Necessity of Accumulating This Fund According to Scientific Principles and a Workable Method

In accumulating the fund referred to in the preceding section it is important for the companies to take into account several other characteristics which differentiate life insurance from other forms of insurance. In the first place, the persons combining for life insurance are not of the same age, and it is clear that on the average those insuring at the younger ages will live much longer before receiving payment on their policies than those who insure at the older ages. Justice, therefore, requires that the premium payments should be graded according to the age when the policy is issued. Furthermore, as future chapters will show, a great variety of policies is on the market, some insuring against death for a limited number of years only while others cover the whole of life, some providing for the payment of premiums for a stated number of years only and others for the entire duration of the contract, some promising the payment of the face of the policy in one lump sum and others for the payment of that sum in a fixed number of installments, etc. Here again justice demands that the rates for each type of policy shall be determined not only with reference to the age of the insured at entry, but also according to the nature of the protection promised.

These complex conditions cannot be treated justly by the companies unless they follow scientific principles in the computation of their rates. Since life-insurance policies promise a definite sum in the event of death, and in some instances in the event of survival at a stated time, it is essential that there be an accurate determination of the liability involved and that an adequate premium be charged which is just as between ages and types of policies. This is especially important because life-insurance contracts, in contrast with most other forms of insurance where the policies are written for only one or at most a few years and are subject to cancellation at the option of either party, are unilateral as against the company and usually extend throughout life or for long periods of time. Later chapters will outline the principles underlying the computation of rates, and the matter will therefore not be discussed in detail at this time. Suffice it to state that the reasons just mentioned make it essential for the companies to compute their premiums on the basis of some table of mortality experience which will indicate to the company the probability of death for average lives at any age.

In addition to the foregoing, life insurance presents a further problem as regards the accumulation of the fund necessary to pay policy claims. Experience has shown that a workable plan of life insurance requires the charge of a uniform annual premium during the premium-paying period. Mathematically, it is possible to consider a life-insurance policy as composed of a series of one-year renewable-term insurances and to make each year's premium just cover the cost of current protection. Under this plan, however, since the rate of death increases with increasing age, the premium will become burdensome and at last prohibitive, with the result that the healthy members of the group will withdraw rather than continue to pay the greatly increased rates. From a practical standpoint it is therefore desirable in the great majority of cases to charge a uniform or level annual premium as contrasted with an increasing one. Mathematically, the two plans are the same, since they are computed on the basis of the same table of mortality experience, but the annual level premium has the great advantage of being moderate in amount and the same from year to year, with the result that policy-holders remain satisfied and soon become accustomed to its payment.

But keeping the premium the same from year to year, instead of increasing it in accordance with increasing age, involves the payment during the earlier years of a sum over and above that required to pay the current cost of insurance. In other words during the early years the company is accumulating a fund out of excess premiums which will be drawn upon in. the later years when the same annual premium becomes insufficient to meet the current cost. This overcharge in the yearly premiums does not belong to the company but is held in trust for the policyholder at an assumed rate of interest for the purpose lust indicated. Considering a large number of policies, this overcharge or unearned premium (usually called the reserve) represents that sum which, together with the future premiums paid by policy-holders, will just enable the company to meet its claims according to the mortality table in use. This method of thus accumulating a reserve fund is fundamental to any sound plan of life insurance. The extent of such accumulations by the companies now in operation in the United States is indicated by the fact that at the close of 1913 the reserve value of the policies in force in the 259 American legal-reserve companies, reported in the Insurance Year Book, amounted to $3,903,000,000 or nearly 84 percent, of their total admitted assets.