Revival: The Business of Insurance (1904)

Alexander Johnstone Wilson

• Publisher: Taylor & Francis
• Year: 2018
• Print ISBN: 9781138554900
• eBook ISBN: 9781351341585
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

This little book is in no sense intended to be of use to insurance experts. It is written by an outsider mainly for the ignorant, for the multitude who either wish to insure their lives, or to whom the insurance agent is for ever coming with his proposals, his promises and blandishments.

My doctrine is that every man ought to insure his life the moment he arrives at a period or position when his responsibility extends over the lives of others. If this duty were regarded as an imperative one by the community at large, there would be little or no necessity for the elaborate machinery required by our life offices to induce people to invest in life or other insurance policies; but as long as apathy prevails, such agencies must be maintained and a ceaseless activity displayed by the offices in tempting investors to enter into policy contracts.

THE
BUSINESS OF INSURANCE

CHAPTER I

GENERAL NOTES ON LIFE
INSURANCE

FEW modern institutions touch the daily life of communities more intimately than life insurance. It is essentially a product of modern civilisation, and implies two essential qualifications for success. The first is continuous peace, and the second is continuing debt. Life insurance is thus the outcome of a high state of civilisation as now understood. We cannot imagine a business of this kind existing and really flourishing in Great Britain during the long struggles between England and France, during the Wars of the Roses, or at the time of the Puritan conflict with Charles I. Down to the Revolution of 1688 we may say that this country afforded no scope for the development of a business of this description, and if that was the case with England, how much more so with continental nations, always at war with each other, subject to continual social disturbances—not merely through disputes about religion and civil liberty, such as lay at the root of the later civil conflicts in England, or to dynastic conflicts, but to the aggressive spirit developed among the democracy, now in one section of the continent, now in another? No one could imagine the Italy of the Middle Ages as a field for the development of life insurance, and were the now ancient and apparently solidly established civilisations of Europe again to become unstable, and conflicts to break out, one of the first of their products to suffer, and perhaps to disappear, might be life insurance.

But peace within is only one of the essentials to the successful pursuit of this form of insurance business. Life insurance especially implies also a revenue from interest, and interest is a product which postulates debt. Debt also cannot come into being in any fashion to be depended upon except when order is completely established within the state, when everything is submissive to established laws and customs. Without that essential qualification nothing is secure, not even mortgages on private property, still less the rent paid for the usufruct of such property, or bonds upon the public revenue.

What then is this business which demands such breadth of foundation? Is it something akin to that “mutual aid” amongst animals and mankind, about which Prince Kropotkin has written so interestingly in a recent book of his bearing this title? In some of its aspects it is just that, but a form of “mutual aid” altogether different from what Kropotkin is dealing with; not different in spirit, perhaps, but essentially of an artificial instead of a natural or (shall I say?) humanitarian character. The first beginnings of life insurance in this country were extremely feeble, and do not yet date back three centuries. It is, indeed, recorded that an office of insurance within the Royal Exchange in London granted policies of life insurance of some sort in the end of the sixteenth century, and there is a case recorded of a dispute in the law courts over one of its policies, but the policy was not at all of the same description as those with which modern and genuine life insurance has made us familiar. It was simply a bet on the life of a man for one year entered into for the benefit of a third party. The office or association that took the money undertook to pay this third party £383 6s. 8d. provided the individual on whose life the policy was effected by him died within twelve months, and the rate of premium charged was 8 per cent. The policy seems to have been underwritten precisely in the same fashion as marine insurance policies are dealt with at Lloyd’s, and were probably then dealt with.

Our oldest life-insuring offices, however, are the Royal Exchange Assurance Corporation and the London Assurance Corporation, both of which came into existence in 1720, when the South Sea Bubble burst. They began to issue life policies in the year following their incorporation, and are in existence to this day, strong and prosperous, if not of the magnitude of some of their younger competitors. There seems, indeed, to have been an older office called the Amicable, chartered by Queen Anne in 1706. Its business has long been merged in that of the Hand-in-Hand Office, but we do not gather that it did much, if any, life business, and the Hand-in-Hand certainly did not take up that line until 1836. Among the old offices our most conspicuous is the Equitable, which came into existence in 1762 as a purely mutual life office, and so successfully has its business been conducted that it remains to this day one of the most prosperous of our life insurance societies, carefully and economically managed, rich and select.

But in what does the business conducted by these life insurance companies consist? In one sense it is a betting business. It takes hazards against death, seemingly reckless hazards from one point of view. A young man for example, at the age of twenty-one, desires to insure the payment of £100 to his relatives in the event of his death. In order to do this he undertakes to pay so much per annum, either during the whole of his life or for a fixed period of years. The payment is, compared with the apparent risk, in all cases at first sight ridiculously small. In the case of some of the best offices it may be less than £2 per annum. Should the purchaser of this contract die within the first year, the £100 he has bargained for is paid over to his heirs. Surely this looks a touch-and-go sort of business, but it is not really so, for reasons which I shall proceed to furnish.

