As we saw in Chapter II, life insurance is a form of investment that should come first on the list of those undertaken by anyone who has dependents to provide for in the event of his demise; and the shares of the companies which provide life and other kinds of insurance will also be found to be highly attractive to anyone who wants the advantage carried by ordinary shares but seeks to reduce the risk that necessarily goes with them.
This attraction consists, as in the example of banks and discount companies, in the fact that enormous funds are handled in proportion to the capital invested, and that insurance is a great huge world-embracing business and is always going on, with a certain ebb and flow of activity and profit, but free from the wide fluctuations that may affect a particular industry. Whether trade is good or bad, those who carry it on have to insure against fire and shipwreck and other trade risks; though if trade is bad there are fewer ships sailing and fewer goods in transit, though there may be more in the warehouses.
Insurance is a very complicated and difficult business, and the complications and difficulties reflect themselves in the accounts and balance-sheets published by the companies, especially those of the kind usually described as composite, because they usually carry on several different kinds of insurance business, the main divisions being life, fire, marine, employers' liability and sickness and accident.
All these different divisions require highly specialized skill, though the life department is now comparatively simple owing to the mass of knowledge that has been acquired, through more than a century of investigation and record, concerning the probabilities of the length of human life. Given the requisite medical skill to judge whether an applicant for insurance is sound in wind and limb—and a few other particulars—or how much allowance should be made for any weakness that may be detected, a skilled actuary can easily work out his expectation of life—barring accidents. Moreover, as the mortality tables on which the companies work are necessarily the result of past experience, and as improved sanitation, medical knowledge and surgery are continually adding to the span of human life, those who sell life insurance have long been selling an article which was really rather less valuable than they believed it to be; and so we constantly find the companies reporting that their mortality experience has been considerably below expectation. Which means to say that the bargain made with the assured has been in favour of the companies, though the assured have been able to share in this advantage by means of "with-profit" policies.[1]
Another factor in their favour is that those who insure their lives are likely from this very fact to be good lives, because they are likely to apply to living the same prudence and forethought and intelligence concerning responsibilities that led them to the act of insuring. So that the life risk is "selected." On the other hand, though the Black Death no longer ravages Europe, influenza sometimes has an appreciable effect on the death-rate.
In other forms of insurance, this favourable selection does not help those who provide them. All ships of any value that sail are insured with their cargoes and in some cases the selection is the other way. At least I have heard it suggested that an owner driver who has insured his car becomes immediately much less careful in driving; and the exponents of auto-suggestion would probably tell us that anyone who insures against sickness is likely to be ill, from the mere fact that he thinks about it.
Competition in insurance is keen, especially in foreign countries, and most of our great composite companies do a large business abroad; and its management needs the highest skill and vigilance to keep an even balance between the necessity of working at rates which shall meet competition and attract custom, and that of making full provision against the risks involved. At the same time insurance business is one in which established reputation and prestige are of enormous value—if you buy a knife or a pair of boots you have got your article and there's an end on't, and you are not concerned further with the seller. If you buy insurance of your warehouse against fire or of your ship against marine risks, you are very greatly concerned to be certain that the seller will, if you have to make a claim at some future date, be not only solvent but prompt and fair in meeting it. It need not be said that in these respects the British offices have an unrivalled reputation the world over, so that as long as they are given a fair chance by local legislators, they are well equipped to keep their flag flying. But it was remarked by the Economist in its issue of May 30, 1925, that "an element of nationalism has to be reckoned with, the tendency in many countries nowadays being to regard insurance as a local preserve for national companies."
The accounts of the composite companies are so voluminous and complicated that any detailed examination of them would only confuse the ordinary investor, for whom this work is devised, and overload this chapter to a weight and size out of all proportion to the scale of our building. As to the balance-sheet, it is enough to say that the "doubtful assets" almost non-existent, if we assume, as we may, that the mortgages are well secured and that the investments are quoted and marketable. In one that is before me the assets are composed as follows:—
| Mortgages and loans | £517,181 |
| Investments | 16,872,725 |
| Freehold and leasehold premises, ground rents, etc. | 1,982,290 |
| Branch Agency and other balances | 3,292,361 |
| Due from other companies, or departments of the company | 910,518 |
| Outstanding premiums and interest | 200,700 |
| Bills receivable | 50,591 |
| Cash and stamps | 2,641,164 |
| £26,467,530 |
It looks like a nice collection, though we are largely left to guess about its contents. Mortgages which we found in Chapter VII to be unsuitable for the private investor we saw at the same time to be excellent for institutions like insurance companies, which can command the skill and attention necessary for their vigilant and constant scrutiny; and their amount in this case is less than half a million out of a total of 26½ millions.
