PRINCIPLES OF INSURANCE THE MACMILLAN COMPANY NEW YORK BOSTON CHICAGO SAN FRANCISCO MACMILLAN & CO., Limited LONDON BOMBAY CALCUTTA MELBOURNE THE MACMILLAN CO. OF CANADA, Ltd. TORONTO PRINCIPLES OF INSURANCE BY W. F. GEPHART, Ph.D. ASSISTANT PROFESSOR OF ECONOMICS OHIO STATE UNIVERSITY Univ. TXtto gork THE MACMILLAN COMPANY 1911 All rights reserved < Copyright, 1911, By THE MACMILLAN COMPANY. Set up and electrotyped. Published September, 1911. Nortoocirj $reg8 J. 8. Cushin>{< CHAPTER I LIFE INSURANCE AND ITS HISTORICAL DEVELOPMENT Insurance is an agreement to pay a certain sum of money to compensate for the loss resulting from some contingent event, in consideration i nsu rance of an immediate cash payment or a series Defined - of payments. The loss insured against may happen soon, may be long deferred, or may never happen. Life insurance is effected by a contract between two parties, the insurer and the insured, in which a determined sum is agreed to be paid to Lifelnsur- a third party, the beneficiary, upon the ance * happening of death, on condition that the second party, the insured, pays certain sums to the first party, the insurer. It is an agreement to pay a cer- tain sum in the future by the insurer in considera- tion of the payment or payments of a certain other sum by the insured. It is a form of social coopera- tion and had its real origin in the wants of the b 1 2 ,, rjfllYCIPf^S '&F INSURANCE family. It is a method of distributing the effects of losses. It is a mutual agreement among many to assume the burdens suddenly falling upon a few. It is also a method of capitalizing future time and energy against premature death. It is therefore based on the fact that a single life has either poten- tial or actual value. From this description of insurance it is evident that there could be no considerable development of . f insurance until society had progressed to Lifeinsur- the stage in which (a) the family was definitely established with social obliga- tion and rights, and (6) the individual as an indi- vidual was valued as a member of society. Until the definite sex relations of the monogamous family were established, there could be fixed no definite obligations upon the different members of the family organization. However, in the monogamous family organization women and children assumed a position at once more definite and important than in the pre- vious family organization. Affection and a sense of responsibility both operated to place definitely upon the husband the duty of caring for his wife and chil- dren. To a less degree only did he feel the obliga- tion of caring for his parents and those of his wife. Thus the possible widow and orphan and infirm parent became a source of solicitude for the husband, who was urged by the definite family bond to make pro- vision from his labor for their care and maintenance. LIFE INSURANCE 8 In the second place, society had to develop to the point of valuing a life as an individual life before insurance could arise. In the earlier history of civilization it was only the exceptional individual, the king, the warrior, or the priest, whose life had any considerable value. Division of labor had not proceeded far and the work of the masses was so simple, that the loss of any one person was not greatly missed, since almost any other person could do his simple task. With the progress of society and the corresponding minute divisions of labor, the life of each came to have a definite value to the other mem- bers of the group, so that it has come to be of great importance to society that each perform his allotted task and make provision for meeting his obligations. Each individual comes into the world in possession of that rich heritage from the past which makes most members of society debtors throughout life. If in addition a man does his share in perpetuating the race by assuming the family relation, society has a right to expect that he will make proper provision to prepare his children to become efficient members of society by providing a fund out of his surplus earnings to equip them properly for life and for the maintenance of his widow in the event of his pre- mature death. Otherwise his family may become a charge upon society. They are a form of debts which must be paid, and it is a kind of dishonesty when no provision for their care is made, no less culpable than 4 PRINCIPLES OF INSURANCE that in which a man refuses to pay his monetary debts. Life insurance thus not only provides for dependents, but it also prevents an increase of the dependent class. The normal development of the family of the deceased husband is permitted, since provision has been made for the education of the children, and the maintenance of the wife, which provision the husband would have made, had he lived. Thus since society is an organism made up of individual units and is benefited by whatever benefits the units, life insurance promotes the well- being of society by properly caring for the social unit, the family. In addition to these purely material values which life insurance secures for the family, it undoubtedly Benefits of does m uch to promote the best family Insurance, life by strengthening mutual affection, by recognizing and meeting family obligations. It doubtless also adds to the efficiency of the family because it relieves the members of it from an anx- iety about the future. Life insurance, then, pro- motes a sense of responsibility, it strengthens family ties, it creates unselfishness and thus produces a high type of a social individual by inculcating the idea of sharing burdens and of practising widespread col- lective cooperation. The direct economic values of insurance are no less evident. We have seen that it makes possible the proper training of the children of the insured by providing a fund for their educa- LIFE INSURANCE 5 tion, thus relieving society both of the burden of support and that of training. It also relieves the insured from anxiety about the future and contrib- utes powerfully to his efficiency in his daily work. Life insurance enforces thrift, for the ordinary contract calls for the payment on the part of the insured of definite sums at stated inter- i nsurance vals. Through lack of foresight or will and Thrift, power few men will save unless under pressure. There is a constant temptation to overvalue the present as compared to the future, not because the latter is uncertain in the minds of most men in their productive years, but because of the intense pleas- ure of present consumption and lack of imagination in visualizing the pleasures of future consumption. Even a large number of those who voluntarily save do so only intermittently. The savings bank depos- itor is constantly tempted both to make his deposit less than he is able to make it and to spend it for conveniences or luxuries. But the possessor of a life insurance policy comes to look upon his pre- mium in much the same light as the giver of a note or mortgage looks upon the interest. It must be paid. Out of the surplus earnings of his productive years, a sum is annually set aside for obligations either already created by his family connections or for his own maintenance after his productive years have passed. If it is a form of a policy which ma- tures in the latter part of a man's normal lifetime, it 6 PRINCIPLES OF INSURANCE may often be invested more wisely as well as more profitably because it is a considerable sum and the individual has had years of experience in business. Meanwhile, during the interval the small yearly con- tributions of each policyholder are combined with those of millions of others and constitute an enor- mous fund of accumulated capital with which to conduct, when it is loaned, the large-scale industrial enterprises of modern times. While the rate of in- terest secured to the individual policyholder on his annual premium may not be large in the abstract, yet through a long series of years it nets him in many cases a greater sum than he would be able to secure, if he were compelled to attempt to keep his small payment continuously invested without loss. Desirable and safe investments are found for these collected funds, which could not be secured by the individual contributors to the fund. Then, too, the final payment to the beneficiary of the sum secured by his small annual payments is certain, even though the assured pays only one year's premium. This may seem inequitable to those who pay into the fund for many years, but we shall see later that the computa- tions are so made that the average result is fair to all. The life insurance company by its small collec- tions from many sources brings together large bor- rowers and many small lenders. Life insurance indirectly creates wealth by enforcing thrift and LIFE INSURANCE 7 saving and by inculcating habits of regularity in living. It directly affects the distribution of wealth in that it is a fund collected from the con- _ Insurance tributions of many and distributed with- andEco- out any necessary relation between the amount paid in and the amount paid out, so far as any one individual is concerned. That is to say, the principal sum may be paid after only one year's pre- mium has been paid, the members of the insured group having by the very fact of their becoming members of the society mutually agreed to bear each other's burdens. We cannot understand in- surance unless we thoroughly understand this prin- ciple, viz. that insurance is based on the idea of mutuality. The conditions precedent for insurance are : (a) There must be a risk of a real loss which 1 neither the insured nor the insurer can conditions ) prevent or hasten; (5) a large number ^insur- of persons must be liable to the risk ; ance. j (c) the casualty contemplated must be likely to fall upon a comparatively small number during any short ) interval ; (d) the probability of its occurrence must be capable of being calculated before its occurrence 1 with some approximation of certainty ; (e) the loss, ( when it does occur, must be considerable enough to f be worth providing against ; (f) the cost of the \ provision must not be prohibitive to large numbers of persons. 8 PRINCIPLES OF INSURANCE It has been stated that life insurance had its ori- gin in the needs of the family and was prompted by _ . , the affectionate solicitude of the head of Historical Origin of it. It must not be concluded, however, that affection has been the only motive present in the historical development of insurance. The gambling or wager aspect has at times played a part. Purely commercial considerations have also been of some importance. It is manifestly impos- sible to fix any particular date for its origin, since like any other complex social institution it has had many different phases in its development. We may, however, divide its development into two periods : (a) that of experimentation, and (6) that of scien- tific exactness. The most important antecedents of present insurance which were characteristic of the experimental stage were as follows : (a) agreements with money lenders to provide money for purposes of ransom in case of capture where an individual went on commercial ventures to foreign lands or religious wars or pilgrimages, or an agreement whereby the money lender paid double or treble a certain sum if the voyager returned, or paid cer- tain sums to his family in case he did not return; (6) the establishment of purely mutual societies, sometimes called fraternities, sometimes guilds, in which each member contributed an equal sum for the payment of fines and forfeitures inflicted on members of the guild who had committed crimes or LIFE INSURANCE 9 who were compelled to pay damages to others for the loss of life or property. When payments on account of death had to be paid, these payments were usually made to the family of the deceased member of the fraternity. This was a form of so- cial insurance which has somewhat of a counterpart in the more scientifically conducted fraternal insur- ance of the present; (7 870 92 570 231 216 187 48 71,601 1,021 71.627 896 93 339 155 79 58 49 70,580 1,068 70,731 927 94 184 95 21 18 50 69,517 1,108 69,804 962 95 89 52 3 3 51 68,409 1,156 6S,842 1,001 96 37 24 52 67,253 1,207 67,841 1.044 97 18 9 53 66,046 1,261 66,797 1,091 98 4 8 54 64,7S5 1,316 65,700 1,148 99 1 1 / 54 PRINCIPLES OF INSURANCE the difference in the mortality rate upon which the premiums are based. Such a mass of information regarding vitality is being collected and such improvements are being made in collecting vital statistics, that we may ex- pect new and more accurate life tables to be supplied from time to time. Such in brief is the history of mortality tables, and it is now our purpose to show in a general way how the tables are constructed and to describe the actual experience under them. On the preceding page the two tables of mortality most commonly used are given, and the reader should familiarize himself with their contents. Some ex- planation of the tables and terms used in connection with them may be given. It will be observed that the tables contain three columns, the second showing the number of persons living at each age, and the third the number dying at each age. A mortality table is, therefore, both a life table and a death table. A mortality table has been denned as Methods of a picture of a generation passing through ooiBstraotinK nf e . It is the " barometer of vital statis- Mortahty Tables. tics." The table is constructed by record- ing the ages of as great a number of persons as possible at a specified time and then tabulating op- posite each age the number who live to that age, the deaths being placed opposite the ages at which death occurred. The probability of death at a particular age is obtained by dividing the number of deaths at MORTALITY TABLES 55 that age by the number living at that age. If, then, the number living at the age at which the table be- gins is multiplied by the probability of dying at that age, the result will be the number of deaths. Then, subtracting this result from the number living at the age, the number of survivors is obtained. This mul- tiplied by the probability of dying in the next year will give the deaths, and so the calculations are con- tinued to the end of the table. Symbols are used in the calculations. Age is represented by re, the num- ber reaching the age by Ix ; the number who die be- tween x and x -f 1 is represented by dx. If we could have a large number of persons who were born on a certain day and keep them under observation until all had died, we would have all the above data. This is manifestly impossible ; nor is it necessary in order to find the probabilities of death and survival. If we have under observation a large number of individuals whose age is known, we can, by noting the age at death, calculate the above proba- bilities. In the first place we must calculate the prob- abilites of survival and death for each year of life, and the first step in doing this is to observe the number who begin any year of life and the number of deaths which occur during that year ; that is, dx divided by Ix equals qx, the probability of dying dur- ing the year ; likewise the probability of living, px equals Ix + 1 divided by Ix. However, in the above case the deaths will occur at different times through- 56 PRINCIPLES OF INSURANCE out the year ; that is, some will die just beyond age x and some will die just preceding age x + 1. If we assume the deaths to be equally distributed through- out the year, we can secure the arithmetical mean by calculating the number who live to the middle of the year. This mean population is called Px. If, then, we divide this average population, Px, into the num- ber of deaths during the year, that is, -, we will Px have the rate of mortality per unit of population for this year, that is, the central death which is called mx. From this central death rate we may calculate the probabilities of death and survival in the follow- ing manner. We have already seen that the probability of a particular event happening is found by dividing the number of possible desired happenings by the total number of possible happenings. If there are 7 balls and 2 are white, the probability of drawing a white ball at a single trial is f . We have seen, therefore, that px = - - and qx = -^. We therefore calcu- Ix Ix late px and qx from mx by the following simple formula : , r, dx Px _ Ix 4- 1 _ Ix dx 2 2 mx Ix Ix -n , dx 2 + mx The relation between the probabilities of life and the rate of mortality having been obtained and the ratio MORTALITY TABLES 57 of mx for all ages having been obtained from the cen- sus returns, the value of px can be obtained from the formula. Thence by continued multiplication a life table can be constructed. A brief application may- be made for age 10 of the American Experience Table. G . 2-mx ., . 2 -.007490 SinCG PX = 2^Tx theref re ** = 2 + .007490 - which equals .992510; the yearly probability of living, and this multiplied by the original 100,000 at age 10 gives 99,251, the second quantity in column one of the Mortality Table. We have assumed in the preceding statements that the population and the deaths at each age were known, but such is not usually the case in census statistics which generally give population and deaths in groups of ages. Even if it were so, any one census year might be so affected by the peculiar conditions of that year, that it would produce in-accurate results. It is, therefore, conducive to accuracy to take the average for a series of years and from these data secure by interpolation the annual values. The mean annual death rate for a series of years, say 10, is calculated as follows: C x equals the death rate for the first year in population, n, and <7 10 equals the death rate for the tenth year. Therefore, the mean annual death rate for a series of 10 years is found as follows : ^ = gi^i+g 3 w g + . - + e 10 ttio _ di + c? 2 + . . . d l0 n x + n 2 + . . . + n 10 n x + n 2 + . . . ?i 10 58 PRINCIPLES OF INSURANCE It is next necessary to find the total lives at risk for the decade or quinquennial period. This is equal to The Lives at the population of the second census minus Risk - the population of the first census, divided by the annual increase per unit of the population. After having obtained the mortality for the group during the period and the total lives at risk during the period, the mortality and lives at risk for each year of the period must be calculated. This is done by interpolating the values for each year, by the method of finite differences, or by the graphic method. Each of these methods is of little value to other than those interested in actuarial science. As lias before been intimated, the insurance com- panies do not derive the mortality tables which they now use from the population statistics of the general census, but from the experience of insurance compan- ies. The data from the last-named source are more accurate, since they make greater efforts to secure the correct age at entry, and know definitely the age at death. However, the principles of procedure in using the data are the same. The phrase " expectation of life " needs explanation at this point. It does Qot in the first place mean the Expectation number of years one can reasonably expect of Life. t live after a certain age. It simply means the number of years that individuals of a certain class live on an average after a certain date. It is the mean after lifetime. It would, for example, MORTALITY TABLES 59 be erroneous for a person at age 40, when the expecta- tion of life is 28.18 years by the American Mortality Table, to conclude that his probable age at death would be 68.18 years, for the most probable time of death is that year beyond 40 when most deaths occur. Another term frequently used is " the probable life- time," which is simply the number of years that an individual has an even chance of living. TheProba- It is found by observing at what age ble Lifetime, beyond the specified age the number then living is reduced one half. For example, the number living at age 30 is by the American table 85,441. At age 68 there are living 43,133, and 40,890 are living at age 69. Therefore, the probable lifetime of a person at age 30 is between 38 and 39 years, which is over three years greater than the expectation of life at age 30. Even after a rate of mortality has been found, either from general population statistics or from the experience of insured lives, the actual mortality of the insured group does not usually correspond to this rate in any single year. It has been particularly difficult to derive a table in which the actual mor- tality closely corresponded to the calculated mortality in very early and very late life. This in no sense invalidates that general law of mortality which is expressed in the mortality tables. These tables have been graduated, by which the accidental irregularities 60 PRINCIPLES OF INSURANCE are smoothed out. The important practical consider- ation of this fact is expressed in the questions, how many lives need a company insure in order to secure these average results of a mortality table, how wide a fluctuation can be permitted, and how can it improve the personnel of its membership in order that it may continue a solvent concern ? If it is to be called upon to pay a larger number of claims before it had calculated that they would fall due, it may fail, both because the principle sum already collected will probably prove insufficient and in addition the force of compound interest has not had time to produce its contribution to the resources of the company. The first problem, that of the number of lives necessary to be insured in order that the actual num- om. t . ber of claims by death may be confined The Number J J of Lives to be within certain limits of the expected is solved as follows : If the probability of an event occurring at a single trial is c?, it will probably happen in m trials dm times. It has been proven that the probable magnitude of the deviations from dm can be expressed by the following formula: \mdp 7T in which 7r equals 3.14159, m the number of trials or lives under observation, p the chance of surviving one year at the given age, and-c? the probability of dying during the year. An application may be thus made. In the American table assume there are 20,000 lives at risk at age 41, where d is .01, the MORTALITY TABLES 61 expected percentage of survivals being therefore .99. The probable extent to which the actual re- sult would differ from this is obtained from the formula thus : 4, 20000 x .01 x .99, 3.1416 which equals 11.2. That is to say, the deviation of deaths from the expected 200 would probably be 11.2, the experienced mortality varying between 189 and 211. Equally simple is the problem of calculating the number necessary to be under ob- servation in order to keep- the actual experience within a certain percentage of the expected. The reader must have realized that a number suf- ficient to display average results must be secured. Insurance deals with the law of average as applied to a considerable group. It would be absurd to at- tempt to conduct the business with a score or more of members, and doubly absurd if they were of the same age, sex, and occupations. In actual practice the companies expect to have a favorable mortality experience ; that is, they make such calculations and allowances as they think will procure for them an actual mortality well below that shown by the table for the respective ages and groups. From this source come what are called mortality savings. In com- panies writing policies, the holders of which receive dividends based on the earnings of the companies, this saving is one of the sources of the fund from 62 PRINCIPLES OF INSURANCE which dividends are paid. These dividends, as we shall later see, are not dividends in the ordinary sense in which this word is used, but are, so far as this mortality savings is concerned, simply the re- turn of overcharges. The difference between the expected mortality on the net amount at risk and the actual mortality less the reserve thereon is the mortality saving. In determining the expected mor- tality for a given calendar year, the old business is assumed to be exposed for the full calendar year ; the new issues of business of the calendar year are assumed to be exposed on an average for only one half the year ; the cancellations of the old business are assumed to be exposed for one half the year ; and the cancellations of the new business are assumed to be exposed for one fourth of the year. Statistics for the past ten years of the ordinary legal reserve and the legal reserve industrial com- panies show the following facts. In the case of thirty-two of the most important ordinary legal re- serve companies the average mortality was 75.43 per cent of the expected, varying, however, from 52.24 per cent to 92.52 per cent. Thirteen of these thirty-two companies experienced a mortality saving of over 30 per cent. In the three leading industrial companies the average for the past ten years of the actual to the expected mortality was 104.05 per cent. Only one of these companies, and this the least important, had an actual experience below the expected. In MORTALITY TABLES the fifty leading ordinary companies the percentage of the actual to the experienced mortality in 1909 was 72.16 per cent. REFERENCES Newsholme, A. Vital Statistics. Chaps. XXII, XXIII, XXIV, XXV. Yale Readings. Vol. I, Chap. VIII. Graham, W. J. Romance of Life Insurance. Chap. VII. Dawson, Miles M. The Business of Life Insurance. Chap. II. Practical Lessons in Actuarial Science. Reports of the Twelfth Census. Parts I, II. Mortality Sta- tistics, 1909. Report on National Vitality. Parts I, II of Vol. III. Senate Document No. 676, Sixtieth Congress, Second Ses- sion. Farr, William. Vital Statistics. Part V, pp. 443-494. The Principles and Practice of Life Insurance. Seventh Edi- tion. Published by the Spectator Company. Bowley, A. G. Elements of Statistics. Second Edition. Part I, Chaps. V, VII, X. Part II. Institute of Actuaries' Text Book. Part II. Proceedings of the International Congress of Actuaries. Proceedings of the Actuarial Society of America. CHAPTER IV THE SELECTION OF LIVES The description given in the preceding chapter of the principles underlying the mortality of lives and the facts which the experience of insurance has dis- closed might lead the reader to conclude that the actual conduct of insuring lives is very simple. However, the first problem which confronts the officials of an insurance company is that of securing a body of individuals whose life experience as insured persons will be in harmony with the principles which have been discussed in connection with the mortality table. Great care must be continually exercised in insuring lives in order that the actual experience will be within reasonable limits of the calculated. It is even more true of the insurance business than of other kinds of business that it should be able to be conducted on the plans laid down before entering upon the actual business. In almost every business adjustments can be made from time to time to bring the original plan in harmony with unexpected changes in the nature of the business ; but in insurance the contracts are not only made for long periods, but also with great numbers of individuals. Therefore, ad- justments can be made only with great difficulty. 64 THE SELECTION OF LIVES 65 The first problem, then, in placing the principles of insurance into practice is to select suitable lives for insurance. By selection is ordinarily selection meant that examination of applicants by Defined - competent physicians in order to exclude all whose present or prospective physical conditions or mental characteristics are below the standard required by the insurance societ}'. This medical examination is, then, one of the methods devised to prevent adverse selection, that is, the conscious or unconscious at- tempt to secure insurance by persons who are unde- sirable risks. Another method used by the company to prevent adverse selection is the incorporation of certain protective clauses in the contract, such, for example, as the suicide clause which frees the com- pany from liability if the insured commits suicide within a certain period, usually one or two years. Adverse selection is again illustrated in the tendency of individual poor risks to select the cheaper plans of insurance, and again in the case of those seeking to defraud the company. Anything which adversely affects the company's interest in so far as it is inter- ested in securing a group of individuals who will experience the normal experience is adverse selection. That is to say, the effort on the part of the company is to secure a group of persons who will have equal chances of risk and benefit from insurance. The lives thus chosen by the company through its agents, who are supposed to exercise good judgment 66 PRINCIPLES OF INSURANCE in soliciting applicants, and the medical examiners, who carefully examine them, are called select lives. It has been found from long experience in insuring lives that the rate of mortality among the recently insured is lower than among the. general population or among a noninsured group of equal ages which has healthy and unhealthy individuals among it. Not only is this true, but it has been found that an insured group recently selected has a lower mortal- ity rate than a group of insured lives of equal age but of longer duration of insurance. For example, 1000 individuals insured at 30 years of age would show for a period of about five years thereafter a lower mortality than the mortality shown for the next five years of 1000 individuals, insured at 25 years of age, but now 30. This temporary Selection advantage to the company is called the benefit of selection. This advantage en- ables a company to use as expenses or as dividends, which may be used to reduce the premiums, the funds thus saved, since this selection means the actual losses will be below the calculated. It is the experience after five years which is used as a basis for operating the company. This favorable mortality on recently insured lives also explains why newly formed com- panies or companies which are increasing their num- bers rapidly have frequently such a low percentage of actual to expected mortality. The explanation of the causes of this lower mortal- THE SELECTION OF LIVES 67 ity among recently insured lives is largely in the fact that chronic diseases have not had time to de- velop and produce their results. The deaths are chiefly due to accidents and to those acute diseases which rapidly produce death. Then, too, acute diseases developing in the early period often become chronic with fatal results at a later period. The rate of mortality, then, among insured lives is, all other things being equal, a result of the age at entry and the duration of membership. The following table adapted from Young's Insurance clearly illustrates the above facts regarding the mortality at different ages and different duration of insurance. Annual Mortality Rate per 1000 in Periods op Insurance Ages in quinquennial groups. Under 5 years duration. 5 years and upwards. Under 10 years duration. 10 years and upwards. Total period of life. 25-29 35-39 45-49 55-59 65-69 6.60 8.30 11.70 18.10 36.30 10. 11. 14.40 24.70 50.60 7.30 9.30 12.50 21. 