Life Insurance: Trends and Problems 9781512817935

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THE S. S. HUEBNER FOUNDATION FOR INSURANCE EDUCATION LECTURES

LIFE INSURANCE: TRENDS AND PROBLEMS

HUEBNER FOUNDATION

LECTURES

LIFE INSURANCE: TRENDS AND PROBLEMS Edited, by

David McCahan, Ph.D. (C.L.U.) Executive Director Foundation The S. S. Huebner for Insurance Education

Philadelphia UNIVERSITY OF PENNSYLVANIA PRESS LONDON: HUMPHREY OXFORD UNIVERSITY

1943

MILFORD PRESS

Copyright

1943

UNIVERSITY OF P E N N S Y L V A N I A

Manufactured

in the United States of

PRESS

America

PREFACE H E a d m i n i s t r a t i v e plan under which the S. S. H u e b n e r F o u n d a t i o n f o r Insurance E d u c a t i o n is o p e r a t e d c o n t e m p l a t e s , a m o n g o t h e r objectives, t h a t provision should be m a d e f o r "publishing research theses and o t h e r studies which constitute a distinct contribution directly o r indirectly t o insurance k n o w l e d g e . " A l t h o u g h this g e n e r a l s t a t e m e n t of publication policy is quite b r o a d in scope, t h e A d m i n i s t r a t i v e B o a r d of the F o u n d a t i o n has felt t h a t , within its f r a m e w o r k , considerable emphasis should be placed upon the publication of m a t e r i a l which would be especially useful t o college or university teachers of insurance in t h e i r instructional w o r k . T h i s a t t i t u d e has been influenced by the following p r i m a r y c o n s i d e r a t i o n s : ( 1 ) T h e conviction t h a t every t e a c h e r w h o is t r u e t o the ideals of his p r o f e s s i o n w a n t s to be fully i n f o r m e d on all m a t t e r s of consequence in the r e a l m w h e r e he specializes. ( 2 ) T h e r e a l i z a t i o n t h a t college and university instruction in insurance has a l r e a d y reached, and will continue to reach, f a r m o r e students in the b r o a d domain of economics, g o v e r n m e n t , sociology and their subdivisions t h a n in such specialized vocational subjects as insurance law, a c t u a r i a l science and insurance medicine. ( 3 ) T h e recognition t h a t a t e a c h e r in the social science subjects must o b t a i n a b r o a d comprehension of the life insurance institution as a whole in its social setting. T h i s must be an " o v e r - a l l " view which not only includes t h e structure, f u n c t i o n s and services of this institution but also its m a n i f o l d i n t e r r e l a t i o n s h i p s with o t h e r institutions which m a k e up A m e r i c a n life t o d a y . ( 4 ) T h e r e a l i z a t i o n t h a t analysis and t h o r o u g h study of all the technical l i t e r a t u r e in life insurance is a timeV

vi

PREFACE

consuming process which is frequently prohibitive f o r the teacher whose duties require that he have an equally b r o a d grasp of other important institutions. T o keep himself conversant with all the developments and the new ideas which are presented in the journals of the actuarial societies, the medical directors, the agency executives, the insurance lawyers, the life underwriters, etc., and to be reasonably well informed on matters of importance which have not been there presented, is no mean task. T h i s initial publication, which is introduced by a statement f r o m T h o m a s I. Parkinson, Chairman of the Cooperating Committee for the Foundation, comprises a series of lectures which was given under the auspices of the Foundation at the University of Pennsylvania during the academic year 1941-1942. Although each of these lectures is a separate entity in itself and every speaker was accorded complete latitude in developing his subject as he saw fit, the various topics were selected by the speakers in cooperation with the Executive Director of the Foundation, who has also assumed the responsibilities of editor, f o r the purpose of giving to the series as a whole a high degree of continuity and unity. W h e n authorizing arrangement f o r this series of lectures, each of which was delivered at a dinner meeting attended by fellows and scholars of the Foundation and teachers on the Insurance D e p a r t m e n t faculty, members of the Foundation's Administrative Board had in mind the desirability of enabling those present and potential teachers of insurance who would be attending these meetings to have the privilege of hearing outstanding leaders in the life insurance field discuss important trends and problems affecting the institution of life insurance as well as the steps being taken to meet the problems. The primary directing principle followed in the selection of

PREFACE

vii

t h e s p e a k e r s w a s their capacity t o m a k e a w o r t h - w h i l e contribution t o the thinking of this t e a c h i n g g r o u p . Publication of these m a n u s c r i p t s w a s a u t h o r i z e d by the A d m i n i s t r a t i v e B o a r d of the F o u n d a t i o n with the sincere h o p e , a n d in the confident belief, t h a t t h e i r r a n g e of usefulness m i g h t be extensively w i d e n e d t h r o u g h m a k i n g t h e m available to teachers a n d s t u d e n t s of insurance in o t h e r e d u c a t i o n a l institutions. I t w a s felt t h a t such publication would be in full accord with the policy above set forth. T h i s p a r t i c u l a r volume is of special significance, n o t only because of the high s t a n d i n g in t h e life insurance w o r l d of those w h o h a v e m a d e it possible and the inh e r e n t quality of their respective c o n t r i b u t i o n s to it, b u t essentially because it m a r k s the beginning of an o r g a n i z e d effort t o p r o v i d e a l i t e r a t u r e especially intended f o r teachers in the b r o a d field of the social sciences. Conscious as these t e a c h e r s are of t h e complexities and ramifications of the subjects with which they deal and t h e inconclusiveness f r e q u e n t l y of t h e r e s e a r c h e s therein, they a r e nevertheless zealous to b r o a d e n t h e i r u n d e r s t a n d i n g and enrich t h e i r teaching. T o t h e m this first volume is d e d i c a t e d . T h r o u g h t h e m it is h o p e d t h a t research m a y be s t i m u l a t e d . F r o m t h e m will be w e l c o m e d substantial p a r t i c i p a t i o n in the subsequent studies, m o n o g r a p h s a n d o t h e r m a t e r i a l s which a r e published u n d e r the auspices of this F o u n d a t i o n . W i t h respect to the present volume, a t t e n t i o n should be called t o the f a c t t h a t the a d d r e s s e s a r e g r o u p e d u n d e r t h r e e h e a d i n g s as f o l l o w s : ( 1 ) public aspects r e l a t i n g t o life insurance; ( 2 ) significant t r e n d s and p r o b l e m s affecting life insurance costs; ( 3 ) significant t r e n d s and develo p m e n t s in distribution and public u n d e r s t a n d i n g of life insurance.

Vili

PREFACE

T h e plan of grouping in the second and third sections which deal with cost and distribution factors was designed to facilitate the study of each factor in the light of others. I t is hoped t h a t such an arrangement may enable teachers to use the material more readily f o r class assignments. T o the authors of the manuscripts who have made this volume possible the editor is indebted f o r an exceedingly fine measure of practical and kindly cooperation. T h e time and care which each devoted to his particular project have lightened the editor's work and enhanced the satisfaction with which he has participated in this joint endeavor. T o D r . S. S. Huebner, M r . F r a n k L. Jones, and D r . H a r r y J . Loman is due the gratitude of the editor f o r friendly counsel and constructive suggestions. To M i s s Anna M . Kelly is due his appreciation f o r valuable editorial assistance. T h e principal regret to which the editor confesses is that it proved impractical to reproduce the highly illuminating and thought-provoking discussion which followed each address as it was given. DAVID

Philadelphia April 1943

MCCAHAN

CONTENTS PACE

PREFACE Part

I.

v Public

Aspects

Relating

to Life

Insurance

I N T R O D U C T I O N , by Thomas I. Parkinson, President, The Equitable Life Assurance Society of the United States, and Chairman, Cooperating Committee for the S. S. Huebner Foundation for Insurance Education

3

I N S U R A N C E S U P E R V I S I O N , by Leroy A . Lincoln, President, Metropolitan Life Insurance Company Essential Elements in Insurance Supervision Early Historical Development of State Supervision Genesis of the National Association of Insurance Commissioners Examination of Companies The Zone System of Examinations Licensing Powers and Their Significance Requirements for Agents' Licenses Reserve Valuation and Non-forfeiture Statutes Contract Provisions Liberalized Through Competition Property and Casualty Insurance Expansion The Rise and Decline of Assessment Insurance Results of the Armstrong Investigation The Wisconsin Legislative Investigation "Committee of Fifteen Bills" New York's Insurance Law Revision The T.N.E.C. Investigation Adequate Opportunity for the Public to Safeguard Its Interests Advantages of Decentralized Regulation and Supervision

9 9 12 14 15 17 18 19 20 22 2i 24 27 28 29 30 30 33

A P H I L O S O P H I C A L V I E W OF LIFE INSURANCE, by Frank L. Jones, Vice-President, The Equitable Life Assurance Society of the United States Self-Preservation and Self-Perpetuation Natural Forces Influence Social Cooperation ix

38 40

CONTENTS

X

PAGE

Competition and Cooperation Equally Essential The Inner Urge Toward Democracy Influences Veering Us Away from Basic Natural Principles Life Insurance Patterned on Natural Principles and Science Operation of Natural Forces Produces Mutations

Part

II.

fecting

Significant Life

Insurance

Trends

and

Problems

42 43 45 47 50

Af-

Costs

L I F E I N S U R A N C E C O M P A N Y I N V E S T M E N T S , by Frank J. Travers, Second Vice-President, The Lincoln National Life Insurance Company Investment Standards Must Be Re-examined Are Bonds More Liquid Than Mortgages? Are "AAA" Bonds Riskless ? Other Assumptions Which May Not Be Tenable Investment Lessons from Company Failures Current Trends and Problems Affecting Investment Safety Investment Risk Needs Thorough Study The Problem of Appraising Management and Trends Private Placement of Bond Issues The Inflation Problem General Investment Policy

55 56 57 58 60 62 64 65 66 68 69

T H E SIGNIFICANCE OF REDUCED INTEREST E A R N I N G S , by Adolph A. Rydgren, President, Continental American Life Insurance Company Reduction in Interest Earnings Increase in Gross Premiums Factors Involved in Change in Non-Participating Premiums Factors Involved in Change in Participating Premiums Reduction in Dividends on Participating Policies Settlement Options Policy Loan Interest Miscellaneous Effects Recapitulation S O M E PROBLEMS O F LIFE I N S U R A N C E MEDIC A L S E L E C T I O N F R O M P A S T T O P R E S E N T , by Donald B. Cragin, M . D . , Medical Director, Aetna Life Insurance Company

75 77 79 80 86 89 90 92 94

CONTENTS

xi PACE

Medical Examination U n i m p o r t a n t in Early Days of Life Insurance T h e Association of Life Insurance Medical Directors Medico-Actuarial Cooperation Mechanical Aids in Selection of Risks Laboratory Aids in Risk Selection

96 98 99 100 102

C O N T E M P L A T E D C H A N G E S IN M O R T A L I T Y TABLES, RESERVE BASES A N D N O N - F O R F E I T U R E VALUES, by Edward E. Rhodes, Vice-President, The Mutual Benefit Life Insurance Company Misconceptions as to Effects of Using American Experience Table of Mortality Tables Based on M o r e Recent Mortality Experience Current T r e n d s in the Bases for Computing P r e m i u m s and Reserves Probable Effects of C u r r e n t Trends T w o Concepts of N o n - F o r f e i t u r e Values Allocation of O p e r a t i n g Expenses Related to N o n - F o r f e i t u r e Value Concept Recommendations of Insurance Commissioners Committee on N o n - F o r f e i t u r e Benefits

107 108 110 111 112 114 116

C O M P A R A T I V E N E T C O S T F A C T O R S IN ORDINARY, G R O U P A N D I N D U S T R I A L INSURANCE, by Valentine Howell, Vice-President and Actuary, The Prudential Insurance Company of America Bases of Net Costs Comparison of Net Costs Group Insurance W e e k l y P r e m i u m Industrial Insurance Monthly P r e m i u m I n s u r a n c e Conclusion

Part III. Significant Trends and Developments in Distribution and Public Understanding of Life Insurance RESEARCH I N L I F E I N S U R A N C E D I S T R I B U T I O N , by M. Albert Linton, President, Provident Mutual Life Insurance Company

118 126 127 132 135 136

Xll

CONTENTS PACE

Aptitude Tests The New Man on the Job Agents' Compensation Compensation of the New Agent Morale Conclusion

141 143 146 148 149 150

T H E P R E S E N T A N D F U T U R E O F S A L E S RES E A R C H I N L I F E I N S U R A N C E , by John Marshall Holcombe, Jr., Manager, Life Insurance Sales Research Bureau Some Early Questions Necessitating Sales Research Some Current Projects for Sales Research The Importance of Integrating Research Activities C O M P A R A T I V E SERVICES IN T H E DISTRIBUTION OF ORDINARY, INDUSTRIAL AND G R O U P L I F E I N S U R A N C E , by Paul F. Clark, VicePresident, John Hancock Mutual Life Insurance Company Life Insurance a Response to Human Needs Our Broadening Conception of Life Insurance Functions Progress in Life Insurance Education Comparative Markets of Ordinary, Group and Industrial Agents Relative Status of the Three Branches Industrial Insurance Frequently Misunderstood Significant Changes in Distribution of National Income Significant Changes in Expenditures of Different Income Groups The Optional Spending Power Situation Probable Effects of Income Changes on Life Insurance Distribution Anti-inflationary Service of Life Insurance

1S4 156 163

165 168 170 172 174 175 178 179 186 188 189

ORGANIZATION AND FUNCTIONS OF THE A G E N C Y IN M O D E R N LIFE I N S U R A N C E DIST R I B U T I O N , by Joseph H . Reese, General Agent, The Penn Mutual Life Insurance Company Introduction Formative Years Systems of Distribution

191 193 196

CONTENTS

xfii PAGE

The Modern Life Insurance Agency Agency Leadership Functional Organization Institutional Functions Sales Distribution Functions Conclusion—The Human Equation

198 202 204 205 213 224

A N E W ERA IN PUBLIC U N D E R S T A N D I N G O F L I F E I N S U R A N C E , by Holgar J. Johnson, President, Institute of Life Insurance Factors Affecting Public Attitude Reasons for Greater Attention to What the Public Thinks Public Opinion as Policy Shaping Factor Bases of Good Public Relations Some Attitudes Regarding Life Insurance Two Groups of Critics Possible Methods of Avoiding Misconceptions Which Produce Criticism Functions of the Institute of Life Insurance INDEX

228 230 231 232 234 235 237 239 243

T H E S. S. H U E B N E R F O U N D A T I O N FOR I N S U R A N C E E D U C A T I O N

COOPERATING C O M M I T T E E

Thomas I. Parkinson, Chairman Leroy A. Lincoln A. A. Rydgren H . H . Armstrong E. E. Rhodes Frank C. Weidenborner O. J. Arnold M . Albert Linton John A. Stevenson

Representing T H E ASSOCIATION OF LIFE I N S U R A N C E PRESIDENTS

Representing T H E AMERICAN LIFE CONVENTION

Representing T H E I N S T I T U T E OF LIFE I N S U R A N C E

ADMINISTRATIVE BOARD

H a r r y J. Loman, Chairman S. S. Huebner, Honorary Chairman David McCahan, Executive Director Ralph H . Blanchard Paul H . Musser Edison L. Bowers Edwin B. Williams

PART I PUBLIC ASPECTS RELATING TO LIFE INSURANCE

INTRODUCTION

THE DEVELOPING NEED FOR HIGHER EDUCATION IN LIFE INSURANCE by T h o m a s I. Parkinson President,

The

Equitable

Life

of the United

Assurance

Society

States

and Chairman, S. S. Huebner

Cooperating

Committee

Foundation

for Insurance

for

the Education

" T T was in making education not only common to all but A in some sense compulsory on all, that the destiny of the free republics of America was practically settled." These words of J a m e s Russell Lowell express not only the point of view of our ancestors with regard to the fundamental importance of having all of the people given the opportunity for acquiring at least a minimum standard of education but they reflect a p r o f o u n d belief in the relationship of that education to the successful functioning of the American plan of government. T h e standard of education necessary f o r efficient functioning of a f r e e republic is not an absolute. It must be considered in relation to the complexities of the economic, social and governmental environment in which people live and work. W h e n the social organism is elementary in form, a high s t a n d a r d of education and of social insight are not required. Native common sense contributes much to the reconcilement of individual and group interests. But when the social organism is complex in character, a broader education which embraces a knowledge of the in3

4

HUEBNER FOUNDATION LECTURES

terplay of conflicting forces and a more highly developed state of social insight are demanded. T h e connection between individual and group interests is more remote and native common sense cannot by itself reach the best conclusions so readily. It is not surprising t h e r e f o r e t h a t as America has grown, the little red schoolhouse has gradually given way to an attractive building of fire resistive construction, the elementary school has been extended to eight grades, the four-year high school has become commonplace and nearly six hundred junior colleges have sprung up in the past few decades to provide an additional two years of educational work because, as stated by the American Council on Education, " I n America the period of general secondary education (now) extends two years beyond the conventional high school course, to the middle of the four-year undergraduate course in the standard college or university." U n d e r normal conditions, the enrollment approximates twentytwo million students in elementary schools and six and a half million students in high schools. T h e trend in higher education has been just as marked. W h e r e a s the early colleges were established by religious interests primarily to provide students with a cultural background for practice in the professions, especially in the Christian ministry, the nature and scope of higher educational institutions have broadened in numerous directions until today some seventeen hundred colleges, universities, professional schools, teachers colleges, normal schools and junior colleges are conducting numerous and varied forms of educational activities f o r at least one and a quarter million students annually who have passed beyond the high school level. Even beyond the four-year college or university level has this same trend extended. Introduction of new subjects, raising of educational standards f o r teaching and f o r the various other professions, the general advance of

INTRODUCTION

5

science through research and the emphasis upon broadening further the various fields o f knowledge have increased the number o f graduate students between five and six fold since the close o f the first W o r l d W a r until, according to the United States Office o f Education, there were nearly one hundred thousand so enrolled in a recent year. M o s t of this educational progress has been achieved during the same period in which the institution of life insurance has been developing. B o t h the educational institution and the life insurance institution may each, as viewed in the broad sense, be said to have found its place in the American way o f life during the same period o f time. And different as their purposes appear and as their practices necessarily must be, they have a great deal in common. Both are concerned with the welfare and progress o f the individual. B o t h make their services available on a broad democratic basis to the great mass o f the people. Both stress the formation o f those character traits which make f o r a strong, self-reliant body politic. B o t h must adhere to sound, well-established principles on which they are grounded and yet must not be oblivious to the demands o f changed and changing conditions. And both are now living in a world o f such complex forces that even the broadest possible knowledge and the utmost skill in its use are none too adequate. I t is on this background t h a t the S. S. Huebner Foundation for Insurance Education was established. In one sense it was a tribute by the institution o f life insurance to a man who had set higher the sights of life underwriting service to the public and who had pioneered in insurance educational work f o r many decades but in a b r o a d e r sense it was a recognition by the institution t h a t education and research can make a distinct contribution to the more efficient functioning o f life insurance in the complex fabric o f life today. T h e need f o r such an organization as the H u e b n e r Foundation and the principal

6

HUEBNER F O U N D A T I O N LECTURES

ways in which it o p e r a t e s are set f o r t h in the following excerpts f r o m the bulletin which announced its c r e a t i o n : " T h e colleges and universities of the country have not, f o r the most p a r t , been adequately staffed with experienced insurance teachers. T h e y h a v e accordingly been handicapped in meeting the d e m a n d on the most satisf a c t o r y basis. T h i s is indeed not surprising when it is realized t h a t , outside of courses in insurance law and actuarial science p r i m a r i l y designed f o r prospective lawyers and actuaries, courses in insurance are comparatively late a r r i v a l s in the curricula of our higher educational institutions, being entirely a development of the twentieth century. "Since the quality and effectiveness of a teacher g r o w with his years of research and continued study, the logical m e t h o d f o r helping to s t r e n g t h e n education in insurance is to s t r e n g t h e n the individual teacher by giving him the o p p o r t u n i t y and the means to b r o a d e n his own u n d e r s t a n d i n g of the subject. T o t h a t end committees representing the Association of L i f e Insurance Presidents, the A m e r i c a n L i f e Convention and the Institute of L i f e Insurance p r o p o s e d to the life insurance companies of the U n i t e d States t h a t they unite in creating t h r o u g h joint contributions ( p r o p o r t i o n e d to the volume of o r d i n a r y insurance in f o r c e ) a f o u n d a t i o n which would provide 1. Fellowships f o r g r a d u a t e study available to teachers now in accredited colleges or universities who desire to study f o r a D o c t o r ' s degree, and who now hold at least a Bachelor's d e g r e e . 2. Scholarships f o r g r a d u a t e study available to recent g r a d u a t e s of accredited colleges or universities w h o desire to p r e p a r e f o r an insurance teaching career by studying f o r either a M a s t e r ' s or D o c t o r ' s degree. 3. Scholarships f o r g r a d u a t e study available to graduates of accredited colleges or universities now associated

INTRODUCTION

7

with insurance companies w h o desire t o p r e p a r e f o r educational w o r k within their own c o m p a n i e s by studying f o r either a M a s t e r ' s o r D o c t o r ' s d e g r e e , such scholarships t o be financed by specific c o n t r i b u t i o n s f o r the purpose unless the f u n d s available f r o m t h e f o u n d a t i o n a r e m o r e t h a n sufficient to m e e t the need f o r fellowships and scholarships a m o n g p e r s o n s p r e p a r i n g f o r t h e teaching p r o f e s s i o n as a life c a r e e r . 4. F o r building up and m a i n t a i n i n g a r e s e a r c h service center in insurance books and o t h e r source m a t e r i a l which would be available t h r o u g h circulating privileges to teachers in accredited colleges a n d universities desirous of conducting research in insurance subjects. 5. F o r publishing r e s e a r c h theses and o t h e r studies which constitute a distinct contribution directly or indirectly t o insurance k n o w l e d g e . " A l t h o u g h the F o u n d a t i o n has n a t u r a l l y c o n c e n t r a t e d , as w a s planned, upon t h e p r e p a r a t i o n of t e a c h e r s f o r college and university t e a c h i n g of insurance t h r o u g h a w a r d s of g r a d u a t e fellowships a n d scholarships, it cont e m p l a t e s , as mentioned in the f i f t h objective above s t a t e d , t h e publication f r o m time t o time of research theses, m o n o g r a p h s and o t h e r m a t e r i a l which will presumably be u s e f u l in insurance e d u c a t i o n a l w o r k . The p r e s e n t volume is the first t o be u n d e r t a k e n .

INSURANCE SUPERVISION

President,

Metropolitan

Life

Insurance

Company

H E phenomenal success of t h e institution of insurance in America has been a t t r i b u t e d to various fact o r s . I t is my personal belief t h a t this success is t h e n a t u r a l o u t g r o w t h of t h r e e f u n d a m e n t a l concepts which a r e m o r e or less peculiar to the U n i t e d States and C a n a d a , the p r i v a t e m a n a g e m e n t of the business of insurance, the competition a m o n g concerns e n g a g e d in t h a t business, and the public supervision which is m a i n t a i n e d o v e r the business. T a k e away any one of these f a c t o r s and a less useful institution remains. P r i v a t e m a n a g e m e n t assures t h e vigorous prosecution of an i m p o r t a n t business which is not t o be h a d u n d e r the b a l e f u l dead hand of public o p e r a t i o n . C o m p e t i t i o n assures the evangelism of the a g e n t , on the one h a n d , and, on the o t h e r , the effort by the companies to devise m o r e and b e t t e r means of c o v e r a g e and of service. Public supervision assures public k n o w l e d g e and confidence t h r o u g h adherence to a set of principles of m a n a g e m e n t and o p e r a t i o n evolved in t h e interest of all the people. In this present discussion I a m u n d e r t a k i n g m o r e particularly t o paint the picture of supervision t o w a r d which I may, p e r h a p s , have an u n p r e j u d i c e d a t t i t u d e because of the f a c t t h a t I have been, in t h e course of my connection with the insurance business, b o t h an official of a super8

INSURANCE SUPERVISION

9

vising d e p a r t m e n t and an official of a large life insurance company. I t is f r o m this combined experience t h a t I set out to discuss the history and the practice of insurance supervision in the U n i t e d States. ESSENTIAL ELEMENTS IN INSURANCE

SUPERVISION

Supervision, in the m e a n i n g in which I conceive it, embraces, first, the enactment of laws applicable t o the conduct of the business; second, inspection and visitation of the various units engaged in the business; and, t h i r d , useful r e p o r t s as to o p e r a t i o n s by such units, sufficient to assure the lay m e m b e r s of the population t h a t those who understand the laws and the proprieties of management have satisfied themselves t h a t such units are conducting this business in the interest of the whole public— policyholders and non-policyholders. O u r courts have, on n u m e r o u s occasions, declared t h a t insurance is a business affected with a public interest and it is taken f o r g r a n t e d in A m e r i c a t h a t the insurance business is a p r o p e r subject f o r s t a t u t o r y regulation and administrative supervision. T h e American concept goes one step f u r t h e r and, besides effecting a system of supervision which will secure adequate protection of the public, it also seeks to avoid undue h i n d r a n c e of any f r e e d o m of p r o p e r development within the business itself so t h a t such business may continue to k e e p abreast of the changing insurance needs of the public. EARLY HISTORICAL D E V E L O P M E N T O F STATE S U P E R V I S I O N

A d m i n i s t r a t i v e supervision of the business of insurance, as we know it today, did n o t have its beginning in this country until about t h e middle of the nineteenth cen-

10

HUEBNER FOUNDATION LECTURES

tury. Insurance did not then have the scope which it has today, nor did it occupy that important place in the economic and social fabric of the nation which it has since attained. Nevertheless, very early in the history of this country we find legislative recognition of the importance of the insurance institution and steps taken to protect the solvency of its guaranties. T h i s early legislation was originally included in special legislative charters granted to particular companies. In granting a charter to the Insurance Company of N o r t h America in April, 1794, the Legislature of Pennsylvania imposed certain restrictions upon the investments of the company, laid down certain requirements with respect to monies that should be " r e s e r v e d " to pay losses and limited its holdings of real estate. Another example is to be found in a somewhat similar special charter for the Massachusetts Fire Insurance Company, granted by an act of the Massachusetts Legislature in 1795, which required that the company's capital be invested in obligations of the United States or the state of Massachusetts or in stock of the Bank of the United States or of any bank incorporated in Massachusetts. In 1807 Massachusetts enacted the first general provision which required every domestic insurance company to file with the legislature a statement of its affairs. This was the forerunner of the modern requirement f o r filing with the insurance commissioner a complete annual statement. In 1827 N e w York enacted a general statute requiring all "monied corporations," which included insurance companies, to file annual statements with the comptroller. T h e statement required by this 1827 Act of N e w York was very sketchy, when compared with the modern annual statement, but at that time it was considered to be exhaustive and far-reaching. T h e signifi-

INSURANCE SUPERVISION

11

cant fact is t h a t these early regulations imposed upon some existing state official, usually a fiscal officer, the duty of enforcing compliance with the statute. M o d e r n supervision h a d its beginning when N e w H a m p s h i r e in 1851 established the first independent B o a r d of Insurance Commissioners, consisting of t h r e e members w h o were to devote their full time to their task. T h e s t a t u t e imposed upon them the duty to examine each year into the affairs of each insurance company and t o r e p o r t to the legislature. In 1852 Massachusetts created an ex-officio B o a r d of Insurance Commissioners, consisting of t h r e e state officials, gave it b r o a d e r powers in 1854, and in 1855 changed f r o m the ex-officio type to a b o a r d of three m e m b e r s appointed by the g o v e r n o r . In 1858 this b o a r d was reduced to two members, and, a t t h a t time, in addition to its o t h e r powers, it was given the novel task of calculating life insurance reserves. This step m a r k e d a new era in life insurance supervision though it was not until 1866 that Massachusetts p r o v i d e d f o r a single commissioner having the powers f o r m e r l y exercised by such b o a r d . In the meantime N e w Y o r k , however, had, in 1859, creatcd the office of Superintendent of Insurance, the first independent and single-headed administrative office in the U n i t e d States charged with the duty of supervising the business of insurance. T h e s e enactments m a r k e d the beginning of insurance supervision in this country as we know it t o d a y a n d the lead of N e w Y o r k and M a s s a c h u s e t t s was gradually followed by o t h e r states. By the early 1870's insurance supervision had become general t h r o u g h o u t the states with a u t h o r i t y exercised either by a special administrative officer charged with the duty of insurance supervision or by some state official whose duties of insurance supervision w e r e embraced with his other s t a t u t o r y duties.

12

HUEBNER FOUNDATION LECTURES

GENESIS OF T H E NATIONAL ASSOCIATION OF INSURANCE COMMISSIONERS

Next came a growing appreciation of the need f o r uniformity and of the opportunity f o r cooperation a m o n g the states so as to make insurance supervision more effective and so as to bring about uniformity in legislation and supervision. T h i s necessity was recognized by the Superintendent of Insurance of N e w Y o r k as early as 1871 when he addressed a letter to the supervising officials of other states suggesting a meeting f o r the interchange of ideas and f o r the development of cooperation. It is interesting to quote the following f r o m a letter of H o n o r a b l e George W . Miller, Superintendent of Insurance of the State of N e w York, dated February 3, 1 8 7 1 : " T h e past and prospective increase in the number of state departments, each established under different laws and adopting different forms, rules, and regulations, has naturally tended rapidly to increase the labors and consequent expense of insurance companies, and, of course, to absorb by so much the security or funds of the insured. . . . T h e most feasible and practicable mode of securing that simplification and unification both of f o r m and of law, which public interests seem to demand, will be found in concertive action on the p a r t of those several state officers charged by their respective states with the supervision of insurance. " A s to the enactment of laws, the earnest recommendation of a convention of such state officers would, no doubt, be recognized as entitled to great consideration by the legislatures of the respective states." Such a meeting was convened in N e w York on M a y 24, 1871, with nineteen state departments represented.

INSURANCE SUPERVISION

13

L e t us observe, in the light of m o d e r n experience, some of the principal questions considered at this meeting, out of which ultimately g r e w the N a t i o n a l Association of Insurance Commissioners. O n t h a t a g e n d a we find the following i t e m s : 1. A u n i f o r m blank f o r the annual r e p o r t s of the companies. 2. T h e acceptance by individual d e p a r t m e n t s , within prescribed legal limits, of the certificates of o t h e r dep a r t m e n t s as to the valuations of assets and liabilities of h o m e companies. 3. A u n i f o r m m e t h o d of valuation of contractual obligations, including the use, f o r t h a t purpose, f o r life insurance companies of a specified m o r t a l i t y table and r a t e of interest. 4. U n i f o r m laws, including u n i f o r m i t y in taxation. 5. T h e best m e t h o d of dealing with companies in distress. T h e meeting lasted ten days and o t h e r problems were discussed, but m a n y of the questions w e r e considered to be of such importance as to justify an a d j o u r n e d meeting in O c t o b e r of t h a t year. O n O c t o b e r 18, 1871, the meeting again convened and this time t h i r t y states were represented. A p e r m a n e n t o r g a n i z a t i o n was f o r m e d known as the " N a t i o n a l Insurance Convention of the U n i t e d S t a t e s . " T h i s title was later changed to the " N a t i o n a l Convention of Insurance C o m m i s s i o n e r s , " a n d in 1935 to t h e " N a t i o n a l Association of Insurance Commissioners." F r o m its very beginning, back in 1871, t h e N a t i o n a l Association of Insurance Commissioners has devoted consideration to an ever-widening scope of supervisory activities as the business has expanded and its problems have increased, step by step, with its g r o w t h in importance in the economic and social d e v e l o p m e n t of the country.

14

HUEBNER FOUNDATION LECTURES E X A M I N A T I O N OF C O M P A N I E S

T h e early r e g u l a t i o n of insurance w a s a l o n g s i m p l e lines. T h e principal concern of early supervision w a s with solvency as reflected by the annual s t a t e m e n t s o f the companies. It h a d not t h e n been r e c o g n i z e d t h a t , in addition t o p r e s e n t i n g a s t a t e m e n t of solvency as o f any g i v e n d a t e , it w a s i m p o r t a n t that the m a n a g e m e n t should be such as t o w a r r a n t e x p e c t a t i o n o f c o n t i n u e d solvency. T h e s t a t u t e s o f that earlier period w e r e g e n erally concerned w i t h such questions as the a m o u n t o f capital and surplus and the basis of reserves f o r l i f e insurance companies. M o d e r n s t a t u t e s relating to the business came a l o n g as the complexities o f the business w e r e m o r e and m o r e a p p r e c i a t e d . Supervisory officials h a v e l o n g h a d the p o w e r o f visitation, e x a m i n a t i o n and inquiry into c o m p a n y affairs tog e t h e r with the p o w e r of licensing, a n d such p o w e r s are m o s t important. T h e y are the source of a u t h o r i t a t i v e official k n o w l e d g e about a c o m p a n y ' s affairs, which, in itself, m a y h a v e no small influence upon c o m p a n y management. T h e r e d e v e l o p e d , h o w e v e r , s o m e undesirable and unethical practices in conducting e x a m i n a t i o n s and these b e c a m e a subject o f discussion at the m e e t i n g s o f the C o n v e n t i o n . A s early as 1 8 8 9 the C o n v e n t i o n p a s s e d a resolution d i s a p p r o v i n g the practice o f c o m m i s s i o n e r s ' m a k i n g e x a m i n a t i o n s at the time of its annual m e e t i n g s . T h i s question o f the conduct o f e x a m i n a t i o n s has received much a t t e n t i o n f r o m the N a t i o n a l C o n v e n t i o n and later, f r o m the N a t i o n a l A s s o c i a t i o n , particularly since the a p p o i n t m e n t o f the s t a n d i n g C o m m i t t e e on E x a m i n a tions in 1 9 1 0 . W h i l e t h e r e could be n o question as t o the l e g a l right o f a s u p e r v i s o r y official t o visit a n d m a k e e x a m i n a t i o n s o f c o m p a n i e s d o i n g business in his state, it s o o n b e c a m e a p p a r e n t that application o f the principle

INSURANCE SUPERVISION

15

of comity between s t a t e s s h o u l d a v o i d any unnecessary exercise of this legal r i g h t so t h a t c o m p a n i e s would n o t be b u r d e n e d with t h e unnecessary expense of u n w a r r a n t e d frequent examinations. T h e s e v a r i o u s discussions resulted in the a p p o i n t m e n t of a s t a n d i n g C o m m i t t e e on E x a m i n a t i o n s in 1910, t h e p u r p o s e of which was to d e v e l o p a p r o c e d u r e which would result in s a t i s f a c t o r y e x a m i n a t i o n s a n d yet avoid t h e evils of duplicate a n d unnecessary e x a m i n a t i o n s . The w o r k of this c o m m i t t e e r e s u l t e d in t h e a d o p t i o n by the C o m m i s s i o n e r s ' C o n v e n t i o n of a by-law which p r o v i d e d t h a t no examination should be conducted by commissioners of states o t h e r t h a n t h e state of domicile unless t h e C o m m i t t e e on E x a m i n a t i o n s first o b t a i n e d t h e consent of the commissioner of the c o m p a n y ' s domiciliary s t a t e o r , in the event such consent should be w i t h h e l d , t h e comm i t t e e satisfied itself t h a t t h e best interests of supervision would be served by conducting the e x a m i n a t i o n w i t h o u t such consent. Also, the by-law c o n t e m p l a t e d participation of o t h e r s t a t e s in e x a m i n a t i o n s conducted by t h e commissioner of the domiciliary s t a t e when requested by him. In the selection of s t a t e s to p a r t i c i p a t e in such socalled " C o n v e n t i o n E x a m i n a t i o n s , " the by-law p r o v i d e d t h a t the committee should, i n s o f a r as practicable, select s t a t e s t h a t would insure a f a i r g e o g r a p h i c a l r e p r e s e n t a tion of all s t a t e s in which the c o m p a n y t r a n s a c t e d business. T H E Z O N E SYSTEM OF E X A M I N A T I O N S

C o n v e n t i o n e x a m i n a t i o n s w e r e n o t i n f r e q u e n t . I t is interesting to note t h a t f r o m A u g u s t 1, 1923, t o N o v e m ber 1, 1926, 104 convention e x a m i n a t i o n s w e r e conducted, and all but six s t a t e s p a r t i c i p a t e d in one or m o r e of these examinations. L a t e r , in 1936, t h e C o m m i s s i o n e r s Asso-

16

HUEBNER F O U N D A T I O N LECTURES

ciation developed and p u t into effect the present system of examination by zones, which is now used by the C o m mittee on E x a m i n a t i o n s and which w o r k s effectively t o insure f a i r geographical representation of t h e states in which the company does business. On D e c e m b e r 8, 1936, the following resolution was a d o p t e d by the A s s o c i a t i o n : " W h e r e a s , this Association at its annual meeting held at St. P a u l this year, decided upon convention examination of all companies doing business in three or m o r e states, t h e r e f o r e , in o r d e r to better carry out the w o r k involved in this operation, it is resolved t h a t the committee on examinations of this Association is hereby a u t h o r i z e d and directed to zone the country into six districts, each of which is to be composed of the eight conveniently adjacent states, with the District of Columbia included in its nearest z o n e ; t h a t on all examinations subject to the convention m e t h o d , each zone in which the company to be examined is doing business shall be represented by an examiner to be chosen and a u t h o r i z e d by the respective states comprising the zone. T h e supervising official of the domiciliary state of the particular company shall n o t i f y the chairman of the examinations committee of the impending examination, w h o shall thereupon n o t i f y the key commissioner in each of the zones in which the company is doing business." A t t h a t meeting the E x a m i n a t i o n s C o m m i t t e e w a s directed to devise machinery to carry out the f o r e g o i n g resolution, and in accordance with such direction a meeting of the C o m m i t t e e was held in Chicago in J a n u a r y , 1937. T h e states were then divided into six zones and a m a n a g e r was n a m e d f o r each zone. T h i s system in general contemplates the participation by representation

INSURANCE SUPERVISION

17

f r o m each zone in an examination by the commissioner of the home state of the examined company, a n d t h a t a copy of the examination r e p o r t shall be sent to each state in which the company is licensed. T h i s m e t h o d of conducting examinations seems, f r o m my observation, t o h a v e o p e r a t e d effectively and satisfactorily d u r i n g the p a s t five years. LICENSING POWERS AND T H E I R

SIGNIFICANCE

Considering next the licensing p o w e r s of the commissioners, it should be borne in mind t h a t the a u t h o r i t y of a commissioner to g r a n t a license, or to r e f u s e one, is one of the strongest and most effective f e a t u r e s of insurance supervision. E v e n in the absence of specific s t a t u t o r y a u t h o r i t y to r e f u s e a license in the case of a company which has been guilty of questionable practices or as to whose solvency and general good m a n a g e m e n t t h e r e is a question, the commissioner can, if he is in doubt, r e f u s e the license, give publicity to his reasons f o r refusing, and put the company in a position w h e r e it must p r o v e its case in court proceedings in o r d e r to secure its license. Such a course results in an airing of the company's management, practices a n d financial condition b e f o r e the public, and is a s t r o n g f o r c e in securing g o o d m a n a g e m e n t . In connection with the subject of licensing t h e r e is a n o t h e r phase of supervision which must h a v e a very real importance, t h a t which h a s to do, in m a n y states, with the licensing of agents in certain branches of the insurance business. T h e dependency of the public on sound advice f r o m individuals w h o h a v e to do with creating and servicing their insurance contracts is a v e r y real dependence. In most cases it is probably the f a c t t h a t the policyholder or prospective policyholder knows no one connected with his insurer except the agent. I n d e e d , it may sometimes

18

HUEBNER FOUNDATION LECTURES

happen that the policyholder may not even know the identity of his insurance company but places his reliance entirely on the individual agent and knows only that agent in his insurance transactions. It is for this reason that the states have properly set up machinery f o r examining into the character, previous business history, and qualifications of prospective insurance agents. R E Q U I R E M E N T S FOR A G E N T S '

LICENSES

Every state in the Union requires that an agent shall be licensed by the state before he may solicit life insurance. As a condition precedent to the issuance of license, each one of these states requires a certification f r o m the company, or someone authorized to act in its behalf, that the applicant f o r an agent's license is a person of such character and responsibility as to justify the issuance of a license f o r the transaction of such business. In addition, thirteen states and the District of Columbia require that applicants f o r license to act as agent f o r either life or accident and health insurance, or both, submit to and satisfactorily pass a written examination as evidence of their qualification f o r license. In two of these jurisdictions license is issued upon certification by the company t h a t the applicant has successfully completed a course of study given by the company and approved in advance by the supervising official, but in the remaining twelve jurisdictions the examination is given by the insurance department. T h e scope of these examinations varies considerably but, in general, they are designed to show an understanding of the general principles of the business to be undertaken, a familiarity with the provisions of the contracts the agent is to sell, and an understanding of the law governing the relations between agent and applicant or policyholder, and between agent and company. Par-

