Hamstringing Insurance

I

THE assets of the life insurance companies chartered in the United States exceeded on December 31, 1926, the market price of all classes of stock of the one hundred corporations whose common stocks were the most active, the highest-priced, and the largest-dividend-paying of all those listed on the New York Stock Exchange.

A giant insurance and investment corporation, after merging these one hundred companies, could have declared a sizable stock dividend and continued cash dividend payments equivalent to the old rates. It could have assumed the bonds of the constituent companies, met the interest payments, and had enough resources left over to set up a respectable surplus. In addition, it could have paid the bankers, lawyers, and economists who planned and effected the consolidation handsome fees for their services.

The newly formed corporation would have had a virtual monopoly over most and a commanding position in all of the iron, steel, nonferrous metal, and oil industries; the telephone, the telegraph, and the express services; the electric light and power and the gas industries, including the supplying of most of the machinery used in these fields; the production of automobiles, except the Ford output; the bottle and can manufacturing industries; the construction of passenger, freight, and sleeping cars and locomotives and their repair, including the furnishing of parts kept in stock; the operation of sleeping cars; the refining of sugar; the preparat ion and sale of tobacco, to say nothing of chewing gum; the mail-order and chain-store business; the fruit-carrying trade; and the making and distribution of farm machinery.

Yet those who owned the insurance companies would have owned them still, and, in a large measure, those who owned the corporations would have owned them still. For policyholders of insurance companies and stockholders of corporations are recruited from the same group, and that group is getting to be pretty much everybody.

Through stock-holding men have become directly owners and partners in enterprise, and through insurancepolicy-holding they have become indirectly creditors of the enterprises which they own.

Any attempt to translate the enormous potential financial power of insurance companies into corporate managerial activity would equal in folly an attempt to level Pike’s Peak with a pumice stone.

This paper advocates no such translation. It does suggest, however, the desirability, in the interest of uniformity, of removing certain restrictions which some of the states impose upon insurance companies in the investment of their funds.

The daily income of some of the largest insurance companies is as much as one million dollars. To find safe and profitable employment for this amount of money in an investment field as wide even as is consistent with safety is no mean task. To find such employment in a field restricted far within the bounds of prudence is a stupendous undertaking.

Each insurance company doing business in more than one state is subject to two classes of regulation: that imposed as a condition of its corporate existence by the state from which it holds its charter, and that imposed by the states in which it hopes to operate.

These regulations as to bond and mortgage investments are well-nigh uniform throughout the nation. They vary as to stock investments. Massachusetts, a comparatively liberal state, permits domestic insurance companies to invest 10 per cent of their capital and surplus in stocks, but no insurance company may own more than 10 per cent of the outstanding capital stock of any one corporation. New York, a more conservative state, forbids common stock investments and allows only 2 per cent of its insurance companies’ total assets to be invested in preferred or guaranteed stocks of solvent corporations. New York cannot, therefore, enjoy fully the liberality of Massachusetts. Texas, which may be denominated provincial so far as its insurance laws are concerned, is fairly liberal in its investment requirements of domestic companies. It imposes upon outside companies, however, the condition that they invest in Texas securities 75 per cent of the legal reserve on policies carried by Texas residents. It defines these securities as Texas state, county, and municipal bonds, mortgages on Texas real estate, and first-mortgage bonds of any solvent corporation chartered under the laws of Texas and doing business in the state. Stocks are not included.

The variation in the requirements of these three states with respect to the investment in stocks is typical, and is sufficient to explain why stocks constitute an almost infinitesimally small percentage of the assets of life insurance companies.

It is to be hoped that the recent revision of the New York law is the beginning of a movement in pivotal states which will make it possible and pract icable for all insurance companies to invest a reasonable amount of their funds in good preferred and common stocks.

