Organization Of Life Insurance Companies
( Originally Published 1911 )
Life insurance defined.—Life insurance is a pro-vision against a hazard which is certain to occur. Here, of course, the element of uncertainty is the time of death. All policies of life insurance—and this is true of accident insurance—are not policies of indemnity, as in the case of property insurance. There are legitimate limitations as to the amount of insurance which may be carried on an individual life, but these are based on moral and financial conditions and have little, if any, relation to indemnity conditions. In other words, it is obviously difficult, if not impossible, to approximate, beyond a certain point, the value of any life.
190. Early conditions unfavorable to insurance.-The theory of probabilities, as has already been explained, was what gave birth to the idea of insurance. Although Pascal developed the theory by applying its mathematical principles to various gambling games, it was not until almost a century later that solid mathematical foundations were laid on which insurance premiums could be based. Unfavorable sanitary and hygienic conditions held back the development of life insurance for some years. In addition to this handicap not only countries but continents were devastated by plagues. This state of affairs placed a temporarily insurmountable obstacle in the way of forming insurance institutions whose business was to rest upon calculations as to the length of life.
From early history, especially from the time when Guilds were formed, there were various attempts at forms of help to a family when death occurred. Probably the nearest approach to modern insurance, however, was the provision made by a traveller who, before going into a distant land, secured a sum which might be used as a ransom if he fell into the hands of pirates. All such projects were, of course, merely the early beginnings to which the present remarkable status of life insurance may be traced.
First English societies.—In 1699 the Society of Assurance for Widows and Orphans was founded in England. It had many elements of a modern life insurance office, but had them only in . a partial degree. Its organization was somewhat similar, it had the premium feature, and contained among other things the unique provision that the clergy or laity "except such as lived in the marsh and unhealthy parts of England" might be admitted by proxy if known to the trustees of the office or to some two subscribers or substantial house-keepers living within the bills of mortality. In 1707 this society had about eleven hundred members. From then on until 1760 there were many organizations for the purpose of insuring lives. The successful ones owed this success largely to the fact that they did not promise a specific sum to the beneficiaries, but at the end of the year divided among them the sums that were subject to distribution that year. Hence, the amount which the beneficiaries received varied according to the number of deaths during the year. This meant, naturally, that the greater the number of beneficiaries the less there was to divide. In 1720 the London Assurance and Royal Exchange companies were chartered. Both had the privilege of doing life insurance business but neither developed it, in the early years at least, to any great extent.
It was in the year 1760 that steps were taken in Great Britain to found an insurance company on a true basis. Although all that had been done previous to this time was excellent educational work, it did not furnish foundations for the later development of life insurance. As nearly as can be estimated, the amount of insurance on lives in Great Britain in this year, 1760, amounted to 350,000 pounds. Two years later "The Society for Equitable Assurance on Lives and Survivorships" was incorporated after several difficulties had been overcome. The project was successfully launched, so that it may be said that modern life insurance dates from the foundation of this society.
All life insurance premiums were based on the tables furnished by the bills of mortality of London and the Breslau Tables. These, in turn, were based on tabulated statistics including healthy and unhealthy lives and per-sons engaged in all kinds of employments. Naturally, the tables based on these conditions showed a much higher death rate than the picked lives which the society insured.
Five periods of development.—In England future development of life insurance fell into fairly definite periods. From 1698 to 1760 was termed "the speculative period," largely because of the uncertain data upon which the societies were organized. From 1762 to 1815 was called "the transition period"; societies gradually found it possible to build more substantial foundations, although the development was slow. The third period, from 1816 to 1844, was called the "Golden Age." Considerable success rewarded the efforts of these twenty-five years, The Fourth Period, from 1844 to 1855, was known as "the period of Bubble Companies." Apparently almost any one could organize a company in that period, in fact many were organized, and on the flimsiest foundations. In due course, how-ever, the crash came and only the solid companies survived. The fifth period began in 1857 and for Great Britain and the United States may be called "the period of the modern insurance company." From that time, except for slight setbacks, the growth has been steady.
