1 1220 _6 C81 THIRD PARTY INSURANCE CORNELIUS CORNELL LAW LFRRARY dlarmii ICam ^rl^anl ICibratg , Cornell University Library KF 1220.E6C81 Third party insurance; being "insurance a 3 1924 018 932 198 The original of tliis book is in tine Cornell University Library. There are no known copyright restrictions in the United States on the use of the text. http://www.archive.org/details/cu31924018932198 THIRD PARTY INSURANCE Being — "Insurance agamat UabiUty imposed bv laic upon an individual, firm or corporation by reaion of injuries to person Cf property sustained by a third person on account of a specified activity of the assured." By MARTIN P. CORNELIUS THE INSURANCE FIELD, Inc. CHICAGO LOUISVILLE ATLANTA NEW YORK SAN FRANCISCO Copyright, 1920 by THE INSURANCE FIELD COMPANY DEDICATED TO H. G. B. ALEXANDER PRESIDENT AND GENERAL MANAGER CONTINENTAL CASUALTY COMPANY PREFACE The business of insuring against loss due to a lia- bility imposed by law has only recently become of relative importance. This branch of the great business of insurance is unique in that the liability of the insurer does not arise by reason of a casualty suffered by the assured, but on the contrary, the carrier be- comes responsible only in the event that the law imposes liability upon the assured on account of in- juries in person or property suffered by third persons. The contract forms which have been created for the purpose of covering this peculiar hazard are ordinarily referred to as policies of employers' liability, work- men's compensation and public liability insurance and it has become customary to use such terms in describ- ing the three divisions of this special insurance. How- ever, the character of the coverage is such that it may be properly and accurately described as third party insurance. While much has been written relative to various phases of this business, no one individual, in so far as the author is aware, has attempted to present a brief and logical analysis of the entire subject in such form that its basic principles may be easily and conveniently mastered by those who have not sufficient time to collate and digest all of the pertinent literature. PREFACE An earnest effort has, therefore, been made to sup- ply a need which is beheved to exist and to provide a compact treatise, covering all phases of this impor- tant subject, suiificiently condensed to be of practical use to those who desire to familiarize themselves only with fundamentals. The devotion of the first two chapters to the general business of insurance may perhaps seem to be inconsistent with the objective just indicated. These two chapters constitute what is in effect a primer of the entire business of insurance and have been included for two reasons. There are certain basic principles common to all forms of insur- ance which may be best elucidated by a comparative analysis of all branches. It is also believed that the student of third party insurance should be familiar with the rudiments of every division of the business in order to obtain a correct perspective from which to view that particular subject. It is hoped that this work may, to some degree, accomplish the purpose by which its author has been actuated. M. P. C. Chicago, June 1, 1920. Third Party Insurance CHAPTER I COVERAGES WHICH HAVE BEEN DEVISED TO MEET VARIOUS INSURANCE NEEDS LAWS OF AVERAGE.— In so far as the mind of man has yet been able to determine, the affairs of the world and the universe, of which it is a part, are governed by certain immutable laws. The origin and development of all religions, sciences, and moral, governmental and social conceptions were brought about by the realization of this principle and the effort of mankind to determine and apply these laws. In this evolution one great obstacle has been encountered, namely, the difficulty of identifying fundamental prin- ciples by the observation of isolated and individual happenings. A too limited perspective has often resulted in serious mistakes. These primal laws are often manifest only to those in a position to determine the general results brought about by the collective effect of a great number of individual events each one of which standing alone has no significance. Experience has demonstrated that fortuitous events of such character as to bring about injury to or destruc- tion of the physical body or property of man are bound to occur. It has devolved upon those engaged in the 7 8 THIRD PARTY INSURANCE business of insurance to observe and record the fre- quency with which any designated casualty occurs among a given number of men and the extent of the loss thereby occasioned. Of course such observation must be extended to include a number sufficiently large to enable the laws of average to operate. With this record as a basis it becomes possible to determine the law of average applicable and to forecast with approximate accuracy the aggregate loss and the average cost of each loss. Being thus enabled to intelligently determine the extent of their obligation, it becomes possible for insurers to contract with those in need of the protection which they furnish. INSURANCE DEFINED.— This contract of insur- ance has been defined as one whereby the insurer undertakes, for a consideration, to compensate another if he shall suffer loss. Insurance, therefore, is a device, which operates to distribute among all the insured the cost of designated individual misfortunes. Each in- sured contributes to a common fund and the insurer acts as a medium for the distribution of such cost. ORIGIN OF INSURANCE.— Insurance had its origin in the application of the principles above indi- cated to the necessities of commerce and industry and with remarkable facility has adapted itself to the advance of civilization. Its growth, particularly in the past fifty years, has been so phenomenal that few people realize what an important factor it is in the daily life of the world and how completely commerce and industry are dependent upon it for existence. THIRD PARTY INSURANCE.— We shall discuss VARIOUS INSURANCE COVERAGES 9 in the following- pages, not the business of insurance generally, but only a particular class of that business. We shall confine our attention to that branch which may be termed third party insurance. This means the insurance against liability imposed by law upon an individual, firm or corporation by reason of injuries to person or property sustained by a third person on account of a specified activity of the assured. Ob- viously, therefore, in speaking of third party or lia- bility insurance, we include the assured's liability to his employes, which may or may not be under a workmen's compensation law, and also his liability to persons who are not employes, i. e., members of the public. LIFE AND ACCIDENT NOT THIRD PARTY INSURANCE. — There are certain contracts of insur- ance other than those we have termed third party contracts, which concern more than two parties. Policies of life and accident insurance name a third person as beneficiary. Upon close analysis it is apparent that in such cases the beneficiary may properly be regarded as the insured and the individual usually referred to as the insured is, in reality, the subject matter of the insurance in somewhat the same sense that property is the subject matter of fire and marine insurance. Perhaps this conception would be more accurately indicated by considering the earning capacity of the person usually referred to as the assured as the subject matter of the insurance. From this standpoint it is apparent that there is no real distinction in principle between the direct property 10 THIRD PARTY INSURANCE insurances and life insurance and that life insurance is not third party insurance within the meaning of that phrase as here used. OTHER FORMS DISTINGUISHED FROM THIRD PARTY INSURANCE.— Also in writing fire and some other of the property insurances, the companies frequently provide that the indemnity shall be payable to a named assured and, in the alternative, to some other person in the event that it shall appear that such other person is the one who has actually suffered loss through damage to or destruction of the property which is the subject matter of the insurance. Obviously contracts of this character are not third party contracts. Agaj,n third parties are interested in policies of Fidelity and Surety insurance, which, as will subsequently appear, are more properly described as Fidelity and Surety bonds. Under such contracts, the insurer, i. e., the surety, agrees to indemnify the insured against the misfeasance or nonfeasance of the third party who is the principal under the bond. In reality, the situation here presented is somewhat similar to that brought about by the issue of a policy of life insurance. The surety may be regarded as the insurer, the obligee under the bond as the insured and the principal of the bond as the subject matter of the insurance. DIRECT LOSS SOMETIMES COVERED.— Inci- dentally, it should be pointed out that in the develop- ment of what may be termed pure third party insurance the logical differentiation above indicated has not always been observed and insurers engaged in this VARIOUS INSURANCE COVERAGES 11 form of insurance have, in some instances, overlapped these logical boundaries and customarily, in connec- tion with third party insurance, give coverage against direct loss to the insured resulting from damage to his own property. Where, as a matter of business practice, it is customary for insurers to issue this form of insurance in connection with third party insur- ance, we shall discuss such extended coverage in con- nection with those particular forms of pure third party insurance which are frequently accompanied by the direct insurance just referred to. BASIC PRINCIPLES APPLICABLE TO ALL INSURANCE. — We do not propose to attempt any exhaustive discussion of the various forms of insur- ance other than third party insurance as above defined. However, as a preliminary to our observations upon third party insurance, it is essential to have in mind, in a general way, the basic principles of all other forms of insurance. The growth of insurance, like that of all other industries, sciences and professions, has been brought about by a process of evolution. That growth has been very rapid during the past fifty years for the reason that during this period the entire world has. experienced a very radical develop- ment, particularly in those forms of human activity which are dependent upon mechanics. Each new invention has accelerated the social, economic, com- mercial and industrial progress of the world. Insur- ance has adapted itself to this progress and, as new hazards have arisen, new forms of insurance have been devised to afford protection against them. Practically 12 THIRD PARTY INSURANCE all of the so-called casualty lines, including third party insurance, have had their birth and growth within this comparatively short period and the underlying causes thereof have been largely common to all. Therefore, in order to obtain a correct perspective from which to view the subject matter of this work, it seems essential that we should be familiar, in a general way, with the development of the entire insur- ance business and with the fundamentals of all the various ramifications of that business. The balance of this chapter has, therefore, been devoted to a dis- cussion of such other forms and we have endeavored to point out briefly the lines along which various branches of insurance have developed, the basic prin- ciples upon which each rests and the general coverage afforded by various sorts of policies. Of course, an attempt to cover the entire field of insurance in one chapter must, of necessity, be simply a resume; and the temptation to enter upon details, we trust, has been successfully resisted. An earnest effort, however, has been made to the end that the statements contained in this chapter, as to the development of the various lines of insurance, their fundamental resemblances and distinctions, be, in so far as they go, accurate. VARIOUS BRANCHES OF INSURANCE.— Speaking broadly, the business of insurance may be divided into four great branches. In the order of their historical development and also, to some extent, in the relative order of their importance, they are : Marine Fire Life Casualty MARINE INSURANCE.— -This is an insurance VARIOUS INSURANCE COVERAGES 13 under which the insurer, for a proper consideration, undertakes to compensate another against direct loss suifered by the insured by reason of damage to or destruction of property through the perils incident to transportation of such property by either land or water. In other words, marine insurance is transporta- tion insurance. It is probably the oldest form of insur- ance, having its origin in connection with the revival of commerce in the twelfth or thirteenth century. In its initial stage contracts of marine insurance were written by individuals and the business was regulated by mercantile custom which became the foundation of all the laws and codes subsequently enacted upon the subject. COVERAGE OF MARINE INSURANCE.— One naturally thinks of marine insurance as a coverage against loss of property due to the perils of the sea. As a matter of fact, the coverage given is much broader than this. It is against damage to or destruction of property through all perils incident to transportation. This means that the marine coverage is against not only damage occasioned by water hazards, but against damage by the action of the elements, including fire, and by collision, theft or any other peril whereby property may be lost or damaged while in process of being carried from one place to another by either land or water. This coverage extends to transportation not only by ships, but by trains and all other forms of conveyance, and includes not only damage to the property itself, but damage to the particular vessel or vehicle by means of which it is transported. 14 THIRD PARTY INSURANCE AUTOMOBILE PROPERTY DAMAGE AND COLLISION. — One of the important branches of third party insurance is automobile insurance, and third party companies customarily insure against not only the liability of the insured imposed by law by reason of injuries to person and property occasioned to third parties by the operation of an automobile, but also against damage to the automobile itself occasioned by collision. This latter form of coverage falls primarily within the scope of marine insurance and was orig- inated by marine companies. Marine companies, therefore, customarily issue policies insuring automo- biles against the perils of fire, theft, transportation and collision. While the third party companies have infringed upon the domain of marine insurance by writing automobile collision, marine companies have, in turn, invaded the logical boundaries of third party insurance and customarily, in connection with their general automobile coverage just described, insure the owner of an automobile against liability for damage to property of others. FIRE INSURANCE.— Fire insurance is of more recent origin and was not undertaken in any practical form until after the great London Fire of 1666. The first fire company in the United States was established in 1752. The general character of this insurance is universally recognized and may be stated broadly as the business of insuring against direct loss suffered by the insured by reason of damage to or destruction of his property due to fire. As an incident to pure fire insurance, the companies sometimes give a cov- VARIOUS INSURANCE COVERAGES 15 erage under which the insured is indemnified against damage to or destruction of property occasioned by the action of the elements other than fire. Most fre- quently this kind of insurance is against damage or destruction caused by tornadoes and cyclones. Such coverage is usually given by a separate policy and may be extended to include damage occasioned by hail. Ordinarily fire companies will not cover stand- ing crops or timber against these casualties although a few of the less conservative companies and also some Lloyds will do so. The bulk of insurance against damage to standing crops, caused by the action of the elements, is taken care of by local concerns, oper- ating under special state statutes, as stock companies, mutuals and inter-insurers. FIRE COMPANIES ALSO WRITE AUTOMO- BILE PROPERTY DAMAGE AND COLLISION. — In our comments upon marine insurance, we have indicated that these companies originated the business of insuring automobiles against the perils of fire, theft, transportation and collision. Since the development of the automobile industry many fire companies have extended their charters so that they are now authorized to give the same coverage. In connection with such insurance, fire companies have followed in the foot- steps of the marine companies and also agree to indem- nify the assured against liability to third persons on account of property damage occasioned by the operation of the insured automobile. This is, of course, purely a third party insurance. ORIGIN AND DEVELOPMENT OF LIFE IN- 16 THIRD PARTY INSURANCE SURANCE. — Life insurance had its origin, as a prac- tical business proposition, nearly a century subsequent to the development of fire insurance. It was not, however, until the last half of the nineteenth century that this business assumed conspicuous importance in the United States. In the past fifty years life insur- ance has achieved a position of very great importance among financial institutions. Beginning just after the Civil War, the business grew with unparalleled rapid- ity and, as everyone knows, at the present time has reached immense proportions. Life insurance con- sists of the issuance of a contract under which the insurer agrees for a designated premium to pay to an indicated beneficiary a certain sum of money upon the death of the insured. LIFE INSURANCE DISTINGUISHED FROM MARINE AND FIRE.— It is in several important respects quite different from marine and fire insurance. The insurance is against a contingency which must certainly occur sooner or later. It is not upon property which has a value comparatively easy to determine and the indemnity is not payable to the insured but to a third party. Basically, however, there is no distinction between life insurance and the property insurances above referred to. In both marine and fire insurance, it is customary to issue what is known as a valued policy. This means that the parties, agree in advance as to the value of the property insured and the insurer agrees to pay that fixed value in the event of total loss irrespective of what the actual value may be at the time of loss. In VARIOUS INSURANCE COVERAGES 17 effect, a life insurance company agrees as to the value of the insured life ; that is to say, as to the loss which will be suffered by the beneficiary in the event of the termination of that life. CHARACTERISTICS PECULIAR TTO LIFE INSURANCE.— There are certain other peculiar characteristics of life insurance which should be pointed out. In life insurance the risk increases with age and hence the company is confronted with the necessity of either increasing the premium each year or fixing- an average premium which will be sufficient to cover the hazard for the entire policy period. The latter alternative has been chosen and this business is ordinarily written on what is known as the level premium basis. In the earlier years of the insurance the premium paid by any given class is much in excess of the actual loss by mortality. The company thereby accumulates a reserve to make up the deficiency in later years. In consequence, life insurance companies have piled up enormous assets, the major portion of which is a trust fund for the benefit of their policy- holders, and these assets have given to them great financial power. LIFE COMPANIES DO BANKING BUSINESS. — The capacity of life companies for the building of large assets has been materially increased by certain other factors. They have grafted upon the basic prin- ciple of their insurance, namely, the protection against loss due to death, certain investment features. Thus, for illustration, the companies issue what are known as endowment policies for which they charge a pre- 18 THIRD PARTY INSURANCE mium greatly in excess of that necessary to take care of the mortality hazard. By reason of this practice the companies are able to guarantee to their assured the return of considerable sums at the end of a fixed period. In this respect the life companies have in- vaded the domain of banking and have induced their policyholders to invest with them sums which, in the aggregate, are stupendous. LIFE POLICY ORDINARILY CANNOT BE CANCELLED. — One other distinction between life and most other forms of insurance is that the company, having once issued its contract, is not permitted to cancel same and must continue on the risk in the absence of fraud perpetrated by the insured in securing the coverage. DIVISIONS OF CASUALTY INSURANCE.— Casualty insurance is a comprehensive term quite loosely used to designate most of the various miscel- laneous lines of insurance other than marine, fire and life. Of these so-called casualty lines, the most impor- tant is liability insurance, which we have termed third party insurance and which, as already indicated, is the form of insurance to which this volume pertains. Before proceeding with our discussion of third party insurance, we will briefly refer to the other casualty lines, which are as follows : Accident Sprinkler Health Steam Boiler Burglary and Theft Fly Wheel Plate Glass Credit Automobile Collision Title Live Stock Fidelity and Surety VARIOUS INSURANCE COVERAGES 19 ACCIDENT INSURANCE.— This insurance is, in so far as death benefits are concerned, a limited form of life insurance. Under policies of accident insurance the insurer agrees to pay a designated amount to the beneficiary in the event that the insured shall come to his death solely as the result of a bodily injury effected by accidental means. These policies also usually provide to pay certain weekly or monthly indemnities direct to the insured in the event that he becomes disabled by reason of such an injury. It is also customary to include health insurance under which the insurer agrees to pay direct to the insured certain indemnities in the event that the insured shall be disabled as the result of sickness. Accident insur- ance had its inception in England, the first policies having been issued about the middle of the nineteenth century. The business was first written in the United States in 1864. It has developed rapidly and is now an important branch of the insurance business. ACCIDENTAL DEATH INSURANCE.— While in the popular conception the death benefit is the most important factor in accident insurance, there is in reality little logical reason for such benefit. There is no more reason why one should insure against death occasioned in this particular way than there would be to insure against death occasioned by tuber- culosis or some one of the other causes by which human life is most frequently terminated. The insur- ance given under these policies against loss due to inability to work by reason of accident and sickness is, however, not only a very necessary form of insur- 20 THIRD PARTY INSURANCE ance, but one of great importance from the standpoint of the companies, the state and the public. ILLOGICAL TO DISTINGUISH CASUALTIES CAUSING LOSS OF EARNING POWER.— In passing it may be pointed out that there is no good reason for any differentiation between disability caused by bodily injury efifected by accident and dis- ability occasioned by what is usually referred to as sickness. The real purpose of both forms of insurance is to protect the insured against loss due to inability to work; in other words, against loss of earning power occasioned by bodily infirmity. It would be more logical and much more satisfactory from the standpoint of everybody concerned if the public could be educated to look at the matter from this viewpoint. Notwithstanding this fact, there has grown up a pop- ular conception on the part of the public and a practice on the part of the companies under which a radical distinction is made between the two forms of dis- ability although it is practically impossible to formu- late any definition of the one which excludes the other. Much difficulty is experienced in adjustment of claims in determining in border line cases just where the lines of demarkation should be drawn. Actuated by an appreciation of the true situation one company has attempted to sell policies covering broadly against inability to work occasioned by any bodily infirmity. Of necessity, the premium for this coverage is high and probably for this reason the attempt has not been entirely successful. The majority of the public now does, and apparently will continue to insist upon pur- VARIOUS INSURANCE COVERAGES 21 chasing these forms of insurance separately and the manifold perplexities incident to such procedure will continue to be experienced by all parties concerned. HEALTH INSURANCE.— This insurance is given by a contract under which the insurer agrees to indem- nify the assured against loss of earning power result- ing from sickness. It had its origin in the so-called friendly societies and trade guilds which existed in certain parts of Europe in the middle ages. It was first undertaken in the United States about the middle of the nineteenth century, but soon thereafter became dormant and was not revived until the latter part of that century. This resurrection came about through the enlargement of coverage given by personal acci- dent policies. Some of the companies engaged in that business adopted the practice of attaching to their policies riders under which they agreed to pay indemnities for loss of time occasioned by certain specified diseases. Thereafter separate policies were issued, the coverage being confined to disability occa- sioned by a few named diseases. From this beginning, within the last thirty years the business of health insurance has grown to considerable proportions and the very restricted coverage originally given has been gradually enlarged until under the more liberal modern policies the companies agree to indemnify the insured against loss of earning power occasioned by all dis- eases. The coverage, of course, naturally runs with that afforded by personal accident policies and is ordinarily given by the same company — frequently under the same contract. 22 THIRD PARTY INSURANCE COMPENSATION LAWS HAVE NOT AF- FECTED ACCIDENT AND HEALTH INSUR- ANCE. — The coverage afforded by accident policies is, in many respects, similar to that given by work- men's compensation laws and, in reality, the one is a supplement to the other. Accident insurers were very apprehensive at one time that the development of the workmen's compensation scheme in the United States would seriously affect their business. As a matter of fact, the passage of the compensation laws has had little, if any, effect upon that business for the reason that the compensation laws do not cover non-occupa- tional injuries and the limitations upon benefits are so restricted that the employe still feels the necessity of additional insurance. Health insurance is, of course, a different matter for the reason that in the United States most of the compensation laws do not as yet cover occupational diseases. There is observable, however, a marked tendency to enlarge the coverage of the compensation laws to cover certain occupational diseases. Presumably any such develop- ment will have little effect upon the business of health insurance for the same reason that the passage of the present compensation laws has not affected accident insurance. BURGLARY AND THEFT INSURANCE.