Politics and Mysteries of Life Insurance

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Contents

cniapter I. Page

Magnitade of the business. Mutnal autocracy. Terrific decadence and its cause. Insurance and accumulation. "Cooperative** pure insurance impracticable. Natural Premium. How the commuted or artificial premium involves a combination of accumulation with insurance. Source of the mystery. Blunder of making the penalty for the non-payment of contracted premiums an increasing one. The endowment swindle. Self-insurance defined. " Insurance value." Difference of American and British life Insurance, 1-16

Cltapter n.

Appendix

Actuaries' Bate of Mortality. The author's acknowledgments. Papers by Mr. Emory McClintock, actuary of the North-western Mutual lafe Ins. Co. of Milwaukee, . 216-238

A

THE POLITICS AKD MYSTERIES

OF

LIFE INSURANCE.

• ••

Chapter I/». /-•. :

In the United States more than half a million of persons, chiefly men, have their Uves insured for the benefit of those who will survive them, or, in many cases, for their own benefit, if they survive a designated age. The business is done entirely by corporations, more or less " mutual " in their constitution or charter, more or less regulated in their conduct by State laws, and more or less preyed upon by State officials.

These corporations, few of which are over thirty years old, differ exceedingly as to the extent and amount of their business, and the magnitude of their resources ; their number of policies ranging from less than one thousand to more than seventy thousand, and their assets, exclusive of future premiums, from less than $100,000 to more than $50,000,000. We haye in fact the anomaly of a company , having an an-

^^am nual revenue of $15,000,000, with about 160,000,000 in hand, which though constitutionally *' mutual^ and theoretically perfectly democratic, is, de facto^ autocratic, the chief officer holding proxies enough to secure his own reflection, in spite of any opposition short of the miraculous. An autocracy may be the best government in the world or it may not be, according to the character of the autocrat. The prejudices of o,ui: country are certainly not in its -zisLjov.^ .In; fli^tS politics of life insurance, whenever . , ^tbiajautocracj^takeBr. place, the individual constitu- /''v! I^iif;: or '"'^^fiafetd&lr •member," finds that if he would retreat from a position where he is a, political cipher, he must make a sacrifice of money in some sort of proportion to the time he has occupied it. He perceives, rather to his dismay, that he went in without stipulating with due caution the terms on which he could get out, in case he should become dissatisfied. If he had exercised that prudence, the autocracy of the corporation would have been under heavy bonds for its good behavior, instead of holding the members under heavier and heavier bonds, to acquiesce in whatever it should please to do.

That the life-insurance policy, in its usual form, is not a bargain which both parties enter into with their eyes open to all its contingencies, is sufficiently obvious, from the rapid rate at which policies are cancelled, with more or less loss to the individual, and

I sometimes with a loss, though generally with a gain, to the company. The rate of cancellation has so much increased of late, that in many companies hardly half of those who enter having bargained to pay from ten to fifty annual premiums, should they live long enough, ever pay the second. A recent State Report, shows 150,000 policies terminated in a single year, and only about 139,000 new ones entered. The fieu^t that imder the ordinary form of poUcy, the longer one stays in the company, the more it costs him to get out, must have something to do in accounting for this immense outward scramble. It cannot be that all these people have backed out because they have ceased to need insurance, or have found themselves mistaken in supposing that they needed it. The supposition is more reasonable that they have discovered the bargain was not quite fit to be made, and that inasmuch as there is a .considerable probability that the necessity for insurance will not continue through the term of the policy, it is better to cancel it while the cost is at its minimum. They may also have discovered that there is far more mystery than democracy in life insurance, no matter how purely mutual the plan. They may have discovered that a life policy under certain legal provisions, designed to protect the interest of the beneficiary, is equivalent to a man's making a will which he cannot himself annul. Few men with their eyes open, would do this, even if the law allowed it.

The object of this volume is to show that all the real benefits of life insurance can be obtained under a policy which can be perfectly understood by both parties, without obliging the individual to submit to any wrong at the hands of an autocratic or pseudo corporation, a policy which provides fairly and equitably for the contingencies of the partj^s ceasing to need insurance, or being unable to pay for it, as well as that of his death.

