The Investment Behaviour of British Life Insurance Companies

Colin Dodds

• Publisher: Taylor & Francis
• Year: 2017
• Print ISBN: 9781138562462
• eBook ISBN: 9781351356541
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

Originally published in 1979, The Investment Behaviour of British Life Insurance Companies provides a critical analysis of the investment policy of the life insurance industry for the period of 1962-76, and attempts to construct an econometric model of the investment behaviour. It looks at the portfolio composition of life funds and their position in the markets for securities in terms of their gross purchases and sales and net acquisitions. It also considers the principles on which life offices appear to operate the principles on which life offices appear to operate in respect of investing their 'reserves' to meet future contingent liabilities. This book will appeal to those working in the field of economic and business.

1 THE BUSINESS OF LIFE INSURANCE

1.1 Introduction

Insurance has been an important method by which the problem of risk in the world of business and in the life of the individual person has been met. Here we are using risk in the Knightian sense (93) in that there will be probability distributions accompanying the outcomes; and as G.L.S. Shackle has argued

For the insurance company … probability provides knowledge. The number of accidents per year per thousand of insured may in many contexts be a fairly stable proportion, changing slowly and steadily as a consequence of social and technological evolution. Thus what is for the individual a non-divisible experiment can become in the hands of the insurance company part of a divisible one. It can be pooled with scores of thousands of others and thus the individual can exchange the certainty of a small loss (the premium on the policy) for the haunting possibility of a total one ((146) pp. 108–9).

Of course, we can distinguish many different forms of insurance contract; although in practice two main classes are recognised – ‘general’ insurance which covers all forms of insurance other than ‘life’ and is written on an annual basis (fire, auto, marine, household, etc.) and ‘life’ insurance which is usually a long-term one in that ‘it provides cover against risk of death or of survivance; … [and] it provides an investment service involving guarantees of future capital security and long-term interest yield’ (A.T. Haynes and R.J. Kirton (76) p. 141).

Whilst not all policies, as we shall see, do combine protection and savings elements, the ability to mix these in various ways has given the life insurance contract great flexibility and thus accounts (in part) for the continual expansion in life business. Likewise the ‘general’ insurance area has expanded and there is continual innovation to produce policies which suit particular needs. But these modern-day conditions have taken a long time to evolve and we need to digress to cover some of the beginnings of ‘insurance’ to see how the foundations for its present success were laid. (For a comprehensive history of insurance see H.E. Raynes (129) (130) (131); also G. Clayton (30), and B. Supple (157). For a short account from 1880 see J. Johnston and G.W. Murphy (87).)

The history of ‘insurance’ in trade and commerce can be traced back to the fourth century BC and certainly it was well developed in Italy and some other European countries in the fourteenth century and whilst Britain was relatively late in developing the insurance contract (it is not until the sixteenth century that records are to be found), by 1570 – the date of the opening of the Royal Exchange – insurance contracts for marine risks were commonplace.

Two strands have been present in these early beginnings of life assurance. The first had its origins and basis in the concept that the hardship caused by death can be reduced or mitigated if a group of people are willing to pool their resources, so as to provide funds for the dependants of the deceased. This can, in fact, be traced back to the Anglo-Saxon period, continuing through the Middle Ages, and the trade guilds were an important force in this process. But the first office to open to the general public was ‘The Society of Assurance for Widows and Orphans’ which was founded in 1699. The objective of this society was to pay £500 on the death of each member out of the contributions of 5 shillings from each of the 2,000 members. Whilst the society only survived for twelve years, allegedly owing to the fact that full membership was not achieved, the principle behind the venture was adopted by the ‘Amicable Society’ in 1706 and this continued in business for over a century. The Amicable charged an annual premium of £6 4s Od and the benefit paid, which once the society was firmly established, varied between £100 and £300, depended on the actual mortality experience. It is also interesting to note that evidence of ‘health and habits’ was required and that later an age entry barrier of 45 was introduced. Many other such schemes flourished over this period.

The second strand we can refer to was the recognition that life assurance could be carried out in a similar fashion to property insurance whereby temporary insurance cover was given and the first recorded instance of this is in 1548 (see Walford (164)) with the insurance of a Master with his ship. But the first term life policy per se for which records exist was that issued in 1583 on one W. Gibbons for one year for £382 6s 8d at a single premium of £8 per cent. Such policies became common in the seventeenth century although Daniel Defoe writing in 1697 did not entirely approve of them.

Ensuring of life I cannot admire; I shall say nothing to it; but that in Italy where Stabbing and Poisoning is so much in vogue, something may be said for it, and on contingent annuities; yet I never knew the thing much approv’d of on any account (41).

Temporary assurance of this type continued well into the eighteenth century particularly with the establishment of supplementary charters for ‘London Assurance’ and the Royal Exchange in 1720. Companies wrote annual contracts (maximum £500 sum assured) at first, irrespective of age with a rate of premium being £5 or £5 5s; though they took the state of health very much into account.

