Insuring Lives and Protecting Families - The Early Years of the $5 Trillion Life Insurance Industry
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19th century blank check from the New-York Life Insurance and Trust Company
It’s hard to believe that life insurance, a $5 trillion industry in the United States, was once considered profane. After all, many initially thought it would be offensive to put a dollar value on a person’s life.
But the insurance industry, which already had been insuring ships and later the lives of marines in England as far back as the 16th century, began informally protecting human lives in the United States in the mid-18th century.
Also in Philadelphia in the 1700s, a charitable organization was developed to help finance and protect the work of Presbyterian ministers and their families. Initially known as the “Fund for Pious Uses,” contributions first went to fund new Presbyterian congregations in New York. The New York congregations later contributed to the fund. After funds were used to aid the widow of a deceased reverend and subsequently helped a minister, the Presbyterian Synod of Philadelphia established the Corporation for Relief of the Poor and Distressed Widows and Presbyterian Ministers. By the early 1760s, the corporation had 43 contributors and had issued 21 policies to ministers.
The Episcopalians in Philadelphia created a similar relief fund in 1769. The evolution of churches into the life insurance business helped eliminate distaste for the concept. In time, attitudes changed to favor the idea of protecting loved ones.
Meanwhile, Alexander Hamilton, who was appointed America’s first Secretary of the Treasury in 1789, was building the foundation of the nation’s financial infrastructure. The US government assumed the debts of the Revolutionary War by issuing interest bearing securities, and Uncle Sam began collecting taxes. Hamilton established the First Bank of the United States in 1791. As a result, the United States was considered a stronger credit risk and issued currency. State chartered banks began springing up.
As the nation prospered in the 19th century, marriage rates and life expectancies rose and infant mortality rates fell, creating demand for greater family protection.
The first US commercial life insurance company — The Pennsylvania Company for Insurance on Lives and Granting Annuities — was chartered in 1812 and funded with $500,000 in capital. The company leased a house at 72 South Second Street in Philadelphia. One of its key founders, Jacob Shoemaker, lived in the house, but used the front and back parlors on the first floor for business. The insurer issued term insurance, whole life, deferred annuities and immediate annuities. The company’s first policy was written on June 10, 1813.
In those days, life insurance was significantly more expensive than it is today. A 40-year-old male paid $3.72 per $100 of whole life insurance coverage, according to the nation’s first mortality table, produced in 1814 by that Philadelphia-based insurer. Today, by contrast, it costs a male only $1.40 per $100 of whole life insurance, reports AccuQuote in Wheeling, IL.
Contributing to the high cost of life insurance in the 18th and 19th centuries were shorter life expectancies. Policies “endowed” faster. In other words, the cash value in the savings portion of the policy more quickly accumulated to an amount equal to the death benefit paid to beneficiaries.
Before The Pennsylvania Company for Insurance on Lives and Granting Annuities could issue a policy, an applicant was required to provide information that included his or her age, state of health, occupation and residence. The individual also had to provide a statement of “insurable interest,” if the policy was taken out on another person. This requirement, aimed at combatting fraud, confirmed that a policyholder had a bona fide interest in designating a beneficiary — such as blood or marriage. The company collected vital statistics from records of the Episcopal Church and the Philadelphia Board of Health. Premiums were based on its mortality table.
PENNSYLVANIA COMPANY FOR INSURANCES ON LIVES AND GRANTING ANNUITIES
|EXPECTATION OF LIVE, PHILADELPHIA, 1814 (in years)|
|Episcopal Board of||Episcopal Board of|
|TABLE OF PREMIUM RATES FOR $100 OF LIFE INSURANCE|
|Age||1 Yr Premium||7 Yrs Annual Pre||Whole Life Annual Pre.||Age||1 Yr Premium||7 Yrs Annual Pre||Whole Life Annual Pre.|
Source: Pennsylvania Company for Insurances on Lives and Granting Annuities
Shoemaker set the pricing and created a reserve fund, financed by 5% of the company’s profits, before dividends were distributed. The company said it would pay claims within 60 days, but declined payments if the insured died by “suicide, dueling or the hands of justice, and travel was restricted to parts of Canada and the United States north of the southern boundaries of Virginia and Kentucky unless the consent of the company were obtained.”
The company paid its first dividend of 4% to stockholders in 1815.
Shoemaker is believed to have been the first North American actuary. Actuaries, so essential to the insurance industry, are mathematicians who use probability and other types of statistics to construct mortality and morbidity tables, calculate premiums, reserves, dividends and insure that the correct amount of death benefits are paid to a policyholder’s beneficiaries.