There are two ways of providing for a surviving family : 1. Insurance, pure and simple ; 2. Accumulation. The former is immediate. It creates an estate instantaneously — so far as the interest therein of heirs is concerned. The latter is slow, entirely too slow for the particular exigency, though it has the advantage that it will benefit the party himself in time. Yet it is what every man attempts, or ought to, whether he insures or not. Of insurance, pure and simple, when you cease to pay and still live, there is nothing left. It would be a somewhat improvident citizen who should insure his life as long as it continued to be productive, and surviving that period, should have to resort to the poorhouse for his own support.

For the purpose of insurance, life is divided into units of time, each measuring a year, during which the risk is assumed not to change, but from any one year of age to that which succeeds it the risk in - creases according to an assumed scale , which is founded on the mortality observed of a large number of lives of the same ages under similar circumstances. Insurance, pure and shnple, is when the risk of each year, no more and no less, is paid for at the beginning, in the course of, or at the end of the year. The perfection of it in theory is what is called ''cooperative insurance," where, for example, a thousand persons agree to pay |1 each to the family of each deceased member. If the agreement is carried out, the first that dies, in consideration of his own obligation to pay, having actually paid nothing, leaves his family $999, drawn from other members. The second leaves $998. And so on. IS. the lives were all of the same age, and unexceptionable in health, an equal payment would be fair, and the number of them within a year could be so nearly predicted as to make it practicable to provide for the death-claims by paying in advance, that is, by premiums equivalent to the risk of the year. If such premiums only were paid, there would, if the calculation proved correct, be nothing left at the end of any year ; and every year, as the vitality of the party decreased, the premium for the year would increase. This premium for a given sum insured, increasing every year according to the increased chance of the party dying in that year, it is convenient to call the natural premium. Insurance, pure and simple, would be by the payment, annually, of these natural premiums. But in reality it does not exist, for reasons that are too obvious to need statement. The ''cooperative plan," so far as it illustrates pure insurance, may be set down as impracticable.

What does exist, is a plan which combines in the same policy a series of pure and simple yearly insuranceSj with a plan of accumulation by annual deposits. And these two processes are so undistinguishably blended in the policy, as to be a perfect mystery to the insured, if not to the officers of the company itself. The insured generally agrees to pay an equal annual premium, either during the whole term of the policy, or a considerable part of it. He knows pretty well that this is larger than the ''natural premium," or what it will cost to insure the amount of his policy the first year. But he is not told in the policy how much of it is for the first year's risk, and how much for accumulation. All the information he can get is, that inasmuch as his policy covers many years, including those future ones in which it will cost more than the whole of his premium to insure the amount of his policy for one year, the company must have something to accumulate to supply the deficiency. He is thus persuaded to leave this matter of the accumulation entirely to the company, and is probably enticed into an agreement that in case he fails to pay any premium when due, he shall forfeit the entire accumulation in the company's hands, or when he wishes to surrender, shall have only what he does not value, a small " paid-up " policy.

Now what is quite plain is, that the policy which combines insurance with accumulation is the right practical thing, if under the right conditions^ inasmuch as every person who needs insurance, also needs to accumulate, so that if he survives the proper period of insurance, he shall have the enjoyment of a more or less considerable accumulation, end because insurance pure and simple is reaUy impracticable, for the want of a sufficient security for the persistence of the natural premiums.

The permanence of the company depends not only upon the premiums being adequate to the risks assumed, but upon the policy-holder's being sufficiently bound to continue, so that the company may have a broad enough basis to realize death-claims nearly according to the assumed law of mortality. Precisely what the penalty of a non-performance of the contract on the part of the policy-holder should be, may be a matter of some doubt or difference of opinion. But that, if possible, it should be greater at the end of the first year than ever after, is simply a matter of demonstration.

Here is a blunder more than a hundred years old. The penalty has been a constantly increasing one I It makes a perfBct farce of the accumulative feature of the policy. It, in fact, enlarges a salutary penalty into a system of betting or gambling on persistence, totally mmecessary and foreign to the aim of the business.

It has been the lot of the writer to be connected practically with life insurance for many years, either as an agent, a state commissioner of insurance, or an actuary. In the latter capacity he has had frequent occasion to ascertain, by various standards, the proper reserve which a company should have, to make distribution of surplus, and to give an opinion on the value of one company's business to be transferred to another. Commencing with a profound conviction of the usefulness of a policy to himself, and no knowledge of the principles of the business whatever, he assumed that science had done for it about all that it could, and for a long time took it for granted that what it had not done could not be worth doing. But old blunders will always show themselves when run into new fields. One, which, though very mischievous when confined to the ordinary whole-life policy — a policy which iteelf commite another bl Jder of covering years of life that are really uninsurable — , might have been tolerated or escaped observation a century longer, forced itself upon his attention when the American appetite for independence and self-insure ance had multiplied endowment policies, of not very long terms. This sort of policy, which is the very perfection of life insurance, the very thing for a high-spirited young man to take, by applying to it the old blunder that always adhered to the life policy of putting expenses and commissions as a percentage on the premium, was converted into a swindle. It was a swindle not easily detected, immensely profitable to the agent, but intensely unsatisfactory to the policy-holder after being found out.