Life insurance in the United States.—The earliest recorded policy in the United States reads as follows :
Insurance is hereby made by Benjamin Lincoln, Esq., on his natural life, age about 56 years, for and during the space of twelve calendar months, to commence from the date hereof, and we, the assurers, do agree that the life of the said Benjamin Lincoln shall be rated at the sum of $1,000 lawful money, for which we have received the premium due us of 5%. In case he shall, during the said term, happen to die, then we will well and truly pay unto his heirs the sums we have hitherto subscribed.
The wealth of the Colonies was not such as to make such provisions feasible. Life insurance in this country began in 1759 when the Presbyterians of New York and Philadelphia secured a charter from the Colonial Government of Pennsylvania. The object of this body was primarily the insuring of the ministers of the Presbyterian Church. Ten years later the clergymen of the Episcopal Church organized companies in the colonies of New York, Pennsylvania and New Jersey. These two institutions may be called transition life insurance companies. Their work was not actual charity, neither was it true insurance. The members did not pay the entire premium, a portion being contributed by other parties interested in the project; to the extent, however, that they were partially self-supporting, they marked a distinct advance from a purely charitable enterprise.
In 1801, it is stated, there were not one hundred policies of life insurance in the United States. The Insurance Company of North America, to be sure, had been chartered in 1794 as a stock company and under its charter could write life insurance. It wrote very little, however. The slow growth of life insurance in this country was due mainly to the same causes as operated in Great Britain and on the continent, namely, the uncertain living conditions. Smallpox and many other epidemic diseases were prevalent.
Three early companies.--In 1818 Massachusetts chartered the Hospital Life Insurance Company with a capital of $500,000, but required that it should pay into the state one-third of its profits from life insurance, after deducting legal interest on the paid-up capital. This tax, seemingly, was sufficient to prevent the development of this branch of the company's business, if, indeed, the time was not too early for such development. The State of New York organized a life insurance and trust company in 1830 with capital of $1,000,-000, and previous to this time there had been organized in Pennsylvania the Pennsylvania Company for the Insurance of Lives. All three companies are actively engaged and successful to-day as trust companies, but have done very little, if anything, with life insurance.
Developments since 1835.-The true beginning of life insurance in the United States dates from 1835. In this year the New England Life Insurance Company was chartered in Massachusetts and the Girard Life & Trust Company in Pennsylvania. Seven years later the Mutual Life of New York was organized. In 1843 the New England company completed its organization, and the Mutual Benefit of New Jersey was chartered. It was in this year, too, that the New York Life Insurance Company completed its organization. Although there were ten companies in existence, the insurance in force at this time was estimated not to exceed $6,500,000. By 1860 this had increased over twenty-five times, to $166,000,000.
It was generally believed that the Civil War would show a lessening of life insurance. The contrary, how-ever, proved to be the fact. While the southern business was of necessity disturbed, the increase in the north was so great that a larger, rather than a smaller, amount continued to be put in force each year. From 1870 to 1880, the period of the great panic, the insurance business went through a process of reorganization. Many companies had been organized and some seventy-one in this decade went out of business. It is estimated that in these ten years the insurance in force decreased from $2,000,-000,000 to $1,500,000,000. In 1880 an advance step was taken and from that time until 1905 it was simply a matter of recording each year a larger success than the past. In the latter year there occurred what is known in history as the "Armstrong Investigation," and while it was thought that the results would be disastrous, they proved to be quite beneficial, so that the business, after pausing very briefly for readjustment, has steadily advanced.
Three main departments.—Such a tabulation usually tells its own story, because the majority of the officials or departments might be common to any corporation. There are, however, three departments of a life insurance company which call for a special word:
(1) THE ACTUarial DEPARTMENT—ThiS department determines the amount of the premiums. Upon its careful solution of the problems involved and upon its correct determination of the charges, rests the success of the company—that is, success in the sense that the company will be receiving for the risk assumed the sum which it ought to receive. The work of the actuary is special and, in addition to calling for mathematical ability, requires a broad general training.