Were two or three people to enter mutually into this kind of contract, one with the other, the risk of loss to survivors would be too great to be borne; but the secret of the ability of life insurance offices to enter into such bargains lies in the averages upon which they work.

For a long time after mutual offices and joint-stock companies began to conduct this description of wagering against death, they worked very much in the dark. In its earlier years, I believe, the Equitable Life Office charged 5 per cent, premium upon the amount insured, no matter what the age of the policy-buyer might be, and it was not until many years had elapsed that the business began to be systematised and its true risks established with scientific exactitude. As late as 1771 the Equitable Life Office charged a premium of £4 1s. 5

d. per annum for insuring £100 upon the life of a person aged thirty. At the present day a non-participating life policy can be procured from the same office by a person of this age for a premium of £2 os. 1d. per annum. Other offices make the bargain come cheaper, in appearance at least.

One thing that almost compelled the pioneers in life insurance business to charge high premiums was the complete ignorance existing with regard to the average duration of life at different ages, or indeed at any age. They worked completely in the dark as to the nature of their risks, and had to guard themselves against loss by charging high premiums. Gradually, however, this ignorance was dispelled, but for many a year—one might say until well into the nineteenth century, when the Institute of Actuaries was formed and set to work to accumulate data in order to establish a scientific basis for the business—the offices had only such imperfect guides as the Carlisle and Northampton tables of mortality provided them with—tables compiled from the death statistics of these two towns, statistics naturally imperfect because deduced from the experiences of longevity in a limited population. Now, however, the average duration of human life, taken at every age from birth to a hundred years, has been established by the accumulation of an enormous mass of authentic statistics; and so exact are the results now tabulated that every life office is in a position to tell almost to a penny the extent of its risks upon each contract entered into. Hence in part the reduction in the scale of premiums, hence also the difference between premiums that insure merely the sum named in the policy and premiums entitling owners of the policy to a share in what are called the “profits.”

Having ascertained the nature and limits of the risk of mortality, what is the principle on which these institutions guide their business, found their contracts? It is the principle of compound interest. Having ascertained the exact amount necessary to levy upon policy-holders in order to secure the offices selling the policy against loss on the average of all the lives insured, the next thing to settle, so as to reach the exact sum safely promisable, is the rate of compound interest at which the net premiums as received and invested may be expected to accumulate. Supposing, to reverse the process, a young man becomes possessed of £100 at the age of twenty-one, and invests this in a security bearing 5 per cent, interest, how long will it take this £100 to become £200, provided the interest received each year is forthwith reinvested at the same rate? That is to say, the first year’s interest of £5 is placed in the same security, and in the second year that £5 also adds 5s. to the amount received on the total invested, and so on until the £200 is reached. How long time must elapse before the original capital is in this way doubled? On a 5 per cent, basis, rather less than fifteen years. Suppose, on the other hand, that the rate of interest is only 2

per cent., it will take nearly twenty-nine years to make the £100 £200.

These examples should enable the reader to grasp the underlying principles upon which insurance offices conduct their business. It would, as a rule, be useless for two or three people to club their life premiums together and invest them in this fashion, and not very profitable, perhaps, for merely several hundreds to do so; but an office which has so established its business that it is able to command an income of many thousands per annum, drawn from the large body of people, the thousands who have entered into contracts with it, is able to place this money out to advantage when the country in which it conducts its business is settled, when the wealth-producing or utilising activity of its civic, mercantile, or national life leads to the creation of many forms of debt of a more or less enduring kind, and when each year’s premiums as invested accumulate at compound interest. The office is then in a position to do exactly for the individual Englishman what he himself might do if he had at the beginning so much capital to put aside and leave undisturbed for accumulation in exactly the same fashion. Its conductors know within very narrow limits what the claims upon the office will come to in an average of years upon a given volume of business, how much they can lay by permanently, what the rate of accumulation at compound interest will be, and how much, therefore, they can afford to promise the insurant, exact allowance made for the ascertained average risk of death.

Remarks of this kind may read dryly enough, but the dryness must be borne with, and the rudimentary elements of the business mastered before much progress can be made in enabling the public to arrive at some conception of the character and limitations of this most modern form of mutual aid—highly scientific, if you will, but also perfectly artificial. One may say that without our National Debt it would never have been possible for life insurance business in this country to develop and attain anything like the proportions it now exhibits. We were the pioneers of life insurance amongst modern nations, it may be added, because we were the pioneers of national debts. Down to a period long posterior to the Revolution of 1789, France had no well-secured debt. The king of the old régime had debts, both private and state, but they were created by each monarch on his own initiative, or arose from the necessities of his absolute administration, and offered no national security akin to that with which our debt, the product of parliamentary vote and sanction, was from the first endowed. Kingly bankruptcies were by no means infrequent.

Without well-secured debts, the interest upon which can be relied upon as absolutely as the successions of seasons, life insurance business could not exist in any satisfactory manner. Precariousness in the receipt of interest upon money invested would necessitate extraordinary precautions on the part of offices granting life policies. The business would, if it existed at all, soon degenerate into a more or less rank gamble. Calculations as to the speed at which money coming in would accumulate at compound interest would be continually upset, and every now and again a wave of insolvency might sweep over the state or community that might bring life and most other forms of insurance business to a standstill.