— This insurance is carried on by companies which issue a contract under which the insurer, for a proper consid- eration, agrees to indemnify the assured against loss of or damage to property occasioned by burglary, robbery, theft and larceny. Like marine and fire, it VARIOUS INSURANCE COVERAGES 23 is a property insurance pure and simple. One of its novel features is that it protects the assured against loss occasioned by the commission of a crime. This form of insurance also originated in England, probably in the year 1865, and was first written in the United States about 1885. It was not, however, until the beginning of the present century that the business assumed any substantial proportions in this country. It is now growing with ever increasing momentum and has already come to be an important branch of the insurance business with prospects of great growth in the comparatively near future. The fact that it is an insurance against loss due to crime and that one branch of the business, namely, theft and larceny insurance, is of such character that fraudulent claims are frequently made, makes the moral hazard a very important one. While this hazard is, of course, one which pertains to all forms of insurance, it is per- haps a more important factor in burglary and theft insurance than in any other. As illustrative of one of the peculiar deviations from the laws of logic in the development of the insurance business, burglary com- panies do not ordinarily insure against automobile theft and larceny except to a very limited extent, the great bulk of this business being carried on by marine and fire companies. PLATE GLASS INSURANCE.— This coverage is also one of the forms of property insurance. It is, of course, of very recent origin and consists of an agree- ment by the insurer for a proper premium to indem- nify the assured for loss of or damage to plate glass 24 THIRD PARTY INSURANCE occasioned by the breakage thereof. One peculiar feature of this insurance is that the insurer does not usually pay to the assured the money value of the property loss sustained, but, on the contrary, exercises the option afforded by the policy to replace the broken glass. A company engaged in underwriting this hazard must, therefore, consider as a very important factor the proximity of the risk to the source from whence replacement glass is obtainable. This peculiar situation makes the adjustment of claims compar- atively simple since no account need be taken of depre- ciation of the subject matter of the insurance as the element of decreased value due to usage is non- existent. In brief, the problems involved are largely the fixing of a proper rate and the development of facilities for economical replacement. AUTOMOBILE COLLISION.— This is purely a direct property insurance. However, as a matter of custom, it is written not only by marine and fire companies, to which classes of insurance it logically belongs, but also by companies engaged in the busi- ness of third party insurance. It is simply an agree- ment by the insurer to indemnify the assured against loss of or damage to the assured's automobile occa- sioned by collision. The coverage may be given in a separate policy, but is ordinarily given by a rider attached to a marine or fire policy or to an automobile public liability policy. LIVE STOCK INSURANCE.-Insurers engaged in this business insure against property loss occasioned to the assured by reason of the death of live stock. VARIOUS INSURANCE COVERAGES 25 The volume of this business is comparatively small but is increasing rapidly. Uncertain at first the business has greatly improved and novv is generally written by specialty companies which are growing in number. There is undoubtedly a real demand for this insurance and it is reasonable to assume that a considerable growth may be expected. SPRINKLER LEAKAGE INSURANCE.— This is another of the property insurances designed to cover the hazard of damage to or destruction of property of the assured occasioned by leakage of water from a sprinkler system which is installed as a protection against fire. This coverage is occasionally extended to include damage to or destruction of property occa- sioned by leakage from sprinkler tanks, as differen- tiated from sprinkler systems proper. Moreover the damage caused by falling sprinkler tanks may be in- cluded. Sprinkler systems are so constructed that they should automatically open at a certain temperature. However, experience has demonstrated that it is, as a practical proposition, impossible to so construct such systems that accidents will not occur, occasioning very serious damage to property by reason of the water from the sprinkler system coming in contact therewith. This business is written by both fire and casualty com- panies. STEAM BOILER INSURANCE.— Such insurance is a combination of third party and direct insurance. The coverage given is against loss sustained by the assured by reason of the explosion or bursting of a steam boiler whether that loss be occasioned by 26 THIRD PARTY INSURANCE damage to the insured's own property or by reason of liability imposed upon the insured on account of injury to the person or property of others. One peculiar characteristic which should here be referred to is the fact that a very large portion of the total outlay of the insurer is in the way of inspection expense. Essen- tially the function of a steam boiler company is to prevent boiler explosions by means of a very efficient inspection department. Inspections are made fre- quently and the expense incident thereto is high, largely exceeding the amount paid out in claims. As a matter of fact, the business had its origin with an association known as the Huddersfield Association for the prevention of steam boiler explosions, formed at Huddersfield, England, about 1854. The sole function of this association was to look after steam boilers and it did not engage in the business of insurance. A few years later this association was absorbed by an insurance company organized for the purpose of insur- ing against this hazard. The business was not under- taken in the United States until about the close of the Civil War. FLY WHEEL INSURANCE.— This form bears a very strong resemblance to steam boiler insurance. The coverage given is substantially the same and the underwriting problems presented are of like character. The protection afforded is a combination of third party and direct property insurance. The insurer agrees to indemnify the insured against loss due to daniage to or destruction of his own property and against liability imposed upon the insured on account VARIOUS INSURANCE COVERAGES 27 of damage received by others in person or property occasioned by the bursting or disruption of a fly wheel while revolving. In practice this coverage is not con- fined solely to damage occasioned by the bursting of a fly wheel, but is extended to include the disruption of any wheel in a system of power transmission. As is the case with steam boiler, the primary function of fly wheel insurance is to prevent the happening of the contingency insured against by an efficient inspection system and hence the cost to the insurer of the main- tenance of such system is a large percentage of total premiums received and ordinarily exceeds claim dis- bursements. The development of fly wheel insurance affords only another illustration of the facility with which the business of insurance adapts itself to the demand for protection on the part of the public due to new hazards brought about by the progress of industry. The business is still in a formative state, the first policies having been issued in the United States about the beginning of the present century. CREDIT INSURANCE.— In many material re- spects credit insurance differs from those forms of insurance which are customarily referred to by the general term "casualty." The coverage afforded is, in some respects, quite similar to that given by the surety companies. It consists of a contract which is issued solely to manufacturers and jobbers under which the insurer guarantees to reimburse the insured for abnor- mal financial loss suffered by reason of the insolvency of individuals, firms and corporations to whom the 28 THIRD PARTY INSURANCE insured sells goods on credit. It is not designed to protect against all loss of this character. It is recog- nized that in conducting this kind of enterprise some loss due to bad debts will necessarily occur and the proprietors of a well managed business make allow- ance for this factor. However, there always exists the possibility of an abnormal loss sufficiently large to be termed a catastrophe and it is against the possibility of extraordinary loss that protection is necessary. The insured retains the normal loss known as the initial or own risk which consists of a certain specified per- centage of annual sales, the amount of which is deter- mined by a calculation which takes into consideration the experience of the insured in the past and the normal loss which is ordinarily sustained by others engaged in the same line of business. As to any indi- vidual debtor, the liability of the insurer is limited to a certain percentage of the debtor's worth as fixed by standard mercantile agency ratings subject further to a specific limit named in the policy. The total limit of the insurer's responsibility under the contract is also definitely fixed therein. An adjustment is made shortly after the expiration of the contract, the total final loss is determined and the insurer thereupon pays to the insured the amount of total loss over the in- sured's retention subject, of course, to the limits of the policy. Credit insurance has been written in the United States for only a brief period, the first policies having been issued at about the beginning of the pres- ent century. VARIOUS INSURANCE COVERAGES 29 TITLE INSURANCE.— Like credit insurance, title insurance is difficult to classify. It is a special insur- ance and is ordinarily carried on as an incident to the real estate abstract business. The contract is, in effect, an agreement on the part of the insurer to indemnify the insured against loss sustained, subject to certain limits, by reason of any defect in title of described real estate. Some companies go further than this and insure against loss or damage due to the unmarketability of the title. Prior to the development of title insurance the sale or mortgage of real estate necessitated the securing of an opinion from an attor- ney relative to the title. The attorney was obligated only to exercise reasonable professional skill and was not obligated as an insurer nor did he have any obli- gation as to any defect which was not shown by the abstract furnished to him for examination. This con- dition, from the standpoint of those dealing in real estate, was exceedingly unsatisfactory. One purchas- ing real estate or loaning money upon the security of a mortgage thereon had no positive guarantee against loss which might be occasioned by reason of the fact that the title was not in the vendor or mortgagor. METHOD OF CONDUCTING TITLE INSUR- ANCE BUSINESS. — In practical operation this busi- ness is carried on by abstract companies which have complete records pertaining to all real estate within the territory in which they issue title policies. The insurer does not contemplate that the loss insured against is likely to occur. In this respect the business is very different from that of life insurance, where the 30 THIRD PARTY INSURANCE loss is certain to occur, and from the other forms of insurance which have already been described where the loss is likely to occur. The title insurer, before issuing a policy, first satisfies itself through investiga- tion of its experts that the loss is not likely to occur. Where the business is properly conducted, the losses paid are almost negligible. The expense of the insurer consists almost entirely in maintaining the complicated organization which makes it possible to quickly and accurately procure the information necessary to satisfy itself as to the status of the title to any given piece of property in its territory. Title insurance originated in the United States about 1876 and has now grown to great proportions. The bulk of the business is of course done in the large cities. FIDELITY AND SURETY.— This term is used to designate a class of business which, in the general development of insurance, has come to be carried on by so-called casualty companies. It is, in many mate- rial respects, quite diflEerent from direct property and third party insurance and, in some measure, resembles credit and title insurance. It also was originated in England and was first attempted in 1840. It was not, however, until a few years later that the first company was organized in that country. The first legislative recognition of this insurance in the United States was in 1853, when the New York legislature enacted a law providing for the organization of fidelity and surety companies. The first company to do business in the United States was organized in 1876 under this law. The coverage given is against financial loss occa- VARIOUS INSURANCE COVERAGES 31 sioned by the dishonesty of a third party or principal or the failure of such third party to perform completely or properly, a given obligation. The principal branch of this business, surety, is not, strictly speaking, insurance at all, but only an enlargement of the banking business. The surety business begins where the banking business ends. The fidelity business, it is true, is essentially an insurance business. Premiums are arrived at by the application of the laws of average and the coverage is, briefly, an agreement on the part of the insurer, for a stated premium, to indemnify the assured against financial loss occasioned by the dis- honesty of another person. It may be aptly character- ized as "honesty insurance." The surety contract protects against loss resulting in the event that a third person shall fail to perform or to properly perform certain designated undertakings. FIDELITY AND SURETY BONDS CON- STRUED AS INSURANCE POLICIES.— Under the law of private suretyship certain very stringent obli- gations rest upon one who is the obligee under a surety bond to protect the surety in the way of giving notices, etc., and the bond is construed most strictly in favor of the surety. For a long time it was con- tended by the companies engaged in this class of business that they were entitled to the same protection as private sureties and that the law of private surety- ship applied in all respects to their undertakings. The legal proposition is, however, now definitely estab- lished that fidelity and surety bonds are, in the eyes of the law, insurance contracts, that they are to be 32 THIRD PARTY INSURANCE construed most strongly against the insurer, i. e., the surety, and that the only obligations which rest upon the insured are those which are clearly stated in the bond or policy. CHAPTER II CHARACTERISTICS COMMON TO ALL FORMS OF INSURANCE ALL FORMS OF INSURANCE HAVE SIMI- LAR CHARACTERISTICS.— All of the branches of the general insurance business which have been re- ferred to in Chapter I have certain common charac- teristics. In the orderly development of the subject matter of this work it seems advisable, before entering upon a detailed discussion of third party insurance, to briefly describe the different kinds of carriers which are engaged in the business of insurance and the various operations, which are common to all, by means of which such business is carried on. INSURANCE LAWS UNSATISFACTORY.— In the absence of statutory provisions to the contrary, the business of insurance may be conducted by an individual. In practice, with the qualified exception of the so-called Lloyds, it is not so conducted. In the United States insurance is carried on under meticulous statutory regulations. The statute books of the sev- eral states contain voluminous insurance codes which apply to the various phases of the business. Unfor- tunately these statutes are not uniform. Further than this, in most instances, no intelligent effort has been made to cover the subject matter thoroughly and scientifically by one piece of legislation. On the con- 33 34 THIRD PARTY INSURANCE trary, these statutes are largely patch work affairs, having been passed from time to time to meet the exigencies of special situations or to gratify the whims or prejudices of legislators. As a consequence, with very few exceptions, the legislation is incomplete, un- scientific and contradictory. NEED FOR UNIFORM LEGISLATION,— The companies are constantly impeded and harassed in their efforts to develop their coverages along scientific and logical lines by the arbitrary requirements and obstacles which must be met and overcome in order to comply with this multiplicity of divergent and ill- considered legislation. Incidentally this situation also involves a great deal of unnecessary expense and duplication. There is, therefore, a crying need for uniform and intelligent insurance legislation based upon careful study and guided by the advice of experts. The Supreme Court of the United States has long since declared that insurance is not commerce and is not subject to federal regulation under those provisions of the constitution pertairiing to interstate commerce. The problem will, therefore, have to be solved by the independent action of the states. INSURANCE CARRIERS.— Insurance is carried on in this country by stock companies, mutuals, mixed companies, reciprocal organizations or inter-insurers, Lloyds' associations and state funds. It is appropriate to here indicate in an elementary way the fundamental distinctions between these various insurers STOCK COMPANIES.-In so far as stock com- panies are concerned, little need be said since a corpo- COMMON CHARACTERISTICS 35 ration organized for the purpose of doing an insurance business is essentially no different from any other. At the present time corporations are not ordinarily cre- ated by individual legislative enactments. There exist in most states laws providing for the creation of var- ious corporations, including those formed to do the business of insurance. One of the notable character- istics of a stock insurance company is that it is organ- ized and operated for profit, which profit consists of the excess of earnings over and above disbursements and liabilities, such earnings being divided at the dis- cretion of and among the stockholders in the form of dividends. MUTUALS. — Mutual insurance companies differ from stock companies in many material respects. The idea of mutual insurance is of very ancient origin and has been carried into effect in various primitive ways from almost the beginning of history. Whenever two or more individuals who are exposed to a common hazard devise some scheme whereby in the event that one of them suffers loss the others contribute in some measure to make him whole, a mutual insurance is effected. The various trade guilds and friendly so- cieties which existed in Europe during the middle ages were nothing more nor less than mutual insurance associations, the purpose of which was to distribute the cost of individual misfortune among some num- ber of persons who were collectively exposed to the hazard thereof. The distinguishing features of pure mutual insurance are that it is not carried on for profit and that the members of the mu- 36 THIRD PARTY INSURANCE tual associations occupy the dual relationship of insured and insurer, the sole object being to provide a necessary protection at the lowest possible cost. Any sort of a mutual insurance undertaking designed to accompUsh this commendable object may be formed in the absence of statutory prohibition and the members thereof may enter into any arrangement relative to their mutual rights and responsibilities which may be satisfactory to them. The question involved is purely one of contract and it is axiomatic that individuals may contract between themselves as they please so long as they do not violate any law or rule of public policy. DIFFERENT KINDS OF MUTUALS.— There are in existence an almost infinite variety of schemes designed to carry the idea of mutual insurance into effect. For the most part in the United States mutual insurance is now regulated by statute. The associa- tions which provide this protection are known by various names as mutual benefit societies, fraternal insurance associations, co-operative assessment com- panies, etc., etc. If in a particular state there is any statute pertaining thereto, these organizations must comply therewith both as to their original creation and subsequent course of conduct. As a general rule the statutes applicable do not impose the same strict requirements as to capital and reserves which apply to stock companies. MIXED COMPANIES.— These insurers partake of the characteristics of both stock companies and mutuala. Under the statutes of many states mutuals COMMON CHARACTERISTICS 37 may be incorporated and frequently must be. They may also, in some cases, have a capital stock and pay dividends to persons other than policyholders. Wher- ever these or other variations from the principle of mutual insurance are adopted, the organization must be classified as a mixed one. If a corporation is formed and certificates of stock issued, it is ordinarily pro- vided that a certain portion of the profits are to be paid to stockholders and the remainder distributed among the insured. Under plans of this character, it may be provided that stock shall be issued only to policyholders or it may be permissible to sell stock to individuals who are not insured. Policyholders may be entitled to participate either in the general profits of the company or in those profits made in the class to which the particular policyholder belongs. Partici- pation in profits brings about a reduction in premium rates. RECIPROCAL ORGANIZATIONS OR INTER- INSURERS. — Such organizations constitute only one of the manifestations of the general principle of mutual insurance. Ordinarily, these associations are created not for the purpose of protecting individuals against calamities directly afifecting the person of the member, such as death, bodily injury or disease, which are the principal objects which have brought about the for- mation of the different mutual associations heretofore referred to. Usually reciprocal organizations are made up of individuals, firms or corporations desiring to enter into a mutual insurance protecting them against the hazards incident to the conduct of their business ; as, 38 THIRD PARTY INSURANCE for illustration, the hazard of property loss due to fire or the hazard of indirect loss occasioned by reason of the liability imposed by law on account of injuries to employes. Such inter-insurers customarily appoint an attorney in fact, skilled in the particular line of insurance which is to be carried on, who, for a certain designated percentage of premiums paid, agrees to undertake the management of the entire enterprise and to pay all expenses involved with the exception of claims and taxes. As is the case with other forms of mutual insurance, the rights and obligations of the members depend entirely upon the contract which is evidenced by the articles of association and contains many variations in detail which it is impossible to set forth in this brief summary. LLOYDS' ASSOCIATIONS.— These insurers are unincorporated voluntary associations made up of a number of individual underwriters who bind them- selves to assume certain designated portions of a given insurance liability. The origin and development of the English Lloyds, known the world over as Lloyds of London, constitute the most romantic and interest- ing episode in the history of insurance. The name "Lloyds" is derived from one Edward Lloyd, who, in the Seventeenth Century, was the proprietor of a small tavern in London. The traders who congregated there made a practice of underwriting — that is to say, of writing their names under certain undertakings of marine insurance. These contracts provided that the underwriters whose names were affixed thereto be- came responsible — each individually and not one for COMMON CHARACTERISTICS 39 the other — up to the amount set opposite their sig- natures. From this beginning the present London Lloyds grew. While their principal business is con- fined to maritime undertakings, the London Lloyds will, for a premium, cover against loss due to almost every sort of a contingency of which it is possible to conceive. Thus one desiring coverage against hazards which do not fall within the generally recognized limits of the different kinds of insurance, previously referred to, must ordinarily look to Lloyds for his coverage. OPERATIONS IN THE UNITED STATES.— Being, to a large extent, free from the regulation and supervision imposed upon incorporated companies, these individual Lloyds' underwriters have, for some years, done a considerable business in the United States. In many states there are no statutory pro- visions applicable to them and in some their opera- tions are conducted in violation of the technical requirements of law. It is said that Lloyds have never failed to pay a meritorious claim and, because of their reputation and the fact that they provide certain cov- erages which it is impossible to obtain elsewhere, their activities have been, to a great extent, tolerated even where the same are in technical violation of insurance codes. Provision has been made in some states for their lawful admission. Following in the steps of the English Lloyds, there have been organized what are known as American Lloyds, modeled, in a measure, after their famous British cousins. The basis of their organization is an agreement resembling that which is 40 THIRD PARTY INSURANCE entered into by the reciprocal organizations or inter- insurers above referred to. The individual under- writers usually contribute to a common guarantee fund and the business is carried on by an attorney in fact who is authorized to bind the individual members on any policy up to an amount which is agreed upon. STATE INSURANCE. — Certain states have re- cently gone into the insurance business and the organizations created by legislatures for the purpose of doing such business are commonly referred to as "state funds." For the most part these funds insure only against the liability of employers of the state, on account of occupational injuries to employes, imposed by the compensation acts. The legislatures in a few states, however, have passed laws authorizing the con- duct of other forms of insurance, such as fire and the coverage against loss due to damage to crops by the action of the elements. These manifestations of paternalistic and socialistic tendencies are naturally of grave concern to all thoughtful citizens irrespective of whether they be interested directly or remotely in the business of insurance. Ordinarily the statutes do not afford a monopoly and the funds compete with other carriers on a more or less equal basis. At the present time, however, there are seven states, namely, Nevada, North Dakota, Ohio, Oregon, Washington, West Vir- ginia, and Wyoming, where the state funds are given a practical monopoly of the compensation business. The methods by which the business of insurance is conducted by state funds are not materially different from those of other insurers. In monopolistic states COMMON CHARACTERISTICS 41 they, of course, do not require any agency force. In competitive states no special provision is made to cover the expense of solicitation, but a more or less active propaganda is carried on for the purpose of securing business. In all states the funds have an advantage over other carriers in that they rec'eive either direct subsidies from the state or, what amounts to the same thing, a considerable portion of the expense incident to their operation is borne by other state departments and paid out of general taxes. One of the distinguishing characteristics of the state fund is that the insurer ordinarily is vested with quasi judicial authority pertaining to the determination of the legal rights of those who make claims against it. It collects the premium, conducts an insurance business and then determines what amount, if any, shall be paid to those who are unfortunate enough to suffer loss by reason of the casualty against which the fund is supposed to protect. This presents a rather startling situation to say the least. The state fund also differs from stock companies at least, in that, as a general rule, it has no responsibility over and above the amount of premiums which may be in its hands at a given time and avail- able for the payment of losses. Also such funds are not subject to the same rigid requirements as to reserves and general financial condition which apply to private carriers. AGENCY DEPARTMENT.