Sixth in a series of popular articles on life insurance as it affects Canadians.
A. M. ALLANMarch151924
GOVERNMENT GUARDIANSHIP IS EFFECTIVE
A. M. ALLAN
Sixth in a series of popular articles on life insurance as it affects Canadians.
LIFE insurance in Canada has shown a remarkable degree of safety. Since its introduction into this country in 1847, it has enjoyed a rapid and consistent growth, with a complete absence of loss to any policyholder, in companies operating on a recognized actuarial basis. In accordance with the act of 1921, the year 1924 will see all Canadian companies, and all companies operating in Canada, on a definitely actuarial basis. This is a record not equalled by our banks, industries, or other forms of enterprise. There has been an ever-increasing protection to policyholders, provided through larger and larger assets and surplus funds, by those companies which have been continuously in the field.
Not only has this protection shown an increase by companies in the field, but even in the case of companies who have been taken over by other companies, there has been no loss borne by policyholders.
Under Canadian laws it is practically impossible for a life insurance company to drift into insolvency. The amount required to be held in reserve to pay all claims and meet policies as they mature is carefully estimated at a low rate of in-
terest, and according to a definite mortality table established by law. The standards of interest and mortality as set forth in the Insurance Act are such as can safely be realized.
For every policy issued a reserve fund must be provided, and as this reserve is liability held by a company for its policyholders and subject to call by them at any time, after three years, upon the surrender of their policies, it is essential that it be held secure against loss, and readily available. To achieve this purpose the Government has undertaken to regulate the investments of life insurance companies, taking the position that the companies have undertaken trusts of the greatest importance, and that those who are named as beneficiaries in the contracts should be protected by law to the fullest extent.
In order to appreciate fully why life insurance is safe, it will be necessary to describe what constitutes the reserve, and give some idea as to how the Government controls the investment of insurance funds.
IF A life insurance policy is to protect the insured during the life of the contract it is necessary to provide not only against the risk of death each year, hut also to accumulate an adequate fund for the purpose of meeting the claim at the maturity of the contract, or at death.
The reserve is accumulated by the method of paying premiums. As explained in a previous article, premiums are computed on the assumption that specified rate of interest will be earned on funds in the possession of the company, and that the mortality experienced among policyholders will be at the rate shown the mortality table.
It is necessary to determine the reserve on the basis of future requirements, because of the fact that life insurance contracts are issued on a non-cancellable basis by the company for a long term, and at a fixed premium. In order that the assumptions of future interest earnings and mortality be made on a safe basis, and the reserve valued so that the continued solvency of the company be assured, the Government has set a certain standard of interest and mortality that can be realized with perfect safety.
The Government considers a company is solvent if, on the basis of this standard of interest and mortality, plus the reserve fund, it is able to pay all claims. The Insurance Act states that, in computing the reserve necessary to be held in order to cover the liability of the company on its policies, the company may employ any of the standard tables of mortality used by it in the construction of its tables, and any rate of interest not exceeding three and a half per cent, per annum. The majority of Canadian companies use the interest rate of three and a half per cent, although a few use a rate of three per cent.
It has been found from experience that a practical plan of life insurance requires the charge of a uniform annual premium during the premium paying period. As the death rate increases with increasing age, it is necessary to calculate the premiums at a high enough rate so that a sufficient reserve will be built up to meet the cost of the insurance in the later years. This necessitates the payment of a larger premium during the earlier years, when the mortality is low, than is necessary to meet the current cost. In other words, the company is, during the earlier years, accumulating a fund out of premiums which will be drawn upon in the later years when the agreed upon annual premium becomes insufficient to meet the current costs. This overcharge does not belong to the company, but is held in trust for the policyholder at an assumed rate of interest for the purpose explained. Taking for granted a large number of policies, this overcharge, known as the reserve, represents that sum which, together with premiums to be paid, will enable the company to meet all claims according to the mortality table used.
It will thus be seen that the purpose of the reserve is to average the varying yearly costs so that the burden of insurance premiums can be carried at all times.
Why Rates Rise With Age
IT IS possible from a mathematical' standpoint to issue insurance on series of one-year-renewable-term contracts, and to calculate each year’s prem-
Ium so that it will just cover the cost of the protection for that year. However, since the rate of death increases year by year, the cost of the protection also increases. This would make it necessary to charge a higher premium each year, and as time goes on the cost would become so great that it would be beyond the ability of the average man to pay, especially as the earning power rapidly diminishes after a certain age is reached. The level annual premium plan overcomes this difficulty. It requires the insured, in the early years, when mortality is low, and his earning power unimpaired, to pay a higher premium than is necessary to meet the current cost, so that when mortality is higher and his earning power is lower,there will be a sufficiënt reserve accumulated to meet the situation.
That the reserve on each policy required by lav/ is sufficient to meet all contingencies, is evidenced by the fact that, even during the war and the influenza epidemic of 1918 and 1919, the mortality experienced did not reach one hundred per cent, of the table used in calculating the risks. Even though, the death rate had equalled one hundred per cent, of the mortality table, the company would still have had sufficient funds to meet the risks.
Owing to the fact that life insurance companies can estimate their daily claims with remarkable accuracy, it is not necessary for them to keep large and non-productive cash balances on hand. Consequently it is the policy of such companies to avoid large cash balances by investing promptly their net incomes. Such investments must be made with the utmost care, in order that the reserves for all contracts, which as a rule do not mature until the distant future, be conserved against loss.. Absolute security of the principal is therefore the chief consideration that guides companies inj^making their investments.
Investing Insurance Funds
THERE are other factors, however, besides security of principal to be borne in mind by the companies. One is: to make their investments yield a return at least equal to the rate which has been assumed for premium and reserve computations. As this is low, being only three or three and a half per cent., the companies’ investments may easily be made with absolute security to yield a higher rate. Then, again, since life companies issue policies that promise loan and cash surrender values upon demand by the insured, they have to protect themselves against any unusual demand ,of this nature by investing a proportion of their funds in securities that are readily convertible into cash. It is also the practice of companies to invest a considerable proportion of their funds in long-term investments. This policy not only lowers the expense of maintaining the investments, but it is apt to secure a better yield over long periods of time.
The Insurance Act requires life companies to insure their funds in such securities as will yield a reasonable return and which will be unquestionably safe as regards both principal and yield. The classes of securities which life companies may invest in are specified by the Act as follows:
Debentures, bonds, stocks or other securities of, or guaranteed by the Dominion Government, or by the government of any province of Canada: bonds issued, or guaranteed by the government of the United Kingdom, or the government of any foreign country, or state of that country, or guaranteed by any municipal corporation in Canada or elsewhere where the company is carrying on business, or bonds secured by rates or taxes, levied under the authority of the Government of any province in Canada, or properly situated in such province and collectable by the municipalities in which such property is situated.
The bonds of any company which are secured by a mortgage or hypothec to trustees or a trust corporation, or otherwise upon real estate or other assets of such company, are further specified as securities in which life companies may invest. Likewise the debentures of any company which has paid regular dividends on its preferred or on its common stocks for a term of at least five years, or the preferred stocks of any company which has paid regular dividend upon such stocks for at least five years, immediately
preceding the[purchase of such stocks are recognized by the Act as suitable securities. The common stocks of any company uppn which regular dividends of at least four per cent, per annum have been paid for seven years, immediately preceding the date of investment, may be purchased by life companies, provided that not more than thirty per cent, of the common stocks, and not more than thirty per cent, of the total issue of any stocks of any company, be purchased. Mortgages on real estate in Canada, or elsewhere where the company is carrying on its business, provided that the amount paid for any such mortgage does not exceed sixty per cent, of the value of the real estate covered, may be purchased.
No life insurance company is permitted to loan any of its funds to any director or officer thereof except on the security of the company’s own policies.
Other Protective Measurés
THERE are a number of other important protective measures in the Insurance Act, some of which may be enumerated'íbriefly as follows:
All life insurance companies are required to keep at the head office of the company, or elsewhere in Canada, all its securities, except such portion of its securities as may be necessary for the maintenance of any foreign branch or branches, or where it is necessary to remove a portion of such securities from Canada for the purpose of exchanging the same for other securities authorized by the Act.
All foreign companies selling life insurance in Canada are required to keep sufficient assets in Canada of a market value at least equal to the amount of their total liabilities to policyholders in Canada, including among such liabilities a reserve of unearned premiums, calculated pro rata for the time unexpired.
Investments and deposits of the funds of any life company must be made in its corporate name, and no director or other officer of the company and no member of a committee having any authority in the investment or disposition of its funds shall accept, or be the beneficiary, either directly or indirectly of any fee,. brokerage, commission, gift or other considerations for, or on account of any loan, deposit, purchase, sale, payment or exchange, made by, or on behalf of the company, or be interested pecuniarily in any such purchase, sale or loan, in any way whatever, except that if he is a policyholder he shall be entitled to all the benefits accruing under the terms of his contract.
If upon examination of a Canadian company’s affairs it appears to the Superintendent of Insurance for any reason that a complete and thorough audit of the books of the company should be made he may nominate a competent accountant who shall make a special audit of the company’s books, accounts and securities and report to the Superintendent.
The Act also provides that every company shall prepare annually, under oath, a statement of its condition and affairs, which shall exhibit the assets and liabilities of the company, and its income and expenditure during each year. In addition companies are required to make halfyearly statements showing in detail all bonds, stocks, debentures and other securities bought, and all loans made, except on mortgages and policies, specifying the amounts in each case, dates of issue and maturity and par value, and the rate of interest payable thereon and the price paid.
Numerous other restrictions are contained in the Insurance Act, which it is unnecessary to enumerate here. Those mentioned already are sufficient to illustrate how closely life insurance companies are supervised by the Government, in order that the trust funds they hold are maintained intact for the protection of the policyholders.
While insurance companies by the Insurance Act are permitted to invest any portion of their funds in the securities described here, it has been the practice of the companies to invest the bulk of their funds in government and municipal bonds and mortgages. One Canadian company at present has its funds invested as follows:
Government and municipal bonds, thirty-eight per cent; first-mortgages, thirty-five per cent; industrial stocks and debentures, three per cent; the balance in loans to policyholders, and real estate holdings.
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