43.50 9.20 11.70 15.20 25.20 51.10 7.30 9.70 13.60 23.50 49. The rate of mortality for those who have not been insured five years, column 2, is less than those who have been insured less than ten years, column 4, and still less than those insured for more than ten years, 68 PRINCIPLES OP INSURANCE column 5. A study of this table will disclose addi- tional important facts regarding the effect of introduc- ing new lives in the different quinquennial periods. The annual rate of mortality at any age is found, as we have shown in the previous chapter, by divid- ing the number of deaths occuring in the year fol- lowing this age by the number of thousands exposed to death at the beginning of the year. Many adherents to the assessment plan of insur- ance have depended upon the introduction of new blood to keep down the increasing death Effect of In- r troducing rate. It will be observed, however, that the benefits are of a decreasing character as the original group becomes older, for the new entrants at the older ages make up such a small part of the whole mass of lives at the increasing age. The older ages are accumulating at a geometrical ratio, and the number of new lives necessary to keep the mortality experience down to that of the earlier ages would have to be very great ; so great, in fact, that in actual experience no company on the assess- ment plan has been able to secure sufficient numbers to keep its mortality experience to that of the earlier years. It is not to be understood, however, that the entrance of young lives does not favorably affect the mortality, but rather that this method cannot be relied upon to correct the errors of unscientific plans of pure assessment insurance. It must also be evi- dent to the reader that if lives were insured on the THE SELECTION OF LIVES 69 basis of mortality tables constructed on the experi- ence of insured groups at different ages, the indi- vidual who insured at an advanced age would pay relatively a larger premium than those who insured earlier in life. That is to say, the benefit of selection is less at advanced ages than at earlier ages. The premium for young lives is established on the ex- pectation that there will be a continual infusion of new blood and these young lives thus receive through many years the benefit of selection from many groups. There is another kind of selection in insurance which may be called self-selection, that is to say, a selection not made by the insurer, but by seif-seiec- the insured. This has been instanced in tion - the case of an applicant selecting particular forms of policies. If it is a poor risk and the applicant is conscious of his impaired life, he is likely to select the policies with low premiums. If he intends to defraud the company, he will make the same selec- tion. It is, therefore, necessary for the company to make its selections as accurate as possible ; that is, it must require medical examination, and take precau- tions to discover the true facts about the applicant. It is true, indeed, that' in certain forms of compulsory insurance of foreign countries for the wage earners no medical examination is made, but in these cases the insurance is required of all members of the group, and since the group is homogenous to a large degree, 70 PRINCIPLES OF INSURANCE selection has already been made. Average results are for these two reasons secured. In the early history of insurance there was no medical examination, but this did not imply that ,, ., , there was no selection. No evil conse- The Medical Examina- quences were experienced from this ab- sence of a medical examination, for the applicant was recommended to the company by a responsible person. He was often questioned by the officials of the company as to his physical condition ; insurance was in general taken out only by the better classes ; competition for business was not very ex- treme ; and lastly the mortality tables used had a wide margin of safety. The actual process of selection now made by an insurance company is usually as follows : The agent seeks the applicant, who may be asked to answer certain questions regarding his physical condition and family history. If the facts disclosed by these answers are decidedly unfavor- able, that is, if he is ill or has recently been ill or belongs to a family which has had numerous mem- bers who have been afflicted with certain very fatal diseases, such as tuberculosis, the applicant is not sent to the medical examiner ; otherwise, he is. The latter asks him more detailed questions regarding his physical history and that of his family, and in addition makes a thorough physical examination. Efforts are also made to secure information as to the use of alcohol and narcotics. The medical ex- THE SELECTION OF LIVES 71 aminer makes a complete report of his findings to the medical department of the company at the home office. Efforts may also be made by the company through independent inquiries and references sup- plied by the applicant to discover the personal habits of the applicant, his financial responsibility, and other facts which will supply information to decide the desirability of the risk. The mortality table assumes that all members of the company enter it in good physical condition, and premiums are based on this assumption. It is the duty of the medical department to make the actual facts correspond to the assumed facts. If all the in- formation elicited is satisfactory, a policy is granted. If the amount applied for exceeds the limit fixed by the company on a single life, the company may accept the application and reinsure a part of the risk in another company. That is, it takes out a policy pay- able to itself in another company for the amount in excess of what it cares to insure a single life. A convenient classification of risk for purposes of discussion, but one which has no legal ciassifica- sanction in the case of ordinary insurance tion of Risks, companies, is as follows : (a) Preferred risks. These are risks which when not affected by the occupation are insurable under any plan of insurance. The individuals composing this class have good physical conditions, weight and height within the standard established, correct habits, 72 PRINCIPLES OF INSURANCE good family history, which means a low mortality under 70 and freedom from constitutional and heredi- tary diseases. (5) Ordinary risks. These applicants are fre- quently required to take that form of policy which will bring the premium paying period within 75 per cent of the life expectation. This is done in order that the possible large claims due to a high mortality will not overbalance the sums paid in by this class and the ac- cumulations on it. Individual members of this class must be in first-class physical condition when insured, but there may be a tendency in the family to certain diseases ; they may be persons who have lost a limb, persons of mixed races; persons who have had re- mote attacks of such diseases as asthma, inflammatory rheumatism, pneumonia, and in some cases blood- spitting, if not recent, provided the family history is good. The preferred and ordinary risks include the vast majority of insured lives, and it is these classes upon which insurance calculations are chiefly made. (e) Doubtful risks. This class includes a great number of individuals and for a great many various reasons. One of the most important classes is over- weights and another underweights ; another class is those who are addicted to the use of alcohol or nar- cotics, although if the amount used of either is in ex- cess of a certain quantity, such persons will not be ac- cepted as risks on any plan of insurance. It is not only because the use of alcohol and narcotics under- THE SELECTION OF LIVES 73 mine the physical constitution, thus making the indi- vidual more subject to disease and less able to resist its attacks, but also because to such individuals fatal accidents are more likely to happen at those times when reason is dethroned on account of the excessive use of the alcohol or the narcotic. In other words it is a question to what extent the shorter duration of life of those who use alcohol is due to the destruc- tive effects of the alcohol and to what extent it is due to their careless mode of living of which the use of al- cohol is the tangible evidence. Underweights and overweights ordinarily demand special treatment. The companies use a comparative table of height and weight. For example, applicants 5 feet 10 inches in height between 30 and 39 should weigh by the table between 134 and 200 pounds, the normal weight being 167, which thus makes a provision for a devia- tion of about 20 per cent. However, if it can be shown that the abnormal weight is a family charac- teristic, the variation is of little importance, all other things being equal. One authority gives the following reasons for underweights being poor risks : (a) They are abnormal and die short of their expec- tation. (b) They are prone to tuberculosis and nervous dis- eases. (c) They are frequently underfed and overworked and suffer from dyspepsia and indigestion. 74 PRINCIPLES OF INSURANCE The overweights are poor risks because : (a) They are abnormal. (5) They are prone to develop heart disease, apo- plexy, and premature arteris scelorosis, diabetes, rheu- matism, and gout. (V) They frequently take little exercise, eat heartily, and are often intemperate in their use of malt liquors. (c?) They frequently succumb to accidents and sur- gical operations. Companies very often grant to young applicants who show underweight or overweight a form of policy which matures before the serious evil effects of this abnormal weight shows itself, such, for example, as a twenty-year endowment policy at age 25 which is completed at age 45. They thus are treated as stand- ard lives. In other cases particular forms of a policy have been granted to the applicant of abnor- mal weight with the restriction as to certain benefits which ordinarily are a part of the contract. Some- times these applicants are permitted to receive par- ticipating policies only on deferred dividend plans of 5 or 10 years or on a longer period of distribution, but not annual dividends. Sometimes they are granted only paid up insurance instead of extended insurance in case they lapse their policies. Other methods of treating substandard lives will be discussed later. Other factors which determine the class to which a particular risk belongs are occupation, sex, race, regions inhabited, family history, mental and moral THE SELECTION OF LIVES 75 characteristics, and each of these calls for a brief dis- cussion. The character of the occupation is important in that it may be extra hazardous as to accidents or it may be unhealthy. It may be stated at this occupation point that the occupation statistics as to Mortality, morbidity and mortality are very incomplete and in- accurate. We doubtless ascribe to certain occupa- tions a degree of danger, both as to accidents and unhealthfulness, which they really do not have. For example, there are certain occupations which are the refuge of the aged and manifestly the death rate is high, but it does not follow that the high death rate is to be ascribed to the character of the occupation. It is never safe to make any deductions of the vital sta- tistics of occupations until one knows the age and sex composition of the individuals employed in the occu- pation. Nevertheless, it is the practice of insurance companies to classify occupations as to their hazard. For example, an aeronaut or a submarine diver will not be insured by many companies and by practically none, except at a very high premium ; the occupation of a railroad engineer is more hazardous than that of a bank clerk ; that of a soldier more hazardous than that of a farmer. That is to say, extra premiums may be charged for extra risks. But the general practice is to permit a change of occupation after in- surance is granted without any change in the pre- mium. This is due in part to a better knowledge of 76 PRINCIPLES OF INSURANCE the real difference in the hazards of different occupa- tions and especially to the competition among companies to make their policies attractive to prospective buyers by a liberalization of the contract through taking off many former restrictions. As to sexes it may be said that women as a class show a lower death rate, especially in the later years Sex Mor- than men do. This is the reverse of what taiity. j s rue in the experience of insured males and females. The statistics of insured women seem to indicate a higher mortality for married women dur- ing the childbearing period than for men or unmarried women of the same age. The practice of companies in insuring women is not uniform. Some accept wo- men at all ages on the same terms as men. Some re- quire an extra premium ; some accept them after the childbearing age has passed ; many accept them only when they are self-supporting in order that there may be no question as to the insurable interest in their life. With the growing freedom of the sex, doubtless there will be more demands from women for insurance on the same terms as men. It is urged that there is more of a hazard in the case of women than in the case of men for the reasons that : ( a ) there is more of a ten- dency on the part of women to understate age in the early years ; ( b ) that a certain delicacy on the part of women, as well as the medical examiner, prevents as thorough a medical examination as in case of men ; (c) that childbearing introduces an extra hazardous THE SELECTION OF LIVES factor ; ( d) that the possession of dependent children also may bring in the question of moral hazard in the case of the widow who is anxious to secure protection for her children in case of her death. Sex mortality for all ages is indicated in the fol- lowing table, taken from Newsholmn's Vital Statis- tics and referring to the population of England during 1891-1895. Mean Annual Rate op Mortality per 1,000 op Each Sex MALE8. Fbmales. Under 5 62.1 52. 5-10 4.5 4.5 10-15 2.5 2.7 15-20 4.0 4.0 20-25 5.3 4.9 25-30 7.2 6.7 35-45 12.2 10.3 45-55 19.8 15.3 55-65 36.3 29.8 65-75 71.9 62.8 75-85 149.9 136.1 85 and up. 290.6 263.8 It will be observed that this table indicates an es- pecially favorable mortality for females in later life. The problem of adjusting the premium for the hazard of childbearing is not difficult. Knowing the mor- tality due to childbirth, the extra premium may be readily calculated. 78 PRINCIPLES OF INSURANCE The hazard due to races can be determined with increasing accuracy as the vital statistics of races be- Race Mor- comes more accurate. In the United States ta^ty- the vital statistics of the registration area show a higher mortality among negroes than among whites. The causes for this condition are too well known to need description. The greater ignorance of the negro race, not only as to sanitary living, but also as to their correct age adds another element to the normal hazard. Some companies practically re- fuse to accept negroes. This is done in various ways, such, for example, as not giving the agent any com- mission for writing the policy ; others discriminate against them in the examination. Many states en- acted laws after the Civil War requiring companies to accept negroes on the same basis as whites in the belief that they were thereby enforcing the spirit of the fourteenth amendment, but in practice such laws can easily be evaded. The hazard connected with regions becomes im- portant in conjunction with or without the race Regional hazard. Some companies solicit insurance Mortality. ou \y m certain states on the principle that the mortality rate is lower in some states than in others. Care must also be exercised in thus ascrib- ing unhealthiness to certain regions without knowing the age composition of the inhabitants of the region. All other things being equal the death rate will be lower in newer regions than in long settled regions. THE SELECTION OF LIVES 79 This is due to the fact that the inhabitants of a new- region are a vigorous class with a lower average age. Few of the insurance companies solicit busi- ness outside of the United States, and many of them have required until the last few years an extra pre- mium for residence or travel in the tropics or polar regions. The refusal of companies to insure lives in certain regions may be due to the unhealthful climate, to the absence of definite knowledge concerning the condi- tions of life in the region, to a difference in social ideas of the regions, or to the particular legal require- ments. It is not infrequent, for example, to have a company cease writing insurance in a state on ac- count of some particular legal requirement which the officials of the company consider unduly burden- some. The hazard due to inheritance or family his- tory is, to a certain degree, of decreasing practical importance. With the advance of the medical sci- ence we are coming to realize that many diseases formerly considered as inherited are not of this de- scription. Moreover, even though there is a tendency to acquire certain diseases on account of the inherited physical constitution, care and attention to living in early life often prevents any fatal consequences. In the past it was the practice in collecting mortality statistics to ignore all that precedes death, such, for example, as the cause of death and duration of illness. Tli is even yet is largely the practice. As a conse- 80 PRINCIPLES OF INSURANCE quence the prevalence of most diseases cannot be accurately known. It is always fallacious to assume any fixed ratio between morbidity and mortality. A certain disease ^-x- is said to be twice as fatal as another, but Morbidity and Mor- this is not an accurate statement, as it is ordinarily made, since in the same disease the number of cases of sickness and death vary at different times and with various classes. The high- est ratio of sickness is often found with the lowest number of fatalities, as, for example, in the case of mumps. Then, too, vital statistics do not accurately inform us as to the amount of sickness and from the viewpoint of insurance as an economic and social institution, sickness is much more important than death. The mental and moral characteristics may be dis- cussed under the head of the moral hazard. The The Moral moral hazard has been denned as that ele- Hazard. ment in the risk due to circumstances or conditions of a personal and secret nature which are not disclosed in the application, although as regards family history and apparent health the applicant seems to be a desirable risk. The answers made to the questions in the application form a larger part of the foundation upon which the contract rests, and it is necessary in order to have a fair contract that the statements be complete, accurate, and true. The con- tract is in one aspect one-sided in that the insured THE SELECTION OF LIVES 81 can abandon it at any time, but the insurer cannot ; and even though the contract is obtained by misrep- resentations, the burden of proof rests upon the com- pany. It is generally true that a company in order to refuse payment must prove that the statements made are not only false, but also that they were will- fully stated falsely. The moral hazard exists in the following cases : (a) When the amount of insurance sought is larger than the income of the applicant will justify. (6) When the beneficiary named has no insurable interest in the life insurance, although this is of de- creasing importance. (V) When the individual is involved in financial difficulties due to a failure in business or to a misap- propriation of funds intrusted to his care. (c?) When the applicant is young and has not yet acquired fixed habits of living. He may become as- sociated with undesirable classes and acquire danger- ous habits. (e) When any of the preceding or other causes may lead to temptations to suicide. Some companies protect themselves in part from this hazard by the suicide clause which provides that in case of suicide within a certain period, usually from one to three years after the issue of the policy, the face of the policy will not be paid. Only the reserve value of the premiums is paid to the beneficiary of the policy. The vital statistics of the United States show for the G 82 PRINCIPLES OF INSURANCE registration districts, which include about one half the total population, that in 1908 the rate of suicides was 18.5 per 100,000 population. These figures, combined with those of 65 American cities which show for 1909 a rate of 20.6 suicides for 100,000 population, make this question of suicide an impor- tant one for insurance companies, especially when it is realized that those insured individuals who commit suicide often have large policies. Statistics show that the rate of suicide per 100,000 population in the 65 American cities has increased from 12.3 per cent in 1890 to 20.6 in 1909. The moral Jiazard is also present when insurance is granted to " cranks," not only because of the adverse effect of this class on mortality, but also because of the effect on the com- pany in securing business among his acquaintances and the likelihood of lapses by this class, as well as the abnormal increase in expense of securing and keeping this type of an individual insured. The methods by which insurance companies are attempted to be defrauded by dishonest applicants are too numerous and too generally well known to need description. Misstatements of age consciously and unconsciously made are very numerous. When unintentionally made, provisions are made in the policy contract for corrections without any loss to the policyholder. The tendency intentionally or unin- tentionally to misstate age is so strong that abso- lutely accurate age statistics for large groups cannot THE SELECTION OF LIVES 83 be expected, even assuming that the best possible system of collecting the statistics is devised. In many cases, the ages of ancestors were never known or have been forgotten ; the causes of death of even the parents of the insured are often unknown. One undoubted fact disclosed by age statistics is, that there is an excessive concentration of ages about years that are multiples of five and to a less degree in even numbered years. It is also evident that the tendency to understate age is stronger than to overstate age for all years except in extreme old age and to a less degree about the ages 18 and 21 when the age of majority for the two sexes is reached. The preceding circumstances described are, then, the causes which produce substandard or under- average lives. The practical problem for The Method the insurance company is, then, having f eati g of these lives that are below the standard ard Lives. risk, how should they be treated, so that they will not adversely affect the experience of the company; otherwise the average age of the group will be affected, for the company assumes that it will be able to insure young and vigorous lives at the correct ages. Nor is the practical effect of insuring a substandard life the same as insuring a life of advanced years with a short expectation of life. An underaverage life may not only have a short expectation of life, but an abnormally short expec- 84 PRINCIPLES OF INSURANCE tation, and if not properly rated so that an adequate premium is collected, it does not pay its due share into the insurance fund. The rate of mortality is, it must be recalled, a result chiefly of two factors, the duration of membership, and the age at entry. The effect of lapses, that is, voluntary withdraw- ing from the insurance group, will be discussed later; but it may be readily understood that if the younger lives lapse in unduly large numbers, the average age will be increased and hence the mortality rate will be increased. Nor can this be prevented by securing new members of the same age to take the place of the lapsed members. This would simply place the company in the same position that it was at the beginning. It must secure, not only new members to take the place of the lapsed ones, but also sufficient other new members to keep down the average age. It has been pointed out that in a mixed table of mortality those who insure young receive a benefit in mortality and consequently in their premiums and dividends from the fact that they have many years yet to live ; and since the company is continually insuring new lives, the past young en- trants will receive the benefits of selection from all the later insured group through many years. Those who do not insure until well advanced in years, do not live through a long series of years from which to derive the benefit of selection from the company which is continually insuring young THE SELECTION OF LIVES 85 lives. They become members of a group and are burdened by the increasing mortality of those who have survived, the benefit of selection having largely disappeared. Concretely this practically means that the young person's prospect of life is increased by these continual additions of younger persons while the person who does not insure until late in life suffers a diminished expectation of life because he becomes a member of a class who have survived from younger ages. The time to take out insurance is, therefore, when the individual is young, because: (a) he is in his productive years ; (5) because he probably has before him many years of obligation to his family ; (c) because he will purchase his in- surance relatively cheaper. With these introductory remarks we may now consider the methods of rating up lives. It must not be understood, however, that all insurance companies have the same standard for a normal life. Not infrequently does an applicant who has been rejected by one company obtain insurance in an- other, and this soon after the rejection. In most companies inquiry is usually made in the application whether the applicant has been rejected by another company, and if he has been recently rejected, this fact will be considered presumptive evidence against granting the application. The variation in com- panies' standards is, however, confined within fairly well defined limits. It is due chiefly to the fact 86 PRINCIPLES OF INSURANCE that different medical examiners do not discover the same facts or to the experience of the company with particular classes of lives. By this is meant that there is no very great difference in the inter- pretation of facts, that is, of the actual physical condition of the applicant when known, but all examiners do not find the same symptoms nor diagnose them in the same manner when found. The chief ways of making adjustment for an im- paired or underaverage life are as follows : (a) Charging the regular premium for rating up a higher age. (6) Writing the policy applied for at the regular premium, but with a proviso that if the insured die within a certain period such as five, or ten years, the face amount of the policy is reduced. This is the lien method. (c) Charging a higher premium. (jP) Granting the insurance applied for, but on a policy different from that applied for ; as, for exam- ple, issuing an endowment policy when the applica- tion was for an ordinary life policy. (e) Issuing the policy on premiums based on im- paired life tables. The first method, that of charging the regular pre- mium for a higher age, has been followed extensively Rating up by the European actuaries. It is simply the Age. to c h ar g e an applicant, for example, at age 40 the premium at age 45, thereby assuming that THE SELECTION OF LIVES 87 his impaired physical condition practically makes his chance of death that of the average person of the latter age. This assumption, that impaired physi- cal condition will cause the risk to increase at an increasing proportion, is not true in all cases. It is doubtless true that tendencies to certain diseases do increase or are constant with increased age, but there are other tendencies to disease which decrease with age. If, therefore, the tendencies either increase or decrease, there should be an adjustment of the pre- mium. The method of thus treating substandard lives is so easy of application from the standpoint of practical administration and its success in the past has been so great, that it continues in great favor. Then, too, since from the standpoint of the company it protects the company, not only for the extra risk at the time, but also in the future, the com- pany is able to insure applicants on plans of insurance such as the limited payment policies which otherwise it would not be able to do. This makes it satisfac- tory to many of the applicants, for in many cases no policy could be sold unless it was the same as some friend of the applicant had. Especially is this plan satisfactory in these days of popularity of the limited payment policies. Few individuals care to be re- stricted to buying an article which most of the peo- ple do not want. The addition to the age is usually under ten years and while the extra yearly amount in the early years is not great, if the individual lives 88 PRINCIPLES OF INSURANCE long, he pays a considerable extra sum. If the sub- standard life is at age 30 and is rated up to age 40, the excess premium is not great for several years at least, but if the substandard life is rated up from 50 to 60 and enjoys the average expectation of the nor- mal individual at age 50, he pays a sum considerable in excess of what he otherwise would have paid. It will not be forgotten, however, that these individuals do not, as a class, enjoy the normal expectation of life of standard lives at their age. Some policyholders naturally object to paying a higher price for the same policy which a friend has, for most persons are unwilling to admit that they are inferior to others. Lapses are not infrequent under this plan of rating up lives, although much de- pends upon the education of the people as to the par- ticular method of treating substandard lives. There are other objections to the above method, but, as has been stated, it seems to have worked in Great Britain, where the people have been educated up to this method. The second method of treating substandard lives, namely, that of placing a lien against the policy, has become very popular in recent years with some American companies. This is the plan under which the substandard risk is accepted at its actual age for the premium at that age, but the full face of the policy is not paid in case of death within certain periods. The deduction from the face decreases as the insured survives beyond the THE SELECTION OF LIVES 89 stated periods until the amount agreed to be paid by the company is the full face value of the policy. This plan was devised to meet the objections urged to the plan of charging a higher premium. It is also an aid in selling insurance, since the policy on the impaired life can often be sold to the person who feels that he is getting the same policy as his neigh- bor and paying the same price for it. Then, too, few individuals are willing to admit that they are sub- standard, not only as to longevity, but as to most characteristics, and thus the vanity of the applicant is satisfied. The applicant has confidence in his ability to live the average length of life, and if he does, his personal judgment has been vindicated without any extra premium, and if he dies, he has no judgment to be vindicated. The beneficiaries will probably be favorably disposed in their judg- ment of a contract from which they benefit. It must be recognized, however, that given a substan- dard life with this lien imposed upon it, which dis- appears completers say after ten years, there is no assurance that the experience of the companies on this class of lives will necessarily be favorable on ac- count of using this method of treatment. It may well happen that at the time the lien disappears the impairment of the life has so progressed that the in- dividual is almost at the point of death ; or the ten- dency to the disease, on account of which the lien was imposed, may have completely disappeared. 90 PRINCIPLES OF INSURANCE The liens do increase the desirability of the insur- ance, but in a manner not really appreciated by the insured at the time of purchasing the policy. In the actual practice of companies these liens are often not nearly equivalent to what the additional premium would be if the plan had been followed of rating up in years the substandard risk. The method of rat- ing up lives by liens as has been stated has more to recommend it as a policy of practical administra- tion than as one of scientific value. Other objections to the plan besides that of not rating the life up sufficiently and hence burdening the ordinary policy- holders unduly with a more than proportionate con- tribution to the insurance fund are, that a policy with a lien cannot be offered as collateral for loans, and, lastly, if such a policyholder dies soon after tak- ing out the policy, his family receives little benefit from his insurance. A method of determining the amount of the lien is as follows : If an applicant, aged 30, shows the di- minished prospect of the life of an average individ- ual of a group at age 40, the difference between the premium at age 30 and 40 is multiplied by the num- ber of years of expectation of life at the actual age. If death occurs the first year, the face of the policy is diminished by this amount. If the insured die the second year, the lien is decreased by one year's dif- ference in premiums. At age 30, suppose an appli- cant has the diminished expectation of an average THE SELECTION OF LIVES 91 person aged 40. The net premium in the American Experience Table with 3 per cent per $1000 on the whole life plan for age 30 is $18.28 and for age 40 is $24.75, the difference being 16.47. The expecta- tion of life at age 30, the actual age, is 35.33 years. This expectation multiplied by $6.47 would give a lien of $224.59 for the first year. Theoretically the lien should be annually decreased, and even then it would not by this method be equivalent to insuring the life at age 40, but in practice the lien period is only for a fixed number of years. Another method is to have the number of years of loading imposed on any life arbitrarily fixed by the chief medical examiner. The method of charging an extra premium has been sufficiently described in connection with the second method to indicate some of its objections. The plan of charging a higher premium, especially if it is on the policy applied for, has little to recom- mend it, either from the standpoint of . scientific accuracy or practical business Higher Pre- operation of the company, unless it is based upon data collected from experience of im- paired lives of the class to which the applicant be- longs. If the higher premium is collected because the applicant is granted a higher premium policy, as, for example, an endowment policy, when the applica- tion was for an ordinary life, the applicant is likely to be dissatisfied. Difficulty may be encountered in 92 PRINCIPLES OF INSURANCE delivering the policy, and even after delivery, lapses are likely to occur on account of dissatisfaction. Moreover, the plan does not often give adequate protection to the company. If, for example, an ap- plicant shows tendencies to tuberculosis and is granted a twenty-year endowment policy when he applied for an ordinary life, the assumption is that he shows the expectation of the average healthy life of the group at that age. But the life is admittedly sub- standard, and an abnormal death rate produces loss to the company, regardless of the plan of insurance. It is true that the company gains the difference in the reserve between the endowment and the whole life plan, but this amount in such cases is often in- significant. The plan of insuring substandard lives on impaired life tables depends upon the applicability of the tables. If it is based on the Institute of Actuaries' Impaired Life Table, it may not have very close appli- cability to risks in America or Australia. It is diffi- cult to devise any method entirely satisfactory for the reason that there is introduced a known abnormal life into a group of normal lives, the degree of ab- normality being impossible to determine. It is the same difficulty which always arises when devising principles and rules to govern a homogenous group and then have introduced into it heterogeneous in- dividuals. It is an attempt to make a rule for the exception. THE SELECTION OF LIVES 93 A movement which has attracted considerable attention within the past few years, and one which affects the insurance of lives, is that of the conserva- conservation of human life. The direct tionofLife. interest of the insurance companies in the subject is largely due to the efforts of Professor Irving Fisher of Yale University, who, being interested in it from purely humanitarian reasons, presented it to the in- surance companies as a proper form of activity for purely business reasons in addition to the humani- tarian element in it. The movement seeks to pre- serve, to broaden, and to extend life. It is well known that the advance in the medical and sanitary science has been very remarkable within the past several decades, and while the general public has received much benefit from the advances made in this science, yet it can hardly be claimed that these many new discoveries in hygiene are known and acted upon by the general public. What is needed is a vigorous campaign to educate the people in better ways of living. The most marked effects of what has been done in the past reflect themselves in the lives of the two classes, the dependents and defectives. The children and the aged are better cared for, and hence more children grow to maturity. The defectives, such as the feeble-minded, the deaf, and the blind are also much better cared for than they formerly were. It must be admitted, however, that these classes are ob- 94 PRINCIPLES OF INSURANCE