Competition, Regulation, and the Public Interest in Nonlife Insurance [Reprint 2019 ed.] 9780520315396

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P U B L I C A T I O N S I N S T I T U T E A N D

O F

O F

BUSINESS

E C O N O M I C

Recent publications

T H E

R E S E A R C H

in this series:

ECONOMIC DEVELOPMENT OF COMMUNIST C H I N A

by Choh-Ming Li (1959) INTRODUCTION TO T H E T H E O R Y OF INTEREST

by Joseph W. Conard (1959) A N T I T R U S T IN T H E M O T I O N P I C T U R E INDUSTRY

by Michael Conant (1960) ECONOMIC DOCTRINES OF K N U T WICKSELL

by Carl G. Uhr (1960) A T H E O R Y O F A C C O U N T I N G T O INVESTORS

by George J. Staubus (1961) O R G A N I Z A T I O N , A U T O M A T I O N , AND S O C I E T Y

by Robert A. Brady (1961)

Competition,

Regulation,

and

the Public Interest in NONLIFE

INSURANCE

PUBLICATIONS OF THE INSTITUTE ECONOMIC RESEARCH UNIVERSITY

OF BUSINESS AND OF CALIFORNIA

Competition, Regulationy and the Public Interest in NONLIFE

INSURANCE

by ROT J. HENSLET

U N I V E R S I T Y OF C A L I F O R N I A

BERKELEY

and LOS ANGELES

1962

PRESS

UNIVERSITY OF CALIFORNIA PRESS BERKELEY AND LOS ANGELES, CALIFORNIA CAMBRIDCE UNIVERSITY PRESS LONDON, ENGLAND ©

1 9 6 2 BY THE REGENTS OF THE UNIVERSITY OF CALIFORNIA

LIBRARY OF CONGRESS CATALOG CARD NUMBER PRINTED IN THE UNITED STATES OF AMERICA

62-15104

I N S T I T U T E OF BUSINESS A N D ECONOMIC RESEARCH UNIVERSITY O F CALIFORNIA,

BERKELEY

David A. Alhadeff, Chairman Michael Conant John W. Cowee Howard S. Ellis Joseph W. Garbarino Robert A. Gordon Dale W. Jorgenson William J. Vatter Richard H. Holton, Director The opinions expressed in this study are those of the author. The functions of the Institute of Business and Economic Research are confined to facilitating the prosecution of independent research by members of the faculty.

To Evelyn and Cary

PREFACE T h e purpose of this study is essentially twofold: (1) to examine some of the important aspects of market structure, market conduct, and economic performance of nonlife insurance, a financial sector of the American economy that lies somewhere between public utility and free market status; and (2) to suggest changes in market conditions in nonlife insurance that seem to offer opportunities for improving economic performance in the industry. Since there are numerous similarities among financial institutions, some of the problems examined in this study are common to other financial sectors of the American economy. Thus the questions raised here may have at least some limited applicability beyond this industry. T h e body of economic theory frequently brought under the broad heading of workable competition has served as a guide for this study. The work of Joe S. Bain has been particularly useful. This study is not to be thought of as a complete industry study, however. Nonlife insurance is a broad activity. Every important aspect of the industry has not been considered; this would be an impossible task. For example, price discrimination has been considered only as it relates to other problems because there has been a recent study of this phenomenon in nonlife insurance 1 and because, despite the attention it receives in industry and regulatory circles, price discrimination does not seem to be as important as some other industry characteristics. An effort has been made to concentrate on an analysis of the aspects of the nonlife insurance market that seem to be most directly linked to performance in the industry. From the analysis of these relationships, tentative policy suggestions have been developed to assist in obtaining industry performance that is more socially satisfactory. The goal of the whole project has been oriented to consideration of plans of action. 2 1 C . Arthur Williams, Price Discrimination in Property and Liability Insurance (Minneapolis: T h e University of Minnesota Press, 1959). a See the argument of August Heckscher, Director of the Twentieth Century Fund, in 1959 Annual Report of the Twentieth Century Fund, pp. 11-14, that we need a closer relationship between social science research and plans of action.

ix

x

Preface

There is a strong tendency in nonlife insurance, as in many other areas of human affairs, to view present policies and practices as the only ones which will permit an activity to survive. This argument was forcefully made in 1944 when a Supreme Court decision3 threatened established practices in nonlife insurance. Compromise legislation eased the industry into another situation. Now this mode of operation is more and more being compared with other possible alternatives. Many spokesmen for the industry are maintaining again that any significant change will threaten the industry. No institutions are immutable, thus every alternative that offers possibilities for increasing the value of an institution to society should be explored. Such is the spirit of this investigation. Many people have helped me with this study. I learned a great deal about the level of competition and its regulation in the industry from a number of discussions with various staff members of the U.S. Federal Trade Commission, the Antitrust Division of the U.S. Department of Justice, the Subcommittee on Antitrust and Monopoly of the Committee on the Judiciary of the U.S. Senate, and several industry trade associations and rate bureaus. Dean E. T . Grether, Professors Joe S. Bain, Michael Conant, John W. Cowee, and Harry J . Solberg of the University of California, and Professor C. Arthur Williams, Jr., of the University of Minnesota, have read the manuscript and given valuable advice at many points. The Institute of Business and Economic Research of the University of California has provided financial and clerical assistance. Mrs. Maude K. Riley, Editor, has been especially helpful. Messrs. Dean Wise and K. M. Hussain helped gather and check materials at various times. Despite all this assistance, mistakes and conclusions alike are my own. Finally, this study was substantially completed in the summer of 1960. Since that time I have been outside the United States in circumstances making it very difficult to collect material or to follow events in the American economy other than in the most general way. It appears, however, that the trends in nonlife insurance observed in this study have broadly continued, and that whatever validity the study had when it was completed still generally holds. Universitas Indonesia Djakarta, Indonesia ' US. v. South-Eastern

R.J.H. Underwriters Association, 322 U.S. 533.

CONTENTS I. The Industry, Its Performance, Interest

and the

Public 1

Property and Casualty Insurance as an Industry 5; The Property and Casualty Insurance Market 6; Economic Function and Justification of Insurance 6; Some Performance Criteria in Insurance 12

II. Size, Number, and Organization of Firms in the Industry

16

Types of Company Organization and Numbers of Each 16; Holding Company Operations 24; Concentration in the Industry 27

III. Channels of Distribution

32

Independent Contractor Agents and Brokers 32; Exclusive Agents 35 Salaried Employees 36

I V . Entry and Exit

38

Entry 39; Exit 66

V . Price Policy and Price Making

70

Meaning of Price Policy 71; Survey of Price Policy and Pricing Practices in the Industry 73; Price Making in the Industry 78; Summary of Price Making in the Industry 101

V I . Industry Performance I: Progressiveness Line Insurance)

(Multiple102

A Standard for Progress 102; Measuring Progress 105

V I I . Industry Performance II: Progressiveness (Automobile Insurance and Accident and Health Insurance) 116 Automobile Insurance 116; Accident and Health Insurance 133; Summary of Progress in Product 148; Contract, Procedural, and Administrative Changes 149

xi

xii

Contents

VIII. Industry Performance III: Product ity, Profit Levels, and Selling Costs

Variety,

Capac154

Product Variety 154; Capacity 156; Profit Levels 165; Selling Costs 179

IX. The Results Insurance

of Past and Present

Policy

in

Nonlife 191

Summary of Industry Performance 191; Industry Structure, Conduct, and Performance 196; Past and Present Policy 203

X. Policy

Alternatives

and Suggestions

207

Some Policy Alternatives 208; A Suggested Policy Combination 215; Conclusion 222

Bibliography

224

Index

249

CHAPTER I

The Industry, Its Performance, and the Public Interest In the United States today, all business firms and nearly all households view property and casualty insurance as a useful, even necessary, service. T h e recent development and extension of this form of risk sharing are illustrated by the following premium data. Annual premium outlays for nonlife insurance in the continental United States have grown from $2.2 billion in 1939 to $17.5 billion in 1958.1 Several factors have influenced this growth: the monetary and real expansion of property values and income flows, collective bargaining, legislation (primarily at the state level), a growing awareness of the benefits of 1 U.S. Bureau of the Census, Statistical Abstract of the United States: 1941 (68th ed.; Washington, 1947), pp. 446, 450; and The Spectator, CLXVII (November, 1959), 49-50. T h e federal government does not collect insurance statistics. Such data as are published in federal reports are reprinted from private-agency publications. For example, the source of the above Bureau of the Census data was T h e Spectator, Philadelphia, Pa., Insurance Yearbook, Insurance by States Volume. T h e Spectator organization and Alfred M. Best Company, Inc., publish various collections of insurance statistics. T h e state regulatory commissions also publish statistical summaries in their annual reports. T h e materials from these various sources differ in many ways—the extent of industry coverage provided, the methods of data classification and analysis used, the time span over which certain series may extend, and the rapidity with which data are made available. In this study the most complete and the most consistent data available, in a form adaptable to the particular problem being discussed, have been used. This has meant drawing upon a variety of sources. If it had been available, a single, complete, consistent, and comparable body of data would, of course, have simplified the analysis. For a comment on nonlife insurance data, see Robert A. Hedges, "Experiment in Financial Analysis of Property Insurers," Journal of the American Association of University Teachers of Insurance, XXIII (March, 1956), 143-144.

1

2

The Industry

and the Public

Interest

pooling resources to meet uncertain losses, and the liberal trend in negligence case awards. Regardless of the combination of reasons underlying its growth, nonlife insurance has become an integral part of the American economy. Nonlife insurance includes a variety of insurance forms; the relative importance of these forms for the United States is presented in Table 1. The three leading groups of similar insurance forms accounted for TABLE 1 CLASSES OP N O N L I F E INSURANCE I N THE U N I T E D STATES

1958 Form of insurance Fire Extended coverage Other allied lines Homeowners' multiple peril Commercial multiple peril Growing crop only Ocean marine Inland marine Accident Accident and health Hospital medical expense Group accident and health Noncancellable accident and health Workmen's compensation Liability other than automobile bodily injury Automobile liability, bodily injury Automobile liability, property damage Automobile physical damage Liability other than automobile property damage Fidelity Surety Glass Burglary and theft Boiler and machinery Earthquake Aircraft physical damage Miscellaneous Total

Premiums (Billions) $ 1.79 .67 .03 .36 .04 .10 .20 .37 .17 .46 2.60 2.40 .22 1.30 .65 2.41 1.09 1.88 .15 .09 .19 .04 .11 .08 .01 .03 .02 $17.5

Percentage of total® 10.3 3.9 .2 2.1 .2 .6 1.1 2.1 1.0 2.6 14.9 13.7 1.3 7.4 3.7 13.8 6.1 10.8 .9 .5 1.1 .2 .6 .4 —

.2 .1

CLXVII (November, 1959), 49-50. • Column total does not equal 100 per cent because of rounding.

SOUBCE: The Spectator,

77.6 per cent of nonlife insurance premiums. In the order of their importance, they were: accident and health insurance, which includes all types of protection, except workmen's compensation, for medical ex-

The

Industry

and the Public

Interest

3

penses or loss of income due to injury or illness; automobile insurance; and fire and allied lines of insurance. These heterogeneous insurance types shown in Table 1 offer the opportunity to insure nearly every chance of loss "which is a proper subject of insurance." 3 The principal risks not included are those usually considered to be life insurance; this area of insurance is defined by the State of California as "insurance upon the lives of persons or appertaining thereto, and the granting, purchasing, or disposing of annuities." 4 In the past each company usually sold only certain types of property and casualty insurance. In fact, before legislation in the 1940's and 1950's, state laws restricted each legal entity to either fire and marine or casualty contracts. 5 Companies circumvented this rule by forming groups of affiliates. Thus the parent company with its subsidiaries was actually a multiproduct insurance firm. By 1950 there were approximately 150 separate property and casualty insurance groups made up of some 480 individual companies. These groups, though they included only a small part of the total number of nonlife insurance companies, provided more than 90 per cent of the total property and casualty insurance sold.6 When the states passed legislation enabling one company to write all classes of property and casualty insurance, company groups were no longer necessary. There has been some movement toward 2

' T h e simple designation "health insurance" is being adopted by many segments of the industry in place of "accident and health insurance," or other terminology. In this study the term "accident and health insurance" will be retained, however, because most of the data and much of the other material, particularly for earlier periods, still appear under this classification. Cf. "Committee on Health Insurance Terminology," Journal of Insurance, X X V I I I (March, 1961), 118-119. Accident and health insurance is provided by both life and casualty companies. In this single instance the two fields overlap. However, the life companies write approximately three-fourths of this type of insurance. See "Reviews and Previews," Best's Insurance News, LV, Fire and Casualty ed. (January, 1955), 17. »California, Insurance Code (1935), sees. 101,120. •Ibid. " B y 1955, multiple-line underwriting laws had been passed in all states, allowing one company to write most types of nonlife insurance if minimum capitalization and other charter requirements were met. For example, California now permits any property or casualty insurer to write all classes of insurance other than life, title, or mortgage. Ibid. (Supp. 1947), sec. 700.01. •Alfred M. Best Company, Inc., Best's Insurance Reports (52d Fire and Marine ed.; New York: Alfred M. Best Company, Inc., 1951), pp. x-xi; and Best's Fire and Casualty Aggregates and Averages (12th ed.; 1951), pp. 27, 47, 66, 114. T h e latter publication lists 1017 companies in 1950, exclusive of county and township mutual organizations. Some indication of the number of these small mutual enterprises is provided by the Directory of Mutual Companies in the United States: Fire and Casualty Insurance, Vol. X I X (Chicago: American Mutual Insurance Alliance, 1957), p. 163, which lists 2497 mutual companies for 1956. T h e greater proportion of these were farm assessment organizations.

4

The Industry

and the Public

Interest

consolidation; this and other aspects of group operations in property and casualty insurance are considered in chapter ii. The economic performance of a group of companies providing substitute products has some connection with the structural characteristics of the market and the conduct of the firms operating in that market. Chapters ii, iii, iv, and v are devoted to questions of property and casualty insurance market structure and behavior. In chapters vi, vii, and viii a group of what seem to be the most important aspects of economic performance for property and casualty insurance are considered. For each aspect of performance a desirable standard or level of achievement is suggested. Wherever possible, a method of measuring each performance aspect is developed. Observed industry results are compared with suggested standards, and finally an appraisal of overall performance is attempted. Since results varied among the performance aspects examined, the final appraisal involved a balancing of various kinds and degrees of performance. A statement of norms or standards of economic performance necessarily involves some initial judgments. The judgments postulated here are the following five: full employment of the economy's resources without inflation; efficient use of the economy's resources by producing at optimum capacity in optimum size production organizations; allocation of the economy's resources by consumer preferences other than antisocial preferences, defined by prevailing ethical standards; 7 allocation of the economy's resources to reach the highest growth rate in the production of goods and services consistent with other values expressed; and distribution of the economy's real output to foster stability, efficiency, and growth, as well as individual free choice (exercised responsibly), incentives, and capacity development. 8 Chapter ix begins with an attempt to draw some conclusions regarding the association of market structure and conduct with performance in this industry. Then, the policies—private and public— that have influenced nonlife insurance in the past are considered. Available policy alternatives are examined and assessed in chapter x and policy suggestions to improve performance are made. 7 Consumer preferences are not independently formed; imitation undoubtedly plays an important role. In addition, preferences may be "created" or at least significantly influenced by advertising and other promotional activity. Thus consumer preference becomes a somewhat shadowy concept and the significance of the allocation of resources to satisfy such preferences appears to be correspondingly tempered. See Tjalling C. Koopmans, Three Essays on the State of Economic Science (New York: McGraw-Hill Book Company, Inc., 1957), pp. 165-166. 8 This probably would mean a further reduction in income and wealth inequality over time.

The Industry Property and Casualty

Insurance

and the Public as an

Interest

5

Industry

It is convenient to think of the firms that provide the various classes of property and casualty insurance as an industry; these organizations share common problems, regulatory rules, and rate-making practices. In 1950, Alfred M. Best Company, Inc., insurance analysts, noted that "the community of interest between fire and casualty companies is emphasized by the fact that about 150 separate stock, mutual, reciprocal and Lloyd's insurance company groups made up of some 480 individual units include both fire and casualty companies. That this same community of interest does not exist between life and either fire or casualty carriers is borne out by the fact that less than a dozen groups include life insurance companies." 9 Since 1950 there has been an increasing tendency for property and casualty insurance groups to form or acquire life insurance affiliates. In 1959 the same Alfred M. Best Company reports that 74 of 137 capital stock fire and casualty groups included life insurance companies.10 This movement probably is the result of a desire to share in the expected rapid expansion of life insurance premiums in coming decades and to acquire facilities to provide a family insurance package that will include all insurance needs and may be merchandised on a monthly-payment plan. Nonlife and life insurance may ultimately merge in this way. The final answer is a number of years away, and it will depend on a number of factors, including permissive state legislation, industry and consumer acceptance, and the growth of social insurance. 11 Important differences between life and nonlife insurance continue to exist; moreover, it is convenient to distinguish the two in terms of availability and manageability of data. Thus in this study we will consider the nonlife industry to include all companies engaged in furnishing one or more classes of property or casualty insurance. Companies that sell accident and health insurance exclusively are in the nonlife industry; those that sell life and accident and health are in ' Best's Insurance Reports (1951), p. x. ""Stock Company Groups," Best's Insurance News, L.XI, Fire and Casualty ed. (June, 1960), 15. 11 See Milton W. Mays, "Significant Contrasts and Comparisons between Life Insurance and the Various Property and Casualty Insurance Fields," Journal of the American Society of Chartered Life Underwriters, VI (June, 1952), 273-284, reprinted in H. Wayne Snider, ed., Readings in Property and Casualty Insurance (Homewood, 111.: Richard D. Irwin, Inc., 1959), pp. 36-47; Richard M. Heins, "Extension of Group Marketing Principles to Property and Casualty Insurance," Annals of the Society of Chartered Property and Casualty Underwriters, X (January, 1958), 14-44, reprinted in Snider, op. cit., pp. 157-177; and T . J. V. Cullen, "An Editorial," The Spectator, CLXIV (November, 1956), 33-34.

6

The Industry

and the Public

Interest

the life industry. This method of distinguishing the two is followed by state regulatory agencies. The Property

and

Casualty

Insurance

Market

The larger company groups are licensed to transact insurance in all states and territories of the United States. Many of the smaller companies are entered in several states.12 Ordinarily, only the small township or county mutual companies operate on a local basis. In 1913 an insurance writer described the United States' insurance market as follows: "The business is essentially inter-state; that is to state, the greater percentage by far of insurance in force on the books of the companies is composed of policies from more than one state." 13 In the years since this was written, the percentage of interstate insurance has grown even larger. The information, quantitative and qualitative, available to judge the performance of the industry is based largely on nationwide aggregates.14 Evidence appears to justify treating the industry as operating in a national market. Economic Function and Justification of

Insurance

The courts long have held that insurance is a service in which the public has a special interest, though the industry has not been specifically designated a public utility. Courts have indicated that ordinarily the public does not have a right to demand and receive service from an insurance company. But the public does have an interest which extends beyond the individual, isolated contracts made between insurance companies and members of the public. Such contracts are interdependent, for they create a fund of which the insurance company is the depository and out of which losses are paid. In this way losses are distributed over a wide area—the disaster to an individual is shared by many.15 12 For a detailed list of companies and the jurisdictions in which they are licensed to do business, see the National Underwriter Co., Argus Fire Chart (Annual ed.; Cincinnati: The National Underwriter Co.); and Argus Casualty and Surety Chart (Annual ed.; Cincinnati: The National Underwriter Co.). 18 W. F. Gephart, Insurance and the State (New York: Macmillan Co., 1913), p. 3. "State insurance departments usually publish premium volume written in their state. To indicate what little meaning they attach to this, other than for tax or rate regulatory purposes, they generally publish also the total United States' writings of companies doing business in their states. "For a discussion of the public interest in insurance, see Emmett H. Wilson, "Property Affected with a Public Interest," Southern California Law Review, IX (November, 1935), 1-13. Examples of decisions emphasizing the public interest in insurance are: German Alliance Ins. Co. v. Lewis, 233 U.S. 389 (1914); La Tourette v. McMaster, 248 U.S. 465 (1919); O'Gorman and Young v. Hartford Fire Ins. Co.,

The Industry

and the Public

Interest

7

This distribution of losses in advance over large groups and its effects constitute the economic function and justification of insurance. The demand for insurance for this purpose has been summarized as follows: T h e d e m a n d for insurance is d u e to o n e of the inevitable facts of h u m a n existence—that despite his best efforts to escape them, m a n is at all times exposed to risks a n d uncertainties. I n the course of time it has been discovered that some types of these risks can be largely eliminated by m e a n s of a system of pooling, or insurance. If risks can be spread over a sufficiently large a n d varied group, w h a t was for the individual a small chance of a severe, p e r h a p s disastrous, loss becomes for the group, a n d for each m e m b e r of it, t h e certainty of a small loss, or in o t h e r words, a small, regular expense which can be provided f o r in advance like o t h e r expenses. 1 8

Frank H. Knight notes that "uncertainty is one of the fundamental facts of life. It is as ineradicable from business decisions as from those in any other field." 17 So long as there is change, there will be uncertainty. Part of this uncertainty arises from instances which occur under conditions of sufficient uniformity and in sufficient numbers to permit establishment of an empirical probability of a given outcome. But the outcome of an instance viewed in isolation will continue to be uncertain. G. L. S. Shackle says, "It is universally agreed that the probability of a single, isolated event has no meaning. . . ." 18 It is only when similar events are pooled that uncertainty becomes a measurable or actuarial risk.19 For the individual or firm facing the 282 U.S. 251 (1931); U.S. v. South-Eastern Underwriters Assn., 322 U.S. 533 (1944). For the pioneer discussion of insurance and economic theory, see Allan H. Willett, The Economic Theory of Risk and Insurance (New York: Columbia University Press, 1901. Reprinted by the University of Pennsylvania Press, Philadelphia, 1951). A recent discussion is Irving Pfeffer, Insurance and Economic Theory (Homewood, 111.: Richard D. Irwin, Inc., 1956). u F. W. Paish and G. L. Schwartz, Insurance Funds and Their Investment (London: P. S. King and Son, Ltd., 1934), p. 2. " Frank H. Knight, Risk, Uncertainty and Profit (Boston and New York: Houghton Mifflin Co., 1921. Reprinted by the London School of Economics, London, 1933), p. 347. 18 G. L. S. Shackle, Expectation in Economics (Cambridge, England: Cambridge University Press, 1952), p. 110. "Albert G. Hart, Anticipations, Uncertainty, and Dynamic Planning (Journal of Business, "Studies in Business Administration," Vol. XI, No. 1; Chicago: University of Chicago Press, 1940. Reprinted by Augustus M. Kelley, Inc., New York, 1951), p. 51, explains conversion of uncertainty into measurable risk in the following way: "Estimates about any future event which is not regarded as certain may involve either uncertainty or risk. T h e event viewed in isolation is always uncertain. But viewed as a member of a group of events so related that their joint outcome is more certain than the individual events in the group, it is a risk. Both to a fire insurance company and to its owner the future of a building . . . is uncertain. But

8

The Industry

and the Public

Interest

possibility of loss from an event that has a numerical probability, insurance is a device to eliminate the risk arising from the dispersion around the mean value of the numerical probability of loss.20 Many events and decisions confronting individuals and firms are essentially unique. No well-founded probabilities for different outcomes can be established empirically or deductively. Human reactions to the uncertainty arising from ignorance of the outcome of these virtually isolated, nonclassifiable instances are important in economics and other social studies. 21 This study considers, however, the economic performance and policy aspects of an industry that has grown up to distribute the losses from events which ordinarily are classifiable and about which probability estimates of future behavior may be obtained. The study's only direct concern with uncertainty not susceptible to measurement arises because measurable uncertainty shades gradually into immeasurable uncertainty. In addition, the vague dividing line between measurable and immeasurable uncertainty will shift as the quantity and quality of data improve. Wide past experience plus an ability to appraise similarities among instances may enable probability forecasts and the provision of insurance before the probability calculus in the strict sense can be applied. 22 A distinction may be made between the interest of consumers and business firms in insurance. Basically, both types of purchasers are using insurance to eliminate the uncertainty associated with particular events, but apparent reasons for wanting to eliminate uncertainty and the effects of doing so may differ in each case. to the company which insures it, assuming that it also insures many comparable buildings, the b u r n i n g of the building is a risk." 20 See Shackle, op. cit., p. 126. 21 For some of the growing literature in this field, see H a r t , op. cit.; Shackle, op. cit.; J o h n Von N e u m a n n and Oskar Morgenstern, Theory of Games and Economic Behavior (2d ed.; Princeton: Princeton University Press, 1947); J a c o b Marshak, " R a t i o n a l Behavior, Uncertain Prospects, a n d Measurable Utility," Econometrica, X V I I I (April, 1950), 111-144; Kenneth J . Arrow, "Alternative Approaches to the Theory of Choice in Risk-taking Situations," Econometrica, X V I V (October, 1951), 404-437; C. F. Carter and others, Uncertainty and Business Decisions (Liverpool: University Press, 1954); P. A. Samuelson, "Probability, Utility, a n d the Independence A x i o m , " Econometrica, X X (October, 1952), 670-678; Friedrich A. and Vera C. Lutz, The Theory of Investment of the Firm (Princeton: Princeton University Press, 1951), p p . 188-190; I. N . Herstein and J . W. Milnor, " A n Axiomatic Approach to Measurable Utility," Econometrica, X X I (April, 1953), 291-297; W a r d Edwards, " T h e T h e o r y of Decision M a k i n g , " Psychological Bulletin, L I (1954), 380-417; R . Duncan L u c e and Howard Raiffa, Games and Decisions (New York: J o h n Wiley a n d Sons, Inc., 1957), p p . 275-326. See also note 27 below. 23 See William Fellner, Monetary Policies and Full Employment Los Angeles: University of California Press, 1946), p . 153.

(Berkeley

and

The Industry C O N S U M E R I N T E R E S T IN

and the Public

Interest

9

INSURANCE

There appear to be a number of reasons why an individual might consider the purchase of insurance against hazards affecting his property or income. (1) Knowledge of the probability of a particular outcome in a given situation is of little value to an individual who conducts the "experiment" only once or, at most, a few times. Deviations from the average outcome may cause an individual consumer's experience to be quite different from the mean expectation. For example, knowledge that the burning rate for private dwellings in the United States is one per thousand per year does not indicate what an individual owning one house may expect. His particular house may never burn or it may burn within the hour. The uncertainty arising from the dispersion around mean values of probable outcomes may be eliminated by the device of insurance.23 (2) An individual consumer may wish to spread his losses through time. Insurance offers that opportunity for insurable risks. Insurance does not, however, reduce the total loss in the economy, unless insured property or income becomes less susceptible to loss upon being insured. Thus, as a group, purchasers of insurance will pay for all losses plus administration costs and profits of insurance organizations. But for an individual the payment of regular premiums serves to spread losses equally through time, though losses will be occurring erratically. This will tend to stabilize the income available to a household. Albert G. Hart points out that increasing the stability of income is likely to increase the total satisfaction derived from any given average income. And large, unpredictable income changes in either direction occasion some waste of past expenditures. 24 (3) The effects of large losses and gains are not expected to be symmetrical for a household. A large loss, whether it be destruction of property or loss of income through personal disability or unemployment, may threaten the standard of life of the household. For this reason, consumers might be expected to wish to eliminate chances of large losses whenever possible. In addition, society may find it undesirable to have individuals assume some types of risks even if they are willing to do so. Commenting on this latter factor, Frank H. Knight says, "Clearly there are limits to the terms on which the members of society are to be allowed to take chances, and notably when 28 21

See Shackle, op. cit., p. 126. Hart, op. cit., pp. 72-73.

10

The Industry

and the Public

Interest

the independent members have dependent upon them other members in whom society is peculiarly interested." 25 Many of the hazards faced by individuals are associated with the type of economy or civilization in which they live. For example, the risks of unemployment, industrial injury, and automobile accident might be viewed as part of the present American industrial society. Spreading losses from these and other similar sources would appear to be desirable to protect minimum standards of living, to allow individuals to develop fully their capabilities, and to assist in stabilizing the economy. (4) Many consumers may have an aversion to risk. This will be true "because of the much-maligned principle of diminishing utility. » 2« That is, progressive reductions in income deprive the individual of successively larger amounts of satisfaction. Therefore, he will seek to avoid chances of loss leading to reductions in income or property. This proposition is essentially a wider application of the increasing disutility of large losses suggested in the previous section. Insurance enables those who feel an aversion to risk to exchange uncertainty for certainty. The widespread sale of insurance and the existence of an extensive social insurance system are evidence of a desire to avoid risk. Risk is not abhorred by all, however. Many seek it. Gambling, amusements, and sports furnish examples of this. Often individuals attempt to eliminate particular kinds of uncertainty and at the same time readily accept other kinds of uncertainty by entering into wagering contracts. These apparently conflicting desires seem to be widespread.27 Our concern in this study is with insurance and its value to those who wish to avoid risk. Consumers have at least two additional interests in insurance. They are concerned with the variety and the price of the product. Assuming that insurance is desired by consumers for the reasons suggested, and perhaps others, the price at which the product is offered is an important factor. Presumably the consumer would like the price to be Knight, op. cit., p. 868. Hart, op. cit., p. 72. 27 For a discussion of utility and accepting and avoiding risk, see Milton Friedman and L. J . Savage, "The Utility Analysis of Choices Involving Risk," Journal oj Political Economy, LVI (August, 1948), 279-304, reprinted in G. J. Stigler and K. E. Boulding, eds., Readings in Price Theory (Chicago: Richard D. Irwin, Inc., 1952); Harry Markowitz, "The Utility of Wealth," Journal of Political Economy, LX (April, 1952), 151-158; A. A. Alchian, "The Meaning of Utility Measurement," American Economic Review, XLIII (March, 1953), 26-50; Robert H. Strotz, "Cardinal Utility," American Economic Review, X L I I I Proceedings (May, 1953), 384-397; G. C. Archibald, "Utility, Risk, and Uncertainty," Journal of Political Economy, LXVII (October, 1959), 4 3 7 ^ 5 0 . See also the references in note 21. 25 28

The Industry

and the Public

Interest

11

as low as possible, consistent with the provision of necessary services and the maintenance of organization solvency. And since consumers' reactions to risk will differ, they will be interested in having some variety of insuring methods and insurance contracts from which to choose. BUSINESS INTEREST IN INSURANCE

Many of the factors mentioned in the discussion of consumer interest in insurance apply equally well to business. For example, the industrial purchaser of insurance also has an interest in price and product variety. It is also true that insurance may enable a firm to distribute some of its losses through time as a certain premium is substituted for an uncertain chance of loss. There are a number of other ways in which insurance may serve an economic function for business. (1) Hart describes the purchase of insurance, the maintenance of liquidity, and the use of unspecialized productive equipment as uncertainty reactions. He says these things . . . are commonly thought of as devices by which the standard deviation of n e t receipts' prospects is reduced at the expense of reducing their expectation value. T o explain the willingness of businessmen to make this supposed sacrifice of income expectations, 'risk aversion' is attributed to them, in the face of m u c h evidence that in some quarters danger is courted. T h i s view of the uncertainty reactions . . . is inadequate. T h e y may be, a n d commonly are, devices for raising the expectation value of net receipts for the life of the firm by reducing their standard deviation for the near future. Risk aversion, then, is n o t necessary for their explanation. 2 »

For those situations to which businessmen have an aversion to risk, insurance is useful. As Hart suggests, it may also be useful where risk aversion is not a factor. (2) Carrying insurance will often improve the credit rating of a firm. This may mean it can obtain more outside funds, and perhaps at lower rates of interest. Paying insurance premiums ordinarily will not reduce appreciably the firm's net receipts in favorable circumstances, but it does offer substantial improvement if events are no longer favorable. 29 (3) Losses and gains are asymmetrical, particularly in the early life of a firm. A small number of unfavorable outcomes amounting to a large enough fraction of a firm's net worth may force it into bankruptcy. For example, a large uninsured fire loss may reduce net worth 28

Hart, op. cit., p. 72. "Ibid., p. 69.

12

The Industry and the Public

Interest

to a level that creditors consider dangerous, and liquidation might follow. Under such circumstances, purchase of insurance is a rational expenditure for the businessman.30 (4) If a capitalist economy is to operate at satisfactory levels and to grow, businessmen must make a succession of investment and other decisions which involve varying degrees of uncertainty. T h e outcome of many or most of these decisions is not predictable in a strict probability sense. William Fellner states, " T h e actual instances faced by businessmen do not belong in homogeneous universes." 31 Part of the uncertainty which surrounds many business problems may be eliminated, however, by insurance and other devices. For example, property and income may be insulated from many hazards that are sufficiently amenable to the probability calculus to permit insurance; any reduction in overall uncertainty might be expected to facilitate decision making. 32 Some Performance Criteria in Insurance Much has been written in the last two or three decades on what is desirable economic performance for the economy in general and individual industries in particular. This discussion has produced some agreement on the broad outlines of economic performance. 33 Complete agreement is impossible and probably undesirable, for establishment of desirable goals of economic performance involves a considerable amount of subjective evaluation. Quite naturally, this leads to varying conclusions, but, in the main, the variations seem to occur largely in what might be called the less relevant rather than the more relevant aspects of economic performance. Certain aspects of economic performance will be more important for particular industries and segments of the economy than for others. Moreover, some aspects of performance, no matter how desirable they may be for the economy as a whole, are not appropriate for a particular firm or industry. For example, a level of full employment (however defined) is a desirable result for the economy. Yet it would be difficult to relate such a norm directly to a firm, or even an industry, See ibid., p. 68, and Shackle, op. cit., p. 126. Fellner, op. cit., p. 153. M See Shackle, op. cit., pp. 111-118. 83 Perhaps a representative statement is found in Edward S. Mason, "Current Status of the Monopoly Problem in the United States," Harvard Law Review, L X I I (June, 1949), 1268, 1280-1285, reprinted in Edward S. Mason, Economic Concentration and the Monopoly Problem (Cambridge, Mass.: Harvard University Press, 1957), pp. 351-370. 30 81

The Industry and the Public Interest

13

while the assumption of a capitalistic form of organization is maintained.34 T h e task faced here is the specification of performance criteria which appear to be of particular importance to this industry and its relationship to the economy. Any performance norm one establishes is based upon a set of value premises. Those upon which this study depends were discussed earlier in this chapter. The performance criteria which appear to be the most important in evaluating the property and casualty insurance industry are briefly discussed in the following sections. PROGRESSIVENESS

Progress in property and casualty insurance may be viewed in two ways: in terms of product and process innovation which increase both the variety and want-satisfying power of the services making up the industry's output; and in terms of changes which reduce costs in the industry and make its services available at lower prices. Both of these aspects of industry progressiveness are directly important for consumers and business and indirectly important for the economy. For economic aggregates, progress in insurance may mean the indirect promotion of higher levels of investment and greater economic stability as uncertainty is further reduced and losses are more widely distributed. Cost-reducing changes mean more efficient use of and better allocation of resources. If cost reductions are not passed on to the buyer as lower prices or better products, profit and income distribution patterns will be affected. 35 PRODUCT V A R I E T Y

The variety of forms and combinations of insurance protection offered by the industry should be large enough to meet all of the socially desirable wants of purchasers. Yet the variety should not be needlessly large; the distinctions between contracts should be genuine. Mere proliferation of insurance policy types that are essentially the same is apt to create costly confusion rather than satisfaction. This will be especially true if directions for the purchase and use of insurance are poor. 34 Some would undoubtedly still argue that it is inappropriate to speak of a full employment norm for a capitalistic economy. 25 In terms of consumer choice it would be preferable to do it by lower prices and let the consumer decide whether or not to purchase additional insurance protection.

14

The Industry

and the Public

Interest

CAPACITY

Capacity involves the ability of the industry to meet the demand for various types of insurance protection. If the benefits from the distribution of losses are to be fully realized, the industry must have sufficient facilities and capital funds to enable any legitimate insurance buyer to obtain protection. Yet there must not be chronic excess capacity in the industry. In insurance this would be represented mainly by unnecessary capital funds. Since insurance capital and reserve funds are subject to quite strict investment regulation, any unneeded funds might find more productive employment elsewhere. Concentration of industry production in units of the most efficient size also is desirable. P R O F I T LEVELS

Profit levels involve cost-price relationships in the industry. The insurance buyer is interested in obtaining the service at the lowest price consistent with reasonable service and assurance that future losses will be paid. Profits over time need not average more than the return on capital necessary to enable the industry to perform expected services adequately. Profits in excess of those necessary to call forth the needed supply of insurance service affect the distribution of income in the economy. This in turn is expected to have effects on such things as the level of employment and the stability of the economy. SELLING COSTS

Selling costs might be considered a special subcase of the cost-price relationship treated under profits. There are essential differences, however. Total costs may be inflated as a result of excessive selling expenditures, yet profits may be small or nonexistent. Only by examination of selling costs per se is it possible to determine whether an industry is devoting excessive quantities of resources to this activity. Insurance would appear to be a type of industry that might be susceptible to larger than necessary selling expenditures. The industry produces a service with which the ordinary purchaser is unfamiliar, and there are no feasible ways to test the product before purchase. Selling costs are also related to industry capacity—particularly the aspects of chronic overcapacity and lack of optimum size units. SUMMARY OF INDUSTRY PERFORMANCE

CRITERIA

The public has an interest in insurance being available for all socially desirable activities that are susceptible of actuarial handling. Not everyone—consumer or producer—will wish to exchange uncertainty

The Industry and the Public Interest

15

for certainty in all insurable situations, but the choice should be available. This means an adequate supply of insurance service at all times. Moreover, the public has an interest in insurance being supplied efficiently with the smallest necessary profit and selling cost payments. The above industry performance criteria have been selected because they seem to offer the best possibility for determining whether or not the industry is meeting the needs of the economy as well as may be expected. Each of these dimensions will be examined in detail in chapters vi, vii, and viii.

CHAPTER II

Size, Number, and Organization of Firms in the Industry

Types of Company

Organization

and Numbers

of Each

Private nonlife insurance companies are organized on four principal bases: capital stock, mutual, reciprocal exchange, and Lloyd's association. In 1958 the estimated numbers and sales of each type were as follows:1 Organization Type Capital Stock Mutual Reciprocal Exchange Lloyd's Association

Number of Companies 733 375 63 16

Premiums (millions) $9,077 3,282 445 24

These premiums represent direct sales to policyholders plus reinsurance premiums received minus reinsurance premiums paid. Re1 Alfred M. Best Company, Inc., Best's Fire and Casualty Aggregates and Averages (20th ed.; New York: Alfred M. Best Company, Inc., 1959), pp. iv, 1, 51, 147, 203, 205. As indicated in chapter i, demonstrably complete data on property and casualty insurance in the United States are not available. The data shown are described as complete for private, commercial insurance organizations, except for the following omissions: insurance written by small township and county mutuals; accident and health insurance written by life insurance companies; and hospitalmedical insurance written by Blue Cross, Blue Shield, or similar nonprofit associations.

16

Firms in the Industry

17

insurance premiums arise from contracts among insurance companies to share risks.2 Division of the original risk enables an insurance company to limit its losses. Yet it can provide insurance service for either of two potentially difficult situations to insure: (1) risks that might result in large single losses and (2) risks, in a particular city or region subject to a common catastrophe exposure, that might result in large aggregate losses. Reinsurance may also be used to reduce the reserve requirements of insurance organizations. (The question of reserves is examined in chapters v and viii.) In addition to the reinsurance facilities provided by the direct writing companies in the United States, there are some 150 professional reinsurance companies operating in the world.3 Most of these are organized on a capital stock basis. Adequate reinsurance facilities, drawing upon companies in all parts of the world in order to achieve the widest possible dispersion of risk, are conceded to be of the utmost importance to the stable operation of the insurance industry. Reinsurance is particularly important for smaller or newer organizations. Each type of company organization is examined more closely in the following sections. CAPITAL STOCK COMPANIES

Capital stock companies have long dominated the property and casualty insurance industry.4 They operate under state charters which require a minimum paid-in capital scaled according to the classes of insurance the corporation seeks to transact. If a capital stock organization wishes to use the multiple-line underwriting powers that have recently been 8 Reinsurance has been defined as "a contract whereby one for a consideration agrees to indemnify another wholly or partially against loss or liability by reason o£ a risk the latter has assumed under a separate and distinct contract as insurer of a third party." Stickel v. Excess Insurance Co. of America, 23 N.E. (2nd) 839, 136 Ohio St. 49 (1939). 'Report of the Sub-Committee to Study the Question of Re-Insurance (Lincoln, Nebr.: National Association of Insurance Commissioners, 1950), p. 36. Robert B. Taylor, former Oregon Insurance Commissioner, believes that the multiple underwriting powers recently granted will augment the domestic reinsurance market. As companies expand their charters and merge their subsidiaries, they will be in a position to insure or reinsure all classes of insurance and will have their assets concentrated to do so. Weekly Underwriter, November 13, 1951, p. 890. Another writer feels that it will still be impossible for the United States to provide an adequate reinsurance market because of the "doubling up" hazard. T h i s means there is a possibility of being deeply involved in any major catastrophe both as a direct insurer and as a reinsurer. Levering Cartwright, "The Lloyd's Reinsurance Hassle," The Spectator, CLXII (April, 1954), 104.

* This is in contrast to the life industry, where the mutual form of organization predominates. See Shephard B. Clough, A Century of American Life Insurance (New York: Columbia University Press, 1946), pp. 30, 126.

18

Firms in the

Industry

enacted, it often has to have a minimum paid-in capital of as much as one million dollars.5 Usually capital stock companies do not participate in or share profits with their policyholders.6 Nonparticipating stock companies solicit business mainly through agents or brokers.7 These representatives are usually compensated by a level commission rate on their total sales—new policies and renewal policies alike. This method of selling insurance has been summarized as follows: "While the services of these middlemen, who are compensated by the companies, add to the expense of doing business, and therefore increase premium rates, it is claimed that their services to the insured in advising on insurance matters, choosing carriers, and securing favorable rates and contracts are well worth the cost." 8 This company-sales representative relationship is known as the American Agency System. It will be discussed structurally in chapter iii; its impact on the industry's performance relative to resource use in selling will be examined in chapter viii. Various reasons are suggested for the domination of property and casualty insurance by capital stock companies—definite rates, security and permanence, wider extent of their business, and agency services.9 Some of these are results rather than causes of comparative success. Another explanation is that the corporate form has been better adapted than the cooperative types of organization to obtaining the funds for minimum paid-in capital requirements and expansion needs. Stock companies have also aggressively expanded total sales and classes of insurance sold. Mutual and reciprocal organizations have often been content to provide a few classes of insurance for a limited group or * This is the requirement in California. See California, Insurance Code (Supp. 1947), sec. 700.01. For a discussion of multiple-line underwriting and capital structures, see Shelby Cullom Davis, "Impact of Multiple Line Underwriting on the Capital Structure of Insurance Companies," The Journal of Insurance, XXV (July, 1958), 61-64. See also U.S. Congress, Senate Subcommittee on Antitrust and Monopoly of the Committee on the Judiciary, Report, The Insurance Industry, 86th Cong., 2d Sess., I960, pp. 195-194. 'Best's Fire and Casualty Aggregates and Averages (1959), pp. 63, 65, 73, 75, 85, 87, shows 60 fully participating companies out of a total of 733 stock companies. Some stock companies may participate in one or a very few classes of insurance, however, to meet price competition from other types of insurers. For example, in workmen's compensation insurance a number of otherwise nonparticipating companies have felt it necessary to share profits with policyholders in order to counteract the appeal of mutual and reciprocal exchange organizations. 7 Participating stock companies may also sell through agents or brokers, but they are likely to offer lower commission scales than the nonparticipating organizations. 'Ralph H. Blanchard, "Insurance Carriers," in G. F. Michelbacher, Casualty Insurance Principles (2d ed.; New York: McGraw-Hill Book Company, Inc., 1942), p. 19. 'Ibid., p. 18.

Firms in the Industry

19

region, expanding only when pressed to do so by policyholders. The experience of the last few decades, however, points to a growing challenge to the traditional stock company method of furnishing insurance service. In 1931 capital stock companies provided 83.5 per cent of the property and casualty insurance sold. By 1958 this had fallen to 69.2 per cent. Mutual and reciprocal organizations have grown more rapidly, largely because of lower prices for the same or similar products.10 A few stock companies sell insurance directly to consumers, without the services of agents or brokers, at generally lower prices. MUTUAL

COMPANIES

Mutual companies, other than purely local organizations, currently amount to slightly more than half of the number of capital stock companies and sell approximately 27 per cent of the property and casualty insurance sold. Mutual organizations are the principal type of participating enterprise in the insurance industry. They are corporations that exist by authority of a state charter as do other corporations. But mutual corporations do not have capital stock or stockholders. Funds, both for minimum statutory surplus requirements and for operating the business, are obtained from policyholders.11 Upon entering into a contract of insurance, an insured becomes a member of the mutual corporation, entitled to a vote—or sometimes additional votes based on the number of policies purchased or value of premiums in force—plus the right to share in revenue in excess of expenses, losses, and additions to surplus. Mutual companies have tended to concentrate on a few classes of insurance, usually one or more of the following: fire, workmen's compensation, automobile, and disability. This tendency, combined with an inclination to focus on a particular industry group or geographical area, has kept most mutual companies smaller than the large stock organizations. Now, however, the mutual enterprises are likely to grow 10 See James F. Crafts, " T h e Great Partnership," Best's Insurance News, L I U , Fire and Casualty ed. (April, 1953), 25; Best's Fire and Casualty Aggregates and Averages (1959), p. 1; and J o h n A. Diemand, Address before the National Convention of the Society of Property and Casualty Underwriters, Los Angeles, California, September 17, 1959, reported in United States Investor, October 12, 1959, pp. 49-50. 11 Mutual companies maintaining a surplus equivalent to the required capital of stock companies may issue policies that are nonassessable; that is, the policyholder cannot be compelled to contribute any funds in excess of his original premium payment, regardless of the fortunes of the enterprise. If a mutual corporation is content to issue assessable policies, as most of the small local organizations do, it may begin operation when a stated minimum of insurance has been applied for and first-year premiums paid. Assessments commonly are limited to an amount equal to the original premium. Blanchard, op. cit., p. 21.

20

Firms in the

Industry

at a faster rate since they are selling a greater variety of insurance types over a wider market area.12 Mutual companies may sell through agents, or they may rely on salaried employees or the recommendation of members to obtain new business. When agents are used, the commission scale is apt to be lower than that among stock companies. We shall examine this aspect of mutual company operations more intensively in chapter iii. Mutual organizations stress several essential differences between their mode of operation and that of the capital stock companies. Mutual insurance is said to be provided "at cost" as mutual companies often return in policyholder dividends sums in excess of losses, expenses, and required or suitable additions to surplus. Expenses tend to be lower because of lower sales expenditures. Policyholders as members of the mutual corporation have the right to participate in control of the organization. As the enterprise grows beyond the small local assessment type of operation, it is doubtful, however, that the average policyholder has any more interest in or effective possibility of exercising control than does the typical stockholder in a stock insurance company. Finally, as a mutual company accumulates surplus to equal the statutory requirements for the classes of insurance being written, it may receive state permission to issue nonassessable policies.13 This is the type of contract issued by mutual companies which are a significant factor in other than purely local markets. Thus, these firms emphasize that they are able to offer the same security as stock companies and, in addition, at-cost insurance in a policyholder-controlled organization. 14 RECIPROCAL EXCHANGES

A reciprocal exchange is a particular type of cooperative organization formed to accept specified risks faced by the exchange's members. In terms of the amount of insurance service provided, this form of organization is of little importance in property and casualty insurance. In a few classes of insurance, however, reciprocals have grown to be of considerable importance. Undoubtedly, reciprocal exchanges have influenced price patterns in insurance by their use of low-cost methods of providing service. 13

Ibid., and Best's Fire and Casualty Aggregates and Averages (1959), pp. 185-201. Maine, New Hampshire, and Massachusetts passed enabling legislation within the last few years to permit nonassessable mutual company policies. All other states had previously done so. See Roger Kenney, Fundamentals of Fire and Casualty Insurance Strength (2d ed.; Dedham, Mass.: Kenney Insurance Studies, 1953), p. 143. " F o r a discussion o£ mutual property and casualty insurance, see ibid., pp. 124— 148, and Blanchard, op. cit., pp. 18-22. u

Firms

in the Industry

21

The insurance provided by reciprocal exchanges has been described as follows: Reciprocal insurance is really inter-insurance—or, to be more specific, it is a n u n i n c o r p o r a t e d g r o u p of individuals agreeing to exchange private contracts of i n d e m n i t y t h r o u g h a socalled attorney-in-fact. W h e n o n e chooses to become a subscriber to a reciprocal, h e becomes just w h a t the n a m e implies. I n reality, he becomes a p a r t n e r in t h e insurance business, assuming his prop o r t i o n a t e share of the risks w r i t t e n by the organization . . . because it is essentially inter-insurance of a n u n i n c o r p o r a t e d g r o u p of i n d i v i d u a l s — a n d each b e a r i n g his p r o p o r t i o n a t e share of the losses, a n d each o w n i n g a share of t h e surplus—the stated 'surplus' is n o t surplus at all, b u t a mere aggregation of credits which belong to the subscribers individually. 1 5

Reciprocal exchanges are managed by an attorney-in-fact (individual, partnership, or corporation). Subscribers delegate authority to the attorney-in-fact to represent them in insuring all other subscribers. Subscribers choose an advisory board from among their number; this board has powers as defined in the articles of association of the exchange or in the subscriber's agreement. These powers may provide for close supervision over the attorney-in-fact and all aspects of exchange operations, or they may be quite modest in scope. A common method of operation is to pay the attorney-in-fact an agreed portion of premiums to defray expenses other than losses and loss expenses. Losses and loss expenses are paid from the portion of premiums not allocated to the attorney-in-fact. If loss payments are less than expected, excess premiums are returned to subscribers as dividends or added to surplus. If loss payments are more than expected, subscribers are usually subject to assessment up to some maximum amount. 16 The kind and amount of regulation imposed on reciprocal exchanges vary quite widely from state to state. But, in general, re" Kenney, op. cit., pp. 158-159. Reciprocals may have group surpluses and thus be difficult to distinguish from mutuals. " F o r example, California, Insurance Code (Supps. 1937, 1939, and 1941), sees. 1390-1402, provides that when a reciprocal exchange has insufficient assets to discharge all liabilities and maintain required surplus, an assessment shall be levied against subscribers to make up the deficiency. T h e power of attorney may limit the contingent liability of a subscriber for assessment. Such liability, however, cannot be less than an amount equal to and in addition to the premium originally paid or deposited under the policy contract or contracts. An exchange which has a surplus of at least one and one-half times the minimum paid-in capital required of incorporated insurers writing the same classes of insurance may be granted a certificate permitting it to issue nonassessable policies. T h e larger exchanges in California operate under such certificates. See Alfred M. Best Company, Inc., Best's Insurance Reports (60th Fire and Casualty ed.; New York: Alfred M. Best Company, Inc., 1959), pp. 584B-589B, 608B-611B, 614B-615B, 651B-652B.

22

Firms in the Industry

ciprocals are less stringently regulated than are stock and mutual organizations. 17 Inter-insurance has been most successful in automobile and workmen's compensation insurance. The geographical area served is usually not extensive, though a few reciprocal exchanges transact business over a wide area. 18 Exchanges are particularly active in California, where they have been aggressive competitors of the stock and mutual companies for automobile and workmen's compensation, among other classes of insurance. 19 Their lower costs of operation, resulting largely from selling through salaried employees or agents compensated by reduced commission scales, enable them to sell insurance at prices substantially lower than those of stock companies operating by conventional agency or brokerage methods. The subscriber to a reciprocal exchange assumes certain responsibilities and receives certain benefits. Both of these are closely related to the type of contract with the attorney-in-fact. Whether the members of an exchange are going to receive insurance that is administered at the lowest possible cost depends mostly on the competence and integrity of the attorney-in-fact. Contract terms largely determine whether subscribers are to have an effective opportunity to participate in the control of the organization. The principal importance of the reciprocal exchange to the insurance industry appears to be the price competition it provides other types of insurers in certain classes of insurance. LLOYD'S ASSOCIATIONS

The term Lloyd's or Lloyd's association stems from the insurance activities of a group of English underwriters, who began to provide insurance against marine perils in the latter part of the seventeenth century. Many of the contracts were negotiated in a London coffeehouse operated by Edward Lloyd—thus the name London Lloyd's or Lloyd's of London. From the beginning the liability of each underwriter was several and not joint. This has continued to the present. " See Blanchard, op. cit., pp. 23-24. " F o r example, the Farmers Insurance Exchange of Los Angeles, California, is authorized to transact business in all states except Alaska, Delaware, New Hampshire, Ohio, R h o d e Island, and Vermont. Best's Insurance Reports (1959), p. 609B. 19 In 1957 reciprocal exchanges wrote 12.6 per cent of the property and casualty insurance sold in California; this contrasts with their 1.7 per cent of United States sales. California reciprocal sales nearly matched mutual sales—12.6 per cent and 15.0 per cent, respectively. State of California, Ninetieth Annual Report of the Insurance Commissioner for the Year Ended December 31, 1957 (San Francisco, 1959), p. 145.

Firms in the Industry

23

A single contract may be underwritten by many individuals, each accepting liability for a designated portion of the risk. Operations have become formalized, so that today groups of underwriters formed into syndicates conduct business through underwriting agents, all within the framework of a British-regulated Lloyd's Corporation and Committee of Lloyd's. Nevertheless, each underwriter acts for himself. The legal, organizational structure merely furnishes facilities and regulates the admission and conduct of members. 20 Groups of underwriters have formed Lloyd's associations in the United States, but their operations have not been significant. The small premium volume for Lloyd's associations shown earlier in this chapter represents the sales of American Lloyd's organizations in the United States and London Lloyd's in the states of Illinois and Kentucky. These two states are the only United States jurisdictions in which the English underwriters are authorized to do business. 21 We can dismiss American Lloyd's associations since they are so small individually and aggregatively that they exert no real influence on the industry.22 London Lloyd's is another matter. This group exerts an influence on American insurance in two ways. It is an important reinsurance market for American insurers.23 It also provides, exclusive of its authorized business in Illinois and Kentucky, some direct property and casualty insurance in the United States. Such direct sales are supposedly limited to classes of insurance or types of individual risks which American companies cannot or do not wish to insure. The impact of London Lloyd's on the American insurance industry will be discussed further in chapter v. 20 For discussions of London Lloyd's and their operations, see C. E. Golding and D. King-Page, Lloyd's (New York: McGraw-Hill Book Company, Inc., 1952); D. E. W. Gibb, Lloyd's of London (London: Macmillan and Co., Ltd., 1957); and Charles H. Groves, Report on Security Available to American Policyholders Under Contracts Issued by Underwriters at Lloyd's London (Denver: Colorado Fuel and Iron Corporation, 1955). a Best's Insurance Reports (1959), p. 574B. ** Such organizations are found principally in Texas, New Mexico, and New York, and even in these areas they write a very small part of the property and casualty insurance sold. Ibid., pp. 561B-577B. a Data are not available on American reinsurance assumed by Lloyd's. Estimates indicate, however, that it provides at least 60 per cent of United States fire reinsurance. Other coverages requiring extensive reinsurance are probably placed there in comparable amounts. See Roger Kenney, " 'Delays Have Dangerous Ends' on this Question of Lloyd's Reinsurance," United States Investor, January 2, 1954, pp. 1012; "And Now a British Surplus Line Company Bites the Dust," ibid., October 5, 1959, pp. 91-98; "The Battle of the Potomac," ibid., October 26, 1959, pp. 55-64; and Report of the Sub-Committee to Study the Question of Re-Insurance, pp. 35-36.

24 Holding

Firms Company

in the

Industry

Operations

Within each type of company organization there has been a marked tendency for enterprises to group into fleets, commonly owned and controlled by a parent firm that acts as a combined holding-operating company. The parent company enters into insurance contracts in its own name, as do each of the subsidiaries. The fleet operation plan emerged in the 1890's. The original impetus and early development were based on company attempts to circumvent widespread industry agreements to limit local agency representation. T o exploit territories more intensively, and yet not technically violate the limiting agreement, firms formed or bought additional companies and appointed sales agents to sell policies bearing the company name of the new subsidiary.24 Later, as casualty insurance grew more important, it provided additional impetus to the development of group operations. T o understand this we need to note the changing pattern of state grants of authority to engage in the insurance business. The first American stock insurance company, The Insurance Company of North America, was granted a charter in 1792 to write all forms of insurance—life and nonlife. Within 50 years both new and renewal charters were being restricted. Many companies had not used their full underwriting powers, and some companies had failed. This led state legislative and regulative bodies to feel that broad powers were unnecessary and dangerous.25 What finally evolved was a general state practice of permitting a company to write only one of the three main groups of insurance coverages—life, fire and marine, or casualty. As casualty insurance became more important the older fire and marine insurance companies formed subsidiaries to offer casualty insurance to their customers. New casualty companies sought fire and marine affiliates to provide complete service for their agents and customers. The tendency to form groups has been more marked among stock companies than among mutual or reciprocal organizations. Nevertheless, cooperative organizations do use this plan of operation. Indeed, some of the largest groups in terms of premium volume are composed of mutual companies. The greater growth of fleets among stock companies was the result of two principal factors. First, most of these companies used commission agents to distribute their contracts, and 24 See "Insurance Groups," Best's Insurance News, LV, Fire and Casualty ed. (June, 1954), 15, and Best's Insurance Reports (1959), pp. vii-viii. 25 See Irving Davis, "Multiple-line Underwriting . . . Chaos or Opportunity?" The Spectator, X V I (August, 1950), 16.

Firms in the Industry

25

a large agency force was considered desirable. Where agency limitation agreements were effective, this meant the creation of additional companies. Second, stock companies usually sold more classes of insurance than mutual or reciprocal organizations. This again meant additional companies if state chartering laws restricted the lines of insurance one company could provide. The pattern of stock company group operations in the past few decades is shown in Table 2. In 1959 the number of companies in a TABLE

2

CAPITAL STOCK INSURANCE COMPANY

GROUPS

1929-1959

Year

Number of companies Number of groups Fire

1959 1958 1957 1956 1955 1954 1953 1952 1951 1950 1945 1940 1935 1929

137 134 128 123 122 120 120 115 113 104 103 93 74 90

Casualty

—

—

—

—

—

—

—

—

—

—

—

—

—

—

—

—

229 262 241 232 287

91 95 73 53 70

Total 388 365 365 357 369 366 355 350 345 320 357 314 285 357

SOTJBCE: "Stock Company Groups," Best's Insurance News, LXI, Fire and Casualty ed. (June, 1960), 15.

group varied from two to 15, and the sales of groups varied from $30 thousand to more than $817 million. 26 The 157 groups operating in 1959 received $8.7 billion in premiums. This was nearly 90 per cent of all insurance sold by stock property and casualty companies.27 Court and legislative actions during the 1940's removed the two most important reasons for group operations. First, a Supreme Court decision of 1944 held insurance to be commerce and thus subject to the Federal antitrust laws; this made industry agreements to limit agency appointments illegal.28 Public Law 28 "Stock Company Groups," Best's Insurance News, LXI, Fire and Casualty ed. (June, 1960), 15. "Ibid. 28 U.S. v. South-Eastern Underwriters Assn., 322 U.S. 533.

26

Firms in the Industry

15 (known as the McCarran-Ferguson Act),29 enacted in 1945, exempted the industry from the Sherman Act, the Clayton Act, and the Federal Trade Commission Act, except for boycott, coercion, or intimidation, if the industry is regulated by state law. Intercompany agreements on agency appointments, agency representation, and a variety of other practices had existed mainly without state statutory sanction. T o get the states to affirm such practices as agency limitation, and thereby comply with the usual interpretation of the regulatory requirements of the McCarran-Ferguson Act, was considered unlikely by the industry. Therefore, stated an industry spokesman in 1950, these agreements were terminated.30 If so, there was no further reason to maintain a fleet of commonly owned and managed companies to circumvent an industry agreement restricting sales representation. Second, the formation of company groups to provide multipleproduct insurance service because state laws restricted each legal entity to certain classes of insurance became unnecessary when states passed multiple-line laws.31 These laws, enacted in the 1940's and 1950's, permitted one company to provide all classes of property and casualty insurance. Thus industry and state restrictions which brought on and fostered group or fleet operations have been largely removed. Nevertheless, the data on insurance groups shown earlier in this chapter do not indicate any concerted movement toward consolidation of subsidiaries, though since 1950 it has been impossible to classify companies as fire or casualty carriers when they are writing both kinds of insurance. The slow movement to merge subsidiaries is probably the net result of a combination of four factors: accumulated practices and techniques of some 50 years of operation make a change difficult; not all groups are set up on a basis readily permitting physical merger; groups operating in more than one state find that lack of standardization among state laws and practices deters merger; and additional pricecutting companies are being formed by some groups to counter the lower prices of some mutual and reciprocal organizations.32 There is a widespread belief that real economies can be achieved by simplifying these now unnecessarily elaborate corporate structures. This and other aspects of multiple-line underwriting will be considered in chapter vi. 59 Stat. 33. Milton W. Mays, "The Half-Century in Property-Casualty Insurance," Journal of the American Association of University Teachers of Insurance, XVIII (March, 1951), 49-50. 81 See "Insurance Groups," p. 15. "Ibid., and Best's Insurance Reports (1959), p. viii. 29 ,0

Firms in the Industry Concentration

in the

27

Industry

T h e market position of groups of commonly owned insurance companies is likely to be an important determinant of market behavior and market results in the industry. A number of indices have been used to express the number and size-distribution of competitors in a market. Most of these measures of concentration have been oneparameter summaries, and they have served mainly as a basis for an appraisal of the effects of concentration. 33 Concentration can be measured in terms of any one of several variables; the most common are employment, sales, value added, value of total assets, and net capital assets. Each of these may be useful for a particular purpose. No one of them can be expected to serve equally well in all circumstances, and comparisons between measures based on a variety of quantities may be more revealing than any single measure. T h e availability and usefulness of data will dictate the measures that can be developed. Some of the common difficulties encountered in measuring concentration are absent in the insurance industry. But some of the measures that are meaningful in other industries are essentially meaningless in insurance. For example, the insurance industry uses relatively little physical capital, and it does not employ large amounts of labor. More importantly, the volume of sales that can be handled with any given quantity of physical facilities or labor force is quite flexible. Small alterations in office techniques, methods of selling, or management procedures may permit substantial variation in output with little change in real capital or labor. Thus it appears that measures based on employment or total assets will not be significant for the industry. And value-added data are not available. Policyholders' surplus (the insurance industry counterpart of net capital assets in other industries) appears to be a useful basis for a measure to express the shape of the distribution of potential industry sales among industry members. Policyholders' surplus is defined as the sum of paid-in capital, net reported surplus, and any special voluntary reserves which are in the nature of surplus.34 Policyholders' surplus is a good indication of the capacity of a group of companies to expand its volume of business in the short run. 35 This is important today, for 83 See Tibor Scitovsky, "Economic Theory and the Measurement of Concentration," and William Fellner, "Comment," in Business Concentration and Public Policy, A Report of the National Bureau of Economic Research (Princeton: Princeton University Press, 1955), pp. 101-116. 84 Best's Fire and Casualty Aggregates and Averages (1959), p. iii. 35 This question is explored in chapter viii.

28

Firms

in the

Industry

one company may write any class of property or casualty insurance simply by meeting any special paid-in capital or surplus requirements to obtain a broader charter. Thus additions to the number of companies selling a particular type of insurance, whether it be a coverage newly developed or one previously written by only a few firms, are likely to come from companies or groups that are already established in the industry. Sales data remain as the most useful quantity, indeed the only quantity, for assessing the present position of groups in the industry. Such data are plentiful and quite complete. Concentration measures based on sales have been criticized because they fail to show vertical integration.36 This is not a problem in insurance. Horizontal integration is more important in insurance in determining the position of groups of companies in the market. Sales measures seem well adapted to show this. Concentration in the industry on the basis of policyholders' surplus and sales, in terms of the percentage of industry totals accounted for by the largest four, eight, and twenty groups, is shown in Table 3. Each group is considered a decision-making unit, though authority may be significantly decentralized among the subsidiary companies in a group. These data indicate that the level of concentration is not high and that market shares have changed rather slowly over the last decade and a half—a period of rapid growth in total premium volume. The proportion of industry policyholders' surplus held by the larger companies is somewhat greater than their share of industry sales. This reflects their greater volume of capital and surplus to each dollar of premium written, and indicates that they are probably in a better position to expand premium volume than their smaller competitors. Market shares do not directly indicate market control or power. But they are one of the factors that deserve careful consideration in attempting to determine the control exercised in a market by the larger firms.37 In the insurance industry, market-share data alone suggest that the larger firms are not likely to exercise significant market control.38 Additional factors must be considered, however, before any " See Scitovsky, op. cit., p. 111. " S e e Edward S. Mason, "The New Competition," The Yale Review, XLIII (Autumn, 1953), 37-48, reprinted in Edward S. Mason, Economic Concentration and the Monopoly Problem (Cambridge, Mass.: Harvard University Press, 1957), pp. 371-381. 88 In particular classes of insurance the larger groups may have much greater shares o£ total sales than the average measures indicate. Segregated data are difficult to obtain, and they may not be very significant, since any company or group can rather easily begin to sell any class of property or casualty insurance.

Firms TABLE

in the Industry

29

3

M E A S U R E S OF C O N C E N T R A T I O N I N P R O P E R T Y AND CASUALTY

INSURANCE

1942-1958 Percentage of industry sales and policyholders' surplus accounted for by the 4, 8, and 20 largest groups" Year

1958 1956 1954 1952 1942

Net premiums written

Policyholders' surplus

4

8

20

4

8

20

18.3 16.1» 15.7 15.3 15.5

29.6 b 26.2 25.2 b 25.4 b 27.0

48.4° 46.7' 45.9f 42.7' 41.9'

27.3 20.4 24.0 22.0 20.7

42.5 32.4 36.7« 33.9 31.8

59.6d 47.6d 56.7h 47.7 49.3

S O U R C E S : Computed from data in Best's Fire and Casualty Aggregates and Averages (4th ed.; New York: Alfred M. Best Company, Inc., 1943), (14th ed., 1953), (16th ed., 1955), (18th ed., 1957), (20th ed., 1959); Best's Insurance Reports (56th ed., Fire and Casualty; New York: Alfred M. Best Company, Inc., 1955), (58th ed., 1957), (60th ed., 1959); Argus Fire Chart (67th ed., Cincinnati: The National Insurance Underwriter Company, 1943), (81st ed., 1957); Argus Casualty and Surety Chart (44th ed.; Cincinnati, The National Insurance Underwriters Company, 1943), (58th ed., 1957). » All company groups are composed of stock companies, unless indicated otherwise. b Two mutual company groups—State Farm Mutual and Liberty Mutual—are included among the eight groups. 0 Four mutual company groups—State Farm Mutual, Liberty Mutual, James Kemper, and Nationwide—and one reciprocal group (Farmers Insurance Exchange) are included among the twenty groups. d Two mutual company groups—State Farm Mutual and Liberty Mutual—are included among the twenty groups. 0 One mutual company group—State Farm Mutual—is included among the four groups. 1 Four mutual company groups—State Farm Mutual, Liberty Mutual, James Kemper, and Nationwide—are included among the twenty groups. * One mutual company group—Liberty Mutual—is included among the eight groups. h Five mutual company groups—Liberty Mutual, State Farm Mutual, James Kemper, Nationwide, and Employer's Mutual—are included among the twenty groups. 1 Three mutual company groups—Liberty Mutual, State Farm Mutual, and Farm Bureau Mutual—are included among the twenty groups. ' Includes only nineteen groups; the slightly lower percentage value may be due to this fact.

conclusions are reached about market control and the more important matter of industry performance. At this point two related questions are relevant: (1) Can market control be exercised in other ways? (2) What is the relationship among groups of firms in the industry? An answer to the second question may provide at least a partial answer to the first.

