Insurance

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Preface

In our day insurance has taken on many forms but always serves the same purpose and is based fundamentally upon the same principles. There is always a more or less undefined risk which is run, involving the possibility of loss uncertain either as to its occurrence or the time of its occurrence, and against this there is protection thru a contract. In its essence, the contract is an agreement among a large number who are exposed to the risk to share the losses when they occur, thus lightening the burden on the individual and making for all a fixed charge instead of a catastrophe for some. The risks are infinitely varied and new forms of insurance are constantly appearing.

These risks affect business in the persons of those engaged in business and in the property dedicated to business purposes. Protection against both risks is more than a personal matter, it is a vital condition of successful business.

It is the aim of the present Text to display the fundamental principles of insurance in general terms, and then to show these principles at work in the various fields in which insurance has been introduced.

In the preparation of this volume Professor Mudgett has had the collaboration of a number of experts. His chapters on lability and accident insur- \"f vi PREFACE ance, on fire insurance and marine insurance, have drawn largely upon material originally furnished to the Institute by Messrs. Michelbacher, Hardy and Huebner. Each of these gentlemen has examined the new manuscript of the present chapters in his special field and made suggestions relative to the treatment. The Institute joins with Professor Mudgett in acknowledging gratefully their aid and assistance.

JOsEPH FRENCH JOHNSON

Table Of Contents

CHAPTER? I RISK AND INSURANCE SECTION

1. The Nature of Risk :

2. The Economic or Financial Aepert ef Rie

Chapter II The Life Risks

1. Risks of the Individual 2) The Lite Risks ° 3. Requirements of the Productive Fyes ‘ vii

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Needs of Old Age. . 3 Aa ee as ee Magnitude of These Rieke net eee

CHAPTER III LIFE INSURANCE PROTECTION Mutuality in Life Insurance

Indemnity in Life Insurance

Contract :

Protection Thru Life Tacurenee 3

Family Protection .

Personal Credit Insurance

Business Insurance

Saving and Investment Benetion ae Tae ie ance Safety Factor

Management

CHAPTER IV LIFE POLICIES AND PREMIUMS Types of Contract

Ordinary Life Policy

Calculating the Premium .

Single Premium

Annual Premium

Premiums Based Upon. ane age

Level Premiums and Annual Costs Policy Reserves and Surrender Values Dividends

Participating Plan

CHAPTER V MODIFICATION OF THE MODERN LIFE POLICY Limited Usefulness of Life Policies CONTENTS 8S SECTION PAGE

2. Methods of Paying Mma Grae the Number : Siete ek0 3. Increasing the Frequency ai Bravia Payments . 74 4. Methods of Paying Losses—Lump Payments 75 5. Income Insurance SS AT 6. Instalment and Annuity PAment: 718 7. Duration of the Insurance 19 8. Purpose of Term Insurance . 80 9. Premiums on Term Insurance . 81 10. Advantages and Disadvantages of awe Tapia nee 84

11. Accentuated Accumulation—Endowment Insurance 7 87 12. Comparison of Policies : 89 13. Providing for Old Age Needs . 91 14. The Disability Clause . ; 95

CHAPTER VI ANNUITIES AND PENSIONS 1. Purpose of Annuities : . 99 2. Kinds of Mee tice mediate ie we L00 3. Guaranteed Annuity OE 4. Deferred Annuities iy BY LOS 5. The Sale of Annuities in the United States eee LOG 6. Pension Systems sneha . 106 7. State and Municipal Pensions . 108 8. Carnegie Foundation Pensions » LLO CHAPTER VII GROUP INSURANCE

1. Nature and Purpose ee ID 2 Wait of Insurance - » 112 3. Mortality Experience - . 114 4. Coverage of the Group Tene Syl A x INSURANCE

SEOTION PAGE Db. sereniiumse ys. = BO eval GL Es 6. Advantages of Cian Taeeradee | PEMORE. a Le %. Objections to Group Insurance . . . . - 116