Mention of the necessity for stability in the rates of interest naturally leads me to discuss other aspects of this investment side of life office business. It had long ago passed beyond a state of dependence upon merely national debts. At the present time the life companies existing in this country have accumulated resources to the amount of nearly £260,000,000. This feat would have been impossible but for the multiplication of public securities into which the money could be transferred. Were a time to come when no more securities could be created, whether through the impossibility of loading a nation with further debts, or through exhaustion in other directions, limits would be placed upon the capacity of life offices to issue policies. The limits would be of various descriptions. Assuming everything else to remain unchanged and the volume of securities to be no longer capable of increase, then competition for these securities would reduce the rates of interest obtainable upon invested money, and life offices would be compelled at once to reduce correspondingly their tempting offers to those desirous of taking out policies. We saw this law in operation to a limited extent while the sinking funds in Consols, established by Mr. Gladstone and other Chancellors of the Exchequer, were in full operation, that is to say, down to 1896. These sinking funds absorbed each succeeding year an additional amount of the capital of the National Debt. So much debt was each year bought in and, to the extent of the amount of the sinking fund, cancelled, and the said amount automatically expended as the interest upon each year’s redeemed stock became available for buying in more stock. As a consequence, the supply of this particular security diminished and its price advanced until it was no longer profitable for our life offices to place any more of their money therein. Most of them realised either all or the greater part of their Consols at the high prices and thus made handsome profits upon their capital, which could be invested to greater advantage elsewhere. Not one of them could afford to buy a stock at a price which yielded little more than 2 per cent. The money thus released found, however, other securities in which it might be placed at figures which still yielded a rate of interest as high as, and probably higher than, that upon which the more careful offices based their expectation of accumulations at compound interest. This perhaps seems abstruse, but I will try to explain it all later if the reader will bear with me meanwhile.

Changes of this description constantly going on involve changes in investment, risks of an unforeseeable kind, and the past generation has witnessed an enormous and continual variation in the position of all life offices in this respect. They have been impelled by the scarcity and dearness of the highest class of investments to spread their money over a variety of interest-bearing securities such as did not exist, and would not have been thought of a generation ago as offering the requisite degree of safety. No full details are given with regard to their investments, but whereas fifty or sixty years ago the life offices had no important outlets for their moneys beyond British Government stocks and mortgages upon real estate throughout the United Kingdom, you cannot now pick up any life insurance office’s report without finding large sums invested in Colonial or Foreign Government securities, in Colonial or Foreign Municipal securities, in Colonial and Foreign Railway debentures, in Indian Railway stocks, in mortgages outside the United Kingdom, and occasionally in unsecured or badly secured debentures of trading corporations, or even in the unsecured stocks of Home and Foreign Railways. What do I mean by “unsecured”? In this instance I mean ordinary stocks with no capital below them, between them and loss through a falling off in revenue.

These changes imply considerably increased risk of loss, and that also is a limitation to the indefinite extension of this kind of business. To be safe it ought not to run any risk of loss of capital, but directly money is invested in any form, risk of loss of capital is implied. Indeed, were there no risk of any description, one might say that in most cases there would be no interest earned. The risk, however, is unquestionably augmented the further afield investments are carried, and in our day it has become more and more a source of anxiety, to life offices especially and to all bodies entrusted in a fiduciary capacity with large sums of money. They must, as the masses of this money become greater, run greater risks, because the proportion of risk to the amount of the capital invested tends to grow larger as the capital sunk accumulates. All the life companies can do is to spread these risks as widely as possible, and to try to select the best amongst the multitudes of investments offering. Mistakes of judgment might involve heavy losses, and even the most careful selection and unremitting vigilance cannot prevent unforeseen influences from coming into play to bring about loss when least expected. The recent story of our National Debt and our Municipal and Railway debenture and preference securities illustrates how danger may arise. Thanks mainly to the enormous cost of the South African War, and likewise, in part, to the consequent complete cessation of purchases for the National Debt sinking fund, as well as to the rapid multiplication of securities of this class, prices for securities esteemed of the highest class have declined by 10 to 15 and even 20 per cent, compared with what they stood at five years ago. Shrinkages of this kind could not be foreseen, and all that is left for institutions caught by this backward wave is to provide for the losses out of their accumulations. If they can do all this without in any way breaking their promises to their clients, they are fortunate.

CHAPTER II

SOME VARI...

Table of contents

• Cover
• Half Title
• Title Page
• Copyright Page
• Table of Contents
• Preface
• Chapter I: General Notes on Life Insurance
• Chapter II: Some Varieties of Life Insurance
• Chapter III: Ordinary Life Insurance
• Chapter IV: How and When to Insure
• Chapter V: Where to Insure
• Chapter VI: Marine Insurance and the Corporation of Lloyd’s
• Chapter VII: Fire and Miscellaneous Insurance
• Chapter VIII: Insurance in Other Countries
• Appendix I
• Appendix II
• Appendix III
• Appendix IV
• Index