BO Firms in the Industry For a long time the property and casualty insurance industry has had an extensive system of self-regulation of rate making and related activities. Effective state regulation was uncommon in the early 1900's. Later, as state regulation was enlarged, insurance companies were frequently able to convince state authorities that it was in the public interest to prevent competition, particularly in price. At the time of the South-Eastern Underwriters Association case, 39 state regulation generally accepted voluntary intercompany agreements to control rate making, contract content, sales commission rates, and sales agency representation. 40 Changes have been made since the Supreme Court decision, but they may not be as sweeping as is often alleged. T h e McCarran-Ferguson Act, 41 which followed the South-Eastern Underwriters decision, affirmed state regulation and in some important ways merely preserved existing practices. Industry self-regulation has been carried out by a host of trade associations. T h e associations primarily concerned with price and product questions (usually called rating bureaus) are now recognized and licensed by the states. T h e locus of bureau control is not always clear. There is some evidence that the larger groups of companies dominate bureau decisions on rates and contracts, the two most important variables in the insuring process. For example, insurance writer Roger Kenney maintains that the National Bureau of Casualty Underwriters, a rate-making organization for stock companies, is disproportionately influenced by the large companies. He says: Rate-making processes have become what amounts to a trade secret possessed by a very small coterie of professional rate makers and shared in by an equally small group of dominating and influential top executives. T h e casualty industry today is "big business" with premiums running into billions and affecting the lives of the great majority of people in this country. T o allow such a business to become but the extended shadow of a very small group of individuals who have every temptation to keep rate-making an adventure in black magic is an open invitation to governmental intrusion. 4 2

This was written in 1952, several years after the states had been given the task of regulating an antitrust exempt industry. Apparently Kenney's principal concern is that industry cooperation may become so » 3 2 2 U.S. 533 (1944). 40 See Mays, op. cit., p. 47. u 59 Stat. 33 (1945) as amended by 61 Stat. 448 (1947). " R o g e r Kenney, "Is Inflation Too Much for the Casualty Industry?" Address before the Pacific Insurance and Surety Forum, Santa Barbara, California, March 13, 1952, reported in United States Investor, March 15, 1952, p. 35. Cf. Elmer A. T waits, "Casualty and Surety Rating Bureaus," Best's Insurance News, LIX, Fire and Casualty ed. (April, 1959), 29-31, 160.

Firms

in the Industry

31

controlled by a few that the federal government will either assume regulation of the industry or remove the antitrust exemption granted the industry on the condition of adequate state regulation. 43 Clearly, the existing pattern of industry cooperation could allow the larger groups to exercise a greater degree of market control than measures of market position indicate. This description of intergroup relations applies to the large portion of stock insurance firms. There are some, however, that do not adhere to agreed rates and policy forms. Mutual and reciprocal organizations have developed their own methods and facilities for cooperation. 44 The tendency to uniformity among them is perhaps not as great as among the stock companies. It also may not be as significant, for these enterprises are owned by the policyholders and redundant premiums may be returned to the policyholders. Mutuals and reciprocals have provided price competition for stock companies—quite strong competition in some lines of insurance, negligible in others. Industry cooperation, regulation, and competition will be explored further in chapter v. a See Kenney, "The Battle of the Potomac," p. 60. " T h e r e are instances of industry cooperation among the various types of nonlite insurance organizations. For example, The National Council on Compensation Insurance combines stock and nonstock insurers.

CHAPTER III

Channels of Distribution

T h e property and casualty insurance industry uses various methods to distribute its services: (1) salaried employees, (2) commission agents who represent one company only and are quite closely controlled by it, (3) commission agents who represent several companies and are considered to be independent contractors, and (4) commission brokers who represent the purchaser of insurance but are compensated by the companies. T h e first two methods are apt to be associated with mutual and reciprocal enterprises, the last two with capital stock enterprises. But there are numerous exceptions. Independent

Contractor

Agents

and

Brokers

Commission agents are typical in capital stock insurance.1 When commission agents are used by cooperative insurers, such agents are likely to have a different relationship with their principals than stock company agents.2 We shall explore this in the following section. The agency system of selling commonly used today by stock property and casualty insurance companies began in the early 1800's. It was not quickly adopted by all stock companies, for, in 1854, of the 65 stock fire insurance companies reporting to the state of New York, only 27 were represented by agents.3 Selling insurance by commission ' S e e A. H. Mowbray and Ralph H. Blanchard, Insurance (4th ed.; New York: McGraw-Hill Book Company, Inc., 1955), p. 301. 2 Stock company agents may represent mutual companies also in certain areas and lines of insurance, usually on terms quite similar to those made by the stock companies. This is said to be fairly common in fire insurance lines in New England. See Roger Kenney, "An Agent 'Rises to Remark' About the Woes of the American Agency System," United States Investor, September 1, 1951, pp. 10-11. "William H. Wandel, The Control of Competition in Fire Insurance (Lancaster, Pa.: Art Printing Co., 1935), p. 104.

32

Channels

of Distribution

33

agents became firmly established in 1904 with the determination in the National Fire Insurance case.4 This decision held that an agent, who typically represents more than one company, perhaps several, and who usually selects the particular company in which a customer's insurance is to be placed, is an independent contractor. Thus an agent solicits insurance on behalf of his agency rather than one of his principals. The court held that an agent working in this way has a property right in the fund of information he has accumulated. This property right is represented by policy expiration data. If an agent retires from business, he may sell his file of expirations. They are not the property of the companies represented. A recent case has reaffirmed this position.5 This somewhat unusual principal-agent relationship has some important implications for the industry. Since the agent controls the business, he can shift it from one company to another. This power virtually compels the companies to buy their business from the agents, and creates an incentive to compete by paying higher commission rates.6 Competition in commissions can be overcome by industry price competition strong enough to make the sale of nonlife insurance through higher commissions and resultant higher premiums quite difficult.7 Through their local and national trade associations agents can exert a great deal of influence on companies to prevent adoption of practices which they feel will endanger their independent contractor position.8 Roger Kenney, speaking of the extraordinary growth in recent years of those insurers selling by means other than the independent contractor agent, says, " T o an unbiased outsider, this growth looks like indisputable testimony to the fact that if the American Agency System . . . did not have court decisions to back up its exclusive right to solicit expirations, it might have disintegrated long ago!" 9 National Fire Ins. Co. v. Sullard, 89 N.Y. Supp. 934, 97 App. Div. 233. 'Heyl v. Emery and Kaufman, Ltd., 204, F. 2d 137 (1953). 8 Wandel, op. cit., p. 11. 7 Industry self-regulation or public regulation would also limit competition in commission rates. 8 For example, the National Association of Insurance Agents recently officially adopted a resolution opposing any commission reduction, use of continuous policies, or direct customer billing and collection by the companies—all of which are being used quite successfully by other types of insurers to undersell the agency stock companies. Joseph A. Neumann, " T h e Agent Is Not on T r i a l , " Best's Insurance Neivs, LV, Fire and Casualty ed. (May, 1954), 22. For a defense of the independent agent by a former president of the National Association of Insurance Agents, see the pamphlet, Robert E. Battles, The Agency System In Relation To Insurance Economics (New York: T h e National Association of Insurance Agents, Inc., 1958). 4

• Kenney, op. cit., p. 12.

34

Channels of

Distribution

All this does not mean that stock companies are at the mercy of their agents. In chapter ii we noted the companies' cooperative arrangements to limit the number of agents per locality. Companies have also made agreements to limit and stabilize commission rates; 10 both of these arrangements have been officially relinquished, however, since insurance was held to be commerce.11 But insurers have not been left powerless. An agent has to have several principals to handle any substantial volume of insurance. Thus the threat of company termination of agency agreements becomes a useful device to influence agents' behavior. Companies probably cannot institute any major changes in the agency system, however, unless they are willing to abandon it. As yet, most stock companies appear reluctant to go this far. Stock companies also sell insurance through brokers, or perhaps it is more nearly correct to say they also buy insurance from brokers. 12 The results for the industry are much the same as they are for agency operations, though the legal relationships are quite different. Unlike agents, brokers do not have contractual relationships with companies. For example, brokers may not bind companies to an insurance contract, as agents may within the scope of their agency agreement. Brokers are considered to be the legal representative of the insurance buyer, negotiating with insurance companies in his interest. 13 The broker is compensated by a company commission, however, and not by the insured. Of course, indirectly the insured pays all expenses of the provision of insurance service.14 Unquestionably brokers own the policy expirations they develop. Therefore, stock companies face the same problem here as they do "Nathaniel L. Goldstein, Attorney General, State of New York, Opinion on Acquisition Cost Conferences, February 24, 1949, in New York State, Ninetieth Annual Report of the Superintendent of Insurance (Albany: New York State Insurance Department, 1949), I, pp. 47a-62a. 11 U.S. v. South-Eastern Underwriters Assn., 322 U.S. 533 (1944). u Brokers are found chiefly in larger cities where many insurance companies have branch or home offices. Certain lines of insurance have come to be handled mainly by brokers. For example, most of the ocean marine insurance in the United States is negotiated by brokers. See Wandel, op. cit., p. 109, and William D. Winter, Marine Insurance (3d ed.; New York: McGraw-Hill Book Company, Inc., 1952), p. 111. 18 L. B. Orfield, "Improving State Regulation of Insurance," Minnesota Law Review, XXXII (February, 1948), 239. " Since the broker serves the insured, but is paid by the insurer, there is a possible conflict with sec. 2(c) of the Clayton Act as amended by the RobinsonPatman Act, which prohibits payment of brokerage fees except for services rendered to the one paying the fees. Some states have enacted legislation legalizing brokers and permitting companies to pay them commissions. In other states they are recognized not at all, or only in special circumstances. See "Federal Trade Commission Surveys State Insurance Laws," Insurance Law Journal, No. 328 (May, 1950), 344.

Channels of Distribution

35

with agents as to what they may do to change methods and commission scales without abandoning the whole system. Brokers also have their own associations to present their views to companies and legislatures. Over half of the states require agents and brokers to be licensed. Licensing laws purport to be in the interest of the public by assuring that only competent individuals with a minimum level of training in insurance are admitted to insurance selling. T h e i r usefulness in achieving this has been questioned. 15 T h e Supreme Court has sustained state statutes regulating and licensing agents and insurers; 1 6 there had been doubt about the legality of such laws after the court's earlier decision interpreting insurance as commerce. 17 Exclusive

Agents

Many mutual and reciprocal exchange enterprises sell their products through commission agents. But the mutual or reciprocal exchange organization agent is likely to represent one company exclusively. 18 He is paid a commission for each new policy sold, and the company usually acquires property rights in the contract. T h u s the company has the right to solicit renewal contracts if the agency is terminated. Renewal policy commissions either are not paid or are paid at a lower rate than initial commissions. Such a cooperative agency company makes but one payment to acquire an insurance contract, or one plus a small renewal payment. 1 9 T h i s contrasts quite sharply with the typical stock agency system, which vests in the agent ownership of renewals and usually pays a level commission scale on all policies— new and renewal. T h e most noticeable effect of exclusive agency methods, compared with independent contractor agency methods, is the reduction in total selling costs. Stock company acquisition costs average approximately "See, for example, "Occupational Licensing Legislation in the States," State Government, X X V (December, 1952), 275-280. " Robertson v. California 328 U.S. 440 (1946). " U.S. v. South-Eastern Underwriters Assn., 322 U.S. 533 (1944). 18 In 1955 there were 90 mutual and reciprocal exchange enterprises entered in California (these firms were the larger organizations of this type, and most of them were entered in states besides California). These organizations distributed their products by the following methods: 33.3 per cent of them sold by exclusive agents; 33.3 per cent by salaried employees; 13.4 per cent by independent contractor agents or brokers; and 10 per cent by a combination of these methods. State of California, Eighty-Eighth Annual Report of the Insurance Commissioner for the Year Ended December 31, 1955 (San Francisco, 1956), pp. 176-179; and Best's Insurance Reports (57th Fire and Casualty ed.; New York: Alfred M. Best Company, Inc., 1956), pp. 3B-658B. 18 S. Alexander Bell, "Competition," Best's Insurance News, LV, Fire and Casualty ed. (October, 1954), 30-31.

36

Channels

of

Distribution

25 per cent. Reductions in these costs, combined with other economies, often permit cooperative organization premium rates that are 20 to 30 per cent less than those charged by stock companies. Frequently, too, there may be an additional profit sharing dividend at policy expiration. These differences in costs and rates have been most noticeable in the field of automobile insurance.21 Stock companies often allege that the difference in commission outlays is a measure of the difference in information and service the buyer receives, particularly after the policy has been sold and the exclusive agent's opportunity to earn further commissions is removed or reduced. The growth in the volume of insurance sold in the last decade by the exclusive agency method suggests that the buyer is not deprived of desired information and service.22 If the original selling agents are failing to service contracts properly, apparently the companies are providing such service in other ways. 20

Salaried

Employees

Some mutual and reciprocal exchange organizations and a few capital stock enterprises sell insurance through salaried employees. This method seems to give the lowest acquisition cost, and it of course gives the company ownership of and direct control over its contract portfolio.23 Cost-reducing techniques are introduced first in this and the exclusive agency systems, for there are no independent contractor agents to oppose changes that look as though they may infringe on their independence. In modern times, salaried employee-selling by stock companies is relatively new and, so far, quite rare. Perhaps the leading example is the Allstate Insurance Company, an affiliate of Sears, Roebuck and Company. Using the chain department store facilities and technique of its parent company, it has grown rapidly.24 The spectacular expansion of this company will undoubtedly influence other stock companies as they search for ways to match the mounting price competition in automobile insurance and other lines. The struggle for the ^ Ibid. 21 James M. Cahill, "What's Ahead?" Best's Insurance News, LV, Fire and Casualty ed. (August, 1954), 22-23. 22 See Kenney, op. cit., p. 12; and Kenney, "Critique of American Agency System," The Journal of Insurance, X X V (July, 1958), 42-49. 23 Bell, op. cit., p. 32. 24 T h e Allstate Insurance Company is currently one of the largest underwriters of automobile insurance. Furthermore, it has had an extraordinarily rapid rate of growth in recent years—in 20 years annual sales have grown from $3 million to $375 million. Alfred M. Best Company, Inc., Best's Insurance Reports (60th Fire and Casualty ed.; New York: Alfred M. Best Company, Inc., 1959), p. viii.

Channels

of Distribution

37

automobile insurance market in the next decade may be between direct or salaried employee writers and exclusive agency writers, with the independent contractor agency stock companies being pushed aside. 25 We shall examine and compare the levels of selling costs associated with the various industry channels of distribution in chapter viii. 26

Bell, op. cit., p. 32.

CHAPTER IV

Entry and Exit T h e nature of competition and the effect of public policy on competition are influenced by the likelihood of newcomers to a market as well as the actual number and relative size of firms in a market. Potential competition, whether from newly organized firms or established firms producing a new product, has received less attention than actual competition in both theory and investigation. But this does not mean that the level of potential competition is an unimportant force in shaping market behavior and performance. 1 It probably is very important, though the task of isolating and estimating its effects is likely to be difficult. Competition is also affected by the likelihood of departure from a market. Barriers to exit are unlikely to be as important as barriers to entry; still they may have a significant effect on market behavior and performance. Since insurance is viewed as a service of more than ordinary importance, a regulatory framework has evolved to protect the public. 2 Part of the protection provided the public is state-com1 Some recent discussions of the meaning and significance of potential competition are Joe S. Bain, Barriers to New Competition (Cambridge, Mass.: Harvard University Press, 1956); Corwin D. Edwards, Maintaining Competition: Requisites of a Governmental Policy (New York: McGraw-Hill Book Company, Inc., 1949), chap, vi; Andreas G. Papandreou and John T. Wheeler, Competition and Its Regulation (New York: Prentice-Hall, Inc., 1954), chap. 12; Preben Munthe, Freedom of Entry into Industry and Trade (Paris: the European Productivity Agency of the Organization for European Economic Cooperation, 1958). For a discussion of the difference between entry by a new firm and an established firm, as well as additional references, see Howard H. Hines, "Effectiveness of 'Entry' by Already Established Firms," Quarterly Journal of Economics, L X X I (February, 1957), 132-150. 2 For examples of judicial and legislative declarations of the nature of the public interest in insurance, see German Alliance Ins. Co. v. Lewis, 233 U.S. 389 (1914); O'Gorman and Young v. Hartford Fire Ins. Co., 282 U.S. 251 (1931); U.S. v. SouthEastern Underwriters Assn., 322 U.S. 533 (1944); U.S., Public Law 15 (McCarranFerguson Act), 59 Stat. 33 (1945).

38

Entry and Exit

39

mission supervision of insurance firms in financial difficulty. This supervision typically consists of conservation of assets on behalf of policyholders and others, rehabilitation of the firm if possible, and finally, liquidation if rehabilitation is impossible.3 Entry

T o enter a market is to become a member of a group of firms producing products that are viewed by buyers as close substitutes. For certain purposes, all firms that are close competitors in this sense may be conveniently described as an industry. 4 In chapter i it was suggested that, for purposes of this study, the firms providing nonlife insurance may be considered an industry and the market for their nonlife insurance products may be considered national. 5 Entry to nonlife insurance may be more precisely defined as constituting: the arrival of a new, independent firm in the industry either through creation of a new firm or an addition to an existing firm's line of products; 6 and the introduction of additional policy-writing capacity to that already in use in the industry. 7 Under this definition, change of ownership or control of an existing organization is not entry. Expansion of the policy-writing capacity of an existing organization is not entry either. Changes of ownership or control or expansions of capacity among established firms in an industry may affect industry competition in much the same way as entry of a new firm with new capacity. At this point, however, we are primarily concerned with the influence of potential rather than actual competition among firms 'See R. C. Lytle, "What Happens When an Insurance Company Goes Broke?" Oklahoma Bar Association Journal, XIII (December, 1942), 318-325, and New York State Insurance Department, Examination of Insurance Companies (New York: New York State Insurance Department, 1954), IV, pp. 409-452. * For a criticism of the use of a group or industry concept in the usual nonhomogeneous product situation, see Robert Triffin, Monopolistic Competition and General Equilibrium Theory (Cambridge, Mass.: Harvard University Press, 1940), pp. 78-79. Triffin indicates, however, that though every firm competes to some degree with every other firm in the economy, it is both possible and desirable to conduct empirical studies in terms of a group of producers of close substitutes. The gain in manageability more than offsets any loss in precision. Ibid., p. 88. * Many firms sell only certain kinds of nonlife insurance, and many sell only in local or regional markets, but the larger firms are likely to sell a wide array of nonlife insurance contracts in a many- if not all-state market. " Presumably the kind of existing firm most likely to add nonlife insurance to its line of products is a financial institution. Under existing laws many financial institutions, particularly banks and life insurance companies, would find it difficult to enter nonlife insurance, because of federal and state restrictions of the types and amounts of assets such enterprises may hold. See Alfred M. Best Company, Inc., Best's Insurance Reports (60th Fire and Casualty ed.; New York: Alfred M. Best Company, Inc., 1959), p. viii. 7 See Bain, op. cit., pp. 4-6.

40

Entry

and

Exit

already in the industry. The nature and level of actual competition are examined in other parts of this study. The degree of difficulty an organization experiences in entering an industry depends on the kinds and levels of economic advantages enjoyed by established firms in the industry, and on the patterns of restrictive devices facing newcomers. The first type of barrier often continues because of the second. Established firms may have advantages based on scale of production, absolute capital requirements, absolute cost, or product differentiation. 8 Established firms may also be protected by private or public limitations on new firms. These limitations assume many forms. Examples are: public requirements of licenses or certificates of convenience; public requirements of minimum amounts of capital; and private or public requirements or restrictions of membership in patent pools, rating bureaus, or other groups. 9 In the following sections we shall examine the factors that seem to determine the degree of difficulty faced by a prospective entrant to the nonlife insurance industry. ECONOMIES OF

SCALE

Comparisons of unit costs among companies or groups of companies in the insurance industry provide some tentative approximations of the relative efficiency of different organization sizes. By examining attained unit costs for various sizes of companies or groups, one may gain an indication of whether new entrants into insurance face significantly higher costs from economies of scale. It was noted in chapter ii that nonlife insurance enterprises have typically operated in groups of commonly owned and controlled companies. Thus the parent company of a group of companies may be considered an independent, decision-making unit, roughly the equivalent of a firm in economic analysis, and each company in a group may be considered analogous to an industrial plant. 10 Of course, the degree of centralization or decentralization may vary widely among groups. 8

Ibid., pp. 11-18. •See Edwards, op. cit., pp. 201-216, and G. E. Hale and Rosemary D. Hale, "Competition or Control I: The Chaos in the Cases," University of Pennsylvania Law Review, CVI (March, 1958), 642. 10 In this study the terms "group" and "firm" are used interchangeably as are "company" and "plant." If an enterprise consisted of only one company, then firm and company would be synonymous. For an interesting development of a definition of a firm as an independent organization dependent upon its profits and losses, see Harvey Leibenstein, Economic Theory and Organizational Analysis (New York: Harper and Brothers, 1960), pp. 153-154. This definition, which does not depend on the objectives of the firm, contrasts with the usual definition that assumes the firm is a profit-maximizing entity.

Entry and Exit

41

Insurance companies sell varying classes of insurance and varying amounts of any particular class. Since the work to be done and the conditions under which it is done differ among insurance classes, expense comparisons among companies (plants) are going to be only very rough approximations of the relationship between unit cost and scale of operation. Nevertheless, S. J . Lengyel reports that in a 1942 study of 195 stock property insurance companies, the total expense ratio fell successively from 48.05 per cent for the smallest companies selling less than $1 million to 39.55 per cent for the largest companies selling more than $10 million.11 A better basis for examining the relationship between unit cost and scale of operation is comparison among groups (firms). Even though various groups of companies do not sell the same relative amounts of the different classes of property and casualty insurance, they are likely to sell most of the principal classes. In this way, varying expense ratios for different classes of insurance may be partially neutralized. Thus size comparisons among groups (firms) are more likely to reflect differences in relative efficiency than are size comparisons among companies (plants). Table 4 shows average expense ratios according to the size of total sales for commonly owned and managed groups of nonlife insurance companies in 1953. In terms of sales volume, the 127 groups shown in Table 4 constitute most of the industry. The expense data for these groups suggest that the largest firms have the lowest unit costs, though the stock organizations exhibit a somewhat mixed pattern—up to the largest group, where a substantial decline in the expense ratio occurs. Stock and mutual groups are likely to follow different price policies; thus if comparisons of actual unit costs of stock and mutual groups were to be made, price differences would have to be considered. A still better basis for examining unit cost and scale of operation is comparison among selected groups (firms). Table 5 shows the data for a selected sample of capital stock nonlife insurance firms, grouped according to size of average annual premiums for 1950-1954. The n S. J . Lengyel, Insurance Companies' Accounts: an Economic Interpretation and Analysis (London: F. W . Cheshire Pty. Ltd., 1947), p. 116. T h e expense ratio is defined as the ratio of incurred expenses—other than those associated with losses—to premiums written. Some of the problems of comparing and interpreting property insurance expense ratios are discussed in Robert A. Hedges, "Experiment in Financial Analysis of Property Insurers," Journal of the American Association of University Teachers of Insurance, X X I I I (March, 1956), 142-146; and "Evaluation of Property Insurance Companies' Expense Ratios," Journal of Insurance, X X V (February, 1959), 1-16.

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T O T A L A V E R A G E E X P E N S E BY SIZE AND T Y P E or

N O N L I F E INSURANCE

GROUP

1953 Average expense ratios 5

Size of group (sales in thousands)

Stock

Mutual

Total

Stock

Mutual

Total

Under $5,000 $ 5,000-9,999 10,000-24,999 25,000-49,999 50,000-99,999 100,000-249,999 250,000 and over Total

15 17 31 21 17 12 4 117

0 1 3 2 3 1 0 10

15 18 34 23 20 13 4 127

37.7 38.1 39.6 36.8 37.2 36.0 31.6

34.9 26.8 21.0 18.5 13.6

37.7 37.9 38.5 35.4 34.4 34.3 31.6

Number of groups

—

— —

—

SOTTRCES: Best's Fire and Casualty Aggregates and Averages (15th ed.; New York: Alfred M. Best Company, Inc., 1954), pp. 3-13, and Argus Fire Chart (77th ed.; Cincinnati: The National Underwriter Co.; 1953), p. 118. 8 The ratio of incurred expenses, other than those associated with losses, to premiums written.

sample includes all firms that sell approximately the same proportions of the various classes of insurance, that use the same method of product distribution (in this case, the independent agency and brokerage system), and that generally follow a common, noncompetitive price policy. Where selected groups of similar firms rather than plants are used as the basis of comparison, two difficulties are avoided or reduced: the question of overhead cost allocation among plants or subsidiary companies does not arise; and the question of overhead and other cost allocation among products does not arise if only those firms are included which sell approximately the same proportions of each type of contract. One can then consider output as a composite of various insurance contracts. The 34 firms (with 135 affiliates) in the sample were selected from 114 firms (with 347 affiliates) listed by Best's as an average for 19501954.12 Of the 80 firms excluded from the sample, 11 yielded incomplete data, 67 specialized in one or a few classes of insurance, and 2 had different distribution channels or price policies. Several of the 13 Best's Fire and Casualty Aggregates and Averages (16th ed.; New York: Alfred M. Best Company, Inc., 1955), p. 13. These totals appear to represent a large proportion of the capital stock enterprises in nonlife insurance on the basis of comparisons with the New York State Insurance Department and The Spectator Insurance Yearbook (Philadelphia, Chilton Company, Inc., 1951-1955).

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firms excluded for atypical product mixes were also using different sales methods or price policies. TABLE

5

AVERAGE E X P E N S E RATIOS B T SIZE GROUPS OP CAPITAL STOCK N O N M F E INSURANCE FIRMS

1950-1964

Average annual written premiums" Under $10,000,000 $ 10,000,000-49,999,999 50,000,000-99,999,999 100,000,000 and over 0 Total

Number of firms 5 15 5 9 34

Number of affiliates 12 51 24 48 135

Average expense ratio b

Standard deviation of expense ratios

43.9 42.1 39.8 37.9

5.7 2.9 3.1 1.1

—

—

SOURCES: Best's Fire and Casualty Aggregates and Averages (12th ed.; New York: Alfred M. Best Company, Inc., 1951), pp. 2-13; (13th ed.; 1952), pp. 2-11; (14th ed.; 1953), pp. 2-12; (15th ed.; 1954), pp. 3-13; (16th ed.; 1955), pp. 3-13. a Retained premium income, direct or through reinsurance. b The ratio of incurred expenses, other than those associated with losses, to premiums written. 0 The largest firm in this class had average annual sales for 1950-1954 of $308 million and an average expense ratio of 36.8 per cent.

T h e trend of expense ratios for the firms shown in Table 5 is steadily downward as firm size increases. The variation among expense ratios within each size class also decreases as firm size increases. The two largest firms in the industry were not included in Table 5 because of their somewhat atypical product and distribution patterns, though their selling methods and pricing practices were comparable. It is interesting to note that these two firms, whose average annual sales for 1950-1954 were $328 million and $430 million, had average expense ratios of 27.2 per cent and 28.6 per cent respectively. Since the differences in the expense ratio data of Table 5 might have arisen by pure chance, the null hypothesis, that the true differences among average expense ratios by firm size classes are zero, was tested against the alternative hypothesis that there are real differences among average expense ratios by firm size classes. The null hypothesis was rejected. The values shown in Table 5 were found to be significant at a level of 1 per cent.13 12 A nonparametric statistical significance test was used: T h e Kruskal-Wallis OneWay Analysis of Variance by Ranks. See Sidney Siegel, Nonparametric Statistics (New York: McGraw-Hill Book Company, Inc., 1956).

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6

A V E R A G E E X P E N S E R A T I O S BY SIZE G R O U P S OF M U T U A L N O N L I F E INSURANCE

FIRMS

1950-1954

Average annual written premiums" Under $25,000,000 $25,000,000-49,999,999 50,000,000 and over0 Total

Number of firms

Number of affiliates

Average expense ratiob

Standard deviation of expense ratios

2 2 3 7

4 4 7 15

32.4 22.0 20.4

5.5 .6 4.3

—

—

SOURCES: The Spectator Fire Index (83rd ed.; Philadelphia: Chilton Company, Inc., 1951), pp. 90-100; (84th ed.; 1952), pp. 98-108; (85th ed.; 1953), pp. 98-108; (86th ed.; 1954), pp. 104-14; (87th ed.; 1955), pp. 106-16; and Argus Fire Chart (75th ed.; Cincinnati; National Underwriter Company, 1951), pp. 96-111; (76th ed.; 1952), 96-111; (77th ed.; 1953), pp. 96-111; (78th ed.; 1954), pp. 102-18; (79th ed.; 1955), pp. 107-23. a Retained premium income, direct or through reinsurance. b T h e ratio of incurred expenses, other than those associated with losses, to premiums written. 0 The largest firm in this class had average annual sales of $82 million and an average annual expense ratio of 18.1 per cent.

Table 6 presents expense ratios by size groups of mutual nonlife insurance firms for the same period, 1950-1954. During this time, mutual organizations supplied approximately 25 per cent of the nonlife insurance sold.14 Such enterprises are very common in nonlife insurance, but they are typically small, specialized operations. The sample of firms included in Table 6 are the few multiple-product mutual groups that appear to be fairly uniform except in size, and for which relatively complete data are available. Compared with the statistics of Table 5, the data summarized in Table 6 represent both a much smaller number of firms and a much smaller share of the nonlife insurance industry. This sample of mutual organizations demonstrates much lower expense ratios throughout the size range than the capital stock enterprise sample. The effect of price differentials makes simple comparisons inappropriate, but, given the size of the difference, the mutual group sample probably has lower unit costs than the stock group sample. Such a difference is likely the result of lower selling expense through the use of salaried representatives or exclusive agents who usually receive lower average commission " Best's Fire and Casualty Aggregates and Averages (1955), p. 1.

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rates than independent agents or brokers. A mutual-organization tendency to provide a smaller number of insurance types than capital stock firms may also contribute to lower operating expenses. The relevant observation here is that mutual organizations also demonstrate a tendency toward lower expense ratios as firm size increases.16 Table 6 includes only 7 mutual firms with 15 affiliates. One would not want to generalize extensively from such data. Yet the performance of these mutual enterprises further supports a conclusion that expenses decrease as firm size increases. The relationship between attained unit cost and size of business operation found in each of the three situations examined—property insurance companies (plants), nonlife insurance groups (firms), and selected samples of similar nonlife insurance capital stock and mutual groups (firms)—indicates there are economies of scale in the industry. In each instance, expense ratios decrease as size of organization increases, with the largest organizations demonstrating the smallest expense ratios.17 From this trend one would expect still larger enterprises to achieve further reductions in unit costs.18 It is, of course, impossible to indicate what size a firm must be for optimum efficiency in nonlife insurance. The optimum, if there be a single such size, is apt to change constantly; to locate it at any time, assuming away the difficulties of isolation and measurement of cost-size relationships, would be very difficult. The evidence provided by the selected samples of firms, Tables 5 and 6, is the most significant, for the influence of other variables is 15

15 Ibid., pp. 30-43, 126-131; and C. A. Kulp, Casually Insurance (3rd ed.; New York: Ronald Press Company, 1956), p. 421. " T h e largest mutual firm had a somewhat atypical product composition and was thus not included in Table 6. This firm, however, had average annual sales of $216 million and the lowest average expense ratio among mutual and capital stock firms: 16.3 per cent. 17 T h e testimony of Professor Robert A. Hedges before the Senate subcommittee studying insurance suggests a tendency in fire and casualty insurance for expense ratios to vary inversely with company size. U.S. Congress, Senate Subcommittee on Antitrust and Monopoly, Committee on the Judiciary, Hearings, The Insurance Industry, Part 2, Ocean Marine, Rating and State Regulation, 86th Cong., 1st Sess., 1959, pp. 1086-1087, 1109-1110. " W h y have large firms failed to take advantage of this apparently unstable market and expand sales, by cutting prices if necessary, until unit costs no longer continue to decline? Several tentative answers are possible: (1) large firms may be in the process of doing this, though industry concentration data presented in chap, ii do not indicate any important movement of this kind; (2) industry regulation tends to restrain growth that would absorb larger shares of the market; and (3) joint action through pricing bureaus and similar industry associations tends to discourage hard competition such as price cutting and to encourage a spirit of "live-and-let-live."

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minimized by the selection of enterprises which are similar except for size. Five-year averages also tend to reduce the effect of short-term or random forces.19 From the data on unit cost and size of operation one might conclude that a new insurance firm will experience some difficulty getting established because of the lower expense ratios of larger firms. Three qualifications should be considered, however, before such a conclusion is made. First, if a potential entrant planned to offer a wide variety of nonlife insurance coverages in a national market, it probably would consider its cost position disadvantageous, perhaps substantially so. But if a new firm planned to concentrate on one or a few types of nonlife insurance in a limited market, estimated unit costs might not deter entry. 20 The continued presence in the industry of small firms serving limited markets with limited product lines demonstrates the ability of these enterprises to enter and to survive. Second, the entry, survival, and growth of the small firm, in the face of what appear to be significant economies of scale, are also influenced by uniform pricing practices in many lines of nonlife insurance. 21 19 For a more detailed analysis of the scale economy question, see Roy J . Hensley, "Scale Economies in Financial Enterprises," Journal of Political Economy, LXVI (October, 1958), 389-398. 20 Recall that the firms of Tables 5 and 6 are multiple-product organizations. It would be impossible to compare the unit costs of these firms with the unit costs of the small few-product, limited market firms, even if trustworthy data were available on the small enterprises. Conditions and costs are likely to vary significantly from product to product and market to market. Moreover, the entire costs of small firms may not be reported as free or undercompensated services are provided, particularly to new or small mutual enterprises. For a discussion of the existence and survival of small firms in the United States and Great Britain, see P. Sargant Florence, The Logic of British and American Industry (London: Routledge and Kegan Paul, Ltd., 1953), pp. 63-66, 337; and P. J . D. Wiles, Price, Cost and Output (Oxford: Basil Blackwell, 1956), pp. 219223. See also Leibenstein, op. cit., pp. 295-316. 21 T h e extent of uniform pricing at the time of the federal government's prosecution of a fire insurance trade association (South-Eastern Underwriters Association) for alleged violation of the Sherman Antitrust Act is suggested by the 1945 report of the New York State Superintendent of Insurance. This report stated that in 1944 in New York State 89.8 per cent of the fire insurance, 85.0 per cent of the fidelity and surety bonds, and 55.1 per cent of the automobile liability insurance were written at identical rates by members and subscribers of single rating organizations in each field. Eighty-Seventh Annual Report of the Superintendent of Insurance (Albany: New York State Insurance Department, 1946), I, p. 39a. T h e significance of uniform pricing has apparently declined somewhat since the 1944 South-Eastern Underwriters Association case (322 U.S. 533). For further discussions of uniform pricing in insurance, see New York State Insurance Department, Examination of Insurance Companies (New York: New York State Insurance Department, 1953), I, p. 8; G. F. Michelbacher, Multiple-line Insurance (New York: McGraw-Hill Book Company, Inc., 1957), pp. 527-528, 537-540; Simon K. Whitney, Antitrust Policies

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These prices appear to be set at a level to cover the costs of nearly all firms agreeing to use them. Since both small and large organizations are in these uniform price groups, the small new entrant may find it is covering its higher costs at the standard price but earning a smaller profit than the larger, lower-cost firms selling at the same uniform price. Industry price behavior and policy will be examined in the following chapter. T o the extent, however, that prices are uniform and set at a level to cover the costs of firms of a wide range of efficiencies, the prospective entrant will face less of a scale economy barrier. Third, any one of the firms in the largest size and lowest cost class of Table 5 supplies a small proportion of total industry output. 22 During 1950-1954, the average annual sales of capital stock firms in the $100 million-and over class of Table 5 were $185 million. This was 2.1 per cent of average annual industry sales, or 2.9 per cent of average annual capital stock company sales. The largest firm in the $100 million-and-over class had average annual sales of $308 million during 1950-1954.23 This was 3.6 per cent of average annual industry sales or 4.9 per cent of average annual capital stock company sales. As previously noted in this section, the two largest firms in the industry had average annual sales of $328 million and $430 million during 1950-1954. T h e smaller of these two firms supplied 3.8 per cent of average annual industry sales, or 5.2 per cent of average annual capital stock company sales; the larger firm supplied 5.0 per cent and 6.7 per cent respectively.24 The 1950-1954 average annual sales of mutual firms in the largest size and lowest cost class ($50 million-and-over, in Table 6) were $75 million. This was .9 per cent of average annual industry sales, or 3.7 per cent of average annual mutual company sales. The largest firm in the $50 million-and-over class had average annual sales of $82 million. This was 1.0 per cent of average annual industry sales, or 4.1 per cent of average annual mutual company sales. Finally, the largest mutual firm in the industry had average annual sales of $216 million during 1950-1954. While this firm was excluded from the sample of Table 6, it had the lowest average expense ratio among capital stock and mutual (New York: T h e Twentieth Century Fund, 1958), II, pp. 356-357; U.S. Senate, Hearings, The Insurance Industry, Part 3, 1959, pp. 1572, 1829-1832, 1847-1848; Part 8, 1960, pp. 4449-4456. 23 Bain calls the proportion of total industry output furnished by an optimal scale enterprise the percentage effect of scale economies on entry. There is also an absolute scale economy effect arising from the amounts of capital investment necessary for efficiency. Op. cit., p. 55. 23 This firm had an average expense ratio of 36.8 per cent, the lowest in the $100 million-and-over class. 24 All relationships were computed from the source materials shown for Table 5.

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multiple-product firms, and it supplied 2.5 per cent of average annual industry sales or 10.7 per cent of average annual mutual company sales.25 No single established firm operating in the lowest unit cost ranges attained in the industry supplies more than 5 per cent of total industry output. This seems to indicate that an entrant could obtain an optimal scale market share at going prices.26 Undoubtedly, scale economies may deter entry to nonlife insurance. If, however, the qualifications just discussed are as significant as they appear, the scale economy barrier is not very high. The new firm is not likely to experience serious difficulty in establishing itself as a limited-product enterprise in a local or regional market. Any difficulty will be further tempered if significant proportions of the lines of insurance to be sold are uniformly priced by industry bureaus. Finally, if it can survive the period necessary to build a sufficient portfolio of business to approach the lowest unit costs found in the industry, the firm probably will not have a market share large enough to disturb industry cost or price patterns. ABSOLUTE CAPITAL REQUIREMENTS

Absolute capital requirements are closely related to scale economies.27 If substantial capital investment is necessary to attain efficient size, potential entrants will be deterred by the absolute size of capital needs and by any disadvantageous interest rates or other terms encountered in the market for capital funds. Lower interest rates and better terms may give established firms absolute cost advantages. The general question of absolute cost barriers to entry will be discussed in the next section of this chapter. In general, established firms are likely to have access to internal funds or to the capital markets at relatively favorable terms. Moreover, the larger the capital requirement for efficient entry, the greater the likelihood that entrants will face disadvantageous interest rates 25 All relationships were computed from the source materials shown for Table 6 and Best's Fire and Casualty Aggregates and Averages (1955), p. 1. 28 It would take a period of time, perhaps several years, to build a large enough portfolio of nonlife insurance contracts to approach the lower unit costs presently attained in the industry. During this time an entrant to the national multipleproduct insurance market would presumably suffer scale disadvantages to some extent. 27 T h e percentage effect of scale economies discussed in the previous section is not related to the absolute-capital-requirement effect in any particular way. One may be important while the other is unimportant, or both may be either important or unimportant. See Bain, op. cit., p. 55.

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28

or other terms. It is difficult to estimate the magnitude of any entrant's disadvantage in securing capital, for we cannot know either the conditions of capital supply or the relative disadvantages a potential entrant will face. But some estimates may be made of absolute capital needs for entry at various scales, and these may be examined for their deterring effect. State laws require minimum amounts of paid-in capital or surplus for many types of insurance enterprises.29 The amounts required are not directly related to the beginning or continuing capital needs of a firm, but are concerned with notions of assuring solvency and protecting policyholders.30 The importance of legal barriers as one type of deterrent will be discussed in a subsequent section of this chapter. Here it is only necessary to note the typical size of states's initial capital requirements. 31 New York, the leading insurance state, and California, a fast-growing insurance state with less stringent regulatory provisions, will serve as examples of these domestic requirements. In New York full multiple-product powers require capital and surplus equal to the aggregate of the requirements of individual lines. Several individual lines have as low a requirement as paid-in capital of $50,000 plus paid-in surplus equal to 50 per cent of paid-in capital. The aggregate paid-in capital and surplus needed to write all nonlife insurance lines is $3,550,000. Of this amount, $2,200,000 must be maintained intact. 32 California also has individual lines of insurance that require only $50,000 paid-in capital plus paid-in surplus equal to 50 per cent of 28 Ibid,., p. 146, and John R. Meyer and Edwin Kuh, The Investment Decision (Cambridge, Mass.: Harvard University Press, 1957), pp. 160-176, 198. 29 Edwin W. Patterson, Essentials of Insurance Law (2d ed.; New York: McGrawHill Book Company, Inc., 1957), pp. 16, 25-26. 80 Ibid., p. 23. 81 Insurance firms organized in other states (foreign) or other countries (alien) may be required to deposit securities or trust funds in addition to their having to meet standards similar to those of domestic organizations. A foreign insurance firm may be permitted to satisfy deposit requirements by a certificate of deposit from the state of domicile. To write two or more lines of insurance, an alien insurance organization must deposit, in New York for example, securities having a par and market value of $500,000 or the minimum capital required of a domestic enterprise writing those lines of insurance—whichever is the smaller. Ibid., pp. 2021; New York, Insurance Law, sees. 40-67, 104; New York State Insurance Department, Examination of Insurance Companies (New York: New York State Insurance Department, 1953), II, pp. 57-115. 82 For a summary of New York provisions, see ibid., pp. 74-79, Tables 1-8. Paidin capital and surplus that must be kept intact may be invested in prescribed types of earning assets. New York, Insurance Law, sec. 79, and California, Insurance Code, sees. 1170-1181.

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paid-in capital. But complete multiple-product operations are permitted with paid-in capital of $1,000,000 plus $500,000 paid-in surplus. 33 The above requirements in both states are applicable to the formation of capital stock organizations. Substantially the same rules apply to enterprises organized as mutuals. 34 Since required capital and surplus funds may be used only for specified types of investments, additional sums are necessary to organize and carry on an enterprise until premium income develops. Moreover, we noted previously that minimum capital requirements are largely unrelated to the capital needs of a new enterprise. Capital requirements for organization and development will vary with the form of organization and the extent of contemplated operations. The latter factor may be principally a function of the size of the geographical area in which insurance is to be sold, but the number of classes of insurance to be sold will also affect organizational and developmental expenses. Organizing a mutual enterprise to furnish one or a few related lines of insurance to a local area can be low in cost.35 Development expenses for these organizations are also likely to be small. Expansion usually depends on the voluntary efforts of policyholder-members rather than on a structure of branch offices or independent sales agencies.36 Incorporated insurance firms have organizational expenses typical of any corporate enterprise. 37 Physical capital requirements, however, are likely to be small compared with those of firms producing tangible products. Office space and equipment and, perhaps, a fleet of motor vehicles constitute the real capital needed to begin operations in insurance. But if a regional or national market is entered, a branch office or sales agency network must be established. This may involve a significant expenditure. For example, the minimum cost of making an insurance agency contact is estimated to be approximately $200. These are the expenses incidental to gaining representation in a going independent agency that will ordinarily have a number of in"Ibid., sec. 700.01. M County or township mutual enterprises are an exception. In California, for example, these organizations may be formed without any paid-in surplus if only fire insurance is to be transacted. A surplus of $50,000 must be maintained if windstorm and similar perils are also to be insured. Ibid., sees. 5050-5094. "Ibid. "Albert H. Mowbray and Ralph H. Blanchard, Insurance (4th ed.; New York: McGraw-Hill Book Company, Inc., 1955), pp. 301-302. 37 Capital stock and mutual organizations are incorporated, reciprocal exchanges and Lloyd's associations are not.

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surance company principals. Since individual companies have as many as 15,000 agents, a considerable investment is represented. 38 Exclusive agency or branch office systems would require larger outlays. In addition, a new insurance firm can expect its stock of insurance contracts to accumulate slowly. Thus working capital needs may be quite large. Purchasers are likely to be wary of a new insurance company. T o overcome sales resistance, new firms have sometimes offered insurance contracts at reduced prices when industry agreements or state regulations did not prohibit price cutting. This practice means smaller total revenue from any volume of sales. T h e reaction of sales may also be different from what is ordinarily expected of a price reduction. Buyers may feel that a new company selling insurance at less than the customary, uniform rates of older and larger companies must be either financially unsafe or avoiding the payment of its claims. New companies have also offered higher sales commissions to induce agents to place new business with them or to shift renewal business from other companies to them. 39 T h e resulting increase in sales expense for new companies may not lead to an increase in their sales and revenues. If established companies tend to match the higher commission scales, the rate at which new firms penetrate the market is not likely to be appreciably different from what it would have been had they adhered to pre-existing commission levels. Since bidding for business by offering higher sales commissions has frequently become quite generalized, an entrant probably cannot rely on this practice to shorten the time needed to develop a portfolio of contracts. 40 What does this discussion suggest regarding absolute capital requirements for efficient entry to nonlife insurance? As we have indicated, a county or township mutual organization may begin operations with very little capital. But the relative efficiency of these small organizations is undetermined. 41 Not only is there a lack of data for * Lengyel, op. cit., p. 138. 88 W . F. Gephart, Insurance and the State (New York: Macmillan Company, 1913), p. 114, and Roger Kenney, Fundamentals of Fire and Casualty Insurance Strength (2d ed.; Dedham, Mass.: Kenney Insurance Studies, 1953), p. 34. 4 0 Competition in commission rates is discussed in William H. Wandel, The Control of Competition in Fire Insurance (Lancaster, Pa.: T h e Art Printing Company, 1935), pp. 9 - 1 1 ; Roger Kenney, "How Near Is an 'Eruption' on Agents' Commissions?" United States Investor, April 4, 1953, pp. 20-22; and Whitney, op. cit., pp. 373-374. T h e effect of competition in sales commission rates on sales expenses in the industry is discussed in chap. viii. 41 These organizations may grow to amass substantial assets, and to provide fairly large absolute amounts of fire and allied insurance coverages. For example, in 1956 there were four county mutuals in California with admitted assets in excess of

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county mutuals, but the scope and mode of operation of these organizations make them noncomparable with large, multiple-product firms. There is no evidence that county mutuals tend to enlarge the geographical and product scope of their operations after they begin to accumulate a surplus. T o expand beyond a county market or into additional products would require these firms to meet broader charter and capital requirements. T o enter a national market (or a regional market that includes New York state) with multiple-product powers, a firm must have minimum paid-in capital and surplus of $3.5 million. 42 T o this sum must be added amounts to develop product distribution facilities and to meet working capital needs. Since New York State requires that only $2.2 million of the initial $3.5 million be kept intact in the form of prescribed assets, $1.3 million may be used for the early needs of an entrant. If an efficient entrant may need up to 15,000 sales representatives at an estimated initial outlay of $200 each, an investment of $3 million is indicated. This expenditure would undoubtedly be spread over some early period of development, but most of it might be undertaken before an appreciable income flow is realized. Thus it appears that a new multiple-product insurance enterprise that is to operate in a regional (including New York state) or national market would have an absolute capital requirement of approximately $5 million exclusive of working capital, and possible "shakedown losses." What these two factors might be is a matter of conjecture, but conceivably they could be at least another $5 million. If exclusive agencies, branch offices, or corporate subsidiaries are used, additional capital will be needed. In his study of manufacturing industries, Bain classifies absolute capital requirements for a single optimal plant as: very large, above $100 million; large, $10 to $50 million; moderate, $2.5 to $10 million; and small, under $2 million. 43 According to our estimate of $5 million, exclusive of working capital, insurance would be in the moderate class. ABSOLUTE COST

Established firms may have absolute cost advantages over potential firms if entrants have to use inferior methods or have to pay higher one million dollars each. In the same year, six California county mutuals had net sales of over $200,000 each. All of these organizations had been in existence 50 to 60 years. California County Mutual Insurance Association, Proceedings, 57th Annual Convention, 1958. 42 T h e size of the New York state market makes it likely that firms contemplating other than a local market will consider New York very desirable if not necessary. 43 Op. cit., pp. 158-159.

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factor prices. If optimal methods and price patterns are either unknown or unavailable, a potential firm will have to plan in terms of less efficient methods or higher factor prices. In the insurance industry it is improbable that secrecy or ignorance concerning the best-known production techniques will place an entrant at a cost disadvantage. Techniques and processes are simple in insurance; moreover, information concerning such methods is readily available from trade associations, regulatory bodies, and suppliers of equipment. There may be instances in which established firms are able to conceal the prices they pay for particular inputs, such as selling or legal services. Lack of information of this kind will increase the uncertainty associated with cost and revenue planning for a potential firm, but it is not likely to be a decisive factor. Furthermore, the simple production processes of the industry have not become structured in a group of patents, developed and controlled by established firms, with attendant opportunities for denying efficient methods to entrants. 45 44

Established firms may also gain cost advantages from control of necessary resource supplies or market imperfections which force higher productive service prices on entrants to an industry. Necessary resources in insurance which might be controlled by established firms and denied entrants or supplied at disadvantageous prices are statistical, reinsurance, and sales services. T h e type of insurance regulatory law passed in nearly all states following the SouthEastern Underwriters Association case 46 and the McCarran-Ferguson Act 47 assures all firms, old and new, access to the statistical services of rate bureaus. 48 However, the interpretation and enforcement of state regulatory laws have frequently failed to protect the rights of firms to subscribe to only part of a rate bureau's services or to deviate from the rates established by a rate bureau for its members. 49 An entrant " Bain, op. cit., pp. 14-16, 144-145. 45 The patent policies of suppliers of data recording and processing equipment may have had some effect on the cost patterns of the insurance industry. Whatever the impact, however, it has presumably been felt by established firms as well as potential firms. " 3 2 2 U.S. 533 (1944). « Public Law 15, 59 Stat. 33 (1945) as amended by 61 Stat. 448 (1947). 48 See C. A. Kulp, " T h e Rate-Making Process in Property and Casualty Insurance— Goals, Technics, and Limits," Law and Contemporary Problems, X V (Autumn, 1950), 513; and U.S. Senate, Hearings, The Insurance Industry, Part 2, 1959, p. 1158; Part 3, 1959, pp. 1792-1794. " F o r a summary of various state approaches to and court decisions on the questions of partial subscribership to rate bureaus and deviation from bureau rates, see Joel B. Dirlam and Irwin M. Stelzer, " T h e Insurance Industry: A Case Study in the Workability of Regulated Competition," University of Pennsylvania Law Review, CVII (December, 1958), 199-215. This matter will be examined fully in chap. v.

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planning to sell its products at rate-bureau determined prices would apparently have no difficulty obtaining statistical services either as a bureau member or subscriber; an entrant planning to sell its products at lower prices might find opposition from both rate bureaus and regulatory authorities. 50 Reinsurance and sales services are necessary for entry to the insurance industry. Forward integration could be used to obtain sales facilities. This would require somewhat greater amounts of capital. By its very nature, however, reinsurance must be obtained from existing insurance organizations. Also, this service is likely to be especially important for the new firm that will generally have limited resources. Here might be an area of possible disadvantage for the potential competitor. Two factors, however, appear to make such a possibility rather unlikely: much reinsurance is provided by alien (primarily English) organizations that are not openly competing in American markets for direct insurance; and the McCarran-Ferguson Act specifically reserves enforcement of boycott, coercion, and intimidation prohibitions to the federal government. 51 These conditions, plus the open, competitive nature of the reinsurance market, are likely to prevent any denial of reinsurance facilities to either new or old firms.62 Management services, while not likely to be susceptible to control by established firms, may be limited in supply and thus present a cost disadvantage for entrants. This may be especially true for the multipleproduct entrant, since there has apparently been a shortage of management personnel with sufficiently broad training and experience to ad50 See, for example, Bradford Smith, Jr., Competition and Regulation in the Insurance Industry (Philadelphia: Insurance Company o£ North America, 1958); Insurance Company of North America, et al. v. Insurance Commission of State of Mississippi and Mississippi State Rating Bureau, 116 So. 2d 224 (1959); and U.S. Senate, Hearings, The Insurance Industry, Part 2, 1959, pp. 1121-1148, 1160-1161, 1195-1242; Part 3, 1959, pp. 1770-1771, 1795-1796, 1887-1889. 61 Public Law 15, 59 Stat. 34 (1945), sec. 3(b). There are some indications that alien reinsurers have provided troublesome competition in the United States direct insurance market at times. American companies have made some attempt to handle the problem by suggesting that such activities may jeopardize the reinsurance business o£ these alien organizations. See U.S. Senate, Hearings, The Insurance Industry, Part 3, 1959, pp. 1497-1504. Nonadmitted, alien organization competition is discussed fully in chap. v. 03 See U.S. Senate, Hearings, The Insurance Industry, Part 1, 1958, pp. 4, 6-237, for suggestions that various stabilizing devices have been used to prevent entry and limit competition in aviation insurance. As a result of these hearings, an investigation of possible violations of federal antitrust provisions is now underway. For a complete description of restrictive practices in property insurance before the South-Eastern Underwriters Association case in 1944, see Frank H. Elmore, Jr., "How Insurance Became Commerce," Journal of American Insurance, X X (July, 1945), 4-7, 14-17, 20-22.

Entry and Exit

55

minister multiple-line insurance operations. T o obtain management services the new firm will probably have to bid them away from established firms. This will be a cost disadvantage; it will be increased by the inefficient use of management in new firms until operations expand enough to spread this type of expense over a substantial volume of output. In addition to management services, market imperfections or market assessments of the risks associated with a new venture may cause an entrant to pay higher prices for other productive services than established firms. This may take the form of higher prices for sales and legal services, or, more likely, higher interest rates for capital funds. Established firms will generally be able to use internal funds for at least a portion of their capital needs. Additional funds may be available at advantageous rates. Furthermore, established firms are less likely to be affected by capital rationing in times of capital shortage. 53 It is impossible to estimate the total absolute cost disadvantage of a potential firm in nonlife insurance. It will depend on such factors as the scale of entry, the product array or mix to be sold, and the market area to be served. In general, however, absolute cost disadvantages would not appear to be serious barriers to entry in nonlife insurance. If state regulation or enforcement of federal antitrust statutes results in access to statistical, sales, and reinsurance services, the remaining significant possibilities for higher costs to entrants are management service outlays and interest rates. At particular times or in certain situations these may constitute a substantial barrier to entry; generally, they would appear to be no more than a modest one. PRODUCT

DIFFERENTIATION

Differentiation of product may hinder entry if it results in significant buyer preference for the products of established firms. T o gain a position in a market where product differentiation is an important element, an entrant will likely have to sell at lower prices or incur higher selling costs.54 Both the size and duration of any disadvantage will be important. If a substantial period of time is needed to establish a market for the products of a new firm, working capital requirements will be increased to cover a period of substandard earnings or losses. There may also be economies or diseconomies of scale in promoting Bain, op. cit., p. 146-147. "See ibid., chap. 4, for a thorough discussion of product differentiation barriers to entry. 63

56

Entry

and

Exit 55

product differentiation. However, the scale pattern in promotion of product differentiation can be considered only in conjunction with the scale pattern in production and distribution. An entrant will want to find the best compromise to minimize the aggregate affect of the two forces. T h e principal basis of product differentiation advantage in nonlife insurance is likely to be buyer preference for insurance contracts of established firms with reputations for financial strength, fair handling of losses, and adequate customer service. Customer inertia or ignorance and established sales-agency systems may also give established insurance firms an advantage over entrants. There are no available estimates of the size and duration of these possible established-firm advantages. One would guess that they are likely to be appreciable and to continue for a substantial period of time. Insurance contracts are promises by insuring organizations to pay if certain events occur. Sometimes these promises extend some distance into the future. Under such circumstances, consumers may place a high value on an organization that has existed a number of years. Certainly, a history of continued satisfactory operation becomes a useful sales promotion point. 56 An entrant's product differentiation disadvantage may appear as various combinations of the following: higher costs in the form of sales-promotion outlays per unit—economies or diseconomies of scale may or may not be present; lower prices per unit; and an extended period of low earnings or losses because of slow accumulation of a portfolio of insurance contracts. T h e existence of a significant amount of common pricing in nonlife insurance suggests that the entrant, particularly a capital stock agency system company, will probably sell at the common price and accept a reduced margin because of higher unit costs of sales promotion or production-distribution. An entrant presumably cannot be denied ac66 Bain suggests that diseconomies of large-scale sales promotion may be more likely than economies. If buyer preferences are strong, attempts by a new firm to dispose of larger and larger quantities will necessitate relatively larger and larger unit selling costs. Even if there should be economies of large-scale sales promotion for both established firms and entrants, the entrant would always be at a net disadvantage. Ibid,., pp. 118-119. 68 Edith Tilton Penrose, The Theory of the Growth of the Firm (New York: John Wiley and Sons, Inc., 1959), pp. 235-236, notes that if an established firm's performance continues to be satisfactory, it may take a long time for a new firm to break down consumer preferences. For a discussion of consumer preferences in the insurance industry for contracts of older, larger firms, when all else is approximately equal, see U.S. Senate, Hearings, The Insurance Industry, Part 2, 1959, p. 1349.

Entry and Exit

57

cess to sales agencies representing a number of insurance companies. But a new insurance firm may have to offer concessions—higher commissions or additional services of various kinds—to obtain access to an agency and to get an active sales response from the agency. Customer preferences for established nonlife insurance companies' products are secured and held by customer service expressed through personal sales representation and by advertising. Insurance advertising stresses the level of company assets, prompt claims settlement, and friendly relationships with local representatives. 57 Personal sales representation is more important than advertising, for relatively small outlays are made for advertising. 58 T h e effect of personal sales representation may be diluted, however, in agency situations involving multiple principals. Here the agent is likely to stress the virtues of his organization and not those of any particular principal or principals. This is even more true of insurance brokers. 59 In summary, an entrant to the multiple-product, national market in nonlife insurance is likely to find some product differentiation barrier. This barrier is likely to take the form of higher costs and reduced margins, though some entrants may also sell at lower prices. It is impossible to estimate the height of this barrier, but it would appear to be significant and to extend over a period of several years. An entrant to a limited market—both in terms of products offered and geographical area covered—may find a lower product differentiation barrier. In many instances, this type of barrier may be quite small for the specialist firm serving a limited market. 60 PUBLIC AND PRIVATE LIMITATIONS ON N E W FIRMS

In previous sections on discussed certain public insurance. These were quirements and possible

capital requirements and absolute costs we and private limitations on entry in nonlife principally minimum paid-in capital rerestrictions on access to necessary resources.

67 Occasionally lower prices will be stressed in advertising. However, such an approach is generally viewed as inappropriate, i£ not unethical, by the industry. 68 Advertising outlays for a sample of 405 capital stock companies (these companies wrote most of the capital stock nonlife insurance written) were .27 per cent of written premiums in 1958. For a sample of 161 of the largest mutual companies they were .51 per cent. Net commission payments for these two groups were 20.86 per cent and 10.44 per cent, respectively. The proportion of these commission payments devoted directly to sales representation to increase established firms' productdifferentiation advantage is unknown. Best's Fire and Casualty Aggregates and Averages (1959), pp. 48, 144. 69 See chap, iii for a discussion of agent and broker ownership rights in insurance contracts. 60 Penrose, op. cit., p. 237.

58

Entry and Exit

In this section the discussion will be expanded and an attempt will be made to evaluate the more important public and private limitations on entry to the nonlife insurance industry. PUBLIC LIMITATIONS

Public limitations on entry may take various forms. 61 In nonlife insurance the main forms are: state requirements of certificates of authority to engage in the insurance business; and state regulations that discriminate against firms organized in other states or countries. Certificates of authority appear to be freely granted to domestic applicants who meet the usual minimum standards for forming business organizations and pay the necessary license fees. In general, there are no restrictions on the numbers of certificates granted. 62 But minimum amounts of paid-in capital are required (in some states deposits of securities are also required) before certificates of authority are issued. As we noted in the section on capital requirements, the amount of required paid-in capital is small for many classes of nonlife insurance. If, however, an entrant wishes to provide multiple-line insurance service, the sums involved may be large enough to have some deterring effect. States frequently protect domestic insurance organizations by discriminating against foreign and alien firms.63 These restrictions of entry often take the form of a special tax on premiums written in a state by firms domiciled in another jurisdiction. Following the SouthEastern Underwriters Association decision,64 which held that interstate insurance transactions were subject to federal jurisdiction, this practice was generally discontinued, for it was thought to be a violation of the commerce clause.65 A subsequent decision, however, held that a discriminatory state premium tax was not unconstitutional, for the McCarran-Ferguson Act,66 by affirming the right of the states to regulate and tax insurance, had removed any possible objections to a tax that differs between domestic and out-of-state companies.67 Since this decision, special premium taxes on out-of-state companies have "See Edwards, op. cit., p. 201; Walter Adams and Horace M. Gray, Monopoly in America: The Government as Promoter (New York: Macmillan Company, 1955), chap. 3; and Munthe, op. cit., chap. 4. 63 Patterson, op. cit., p. 19. 83 Edwards, op. cit., pp. 206-212, discusses the prevalence of laws designed to protect local business. " 322 U.S. 533 (1944). " Dirlam and Stelzer, op. cit., p. 202. 68 59 Stat. 34 (1945), sec. 2. 97 Prudential Ins. Co. v. Benjamin, 328 U.S. 408 (1946).

Entry and Exit

59

again become common. These taxes differ in rates and methods of application, which creates a burden for the entrant to a regional or national market. In addition, the discriminatory rates may amount to a two or three per cent increase in costs for the entering foreign or alien firm.68 Special security deposit requirements and fees for out-of-state companies have also become more common. 69 This practice, too, may be a deterrent to the potential firm, especially the firm planning to enter a wide geographical market. Clearly, public limitations may deter entry to nonlife insurance. Again it is impossible to estimate how important such a deterrent may be, though some suggestions are present. In our previous discussion of absolute capital requirements we noted how minimum paid-in capital regulations operate to increase the amount of capital needed to gain access to nonlife insurance. And here we have seen that discriminatory tax provisions and security deposit requirements may also deter entry into this industry. Particular combinations of public limitations may constitute a significant barrier to entry. Such combinations could develop for the multiple-product firm entering a wide market which presents a number of discriminatory requirements for out-of-state firms. In most instances, however, public limitations will probably amount to no more than a modest barrier to entry. PRIVATE

LIMITATIONS

Established firms ma" use a variety of tactics to discourage the entry of new firms to a market. 70 These restrictive practices may be used by single firms or combinations of firms,71 that is, firms at the same process level within an industry or at different process levels. 72 In nonlife insurance the activities of combinations of firms have been more important than those of single firms. In our previous discussion of absolute cost barriers to entry, we noted that in the past nonlife insurance trade associations have often denied necessary statistical, reinsurance, and sales services to actual and potential competitors unless association price and product policies were followed. Such restrictions were to be eliminated by the South-Eastern Underwriters Dirlam and Stelzer, op. cit., p. 202. Kulp, Casualty Insurance, p. 565; and U.S. Industry, Part 2, 1959, pp. 1072-1073. 70 See Joe S. Bain, Industrial Organization (New 1959), pp. 324-332; and Munthe, op. cit., pp. 17-28, 71 Ibid., p. 35. 72 Munthe, ibid., refers to these two types of zontal and vertical agreements. 68

68

Senate, Hearings,

The

Insurance

York: John Wiley and Sons, Inc., 35-41. restrictive arrangements as hori-

60

Entry and

Exit

Association decision and the McCarran-Ferguson Act. 74 At least a residue of restrictions continued, however.75 One pattern of these restrictions has been revealed in a series of actions by the Antitrust Division of the Department of Justice acting under section 3(b) of the McCarran-Ferguson Act. This section reserves for the federal government antitrust jurisdiction over situations involving boycott, coercion, or intimidation. In a group of three cases the Antitrust Division has successfully sustained charges of group boycott by associations of nonlife insurance agents.76 In each instance local insurance agents associations controlling the major portion of nonlife insurance business in the area were boycotting mutual and participating stock insurance companies and denying association membership to agents representing such companies.77 The courts concluded these boycotts were designed to resist any reduction in the cost of insurance through a reduction in agency commissions. Restrictions of the kind revealed in these cases are aimed primarily at uncooperative actual competitors. They would, of course, also apply to an entrant firm wishing to transact business at other than standard rates and commissions. Presumably exclusionary conduct by insurance agency or brokerage groups is now less likely.78 Another form of private group limitation in nonlife insurance is the opposition of rate bureaus to deviations from bureau-established rates or the independent filing of lower rates by individual companies. The head of the Antitrust Division of the Department of Justice has indicated that a pattern of rate-bureau activity seeking uniform rates 73

322 U.S. 533 (1944). "Public Law 15, 59 Stat. 33 (1945) as amended by 61 Stat. 448 (1947). 76 See, for example, the testimony of the head of the Antitrust Division, Department of Justice, and the testimony of a multiple-line insurance company executive, in U.S. Senate, Hearings, The Insurance Industry, Part 2, 1959, pp. 920926, 1124-1126. 78 United States v. Insurance Board of Cleveland, 144 F. Supp. 684 (1956); United States v. New Orleans Insurance Exchange, 148 F. Supp. 915, affirmed 355 U.S. 22 (1957); United States v. Baton Rouge Insurance Exchange, Civil No. 2088, E.D. La., June 27, 1958. 77 U.S. Senate, Hearings, The Insurance Industry, Part 2, 1959, pp. 920-922. " I n the New Orleans Insurance Exchange decision, the final judgment directed the government to file a report with the court, one year from the effective date of the judgment, indicating whether or not the boycotts outlawed by the decree had been eliminated. The Department of Justice filed its report July 15, 1959, indicating considerable progress. The Department proposed to continue investigating competitive conditions and to submit a supplementary report on the conclusion of such investigation. See Report of the Government Submitted Pursuant to Section X of the Final Judgment Entered in United States v. New Orleans Insurance Exchange, filed July 15, 1959, United States District Court, Eastern District of Louisiana. 73

Entry and Exit

61

could amount to boycott, coercion, or intimidation, and thus be subject to federal antitrust jurisdiction. 79 Present state insurance regulatory laws have generally been understood to recognize rate bureaus as aggrieved parties before state insurance commissions and the courts in rate deviation or independent rate filing proceedings. 80 In this way, groups of companies acting through rate bureaus have opposed the proposals of certain companies to sell particular kinds of insurance at rates less than those established by rate bureaus. Hearings and litigation have been protracted. 81 It is not clear whether this type of market behavior constitutes coercion that may be reached by federal antitrust law, but it is clear that freedom of independent action is limited by these practices. An entrant wishing to sell insurance at prices less than those established by a rate bureau for comparable contracts might be opposed by the bureau on the grounds that the lower rate is not based on accumulated experience. Since the bureau rate is related to a body of empirical material, it is sometimes suggested that theirs is the proper rate and anything lower must be either inadequate for long-run solvency or unfair competition. 82 Besides its inability to demonstrate statistically its justification for a rate lower than that established by a rate bureau, a new firm is unlikely to have the resources to carry through a series of insurance commission hearings and court appeals. Thus the fear of rate-bureau opposition may be all that is needed to make an entrant give up any plan for entering a market at less than standard prices. 83 It is difficult to estimate the significance for entry of group pressure for uniform insurance pricing exerted by rate bureaus. It is apparently more important in fire and related lines of insurance than in other areas of nonlife insurance. 84 And, of course, it has significance only in terms of entry at reduced initial prices. 79 U.S. Senate, Hearings, The Insurance Industry, Part 2, 1959, pp. 925, 930-931, 940. T h e Department of Justice has shown an interest in instances of rate bureau opposition to rate deviation and independent rate applications. Presumably an effort is being made to determine whether such actions amount to coercion. See, ibid., pp. 940, 1153-1154. 80 Ibid., Part 3, pp. 1794-1797, 1801-1803, 1843-1845. 81 Most of the actions have involved the fire insurance operations of two organizations—The Insurance Company of North America and the Allstate Insurance Company. These are large institutions that have shown a propensity to compete actively in terms of price. Ibid., Part 2, pp. 1131-1145, 1160-1179, 1250-1263, 1270. 83 See ibid., Part 3, pp. 1440, 1446-1456,1691, 1717, 1766, 1770. 83 For discussions of the possible difficulties faced by new or small firms attempting to sell insurance at rates lower than those established by rate bureaus, see ibid., Part 2, pp. 938-939, 1129, 1179, 1224. »Ibid., pp. 1132-1133; and Part 3, pp. 1794-1795.