INSURANCE SUPERVISION

19

ticular a t t e n t i o n is given t o laws p r o h i b i t i n g twisting, rebating, and misrepresentation. Some questions typical of those which may a p p e a r on the examinations given t o applicants f o r license to act as life insurance agents a r e : 1. E x p l a i n w h a t is m e a n t by the following t e r m s : ( a ) Reserve basis; ( b ) interest basis; ( c ) m o r t a l i t y t a b l e ; ( d ) l o a d i n g f o r expense of m a n a g e m e n t . 2. W h y is it necessary to state in using dividend illustrations t h a t they are neither estimates n o r g u a r a n t e e s of f u t u r e dividends? 3. W h a t is m e a n t by "insurable i n t e r e s t ? " 4. W h a t supervision has the State Insurance D e p a r t ment over companies? 5. ( a ) Define o r d i n a r y life insurance. ( b ) Define industrial life insurance, (c) Define g r o u p life insurance. 6. ( a ) W h e n should industrial insurance be recommended? ( b ) W h e n should o r d i n a r y insurance be recommended ? 7. N a m e five uses f o r life insurance. W h i l e the p r i m a r y responsibility f o r the selection and appointment of an agent must be placed upon the company, the expanding scope of the concern of supervisory authorities with the character and qualifications of agents selected f o r a p p o i n t m e n t serves to e m p h a s i z e the importance of p r o p e r selection and t r a i n i n g of agents. RESERVE V A L U A T I O N A N D N O N F O R F E I T U R E S T A T U T E S

N o n f o r f e i t u r e statutes relating t o life insurance policies were first enacted in 1861. D u r i n g t h a t year the Legislature of t h e C o m m o n w e a l t h of M a s s a c h u s e t t s a d o p t e d w h a t came to be known as the " N o n f o r f e i t u r e L a w of 1 8 6 1 " which required life insurance companies to p r o v i d e n o n f o r f e i t u r e values based u p o n net level premium reserves computed on the A c t u a r i e s ' T a b l e of

20

HUEBNER FOUNDATION LECTURES

M o r t a l i t y , with interest at 4 per cent. T h e lead of Massachusetts was followed by others, and today thirtysix states and the District of Columbia have statutes on this subject. As I have previously pointed out, Massachusetts in 1858 was also the first state to require its insurance supervisory officials to calculate life insurance reserves. T h i s 1858 statute prescribed no standard f o r the valuation of reserve liability, but empowered the commissioners to select the table of mortality, the rate of interest, and the reserve basis to be used in determining the reserve liability of companies doing business in Massachusetts, and may be considered as the beginning of what we know today as statutory minimum valuation standards. In 1863 a statute was enacted in Massachusetts prescribing, as the basis of valuation f o r a test of solvency, the same standards which had been prescribed for n o n f o r f e i t u r e values in 1861. By 1871 there were thirteen states which had enacted statutes prescribing a specific mortality table and rate of interest as the standard of valuation for testing the solvency of life insurance companies. It is f r o m these minimum s t a n d a r d s of valuation prescribed by these statutes the term "legal reserve life insurance" is derived. T h e lead of these states was followed by others so that the system of level premium legal reserve life insurance, as we know it today, soon became well established in the United States. C O N T R A C T PROVISIONS L I B E R A L I Z E D

THROUGH

COMPETITION

Competition and not statutory requirements resulted in the gradual expansion of the benefits and provisions of life insurance policies. Liberal cash surrender values, loan values, grace periods, reinstatement clauses, incon-

INSURANCE SUPERVISION

21

t e s t a b l e clauses, l i b e r a l i z a t i o n of t r a v e l r e s t r i c t i o n s , c h a n g e of beneficiary p r o v i s i o n s , clauses p r o v i d i n g f o r a d j u s t m e n t i n s t e a d of f o r f e i t u r e f o r m i s s t a t e m e n t of a g e , i n s t a l m e n t o p t i o n s , a n d o t h e r of t h o s e benefits w h i c h m a k e u p a m o d e r n l i f e i n s u r a n c e policy w e r e i n t r o d u c e d g r a d u ally, by o n e c o m p a n y o r a n o t h e r a n d , as e x p e r i e n c e p r o v e d t h e i r f e a s i b i l i t y , t h e y w e r e a d o p t e d m o r e o r less generally by p r o g r e s s i v e c o m p a n i e s , a n d s u b s e q u e n t l y f o u n d their way into statutory requirements. I t w a s n o t until a f t e r t h e legislative i n v e s t i g a t i o n a n d r e p o r t by t h e A r m s t r o n g C o m m i t t e e in N e w Y o r k , which C o m m i t t e e w a s a p p o i n t e d in 1905 a n d r e p o r t e d in 1 9 0 6 , t h a t s t a t e s b e g a n t o enact, s o m e w h a t g e n e r a l l y , w h a t a r e n o w k n o w n as " s t a n d a r d p r o v i s i o n s t a t u t e s , " r e q u i r i n g t h a t life i n s u r a n c e policies include c e r t a i n p r o v i s i o n s a n d exclude c e r t a i n o t h e r p r o v i s i o n s . I n 1 9 0 6 , as t h e r e s u l t of t h a t i n v e s t i g a t i o n , t h e N e w Y o r k L e g i s l a t u r e first e n a c t e d a s t a t u t e p r e s c r i b i n g t h e exact f o r m a n d exact w o r d i n g f o r l i f e i n s u r a n c e policies t o b e issued a f t e r J a n u a r y 1, 1 9 0 7 . I t w a s soon r e a l i z e d t h a t t h e r i g i d i t y of such s t a t u t o r y policy f o r m s d e s t r o y e d l e g i t i m a t e c o m p e tition a n d h i n d e r e d , if it d i d n o t e n t i r e l y p r e v e n t , d e v e l o p m e n t and i m p r o v e m e n t of benefits o f f e r e d t o p o l i c y h o l d ers. C o n s e q u e n t l y , this e n a c t m e n t w a s r e p e a l e d in 1 9 0 9 and there was substituted a s t a n d a r d provisions statute r e q u i r i n g l i f e i n s u r a n c e policies t o c o n t a i n , in s u b s t a n c e , c e r t a i n p r o v i s i o n s w i t h o u t t h e r e q u i r e m e n t of specific w o r d i n g . O t h e r s t a t e s s o o n f o l l o w e d suit a n d a l s o req u i r e d c o m p a n i e s t o file t h e i r policy f o r m s w i t h , a n d secure t h e a p p r o v a l o f , t h e i n s u r a n c e s u p e r v i s o r y official of t h e s t a t e in w h i c h t h e policy f o r m s w e r e t o b e u s e d . M o s t of t h e s e s t a t u t e s wisely c o n t a i n e d an a d d i t i o n a l p r o v i s i o n a l l o w i n g t h e i n s u r a n c e s u p e r v i s o r y official t o a p p r o v e policy f o r m s t h e p r o v i s i o n s of w h i c h a r e m o r e liberal t h a n t h o s e r e q u i r e d by s t a t u t e . I t is significant

22

HUEBNER FOUNDATION LECTURES

that, with few exceptions, the provisions required by such statutes had already been devised by one or more life insurance companies and that their use had become quite general b e f o r e the requirements were imposed by law. T h i s natural course of development demonstrates the desirability of allowing companies freedom to adopt new forms and provisions and the inadvisability of retarding improvements by any process of statutory freezing. P R O P E R T Y A N D CASUALTY I N S U R A N C E E X P A N S I O N

In the fields of property insurance and casualty insurance there has been a remarkable development since the establishment of the National Convention (now Association) of Insurance Commissioners. As our population has increased, our cities have grown, and there has been concentration of property values in the great cities and numerous new f o r m s of economic activity have become common, all involving risks and requiring protection. It is interesting to note how greatly the various forms of coverage offered by fire and casualty insurance companies have expanded since 1873 when the state of Massachusetts enacted the first s t a n d a r d f o r m of fire insurance policy in the United States. Instead of a policy simply indemnifying the owner f o r destruction of property specifically located, as in 1873, we have today an extensive line of insurance contracts covering property in transit, as well as use and occupancy insurance contracts to cover the fixed charges and earnings loss to an owner while awaiting the reconstruction of destroyed property. W o r k m e n ' s Compensation Acts began to be adopted a f t e r the turn of the century and a new f o r m of insurance coverage f o r this risk has rapidly expanded. T h e surety bond, rapid expansion of the use of fidelity insurance, the development of f o r g e r y bonds, and other forms of cov-

23

INSURANCE SUPERVISION

erage too n u m e r o u s to mention have m a r k e d the response of insurance carriers to the d e m a n d s of the public f o r adequate coverage. In the field of p r o p e r t y insurance the m a t t e r of ratemaking assumes g r e a t importance. I t is in the interest of policyholders t h a t rates should be a d e q u a t e because adequate r a t e s are necessary to assure security. Voluntary associations were f o r m e d f o r the p u r p o s e of m a k i n g rates f o r different types of p r o p e r t y and casualty insurance and gradually the states t o o k over some f o r m of supervision of their rate-making activities. T H E RISE A N D D E C L I N E O F ASSESSMENT

INSURANCE

Assessment insurance in one f o r m or a n o t h e r flourished in the earlier years. F o r a time these o r g a n i z a t i o n s were able to offer insurance at rates which seemed low compared to legal reserve life insurance. T h e business was recognized by statute in m a n y states and n o t prohibited in others. A t first these o r g a n i z a t i o n s seemed to p r o s p e r , but the inadequacy of their r a t e s and the n a t u r a l increase of the r a t e of premium incident to increasing age eventually led to dissatisfaction and to their discontinuance as going concerns. Finally the state of N e w Y o r k enacted a statute prohibiting the creation, a f t e r J u n e 1, 1906, of new life companies to do business on the assessment plan, and prohibiting the admission of any such foreign assessment companies a f t e r t h a t d a t e . F r a t e r n a l organizations were excepted f r o m this prohibition, but in 1929 it was extended to cover f r a t e r n a l s . T h e r e is little assessment business transacted in the U n i t e d States today. Some of the well-managed older assessment companies ultimately recognized the fallacy of the principles of assessment insurance and a d a p t e d themselves to insurance on the legal reserve basis. Likewise the well-man-

24

HUEBNER FOUNDATION LECTURES

aged and substantial f r a t e r n a l societies have pretty generally adopted the legal reserve system of valuation, so that except f o r a few companies of no great prominence, assessmentism is not a factor of importance in the life insurance business in the United States today. The National Association of Insurance Commissioners is entitled to credit f o r its p a r t in bringing about this result. R E S U L T S OF T H E ARMSTRONG I N V E S T I G A T I O N

Until 1906 the general concept of the duties of the insurance commissioner or superintendent of insurance was largely limited to the determination of solvency o r insolvency of companies organized in or licensed to transact business in his state. Investigations into the b r o a d e r spheres of management and managerial practices had not been accepted at that time as one of the duties of the Superintendent of Insurance. T h e " A r m s t r o n g Committee" of the N e w Y o r k Legislature already referred to, made a sweeping investigation into the business of life insurance and the practices of companies doing business in the state of N e w York, rendering its report under date of February 22, 1906. T h e Committee had as its principal counsel H o n o r a b l e Charles E . Hughes, subsequently Chief Justice of the Supreme Court of the United States. W i d e publicity was given throughout the press to the conduct of the Committee's investigation and the practices revealed by its inquiries. Its work made a p r o f o u n d impression throughout the country, and its reports led to the adoption of extensive changes in the life insurance laws not only of the state of N e w York but also of other states. One of the important results of the work of the Committee was to broaden the concept of the scope of an insurance commissioner's activities to include not only

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a t e s t i n g of solvency, b u t t h e d u t y t o i n v e s t i g a t e i n t o any a n d every p h a s e of i n s u r a n c e c o m p a n y m a n a g e m e n t t h a t w o u l d affect t h e i n t e r e s t of t h e p o l i c y h o l d e r s o r t h e public. I t is p r o b a b l e t h a t v e r y f e w i n d i v i d u a l s in t h e g e n e r a l public h a v e any clear c o n c e p t i o n of t h e scope of I n s u r a n c e Department examinations. T a k i n g N e w Y o r k as an i l l u s t r a t i o n , t h e law r e q u i r e s t h a t t h e S u p e r i n t e n d e n t of I n s u r a n c e shall e x a m i n e d o m e s t i c life, c a s u a l t y a n d s u r e t y insurance c o m p a n i e s a t l e a s t once in t h r e e y e a r s a n d shall e x a m i n e o t h e r t y p e s of i n s u r a n c e c a r r i e r s once in five y e a r s . T h e s e a r e k n o w n as r e g u l a r e x a m i n a t i o n s a n d m a y , at any time, if occasion s u g g e s t s , b e s u p p l e m e n t e d by special e x a m i n a t i o n s . I n t h e case of a r e g u l a r e x a m i n a t i o n of o n e of t h e v e r y l a r g e life i n s u r a n c e c o m p a n i e s , t h e t i m e e l a p s e d f r o m t h e c o m m e n c e m e n t of t h e e x a m i n a t i o n until t h e final filing of the report generally a m o u n t s to about a year and a half. R e c a l l i n g t h e f a c t t h a t such e x a m i n a t i o n s a r e r e q u i r e d t o be m a d e in t h e case of l i f e i n s u r a n c e c o m p a n i e s once in e v e r y t h r e e y e a r s , it is a p p a r e n t t h a t t h e D e p a r t m e n t is in a c t u a l course of e x a m i n i n g a n d c h e c k i n g u p t h e v a r i o u s activities of such a c o m p a n y f o r a b o u t fifty p e r cent of the time. T h e s e r e g u l a r e x a m i n a t i o n s consist in a v e r y d e t a i l e d inquiry into t h e c o m p a n y ' s o p e r a t i o n s , t h e n a t u r e a n d sufficiency of its i n v e s t m e n t s , t h e c o m p a n y ' s a c c o u n t i n g practices, its m a n n e r of d e a l i n g w i t h p o l i c y h o l d e r s a n d with claims, a n d a t h o r o u g h - g o i n g inquiry i n t o e v e r y t h i n g p e r t i n e n t t o t h e c o n d u c t o f its business. I n t e r v i e w s w i t h t h e c o m p a n y ' s o p e r a t i n g h e a d s a n d e x a m i n a t i o n of b o o k s a n d files a r e intensive. N o t h i n g is o v e r l o o k e d o r n e e d b e overlooked because the Insurance D e p a r t m e n t examiner h a s a legal r i g h t t o r e q u i r e p r o d u c t i o n a n d disclosure of p a p e r s a n d all f a c t s h a v i n g t o d o w i t h t h e c o m p a n y ' s

26

HUEBNER FOUNDATION LECTURES

operations. In the case of mutual life insurance companies or companies issuing policies entitling the policyholder to participate in the earnings of the business, the D e p a r t m e n t examiners give particular attention to the allocating of so-called dividends and the propriety of such allocation. T h e s e examinations are carried on by a corps of examiners the members of which, in some states, as in the state of N e w York, are experienced D e p a r t m e n t representatives selected under the processes of Civil Service requirements. One of the most important recommendations of the A r m s t r o n g Committee was t h a t which resulted in the law t h a t placed a limit upon the cost of acquisition of new business and the aggregate expenses of life insurance companies doing business in the state of N e w York. T h i s statute not only applied to companies chartered by the state of N e w Y o r k but had the effect of compelling all life insurance companies doing business in the state of N e w Y o r k to limit their expenses as prescribed by the statute. T h i s enactment had a most p r o f o u n d effect on the conduct of the life insurance business, and was greatly in the interest of policyholders. A n o t h e r important recommendation of the Committee which was enacted into law was that prescribing the method of electing directors of mutual life insurance companies in N e w York. T h i s law, in substantially its original f o r m , is on the statute books today. I t w a s thoroughly considered and studied in a subsequent investigation which I will r e f e r to later, but was not changed because of the prevailing opinion that it could not be improved upon. It has governed all such elections in N e w Y o r k since its enactment, and has proved satisfactory f r o m the viewpoints of policyholders, the companies, and the state.

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As a result of the activities of the A r m s t r o n g C o m m i t tee, o t h e r states became interested in the revision of their insurance laws relating to life insurance. T H E WISCONSIN L E G I S L A T I V E I N V E S T I G A T I O N

T h e Legislature of the State of Wisconsin also appointed a J o i n t Legislative C o m m i t t e e in 1905 to investigate the business of life insurance in t h a t state. The Committee was expressly directed to investigate expenditures of all kinds, m e t h o d s of securing business a n d paying commissions and compensation, the n a t u r e and condition of investments, the m e t h o d of m a k i n g investments, and the m a n n e r in which investments were s a f e g u a r d e d . I t was specifically p r o v i d e d t h a t " T h e mention of any particular lines of inquiry herein, shall not limit in any measure the field of investigation which said C o m m i t t e e is empowered to e n t e r . " T h i s C o m m i t t e e sent a questionnaire to practically all life insurance companies doing business in the state and held sixty public hearings. In its report filed December 1, 1906, the C o m m i t t e e s t a t e d : " W e have not confined our investigation t o the particular lines of inquiry specified in the act of appointment, but have, as f a r as our limited time would permit, examined into the internal m a n a g e ment of the companies u n d e r investigation; their m e t h o d s of electing t r u s t e e s ; their f o r m s of application and policy c o n t r a c t s ; loan a g r e e m e n t s ; settlement of d e a t h claims, f o r f e i t u r e and s u r r e n d e r of policies, and g a t h e r e d a large quantity of d a t a bearing upon life insurance as an economic and social institution, a n d pursued lines of investigation into all m a t t e r s having a direct b e a r i n g upon the cost of insurance and m a n a g e m e n t of companies and their t r e a t m e n t of policyholders."

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HUEBNER FOUNDATION LECTURES

T h e C o m m i t t e e r e c o m m e n d e d twenty-one s t a t u t o r y enactments, the m o s t i m p o r t a n t of which d e a l t with ( 1 ) r e g u l a t i o n of the election of d i r e c t o r s a n d trustees of d o m e s t i c m u t u a l i n s u r a n c e companies, ( 2 ) s t a n d a r d provisions f o r l i f e i n s u r a n c e policies, ( 3 ) limitation upon the a m o u n t of p r e m i u m which m i g h t be c h a r g e d a n d l i m i t a t i o n of expense, a n d ( 4 ) prohibition of r e b a t i n g and misrepresentation.

" C O M M I T T E E OF F I F T E E N B I L L S "

In o r d e r to p r o m o t e u n i f o r m i t y in l i f e insurance r e g u l a tion, P r e s i d e n t T h e o d o r e R o o s e v e l t c a l l e d f o r a c o n f é r ence of g o v e r n o r s , a t t o r n e y s g e n e r a l a n d insurance commissioners f o r the p u r p o s e of considering the r e s u l t s of the A r m s t r o n g C o m m i t t e e ' s i n v e s t i g a t i o n s a n d recomm e n d i n g the e n a c t m e n t of u n i f o r m s t a t u t e s r e l a t i n g to l i f e insurance t h r o u g h o u t the v a r i o u s s t a t e s . In a n add r e s s d e l i v e r e d b e f o r e the 1 9 0 9 m e e t i n g of the A s s o c i a tion of L i f e I n s u r a n c e P r e s i d e n t s , J o h n A . H a r t i g a n of M i n n e s o t a , P r e s i d e n t of the N a t i o n a l Convention of I n s u r a n c e C o m m i s s i o n e r s , pointed out that this conf e r e n c e w a s c a l l e d because the r e v e l a t i o n s of the A r m s t r o n g C o m m i t t e e h a d been so m i s r e p r e s e n t e d and m a g nified by a s e n s a t i o n a l press t h a t public confidence in the institution of i n s u r a n c e w a s s h a k e n . T h e purpose of the conference w a s to a s s u r e the people t h a t effective m e a s u r e s w o u l d be t a k e n to p r o t e c t t h e i r interests, a n d to f o r m u l a t e a n d p r e s e n t to the s t a t e s a sane body of l a w s which, w h i l e s a f e g u a r d i n g p o l i c y h o l d e r s ' interests, w o u l d not i n t e r f e r e w i t h the l e g i t i m a t e a n d p r o p e r prosecution of the business by t h e c o m p a n i e s . T h a t c o n f e r e n c e met in C h i c a g o in F e b r u a r y , 1 9 0 6 , a n d a p p o i n t e d a comm i t t e e of fifteen to d r a w up such a body of s t a t u t e s . Its

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r e p o r t , subsequently r e f e r r e d to as the R e p o r t of the Committee of F i f t e e n , became the f o u n d a t i o n of m a n y life insurance enactments t h e r e a f t e r passed by legislatures of the various states. Commissioner H a r t i g a n said t h a t " T h e greatest accomplishment in the line of u n i f o r m i t y was the enactment in m o r e t h a n twenty states of the laws known as the ' C o m m i t t e e of F i f t e e n Bills.' "

N E W VORK'S I N S U R A N C E LAW

REVISION

T h e N e w Y o r k Legislature of 1937 a p p o i n t e d a J o i n t Legislative C o m m i t t e e on Revision of Insurance L a w s . T h i s Committee was required to " m a k e a comprehensive study and analysis of the provisions of the Insurance L a w s of this State f o r the p u r p o s e of ascertaining and determining ambiguities, weaknesses and d e f e c t s presently existing in such laws and revising, clarifying a n d recodifying the s a m e . " T h e resolution f u r t h e r states, " T h e study of any subject, m a t t e r or thing a d j u d g e d by the Committee to be g e r m a n e to the study and w o r k hereby directed to be m a d e and p e r f o r m e d , or h e l p f u l to it in connection therewith, shall be deemed to be within the scope of the C o m m i t t e e ' s p o w e r s . " T h a t C o m m i t t e e was continued by legislative sessions of '38, '39, ' 4 0 and '41. I t conducted numerous hearings a n d r e c o m m e n d e d extensive revisions and changes in the Insurance L a w of N e w Y o r k which resulted in a new and revised C o d e being enacted by the L e g i s l a t u r e of 1939. Subsequent t o the original o r g a n i z a t i o n of the C o m m i t t e e , its p o w e r s were extended to include specifically the a u t h o r i t y to investigate the business of industrial life insurance. T h e Committee conducted an extensive inquiry by questionnaire and public hearings, and its r e p o r t s m a d e n u m e r o u s recommendations f o r revisions of t h e law respecting in-

30

HUEBNER F O U N D A T I O N

LECTURES

d u s t r i a l life insurance, m o s t of which, h o w e v e r , h a d alr e a d y been tested, p r o v e n a n d put into effect by t h e p r o g r e s s i v e c o m p a n i e s t r a n s a c t i n g this kind of business. THE T.N.E.C.

INVESTIGATION

I n 1938 the C o n g r e s s , u p o n the r e c o m m e n d a t i o n of President Roosevelt, appointed the " T e m p o r a r y National E c o n o m i c C o m m i t t e e " t o m a k e a f a r - r e a c h i n g investigation into t h e economic system of the country. In the P r e s i d e n t ' s m e s s a g e t o C o n g r e s s on A p r i l 29, 1938, which resulted in the a p p o i n t m e n t of the T e m p o r a r y N a t i o n a l E c o n o m i c C o m m i t t e e , he s a i d : " T h e t r e m e n d o u s investment f u n d s controlled by o u r g r e a t insurance companies h a v e a certain kinship t o investment t r u s t s , in t h a t these companies invest as t r u s t e e s t h e savings of millions of o u r people. T h e Securities and E x c h a n g e Commission should be aut h o r i z e d to m a k e an investigation of the facts relating to these investments with p a r t i c u l a r relation to t h e i r use as an i n s t r u m e n t of economic p o w e r . " T h e C o m m i t t e e was t h u s p a r t i c u l a r l y c h a r g e d with investigation of the c o n c e n t r a t i o n of economic p o w e r alleged t o be exercised t h r o u g h t h e life insurance business but its a u t h o r i t y w a s c o n s t r u e d to be sufficiently b r o a d t o p e r m i t it, t h r o u g h the Securities and E x c h a n g e Commission, to go deeply into every p h a s e of the life insurance business. N o legislation has so f a r resulted f r o m t h a t inquiry. A D E Q U A T E O P P O R T U N I T Y FOR T H E P U B L I C TO S A F E G U A R D ITS I N T E R E S T S

I n conclusion, we m a y o b s e r v e t h a t almost f r o m its inception in this c o u n t r y the business of insurance has

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been s u b j e c t e d t o s u p e r v i s i o n , g e n e r a l l y a t t h e h a n d s of an official especially c h a r g e d w i t h t h i s activity as his sole duty, a n d t h a t this s u p e r v i s i o n h a s b e e n s u p p o r t e d by a n e x p a n d i n g v o l u m e of s t a t u t o r y l a w r e g u l a t i n g t h e conduct of t h e business. I n a d d i t i o n , t h e business, o r c e r t a i n p h a s e s of it, as public i n t e r e s t h a s s e e m e d t o suggest, h a v e been s u b j e c t e d t o t h o r o u g h g o i n g legislative inquiries. I t w o u l d a p p e a r , t h e r e f o r e , t h a t t h e r e is a n d h a s b e e n n o lack of o p p o r t u n i t y a d e q u a t e l y t o p r o t e c t t h e public's i n t e r e s t in t h e c o n d u c t of t h e business of i n s u r a n c e in any of its b r a n c h e s . T h e l e g i s l a t u r e , as t h e r e p r e s e n t a t i v e of the people, h a s t h e r e s p o n s i b i l i t y t o enact s t a t u t e s exp r e s s i n g t h e will of t h e p e o p l e o r t h e j u d g m e n t of t h e l e g i s l a t u r e g o v e r n i n g t h e business. T h e r e h a s b e e n n o lack of s t a t u t o r y e n a c t m e n t s . T h e b o d y of I n s u r a n c e C o m m i s s i o n e r s h a s b e c o m e i n c r e a s i n g l y effective, a n d t h e scope of t h e i r s e v e r a l p o w e r s a n d activities h a s continually b r o a d e n e d a s t h e business h a s g r o w n in e c o n o m i c a n d social i m p o r t a n c e . T h e a u t h o r i t y t o m a k e e x a m i n a tions of i n s u r a n c e c o m p a n i e s is w i t h o u t l i m i t a t i o n as t o t h e scope of such i n v e s t i g a t i o n s . T h e r e a r e n o s e c r e t s t h a t m a y be k e p t f r o m e x a m i n e r s . T h e m o d e r n a n n u a l s t a t e m e n t b l a n k s r e q u i r e a c o m p l e t e e x p o s i t i o n of a comp a n y ' s business c o n d u c t f o r t h e c u r r e n t y e a r a n d f r o m it any c o m p e t e n t d e p a r t m e n t official m a y f o r m an a c c u r a t e j u d g m e n t of t h e t r e n d of t h e c o m p a n y ' s business. L e g i s lative b o d i e s h a v e f o u n d it possible t o lay b a r e t h e w h o l e h i s t o r y of t h e business w h e n e v e r t h e y f e l t it d e s i r a b l e t o d o so, a n d legislative i n v e s t i g a t i o n s h a v e n o t b e e n n o t a b l e f o r t h e i r t e n d e r solicitude f o r such business. W e l l c o n d u c t e d c o m p a n i e s h a v e w e l c o m e d n o t only s t a t u t o r y and a d m i n i s t r a t i v e r e g u l a t i o n b u t e v e r y f a i r inquiry. S t a t u t o r y e n a c t m e n t s a n d t h e v e r y f a c t of s u p e r v i s i o n h a v e , n o d o u b t , b e e n a m o s t effective a i d in g e n e r a l l y

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discouraging those with improper motives f r o m entering into the business of life insurance or any other branch of the insurance business. T h e r e have been exceptions, of course, but insurance is recognized as a business in which only men of sound character and ability should be entrusted with management. M a n a g e m e n t is good or bad, depending upon the character, ability, and industry of the men who constitute it. Supervision is good or bad, effective or ineffective, depending upon the character, ability and industry of the men who are appointed to supervise the business. Likewise, the laws governing the business reflect the character, ability and industry of the legislators. W e cannot eliminate the human element, the tendency to weakness or e r r o r , f r o m either management or supervision. If we desire effective supervision, and I believe the business generally does desire just that, we must support a plan of supervision which furnishes the greatest number of safeguards against the human element of weakness and tendency to e r r o r . T h e public seeks the maximum of insurance protection under sound supervision. T h e legislature is the judge of what laws should be enacted to govern the business. T h e legislature or the head of the state government appoints the officer to enforce the laws enacted by the legislature, except in one or two states where that officer is elected by the people. T h e legislature has the power to make such inquiries into the conduct of the business as it deems sufficient and necessary, and this applies in every state in which a company does business. W i t h few exceptions of minor importance, insurance companies ope r a t e in a number of states and are subject to the supervision of a number of state insurance departments. M a n y of the large companies do business in most, if not all, of the states. I t does not stand to reason t h a t all

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the supervisory officials and all the legislatures will fail to p e r f o r m their duty all at the same time. T h e r e can be no substitute f o r character, ability, and industry in the conduct of the business. G r a n t e d character, there will be a fair consideration of the public interest, and it is conceivable that the business could be conducted fairly and efficiently by men of character in the absence of statutory regulation or supervision. But no such procedure would absolutely guarantee proper protection of the public interests on every hand. So we accept supervision in the insurance business as a very proper, a very necessary, and f r o m the standpoint of those who would conduct the business in the public interest, a very desirable and helpful p a r t of the business. If supervision had p e r f o r m e d no other function than generally to discourage men lacking in character and ability f r o m entering the business, it would have gone a long way toward protecting the public. I f , however, there be derelictions in management, if men get into the business who are not of the character requisite f o r its proper conduct, some or all of these various jurisdictions for public protection are ccrtain to intervene. ADVANTAGES OF DECENTRALIZED REGULATION A N D SUPERVISION

T h e American system of regulation and supervision of the business of insurance by the several states has f r o m time to time been subjected to criticism on the ground of lack of uniformity in both statutory regulation and administrative supervision. I submit t h a t this criticism is not justified. T h e r e are, of course, some differences as between various jurisdictions. T h e y are at times annoying and it is natural to compare this situation with one in which there might be absolute uniformity. T h e s e con-

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ditions have gradually been diminished by the forces which I have discussed and it is now possible f o r one company to transact business throughout the entire country without encountering any considerable difficulty. Indeed, in all m a t t e r s having to do with the general operation of the business, investments, policy f o r m s and general requirements, the American system does lend itself to substantial uniformity and such differences as may prevail as between the laws of different states have to do with relatively minor aspects of the business. N o where else in the world is it possible to transact an equal volume of business without encountering vastly greater difficulties, growing out of differences in language, laws and currencies. I t has been characteristic of the business of insurance in the U n i t e d States t h a t it has been subjected to the authority of each of the states severally rather than to a single concentrated authority, and that very fact avoids risks that would obtain if one centralized authority had nation-wide supervision. If such a concentrated authority should be autocratic and narrow-minded, it might stifle expansion. If it were incapable or venal, it might be wholly destructive. It is more difficult to check the excesses of centralized authority than the occasional excess on the p a r t of one or another element of a diffused authority, which element is closer to the people. And so it appears that, in the supervision of insurance, ample opportunity has been afforded f o r the protection of the public interest through a system under which the supervisors are in close touch with the people to be served and able to i n f o r m themselves concerning the public need, a system which provides the greatest safeguards against human e r r o r . One can hardly review the history of insurance supervision in the U n i t e d States and the successes achieved by

INSURANCE SUPERVISION

35

t h e business of i n s u r a n c e w i t h o u t b e i n g p r o f o u n d l y imp r e s s e d w i t h t h e c o n t r i b u t i o n w h i c h h a s b e e n m a d e by legislation and supervision. T h a t such l e g i s l a t i o n a n d such s u p e r v i s i o n h a v e d e v e l o p e d so s a t i s f a c t o r y a business w i t h i n t h e j u r i s d i c t i o n of t h e r e s p e c t i v e s t a t e s i n s t e a d of u n d e r t h e aegis of t h e n a t i o n a l g o v e r n m e n t is c o n v i n c i n g r e a s o n f o r t h e p r e s e r v a t i o n of t h a t s y s t e m . W h i l e t h e r e m a y be s o m e j u r i s d i c t i o n s in w h i c h t h e l e g i s l a t i o n a n d t h e s u p e r v i s i o n a r e a d m i t t e d t o be m o r e effective t h a n in o t h e r s , t h e l a t i t u d e w h i c h is a f f o r d e d f o r d e v e l o p m e n t u n d e r forty-nine different jurisdictions gives r o o m f o r p r o g r e s s which is n o t t o be h a d u n d e r a single, all-comp r e h e n s i v e j u r i s d i c t i o n . T h e h u m a n e q u a t i o n is b o u n d t o be t h e s a m e in e i t h e r e v e n t , b u t t h e m a t h e m a t i c a l p r o b a b i l i t y of g o o d s u p e r v i s i o n in m o s t , a n d p e r h a p s in all, s t a t e j u r i s d i c t i o n s is g r e a t e r t h a n t h e p r o b a b i l i t y of a n equally s a t i s f a c t o r y t y p e of s u p e r v i s i o n f r o m o n e single source. T h e A m e r i c a n public can well be p r o u d of its i n s u r a n c e business c a r r i e d o n u n d e r s t a t e s u p e r vision, a n d i n s u r a n c e c o m p a n y m a n a g e m e n t can well be p a t i e n t w i t h i s o l a t e d instances of f r i c t i o n in r e l a t i v e l y small p h a s e s of t h e business, as it v i e w s with s a t i s f a c t i o n t h e public acceptance of t h e business as a w h o l e .

A PHILOSOPHICAL VIEW OF LIFE INSURANCE

O U R work here ( a t the University of Pennsylvania) f o r the past academic year has followed the pattern of research. Inasmuch as the subject m a t t e r of your studies has been found in the general fields of sociology and economics, you have probably looked into the behavior of men largely f r o m the point of view of their social and economic attitudes and activities, and with respect to some of their cooperative desires, but not likely with reference to their instincts and to the effects of natural law upon them. Accordingly, the results of your researches will be stated somewhat empirically. A measure of man's essential or fundamental drives is not to be found in statistical data of his daily routines. H e is superficially irrational. H e sets up all kinds of civil laws and regulations, or accepts them as valid, only to set them aside when no one is looking. I t isn't beauty alone t h a t is skin deep. T h e r e f o r e , we must often take a deeper look into m a n — o n e which may well be called philosophical. Philosophy may be defined as the study and knowledge of the principles t h a t cause, control or explain facts and events. T h e study of natural science and the examination of nature's behavior are thus encompassed by philosophy. 36

A PHILOSOPHICAL VIEW

37

I n n a t u r a l sciences, a s d i s t i n g u i s h e d f r o m so-called social sciences, p r o c e d u r e is f r o m a d i f f e r e n t p o i n t of v i e w ; in t h e f o r m e r w e find a n a b s o r p t i o n in t h e n a t u r a l ; t h a t is, in n a t u r e , in l i f e i t s e l f ; in t h e l a t t e r , e x p e r i e n c e r a t h e r t h a n r e a s o n is u s e d . A d e f i n i t i o n of science t h a t s e e m s r e a s o n a b l e is t h a t it is t h e r e c o r d of t h e b e h a v i o r of n a t u r e o r of l i f e , b o t h in its p r e s e n t l i v i n g c o n d i t i o n a n d in its p a s t c o n d i t i o n of living, like coal, oil, r o c k , b o n e s , soil, petrified objects, to n a m e only a limited number. We t h i n k c u r r e n t l y of b e h a v i o r l a r g e l y a s h a b i t b u t in its b r o a d e r a p p l i c a t i o n s it is wise t o i n c l u d e t h o s e e v o l u t i o n a r y , c o o p e r a t i v e , a n d c o m p e t i t i v e f o r c e s w h i c h a r e imp o s e d by n a t u r e t h r o u g h n a t u r a l l a w s . M a n is t h e i m p o r t a n t u n i t of n a t u r e w h i c h lives in b o t h t h e n a t u r a l a n d t h e e m p i r i c a l fields of s t u d y . A s a biological c r e a t u r e h e m a y be s t u d i e d , f o r e x a m p l e , as evol u t i o n a r y in p e r s o n a l a n d r a c i a l c h a r a c t e r i s t i c s ; p h y s i o logical as t o a n a t o m i c a l , c h e m i c a l a n d p h y s i c a l a s p e c t s ; a n t h r o p o l o g i c a l a s t o his o r i g i n a n d n a t u r e ; a n d , as a social c r e a t u r e , h e m a y b e s t u d i e d in t h e a t m o s p h e r e of h i s i n s t i t u t i o n s as a s o r t of s l a v e t o c u s t o m s . In life insurance we s t a r t with a fairly well-developed natural l a w — t h a t is, t h e b e h a v i o r of l i f e w i t h r e f e r e n c e t o its s p a n . F r o m t h e r e s u l t s of s t u d i e s of such b e h a v i o r w e r e a c h a n a t u r a l m a t h e m a t i c a l c o n c e p t of s t a b i l i t y in h u m a n life which, when a v e r a g e d , or viewed f r o m the p o i n t of v i e w of p r o b a b i l i t i e s , is a d e p e n d a b l e m e a s u r e o f t h e t y p e of l o n g e v i t y w e w a n t t o e m b r a c e in a p r o g r a m of g r o u p c o o p e r a t i o n . I f w e d e a l w i t h d i f f e r e n t races, o r different occupations, or different t h e r m o m e t r i c exposu r e s , o r w i t h o t h e r d e g r e e s of v a r i a t i o n , w e s i m p l y use the a p p r o p r i a t e b e h a v i o r s of life with r e f e r e n c e to these. T h u s , e v e n in a n a t m o s p h e r e of e m p i r i c i s m w e c o n s i d e r m a n a creature of nature. W h e n v i e w e d as a b u s i n e s s , t h e r e f o r e , l i f e i n s u r a n c e

38

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s t a r t s with a n a t u r a l f a c t o r of life's b e h a v i o r s , which, so f a r as I know, cannot be f o u n d in o t h e r businesses. A s an o r g a n i z e d institution, a life insurance company, which h a s g o o d m a n a g e m e n t , and t h a t m e a n s as well the p r o p e r use of the basic nature-laws of longevity, is b e t t e r able t o survive than most o t h e r social a n d economic groups, such as a r e f o u n d in m a n u f a c t u r i n g , banking, m e r c h a n d i s i n g , a n d o t h e r occupations. T h i s is due not only to n a t u r a l basic f a c t o r s , but because supply a n d d e m a n d , and profit and loss, are relatively u n i m p o r t a n t in one, and a l m o s t a l l - i m p o r t a n t in the o t h e r s . T o illustrate t h a t point, we m a y r e f e r to such variables as style, appetite, and utilities in g e n e r a l business as basic considerations, while in life insurance t h e r e is, to a considerable d e g r e e , a p r o g r a m based upon the urges of h u m a n life, including h u m a n instinct. W e m a y say with t r u t h t h a t the m e r c h a n d i s e of commerce is perishable g o o d s ; and t h a t the m e r c h a n dise of life insurance is imperishable love. SELF-PRESERVATION

AND

SELF-PERPETUATION

T h e f u n d a m e n t a l instincts of animal life, including m a n , a r e generally considered to be t w o ; namely, selfp r e s e r v a t i o n and s e l f - p e r p e t u a t i o n . W e find in these instincts the urge to p r o t e c t and to p r o j e c t . T h e n a t u r a l w o r l d is ruthless. A noted scientist h a s s t a t e d a rule which illustrates t h a t c o n d i t i o n — i t is t h a t the end of every wild animal is a t r a g e d y . W e need only to n u m b e r t h e casualties of w a r , disease, accidents, e a r t h q u a k e s , d r o u g h t , volcanoes, deluges and glaciers, to be conscious of the a w f u l h a z a r d s to both p r o t e c t i o n a n d p r o j e c t i o n . I t is a fight t h a t never ends. I n a recent article in the Magazine of Natural History, t h e a u t h o r estimates t h e l i f e t i m e of the d i n o s a u r s on t h e e a r t h a t one h u n d r e d f o r t y million years, a n d their t o t a l d i s a p p e a r a n c e in only

