Capital Risks and Insurance

How can a person secure maximum safety in the conduct of his investment enterprise?

For two reasons no better answer can be given this question than to refer to the policies and practices of successful insurance companies. First, insurance is a business of accepting risks. Every life, every piece of property, every contract, insured, is a risk on which the company runs a chance of loss. Yet no other human institution has succeeded so well in building upon a foundation of uncertainties a structure of certainty. Secondly, by the nature of their business insurance companies are among the largest and most experienced investors. Investment being but the application of underwriting principles to the ownership of capital risks, who better than experienced underwriters should know how to secure maximum safety in investing? What the companies have learned in one field should benefit them in the other.

Every prospective life and fire risk is examined and rated. Only the better risks are accepted. Limited amounts are placed on each individual risk, on each individual type of risk. So with investing, every prospective capital risk should be carefully examined and only the better ones accepted. Only limited amounts should be invested in any one company, type of security, or section of the country. Regular inspection should be made of risks acquired, and questionable ones eliminated.

The fire companies offer the most fertile field for our observation. The ten largest fire companies are all stock companies, sound and progressive. Their investing is not restricted by law. Their underwriting of late years has been less and less profitable because of an unfavorable loss trend. Therefore they are compelled to invest well in order to remain in business. Over the last fifteen years the average investment result of the four most successful of these ten, judging success by aggregate investment gain and income, was 60 per cent better than the average of the other six companies. These observations will be confined to the average for the ten companies. It must be remembered, too, that fire-company investment policies cannot be exactly those of the individual investor, the college, or the hospital. Each investor has his own problem. The fire company must be prepared to meet a conflagration loss on short notice, and consequently maintains a large fund of cash or short-term obligations. A number of the companies are equipped with investment research departments, whose facilities enable them to find opportunities the average investment committee would never hear of, and to dispose of poor risks before the rank and file of investors realize they are poor.

On December 31, 1926, the invested assets (at market value) of the ten largest fire companies were divided as follows: real estate— 1.8 per cent; mortgages —.7 per cent; bonds — 49.5 per cent; stocks — 41.6 per cent; and cash — 6.4 per cent. Bonds and stocks were the chief items. The lowest proportion in stocks for any one company was 19.1 per cent, the highest 73.6 per cent. The lowest in bonds was 22.3 per cent and the highest 65.8 per cent. Somewhere between these extremes, probably, lie the correct percentages for the big fire company which wishes to secure the maximum profit consistent with maximum safety. The individual, the college, the hospital, could with equal safety own a larger proportion of stocks than the fire company.

These figures show merely a cross section of the investments owned on one particular day. How have they been on other days? What will they be December 31, 1927? Looking at cross sections taken on December 31 for each year from 1910 to 1926 inclusive, we find the stock proportions gradually decreasing from 38.1 per cent in 1910 to 27 per cent in 1919, and then gradually increasing to 41.6 per cent in 1926. Over this period, bond proportions gradually increased from 51.6 per cent in 1910 to 62.2 per cent in 1919, and then gradually decreased to approximately 49.5 per cent in 1926. From these figures it seems fair to conclude that the fire companies believe in owning large proportions of stocks and that they do not acquire or unload stocks to take advantage of bull or bear markets.

On December 31, 1926, bonds then held by the ten companies had appreciated 3.6 per cent, stocks 33 per cent. On December 31, 1921, — the depression year, — bonds then held had depreciated 1.5 per cent, stocks had appreciated 11.1 percent. From these figures and others covering gains and losses taken, it is evident that stocks have proved profitable. It is interesting to find that bank and insurance stocks have been among the most profitable classes owned. Dividing the stocks into common and preferred, the proportions of late years have been about 75 per cent and 25 per cent respectively. In 1921 appreciation on common stocks then held was 18 per cent, depreciation on preferred was 1.2 per cent. In 1923 appreciation on common was 22.5 per cent, on preferred 3.1 per cent. Figures for 1926 are not yet compiled. While the companies evidently believe more in common than in preferred stocks, and justifiably so, they nevertheless give the preferred a substantial representation. The lesson for the investor is not to confine himself to the one ‘ best’ type of risk. Something unforeseen might weaken that type. The average grade of stocks represented in insurance portfolios is high, and investment in new and unproved managements is strictly avoided.

To sell a weak security is just as important as to buy a sound one. Yet few investors realize this. Many are still buying ‘permanent’ investments. Averaged over the past six years, the four most successful of these ten investors have annually disposed of 20 per cent of their invested assets. The six less successful have disposed of 13.5 per cent annually. Weeding out pays. It must be remembered, of course, that fire companies constantly maintain large holdings of short-term bonds, which often are sold before maturity, either to pay fire losses or to be reinvested to better advantage. Individuals, hospitals, and colleges should not have any such high rate of turnover as this, but it is safe to say that nine out of ten investors, institutional and individual, err on the inactive side. A recent report of the Carnegie Corporation says: ‘The funds of a great endowment can be kept intact only by a systematic revision month by month of all the securities of the endowment and by a continuous process of sale and exchange as circumstances may affect the financial soundness of this or that security.’

Few fire companies maintain adequate departments for investment research, although the practice is amply justified by results. The great majority still operate under the illusion that investing is a business which requires only a small fraction of the time of any lawyer, merchant, manufacturer, or banker whose success in one field, though acquired through years of hard work, immediately qualifies him as an expert investor. When investment is recognized as an increasingly intricate business, demanding as the price of success the same study, care, attention to detail, and devotion to research other businesses are demanding, maximum safety with maximum profit will become somewhat less of a phenomenon.