62

Entry and Exit

There have been some cases of tie-in sale limitations in nonlife insurance. Some lending institutions have required that borrowers protect mortgaged property with insurance in a particular company or purchased through a particular agent or broker. 85 More important for an examination of entry conditions in the industry is the tendency for mortgage companies to distrust the insurance contracts of new or small companies. Apparently it is quite common for lenders to reject the insurance policies of small companies.86 This may reflect the lenders' desire for maximum safety or a desire to insure in a particular company for one reason or another. Whatever the explanation, the practice limits the market for the small, new firm. Finally, there have been some efforts to augment private limitations by legislating them into public limitations. These efforts have generally taken the form of proposals to change state insurance reguktory statutes to require all companies to belong to rate bureaus or to sell insurance contracts at common prices. A few states now have laws requiring membership in rate bureaus and a substantial degree of rate uniformity in certain classes of insurance. 87 There have been some attempts to extend this type of law to additional states. So far these attempts have been unsuccessful.88 Private limitations on entry into nonlife insurance are most significant in the area of fire and allied types of insurance. They generally take the form of pressures to conform to price or product policies developed by groups of companies acting through legislatively approved rate bureaus. These practices have sometimes fallen under boycott, coercion, and intimidation prohibitions. The federal government appears to have been quite successful in eliminating the more flagrant instances. T o what extent similar, and perhaps less significant, activity continues it is impossible to say. Again, as we have noted so many times in our discussion of entry conditions, private limitations will assume importance only for the entrant that wishes to sell at reduced prices. The entrant that conforms to price and other policies dem The federal government recently obtained a decree prohibiting, as a coercive practice, an arrangement tying property insurance to mortgage loans. United States v. Investors Diversified Services, 102 F. Supp. 645 (1954). 86 U.S. Senate, Hearings, The Insurance Industry, Part 2, 1959, pp. 1354, 1363-1364. " T h e laws of Louisiana, Mississippi, North Carolina, Texas, Virginia, Washington, and the District of Columbia impose stricter requirements regarding rate bureau membership and rate uniformity than those of other states. Ibid., pp. L183— 1184,1196. 88 For example, uniform rate or mandatory bureau membership legislation has recently failed to pass in Kentucky, New Hampshire, New York, and West Virginia. Ibid., pp. 1196, 1230; and Part 3, pp. 1579-1585.

Entry and Exit

63

veloped on the basis of industry averages would appear to face little if any private limitations to entry. SUMMARY OF ENTRY

In previous sections of this chapter we have discussed what appear to be the most important barriers to entry in nonlife insurance—scale economies, absolute capital requirements, absolute costs, product differentiation, and public or private limitations. These factors differ in importance, though potentially each of them could significantly impede entry under the proper combination of circumstances. Only two, or possibly three, of them seem to present more than moderate barriers to entry under present conditions in the industry. Absolute capital requirements, absolute costs, and public limitations are the less significant types of barriers. Among these lesser barriers, absolute capital requirements is probably the most important. An optimal size entrant, probably a multiple-product, national market organization, could expect some deterring effect from the size of absolute capital needs—perhaps up to $10 million—and possible disadvantageous rates or terms for such funds. Absolute cost disadvantages would be incurred principally as shortages of trained and experienced managerial personnel. An entrant probably would not experience serious resource disadvantages since the South-Eastern Underwriters Association decision. 89 Public limitations largely assume the form of increased capital needs to comply with minimum paid-in capital laws or increased costs because of discriminatory state tax or fee provisions. T h e total effect of these three types of barriers to entry might amount to a moderate deterrent for a national market entrant. For the typical local market entrant, any deterring effect of these factors would be quite small. Scale economies, product differentiation, and private limitations appear to be more important barriers to entry, though certain tempering influences may reduce the height of these barriers to a moderate level also. Product differentiation is probably the most important barrier to entry in nonlife insurance. Because of the intangible nature of the product and the time span involved, customer preference for the contracts of long-established firms may be quite marked. Again the national market entrant will face a greater disadvantage than a local entrant slipping into the interstices of the bigger market. Potentially, scale economies are a substantial barrier to entry, for the available evidence suggests the largest firms in the industry are on the 88

322 U.S. 533 (1944).

64

Entry and Exit

average the most efficient. Joint price making on the basis of average costs diminishes the scale economy effect, however. And the more new, small firms there are in any concerted pricing arrangement, the less effective will be the scale economies. Private limitations in the form of an array of coercive holding and harassing actions have had some deterrent effect on entry, principally through discouraging plans to enter with reduced prices. The sum of these three more important barriers to entry may be an appreciable deterrent for a national market entrant; for the local entrant, the effect would be smaller. The total condition of entry to nonlife insurance cannot be stated as a simple numerical measure or index. Even qualitative judgments need to be formulated cautiously and tentatively, for they must be largely speculative. The following two generalizations are suggested, however: the multiple-product, national market entrant is likely to find a moderate-to-significant barrier to entry; and the limited-product, local market entrant is likely to find an insignificant-to-moderate barrier to entry. Witnesses before the Senate committee studying insurance frequently referred to a condition of easy entry to fire and casualty insurance. From the context of the discussions, they were apparently thinking principally of limited-product, local market entry.90 Recent entry data in nonlife insurance are examined in the following section. ENTRY,

1949-1958

The record of entry into an industry does not prove or disprove a pattern of past or future conditions of entry, for entry conditions are likely to be constantly changing. 91 But an examination of the pattern of entry into an industry over a recent span of time should provide a better understanding of the role of potential competition in that industry. Whether that role changes depends upon the kind and magnitude of changes that occur in the factors influencing entry. In nonlife insurance the South-Eastern Underwriters Association decision92 and the McCarran-Ferguson Act 93 are a dividing point in the history of the industry. The impact of these events on nonlife insurance is undoubtedly exaggerated at times, but there have been significant changes in the industry since these proceedings.94 Thus our "See, for example, U.S. Senate, Hearings, The Insurance Industry, pp. 956, 1051, 1081, 1299; and Part 3, 1959, p. 1656. 01 See Bain, Barriers to New Competition, p. 17. " 322 U.S. 533 (1944). M Public Law 15, 59 Stat. 33 (1945) as amended by 61 Stat. 448 (1947). 64 See Dirlam and Stelzer, op. cit.

Part 2, 1959,

Entry and Exit

65

examination of entry into the industry will be confined to the period after these events. A substantial expansion in the number of firms listed in the nonlife insurance industry has occurred in the last decade and a half. 95 It is not clear how much of this expansion amounts to entry as defined in this chapter—a new, independent firm in the industry, and the introduction of additional policy-writing capacity to that already in use in the industry. Some of the new companies are undoubtedly new subsidiaries of existing firms, and some are probably the result of a more complete listing of companies. Thus entry in the sense of new resources in the industry, managed by new decision-making units, has probably not been as extensive as comparisons of numbers of companies at various time periods indicates. TABLE 7 ENTRY INTO THE NONLIFE INSURANCE INDUSTRY

1949-1958 Form of organization Year 1949 1950 1951 1952 1953 1954 1955 1956 1957 1958 Total

Total Stock

Mutual»

Reciprocal

Lloyd's

22 25 12 22 20 23 34 21 24 11 214

2 6 1 2 4 3 4 1 1 0 24

1 0 0 3 4 0 2 1 4 2 17

0 1 2 1 0 1 1 0 0 0 6

25 32 15 28 28 27 41 23 29 13 261

SOURCES: Best's Insurance Reports (Fire and Casualty, 60th Annual ed.; New York: Alfred M. Best Company, Inc., 1959), pp. 1-1178, 1B-662B. • Includes only companies with at least $200,000 of admitted assets and $200,000 of income from premiums and assessments.

Table 7 shows the numbers of new, independent nonlife insurance firms introducing additional policy-writing capacity into the industry during the period 1949 to 1958. Firm listing may be more complete in the latter part of the period covered. Presumably this is not a very important source of bias. Table 7 does not include all new firms— many quite small ones, particularly in the mutual group, are not in95

Whitney, op. cit., p. 378, indicates 530 companies in 1946 and more than 1400 in 1955.

66

Entry

and

Exit

eluded. Expansions of capacity or other organizational changes taking place by formation of a subsidiary company are also excluded since this does not constitute entry as defined in this study. T h e data summarized in Table 7 appear to be a fairly complete record of entry into nonlife insurance by firms other than the small local market entrants, typified by the small county or township mutual. T h e firms shown in Table 7 had generally entered a one- or few-state market; many of them were selling only one or a few types of insurance. In general the data of Table 7 appear to be consistent with our previous conclusion that entry into a limited area and product market in nonlife insurance is likely to be comparatively easy. 96

Exit Exit is being used here in what seems to be its generally accepted meaning in economics and business, that is, the removal of an independent decision-making unit from an industry. Exit regularly occurs in at least three ways. (1) A firm becomes insolvent. T h e cause is usually said to be a failure to cover at least long-run cash outlays,97 though a sudden, unexpected event such as a large uninsured fire loss may cause an apparently successful operation to fail. (2) A firm retires. Presumably a firm that is not in danger of becoming insolvent will still retire voluntarily from an industry if its estimate of opportunity costs suggests resources could be more profitably used elsewhere. (S) A merger occurs. Imminent insolvency or a voluntary desire to retire may lead to consolidation and the disappearance of a decision-making unit. Mergers, of course, occur for many other reasons also. 98 Conditions of exit in an industry are not likely to be as important an influence on industry conduct and performance as are conditions of " D a t a on the entry of the very small local firm are not generally available, though presumably the state insurance commissions have such information. No attempt was made to compile these data for this study because the kind of entrant that is expected to be most significant for the performance of the industry is the firm which enters at least a state-wide market under conditions indicating an intention to expand both geographical and product markets. The local mutuals tend to remain local mutuals. OT Business failure, as the term is sometimes used, may not always lead to the removal of a firm from an industry. For example, Dun and Bradstreet, Inc., Commercial Failures in an Era of Business Progress: 1900-1952 (New York: Dun and Bradstreet, Inc., 1953), p. 7, includes as business failures all organizations involved in court proceedings or involuntary actions which are likely to end in loss to creditors. Included are reorganizations and arrangements which may or may not lead to the discontinuance of a firm. M See Jesse W. Markham, "Survey of the Evidence and Findings on Mergers," in National Bureau of Economic Research, Business Concentration and Price Policy (Princeton: Princeton University Press, 1955), pp. 141-182.

Entry and Exit

67

entry." T h e principal way in which exit may become a factor is through pressures for government-sponsored or approved programs to protect firms in industries characterized by easy entry and slow exit. 1 0 0 T o some extent, nonlife insurance appears to be such an industry. Exit from the insurance industry, whether it is voluntary or involuntary, is typically a state-regulated, time-consuming procedure. 101 Since state regulation is to a large extent directed toward preserving company solvency, state insurance laws contain provisions for rehabilitating insurers whose financial condition appears to endanger the interests of policyholders or creditors. 102 T h e insurance commissioner may obtain a court order to act as conservator. This vests title to the assets of a company in the commissioner. 103 He may continue to operate the company until rehabilitation is achieved or until it becomes apparent that rehabilitation is impossible. In the latter case, the commissioner obtains court permission to proceed as a liquidator of the firm.104 Conservatorship procedures may have enabled some insurance firms, which would have been dissolved under usual insolvency practices, to continue in business. This may have benefited policyholders and others. It is not clear, however, what the costs have been in terms of efficiency of operation. Voluntary retirement from the insurance business is likely to take place by consolidation with another firm or by reinsurance of all policy obligations in another firm. T o retire by permitting insurance policies and claims to expire may impose a delay of several years, for both policy and claim obligations may extend over a number of years. Exit by consolidation or reinsurance is generally a supervised process. 105 It is not always clear when an exit has occurred in nonlife insurance, for many mergers are merely consolidations of affiliates within a group of commonly owned companies. Disappearance of an independent decision-making unit does not take place under such circumstances. Reported data do not clearly distinguish between this type of merger " J o e S. Bain, "Conditions of Entry and the Emergence of Monopoly," in Edward H. Chamberlin, ed.. Monopoly and Competition and Their Regulation (London: Macmillan and Co., Ltd., 1954), p. 216. 100 Ibid., p. 240. 101 See New York State Insurance Department, Examination of Insurance Companies (New York: New York State Insurance Department, 1954), IV, pp. 409-452. 102 Patterson, op. cit., p. 23. See California, Insurance Code (1935, as amended), sees. 980-1090, for an example of state laws covering insolvency. 103 Ibid., sec. 1011. 1M Ibid., sec. 1016. l t e See, for example, ibid., sees. 1043, 1070-1090.

68

Entry

and

Exit

and the type which eliminates an independent insurance organization. Furthermore, conservatorship, receivership, and liquidation procedures frequently extend over a long period, so it is difficult to establish whether exit ever actually occurs and, if it does, when it occurs. These and other less significant difficulties make it impossible to establish definitely what exit has taken place. But some estimates are possible. Table 8 shows a summary of recent industry exits, constructed from insurance company retirements compiled by Alfred M. Best and Company. Mergers are eliminated, since consolidation of firms within insurance groups is not distinguished from merger of independent organizations. This omission may be largely offset by the inclusion of firms in receivership, for undoubtedly some of these do not become exits. It is also possible that some firms shown as having reinsured all their obligations do not become exits. Even with these qualifications, however, Table 8 indicates that exits are occurring from nonlife inTABLE

8

E X I T FROM THE N O N L I F E I N S U R A N C E

INDUSTRY

1949-1958

Year 1949 1950 1951 1952 1953 1954 1955 1956 1957 1958" Total

Form of organization 0 Stock

Mutual

Reciprocal and Lloyd's

3 4 7 4 8 10 15 21 18 3 93

18 15 11 15 10 17 22 15 18 1 142

5 4 2 2 3 6 6 6 0 1 35

Total 26 23 20 21 21 33 43 42 36 5 270

SOURCES: Best's Insurance Reports (Fire and Casualty, 59th Annual ed.; New York: Alfred M. Best Company, Inc., 1958), pp. 698B-708B. " Includes firms listed as discontinued, dissolved, license not renewed, liquidated, reinsured, in receivership, and in liquidation. Does not include firms listed as consolidated, merged, and in conservatorship. Only three firms were shown in conservatorship during this period—one capital stock company in 1952 and two capital stock companies in 1954. b D a t a for 1958 extend only to M a y 15, 1958.

surance. The largest number of these are mutual organizations, and they have generally been the small county or township organi-

Entry and Exit

69

106

zations. Thus it is difficult to say how important an effect the more common industry exit in recent years has had on the conduct and performance of other firms in the industry. Exit is possible, though it would appear to be slow. State regulatory procedures designed to avoid insolvencies and official sanction of joint costing and pricing arrangements based on group averages probably tend to retard exit. 109 The mutual company exit of Table 8 is not comparable with the mutual company entry of Table 7, for there is no $200,000 size limitation on the exit data. More complete data are available for exit than for entry.

CHAPTER V

Price Policy and Price Making T h e price of a good or service results from the interaction of many forces. Identifying and explaining these forces have occupied economists and others for a long time. Presumably the principal basis of this interest is a desire to predict behavior and to prescribe policy. Up to a few decades ago, price determination and its results in terms of resource allocation, income distribution, and level of resource use were usually explained as automatic processes generated by a freely competitive market economy. Policy prescriptions were usually few, for it was widely believed that the long-run tendencies of such a system were both optimum allocation and employment of resources. T h e experience of the 1930's raised serious doubts about the automatic, competitive nature of the American economy. 1 Price behavior, business price policies, and the extent of business controls over price assumed a new importance in many explanations of the operation of the economy. An organized effort was made to gain a better understanding of price questions and to develop some broad public policy in regard to prices. 2 This sweeping investigation led to the accumulation of a 1 See Stephen H. Sosnick, "A Critique of Concepts of Workable Competition," Quarterly Journal of Economics, LXVII (August, 1958), 383-384, and the references given there. ' The Temporary National Economic Committee was established in 1938 to investigate the existing price system and its effect upon the operation of the economy. Public Resolution No. 113, 75th Cong., June 16, 1938. For a discussion of some of the possibilities and problems of such a study, see Edward S. Mason, "Price Policies and Full Employment," in C. J . Friedrich and Edward S. Mason, eds.. Public Policy (Cambridge, Mass.: Harvard University Press, 1940), pp. 25-58, reprinted in Edward S. Mason, Economic Concentration and the Monopoly Problem (Cambridge, Mass.: Harvard University Press, 1957), pp. 134-167.

70

Price Policy and Price Making

71

great amount of information but very little in the way of specific policy recommendations. 3 Concern with the post-World W a r II price inflation has brought a revival of interest in price behavior and its relationship to the operation of the economy. 4 Before turning to a discussion of price policy and price making in nonlife insurance, we need to consider at greater length what is meant by the term "price policy." Meaning

of Price Policy

A policy is a plan or course of action. Presumably it outlines an approach to a goal or a set of goals. Simple, observable relationships between policies and goals are unlikely, however, for goals are frequently neither defined nor expressed. Policies may be all that are observed. 5 Yet any particular set of policies implies a particular set of objectives. But policies and goals—means and ends—may become so intertwined that goals are modified and policies assume significance for their own sake. Price policy depends on freedom to choose lines of action which are felt to be important to achieve some purpose—express or implied. There are public price policies as well as private business price policies. And business price polices may be either individual or group. 8 Public "See J . K. Galbraith, "Monopoly and the Concentration of Economic Power," in Howard S. Ellis, ed., A Survey of Contemporary Economics (Philadelphia: The Blakiston Company, 1948), pp. 120-124. 'See, for example, U.S. Congress, Joint Economic Committee, The Relationship of Prices to Economic Stability and Growth, Compendium of Papers Submitted by Panelists Appearing before the Joint Economic Committee, 85th Cong., 2d Sess., 1958. A broad study of employment, growth, and price levels undertaken by the Joint Economic Committee under Senate Concurrent Resolution 13, 86th Cong., 1st Sess., 1959, has resulted in a number of hearings, study papers, and reports. For a summary and listing of materials, see U.S. Congress, Joint Economic Committee, Employment, Growth, and Price Levels, Senate Report No. 1043, Report of the Joint Economic Committee, 86th Cong., 2d Sess., January 26, 1960. An example of a privately sponsored study of price behavior and price policy is A. D. H. Kaplan, Joel B. Dirlam, and Robert F. Lanzillotti, Pricing in Big Business: A Case Approach (Washington, D.C.: T h e Brookings Institution, 1958). See also Alfred R. Oxenfeldt, Industrial Pricing and Market Practices (New York: Prentice-Hall, Inc., 1951). " Kaplan, Dirlam, and Lanzillotti, op. cit., pp. 12-13, 276-278. For a discussion of conflict and goal formation in organizations, see James G. March and Herbert A. Simon, Organizations (New York: John Wiley and Sons, Inc., 1958), pp. 117-131. See also William J . Baumol, Business Behavior, Value and Growth (New York: Macmillan Company, 1959), pp. 45-53; and Alfred R. Oxenfeldt, "Cyclical Implications of Private Pricing Policies," in U.S. Congress, The Relationship of Prices to Economic Stability and Growth, p. 462. • Edwin G. Nourse, " T h e Meaning of 'Price Policy,'" Quarterly Journal of Economics, LV (February, 1941), 192,205.

72

Price Policy and Price

Making

price policy may directly regulate or indirectly influence. Its role will depend on how the public views the actual or prospective results of private price policy. 7 Business price policy is meaningful only for firms that have some control over their own prices. 8 This area of control within which price policy may be formulated can be widened by collusive action, by trade association activities, and by price and product techniques. For example, price discrimination may not only exploit a position of market control but it may also extend the degree of market control.9 Business price policies are clearly related to the structure of markets. 10 Such a relationship, if invariant, could be the basis of the explanation and prediction of business price policies and practices. 11 As yet there is not enough evidence to establish trustworthy relationships between market structure and price policies. Nor is it clear that other variables, such as the discretion of management, historical development of a firm, and absolute size of a firm, are not also important in determining price policy. 12 Nonetheless, it would appear that an understandirg of market structures and their differences may provide a basis foi explaining many aspects of business price policies. Business price policy may take many forms. Examples are: price uniformity; price discrimination; price stability; price leadership or followership; prices set to achieve a target return on investment; prices set to deter entry; and prices set to achieve maximum sales.13 Innumerable combinations of these and other policies are possible. And, of course, price policy is not planning in isolation. It is mixed with technological, wage, investment, marketing, and many ether plans. Perhaps price policy may be viewed, however, as the key eleIbid., pp. 201-203, 207. ' E d w a r d S. Mason, "Price and Production Policies of Large-Scale Enterprise," American Economic Review, X X I X (March, 1939), 61-62, emphasizes that lor a firm to have a price policy it must not only have some degree of market control but must also sell at quoted prices. Mason notes that price policies are likely to be a feature of all markets except agriculture and the organized produce and securities exchanges. See also Edward H. Chamberlin, Towards a More General Theory of Value (New York: Oxford University Press, 1957), p. 25. "See Mason, "Price Policies and Full Employment," pp. 29-30. " F o r a summary and discussion of what may constitute the structural :haracteristics of markets, see Sosnick, op. cit., pp. 386, 389-391, 419-423. 11 Committee on Price Determination for the Conference on Price Research, Cost Behavior and Price Policy (New York: National Bureau of Economic Research, 1943), p. 281; and Mason, "Price and Production Policies of Large-Scale Enterprise," pp. 68-73. " K a p l a n , Dirlam, and Lanzillotti, op. cit., pp. 251-290; and Nourse, op. cit., pp. 186-187. See also Sosnick, op. cit., pp. 395-397. 13 Kaplan, Dirlam, and Lanzillotti, op. cit., p. 128; and Committee on Price Determination for the Conference on Price Research, op. cit., p. 279. 7

Price Policy and Price Making

73

ment—something of an index—of all these plans. 14 Price policies are formed and carried out by individual firms or by groups of firms. Some combination of individual and group action would appear likely. How formalized the group action becomes will depend on a number of factors, especially the role of antitrust policy. 15 W e shall see that the provisional antitrust exemption, provided the nonlife insurance industry by the McCarran-Ferguson Act, 1 6 recognized under state regulation a quite highly developed system of group price policies. Survey of Price Policy and Practices in the Industry

Pricing

For the past four or five decades the dominant private price policy in nonlife insurance has been price uniformity. 17 T h i s policy, taking a variety of forms to subdue or eliminate price competition as an industry characteristic, has centered around price-making combinations. T h e success of these combinations has varied as membership in the combinations has been more or less complete, as combination enforcement devices have been more or less effective, and as public intervention has been more or less active. 18 Industry emphasis on price uniformity has not precluded consideration of other price policies. Firms or combinations of firms in nonlife insurance have followed several other price policies as well. (1) Price discrimination has been used, though state regulation has generally been opposed to such practices. T o d a y state insurance laws " S e e Edwin G. Nourse, Price Making in a Democracy (Washington, D.C.: The Brookings Institution, 1944), p. 317. " S e e Simon N. Whitney, "The Influence o£ the Antitrust Laws and Related Governmental Policies on Prices," in U.S. Congress, The Relationship of Prices to Economic Stability and Growth, pp. 558-563, and Mason, "Price Policies and Full Employment," pp. 32-33. " 5 9 Stat. 33 (1945), as amended by 61 Stat. 448 (1947). 17 For a sample of varying expressions of this policy and explanations of it, see New York, Report of the Joint Committee of the Senate and Assembly (Merritt Committee Report), Legislative Document No. 30, 1911, I, 108; New York State Insurance Department, Examination of Insurance Companies (New York: New York State Insurance Department, 1953), I, pp. 112-113; Robert I. Mehr and Emerson Cammack, Principles of Insurance (rev. ed.; Homewood, 111.: Richard D. Irwin, Inc., 1957), p. 806; U.S. Congress, Senate Subcommittee on Antitrust and Monopoly of the Committee on the Judiciary, Hearings, The Insurance Industry, Parts 2 and 3, Ocean Marine, Rating and State Regulation, 86th Cong., 1st Sess., 1959, pp. 1050-1054, 1088-1091, 1583, 1766-1770, 1794-1795; Thomas C. Morrill, Fire Insurance Terms and Discounts (New York: New York State Insurance Department, 1950), p. 10. 18 Mason, "Price and Production Policies of Large-Scale Enterprise," p. 70, emphasizes that controlled price competition is not a policy limited only to large firms or markets in which sellers are few—in other situations such a policy simply becomes more difficult to control effectively.

74

Price Policy and Price

Making

direct that insurance premiums shall not be unfairly discriminatory.19 (2) The nonlife insurance industry has maintained, since regulation of its activities became fairly widespread, that it should be permitted to price its products to produce revenue sufficient to cover all costs and to earn at least a minimum additional amount for stockholder dividends or additions to surplus. For the capital stock organizations this policy has taken the form of profit formulas designed to return a target amount on sales.20 Moreover, profits are calculated only on insurance transactions. Investment earnings are not included. Regulatory officials and the industry have disagreed on this question, but investment earinings have not yet been considered in rate determination.21 (3) Many times there has been no apparent plan that could be called a price policy other than following the market.22 At times this might have been evidence of a policy of price leadership; generally it was probably not, for there are no firms which control enough of the market to function effectively as a leader.23 (4) The most frequently expressed price policy in the industry is that premiums shall not be excessive, inadequate, or unfairly discriminatory. This rather ambiguous statement is something of a combination private business and public price policy. It is expressed as public policy in state insurance laws.24 Yet the drafting of existing legislation was a joint project of industry committees and state insurance commissioners. Thus this policy is also an expression of private price policy in the industry, or perhaps an expression of a compromise between private and public policy. Price policy may emphasize cost, demand, competition, or other "C. Arthur Williams, Jr., Price Discrimination in Property and Liability Insurance (Minneapolis: University of Minnesota Press, 1959), pp. 54-79. 20 See Harry J. Solberg, "The Profit Factor in Fire Insurance Rates," Journal of Insurance, XXIV (November, 1957), 24-25. a Ibid., 28-31. 23 Cf. Kaplan, Dirlam, and Lanzillotti, op. cit., p. 127. 23 It is possible that leadership may be exerted by some combination of a few of the larger firms through their essentially perpetual membership on numerous rate bureau and trade association committees. See, U.S. Senate, Hearings, The Insurance Industry, Part 2, 1959, pp. 1123, 1126, 1135-1158, 1155-1156, 1260-1263, 1270-1272; Part 3, 1959, pp. 1484-1488, 1696-1699; Part 4, 1960, p. 2224. 24 Model rate regulatory bills developed by the National Association of Insurance Commissioners-All Industry Committees, following passage of the McCarran-Ferguson Act in 1945, stated that nonlife insurance rates were not to be excessive, inadequate, or unfairly discriminatory. See, for example, ibid., Part 3, pp. 17921794; Joel B. Dirlam and Irwin W. Stelzer, "The Insurance Industry: A Case Study in the Workability of Regulated Competition," University of Pennsylvania Law Review, CVII (December, 1958), 200-202; and California, Insurance Code (Supp. 1947), sec. 1852.

Price Policy and Price Making

75

25

factors such as government regulation. In nonlife insurance, cost and government regulation seem to be the most important influences on price policies and practices. In the industry a presumption exists that these should lead to a significant degree of price uniformity, free from the dangers of widespread price competition. What are the goals of these price policies? In the private business area we have no clear statements. Presumably insurance firms wish to cover all costs over the long run so that they can continue in business. The capital stock organizations frequently mention fair or reasonable profits. For many lines of insurance these have been stated as target rates of return on sales—approved, at least tacitly, by regulatory authorities. Expanding the volume of sales is often stressed also. This may assume the status of a goal, subject to the constraint of covering all costs over time.26 Insurance rates shall not be excessive, inadequate, or unfairly discriminatory: quite clearly, the public goals inherent in this combination public and private provision are company solvency and some notion of fair treatment of the insuring public. 27 Before we begin to examine how price policies have been put into practice in the industry, we need to consider briefly the present pattern of governmental regulation and how it developed. Private price policies are conditioned by this; public price policies are reflected in it. GOVERNMENT REGULATION

Today price making in the industry is subjected to a legal framework of control in all states, the District of Columbia, and Puerto Rico. The basic regulatory law is generally quite similar in all jurisdictions. Interpretation and enforcement may vary widely, however. The present pattern of regulation is an outgrowth of the Supreme Court's action in 1944 declaring that the insurance business is commerce and insurance conducted across state lines is interstate commerce and thus subject to federal antitrust laws.28 An attempt to 55 Wroe Alderson, "Business Price Policies and Economic Stability," in U.S. Congress, The Relationship of Prices to Economic Stability and Growth, 1958, p. 404. Baumol, op. cit., pp. 4 7 ^ 8 . "See, for example, New York State, Seventy-Seventh Annual Report of the Superintendent of Insurance (Albany: New York State Insurance Department, 1936), I, p. 11. 28 U.S. v. South-Eastern Underwriters Assn., 322 U.S. 533 (1944). For discussions of this case and the events leading up to it, see Irwin M. Stelzer, "The Insurance Industry and the Antitrust Laws: A Decade of Experience," Insurance Law Journal, No. 386 (March, 1955), 137-141, and Frank H. Elmore, Jr., "How Insurance Became Commerce," Journal of American Insurance, XXII (July, 1945), 4-7, 14-17,20-22.

76

Price Policy

and Price

Making

get general legislative exemption from the Sherman and Clayton Acts failed, 29 but a compromise measure affirmed the principle of state regulation and, in general, made the federal antitrust laws applicable to the industry only to the extent that it was not regulated by the states.30 When the McCarran-Ferguson Act was passed, state regulation varied from fairly complete supervision of all classes of insurance in New York state to essentially no regulation in a number of states.31 Collaboration, particularly on price, was common. Where state antitrust legislation existed it had proved ineffective, or in some instances it had been held nonapplicable to insurance. 32 Owing to lack of success with statutes prohibiting combinations of insurers to fix rates, states concerned with the problem undertook regulation of the industry. Insurance companies sought to avoid this regulation. But in 1869 a Supreme Court case had established that insurance regulation was a valid exercise of the police power of a state.33 In an aside the court stated that the business of insurance was not commerce. In a long line of subsequent cases involving the validity of state regulation, this statement was accepted without analysis.34 In 1944, when questions of 28 See C. A. Kulp, Casualty Insurance (3d ed.; New York: T h e Ronald Press Company, 1956), pp. 549-550. For the Senate debate on whether the insurance business should be granted an exemption from federal antitrust law, see U.S. Congressional Record, 79th Cong., 1st Sess., 1945, XCI, Part 2, pp. 1442-1444, 14741489. 110 Public Law 15 (McCarran-Ferguson Act) 59 Stat. 34 (1945), as amended by 61 Stat. 448 (1947). 81 James B. Donovan, "Regulation of Insurance Under the McCarran Act," Law and Contemporary Problems, XV (Autumn, 1950), 483. m See Clarence W. Hobbs, "State Regulation of Insurance Rates," Proceedings of the Casualty Actuarial Society, XI (June, 1925), 218-221. An example of one way in which state antitrust statutes were avoided is provided by Crow v. Fireman's Fund et al., 52 S.W. 595 (1899). Missouri enacted an antitrust act in 1899. It was amended to apply to insurance and insurance companies then abandoned concerted rate making within that state. But companies supplied their agents in Missouri with rate manuals, and the agents formed "social" clubs with a secretary who checked copies of all policies to see that uniform manual rates had been charged. T h e court held this practice to be a violation of the state antitrust laws. Another device to avoid state antitrust laws was the use of advisory rates instead of mandatory rates. T h e Temporary National Economic Committee investigation developed information to show that as early as 1910 and 1911 the legal committees of casualty rate bureaus made studies of all state antitrust laws and state court decisions. From these studies, schedules were prepared to inform casualty insurance organizations in which jurisdictions advisory rather than mandatory rates were to be provided. See TNEC Monograph No. 10, Life Insurance (1940), p. 4169. *>Paul v. Virginia, 8 Wall. 168 (1869). M Ducat v. Chicago, 10 Wall. 410 (1870); Liverpool Ins. Co. v. Mass., 10 Wall. 556 (1870); Phila. Fire Assoc. v. N.Y., 119 U.S. 110 (1886); Hooper v. Calif., 155 U.S. 648 (1895); New York Life Ins. Co. v. Cravens, 178 U.S. 389 (1900); Nutting v. Mass., 183 U.S. 553 (1902); N.Y. Life Ins. Co. v. Beer Lodge County, 231 U.S. 495

Price Policy

and Price Making

77

interstate commerce and the power of Congress to regulate interstate commerce were raised, the court held the interstate aspects of insurance to be subject to congressional jurisdiction.35 This decision apparently surprised many people in the insurance industry, though it is difficult to see how the court could have ruled otherwise when it was presented with a federal question.36 State regulation immediately became a desirable set of conditions to be retained.37 The McCarran-Ferguson Act seemed to call for stronger, more systematic regulation if state control was to continue.38 T o secure state regulation which they believed would be adequate, an all-industry committee and a National Association of Insurance Commissioners' committee worked out model rate regulatory bills.39 With modification, the bills were eventually passed by all states.40 These laws permitted joint rate making to continue. Active state supervision was to be instituted, however. The following points summarize the main principles of the fire, marine, and casualty insurance regulatory bills and the typical state rate regulatory law which developed from them.41 1. All rates are to be filed, accompanied by s u p p o r t i n g data, w i t h the state insurance commissioner. Generally this will be d o n e by a r a t e b u r e a u . 2. Proposed changes in rates are n o t effective u n t i l a f t e r a waiting period, d u r i n g which the supervisory official examines the proposed change. (1913); German Alliance Ins. Co. v. Lewis, 233 U.S. 389 (1914); and Colgate v. Harvey, 396 U.S. 404 (1935). T h e right of a state to regulate insurance rates was specifically affirmed by the German Alliance case. » U.S. v. South-Eastern Underwriters Assn., 322 U.S. 533 (1944), pp. 539, 553-561. 88 See Ralph H. Blanchard, "Governmental Regulation o£ Insurance," Journal of American Insurance, XXII (May, 1945), 15. 87 Blanchard speaks of the "fervor for preserving state regulation, which overnight acquired tremendous virtue." Ibid. 38 Sec. 2(b) of the amended McCarran-Ferguson Act stated that after June 30, 1948, the Sherman Act, the Clayton Act, and the Federal Trade Commission Act (all, as amended) "shall be applicable to the business of insurance to the extent that such business is not regulated by State law." Sec. 3(b) retained federal jurisdiction over "any agreement to boycott, coerce, or intimidate, or act of boycott, coercion, or intimidation." Furthermore, when President Roosevelt approved the act he stated: "Congress did not intend to permit private rate fixing, which the Antitrust Act forbids, but was willing to permit actual regulation of rates by affirmative action of the states." White House press release, March 10, 1945, quoted in U.S. Senate, Hearings, The Insurance Industry, Part 2, 1959, p. 920. 89 See ibid., Part 8, 1960, p. 4566, for the composition of these committees. 10 "Federal Trade Commission Surveys State Insurance Laws," Insurance Law Journal, No. 328 (May, 1950), 339-342. "•Ibid., 341. Because of their special nature, or because of other applicable legislation, life, accident and health, aviation, and ocean marine insurance, as well as reinsurance, were not included.

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Price Policy and Price

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3. Rates may not be excessive, inadequate, or unfairly discriminatory. 4. If rates do not meet standards, that is, are judged to be excessive, inadequate, or unfairly discriminatory, officials can disapprove them during the waiting period or at any time thereafter. 5. Companies may be members of or subscribers to rate bureaus and thus collaborate on rates, but bureaus are subject to supervision. 6. A member or subscriber company may apply to the insurance commissioner to deviate from bureau rates. 7. Companies cannot be compelled to be members of or subscribers to rate bureaus. Thus independent rate filing is possible if acceptable supporting data can be provided. 42

A few states, notably California, enacted a somewhat less stringent law. For example, the California law does not require that rates be either filed with or approved by the insurance commissioner. He may, however, request that they be filed.43 The California law also prohibits rate agreements. California's liberal law is nullified to a considerable extent by the strict law in New York. All major companies are entered in New York State and have to adhere to its regulatory practices. And it seems that rate bureaus test their rate filings in New York before making changes in other states.44 Price Making

in the

Industry

In this section we will examine what seem to be the most important forces influencing the determination of premium rates in the industry: losses, expenses, demand, competition, collusion, and regulation. Though these factors are all interrelated, it will be easier to discuss them separately or in convenient groups. COST FACTORS

If an organization is to break even and remain in business, the insurance premiums it collects must cover two things in the long run: losses and expenses. Each of these categories of insurance cost will be examined in turn. " S e e U.S. Senate, Hearings, The Insurance Industry, Part 2, 1959, pp. 1167-1179. A few states do not permit independent rate determination. See ibid., pp. 1222-1230. " S e e Margaret Rohrer, State Regulation of Insurance, State of California 1951 Legislative Problems, No. 2 (Berkeley: University of California Bureau of Public Administration, 1951), p. 6. " For a discussion of the rigidity of state laws and the extraterritorial effect of the New York law, see Roger Kenney, "These Critical Days in the Casualty Insurance Business," United States Investor, January 12, 1952, p. 26. See U.S. Senate, Hearings, The Insurance Industry, Part 1, 1958, pp. 206-208, for an elaboration of the extraterritorial aspects of the New York law by a member of the New York State Department of Insurance.

Price Policy

and Price Making

79

LOSS RATIOS

When a large number of similar cases are considered, the possibility of loss from a specific peril is predictable; when a particular case is considered, the possibility of loss is a matter of chance. Combining similar cases is the basis for estimating the expected loss costs of an insurer. Particular cases are combined into classes according to attributes which seem to make them approximately equally susceptible to loss from the peril under consideration. For example, private dwellings of wood frame construction may form a reasonably homogeneous class for the chance of loss from fire, as do workmen employed as carpenters for the chance of loss from industrial accident, or restaurants for the chance of loss from robbery. Collected data on previous losses in each classification are used to estimate future losses for that class.45 Not all subjects of insurance fall into reasonably homogeneous groups for determining past loss experience and estimating future loss probabilities. Variations from basic classifications are handled by adjustments based on special experience or merit factors, and by schedules which allow for supposed differences in susceptibility to 45 Somewhat detailed procedures have been developed for collecting and analyzing loss statistics to obtain probability estimates of future losses. T o cope with a dynamic world, rating organizations have attempted to interject trend or rate level adjustment factors into their loss estimate computations. (For an example of an attempt to develop prospective loss costs, see J. Edward Faust, Jr., "Automobile Bodily Injury Liability Rate-Making on a Prospective Basis," Proceedings of the Casualty Actuarial Society, XLIV [November, 1957], 11-18). These trend factors are in large part necessarily a matter of judgment, for they rest upon estimates of variables such as levels of prices and economic activity in future periods ranging from one to five years. Professor Blanchard summarizes loss estimation and the part judgment plays in it this way: " T h e problem of recording what losses have occurred has been pretty well solved and records of most major lines are reliable, though not always up to date. Estimates of outstanding losses, though sometimes made with an eye to considerations other than those of strict accuracy, are capable of remarkably exact calculation. A considerable element of judgment and even of expediency enters into classification, but given a system of classification, the records accumulated can be, and mostly are, reliable. " T h e big difficulty arises in attempting to use those records as a basis for predicting future losses. . . . T h e answer must be largely a matter of judgment, and judgment has a way of itself resting on the past and of being warped by bias. T h e bias is not necessarily that of direct financial self-interest; it may be that of position, of tradition, or of eventual financial self-interest. . . ." Ralph H. Blanchard, "Judgment Helps Set Our Rates," The Spectator, CLXI (August, 1953), 15, 74. Cf. Harold C. Atkiss, Fire Insurance Rate Making (New York: New York State Insurance Department, 1950), Part 1. (In future references this will be the Atkiss Report.) Atkiss points to a lack of adequate statistics and the failure to devise a method of uniform interpretation of existing statistics. Particularly is this true in regard to the reserves maintained by companies for reported but unpaid losses.

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and Price

Making

46

loss. There is a real need to accumulate data on losses more effectively and to use these data more extensively in predicting loss costs. However, if a subject of insurance differs substantially from all others in a variety of ways, estimates of future losses will be almost entirely a matter of judgment. Because of his experience, the judgment of the professional insurer should still be superior to that of the individual or business firm facing the chance of loss. A genuinely unique case may also be rare. Thus combined loss experience can be used, at least in part, for most problems.47 Suggestions have been made to simplify the process of loss estimation by reducing the multiplicity of classes and subclasses. In some areas of insurance this has been done. 48 A smaller number of readily distinguishable classes, with an adequate body of loss data in each, may be more useful and practical than many highly refined ones with too small a number of exposures and insufficient geographical dispersion.49 Any increase in price discrimination might be compensated by increased precision in loss estimation because of the greater amount of loss experience in each class. The problem is the same in all lines of property and casualty insurance—to make the best use of past losses to establish estimates of future losses. But the quantity and quality of the data available and the techniques used to predict losses vary quite widely among classes "Schedule rating is widely used to estimate probable fire insurance losses for nondwelling buildings and their contents. Some 70 per cent of New York City fire insurance premiums are derived from the application of schedule rates. Atkiss Report, p. 15. Atkiss emphasizes that the modification of a basic estimate of probable fire loss for a particular structure or its contents by the application of a schedule of credits and charges is purely a matter of engineering judgment. For example, no statistics are kept to substantiate granting a credit to a hotel with fire doors in contrast to one without such devices; it is merely felt that the former will be less likely to burn and less likely to do so by an arbitrary relative amount. See also U.S. Senate, Hearings, The Insurance Industry, Part 3, 1959, pp. 1434-1435. "See Frank H. Knight, Risk, Uncertainty and Profit (Boston and New York: Houghton Mifflin Co., 1921. Reprinted by the London School of Economics, London, 1933), p. 250; and Allan H. Willett, The Economic Theory of Risk and Insurance (New York: Columbia University Press, 1901. Reprinted by the University of Pennsylvania Press, Philadelphia, 1951), pp. 71-89. 18 In particular, substantial reductions have been made in the number of statistical classes in fire and workmen's compensation insurance. Robert E. Dineen, "Five Steps Toward Better Fire Rates," American Management Association, Insurance Series, No. 76, 1948, reprinted in H. Wayne Snider, ed., Readings in Property and Casualty Insurance (Homewood, 111.: Richard D. Irwin, Inc., 1959), pp. 313-314; and Paul U. Sunderland, Jr., "Workmen's Compensation Ratemaking," Annals of the Society of Chartered Property and Casualty Underwriters, VII (March, 1955), 169. 48 See Laurence H. Longley-Cook, "Problems of Fire Insurance Rate Making," Proceedings of the Casualty Actuarial Society, XXXVIII (November, 1951), 94-102, reprinted in Snider, op. cit., p. 331.

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50

of insurance. It was recognized early in the industry that few, if any, insurers could hope to do enough business in any line of insurance to be able to make reliable loss predictions. Pooling of company loss experience was the obvious answer.51 But cooperation did not stop there; perhaps that was not all that had been intended. 62 Cooperation also included collection of expense data, rate making itself, and many other activities. Before noting how such extensive cooperation developed and what its influence may be, it is necessary to examine the expense portion of the premium rate. EXPENSE RATIOS

Expenses and profits represent the cost to the public of maintaining the institution of insurance. 53 Profits are not costs or expenses in an accounting sense, but they are in a social sense.54 The social cost of insurance—expenses and profits—varies among lines of insurance. Expense ratios of 60 per cent or more of written premiums are found on lines of insurance for which companies furnish many services in addition to the payment of losses. For example, in boiler and machinery insurance extensive engineering and inspection service is provided by the insurance industry. Perhaps the fire insurance expense ratio recently used in New York State is a good example of the level of expenses associated with a long established and widely sold class of insurance. Fifty-two and one-half per cent of the premium rate determined by the licensed fire insurance rating bureau in New York has been allocated to the payment of ex60 See ibid., pp. 326-330; T h o m a s H . Carlson, "Statistical and Actuarial Procedures in Liability Insurance," Journal of the American Association of University Teachers of Insurance, XVII (March, 1950), 5-12, reprinted in Snider, op. cit., pp. 335-343; Clyde H. Graves, "The Uniform Statistical Plan for Fire and Allied Lines," Proceedings of the Casualty Actuarial Society, X L (November, 1953), 40-59. 61 Irwin M. Stelzer, "Economic Consequences of a Successful Antitrust Prosecution," Insurance Law Journal, N o . 373 (February, 1954), 87-88. 52 For example, the Inland Marine Underwriters Association, consisting of the principal capital stock companies writing inland-marine insurance, was established January 1, 1931, for the stated purpose of stabilization and cooperation. Uniform rates, forms, and agency commissions were its objectives. See T . C. Anderson, "What Will Rate Regulation Mean to Inland Marine Insurance?" Journal of American Insurance, X X I I I (February, 1946), 16. One study of trade associations in the United States indicates that sixty insurance associations were formed during the period 1860-1938. T h e s e were national or regional bodies and were predominately in the property and casualty industry. T N E C Monograph N o . 18, Trade Association Survey (1941), pp. 369, 403-404. 63 R a l p h H . Blanchard, "Losses, Expenses and Profits," Best's Insurance News, LIII, Fire and Casualty ed. (March, 1953), 50. Expenses include the cost of loss prevention services. M See S. J. Lengyel, Insurance Companies' Accounts: An Economic Interpretation and Analysis (London: F. W . Cheshire Pty., Ltd., 1947), p. 115.

82

Price Policy and Price

Making

penses and profit. It is only recently that expenses have been segregated by nature and source in any systematic way in property and casualty insurance, and much more remains to be done here. 56 In connection with a related, yet distinct, aspect of expenses, the nonstock insurers in the industry are considered to be further advanced than stock companies in the methods used for adjusting their expense structure to the service rendered and needed. 57 The expense and profit portion of the premium rate covers all costs of operating an insurance enterprise, except expenses incidental to the adjustment and payment of losses. These are classified as additions to loss payments, and thus are a portion of the loss ratio. 55

INDUSTRY COOPERATION ON LOSS AND EXPENSE FACTORS—THE ROLE OF BUREAUS IN RATE MAKING

Industry cooperation to pool loss experience and gain as broad a statistical base as possible for loss prediction has long been considered desirable. Cooperation has generally extended far beyond collecting and interpreting loss data, however. For this study, the most important additional type of cooperation is collective rate making. Industry performance is also affected, however, by cooperative activities in such areas as legislative lobbying, advertising and public relations, engineering and loss prevention, and insurance education. Various reasons are given to support a widely held belief within the nonlife insurance industry that collective price making through the use of rate bureaus is a desirable practice. It is said that the industry has certain unique characteristics which make independent price making both impractical and unstable. 58 First, price competition can be destructive. Since the 66 Thomas C. Morrill, " T h e Term Rule," Insurance Law Journal, No. 329 (June, 1950), 416. Morrill, a former member of the New York Insurance Department, remarks that "when 52\4 P e r c e n t of the premium dollar goes for expenses and profit . . . it seems obvious that we ought to be looking for ways to reduce expenses. . . ." T h e expense allowance is not a constant; it may vary from one rate filing to the next. M See Insurance Accounting and Statistical Association, Insurance Accounting: Fire and Casualty (Philadelphia: Chilton Co., Inc., 1954), pp. 86-124; U.S. Senate, Hearings, The Insurance Industry, Part 3, 1959, pp. 1680-1681; New York State Insurance Department, Examination of Insurance Companies (New York: New York State Insurance Department, 1954), IV, pp. 69-203. 57 See Blanchard, "Judgment Helps Set Our Rates," pp. 74-75. 68 See, for example, John W. Cowee, Federal Regulation of Insurance (Wisconsin Commerce Reports, Vol. II, No. 3; Madison: University of Wisconsin Bureau of Business Research and Service, 1948), pp. 6, 72-73; Mehr and Cammack, op. cit., pp. 806-807; New York State, Examination of Insurance Companies, I, pp. 112-113; Dirlam and Stelzer, op. cit., pp. 200-201; U.S. Senate, Hearings, The Insurance Industry, Part 2, 1959, pp. 1064-1066.

Price Policy and Price Making

83

insurer cannot know his exact costs in advance, he will be tempted to cut price below levels necessary to maintain solvency. Second, the purchaser of an insurance contract is obtaining a promise of future performance that depends upon the solvency of the insurer. Collectively made rates are more likely to assure company solvency, since they are derived from group averages. And third, it would be inefficient and too costly for individual insurers to develop the necessary information for price making. This would be particularly true of those subjects of insurance that are rated by a schedule of credits and charges from a base rate after an inspection by an engineer or other technician. These arguments suggest several questions. What does destructive competition mean in terms of profit or insolvency rates? How much competition can an industry have before it becomes destructive? Are loss costs in nonlife insurance nebulous enough to cause insurers to underestimate them regularly if they act independently? Are there feasible alternatives to fairly uniform, collectively made rates oriented toward maintaining insurer solvency? Some of these questions will be examined later in this chapter, where the role of competition and governmental regulation in rate making is discussed. And some of them will be examined in chapter x, where alternative policies for the industry are taken up. In this section we are interested in the way rate bureaus convert loss and expense elements into premium rates. Cooperative rate making is typical in most lines of property and casualty insurance.59 Each major line or group of lines of insurance has a rate bureau which develops premium rates for members and subscribers.60 Bureaus are commonly national or regional; state or local bureaus are usually formed only to meet the legal requirements of a particular jurisdiction. Stock and mutual companies ordinarily have separate bureaus. Sometimes, however, a stock or mutual company bureau may function for both types of insurers as well as reciprocal exchange and Lloyd's association types of organizations. There are also some independent bureaus serving all types of insurers. Stock and mutual company bureaus frequently cooperate on rate 69 Accident and health insurance and some lines of marine insurance are the principal areas in which cooperative rate making is not common. Ibid., p. 1065; Kulp, op. cit., pp. 534-535; Simon K. Whitney, Antitrust Policies (New York: The Twentieth Century Fund, 1958), II, p. 377. 60 Bureaus are supported by assessments on member and subscriber companies, and governed by committees of representatives from member companies. Generally each member company has one vote; however, representatives of the larger company groups are often predominant on bureau committees. U.S. Senate, Hearings, The Insurance Industry, Part 3, 1959, pp. 1485-1488; Part 4, 1960, pp. 2224, 2227.

84

Price Policy and Price

Making

making, contract forms, or other problems. 61 T o make and administer rates, bureaus engage in a number of activities. Among their more important functions are: 62 collecting statistics from insurers; developing policy provisions and forms; developing rates and rating plans; publishing and maintaining manuals of rules and rates; filing rules and rates with state supervisory authorities for members and subscribers; and acting as official statistical agents for state supervisory authorities. The data which insurers report to rate bureaus are transformed into premium rates by the addition of profit, premium tax, license fee, and, sometimes, conflagration or contingency factors to the predicted loss ratios and average expense ratios for each line of insurance. The size of the profit and contingency factors has been largely a matter of negotiation between rate bureaus and regulatory bodies, when regulation was involved. Before rate regulation, the bureaus made what were termed reasonable additions for profit. This practice is apparently now followed for lines that are regulated little, if at all—such as aviation insurance. (The question of insurance profits will be discussed fully in chapter viii.) For those subjects of insurance that are reasonably homogeneous, relative to the chance of loss from a particular peril, class or manual rates are developed. For subjects presenting unique conditions, the bureaus usually publish rules for determining a rate. In some instances, bureaus may establish an individual rate on the basis of information furnished them by interested parties. The technique of bureau rate making is not given wide publicity. 63 In part, this is undoubtedly because the process is detailed and technical. Perhaps it is also because it is sometimes difficult to explain rate-bureau decisions.64 Judgment enters the rate-making process at 61 New York State Insurance Department, Examination of Insurance Companies, I, pp. 215-217; and Elmer A. Twaits, "Casualty and Surety Rating Bureaus," Best's Insurance News, L I X , Fire and Casualty ed. (April, 1959), 160. m Ibid., p. 30. 83 Examples of discussions of the process of rate-bureau price making are: Clarence W. Hobbs, Workmen's Compensation Insurance (2d ed.; New York: McGraw-Hill Book Company, Inc., 1939), pp. 484-634; Ralph M. Marshall, "Workmen's Compensation Insurance Ratemaking," Proceedings of the Casualty Actuarial Society, X L I (May, 1954), 12-84; Twaits, op. cit., pp. 29-31, 160; At kiss Report, Part 1; C. A. Kulp, " T h e Rate-Making Process in Property and Casualty Insurance—Goals, Technics, and Limits," Law and Contemporary Problems, XV (Autumn, 1950), 493522; Jules Backman, Surety Rate-Making: A Study of the Economics of Suretyship (New York: T h e Surety Association of America, 1948), pp. 332-347; and U.S. Senate, Hearings, The Insurance Industry, Part 3, 1959, pp. 1429-1446. " T h e insurance analyst of a financial journal characterizes bureau rate making as " a trade secret possessed by a very small coterie of professional rate makers and shared in by an equally small group of dominating and influential top executives."

Price Policy and Price Making

85

various points, even in those lines of insurance where data are most plentiful. 65 Joint pricing through rate bureaus is not confined to the nonlife insurance industry. Transportation, for example, is also characterized by group rate making. Conferences, bureaus, or associations for collective pricing have long been used by the rail and ocean common carriers. The newer road and air carriers follow similar practices.66 Transportation and insurance are both service industries, but they have little else in common. Common carriers are public utilities, the number of independent firms is generally not large, real investment is substantial, fixed costs in relation to variable costs are high, and unused capacity is common.67 These conditions are expected to lead to pricing below total cost and insolvencies if suitable stabilizing devices are not developed. Rate bureaus have apparently served to stabilize pricing for common carriers, particularly in the rail, ocean, and air industries. 68 We have seen that cooperation through rate bureaus is also considered necessary in nonlife insurance to prevent widespread pricing below total costs and insolvencies. Yet none of the economic characteristics described for transportation are true of nonlife insurance. 69 Later in this chapter, and in chapter x, we shall examine whether or not other characteristics, such as the inability to foretell loss costs precisely, are sufficient reason to expect independent pricing in insurance to lead to market conduct similar to that in the transportation field. INFLUENCE OF GOVERNMENT ON LOSS AND EXPENSE FACTORS— T H E ROLE OF REGULATION IN RATE MAKING

The role of government in rate making has been increased at both the state and federal levels since the South-Eastern Underwriters Association case70 and the McCarran-Ferguson Act.71 Before this time Roger Kenney, "Is Inflation T o o Much for the Casualty Industry?" United States Investor, March 15, 1952, p. 35. 65 For a discussion of the role of judgment in insurance pricing, see Irving Pfeffer, Insurance and Economic Theory (Homewood, III.: Richard D. Irwin, Inc., 1956), pp. 66-67. M For a recent survey of group pricing in transportation, see Daniel Marx, Jr., "Group or Conference Rate-Making and National Transportation Policy in the United States," Law and Contemporary Problems, X X I V (Autumn, 1959), 586-604. " Ibid., pp. 591-592. M Ibid., pp. 592-594. " S e e Bernard R. Stone, "Rate Regulation vs. Rate-Making," Insurance Law Journal, N o . 385 (February, 1955), 108. '"322 U.S. 533 (1944). 71 Public Law 15, 59 Stat. 34 (1945), as amended by 61 Stat. 448 (1947).

86

Price Policy and Price Making

the federal government played no part in the regulation of insurance rates, other than affirming by court decisions the rights of the states in this area. The federal government is now involved, since the federal antitrust exemption granted the industry was not complete. To the extent that business is not regulated by state law, federal antitrust law applies,72 and coercion, intimidation, and boycott are expressly subject to federal antitrust law.73 Agreements to deny reinsurance facilities or sales-agency representation to any company that does not cooperate on rates or other matters are now illegal. Such practices were apparently quite prevalent in earlier times,74 but the industry maintains that restrictions of this type have now been eliminated. 75 In chapter iv we noted that the Department of Justice has found a basis for a few actions and has investigated a number of others, so all restrictions have not been removed. But clearly there has been a very significant improvement. 76 This should mean easier entry into the industry 77 and conditions more conducive to growth for new or small firms. It should also tend to promote price competition, as companies that wish to compete in price presumably now have the opportunity to gain access to reinsurance and sales facilities formerly closed to price cutters. We saw how the state rate-regulatory laws have been enlarged since the McCarran-Ferguson Act. These new and revised state laws provide for the authorization and regulation of cooperative rate-making organizations. The bureaus collect loss and expense data and develop rates as they did previously. In most states, however, rates are now filed with the state supervisory authorities. These officials, aware that the federal government may intervene if state regulation of cooperatively made rates is thought to be inadequate, may examine rate levels more carefully now, if budgets permit. 78 However, the rates made 73

Ibid., sec. 2(b).

'"Ibid., sec. 3(b). The interstate aspects of the insurance business are also subject

to federal labor legislation. Ibid,., sec. 4, and Polish National Labor Relations Board, 322 U.S. 643 (1944).

Alliance

v.

National

"Elmore, op. cit., pp. 4-7. "Milton W. Mays, "The Half-Century in Property-Casualty Insurance," Journal

of the American

Association

of University

Teachers

of Insurance,

XVIII (March,

1951), 48-49; and Charles P. Butler, "Activities of Agents Under the McCarran Act," Law and Contemporary Problems, XV (Autumn, 1950), 568-574. 78 Stelzer, op. cit., pp. 148-150. 77 See chap. iv. 78

North

Little Rock

Transportation

Co. v. Casualty Reciprocal

Exchange,

181 F.

2d 174 (1950), was the first judicial test of the type of state regulation passed to provide adequate state control of insurance as required by the McCarran-Ferguson Act. The plaintiff alleged that the jointly made taxicab liability insurance rates charged him by a stock insurance company were illegal price fixing despite the McCarran-Ferguson Act and the Arkansas rate regulatory law. The Circuit Court of

Price Policy and Price Making

87

and filed by bureaus are still based on pooled loss experience as well as pooled expense experience plus a profit allowance. Since expense and profit elements cannot be uniform for all companies, any rate agreed upon in a rate bureau is likely to be weighted to protect the less efficient members.79 Any tendency for rates to adjust to a level that covers the costs of all firms will be reinforced by regulatory concentration on assuring company solvency. In general, the system of state regulation now in effect seems capable of providing adequate and nondiscriminatory rates as required by state laws. It is not so clear that the system can provide rates which are not excessive, as the laws also require.80 The new state regulatory laws generally provide that rate bureaus shall permit any insurance company, not a member, to become a subscriber to rating services. The subscribing company agrees to adhere to the rating organization's rates, filed with the state insurance commissioner, for member and subscriber companies alike. Any member or subscriber, however, may apply to the commissioner to deviate from the rating organization's rates. This provision seems to offer a potential basis for quite substantial changes in industry price-making procedures. How much this potential is realized depends upon how many companies wish to deviate in rates, and, more importantly, how many of those wishing to deviate are given permission to do so by the commissioners. In 1954 one observer noted, "Supervisory officials and rating bureaus have shown either extreme reluctance or outright antagonism toward attempts of members or subscribers of rating bureaus to pass on to the insuring public the results of economies in operation." 81 Appeals affirmed that the existence of state regulatory legislation freed rate-making activities from the application of federal antitrust law. T h e Supreme Court declined to hear an appeal. This suggests that the original requirement of affirmative state rate regulation may not be very strictly interpreted. At the time of the case the Arkansas Insurance Department had an annual budget of $64,064. T h e commissioner's annual salary was $5,000. Annual automobile liability premiums alone were $4,322,690 in the state. This suggests that some states are not going to be able to regulate the industry affirmatively even if they have the desire to do so. For a discussion of the significance of this case for insurance rate making and regulation, see "State Supervision over Insurance Rate-Making Combinations under the McCarran Act," Yale Law Review, L X (January, 1951), 160-169. T h e opinion is expressed in this article that this court decision "affirmed the irrelevancy of actual state control. Thus the decision clears the way for recurrence of the very industry practices which lead the federal government to assert antitrust jurisdiction." " S e e , for example, U.S. Senate, Hearings, The Insurance Industry, Part 2, 1959, pp. 1225-1227. 80 A similar opinion is expressed by George K. Gardner, "Insurance and the Antitrust Laws—A Problem in Synthesis," Harvard Law Review, L X I (January, 1948), 269-270. 81 Robert E. Ely, "Governmental Regulation of Insurance Marketing Practices," Insurance Law Journal, No. 374 (March, 1954), 192.

88

Price Policy and Price

Making

Later observations have been more optimistic.82 Yet there is still strong opposition in the industry and among some state regulators to rate deviation. 83 W e shall examine rate deviations further in a subsequent section on competitive forces in insurance rate making. D E M A N D FACTORS

Rate-bureau price making sounds much like full-cost pricing. T h e price of a unit of insurance service seems to be set by the estimated full cost (including profit) of providing that unit, without regard to demand. T h e assumed volume rate upon which expense ratios are based is not clear. A n average expense ratio is used, which apparently covers the expected expenses of most bureau members selling a reasonable amount of any class of insurance being rated. This will be discussed further in the section on competition. Whenever loss or expense ratios change, bureaus are generally expected to adjust rates accordingly. Thus the full-cost principle of pricing seems to characterize both price setting and price changing in the industry. Full-cost pricing depends on an impure market. Interfirm rivalry must be of a nature that permits a seller some discretion in pricing. This might be based on sale of a unique product whose crosselasticity with other products is relatively small; a price leadership position strong enough to set prices; customary cost and profit rules; or essentially equal costs or cost changes.84 Category three seems best to characterize jointly made insurance rates. A rate bureau representing a substantial portion of the industry is in a strong position to set prices. It may do this both for its members and a share of the nonbureau companies who may not wish to compete on price or may be influenced by various devices into not competing. For example, rate bureaus may be able to establish a presumption that bureau rates are the minimum rates possible to assure company solvency.85 Other devices are to obtain state legislation recognizing bureau rates only, or to make deviation from bureau rates so difficult that many companies For example, Dirlam and Stelzer, op. cit., pp. 213-215. See Roger Kenney, "Rate Deviations Become Whipping Boy of Reactionaries in Insurance Industry!" United States Investor, June 15, 1957, pp. 23-38; and U.S. Senate, Hearings, The Insurance Industry, Part 3, 1959, pp. 1407, 1581-1585, 1766-1771. 84 See Richard B. Heflebower, "Full Costs, Cost Changes, and Prices," in National Bureau of Economic Research, Business Concentration and Price Policy (Princeton: Princeton University Press, 1955), pp. 361-381. This paper is a good summary of the full-cost principle and the literature on the subject. 86 U.S. Senate, Hearings, The Insurance Industry, Part 2, 1959, pp. 1056-1057, 1135, 1209-1210, 1218-1220; Part 3, 1959, pp. 1465,1691, 1770-1771. 82

83

Price

Policy

and Price

Making

89

will be reluctant to attempt it. Despite the apparent applicability of full-cost pricing to much of insurance premium rate determination, demand does seem to influence rate making in several ways.87 The rates developed by rate bureaus are quoted prices. Rate manuals are distributed containing class rates for homogeneous groups as well as rates for a large number of partially unique subjects of insurance, such as individually schedule-rated buildings for fire insurance. Special instructions are circulated for rarely insured risks. Yet all this does not mean that quoted prices are always actual prices. If a rate bureau maintains a stamping or audit section to check copies of each contract to enforce conformity to rates and rules, the quoted price is also likely to be the actual price. Stamping is usual in fire insurance and at least fairly common in several other lines of property and casualty insurance. 88 In many areas of nonlife insurance, however, rigorous enforcement provisions are not incorporated in the rate-making machinery. Here demand may result in an individual company writing a contract, particularly a large one, at rates less than those established by the bureaus. 89 The widespread use of premium discounts for payment in advance on two-, three-, four-, or five-year insurance contracts seems to be a gesture toward demand. It has been pointed out that there is no statistical evidence to justify the discounts commonly allowed. 90 Term discounts have been in existence in fire insurance for many years and have been introduced in other lines as circumstances seemed to warrant their use. 91 After a pattern of discounts has been in effect for a time, 86

88 Ibid., Part 2, 1959, pp. 1128-1129, 1162-1163, 1224-1228, 1230-1233, 1312-1319, 1353-1354; and James M. Cahill, "What's Ahead?" Best's Insurance News, LV, Fire and Casualty ed. (August, 1954), 48. 81 Heflebower, op. cit., pp. 366-367. 88 Elmore, op. cit., p. 5; and U.S. Senate, Hearings, The Insurance Industry, Part 3, 1959, pp. 1445-1446. 89 See Irene Till, " T h e Fiction of the Quoted Price," Law and Contemporary Problems, IV (June, 1937), 363-374. Discussions with insurance company personnel suggest that such semihidden price deviations are common enough to be a factor in price determination when large premiums are involved. 80 For example, Morrill, " T h e T e r m Rule," pp. 413—414, 416; and Backman, op. cit., pp. 377-378. 81 T h e term discounts for payment of premium in advance on fire insurance policies extending beyond one year have been reduced recently in most states. This was apparently because state regulators felt they could not assert rates were affirmatively regulated when large, unsupported discounts were permitted on contracts extending beyond one year. Insurance companies were also dissatisfied with the expanding use of premium financing to gain discounts. It is not clear how closely the new discount schedules reflect actual differences in cost. Morrill, Fire Insurance Terms and Discounts, pp. 9-64, 76-93; and U.S. Senate, Hearings, The Insurance Industry, Part 3, 1959, pp. 1548-1549.

90

Price Policy and Price

Making

full-cost pricing, ignoring demand, might well be built atop such a structure. But the introduction of term rules, at least, may be a concession to demand on the part of rate bureaus. There are also indications that rating bureaus modify established prices when numerous complaints from members indicate sales resistance for particular coverages. This is especially true of cost-calledfor price increases, which prove to be unusually unpopular with member companies. Another approach to this problem is to alter the product, or rather to offer an alternative product that is in a price range that may be more readily sold. A common practice has been to introduce deductible coverage when the cost of full coverage reaches a level thought to be outside the price range of most buyers.92 SUMMARY OF COST AND DEMAND FACTORS

For most companies in the industry, costs are collectively determined. Rate bureaus gather loss and expense data from their members and subscribers.93 These data are used to develop premium rates. Presumably rates are set at a level to cover estimated probable losses, estimated expenses of most, if not all, companies, and a profit. This suggests that insurance rates are determined according to full-cost pricing principles. It is more likely, however, that the estimated full cost of insurance service serves merely as a point of departure in determining the final price. Forces of demand cause at least some portion of total insurance sales to be at prices less than those suggested by full-cost estimates. Sales at prices below bureau quotations seem to be fairly common. This is especially true in fields where price-enforcement machinery is absent or ineffective. Discounts for purchasing insurance for a period in excess of one year are common in the industry. Such discounts seem to bear very little relation to differing costs. Bureau price changes are also often made or deferred on bases other than strict adherence to cost factors. The conclusion seems inescapable that both cost and demand influence premium rate determination. COMPETITIVE FORCES

Despite widespread concerted price making and state regulation of rates, there is price competition in the nonlife insurance industry. This competition may be discussed in terms of (1) competition among 82

Backman, op. cit., p. 106. T h e experience of the most recent five years is often used to develop loss and expense ratios. In some instances, the reported results of the most recent three years may be used. 98

Price Policy and Price Making

91

members and subscribers of an individual rate bureau; (2) competition between rate bureaus or rate bureaus and independent companies; and (3) competition between rate bureaus or independent companies and alien organizations, chiefly London Lloyd's. INTRABUREAU

COMPETITION

We noted in our discussion of the influence of demand on insurance rate formation that bureau members and subscribers do not always sell insurance at the quoted price provided by rate bureaus. For instance, the larger insurance brokerage firms may determine what they feel is a reasonable price for the consolidated insurance needs of an important client, and then shop among insurance companies until one is found that will accept the block of coverage at or near the broker's price. Fellow bureau members may be able to quote different total premiums by not charging bureau rates for some or all types of insurance. Companies may also interpret merit or experience rating formulas flexibly to give lower total premiums. This kind of price competition is usually not considered in discussions of the insurance market. It is difficult to assess its significance. It may be fairly important for purchasers of large amounts of insurance. Competition among companies affiliated with the same rate bureau is now more likely to occur by deviations from bureau rates. Rateregulatory laws generally provide that rate bureau members and subscribers may deviate from uniform bureau rates.94 A deviation is a percentage modification of the bureau rate filed with supervisory authorities. Modifications may be upward or downward; however, upward deviations are not expected, for an insurer could not hope to sell any appreciable amount of a line of insurance at a higher price than that charged by all other members or subscribers of that bureau. Deviations are quite distinct from independent rate making and filing, though the price competition effects of the two may be similar. Deviation provisions were included in rate-regulatory laws to meet the apparent intent of Congress that the McCarran-Ferguson Act not eliminate price competition but regulate price cooperation that would otherwise be a violation of federal antitrust law.95 State regulatory authorities, at least, seem to have been aware of the need to establish M Massachusetts and Texas require complete uniformity of rates on certain coverages. All other states provide for deviation on most types of nonlife insurance. U.S. Senate, Hearings, The Insurance Industry, Part 2, 1959, pp. 1201-1202. " F o r an indication of Congressional intent, see U.S. Congress, House Committee on the Judiciary, Expressing the Intent of the Congress with Reference to the Regulation of the Business of Insurance. Report No. 143, 79th Cong., 1st Sess., February 13, 1945, p. 2.

