical with the "bank draft" sometimes spoken of in ad- vertisements; bank drafts are not promises, but or- ders to pay. The best possible expression of an agreement to pay is the simplest, namely: I promise to pay. The verbose and tautological manner in which this agreement is set forth in most policies is a relic of the days ^when men were not expected to un- derstand their policies, but to be awed at the learn- ing embodied in them. Contracts to pay money should specify clearly for what consideration (especially if not already per- formed and to be performed in future), at what time and place, upon what conditions, and to what per- son or persons the money is to be paid. These par- ticulars are necessary for a self explanatory contract, and it is not a matter to be proud of if an apparent simplicity of wording has been attained by leaving any of these essentials incomplete or bj referring to another paper for explanations. The reference to the application as a partial con- sideration has already had attention. Immediately following this the real consideration is commonly specified, although in some contracts no mention of this is made until later. Rhetoric, business usage 117 and common sense, however, accord first place in simple contracts to a recital of the consideration. In life insurance the consideration usually comprises a sum of money paid in advance and a like sum to be paid at regular intervals thereafter for a specified term or during life. Some companies stipulate that these premiums must be payable at the home office, another antiquated condition fallen wholly into des- uetude. Many stipulate for payment before a desig- nated hour and almost all for payment upon a defi- nite day. In practice so rigid rules are rarely enforced, but they are there to enforce whenever com- panies see fit to do so.. The payment of a life insur- ance premium has little in common with a business obligation; and when the invested value will sustain the insurance, certainly a little latitude may safely be granted, subject to a fair interest charge so that it will not be lightly taken advantage of. Such grace provisions are now to be found in the policies of several leading companies. The time of claim payment is variously expressed as within a certain period after due receipt and approval of the proof of death or immediately there- upon. There appears to be no good reason why there should be delay after the death of the insured is satisfactorily proved and the identity of the claimant established. This includes, of course, any inquiry found requisite aside from the regular proofs. A clear case should be made out; but, when that is done, there should be prompt settlement. The taking ad- vantage of such clauses to mulct the beneficiary of part of the proceeds of the policy in the form of a discount is a practice now happily obsolete — dead in lis its sins. A life insurance policy should be a promise to pay a definite amount at once upon the death of the insured; but no interest should be allowed be- cause of unavoidable delay and no discount charged because of prompt action. Conditions compelling the filing of proofs within a specified time and limit- ing the time for legal action are both very objection- able, as serving no good purpose and likely to defeat just claims. It is not always possible in this age of travel for even the fact of death to become known within a short time; and a claim against an honest company like one against an honest man should never be considered outlawed. The endowment agreement, for payment during the lifetime of the in- sured, of course, offers no difficulties. The place of payment is usually the chief ofl&ce of the company. So long as this is construed to mean merely that the claim will be paid in the exchange of that city it is unobjectionable. A literal construc- tion would be ridiculous. Despite the pretenses to simplicity of contract, the conditions of jDayment are so manifold, diverse and complex even in the simplest policy forms that it is not considered feasible to place them in proper order in the contract. They are consequently relegated either to a second page or to the application, as the case may be. Chief among these conditions are the following, commonly imposed for one, two or three years only: Prohibition against residence or travel in the tropics, or in certain parts of this country, or in places where yellow fever or cholera are epidemic; prohibition against engaging in various occupations, such as mining, submarine operations, blasting, manufacture 119 of explosives, handling dynamos or electric wires, service on railway trains or vessels; prohibition against engaging in a duel. The usual practice is to refuse payment, if at all, only when death is incurred because of a breach of these conditions; but most contracts are void by their terms whenever these prohibitions are disregarded, and companies have pleaded such breaches in avoidance of claims arising from causes quite other than the ones put forth in the plea. Suicide has been included as a ground for refusal to pay in the policies of all companies with one honor- able exception. Statisticians and specialists in brain diseases have, from altogether different premises, long ago united in the general conclusion that few suicides occur except as the result of mental disease. Despite the most rigid provisions in that regard, covering self-destruction, whether sane or insane, voluntary or involuntary, companies have repeatedly found themselves compelled to pay claims of this nature. No other single condition has ever proved so com- pletely bootless, nor any so extremely unpopular. The engaging in military or naval service except in times of peace is usually interdicted, sometimes only temporarily, sometimes permanently. Other com- panies permit the engaging in this or any other occu- pation and residence in anyplace, subject to the usual extra premiums, which are a lien against the policy from that date. It is doubtful whether an inhibition against military service might not be considered void as against public policy, as well as void because the infraction was involuntary, wherever the enlist- ment was a forced one. 120 Similarly, whether so stipulated in the policy or not, it might be found against public policy to sus- tain an action when death was occasioned in or be- cause of a violation of law; although it is by no means clear that an innocent beneficiary should be made to suffer. Sucli a condition is in most policies. It is a common though not universal practice of companies to pay as a surrender value the reserve on policies voided by a breach of these conditions upon the death of the insured. Such is definitely agreed upon in some policies. The existence of any or all these conditions has been felt to place an unfortunate limitation upon the usefulness of insurance by attempting to circumscribe the future activities of the insured. It is nearly as impossible for a man to govern his future mode of life, his choice of occupations, his place of residence or route of travel, or even his habits, as to determine the disease which will one day carry him off. He naturally desires insurance to cover all possible con- tingencies and every exception is a positive and a seri- ous detraction from its utility. Companies are, of course, justified in guarding themselves against being used as conveniences for clever rascals who endeavor to get a bargain in insurance, well aware that their prospective occupations imply a greater risk than their premiums provide for, or that some change wrill render them uninsurable. It is upon that ground that the retention of these various conditions is de- fended; and the logic is rather better than the aver- age reasons put forward for objectionable clauses. The trend is now toward greater liberality in this re- 121 gard and one company has already removed all con- ditions and restrictions. A more disagreeable and less defensible condition than of any of these, is a stipulation for the privilege of cancelling the policy during the lifetime of the in- sured upon proof that he has formed habits tending to shorten his life, has had delirum tremens or has been convicted of felony. A provision for cancella- tion of a fire policy after the building has taken fire would be a fair parallel. Nothing is better under- stood nowadays than the fact that habits are dis- eases, capable of thorough diagnosis and often of cure; and surely nothing is more certain than tTiat many innocent men are convicted of felonies, that many guilty men are not very bad, and that more reprobates are outside prison walls than in. Any stipulation intended to leave a man without insurance and a family without protection just when most needed, and most clearly impossible to obtain otherwhere, should be roundly condemned. 122 POLICY CONTRACTS— TO WHOM PAYABLE. As was circumstantially set forth in the first of these papers, insurance is a contract for indemnity, for making good that which is lost. Consequently, insurance cannot properly be granted to anyone ex- cept the person or persons who have a financial in- terest in the thing or persons insured, nor, indeed, according to the better authorities, even to such be- yond the cash value of their interest. This principle is generally enforced by law under the broad appli- cation of the maxim "against public policy," though a fair construction of insurance contracts and con- sideration of their indemnity basis would seem to render all reference to such general law unnecessary. However, it would certainly seem to be against pub- lic policy in the highest degree to permit a man who has no interest in another man's house to acquire an interest in having the same destroyed by fire. Different in degree, but not in character, is the case of prop- erty insured beyond its value, for to the extent of the over-insurance the policyholder is interested in having the property burn; the preponderance of self-interest is on that side. But if this be repugnant to public policy, it is surely more outrageous and in fact, criminal to permit any person to acquire an interest in another's dying who has not at least an equal interest in his living. Such a license would be to in- cite to murder. 