— The life blood of any insurance company comes primarily through its agency department. It is one of the characteristics of insurance that while it is, perhaps, the most beneficent 42 THIRD PARTY INSURANCE of all commercial institutions, the organizations which are engaged in this enterprise have found it necessary to obtain the great bulk of their business by an active personal solicitation carried on through agents. An anomalous situation is, therefore, presented requiring those engaged in providing a thing that is absolutely essential to seek out their patrons among the high- ways and byways. It is true that this necessity does not lie so heavily upon those carriers whose function it is to protect against property loss. Thus the condi- tion above referred to is not so acute as regards marine and fire insurance and some of the similar commercial coverages, the necessity for which has come to be gen- erally recognized, as it is with reference to life insur- ance and the casualty lines which are known as acci- dent and health. Nevertheless, to a surprising degree, the foregoing statement applies to all forms of insur- ance notwithstanding the fact that it would be natural to assume that the necessity for insurance is so appar- ent that the same would be purchased by those having need of it without solicitation. COMPETITION.— It must be conceded that this qualification is pertinent, namely, that the solicitation of some kinds of insurance, the need for which is now universally felt, is from the standpoint of the indi- vidual carrier made necessary, to a large extent, by competitive considerations. In other words, the prob- lem presented in such cases is, in a considerable measure, simply that of inducing the public to carry an insurance which would be considered necessary irrespective of solicitation, in a particular company. COMMON CHARACTERISTICS 43 Even in such cases, however, where there is no moral hazard present ; that is to say, where there is no dispo- sition on the part of the assured to defraud the insurer, there is observable a marked tendency to under-insure and one of the functions of the solicitor is to demon- strate to the prospective assured the necessity ot adequate insurance. WHY SOLICITATION NECESSARY.— If one were inclined to seek out the psychology of this situ- ation, it would, no doubt, be found to rest in a con- siderable measure upon the natural optimism of man. While everyone recognizes that the manifold casual- ties against which it is the province of insurance to protect are bound to occur, the average individual seems to have firmly implanted in his mind the con- viction that the hand of misfortune will touch him lightly, if at all, and that the other fellow is the one who will experience those vicissitudes which inevitably accompany all forms of human activity. THE PROPOSAL. — Having been successful in his solicitation, it becomes the function of an agent to sub- mit to his company the necessary data whereby the company may form an intelligent idea of the character of the risk submitted and determine whether or not it desires to issue the coverage applied for. This data in the first instance must be obtained from the applicant and all kinds of insurance companies place in the hands of their solicitors certain printed forms which are known by various names as applications, schedules of warranties, daily reports, proposals, etc. In refer- ring to this piece of paper, we shall hereafter use tke 44 THIRD PARTY INSURANCE word "proposal." The purpose of this proposal in all cases is to indicate to the agent the information which it is necessary for him to obtain from the applicant and to provide a method whereby such information may be transmitted to the company in the form of a written memorandum. In soUciting some forms of insurance it is customary, after this proposal is prop- erly made out, to require the applicant to sign it. Ordinarily, however, such requirement is not cus- tomary and the memorandum is filled out by the agent on the basis of information obtained by him from the applicant. In nearly all cases it is now the practice, and, in fact, the laws of many states so require, for the company to incorporate a copy of this proposal as a part of the policy. It is then provided that the policy is issued on the faith of the statements contained in the proposal and that the assured by the acceptance of the policy vouches for their truth and agrees to be bound thereby. WARRANTIES AND REPRESENTATIONS.— The procedure above outlined has given rise to a mass of litigation. The branch of insurance law here applic- able is referred to as the law of representations, war- ranties, estoppels and waivers. It is manifestly im- possible here to do more than to touch very lightly upon these complex subjects. The precise legal effect brought about in the event that it develops that any of the statements contained in the proposal are wholly or partially untrue depends upon many factors, most ifnportant of which are the wording of the contract and the law of the particular jurisdiction which is COMMON CHARACTERISTICS 45 applicable to the construction thereof. The peculiar character of the contract of insurance has given rise to the development of an entirely new branch of juris- prudence. The general principles of law applicable to the construction of contracts have, in so far as insur- ance contracts are concerned, been radically modified by the decisions of courts and the enactments of legis- latures. The impelling motive has been a recognition of the peculiar character of the insurance contract in that it is unilateral, that is to say, its form is in prac- tice determined solely by one of the parties — the in- surer — with the primary purpose of protecting its own interests. The whole trend in the development of insurance law has been to devise and apply to the con- struction of insurance contracts new principles cal- culated to place the insured on an equal footing with the insurer. Without entering into any of the refine- ments and subtle abstractions incident to this branch of the law, it is sufficient to say that as a general proposition under present day conditions the obliga- tion which rests upon the assured in connection with the information given to the company in the proposal is only to exercise good faith. UNDERWRITING DEPARTMENT.— Upon re- ceipt of the proposal it devolves upon the underwriting department to determine, first, whether the risk is insurable and, if so, the precise form of contract under which it should be covered and the premium which should be charged. In this connection various sorts of investigations calculated to bring to light facts other than those indicated in the proposal, or to confirm 46 THIRD PARTY INSURANCE statements therein contained, are conducted. These investigations are carried on in divers ways dependent upon the subject matter of the insurance and the par- ticular methods whereby the supplementary informa- tion is best obtainable. METHODS ADOPTED BY MARINE AND FIRE COMPANIES.— In conducting the business of marine and fire insurance, the companies, to a very considerable extent, make this investigation prior to the receipt of the proposal or, to put it another way, such companies have investigated and classified all prospective risks. Thus the marine companies have, in the development of their business, created an or- ganization whose function it is to survey and classify all vessels and, upon the receipt of a proposal, a marine company finds it necessary only to turn to the records which have been thus compiled to ascertain in detail practically all of the material facts pertaining to the particular risk for which coverage is desired. Likewise the fire companies, through a central organi- zation, acting in behalf of all, have prepared very elab- orate maps of all property which is likely to become the subject matter of their insurance and at tre- mendous expense and in various ways have so fortified themselves with detailed information as to such prop- erty that a well equipped ofiSce can, in an instant, in- form itself as to most of the physical characteristics of the proposed risk which it is necessary for the under- writing department to possess in order to cover same intelligently. CLEARING HOUSES MAINTAINED.— Actuated COMMON CHARACTERISTICS 47 by the same necessities, practically all other insurers have devised methods whereby information additional to that contained in the proposal, or calculated to con- firm or discredit same, may be quickly and conven- iently obtained. The comparative efficiency of these various methods depends, in a great measure, upon the length of time the particular class of insurance has been in existence. Generally speaking, the more recent its origin the more deficient is this check-up system, due to the fact that it takes a considerable period of time to compile the necessary data and to devise ways by which it may be rendered readily accessible. There are many different methods of ac- complishing this same general purpose. For the most part the desired result is effected by the establishment of an organization in the nature of a clearing house to which all companies report applicants who have been rejected, or insureds who have been found to be undesirable. It is the business of the clearing house to properly digest and in turn to pass along to the individual companies, usually by memorandum cards, the experience of all. Upon receipt of each proposal the card indexes thus obtained are examined and if there is in existence any record indicating the applicant to be undesirable the underwriting department is made cognizant of such record. The companies also frequently conduct individual investigations and examinations. Thus life companies require medical examinations and make inspections for the purpose of ascertaining the physical, moral, social and financial status of the applicant. In connec- 48 THIRD PARTY INSURANCE tion with the handHng of many of the miscellaneous casualty lines, particularly those covering hazards incident to various sorts of mechanical equipment, this investigation is carried on by what is known as an inspection department. METHODS OF DETERMINING PREMIUM.— Thus far in our consideration of the various branches of insurance we have purposely refrained from enter- ing upon any discussion of a very important and com- plex subject, namely, the methods which have been devised by the companies for fixing the premium which is to be charged for their policies. This subject is so intricate that it would be impossible in a work of this character to attempt to cover it in detail. For our present purposes it is sufficient to say that the inspection departments play an important part in the fixing of rates and it is their function to apply the rating systems applicable, in so far as they pertain to mechanical and physical hazards. Attention should also be called to the fact that in handling certain classes of insurance, notably steam boiler, fly wheel, elevator, sprinkler and other similar lines, the com- panies not only make a preliminary inspection for the purpose of classifying the risk and determining the rate, but thereafter, during the Hfe of the policy, make periodic inspections with the double object of pro- tecting the company against newly developed hazards and of affording service to the assured. PHYSICAL HAZARDS A FACTOR IN DE- TERMINING PREMIUM.— The estabHshment of what we have referred to as the inspection depart- COMMON CHARACTERISTICS 49 ments of insurance companies was, no doubt, pri- marily due to the natural motive of self protection, and, secondarily, to the development of scientific rating. The companies recognized at the very outset the necessity of decreasing their hazard by taking measures to prevent, in so far as might be possible, the happening of the casualty insured against. In the course of time experience enabled them to measure certain recognized hazards with approximate accuracy and to determine, on the basis of averages, the effect which the existence or non-existence of certain com- mon sources of danger has upon claim cost. In the evolution of various rating systems this effect was transposed into terms of premium and it became cus- tomary to fix certain basic rates reflecting the hazard of the average risk and to modify such rates in the event that the risk should be better or worse than the standard fixed upon as an average. This modification has been carried into effect by applying credits or debits to the basic rate. BENEFITS TO PUBLIC RESOLTING FROM WORK OF ACCIDENT PREVENTION.— Natur- ally the correction of preventable hazards directly affects third persons who are not parties to the insur- ance contract and whose interests, to be frank, were not originally taken into consideration at all. Irrespec- tive of the motives lying behind the great work which has been done by insurance companies along these lines, it is quite obvious that it has resulted in much benefit to the public in that it has materially reduced the number of preventable accidents and thereby 50 THIRD PARTY INSURANCE lightened the burden of human misery. The tremen- dous importance of this work, from the standpoint of social welfare, is only now coming to be recognized. The activity of the insurance companies has permeated into all commerce and industry and there can be no doubt but that it has resulted in almost incalculable benefit to mankind. In fairness to the insurance com- panies, it should also be said that in the development of the science of accident prevention the insurers be- came more and more impressed with its importance and with the service which they were thereby per- mitted to render and, actuated by the most commend- able motives, have gradually extended this service beyond their original conception of it and beyond the limits which would be fixed were they now actuated by entirely selfish motives. Indeed, the desire to couple up with their business activities schemes designed for the general benefit of society has been repeatedly indi- cated in recent years. POLICY FORMS.— Having gathered together, in the manifold ways above indicated, all of the essential facts pertaining to the risk which is the subject matter of the proposal, the underwriting departments of the companies are enabled to determine whether the risk is insurable, and, if so, to issue the policy in correct form and at adequate rates. While contracts of insur- ance, in the absence of statutory provisions to the contrary, may be made by parole, such procedure is rarely, if ever, followed in actual practice. In fact, at the present time, the statutes of many of the states not only require that the contract be in writing, or rather COMMON CHARACTERISTICS 51 printed, but prescribe the precise form of such con- tract. This is now generally true as regards fire and life insurance and also the casualty lines known as workmen's compensation, accident and health. As yet the states have, subject to some qualifications, refrained from passing similar laws pertaining to other insur- ance, but there is observable already a disposition to extend this legislation to include all forms of insurance. BINDERS. — Our statement to the effect that parole contracts are never made is subject to the qualification that in conducting some lines of insurance it is cus- tomary for an agent having policy-writing powers to bind a risk either by parole or by a brief written memorandum known as a binder, pending determina- tion by the company as to whether the risk will be accepted and, if so, on what basis. This procedure is confined, for the most part, to the large cities where competition is keen and where much of the business comes to the general agent through brokers. The practice of giving verbal binders is generally recog- nized to be an exceedingly bad one and is looked upon with disfavor by all of the companies. Agents are only permitted this latitude under exceptional circum- stances and the authority is also confined to those agents in whose conservatism and general knowledge of the business the companies have special confidence. Written binders are usually issued to cover for a period of ten days within which period, theoretically, the company is able to determine whether the risk should be accepted and, if so, on what basis. Also, theoret- ically, the company should receive premium for 52 THIRD PARTY INSURANCE the coverage thus given. In actual operation many- abuses of this practice have crept into existence. Fre- quently binders are renewed for successive periods and in those cases where the company finally determines that it will not accept the risk, it is often impossible, particularly where no claims have arisen, to collect premium for the temporary coverage which has been afforded. This means in the last analysis that the companies must charge a sufficient premium to other insured to make up the losses brought about in this manner. From time to time the companies have pro- mulgated rules calculated to eliminate the pernicious effect of such practice in so far as is possible under existing conditions. The problem presented, however, is yet far from a satisfactory solution and it is one of those which require constant attention. THE ACCOUNTING DEPARTMENT.— Having issued its policy the next problem presented to an insurance company is to collect premium and keep proper record thereof. This work comes within the province of what is known as the accounting depart- ment. The mere statement of the duties to be per- formed by that department would indicate that they are comparatively simple. When, however, one stops to consider the vast number of individual accounts which must be carried and the multitude of perplexi- ties which develop in actual practice in the collection of this money, the difficulties with which the account- ing department is confronted will be apparent. This statement may be emphasized by calling attention to the fact that premiums for the thousands of policies COMMON CHARACTERISTICS 53 which are in force upon the books of any one of the larger companies are not always paid annually but, on the contrary, are frequently paid in weekly, monthly, quarterly or semi-annual installments. These prob- lems are, of course, not essentially different from those presented to any large commercial institution which does business throughout a vast territory with a great number of people. Obviously the accounting depart- ment must be under intelligent management, a high degree of organization maintained and efficient sys- tems devised for the proper handling and recording of the manifold mathematical calculations which are involved. All of the states now require insurance companies to make annually to the state insurance departments a very elaborate report as to their opera- tions. These annual reports are ordinarily made up by the accounting department and the preparation thereof constitutes one of its important duties. STATISTICS. — The rates charged for insurance depend, in a large measure, upon the experience of the companies and in order to arrive at these rates intelli- gently they find it necessary to keep detailed experi- ence statistics to the end that rates may, from time to time, be revised and corrected. The compilation of these statistics and the mathematical calculations necessary to the application thereof in determining rates are matters which are ordinarily handled by the statistical department. The comparative importance of this department, of course, varies greatly with the different lines of business. In some instances the sta- tistical work is carried on as a part of the general 54 THIRD PARTY INSURANCE operations of the accounting- department. In other cases the statistical department is a distinct one. Be- cause of the general similarity of the work which is carried on by the accounting and statistical depart- ments the line of demarcation is sometimes quite hazy. The fundamental difference is that the work of the accounting department pertains to live issues whereas the statistical department is concerned with transac- tions which are completed and with the lessons which may be learned from the scrutiny and analysis of past experience. CLAIM DEPARTMENT.— Inasmuch as the justi- fication for the existence of any insurance company is the part that it plays as the medium for the equitable distribution of the cost incident to the misfortunes of its policyholders, it is apparent that the claim depart- ment is a very important one. The ideal of any claim department should be to pay to every claimant pre- cisely what he is entitled to under the terms of his contract — no more and no less. It should dispense even handed justice and be actuated by no consider- ation whatsoever except the fixed purpose to accom- plish the end just indicated. All insurance contracts contain provisions relative to the payment of claims which are broadly similar. They require that a notice be forwarded to the company as soon as possible after the happening of the casualty which has caused or may give rise to a covered loss. The receipt of this notice starts the machinery of the claim department in motion. Practically all policies also provide that be- fore indemnity is payable the claimant must forward COMMON CHARACTERISTICS 55 to the company some sort of a formal proof of loss. The forwarding- of the notice and the filing of proof are the principal burdens which rest upon the claimant under any insurance policy. It goes without saying that there also rests upon such claimant the obliga- tion to exercise good faith, to refrain from action cal- culated to prejudice the interests of the insurer and in case of damage to property to do what may be neces- sary to protect and preserve same. While it is the duty of the claim department to pay any amount to which the claimant may be entitled, it is also its duty to other policy-holders and to those who may have an owner- ship interest in the company to use such means as may be necessary to avoid the payment of non-meritorious claims or the over-payment of valid claims. METHODS ADOPTED TO AVOID OVER PAY- MENT. — The claim departments of the various com- panies have found it necessary to devise methods, suit- able to the exigencies of the particular case, calculated to eliminate the possibility of payments in excess of policy obligations. The first thing that a claim depart- ment must do upon the receipt of the preliminary notice is to check up the coverage; that is, to satisfy itself that the company had a policy in eflfect at the time of the alleged accident covering the particular casualty reported. This involves in the first instance an examination of the proposal. Having ascertained that the company covers a loss such as has been re- ported, the next step is to determine by appropriate methods that the loss reported has actually occurred. This verification is ordinarily accomplished through 56 THIRD PARTY INSURANCE personal investigation made by direct representatives of the claim department which accomplishes the double purpose of confirming the loss and ascertaining, where the question is an open one, the amount thereof. Thus the claim department, through its independent investi- gation, is assured that the final proof of loss as pre- sented is correct. In the event that this verification is made, it then becomes its duty to pay the amount shown to be due on the face of the proof and to take proper receipt as the evidence of such payment. ESTIMATED RESERVES.— Because of the in- vestigations which the claim departments of all com- panies find necessary, there ensues, subsequent to the receipt of the notice and prior to payment of loss, a period during which the company is aware of the fact that in all probability it must pay a claim. No accurate determination of the company's financial condition can be made without taking this pending liability into con- sideration. Also where claims are contested, there always exists the possibility of a final court decision unfavorable to the company and this contingent lia- bility must also be taken into consideration in determining the financial condition of a company at any given time. Further than this, under many poli- cies, benefits are payable in installments. The com- pany may have a fixed liability to pay a large amount in installments over a period of months or years. It is therefore necessary to set aside certain funds which are known as reserves to take care of contingent lia- bilities. The claim department must make an adequate estimate of reserves on individual cases, the aggregate COMMON CHARACTERISTICS 57 of which will indicate to the management of the com- pany with approximate accuracy what this liability is. Also the statutes of most of the states contain specific requirements as to the reserves which must be carried by insurance companies. CLAIMS INVOLVING PROPERTY LOSS.— In handling claims arising under marine and fire policies and under those casualty contracts which insure against direct loss of or damage to property, it is usually very easy to determine whether a loss has occurred. The greatest difficulty which is experienced in connection with the adjustment of these claims is to determine the amount of the loss. This work can only be efficiently done by experienced experts who have the ability not only to actually determine that amount but also are possessed of a sufficient degree of diplom- acy and tact to enable them to satisfy the assured of the correctness of their decision. CLAIMS UNDER LIFE, ACCIDENT AND HEALTH POLICIES.