92

Price Policy and Price

Making

in the new legislation the opportunity for price competition if state regulation were considered adequate.96 If a member or subscriber wishes to deviate from the uniform rates filed by its rate bureau, the deviation procedures established in the new laws generally require that he apply to the state insurance authority specifying the basis for the deviation requested, and send a copy of the deviation application to the rate bureau. T h e state insurance authority must then hold a hearing at which the rate bureau may appear, unless both the applicant and rate bureau waive such a hearing; give consideration to the available data and the rating principles of adequacy, nonexcessiveness, and nondiscrimination, in considering the deviation application; and permit the deviation if the resulting rate will not be inadequate, excessive, or unfairly discriminatory.97 T o prevent use of the deviation process to bid for a particular insurance account and then return to the higher bureau rate for all other insureds, the laws provide that a deviation shall be in effect for one year. It may be desirable to oppose possible discrimination in this way, but annual applications for renewal of deviations seem unnecessarily onerous. If an insurer's deviation is continuously opposed by members of its rate bureau, an annual hearing and perhaps court proceedings will take place.98 Deviations are usually expected to be based upon expense savings. Loss cost or pure premium savings could also be grounds for deviation, but it is felt to be unlikely that an insurer can expect to have an important and dependable degree of control over this factor.99 What constitutes expense (or loss) savings sufficient to support granting a deviation is a critical question. It can be argued, as have some rate bureaus at times, that no individual insurer is likely to have sufficient statistical experience to justify his having a rate lower than that developed from the body of experience collected by a bureau.100 If this position were accepted by state insurance authorities, a one96 See National Association of Insurance Commissioners, Proceedings (1946), pp. 99, 122-123, 367, 397-422. 07 This discussion of deviation procedures is based largely on New York, Insurance Law, sec. 185(4) (Supp. 1948). For an elaboration, see New York State Insurance Department, Examination of Insurance Companies, V, pp. 265-275; and U.S. Senate, Hearings, The Insurance Industry, Part 3, 1959, pp. 1446-1453, 1795-1797. 98 Ibid., p. 1795. 99Ibid., p. 1797; and Kulp, " T h e Rate-Making Process in Property and Casualty Insurance—Goals, Technics, and Limits," pp. 514—515. 100 U.S. Senate, Hearings, The Insurance Industry, Part 2, 1959, p. 1214; Part 3, 1959, pp. 1465-1466, 1583, 1765-1768.

Price Policy

and Price Making

93

price system would result, despite the deviation sections of rate regulatory laws.101 The number of deviations from bureau rates and policy forms has increased noticeably since the change in state laws began to take effect in the late 1940's. Table 9 shows the number of deviations and independent rate filings in effect in fire and associated types of insurance in 1948 and 1958. TABLE 9 R A T E D E V I A T I O N S , I N D E P E N D E N T R A T E F I L I N G S , AND V A L U E O P P R E M I U M S W R I T T E N UNDER D E V I A T I O N AND I N D E P E N D E N T F I L I N G S I N F I R E AND ASSOCIATED T Y P E S OP I N S U R A N C E — C O U N T R Y W I D E

1948 and 1958

Deviations in effect

Independent rate filings in effect

Premiums at deviated and independently filed rates" (millions)

Premiums at deviated and independently filed rates as percentage of total premiums 6

1948

1958

1948

1958

1948°

1958d

1948°

1958"

811

5,059

217

1,326

$33.8

$328.7

$3.5

$14.4

S O U R C E S : Material filed October 1, 1959, by the National Board of Fire Underwriters with U.S., Congress, Senate, Subcommittee on Antitrust and Monopoly, Committee on the Judiciary, Hearings, The Insurance Industry, 86th Cong., 1st Seas., 1959, Part 8, pp. 4761-4763, 4835. • Does not include premiums written under independent filings by nonmembers or nonsubscribers of the rating bureau, or through an independent rating bureau. Examples of the above include premiums written by assessment mutuals, county mutuals, cooperatives, reciprocals, and associated factory mutuals. b The total premiums for fire, extended coverage, allied lines, and homeowners insurance for 1948 and 1958 are not completely comparable; thus the percentages shown should be taken as an expression of general order of magnitude only. 0 Includes fire insurance, extended coverage insurance, and allied lines insurance. d Includes homeowners insurance in addition to the coverages shown in 1948.

Numbers of deviations in existence or rates of increase in deviations are not as significant as is often suggested for estimating the role of this form of price competition. Many deviations are modifications of insurance contracts; thus they are product rather than price competition. Furthermore, many price deviations apply only to a rather narrow area of insurance, so their significance may be quite limited. The best indicator of the importance of price competition by means of rate deviation would be the proportion of total premiums in each of 101

Ibid., p. 1797,

94

Price Policy and Price

Making

the important areas of nonlife insurance written at deviated rates. But state authorities do not segregate data in this way. All we have is the percentage of premiums written at less than uniform bureau rates. Included in this category are the operations of companies that price independently and companies that participate—that is, pay dividends at the end of the policy term—as well as companies that deviate. Firms seeking to reduce rates by deviation have been opposed in some instances by fellow bureau members acting through the rate bureau. Appearing as an aggrieved party, bureaus have requested hearings before insurance authorities, and when rulings have gone against them they have in a few cases appealed to the courts.102 The Senate hearings on the insurance industry devote a great deal of attention to the question of opposition to rate deviations.103 The companies whose deviation plans are opposed feel that they are subjected to expenses, delays, and in some cases postponements or denials of their applications, because those companies that prefer uniform rates are determined to prevent price competition. The companies, bureaus, and occasionally regulatory authorities opposing deviations assert they do it to clarify portions of the regulatory laws and to prevent inadequate rates, in particular loss-leader types of price cutting. Those who defend the instances of opposition stress the relatively few times it has occurred. It is pointed out that from 1948 to 1959 only 231 hearings on deviation applications were requested by rate bureaus and only 7 appeals from these hearings were taken. This record is cited in 103 Much of the opposition has centered on the deviation applications of the Insurance Company of North America, a large capital stock organization that has quite aggressively pursued price competition on certain classes of insurance in a number of states. In some instances this company has received deviations on the basis of expense savings from reduced sales commission scales. This has been unpopular with insurance agents and rate bureaus alike; the bureaus apparently feel that their uniform higher rates will inevitably be questioned, for they permit an unnecessarily large selling cost allowance if an individual company is able to provide similar service at lower cost. See Cook County Inspection Bureau v. Day, 349 111. App. 459, 110 N.E. 2w 874 (1953). T h e difficulties encountered in deviation procedures led some companies to withdraw from rate bureaus for the types of insurance they wished to sell at lower rates, and to file these rates, independently of any bureau, directly with the state insurance department concerned. This practice of partial subscribership—for these companies continued to subscribe to rate bureaus for the classes of insurance which are individually inspected and rated—was also opposed by some companies acting through rate bureaus. T h e right of partial subscribership seems to have been established by Cullen v. Bohlinger, 284 App. Div. 963, 136 N.Y.S. 2d 361 (1954); 308 N.Y. 1049, 124 N.E. 2d 342 (1955); 308 N.Y. 886, 126 N.E. 2d 564 (1955); 350 U.S. 803 (1955); and Pacific Fire Rating Bureau v. Ins. Co. of North America, 83 Ariz. 369, 321 P. 2d 1030 (1958). lca

U.S. Senate, Hearings, The Insurance Industry,

Parts 2 and 3, 1959.

Price Policy and Price Making

95

defense of charges that rate bureaus have abused hearing and appeal rights to stifle price competition. 104 This seemingly insignificant amount of opposition needs to be carefully considered. If opposition is centered on the important price reductions made by larger companies, and if this opposition is successful to the extent that the amount of the price reduction is reduced, or long, expensive delays are involved, then other companies, particularly smaller ones, will be less likely to attempt it. 105 Clearly price competition does occur among members and subscribers of the same rate bureau by means of rate deviations. Furthermore, the amount of this form of price competition seems to be increasing. 106 There are still problems, however, which limit the amount of effective price competition which deviation processes can provide. One of the most important of these is the requirement that deviations be reestablished annually. This is an invitation to recurring formal opposition. Continuous filing of data to support a deviation may be justified by regulators, but once a deviation is granted there seems to be no reason why it could not continue until data suggest to the regulator that it needs to be modified. 107 Another problem is the right of rate bureaus to appear as aggrieved parties in deviation application proceedings. If deviation is to be a route to real price competition, then combinations of competitors cannot be granted a legal right to try to block price reductions by appearing as aggrieved parties in hearings and judicial proceedings. 108 Finally, there is the question of how many deviations can be handled by state insurance regulators if they are going to examine data and conscientiously attempt to determine whether deviations meet the rating standards of adequacy, nonex101

Ibid., Part 3, p. 1659. Ibid., Part 2, pp. 1312, 1319; Part 3, p. 1795. 100 Dirlam and Stelzer, op. cit., pp. 212-215. ™ Ibid. 108 U.S. Senate, Hearings, The Insurance Industry, Part 3, 1959, pp. 1796, 1844. T h e question of who is to be recognized as an aggrieved party in opposition to rate reductions has not been finally settled. A series of New York cases has affirmed the decision of a New York superintendent of insurance granting a rate bureau the right to a hearing to protest the independent filing of a rate below the bureau's uniform rate level. This treats a rate bureau as if it were an aggrieved party, though the question of what constitutes an aggrieved party was not answered directly. Cullen v. Holz and Allstate Insurance Company, 152 N.Y.S. 2d 163 (1956); 181 N.Y.S. 2d 162, 181 N.Y.S. 2d 163 (1958); 182 N.Y.S. 2d 324 (1959); 191 N.Y.S. 2d 167 (1959); Cullen v. Holz and Insurance Company of North America and Philadelphia Fire and Marine Insurance Company, 184 N.Y.S. 2d 578 (1959); 185 N.Y.S. 2d 740 (1959). A Virginia case has held that a group of insurance agents is not an aggrieved party before state insurance authorities in regard to matters of insurance rates, even though questions of insurance commission scales are involved. Virginia Association of Insurance Agents, etc. v. Commonwealth of Virginia, 110 S.E. 2d 223 (1959). 10S

96

Price

Policy

and Price

Making

cessiveness, and nondiscrimination. There are suggestions that the present flow of deviations may be taxing the facilities of some state insurance departments.109 Price competition may also occur among members and subscribers of a bureau by payment of dividends at the end of policy terms. These dividends presumably reflect loss and expense savings on various classes of insurance. As loss and expense factors vary among companies, dividends will vary too. This form of price competition has been quite common among mutual and reciprocal exchange organizations. Capital stock companies may also use a dividend approach. There seems to be little, if any, opposition from state regulatory authorities to price competition through dividend scales, for the dividend approach is less of a threat to rate adequacy than the deviation approach. Rate bureaus are less concerned about refunds of redundant premiums than they are about lower initial premiums, because the former is a much softer type of competition. It is less appealing to both the buyer and seller because: dividend rates are uncertain and difficult for the buyer to compare; the buyer is deprived of the use of his money for the period in which the redundant premium is held; returning dividends is costly and complicated for the seller; and the seller may pay extra nonrefundable premium taxes and sales commissions.110 INTERBUREAU OR INDEPENDENT COMPANY

COMPETITION

The most significant kind of price competition in the industry seems to be that furnished by the mutual, reciprocal, and nonbureau stock companies. They often write insurance at rates of 20 to 30 per cent below those of the nondeviating stock company members of rate bureaus.111 Reduced prices may be in the form of lower initial rates or dividends at the end of the policy period. Mutual companies usually have their own rate bureaus. If the rates established by these bureaus are related to predominately mutual company loss and expense statistics, they are likely to be lower than rates for similar coverages developed by predominately stock company rate bureaus. This will be true mainly because mutual organizations generally have lower selling expenses. Members and subscribers of mutual rate bureaus may also deviate from the uniform bureau rate, or they may pay dividends. Thus there are opportunities for interbureau rate competition in terms of the uniform rates established by different bureaus for their own 10"

U.S. Senate, Hearings, The Insurance Industry, Part 3, 1959, pp. 1717-1718. Ibid., Part 2, p. 1228. U1 Ibid., pp. 1234, 1243, 1293; and S. Alexander Bell, "Competition," Best's Insurance News, L V , Fire and Casualty ed. (October, 1954), 29-31. 110

Price Policy and Price Making

97

members or subscribers, as well as opportunities for rate competition among members of different bureaus by deviation or dividend procedures. There are a substantial number of companies that are not affiliated with rate bureaus of any kind but operate independently. The laws of 44 states permit independent rate filing; in the other jurisdictions independent companies must affiliate with a bureau and attempt to deviate or pay dividends if they wish to compete in price.112 Many of these independent companies belong to the National Association of Independent Insurers, a trade group that does not make or file rates but provides statistical and other services.113 This association consists of nearly 400 companies of all organizational types.114 It is licensed by the states as an advisory organization, which enables it to provide a range of services short of rate making and filing. It is said that the association encourages independent action and experimentation and discourages uniformity, especially in price.115 If so, this seems to be a unique trade group in nonlife insurance. In the previous section we noted that difficulties encountered in the deviation method of reducing rates caused some firms to undertake independent operation for certain classes of insurance which they wished to sell at reduced rates. These companies wanted to continue to use rate bureau facilities for those coverages requiring technical assistance. This meant they were partial subscribers to rate bureau services. Some rate bureaus have opposed partial subscribership. It is now apparently established, however, that a company can subscribe for any or all of a rate bureau's services.116 This should tend to increase the amount of independent action in the lines of insurance which do not use complicated rating and filing procedures. On occasions, rate bureaus as aggrieved parties have opposed the independent rate making and filing of both wholly independent and partially independent firms. The grounds for opposition have been twofold: the independently filed rates fail to meet statutory requirements of adequacy or nondiscrimination; and the independently filed rates make unauthorized use of accumulated data and procedures developed by a rate bureau. 117 In the previous section we noted the restrictive effect on competition of permitting rate bureaus to intervene as aggrieved parties to oppose rate deviations. Competition is m

U.S. Senate, Hearings, The Insurance Industry, Part 2, 1959, p. 1204. Ibid., p. 1201. 114 Ibid., pp. 1195, 1200. ™ Ibid., p. 1201. "»See note 102 above. U7 See U.S. Senate, Hearings, The Insurance Industry, Part 3, 1959, pp. 1457-1463. 118

98

Price Policy and Price

Making

likely to be even more importantly influenced by permitting rate bureau opposition to independent rates. The most significant price competition seems to come from independent companies. T o allow combinations of competitors to oppose this through administrative hearings and court appeals can only reduce the amount of price competition. It would seem to be the duty of regulatory authorities to determine whether independently filed rates are inadequate or discriminatory. Combinations of competitors cannot be free of a conflict of interest in the matter. 118 The new state regulatory laws generally provide that a rate filing may be supported by the experience of other insurers or rating organizations. Rate filings and supporting data are, therefore, considered public property. 119 Some rate bureaus have made their data and their procedures available to anyone wishing to purchase them. 120 Others have maintained these materials were available only to members or subscribers. Part of the opposition to partial subscribership has been the alleged use of rate bureau materials to support the independently filed portions of partial subscribers' operations. 121 The cases affirming the right of partial subscribership also seem to have established the right of those filing independently to use the filed materials of other insurers or rate bureaus. 122 The question of whether a fee should be paid for the use of materials that others have filed with public authorities does not concern us here. 123 Price competition from mutual, reciprocal exchange, and nonbureau stock companies has clearly been an active factor in the determination of rate levels in some lines of property and casualty insurance. The best example is automobile insurance. Aggressive price competition in this field has undoubtedly forced stock company rate bureaus to place rates at lower levels than would have been done otherwise. T o a lesser degree the same result is discernible in some other insurance classes.124 This form of price competition has not yet threatened the overall dominance of the uniform-price stock companies in nonlife u8

119 120

Ibid., pp. 1448, 1796.

Ibid., pp. 1793-1794.

Ibid., p. 1441.

^ Ibid., pp. 1436-1439, 1457-1458. 122 Note 102 above. See also U.S. Senate, Hearings, The Insurance Industry, Part 3, 1959, pp. 1376-1377,1887-1888. 128 Ibid., pp. 1887-1888. m F i r e , workmen's compensation, liability, and some types of bonds are the other lines of insurance in which price competition has had the most influence. See Backman, op. cit., pp. 106-107; and Roger Kenney, "See Here, Mr. Editor—On This Matter of Revision of Agents' Commissions!" United States Investor, June 6, 1953, p. 39.

Price Policy and Price Making

99

insurance. However, mutual, reciprocal exchange, and nonbureau stock organizations have steadily, if slowly, enlarged their market share. In 1958 they had approximately 29 per cent of the total property and casualty insurance sales. A little over two decades ago they had approximately 17 per cent. 125 ALIEN ORGANIZATIONAL COMPETITION

Alien corporations and several hundred individual underwriters operating through Lloyd's of London are alleged to do a substantial insurance business in the United States. The greater share of this is in reinsurance. It is believed, however, that a significant amount of direct insurance is also written. 126 London Lloyd's are licensed in Illinois and Kentucky, and in other jurisdictions they operate as nonadmitted insurers. Reinsurance has never been regulated to any extent by the states. Thus nonadmitted alien reinsurers operate without restriction. Data are not available on the volume of reinsurance provided by these organizations, but sales are considered to be large.127 Alien reinsurers compete freely in price. Since they apparently provide a significant portion of the supply of reinsurance service, they are an active factor in determining its price. This in turn can be expected to affect prices in the direct insurance market. A firm that has negotiated an attractively priced reinsurance contract with an alien reinsurer will be in a position to reduce its prices by deviation, independent filing, or participation, if it wishes to do so and if existing regulatory and cooperative arrangements allow it. The direct insurance sales of nonadmitted alien organizations are made under state surplus line laws. These laws provide that individuals or firms who cannot secure insurance in admitted, licensed companies may purchase coverage from nonadmitted companies through licensed surplus-line brokers.128 London Lloyd's are apparently the principal 126 Alfred M. Best Company, Inc., Best's Fire and Casualty Aggregates and Averages (20th ed.; N e w York: Alfred M. Best Company, Inc., 1959), p. 1; and James F. Crafts, "The Great Partnership," Best's Insurance News, LIII, Fire and Casualty ed. (April, 1953), 25. 128 See H . P. Stellwagen, "Competition in Casualty Insurance," The Spectator, CLXI (July, 1953), 16-17, 58-59; Levering Cartwright, "The Lloyd's Reinsurance Hassle," The Spectator, CLXII (April, 1954), 107; Sub-Committee to Study the Question of Re-Insurance, National Association of Insurance Commissioners, Report (Lincoln, Nebr.: National Association of Insurance Commissioners, 1950), pp. 3-9, 35-37; U.S. Senate, Hearings, The Insurance Industry, Part 2, 1959, p. 1350; Part 3, 1959, pp. 1497-1518. 127 Ibid., Part 1, 1958, pp. 128-131; Part 3, 1959, pp. 1502-1503, and Sub-Committee to Study the Question of Re-Insurance, op. cit., pp. 36-37. 128 See, for example, California, Insurance Code (1935, as amended), sees. 17601779. Surplus line laws are summarized in U.S. Senate, Hearings, The Insurance Industry, Part 7, I960, p. 3891.

100

Price Policy and Price

Making

market for risks which admitted insurers cannot or do not wish to insure. Critics of alien competition assert that surplus line laws are so elastic that they are a vehicle for siphoning some very desirable insurance risks from the American market. Presumably, insurance buyers are attracted by lower rates or more liberal contracts.129 Any assessment of the significance of competition from nonadmitted alien organizations must be based on qualitative information. Little, if any, data have been developed. The conclusion seems warranted, however, that in the reinsurance market nonadmitted organizations are an important force. They supply a substantial volume of such service and their prices are competitive. The influence of nonadmitted alien insurers on the final insurance market is both indirect, through influencing the cost of reinsurance, and direct, through selling to final purchasers. Lloyd's and others may find surplus line laws an opening to obtain some business by offering better prices and terms. This is beneficial for the American insurance purchasers who can make such arrangements, but in the aggregate the price behavior of the broad group of United States companies apparently has not been affected very much, if at all. SUMMARY OF COMPETITIVE FORCES

Price competition is not typical in the nonlife insurance industry. A large majority of companies join together in rate bureaus to write essentially uniform contracts at uniform prices. Governmental bodies have frequently been convinced by the companies that competition should be eliminated or carefully restricted. Price competition is found in the industry, however, and it has been increasing. The most significant source of such competition are mutual companies, reciprocal exchanges, and nonbureau stock companies. These organizations sell over one-fourth of the total nonlife insurance sold. At the present time their competition is felt most keenly in the automobile insurance field. Price competition by deviation from uniform bureau rates has also been increasing, and it may continue to develop. However, bureaus and their members can be expected to oppose deviation applications of lower cost affiliates. Under such circumstances, state regulators are not likely to encourage applications, and applications that are received will probably be scrutinized very carefully. The only sector of the industry that clearly has had its rates conditioned by the degree 129 Cartwright, op. cit., p. 107; Roger Kenney, "Some 'Second Thoughts' o n the Senate Subcommittee Hearings on Insurance," United States Investor, August 22, 1959, p. 23; and U.S. Senate, Hearings, The Insurance Industry, Part 3, 1959, pp. 1498-1509.

Price Policy and Price Making

101

of existing price competition is automobile insurance. In other classes of insurance price competition seems to vary from a moderately important to a negligible factor in determining rates. Summary

of Price Making

in the

Industry

T h e price of property and casualty insurance is typically determined by private rating organizations maintained by the companies. These bureaus collect both loss and expense data from their members. From these data estimates of future losses and expenses are made. A profit allowance is added to loss and expense estimates to give a premium rate per unit of exposure to any given peril. Since no one firm is likely to sell enough of any class of insurance to establish reliable probability estimates of future losses, pooling of loss experience is probably necessary and beneficial. But pooled expenses bring a significant measure of price stabilization. T h e level on which prices are stabilized is expected to be one which covers the costs of all or nearly all firms. 130 This tendency may be modified somewhat by universal state regulation, which ordinarily requires rate bureaus to be licensed and their rates to be filed with the state insurance commissioner. State regulation is geared, however, to maintaining company solvency, so regulators are not likely to insist on rate schedules which do not cover the costs of most companies. 131 Price competition, while not a major feature of most sectors of the industry, may also modify the tendency toward price stabilization at levels which cover the costs of nearly all firms in the industry. Despite the mitigating forces of state regulation and price competition, property and casualty insurance rates seem to be typically established by rate bureaus that must consider the interests of all insurers concerned—the least as well as the most efficient. 130 See Arthur R. Burns, The Decline of Competition (New York: McGraw-Hill Book Company, Inc., 1936), pp. 266-270. 131 For a discussion of the effect of state regulation as it is presently constituted, see "State Supervision over Insurance Rate-Making Combinations under the McCarran-Ferguson Act," p. 161.

CHAPTER VI

Industry Performance I: Progressiveness

(Multiple-Line Insurance)

Criteria of economic performance for nonlife insurance were proposed in chapter i. Each of the dimensions of industry performance selected will now be examined in detail—progressiveness in this and the following chapter; product variety, industry capacity, profit levels, and selling costs in chapter vii. A desirable standard will be suggested for each dimension, and, if possible, a method of measurement for each dimension will be devised. Finally, the performance of the industry in respect to each criterion will be appraised to see how it compares with the chosen standard. Since some of the performance dimensions do not lend themselves readily to measurement, qualitative judgments will sometimes have to replace quantitative estimates. A Standard for Progress Progress is often described as the expansion over time of magnitudes such as total output, per capita output, or population. 1 Mere quantities are only partial indicators of progress, however, for both qualitative aspects of change and the relationship between rates of change of various magnitudes must be considered if net welfare effects are to be appraised. 2 1 For discussions of economic growth, including possible dimensions for measuring such growth, see Universities-National Bureau Committee on Economic Research, National Bureau of Economic Research, Inc., Problems in the Study of Economic Growth (New York: National Bureau of Economic Research, Inc., 1949), and Jacob Viner, International Trade and Economic Development (Oxford: at The Clarendon Press, 1957), pp. 94-102. 2 See John M. Clark, "Common and Disparate Elements in National Growth and Decline," in Problems in the Study of Economic Growth, pp. 23-26.

102

Multiple-Line

Insurance

103

An industry cannot be made responsible for definite contributions to indicators of average or aggregate progress, even though the expansion of these quantities is a desirable and expected aspect of performance for the economy. Nevertheless, a comparison of the growth of nonlife insurance with the growth of two common aggregates may give some indication of the changing role of insurance service in the United States. Relative trends in total output, population, and nonlife insurance are shown in Chart I. T h e reduction of uncertainty as insurance coverage has expanded has surely been reflected in an expansion of aggregate output in the economy. The direct contribution of nonlife insurance to total output is a matter of a few billion dollars; the indirect contribution may be many times this amount. T o examine this indirect contribution of the industry, we will appraise its progress in terms of product innovation and introduction of cost- and price-reducing changes. Progressiveness in product is likely to mean more than meeting the obvious demands expressed by others. It may mean developing new products or processes in advance of easily foreseeable demand, to enable other segments of the economy to enter fields formerly viewed as impractical. This form of innovation appears to be particularly important for nonlife insurance, since the primary function of the industry is accepting and consolidating risks to reduce the level of uncertainty. It is not easy to establish standards of progress; the task may be specially difficult in industries producing intangible services. Establishing methods of measurement—devices to appraise the present performance of the industry in terms of chosen standards—also creates problems. Tentatively, a minimum standard of progress for the industry would be its willingness to provide insurance for risks which are insurable (permit statistical or mathematical handling), and which are generally considered socially desirable to insure. What constitutes a socially desirable insurance situation is itself a problem—what of the accident-prone people, the careless people, the reckless people? Should any or all of these be provided insurance if it is actuarially feasible? Similarly, should insurance be available to people who, if insured, would injure their own persons or, more likely, destroy their own property? And, further, there is the problem of whether insurance, if actuarially possible, should be available against such events as marriage, divorce, and parenthood. Public policy will presumably always wish to deny insurance to those who wish to destroy willfully, though even here a distinction between positive and merely passive actions may not be clear. For example, there are degrees of volition, and how

104

Multiple-Line

Insurance

CHART 1 SELECTED ECONOMIC MAGNITUDES I N THE UNITED STATES,

1900-1957

10,000 9000 8000 7000 6000 SOOO 4000 3000

Property and Casualty Insurance Premiums (Millions of dolíais)

2000

1000

188

G.N.P. (Billions oi dollars)

700 600 500 400 300 200

90 70

Population -(millions)

100 80 60 SO 40 30 20

1900

Sources: Population, U.S. Department of Commerce Statistical Abstracts of the United States (1959), p. 5. G.N.P., National Bureau of Economic Research, Inc., Income in the United States 1909-1919 (v. 1,1921) p. 143 (for 1909-1919); Simon Kuznets, National Product since 1869 (1946), p. 51 (for 1920-1928); U.S. Department of Commerce, United States Income and Output, November, 1958, pp. 118-119 (for 1929-1957). Property .and Casualty Insurance Premiums, The Spectator, CLXVI (July, 1958), 40. 1910

1920

1930

1940

1950

I960

Multiple-Line

Insurance

105

is one to distinguish between recklessness and self-caused losses—at some point the two may nearly merge. 3 T h u s an exact specification of what is socially desirable to insure is impossible, for the socially desirable shades into the socially undesirable, and, too, society's standards are dynamic rather than static. Yet we can say that at any time, we could expect progress in nonlife insurance to be a willingness to provide insurance for actuarially feasible situations which meet apparent public welfare needs as suggested by current legislation, court decisions, and public opinion. This willingness to provide socially desirable insurance would be evidenced by the industry's success in developing risk-sharing services without undue delay and at the lowest possible cost. Presumably the list of insurable risks will grow constantly as the quantity and quality of data increase. T h e more rare and unique features characterizing an event, the more difficult will be classification and the establishment of estimates of probable future behavior. In these situations the industry's willingness to pioneer and extend risk-sharing services at a cost based upon all the data obtainable may make it possible to extend investment beyond what would be possible otherwise. This should result in an acceleration in the growth of total output as particularly risky types of investment are made feasible before the time they would be undertaken otherwise. Measuring Progress How can the level of progress attained in the industry be determined? And how closely does it meet the standard just discussed as desirable? Even if it were available, no simple numerical measure would be appropriate for the complicated problem situation of progress in nonlife insurance. It is possible, however, to examine some of the types and quantities of insurance offered and the prices asked for them over a recent span of years. Such an examination will provide some basis for assessing progress in the industry. What has the industry done relative to experiments with new methods, new products, or variations of existing products? Have there been steady improvements leading to reductions in cost, improved quality of product, or adaptations of basic products to make them 3 For a discussion of losses that are self-inflicted and losses that are the result of a failure to protect, see Albert H . Mowbray and Ralph H . Blanchard, Insurance (4th ed.; New York: McGraw-Hill Book Company, Inc., 1955), pp. 21-22.

106

Multiple-Line

Insurance

more useful in the present-day economy?4 Perhaps the discussion of progress in product can best be handled by classifying change or the need for change into two broad categories: (1) new types of products and adaptations or reformulations of old types, and (2) procedural, administrative, or contractual changes. The latter category includes in the main alterations designed to reduce cost or increase the purchaser's satisfaction by revising policy language, simplifying and speeding loss settlements, or other changes made to facilitate understanding and usefulness of the insurance contract. N E W PRODUCTS OR ADAPTATIONS OF OLD PRODUCTS

Since this is an appraisal of the present performance of the industry, we are concerned with insurance products that have developed or changed to meet the needs of the modern American economy. In a sense, the coverages ordinarily classified as casualty insurance are all of this sort. In 1900 net premium volume for casualty insurance was $27.2 million; in 1958 it was $8.2 billion.5 In 1900 accident and health, automobile, workmen's compensation, and liability coverages were either unheard of or sold only in insignificant amounts. They constituted more than 70 per cent of casualty insurance premiums in 1958.« In the field of accident and health insurance, development has been very rapid in recent years. This type of insurance has grown from a premium volume of $220 million in 1928 to $5.8 billion in 1958—a rate of premium growth unequaled in the history of insurance.7 Accident insurance is one of the oldest forms of insurance written, but it was not until the last two decades that it began to undergo such extensive changes and growth.8 These new coverages have developed to fulfill a need for distributing losses, a need which has become more apparent with the growth and increasing complexity of an industrial economy and the way of life associated with it. The relevant question today is, how has the in' This formulation of the problem follows that of Donald Wallace, "Industrial Markets and Public Policy: Some Major Problems," in C. J. Friedrich and Edward S. Mason, eds., Public Policy (Cambridge, Mass.: Harvard University Press, 1940), p. 110. s The Spectator, CLXVI (July, 1958), 40, and CLXVII (June, 1959), 47. 'Ibid., CLXVII (November, 1959), 49-50. 'James E. Powell, "Another Round in Compulsory A & H Fight," The Spectator, CLXII (June, 1954), 36, and The Spectator, CLXVII (November, 1959), 49-50. 8 Ralph H. Blanchard, "Casualty Insurance," in G. F. Michelbacher, Casualty Insurance Principles (2d ed.; New York: McGraw-Hill Book Company, Inc., 1942), p. 11, indicates modern casualty insurance began in the United States in 1864, with the first writing of accident insurance.

Multiple-Line

Insurance

107

surance industry met this demand over time? Has it altered the coverages just characterized as essentially new and developed others to achieve wider distribution of losses in the economy? To derive any conclusions, one must trace recent behavior in the areas of insurance that have become most important to the economy in recent times. Gauged by the amount and intensity of discussion among buyers, insurers, and regulators, these areas are: (1) multiple-line insurance, (2) automobile insurance, and (3) accident and health insurance. Each of these will be examined in turn. MULTIPLE-LINE INSURANCE

The term multiple-line insurance is used in different ways. It can mean combining all insurable risks into one contract to provide allrisk insurance. Only noninsurable perils are excluded. Actually, a somewhat more modest goal is usually proposed: combining some of the coverages now largely written under separate fire, marine, or casualty insurance contracts into one contract to achieve multipleperil insurance. Exclusions may still be quite plentiful to delimit the coverage and to exclude perils ordinarily considered noninsurable by private companies. An example of the latter type of exclusion is war. Multiple-line underwriting has been characterized as "the concept which is revolutionizing American insurance thinking." 9 Perhaps this statement is overdrawn, but the varied aspects of multiple-line developments are bringing significant changes to the industry. State legislation permitting one company to write all lines of property and casualty insurance does not automatically create multiple-line insurance policies either of the all-risk or multiple-peril type.10 A complex of obstacles remains—some real, some imaginary—to hamper industry adoption of multiple-line principles. Significance of Multiple-Line Insurance. T h e new, broad underwriting powers seem to have a different kind of significance f r o m "John D. Phelan, "Background of Multiple Peril," The Annals of the Society of Chartered Property and Casualty Underwriters, V (1953), p. 2. Both all-risk and multiple-peril contracts have always been used in the marine insurance field, where the fundamental philosophy has been to insure against loss per se rather than specific kinds of losses. See W i l l i a m D. Winter, "The Multiple Line Concept," in N e w York State Insurance Department, Examination of Insurance Companies (New York: N e w York State Insurance Department, 1953), I, pp. 527-564, reprinted in H. Wayne Snider, ed., Readings in Property and Casualty Insurance (Homewood, 111.: Richard D . Irwin, Inc., 1959), pp. 89-116. 10 By 1955 multiple-power charter laws had been enacted in all states. Benjamin N . Woodson, "All-lines Underwriting: N e w Fashion or N e w Era?" Journal of the American Society of Chartered Life Underwriters, XII (Winter, 1957), 69-96, reprinted in Snider, op. cit., p. 130.

108

Multiple-Line

Insurance

what they had in the early history of insurance in the United States. 11 T h e kinds of insurance for which the powers may be used have multiplied many times. T h e economy has grown and become more specialized, more productive, and more interdependent. And the magnitude of investment, upon which insurance has a dual impact through its collection of liquid funds and its reduction of uncertainty, has become even more vital to an economy dependent upon a high level of aggregate demand. Multiple-line underwriting powers appear to offer substantial benefits for the public. 1 2 Roger Kenney summarized these expected benefits as follows: " T h e legislation enabling fire and casualty companies to operate on a multiple line basis was passed on the theory that not only would broader coverage be afforded the policy buyer, but there would be certain loss and expense savings." 1 3 Thus multiple-line insurance seems to offer two things: a wider choice of product to insurance buyers; and a possibility of savings in the cost of furnishing insurance for those who wish to purchase the new combinations and perhaps for all insurance purchasers. Presumably, the policy buyer's choice of contract might now, or eventually, include all-risk policies; that is, the only exclusions would be perils not amenable to insurance principles. Further adjustments in state laws and revisions in rating techniques and organizations will 11 In 1792 the first incorporated insurance company in the United States, T h e Insurance Company of North America, received a grant of authority to write life, fire, and ocean marine insurance. Broad charters soon were replaced with restricted ones, however. Only in the last few years have individual companies again been able to write both property and casualty lines of insurance. See New York State, Fifty-Sixth Annual Report of the Superintendent of Insurance (Albany, New York: New York State Insurance Department, 1915), I, pp. 36-39; and Irving Davis, "Multiple-line Underwriting . . . Chaos or Opportunity?" The Spectator, XVI (August, 1950), 16. " T h e r e are many discussions of multiple-line insurance and its possible effects. For examples of typically optimistic appraisals, see Alfred J . Bohlinger, " T h e Prospect for Multiple Peril Underwriting," Weekly Underwriter, August 25, 1951, pp. 424-426, and September 22,1951, pp. 691-692; Roger Kenney, "These Stirring Days in the Casualty Business," United States Investor, May 9, 1953, pp. 13-20; Ralph H. Blanchard, "Risk and Insurance," Weekly Underwriter, March 29, 1952, pp. 826, 830-831, 834; Roy C. McCullough, "Philosophy and Background of Multiple-Line Underwriting," Journal of Insurance, X X V (July, 1958), 11-14; and Winter, op. cit. Somewhat cautious views are expressed by Ellis H. Carson, "Creative Use of Writing Power," Insurance Buyer, VI (May, 1951), 13-14, and Harry F. Perlet, "Impact of Multiple Line Underwriting on Coverages, Contracts, and Operating Results," Journal of Insurance, X X V (July, 1958), 15-22. G. F. Michelbacher, Multiple-line Insurance (New York: McGraw-Hill Book Company, Inc., 1957), is, despite the title, only partly concerned with the concept of multiple-line insurance. 13 Roger Kenney, "Let's Have No 'Phony War' on Package Policies," United States Investor, June 20, 1953, p. 106.

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be necessary before all-risk coverages become widely available. Less than all-risk policies still offer advantages to the insurance buyer, however. Multiple-peril contracts which combine a group of coverages formerly written separately reduce the possibility of gaps between coverages and nonconformity of amounts and types of coverage. Loss settlement is also likely to be simpler and more certain when only one insurer is involved. If anticipated cost reductions were passed on to the purchaser, loss and expense savings for the buyer of multiple-peril or all-risk policies could be quite substantial. Cost reductions for insurers can come from a number of sources. Those most likely are: (1) simpler corporate structures, resulting in a reduction in expenses—such as tax and license fees, salaries, and coordination expenses—plus greater efficiency through gradual elimination of the now redundant insurance fleet;14 (2) better spread of risks in those categories where seldom-purchased coverages are automatically part of the contract, thus eliminating possibilities of selection against the insurer (though this will be a disadvantage to buyers who do not wish to insure against such perils); 15 and (3) cheaper administration by combining coverage for several perils, leading to savings in such items as clerical, statistical, underwriting, and loss adjustment expenses. Sales agencies in particular should be able to reduce clerical and administrative expense, for an agency need no longer represent a number of companies. T h e savings being passed on to buyers under multiple-line homeowners' policies have amounted to as much as 40 per cent of the separate cost of the included coverages.16 Development of Multiple-Line. T o what extent have the expected results emerged? Speaking before the American Association of University Teachers of Insurance in Boston in 1952, an industry representative, H. Clay Johnson, said, W h i l e it is true that there have b e e n s o m e significant d e v e l o p m e n t s in the field of m u l t i p l e l i n e u n d e r w r i t i n g w h i c h represent attempts at carrying o u t 14 T h e former Superintendent of Insurance for the State of New York, Alfred J. Bohlinger, op. cit., p. 692, stresses anticipated economies resulting from elimination of insurance fleets. 15 See Robert I. Mehr and Emerson Cammack, Principles of Insurance (Rev. ed.; Homewood, 111.: Richard D. Irwin, Inc., 1957), pp. 666-668, and Winter, op. cit., pp. 101-102, for discussions of selection against the company or adverse selection. In the simplest sense, adverse selection means that only those who expect a loss from a particular peril are insuring against its occurrence. " Kenney, "Let's Have N o 'Phony War' on Package Policies," p. 99. For a discussion of rate credits for package insurance arrangements, see William H. Rodda, "Multiple Line Underwriting-Rating Methods," Journal of Insurance, XXIV (September, 1957), 135-139.

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the underlying purpose of the legislation, on the whole not a great deal of progress has been made in this direction. . . , 1 7

Writing at about the same time, Roger Kenney, a sympathetic critic of the industry, spoke of ". . . the criticism so often heard today that the great bulk of the fire and casualty industry is giving mere lip service to multiple line operation. . . ." 1 8 These statements, from sources expected to be charitable, suggest that the industry initially failed to grasp an important opportunity. There are indications, however, that the industry is moving toward better utilization of its enlarged powers. Most of these are in the field of homeowners' policies, though the first true multiple-peril coverage developed under multiple-line authority was a contract known as the Manufacturers' Output policy. 19 This contract includes fire, inland marine, and casualty elements. Homeowners' multiple-line policies of various types have developed in recent years.20 They have been both named-peril and all-risk packages. California and Pennsylvania have been proving grounds for multiple-line policies. Specially favorable legislation in these states is conducive to the development of new coverages. For instance, California has two unique provisions in its insurance code: first, a new policy may be offered without filing it or its rate schedule with the insurance department; and second, though California has a statutory standard fire policy, multiple-line policies, including the hazard of fire, may be issued without quoting the wording of the California Standard Fire policy. 21 Under the influence of these provisions, various companies have developed multiple-line contracts for owners of dwelling-type properties in California. 22 These policies are generally nonoptional combinations (the buyer is required to take the entire package), though Reported in Weekly Underwriter, January 5, 1952, p. 5. "These Stirring Days in the Casualty Business," p. 14. " P h e l a n , op. cit., p. 3. 20 T h e Insurance Company of North America and its affiliates were among the first to introduce such policies to homeowners in Pennsylvania and California— indivisible packages for indivisible premiums. Coverage is provided against fire and allied perils for real and personal property, theft, and personal liability to third parties. See Thomas J . Yborra, "Multiple Peril Policies used in Pennsylvania," The Annals of the Society of Chartered Property and Casualty Underwriters, V (1953), 6-10. 21 California, Insurance Code (Supp. 1951), sec. 2070, permits multiple-peril policies to provide fire insurance without printing the statutory fire insurance contract. Prior to this revision, only the Personal Property Floater type of marine insurance could omit the language of the fire insurance policy. 22 See J . Folger Allen, "California Multiple Peril Policies," The Annals of the Society of Chartered Property and Casualty Underwriters, V (1953), 11-19. 17

18

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111

most companies offer both a named-peril and an all-risk form in addition to the conventional fire and optional allied coverage type of contract. Thus all varieties of coverages and combinations are available to the purchaser.23 The exclusions contained in the all-risk contracts are those perils normally considered to be uninsurable. These are such things as faulty design, defective work, material deterioration, and war. Multiple-line homeowners' policies have spread from California and Pennsylvania until they are available throughout the United States, modified to meet the requirements of individual states. In 1958, 2.1 per cent of nonlife insurance premiums were classified as homeowner's multiple-peril insurance.24 Several multiple-line contracts for business property and operations have been developed, though the rate of development in this area has been slower than in the personal-residential field. Actually, in addition to ocean marine insurance, multiple-peril and all-risk types of contracts have been available for certain limited groups of commercial enterprises for many years.25 Written by marine insurance organizations, these contracts were generally classified as inland marine insurance, though the contracts usually covered perils which were separately classified as fire or casualty coverages. Multiple-line insurance for business has built upon the examples of inland marine insurers; new types of contracts have been devised, new types of businesses have been insured. In some instances a business firm now has a wider choice of insurance products.26 Yet the amount of all-risk or multiple-peril insurance written for commercial enterprises remains small. In 1958, .2 per cent of nonlife insurance premiums were classified as commercial multiple-peril insurance.27 More importantly, insurers continue to emphasize insurance against loss from specified perils rather than insurance against loss. The shift from " F o r example, see William E. Brady, Jr., "Multiple Peril Policies in California," The Annals of the Society of Chartered, Property and Casualty Underwriters, V (1953), 20-23, for a description of the all-risk and named-peril, multiple-peril contracts offered by the Founders Insurance Company. 21 The Spectator, C L X V I I (November, 1959), 49-50. 2 5 Such a contract for jewelers has been in use for approximately a half century. C. E. Tomlinson, "Business Contracts: Developments and Trends in Multiple Line Underwriting," Journal of Insurance, X X I V (September, 1957), 152. 29 T h e all-risk and multiple-peril contracts developed by inland marine insurers before the multiple-powers legislation of the 1940's and 1950's led to complaints by fire and casualty companies. As a result, the state insurance commissioners established underwriting boundaries for fire, marine, and casualty companies. These limitations, known as the Nationwide Definition, sharply restricted the wide powers that had been assumed by inland marine insurers. See Winter, op. cit., pp. 98-99. " The Spectator,

C L X V I I (November, 1959), 49-50.

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compartmental insurance to multiple-line insurance has not been made.28 Over a decade has passed since the enactment of multiple-power legislation. Changes have occurred; yet apparently the full potential of multiple-line insurance has not been exploited. What are the most important deterrents? And are they within the control of the industry? Obstacles to Multiple-Line Growth. Obstacles to more rapid progress in multiple-line insurance are a mixture of rating, legal, financial, and personnel problems. 29 The rating problem centers around two questions: state rating versus national rating; and new statistical classifications resulting in an indivisible premium versus an aggregation of several coverages with a divisible premium. The present multiple-line rating machinery seems to be unduly antiquated. Irving Davis has criticized the maze of rating bureaus and boards in this way: According to former Superintendent [State of New York Insurance Department] Dineen's analysis, there are 150 fire insurance bureaus and boards and 70 casualty bureaus, for which companies reported expenditures of $31,000,000 in their annual statements (includes stock and mutual companies). President Harold V. Smith of the Home [Insurance Company] said there were 144 bureaus to which a company would have to belong if it wished to do business on a multiple-line basis in all 48 states.30

The Multiple Peril Insurance Rating Organization was established in 1951 to cut through this array of overlapping rating organizations and develop policies through national rating on an indivisible premium basis. In opposition to this, the Interbureau Insurance Advisory Council was organized in 1953 by a large group of companies to study package policies on a specified peril and divisible premium basis. These two organizations were merged in 1957.31 Presumably both approaches to multiple-line pricing will continue to be explored by the new organization, The Multi-Peril Insurance Conference. National rating represents a sharp break from what the fire industry has been doing for many years. A coordinated approach is needed, however, whether it be within the framework of the present fire and casualty rating machinery or by means of some plan such as the national, indivisible 28

Michelbacher, op. cit., p. 25; and Winter, op. cit., p. 100. See Garrett W. Roerink, "What Do We Want in Multiple Peril Policies?" The Annals of the Society of Chartered Property and Casualty Underwriters, V (1953), 26; and Michelbacher, op. cit., pp. 14-16. 80 Irving Davis, "Multiple-line Underwriting . . . Chaos or Opportunity?" The Spectator, XVI (September, 1950), 20. See also Rodda, op. cit., p. 133. 81 Letter from Harry F. Perlet, General Manager, Multi-Peril Insurance Conference, New York, July 3, 1958. 29

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premium arrangement of the former Multiple Peril Insurance Rating Organization. The latter approach appears to offer advantages, since it would necessitate a hard look at the efficacy of continuing the heterogeneous, expensive rating structure built up over so many years.32 The issue is whether contracts that are to cover a number of perils and to be sold nationwide can be cheaply or effectively developed through innumerable statistical and rating organizations which operate in terms of one or a few classes of insurance. It seems fairly clear that they cannot. A former New York insurance commissioner recommends placing rating organizations on a nationwide basis to avoid the expense and difficulty of processing a national program through many local rating organizations. 33 Lack of progress in solving the rating problems associated with multiple-line underwriting is not entirely attributable to company lethargy and disagreement. State legislation has also restricted developments. Legislative impediments to multiple-line underwriting are common despite enabling legislation in all states. Following the South-Eastern Underwriters Association case and the McCarran-Ferguson Act,34 most states adopted measures requiring rigid rate and policy form approval by insurance departments. 35 These statutes and their interpretation impose restraints on development of multiple-peril contracts. For example, rates often have to be substantiated by loss statistics before they will be approved for use. Obviously such statistical evidence is unavailable for a policy covering multiple perils on an indivisible premium basis—some of the perils may have been uninsured previously, or insured in a very limited way. Incomplete loss data are even more typical of all-risk contracts.3® The solution seems to lie in less restrictive rate-regulatory laws. Multiple-peril, indivisible rates are regarded as practicable if they reflect recorded loss cost factors for perils generally insured, such as fire, and adjusted loss cost factors for perils rarely, if ever, insured. The element which arouses objection is the adjusted loss cost factor for perils rarely, if ever, insured previously. Judgment must be employed here. If machinery is set up to yield statistics to check this judgment in the future, such a method does not seem to differ mark33

See Kenney, "These Stirring Days in the Casualty Business," p. 13. Bohlinger, op. cit., p. 692. 34 322 U.S. 533 (1944), and 59 Stat. 33 (1945), as amended by 61 Stat. 448 (1947). 36 See the discussion of rate making in chap. v. "•See Johnson, speech reported in Weekly Underwriter, January 5, 1952, p. 5; and Roger Kenney, Fundamentals of Fire and Casualty Insurance Strength (2d ed.; Dedham, Mass.: Kenney Insurance Studies, 1953), pp. 237-238. 33

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edly from the problem in cost estimation facing many firms and industries in the economy.37 Another obstacle is the standard fire insurance policy which many states have incorporated into their insurance codes.38 The use of a standard fire insurance policy has aided purchaser understanding and protection, uniformity of legal interpretation and claim settlement, and improved loss statistics. But the frequent requirement that its exact form and content be included in every contract insuring the fire hazard restricts the development of multiple-peril policies. Varying tax laws also create impediments. When taxes for fire insurance and casualty insurance are levied at different rates or in different ways, it is difficult to allocate the proper tax on an indivisiblepremium, multiple-peril policy.39 The financial problem stems from state legislation also. State requirements to qualify for a multiple-line license are generally stated in terms of an adequate policyholders' surplus—and what is "adequate" is subject to disagreement. 40 If the requirements are set too low, company solvency may be endangered. If set too high, they place small and growing firms at a disadvantage or close this type of market to them altogether. 41 An insufficient supply of trained personnel may be a deterring force to the development of multiple-line underwriting. Industry members have stressed this factor. 42 For a single firm to handle all types of fire and casualty insurance, and to do so in new ways, makes additional demands upon personnel, particularly management. A compensating factor is that many companies have been operating as members of groups writing both fire and casualty. Even though any one company " An insurance industry executive, Percy Chubb, strongly emphasizes the need for proceeding in this way if the industry is to keep pace with the new demands being made upon it. An address before the New York Young Men's Board of Trade (n.d.), reported in Weekly Underwriter, June 14, 1952, pp. 1538-1540. 88 The New York Standard Fire Policy has been adopted by 46 states, 29 by legislation. Johnson, speech reported in Weekly Underwriter, January 5, 1952, p. 5. " See Roerink, op. cit., p. 28. 40 Policyholders' surplus means the total net worth of a firm—capital stock and surplus. For a mutual company it would be surplus. See Robert B. Mitchell, Financial Analysis of American Stock Fire Insurance Companies from 1926 to 1936 Inclusive (Philadelphia: University of Pennsylvania, 1939), chap. ix. a Roger Kenney, "Time to Iron Out the Wrinkles in Multiple Line Legislation," United States Investor, June 30, 1951, pp. 51-52, stresses that the very least that needs to be done in states with policyholder surplus requirements of $1,000,000-ormore is to allow smaller companies with a smaller policyholders' surplus to write certain types of multiple-line coverages—especially when recourse to reinsurance facilities is possible. 12 The Spectator, CLXI (June, 1953), 15.

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may have been concerned with only one field, management and coordination have been carried on in terms of the entire group. Vigorous attack by the industry would eliminate many of the obstacles discussed above. In the main, restrictive legislation would yield to a concerted effort by the industry to obtain its repeal. Much of it is a remnant from previous days, now contradictory with new multipleline underwriting legislation. One gains a distinct impression that an important reason why progress has not been more rapid in multipleline insurance underwriting is a lack of enthusiasm for it on the part of much of the industry. Many industry members have apparently looked quite favorably upon the obstacles to this type of change. 43 Early in the 1950's Irving Davis summarized the impact of multipleline underwriting on the industry in this way: N o human institution can utterly resist change. Insurance, so interwoven in the fabric of our social and business life and in our financial-economic structure, has arrived at that point where the changes wrought in the insurance pattern by industrial, technological, and sociological developments require more than a patching up job. . . . All this means change—change in loss forms, rating systems, in fact, a change in basic philosophy of underwriting. Not today or tomorrow, but sooner than many of us think. 44

What is involved is a shift from an industry which deals primarily in carefully defined and restricted contracts on one or a few perils that have long foundations of experience, to an industry which deals also in broad, all-inclusive contracts. Initially, the broader contracts will be based partially on the professional risk bearer's judgment. " See Roger Kenney, " 'Package Policies' Pointing Up Economic Waste in Present Rating Machineryl" United States Investor, January 31, 1953, pp. 9-12; and Winter, op. cit., pp. 104-105. 44 Irving Davis, "Multiple-line Underwriting . . . Chaos or Opportunity?" The Spectator, XVI (September, 1950), 20.

CHAPTER VII

Industry Performance II: PrOgreSSWeneSS

(Automobile Insurance

and Accident and Health InsuranceJ

In chapter vi it was suggested that progress in nonlife insurance products could be discussed in terms of: (1) new types of products and adaptations or reformulations of old types; and (2) procedural, administrative, or contractual changes leading to reductions in cost or increases in purchaser satisfaction. The new types of products or adaptations of old products chosen to represent the industry's response to changing conditions were multipleline, automobile, and accident and health insurance. In chapter vi the general question of industry progress was discussed and multiple-line insurance was considered. In the first part of this chapter we shall continue this discussion by examining automobile insurance and accident and health insurance. Then we shall turn to an examination of industry progress in terms of cost reductions and increased purchaser satisfaction from procedural, administrative, or contractual changes. Automobile

Insurance

Problems have been created by the operation of an ever growing number of motor vehicles in our society.1 The 48 million vehicles operating 1 In 1900, 8,000 motor vehicles were registered in the U n i t e d States, and factory sales were 4,000; in 1950, 49,162,000 vehicles were registered a n d factory sales were 8,003,000; and in 1958, 68,299,000 vehicles were registered and factory sales were 5,135,000. U.S. Bureau of the Census, Statistical Abstract of the United, States: 1959 (80th ed.; Washington, 1959), p. 558. A u t o m o b i l e insurance sales grew concomitantly, reaching $2.7 billion i n 1950 and $5.3 billion i n 1958. The Spectator, C L I X (November, 1951), 82, and CLXVXI (November, 1959), 53.

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in the United States at mid-century were causing estimated annual deaths of 35,000 and personal injuries (disabling beyond the day of accident) of 1,200,000.2 In 1958 there were 37,000 deaths and 1,350,000 injuries. 3 And there was every indication that deaths and injuries would remain large if not increase as the number of vehicles increases and facilities for handling them become more taxed. Property damage losses are more difficult to estimate. However, the National Safety Council indicated property damage in motor-vehicle accidents of $1.2 billion in 1950 and $1.9 billion in 1958.4 Total costs of motor-vehicle accidents were estimated as $3.1 billion in 1950 and $5.6 billion in 1958.5 The problems created by automobile accidents may be divided into three groups: how to reduce the number of accidents; how to structure the law and the courts to allocate the consequences of accidents in the best interests of society; and how to arrange for the payment of claims permitted by the legal system existing at any time. 6 Literature on the automobile accident problem has been accumulating for many years. Before World War II a number of alternative solutions were proposed and examined. 7 The problem received little notice during the war, however, as the conditions of automobile use changed sharply. But since the war, automobile accidents and their consequences have been receiving increasing attention. 8 2

National Safety Council, Accident Facts, 1951, p. 43. 'Ibid., 1959, p. 40. Trends in death rates are as follows: (1) deaths per 100,000 population declined from 25.1 in 1938 to 21.4 in 1958, but since the abnormal war years this rate has remained fairly constant in the low 20's; (2) deaths per 10,000 motor vehicles declined steadily from 10.9 in 1938 to 5.4 in 1958; and (3) deaths per 100 million vehicle miles also declined steadily from 12.0 in 1938 to 5.6 in 1958. Ibid., p. 59. 4 Ibid., 1951, p. 4, and 1959, p. 4. 'Ibid., 1959, pp. 4, 59. Total costs are defined to include estimates of income loss, medical expenses, insurance expenses, and property damage. 'See Richard M. Heins, "Compensating the Automobile Accident Victim," Journal of Insurance, XXIV (September, 1957), 76. 'See, for example, Columbia University Council for Research in the Social Sciences, Report by the Committee to Study Compensation for Automobile Accidents (Philadelphia: International Printing Co., 1932); Patterson H. French, The Automobile Compensation Plan (New York: Columbia University Press, 1933); Massachusetts Legislative Council, Report of the Special Committee to Study Compulsory Motor Vehicle Liability Insurance and Related Matters, Senate 280, 1930; New York State, Eightieth Annual Report of the Superintendent of Insurance (Albany: New York State Insurance Department, 1939), I, pp. 20-26; Young B. Smith, Austin J. Lilly, and Noel T. Dowling, "Compensation for Automobile Accidents: A Symposium," Columbia Law Review, XXXII (May, 1932), 785-824; a symposium in Law and Contemporary Problems, III (October, 1936), 465-510. 'Examples of postwar discussions are: George H. Kline and Carl O. Pearson, The Problem of the Uninsured Motorist (Albany: New York State Insurance Department, 1951); Heins, op. cit.; John F. Adams, "Research Dealing with the Financial Consequences of Automobile Accidents," Journal of the American Association

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POSSIBLE CONTRIBUTIONS OF

and Health

Insurance

INSURANCE

The possible contributions of insurance to the problem of automobile accidents and losses fall into two groups—activities aimed at accident reduction and insurance activities per se, that is, combining risks to spread losses over as wide a group as possible. Accident prevention is the primary objective of society in this field, and the industry appears to be making valuable contributions toward this goal. The position of insurance regarding loss prevention in automobile and other accident areas was summarized by Henry S. Moser in an address before the Insurance Law Section of the American Bar Association, September 17, 1951: T h e direct social loss to t h e n a t i o n f r o m d e a t h a n d disability is o n e which is unrecompensable. I t can b e lessened only by accident reduction, which m u s t be the p r i m a r y concern of legislative commissions, of t h e insurance industry a n d of the m e m b e r s of the bar. Saving lives is m u c h more i m p o r t a n t t h a n m o n e t a r y r e i m b u r s e m e n t . Legislatures, civic organizations, b a r associations a n d all of us individually should therefore work for street a n d highway improvements, f o r the strengthening of drivers' licensing a n d m o t o r vehicle registration laws a n d f o r rigid e n f o r c e m e n t of such acts, f o r expansion of driver education, f o r periodic inspection of m o t o r vehicles, f o r reexamin a t i o n of drivers a n d f o r u n i f o r m traffic laws. 9

In addition to accident prevention work through educational campaigns, sponsorship of driver training programs, and the like, the insurance industry attempts to emphasize safety by various pricing and policyholder selection practices.10 of University Teachers of Insurance, XXIII (March, 1956), 135-141; New York State, Report of the New York State Joint Legislative Committee to Study the Problem of Unsatisfied Judgment Fund and Compulsory Insurance, Legislative Document No. 36, 1957; California Legislature, Semifinal Report of the Assembly Interim Committee on Finance and Insurance, sec. 3, Automobile Compensation Insurance, 1953; California Legislature, Final Report of the Traffic Accident Consequences Subcommittee of the Committee on Judiciary, Assembly Interim Committee Reports, Vol. 20, No. 6, 1959; Frank P. Grad, "Recent Developments in Automobile Accident Compensation," Legislative Drafting Research Fund of Columbia Law School, 1949, reprinted as Appendix No. 17 of California Legislature, Semifinal Report of the Assembly Interim Committee on Finance and Insurance; and Joseph P. Murphy and Ross D. Netherton, "Public Responsibility and the Uninsured Motorist," Georgetown Law Journal, XLVIII (Summer, 1959), 700-745. ' Quoted in Kline and Pearson, op. cit., p. 8. "Examples are rating plans which modify basic rates by the loss experience of the policyholder, or by comparison of the policyholder's equipment or mode of operation with some standard. Merit rating plans, which qualify an individual automobile owner for a small reduction in premium if he has not been involved in an accident in a stated past period, are often cited as an example of adjusting rates to

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Automobile accidents have not diminished as the volume of automobile insurance has increased. There are no data, however, to indicate that accidents have increased as the percentage of insured drivers has increased. 11 As the industry has expanded its sales of automobile insurance and expended more resources in automobile safety work, it may well have had a salutary effect on the number of accidents, reducing their rate of increase. There is no way to determine this. It might be relevant to ask what part, if any, of automobile accident prevention work is a function of the insurance companies. 12 Is this not an activity which benefits all of society? Further, what part of the benefits of insurance company accident prevention will be passed on in lower premiums? Presumably the expenses of such work result in higher premiums, at least initially. T h e principal contribution the insurance industry can make is the provision of insurance for losses caused by automobile accidents. T h e irreducible minimum of automobile accidents unquestionably will be large. For the individuals involved, these accidents are unexpected and the losses which follow are often large. In terms of the public interest in insurance, there is a strong presumption in favor of achieving as wide and regular distribution of these losses as possible. T o do so will mean that no one individual or firm will suffer large losses with their probable undesirable effect on living standards and enterprise operation. Automobile accidents may be an area in which society does not wish to allow individuals to bear their own risks of loss, even if they are willing to do so. 13 T h e gains from loss distribution may be measured in terms of higher average satisfaction for the population, higher productivity, and less waste of resources in prolonged legal maneuvers to attempt to shift losses after they have occurred. reward safety and to provide an incentive for safety in the future. It is questionable whether a rate reduction of 5 or 10 per cent has any effect on the driving habits of the average motorist. 11 See Fleming James, Jr., "Accident Liability Reconsidered: T h e Impact of Liability Insurance," Yale Law Review, LVII (February, 1948), 562. T h e increase in the number of reported nonfatal accidents in Massachusetts following the introduction of compulsory automobile insurance in 1927 is viewed as an increase only in reported accidents and not in the incidence of accidents. "Statistics on total automobile accident loss prevention expenditures are not available; neither is an allocation of insurance expenses made to reveal company expenditures for such purposes. " See Frank H. Knight, Risk, Uncertainty and Profit (New York: Houghton Mifflin Company, 1921. Reprinted by the London School of Economics, London, 1933), p. 368.

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Criticisms have been made of the inadequate loss distribution achieved by insurance. 14 The amount of loss distributed depends on the volume of risk transferred to the industry and the terms on which it is transferred. PROPOSALS TO SECURE W I D E R DISTRIBUTION OF LOSSES

State legislation requiring financial responsibility of motorists has been widely adopted. These statutes differ in various ways, particularly in terms of the point at which financial responsibility must be shown. Three states require all motorists to demonstrate financial responsibility at registration and during subsequent operation of vehicles.15 These statutes are commonly referred to as compulsory automobile insurance laws, though financial responsibility may be demonstrated other than by the purchase of an automobile liability insurance policy. The majority of motorists, however, satisfy the law by the purchase of an insurance policy. Much more common is the type of statute usually known as a safetyresponsibility law. Every state, other than the three just mentioned, has some variant of this legislation in force.16 Originally these laws had two purposes: to prevent accidents, and to increase the opportunity for victims to recover damages.17 The earlier laws varied considerably from state to state, but, in general, motorists were required to prove financial responsibility for future accidents after being involved in an accident or convicted of a serious traffic violation. Failure to provide proof of financial responsibility, and in many states the failure to pay any judgment arising out of the accident which brought the motorist under the law, meant loss of driving and vehicle registration privileges.18 Such financial-responsibility laws were expected to " T h e following is a typical criticism: "Insurance in this field seems to have fallen far short of a complete solution of the social problem. Many losses occur which cannot be redressed. Insurance coverage is still not as widespread as it should be, and payments made, particularly in serious accident cases, are very often inadequate to cover the losses sustained." Fleming James, Jr., and John V. Thornton, "The Impact of Insurance on the Law of Torts," Law and Contemporary Problems, XV (Summer, 1950), 443. "These states are: Massachusetts, General Laws (Supp. 1925), chap. 346, Annotated Laws (1933), chap. 90, sees. 1A, 34A-34J; New York, Vehicle and Traffic Law (Supp. 1956), sec. 93; and North Carolina, General Statutes (Supp. 1957), chap. 20, sec. 309. Similar requirements have been studied in many other states; further legislation of this type appears likely. M C. A. Kulp, Casualty Insurance (3d ed.; New York: The Ronald Press Company, 1956), pp. 210-215. 17 Grad, op. cit., p. 81. 18 Ibid.

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deter accidents and assure future victims of some recovery. Later statutes, called security-responsibility laws, were more stringent in their requirements for posting security. A deposit of security for the first accident was required, no adverse judgment being necessary to deprive a motorist of his driving privileges.19 Of course, a victim of the first accident is still not going to receive compensation if an uninsured negligent motorist does not deposit security or does not have any assets. Security-responsibility laws have become the predominant form of legislation. Though the term "safety responsibility" is still generally applied to them, few claims are now made for their being safety measures; they do, however, provide an incentive to become financially responsible before the first accident.20 This usually means buying an automobile liability insurance policy. Perhaps 90 to 95 per cent of the motorists in a state with a well-administered security-responsibility law will ultimately purchase liability insurance. 21 The insurance industry has approved of financial-responsibility and security-responsibility legislation as devices for indirectly forcing the insurance of automobiles. But the industry has vigorously opposed compulsory insurance laws.22 Insurance company opposition to compulsory insurance has been based principally on fear of political interference with insurance premium rates and contracts. 23 Insurance companies have other objections also; most of these are technical-administrative criticisms of the way the Massachusetts law has operated. 24 Repeating an earlier proposition, the volume of loss distributed by the device of automobile insurance depends upon the amount of insurance purchased and the terms on which insurance organizations accept the losses of accident victims. The terms of the insurance contract are embodied in the insuring clause, the exclusions, and the limits on loss size. But in the field of liability insurance an even more important factor is the basic philosophy underlying the insuring clause. Fault has been the dominant principle of liability. 25 Con10

Ibid,., p. 83. Ibid. 21 See California Legislature, Final Report of the Traffic Accident Consequences Subcommittee, p. 11; and Arthur C. Mertz, "The Uninsured Motorist," Journal of Insurance, XXIV (September, 1957), 123. 22 Grad, op. cit., p. 81, indicates that financial-responsibility and security-responsibility laws were sponsored by the insurance industry as an answer to the increasing demand for compulsory automobile liability insurance. 23 Heins, op. cit., p. 95. 24 For a complete statement of criticisms, see Kline and Pearson, op. cit., pp. 53-69. 28 See William L. Prosser, Law of Torts (2d ed.; St. Paul: West Publishing Company, 1955), pp. 1-25, 116-175; and Fleming James, Jr., "Accident Liability: Some 20

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sequently, the liability insurance contract is based on the rule of negligence—an insurance company agrees to accept the risk of a loss (as limited in the contract) for which the insured may be legally liable.26 If the negligence liability principle were replaced in the automobile accident field by an absolute liability principle, the insuring clause of the liability contract would be substantially modified. Payment for injury or damages would occur regardless of fault. Accident victims who had been barred from recovery by the doctrines of negligence would be allowed to collect, for absolute liability would be imposed on motorists for all injuries or damage in which their vehicles were involved. The criterion suggested earlier for attaining the maximum industry contribution to the problem of automobile accidents and losses was achievement of the widest possible distribution of such losses. Substituting absolute liability for negligence liability would effect much wider distribution of losses. On this basis alone it seems to be desirable.27 Workmen's compensation statutes have put absolute liability, compulsory insurance (or an acceptable substitute), and a schedule of payWartime Performance-Progress Developments," Yale Law Review, LV (February, 1946), 365. Cf. Albert A. Ehrenzweig, Negligence Without Fault (Berkeley and Los Angeles: University of California Press, 1951), for a discussion of negligence without fault in a modern enterprise society. 20 Some jurisdictions require that an injured party be non-negligent to recover damages, others follow a rule of comparative negligence, which allows a negligent injured party to collect damages if his degree of negligence was less than that of the other party. Kline and Pearson, op. cit., p. 6 and Heins, op. cit., p. 77. Insurance companies have opposed comparative negligence laws, maintaining that they lead to carelessness and to higher damage payments by courts and juries; Ray Murphy, General Counsel of the Association of Casualty and Surety Companies, Address before the San Francisco Commercial Club, April 17, 1953, reported in the San Francisco Chronicle, April 18, 1953, p. 8. There are no data to indicate whether such results follow. Increased carelessness seems quite unlikely. One would not expect individuals to become more lax and subject themselves to injury merely because the law allows them redress if their degree of negligence is less than that of the other party. Higher total damage payments would be expected to follow introduction of a rule of comparative negligence, for loss distribution would occur in cases of dual negligence, whereas it would not under a rule of strict negligence. This does not appear to be undesirable in itself; rather, it would seem to be as desirable as any extension of loss distribution payments. Of course, there may be other objections to comparative negligence rules, such as difficulties of administration, which would make them impractical. 27 For discussions of plans based on absolute liability combined with compulsory insurance and a schedule of payments for losses, see French, op. cit.; Columbia University Council for Research in the Social Sciences, op. cit.; California Legislature, Semifinal Report of the Assembly Interim Committee on Finance and Insurance.