CHAPTER VIII FUNCTIONS OF INSURANCE CARRIERS—THE OLD LINE

COMPANY 1. Functions of the Insurance Carrier . . . . 119 2° They Underwriting? Function @.0 96.6 ene ee ee 3. ‘Insurance-Writing=Munction as | 0) epee 4. Administrative, Punction= / slo) 4) 7 eee ee ee 5. Old Line Company’s Guarantee . . . . . 124 6G.) Kinds of ;Companicsams Ga au ts se ee 7. Method of Underwriting .. wd. rs Be ee 8. Method of Recruiting Policy- fielders oa ee ee 9. The Industrial Insurance Company . . . . 129 CHAPTER IX ASSESSMENT AND FRATERNAL INSURANCE

. Nature and Origin of the Assessment. . . . 132 2. Underwriting Methods. . . ete feats: 3. Grading Premiums by Age at Entr ACCRA Shia Loe 4. Variable Premiums .. v= Sete Loe 5. Comparison with Old Line C omipanies!. (js Mate 137 6" Fraternal Instranceesvas ee ee eee ie cGontracts ys. ge en te 8. Insurance- EW etcie Methods Pe ay ee, ee os

CHAPTER X GOVERNMENT LIFE INSURANCE

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SECTION 2. War Risk Insurance ; 3. Soldiers’ and Sailors’ Insurance 4. Its Educational Effect CHAPTER XI ACCIDENT AND HEALTH RISK 1. Personal Insurance ‘2. Magnitude of the Accident igh 3. The Ill Health Risk 4. Accident Prevention 5. Accident Prevention Methodas. : 6. Factors in Preventive Work : 7. The Result of Accident Prevention Wore ; 8. Non-Industrial Accidents 9. Rehabilitation 10. Prevention of Illness ; 11. Methods of Health Canaan ; 12. Results of Health Conservation 13. Application of the Method of Insurance ts cere dent and Health Risks CIBUNIPAM ENR: SUT PERSONAL ACCIDENT AND HEALTH INSURANCE 1. Nature and Extent of This Kind of Insurance 2. The Contract of Insurance and Its Coverage:

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Term of the Contract

Accidents and Illnesses Covered by the Boles Benefits Under Accident and Health Policies .

Restrictions on Benefits Supplementary Benefits Settlement Claims

Chapter I Risk And Insurance

1. The nature of risk—Human activity is ordinarily directed to the attainment of a definite end or object but a multitude of circumstances may intervene to prevent the realization of a given purpose. Ina simple case a business man who expects to reach his office at 9.00 A. M. may be delayed by his train. More significant in its consequence to him would be the case in which he invests in a stock or bond, with the expectation of selling it at a premium of 10 per cent or of receiving from it an income in the form of dividend or interest, only to find that the security declines in price or that the corporation fails to earn or to pay the expected income. Again a man may set up in business for himself with the confident expectation that in a few years he will prosper; and on the basis of this expectation he may marry, build a home and assume various other obligations the fulfilment of which will depend on the future of his business. Granted his ability to conduct the business successfully, his efforts may fail thru death, thru the theft of funds by an employe, or even thru the failure of his bank. Illustrations might be continued indefinitely, 1 varying from the simple and relatively inconsequential case of the delayed train to catastrophes that involve the whole future of an individual or bring lasting ill-effects to an entire community. Thru them all runs the common principle that human activities, tho directed toward definite ends, are subject to many uncertainties. Particular results are expected but, thru unforseen occurrences, are not attained.

It is these uncertainties in life, these possibilities that catastrophe or calamity may fall upon a particular individual at an unexpected moment and prevent the carrying out of well laid plans that give rise to insurance. It has often been said that insurance is a solution of the economic problem of risk. While the illustrations given above indicate something of the nature of risk, its meaning may be brought into clearer relief by certain distinctions between terms. A catastrophe or calamity is an accomplished fact with consequences that may be measured or defined. A risk, however, is not a catastrophe; it has no objective existence, but is subjective, and denotes the uncertainty where or when or upon whom the catastrophe may fall. This element of uncertainty explains the essential nature of risk.