The headlong rush into endowment policies, which began about fifteen years ago, without correcting the British error in loading the premiiuns and assessing expenses, and without distinguishing between the insurance and self-insurance of a policy, is what has brought life insurance in this country to its present grief. This volume is designed to call public attention to the subject in such a way that our companies, which, in spite of all their errors, are generally in a sound condition, shall be obliged in their future business to give endowment policies that are fit to be made. When this is done, there will be small demand for any other kind.

The first thing to be done is to achieve a distinct definition of the terms we skall have occasion to use.

Self-Insukance.

This element of a life-insurance policy always

exists whenever more than the natural premium for

a single year, with the working expenses thereof,

is paid. It is the same as the reserve on the policy,

1*

— T at the end of the year, and is commonly called the value of the policy. The propriety and significance of the term ^ self-insurance '' will be best understood by an example.

Assuming interest at 4 per cent. , and the American Table of Mortality (that prepared by Mr. Sheppard Homans, on the experience of the Mutual Life Ins. Co. of New York) , the annual premium for a whole-life policy of $1,000, at the age 40, apart from the addition or *' loading '' for expenses, is $22.36. This is the mathematical equivalent, under the assumptions, to the series of net natural increasing premiums, beginning with $9.42. But if $22.36 is paid instead of the $9.42, it is important to remark that the risTc to be borne by the corrt" party on the policy is diminished. It is supposed, for the sake of simplicity, that the death-claim, if it occurs, is settled at the end of the year, till which time the provision for it paid or in hand, at the beginning of the year, is on interest at 4 per cent. If only the natural premium of $9.42 has been paid, amounting to $9.79, at the end of the year, and the party dies, the other members, that is, the company, has to pay $1,000— $9.79=:$990.21. K $22.36 has been paid, amounting to $23.25 at the end of the year, then the company has to pay but $1,000 — $23.25=:$976.75. Hence the risks in the two cases are in the ratio of 990.21 to 976.25, and if the former is called an insurance of ^l^OOOy then the latter is

976.75 an insurance of only qqa'qi X 1000=986.41. And

the difference, 1000 — 986.41 = 13.59, is not insured by the company. But since the heir receives it as part of the death-daim, it is reasonable to say that the party insured himself to that extent. Thus, on account of the increase of the artificial net premium over the natural one of the year, for the amount insured, th^ business of the year necessarily resolves itself into two generically distinct transactions. First, the party buys of the company an insurance of $986.41, for which he

pays the natural net premium of iaaa x9.42=:

9.29. Consequently the balance of his premium, 22.36 — 9.29=13.07, is a mere savings bank deposit, which, increased at 4 per cent., makes up $1,000, by setf-insurance or accumulation.

If the death does not occur, then the $13.59 must remain in the company's hands, by mathematical necessity, as well as legislative enactment, to diminish future risks, which is the same thing as to provide against future deficiencies of the level premium. It is, in fact, a trust fund, accepted on the condition that it shall count on the death claim, if it occurs, and remain on hand to diminish the future risks, if it does not. It is not available for a claim on any other policy.

The effect of paying the $22.36 the seoond year,

12 PoUHcs and Mysteries of

is, that the company will have $35.95, which, at the end of the year will amount to $37,39, instead of the $10.01 which it would have had if only the natural premium for $1,000 had been paid. Hence the risks this second year are in the ratio of 989.99 to 962.61. Consequently, the insurance done by

962.61 the company is 5^=^ X 1000=972.34, and the balance, $27.66, is the *sdfAnsurance<t reserve, or "value of the policy," at the end of the second year.*

It would be better, always, to call this the sdf-- insurance value of the policy, to distinguish it from another very important and diflferent "thing, which is properly the insuraruie value of the policy, that is, the sum which, paid in advance, under the assumptions, would exactly pay for all the insurance which the company is to do under the policy, as distinguished from that which the party is to do himself.