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ments for losses into negligence law. 28 The cidents is summarized that such a plan be katchewan:

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effect in what was formerly a large area of case for similar treatment of motor-vehicle acin the report of a committee recommending adopted in the Canadian province of Sas-

T h e factors which have made acceptable, and even desirable, public intervention in the field of industrial accidents, are present in no less degree in the field of automobile accidents. T h e automobile performs an essential function in the modern economy. It is a dangerous instrument which, out of control for the minutest space of time, may cause great damage. As stated earlier, every motorist is, because he is human, negligent at some time or other while on the highway and it is largely a matter of fortune whether or not someone is in a position to suffer injury through his neglect at the time. At common law, the most that such a motorist could hope for was that the person injured was himself negligent in such a way as to contribute to the accident, for then, the injured party could recover nothing. T h e most that the injured party could hope for was that the man who caused the injury was wealthy or insured. 29

Some individuals in the insurance industry have begun to recognize that the natural result of structural and institutional changes in the United States is a movement toward group responsibility for automobile accident losses.30 Fleming James and John V. Thornton, respectively members of Yale University and New York University law 28 See James, "Accident Liability: Some Wartime Performance-Progress Developments," p. 366. M Special Committee o£ the Saskatchewan Government Appointed to Study the Problem of Compensation of Victims of Automobile Accidents, A Report on the Study of Compensation for Victims of Automobile Accidents, 1947, pp. 12-14. 30 Representative of such a position are the following statements: "I wonder if there is not beginning to be some feeling that the automobile has become such an indispensable part of our social and industrial lives as to justify thinking seriously of paying all automobile accident victims a reasonable compensation, and charging the cost of the accidents to automobile owners as a group rather than to the particular owner who happened to be in that particular accident." Franklin J. Marryott, "New Fields of Potential Loss," Insurance Buyer, VII (June, 1951), 10. ". . . During the past 15 or 20 years a broader and broader concept of what constitutes social insurance has been adopted in this country. . . . Reflecting this very definite social trend, compulsory automobile insurance has been taking its place— gradually to be sure, but nonetheless certainly—beside workmen's compensation as a necessary social measure. . . . People have come to consider the operation of the motor car on the public highways as a greater potential hazard to themselves than anything experienced in their every day employment. And this has served to strengthen their conviction that automobile liability insurance should be regarded as automobile compensation insurance in which the question of individual negligence or fault is of little or no importance—just as is the case with workmen's compensation insurance." Roger Kenney, "Is Inflation Too Much for the Casualty Industry?" United States Investor, March 15, 1952, p. 32.

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faculties, urge adoption of automobile compensation in the United States: . . . Automobile compensation could be patterned after the workmen's compensation systems, which have been widely adopted. . . . In both instances there is exacted regularly, year after year, a certain toll of property damage and human suffering. In both instances a measure of such damage seems to be a necessary concomitant of industrial civilization. This is not to say that the toll cannot be reduced. Certainly it can and should be. But . . . there will always be a basic residuum of destruction, and it seems clear that the consequences of this destruction should be borne by society at large, rather than by the individual. . . . The principle of fault, whatever may be its merits in certain areas of tort, clearly seems to have no sound application in a field where injuries are so widespread as to be virtually a necessary incident of industrial society. . . . The next logical step is to accelerate the slow process of expansion of insurance coverage by the adoption of a system of automobile accident compensation. 31 These are cogent arguments for abrogating the rule of fault in automobile accidents. COMPARISON OF PROPOSALS

Is the insurance industry hindering progress by vigorously opposing absolute liability, compulsory insurance, and scheduled loss payments? Some conclusions may be reached by comparing the industry's solution in this area to these other plans. 32 The insurance industry advocates strict motor vehicle law enforcement, traffic control, and driver education programs, together with more effective security-responsibility legislation. And in recent years, as the fear of compulsory insurance has increased, much of the industry has supported unsatisfied judgment funds, vehicle impounding laws, and uninsured motorist insurance. 33 These adjuncts to security81

James and Thornton, op. cit., pp. 4 4 3 ^ 4 4 . A s used by French, op. cit., Columbia University, Council for Research i n the Social Sciences, op. cit., and most others in the United States, the term "automobile compensation insurance" embodies three elements: compulsory insurance, liability without fault, and a schedule of loss payments. Many European countries have enacted compulsory insurance laws, with perhaps the majority of them assessing liability without fault, but with only a few taking the additional step of placing indemnification payments upon a compensation basis. See Kline and Pearson, op. cit., pp. 14, 19; Columbia University, Council for Research in the Social Sciences, op. cit., pp. 33, 212; and N e w York State, Ninety-Fourth Annual Report of the Superintendent of Insurance (Albany: N e w York State Insurance Department, 1953), I, p. 11a. M

" See Paul S. Wise, "The Problem of the Financially Irresponsible Motorist and the Uncompensated Accident Victim," Journal of Insurance, X X I V (September, 1957), 105, 112; Mertz, op. cit., pp. 130-132; R. Newell Lusby, "The Uninsured Motorist

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responsibility laws will be discussed in the following section. Everyone agrees that better accident prevention laws, more systematically enforced, are desirable. Beyond that, nearly everyone agrees that the financially irresponsible motorist is a problem. Disagreement arises over the best method to effect financial responsibility for all motorists and over whether the basis of liability should be changed. The three most frequently suggested proposals—security-responsibility statutes, compulsory insurance, and automobile compensation insurance 34 —will be summarized and compared in the following sections.35 THE SECURITY-RESPONSIBILITY

APPROACH

The insurance industry maintains that after security-responsibility laws have been in force for a reasonable time, nearly all motorists will be forced to obtain insurance.36 As evidence that such a law creates financial responsibility, the industry points to the substantial amounts posted as security each year by those who have not obtained insurance and do not wish to have their driving privilege suspended for inability to satisfy a judgment which might be levied against them. Over a million dollars in security was posted annually in New York state for a number of years before compulsory insurance was made effective.37 But before this is accepted as evidence of the workability of security-responsibility laws in assuring —Several Points of View," Journal of Insurance, XXIV (September, 1957), 114-117; Heins, op. cit., p. 97; California Legislature, Final Report of the Traffic Accident Consequences Subcommittee, pp. 13-15. 84 Professor A. Ehrenzweig, University of California School of Law, offers a method of handling automobile accident claims which cuts across the above lines in a number of ways. His plan does not involve compulsion, but it does provide for recovery for all accident victims, regardless of fault (with some modifications), on the basis of a compensation schedule. Any car owner taking accident insurance for himself, passengers in his car, and third parties injured by his car would be free of liability unless he was guilty of drunken or reckless driving. Insurance against this kind of activity would not be possible. Any injured party covered by such a policy would be entitled to compensation on a predetermined basis without having to prove the driver negligent. Ehrenzweig feels redress would be certain and prompt, court calendars would be relieved, and insurance premiums reduced. A special fund would be set up to compensate claimants not covered by the plan. Albert A. Ehrenzweig, "Full Aid" Insurance for the Traffic Victim (Berkeley and Los Angeles: University of California Press, 1954), pp. 30-40. 86 For a comparison of these proposals by a former New York Insurance Commissioner, see Alfred J. Bohlinger, "Which Road for the Uninsured Motorist?" Weekly Underwriter, November 17,1951, pp. 1244-1247, 1270. 16 A financial-responsibility law first became effective in New York in 1929. In 1955 some 95 per cent of the state's motor vehicles were insured. A joint legislative survey in 1937-1938 had estimated 33 per cent were insured at that time. Kline and Pearson, op. cit., pp. 10, 18, 29, and Mertz, op. cit., p. 123. " N e w York, Vehicle and Traffic Law, sec. 93 (1956), effective February 1, 1957.

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payment for just claimants, one must consider the rate at which such security has been released and the amounts of security posted compared with annual uninsured losses. New York law allowed the release of posted security if no suit was instituted within one year of the date of the accident. Under this provision, approximately one million dollars was released annually during recent years. Thus it has become essentially a revolving fund. What did one million dollars mean in terms of the estimated annual uninsured loss in New York for which motorists would be legally liable? In 1952 uninsured losses were estimated at $14.5 million. This was based on an estimate of 90 per cent insured vehicles and the losses paid on these by the insurance carriers. If 95 per cent were assumed insured, the uninsured loss estimate would be $7.25 million. A one million dollar security deposit, most of which was apparently returned, now seems merely a token.38 Unsatisfied judgment funds, vehicle impounding laws, and uninsured motorist insurance have been suggested as aids to security-responsibility laws. Unsatisfied judgment fund laws establish a fund from which uncollectible automobile accident judgments may be paid.39 Though the laws differ in the details of how these funds are to be financed and what shall be considered a proper claim against them, in general they provide a means for compensating the non-negligent victim after he has converted his claim against a negligent motorist into an unsatisfied judgment. The insurance industry views unsatisfied judgment legislation as an alternative to compulsory insurance. Since almost any alternative is considered preferable to compulsory insurance, the industry has generally supported unsatisfied judgment laws.40 Misgivings are expressed, however, concerning further state participation in insurance matters through the operation of these funds.41 Unsatisfied judgment funds generally require exhaustion of legal processes before compensation from the fund. This may mean that the amount of additional losses distributed will be quite modest.42 118

Data from Kline and Pearson, op. cit., pp. 12, 32. »"Examples of states with such provisions are: New Jersey, Statutes Annotated, sees. 39:6-61-39:6-91 (1952), sec. 39:6-63 (Supp. 1958); North Dakota, Revised Code, sec. 39-1702-1704 (1947, Supp. 1957); Maryland, Annotated Code, Art. 661,4, sees. 150-179 (1957); New York, Insurance Law, sees. 600-626 (1958). 40 Wise, op. cit., p. 105. 41 Ibid. "For a list of weaknesses of unsatisfied judgment funds, see Heins, op. cit., pp. 96-97.

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Automobile impoundment acts are designed as an additional incentive to motorists to insure. Vehicles are impounded if the owner cannot furnish proof of financial responsibility at the time of an accident. Releases are granted when security is provided, or, usually, at the expiration of a designated period of time if no action has been filed. Impoundment statutes have been enacted in some Canadian provinces.43 Undoubtedly this type of legislation emphasizes the importance of carrying automobile insurance. However, such laws do not assure financial responsibility for all motorists. And it is unlikely that the sums received from the forced sale of impounded vehicles will provide very significant relief for accident victims.44 Uninsured motorist insurance has recently been advocated by the insurance industry as a voluntary method of providing compensation for accident victims unable to collect from negligent, financially irresponsible motorists. This form of insurance, which became available in 1955, extends the automobile insurance contract to provide insurance against losses caused by uninsured motorists.45 Numerous criticisms have been made of this approach; for example, insuring organizations may have a conflict of interest, pedestrians without automobile insurance are unprotected, and insureds are paying for losses that should be paid for by negligent motorists.46 California has recently enacted legislation requiring all automobile liability insurance policies sold or delivered in the state to contain a provision for financial protection against bodily injury caused by uninsured motorists.47 New York had previously passed similar legislation.48 This body of legislation—security-responsibility laws assisted by some combination of unsatisfied judgment, impoundment, or uninsured motorist laws—comprises what the insurance industry often calls the "voluntary way" to solve the problem of the uninsured motorist. As a group, these laws are held to achieve virtually complete insurance coverage, thus assuring the ability of motorists to respond if liable for damages. Unsatisfied judgment funds and uninsured motorist insurance are expected to fill gaps created by those vehicle owners who neglect or refuse to secure insurance. a Ibid., p. 97. "See Kline and Pearson, op. cit., pp. 38^10, for a discussion of vehicle impoundment. 45 Lusby, op. cit., pp. 114-116. "Ibid., and Wise, op. cit., pp. 112-113. "Insurance Code (Supp. 1959), sec. 11580.2. Insurer and insured may agree to waive this uninsured motorist provision. 48 Insurance Law (Supp. 1958), sees. 600-626.

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THE COMPULSORY INSURANCE APPROACH

Compulsory insurance laws require every motorist to be financially responsible before an accident occurs; security-responsibility laws permit one accident before financial responsibility must be shown. The essential distinction between the two approaches is that the compulsory insurance laws require motorists who have not been insuring to do so if they wish legally to register and operate their vehicles.49 Besides this requirement of universal insurance, other advantages attributed to compulsory insurance are: the law can be as broad or as restrictive as a state wishes; and it will secure the payment of nearly all just claims. Arguments against compulsory insurance fall into two categories: objections of a technical, administrative, or procedural nature, and objections of an economic or ideological nature. The first class of objections is based largely on the Massachusetts law which has been in effect since 1927. For example, this law does not apply to property damage, guest occupants of a vehicle, or out-ofstate drivers. These are criticisms of the way a particular law has been drawn and is administered. They may be largely avoided by drawing a law differently and by interstate cooperation. The second class of objections consists mainly of the following four points: monopolistic or competitive state insurance funds are likely to follow laws requiring insurance of every motorist; rates are apt to become entangled with politics; insurance companies may be subjected to greater control of rates, coverages, policy forms, and methods of doing business; and the costs of insurance will be increased because of additional claims, perhaps partly fraudulent, and increased administrative and handling expenses.50 Some critics also allege that compulsory insurance will be merely a stepping stone to automobile compensation insurance. These conditions may develop. They are not inevitable, however. Nor are solely unfavorable consequences inevitable if such conditions 19 In 1953 the N e w York Insurance Department reported: "For nearly a quarter of a century the State of N e w York has been trying to rid its roads of the financially irresponsible motorist. Despite all efforts, between 200 and 400 thousand motorists continue to operate their vehicles without insurance. Each year they kill, injure and destroy the property of thousands of innocent victims without being able to respond in damages. Each year they cause losses running into many millions of dollars." N e w York State, Ninety-Fourth Annual Report of the Superintendent of Insurance (Albany, N e w York State Insurance Department, 1953), I, p. 14a. 60 For a detailed treatment of the arguments for and against compulsory automobile insurance, see Kline and Pearson, op. cit., pp. 53-72.

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should develop. For example, the development o£ competing state insurance funds, under conditions of legitimate competition with private insurance, could be desirable for the purchaser in terms of the incentive created to reduce costs and increase efficiency. The possibility of state insurance funds developing is discussed in the following section on automobile compensation. It is common to assume that compulsory automobile insurance will mean higher premium rates. Such an assumption is usually based on an expected increase in claims and an increase in the expense of processing and handling insurance contracts. If a state has a low percentage of insured motorists at the inception of a compulsory law, a large increase in claims will follow. Some of these will be fraudulent, as they would be under an increase in insurance due to a securityresponsibility law or any other reason. One cannot say that the amount of fraudulent claims will be relatively higher under a compulsory law. It appears that changing to compulsory insurance in a state that has over 90 per cent of its motorists insured under a security-responsibility law would not result in any appreciable increase in fraudulent claims. Payment of additional legitimate claims is desirable and would not necessarily lead to increases in rates, for the additional losses paid should be matched by additional premiums received. Whether handling expenses will increase depends mostly on what a particular compulsory law requires in the way of additional filings, notices, and similar procedures. Any increases in expenses might be offset by reductions in sales expenditures. The expenses associated with selling automobile insurance should decline when everyone is required to purchase insurance in order to register a motor vehicle. THE AUTOMOBILE

COMPENSATION

APPROACH

Automobile compensation insurance goes well beyond both the security-responsibility law approach and the compulsory insurance approach; in addition to compulsory insurance, it proposes liability without fault and a compensation schedule of loss payments. From the standpoint of making the fullest possible use of risk transference to distribute losses, automobile compensation unquestionably offers the greatest advantages. Every victim of an automobile accident will be able to collect some amount to contribute to his loss. The lengthy, expensive litigation frequently necessary today to secure payment should become unnecessary. In addition, settlement for a small sum far less than the actual loss will be less likely. A number of students of law, insurance, and other social sciences are either urging such a

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to automobile accidents—other measures being interim stopgaps.51 plan or speaking as though they were resigned to it as the best solution The insurance industry's principal objection to automobile compensation is that state insurance may follow the institution of absolute liability, required insurance, and an administratively supervised schedule of loss payments. This, it is often stated, would lead to costly, inefficient service, political control, and other undesirable results. It is not the purpose of this study to examine these questions. Since this is a study of private insurance, however, it is relevant to examine the likelihood of state insurance supplanting private insurance if automobile compensation should be put into operation. One insurance executive has expressed the following opinion: ". . . The business of insurance did survive the enactment of [workmen's] compensation laws and it undoubtedly can and will survive a drastic change in the procedure by which damages arising out of the use of the automobile are determined." 52 Eighteen states and Puerto Rico have funds organized to provide workmen's compensation insurance; eleven states are competitive. 53 The majority of these state funds were organized between 1911 and 1920, a time of rapid growth in state workmen's compensation legislation. A few funds were formed as late as the 1930's.54 In states with competitive insurance funds, approximately 75 01 For example, see Columbia University Council for Research in the Social Sciences, op. cit., pp. 132-135; Grad, op. cit., pp. 89-92; Harold F. McNiece and John V. Thornton, "Is the Law of Negligence Obsolete?" St. Johns Law Review, XXVI (May, 1952), 255-277, and "Automobile Accident Prevention and Compensation," New York University Law Review, XXVII (October, 1952), 585-613; Robert S. Marx, "Compensation Insurance for Automobile Accident Victims: T h e Case for Compulsory Automobile Compensation Insurance," Ohio State Law Journal, XV (Winter, 1953), 134-149, and " 'Motorism,' Not 'Pedestrianism': Compensation for the Automobile's Victims," American Bar Association Journal, XL (May, 1956), 421-426, 477-482; James and Thornton, "Impact of Insurance on the Law of Torts," pp. 431, 443; Roger Kenney, " T h e Way Is Being Paved for Automobile Compensation Insurance," United States Investor, October 19, 1959, pp. 81-88. For a statement of the opposition viewpoint, see Bruno H. Greene, "Must We Discard Our Law of Negligence in Personal Injury Cases?" Ohio State Law Journal, XIX (Spring, 1958), 290-312. For a discussion of changes in tort liability and insurance in various western countries, see W. Friedmann, Law in a Changing Society (London: Stevens & Sons Limited, 1959), pp. 126-164. 62 James F. Crafts, "What Will the Verdict Be?" Address before the Insurance Law Section of the American Bar Association, San Francisco, September 16, 1952. 68 Herman Miles Somers and Anne Ramsey Somers, Workmen's Compensation (New York: John Wiley and Sons, Inc., 1954), p. 96. 84 New York, Oklahoma, and Puerto Rico established state insurance funds for writing workmen's compensation insurance in 1935, 1933, and 1935, respectively. The Insurance Almanac (New York: The Weekly Underwriter, 1951), p. 161. No exclusive state funds have been established since 1920. Harold A. Katz, "Workmen's Compensation in the United States," Insurance Law Journal, No. 427 (August, 1958), 521.

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per cent of workmen's compensation insurance is written by private insurance carriers.55 This does not seem to indicate an inevitable tendency for the state to enter an area of required insurance; certainly no such trend is noticeable in workmen's compensation insurance. Perhaps automobile insurance would be a different matter—more people are directly concerned with this type of insurance. Massachusetts is the only state with a significant history of required insurance, and no state insurance facility has developed in that state. 56 But a single instance is not a trustworthy basis for generalization, either for or against a tendency for state insurance to be associated with required insurance. CONCLUSION

One fact seems reasonably clear. A significant opportunity still exists to insulate individuals against automobile accident loss by further extension of liability insurance. Perhaps through security-responsibility statutes the use of insurance will become nearly as widespread as through compulsory insurance laws. There are time lags, however; furthermore, security-responsibility laws are likely to require more assistance from unsatisfied judgment funds, impounding acts, and uninsured motorist insurance. Between the two approaches, the force exerted on the motorist to insure probably differs very little, if the security-responsibility method comes to consist of a group of the above laws. If there is going to be a demand for state insurance, it would seem to be virtually as likely to emerge under a group of security-responsibility laws, designed to achieve complete insurance, as under compulsory insurance. One very important distinction still exists between the security-responsibility and compulsory methods (still under present liability rules): that is the possibility of one accident occurring under the security-responsibility method before financial responsibility must be shown. This would have to be considered a disadvantage. " R o b e r t I. Mehr and Emerson Cammack, Principles of Insurance (Rev. ed.; Homewood, 111.: Richard D. Irwin, Inc., 1957), p. 432. M O n e opponent of compulsory automobile insurance explains the absence of a state fund in Massachusetts by the ability of private companies in Massachusetts to make up for restrictions in that state, by operations in other states and by an advisory opinion of the Massachusetts Supreme Court to the state legislature that an automobile insurance fund would be unconstitutional. Lusby, op. cit., pp. 118-119. Neither of these explanations seems very compelling. Profit-seeking insurance organizations are not likely to continue to operate for three decades under undesirable circumstances, even though there may be opportunities to discriminate in other areas or they may have strong feelings about thwarting the development of state insurance. Constitutions, particularly state constitutions, are also amended quite frequently.

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Automobile compensation seems to offer advantages over both approaches. T h e two aspects of this plan which separate it markedly from either of the others are the imposition of absolute liability upon owners of motor vehicles for all injuries involving their vehicles, and the limitation of damages to a predetermined schedule of medical expenses and estimated economic loss suffered. All automobile accident cases would be removed from the courts and handled—it is hoped—by a speedier, simpler, and cheaper administrative commission procedure, similar to that which now operates in connection with workmen's compensation. In providing modest but, presumably, adequate compensation for all motor vehicle injuries, this plan definitely comes closer to complete distribution of automobile losses. There are possibilities of savings beyond those of the present system of court settlement for disputed claims. And since a compensation schedule would limit the amount of any one claim, some relief would be given to a condition the insurance industry has considered to be a problem—large jury awards. There is no perfect solution to the automobile accident problem, unless it be elimination of all accidents, and, of course, this is not possible. Beyond that, automobile compensation seems to offer the most likely way to reduce to a minimum the economic consequences of these accidents. If this is true, the industry is hindering progress by its dogmatic stand in opposition to all but security-responsibility methods. In the post-World War II period, two quite different sources have summed up the automobile accident situation with remarkable clarity: . . . Action must and will be taken in the near future. . . . It will be futile if not fatal to any group or interest, insurance carriers, automobile dealers, manufacturers, or others to attempt selfishly to prevent or unduly delay action in the purported hope of a perfect solution. In the absence of a compensation plan, it would appear that improvement in the present method of assessing damages by a more accurate and speedy determination of liability and of the amount of damages is imperative. Reallocation of costs resulting from compulsory insurance and improvement of administration of the liability should not be confused with the idea of increasing the costs. Increased cost would result only if the damages awarded exceeded the victim's loss. 57 Even if the present system improves, it is not likely to be permanent, but rather to yield to a system of full social insurance with the government playing a role at least as important as that which it plays in workmen's compensation. T h e question of how long the present system will endure is " A l b e r t H. Mowbray, Insurance (3d ed.; New York: McGraw-Hill Book Company, Inc., 1946), p. 602.

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likely to depend on how progressive and far-sighted the insurance companies are, and on the success of such legislative half-way measures as compulsory insurance, financial responsibility laws, and the like. 5 8

Accident and Health Insurance The final area chosen for examination under the topic of industry progress in product and service has caused perhaps as much discussion as multiple-line insurance and automobile insurance combined. Insurance industry journals are packed with material praising, exhorting, and apologizing; legislative committee hearings and reports amount to many volumes; and regulatory bodies seem to find more work here than in any other field of insurance. We are concerned with insurance designed to provide protection against the expenses and income losses of accident and illness. Problems arise concerning how to achieve widespread prepaid insurance protection,59 and, in so doing, to make provision for preventive medicine and for the expansion of health personnel and facilities. Insurance protection is provided by commercial insurance, nonprofit plans such as Blue Cross for hospital care and Blue Shield for medical care, and by governmental programs.60 Our problem is to evaluate what commercial insurance, particularly nonlife insurance, is contributing to progress in this area. 61 68 James, "Accident Liability Reconsidered: T h e Impact of Liability Insurance," p. 570. 69 T h e protection will be mainly for medical care and loss of income as a result of nonoccupational causes. Occupationally connected medical expenses and loss of income have been handled by workmen's compensation statutes in force in all states and territories (nonoccupational cash sickness benefits are being paid in four states). However, the coverage afforded by these laws is incomplete, and the maximum amounts payable, especially under loss of income provisions, are woefully low. Thus there is a need for increasing the scale of benefits here, or supplementing them by additional prepaid insurance. See Harold A. Katz and Estelle M. Wirpel, "Workmen's Compensation 1910-1952: Are Present Benefits Adequate?" Insurance Law Journal, No. 362 (March, 1953), 166-173, for a description of how the relationship between the maximum loss of income benefit payable per week and what has steadily declined in both dollar and real terms since the inception of most acts in the first two decades of this century. See also Alfred M. Skolnick, "Trends in Workmen's Compensation: Coverage, Benefits, and Costs," Social Security Bulletin, X X I (August, 1958), 4-16; and Katz, op. cit., 519-528. ""Agnes W. Brewster, "Voluntary Health Insurance and Medical Care Expenditures, 1948-1958," Social Security Bulletin, X X I I (December, 1959), 3-4. 61 For discussions of the varied aspects and problems of medical care, loss of income, and public and private health insurance in the United States, see three articles by Herman M. Somers and Anne R . Somers: "Private Health Insurance Part I: Changing Patterns of Medical Care Demand and Supply in Relation to Health Insurance," California Law Review, X L V I (August, 1958), 376-410; "Private Health Insurance Part I I : Problems, Pressures and Prospects," Ibid., X L V I (October, 1958), 508-557; and " T h e Interrelationships of Public and Private Health and

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T A B L E 10 PERSONS PROTECTED AGAINST HOSPITAL E X P E N S E S , SURGICAL E X P E N S E S , REGULAR M E D I C A L E X P E N S E S , AND L o s s OF INCOME BY PRIVATE INSURANCE

1955 AND 1958»

Type of protection

Hospital expense Surgical expense Regular medical expense Loss of income

Persona protected (in thousands) 1955

1958

107,662 91,927 55,506 30,344

123,038 111,435 75,395 31,670

SOURCES: Health Insurance Council, The Extent of Voluntary Health Insurance Coverage in the United States as of December 81, 1955, and The Extent of Voluntary Health Insurance Coverage in the United States as of December 31, 1968. ® Data are for the end of the year.

Table 10 shows the number of persons protected by private accident and health insurance in two recent years as reported by the Health Insurance Council, a parent association of accident and health trade associations. A large proportion—perhaps three-fifths—of these persons secured their insurance coverage through an employee benefit plan of some sort, paid for in full or in part by employers.62 Ninety-six per cent of the hospital, surgical, and medical expense coverage was provided by insurance companies and Blue Cross-Blue Shield organizations; independent plans—industrial, community, consumer-sponsored, private group clinics, and college health plans—provided the remainder. Table 11 shows how hospital, surgical, and medical expense protection was distributed among insuring organizations. Loss of income insurance is not written by the nonprofit Blue CrossMedical Care Programs," Labor Law Journal, X (July, 1959), 468-474. See also Markley Roberts, Trends in the Supply and Demand of Medical Care, U.S. Congress, Joint Economic Committee Study Paper No. 5 (Washington: U.S. Government Printing Office, 1959); and Joseph W. Garbarino, "Price Behavior and Productivity in the Medical Market," Industrial and Labor Relations Review, XIII (October, 1959), 3-15. M Somers and Somers, "Private Health Insurance Part I," p. 378. For summary of the pattern of health insurance growth in the United States, see Roberts, op. cit., p. 58.

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TABLE 11 DISTRIBUTION OP HOSPITAL, E X P E N S E , SURGICAL E X P E N S E , AND REGULAR MEDICAL E X P E N S E PROTECTION AMONG T Y P E S OP INSURING ORGANIZATION

1955 AND 1958® Percentages provided Type of protection

Hospital Surgical Regular medical

Insurance companies

Blue CrossBlue Shield

Independent plans

1955

1958

1955

1958

1955

1958

52 57 42

54 57 44

44 39 50

42 38 49

4 4 8

4 5 7

SOURCE: Health Insurance Council, The Extent of Voluntary Health Insurance Coverage in the United States as of December 31, 1955, and The Extent of Voluntary Health Insurance Coverage in the United States as of December 31, 1958. ' Data are for the end of the year.

Blue Shield groups. In addition to the 31,670,000 individuals listed as being covered by insurance companies for this hazard at the end of 1958, 1,200,000 persons are reported as covered by union-administered plans and employee mutual benefit associations.63 Also, nine million persons are estimated to be covered against loss of income by paid sick-leave provisions of either private or public employers.64 Beyond the private programs there are a wide variety of governmental plans—federal, state, and local—providing for hospital and medical care or payments for income loss incurred through sickness or disability. Some of these are merely prescribed by statute, with private companies providing the insurance coverage in most cases. The best example of this is workmen's compensation, which provides medical expense and loss of income payments for occupationally-con63 Health Insurance Council, The Extent of Voluntary Health Insurance Coverage in the United States as of December 31, 1958 (New York: Health Insurance Council, 1959), pp. 25-26. u Ibid., and Alfred M. Skolnick, "Income-Loss Protection Against Short-Term Sickness: 1948-1958," Social Security Bulletin, XXIII (January, 1960), 6-7. Of this nine million persons, 3,200,000 are reported to be covered by formal private industry sick leave plans. Barkev S. Sanders, "Health Insurance for Workers and Their Families," in W. S. Woytinsky, Employment and Wages in the United States (New York: The Twentieth Century Fund, 1953), pp. 217-218, feels the number of persons in private industry with appreciable sick-leave protection against wage loss is overestimated,

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65

nected disability. A few states recently enacted laws to extend some benefits to workers with nonoccupational disabilities.66 There are four federal medical care programs for civilians: provisions for merchant seamen enacted in 1798 and resulting in the marine hospitals and the Public Health Service; provisions for war veterans; provisions for railroad employees; and provisions for dependents of members of the armed forces.67 State and local governments provide medical care for certain categories of the chronically ill and the medically indigent. 68 Some rough conception of the magnitude of total governmental aid may be obtained from estimates supplied by Sanders. He estimates the total loss for the entire population in 1949 due to medical expenditures and loss of earnings from nonoccupational total disability to be $24.9 billion. Total indemnity payments from all sources were estimated as $1.9 billion, or 7.5 per cent of the loss. Thirty-eight per cent of this was paid by federal, state, and local governmental agencies, 33 per cent by commercial insurance, and 29 per cent by Blue Cross-Blue Shield and other nonprofit programs. 69 Since 1946, public health expenditures by federal, state, and local government units have been approximately 25 per cent of the total expenditures on health and medical care. This level of public participation represents a significant increase over earlier times. For example, in 1929 public expenditures were about 15 per cent of the total. 70 Our interest centers on commercial accident and health insurance written by nonlife insurance companies. Accident and health insurance is the one important instance where life and nonlife insurance companies provide services that are very close substitutes. Both types of carriers write the coverage. Life insurance companies write approximately three-fourths of this type of coverage; however, most of the major casualty insurance companies consider accident and health insurance an important line of insurance. Also, regulatory bodies consider companies writing only accident and health insurance as casualty companies rather than life insurance organizations for purposes of classification and regulation. * See Skolnick, "Trends in Workmen's Compensation," pp. 4-16. M Rhode Island, California, New Jersey, and New York have such provisions. In all these states except Rhode Island the insurance industry participates in the program. See Sanders, op. cit., pp. 220-222, for a complete description of these plans. "Brewster, op. cit., p. 3. 88 Sanders, op. cit., pp. 218-224. "Ibid., Appendix Table 51, p. 640. These figures do not include occupational losses or payments; Sanders estimates that 95 per cent of our health hazards are nonoccupational. Ibid., p. 204. 70 Roberts, op. cit., p. 50.

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POSSIBLE CONTRIBUTION OF H E A L T H INSURANCE

Family or individual budgeting for accident and health hazards has little value. Even though national averages may indicate expenditures of 4 to 5 per cent of disposable personal income for medical outlays, an individual cannot predict what his expenses will be.71 Budgeting is even more difficult today than formerly, for major advances in medicine have made medical care more costly and yet more indispensable precisely because it can accomplish more.72 The Magnuson report,73 probably the most important study of the financing and organization of medicine in the last two decades, proposed that the basis for judging whether private prepayment plans meet the people's health needs should be how well they meet the following criteria:74 (1) Provide protection against the entire cost of personal health services. This would not preclude the use of a deductible provision to eliminate small expenses, but it would include preventive services, diagnosis, treatment, and rehabilitation in and out of the hospital.75 (2) Provide protection such as that just described for all those gainfully employed in the economy and their dependents. "Gainfully employed" would be interpreted to include workers in small groups, the self-employed, and rural workers. (3) Provide services in a way which leads to maximum efficiency in the use of personnel and facilities, and allows continued development of health personnel and facilities, both in quantity and quality. (4) Recognize responsibility to the public interest. Ordinarily this would mean inclusion of consumer representatives in policy-making groups and, the commission says, "in numbers at least equal to that given representatives of groups providing the services." 76 71 Private expenditures for medical care and health insurance have edged upward from 4.0 per cent of disposable personal income in 1948 to 5.2 per cent in 1958. Brewster, op. cit., p. 4, Table 1. " F o r a summary of the scientific revolution in medicine, see Somers and Somers, "Private Health Insurance Part I," pp. 380-382. 73 President's Commission on the Health Needs of the Nation, Building America's Health (5 vols.; Washington: U.S. Government Printing Office, 1952-1953). 71 Ibid., I, pp. 43-44. 75 Jerry Voorhis, testifying before the U.S. Congress, House Committee on Interstate and Foreign Commerce, Hearings, Health Inquiry (Voluntary Health Insurance), 83d Cong., 2d Sess., 1954, Part 6, pp. 1756, 1773, emphasized that there are two parts to the problem of health for the people: (1) preventive care, that is, health education, health examinations, and preventive medicine, and (2) coverage for catastrophic illness. T h e two are inseparable, for catastrophes cannot be handled economically without preventive care. 7a President's Commission on the Health Needs of the Nation, op. cit., I, p. 44.

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As the nonlife insurance companies are presently constituted in the United States, it is difficult to visualize an operational plan wheieby consumers could take part in health insurance decision making to any appreciable extent. Responsible consumer opinion would undoubtedly help to clarify problems concerning what consumers want and vhat the private insurance industry may supply. Private, nonprofit orepayment plans, such as Blue Cross, could more easily arrange for tonsumer representation. Some of these plans are doing so now. The o:her standards do not seem unduly onerous. Full exploitation of the potentialities of insurance in this area appears to require that the) be quite closely approached. What is the insurance industry contributing to this problem? 7' In terms of numbers alone, a large variety of coverages are offered, and they are being supplied to a steadily increasing percentage of the population. At the end of 1958 more than 70 per cent of the population had some medical care insurance protection. 78 Slightly nore than half of this protection is provided by insurance companies, the rest by nonprofit plans. 79 Insurance industry members are proud of their part in this.80 Many of them readily admit, however, that a great deal of this growth may have been a result of the increased secu ityconsciousness which grew out of the decade of the 1930's and the social legislation of that time. 81 " T h e discussion will include accident and health insurance as written by ooth life and nonlife companies, for there is no way to distinguish between them ejcept on the basis of volume of writings. This is divided about three to one in favir of life companies, so they must bear at least an equivalent share of the responsilility for performance in this field of insurance. re Roberts, op. cit., pp. 56-57. See Table 8, this chapter, and Brewster, op. cit., p. 5, Table 3. 80 A not unusual statement is that of Edwin J. Faulkner, a company execitive, before the U.S. Congress, House Committee on Interstate and Foreign ComnErce, Hearings, Health Inquiry, Part 6, p. 1321: "It is doubtful that American annals record a more amazing record of grtwth and service than that of accident and health insurance. When the twentieth century dawned there were some 47 companies in the business with some 461,000 policies in force. Today approximately 600 insurers are active in providing accilent, health, hospital, and medical expense insurance to more than 51 million insireds under group and individual hospital policies and more than 29 million insireds under group and individual loss of income contracts. This growth has been pralleled by a continuing improvement in the degree of the protection provided." Examples of recent articles by the director of Information and Research, H;alth Insurance Association of America, commending the industry are: J. F. Follnan, "Some Medico-Economic Trends," Journal of Insurance, XXVII (June, 1960), 4i-58; and "New Frontiers," Best's Insurance News, LXI Life ed. (April, 1961), pp. 6i-71. 81 For discussions of the influence of government participation in health progams on private insurance, see James Powell, "Another Round in Compulsory A ard H

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Laudable as it may be, sheer growth does not indicate whether the industry is making the maximum possible contribution to progress in distributing the losses from personal accidents and ill health. We need to look at how many remain unprotected, and whether they can be brought under insurance protection by private companies. Perhaps most important of all, we need to look at the quality of the protection being provided. What part of the losses being incurred does it cover? Is any contribution being made to preventive care? Is any contribution being made to economical and efficient use of medical resources? Is any contribution being made to the expansion of medical resources? Finally, is the industry hindering development in areas where it may never be able to fulfill the needs of the people by its general opposition to all public programs except local stopgap measures. At the end of 1958 approximately 29 per cent of the civilian population had no health insurance protection. 82 What proportion of these are potentially insurable is not known. Many factors influence the ownership of health insurance. Some of the more important are: underwriting practices of insurance carriers; and individual or family characteristics such as employment status, family income, age, level of education, residence—rural or urban—and level of average medical needs. Frequently these factors overlap. Those without health insurance are apt to be characterized by periodic lack of employment, low income, advanced age, below-average education, rural residence, and above-average medical needs.83 Some suggestion of the importance of income levels for the ownership of insurance may be obtained from Table 12, which shows ownership of hospital expense insurance by income groups for fiscal 1953. The ownership of hospital expense insurance is much less common among those with family incomes of less than $4,000. The budgets of these groups may seriously restrict further purchase of health insurance protection at present premium levels. Furthermore, many of these lowincome units are composed of individuals of advanced age who are likely to have above-average medical needs. The proportion of families Fight," The Spectator, CLXII (June, 1954), 36-37; Roger Kenney, "Public Relations Problem of Accident and Health Industry Far from Solved," United States Investor, February 13, 1954, p. 13; and Somers and Somers, "Private Health Insurance Part II," pp. 552-554. 83 Ibid., 518. By the end of 1960 the proportion of the population without insurance had apparently been reduced somewhat more, to approximately 27 per cent. Follman, "New Frontiers," p. 65. 83 See Somers and Somers, "Private Health Insurance Part II," pp. 517-519.

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12

OWNERSHIP OF HOSPITAL EXPENSE INSURANCE BY INCOME GROUPS 1 9 5 3

Family income

Persons (millions)

Per cent

$7,500 and over 5,000-7,500 4,000-5,000 2,000-4,000 Under 2,000

20 36 25 50 24

71 71 66 51 25

SOURCE: U.S., Congress, House, Committee on Interstate and Foreign Commerce, Hearings, Health Reinsurance Legislation, 83rd Cong., 2d Sess., 1954, p. 23.

and unattached individuals with personal incomes of less than $4,000 has remained almost constant in recent years at approximately 35 per cent. 84 The quality of the protection provided for those with insurance coverage is an important factor. In 1958 the estimated private expenditure for medical care was $16.4 billion. 85 Table 13 summarizes the distribution of these outlays and indicates the role of private insurance benefits.88 In addition to the expenditures listed in Table 13 for medical care, accidents and ill health cause income losses. Sanders estimates that the wage loss from temporary and permanent total nonoccupational 84 Selma F. Goldsmith, "Income Distribution by Size—1955-1958," Survey of Current Business, X X X I X (April, 1959), Table 2, p. 11. 66 Brewster, op. cit., p. 4, T a b l e I. M Follman, "New Frontiers," p. 66, argues that it is misleading to relate insurance benefits paid to the total private expenditures for medical care, because the total "includes many medical costs which are inconsequential to the individual or family, nonmedically dictated, optional or luxury in nature or which can hardly be considered medical care at all." Follman then suggests that benefits paid should be related to the covered medical expenditures of insured persons. If this is done, 75 to 96 per cent of hospital expenditures and 62 to 84 per cent of surgical expenditures are covered. Clearly the latter relationship is more favorable to the industry, b u t one may have reservations about judging the significance of medical outlays by whether or not they are covered by insurance. One of the criteria suggested by the President's Commission on the Health Needs of the Nation, op. cit., I, pp. 43-44—that the private plans should be judged by the extent to which they provide protection against the entire costs of health services (except for deductibles to eliminate small expenses) including preventive services, diagnosis, treatment, and rehabilitation—would appear still to be valid. W h a t proportion of total expenditures falls outside these categories, and is thus insignificant, is difficult to say.

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T A B L E 13 PRIVATE E X P E N D I T U R E S FOB M E D I C A L C A R E : DISTRIBUTION AND PROPORTION COVERED BY PRIVATE H E A L T H INSURANCE 1 9 5 8

Type of expenditure

Hospital Medicines and appliances Physicians Dentists Other Total

Amount (millions) $ 5,102 4,362 4,290 1,674 969 $16,397

Percentage distribution 31.1 26.6 26.2 10.2 5.9 100.0

Met by private health insurance Amount

Per cent

$2,591

50.8

1,286

30.0

a a a

$3,877

23.6

SOURCE: Agnes W. Brewster, "Voluntary Health Insurance and Medical Care Expenditures, 1 9 4 8 - 5 8 , " Social Security Bulletin, X X I I (December, 1 9 5 9 ) , 3 - 9 . • Some other benefits contribute to this service, but amounts cannot be identified.

disability in 1949 was $11.9 billion. Five per cent of this loss was paid by insurance. 87 He estimates that an additional wage loss of $10 billion was caused by partial disability. Data are not available on the part of this reimbursed by insurance, but it was undoubtedly less than that for total disability. 88 The Social Security Administration has estimated income loss from nonoccupational short-term sickness89 to have been $4.4 billion in 1949 and $7.5 billion in 1958. In these years private insurance benefits were $321.8 million, or 7.3 per cent of the loss, and $883.0 million, or 11.8 per cent of the loss, respectively.90 Wage loss from occupational disability is considerably less than that from nonoccupational disability. The estimated loss in 1949 from workconnected injuries was $2 billion. Some half of this represented time lost by those subject to federal and state workmen's compensation laws.91 For this group, the estimated proportion of loss compensated by benefit payments was 30 per cent for all injuries. If compensation 87

Sanders, op. cit., Appendix Table 51, p. 640. Ibid., pp. 204-205. 89 Short-term sickness is defined as short-term or temporary non-work-connected disability (lasting not more than 6 months) and the first 6 months of long-term disability. Skolnick, "Income Loss Protection Against Short-Term Sickness: 19481958," p. 4. 90 Ibid,., pp. 4-6. "Sanders, "Protection Against Work Injuries," in Woytinsky, Employment and Wages in the United States, p. 186. 88

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payments are related to the loss of all injured workers, whether subject to workmen's compensation laws or not, the ratio of estimated benefits to incurred losses becomes 22 per cent. 92 Workmen's compensation benefit schedules have been liberalized during the 1950's, but they still cover less than two-fifths of the total wage loss caused by occupational disability. 93 Whether one considers the purpose of accident and health insurance to be protection against the costs of catastrophic disability or protection against all costs of disability, much of the insurance offered is quite limited. 94 Testifying during the House of Representatives health hearings in 1954, Dr. Paul B. Magnuson, Chairman of the President's Commission on the Health Needs of the Nation, said: . . . During its [the Commission's] year of deliberations, we heard more than 800 witnesses, and most of them were severely critical of the limited coverage offered by present insurance plans. . . . T h e growth of private health insurance in the past two decades is deeply gratifying, but it must broaden its sights in the coming years. 95

Until recently, the most rapid expansion of private health insurance has occurred in the areas of hospitalization and surgical cost insurance;98 even here, however, protection is often inadequate. In particular, the duration-of-coverage limitations found in typical contracts may restrict or terminate coverage when it is needed most. 97 m

Ibid., p. 201. Skolnick, "Trends in Workmen's Compensation," p. 12. For further discussions of workmen's compensation benefits, see Arthur H. Reede, Adequacy of Workmen's Compensation (Cambridge, Mass.: Harvard University Press, 1947); Somers and Somers, Workmen's Compensation, pp. 38-92; Katz, op. cit.; Earl F. Cheit, "Benefit Levels in Workmen's Compensation," Monthly Labor Review, LXXXI (July, 1958), 723-730; and Herman M. Somers, "Myth and Reality in Workmen's Compensation," Workmen's Compensation Problems, Bulletin 192, U.S. Department of Labor, Bureau of Labor Standards, 1956, pp. 18-31. M Workmen's compensation benefits are set by statute, so inadequacies in this area are the primary responsibility of federal and state legislative bodies rather than the insurance companies which are providing the coverage. M U.S. Congress, House Committee on Interstate and Foreign Commerce, Hearings, Health Inquiry, Part 6, p. 1499. M A new type of commercial insurance, known as major medical insurance, is currently growing more rapidly than any other type of health insurance. Health Insurance Council, The Extent of Voluntary Health Insurance Coverage in the United States as of December 31, 1958, pp. 19>-22; and Somers and Somers, "Private Health Insurance Part II," pp. 527-528. Initially the industry reacted slowly to the demand for major medical expense insurance; but when it became evident that there was a large market for this type of coverage, companies scrambled to provide it. 97 Representative John W. Heselton, Committee on Interstate and Foreign Commerce, said in regard to hearings on health insurance before that committee: "We have heard of thousands and thousands of cases where the person of moderate w

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Inadequate loss payments may be explained by a variety of factors, not all of which the insurance companies are in a position to control. If the full loss is covered in each case, the cost will be greater than for partial coverage, and many people might be unable to purchase any insurance at all. 98 Unless offsetting economies or productivity gains are realized, this will be even more true of comprehensive health insurance plans that provide essentially complete protection against all health hazards as well as preventive care. Significant opportunities for increases in efficiency and productivity appear to be available if insurers and suppliers of medical services are willing to adopt the necessary institutional rearrangements." About 5 per cent of the population are enrolled in these comprehensive plans.100 Another obstacle to full coverage of individual losses is the practice of setting fees for medical service, when insurance is involved, at a level which exceeds the insurance payment by some traditional or generally accepted amount. 101 Expansion of benefits, both to additional hazards and to larger proportions of losses caused by hazards presently covered, is within the control of the insurance industry. Benefit expansion of the latter type depends primarily on reductions in company expense ratios or profit margins to allow policyholders larger premium returns in the form of claim payments.102 Plans to distribute losses from health hazards must also consider preventive care and allocation and efficient use of medical facilities, as well as their maintenance and expansion. One student of health means after 13 weeks or 26 weeks or whatever period they are covered, after the benefits have been exhausted is simply up against a problem and has to rely on something like the infantile paralysis fund, if that disease is involved, or he has to throw himself on charity." U.S. Congress, House Committee on Interstate and Foreign Commerce, Hearings, Health Inquiry, Part 6, p. 1235. " E l i Ginzberg, " W h a t Every Economist Should Know About Health and Medicine," American Economic Review, X L I V (March, 1954), 114, notes that the President's Health Commission found that health insurance plans were falling short of their objectives largely because many people were unable to pay the premiums. Insurance companies emphasize that, contrary to general belief, they offer benefits substantially larger than those usually purchased. Irving Davis, " T h e Medical-Care Report—A Summary," The Spectator, X V I I (September, 1951), 20. 89 Somers and Somers, "Private Health Insurance Part II," pp. 534-538. 100 Ibid., p. 518. Seymour E. Harris, " W h a t Every Economist Should Know About Health and Medicine: Comment," American Economic Review, X L I V (December, 1954), 926, feels the opposition of the American Medical Association to comprehensive prepayment health plans has been a crucial factor in their slow growth. 101 Ibid.; Somers and Somers, "Private Health Insurance Part I I , " pp. 533-534; and Follman, "Some Medico-Economic Trends," p. 56. 102 See William B. Cornett, Address before the Accident and Health Club of New York, October 3, 1951, reported in Weekly Underwriter, October 6, 1951, p. 828.

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insurance problems has said that under commercial insurance, Preventive medicine is ignored as the whole emphasis is placed on treatment of sickness or injury." 1 0 3 In reply, insurance companies' representatives assert that diagnostic benefits are available as part of the medical expense line of insurance. 104 Nonetheless, it seems to be true that the bulk of the commercial accident and health insurance ¡old carries few provisions for preventive care. 105 This fact is especially important, for neglect of preventive measures can only lead to consequent increases in serious illness. T h e long-run gains from thoroughgoing practice of preventive medicine are not readily estimable, but they are felt to be large. 106 Certainly the inclusion of preventive services will increase costs initially, but in later years markedly lower costs nay result. 107 Commercial insurance has a mixed influence on the allocation ind use of medical personnel and facilities. If it leads to more intensive use of resources, the effects may be beneficial for the community, up to the point of overutilization of capacity where costs rise sharply or the quality of services deteriorates. Of course, if medical resources are already inadequate, then more intensive use might be expected to result eventually in an increased supply of such resources. 108 However, social capital, such as hospital and medical school facilities, responds slowly, if at all, to market forces. Thus public assistance of some sort probably will be needed before any appreciable expansion of facil ties will result. 109 T h e present pattern of health insurance may also lead to a distortion of medical resource use. Since hospitalization insunnce is the typical coverage held, there is a tendency for services, wlich 103 Franz Goldmann, Voluntary Medical Care Insurance in the United States (Mew York: Columbia University Press, 1948), p. 77. 101 See Davis, op. cit., p. 20. 106 Ibid. 1M See U.S. Federal Security Agency, Social Security Board, Need for MedicalCare Insurance, Bureau of Research and Statistics Memorandum No. 57, 1944, p. 1. t m See Goldmann, op. cit., p. 195. 108 Most studies conclude that there is a shortage of medical resources in the United States in terms of what is needed to provide reasonably adequate cart for the entire population. Probably there is also a shortage in terms of the abiliy to provide the care demanded by those who can afford to purchase the medical-dental care they wish to buy on the common fee-for-service basis. See, for example, U.S. Congress, House Committee on Interstate and Foreign Commerce, Hearings, Hialth Inquiry, Part 1; President's Commission on the Health Needs of the Nation op. cit., Vol. I; Harris, op. cit., pp. 922-928; Roberts, op. cit., pp. 65-76; Somers and Somers, "Private Health Insurance Part I," pp. 395-397, 409, and "Private Healti Insurance Part II," p. 557. Cf. Eli Ginzberg, "Reply," American Economic Review, XLIV (March, B54), 929-931, who feels that the existence of a shortage has not been shown. 109 Harris, op. cit., pp. 923-928.

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ordinarily could be provided in the home or doctor's office, to be performed instead in the hospital.110 There is also a waste of resources involved in the patchwork of insurance coverages that has developed in the rapid expansion of the past two or three decades. Claims adjusters indicate that the extent to which duplication and overlapping exist is not sufficiently appreciated.111 Further development of comprehensive medical service coverage would eliminate much of this inefficiency. The saving would be an appreciable contribution to more extensive insurance. EVALUATION OF COMMERCIAL HEALTH INSURANCE

Commercial accident and health insurance has contributed a great deal to bringing some insurance to a great many people. Yet more than one-fourth of the population is still without insurance. And those who have insurance have transferred only a portion of their risk of loss— usually limited hospital expense and surgical costs. The cost of coverage may also be high in terms of the proportion of total premiums allocated to insurance company expenses. This is especially true of individual policies, for such contracts typically return only about 50 per cent of the premium to the policyholder as loss payments. Group policies, however, appear to return about 90 per cent to the policyholder.112 There has been a steady movement toward group insurance.113 This is a beneficial trend, for it means more liberal contracts and cheaper insurance.114 Here seems to be the best way for commercial health insurance to achieve its maximum potential, particularly if group coverage evolves into widespread prepayment service plans coupled with n0 President's Commission on the Health Needs of the Nation, op. cit., V, p. 412; and Somers and Somers, "Private Health Insurance Part I," p. 392. 111 President's Commission on the Health Needs of the Nation, op. cit., V, pp. 411-412. See also Follman, "Some Medico-Economic Trends," p. 56. 113 Brewster, op. cit., p. 8, Table 5. ua Somers and Somers, "Private Health Insurance Part II," pp. 510-511. 111 Group insurance does not necessarily mean adequate low-cost benefits for all. For example, the following statement by an insurance industry member points to the need for additional extensions of coverage under the typical group plan: "One reason for the widespread adoption of group insurance plans has been their low cost. This low cost has been possible because the plans do not, for instance, protect the retired employees, or in many cases, the dependents of workers. Sooner or later we must face this issue of low cost versus adequacy. It seems to me that we must concentrate on two of these shortcomings in our present insurance coverage. T h e first is the chronically ill. T h e second is the excessive duplication, the overlapping, and the gaps in the different kinds of coverages which are now issued." Murray D. Lincoln, quoted in President's Commission on the Health Needs of the Nation, op. cit., V, p. 411.

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the group practice of medicine. The pressures are in this direction.115 This possibility was summarized by Goldmann as follows: T h e r e is a unique chance for voluntary medical care insurance to make real progress within its natural limitations, to help tens of millions of selfsupporting people develop the capacity and opportunity to lead personally satisfying and socially useful lives. It lies in the combination of group prepayment and group practice, wherever feasible, and in the inclusion of comprehensive professional services and hospitalization in one p r o g r a m . 1 1 6

This means movement toward group contracts providing comprehensive care and group practice of medicine centered on modern hospital facilities for both in-patient and out-patient care.117 The insurance industry can assist in this development by shifting its emphasis from indemnity insurance to comprehensive service insurance. The latter form of coverage tends to encourage group medical practice oriented around hospital facilities, and closer cost and quality control of medical services. Indemnity insurance underwrites and tends to encourage single fee-for-service medical practice. This approach has failed to exploit fully the opportunities for cost control, economies of large-scale organization, and improvements in productivity.118 Several of the larger comprehensive plans are insuring families against as much as three-fourths of their annual medical care costs, for premiums of about $150 to $180 per year. Typical indemnity plans insure against approximately one-fourth of annual family medical outlays for premiums of about $110 to $115 per year.119 This experience seems to demonstrate the economic feasibility of comprehensive service insurance for a large part of the population, as well as the existence of cost savings.120 The quality of the medical care provided under the comprehensive service plans is perhaps even more important than the cost. Quality is difficult to measure, but studies that have attempted to do so have been generally favorable to the comprehensive plans.121 Group medical practice, hospital center organization, emphasis on preventive care, and 116 See Somers and Somers, "Private Health Insurance Part I," pp. 395-405, and "Private Health Insurance Part II," pp. 524-527. UB Goldmann, op. cit., p. 203. 117 President's Commission on the Health Needs of the Nation, op. cit., I, p. 22; and Somers and Somers, "Private Health Insurance Part I," pp. 403-405. See also Foilman, "Some Medico-Economic Trends," p. 55. 118 See Somers and Somers, "The Interrelationships of Public and Private Health and Medical Care Programs," pp. 470-472. 119 Somers and Somers, "Private Health Insurance Part II," pp. 534-536. 130 Ibid., pp. 536-538. 121 Ibid., pp. 540-542.

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similar features of comprehensive care plans are thought to promote quality service.122 Finally, assuming private insurance is able to bring a reasonably adequate program to the majority of the self-supporting within a few years, what is to be done for those who still will not have health insurance? Private insurance cannot be expected to protect those who are medically indigent. These people are going to require public assistance. 123 From a social standpoint the cheapest way to achieve the widest distribution of loss for these, and for all of the population, would be some form of national health insurance. 124 Within the context of a system retaining a private sector for health insurance, what are the alternatives to cover those who cannot afford to purchase insurance? T h e industry generally maintains that these people are the burden of the state and local community, and the federal government should not set standards, subsidize, or attempt to bring this group within the orbit of those to be covered by insurance, for this would lead to compulsory insurance with government subsidy and control. 123 T h e industry position is probably partly a propagandist device and partly a reflection of its fear of public action. T h e insurance industry does not seem to appreciate that public and private programs can be mutually supporting, despite the assistance that private insurance has received from the national social security program, 126 T h e industry may indirectly hamper the achievement of maximum health for the entire population by its refusal to cooperate closely with public forces. Private opposition to all that is public could ultimately lead to replacement of the private by public. 127 Ibid. U.S. Congress, House Committee on Interstate and Foreign Commerce, Hearings, Health Inquiry, Part 6, p. 1501. 121 See statement of Emily H. Huntington, President's Commission on the Health Needs of the Nation, op. cit., V, p. 420. 125 j o r example, Powell, op. cit., p. 76. See also Follman, "Some Medico-Economic Trends," p. 50. How many individuals are medically indigent is not known. T h e President's Health Commission said, "The number of patients who receive all or part of their medical care through charity or public assistance is very high. . . . There are many more who get inadequate care or no care at all when they need it." President's Commission on the Health Needs of the Nation, op. cit., I, p. 43. 120 Somers and Somers, "The Interrelationships of Public and Private Health and Medical Care Programs," p. 471. For a succinct statement of how we have failed throughout the economy to take advantage of the mutually supportive nature of public and private actions, see Horace M. Gray, "Private Affluence and Public Poverty," Illinois Business Review, XVI (September, 1959), 6-8. 127 For discussions of the initiation of a system of public hospitalization insurance in Canada at a time when private insurance roughly paralleled that in the United States, see Agnes W. Brewster, "Canada's Federal-Provincial Program of Hospitalization Insurance," Social Security Bulletin, X X I I (July, 1959), 12-16; and W. Douglas 122

123

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Kenney notes, ". . . The great and pressing job now facing private enterprise [in accident and health insurance] is to prove that it isn't a selfish and premium-hungry squatter on a governmental preserve." 1 2 8 Summary

of Progress

in Product

T o assess the development of insurance coverages, three fields were examined. These fields were selected because they are currently receiving the most attention from buyers, insurers, and regulatory bodies. Perhaps what the industry is doing there best characterizes its response to changing conditions. One of these areas of insurance, multiple-line underwriting, represents largely new coverages and practices for the American property and casualty insurance industry. The other two fields represent problem areas that exhibit increasing public recognition of the benefits of widespread distribution of loss. In automobile and health insurance we see the industry's reaction to demands that insurance be made available, perhaps even compulsory, for all. The industry's response in the multiple-line area has been slow and cautious. More than a decade after it was first considered, some companies have shown vision in developing a variety of multiple-peril policies. Little has been done in developing true all-risk coverages. 129 Legislative restrictions, in particular the strict rate-regulatory laws, have hampered change. Also important is the opposition of a significant part of the industry that advocates caution to avoid undermining established rates and procedures. There is a long way to go before the full potentialities of multiple-line powers are realized. In the areas where so many of the aspects of social insurance are present—automobile and accident and health—the industry has continued to provide more insurance and better insurance. Two types of exogenous forces have contributed to the great expansion of private insurance: the stimulus of legislation and threatened legislation; and the expansion of demand from such forces as increased security-consciousness, growth of organized labor and collective bargaining, management's increasing emphasis on human relations in industry, and technological advances in medical care. The industry can be criticized Bell, " C a n a d a : H e a l t h Plans Nationalized," The Spectator, C L X V I I (June, 1959), 42-43, 80. ^ K e n n e y , " P u b l i c Relations Problem o£ Accident and H e a l t h Industry Far from Solved," p. 13. See William D. Winter, " T h e Multiple L i n e Concept," in New York State Insurance Department, Examination of Insurance Companies (New York: New York State Insurance Department, 1953), I, p p . 527-564, reprinted in H . Wayne Snider, ed., Readings in Property and Casualty Insurance, p p . 89-116.

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for promoting the belief, or at least allowing it to persist, that private insurance can do nearly everything in these areas, and for opposing virtually all public measures. As the economy expands and matures, such traditions as the law of negligence and voluntary insurance are likely to be deemed unacceptable solutions in certain areas. If the insurance industry cooperates in seeking new solutions, it should be able to assist in implementing whatever answer is selected. In terms of striking any net balance on substantive progress in the industry, the conclusion is evident that changes have been made slowly. Many of the changes that have been made seem to be a result of the insistent demands of insurance buyers or the public, rather than independent action by the industry. One could reasonably expect more from the industry. Contract, Procedural,

and

Administrative

Changes

In this section we will examine progress in terms of those changes which reduce cost or increase understanding and satisfaction but ordinarily do not alter the coverage afforded by the contract. T h e discussion will be divided into two parts: those changes which operate mainly to reduce costs, and those which increase understanding and satisfaction without reducing cost, and perhaps even raising it. COST-REDUCING

INNOVATIONS

Techniques which have led to reduced costs for the specialty insurance companies are continuous policies, direct billing, and cash-in-advance sales. 130 Each of these will be discussed in turn. Selling through exclusive agents or salaried employees has also reduced costs. This will be examined in chapter viii along with other aspects of selling costs. Continuous contracts offer an appreciable savings in cost, and they eliminate the possibility of an inadvertent lapse in coverage. 131 The principal opposition to this type of contract comes from independent insurance agents and brokers. They feel this will increase the difficulty of shifting coverage from one agent or broker to another. They speak of rigidity being introduced in this way. 132 However, as long as con180 The term "specialty company" is applied to insurers specializing in one or a few lines of insurance, usually automobile or fire, and selling directly to the consumer rather than going through independent agents or brokers. m Segregated statistics indicating the magnitude of any such saving are not available. But it is felt that elimination of a renewal policy on each anniversary date will result in a large saving in clerical time for companies and agencies, as well as a less important saving in supplies. 132 See John F. Neville, "Continuous Policies," Best's Insurance News, LIV, Fire and Casualty ed. (February, 1954), 21-23.

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tracts contain cancellation rights for both parties, there seems little basis for the fear that continuous policies will make it unduly difficult for an insured to change from one agent or company to another. Indeed, a cogent argument might be made in favor of introducing additional friction into the company-agent-customer relationship. With a large share of the consumer insurance lines being written at parallel prices by agency companies, the frequent shifts that occur may be largely fortuitous and may not result in any genuine increase in consumer satisfaction. The costs involved for the industry are real: new policy expenses, investigations, intercompany checks, and perhaps higher initial commissions for the new agent. Also, the consumer may have a product each time he shifts which is, at least temporarily, of reduced quality—for claim settlement may have some connection with the time a risk has been carried. T o make the transfer process a bit more difficult might tend to restrict its incidence to cases involving genuine utility gains. The same end could be achieved by greater consumer knowledge. Only in fidelity and surety bond coverages do the majority of carriers regularly use continuous contracts. A partial approach to the savings of continuous policies is the substitution of a renewal certificate for a renewal policy.133 There has been some movement toward the use of such certificates, but any real development has been prevented by the reluctance of insurance agents to use them. An analysis of the use of renewal certificates prepared in 1942 by the Business Development Office of the stock fire insurance companies reported: M a n y agents have stated that they e x p e r i e n c e considerable difficulty in justifying their right to c o n t i n u e d r e n e w a l commission, particularly w h e n there are n o changes to b e m a d e or particular services to be rendered from o n e renewal to the next. If a n agent occasionally has this difficulty in the case of renewal policies, renewal certificates m i g h t make his position still more difficult to d e f e n d . 1 3 4

Direct billing also offers a possibility of cost reduction. Resources would be saved by the elimination of the agent from the invoicepayment flow. This procedural change might also lead to quicker, more certain premium collection, since the buyer would view the 183

T h e New York Insurance Department found in an analysis of comparative costs that there was a saving of 71.6 per ccnt in time on each transaction by use of renewal certificates rather than policies. Thomas C. Morrill, "The Term Rule," Insurance Law Journal, No. 329 (June, 1950), 416. 134 Quoted in ibid.

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whole operation as a typical, routine billing and payment process.135 This seems to have been true for life insurance. This would reduce the cost of financing premiums up to sixty days or more by agent or company, as is now quite typical.136 Again, principal objections come from agents and brokers. Objections are based on a fear of loss of contact with the policyholder and a feeling that companies might begin to consider bypassing the agent in other respects as well, perhaps ultimately leading to his elimination altogether. Direct billing is generally not used by capital stock agency companies. Cash sales, that is, collection of premiums at the delivery of the policy, would lead to self-evident savings over a system which may unofficially finance the premium up to sixty days or more. However, those companies, largely the specialty writers, that have collected in advance have offered a six-month or a three-month continuous policy. This offsets a great amount of the saving realized by strict cash selling.137 The total savings attributable to the use of continuous policies, direct billing, and payment in advance is at least 25 per cent of the cost of the traditional agency method of handling these functions. This might be on the order of 5 to 10 per cent of the final sale price of insurance. Companies making extensive use of these techniques are selling 25 to 30 per cent below regular agency companies. However, they realize additional savings in selling costs and perhaps in the selection of policyholders.138 CLARIFYING

INNOVATIONS

Simplification and standardization of contracts lead to greater clarity in insurance. This in turn increases consumer confidence in the mechanism and results in greater satisfaction.139 135 See Roger Kenney, "A 'Heavy Summons Lies Like Lead' Upon the American Agency System!" United States Investor, February 27, 1954, p. 17. 138 Premium balances amounted to 6.2 per cent of total assets for 750 stock fire and casualty companies at the end of 1956; this amounted to $1.1 billion. T h e r e is no indication of the average time the companies carry such balances. However, agency contracts often require agents to remit to the company sixty days from the effective date of the policy. Alfred M. Best Company, Inc., Best's Fire and Casualty Aggregates and Averages (18th ed.; New York: Alfred M. Best Company, Inc., 1957), p. 50. 137 Today a great many companies offer short-term automobile policies, though many of them d o not aggressively promote such contracts. 138 See Kenney, " A 'Heavy Summons Lies Like Lead' Upon the American Agency System!" pp. 16-17. 139 See J . E d w a r d Hedges, "Improving Property and Casualty Insurance Coverage," Law and Contemporary Problems, X V (Summer, 1950), 358.

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Simplification of the insurance contract has long been advocated, particularly by the large industrial purchasers of insurance. 140 Simplification may mean a reduction in the length of some contracts, a redesigning of others to give exclusions equal prominence with insuring clauses, or in almost all instances a simplification of policy language. This latter requirement is one that is long past due. Contracts are often drawn in ponderous, obscure words and phrases. A n extreme example of this is the ocean marine policy, which contains terms dating back for centuries. 141 T h e industry justification for traditional phrasing at the expense of clarity is that certainty of interpretation has become reasonably assured as a result of innumerable court decisions. T o change the language of a contract is to invite disagreement over its interpretation. Nonetheless, a gain in clarity is needed in many areas. Some uncertainty as to just what the legal limits of coverage might become would be a small price to pay. 142 Standard contracts undoubtedly benefit the purchaser of insurance. They enable him to determine more readily what risk he is actually shifting to the insurance company. Too, they simplify loss settlement procedure, thus reducing controversy, delay, and disappointment for the policyholder. Furthermore, standard contracts enable comparisons in price to be made where such differences exist. In certain lines standard contracts have become almost universal. Examples are the individual automobile and dwelling fire policies, though one aspect of the increased competition in automobile insurance is some movement away from standardization. In some lines—notably accident and health, and some types of inland marine and casualty coverages—the heterogeneous array of contracts leads to confusion and makes comparison difficult. And if loss statistics are to be meaningful as a guide to prediction, they must be comparable or reduceable to a comparable basis. Conversely, standardization may be carried to undesirable lengths. If it is practiced completely and rigidly, it may become a vehicle for 110 For example, see "What the Critics Say," Report on the American Management Association Insurance Conference, May 5-6, 1947, New York, Journal of American Insurance, X X I V (June, 1947), 27-28; Ernest L . Clark, " A Buyer's Eye View o£ the Past Year," Insurance Buyer, V I I (August, 1951), 7; and Hedges, op. cit., p. 362. 111 See Victor Dover, Elements and Practice of Marine Insurance (London: H. F. and G. Witherby, Limited, 1951), pp. 47-133, and K. J. Flockton, The Insurance of Ships (London: Witherby and Co., Ltd., 1953), pp. 21-28. 112 Hedges, op. cit., p. 355, notes that the institutional barrier to changes in wording or terminology is especially strong among the companies working through the large bureaus; the problem of getting agreement on proposed changes has sometimes retarded improvement. Often the nonbureau or small-bureau companies have led the way.

