A NEW MODE OF TESTING THE ECONOMY OF THE EXPENSES OF MANAGEMENT IN LIFE INSURANCE.
How to determine the general ratios of the expenses of management of life insurance companies has hitherto been an unsettled question, and I think no serious attempt has been made before my own to study this question exhaustively, and reach a scientific conclusion.
Believing that, one is contained in the following statement, I respectfully submit it to the criticism of others.
It has generally been taken for granted that the measure of economy of life insurance expenses may be expressed by the single ratio of expenses to one feature of the business, such as the premium income, or the total income (premium and interest), or the mean amount of all policies outstanding. But this is not the case. No exhaustive reason has been shown for preferring one of these bases of ratio to another, and, indeed, no reason well supported by argument has been shown for employing either. On the other hand, no better evidence is needed of the importance of establishing a uniform and demonstrably sound basis, than the fact that it is common for companies to refute one another's claims to superior economy, and totally confuse the public, by opposing ratios found in one way by ratios found in another—that one of two companies which appears the most economical according to one test being apparently the least so according to another.
The economy of the expense of any transaction, or work, can only be intelligently judged by the value of the result. This truth is too well recognized to need illustration, and it only needs to be called to mind, to perceive both the error of ratios of expense based on premium, which is not the result but the raw material, so to speak, of insurance transactions; and what, on the contrary, the true basis is.
It is thus clear that in insurance the economy of expense must be judged, not by comparison with the premiums paid, but by comparison specifically with the resulting advantages in fact secured by such payments. Now these are of two kinds: which may be called the insurance advantage and the investment advantage.
(1) Each death claim paid is an insurance advantage, though it is so only to the extent of the excess of the amount of the policy which has become a claim over its premium reserve, or value, for the latter being the balance (with interest) of the policy holder's own premium money, could have been left or secured to his representatives without the intervention of the policy and company.
It is true that the advantage or benefit of insurance does not consist in adding anything to the wealth of a company, but only consists in drawing from the premiums paid into its treasury by the policy holders generally, to meet each death claim which arises; or can only be called an advantage of distribution, or process of collecting aid from the living members, to assist the representatives or dependents of the deceased ones; but it is not the less on this account an advantage worth same expense in securing.
(2) Interest realized by the investment of premium while it is in the keeping of a company is an advantage; in every sense so, since it comes wholly from outside sources, and accrues proportionally to all members; it may be called, as above, the investment advantage, and of course justifies some expense to secure it.
Hence the expenses incurred by any company in a given; time must be divided into two parts, one being the expense incidental to insurance, and the other that incidental to investment, which parts are to be compared respectively with the insurance claims met, and interest receipts of the company for the same time; or what is equivalent in the latter case, the net rate of interest earned after deducting the incidental investment expense may be found.
When this process shows that one company has earned a higher rate of interest than another, at the same time that its insurance expenses bear a lower ratio to its insurance claims paid, there is no escape from the conclusion that during the period under observation it has served its policy-holders more economically, and the test is therefore scientific. Though, if one company shows a higher rate of interest, while the other shows a lower ratio of insurance expense, it will still be necessary, to complete the test, to equate either the rates of interest or the ratios of insurance expense (it does not practically matter which), and note how this affects the relation of the duly corrected ratios on the other score.
To be exact, if the average vitality of the members of the two companies differ (other things being equal, it is always cheapest to belong to that company which has the lowest death rate), the ratios of insurance expense to expected, as well as actual, claims of each must be found, and equated.
The science of this procedure, or mode of testing expenses, and also its practical simplicity, may be more clearly perceived by reference to its practical application in the following table:
Table Exhibiting Ratio of Expense, Determined by the New Mode, of Companies Doing Business in Massachusetts during the Year 1883.
