On the Interpretation of the Statements required by the "Life Assurance Companies Act, 1870", with special reference to the question of Expenses. By DAVID DEUCHAR, F.I.A., F.F.A., Secretary and Joint Actuary of the Edinburgh Life Assurance Company.

[Read before the Actuarial Society of Edinburgh, 1 April 1874.]

SINCE the passing of the Life Assurance Companies Act, 1870,

the accounts and valuation statements lodged by the various companies with the Board of Trade, in accordance with the requirements of the Act, have been printed and published annually. The valuation returns afford, in the majority of cases, sufficient information to enable an actuary to form a tolerably correct opinion of the financial strength or weakness of the companies to which they refer. In some cases, however, owing to the special character of the facts brought out in the schedules, it is important that the actuary should have before him, when testing the sufficiency of the reserve, some facts, relating to the growth of the business, and the purposes to which the expenditure has been applied, which are not elicited by the Act. For instance, he should know the annual amount of new business which has been transacted, and the annual amount of assurances surrendered and dropped, as well as the claims by death, in order to enable him to form an opinion as to the average duration of the existing policies. He should also have a division of the expenses, showing those applicable to new business and those applicable to the management of business. already acquired. An approximation to these particulars may generally be made by the actuary after a study of the reports and other voluntary publications of the companies; so that, on the whole, it may be said that the Act affords to the public the means of judging, through the medium of the actuarial profession, of the relative positions of the various offices as regards stability and profitableness.

In the interpretation of the results exhibited by the Valuation Statements, serious errors are not likely to be made, as it is admitted that this portion of the Government Returns is capable of being thoroughly understood by actuaries alone. It is quite otherwise with the Revenue Accounts and Balance Sheets, which present no appearance of difficulty to the non-actuarial mind, and which are carefully scrutinized and commented on by persons altogether outside of insurance circles. The Revenue Accounts especially come in for a large share of public notice, and on no point is there

a greater concentration of attention than on expenses. Comparisons are instituted by policyholders, by the public press, and by some of the offices themselves, between the respective rates of expenditure of the various life assurance companies; and tabular statements are published showing the rates of expenditure of all the companies. In thus devoting special attention to the subject of "expenses", the public are following a true instinct, as the subject undoubtedly merits all the attention which it is receiving; but I think it can be shown that the matter is not so entirely devoid of complexity as would at first seem to be the case.

The rate of expenses is generally reckoned on the total premium income, including both first premiums and renewals. Where the expenses incurred at the commencement of the assurance do not differ to any great extent from the annual expenses thereafter, this mode of reckoning the expenses is a suitable one. This is probably the case, to some extent, with a few of the existing life assurance offices. Some of the legal offices, for instance, do not require to go to any expense in forming agencies or obtaining business. Their shareholders are members of the various legal bodies, and many of these shareholders act as agents for their respective companies, receiving a moderate commission. The business of these offices consists, in great part, of life assurances obtained in connection with loans on life interests, or on other forms of security in which a life assurance is required in order to protect the lender. Business of this kind is not influenced by advertising or canvassing. The borrower asks his solicitor to find him a sum of money on a certain security, and the solicitor, as agent and as shareholder, has a double interest in sending his client to his own company. The assurances required in connection with loans are frequently of very large amount, and in consequence of this, the offices transacting this class of business frequently require to share their risks with other companies. Reassurances are obtained from these other companies on different lives, in return for the sums thus given off; and a very considerable proportion of the business of the legal life offices must consist of these reassurances. They must also occasionally receive proposals for assurance on the lives of their own shareholders and their clients for family purposes. Probably, however, the bulk of the business of such offices generally consists of assurances in connection with loans and reassurances. More especially when the commission on the first premiums is only 5 per-cent, the medical fees being comparatively relatively unimportant, in consequence of the average sum assured

necessary

to say

on each life being large, it is not surprising that business of this class involves very little preliminary outlay. It is also scarcely that business of this class cannot fail to prove extremely profitable, if the mortality is found to be favourable. In addition to the advantages derived from a very moderate rate of expenditure, there are considerable gains from the high rate of interest realized on the class of transactions cultivated by such offices,-not because the securities are in any way inferior to others of a simpler character, but merely because these securities are unsuitable to any ordinary lender.

