Risk Theory Seminar Research Articles

Basic Financial Differences of Substandard Automobile Insurers

The substandard automobile insurance companies have produced more than their share of failures and have been something of an embarrassment to the rest of the insurance industry. The causes of the high rate of failure are a source of considerable national concern. The substandard companies fill an need and serve a certain group of insurance buyers who have no other market. The identification of the best of the substandard insurers is of interest to many who deal with them. This paper attempts to set forth basic differences in the readily available financial data of the substandard companies as opposed to the data found in other company groupings. Only Illinois domiciled companies are included in the company samplings to preserve some homogeneity of legislative and regulatory climate. Ratio analysis is used to project the differences. The adequacy of published data appurtenant to substandard companies is also treated. The purpose of this paper is to see if a cursory. examination of the financial statements of various categories of insurance companies with respect to size, and also with respect to the primary class of business written, can be shown to differ widely in various groups of companies. More particularly, do the financial statements of companies specializing in substandard automobile insurance differ widely from other insurance companies, and do these differences, if tlhey are found Campbell K. Evans, Ph.D., C.P.C.U., is Associate Professor of Insurance at Illinois Wesleyan University. Before moving to his present position, Dr. Evans was a member of the faculty at the University of Illinois. The author wishes to acknowledge support of the Risk Theory Seminar from the Cooperative League of the United States of America, including the following companies: Desjardins Mutual Life Insurance Company, Mutual Service Insurance Company, Co-operators Insurance Association, Co-operative Insurance Services, Ltd., La Societe d' Assurance des Caisses Populaires, Nationwide Insurance Company, and League Life Insurance Company. This naner was submitted in April. 1963. to exist, have a bearing on the financial stability of the company? If there are immediately apparent factors which come to light, through an examination of the publicly available data of insurance companies, indicating a probable rate of survival or failure in the market place, then the identification of such landmarks could be of great benefit to those charged with the responsibility of placing insurance for others and to those with regulatory responsibilities. On the other hand, if the readily available financial data do not reveal clues as to the future financial health of the particular company, then those faced with company selection and company supervision have a somewhat more difficult task. They must look beyond the commonplace data into filings and into the background data and insider data which may be available only to regulatory authorities.

Tax-Sheltered Annuities: Purchase Decisions

When an employee is given the opportunity to elect a tax-sheltered annuity contract in lieu of part of his regular compensation, he is faced with a number of decisions. Should he participate in the plan? If so, how much of his salary should he divert into the annuity? Where there is a choice, what insurer should he select to underwrite the contract and what kind of annuity contract should he elect? These decision areas are examined with the purpose of developing some meaningful guidelines for use in making what are by no means simple determinations. Employees of educational, charitable, and religious organizations are eligible for a unique Federal income tax benefit. Ordinarily, when an employee is given nonforfeitable rights in an annuity contract purchased for him by his employer, he must include as current income the premiums paid by his employer. But within limits, an employee of an educational, charitable, or religious organization is not required to report these premiums as current income. The proceeds of the annuity, when received, however, must be reported as gross income. The right of certain employees to exclude from current income employer-paid premiums for nonforfeitable annuity contracts is not new. Since 1942, the Internal Revenue Code has provided employees of certain organizations an income tax benefit for these annuities. However, prior Robert I. Mehr, Ph.D., is Professor of Finance in the University of Illinois. Dr. Mehr is President of the American Risk and Insurance Association, Chairman of the Executive Committee of the Pacific Insurance Conference, Chaplain and Founder of the Risk Theory Seminar, a former member of the Board of the American Finance Association, Past President of the American Society for Insurance Research, Founder and Chairman of the InterAmerican Insurance Forums, and a two-time winner of the Elizur Wright Award for outstanding original contribution to the literature of risk and insurance. This paper was submitted in October, 1967. to the Technical Amendments Act of 1958, hamstringing administrative decrees rendered these provisions ineffective. One of these restrictions prohibited employees from requesting reductions in cash salaries to provide funds for the purchase of annuities by employers. Another restriction limited the amount which could receive tax shelter to 10 per cent of the income received from such employers. Some tax authorities, including Congressman Mills, believed that the Revenue Service had exceeded its authority in issuing these regulations. Agitation for Congressional clarification resulted in the 1958 revision of the Code provisions for tax-sheltered annuities. Section 23 of the Technical Amendments Act of 1958 added Section 403(b) to the Internal Revenue Code of 1954 to dispel some of the doubts raised by the Regulations pertinent to Section 403(a), the predecessor of Sec-

Investment Life Insurance versus Term Insurance and Separate Investment: A Determination of Expected-Return Equivalents