123 Therefore, it ma^^ be broadly stated that Hfe insur- ance should not be made pa3^able to any person who is not interested in the life of the insured to the full amount of the policy. Concerning relatives the case usually presents no difficulty, since the interest of wife and children in a man's life is only bounded by the value of the life itself and that is usually, though not always, a larger amount than he is likely to in- sure for. The interests of father, mother and colla- teral relatives are really prospective only, unless they are alread3^ actually dependent upon the in- sured; for otherwise they will have no claim upon the insured at law unless reduced to poverty and helplessness, and not then unless he can do more than care for his immediate family. Relatives further removed than brothers and sisters, and pos- sibly their descendants— such relatives as grand par- parents, uncles, aunts and cousins — have no genuine interest whatever in a man's life unless an interest is created by the voluntary assumption of care of them by the insured. Such an interest as a basis for in- surance is regarded with suspicion, both by coiirts and companies, because, if permitted in the case of others than blood relations, it would open the door for extended litigation and for the perpetration of fraudulent insurances, really of a gambling charac- ter. Notwithstanding this, there are no doubt spe- cial circumstances which may give one person moral and even legal claims upon another, because of the relations created by personal preferences and friend- ship; and there is no good reason why, when the fact of such relations is established and the responsibility confessed by the insured, an insurance should not be 124 granted. A common case is where an engagement to marry has been entered into; insurance in favor of the fiance has been repeatedly held valid by the courts and is not disfavored by companies. Another, but not so frequent a case, is that of parentage out- side of marriage; the obligation of the father to sup- port his offspring is every day more firmly upheld by courts and upon that obligation an insurance may very properly be based. The mother of such a child is, however, up to the present not considered to have any such interest in its father's life as will support an insurance. The law persistently disregards the mutual responsibilities actually created by concubin- age and refuses to a woman, who has been robbed of everything else, even recognition pf an interest in the life of him who often alone stands between her and further degradation. Such law is monstrous and against the good morals which it is intended to protect; for it is not by lessening the responsibilities of men because of wrong-doing that it will be checked; it were more to the purpose as well as more just to heavily increase them. That to admit the insurable interest of a mistress in her lover's life might lead to murder when she feared that he was about to de- sert her is true; equally and similarly true is it when the beneficiary is a wife instead of a mistress. Were the legal right of a lem an to protection and assist- ance once recognized, she would have no greater rea- son to punish desertion with death than would a wife. Some companies, at the imminent risk of hav- ing to pay the amount a second time to other claim- ants, have issued insurances to mistresses and duly paid the same, a deed greatly to their credit. 125 The intereit of a creditor is recognized as an insur- able interest, but, by the better authorities, not to an amount exceeding his legal claim against the in- sured. Decisions have been made, not merely sup- porting the contrary idea, but even holding that as the insurance was valid in the beginning it is not in- validated by the payment of the debt and consequent cessation of all interest. Such law is a disgrace to the bench and is the result of mere sophistry, coupled with complete disregard of the proper nature of an insurance contract. Applied to fire insurance, it would continue in the holder of a policy a right to insurance upon property already sold; that would be at once repudiated. It has not merely been occasion- ally sustained, however, in the case of life insurance in favor of creditors, but has been sustained as a legal principle with practical unanimity in the case of insurance in favor of a wife afterward legally di- vorced. Thus courts, which deny txie claim of an adulteress upon the man who has seduced her, sup- port her claim for insurance upon the husband from whom her sin has legally separated her. This trav- esty upon justice is a disgrace to civilization. The general principle that insurance should be in- demnity based upon an actual interest, not exceed- ing that interest and not extending beyond that in- terest, is a safe one and the true one. That a man has an interest in his own life to its full value has come to be fully recognized. His right to mortgage his future by debt is a practical illustration of that interest. Therefore, it is not con- sidered in any way improper to permit him to insure his life in favor of himself, thus protecting not merely 126 a single obligation to one person or a few persons, but all his obligations to everybody and insuring an estate which otherwise might never be left behind him. Confirmed bachelors, having also no near rela- tives or other person for whom they care, often see fit to carry large insurances to protect beyond any possibility their names from dishonor, because of shrinkage of estate. Provided al w ays that the estate is solvent, the right of a man to dispose by will of the proceeds of a life policy, payable to himself, is no more open to question than his right to dispose of any other property in similar manner. By special legislation in some States the right of a wife and and children as against creditors in insurance upon a husband's life, the premiums on which have been paid by him, or with funds contributed by him, is limited. Of course, where a policy is directly pay- able to the insured's administrators, executors and assigns, the insurance policy becomes part of his estate and subject to all laws relating thereto. In- surable interest in those claiming by will is no more required than in the case of any other property con- veyed by will. Of course the ownership of a life policy carries with it the right of assignment to others, but the prepon- derance of legal opinions is that such assignment is valid only to the extent of the actual interest of the assignee at the time of death of the insured and void if no such interest exists. The same sophistry, however, which has led courts to uphold other contracts, al- though all interest in the life has ceased, has in the same manner led them to pronounce assignments good be- cause an interest existed at the time of the assignment, 127 though such interest has ceased. Assignment by a beneficiary other than the insured is not encouraged by companies and is looked upon with great suspicion, although such assignments, when they likewise con- vey the interest upon which the insurance is based, would seem to be unobjectionable. Otherwise they would be subject to the objection urged against the permission of any other manner of holding insurance upon a life in which one is not beneficially interested. Nearly all companies demand notice of any assign- ment, together with a copy, before the same shall be binding upon the company and many companies re- fuse to be responsible for the validity of any assign- ment. By this means they endeavor to shield them- selves and turn the quarrels between contesting claim- ants into a fight with each other instead of with the company. Whether payment to a person not legally entitled to it ^would be considered good as against the legally rightful claimant may be doubted, even though the company in the contract disclaims all responsibiHty. Other companies require proof of the fact and amount of interest before paying the pro- ceeds of a policy to an assignee; and if his interest is less than the whole, or if any doubt exist, such com- panies usually demand the signature of the adminis- trator or executor of the insured as well as the sig- nature of the assignee to the receipt. This course protects at once the company and the often helpless dependents of the deceased, who otherwise are like to be robbed by merciless usurers who have obtained possession of policies because of the dire necessities of a sick and unfortunate man. Even when a beneficiary is named in a policy, it is customary to make it payable in case of survival to 128 the insured, and he is given the right to the surplus, often the right to the surrender value and practically always the right to the endowment or tontine settle- ment. When this is not the case, and particularly when the beneficiaries are minors or (in some States where the disabilities yet exist) married women, it is often found impossible to free the policy so as to sur- render it or assign it, or even to utilize the value of it upon maturity. Precisely the same state of affairs may be brought about by an assignment. An attempt to make policies directly payable to persons having legally no insurable interest has lately been made by writing the policy payable to devisees of the insured. In the opinion of some attorneys the effect of this is to warrant the company in paying directly to persons designated by will, without regard to the claims of creditors of the estate, of which, they hold, the policy or its proceeds never become a part. Undoubtedly it is possible to limit the payment as against the insured so that he cannot dispose of the policy in any but the specified manner. But as against creditors claiming through him it is tolerably clear that any such limitations would be void; for a man cannot dispose by will of anything not his ow^i and, therefore, of nothing which is not legitimate subject for levy to satisfy the claims of a creditor. The com- pany which pays devisees without the intervention of executors might find themselves compelled to pay again by order of court; for it has long been settled that a devise is not good unless there be something left after the claims of creditors are satisfied. Whether lield legal or not, such course should be avoided by companies as leading to a neglect of the real pur- pose of insurance, namely, indemnity. 