The case of a low rate of expenditure on the acquisition of business is, however, by no means a common one. When the business is of the ordinary class, and does not come to the office of itself, but has to be sought after, the proportion of the first premium which is swallowed up in expenses is necessarily high. The cultivation of an ordinary agency for a life assurance company requires great perseverance and tact. The agent who trusts to an announcement on a brass plate or in a window-blind, to bring to him "Persons desirous of effecting assurances on their lives", will in most cases very soon come to the conclusion that there are no such persons in his part of the country. In order to be successful, the agent must give time and attention to the subject. His difficulties do not arise mainly from the competition of other companies' agents-although this is not to be despised,-but rather from the apathy and indifference of the majority of the public. If, therefore, life assurance business is to be carried on extensively, it is absolutely necessary that active and energetic agents should be secured.

The usual inducements offered to agents with the view of securing new business, are (1st) a higher commission on the first premium; (2nd) occasional advertisements in the local papers; and (3rd) a liberal supply of circulars and other documents to be issued to the public. But these inducements are not as a rule very successful in getting the agent to devote time to the work. Some agents never issue the circulars which are sent to them from time to time for distribution. Others, again, issue them, but take no further trouble in the matter. The majority of the agents make some efforts, but not in a systematic way; and the consequence is that they do not secure nearly the amount of business which they might obtain by working diligently and systematically. It is rare that an agent becomes successful without having been visited by an officer of the company, and the repetition of such visits from

time to time is in many cases almost a necessity. The establishment of a personal relationship between the agent and the office is generally attended with great success, but this necessarily involves a considerable expenditure. Even though much attention be given to the agencies, it is impossible to secure the success of all the agents, and in individual cases expenditure must frequently be made without any adequate return.

Let us, in the first place, consider the minimum expenses likely to be incurred in connection with business obtained through ordinary agencies, exclusive of share of the head office expenses. Assuming that the policies effected through ordinary agencies are, on the average, for £500 each, and that ten such policies are introduced by the agent during each year, producing an annual premium income of £150, the following will be the actual outlay thereon:

Cost of prospectuses, circulars, policy forms,
proposal forms, &c.

Carriage of do. from head office, and postages

Policy stamps

Commission of 10 per-cent on the first pre

miums.

£ s. d.

0 10 0

This sum is equal to nearly 20 per-cent on the gross amount of the premiums received for the first year.

An annual business consisting of ten policies for a total sum of £5,000 may appear small; but it must be higher than the average amount of business done through a single agency. One hundred such agencies would produce an annual new business of £500,000, which is about the average amount transacted by the Scottish offices, while the average number of agencies in the case of these offices is probably at least 500 instead of 100. It is evident, therefore, that an agency such as that described must be charged with a considerable share of the general expenses of management, in addition to the items mentioned above; and if this share were added, the rate of expenditure on the amount of the first premiums would be very largely increased, as I shall have occasion to show in a subsequent portion of this paper.

If, then, it can be shown that the total expenses of procuring assurances are rarely less in an ordinary company than 50 per-cent on the amount of the first year's premiums, while the expenses of managing the business after it has been acquired, rarely reach 10 per-cent on the amount of the second and subsequent years' premiums, it follows that the ordinary mode of reckoning the expenses on the total premium income, without discriminating between old and new business, is incorrect, and does not afford sufficient means of judging as to the cost at which a company is worked. In the case of all recently established offices, the proportion of new premiums to renewal premiums must in ordinary circumstances be very much greater than that which exists in the case of old companies; and on this account, the rate of expenditure of the first mentioned class of offices, when reckoned on the total income, must be higher than that of old offices, even though the new business is acquired by the young offices at a lower rate of initial expenditure than that which the older companies are paying.

Let us consider the case of two offices, A and B, each possessing a premium income of £100,000, but whose rates of expenditure, as ordinarily reckoned, differ widely-A's being only 12 per-cent, while B's is 18 per-cent. In such a case the public are apt to consider that A must be a very much better office for the insured than B, where the rate of expenses is 1 times that of A. It is quite possible, however, that a more discriminating comparison will reveal that office B is very much more economically managed than office A. For instance, A's premium income may be made up of £2,222 of new premiums obtained at an expenditure of 100 per-cent, and £97,778 of renewal premiums, on which the expenses are 10 per-cent, making up the 12 per-cent on the total premium income already mentioned. On the other hand, B's premium income may consist of £24,712 of new premiums obtained at a cost of 50 per-cent, and £75,288 of renewal premiums on which the rate of expenditure is 7 per-cent, making together a rate of 18 per-cent on the total premium income. Thus B's initial expenditure may be only one-half of that of A, and its renewal expenditure may be only three-fourths of that of A; and yet, in

the

eyes of the public, and in the tabular statements showing the rates of expenses of the various offices, B appears as if managed very extravagantly as compared with A.

Enough has been said, I think, to show that, in the first place, of acquiring business are generally quite of a different character from those of managing it after it has been gathered in,

the

expenses