As a test of sentiment of those most vitally interested in the liberalization of the investment opportunities enjoyed by life insurance companies, this question might be put to a responsible official of some reputable and reliable insurance company: ‘Would you be unwilling for your company to buy a reasonable amount of the common stock of any of the corporations whose bonds you already hold?’ And this to any policyholder of the company who is also a conservative investor: ‘Would you be unwilling for your insurance company to invest in the same stocks which you yourself hold, and to an equal amount?’

The broadening of the field of investment for insurance funds so as to include those stocks generally recognized as belonging to the investment class would be advantageous to the policyholders, to the insurance companies, and to corporations. Moreover, it would tend to have a stabilizing effect upon the stock market.

II

The relationship which exists between an insurance company and the policyholder is contractual, legal, financial. The contract establishing this relationship calls for the payment of fixed sums of money conditioned in amount and method of payment upon eventualities mutually agreed upon.

On the other hand, the relationship which exists between the policyholder and his beneficiaries or dependents is social, implying a moral rather than defining a legal obligation. The ultimate object of the insurance contract is to help the insured meet these moral and social obligations to his dependents.

The safeguards and restrictions which the various states have thrown around the investments permissible to insurance companies are admirably adapted to the protection of the legal contracts which exist between the companies and their policyholders. They are ill adapted for the complete or even the partial protection of the moral and social obligations of the insured to his dependents.

The present arrangement leaves the dependents, the main objects of the whole insurance scheme, exposed to an insurable but as yet uninsured hazard — namely, the loss incident to a decline in the purchasing power of money.

The next great forward step in insurance bids fair to be the working out of a plan for the protect ion of the purchasing power of the estate which insurance is designed to create.

Because of the recent price revolution, many dependents for whom adequate protection had been made under the old order found the provision inadequate under the new. The real value — the comfort-commanding power — of so many life insurance policies has been halved recently that it is not necessary now to amplify.

The hazard of the declining purchasing power of money rests altogether upon the insured, and is borne largely by the beneficiaries. This risk should be underwritten by insurance companies and should be paid for out of a reserve set up for that purpose. The means are at hand for setting up and maintaining such a reserve, and can be used if the state laws are so liberalized as to make it practicable for insurance companies to invest a reasonable amount of the funds of their policyholders in good common stocks.

Insurance is the only method yet devised whereby a man can create an estate and then pay for it if he lives and have his indebtedness on account of it canceled if he dies. But the preservation of the purchasing power of an estate is scarcely less important than its creation. Striving to create that which in the end proves not to be, is futility.

So long as the purchasing power of money fluctuates, some way must be sought by policyholders whereby they can keep step with what Professor Fisher calls the ‘dance of the dollar.’

In the absence of institutional means, resort must be had to individual plans and effort for protecting the purchasing power of the estate created by insurance.

A recognition within the last few years of the fact that a diversified investment in common stocks of sound corporations affords a means of keeping step with the dizzying dollar has led to the establishment of investment trusts.

Since an insurance company can create an estate before it is paid for, but cannot preserve its purchasing power, and since a trust or an investment trust can preserve an estate already created and paid for, but cannot create one in advance of payment, he who would both create and preserve must hesitate between two plans and adopt neither. The creation of an estate and the preservation of its purchasing power should go hand in hand, and life insurance companies should so operate as to perform both functions. Until such time as they may do both, or until investment trusts expand their activities to include insurance features, he who would both create and preserve his estate must rely upon such means as are available to him as a lone individual. The efforts of two men to meet the situation are responsible for this paper.

They both carry insurance. They have borrowed on their insurance policies and have used the funds to purchase good stocks on a conservative margin. Having already created an estate of a given number of dollars by means of insurance, they are now predetermining its character. Upon the death of either, his widow can pay his debts and have left unencumbered an estate consisting of stocks, the purchasing power of which has through the years gone up and down as the purchasing power of money has gone down and up. For, generally speaking, periods of rising prices — that is to say, periods of declining purchasing power of money — are periods of increasing profits, and vice versa. And profits accrue to stockholders only.

