Investment of Life Insurance Funds (Anniversary Collection) by David McCahan

CHAPTER I
INTRODUCTIO N
By D AVI D M C C AHAN 
H o w LIFE INSURANCE GENERATES SAVING
Tha t the operations of life insurance companies in the twentieth
century should generate a substantial volume of saving is inevitable.

Ther e are a numbe r of underlying reasons for this but
foremost among them is the very elementary but highly significant
fact that the probability of death rises with an increase in age.
Were this not so, life insurance could be written on much the
same general basis as fire insurance or numerous other forms of
property and casualty coverage. Th e procedure would be essentially

one of spreading over the many the losses of the few through
the "magic of averages." And the principal capital funds arising
from the process would be from premiums paid in advance, incurred

losses not yet paid out, or those funds which are contributed

directly or indirectly to guarantee that losses will be met
in the event that the spreading should not function smoothly. In
other words, the aggregate capital funds incident to the business
would, with respect to the volume of risk assumed, probably be
on about the same scale as we associate with certain other lines
of insurance.
But when we start with this rising rate of mortality and then
couple with it the understandable reluctance on the part of the
public to pay a premium that would, after age 10, continuously
increase with age until it would reach prohibitive levels, we realize
that the level premium plan is the only practical way in which life
insurance can be written for individuals on any substantial scale. 

INVESTMENT OF LIFE INSURANCE FUNDS
The writing of annual renewable term policies on separate lives
may be theoretically possible and have some uses of limited application,

but as a general solution for providing life insurance
coverage it is impractical. Group contracts constitute an extremely

important exception but do so only because the conditions under

which the group is composed and the manner in
which the cost is spread over employer and employees tend to
minimize lapsation, cut the expenses of operation, and conceal
(at least from the mass of employees) the effect of the rising mortality

cost. In substance, the operation of a group life plan, with
minor exceptions, does give participants not only a fixed premium,

but one which for older employees is fixed at a level under
actual cost.
Level premiums actuarially related to a rising mortality rate
obviously involve a charge which during early years will be
greater than the actual mortality cost. This excess must be retained

and kept safe for policyholders. Moreover, life insurance
companies must set up as a liability on their books a reserve
which can be popularly thought of as representing this excess even
though it is measured with reference to the obligations of the
future rather than the experience of the past. Because of the state
legislation respecting the basis for constituting this liability, it
has come to be known as the "legal reserve." Although the amount
of life insurance reserve for any given company in proportion to
the face value of its outstanding contracts will necessarily vary
with a number of different factors, of which the type of contract
is an exceedingly important one, the aggregate becomes substantial

with the passage of time and the growth in volume of business.
Parenthetically, it should be noted that the excess payments
incident to the level premium system, to which reference has been
above made, also give rise to certain nonforfeiture values on the
part of the policyholder. A schedule of such values, based upon
certain mortality, interest and expense assumptions, is incorporated

into his contract at issuance. The options which he is given
of receiving extended term insurance, taking a fractional paid up
policy or surrendering for cash are, as is also the case with the
right to borrow, related to the excess that he has paid in premiums
over and above what is necessary to meet the costs up to the time
that such a right is exercised. The worth of these pre-maturity 

Investment of Life Insurance Funds (Anniversary Collection) by David McCahan