jectively and temporarily a burden on the productive classes. It may be possible, as some believe, to secure a class of old people who retain their mental vigor sufficiently to be of great value to the other members of society who do not have that wisdom which comes alone from age and experience. Least attention, however, has been given to the productive classes, the men and women of adult and middle life, who are the chief factors in determining the efficiency and worth of a civilization. The movement has for its purpose the lengthening and broadening of life at all ages, and the effect on the insurance business is readily perceived. Insur- ance of lives is based to a large degree upon a mor- tality table or rate of deaths among a selected group of the population. Such a movement would, if suc- cessful, affect the death rate by lowering it. It would extend the productive years of the insured's life ; it would add to his efficiency while he is a pro- ducer ; it would create a finer sense of his obligation to take insurance. We have seen that a mortality table is drawn up on the assumption that it is subject to secular and temporary changes, and this movement would favorably affect both changes. By thus lowering the death rate, it would lower the greatest single cost of insurance, namely, the mortality cost. The movement if most successful would prevent un- timely death, so that a smaller sum could be charged as a premium, but it would be as sufficient as the THE SELECTION OF LIVES 95 larger sum now collected because it would secure greater additions from its compound interest accumu- lations. It would increase the expectation of life. Not only the average length of life would be affected, but also the breadth of life, for life is narrowed by morbidity. The length of life is usually only ex- tended by controlling sickness, so that the prevention of sickness is the primary object of the science of hygiene. If it is true, as has been stated, that " one third of the deaths are preventable, that is, postpon- able " and that " it is within the power of man to rid himself of every parasitic disease," then the signi- ficance of any efforts which seek to extend and broaden life is very important. The particular methods by which these results are proposed to be brought about are in general as fol- lows : First, by affecting heredity. This may be done by creating such public opin- conserving ion as will consider with disfavor the mar- riage of the physically and mentally unfit and the propagation of their kind. This result may be aided by legal restrictions on marriage. Second, by hygienic laws and the activities of the federal, state, and local governments, such, for example, as by quarantine reg- ulations, pure food laws, pure water supplies, milk inspection, regulation of hours and conditions of labor, and installation of safety devices. Third, by semi- public hygienic activities. This includes medical re- search and instruction, which results in the discoveries 96 PRINCIPLES OF INSURANCE of preventative medicine, of antiseptics, and especially making public property the knowledge thus acquired. It is only within the past few years that the medical profession, as such, has done much to educate the public in the proper care of the body. Semipublic institutions, such as hospitals, sanitariums, and asylums are doing much in this connection. The public schools are beginning to give more attention to the health of the pupil, and much good can be expected from this source. Fourth, by activities of private associations, such as societies to prevent 'the spread of contagious diseases, corporations seeking to care for the health of their employees, and life insurance companies. Fifth, by the practice of personal hygienic habits as a result of the activities of such associations previously mentioned and a better realization of their importance. The conservation of life depends, not only upon the collective activities of all on a wide scale to prevent contagious and other unnecessary diseases, but also upon the care with which an individual looks after his daily health. That is to say, length of life is a personal and an impersonal matter. The individual must help himself and be helped by his fellows. He has a right to expect that his fellows will not unneces- sarily expose him to a disease, but his fellows also have a right to demand that he will not so injure his vital powers by acquiring improper habits, and by lack of exercise, that he will become an easy prey to disease. THE SELECTION OF LIVES 97 The question arises, to what extent is the insurance company justified, if at all, in taking part in this movement to conserve life? It calls for Relation of an expenditure of money and an insurance J nsuran c * ** Companies company has no money other than that to Conserva- which it receives from its policyholders. faono It is a trustee of these funds whether it be a stock company with its self-chosen officials or a mutual company with its officers chosen by the many mem- bers of the company. It is urged that precedents are found for* life insurance companies in the case of fire insurance companies which have spent large sums of money in various ways to reduce the fire hazard ; also in the activities of liability and accident com- panies which spend considerable sums in inspection work and in devising protective devices of various kinds to which they call the attention of employers and their insured members. It is admitted by all that the insurance organizations are chiefly business and not philanthropic organizations. Is such an organi- zation justified in making any expenditure which does not directly effect a saving for its members? It is scarcely likely that our courts will take any other point of view, and it would not seem reasonable that they should. A particular activity of an insur- ance company need not, however, for this reason bene- fit only the members of the insurance group. It may benefit the general public as well. But ought not the activity to benefit the insured lives in particular 98 PRINCIPLES OF INSURANCE and the general public only incidentally ? Then, too, even assuming that the monetary benefit of activities to conserve life is clearly shown, there yet remains a very great practical objection. Would other com- panies cooperate in a general action for this purpose ? If one or several companies should undertake this expenditure, it might unfavorably affect their expense ratio as compared with other companies, for assum- ing the justification and benefits of such a movement, the policyholders of other companies would equally benefit. The objections may then be summarized as follows : (a) The legal objections. (5) The difficulty of securing proper cooperation. REFERENCES Harbaugh, C. B. The Selection of Risks by the Life Insurance Solicitor. Dawson, Miles M. The Business of Life Insurance. Chaps. XXV, XXVI. Roche, J. F. A Method of Handling Impaired Life Risks. Stillman, Chas. F. The Life Insurance Examiner. Fricke, William. Insurance, pp. 278-310. Alexander, William. The Life Insurance Company. Part II, Chap. V. Yale Readings. Vol. I, Chap. XXI. Report on National Vitality. Parts III, IV of Vol. Ill, Senate Documents No. 676, Sixtieth Congress, Second Session. Bowley, A. L. Elements of Statistics. Part I, Chap. VI. Publications of the American Statistical Association. CHAPTER V THE COMPANY Life insurance companies may be classified with reference to the system under which they operate, with reference to the character of the _ _ Classifica- internal control of the companies and with tion of Com- reference to the character of the policy's &me ' participation in the earnings. According to the first basis of classification we have old line, assessment, and fraternal companies. According to the second basis of classification we have the stock, mutual, and mixed companies and according to the third method of classification participating and nonparticipating com- panies. An old line company is one which sells policies for a premium fixed in amount during the length of the contract, and which accumulates a sinking The Old fund or reserve to meet all claims upon r"^* 8 * 1 the company. The word " old " has no Company, reference whatever to the length of time that the company has been in business, since the youngest company organized under this plan is as " old " as any other in existence. Without anticipating the later discussion of the premium, it may readily be seen from what has been said of the risk that the 99 100 PRINCIPLES OF INSURANCE necessity of reserve is the effect of not collecting an increasing premium for the increasing risk of death. More than the actual cost of carrying the individual risk is collected in the early years of the policy in order that less than the actual cost may be collected in the later years of the policy and thus the absolutely small charges of the earlier period and the excessively large ones of the later period are equated into a moderate charge for the whole period of the policy. The assessment system of life insurance is that ono under which theoretically the cost of the insurance is annually collected from the members by X JIG ASSCSS" ment Com- assessing .on them the costs. In practice there has been so many modifications of this theory that it is difficult to characterize the as- sessment plan ; but the essential idea in this system is that no reserve is collected. In no plan of assess- mentism is the policyholder guaranteed a level premium. In its earliest form an assessment or a collection was made from each member upon the death of a member. Later a definite sum was prom- ised in each case of death, and each member was charged a certain sum at entry, but it was not at first based upon his age at entry. Age at entry was later taken into consideration, but it was soon per- ceived that the persisting old member was paying the same sum as the young entrant. Whatever of equity there had been at the beginning of the com- pany soon disappeared, so that with the increasing THE COMPANY MJ death rates of the later years, the healthier old members tended to withdraw on account of the high cost. The sums collected were usually arbitrarily fixed without reference to mortality tables. It was an attractive plan to many because it seemed that men paid for their insurance as they got it. The present plan in some companies is to charge a sum at entry, based upon the age at entry and on a contract which provides that such additional assessment may be levied from time to time, as the needs of the com- pany demand. This sum is frequently in excess of the current costs of the insurance during the early years of the organization and thus affords for a time a fund. In some cases a membership fee is collected, which also aids in establishing a fund. However, in practically all the plans of pure assess- ment insurance the premiums collected are not suf- ficient premiums as required by the most reliable mortality table. The plans are too often devised to make it appear that the buyer of the assessment in- surance is getting it cheaper than he would old line insurance. Insurance, like any other commodity, has its price, and no visionary plans can make it cheaper. Indeed, insurance costs are more definite than most costs, for they have a limited range. The stern fact of certain death and a fairly definite rate of dying confronts all those who sell the commodity insur- ance. No such reductions or fluctuations in cost from year to year are present, as in the case of the I 'ID '2 [ PRINCIPLES OF INSURANCE production of material goods on account of the use of improved appliances or other changes. Only the very gradual improvements in conditions of living, better care of the sick, more successful surgical operations, and more secure and better investments can cause permanent reductions in the cost of in- surance. It is not a difficult matter to determine whether the premiums collected by assessment com- panies are sufficient, since mortality tables and inter- est calculations will disclose the fact. It will be recalled from our past discussion that assessment companies are of two kinds, the pure business assessment company, and the fraternal com- pany doing business on the assessment plan. Such companies have been in the past relatively free from the compulsory valuations required by state depart- ments of old line companies, and it is for this reason alone that many of them have been able to continue in business. The fraternal assessment companies especially have been considered purely voluntary and private associations, and it has been difficult and in most cases impossible to bring them under the regu- lation of the state. It has been argued that they are not organized for profit and they have always had sufficient representation and political influence in the state legislatures to defeat regulative legislation. As a matter of political expediency the party in power has often hesitated to oppose them lest future votes might be lost. The evils of the purely business THE COMPANY 103 assessment system have become so generally recog- nized, however, and the activity of the state along the line of protective legislation has so increased that uniform laws recommended by the association of state insurance commissioners seem likely to be adopted in many states. The fraternal assessment societies themselves have accepted the principle of the recommendations, and while the adoption of them will not completely rectify the errors of the past, yet it is a long forward step and in the end will result in placing assessment insurance on a scientific basis. No well-wisher of insurance has any desire to force fraternal insurance companies out of business, for they have much to recommend them in addition Fraternal to the lower cost at which they may trans- insurance, act insurance, as compared with the old line insurance company. It is unreasonable to suppose, however, that the people of the twentieth century with their increasing care for system in organization of business will much longer permit such a blot in the insurance business as the old unscientific and practically dis- honest assessment company. So far as the plans of fraternal companies are the same as the unscientific assessment plan, so far are they unable to meet their obligations and no specious appeal to the sentiment of fraternity should be permitted to conceal the injustice of the plan. What more elementary requirement is there about fraternity than that 104 PRINCIPLES OF INSURANCE brothers should meet their obligations ? What more fundamental characteristic of real fraternity should be observed, than honesty in making a contract and fidelity in carrying it out ? If fraternity is not to be a farce, those who are responsible for the millions of fraternal assessment insurance now in force must make adequate provision for the meeting of the obligations now unprovided for. Much of the fraternal insurance of the assessment character now held has not been paid for. In many cases less than one third is paid for, that is to say, for every $1000 of insurance in force $600 of it is a worthless promise to pay. The National Fraternal Congress table of Mortality is much lower than the American table and certainly no rates lower than those called for by the former table should be permitted. The death rates in some of the fraternal organizations are now in excess of the rates of the Fraternal Table and even in excess of the rates of the American Mortality Table. It is not too much to expect that other states will follow the lead of Iowa and prohibit the organization of any insurance society on the old assessment plan or even permit the organization of any new company on any other plan than one which will absolutely guarantee the collection of a premium which with safe and wise investments will meet all future demands. It is a kind of dishonesty, which, although often originating in laudable motives, has been all too prevalent in the past. THE COMPANY 105 There is, then, but one system of life insurance. There can be but one system from the standpoint of premium collections, and that is one under only One which such a premium will be collected as T e s y stem the rate of mortality and rate of interest ance. show are sufficient. All these other so-called systems of insurance should be classed with the gambling contracts of the early developmental stage of insur- ance. The only difference is that in assessment insur- ance there was not always an intent to deceive, while in the gambling contracts this intent was either always consciously present, or it was a purchase and sale of mere chance. However, if in last analysis, injustice results, it makes little difference to the bearer of it whether the original purpose was good or bad. The penalty of ignorance, both in written and unwritten law, is no less severe than that of knavery, and it is the concern of society to protect itself from its well meaning but ignorant members no less than from its dishonest members. As has been well said, " assessmentism has merited a sentence of legal death and fraternalism a suspended sentence." We have now to consider the second classification of companies, viz. stock, mutual, and mixed com- panies. The stock company is one or- The Stock ganized by private individuals who have Plan * subscribed capital stock sufficient to convince the state that the companies will be able to meet their obligations. It is owned and controlled by the stock 106 PRINCIPLES OF INSURANCE contributors, who select the officials. All the profits in the pure stock companies go to the stockholders, and all policies are issued on the non-participating plan. If a company organized as a stock company issue policies which share in the surplus earnings of the company and also permits policyholders to have some part in the management of the company, then such a company is properly called a mixed company. It is claimed for this kind of a company that the self-interest of the stockholders will guarantee fidelity to their trusteeship in caring for of the stock the policyholders funds and that competi- tion of other stock and mutual companies will guarantee a fair cost of insurance to the poli- cyholder. It is also argued that the stockholders have every interest in selecting the most efficient officials and this they are free to do without any interference from the uninformed policyholders who theoretically can dominate the policy of strictly mutual companies. The stock company was the first to develop both in England and America be- cause the capital was a partial guarantee of the contracts in the early days of insurance when the mortality tables were not known to be sufficiently accurate to assure solvency from the annual contri- butions by the members of mutual companies. It is assumed under the stock plan that a small addition is made to the actual net premium, and this becomes THE COMPANY 107 the fixed premium to the policyholder. Any losses are borne by the stockholders and any profits go to them as payment for the risk incurred. The element of risk, however, so far as it is one of mortality rate is not great, for such a mass of experience is now available that there is little excuse for any insurance organization not collecting sufficient premiums for the actual mortality to be experienced. In a strictly mutual company there is no capital stock and hence no stockholders. The company is the policyholders, who select their officials The Mutual and control the management of the com- Plan - pany. The older mutual companies have no capital stock and the newer ones in most cases only a nomi- nal capital. It is often provided that those who ad- vance the capital necessary to start the company shall receive a certain interest, say 10 per cent, for the risk up to the time at which the capital may be retired when a reserve and possibly a surplus has been accumulated. The policyholders in a mutual company pay a premium in excess of the actual mortality premium demanded and also in excess of the premium for the same kind of a policy in a strictly stock company, but whatever of this pre- mium is not necessary, as the future experience of the company shows, is returned to them. The re- turn of this overcharge is called a dividend and hence the policy in a strictly mutual company is said to be a participating policy. 108 PRINCIPLES OF INSURANCE It is claimed for this form of company that it has no dividends to pay the stockholders and can man- age its affairs in such a manner as the Advantage oftheMu- policyholders decide is proper. Some tual Plan. , . , . , . . mutual companies, however, issue policies at such a rate that the contract does not entitle the holder to share in the dividends, that is to say, his future overcharges are supposed to be discounted in the form of a lower premium. If a surplus is ac- cumulated in addition to the reserve, this is also the property of the policyholders. This surplus is accumulated for emergencies, that is, for higher mortality claims or to enable the company to give its policyholders the same general dividends or re- turns that it has been making in the past, or to cover any depreciation in assets. In the mixed plan there are stockholders who re- ceive dividends on the capital which they have ad- The Mixed vanced. A certain rate of interest is fixed Plan - to be received by the stockholders and all surplus earnings are then distributed to the policy- holders. In some cases no limitation is fixed as to the amount which the stockholders are entitled to receive and they may take what they please, although they are compelled by the participating policy contracts to make some distribution to such policyholders. Some states require the retirement of the stock and fix the maximum interest to be paid, while others have no special requirement. Most of the companies THE COMPANY 109 now organized have capit.il stock because most states require a guarantee capital for the organization of a company. We have thus stated the theoretical basis of the different kinds of companies, but in actual practice there are some points of difference. At first the stock company was the rule, but soon the mutual company came in vogue. The large dividends paid by many of the mutual companies attracted the attention of certain investors inclined to speculate, and stock com- panies were organized in larger numbers. Later the mixed company became the rule. It must be pointed out that in actual practice the difference between stock and mutual companies is more apparent than real. The ordinary _ rr * Companson reader could not determine from the rate of Kinds of . , - . <. . i i Companies. books of two such companies which was a mutual and which was a stock company. It is true that there is a general tendency for stock com- panies to sell only nonparticipating insurance. The recent investigations of the insurance business by New York and other states resulted in laws requir- ing either that a company should confine itself to writing participating or nonparticipating policies or should keep separate accounts of the two classes of business. This was done in the belief whether or not justified by the facts that the company's earnings on participating policies were used to make lower rates for the nonparticipating policies. It 110 PRINCIPLES OF INSURANCE does not necessarily follow because there are stock- holders who receive dividends that the net cost of the same kind of a policy to the insured in a stock company will for this reason be higher than the net cost at the end of a contract in a mutual company. The net cost of an insurance policy to the holder is a function of so many variables that an excess at one point in the cost may be balanced by a saving at another point. Nor does the distinction based on the fact that in one case the company is controlled by the stock- The Proxy holders and in the other case by the policy- wntromn f holders amount to very much in real prac- Companies. tice. The management of a mutual as well as a stock company is controlled by very few men. We have seen that a stock company sometimes permits its policyholders to vote, but in neither this case nor in the case of a mutual company does the average policyholder ordinarily exercise this right. Few of the policyholders could attend in person the meeting, and even if they did, they are not ordinarily well enough informed upon the subject to vote in- telligently. In most companies the proxy system is followed. Under this system the policyholder, either at the time of purchasing a policy or later upon in- vitation from the officials of the company, when a notice of a meeting of the officials is sent, gives his proxy or right of voting to the president of the company. This system permits the company to be THE COMPANY 111 directed by the board of directors and its chosen executive officials, who doubtless are in position to pass most intelligently on the questions which come up for decision. It is urged as an advantage of mutal companies that the policyholder has an opportunity in times of crises in the company's affairs to express his will and thus correct evils. This is a of Mutual power more theoretical than actual, for the history of insurance affords no clear-cut case when this has accomplished any great reform. The com- petition of other companies, both mutual and stock, and the knowledge of this final power resting in policyholders, together with the supervision by the state, are the really protective forces for the policy- holder in securing honest and efficient administration of the company. It was thought by some that the mutual company would afford a means of educating the people to an understanding and appreciation of insurance. Some efforts have been made to organize the policyholders into local associations which could make their will known to the home office, but such attempts have not been successful. The average policyholder knows little about even the policy he owns and still less about the insurance business and with the protection afforded by the state there is no immediate prospect that he is going to make much effort to inform himself on the subject. Efforts must be made by the company to educate him to a more 112 PRINCIPLES OF INSURANCE intelligent appreciation of insurance, supplemented by the work of educational institutions. The apathy of the average policyholder is surprising, even when it can be shown that the cost of his insurance is to be affected, as in the case of adverse legislation. He is too busy, as he thinks, in his business and profes- sional work, to give attention to insurance. There is, then, in the actual conduct of the business little difference between a stock and a mutual company so far as the question is concerned as to what indi- viduals shall direct the affairs of the company. In either kind of a company it is a few men and not the rank and file of policyholders. The third classification that of participating and nonparticipating companies is not a fundamental Participating distinction. It is classification of kinds of and Non- business or policies rather than companies, Companies, for a company which ordinarily writes only policies which share in the earnings that is, receives dividends may in some case refuse for special reasons to permit an individual to have such a policy, or at least one upon which the dividends are annually distributed. Indeed, it was a very common practice of both stock and mutual companies to write both participating and nonparticipating policies pre- vious to the investigations of the insurance business in 1905. As a result of the disclosures in this inves- tigation, companies were required by some states to keep separate the accounts of the two kinds of busi- THE COMPANY 113 ness. This required such a vast amount of work and consequent expense, that most of the companies now confine themselves to writing either participating or nonparticipating policies, and for this reason the above classification is given. We may diverge at this point in the discussion to explain how the action of any one important state mav force a company to adopt in con- . . . .. . HowtheRe- formity to such action a uniform practice quirements in all the states in which it writes insur- of one st * ie . may control ance. Suppose Ohio would require that Policies for , . . . , . . , . ,., all States. a certain provision be printed in every life insurance contract issued or delivered to a citizen of that state. This means that all life insurance com- panies doing business in Ohio must have printed one set of policies for Ohio and another set for other states, or it must include this provision in all its poli- cies. If the requirement is one which, if not included in policies in other states, means a marked saving, the compan} 7 may decide to pay the extra printing bill. If it is an important reform, it is likely to be adopted by other states, and the company will very probably incorporate it voluntarily in its policies. However, in the actual practice of insurance the policy require- ments of less than a dozen states practically decide the terms of the printed contract. Competition of other companies from various states is also a power- ful force in bringing about general uniformity in the terms of the printed policy. 114 PRINCIPLES OF INSURANCE The organization of a life insurance company, whether on the stock, mutual, or mixed plan, requires severa l stages. In addition to the general zationofa laws governing the organization of all corporations, practically all the states have special laws which govern the organization of life insurance companies. In many states a minimum number of persons who may organize such a company is fixed by the statute. These several persons agree to advance certain sums of money for the initial ex- penses, for even if it is a purely mutual company a kind now seldom organized a certain amount of capital is required for the initial expenses. The interested persons hold a meeting to decide the kind of a company which is to be organized and the amount of capital stock which is to be issued. The officials of the company are also chosen. Most of the states require a certain minimum of capital stock for the ordinary mutual company, and in many cases the. capital stock must be paid up. This minimum capi- tal is required as a deposit fund, held by the state in invested securities, the income of which goes to the company. This deposit fund is supposed to give greater security for the policyholders, but if the company is operating on scientific plans and its trans- actions are carefully supervised by the state, the ne- cessity for such a deposit is not evident. After the above requirements have been met, the interested persons apply to a state official, usually THE COMPANY 115 the secretary of state, for articles of incorporation, which are usually called a charter. The state official makes an examination of the terms upon securing the which the company proposes to organize Charter - and do business in order to discover whether the proposed plans violate the state constitution or state laws. Certain matters may be referred to the chief law officer of the state, the attorney-general, and cer- tain other matters, having to do with the financial security to the insurance commissioner. If, then, the state official, empowered to grant articles of incorpo- ration to insurance companies, is satisfied with the terms proposed, a charter is issued. The charter does not, however, grant a right to do an insurance business. It merely grants the right to proceed with the organ- ization of the company, and it frequently happens that several years elapse after a charter is granted before a company begins writing business. It also Jiappens in some cases that the company is not able to effect an organization and never applies for a license to write policies. The next important step after se- curing a charter is to dispose of the stock. A well marked evil has developed in connection with the organization of the numerous new companies since 1905. This consists in the very large commis- sion given to agents by proposers of a new company for selling the stock of the new company. Not infrequently are these stock salesmen permitted as high as 20 per cent commission, and when it happens 116 PRINCIPLES OF INSURANCE that the officials of the new company are also the stock salesmen, the evil is particularly glaring. Sometimes shares of stock are either given or sold at a large discount to influential men in a community in order to capitalize their name, and thus sell stock in their community. This last evil is doubtless difficult to correct, but the former can be remedied by limiting the commission permitted to sellers of the stock of new companies. The expenses of such sales do vary considerably in different sections of the country, but this variation can be taken into consider- ation by each legislature in establishing the limit. There should be no place in the insurance business for the professional promoter. In order to control the organization of companies more carefully, some states have given to the insurance commissioner control of the activities of companies immediately after a charter is issued, that is, during the period of formation. After the stock has been sold and other details of the organization have been worked out, the company applies to the insurance commissioner for a license to do business. The insurance commissioner then makes an examination of the company's condi- tion, and its transactions since it received its articles of incorporation, and the plans under which it proposes to do business, the policies it proposes to issue, and other matters to see that the laws gov- erning the operation of insurance companies are not violated. Particular attention is given to the finan- THE COMPANY 117 cial condition of the company. If he is satisfied on all these points, a license is issued to the company, and this marks the time of the real beginning of doing an insurance business. It must be evident that the expenses incident to the establishing of a new company in the insurance business are very considerable. In addi- J Expenses of tion to the usual expenses of establishing Organiza- an ordinary business, such as rent, office equipment, and salary of higher officials, the very difficult problem of securing a working force, that is, agents to sell the policies must be solved. There are not as in most kinds of business a number of workers waiting for positions. The insurance agent should be a skilled workman. It usually re- quires a certain amount of training to be able to sell insurance. The new company must, therefore, either induce agents to leave other companies or train the inexperienced man. The successful agent of the established company is ordinarily not anxious to connect himself with a new company for, all other things being equal, it is easier to sell insurance for an established company than for a new company. Con- sequently the new company often is compelled to make an offer of a higher commission in order to induce him to become their agent. But it is entirely too expensive to thus purchase all its agency force ; so the new company endeavors to secure a certain number of trained men, who then build up an agency 118 PRINCIPLES OF INSURANCE force by training new men. There is in the insur- ance business, as in all businesses, a certain number of "floating" workmen, but they are not a class upon which a company can depend for substantial results. The charter and the license granted to the com- pany in a particular state do not confer the right to do business in any other state. It must be ad- mitted to do business by the authorities of each state in which it seeks to do business. However, by the operation of state comity the entrance into other states is usually a simple matter. Some companies do business in all the states ; some confine them- selves to certain sections of the country. The new company gradually organizes its business in other states, usually in the adjoining states first, but entering as quickly as possible the states of dense population. The process of organizing a fraternal insurance company is somewhat different from that of the The Organi- ordinary stock or mutual company. It zation of a j iag k een stated that efforts have been made Fraternal Company. for several years to bring this class of companies under more strict control as to their organization and operation. The officials of such companies and the national associations of insurance commissioners have agreed upon a bill which has been enacted into law in some states and of which enactment is pending in other states. THE COMPANY 119 The chief provisions of this bill are as follows : (a) a definition is given of fraternal benefit so- cieties ; (5) the reserve for extended standard and paid up protection and withdrawal Provislons * * * governing equities must be accumulated and main- Organization tained under a table of mortality not lower J nsu r r ance than the American Experience Table on a Societies. 