A PHILOSOPHICAL VIEW

39

a s h o r t p e r i o d . T h e y f a i l e d t o a d a p t t o t h e n e e d s of selfd e f e n s e a n d s e l f - p e r p e t u a t i o n . T h e instinctive g r o u p i n g of a n i m a l s i n t o h e r d s , d r o v e s , schools, flocks and bevies is n o t e n o u g h , n o r is size, n o r p o w e r , n o r f e r o c i t y . S o m e of t h e p r i m a t e s , especially, d e v e l o p e d s o m e t h i n g like intelligence t h r o u g h o u t t h e millions of y e a r s t h e y w e r e e v o l v i n g , a n d so a d d e d social c o l l a b o r a t i o n to instinctive d e s i r e s . In t h a t w a y t h e y finally a r r i v e d a t intelligence as a h a n d m a i d e n o r as a s u p p l e m e n t t o t h e i r p r i m a r y instincts. T h e i n t e r v e n i n g c e n t u r i e s w e r e t o o c o m p l e x a n d t o o m a n y t o classify, so l e t ' s simply n o t e t h a t t h e instincts u r g e d a n d p r e v a i l e d , w i t h t h e c o n c o m i t a n t a n d c u m u l a t i v e u r g e to f o r m social o r g a n i z a t i o n s t o give t h e m p r o g r e s s i v e l y a chance t o r e a c h e v e r e n l a r g i n g satisf a c t i o n s . T h e w o r d s a n d t h e i d e a s of p r o t e c t i o n a n d of p r o j e c t i o n a r e f o u n d a t i o n a l to l i f e a n d t o life i n s u r a n c e ; t h e y m a y still be r e g a r d e d l a r g e l y as n a t u r a l f o r c e s , r a t h e r t h a n e m p i r i c a l ones, t h o u g h c o m p o u n d e d of b o t h n a t u r a l l a w a n d rules of social e x p e r i m e n t a t i o n . T h e " l o n e - w o l f t h e o r y , " t h a t is, t h e possibility of " g o ing-it-alone" h a s a l w a y s b e e n a t e m p t a t i o n , but in p r a c t i c e it r u n s into so m a n y i m m e d i a t e a n d d e v a s t a t i n g difficulties t h a t it m u s t be a b a n d o n e d , o r t h e consequences s u f f e r e d . N a t u r e p u t s a c o m p u l s i o n on t h e social p r a c t i c e of coo p e r a t i o n in m a n y w a y s , b u t w i t h g r e a t e s t f o r c e in t h e device of sex, in b o t h a n i m a l a n d p l a n t life. T h e pull of t h e instinct of s e l f - p e r p e t u a t i o n , as a n a t u r a l law, h a s seemingly included t h e i n t e r n a l d r i v e t o set u p such o r g a n i z a t i o n s as will p r o m o t e p e r p e t u a t i o n even t h r o u g h t h e use of e m p i r i c a l rules which a r e s t r o n g e n o u g h to be r a t e d as laws, f a u l t i l y I t h i n k , by m a n y w r i t e r s on social a n d economic t h e o r i e s . T h e r e is m u c h d o u b t on t h e p o i n t of t h e i r b e i n g f o u n d a t i o n a l e n o u g h f o r t h e c a t e g o r i e s of law, b u t s u r e l y t h e y a r e c o m p e l l i n g e n o u g h t o be of social use. I n t h e t w i l i g h t z o n e t h e r e is o v e r l a p p i n g in w h i c h

40

HUEBNER FOUNDATION LECTURES

both instinct and organized intelligence play their p a r t s ; f o r example, in the compulsions of parental love, and the rearing and defense of the youth of the animal. In the limited scope of every individual, there is a constant facing of the fact of self-insufficiency. In the realm of space he found sufficiency so long as he was a sort of geographical f r o n t i e r s m a n — h e could hunt, fish and g r a z e . T h e r e is yet a longing in man f o r the frontier, and even a necessity in the animal kingdom outside of man. W h e n space everywhere becomes crowded, both men and animals must join to avoid elimination. N A T U R A L FORCES I N F L U E N C E SOCIAL C O O P E R A T I O N

T h e r e may be much truth in the statement that the only conspicuous advance in human contributions to social advancement are in the field of tolerance, where some slight gains have been noted. In any event, it doesn't seem obvious that gains by means of trial and error have been deep-seated; though practical science has added greater benefits to peace, and greater t e r r o r s to w a r . D r . John Stewart, an eminent professor of astronomical physics, has been seeking to apply scientific laws to social relationships. H e is said to believe that there are many similarities between the laws that govern the planets and the laws that govern human behavior. H e gives, as probably a minor example, the evidence that the influence of a group of people tends to be proportional to their number divided by their distance away, thus suggesting a law not unlike N e w t o n ' s law of gravitation in physics. O t h e r men have shown such mathematical results. In the realm of space or distance men are surely not influenced equally by social drives f r o m a central point. T h e r e is an estimate of a billion and a half of people

A PHILOSOPHICAL VIEW

41

o n t h e e a r t h . N o t a f o u r t h of t h e s e p e o p l e in a n y g r o u p i n g could a g r e e on t h e e s s e n t i a l s o f , say, g o v e r n m e n t , education, religion, business, o r o t h e r social s t a n d a r d s . If we s h o u l d consider space a n d d i s t a n c e a l o n e , in sett l e m e n t s at peace t a b l e s , f o l l o w i n g w a r s , w e w o u l d t h i n o u t such a d o c t r i n e as t h e F o u r F r e e d o m s , v a l u a b l e as it seems, w h e n w e t r y t o a p p l y it at such l o n g d i s t a n c e s f r o m its o r i g i n . H o w e v e r , it is w o r t h n o t i n g t h a t in a u n i v e r s e of space a n d d i s t a n c e , t h e o p i n i o n s a n d t h e m o t i v a t i o n s of m e n a r e influenced by n a t u r a l p h e n o m e n a . T h e n , t o o , t h e r e is t h e r e a l m of t i m e . T h e b e h a v i o r of n a t u r e g a v e m a n t h e u r g e a n d t h e p a t t e r n of timer e c k o n i n g . T h e m o v e m e n t s of t h e e a r t h a n d t h e m o o n , in t h e i r r e l a t i o n s h i p t o t h e sun, w e r e b e s t o w a l s of concept i o n s of r e g u l a r i t y , r o u t i n e a n d s t a b i l i t y — a l l of t h e s e a r e f o u n d a t i o n a l t o social c o l l a b o r a t i o n , a n d t o scientific a n d t o h i s t o r i c a l c o m p a r i s o n s . E v e n w i t h such a b o o n , t i m e is yet the g r e a t u n c e r t a i n t y t o t h e i n d i v i d u a l a n d t h e r a c e . T h o u g h in a race like t h a t of t h e d i n o s a u r s , t i m e m a y be as l o n g as o n e h u n d r e d f o r t y million y e a r s , it r e m a i n s t r u e t h a t in an i n d i v i d u a l d i n o s a u r , o r t r e e , o r m a n , l i f e h a s absolutely n o t i m e - g u a r a n t e e . T h e c o n s t a n t fight by nature's individuals to face the uncertainties with some h o p e of success is as i n t e r e s t i n g a field of s t u d y as can b e set a p a r t , t h o u g h a l w a y s t h e r e m u s t b e c o m p a r a t i v e futility. L e t us l o o k at t h e t r e e as a n i l l u s t r a t i o n : H e r e w e h a v e exemplified t h e g r e a t t r u t h t h a t s e e m i n g l y d i v e r s e f o r c e s a r e in f a c t c o o p e r a t i v e on t h e p o i n t of s u r v i v a l . N o t r e e ever b e c o m e s a l a r g e one, as w e conceive l a r g e ness in t r e e s — t a l l , m a j e s t i c , a n d g e n e r a l l y u s e f u l — w h e n it g r o w s alone. A t r e e w i t h such p o t e n t i a l c h a r a c t e r i s t i c s loses its i n n a t e u r g e , by b e i n g a " l o n e - w o l f , " e v e n w h e n it h a s a s e t t i n g which e x p o s e s it c o n s t a n t l y t o g o o d soil,

42

HUEBNER F O U N D A T I O N LECTURES

full sunlight and no struggle f o r moisture. I t may a d o r n a lawn, or f u r n i s h some shade f o r the h e r d , but it becomes only a glorified b u s h — a sort of scatterbrain. COMPETITION AND COOPERATION EQUALLY ESSENTIAL

N a t u r e compels the use of both competition and cooperation as necessary forces in m a k i n g a f o r e s t , in which the single t r e e also becomes a g r e a t tree. W e have only to observe the fight f o r the sun, which forces a reaching u p w a r d , and the fight f o r moisture, which forces a reaching d o w n w a r d , to see t h a t a f o r e s t is a cooperative g r o u p of individual trees in which each t r e e is also a competitor. C o o p e r a t i v e l y the f o r e s t holds the moisture by the processes of detention and of s h a d e ; likewise cooperatively, the trees hold the possibility f o r each to gain t h r o u g h struggle a destiny it d e s e r v e s — n o t an isolationist w h o is t o o f a t ( a t the t o p and the b o t t o m ) to fight. T h e life span of some trees is equal to the sum of a h u n d r e d spans of humans. H o w majestic and relatively p e r m a n e n t is a tree when we can sit in its shade and p o n d e r on the kind of f o r e b e a r s we h a d in our g r a n d p a r e n t s , one h u n d r e d generations back when t h a t t r e e was a sapling! D i d they descend f r o m H a m , or was it f r o m Shem or J a p h e t h ? T h u s , in n a t u r e we find the really i m p o r t a n t guides f o r individuals, as such, or in cooperation with o t h e r s . W e suffer f r o m a lack of exposing our population, especially our youth, to n a t u r e ' s ways, out of which might g r o w sounder philosophies, g r e a t e r g r o w t h , and better civil laws. L o o k at cross fertilization, at survival through instinctive t h r i f t , at special a d a p t a t i o n s , and at t h e very principles of life's g r e a t e s t g l o r y — t h a t of g r o w t h , and we have some of n a t u r e ' s behaviors as guides, r a t h e r than those of men's merely superficial behaviors which are o f t e n used in a t t e m p t s to a r r i v e at so-called laws of so-

A PHILOSOPHICAL VIEW

43

ciety and which m u s t a l w a y s be n o n e a r e r scientific than t o b e called, r a t h e r cloudily, empiric. I t m a y be s a i d t h a t life insurance u s e s e n o u g h o f n a t u r a l l a w t o give a s s u r a n c e o f its f u n d a m e n t a l s o u n d n e s s — longevity, individual insufficiency, c o o p e r a t i o n , a r e all elem e n t s o f life i t s e l f . T h e s e f a c t o r s a r e s u b s t a n t i a l and u s e f u l because of their instinctive u r g e . T h e r e is a s e e m i n g clash of view when it is a s s e r t e d t h a t m e n are both g r e g a r i o u s a n d individual. T h e illustration of the f o r e s t a n d the tree s e e m s u n d e r s t a n d a b l e e n o u g h , but where l o c o m o t i o n , h u n g e r , p r o w e s s a n d c o m b a t i v e ness a r e elements, a s t a t e o f c a v e a t d o e s surely exist. I t s e e m s p a r a d o x i c a l t h a t in such conditions of tension and f e a r , even wild men a r e b r o u g h t t o g e t h e r in f a m i l y and t r i b e ; and tribes into n a t i o n . H e r e again are nature's c o m p u l s i o n s to b e both individual a n d s o c i a l . In the whole g a m u t of the so-called intelligentsia, f r o m the a n t h r o p o l o g i s t to the d o c t r i n a i r e , we find no important conflicts of view that m a n s t r i v e s to be b o t h individual and social, a n d t h a t he will fight to be b o t h . When n a t u r e thus c o m p e l s , we a r e f o r e v e r out o f line in our a t t e m p t s to disinherit a d e m o c r a c y by s u b s t i t u t i n g theocracy or a u t o c r a c y a s s y s t e m s with which we a r e t o live f r o m g e n e r a t i o n to g e n e r a t i o n . T h e p r e s e n t g l o b a l struggle is just a n o t h e r illustration of the o l d s t r u g g l e between the two s y s t e m s . T h e h o p e of the A l l i e s f o r success is g r e a t and will b e c o m e g r e a t e r b e c a u s e the n a t u r a l o r basic pulls on m a n ' s s t r e n g t h a r e instinctively in s u p p o r t of their objectives. T H E I N N E R URGE TOWARD DEMOCRACY

It is both p r a c t i c a l and f o r t u n a t e t h a t the w i s e men, o f the millennia o f the p a s t , o r g a n i z e d institutions, even g o v e r n m e n t s , o f , by a n d f o r the d e m o s . I t w a s a n d is

44

HUEBNER F O U N D A T I O N LECTURES

n a t u r a l to be democratic. W i t h little doubt it may be said t h a t democracy was the earliest f o r m of society, a n d t h a t it is t h e most persistent, since it recurs as a type a f t e r each a t t e m p t to submerge it. T h e most n a t u r a l prog r a m of protection of the individual, and of offering an o p p o r t u n i t y f o r f r e e d o m , is democracy. W e must look upon it as a philosophy of life, not simply as a f o r m of political g o v e r n m e n t . Despite this compulsion of nat u r e ' s laws, we continue to create institutions, a n d to involve the w o r l d in struggles to force both autocratic and socialistic controls on man, when both a r e a n t a g onistic to f u n d a m e n t a l urges. Lincoln's G e t t y s b u r g address h a d its g r e a t e s t appeal and its climax in a time of test to a democracy of g r e a t size, geographical and numerical, in contrast with most other democracies of smaller size and lesser p o w e r s of resistance. H i s w o r d s were " t h a t this N a t i o n , under God, shall have a new birth of f r e e d o m , and t h a t g o v e r n m e n t of the people, by the people, and f o r the people shall not perish f r o m the e a r t h . " I t is well to note the s t a t e m e n t — " a new birth of f r e e d o m . " M e n desert it or are forced to a b a n d o n it, but n a t u r a l law guides t h e m to it again and again. E v e n today, in a test which is world-wide, we are encompassed by a disturbing f e a r t h a t even g r a n t s of domestic p o w e r to w a r and g o v e r n m e n t authorities in democracies may be h a r d to annul in a time of peace. B e f o r e the w a r we expressed fears, still with us, t h a t in restraining individualism, gone p r o u d and strong, we m i g h t destroy democratic institutions. Investigations, s o m e w h a t p r e j u d i c e d ; laws, o v e r - r e g u l a t o r y ; favoritisms, o v e r e m p h a s i z e d ; and doctrines, subversive, a r e the results which a u g m e n t those f e a r s . D e m o c r a c y leads us back to the t h r e e concepts of its philosophy—justice, equality and f r a t e r n i t y .

A PHILOSOPHICAL VIEW

45

I N F L U E N C E S V E E R I N G US AWAY FROM BASIC N A T U R A L PRINCIPLES

W e have a d o p t e d the l a n g u a g e and the f o r m of justice, but we need only serve on juries to be convinced that justice and equality are not always attained by them. Prejudices, social inequalities, sympathies, and personalities are heavy factors which militate against justice. E v e n courts of g r e a t jurisdiction are swayed by political pressures and personal attitudes. Citizenship, which surely should reflect equality, is tarnished by race and sex discriminations. T h e right to vote is modified. C l a s s distinctions are paraded before us, and special g r o u p s are punished or f a v o r e d , even by legislative acts. T h e conservative and thrifty are forced to carry the financial load of support of the improvident by such a tax rule as "ability to p a y " — not an act of either justice or equality. T h e s e are political manifestations of a democracy, which, even so, are more satisfying to citizens than a straight-jacketing of all. In no branch of civilized life do we seem to depart so greatly f r o m fundamental concepts as in civil law. T h o u g h logic seems to be a sort of professional claim of the rank and file of lawyers, and the expectation of litigants, there is, in fact, the following of the trails of recent precedents, until a minor revolution blazes a new trail. Even the decisions of our highest courts, all composed of lawyers, with reference to the powers of the F e d e r a l Government in relation to the rights of the S t a t e s of the Union, are examples of conflicting and even opposite philosophies. O v e r a portal to the Y a l e L a w School there is chiseled in stone a precept of J u s t i c e Oliver Wendell H o l m e s . It is t h i s : " T h e L i f e of L a w has not been logic, it has been experience." H e r e is the perfect definition of empiricism. N o wonder that the case method rather than fundamental principles became the routine o f instruction in law. International law breaks d o w n ; national law

46

HUEBNER FOUNDATION

LECTURES

veers with political and personal opinion. W h a t else may we expect f r o m even supreme courts than reversals of established practices when both logic and experience are set aside. A stabilizing force should be found in basic traits, and not in illogic, nor in an overemphasis of the philosophy of civil punishment. 1 In the purely economic institutions we likewise find that equality, justice and cooperation are o f t e n tainted, though as in political practices we constantly proclaim that we have the ideal of the well-being of all. T h e two basic methods, b e f o r e mentioned, of operations in business are guiding in general. W h a t e v e r merit they have is constantly modified by unfair competition; trusts; patents; sweat shops; labor unions; and governmental controls. Democracy tries to survive under such absurd economic theories as the value of scarcity; the destruction of goods; the control of prices; the rules of bankruptcy; government competition; the hoarding of gold; the annulment of contracts; and the manufacture of money and credit. H o w very f a r we travel f r o m justice, equality and cooperation, and still preach democracy! Some of these difficulties may be found in the fact that the complicated structure of business operates at too great a distance f r o m natural law. Business veers like a weathervane under the spell of empirical rules which vary with the opinions of so-called and mis-called specialists. Look at recent controls in time of peace, and added ones in time of w a r — t h e y effect even destruction of man's business institutions. N o t only business, but government and universities have suffered f r o m the advocacy of many theories which an eminent Englishman called oddities. 1 Our civil law is an outgrowth and continuance of Roman civil law. W e got even the name from Rome. However, its departure from natural law seems obvious. Cicero said: "Law is the highest reason, implanted in Nature." Blackstone comments "that this law of Nature, being co-eval with mankind is superior in obligation to any other. N o human laws are of any validity if contrary to this."

A PHILOSOPHICAL VIEW L I F E I N S U R A N C E P A T T E R N E D ON N A T U R A L

47 PRINCIPLES

AND SCIENCE

L e t us l o o k at life insurance in the c a t e g o r i e s of business and g o v e r n m e n t . In its s t r u c t u r e we find a b a s i c law o f l i f e ; in its o p e r a t i o n we set up s o u n d rules o f e q u a l i t y ; in its services we seek a n d a t t a i n justice. In its p h i l o s o p h y o f c o o p e r a t i o n it achieves p r a c t i c a l results, even by g r a d ing inequality into equality. C o m p l a i n t s of f a v o r i t i s m , c o m p a r a t i v e injustices, o r of inequalities a r e negligible. L i f e insurance d e a l s with the individual a s a unit, with the p o w e r of u n h a m p e r e d choice in the decisions he m a k e s . H e c h o o s e s h e r e to s a t i s f y b o t h the individualistic a n d the g r e g a r i o u s u r g e s of h u m a n b e i n g s . O n the one h a n d he m u s t p o s s e s s the individual v a l u e s o f g o o d h e a l t h , o f g o o d conduct and of the habit of t h r i f t a s n e c e s s a r y contributions to the g r o u p — i t will be n o t e d t h a t here health and conduct are as i m p o r t a n t a s t h r i f t . O n the o t h e r h a n d the individual retains the right t o enter a n d t o w i t h d r a w at will. In a w o r d , the institution of life insurance offers the o p p o r t u n i t y and the m a c h i n e r y f o r both financial and social c o o p e r a t i o n but l e a v e s the election t o d o s o in the control o f the individual. U n d e r h u m a n m a n a g e m e n t it d e v e l o p s a d d e d s t r e n g t h s a n d w e a k n e s s e s . H o w e v e r , the periodic e x a m i n a t i o n s by s t a t e a u t h o r i t i e s result usually in only minor d e v i a t i o n s b e c a u s e b a s i c a l l y the o p e r a t i o n s a r e p a t t e r n e d on the block o f n a t u r a l principles and scientific rules. L i f e insurance is an institution o f t h a t kind. T w o p a r a g r a p h s f r o m the E n c y c l o p e d i a B r i t t a n i c a a r e helpful to us at this p o i n t : " A s n a t u r e is s t u d i e d a n d s u b d u e d , a n d a s society is d e v e l o p e d , the element o f chance is s l o w l y eliminated f r o m l i f e . In a p r o g r e s s i v e society, education, science, invention, the a r t s o f p r o d u c t i o n , with regular g o v e r n m e n t a n d civil o r d e r , s t e a d i l y w o r k to-

48

HUEBNER FOUNDATION LECTURES gether to n a r r o w the realm of chance and to extend t h a t of foresight. But a f t e r they have done their best to conquer the forces of nature and regulate human passions, so t h a t achievement shall follow purpose with uniformity, there remain certain events which may disturb all anticipations, and in spite of any man's best wisdom and effort may deprive him of the fruits of his labor. T h e s e are mainly t w o : ( 1 ) damage to property . . . ( 2 ) p r e m a t u r e death. " T h e direct contribution of insurance to civilization is made, not in visible wealth, but in the intangible and immeasurable forces of character on which civilization itself is founded. It has done more than all gifts of impulsive charity to foster a sense of human b r o t h e r h o o d and of common interests. It is impossible to conceive of our civilization in its full vigor and progressive power without this fundamental law of practical economy, that he best serves humanity who serves himself, with the golden rule of religion, 'Bear ye one another's burdens.' "

T h e elements of a free society have been suggested and nearly always used when new needs arose to pull man back to his instinctive urges. Well-known instances of this are the overthrow of the Roman E m p i r e ; the Great C h a r t e r ; the French Revolution; the Declaration of Independence; the creation of the American Constitution; and the adoption of the Bill of Rights. T h e ideas that came to the f o r e in each such revolution were equality, justice, and f r a t e r n i t y ( c o o p e r a t i o n ) . Again let us say that it is likely t h a t these words will always persist as rallying points in ever-forming, new groupings of mankind, because they are calls f r o m natural impulses to enjoy life's greatest urges.

A PHILOSOPHICAL VIEW

49

Only a few of m a n ' s created social institutions have reached or a p p r o x i m a t e d all of these t h r e e ideals. W h a t g r e a t e r achievement can a democratic institution proclaim t h a n to say it offers a p r o v e d social service, a n d an economic grouping of forces which may be shared, with a d v a n t a g e s to each and all, a n d with compulsions on none. D a r w i n P . Kingsley contributes a s t r o n g m e s s a g e : " O u r members pay f o r w h a t they get and get w h a t they pay f o r . If they become slack they get an equity. T h e p o o r man gets just w h a t the rich man g e t s — w h a t he is equitably entitled t o ; and he gets it. W h a t a man pays and w h a t he gets in life insurance a r e not, however, to be m e a s u r e d by the usual rules of business. W h a t he pays and w h a t he or his get are impressed with a social p o w e r and usefulness unknown to m e r e money. " W h a t I am discussing now is life insurance, not merely as a social plan, a conserver of human values, but as a system of g o v e r n m e n t . I am contrasting its practical workings, if you please, with the practical workings of democracy. In the very substance of its organization, in the democracy of its general p r o g r a m , there lies in life insurance an inescapable responsibility, an inherent justice, a fine balance between rights and obligations which is largely absent in any existing republican or democratic plan of social and political control. H e r e a m a n is w o r t h just w h a t he is w o r t h ; he is not just as good as every o t h e r m a n . H e cannot spend o t h e r people's money to his own a d v a n t a g e while paying no taxes himself. H e cannot ride any distance on any subway and charge a third of the cost of t h a t ride up to t h e taxpaying public.

50

HUEBNER FOUNDATION LECTURES " T h e typical insured man is, in both his power a n d his obligations as an insurant, an almost perfect illustration of what the citizen should be in a democracy."

2

T h e o d o r e Roosevelt also gave emphasis to its natural urge when he s a i d : " I think there is one point the preachers have overlooked, namely, that life insurance is applied Christianity. W h y ? Because Christianity means love, and life insurance is where you do something about it." T h u s nature's compulsion of love becomes a basic guide of behavior. O P E R A T I O N OF N A T U R A L FORCES PRODUCES MUTATIONS

N a t u r e is also ruthless in many of its manifestations. F r o m its pressures we get violence, as well as light, heat, companionship and g r o w t h . It is never stable; neither is man. H e has a natural drive to be creative or synthetic. Such an urge is and was present in all life, leading up to, and paralleling man's appearance in the roll of creation. It requires only casual observation to see both evolution and g r o w t h . N a t u r a l law operates to produce size, numbers, and differentiation. I t plays its p a r t too in refinements. W h o can say that the instinct or urge to self-perpetuation is not the powerful force in the practice of much of life to build a shelter, and to store food, as well as to create offspring? T h e processes of chlorophyll in plants, little understood, and likely similar processes or purposes in animals, are involuntary forces which create new tissues and thus augment living units. H o w much of the creative results of man are the lengthening of his instincts? Results are too complex to attribute percentages to natural and to social forces. I t can be 2

From "Life Insurance is Light."

A PHILOSOPHICAL V I E W

51

said t h a t even t h r i f t , a g r e a t f a c t o r in economic life, is not simply a social g a i n or loss, t h o u g h it h a s c u l t u r a l r e f i n e m e n t s — i t s roots a r e deep, a n d it is a k i n to the creative, and p r o b a b l y to the g r e a t e s t of all of l i f e ' s m y s t e r i ous p o w e r — t h a t of g r o w t h . A n d so w e p r e s e n t t h r i f t a s a p h a s e of l i f e insurance which is s e c o n d a r y only to protection, and both c a t e g o r i c a l l y p h i l o s o p h i c a l . M a n seems also to c r a v e s t a b i l i t y a n d c a l m , in the midst of all this. H e w a n t s the a d v a n t a g e s of n a t u r a l l a w , but the n e u t r a l i z a t i o n of its t e r r o r s a n d crudities, so he evolves ethics. T h e g r e a t e s t ethical concept is t h a t of the golden r u l e — a g l o r i f i e d expression of m u t u a l tolerance. M a n has t r a v e l e d f a r t h e s t in his experience to a r r i v e at such a rule or u n d e r s t a n d i n g t h a t r i g h t s a n d duties a r e c o m p l e m e n t a r y . Other gains are expressed in such r e c o r d e d g u i d e s as the C o m m a n d m e n t s , which w e r e evolved t h r o u g h both m o r a l a n d political p r e a c h ments, and a r e basic to both civil l a w a n d to ethics. J u s t how much of our ethical b e h a v i o r s p r i n g s f r o m n a t u r e ' s compulsions, and h o w much f r o m social acceptances, I do not know. T h e d e g r e e s of each a r e v a r i a b l e s , which m a n i f e s t themselves at w o r s t and at best in w a r a n d in peace. W a r is a destruction of v a l u e s . A t its end t h e r e is a peace p r o g r a m which a t t e m p t s to m a k e the w a y c l e a r f o r a rebuilding of v a l u e s . W i t h l e a d e r s h i p s b r o k e n down a n d eliminated, t h e r e will need to be a peace which as in p r e v i o u s w a r s of extent, is s l a t e d to be " a p e a c e w i t h j u s t i c e . " If w e can s t a r t a new peace p r o g r a m w i t h sincerity on the scale of e q u a l i t y , j u s t i c e a n d f r a t e r n i t y , we shall enlist the instincts of men, a n d thus h a v e a natu r a l consent or a g r e e m e n t . In s e e k i n g to p r o t e c t and to project, n a t u r e has e v o l v e d m a n y devices, such a s m i g r a tion, f u r b e a r i n g , color a d a p t a t i o n s , h i b e r n a t i o n , the tooth, the claw, and c o o p e r a t i o n . M a n h a s a d d e d w e a p -

52

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ons and p r o p a g a n d a . But in his periods of peace, man beats his sword into plowshares and rises to heights bef o r e unknown, by deeper investigations into natural laws and by ethical consideration of others. Seventy million people in this democracy alone have committed themselves to a p r o g r a m which embodies nature's strongest compulsions and society's most effective ethical standards—namely, to protect and to project under conceptions of equality, justice and fraternity. T h o u g h it is a planned program, it is based on sound principles—it is life insurance.

PART II SIGNIFICANT TRENDS AND PROBLEMS AFFECTING LIFE INSURANCE COSTS

LIFE INSURANCE COMPANY INVESTMENTS by Frank J. Travers Second

I ice-President, The Lincoln Insurance Company

National

Life

R I T I C S and f r i e n d s a l i k e a g r e e t h a t the investment record of life insurance d u r i n g the difficult depression y e a r s is exceptional and c o m m e n d a b l e . W h i l e t h e r e w e r e some l i f e c o m p a n y f a i l u r e s , the a g g r e g a t e losses represent less than one per cent of t o t a l p o l i c y h o l d e r s ' funds. M u c h credit f o r this fine record must be a w a r d e d to D r . H u e b n e r a n d o t h e r insurance a n d investment teachers, w h o y e a r s a g o l a i d a f o u n d a t i o n of sound principles upon which t h e i r f o r m e r s t u d e n t s h a v e built a vast investment s t r u c t u r e . I N V E S T M E N T S T A N D A R D S M U S T BE

RE-EXAMINED

H o w e v e r , w e a r e not h e r e to reminisce. L i f e insurance cannot s a f e l y i m i t a t e the m y t h i c a l b i r d t h a t a l w a y s flew b a c k w a r d because it w a s i n t e r e s t e d only in w h e r e it h a d been. T h e responsibility of insurance t e a c h e r s a n d life insurance i n v e s t m e n t m a n a g e m e n t is f a r g r e a t e r t h a n in the p a s t . T h e q u a n t i t y of f u n d s to be a d m i n i s t e r e d is six times as g r e a t as it w a s at the t i m e of the first World War. T h e s e a s s e t s r e p r e s e n t a l a r g e a n d increasing s h a r e of the n a t i o n ' s s a v i n g s . T h e i r s a f e t y is challenged by new a n d p o t e n t f o r c e s a n d t r e n d s . Accordingly, I w o u l d s u g g e s t t h a t insurance a n d investment t e a c h e r s t r y to i m p r e s s upon their s t u d e n t s the need of 55

56

HUEBNER FOUNDATION LECTURES

an open, questioning type of mind and an unwillingness to take f o r g r a n t e d the generally accepted investment m a x i m s and rules of thumb and prejudices. T h e r e is no serious quarrel with Patrick H e n r y ' s statement, " I have but one lamp by which my feet a r e guided, and that is the l a m p of experience. I know of no way of judging the future but by the p a s t . " Nevertheless, investors are o f t e n too much inclined to assume without question that what has been true will continue to be true. J u s t as there is danger in reliance solely upon reason and intuition, ignoring the past, there is danger too in a purely statistical or static a p p r o a c h to investment analysis; and I r e f e r not merely to that superficial school of investment management which delves no deeper than " t i m e s interest e a r n e d " and " r a t i o of debt to p r o p e r t y . " I shall try to illustrate these points. A R E BONDS MORE L I Q U I D T H A N M O R T G A G E S ?

A s a result of experience and observation during the last severe depression, it is rather generally believed that bonds are liquid and real estate m o r t g a g e loans are semif r o z e n . T o a l a r g e extent that was true, but recent developments tend to m a k e bonds less liquid and real estate m o r t g a g e loans m o r e liquid. M a j o r i t y proportions of many bond issues have been absorbed by life insurance companies. T h e marketability which bonds f o r m e r l y possessed because of their b r o a d distribution a m o n g banks, trust funds and individuals, is no more. B o n d issues have been set up to mature in the distant future and, worse yet, with little or no debt repayment provision. On the other side of the picture, it is certainly true that real estate m o r t g a g e loans m a d e in the 1 9 2 0 ' s typically p r o v i d e d f o r little or no debt repayment, with the result that losses were unnecessarily large

INSURANCE INVESTMENTS

57

in the real estate slump of the 1930's. Since then mortgage lenders generally have insisted upon complete debt repayment within a reasonable period of years. In residential lending this safeguard has been insisted upon by the Federal Housing Administration. T h u s , real estate mortgage liquidity has been improved both by provision f o r steady repayment of the debt each year over a reasonable period of time and by an active m o r t g a g e market in the case of standardized residential m o r t g a g e loans; whereas many corporation bonds have degenerated, so to speak, in that their n a r r o w e r and more concentrated ownership has cut into their marketability, and their longer maturities and inadequate debt repayment provisions have reduced both safety and liquidity. Yet the inertia of investors' thinking is such that the better past performance of bonds permits them to sell at substantially lower interest yields than can be had f r o m best quality mortgages.

A $ E " A A A " BONDS R1SKLESS?

Another example of static investment attitude is the typical view that " A A A " r a t e d bonds are almost riskless investments. Presumably conservative investors made the same mistake back in the 1890's when the outlook f o r the railroads seemed so secure that top credit bonds having no debt reduction provision and maturing in one hundred years found a ready m a r k e t . A t one time life insurance holdings of railroad bonds constituted one-third of total assets. In the past decade public utility bonds have been the favored credits. About one-third of the recent yearly increases in life company assets is represented by public utility bonds. Typically, these bonds mature thirty years a f t e r issue but provide f o r no more than a one per cent yearly sinking fund, so they may as

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well have maturities of one hundred years. As a practical matter, it is absurd to assume t h a t these bonds are anything like riskless, and surely their 2 ^ per cent interest return offers inadequate compensation f o r the risk. OTHER ASSUMPTIONS W H I C H MAY NOT BE TENABLE

A t the other extreme of the type of thinking which assumes that an industry which is prosperous today will continue to prosper indefinitely, one may get into the habit of assuming that all enterprise follows a s t a n d a r d pattern of growth, maturity and decay. T h e gas industry has been a striking exception and an example of resourcefulness. A f t e r three-quarters of a century the gas lighting business was menaced by the development of the incandescent bulb. T h e gas industry responded by promoting the gas cooking stove. M o r e recently it has tried to offset electric cooking stove competition with house heating, making use of cheap natural gas wherever possible. Another illustration of rigidity in investment thinking is overemphasis upon mere terminology or description of securities. T h e collapse in the early 1930's of numerous first m o r t g a g e real estate gold bonds and first mortgage railroad bonds has reduced the glamor of the words "first m o r t g a g e . " T h e comparative yield and earnings' support of bonds and certain classes of stocks may, in time, condition our statutory and regulatory favoritism f o r bonds and prejudice against stocks. M o r e and more, investors and supervising authorities are looking behind the mere title of a security to ascertain the priority of the claim upon the company's earning power and the adequacy and stability of those earnings. An additional example of the need f o r a more critical investment attitude is the occasional misapplication of

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the rule t h a t s h o r t m a t u r i t y o b l i g a t i o n s p r o v i d e liquidity. T h e r e are many instances w h e r e m a t u r i n g principal cannot be m e t f r o m c u r r e n t e a r n i n g s and can be p a i d only by extension of the loan or r e f u n d i n g . T h e r e is no real liquidity in such an investment. I t is w a s t e f u l t o accept the low yield which accompanies such s h o r t m a t u r i t y b o n d s ; it is expensive to p a y f o r liquidity a n d n o t get it. P e r h a p s the most unjustifiable p r e s u m p t i o n of all is to assume f r o m the excellent r e c o r d of life insurance solvency t h a t their diversification of i n v e s t m e n t risk m a k e s t h e m impregnable, r e g a r d l e s s of i n v e s t m e n t policy. Of course, it is t r u e t h a t while the public in the late 1920's was buying Cities Service, A l l e g h e n y C o r p o r a t i o n , Insull Utilities, and o t h e r holding c o m p a n y c o m m o n stocks, life companies in c o n t r a s t w e r e buying chiefly t h e u n d e r l y i n g b o n d s of utilities and r a i l r o a d s . I n s t e a d of investing in real e s t a t e equities or second m o r t g a g e s , life companies w e r e p u t t i n g their policyholders' f u n d s into first m o r t g a g e s on real e s t a t e p r o p e r t i e s . V e r y p r o p e r l y , life insurance investments have, f o r the m o s t p a r t , been of a type which have a p r i o r claim u p o n t h e e a r n i n g s of the issuing c o r p o r a t i o n . But, it is increasingly difficult f o r life companies t o m a i n t a i n this p r i o r i t y principle. The public h a s been e a g e r f o r financial security and life insurance f u n d s have g r o w n r a p i d l y in a p e r i o d w h e n t h e r e has been a contraction in p r i v a t e c o r p o r a t i o n and municipal debt. G r e a t quantities of debt f o r m e r l y available f o r conservative investment a r e no l o n g e r eligible or desirable. M o r e o v e r , life insurance investments w e r e tested qualitatively d u r i n g t h e 1 9 3 0 ' s but w e r e not severely tested f o r liquidity. P r e m i u m a n d i n t e r e s t income w e r e sufficient to meet cash r e q u i r e m e n t s and t h e r e was little need to offer securities f o r sale. A t a time when individuals and institutions on every h a n d a r e offering securities and trying t o raise cash, t h e r e is little r e a l

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liquidity except in very short maturity obligations of unquestioned credits. U n d e r the pressure to earn a livable interest return, life companies have in recent y e a r s turned increasingly to long maturity bonds. W h i l e the flow of life insurance cash income in relation to disbursements still suggests no early need of liquidity, it should be recognized that the life insurance business may some day reach a point where total assets begin to decline and it may then be too late and too costly to r e a r r a n g e maturities properly. In making the point that the investment student should be alert to changing conditions, I am not hinting that the old investment principles no longer apply. S a f e t y of principal, continuity and adequacy of investment income, diversification of risk, marketability and liquidity are still fundamental. T h e fundamentals do not change— witness S h a k e s p e a r e ' s formula for sound investment, in the r e m a r k s of the merchant shipper Antonio: "I thank my fortune for it, my ventures a r e not in one bottom trusted, nor to one place, nor is my entire estate upon the fortune of the present y e a r . " T h e ancient formula still holds, but its s a f e application requires vigilant attention to changing factors which must constantly be appraised and reappraised.

INVESTMENT LESSONS FROM COMPANY FAILURES

T h e r e a r e valuable lessons to be learned from the failures which have occurred in life insurance. T h e least f a v o r a b l e financial experience was in the 1870's. A t the beginning of that decade seventy-one life insurance companies reported to the New Y o r k Insurance Department. During the next ten y e a r s forty-six companies stopped doing business and losses to policyholders were heavy. R e f e r r i n g to the causes of these failures, J o h n M c C a l l in

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1898 stated t h a t only one company failed because of erroneous mortality assumptions; the others failed because of extravagant, wasteful and dishonest management, and especially bad investments. D u r i n g the trying years of the 1930's some nineteen life companies failed (none in New York S t a t e ) , with indicated loss to policyholders in each case of one million dollars or more. As in the 1870's, the chief cause of failure was bad investing, overconcentration of funds in a single investment risk. Some of the life companies which failed had f r o m 9 per cent to 30 per cent of their assets in a single bond or stock issue or real estate mortgage. N o t only was there overconcentration, but the character of the risk in nearly every instance was open to serious criticism. T h e avoidance of overconcentration does not itself assure safety. At least one life company which failed had spread its risks broadly but clearly had been w h a t bond men call a "yield buyer." I t managed to choose small quantities of nearly all the available mediocre investment risks! This accusation of "yield b u y e r " deserves f u r t h e r discussion. It is natural f o r investors to be tempted to earn a higher yield by choosing less-than-top grade securities. T h e r e is often a lurking suspicion, particularly cherished by beginners or superficial observers, that financial institutions are hidebound by law and tradition; that they are a f r a i d to take risks and their interest earnings are, therefore, unduly depressed. Bond salesmen sometimes complain t h a t life insurance investment buyers are unwilling to take chances because they want to "play s a f e . " At so astute a gathering as that of a recent actuarial society meeting there were whisperings that the reason f o r present low interest earnings is nothing more than the unwillingness of investment men and finance committees to take risks. All this seems naive to anyone who has

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acquainted himself with the considerable risk present in the so-called top g r a d e bonds and who is aware of the powerful forces working t o w a r d lower interest rates, but it does illustrate the widespread urge to " o u t s m a r t the m a r k e t . " In this connection, I think it is of great interest that the N a t i o n a l Bureau of Economic Research study of corporate bonds issued during the last forty years indicates that on bonds highly rated at time of issue the ultimate yield has been substantially greater than the ultimate return f r o m bonds rated only mediumquality at time of issue, although the latter, obviously, showed a higher rate of return at the time of purchase. In prosperous times, medium-quality bonds ordinarily hold up but, a f t e r all, the real test of sound investing comes in hard times. It is probably safe to theorize that the investment demand for extra yield is usually so great that extra risk bonds tend to be overvalued and best quality bonds tend to be relatively undervalued. At the present time the yield spread between the highest and medium rated utility bonds is unusually n a r r o w .

C U R R E N T T R E N D S A N D PROBLEMS INVESTMENT

AFFECTING

SAFETY

W h a t are some of the newer trends and problems affecting the safety of life insurance investments? In the case of m o r t g a g e loans the changing character of downtown areas and real estate values is noteworthy. In most of the large cities so-called blight has developed in ringlike fashion around the main shopping area as a result of the parking problem and the growth of neighborhood shopping centers. L o a n s upon commercial properties are certainly not f r e e f r o m risk. A p a r t m e n t house properties in some areas are changing hands at mere fractions of original cost. T h e i r earnings have been hurt by

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h e a v i e r taxes, n e i g h b o r h o o d obsolescence, a n d o t h e r factors, including p r e s s u r e on r e n t levels, induced by the ease with which t h e a p a r t m e n t d w e l l e r can acquire a h o m e of his own. T h e s e same influences affect t h e value of existing residences also, a n d h a v e a direct b e a r i n g u p o n the s a f e t y of m o r t g a g e loans. In the field of t r a n s p o r t a t i o n , financial h i s t o r y shows w h a t h a p p e n e d to the e a r n i n g p o w e r of canals a n d toll r o a d s when the r a i l r o a d s w e r e laid alongside of t h e m . In the past few d e c a d e s the construction of p a v e d highw a y s has h a d a similar competitive effect u p o n the railr o a d s . A f t e r this w a r s u p e r h i g h w a y s will no d o u b t be built and several t h o u s a n d i m p r o v e d a i r p o r t s will almost literally p a r a l l e l t h e r a i l r o a d s . C o m e s n o w the f r e i g h t c a r g o a i r p l a n e with cubical content nearly as l a r g e as t h a t of a r a i l r o a d f r e i g h t car, able t o c a r r y eight tons of f r e i g h t at 2 0 0 miles p e r h o u r . W h o can p r e d i c t the r a i l r o a d s ' e a r n i n g p o w e r ten or t w e n t y y e a r s h e n c e ? T h u s , c h a n g e of a financially destructive n a t u r e goes on in almost every p h a s e of life insurance i n v e s t m e n t . In recent y e a r s a sizable outlet f o r life c o m p a n y f u n d s has been the electric i n d u s t r y . H e r e t h e r e is no discernible i m m e d i a t e t h r e a t t o e a r n i n g p o w e r and the r a p i d g r o w t h in the use of electricity p r o v i d e s a s a f e t y f a c t o r . But w h o can say t h a t this i n d u s t r y will r e m a i n u n h u r t by the discoveries of scientists? N e w f o r m s of energy m a y be devised. Electricity m a y be t r a n s m i t t e d o v e r much g r e a t e r distances so as t o r e n d e r obsolete all but t h e most efficient p r o d u c e r s . L o w cost Diesel units m a y become feasible f o r commercial buildings and industrial p l a n t s and even f o r the h o m e . I t is h a r d to believe t h a t t h e r e will not be i m p o r t a n t changes in the c h a r a c t e r , volume and e a r n i n g p o w e r of the electric business as well as of m o s t o t h e r kinds of business in the next ten o r twenty y e a r s .