129 POLICY CONTRACTS-»SURRENDER AND LOAN PRIVILEGES. There is a wide variation in the privileges actually given when a policy is loosely said to be '* non-for- feiting" after a certain time. This term, which is so frequently used in describing life policies, in prac- tice merely means that some sort of value may be accorded the insured upon surrender after a certain period. It may indicate that the insurance will be continued in full force under an extension clause without any action on the insured's part, or, on the contrary, it may mean that an utterly insignificant paid-up insurance will be granted provided applica- tion is made for it within a very limited time. There is just one thing that it is sure not to mean and that is, what it says. The original policy is forfeited in all cases for non-payment of premium, and any in- surance given in its stead is either for a different amount or of a diiferent character or both. The only company which really exhausts the value of a policy in maintaining it is the Australian Mutual Proi-.ndent Society of Sydney, New South Wales, Aus- tralia. In insurance as in politics it would seem that we have much to learn from the newest world of all. In this country, however, non-forfeiture at the best means merely that the insurance is carried on for the full amount without anj act of the insured so long as the reserve will carry it as a term policy. Such 130 term insurance does not participate in profits; neither does it represent the profits already accumulated, if any. The insured commonly has no right to pay his premiums during such extension, unless he can pre- sent proof of good health, UQr even then unless he ap- plies within a limited time. The only exception to this sweeping rule is the one month grace allowed by a few companies. The rule is that once started, the extended term insurance inexorably runs out its stated course, expiring on a certain day, though the insured be then upon his dying bed. Even this poor substitute for actual non-forfeiture provisions has been adopted by but few companies, the most avoiding it on the ground of '' adverse selection." Where extended insurance begins immediately upon the non-payment of premium, most companies per- mit the selection of a paid-up insurance for a reduced amount instead, either at the time of failure to pa^-- or in some cases for a limited period thereafter. This form of surrender value — namely, paid-up insurance — has been the most popular with companies, though hardly so with the public, and is now the most com- mon value given. In a majority of cases it is not given as a matter of right, but as a privilege to be taken advantage of within a few months or else for- ever lost. How the amount of this paid-up insur- ance is usually determined has already been fully treated in earlier papers of this series. It is enough to say at this juncture that the paid-up policy granted is ordinarily manifestly unfair as compared with the values given those who continue. It is practically always charged for at participating rates, while in fact non-participating. Some companies 131 have of late changed the provisions of their policies, so that now paid-up insurance begins by stipulation at once upon lapse, thus recognizing it as a right in- stead of a privilege. Many companies, however, following the course taken by certain very large com- panies, require the surrender of the policy and appli- cation to be made for paid-up insurance within six months after non-payment, or the right to such paid- up insurance is forfeited. The privilege of surrendering policies for a cash value is confined in most companies to the terminal privilege in investment policies. Otherwise it is re- garded as a great favor, to be granted with caution and upon special occasions only. A few companies have conceded the privilege of surrendering for cash at intervals of one to five j-ears and a very few the privilege of surrendering for cash at any time. The Massachusetts companies are compelled by the law of that Commonwealth to grant cash values within a certain percentage of the full reserve. These com- panies are as yet practically alone in regularly grant- ing cash values upon policies other than tontine or accumulated surplus contracts. The laws of the same State make paid-up policies given upon sur- render participating in future profits. Outside of the Massachusetts companies, several have of late years granted cash values after a certain time equal to the full reserves, such values being given only upon policies where the surplus accumu- lates and is not paid upon surrender. One company, which which was almost a pioneer in this direction, on such policies pays all dividends in the form of reversionary additions for a number 132 of years in order to avoid the name of tontine, which it professes to abhor; upon surrender before the close of the distribution period the company allows the full reserve as a cash value, but forfeits the value of all dividend additions as a surrender charge. The same company issues another policy in which it ap- plies all surplus to accelerate the maturity of the policy as an endowment. In that case one gets no benefit from the dividend if he dies; in the former case, he gets no benefit if he surrenders. Thus in sep- arate policies the twin advantages claimed for ton- tine are utilized and at the same time all sin avoided — a trick that reminds one of how the two nuns in Tristram Shandy escaped sin by each pronounc- ing a part of the wicked word. In any event, the course of this company in giving cash values equal to the reserves, even though the surplus be forfeited, has proven popular and has, in consequence, been imitated by several companies, which now adorn their policies with columns of cash surrender values. The nigger in the woodpile is of course the forfeited surplus; and one small company frankly so avows in a policy wherein it tries to ride two horses at once by permitting either annual or accumulated dividends. The penalty it puts upon choosing the former at any time is that all other surrender priv- ileges are abridged both in amount or character and the cash surrender entirely withdrawn. Not all com- panies have this virtue of frankness. There is almost as great variety in loan as in sur- render privileges. A condition, formerly very com- mon, but now falling into disuse, provided for a loan of a definite proportion of the premium annually, or, 133 rather, for the acceptance of notes as part payment of premiums. This plan was designated the ''pre- mium-loan plan," although really not a plan at all, since it was applied to all plans in most companies. These premium-notes commonly bear interest at a rate in excess of the company's earnings, and at one time formed a considerable part of the assets of -many companies. From the standpoint of security only they were justly regarded the safest possible invest- ment. But as such notes were obtained by the repre- sentation that dividends would wape them out, their accumulation signified gross cause for disaffection among the policyholders. They lapsed in great num- bers under the pressure of increasing cost and decreas- ing insurance, leaving the notes and their reserves to cross accounts. Originally, in a few instances, these notes were binding against the promissors in any event, but latterly they have by their terms been col- lectable only from proceeds of the policies. Yet other companies, which have long since dis- carded the delusive premium loan system, make loans for the purpose only of sustaining the insurance in force. In other words, they will upon application advance a premium or premiums to an amount within the reserve value and hold same as a lien against the policy. But few companies make any general application of this system, which in spite of its narrowness commends itself as a good feature. Others, following the lead of a certain great com- pany in a so-called special form of policy, permit the borrowing of any or all premiums after a fixed num- ber of years, giving no privileges before that time. This feature has been made a catch by agents to such 134 an extent that it is likely to have a boomerang ef- fect, which will be unfortunate, as it is really a valu- able privilege as things go now-a-days. A verj^ small number of companies, and they for the most part what is known as cash value compan- ies, stipulate for loan privileges without assuming any custodianship over the insured's affairs, that is, without dictating what shall be done with the money borrowed. These privileges, however, are made as useless as possible by the foolish restrictions thrown about them. In many cases loans are not granted except upon the anniversary of the policy, which means, in practice, not when the money is needed unless to pay premiums. The amount loaned rarely exceeds three-fourths the reserve and is usually much less. Consequently under the pressure of great need for