This character may be further emphasized by noting the difference between risk and chance or probability. If for example ten coins are thrown at a time, there is a probability of getting five heads. The uncertainty hes in whether five heads will appear in any single throw. In the long run, or on the average, about five heads will result per throw of ten coins but | there is great uncertainty as to the exact result in a single trial. The principle here illustrated applies directly to the risks that are of social or economic consequence. ‘The facts may show for example that a fairly constant amount of property is lost by fire every year in the United States. This is a distinct social loss and may be so charged—in order to enjoy a given amount of goods we must produce a greater quantity, that which is enjoyed plus that which is burned. In this broad sense, there is no uncertainty involved in fire losses, but destruction by fire has a further, and probably a greater, significance. Legal title to this product, and therefore the right to its enjoyment, is held by various persons in the community who are the losers when destruction by fire takes place. They, as individuals, cannot set aside a small portion of their product to replace that destroyed since all that they have may be destroyed. The significant fact then lies not in the certainty that a given amount of destruction will occur in the United States, but in the uncertainty as to the amount of loss which will fall on particular individuals.

2. The economic or financial aspect of risk.—Risks or uncertainties, as may be inferred from the illustrations given, may vary greatly in their consequences. The particular consequences which are of importance here and which have. brought about the development of insurance protection are those which in some way affect economic welfare. Catastrophes may occur or uncertainties may exist, the outcome of which will in no way affect the financial status of individuals or the economic welfare of the community. ‘They may be ever so serious in their effect upon community life and equally so upon individuals but until they are in some way measurable in terms of income to the community or to groups of individuals, a solution involving the principles of insurance is not sought. The destruction of property by fire is of immediate concern to the owners of property, since such losses at once affect their incomes. They have therefore sought and have obtained the protection of insurance, and fire insurance organizations of various kinds operate thruout the civilized world today.

Another instance, differing in some of its aspects, illustrates the economic characteristic of risk and its bearing on the development of insurance protection. The agitation which developed in the United States in the later ’90s and the first decade of the twentieth century regarding the effects of industrial accidents upon the injured individuals, their families and eventually upon the welfare of the entire country led to the demand that the states should by legislative enactment furnish the protection of insurance to the victims of industrial accidents. The movement spread rapidly, following the enactment of a workman’s compensation law in New York in 1910, until in a single decade all but four or five states in the union passed similar laws.

3. The source of economic risk.—The uncertainties connected with economic activity lie in the structure of our economic organization. Commodities or services are produced by individuals and offered in the market in exchange for other commodities or services that these individuals desire. The extent to which individuals are able, therefore, to supply their wants depends fundamentally on the things which they produce or the services which they render. When aman ceases to produce it may mean the loss of income with which he purchases common necessaries of life. Thus the family, in a very important sense, is an economic organization. The ability of the parent to supply his children with economic goods and services and with the cultural and educational advantages of the community depends in no small degree on his income. Yet the uncertainties to which the parent may be exposed in the earning of this income may stand in the way of his fulfilment of these responsibilities to the child. The parental responsibility which is thus assumed can be fulfilled only in time and if death overtakes a man before the time for the rearing of children has elapsed, his responsibility can not be met directly.

Not the family alone but organization for economic activity, or business organization, is to a large extent individual. Single business men or partnerships or small establishments are still the common order of things in many trades and businesses. Like families, they are exposed to many uncertainties, generally because of the very fact that the scope of their operations is small. Because of its great size, only a small element of uncertainty is involved in the fire losses of a transcontinental railroad corporation, but to the small retail grocer the fire hazard presents a real risk that may be his complete undoing unless he has the protection of insurance.