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In fact, should we not accept as one fundamental principle that investment risk is in proportion to time exposure? A n d as a corollary, investment risk is in proportion to the rapidity with which debt repayment is p r o v i d e d ? H o w little attention is paid to these s a f e t y f a c t o r s by the investment rating services and by investors generally! Likewise, we would suggest the proposition that it is unwise to overemphasize brick and m o r t a r values as the basis f o r security. T h e r e is an element of truth in the quip that the curse of m o r t g a g e lending is the practice of a p p r a i s a l ! In the last analysis, debts are paid f r o m earning power. I N V E S T M E N T R I S K N E E D S T H O R O U G H STUDY

I have r e f e r r e d to the N a t i o n a l Bureau of Economic Research bond research. Other valuable investment risk studies have been m a d e by the F e d e r a l H o u s i n g Administration, the savings banks of the N e w Y o r k City area, and by individual insurance companies. T h e r e is need f o r additional investment risk study. T h e problem is not only to measure comparative risk but more important to determine how to set up various types of loans and bonds so as to minimize risk. It is sometimes a s k e d : " W h y cannot investment risks be g r a d e d as in life underwriting, and part of the higher interest received f r o m unusual investment risks be set aside in a reserve to offset l o s s e s ? " I believe that some p r o g r e s s has been and will continue to be m a d e in this direction. T h e r e is at least one important difference between life and investment underwriting. E x c e p t f o r r a r e epidemics, which seem to occur chiefly a f t e r long wars, the death rate is fairly uniform f r o m year to year whereas investment mortality is affected by the comparatively short business cycles. Investment casualties and

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interest d e f a u l t s a r e likely to "bunch u p " and occur at about t h e same time in the case of m e d i u m g r a d e and weak credits. Continuity of investment income is necessary to life insurance solvency. T H E PROBLEM OF APPRAISING M A N A G E M E N T AND TRENDS

A n o t h e r present-day investment problem is the difficulty of accurately appraising m a n a g e m e n t , p e r h a p s no m o r e so t h a n in t h e past, except t h a t in the old days the lender o f t e n h a d the a d v a n t a g e of personal knowledge of t h e b o r r o w e r , a n d still does in the case of an institution which lends in its own a r e a . Ordinarily, considerable reliance is placed upon the reflection of m a n a g e m e n t ability in the o p e r a t i n g figures of the past. T h i s leaves much to be desired because m a n a g e m e n t personnel may shift or its effectiveness may be reduced by ill health or o t h e r developments. T h e r e are limitations in accounting m e t h o d s and r e p o r t i n g ; and unless the investor knows a g r e a t deal about the assumptions m a d e in the p r e p a r a t i o n of financial r e p o r t s , he may obtain a d i s t o r t e d view of t r u e o p e r a t i o n s a n d earning p o w e r . I believe t h a t an excellent contribution to t h e a r t of investment analysis can be m a d e by a well-planned research into this problem of m a n a g e m e n t appraisal at long distance. T h e n there is the financial m o r a l s risk with which, f o r t u n a t e l y , we need not o f t e n be concerned these days. I t is a tribute to the integrity of business men t h a t episodes like those of K r u e g e r & T o l l and M c K e s s o n & Robbins a r e so r a r e . Likewise, instances of bond f o r g e r y have been infrequent. A life insurance investor purchasing m a n y millions of securities should, however, be on g u a r d against these possibilities of f r a u d and deception. One of the h a z a r d s against which investment students

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should be f o r e w a r n e d is the temptation to guess the money m a r k e t or the business trend, f o r example, to say, " T h i s is a good time to buy second-grade b o n d s , " or " T h i s market has gone about as high as it is going to go so let us sell now and buy back later at a lower price." T h i s approach is less typical of life insurance investors than other types of investors, but it is not rare. In 1937 a number of bond houses and investment bankers advised their clients to switch f r o m top quality to second-grade securities, because the earnings of second-grade companies were improving with more active business conditions and the prospective stiffening of interest rates would h u r t the price of top-grade bonds. T h i s proved to be a costly forecast to any investor who was thus persuaded, f o r the depression of 1938 suddenly appeared and second-grade securities dropped sharply in price. I know of a bank which several times during the past half dozen years decided that the Government bond market was as high as it was going to go and each time it "took profits," only to be disillusioned and later reinvest in Government bonds at still higher levels. T h e alleged "taking of profits" was obviously a deceptive and costly operation.

P R I V A T E P L A C E M E N T OF B O N D ISSUES

As insurance teachers, you are doubtless much interested in the so-called private bond placement trend. About one-third of the bond issues of recent years are in this category. Inasmuch as this type of loan is placed with only a few insurance companies, sometimes with only one, it is evident t h a t the several hundred remaining insurance companies and innumerable banks and other investors are correspondingly deprived of an opportunity to spread their investment risks. Occasionally the insurance companies which participate may rightly be accused

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67

of overconcentration of funds, although f o r the most p a r t the participating life companies are so huge that an investment of $25,000,000 or $50,000,000 is still a modest proportion of their total assets. P e r h a p s a more serious objection f r o m the policyholders' angle applies to the terms of the loan. In the absence of serial maturities or adequate sinking fund provisions, a private bond placement on a utility or industrial property is much like the real estate m o r t g a g e loans on special purpose properties in the 1920's, which investors eventually learned to abhor. W h e n an insurance company makes such an investment, it may be "locked in." W h i l e it has the legal right to sell, it seems reasonable that a reoffering of the bonds f o r sale to the general public, including insurance companies and banks, might arouse widespread suspicion and call attention to any deterioration in the credit. In effect, the insurance company becomes a p a r t n e r in the business, almost obligated to supply needed additional capital in times of stress; and, although a partner, the insurance company does not participate in the borrower's prosperity although it does share the risks of the business. Of course, to a large extent a giant life company is pretty much "locked in" anyway on a huge block of bonds whether privately or publicly distributed. T h i s is simply a penalty of bigness, which however can be offset by insistence upon reasonable maturities and serial repayment or adequate sinking funds. A very recent trend which investors should watch closely is the tendency on the p a r t of some industrial corporations to " f r e e z e u p " as accountants say, that is, to experience a weakening in their current assets position. If some time a f t e r the close of the war there is a great surplusage of manufacturing capacity and goods, companies which have a high ratio of inventories to n o r m a l earnings and which have a weak working capital position

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HUEBNER FOUNDATION LECTURES

may undergo a severe solvency test comparable to the 1920-21 situation. T H E INFLATION PROBLEM

Another trend t h a t we all recognize is the growing inflation t h r e a t in the considerable expansion of bank deposit money over the last eight years and especially over the near f u t u r e if the Government continues to rely largely upon the sale of its securities to commercial banks. Financial writers customarily assume that Government bonds are approximately riskless. Obviously this is more likely to be so when the Government debt is one billion dollars, as it was prior to the last war, than when it is one hundred ten billions as forecast for mid1943. Yet, despite the inflation threat, this country's capacity to produce goods a f t e r the war will again be so great that one wonders whether, in the long run, the cost of living trend will not more likely be down than up. Life insurance obligations are payable in dollars and no promise is given to maintain the policy's purchasing power. I wish we knew of some investment method of insuring a given standard of living. Some years ago a prominent economist who was once with a large investment trust made a caustic comment a$ to the failure of life insurance companies to insure purchasing power. I had to remind him that this was the task the investment trusts h a d undertaken to p e r f o r m . Some of the investment trusts have been managed by extremely able men, but their efforts to maintain purchasing power have not worked out so well. By way of explanation, one capable investment trust officer aptly explains that it is difficult to be rational in an irrational world. In any event, life insurance companies have a man-sized job to make good their dollar contracts, quite apart f r o m pur-

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c h a s i n g p o w e r c o n s i d e r a t i o n s . D u r i n g a n d a f t e r t h e first W o r l d W a r t h e cost of living p r a c t i c a l l y d o u b l e d , y e t t h e i n s t i t u t i o n of l i f e i n s u r a n c e c a r r i e d on, a n d in m a n y i n s t a n c e s t h e n , as n o w , t h e p o l i c y h o l d e r ' s best inflation protection was to purchase additional insurance to match t h e h i g h e r cost of living. A n y o n e w h o is d e p e n d e n t u p o n an a n n u i t y income d u r i n g such a p e r i o d is clearly a t a d i s a d v a n t a g e , a n d it is n o t much s a t i s f a c t i o n t o h i m t o recall t h a t he h a d a n e q u a l l y g r e a t a d v a n t a g e in y e a r s like t h e e a r l y 1 9 3 0 ' s w h e n t h e cost of living w a s l o w . O n t h e c o n s t r u c t i v e side in t h e b a t t l e a g a i n s t p o s t - w a r inflation, life c o m p a n i e s can only j o i n t h e r a n k s of t h o s e w h o u r g e t h a t a l a r g e s h a r e of w a r cost be p a i d f o r f r o m t a x a t i o n now, a n d t h a t as m u c h as possible of t h e r e m a i n i n g costs be r a i s e d f r o m n e w l y c r e a t e d savings, i n v e s t e d in G o v e r n m e n t b o n d s . W e h a v e m e n t i o n e d s o m e of t h e f a c t o r s which cont r i b u t e d t o t h e decline in i n t e r e s t r a t e s o v e r t h e 1 9 3 3 - 4 1 p e r i o d : h e a v y g o l d inflow, h i g h e r v a l u e o n g o l d , declini n g v o l u m e of p r i v a t e a n d c o r p o r a t e d e b t , s m a l l comm e r c i a l d e m a n d f o r l o a n s , a n d i n c r e a s e d v o l u m e of insurance f u n d s seeking i n v e s t m e n t . T h e g o l d inflow t r e n d h a s s t o p p e d a n d it is conceivable t h a t a f t e r t h e w a r t h e o u t f l o w will be c o n s i d e r a b l e . T h i s c h a n g e in an i m p o r t a n t t r e n d is w o r t h n o t i n g a n d w a t c h i n g c u r r e n t l y , a l o n g w i t h o t h e r v e r y r e c e n t t r e n d s like c o m m e r c i a l l o a n e x p a n sion, public w i t h d r a w a l of d e p o s i t s e v i d e n c e d by i n c r e a s e d c u r r e n c y in circulation, a n d h e a v y F e d e r a l b o r r o w i n g , offset in p a r t by n e w l y c r e a t e d i n d i v i d u a l s a v i n g s i n v e s t e d in D e f e n s e b o n d s .

G E N E R A L I N V E S T M E N T POLICY

I n t h e concluding section of t h i s p a p e r I s h o u l d like t o t r e a t briefly of g e n e r a l i n v e s t m e n t policy. W h e n we

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see compilations showing how the aggregate of life insurance funds are invested, so much in real estate mortgages, so much in utility bonds, and so on, it is not always realized that company policies vary greatly, even a m o n g companies operating under the statutory limitations of a particular state. Some life companies have almost no bonds, p r e f e r r i n g real estate mortgages, perhaps because mortgages bear a higher interest rate and can be made in an area with which the company is thoroughly familiar, whereas it may not be equipped to analyze and supervise bonds issued by corporations operating at distant points. Some m o r t g a g e lenders p r e f e r f a r m loans; others concentrate on urban lending. In city loans, certain companies p r e f e r commercial properties while others p r e f e r residential properties. Some of the very large life companies have concentrated their mortgage lending in the N e w York City area while others diversify their lending areas. Some life companies have 50 per cent of their assets in United States Government bonds and others have no more than 5 per cent. T h i s particular difference in policy is not always a m a t t e r of choice. T h e rate of interest required to maintain policy reserves varies greatly, ranging f o r example, f r o m 2.8 per cent to 3.5 per cent among the largest life companies. In the management of a huge volume of funds, there is a vast difference in investment policy flexibility between having to earn 3.5 per cent and having to earn only 2.8 per cent. T h e need f o r interest earnings has been so great that most companies have h a d to seek, safe investments other than the comparatively low yielding United States Government bonds. On the other hand, considering comparative risk, maturities, and tax exemption, United States Government bonds have, during most recent years, looked like better values than utility and railroad bonds, just as U n i t e d States D e f e n s e Savings bonds today are an out-

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standing value compared with other bonds, quite apart f r o m patriotic considerations. In the choice between municipal and c o r p o r a t e bonds, municipal bonds f o r the most part appear to be less subject to obsolescence. A l s o they usually have the advantage of complete debt repayment over a reasonable period o f years. T h e contrast is particularly sharp between the debt repayment policies o f municipal and privately-owned electric companies. Some life companies, which f a v o r c o r p o r a t e bonds, own no railroad securities while others own more railroad securities than utilities. T h e volume o f industrial bonds available to and desirable f o r life insurance investors is limited, but again you will find considerable diversity o f investment policy based upon differences in appraisal o f risk and outlook, yield and like factors. M a n y life companies own no stocks, either f r o m choice or legal restriction. O t h e r s hold a modest proportion o f preferreds, and a small group will own some stocks o f banks and other enterprises. Unless a life company has a substantial surplus, it cannot safely carry a l a r g e proportion o f assets in stocks so long as the regulating authorities p r e f e r to emphasize market quotations over income f o r year-end asset valuation purposes. T h i s is probably unfortunate under present conditions when stocks are historically low in price and high in yield, compared with bond yields; and many o f A m e r i c a ' s best-managed and most promising companies have little or no debt in which insurance companies may invest. T h e n there is the question o f general policy and attitude toward investment risk. W e have commented upon the danger o f trying to " o u t s m a r t the m a r k e t , " but there are times when a prudent investor should be willing to accept extra risk provided always that the compensation in terms o f yield is correspondingly adequate. Prefer-

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ably this compensation should.be available in terms of a substantial discount as well as in extra yield. T h u s , f o r a given investment risk, a 3 per cent bond priced at 7 0 to yield 4 per cent to maturity, is to be preferred over an equally secured 4 per cent bond selling at par. If the discount bond is non-callable, so much the better. In the design and redesign of investment policy, as with most problems, " t w o heads are better than one," if the heads are well chosen. Advice and criticism f r o m informed outsiders who can present a fresh point of view can be extremely helpful. While security analysis is difficult enough, the investor can easily obtain advice on t h a t subject; but with general investment policy, the investor will find few advisors who are both willing and able to be helpful. I should like to pass along a suggestion which has been useful in my own limited experience with investment teaching, namely, to require the student to analyze thoroughly the securities of utilities, railroads, industrial and commercial companies serving his own community. T h i s approach brings close to him a problem which otherwise may seem remote and abstract; and his personal knowledge of the managements, supplemented with interviews, will add interest as well as helpful information. Investment procedure f o r the immediate future may become simplified by the placing of all new funds in United States Government bonds, partly f r o m choice and partly f r o m necessity; f o r there may soon be a moratorium on all other new financing. W h e n the war is over, there will be once more the gigantic task of conserving more than thirty billions of life insurance assets, besides the task of earning around 3 per cent interest year a f t e r year. N e w investment considerations will then arise to complicate the already difficult investment management problem. In helping to solve these problems,

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the t e a c h e r s of insurance and investment h a v e both an o p p o r t u n i t y a n d a responsibility. Y o u a r e o f t e n in a position t o visualize the b r o a d p r o b l e m a n d its solution with f a r b e t t e r perspective t h a n the insurance company investment officer. T h e institution of life insurance must be p r e s e r v e d if we a r e t o win the peace as well as the w a r , and I am confident t h a t insurance t e a c h e r s will, in the f u t u r e as in the p a s t , d o t h e i r full s h a r e .

THE SIGNIFICANCE OF REDUCED INTEREST EARNINGS by Adolph A . Rydgren President,

Continental

American

Life Insurance

Company

H E income o f a life insurance company consists almost entirely o f premiums and interest. W i t h the exception o f dividends, the disbursements o f a life insurance company, being mainly f o r claims and expenses, a r e quite independent o f the interest e a r n e d .

I n o r d e r to

k e e p its surplus intact when interest earnings diminish, a l i f e insurance c o m p a n y must either increase premiums o r decrease dividends. A n assumed interest r a t e is involved in the calculation o f premiums

and r e s e r v e s

for

life

insurance

policies.

W h e n a p a r t i c i p a t i n g life insurance policy is issued, f o r example, on the basis o f the A m e r i c a n E x p e r i e n c e T a b l e o f M o r t a l i t y and 3 p e r cent interest, the net premium is computed on the assumption t h a t the death r a t e will be precisely in a c c o r d a n c e with t h a t o f the A m e r i c a n E x p e r i ence T a b l e o f M o r t a l i t y and t h a t the company will earn a net effective r a t e o f interest o f 3 per cent each year until the policy t e r m i n a t e s by d e a t h , m a t u r i t y or expiry. R e s e r v e s a r e c o m p u t e d on the same assumptions.

The

g r o s s premium is the a f o r e s a i d net premium plus a loading f o r all o r p a r t o f the expenses and contingencies.

If

the net effective r a t e o f i n t e r e s t actually earned exceeds the r a t e assumed, in this case 3 per cent, then the excess interest e a r n e d on the r e s e r v e represents t h a t s h a r e o f the surplus interest earnings.

policy's

Such share o f

excess interest earnings, plus the policy's share o f mor74

REDUCED INTEREST EARNINGS

75

tality savings, plus the aforesaid loading, less the actual expenses and less a contribution t o w a r d the growth of the f r e e surplus funds of the company, is the amount which the company apportions to that policy as a dividend. If the net effective rate of interest actually earned be less than the rate assumed, then there is an interest loss; but other elements of gain may more than offset such loss, so that on the whole a dividend may still be earned. T h i s in brief describes the composition of premiums, reserves and policy dividends, including the significance of the interest factor in each. REDUCTION IN INTEREST EARNINGS

Just what has happened to the interest rate earned by the life insurance companies? T o answer this question, I tabulated the net rate of interest earnings, according to Best's Life Insurance Reports, of the ten largest life insurance companies of the U n i t e d States ranked by assets. T h e assets of these ten largest companies aggregate 70 per cent of the total assets of all the life insurance companies in the country. T h e s e ten companies are as follows : Ordinary Participating: T h e Equitable L i f e Assurance Society of the United States; the M u t u a l Benefit L i f e Insurance C o m p a n y ; the M u t u a l L i f e Insurance Company of N e w Y o r k ; the N e w York L i f e Insurance Company; the N o r t h w e s t e r n M u t u a l L i f e Insurance Company; and the Penn M u t u a l L i f e Insurance Company. Ordinary and Industrial Participating: The Metropolitan L i f e Insurance C o m p a n y ; the Prudential Insurance Company; and the J o h n Hancock M u t u a l L i f e Insurance Company. Ordinary Non-Participating: T h e T r a v e l e r s Insurance Company.

76

HUEBNER FOUNDATION LECTURES Year 1928 1929 1930 1931 1932 1933 1934 1935 1936 1937 1938 1939 1940

Net Rate of Interest Earned by Ten Largest Companies P e r Cent 5.0 5.0 5.0 4.9 4.7 4.2 3.9 3.7 3.7 3.7 3.6 3.5 3.4

NOTE: The foregoing net rate of interest is the net rate earned on the total funds of these companies a f t e r deduction of investment expenses, including apportioned expenses, but before deduction of investment losses or addition of investment gains. The net rate of interest adjusted for capital gain or loss is not published.

W h a t has happened to interest earnings during the past ten y e a r s is aptly expressed by M r . Elbert S. Brigh a m ' s report entitled, "Investing for Security of H o m e and N a t i o n " to the Association of L i f e Insurance Presidents at its December, 1941, meeting: " N e t investment earnings of the 49 companies (representing 92 per cent of the total admitted assets of all U n i t e d States legal reserve life insurance companies) on mean ledger assets dropped from a rate of 5.03 per cent in 1930 to 3 . 4 4 per cent in 1940. T h i s decline in earnings has meant that during the ten years, 1931 to 1940 inclusive, the net investment income of all U n i t e d States legal reserve life insurance companies w a s over $ 2 , 4 0 0 , 0 0 0 , 0 0 0 less than it would have been at the 1930 level. F o r 1940 alone, net investment income w a s approximately $ 4 2 5 , 0 0 0 , 0 0 0 less than it would have been at the 1930 r a t e . T h i s income reduction for 1940 is a sum nearly equal to the dividends actually paid and

REDUCED INTEREST EARNINGS

77

credited to policyholders; and is a sum g r e a t e r by $105,000,000 than was paid f o r initial premiums on new insurance." T h e loss in interest income amounting to $425,000,000 in 1940 is at the rate of $3.60 per year per thousand of life insurance then in force. T h e life insurance business has had to adjust itself to this huge loss in interest income. Premium rates can be increased and many companies have increased premiums. Premiums can be increased, however, only in respect to policies subsequently issued; for a life insurance company has no power to increase the premium on a policy already in force. If the policy be participating, then dividends can be reduced, and dividends have been substantially reduced on old as well as on new policies. Changes have likewise been made in certain policy provisions, such as in the settlement option provisions and in the rate of interest charged for policy loans.

INCREASE IN GROSS P R E M I U M S

T o illustrate what change has been made in gross premium rates, I compared the published premium rates of the same ten largest companies f o r 1941 with those f o r 1929. / Generally speaking, the high premium participating companies had not changed premium rates. All six of the ordinary mutual companies listed above are in this category. In 1929, for example, these companies computed premiums and reserves on a 3 per cent interest basis and gross premiums f o r ordinary life insurance issued at age 35 varied f r o m a low of $26.35 per thousand to a high of $28.11 per thousand, averaging $27.32 per thousand. All six of these companies have main-

78

HUEBNER FOUNDATION LECTURES

tained the same premium scale through the year 1941. T h e one non-participating company on the list in 1929 maintained reserves on the 3 l / 2 per cent interest basis, charging a premium f o r ordinary life insurance at age 35 of $19.71 per thousand. Its 1941 business is on the 3 per cent reserve basis and the corresponding premium is $22.24. T h i s premium has been increased $2.53 per thousand, or by 13 per cent. All three industrial companies were on the 3 l / 2 per cent reserve basis in 1929, charging f o r ordinary life insurance at age 35 a premium varying f r o m $21.40 to $25.88, and averaging $23.83. Before 1941, each of these companies had changed its reserve basis, two to the 3 per cent reserve basis and one to the 3 J4 per cent basis, thereby increasing gross premiums. These are participating premiums, and it is interesting to note that the 1929 participating premium of one of these companies is actually lower than the present non-participating rate. T h i s is a fair picture of what has happened to premium rates in the life insurance business as a whole up to the year 1941. Generally speaking, high participating premiums had not been changed, whereas low participating and non-participating premiums had been increased. As will be more fully explained later on, a f u r t h e r increase in premium rates by assuming a lower rate of interest than 3 per cent, was impeded by legal restrictions until well into the year 1941. Such legal restrictions have now been substantially removed. T w o of the large industrial companies announced a f u r t h e r increase in premium rates effective J a n u a r y 1, 1942; one such company has cut the assumed interest rate to 2 ^ per cent and the other to per cent. One of the large ordinary companies recently announced that in the near future its premium rates would be computed on the 2y 2 per cent interest basis. T h e evidence is t h a t a number of other

REDUCED INTEREST EARNINGS

79

participating companies a r e likewise considering an increase in premiums by reducing the interest assumption to 2 J/2 per cent. FACTORS INVOLVED IN C H A N G E IN

NON-PARTICIPATING

PREMIUMS

Gross premiums f o r non-participating insurance are computed on exceedingly close estimates of probable f u t u r e mortality, interest a n d expenses. T h e r e is no necessary connection between the m o r t a l ity and interest assumptions involved in the calculation of non-participating gross p r e m i u m s and the assumptions involved in the calculation of reserves f o r the same policy. F o r example, one of the leading non-participating companies, a few years ago, computed its p r e m i u m s on the basis of a m o d e r n select table of m o r t a l i t y with a decreasing rate of interest, decreasing f r o m 5 per cent in the early policy years to per cent in the later policy y e a r s ; whereas reserves on the same policy were computed according to the A m e r i c a n Experience T a b l e of M o r t a l i t y and 3y 2 per cent interest. Since a change in t h e p r e m i u m scale is the only way in which a non-participating company can a d j u s t itself to changed conditions, it follows t h a t non-participating premiums are quite sensitive to any significant change in the probable f u t u r e m o r t a l i t y , interest and expense rates. M a n y of the non-participating companies have, f o r example, increased the p r e m i u m scale twice d u r i n g the past ten years to reflect reduced estimates of f u t u r e interest earnings. T h e ultimate determining f a c t o r in the decision of a non-participating company respecting its p r e m i u m scale, w h e t h e r to maintain the then existing p r e m i u m scale or whether to increase or decrease it, is w h a t r a t e of gross

80

HUEBNER FOUNDATION LECTURES

premium will yield a reasonable profit to stockholders in the light of probable f u t u r e rates of mortality, interest and expense. In timing the date when any such change shall become effective, the non-participating company is influenced by the then existing competitive situation, by the expense involved in making the change, and by the probable reaction. A non-participating company may disregard a fluctuation of substantial proportions if it feels it is of a non-recurrent type, such as the influenza epidemic of 1918, and yet feel it necessary to take cognizance of a change of conditions of much smaller magnitude if it feels that the change is likely to persist f o r a long period into the f u t u r e . FACTORS INVOLVED IN C H A N G E I N

PARTICIPATING

PREMIUMS

T h e typical participating premium rate structure is intended to be continued unchanged over long periods of time. Typical participating premiums have been computed on conservative assumptions of mortality and interest, with the expectation of substantial margins f r o m those sources; the highest participating premiums include a loading fully sufficient to cover estimated expenses, whereas low participating premium rates anticipate using some of the probable profit f r o m mortality and interest f o r expenses. T h e fundamental concept of a participating premium is a redundant premium conditioned by the promise to return to the policyholder the excess of such premium over the actual cost. V A participating premium may be redundant even when the rate of interest actually earned is less than that assumed in the calculation of the premium. Generally spea;king, all but the most drastic changes in mortality, interest and expense rates are re-

REDUCED INTEREST EARNINGS

81

fleeted not in a change in the premium scale but in a change in the dividend scale. N o t all participating premium rate structures are in the same category. Some participating premiums are just enough higher than the then current non-participating premiums to give promise of the minimum dividends which would appear seemly to policyholders. Such extremely low participating premiums are just as sensitive to changing conditions as are non-participating premiums. O t h e r participating premiums grade upward f r o m such minimum premiums and, generally speaking, are sensitive to changing conditions in inverse proportion to the margins f o r probable dividends contained therein. A decision to change the participating premium scale involves a number of factors. W h i l e the dominant basic factor determining the non-participating premium scale, namely, what the insurance will cost according to a close estimate of future mortality, interest and expense rates, is in the background of any such decision, in practice participating premiums should always exceed such probable basic cost. An increase in participating premiums is, therefore, determined by factors other than the mere bare sufficiency of the premium scale. W h e n the net effective rate of interest earned by a life insurance company falls below and remains f o r more than a few years below the rate of interest assumed in the calculation of premiums and reserves, then there may develop conditions which do violence to the principle of mutuality or equity, even though the premium be redundant. U n d e r such conditions, the surplus earnings of a particular policy may become negative. T h e typical Retirement Income E n d o w m e n t policy, f o r example, accumulates a reserve which f o r some years prior to maturity exceeds the face of the policy; under such con-

82

HUEBNER FOUNDATION LECTURES

ditions there can be no mortality profit, and if actual expenses plus interest loss exceed the loading, then that policy is a drain either on the surplus earnings of other policies, or is a drain on the company's accumulated surplus which presumably must subsequently be replenished out of the surplus earnings of other policies. If all surplus earnings during early policy years be apportioned to such a policy as dividends, then the subsequent loss on such a policy is inevitably shifted to other policies in thé same company. In practice it is exceedingly difficult to avoid inequity under these conditions. Incidentally, this is why the interest rate assumed in reserve calculations should be lower and in practice usually is lower for participating than f o r non-participating policies. In order to avoid any possibility of such inequity, the participating premium should, therefore, involve a rate of interest below which the interest rate cannot fall f o r more than a few years during the entire f u t u r e existence of such policy, so that the surplus interest earned by that policy can never become negative f o r long. Just now it is anybody's guess what the low point in the interest rate will be. T h e r e has never been a time when it has been so difficult to predict the future low point in the interest rate. W e may be entering an era of entirely different political and economic phenomena where predictions based on the democratic laissez faire economy are worthless. T h e r e are strong practical objections to adopting a very low interest rate in the calculation of participating premiums. Other assumptions remaining unchanged, a reduction of one-half of 1 per cent in the assumed interest rate increases gross premiums by approximately 6 per cent; both policy dividends and reserves would be increased. While such an increase in gross participating premiums does not appreciably affect the net cost to a

REDUCED INTEREST EARNINGS

83

policyholder w h o s u r r e n d e r s his policy at the end of twenty years, this being the net cost illustration m o s t commonly used by agents ( t h e i m p o r t a n t element of interest is o m i t t e d f r o m such commonly used i l l u s t r a t i o n s ) , the f a c t remains t h a t the net cost, p r e m i u m less dividend, to the continuing policyholder is substantially increased d u r i n g each of the early years of the policy, thus r e n d e r ing it m o r e difficult f o r the policyholder to purchase and continue a given a m o u n t of life insurance. C o m p e t i t i o n is also a f a c t o r . W h i l e competition a m o n g the p a r t i c i p a t i n g companies is chiefly concerned with the net cost t o the policyholder, namely, p r e m i u m s less dividends less cash value, t h e r e is some evidence t h a t the lower the gross p r e m i u m the easier the sale. A n increase in p r e m i u m s automatically increases expenses, thus indirectly increasing the ultimate, as well as the immediate, cost to the policyholders. If the agent receives the same r a t e of commission on the higher premium, his commission increases in the same p r o p o r t i o n as the p r e m i u m increases. T h e clerical cost of collecting p r e m i u m s and of servicing policies in f o r c e is, generally speaking, a f u n c t i o n of the n u m b e r of items involved and is little g r e a t e r on a l a r g e policy t h a n on a small policy. T h e evidence seems to be t h a t , o t h e r things being equal, an increase in t h e p r e m i u m scale results in a smaller a v e r a g e a m o u n t of insurance p e r policy. T h i s f a c t n o t only justifies the continuance of the old commission scale, but also increases general o v e r h e a d expense, including h o m e office expense, p e r t h o u s a n d d o l l a r s of insurance. T h e s e very practical considerations limit the d e g r e e of conservatism involved in fixing the r a t e of interest f o r the c o m p u t a t i o n of p a r t i c i p a t i n g p r e m i u m s and reserves. I t may be b e t t e r f o r t h e policyholders as a whole to maintain a g r o s s p r e m i u m scale which m a y in the r e m o t e f u t u r e result in a little inequity, r a t h e r t h a n t o increase

84

HUEBNER FOUNDATION LECTURES

the premium scale, which both reduces the amount of insurance that policyholders can afford to own and increases the expense rate per thousand of such insurance. Despite the reluctance to change a participating premium rate structure which has been in existence f o r a great many years, a participating company is concerned when the interest rate, earned or likely to be earned in the near future, falls to a point about one-half of 1 per cent higher than the rate of interest assumed in premium and reserve calculations. At about this point, if the American Experience Table of Mortality be used in the calculation of premiums and reserves, dividends cease to increase with increasing duration of the policy, except during the early years of the policy when the expense rate may be graded downward. Any further drop in the interest rate, even if it remains above the valuation rate of interest, produces a dividend scale which ultimately decreases with increasing duration. T h e participating companies have been concerned, perhaps unduly concerned, over the possibility of such a reducing dividend scale, mainly because policyholders might react very unfavorably to it. Policyholders have become so accustomed to a scale of dividends which increases with increasing duration, that they might conclude the company is each year reducing the dividend scale and is earning less and less each year. I suspect, too, a policy which costs a little less each year affords much more satisfaction to a policyholder than does a policy which costs a little more each year. A downward trend in cost seems psychologically right. While any participating company may, by the device of amortizing excess first-year expense by means of a reducing expense charge over the first fifteen or twenty policy years, defer the unfavorable reactions resulting f r o m an otherwise diminishing scale of dividends, nevertheless the situation is one which the

REDUCED INTEREST EARNINGS

85

p a r t i c i p a t i n g companies have very much in mind in any decision to maintain or change the c u r r e n t scale of p a r ticipating premiums. T h i s is f u r t h e r discussed in the section on dividends. F o r several years, an increasing concern has been felt over the 3 per cent interest assumption in p a r t i c i p a t i n g policies. U n t i l the year 1941, h o w e v e r , the life companies w e r e effectively estopped f r o m a d o p t i n g a lower interest r a t e f o r the calculation of reserves by reason of the existing state laws and insurance d e p a r t m e n t rulings. Some three or f o u r years ago, we in our company became interested in the possibility of employing 2]/2 per cent interest in the calculation of p r e m i u m s and r e s e r v e s ; but on corresponding with the insurance d e p a r t m e n t s of the states in which we do business, we f o u n d t h a t five such states prohibited the use of a lower r a t e of interest than 3 per cent in the calculation of reserves and at the time it was the ruling of the respective insurance commissioners that such prohibition applied to foreign companies as well as to domestic companies. T h e law in some such states was changed during the year 1941 to p e r m i t t h e use of a r a t e of interest lower than 3 per cent in the calculation of reserves, and it is my u n d e r s t a n d i n g t h a t the remaining few states which still by law p r o h i b i t a r a t e of interest of less t h a n 3 per cent f o r reserve purposes have since ruled t h a t such prohibition does not apply to foreign companies doing business in such states. In o t h e r words, the situation now seems to be t h a t with the exception of the companies domiciled in only a f e w states, the companies can now legally compute p r e m i u m s and reserves on the basis of a r a t e of interest less t h a n 3 per cent. W e have already observed t h a t a few companies have recently announced a change to the 2l/2 p e r cent o r per cent interest basis and t h a t many o t h e r companies are likely to do so in the near f u t u r e .

86

HUEBNER FOUNDATION LECTURES

REDUCTION IN DIVIDENDS ON PARTICIPATING

POLICIES

I t is consistent with the principles governing the issuance of participating life insurance, that during the past ten years there has been a great reduction in dividends and t h a t such reduction has closely followed changes in f u n d a m e n t a l operating conditions. T h e following table illustrates the increase in net costs during recent years. In order to compile the experience of a somewhat larger number of homogeneous companies, I show the average twenty-year net cost on two bases for the ten largest participating companies, excluding industrial companies, doing business in the state of N e w York. These are the net costs f o r an O r d i n a r y L i f e policy, issued at age 35, based on the then current dividend scale. T W E N T Y - Y E A R N E T C O S T P E R $1,000 O F T E N L A R G E S T PARTICIPATING ORDINARY COMPANIES

Year 1929 1930 1931 1932 1933 1934 1935 1936 1937 1938 1939 1940 1941

Premiums Less Dividends for 20 Years Less Cash Value End of 20 Years

Premiums Less Dividends for 20 Years

....

$30 30 31 46 59 78 80 86 86 84 88 87 94

$356 356 357 371 385 404 407 414 414 412 416 414 421

Increase in net cost ( 1 9 2 9 - 1 9 4 1 ) . . .

$64

$ 65

Percentage increase in cost to continuing policyholders

18%

Such 1941 net cost f o r twenty years is $65 higher than the 1930 net cost; this is an increase in the cost of insurance of $3.25 per thousand dollars per year. It

R E D U C E D I N T E R E S T EARNINGS

87

represents an 18 per cent increase in the cost of owning a given amount of ordinary life insurance. It is interesting to compare this increase with the increase o f $ 2 . 5 3 in the non-participating premium charged f o r the same policy by the one non-participating company included in the original list o f the ten largest companies. Some of the life insurance companies, which have in force participating insurance valued on a 3 y 2 per cent interest assumption, are now distributing policy dividends according to a dividend scale which produces, in an important segment of their business, dividends which diminish from year to year with increasing policy duration. I have already pointed out that this is a condition which the companies hoped to avoid. T h e company I am associated with is in this category. T h u s far, this condition which, from the policyholder's viewpoint, means a dividend cut each and every year, has not created anything like as much adverse policyholder reaction as we had anticipated. Concrete evidence of the relative lack o f adverse policyholder reaction is indirectly evidenced by the fact that in my company the renewal lapse rate, that is the lapse rate on policies more than one year in force, is now at the all time low point in the history of the company. A dividend scale, reflecting current low actual interest earnings, applicable to policies valued on a 3}/ 2 per cent interest basis, may under some situations produce negative dividends. W h a t a life company should do about a participating policy which no longer earns a dividend and which may actually be carried at a loss, poses another of those intricate questions involving equity among policyholders as well as a host o f practical considerations. Considering only the f a c t o r o f equity among policyholders, I am disposed to the opinion that the ideal practice would be t o withhold, during the years when a

88

HUEBNER FOUNDATION LECTURES

policy is contributing to the surplus earnings of the company on policies which, in the judgment of the management of the company, may ultimately result in a surplus loss, an amount which, in the judgment of the management, is sufficient to offset such potential future loss. T h i s is, of course, an extreme position—a position which may or may not be justified in practice. Insurance department examiners might question the withholding of such surplus earnings f o r such purpose. At best any such withholding of surplus must be based on assumptions which are little better than guesses into the future. A company proposing such action might find itself limited by legal restrictions; for example, the state of N e w York establishes an upper limit for the surplus which may be held by any life insurance company. Such withholding of all or a p a r t of surplus earnings on such policies might react very unfavorably on the policyholders involved and their unfavorable reaction is apt to be reflected in an even stronger adverse reaction among the sales forces of the life insurance companies, particularly the agents involved in the sale of such policies. Moreover, perfect equity is unattainable in practice, even under the most favorable of earning conditions, for in order to keep the cost of dividend calculations within reasonable limits, it is necessary to make broad average assumptions all along the line. In many cases an apparent inequity may not be a real inequity at all. T h i s is a new situation f o r the life companies and to date only an insignificant segment of business of some companies produces a surplus loss. It will be interesting to observe how it will be met during the next few years when such cases are likely to increase many fold due to a probable f u r t h e r drop in interest earnings on total funds.

REDUCED INTEREST EARNINGS

89

SETTLEMENT OPTIONS

T h e r a t e of interest assumed in the calculation of or g u a r a n t e e d in the various settlement options contained in life insurance policies has been drastically reduced. T o illustrate w h a t has h a p p e n e d in this respect, I am presenting the facts about t h e ten largest life insurance companies in the country. T h e six largest m u t u a l companies, all of which have m a i n t a i n e d t h e 3 per cent reserve basis d u r i n g the period in question, in 1929 g u a r a n t e e d 3 per cent interest on policy proceeds l e f t with the c o m p a n y ; in 1941, one such company g u a r a n t e e d only 2 per cent interest, three g u a r a n t e e d 2l/2 per cent interest, one g u a r a n t e e d 3 per cent interest, and the o t h e r g u a r a n t e e d 3 per cent interest on n o n - w i t h d r a w a b l e f u n d s a n d only \y2 p e r cent interest on w i t h d r a w a b l e f u n d s . O f the three large industrial companies, all of which held 3^4 per cent reserves in 1929, and all of which in 1929 guaranteed 3 r / i per cent interest on policy proceeds l e f t with the company, two g u a r a n t e e d only 2 ^ per cent on such proceeds in 1941 and the o t h e r g u a r a n t e e d 3 p e r cent. T h e non-participating company included in the list did not automatically include settlement options in its policies either in 1929 or iq 1941. M o s t of these life companies now assume or g u a r a n t e e a lower r a t e of interest in p a r t i c i p a t i n g settlement options than they assume in t h e calculation of p a r t i c i p a t i n g premiums and reserves f o r t h e same policy. T h e r e a r e t w o i m p o r t a n t reasons w h y the interest r a t e assumed f o r settlement options should be lower t h a n t h a t assumed f o r reserves: ( 1 ) T h e settlement option benefit begins a f t e r the termination of the basic policy c o n t r a c t ; thus u n d e r settlement options we must project our interest assumptions a g o o d m a n y y e a r s f u r t h e r into the

90

HUEBNER FOUNDATION LECTURES f u t u r e than is necessary under the basic policy contract. ( 2 ) U n d e r settlement options, there is a complete absence of other sources of profit which normally exist in the shape of loading and mortality profit under the basic policy contract, so that even the expense of handling settlement options must come f r o m excess interest earnings.