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hampering change and competition, both price and nonprice. Moreover, the perils individuals face are not standard; there will always be a need for nonstandard or flexible contracts. A proper blend of standardization and product competition is difficult to define and, presumably, to obtain. At any one time only qualitative judgments will be possible regarding whether optimum conditions exist. At the present time there appears to be a need for an extension of standardization. 143 Contracts need simplifying and redesigning to increase clarity and understandability. In some cases it would seem desirable to sacrifice some court-tested phrases to achieve simpler contracts which would increase buyer confidence and satisfaction. Recent years appear to have brought greater attention to this problem, but there is an opportunity to do more. Standardization has moved at a faster pace than simplification. Some measure of standardization has been achieved in all lines, the least in accident and health coverages. Here, in particular, there is a need for additional uniformity. Standardization can also be a mechanism for parallel action among companies and for hindering desirable innovations. But on net balance, insurance contract standardization seems to have added more to consumer welfare than it has extracted. 118 See U.S. Congress, Senate Subcommittee on Antitrust and Monopoly of the Committee on the Judiciary, Report, The Insurance Industry, 86th Cong., 2d Sess., 1960, p. 247.

CHAPTER VIII

Industry Performance Product Variety,

III:

Capacity,

Profit Levels, and Selling Costs

T h e remaining aspects of industry performance we wish to examine are: product variety, industry capacity, profit levels, and selling costs. Each of these will be considered in turn in this chapter. Product

Variety

Variety of product is a desirable industry result if efficient consumer use is attained by the satisfactory adaptation of the array of products offered to policyholders' needs. It is difficult, however, to establish a standard for resource allocation to these purposes. Rational and irrational preferences among purchasers probably cannot be distinguished. In addition, preferences are conditioned by sales promotion. Thus any purchaser's preferences are likely to be partly his own and partly those imposed upon him. It seems impossible, therefore, to develop a norm of a desirable level of resource use in product variety which rests on the demonstrable maximization of purchaser satisfaction. However, some generalizations may be useful regarding the extent of product variety in insurance and whether or not any opportunities to improve industry performance in this respect seem to exist. Both kind and size of risks faced by members of the economy vary widely. T h e kinds of risks and the portions of them which individuals wish to eliminate vary also. This means that if the industry is to 154

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satisfy these varied demands, it must provide a substantial variety of insurance contracts and assist in fitting them to policyholders' specific needs. Some aspects of product variety were considered in the previous two chapters on progress in nonlife insurance. T h e discussion there was concerned primarily with whether the industry was developing new products at a rate to serve the economy most satisfactorily. For example, multiple-peril insurance coverages are an increase in the variety of products being offered by the industry. Variations in product clearly can be carried to undesirable limits. If differences among products are insignificant, they merely confuse, and may therefore reduce rather than increase utility for the buyer. 1 Insurance is a product about which the typical purchaser has very little knowledge. For this reason it may be more susceptible to undesirable amounts of product variation than are products that the buyer can more readily judge. 2 T h e variety of products the industry can be expected to supply is a contract for the insurable perils from which society currently considers it desirable to permit transfer of the risk of loss. For example, it might not be considered socially desirable to permit insurance against divorce, even though probability estimates of its incidence may be available. T h e industry may also be reasonably expected to provide insurance if informed judgment can be combined with some empirical evidence to give an approximation of a numerical loss probability. W e concluded in the previous two chapters, after an examination of the industry's response to the economy's changing conditions and demands, that frequently genuine product variety had not been extended as promptly or completely as would be desirable. Another aspect of product variety is the combination in which a product may be offered. T h e industry docs not sell separately every form of insurance for which it has established probability estimates and premium rates. T h o s e kinds of insurance that companies feel are going to be especially sought by some purchasers, because of their high expectation of loss, are often sold only in combination with other coverages. T h e buyer may have to purchase insurance that he does not want in order to obtain the coverage he does want. Com1 See Harvey Leibenstein, Economic Theory and Organizational Analysis (New York: Harper and Brothers, 1960), pp. 109-110, and Albert H. Mowbray and Ralph H. Blanchard, Insurance: Its Theory and Practice in the United States (4th ed.; New York: McGraw-Hill Book Company, Inc., 1955), p. 249. Mowbray and Blanchard suggest that some of the product variety in accident and health insurance may be o£ dubious value. 2 See Donald Wallace, "Industrial Markets and Public Policy: Some Major Problems," in C. J . Friedrich and Edward S. Mason, eds., Public Policy (Cambridge, Mass.: Harvard University Press, 1940), p. 112.

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panies maintain that package sales are necessary to avoid adverse selection, that is, the purchase of a particular type of insurance only by those expecting a loss. If rates are based on probability estimates of expected losses, there seems to be no reason why each type of insurance could not be sold separately to those wishing to purchase it this way. However, insurance firms maintain that buyers often do not know the most important perils they face in terms of the possibilities of large losses. Buyers want to purchase insurance against frequent small losses. This is expensive for the industry to administer, and consequently much more expensive for the purchaser than carrying the risk himself. By selling insurance in combinations of coverages, the buyer can be forced to purchase protection against possible large losses. A t the same time, the cost of providing coverage on more frequent, smaller losses is reduced.3 The best answer to this problem would seem to be adequate information for buyers, so they could more intelligently choose their insurance protection. Adequate information, particularly for the individual or head-of-family policyholder, is likely to mean, in addition to complete, objective information on the current developments in insurance, analysis of the prospective policyholder's potential sources of loss and assistance in efficiently fitting insurance to these risks. This process has been developed quite extensively in life insurance. Much more could be done in nonlife insurance. Product variety in insurance presents a mixed picture. In certain fields, notably accident and health, less variety would seem to be desirable. In such areas less competition in product and more in price or in other dimensions might tend to diminish excessive and spurious product variety. In many areas additional product variety in terms of more rapid development and introduction of new products is needed. This particular aspect of product variety was examined in chapters vi and vii. In terms of the combinations in which coverages are sold, there is a definite opportunity for improvement. T o enable intelligent allocation of expenditures to insurance, more objective information on risks of loss and related insurance possibilities should be provided the public. T h e industry has a definite responsibility to do more to develop ways to fit the product to policyholders' needs. Capacity In property and casualty insurance the term "capacity" is not applied in its ordinary sense. Though there does not seem to be any precise " O f t e n the industry has also added "salable" features to contracts to cover small losses at substantial expense to the policyholder.

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definition of capacity, in the ordinary sense it usually means some maximum commodity or service output from a given quantity of fixed productive facilities. Time and cost limitations must be kept in mind if the concept is to have any real meaning. T o speak of given plants or facilities introduces a time element. In regard to cost, one must mean that some reasonable relationship exists between price and cost; otherwise, if price exceeded cost by a large enough margin, it would always be possible to have further expansions in output. Often the cost difficulty is resolved by considering capacity output as that amount at which the lowest average unit costs are achieved. This may be a conceptual resolution only, for in practice it may be difficult to determine.4 These refinements are not critical for our present discussion. W e merely need note that in industrial areas, capacity means the ability to produce commodities, and this depends quite directly on the quantity and quality of the capital goods available at any time. In contrast to this, the insurance industry is scarcely dependent at all upon physical capital resources. Of course, office space, recordkeeping equipment, communication facilities, and similar types of resources are necessary in some minimum amount, but the quantity of insurance that can be supplied with a given quantity of these is quite elastic indeed.5 What is necessary to do business in insurance is a pool of capital funds, not to be turned into plant and machinery or inventory stocks, but to be converted into high-grade governmental and industrial securities.8 These earning assets, a share of which is ordinarily very liquid, serve to comply with state requirements of minimum capital funds to engage in the insurance business.7 Minimum capital or surplus has merely a guarantee function. T h e price of a unit of insurance is presumed to be sufficient to cover expected losses and expenses associated with that unit of insurance. However, since premiums are based on past average losses and expenses, a reserve is believed necessary to protect against catastrophes, conflagrations, and other extraordinary events which may deviate from past experience. Minimum capital requirements vary among the states, but compared to the amount needed to initiate most industrial enterprises, they are small. Thus the insurance supply curve has come to be considered 4 For a discussion of the term "capacity," see George J. Stigler, The Theory of Price (New York: Macmillan Company, 1949), pp. 275-276. 5 S. J. Lengyel, Insurance Companies' Accounts: An Economic Interpretation and Analysis (London: F. W . Cheshire Pty., Ltd., 1947), pp. 88-89. 6 Shelby C. Davis, " T h e Great Attractiveness of Insurance Stocks," The Commercial and Financial Chronicle, September 24, 1953, p. 1119. * See the discussion of entry requirements in chap, v, and Lengyel, op. cit., p. 89.

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almost infinitely elastic. This may well be true on any long-run basis, so long as industry earnings are sufficient to attract new capital. There are other forces, however, which may operate to create excess or undercapacity in the industry for unduly long periods of time. 8

A

STANDARD FOR

CAPACITY

A reasonable standard to obtain the maximum benefits from insurance would seem to require sufficient capital funds in the industry so that anyone wishing to transfer a risk of loss may always do so, providing he is willing to pay a premium that covers costs in the long run. This standard will probably mean excess capacity, that is, unneeded capital funds in the industry, during cyclical downswings or periods of slow growth in the economy. But the consequences of a moderate degree of this kind of overcapacity do not seem to be very harmful. There may even be some desirable indirect effects. CAPACITY IN T H E

INDUSTRY

In the post-World War II period until well into 1953 the industry did not have sufficient capacity to absorb all the premiums that were offered. This was particularly true of automobile and fire insurance. 9 There was a great amount of discussion of the problem during this period by those seeking insurance, insurers, and regulatory bodies. There does not seem to have been any thorough study made of it; however, many solutions were offered. The reasons often given for the failure of the supply of insurance service to keep pace with demand during this period are inflation coupled with a very rapid expansion in industrial plant and equipment, inventory stocks, residential and commercial construction, and holdings of consumer durables.10 More correctly, these are the reasons 8 See A. H. Mowbray, Insurance: Its Theory and Practice in the United States (New York: McGraw-Hill Book Company, Inc., 1946), pp. 473-474. "See Roger Kenney, Fundamentals of Fire and Casualty Insurance Strength (Dedham, Mass.: Kenney Insurance Studies, 1949), p. 43; Chester M. Kellogg, "Pitfalls of Financial Statements," Address before the New York Chapter, National Insurance Buyers Association, Inc., New York, November 20, 1952, pp. 6 - 7 ; " 'Everybody Wants to Get into the Act' on Insurance Capacity," Journal of American Insurance, X X I V (November, 1947), 3-4; L . C. Irvine, "Inflation's Effect on Insurance Practices," The Insurance Buyer, VII (June, 1951), 12. 10 See Irvine, op. cit., p. 3; Chester M. Kellogg, " T h e Capacity Problem," Journal of the American Association of University Teachers of Insurance, X V I (March, 1949), 5 - 7 ; "Management Speaks out on Insurance Problems," Journal of American Insurance, X X I V (December, 1947), 25-28.

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why the demand curve for insurance shifted. T h e principal reasons why supply failed to expand as rapidly as demand are the legal and administrative requirements of state regulation and a reluctance or inability to obtain enough new capital funds for the industry. 12 In regard to regulatory requirements, most state insurance codes require that the entire amount of a prepaid insurance premium be placed in a liability account. T w o reasons are given for this rule: the company is obligated to cover the risk for the remainder of the policy period; and most property and casualty insurance policies permit the insured or insurer to cancel the contract, and on cancellation the unearned premium must be refunded. Insurance companies and regulatory bodies refer to the quantity of written but unearned premiums at any given time as unearned-premium reserves. T h e commonly accepted concept of a reserve is a fund, usually a portion of surplus, voluntarily set aside for a particular purpose. Insurance companies have this type of reserve, but since the unearned-premium reserve is a statutory liability, it is quite different. 13 11

T h e effect of unearned-premium reserve statutes upon property and casualty insurance operations is given as follows by an insurance actuary: T h e reserve is r e q u i r e d by law in most states to be c o m p u t e d u p o n the basis of gross premiums, i.e., the p r e m i u m s c h a r g e d the insured, a n d no is allowed

for

expenses

incurred

or paid.

deduction

Since a large p r o p o r t i o n of the

e x p e n s e is i n c u r r e d at the i n c e p t i o n of the c o n t r a c t (particularly commission a n d o t h e r acquisition cost), the r e q u i r e m e n t of c o m p u t i n g reserves on gross p r e m i u m s results in

a substantial

drain

upon

surplus,

particularly

in

the

case of a n e x p a n d i n g carrier. . . , 1 4

If a firm's sales volume remains constant, and if premiums are sufficient to cover losses and expenses, written premiums added to the " F r a n k B. Flahive, Vice-President, Columbia Engineering Corporation, New York City, stated in a conference on insurance capacity that "insurance has become just as important an element in large business as finance, and as labor and material costs." Reported in ibid., p. 25. n See Ingolf H. E. Otto, "Capacity," Journal of Insurance, X X V I I I (March, 1961), 53-70, for a somewhat different classification of causal factors and an attempt to analyze capacity in a macroeconomic framework. 13 For a discussion of insurance reserves and the unearned-premium reserve in particular, see Kellogg, " T h e Capacity Problem," p. 1; G. F. Michelbacher, Multiple line Insurance (New York: McGraw-Hill Book Company, Inc., 1957), pp. 114-139; New York State Insurance Department, Examination of Insurance Companies (New York: New York State Insurance Department, 1954), III, pp. 95-126. 14 G. F. Michelbacher, Casualty Insurance Principles (2d ed.; New York: McGrawHill Book Company, Inc., 1942), pp. 265-266. Italics added.

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unearned-premium liability account will be matched by earned premiums being withdrawn from it. The earned premiums being freed from the unearned-premium reserve account will cover all initial expenses on new business, plus losses, additional expenses, and profits. Thus past accumulated surplus will not be affected. However, when insurance sales are expanding rapidly, as they were in the post-World War II years because of inflation and producer and consumer capital growth, a statutory underwriting loss will be experienced and surplus will be reduced.15 A numerical example will show what is meant by a statutory underwriting loss and a subsequent accounting reduction in surplus. This will occur during a period when the unearned-premium reserve account is growing as a result of an expansion in insurance sales. The following example assumes that losses are 55 per cent of earned premiums, that 40 per cent of net written premiums are incurred as expenses at the time of sale, and that state law requires an unearnedpremium reserve of 100 per cent of that pro-rata portion of net written premiums which are unearned.16 Net Premiums Written Net Premiums Earned Losses Incurred (55% of Earned Premium) . . $330 Expenses Incurred (40% of Written Premium) .. 400 Total Losses and Expenses Incurred Statutory Underwriting Loss (Net Premium Earned less Total Losses & Expenses Incurred)

$1,000 600

730 130

This means surplus will be reduced by $130. If industry sales are expanding rapidly, the reduction in surplus can be quite substantial. Nothing is implied here regarding actual profits in the industry. This question will be taken up in a later section. When a firm's surplus is exhausted it cannot continue to expand premium volume, unless additional capital is obtained.17 Practically, an organization must restrict volume or obtain additional funds long "Kellogg, " T h e Capacity Problem," pp. 1-2, indicates that total fire and casualty insurance premiums nearly doubled in the 1943-1948 period, from $3 billion to billion, but policyholders' surplus rose only $14 billion. In the two year period 1945-1947, premiums increased $2 billion, yet policyholders" surplus fell $100,000. Net surplus dropped from 33.1 per cent of the industry's assets in 1941 to 28.4 per cent in 1950, and during this period the companies added more than $300,000,000 new capital funds. Joseph M. McCarthy, "Assets and Liabilities—1941 to 1950," The Spectator, X V I I (November, 1951), 42-43. " T h i s example is taken from L . L. Hansell, "Underwriting Results," Best's Insurance News, LV, Fire and Casualty ed. (August, 1954), 57. 17 See, for example, California, Insurance Code (1935 as amended), sees. 980-994.

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161

before its surplus is exhausted. Many state insurance departments begin to caution insurance firms against further expansion when the relationship of annual premiums written to policyholders' surplus reaches what are considered dangerous levels. Other factors are considered as well, but seldom would a company be permitted to allow the majority of its surplus to be absorbed by new premium volume. 18 These administrative rulings ostensibly are undertaken to assure company solvency and, in turn, protect the policyholder. The situation was further aggravated during a part of the postWorld War II period by premium rates which lagged behind increasing loss and expense ratios. Where underwriting losses were suffered, surplus was further penalized. This was true in certain kinds of automobile and fire insurance.19 This conjucture of events resulted in a shortage of insurance facilities, particularly in those fields where underwriting losses were being felt or threatened. The condition was well summarized by Howard R. Bowen, then Dean of the University of Illinois College of Commerce: A serious strain o n the insurance facilities of this country has resulted f r o m the great e x p a n s i o n in economic activity, t h e inflation of p r o p e r t y values, t h e difficulties of r e p l a c i n g facilities, a n d t h e increase i n losses. . . . W h a t to d o a b o u t it is very m u c h in the m i n d s of insurance buyers, insurance companies, a n d state regulatory agencies. 2 0

By 1953, insurance markets had improved substantially. The relief seems to have been due to a number of remedial factors. Probably 18 New York State plays a major role in insurance regulation. Since all important companies are entered there, a significant extraterritorial effect is registered on company operations throughout the United States. In regard to their administrative practices concerning individual companies' premium volume, a member of the New York Insurance Department says: "There is no present statutory provision in our state relating to the regulation of premium volume. However, it has been our practice to handle the matter on an administrative basis, and to confer with the managements of those insurers which in our judgment are writing business at a rate which does not impress us as conservative. We have no hard and fast rule in this connection, but as a starting point, and in particular relation to Casualty business, we regard a ratio of two to one ($2.00 of net annual premiums written to each $1.00 of surplus to policyholders) as conservative. There are many facets which must be considered in reaching a final decision in given cases; for example, the extent to which rate increases may have raised volume without increase in unit exposure; consistent quality of business; the extent to which the expense ratio of the particular insurer is better than the average for the industry; reinsurance facilities; relative liquidity of the particular insurer, etc." William C. Gould, Chief of the Property Bureau, State of New York Insurance Department, letter of March 30, 1954. 19 See Kellogg, " T h e Capacity Problem," p. 1. Otto, op. cit., pp. 58-62, stresses the restrictive effect on capacity of rigid, regulated rate structures. 20 "Management Speaks Out on Insurance Problems," p. 28.

162

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and

Selling

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most important was a decline in the rate of total premium growth. This, along with widespread rate increases, a leveling off of the price level, the writing of certain kinds of insurance (notably automobile and fire) for shorter terms, and some new capital investment, made it possible for the industry to meet most insurance needs. 21 Of the forces over which the industry had control, the greatest emphasis was placed on rate increases. Increases were needed in certain lines, particularly automobile insurance. 22 But less consideration seems to have been given to substantially increasing the capital funds in the industry. 23 T h e wide publicity given to underwriting losses suffered in 1951 may have had a dampening effect on the formation of new companies. 24 Established firms were apparently reluctant to engage in any widespread new financing, despite the fact that insurance stock issues seem to have sold satisfactorily. 23 T h e industry apparently viewed the situation much less seriously than many buyers, largely major industrial purchasers of insurance, and agents and brokers who 21

Kellogg, "Pitfalls of Financial Statements," pp. 6-7. T h e capacity of the industry is also dependent on reinsurance facilities which allow companies to transfer a portion of their risks to others. T h e reinsurance market became tight in this period also as a result of inflation and rising losses. Relief resulted from a stabilized price level, the slow movement toward expanded charters and fleet mergers under multiple line practices, allowing companies to reinsure all classes of insurance, and the formation of some new reinsurance pools in the United States. In addition, extensive use was m a d e of foreign reinsurance facilities, particularly London Lloyd's. See Weekly Underwriter, October 13, 1951, pp. 890, 898. Buyers who were unable to obtain coverage in the American market d u r i n g the period of greatest stringency did not necessarily have to assume their own risks. Many of them secured insurance from nonadmitted foreign insurers, particularly London Lloyd's. Surplus line laws in a n u m b e r of states provide t h a t those who cannot secure insurance in admitted carriers may place such coverage in nonadmitted carriers. See, for example, California, Insurance Code (1935 as amended), sees. 1760-1779. 23 See California, Eighty-Fifth Annual Report of the Insurance Commissioner (1952), pp. 20-22, a n d Roger Kenney, " T h e Real Reasons for the Restricted Market in Automobile Insurance," United States Investor, December 8, 1951, p p . 49-50. 23 McCarthy, op. cit., pp. 42-43, indicates t h a t over $300,000,000 new f u n d s were invested between 1941 a n d 1950. T h i s is not an impressive sum for an industry that had grown to an a n n u a l sales volume of $6.9 billion by 1950. 24 The Economist, July 12, 1952, p. 140. New York Insurance D e p a r t m e n t statistics show that the total n u m b e r of property a n d casualty companies remained essentially stable f r o m 1940 to 1951. New York State, Ninety-Third Annual Report of the Superintendent of Insurance (New York: New York State Insurance Department, 1952), II, p. 9a; III, p p . 8a-9a. 25 Davis, op. cit., pp. 1119, 1138-1139. Cf. Kenney, Fundamentals of Fire and Casualty Insurance Strength, p p . 82-83, who states that at the height of the inflation fire and casualty company common stock issues were sold to yield 4i/£ to 5i/ 2 P e r cent. This, he feels, was a high price to pay for new funds. See also Otto, op. cit., p. 60.

Variety,

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26

were selling insurance. T o obtain new funds by stock issues makes it more difficult to maintain dividends in stringent times. T o wait and let such funds build up, by accumulation of surplus as rate increases and possible loss rate decreases occur, eliminates this disadvantage. Analysts seem to agree that nonlife insurance, particularly fire insurance, was overcapitalized in the 1930's. This is alleged to have had an upward pressure on rates as companies sought to maintain customary dividends.27 Another, and perhaps more serious, undesirable effect of overinvestment in insurance is that the uses of capital funds are regulated by state law.28 Property and casualty insurance investments are not as closely supervised as those of life insurance. But investments in nonlife insurance are largely restricted to mortgages and stocks and bonds of old, reliable enterprises that have long maintained adequate interest and dividend records.29 Unneeded funds which accumulate and are subject to these requirements, desirable though they may be for the policyholders' protection, necessarily mean that owners or policyholders are deprived of the option of placing such funds elsewhere. New ventures might have been chosen whose expected contributions to the economy's growth were greater than those from the bidding of proven securities away from another holder. If the proven securities are new issues, one cannot say categorically that the same funds placed in risky or new ventures would yield greater benefit to the economy. They might not. These are not extremely serious indictments of some excess funds in insurance. They have gone largely unnoticed. As Davis says, "Insurance is not plagued with a capacity problem which has made other industries uninviting . . . and susceptible to the spiral of over capacity, price cutting and dearth of profits." 30 Certainly excess capital in insurance is not the same as idle blast furnaces, textile spindles, or other industrial equipment. 28 Perhaps insurance firms merely wished to create such an impression. One report said: "The impression seems to be general that the tendency of fire insurance company executives in the present situation is to maintain a stiff upper lip and a dignified silence—in the hope that the storm will blow over . . . and normalcy in the fire insurance business will return. . . . T h e impression also seems general that such an attitude is in error, and that unless proper steps are taken the lack of capacity will remain a problem for a long time to come." " 'Everybody Wants to Get into the Act' on Insurance Capacity," 3. '"See Kellogg, "Pitfalls of Financial Statements," p. 7, and Kenney, Fundamentals of Fire and Casualty Insurance Strength, p. 8228 David F. Jordan and Herbert E. Dougall, Investments (6th ed.; New York: Prentice-Hall, Inc., 1952), p. 536. 29 Ibid., and The Economist, June 28, 1951, p. 245. 30 Davis, op. cit., p. 1138.

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Some reasonable amount of excess facilities in insurance offers certain advantages that may counterbalance or even outweigh the disadvantages. Insurance firms bidding for a limited supply of high-grade securities will tend to keep their price up and the interest rate down. In an industrial society dependent on a high level of real investment, a low interest rate is presumed desirable, except in periods of strong inflationary pressures.31 The connection between the rate of interest and the volume of investment is sufficiently indistinct, however, and there are so many more powerful forces operating to determine the price of capital funds that this advantage is probably a minor one. A more important reason to maintain ample funds in the insurance industry at all times, except perhaps at the very peak of strong booms, is the margin such funds provide for growth in the economy. On the other hand, it would not be desirable to have funds so plentiful in the industry over the cycle that the price of insurance becomes higher than necessary just to provide a return on unneeded capital. Kellogg points out that the industry was indeed fortunate in entering the last period of inflation and rapid growth in an overcapitalized position. Otherwise the situation would not have been met as well as it was.32 Capacity in insurance depends not upon physical facilities but upon a pool of capital funds.33 Under state laws a minimum level of capital or surplus funds is necessary to engage in the insurance business. This is to provide security for the policyholder, it is said. Beyond this, however, additional surplus is necessary to meet administrative requirements of regulatory bodies and to enable unearnedpremium reserve requirements to be met during times of growing premium volume. Thus insurance capacity hinges upon an adequate level of net financial assets to meet the body of statutory and administrative rulings which affect the industry. A somewhat more than adequate supply of such assets does not mean idle or wasted resources. Therefore, in view of the importance of a ready insurance market to individuals and firms in an industrial society, the insurance industry should maintain sufficient capacity at all times to allow easy transference of all legitimate risks. In the last quarter-century, the industry apparently failed to do this for only six to eight years in the 1940's 81 For a discussion of interest rates and investment, see Robert A. Gordon, Business Fluctuations (New York: Harper and Brothers, 1952), pp. 517-524. w Kellogg, "Pitfalls of Financial Statements," p. 7. 88 Office space and equipment, motor vehicles, and similar capital facilities are necessary to obtain, process, and service insurance contracts. But the value of such real capital compared to the required capital and surplus funds is very small.

Variety,

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165

and early 1950's. This is not a bad performance. But it could have been a better performance had the industry responded more quickly to the great increase in demand it faced as a result of inflation and the growth of insurable values. The industry was reluctant to expand capacity by capital issues. The more common tendency was to press for rate increases and then hope capacity would expand as a result through the slow accumulation of surplus. From 1940 to 1953, for example, stock companies expanded capital $313,696,467. In the same period the growth in surplus was $2,220,222,400.34 The long-run supply curve for insurance may well be very elastic, but the short-run curve has not been. The industry can meet the needs of the economy more adequately by consciously endeavoring to increase the speed with which it reacts to increases in demand for its services. If substantial decreases in demand should occur over a long period, then funds should have the opportunity to move out of the industry. This could be accomplished by paying dividends out of surplus or retiring stock. The expected growth in the economy plus the expected growth in the use of the principles of insurance make it unlikely that any extended period of lessened demand will occur in the next decade or two. Profit Levels In chapter v we examined price making in the nonlife insurance industry. Here we are interested in the profit margins that result from the relationship between costs and prices in the industry. Selling expenses are part of costs, and as such they are included in our discussion of costs, prices, and profit levels in this section. However, since selling costs make up a substantial part of the total expense of insurance companies, it is desirable to examine this type of expense in somewhat greater detail. This task will be attempted in the succeeding section of this chapter. STANDARD FOR PROFITS

Profits may be viewed in two ways: from the standpoint of the firm they are revenues in excess of total costs; from the standpoint of " A l f r e d M. Best Company, Inc., Best's Fire and Casualty Aggregates and Averages (15th ed.; New York: Alfred M. Best Company, Inc., 1954), p. 16. During the whole inflationary period, a factor in the expansion of surplus was the appreciation of the companies' investment portfolios. "Reviews and Previews," Best's Insurance News, LV, Fire and Casualty ed. (January, 1955), 14. Increases in surplus also occurred as a result of the sale of stock at prices above par value. See Roger Kenney, Fundamentals of Fire and Casualty Insurance Strength (2d ed.; Dedham, Mass.: Kenney Insurance Studies, 1953), pp. 14-16.

166

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society they are an expense, since they enter into the final price of goods and services.35 Therefore, the optimum-profits performance of the insurance industry for society is the minimum level of profits that will bring about the quantity and quality of insurance service desired. Blanchard has stated a general norm for profits in insurance: That profit is justified which induces insurers to continue to furnish and to develop insurance in the public interest, to take the trouble and risk. Greater profit is not justified. I am not impressed by comparisons between insurance profits and those made on butter, furniture, clothing, or in providing electricity or telephone service. The inducement needed to secure a supply of those commodities and services may be more or less than is the case in insurance, but it is not relevant. 38

What this profit would need to be in insurance is not entirely clear. Presumably it would have to cover pure interest and risk. Other elements that need to be considered, though not necessarily included in any justifiable profit level, are a reward to management, profit taxes, and a contribution to surplus. 37 Let us consider each of these as it applies to property and casualty insurance. PURE INTEREST RETURN

T h e pure rate of interest may be defined as "the amount that has to be paid to an investor for parting with control of his capital without risk or any cost or inconvenience." 38 It is essentially the basic rate of interest on the safest investments. T h e yield on obligations of the federal government is sometimes suggested as approximately what is meant by the pure rate of interest. Such factors as market frictions, forces of competition, and differing supplies of various maturities may cause variations in yields among government issues, even though all are virtually riskless from the standpoint of capital loss. In such situations, the lowest rate on any type of governmental obligation would seem to be an indication of the pure interest return. 86

For a discussion of this distinction, see Lengyel, op. cit., p. 115. Ralph H. Blanchard, "Losses, Expenses and Profits," Best's Insurance News, L1I, Fire and Casualty ed. (March, 1953), 50. See also Stephen H . Sosnick, "A Critique of Concepts of Workable Competition," Quarterly Journal of Economics, LXXII (August, 1958), 407. 17 Sosnick, pp. 397-398; and Eli W. Clemens, Economics and Public Utilities (New York: Appleton-Century-Crofts, Inc., 1950), pp. 218-224. See also B. S. Keirstead, Capital, Interest and Profits (New York: John Wiley and Sons, Inc., 1959), pp. 28-41. 38 Clemens, op. cit., p. 219. For a recent, comprehensive treatment of the subject of interest, see Joseph W. Conard, Introduction to the Theory of Interest (Berkeley and Los Angeles: University of California Press, 1959). 38

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167

RISK

T h e risk of capital loss in the insurance business is often considered to be quite low. Gephart says, T h e application of the insurance p r i n c i p l e presents n o great difficulties. . . . T h e r e is n o great risk to be assumed by the organizers. . . . In fire insurance the b u r n i n g rate is fairly well k n o w n . I n o t h e r kinds of insurance the data may not be either as c o m p l e t e or as accurate, b u t few i n h e r e n t difficulties will be f o u n d in placing in o p e r a t i o n the insurance principle. Insurance is, in other words, a safe business. 3 9

This statement was made in 1913. Another student of the industry emphasizes that the degree of risk has steadily diminished. 40 T h e extension of reinsurance in all its forms over the past generation has softened the blow of catastrophe and taken much of the risk out of the ownership of insurance stocks. Today insurance company common stocks (companies have almost universally issued only common stocks) are "closer to preferred stocks if not superior to them and bordering indeed upon obligations." 41 T h e one great catastrophe hazard, war, has been accepted as a social risk. Almost all nonlife insurance contracts contain a war exclusion. Another factor contributing to lessened risk of capital loss is more systematic state regulation, since insurance was declared commerce by the Supreme Court in 1944.42 This regulation aims primarily to maintain insurance company solvency. Whatever its other effects on the industry and purchasers of insurance, regulation does reduce further the risk of loss of capital for the holder of insurance securities. Of course, there are those who feel that insurance is still a risky business, subject to large catastrophe hazards. 43 T h e industry as a whole is confronted with catastrophe hazards, but the accepted use 30

W. F. Gephart, Insurance and the State (New York: Macmillan Company, 1913), 5. 40 Davis, op. cit., p. 1138. Davis, a former First Deputy Superintendent of Insurance, State of New York, cites the November 1950 hurricane as an example of the fact that much of the risk has been taken out of the insurance business. This storm was acknowledged to be the worst insurance disaster in fifty years. Yet the company affected the most proportionately was able to cover its losses through its normal cash flow. Not a single security was sold, and surplus was decreased by only 10 per cent. a Ibid., p. 1119. 42 U.S. v. South-Eastern Underwriters Assn., 322 U.S. 533. 43 For example, Roger Kenney, "This Question of 'Profit' in the Fire Insurance Business," United States Investor, November 29, 1947, pp. 9-12, and "Extended Cover a National Problem!" ibid., April 28, 1951, pp. 13-17. P.

168

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of reinsurance to spread risk among insurance enterprises throughout the world makes the hazard faced by any one firm a manageable one. Insurance companies do fail, so there is some risk connected with the industry. 44 And the risk may increase with the apparent trend toward more price competition in certain parts of the industry. T h u s a payment in excess of pure interest is necessary and warranted, though such payment apparently need not be very large. REWARD TO MANAGEMENT

T h e r e is no evidence in insurance to indicate that management owns any appreciable amount of company stock. 45 T h u s they will not generally share directly in profits. They may do so indirectly, through bonuses based on company earnings or through salaries scaled, to some extent, to the size of the operation, which in turn may be conditioned by the level of profits to reinvest over a span of years. A justifiable profit level as stated at the beginning of this section would not need to contain a provision for management. PROFIT TAXES

When speaking of the profit return necessary to maintain the insurance industry and enable it to expand, it is impossible to ignore the problem of taxes. States commonly impose gross premium taxes, often at discriminatory rates on foreign companies. 46 These are handled as an expense and become part of costs. It is the federal income tax that poses a problem so far as profit margins are concerned. Since we are attempting to appraise the level of profit in insurance " S t a t i s t i c s on the n u m b e r of insurance failures that have resulted in partial or complete loss of shareholders' investments are not available. Insurance departments, especially New York State, list changes in companies, but the greater majority that retire either merge with others or reinsure their contracts so that little if any loss occurs for policyholders or owners. See chap, iv for a discussion of insurance company exit. See also U.S. Congress, Senate Subcommittee on Antitrust and Monopoly of the Committee on the Judiciary, Report, The Insurance Industry, 86th Cong., 2d Sess., 1960, p p . 228-236. 45 Roger Kenney notes, " . . . By and large, there is comparatively little management ownership in the fire and casualty business. T h e stock-holdings of the top managements are comparatively small—speaking on a broad general basis." " I s the Capacity Problem Nearing a Solution?" United States Investor, October 30, 1948, P . 17. " L . B. Orfield, " I m p r o v i n g State Regulation of Insurance," Minnesota Law Review, X X X I I (February, 1948), 254; J o e l B. Dirlam and Irwin M. Stelzer, " T h e Insurance Industry: A Case Study in the Workability of R e g u l a t e d Competition," University of Pennsylvania Law Review, CVII (December, 1958), 204; J o h n W. Cowee, "Insurance Company T a x a t i o n — T h e General I m p a c t , " Journal of Insurance, X X V I (Spring, 1959), 16; and U.S. Senate, Report, The Insurance Industry, p p . 156-160.

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169

from the standpoint of desirable performance, we will consider margins before income taxes. There are additional reasons for doing so: data normally are given in such terms, and the underwriting profit in insurance subject to profit taxes is statutory underwriting profit.47 This is a special definition of profit on sales consistently adhered to and defended by the industry, for under the generally normal industry trend of rising premium volume, it produces lower profits than would any more conventional method of profit determination. Statutory underwriting profits have been accepted as the basis of federal income tax liability from underwriting and state insurance rate regulation.48 Statutory sales profits will be examined along with other types of profits in subsequent paragraphs, but for the moment we need only note that they may reduce the impact of income taxation in many years. CONTRIBUTION TO

SURPLUS

If profit margins are large enough to permit a contribution to surplus, in addition to allowing dividend payments which maintain the companies' stock at satisfactory prices and enable the industry successfully to market new issues, then the policyholder is assisting the expansion of the insurance business.49 That this has been occurring in the insurance industry is suggested by the relatively greater proportion of stock company expansion through increases in surplus rather than increases in capital. From 1910 to 1958 the capital of stock company property and casualty insurance companies increased from $121,583,000 to $950,754,618, or 658 per cent. In the same period the surplus of these companies grew from $245,828,000 to $5,994,653,717, or 2,339 per cent.50 This growth in surplus is not due entirely to retained earnings. Portfolio appreciation and premiums on stock issues have also contributed. Available statistics on industry surplus do not separate retained earnings from other sources of change in surplus. However, between 1910 and 1958, appreciations and depreciations in " "Second R e p o r t o£ the Special Sub-Committee of the Fire and M a r i n e Committee, R e Underwriting Profit or Loss, and the Commissioners' 1921 Standard Profit F o r m u l a , " October 9, 1947, Proceedings of the National Association of Insurance Commissioners (1948), p. 87. T h i s report is largely the work of Roy C. McCullough, formerly with the New York State Department of Insurance. I t will be cited in future as the McCullough Report. aIbid., pp. 87, 9 7 - 9 8 , and Cowee, op. cit., pp. 16-17. Investment income is taxed separately. 4 8 Clemens feels there is no justification for requiring the consumer to finance expansion. If surpluses are to be built up, they should be at the expense of dividends. Op. cit., p. 224. " C o m p u t e d from d a t a in Best's Fire and Casualty Aggregates and Averages (1959), p. 20.

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portfolio values would be expected to cancel out to some extent. Surplus did fall appreciably in the 1931-1935 period, primarily from portfolio depreciation. 51 The contribution of premiums on stock sales to surplus between 1910 and 1958 may have been as much as the growth in capital stock, that is, approximately $800 million. This leaves retained earnings as the major source of additions to surplus. Throughout most of the period for which the expansion in surplus is cited, dividend payments were apparently high enough to cover interest and risk elements. More important, dividends were sufficiently regular so that the industry apparently could have financed expansion through the capital markets. 52 The tremendous plow back that did occur, of course, influenced the price and desirability of insurance companies' securities. One cannot say definitely what would have resulted had profit levels been no more than enough to make the same dividend payments. T o recount what justifiable profit in insurance would cover, we find a pure interest return and a risk payment, which would not appear to be large in today's industry. Allowances for management, income taxes, or contributions to surplus do not appear necessary. What the sum of these elements means, in terms of a level of profits in relation to invested capital or some similar base, it is not possible to ascertain other than in a very approximate way. Blanchard notes that "attempts have been made to determine a 'reasonable' profit, and to support various percentages by formula, analysis, and analogy. . . . What profits should be is a matter of judgment. . . ." 53 McCullough proposes that 6 per cent on the risk capital invested in the insurance business is a reasonable and adequate return based on the actual results shown over a recent span of years.54 This would ordinarily permit a 4 per cent dividend on invested capital and a 2 per cent retention in the business. The 2 per cent for accumulation of surplus he seems to view as a risk payment, saying, "It would . . . offer the possibility of increased earning power and capital appreciation to compensate for the opposing risk of capital loss." 55 In another section of his report he emphasizes that expansion for stock insurance 61 Surplus fell from $1,173,569,000 in 1931 to a low of $793,808,000 in 1932. The 1930 figure was not equaled until 1935, when surplus amounted to $1,355,115,000. Ibid. 62 See Davis, op. cit., pp. 1119, 1138-1139, and W. Kent Cochran, "Insurance Company Stocks," United States Investor, October 6, 1951, pp. 57-63. 63 Blanchard, op. cit., p. 51. 64 McCullough Report, p. 112. K Ibid.

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should come "not from the policyholders but from the stockholders who will be the ultimate beneficiaries of the expansion of the industry." 56 Since 1910, investment earnings for stock insurance companies, as a percentage of assets, have varied from a high of 5.89 per cent in 1916 to a low of 2.30 per cent in 1952. Earnings have not been more than 3.0 per cent since 1937.57 T h u s the average investment return on the type of securities in which the industry invests has been less than 3 per cent for the last decade and a half—less than 2.6 per cent every year since 1944.58 Some additional payment is undoubtedly due the individual who places his capital at the risk of the insurance business. But the current risk seems to be small, perhaps 1 to 3 per cent. This results in a total of 4 to 6 per cent. This is only a most tentative suggestion, however, of the average level of return which seems to have been necessary to maintain and to expand the industry over the past few decades. Variations in cyclical and competitive forces, money market conditions, and legal and institutional factors will mean that the justifiable profit level will differ in the short run, and perhaps over the long run as well. INDUSTRY PROFIT MARGINS

In the following sections we will consider possible bases for determining profit margins in the industry and some of the margins that have been prevailing. BASES FOR MEASURING PROFIT

T h e bases available for measuring profitability in the industry are: (1) sales or the turnover represented by earned premiums; (2) paid-up " Ibid., p. 94. 67 Best's Fire and Casualty Aggregates and Averages (1959), p. 22. T h e ratios shown are based on total assets. T h e y would be larger it based on invested assets, for 10 to 15 per cent of stock company assets seem to be ordinarily in the form of cash and premium balances due. 68 Ibid. At the end of 1950 the five leading types of securities held by stock insurance companies were: Security

Percentage of T o t a l Assets

U.S. Government Bonds Industrial and Miscellaneous Stocks Bank and Insurance Company Stocks State and Municipal Bonds Public Utility Stocks

38.7 15.1 9.2 5.7 4.6

William M. Montgomery, "Stock Companies' Security Holdings," The XVII (November, 1951), 46.

Spectator,

172

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share capital; and (3) shareholders' equity. The last measure is the difference between balance-sheet assets and liabilities. Since insurance companies do not do any debt financing, this is equivalent to what is sometimes called total net assets (total assets minus current liabilities). Sales Profit Margins. The industry has traditionally used sales as the basis for profit calculations, and generally a special version of profit on sales, which gives a smaller profit when sales are increasing and a larger profit when sales are decreasing.60 This is known as "statutory underwriting profit" and is simply the ratio of earned premiums to dollar profit. The term statutory underwriting profit comes from state recognition of this method of profit determination. Dollar profits are obtained by deducting all incurred losses and incurred expenses from earned premiums. Since the expenses incurred when a policy is written are approximately 90 per cent of total expenses for the life of the contract, sales profits are misstated by the amount of prepaid expenses incorrectly charged to the year the contract is written. In a period of rising premium volume, written premiums will exceed earned premiums and statutory underwriting profit will be less than actual underwriting profit. In a period of declining premium volume, statutory underwriting profit will be more than actual underwriting profit.61 Statutory underwriting profit may be adjusted to give an approximation of actual underwriting profit in either of two ways: (1) The ratio of losses and loss expenses incurred to earned premiums is added to the ratio of expenses incurred to written premiums and the sum subtracted from 100 per cent. The difference will be actual underwriting profit or loss. This technique merely spreads expenses over the life of the contract instead of charging them entirely to the year in which the contract is written. (2) Thirty-five or 40 per cent of the increase in unearned premium reserves (approximately the value of prepaid expenses and expected sales profits) is added to dollar statutory underwriting profit.62 The sum is divided by earned premiums to give an estimate of actual underwriting profit. These adjustments are widely used by insurance analysts, security 59

See Lengyel, op. cit., pp. 128-129 " R o g e r Kenney notes that "profit, from time immemorial, has been expressed in a percentage of the premium." "An Agent Complains About Worship of Percentages in Setting Commissions," United States Investor, March 1,1952, p. 17. " F o r discussion of statutory underwriting profits, see Hansell, op. cit., pp. 57-58; Kellogg, "Pitfalls of Financial Statements," pp. 2-3; and McCullough Report, pp. 84-97. 63 If premium volume were declining, it would be necessary to substract a similar percentage of the decline in the unearned premium reserve from the statutory underwriting profit 68

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173

analysts, and insurance organizations when offering stock issues for sale.63 The defect in the second method of adjustment, says McCullough, is that it throws all the anticipated sales profit into the year in which the policy is written rather than spreading it over the term of the contract. This method also anticipates a profit which may not be realized if losses or the few expenses that were not prepaid should rise.64 TABLE

14

STATUTORY U N D E R W R I T I N G P R O F I T AND A D J U S T E D U N D E R W R I T I N G FOR A L L C A P I T A L STOCK C O M P A N I E S

PROFIT

1920-1958

Year

Statutory underwriting profit

Adjusted underwriting profit"

1920 1925 1930 1935 1940 1945 1950 1951 1952 1953 1954 1955 1956 1957 1958

-2.5 -4.0 -1.3 6.4 4.3 1.5 4.0 0.2 3.1 5.0 5.5 3.5 -1.8 -4.3 -1.1

2.9 -0.8 -1.9 7.6 6.5 4.2 7.0 2.9 5.6 6.9 6.4 5.1 -0.5 -2.9 0.0

SOURCE: Best's Fire and Casualty Aggregates and Averages (20th ed.; New York: Alfred M. Best Company, Inc., 1959), pp. 22, 27. " Calculated as follows: the ratio of losses and loss expenses incurred to earned premiums was added to the ratio of expenses incurred to written premiums and the sum subtracted from 100 per cent.

Table 14 shows statutory underwriting profit and actual or adjusted underwriting profit for all stock companies over recent decades. These data indicate the degree and direction in which sales profits are misstated by the use of the statutory method of computation. McCullough has compared statutory underwriting profit and adjusted underwriting profit by five-year averages for capital stock fire 83 For example, Hansell, op. cit., pp. 56-59; Alfred M. Best Company, Inc., Best's Insurance Reports (58th Fire and Casualty ed.; New York: Alfred M. Best Company, Inc., 1957), pp. xiii-xiv; Jordan and Dougall, op. cit., p. 539; Kellogg, "Pitfalls of Financial Statements," pp. 3-5. MMcCullough Report, p. 86.

174

Variety, Capacity, Profit, and Selling

Costs

insurance companies admitted to New York state. T h e results are summarized in Table 15. T A B L E STATUTORY UNDERWRITING FOR C A P I T A L STOCK F I R E

15

P R O F I T AND A D J U S T E D

UNDERWRITING

I N S U R A N C E C O M P A N I E S E N T E R E D IN N E W

1921-1945

PROFIT YORK

Period

Statutory underwriting profit

Adjusted underwriting profit

1921-1925 1926-1930 1931-1935 1936-1940 1941-1945

-3.4 1.8 7.4 4.1 -0.5

-1.9 2.6 5.4 5.5 1.1

S O U R C E : "Second Report of the Special Sub-Committee of the Fire and Marine Committee, Re Underwriting Profit or Loss, and the Commissioners' 1921 Standard Profit Formula," October 9, 1947, Proceedings of the National Association of Insurance Commissioners (1948), p. 93.

T h e difference between statutory and adjusted underwriting profit and the direction in which the difference predominately varies are quite striking. It is perhaps not surprising that the industry insistently opposes any change in the method of profit determination for rateregulatory and federal tax purposes.05 Insurance organizations also emphasize statutory underwriting profit margins in their relations with the public, except when seeking new capital. Underwriting profit, statutory or actual, is not a useful measure for investigating necessary or justified profits, for underwriting profit can only indicate the extent to which profit enters into the price charged for insurance. Equity Profit Margins. T o form any conclusions reShareholders' garding the size of existing profit levels in the industry, dollar profits must be related to a measure of capital at risk in the industry. Only in this way is it possible to compare the actual return with what is considered necessary to obtain the use of capital funds. Shareholders' equity represents total capital at risk in stock insurance. 66 Dollar 66 See Proceedings of The National Association of Insurance Commissioners (1949), pp. 456-458, and Harry J . Solberg, " T h e Profit Factor in Fire Insurance Rates," Journal of Insurance, X X I V (November, 1957), 26-28. 66 Shareholders' equity, balance sheet net worth, net total assets, and capital at risk are all essentially equal in stock insurance. This is true bccause: (1) insurance liabilities are predominantly current; and (2) companies obtain capital only from the sale of common stock (including premiums on the sale of stock) and retained earnings from underwriting and investment activities. During periods of rising sales, balance-sheet shareholders' equity will be an understatement of actual share-

Variety,

Capacity,

Profit,

and Selling

Costs

175

profits related to this magnitude provide an indication of whether profits in excess of levels necessary to maintain and expand insurance have been characteristic of the industry. Computed profit rates based on shareholders' equity, and also on paid-in capital, are shown in Table 16. T h e total dollar profits shown in column two are an estimate of all earnings from both underwriting and investment operations. Column four shows rates of profit on shareholders' equity in excess of the average rate of investment return stock companies obtained on their assets. Column five shows rates of profit on outstanding stock or paid-in capital. T h e per cent of return on shareholders' equity in excess of the average rate of return on assets, column four of Table 16, is an estimate of shareholders' earnings as a result of their having placed their capital funds in the insurance business. 67 If shareholders had purchased an array of securities similar to those held by average industry members for each of the years shown, they would have earned an average interest return approximately equal to that subtracted from total profit on equity to give column four of Table 16. This margin above average interest return on insurance company assets may be viewed as risk premium and excess profit. 08 It was suggested earlier that the insurance business today is not basically risky. T h u s one must tentatively conclude that profits in excess of those necessary to maintain and to expand the business have been in existence for most of the years shown in Table 16. If a risk premium of 2 or 3 per cent, even 5 per cent, is granted, rates of more than 10 percentage points in excess of that were earned in more than one-half of the years shown. Excess profits just under 10 per cent were holders' equity by the amount of the prepaid expense item in the unearned-premium reserve account. T h e opposite is true in a period of declining sales. For a discussion of some of the industry controversy over profits and the use of shareholders' equity as a base for profit calculation, see C. A. Kulp, Casualty Insurance (3d ed.; New York: Ronald Press Company, 1956), pp. 578-580. 67 T h e amount of capital voluntarily placed in the business is small compared to that involuntarily left in the business. Current surplus is over five times paid-in capital. Presumably insurance stockholders have neither much interest, nor opportunity to take an active part, in decisions on levels of dividend payments and retained earnings. M Actually there are grounds for considering that the insurance shareholder is gaining a valuable service by placing his capital funds in the industry, for he benefits from the experience, skill, and complete information of company investment departments. Any individual's risk of capital loss may be considerably less if he purchases securities indirectly through insurance company shares rather than directly. T h e apparently rather small risk of insurance company capital loss may be balanced or overweighed by the investment trust service of the companies. If this is true, any risk premiums due insurance shareholders are small or even negative.

176

Variety, Capacity, Profit, and Selling

Costs

TABLE 16 A V E R A G E P R O F I T R A T E S B A S E D ON S H A R E H O L D E R S ' E Q U I T Y AND P A I D - I N C A P I T A L S T O C K P R O P E R T Y AND C A S U A L T Y C O M P A N I E S S E L E C T E D Y E A R S

Year

1931 1935 1940 1945 1950 1951 1952 1953 1954 1955 1956 1957d 1958

Total earnings" Shareholders' (millions) equity (%) $

19° 433° 166 612 938 701 883 735 2,030 1,521 526 -407 $2,074

1.3 24.3 7.5 19.4 22.2 15.4 17.8 14.1 30.3 19.7 6.7 -5.7 24.0

CAPITAL 1931-1958

Shareholders' equity (%) minus avg. interest rate on assets'5

Paid-in capital (%)

-2.6 21.1 4.6 16.9 19.7 12.9 15.5 11.7 27.8 17.3 4.3 -8.3 21.4

3.1 100.9 34.3 105.7 127.4 94.8 116.3 92.0 244.1 166.9 56.3 -42.5 218.1

S O U R C E S : Best's Fire and Casualty Aggregates and Averages (15th ed.; New York: Alfred M. Best Company, Inc., 1954), p. 22; (1955), p. 22; (1956), p. 22; (1957), p. 24; (1958), p. 24; (1959), pp. 20, 22, 26, 27; The Spectator, Insurance Yearbook (Casualty and Surety vol.; Philadelphia: Chilton Company, Inc., 1941-1942), p. xvii; (Fire and Marine vol.; 1946-1947), p. xxvii; (Casualty and Surety vol.; 1946-1947), p. xxv; (Fire, Marine, Casualty and Surety vol.; 1951-1952), p. x. • Total dollar earnings were obtained by multiplying annual earned premiums by the adjusted underwriting profit rate (100 per cent minus the sum of the ratio of incurred expenses to written premiums and the ratio of losses and incurred loss expenses to earned premiums), and adding to this the reported investment profit or loss. This gives an estimate of total dollar profit or loss from all sources. Investment profit or loss is affected by changes in portfolio valuation. During this period, except for 1931 when special convention values were used, stocks were taken at market value and bonds at amortized value. If interest earned alone had been used rather than profit or loss on investments, that is, portfolio appreciation or depreciation were excluded, profit rates would have been higher in 1931, 1940,1953, and 1957, and lower in other years. There are advantages and disadvantages to either method. In this study investment profit or loss has been used since the industry treats portfolio value changes as additions to or reductions in surplus. b The ratio of net dollar interest earned to total dollar assets is subtracted from the profit rate on shareholders' equity. If information were available regarding the average amount of assets invested in earnings securities, it would be a more correct basis for this ratio. However, since the level of invested assets varies constantly in each company, and there are several hundred companies involved in the aggregates used here, it seems impossible to make any trustworthy estimate of the aggregate value of invested assets. Hence, total assets are used. However, it is believed that an average of not more than 10 to 15 per cent of total assets are in cash or other nonearning form. 0 Adjusted underwriting profit was obtained by using written premiums rather than earned premiums as described in note a. Statistics on earned premiums for these two years were not available. The difference between the two aggregates in this period is expected to be negligible. d In 1957, Best's reports earned investment income of 1461 million and adjusted sales losses of $241 million. If the sum of these returns had been used rather than profit or loss on investments (—$166 million) plus the loss on sales, the profit rate on shareholders' equity would have been 2.6 per cent instead of —5.7 per cent.

Variety,

Capacity, Profit, and Selling

Costs

177

earned in two additional years. In four years the return failed to cover interest and a risk premium as tentatively set forth above, but in two of these years the discrepancy was small. The principal basis for profits in excess of those necessary to support the industry seems to be rate making in concert.69 Rate regulation has not kept total profits at the lowest possible levels.70 It is important to note that there is a wide variation in costs and profit rates among firms. Short-run cost ratios depend on a number of variables, including the size of the business, variations in the average rate of premiums, the average amount of premium per policy, the method of allocation of expenses to the different classes of the business, the proportions of the various classes of insurance written, the proportions of direct insurance and reinsurance in the total business, and the relative rate of growth of the business.71 Since these vary markedly through time and from company to company, profit rates also vary. The data in Table 16 are aggregates and thus are inapplicable to any one insurance firm. VALUATION O F INSURANCE LIABILITIES AND PROFITS

Lengyel discusses a profit-conditioning factor that is unusual in insurance.72 This is the ease with which the technically estimated main liabilities may be adapted to profit concealing. In most types of businesses, liabilities have a nominal value, that is, the actual value is stated and the liability is not subject to a valuation procedure. In nonlife insurance, however, the principal liabilities—unearned premium liability and outstanding claim liability—offer opportunities for differences in valuation. In most American states the unearned premium liability is statutorily placed at 100 per cent of that pro-rata portion of the net written premium which is unearned, so differences in valuation are not likely to occur here. However, despite some general state rules in this area, there are wide variations in company practices relative to outstanding loss liabilities. Persistent overestimation of these liabilities leads to understatement of profits, whether w McCullough notes in this regard: ". . . Income can be realized and stockholders can be induced to invest in the insurance business only if the companies make profit. For this reason, it is essential that the business make a reasonable profit. On the other hand, since the price of their service is in the main determined by collective action through rating bureaus, it is necessary to provide, by means of regulation, rates that are not so high as to return an excessive profit to the companies." McCullough Report, p. 99. 70 See Solberg, op. cit., pp. 31-33. Cf. Otto, op. cit., pp. 59-60. 71 Lengyel, op. cit., pp. 116-120. 72 Ibid., pp. 91-93.

178

Variety,

Capacity,

Profit,

and Selling

Costs

it be deliberate policy or extreme caution. A slight change in the level of loss liabilities can lead to wide fluctuations in profit positions for those companies which have quite large liabilities of this sort. And all companies writing an appreciable amount of casualty business will have significant loss liabilities. States may not adequately control this element, particularly as to whether it is excessive or not. Some observers maintain that federal tax authorities will prevent profit concealment in this way.73 There is not any evidence to indicate whether reliance on this device is justified or not. This discussion of profits has been concerned only with capital stock insurance firms. Mutual and reciprocal-exchange insurance organizations are owned by their policyholders, and presumably any earnings above cost are distributed to the policyholders. 74 Insurance companies obtain income from two sources—the sale of insurance service and the investment of capital, surplus, prepaid premiums, and unpaid loss reserve funds in earning assets. Any evaluation of necessary profit in the business must consider the total amounts earned from both of these sources. T h e way insurance accounts are kept, partly because of state regulatory requirements, and partly because of insurance company desires to make profits appear as low as possible, tends to obscure profits. In deriving profit the industry and regulatory authorities do not consider investment income. Furthermore, they do not adjust the income from the sale of insurance to spread prepaid expense throughout the term of contracts. This abbreviated estimate of income is related to earned premiums. T h e resulting rates of return on sales are generally quite modest. When total adjusted income is related to a more realistic base, larger rates of return are obtained. 75 Between 1931 and 1958, estimated rates of return on shareholders' equity varied from a low of —5.7 per cent to a high of 30.S per cent. Most of these years showed returns of more than 15 per cent. 73 For example, Roger Kenney, "This Movement to Eliminate Schedule P from the Casualty Statements!" United States Investor, N o v e m b e r 3, 1951, pp. 33-38, and "Again, T h a t Question of More Uniformity of Loss Reserve Practice!" ibid,., December 29, 1951, pp. 9-12. 74 It is quite likely that in the typical larger m u t u a l or reciprocal exchange organization, the policyholder, as technical part owner, has little influence on such matters as the rate of expansion in surplus. 79 Cochran, op. cit., p. 58, notes that to evaluate insurance company stocks many adjustments of company- and state-required statistics are necessary. Company reports are too meager, and the standard form reports (known as convention reports) made to state insurance commissioners are prepared primarily for guaranteeing company solvency. N e i t h e r kind of report attempts to report annual profits accurately.

Variety,

Capacity,

Profit,

and Selling

Costs

179

We tentatively concluded that a rate of return on shareholders' equity above the average rate earned on investment in the industry, plus a risk premium, was profit in excess of necessary payments to maintain and to enlarge the industry. T h e amount of this excess seems to have been 10 to 15 percentage points in a majority of the years examined. Such a conclusion is at least partly confirmed by the analysis of Shelby C. Davis, former member of the New York State Insurance Department. He notes that in 1953 the average yield in terms of dividends paid on some dozen leading insurance stocks was 3.33 per cent. However, this payment was made with less than 45 per cent of the investment income of the companies. Over half of the investment income and the underwriting income were retained. Davis estimates that one can expect an average 5 per cent return plus an average 10 per cent annual appreciation from high grade, low risk, dividend-secure insurance stocks.76 T e n to 15 per cent profit on shareholders' equity above what seems to be necessary to sustain a valuable industry is perhaps not unconscionable, but it is a tax on policyholders which seemingly could be lessened by eradicating further some of the restraints in the pricemaking process.77 Selling Costs In the last section we considered the margin between total cost and total revenue for stock insurance companies. T h e total cost estimates necessarily contained the amounts being devoted to selling the product. However, since "acquisition expenses are one of the largest single elements in ultimate premium costs," 78 it seems advisable to examine them in somewhat more detail. Acquisition costs, production costs, selling costs—all often used as synonomous terms in insurance—are fairly clear conceptually. They are not nearly so well defined statistically. As in other spheres of economic activity, selling costs in ™ Op. cit., p. 1138. " T h e 1947-1950 average ratio of profits before federal taxes to stockholders' equity for all private manufacturing corporations was 24.6 per cent. During 1951— 1958, it varied from 15.4 to 27.3 per cent. Economic Report of the President, January 1953, p. 202; January 1954, p. 216; January 1955, p. 192; January 1956, p. 226; January 1957, p. 179; January 1960, p. 221. Recall, however, the statement of Professor Blanchard: "I am not impressed by comparisons between insurance profits and those made on . . . [other goods and services]. T h e inducement needed to secure a supply of those commodities and services may be more or less than is the case in insurance, but it is not relevant." "Losses, Expenses and Profits," p. 50. "Nathaniel L. Goldstein, Attorney General, State of New York, "Opinion on Acquisition Cost Conferences," February 24, 1949, in New York State, Ninetieth Annual Report of the Superintendent of Insurance (Albany: New York State Insurance Department, 1949), I, p. 49a.

180

Variety,

Capacity, Profit, and Selling

Costs

insurance are incurred to persuade a buyer to purchase, and more often to purchase from a particular source. They are not incurred to render a service to the buyer, though as far as they provide him with truthful information to enable rational choice they are providing a useful service.79 Persuasion in insurance largely takes the form of a personal appeal by agents or brokers. Mass appeal by advertising makes up a relatively small part of total selling-cost expenditures for the industry. 80 A

DESIRABLE LEVEL OF SELLING COSTS

It is not any easier to establish a norm for selling costs in insurance than in other sectors of the economy. It is perhaps even more difficult in insurance, for purchasers are typically inexpert in matters involving risk sharing. The product cannot be successfully tested before or during consumption. Under these circumstances, there is a danger of excessive use of resources in sales activities, resulting in wastes for the community. 81 It is not clear how much information would be necessary to enable purchasers to choose rationally between insuring at prevailing prices and assuming risks of loss themselves. T o add to the haze, there is no way to determine what part of the resources being used for selling activities in insurance are providing useful information, and what part are providing no useful information, if not misleading the purchaser. Clearly some selling costs are necessary in nonlife insurance. From a social standpoint, they should not exceed the point where resources so used are yielding a smaller social return than they would in some alternative use. What this means in terms of dollar outlays or percentages of premium dollars, one cannot say. However, if we examine estimated selling costs for various types of insurance organizations, we may be able to suggest what seem to be undesirably high levels of selling costs. In 1958 the average commission rate paid by 370 mutual companies was slightly more than 10 per cent. In the same period, 730 stock companies paid an average of just under 21 per cent. The sum of all " S e e J. Steindl, Maturity and Stagnation in American Capitalism (New York: Augustus M. Kelley, Inc., 1952), pp. 55-57, and Arthur R. Burns, The Decline of Competition (New York: McGraw-Hill Book Company, Inc., 1936), pp. 373-374. 80 In 1958, for example, for capital stock insurance companies the average net sales commission paid was 20.86 per cent of written premiums. Advertising expenses paid were .27 per cent of written premiums. Best's Fire and Casualty Aggregates and Averages (1959), p. 48. 61 See Wallace, op. cit., p. 112.

Variety, Capacity, Profit, and Selling

Costs

181

other expenses of the two types of organizations was the same.82 T h e average selling cost expenditures of mutual organizations may indicate a desirable level of sales expense for the industry. Are insurance buyers satisfied with the information and service they receive from this level of expenditure? Statements by industry analysts and members regarding the present height of stock agency company selling expenditures may also provide further suggestions as to whether the selling costs of these organizations are excessive. W H A T CONSTITUTES SELLING COSTS IN INSURANCE

The commission-paid agents and brokers are frequently considered to represent selling costs in nonlife insurance. But commissions and total sales outlays are not necessarily identical. Other expenses are involved in obtaining new insurance contracts and retaining old contracts. Examples are: salaries of personnel largely engaged in assisting agents and brokers to sell, traveling expenses, offices provided agents and brokers, certain portions of head office and branch office expenses, advertising, and sales promotion. 83 Agents and brokers may also perform services not directly assignable to selling. Extra commissions are allowed certain kinds of agents for providing particular customer services ordinarily handled by company offices.84 Yet commission expenses are not segregated to show this. Nor are the above expenses broken down to show their estimated selling cost content. 85 Lengyel suggests that "theoretically the extreme limits of production costs are given in the charges of an office which stopped the writing of new business as compared with an office in full activity." 86 He admits, however, that this is impractical, and that such extreme limits are probably too wide. Total commissions paid or total commissions paid plus the industry's small advertising expenditures seem to remain the best estimate possible of selling costs. This assumes that the nonselling expenses in commissions are approximately canceled by the selling expenses in the other costs of operating the business. 82 "Operating Expenses," Best's Insurance News, L X , Fire and Casualty ed. (December, 1959), 14-15. 83 See Lengyel, op. cit., p. 98. 84 Agents are often classified as local, regional, or general, with commissions scaled according to whether they render services usually performed by the companies. Competition among companies for desirable agents may result in commission rates to some that include payment for services which are not actually performed. See Kenney, "An Agent Complains About Worship of Percentages in Setting Commissions," p. 16. 86 Advertising is shown separately, but it is relatively small. 80 Op. cit., p. 98.

182

Variety, Capacity, Profit, and Selling

SELLING C O S T L E V E L S IN T H E

Costs

INDUSTRY

The proportion of total cost devoted to selling expenditures varies quite widely among types of organization. It also varies among firms within any type of organization, when the method of selling or the classes of business sold differs. The examination of industry channels of distribution in chapter iii indicated that capital stock agency companies write approximately three-fourths of the total property and casualty insurance sold. These companies sell their services through agents, who are independent contractors.87 Compensation is on the basis of a percentage of total sales. Commissions on both new and renewal policies are generally at the same rate. Commission rates vary by lines of insurance, often being as low as 10 per cent on workmen's compensation insurance and as high as 45 per cent on dwelling fire insurance. Scales seem to have increased through the years, at least up until recent decades.88 Competition has often taken the form of increased commission scales, particularly in generally profitable lines such as dwelling fire insurance. The agent controls the business. He can shift it from one company to another; thus an individual company may find it easier to increase volume by offering a higher commission scale to entice business from other companies.89 If retaliation is slow or spotty, the incentives for this expense-raising type of competition may be quite strong. The pricestabilizing tendencies of collective price making among insurance companies and the strong resistance of agents' associations to commission reductions will curtail price competition and tend to produce market behavior such as competition in commission scales. High commission scales have also had a tendency to increase the number of agents beyond the point where they serve an economic purpose.90 " I n the larger cities, brokers may replace agents; in certain lines of insurance most of the business may be negotiated by brokers. This is true, for example, of ocean marine insurance. William D. Winter, Marine Insurance (3d ed.; New York: McGraw-Hill Book Company, Inc., 1952), p. 111. 88 See Mowbray, op. cit., p. 319. Average fire insurance commissions are shown as 11.3 per cent in 1860-1870, 26.8 per cent in 1930, 24.6 per cent in 1953, and 22.5 per cent in 1958. William H. Wandel, The Control of Competition in Fire Insurance (Lancaster, Pa: Art Printing Co., 1935), p. 67; and Best's Fire and Casualty Aggregates and Averages (1954), p. 34; (1959), p. 40. w Simon K. Whitney, Antitrust Policies (New York: The Twentieth Century Fund, 1958), II, pp. 373-374; U.S. Congress, Senate Subcommittee on Antitrust and Monopoly, Committee on the Judiciary, Hearings, The Insurance Industry, Part 2, Ocean Marine, Rating and State Regulation, 86th Cong., 1st Sess., 1959, p. 1080; Wandel, op. cit., pp. 9-11; Otto, op. cit., p. 61. 80 Wandel, op. cit., pp. 106-107.

Variety,

Capacity,

Profit, and Selling

Costs

183

Entry into this phase of the business is unrestrained. The only requirements are a license and a company to represent. Both of these are obtained easily at most times and in most jurisdictions, although agents usually have to pass an examination to secure a license. This easy entry into insurance sales has not reduced commission scales to any appreciable degree. The explanation for this seems to be the two factors noted above—the influence of agents' associations in maintaining what they consider proper minimum rates and companies competing in terms of higher commissions rather than lower prices for insurance services. INSURANCE AGENCY INCOMES

High sales commission rates do not necessarily mean high dollar incomes for the majority of insurance agencies or brokerage offices. Many are small or part-time and earn relatively low incomes. The results of a study of insurance agencies based on a sample of five thousand agencies in the United States (including Hawaii) and Canada are shown in Table 17. The agencies surveyed had annual sales TABLE

17

INSURANCE AGENCY SIZE AND INCOME 1949 AND 1953

Size» (sales in thousands) $

15-30 30-60 60-100 100-200 200-400 400-1,000 $1,000-1,750

Percentage in each size class

Average income per owner or partnerb (thousands)

1953

1949

1953

1949

9 20 23 28 15 5

9 26 24 24 12 5

$ 1.9-2.0 3.7-4.5 6.5-7.0 7.5-8.4 9.8-11.4 $16.9-17.9

—

—

$ 3.0-4.3 5.6-6.8 7.8-8.1 10.3-10.7 17.1-17.5 18.6-22.0 $18.1-31.6

—

SOURCE: James R. Gregory, What It Costs to Run an Insurance Agency (Indianapolis: The Rough Notes Company, 1954). s The agencies reporting wrote life insurance and earned some income from activities other than the sale of property and casualty insurance; however, the latter seems to have been their principal source of income. Complete details of the study have not been published, but it appears to supply reasonably authentic information on agency size and income. b The two incomes shown per agency member per year are described in the survey as the average income for agencies of less than average profitability and agencies of more than average profitability respectively.