Of the investments, four millions odd are British Government securities, £953,000 are Indian and Colonial Government, £2,886,000 Foreign Government, and £6,784,000 are Railway and other debentures and debenture stocks, home and foreign, these items making up nearly £14¾ millions out of the total of 16¾. British municipal and county securities only amount to £128,000, and there are £290,000 of "Railway and other" ordinary stocks and shares.
It was noted above that the list of investments is almost entirely uninforming. The insurance companies are bound by the Assurance Companies Act of 1909 to draw up a balance-sheet according to the Third Schedule of the Act. The headings shown are those provided by the Schedule. As usually happens with these well-meant official regulations, those bound by them naturally think that, having duly followed them, they have done all that is required, and as we see, the Schedule drawn up by the wisdom of Parliament seems to be designed to tell us almost nothing about the investments of insurance companies.
It makes the companies show (which is something) how much is in British Government securities, but such headings as Railway and other debentures or ordinary stocks, and Foreign Government securities are quite worthless to anyone who wants to know what securities the companies hold. Foreign Government securities range from the obligations of the United States to those of Honduras; and "Railway and other ordinary" might include wild cat mining or oil shares. It would be an education for most of us to be able to see what are the investments of the great insurance companies; as it is, we can only see that they are divided into certain headings, and once more call upon that confidence in the directors and managers, which has so often to act as a crutch for the groping investor, to guide us to the belief that all these are sound and suitable. Fortunately the crutch generally does its work; but if all the great insurance companies would publish with their balance's heets a full list of their investments, they would provide a most useful guide to those who are less well equipped for selecting securities.
That there is no objection to their doing so is shown by the fact that some of them do it. The balance-sheet of the Clerical, Medical and General Life Assurance Society, for example, gives every investment in detail, and a very interesting study they make, and will repay careful examination by investors who want to see how this successful company succeeds in earning a net yield of £4 15s. 4d. per cent., after deduction of income tax, on its invested funds. Points that strike one are the small amounts held in Home Railway prior charge stocks (£19,000) and home municipal securities (£10,000), though the loans on parochial and other rates come to a handsome sum (£298,000). The outstanding features, however, are the imposing figures of the mortgages (£2,013,000) and the British Government securities and guarantees (£2,180,000), which with the various loans (£1,106,000) make up well over five millions out of a total of £8,881,000 of assets.
As to the complications of insurance accounts and the high proportion of net revenue that the companies put to reserve, both will best be exemplified by the following extracts from the first article in the Economist's Insurance Supplement of July 12, 1925, giving the generals results for the year 1924:—
"In this brief preliminary survey we are concerned with the broad effects of the year and its contribution to the resources of British insurance. It is rather misleading to talk or write of 'profits' when we are considering the underwriting surpluses of insurance companies, those balances of the annual premiums which remain over after claims, expenses, and unexpired liabilities have been met. In the technical and legal sense they are, of course, profits belonging to the shareholders. But, unlike the profits of an ordinary trading company, they are not, except to a very small extent, available for distribution. These annual profits of insurance—or, as we prefer to call them, these annual surpluses—are the materials, and the sole materials, out of which the powerful structure of insurance is built up. They provide the slowly accumulating reserves for contingencies upon which security rests, and without which insurance, from the public point of view, would be little better than a gamble. In order to achieve security of the highest class, these annual surpluses, when they are earned, are always treated as funds held in trust for the public rather than as cake to be cut up and divided among shareholders. Out of them British taxes are paid, and almost the whole balance, sometimes even more than the balance, is put away to permanent reserve. Dividends are based, not on these surpluses, but upon the interest earned by the reserves. This sound system of insurance finance has been taught to the world by the British companies, and no other system will give that endurance and impeccable security which is of the essence of insurance, and without which insurance is a mockery.
"Last year the fire insurance offices did fairly well, in spite of rather unfavourable results in the United States. The accident and miscellaneous departments, though not productive of large surpluses, did better than in 1923. Marine insurance remained in the trough of the wave, and showed few, if any, signs of becoming seaworthy. Life assurance was prosperous, but as the bulk of the surpluses in this class of insurance, even in proprietary companies, goes in bonuses to policy-holders, it is not a large contributor to profit and loss accounts.