The growth of corporate organizations in some industrial fields and the accompanying increase in the size of the business unit has not in all cases decreased risk; in some respects the contrary has occurred. With the change of methods of production from the domestic system to the modern, highly organized factory, a speculative factor that is entirely new has been introduced into business affairs. The productive process has been lengthened, the trade area has been enlarged and production has become in many instances a matter of making goods to satisfy future expected wants. The craftsman of an earlier economic period made goods to fill definite orders; the captain of industry today guesses the market which will exist three months, six months or a year hence and makes his goods in advance to supply this demand when it arises. In so doing he may make many mistakes as the alternate periods of prosperity and depression indicate.

The increasing size of industrial establishments or of groups of industrial activities operated under a unified control has thus lessened some risks and brought others in their place. The growing tendency to combination among industrial corporations rests in large part on the desire to reduce the speculative risks here discussed. Monopolistic control or the development of understandings between a few large concerns tends to do away with the ruinous competition which is the dangerous element in such speculative industry. In a broad discussion of economic risks, therefore, and of methods of reducing or eliminating them, industrial combination should take its place beside insurance.

4. The consequences of risk.—One characteristic feature in the development of insurance protection is directly related to the incidence of uncertain losses. Where those exposed to loss are in a position to demand effective protection and to make a reasonable payment, in the form of an insurance premium, for that protection, insurance organizations are developed readily in response to such a demand. Where the demand can not be made effective thru the offer of a reasonable premium, the coverage of uncertain losses develops much more slowly—as a rule, only thru the affirmative action of the state. If social welfare is adversely affected thru the incidence of uncertain losses upon particular individuals or groups in society, and these groups are not in a position to demand and pay for insurance protection, the state may, by legislation, force the establishment of such protection. The forces which brought about the development of two types of insurance in the United States, fire insurance and workmen’s compensation insurance, illustrate the contrast here presented.

5. Classification of economic risks —The extent to which insurance has been developed to deal with specific risk problems is partially indicated by the following two-fold classification:

A. Risks to persons

. Death

. Accident

. Sickness Invalidity Unemployment

Old age B. Risks to property Fire

Marine

Burglary and theft Explosion Negligence

Hail and windstorm Accident

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The subdivisions of these two classes represent, in each case, a specific type of catastrophe, the occurrence of which may in some way affect the economic status of individuals and for protection against which various types of insurance organizations are now in operation. ‘These two classes, risks to persons and risks to property, do not however, exhaust the possibilities of insurance, nor do they afford a complete list of the instances in which the principle.of insurance has actually been applied.

A further classification, which includes the two above given but which is broader than either, distinguishes between different types of risks to business enterprise. ‘They may be subdivided in various ways but for purpose of showing the possibility of dealing with them by means of insurance the following is most appropriate: A. Personal and property risks (Include risks shown in classification above) B. Speculative risks, due to 1. Changes in wants 2. Changes in methods of production

In meeting the problems of speculative business risks, less use has been made of the principle of insurance than in the two classes first given. In some cases other methods have been found and in others the problem is still unsolved. Credit insurance might be considered an instance of the application of insurance to speculative risks. The most important case, both because of the magnitude of risk and because of the scope of its operations, lies in the field of speculation; for speculation, as will be seen later, is an application of insurance principles to the problem of economic risk.

6. The solution of the risk problen—risk control.— The economic problem of risk, which has been discussed in the previous section, can be solved in one or both of two ways: (a) by control of the risk, resulting in a reduction of actual losses; or (b) by insurance, or a distribution of uncertain losses and a reduction of the uncertainty. The two methods are not exclusive but interdependent. It will be found that in many cases they operate side by side, that the organization or agency which carries the insurance attempts at the same time to control and reduce hazards. Since the two solutions are, however, distinct in principle, general principles of each must be considered separately.

7. Risk control or conservation.—The conservation movement, so-called, received a great impetus in the United States some ten or fifteen years ago. Before that time efforts at conservation had been made piecemeal in various fields but the attention of the nation as a whole had not been concentrated upon the wastes and losses of human effort or of material resources. Such phrases as “conservation of life” and “conservation of natural resources” became catch words of everyday discourse. Altho much has been accomplished, much remains yet to be done. This propaganda probably brought to many people their first appreciation of the great losses involved in many economic risks, yet conservation or risk control had been developing for a long time and important results had been accomplished in many fields. Some indication of the extent to which control methods have been developed in some fields of economic risk will be given in this section, while the methods and results in other fields will be indicated more fully in connection with the discussion of particular kinds of insurance.