184

Variety,

Capacity, Profit, and Selling

Costs

volumes ranging from $15,000 to $1,750,000. The income shown per agency owner or partner is that before imputed costs for owner's services or invested capital. COMMISSION RATE AGREEMENTS IN T H E INDUSTRY

Nonlife insurance organizations have attempted to limit commission rates by agreement at various times. The primary objective has been to establish maximum commission scales to eliminate competition for business by offering higher commissions.91 Commission agreements were known as acquisition cost conferences. These arrangements were said to benefit the public through restraining increases in expenses which would otherwise occur. The conferences also placed quotas on the number of agents each company might have per geographical area.92 Commission agreements in some lines of insurance, particularly fire, often employed boycotts and sanctions against nonconforming companies, denying them the use of reinsurance and other business facilities.93 After the South-Eastern Underwriters Association case and the McCarran-Ferguson Act, these coercive arrangements were clearly illegal.94 The status of the simple agreements among companies to fix commission rates was in doubt as well. In 1949 the attorney general of New York State, in answer to a request from the superintendent of insurance, offered the opinion that this kind of concerted action was prohibited by a 1948 amendment to New York antitrust law.95 The amendment brought aspects of insurance not regulated by the state within the scope of state antitrust legislation. The attorney general did not feel commission rate agreements were subject to direct regulation by the state department of insurance, thus they were subject to antitrust law. He cited the Socony Oil Company case to support his contention that all unregulated price combinations are illegal per se, regardless of their reasonableness.96 As a result of this ruling in New York, where all major companies operate, commission fixing 91

See Mowbray, op. cit., p. 319. Nathaniel L. Goldstein, "Opinion on Acquisition Cost Conferences," February 24, 1949, in N e w York State, Ninetieth Annual Report of the Superintendent of Insurance, I, pp. 49a-50a. 83 U.S. Senate, Hearings, The Insurance Industry, Part 2, 1959, pp. 919-920. 94 322 U.S. 533 (1944), and Public Law 15, 59 Stat. 33 (1945), as amended by 61 Stat. 448 (1947). 85 Goldstein, op. cit., pp. 47a-48a, and N e w York, General Business Law, art. 22 (Supp. 1948). See also Robert E. Dineen, "Acquisition Cost Conferences—1949 Developments," Insurance Law Journal, N o . 315 (April, 1949), 269-274. 86 United States v. Socony-Vacuum Oil Company et al., 310 U.S. 150 (1940). M

Variety,

Capacity,

Profit,

and

Selling

185

Costs

h a s l o s t m u c h o f its f o r c e . S u c h a g r e e m e n t s as m a y n o w b e i n o p e r a t i o n are essentially partial or tacit, a n d apparently rather ineffective.97 STOCK COMPANY SELLING COSTS T h e average commission r a t e for 7 3 0 stock c o m p a n i e s in 1958 was 20.9 per

cent.

The

total

36.1 p e r cent.98 I n

average

expense

themselves

ratio

for

these

companies

these sales cost ratios d o n o t

was

indicate

the existence of e i t h e r a desirable level o r a n excess level of

selling

costs. W e m a y g a i n suggestions, h o w e v e r , o f w h e t h e r t h e y a r e

higher

than necessary by e x a m i n i n g some of the reactions of stock industry members

company

t o these levels of selling costs. F o l l o w i n g

this

we

shall c o m p a r e average selling outlays of stock insurers a n d o t h e r types of insurers. STATEMENTS ON INDUSTRY SELLING COSTS In

discussing

the expense

portion

of the premium,

an

executive

of

o n e o f t h e s t o c k a g e n c y i n s u r a n c e g r o u p s says, . . . T h e A m e r i c a n A g e n c y System will h a v e to c h a n g e its m e t h o d s of merc h a n d i s i n g so t h a t a larger p e r c e n t a g e of t h e p r e m i u m d o l l a r is r e t u r n e d to policyholders in the form of p a y m e n t for losses. . . . W e n o w e x p e c t to pay o u t for losses a n d the e x p e n s e of h a n d l i n g losses a n d for various taxes . . . exclusive of i n c o m e taxes, b e t w e e n 5 5 a n d 6 5 % of p r e m i u m s . . . . T h e objective should be . . . b e t w e e n 6 5 a n d 7 5 % of p r e m i u m s f o r the average of all classes w r i t t e n by fire a n d casualty c o m p a n i e s . . . . Yes, I a m

talking

a b o u t r e d u c e d commissions . . .09 A n o t h e r representative of one of the larger stock agency

insurance

g r o u p s h a s suggested that, f o r c e r t a i n classes o f i n s u r a n c e , t h e

agents'

97 Milton W . Mays, " T h e Half-Century in Property-Casualty Insurance," Journal of the American Association of University Teachers of Insurance, X V I I I (March, 1951), 48^19. Cf. California League of Independent Insurance Producers et al. v. Aetna Casualty and Surety Company, et al., 175 F. Supp. 857 (N.D. Calif. 1959); 179 F. Supp. 65 (N.D. Calif. 1959). In this case a group of California insurance agents are charging capital stock agency companies with boycott as a result of a 5 per cent reduction in commission scales put into effect by the automobile insurance rate bureau. For the agents' version of this controversy, see "Anti-Trust Action Filed by League," California Agency Bulletin, X X I X (January, 1959), 5-7. See also '"Insurance —Refusal of Insurance Companies to Deal With Agents Except at Fixed Commission Is Boycott Under Section 3(b) of McCarran Act and Subject to Sherman Act," Virginia Law Review, X L V I (May, 1960), 781-783. 98 Best's Fire and Casualty Aggregates and Averages (1959), pp. 38-49, and Operating Expenses," p. 14. " J a m e s F. Crafts, " T h e Great Partnership," Best's Insurance News, LIII, Fire and Casualty ed. (April, 1953), 26-27.

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Capacity, Profit,

and Selling

Costs

compensation be determined by what the policyholder is willing to pay above a net figure. He says, C o u l d they [class rated subjects such as automobiles a n d dwellings] b e rated as a class o n a net rate basis, e n o u g h to cover losses, fixed expenses, a n d a h o p e f u l profit, a n d then the agents could charge the customer whatever they could get for their services above the net figure.100

The National Association of Insurance Agents opposes such a proposal. They see in it the destruction of the agency system as it is presently constituted, for it would be impossible to maintain levels of commission rates if they were divorced from insurance company prices for risk-bearing services.101 Furthermore, it might be a problem to obtain commission payments from customers equivalent to those currently prevailing if commissions were shown separately and were thus available to compare with the service being furnished by the agent. Finally, additional incentives would be provided for companies to begin direct sale of insurance services.102 The capital stock companies do not appear ready to abandon the independent agency system of distribution. T o price insurance on a net basis and let the agent charge whatever he could get for his services would drastically alter the system, if not destroy it. Thus such a sweeping change is not likely. But some capital stock agency groups have formed low-price subsidiaries to sell through their regular agency channels at reduced commission rates and with the use of procedures generally condemned by agents.103 If this practice should become widespread, the independent agency system will have been significantly reshaped. So far, low-price subsidiaries have generally concentrated on automobile insurance, the field in which price competition has been most intense from the organizations with lower selling costs.104 100 John North, President of the Phoenix of Hartford Insurance Group, quoted by Roger Kenney, "A 'Heavy Summons Lies Like Lead' Upon the American Agency System!" United States Investor, February 27, 1954, p. 18. 1(n See Joseph A. Neumann, "The Agent Is Not on Trial," Best's Insurance News, LV, Fire and Casualty ed. (May, 1954), 102. 103 Roger Kenney asserts that ". . . if the American Agency System . . . did not have court decisions to back up its exclusive right to solicit expirations, it might have disintegrated long agol I shall be so bold as to say that there are top executives in the stock fire and casualty field who are viewing with envious eyes this unusual and striking growth of the direct writing mutuals—and if it were not for the prodigious cost involved, would give serious consideration to direct representation." "An Agent 'Rises to Remark' About the Woes of the American Agency System," United States Investor, September 1, 1951, p. 12. 108 Best's Insurance Reports (1959), p. viii, and "Stock Company Groups," Best's Insurance News, LXI, Fire and Casualty ed. (June, 1960), 15. 10t Ibid.

Variety,

Capacity,

Profit, and Selling

Costs

187

M U T U A L C O M P A N Y SELLING COSTS

T h e increasing market share of insurance organizations with lower selling costs has caused capital stock organization representatives to question the levels of selling costs associated with the independent agency system of distribution. Table 18 shows the change in market shares over the last few decades. TABLE 18 DISTRIBUTION OP N O N U F E INSURANCE SALES BETWEEN CAPITAL STOCK AND OTHER FORMS OF ORGANIZATION 1931, 1951, AND 1958

Percentage of total premium volume Year

Capital stock companies

Mutual, reciprocal, and Lloyd's

1931 1951 1958

83.6 74.1 70.8

16.4 25.9 29.2

SOURCE: James F. Crafts, "The Great Partnership," Best's Insurance News, LIII, Fire and Casualty ed. (April, 1953), p. 25, and Alfred M. Best Company, Inc., Best's Fire and Casualty Aggregates and Averages (20th ed.; New York: Alfred M. Best Company, Inc., 1959), p. 1.

During the approximately three decades shown in Table 18, capital stock companies sales expanded 492 per cent while the sales of other forms of organization were expanding 1,245 per cent. 105 One capital stock organization executive attributes the more rapid growth of the nonstock organizations to their appeal to policyholder price consciousness, which he feels those in the independent agency system of operation have not fully appreciated. 106 T h e average commission rate for 370 mutual companies in 1958 was 10.1 per cent; the total average expense ratio was 25.6 per cent. These companies wrote a combined premium volume of $3.1 billion in this year. Comparable figures for 730 stock companies which wrote a total volume of $9.1 billion were 20.9 per cent and 36.1 per cent, respectively. Expenses other than commissions were 15.5 per cent for 105

Best's Fire and Casualty Aggregates and Averages (1959), p. 1. Crafts, op. cit., p. 25.

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Capacity,

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and Selling

Costs

both types of carriers. Thus the total expense advantage of 10.5 percentage points shown by the mutual organizations is attributable to commissions.107 C O M P A R A T I V E G R O W T H O F INSURANCE USING VARIOUS SELLING

ORGANIZATIONS

METHODS

Particularly in the field of automobile insurance, organizations with lower selling costs and lower final premiums have, as a result of this and other savings, shown phenomenal growth in the last decade. Frequently these firms are mutuals, though capital stock and reciprocal exchange organizations are included among them. These organizations, regardless of their legal form, are now frequently known as specialty companies. 108 Table 19 shows the comparative growth of the five largest specialty company groups, the five largest capital stock agency company groups, and all companies combined for the period 1949 through 1959. 109 The specialty company groups shown have concentrated on automobile insurance, though they are now writing an expanding volume of other classes of insurance as well. 110 However, the very rapid rate of growth shown by these organizations in automobile insurance 111 has apparently convinced stock agency companies that to remain in the automobile insurance field they must reduce expenses, especially selling expenses.112 Whether this can be Data taken from "Operating Expenses," pp. 14-15. A specialty company is one utilizing cost-reducing techniques of every kind, such as continuous policies, direct billing, and payment in advance. They write either directly or through exclusive agents who frequently receive initial commissions only. If renewal commissions are paid, they are nominal. T h e company ordinarily has title to renewals. These savings, plus additional ones because of careful screening and classifying of buyers, permit writing insurance at rates of 20 per cent or more below those of the typical stock agency company. See S. Alexander Bell, "Independent's Experience," Best's Insurance News, L X I , Fire and Casualty ed. (June, 1960), 107-110; and U.S. Senate, Hearings, The Insurance Industry, Part 2, 1959, pp. 1242-1245, 1263-1270, 1292-1298, 1356-1359. 109 For additional material on comparative growth rates of different types of organizations, see ibid,., Part 8, 1960, pp. 4944-4945. 110 Ibid., Part 2, 1959, pp. 1242-1245, 1263-1270, 1292-1298, 1356-1359. m B e l l , op. cit., p. 110, estimates that the four largest specialty company groups had at least 30 per cent of the private passenger automobile insurance market at the end of 1959. 112 In 1951 Roger Kenney wrote that "competition of the stock companies with direct writers, agency mutuals and reciprocals of all classes is going to make a lower commission scale mandatory in the months and years ahead." "Smaller Agents' Commissions to Come on Automobile Insurance," United States Investor, August 25, 1951, p. 18. During 1958 the stock company rate bureau began to develop a reduction in the production cost factor of private passenger automobile rates from 25 per cent to 20 per cent in New York State. Interviews with members of the New York State Insurance Department and the National Bureau of Casualty Underwriters, August 107

108

Variety, Capacity, Profit, and Selling Costs TABLE

189

19

COMPARATIVE GROWTH OF L A R G E S T SPECIALTY COMPANY G R O U P S , L A R G E S T STOCK AGENCY COMPANY G R O U P S , AND A L L COMPANIES AND G R O U P S C O M B I N E D 1949-1959

Net premiums written (thousands)

Insurance groups

1949 Specialty groups State Farm» Allstate b Nationwide" Farmers Insurance (Calif.) 0 Government Employees b Total

$

85,547 45,279 47,728 57,651 6,615 242,820

1959 $

Percentage increase 1949 to 1959

471,167 438,581 224,769 175,435 56,959 1,366,911

451 869 371 204 761 463

Largest capital stock agency groups Travelers Aetna Life America Fore-Loyalty d Hartford Fire Continental-National"1 Total

269,323 205,760 225,272 247,220 $ 90,775 $1,038,350

816,977 665,418 537,689 478,286 $ 358,565 $ 2,856,935

203 223 139 93 295 175

Total of all companies and groups—countrywide

$6,356,176

$13,756,810«

116

SOURCES: "Stock Company Groups," Best's Insurance News, L X I , Fire and Casualty ed. (June, 1960), 161; Alfred M. Best Company, Inc., Best's Fire and Casualty Aggregates and Averages (20th ed.; New York: Alfred M. Best Company, Inc., 1959), p. 1; Best's Insurance News, L X , Fire and Casualty ed. (April, 1960), 13, and L X I , Fire and Casualty ed. (July, 1960), 13-14. a Mutual Company group. b Capital stock company group. 0 Reciprocal exchange company group. d Mergers materially affected growth of the group. 6 Estimated. d o n e sufficiently to a p p r o a c h the prices of the specialty

companies,

while a t the same t i m e a n i n d e p e n d e n t c o n t r a c t o r agency system is r e t a i n e d , seems d o u b t f u l . 1 1 3 T h e

a l t e r n a t i v e is t o a d o p t m o r e

m o r e of the techniques of specialty c o m p a n i e s ,

the ultimate

and limit

18-23, 1958. This reduction has since been put into general effect. Bell, op. cit., 110. Agents' groups have been opposed to this change; their most vigorous opposition has been the California antitrust action against insurance companies. See "Full Review of Our Anti-Trust Stand," California Agency Bulletin, XXVIII (July, 1958), 5-8, and footnote 97 above. v* Bell, op. cit., p. 110.

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Capacity,

Profit,

and Selling

Costs

being replacement of the independent contractor agent method of selling. On the average, capital stock agency insurance company selling costs seem higher than necessary. This is especially true if selling costs are considered in conjunction with average profit levels in the industry. Past tendencies to compete in commission rates and numbers of agencies, rather than in the price of insurance, have resulted in many small, high-cost sales outlets. When stock agency companies are subjected to sufficient price competition from lower-cost insurers, strong incentives are created to cease competition in commissions and agents and concentrate on reducing costs. Such a corrective process appears to be underway in automobile insurance. Mowbray emphasizes that if the agent as a middleman can be eliminated and as good a selection and distribution of risks secured, selling expense may be greatly reduced and the price of insurance lowered. 114 If collective action on the part of agents and companies can be made less significant, there is a possibility that the stock agency companies will be subjected to greater pressure to bring selling costs into closer alignment with the information and services insurance buyers seem to wish. This assumes that buyers' ready acceptance of the lower-priced product being offered in automobile insurance is a criterion of their wants and needs. U1

Op. cit., p. 319.

CHAPTER IX

The Results of Past and Present Policy in Nonlife Insurance I n the first part of this chapter we shall summarize the economic performance of the nonlife insurance industry. T h i s will serve as a basis for a discussion of the relationship among industry structure, conduct, and performance. 1 It will also be useful as a point of departure for assessing past and present policy in the industry and suggesting possible policy alternatives and changes needed to improve industry performance. These latter questions will be discussed in chapter x . Summary

of Industry

Performance

T h e performance of the property and casualty insurance industry has been examined in terms of the following dimensions: (1) progressiveness in expanding coverage and services; (2) variety of coverages and combinations of coverages offered and their adaptation to buyers' 1 Market structure refers to the organizational characteristics of the nonlife insurance market, while market conduct refers to the methods used by insurance organizations to adjust to the markets in which they operate. Structure and conduct are not unique, systematically related concepts which define every aspect of a market; rather, they are somewhat flexible categories which permit adaptation to particular problems and situations. Yet there are likely to be some observable relationships between structure, conduct, and performance. For complete discussions of these issues, see Joe S. Bain, Industrial Organization (New York: John Wiley and Sons, Inc., 1959), pp. 4-11, 295-298, 406-423; and Stephen H. Sosnick, "A Critique of Concepts of Workable Competition," Quarterly Journal of Economics, L X X I I (August, 1958), 386-387.

191

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Policy in Nonlife

Insurance

needs; (3) capacity, that is, the relationship between the quantity of capital funds at risk in the industry and the quantity of funds legally and administratively required to furnish the amount of insurance likely to be demanded in the future; (4) profit margins resulting from the pattern of industry costs and prices; and (5) selling costs, that is, the part of total costs devoted to sales activities. For each performance criterion a generally desirable level of achievement was suggested. Wherever possible, a method of measuring industry performance in each dimension was developed. Finally, a comparison was made between the stated desirable level of performance for each dimension and that prevailing in the industry. The conclusions are summarized in the following sections. INDUSTRY PROGRESSIVENESS

Our examination of industry progressiveness was concerned mainly with two things: the development of new insurance coverages or the reformulation and extension of old coverages to widen the extent of loss transference in the economy; and administrative, contractual, and similar types of changes which reduce the cost of providing insurance or increase buyer understanding of and satisfaction from insurance. Unqualified growth in insurance sales has been rapid. This is not as important, however, as progress in the type of insurance product offered by insurers. Here may be one of the more significant factors which can either aid or limit over-all economic expansion. The ability to quantify uncertain possibilities of loss, by reducing them to an insurance premium expense, undoubtedly has a salutory effect on technological development and application. 2 The insurance industry was found to be cautious in its acceptance of new coverages and extensions or regroupings of coverages into patterns other than those long offered by the majority of insurers. Where these types of changes have resulted in the most discussion in the last decade—multiple-line insurance—the industry has moved slowly. The reasons for this are not all the direct responsibility of the industry. Some very important restrictions are found in both the new rigid rating laws and in some of the older legislation that is no longer consistent with the broader underwriting powers granted by multiple-line enabling acts. But indirectly the industry has to accept a large share of the responsibility 2 T h e ability to purchase insurance coverage has been said to be as important to an industrial society as finance, labor, and materials. See for example, "Management Speaks Out On Insurance Problems," Journal of American Insurance, XXIV (December, 1947), 25.

Past and Present

Policy in Nonlife

Insurance

193

for these legislative deterrents. It has either sponsored many such laws or has failed to seek aggressively their appeal. In the two principal areas where social insurance aspects have become more and more important—accident, health, and loss of income insurance and automobile insurance—most of the industry has dogmatically opposed virtually all reforms. It has usually maintained that the ultimate result in each case would be state insurance. In unguarded moments, the admission has been made that workmen's compensation legislation has allowed private insurance to continue in most jurisdictions. There has not been any appreciable tendency for state insurance, monopolistic or competitive, to widen its activities in this field. In terms of the quantity of insurance sold, the industry has made great strides in both of these quasi-social areas. But in terms of the quality of the coverage offered, the number who do not have any or only partial coverage, and the duplication and waste that is involved, there is much to be done. The industry's strong opposition to public measures other than locally administered charity may have hindered the best solution to the problem of achieving the maximum amount of loss distribution. The ultimate solution seems likely to combine public and private approaches. By its stand, the industry may find it has actually narrowed rather than widened the private sphere. In the field of cost-reducing methods, the traditional relationship between company and agent among the stock companies has prevented the instituting of many clearly lower cost practices. They are being aggressively used by some companies, particularly in automobile insurance. Thus it will be possible to see if the buyer is willing to pay 25 to 30 per cent more for the information and service allegedly provided by the independent contractor agent. The conclusion is that the industry has not been as progressive in developing new and better coverages, handled at less expense, as the public has a right to expect. PRODUCT V A R I E T Y

The industry offers a wide variety of coverages. In respect to these, there appear to be opportunities to improve performance in the following ways. There is excessive variation of product in accident and health insurance and perhaps in some other areas. Additional standardization and elimination of some policy features of dubious value would be beneficial. Another distinct improvement would be to fit more systematically the array of insurance products—in terms of separate contracts or any necessary combinations—to the policyholder's

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Past and Present Policy in Nonlife

Insurance

needs. The industry has not developed very effective programs for the orderly allocation of available premium funds to the variety of risks faced by each policyholder. These suggestions for improvement in the variety of product offered by the industry are additions to those made under progress. There it was noted that the industry has been quite slow in developing additional varieties of product which apparently would be beneficial to insurance purchasers. INDUSTRY CAPACITY

Capacity in property and casualty insurance differs markedly from that in industries producing commodities, for only a few physical facilities are required to furnish practically unlimited insurance services.3 From this standpoint, it is correct to say that the supply of insurance is essentially completely elastic. However, state regulation, primarily in the interest of company solvency, requires minimum capital funds before a firm may engage in the business of accepting insurance risks. In addition, most states administratively enforce rulesof-thumb relationships between sales volume and capital funds. These go considerably beyond the required capitalization. All this means that as the industry expands its writings rapidly, policyholders' surplus will be absorbed into the unearned premium liability account to cover the prepaid acquisition expenses. (Most state laws require an unearned premium reserve of 100 per cent of that pro-rata portion of net written premium which is unearned.) Therefore, it is entirely possible for the industry to find itself unable to supply the insurance protection being demanded by the economy. This seems to have been true of the period from the end of World War II until near the mid-fifties. The answer, within the given context of state laws relative to unearned premium requirements, is to expand capital or surplus, and to do it with sufficient foresight so that shortages do not result. Conversely, too much capital may be either placed or left in the industry, leading to upward pressure on premiums to provide traditional rates of return on the total investment in the industry. This may have been true during the 1930's. It is to be noted, however, that excess funds in insurance do not mean unused facilities in the sense that excess capacity ordinarily does in "There are, of course, limits to the supply of insurance service that may be provided by a given level of personnel in the industry. These limits may be quite wide, however, particularly regarding management personnel. See Edith T . Penrose, The Theory of the Growth of the Firm (New York: John Wiley and Sons, Inc., 1959), pp. 49-54. But it may be quite correct to think of personnel—at least that core of trained, experienced people necessary for the industry to function—as a kind of fixed cost for society, representing a form of fixed plant.

Past and Present

Policy

in Nonlife

Insurance

195

the industrial sector of the economy. At most, the impact of extra funds in insurance is the rate pressure just mentioned and competition for high-quality securities, leading to possible changes in their prices and the interest rate. Substantial excess capacity seems unlikely in the next few years. T h e more important consideration is to maintain sufficient funds in nonlife insurance to provide an expanding economy with the opportunity to shift all legitimate risks of loss that are insurable. PROFIT MARGINS

Profit margins are difficult to isolate in the industry. This is the result of a system of accounts geared primarily to regulatory requirements for assuring solvency. A partial or unadjusted profit rate based on sales is the basis of profit tax liability and rate regulation. Insurance firms generally use this partial rate when reporting profits for other purposes, for it tends to be smaller than margins obtained from the use of other bases. Reported data must be adjusted to obtain an approximate rate of return of capital at risk in the industry. It is also necessary to include earnings from industry investments. So far, the industry has been quite successful in keeping regulators from considering investment income. After adjustments and estimates, we tentatively concluded that the average rate of return on capital at risk in the industry has frequently been 10 percentage points or more above what would seem to be necessary to obtain capital, mainly a basic interest return and an estimated return for risk. T h e principal source of this excess seems to be collectively-made rates, which are set to cover the costs of most industry members and are regulated on the basis of total costs plus an unadjusted or partial sales profit. SELLING COSTS

Selling costs make up a large part of the total expense element in property and casualty insurance. Therefore, such costs were examined separately. As with profits, selling costs are not easy to isolate. T h e best estimate seems to be the reported commissions paid plus advertising expenditures. T h e latter item is negligible. Commissions paid do not include some nonsegregated company expenses which are devoted to selling. In some cases, however, they do include certain nonselling services provided by agents or brokers. Perhaps the two cancel each other. In any event, sales commissions are generally viewed as a good approximation of industry selling effort. There is no way to determine an optimum expenditure of resources on selling insurance. T h e product is one about which the average buyer is largely

196

Past and Present Policy in Nonlife

Insurance

uninformed. There are no suitable ways to test it before purchase, or before a loss occurs. This means information is necessary. It also means there exists a danger of excessive and undesirable use of resources in selling. 4 Selling costs may be approached indirectly by examining the sums being spent on selling by the rapidly growing companies selling at lower prices; and the statements of company representatives of the higher selling cost and consequently higher price stock agency companies. These two are obviously interrelated. T h e lower price companies are currently increasing their sales much more rapidly than the stock agency companies, while spending approximately one-half as much on selling activities. This has resulted in frequent declarations by stock agency company executives that selling and other expenses must be reduced. However, the independent contractor agent makes a reduction in commissions most difficult for stock agency companies. T h e agent feels that cost-reducing methods like continuous contracts, direct billing, and payment in advance would undermine his status and lead to direct selling by the companies. Perhaps it would. Anyway, the customary commission scales, averaging approximately 21 per cent of written premiums for capital stock nonlife insurance, seem higher than necessary. Certainly the growth of companies operating at scales of approximately 10 per cent of written premiums suggests this is true. What is the over-all appraisal of nonlife insurance performance? Certainly the industry is within what might be loosely characterized as the limits of tolerance. One cannot say the industry must be drastically changed to make it a useful segment of the economy. There are real opportunities, however, for the industry to supply better and cheaper insurance protection. Alternative proposals to accomplish this will be considered in the following chapter, and a recommendation of the best combination of policy proposals, private and public, will be made. Industry

Structure,

Conduct,

and

Performance

We have concluded that there are significant opportunities to improve performance in nonlife insurance. Profits and selling costs appear to be higher than necessary. Progressiveness in product and cost-reducing methods has lagged. Product variety is perhaps excessive in some 1 Donald Wallace, "Industrial Markets and Public Policy: Some Major Problems," in C. J. Friedrich and Edward S. Mason, eds., Public Policy (Cambridge, Mass.: Harvard University Press, 1940), p. 112.

Past and Present

Policy in Nonlife

Insurance

197

fields. The industry could more effectively assist policyholders to arrange their insurance programs. At times the industry's adjustment to changes in demand for its services has been slow. These market results are influenced by the structure and conduct of the insurance market. MARKET

STRUCTURE

The principal structural characteristics of the nonlife insurance industry were examined in chapters ii, iii, and iv. Briefly summarized, they are as follows (market conduct will be summarized subsequently): NUMBERS OF FIRMS

Numbers of sellers are large. There are more than one thousand separate legal entities selling property and casualty insurance coverages in other than purely local markets. But absolute numbers must be qualified in several ways. Not all of these companies are selling the same classes of insurance. Many of them concentrate on one or a few lines. Thus the total number of companies does not in any way indicate how many competing suppliers there are in any field of insurance. As far as type of organization is concerned, companies that are of any significance in the market are divided into capital stock and cooperative forms of enterprise. Cooperatives are organized as mutuals or reciprocal exchanges. Alien insurers, principally Lloyd's of London, are also important in the American insurance market. Their greatest influence is exerted through reinsurance activities, but London Lloyd's also does an appreciable amount of direct business. Within each major type of organization companies are typically grouped into fleets of from two to a dozen or more legal entities. These groups of companies are commonly owned and managed, so the number of wholly independent decision-making units or firms in the industry is much smaller than the total number of companies, perhaps one-third less. INDUSTRY

CONCENTRATION

As far as market shares are concerned, no one group of companies has a substantial share of the total nonlife insurance market. The four largest groups supply approximately 18 per cent of total insurance service. The 20 largest groups supply approximately 48 per cent. These are over-all estimates and must be qualified by the fact that regional differences and differences in the product mixes of various groups are not taken into account. The pattern of collective action in the industry also makes market concentration data quite inconclusive. The few larger groups may exert a great deal of influence on industry

198

Past and Present Policy in Nonlife

Insurance

prices, contracts, and other variables through their activities in the trade associations. There are suggestions of this,5 but evidence is not available to prove or disprove it. CHANNELS OF DISTRIBUTION

Insurance companies distribute their services to buyers in two basic ways. The stock companies generally sell through independent contractor agents or brokers. Courts have ruled that these agents and brokers are legal owners of the contracts they solicit and place with insurance organizations.6 Therefore, agents and brokers may shift contracts from company to company as sales commission rates or other inducements are changed. Many cooperative organizations and a few stock companies sell through exclusive agents or salaried employees. The agency-company relationship is usually quite different here. The agent represents one company only. He solicits insurance for the company he represents rather than for his agency, and he is generally compensated at a lower commission scale, often receiving different rates of commission on new and renewal policies. In both systems of distribution, sales are made by the agent at quoted prices fixed by his principal. Typically the company will obtain its prices from a rate bureau of which it is a member or subscriber. In some cases large brokerage offices may be a significant factor in negotiating the final price for large insurance accounts. ENTRY AND EXIT

Entry into the nonlife insurance industry is comparatively easy if it occurs in limited area and product markets. Physical capital requirements are small. Capital funds to meet state guarantee requirements depend upon the classes of insurance a firm wishes to write. To enter a regional or national market with a multiple-line charter, an initial fund of capital as high as $5 million may be required. Further sums, perhaps an additional $5 million may be needed for working capital until a large enough portfolio of contracts is developed eFor example, see Roger Kenney, "Is Inflation T o o Much for the Casualty Industry?" United States Investor, March 15, 1952, p. 35; U.S. Congress, Senate Subcommittee on Antitrust and Monopoly of the Committee on the Judiciary, Hearings, The Insurance Industry, Part 2, Ocean Marine, Rating and State Rate Regulations, 86th Cong., 1st Sess., 1959, pp. 1135-1137, 1155-1156, 1260, 1270-1272; Part 3, 1959, pp. 1484-1491, 1538-1548, 1686-1688, 1696-1698. •Independent agents typically represent a number of companies. Brokers are representatives of the buyer; they obtain contracts for their clients from any insurance organization that is willing to do business with them.

Past and Present Policy in Nonlife Insurance

199

to provide a supporting flow of income. Product differentiation disadvantages are likely to be the most important deterrent for a new firm. Scale economies are a potential barrier to entry, but they may not be a real barrier if bureau rates are high enough to cover the costs of virtually all companies. Formerly, firms unwilling to conform to industry price and product practices were denied access to reinsurance, sales outlets, and trade association statistical services. This type of obstacle has been eliminated or greatly reduced since the SouthEastern Underwriters Association case7 and the McCarran-Ferguson Act.8 We concluded that entrants to the multiple-product, national insurance market may find an over-all moderate-to-significant barrier to entry. Entrants to limited-product, local, or regional markets are likely to find insignificant-to-moderate barriers. Exit is not free in insurance. A firm voluntarily retiring from business must have its plans for reinsuring its outstanding contracts approved by state insurance authorities. If a firm is forced to retire because of insolvency, liquidation will generally be handled by state insurance authorities. M A R K E T CONDUCT

The more important aspects of market conduct in nonlife insurance were examined in chapter v. Cooperation is the outstanding feature of patterns of behavior followed by insurance enterprises. Cooperation is fostered by comprehensive trade associations within each organization type in the industry. These associations or bureaus develop prices, contract forms, and perform a host of other activities.9 The capital stock agency companies are likely to be noncompetitive in price and contract forms.10 Mutual and reciprocal-exchange enterprises provide price competition between themselves and stock companies, and within their own types of organizations.11 ' 322 U.S. 533 (1944). 8 Public Law 15, 59 Stat. 33 (1945), as amended by 61 Stat. 448 (1947). 0 Mutual and reciprocal exchange organizations may make use of capital stock company bureau services as subscribers rather than members. This has become possible since the state law changes following the McCarran-Ferguson Act. Ibid. "Capital stock companies are not wholly noncompetitive in price, for there are independent or deviating companies that sell some classes of insurance at prices below those of rate bureaus. a Mutuals and reciprocal exchanges frequently compete by means of dividends at the end of the policy period. This is not as effective as competition in initial price, however. See, for example, U.S. Senate, Hearings, The Insurance Industry, Part 2, 1959, pp. 1215,1228,1250-1251, 1313.

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Past and Present Policy in Nonlife

Insurance

INFLUENCE OF INDUSTRY STRUCTURE AND CONDUCT ON PERFORMANCE

What is the influence of industry structure and conduct on progressiveness, product variety, capacity, profit levels, and selling costs? Progressiveness in product and cost-reducing techniques is presumed to have a connection with the expectation of realizing extra profits from undertaking such changes. Progressiveness is also presumed to depend to some extent on past profits, which allowed an accumulation of funds to permit research and to serve as a cushion against any extra risks which may arise from experimenting with new products and techniques. In insurance past profits have been high enough on the average to permit large accumulations of surplus. Research is neither very extensive nor costly. There will be some additional risk associated with developing new coverages, but accumulations of past profits would seem to be sufficient to compensate for this. Yet progress has been slow. A partial explanation may be the pattern of price and insurance contract development through industry bureaus. Any new coverage or change in coverage typically goes through the bureaus and must be accepted by the majority of members before it is adopted. This often means delay. Furthermore, it means that no one company is apt to benefit very much from developing a new coverage. It will be available to all bureau members at approximately the same time. Cautious, conservative companies can delay, if not prevent, the introduction of new coverages or techniques for long intervals of time. It has been noted that the small bureau or nonbureau companies are often leaders in developing innovations in the industry. 12 Another deterrent to progress is state regulation. This may be more important than market structure and conduct, though the pattern of regulation influences the industry's structure and conduct. The rigid rating laws which most states have adopted since 1945 tend to slow the rate of change. Even though these laws may not always be vigorously enforced, they usually require that rates be filed with state insurance authorities. Filed rates must be substantiated by empirical data. California's experience serves as an illustration of this point. Policy innovations have been frequent in that state compared to other states. California has a liberal regulatory law which does not require that rates be filed with the insurance commissioner.13 Another re12 J. Edward Hedges, "Improving Property and Casualty Insurance Coverage," Law and Contemporary Problems, XV (Summer, 1950), 355. " S e e Margaret Rohrer, State Regulation of Insurance, State of California 1951 Legislative Problems, No. 2 (Berkeley: University of California Bureau of Public Administration, 1951), p. 6. For a summary of statistical filing requirements by states, see U.S. Senate, Hearings, The Insurance Industry, Part 8, 1960, pp. 45144516.

Past and Present

Policy in Nonlife

Insurance

201

strictive aspect of state regulatory laws is the necessity for an essentially national business to comply with varying state laws and interpretations. By the early 1900's, observers were criticizing what they called confusing, burdensome state regulation for its restriction of progress in an interstate industry.14 There have been gains in uniformity through the years, but the industry still operates under a heterogeneous group of regulations and varied interpretations by state regulators.15 There is not any readily apparent market structure or conduct explanation of the industry's performance in regard to product variety. The cooperative pattern of contract form development and approval through trade association bureaus may be an important reason why certain coverages are sold only in combination with others. Why there is excessive product variety of doubtful usefulness for the buyer in some fields is probably not explainable in terms of industry structure and behavior. The importance attached to price uniformity in the industry undoubtedly influences the level of product competition. The pattern appears to be: greatest standardization of product where price competition is least active—fire insurance, for example—and greatest variety where price competition is more active, such as accident and health insurance. Automobile insurance, with its active price competition and, so far, relatively inactive product competition, seems to be an exception. Probably a more important reason for any excessive product variety in nonlife insurance is the nature of the product itself, its unfamiliarity to the buyer, and the impossibility of objectively testing it. The failure of the industry to adjust capacity promptly to demand is perhaps a reflection of the cautious, conservative approach to changing conditions that has been quite typical of a portion of the " F o r e x a m p l e , L . A. Anderson, " C o n s t i t u t i o n a l Aspects of Federal R e g u l a t i o n of I n s u r a n c e C o m p a n i e s , " Proceedings of the National Convention of Insurance Commissioners (1901), p p . 42-60; J o h n F. Dryden, " T h e R e g u l a t i o n of Insurance by Congress," in J o h n F. Dryden, Addresses and Papers on Life Insurance and Other Subjects (Newark: T h e P r u d e n t i a l Insurance C o m p a n y of America, 1909), p p . 175196; S. S. H u e b n e r , " F e d e r a l Supervision a n d R e g u l a t i o n of I n s u r a n c e , " Annals of the American Academy of Political and Social Science, X X V I (November, 1905), p p . 67-95; W . F. G e p h a r t , Insurance and the State (New York: M a c m i l l a n C o m p a n y , 1913), p p . 3-4. w See Noel T . Dowling, "Congress a n d I n s u r a n c e , " Journal of Public Law, V (Spring, 1956), 114; U.S. Senate, Hearings, The Insurance Industry, P a r t 2, 1959, p p . 1051, 1059-1060, 1063-1064, 1072, 1079; P a r t 3, 1959, p p . 1823-1825; P a r t 8, 1960, " S t a t e R e g u l a t i o n of I n s u r a n c e , " S t a t e m e n t s u b m i t t e d by the C o m m i t t e e o n Preservation of State R e g u l a t i o n , N a t i o n a l Association of I n s u r a n c e Commissioners, p p . 4837-5021; U.S. Congress, Senate S u b c o m m i t t e e on Antitrust a n d M o n o p o l y of the C o m m i t t e e o n the J u d i c i a r y , Report, The Insurance Industry, 86th Cong., 2 d Sess., 1960, p p . 174-213, 243-247.

202

Past and Present Policy in Nonlife

Insurance

industry. Conservatism is accentuated through the trade associations and by the pattern of industry regulation. Average industry profit levels that appear to be larger than necessary are explained mostly by price making in concert. The interests of all insurers in a rate bureau must be considered, the least efficient as well as the most efficient. Regulators are concerned primarily with maintaining solvency. Therefore, they are not likely to object to rates which enable most companies to survive, so long as companies are reasonably efficient and rates are not flagrantly high. 17 The amount of price competition provided by independent or deviating companies, mutuals, and reciprocal exchanges has generally been insufficient to put much pressure on uniform price patterns. In recent years this has changed, particularly in automobile insurance and to a lesser extent in certain kinds of fire insurance. The acceptance of sales profit margins as a guide for state rate regulation may also mean that substantial profits on shareholders' equity will go virtually unnoticed. Easy entry will not necessarily operate to drive prices down and reduce profits, because new entrants may find it simpler to charge the stable bureau prices. New firms then compete for a share of the market by paying higher commissions or engaging in other forms of nonprice competition. 18

The industry method of calculating and reporting profit gives an appearance of low profitability, which may have a tendency to keep new capital from gravitating to the industry. Other industries may be making larger excess profits also, in terms of the definition used in this study, so investment in the insurance industry may not be attractive even when something akin to actual profit is estimated. High selling expenditures in the industry may be explained by: independent contractor agent selling by capital stock companies; lack of price competition among stock companies, which means competition for additional business has often taken the form of competition in commission rates and agents; and by the nature of the product, which u During the late 1940's when a lack of underwriting capacity was noticeable in the industry, a company executive was quoted as saying: ". . . The insurance industry is slow to adopt changes . . . but . . . the insurance business also is patient in times of adversity, and . . . its resistance to change serves as an antidote to panic action." J . Victor Herd, quoted in "Management Speaks Out on Insurance Problems," 26. " S e e "State Regulation of the Insurance Business and the Sherman Anti-Trust Act," University of Pennsylvania Law Review, XCVI (December, 1947), 223-230; U.S. Senate, Hearings, The Insurance Industry, Part 2, 1959, pp. 1225, 1228; Charles P. Scully, "The Future of Workmen's Compensation," Insurance Law Journal, No. 440 (September, 1959), 549; Report of the Attorney General's National Committee to Study the Antitrust Laws (1955), pp. 290-291.

Past and Present

Policy in Nonlife

Insurance

203

is susceptible to large selling outlays. The injection of a degree of price competition into an area of insurance seems to lower selling costs and reduce or eliminate competition in commission scales. At least this is the result in automobile insurance today. Industry performance in property and casualty insurance clearly is associated with price-making practices. In the industry this depends mainly on rate bureau activities which have grown up over the years. Such bureaus and their activities are now legally recognized and in form regulated by the states. Deviations from uniform bureau rates and independent rate making are permitted by most state statutes. The processes are cumbersome and open to opposition from groups of competitors, however.18 Channels of distribution in the industry seem especially important for the level of selling costs. There are substantial numbers of sellers in the industry, even when company group operations are taken into account. Entry is comparatively easy. The influence of large numbers of firms and rather easy entry is dampened or nullified, however, by concerted action through trade associations and sale of a large portion of the industry's output by organized independent contractor agents. Past and Present Policy

In the remainder of this chapter we shall briefly examine the private and public policies that have guided nonlife insurance in the past and that serve to guide it today. This discussion will summarize much of the material which has been developed in substantial detail in earlier chapters. This discussion will also be the basis for our examination of policy alternatives in the succeeding chapter. In Paul v. Virginia19 the Supreme Court held a state had the right to regulate a foreign insurance corporation. This set the pattern for a system of state-sanctioned self-regulation in the insurance industry which continued until 1944.20 There were interludes in which particular jurisdictions made some efforts to enforce state antitrust laws against joint action in insurance. 21 All states did not have antitrust laws applying to insurance, however. Many of those who did have 18 See "Insurance—Rate Regulation—Competitors' Standing to Seek Administrative Review of Rate Filings," Michigan Law Review, LVIII (March, 1960), 730-753. " 8 Wall, 168 (1869). M See U.S. Senate, Hearings, The Insurance Industry, Part 2, 1959, pp. 919-920, 1123-1124; Part 3, 1959, pp. 1794-1795. 21 Francis R. Stoddard, "The State Supervision and Regulation of Insurance Rates," Proceedings of the National Convention of Insurance Commissioners (1922), p. 107.

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Insurance

them agreed rather quickly to make them nonapplicable to insurance so long as some gesture at state regulation was made. 22 State antitrust laws which did not exempt insurance were quite successfully avoided by private rating organizations formed to promulgate advisory rates for companies wishing to buy them. 23 Thus private policy in insurance was directed toward uniformity and stability by concerted action on price, product, and other variables. Public policy, which was held to reside in the states, generally adopted the private viewpoint that unrestrained price competition was undesirable in nonlife insurance. 24 Public policy, when it was articulated and applied, was directed toward regulation of the industry's collective activities. This was done with varying degrees of rigor and success.25 Present public policy dates from the South-Eastern Underwriters Association case of 1944. 26 This decision destroyed the fiction that insurance was not commerce and brought the interstate aspects of the business within federal law. The industry's request for complete exemption from federal antitrust law was not granted, though the request was given serious consideration.27 Compromise legislation granted an exemption to the extent that the industry is regulated by state law. 28 The Sherman Act applies to boycott, coercion, or 22 See James B. Donovan, "Regulation of Insurance under the McCarran Act," Law and Contemporary Problems, XV (Autumn, 1950), 483^184, and Clarence W. Hobbs, "State Regulation of Insurance Rates," Proceedings of the Casualty Actuarial Society, X I (June, 1925), pp. 218-221, 272-274. 23 Stoddard, op. cit., p. 107; and Spencer L. Kimball and Ronald N. Boyce, " T h e Adequacy of State Insurance Rate Regulation: T h e McCarran-Ferguson Act in Historical Perspective," Michigan Law Review, LVI (February, 1958), 549. 24 T h e Merritt Committee Report of New York State is usually cited as the first important, official recognition of the fact that competition in rates had been largely closed by private combination and that this was probably in the public interest in terms of a more stable insurance industry. See New York, Report of the Joint Committee of the Senate and Assembly, Legislative Document No. 30 (1911), I, pp. 108, 125. See also New York State Insurance Department, Examination of Insurance Companies (New York: New York State Insurance Department, 1953), I, pp. 112-113. 25 For a summary of the history of insurance regulation, see Edwin W. Patterson, The Insurance Commissioner in the United States (Cambridge, Mass.: Harvard University Press, 1927), Appendix A, pp. 513-537. See also James B. Donovan, "Insurance—The Case in Favor of Existing Exemptions from the Antitrust Laws," Federal Bar Journal, X X (Winter, 1960), 59-60. 28 U.S. v. South-Eastern Underwriters Assn., 322 U.S. 533. 27 See U.S., Congress, Joint Subcommittee of the Committees on the Judiciary, Hearings on S. 1362, H. R. 3269, and H. R. 3270, Parts 1-6, 78th Cong., 1st and 2d Sess., 1943-1944; and Frank H. Elmore, "How Insurance Became Commerce," Journal of American Insurance, X X I I (July, 1945), 20. 28 Public Law 15 (McCarran-Ferguson Act), 59 Stat. 33 (1945), Sec. 2(b), as amended by 61 Stat. 448 (1947). For discussions of what the term regulation by State law may mean, see Kimball and Boyce, op. cit., 545-578; Franklin P. Michels, "Insurance—

Past and Present Policy in Nonlife Insurance intimidation.29

Thus

the industry's antitrust e x e m p t i o n

205 is t o

some

e x t e n t i n c o m p l e t e as well as p r o v i s i o n a l . 3 0 B u t p r e s e n t p o l i c y , p u b l i c a n d p r i v a t e , differs f r o m t h e p a s t o n l y in d e g r e e . S t a t e r e g u l a t i o n has b e e n s t r e n g t h e n e d , at least in f o r m . 3 1 P r i v a t e s e l f - r e g u l a t i o n has b e e n w e a k e n e d . B u r e a u a c t i v i t y c o n t i n u e s , t h o u g h it is specifically b r o u g h t w i t h i n t h e states' licensing a n d r e g u l a t o r y p o w e r s . I n d u s t r y

weapons

a g a i n s t n o n c o n f o r m i n g firms h a v e "been b l u n t e d o r e l i m i n a t e d . I n d e pendent action through rate deviations a n d independent rate

filings

has b e e n g e n e r a l l y r e c o g n i z e d a n d g i v e n b r o a d e r s c o p e . 3 2 A p p r o x i m a t e l y a d e c a d e a n d a h a l f h a v e e l a p s e d since t h e S o u t h Eastern

Underwriters

Association

decision.33

This

is

undoubtedly

insufficient t i m e f o r all t h e results t o h a v e d e v e l o p e d . C l e a r l y ,

the

d e c i s i o n has h a d beneficial effects in r e d u c i n g t h e level o f r e s t r i c t i o n s T h e Case Against Broad Exemptions from the Antitrust Laws," Federal Bar Journal, X X (Winter, 1960), 71; Donovan, "Insurance—The Case in Favor of Existing Exemptions from the Antitrust Laws," pp. 61-64. 28 Public Law 15, sec. 3(b). 30 In 1958 the U.S. Senate Subcommittee on Antitrust and Monopoly of the Committee on the Judiciary began a general study of the insurance industry, to examine "the manner in which the states have exercised their stewardship over the business of insurance." Statement of Senator Joseph C. O'Mahoney, Hearings, The Insurance Industry, Part 1, 1958, p. 3. 81 Kimball and Boyce, op. cit., pp. 556, 565, 576, point out that state regulation still varies widely and can scarcely be called adequate in many states. See also U.S. Senate, Report, The Insurance Industry, pp. 246-247. 83 Joel B. Dirlam and Irwin M. Stelzer, " T h e Insurance Industry: A Case Study in the Workability of Regulated Competition," University of Pennsylvania Law Review, CVII (December, 1958), 199-215, are optimistic concerning the changes that are occurring in the industry under the modified state regulation, which resulted from the South-Eastern Underwriters Association decision and the McCarranFerguson Act. Cf. "Insurance—Rate Regulation-—Competitors' Standing to Seek Administrative Review of Rate Filings," pp. 730-753, which queries the amount of active price competition expected under deviation and independent rate filing procedures which recognize rate bureaus or competing insurers as interested parties with a right to challenge price reductions. See also U.S. Senate, Hearings, The Insurance Industry, Part 2, 1959, pp. 1124-1125, for the testimony of an executive of a deviating stock company that self-control continues in the industry through the system of rate bureaus acting under the protection of state laws. Louis B. Schwartz, Report of the Attorney General's National Committee to Study the Antitrust Laws (1955), p. 290, comments, "Most assuredly state regulation is not going to provide any substitute for competition in keeping insurance rates down. In the first place, state regulation is primarily concerned with the financial security of the insurers, i.e., adequacy of reserves and propriety of investments. Gradually the industry has swung the state regulators towards the notion that the best way to guarantee safety is to prevent rate cutting." (Italics in the original.) Clair Wilcox, Public Policies Toward Business (Homewood, 111.: Richard D. Irwin, Inc., 1955), p. 603, feels that state insurance rate controls are likely to be ineffective, for the power to formulate rates is largely delegated to rate bureaus. T h e result is that the public is protected neither by competition nor effective regulation. 83

322 U.S. 533 (1944).

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in Nonlife

Insurance

in the industry and in enlarging the scope of independent action.34 The effect on over-all industry performance has not been marked as yet, however. Average profit and selling cost levels have not changed appreciably.36 Progressiveness may have been slowed further by tighter control laws. The basic feature of previous private policy is still in effect—joint action on price and other important variables.36 Presumably such concerted action is more closely regulated now. 37 Overall market results in the industry do not yet indicate that this is necessarily true. 84 T h e South-Eastern Underwriters Association case seems to have been an instance of antitrust enforcement in which economic analysis, by design or accident, came into play along with legal analysis. For a discussion of the need for more economic analysis in antitrust enforcement, see E. T . Grether, "Economic Analysis in Antitrust Enforcement," Antitrust Bulletin, IV (January-February, 1959), 55-76. See also Edward S. Mason, "Market Power and Business Conduct: Some Comments," American Economic Review, XLVI (May, 1956), 471-481, and Kingman Brewster, Jr., "Enforceable Competition: Unruly Reason or Reasonable Rules?" American Economic Review, XLVI (May, 1956), 482^89. 86 See chap. viii. 86 U.S. Senate, Hearings, The Insurance Industry, Part 2, 1959, pp. 1124-1125. " R o b e r t Kramer, "Foreword," Law and Contemporary Problems, XV (Autumn, 1950), 471-472, commented, "It remains to be seen whether state administrators, with their new powers over insurance, will permit themselves gradually to become spokesmen primarily for the insurance business." Professor Schwartz in the Report of the Attorney General's National Committee To Study the Antitrust Laws, p. 290, suggests state regulators have been swung toward the viewpoint of the companies on rate questions.

CHAPTER X

Policy Alternatives and Suggestions

In the previous chapter we discussed the relationship of industry performance to market structure and conduct in nonlife insurance today. W e also examined the public and private policy which is associated with market structure in the industry, and which to a considerable extent constitutes market conduct in the industry as well. T h i s policy, public and private, conditions and shapes structure at the same time that it reflects structure and affects performance. 1 Opportunities to improve performance in the nonlife insurance industry appear to be present. In this chapter we shall examine some policy alternatives and attempt to analyze what their effects might be on industry structure, conduct, and performance. 2 W e are interested primarily in improving performance; to see whether an alternative policy is likely to lead to better results, it is necessary to consider structure and conduct aspects of the proposed change. 3 In later sections we shall consider the application to nonlife insurance today of some of the policies that have been tried, at least in 1 F o r a discussion of the interrelationship of structure, conduct, and performance, and the various directions of causality among them, see Stephen H. Sosnick, "A Critique of Concepts of Workable Competition," Quarterly Journal of Economics, LXXII (August, 1958), 386-387. 1 A variety of public policies is discussed in Donald Wallace, "Kinds of Public Control to Replace or Supplement Anti-Trust Laws," American Economic Review, X X X (March, 1940), 194-212; Joe S. Bain, Industrial Organization (New York: John Wiley and Sons, Inc., 1959), chaps. 13-15; Martin L. Lindahl and William A. Carter,

Corporate Concentration and Public Policy (3d e d . ; E n g l e w o o d C l i f f s , N . J . : P r e n t i c e -

Hall, Inc., 1959), chaps. 26-27. "Sosnick, op. cit., pp. 395-415.

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208

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Alternatives

and

Suggestions

part, in the past and some of the policies that have been advocated at various times. Then a combination of policies that appears to offer the best prospect of improving industry performance will be discussed. Some Policy

Alternatives

Three broad, quite distinct types of public policy changes that might be made in nonlife insurance are: (1) substitute major federal regulation (all interstate aspects of the business) and minor state regulation for the present division of responsibilities, which is major state regulation and minor federal regulation; (2) have government provision of many more, if not all, nonlife insurance services; and (3) establish a fully competitive market in the industry by removing the existing antitrust exemption. Each of these will be discussed in turn. FEDERAL

REGULATION

If federal regulation of all of the interstate aspects of nonlife insurance should replace the present system of delegated state regulation, several results would be expected to follow. 4 4 There is a staggering amount of material on the subject of federal versus state regulation in the insurance field and in general. For representative examples, see L. A. Anderson, "Constitutional Aspects of Federal Regulation of Insurance Companies," Proceedings of the National Convention of Insurance Commissioners (1901), pp. 42-60; S. S. Huebner, "Federal Supervision and Regulation of Insurance," Annals of the American Academy of Political and Social Science, XXVI (November, 1905), 67-95; John F. Dryden, Addresses and Papers on Life Insurance and Other Subjects (Newark: T h e Prudential Insurance Company of America, 1909); Rainard B. Robbins, "Federal vs. State Supervision of Insurance," Proceedings of the Casualty Actuarial Society, XXV (May, 1939), 313-338; "Chicago Bar Panel Discusses Federal Supervision," Journal of American Insurance, XXI (February, 1944), 15-16, 18; John W. Cowee, Federal Regulation of Insurance, Wisconsin Commerce Reports, Vol. II, No. 3 (Madison: University of Wisconsin Bureau of Business Research and Service, 1948); L. B. Orfield, "Improving State Regulation of Insurance," Minnesota Law Review, XXXII (February, 1948), 219-261; "Regulation of Insurance: Another Jurisdictional Battleground?" Journal of Public Law, V (Fall, 1956), 494-503; Margaret Rohrer, State Regulation of Insurance, State of California 1951 Legislative Problems, No. 2 (Berkeley: University of California Bureau of Public Administration, 1951); Arthur Vorys, "Insurance Supervision and Current Trends," Insurance Counsel Journal, XXVI (January, 1959), 4348; Robert N. Gilmore, Jr., "Federal vs. State Regulation," Best's Insurance News, LX, Fire and Casualty ed. (May, 1959), 111-116; "Insurance—Regulation— T h e Extraterritorial Effect of Insurance Regulation, with Particular Emphasis on New York," Michigan Law Review, LVIII (February, 1960), 558-570; Ben W. Lewis, "The Bogie of Federal Regulation," Public Utility Fortnightly, August 31, 1933, pp. 252-259; Franklin H. Cook, Principles of Business and the Federal Law (New York: Macmillan Company, 1951), chaps, ix-xi; Merle Fainsod, Lincoln Gordon, and Joseph C. Palamountain, Jr., Government and the American Economy (3d ed.; New York: W. W. Norton and Company, Inc., 1959), chap. 9.

Policy

Alternatives

and Suggestions

209

First, supervision might be expected to be simpler, more efficient, and cheaper as one regulatory body replaces numerous state organizations. An important weakness of present-day regulation is the variation in standards and abilities among the states, despite attempts to achieve uniformity.5 The caliber of regulatory personnel in state commissions is often not as high as desirable because of small state budgets, a shortage of properly qualified individuals, the practice of making political jobs out of key commission posts, and better opportunities in the industry itself. Many state commissioners are enroute to or from an industry post.6 Presumably some of these factors would improve under federal regulation. Second, interstate barriers to the insurance business would be largely eliminated. Such uneconomic devices as countersignature laws, which require that a local agent be paid part or all of the commission on insurance accounts in his state written by an out-of-state agent, would be removed.7 If federal regulation included issue of national corporate charters for interstate insurers, then the conflicting corporate requirements, asset deposit laws, tax laws, and guarantee capital rules of the states would be nullified. 8 Third, company solvency would presumably be more easily assured. One central agency would be setting standards and making examinations to see that they are met.9 6 See Spencer L. Kimball a n d Ronald N. Boyce, " T h e Adequacy of State Insurance R a t e Regulation: T h e McCarran-Ferguson Act in Historical Perspective," Michigan Law Review, LVI (February, 1958), 556, 565; and U.S. Congress, Senate Subcommittee on Antitrust and Monopoly of the Committee on the Judiciary, Hearings, The Insurance Industry, Part 2, Ocean Marine, R a t i n g and State R a t e Regulation, 86th Cong., 1st Sess., 1959, p. 1060-1061; cf. Part 8, 1960, "State Regulation of Insurance," Statement submitted by the Committee on Preservation of State Regulation of the National Association of Insurance Commissioners, November, 1959, pp. 4837-5021; U.S. Congress, Senate Subcommittee on Antitrust a n d Monopoly of the Committee on the Judiciary, Report, The Insurance Industry, 86th Cong., 2d Sess., 1960, p p . 109-247. " E d w i n W . Patterson, Essentials of Insurance Law (2d ed.; New York: McGrawH i l l Book Company, Inc., 1957), p. 9; a n d U.S. Senate, Report, The Insurance Industry, p p . 129-132. ' F o r a discussion of resident agent laws, see "Resident Agent Laws," Columbia Law Review, XXXVII (April, 1937), 681-686; a n d "Insurance—Regulation—The Extraterritorial Effect of Insurance Regulation, with Particular Emphasis on New York," p. 569. T h e s e laws were held constitutional in Osborn v. Ozlin, 310 U.S. 53 (1940). 8 See George W . Stocking a n d Myron W. Watkins, Monopoly and Free Enterprise (New York: T h e T w e n t i e t h Century F u n d , 1951), p p . 446, 507-508; L i n d a h l and Carter, op. cit., p p . 656-657; U.S. Senate, Hearings, The Insurance Industry, Part 2, 1959, pp. 1070-1072, 1075-1077. " T o minimize the inherent difficulties involved in state insurance commissions examining a n interstate business, state insurance authorities have cooperated to work out geographical zone procedures for conducting insurance company exami-

210

Policy Alternatives

and

Suggestions

And fourth, some control of alien organizations such as London Lloyd's might be possible. At least, international reinsurance and the direct writings of nonadmitted alien insurers would not pose as great a problem to the federal government as it presently does to the states.10 States are now unable to agree whether insurers should be allowed to take credit for reinsurance placed with reinsurers outside the states' jurisdiction. The insurance industry long sought federal regulation to escape from the conflicting jurisdictions of the several states in which most major companies do business.11 Courts consistently held that states had the right to regulate the business. It was not until 1944 that a clearcut national issue was presented to the Supreme Court. It then held, in contrast to early dicta, that insurance was commerce and subject to federal law.12 By this time support for state regulation was widespread in the industry. 13 A number of arguments have been made favoring state regulation: insurance is essentially a local transaction and should be locally regulated; a dual system would result from federal regulation, with additional confusion and expense; federal regulation would deny opportunity for local experiment; the states would lose revenue; and state regulation is less bureaucratic. 14 There seems to be little merit to many of these arguments. They are either not true or need not be true under properly drawn and administered federal regulation. 15 That they are chiefly rationalizations is indicated nations. T h e results have not been entirely satisfactory. See ibid., pp. 1062-1064, 1067-1069; Roger Kenney, "More Sense and Less Politics in Convention Examination of Insurance Companies!" United States Investor, February 3, 1951, pp. 11-14; Kenney, "The Battle of the Potomac," ibid., October 26, 1959, pp. 65-64; U.S. Senate, Report, The Insurance Industry, pp. 176-179. For a description of examination procedures, see New York State Insurance Department, Examination of Insurance Companies (New York: New York State Insurance Department, 1953), II, pp. xiii-xxx, 129-549, 587-639. 10 Roger Kenney, "A Word of Warning About These Latter Day 'Lloyd's Cover Notes,'" United States Investor, July 11, 1959, pp. 47-52, and "Some 'Second Thoughts' on Senate Subcommittee Hearings on Insurance," ibid., August 22, 1959, p. 23; U.S. Senate, Hearings, The Insurance Industry, Part 3, 1959, pp. 1496-1518. "Huebner, op. cit., pp. 70-73, 92-95, and John F. Dryden, "The Regulation of Insurance by Congress," in Dryden, Addresses and Papers on Life Insurance and Other Subjects, pp. 176-177, 186, 189, 192. u U.S. v. South-Eastern Underwriters Assn., 322 U.S. 533 (1944). 13 Robbins, op. cit., pp. 322-324, and Ralph H. Blanchard, "Governmental Regulation of Insurance," Journal of American Insurance, XXII (May, 1945), 15. " F o r example, see U.S. Senate, Hearings, The Insurance Industry, Part 2, 1959, pp. 1197-1198. 15 For a discussion of the technique of groups which maintain that a certain function belongs to the states even though it is clear they cannot handle it adequately, see U.S. Congress, Temporary National Economic Committee, Economic Power and Political Pressures, Monograph No. 26 (1941), pp. 10-14.

Policy

Alternatives

and Suggestions

211

by the following statement of Chase M. Smith, general counsel of the Lumbermans Mutual Casualty Company: "The case for state supervision is that it is here, we have it, it is an established system, and for at least two generations we have developed it and gotten accustomed to it. Even if it is bad, we are used to it." 16 Clearly, there seem to be advantages to federal regulation of the interstate features of an antitrust-exempt insurance industry. If the only alternative to current policy were substitution of federal for state regulation, the change would appear to be beneficial. There are combinations of alternatives, however, which offer better possibilities for improving industry performance. GOVERNMENT

INSURANCE

Another possibility is state insurance. T h e state, that is, various governmental bodies, now provides protection against loss in a number of fields—principally the types of risks the private industry has been unable or reluctant to assume. Examples are war insurance, certain kinds of crop insurance, and mortgage and credit insurance. State insurance as a policy alternative for the industry would include far more than this. One alternative would be complete government insurance through nationalization of all aspects of the business. A less thoroughgoing alternative would be enlargement of competitive government insurance facilities. These are now largely confined to the field of workmen's compensation insurance. T h e former alternative, nationalization, is not realistic in the United States today. It is not clear that it offers any advantages in the present American mixed enterprise system, and there are many disadvantages in terms of the political and practical obstacles to putting such a change in operation. Many countries—for example, France, Germany, Norway, Belgium, England, Australia, and New Zealand —provide either monopolistic or competing state insurance facilities for many forms of insurance.17 In these countries, however, the concept of what constitutes the public responsibility and the quantity of trained and responsible civil servants in the field of insurance differs from that in the present-day United States. This is not to say that state insurance might not become feasible at some future time. 18

"Chicago Bar Panel Discusses Federal Supervision," p. 18. See W. F. Gephart, Insurance and the State (New York: Macmillan Company, 1913), pp. 15-21; Orfield, op. cit., 241; Alan T . Peacock, The Economics of National Insurance (London: William Hodge and Company Limited, 1952), pp. 36-42; Alfred 17

J. B o h l i n g e r a n d T h o m a s C. M o r r i l l , Insurance Supervision and Practices in England

(New York: New York State Insurance Department, 1948).

212

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Suggestions

Enlargement of competing state insurance facilities might be a useful device to consider. In fields where private insurance has proven particularly unprogressive or costly, the formation of competing state insurance funds offers an opportunity to provide an incentive for improved industry performance. Competitive workmen's compensation insurance funds now exist in eleven states.18 State compensation insurance laws differ quite widely, so it is difficult to generalize regarding the effect of these state facilities on the performance of private insurance. Furthermore, the number of instances and the limited scope of these examples of state insurance competition are much too small to serve as a basis for assessing the efficacy of such a policy. Selective use of competing state insurance enterprises seems to merit careful consideration among any group of proposals designed to improve the market results of private insurance.19 A COMPETITIVE INSURANCE MARKET

In its simplest and most complete form, a policy of competition would require industry members to act independently in matters of data collection, data interpretation, price formation, and so on. Such a policy would remove the industry's antitrust exemption under the McCarran-Ferguson Act.20 At various times in the past some states tried enforcing competition, with very little success.21 But one would not expect individual states to be able to enforce antitrust policies 18 Arizona, California, Colorado, Idaho, Maryland, Michigan, Montana, New York, Oklahoma, Pennsylvania, and Utah. 18 See Frank Lang, Workmen's Compensation Insurance: Monopoly or Free Competition? (Chicago: Richard D. Irwin, Inc., 1947), chap, i, for a discussion of state insurance in workmen's compensation. 20 59 Stat. 33 (1945), as amended by 61 Stat. 448 (1947), sec. 2(b). Certain conduct of marine insurance companies is also exempt from antitrust law under the Merchant Marine Act, 41 Stat. 1000 (1920), sec. 25. For discussions of the antitrust exemption in insurance as well as antitrust exemptions in general, see Clair Wilcox, "The Verdict on Antitrust and Its Significance," American Economic Review, XLVI (May, 1956), 490-491; William L. McGovern, "Antitrust Exemptions for Regulated Industries," Federal Bar Journal, XX (Winter, 1960), 10-17; G. Warren Nutter, "Monopoly, Bigness, and Progress," Journal of Political Economy, LXIV (December, 1956), 524; Report of the Attorney General's National Committee to Study the Antitrust Laws (1955), pp. 261-293; Carl Kaysen and Donald F. Turner, Antitrust Policy: An Economic and Legal Analysis (Cambridge, Mass.: Harvard University Press, 1959), pp. 189-213, 289-291; James B. Donovan, "Insurance—The Case in Favor of Existing Exemptions from the Antitrust Laws," Federal Bar Journal, XX (Winter, 1960), 56-65; and Franklin P. Michels, "Insurance—The Case Against Broad Exemptions from the Antitrust Laws," Federal Bar Journal, X X (Winter, 1960), 66-73. 21 Francis R. Stoddard, "The State Supervision and Regulation of Insurance Rates," Proceedings of the National Convention of Insurance Commissioners (1922), p. 107.

Policy Alternatives

and Suggestions

213

against an interstate industry. T h e industry was also quite successful in convincing those states which did undertake reasonably vigorous enforcement that active rate competition inevitably leads to widespread bankruptcies in the industry, with consequent detrimental effects for policyholders and state revenues. If federal antitrust legislation were enforced in the industry, it would be likely to force prices, profits, and selling costs down. However, if each company were required to use its own statistics for establishing probability estimates of future losses, there probably would be a deterioration in such estimates, and consequently in the quantity and quality of insurance service. This would be particularly true of the smaller enterprises that will not ordinarily sell a large enough volume of most classes of insurance to obtain reliable probabilities of future losses. Larger groups of companies that have been in operation for long periods would perhaps not be very seriously handicapped. Federal and state governments and the industry have been in nearly complete agreement on the desirability of pooling loss experience.22 This seems to be justified. Once the desirability of pooling loss data is conceded, however, a policy of active price competition becomes difficult if not impossible unless additional steps are taken to see that pooling stops with loss data. There will be a constant temptation to enlarge pooling of loss data to include expense data and price making as at present.23 It is unrealistic to expect continuous, effective price competition in the industry as long as loss statistics are gathered and processed by industry-sponsored and controlled bureaus.24 A policy of enforced independent action in nonlife insurance might mean that price reductions in the industry would be carried beyond the point of weeding out inefficient firms. If forced failures became numerous, some policyholders would suffer, at least during the transition to a new equilibrium in the numbers of firms in the industry. This will be discussed further in the next section. The possibility of price cutting leading to monopoly through the elimination of most of the firms in the industry seems quite unlikely with the industry's entry conditions, ratio of fixed to variable costs, and type of product. 25 23 U.S. Senate, Hearings, The Insurance Industry, P a r t 3, 1959, p p . 1 4 3 1 , 1 8 4 0 1 8 4 3 ; Report of the Attorney General's National Committee to Study the Antitrust

Laws, pp. 290-291. "Ibid.,

p. 291.