mone^^, one is strongly tempted to surren- der and get more. A company can better afford to loan the full reserve and keep the patron than pay the full reserve and lose him; its own paper should be a good security for all it will pay for it. One com- pam^ has partially recognized this hj agreeing to loan at the end of five-year periods the full reserve; but between the periods the amount loaned does not increase. So this is no more than a hint of what ought to be. Perhaps nothing more thoroughly illustrates the view taken by companies that the foregoing are privileges and not rights than the fact that without exception it is stipulated that no surrender value or loan will be allowed until after a specified period. Be this period long or short — and it is commonly long enough— to insist upon it is to insist that what 135 is granted is not a man's right to his own, but a con- cession of what he is in no wise entitled to. For to take the former view would be to stultify the condi- tion, since to render to another what is his is but one's bounden duty at all times without unreason- able delay. The cause of this condition is no more honorable to companies than is the fact. For it has been adopted in order to shield companies in paying larger first year's commissions than first year's premiums justify. Not daring, or, at least, not car- ing to render a true account of such outlay, compan- ies have adopted the subterfuge of refusing any sur- render value until the cost of obtaining the insurance has been covered without trenching upon the re- serve. 136 POLICY CONTRACTS.— SURPLUS CONDITIONS. Though the methods of determining the surplus belonging to a policy have already been described, it is perhaps wise to preface this paper by a simple for- mula, adapted to any policy, viz: to the accumulation, if any, at the beginning of the year add the premium or premiums as received; improve the sum at the rate of interest actually earned by the company; from the amount thus obtained deduct the policy's share of the company's actual expenses and also its net share of losses determined by its actual insurance, or the differ- ence between the face of the policy and its accumulated value. The remainder will be the present value of the policy, or the fund actually accumulated because of it. Deduct from this the net reserve required by the company's standard (not less than the legal reserve) and the remainder is surplus, not being required to fulfill the purposes of the policy. That it is sur plus belonging to the policy is not so sure, since by agreement its eventual ownership may be conditional. That it has been contributed by the policy is likewise doubtful, since the policy may before its term expires result in a loss instead of a profit. But the amount thus determined is for the present an apparent con- tribution from the policy's premiums and, if surplus is now to be divided, it should be declared to that policy. If division of surplus is deferred, the ac count can be carried along and either augmented by 137 the withdrawal of others or cancelled by the surren- der of the policy. But when division is actually made, it is or should be made in precise accord with this formula. In order to veil departures of greater or less im- portance from this method, companies have seen fit to invest the apportionment of surplus with an air of impenetrable mystery. Upon it the skill of the actuary must be directed and none but adepts is thought able to comprehend the workings of his scientific hand. The uninitiated are supposed to accept the findings with a feeling of grateful awe; w^hich they do — but not without distrust. Means of witholding an ample surplus even on an- nual dividend plans have already been suggested in the simple expedient of deferring payment of dividends one or more years after same have been earned. Tontine and other accumulated dividend plans ofcourse render even this expedient unnecessary, since the very essence of such contracts is the piling up of surplus. No excuse is manifest, therefore, for deducting aught from the amounts due by the for- mula already given, and yet less excuse for refusing a fair accounting when desired. Nevertheless, no less than twelve companies, among which are several of the great institutions of international repute, insert in fine type in their applications the following pledge: '* That in any distribution of surplus or profits the principles and methods which may be adopted by said company for such distribution, and its deter- mination of the amount equitably belonging to any policy which may be issued under this application, shall be and are hereby ratified and accepted by and 138 for every person who shall have or claim any interest under such policy." One of the great companies has but lately become ashamed of this cumbrous clause, which sounds like the incisive words- of a judgment note, and so have improved it as follows: '' That the distribution of surplus which may be adopted and approved by the society is hereby accepted by me in my own behalf and for every person who shall have any interest in the policy now applied for." It will be observed that in both these agreements the applicant approves not merely present methods, of which he conceivably might know something, but methods to be as well, of which surely no one has any knowledge. This uncertainty is by almost all other companies transferred to the policies and there appears in vague clauses about ** Surplus then apportioned" or ** pro- fits then determined" or equally unmeaning phases. One large company, and one only, openly stipulates in the policy for similar approval of the company's future action to that demanded in the applications mentioned; but the most of them dodge the issue. Among companies doing an annual dividend business only, there is often silence on the entire subject, no mention of dividends anywhere. One great com- pany refers the insured to its charter for instructions in that regard. Copies of its charter are not readily available to the public; but, if an Iowa policyholder lately in the courts against the company is to be be- lieved, this company is supposed to divide all surplus above a fixed amount. It is to be feared that the company misreads that ancient document, as the 139 general surplus seems vastly to exceed the amount specified. But one of all the companies endeavors to give any- clear agreement as to the dividend it will pay. Its agreement, though marred by too many qualifica- tions, is so much superior to any other that it should be inserted here: '' This policy shall, if kept in force, share in the surplus, according to the company's us- age, at each distribution after years from the date hereof, until all contributions to the surplus found in the course of making such distributions to have arisen from this policy shall have been returned; but no dividend shall be pa3^able at or after the time de- fault may be made in the payment of any premium." The fact that long-term dividend plans in point of time succeeded annual dividend plans embarrassed with a past the companies adopting the new plans. For they felt it incumbent upon them to so write their new contracts as to make them intelligible in some sense to their old patrons. Therefore the system adopted by each company was its own adaptation to the prevailing modes of expression and thought. A more or less definite analysis of the sources of ex- tiaordinary profit was commonly given in the poli- cies. New and very peculiar phrases came to be used in this connection, such as '* profits from lapses" and most especially ''profits from losses," all meant to ex- press the very simple idea that all profits should be- long to the policies in force when dividends were de- clared. Awkward methods of putting this proposi- tion are not yet out of vogue entirely, although the leader in this form of policy has long since eschewed all unnecessary verbiage, saying only ''shall partici- 140 pate in the accumulated surplus derived from policies on the tontine plan, both existing and discontinued, as may then be apportioned. " One company at least gives a circumstantial account of how such surplus is to be derived, dividing its policies into classes according to year of termination of dividend period. It takes the precaution, however, of binding the insured by his application to accept whatever it may offer. An- other company proposes to calculate dividends an- nually and purchase therewith simple or pure en- dowments, all due at a certain time. This to a de- gree only is supposed to give a *' profit from losses," as it is called— to a degree only, because pure en- dowment rates are calculated usually on a low mortality table. Such rates are presumably loaded and are certainly based on less interest expectation than the actual, thus giving scant value in both par- ticulars unless participating themselves, which is not stipulated. Such endowments, though full-paid, are also forfeited upon non-payment of premium on the original policy, though no corresponding gain is given upon persistency. Almost all companies now stipulate for cash divi- dends, but one or two declaring reversionary divi- dends with cash privileges and a few more permitting the choice of reversionary dividends without re-ex- amination either in the application or under strict conditions at a later date. One company permits the selection of reversionary dividends when the first dividend is declared, if then in good health. On long-term dividend contracts it has come to be customary to allow several options as to the disposi- tion of the surplus and, in fact, of the entire value of 141 the policy in most cases. The options usually in- clude cash and reversionary privileges together v^ith the right of annuity conversion; similar privi- leges are conceded in the disposition of the entire proceeds of