4 per cent basis ; (c) membership is limited to per- sons between 16 and 60 years of age who have been examined by a legally qualified physician ; (d) no society can be incorporated in or admitted to the state in the future which does not provide for stated periodical contributions sufficient to provide for meet- ing the mortuary obligations when valued upon the basis of the National Fraternal Congress of Mortality or any higher standard with interest assumption not more than 4 per cent ; (e) the investments of funds must be in such securities as are permitted for the in- vestment of the assets of regular life insurance com- panies ; (/) there must be at least seven incorpora- tors of the proposed company ; (jf) the organization must be completed within a year during which time a bond is held by the insurance commissioner and a certain minimum amount of insurance must be writ- ten ; (Ji) annual reports must be made to the state commissioner of insurance, and beginning with 1914 a report of the valuation of policies must be sent to each beneficiary ; (t) if the valuation of the certifi- cates on December 31, 1917, shall show that the pres- 120 PRINCIPLES OF INSURANCE ent value of future net contributions together with the admitted assets is less than 90 per cent of the present value of the promised benefits, the deficit shall be reduced at a certain rate at each succeeding triennial valuation until it is removed and in case of failure, proceedings for dissolution of the organization shall be instituted. By the preceding provisions and others, fraternal insurance is brought under more careful control with a view of assuring that all the obligations will be met. Exemptions are made in the case of certain societies. The state of Massachusetts has recently passed a law which permits the savings banks to establish de- partments for selling industrial insurance. No agency force is employed and the success of the plan is yet to be shown. The internal operation of the company after once organized is much the same as that of any other cor- The internal P 01 * a ti n which has to do with collecting Organization investing, and disbursing sums of money. and Opera- tionofa The board of directors has complete gen- Company. era } SU p erv i s i on f the company. It chooses the president and the other principal officers. The board divides itself into various standing committees, which usually act for the board as a whole. The number of committees varies in different companies, but there is usually a committee on death claims, one on agencies, one on accounts, one on finance, and an executive committee. These committees meet as THE COMPANY 121 often as is necessary. They listen to reports from the heads of the departments over which they have supervision. At stated intervals the whole board meets to ratify the action of committees, to discuss general policies of management and other matters which pertain to the business of the company. The board of directors delegate very large powers of an executive nature to the president. At most it lays down policies or adopts them upon the suggestion of the president and then intrusts the details of execu- tion to the principal officers. The presi- The Presi- dent of an insurance company is, therefore, dent * an important official. He needs to be well informed on financial matters, and at least well enough in- formed in the work of the other departments to make intelligent recommendations to them and inter- pret the results secured. He is a counselor for his board of directors, a director for the subordinate offi- cials, and a protector for the policyholders. There may be several vice presidents, each of whom may be at the head of a department, the work of which is to be described later. The other treasurer is responsible for the prompt col- 0fficers - lection and safe-keeping of all funds and the over- sight of all investments. The investments are not made by the treasurer, but by the committee of the board of directors or the president acting for or with the board or with the committee. The secretary has supervision and charge of the records of the company 122 PRINCIPLES OF INSURANCE and the correspondence. The actuary has charge of all the subjects which pertain to premiums. He pre- pares premium tables, tables of loans and surrender values, calculates the reserves and dividends and the mortality experience of the company. Many special calculations are annually required in a large company as to premiums, results secured on past policies, and the preparation of gain and loss exhibits. All this work is done by the actuary. He is the one indis- pensable official to guarantee that the business is scientifically conducted. His recommendations may not always be followed, but if they were, it would go far towards guaranteeing safe insurance. The med- ical director has charge of the force of medical ex- aminers. He selects the physicians to act as the company's examiners and is the final authority on the desirability of a risk from a physical standpoint. All examinations made by the local examiner are submitted for his final approval. He advises the officers and board of directors on all matters pertain- ing to his department. The work of an insurance company may be divided into the following departments : executive, medical, actuarial, legal, financial, and agency. Ad- mentsof a ditional departments, such as accounting, statistical, and investment may be found. The work of some of these departments has previ- ously been described sufficiently, but others demand a more detailed consideration. THE COMPANY 123 The legal department concerns itself with the conduct of cases before the courts, arising out of contested claims, foreclosures of mortgages, clear- ing titles to property, and a wide variety of other subjects. It must also see that bonds are properly drawn up, that the security supporting them is good, that the policies state precisely what is intended, and that notes are properly drawn. It keeps the officials informed as to the character of old and new laws enacted by the legislatures affecting insurance. The statistical department not only tabulates the varied experience of the company on insured lives and on its investments, but it also interprets these statistics in order that the future conduct of the business may be improved from the experience of the past. The deductions made are of especial value to the executive and actuarial departments. The agency department is one of the most impor- tant of all departments, for it is the one which secures the business for the company. At the head of this department is a superintendent of agents, who is sometimes a vice president of the company. Several plans of organizing the agency force are in vogue : (a) the general agency system ; (6) the direct agency system ; () by enacting from time to time laws in reference to their operation which have to do with the terms of the contract, the investment of funds, the expense for business, standards of solvency, taxation, and a wide variety of subjects ; () Calculate a life annuity due. ( os a> a" 8 e 11 r ce it tii scim dolls spon orth out be o ivest rest o p isth o be c a a 'be OS .a jg 8 "OS'S a> a at 3 pe payable i This d. mber of for corre resent w iunts set unts to ig and in und inte essary t in col. 4 i ih year. bo ^ be a *ir fl5 C* ^-* amc: amo in nil mpo nee out f eac a X O -B 3 C ^ 1 e v 2 C "S B J .C be V 3 be "> worth o; mnd disco in columi )lied by th t in colum ar, will gi' t in colum worth of ; or the ; at the beg er cent co ce sums claims set e at end o "3 p be 3 > S 3 11 8*1 resent compc stated multij set ou ingye set ou resent col. 4 lected at 3 p produ< death fall du < ft to -< fi 6 50 69,804 962 $ 962,000 End 1st year $.970874 933.981 51 68,842 1,001 1,001,000 it 2d " .942596 943,539 52 67,841 1,044 1,044,000 " 3d " .915142 955,409 53 66,797 1,091 1,091,000 44 4th " .8S8487 969,339 54 65,706 1,143 1,143,000 " 5th " .862609 985,962 55 64,563 1,199 1,199,000 " 6th " .837484 1,004,143 56 63,364 1,260 1,260,000 " 7th " .813092 1,024,495 57 62,104 1,325 1,325,000 " 8th " .789409 1,045,967 58 60,779 1,394 1,394,000 44 9th " .766417 1,068,386 59 59,3S5 1.468 1,468,000 M 10th " .744094 1,092,330 60 57,917 1,516 1,546,000 4 11th " .722421 1,116,863 61 56,371 1,628 1,628,000 11 12th " .701380 1,141,842 62 54,743 1,713 1,713,000 " 13th " 6S0951 1,166,471 63 53,030 1,800 1,800,000 " 14th " .661118 1,190,012 64 51,230 V89 1,8S9,000 44 15th M .641862 1,212,477 65 49,341 1,980 1,980,000 11 16th " .623167 1,233,869 66 47,361 2.070 2,070,000 " 17th * .605016 1,252,383 67 45,291 2,158 2,158.000 " 18th " .587395 1,267,598 68 43,133 2,243 2,243,000 " 19th " .570286 1,279,151 69 40,890 2,321 2,321,000 11 20th M .553676 1,285,083 70 38,569 2,391 2,391,000 " 21st 44 .537549 1,285,281 71 36,178 2,448 2,448,000 44 22d " .521893 1,277,593 ^ 72 33,730 2,487 2,487,000 44 23d " .506692 1,260,145 ^73 31,243 2,505 2,505,000 44 24th 44 .491934 1,232,295 74 28,738 2,501 2,501,000 44 25th " .477606 1,194,493 75 26,237 2,476 2,476,000 44 26th 44 .463695 1,148,108 76 23,761 2,431 2,431,000 44 27th 44 .450189 1,094,409 77 21,330 2,369 2,369,000 44 28th " .437077 1,035,436 78 18,961 2,291 2,291,000 44 29th 44 .424346 972,176 79 16,670 2,196 2,196,000 44 30th " .411987 904,723 80 14,474 2,091 2,091,000 44 31st 44 .399987 836,372 81 12,383 1,964 1,964,000 44 32d " .88S337 762,693 82 10,419 1,S16 1,816,000 44 33d 44 .377026 684,679 83 8,603 1,648 1,648,000 44 34th 44 .366045 603,242 84 6,955 1,470 1,470,000 44 35th " .355383 522,413 85 5,485 1,292 1,292,000 " 36th " .345032 445,781 86 4,193 1,114 1,114,000 44 37th " .334983 373,171 87 3,079 933 933,000 44 38th 44 .325226 803,436 88 2,146 744 744,000 44 39th 44 .315754 234,921 89 1,402 555 555,000 44 40th " .306557 170,140 90 847 8S5 385.000 41st 44 .297628 114,587 91 462 246 246,000 44 42d " .288959 71,084 92 216 137 137,000 ' 43d 44 .280543 38,434 93 79 58 58,000 " 44th 44 .272372 15,798 94 21 18 18,000 44 45th 44 .264439 4,760 95 3 3 3,000 " 46th " .256737 770 Totals 69,804 $69, SO 1,000 $38,756,240 THE PREMIUM 137 of a contract and no one knows when he will die, each should pay $555.22, or $38,756,240 divided by 69,804. This is the net single premium for a whole life policy of $1000 at age 50. The table shows in detail the processes in the calculation. If we wish to calculate the net single premium for a policy which is not for life but for only a term of years, say twenty, we add the present values for the first twenty years and divide by the 69,804 which would give $317.60, which is the net single premium at age 50 for a twenty-year term policy. This is less than the preceding net premium because in this case we assume that the company obligated itself to pay $1000 only to those who died during the next twenty years. Those living beyond 70 would under such an assumption be paid nothing. However, for very obvious reasons few persons wish to pay for their insurance at one payment, although such a payment can be made for a policy to an insurance company. It is purchasing protection far distant in a future which the purchaser may not live to enjoy. He prefers to purchase protection as he lives, that is, by installments or in annual periods. That is, the ordinary buyer of insurance desires to pay an- nual premiums and not single premiums. It is, then, necessary to express the net single premium in net annual premiums. As we proceed to calculate other forms of pre- miums, let the reader remember that they are equiv- 138 PRINCIPLES OF INSURANCE alent in value to the single premium. As the first Th Wh l s ^ e P * n ca l cu l a tiug the net annual premium Life Pre- for a whole life policy, we must make our second calculation (6), that is, calculate a life annuity due. An annuity due is the pay- ment of a stated sum at the beginning of the year to a person as long as he lives. It is thus the exact opposite of an ordinary life policy, since the latter is paid only in case of death. The value of the annuity due is the sum which the company must receive in order to make its annual payments at the beginning of the year to those living. Whereas the premium is ordinarily the small annual sum paid in order to re- ceive the large sums at the close, the annuity calls for the large sum paid to the company at the beginning in order that it may pay the small annual sums at the beginning of each year. The value of the annuity is calculated in the same manner as the single premium. Reverting to our first example of 1000 men at age 50, of whom 200 die the first year, 300 the second year, and 500 the third year, the problem is, how much should each of these 1000 men pay to a company in order that each shall receive $1 at the beginning of each year that he is alive ? Manifestly % 1000 is demanded now to pay the 1000 now living, hence there is no interest. But at the beginning of the second year only 800 are alive and at the beginning of the third year only 500 are alive. That is, the company will have to THE PREMIUM 139 pay out a total of $ 2300. But the second and third payments have the benefit of interest for one and two years, respectively. Therefore, we calculate the present worths of $1000 due now, $800 due one year from now, and $500 due two years from now. These amount to $2248.0172, which is the amount that the company must collect now in order to pay a $1 annu- ity to each now, and to each of the survivors at the be- ginning of each year that he lives. This sum divided by 1000 equals $2,248, which is the sum each annui- tant must pay under the assumption, if he is to receive the $1 at the beginning of each year that he lives. If now we substitute the American Mortality . Table and follow the same process of calculation, we find that the value of a life annuity at age 50 is f $ 15.27 ; that is, such a payment made by each of the 69,804 persons at age 50 will secure to each, a pay- ment of $1 now and a like payment to each sur- vivor at the beginning of each year from 50 to 95 in- clusive. If we desire, as in the former case, to determine the sum that should be paid by each of the 69,804 persons at age 50 in order to purchase a twenty-year annuity of $1, we simply calculate the present value of each of the sums demanded at the beginning of each of the years and divide it by 69,804. This is $12.92, a less sum than the former, because the annuity of $1 does not need to be paid by the company to each person surviving beyond the sixty-ninth year or twenty years beyond fifty. 140 PRINCIPLES OF INSURANCE The purpose in calculating an annuity was to use it as a means of changing the net single premium into a series of net annual premiums. We have seen that atage 50 the sum of $15.27 will purchase a life annuity of $1. That is, $1 can be paid to him now and at the beginning of each year to which the applicant survives. Therefore, -$555.22, the net single premium, will purchase as many dollars of an annuity as $15.27 is contained in it, which is $36.36. That is, the $36.36 paid now and at the beginning of each year to which the person survives is the equiva- lent of $555.22 paid now and once for all time. Since this $555.22 was the net single premium for $1000 of insurance, so must its equivalent, the $36.36, purchase by these annual payments the right to re- ceive $1000 insurance. This $36.36 is, then, the net annual premium for a $1000 policy on the whole life plan at the stated age. It must be evident to the careful reader that the method of calculating the payments for the purchaser The Term wno neither wishes to pay a single pre- Premium. mium nor annual premiums throughout his life is simple. Suppose he wishes to pay for his $1000 life policy in five annual payments. We must in this case calculate the equivalent of $555.22 the single premium in terms of a five-year annuity. By the previous method we calculate the present values of the sums due at the beginning of each of the five years, and find that $4.5^>is the value of an annu- THE PREMIUM 141 ity temporary for five years. Dividing this into the single premium, we have $121.08, the net annual pre- mium for a five-payment life policy of $1000 at age 50. If it is desired to calculate the net annual pre- mium for a twenty-payment life policy of $1000, the same method is used. That is, we calcu- , The Limited late the value of an annuity temporary Payment for twenty years, the first payment due im- renuum * mediately, assuming as has been the case in all the illustrations that age 50 is selected and the American Mortality Table with 3 per cent interest accumula- tions. The value of this annuity is $12.92. We then divide this into the net single premium for a whole life policy, a sum previously calculated to be $555.22, and get as a quotient $42.95. This is the* net annual premium for a twenty -payment life policy of $1000 at age 50. There remains, then, only one other of the impor- tant premiums to be calculated, namely, the endow- ment policy premium. An endowment policy premium is composed of a pure en- mentPre- dowment premium and a term policy premium. A pure endowment is that form of a policy which guarantees the payment of a stated sum on condition that an individual lives to a certain date. In case of death previous to this time the sum named is not paid. Such policies are not frequently written and the words " endowment policy " now mean a pure endowment policy combined with a term policy. 142 PRINCIPLES OF INSURANCE To calculate the premium on such a policy we must, therefore, calculate the premium on a pure en- dowment and the premium on a term policy. The sums of these will be the premium of the endowment policy. The problem is : calculate the net annual premium for a twenty-year endowment policy at age 50. We first determine the net single premium for a twenty-year pure endowment policy at age 50. That is, for what sum can a company agree to pay $1000 to each of the persons living at age 70? By reference to the mortality table we learn that of the 69,804 persons living at age 50 only 38,569 will be living at age 70, and hence the assumed company will be called on to pay out $ 38,569,000, at the end of twenty years. But the company can earn for twenty years 3 per cent interest on the single premium to be paid now. Hence the present value of the above sum is $21,354,729, and this is the sum to be collected at once from the 69,804 persons. Therefore, the net single premium would be $305.92. But again few will care to pay single premiums, preferring to pay annual premiums. We therefore calculate the value of a $1 annuity temporary due now and at the beginning of each of the succeeding 19 years. This we previously found to be $12,926. Dividing the single premium $305.92 by 12^926 we have $23.67, the net annual premium for a $1000 pure endow- ment policy at age 50. Adding to this the net annual premium for a twenty-year term policy, $24.57, we THE PREMIUM 143 have $48.24 as the net annual premium for the com- monly sold twenty-year endowment policy which in this case was at age 50. The premium for the twenty- year term policy is calculated by the same method that the five-year term premium was previously calculated. It must be evident that while we have selected age 50 for our calculations, any other age could have been selected, and exactly the same methods would be used. The student should familiarize himself with the methods by calculating for different ages the net single, the net annual pramiums on whole life policies, and the net annual premiums for limited payment and endowment policies. It must also be evident to the thoughtful reader that the net premiums of com- panies which use the same mortality table and the same rate of interest will be the same for the same kind of policy. But this net premium is not the one which appears in the rate book of companies nor the premium which is quoted by the agent as the price of a particular policy. It is the gross premium which is usually meant when the word premium is used. The gross premium is the net premium plus the ad- ditional sum added for expenses and contingencies, which added sum is called the loading. The Gross The earlier method of loading was to add Premium, to the net premium a certain per cent of itself. It is not an easy matter in any business to separate and properly assess the expenses of the business, and in the insurance business the problem is particularly 144 PRINCIPLES .OF INSURANCE difficult. There are joint, fixed, and variable ex- penses, almost defying any scientific analysis. For example, the expense of rent is largely fixed. An office force of a hundred persons is required to transact a certain amount of business, but probably an addition of fifty persons could transact twice as much business. It is not surprising, therefore, that there has been considerable difference of opinion, and, consequently, differences in the practice of companies in Loading. the method of loading policies. Nor is it surprising that rough and ready principles have often been used, which later investigation has shown re- sulted in loading too heavily some 'forms of policies. The 3 per cent interest assumed is theoretically redundant enough to balance the losses due to un- fortunate investments because the companies have for many years earned more than this rate. Likewise the assumed mortality is high enough in comparison with the actual mortality to make up for all contin- gencies that arise from unexpected mortality. This, then, leaves the loading to be used indiscriminately for expense. Now it is evident that the first year's expenses on a policy are greater than that of any suc- ceeding year, for the agent's commission, the exam- iner's fee, and the expense of issuing the policy, each comes in the first year. After this the expenses on a single policy for any year are comparatively small. In view of these facts the scheme was devised of writing policies on the preliminary term plan. That THE PREMIUM 145 is, the first year of the insurance is written on the one- year term plan, and this is followed by Preliminary the regular policy plan. If the contract is Term Plan, a twenty -payment life policy it would be written as a one-year term policy, followed by a nineteen-payment life policy. This does not mean that there are two contracts, but that the first year is considered term in- surance. The premium collected is usually the same for the first year as for the succeeding years, but since the first premium is considered as purchasing only one-year's insurance, it does not need to make any contribution to the reserve. There is, therefore, a wide margin between the net premium for the one- year term insurance and the actual premium collected. This difference is used to meet the large expenses of the first year. For example, the net one-year term premium for $ 1000 insurance at age 30 under the American Mortality Table at 3 per cent is $8.18, while the quoted premiums for a twenty payment policy at this age from the rate book of a company writing insurance On the preliminary term plan is $31.72. The difference is the sum taken for the first year's expenses. This preliminary term plan of writing insurance is widely used both in America and Europe. Several other devices are in use to provide for the large expenses incident to the first year of insurance, such, for example, as the modified preliminary term plan, the select and ultimate plan, but each has the same purpose in view. L 146 PRINCIPLES OF INSURANCE A common classification of expenses of an insur- ance company is as follows : (a) new business ; (6) collections ; ( write a regular policy on the preliminary term plan, that is, make a twenty-payment policy a one-year term policy, followed by a nineteen-payment life policy. This subject will be discussed further when we treat of the premium and the reserve. Fourth, endowment policies, which mature in case of death during a specified period or in case of sur- vival to the end of that period. This policy is a combination of a term policy and a pure endowment policy, which pays only in case of survival. Endow- ment policies are usually for quinquennial periods of 15, 20, 25, 30 years or mature at quinquennial ages such as endowments at age 50, 55, 60, 65, etc. A double endowment pays, for example, $2000 in case of survival or $1000 payable in case of death, and a semiendowment pays $500 in case of survival or POLICIES 153 % 1000 payable in case of death. Endowment policies may be paid for by annual premiums until the end of the endowment period or they may be paid for by a limited number of premiums, that is, by ten premiums, fifteen premiums, or twenty premiums. In this event they are called, for example, a ten-pay- ment twenty-year endowment policy. Policies may be classified in the second place on the basis of dividends, that is, participating policies, those which share in the earnings of the ciassifica- company and nonparticipating policies, tionofPoii- , , i , . i . cies accord- those which do not share in the earnings ingto of the company and therefore have a lower Dlvldends - premium than the participating policies of the same kind and for the same age. The participating poli- cies may participate annually, quinquennially, or at longer periods, although the longer periods have been forbidden in many states. The dividends may be used I to reduce the premium, to buy additional insurance, v to hasten the endowment, to shorten the premium pay- 1 ing period, to accumulate interest with the company * for the policyholder, or they may be taken in cash. i" In the third place, policies may be classified on the basis of the kind of premium, that is, those in which the premium is a natural premium, ciassifica- a single premium, or the level annual tionofPoii- cies accord- premium. In this classification, the first ingto is of least importance, for few policies are emmms - written on this plan. Policies in assessment soci- 154 PRINCIPLES OF INSURANCE eties may be written with premiums below or above the natural premium, although this premium in theory is the basis of the assessment plan of insur- ance. Some policies are written with a compara- tively low premium for the first five years and a larger premium thereafter ; others are written with a large premium to begin with, and the premium is reduced by fixed amounts at stated periods thereafter. Again policies may be classified on the basis of the character of the settlement. That is, the policy Classifica- ma ^ P rov ide at maturity for a cash settle- tionofPoii- ment, for installments, for bonds, for cies by . . . . .. Modes of annuities, or tor continuous installments. Settlement. j t mugfc not be un d e rstood, however, that it is intended to convey the idea that each one of these plans is mutually exclusive of all others. As a matter of fact, they are not. For, example one may purchase by a single premium a twenty-year endow- ment policy, the settlement of which may be in cash, in installments, or in annuities. Again any ordinary form of policy may be pur- chased on the nonpar ticipating plan. Many other different combinations of the previous classifications may be made. The most important classification of policies is that of life, term, limited payment life, and endow- ment policies. This is the classification ordinarily meant when a person speaks of the different kinds of policies. The one hundred or more different POLICIES 155 kinds of policies are usually some form of these four kinds of policies. For example there is a joint life policy which may be purchased by husband and wife. The face of such a policy is paid upon the first death The Joint that is, of either husband or wife. Or m * Polic y- a joint policy may be purchased by a group of men associated in business which is payable at the first death of one of the partners in the business. There are very decided objections to this policy, both from the standpoint of the company and the insured. Companies usually prefer to write single policies on each life of the persons desiring protection. In the case of husband and wife, if the latter die first, the husband may not then be insurable at this latter date, and yet he may have obligations, such as young children, which would demand that he have insur- ance. If each had carried individual policies, all the benefits from a joint policy would have been realized and in addition the children would be better cared for in the event of the death of the husband, subsequent to that of the wife. In the case of partners in business, the death of any part- ner terminates the insurance, the protection, but if there are more than two members in the firm, there still exists a reason for insurance as a firm asset. If a partner withdraws from the firm, there is no reason for the further existence of the joint partnership policy, whereas if there had been individ- 156 PRINCIPLES OF INSURANCE ual policies, the withdrawal of a member of the firm would have simply involved the change of the beneficiary. A policy somewhat similar in purpose to this, and one that is becoming more numerous, is that in which a corporation takes out a policy in its favor upon the life of its president or on the life of some expert employee. There is also a return premium policy in which not only the face of the policy is paid, but also a certain portion or all of each premium is returned if death occurs within a specified time. This manifestly calls for an extra premium, and the objections to such a policy are evident. There are many other forms of policies, but the more important of them will be considered in the discussion of the method of settlement of policies in the latter part of the chapter. In attempting an analysis of the policy contract it is difficult to make statements which apply in all , . _ cases to the different policies now in force. Analysis of * the Policy This difficulty arises from the fact that the insurance business is a subject for regulation by the numerous states and not the national government, and consequently the policy contract is theoretically and actually in many cases what the various legislatures choose to make it. Much has been done in the way of state uniformity, but much yet remains to be done. In many partic- POLICIES 157 ulars little of state comity has been recognized. The characteristics of the state legislation as per- taining to the policy contract were so changed after 1905, as a result of the insurance investigation, that a description in general terms of the policy pro- visions previous to that date and an outline of the chief requirement adopted since 1905 as they apply to the contract are given. Let not the reader forget, however, that we are attempting to state what is true of forty-five different and independent states' regulations and also what is true of several times that number of insurance companies, for the policy con- tract is in part what the different legislatures say it shall be, and in part what the different companies wish it to be. The policy contract in the early history of insur- ance had what now seem very many harsh pro- visions. The insured had practically no privileges. The contract was a whole life ment of the policy contract which was absolutely null cy * and void, not only for failure to pay premiums, but also for changes in place of residence and occupation. Companies could easily avoid payment of the policies because warranties and not representations were the rule, with the consequence that many of the insured lost the result of their payments for many years, since warranties must be absolutely true and repre- sentations need be only substantially true. Partly as a result of the harsh terms of this contract the 158 PRINCIPLES OF INSURANCE whole life policy as a form of insurance came into an ill-repute, from which it has not yet recovered. This form of policy deserves greater popularity and will certainly have it when the purchasers of insurance learn to appreciate its merits. The average agent does not make much effort to sell this policy at present because he often does not recognize its value, and also because it is usually easier to sell some other form of a policy and because his com- mission is larger on the larger premium policies. The historical development of the form of the policy was, in order, a whole life policy, a limited pay- \ ment life policy, and an