— No doubt the least difficult of all claims which are presented against insurance companies are those made under life policies. In such cases it is ordinarily a simple matter to confirm the happening of the casualty insured against, to-wit, death, and the amount is definitely fixed by the policy. Hence where premium has been paid and no fraud has entered into the procurement of the policy, contro- versies rarely arise and claims are paid on the basis of the final proof with very little supplementary investi- gation. Death claims under personal accident policies are of a quite similar character with the exception that 58 THIRD PARTY INSURANCE there frequently arises a question as to whether the death was in fact occasioned solely by reason of a bodily injury effected by accidental means. Differ- ences of opinion as to the cause of death in border line cases have given rise to a considerable amount of liti- gation under these policies. This is one of the evils incident to any form of limited coverage and empha- sizes the comments already made upon this limited life insurance. So also in handling claims arising under those policies which provide to pay indemnity for dis- ability occasioned by accident and sickness, it is often difficult to determine whether disability was in fact due to a bodily injury effected by accidental means or was occasioned by sickness. These claims also are similar to property claims in that the exact amount of loss suffered, i. e., the real duration of the disabiUty, is, in many cases, a matter concerning which the parties to the contract differ. THIRD PARTY CLAIMS. — Because of the peculiar character of third party coverage, the hand- ling of claims requires special consideration. While this subject will be taken up in detail subsequently, it would, perhaps, be advisable to here indicate briefly certain fundamental distinctions between claims aris- ing under policies giving direct coverage and those arising under third party policies. In the latter case the insurer deal's primarily with a third party who is not an assured and to whom the company has no direct obligation. Under such policies the carrier is only obligated in the event that it develops that such third party has an enforceable claim at law against COMMON CHARACTERISTICS 59 the assured by reason of the happening of a con- tingency such as is specified ir. the policy. Primarily the only duty of the insurer is to protect the insured. As is the case with policies giving direct insurance, the third party policies require the assured to imme- diately give to the company a written notice of the happening of an accident which may involve a legal liability of the insured to a third party who has been injured in person or property. Upon the receipt of such notice the insurer in effect steps into the shoes of the insured and thereafter does what may be neces- sary, in the way of investigation, settlement, or de- fense of suits, to properly protect the rights of the insured. The policy stipulates that the insured must co-operate with the insurer as may be requested by it and refrain from taking any action calculated to impair any rights which the insurer may have in the premises. In such cases no proof of loss is required of the in- sured for the obvious reason that the matter is solely in the hands of the insurer and it is up to it to deal with the claimant in the name of the insured and dis- pose of the claim on such basis as it may see fit. SUBROGATION CLAUSE.— Our general outline of the duties of the claim departments of the several companies would not be complete without a brief ref- erence to a clause which is contained in practically all policies with the exception of life, accident and health, to the effect that the company is to be subrogated to the extent of its liability to the rights of the insured against any other person, firm or corporation grovfing out of the accident causing the loss. This clause 'so 60 THIRD PARTY INSURANCE provides that the insured, at the request of the company, will formally assign such rights to it and will do everything else that may be necessary to enable the company to avail itself of the benefits inuring to it thereunder. It is the duty of the claim department to avail itself of the rights which the company has under the subrogation clause and thereby, to the extent of recoveries obtained, reduce the aggregate claim expense. It is only fair that the insurer, to the extent of its payment, should be subrogated to the rights of the insured. It would be manifestly unjust to allow the insured reimbursement under the policy and a further reimbursement by means of an action against the third party. For these reasons substantially similar clauses are contained in marine, fire, plate glass, burglary, automobile collision, live stock, sprinkler, steam boiler, fly wheel, credit, title, surety and third party policies. The peculiar character of the surety business has brought about a slight variation of the principle here applicable. Thus as a preliminary to the issuance of some bonds, fidelity and surety companies require the person whose honesty is insured, or the person who is to perform a given undertaking which is the subject matter of the insurance, to enter into a written agree- ment to reimburse the insurer for loss suffered by it on account of his dishonesty, misfeasance or nonfeasance. There is no logical reason why the subrogation clause should not be inserted in policies of life, accident and health insurance, but, for some unexplainable reason, it is not customary to do so. THE LAW DEPARTMENT.— Like all other cor- COMMON CHARACTERISTICS 61 porations which carry on an extensive business, insur- ance companies find it necessary to maintain law- departments. They must often defend themselves against suits brought upon non-meritorious claims or instituted by persons who believe that they are entitled to more indemnity than that for which the company considers itself liable. All third party claims are embryonic law suits and the law department plays a particularly important part in the conduct of this busi- ness. We have previously pointed out that the unusual nature of the insurance contract has given rise to the development of a distinct jurisprudence, ordinarily referred to as insurance law. Naturally insurance com- panies must employ attorneys who are specially skilled in this branch of the law. The manifold contingencies against which insurance protects make it necessary for the companies to use a great variety of policy forms. As the business is going through a radical process of evolution, these forms are constantly changing. Also active competition has brought about an effort on the part of the companies to assist their agency organiza- tions in the solicitation of business by furnishing them with policy forms containing novel and attractive features. Hence one of the important duties of the law department is to prepare these forms. The quasi public character of the insurance business has led the various states to undertake a very thorough regulation of the business. Thus the statutes of most of the states set forth with particularity just how companies may be organized, what classes of business may be conducted by them and the manner in which such business must 62 THIRD PARTY INSURANCE be carried on. The great amount of detail work inci- dent to a proper supervision of a business which, in its various ramifications, is so complex, has made it neces- sary for the legislatures of the various states to pro- vide for the establishment of insurance departments which perform the manifold duties incident to the supervision of the companies operating in the particu- lar state. Under such circumstances there arise daily various issues, largely of a technical or legal nature, which must be taken up with the insurance depart- ments and this important work is of such character that it naturally falls, in a great measure, upon the legal department. CHAPTER III THE VARIOUS THIRD PARTY COVERAGES SPECIAL NEEDS HAVE BEEN PROVIDED FOR. — In the development of third party insurance the insurers, Hke those engaged in other branches of the business, have found it necessary to meet special needs by special contracts designed to provide the insured with the particular coverage which the peculiar nature of his undertaking requires. These different forms have, by usage, come to be known by names which indicate to one familiar with the business the extent of and exceptions to the coverage afforded. These several coverages, having been created to meet the exigencies of particular situations, differ from one another, not only in the insuring clause which defines the responsibility assumed by the insurer, but also in the method provided for the determination of premium, the exceptions to coverage which are appropriate to each and in a few other less important particulars. On the other hand, the different policies contain cer- tain standard clauses, the necessity for which has been demonstrated by experience, which are common to all. In so far as these standard clauses are concerned, it is unnecessary to discuss them in connection with each form of coverage and we shall, therefore, defer such discussion. DIVISIONS OF THIRD PARTY INSURANCE. — As a preliminary to a somewhat exhaustive consider- 63 64 THIRD PARTY INSURANCE ation of the various third party lines, we have devoted this chapter to a brief statement as to the nature of each coverage and the method by which premium is determined. We shall not here attempt to cover in detail all of the special exceptions to the general obli- gations assumed by the insurers, nor, in outlining the several methods by which the premium is determined, shall we do more than to describe those rating sys- tems which are applicable to the average risk. All special deviations which have been devised to meet unique or unusual situations will be ignored. Such procedure is desirable because the reader will be able to more readily understand the different coverages through the immediate presentation of the basic prin- ciples of each accompanied by a short analysis indi- cating, in a fundamental way, the respects in which each differs from and resembles the other. It should further be stated that in describing the methods of determining premium, we have confined ourselves to those used by members of what is known as the National Workmen's Compensation Service Bureau of New York City, of which Bureau more will be said later. We feel that there can be no serious question but that the rating methods adopted by members of this Bureau, while still far from perfect, are, on the whole, the best and most scientific which third party insurers have yet been able to devise. The several recognized third party forms now in general use are: Manufacturers' Employers' Vessel Employers' Liability Liability Workmen's Compensation Contractors' Employers' Manufacturers' Pu'blic Liability Liability THIRD PARTY COVERAGES 65 Contractors' Public Liability Automobile Collision Vessel Public Liability Teams' Public Liability General Liability (otherwise Teams' Property Damage known as Owners' Land- Owners' Contingent (or Pro- lords' and Tenants' Public » 4.- ^ n ..i- t • l-,- Liability) *"*'^^) P"bl"= L,ab.hty Elevator Public Liability Contractors' Contingent (or Elevator Property Damage Protective) Public Theatre Public Liability Liability Automobile Public Liability Physicians' and Surgeons' Automobile Property Public Liability Damage Druggists' Public Liability STEAM BOILER AND FLY WHEEL.— To the foregoing there should, perhaps, be added steam boiler and fly wheel. This because such policies frequently are extended to include the liability of the assured on account of damage to the person or property of others occasioned by the bursting of steam boilers or fly wheels. However, liability on account of personal injuries to employes is covered by employers' liability and compensation policies and that growing out of personal injuries sustained by persons other than employes is covered by the public forms above listed. EMPLOYERS' LIABILITY.— In the foregoing list of third party coverages we have placed employers' liability before workmen's compensation because the latter is the outgrowth of the former. The develop- ment of workmen's compensation business in the United States to its present immense proportions has taken place entirely within the last ten years for the very simple reason that the first compensation act which stood the test of constitutionality was passed in 66 THIRD PARTY INSURANCE the United States in 1911. Employers' liability busi- ness, on the contrary, has been written in the United States since 1886. As will subsequently appear, the workmen's compensation laws provide a substitute for the rules fixing the liability of a master to his servant which were in existence prior to their passage. The liabiUty imposed by workmen's compensation laws is merely a new form of employers' liability. Hence the companies which were engaged in that business pre- vious to the compensation innovation have continued to write the new form of employers' liability which is commonly referred to as workmen's compensation insurance. INSURING CLAUSE OF MANUFACTURERS* EMPLOYERS' LIABILITY POLICY.— Under the insuring clause of this policy the insurer agrees to indemnify the assured against loss from the liability imposed by law upon the assured for damages on account of bodily injuries, including death resulting therefrom, accidentally suffered, or alleged to have been suffered, within the policy period, by any em- ploye of the assured while within or upon the premises described in the policy or the ways immediately adja- cent thereto by reason of the operation of the trade or business specified in the contract. It is further pro- vided that such injuries so sustained elsewhere shall also be covered if suffered by an employe of the assured while actually engaged in the described business. METHOD OF DETERMINING PREMIUM.— The premium which the employer pays for the protec- tion given by an employers' liability or workmen's com- THIRD PARTY COVERAGES 67 pensation policy is determined in this manner. Prac- tically all of the various industrial enterprises which are conducted throughout the United States have been classified by the companies and what are known as classification manuals have been prepared setting forth such occupational classifications and indicating the rate which is to be charged for each. This rate is ap- plicable to each unit of $100.00 of pay roll earned dur- ing the policy period by employes engaged in covered operations. The premium therefor is arrived at by mul- tiplying the number of units earned in each classifica- tion by the rate applicable to such classification. Total premium is, of course, determined by adding the pre- miums applicable to the several classifications. ESTIMATED PAYROLLS AND AUDITS.— Of course, an employer who takes out his policy today does not know just what his payroll for the ensuing policy term will be. The following plan has been devised to meet this situation. The insured estimates to the company the amount of payroll which he be- lieves, on the basis of past experience or present expectations, will be earned in the several classifica- tions and pays to the company an advance or deposit premium based on such estimate. The policy provides that the company may, at the expiration of the policy term, or at stated periods within that term, if premium is paid on a monthly, quarterly or semi-annual basis, audit the books of the insured for the purpose of deter- mining the payroll earned in the classifications covered by the policy. It is further stipulated that in the event that such audit develops a payroll in excess of the 68 THIRD PARTY INSURANCE estimate the insured shall immediately pay to the com- pany the proper additional premium, or, in the alter- native, the company shall return the excess. CONTRACTORS' EMPLOYERS' LIABILITY. — This form is almost identical with the manufac- turers' employers' liability policy above described. The manufacturers' form is issued to concerns engaged in manufacturing or other similar operatioris at a fixed place. The contractors' form is issued to contractors and other employers who conduct their operations at various places within the general territory designated in the policy. Certain technical underwriting consid- erations make it advisable to use the two forms. The dififerences between the two are, to a considerable extent, the same as those which exist between the manufacturers' public and contractors' public forms. Such distinctions will be pointed out in our discussion of the public forms. VESSEL EMPLOYERS' LIABILITY POLICY. — This form is another variation of employers' liability coverage which has been prepared by some of the companies to be issued to assured who are engaged in the business of operating various sorts of vessels. No underwriting or other consideration makes it nec- essary to use this special form and it differs in no material respect from the other employers' liability forms already referred to. Most of the companies consider it unnecessary to add to their multiplicity of forms by the use of this one. WORKMEN'S COMPENSATION.— The contract under which the form of employers' liability known as THIRD PARTY COVERAGES 69 workmen's compensation is written, is basically the same as the employers' liability policy above described. The essence of it is that the company agrees to assume the liability imposed upon the insured employer by a particular compensation act on account of occupational injuries suffered by employes while engaged in the operations which are described in the policy. In addi- tion to this obligation, compensation policies ordinarily contain a second insuring clause of the same character as the insuring clause contained in the employers' Ha- bility policy. The reason for the insertion of this secondary insuring clause is this. In many of the states the compensation acts apply only to certain hazardous employments. Frequently it is difficult to determine whether a particular employment is within the terms of the act. Also, under certain circumstances in some states, an employe is not restricted, in the event of occupational injury, to the rights given to him by the compensation act, but may bring suit to collect damages to which he is, or claims to be, entitled under other laws. In order to give complete coverage and to meet all eventualities of this character the supple- mentary employers' liability insuring clause is inserted in a policy of compensation insurance. COMPENSATION INSURING CLAUSE.— By the principal insuring clause the company assumes all liability imposed upon the employer by the compen- sation act, which includes not only the liability to pay indemnities, but the obligation for medical, surgical, nurse or hospital services, medical or surgical appa- ratus or appliances and medicines for which the em- 70 THIRD PARTY INSURANCE ployer is made responsible by the compensation act. In other words, the company steps into the shoes of the insured employer and relieves him of liability which may be imposed by the act. While all other third party contracts designate a specific limit of lia- bility, it is now customary to cover workmen's com- pensation liability without any limit whatsoever. This practice is due to the fact that in most states the compensation acts themselves provide that there must be no limitation upon the obligation of an insurer. The companies protect themselves against catastrophe loss by making reinsurance arrangements. PROVISIONS PECULIAR TO COMPENSA- TION POLICIES.— The compensation policy differs from other third party contracts for the reason that most compensation laws require certain special pro- visions to be inserted in policies covering the liability which they impose. These requirements vary, but their uniform purpose is to protect the injured work- man. The following will be sufficiently illustrative to indicate the general scope of these special provisions. Insurers are required to stipulate in their policies that the obligation assumed thereby shall be considered as a direct obligation to the injured employe or his dependents and that the insurer is to be primarily liable to them. It is also provided that the insurer may be made a joint party defendant in proceedings under the act, that the jurisdiction of the insured shall be the jurisdiction of the insurer, that it shall be bound by and subject to all judgments rendered against the insured and that the rights of the injured employe or THIRD PARTY COVERAGES 71 his dependents shall not be affected by the insolvency of the assured or his failure to comply with the terms of his policy. MANUFACTURERS' PUBLIC LIABILITY POLICY. — By this policy the insurer agrees to indem- nify the assured against loss from the liability imposed by law for damages on account of bodily injuries, including death resulting therefrom, accidentally suf- fered, or alleged to have been suffered, within the policy period by any person or persons not employed by the assured while within or upon the premises described in the policy or the ways immediately adja- cent thereto by reason of the operation of the trade or business described in the policy. Such injuries so sustained elsewhere are also covered if caused by an employe of the assured while actually engaged in the described business. This policy, with the exception of the insuring clause, is not essentially different from the manufacturers' employers' liability form which we have already described. The fundamental difference between the two contracts is that the one covers only the liability imposed upon the insured employer on account of injuries to his employes while, in the other, the obligation of the company is confined solely to liability imposed on account of injuries to persons who are not employes. PREMIUM FOR MANUFACTURERS' PUBLIC POLICY. — The method of determining premium for this form is that which we have already indicated is used in fixing the premium for the employers' liability policies. 72 THIRD PARTY INSURANCE DISTINCTION BETWEEN MANUFAC- TURERS' AND CONTRACTORS' PUBLIC LIA- BILITY. — We have already pointed out that a dis- tinction is made between manufacturers' employers' liability and contractors' employers' liability. The same reasons which brought about the creation of these two forms have given rise to the distinction which exists between manufacturers' pubHc liability and contractors' public liabiUty policies. The manu- facturers' public form is issued to all sorts of manufac- turers, factory owners, those engaged in the operation of ware houses and other similar operations which are, for the most part, carried on at one place. On the other hand, the contractors' form is issued to con- tractors, electric light, power, telegraph and telephone companies and other employers who conduct their operations at various places. The insuring clause of the manufacturers' policy covers liability on account of bodily injuries suffered by persons not employed by the assured while upon the premises described in the policy or the ways immediately adjacent thereto by reason of the operation of the described business. Such injuries so sustained elsewhere are also covered if caused by an employe of the assured while actually engaged in such business. The insuring clause of the contractors' form covers such injuries suffered by such persons by reason of the work described in the schedule while at the places designated in the schedule during the progress of the work. In writing the con- tractors' form it is not customary to indicate in the schedule any special place where the work is carried THIRD PARTY COVERAGES 73 on, but, on the contrary, such territory is usually only restricted to a particular city, county or state. Hence the contractor is at liberty to carry on operations at any place within the described territory. INJURIES OCCURRING DURING PROGRESS OF WORK COVERED.— It will be noted that under the contractors' form liability is restricted to injuries occurring during the progress of the work while no such restriction is contained in the manufacturers' policy. This difference in coverage is occasioned by the peculiar character of a contractor's operations. A manufacturer carries on his operations continuously at one place. On the other hand, a contractor may be occupied for a portion of the policy term in erecting a building at one place and after the completion of his job move on to another location within the territory described in his policy and erect another building or the contractor's operations may be, and frequently are, restricted to a particular trade. Thus a plumber may work at a dozen dififerent locations in a week. Fre- quently after the contractor has finished his work and gone elsewhere some defect in the structure or a portion of the structure which has been built or in- stalled by the contractor may develop causing injuries to members of the public. The accident may happen immediately after the termination of the work or a long time thereafter. For this reason claim may be made against a contractor today alleging injury due to negligent work performed a year ago. Manifestly it is necessary for an insurer issuing this kind of cover- age to put some definite time limit upon its responsi- 74 THIRD PARTY INSURANCE bility. Hence the coverage of the contractor's policy is limited by the insuring clause to injuries occurring during the progress of the work. ELEVATORS AND OTHER HOISTING DE- VICES. — The manufacturers' pubHc policy provides that the company is to have no liability on account of injuries or death suffered by any person while in or upon any elevator or other hoisting device or entering upon or alighting therefrom or being in or about any elevator well, shaft, hoistway or equipment thereof. This exclusion is made because the premium charged for the manufacturers' public policy is not sufificient to cover the hazard of elevator accidents. This cov- erage is given under a separate elevator policy which will be discussed later. A contractor, however, cus- tomarily uses various hoisting devices of a temporary character in connection with his building operations and hence it would not be fair to insert this exclusion in a contractor's public policy. In fixing the premium for this insurance, hazards of this character are taken into consideration. It is not possible to follow the plan adopted in the manufacturer's case of issuing a sep- arate elevator policy because the hoisting devices used by the contractor are not permanent nor are they of such character that they can be accurately described and identified. CONSTRUCTION, DEMOLITION, REPAIRS AND EXPLOSIVES.— The manufacturers' form also excludes liability on account of injuries suffered by any person caused by any construction or demolition or the making of additions or alterations or extra- THIRD PARTY COVERAGES 75 ordinary repairs or mechanical demonstrations or the installation of any mechanical equipment, unless a written permit is granted by the company specifically describing the work. The very nature of the con- tractor's operations makes it impossible to insert this exception in the contractors' policy. It is a proper exception to the coverage of the manufacturers' form for the reason that in fixing the premium for such form the companies naturally do not take into consideration those unusual hazards which are not incident to the general business in which the insured is engaged. It is, therefore, necessary to eliminate such liability unless special permission is secured from the company in which event a proper additional premium is charged if the work is sufficiently extensive to warrant. In the case of a contractor these hazardous occupations are a part of his regular work and the premium is, there- fore, made adequate to cover same. For the same reasons the manufacturers' policy ordinarily excepts liability for injuries caused by the manufacture or presence within the premises of any material intended for use as an explosive. Contractors frequently use various sorts of explosives in connection with their regular operations and this exception, therefore, does not appear in the contractors' form. VESSEL PUBLIC LIABILITY.— The remarks which we have already made pertaining to vessel employers' liability are pertinent here. The vessel public liability policy is simply a variation of the manu- facturers' public liability form. A few companies which write a considerable number of vessel risks use 76 THIRD PARTY INSURANCE a special vessel form which varies in minor details from the regular manufacturers' public liabiHty form. In practice most of the companies use the manu- facturers' public form to cover risks of this character. GENERAL LIABILITY, OTHERWISE KNOWN AS OWNERS', LANDLORDS', AND TENANTS' PUBLIC LIABILITY.