It will readily be perceived that the ratio in which the two processes of insurance and self-insurance or accumulation, enter into the business of each year can be as easily and accurately precalculated as anything else relating to the business, so that there is no excuse for keeping mixed up in mystery two things that are essentially different, and

* The results would be slightly different by the Actuaries' Mortality, for which see Appendix.

life Insurance. X3

both perfectly simple and intelligible by themselves. And since the working expenses of a life-insurance company are much larger than those of a savings bank having the same amount of funds on hand, it is quite obvious that while the various premiums paid are divided between insurance and self-insurance in exceedingly different ratios, only the wildest wreck of equity can result from assessing the expenses upon the premiums paid. Much less would come from assessing them on the amount of the policy, but that would only about half correct the blunder in the average case. There can be no reasonable correction till the insurance is carefully distinguished from the self-insurance on every policy, and the significance of the *' insurance value " of every policy is recognized, — ^in short, till the insurance is treated on insurance principles, and the accumulation on savings bank principles.

The peculiarity by which American is distinguished from British life insurance, is the more distinct and pronounced recognition on this side of the water of the reserve on each and every policy as a trust fund, applicable only to the claim on that particular policy . . Or what is the same thing, the recognition of the aggregate net value of all the outstanding policies as a matured liability to the living policy-holders. To this the American companies are more or less bound by State law, while the British are left entirely to be a law to themselves.

The practical difference is one of life and death, as a general fact. An American company may die, but unless it criminally evades the law, it will die solvent, — a much milder calamity than that which overtakes about nine-tenths of the British offices. This means that it will be able to return to the policy-holders the trust fund, or accumulation. It will only be unable to continue its insurances. Even this mild calamity which is now impending, more or less, over all our offices, might be averted by heroically correcting the blunder of mixing things which are not homogeneous.

Were the business of life insurance in this country practically in the hands of scientific men, the practical errors would soon be corrected. What little science has been turned in this direction is all right, but it is very little regarded. The man who controls the biggest pile of policy-holders' money, regards scientific men not as guides but tools. If one does not suit him, he tries another. Aip to the men who control the smaller piles, they look to the bell-wether, and not to the stars, for their courses. The only hope of improvement is in the growing intelligence of the people themselves.

It is only by the cultivation of thought, truth, and justice among mankind, that useful institutions can be kept from decay. There was included in life insurance at the start, too much falsehood, not by evil intention, but want of thought. It was immensely increased on this side of the water, when we made our policies, as we had good reason to do, more accumulative^ and this was for want of thought. But a falsehood which creeps in imwittingly may be adopted by men of mercenary motives, and used wittingly, with high pretensions, for a mean purpose. This has been done. Its tendency is but too plain. • Let us suppose an institution, intended to promote a universal regard for truth, should use a lie to frighten people from lying; plainly, whatever might be its temporary success, it could not be permanent. Organized falsehood, no matter how good its motive, grows into certain failure. Power without justice, proves its own executioner. Truth is, after all, the vital force of society, transmuting itself into the forms of justice, order and happiness. Falsehood, father and mother of ignorance, is the principle of social disease and death. Nothing which is good for society courts concealment. Life insurance will be good for society, when the poUcy conceals nothing, but speaks so plainly on every point, as to leave the agent no opportunity to lie, if so disposed, nor the policy-holder any claim to be dissatisfied, unless it is with himself.

The writer has discussed this subject in various journals, as different points and aspects of it have arisen during the last three years, and published a set of precalculated working tables.

with an introductory explanation, designed to give information to tiie ordinary, as well as the scientific reader. It appears to him that the happiest of these attempts to popularize a very dry though important subject, will be more useful to the reader who wishes to get at the marrow and merits of it, than any set treatise. He has, therefore, arranged in the following pages, a selection from them. The algebra, which is more or less sparsely scattered through them, may be skipped without losing the pith of the matter. It is not to be supposed that the ordinary reader will in all cases become convinced that the solution of the difficulty here proposed, is the correct one, or the best that can be. He will wish to hear the other side, but he will not fail to notice this, that a liberal prize is offered to any one, who within a year will produce a justification of the practices of the life insurance companies, by me stigmatized as errors and blunders. The companies that persist in these errors and blunders, have a pretty strong inducement to add to this prize, should there be need of it. Therefore, if the attacks I have herein made on the received and long practised mode of doing the business, are not fully answered and repelled before a year comes round, from the date of that offer, the public will certainly know that it is because science and money can't do it.