endowment policy. In time there was developed a form of policy which provided for an annuity to the beneficiary only after the death of the insured. But this had the short-coming that the beneficiary might die first and the insured would have paid premiums, as he erroneously argued, on which nothing was given in return. This caused the installment plan to be devised, under which the proceeds of insurance policies are paid during a stated period of years, usually from five to twenty. This form was later modified so that not only the installments certain were paid during the period provided, but also payments of equal amounts were made to the beneficiary if the beneficiary lived beyond the period named in the installment clause. The policy after having been granted by the executive department of the company does not as POLICIES 159 a general rule become binding on the company until it has been accepted by the insured in good health and the first premium has been paid by Terms of the him. A receipt called "the binding re- Polic y. ceipt" may be issued by the agent for the pre- mium which is paid at the time of soliciting the application. This binds the company to pay the face of the policy as soon as it is issued. All pre- miums are paid "in advance." Premiums p aym entof are not in reality paid in advance for Premiums, the insured, the purchaser gets his commodity protection as soon as he receives and pays for the policy. The title to the policy may rest either in the insured or the beneficiary, depending Title to the upon whether, under the terms of the con- Polic y- tract, the insured may at will change the beneficiary. If he may so change it, then the beneficiary has only a contingent interest, since the insured may at any time nominate another beneficiary, such as his estate or another party. Otherwise the policy can be trans- ferred to another only by assignment by the insured. The laws of the greater number of states do not make the proceeds of the insurance policy an asset for meeting the debts of the insured, unless insurable it is made payable to his estate, or unless ^to* 8 *- possibly the creditors can prove that an insolvent debtor took out the insurance after insolvency with | fraudulent intent. In this connection the question of what constitutes an insurable interest arises. It 160 PRINCIPLES OF INSURANCE may be stated that this interest exists in all cases when the proposed beneficiary is dependent upon the insured for support, or is his creditor, or would suffer a monetary loss by the death of the insured. Mere affection or mental anguish does not constitute a basis for an insurable interest. Nor does relation- ship in itself establish an insurable interest unless, as is often the case, the relationship involves legal claims. A brother may, for example, have an insurable interest in a brother if he has advanced money for his educa- tion. The underlying principle of the insurance contract is indemnity, that is to say, it is a com- pensation for a loss sustained. It therefore follows as a consequence that the idea of profit is excluded so far as the insured is concerned, and the idea of pecuniary interest included so far as the one having an insurable interest is concerned. The amount of the insurance is ordinarily a matter to be decided by the company and the insured, but if the amount of the insurance taken out by a creditor on the life of his debtor is far in excess of the credi- tor's claims, the contract may be declared a wager by the courts and therefore be illegal. It must be understood that there is a difference between an insurable interest and the right, legal or The Bene- otherwise, of the insured to select his bene- ficiary, ficiary. The first has to do with the right of A to take out insurance on B in favor of himself or to have B insure himself in favor of A. The sec- POLICIES 161 ond has to do with the right of B to select his bene- ficiary. It is becoming increasingly the practice of companies and courts to permit the insured who pays his premiums from his personal income to select whom- ever or whatever he pleases as his beneficiary, since ordinarily a person always has an insurable interest in his own life. This practice is but in harmony with the general principle that one has a right to do with his own as he chooses, so long as he does not injure others or himself in the disposition which he makes of it. However, neither the companies nor the courts could afford to encourage crime by permitting an individ- ual to take out a policy on the life of an individual in the prolongation of whose life he would not be inter- ested. When it is stated that the insurance contract is an unfair one because the insured is not bound to con- tinue as a party to it while the insurer is . f J Legal Con- SO bound, it must be remembered that the stmction of insurer has laid down in the contract the conditions or has accepted the conditions as fixed by the state under which alone the insured may discon- tinue as a party to the contract. Life insurance con- tracts, like all other contracts, are construed by the courts against those who frame them on the theory that the makers of the contract have drawn them in their own interests. If there is an apparent conflict between clauses in the body of the contract and clauses attached or written, 162 PRINCIPLES OF INSURANCE the latter take precedence over the former. It is customary for the contract to contain a clause which specifically states that the company is not bound by statements of the agent ; that the printed contract is the sole contract between the company and the insured. Undoubtedly some purchasers of insurance have been deceived or misled by the state- ments of agents, but recourse does not ordinarily lie ty in an action against the company for statements made by the agent. It is the duty of the buyer to acquaint himself with the terms of the contract before he ac- cepts it. It may well happen that the buyer of legal reserve insurance will not get what he wants, but there is little danger that he will not get the worth of his money in these days of competition among the old line insurance companies and the state regulation of their business. Less than 1 per cent of the claims against insurance companies are contested in the courts by the companies. It is also significant that the companies win more than 75 per cent of these contested claims, for no company will contest a claim on trivial grounds. While it is not a part of the contract it is a prin- ciple of all companies to establish the minimum and maximum age below or beyond which they will not write policies. The lower limits vary from 15 to 21 years of age and the upper from 60 to 75. The object is to confine the premium paying period to the productive years of life. The so-called investment POLICIES 163 policies are sold by some companies after age 60 of the applicant, and children's policies are sold by in- dustrial companies merely to cover funeral expenses. The disability clause recently included in the policies of some of the companies has attracted considerable debate. It usually provides for a cessation The Disabii- of premiums when the insured becomes *ty Clause. totally and permanently disabled as a result either of bodily or mental disease or accident. In some cases the period of insured disability is limited, that is, it does not extend beyond 60 or 65 years of age. In some cases the company offers the disabled a cash sum in cancellation of the policy or agrees to pay the face of the policy in installments or grants an annuity. The debate on this clause centers around two points : First, how much of an addition should be made to the regular premium for this clause, or, in other words, how much should be charged for the disability insur- ance. The number of insured individuals or even the number of such individuals in the population group who thus become disabled is not known. The problem of cost is far yet from solution, but a very common charge is either 25 or 50 cents per year per $ 1000 of insurance. In some states the life insurance policies may not contain this disability clause. It must constitute a separate policy with its own pre- mium and terms. In Ohio, the disability clause may be inserted in life insurance policies, but the clause must provide for its own premium and for its own 164 PRINCIPLES OF INSURANCE cancellation, so that the clause becomes in effect an independent contract. The second point of debate is the determination of what constitutes a total and permanent disability. An answer to this question is difficult to get which is satisfactory to the contracting parties. An appar- ently permanent disability sometimes becomes only temporary, and in these days of minute division of labor a disability must be quite complete in order to make the insured absolutely unable to earn anything. In an effort to make this clause more specific, some com- panies make a partial definition of this phrase by stating that a loss of both eyes, of hearing, or of both hands, or of both feet constitutes total disability and it then permits the remaining causes and conditions of disability to be decided later. The practical ad- ministrative difficulties are not thus solved, and it is very questionable whether this attempt to combine in one policy life and accident insurance will redound to the advantage of either form of insurance. It is always conducive to scientific accuracy to have as few as possible varying forces about which to treat in insurance, not to mention the administrative diffi- culties which are always present in applying any scientific principle. The disclosures which were made as a result of the The stand- investigations of the life insurance busi- ard Policy. ness j n 1905 led to laws establishing a standard policy in New York, but this soon gave way POLICIES 165 to standard provisions in the policies. The require- ment of standard provisions is now the general rule in most states, and what we have to state farther about the policy contract will be included in our description of these standard provisions. It must not be inferred that the privileges, or the liberal provisions, as they are called in present poli- cies, were adopted wholly as a result of legislative compulsion. In fact, the liber- zation of the alization of the policy is not due primarily to legislative enactment but to the following causes : First, in the early days of insurance no data had been accumulated to determine conclusively that the pro- posed plans could be successfully applied. To guarantee solvency as completely as possible, absolute forfeiture was provided in many cases in order that the insurance fund might be augmented ; extra premiums were required for a change of occupation and residence, even though the latter was in the same latitude ; premiums paid in were forfeited in case of suicide, death at the hands of justice, or in the mili- tary or naval service, or if the statements made in the application were untrue in any respect. When ex- perience disclosed that many of these restrictions were unnecessary and the decision of courts failed in some cases to recognize their validity, the companies gradually began to omit the harsher restrictions. Second, as insurance companies became more numer- ous, the competition thus brought into existence did 166 PRINCIPLES OF INSURANCE more than all the legislation to liberalize the insur- ance contract. The beneficent effects of competition have clearly shown themselves in the case of the in- surance business. Companies have so vied with each other in making the policy contract attractive to the purchaser that it may be increasingly true that one of the chief functions of state supervision will be to compel companies to keep their liberality within the bounds of safety. The above statement seeks in no manner to minimize the actual accomplishments of legislative enactments and state supervision, but the chief work in liberalizing the contract has been vol- untarily done by the companies as a matter of busi- ness. The best work of the state has been in establishing standards of solvency and compelling, by continuous supervision, the companies to maintain these standards. The important standard provisions of policies are as follows : First, the distribution of the surplus, that is, the payment of dividends, must be made annually after standard tne third year of the policy. In some Provisions, states dividends may be paid quinquenni- ally. The details of this provision are reserved for discussion in a succeeding chapter. Second, loans must be granted up to the reserve value of the policy, less a small deduction of not more than 2| per cent of the face of the policy. A failure to pay the loan does not forfeit the policy POLICIES 167 unless the total indebtedness should exceed the re- serve value of the policy ; and then 30 days' notice must be given the insured before canceling the policy. Third, the policy must contain a copy of the ap- plication, and the policy with the application must constitute the entire contract. All statements of the insured are to be considered as representations and not warranties. Fourth, one month's grace must be permitted for the payment of any premium after the first. Fifth, a table must be in the policy which shows the loan values, and nonforfeiture values in case pre- miums are not paid. Sixth, reinstatement must be granted within three years after a premium has not been paid upon the payment of the premiums in arrears with interest provided the insured can supply evidence to the company that he is insurable. Seventh, death claims must be paid within at least sixty days after due proof of the death of the insured. Eighth, a table must be in the policy which shows the amount of installments in which the proceeds of the policy may be payable. Ninth, the policy must definitely set forth the op- tions of settlement. The policy is matured either by death or by completion of the contract, as, for ex- ample, by the payment of all premiums in the case of a twenty-year endowment policy. The question 168 PRINCIPLES OF INSURANCE then arises, How shall it be settled ? The insured may elect to receive cash, or to apply the cash due to the purchase of increased insurance or of an annuity. In a great many policies he may elect to receive a part of the cash due and the remainder in install- ments. In fact, one can purchase a contract from a life insurance company which will provide for almost any kind of a settlement upon maturity of the policy. Tenth, a clause which provides that the insured in case he defaults his premiums shall not forfeit his insurance, but shall be entitled to receive either paid up insurance or extended in- surance or a cash sum. These sums must be equal at least to the reserve held on the policy and the divi- dends due on the policy less any indebtedness on it and less a sum not in excess of 2J per cent of the face of the policy. The causes which have been responsible in most cases for a forfeiture are (a) nonpayment of pre- mium when it was due ; (6) residence in an un- healthy climate, change of occupation, or suicide ; (c) fraud in obtaining a policy; (c?) the absence of an insurable interest. The last two causes have not been modified to any extent by the action of legis- latures or by the companies, except, as we shall see later, a definite period is fixed within which actions at law must be instituted to determine whether fraud- ulent means have been used. The first and second reasons for forfeiture have been very materially modi- POLICIES 169 fied, both by law and action of the companies. The Massachusetts legislature under the leadership of Elizur Wright, its noted insurance commissioner, led the way in requiring nonforfeiture provisions in a policy when it required all companies doing business in that state to grant a retiring policyholder extended insurance. This law was passed in 1861. The length of time the insurance was extended beyond the date of withdrawal was determined as a matter of course by the reserve value of the policy. We shall remember that in level premium insur- ance the policyholder pays more than the natural premium or cost of his insurance in the early years and accumulates a reserve and pays perhaps less than the cost in the later years. Many of the companies at this time were paying either surrender or cash values, but the companies did not incorporate in the policy what some were doing in practice. A cash surrender clause did not appear in any policies until 1869 and did not become a general practice whether made a part of the policy or not, until very recent years. Both the cash surrender value and the extended in- surance, which, as its name implies, is extending to a future period the face of the policy after premiums are no longer paid, were feared by the company offi- cials. They feared an unfavorable selection. Forfeiture on account of a change in residence or occupation has tended to disappear on account of the better knowledge of regions, dangers of occu- 170 PRINCIPLES OF INSURANCE pations, and better understanding of sanitary and hygienic principles. The companies now refuse to insure those who live in certain districts or those who are engaged in certain occupations. The few insured lives who do go to these unfavorable regions or engage in hazardous occupations do not appear to produce serious results on the mortality experience of the companies. An example may be given of what this nonforfeiture meant fifty years ago in compari- son with policies now written by a reference to the policy provisions of one of the large life insurance companies' policies. The purchaser agreed fifty years ago that his policy became null and void if with- out the company's consent he passed beyond the settled limits of the United States or Canada or even visited those parts of the United States west of longi- tude 100 . Nor could he go south of Virginia and Kentucky in the summer time or live within ten miles of the Mississippi or Missouri rivers south of latitude 40. All service on boats or trains was for- bidden, as well as military service except in time of peace. Death by suicide, duelling, and execution by the state voided the policy. At present all policies in this company are free from restrictions of resi- dency, travel, or occupation, and failure to pay the premium after two full premiums have been paid does not void the policy. Eleventh, a clause must be in the policy, which provides that the policy is incontestable after two POLICIES 171 years for practically all causes except the nonpay- ment of the premium. Some companies have vol- untarily made their policies incontestable i nC0 ntesta- after one year. By contestability is meant bmty - the right of the company to contest in the courts any claim which arises under the policy contract. There has been much discussion of this clause, both as to its advisability and as to the extent to which it binds the company. It is a means of affording greater se- curity to the older policyholders. Its adoption has manifestly led to the withdrawal of other restrictions since if this clause is binding on the company, the latter is not free to resist any claims made upon it by a policyholder who has violated any one of the many earlier restrictions of the policy. It led to a with- drawal of many of these former restrictions. The question naturally arises, Should a company be thus prevented from resisting the payment on a policy which was obtained by fraud? Does public policy demand that the wit and ingenuity of the company officials should be pitted against that of the individ- ual who seeks to obtain for himself or others money by fraudulent means ? In actual practice it means that the company must discover, before issuing the policy or within a comparatively short part of the time that the contract runs, whether fraud has been used; It has been held (Reagon v. Insurance Com- pany, 76 N. E. Reporter, 217) that a provision in a life policy which makes it incontestable for fraud 172 PRINCIPLES OF INSURANCE from date of issue is invalid but that such a provision, operative after a certain date, is valid. There is without doubt a danger from making the policies too liberal in this particular, not so much because the financial security of the company is seriously injured, but rather in thus permitting, if not encouraging, fraud. This clause indicates more forcibly than does any other the reaction that has taken place against the harsh restrictions of the old policy contract. The companies have sought to make their policies more attractive by thus liberalizing them, and the modifi- cations have resulted more from business competition than from legislative or judicial action. Twelfth, a title on the face and on the back of the policy correctly describing the same. In addition to the above standard provisions, there are also standard prohibitions which are required standard with a view of protecting the policy- Prohibitions. no l c l er . Among these prohibitions, the following important ones may be mentioned : First, the failure to pay a loan or the interest on it may not forfeit a policy if the total indebtedness is less than the loan value and in no case can forfeiture for this failure take place before the policyholder has been notified at least one month previous to the forfeiture. Second, no policy may contain a provision limiting the time within which any action at law or in equity may be commenced to less than five years after the cause of action shall accrue, POLICIES 173 Third, no clause may be included by which the policy shall purport to be issued or to take effect before the original application for the insurance was made, if thereby the insured would rate at a younger age than his actual age at the time at which application was made. This clause permits only the age at the nearest birthday to be taken and prevents " dating back " of policies, a method of rebating practiced by some agents. Fourth, no provision is permitted for a settlement at maturity of less value than the amount insured on the face of the policy plus any dividend additions and less any indebtedness. Fifth, no policy can be issued until the form has been filed and approved by the insurance commis- sioner. This prohibition is intended to prevent the numerous " frill " policies, designed to attract the impressionable purchaser, but which had little to commend them. Both the standard provisions and the standard prohibitions are now used in many states. There is little prospect that the problem of monop- oly will have to be met in the insurance world. The principle of diminishing returns oper- Absence of ates very clearly. Other conditions Monopoly in the Insur- preventing a monopoly are : (a) the com- ance Busi- parative ease of organizing new companies, ness ' both on account of the small amount of capital re- quired and the comparative ease with which legal 174 PRINCIPLES OF INSURANCE requirements may be met. Potential competition is always present, although the number of new companies which are organized and prove success- ful is not large. However, the economies to be se- cured by consolidation of many companies with a view of establishing monopolistic conditions are not important. (5) The local pride that is taken in a home in- surance company. ( lus - which the officials of the company decide may safely be returned to the policyholders. This fund is sometimes called the profit or interest fund, but it will contribute to a better understanding of insurance if a more careful use of the words is preserved. Profit is the chance element in production and could be properly applied to the life insurance business in two cases First, in the early days of insurance when, 196 PRINCIPLES OF INSURANCE on account of the high rate of lapses and the terms of the contract, considerable sums were forfeited to the company ; second, when a pure stock company sells nonparticipating policies and by unusually good investments is able to sell insurance at a low net cost and still has a fund to divide among the stock holders. The profits constitute a fund out of which real dividends are paid. Nor should interest be confused . ~ with dividends. Interest is the sum paid The Charac- r ter of Divi- by the borrower to the lender for the use of capital. It is a guaranteed return as in the case of bonds, mortgages, collateral loans, or personal security. The policyholder is neither guaranteed an interest nor promised a dividend. He agrees to purchase an article indemnity the cost of which cannot be exactly determined at the time of purchase on the condition that any excess payment in the case of a participating policy will be returned to him. In case of a nonparticipating policy the possible excess cost is discounted in the form of a lower premium. The only sources of income for an insurance com- pany are the present and future premiums from its policyholders and the returns from the investments of the assets which have been accumulated from past premiums. If this income is in excess of the needs of the company, the practical question arises, How shall the overcharges be returned to the policy- THE RESERVE, SURPLUS, AND DIVIDENDS 197 holders ? In other words, How shall the company- determine the amount of the so-called dividend which shall be paid to each ? We assume that the amount which is held for the reserve, and the contingent re- serve has already been accurately determined. A question now arises which is not easily decided and one upon which there is much difference of opinion, namely, the distribution of dividends. In the earlier days of insurance it was the practice to distribute the surplus earnings on the basis of a percentage of the premium without re- The methods gard to the kind of policy or length of f A .PP r - time that the policy had been in force. Dividends. The chief error in this plan was that a policy in its later years received no more than in its earlier years when, as a matter of fact, its large reserve accumula- tion was contributing annually from its interest earnings a greater sum to the surplus which was being divided. This percentage plan had little to recommend it other than its simplicity, and it was generally superseded by the contribution plan. This plan is, as its name implies, the method by which it is sought to return to each policy that share in the surplus which it has contributed. _ r The Contri- It takes into consideration the kind of bution policy, its duration, and the age of the in- sured. A policy is credited for any given year with the terminal reserve of the preceding year, the annual premium of the current year and the interest earned 198 PRINCIPLES OF INSURANCE therefrom during the year. It is debited with the proportionate share of the expenses of the year which this policy should bear, the mortality cost of the insurance for the year, and the reserve for the end of the year. The difference constitutes the accumu- lations on this policy. If the total of the amounts so calculated for each policy should exceed the amount which has been set aside for distribution, a pro ratio reduction is made. If the policy has been debited with an $8 contribution to the annual mortality and the actual mortality is only 75 per cent of the calculated, there is then only $6 to be paid and the % 2 is that part of the entire surplus contributed by this policy, so far as mortality surplus is concerned. Likewise if 3 per cent is the interest assumed and 5 per cent net is earned, the 2 per cent is a surplus ; and if the initial reserve for the year is $100, this policy will secure $2 from this source. Similarly, if the loading is $7 and the actual expense charged to this policy is only $5, the remaining $2 will be the surplus from this source. Adding these amounts the policyholder would secure a dividend of #6. This method would appear from the description equally as simple as the earlier percentage method and theoretically there seems to be little to criticize in it. However, difficulties are experienced in apply- ing this plan and many modifications of it are made in practice. The chief difficulty centers in attempt- THE RESERVE, SURPLUS, AND DIVIDENDS 199 ing to apportion to each policy for each year of its duration its proper share of the expenses. We have already seen how complex the expenses of an insur- ance company are, not only because the individual policy expenses vary at different times, being very high when issued and later decreasing, but also be- cause there are so many joint expenses. The idea at the basis of the contribution plan is that no member or class of members should have assessed upon him or them the expense due to any other insured individ- ual or groups of insured individuals, assuming that such sufficient numbers and amounts of insurance have been obtained as will secure average results. However, if cancellations are too numerous, or if numbers have not yet been obtained to secure these average results, should not the present policyholders pay a part of the expense from which they will benefit because they are assured of average results ? It is true that many of the expenses can be identi- fied. The expenses of investments can be discovered- and assessed with a reasonable degree of ^.^ ta . ft Difficulty of accuracy. The same is true of the med- assessing ical examination, the agency fees, rent, and supplies. The salary of officials, clerks, and office ex- penses, also, have some relation to the amount of busi- ness done. But assuming these last-named expenses at a given amount when a given volume of business has been transacted, it does not follow that a busi- ness of double this volume would require a doubling 200 PRINCIPLES OF INSURANCE of these expenses. Nor do such expenses as advertis- ing and postage bear any necessary relation to the business transacted. The expenses due to settle- ment of policies often vary greatly. The same is true of taxes which vary greatly in different taxing districts. If one state levies a tax of 2| per cent and another state a tax of 1 per cent on the premiums col- lected in the state, should the policyholders in the latter state help to pay the tax in the former state ? Theoretically they should not, but practically it is im- possible to assess the tax on the policyholder in the former state in the form of a higher premium. The difficulty, then, of determining accurately in- dividual policy expenses is apparent and in practice the companies are forced to group some of these ex- penses and assess them upon the premium or upon the death cost. Mr. Daniel H. Wells, the actuary of the Connecticut Mutual Insurance Company has ad- vanced the following plan for assessing expenses : (a) assess the investment expense upon the invest- ment income ; ( b ) assess upon the premiums such ex- penses as are determined by the premium ; ( c) assess upon the death cost or technically the cost of insurance all other expenses. This plan has the merit of defi- niteness, but it does not guarantee that the various expenses will be properly identified and assigned to the proper place. This plan would imply that the ex- pense of securing new business would be borne in toto by the new members which could be done only on a THE RESERVE, SURPLUS, AND DIVIDENDS 201 preliminary term plan or its equivalent. The old line companies which set aside a full reserve from the start must borrow from the surplus to ;>iy initial ex- penses. The public has become supersensitive and often unfair in its criticisms of the conduct of the insur- ance business within recent years because the manage- ment of such business has not upon demand come forth with hard and fast rules for determining each element in the expense of conducting the business. If the same demand had been made of the management of most private enterprises, the reply would have been almost equally unsatisfactory. None the less it is important in the business of such a quasi public char acter as the insurance business that plans as definite as possible for determining expenses be devised and followed. Absolute definiteness cannot be secured for the best devised principles for assessing insurance expense will meet many difficulties when the attempt is made to apply them. The annual dividend plan of paying dividends is now the general method with' companies that write participating policies. The dividends accruing may be used by the policyholder to reduce the premium, to purchase additional insurance, as a deposit with interest, as a cash payment, or in several other ways frequently found in life insurance policies. The deferred dividend plan was extensively used previous to the legislation which followed the insur- 202 PRINCIPLES OF INSURANCE ance investigations of 1905. This plan provided that no dividend would be paid until the close of certain periods, usually 5, 10, 15 or 20 Dividend years. Such policies were often called accumulation, distribution, or semitontine policies. The theory underlying this plan was that it tended to security since an interval of this length would be a safer basis on which to determine the real gains than would a year, and second, that the persist- ing policyholder was more entitled to whatever gain resulted rather than the policyholder who lapsed, but who under an annual dividend plan en- joyed a reduction in his insurance cost by receiving the annual dividend. It is evident that under the deferred dividend plan the company holds large sums, and this condition theoretically not only insures a greater guarantee of solvency, but also by its com- pound interest accumulations and wise investments returns to the surviving policyholder a large amount of so-called dividends. In practice, however, these expected greater results were not always obtained. It was found that these large funds were a continual temptation for extravagant expenditures by the management of some companies. No accounting to the policyholders for this sum was necessary until the close of the period and in the strong competition for business the management of some companies de- pleted this fund. Then, too, the agents of the com- panies often made extravagant statements and THE RESERVE, SURPLUS, AND DIVIDENDS 203 promises to prospective purchasers of policies regard- ing the amount which they might expect these deferred dividends to be. The policy contract did not guar- antee any specified dividend and when the time for distribution came, many policyholders were disap- pointed because their dividends were much smaller than they had been led to believe they would be. Some companies issued estimates of dividends, but these were not always accepted by the public as esti- mates. Doubtless many officials and agents were sincere in thinking