T h e aforesaid reduction in the interest rate guaranteed or assumed in settlement options contained in policies now being issued does not apply to policies heretofore issued with more liberal settlement options. I t is obvious t h a t there exists a huge volume of insurance in force containing settlement options which assume or guarantee 3 J/2 per cent interest. Such liberal settlement options are now of more than normal value to both policyholders and beneficiaries provided the policy proceeds are not needed immediately when the policy becomes a claim. Conversely, the existence of so large a volume of actual and potential settlement option funds on which the company must pay Z l / 2 per cent interest presages a sizable loss to the companies during at least the next few years when actual net interest earnings will likely be less than 3^2 per cent. POLICY L O A N I N T E R E S T

T h e policy loan interest rate has been reduced in new policies. W i t h one exception, all policies issued in 1929 by the ten largest life insurance companies provided f o r 6 per cent interest on policy loans; the policies issued by one of the ten companies provided f o r 5 V2 per cent interest payable in advance. N o w , the policies issued by nine of these ten companies provide f o r 5 per cent interest on policy loans and the other company charges 4.8

REDUCED INTEREST EARNINGS

91

per cent payable in advance, which is the approximate mathematical equivalent of 5 per cent. T h i s reduction in the policy loan interest rate applies of course only to new policies. T h e rate of policy loan interest is by law fixed at the time the policy is issued. It follows that at the present time 6 per cent interest is being received by the life companies on the bulk of existing policy loans. Some other aspects of the policy loan situation are well expressed by M r . W a l t e r L e M a r T a l b o t in a paper entitled, " T h e W h y and W h e r e f o r e of L i f e Insurance F u n d s " presented at the 1940 meeting of the Association of Life Insurance Presidents. I q u o t e : " T h e present policy loan total is $2,767,000,000, representing 9.8 per cent of admitted assets. P r i o r to the depression, a policy loan ratio ranging f r o m 12 per cent to 14 per cent of assets was regarded as normal. Following the increase in such loans, as a result of depression demands, to nearly 18 per cent of assets in 1932 and 1933, the decline to the present level indicates that policyholder habits may be changing with respect to the use of this source of credit. In p a r t at least, this lower level of policy loans may reflect improved economic conditions for some of our policyholders, and, if so, it augurs well f o r greater persistency. But some of it is very likely related to the readiness of banks at this time to make loans on the gilt-edge security of life insurance cash values at slightly lower interest rates than would be justified for life insurance companies. T h e bank can time its loan, raise its r a t e with the market, and it can skim the cream by avoiding the vast miscellany of small loans which load the insurance company's cost of loan administration. It should be remembered t h a t the life insurance companies cannot take only the large loans and leave to the other lenders the small ones t h a t are expensive to

92

HUEBNER FOUNDATION LECTURES

handle.

T h e y must by legal compulsion lend w h a t e v e r

amount, up t o the l o a n value o f the policy, is d e s i r e d by the policyholder.

T h e banks, on the o t h e r h a n d , can a n d

do t a k e only the l a r g e loans on which t h e expenses

of

handling a r e relatively s m a l l . "

MISCELLANEOUS EFFECTS T h e f o r e g o i n g a r e t h e m o s t noticeable as well as t h e chief effects on life companies and policyholders o f t h e g r e a t l y reduced rate o f interest earned on l i f e c o m p a n y funds.

T h e r e have been a number o f minor effects.

M o s t l i f e insurance policies contain a dividend o p t i o n p e r m i t t i n g the policyholder t o leave dividends w i t h t h e company a t i n t e r e s t ; t h e r e has been a tendency t o r e d u c e the r a t e o f interest g u a r a n t e e d by the companies on such dividends l e f t on deposit with the companies as well as t o reduce o r a l t o g e t h e r eliminate any excess o r surplus interest on such dividend deposits. T h e r e has been a tendency during m o s t o f the p a s t decade f o r investment funds to flow t o w a r d the l i f e insurance c o m p a n i e s — f u n d s which under m o r e n o r m a l conditions would not have sought the life insurance

outlet.

O n e o f t h e chief indications o f this tendency h a s been a vast increase in the amount o f single p r e m i u m insurance sold in recent y e a r s .

T h e e x t r a funds thus

flowing

into

the coffers o f the life companies reached such huge p r o p o r t i o n s t h a t in recent y e a r s the companies h a v e t a k e n successive steps to discourage and reduce the v o l u m e n o t only o f single p r e m i u m insurance but also o f o t h e r f o r m s w h e r e t h e investment element is l a r g e .

One o f the large

companies recently announced t h a t commissions on annual premium endowment policies and o t h e r high-priced policies would be reduced in o r d e r t o discourage t h e solicitation o f such business.

T h e low r a t e o f interest a t which

REDUCED INTEREST EARNINGS

93

money can currently be safely invested, low even as comp a r e d with the average rate of interest earned on the whole of the f u n d s of a life company, explains why such money flows into the life companies as well as why the companies are discouraging such business. T h e 1.6 per cent drop in the rate of interest earned by the life companies on all their funds, the fact that in many cases the interest rate earned is now less than the rate required to maintain all or part of the reserves of some companies, and the likelihood that the interest rate earned by the life companies on total funds will continue to diminish toward the substantially lower rate of interest now obtainable on new investments, naturally require us t o examine the ability of the companies to continue to meet all policy obligations. T h i s question is easy to answer in the aggregate. During the year 1940 the life insurance companies as a whole distributed 4 5 6 million dollars in policy dividends, another 18 million dollars in dividends to stockholders and added 90 million dollars to surplus, indicating total surplus earnings of 565 million dollars. Quite obviously, interest earnings could have been 565 million dollars less than what they actually were in the year 1940, without even touching the existing surplus funds of the life insurance companies. I t is clear that in the aggregate, huge margins of surplus earnings still exist to cushion and completely absorb any conceivable f u r t h e r decrease in the interest r a t e . As a m a t t e r of fact, insofar as the companies as a whole are concerned, the situation is even more comfortable than t h a t indicated in the preceding p a r a g r a p h . F r o m the table appearing in the early p a r t of this paper, you have observed that even during the recent period of extraordinarily rapid reduction in the rate of interest obtainable on new investments, it required ten years f o r

94

HUEBNER FOUNDATION LECTURES

the interest rate on total company funds to fall f r o m 5 per cent to 3.4 per cent. T h e relatively slow rate at which the interest earned on total company funds diminishes during a period of even rapidly diminishing interest rates on new investments affords the life companies plenty of time to adjust themselves to the new conditions. It is quite conceivable that, in the a g g r e g a t e , surplus earnings may be just as great in 1945 as they were in 1940, even though the rate of interest earned on total funds may continue to diminish, f o r in 1945 there will be a much smaller proportion of reserves computed on the 3 y 2 per cent basis, there will be a correspondingly larger proportion of reserves computed on the 3 per cent interest basis, and by that time there will even be an appreciable proportion of the reserves computed on an interest basis as low as 2 ] / 2 per cent. In short, the life insurance companies as a whole are so strongly fortified with annually recurring surplus earnings f r o m various sources and on top of that are so strongly fortified by existing surplus funds, that no conceivable future drop in the interest rate can in the a g g r e g a t e impair the ability of the life insurance companies to carry out their contractual obligations.

RECAPITULATION

I have no intention of attempting to recapitulate fully how the life companies and their policyholders have been affected by the drastic reduction in the interest rate; but I do want to repeat the most significant effects. T h e cost of life insurance protection has been increased. T h e companies have either increased premiums, or have reduced dividends, or both. A host of totally new problems have been thrust upon the managements of the life companies and I have attempted to delineate the divers ways in

REDUCED INTEREST EARNINGS

95

which these p r o b l e m s h a v e been solved or a r e on t h e w a y t o w a r d being solved. Nice p r o b l e m s of equity h a v e been posed and the probabilities a r e t h a t these p r o b l e m s involving equity will become m o r e serious and m o r e i m p o r t a n t d u r i n g t h e next f e w y e a r s . Finally, when it is r e m e m b e r e d t h a t d u r i n g t h e p a s t ten y e a r s the life companies have not only successfully w i t h s t o o d a d r o p in interest t o an u n p r e c e d e n t e d l y low r a t e , but h a v e also a b s o r b e d out of c u r r e n t e a r n i n g s a sizable investment loss, and when one views the p r e s e n t s t r e n g t h of t h e life insurance s t r u c t u r e as evidenced by b o t h existing surplus f u n d s and c u r r e n t surplus earnings, one is a m a z e d anew over the almost inconceivable s t r e n g t h of the life insurance s t r u c t u r e in this c o u n t r y .

SOME PROBLEMS OF LIFE INSURANCE MEDICAL SELECTION FROM PAST TO PRESENT by D o n a l d B. Cragin, M . D . Medical Director,

Aetna Life Insurance

Company

I

T is always with considerable agitation t h a t I approach a lay audience to talk on medical subjects. T h e language of medicine is in a class by itself and trying to reduce it to understandable and accurate translation does not always give happy results. H o w e v e r , it seems t h a t a little excursion into the subject of " H o w Medicine G o t Into the Insurance Business" might be of value to you in your f u t u r e work and f o r that reason an attempt will be made to give you the groundwork which has led up to the present status. MEDICAL E X A M I N A T I O N U N I M P O R T A N T I N EARLY DAYS OF LIFE INSURANCE

Insurance got along f o r quite some years without any medical aid. T h e actuaries have explained to you the composition and f u n d a m e n t a l s of their tables and how they were brought about. A t the inception of this work medicine was in a chaotic stage. Occasionally a brilliant mind m a d e some anatomical or physiological discovery which still holds but medicine per se was pretty much a mess of ignorance, superstition and charlatanism. T h e physician, the apothecary, and the barber surgeon were 96

MEDICAL SELECTION

97

all taking toll of lives with t h e most, t o us of this age, astounding or even ridiculous procedures. T h e r e was no a t t e m p t to teach in a methodical m a n n e r . Certain schools, usually h e a d e d by one keen mind, g a v e instruction to those w h o could a f f o r d the fees. N o degrees were given and a f t e r instruction each student w a s t u r n e d loose without license to practice his science or a r t or w h a t e v e r he cared t o call it. N o w o n d e r the business men and m a t h e m a t i c i a n s t o o k no heed of morbidity but paid all their attention to a t t a i n e d age a t d e a t h in relation to population. Even a f t e r the m o r t a l i t y tables were constructed, the usual procedure in E n g l a n d w a s f o r the subscriber, as t h e applicant f o r a policy was called, to sign t h e deed a n d within six months to a p p e a r b e f o r e t h r e e or m o r e trustees and have his policy a p p r o v e d and signed by the secretary in their presence. If required by t h e trustees, he h a d t o "produce a certificate of his age, and also an affidavit t h a t he h a d not any known d i s t e m p e r upon him, a n d t h a t he was in a very g o o d state of health, and the trustees should have the p o w e r to r e f u s e the person if it a p p e a r e d he w a s sickly and infirm, or did n o t produce the certificate, or t h a t in any o t h e r respect he w a s n o t qualified f o r memb e r s h i p . " I n h a b i t a n t s of certain p a r t s of E n g l a n d which were considered m a r s h y a n d unhealthy were n o t allowed to apply f o r a policy. T h i s , as you can see, w a s a sort of glorified non-medical application, since a t least the trustees, who were interested in t h e f u n d s of the company a n d the underwriting, h a d a chance to see the applicant and it was not l e f t to the discretion of an interested agent. A b o u t 1742 t h e r e were a p p a r e n t l y enough qualified doctors in practice so t h a t a certain a m o u n t of medical examination was m a d e b u t t h e system was n o t general and it was not until some t i m e - l a t e r t h a t medical blanks were devised f o r the p u r p o s e . G r a d u a l l y the system

98

HUEBNER FOUNDATION LECTURES

passed f r o m recommendation by the family physician to medical opinions of doctors chosen by the company. In the late 1700's and the early 1800's medical schools began to give correlated and orderly courses but it was well into the middle of the 1800's before the modern concept of medical teaching had taken hold and schools were organized to teach, not only by lectures and demonstrations, but by bedside instruction, coupled with pathological, histological, and chemical laboratory instruction. Virchow's cellular theory and the bacteriology of Pasteur and Koch, to name only a few, put medicine "on the m a p " and gave impetus to an undreamed of excursion into the study of the human body and mind in its utmost complexities. T h i s in turn stimulated the study of human environment, sanitation, and other public health activities. In addition to the use of the five senses, mechanical aids as well as chemical aids were brought f o r t h to assist in our investigations and diagnoses. A modern medical school's mechanical and chemical departments will rival any machine industry in the world so f a r as precision instruments and apparatus are concerned. All very well, but what bearing has all this on insurance ? T H E ASSOCIATION OF L I F E I N S U R A N C E MEDICAL DIRECTORS

Let us go back just a bit in our chronology. T h e first medical directors were probably the family physicians of the presidents of the companies or their leading stockholders, a practice not entirely dispensed with at present. T h e r e was no training period, simply because there was no one to do the training. T h e M . D . ' s judgment, shrewdness, acumen, intuition, or what-have-you was supposed to be all that was necessary. N o formal studies were made.

MEDICAL SELECTION

99

In 1 8 8 9 D r . J o h n K e a t i n g , M e d i c a l Director of the Penn M u t u a l L i f e I n s u r a n c e C o m p a n y of P h i l a d e l p h i a , g o t t o g e t h e r t w e n t y - s e v e n m e d i c a l d i r e c t o r s in the U n i o n L e a g u e C l u b of N e w Y o r k C i t y to discuss the expediency of e s t a b l i s h i n g a p e r m a n e n t o r g a n i z a t i o n of medical directors of the l i f e insurance companies of A m e r i c a . T h i s w a s in M a y . In D e c e m b e r , 1889, eighteen of the o r i g i n a l twenty-seven m e t and o r g a n i z e d the Association of L i f e Insurance M e d i c a l D i r e c t o r s , its object being the promotion of m e d i c a l science a s applied to life insurance by personal intercourse with its members, presentation of p a p e r s , etc., f o r the a d v a n c e m e n t of the g e n e r a l interests of life i n s u r a n c e . T h e first m e e t i n g w a s held in N e w Y o r k City, the only f o r m a l p a p e r being r e a d by D r . B e r n a c k i of the G e r m a n i a on "Influence on L o n g e v i t y of the U s e of L a r g e Quantities of B e e r . " F r o m then on until 1 9 0 1 the p a p e r s w e r e l a r g e l y clinical, on albumin, casts, h e a r t m u r m u r s , etc., but in the y e a r 1 9 0 1 D r . Oscar R o g e r s p r e p a r e d a p a p e r on " B u i l d as a F a c t o r Influencing L o n g e v i t y . " T h i s w a s r e a l l y the first m e d i c o - a c t u a r i a l p a p e r to be r e a d . In 1 9 1 0 M r . A r t h u r H u n t e r proposed a medico-actuarial i n v e s t i g a t i o n which w a s u n d e r t a k e n and published in 1912 as the M e d i c o - A c t u a r i a l M o r t a l i t y I n v e s t i g a t i o n .

MEDICO-ACTUARIAL

COOPERATION

F r o m t h a t t i m e on the a c t u a r i e s a n d medical men h a v e gone h a n d in h a n d and a number of studies h a v e been m a d e w h i c h enable us to u n d e r w r i t e s u b s t a n d a r d cases which h i t h e r t o w e w o u l d h a v e d r e a m e d impossible. T h i s h a s been a fine t h i n g f o r both a g e n t s and companies, to s a y nothing of t h e p o p u l a t i o n at l a r g e . T h e w a y the s y s t e m w o r k s is, briefly, as f o l l o w s : A certain i m p a i r m e n t is up f o r i n v e s t i g a t i o n . A number of

100

HUEBNER F O U N D A T I O N LECTURES

the larger companies are asked to contribute their experience. T h i s aggregate is taken by the actuaries and divided into homogeneous groups as f a r as possible. These groups are divided into the number exposed to the risk, both s t a n d a r d and -substandard, the actual deaths and the expected deaths. F r o m these data the ratio of actual to expected is obtained. T h e material is f u r t h e r broken up into two groups, by policy years, and by age at issue, and treated as above—i.e., exposed t o risk, actual deaths, expected deaths, and the ratio. Finally the number of deaths is given f o r the principal causes in the groups studied and the average age at entry. F r o m these studies the expected mortality in percentage is shown and the ratio can be made to fit. T h e answers have been, at times, a bit startling and in one or two cases have not proven accurate, but, on the whole, if studied with due care and in view of clinical facts, they do very well although they are constantly changing as medicine progresses. M E C H A N I C A L AIDS I N S E L E C T I O N OF RISKS

I spoke a while back of mechanical devices as aiding in insurance underwriting. Probably the second hand of a watch was the first one ( 1 5 0 0 ) , enabling accurate pulse counts. T h e stethoscope and its modification ( 1 8 1 9 ) is another device which allows us to diagnose accurately heart murmurs and various lung conditions. W i t h the addition of electrical appliances the stethoscope has become a wonder machine, amplifying or diminishing sound at the o p e r a t o r ' s will and allowing anywhere f r o m a small number to a r o o m f u l of people to hear simultaneously the h e a r t action, hreath sounds, friction rubs, or whatever is under consideration; and, with the damping of extraneous sound, simultaneous graphic records can be

MEDICAL SELECTION

101

m a d e which show t h e pulse r a t e , the e l e c t r o c a r d i o g r a m tracing, the r e s p i r a t i o n r a t e and any h e a r t m u r m u r s which may be p r e s e n t . T h i s shows the relation of the m u r m u r to the two h e a r t sounds and is quite valuable in picking up t h e elusive presystolic m u r m u r . T h e r e a r e still refinements to be m a d e but they will come in time. A t this point let me illustrate how much tuberculosis u n d e r w r i t i n g is d e p e n d e n t upon mechanical aids. The tape measure, the scales, the stethoscope, and the X-ray are all used to obtain height, weight, chest expansion, and signs of old processes or active ones. T h e findings of these are checked by a p h o t o g r a p h of the lung area and a microscopic study of any bacteria present. W i t h the evidence thus f u r n i s h e d we can do a p r e t t y accurate job of estimating the applicant's longevity. T h e only o t h e r device needed is a calendar to compute the age. T h i s is a f a r cry f r o m the day when my own company p r o m p t l y rejected any person w h o h a d a family history of tuberculosis. T h e day when any h e a r t m u r m u r case was rejected is not so r e m o t e . T h e classification of m u r m u r s into functional and organic is always a m o o t point a m o n g the clinicians but we in the medical end of the insurance business can do some very close u n d e r w r i t i n g on five f a c t o r s ; namely, the location of the m u r m u r , i.e., which v a l v e ; the time, systolic or diastolic; if t r a n s m i t t e d , in which direction; d e g r e e of any e n l a r g e m e n t ( h y p e r t r o p h y ) ; and any history of p a s t r h e u m a t i s m or o t h e r infectious disease. W h e n t h e r e is irregularity, we b r i n g the electrocardiog r a p h into the picture. T h i s is an instrument which gives a graphic record of the electrical impulses created by contraction of the h e a r t muscle; also the r a t e and steadiness of the b e a t . A n y d a m a g e to h e a r t muscle along the line of current is shown on the g r a m . But alas, the electro-

102

HUEBNER FOUNDATION LECTURES

c a r d i o g r a p h is fallible f o r it gives the condition only at the time of the sitting. M a n y a person who has h a d a severe coronary attack can show what is considered a normal g r a m ; but on the irregularities of pulse, the electrocardiogram shows accurately what and where they are. By its use many an applicant has received s t a n d a r d insurance where formerly he would have been rated. LABORATORY AIDS IN R I S K S E L E C T I O N

Another valuable addition to our armamentarium is the sugar tolerance test. B e f o r e diabetes became a household word, specimens of urine containing sugar were looked upon askance and several specimens were necessary b e f o r e any underwriting could be done. T h i s was a most inaccurate, hit-or-miss method and the mortality, in at least one company, was most unsatisfactory. T h e n studies were m a d e of the sugar content of the blood and it was soon found that certain criteria could be quite definitely stated f o r what might be called a normal fasting blood sugar, and that by plotting a curve f r o m postprandial specimens of one-half, one, two, three, and four hours, a positive or negative diagnosis could be made. T h e sugar tolerance test also picks up a class called potential diabetics and, most interesting of all, the renal or alimentary glycosurias, in which, although sugar may be present in the urine, the blood sugar is normal and the presence of urinary s u g a r is thought to be harmless. M a n y a renal glycosuria has been m a d e miserable by unjustified treatment. W i t h simplification of methods and especially the Folin M i c r o method of chemical analysis, we can disturb the applicant very little with our sugar tolerance test, only two blood specimens being n e e d e d — a f a s t i n g and a postprandial at one and one-half hours. T h i s , I hasten to add, is my own company's prac-

MEDICAL SELECTION

103

tice, now in its f o u r t e e n t h year of use. O u r m o r t a l i t y has been very f a v o r a b l e so f a r , a f t e r f o u r t e e n years of experience. T h e albumins a r e always interesting. Albumin per se at the younger ages is not very serious but when it is combined with either casts, cellular elements, blood, epithelium, low or high specific gravity, high blood pressure, overweight, past history of nephritis or renal colic, either singly or in combination, the picture changes entirely and sometimes all our resources of various chemical, X-ray, and microscopical examinations are b r o u g h t into play. W e not infrequently require exhaustive studies b e f o r e clearance can be m a d e . W h e n one gets into the anatomy of the kidney and realizes t h a t t h e r e are forty-five miles of renal tubules, to say nothing of a considerable number of miles ( e i g h t e e n ? ) in the male generative organs, it is no w o n d e r t h a t an occasional pus or r e d blood cell is h a r d to place. In passing, it is a m a t t e r of fact t h a t the average n o r m a l person has about two-thirds m o r e kidney tissue t h a n he can possibly use. In o t h e r words, if the kidney tissue w o r k e d twenty-four h o u r s a day at full capacity, it could filter about 1700 liters of fluid instead of the n o r m a l 1500 c.c. T h i s accounts f o r the fact t h a t a slow invasion of kidney tissue, such as is seen in chronic interstitial nephritis, may go on f o r a number of years with the patient living in c o m p a r a t i v e c o m f o r t if there are no acute episodes. W i t h the a d v e n t of research l a b o r a t o r i e s in the various Industries we are now running into new occupational diseases and h a z a r d s . In my own company we have been experimenting f o r t h r e e years with the detection of metallic elements by the use of the s p e c t r o g r a p h . W i t h this equipment, the b e a m of light caused by the burning of any metallic substance can be b r o k e n up into lines, each one representing a certain element, and a p h o t o g r a p h m a d e

104

HUEBNER FOUNDATION LECTURES

of these lines; thus not only positively identifying the element but giving a graphic record of the same. By certain mathematical formulae concerned with the density of the line, the amount of metallic element present can be expressed as a decimal and carried even to the fifth point. Fluids containing metals in solution can also be graphed by a method called "absorption," the ray of light being intercepted by the color of the fluid, thus reducing or extinguishing some of the rays before the light reaches the spectrum. T h i s method is very valuable in picking up the hemoglobin pigments which have to do with the different anemias or in studying carbon monoxide poisoning—a most interesting project. T h e value of the X-ray is well known to you all in diagnosing tuberculosis, not only of the lungs, but of the bones. I t likewise aids in ascertaining the size of the heart, the presence of gall stones, kidney stones, bladder stones (not infallible) and in the diagnosis of ulcer (peptic and intestinal) as well as obstructions, diverticuli, cancer, etc. I t is also useful in fractures, sinus disease, cancer of the bone, etc. T h e study of blood pressure is a comparatively recent innovation and has been subject to various insurance investigations since 1919 when Rogers and H u n t e r gave a brief analysis of 62,000 readings. T h e only trouble about reaching conclusions as to blood pressure is in getting a homogeneous group. In one investigation of data furnished by thirty-two companies there were eighteen different directions f o r taking pressure. However, since then an article has been published in the Journal of the American Medical Association (July 22, 1939) on a standard method of taking pressure. W e are demanding that for insurance work this method shall be used and as the years pass we shall be able to obtain f a r more accurate data than ever before

MEDICAL SELECTION

105

by adhering to this method. Blood pressure is a variable f a c t o r and it reacts to various forms of external and internal stimulation, such as emotion, food intake, etc. F o r general purposes any group of systolics of 140 or over, no m a t t e r what the age, is to be regarded as eventually showing an increased mortality; likewise, diastolic readings of 85 or over indicate higher mortality. T h i s brief outline will give you some idea of the way in which medicine got into the insurance business and its value in selection. Certain changes will occur as new methods and instruments are brought into the field. W e must be prepared to accept them readily and be on the alert to see their application to our needs.

CONTEMPLATED CHANGES IN MORTALITY TABLES, RESERVE BASES AND NON-FORFEITURE VALUES by

E d w a r d E . Rhodes Fice-President,

The Mutual

Benefit

Life Insurance

Company

I

N what I say tonight regarding the subject which has been assigned to me, I shall confine my remarks to the business of mutual life insurance, primarily, because I know more about it than other forms of life insurance, but also because a very large proportion of the life insurance business is conducted upon the mutual plan. I suppose you are all more or less familiar with the concept t h a t a mutual life insurance company is a copartnership in which the policyholders, who are the members of the company, furnish the required capital through the payment of their premiums. T h e premiums are necessarily computed on a redundant basis in order to make a company safe beyond peradventure. F o r many years past, the companies have used the American Experience T a b l e of M o r t a l i t y f o r the computation of premiums and reserves. Non-forfeiture values have also been based thereon. T h e American Experience T a b l e of M o r t a l i t y , which was compiled in the sixties, does not set f o r t h the death rates which now prevail or which have prevailed f o r several years p a s t ; in fact, it cannot be said to measure the death rate among insured lives when it was compiled. 106

RESERVES AND VALUES

107

M I S C O N C E P T I O N S AS TO E F F E C T S O F USING A M E R I C A N E X P E R I E N C E T A B L E OF MORTALITY

Because companies have calculated premiums and reserves upon the American Experience Table, which shows higher death rates than those realized, t^iey have been quite severely criticized by men who do not have a clear conception of the subject. It has been said t h a t by the use of the American Experience T a b l e premiums are higher than they need to be and that unnecessary reserves are accumulated. T w o facts completely r e f u t e this charge. One is that the cost of insurance is determined by actual experience and not by the assumptions used in the computation of premiums. T h e other is that if a more modern table of mortality were adopted showing lower death rates at the lower ages than those shown in the American Experience Table, higher reserves on premium paying policies rather than lower would be accumulated. U p to the present time there have been three sources of redundancy in the calculation of premiums—a redundancy arising f r o m the use of a mortality table showing higher death rates than those generally experienced, a redundancy arising f r o m the fact t h a t a lower rate of interest than that expected to be earned is assumed f o r the calculation of premiums and reserves, and a redundancy arising f r o m the fact that the provision f o r t h a t p a r t of the premium which is intended to meet expenses and contingencies is larger than that normally required. W i t h the proposal to depart f r o m the old American Experience T a b l e and to adopt a table conforming more closely to the death rates now prevailing, the companies would lose to a very large degree the redundancy in the premiums arising f r o m the use of a mortality table showing a higher death rate than that which is actually experi-

108

HUEBNER FOUNDATION LECTURES

enced. W i t h the decline in interest rates to a point approaching that required to maintain the policy reserves, t h a t particular measure of redundancy is being lost to a large extent. W i t h the proposal to adopt a modern table of mortality, and the compulsion to adopt a lower interest rate f o r the calculation of premiums and reserves, the companies are faced with a rather serious problem. Notwithstanding the fact that the American Experience T a b l e is f a r f r o m accurately representing the death rate t h a t has been and is being experienced, it has served its purpose splendidly. As I have said above, its use has not increased in any degree the cost of insurance, nor would the use of a modern table reduce the cost of insurance. F o r all practical purposes, an empirical table would serve the purpose of the business quite as well as another table produced by scientific means. T A B L E S BASED ON MORE R E C E N T MORTALITY EXPERIENCE

In 1911 the National Association of Insurance Commissioners (then known as the National Convention of Insurance Commissioners) suggested that the Actuarial Society of America construct a new mortality table covering the general experience of the companies among normal lives. At that time the Society was engaged in the Medico-Actuarial M o r t a l i t y Investigation, the results of which were a f t e r w a r d s published in five volumes. A t about the time of the completion of this work in 1914' the Insurance Commissioners again requested the Actuarial Society to compile a new table. T h e work was promptly undertaken and the results were published in 1918. A committee of actuaries of state insurance dep a r t m e n t s and a committee of the American Institute of Actuaries cooperated with the committee of the Actuarial

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Society. T h e new table is known as the American M e n Ultimate T a b l e o f M o r t a l i t y . Death rates shown therein at the lower ages are considerably under those o f the American Experience T a b l e . F o r one reason or another, the new table did not come into general use. In 1937 the then president of the National Association of Insurance Commissioners delivered an address entitled, " S o m e Observations on the Need for a N e w M o r t a l i t y T a b l e . " Following this address, the Association appointed a committee consisting of actuaries o f state insurance departments and representatives o f the Actuarial Society and the American Institute of Actuaries. T h i s committee made its final report in J u n e , 1 9 3 9 . I t recommended changes in the valuation laws of the several states which would facilitate the adoption of modern mortality tables. I t constructed an empirical table representative of modern mortality among insured lives but it did not recommend this table for the computation of premiums and reserves. T h e table differed materially from the American Men Ultimate T a b l e and much more materially from the American Experience Table. A t the meeting o f the National Association of Insurance Commissioners at which the committee to study the need for a new mortality table made its final report, it was authorized to study non-forfeiture benefits and related matters. T h e final report thereof was made in September, 1 9 4 1 . T h e committee prepared and made a part of its report a new mortality table which was given the name of "Commissioners 1 9 4 1 Standard Ordinary M o r t a l i t y T a b l e . " T h e new table was based primarily upon data compiled by the J o i n t Committee on M o r t a l i t y of the Actuarial Society o f America and the Association of L i f e

110

HUEBNER FOUNDATION LECTURES

Insurance M e d i c a l Directors, and published from time to time in the Transactions of the Actuarial Society. T h e death rates shown in the Commissioners Table for ages below thirty-eight were generally under those shown in the American M e n T a b l e . For older ages there was no material difference. T h e committee did not recommend that the Commissioners Table be used to the exclusion of other tables which were representative of modern mortality. C U R R E N T T R E N D S IN T H E B A S E S FOR C O M P U T I N G P R E M I U M S A N D RESERVES

I have referred to the decline in the rate of interest earned upon the investments of the companies. One needs more imagination than I have to predict the future rate, but I think it may reasonably be expected that the law of supply and demand, which normally controls the interest rate, will have little effect upon it for some years to come. W i t h the beginning of the present century, companies which had been using a rate of 4 per cent for the calculation of premiums and reserves adopted, quite generally, a rate of 3 per cent or 2>y2 per cent for policies thereafter issued. I think that another change is now imminent, and I shall not be surprised if, in the not distant future, companies adopt a lower rate than 3 per cent. It may be that some companies will go as low as 2 per cent. W i t h the change in the rate of interest used for the computation of premiums and reserves, it will not be surprising if a number of companies adopt a more modern table of mortality than the American Experience Table, and I think the trend will be toward the American M e n Table.

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111

PROBABLE EFFECTS OF C U R R E N T TRENDS

T h e " n e t " p r e m i u m s computed according to the A m e r ican M e n T a b l e without any provision f o r expenses or contingencies will be less at the lower ages than those computed according to the American Experience T a b l e . Policy reserves, however, will be higher in the a g g r e g a t e , assuming t h a t in both instances the same r a t e of interest be used. T h e adoption, however, of a lower r a t e of interest f o r the computation of p r e m i u m s and reserves by the American M e n T a b l e t h a n is used f o r like computations by the American Experience T a b l e will have the effect of increasing the reserves, and I might say t h a t a change in the interest r a t e f r o m 3 per cent to 2y 2 per cent or 2 per cent will have m o r e effect upon the reserves which the companies will hold t h a n a change in the mortality table. I have said t h a t in adopting a m o r t a l i t y table which was m o r e nearly representative of current d e a t h rates than the A m e r i c a n Experience T a b l e , the companies would lose in considerable measure the redundancy in the premium rates now used. In a d o p t i n g a lower interest r a t e some small p a r t of this redundancy would be regained. In o r d e r t h a t the gross p r e m i u m s m i g h t suffice f o r all purposes, the provision therein f o r expenses and contingencies would have to be very carefully considered. I think it would be reasonable to expect t h a t the tables of rates which will be a d o p t e d in connection with the changes I have discussed will n o t differ very materially f r o m the tables now in use. If a lower m o r t a l i t y table and a lower interest r a t e than those now in use be a d o p t e d , t h e r e will be a change in the incidence of the cost of life insurance. In the early policy years the cost would be heavier while in later y e a r s it would be lighter. T h i s would be

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HUEBNER FOUNDATION LECTURES

primarily due to the larger margins of interest upon the higher reserve. In the long run the cost would be about the same, other conditions being equal. T h e r e would be no real point to the argument that a man should insure his life b e f o r e the change took effect in order to get his insurance at a lower net cost. T h e real cost is determined by the actual earnings and not by the assumptions used in the computation of premiums and reserves. T W O C O N C E P T S OF N O N - F O R F E I T U R E V A L U E S

W h e n we come to the question of non-forfeiture values, we find there are two schools of thought that are widely different. One school holds that the reserves accumulated under individual policies are not true reserves. It is said t h a t the reserve that should be held for one policy should approximate the face value of the insurance because the insured is about to die, and that the reserve f o r another policy on the life of a man who is extremely vigorous should be less than the tabular reserve computed by the mortality table. I am f r a n k to say that I do not agree with t h a t view. T h e business of life insurance is a business of averages. T h o s e who are of a certain age and who come in at the same time and f o r the same f o r m of insurance constitute a class. T h e y enter the company upon the same footing, and the status of the individual members of the class should not be t h e r e a f t e r changed. I do not need to remind this group t h a t under the level premium plan of insurance the net premium is larger than t h a t required to provide the insurance in the early years, while in the later years it is less than that required. I t is this excess premium paid in the early years which is used to accumulate a reserve, the interest upon which, when added to the net premium, will suffice to pay for the insurance in the later years. In other words, the reserve

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can be said to represent unearned premiums. T h e premiums being the same f o r each member of the group, it would seem that the reserve must be the same f o r each member. I t has been held by the courts that if a mutual company be liquidated, each policyholder's interest in the assets available f o r distribution a f t e r the claims of creditors have been satisfied would be represented by the proportion which the tabular reserve on his policy was of the total tabular reserve. I t would seem t h a t the equitable principle which governs the interest of a policyholder in case of liquidation is applicable if a policy be surrendered. T h e argument that average reserves are not the true reserves for individual policies does not carry with it the implication that there should be any difference in the surrender value of policies in the same group. T h e argument is made primarily f o r the purpose of establishing surrender values which are not based upon the accumulated reserve. T h e r e are many actuaries who hold that surrender values should be based upon what are known as "asset shares." T h e s e are based upon an estimate of the funds pertaining to a particular group of policies a f t e r crediting t h e r e t o the premiums paid less the outgo in connection therewith f o r policy claims and other disbursements. T h e balance is accumulated yearly at an assumed r a t e of interest. In determining the value of the fund, consideration is sometimes given to a deduction t h e r e f r o m f o r the purpose of maintaining contingency reserves. T h e r e is no element of the fund which is based upon fact. In determining, f o r example, what premiums will be received, an assumed rate of persistency must be used. I very seriously doubt whether any asset shares, even

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HUEBNER F O U N D A T I O N LECTURES

when constructed by the most conservative actuary, h a v e held good f o r any material length of time. ALLOCATION OF OPERATING EXPENSES RELATED TO NON-FORFEITURE VALUE CONCEPT

In the m a t t e r of assessing the expenses of operation, particularly with r e g a r d to acquisition costs, there are p e r h a p s as many views as there are actuaries. Advocates of asset shares hold that each group should pay its own way. One difficulty with this view is that, even in the largest company, no group is sufficiently large to enable the law of averages to work. T h e r e are undoubtedly groups in every company which, because of early death claims in excess of those expected, have been and may always be in the red. T o hold that each group shall be independent of all other groups is, in effect, to establish several little companies within a company.* It is needless to say t h a t in practice the theory is not fully carried out. Old policyholders have a financial interest in the new policies which are put on the books. As life insurance is now conducted, the first year's premium is not sufficient to pay the expense of acquisition and the expense of management, together with the death claims that accrue the first year, and also to set up the policy reserve required by law. T h e r e are those who say t h a t the deficit should be charged to the reserve and that this deficit in the reserve should be m a d e up out of the company's surplus. I do not think t h a t is the correct view. T h e reserve is t h a t p a r t of the net premium which is held back, improved with interest and not used to pay death claims. T h e required reserve is intact the minute the policy is issued and the first premium paid thereon. It is the acquisition costs in excess of those provided for in the premium which are met out of the surplus. T h i s surplus,

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115

of course, has been accumulated by policyholders of earlier times. They invest a p a r t of the surplus in new business and they are justified in doing so within proper limits. T h i s investment must be considered in determining both non-forfeiture values and the allocation of surplus in the f o r m of dividends. As an investment, it may prove to be profitable or it may prove to be unprofitable. If it be unprofitable, new business has been acquired at too high a cost. T h e allowance of non-forfeiture values is purely a question of equity, and equity should prevail regardless of its cost. In determining what is equitable, the interest of both old and new policyholders should be considered. A policyholder having entered a company, secures the advantages arising f r o m the successful conduct of the company's affairs over a long period of years, and should not be permitted to sever his membership under conditions which would leave the company in a weaker situation than it was when he entered it. T h e view has been entertained at times that as a rule the policyholders who terminate their insurance are generally in better health than those who continue to be members, and that, therefore, a company suffers a loss by reason of their withdrawal. I do not think that much weight is given to this view at the present time. One might argue that a policyholder, having paid f o r insurance, should be given as much insurance as he has paid f o r and that there is no obligation resting upon the company to pay a cash surrender value. H o w e v e r that may be, such values have become an established feature of the business. T h e y are now required by law and were granted by several companies b e f o r e there was any statutory requirement. T h e laws of several states require that non-forfeiture values be allowed either in the f o r m of cash or of paid-up

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or extended insurance beginning at the end of the third policy year. T h e formula f o r determining the minimum values is a simple one and the companies generally have been able to comply with the real legal requirement a n d d r a f t their policy forms in a manner that is easily understood. T h e chief objection to the non-forfeiture laws of many states is that the values allowed in the f o r m of cash or of insurance must be mathematically equivalent. Experience has shown that the value allowed in the f o r m of extended or term insurance should have a smaller present value than the cash value. T h i s is because of the adverse selection manifested by those policyholders who avail themselves of the extended insurance option. T h e companies generally allow larger values than those prescribed by law, and, so f a r as I know, there is no complaint that the values allowed are illiberal. R E C O M M E N D A T I O N S OF I N S U R A N C E

COMMISSIONERS

C O M M I T T E E ON N O N - F O R F E I T U R E B E N E F I T S

I have r e f e r r e d to the committee of the National Association of Insurance Commissioners appointed to study non-forfeiture benefits, the final report of which was made in September, 1941. T h e report is contained in a pamphlet of more than two hundred pages. T h e chief conclusion of the committee was that nonf o r f e i t u r e values should be based upon "asset shares" r a t h e r than upon the statutory reserve. In pursuance thereof, it devised an entirely new formula f o r the determination of non-forfeiture benefits. T h i s formula would provide minimum values in excess of the minimum values now required, but it does not appear that the allowance of values determined by the committee's formula would be burdensome upon any company. T h e chief objection t h a t may be raised thereto is that the formula is so com-

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117

plicated t h a t it cannot be embodied in t h e policy contract in l a n g u a g e which would be intelligible to anyone w h o was not an actuary. T h e committee suggests t h a t the value of each n o n - f o r f e i t u r e benefit can be expressed in the policy " a s the difference between t h e p r e s e n t value of the benefit and the present value of a p e r c e n t a g e of the gross p r e m i u m s . " T h e suggested language does not, in my opinion, m e e t the requirements of a policy of life insurance. The reference to the present value of the benefits is particularly objectionable. T h e r e has not been, so f a r as I know, any judicial construction of the m e a n i n g of those words, and I think there is considerable d a n g e r in the use thereof. T h e r e p o r t of the committee was r e f e r r e d to a specially appointed committee of the Commissioners f o r its consideration. W h a t action will finally be taken t h e r e o n by the N a t i o n a l Association of Insurance Commissioners is unknown at this time. 1 M a n y of the r e c o m m e n d a t i o n s will require special legislation. W h a t e v e r may be the outcome, the public may be assured t h a t life insurance will continue to be sold on f a i r and equitable t e r m s . 1 EDITOR'S NOTE:—Mr. Rhodes prepared this address prior to the meeting of the National Association of Insurance Commissioners on December 1, 1942, w h e n the Model Bill providing for reserve valuation and nonforfeiture benefits was adopted.