These men may not have acted wisely. They may fail in their object. But as yet no insurance company, bank, or investment trust furnishes an institutional service through which they can create an estate and preserve its purchasing power while they are paying for it.

III

From the standpoint of the insurance companies themselves, it is highly desirable that an element of elasticity be introduced into their holdings. If permitted to invest in good common stocks, they would become part owners in industry in behalf of all their policyholders, both those who own stock on their own account and those who do not. The companies would share, for their policyholders, in such economic development as might take place. So sharing, additional funds would become available for permitting a reduction in premiums, for the payment of larger dividends, or, what is better still, for additional paid-up insurance, any one of which is of the essence of preserving the purchasing power of the unpaid-for insurance estate.

Many insurance contracts now in force were entered into at a t ime when bonds and mortgages eligible for life insurance investment produced a higher rate of return than similar securities do now. The majority opinion among business men and economists is that, barring war or some other capitalwasting catastrophe, the trend of the long-term interest rate is and will be definitely downward for some time to come. The capital-producing capacity of the country is so great — and it is becoming increasingly greater —that the price of capital will decline. Some go so far even as to predict a 3 per cent return in the not distant future on such high-grade bonds as those generally held by insurance companies. The investment of funds now being collected from policyholders, or the reinvesting of those which become available through the maturity or the calling of securities already owned, in low-interest-bearing securities now eligible for insurance-company investment is continually lowering the average yield on all holdings. Yet insurance companies must continue to meet those contracts already entered into which call for the payment of definite sums of money.

Insurance companies, as well as other investment institutions, are now doing business in a falling market. They are meeting with the same difficulties experienced by others similarly situated. They are finding it hard to buy at a fixed price and sell at a profit on a declining market. They cannot go on indefinitely buying income at a fixed price and selling it at a declining one. Should the decline in interest rates continue long enough, it is conceivable that insurance companies might have to raise premium rates in order to secure sufficient money with which to purchase enough income to meet their maturing obligations.

An escape from such a possibility is to be found in the more lucrative employment of their funds. A more lucrative employment is the investment of a reasonable portion of their resources in high-grade common stocks.

This would involve little or no risk, and occasion little, if any, additional expense. No institutions are in a better position than life insurance companies to know or to find out what stocks of what corporations rank as investments. Moreover, the machinery for investigating and passing upon the character of stocks is already set up and has long been in operation in connection with the determination of the character of other securities.

There is considerable irony in the fact that so much machinery has been set up to help the policyholder create an estate through the purchase for him of mortgages and bonds, commonly believed to be the safest securities, while he has been left to fend for himself in his attempt to preserve his estate through the purchase of stocks commonly supposed to be less safe than bonds. His point of greatest danger is his point of least protection. The present arrangement reverses the natural order. But it was said long ago that the first shall be last and the last first, and that to him that hath shall be given and from him that hath not shall be taken away even that which he hath.

IV

Industrial, public utility, and railroad corporations would all benefit if their share capital should become generally eligible for life insurance investment. Eligibility for investment does not imply obligation on the part of the insurance company to invest. The possible broadening of the market for corporate stocks would enable successful corporations to raise larger percentages of their necessary capital through the sale of stock, and thus to maintain a healthy financial structure.

Of the twenty-one and three-quarter billions of dollars of capitalization of the Class I, II, and III railroads on January 1, 1927, about twelve and a third billions, or nearly 60 per cent, were represented by bonds of various kinds. Of these bonds, insurance companies own in the neighborhood of two and a half billions. This is a few millions more than the bonded indebtedness of those public utility, industrial, and miscellaneous corporations already referred to as being dominant in industry.

Had insurance companies in the past been free to invest in good railroad stocks, the risk incident to the conduct of railroad business would not be so concentrated as now. Railroad capitalization would not be bond topheavy, and that risk due solely to such a situation would not have developed. Risk prevented does not have to be avoided or borne.