— The owners and tenants of buildings not used for manufacturing purposes or as factories, warehouses, etc., are not exposed to precisely the same sort of public hazard as are manufacturers. Even where business enterprises are conducted in such buildings, the situation is so different that it has not been found practicable to fix premium on a payroll basis. This condition is primarily due to the fact that injuries to members of the public for which the owner or tenant of such a building may become responsible under the law are not ordinarily due to the operation of machinery or the direct negligence of employes but rather to the physical condition of the premises. The general liability form is, therefore, used to cover pri- vate dwellings, apartment houses, ofifice buildings, churches, clubs and hotels, public libraries, museums and picture galleries, retail and wholesale stores of all kinds, restaurants, vacant land, wharf and water-front property, etc. PREMIUM FOR GENERAL LIABILITY POL- ICY. — The premium is not determined on the basis of payroll, but is arrived at by charging a certain rate for each foot of frontage on a street or other passage- way, which is used by the public, plus a certain addi- tional rate for each one hundred square feet of floor THIRD PARTY COVERAGES 11 space or area. Of course, the liability of owners and tenants on account of accidents occurring on or about their premises varies greatly dependent upon the pur- pose for which the building is used. Thus the liability hazard of the owner or tenant of an apartment build- ing is much less than that of the owner or tenant of a department store, a barber shop or a meat market for the reason that the number of persons likely to be in or about an apartment building is relatively small and the physical hazards are also of a much more limited character. The difference in hazard is reflected in the rates. INSURING CLAUSE GENERAL LIABILITY POLICY. — The company agrees to indemnify the assured against loss from the liability imposed by law upon the assured for damages on account of bodily injuries, including death resulting therefrom, acci- dentally suffered, or alleged to have been suffered, within the policy period by any person or persons not employed by the assured while within or upon the premises described in the schedule or upon the side- walk or other ways immediately adjacent thereto. It will be observed that the principal distinction between the obligation thus assumed and that assumed under the public liability policies already referred to, is that the general liability policy covers broadly against in- juries sustained by members of the public while within or upon the premises described in the policy or the sidewalk or other ways immediately adjacent whereas the other forms define the liability assumed as that imposed upon the assured on account of injuries sus- 78 THIRD PARTY INSURANCE tained by reason of the operation of the trade or busi- ness described in the policy. On the other hand, the coverage of a general liability policy is restricted definitely to injuries occurring on the premises or the ways immediately adjacent thereto, whereas the other forms cover not only injuries received at the place described in the policy but elsewhere if occasioned by the conduct of the operations described in the policy. With the exception of this distinction in the insuring clause and the difference in method of determining premium, there is no substantial difference between the general liability form and those we have already discussed. ELEVATOR PUBLIC LIABILITY.— This policy is designed to protect the assured against the liability imposed by law upon him on account of injuries occa- sioned to members of the public by reason of the main- tenance or operation of elevators. As we have already seen, the manufacturers' public policy eliminates all responsibility on the part of the company for elevator accidents. So, also, the exclusion clause of a general liability policy contains a provision relieving the com- pany from liability unless the elevator is specifically described in the policy and a premium paid therefor. In both instances this practice is followed because the rates are not adequate to cover this hazard. In prac- tice it has been found better not to increase such rates to the end that the policies just mentioned may cover elevator accidents but rather to consider the elevator hazard as a separate one to be taken care of by the payment of distinct additional premium. Therefore, if THIRD PARTY COVERAGES 79 the risk is one to which it is customary to issue a gen- eral liability policy, the elevator coverage may be in- cluded, in which event a separate premium is charged and the elevator covered is described therein. Even where a general liability policy is issued a separate elevator policy may be issued and in other cases ele- vator coverage must be given by an elevator public policy. INSURING CLAUSE OF ELEVATOR POLICY. — Under the insuring clause of this policy, the com- pany agrees to indemnify the assured against loss from the liability imposed by law for damages on account of bodily injuries, including death resulting therefrom, accidentally suffered, or alleged to have been suffered, within the policy period by any person or persons not employed by the assured while within any of the elevators or other hoisting devices described in the policy or the wells, shafts, or hoistways thereof, or while entering upon or alighting from such elevators or hoisting devices. PREMIUM FOR ELEVATOR POLICY.— The premium charged is a fixed amount per elevator de- pending upon the type of elevator, the place where it is situated and the purpose for which it is used. In other respects the elevator public policy does not differ materially from the other third party contracts already described. ELEVATOR PROPERTY DAMAGE.— While, as will appear from a reading of the insuring clause of the elevator public policy, the company assumes no responsibility on account of damage to the property 80 THIRD PARTY INSURANCE of third persons, occasioned by the maintenance or operation of the insured elevator, the companies some- times attach a rider to the elevator policy extending the coverage to include such liability. The demand for this protection comes largely from those engaged in the automobile garage business who have an eleva- tor on their premises used for the purpose of raising and lowering automobiles belonging to their patrons. An additional premium for each elevator insured is charged if the poHcy is so extended to cover property damage. THEATRE PUBLIC LIABILITY.— This policy is, in reality, simply a general liability policy, the cover- age given being precisely the same. The only distinc- tion between the two forms is that the peculiar character of the coverage makes it necessary to adopt a special method of determining premium. The hazard involved in connection with theatre risks cannot properly be reflected by a premium based upon area and frontage and hence the companies charge a certain amount per seat. This means that the premium depends upon the seating capacity of the theatre. The coverage may, therefore, be given by a general liability policy with a rider attached substituting the method of premium determination just indicated for that set forth in the policy or a special theatre policy may be used wherein the rating system applicable is provided for and the provisions relative to area and frontage eliminated. Elevator public liability may be given as a part of the theatre policy in the same manner as it is given as a THIRD PARTY COVERAGES 81 part of a general liability policy or a separate elevator policy may be issued. AUTOMOBILE PUBLIC LIABILITY.— The de- velopment of automobile public insurance affords a graphic illustration of the facility and rapidity with which insurers meet new needs created by new inven- tions. The growth of the automobile industry is one of the industrial marvels of the age. The business of insuring against the hazard created by the operation of motor vehicles has kept pace with the growth of the industry and while practically its entire development has taken place within the past fifteen years, it is now, next to workmen's compensation, the most important third party line. Notwithstanding its present immense proportions the business is only in its infancy and it is safe to predict that its mushroom-like growth will continue for a considerable period in the future. INSURING CLAUSE OF AUTOMOBILE PUB- LIC POLICY. — Under this policy the insurer agrees to indemnify the assured against loss from the liability imposed by law upon the assured for damages on account of bodily injuries, including death resulting therefrom, accidentally suffered, or alleged to have been suffered, within the policy period by any person or persons not employed by the assured by reason of the ownership, maintenance or use of the automobiles described in the policy. METHODS OF DETERMINING PREMIUM FOR AUTOMOBILE PUBLIC POLICIES.— By reason of the rapid development of this business the problems in- cident to a scientific determination of rates are still far 82 THIRD PARTY INSURANCE from solution. The difficulties encountered in this con- nection are increased by the manifold complications occasioned by reason of the variation in hazard as be- tween different types of motor vehicles and the great number of uses to which they are now put. Our pres- ent purpose will be accomplished by a brief and gen- eral statement as to the principal rating methods commonly used at this time. We shall not attempt to touch upon the many special rating rules applicable to more or less unique and extraordinary situations, but will content ourselves with a general statement of basic methods. Motor vehicles, from the standpoint of the insurer, are roughly divided into four classes — Private Passenger Public Commercial Manufacturers and Dealers PUBLIC LIABILITY PREMIUM FOR PRI- VATE PASSENGER CARS.— The method of de- termining premium for cars of this character now used by most of the standard companies is as follows : All cars are listed alphabetically in the rate manual and opposite each car as therein listed appears a symbol. These symbols are determined by the rate makers and, in a general way, depend upon the list price of the car, the theory being that the list price indicates the rela- tive hazard of different cars which is, of course, largely dependent upon weight, size and speed. There are four of these symbols. For rating purposes the United States is divided into eight territorial schedules. The particular schedule applicable depends upon where the car is principally maintained and operated. The sym- bol having been determined it is only necessary to turn THIRD PARTY COVERAGES 83 lo the rate schedule and ascertain the rate applicable to that symbol in' the territory where the car is prin- cipally used. Certain discounts from the rate thus de- termined are allowed depending upon the precise pur- poses for which the car is used and the persons by whom it is driven. It should be here noted that the division of cars on the basis of symbols is not ap- plicable to electric vehicles or to the two-wheeled ve- hicles which are known as motorcycles. All electric vehicles are placed in the same category and the prem- ium for all such vehicles is the same, varying only with the territorial schedule. The same rating method is pursued with reference to motorcycles. PUBLIC LIABILITY PREMIUM FOR COM- MERCIAL CARS.— The term "Commercial" is used to designate those automobiles which are used for various sorts of commercial delivery. The premium for such cars is not determined in the manner de- scribed in the preceding paragraph, but depends, in the first instance, upon the business in connection with which they are used. These various businesses have been divided into four classes. The premium for any- one depends primarily upon the territory in which the car is principally maintained and operated and the same territorial schedules which apply to private pas- senger cars are applicable. A further sub-division is made depending upon load capacity and three load- capacity classifications have been established. Thus the rate is determined by first ascertaining the occupa- tional classification. Next must be ascertained the load capacity classification and then reference made to 84 THIRD PARTY INSURANCE the territorial schedules which show rates for each classification in each territory. PUBLIC LIABILITY PREMIUM FOR PUBLIC AUTOMOBILES. — Speaking generally, public auto- mobiles are those used for the purpose of transporting passengers for hire. The premium for motor vehicles used for such purpose, is determined in the following manner: All livery automobiles are classed together and premium paid at a fixed rate per car which varies with the territorial classification. Hotel omnibuses and taxicabs are handled in the same manner. The prem- ium for all other public automobiles is based primarily upon the passenger-carrying capacity and varies with the territorial schedule. Manifestly the public hazard incident to the operation of passenger-carrying vehicles is much greater than that involved in connection with the operation of any other cars. Public vehicles are ordinarily in use all the time and at places where there is likely to be a congestion of pedestrians and vehicles. These vehicles carry passengers and, in many in- stances, the owner is a common carrier and obli- gated to use that high degree of care which the law imposes upon common carriers. Therefore, the rates for all sorts of public motor vehicles are relatively higher than the rates charged for other automobiles. Naturally the coverage given includes the so-called passenger hazard. That hazard may, however, be eliminated by endorsement, and, in such case, a mate- rial reduction in public rates is allowed. PUBLIC LIABILITY PREMIUM FOR MANU- FACTURERS' AND DEALERS' AUTOMOBILES. THIRD PARTY COVERAGES 85 — This premium is determined either on a named chauf- feur, a specified car or a payroll basis. Under the first method the cars covered are not specifically described in the policy. It is provided that all cars which the as- sured uses for the purpose indicated in the policy shall be covered but only while being driven by a named chauffeur. A fixed premium for each chauffeur so named is charged, the amount of which depends upon the territory in which the car is principally maintained and operated. The so-called specified car basis is the same as the foregoing with the exception that each car covered is described and identified in the policy and the premium charged is the same as that applicable to each named chauffeur when coverage is given under the named chauffeur plan. When written on a payroll basis the policy covers all cars used in connection with the business of a manufacturer or dealer at cer- tain rates per $100.00 of payroll earned by the assured's employes. These rates vary with the territorial classi- fications also with the amount of annual payroll, the first $10,000 taking a certain rate, the next $15,000 a lower rate and all payroll over $25,000 a still lower rate. If the assured does any livery business an addi- ional rate is charged based on each unit of $100.00 of livery earnings. As is the case with other policies writ- ten on payroll basis, the assured estimates the amount of payroll which will be earned during the policy term and pays an advance or deposit premium which is ad- justed on the basis of audit made by the company. The same procedure is followed with reference to livery earnings. 86 THIRD PARTY INSURANCE AUTOMOBILE PROPERTY DAMAGE. — This coverage is substantially the same as that known as automobile public with the exception that it applies not to personal injuries but to property damage sus- tained by members of the public by reason of the oper- ation of the insured automobile. Ordinarily a separate policy is not issued and the protection is afforded by attaching a rider to the automobile public policy. Sometimes the coverage is embodied in the public policy. The premium is arrived at in precisely the same way as is the premium for the public policy. AUTOMOBILE COLLISION.— This contract con- sists of an agreement on the part of the insurer to indemnify the assured against actual loss or damage to his automobile resulting solely from accidental col- lision of such automobile with any moving or station- ary object, excluding all loss or damage caused directly or indirectly by fire. As is the case with property dam- age, this coverage may be given by a separate policy or afforded by a rider attached to the public policy or embodied in the public policy. It is customary to write collision insurance in two forms, one known as full coverage and the other as deductible. As indicated by its name the full coverage collision contract covers all loss occasioned by damage resulting from collision. Under the deductible coverage contract it is provided that a certain amount is to be deducted from each claim when determined and the insurer is to be liable only for the loss in excess of that amount. The com- pany's liability is always limited to the actual intrinsic "alue of the property at the time of the accident or THIRD PARTY COVERAGES 87 the cost of the suitable repair or replacement thereof. AUTOMOBILE COLLISION PREMIUM.— The rates for private passenger and commercial cars are determined in the following manner. The classification manuals show symbols for collision premium for each car listed. In a general way these symbols are deter- mined by the rate makers with reference to the list price of the car. The rates as indicated by such sym- bols vary with the territory in which the cars are prin- cipally maintained and operated and the character of the coverage — whether full or deductible. Such rates for private passenger cars also vary with the age of the car. Thus, having ascertained the symbol, reference is made to the territorial schedule, which shows rates in each territory for each symbol and also for each age classification of private passenger cars. Separate rates are, of course, shown for full coverage and deductible coverage. The premium for public and for manufac- turers' and dealers' automobiles is determined by add- ing a specific percentage to the private passenger or commercial premium ascertained as above indicated. TEAMS' PUBLIC LIABILITY — INSURING CLAUSE. — By the insuring clause of a teams' pubHc policy, the company agrees to indemnify the assured against loss from liability imposed by law for damages on account of bodily injuries, including death resulting therefrom, accidentally suffered, or alleged to have been suflFered, within the policy period by any person or persons not employed by the assured by reason of the ownership, maintenance or use of any team or teams described in the policy while in charge of the 88 THIRD PARTY INSURANCE assured or his employes in connection with the trade or business described in such poUcy. The policy further provides that the word "team" as used therein means any vehicle not self propelled drawn by one or more horses or other draft animals. TEAMS' PUBLIC PREMIUM.— Manifestly it is impossible to identify vehicles of this character in the same manner as a motor vehicle; hence an entirely different ratfng system has been devised. The same occupational classifications which are used in connec- tion with the writing of employers' liability, compen- sation and manufacturers' and contractors' public lia- bility are the basis for the determination of teams' public premium and the manual shows a teams' rate for each such classification. This rate varies with the territory in which the team is maintained and used. Certain special kinds of vehicles, such as ambulances, mail wagons, omnibuses, etc., which cannot be assigned to manual classifications, are rated separately and such rate also varies with the territory in which the assured's operations are carried on. The rate is always a fixed charge per team. The number of teams used is arrived at by taking the total payroll earned by all drivers for the policy period and dividing same by the average wage of a driver for such period. Inasmuch as no team can be operated without a driver the theory is that the average number of drivers indicates the average number of teams used during the policy period. As is the case with other policies written on payroll basis, the assured estimates the probable pay- roll, pays advance premium in accordance therewith THIRD PARTY COVERAGES 89 and final adjustment is made on the basis of the com- pany's audit of the assured's books. TEAMS* PROPERTY DAMAGE.— This coverage is given ordinarily by the attachment of a rider to the teams' public policy. The obligation assumed by the insurer is exactly the same as that assumed under an automobile property damage contract with the excep- tion that the liability is defined as that imposed by law upon the assured for damages on account of injury to or destruction of property resulting from accident due to the ownership, maintenance or use of the in- sured teams. The rate is a certain percentage of the rate charged for teams' public coverage subject to cer- tain minimum premiums dependent upon the popula- tion of the town or city in which teams are maintained and used. OWNERS' CONTINGENT (SOMETIMES CALLED PROTECTIVE) PUBLIC LIABILITY. — When the owner of property desires to erect a build- ing thereon or to repair or alter an existing building, he ordinarily lets a contract to an independent con- tractor to do this work. It is a maxim of the law that a principal is not responsible to members of the public who have been injured by the operations of an inde- pendent contractor. Nevertheless, a member of the public who has received an injury due to the inde- pendent contractor's operations ordinarily joins the owner as a defendant in a suit brought against the contractor. While if such contractor is an independent contractor, the owner has no responsibility, it is in- cumbent upon him to estabhsh in court the facts 90 THIRD PARTY INSURANCE relieving him of responsibility. This procedure in- volves the expense, annoyance and uncertainty inci- dent to litigation. The contingent policy has been devised to protect an owner under such circumstances. Primarily it is a defense policy and it is only rarely that an insurer becomes obligated to pay indemnity on account of loss suffered by the assured through the recovery of a judgment against him. This is true be- cause the assured warrants in the policy that he will have nothing to do with the conduct of the operations of the independent contractor. If this warranty is true a judgment cannot be recovered against the owner. If judgment is recovered it ordinarily follows that the warranty was untrue and the insurer is not liable. This general statement is subject to the qualification that an owner sometimes furnishes material, tools or equipment to the contractor. If the injury upon which claim is based is due to a defect in same, the owner may have a direct responsibility which would be cov- ered by a contingent policy. For reasons above indi- cated, a contingent policy cannot be issued to cover operations performed by direct employes of the as- sured. If the owner to whom such policy is issued employs any superintendent, watchman or laborers upon the premises, such employes must be covered by an employers' liability or workmen's compensation policy in the same company and the owner must also carry direct public insurance. INSURING CLAUSE OF OWNERS' CON- TINGENT (OR PROTECTIVE) PUBLIC LIA- BILITY POLICY.— Under such a policy the insurer THIRD PARTY COVERAGES 91 agrees to indemnify the assured against loss from the liability imposed upon him for damages on account of bodily injuries, including death resulting therefrom, accidentally suffered or alleged to have been suffered, within the policy period by any person or persons not employed by the assured by reason of (1) the neg- ligence of any independent contractor of the assured while actually engaged in the work described in the policy at the place therein stated; (2) materials or appliances intended for such contractor's operations while upon the premises described in the policy or law- fully maintained upon the ways immediately adjacent thereto. The policy further provides that it is not to cover liability on account of injuries occasioned by any employe of the assured or by faulty work as dis- tinguished from acts of negligence in the actual doing of the work. This last mentioned exception is im- portant since were it not for such exception the insurer might become liable to defend or indemnify the assured against claim for loss due to faulty construc- tion based upon accident happening long after the completion of the work or, what is more important, the termination of the policy. PREMIUM FOR OWNERS' CONTINGENT (OR PROTECTIVE) PUBLIC LIABILITY POL- ICY. — This premium is computed at a certain rate for each $100.00 of the total cost of all work covered by the policy, including both labor and materials. The basic rate applies where the owner furnishes no mate- rial, tools or equipment. If the owner furnishes any 92 THIRD PARTY INSURANCE portion of the material or equipment, subject to certain exceptions, this rate is doubled. CONTRACTORS' CONTINGENT (SOMETIMES CALLED PROTECTIVE) PUBLIC LIABILITY.— Frequently a contractor who has undertaken to do cer- tain work sub-lets portions of the work to sub-contrac- tors. The contractor becomes a principal and the sub- contractor may be an independent contractor as to him. Under such circumstances, the contractor is in need of the same protection which is given by the owners' contingent policy above described. Third party com- panies therefore issue what is known as a contractors' contingent liability policy which in all essential re- spects is precisely the same as the owners' contingent liability policy and the remarks made relative to the owners' policy are here applicable. The insuring clause is the same as that of the owners' policy with the exception that the assured is referred to as a con- tractor and the sub-contractor as an independent sub- contractor. The premium for the contractors' policy is arrived at in exactly the same way as is the premium for the owners' policy. It is based upon each $100.00 of the total cost of the work sub-let, including labor and material. Of necessity the relationship between a contractor and an independent sub-contractor is closer than that which exists between an owner and an inde- pendent contractor. The contractor frequently con- ducts operations at the same place as the independent sub-contractor and the probability of his being joined in a suit growing out of the negligence of the sub- contractor is thereby enhanced. Therefore the rate THIRD PARTY COVERAGES 93 charged for the contractors' poHcy is higher than that which is charged for the owners', the basic rate being applicable when the contractor furnishes no material, tools or equipment for the use of the sub-contractor and such basic rate doubled where any portion of such material, tools or equipment is supplied by the con- tractor. If the contractor is himself conducting any operations at the place where the independent con- tractor does his work a contingent policy will not be issued unless such contractor carries with the insurer employers' liability, or compensation, and public lia- bility insurance covering that portion of the work which he performs. PHYSICIANS' AND SURGEONS' PUBLIC LIA- BILITY. — Third party insurance exists because of the fundamental legal conception that all persons who fail to conduct themselves with due regard for the rights of others are responsible to those thereby suffer- ing loss. The measure of care and skill which any per- son is required to exercise to avoid injury to others depends entirely upon circumstances. To put the proposition succinctly, it is simply one of ordinary common sense. If one gains a livelihood by the exer- cise of a profession requiring special skill, learning and ability, he is bound to conform to the reasonable and ordinary standards of his profession and if his con- duct does not measure up to those standards he must respond in damages to those injured by reason of his deficiencies. Self-preservation is the first law of nature and, from the standpoint of any individual, the most important things in the world are life and health. 