The purpose of this paper is to analyze the provocative proposition of substituting for investment life insurance a program of term insurance and separate investment. The approach is to calculate an expected-return equivalent, that is, the rate of return net of taxes and investment expenses that one would have to expect from a separate investment fund plus term insurance over some duration, such as twenty or thirty years, in order to attain at least the equivalent of the performance of investment life insurance, taking into account the probability of persisting in either scheme and the time value of money. In the current environment of aggressive competition for the individual's savings dollar, one is frequently confronted with comparisons between investment life insurance and other investment media. The extent to which investment in life insurance is discouraged by proponents of other media is epitomized in the expression buy term and invest the difference. The slogan implies that one is better off if, instead of buying investment life insurance, he uses the same financial outlay to purchase an equivalent amount of term insurance protection at a lower J. Robert Ferrari, Ph.D., C.L.U., A.C.A.S., is Assistant Professor of Insurance in the Wharton School of Finance and Commerce of the University of Pennsylvania. Dr. Ferrari is co-author of Life Insurance and/or Mutual Funds and of The Private Insurance of Home Mortgages. The author gratefully acknowledges that the bulk of the research for this paper was financed by a summer research grant from the National Science Foundation. The author is indebted also to Howard Simkowitz and James O'Grady, graduate students at the University of Pennsylvania, who performed much of the computational work for this paper, and to Joseph M. Belth, Indiana University, who offered much helpful criticism. A draft of this paper was presented at the 1967 Risk Theory Seminar in Philadelphia, Pa. premium and invests the remainder (the difference) in a separate investment. This proposition is well-recognized by anyone familiar with life insurance and it has stimulated a great deal of interest in the relative investment merits, or demerits, of life insurance. However, the generally accepted of analyzing the relative investment return in life insurance is subject to a number of shortcomings. Accordingly, the three-fold purpose of this paper is: (1) to describe and analyze the traditional Linton method for determining the investment return that an investor must expect to earn if a plan of term insurance and separate investment is to be at least as favorable as an equivalent financial outlay in investment life insurance; (2) to describe an alternative that alleviates many of the shortcomings of the traditional approach; and (3) to present the results of the application of this new to a number of modern life insurance plans.

The Impact of Lapse Rates on Life Insurance Prices

The purpose of this paper is to measure the effect of changes in lapse rates on the price of life insurance protection to policyholders. The magnitude of the changes in lapse rates to be considered is determined by reference to data on lapse rates in various companies. Then, the impact of changes in lapse rates is compared to the impact of changes in mortality rates. The conclusions are that lapse rates have a substantial effect on price, and that consideration should be given to the use of expected lapse experience in the classification of life insurance applicants. The discontinuation of life insurance Joseph M. Belth, Ph.D., C.L.U., C.P.C.U., is Associate Professor of Insurance in the Graduate School of Business at Indiana University. He is author of Participating Life Insurance Sold by Stock Companies (1965), for which he received the 1966 Elizur Wright Award of the American Risk and Insurance Association, The Retail Price Structure in American Life Insurance (1966), and A Report on Life Insurance (1967). Dr. Belth is a frequent contributor to this Journal and serves as its Communications Editor. He has received four N.A.I.I. awards for papers published in this Journal. This paper was first presented on September 1, 1966, at the Fourth Annual Risk Theory Seminar of the American Risk and Insurance Association. The author wishes to acknowledge the financial support provided to the Risk Theory Seminar by the Cooperative League of the United States of America, including the following companies: Desjardins Mutual Life Insurance Company, Mutual Service Insurance Company, Cooperators Insurance Association, Co-operative Insurance Services, Ltd., La Societe d'Assurance des Caisses Populaires, Nationwide Insurance Company, and League Life Insurance Company. The author also wishes to acknowledge the asistance of Cheyeh Lin, then a doctoral candidate in Indiana University's Graduate School of Business and presently Assistant Professor of Finance at the University of Cincinnati, who handled a considerable portion of the data processing and tabulation of the results. The author alone, however, assumes full responsibility for the views expressed in the paper and for any errors that may remain. The computer used was the CDC 3600 in Indiana University's Research Computing Center. policies by policyholders prior to maturity or death is recognized as an important factor in the prices that life insurance companies charge their policyholders. For example, the tendency of increased lapse rates to increase the level of life insurance prices is generally cited as one of the primary reasons for discouraging the replacement of existing policies.' Nevertheless, the lapsation problem is usually referred to only in general terms, and, as far as the author has been able to determine, no specific analysis of the impact of lapse rates on prices has ever been published. The purpose of this paper, therefore, is to attempt to measure the effect of changes in lapse rates on the price of life insur-

