The principle of mutuality requires that the burden of expense in life
insurance should be borne by all the members equally; but, even with
the most careful adjustment, the allowance usually made is
considerably in excess of what is needed in the regular companies
doing business on the "level premium" plan.
It is customary in these companies to add to the net premium a
percentage thereof to cover the expense account. This practice, though
in harmony with the "commission system," is so clearly defective and
so far removed from the spirit of life insurance mathematics, that it
scarcely deserves even this passing notice.
It is generally understood that these corporations combine the
functions of the savings bank and life insurance company, and it is
only by separating the two in our minds as far as possible that we can
obtain a clear conception of the laws that should govern the
apportionment of the expenses among the great variety of policies.
While it is a comparatively simple matter to state the amount of
either the insurance or savings bank element in a single policy, it is
by no means easy, as things go, to classify the company's actual
expenses on this basis.
Fortunately, we can pretty accurately determine what these amounts
should be in any particular case.
In the first place, there are institutions in our midst devoted solely
to receiving and conserving small sums of money; doing, in fact,
exactly what our insurance companies are undertaking to do with the
reserve and contributions thereto. These savings banks are required by
law to make returns to the State commissioner, from whose official
report we can get a very good idea of the expense attendant on doing
this business.
Confining ourselves to the city banks, where the conditions more
nearly resemble those of the insurance companies, we find in
thirty-eight combined institutions for saving in the State of
Massachusetts a deposit in 1888 of $192,174,566, taken care of at an
aggregate cost of $455,387, or about 24-100 of one per cent.
The same ratio carried out for all the savings banks in Massachusetts
gives a trifle over 25-100 of one per cent.; we may, therefore,
consider ¼ of one per cent. as expressing pretty nearly the cost of
receiving, paying out, and investing the savings of the people.
We must remember in this connection that in the popular estimation,
the savings bank is an important factor in the public welfare, and in
the towns and smaller cities there are often found public spirited men
willing to give their services to encourage this mode of saving; but
public sentiment has not yet given to life insurance the place which
it is destined, sooner or later, to occupy by the side of the savings
bank. Hence the services of able managers can only be obtained by a
liberal outlay of the corporate funds. A satisfactory adjustment of
the matter of expenses will, perhaps, do more than anything else to
bring about this recognition on the part of the public.
In the case of the savings bank it is safe to say that for double the
present outlay a liberal salary could be paid to all the officers.
Following the analogy, we are led to infer that if this be the case in
savings banks, then ½ of one per cent. of the reserve should be an
ample allowance for the special labor required in the purely banking
portion of the business.
In this we have the concurrence of the late Elizur Wright. In an essay
on this subject he says:
"The expenses of the five largest savings banks in Boston, in
1869, did not exceed 4-10 of one per cent. on $28,000,000
deposited in them. They certainly had twice as many transactions,
in proportion to the deposits, as any life insurance company could
have with the same amount of reserve, so that ½ of one per cent.
on the reserve seems to be ample for all working expenses save
those of maintaining the agencies and collecting the premiums."
This need hardly be looked upon as an admission that it costs twice as
much to care for the funds of a life insurance company as for those of
a savings bank. A liberal expense allowance must be made at the
outset, seeing that an error in this particular cannot easily be
rectified after the policy is issued. The dividend, or, to speak more
correctly, the annual return of surplus, will correct any overpayment
on this account.
There is another expense which seems inevitable. This is the
government tax on insurance companies, amounting in the aggregate to
nearly 1/3 of one per cent. on the reserve.
When we consider that these institutions are intended to encourage
thrift and to relieve the community from the care of numberless widows
and orphans, it seems a clear violation of the principles of political
economy to levy a tax on this business; still, whatever our opinion
may be as to the justice or injustice of the imposition, the tax is
maintained and must be provided for. Consequently a further allowance
of ½ of one per cent. must be added to the net premium to cover the
same, making a total of 1 per cent. of the reserve for banking
expenses and taxes. Considering this point as settled for the time
being, let us proceed to investigate the insurance expenses.
Here, again, we are fortunate in being able to refer to the official
reports of a class of corporations doing nearly, if not quite pure
insurance.
The assessment societies, outside of the fraternal and benevolent,
reporting in 1889 to the insurance commissioner of Massachusetts, show
outstanding risks amounting to $733,515,366. Losses to the amount of
$7,270,238 were paid during the year at a cost for transacting the
business of $2,403,053, which includes among other items "agency
expenses and commissions," which amount to about $1,203,000, or 17 per
cent. of the cost value of the insurance actually done. It would seem
as if an allowance of 20 per cent. would be a liberal one in the case
of the regular companies, which surely have as good facilities for
doing business as the assessment societies.
As far as insurance is concerned, there is less difference between
regular and co-operative companies than is generally supposed. Regular
companies assess each policy in advance for a year's insurance at a
time, while co-operative societies furnish insurance only from one
assessment to another. The difficulty in the way of collecting the
assessment in the latter case would seem to be greater than in the
former, owing to the more permanent nature of the regular insurance
contract.