94 THIRD PARTY INSURANCE Physicians and surgeons practice a profession which directly aflfects both life and health and hence, under the law, are obligated to possess and exercise a high degree of skill, the standard, of course, varying with the development of the science. Physicians and sur- geons, therefore, occupy a somewhat unique and, from one viewpoint, an unenviable position in that any failure or alleged failure to conform to such standard is likely to result in serious financial loss. Conse- quently, their peculiar need for protection has been met by third party insurers. Irrespective of whether a physician or surgeon is possessed of reasonable skill, he cannot guarantee success and it is frequently diffi- cult to determine whether or not unfavorable results are due to lack of professional ability. Physicians, and particularly surgeons, are dealing with such vital mat- ters that claims for large damages are likely to be made upon them at any time. Assuming that no lia- bility exists the expense of successful defense is very considerable. Compromise is ordinarily out of the question as the making of a settlement would be con- strued by the public as a confession of weakness and would seriously affect the assured's professional stand- ing. Hence practically all such claims must be litigated and the policy is, therefore, peculiarly a defense policy. INSURING CLAUSE — PHYSICIANS' AND SURGEON'S PUBLIC LIABILITY.— The contract which has been prepared to meet the special need just referred to provides in the insuring clause that the insurer shall indemnify the assured against actual loss resulting from claims upon the assured for damages THIRD PARTY COVERAGES 95 on account of bodily injuries or death suffered, or alleged to have been suffered, by any person or per- sons in consequence of any malpractice, error or mis- take committed, or alleged to have been committed, during the policy period by the assured personally in the practice of his profession or by any practicing physician, surgeon, dentist or registered nurse while acting as an assistant under the professional instruc- tion of the assured. To this general obligation, certain exceptions are made, namely, the policy does not cover claims arising by reason of injuries or death of any person shown to have been caused by the assured or any assistant while to any extent under the influence of intoxicants or narcotics, or while engaged in the performance of an unlawful act. Neither does it cover liability for such injuries or death caused by the assured or any assistant while engaged in the per- formance of any duties under any contract of employ- ment of the assured for which he is paid a stated salary or commission. Aside from the insuring obligation the policy is substantially the same as the other public forms. The assured is required to give notice upon becoming aware of the happening of any event which is likely to cause liability or to result in a claim for damages and the insurer agrees to defend all suiti based upon such claims. For reasons above indicated, the insurer does not reserve the right to compromise claims at its option. PREMIUM FOR PHYSICIANS' AND SUR- GEONS' PUBLIC LIABILITY.— The premium for this policy if the assured employs no assistant is a 96 THIRD PARTY INSURANCE flat charge which is the same in all territories. If the assured employs any physician, surgeon, dentist or registered nurse, an additional flat charge is made for each of such assistants. DRUGGISTS' PUBLIC LIABILITY POLICY- INSURING CLAUSE.— Practically everything which has just been said relative to the physicians' and sur- geons' liability policy is here applicable. The drug- gists' policy has been devised to meet a need growing out of the same general circumstances. Under the insuring clause the insurer agrees to indemnify the assured against loss arising or resulting directly from claims upon the assured for damages on account of bodily injuries or death accidentally suffered, or alleged to have been suffered, by any person or per- sons in consequence of any error or mistake made, or alleged to have been made, during the policy period in preparing, compounding, dispensing, selling or deliv- ering at or from the premises described in the policy any of the drugs, medicines or merchandise custom- arily kept for sale in drug stores. This agreement is qualified by provisions to the effect that the policy shall not cover injuries shown to have been caused by any person employed in violation of law or caused by failure to comply with any statute or local ordinance or in consequence of the performance of any unlawful act by the assured or any of his employes. Liability of others assumed by the assured under any contract or agreement, express or implied, is also excepted. PREMIUM — DRUGGISTS' PUBLIC LIABIL- ITY.— The premium charged for this poHcy is a THIRD PARTY COVERAGES 97 specific rate for each person engaged in the operations of the assured. A flat charge per annum is made for each manager, active proprietor or other employe registered or licensed to compound prescriptions. A lower rate is charged for each manager, active pro- prietor, assistant pharmacist or prescription clerk who is not registered or licensed to compound prescriptions. A still lower rate is charged for each other employe. A minimum premium is fixed for each store or busi- ness location. As is the case with the policies for which premium is based upon payroll, the assured estimates the average number of persons employed in each classification and pays an advance premium based upon such estimate. Adjustment of premium is made on the basis of the average number of employes as shown by final audit of the assured's books. CHAPTER IV STANDARD PROVISIONS OF THIRD PARTY POLICIES COMPARISON OF POLICIES.— In the preceding chapter we have shown in what material respects the several third party policies differ from one another. The heart of any policy is the insuring clause in which the insurer defines the Hability which it assumes. It is customary in drawing insurance contracts to make the insuring clause as brief as possible and to so word it as to cover, in general terms, the obligation which the insurer undertakes. Insurers, however, usually find it necessary to embody in the contract certain limitations upon or exceptions to the compre- hensive obligation set forth in the insuring clause and it is, therefore, customary to insert in the policy a clause indicating such limitations and exceptions, which is known as the exception clause. Having de- fined the obligation assumed, the next step of the policy draftsman, in the order of relative importance, is to state the premium consideration which the in- surer is to receive and to indicate the manner in which it is to be determined. Any attempt to distinguish one policy from another will resolve itself largely into a discussion of the insuring, exception and premium clauses. For this reason the preceding chapter has been principally devoted to them. With the excep- tion of these three clauses, third party policies are, for 98 STANDARD POLICY PROVISIONS 99 the most part, the same and consist of certain pro- visions which may be properly referred to as standard. In connection with our discussion of them we shall point out the differences in the exception clauses which have not as yet been referred to. OBLIGATIONS SUPPLEMENTARY TO IN- SURING CLAUSE.— In addition to the coverage given by the principal insuring clause, third party companies also assume certain supplementary obliga- tions. Their primary obligation pertains to the liabil- ity which the law imposes upon the assured on account of injuries received by third persons. The event which gives rise to such liability must, of necessity, be an accident causing such bodily injuries. INVESTIGATION OF ACCIDENTS.— Logically, therefore, the first supplementary obligation which the insurer undertakes is to make, at its own expense, a thorough investigation of all accidents reported to the insurer to which the policy applies. In the last analy- sis, the third party insurer can only become liable under its policy after the assured has been found liable in some sort of a judicial proceeding. It is, therefore, essential that the facts pertaining to the accident be immediately determined. Unless settlement is effected the facts will ultimately have to be established before some tribunal which sits for the purpose of ascertain- ing whether the assured is liable to a third party, and, if so, for what amount. For this reason, it is also important that proper steps be taken to the end that the facts may be shown by evidence at the trial or hearing. 100 THIRD PARTY INSURANCE DEFENSE OF SUITS. — Under this supplement- ary agreement the insurer undertakes to defend in the name and on behalf of the assured any suits, even if groundless, brought against the assured to recover damages on account of such bodily injuries as are described ,in the insuring clause unless the insurer shall elect to effect settlement thereof. This provision is common to all third party policies, but is modified to some extent in compensation policies. In most states the compensation laws themselves create quasi judicial bodies whose function it is to determine ini- tial questions of liability arising under the compensa- tion acts. Hence the agreement in the compensation policy is to defend in the name and on behalf of the insured employer any suits or other proceedings which may at any time be instituted against him on account of such injuries. Also the reservation "unless the Company shall elect to effect settlement thereof" is omitted for the reason that, as a general proposition, a claim arising under the compensation act is not susceptible to compromise. Questions of negligence or contributory negligence are not involved and the assured is either liable for a fixed sum or is not liable at all. Also the insurers do not reserve the option to settle claims in policies of physicians' and surgeons' and druggists' public liability. Ordinarily the assured under one of these policies would have a very valid objection to such settlement as it would probably be construed as an admission of lack of professional skill. Inasmuch as the insurer's liability, unless the claim is settled, is dependent upon the result of a legal STANDARD POLICY PROVISIONS 101 proceeding, it is entirely logical that the insurer, being the party principally interested in the outcome, and, in most cases, the only one interested, be vested with authority to defend suits. From this viewpoint, the obligation must be considered in the Hght of a nec- essary privilege. In fact, as will subsequently appear, third party policies also provide that the insurer shall have the exclusive right to defend suits. AGREEMENT TO DEFEND INCLUDES GROUNDLESS SUITS.— This supplementary agree- ment pertains to all suits, "even if groundless." Mani- festly there always exists the possibility that non- meritorious claims will be made against the assured and suits brought in an effort to collect them. If the alleged accident out of which the alleged liability grows is of a character which would be covered by the policy if the claim were meritorious, the insurer agrees to defend. From the standpoint of the assured this agreement is essential as otherwise he would not have complete protection. This same consideration lies back of the wording of the insuring clause which we have already seen refers to bodily injuries acci- dentally suffered or alleged to have been suffered. Some of the companies do not content themselves with a simple agreement to defend suits, even if groundless, but elaborate their promise by the use of wording substantially as follows: "including suits alleging such injuries and demanding damages therefor although such suits, allegations or demands are wholly groundless, false or fraudulent." This prolixity is, of course, unnecessary. 102 THIRD PARTY INSURANCE INSURERS RESERVE RIGHT TO SETTLE.— The obligation to defend suits is qualified in all third party contracts, with the exception of compensation, physicians' and surgeons' and druggists' policies, by the following words "unless the Company shall elect to effect settlement thereof." This reservation is necessary because, in the practical handling of claims, it is frequently more economical to settle than to liti- gate. Hence, the insurer must reserve the right to settle if it so desires. EXPENSES OF INVESTIGATION AND DE- FENSE AND INTEREST UPON JUDGMENTS.— Third party insurers also customarily agree to pay all expenses incident to investigation conducted by them and all expenses and costs arising in the defense of legal proceedings. The agreement to make the investigation and to conduct the defense would un- doubtedly carry with it the obligation to pay the costs incident thereto, but, in order to make their policies more attractive and to eliminate the possi- bility of misunderstanding, the insurers make special provision to this effect. They also agree that these expenses will be paid by them without reference to the limits of liability set forth in the policy. This agreement becomes important in those cases where the insurer pays in settlement an amount equal to its limit or where the judgment equals or exceeds such limit. In either event any expenses of the char- acter above referred to, even if over such limit, are paid by the insurer. In cases where a judgment is rendered against an assured and appeal is taken, the STANDARD POLICY PROVISIONS 103 judgment may remain outstanding for a period of months or years and the item of interest on such judgments becomes an important one. Prior to the entry of a judgment a claim for damages is unliqui- dated and the defendant has no obligation to pay interest until after the amount of his liability has been determined in a judicial proceeding. That amount is not determined until after a nisi prius court has entered its judgment. From the date of such judgment it bears interest at the rate provided by the statutes of the state. Until recently it was the custom of third party insurers to agree to pay interest only on that portion of the judgment not in excess of the policy limit. Some of the companies now obligate themselves to pay, without reference to policy limits, all interest on judgments. IMMEDIATE SURGICAL AID.— In the event that a third party receives personal injuries, occa- sioned in connection with some covered activity of the assured, humanitarian considerations require that the injured person be given immediate surgical aid. Also it is to the manifest interest of the insurer and the assured to minimize possible liability by providing such surgical aid. Under such circumstances, action must be taken at once and ordinarily if the assured is to provide effective surgical assistance he must act on his own responsibility without taking time to con- sult with the insurer. Therefore, an exception to the general rule that no expense must be incurred without the consent of the insurer is made and the assured is permitted to use a reasonable discretion and to 104 THIRD PARTY INSURANCE incur such expense as may be necessary in providing immediate surgical assistance. In its policy, the insurer obligates itself to pay such expense so in- curred. In some of the modern third party policies, the insurer goes further, and, in the clause now under discussion, also agrees to pay the expenses necessarily incurred by the assured at the time of the accident in removing the injured person to a suitable place. LIMITS OF LIABILITY.— With the exception of compensation contracts, all third party policies fix certain limits of liability beyond which the insurer is not to be responsible. In the United States these limits are ordinarily fixed at $5,000 for loss from an accident resulting in bodily injuries to or in the death of one person only, and, subject to the same limit for each person, the total liability of the company for ioss resulting from any one accident resulting in bodily injuries to or in the death of more than one person is limited to $10,000. The limit fixed for automobile and teams' property damage is the actual intrinsic value of the property damaged at the time of the acci- dent or the cost of suitable repair or replacement not exceeding $1,000, which limit applies to each vehicle. The liability under the collision contract is limited to the actual value of the damaged automobile at the time of the accident or the cost of suitable repair or replacement. In many cases the assured desires that these limits be increased and such increase is permis- sible upon payment of additional premium. The manuals issued by the companies contain limit tables indicating the percentage of additional premium which STANDARD POLICY PROVISIONS 105 is to be charged for various increases over the stand- ard limits. It is not permissible to reduce premium for lower limits. In the event that the assured desires Umits larger than the insurer wishes to carry itself, it is customary for the insurer to secure reinsurance from other companies. The precise amount which any one company retains as its own liability is entirely a matter of individual discretion and varies, in a gen- eral way, with the size of the company and its financial resources. In determining the limits to be retained by it, the insurer must conform to the principle that it cannot afford to place itself at hazard on any one risk in an amount which will seriously impair surplus if maximum loss occurs. It is customary to write compensation policies without any limit. This be- cause, in most states, the compensation acts provide that the insurer must assume an unlimited liability. Therefore, compensation insurers, unless they have almost unlimited resources, must have proper rein- surance arrangements. OBLIGATIONS RESTING UPON ASSURED- FORFEITURE CLAUSE.— We have now discussed all of the obligations which the insurer undertakes in a third party policy. The policy also sets forth certain qualifications upon the general liability assumed and imposes various responsibilities upon the assured. If the assured fails to comply with his agreements, then the insurer may fairly take the position that it should not pay indemnity. The courts in some states have held that the failure of the assured to comply with his agreements will not relieve the insurer of the 106 THIRD PARTY INSURANCE obligation to perform its promises unless the policy specifically so provides. This holding constitutes a departure from general rules of law applicable to the construction of contracts. In order to protect them- selves, insurers ordinarily insert in their policies, as a preface to the recitation of the things which the assured must do, a provision substantially to the effect that failure on the part of the assured to comply with any of said conditions shall forfeit the right to recov- ery. Subsequent to this so-called forfeiture clause, the conditions to be complied with by the assured are set forth in such order as may conform to the individual preference of the policy draftsman. We shall discuss these provisions in what we regard to be their logical order. NOTICE. — The third party policy requires the as- sured to give to the company immediate notice of the happening of an accident out of which liability may arise. This requirement is of the utmost impor- tance since the carrier has no knowledge of the occur- rence of the event which may render it liable until the receipt of such notice. The notice sets the machinery of the claim department in motion and enables the insurer to do all of the various things which are necessary to properly protect the rights of itself and its assured. The insurer must not only have notice that the accident has happened, but also certain detailed information pertaining thereto, the exact nature of which varies with the kind of policy. It is, therefore, customary for the insurers to send out with their policies printed notice forms containing STANDARD POLICY PROVISIONS 107 interrogatories to be answered in writing by the assured, designed to elicit that information most essential in handling claims under the particular policy to which the notice form pertains. It is further pro- vided in the notice clause that the assured must give immediate notice of claims for damages and that if any suit is brought against the assured he shall imme- diately forward to the office of the insurer every sum- mons or other process served upon him. Inasmuch as the insurer is obliged to defend suits it is obvious that it must be immediately furnished with any sum- mons or other process served upon the assured in order that it may have an opportunity to enter the appearance of its attorneys and to file the necessary pleadings to prevent a default judgment. INSURER'S EXCLUSIVE CONTROL OF CLAIMS AND LITIGATION— CO-OPERATION BY ASSURED. — All third party policies provide in substance that the insurer is to have the exclusive right to contest or settle claims and suits brought upon same, that the assured shall not incur any expense, with the exception of that authorized by the insuring agreements, and may not settle any claim or suit without the written authority of the insurer. Such policies further provide that the assured shall not interfere in any way respecting negotiations for settlement or the conduct of legal proceedings, but shall, at all times, at the request of the insurer, render to it all possible co-operation and assistance. To the same end it is stipulated that the assured shall not voluntarily admit any liability for an accident and 108 THIRD PARTY INSURANCE that any loss arising from a liability voluntarily assumed shall not be covered. All of these provisions are of the essence of third party contracts. The lia- bihty is an unliquidated one and depends primarily upon questions of fact and individual judgment and, in the last analysis, upon the decision of a court or jury. It would be impossible for any insurer to under- take this sort of a responsibility unless vested with the control of the various proceedings by which its liability is to be ultimately determined. Otherwise it would be absolutely at the mercy of a dishonest or indifferent assured. The factor of dishonesty is not ordinarily an important one since, in most cases, the assured has every reason to co-operate with the in- surer when it comes to dealing with a third party who is making claim for damages against him. On the other hand, the average assured is absolutely incom- petent to conduct the investigations, negotiations and litigation growing out of a claim of this kind. In almost every case, the assured, if given any latitude whatsoever, will, through ignorance or lack of judg- ment, make serious mistakes. Inasmuch as the whole theory of third party insurance is to indemnify against a liability imposed by law, it is, of course, essential to stipulate that the insurer is to have no responsi- bility as to a liability voluntarily assumed by the assured. EXCEPTION CLAUSE,— We have already found it necessary, in pointing out the distinctions between the insuring clauses of third party policies, to discuss, to some extent, the variations in the exception clauses. STANDARD POLICY PROVISIONS 109 In addition to the points which have already been discussed, there are certain other respects in which the exception clauses of the various third party pol- icies differ and many others in which they resemble one another. In considering these variations it is advisable to group the policies, placing together those which are of the same general character. The forms naturally divide themselves into three groups. In the first may be placed the two manufacturers' policies — employers' and public, the two contractors' policies — employers' and public, the two vessel policies — employers' and public, the workmen's compensation policy and the two contingent policies — owners' and contractors'. The second group includes the general liability, elevator public, elevator property damage and theatre public forms. The third group consists of automobile public, property damage and collision and teams' public and property damage. We have disregarded the physicians' and surgeons', and drug- gists' policies for the reason that the exceptions to the liability assumed by the insuring clauses have already been fully covered. EXCLUSION OF LIABILITY UNDER COM- PENSATION ACTS— GROUP I.— Each of these policies, except, of course, the compensation form, provides in the exception clause that it is not to cover liability of the assured under any workmen's com- pensation act. The necessity for inserting this stipula- tion in the employers' liability policies is apparent as otherwise they would also include liability under com- pensation acts. Inasmuch as the public policies cover no THIRD PARTY INSURANCE only injuries sustained by members of the public, it would seem that the exception would not be necessary. In many of the states, however, the compensation acts are so drawn as to make employers liable to pay com- pensation not only to persons whom they regard as their employes but also to some persons whom the em- ployer would ordinarily consider to be members of the public as to him. Thus, under some of the acts, one who permits the employes of another to work on his prem- ises is, under certain circumstances, liable under the workmen's compensation act on account of injuries sus- tained by such employes. Also many of the acts make an employer responsible to pay compensation to em- ployes of an independent contractor or sub-contractor when such contractor or sub-contractor is financially irresponsible and does not himself carry compensation insurance. Therefore, to prevent misunderstanding, it has been found advisable to insert this exclusion in the public policies. INJURIES SUFFERED OR CAUSED BY EM- PLOYES ON WHOSE PAYROLL PREMIUM IS NOT PAID— GROUP I.— In all of the employers' liability policies it is customary to stipulate that the insurer is to have no liability on account of injuries sustained by any employe whose remuneration is not included in the estimate appearing in the schedule. This is only another way of saying that the insurer is not to be responsible for injuries to persons on whose payroll premium is not paid. The necessity and rea- sonableness of this stipulation is apparent. Actuated by the same considerations most insurers provide in STANDARD POLICY PROVISIONS 111 their public policies, the premium for which is based upon payroll, that they are to have no responsibility on account of injuries caused by any employe unless his remuneration is included in such estimate and premium paid thereon. CLAUSE MODIFIED IN COMPENSATION FORM. — The same provisions might well be in- serted in a compensation policy. However, the peculiar character of that business has occasioned material modifications in this as in many other of the so-called standard provisions. The underlying thought is that the purpose of the compensation acts is to protect injured employes and their dependents and that they should not be deprived of this protection by reason of oversight or lack of good faith on the part of the employer. Hence the universal standard work- men's compensation policy form, now in general use throughout the United States, does not contain any exception of this character, but does provide affirma- tively that coverage is to apply to injuries sustained by any person or persons employed by the assured whose entire remuneration is included in the remuner- ation upon which premium is to be computed. This provision is, however, qualified by the stipulation that the policy is to apply to injuries sustained by reason of the operations described, including all operations incident thereto of connected therewith whether such operations are conducted at the places described in the policy or elsewhere. It is further provided that if any operations are undertaken by the assured but are not described or rated in the policy, the assured is to pay 112 THIRD PARTY INSURANCE premium thereon at the time of final adjustment in accordance with the carrier's rates applicable to such work. It is also stipulated that any default of the assured after the accident in the payment of premiums shall not affect the obligations of the insurer insofar as the employes of the assured are concerned. LIABILITY EXISTS WHERE PAYROLL NOT INCLUDED IN ESTIMATE.