that the company would be able to pay the sums indicated in the estimates, but they made the mistake of assuming that the interest rate would continue as high in the future as it had been in the past, and the further mistake of assuming a heavier lapse rate than actually occurred. Many policyholders consequently believed that they had been intentionally deceived, as doubtless some were, and they expressed their demand to the state leg- islatures, which enacted the annual distribution laws. The tontine plan has long ceased to be of any great importance. The pure tontine plan was one by which the lapsing policyholder received The Tontine neither dividends during duration of in- Plan - surance nor cash surrender at the time of lapse. The total contributions and their earnings were di- vided at the close of a period among the members who persisted. This plan became illegal in time 204 PRINCIPLES OF INSURANCE and gave way to the semitontine and other plans of deferred dividends. The annual dividend plan affords a method of se- curing the insurance at an immediate and continuous a lower cost, and since insurance is primarily Dividend a protection and not an investment, the plan will probably prove more and more popular as the purchasers of insurance come to understand bet- ter this plan of paying dividends. This statement does not imply that for the same policy at the same age the annual dividend plan has resulted in a lower net payment for the insurance than on the deferred dividend plan, since the company might have been able to keep what has been paid in annual dividends so invested that it would have earned a larger sum in their possession than when it was invested by the policy- holder. Indeed, when considered individually, the chances of securing a better investment of this divi- dend sum by the company are decidedly more favor- able than when it is invested by the average policy- holder. REFERENCES Dawson, Miles M. The Business of Life Insurance. Chaps. V, XIX. Smith, G. W. Notes on Life Insurance. Chaps. Ill, VII. Yale Readings. Vol. I, Chap. XIII. Report of Joint Committee of Senate and Assembly of New York, pp. 378-388, 418-429. CHAPTER IX INVESTMENTS AND INTEREST One of the most difficult problems in the practical operation of a life insurance company is the manage- ment and investment of insurance funds. _. _ The Impor- The importance of this subject is due tanceof chiefly to the fact that these funds are ad- vance collections from the policyholders to aid in the payment of claims which will not fall due for many years. The contract made by the company is with one person, but the benefit is usually paid to another person. It is this reserve fund which guaran- tees the payment at maturity of these long time con- tracts in which several parties are interested and whose payment means so much to the beneficiaries. The calamity which would result if all the insurance companies should default their contracts is beyond imagination. From the previous discussions, it will be understood that the assets must be at all times so invested as to equal at least the reserve value of the policies, for this is not only a requirement of the statutes, but, as we have seen, is also absolutely necessary under the level premium plan in order to mature the contracts. In addition those companies 205 206 PRINCIPLES OF INSURANCE which pay dividends expect to secure from their investments a part of the surplus from which divi- dends are paid. So large in amount have these funds become and such great financial ability is re- quired for their wise management, that this problem may well be considered one of the most difficult in the insurance business. We will discuss the subject of investments under the following heads : (a) the character of the investments in the past and present ; (6) the rate of interest secured on the different kinds of investments at different periods. The topic of the legal requirements in regard to investments is re- served for a detailed discussion in a later chapter. An investigation of the investments of life insur- ance companies in the past shows that in 1851 the ^ 'im. Connecticut Mutual Life Insurance Com- The Charac- ter of the pany and the Mutual Benefit Life Insurance Company of New Jersey, which are two of the oldest and may be taken as representative com- panies, had 56 per cent of their assets invested in premium notes, that is, notes given by the insured for premiums due. Of the other assets derived from cash payments held at that date 26 per cent was in real estate, about 9 per cent of the remainder was in city bonds and bank stocks, and about 9 per cent was held as cash. A very marked decrease in premium notes then followed, so that in 1858 only 21 per cent of the assets of the four largest companies was in the form of premium notes. Of the remaining 79 per INVESTMENTS AND INTERESTS 207 cent of the assets about 67 per cent was in mortgage notes. The cash item as a relative percentage did not among companies as a whole show any marked ten- dency to decrease preceding 1905. Cash The Cash held in the office has constituted a temp- Item - tation which the management of some companies has not been able to resist, as the insurance investi- gations begun in 1905 disclosed. The cash item in theory should consist of money held to pay matured policy claims falling due whether these be death claims, endowment claims, annuity claims, or cash surrender values ; money held for current expenses and cash awaiting investments. Insurance officials are not always able to find immediate investments of a desirable character. There has been a tendency in some cases to hold an unduly large amount of cash which went to the call loan market. As is well known, the interest rate on these loans is often very high, but the risk is also often great. Security should be the first criterion of judging the excellence of an insurance investment rather than the high rate of return secured. It is desirable, of course, to secure high interest returns, since this may result in greater dividends and lower premiums to the policyholder, but the fundamental question is to decide how high a rate of interest can be secured consistent with the security of the investment. It was shown in the re- cent investigations that as high as 20 per cent of the 208 PRINCIPLES OF INSURANCE funds of some companies was deposited in banks and trust companies. In some cases the officials of the insurance company were officials or directors of the bank and trust companies. This situation would seem a very natural condition of affairs when it is re- called that the insurance company has large funds to loan and that the bank and trust companies are institu- tions for making loans. This dual relationship, how- ever, often placed the insurance official in a position in which there was a conflict of interests. As an in- surance official, he should desire to secure as much in- terest as possible for the insurance fund. As a bank or trust company official, he would be interested in having the insurance company keep as much cash as possible in the bank or trust company without it bearing interest. Then, too, we shall see that the field of desirable loans for insurance funds is much more restricted than in the case of these other two financial institutions. There is, therefore, a constant temptation to make loans of the less suitable kind. In 1860 a large part of the assets of life insurance companies was in notes, given for premiums. In . 1870 of the seventy-one companies doing Notes and business in Massachusetts there were o cy oans. twen ty_three which did not hold interest bearing securities equal to the reserve value of the outstanding policies. When the panic of 1873 oc- curred, many of these companies failed, partly be- cause these premium notes became worthless and INVESTMENTS AND INTERESTS 209 partly on account of the high and strict reserve val- uations required by some of the state laws. Others reduced the number of premium notes. It is now the practice to collect the premiums, then loan on policyholders' notes up to the reserve value of the policy. A very common method of paying a pre- mium due is for the policyholder to borrow from the company on his policy. This is debited against the policy, and since the loan is based on the reserve value of the policy, there is no such danger as in the earlier plan of premium notes. Loans, of course, are secured on the policy for other purposes than paying the premium. Premium notes are valuable as assets only to the extent that they are covered by the re- serve value of the policy, since the company is re- lieved to this extent of its obligations to the policy- holder. The other questions which arise in connection with loans are (a) to what extent loans on policies are conducive to lapses, and (6) the effect that Danger of they have in requiring the company to Policy Loans, keep on hand a larger amount of cash than would otherwise be necessary, Jbhereby preventing an inter- est accumulation from these uninvested funds. It is true that in the seventies a large number of policy- holders who had given premium notes lapsed, but evidence is not conclusive that the plan of loans now followed is conducive to lapses. It is not so much that they cause lapses, but rather that they often go 210 PRINCIPLES OF INSURANCE far to defeat the purpose of insurance and therefore the ultimate effect is much the same as if the policy- holder had lapsed. The ease with which a loan is secured on a policy is often a great temptation to many policyholders, with the result that the insurance loan is devoted to speculative enterprises. The wife or children or other dependents for whose benefit the insurance is carried sometimes know nothing about these loans, and as a consequence they find in case of the death of the insured that they have less protection than they expected. The companies may or may not make efforts to secure the payment of the loan, but too often the policyholder has not the will to pay it even when he is able to do so. There is no one to compel him to pay it, as is the case with the ordinary loan. The policy loan provision is largely an outgrowth of the strong competition among companies for business, and this provision was writ- ten into the contract as an inducement for the pro- spective purchaser to buy insurance. As to the second point, viz. that the loan feature requires companies to keep a larger amount of cash, Policy Loans it may be stated that these loans place a and Sol- strain on the company at certain times. vency of the r ' Company. That is to say, the demand for loans is greatest in times of industrial depression and in periods of speculation. If the increased demand oc- curs in the first period, the company is likely to be receiving less in cash payments for premiums due, INVESTMENTS AND INTEREST 211 If, therefore, it is forced to sell some of its securities, it will not receive a good price for them, or if it is forced to borrow funds to accommodate its policy- holders under the terms of the contract, the rate of interest which it will be forced to pay is high. If the increased demand comes at times of speculative activity, there is great danger that the investment made by the policyholder from the loan on his policy will be unfortunate and he will therefore be less able to repay the loan as well as the future premiums. During the financial depression of 19J7 many policy- holders took advantage of the loan benefit in their policy and borrowed very large sums in the aggre- gate from the companies. While the companies met these demands with commendable promptness, yet to some of the companies it became a troublesome question. On account of their experience at this time, some of the companies seek to protect them- selves by requiring that a notice shall be given to the company when a loan is desired in much the same manner as is done in the case of depositors in Savings Banks. This restriction will doubtless do much to- protect the company, but it is not an absolute protec- tion against the loan question becoming a serious one. When the loan is made to pay premiums, it is in its least objectionable form. It may be stated as a superficial reply to the whole question of loans that the reserve is the policyholder's property and that he ought to be allowed to use it as he pleases. A 212 PRINCIPLES OF INSURANCE moment's consideration will, however, disclose the fallacy of such a statement, since, carried to its logical conclusions, it would mean that there would be no such a person as a beneficiary. It is above all for such a person or persons that the institution of in- surance was devised. The insurer cannot, from one point of view benefit by his insurance. The signifi- cance of the subject may be inferred from the fact that in 1908 the loans made to policyholders by the Life Insurance Companies in the United States aggre- gated about $400,000,000, or about 13 per cent of the total admitted assets. In 1860 loans on mortgages made up 59 per cent of the assets, but this proportion had decreased to Mortgages 44 per cent in 1870. During the Civil and Bonds. w ar t h e United States bonds could be purchased so as to yield a high rate of interest, and insurance companies very largely followed the prac- tice of investing all their available funds in these bonds. It must be recalled that corporation securi- ties which were later available in such desirable quantities were not to be had to any large extent until in the last quarter of the nineteenth century. When the premium on gold began to decrease and the interest on the United States bonds declined, the insurance companies began to seek mortgage loans. The middle west during the third quarter of the century sought large amounts of capital for the construction of its railways and the general INVESTMENTS AND INTEREST 21:5 development of the region. Interest rates were high and large amounts of insurance funds were invested in the west. Mortgage loans increased rapidly from about 1865 to 1875 and then decreased until about 1885. The panic of 1873 forced the insurance companies to foreclose many of their mortgages, with the result that they found them- selves in possession of considerable real estate. This was a species of property not suitable for pos- session by an insurance company since the expenses of management are not only excessive but these assets are not easily convertible. The real estate investments of an insurance com- pany are usually limited by law to a Home Office building in which to transact its business. Usually the law requires that the property obtained by foreclosure must be sold within two years. We have shown why the company does not want to retain, unless necessary, the second kind of real estate. All companies do not own their office buildings. Many rent office space. However, there was a very marked tendency as the companies grew in size to construct their own office buildings. This policy, it was argued, would be a good advertisement for the company and as a result many of the companies spent profusely for the construction of office buildings. Nor was the policy confined to the large companies. Later investigation showed that in many cases no adequate 214 PRINCIPLES OF INSURANCE financial return was secured on these office buildings and in some cases misappropriation of funds was disclosed by permitting allied trust companies to use parts of the buildings at a nominal rent. Since 1905 the office buildings are showing better returns, and in several cases the branch offices of the larger companies have been sold. Foreign bonds have been purchased only by those companies writing business in foreign countries in Government which the law requires such an invest- Bonds. . merit. The early insurance companies in- vested considerable funds in the bonds of the different states during the period from 1835 to 1855. Many of the states were undertaking vast schemes of in- ternal development, such as the construction of canals, railways, and roads. On account of the de- mands of the rapidly growing states of the middle west and south, state bonds were very numerous. However, some of the states repudiated their debts, and considerable sentiment favored the same policy in other states. This caused the state bonds to be- come unfavorable securities. Since 1865 state bonds have not been numerous. City expenditures began to increase very rapidly after the Civil War, for the rapidly increasing urban population demanded many improvements in the cities. In 1880 about 15 per cent of the insurance companies' assets were invested in city bonds. Some cities attempted to repudiate their debts and in many cases great difficulty was INVESTMENTS AND INTEREST 215 experienced with these investments in city bonds. As a result the insurance companies did not for some time seek these investments. State legislatures either of their own volition or as a result of a re- quest from the cities were continually legislating on the subject of the city tax rate and the power of the city to contract debts. There is a tendency in later years, however, for the companies to seek again this form of a loan, for the security of city bonds has improved. A very great increase in the investments in corpora- tion securities occurred in the last quarter of the nine- teenth century, and especially since 1890. investments Both stock and bonds were purchased, al- ^on s'ecuri"- though the investigations of the insurance ties, business in 1905 resulted in the passage of laws by various states which either wholly prohibited or limited insurance investments in stocks. The objections to investments in stocks are twofold : (a) A stockholder is a participant in the management of the corporation whose stock he holds and manifestly such a function is not desirable for an insurance company. The in- surance company thus becomes more than what the theory underlying its organization assumes that it is. That is to say, it becomes more than a trustee. It becomes a manager or a partner in a private business. (6) In the second place stocks fluctuate greatly in value, thus causing the question of the solvency of the insurance company or its ability to pay dividends 216 PRINCIPLES OF INSURANCE to arise continually with every change in the success of the commercial enterprises in which the funds are invested. The two most fundamental words in the insurance business, the two most pregnant with the purpose and theory of insurance, are certainty and stability. In 1908 the statistics of the ordinary life insurance companies showed that they owned over one billion investments dollars of bonds and almost one billion of in stocks. loans and mortgages. The amount of stocks held was only 1133,000,000. The New York law required, as a result of the investigations, that the companies should dispose of their stocks. This was done on the theory that the holding of stocks would be a continual temptation to the insurance officials to organize and finance new companies from which they as individuals would gain. It was not desirable, so it was argued, for insurance officials to loan money to themselves as officials of other com- mercial corporations. This meant that the insurance funds were to be considered as trust funds, and as such were to be protected by every possible safe- guard in order to insure that the funds should be kept intact even if only a low rate of interest was earned. It is quite true that the net return on stocks is often higher than on bonds, since the inter- est paid on bonds is subject to the fluctuating pur- chasing power of money and the loss falls on the bondholder while in the case of stocks the loss may INVESTMENTS AND INTEREST 217 be recouped by an increase in the selling value of the stock. The following table taken from that valuable source of insurance statistics, the Year Book of the Spectator Company, is given to indicate the present character of the insurance investments. It will be understood that in the case of individual companies the characteristics of the investments differ very widely. For example, one of the older companies of the middle west has had throughout its history a very large part of its assets invested in mortgages on real estate and has been able to receive throughout its history excellent results on this class of investments. The following table shows the approximate distri- bution of the investments of one hundred and sev- enty-three life insurance companies' admitted assets. Total admitted assets Invested in real estate . . Invested in loans and mort- gages Invested in loans . . . Invested in stocks . . . Invested in collateral loans Invested in premium notes Invested in loans to policy holders Cash in office and banks . $3,000,000,000 125,000,000 913,000,000 1,354,000,000 131,000,000 15,000,000 25,000,000 394,000,000 53,000,000 4.04 per cent 29.60 per cent 43.88 per cent 4.24 per cent .48 per cent .79 per cent 12.76 per cent 1.73 per cent Let us now examine the rate of interest which the companies assumed they would earn and then inves- tigate the actual rates of interest earned. In the 218 PRINCIPLES OF INSURANCE earlier practice of insurance the ordinary life policy was most generally written and the average rate of interest earned was not so important as Assumed * interest when endowment and limited payment policies came to be written, because these early policies had no provisions for cash surrender and loan values or annual dividends, and a failure to pay premiums usually forfeited the policy. There were considerable gains from lapses. When state super- vision began in the fifties, some rate of interest earn- ings had to be assumed in order to value the policies. Elizur Wright, the insurance commissioner of Massa- chusetts secured the passage of a law in that state in 1857 which required the companies to assume a 4 per cent interest earning as a basis of computing their liabilities. Georgia established the same basis in 1859, but no other state adopted a basis until after the Civil War. The action of these states had, how- ever, caused most of the companies to adopt the 4 per cent basis of valuation. In 1862 eleven of the seventeen companies doing a level premium business were on a 4 per cent basis, three on a 5 per cent ba- sis and one on a 6 per cent basis. The high interest rates of the Civil War period caused New York in 1866, to pass a law requiring a 5 per cent basis, but this was lowered to 4J per cent two years later. In 1873 Maine, New Hampshire, Connecticut, and Illi- nois required a 4 per cent basis and fifteen other states required a 4J per cent basis. The hard times INVESTMENTS AND INTEREST 219 of this period caused a decided tendency to assume a 4 per cent basis, but very few insurance officials thought that a lower rate would be necessary for some years. The Connecticut Mutual Company an- nounced, to the surprise of the insurance world, that beginning with 1882 its new business would be writ- ten on a 3J per cent basis, but no state required a 3J per cent basis before January 1, 1901. At the pres- ent time practically all business is written either on a 3J per cent or 3 per cent basis. Such has been the history of the different rates of interest earning assumed. What has been the his- tory of the actual interest rate earned ? Actual Inter- In 1859 seven level premium companies e st Earnings. were earning from 5.4 per cent to 6.4 per cent. In 1861 eleven companies earned a rate below 6 per cent, but on account of the high interest rates of the Civil War period the decade from 1860 to 1870 shows the highest rate of earning of any decade in the his- tory of insurance. Eleven companies earned above 10 per cent, seventeen earned between 9 per cent and 10 per cent, twenty-four between 8 per cent and 9 per cent, thirty-seven between 7 per cent and 8 per cent, and forty between 6 per cent and 7 per cent. On account of the hard times, the large number of premium notes and other minor contributing causes, many companies failed in the decade 1870 to 1880, although the average earning of all companies was above 6| per cent. This resulted, however, from the 220 PRINCIPLES OF INSURANCE very high earnings of a few companies. After 1880 the decline in average earnings began and no com- pany maintained a level earning of 6 per cent. Dur- ing the decade 1890 to 1900 the average rate of earnings for most companies was below 6 per cent. Only two companies maintained a level rate of 5 per cent. During the years 1899 to 1908 inclusive, the average rate of interest earned by the twenty-five leading companies was 4.68 per cent. The earnings on particular classes of investments may be briefly described. The earnings on real . estate were fair during the sixties but Earnings on specified decreased during the next decade. In the decade from 1890 to 1900 the earnings on real estate were on an average below 3 per cent in many of the companies. During the latter part of the decade from 1900 to 1910 the earnings on real estate have greatly improved as a result of the great increase in real estate values. The laws of some states do not permit insurance companies to hold real estate except for office building purposes. Dur- ing the years from 1860 to 1880 the earnings on mortgage loans were in general very satisfactory, but during the next two decades the earnings on loans of this character were much less. A few companies have been able to secure almost continuously satis- factory results from mortgage loans. We have previously described why the investment in govern- ment bonds brought high returns during Civil War INVESTMENTS AND INTEREST 221 times and why the insurance companies tended to reduce their investments in these securities. In the last quarter of the nineteenth century very large investments were made in the stocks of railroad and industrial corporations, but for the reasons already stated the investments in stock have been so reduced that in 1908 only 4.61 per cent of the total assets of the one hundred and fifty-seven life companies was invested in stocks. The laws of the states restrict the kinds of invest- ments open to insurance companies. No specific rules can be laid down for the investment principles of insurance funds, which will be applicable governing . Investments to all companies or even to a single com- f insurance pany at all times. It is a matter which Funds - must be adjusted to suit the changing conditions of the investment market. Those in charge of the finances of insurance companies must regard not only the interest of present policyholders, but must also anticipate the interest of the policyholders of the future. Subject to certain special conditions the following principles may be stated as applying to the investment of insurance funds : (a) The funds should be so invested that they will be subject to the least possible fluctuations in their value. Stable results for obvious reasons must be secured. (5) Subject to the above limitation the investments should be such as will bring the highest possible returns, for this means lower cost of insurance to the 222 PRINCIPLES OF INSURANCE policyholder from whom the funds have been collected. (\ those who receive mod- nary Life v - / Policy. erate but certain incomes during the productive years of their lives and who have large family obligations. They are able on account of the low premium to carry a large amount of insurance during the period of dependency of the children and beyond this period the premiums may either be paid in part by the children or the policies surrendered or changed to paid up insurance, assuming that the policyholder is not financially able to keep up the INVESTMENTS AND INTEREST 227 payments. The ordinary life policy of a present-day insurance company has so many privileges in the contract and is so excellent as to its general character that it is a great misfortune, both to the public and the insurance business, that it is not more frequently sold. There is some evidence, however, that this policy will become more popular, as the public and the insurance officials become divorced from the idea that insurance is an investment. The limited payment life policies commend them- selves to those individuals who desire their premium payment period to be confined well within Advantages their productive years. This policy will ofthe r J . Limited appeal to the young man who is uncertain Payment of an income after a given period or who cies * does not wish insurance to be a part of his annual expenses after middle life. Out of the relatively large and certain income of his early productive years, he pays for his insurance. He has the satisfaction of realizing that he has purchased and paid for the pro- tection which his family has a right to expect from him. This policy is also often selected by the man of middle age who has previously neglected to pur- chase protection, but who wishes then to buy it and pay for it while he is yet a producer. The ordinary life policy premium may cause an undue pressure on the decreasing income of his declining productivity. The length of the premium paying period, that is, whether a 10, 15, 20 or 30 year life payment policy 228 PRINCIPLES OF INSURANCE is selected, will be determined by the prospect of his years of productivity. The man of 45 years of age can purchase a ten payment policy and thus complete his payments well within his productive years. The young man of 25 years of age, receiving a salary which will probably decrease rapidly after 45, can purchase a twenty payment policy at a rate not greatly in excess of the ordinary life policy premium and complete his payments before his salary decreases. The endowment policies commend themselves to those who desire to have in addition to the protection Advantages a material incentive to save. The pre- of the En- miums are considerably higher than those in dowment J Policies. the other policies for the reasons discussed in a previous chapter. They not only afford a means of saving for the young man or woman, but they also mature at a time when the individual, as a result of his larger business experience, is often better able to make profitable investments of large funds. If past investments have been wisely made from other sav- ings and the individual does not need the face of the policy for current use, he may purchase a considerable amount of paid up insurance because his insurance premiums have been large. Again this policy has larger loan values than any other policy, and this sometimes becomes an advantage for the young person. The argument that the individual could secure a better return if he would invest his savings in a sav- ings institution, organized for that purpose, is more INVESTMENTS AND INTEREST 229 interesting than true, for the average individual will not save regularly unless under pressure. No one compels him to go to the savings bank to make his deposits and no one prevents him from withdrawing them at his pleasure. The term policy can be recommended only as a temporary expedient. It is no cheaper than any other form of insurance, but since the im- . a Advantages mediate outlay is small, it commends itself of the Term to those who incur temporary obligations or to the man with the family whose present financial condition will not permit of larger outlays for insur- ance, but whose financial condition in the near future will permit a transfer to one of the other kinds of policies. After deciding the kind of a policy which he needs, the prospective purchaser must select a company, and this is a selection which is doubtless made selecting a with the least intelligence because the Company, average person does not know how to compare com- panies and the average insurance agent does not make a practice of advertising the good points of companies other than the one whose policies he sells. The prospective purchaser should examine the annual reports of the companies, the annual statements made to his state insurance department and the gain and loss exhibit, if the latter is available. From these sources he will secure information on the fol- lowing subjects : (a) The character of the investments, 230 PRINCIPLES OF INSURANCE that is, in what manner the insurance funds are secured and what they are earning ; (5) the liabilities of the company and the relation of the assets to it ; (c) the expenses, that is, how much money is being spent to maintain the company a going concern and how much money is spent to secure new business; (c?) the ratio of actual to calculated mortality ; (e) the number of lapses; (/) the amount of the surplus and the manner of its division, that is, how much is retained, how much is paid to policyholders as dividends, and how much to stockholders, if it is a stock company. It will also be advisable for the intending purchaser to ask the companies in which he is interested or the agents to supply him with a statement of the Com^an/by dividends paid on policies of the kind its Divi- which he desires. This statement should dends. show the dividends paid for the past several years, for manifestly one year's dividends are not sufficient to determine a fair judgment. He will not lay too much stress on dividends as a crite- rion for comparing companies because a good policy has many other important characteristics besides good dividends. If the purchaser is seeking to com- pare participating with nonparticipating policies, he will need to be careful, lest he make false conclusions in regard to apparent cheapness. The dividend scale on the particular policy of the participating company will aid in comparison. That is, he can INVESTMENTS AND INTEREST 231 deduct it from the premium and compare the result with the premium of the nonparticipating company. However, this is not conclusive proof. He must ask himself what return he could secure for himself on these small annual sums which represent dividends paid to him by the participating company or not collected from him by the nonparticipating company. He must understand that the nonparticipating premium includes a loading, but not the same degree of loading as does the participating premium. Possibly some participating company can secure for him accumula- tions which in the end will make his participating policy quite as cheap as his nonparticipating policy. It is not sought in these statements to make any claims of advantages for either one or the other kind of policy, but rather to encourage the purchaser to make a careful investigation in order that he may secure that policy which is best suited to his needs. After the prospective purchaser has informed himself on these points, he will then make a compari- son of the terms of the contract of different comparing