| Name of Company. | Location. | Death claims paid. | Estimated Premiums. Reservethereon. | Difference or Net insurancefurnished. | Expense on the score ofInsurance. | Expense per $100 of claims paid. | Interest Receipts. | Expense on the score ofinvestment. | Net Rate of interest earned. | ||
|---|---|---|---|---|---|---|---|---|---|---|---|
| Rate. | Rank. | Rate. | Rank. | ||||||||
| Berkshire | Mass. | $208,147 | $46,605 | $161,524 | $122,779 | 75.4 | 14 | $194,067 | $15,809 | 5.25 | 16 |
| [[7]]JohnHancock | " | 169,604 | 25,117 | 144,487 | [[8]]228,566 | 158.2 | 24 | 135,597 | 11,686 | 3.65 | 26 |
| Mass. Mutual | " | 426,995 | 86,215 | 340,780 | 232,400 | 68.2 | 10 | 428,255 | 33,176 | 6.03 | 7 |
| N. England Mutual | " | 1,039,694 | 235,630 | 804,064 | 311,879 | 38.8 | 3 | 995,883 | 69,908 | 6.40 | 4 |
| State Mutual | " | 121,969 | 22,493 | 99,476 | 98,839 | 99.4 | 19 | 143,751 | 13,057 | 4.51 | 24 |
| Ætna | Conn. | 1,302,807 | 364,510 | 938,297 | 460,014 | 49.0 | 6 | 1,760,372 | 118,962 | 6.22 | 5 |
| Connecticut General | " | 87,639 | 15,624 | 72,015 | 46,113 | 64.0 | 9 | 95,580 | 5,407 | 7.03 | 1 |
| Connecticut Mutual | " | 2,867,489 | 881,600 | 1,985,889 | 622,941 | 31.4 | 1 | 3,041,125 | 238,944 | 5.70 | 10 |
| Equitable | N.Y. | 3,072,232 | 483,950 | 2,588,282 | 1,884,108 | 72.8 | 12 | 2,743,024 | 216,725 | 5.42 | 12 |
| Germania | " | 606,072 | 149,950 | 456,122 | 325,662 | 71.4 | 11 | 508,702 | 47,193 | 4.85 | 22 |
| Home | " | 205,921 | 48,603 | 157,318 | 155,192 | 98.6 | 18 | 260,506 | 19,917 | 4.86 | 21 |
| Homoeopathic | " | 35,610 | 6,340 | 29,270 | 48,734 | 166.5 | 25 | 42,814 | 2,935 | 6.20 | 6 |
| Manhattan | " | 687,171 | 183,450 | 503,721 | 266,305 | 44.9 | 5 | 627,628 | 44,081 | 5.82 | 8 |
| [[7]]Metropolitan | " | 638,639 | 18,322 | 620,317 | 1,161,893 | 187.3 | 26 | 106,916 | 9,098 | 4.90 | 20 |
| Mutual Life | " | 5,172,275 | 1,407,700 | 3,764,575 | 1,480,198 | 39.3 | 4 | 5,042,964 | 466,739 | 5.01 | 19 |
| Mutual Benefit | N.J. | 2,160,991 | 550,890 | 1,610,101 | 521,829 | 32.4 | 2 | 2,072,629 | 169,913 | 5.61 | 11 |
| National | Vt. | 174,767 | 29,127 | 145,640 | 77,861 | 53.5 | 7 | 149,010 | 10,100 | 5.26 | 15 |
| New York Life | N.Y. | 2,408,636 | 574,150 | 1,834,484 | 1,995,102 | 108.8 | 21 | 2,676,592 | 236,884 | 5.03 | 18 |
| Northwest'n Mutual | Wis. | 990,692 | 190,500 | 800,192 | 630,582 | 78.8 | 15 | 1,200,001 | 88,527 | 5.80 | 9 |
| Penn. Mutual | Penn. | 601,625 | 107,600 | 494,025 | 309,858 | 62.7 | 8 | 463,567 | 37,131 | 5.38 | 13 |
| Provident Life and Trust | " | 280,817 | 49,865 | 230,952 | 222,665 | 96.4 | 17 | 340,115 | 33,294 | 4.26 | 25 |
| Provident Savings | N.Y. | 24,875 | 1,828 | 23,047 | 51,608 | 233.9 | 27 | 4,955 | 2,579 | 1.70 | 27 |
| Travelers' | Conn. | 235,001 | 42,243 | 192,758 | 144,621 | 75.0 | 13 | 331,623 | 22,476 | 6.42 | 3 |
| Union Mutual | Maine | 377,547 | 88,520 | 289,027 | 237,913 | 82.3 | 16 | 301,499 | 28,754 | 4.66 | 23 |
| United States | N.Y. | 283,304 | 69,245 | 214,059 | 277,919 | 129.8 | 23 | 271,594 | 23,460 | 5.09 | 17 |
| Vermont | Vt. | 13,000 | 1,542 | 11,458 | 13,613 | 118.8 | 22 | 12,917 | 822 | 5.33 | 14 |
| Washington | N.Y. | 356,289 | 71,820 | 284,469 | 289,461 | 101.8 | 20 | 446,998 | 32,249 | 6.78 | 2 |
| Totals | $24,549,808 | $5,753,439 | $18,796,369 | $12,177,655 | 64.8 | $24,398,684 | $1,999,826 | 5.42 | |||
| Collective Business ofAssessment Societies Doing Business in the State (excepting SecretSocieties). | |||||||||||
| 46 Societies | $735,383 | $237,770 | 32.3 | ||||||||
The figures given in this table are drawn from the last annual report of the Insurance Commissioner of Massachusetts, excepting the premium reserve on death claims, which, as well as the division of the total expenses of each company into insurance and investment expenses, I have estimated on a uniform rule. This was for lack of the actual data in these particulars, which the report did not give, as it is desirable that future ones may.