— Therefore, as a prac- tical proposition, an insurer is liable under a compen- sation policy to pay compensation claims even though they are based upon injuries received by employes whose wages are not included in the original estimate. In one state — Michigan — compensation carriers are compelled to agree that their policies shall cover all business in which the employer is engaged at the time the policy becomes effective, irrespective of whether such business is described in the policy, and all other operations in which the assured may engage during the life of the policy. This presents the rather unusual situation of an insurance carrier being obliged to cover risks other than those specifically contracted for and places the burden upon it of making such investiga- tions as may be necessary to the end that it receive premium to which it is entitled. The only way that the insurer can protect itself is to make careful audit of the assured's books for the purpose of ascertaining all work that has been done during the policy term in addition to that particularly specified. While the situ- ation is not the same with respect to other payroll policies, it is not customary for insurers to deny lia- bility in cases where they believe the assured has acted STANDARD POLICY PROVISIONS 113 in good faith. In such cases the companies ordinarily take care of the liabiHty even though it is not spe- cifically included in the policy and collect premium as shown by final audit. A few companies have recently liberalized their public policies, premium for which is based on payroll, by stipulating that they are to cover new work undertaken after the issue of the policy. In this event these policies provide that the assured is to keep record of payroll expended in new operations and pay premium thereon at the companies' rates applicable to such operations. CONTRACTORS AND SUB-CONTRACTORS— GROUP I. — Employers' liability policies, and the pub- lic liability policies for which premium is determined on payroll basis, also stipulate that there is to be no liability on account of injuries caused or suffered by any contractor or sub-contractor or the employes of either. In effect this exclusion is only a specific reiter- ation of the payroll exclusion just referred to. The premium for all of these policies is based upon the pay- roll of employes and does not contemplate that the remuneration paid to contractors and sub-contractors, or the payroll of their employes, will be included in the original estimate or taken into account on final audit. For reasons already stated, the universal stand- ard workmen's compensation policy form does not contain this exclusion. Of course, this form only purports to indemnify the assured on account of in- juries received by his employes and ordinarily neither a contractor or a sub-contractor or their employes would fall within the coverage. Further than this. 114 THIRD PARTY INSURANCE in most cases, the assured would have no responsibility under the compensation act on account of injuries to them. However, if the particular compensation act provides that under certain circumstances an employer may be liable to pay compensation to employes of contractors or sub-contractors, it is probable that under the universal form the insurer would be obliged to protect the assured or, in any event, to indemnify the injured employe or his depend- ents if collection could not be made from the imme- diate employer. PERSONS EMPLOYED IN VIOLATION OF LAW — GROUP I.— With the exception of the com- pensation and contingent forms all of the policies fall- ing within this group stipulate that the insurer is to have no liability on account of injuries suffered or caused by employes employed in violation of law as to age or under the age of fourteen years if there is no legal age limit. In the event of injury to such an infant, it is very difficult to maintain a successful defense to a suit for the reason that the defense of contributory negligence is, as a practical proposition, unavailable. While, under the law in most jurisdic- tions, an infant over the age of seven years may be guilty of contributory negligence, the jury are per- mitted, in determining that question to hold the infant only to that degree of care which an individual of his age would reasonably be expected to use under the circumstances. Also, under the law applicable in many states, the act of the employer in permitting an infant of tender years to operate any sort of dangerous STANDARD POLICY PROVISIONS 115 machinery is either conclusive evidence of negligence or closely akin thereto. Where injury to another is caused by such an infant the employer is likely to be held liable on the theory that he was negligent in entrusting his affairs to an irresponsible employe. Aside from the difficulty of handling claims and suits insurers are further influenced by the fact that the wages of such employes are small and the premium correspondingly low and that an assured who makes a practice of employing such persons is likely to be generally careless and indifferent to the welfare of his employes. This exception is not contained in the universal standard compensation policy as a restric- tion upon the principal insuring clause. In the sec- ondary insuring clause, which, as we have already seen, provides for general coverage against employers' liability, the qualification is made and the agreement pertains only to persons legally employed. The exclu- sion is not usually made in the contingent forms be- cause the coverage is otherwise so carefully restricted that it is not necessary. INJURIES OCCASIONED BY VEHICLES OR DRAFT ANIMALS— GROUP I.— The public forms included in this group, with the exception of the con- tingent policies, stipulate that the insurer is to have no liability on account of injuries caused by any driv- ing or draft animal or by any vehicle or any person in charge thereof. As we have already seen, the lia- bility for injuries suffered by members of the public occasioned by the use of vehicles or draft animals is taken care of by automobile or teams' public policies 116 THIRD PARTY INSURANCE for which specific premium is paid. Inasmuch as the insuring clauses of the public policies included in Group I are sufficiently broad to cover injuries of this character, it is necessary to exclude them. This excep- tion is not found in policies of employers' liability or compensation insurance which cover all such injuries to employes. While it would be logical to insert it in the contingent policies, it is not customary to do so for the reason that the liability assumed by these policies is so restricted that it is not considered necessary. ACCIDENTS OCCURRING BEFORE PREMISES FULLY COMPLETED— GROUP I.— It is customary to exclude from the coverage of the manufacturers' policies any accident occurring before the premises are fully completed and ready for occu- pancy. This because the premium for these policies is calculated to cover only the hazard of the manu- facturing operations and not risks incident to construc- tion. For reasons previously referred to this qualifica- tion does not appear in the contractors', workmen's compensation or contingent forms. GROUP II. — These forms also contain many of the exclusions which have already been discussed in Chap- ter III and in connection with our consideration of Group I, namely, those pertaining to infant employes ; vehicles and draft animals; construction, demolition, extraordinary repairs, etc.; the manufacture or pres- ence within the premises of materials intended for use as an explosive; and also the important provision to the effect that the policy is not to cover hability under any workmen's compensation act. They do not con- STANDARD POLICY PROVISIONS 117 tain the exclusions pertaining to payroll nor those relative to contractors and sub-contractors. GROUP III — AUTOMOBILE PUBLIC — The automobile public policy provides that the insurer is not to be responsible for injuries caused by any auto- mobile while driven by or in charge of any person under the age of sixteen years or under the age limit fixed by law. This provision is analogous to a similar clause contained in the forms included in Groups I and II which has already been discussed. The automobile policy also stipulates that the carrier is to have no liability for accidents occurring while the insured auto- mobile is being operated in any race or speed trial. The necessity of this exclusion is so apparent as not to require further comment. The policy also excepts lia- bility on account of injuries occasioned by an automo- bile which is maintained, garaged or driven for any pur- pose or by any person other than as specified in the policy. This exclusion is necessary because the rate de- pends upon the purposes for which, and in certain cases the persons by whom, the car is operated. It is next stipulated that the carrier shall have no liability while the insured car is being operated without the limits of the United States of America or the Dominion of Canada. It is permissible to extend territorial limits by the payment of an additional premium. Inasmuch jis the policies included in Group III cover only the liability of the assured to members of the public, these forms, like those already referred to, exclude liability under any compensation act. 118 THIRD PARTY INSURANCE AUTOMOBILE PROPERTY DAMAGE — GROUP III. — In addition to the exclusions contained in the automobile public policy, the insurers, when coverage is extended to include property damage pro- vide that there is to be no Hability on account of in- jury to or destruction of property of the assured or his employes or of others while in charge of the assured or his employes or carried in or upon any insured auto- mobile. Since the property damage contract is purely a third party one, it is necessary to stipulate that the insurer is not to be liable on account of damage to property belonging to the assured. Liability for dam- ages to property belonging to employes of the assured, is excluded to eliminate troublesome claims and a pos- sible moral hazard. As to property of others in charge of the assured or his employes, or carried in or upon the insured automobile, it is manifest the assured is under certain special liability. In most cases he would be in the position of being a bailee or a carrier for hire and bound to exercise a very high degree of care. In fixing the premium the companies do not contemplate any special hazard of this character. Hence it is necessary to exclude same. AUTOMOBILE COLLISION — GROUP III.— Where full coverage automobile collision insurance is granted the insurer stipulates against liability for loss of or damage to tires of any insured automobile through puncture, cut, gash, blowout or other ordinary tire trouble, excluding in any event loss of or damage to any tire unless caused in an accidental collision which also causes other loss or damage to the insured auto- STANDARD POLICY PROVISIONS 119 mobile. The purpose of this exclusion is to eliminate minor claims and to do away with the misunderstand- ing and dissatisfaction almost certain to arise if dam- age to tires is covered for the reason that very fre- quently it is difficult to determine whether such dam- age is due to a collision as defined in the contract or to ordinary wear and tear. In the case of deductible col- lision, it is not necessary to insert this exclusion be- cause the assured is obliged in any event to stand the first $50.00 or $100.00 of loss due to one accident. All of the collision forms exclude loss or damage caused directly or indirectly by fire from any cause. This is a hazard not contemplated by the insurer and is taken care of by automobile fire policies. TEAMS' PUBLIC AND PROPERTY DAMAGE — GROUP III. — The exception clause of the teams' public policy relieves the insurer of liability on account of injuries caused by: any person employed in viola- tion of law as to age or under the age of fourteen years if there is no legal age limit ; any driving or draft animal or any vehicle while driven by or in charge of any person under the age of sixteen years ; any animal under saddle; any animal or team while being ridden or driven in any race or speed trial; any animal or team while being used for pleasure purposes. The first, second and fourth exceptions just mentioned are similar to those we have already considered and re- quire no further comment. As to the third and fifth, it is not customary to cover liability for injuries occasioned by any animal under saddle or by any animal or team while being used for private pleasure 120 THIRD PARTY INSURANCE purposes. No doubt the reason is that there has been no demand for this form of insurance. The teams' public policy also excepts liability of the assured under any workmen's compensation act. The additional exceptions made by the insurers where public coverage is extended to include property damage are precisely the same as those made to the automobile property damage coverage and have already been fully dis- cussed. CANCELLATION.— It is customary for third party insurers to stipulate in their policies that the same may be cancelled at any time by either of the parties. The precise wording of the cancellation clause depends, in some measure, upon the law of the state where the policy is issued and, to some extent, upon the individual preference of the policy draftsman. In substance, this clause provides that the policy may be cancelled by written notice from either party to the other stating when thereafter cancellation shall be effective, or it may be agreed that cancellation shall be effective only after the expiration of a given number of days — usually five or ten — from the date the notice is received. It is further customary to stipulate that if cancelled by the company notice mailed to the address of the assured as it appears in the policy shall be sufficient and that the insurer's check mailed to the assured at such address shall be a sufficient tender of any unearned premium. If the policy is written on payroll basis, it is provided that no premium shall be returned until a statement of actual compensation earned by all employes of the assured during the time STANDARD POLICY PROVISIONS 121 the policy has been in force shall have been furnished to the insurer by the assured and audited by the insurer if it so desires. Some of the compensation laws provide that a compensation policy may not be cancelled without previous notice to the compensation board, commission or other state agency. Hence the universal compensation policy provides that the law of any state in which the policy applies, which requires that notice of cancellation shall be given to any board, commission or other state agency, is made a part of the policy and cancellation in such state shall not be effective except in compliance with such law. SHORT RATES AND MINIMUM PREMIUMS. — Because of the fact that the insurer incurs consid- erable expense in connection with the solicitation of the insurance, the writing of the policy, the proper recording of premium, etc., it is apparent that every time a policy is issued the insurer is put to certain expense which has nothing to do with the liability assumed. Third party policies are ordinarily issued for a period of one year although certain policies, notably general liability and elevator, are frequently issued for three years. In computing the premium for the policy period expenses just referred to are included as a loading upon the premium for such period. When the policy is cancelled by the assured prior to natural expiration, the company, therefore, suflFers a loss. In order to compensate themselves in such cases the insurers provide in the cancellation clause that if a policy is cancelled by the assured, except when retiring from business, the company is 122 THIRD PARTY INSURANCE to receive, not that proportion of the entire premium which the period the policy has been in force bears to the full term, but a greater amount which is known as a short-rate premium. In all of these policies is printed a short-rate table which shows the short rates applicable in the event of cancellation by the assured at any time within the policy period in terms of per- centages of the full premium. The same reasons which have made it necessary for the insurers to require short rate premiums have also led them, in many instances, to fix certain minimum premiums which must be paid irrespective of the size of the payroll or of the area or frontage or of any other factor which enters into the determination of premium. If a min- imum premium is fixed the cancellation clause, there- fore, also provides that the insurer shall, in no event, receive less than such minimum. ACTIONS.— The reader is already familiar with the theory that third party policies are contracts of indemnity and that the insurer is under no obligation to the third party whose injury in person or property gives rise to its liability. The sole obligation of the insurer is to indemnify the assured against loss. Therefore, such policies, until recently, have always contained in the action clause, a provision to the effect that no action may be maintained against the insurer unless it be for the recovery of money actually paid by the assured, in full satisfaction of a final judgment against the assured by the court of last resort after trial of the issue, or pursuant to an agreement between the parties with the written consent of the insurer. STANDARD POLICY PROVISIONS 123 It has, in the past, frequently happened that final judgment has been recovered against the assured by some person injured in person or property and that such judgment proved uncollectible because of the in- solvency or bankruptcy of the assured. In such cases the insurers have escaped liability for the reason that the assured, being unable to pay the judgment, has suffered no loss. THIRD PARTY HELD TO HAVE DIRECT INTEREST. — This proposition would appear to be so fundamental as not to be susceptible to question. Notwithstanding the" courts of a few states have arbi- trarily held that although the third party is an utter stranger to the conract he must, in the eyes of the law, be considered as an interested party and one to whom the insurer has a direct responsibility. Such courts have held that where the assured is insolvent a recovery by the plaintiff of the amount of the judg- ment, not in excess of the limit of the policy, may be had direct against the insurer. Apparently the theory upon which the courts have proceeded in thus violating fundamental rules of law is that considerations of public policy are sufficiently weighty to justify their decisions. This action of the courts has been followed up by statutes in some of the states requiring that the policy provide to pay direct to the claimant under such circumstances. For illustration, in the state of New York, by legislative enactment, third party com- panies must agree in their policies that the insolvency or bankruptcy of the assured shall not release the insurer from the payment of damages and in case an 124 THIRD PARTY INSURANCE execution is returned unsatisfied in an action brought by the injured person, or his or her personal repre- sentatives in case death results from the accident, because of such insolvency or bankruptcy, an action may be maintained against the company for the amount of the judgment not exceeding the policy limit. Substantially similar statutes are in force in several of the other states. We have already seen that in so for as compensation coverage is concerned, the laws have gone even further and practically make the injured third person a party to the insurance agree- ment, at the same time requiring that provisions to this effect be inserted in the compensation policy. Many of the third party companies have submitted to the inevitable and, at the present time, are liberal- izing their action clauses, using practically the lan- guage required by the New York statute above referred to, even in states where the law does not require them to do so. LIMITATIONS.— In the action clause it is also customary to stipulate that in no event shall any action be maintained against the company unless brought within a certain period after right of action accrues. Until recently this period has usually been fixed at one year. At the present time many of the companies have extended the period to two years. Also the statutes of some of the states fix the limit of time within which suit may be brought upon an insurance policy and require that such limit be inserted in the policy. To meet situations of this character it is customary to supplement the action clause by an STANDARD POLICY PROVISIONS 125 agreement to the effect that if any time limitation of the policy with respect to giving notice or instituting suit conflicts with the law controlling the contract, the minimum period permitted by such law shall be considered as substituted for such limitation. It is scarcely necessary to say that some reasonable limit of time within which action may be brought must be fixed by the companies, otherwise it would be impos- sible for them to intelligently estimate outstanding liability. SUBROGATION CLAUSE.— This clause is an agreement to the effect that if the insurer pays loss under the policy, it shall be subrogated to the amount of such payment to all rights of the assured against any person, firm or corporation arising out of the acci- dent causing such loss. The effect of this clause is to enable the insurer, in the event that it becomes liable by reason of the negligence of some person other than the assured, to reimburse itself to the extent of such liability by enforcing the legal rights of the assured against such other person. The underlying equitable consideration is that the assured is only entitled to be made whole and should not be permitted to collect his loss from the insurance company and then to again collect it from the person whose negligence brought it about. An agreement of this character is found in practically all policies of insurance with the exception of life, accident and health. PHRASEOLOGY OF SUBROGATION CLAUSE. — The particular phraseology of the clause varies in the policies of different companies. Most companies 126 THIRD PARTY INSURANCE provide in substance that in the event the insurer shall pay loss under the policy it shall be subrogated to the amount of such payment to all rights of the assured against others arising out of the accident. It fre- quently happens, however, particularly where pay- ments are deferred that it becomes to the interest of the insurer to enforce its subrogation rights prior to the time when payment is actually made to the assured. Hence the policies of at least one company stipulate that if the company becomes liable for payment of loss under the policy it is to be entitled to subrogation to the extent of such liability. The various subrogation clauses also provide that the assured is to do every- thing which may be necessary to enable the insurer to enforce the rights accruing to it thereunder. This means that where the insurer so requests, the assured must formally assign his claim, must permit the in- surer to bring suit in his name, etc. OTHER INSURANCE.— This clause is also one common to practically all policies of insurance except life. Its effect is to prorate any loss among all insur- ance carriers who are on the risk. The wording is sub- stantially to the effect that if the assured carry a policy of another insurer against a covered loss the assured shall not be entitled to recover from the in- surer a larger proportion of the entire loss than the amount otherwise payable bears to the total amount of insurance. This is a very essential provision in all direct property coverages in that its tendency is to eliminate the moral hazard incident to over-insurance. Thus if the owner of property worth $5,000.00 takes STANDARD POLICY PROVISIONS 127 out a fire policy in that amount with one company and nine other policies for equal amounts in nine other companies, a very persuasive incentive would exist to bring about an incendiary fire were it not for the clause in question. The operation of such clause, however, would make each company liable only for that propor- tion of its policy which $5,000.00 bears to $50,000.00. In other words, each of the companies would be liable for $500.00 and the assured would be able to collect only the actual value of the property. CLAUSE OF LITTLE VALUE IN THIRD PARTY POLICY.— While the clause is indispensable in writing all sorts of direct insurance, it is of very little value in a third party policy. The liability of third party companies is only to indemnify the assured against loss by reason of liability imposed by law on account of injuries to third persons. There exists, therefore, no possibility of the assured being able to make an unwarranted profit by the carrying of an ex- cessive amount of this insurance, since in no event, does he receive anything himself and is only made whole for a liability imposed upon him. As has already appeared, he may secure additional insurance beyond the standard limits by the payment of an additional premium which is only a fraction per unit of coverage of premium charged for the first limits. To be more specific, if an assured desires to increase the ordinary $5,000.00 limit for one person injured in one accident to $10,000.00 he is only required to pay for the second $5,000.00 a small percentage of the premium charged for the first. Manifestly it would not be to his interest 128 THIRD PARTY INSURANCE to go to another company and take out another policy with a first limit of $5,000.00 as the two would cost him considerably more than one $10,000.00 policy. Of course in those rare cases where the assured has more than one policy covering the same liability the clause is of benefit to the insurer in that it restricts its liabil- ity to a pro rata of the entire insurance and compels the assured to collect a proportionate amount from each carrier. INSPECTION. — The inspection clause gives to the carrier the right and opportunity to inspect at any reasonable time the work, operations, premises, equip- ment, machinery, vehicles, etc., which may be the sub- ject matter of the insurance. In some forms of policies it is customary to provide that any of the insurer's inspectors may suspend the insurance if upon inspec- tion they deem it advisable to do so and that in such event notice of such suspension and the reason there- for must be in writing as also must be notice of re- instatement. Where the right to suspend insurance is reserved the insurer agrees to return the pro rata part of the premium for the period of suspension. The reasons by which the insurers are actuated in inserting this clause in their policies are so apparent that it would be a waste of space to state them. ALTERATIONS.