companies. This problem has been solved the Contract, in part for him by the enactment of the standard provision laws which require all policies to contain certain provisions, which have been discussed in a pre- vious chapter. There remains, however, some points of difference in the policies of different companies. He will examine the options in settlement, both upon maturing and lapsing the policy; the restrictions of the 232 PRINCIPLES OF INSURANCE policies ; the terms or conditions of loans ; the freedom with which he may change to other forms of policies and change the beneficiary. He will also examine the guaranteed values, if any, on the different policies. He may also give some weight to the character of the representatives of the companies who solicit his insurance, for a good insurance company will not knowingly keep in its employment a dishonest rep- resentative. After he has made all these examinations and comparisons, the purchaser of insurance should complete the task by acquainting himself thoroughly with the terms of his contract. Every sentence deserves careful study, and he owes it to himself, his family, and society to make himself an intelligent holder of insurance in order that he may fulfill his part of the contract, secure the protection for his family, and become an interpreter to and missionary for the uninsured. REFERENCES Zartman, Lester. The Investments of Life Insurance Compa- nies. Annals American Academy of Political Science. Vol. XXVI, pp. 256-268. Dawson, Miles M. The Business of Life Insurance. Chap. XXVII. Graham, W. J. The Romance of Life Insurance. Chap. XI. CHAPTER X THE RELATION OF THE STATE TO INSURANCE We have seen from the previous description of the character of insurance and the methods of its sale that it is a business which must concern it- The Theory self with large numbers of individuals, It f the , s * te Regulation demands an agreement between sellers and of insurance, buyers of a valuable thing indemnity in which the terms of the sale are frequently misunderstood. It demands the association of individuals in order to secure a thing which no one could secure for himself. It is a cooperation among many in which a general interest is present, but in which also an individual or a group of individuals may seek to benefit at the ex- pense of the many. The contracts which are made run for long periods of time and the settlements for which they provide cannot be enforced in most cases by the original party to the contract, but must rest either upon the good faith of the other party or upon the compulsion of a third party the state. Since the obligations of an insurance company are chiefly in the future, errors due to ignorance or dis- honesty do not immediately disclose themselves. The policyholder cannot usually withdraw without loss to himself. The business of insurance, both on 233 234 PRINCIPLES OF INSURANCE account of the difficulty in comprehending the prin- ciples underlying it and also on account of the com- plexity of its actual transaction, is such that the average policyholder cannot determine for himself the soundness of the company. Even if he should discover evils in its operation, he usually neither knows how to correct them nor how to protect him- self. The business of insurance is almost wholly conducted with the funds of the policyholder who receives for his payments a simple promise to pay a sum at some future time. There would therefore seem to be good reasons for the activity of the state in order that the principles of justness and equity may be preserved. The state should not only protect the weak against the unjust activity of the strong, but it should also prohibit large numbers of its citizens from doing an injury to themselves. In this last mentioned capacity, it should, for example, prohibit a group of individuals from organizing themselves into a body to do a thing which past experience has shown to be impossible. The state is particularly interested in compelling contracts to be carried out and since the insurance contract in- volves rights and benefits beyond the lifetime of one party to the contract, it finds an important sphere of action in the insurance business. It is also inevitable when a business has to do with so many persons, as does insurance, that some of these persons will at times attempt to practice fraud on the group, and this RELATION OF THE STATE TO INSURANCE 235 practice the state must seek to prohibit. Although insurance is a business in which many are necessarily interested, its very character precludes the many| from having any direct part in the actual conduct of\ the business, and it is therefore incumbent upon the state to do what it can to protect the many against the possible carelessness, ignorance, or dishonesty of some officials of the companies. It is coming to be more clearly recognized that the state amidst the present-day complexity of commer- cial activities and the intricacies of modern business organization cannot depend upon publicity and com- petition to secure protection to its citizens. If pub- licity simply means informing the public of what an organization is doing, the state defaults its duty to its citizens by this negative approval of the thing done and leaves in many cases but an incomplete means of redress, and in other cases none to its citizens. While the old recipe of competition has secured some very good results in the insurance business, especially in the liberalizing of the policy contract, yet it has failed in many other respects. Indeed, the excessive competition for business among some companies has led to extravagant expenditures, discriminations, and other well-marked evils until we have felt the need of protection against the evils of competition rather than incentives to greater competition. Since the state is responsible for the existence of corporations and since the rights granted to insurance 236 PRINCIPLES OF INSURANCE corporations lead to the creation of trust funds, it follows that the state must see to it that these sacred obligations are met by the creature which it has called into existence the corporation. At the time of the adoption of the Constitution and for many years later, the general principle of little government interference in industry was followed. Few evils, so far as insurance was concerned, resulted, for, as we have seen, little of insurance was transacted until after 183,5. Whatever supervision there was of the insurance business was at first primarily for the purpose of ob- Character of taining a basis for raising revenue, and tioVbefore" tms ' ** ma y ^ e a dded, * s st ^ an important 1855- reason for supervision. In the licensing of companies and the prevention of fraudulent com- panies from operating within a state, the interest of policyholders was probably of secondary importance. In time, however, as the business grew in size and complexity, there was a growing realization that the state must take a more active part in regulating a business which affected so large a number of people. In addition, there had been organized many compa- nies of a fraudulent character between the years 1825 and 1850 or, if not fraudulent, organizations which operated upon the unscientific plan of assessmentism. The evils which resulted from the operation of these companies were probably the most direct cause for the demand to arise, that the business of insurance RELATION OF THE STATE TO INSURANCE 237 be more closely supervised by the state. Previous to 1855 the state had been satisfied to lay down in general laws the terms under which an insurance company could be organized and operated. No de- tailed reports were required to be filed and no re- serves to be maintained. Massachusetts was the first state to establish a state insurance department. This was done in 1855, and the action of Massachusetts was fol- E Stablish _ lowed by New York in 1859, by Connecti- ment of state cut in 1865, by Ohio in 1867, and by ofinsur- Michigan in 1871. Every state in the ance * Union now supervises the insurance business, although in some states the department is only a separate bureau under the direction of some other department of state. Where there is no separate department, the work is usually placed under the charge of the auditor, treasurer, or secretary of state. The departments or bureaus are supported by fees and taxes collected from the insurance companies, but the amount of funds collected bears no definite rela- tion to the cost of maintaining the department. Although Massachusetts established her insurance department in 1855, no standards of solvency were required until 1861.. No other state es- How the tablished such standards until after the S1 *te Regu- lates Insur- Civil War. The state regulates the busi- ance. ness of insurance in general in two ways : (a) by laws governing the organization of companies ; (6) 238 PRINCIPLES OF INSURANCE by laws governing the operation of companies. Again the difficult task confronts us of making statements which will be true in the different states, for whatever supervision there is results directly from the action of each of the state legislatures. In addition to the general laws governing the or- ganization of corporations, there are in most states Regulations special laws which govern the organization in respect to f i nsurance companies. The terms under organizing Companies. which such companies can be organized differ according to the character of the organization, such, for example, as the special laws governing the organization of a fraternal society or the ordinary level premium life insurance company. Since the latter companies do the greatest amount of the busi- ness and also are the ones to which regulation is chiefly directed, our description of the regulation of the organization and operation of insurance companies may be taken as applicable to this kind of a company. A very general requirement for such corporations is that they must deposit with the treasurer of state securities to the value at least of $100,000. This is a requirement for both stock and mutual companies proposing to insure lives on the level premium plan. Massachusetts made this requirement of the New England Mutual, which was organized in 1835, twenty years before her state insurance department was established. In some states there is a provision requiring the fiELATIOtf OF THE STATE TO INSURANCE 239 retirement of the stock of the proposed mutual com- pany with a maximum interest paid upon the funds which have been advanced by the incorporators of the company as a necessary capital to pay the large initial expenses of starting the company in business. The laws governing the organizations of com- panies differ, of course, in the various states, but the general purpose in all cases is to lay down such principles, as will insure the ability of the compa- nies to meet their obligations. The value of a deposit as a guarantee fund after the company is a going concern is very questionable, since the company is setting aside a reserve and probably a surplus. If the assets of a company are carefully inspected and the transactions of the company supervised, this would seem to give all the required safety, so far as solvency is concerned. If a company organized in one state desires to do business in another state, it must comply with the conditions laid down by the state which Lawsgov- it enters. Insurance is not commerce, erning Com- panies doing according to the decision of the Supreme Business in Court and the various states may lay the Home down in detail the conditions under which State - a company is permitted to do business. They must satisfy the authorities of the state that they are able to meet their obligations. A copy of the charter granted by the parent state, as well as a certificate showing that it is authorized to do busi- 240 PRINCIPLES OF INSURANCE ness, is filed ; also a statement of its financial condition showing income, disbursements, and a certificate showing that it has deposited with the offi- cials of the home state a deposit, usually a minimum one of 1100,000. It also files the valuation of its policies made by the insurance department of the home state and a copy of all the policies which it proposes to write. Its agents appointed or to be appointed must secure a license from the proper authority. Other information bearing upon the character of the company and its methods of oper- ation is secured by the proper state authority, usually the state insurance commissioner. If all this information seems to satisfy the state laws, the company is admitted by a certificate from the commissioner of insurance to do business in the state. The admitted company is then subject in its operation to the laws of the state on insurance. Some states entrust very large powers to the commissioner of insurance, while others lay down in statute law in detail the requirements for transacting the insur- ance business and require the commissioner to exe- cute these laws with little discretionary powers. In either case the courts of the state can restrain the officials from violating the principles of equity. In most states the certificate of the commissioner of insurance regarding the condition of the company is accepted in other states, but an examination of a foreign company can be made at any time and RELATION OF THE STATE TO INSURANCE 241 such examinations, although not infrequent in the past, are becoming less frequent. One of the most important committees of the National , , r Examination Association of Insurance Commissioners ofCom- is the committee on examinations. This pames * committee acts as a clearing house of informa- tion for the various state departments of insurance. It has already done away with some of the evils connected with the numerous and sometimes un- necessary examinations made by numerous states. The examinations made by this committee are ac- cepted in many cases by the state departments, al- though, of course, any state has the right to conduct a separate examination. The examinations made by this committee and used by the various state de- partments does not refer to the annual examinations, but to those comprehensive examinations of a com- pany's business which are made from time to time, especially when suspicion arises concerning the con- duct of a company's affairs. Such examinations would naturally be of companies doing business in several states at the particular time. Independent of these special examinations each state makes an examination of its own companies. In some states this examination is required every year ; in other states every two or three years. This annual, biennial, or triennial examination by the state department ordinarily concerns itself with an examination of the transactions of the company 242 PRINCIPLES OF INSURANCE during the preceding calendar year. The exam- iners take the last annual report and verify it. The items of income and disbursement are checked from the company's books. The assets are inspected ; all mortgages are inspected as to title and their propor^ tion to the value of the property ; the cash in office and banks is checked ; and care is exercised to dis- cover any weakness or any statutory violations of the investments. The liabilities must also be carefully investigated. The principle of state comity applies in many particulars, but it has far from accomplished com- plete uniformity. The National Associa- in insurance tion of Insurance Commissioners has done much in establishing uniformity in certain directions, such, for example, as providing uniform blanks upon which a company reports its condition to the insurance department. In many other cases, especially taxation, no uniformity is found. It is also generally true that home companies are favored over those of other states in one way and another. A favorite method is by a lower rate of taxation or no taxation at all on premium receipts. The state has laid down certain standards of solvency by requiring the use of one of the accepted mortality tables and the valuation of Laws gov- J erning Sol- policies must be made according to that table with interest at 3 per cent or 2>\ per cent. In determining the reserve liability of a life RELATION OF THE STATE TO INSURANCE 243 insurance company the state insurance department generally uses mean or midyear reserves on the assumption that policies issued uniformly throughout the year are all, on the average, issued July 1 of that year, and hence when the valuation of a com- pany's policies are made, as of December 31 of any year, the policies are all at their midyear. The mid- year, or mean reserves are obtained by taking the half sum of the reserves at the beginning and end of each year on the assumption that a full annual pre- mium is paid on every policy. Consequently de- ferred premiums to complete a full policy year are allowed in the assets. In industrial insurance the mean reserves just referred to are reduced by one half a net annual premium for a given kind and age, and deferred premiums are not allowed in the assets. On account of the heavy lapses in industrial insurance some reduction is usually made on first year reserves about one half and on second year reserves about one quarter. The chief difference of opinion as to the proper methods of determining solvency has arisen in connection with the valuation of first year busi- ness. New York uses the select and ultimate method ; that is, it assumes 50 per cent of the ex- pected mortality will result on first year's business, 65 per cent on the second, 75 per cent on the third, 85 per cent on the fourth, and 95 per cent on the fifth. This assumption permits mortality gains to 244 PRINCIPLES OF INSURANCE be used for expenses. In other states the pre- liminary term or modified preliminary valuations are used. The latter plan views the first year of insurance as term insurance or part term insurance, thus also setting free a large part of the premium for the large expenses connected with writing the policy. In valuing assets certain rules are laid down for valuing stocks and bonds. The market value on December 31 has generally been used, but in the last two or three years the amortization plan has been adopted, by which the values do not fluctuate with the market, but increase or decrease uniformly to par value so as to yield the same effective rate of interest throughout the period. Home Office build- ings and real estate owned by the company are valued by the local appraisers who know the value of the property. A requirement of many states is that a company is not permitted to write both participating and non- participating policies or, if, both kinds are tory Re- written, it is required that they be kept qmremens. se p ara e j n ne bookkeeping of the com- pany. The tendency is for stock companies to write nonparticipating policies and mutal companies to write participating policies. It was urged that the evidence in the insurance investigation beginning in 1905 showed that in actual practice the equity of each kind of policyholders was not observed. Annual distribution of dividends is a very general RELATION OF THE STATE TO INSURANCE 245 requirement. Standard provisions are required in all policies. These have to do with cash surrender values, options in settlement, loans, lapses, payment of premiums, and claims and many other subjects which are of general interest to all possessors of an insurance policy. As a result of the investigation, New York re- quired a standard policy, but after two years' ex- perience with it, the law was changed to require standard provisions in policies. The subject of investments is one upon which there has been a great amount of legislation. Not only has the state prohibited certain kinds of investments, as, for example, the permanent possession of real estate, but it has further limited them by specifying in what kind of securities the assets can be invested. This kind of regulation was adopted in many states before the establishment of the insurance departments, since the importance of having these funds securely in- vested was early recognized. The first restrictions were chiefly applicable to the original deposit, but by 1875 a number of states had restricted the invest- ments of the general assets. At present the restric- tions as to the character of the securities differ con- siderably in the different states. In all states invest- ments in government bonds are permitted, although a few states limit the investment in bonds of other than the home state. Some confine mortgage loans to the home state of the company. Most of the 246 PRINCIPLES OF INSURANCE states very carefully restrict the investments in cor- poration securities. New York prohibits all com- panies doing business in the state from investing in corporation stocks. Ohio follows the same practice. In the latter state, state and local government bonds cannot be purchased when their market value is less than 80 per cent of their par value. We may summarize the regulations regarding in- vestments as follows: (a) The tendency to prohibit the investments in real estate except for Home Office Buildings is marked, but more liberality is made in regard to loans on real estate ; (b) more liberal pro- visions regarding the investment in public securities and stricter regulations of the investments in cor- poration securities is the general rule. Some states, notably Texas, have shown a decided disposition to require a large amount of the reserve funds on policies to be invested in the Investments x of Reserves securities of the state. Texas has not, m however, been alone in the effort to make a market for the securities of the state, for almost all the early charters showed a tendency to confine the investments to the home state. So far as the legis- lation had for its purpose the protection of the funds by making possible a better knowledge of their actual value, there was some justification for the policy in the early days, when correct estimation of the value of securities could not be easily made. So far as the legislation has for its purpose the keeping of money RELATION OF THE STATE TO INSURANCE 247 within the state, it was more than questionable, for if the securities purchased must have a market made for them, this fact was at least presumptive evidence that these securities might not be desirable ones for an insurance company. The purpose of regulating the investments of in- surance has been to limit the investments to such securities as will bear the inspection of the public and guarantee the security. of the funds. There are many who think that the restrictions are too severe and that a wide range of investments should be per- mitted under the supervision of the insurance depart- ments. But the element of risk is so frequently present in corporation securities and the public de- mand is so insistent, and rightly so, for security as the first test of an insurance investment, that notwith- standing the greater return to be often procured from corporation securities, there is no immediate prospect that the field of investments will be widely extended. Certain regulations have been attempted in regard to the remuneration of officials and agents. Some states have established a maximum salary _ , . J Salaries and to be paid to the president and maximum Commis- commissions to agents and especially the amount of renewal commission to be paid, that is, the amount paid to the agent on premiums subsequent to the first. Most of the states have laws prohibiting rebating, that is, the reduction by the agent to the purchaser 248 PRINCIPLES OF INSURANCE of the first premium ; in most cases the penalties imposed apply only to the agent giving the rebate. There is a tendency in some quarters to Rebating. . J . . / , punish both the recipient and giver of a rebate. No company or its employees are permitted in most states to issue any estimate misrepresenting the terms of any policy issued by it or the benefits or advantages promised. New York also established a limitation on the amount of new business which could be written in any New Busi- one year. This limit is decreasing in its ness. percentage with the increase in the amount of business on the books of the company. The New York law also limits the amount of the contingent reserve or surplus which can be held by a company. All the states require annual reports to be made to a state department by each company doing business Annual Re- i Q the state. While the regulations on wrts. this subject differ somewhat in the different states, there is a tendency to secure uniformity in these reports, as a result of the activities of the Na- tional Association of Insurance Commissioners, which has a permanent committee on blanks that has drawn up uniform blanks, upon which the different kinds of insurance companies report. These blanks are re- vised from year to year as new laws or experience may necessitate. The chief items of information found in these reports are as follows : first year's pre- miums, renewal premiums, interest, and rents, which RELATION OF THE STATE TO INSURANCE 249 comprise the source of income ; the amount paid for losses and matured endowments, annuities, divi- dends, salaries, taxes, and expenses, which make up the chief disbursements ; various schedules, such as the schedule showing the dividends paid on different kinds and classes of policies and the schedule showing the character of the investments. Other parts of the report show the condition of the reserve, surplus, the assets, and liabilities of all kinds. The report as a whole gives to the public an analysis of the financial condition and the status of the company, as well as information about commissions, medical ex- aminations, advertising, taxes, legal expenses, lapses, the surplus, reserve, and other items, which will give to the public a knowledge of the transactions of the company. There is a very marked tendency to require the reports to be made in greater detail. The subject of taxation is one to which the com- panies have most consistently and continuously ob- jected. These objections are based upon x^. V . Taxation. two grounds ; First, it is argued, that in- surance is not a proper source of revenue for the state, and second, that there is no uniformity in the tax in the different states. It is argued that insurance is not productive ; that it does not lead directly to the creation of wealth, but on the contrary aids greatly in the more equal distribution of wealth ; that it is a fund set aside from income to care for those de- pendent upon the producer and thus relieves the state 250 PRINCIPLES OF INSURANCE from supporting some who otherwise would either become subject to their charity or would, through lack of adequate preparation, be inefficient producers and citizens ; that the insurance policy is not a form of income bearing property ; that the premiums are a form of a self-imposed tax. It is urged that the policyholder must in the end bear the tax in the form of a higher premium, and thus the tax acts to discourage insurance by increas- ing its cost. That whatever of funds are collected from policyholders are so invested that they either bear a tax by their investment in real estate loans or aid the treasury of the state, if they are invested in state or local government securities. At the farthest those who object to taxation of insurance receipts would permit only such a tax as would support the insurance department of the state, that is, an inspec- tion tax or fee. The taxes are usually levied on the gross premium receipts derived from the policyholders in the state, but in addition there is sometimes a state license tax, a charge for filing the annual statement, agent licenses, and a city and county tax on premiums. The last name is a peculiarity of the taxes of several of the southern states. The home companies are frequently exempted from paying some of these taxes, but this practice does not often accomplish the purpose intended, that is, it does not give preference to home companies, be- cause most of the states have a retaliatory law which RELATION OF THE STATE TO INSURANCE 251 is automatic in its operation. An Ohio company, for example, although exempt from taxes on its premium receipts in Ohio, must pay taxes in other states where it does business, because the home companies of those other states must pay premium taxes in Ohio, if they do business in Ohio. The state tax on gross premiums, although in a few cases it is on the net receipts, varies from 1 per cent to 3 per cent. The amount collected by the states in the form of licenses, fees, fines, and taxes exclud- ing taxes on real estate owned from ordinary life and industrial companies in 1909 was $9,708,241. This was 2.4 per cent of the total premium receipts of these companies during that year. It has been urged that the tax should be added to the premiums charged in each state and therefore assessed upon those policyholders whose state exacts the tax. What- ever theoretical justification this plan has as a matter of equity, it is practically impossible, since among other difficulties it would involve different rate books, policies, and reports for the different states, and add enormously to the bookkeeping work of the company and doubtless would be a violation of the antidis- crimination statutes of some states. The reasons for the existence of the tax are not difficult to understand. The legislator in a democ- racy is constantly seeking revenue from sources from which objections will not be made. The large ac- cumulations of funds by the insurance companies can 252 PRINCIPLES OF INSURANCE be used without great popular objection. Notwith- standing that these funds are chiefly liabilities for obligations already incurred, they afford a ready source of revenue. The real owners of these funds the policyholders do not often perceive the bur- dens, since they are very numerous and the amount borne by each is very small. The availability of the funds for taxation and the absence of any great popular objection to the tax would therefore seem to be the chief reason for the tax. It is easy to get and therefore is taken without much consideration of the equity of the taking. From insurance officials and many students of in- surance a demand has arisen for the federal regulation a . of insurance. This can be accomplished Federal ver- * sus state either by an amendment to the constitution egua on. or ^ securing a reversal of the decision of the Supreme Court in the case of Paul v. Virginia, in which the court decided that insurance was not commerce and therefore not subject to the regulation of Congress. We may briefly summarize the reasons for this demand for federal regulation : First, the busi- ness has become interstate in its character, for no im- portant company confines its activities to a single state. By entering a number of states, it secures a wider distribution of its risk on lives as well as on its investments and thus is likely to secure better average results. Second, the very general absence of uniformity in the regulations of the different states RELATION OF THE STATE TO INSURANCE 253 which makes more difficult and expensive the trans- action of the business. Third, the heavy burden placed on the business in the form of taxes and the lack of uniformity in these taxes. Fourth, the dif- ference in the state laws governing the making and construing of the contract, and the limitation placed upon the judicial rights of the company. At least fifteen states have enacted a law which either prohibits or very greatly restricts the right of a company to remove a case from the state to the fed- eral courts. In case the company does remove the case, the insurance commissioner is given the right to revoke its certificate to do business in the state. Fifth, the preference of home companies over com- panies of other states. Sixth, the failure of publicity and regulation under state laws to accomplish their purpose. Publicity as it is now provided cannot protect the policyholder in many respects. Many policyholders cannot analyze the reports of companies sufficiently to determine their conduct and even many more policyholders are not sufficiently interested to make the attempt. Much greater positive protection could be secured by enforcing responsibility upon the trus- tees of insurance companies, by making them liable for the acts of officials whom they are chosen to di- rect. Seventh, the character of the insurance de- partment officials in the states. In a number of states this official is elected by the people or by the 254 PRINCIPLES OF INSURANCE legislature and in other states appointed by the gov- ernor. In either case, it is argued that his election or appointment is likely to be a proof of the ability of the official as a politician rather than an indication of his ability to perform the duty of this office which requires considerable knowledge of a technical char- acter. It is doubtless true that the office has been the tool of politics too frequently, but within the last decade there has been a marked improvement in the personnel of the state insurance commissioner. The office is, however, usually of too uncertain tenure for a commissioner to accomplish very much in a constructive way, even if he is an able one. After an official has been in office long enough to learn the business, he is likely to be replaced by another member of his political party or some one from the opposing political party. However, much of the work has become so technical that the clerical force cannot be immediately changed with every change in the chief officials, and this fact largely explains why the state supervision has been as effi- cient as it has been. Notwithstanding the many valid objections against state regulation of the insurance business, it is not probable that we are soon to have federal regulation. This is not to be explained by the difficulty of secur- ing an amendment to the constitution nor on the ground that the Supreme Court is not likely to re- verse itself. It is primarily due to the fact that the RELATION OF THE STATE TO INSURANCE 255 states have no desire to give up its regulation. They would resist any attempt to transfer its regulation to the federal government. It is too important a source of revenue for the states and^too majiy oppor- tunities are present to benefit the people of one state apparently at the expense of another state by secur- ing from foreign companies large revenues. The people at large have not yet a sufficient understand- ing of the character of insurance to perceive its so- cial significance and to comprehend that it is a business of general rather than local interest. REFERENCES Publication of American Economic Association. Third Series, Vol. VIII, pp. 137-204. Vol. X, No. 4. Yale Readings in Insurance. Vol. I, Chaps. XXIII, XXIV. Dryden, John F. Life Insurance and Other Subjects. Chaps. IX, X. Wolfe, S. H. The Examination of Life Insurance Companies. Report of the Joint Committee of the Senate and Assembly of New York to investigate Insurance, 1906. The Insurance Year Book, 1910, pp. 33-114. Published by the Spectator Company. CHAPTER XI INSURANCE FOR THE WAGE EARNERS We shall include under the discussion of indus- trial insurance a description of the industrial insur- Protection ance sold by the private companies Working organized for that purpose, the various Classes. plans of workingman's insurance, the employer's liability insurance, the old age pension plans and state insurance. Our chief purpose is to describe the principal means employed to secure protection for the wage-earning class. In addition to the above enumerated plans it must be understood that such work of protection is carried on by local relief societies of many descriptions, by fraternal societies, and by trade-unions. These methods are usually so simple and well known that they do not demand a detailed discussion. It is also true that ordinary life insurance is carried by many of the wage-earning class. The term " wage-earning class " may be a somewhat indefinite one, but the phrases "laboring class" and "industrial insurance" have to most minds definite significance, and in the business of insurance there have been developed particular forms of insurance to serve the wage-earning class. 