the policy, if desired. Stipulations for re-examination in case the amount of insurance is in- creased are usual, but not universal. Some compan- ies also permit the total cash value, or part thereof, to stand as a combined paid-up policy for its face and an annuity equal to 3, 3V2 or 4 per cent, upon the amount, thus converting by a subtle casuistry insur- ance into pure investment. Even this is not sufficient in all cases, and by a peculiar jugglery the income is made to appear to be 5, 6, 7 or even 10 per cent., the additional being paid for by the collection of a sufficient deferred annuity premium as a part of the original premium. All possible efforts are put forih to make these options attractive to the patron who, how- ever, upon one or the other will get but fair value for his money and ought to expect no more. 142 INSTALMENT, ANNUITY AND TRUST CON- TRACTS. The fact that the Yalue of a man's life cannot be adequately expressed in a lump sum is especially evi- dent when the person interested in the life depends upon the man not merely for an income, but for proper directions as to the care and use of it. The immediate expression of a husband's value to his v^ife in a financial sense is the income he affords her, assured against all contingencies except his ow^n dis- ability or death and protected against herself by care and caution and by the very nature of the case not subject to discount or w^aste. A life policy is in- tended to cover the contingency of death and other forms of insurance as yet imperfectly cover the con- tingencies of temporary and permanent disability. But since life insurance is to indemnify a loss, it should in such cases provide an income of the same nature and with similar safe-guards. This, it is now gener- ally understood, the mere payment of a lump sum upon the death of the insured utterly fails to do in a large majority of cases. For such sum is at once at the disposal of the beneficiary, subject to losses in investment, to waste, to loss by over-confidence in others, to seizure by creditors, and, though escaping aH these, to constant diminution by use. The ingenuity of actuaries was long ago brought to bear upon this problem, and in England, at least, what is known as survivorship annuities have shared 143 the general popularity of life annuities. These con- tracts, now issued by but few American companies and rarely by them, provide for the payment of an annuity for life to a certain person from and after the death of another. It is purchasable at a level annual premium upon either of two tables, one pro- viding for the return of premiums in event of the prior death of the beneficiary and one having no such pro- . vision. These contracts provide the desired income for the entire life of the beneficiary and the income might be made inalienable by a stipulation against its negotiation. Such a contract would, however, be the absolute property of the beneficiary, and as such subject to sale under execution for her creditors, the same as any other bond. Unless coupled with a condition of non-negotiability, it could be sold or pledged at will; and not even an agreement of that sort could operate to prevent the company and bene- ficiary agreeing to cancel the contract for a consider- ation. It is doubtful whether an agreement on the part of the company not to purchase would be good after the death of the insured; for then, at least, the company and beneficiary are principals to the con- tract, and may alter it by agreement in that respect and any other. An objection which has probably proven most completely fatal to the popularity of these contracts is, that upon the death of the specified beneficiary the insurance ceases, while the value of the life insured is unimpaired, and the only change is that it has inured to another person's benefit. This is particularly enforced upon men's minds by the fact that at such a juncture insurance may not be attain- able because of altered health conditions. 144 Within the past decade, and under various names and pretentions, a plan to provide an income by mak- ing policies payable in instalments has been intro- duced to the public, often with a flourish of trumpets as if something wonderful had been discovered. One company, at least, made no change in existing policies, except to add a memorandum agreeing to pay the principal sum in a specified number of equal instal- ments, crediting all balances with the net average in- terest earned by the company and paying accrued interest with each instalment. One or two others used a similar memorandum, except that interest was not paid in addition to instalments but was used to lengthen the term of payments. In both cases there was usually a stipulation in the contract that the policy should not be negotiable— a stipula- tion, which, however, is in the case of notes con- sidered beneficial to the payer and which certainly might be done away with by agreement. Yet other companies issued new forms of policy, promising directly to pay a certain sum per annum for a certain number of years. For such policies a premium was collected suflicient to furnish an insur- ance equal to the present value of such instalments discounted to the dateof payment of first instalment. The rate of discount is usually 4 per cent, and the actual insurance is not the sum of the instalments, but the discounted value. These plans furnish a definite income, but one not certain to endure so long as required or for the life of the beneficiary, so as to adequately indemnify the financial loss occasioned by the death of husband or father. In fact, such pro- visions are not more likely to fulfill the required con- 145 ditions cf permanency, certamt\^, impregnability and non-negotiability than would be the payment ot a lump sum. For it is certainly possible that with a sufficient cash estate one might provide for one's-self an income for life, however long, while an instalment provision is certain by its terms to fail after a com- paratively short period. Any endeavor to continue a control over w^hat shall be done with this income after the insured's decease by stipulations for rever- sions, forfeitures or change of beneficiaries are futile. Upon the death of the insured such a contract be- comes the personal property of the beneficiary, who assumes the position of one principal to the contract. A stipulation that the contract shall not be nego- tiable would operate to prevent him from disposing of the same; but, having once come into possession, the ownership cannot be taken from him and trans- ferred to another by any stipulation in the contract. Despite any condition to the contrary, the death of the beneficiary after the death of the insured will re- sult in the passing of the title to the heirs of his estate. The entail of property, personal or real, is strictly forbidden both by constitutional and legal provisions and will in all cases be declared void by the courts. Some companies issuing instalment policies, or policies having attached to them instalment memo- randa, are by their charters compelled to pay all death claims within a specified time after the receipt of proofs of loss; in which case it would seem doubt- ful whether an instalment contract would be sus- tained at law at all. The right of companies to act as banks of deposit, crediting interest on funds left 146 iii their hands after the decease of the insured, is also questionable; and it is not clear that a claim of that nature would have standing in the courts. In instalment contracts such as have been described, there are commonly provisions for commuted or dis- counted values after the death of the original bene- ficiary. One life insurance company, which has by its char- ter the right to act as trustee, calls an instalment contract issued by it a ** trust certificate," and ex- pressly agrees that the carrying out of the instalment provisions shall be a trust. In that case, if the clause has any legitimate meaning, the company is during the lifetime of the designated beneficiary his trustee, which would probably operate to remove the policy from his control and from the reach of creditors claim- ing through him. That such is the intent, however, is not clearly indicated by the words of the contract, and the company in question does not report trust items among its liabilities. Another company, which operates a trust depart- ment under its own charter, lias a contract designat- ing such department as trustee for the beneficiaries, and is thus enabled to make an agreement to hold the proceeds of the policy in trust, paying over a cer- tain amount each year, and accumulating the re- mainders at a fixed interest. Such an agreement makes thecompany in its dual capacity both princi- pals to the contract, vests in it the title to the policy and its proceeds and only the use thereof in the bene- ficiary and the reversion after the ofiices of the trust have been performed in the insured. This makes the beneficiary, or cestui qui trust as he is now called. 