These early beginnings of societies such as the Amicable – which gave in effect ‘permanent’ assurance – and the others which sold ‘term’ assurance were still a long way from writing the contracts which are used today. In fact, this period is often referred to as the ‘hit and miss’ or unscientific period of life assurance in that there was no formal actuarial basis for the calculation of premiums. Development in the late seventeeth century, however, provided a base to work on in that J. de Wit in 1671 wrote a report for private circulation on the value of life annuities in Holland (see F. Hendricks (80) for a translation) which indicates that he had a firm idea of mortality rate as it applied to a group of annuitants. In addition, work by W. Petty (122) on bills of mortality of London again increased knowledge of mortality. But it was Halley who, in a paper published in 1693, using the bills of mortality in the City of Breslau, pioneered the use of mortality tables in life assurance arguing that the price of assurance on lives ‘ought to be regulated by the age of the person on whose life the assurance is made’ (73, p. 105).

The most significant development in the eighteenth century was the work of James Dodson. He felt that the mutual protection as practised in earlier schemes had two main disadvantages. In the first instance most schemes had contribution rates set irrespective of age so that it was unfair on younger contributors. Secondly, in a year with fewer contributions and more claims there would be little to pay out to the beneficiaries. Instead he proposed a scheme in 1750 which would offer the benefit of level premiums over long-term contracts; but he could not get a Royal Charter. As an alternative he had to establish a mutual society of partners which in the event was not finally formed until 1762 (five years after Dodson’s death) and became known as the Society for Equitable Assurance on Lives and Survivorship, owing its existence to one Edward Rowe Moore. It had four main innovations: (1) it was a self-capitalising mutual fund; (2) it offered level premiums that enabled people to continue insurance into their high-risk years without penalty; (3) it offered several types of policies; (4) payments were made in cash or annuities.

It is on the basis set out by the Dodson innovation (and the subsequent success of the ‘Equitable’) that the whole edifice of life assurance as it is today has been laid. The developments in actuarial science were applied in the Society for Equitable Assurance and we can usefully segment four stages in the history of life assurance from this date:

1762–99	application of scientific principles;
1800–1914	rapid growth of life assurance and development as financial institutions; consolidation and application of principles of life assurance to Friendly Societies, pension funds and social insurance and the emergence of insurance supervision;
1915–39	intermediate phase but questioning of principles under lying investment;
1940 to date	re-examination of fundamental principles, innovation and further growth.

Certainly by the end of the eighteenth century, life assurance was firmly established and other forms of insurance too were well developed, though the state had also found the need to legislate in 1774¹ and to introduce the concept of ‘insurable interest’ to prevent the gambling which had resulted from policies being issued against a number of contingencies such as the life of a highwayman. As H.E. Raynes (131) points out: ‘There was absolutely nothing on which a policy could be opened that was not employed as the opportunity of gambling’ ((131), p. 137).

The nineteenth century, as we have indicated, witnessed the growth and consolidation of life assurance business and although they were only one of many other types of financial institution that emerged and developed in this period (e.g. building societies), several factors have marked them out for a special place in the saving and investment processes over this period. Whilst their relative size and rapid growth are significant in themselves, their long-run outlook coupled with the need for markets to invest their accumulating funds have been critical factors in determining the principles which should govern the portfolio distribution in terms of the type of assets to hold. A.H. Bailey (5) was, in 1862, the first person to attempt to set these principles down into a coherent framework and since these early beginnings there has been an ongoing debate on the nature of investment criteria. However, we need to recognise that the growing needs of the life offices have also been influential factors in shaping the evolution of the capital market.

Increasingly the state has involved itself in establishing broad controls of life assurance and the regulating framework was established in Acts in 1867, 1870 and 1872. Requirements were established for minimum capital stock outstanding, a deposit of £20,000 to be made to the Paymaster General, separation of life assurance and accident insurance business records and the filing of accounts with the Board of Trade. But governments had recognised the difference between life assurance and other forms of saving by giving tax concessions to the policy-holders and these have been retained to the present time. Further legislation in 1909 retained the regulating provisions of previous legislati...

Table of contents

• Cover
• Half Title
• Title Page
• Copyright Page
• Table of Contents
• List of Tables and Figures
• Acknowledgements
• Preface
• 1. The Business of Life Insurance
• 2. The Flow of Funds through the Life Insurance Sector
• 3. The Objectives and Constraints on Investment Policy
• 4. The Empirical Evidence on Investment Behaviour
• 5. Modelling Life Office Investment Behaviour: Individual Demand Specifications
• 6. Modelling Life Office Investment Behaviour: Sector Specifications
• 7. Conclusions
• Appendix
• References
• Index