256 INSURANCE FOR THE WAGE EARNERS 257 Industrial insurance may be supplied in the follow- ing ways : (a) By private stock companies organized for profit. (>) By private mutual companies. (000,000 and the loss payments insurance, for the year about .$10,000,000. The ex- pense of conducting such insurance is large, for in addition to the ordinary expenses of an insurance company, such as soliciting the insurance and office expenditures, the expenses of inspection and settle- ment are very much larger than in an ordinary company. The very numerous changes which are being made by legislatures and courts in reference to the relation of employer and employee are produc- ing very great changes in this form of insurance. Policies are being changed to comply with the new conditions. There are many objections to the compensation of workmen under the law of negligence, but the most Objections important objection is that in the actual to Em- working of the principle, the workmen Liability receive a small part of the sum paid by Insurance. tne em pl over f or sucn purpose. The New York employer's liability commission states in its report of 1910 that the statistics collected from INSURANCE FOR THE WAGE EARNERS 277 nine insurance companies which keep separate employer's liability records show that on an average only 36.34 per cent of what the employer pays in premiums for liability insurance goes to the injured workmen. That is, for every $100 paid by the employer for protection, less than $37 is paid to his injured workman. The $63 is paid to attorneys, claim agents, and for the cost of soliciting the busi- ness and for administration. It must be understood that this contract of insurance covers only the legal liability of the em- ployer to his employee and not the moral obligation which either the employer or of the society owes to the workingman. Then, too, as we have seen, this form of insurance has not been applied to some plants and scarcely at all to some industries, such as the agricultural industry. It must be evident, therefore, that great numbers of the industrial classes are not now protected from the risks inevitably associated with their employment and which they must accept because they must sell their product labor ; and in contrast with all other products the seller the workman must deliver himself with his product. The purpose of the changes now being made is to increase the protection to the working class, and the final result will probably be to lay down a broad policy of workingman's compensation under which he will be protected for all occupational injuries ; or, if carried still farther, the working classes 278 PRINCIPLES OF INSURANCE will be protected against unemployment, sickness, and infirmity. In any case liability insurance will have a wonderful development and two methods of providing this insurance may be supplied. It may be secured from private companies, organized for this purpose. This is the chief method now in vogue. In this event the cost of the greater protection will be shifted ultimately to society by the employer in an increased price for the goods. If the industrial nations should adopt the principle at different times, it may mean hardships to particular employers in different countries in that their cost of production will be increased. This protection may be supplied directly by the state. In this event the funds for this purpose would Protection be collected by taxation, and society would by the state. a j s0 Dear the cost. No general agreement can be secured as to which of these methods would be most economical and most advantageous from a social standpoint. It must be realized that the cost of industrial accidents, unemployment, and dependent old age is now being borne by society in the form of charity and various means of relief and assistance. The important points to realize are, first, that those who suffer from these industrial accidents are often not well enough cared for to maintain themselves as efficient industrial and social workers, and second that in the present methods of relief, there is great danger of pauperizing them by creating the idea that INSURANCE FOR THE WAGE EARNERS 279 Jbhe relief is given to them as a matter of sympathy and not as a matter of justice. The costs of progress are always present. A part of these costs is a social cost and should be paid for by society. Another part may well be considered an individual cost, and it is too much to expect that the state in some mysterious manner is to be able to prevent misfortune from occurring to any of its mem- bers, or, if it does occur, to indemnify him for the loss sustained on account of his own ignorance, lack of thrift, and industry. Society must see to it that the individual is given a chance to do and an incen- tive to do, but no more fatal check to progress could be established than a system which would encourage the individual member of society to look to his fellow-members to do his share of the world's work, to reimburse him for all his personal misfortunes and to rectify all his mistakes. The activity of the state in the United States in regard either to aiding directly the wage earner or compelling insurance of the working class Government has been limited. Its chief activities are Pensions- confined to federal, state and municipal pensions. The federal system of pensions for those who have served the state in time of war is too well known to need description. This has been also applied to the life-saving service and to the army nurses. It has been proposed to apply it to all civil service em- ployees, as is. the case in most countries, but the 280 PRINCIPLES OF INSURANCE proposal has never been accepted in the United States. The southern states also provided a pension system for those who served the confederacy during the Civil War. It is true that this form of insurance as well as that of the cities applies to a particular class of workers, but no account of industrial insur- ance would be adequate without reference to these systems. A number of cities in different states provide a pension fund for the firemen, policemen, and teachers. Municipal ^ n ^ ne case f the first and second class Pensions. ^he f un j s are derived from various sources. Sometimes the proceeds or parts of the proceeds of special taxes are set aside for this purpose. The subject has caused considerable discussion and the laws providing for such pensions have been frequently a matter for adjudication by the courts, since the laws governing municipal action differ in the dif- ferent states and are frequently changed. Benefits are generally paid to the widow of the employee of the city in case of death, and a pension is granted to minors. After a certain period of service, the employee may be retired on a pension, or a pension may be paid for disability acquired in the service of the city. Teachers' pensions are on much the same plan, although laws attempting to secure a compul- sory contribution from the employee have been de- clared unconstitutional in several states, such as Ohio and Minnesota. The next step will probably INSURANCE FOR THE WAGE EARNERS 281 be to require compulsory contribution. The argu- ments for and objections to such plans of insurance will suggest themselves, and since all these plans are yet in their developmental stages, no detailed account of them is here attempted. The state which has gone the farthest in legislat- ing on insurance for the industrial classes is Mas- sachusetts. In 1907 this state passed a law state which permitted savings banks to estab- insurance, lish departments to sell life and old age insurance. The cost of administration is sought to be kept low by its association with the banking activities and by the absence of solicitors. The past experience of providing insurance without solicitors has not proved successful, but it is hoped that the insurance under this plan will be solicited by organizations, such as labor unions, benefit associations, and employers who seek to have their members or workmen insured. The plan has not been in operation long enough to decide its success or failure. It is in the European and Australian countries that we find the best example of state activity in reference to insurance for the industrial state Insur- classes. We shall select Germany, Eng- y^eYn land, and the Australian countries as Nations, typical of the most advanced action in this direc- tion. Germany provides for compulsory accident, sick- ness, and old age insurance. The insurance of 282 PRINCIPLES OF INSURANCE workmen against accidents dates from the imperial law of 1884, which with its later amendments re- quires compulsory accident insurance to State Insur- ^ * / ance in be paid to practically all workmen, mana- gers, and administration officials whose salary does not exceed $750 per annum. The en- forcement and administration of the law is very largely in the control of the employers with state supervision. Mutual associations of employers in the same or closely allied trades or industries are formed. These associations determine the amount to be paid by each employer. This payment is based on the pay roll and the risk of the particular factory or plant. The compensation to the injured workman in- cludes the following : (a) medical attendance, in- eluding bandages, crutches, spectacles, paid in etc.; (b) a weekly payment, based on the wage received, the extent and dura- tion of the disability ; (m any. reS p 0ns j ^^^y tends to be very much central- ized. The departments are similar to those in an ordinary life insurance company with the exception ACCIDENTS AND HEALTH INSURANCE 299 that the claim department is of relatively greater im- portance. It can be readily understood why the claim department is of such importance, for in the ordinary life insurance contracts the conditions under which a claim is paid are much more specific and definite. The premium which is charged for an accident policy depends upon the hazard of the employment in which the purchaser is engaged. This xh e p,.^ hazard is obtained from the collected data mium - of accidents in various occupations and from these data classes are constructed. The classification directly determines the premium, so that one person may be compelled to pay twice as much as another of the same age for the same amount of accident insurance. Remembering that the policy provides indemnity, it may be understood why an insignificant injury, incurred in one occupation may have no significance significance in another one. A slight o fanIn J uf y. injury to the hand worker may be a serious one for him but scarcely affects the earning power of the teacher or lawyer. Then, too, the hazards in occupa- tions are continually changing on account of improved appliances, the use of dangerous machines, dangerous material, and for many other reasons. Even assuming, therefore, that the most complete statistics of injuries were available for any one year, the same statistics would probably not be applicable for a later year, 300 PRINCIPLES OF INSURANCE There is also the difficulty of properly valuing such factors as the effect which an occupation has upon the physical condition of the insured in making him more liable to accidents. Then, too, what an individ- ual does when he is not employed in his regular occupation affects the hazard of the risk on him. For example, occupations which are subject to periods of interruption will result in some of the workers doing such acts as will make them more liable to accidents when they return to their regular work. The more regular the employment, and the less diverse the ways in which the individual employs his time out- side of his regular work, the more accurate is the classification likely to be. However, it must be remembered that all insurance has to do with large numbers and that it cannot be expected that individ- ual exactness will always be secured. If insurance classification secures relative equity as regards classes, it has gone far to justify itself as scientific. It has been stated that the claim department is of great importance in accident and health insurance. Settling This is so, not only because it is not always Claims. an easv ma tter to determine the indemnity to which the honest claimant is entitled, but also be- cause many attempts are annually made to defraud the company. The claimant may deliberately injure himself. This is especially likely to happen at times when he is out of work. He may even pretend an injury has been suffered, or attempt to prolong his ACCIDENTS AND HEALTH INSURANCE 301 illness, or make claims for injuries which are not covered by the policy. Each claim must be examined, not because a majority of them are fraudulent, but in order to protect the honest claimant by refusing to pay the dishonest claim. Manifestly the honest claimant must even then pay in the form of a higher premium a part of the cost of discovering these fraud- ulent claims by a higher expense for operating the company. The relation of the state to the business of accident and health insurance is much the same as to other insurance. We have seen that a deposit and T he a reserve with limitations as to the character *?Jf l H5 of the State of the securities purchased is established by to Accident the state. Annual reports are also required, insurance However, practically all the legislation up Companies, to within the last few years has been to secure solvency of the company. Since 1908 there has been action and action is pending in other states to require standard provisions in all accident and health policies. Such legislation is intended to protect the policy- holder in other than matters of solvency. New York passed such a law in 1909 and as the laws either enacted or proposed follow in general the New York statute, the chief provisions of the law may be stated. The standard provisions for all accident and health policies include among other provisions standard the following : Provisions. 302 PRINCIPLES OF INSURANCE (a) A copy of the application must be issued with the policy. (5) A provision which specifies the time within which notice of the accident or disability shall be given. This period shall not be less than twenty days from the date of the accident nor less than ten days from the date of the beginning of the disability from the sickness upon which the claim is based, pro- vided that in case of accidental death immediate notice may be required unless the notice therein specified shall be shown not to have been reasonably possible. (i_ which may be mentioned the following : tions - (a) A provision limiting the time at which an action at law or equity may be commenced to less than one year from the date when final proofs of the claim were filed. (b) A provision which prevents the deduction of any premium or assessment from the indemnity un- less such deduction is covered by a written order or note. (tf) A provision which limits the amount of in- demnity to be paid to a sum less than the indemnity payable under the terms of the policy and for which the premium has been paid unless other such insur- ance is carried without notice to the company. The premiums written in 1909 amounted to $24,- 794,108 and the losses were 19,903,379 or a loss of 44 per cent. The greatest needs in personal acci- dent insurance are for a greater degree of cooperation among companies in order that the specific experience of each may be tabulated with a view of making the 304 PRINCIPLES OF INSURANCE classifications more scientific and by cooperation to check the evils of excessive competition. BIBLIOGRAPHY Alexander, William. The Life Insurance Company. Annals American Academy of Political Science. Vol. XXXVI. Benefit Features of American Trade-unions. United States Department of Labor Bulletin, No. 22. May, 1899. Bowley, A. L. Elements of Statistics. Brown, Benjamin P. The Brown Book of Life Insurance Economics. Brqwn, Mary W. The Development of Thrift. Dawson, Miles M. The Business of Life Insurance. The Elements of Life Insurance. De Leon, Edwin W., and Moon, Sidney N. The Law of Lia- bility. Dicksee, L. R., and Blain, H. E. Office Organization and Management. Dryden, John F. Life Insurance and Other Subjects. Educational Leaflets. The Mutual Life Insurance Company. Educational Series. The North -Western Mutual Life Insurance Company. Elliott, Charles B. The Law of Insurance. Fackler, Edward B. Notes on Life Insurance. Fark, William. Vital Statistics. Frankel, Lee K., and Dawson, Miles M. Workingmen's Insurance in Europe. Fricke, W. A. Insurance. A Text Book. Graham, W. J. Romance of Life Insurance. Harbaugh, C. R. The Selection of Risks by the Life Insur- ance Solicitor. Causes of Disability. Henderson, C. R. Industrial Insurance in the United States. ACCIDENTS AND HEALTH INSURANCE 305 Henprick, B. J. The Story of Life Insurance. How to buy Life Insurance " Q. P." Institute of Actuaries' Text Book. Jevons, Stanley W. Principles of Science. Journal of the Institute of Actuaries. Lewis, Frank W. State Insurance. Newsholme, A. Vital Statistics. Pearson, Karl. Chances of Death. Vol. I. Grammar of Science. Principles and Practices of Life Insurance. Seventh Edition. The Spectator Company. Proceedings of the Actuarial Society of America. Proceedings of the Association of Life Insurance Presidents. Proceedings of the International Congress of Actuaries. Publications of the American Economic Association. Third Series. Vol. VIII, X. Publications of the American Statistical Society. Reports Annual of State Commissioners of Insurance. Report on National Vitality. Parts I, II of Vol. III. Senate Document, No. 676, Sixtieth Congress, Second Session. Report of the New York Joint Committee of the Senate and Assembly on Life Insurance, 1906. Report of the New York Liability Commission, 1910. Report of the Ohio Liability Commission, 1910. Report of the Royal Commission on Insurance. Part I. The Commonwealth of Australia, 1908. Report of the Royal Commission of Canada on Life Insur- ance, 1907. Richards, George. A Treatise on the Law of Insurance. Roche, J. F. A Method of Handling Impaired Life Risks. Schloss, D. F. Insurance against Unemployment. Seager, Henry R. Social Insurance. Stillman, Charles F. The Life Insurance Examiner. Venn, John. Logic of Chance. Walford, Cornelius. Cyclopedia of Insurance. Wambaugh, Eugene. A Selection of Cases on Insurance. Willard, Charles E. The A B C of Life Insurance. 306 PRINCIPLES OF INSURANCE Willett. Allen H. The Economic Theory of Risk. Columbia University Studies in Economics, History, and Public Law. Vol. XIV. Willoughby, W. F. Workingmen's Insurance. Wolfe, S. R. Inheritance Tax Calculations. The Examination of Insurance Companies. Yale Readings in Insurance. Vol. I. Year Book, The Life Insurance, 1910. The Spectator Company. Young, T. E. Insurance. Young, T. E., and Masters, Richard. Insurance Office Organization, Management, and Accounts. Zacher, G. Die Arbeiter-Versicherung im Auslande. Zartman, Lester. The Investments of Life Insurance Com- panies. INDEX Accident Insurance : character of, 290. how the business is transacted, 295, 297. origin and definition of, 290. significance of an injury in, 299. Actual experience and calculated experience, 64. Actuarial Science, 15. Actuary, the duties of, 122. Agency department, 123. Agency force, the, 123. Agency systems : brokerage, 125. direct, 124. general, 124. Agent : characteristics of a good, 127. the old and new type, 126. Agents, procuring of, in new com- panies, 117. Aggregates of Life Insurance, 30. Alcohol and narcotics, influence on the risk, 72. American Experience Table of Mortality, 50. Amicable Society, The, 12. Ancient Order of United Work- men, 22. Annual dividend plan, 204. Annual rate of mortality, calcula- tion of, 68. Annuities, 9, 174. kinds of, 175. Annuity : definition of, 175. due, calculation of, 137. Arithmetical mean, 56. Assessment company, The, 22, 100. Assessment insurance : in Europe, 21. in United States, 21. Assessment plan forbidden in Iowa, 104. Average results, 36. B Beneficiary, The, 160. Benefits of life insurance : economic, 6. social, 4. Benefits of selection, 50. definition of, 66. Bernoulli, theory of probability 32. Binding receipt, 159. Board of directors, committees of, 120. Bonds: foreign, 214. government, insurance invest- ments in, 212. relation to investments, 215. Breslau, 11. population table, 48. Brokerage system, 125. Business assessment company: beginning of, 22, 25. evils of, 101. Carlisle table, The, 48. Cash item, The, 207. Cash surrender, The, 168. Casualty insurance, 269. 307 808 INDEX Chance in the theory of proba- bilities, 31. Charter of insurance companies, 115. Claims in accident insurance, 300. Combined Experience Table, 49. Commissioner of insurance, 237, 240. Commissions: of agents, 124. regulation of, 238. Companies: classification of, 99. compared, 105. comparison of participating and non-participating, 112, 231. examination of, 241. operation of, 120. organization of, 114. Company : accident insurance, 297. selection of a, 229. Compound interest calculations, 43. Compulsory insurance and medi- cal examination, 70. Conditions precedent for life in- surance, 7. Conservation of life, 93. Relation of insurance com- panies to, 97. Conserving life, methods of, 95. Contracts: comparison of, 231. liberalization of, 165. one-sided, 80. parties to, 150. Contribution plan, The, 197. Control of insurance companies by legislation, 126. Cooperation among companies in industrial insurance, 275. D Data, early, for scientific insur- ance, 10. Departments of a company, 122. Deposit fund, 114, 295. Depression period of insurance, 17. Disability clause, the, 163. Distribution of wealth affected by life insurance, 7. Dividend: annual plan, 204. deferred plan, 202. Dividends: a return of overcharges, 62. character of, 196. methods of apportioning, 197. E Employer's Liability Commission of New York, 276. Employer's liability, under the Roman laws, 271. Employer's liability insurance, 269. future of, 278. in England, 272. in United States, 272. objections to, 276. purpose of, 273. theory of, 270. Endowment policies, advantages of, 228. English Actuaries' Table, 49. Episcopalian Ministers' Fund, 13. Equitable Society of London, 12. Expectation of life, 58. Expenses: classification of, 145. difficulty of assessing, 199. importance of, 190. limit of, for new business, 191. the first year, 199. Experimentation, period of, in in- surance, 8. Extra premium: objection to, 91. Factors affecting birth and death rates, 48. Farr, Dr. William, 51. INDEX 309 Fisher, Professor Irving, 93. Formula: for calculating the magnitude of deviation, 60. for compound interest calcula- tions, 45. for mortality tables, 56. for present worth, 45. Fraternal companies, evils of, 103. Fraternal insurance on assess- ment plan, 24. Fraternal societies: changing to scientific plan, 27. not interfered with by state, 26. Fraud in insurance, 82. G Gambling and insurance distin- guished, 37. General Life and Trust Company of Philadelphia, 14. General or population mortality tables, 48. Graunt, John, publications of, 11. Greups, not individuals, subject- matter of insurance, 36. II Halley's mortality table, 11. Hazard: in case of women, 76. the moral, 80. Health insurance, 292. Healthy English Table, 51. Healthy Males Table, 51. Hereditary tendencies, 79. Historical development of insur- ance, 8. in America, 12. Homans, Sheppard, 50. Homogeneous group necessary for insurance, 35. Ignorance of legislators regarding, insurance, 19. Ignorance of public regarding in- surance, 20. Imperial Statistical and Insurance DepartmentS/of Germany, 52. Income, source of insurance com- pany's, 187. Industrial and General Insurance Company, 27. Industrial insurance, 27. amount in force 1910, 261. benefits of, 262. by savings banks, 120. insurance at wholesale, 29. origin of, 27. plans of companies, 261. purpose of, 28. relation to guilds and fraterni- ties, 264. Injury, significance of, 163, 299. Inspectors in liability insurance, 275. Installment plan, 154. Insurable interest, 159. Insurance : a business, not philanthropy, 97. amount of, 160. a mutual contract among indi- viduals, 37. buying of, 223. combination of risks, 34. defined, 1. not commerce, 252. selling of, 126. when it should be taken, 85. Insurance business, subject to law of decreasing cost, 192. Insurance commissioner, work of, 115. Insurance Company of North America, 13. Insurance departments: beginning of, 237. of states, 237. Interest accumulations: determine in part the premium, 43. Interest earnings: actual, 219. assumed, 218. 310 INDEX Investigation of insurance com- panies by New York, 18. Investments, 40. character of, 206. importance of, 205. in corporation securities, 215. in stocks, objections to, 216. principles governing, 221. regulations of summarized, 246. security the first requisite, 223. statutory requirements regard- ing, 245. Lapses, relation to profit, 193. Laws: proposed for Fraternal Com- panies, 119. to regulate insurance business, 18. Legal department of companies, 123. Legal reserve insurance defined, 21. Level premium insurance, 21. Lien: determined how, 88. on policy, 88. Life insurance: a form of cooperation, 3. basis of, 2. best investment for small sav- ings, 5. defined, 1. early forms, unscientific, 8. its relation to economics, 7. origin of, 2. real beginning of, 12. requisities for its development, 2. Life Insurance Company of Vir- ginia, 28. Limit of single risk, 41. Lives at risk, calculation of, 58. Loading, 144. method of, 143, 144, 147. Loans on policies: amount in 1908, 212. relation to lapses, 209. London Assurance Company, 12. London Bills of Mortality, 10. M Magnitude of deviation, formula for 60. Maximum age limit for a policy, 162. Mean annual death rate, calcula- tion of, 56. Medical director, duties of, 122. Medical examination, 70. Mercers Company office in Lon- don, 11. Metropolitan Industrial Insurance Company, 260. Metropolitan Life Insurance Com- pany of New York, 28. Milne, Joshua, Mortality Table, 48. Minimum age limit for a policy, 162. Mixed plan, definition of, 108. Modern insurance, origin of, 11. Money lenders, early relation to insurance, 8. Monopoly, absence of, in insur- ance, 173. Morbidity and mortality, 80. Mortality cost lowered by educa- tion, 94. Mortality rate, two factors of, 84. Mortality savings, source of, 61. Mortality tables, 53. American Experience Table, 135. character and origin of, 47. construction of, 54. defined, 47. tables in use at present, 49. Mortgages: relation to investments, 212. relation to term Insurance, 152. Mutual Benefit of New Jersey, 14. Mutual companies, control of, 111. Mutuality, basis for insurance, 7. Mutual Life of New York, 14. Mutual plan, definition 6f, 107. INDEX 311 Mutual societies, early forma of insurance, 9. N National Convention of Insurance Commissioners, 241. National Fraternal Congress Table, 52. Negroes not generally accepted as risks, 78. Net cost of policy, 110. New business : limitation on, 248. significance of, 191. New England Mutual of Massa- chusetts, 14. New lives, effect on assessment companies, 68. Newsholmn's Vital Statistics table, 77. New York fire, its influence on life insurance, 14. New York Life, organization of, 14. Non-participating company, 112. Northampton Table of Mortality, 12. a population table, 48. Notes accepted for premiums due, 16. Number of lives necessary to be insured, 60. Occupation mortality, 75. Occupations classified according to hazard, 75. Old line company, definition of, 99. Old line insurance, 21. Ordinary life policy, advantages of, 226. Organization, expenses of, 117. Organizations voluntary for in- surance, 263. " Out of work " benefits, 264. Overweights, 74. Participating company, The, 112. Pensions : government, 279. old age in Germany, 284. Policy: accident, evolution of, 291. benefits of, 293. classified according to dividends, 153. definition of, 150. development of, 157. forfeiture of, 168. incontestability of, 171. joint life, 155. legal construction of, 161. loans on, 208. no " best," 225. not an investment, 224. of a corporation on its presi- dent, 156. ordinary classification of, 154. return premium, 156. standard prohibitions of, 172, 303. standard provisions of, 166, 301. tends to be same in all states, 113. terms of, 159. the standard, 164. title to, 159. Policyholder, attitude towards the company, 111. Preliminary term plan, The, 144. Premium notes, 208. Premiums: definition of, 130. in accident insurance, 299. in assessment companies, 147. in industrial insurance, calcu- lation of, 148. in liability insurance, calcula- tion of, 274. kinds of, 130. level, 131. limited payment, 141. net annual, 138. 312 INDEX Premiums : net annual, calculation of, 137. net level, 132. net single, calculation of, 135. net single for a term of years, 140. on industrial policies, 261. payment of, 159, 167. term, calculation of, 140. the endowment, calculation of, 141. the gross, 143. whole life, calculation of, 137. Presbyterian Ministers' Fund, be- ginning of, 13. President, the duties of, 121. Price, Dr. Richard, 12. Probability: of death, determination of, 56. of dying during year, 55. of living during year, 55. theory of, 31. Probable life time, 59. Protection for working classes, 256. Proxy method of controlling com- panies, 110. Prudential Assurance Company of England, 27, 261. Prudential Insurance Company of New Jersey, 261. Publicity in insurance business, 235. R Race mortality, 78. Radix of mortality table, 47. Rating up lives: effect on lapses, 87. methods of, 86. Real estate: amount limited by law, 213. relation to investments, 213. Rebating, 248. Recently insured lives, 66. Regulation : federal, of insurance, 252. federal versus state, 252. state, charact 3r of, 236. state, methods of, 237. state, reasons for, 234. state as to organization of com- panies, 238. state theory of, 233. Regional mortality, 78. Reinsurance, 71. Reinsurance fund, 179. Relief departments: of corporations, 267. organization of, 268. Relief societies, local, 266. Reports: annual, required by state, 248. character of state, 126. Requirements, statutory, 244. Reserve: calculation of, 179. cause for legislative enactments, 184. defined, 43. described, 178. in accident insurance, 298. individual, 180, 184. investment of, 181. investment of, within the state, 246. not like the bank reserve, 185. not understood by early policy- holders, 15. on limited payment policy, 183. origin of, 179. rule for calculating, 185. the same under annual and single premium, 182. the terminal, 180. Residence, change of, 165, 168. Retaliatory laws, 242. Risk: amount at, 146. classification and description of, 71. defined, 38. factors, determine the class of, 74. measurement of, 38. Royal Exchange, formation of, 12. INDEX 313 Salaries, regulation of, 247. Savings: from interest, 187. from loading, 189. from mortality, 188. Scientific insurance: beginning of, 12. Scrip certificates, 16. Secretary, duties of, 121. Selection: adverse, 65. defined, 65. of lives, 64. present process of, 70. Select mortality table, defined, 50. Self-selection, 69. Sex mortality, 76. Sex Mortality Table, 77. Simpson, 11. Sinking fund, 178. Society, well being of, promoted by insurance, 4. Society for the Assurance of Wid- ows and Orphans, The, 13. Solvency: laws governing, 242. relation to first year's business, 243. South Sea Bubble, 12. Spectator Company's Year Book, 217. Speculation, companies organized for, 17. State, relation of the, to insurance, 233, 301. State insurance: benefits of, 278, 281. in foreign countries, 281. in Germany, 282. State insurance departments : in Australian countries, 288. in England, 285. in Germany, 284. in Massachusetts, 281. in New Zealand, 288. Statistical departments of com- panies, 123. Stock plan, The, defined, 105. advantages of, 106. Substandard lives, treatment of ,83. Suicide: its effect on risk, 40. rate in U. S., 82. Surplus, The, 186. legal limitations of, 194. origin and composition, 187. the divisible, 195. Table, Young's, of insurance, 67. Tables of mortality, 47, 53. Tax: county, on premiums, 251. reason for its existence, 252. state, on gross premiums, 251. state license, 251. Taxation of insurance companies, 249. Term policy, advantages of, 229. Theory of life insurance, 31. Theory of probabilities applied to life insurance, 33. s Thrift, promoted by insurance, 5. / Tontine plan, The, 203. Trade-union insurance, 265. Treasurer, the duties of, 121. U Ulpian mortality table, 9. Ultimate mortality table defined, 50. Under average lives, 35. Underweights poor risks, 73. Unearned premium income, 178. Uniformity through a period necessary for insurance, 36. W Wage-earners insurance, 256. protected by state, 278. Warranties and representations, 171, 157. Wells, Daniel H., 200. Western and Southern Industrial Insurance Company, 28. Wright, Elizur, 169. T HE following pages contain advertisements of a few of the Macmillan publications on Economics. BOOKS ON ECONOMICS, FINANCE, ETC. Principles of Economics By F. W. 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