147 a passive person, acquiring the title to each payment as it is received and not before. Of course he cannot alienate what he does not own, nor can his creditors seize what is not his; so the provision for his future cannot be destroyed by any act of his. The safety of the fund is by the charter guaranteed by the assets of the trust department and the capital of the com- pany, but not by the assets of the insurance depart- ment. Whether the income from such a fund would last throughout the life of the cestui qui trust would depend upon the amount of income, rate of interest and amount of fund. Unless the income were limited to about the annual interest, the estate might easily fail to accomplish the desired end. Another very large compan3% which has by its charter trust powers, attaches to its policies a trust memoran- dum creating in itself, not a trust of the policy, but an executory and revocable trust in the proceeds there- of for the benefit of the designated cestui qui trust and with reversion to the insured. The trustee is instructed to pay from the fund a designated sum annually until all is expended and agrees to credit interest at not less than a certain rate per cent. It is held that such trusts are first liens against its en- tire assets, it being a mutual company. The effect of the trust, being executory, is that the title to the policy is potentially in the insured until his death; and the effect of that might be to avoid the trust in favor of the creditors of his estate. Any policy which can be put into negotiable con dition can be utilized to accomplish the purpose more effectively than any of the forego mg, by assigning the same to a trustee with instructions to at once 148 invest the proceeds thereof in an annuity upon the life of the cestui qui trust, but in the name of the trustee, such trustee to receive and pay over to the cestui qui trust the annuity instalments. This will provide an income for the whole life of the benefici- ary, the amount of the income increasing, the longer the original insured lives. The intervention of the trustee effectually prevents the alienation, discount or pledge of the income or its seizure by creditors. As it becomes an executed trust at once, the policy cannot be seized for debts of the estate unless the in- sured was insolvent when the assignment was made. As the policy and annuity contracts are both assets easilj^ distinguishable, the failure of the trustee would result only in the contracts being turned over by the court to a new trustee and the carr^nng out of the trust by him. The only point of risk would be the company issuing the insurance and annuity con tracts, and, of course, great care should always be used in selecting it. 149 APPENDIX. Sample of simple form of annual dividend policy. No. 100,000. Amount, $10,000. Age, 35. Premium, $271. THE LIFE INSURANCE COMPANY OF CHICAGO, in consideration of two hundred seventy-one dollars and the payment of a like sum on the first day of July every year during the continuance of this policy, PROMISES TO PAY, upon proof of the fact and manner of death of John Doe TEN THOUSAND DOLLARS to Mary Doe, his wife, or, in event of her prior death, to the executors, administrators or assigns of the insured. John Doe is hereby made a member of this mutual company, which further agrees to receive the premi- ums upon this policy, to improve the same at the actual net average rate of interest earned on the mean assets of the company, to deduct at the close of each polic3^ year the actual cost of the net insur- ance furnished, to reserve for reinsurance such an amount as may be required, and to return annually to the holder of this policy, in cash or an equivalent paid-up insurance as he may elect, the surplus of this fund. The company will loan the holder of this policy in an amount not exceeding its then reserve, upon tfie 150 security of the policy, and will prefer such securities in making loans; but one annual premium must be paid in advance from proceeds of such loan. The failure to pay a premium when due shall be construed to be an application for such a loan in the amount of the premium, such advance to bear six per cent interest, payable annually; and if the value of the policy exceeds the net amount due (that is, the premium less any abatement by surplus), the policy shall be continued in force subject to a lien for amount advanced and interest thereon. If the value is less than the net amount required, the value shall be ap- plied to continue the insurance at the one-year term rates of the company. Upon the surrender of this policy at any time the company will pay its net cash value, provided that the company may demand reasonable notice of with- drawal; or instead of cash the holder may, at his op- tion, take the equivalent value in paid-up insurance, in continued insurance, in a life annuity, or an an- nuity for a term of years. Notice of any assignment must be given the com- pany, and proof of interest will be required. Executed at Chicago July 1, 1893. Simple form of deferred dividend policy. No. 100,000. Amount, $10,000. Age, 35. Premium, $271. THE LIFE INSURANCE COMPANY OF CHICAGO, in consideration of two hundred seventy- one dollars and the payment of a like sum on the first day of July every year during the continuance of this policy, 151 Upon proof of the fact and cause of death of John Doe, TEN THOUSAND DOLLARS to Mary Doe, his wife, or, in event of her prior death, to the executors, administrators or assigns of the insured. John Doe is hereby made a member of this mutual company, which further agrees to receive the premi- ums upon this policy, to improve the same at the actual net rate of interest earned upon the mean assets of the company, to deduct at the close of each policy year the actual cost of the net insurance fur- nished, and to continue this accumulation for twenty 3^ears, at the close of which period, if the insured be then living and this policy in force, the company will, at the option of the holder, either redeem this policy by paying the entire accumulation in cash or by issuing an equivalent paid-up life policy, or by issuing an equivalent paid-up annuity for life or a term oi years, or w^ill permit this policy to be continued for a second accumulation term often, fifteen or twenty years, and will pay over any excess of the accumu- lated value of this policy over its reserve, either in cash or in an equivalent paid-up addition to this policy, or in a paid-up annuity for life or a term of years. The company will loan the holder of this policy in an amount not exceeding its then accumulated value, upon the security of the policy, and will prefer such securities in making loans; but one annual premium must be paid in advance from the proceeds of such loan. The failure to pay a premium when due shall be 152 construed to be an application for such a loan in the amount of the premium, such advance to bear six per cent interest, payable annually; and if the value of the policy exceeds the amount of the premium, the policy shall be continued in force subject to a lien for the amount advanced and interest thereon. If the value is less than the premium, it shall be applied to continue the insurance in force at the one-year term rates of the company. Upon the surrender of this policy at any time the company will pay its net cash value, provided that the company may demand reasonable notice of with- drawal. Notice of any assignment must be given the com- pany, and proof of interest will be required. Executed at Chicago, July 1, 1893. Sample form for trust assignment to secure income. I hereby assign to the Equitable Trust Company, a corporation incorporated under the laws of Illinois, and with its principal office at Chicago, all my inter- est in policy No. 100,000 on my life in the Life Insur- ance Company of Chicago, in trust, however, for Mary Doe, my wife, and on the following conditions: If the said Mary Doe shall survive me, the said Equitable Trust Company shall collect the proceeds of the said policy of insurance, and shall purchase therewith from the said Life Insurance Company of Chicago an annuity for the life of the said Mary Doe, but in the name of the said Equitable Trust Com- pany as trustee for the said Mary Doe; and the said Equitable Trust Company shall collect the instal- ments upon the said annuity as the same shall be- 153 come due and payable, and after deducting a fee oi two per cent thereon shall pay the same over to the said Mary Doe on the first day of the month next succeeding the date of such collection. In event of the death of the said Mary Doe or of her legal sepa- ration from me, this deed of trust shall be void, and the said Equitable Trust Compan^^ shall, upon re- ceipt of a fee of twenty-five dollars, reassign the said policy of life insurance to me. Executed at Chicago July 1, 1893, and Accepted at Chicago July 1, 1893. 155 TABLE OF CONTENTS. INSURANCE IN GENERAIv Pages 3—7 Mutual burden-bearing. Indemnification. Rates made by application of rules of average. Hazard in health and life in- surance an increasing one. Real insurance is only against pre- mature death. Cancellation by company not admissible. Con- sequently care both in drawing up contracts and in selecting risks. Tendency in England to less strict requirements as to health, in this country to more. Classification is desirable. In- surance is to indemnify loss. Interest is pre-supposed. Amount of insurance should be limited to value to beneficiary. Insur- ance on life, limited-payment and endowment plans automatic- ally adjust to diminishing value of life. VITAIv STATISTICS Pages 8—20 Very accurate statistics desirable. Public demands a policy which cannot be terminated by company. Hence company must be more cautious about its agreements. Assessment insur- ance only an apparent exception. Mortality tables must cover the whole period of life. Benefit of selection lost in five years. Companies must expect the average mortality of the country. Company must fix the rate for each year in advance. Statistics covering thousands of lives needed. First compilation was by John Graunt in 16G2. More complete tables by Edmund Hailey in 1693. Insurance had begun in crude attempts. Good tables in 1742 by Johann Peter Suessmilch, by Menander in 1741. In 1765 the Equitable Life Insurance Institution started in London on mutual principle. In 1815 Milne compiled tables from ex- perience of city of Carlisle. Later the Actuaries' tables from experience of seventeen companies. American experience tables from experience of Mutual Life, compiled by Sheppard Homans. Limit of life placed arbitrarily at 95 or 100. Meech's tables, compiled