COMPARATIVE NET COST FACTORS IN ORDINARY, GROUP AND INDUSTRIAL INSURANCE by Valentine Howell Vice-President

and Actuary,

The Prudential of A m erica

Insurance

Company

I

T will be obvious to an unprejudiced group of people such as this t h a t the relative net cost of these three kinds of life insurance is wholly dependent upon the nature of the coverage furnished. Each stands on its own feet, and in a company furnishing all three, all accounting items are completely segregated. Neither is one division o p e r a t e d on a more extravagant basis than any other, the policy being so to operate the company that it might be able to continue in business with a minimum of disturbance if any of the divisions were completely eliminated. W h i l e many companies write ordinary business only, practically all companies writing industrial write ordinary as well; and group also is invariably accompanied by ordinary. Finally, the three largest industrial companies write all three lines. T h e point is, that the comparative f a c t o r is always present. I assume that my present audience is already familiar with the characteristics of these three types of insurance and hence that it will not be necessary to describe them. I will confine myself, t h e r e f o r e , to questions relating to their net costs. BASES OF N E T COSTS

As you doubtless know, the net cost of any kind of life insurance is dependent upon the rate of mortality actually 118

COMPARATIVE NET COST

119

experienced (and sometimes the rate of disability and of death by accident) ; the rate of interest earned, including, for convenience, capital losses or gains from investments; possible profits from terminations; and the rate of expense incurred, the principal expense items being agency expenses and commissions (both first year and renewal), expenses of operations of the home office, and taxes. While I propose to deal almost exclusively with participating insurance, this might be a good place to mention that these factors are of just as much importance in the case of non-participating policies, where they must be estimated in advance when the premium rates are calculated. Here, if the estimates made are too sanguine, the company will meet any resulting deficit, in excess of the safety margin in the premium rates, from stockholders' surplus or dividends, or from gains in other more profitable sections of the business. Obviously, all of the above net cost factors are common to each of the three lines of business under discussion. But, because of the extremely diverse nature of the three types of coverage, there is a wide variation in their relative importance. Mortality.—The mortality rate (analyzed, of course, by age and duration after examination) tends to be more uniform among the various ordinary companies than is generally realized. One evidence of this is the relatively favorable mortality that the large industrial companies experience on their ordinary business, which is written on many of the same individuals who also buy industrial insurance. ( I t is, however, slightly higher than the average of all purely ordinary companies.) Companies operating largely in the rural sections of the country, particularly in the Middle W e s t and in Canada, have an advantage in mortality. T h e mortality on policies for large amounts became markedly unfavorable shortly be-

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f o r e the onset of the depression, so t h a t companies specializing in this type of business suffered accordingly, but this excess mortality has now largely disappeared. Business submitted by brokers (not full-time employees of any one company) has been thought to carry a higher mortality, possibly because brokers tend to submit relatively more of the large policies. Commencing at the time of the last war, the practice was instituted of writing some of the smaller policies without medical examination. T i m e has shown that this business is subject to a definitely higher mortality in the early years a f t e r issue. T h i s extra mortality is much more m a r k e d among older applicants, beginning at about age 35, and enough is now known about the subject to enable the companies to weigh the extra mortality against the medical fee saved and hence to determine the proper amount and age limitations. A n o t h e r special case is t h a t in which a considerable proportion of policyholders (presumably in good health) terminate their policies in a company whose reputation is impaired. As might be expected, the mortality of the remaining lives is higher than average. T o repeat, however, the remarkable f e a t u r e of ordinary insurance mortality is its uniformity among companies. In general, mortality shows at the present time no slackening in its tendency to improve year by year. T h e effect of the widespread use of insulin and of the modern methods of treatment of pneumonia is evident at the older ages. In most companies, the mortality profit has now become, if not the sole, at least by f a r the most important source of policy dividends. Disability.—Court decisions have held that the total and permanent disability clause (also the benefit in event of death by accident), where a p a r t of the contract, is participating in its nature. Gains and losses consequently

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121

e n t e r into t h e policy d i v i d e n d a n d m o d i f y it as c o m p a r e d t o the dividend on a similar policy w i t h o u t such special clauses. Some c o m p a n i e s h a v e t h e r e f o r e seen fit t o diff e r e n t i a t e in their d i v i d e n d scale b e t w e e n policies w i t h a n d w i t h o u t these benefits. T h e disability benefit h a s been r e f e r r e d to as " t h e a c t u a r y ' s m i s t a k e . " If I t h o u g h t t h a t t h a t was his only m i s t a k e my self-esteem would g o up several p o i n t s ; h o w e v e r , I a m p r e p a r e d t o a d m i t t h a t the subject h a s p r o v i d e d the a c t u a r y with some p a i n f u l education, which education, in my p e r s o n a l belief, will be sufficient t o perm i t the companies some d a y t o re-enter the disability income field. T h e p o i n t h e r e is, t h a t in a l m o s t all cases the premiums charged have proven inadequate and the disability " f a c t o r " h a s been negative, o p e r a t i n g to reduce t h e policy dividend a t the p r e s e n t time by an a v e r a g e of m o r e t h a n $2.SO per t h o u s a n d . Interest.—Interest a n d i n v e s t m e n t r e t u r n s h a v e , on t h e whole, shown m o r e v a r i a t i o n s a m o n g c o m p a n i e s t h a n an insider would h a v e expected ten y e a r s o r so a g o . D e c r e a s e s in interest r e t u r n s h a v e p r o v e n to be of much m o r e i m p o r t a n c e t h a n i n v e s t m e n t losses, a l t h o u g h t h e l a t t e r a r e still being i n c u r r e d by t h e companies. The p r i m a r y reason f o r t h e differing r a t e s of r e t u r n is, of course, the composition of t h e assets. O t h e r f a c t o r s a r e t h e size of the company, t h e v i g o r with which i m p a i r e d assets h a v e been w r i t t e n d o w n , a n d t h e c o n s e r v a t i s m of t h e c o m p a n y ' s investment policy p r i o r t o 1930. W i t h respect t o m o r t g a g e s , an obvious c o m p a r i s o n is the a m o u n t of real e s t a t e held ( o t h e r t h a n h o m e office p r o p e r t i e s ) r e l a t e d t o t h e size of the m o r t g a g e l o a n account, and t h e r a t e of r e t u r n on such real e s t a t e . A high p e r c e n t a g e of r e a l e s t a t e o w n e d indicates, of course, e i t h e r t h a t t h e c o m p a n y ' s loans h a v e n o t been m a d e on a conservative basis, o r t h a t t h e r e h a v e been f e w new

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m o r t g a g e s acquired since 1930, o r b o t h . N e w m o r t g a g e s m a d e since 1930 h a v e been, on the whole, the m o s t profitable type of investment f o r the companies, so t h a t a company with a vigorous m o r t g a g e loan o r g a n i z a t i o n is advantageously situated. T a k e n in b r o a d groups, a n d with exceptions in the case of individual companies, m o s t m o r t g a g e loans h a v e p r o v e n t o be satisfactory investments. Such g r o u p s r a n k as t o desirability in about the following o r d e r : ( 1 ) F a r m loans m a d e on a conservative basis on f a r m s in f a v o r a b l e locations. ( 2 ) A p a r t m e n t house loans and those on twofamily dwellings. ( 3 ) L o a n s on single family dwellings (largely because of the a t t r a c t i v e r a t e s at which the loans were originally m a d e ) . ( 4 ) L o a n s on business and mercantile properties. ( 5 ) F a r m loans in m a r g i n a l areas. ( 6 ) A small g r o u p of loans m a d e on clubs and places of amusement. I n relating the r a t e of loss on m o r t g a g e s with t h a t on bonds, the much higher r a t e of interest obtained on the m o r t g a g e s , and the consequent higher r a t e of return even a f t e r deducting the expense of securing and administering t h e loans, should be taken into account. T h e situation of the bond account is intimately related t o the p r o p o r t i o n of r a i l r o a d bonds entering into its composition, a l t h o u g h this is no longer quite as i m p o r t a n t a consideration as it was p r i o r to recent improvement in t h e earnings of the r a i l r o a d s . F r o m the viewpoint of r a t e of r e t u r n , the a m o u n t of G o v e r n m e n t bonds (particularly those of s h o r t t e r m ) a n d cash in banks is important, as a high p r o p o r t i o n of assets in these categories indicates a lack of aggression in the company's investment

COMPARATIVE NET COST

123

policy. Over the past few years, all companies have had extreme difficulty in finding suitable investments. T h i s is one factor entering into net cost, in which a well-managed, small or medium-sized company tends to have a definite advantage over a larger one. Over all, the amount of interest earned in excess of that required for the accumulation of reserves has been reduced to a very small fraction of that available twelve years ago. It has been estimated that, in the aggregate, the gains from interest available for dividends have been reduced by about two and one-half billion dollars over the period, as compared with the situation if interest rates had remained at 1930 levels. Gains from Terminations.—Normally, the termination of a policy results in a very slight profit to the company, although a surrender value granted at a time of financial stringency, or when interest rates on new investments are high, may result in a loss. But the amount of the gain or loss cannot be computed as the difference between the value granted and the reserve liability on the policy which is released on termination, since the reserve released is determined by statute and bears no necessary relation to the contribution to surplus built up on the surrendering policy, the rate of growth of which is retarded by the higher initial expense. Profits f r o m terminations are not, as a rule, an appreciable factor in net cost. Expense.—An economical, expense-minded administration, coupled with a relatively small group of aggressive, well-trained salesmen, each of whom makes a good income f r o m a large volume of sales on a relatively low commission basis, is a combination that goes a long way towards securing a low net cost f o r any company. It must be admitted t h a t there is a considerable difference among companies in this respect. Theoretically, the larger companies should have the advantage, as certain

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HUEBNER FOUNDATION LECTURES

economies of operation are possible merely because of size, and it is in many cases easier to attract successful salesmen because, since the company is well known, time need not be spent satisfying the prospect that it is the right company to insure in. On the other hand, some medium-sized companies are outstandingly well managed as respects economy, and are very favorably known t o the public. T h e r e is also probably a point when f u r t h e r increase in size brings no added efficiency of operation. As"far as agency costs are concerned, while it is true that the soundest way to secure new business is on the basis of low net cost and good reputation, the more effective means ( f r o m the viewpoint of rate of g r o w t h ) is undoubtedly to bring in many new salesmen on attractive terms, so that the management may be tempted to sacrifice net cost to growth. Over the past few years, expenses have shown a tendency to increase somewhat, and this trend will probably continue f o r some years in the future. In the case of one large company, ordinary expense rates, considered as a percentage of the premiums, were approximately as follows f o r the year 1940: Commissions, and agency supervision Other expenses except investment expenses Taxes, other than those charged to investments.... Total, per cent of premiums

7.4% 5.4 2.3 15.1%

" O t h e r " expenses are mainly expenses of administration at the home office. Of the 15.1 per cent total expense rate, approximately 5.0 per cent was f o r first year and 10.1 per cent was f o r renewal expense. But note that the 5 per cent " n e w " expenses are in relation to all premiums, new and renewal. New expenses, of course, are a very much higher percentage of new premiums.

COMPARATIVE NET COST

125

Because the companies charge varying scales of participating premiums, an expense comparison of one company with another on a premium percentage basis is misleading. T h e r e is available in published f o r m a comparison of renewal expense rates. Renewal expenses, obtained by making certain assumptions as to the incidence of first year expenses, are here expressed as so many dollars per thousand of insurance in force. In order to show the present variation in expense, twelve of the better known companies were picked at random and tabulated in the table given below. A B C D E F G H I J K L Average

$2.64 2.95 3.00 3.05 3.09 3.19 3.38 3.55 3.78 3.80 3.86 4.23 $3.38

Savings Bank Life Insurance.—It is mainly in connection with this matter of expense that savings bank life insurance finds its justification for existence. N o commissions are paid, hence it may legitimately be claimed that savings bank insurance is cheaper by about the percentage of premium applicable to commission payments. Other expenses may be less also, as certain clerical and supervisory work can be done by the bank without adding to its staff, but this is a temporary condition only, since eventually, as the business gets to be more extensive and more complicated to administer, there is no reason why it should be handled any more cheaply by the banks than by the insurance companies. I t is a pity that an advan-

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tage equaling about 5 per cent of the premiums should be exaggerated to one of 25 per cent and upwards, as is done by some advocates of savings bank insurance. COMPARISON OF NET COSTS

A buyer of life insurance is naturally interested in a comparison of probable future net costs as among the various ordinary companies. If it were practicable, his survey of this problem should attempt to consider the individual factors of net cost along the lines I have indicated. F o r the most part, however, such a course is not practicable, if f o r no other reason than because the underlying information is not completely available. In particular, little information of value is available concerning the mortality rate of the company. Unless it is analyzed by age and duration it is of little use for comparative purposes, and the ratio of "actual" to "expected" formerly contained in the annual statement blanks is largely dependent on the age composition of the business, to say nothing of the mortality table on which the "expected" is based. This is also true of the loss f r o m disability, and while much more information is available with respect to investments and expenses, a wide knowledge of insurance matters is necessary if the figures are to be interpreted properly. Dividend Scales.—A much simpler comparison, readily available in various life insurance publications, is that of the "net cost" of the policies of the various companies over a period of ten or twenty years in the past, known as policy histories; or a tabulation of net costs over a tenor twenty-year period in the future, on the assumption that the current "scale" of dividends is continued for the period without change. During the relatively stable

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127

p e r i o d e n d i n g in 1 9 3 0 these c o m p a r i s o n s w e r e o f r e a l a i d t o the b u y e r , but a t the present time f u t u r e net c o s t s , b a s e d on p r e s e n t d i v i d e n d s , a r e a v e r y uncertain g u i d e . T h i s is s o f o r t w o r e a s o n s . In the first p l a c e , g e n e r a l insurance opinion is that d i v i d e n d s will be r e d u c e d still f u r t h e r in the f u t u r e , s o that the p r e s e n t d i v i d e n d s indic a t e a m o r e f a v o r a b l e picture t h a n will actually o b t a i n . A m o r e i m p o r t a n t r e a s o n , h o w e v e r , is t h a t t h e r e is m o r e v a r i a t i o n a t the p r e s e n t time t h a n e v e r b e f o r e in the degree of conservatism of company management. Thus a p r e s e n t high net cost m a y , a n d g e n e r a l l y d o e s , indicate t h a t the c o m p a n y is not so f a v o r a b l y s i t u a t e d , but it m a y a l s o m e a n simply t h a t a l a r g e r t h a n a v e r a g e p r o p o r t i o n of the e a r n i n g s of the current y e a r is b e i n g a d d e d to surplus, used to write d o w n a s s e t s to a m o r e c o n s e r v a t i v e figure, or a p p l i e d to s t r e n g t h e n r e s e r v e s ( e i t h e r policy r e s e r v e s in v a r i o u s c a t e g o r i e s , o r special r e s e r v e s f o r contingencies).

GROUP I N S U R A N C E

T u r n i n g now to the subject o f g r o u p insurance, we find t h a t the net cost of this insurance, while b a s e d on the s a m e f u n d a m e n t a l f a c t o r s , combines t h e m in v e r y different p r o p o r t i o n s . G r o u p insurance is prim a r i l y t e m p o r a r y insurance, usually continuing only o v e r the s p a c e o f the e m p l o y e e ' s active l i f e t i m e , o r f o r a s h o r t e r p e r i o d , if the e m p l o y m e n t with the g r o u p policyh o l d e r is t e r m i n a t e d . I t is w r i t t e n w i t h o u t m e d i c a l exa m i n a t i o n , but b e c a u s e the e m p l o y e r p a y s a p a r t o r all o f the cost, a d v e r s e m o r t a l i t y d u e to anti-selection is m i n i m i z e d , a n d , a l s o , f o r this r e a s o n , little individual s a l e s solicitation is necessary, so t h a t the s a l e s cost is low a s c o m p a r e d with individual policies. B e c a u s e the busi-

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HUEBNER FOUNDATION LECTURES

ness is handled so largely in bulk, with a minimum of individual attention, administrative costs are also down. T h e coverage takes the f o r m of renewable t e r m insurance on the individual lives; consequently, the reserve element is negligible and investment problems are unimportant. Comparative Premiums.—Practically all g r o u p insurance is participating, participation taking the f o r m either of dividend payments, or of refunds of premium, or f u t u r e premium adjustments based on the experience of the group. W h i l e tabular premiums, therefore, do not determine the final cost, it may be of interest to compare the yearly renewable term premiums charged on a s t a n d a r d group with those charged individuals on the yearly renewable term basis. YEARLY R E N E W A B L E TERM Age

Group

20 30 40 50 60

$5.87 6.43 7.85 13.78 29.39

Individual $7.60 8.60 10.72 17.55 33.42

Premiums are generally paid monthly under group insurance, and the tabular monthly premium per thousand of insurance f o r s t a n d a r d groups is the average of the premiums f o r the individuals m the group and usually varies between 75 cents and $1.00 per month. Of this, the employee himself generally pays 60 cents, and the employer pays the remainder. Group Mortality.—The mortality rate experienced on groups other than in certain industries classified as subs t a n d a r d shows the following comparison with presentday mortality on ordinary policies a f t e r the effect of medical selection has worn off.

COMPARATIVE NET COST

129

D E A T H R A T E PER 1,000 Age

Group

Ordinary

23 33 43 53 63 73

1.70 2.38 4.85 11.66 26.50 64.72

2.35 2.83 5.86 12.95 30.11 69.93

It will be seen that the mortality under group policies, excluding cases on a substandard basis, is appreciably better than that on standard ordinary business. T h e main reason f o r this is that death ensuing a f t e r a long illness is often not covered under a group insurance policy as, due to ill health, the insured has not been employed for some time prior to his death. T h e hardship on the individual resulting f r o m this situation is, however, ameliorated by a provision in all group policies that on termination of employment the employee has the right to convert his group coverage to an ordinary life policy at his attained age without medical examination. As might be expected, a very high rate of mortality is experienced on these conversions, and this conversion cost is charged against the group policy, forming one of the elements in its net cost but not appearing in its mortality rate. Some years ago another important element in the cost of group insurance was the total and permanent disability benefit, which took the form of payment of the sum insured in a lump sum or in instalments over a short term of years, generally five. Prejudiced court decisions, especially in the South, so widened the definition of disability that the cost of this benefit became prohibitive and it has not been included in new policies f o r some time. Group Expenses.—One of the principal expenses f o r group insurance is commissions. H e r e we have a real

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difference f r o m ordinary insurance in t h a t the commission rate paid is not a flat percentage but decreases sharply with increased size of the group. A commission scale commonly used is as follows : COMMISSION SCALE Part of Premium $1,000 and under 1,000 to $5,000 5,000 to 10,000 10,000 to 20,000 20,000 to 30,000 30,000 to 50,000 Over $50,000

First Year 20% 20 15 \2'A 10 5 2^

Ren'ls for 9 Yrs. 5% 3 VA VA VA VA 1

Another important item is premium taxes which are, of course, a u n i f o r m percentage of the premiums paid. T h e expenses of selling ( o t h e r than commissions), but including the enrolment of the employees and the issuance of policies and certificates, likewise decrease with increased size as does the year-to-year expense of administration. T h i s is accentuated by the fact that f o r the larger groups the employer does a great deal of the work such as enrolment, issuing certificates and noting beneficiary changes that the insurance company does itself f o r the smaller groups. T o illustrate the effect of size of group upon total expenses including commissions, suppose we have groups with 50, 250, 1,000 and 5,000 lives in each of which the average amount of insurance is $1,500 per life and the average premium rate $1.00 per month per $1,000. Then, with a considerable p a r t of the initial expenses amortized or spread over the subsequent years, the total expense charges might be somewhat as follows, as a percentage of p r e m i u m s :

131

C O M P A R A T I V E N E T COST E X P E N S E CHARGE Number of Lives SO 250 1000 5000

1st Year 37% 28J/2 20

2nd-10th Years 28% 18^ 11^ IVi

11th and Subsequent Years 1 9 5 4

In addition to the expenses and death claims, the group premiums must also cover the extra mortality arising f r o m conversions, previously explained, and the contingency reserves which must be set up to anticipate possible extraordinary losses such as catastrophes or epidemics. T h e margin available a f t e r these items are paid is that f r o m which dividends are apportioned, determining the net cost. Group Insurance Net Cost.—The net cost of group insurance is fundamentally based on the theory of experience rating; t h a t is, the larger the aggregate exposure f o r the particular group, the more the net cost depends on the individual loss rates of the group and the less on general experience factors f o r all groups together, of the type usrtl in determining dividends on individual policies. Over and above the loss experience, the "net cost" of group insurance—used here in a different sense than in the case of ordinary policies—can best be expressed by showing the percentage of the premium that the life insurance company expects to retain f o r expenses and f u t u r e adverse mortality fluctuations. F o r all the g r o u p business of one large company, the aggregate retention in a single calendar year, as a percentage of premiums, might be somewhat as follows: Less than 200 lives 200-500 lives 500 lives and over

25% 18

8

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T h e s e are, of course, aggregate and the results f o r any particular group vary widely f o r several reasons. First, because of duration, the retention being generally greater in the early years and less in the later. Secondly, because in each year many groups, particularly the smaller ones where the fluctuation is naturally greater, will have claims in excess of the year's premiums on such group so that the excess must be borne by the other groups. In considering comparative net cost it should be borne in mind t h a t these percentages are of much smaller premiums than in the case of ordinary or industrial so that even f o r the smallest groups the actual retention per thousand of insurance is less than it is f o r individual insurance. WEEKLY PREMIUM INDUSTRIAL INSURANCE

W e e k l y premium industrial insurance has had some h a r d things said of it, some of which were no doubt justified. I question, however, whether it is generally realized that many of the criticisms that are leveled at weekly premium insurance r e f e r to conditions that may have existed in the past, but which are no longer present. F o r example, most people have the impression that the policy terms are illiberal, whereas the truth is that the present-day industrial policy of the large companies is largely identical with an ordinary policy except, of course, as r e g a r d s optional methods of settlement, policy loans and a choice of modes of application of dividend payments. In particular, the surrender charges are based on the same formulae as f o r ordinary policies, a beneficiary is named in the policy, and its contestability is limited to the same circumstances that would also apply to an ordinary policy. Net Cost.—Perhaps, however, the most serious misconception about weekly premium insurance is its relative

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133

cost compared with ordinary insurance. I will venture to say that some of the people here tonight would not know whether it was nearer the truth to say that weekly premium insurance costs 25 per cent more than ordinary, or that it costs two or three or four times as much. Some of these misconceptions, of course, are due to the confusion in the meaning of the word "cost." If the cost of insurance over a twenty-year period is assumed to be the difference between the total net payments over the period and the cash surrender value at the end of that time, the effect of interest and survivorship being ignored, then the "cost" of an ordinary policy at age 30 may be as little as $2.00 per year per $1,000; and if the additional cost of a weekly premium policy is about 25 per cent of the premium, or $5.00, the industrial "cost" might be said to be three and one-half times as much as the ordinary. T h e practice of showing net cost as the difference between the net payments and the cash surrender value, by the way, is a usual one in life insurance circles, in spite of its theoretical incorrectness and absurd results. By it, the "net cost" of endowment contracts can often be shown to be less than nothing; and if the interest basis used in the computation of premiums and reserves is reduced to 2 y2 per cent, as has recently been done in my own company, the increase in the cash surrender value at the end of twenty years more than offsets the increase in the net payments so that the "net cost" appears lower than before, although the reverse is actually the case. T h e actual relation between the net outlay f o r weekly premium insurance and that for ordinary insurance is difficult to obtain, due to the use of widely differing mortality tables and, in the case of one company, to the allotment of dividends to the industrial solely in the form of paid-up additions. T h e New York State Insurance Department has stated that in the case of one large

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company, "the average excess of the weekly premium industrial net cost over that of ordinary insurance of a comparable mortality was, expressed as a percentage of the industrial gross premium, as follows: Over Over Over Over

%

a 5-year period a 10-year period a 15-year period a 20-year period

14 IS 15 14

Mortality.—Note particularly the statement "of a comparable mortality." T h e mortality among industrial policyholders is higher than that of ordinary policyholders to the extent that the premium required, a p a r t f r o m expense, is about 10 per cent more. T h i s is because the broad class to whom industrial insurance is available includes many individuals whose occupation or physical condition would preclude their securing ordinary insurance except on a substandard basis. T h i s b r o a d coverage is a great advantage f r o m a social viewpoint, whereas the many policies of small amounts involved would make the cost of comprehensive medical examinations exceed the amounts saved f r o m a more favorable mortality. T h e following comparison of recent mortality rates for industrial and ordinary insurance shows the difference : MORTALITY RATES PER 1,000 Age 23 33 43 53 63 73

Ordinary

Industrial

2.35 2.83 5.86 12.95 30.11 69.93

3.19 5.09 9.72 19.81 41.40 84.81

Expense.—Since the 14 to 15 per cent excess cost of industrial insurance is on the basis of industrial mortality

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135

in both cases, it follows t h a t anyone eligible f o r standard ordinary insurance, with its more favorable mortality, pays an additional 25 per cent of the industrial premium f o r weekly premium industrial insurance, of which about 10 per cent is f o r mortality and about IS per cent f o r expense. Of the 15 per cent expense charge, the largest single item, amounting to upwards of 10 per cent, is the cost of the weekly house-to-house collection of premiums. T h i s may seem high; it is, however, in most cases the most economical method of making weekly collections. Consider, f o r example, the fact that if the policyholder mailed in his 25-cent average premium every week, the 3cent postage alone would amount to over 10 per cent. O r if he or she took the bus down to the district office to pay a premium of as much as 50 cents a week, and charged the cost of the trip home to other errands, the cost would still be as much as 10 per cent of the premium. Yet there is plenty of evidence that some people will either pay their insurance weekly, and then only a f t e r persuasion by the agent, or they will not voluntarily carry any insurance at all. MONTHLY PREMIUM INSURANCE

Over the past fifteen years, the large industrial companies have introduced and pushed the sale of monthly premium insurance in amounts between $500 and $900. T h e standards of selection are intermediate between weekly premium and ordinary insurance, and the costs of collection are naturally much less than f o r weekly premium. I think you will agree that this constitutes the most sensible method of reducing the cost of industrial insurance to the wage-earner.

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I hope that I have been successful in giving to my hearers an idea of the relative costs of these three varieties of life insurance, together with some additional information as to their nature, and of the purposes they are intended to fulfill. I hope, too, that I have succeeded in conveying some measure of my own conviction that each is fully justified, so long as its use is limited to those particular groups of individuals f o r whom it was intended.

PART III SIGNIFICANT TRENDS AND DEVELOPMENTS IN DISTRIBUTION AND PUBLIC UNDERSTANDING OF LIFE INSURANCE

RESEARCH IN LIFE INSURANCE DISTRIBUTION by M . Albert Linton President,

Provident

Mutual

W

Life Insurance

Company

H E N the average man thinks of research he probably thinks of some laboratory—perhaps a chemical laboratory—where skilled scientists with test tube and balance are delving into the mysteries of organic and inorganic substances. H e is likely to think in terms of projects which can be formulated ultimately with mathematical precision and exactitude. Chemistry, engineering, bacteriology and many kindred fields of research appear to the man in the street to lead to precise conclusions. Consequently, people sometimes tend not to appreciate adequately the value of research projects where the conclusions cannot be formulated with precision and exactitude. Research in the field of life insurance distribution which we are about to consider does not lead to conclusions which can be formulated with the exactitude of mathematical science. W e are dealing in large measure with the myriad characteristics and emotional reactions of human beings, and the conclusions to be drawn f r o m research in that field can at best be approximate only. Despite this fact, the results of such research are of the utmost importance to the business of life insurance; and with the passing of time are becoming more reliable and worthy of the most serious consideration. 139

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Starting at the very beginning of the process of life insurance distribution, the finding out of what the public wants in the way of life insurance contracts and service is a field of research that naturally suggests itself. In view of the fact that tens of thousands of agents are in contact with present and prospective policyholders every day, continuous research may almost be said to be going on in that field. As a consequence new types of policies have been developed over the years to meet situations uncovered by the work of field men; and similarly new and improved services have been developed for the benefit of the insuring public. Competition, of course, plays a large part in making sure that any significant improvement developed by one company will be adopted by others. It is doubtful therefore whether any separate and distinct research project would develop more valuable information than that which the companies now obtain in the normal course through the activities of their agents in the field. One of the most fruitful fields of research has to do with the type of person who is likely to be qualified to sell life insurance. In the past the companies have relied entirely too much upon a mere "trial and e r r o r " method of discovering a man's aptitudes. Thousands of men have been taken into agency organizations, given a minimum of training f o r their job, and then sent out to sink or swim. M a n y sank and were lost to the business. In the process, however, they did themselves and the institution of life insurance very little good. As a matter of fact, a large percentage of them left unfavorable impressions upon tens of thousands of persons who were irritated by the methods of approach and presentation of these unqualified representatives of our business. To them is largely to be ascribed the designation of " p e s t "

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141

which has all t o o f r e q u e n t l y been applied t o the life insurance agent. T h i s is most u n f o r t u n a t e since the relationship between policyholder and agent should be a n o r m a l and easy one. A d e q u a t e life insurance service requires t h a t the cards be laid on the table, so to speak, t o the end t h a t the agent may have the facts upon which to recommend t h e type of life insurance and t h e m e t h o d of settlement t h a t best fit the needs of his client. T h e utterly unqualified men who have gone out with a r a t e book t o solicit life insurance represent the complete antithesis of this kind of relationship, and have done m o r e t h a n any o t h e r one thing to give life insurance selling a bad n a m e and t o make m o r e difficult the w o r k of the qualified life underwriter.

APTITUDE TESTS

In a situation such as this, it is obvious t h a t there would be g r e a t utility in a practicable aptitude test which would assess the probability t h a t a m a n would be successful in life insurance selling. A p t i t u d e tests h a v e long been used in the field of education and in connection with employment in o t h e r types of w o r k . W h y not a t t e m p t to develop a similar tool f o r use in connection with the job of selling life insurance? T h e subject has been a m a t t e r of intensive study by t h e L i f e Insurance Sales Research Bureau f o r a number of y e a r s . In 1932, D r . A . W . K o r n h a u s e r of the University of Chicago started w o r k i n g with the Bureau on a project f o r developing a measure of a p t i t u d e t o be used as above indicated. A f t e r he h a d completed his p a r t in t h e work, the Bureau continued the p r o j e c t by g a t h e r i n g ratings f r o m a large number of agents, testing t h e ratings against actual results, and bringing the p r o j e c t to the point w h e r e it could

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be announced f o r general use. T h e announcement was made late in 1938. T h e Aptitude Index consists of two parts. One is a system of scoring based on personal history items, and the other a system of scoring based on personality characteristics. T h e basis for each of the scores is simple and factual. T h e operation of the plan is automatic, no judgment being involved. A rating is determined for each of the two parts, and then a combined rating of the two is produced. I t has been found that actual results follow the ratings with considerable accuracy. Some weaknesses developed in attempting to apply the ratings to prospective agents in the youngest age group, but even in that area the ratings have some value. At present the Aptitude Index is being used widely throughout the United States and Canada. Latest information f r o m the Bureau indicates that about sixty companies are requiring the test of all prospective agents who are new in the business, and about thirty-two additional companies are recommending it although not requiring it. These two groups combined account for about 55 per cent of all the ordinary life insurance produced by United States and Canadian companies. T h e Aptitude Index of the Sales Research Bureau is not the only such test in use today. T h e best known of the others is that originated by D r . Verne Steward of California. T h e distinctive feature of D r . Steward's test is that he does not attempt to produce a combined rating for the dozen or more characteristics measured by his test, but suggests that the ratings be examined individually to determine weaknesses which might be hidden in a total score. These attempts to find reliable tests of the aptitude of prospective agents represent a very wholesome trend in our business. However, it cannot be too strongly stressed

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t h a t aptitude tests, no m a t t e r h o w carefully refined, will never do m o r e than assist in the p r o b l e m of developing capable life insurance agents. T h e tests a r e simply valuable tools in the hands of the w o r k m a n . T h e w o r k m a n — t h e g e n e r a l agent or m a n a g e r — m u s t still m a k e exhaustive investigations of the b a c k g r o u n d and qualifications of prospective life insurance agents b e f o r e taking them into his o r g a n i z a t i o n . H e must then give adequate weight to his own j u d g m e n t and not be unduly swayed by the result of a p a p e r test. H e must still h a v e the ability to bring out the latent abilities of the new man and be able t o give him the kind of t r a i n i n g and supervision t h a t will enable him to achieve his objective as a life u n d e r w r i t e r . A p t i t u d e tests have a n o t h e r i m p o r t a n t by-product value. T h e y quite properly give the prospective agent a feeling t h a t his qualifications a r e being t h o r o u g h l y appraised. Subsequently if offered a contract he has an a d d e d feeling of confidence in his ability to m a k e good. T H E NEW MAN ON T H E JOB

H a v i n g taken on a new man who has satisfactorily passed the tests and been a d j u d g e d a potentially successful life insurance salesman, w h a t are the next steps in his d e v e l o p m e n t ? W h a t m e t h o d s of training a r e best a d a p t e d to his needs? W h a t w o r k habits should be inculcated? Should he a t t e m p t t o sell at the outset or should he begin with some type of preliminary survey w o r k which would b r i n g him into contact with clients without his being under the pressure of having to a t t e m p t a sale? All of these h a v e been, and will continue to be, subjects f o r research. A g r e a t deal t h a t is helpful has already been accomplishedOne of the problems the o r d i n a r y branch of the life

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insurance business has found difficult of solution is that of determining what constitutes a satisfactory unit of work in life insurance selling. In the weekly premium field the problem is relatively simple. A new man is assigned a definite group of policyholders in a given locality and his job of collecting the premiums every week by personal calls is definite and clear cut. Upon this foundation he can build the sale of new insurance to meet the needs of his clients. T h e important thing, however, is the fact that he has f r o m the very start a definite task to p e r f o r m for which he receives pay and which is relatively easy to supervise. H e does not have to depend upon commissions f r o m the sale of new insurance for his basic income. Developing in the ordinary field something comparable to the specific job of the weekly premium agent is a fruitful field f o r research. Success would contribute greatly to the number of those giving promise of having life insurance selling ability who would finally emerge as qualified, established agents. T h e r e is one question in which I have been interested for a long time personally without having found the answer. I t has to do with the proportion of the attempts to close sales of life insurance that are successful as compared with a similar figure for other lines of salesmanship. If, f o r example, an agent on the average is successful in x per cent of his attempts to close during, say, his first or second year in the business, is the percentage high or low as compared with that of salesmen in other lines of business? If it is low it means that in a large percentage of cases he is turned down and must overcome the discouragement and feeling of frustration that are likely to follow. If the proportion of unsuccessful attempts to close is much higher f o r the life insurance business than f o r other lines

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o f selling, it would indicate especial need f o r a change in technique t h a t would reduce to a minimum this negative aspect o f the selling process. I t takes strong will power, enthusiasm and dedication to the j o b to overcome the effect, f o r example, o f twenty turndowns to every successful close. H e r e is a field f o r research which, if successful, might be quite helpful in the m a t t e r o f agents' training, supervision and compensation. A n o t h e r important problem in building a successful agency force is that o f discovering, a f t e r a reasonable time, whether or not a new recruit is likely to make the grade. F o r example, is there any practicable test based upon an agent's performance that could be used f o r this purpose? T h e L i f e Insurance Sales Research Bureau has made numerous studies in this field and has provided helpful suggestions based upon what the new man is able to accomplish in his early months o f life insurance selling. A s in many o t h e r phases o f the life insurance business, we are dealing with averages. Individual exceptions to any rule are bound to occur. H o w e v e r , a yardstick that can be readily applied has been found very useful in practice in eliminating, early in the game, men who apparently were reasonable prospects f o r the salesman's j o b but who upon trial proved to be disappointments. U n d e r selling conditions as we have known them in the last ten years, the older agents have in many instances found it difficult to adjust themselves to changed circumstances. I n consequence, efforts have been made to discover methods o f keeping the old men fully equipped to meet new conditions; and research has been helpful in guiding agency heads in dealing with that problem. T h e established agent has been given special courses o f training in prospecting and the changed techniques o f selling, with satisfactory results in many instances. P r o g r a m s o f successful procedure have been developed by research

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into the characteristics of the methods that have been found to work in various agencies. By finding elements common to several successful programs, the development of a program t h a t has the maximum probability of being successful in any given situation is much enhanced. AGENTS' COMPENSATION

T h e broad field of the compensation of the agent who solicits ordinary insurance is a f r u i t f u l one not only f o r research but f o r pioneer thinking. Over the years, many methods of compensating agents have been tried but the overwhelming choice has been a commission plan which directly relates the compensation to the business actually done. During the period of apprenticeship the plan has been supplemented by advances or loans, or has been replaced f o r a time by a straight salary or by part salary and part commission. H o w e v e r , the objective of all of these plans has been to qualify the new recruit to make a satisfactory living on a straight commission basis. Practically no one has contemplated continuing advances or subsidies as a regular p r o g r a m a f t e r the period of apprenticeship has been completed. In the development of the commission system of compensation, the tendency has been to pay a relatively large first commission and a series of nine smaller renewal commissions. F o r companies doing business in New York State, the standard f o r such policies as ordinary life may be said to be 50 per cent and nine 5's. Many billions of life insurance have been produced and paid f o r on that basis. A criticism leveled at that scale has been that too much emphasis has been placed upon the first premium, with the result that the agent has had but a minor interest in the renewal commissions and hence in the conservation

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of the business he has written. A n o t h e r criticism has been that a f t e r ten years the agent receives no compensation despite the fact that he may have to spend considerable time giving service to the policyholders in connection with option settlements, policy loans, and overdue premiums. Still another criticism has arisen following the development of the interest in old-age pensions coincident with the advent of Social Security. It is that the plan of compensation does not make adequate provision f o r the agents' declining years. These three points were clearly r e f e r r e d to in a resolution adopted at the meeting of the N a t i o n a l Association of Life Underwriters held in this city in 1940. T h e resolution requests life insurance companies to adopt plans of agents' compensation within the following principles : 1. T h a t compensation be redistributed in such a way as to give greater reward to the permanent agent who writes business of good quality. 2. T h a t a service fee be provided during the life of each policy and during the continuance of the service of the producing agent. 3. T h a t there be provided a standardized and contributory retirement life income plan for agents reaching a specified age and a specified length of service. Recognizing the need f o r research and study in the field of agents' compensation, the L i f e Insurance Sales Research Bureau in the latter p a r t of 1939 appointed a committee of company officers and two members of the Bureau staff to have the m a t t e r under their care. T h i s committee too h a d in mind the need f o r changes along the lines indicated in the foregoing resolution. Accordingly, a f t e r considerable study it recommended for the consideration of the companies, a revised scale of commissions which reduced the first year commission by 20

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per cent, increased the first two renewal commissions substantially, reduced somewhat the remaining seven renewal commissions, and, in return for a reduction in the vested interest in certain renewal commissions in the event of cancellation of the contract, added non-vested continuous 2 per cent service fees throughout the premium-paying period of the policy. A full report on pensions for agents was also issued. It included a review of the basic principles to be kept in mind in establishing a pension plan and gave a brief description of the plans already in actual use. Both reports have stimulated much thought in life insurance home offices and some companies have made changes along the lines indicated in the reports. COMPENSATION OF T H E NEW AGENT

T h e compensation of the new agent is the subject of another report made by the Bureau Committee. T h e conclusions reached in that report are not as specific as in the case of the other two, but nevertheless are helpful in highlighting the basic problems of management involved in the successful induction of qualified agents under conditions of modern intensive selling. Present methods of financing the new man are reviewed and the advantages and shortcomings of each described. In the process of studying the new man problem a number of questions were raised upon which further light is required. Among them are such questions as the following: 1. Is the work of the new man properly organized, and do we ask him to do what he is not yet qualified to do? If so, what special treatment does he need? 2. Is there, or should there be, something else f o r him to do during at least a part of his apprenticeship?