The capitalization of many industrial and public utility corporations, and possibly one or two railroads, consists entirely of one class of stock. This is wholesome. When such is the case, the security partakes of the character of a bond in the matter of safety and retains its character as stock in that it shares in profits. Had insurance companies been given more latitude in the past, they would undoubtedly now be comparatively heavy stockholders of those sound corporations of conservative financial structures. Moreover, the influence of the insurance companies would have made for capitalizations consisting of larger percentages of stock.

V

It may not be susceptible of direct proof, but it seems to be a reasonable assumption that the advent of insurance companies as factors in the stock market would have a stabilizing effect upon the market. The question is immediately raised whether it would not have exactly the opposite effect. Would not the insurance companies buy stock, lock it up, and leave a floating supply so small as to make possible corners, and to be insufficient for the speculative appetite? Those who hold this to be true reason by analogy that insurance companies would pursue the same policy as to their stock holdings as they do now with respect to their bond holdings.

While it is true that insurance companies are interested mainly in income, they are not averse to selling one income and buying another of equal size and certainty at a smaller price. It is generally true that they hold their bonds for comparatively long periods of time, but this is because of the fact that the price varies within small range and slowly, a circumstance due to the gradual change in the interest rate at which bond income is capitalized in determining bond prices.

This policy of insurance companies has resulted partly, no doubt, from the restrictions and conditions under which they have operated. If conditions should be changed so as to permit them to invest in stocks, there is no reason to believe that their action would not be in conformity with the changed circumstances.

As already suggested, it is probable that the total amount of corporate stocks would eventually be increased if insurance companies appeared as buyers in the market. The increase would make for market stability.

There is the possibility that a given amount of stock in the hands of insurance companies, with all their facilities for knowing economic and financial conditions, would be more fluid than an equal amount widely scattered among many individuals. Viscosity and inertia increase with numbers. Insurance companies, by buying and selling or by standing ready to buy and sell stocks on the basis of conditions, whether present or future, as ascertained or carefully predicted by their highly trained and highly specialized organizations, would aid materially in determining and discounting accurately and conservatively those factors which determine, or are supposed to influence, stock prices.

Where knowledge is, doubt and uncertainty and fear do not abide. Insurance companies doubtless could substitute much market fact for what is now market fiction. To the extent that they did so, factors making for uncertainty, and therefore for speculative activity, would be eliminated and supplanted. There would be more sweep and swell and less splatter and splash in the stock market.

VI

But, however convincing the logic of facts, it is the logic of events which will bring the question of liberalizing investment opportunity for insurance companies to the fore for discussion, decision, and action. Foreign insurance companies doing business within the United States enjoy wider investment opportunities than those enjoyed by the companies holding charters from the various states.

One company writing insurance widely in the United States, but chartered by a foreign country, lays claim to the distinction of being the largest single common stockholder of the largest single corporation in the world, a corporation whose business is largely within the United States.

This corporation pays the foreign insurance company nine dollars a share dividend on every share held, and every two years or so sells it additional stock on such terms that the rights to subscribe are worth from six dollars to fifteen dollars per share. This is the equivalent of an extra annual cash dividend of from three dollars to seven dollars and a half a share. This, together with the regular dividend, amounts to an annual income of some twelve to sixteen dollars and a half a share. At a price of one hundred and forty dollars to two hundred dollars a share, this is a yield to the foreign insurance company of about 8 1/2 per cent on its investment. The Massachusetts law designates by name as eligible for the investment of the funds of certain types of life insurance companies the bonds of this same corporation and its operating subsidiaries. The bonds of the corporation are now selling at a price which yields only from 4 1/4 to 4 3/4 per cent.

It is no wonder that this foreign insurance company can pay bigger dividends and give more paid-up insurance for the same premiums as those charged by state-chartered companies. Money talks.

State-chartered insurance companies are beginning to demand equality of investment opportunity. And they should have it, not only because they must have it in order to compete on equal terms with foreign companies, but also because it is economically sound that they should have it.