from experience of thirty American companies. No resulting attempt to classify risks. Arbitrary standards adopted first by Massachusetts, then by nearly all States. Elizur Wright did not consider the Actuaries' table a final standard. He was collecting American experience. Error in Wright's view. Gain in mortality is absolute, not temporary. Variations of Meech's tables from others small because of assumed limit of life. One company reduced rates for a time. Actuaries' and American Experience tables now used by all authorities. Actu- 156 ries' table given with rates of mortality at different ages and also terms of expected life. RATB-MAKING— TERM AND NATURAL PRE- MIUM Pages 21—20 Insurance a year at a time. Formula for natural premium. Natural premium simplest plan, but last to come into use. Is not now generally understood. Sheppard Roman's term plan. Construction of rates. Present imitation of level pre- mium. Formula for single premium for term insurance. For- mula for level annual term premium. Use of present value of an annuity of one dollar. Loading. RATE-MAKING-WHOLE LIFE Pages 27—30 Eventual death certain. Hence whole life policy covers cer- tainty as well as chance. The time of death only is uncertain. Calculation of (1) when amounts of insurance must be paid, (2) net present amount in hand necessary to pay them, (3) what sum each must pay in now to make up this amount, (4) present value of an annuity of one dollar, (5) what annual amount is equiv- alent to single premium required. Use of commutation and logarithmic tables. Loading. RATE-MAKING — LIMITED PAYMENT LIFE AND ENDOWMENT Pages 31—36 Endowment the opposite of life insurance. Combining the two. Attracts the best lives. Analysis of rates for pure endow- ment. Combined with term rates gives endowment insurance premium. Semi-endowment premiums. Limited-payment life policies really term insurance combined with an endowment equal to net single premium at close of term. The single pre- mium for such a policy and for a whole life policy necessarly the same. Gain because of lower death rate in endowment in- surance. Endowment insurance not the same as carrying terim insurance and investing the remainder of the premium else- where. Loading. RATE - MAKING — SPECIAL AND UNUSUAL CONTRACTS Pages 36-40 Premiums otherwise than annual. Arbitrary increase. As- sumption that the deferred premiums are credits. Amount of extra charge. Extortion practiced in the case of monthly pay- ments. Excuse for large addition to weekly payments. Return premium charges. Method of arranging insurance for increas- ing amounts. Its application in return premium plans. Install- ment insurance really for a discounted amount. Guaranteed interest or debenture contracts. Method by which interest above the actual guarantee is provided for. 157 RATE-MAKING— THE LOADING Pages 41-45 What net rates cover. No provision for expenses or variations in mortality, losses on investments, etc. EHzur Wright's con- tention for the necessity for loading. Euture premiums will be required to cover future exigencies. Probable attitude of Wright toward contracts for permanent renewal commissions. Loading , is usually a percentage of premium. No pretense of scientific accuracy. Sheppard Homans' separation of elements of loading in natural premium rates. Expense portion a certain amount per thousand of insurance; portion for other purposes a percent- age on net premium. Necessity caused by manner of paying conmiissions. Homans does not make distinction on first year's premium. Margin for excessive losses properly a percentage of term or, indeed, any life net premium. Two items should be kept separate. No ample provision for decrease of interest possible except by assuming a certainly safe rate originally. Present practices. PREMIUMS— THEIR COMPONENT PARTS Pages 46-51 All premiums on policies which cover the contingency of death only consist of two parts, loading and net premium, all of which is solely for mortality purposes. Interest is required to help out the net premiums, which do not fully cover the mortality. Erroneous ideas of the three-fold nature of such premiums. Separation of net premium into mortuary and re- serve elements. Really means merely money to be expended to-day and money to be expended to-morrow. Money to be paid out to-day varies and the reserve varies in inverse ratio. Really no distinction between the two. In net premium no provision is made for anything but the payment of losses. Exemplified by single premium. Reserve comprises all future mortuary demands discounted. Reserve in whole life and term policies is to make good the deficiency of future premiums. So-called self-insurance fund. Actual elements of whole life net premium are term insurance to limit of life and pure endow- ment premium for an endowment due at the extreme limit ot life. The endowment element is very small, being but one cent at age 50 for an endowment of one thousand dollars due at age 100. Deposits for reserve cover not only the reserve on the en- dowment element but on the term element as well. Tables of insurance cost. Elements of premium on endowment insur- ance. Cost of insurance not a mortuary element. RE-INSURANCE RESERVES Pages 52—57 Amount formerly left to companies. Governmental interfer- ence in England. American tendencies toward recklessness. Part of Elizur Wright in establishing reserve requirements. Peculiar ideas of reserves. Actuary Nelson's contention. Wright 158 held that it should not be assumed that a company would take another's risks at a less premium than the latter was receiving, nor at a less rate than the net premium. Enough must be re- served to make sure that an average company could afford to re-insure the risks. Example of a one-year term policy. One- year term and single payment policies give no difficulty. In whole life policies the re-insuring company must be paid enough to make good the difference between the premium on original policy and premium which would be charged at in- sured's present age. This is the present value of an annuity for the life of the insured equal to the difference between the premiums. If premium is lower than net premium, an annuity equal to the deficit is also charged for. Reserves on limited- payment and endowment policies calculated in similar man- ner. Reserves on policies paid by less than annual premiums calculated as if paid annually and deferred premiums treated as temporary credits. SURPLUS— WHENCE DERIVED Pages 58—63 Three sources of profit. Two simpler are from higher in- terest or lower expense than was counted on. A profit from in- terest must be practically certain or rates would plainly be too low. Such was not always understood. A company with a six per cent reserve. Gains from a salvage on the loading should be constant. Extravagance of American companies makes gains from this source average little. In some cases there is a deficit to be made good from other gains. That amounts to an as- sumption that the net premium is more than equal to its offices. No gain certain from loading on limited payment premiums when not all expended in the current year. Some of the load- ing should be reserved to cover expenses after the premium-pay- ment period. Savings on mortality estimates. Death not a chance but a certainty— only time of death uncertain. Apparent gain by saving on estimates not real; gain is only the interest on apparent gain for an uncertain period. No provision in pre- mium for paying claims at another time. Real gain in addi- tion to interest is the premiums to be paid by those who do not die as expected. To reach the deduction to be made from the apparent gain, calculate what would be necessary to reinsure these unexpected survivors, in other words, the :»-eserves on their policies. The same is true in endowment insurance, and in term insurance. But in term insurance for one year or less it is otherwise, such being renewable if at all for the future premiums. So the apparent gain corresponds to the real gain. A formula for ascertaining the surplus earnings of a company. SURPLUS— HOW APPORTIONED Pages 64—68 No trouble in purely stock companies. Life insurance natur- ally a mutual operation. Logic requires a system which will 159 induce men to pay ample rates. Competition transferred from price to cost. Various methods of dividing surplus. One large American company employs a mysterious method. The contri- bution plan. Salvage on the loading in proportion to the load- ing, excess interest in proportion to mean policy assets and mor- tality gains in proportion to tabular cost of insurance. Division of premium for bookkeeping convenience. Net loss is amount of policy less the reserve. Hence current cost of insurance is net natural premium on net amount at risk. SURPLUS— HOW AND WHEN DISTRIBUTED. ..Pages 69—78 Early practice was reversions. Soon temporary additions were used by some as more attractive. Reversions increased re- serve values which companies did not recognize, but forfeited same with original insurance upon non-payment. Recognition of insured's rights in this even after non-payment brought about recognition of his right to say in what form he wished surplus applied. So conversions of additions into cash were permitted. Actuaries objected on the ground of adverse selection. There- fore cash dividends became the rule with limitation of choice of additions. Dividends also applied to permanently reduced premiums. Also in reduction of premiums for a fixed term. Dividends deferred for several years. Reason for such action. Term shortened' in answer to clamor for cheaper insurance. Result of adoption of short terms is that not all surplus is divided. Cause of introduction of tontine dividend plan was lapse rate. Real cause of popularity was apparent cheapness, giving an in- vestment at about the price charged for life