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3. Is the conception of the independent contractor a fallacy? 4. W h a t is the agent's function—salesman, servicer of business after it has been put on the books, or a combination of the two? 5. Should management take over some of the agent's functions? 6. Should the number of agents in an agency be limited? 7. Does the weekly premium system offer some hints as to how the ordinary system might be improved? These questions provide a fertile field for further research and study. Furthermore, it should not be concluded that the last word has been said on the subject of agents' compensation in general. That deserves continuous long-range study in the light of new developments. MORALE

Finally a word about another subject that has been the object of research by the Life Insurance Sales Research Bureau. The Bureau set itself the task of discovering the predominating characteristics of life insurance agencies which are successful and of those which are unsuccessful. Accordingly twenty agencies were studied by a corps of interviewers trained in research methods. Personal interviews were had with individual members of each agency. Intelligent care was taken to put the persons interviewed at their ease and to eliminate the personal bias of the interviewer. From two to six weeks were spent in each of the agencies studied. The job was thus done carefully and exhaustively. In particular it was desired to appraise the place of that intangible element morale in the management of an agency. It was

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f o u n d t h a t it played a most i m p o r t a n t p a r t . T h e study covered several years and was completed in 1940. T h e results w e r e published in f o u r large pamphlets. T h e title of each gives a brief idea of the g r o u n d covered. Volume I on " M o r a l e — T h e M a i n s p r i n g of M a n a g e m e n t " gives an overall view of w h a t m o r a l e is and why it is valuable, and shows how it can be measured. Volume I I on " M o r a l e — W h a t I t Is and W h a t It D o e s " p r e s e n t s a close-up view of m o r a l e ' s essential factors, a n d outlines t h r e e main principles governing its g r o w t h . V o l u m e I I I on " M o r a l e — H o w t o Build I t " takes up each of the t h r e e principles in turn, illustrating and showing its application. Volume I V on " M o r a l e and M o t i v a t i o n " illustrates the effect on agents' m o r a l e of the commonly used m o t i v a t i o n m e t h o d s . T h e t h r e e principles e m p h a s i z e d t h r o u g h o u t the rep o r t s a r e ( a ) the principle of individual recognition, ( b ) the principle of p e r s o n a l security, and (c) the principle of p r o f e s s i o n a l skill. T h e p a m p h l e t s have been widely used a n d are a valuable research contribution to the b e t t e r distribution of life insurance. CONCLUSION

In w h a t h a s been said n u m e r o u s references have been m a d e to the L i f e Insurance Sales Research Bureau which is a cooperative enterprise s u p p o r t e d by about 116 U n i t e d States a n d C a n a d i a n life insurance companies. It is to be expected t h a t the most concentrated research w o r k in the field of life insurance distribution would be done by the B u r e a u . H o w e v e r , a n u m b e r of individual life insurance companies themselves maintain d e p a r t m e n t s devoted to agency research a n d m a n y i m p o r t a n t problems are being studied by t h e m .

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These company research departments, of course, spend most of their time on problems related to the particular companies concerned. T h e y develop facts of great practical value to the men who have charge of individual agencies. T h e y act as a clearing house of information in which the various agencies of the company are interested. T h e y provide the data upon which many policies of the agency department are determined. As we look into the future and envisage the problems that will call f o r solution, it is clear that fundamental painstaking research will play an increasingly important part in life insurance distribution.

THE PRESENT AND FUTURE OF SALES RESEARCH IN LIFE INSURANCE by J o h n M a r s h a l l Holcombe, J r . Manager, Life Insurance Sales Research Bureau

I

T seems to me this evening, as I meet f o r the first time the fellows and scholars of the Huebner Foundation, that I am facing a group of men whose presence together is of marked importance to the life insurance business. In the first place, the Huebner Foundation is an example of what can be achieved when competing companies cooperate in common aim. H a d it not been f o r the contributions of many companies you would not be here tonight. N o one company could have made the Huebner Foundation possible. In addition, there is a very great significance to the life insurance business and to society in the objective of this Foundation. Stated in its simplest terms, this objective is the improvement of the teaching of life insurance throughout the United States. A s you men are brought face to face with the experience of D r . Huebner and his associates, with the methods of teaching which they have developed through the years, with all of the countless contacts between the life insurance business and the University of Pennsylvania, you are laying a foundation f o r teaching the youth of America about life insurance in a way which could not be achieved until your instruction f o r future teaching was centralized in such a University as this. 152

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I am going to talk to you tonight about sales research. You have a l r e a d y had one talk on this subject by President Linton of the Provident M u t u a l . It is heartening to those of us who are studying the distribution problems of life insurance to find the Huebner Foundation presenting to you two talks on this subject. I d a r e say that if this Foundation had been established twenty y e a r s ago, it is altogether likely that there would not have been even one speaker on the subject of sales research. It is an evidence that we are making progress in our attack upon some of the vital problems in distribution. J u s t as the Huebner Foundation is an example of what cooperation between competing companies can produce, so I appear before you this evening as a representative of the L i f e Insurance Sales Research Bureau, itself an example of what companies in cooperation can accomplish which they could not accomplish separately. T h e Bureau not only has used the relatively modern method of pooling the experience and wisdom of competitors, but in addition to that, has gone to industry and has attempted to extract f r o m research in the industrial field all of the techniques which seem capable of being transf e r r e d to life insurance sales problems. In our Bureau we are not dealing with test tubes and inanimate matter, but with the much less understood problems of human relations in their broadest sense. But despite the fact that we are dealing with the animate as distinguished f r o m the inanimate, we have been able to use many of the techniques developed by research men in lines f a r removed from the life insurance business. Perhaps it is not amiss for you to know that no business other than life insurance has ever established in the U n i t e d States an organization whose sole purpose is to study the distribution problem. Our Bureau has no concern with the investment, underwriting or other problems

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of life insurance; we are designed to give our entire attention to the selling activities in their broadest sense. SOME EARLY QUESTIONS NECESSITATING SALES RESEARCH

W h e n the Bureau was organized in 1922 there was a considerable body of opinion which believed that there were few if any questions which could be analyzed and f o r which significant answers could be secured. Nevertheless, some thoughtful observers of life insurance were asking significant questions. H e r e are some which were asked about our selling expense : 1. Are the policyholders of a life insurance company justified in expecting that with increase in volume of business there should occur an appreciable decrease in selling expense r a t e ? 2. Is permanent adherence to the present basis of compensation to field representatives likely to be f o r the best interest of company, policyholder, and agent alike? 3. H a s the policy of extensive territorial cultivation, often on a national scale, which so many companies have fostered in the past, justified itself by the operating results achieved? 4. Should life insurance companies continue to multiply the great variety of forms of protection already in existence, or is the time approaching when they will be justified in conforming to the trend of simplification which is manifesting itself with accelerating speed in other lines of business? 5. Is it logical to assume that there are optimum size limits which may be applied to field organization units and that reduction in selling expense is contingent upon maintenance of a sound balance of all influential factors within those limits?

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I give you these as examples of questions which were asked twenty years ago. Some of the questions a r e not yet answered, but research will g r a d u a l l y develop answers on a much m o r e scientific basis t h a n w a s t h e case b e f o r e sales research was used f o r this p u r p o s e . T h e r e a r e countless ways of looking at the p r e s e n t situation in life insurance distribution. I t would be highly enlightening if I could give you a complete p h o t o g r a p h of present selling conditions. T h i s I cannot do, but I can illustrate w h a t the Bureau is trying to do in p h o t o g r a p h ing present conditions by giving you some figures in r e g a r d to the change in the number of contracts now in force to sell life insurance. I am giving you these figures as an example of h o w factual m a t e r i a l can be assembled and thus clarify the problem to be solved. T h e figures which I am about t o give you were pooled by the Bureau f r o m the individual company records of thirty-seven companies handling o r d i n a r y insurance only. U s i n g 1934 as a base and calling t h a t 100 per cent, it is interesting to find t h a t at the p r e s e n t time ( e i g h t years l a t e r ) the number of full-time contracts has d r o p p e d to 65 per cent of w h a t it was in 1934. In the case of p a r t time contracts, the d r o p h a s been to 66 per cent. In the case of b r o k e r s ' contracts, the number has increased f r o m 100 t o 105 p e r cent. W h e n we p u t all of the contracts t o g e t h e r , we find t h a t the number thereof has decreased to 72 per cent of w h a t it was in 1934. D u r i n g t h a t same time the new business of these companies h a s d r o p p e d to 97 per cent. T h u s when we combine these t w o index figures, we find t h a t the s h a r e of new business per agent has gone up 35 per cent. T h i s figure is encouraging because it tends to show thsrt the a m o u n t of business sold p e r agent h a s increased. W h i l e this is not a g u a r a n t e e t h a t the income p e r agent

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has increased, it certainly tends to indicate the likelihood of t h a t in those particular companies. SOME C U R R E N T PROJECTS FOR SALES RESEARCH

I give you these figures to show you the opportunity which an organization like the Research Bureau possesses of drawing together enough figures to indicate certain trends. W h e n we have discerned a trend, we can then begin to clarify the problems which we should be studying at a particular time. You will recall that M r . Linton mentioned eleven projects in sales research, on some of which work has already been done and on some of which it is to be done in the future. These eleven projects were ( 1 ) new policies—what the public wants; ( 2 ) selection of agents; ( 3 ) elimination of unfit agents; ( 4 ) training and development of the new agent; ( 5 ) determination of the unit of work f o r the agent; ( 6 ) the "closing r a t i o " in life insurance selling as compared with other fields of selling; ( 7 ) a yardstick f o r judging the success of the new agent—the indication that six months' results are a guide to the future success of a m a n ; ( 8 ) keeping old men up to d a t e ; ( 9 ) compensation of agents; ( 1 0 ) possible " r e f o r m s " in the agent's job; and ( 1 1 ) morale. Out of the many research projects which we are either studying or might be studying, I shall consider some of the ones which were covered by M r . Linton and add a few others. 1. The Need for a Public Opinion Poll in Life Insurance.—In recent years, as you are all aware, there have been developed several techniques f o r securing and measuring the opinion of various groups of people. W e have such things as the Gallup Poll and similar investigations of opinion on many different types of questions. In addi-

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tion to t h a t , certain g r e a t corporations, such as G e n e r a l M o t o r s , u n d e r t a k e to find out the opinion of their cust o m e r s r e g a r d i n g the p r o d u c t s which the company sells. I t has been f r e q u e n t l y believed t h a t such an investigation should be m a d e in the life insurance field. T h e r e a r e now trained investigators who are available f o r such a study. T h e r e a r e many questions on which life insurance policyholders have, o r at least ought to have, opinions. T h e job has been done several times, but there a r e certain angles of the relationship between life insurance a n d its policyholders which have not been t h o r o u g h l y explored. Doubtless no one company would be likely t o do it on a b r o a d scale. I t looks, t h e r e f o r e , like a cooperative research job. T h e trouble is t h a t it is extremely h a r d to foretell w h a t the results will be, and because of this uncertainty it is difficult to persuade the company officers t h a t the necessary investment would yield adequate dividends. 2. Should Number of Different Policies Be Decreased?—We f r e q u e n t l y receive suggestions t h a t life insurance should follow industry in cutting down the number of policy f o r m s which are available as we are all conscious a t the m o m e n t of t h e fact t h a t under the stimulus of w a r , m a n y industrial c o r p o r a t i o n s are cutting down t h e number of models which they sell. T h e r e is much to be said in f a v o r of a life insurance company's having n u m e r o u s policy f o r m s in o r d e r t h a t it can cover t h e many needs which the public possesses a n d which can be covered only by life insurance. W h i l e t h e basic f o r m s of life insurance policies are limited in number, t h e r e are countless variations which have come into existence in recent times. T h e a r g u m e n t t h a t there a r e t o o many is based on the fact t h a t many of these f o r m s are sold so rarely t h a t the expense of producing them a n d the expense of keeping t h e rates on them in the r a t e book

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is something which might well be eliminated, and thus cause a sizable economy. On the other hand, the rapidly expanding use of life insurance in m o d e r n society and in m o d e r n business has probably been facilitated by the presence of a very wide variety of f o r m s . T h e r e have frequently been criticisms t h a t policy f o r m s h a v e been created by men who did not understand the m a r k e t — t h a t they t h e r e f o r e produced something which h a d little sales appeal. T h e whole question is one which merits study on a b r o a d scale. 3. The Need for Clearly Defined Aims.—It is easy to say t h a t a company should know w h a t its principal objectives are. I t is easy to say that a d e p a r t m e n t within a company should know w h a t its objectives are. In fact, p e r h a p s a visitor f r o m another planet would assume that this was so basic t h a t all corporations and businesses would have such objectives carefully written out and constantly b r o u g h t to the attention of all employees, both executive and otherwise. T h a t such is not the case is clear to us all. F u r t h e r more, we all know that corporations tend not to a t t e m p t to put down on p a p e r w h a t their objectives are, any more t h a n a family a t t e m p t s to put down on p a p e r w h a t its objective is. T h e y seem to be taken f o r g r a n t e d . T h e r e is, however, a slowly growing tendency on the p a r t of life insurance to a t t e m p t to clarify the company and d e p a r t m e n t a l objectives, in o r d e r t h a t the whole strength of the company can be aimed at a known and expressed objective r a t h e r t h a n an assumed one. F o r example, in the case of the agency d e p a r t m e n t , it is common to find t h a t in such a m a t t e r as the t e r r i t o r y in which the company sells, the present situation has grown up t h r o u g h a series of chance occurrences. I t is ordinarily difficult, if not impossible, to show t h a t the t e r r i t o r i a l organization has been dictated by a carefully

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c o n s i d e r e d c o m p a n y objective. I n f a c t , t h e w i d e e x t e n t of t e r r i t o r y c o v e r e d by s o m e c o m p a n i e s h a s in r e c e n t y e a r s p r o m p t e d t h e m to w i t h d r a w f r o m a c o n s i d e r a b l e a m o u n t of t e r r i t o r y a n d t h u s seek e c o n o m i e s of s o m e importance. U n t i l a c o r p o r a t i o n clarifies b o t h its c o m p a n y a n d its d e p a r t m e n t a l objectives, it is badly h a n d i c a p p e d in h a v i n g t h e w h o l e s t r e n g t h of its p e r s o n n e l d i r e c t e d a l o n g s i m i l a r lines. T h e r e is much f o r r e s e a r c h to d o in this d i r e c t i o n . 4 . Analysis

of Distribution

in Life

Insurance.—Just

as t h e r e is need f o r a n a l y z i n g t h e objectives of a comp a n y , t h e r e is a very g r e a t need f o r an analysis of t h e t h r e e m a j o r j o b s in life insurance s e l l i n g — t h a t is, t h e j o b of t h e agency d e p a r t m e n t a t t h e h o m e office, t h e j o b of m a n a g e m e n t in the local office, and t h e j o b of t h e s a l e s m a n h i m s e l f . I t is f r o m o u r f a i l u r e s in t h e p a s t p r o p e r l y t o a n a l y z e each of these jobs t h a t much of o u r c o n f u s i o n exists. In t h e case of t h e agent, this is clearly n o t i c e a b l e . Is his j o b simply t h a t of selling a n d n o t h i n g e l s e — o r is it a c o m b i n a t i o n of selling a n d l a t e r s e r v i c i n g ? If he is solely a salesman, should t h e h o m e office m a i n t a i n t h e only r e l a t i o n s h i p with t h e policyholder t h e r e a f t e r by s e n d i n g h i m r e n e w a l notices but n o t h a v i n g t h e a g e n t h a v e any h a n d in t h e collection of t h e p r e m i u m ? Not only is t h e r e f r e q u e n t d o u b t as t o w h e t h e r t h e s a l e s m a n s h o u l d fulfill t h e t w o m a j o r f u n c t i o n s of selling a n d servicing, but t h e r e h a s been a g r a d u a l t e n d e n c y in t h e l a s t t w e n t y y e a r s f o r m a n a g e m e n t t o t a k e o v e r c e r t a i n of t h e f u n c t i o n s of t h e a g e n t which he f o r m e r l y h a n d l e d . A n e x a m p l e of this occurs in t h e m a t t e r of p r o s p e c t i n g . T w e n t y - f i v e y e a r s a g o h o m e offices b e g a n f r e q u e n t d i r e c t m a i l c a m p a i g n s in o r d e r t o help a g e n t s g e t p r o s p e c t s . T h e y did this because they t h o u g h t it w a s a b e t t e r division of l a b o r t h a n t h e f o r m e r division. I m e n t i o n t h e s e exa m p l e s m e r e l y t o s h o w t h a t t h e r e h a s f r e q u e n t l y been a

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lack of clarity as to what a particular job is and, secondly, an understanding of why it is being tried out in the way that it is handled at a particular time. Research has much to do in this direction. 5. Distinguishing Between the Functions of the Agent and the General Agent.—The marketing of life insurance developed first the agent, and second the general agent or manager. This evolution seems to have left a considerable lack of distinction between what the two jobs were intended to accomplish. T h e original concept of the general agent was that he was primarily a salesman and only secondarily a manager of salesmen. In fact, it was not until the last twenty years that a thorough clarification of the differences between the two jobs has been made. T o d a y it is recognized that the job of personal selling and the job of directing others are two very different operations. 6. Selecting the General Agent or Manager.—Having thus clarified what the job of management means and requires, the first step is to give some attention to the kind of men who should fill that position. T h e traditional way to appoint a general agent or manager has been to appoint a man who has become prominent either in his own company or in another company as a successful salesman. Since the gradual recognition of the fact that the two jobs are fundamentally different, there has come a parallel recognition of the fact that success as a salesman is no very solid guarantee of success as a manager. T h e traditional basis f o r picking out a man to be a m a n a g e r — namely, successful selling—is t h e r e f o r e now in process of being widely abandoned. In its place, what can be f o u n d ? T h e Research Bureau has been at work f o r three or f o u r years in an effort to see if there are some objective measurements which can be put into the hands of life insurance companies which will assist them in eliminating men whose

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past history and aptitude give an indication that they will not succeed as managers. It is a long process, but our hopes are gradually rising that something can be done in this direction. 7. Training the General Agent or Manager.—The next step following the selection of the manager is his adequate training. Keeping in mind the fact that we have now clarified what we expect the manager to do, it is altogether reasonable to expect that we can create a training program in management which will avoid some of the errors of the past. Until a dozen years ago, such training in management as existed was done by individual companies, and then only occasionally. For the last twelve years the Research Bureau has been holding Schools in Agency Management, at which present and prospective incumbents have been trained for a two-week period of intensive study in such things as the recruiting, selection, training, compensation, and stimulation of life insurance agents. That these schools have been patronized by all kinds of companies, both large and small, old and young, is an indication that the basic idea is sound. 8. Building Agency Morale.—Mr. Linton spoke of the studies in morale which the Bureau has recently made. T h e series of booklets in which these studies were reported is an example of the literature which the Bureau has been preparing as a means of helping companies in the training of their managers. W h e n the Bureau started its work twenty years ago, there was scant literature on management. T o d a y there is much, and the morale books are an example of what long and painstaking research can produce f o r the guidance of men whose problems revolve around the more adequate direction of salesmen under their control. 9. The Selection of Agents.—Having thus considered the analysis of the manager's job as well as the selection

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and training of the man who is to carry it out, we may go on to the problem of the agent. In the last twenty-five years much has been done to assist business in the selection of personnel, largely in clerical jobs and much less in selling operations. Even so, there have been certain objective measurement devices which have been widely used throughout American business, such as the Strong Vocational Interest Test, and other similar devices. T h e life insurance business, through its Research Bureau, decided ten years ago that it ought to study the problem in some detail and see if a measurement device could be produced which would predict success or failure in life insurance selling. A f t e r this decade of study, the Bureau produced the Aptitude Index to which M r . Linton referred and which now is giving most gratifying results. W e shall attempt its refinement, of course, but that we have taken a sound step f o r w a r d seems unquestioned. 10. The Compensation of Agents.—The compensation of life insurance agents is something which has been intensively discussed in the last few years. In its attack upon this problem, the Bureau used an interesting technique and one which seems capable of considerable extension. In many studies we have used our own staff exclusively, but in the matter of compensation we had our own staff augmented by a Committee on Compensation composed of company and agency representatives. T h i s Committee consisted of presidents, actuaries, and agency officers as well as two field men—one at the head of an agency and one a salesman. Guided by a group so broadly representative of the entire life insurance institution, our attack on the problem has met with much success, and several publications have already been put out which seem likely to clarify the thinking which will be essential on this intricate problem before it is solved. 11. The Training of Agents.—Next in logical order

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f o r consideration a f t e r the selection and the compensation of the agent conies his training. L i f e insurance has been s u r f e i t e d with training material f o r agents d u r i n g the last decade especially, but actually f o r a much longer time. T h e r e is no denying the fact t h a t much t r a i n i n g m a t e r i a l h a s been thrown t o g e t h e r in a hasty and superficial f a s h i o n . It is the job of research to assist in b e t t e r training m e t h o d s and even in the p r e p a r a t i o n of actual t r a i n i n g m a t e r i a l , all of which should be based on a bett e r u n d e r s t a n d i n g t h a n we now possess of w h a t life insurance selling means. 12. The Problem of Costs.—We have been considering some r a t h e r specific agency operations, but we now come to an effort to study the whole efficiency of our field o p e r a t i o n s . Such a study includes the m e a s u r a b l e cost of o p e r a t i o n , and here again the Bureau has h a d occasion to a p p o i n t a committee of company officers to a u g m e n t the w o r k of its present staff. T h i s C o m m i t t e e on Costs has only recently been appointed, but we anticipate t h a t its studies will measurably improve our u n d e r s t a n d i n g of the significance of the cost figures which we h a v e been collecting. T H E IMPORTANCE OF INTEGRATING RESEARCH ACTIVITIES

N o one could remain in the Research Bureau f o r any length of time without realizing t h a t one of the basic facts in o u r problem is to recognize the interrelationship of all of t h e f a c t o r s which I have just discussed. T h e r e have been men w h o p r o f e s s to think t h a t if we could devise a b e t t e r compensation plan our troubles would all be o v e r . T h a t this is an entirely u n w a r r a n t e d conclusion seems obvious, but it is frequently n o t t h o r o u g h l y u n d e r s t o o d . I t is difficult to make progress on all f r o n t s

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at the same time. In the words of the army, we have certainly pushed out some "salients" by the production of such an aid in selection as the Aptitude Index or such an aid in morale building as our morale books, but the problem of having our whole f r o n t move f o r w a r d is something which requires not only the highest degree of imagination but a very great deal of patience on the p a r t of our supporting companies. T h e severest critics of our f o r m of life insurance distribution apparently have believed that the entire structure needs a revolutionary change. I am reminded of an alleged motion in a legislative body in England to this effect: " I move you, sir, that we have a new bridge over the T h a m e s . I move you, sir, that it be constructed out of the same materials that are now in the existing bridge over the T h a m e s . And I move you lastly, sir, t h a t we use the old bridge during the time when the new bridge is being constructed." T h a t is substantially the position in which life insurance finds itself today. W e must improve our present structure while we both glimpse and build the new. T h a t it can be done is the hope of all those who are carefully at work t o w a r d that objective. On one thing there is unanimity of opinion—we do not wish to throw away the present structure because there is much in it which is sound, but we certainly can achieve, through long research, changes which are not merely " g a d g e t s " hung on the present structure but are soundly conceived organizational improvements. I cannot close this talk on a better note than M r . Linton used in the close of his t a l k : " A s we look into the f u t u r e and envisage the problems which will call f o r solution, it is clear that fundamental, painstaking research will play an increasingly important p a r t in life insurance distribution."

COMPARATIVE SERVICES IN THE DISTRIBUTION OF ORDINARY, INDUSTRIAL AND GROUP LIFE INSURANCE by Paul F. Clark Vice-President,

John Hancock

Mutual

Life Insurance

Company

5 a preliminary to a discussion of the comparative distributive services of the Ordinary, Industrial and G r o u p departments of the life insurance companies, let us review very briefly the origins of life insurance so that we may understand better how the three great branches of the life insurance business arose and the necessity f o r them. LIFE I N S U R A N C E A RESPONSE TO H U M A N NEEDS

Historically, life insurance originated quite casually out of w h a t we now call marine insurance. W e are told that the Phoenician traders, as long as f o u r thousand years ago, made a practice of banding together and agreeing t h a t if one of them were to lose a ship, all in the group would share the loss rather than let it fall exclusively on the owner of the vessel. This, obviously, was a rudimentary f o r m of marine insurance. The Phoenicians, however, went f u r t h e r in t h a t they also agreed, f r o m time to time, that if the captain of the vessel were lost at sea, as well as the ship, they would jointly make a payment to compensate f o r his loss. 165

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T h i s same practice was adopted in the fourteenth century in England by certain Italian financiers and by a colony of Danish, Flemish, and German merchants and t r a d e r s located in London. In this practice we find the beginning of Lloyd's, so named because these men were in the habit of gathering at E d w a r d Lloyd's Coffee Shop where the opportunity was afforded them to write their names at the bottom of a paper posted on the wall, setting f o r t h the details of a proposed voyage. In writing their names they stated how much of the risk they personally were willing to carry. These were the first " u n d e r w r i t e r s . " T h e first "policy" of which we have any record was written on the life of William Gibbons, a sailor of London, in 1583. Thirteen men were " o n " the risk and the policy cost Gibbons a premium of 8 per cent of the face amount for one year's protection. These casually f o r m e d groups of insurers, like the Phoenicians, thus did occasionally insure a man's life f o r a period of time, as well as the vessel on which he was sailing. T h i s account of the origin of life insurance is historically true, I believe. W e shall have to look much deeper than this, however, if we are to understand the real origin of life insurance. As a matter of economics and sociology, life insurance arose out of the emergence of a new type of civilization following the Industrial Revolution. In a nomadic, an agrarian, a feudal, or even in a handicraft type of civilization there was no real need f o r life insurance. In such civilizations the human life values destroyed by death were not replaceable with money. T h e family unit was not shipwrecked by death so f a r as continued economic existence was concerned. H o w e v e r , under the new economic and sociological conditions that arose with the spread of the Industrial Revolution, the losses to the family attendant

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u p o n the d e a t h of the b r e a d w i n n e r became acute. In this case the destruction of t h e h u m a n life value l e f t t h e surviving family w i t h o u t m e a n s of s u p p o r t , and dire p o v e r t y o f t e n ensued. "Necessity is the m o t h e r of invent i o n , " and as a need arises, some m e a n s of s a t i s f y i n g t h a t need likewise develops. L i f e insurance came in response to a n e e d ; it did not arise because someone h a d a b r i g h t idea of setting up a new financial process. I t is interesting t o note, in this connection, t h a t in the U n i t e d States, which has experienced the g r e a t e s t indust r i a l d e v e l o p m e n t , t h e r e has likewise been built up t h e g r e a t e s t a m o u n t of life insurance p r o t e c t i o n . W e a r e not concerned at this time with t r a c i n g the d e v e l o p m e n t of life insurance f r o m its e a r l y beginning in historical sequence down to the p r e s e n t time, f o r I am sure you a r e all m o r e or less f a m i l i a r with the history of life insurance in this country. F o r instance, all of you doubtless k n o w t h a t the o r d i n a r y branch of the business h a d its beginning in the U n i t e d States in t h e period between 1759 and 1842, a l t h o u g h it p r o b a b l y was n o t until a f t e r 1880 t h a t the business o b t a i n e d a real d e g r e e of stability, b o t h in m a n a g e m e n t and distribution, a n d n o t until a f t e r the r e f o r m s following t h e A r m s t r o n g I n v e s t i g a t i o n in 1906 t h a t the institution became t h e t r u s t e d instrument of finance which we k n o w t o d a y . Likewise, we k n o w t h a t the d e v e l o p m e n t of industrial life insurance b e g a n with T h e P r u d e n t i a l A s s u r a n c e C o m pany, L t d . , in E n g l a n d , in 1854, and t o o k r o o t in t h e U n i t e d States d u r i n g the period between 1875 a n d 1879. I t w a s not until 1911 t h a t we find the introduction of g r o u p life insurance in t h e U n i t e d States, a n d n o t until 1919 t h a t the first y e a r of real production occurred, when t h e a m o u n t of such insurance in f o r c e w a s increased by o v e r a half a billion dollars.

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OUR B R O A D E N I N G C O N C E P T I O N OF L I F E I N S U R A N C E FUNCTIONS

T h r o u g h all these years there has been a continual development in our conception of the functions of life insurance. Originally, it was thought of simply as a burial f u n d . T h i s developed into the conception of a fund to be paid at death, sufficient in amount to clean up outstanding indebtedness as well as current expenses. It did not take men long to reach the conclusion, however, t h a t since life insurance was practical for the purposes just mentioned, it was likewise an ideal instrument f o r the creation of an estate for those dependent upon them. I t was as the result of a need for a reasonable income distribution of the estate so created that settlement options were devised and life insurance became recognized as an ideal method of estate distribution. H o w ever, since settlement options were a useful device to be applied to insurance at death, it soon became evident t h a t they were an equally happy device for the achievement of income in the old age of the insured himself. Consequently, we had the conception of life insurance as an instrument to achieve personal retirement. T h e n came the development of life insurance to indemnify business against the loss of life value in management. W i t h the advent of the Federal estate tax in the second decade of this century, men began to realize that life insurance was an ideal method for conserving a general p r o p e r t y estate subject to shrinkage by taxes, administration costs, etc. In the last twenty years the conception of life insurance as a highly desirable f o r m of property has spread widely among our people. T h e y discovered, when one applies the score of qualifications f o r a good investment to life insurance and to other forms of property, that life insur-

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ance outranks them all in its ability to produce not only emergency cash, but maximum guaranteed income at the times and in the emergencies when cash and income are most needed, namely, death, old age, disability, loss of business, or employment. T h e eight concepts as to the functions of life insurance just mentioned— Burial Fund Clean-up Fund E s t a t e Creation Income Creation Retirement Income Business Indemnification E s t a t e Conservation F o r m of Property can all be summarized in the two following fundamental ideas: 1. Life insurance is the application to the human life values of those procedures in economics which we customarily apply to property values, namely, Appraisal Capitalization Indemnification for loss Depreciation of value Liquidation Distribution 2. In the process of performing these services f o r the human life values, life insurance is directly or indirectly creative of new property values in f o u r ways, n a m e l y : T h r o u g h promotion of personal endeavor on the p a r t of the premium p a y e r ; through stimulation of systematic t h r i f t ; through provision of an ideal investment medium; and through the creation and maintenance of credit. D r . H u e b n e r has made a great many outstanding contributions to the institution of life insurance, but none of

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more practical value than the c r y s t a l l i z a t i o n of these t w o basic theorems, which h a v e now become cornerstones of our modern philosophy of l i f e insurance. T h e s e modern services of l i f e insurance necessitate both an educated public as well as educated life insurance representatives. T h e distribution of life insurance occurs in at least the f o l l o w i n g manners, n a m e l y : Policy peddling for undefined needs Single needs selling, or so-called p a c k a g e selling O r g a n i z e d p a c k a g e sales Programming E s t a t e analysis and conservation service W i t h the exception of policy peddling, all of these methods of distributing l i f e insurance require that life u n d e r w r i t e r s be t r a i n e d in a k n o w l e d g e of the services which life insurance affords. It is likewise necessary that we develop a public appreciation of the value of these services. PROGRESS IN L I F E I N S U R A N C E E D U C A T I O N

L e t us clearly recognize the outstanding w o r k that is done here at the W h a r t o n School in s p r e a d i n g the knowledge of what life insurance is and w h a t it does. I do not r e f e r only to those who specialize in insurance but r a t h e r I have in mind the whole body of students and Alumni of this School. T h e u n d e r s t a n d i n g of the functions and benefits of l i f e insurance by the people of P h i l a d e l p h i a and its environs, f o r example, is f a r g r e a t e r than the knowledge of life insurance in Boston and vicinity, w h e r e , until recently, there h a s been p r a c t i c a l l y no collegiate instruction in l i f e insurance functions and f u n d a m e n t a l s . M a y we even hope t h a t the time will come when the elementary principles of life insurance will be t a u g h t in our public schools.

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O n e of the objectives of the A m e r i c a n College of L i f e U n d e r w r i t e r s , with which you a r e all acquainted, is the p r o m o t i o n of insurance education in the schools, colleges a n d universities. Recently the H u e b n e r F o u n d a t i o n established certain fellowships, which many of you in this g r o u p hold, and this is an i m p o r t a n t step f o r w a r d in the dissemination of a better knowledge of life insurance a m o n g college students, and, t h r o u g h them, to the g r e a t A m e r i c a n public. A n o t h e r objective of the American College of L i f e U n d e r w r i t e r s is the p r o m o t i o n of the C. L . U . movem e n t — a n enterprise in which it has been gloriously successful. T o o long the masses of the American people have been economic illiterates, a l t h o u g h this condition has shown some recent i m p r o v e m e n t . T h e concept of " w e a l t h " as "income" r a t h e r t h a n as " c a p i t a l " (in other w o r d s the adoption of t h e E u r o p e a n conception instead of the traditional American idea of w e a l t h ) is one m a r k of a m o r e m a t u r e d people as opposed to an immature, pioneering people ( a l t h o u g h t h e r e m a y have been times recently when many of us wished we were still in the pioneering s t a g e ) . H o w e v e r , here the annuity f e a t u r e s of our business function perfectly. Both the life u n d e r w r i t e r s and the life insurance companies a r e thoroughly a w a k e to t h e requirements of the situation. T h i s is true in all branches of the business, w h e t h e r o r d i n a r y , industrial or g r o u p . Technical knowledge t o d a y is a sine qua non, and t o d a y agents in all the fields of distribution, o r d i n a r y , industrial and group, a r e acquiring knowledge and skill in its practical application to the problems of life a n d living. I know of no o t h e r business in which educational development is given so much attention as in the business of life insurance. T h e r e are constantly recurring educational courses and schools

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in agencies, conferences and conventions at head offices, home office schools, etc. Moreover, as you no doubt know, the L i f e Insurance Sales Research Bureau, which has just completed the first twenty y e a r s of its existence, is devoted to developing methods of distributing life insurance more effectively, at lower costs, to better serve the American people. l i k e wise, the American College of Life Underwriters, whose program of study and training culminates in the C. L . U . designation, has now had fifteen years of experience in promoting the cause of professional life underwriting. C O M P A R A T I V E M A R K E T S OF O R D I N A R Y , G R O U P A N D INDUSTRIAL AGENTS

Just as life insurance itself evolved out of the economic needs attendant upon a new type of civilization, so the development of the three great departments in the field of life insurance has grown out of a specialized need for the coverages they represent. Ordinary insurance in the United States has now behind it a history of over one hundred y e a r s ; industrial insurance more than sixty years; group insurance approximately thirty years. It is frequently thought by the uninformed that the fields of activity of the representatives of these three departments are sharply defined and mutually exclusive. Such, however, is not the case. The distributive services in all three departments overlap. T h e agent of the ordinary department, it is true, is limited to sales of ordinary insurance and perhaps to group insurance, if his company underwrites mass forms of insurance, but he never serves the largest m a r k e t — the buyer of weekly premium insurance. H e generally works on a purely commission basis.

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T h e representative of the g r o u p d e p a r t m e n t is limited to sales of mass f o r m s of insurance. Frequently, however, his w o r k is done in cooperation with agents of the o r d i n a r y or industrial departments, or even with independent insurance brokers who may have discovered the prospective buyer. H e is a salaried representative of the home office. Some g r o u p representatives are purely salesmen, but many of them are strictly service men. W h i l e he sells no ordinary insurance and no industrial business, the people who are protected by his policies a r e also buyers of individual contracts f r o m either the ordinary or the industrial agent. T h e agent in the industrial d e p a r t m e n t is the one agent in the life insurance field who may on different occasions sell o r d i n a r y , industrial and g r o u p insurance. In o t h e r words, his f u n d a m e n t a l charter or contract a u t h o r i z e s him to serve the entire m a r k e t of life insurance. H e is also compensated by a combination of salary and commissions, enjoying the a d v a n t a g e s and avoiding the disa d v a n t a g e s of either an all-commission or an all-salary plan. T h e o r d i n a r y branch of the business is o r g a n i z e d under either the general agency or the branch office m a n a g e r i a l system f o r the purpose f u n d a m e n t a l l y of meeting the insurance needs on an individual basis of t h e families in this country w h o enjoy an income in excess of $ 3 , 0 0 0 . U p o n occasion, of course, the representatives of the o r d i n a r y d e p a r t m e n t will serve the needs of t h e familyincome g r o u p who fall in the $2,000 to $ 3 , 0 0 0 class. I t is p e r f e c t l y s a f e to say t h a t the ordinary agent in this country is principally interested in these u p p e r income groups. T h e f u n d a m e n t a l function of the industrial agent is to serve t h e needs of those families receiving incomes of $ 1 , 0 0 0 t o $2,000, plus many of those families falling in

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the $2,000 to $3,000 group. Very often, however, his work carries him to the families having an income under $1,000. U p o n occasion he will find opportunity f o r serving people in the top-income group, namely, those enjoying incomes of $5,000 and over. R E L A T I V E S T A T U S OF T H E T H R E E B R A N C H E S

You may be interested in the following division of life insurance in the U n i t e d States at the end of 1940 among the three branches of this business. W e find that of the total amount of insurance in force, 68.8 per cent of it was on the ordinary f o r m ; 13 per cent on the group f o r m ; and 18.1 per cent on the industrial f o r m . Of the new business written during 1940, 58.2 per cent of it was ordinary, 13.0 per cent group, and 28.8 per cent industrial. It is interesting and significant to note that of the total ordinary insurance in force, 32 per cent of it was in force in industrial companies, and that of the total ordinary new business written in 1940, 38 per cent of it was sold by the industrial companies, which is indicative of a new trend in insurance purchases. T h e s e latter figures are important, when we consider that out of the total number of companies—365—selling life insurance in this country, only about one hundred of them sell industrial insurance and that there are n o t more than twelve or fifteen of these companies of substantial size; in fact, there are only f o u r industrial companies t h a t do business in N e w Y o r k State. I t is a bit surprising, therefore, to note t h a t 38 per cent of the total ordinary new business in 1940 was written by these few companies which do weekly premium business. A n o t h e r figure which may be of interest is one given by the L i f e Insurance Sales Research Bureau Census of

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A g e n t s as of A u g u s t 31, 1940. A t t h a t time the Bureau estimated t h a t t h e r e were 191,800 people h o l d i n g contracts t o sell life insurance in the U n i t e d States. O f this number 63.7 per cent held o r d i n a r y contracts and 36.3 per cent industrial contracts. T h e 6 9 , 6 0 0 people who held industrial contracts were on a full-time basis, but of those w h o held o r d i n a r y contracts, 50 per cent only were on a full-time basis, 18 per cent were on a p a r t - t i m e basis and 32 per cent held b r o k e r s ' contracts. W h i l e we a r e on statistics, you may be interested to know t h a t out of the total of a p p r o x i m a t e l y 3 , 0 0 0 , 0 0 0 calls m a d e daily by various life insurance representatives in this country, approximately 1,000,000 calls a r e wholly f o r service of existing policies and have nothing to do either with selling new insurance or with collecting p r e m i u m s on old insurance. W h e n we think of the distributive services of the life insurance companies I presume t h a t most of us naturally think of the o r d i n a r y agent since he is the one with whom people of our type come mostly into contact. H e has the respect of all of us in those cases w h e r e he has properly fitted himself to serve his clients. Some of us also know of the excellent w o r k that is done by the g r o u p representative w h o sells many f o r m s of mass insurance to manuf a c t u r i n g and business concerns. H o w e v e r , I suppose relatively few of us realize t h a t t h e r e are ten or a dozen well-recognized f o r m s of g r o u p insurance and t h a t new f o r m s a r e being developed almost yearly as new needs f o r mass f o r m s of coverage a r e discovered. INDUSTRIAL I N S U R A N C E F R E Q U E N T L Y MISUNDERSTOOD

M o s t u n f o r t u n a t e l y , however, it seems to me t h a t the distributive service of the industrial d e p a r t m e n t has been grossly u n d e r r a t e d and even at times u n f a i r l y maligned.

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I t is alleged that the cost of weekly premium insurance is greater than it should be f o r the service rendered. I am convinced that such is not the case. T h e distribution of life insurance is often compared with the distribution of a commodity such as coal. You and I know t h a t large manufacturing plants and big users of coal, buy what is known as bunker coal and buy it at a very low price. T h e ordinary householder, however, buys his coal by the ton and pays f o r it a much higher price than the concern which buys the bunker coal in carload lots. D o we think that this householder was cheated because he paid more per t o n ? W e likewise know that among people of very small means who perhaps live on the upper floors of tenement houses, there is not money enough available to buy coal by the ton, so it is bought by the bag. Let us suppose that this tenement-house dweller pays $1.00 for a 100-pound bag. D o we believe that this tenement-house dweller was robbed because he paid much more per hundred pounds than the householder who bought his coal by the ton, or do we assume that the cost of delivery and special service justified the extra cost? So it is in the distribution of life insurance. The cheapest f o r m of life insurance sold in terms of death benefit is that sold by the group department. I t is comparable to the bunker coal that is sold in big lots to the manufacturing plant. T h e ordinary insurance is comparable to the ton or five tons of coal sold to the householder. T h e weekly premium or industrial policies are analagous to the 100-pound bag of coal sold to the tenement-house dweller. I t costs money to make fiftytwo collections a year at the homes of the buyers, with possibly a number of back calls f o r each one of those fifty-two regular calls. Let us remember, too, t h a t the mortality h a z a r d assumed is greater among the industrial workers than the

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m o r t a l i t y h a z a r d a s s u m e d w h e n an insurance c o m p a n y sells a white-collar w o r k e r . L e t us likewise r e m e m b e r t h a t some industrial c o m p a n i e s a f f o r d t h e i r policyholders f r e e nursing service a n d o t h e r h e l p f u l services f o r the p r o l o n g a t i o n of life and i m p r o v e m e n t of living conditions. T h e i m p o r t a n t thing, h o w e v e r — e v e n m o r e i m p o r t a n t t h a n any of the things I h a v e m e n t i o n e d — i s t h a t it is not a case of w h e t h e r t h e cost of insurance is high or low, but r a t h e r w h e t h e r this g r o u p is t o h a v e life insurance or is not to have life insurance. L e t us m a k e no m i s t a k e a b o u t t h a t . T h e typical buyer of weekly p r e m i u m insurance cannot get t o g e t h e r an a n n u a l p r e m i u m , a semi-annual, o r even a q u a r t e r l y p r e m i u m . If he is t o h a v e insurance at all, he must pay f o r it at weekly intervals. In course of time he builds up a considerable equity in his insurance policy, and t a k i n g t h e typical policyholder in t h e mass, it is certain t h a t in times of g r e a t emergency this equity is not only of considerable help to the w e l f a r e of t h a t insured and his family, but likewise results in a real service to the whole n a t i o n . A s the p r e s i d e n t of my company has so aptly described it, " I n d u s t r i a l insurance is the p o o r box of o u r p a r i s h . " I t is not alone in m a t t e r s of life insurance t h a t the weekly p r e m i u m a g e n t serves his p e o p l e — i t is to him they look f o r advice in m a n y business emergencies and he becomes in n u m b e r l e s s cases a t r u e counsellor of the family. T h e r e are m a n y m e n on the debits in this country who are r a n k e d by t h e i r people as t r u e f r i e n d s and benefactors, along with t h e p a r i s h priest a n d t h e neighb o r h o o d doctor. M a y I especially c o m m e n d t o the attention of you people w h o a r e p r e p a r i n g t o teach life insurance in the v a r i o u s colleges and universities, the desirability of acquainting yourselves fully with a k n o w l e d g e of the i m p o r t a n t services r e n d e r e d by the weekly p r e m i u m d e p a r t m e n t to the g e n e r a l public.