(2) THE MEDICAL DEPARTMENT—The medical department is the door, so to speak, through which the applicant must pass before he can even be considered from the premium standpoint. This and the actuarial department are of equal importance. The medical director, who is of course a trained physician, must have in addition to that training expert judgment in passing upon lives for the purpose of insurance. Such a qualification is not, and cannot be, the result of school training, but is a special viewpoint which direct experience alone is able to give to a satisfactory degree.
(3) THE AGENT—The insurance agent is the real business-getter in life insurance, and the active force be-hind any company's development and success. Men may take the initiative in seeking out a company in order to protect their property by policies of insurance, but rarely do they do so in life insurance. It is even said that if one does so he should be examined three times and then rejected. This is because a person so rarely seeks life insurance that companies feel that there must be something unusual about the applicant's case which the ordinary method of investigation will not reveal. Probably 99 per cent of all life insurance policies are sold by the direct solicitation of the agent. In fact, the business would stop to-morrow if the agent ceased to preach the gospel of life insurance. The rewards in this field are large to the successful agent, since he earns not only the initial commission but also the renewal commission, which normally runs through several years. Thus the agent can build up a business which gives him a steady income for his past labors.
The most effective form of agency organization, perhaps, has not yet been decided upon. There is the home office system where everything radiates from one central office, and the so-called branch office system where branches are built up in important centers. There has always been a difference of opinion as to the relative merits of each. It is safe to say, however, that the branch office system is gradually being superseded by the plan which controls the agency organization direct from the head or home office.
198. Economic importance of life insurance.—The status of life insurance as an economic factor can quickly be grasped by considering a few general statistics dealing with the various features of all the business, December 31, 1913, for example :
(a) AssETs—These totaled $4,351,747,000, the following being the most important features:
Real Estate $147,000,000
(b) LIABILITIES—Exclusive of capital, which amounted to $11,000,000, these totaled $4,209,000,000, leaving the net surplus over and above all liabilities $131,000,000. The principal items were:
Reinsurance Reserve $3,677,000,000
(c) INCOME-This amounted to $839,000,000, the principal item being:
This item should be divided into two groups, as follows: New premiums, $74,000,000; renewal premiums, $430,000,000; interest, $188,000,000.
(d) DISBURSEMENTS—These totaled $594,000,000, principal items being:
Death Claims $193,000,000
(e) INSURANCE IN FORCE—The total was $18,000,502,971; the increase during the year 1913 being $1,033,055,496.
These statistics, taken from the reports made to the Insurance Department of the State of New York, cover the business of eleven companies of New York State, twenty-three companies of other states, and one foreign company. They are what are known as ordinary life insurance companies. Four of the companies are doing the principal industrial business and these figures are included in the reports which have been quoted. One is a New York company, two are located in New Jersey and one in Massachusetts.
The economic importance of life insurance may be seen by comparing the assets with savings bank deposits in the United States. These insurance assets for the year 1913 totaled $4,727,000,000. This shows that the amount devoted to life insurance approximately equals the savings bank deposits of the United States.