Actuarial mathematics had its roots in 17th century England. Edmond Halley, the Oxford-educated English astronomer better known for a comet that bears his name, is credited with developing the first mortality table in 1693. James Dodson, founder of the Equitable Life Assurance Society in England, developed a level premium system that led to the establishment of the Society for Equitable Assurances on Lives and Survivorship in London in 1762.
Richard Price, an Englishman who wrote a life insurance text book, Observations of Reversionary Payments: On Schemes for Providing Annuities, published in 1771, was critical to the field. His book included the most accurate mortality table of its time and led insurance companies to more precisely calculate premiums and insure high-risk applicants.
The nation’s first mutual life insurance company, New England Mutual Life Insurance, was chartered in 1835. Mutual insurance companies are owned by policyholders and pay them dividends based on excess profits.
By 1840, there were about 840 US banks taking in deposits and making loans and nearly $5 million in life insurance was in force — half with New York Life Insurance and Trust Company. By 1844, 34 insurance companies had been chartered. Real US per capita Gross National Product had more than doubled from $50 in 1790 to $125 by 1850.
Easier access to the capital markets had been fueling the insurance company start-ups. Insurers formed joint-stock companies that sold options to buy stock directly to the public, without an investment banker intermediary. Subscriptions, which ranged from $10 to $1,000 per share, were paid over time. Mutual insurance companies had similar set-ups with their policyholders directly.
With a securities market, insurance companies could tap premiums, pay claims and profit on investment spreads and proper underwriting. Insurance companies invested in stocks, bonds, loans and government securities that paid dividends and interest.
The growing insurance industry, however, was not without problems.
By the mid-1800s, more than half had gone out of business due to poor policy sales. Companies that terminated charters often had limited local business. People began losing faith that insurers would pay claims.
Regulations had begun to evolve.
New York State in 1840 adopted a law preventing creditors from seizing a widow’s death benefits. Other states soon followed suit.
The first state insurance department debuted in Massachusetts in 1858. Elizur Wright, actuary with New England Mutual, served as its insurance commissioner for eight years. Wright established standards for life insurance company solvency and policyholder withdrawals. As commissioner, he required insurers to hold adequate reserves to guarantee that death benefits would be paid. Non-forfeiture provisions mandated that policyholders receive any equity accumulated in his or her policy cash value if coverage were canceled.
The development of regulations helped spark greater awareness of life insurance.
Wright, upon stepping down as Massachusetts insurance commissioner, helped mobilize the actuarial profession to share ideas and improve the business. The Actuarial Society of America, now the Society of Actuaries, debuted at the Astor House in New York in 1889.
Insurers found they could lower investment costs and risks by investment diversification and risk pooling. Thanks to attractive market rates, they were able to invest well and pass on those benefits via attractive rates on policyholders’ cash value. From 1790 to 1849, the stock market grew at a 6.4% annual rate. Government bonds grew at a 5.8% annual rate.
Credit: Wikimedia Commons
Insurance companies, though, were prohibited from speculating with policyholder money. That’s because the Pennsylvania charter of the Insurance Company of North America in Philadelphia, as far back as 1794 had set a precedent limiting investment speculation. Company investments were limited to government securities, bank debt and other bond issues. The company was prohibited from trading securities or conducting banking business.
Over the years, the lump sum benefits of insurance policies have triggered policyholder dishonesty, greed, fraud, and insurance company mismanagement and discrimination. Perhaps one of the greatest injustices still playing out today is that African Americans have historically paid more for life insurance than white policyholders. In the 1880s and 1890s, a number of states prohibited the setting of life insurance rates based on race, so many companies simply stopped selling insurance to African Americans.
A few insurance company actuaries, though, found a mathematical way to get around these state discrimination prohibitions. They developed a concept, known as “impairment,” that incorporated race and geography into the calculation of mortality and premium rates. As recently as the 1900s, it was reported that African Americans were charged 35% more than white policyholders for life insurance. By 1960, race-based pricing was stopped, but many policies — often small “burial” policies — are still being adjusted by state insurance commissions and the courts today. In the early 2000s, some of the nation’s largest life insurers had announced multi-million-dollar race-based pricing settlements.
More recently, state regulators were cracking down on insurers who failed to proactively notify beneficiaries that they were entitled to life insurance benefits.
Insurers, though, also have been victims. Insurance fraud runs $80 billion a year, according to the Insurance Information Institute, New York.
Despite these intransitivities, the United States, with a population of 313 million, has benefited dramatically from life insurance. The American Council of Life Insurers reports that in 2010, more than 900 life insurance companies paid out $151 billion in benefits.
Alan Lavine is a columnist for Dow Jones MarketWatch’s Retirement Weekly publication and a contributing editor to Financial Advisor and Registered Rep magazines. He is author of 15 books including Your Life Insurance Options (Wiley), which was endorsed by the Financial Planning Association.
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