Quantitative Determinants of Income with Some Implications to Insurance

By use of 1960 census data on the characteristics of the United States population, this study attempts to establish the significant variables which may be used to determine income, and to calculate the extent of the relationship of these variables to the level of income. The methods used involve standard factor and correlation analysis. After the have been isolated and variance quantified, an attempt is made to construct an econometric model of income. Application of the results to various fields of endeavor related to Risk and Insurance are suggested. Quantitative of are those variables which have a measurable relationship to the level of income. Alfred E. Hofflander, Jr., Ph.D., C.L.U., C.P.C.U., is Assistant Professor of Insurance in the University of California at Los Angeles. His earlier teaching experience included service at Florida State University and the University of Texas. He is Assistant Editor of this Journal, is Associate Editor of the CPCU Annals, and was formerly Editor of the North Florida Business Review. Dr. Hofflander was a Fellow in the Huebner Foundation for Insurance Education. This paper was presented at the 1966 Risk Theory Seminar and was sponsored in part by the UCLA Division of Research and The University of Texas, College of Business Administration Research Foundation. In addition, the author wishes to acknowledge the support of the Cooperative League of the United States of America, including the following companies: Desjardins Mutual Life Insurance Company, Mutual Service Insurance Company, Co-operators Insurance Association, Co-operative Insurance Services, Ltd., La Societe d'Assurance des Caisses Populaires, Nationwide Insurance Company and League Life Insurance Company. Certain data used in this paper were derived by the author from a tape file furnished under a joint project sponsored by the United States Bureau of the Census and the Population Council and containing selected 1960 census information for a 0.1 per cent sample of the population of the United States. Neither the Census Bureau nor the Population Council assumes any responsibility for the validity of any figures or interpretations of the figures published herein based on this material. In words, the extent of the relationship is quantitative. No implication is involved conceming causality which might exist between and the various determinants. The word determinants is used in a descriptive sense, in that these factors do not necessarily cause to be what it is, but that the analyst can, within a certain range, determine a hypothetical level of by knowing the significant variables and their relationships. The fact that variables are quantitative presupposes the ability of the analyst to perceive changes in the variables and to measure the related variance. The fact that variables are determinants means that they may be used to estimate levels of income. The term income refers to wage and salary income, self-employment income, and/or other received over the period of a year.' The size of an individual's is the result of the interaction of many factors, of which some are measurable and others are, for practical purposes, non-measurable. Age, education, occupation, number of weeks worked per year, geographic loI Miller, Herman P., Income of the American People. Social Science Research Council. (New York: John Wiley & Sons, Inc., 1955), p. 13.

Industrial Life Insurance Prices

Joseph M. Belth, Ph.D., C.L.U., C.P.C.U., is Associate Professor of Insurance in Indiana University's Graduate School of Business, and is Communications Editor of this Journal. Formerly Assistant Director of Continuing Education for the American College of Life Underwriters and the American Society of Chartered Life Underwriters, and a former life agent, Dr. Belth graduated summa cum laude from Syracuse University, and did his graduate work at the University of Pennsylvania under a Huebner Foundation fellowship. He is a frequent contributor to this Journal, and is a three time recipient of one of its N.A.I.I. awards. Dr. Belth is author of Participating Life Insurance Sold by Stock Companies (1965). E. J. Leverett, Jr., M.B.A., is Assistant Professor of Insurance in the University of Georgia's College of Business Administration. He is a candidate for a D.B.A. degree in Indiana University's Graduate School of Business and studied under an H. B. Earhart Foundation fellowship. Mr. Leverett operated an agency for ten years before resuming his studies at North Texas State University, where he received his M.B.A. degree in 1962. He has taught at North Texas State University and Indiana University. This paper was originally presented at the Second Annual Risk Theory Seminar, which was held August 28-30, 1964, in Chicago. The calculations were performed on the IBM 709 in Indiana University's Research Computing Center. The authors are grateful to several life executives and regulatory officials who made extensive comments on an early draft of the paper. However, the authors alone assume full responsibility for the views expressed. 1The expression life insurance is a misnomer. It refers to that segment of the individual life market that is serviced by agents who usually collect premiums at the homes of policyholders, in contrast to the segment of the market in which premiums are generally paid by mail. Premiums on industrial policies are usually payable weekly or monthly, while premiums on ordinary policies are payable annually, semi-annually, quarlife is sometimes viewed as a declining one. Yet there is considerable evidence to support the theory that industrial life is actually increasing in importance, particularly when certain difficulties with the existing statistics are taken into consideration.2 Even without adjustment for the statistical problems, there was approximately $40.5 billion of industrial life in force in United States companies at the end of 1963, and the 1963 premium income generated by this business was approximately $1.4 billion.3 It has been estimated that the 98 million industrial policies in force at the end of 1961 provided life protection for approximately 65 million people.4 Perhaps the most extensive study of industrial life prices was the one conducted in the late 1930's by the New York Insurance Department.5 This study