Investments of insurance companies.—The large sums carried as reserves by life insurance companies, and which must necessarily be carried, make the question of their investment of more than passing interest. The life insurance company stands in a unique position in regard to its investments. Its practice is different from most other corporations, since it is seldom, if ever, subject to a sudden or unusual demand upon its funds. There is no danger, as in the case of fire insurance, of a conflagration hazard which may call for 40 per cent of all the assets engaged in the business of fire insurance as in San Francisco in 1906. The life insurance company can determine with considerable accuracy the calls that will be made upon it during a given year. It can very well apportion in advance the expenditures and can also fairly well determine its income. This peculiar position, therefore, makes it possible for life insurance companies to consider long-term investments which in many other cases would not be possible. Since the Arm-strong Investigation in 1905 the rules governing life insurance investments have been brought within a some-what strict compass, and in due time the companies will be expected to dispose of so-called stock holdings. This is a natural consequence of the view taken during that year that stock holdings meant ownership and are not strictly investment securities. As a matter of fact, it was held that in owning stock the insurance companies were putting themselves in the position of owners and might, perhaps, in order to insure the success of an enterprise, be led to devote an undue part of their income to one or more enterprises solely because they wished to protect their stock holdings. To adjust matters, the broad rule was laid down that within five years all stock holdings must be disposed of and likewise any real estate beyond that needed for the home office purposes and beyond that acquired by foreclosure proceedings in connection with loans. When the assets totaled $2,000,-000,000 a compilation of the different types of investments showed the following results, round figures only being used:
Foreign Government Bonds $50,000,000
Mortgages on Real Estate $550,000,000
In the proportion of stocks to bonds this would be about as one to six. The other investments at this time were :
Premium Loans and Notes $120,000,000
One investment feature, worthy of more than passing notice, is the item "Premium Loans and Notes." In 1903 these amounted to less than $200,000,000. At the close of business in 1913 the loans on policies amounted to $589,000,000. In a period of ten years, then, this type of loan, which in a sense is an investment, had practically tripled.
Insurance of premium loans. The increasing tendency on. the part of the insured to borrow against the cash value of a policy is viewed with a good deal of apprehension by insurance leaders. The main object of insurance is to provide for the beneficiary. If the insured cuts down this benefit by loans, the purpose of the insurance is defeated. The panic of 1907 was largely responsible for the increase in the loan item. Here is what really happened. During the panic many people were led to raise capital by means of loans on their life insurance policies, other sources being closed. This caused the practice of borrowing to spread, since panic conditions drew attention to the fact that an insurance policy was available at any moment for a loan upon its cash value.
Unlike a savings bank, an insurance company cannot protect itself by a sixty-day provision. In most cases, if the cash value of the policy exceeds the required loan, the insurance company must let the applicant have the money. A loan may be slightly better than cancelling the policy, since the policy is still in existence and to that extent has some hold on the insured. But the practice of considering the cash value of an insurance policy much the same as a savings bank deposit is having, and undoubtedly will continue to have, a bad effect on the main purpose for which the life insurance premium is paid—that is, the protection of the beneficiary.
Life insurance as an investment.—In a sense, perhaps, the modern method of selling life insurance as an investment is responsible for emphasizing the loan feature of policies. Loans at first were infrequently taken out, and were given merely to take care of premiums if the insured did not have the money at the time the payment was due; but long ago this condition passed and loans have become a harmful feature.
It should be observed that although the insurance company receives a fair rate of interest on these loans—higher usually than their average return from other sources—they are not thereby better off than as though they had the funds in some other form of investment. It is a special type of loan, one which cannot be called and one, in fact, about which the companies can do nothing so far as collecting it is concerned, unless the insured chooses to pay it. If he pays the interest, the loan may continue until the policy terminates and then be struck off in settling the policy. An insurance company should invest its funds to the best of its ability but the policy loan feature ties them up as a special investment. One curious fact about this type of loan is that it is seldom repaid. This emphasizes its danger to the business of life insurance. Apparently it is not regarded in the same light as other loans but is considered by the insured as something which belongs to him, to which he is entitled, and which he will use as he pleases.
Insurance companies not savings banks.-Some insurance literature compares life insurance with the savings bank deposits in such a way as to give the idea to the insured that life insurance has in addition to insurance protection, all the advantages of a savings account. The advantage is in favor of Life Insurance for over 27 years.
Such comparisons are sure to make the insurance applicant feel that the cash value of the policy stands the same as the savings bank deposit and that he may draw on it at will. But he does not realize, unfortunately, that he cannot have it both as a savings bank deposit and as life insurance.