See U.S. Senate, Hearings, The Insurance Industry, Part 3, 1959, pp. 1605-1610; Stocking and Watkins, op. cit., pp. 254-255. 25 Kaysen and Turner, op. cit., pp. 195-196. Cf. U.S. Senate, Hearings, The In21

surance Industry, P a r t 3, 1959, p. 1465.

214

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and

Suggestions

Still, a policy requiring insurance enterprises to act independently in all phases of their operations does not seem to be either a practical or a desirable alternative. T o do so would mean foregoing gains in predictability from massed loss statistics. Continuous, effective price competition is desirable and probably necessary in all branches of private insurance to promote efficiency and to keep prices at the lowest possible levels. Nonprice competition, which is heavily emphasized in the industry, is likely to be an inefficient means of achieving these goals.26 Rate regulation, imposed through state commission review of insurance rates developed and proposed by the interstate industry, is also likely to be a cumbersome and ineffective way to bring about efficiency and low prices. This is particularly true when the industry is the sole source of the information (in most cases industry trade associations are appointed as the statistical agency for the states) by which rates are judged. 27 Rate regulation as a device for achieving efficiency and low prices is difficult if industry output is largely a simple, fairly homogeneous product produced by one or a few enterprises, as is the case in most industries recognized as public utilities. 28 The complexity of rate regulation grows if industrial output is a variety of products produced by numerous enterprises with differing cost structures. The result of rate regulation in an industry such as nonlife insurance is likely to be a high degree of rate uniformity, either permitted or imposed.29 Otherwise, regulation becomes impossible.30 Thus active price competition becomes very useful for a private insurance industry such as exists in the United States today. Yet this competition should not be at the expense of maximum efficiency in the estimation of future losses in the various branches of the industry. Independent action in regard to collection and processing of loss data seems likely to lead to deterioration in loss prediction. At the same time, collaboration in this aspect of industry operations seems even more likely to lead to deterioration in price competition. Rate regulation at the state level 28 See Lindahl and Carter, op. cit., pp. 404-408; William H. Rodda, "Multiple Line Underwriting—Rating Methods," Journal of Insurance, X X I V (September, 1957), 143; N e w York State Insurance Department, Examination of Insurance Companies, I, p. 75; Report of the Attorney General's National Committee to Study the Antitrust Laws, p. 291; U.S. Senate, Hearings, The Insurance Industry, Part 2, 1959, pp. 916, 1051-1055; Simon K. Whitney, Antitrust Policies (New York: T h e Twentieth Century Fund, 1958), II, pp. 357-359. 27 U.S. Senate, Hearings, The Insurance Industry, Part 3, 1959, pp. 1601-1602, 1608-1610, 1641-1642, 1895-1898. 28 See Bain, op. cit., pp. 589-602. 29 Whitney, op. cit., p. 355. B0 U.S. Senate, Hearings, The Insurance Industry, Part 3, 1959, pp. 1888, 1895-1897.

Policy

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and Suggestions

215

cannot be expected to substitute for effective price competition in an interstate industry. Thus we are led to examine a combination of policies which offer the possibility of the gains from pooling loss statistics and yet do not continually endanger the benefits of price competition. A Suggested Policy Combination A combination of policies might eliminate or mitigate the undesirable features of any one approach, and yet realize the opportunities offered by each for achieving better economic results. The combination of policies suggested here is based on the assumption that every possibility of utilizing the effectiveness of competition should be explored before it is irrevocably supplanted by federal or state regulation. More regulation per se does not offer attractive possibilities, unless all else has clearly failed.31 More regulation in insurance since 1945 has not brought about sweeping changes; improvements over the previous ineffectively regulated private collectivism have been associated mainly with the increasing scope for independent action in the industry.82 The policy combination suggested here is a threefold one. It should be considered as a single proposal, however, with any one of its three facets being essentially equally important. The three aspects of the proposal are: (1) industry-wide independent action in the expense and profit portions of insurance premiums; (2) collection and processing of loss statistics by a federal agency in which industry members are represented along with public representatives; and (3) federal regulation of the interstate aspects of the business, focusing on the establishment and enforcement of financial standards. The three parts of this proposal are interdependent, and any one of them alone, with the exception of the last one, is not likely to yield substantially better industry results. INDEPENDENT ACTION IN EXPENSES AND PROFITS

The expense ratios and profit margins of various companies cannot conceivably be the same. T o collaborate on this portion of the price of insurance means that the expenses of most collaborating companies will be covered. Resulting premium rates will be higher on the average a See Ben W. Lewis, "State Regulation in Depression and War," American Economic Review, XXXVI (May, 1946), 402-404, and Bain, op. cit., pp. 601-602. 82 Joel B. Dirlam and Irwin M. Stelzer, "The Insurance Industry: A Case Study in the Workability of Regulated Competition," University of Pennsylvania Law Review, CVII (December, 1958), 199-215.

216

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and

Suggestions

than they would be if each company used its own expense data to establish its rates. Rate deviation and independent rate-filing procedures in most states now permit firms with lower expense ratios (in some cases lower loss ratios might also be acceptable) to reduce premium rates. We have seen that in some branches of nonlife insurance, particularly automobile insurance, a significant amount of price competition has developed in this way. Much more may develop if these provisions are liberally administered. Yet there are serious obstacles to this method of price competition which make it costly and uncertain for firms using it and, undoubtedly, prevent many price reductions that would otherwise take place.33 Mutual and reciprocalexchange organizations often make differences in expense ratios effective by paying policyholder dividends at the end of the policy term. We noted, however, that this procedure is less efficient and is also a softer form of competition than lower initial premiums.34 Elimination of price fixing based upon an average expense ratio that covers the costs of most firms has been advocated many times. The federal government took such a stand in its argument of the South-Eastern Underwriters Association case.35 Since the passage of the McCarran-Ferguson Act in 1945 permitting regulated price fixing, critics have questioned the advisability of allowing rates to be jointly established. They stress the nonuniformity of expense and profit among firms, and point to how collective rates will tend to be weighted to protect the less efficient operators.36 As a first step toward independent action among firms in regard to the expense and profit portions of premium rates, it would be necessary to remove the industry's antitrust exemption. To prohibit joint price making among interstate firms without bringing about any M See chap, v above, and "Insurance—Rate Regulation—Competitors' Standing to Seek Administrative Review of Rate Filings," Michigan Law Review, LVIII (March, 1960), 737-738, 751-752. " S e e U.S. Senate, Hearings, The Insurance Industry, Part 2, 1959, pp. 1215-1216, 1228, 1250-1251, 1313. 86 "Arguments Heard in Anti-Trust Case," Journal of American Insurance, XXI (February, 1944), 5-8, 19; Frank H. Elmore, Jr., "How Insurance Became Commerce," Journal of American Insurance, XXII (July, 1945), 4-7, 14-17, 20-22; U.S. Congress, Joint Subcommittee of the Committee on the Judiciary, Hearings on S. 1362, H. R. 3269, and H. R. 3270, Part 1, 78th Cong., 1st Sess., 1943, p. 65. 36 See, for example, "State Supervision over Insurance Ratemaking Combinations under the McCarran Act," Yale Law Journal, LX (January, 1951), 167; "State Regulation of the Insurance Business and the Sherman Anti-Trust Act," University of Pennsylvania Law Review, XCVI (December, 1947), 230; Michels, op. cit., p. 68; Charles P. Scully, "The Future of Workmen's Compensation," Insurance Law Journal, No. 440 (September, 1959), 549; U.S. Senate, Hearings, The Insurance Industry, Part 2, 1959, pp. 1051-1054, 1064, 1085-1090, 1225-1227.

Policy

Alternatives

and Suggestions

217

additional changes in the industry's pattern of operation is probably neither desirable nor practical. Full antitrust enforcement as an alternative policy was discussed in a previous section and rejected. If an additional provision is made for pooling loss experience, however, prohibiting price making in concert may be both beneficial and feasible. PUBLIC COLLECTION AND PROCESSING OF LOSS STATISTICS

Invariably, all proposals to permit or require price competition in insurance assume that it is beneficial to continue pooling empirical data to establish estimates of loss probabilities. This is almost always to be done by the present trade associations or bureaus in the industry. It is unrealistic to assume that this can be done without its disturbing continuous, active competition in the expense and profit portions of the price of insurance. Collaboration that goes far enough to collect and process loss data will make rate competition uncertain if not unlikely. Loss statistics could be collected by a public agency, however, and probability estimates for all classes of insurance made available, on an advisory basis, to all insurance enterprises.37 This would assure that loss estimates were based on the most complete data available. The savings from the elimination of many of the countless local, regional, and national bureaus should be substantial.38 T h e credibility of loss estimates would also be increased in fields where rates are now related to scanty, partial data.39 This administrative agency should include both industry and public representatives, plus a staff of technicians. It would function as a service organization with the power to request all data necessary to enable it to establish the best possible estimates of future losses for each class of insurance. In addition, the agency should carry out inspection and engineering tasks for estimating the expected losses of "Ibid., pp. 1077-1078. Data classification systems would have to be adopted which permit collection, consolidation, and analysis of loss data from all insurers. This should be done in a way to permit maximum price and contract flexibility for insurers. Undoubtedly classifications will be modified and changed frequently; indeed they must be, if the industry is to keep pace with or, better yet, lead the developing pattern of demand for insurance. A t the time such a system is instituted, there will have to be certain compromises and technical changes in the data collection and reporting systems now in use. However, there do not appear to be any insuperable problems in putting into effect a national statistical system of this kind that would be acceptable to all parties concerned. Something very similar is now in use in certain sectors of the industry, for example, workmen's compensation insurance. 38 Ibid., Part 3, 1959, pp. 1578-1579. There has been a movement to consolidate and broaden the scope of the private bureaus. "Ibid., Part 2, 1959, pp. 1056-1057.

218

Policy Alternatives and

Suggestions

nonhomogeneous properties and risk situations. This work is now handled by private bureaus. Many, if not most, insurance firms will find that it is more efficient to have at least part of this work done cooperatively. Private bureaus now argue that it is generally impossible for insurance firms to do their own inspection and engineering work for establishing schedule rates in fire insurance.40 T o provide this service through a public agency, in which industry members play a significant role so that the facility is responsive to industry needs, would tend to produce at least two kinds of desirable results. It would permit maximum exploitation of scale economies and other cost reductions in connection with the most complete system of loss statistics possible. And it would preclude any undesirable joint action on expense and profit matters, resulting from solely private cooperation on loss matters. Yet individual firms would be encouraged to do any inspection, engineering, or loss-prevention work they desired. The incentives to do this would be greater than they are now, for the likelihood of individual company gains from reductions in expenses or losses would be greater under individual pricing than they are under a system of uniform prices with the present deviation and independent filing provisions. Dual and complementary functions between private firms and a public agency on inspection, engineering, and loss prevention would appear to be both possible and desirable. The public agency would merely be charged with providing the minimum level of such services needed by most insurance organizations to formulate rates. Perhaps it would also be possible for the public agency to begin systematically to develop a statistical basis for the loss-probability differences among commercial properties and other individually rated risks. These differences are now almost invariably based on engineering judgment only. Loss statistics are used only to adjust levels of rates. Fire insurance rate making is particularly vulnerable in this regard. 41 Research and development on other aspects of losses, loss statistics and their use, as well as related problems concerning risk sharing, could be promoted by a public agency such as the one '"Ibid., Part 3, 1959, pp. 1436-1437, 1465, 1884. aIbid., pp. 1434-1436. T h e general manager of the New York Fire Insurance Rating Organization testified during the U.S. Senate insurance hearings that there are so many items of credit and charge in a fire insurance rate schedule that it would be impossible to develop statistical records for them. Ibid., p. 1435. Yet the final rate depends to a substantial extent on values assigned to each of these credits and charges. Various schedules are also used, even though conditions are similar; this is apparently partly due to accident and partly due to the existence of numerous rate bureaus. See Robert E. Dineen, "Five Steps Toward Better Fire Rates," American Management Association, Insurance Series, No. 76, 1948, pp. 3-13.

Policy Alternatives

and Suggestions

219

suggested here. The amount of research being done in nonlife insurance today is quite small, and much of it is directed toward quite narrow problems.42 The National Association of Insurance Commissioners is a voluntary organization which has to depend upon individual states, frequently New York, or the insurers themselves for research assistance.43 Surely this is not a desirable situation. Substantial gains in economy and efficiency should result from collection and processing of loss data by a public agency. An opportunity for undesirable private company collaboration to develop would also be eliminated. Rate regulation of the type now being attempted by the states as a substitute for competition would not be necessary. FEDERAL REGULATION OF INTERSTATE

INSURANCE

Finally, federal standards and examinations should be instituted to assure sound financial conditions in the industry. This would replace the present state examination and regulation of interstate companies. Economies and efficiencies should result here also. It would be desirable to have federal incorporation of interstate insurance companies, but it is not a necessary part of this combination policy proposal. The essential element is federal standards and supervision of company investment and reserve practices to assure that policyholder obligations will be met as they develop. In this connection, there is a definite need to develop a measure of nonlife insurance firms' liabilities, not related to the rate level, which can be used in judging the financial standing of these companies. At present the unearned premium reserve, a statutory liability equal to the full amount of all written but unearned premiums, is the principal criterion of technical solvency for nonlife insurance organizations.44 Yet this deferred income account overstates liabilities, for state statutes do not recognize deferred charges related it it.48 Since the unearned premium reserve corresponds to premiums, it reflects a firm's rate level. If a company reduces rates, its unearned premium reserve will be reduced. But there will be no corresponding reduction in the losses such a company would expect to pay if it continues to accept the same types of insurance risks.46 This means that the financial standing of nonlife insurance enterprises needs to be judged in ways other than unearned 42 U.S. Senate, Hearings, The Insurance Industry, Part 2, 1959, pp. 1060, 1076, 1105-1106. " Ibid., pp. 1060, 1106; Part 3, 1959, pp. 1895-1896. "For an explanation and discussion of the unearned-premium reserve, see chaps, v and viii. "Ibid., and U.S. Senate, Part 2, 1959, pp. 1092-1093. "Ibid.

220

Policy Alternatives and

Suggestions

premium reserves. Greater reliance on levels of policyholders' surplus, and development of rating approaches based upon predictable losses and units of exposure to losses in each branch of nonlife insurance are possible lines of improvement. 47 National standards and financial examinations of interstate organizations are not going to retard these needed developments; rather, they should accelerate them, for industry opposition to these fundamental changes is less likely to be effective against the federal government than it is against many state governments. The states will be free to continue study and experimentation with financial stability questions in the intrastate sphere, and will not be hindered by the need to strive for a uniform approach to an interstate industry by difficult, voluntary zone arrangements. In conjunction with federal examination and financial safety provisions, it would be desirable to establish in nonlife insurance a program similar to that of the Federal Deposit Insurance Corporation in banking and the Federal Savings and Loan Insurance Corporation in the savings and loan field. This would be an assurance that policyholders would not lose from any reasonably expected rates of insolvency in the industry, and it would reduce the pressure for protection of competitors in nonlife insurance at the expense of lower average rates for policyholders.48 SUMMARY OF POTENTIAL

RESULTS

Desirable industry-wide services would be provided by an administrative agency made up of both industry and public members. Federal examinations and financial safety requirements would be instituted, perhaps similar to those presently used in the banking system. Each insurance organization would establish its own rates based upon national, public loss data and its own individual expense data and profit goals. A greater degree of price competition should ensue and reduce average levels of profits and selling costs which appear to be higher " See R o g e r Kenney, Fundamentals of Fire and Casualty Insurance Strength (2d ed.; D e d h a m , Mass.: Kenney Insurance Studies, 1953), chap, x x x i , and J a m e s R o l a n d McPherson, " M u l t i p l e - M u l t i p l e L i n e s , " Journal of Insurance, X X I V (September, 1957), 147. " T h e r e has been some tendency for states to require contributions by insurers to f u n d s administered by the state a n d out o£ which deficiencies of insolvent insurers are to be met. R a l p h H . Blanchard, " R i s k and Insurance," Weekly Underwriter, March 29, 1952, p. 826; and C. A. K u l p , Casualty Insurance (3d ed.; New York: T h e R o n a l d Press, 1956), p p . 607-608. Such a plan would be much more realistic on a national scale. For a discussion of a national plan, see U.S. Senate, Hearings, The Insurance Industry, Part 2, 1959, p p . 1071-1072.

Policy

Alternatives

and Suggestions

221

than necessary. Progressiveness would probably improve as the necessity for complying with rigid state rating laws was removed. Capacity adjustments would certainly be as good or better. Product variety might also improve under the pressure of competition. T h e purchaser of insurance should gain substantially from these changes. T h e individual firm should also gain. Freedom to experiment would be widened. Cost-reducing techniques would offer greater and more immediate possibilities of additional returns as cumbersome, uncertain deviation and independent rate filing were eliminated. Would unrestricted competition in the expense and profit portions of insurance prices lead to ruinous competition and widespread insolvency in the industry today? Many people in the industry (including state regulators) argue that it would. 49 These people frequently recite numerous insurance company failures in earlier competitive days, usually in the 1800's, before industry self-regulation became effective. 50 Today there appears to be no reason why price competition should inevitably become destructive in the industry. 51 Accident and health insurance, portions of marine and aviation insurance, and reinsurance do not have regulated rates. California and, to a lesser degree, a few other states do not generally regulate insurance rates. Mass bankruptcies have not occurred in any of these situations. 52 Life insurance firms operate independently. Each company typically determines its own rates by applying its estimated expense ratio to loss probabilities which have been largely determined on a mass basis, though individual firms may also modify loss probabilities to fit their own particular type of operation. 53 Logically, the insurance industry is not among those which would be expected to be subject to ruinous competition. Such industries usually have high physical capital requirements, and they face quite widely fluctuating demands for their products. Their high fixed costs exert pressure on them to get and maintain volume over which to spread the fixed costs. T h e result may be prices that are pushed so "For summaries of these opinions, see Michels, op. cit., pp. 67-68; Irwin M. Stelzer, "The Insurance Industry and the Antitrust Laws: A Decade of Experience," Insurance Law Journal, No. 386 (March, 1955), 141; U.S. Senate, Hearings, The Insurance Industry, Part 2, 1959, pp. 1057-1061, 1064-1067; Part 3, 1959, pp. 1465-1466. 60 See Kimball and Boyce, op. cit., pp. 547-549. M U.S. Senate, Hearings, The Insurance Industry, Part 2, 1959, pp. 1064-1065, 1090-1092. Ibid., pp. 1052-1054, 1065, 1091-1092; Part 3, 1959, pp. 1883-1888. 63 Nathan R. Berke, "A Legal-Economic Discussion of the 'S.E.U.A.' and 'Polish Alliance' Cases," Insurance Law Journal, No. 258 (July, 1944), 397, points out that "competition . . . should not have any perilous consequences for fire insurance. . . , It ha? not had for the life insurance companies,"

222

Policy Alternatives

and

Suggestions

low that many competitors are driven bankrupt. 54 Fixed costs do not make up a large part of nonlife insurance costs; demand does not fluctuate markedly. There remains a possibility, however, that some insurance enterprises might feel that they would have better loss experience than the average probability for any class, and they might cut price below the combined total of average expected losses and their own expected expenses. Widespread, excessive optimism among insurance firms regarding the types of customers they think they are insuring seems unlikely if complete, timely loss statistics are made available to all firms. Thorough, regular federal examinations based on suitable financial standards, subject to continuous study for improvements, should tend to uncover most situations of widespread pricing below cost. Nonlife insurance should experience a secular expanding demand for its services as per capita incomes continue to grow and as greater use is made of insurance principles for the distribution of losses. An industry with this expected time pattern of demand for its output is not likely to be troubled with continuous, aggressive price cutting. There will be insolvencies under the combination of policies suggested here. Yet their number should be no greater, perhaps smaller, than is true today under an antitrust-exempt, state-regulated system. The policyholder will gain an opportunity—the best opportunity that feasible industry reforms appear to provide—for permanently more efficient and less costly insurance service. To attempt to eliminate essentially all insolvencies will exact a high price for security and stability in terms of average rate levels and reduced incentives to efficiency.65 Public collection and processing of loss data, federal financial standards and examinations for interstate firms, and a federal insurance agency arrangement to distribute the losses of insolvent interstate organizations will tend to keep insolvencies and their effect at as low a level as can be expected in a private industry. Conclusion The economic performance of the property and casualty insurance industry is in many respects quite good. The volume of loss distributed in the economy has increased very rapidly in recent decades. Yet there are opportunities for worthwhile improvements in performance which would benefit the insurance buyer. A reasonable opportunity exists to obtain these benefits and at the same time rid the industry of a rigid, costly, state-imposed system of price controls. 64 65

See Kaysen and Turner, op. cit., pp. 195-198. Michels, op. cit., p. 68, and Whitney, op. cit., pp. 358-359.

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223

In many ways the structure of the industry would be expected to give very good performance according to economic theory. There are large numbers on both sides of the market, with no dominant buyers or sellers. Entry is not difficult. Physical capital requirements are low. These presumably desirable conditions are nullified to a great extent, however, by concerted price making and selling through independent agents by a great many firms. Apparently, these two characteristics plus a widely varying pattern of state regulation are the most important causes of the principal poor performance aspects of the industry. We have tentatively suggested that industry performance might be improved by: (1) promoting continuous, active industry-wide competition in the expense and profit portions of insurance premiums; (2) replacing the present private bureaus by a joint industry-public managed federal agency that would establish estimates of future losses for all types of insurance and perform other service functions for the industry; and (3) instituting federal standards and examinations to assure, as far as reasonably possible, financial safety for the policyholder.

BIBLIOGRAPHY

Books, Monographs,

and

Collections

of

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Adams, Walter, and Horace M. Gray. Monopoly in America: The Government as Promoter. New York: Macmillan Company, 1955. Anderson, Odin, W., and Jacob J . Feldman. Family Medical Costs and Voluntary Health Insurance: A Nationwide Survey. New York: McGrawHill Book Company, Inc., 1956. Argus Casualty and Surety Chart. Cincinnati: T h e National Underwriter Company, Annual eds. Argus Fire Chart. Cincinnati: T h e National Underwriter Company, Annual eds. Atkiss, Harold C. Fire Insurance Rate Making. Part 1. New York: New York State Department of Insurance, 1950. Backman, Jules (ed.). Price Practices and Price Policies. New York: T h e Ronald Press Company, 1953. Backman, Jules. Surety Rate-Making: A Study of the Economics of Suretyship. New York: T h e Surety Association of America, 1948. Bain, Joe S. Barriers to New Competition. Cambridge, Mass.: Harvard University Press, 1956. . Industrial Organization. New York: John Wiley and Sons, Inc., 1959. Battles, Robert E. The Agency System in Relation to Insurance Economics. New York: T h e National Association of Insurance Agents, Inc., 1958. Baumol, William J . Business Behavior, Value and Growth. New York: Macmillan Company, 1959. Best's Fire and Casualty Aggregates and Averages. New York: Alfred M. Best Company, Inc., Annual eds. Best's Insurance Reports. New York: Alfred M. Best Company, Inc., Annual eds. Bohlinger, Alfred J., and Thomas C. Morrill. Insurance Supervision and Practices in England. New York: New York State Insurance Department, 1948.

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Pacific Fire Rating Bureau v. Insurance Co. of North America, 83 Ariz. 369, 321 P. 2d 1030 (1958). Paul v. Virginia, 8 Wall. 168 (1869). Philadelphia Fire Association v. New York, 119 U.S. 110 (1886). Polish National Alliance v. National Labor Relations, 322 U.S. 643 (1944). Prudential Insurance Company v. Benjamin, 328 U.S. 408 (1946). Robertson v. California, 328 U.S. 440 (1946). Stickel v. Excess Insurance Company of America, 23 N.E. 2d 839, 136 Ohio St. 49 (1939). Travelers Health Association v. Federal Trade Commission, 262 F. 2d 241 (1959); cert, granted, 359 U.S. 988 (1959), 80 S. Ct. 717 (1960). United States v. Baton Rouge Insurance Exchange, Civil No. 2088, E.D. La., June 27, 1958. United States v. Insurance Board of Cleveland, 144 F. Supp. 684 (1956). United States v. Investors Diversified Services, 102 F. Supp. 645 (1954). United States v. New Orleans Insurance Exchange, 148 F. Supp. 915 (1956), affirmed 355 U.S. 22 (1957). United States v. Socony-Vacuum Oil Company, et al., 310 U.S. 150 (1940). United States v. South-Eastern Underwriters Association., 322 U.S. 533 (1944). Virginia Association of Insurance Agents, etc. v. Commonwealth of Virginia, 110 S.E. 2d 233 (1959).

INDEX Accident and health insurance, 133-148; outlays for, 2-3; types of underwriting companies, 5-6; group policies, 145146; need for standardization of contracts, 152, 153, 156; price competition and product variety, 201 Actuarial risk, 7-8. See also Statistics Adams, John F., 117, n. 8 Adams, Walter, 58, n. 61 Administration. See Management and administration Advertising, 57, 180 Agencies and agents: role of, 18, 20, 22, 32-36, 182-183, 198; role in holding company operations, 24; in- fleet opera 1 tion, 24-26; relationship to principals, 32-36; exclusive agents, 35-36; initial contracting cost, 50, 52; problems .of new companies, 56-57, 86; boycott of mutual companies, 60; access to representation by, 86; opposition to continuous policies, 149-150; resistance to renewal certificates, 150; direct billing circumvention of, 150-151; income levels of, 183-184; pro's and con's of change in system, 185-186. See also Commissions; Selling Alderson, Wroe, 75, n. 25 Alfred M. Best Company, Inc., 5 Alien companies: capital requirements, 49; reinsurance by, 54; legal discrimination against, 58-59; competition from, 99-100; federal regulation, of, 210. See also Lloyd's associations; Lloyd's of London Allen, J. Folger, 110, n. 22 Allstate Insurance Company, 36 American Agency System: description, 18; court support of, 33; needs for and resistance to change in, 185-186 Anderson, L. A., 81, n. 52; 201, n. 14; 208, n. 4 Annuities, 3

Antitrust exemption. See Competition Archibald, G. C., 10, n. 27 Armed foices dependents medical care program, 136 Arrow, Kenneth J., 8, n. 21 Associations. See Rate bureaus; Trade associations Atkiss, Harold C., 79, n. 45; 80, n. 46; 84, n. 63 Attorney-in-fact, 21, 22 Automobile compensation insurance, 123-124, 129-131, 132 Automobile insurance, 116-133; outlays for, 2-3; mutual companies' concentration on, 19; reciprocal exchanges in, 22; company structure, selling method, and rate variations, 36-37; product standardization, 152, 201; post-World War II undetcapacity, 158; surplus drains, 161; rate increases and meeting expansion needs, 162; commission competition in sale of, 186; price competition, 201, 216; selling method influence on growth, 188 Aviation insurance, 84 Backman, Jules, 81, n. 63; 90, n. 92; 98, n. 124 Bain, Joe S„ ix; 38, n. 1; 39, n. -7; 47, n. 22; 48, n. 27; 52; 53, n. 44; 55, nn. 53, 54; 56, n. 55; 59, n. 70; 64, ii. 91; 67, n. 99; 191, n. 1; 207, n. 2; 214, n. 28; 215, n. 31 Bankruptcy. See Exit Failures; Solvency Battles, Robert E., 33, n. 8 Baumol, William J., 71, n. 5; 75, n. 26 Bell, S. Alexander, 35, n. 19; 36, n.,23; 37, n. 32; 96; 111; 188, nn. 108, 111; i89, nn. 112, 113 Bell, W. Douglas, 147, n. 127 Berke, Nathan R., 221, n. 53 Blanchard, Ralph H., 18, n. 8; 19, n. 10; 20, n. 14; 22, n. 17; 32, n. 1; 50, n, 36;

249

250

Index

77, nn. 36, 37; 79, n. 45; 81, n. 53; 82, n. 57; 105, n. 3; 106, n. 8; 108, n. 12; 155, n. 1; 166; 170; 179, n. 77; 210, n. 13; 220, n. 48 Blue Cross, 133-138 passim Blue Shield, 133-136 passim Bohlinger, Alfred J., 108, n. 12; 109, n. 14; 113, n. 33; 125, n. 35; 211, n. 17 Boulding, K. E., 10, n. 27 Bowen, Howard R., 161 Boyce, Ronald N., 204, nn. 23, 28; 205, n. 31; 209, n. 5; 221, n. 50 Brady, William E., Jr., I l l , n. 23 Brewster, Agnes W., 133, n. 60; 136, n. 67; 137, n. 71; 138, n. 79; 140, n. 85; 141, table n.; 145, n. 112; 147, n. 127 Brewster, Kingman, Jr., 206, n. 34 Brokers and brokerages, 18, 32-36, 99100. See also Agencies and agents Burns, Arthur R. ( 101, n. 130; 180, n. 79 Butler, Charles P., 86, n. 75 Cahill, James M„ 36, n. 21; 89, n. 86 California: reciprocal exchanges, 22; capital requirements, 49-50; regulatory leniency, 78; multiple-line policies, 110-111; uninsured motorist insurance, 127; product innovation, 200 California Standard Fire policy, 110 Cammack, Emerson, 73, n. 17; 82, n. 58; 109, n. 15; 131, n. 55 Canada, 127 Cancellation of continuous policies, 149150 Capital funds: need for, 14; of capital stock companies, 17-18, 49-50, 169; of mutual companies, 19; entry requirements, 48-52, 55, 58-59, 198-199; legal requirements vs. true needs, 50-51; impediments to multiple-line development, 114; and underwriting capacity of the industry, 157-165, 169; lag in expansion of, 162, 164-165; investment practices, 163-164; influence on pricing and profits, 163; return on, 170171; and shareholders' equity profit margin, 174r-177. See also Solvency; Surplus Capital stock companies: size and number of, 16; capitalization, 17-18, 49-50, 169; structure and operation, 17-19; reinsurance companies, 17; fleet operations, 24-25; agency relationships, 3236; commission levels, 35, 180-181; economies of scale, 40-48; sales levels, 47-48; organizational and develop-

mental costs, 50-51; pricing disadvantages of new companies, 56; entries since 1949, 65-66; exits, 68; profit formulas in pricing, 74; adjustment of expenses to services, 82; cooperation with mutual companies, 83-84; premium dividends, 96; neglect of direct billing, 151 profit levels, 165-179; expansion techniques, 169, 187; investment earnings, 171; statutory vs. adjusted underwriting profit, 173-174; shareholders' equity profit margin, 174-177; expense ratios, 185; selling method, 198. See also Agencies and agents; Competition; Government regulation; Pricing; Profits; Rate bureaus; Trade associations Carlson, Thomas H., 81, n. 50 Carson, Ellis H„ 108, n. 12 Carter, C. F„ 8, n. 21 Carter, William A., 207, n. 2; 209, n. 8; 214, n. 26 Cartwright, Levering, 17, n. 3; 99, n. 126; 100, n. 129 Casualty insurance. See Nonlife insurance; see also specific classes of casualty insurance Chamberlin, Edward H., 67, n. 99; 72, n. 8 Chubb, Percy, 114, n. 37, 142, n. 93 Clark, Ernest L„ 152, n. 140 Clemens, Eli W., 166, nn. 37, 38; 169, n. 49 Clough, Shephard B., 17, n. 4 Cochran, W. Kent, 170, n. 52; 178, n. 75 Commissions: of capital stock company agents, 18; of mutual company agents, 20; of reciprocal exchange agents, 22; competition for agents, 33, 51; intercompany agreements controlling, 34, 184-185; on new and renewal policies, 35; renewal certificate threat to, 150; levels of, 179-190 passim Competition: concentration patterns and trends, 27-31; regulatory restriction of, 30-31; in agency commissions, 33, 34, 182-184 passim; entry conditions, 38-64, 198-199; vs. uniform pricing, 46-47, 60-61, 70, 72, 78, 82-83, 90-101, 199; for management personnel, 5455; in reinsurance market, 54; agents' boycott of mutual companies, 60; tiein requirements of lending institutions, 62; interstate commerce status of insurance, 75-76, 86, 205-206; legal sanctions, 91-92; by coverage vs. by

Index price, 93; rate bureau opposition to, 94-95, 97-98; among various types of companies, 96-99; premium dividend technique, 96, 216; role of National Association of Independent Insurers, 97; influence of alien companies, 99100; influence on coverage, 152-153, 201; state antitrust laws, 203-204; government vs. private underwriting, 129, 130-131, 211-212; trends and needs, 212-215; benefits of government data collection and processing, 217219 passim. See also Court actions; Government regulation; Pricing; Rate bureaus; Uniform rates Comprehensive medical care coverage, 140-148 passim Compulsory motorist's financial responsibility insurance, 120, 121, 128-129 Compulsory insurance: financial responsibility of motorists, 120, 121, 128-129; workmen's compensation, 122-124; unsatisfied judgment fund alternative, 126; for medical care, 147; government insurance Conard, Joseph W., 166, n. 38 Conservatorship, 66-69 passim Consolidation, 66-69 passim Consumers. See Policyholders; Public interest Contingency factors, 84 Continuous policies, 149-151 Contracts: cooperation in development of, 84; rate bureau review of, 89; modification of, 93; in multiple-line insurance, 107; industry fear of political interference in, 121; changes procedures, 149-153 passim; continuous policies, 149-150; simplification and standardization, 151-153. See also Coverage Cook, Franklin H., 208, n. 4 Cornett, William B., 143, n. 102 Costs, 13-14; types of company and, 19, 41-45 passim; of mutual company operations, 20; reciprocal exchange company advantages, 22; of selling, 3536, 96, 179-190; of selling by salaried employees, 36; economies of scale, 4048; of entry, 46, 50-51, 53-55; and true capital needs, 48; of initial contract with agencies, 50, 52; product differentiation and, 55; discriminatory taxes, 58-59; rehabilitation of insolvent companies, 67; influence on pricing, 7475, 78-89, 92-93; loss ratios, 79-81, 161;

251

full-cost principle vs. demand factors, 88-89; and premium dividends, 96; multiple-line savings, 108-109; of rating bureau operations, 112-113; motorvehicle accident damage, 117; administration of compulsory automobile insurance, 128, 129; impact of preventive medical care on, 144; of individual vs. group health premiums, 145; of group vs. individual medical practice, 146; procedural innovations for reduction of, 149-151; of policy shifting, 150; of direct billing, 150-151; of coverage against small losses, 156; in calculation of statutory underwriting profit, 172173; variations in, 177; effects of competition, 182-183, 213; trends, 192-193; independent action on, 215-216; of government statistical services, 217-219 passim. See also Commissions; Expense ratios; Pricing County and township mutual companies, 51-52, 68-69 Court actions: support of American Agency System, 33; National Fire Insurance case, 33; access to bureau statistics, 53-54; against discriminatory taxes, 58; against practices restricting entry, 59-60; rate bureau appeals against pricing deviations, 94-95; and standardization of interpretation of contracts, 152; support of state regulation, 210. See also Supreme Court actions Coverage, 13; engineering and inspection services, 81; deductible technique, 90; of multiple-line contracts, 107; of Manufacturers' Output policy, 110; liability principles in automobile and workmen's compensation insurance, 121-124; uninsured motorist insurance, 127; automobile compensation approach, 128-132 passim; accident and health insurance, 138, 140-148 passim; conservatism in revision of, 148-149; variety in, 154-156, 192-194; package sales, 155-156; influence of industry structure on, 200-201. See also specific types of coverage Cowee, John W., 82, n. 58; 168, n. 46; 208, n. 4 Crafts, James F., 19, n. 10; 99, n. 125; 130, n. 52; 185, n. 99; 187, n. 106 Credit insurance, 211 Creditors, 67 Credit rating, 11

252

Index

Crop insurance, 2U Gullen, T . J. V., 5 Davis, Irving, 108, n. 11; 112; 115; 143, nn. 98, 101; 144, n. 104 Davis, Shelby Cullom, 18, n. 5; 157, n. 6; 162, n. 25; 163; 167, n. 10; 170, n. 52; 179 Deductible coverage, 90 Demand factors, 88-90 Deviations. See Competition; Pricing; Rate bureaus Diemand, John A., 19, n. 10 Dineen, Robert E„ 80, n. 48; 112; 184, n. 95; 218, n. 41 Direct billing, 150-151 Dirlani, Joel B„ 53, n. 19; 58, n. 05; 59, n, 68; 61, n. 91; 71, nn. 4, 5; 72, nn. 12, 13; 74, nn. 22, 24; 82, n. 58; 88, n. 82; 95, n. 106; 168, n. 46; 205, n. 32; 215, n. 32 Disability insurance, 19 Discounting, 89-90, 91 Dividenck. See Premium dividends; Profits Donovan, fames B., 204, nn. 22, 25; 205, n. 28; 212, n. 20 Dougall, Herbert F.., 163, n. 28, 173, n. 63 Dover, Victor, 152, n. 141 Dowling, Noel T „ 117, n. 7; 201, n. 15 Dryden, John F., 201, n. 14; 208, n. 4; 210, n. 11 Edwards, Corwin D„ 38, n. 1; 40, n. 9; 58, nn. 61, 63 Edwards, Ward, 8, n. 21 Ehrenzweig, Albert A., 122, n. 26; 125, n. 34 Ellis, Howard S„ 71, n. 3 Elmore, Frank H „ Jr., 54, n. 52; 75, n. 28; 86, n. 74; 89, n. 88; 204, n. 27; 216, n. 35 Ely, Robert E., 87, n. 81 Engineering services, 81, 217-218 Entry, 38-66, 86, 198-199 Exit, 38-39, 66-69, 199,213 Expense ratios: and pricing, 81-82; trends, 161; of capital stock companies, 185; of mutual companies, 187. See also Costs Expiration and renewal rights, 33-35 passim; 150 Failures, 66-69 passim, Solvency Fainsod, Merle, 208, n. 4

213. See also

Faulkner, Edwin J., 138, n. 80 Faust, J. Edward, Jr.,- 79, n. 45 Federal Deposit Insurance Corporation, 220 Federal Savings and I.oan Insurance Corporation, 220 Fellner, William, 8, n. 22; 12; 27, n. 33 Fidelity bonds, 150 Fire and allied insurance: outlays for, 2-3; mutual companies' concentration on, 19; uniform vs. independent pricing, 61, 93-94, 201; restrictions against entry, 62; regulatory principles, 77-78; expense ratios in pricing, 81-82; rate bureau review of contracts, 89; term discounts, 89; in multiple-line h o m e owners' policies, 110-111; in marine multiple-line policies, 111; standardization of contracts, 114, 152, 201; postWorld War II undercapacity, 158, 16lj overcapitalization in 1930's, 163; statutory and adjusted underwriting profit, 174; commissions, 182, 184; inspection and engineering problems, 218 Flahive, Frank B„ 159, n. 11 Fleets, 25-26; • 109, 188-489.' See also Holding companies Flockton, K. J., 152, n. 141 Florence, P. Sargant, 46, n. 20 Folltnan, J. F., 138, n. 80; 139, n. 82; 140, n. 86; 143, n. 101; 145, n. I l l ; 146, n. 117; 117, n. 125 Foreign companies, 168 French, Patterson H„ 117, n. 7; 122, n. 27; 124, n. 32 Friedman, Milton, 10, n. 27 Friedmann, W., 130, n. 51 Friedrich, C. J., 70, n. 2; 106, n. I; 155, n. 2; 196, n. 4 Galbraith, J. K., 71, n. 3 Garbarino, Joseph W., 134, n. 61 Gardner, George K„ 87, n. 80 Gephart, W. F„ 6, n. 13; 51, n. 39; 167; 201, n. 14; 211, n. 17 Gibb, I). K. W„ 23, n. 20 Gilmore, Robert NT., Jr., 208, n. 4 Ginzberg, Eli, 143, n. 98; 144, n. 108 Golding, C. F.„ 23, n. 20 Goldmann, Franz, 144, nn. 103, 107; 146 Goldsmith, Selma F., 110, n. 84 Goldstein, Nathaniel I.., 34, n. 10; 179, n. 78; 184, nn. 92, 95 Gordon, Lincoln, 208, n. 4 Gordon, Robert A., 164, n. 31 Gould, William C„ 161, n. 18

Index Government insurance, 211-212; automobile and workmen's compensation funds, 126, 130-131; sickness and disability programs, 135-136, 147 Government regulation: of reciprocal exchanges, 21-22; of agents and brokers, 35; maintenance of capital funds and reserves, 38-39, 66-69, 163, 167168; of access to rate bureau statistics, 53-54; certificates of authority, 58; of foreign and alien companies, 58-59, 203, 210; rate bureau role in, 61, 81; of pricing, 71-78 passim, 85-88, 91-92, 94r-95, 214; differences among states, 76; model bills for, 77-78; limitations of supervisory bodies, 86, 95-96; of reinsurance, 99; of multiple-line contracts and rates, 110,113-114; classification of accident and health carriers, 136; effect on supply, 159-161; effect on profit level, 177; effect on product variety, 200-201, 211; antitrust enforcement, 203-20(> passim, 212-213, 216-217; industry influence on, 204; federal vs. state, 208-211; federal standards and examinations, 219-220. See also Court actions; Legislation and legal requirements Crad, Frank P., 118, n. 8; 120, n. 17; 121, n. 22; 130, n . 5 1 Graves, Clyde H„ 81, n. 50 Gray, Horace M„ 58, n. 61; 147, n. 126 Greene, Bruno H., 130, n. 51 Gregory, James R., 183, table n. Grether, E. T „ 206, n. 34 Group health insurance, 145-146 Groves, Charles H., 23, n. 20 Hale, G. E., 40, n. 9 Hale, Rosemary L)., -10, n. 9 Hansell, L. L„ 160, n. 16; 172, n. 61; 173, n. 63 Harris, Seymour F.., 143, n. 100; 144, nil. 108, 109 Hart, Albert G., 7, n. 19; 8, n. 21; 9; 10, n. 26; 11 Health insurance. See Accident and health insurance Health Insurance Council, 134 Heckscher, August, ix, n. 2 Hedges, J . Edward, 151, n. 139; 152, nn. 140, 142; 200, n. 12 Hedges, Robert A., 1, n. 1; 41, n. 11; 45, n. 17 Heflebower, Richard B., 88, n. 84; 89, n. 87

253

Heins, Richard M., 5, n. 11; 117, nn. 6, 8; 121, n. 23; 122, n. 26; 124, n. 33; 126, n. 42 Hensley, Roy J., 46, n. 19 Herd, J. Victor, 202, n. 16 Herstein, I. N„ 8, n. 21 Heselton, John W., 142, n. 97 Hines, Howard H., 38, n. 1 Hobbs, Clarence W., 84, n. 63; 204, n. 22 Holding companies, 24—26 Homeowners' multiple-line insurance, 110-111

Hospitalization insurance. See Accident and health insurance Huebner, S. S„ 201, n. 14; 208, n. 4; 210, n. II Huntington, Emily H., 147, n. 124 Illinois, 23, 99 Illness. See Accident and health insurance Income loss. See Accident and health insurance; Workmen's compensation Industry associations. See Rate bureaus; Trade Associations Injury insurance. See Accident and health insurance; Automobile insurance; Workmen's compensation Inland marine insurance. See Marine insurance Insolvency. See Failure; Solvency Inspection services, 81, 217-218 Insurance commissioner functions, 67, 77. See also Government regulation Interbureau Insurance Advisory Council, 112 Inter-insurancc. See Reciprocal exchanges Irvine, L. C., 158, nn. 9, 10 James, Fleming, Jr., 119, n. 11; 120, n. 11; 121, n. 25; 123; 124, n. 31; 130, n. 51; 133, n. 58 Johnson, II. Clay, 109, 113, n. 36; 114, n. 38 Jordan, David F„ 163, n. 28; 173, n. 63 Kaplan, A. D. H„ 71, nn. 4, 5; 72, nn. 12, 13; 74, n. 22 Katz, Harold A., 130, n. 51; 133, n. 59; 142, n. 93 Kaysen, Carl, 212, n. 20; 213, n. 25; 222, n. 54 Keirstead, B. S., 166, n. 37 Kellogg, Chester M., 158, nn. 9, 10; 159, n. 13; 160, n. 15; 161, n. 19; 162, n. 21;

254

Index

163, n. 27; 164, n. 32; 172, n. 61; 173, n. 63 Kenney, Roger, 20, n. 13; 21, n. 15; 23, n. 23; 30; 32, n. 2; 33; 36, n. 22; 51, nn. 39, 40; 78, n. 44; 85, n. 64; 88, n. 83; 98, n. 124; 100, n. 129; 108; 109, n. 16; 110; 113, n. 32; 114, n. 41; 115, n. 43; 123, n. 30; 130, n. 51; 139, n. 81; 148; 151, nn. 135, 138; 158, n. 9; 162, nn. 22. 25; 163, n. 27; 165, n. 34; 167, n. 43; 168, n. 45; 172, n. 60; 178, n. 73; 181, n. 84; 186; nn. 100, 102; 188, n. 112; 198, n. 5; 210, nn. 9, 10; 220, n. 47 Kentucky, 23, 99 Kimball, Spencer L., 204, nn. 23, 28; 205, n. 31; 209, n. 5; 221, n. 50 King-Page, D., 23, n. 20 Kline, George H., 117, n. 8; 118, n. 9; 121, n. 24; 122, n. 26; 124, n. 32; 125, n. 36; 126, n. 38; 127, n. 44; 128, n. 50 Knight, Frank H., 7; 9; 80, n. 47; 119, n. 13 Koopmans, Tjalling C., 4, n. 7 Kramer, Robert, 206, n. 37 Kuh, Edwin, 49, n. 28 Kulp, C. A., 45, n. 15; 53, n. 48; 59, n. 69; 83, n. 59; 84, n. 63; 92, n. 99; 120, n. 16; 175, n. 66; 220, n. 48 Kuznets, Simon, 104, chart n. Lang, Frank, 212, n. 19 Lanzillotti, Robert F., 71, nn. 4, 5; 72, nn. 12,13; 74, n. 22 Legal services, 55, 61 Legislation and legal requirements, x; for multiproduct companies, 3-4, 26; and company specialization, 3-4, 24; for fleet operations, 25-26; state capitalization requirements, 49-52 passim; access to rate bureau statistics, 53-54; maintenance of reinsurance competition, 54; discriminatory premium taxes, 58-59; and entry conditions, 59-60, 62; industry influence on, 74; federal affirmation of state regulation, 76; congressional jurisdiction, 77; model bills for regulation, 77-78; status of bureau rates, 88; competition vs. price cooperation, 91-92; impediments to multiple-line development, 113-115 passim; standard fire insurance policy, 114; financial responsibility of motorists, 120-133 passim; absolute liability and compulsory coverage in workmen's compensation, 122-124; unsatisfied judg-

ment funds, 126; uninsured motorist insurance, 127; vehicle impoundment, 127; as stimulus to private coverage, 148; unearned-premium reserves, 159161; statutory sales profits, 169; statutory underwriting profit, 172-174; valuation of liabilities, 177-178; prohibition of commission agreements, 184; federal vs. state, 208-211. See also Court actions; Government regulation Leibenstein, Harvey, 40, n. 10; 46, n. 20; 155, n. 1 Lengyel, S. J., 41; 51, n. 38; 81, n. 54; 157, nn. 5, 7; 166, n. 35; 172, n. 59; 177; 181 Lewis, Ben W., 208, n. 4; 215, n. 31 Liabilities, 177-178 Life insurance: definition, 3; affiliation with nonlife companies, 5; accident and health insurance coverage by, 136; direct billing savings in, 151; consumer education, 156 Lilly, Austin J., 117, n. 7 Lincoln, Murray D., 145, n. 114 Lindahl, Martin L„ 207, n. 2; 209, n. 8; 214, n. 26 Liquidation, 66-69 passim Lloyd's association companies: size and number of, 16; structure and operation, 22-23; entries, 65-66; exits, 68 Lloyd's of London, 99-100, 197 Longley-Cook, Laurence H., 80, n. 49 Loss costs. See Loss payments; Loss ratios. See also Costs; Statistics Loss payments: pre-scheduling of, 122125 passim, 132; security-responsibility approach, 126; fraudulent claims, 129; jury awards, 132; for medical care, 140-143; for income loss, 141-142. See also Statistics Loss ratio influence on pricing, 79-81 Luce, R. Duncan, 8, n. 21 Lusby, R. Newell, 124, n. 33; 127, n. 45; 131, n. 56 Lutz, Friedrich A., 8, n. 21 Lutz, Vera C., 8, n. 21 Lytle, R. C., 39, n. 3 Magnuson, Paul B., 137, 142 Management and administration: policyholder participation, 20; of reciprocal exchanges, 21, 22; problems of new companies, 54-55; efficiency of handling multiple-line coverage, 109; personnel problems in multiple-line development, 114-115; of compulsory

Index automobile insurance, 128, 129; trends, 149-153 passim; rewards to management personnel, 168; limitations of state regulatory bodies, 209 Manufacturers' Output policy, 110 March, James G., 71, n. 5 Marine insurance: regulatory principles, 77-78; multiple-line policies, 111; variety in coverage, 152 Markham, Jesse W., 66, n. 98 Markowitz, Harry, 10, n. 27 Marryott, Franklin J., 123, n. 30 Marshak, Jacob, 8, n. 21 Marshall, Ralph M., 84, n. 63 Marx, Daniel, Jr., 85, n. 66 Marx, Robert S., 130, n. 51 Mason, Edward S., 12, n. 33; 28, n. 37; 70, n. 2; 72, nn. 8, 9, 11; 73, nn. 15, 18; 106, n. 4; 155, n. 2; 196, n. 4; 206, n. 34 Massachusetts, 121, 128,131 Mays, Milton W., 5, n. 11; 26, n. 30; 30, n. 40; 86, n. 75; 185, n. 97 McCarran-Ferguson Act, 25-26, 30, 53, 54, 58, 60, 64, 73, 76, 77, 85, 86, 91, 113, 184, 199,216 McCarthy, Joseph M., 160, n. 15; 162, n. 23 McCullough, Roy C., 108, n. 12; 169, n. 47; 170; 172, n. 61; 173; 177, n. 69 McGovern, William L„ 212, n. 20 McNiece, Harold F., 130, n. 51 McPherson, James Roland, 220, n. 47 Medical insurance. See Accident and health insurance Mehr, Robert I., 73, n. 17; 82, n. 58; 109, n. 15; 131,n. 55 Merchant seamen medical care program, 136 Mergers, 66-69 passim Merit ratings, 91 Mertz, Arthur C., 121, n. 21 Meyer, John R„ 49, n. 28 Michelbacher, G. F., 18, n. 8; 46, n. 21; 106, n. 8; 108, n. 12; 112, nn. 28, 29; 159, nn. 13,14 Michels, Franklin P., 204, n. 28; 212, n. 20; 216, n. 36; 221, n. 49; 222, n. 55 Milnor, J. W„ 8, n. 21 Mitchell, Robert B., 114, n. 40 Montgomery, William M., 171, n. 58 Morgenstern, Oskar, 8, n. 21 Morrill, Thomas C„ 73, n. 17; 82, n. 55; 89, nn. 90, 91; 150, n. 133; 211, n. 17 Mortgage insurance, 62,211 Moser, Henry §„ 118

255

Mowbray, A. H., 32, n. 1; 50, n. 36; 105, n. 3; 132, n. 57; 155, n. 1; 158, n. 8; 182, n. 88; 184, n. 91 Multiple-line insurance, 107-115 Multi-Peril Insurance Conference, 112 Multiple Peril Insurance Rating Organization, 112, 113 Munthe, Preben, 38, n. 1; 59, nn. 70, 72 Murphy, Joseph P., 118, n. 8 Murphy, Ray, 122, n. 26 Mutual companies: size and number of, 16; specialization, 18; growth of, 19, 187; structure and operation, 19-20; exclusive agents for, 35-36; economies of size, 40-48; capital requirements, 49-50; organizational and developmental costs, 50-51; county mutuals, 51-52; agent boycott of, 60; entries since 1949, 65-66; exits, 68; cooperation with capital stock companies, 8384; premium dividends, 96, 216; influence on pricing, 96-99; commission rates, 180-181; selling costs, 187-188, 198 National Association of Independent Insurers, 97 National Association of Insurance Agents, 186 National Association of Insurance Commissioners, 77, 219 National Bureau of Casualty Underwriters, 30 National economy: economic function of insurance, 6-12; relationship to insurance needs and trends, 12-15, 103-105, 158-165 passim; relationship of income to health insurance ownership, 139-140 National Safety Council, 117 Netherton, Ross D„ 118, n. 8 Neumann, John Von, 8, n. 21 Neumann, Joseph A., 33, n. 8; 186, n. 101 Neville, John F., 149, n. 132 New York State: capitalization requirements, 49, 52; regulation, 76, 78; fire insurance expense ratio, 81-82; security-responsibility approach, 125126; uninsured automobile losses, 126, 127; antitrust provision against commission agreements, 184 Nonassessable policies, 20 Nonlife insurance: classification of, 2-3; definition, 5; economic function of, 6-12; specialization, 24; sales patterns, 47-48; employee benefit plans, 134-136

256

Index

passim; demand-supply balance, 158165; selling costs, 179-190; government programs, 130-131, 211-212. See also Coverage; specific types of coverage Nonlife insurance industry: size and growth of, 1-2, 19-20, 157-165, 188190, 194-195; competition vs. concentration patterns and trends, 3, 27-31 (see also Competition); classification of carriers, 3-4, 136; performance criteria, 4, 12-15, 102-107, 191-203; structure of, 5-6, 16-31, 32-37, 109, 196-199 200-203; profit levels, 14, 165-179; holding companies, 24-26; entry, 3864, 198-199; economies of size, 40-48; exit, 66-69, 198-199; pricing policies and practices, 73-101; fleets, 109, 188199; interest in prevention, 118-119; opposition to compulsory insurahce, 121; support of unsatisfied judgment fund approach, 126; support of uninsured motorist insurance, 127; opposition to automobile compensation, 130, 132; opposition to public health insurance, 147; conservatism in revising coverage, 148-149; market conduct, 199; needs and suggestions for change, 207-223; position on government regulation, 210-211. See also Agencies; Capital stock companies; Costs; Coverage; Government regulation; Mutual companies; Pricing; Reciprocal exchanges; Trade associations North, John, 186, n. 100 Nourse, Edwin G„ 71, n. 6; 73, n. 14 Nutter, G. Warren, 212, n. 20 Ocean marine insurance. See Marine insurance O'Mahoney, Joseph C„ 205, n. 30 Orfield, L. B., 34, n. 13; 168, n. 46; 208, n. 4; 211, n. 17 Otto, Ingolf H. E„ 159, n. 12; 162, n. 25; 177, n. 70 Oxenfeldt, Alfred R., 71, nn. 4, 5 Paish, F. W., 7, n. 16 Palamountain, Joseph C., Jr., 208, n. 4 Papandreou, Andreas G., 38, n. 1 Participating stock companies. See Mutual companies; Reciprocal exchange companies Patterson, Edwin W., 49, n. 29; 67, n. 102; 204, n. 25; 209, n. 6 Peacock, Alan T „ 211, n. 17

Pearson, Carl O., 117, n. 8; 118, n. 9; 121, n. 24; 122, n. 26; 124, n. 32; 125, n. 36; 126, n. 38; 127, n. 44; 128, n. 50 Pennsylvania, 110; 111 Penrose, Edith Tilton, 56, n. 56; 57, n. 60; 194, n. 3 Performance criteria, 4, 12-15, 102-107, 191-203 Perlet, Harry F„ 108, n. 12; 112, n. 31 Personnel. See Management and administration Pfeffer, Irving, 7, n. 15; 85, n. 65 Phelan, John D., 107, n. 9; 110, n. 19 Policies. See Contracts; Coverage Policyholder: broker's relationship to, 34; protection of, 49, 67 (see also Solvency); attitude towards new companies, 51; preference for established companies, 56-57; rate advantages of large purchasers, 91; benefits of multiple-line insurance, 108-109; financial responsibility of motorists, 120-133 passim; holders of accident and health insurance, 134-135, 139-140; participation in health insurance decision making, 137-138; comprehension of contracts, 151-133, 155, 156; profit distribution to, 216 Policyholders' surplus. See Surplus Powell, James E„ 106, n 7; 138, n. 81; 147, n. 125 Premium dividends, 18-20 passim, 96, 216 Premiums, 1-2, 58-59 Preventive medical care coverage, 143144 Pricing, 70-101: influence of mutuals and reciprocal exchanges, 20, 22, 9699; self-regulation, 30-31; selling costs and, 33, 36; cost factors and, 41, 78-88, 92-93, 109, 151; and entry conditions, 46-47, 56; techniques of new firms, 51; access to rate bureau information, 53-54; product differentiation and, 55, 93; boycott against reductions in, 60; bureau vs. independent rates, 60-62, 73-74, 82-85, 87-88, 97-98, 215-216; types of policies, 72; discriminatory practices, 73-74; profit formulas for, 74, 174; government regulation, 75-78, 85-88; demand factors and, 88-90; quoted vs. actual rates, 89-91; deductible coverage adjustments, 90; competitive forces, 90-101, 182-183, 212-215 passim; of large clients' consolidated coverages, 91; merit ratings,

Index 91; role of premium dividends, 96, 216; o£ reinsurance, 99; of multiple-line coverage, 109, 112-113; effect of prevention activities, 119; political interference, 121; of compulsory automobile insurance, 129; full vs. partial health loss coverage, 1-13; effect of procedural innovations, lot; lag in revision of, 161; role in expansion of underwriting, 162; relationship to profits, 177, 202; by specialty companies, 188-189; influence on performance, 203; effects of data pooling, 213. See also Costs; Rate bureaus; Statistics Probability. See Statistics Product differentiation. See Coverage; Specialization and differentiation Profit: criteria for, 14; of capital stock companies, 18; premium dividends, 18-20 passim, 96, 216; rights of reciprocal exchange subscribers, 21; role in pricing, 47, 74, 81-82, 177, 202; of new companies, 56-57; rate bureau negotiations on, 84; capitalization level and, 163; industry performance, 165179; trends, 170, 195; sales profit margin approach, 172-174; shareholder's equity margin approach, 17-1-177; liability valuation and, 177-179; influence of competition, 213; independent action, 215-216 Property insurance. See Nonlife insurance. See also specific types of coverage Prosser, William L., 121, n. 25 Public Health Service, 136 Public interest, 6-12 passim; in automobile risk distribution, 119-133 passim; in health risk distribution, 137-138; medical care for the indigent, 147; national differences in concept of, 211

Raiffa, Howard, 8, n. 21 Railroad medical care program, 136 Rate bureaus: status and functions, 3031, 77-78, 82-85, 97, 199; structure, membership, and subscribership, 5354, 83-84, 87, 97-98, 112-113; independent vs. uniform rates, 60-62, 8990, 91-96; determination of fire insurance rates, 81 -82; government regulation of, 86-87, 203-206 passim; fullcost principle vs. demand factors in computations of, 88-89; review of contracts by, 89; interbureau competition, 96-97; of mutual companies, 96-97; in-

257

fluence on coverage, 200; substitution of government data collection and processing, 217-219. See also Competition; Pricing Rate deviations. See Competition; Pricing Rates and rate making. See Pricing Receivership, 67-69 passim Reciprocal exchanges, 20-22, 35-36; size and number of, 16, 19, 65-66; specialization, 18; exits, 68; premium dividends, 96, 216; influence on pricing, 96-99 passim Reede, Arthur II., 142, n. 93 Refunds and rebates. See Discounting; Premium dividends Reinsurance: function of, 16-17; Lloyd's of London, 23; new companies' access to, 5-1, 86; restrictive practices, 59; of obligations of retiring companies, 67; pricing of, 99; regulation of, 99-100, 210; alien companies, 99-100, 197; expansion of, 167-168 Renewal certificates, 150 Reserves. See Capital funds; Surplus Restrictive practices. See Competition; Government regulation; Rate bureaus Robbins, Rainard B., 208, n. 4; 210, n. 13 Roberts, Markley, 13-1, nn. 61, 62; 136, n. 70; 138, n. 78; 144, n. 108 Rodda, William H., 109, n. 16; 214, n. 26 Roerink, Garrett W., 112, n. 29; 114, n. 39 Rohrer, Margaret, 78, n. 43; 200, n. 13; 208, n. 4 Safety responsibility laws, 120-122 Samuelson, P. A., 8, n. 21 Sanders, Barkev S., 135, n. 64; 136, nn. 66, 68; 140; 141, nn. 87,91 Savage, I.. J., 10, n. 27 Schwartz, G. G., 7, n. 16 Schwartz, Louis B., 205, n. 32; 206, n. 37 Scitovsky, Tibor, 27, n. 33; 28, n. 36 Scully, Charles P., 202, n. 17; 216, n. 36 Security-responsibility insurance, 125-127 Securitv-responsibilitv laws, 121-122 Selling: costs of, 14,' 44-45, 96, 179-180, 195-19(5 (see also Commissions); agency limitation agreements, 24-26 passim; by salaried employees, 36-37; product differentiation and, 55, 90; company reputation and, 56-57; personal sales representation, 57; cash sales, 151; package coverage, 155-156; channels

258

Index

of, 198 (see also Agencies and agents; Brokers) Senate hearings, 94 Services. See Coverage Shackle, G. L. S., 7; 8, nn. 20, 21; 9, n. 23; 12, nn. 30, 32 Siegel, Sidney, 43, n. 13 Simon, Herbert A., 71, n. 5 Skolnick, Alfred M., 133, n. 59; 135, n. 64; 136, n. 65; 141, n. 89; 142, n. 93 Smith, Bradford, 54, n. 50 Smith, Chase M., 211 Smith, Harold V., 112 Smith, Young B., 117, n. 7 Snider, H. Wayne, 5, n. 11; 80, nn. 48, 49; 81, n. 50; 107, nn. 9, 10; 148, n. 129 Solberg, Harry J., 74, n. 20; 174, n. 65; 177, n. 70 Solvency: state regulation and, 67; justification of noncompetitive pricing, 8283; risk level, 167-168; federal regulation, 209; federal standards and examinations, 219-220. See also Capital funds; Failure; Surplus; Unearned premium reserve Somers, Anne Ramsey, 130, n. 53; 133, n. 61; 134, n. 62; 137, n. 72; 139, nn. 81, 83; 142, nn. 93, 96; 143, n. 99; 144, n. 108; 145, nn. 110, 113; 146, nn. 115, 117, 118, 119; 147, n. 126 Somers, Herman Miles, 130, n. 53; 133, n. 61; 134, n. 62; 137, n. 72; 139, nn. 81, 83; 142, nn. 93, 96; 143, nn. 99, 101; 144, n. 108; 145, nn. 110, 113; 146, nn. 115, 117, 118, 119; 147, n. 126 Sosnick, Stephen H., 70, n. 1; 72, n. 10; 166, nn. 36, 37; 191, n. 1; 207, nn. 1, 3 South-Eastern Underwriters Association case, 25, 30, 53, 58, 59-60, 64, 75, 85, 113, 184, 199,204, 216 Specialization and differentiation, 55-57, 90. See also Coverage Specialty companies, 188-189 State insurance, 211-212 Statistics: access to, 53-54, 59-60, 98; as basis of uniform rates, 61, 82-85, 92-93, 113, 213-214; classification of, 79-81; as basis for discounting, 89; services of National Association of Independent Insurers, 97; multiple-line rating problems, 112-113; comparability problems, 152; of selling costs, 179-181; in a fully competitive market, 212, 213-214; role of trade associations, 214; government collection and processing, 217-219. See also Rate bureaus

Steindl, J., 180, n. 79 Stellwagen, H . P., 99, n. 126 S telzer, Irwin M., 53, n. 49; 58, n. 65; 59, n. 68; 64, n. 94; 74, n. 24; 75, n. 28; 81, n. 51; 82, n. 58; 86, n. 76; 88, n. 82; 95, n. 106; 168, n. 46; 205, n. 32; 215, n. 42; 221, n. 49 Stigler, G. J., 10, n. 27; 157, n. 4 Stock companies. See Capital stock companies Stocking, George W„ 209, n. 8; 213, n. 24 Stoddard, Francis R., 203, n. 21; 204, n. 23; 212, n. 21 Stone, Bernard R., 85, n. 69 Strotz, Robert H., 10, n. 27 Subsidiary companies, 3-4. See also Fleets; Holding companies Sunderland, Paul U., Jr., 80, n. 48 Supreme Court actions: threat to practices, x; antitrust ruling, 25, 30 (see also South-Eastern Underwriters Association case); affirmation of state regulatory power, 35, 76, 203; interstate commerce status of insurance, 75-76; affirmation of congressional jurisdiction, 77. See also Court actions Surety bonds, 150 Surplus: of mutual companies, 20; as measure of industry concentration, 2731; unearned-premium reserve problem, 159-161; expansion of, 165, 169171 Surplus-line brokers, 99-100 Taxes: discrimination against foreign and alien companies, 58-59; problems in multiple-line development, 114; influence on profit level, 168-169; consideration in profit calculation, 174; and loss liability concealments, 178 Taylor, Robert B„ 17, n. 3 Termination, 142 Thornton, John V., 120, n. 14; 123; 124, n. 31; 130, n. 51 Till, Irene, 89, n. 89 Tomlinson, C. E., I l l , n. 25 Township mutual companies, 51-52, 6869 Trade associations: National Bureau of Casualty Underwriters, 30; role in agency relationship, 33, 182, 183; restrictive practices of, 59-60; influence on price policy, 72; National Association of Insurance Commissioners, 77, 219; National Association Independent Insurers, 97; Multiple Peril Insurance

Index Racing Organization, 112, 113; Interbureau Insurance Advisory Council, 112; National Safety Council, 117; in accident and health insurance field, 134; National Association of Insurance Agents, 186; influence of large companies in, 197-198; role in market conduct, 199; influence on product variety, 201; influence on capacity, 202; role in compiling statistics, 214 Triffin, Robert, 39, n. 4 Turner, Donald F., 212, n. 20; 213, n. 25; 222, n. 54 Twaits, Elmer A., 30, n. 30; 84, nn. 61, 63 Unearned-premium reserve, 159-161,219220 Uniform rates. See Pricing; Rate bureaus Uninsured motorist insurance, 127 Unsatisfied judgment funds, 126 Vehicle impoundment laws, 127 Veterans medical care program, 136 Voorhis, Jerry, 137, n. 75 Vorys, Arthur, 208, n. 4 Wallace, Donald, 106, n. 4; 155, n. 2; 180, n. 81; 196, n. 4; 207, n. 2

259

Wandel, William H„ 32, n. 3; 33, n. 6; 34, n. 12; 51, n. 40; 182, nn. 88, 89, 90 War insurance, 211 Watkins, Myron W„ 209, n. 8; 213, n. 24 Wheeler, John T „ 38, n. 1 Whitney, Simon K., 46, n. 21; 51, n. 40; 65, n. 95; 73, n. 15; 83, n. 59; 182, n. 89; 214, nn. 26, 29; 222, n. 55 Wilcox, Clair, 205, n. 32; 212, n. 20 Wiles, P. J . D., 46, n. 20 Willett, Allan H., 7, n. 15; 80, n. 47 Williams, C. Arthur, ix, n. 1; 74, n. 19 Wilson, Emmett H., 6, n. 15 Winter, William D., 34, n. 12; 107, n. 9; 108, n. 12; 109, n. 15; 111, n. 26; 148, n. 129; 182, n. 87 Wirpel, Estelle M., 133, n. 59 Wise, Paul S., 124, n. 33; 126, n. 40; 127, n. 46 Woodson, Benjamin N., 107, n. 10 Workmen's compensation: mutual companies' concentration on, 19; reciprocal exchanges, 22; inter-insurance, 22; absolute liability and compulsory coverage, 122-124; state vs. private funds, 135-136, 211, 212; commission level, 182; loss payments, 141-142 Woytinsky, W. S., 135, n. 64; 141, n. 91 Yborra, Thomas J., 110, n. 20