insurance. Long dividend period seems the only feature likely to prove perma- nent. Hardships of forfeiture largely diminished. No apparent demand for relaxation of forfeiture at death. Men seem to feel that to survivors belongs the surplus, for they only have contrib- uted it. Tontine surplus formula. Great latitude given in ap- plication of surplus. Unfairness of charging tontine policy- holder full participating rates for non-participating policy while holderof limited-payment policy is furnished a participating pol- icy at the net rate. Same as to purchase of paid-up annuity. Ex- cuses for this course. Long dividend periods increase safety of companies. Other benefits of such plan. EXPENSES— HOW ASSESSED Pages 79-85 Little attention from actuaries. Early practice to charge for expense in proportion to premium. But slight variation yet. Loading considered the expense element and expenses charged upon that. Plan proceeds from wrong premises. How about cases where actual expense exceeds total loading? Pressure of brokerage system. Wrong of using a greater amount for ex- penses because of age of member recognized by Sheppard Homans. Reported recent action of New England Mutual. In- justice of practice in regard to single premiums. Injustice of expense charge against endowment premiums. Illustration ot this unfairness. A handicap to the investment. Cut rates in one company. SURRENDER VALUES -PAID-UP INSURANCE. . .Pages 86-92 Early practice was forfeiture upon non-payment. Not pro- tested against while life plan was universal. General feeling of dissatisfaction and its causes. Introduction of investment insur- ance created demand for surrender values. In which case anal- ogy was with purchase of property instead of with fire insurance. Popular indignation in England and America. Elizur Wright's work in Massachusetts. Adoption of non-forfeiture provisions by the New York Life. General acceptance of non -forfeiture principles, checked by tontine reaction, but now universal. Variety of plans for determining values to be allowed. In case of limited-payment and endowment polices, prevailing method is to give paid-up insurance in proportion to number of premiums paid. Simple and intelligible formula for determining the proper amount of paid-up insurance due upon surrender of a life policy. Most involved formula in common use for no good reason. Harsh conditions often imposed. Correct formula for limited- payment and endowment policies, giving a less value than the usual plan in the earlier years but a greater in the later years. Definition of net single premium as used in the foregoing. SURRENDER VALUES — EXTENDED INSUR- ANCE - Pages 93—98 Nature of the reserve. Origin of idea of extended insurance. Grace in payment. Arguments pro and con. Same privileges allowed upon request amount to discrimination. Private in- structions to agents. Grace at the discretion of the officers. Using the reserve to pay premiums on the original policy. Elizur Wright's system of extensions. He prepares a complete table of net single premiums. Assumes that sole object of policyholders is to secure insurance. Missouri only compels extensions. Adaptation of extension system to endowments. Extension is non-participating. Actuaries object to extensions only when they are optional with holder. Practice of Australian company. SURRENDER VALUES— CASH Pages 99—103 Formerly if given at all, as a great favor and not as a right. Pretense of managers. Originally no definite idea of reserves. In mutual companies the insured should not be considered to have parted with the ownership of his money becausehe has in- trusted it to the company. All that remains of it after j ust claims upon it have been liquidated belongs to him. Elizur Wright's surrender charge. Possible loss by adverse selection counter- 161 balanced by greatly increased cost of inducing men to buy a policy which means great loss unless completely paid. Danger of run upon companies. Such danger if it exists, is the fault of the companies, who would never have been compelled to promise such values in advance had they shown a disposition to act fairly without being compelled to do so by the letter of their policies. Notice is often required. PREMIUM AND OTHER LOANS Pages 104—108 Objection of adverse selection could not well apply. It makes life insurance more efficacious. Investment policies will con- tinue to be regarded low-class investments so long as companies discredit their own promises to pay. Objection of danger of a run cannot apply. Reasonable expectations. Should loan to the full reserve if at all. Practice of banks. Loans to pay prem- iums. The part-note plan. Notes to be covered by dividends. Result was increasing payments and decreasing net insurance. Loan of full premium upon request. Similar loans guaranteed for a fixed term of years, covering all premiums. Diversity of practice of companies. Loans from 50 to 90 per cent of the re- serve. One company discriminates against the holders of ac- cumulated surplus policies. But one company loans the full reserve, and that only at five year intervals. POLICY CONTRACTS— THE APPLICATION.. .Pages 109— 115 Reference to application. Same declared to be warranty. Character of the communications and promises referred to. Effect of a warranty to render the importance of the error im- material and the sincerity of the answer unavailing. How they differ from representations. Courts and juries endeavor to undo the wrong of such a stipulation by avoiding the condition when- ever possible. This does not remove the odiun from the com- panies which retain this ancient weapon. If company cannot prove fraud, it has no right to expect men to believe that there has been fraud. Illustration of the defenceless condition of the policyholders. Assessments and fraternal societies even greater sinners. Results of the practice are a marked preference for companies with incontestable policies, adverse legislation, attaching a copy of the application to the policy. Application made the hiding-place for many stipulations which companies would have been ashamed to have in their policies. Policies free from conditions while the back (called the front) of appli- cations is full of them. Warrant not to kill yourself. Waver of statutory rights not valid. Many other obnoxious conditions. POLICY CONTRACTS— THE PROMISE TO PAY Pages 116—121 Fonn is that of a simple contract like a promissory note. Consideration should be clearly specified. Mention of consider- 16^ ation should come first in the contract. Rigid stipulations of some companies. Time of payment of amount of policy. Con- ditions limiting time for filing proofs and for bringing action for recovery. Place of payment usually home office. Conditions of payment are so manifold and complex that they are never given in their proper place, near the promise, to pay. List of conditions frequently imposed. Pleading breach of conditions in avoidance of claims even when such violation had nothing whatever to do with cause of death. Suicide clauses. Military and naval service. Custom to pay a surrender value upon sur- render of void policies. All conditions circumscribe the use- fulness of insurance, One company has removed all conditions. Provision for cancellation. POLICY CONTRACTS— TO WHOM PAYABLE. .Pages 122—128 Insurance a contract of indemnity. Hence not given to per- sons not interested in the thing insured. Illustrated by fire insur- ance. Interests of relatives direct and collateral. Certain hard- ships. Interests of creditors limited by amount of debt. Interest in one's own life. Right of assignment. Court sophistry. If assigned by beneficiary must convey also the insurable interest. Notice of assignment. Survivorship reversion. Policies payable to devisees. Not good as against creditors of estate. POLICY CONTRACTS— SURRENDER AND LOAN PRIVILEGES Pages 129-135 Non-forfeiting means a variety of things. At best it means extension; at worst a small paid-up, non-participating policy if applied Tor within a short time. Characteristics of extensions. Paid-up insurance conditions. Cash surrender privileges. Pe- culiar action of a non-tontine company. Custom of endorsing cash values. Old part-note plan. Loans to pay premiums only. Loaning all or any premiums after a fixed date. Loans without dictation. Foolish and annoying conditions. Loans usually too small a part of the value. POLICY CONTRACTS— SURPLUS CONDITIONS . Pages 136-141 General formula to determine amount of surplus. Made a mysterious operation by companies. Retaining a surplus. Con- ditions in applications of several companies. Similar clauses or indefinite agreements in most policies. Often entire silence on the subject. One company refers to its charter. But one com- pany offers a definite agreement. Embarassment in introducing long dividend periods. Built upon foundation of annual divi- dends. So-called profits from lapses and losses. Peculiar forms of stating this. Surplus applied to purchase of pure endow- ments. Options of settlement offered. Income options often deceptive. 163 INSTALMENT, ANNUITY AND TRUST CON- TRACTS Pages 142-148 Value of human life not expressed in a lump sum, but in an income. Contingencies to be covered. Former methods of meeting this fact. Objections. Modern instalment policies. Objections. Charter provisions of some companies. Provisions for commuted values. Trust agreements, both spurious and genuine. A duplex company. Objections. A mutual company with trust powers. Trust is executory and does not vest title. A more effective provision. APPENDIX— SAMPLE ANNUAL DIVIDEND POLICY WITH- OUT CONDITIONS. SAME WITH LONGER DIVIDEND PERIOD AND OPTIONS. SAMPLE ASSIGNMENT IN TRUST TO SECURE INCOME FOR WIFE FOR LIFE. UNIVERSITY OF CALIFORNIA LIBRARY — rf-fABtt^^ltJHE.^AST DATE mi 10 191P 1 NOV 301918 JUL m rm MAR 1' Nov 8 IftI ^?R 14 1S24 YB 17992