The prevention of losses is closely associated with insurance since no money indemnity can fully compensate for a loss. Even in those forms of insurance where the coverage has been made most nearly complete it has been found desirable or necessary to restrict the indemnity to a figure somewhat less than the actual loss. The value of property destroyed by fire may be replaced and yet the insured may suffer a great deal thru the cessation of his business operations and the loss of trade, which are consequences of the fire. ‘The community also suffers a loss thru the destruction of property and impairment of productive capacity. The individual exposed to risk is interested in risk control because it reduces his costs, it obviates losses against which he can not obtain protection, and it lowers the premium charge which he must pay for insurance; the interest of the state arises from the harmful effects of losses upon the public welfare.

8. Conservation and property risks —The greatest progress in controlling property risks has probably occurred: in the field of fire prevention, or fire insurance engineering, as it is now called. Inspection services in individual business establishments and by the officials of a few cities help to remove some of the causes which start fires; a considerable movement has begun in the way of educating the public and property owners as to the causes of fires; fire prevention week is a regular annual event in many places; fire drills take place in schools and factories. Standards of building construction for the purpose of checking and resisting fire have been established and conditions existing in many localities have been improved. Fire extinguishing and _ notification facilities have been perfected in recent years and their use greatly extended. While all of these factors have contributed greatly to decrease fire losses there still occurs an appalling destruction of property by fire that totals several hundred million dollars in value annually.

The steam boiler explosion hazard offers an illustration in which efforts at conservation and prevention of property destruction are closely associated with the insurance of the risk. When steam boiler insurance was first attempted the plan was deliberately undertaken, by a careful inspection service on the part of the insurance companies, to prevent every boiler explosion that could possibly be prevented and to insure the few cases that were certain to occur despite inspection.

Other cases of conservation occur in the field of property risks to which more detailed attention is given later. In some cases the assistance of: the law, common or statutory, is utilized to make conservation measures effective, in other cases cooperative ac-_ tion on the part of interested property owners, insurance companies or the state accomplishes this purpose.

9. Conservation and personal risks——What is known as the conservation “movement” emphasized particularly the conservation of life. Piecemeal efforts in this direction by city, state and federal public health authorities had been made long since, but no concerted national attention had been given to the problem and the public seemed to be unaware of the effects of illness, disease, and premature death on the population. Insistent propaganda in special fields, as that against tuberculosis, has brought noteworthy results but this is still a partial and not a general effort to solve the problem. In recent years a few life insurance companies have established a service whereby their policyholders may obtain yearly a free medical examination. The few results which have been published indicate that the mortality savings thus effected much more than pay the cost of the service. The plan has not been developed broadly and there is still no such thing as a fully aroused and intelligent public interest in the United States on the question of life and health conservation.

More significant from the viewpoint both of results and of methods have been the developments of the last ten years in the field of accident prevention. Comparatively little was done in the way of accident prevention before the coming of workmen’s compensation. ‘There were indeed factory inspection laws, many of them dead letters, and there was some attempt in the more progressive industrial states to deal with the problem of industrial accidents from a prevention standpoint. But the coming of workmen’s compensation threatened to place upon industry a possible heavy burden of accident cost which must surely have been reflected in insurance of premiums paid by employers; hence there arose at once a demand from them for the prevention of accidents and a reduction of costs thereby. The history of the last ten or fifteen years has been one of decided progress. The insurance companies have taken up accident prevention, the states have become more efficient in this work because they have had an aroused public opinion behind them, and employers have combined and cooperated in a great many ways to bring about a reduction of accidents. So rapidly has our knowledge of accident prevention methods been advanced that one of the foremost safety experts in the country has in recent years declared it to be a thoroly established fact that eighty per cent of the accidents in industry are preventable.