In compensating agents the assessment companies naturally pay in
proportion to the insurance obtained, inasmuch as there is no other
basis to go upon, but regular companies usually pay the agent a
percentage of the premium _which includes a considerable trust fund_
over and above the assessment for actual insurance. It is easily seen
that by the last method the agent's compensation increases in
proportion to the amount of savings bank business forced upon the
company.
To realize how far we are from anything like a scientific, not to say
common sense basis for insurance expenses, we have but to examine the
following list, which gives the ratios between the expenditures for
general expenses in 1889, and those for the extension of the business.
For every $100 used in a general way, the different companies spend
for commissions and agency expenses: $37, $66, $67, $78, $91, $106,
$110, $113, $120, $140, $157, $161, $173, $175, $186, $189, $200,
$202, $222, $264, $311, $346.
It will doubtless be said that I am taking a very advanced position
when I say that in the ideal life insurance scheme there is no place
for the commission system. Solicitors will be a necessity only so long
as they are in the field, but fifty years of life insurance has taught
our community its true value and, thanks to the modern press, the
institution it is no more likely to fall into desuetude than is
Christianity or the moral law.
For the convenience of bringing the company to the individual, the
latter should be willing to pay a fee. The man who renders another a
service or puts his superior knowledge at another's disposal should
look to the party benefited for his remuneration. Any compensation
given for such service to a go-between by a mutual company is paid by
all, and the question arises, Is the advantage to the company of
sufficient importance to warrant the imposition of this tax upon all
its members promiscuously? The following, from the Massachusetts
Insurance Commissioner's Report for 1885, leaves no doubt as to the
convictions of the writer on this important matter:
"The expensiveness of the life insurance policy is not because the
level net premium is too high, for the premium is absolutely just,
and the policy holder gets full value; but the complaint justly
applies to the excessive expense charge. A person who wants
insurance, life or fire or other, should be able to buy it at
first cost without paying tribute of profits to middlemen. To that
complexion the matter will finally be brought by the force of
intelligent opinion, whatever resistance may be opposed by persons
whose thrift lies in the perpetuation of the expensive system now
in fashion."
It requires but a slight degree of prophetic vision to predict that in
a very few years the companies in self defense will be obliged to
change their method of compensating agents.
Several companies have already begun the reform by grading
commissions; granting a percentage proportional to the amount of
insurance likely to be done on the policy. Other companies have simply
reduced the amount of the commission rate, thus virtually withdrawing
from active competition.
This will, in a certain degree, explain the wide variation in the
figures given above, where it is noticed that, in five companies out
of twenty-two, the total agency expenditures amount to less than the
general expenses, while in six cases the companies spend more than
double as much on the former as on the latter. In either class we find
representatives of the five largest companies in the country.
On applying the foregoing ratios to the business of the existing
companies we find that, calling the theoretical expenses $100, the
actual expenditures for 1889 were as follows: $112.67, $118.34,
$150.40, $194.48, $208.16, $208.53, $228.66, $235.89, $248.44,
$250.79, $258.33, $258.57, $265.14, $267.19, $267.92, $274.47,
$294.17, $314.96, $335.70, $377.94, $616.70.
In this discouraging exhibit there is one ray of comfort. The combined
assets of the two companies heading the list amount to over
$100,000,000. There is no question as to their financial standing, and
both show a large increase in membership over the previous year. I may
also say here that it is a difficult matter to get at the actual "cost
of insurance" in the various companies. Many of them, on their own
acknowledgment, do not compute the advance cost of carrying their
"amount at risk," and others, for reasons of their own, do not care to
state the figures. In cases where the correct figures were not
obtainable, I have assumed the cost to have been 1-1/3 per cent. of
the mean amount at risk.
If we should, in our comparison, omit the actual agency expenses and
commissions, the ratios would stand as follows:
Where I would allow $100 the companies actually used: $43.17, $55.90,
$65.21, $77.21, $82.39, $88.34, $91.99. $91.98. $92.19, $94.65,
$97.15. $99.55. $99.11. $102.86, $109.35, $125.05, $133.03, $141.92,
$195.90, $207.06, $287.72.
As might be supposed, the first two ratios are those companies before
alluded to. These companies might have doubled their advertising
account and expended $300,000 between them on agents' salaries, and
still have kept within my allowance.
Admitting, for the present at least, the reasonableness of the
proposed allowance for the expenses of the banking and insurance
departments of the business, we have before us the problem how to
equitably adjust the burden among the great variety of policies.
In the first place, _there should be no policy in the company that
does not contribute its proportionate share of the expense allowance
during every year of its life_. I make a special point of this, for at
present the policies which have become paid up, either by the payment
of a single premium at the outset or by the completion of a stipulated
number of payments, contribute practically nothing to the expense
account after the premium payments cease.
The following plan, I think, complies with all the requirements of the
problem. By the proposed method every policy, at all stages of its
existence, contributes its exact share to the expense fund, whatever
its plan of payment may be.