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H e r e let us consider f o r a few minutes where we now stand in the distribution of life insurance and what the f u t u r e holds. F o r this purpose we shall find Charts N o . 1 and N o . 2 most interesting in disclosing the complete realignment of optional spending power among different classes of our population today as compared with five or six years ago. In 1935-36 our national income was approximately sixty billions of dollars ( $ 6 0 , 0 0 0 , 0 0 0 , 0 0 0 ) . T h i s income was distributed as follows among 39,458,300 consumer units, a consumer unit being defined as a family or an individual maintaining an independent economic status. Group A B C D E

No. in Group 927,000 1,818,000 4,434,000 13,920,000 18,359,000

Per Cent of Population 2.4 4.6 11.2. 35.3 46.5

Income Over $5000 $3000-$5000 $2000-$3000 $1000-$2000 Under $1000

In 1942 the national income will be approximately one hundred billions of dollars ( $ 1 0 0 , 0 0 0 , 0 0 0 , 0 0 0 ) . This anticipated income, according to the most reliable estimates, will be distributed to 38,800,000 consumer units. Assuming t h a t the aggregate income is divided among five groups ranged according to size of income, each group containing the same proportion of total consumer units as in the 1935-36 distribution, it is estimated that the range of income f o r each group will be as follows: Group A B C D E

No. in Group 911,000 1,788,000 4,360,000 13,688,000 18,053,000

Per Cent of Population 2.4 4.6 11.2 35.3 46.5

Income Over $7370 $4900-$7370 $3720-$4900 $1980-$3720 Under $1980

COMPARATIVE DISTRIBUTION SERVICES

179

SIGNIFICANT CHANGES IN EXPENDITURES OF D I F F E R E N T INCOME GROUPS

C h a r t N o . 1 shows how each of the g r o u p s w h o shared the sixty billions of d o l l a r s spent t h a t income in 1935-36. C h a r t N o . 2 shows how it is assumed t h a t identical percentages of the population will spend their share of the increased national income of one h u n d r e d billions of dollars in 1942. T h e following a r e the direct comparisons by g r o u p s : Group

A—

In 1935-36, those in G r o u p A, receiving over $ 5 , 0 0 0 , averaged to s p e n d : $ 4 , 5 5 9 f o r w h a t we t e r m "Basic Living C o s t s " — f o o d , clothing, shelter and medical care—indicated by the white base of the first section of C h a r t N o . 1. T h e y a v e r a g e d to spend : $ 7 9 9 in taxes, indicated by the black block at t h e top of the first section of C h a r t N o . 1. T h i s l e f t t h e m t o spend as they pleased f o r such items as automobiles, recreation, education, luxuries, savings and insurance, an a v e r a g e o f : $ 7 , 2 2 4 which is indicated by the shaded area of the first section of C h a r t N o . 1. In 1942, this 2.4 per cent of t h e population which represents the highest income g r o u p , will receive m o r e than $ 7 , 3 7 0 . T h i s g r o u p will a v e r a g e t o s p e n d : $ 5 , 4 7 1 f o r basic living costs—indicated by the white base of t h e first section of C h a r t N o . 2.

180

HUEBNER FOUNDATION

LECTURES

AN ESTIMATE OF HOW AMERICAN INCOME AND 1935-36

AVERACC CROIS N I COME TTq» TAXCJ i

TOTAL OPTIONAL SPENDING

POWER

BILLIONS or DOLLARS

¿4SS9RASIC LIVINC COSTS VIM

INCOC M E C RE OUPS A B C O N SU M 181*000 U N IT « R 927,000 4.4J4000

EXPLANATORY D A T A

REGARDING

CHARTS

In 1935-36 our national income w a s approximately sixty billions of d o l l a r s ; the National Resources Committee estimated that this income w a s distributed among the 3 9 , 4 5 8 , 3 0 0 consumer units ( a consumer unit is a f a m i l y or an individual maintaining an independent economic status) in about the manner illustrated by C h a r t No. 1. In this chart the w i d t h of each bar represents the number of consumer units in that income group and the height of the bar represents the average gross income of the members of the group. T h e black portion at the top of each bar represents the estimate

C O M P A R A T I V E D I S T R I B U T I O N SERVICES

181

SPENDING POWER HAVE CHANGED IN SIX YEARS 1942

CHART Na 2

of the average tax paid by the members of each group. T h i s tax estimate includes Federal and State income taxes, poll taxes, and certain personal property taxes. W e have grouped several essential items of living costs together, calling their total, Basic Living Cost. Basic Living Cost comprises expenditures for food, clothing, shelter, and medical care. T h e figures used in C h a r t No. 1 are estimates by the National Resources Committee growing out of a survey of 300,000 families. T h e balance obtained by subtracting taxes and basic living costs f r o m gross income has been called "optional spending power."

182

HUEBNER FOUNDATION

LECTURES

T h e y will average to s p e n d : $ 3 , 1 9 6 f o r taxes, indicated by the black block at the top of the first section of Chart N o . 2. T h i s will leave them an average o f : $ 6 , 2 0 3 f o r optional spending p o w e r — i n d i cated by the shaded area of the first section of Chart N o . 2. T h i s represents a reduction in a v e r a g e optional spending power of $ 1 , 0 2 1 . Group

B—

N o w , take Group B, 4.6 per cent of the population, which in 1 9 3 5 - 3 6 had an average income of f r o m $ 3 , 0 0 0 to $ 5 , 0 0 0 . O f this amount, they a v e r a g e d to s p e n d : $ 2 , 1 6 8 for basic living costs, indicated by the white base in the second section of Chart N o . 1 ; and— $ 2 0 f o r taxes, indicated by the black block at the top of the second section of Chart N o . 1; which l e f t t h e m —

This is the portion of income that may be used for automobile, recreation, education, all luxuries, savings and insurance. It has been estimated that our national income in 1942 will be approximately one hundred billions of dollars. Federal individual income taxes alone will probably rise to between four and five billions. Basic living costs have risen, since 1936, about 20 per cent. Just how the new larger income will be distributed cannot, of course, be forecast with scientific accuracy. There are indications, however, that the new added income has not followed the 1935-36 pattern, but has been distributed more largely among the middle and lower economic groups. One estimate of the 1942 distribution is shown in Chart No. 2. In this chart the income groups, Ai, Bi, Ci, Di, Ei, represent, in each case, the same per cent of the total as the corresponding groups A, B, C, D, and E in Chart No. 1.

C O M P A R A T I V E D I S T R I B U T I O N SERVICES

183

$1,466 to spend as they pleased. This optional spending power is indicated by the shaded area of the second section of C h a r t N o . 1. In 1942, this 4.6 per cent of the population will receive f r o m $4,900 to $7,370, in place of incomes averaging f r o m $3,000 to $5,000. This group will average to spend: $2,602 for basic living costs, indicated by the white base in the second section of C h a r t No. 2; and— $380 f o r taxes, indicated by the black block at the top of the second section of C h a r t N o . 2; which will leave them an average o f — $2,734 f o r optional spending power—indicated by the shaded area of the second section of C h a r t N o . 2. This represents an increase in average optional spending power of $1,268. Group

C—

Now, look at G r o u p C, 11.2 per cent of the population, which in 1935-36 had an average income of f r o m $2,000 to $3,000. Of this amount they averaged to spend: $1,594 f o r basic living costs, indicated by the white base in the third section of Chart N o . 1; and— $9 for taxes, indicated by the black block at the top of the third section of C h a r t N o . 1; which left t h e m — $ 7 8 2 to spend as they pleased. This average optional spending power is indicated by the shaded area of the third section of C h a r t No. 1.

184

HUEBNER FOUNDATION LECTURES

In 1942, this 11.2 per cent of the population will receive f r o m $3,720 to $4,900, in place of incomes averaging f r o m $2,000 to $3,000. T h i s group will average to s p e n d : $1,913 f o r basic living costs, indicated by the white base in the third section of C h a r t N o . 2; and— $210 for taxes, indicated by the black block at the top of the third section of C h a r t N o . 2; which will leave them an average o f — $2,128 f o r optional spending power—indicated by the shaded area of the third section of C h a r t N o . 2. T h i s represents an increase of $1,346 in average optional spending power. Group

D—

T h i s group comprising 35.3 per cent of the population in 1935-36 had an average income of f r o m $1,000 to $2,000. Of this amount they averaged to spend: $1,077 for basic living costs, indicated by the white base in the f o u r t h section of C h a r t N o . 1; and— $5 f o r taxes, indicated by the black block at the top of the fourth section of C h a r t N o . 1; which l e f t t h e m — $ 3 2 4 to spend as they pleased. T h i s average optional spending power is indicated by the shaded area of the f o u r t h section of C h a r t N o . 1. In 1942, this 35.3 per cent of the population will receive f r o m $1,980 to $3,720, in place of incomes aver-

C O M P A R A T I V E D I S T R I B U T I O N SERVICES

185

aging f r o m $1,000 to $2,000. T h i s group will average to s p e n d : $1,292 for basic living costs, indicated by the white base in the f o u r t h section of C h a r t N o . 2; and— $53 for taxes, indicated by the black block at the top of the f o u r t h section of C h a r t N o . 2; which will leave them an average o f — $1,435 f o r optional spending power—indicated by the shaded area of the fourth section of C h a r t N o . 2. T h i s represents an increase in average optional spending power of $1,111. Group

E—

T h i s group with 46.5 per cent of the population in 1935-36 had an average income of under $1,000. Of this amount they averaged to spend: $562 for basic living costs, indicated by the white base in the fifth section of C h a r t N o . 1; and— $3 f o r taxes, indicated by the black block at the top of the fifth section of C h a r t N o . 1; which left t h e m — $24 to spend as they pleased. T h i s average optional spending power is indicated by the shaded area of the fifth section of C h a r t N o . 1. In 1942, this 46.5 per cent of the population will have an average income of under $1,980, in place of an average income of under $1,000. T h e y will average to spend: $ 6 7 4 for basic living costs, indicated by the white base in the fifth section of C h a r t N o . 2;

186

HUEBNER FOUNDATION LECTURES

and— $10 f o r taxes, indicated by the black block at the top of the fifth section of C h a r t N o . 2; which will leave them an average o f — $415 f o r optional spending power—indicated by the shaded area of the fifth section of C h a r t N o . 2. T h i s represents an increase in average optional spending power of $391. T H E OPTIONAL SPENDING POWER SITUATION

You will note differences in total optional spending power as indicated by the shaded blocks in the open areas on C h a r t s N o . 1 and N o . 2. T h e s e differences may also be summarized in tabular f o r m as follows: TOTAL OPTIONAL SPENDING POWER 1935-36 (billions) $6.7 2.7 3.5 4.5 0.4

Group A B C D E Total

$17.8

Group

1942 (billions)

Ai B, G D, Ei

$5.7 4.9 9.3 19.6 7.5 Total

$47.0

F r o m the above figures, it will be noted that in 193536 the D group, comprising approximately 13,920,000 consumer units, had a total optional spending power of $4,500,000,000. In 1942 the comparable group of approximately 13,688,000 consumer units will have a total optional spending power of $19,600,000,000. In 1935-36, the C group, comprising approximately 4,434,000 units, had a total optional spending power of $3,500,000,000. In 1942 the comparable group of 4,360,000 units will have a total optional spending power of $9,300,000,000.

COMPARATIVE D I S T R I B U T I O N SERVICES

187

In 1935-36, the E g r o u p , comprising approximately 18,359,000 units, had a t o t a l optional spending p o w e r of $ 4 0 0 , 0 0 0 , 0 0 0 . In 1942 the comparable group of 18,053,000 units will have a t o t a l optional spending p o w e r of $ 7 , 5 0 0 , 0 0 0 , 0 0 0 . In 1935-36 the A g r o u p , comprising approximately 9 2 7 , 0 0 0 units, had a t o t a l optional spending power of $6,700,000,000. In 1942 t h e c o m p a r a b l e g r o u p of 9 1 1 , 0 0 0 will have a t o t a l optional spending power of $5,700,000,000. In 1935-36 the B g r o u p , comprising approximately 1,818,000 units, h a d a t o t a l optional spending power of $2,700,000,000. In 1942 the c o m p a r a b l e group of 1,788,000 will have a t o t a l optional spending power of $4,900,000,000. T h e r e f o r e , the increases in income, in taxes and in basic living costs have b r o u g h t about a complete realignment of optional spending p o w e r . In 1935-36 the l a r g e s t t o t a l optional spending power was found in G r o u p A , r e p r e s e n t i n g 2.4 per cent of the population ( 9 2 7 , 0 0 0 u n i t s ) . T h e largest total optional spending power is now f o u n d in G r o u p D , representing 35.3 per cent of the population ( 1 3 , 6 8 8 , 0 0 0 u n i t s ) . T h e complete realignment makes the following changes in optional spending p o w e r : OPTIONAL SPENDING POWER 1935-36 (billions)

Group A D

$6.7 4.S 3.5 2.7 0.4

C

B E Total

$17.8

REALIGNMENT 1942 (billions)

Group

Di Ci

$19.6 9.3 7.5 5.7 4.9

E, Ai Bi Total

$47.0

188

HUEBNER FOUNDATION LECTURES

T h e s e figures show us in summary that where in 193536 G r o u p A had $1.00 optional spending power, in 1942 it will have 86 cents; t h a t where G r o u p B had $1.00 it will now have $1.86; that where G r o u p C had $1.00 it will now have $2.72; that where G r o u p D had $1.00 it will now have $4.43; and that where G r o u p E had $1.00 it will now have $17.29. In other words, Groups D and E combined, which account f o r 81.8 per cent of all consumer units, will have $5.53 optional spending power this year, where they had only $1.00 in the years 1935-36. T h e s e figures represent a tremendous shift in relative incomes. T h e y represent not only changed economic conditions due to defense and war activities but also they are a result of the new philosophy as to redistribution of national income and wealth. P R O B A B L E E F F E C T S OF I N C O M E C H A N G E S O N L I F E INSURANCE

DISTRIBUTION

H o w will these changes affect the life insurance business as regards the relative distributive services of the ordinary, industrial and group divisions of the business? I t seems probable to me that a larger percentage of the total insurance sold will be sold by the industrial and group departments than formerly because these departments are particularly organized to provide coverage f o r the D and E groups in our population. I think it probable that the industrial agents who write ordinary insurance as well as weekly premium insurance will in the future write a larger percentage of the total amount of ordinary insurance sold than hitherto. I think it is very possible that the average sized case sold by the agent of the ordinary department will decrease. I think, also, the ordinary agent will write a larger number of cases. I think it is equally possible t h a t the average sized

COMPARATIVE DISTRIBUTION SERVICES

189

o r d i n a r y case sold by the industrial agent will increase. I anticipate t h a t all f o r m s of m a s s insurance sold by the g r o u p d e p a r t m e n t will greatly expand in volume. Both t h e relatively poor man and t h e relatively rich m a n are g o i n g to desire l a r g e r g r o u p coverage, in my j u d g m e n t , because of its lower cost. All of these changes will present difficult r e o r g a n i z a tion p r o b l e m s within the life insurance business. D u r i n g the p a s t six or seven years t h e r e has occurred a m a r k e d s h r i n k a g e in the number of agents operating u n d e r fulltime contracts in the o r d i n a r y d e p a r t m e n t , and I think it is possible t h a t this tendency m a y be accelerated by the s h i f t in optional spending power which we have discussed. I anticipate t h a t there will be a very considerable expansion in the g r o u p and o t h e r mass f o r m s of insurance, requiring a l a r g e r personnel. I t may be t h a t we shall see in some areas an expansion in the sales force of the industrial p a r t of our business.

A N T I - I N F L A T I O N A R Y SERVICE O F L I F E I N S U R A N C E

I n r o u n d figures, we know t h a t the American people this year will have thirty billion dollars m o r e of optional spending p o w e r t h a n they h a d five or six years ago. W e likewise know t h a t because of the necessities of p r o d u c t i o n f o r w a r , the a m o u n t of normal consumer g o o d s will be g r e a t l y restricted. H e r e i n lies a menace to o u r national w e l f a r e , since out of such a condition d a n g e r o u s inflation could arise. E v e n t h o u g h the Congress enacts a tax bill designed to a b s o r b much of this additional spending power, and even t h o u g h some f o r m of compulsory saving may be enacted into legislation, t h e r e probably will still remain heavy excess f u n d s in the hands of the people when m e a s u r e d against t h e quantity of goods available f o r purchase.

190

HUEBNER FOUNDATION

LECTURES

T h i s situation offers a challenge to the life insurance companies and their representatives in all three divisions of the business, and in it they will find an opportunity to render a great service to their country by inducing the average person to put a larger portion of his surplus dollars into Government bonds and also into the other soundest investment we k n o w — L i f e Insurance. A t this time I am making no prophecy as to what may happen when eventually this war is over and the problems of the readjustment and reconstruction era are upon us except to say that this war must eventually be paid f o r and that can only result in higher taxes and a reduced scale of living. H o w e v e r , our job today is to carry on and to win this war. T o this purpose life insurance companies are dedicating their best efforts, and through the purchase of Government obligations in large amounts will help to finance the war. L i f e insurance men will do their part also, now, as in the last war, both in service to the country and in the buying and selling of bonds. America must win.

Sources consulted in preparing the charts for this address were: Publications of the National Resources Committee. The National Industrial Conference Board. The Federal Reserve Bulletin. U. S. Federal Income T a x Law. Temporary National Economic Committee, Monograph "Who Pay the Taxes?"

ORGANIZATION AND FUNCTIONS OF THE AGENCY IN MODERN LIFE INSURANCE DISTRIBUTION by Joseph H . Reese General Agent,

The Penn Mutual

Life Insurance

Company

INTRODUCTION

I

T is not my purpose to lengthen the discussion unnecessarily this evening by an attempt to a n a l y z e the importance o f the distribution system in our economy. I believe, h o w e v e r , it is important to recognize that if a product contributes to the well-being or social progress o f people, methods must be devised to make them realize the a d v a n t a g e s and w a y s in which it can be used as effectively as possible. W i t h o u t an adequate and satisfactory distribution system, the value o f any product becomes purely academic and its practical use limited solely to a chosen f e w . V i r t u a l l y e v e r y t h i n g we possess has been sold to us or our f a t h e r s in one fashion or another f r o m the beginning o f time. O n the life insurance agencies fall virtually all the basic responsibilities inherent in the transition o f life insurance f r o m an academic idea to a practical, w o r k a b l e contribution to economic stability. T h e evolution o f the agency in the distribution field o f life insurance provides as interesting and fascinating a study as the development and functioning of the modern family as a distinctive unit o f society. A l t h o u g h my subject tonight is neither history nor evolution, any study of the o r g a n i z a t i o n and functions o f the modern life in191

192

HUEBNER FOUNDATION LECTURES

surance a g e n c y n e c e s s a r i l y r e q u i r e s some e x a m i n a t i o n of its antecedents so t h a t a r e a l a p p r e c i a t i o n of the trend in m a r k e t i n g l i f e insurance m a y be d e v e l o p e d . T h e contact point of the institution of life insurance with society a t l a r g e is, in r e a l i t y , the a g e n t . W h i l e some l i f e insurance is d i s t r i b u t e d without the services of an a g e n t , the a m o u n t r e p r e s e n t s such a n e g l i g i b l e portion of the insurance o w n e d by the A m e r i c a n public, t h a t a t the m o m e n t w e can d i s r e g a r d it. In view of the fact, t h e r e f o r e , t h a t the a g e n c y ' s p r i m a r y o p e r a t i o n is to deal with and t h r o u g h a g e n t s , it is p r o b a b l e that some brief e x a m i n a t i o n of the c h a r a c t e r and function of the agent m i g h t be in o r d e r . A s an i n d i v i d u a l , he h a s been a n a l y z e d , v i s u a l i z e d , criticized a n d defined by m a n y persons f r o m e v e r y conceivable point of v i e w . J o h n A . Stevenson, P r e s i d e n t of the Penn M u t u a l L i f e Insurance C o m p a n y , r e f e r s to t h a t c o m p a n y ' s a g e n c y force a s " O u r T r u s t e e s in T h e F i e l d . " H e h a s pointed out t h a t w h a t e v e r p r e s t i g e the C o m p a n y m a y possess w i t h the A m e r i c a n public is l a r g e l y in the h a n d s of the a g e n c y force. T h e a g e n t himself is a composite picture of w h a t some i n d i v i d u a l s feel a r e opposites, in t h a t his c a l l i n g h a s all the a t t r i b u t e s of the true profession, y e t he must also be a " s a l e s m a n . " He must b r i n g to his w o r k a high d e g r e e of i d e a l i s m a n d skill c o m p a r a b l e to the i d e a l i s m a n d skill r e q u i r e d of the doctor or l a w y e r in d e a l i n g with m a t t e r s c e r t a i n l y of the most confidential n a t u r e . H i s ethical s t a n d a r d s must be, and a r e , p r o d u c t i v e of h i g h - g r a d e w o r k . A t the point w h e r e the economic need f o r l i f e insurance becomes acute, it is u s u a l l y too l a t e f o r the services of the l i f e insurance m a n . H e must t h e r e f o r e assume a v e r y serious responsibility closely a n a l o g o u s to t h a t of the m i n i s t e r in p r e a c h ing the g o s p e l — h i s m e s s a g e s being the gospel of preventing the t r a g i c consequences of i m p r o v i d e n c e .

AGENCY ORGANIZATION

193

FORMATIVE YEARS

Previous to the formation o f a group o f now prominent life insurance companies in the 1 8 4 0 ' s , there existed no actual solicitation o f life insurance as we now understand this t e r m . L i f e insurance institutions were established but passively waited for business to come to them. Such life insurance as was written was largely secured through the incidental activities o f lawyers and financial men in the local communities. T h e period f r o m 1 8 4 0 to the Civil W a r witnessed the gradual development of life insurance selling in this country. W i t h the formation o f many new companies in the early part o f this period, there was gradually stimulated an interest in the selling o f life insurance as a full-time j o b . T h e r e existed virtually no agencies in the modern concept. Gradually, however, individuals serving communities f o r the more aggressive life insurance companies acquired the right to appoint sub-agents. T h u s was created the embryo o f what we know today as the American Agency System. During the Civil W a r period, and immediately therea f t e r , the wide-spread adoption o f the agency principle infused new life into the life insurance business. I t provided a generating force producing a new life and vitality to public ^acceptance. Its effect was much like the introduction o f motive power in a becalmed sail boat. A t this" point begins the real significance o f the agency in the distribution picture. T h e recruiting o f agents and the gradual acknowledgment o f responsibility in the crea-, tion o f training facilities were the true and primary functions of the agency leader. I t is true that, in the early days, training was quite superficial; the new man acquired his knowledge f r o m the reading o f articles describing life insurance, through pamphlets issued by the companies and by practice in the field. Company activities during this period were largely devoted t o the expansion o f the

194

HUEBNER FOUNDATION LECTURES

agency principle into a national system. Modern marketing and sales management principles had little part in this organizational effort. Competition was savage and largely based on the arithmetical factors of cost and speculative contracts. It was natural, under these conditions, that many vicious practices became prevalent and the growth achieved resulted largely from the inherent merit of the product plus a not too creditable degree of pressure salesmanship. New philosophies are rarely born overnight. They represent in most cases a trend created by far-seeing individuals who gradually develop acceptance of their views, and who triumph over the unfavorable practices of the past. Nevertheless, if a single incident can establish a major change in trend, the Armstrong Investigation in New York (1906-07) represented the birth of a new era. The period from 1907 to 1941, with minor setbacks in the early depression years of the 1930's, represented the greatest period of life insurance development. T h e application of sound marketing principles really dates from this period. Many individuals contributed substantially to the efforts designed to lift life insurance selling into the present concept of a professional endeavor. Research and education became the new theme in agency development. D r . Huebner, the late Edward A. Woods, D r . John A. Stevenson and many others were representative of the leaders of thought in this period of growth. They contributed a wealth of ideas as well as inspiration and enthusiasm to a field quite receptive to this new ideology. Educational courses for life insurance selling in collegiate environment had their birth and grew. Many outside influences contributed to the transition in methods. Marketing and merchandising methods in other

AGENCY ORGANIZATION

195

industries were being subjected to scientific analysis and improvement and it was inevitable t h a t life insurance should be influenced immeasurably by advanced thought in this r e g a r d . T h e impact of economic and political factors such as the first W o r l d W a r , the subsequent financial boom and the safety record of life insurance during the early 1930's created the greatest upsurge of public acceptance in the history of the business. T h e internal leadership in the life insurance business recognized and made a serious effort to meet the obvious need f o r a technological development in management methods, and many cooperative groups were established in the interest of progressive research in the distribution field. T h e Association of Life Insurance Presidents, the Association of Life Agency Officers, the local general agents' groups and agents' organizations, such as the N a tional Association of L i f e Underwriters, although actually f o r m e d in some cases prior to this period, established their greatest influence in developing public acceptance of the agent's proper place in serving the requirements of modern life insurance needs. M a n y collateral organizations, functioning with and without the sponsorship of life insurance companies, contributed much to this educational advancement. T h e L i f e Insurance Sales Research Bureau, the American College of Life U n d e r w r i t e r s and the Institute of L i f e Insurance are examples of institutions which have played a prominent p a r t in the field of life insurance education. Privately developed educational service organizations aided materially in providing agency leaders with the equipment f o r better training. Insurance periodicals, the Research and Review Service, the D i a m o n d L i f e Bulletins and even such business publications as those of Prentice-Hall and

1%

HUEBNER FOUNDATION LECTURES

the Commerce Clearing H o u s e devoted many pages of space to the advancement of the agent's professional capacity. SYSTEMS OF DISTRIBUTION

In the main, life insurance sales organizations fall into two general classifications—general agencies and managerial agencies. In a word, managerial agencies are direct branch offices of the company under the leadership of a salaried manager who retains no financial equity in the agency as a business enterprise. All expenses incident to its operations are defrayed by the company itself, profits a n d / o r losses reverting to the same source. T h e general agency, on the other hand, is in a sense an independent business owned and operated by the general agent under a contractual relationship with the company. T h e expense problems are his as well as the profits or losses. However, in operation, the two types of agencies differ so slightly that I believe we are safe in treating them alike insofar as their set-up and functions are concerned. Before examining the modern agency, a brief word might be in order regarding distribution methods in use independent of the agency system. Probably the outstanding example of over-the-counter selling is that of the oldest life insurance company in existence, the Equitable L i f e Assurance Society of England. T h e year before the second W o r l d W a r , when close to 180 years old, it sold less than 2,000 life insurance policies which might be contrasted with the 4,677 life insurance contracts sold by my own agency in 1941 (not a particularly good y e a r ) . It becomes obvious that even the prestige of its venerable old age has not been sufficient to provide wide public acceptance of the merits of its service to the community. T h e mails have also been used to distribute life insur-

AGENCY ORGANIZATION

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ance. T h e best known company in this country using t h a t method o f distribution wrote but $ 3 , 6 0 0 , 0 0 0 o f business nationally in 1 9 3 8 . Again if contrast may be used, I point to the fact that in that year my own agency here in Philadelphia paid f o r approximately $ 1 8 , 0 0 0 , 0 0 0 . One o f our large mail order houses, with some 1 0 , 0 0 0 , 0 0 0 regular customers and 4 0 , 0 0 0 employees, attempted the distribution o f life insurance by the justly famous catalogue m e t h o d . A f t e r four years o f experiment, as a result o f the lack o f success o f this method, it discontinued sales. Savings bank life insurance ( a subject undoubtedly o f independent study by you) at this writing has had a history o f some thirty years o f operation in M a s s a chusetts and several years in N e w Y o r k State. Connecticut also has provided by law f o r this form o f distribution. In O c t o b e r of 1 9 4 0 , there was approximately $ 1 9 1 , 5 0 0 , 0 0 0 face value o f savings bank life insurance in force. A g a i n , f o r the sake o f contrast, at the present writing my own local agency has approximately $ 2 6 5 , 0 0 0 , 0 0 0 o f life insurance in force. T h i s comparison is not entirely a f a i r one because many other factors would have to be taken into consideration—population density and limitations o f individual volume, as well as the contribution o f the services o f the life insurance man himself. I t would seem to indicate, however, that the savings bank method o f distribution lacks any f a c t o r o f tremendous public appeal and certainly a direct examination o f the two methods would develop an appreciation o f the advice and counsel which a competent life underwriter renders. T h e s e constitute the essential distributive mediums outside the agency system unless we are to include Government w a r risk insurance and social security as a p a r t o f our study.

198

HUEBNER FOUNDATION LECTURES T H E MODERN LIFE INSURANCE AGENCY

It can readily be seen f r o m the brief historical matter presented up to now, that the modern life insurance agency is distinctly a product of evolution and as long as the appreciation f o r life insurance grows among civilized people, it is probable that the agency, as such, will have an important function to p e r f o r m . F o r this reason any organization chart would represent merely a momentary glance at one particular point in this process of evolution. It must be recognized that in such a glance we will see many functions which, like T o p s y in "Uncle T o m ' s Cabin," have "just growed." T h e r e will be other functions that have been superimposed on the agency's responsibilities by the impact of the leaders of today's generation. In addition we will see some functions which, at the moment, are merely in the embryonic stage and may not reach the fulfilment of their effectiveness f o r many years to come, or conceivably may disappear as the result of changes in methods impossible to foresee today. T h e introduction of war into the picture unquestionably clouds the view of the morrow to such an extent t h a t the projection of long-range planning is difficult, if not utterly impossible. Social experiments, like little clouds on the horizon, may contribute to or utterly destroy the convictions held by the leaders in the distribution of life insurance today. I t is my purpose to submit f o r your consideration some organizational charts, attempting to break down in what might appear to be a very mechanical way, the organization and functions of a modern life insurance agency. In doing this I am conscious of the danger of destroying the most important characteristic of a life insurance agency, namely its dynamic personality. T h e agency must personify action. I t does not open at nine o'clock and

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close at four-thirty. I t s representatives are literally in action around the clock. I t is furthermore necessary in presenting material on this subject to recognize t h a t the essential functions o f an agency are not altered by size or locality. I t is true t h a t the treatment o f these functions conceivably may vary somewhat between a metropolitan and a rural agency. A degree o f specialization may produce variations. T h e s e , however, are subjects f o r an entirely different study than we are attempting here. T h e well organized agency has become very definitely a business distribution machine. T h e allocation o f responsibilities among the personnel is the only f a c t o r a f fected by the size o f the agency. M a n y varying duties assumed as a m a t t e r o f course by the general agent himself in the smaller agency develop into separate operating departments in the larger agency, and the general agent in the larger agency gradually assumes more o f the functions o f the pure executive in his direction o f the agency's operations. In the charts which I will explain in some detail, the only basic change in operations f r o m the small to the large agency is illustrated by the introduction o f a staff executive committee and unit divisions o f agents providing the flexibility and direction needed in the large agency. T h e factors t h e r e f o r e applicable solely to the large agency have been surrounded by dotted lines where shown in the c h a r t . F o r all practical purposes, the organization o f the small agency's activities in all respects is identical with that o f the l a r g e agency even though the general agent o f the small agency, o r one o r more o f his assistants, may have to assume responsibilities in several segments o f the so-called departmentalization. Technically, the agency is a happy combination o f line and functional organization. F r o m the general agent t o

200

HUEBNER FOUNDATION LECTURES

ORGANIZATION AND FUNCTIONS CHART THE MODERN LIFE INSURANCE A G E N C Y GENERAL AGENT OR MANAGER Business Executive Sales Manager Organisation Director Inspirational Leader Public Relations Control

INFORfAAL AGENTS' ADVISORY COMMITTEE

SECRETARY A N D / O R EXECUTIVE ASSISTANT

For maintenance of direct agent reaction on Agency1s policies and project« (revolving)

Responsibility for execution of a l l details and supervision of O.A.'s tins

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STAFF " EXECUTIVE COMMITTEE

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Advisory Board on Agency Policies

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X INSTITUTIONAL

SALES

FUNCTIONS

( f o r these functions, see Chart N o . 2 )

DISTRIBUTION

FUNCTIONS

( f o r these functions, see Chart N o . 3 )

DIRECT SUPERVISION Field Training Joint work Counsel on eases Correcting weaknesses Closing advice Quota assignments Personal financial counsel

UNIT DIVISIONS

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the supervisor to the agent is the line of flow f o r ideas, stimulation, training and most of the other requirements. T h i s flow of course is not entirely one way. It is probable t h a t it operates Tnore like an alternating current than as a current flowing constantly in one direction. If the f o r m of organization grows so complicated that the agency leader, whether general agent or manager, becomes more than one step removed f r o m the active agent in the field, much of the efficiency of the agency as well as quality of leadership is dissipated. T h o s e of us who have served in the nation's army remember with h o r r o r the complicated system of paper work which required a piece of correspondence to travel " t h r o u g h channels." I remember the day with much amusement when some simple request of the ordinary doughboy was transmitted f r o m rank to rank, upward and return, and the abundance of comments and official signatures which ultimately appeared on the declination or approval. T o maintain closer supervision f r o m top to bottom, therefore, the actual direction of each agent's activities should never be more than one supervisor removed f r o m the general agent himself, and the agency head should be at all times readily accessible to all agents on whatever problem they may deem important enough to bring to his attention. I t will be noted in the chart t h a t the main line of supervisory control is directly down the center, in the smaller agency f r o m general agent direct to the agent and in the larger agency through the supervisors in accordance with the breadth of the agency's operations. Even in the larger agency the so-called staff executive committee may have executive responsibilities incident to the functional phases of the agency's activities but at the same time its primary purpose is to act as an advisory

202

HUEBNER FOUNDATION LECTURES

b o a r d to the general agent on matters of policy. T h e staff committee is usually made up of the leading supervisors in the agency. AGENCY L E A D E R S H I P

I t might be well before delving too deeply into this spcalled line organization, to pay some attention to the qualifications of the general agent or manager himself. H e must be, first of all, a business man with a comprehensive understanding of managerial functions and with the capacity f o r p e r f o r m i n g them. As a sales manager, he must possess not only a sound organizational ability but he must be an inspirational leader, commanding the respect of his associates not only f o r his leadership qualities but f o r his technical ability as well. T h e men he directs are the company to thousands of people. In fact, I have a suspicion there are millions of policyholders who haven't the least idea as to the location of the home office of the company in which they have their insurance. T h e general agent or manager, therefore, has much of the responsibility of the company's and the agency's public relations policy, and the prestige of the company served by the agency is in many cases solely in his hands. H e must be constantly aware that his objective today is not solely to build a larger organization. T h e service his agency is rendering the community, the quality of business written by his agency and the cost of its acquisition are m a j o r questions to be considered in his planning. Executive planning and direction of the agency involve the introduction of methods differing but slightly f r o m the necessary, effective methods in any efficient business enterprise. T h e multiplicity of detail in which almost any executive can become enmeshed must be transferable

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to a secretary, or executive assistant, as the scale of the agency's operations grows larger. T h e policies and plans created f o r the agency activities necessarily must be keyed to the thinking processes and spirits of the men representing the agency in the field. It is a wise general agent, therefore, who maintains closely at his elbow an informal agents' advisory committee, acting effectively as a testing ground for his plans f o r the agency as a whole. Direct supervision is unquestionably the m a j o r responsibility of the agency staff. W h e t h e r this is the general agent's responsibility, or that of his supervisory assistants, or of individuals charged with the supervision of units of man power within the agency, the m a j o r p a r t of the time consumed is directly related to the problems of the life underwriter himself. I assure you this temperamental prima donna, as he has been called, does have problems. F r o m the day he enters the business until his last day in service with the agency, he is constantly in need of sympathetic attention. T h r o u g h field training and joint work, he is encouraged to develop habits of effort without which he rarely becomes successful. H e must have counsel on cases. H i s weaknesses must be corrected. M e t h o d s of closing, prospecting and the various factors leading to a more effective sales technique must be developed. H e must be stimulated by quota assignments and certainly, last but not least, he must have counsel r e g a r d i n g his personal financial problems. T h i s latter may seem inconsistent with the basic nature of his business and yet we are all quite familiar withithe axiom of the shoemaker's children. T h e agent is the tool that carves out the business results, giving significance to the agency with the public and the company. T h e care exercised, therefore, in keeping him s h a r p and efficient should exemplify the pride

204

HUEBNER FOUNDATION LECTURES

in handling possessed by any really good workman. T h e breadth o f his service should be a constant source of inspiration and stimulation to the agency leadership. T h e general agent's assistants charged with the direct supervision o f the agency's man power should be essentially general agents in the making. T h e i r leadership and his training in connection therewith should be such that he is prepared at all times to surrender them to the company for general agency replacements occasioned by the normal turnover in its general agency force. T h e i r qualities of understanding, therefore, should be developed in the terms of their capacity some day to fill his shoes should the opportunity arise. As an agency expands in man power, the general agent's supervisory assistants take on many of the aspects of junior general agents. T h e y are frequently called unit managers and the agency is divided into operating units consisting of from ten to twenty underwriters under each manager. A closer tie-in with the individual underwriter's problems is effected by this form of administration. At the same time greater opportunity is created for the maintenance o f competitive team-play within the organization. T h e s e units exist solely for supervisory purposes, maintaining none of the institutional functions discussed later.

FUNCTIONAL ORGANIZATION

Probably the greatest change between the agency of yesterday and that of today is in its functional organization. Technological advance has introduced many functions scarcely envisaged by early agency leaders. W h e t h e r this technological advance can be attributed to outstanding leadership and true trusteeship understanding within the business, or whether the gradual education of the public and its consequent demands have enforced it, is o f

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little consequence. It is here, nevertheless. T h e agency leadership that has not recognized its responsibility in this connection is gradually passing f r o m the current scene. T h e functional organization of the agency, for the want of better names, can be divided essentially into two principal p a r t s ; that is, institutional functions embodying most of the fixed operations of the business itself, and the sales distribution functions contributing to the dynamic character of the agency as a productive branch of the company's distribution outlet. Into the first division must go the top limits of efficiency in the way of an organization set-up. Into the second must be poured the limit of imagination, originality and force. While in actual operation they may appear to be somewhat intermingled, f r o m a functional standpoint they are distinctly separate. This distinction will be more evident f r o m Charts 2 and 3 which present in outline f o r m the principal functions in each group. In the interests of clarification, each division has been separated into three sections. U n d e r the Institutional Functions have been placed— 1. Premium Collection and Record Maintenance 2. Service 3. General Administration T h e Sales Distribution section will be discussed under the headings— 1. Sales Promotion 2. Education and Research 3. Expansion and Replacement INSTITUTIONAL FUNCTIONS

T h e treatment of the Institutional Functions varies somewhat with company practices in the same manner

206

HUEBNER FOUNDATION LECTURES

IN5TITUT10N/M.

fUNCTIONS

I PREMIUM COLLECTION AND MAINTENANCE

ADMINISTRATION FINANCE AND BUDGET COKFJtßL I

PREMIUM COLLECTION

Bookkeeping on inocoe end expenses. Budget and cost accounting supervision. A l l financial statements to Company and agents. Agents' contract«. Agents' advance accounts. Kcw agent financing-control. Banking relationships.

Mail Collections. Cashier Collections. Settlements on new business. I ACCOUNTINO PnuiuB Bookkeeping. Coomissioa Statements. I ~ MAINTENANCE

NEW BUSINESS HANDLING AND U M D E m r r D c department CONTACT

Policyholder records. Record of new polloles.

A l l details in handling applications for new business. Maintenance of records incident thereto. Follow-