The remaining field of personal risk, where prevention methods are greatly needed and where very little has been accomplished to date, is that of unemployment. The analogy of accident prevention leads to the conclusion that the prevention of unemployment. as of other serious economic losses and wastes, will proceed with great strides only when the problem is considered in connection with insurance, and when there has come to be recognized a more thorogoing community responsibility for these risks. Given this recognition and a clear agreement as to where to assess the cost in the first instance, those who must first bear the burden of cost will no doubt organize preventive methods.

It is coming to be generally recognized now that the prevention of unemployment involves a fundamental diagnosis and thorogoing remedies. The problem is closely related to the business cycle and the eventual solution will probably come only if means can be found of dealing in a much more fundamental way with the business cycle.

10. Conservation and risks to business enter prise.— Speculative business risks offer few instances in which the method of insurance has been used to solve the risk problem. Except thru the development of speculative and future trading it is probable that insurance can not be used in any thorogoing solution. Here again we are dealing with problems of the business cycle and, if remedies are possible, it is evident that they must be fundamental. Methods of conservation or of prevention have not gone far as yet and to find the successful method of approach is one of the great tasks before the economists and business men of today.

11. Insurance as a solution of the risk problem— nature of insurance-—The complete solution of the economie problem of risk involves both the method of risk control discussed above and that of insurance ‘which occupies the remainder of this chapter. The former seeks to reduce the actual frequency and severity of losses that occur, and it is a fundamental and far-reaching solution. Some types of economic catastrophe, however, can never be done away with entirely and, in our imperfect world, others never will be; hence risk control becomes after all only a limited solution. Uncertain losses will occur, and will fall with fatal result upon individuals unless some xIxX—3 method is found for alleviating their effects. The method of insurance distributes among a large group of persons the uncertain losses which fall upon the individual members of the group, distributing them in such manner that the share of each in the payment for such uncertain losses is relatively small, relatively stable in amount from time to time, and is not an impossible economic burden. Insurance is, therefore, ordinarily defined in the text books as a method of distributing losses and eliminating uncertainty. The statement points to two essential characteristics of insurance, one objective, the other subjective, which have made it such a valuable social institution.

The objective aspect of distributing losses is illustrated in the case of fire losses among property owners, few of whose properties burn, and where the losses of these few are distributed among all those who may be exposed to fire loss. Subjectively considered, insurance eliminates not the uncertainty as to whose property will be burned, but the uncertainty whether the financial Joss from the destruction of particular properties will fall heavily, or even fatally, upon their owners. Men carry on their economic activities as individuals and their economic success is conditioned upon purchases and sales in competitive markets that do not permit large margins for catastrophic losses that come infrequently. If then the uncertainty as to the actual items of property which will burn may be associated with a certainty that the financial loss will be carried, not individually, but by the group of all interested property owners, business men and property owners are placed in that subjective attitude where they will engage in business ventures and in the ownership of property, and the whole society benefits therefrom.

12. Scientific basis of insurance—the theory of probability—The presuppositions of the previous paragraph are that uncertainties to the individual can be made certainties for the group. ‘Tho it can not be known whether a particular property will be burned there is a reasonable certainty that about the same proportion of all property exposed io fire will be burned in a given year. Upon the validity of this assumption rests the whole science of insurance. It is based upon the mathematical theory of probabilities, the latter founded on the notion that every event is an effect for which there is some antecedent cause or complex of causes. In social or economic relations these causes are too numerous and _ too complex ever to be traced in detail, but for the purpose of insurance, it is not necessary to know causes, so long as the effects are sufficiently regular in character.

13. Application of this principle to economic risks.—By the collection of data on the frequency and magnitude of uncertain losses in the past and by the use of such data to measure or estimate the frequency with which such losses will occur in the future the principles of probability can be applied to economic risks. If, for instance, observation of past experience has shown repeatedly that about ten persons die each year among one thousand exposed to death, this ratio of ten per thousand can be used as an estimate of the frequency with which deaths will occur in the future among persons similarly situated.