Let us, as an illustration, examine the case of a ten year endowment
policy, taken out at age 30, and consider it under three aspects,
first, as paid for in advance by a single payment, second, as paid by
five annual payments, and third, as paid for annually throughout the
term. I have used this short term endowment policy simply for
convenience, the rule applying equally to policies of longer term or
to the ordinary life policy, which is, in fact, an endowment policy
payable at death or age 100.[1]
[Footnote 1: The expense allowance on a plain life policy for $1,000,
taken at age 33, would be about $5.29; net premium (com. ex. 4 per
cent.), $18.04; total office premium, $23.33; present rate $24.10.]
Taking the case of the single premium endowment policy for $1,000, we
find that the following sums are required, each year to provide for
the care of the reserve and to pay the government fees (1 per cent. of
reserve):
1st year $6.9982 | 6th year $8.4136
2d " 7.2560 | 7th " 8.7381
3d " 7.5258 | 8th " 9.0781
4th " 7.8082 | 9th " 9.4346
5th " 8.1039 | 10th " 9.8086
The insurance expenses should be covered by the 20 per cent. allowance
given below:
1st year $ .4422 | 6th year $ .2566
2d " .4100 | 7th " .2076
3d " .3762 | 8th " .1556
4th " .3402 | 9th " .0988
5th " .2996 | 10th " .0344
Consequently the total contribution required from this policy each
year is:
1st year $7.4404 | 6th year $8.6702
2d " 7.6660 | 7th " 8.9457
3d " 7.9020 | 8th " 9.2337
4th " 8.1484 | 9th " 9.5334
5th " 8.4034 | 10th " 9.8430
The present value of all these contributions is found to be, at 4 per
cent. interest, $71.6394; in other words, this sum paid at the outset,
provides a fund from which we may deduct the current expenses of each
year in advance, and by accumulating the balance at the assumed rate
of interest from year to year, we shall have enough to pay the
anticipated expenses, leaving nothing over.
In the above case the sums in hand at the beginning of the year are as
follows:
1st year $71.3694 | 6th year $42.6981
2d " 66.7669 | 7th " 35.3890
3d " 61.4650 | 8th " 27.5009
4th " 55.7055 | 9th " 18.9979
5th " 49.4594 | 10th " 9.8430
We find a somewhat different condition existing during the first years
of a 5-year endowment policy. As there is more insurance and less
banking, the requirements are as follows:
------------+----------+-----------+--------+---------+
| 1 P. Ct. | 20 P. Ct. | | |
| on | on | Total. | Initial |
| Reserve. | Cost. | | Fund. |
------------+----------+-----------+--------+---------+
1st year | $1.5038 | $1.2572 |$2.7610 |$12.9769 |
2d " | 3.0406 | 1.0216 | 4.0622 | 23.6015 |
3d " | 4.6503 | .7852 | 5.4355 | 33.2979 |
4th " | 6.3367 | .5378 | 6.8745 | 41.9538 |
5th " | 8.1039 | .2996 | 8.4035 | 49.4594 |
6th " | 8.4136 | .2566 | 8.6702 | 42.6981 |
7th " | 8.7381 | .2076 | 8.9257 | 35.3890 |
8th " | 9.0781 | .1556 | 9.2337 | 27.5009 |
9th " | 9.4346 | .0988 | 9.5334 | 18.9979 |
10th " | 9.8086 | .0344 | 9.8430 | 9.8430 |
------------+----------+-----------+--------+---------+
As the premium payments extend over only five years, the expense
contributions must all be paid during that time and are most
conveniently made by a uniform addition to the net premium.
The present value of the amounts in column 3 is $60.0819, and the
equivalent annuity for five years is $12.9769. This amount, received
for five consecutive years, will put the company in funds to pay
current expenses and leave a reserve of $42.6981 at the beginning of
the sixth year, which, as we have seen in the analysis of the
single-premium policy, is the sum required for future expenses on the
paid up basis.
In like manner we find that the 10-year annuity equivalent to the
present value of the annual contributions in the case of an
annual-payment policy is $5.534, thus:
------------+----------+-----------+--------+---------+
| 1 P. Ct. | 20 P. Ct. | | |
| on | on | Total. | Initial |
| Reserve. | Cost. | | Fund. |
------------+----------+-----------+--------+---------+
1st year | $.8234 | $1.3514 |$2.1748 |$ 5.5340 |
2d " | 1.6473 | 1.2478 | 2.8951 | 9.0275 |
3d " | 2.5096 | 1.1388 | 3.6484 | 11.9116 |
4th " | 3.4124 | 1.0210 | 4.4334 | 14.1277 |
5th " | 4.3572 | .8916 | 5.2488 | 15.6161 |
6th " | 5.3479 | .7534 | 6.1013 | 16.3160 |
7th " | 6.3853 | .5966 | 6.9819 | 16.1572 |
8th " | 7.4726 | .4270 | 7.8996 | 15.0763 |
9th " | 8.6127 | .2418 | 8.8545 | 12.9977 |
10th " | 9.8086 | .0344 | 9.8430 | 9.8430 |
------------+----------+-----------+--------+---------+
The present value of the ten yearly expense items given in the "total"
column above is $46.6812, which is equal to a ten-year annuity of
$5.534. The several premiums stand now as follows: