# The Story of Life Insurance/Chapter I

For the last thirty-five years a constant warfare has waged in the United States between the good and the bad in life insurance. On one side have ranged honesty, economy, and fair and liberal treatment of the insured; on the other, dishonesty, extravagance, and absolute disregard of policy-holders' rights. Certain companies have treated life insurance as a great beneficent institution, organized for the purpose of protecting the weak and the dependent against adverse fortune; others have regarded it largely as a convenient contrivance for enriching the few men who happened to have usurped control.
In this thirty-five years the history of American life insurance has been one of progressive degeneration. The people have forgotten the old ideals; have persistently abandoned good life insurance and taken up with bad. They have for the larger part ignored the teachings of our great American leaders—men like Elizur Wright, of Massachusetts, the originator of nearly everything that is best in the American system, Jacob L. Greene, of Hartford; and Amzi Dodd, of New Jersey, and have sought the leadership of men who have degraded the whole institution. They have thus displaced the United States from the world leadership in life insurance which it formerly held, and have made what was one of our greatest claims to national distinction the cause of what is, in many ways, our most shameful national scandal.
To show this deterioration in quality we need not necessarily look far. The most popular companies, indeed, have largely ceased to do a life-insurance business at all. If you study the literature they circulate, you will find the life-insurance feature of their contract only incidentally mentioned. They talk little about protection of one's family, but much about savings banks, investments, guaranteed incomes, five per cent Consols, and gold bonds. They ask you to buy their policies, not that thereby you may provide financial protection for your dependents, but that you may thereby reap financial advantage yourself. They appeal, not to your sense of responsibility, but to your cupidity. They preach life insurance, not as a boon to the poor and the defenceless, but to the fortunate and the rich. In a word, they have grafted upon tho simple life insurance idea endless investment and gambling schemes, most of which are fallacies and some of which are palpable frauds. Consequently hundreds of thousands profit little, or not at all, from the insurance feature of their contracts. In the majority of cases they ignore it entirely. The real situation was eloquently summed up at the recent New York life-insurance investigation. It then appeared that at least one-third of the insured abandoned their policies, at great loss to themselves, after they had been in force for one or two years. Of those that are left two-thirds, at particular periods, surrender them, taking in exchange certain so-called "cash profits," thus leaving their families unprovided for. In other words, out of every hundred only about twenty have entered the company for the insurance protection; or, if they have, have not yielded to the temptation of a cash reward and abandoned it.
If we wish mere life insurance unencumbered with modern improvements we must go to Connecticut, Massachusetts, New Jersey, and one or two other states. There we shall find great companies limiting their activities to one single end—the insuring of lives. They do not deal in investments, do not act as savings banks or lotteries. They collect from the insured during life certain stipulated sums, and, in the event of death, pay over to the widows certain equivalent indemnities. They collect from each member precisely the same pro rata price for the particular service rendered; and base this price upon certain well known mathematical laws which closely determine the exact cost. They treat all the insured upon a strictly " mutual basis," which, in the last analysis, means insurance at its actual cost, and that actual cost to all. They furnish this article at a lower price than present quotations for the New York variety. They do it, too, without the elaborate machinery found so indispensable upon Manhattan Island. They have no subsidiary banks or trust companies; no string of office buildings stretched all over the civilized world; no alliance with captains of industry in Wall Street; no array of extravagantly salaried officers; no corruptionists in every important state capitol. They do not have enormous surpluses unjustly withheld from the policy-holders to whom they belong; do not pay in commissions for new business larger sums than that business is worth; do not write insurance in forty-five states and all foreign countries, including China, Japan, Borneo, and Malaysia; they remain quietly at home insuring only respectable heads of American families in good physical condition.

## No Real Dividends in Life Insurance

Before this story is told in detail, we must have a clear conception of what life insurance, stripped of its mystifications and falsehoods, actually is. We must acquaint ourselves with the ordinary terms of the business: the premium, the reserve, the surplus. Upon no other subject is the public ignorance so profound. And yet, in itself, hardly any subject is more simple. Necessarily, first we must disabuse our minds of certain preconceptions. Life insurance, for example, is not a business. It is not an enterprise in which capital engages for the sake of profit. There are stock companies; but for the most part they pretend that they provide life insurance at its actual cost; that all so-called "profits" go to the insured. Theoretically, at least, and in many instances actually, these great companies are trusts, in the real meaning of the term; their directors are trustees in the most sacred sense. Similarly, life insurance is not gambling. As now practised, certain lottery attachments have been added to it; at times it has been reduced almost to the par of faro and roulette. Above all, life insurance is not an investment. The word "dividend" applied to it has been the most prolific cause of evil. Properly, as will be explained later, there is no such thing. There can be no dividend, no profit—no investment—because, even under the most favourable circumstances, the expenses of management are so great. For every dollar collected by a life insurance company, it expends anywhere from eighteen to fifty cents in expenses; manifestly it cannot invest the rest so as to pay you any investment return.

## Life Insurance Merely Indemnity—Not Investment

Life insurance is one thing, and one thing only. In the social and economic order it performs a single and a simple service. It is the money indemnification for the destruction of a valuable human life. We insure our lives for the same reason that we insure our houses and our ships. All three things have money value; all stand momentarily in danger of destruction; and all are insured for the purpose of recouping ourselves and our dependents for their loss. This protection is something that we buy. We pay money for it; that is, it is an outgo—an expenditure; never an income. Our compensation is the great one that, when we die, our dependents will not be beggared. This is so great an advantage, it adds so wonderfully to the sum of human happiness, that we are willing to pay for it all that it costs. No one regards the insurance upon his house—one's fire insurance—as an investment—as something upon which he receives an annual income; and no more should he so regard the insurance upon his life.
With certain limitations, which will be detailed subsequently, life insurance is a science. It is scientific because it deals with one of the few certainties of human experience—that is, death itself. If a company contracts to pay a certain amount at death it knows that it will have to fulfil that promise; it knows, that is, that the insured will die. Furthermore, it knows, within certain limits, when he will die. It cannot predict this in the individual case, of course. It does not know when you will die or when I will die; but, if it insures a sufficient number of persons of your age, it knows how many of them will die each year, A mysterious law apparently regulates their taking off. It might have, for example, 100,000 men aged 30, living in London; another 100,000 aged 30, living in New York; another 100,000 aged 30, living in San Francisco. At the end of the first year, it will find that 840 out of its London group have died; 840 out of its New York group; 840 out of Its San Francisco group. At the end of the second year 844 will have quietly dropped out of each of the three groups. In the tenth year 885 in each group will die; and so on, the original 100,000 being regularly and gradually diminished every twelvemonth. In the sixty-sixth year only three or four men in each of the three groups will be alive; and these, at the ripe age of 96, will pay their final tribute to nature. There may, of course, be slight variations in this program; but these will not be sufficiently marked to disturb any calculations based upon them. For all practical purposes the uniformity is so pronounced as to merit the name of a natural law. This law has been the gradual discovery of the last two centuries. It has been found out purely by observation. The records of many English parishes, the births for particular years, and the records of the deaths through succeeding years, have been carefully tabulated. Census returns of particular towns and counties have been compared with the death returns. Above all, the experience of the life-insurance companies themselves has been taken as a guide.
Before this mortality law was discovered, life insurance was the favourite device of swindling rogues. It was unsafe; invariably failed; and was consequently held in the utmost disrepute. Since this law was discovered and honestly utilized life insurance has been a science. Any merchant who knew just what his expenditures would be through a long series of years, and who had the power to adjust his income so as to equal them, could not possibly fail. That is the position of the life insurance company. Any accurate mortality table, common honesty, and good executive judgment—with these as capital no life insurance company could possibly collapse. Fire, marine, and other forms of insurance are not thus scientifically based. These companies cannot figure in advance their future losses. No natural laws regulate the burning of houses or the destruction of ships.

## Two Scientific Bases of Life Insurance—Mortality Law and Interest Rate

The application of this mortality law to the cost of life insurance may now be illustrated in its simplest form. Let us take 1,000 men, all aged 40, who desire to insure their lives. They might take out policies in some existing company, but not necessarily—they can carry their insurance just as well themselves. So they enroll themselves into what may be called a life-insurance association. They agree that $1,000 shall be paid to the widows of all that die. The association also decides to start with a fund precisely large enough to pay all policy claims as they mature. All members will pay into this fund their pro rata share in advance. In other words, the association decides to adopt what is known as the single premium system. Its only problem is the practical determination of what this single payment should be. Obviously, since there are 1000 members and $1,000 is to be paid on the death of each, the association will have to pay out ultimately $1,000,000. By the aid of its mortality tables it calculates in advance the payments to be made each year, It finds, according to these tables, that the limit of human life is ninety-six years; inasmuch as all members are in their fortieth year, its payments will range along a series of fifty-six years. In the earlier years these deaths will be comparatively few, and few payments will therefore have to be made. In twenty or thirty years, as the members become older, deaths, and consequently death payments, will become more numerous. In forty years both will decrease—simply because there will be fewer members left to die. In the fifty-sixth year the ultimate survivor, ninety-six years old, will die, and the association will pay out its last $1,000 to his heirs.
    1↑ Actually, according to the American experience table, not one out of 1,000 starting at age forty would be alive at age ninety-six. If we wish perfect accuracy we should have to base our illustration upon 78,106 lives, the number living at forty of 100,000 starting at age 10. Of this 78,106 lives, the last three will die at age ninety-six. The above illustrations are based upon 1,000 lives, however, for the sake of complete clearness.
In all, therefore, the association will pay its $1,000,000. out in fifty-six annual sums. To meet these obligations it will not need to have in hand, at the beginning, a sum of $1,000,000. If all members should die the day immediately following its organization, $1,000,000. would actually be required. But the deaths will be distributed annually through half a century. If the association started with $1,000,000. it would be guilty of rank extravagance, because money, properly invested, earns interest. The association would need, therefore, not $1,000,000. but a sum which, properly invested, would produce that amount precisely in the annual instalments required. Before deciding what contributions to levy upon its members, the association would have to decide upon, the rate at which to invest its funds. If it assumes a high rate, it would not need so large a cash fund; if a small rate, it would need much more. In case of a high rate, that is, its interest earnings would contribute more to the annual sums required than in case its interest rates were low. But the association must exercise much conservatism. Its contracts extend through half a century. That is a long time; and the interest rate fluctuates. If the association should adopt a high rate, it might, after a few years, find itself unable to earn it. Therefore It would not realize the annual sums required to meet its death payments; in other words, it would be insolvent. It will therefore adopt an investment rate so low that it can confidently figure upon earning it through the whole fifty-six years its contracts run. In strict conservatism it may place it as low as three per cent. By the aid of the mortality table, which shows the number of deaths each year, and the adopted interest rate, which shows the amount contributed to the fund by interest earnings, the amount needed by the association, when it starts, can be mathematically determined. The first year, for example, the association must pay out $9,000 to the widows of the nine members who die. To meet that payment the association must have, not $9,000, but a sum which, invested at 3 per cent, for one year, will equal $9,000. Such a sum is approximately $8,730. In the second year the association must pay out $9,000 to the widows of nine more deceased members. It must thus have in hand, at the start, a sum which, compounded at 3 per cent, interest for two years, will aggregate $9,000. That is, it will need only $8,460. The amount needed to have in hand, at the beginning, to meet each year's payments, it thus fully calculates in advance. By adding these fifty-six separate results it has the total cash fund required. By dividing this result by 1,000, the original number of the association, it has each member's precise contribution to the fund.
At the beginning, therefore, it is plain why life insurance, in the usual commercial sense, is not an investment. The company puts your premiums at interest, not that it may furnish you a return in addition to the insurance, but that it may accumulate a fund out of which the policy itself is paid.
In its bare essentials this is all there is to life insurance. This great institution rests upon two solid bases; the law of human mortality and that of compound interest. Theoretically only one is indispensable; the mortality law. This enables the company to foresee, for a long period of years, its annual expenditures, and consequently to make provision for their payment. With this principle alone, however, life insurance would not be an accomplished reality, because its cost would be excessive. The interest element, by making life insurance cheap, brings it within the purview of the poorest citizen. It transforms life insurance from an unutilized theory into a most salutary fact. In dealing in both these principles, moreover, we are dealing with moral certainties. Given a certain number of lives of a certain age, nothing is more clearly demonstrated than the order in which they will die. Given a certain amount of money, invested at a certain rate of interest, nothing is more self-evident than its precise accumulation in a given number of years. If all life-insurance companies thus used the same mortality tables—anticipated, in other words, the same number of annual deaths—and invested the premiums at the same rate of interest, the cost of the actual insurance would in all cases be the same.
We have explained this great life insurance principle on the basis of the single premium—the payment down, in a lump sum in advance, of the entire cost of the life insurance—chiefly in the interest of simplicity. As s matter of fact, few buy their life insurance this way. They make to the common fund not one large contribution, but a smaller one each year, A considerable number pay this uniform sum throughout life. They pay, that is, what is technically known as a level premium. The majority pay an annual level premium not through life, but for a stated number of years—twenty, fifteen, ten, or perhaps five. After this premium paying period has elapsed, their policy is, in life insurance terms, paid up. They pay no more; all they have to do to get the full value is to die. All these various premium systems—annual level, twenty payment, fifteen payment, ten payment, or five—are derived from the single payment, already detailed; all are simply variations of it. All premium calculations are first made upon the theory that the cost is paid in one large sum; and from this result the proper charge, if paid annually through life, or if paid annually for a limited number of years, is hardly worth while to describe in detail how the single premium is thus commuted into these several guises. The explanation involves many details, and the discussion of another subject—that of annuities. It is sufficient to bear in mind that, from the standpoint of the company, the single premium, the annual level premium, the limited payment premiums are all mathematical equivalents.

## Pay as You Go System a Failure

Probably some members of our hypothetical association would propose the method of payment technically known as the natural premium. They would divide each year's losses among each year's survivors. If nine men died the first year, necessitating the payment of $9,000, they would assess this amount among the 991 who remained. They would tax each man about $9.08. They would likewise assess the next year's losses, another $9,000, among the 982 members who survived; making each one's contribution for that year about $9.16. They could make out a plausible argument for this procedure. They would say that this was plain business sense. They would point to the fact that every man paid each year the precise cost of his insurance; and they would assert that this cost would be much lower than under the level premium plan. They would also claim that no large fund would accumulate in the treasury; and that consequently the interest factor could entirely be disregarded. They would clinch their argument by calling attention to the fact that under the level premium plan a thousand dollars' worth of insurance would cost, at its net price, $24. a year; and under the plan they suggest, nine dollars and a few cents the first year, and a slightly increasing price each year thereafter. Indeed, they could make so excellent a case that, had the association not the experience of two centuries to guide it, they would probably carry the day. Theoretically, the natural premium plan is flawless; practically, it never works. It increases the cost of insurance every year; at first almost inappreciably, but later on enormously. In the first year, when the deaths are few—only nine in a thousand—it taxes each member only nine dollars and a few cents. In the thirtieth year, however, the association contains only about 490; that is, 510 have died. That year, it loses 29 members and is thus called upon to pay out $29,000; therefore it charges the survivors $62. each. By this time it finds that the increasing annual premium is much larger than the discarded uniform annual premium. But its troubles have only begun. Its members are now all seventy-one years old; and they die very rapidly. The association is thus embarrassed from two standpoints. It has to pay out larger death sums each year, and each year it has fewer members upon whom to assess them. In the case of the last surviving nonagenarian the situation would be absurd. The association—an association now only theoretical because all its members are dead—would have to pay out $1,000, but would have no members to levy upon. If it made the natural premiums payable at the beginning of each year the last survivor would have to advance the whole $1,000 with which to pay his own death claim.
In this there is nothing actuarially unscientific or unjust. But in practice it never succeeds. It has been tried thousands of times and it is the basis of the numerous assessment and fraternal orders now dying a lingering death. All these associations prosper in the earlier years, when deaths are few and assessments consequently low. All begin to lose members as deaths and assessments increase. Men simply will not pay these largely increased premiums in the later years; consequently they retire and the assessment schemes collapse.

## Reserves: Advance Payments for Insurance

The association thus finally decides that each member shall pay for his $1000 insurance by contributing $24 to the common fund each year as long as he lives. It therefore collects in advance from its 1,000 members $24,000 the first year. It promptly invests this at three per cent, thus increasing it in one year to $24,720. It pays out this year only $9,000 to the beneficiaries of its nine deceased members. It therefore has left in its treasury $15,720—the amount of all the premiums, plus one year's interest, which has not been used. Dividing this $15,720 fund by 991, the number of surviving members, it has a credit of about $15 to each surviving policy-holder. That is the amount of the first year's premium, plus interest, which has not been used in paying death claims. The association collects $24 the second year from the 991 remaining policy-holders, a total of $23,784. It adds this to the $15,720 in the treasury, thus obtaining a fund of $39,504. It invests this again at 3 per cent, thus increasing the fund to $40,689. It pays out $9000 as policy claims, thus decreasing the fund to $31,689. It divides this among the 982 remaining members, crediting each with a fund of approximately $32. It finds that that is the amount of each policy-holder's premium for two years, improved at compound interest, which has not been used in paying death claims. It finds, in other words, that it collects from every policy-holder, under the level premium plan, more money than it needs to meet its expenditures, simply because its death losses, in the earlier years, are comparatively few.
The association goes on thirty or forty years; and then develops a new situation. In its thirtieth year it has 490 surviving members. It collects from each $24. and thus from all $11,760, which, with three per cent, interest added, equals $12,112. But it loses by death in the thirtieth year thirty-two and must therefore pay out $32,000. Manifestly this year's income does not suffice for the outgo. It has collected only about $12,000.; and must pay out $32,000.! The association, therefore, makes up the difference by drawing upon the unused payments of the earlier years. By this time its total unused fund—unused premiums, that is, plus compound interest—is very large, and the appropriation for this thirtieth year deficit diminishes it only slightly. The association through the remaining years will never collect enough again to meet its annual payments; every year the deficits will increase; but the accumulations from the unused premiums and interest of the first half of its existence will precisely enable it to come out whole.
The association calls these accumulations on the premium payments of the earlier years its reserves. It figures out the accumulation upon each policy, and calls it the reserve upon that particular policy. In other words it reserves the unused premium payments of the earlier years, when deaths do not devour all the money paid in, and pays them out in the later, when deaths more than use up the annual payments. It must keep these reserves simply because it collects its contributions in uniform annual sums, in the earlier years too much, the later years too little, in deference to the majority of its members who insist upon paying that way. In another article the nature of this reserve will be analyzed in detail. At this point its great importance in life insurance only need be insisted upon. In fact it is the one test of solvency.
If our association honestly reserves these unused early payments it cannot possibly fail. If it steals or wastes them it must ultimately collapse. It could steal them for many years, however, without detection, because for about half its existence it would collect more than enough money each year to pay that year's death losses. When it reached those later years, however, when each year's collections did not pay each year's losses, its dishonesty would stand revealed. Under modern conditions our association would find it difficult to do this. It would find that every state had organized insurance departments to prevent this very thing. Every year all its policies would be inventoried and the amount of necessary reserve on each one computed. If our association did not have that precise amount in its treasury, or assets to cover it—bonds, mortgages, etc.—the receiver would be called in and the shutters go up. Its reserves, that is, are an insurance company's liabilities. The chief function of the insurance departments is to act as watchdogs of these reserves; and this, whatever their other shortcomings, they successfully do.

## How the Agent and the Officers are Paid: A Tax on Every Premium

One life-insurance association thus discovers the annual price of a $1000 policy at age 40. It has thus determined, however, merely the net cost; the cost, that is, of the actual insurance. It has made no provision for the second element of cost in life insurance; that is, the expenses of company management. But it must have a chief manager of the fund—a president, several assistants, clerks, and office boys. It must have an office in which to conduct business; furniture, stationery, postage, and so on. Above all, unless all its 1,000 members join spontaneously, it must have a lively force of insinuating gentlemen to persuade them in—that is, life insurance agents. All these things, especially the agency force, cost money. For want of a better system the association clumsily adds to every premium a certain annual sum to provide a special fund to meet these expenses. Perhaps it increases the annual premiums from $24. to $32.—the extra $8 being for expenses. It calls this addition a loading. Its total premium, in other words, consists of two parts: the amount actually needed to meet all death claims, as indicated by a mortality table, and decreased by interest earnings at a particular rate; and the amount added to cover the cost of management.

## Why There Is a Surplus: Three Sources of Gain

When the company applies these hypothetical rates to tho actual business of insuring lives, however, the situation changes. It finds that the scheme does not work with quite the precision anticipated. It discovers that the deaths do not occur quite as the mortality table provides; that the interest rate earned is not always three per cent; that the expenses do not always amount to the same sum as the loadings. It finds that it has based its charges upon three separate theories—a theory concerning the yearly death-rate, a theory concerning the interest earned, and a theory concerning the expense of management. Its theory concerning the death-rate pretty closely coincides with the facts; its theory concerning the interest rate shows greater divergence; and its theory concerning the management expenses is usually woefully mistaken. If its death-rate were precisely that indicated by the tables; if it earned precisely the three per cent, interest figured upon, not a penny more, not a penny less; If it spent in management expenses precisely the amounts provided in the premium loadings; the cost of insurance would manifestly be precisely what was charged. Because all these factors vary, and vary, too, from year to year, the actual cost of insurance varies, also from year to year. But, fortunately for the cause of life insurance, it varies always in one direction. The company's charges, that is, always exceed the actual cost. It almost invariably has fewer death losses than the mortality tables indicate; and it commonly earns more interest than the estimate assumes. That is to say, it pays out each year less than it has provided for; and earns, in interest, more than it needs to pay all claims. A company properly conducted also uses less every year for expenses than the amount provided in the premium loadings.

## First Possible Saving: From Mortality

These several gains depend, of course, upon the honesty and ability with which the company is managed. Its mortality table is that formulated by Shoppard Romans in 1865 from the actual experience of The Mutual Life. That table is based upon selected lives—lives that have been insured, and consequently assumed to have been in at least average good health. If the company's medical department is inefficient or corrupt, if it insures consumptives, paralytics, and physical degenerates, either because it knows no better or is impelled by the furious ambition of the management to do a large business, manifestly its mortality showing will be bad, perhaps even sinking below the standard of the table. But if it exercises unusual care, and takes people only in the finest physical condition, it will make a much better showing than the table; the company will not have to pay aa much in death losses as it supposed; therefore it will have a considerable "saving from mortality."

## Second Possible Saving: From Interest

If it invests the premiums with bad or dishonest judgment, if it buys depreciated bonds merely because its investment department has been annexed by a Wall Street banking house; if its directors constantly unload upon it, at a good profit to themselves, investments which they themselves have purchased on the quiet; if its directors receive a substantial "rake off" on every investment made, evidently it will make a bad showing on its interest earnings. But if it invests the premiums with good judgment, it will make more than the interest rate required. Its premium prices, for example, may be based upon a three per cent, investment rate; three per cent, that is, is all it must earn to pay obligations. But by carefully making investments it may actually earn four or five or even six. That is, it earns one, two, or three per cent, more than it needs. It thus has a "saving from interest."

## Third Possible Saving: From Management Expenses

Again, if the company is extravagantly conducted; if it has many and ridiculously salaried officers; if it pays out enormous sums in commissions to agents, and supplies them, gratis, with traveling bags and fountain pens—manifestly it will swallow all, frequently more, than these "loadings." But if the machine is economically managed, it will save a considerable portion of the expense charges. There will thus be a "saving from loadings."
Every company, as has been said, shows these savings every year, though in varying degrees. Every company, that is, charges the policy-holder more than the actual insurance costs. It is not properly subject to criticism for this. It cannot foresee, in advance, precisely what that charge should be. It bases its prices upon a mortality table which, for all practical purposes, is correct; upon an interest rate so low that it can certainly be earned; upon an expense rate which, even under the most adverse circumstances, should be sufficient. It charges this excess so as to be absolutely on the safe side—so that it may surely meet all its obligations.
Thus, inevitably, at the end of each year, the company has in its treasury a goodly sum, representing money taken from the policy-holders in excess of the real cost of the insurance. This is popularly known as its surplus. The surplus thus measures the difference between the theoretical and the actual cost. It is the precise amount which the policy-holders have been overcharged. "What," say the directors, "ought we to do with it? We have paid all our policy obligations and laid by for reserve the precise amount needed for our future payments, and have this extra amount on our hands which we do not need and can never legitimately use. We do not need to keep it until next year, because there will also be a surplus left over after next year's business. Must we spend this surplus in some foolish way? Give it to charity? Put it in our own pockets?" The puzzle is easily solved. What, according to its professions, does the company exist for? Simply to furnish life insurance to its members at its exact, mathematically ascertained cost. It finds, at the end of each year, that it has charged too much, Obviously it should return to the policy-holders the amount of that overcharge.

## "Profits" Merely the Overcharge: "Dividends" its Repayment

These repaymenta of "surplus" are what are popularly called "dividends." They are the "profits" of life insurance. They are the "investment return" on your premium. Actually they are none of these things. They are simply the repayment of the excess cost of the insurance. Let us seek a homely comparison. You send a messenger-boy to buy you a quantity of cigars. Not being sure what the exact cost will be you give him a two dollar bill. He pays $1.50 and returns with your cigars and fifty cents change. You would hardly regard that fifty cents as a "dividend" upon your purchase of cigars. Your messenger-boy has simply returned your overpayment. Your position is precisely the same when you buy a policy of life insurance. Your company does not know, at the beginning of the year, what the exact cost will be, but, to be on the safe side, charges you an excess price. At the end of the year it gives you back—or at least it should—your change, and miscalls it a "dividend." If agreeable, instead of actually taking the fifty cents change from the messenger-boy, you might send him back to buy more cigars with it. Similarly, instead of taking your life insurance "dividend" in cash, you might let the insurance company keep it and give you the extra amount of insurance it will buy. Again, you might let the messenger-boy keep the fifty cents because you intend to send him to buy cigars a few days hence. Similarly, you might let the insurance company keep the "dividend," and apply it to buy your insurance next year; that is, to reduce the next year's premium.
Many of our largest insurance companies differ from this messenger-boy in one important respect. He usually comes back with your fifty cents. Most insurance companies, however, in the case of a majority of their policy-holders, do not come promptly back with the annual overpayments. They hold the change.
When the people complain that the current price of life insurance is excessive, they simply mean that these overpayments are not returned—or at least not in the proportion that they are paid in. If the companies are honestly and ably managed and these overpayments are equitably returned; there could not possibly be any excess cost. Thus we have formulated a rule by which we can measure the relative prices charged by the several companies. If we take the actual premium paid each year and subtract from this each year's "dividends," or returned overpayments, we shall have the actual net prices charged for the insurance.

## Insurance Cost When These Overcharges are Annually Returned

Let this rule therefore be applied to several companies, all of unquestioned solvency. You are forty years old, in good health, and seek a $10,000 ordinary policy of life insurance. You decide first, for example, upon the Connecticut Mutual. You are charged an annual premium of $309.40. After a year the company finds that it has overcharged you precisely $38.50; and returns that in the guise of a "dividend." Manifestly your insurance has cost you exactly $270.90. You pay $309.40 the second year. After this has passed, the Connecticut Mutual finds it has overcharged you $41.50; and sends you a check for that sum. This year your insurance has cost $267.90—a little less than the year before. You pay regularly for several years the same $309.40; and every year the amount paid back at its end increases. In the twentieth year you pay the same $309.40; but at its end receive back a check for $91.50—thus decreasing the net insurance cost to $217.90.
    2↑ According to 1906 scale of dividends.
Thus each year you receive a larger "'dividend"; each year, that is, the actual cost of your insurance is decreased. The explanation is, briefly, that the reserve on your pollcy, as is explained above, grows larger every year, and the interest earned on it each year therefore increases. Suppose that at the same time you took your $10,000. policy in the Connecticut Mutual, you had taken an identical policy in the Mutual Benefit. You would pay the same initial premium, $309.40. In this case, instead of taking your "dividend" in cash, you might advantageously buy additional insurance with it. Your "dividend," that is, would be regarded as a single premium, and the amount purchased placed to the credit of the policy. At the end of the first year, therefore, instead of $10,000 insurance, you would have in the neighbourhood of $10,153. As in the Connecticut Mutual, your "dividends" would increase every year. In twenty years, if you used them to buy this additional insurance, your policy, originally for $10,000, would have increased to one for about $13,000. If you had taken out similar policies in the Northwestern Mutual of Milwaukee, the State Mutual of Massachusetts, the Massachusetts Mutual, and a few other so-called annual dividend companies, the results would have been similarly favorable. Your policy would constantly grow larger or its actual annual cost would steadily decrease. Both results would be explained by the fact that the companies, at the end of each year, returned to you the overcharge made at the beginning.

## Insurance Cost When This Overcharge Is "Deferred" or "Accumulated"

Let us suppose, however, that, at the same time that you entered the Connecticut Mutual and the other annual-dividend or annual-repayment companies, you took a $10,000. policy in the Equitable. You should pay $330.10—more than $20. more at the beginning than the other companies charged. You hold the policy a year, but receive back from the company not a single penny of your overcharge! Thus far you have paid $330.10 in the Equitable for precisely the same policy that cost you $270.90 in the Connecticut Mutual—a difference of $59.20. The Equitable charges you $20. more in the first place, and then neglects to pay back the excess price. Perhaps, at the same time, you take out another $10,000. policy in the New York Life. You pay precisely the same initial price that you paid the Equitable—that is, $330.10, A year passes; you get back no overcharge! You have also taken a $10,000. policy in the Mutual Life. You pay $327.60—slightly less than in the Equitable and New York Life; and also fail to get back your overpayment. All your excess payments—all your "dividends," if you wish—are tightly locked up in the company's vault.
You note that this procedure differs from that of the "smaller companies," and you write for an explanation. The Equitable informs you that you have a "deferred dividend" policy; the Mutual that you have a "distribution" policy; the New York Life that you have an "accumulation" policy. You inquire the meaning of these somewhat doubtful expressions; and learn that in the Equitable your "dividends" are not paid annually, hut "deferred" for a certain period, usually twenty years; that in the Mutual, they are held, also usually for twenty years and then "distributed;" and that in the New York Life they are "accumulated" for twenty years and then paid back. By inquiring more deeply, however, you learn that these Equitable "dividends" are not necessarily "deferred" for your benefit, but, in the majority of cases, for the benefit of others; that the Mutual's, after being held for twenty years, will not necessarily be "distributed" to you, but, it is more than likely, to some one else; that those of the New York Life, after being "accumulated" for twenty years, are quite likely to be paid over to Tom, Dick, or Harry. You learn that, in two contingencies, both of which are extremely likely, you will got no "dividends," no repayments, at all. If you should have hard luck, and fail to pay your premiums for any one of the twenty years the overpayments are held in the company's treasury, you would forfeit all these "deferred," "distributed," or "accumulated dividends." If at any time in these twenty years you should die, you would also forfeit all your overpayments. Only in case you live for twenty years, and promptly pay your annual premiums, will you get back your annual overpayments. And then you get back precisely what the company sees fit to pay you—not a penny more. If you study your contract—your policy, that is—you will learn that the company has not legally obliged itself to pay you a single dollar! Your share of the twenty years' accumulated surplus is merely what is "equitably determined by the actuaries of the company." You find that the company is not obliged to give you any accounting; to tell you how much has been "saved" from your premiums each year; to let you know whether they have been carefully kept, or whether they have been squandered. If you could get at the company's books, you would learn that, in fact, it keeps no actual account; that it lumps all its annual overpayments or "dividends" in one sum, and not until the nineteenth year makes any attempt to determine how much should come to you and how much to me. If, angered by these discoveries, you attempted to haul the Equitable, the Mutual, and the New York Life to court and demand, as a policy-holder, to learn precisely what your dividend amounts to, you would find that there is a law that, in effect, prevents you from doing this very thing. In other words, in taking a deferred dividend policy, you had authorized the company to keep your accumulated overpayments for twenty years; to pay them back to you only in the event that you had not died or lapsed; to pay back then, only such small sums as it might choose; and to render you no accounting whatever and to keep none!

## Poor Discriminated Against in Favor of the Rich

This elaborate machinery, you will discover, has been admittedly evolved for the purpose of perpetrating a great injustice. The company declines to pay back these excess charges to those who die or drop their policies in order that it may pay them, instead, to those who live and persist. In other words, it does not treat all its insured upon an equal basis; does not charge all the same price for their insurance; does not preserve "mutuality." It discriminates, too, against its least fortunate members. Manifestly, if you die, your widow needs these dividends, or the insurance they represent, much more than if you live. The deferred dividend companies take this money from the widows of their dead members and give it to their persisting policy-holders. Again, if you lapse your policy, it is usually because you haven't the money to continue it. The deferred dividend companies take advantage of this misfortune to deprive you of certain equities. Your "dividends" go to swell the account of those who have been able to keep up their regular payments. The deferred dividend plan is thus clearly a discrimination against the unfortunate in favor of the prosperous. It overcharges most—and they the less prosperous—in order that it may undercharge a few—and they the more fortunate. Actually, as we shall see, it does not even treat its minority fairly. Far from paying back to the persistent the "dividends" of all who die and lapse, it does not always pay back their own!
Let us imagine, for a moment, a savings bank organized on this basis. It requires all depositors to leave with it stipulated sums each year. It declines to pay interest annually; but proposes to hold all earnings in its own treasury for twenty years. It is not obliged to keep an accounting of the earnings; in fact does keep no accounting; and has secured the passage of a state law that prevents any depositor from demanding one. It will pay these accumulated earnings only after twenty years, and then pays just what its trustees deem fair and "equitable." To depositors who have died in that twenty years it will pay no interest at all; when they die their widows get simply the principal. To those who fail to keep up their annual deposits they will pay no interest. If they drop out, they get simply the original sums paid in. After twenty years, however, the trustees promise to pay to all who live and have regularly made deposits, all the earnings accumulated upon the deposits of those who have died or "lapsed." In the end, however, many of the favored few will discover that they have not only not received these additional sums, but not always the entire interest upon their own deposits.
That is the gist of the much-discussed "deferred dividend" policy. As will be explained, this is only the survival of a scheme which was much worse. This is what the great Henry B. Hyde called "semi-tontine"—half tontine. His pet plan, whole "Tontine," was so iniquitous that it was virtually suppressed by law.
Let us see how the idea practically works itself out. Every insurant on the deferred dividend plan belongs to one of three classes; he pays his premium for a few years and then lapses; he pays and dies; he pays and survives the deferred dividend period. Let us suppose that he belongs to the first class. He has a $10,000 policy in the Equitable, for which he pays $330 a year. He pays for fifteen years; then is forced by adverse circumstances or other reasons to drop his policy. He gets back $2,784. This is his so-called surrender value; it is not a "dividend" and has no relation to one. Has any "surplus" accumulated in those fifteen years? Of course; but it is held tightly by the company. Let us suppose that he held this same policy in the Connecticut Mutual. Again he pays for fifteen years and then lapses. The Connecticut Mutual pays him a cash surrender value of $2,650. In addition it pays some $1,214 accumulated "dividends." That is to say, the insured is just $1,391. better off for having taken his policy in a conservative company. If he had insured in the Mutual Benefit, or the Massachusetts companies, the showing would have been similarly favorable. If he had insured in the New York Life, the Mutual, or any other of the New York companies, his annual overpayments would likewise not have been paid back, but diverted into the general "dividend" fund.
    3↑ Allowance is made, in arriving at this result, for the fact that the insured in the Connecticut Mutual has paid $310.50 less in premiums than the Equitable rates.
Let it be assumed, however, that the insured pays $330. regularly to the Equitable for nineteen years, and then dies. Now, if ever, he should be justly treated by his insurance company. By dying he has realized the very contingency for which he had insured. His widow receives the face value of the policy—an even $10,000.—nothing more. You think she is entitled to no more? But she is. Her husband, all these nineteen years, has paid greatly in excess of the cost of that $10,000. of insurance; and she should receive that excess, either in cash or in the additional insurance it will buy. If that policy had been taken out in one of the old-fashioned companies and the insured had left his "dividends" with the company—left them voluntarily, subject to withdrawal at any time, the widow would have received nearly $2,100. in addition to the $10,000.—a total of $12,100, against the $10,000 paid by the New York companies. If, instead of taking these dividends in cash, the insured had used them, year after year, in purchasing additional insurance, his widow would have received in the neighborhood of $13,000. That is, had he insured in a company which returned his surplus annually and had died in the nineteenth year, his family would have been just $3,000 better off. The iniquity of the system was well emphasixed in the case of a well-known citizen of Milwaukee, who recently died. This policy-holder had taken out a $50,000. contract February 10, 1894. His deferred dividend period ran for ten years. He died February 4, 1904—just six days before the completion of his term. His beneficiaries received an even $50,000.—and no "dividends." Had the insured lived only six days more they would have received dividends amounting to $17,000. Had he taken an annual policy, purchased each year additional insurance with his dividends, his family would have received about $77,000 when he died. All these advantages he lost merely by dying six days before his policy matured. On a smaller scale that episode is repeated hundreds of times every day.

## Sixty Per Cent Get no Dividends at All

According to the actual experience of the three big New York companies, sixty per cent of all their deferred dividend policy-holders either die or lapse before the termination of the deferred dividend period. In other words, sixty per cent of all their policy-holders do not get back the sums they are annually overcharged for their insurance. Sixty per cent, have absolutely no chance of getting out whole. If these sixty per cent should take policies in the companies which annually returned their surplus, they could peacefully die without depriving their families of the protection actually paid for in good cash; or retire from the companies without losing the large amounts they had unnecessarily paid in.
Evidently the remaining forty per cent constitute the fortunate class who live and pay. As a reward they are to receive not only their own overpayments, but the overpayments of all the unfortunate who have died and the poverty stricken who have lapsed. Forty per cent of the policy-holders, that is, are to get, not only their own "dividends," but the "dividends" of the sixty per cent, who get none. Their deferred dividends, swelled from these two sources, evidently should be enormous. They were persuaded to leave their overpayments for ten, fifteen, or twenty years—usually twenty—by certain "estimates" as to profits, officially issued by the companies. They did not insure primarily to protect their families, but to get the large sums of which so many hundreds of thousands of unfortunates have been deprived. They have played the game and have won; what have been the gains? Let us see first what they were led to expect; and how these expectations were fulfilled. In 1873, for example, you took out a $10,000 policy in the Equitable. What you got was not then described as a "deferred dividend," but a "Tontine-Savings Fund policy." You paid a premium of $313 for twenty years—a total of $6,260. Your agent informed you that by leaving your "dividends"—your overpayments, that is—with the company you would get, at the end of the twenty year period, a cash bonus of $9,556 in addition to the insurance. Your "investment return"—your "savings fund"—plus the life insurance, would amount to that much. Your friends who insured in 1874, 1875, 1876, 1877, and 1878 were furnished the same estimate of winnings. You paid your premiums faithfully for twenty years, and grew gray-haired so doing, constantly having ahead the large sum which was to lighten the cares of old age. In 1893, instead of getting a check for $9,556., you got one for $4,365.—a drop of 55 per cent. You had paid $6,260. exclusive of interest; had expected an investment return of $3,296. and had realized an investment deficit of $1,895.—a total disappointment of $5,190. However, you were among the lucky ones. Your friend who had insured in 1874 in the expectation of getting $9,556., got in 1894 only $4,105.; your friend who insured in 1875, under the same hallucination, got in 1895 only $3,795. The "dividend" dropped in 1897 to $3415., in 1901 to $3,110., in 1904 to $2,850.! You had not earned these "dividends" yourself; they were not your "overpayments;" they were your overpayments plus your share of the thousands of dead and unfortunate men who had been grossly overcharged all these years.

## Deferred Dividends Frequently Exceeded by Annual

All this time, the old-fashioned companies have paid their "dividends" annually; have paid back to each policy-holder each year precisely his own overpayments. They have not paid me the surplus that belongs to you; nor to you the surplus that belongs to me; they have treated us all fairly and honestly, and given us all our insurance at its actual cost. In spite of this in many cases they have paid annual dividends to all who have insured actually more than the New York companies have paid to forty per cent. The New York companies arrange their policy-holders chiefly in three classes; those who wait ten, fifteen, and twenty years for their "dividends." Ten years' annual "dividends" in the old-fashioned companies regularly amount to more than the ten-year "dividend" in the New York companies. In fact, the showing is so much against the latter companies that they no longer publish their results. The same is true of the fifteen-year periods. If you took a $10,000. policy at forty—or almost any other age—in the Connecticut Mutual in 1890—your insurance cost—the premiums for 15 years, less the cash value at the end of 15 years—would amount to $776.50. In the Equitable for the same period, and on the same basis of comparison, your insurance would have cost $951.70. In spite of the fact that you ran no risk of losing your "dividends" by death or lapse in the Connecticut company, your insurance actually costs you $175.20 less than in the New York concern, in which you daily ran such risk. If we extend the comparison to the twenty-year classes, here also occasionally, though not uniformly, the New York companies make an unfavourable showing.
Normally, of course, annual "dividends" could hardly be expected to compare favorably with deferred; because, as already explained, the latter are swelled by the forfeited "dividends" of the sixty per cent who do not survive the deferred dividend periods. In justice to the annual companies we should compare their "dividends" with the annual "dividends" paid in New York. The Equitable, the Mutual, and the New York Life, if forced to it, will issue annual policies. They pay higher commissions on the other kind; but still they carry a considerable amount of insurance on the annual plan. Only by comparing results on these identical policies does the extravagance of the larger companies stand revealed. The "dividends" paid by the outside companies, on identically the same policies, are frequently nearly twice the amounts paid in New York.

## "Surplus" not "Strength"; Merely Signifies Excessive Cost

In a word, the biggest New York companies enormously overcharge the insured. The surpluses of which they boast so largely in part measure the extent of this overcharge. These surpluses, of course, are not properly surpluses at all. The Equitable, in its last report, claims a surplus of nearly $81,000,000. Of that, $71,000,000. consists of withheld "dividends." The Equitable retains this vast sum by virtue of the deferred dividend scheme; it is money, which, according to its own claim, it keeps in its treasury instead of distributing among those to whom it belongs—the policy-holders. It calls this surplus "strength"; more properly we should call it "injustice." The Mutual has some $70,000,000. similarly withheld; the New York Life some $47,000,000. These companies have these great surpluses simply because they do not promptly return the excess cost of insurance; the outside companies have proportionately small surpluses because they do. When the Equitable advertises that it has a surplus of $80,000,000. it brazenly makes public its policy of overcharging its insured. The New York Life, in boasting of its $47,000,000.; the Mutual, in boasting of its $70,000,000. lay themselves open to the same charge. An insurance company with a big surplus occupies precisely the same position as a government with a big surplus. In both cases the surplus means the same thing. In a government it means that the people have been overtaxed; in a life-insurance company it means that they have been overcharged.
    4↑ This has recently been down by the Superintendent of Insurance to $67,000,000.
One great difference there is, however. A great government is responsible for every penny of its surplus. A life-insurance company is not. Its policy contracts are so written, as we have seen, that it can turn over to the insured just as much, or just as little, as it pleases. The Equitable can pay back to its policy-holders the whole $71,000,000. deferred dividend surplus; or not a penny. Mr. Ryan, who owns a majority of the stock of the Equitable, could dump anywhere from $50,000,000. to $60,000,000. into the sewer, and still be entirely able to meet all his policy obligations. In addition to this surplus, be it remembered, the Equitable has nearly $450,000,000. in reserves; that is the amount it must keep on hand in order to be solvent. All above that figure is surplus—unnecessary amounts collected from policy-holders. Its managers can use the whole amount in wasteful expenditure; and yet, according to court decisions, no one can hold them to account. Moreover, they can spend the whole amount and yet not endanger the company's solvency!

## A Constant Temptation to Extravagance and Dishonesty

And thus the story of life insurance in this country is the story of the surplus. It is this accumulation of the excess cost of the insurance, which has debauched the life-insurance companies. Mr. Hyde, Mr. McCurdy, and Mr. McCall have had constantly at their disposal these enormous sums. They have been able to defer their repayment for twenty years; and have then been obliged to pay back only such small sums as they chose. Instead of paying it back, they have dissipated enormous sums. Did they wish to increase their salaries? There was the surplus from which such increases could be taken, Did they wish to make provision for a large number of poor relations? They promptly set them all to feeding upon the surplus. Does Henry B. Hyde need some $600,000. to save one of his demoralized bank accounts from solvency? The Equitable's surplus provides the necessary amount. Do they all control certain trust companies which require large deposits with which the stock market may be played and big dividends earned? The surplus furnishes anywhere from $10,000,000. to $30,000,000. for this benevolent purpose. Does Mr. Hyde need money to rent space and furnish up safe deposit vaults for a company controlled by himself and friends? Why, take it out of the surplus, of course! Is Mr. McCall moved to contribute $150,000 to several national campaign funds? Again the surplus is drawn upon. Is a fund of some $1,300,000. needed for the purpose of bribing legislators? The surplus will not mind a little thing like that. Are $3,000,000. or $4,000,000. needed to help float certain unfloatable bonds? Again there is the surplus. Above all, do the companies require large sums to pay extravagant commissions to a corrupt agency force, so that they may bring in more policy-holders who will begin piling up more surplus? Does the New York Life need $13,000,000. for this purpose above the charges for commissions actually provided in this same new business? It is quietly "borrowed" from the surplus. And so on. The companies have no desire, however extravagant and expensive, which the long-suffering surplus cannot gratify. The surplus maintains Houses of Mirth at Albany; dines the French Ambassador; conveys young Mr. Hyde and his friends all over the United States in private palace-cars; supports an endless array of bygone political hacks; pensions "rantankerous friends from up the river," and other custodians of dangerous life insurance secrets; provides United States Senators with $20,000. yearly retainers; keeps in steady employment a fine assortment of journalistic talent, ready to sing the praises of New York life insurance. The policy-holders slave year after year building that surplus up; the methods of Mr. Hyde, Mr. McCall, and Mr. McCurdy have contributed quite as much toward pulling it down. The actual sum standing on each company's books is the resultant of these two opposing forces.
In the last analysis, then, what is the surplus? It is what is left of the policy-holders' overpayments for "dividend" purposes, after certain extravagant and reckless managements have finished dipping into them. In fact, as will be shown subsequently, the present surplus system was created for this very purpose. Henry Baldwin Hyde, the man who devised the plan, did so largely that he might quietly make money out of his great trust. How Mr. Hyde, by aid of his surplus, demoralized the whole life insurance business, and induced the present scandals—this is the story which will be told in subsequent articles.