"While making up the figures for the table of general results on the opposite page, we have observed certain recognized principles. The underwriting surpluses in the fire, accident and miscellaneous accounts were arrived at after charging against premiums all the claims paid and outstanding, all expenses and commissions, including those carried to profit and loss accounts, and including colonial and foreign
Underwriting Results, Interest, Taxes and Dividends
| Company. | Net Underwriting Surplus. | Interest Net, less Debenture Interest. | Taxes. | Dividends for 1924. |
|---|---|---|---|---|
| £ | £ | £ | £ | |
| Alliance | 449,805 | 303,733 | 17,125 | 434,000 |
| Atlas | 174,603 | 122,127 | 46,762 | 143,000 |
| British Dominions | 43,964 | 117,335 | 25,000 | 143,152 |
| British General | 86,933 | 50,100 | — | 40,687 |
| Caledonian | 74,328 | 74,052 | 30,925 | 74,981 |
| Commercial Union | 1,018,201 | 728,163 | 271,433 | 826,000 |
| Employers' Liability | 121,603 | 268,537 | 116,079 | 287,818 |
| General Accident | 175,428 | 179,221 | 143,821 | 89,358 |
| Guardian | 248,577 | 142,283 | 48,776 | 163,069 |
| London Assurance | 115,729 | 237,429 | 50,000 | 212,865 |
| London and Lancashire | 754,158 | 387,001 | 184,741 | 407,603 |
| Motor Union | 62,126 | 69,225 | — | 84,940 |
| North British | 575,058 | 398,596 | 101,711 | 375,554 |
| Northern | 222,999 | 246,682 | 56,037 | 297,254 |
| Phoenix | 383,742 | 421,772 | 55,621[2] | 463,556 |
| Royal | 781,937 | 1,034,245 | 130,000 | 1,134,351 |
| Liverpool and London and Globe | 511,260 | 382,222 | 50,000 | 413,777 |
| Royal Exchange | 90,909 | 170,688 | 48,254 | 152,898 |
| Scottish Union | 201,095 | 124,669 | 62,938 | 116,250 |
| Sun | 220,388 | 181,220 | 48,579 | 186,000 |
| Yorkshire | 156,895 | 98,966 | 58,844 | 112,548 |
taxes when specified in the companies' accounts, and the amounts required to maintain the reserves for unexpired risks at 40 per cent. of the premium incomes. When the premium income falls the yearly contribution to current reserve is negative, and becomes an addition to the surplus; but when the premium income increases it is positive, and a reduction of the apparent surplus. With marine insurance we have been obliged to adopt a different system. No one knows how a marine account works out except the officials of the individual companies, and they only after an account has been finally closed. For marine surpluses we have taken the amounts transferred to profit and loss by the companies in respect of the latest closed year. For the contribution of life assurance we have taken those amounts which have been disclosed by valuations as belonging to shareholders, and accordingly carried to profit and loss.
"So much for surpluses. The interest receipts are those yielded by the available funds, other than life and capital redemption, less income tax and less debenture interest payable by the companies. The taxes, which are chargeable against surpluses, are in most cases British taxes only. But where a few companies have lumped all their taxes together and put them into profit and loss account, we have been obliged to follow them. Dividends are those provided in respect of 1924; many of them have been increased as compared with 1923. Increases in dividend are permissible, as and when the interest yielded by the funds increases.
"After applying the above principles we find that the total surpluses of the twenty-one companies in our table amounted to £6,469,747 before charging taxes. Taxes, net, required in the aggregate £1,535,404, so that there remained £4,934,343 as the final surplus from all sources on about £100 millions of premium income (excluding life premiums). The dividends provided for 1924 cost £6,159,661, towards the payment of which the interest receipts on the funds yielded £5,638,288, leaving only £521,373 to be drawn from the surplus. We see, therefore, that the aggregate surplus of £4,943,343 was disposed of as follows: £4,412, 970 undivided and set aside to strengthen reserves, and £521,373 expended in the payment of dividends."
It is an amazing exhibition of successful business and financial strength, and those who acquire proprietorship in it by a purchase of insurance shares do so usually at prices which make them pay high for a partnership in these assets and this wonderful organization. Many insurance shares stand at prices which yield to the buyer a rate of dividend which is considerably below the yield from Government securities—some of them less than 3 per cent.—and so discount a good deal of future increase. The few debenture stocks that these companies have outstanding are as fine a security as anyone could want, but they are scarce and high priced and difficult to buy.
- ↑ See Chapter II, p. 28.
- ↑ Refund