This, however, does not injure the value of the table for illustrating the mode of procedure, for which purpose mainly it is presented. The companies whose figures I have used, moreover, have no occasion to complain of this, as my estimate certainly gives all ratios of insurance expense lower than they would appear if I had known, and used, the exact actual premium reserve on death claims, and all probably bear nearly the same ratio to each other as they would in that case.
As the object of this statement is to explain the new method, and not to defend my particular estimates in applying it, I forbear to state on what rules I have made them. Expense which is not ascribed to insurance must be ascribed to investment, and as in comparing any two companies, their two ratios of one kind or the other must be equated, to decide the question of economy between them, it may well be left to any company to say what the fair division of its own expenses is.
Moreover, there can be but little motive to make a false division; for to successfully compete for business, a company having large investments has as much need to show a high net rate of interest earned as a low rate of insurance expense. Again, it is not my purpose to pass judgment on the economy or extravagance of any ratio of expense shown in the table. It is not a fact exhibited for the first time by my figures, that the ratios of some companies are more than double those of others. The same fact would be displayed in about as high a degree by ratios based on premium income, or any other incorrect basis. Custom, the balance of opinions, and competition may well be left to decide what ratios of expense are high, and what are average, or low. And their decision is to be gathered only from statistics.
What I do claim is that the mode of determining ratios herein explained is the only intelligible and scientific one, and the only one proper to employ in statistical tabulations and investigations.
As such, it calls attention to the fact that the amount of insurance claims met, and of interest receipts, are limits which the corresponding expenses cannot exceed, certainly for a series of years together, without making the expense more than the advantage of the business. To keep this fact in view, as a preventive of extravagance, is not the least valuable service the new mode may render. It may be seen that there are eight cases in the table, in which the ratio of insurance expense points to expenses exceeding the insurance claims met in the same time, yet the reader need not hasten to conclude that the same companies will permanently show similar ratios, or have no good reasons to give for the ones which now appear. I may remark, however, that it is an evidence of the scientific mode in which the figures are presented, that it facilitates such explanations as are pertinent of any of the ratios.
For instance, some of the ratios are undoubtedly affected by the fact that the claims for the year of the company in question have been exceptionally high or low, or that the company (being of recent organization perhaps) has just incurred exceptional expense to increase its business, the advantage of which will appear later, etc. But I leave to the companies themselves to show to what extent such circumstances have affected their ratios; except that, in regard to the several net rates of interest earned, it is proper to say that in all cases in which they considerably exceed the average of 5.42 per cent. it will be found, by referring to the details of interest receipts reported to the Commissioner, that the excess is owing to the fact of exceptional profits by the sale of stocks, or recovery on investments previously reckoned as loss.
WALTER C. WRIGHT.
Medford, Mass., Sept., 1884.
Including industrial business.
Includes $18.867 depreciation.
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