— The last of the so-called third party standard provisions is one which is common gen- erally to all policies of insurance and is designed to protect the insurers against claims which are not cov- ered by the printed policy. In the alteration clause, therefore, the companies stipulate, in substance, that STANDARD POLICY PROVISIONS 129 the policy is to constitute the entire contract and that no assignment of same or of any claim thereunder nor any change, waiver or extension of its terms shall be valid unless endorsed on the policy and signed by an officer of the insurer. The stipulation that the policy is to constitute the entire contract is essential in order to avoid claims based upon alleged oral or written vari- ations or extensions of the coverage defined therein. The reason lying back of the provision relative to assignment of the policy is that the insurer naturally does not desire to deal with an assured other than that named in its policy. We have already seen that in- surers closely scrutinize applicants and have devised various ways to avoid the possibility of issuing a contract to an applicant who, for some reason, is not desirable. All of this work would go for nothing in the event that the assured, having received his policy, could assign it to some other person without the con- sent of the company. Another motive by which the carriers are actuated is that were promiscuous assign- ments permissible much difficulty would be experi- enced because of the fact that in the event of loss claims would likely be made by several parties and the insurer thereby put to considerable trouble and expense. While the alteration clause ordinarily re- quires that the consent of the carrier to change in contract or to assignment must be endorsed upon the policy, in actual practice these things are accomplished not through endorsement but by the attachment of a rider which is executed by the proper officers of the insurer. 130 THIRD PARTY INSURANCE NOTICE TO OR KNOWLEDGE POSSESSED BY AGENT OR OTHER PERSON.— The alteration clause also customarily stipulates that notice to any agent or knowledge possessed by any agent or other person shall not be held to effect a waiver or change of any part of the pbHcy. The policy requires that a written notice of accident must be given to the insurer or to an authorized agent. The stipulation just re- ferred to is to do away with the possibility of claim being made that verbal notice was given or that the agent had knowledge of the loss. In such cases it is almost impossible for the insurer to establish the con- trary. Notice in writing is required in order that there may be concrete evidence as to whether or not the necessary notice has been given within the time required by the policy and the provision in the alter- ation clause now under consideration is designed to strengthen the notice requirement and to prevent an unscrupulous assured from avoiding the effect thereof. The agreement that knowledge possessed by an agent or other person shall not be held to effect a waiver or change of any part of the policy is inserted with particular reference to the warranties made by the assured in the proposal. Where it develops that such warranties are untrue claim is frequently made that the soliciting agent was apprised of the truth but nevertheless in making up the proposal failed to state the facts. The general rule of law appHcable under these circumstances is that the knowledge of the soliciting agent is the knowledge of the insurer and that such action of the agent constitutes a waiver by STANDARD POLICY PROVISIONS 131 the company of its right to insist upon the defense of false warranty. To a layman it might seem that the companies have fully protected themselves against such claims of waiver by the use of the clause just referred to. In most of the states, however, the courts have held that notwithstanding the express provision in the policy to the contrary, the knowledge of an agent is knowledge of the company and where the truth is known to the agent the company may not set up this defense. In a few of the states it is yet possible for an insurer to rely upon the express wording of the contract into which it has entered and hence the agree- ment is still of some value. THE SCHEDULE. — It is customary to include in third party policies a copy of the proposal and this copy is ordinarily referred to as the schedule. In it appear the name, address and description of the assured, the period of the policy, a description of the subject matter of the insurance, the premium rates and the warranties made by the assured. Usually the schedule is the only portion of the policy contract which is not entirely in type. The various matters just referred to are inserted in the schedule by the policywriter. CHAPTER V EMPLOYERS' LIABILITY AND WORKMEN'S COMPENSATION ORIGIN AND DEVELOPMENT OF THE LAW OF EMPLOYERS' LIABILITY.— The conception that aw employer has a certain responsibility in the event that bodily injury to an employe be occasioned by the negligence of the employer has existed in one form or another since the very beginning of history. It would not be within the proper scope of this work to attempt a historical sketch of the development of these laws of liability interesting though such inquiry would be. We shall, therefore, not concern ourselves with the Jewish or Roman or other of the ancient codes bearing upon this subject, but shall confine our- selves to a brief outline of the development of the liability law applicable to the relationship of master and servant in England. It is scarcely necessary to say that this law as developed in the United States is based upon the English law of which ours is an off- shoot. The underlying principles had their root in the English common law, a system developed during a long period of years and made up of rules, customs, precedents and traditions which finally be- came crystalized in the decisions of the English courts. This so-called English common law is in force in England to this day and also in most of the states of the United States subject to modifications, defi- 132 EMPLOYERS' LIABILITY 133 nitions and enlargements which have been made by the English Parliament and the legislatures of the various states. FEW CONTROVERSIES PRIOR TO THE DE- VELOPMENT OF MODERN INDUSTRY.— Dur- ing the time that the common law was being developed in England, there was little occasion for controversies between employers and employes. All manufacturing and fabrication were of the most primitive character — carried on by hand at the home of the artisan. In nearly all cases the work was done by members of the employer's family and by a few servants or apprentices who were practically members of his family. Modern industrialism was a thing yet undreamed of. This situation is brought forcibly home to us when we con- sider that the English courts did not have occasion to consider the rules applicable to the liability of a master for personal injury received by an employe in the course of employment until 1837 in which year the famous case of Priestly versus Fowler was decided. NEGLIGENCE AND CONTRIBUTORY NEG- LIGENCE. — It has always been recognized that every individual owes to other individuals the duty of using reasonable care to prevent injury to them. If, there- fore, one be injured by the negligence of another he is entitled to damages subject to the qualification that a person whose own negligence contributes to his injury cannot recover. In this respect the law governing the general relationship between individuals is identi- cal with that, which, under the common law, governed the relationship of master and servant. 134 THIRD PARTY INSURANCE DOCTRINES OF FELLOW SERVANT AND ASSUMED RISK. — Under the common law, devel- oped as above indicated, certain other rules governing the relationship of master and servant were gradually- evolved. In substance these rules were to the effect that the employer owed to his employe thedutyofusing reasonable care to avoid injury to the employe, furnish- ing and maintaining safe work places, machinery and appliances, hiring competent servants and warning the servant of all dangers of the work known to the master and not known to the servant. The master having ful- filled these obligations had no responsibility to the servant on account of personal injuries received in the course of his employment. The servant could not re- cover damages on account of such injuries even though the master had not fulfilled his duty as above indicated if it appeared that the injury was due to the action of a fellow servant or to a hazard which was inherent in the employment and which was just as obvious to the servant as it was to the master. A servant seeking to recover damages from his master on account of per- sonal injury received in the course of his employment had first to establish that the injury was caused by a breach of one or more of the duties which the common law placed upon the employer. If the employe was able to establish a case there remained to the master the de- fense of contributory negligence and the two additional defenses just mentioned. DOCTRINES OF FELLOW SERVANT AND ASSUMED RISK EQUITABLE UNDER PRIMI- TIVE CONDITIONS.— Under conditions as they EMPLOYERS' LIABILITY 135 existed in England a century ago and in this country during its early history, there were obvious reasons for the development of these doctrines. It was con- sidered that where the servants were closely and in- timately associated, each entirely familiar with the personality, character and habits of the other, there was no good reason why a master should be held liable for an injury to one servant due to the carelessness of another. The theory was that the servant, being as familiar or even more familiar with the characteristics of his fellow than the master, was in a position to pro- tect himself. If one servant was careless it was the privilege of the other to leave the employment or to take such measures as he might deem expedient to avoid injury. The doctrine of assumed risk may also be justified as a proper and reasonable rule when applied under these primitive conditions. There was practically no machinery in the sense that we now use that term. The tools and appliances used were of the most simple character. The dangers incident to the handling of these tools and inherent in the employment were perfectly obvious to the servant. If realizing these dangers the servant chose to pursue the employ- ment, it was considered that the master had no re- sponsibility for injury due to such obvious risk. In other words, it was held that the servant assumed this risk. DEVELOPMENT OF MODERN INDUSTRIAL SYSTEM. — We are all familiar with the tremendous development in industrial activity, that is to say in all forms of manufacturing and fabrication, which has 136 THIRD PARTY INSURANCE taken place in this country and in England during the past century. The so-called "cottage" or "handiwork" system has been entirely displaced by the "factory" system. The close personal relationship between mas- ter and servant has, for the most part, disappeared. Great factories, manufacturing all varieties of products by means of intricate and dangerous machinery, have been built. There has been a most radical change in all factors upon which the relationship of master and servant is based. The conditions out of which the common law grew, have disappeared and in their place has grown up a colossal industrial system. UNDER MODERN CONDITIONS THESE DOCTRINES INEQUITABLE. — With changing conditions the underlying factors out of which these doctrines grew disappeared, but the doctrines re- mained. As industrialism progressed the application of these doctrines, which were all very well at the time they were evolved, gave rise to manifest inequities. Cases arose where a servant was injured by the negligence of a fellow employe whom he had never before seen and with whose characteristics he was not familiar. The injury was due to a condition against which the injured servant had no opportunity to protect himself. Nevertheless, it was held that the doctrine must be applied and even though the injured servant had exercised due care for his own safety, neither he nor his dependents had any recourse. For the same reason, many injuries were received by em- ployes by reason of hazards which were in fact inherent in the employment, but against which the EMPLOYERS' LIABILITY 137 servant could not, as a matter of fact, be fairly con- sidered to have had an opportunity to protect himself. In short, as the industrial system developed it became more and more manifest that these doctrines were inequitable and unjust. EMPLOYERS' LIABILITY ACTS. — Our law develops slowly and a principle once established is exceedingly difficult to change. Gradually, however, the inequity of these old common law doctrines became so apparent that the Parliament of England and the legislatures of the various states began to pass statutes calculated to alleviate this condition. Preliminary to the changes brought about by such statutory enact- ments there was much unrest and agitation by various labor organizations in this country and in England. As a consequence, a committee of Parliament was finally appointed to investigate the subject. The result of their investigation was the passage in 1880 of the employer's liability act, which has served as a model for similar statutes in the United States. At the time these various statutes modifying the com- mon law were passed, the doctrine of contributory negligence was still generally recognized as sound. It was conceded that an employe whose injury was con- tributed to in whole or in part by his own negligence had no right to recovery. The employer's liability acts, therefore, did not, in any wise, modify the com- mon law doctrine of contributory negligence. To avoid misapprehension, it may be well to say at this point that we are now speaking very generally. Employer's liability acts were not all the same. In fact, some of 138 THIRD PARTY INSURANCE them went so far as to modify the doctrine of con- tributory negligence, substituting in lieu thereof a so-called doctrine of comparative negligence to the effect that the master be held liable for injuries to his servant if he should be very negligent and the servant only a little negligent. It would be inadvisable in a work of this sort, dealing only with fundamentals, to make any attempt to discuss variations of this character. EMPLOYERS' LIABILITY ACTS DID NOT CREATE NEW CAUSE OF ACTION.— The prin- ciples which underlie the compensation acts were not then recognized as sound. There was no intent to revolutionize the fundamentals of the common law as applicable to the relationship of master and servant, but simply to ameliorate certain inequities, which, by reason of changed industrial conditions, were brought about by the application of the assumed risk and fel- low servant doctrines. Indeed, it was primarily the fellow servant rule at which these enactments were directed. The acts did not create any new cause of action nor take away any existing remedies. Neither did they entirely take away any existing defenses. It was still considered fair to apply the fellow servant rule to certain fellow servants and the doctrine of assumed risk as to certain inherent hazards. It was recognized that under industrial conditions as they then existed the master ordinarily did not personally direct the work and that such supervision was carried on by foremen who were selected by the master and who in effect were his personal representatives. It was EMPLOYERS' LIABILITY 139 considered that under these circumstances the master should be bound by their actions to the same extent as if personally present. This new doctrine was known as the "Vice Principal Doctrine." The acts provided that the vice principal was not to be considered as a fellow servant of subordinate employes and that such em- ployes were not to be held to have assumed those haz- ards which might exist or be developed by reason of the action of the vice principal. The employer, how- ever, had still open to him, without any qualification, the defense of contributory negligence and also, sub- ject to the qualifications above indicated, the defenses that the servant had assumed the risk or that the injury was occasioned by the negligence of a fellow servant. OTHER DEFECTS IN COMMON LAW SYS- TEM. — In their efforts to follow precedents and, at the same time, to do justice, the courts evolved many rules and fine spun distinctions. Cases involving responsi- bility of employers for injuries to employes became more and more numerous. Literally thousands of decisions were handed down each year. Not only were the decisions in the various states in conflict, but also in many instances there was conflict in the decisions of courts in the same state. The liability of the employer and the rights of the employe became more and more difficult to determine. Industrial de- velopment became more rapid, new processes, new machinery and new inventions came faster and faster. The courts became clogged with litigation and weighed down with the various rules, doctrines, differentiations 140 . THIRD PARTY INSURANCE and distinctions which were evolved for the purpose of adhering to precedent and at the same time doing justice. Where the facts were such as to enable the employe to recover damages, the question was pre- sented as to just how much he could recover. Under the common law system this matter was left entirely to the discretion of the jury. The damages were un- liquidated. Subject to proper instructions and a cer- tain amount of control by the court the compensation which an employe received depended entirely upon the judgment of twelve jurors. It is obvious that under this system there could, from the very necessity of things, be no uniformity in the amount of damages recoverable. Under precisely the same circumstances one workman, might recover $10,000 and another workman $500. DELAYS AND INEQUITIES INCIDENT TO COURT PROCEDURE.— There are certain rules of evidence which the law provides must be observed in the trial of cases in the courts. Primarily these rules are based upon sound principle, but the inception of most of them took place at a time when conditions were very dissimilar to those now existing. A subject so complex as this naturally gave rise, by reason of ■ the multitude of decisions, to conflicting rules. The law of evidence became more and more complex and divergent. Under these uncertain and difficult con- ditions the injured employe, if he could not arrive at a satisfactory settlement with his master, had no re- course but to start action in the courts. In many juris- dictions cases were not reached for trial for months WORKMEN'S COMPENSATION 141 and even years. In addition to this the finding of the first court was not conclusive. Either party was priv- ileged to appeal to one or more appellate courts on matters of law or fact. Unless an injured employe could immediately agree with his employer upon the amount he should receive, it was essential for the employe to place his case in the hands of an attorney. It was necessary that such attorney should be familiar with the mass of decisions applying to the question of liability, and with the procedure necessary to be fol- lowed in order to enforce that liability. The attorney was obliged to spend many hours in preliminary study, in the trial of the case, in the writing of an elaborate brief and in the argument of the case in various ap- pellate courts. No matter how fair an attorney might be he was entitled by reason of the time and effort necessary to carry the case to a successful conclusion, to a considerable fee. In addition to all this, there grew up in all large cities a class of attorneys known as ambulance chasers, consisting of unscrupulous members of the profession who specialized in matters of this character and who did not hesitate to exact fees which were out of all proportion to the work done. The consequence was that even in cases where claim- ants were successful a very large part of the amount ultimately recovered was absorbed by their attorneys' fees and the various expenses incident to the prepara- tion, trial and appeal of their cases. DEVELOPMENT OF WORKMEN'S COMPEN- SATION. — Gradually it was recognized that some- thing radical must be done to ameliorate this condition. 142 THIRD PARTY INSURANCE In the meantime in Europe, starting in Germany in the early eighties, an entirely different principle of lia- bility as between master and servant had been devel- oped. This principle first found expression in the passage of a workmen's compensation law in Ger- many in 1884. The various continental countries fol- lowed the lead of Germany, and, in 1897, England passed the workmen's compensation law which served as a basis for the compensation acts subsequently enacted in this country. The first of these compensa- tion laws which stood the test of constitutionality was the New Jersey law, which was passed and approved in 1911. The enactment of this legislation in other states followed with startling rapidity until at the present time there are workmen's compensation laws in force in forty-two states and three territories. These workmen's compensation laws constitute a radical de- parture from the theory of the common law and all previous statutes modifying it. The liability .which they impose rests upon an entirely new theory. The employer is made liable for all occupational injuries suffered by his employes. The underlying thought is that the employer should pay for such injuries in the same manner that he pays for damages to his machin- ery. It is considered that personal injuries to workmen are just as much incident to and inherent in the indus- try as is the breaking down of mechanical appliances. Under these laws, it is only necessary for the employe or his dependents to show that an injury has been re- ceived and that such injury arose out of and in the course of the employment. Upon such showing the WORKMEN'S COMPENSATION 143 claimant is entitled to the indemnity provided by the law. On the other hand, the employer is relieved of the uncertainty, expense, and constant source of irritation which has frequently strained his relationship with his employes. IMPROVEMENTS BROUGHT ABOUT BY COMPENSATION ACTS.— In substance, the com- pensation acts provide for the payment of specific amounts in installments for loss of life or of any mem- ber of the body, the exact amount payable being dis- tinctly specified and based upon a percentage of the wage of the employe. They further provide that in the event the injury causes total permanent disability the employe is to receive a certain percentage of his wages for a stipulated period, and if it causes tempor- ary total disability such payments are due during the period that he is unable to work by reason of the injury. Indemnities determined in the same general manner are also provided for cases where injury causes permanent partial or temporary partial disability. Therefore, there are two fundamental distinctions be- tween the new system and the old, namely : 1. A liability exists for every injury arising out of and in the course of employment. 2. The acts specify the precise amount of this lia- bility. Most of the acts provide for the appointment of a commission, usually referred to as the Industrial or Compensation Commission or Board, consisting of from three to five individuals. To these individuals, and subordinates selected by them, is intrusted the 144 THIRD PARTY INSURANCE administration and enforcement of the act. The old jury system is entirely eliminated as is also the old system of pleadings. PROCEDURE IN CONTROVERTED CASES.— If a controversy arises it is only necessary for the employe to file a simple petition with the Commission or Board. In most states the preliminary hearing is held before a referee in a very informal manner. The compensation acts provide that at these hearings the primary object shall be to get at the truth. They intimate in one way or another that the technical rules of evidence are, to a very great extent, to be disre- garded. After the arbitrator has heard and considered the evidence he enters an award. An appeal lies from his decision to the full board or commission. This appeal must be perfected in a short time or the decision of the arbitrator is final. The procedure incident to appeal is simple and informal. The decision on this appeal is final as to the facts. Most of the acts pro- vide, however, that a further appeal to the courts may be taken on questions of law only. In a few states the original jurisdiction in controversies arising under compensation acts is still left with the courts. Even in these states, however, the acts do away with the jury system and the matter is heard and summarily disposed of by the court sitting in the capacity of an arbitrator. COST OF COLLECTION SMALL.— In these proceedings it is not necessary for the claimant to have an attorney. He may present his case himself or if he is unable to do so adequately it is the custom for WORKMEN'S COMPENSATION 145 the arbitrator to assist the claimant in the presentation of his case to the end that all of the facts may be brought forth in as simple and expeditious a manner as possible. As a consequence of this new system of administration, the process of recovery under the com- pensation laws has come to be not only inexpensive to both parties but expeditious as well. The long delays incident to court procedure have been eliminated. Most of the acts provide that when a claimant is repre- sented by an attorney his fee shall be fixed by the Commission not in excess of a certain limited per- centage of the amount recovered. The net result is that under the new scheme of things, the money paid by the employer on account of work injuries actually reaches the injured workman or his dependents and is not wasted and eaten up in the process of ascertaining and collecting the amount due. DEFECTS IN PRESENT SYSTEM.— Of course there is no such thing as perfection and a number of defects have developed in the new system. While they are by no means as serious as those inherent in the old, nevertheless, there is still room for improvement. As, perhaps, might have been expected, the various boards, to which have been intrusted the administration of the compensation laws, have, in many instances, in their effort to eliminate old conditions, gone too far. As a result practically every question which has arisen under the compensation acts has been decided in favor of the injured employe. Perhaps the most serious aspect of this situation has been the tendency of the boards to include by their construction occupational 146 THIRD PARTY INSURANCE diseases within the scope of the compensation acts. The Enghsh compensation act specifically provides that certain occupational diseases, as distinguished from injuries, are included wivhin its coverage and that the employer must pay indemnity for loss of time so occasioned. The compensation acts which have been passed in most of the states do not so specifically include occupational diseases. Naturally, in this coun- try, the English decisions, at the outset, in the absence of any decisions of our own, were given great weight. In a considerable number of these cases the distinction between the English act and our acts was not appre- ciated. In computing premiums to be charged for this coverage, the insurance companies have proceeded on the assumption that the compensation acts, unless they so specifically provide, do not include any sort of occupational disease. Nevertheless, in border line cases, the employers and their insurance carriers have been held liable in many instances where disability was in fact due to an infirmity in the nature of a disease rather than a bodily injury. INSURANCE AGAINST EMPLOYERS' LIA- BILITY. — The need for protection against the liabil- ity imposed by law upon an employer by reason of occupational injuries brought into existence the busi- ness of employers' liability insurance. It originated in England and was first written in the United States in the year 1886 by the United States branch of an English company. Employers' liability was the first of the third party lines to be written. It has been fol- lowed by the various third party public coverages WORKMEN'S COMPENSATION 147 which have already been referred to. We have in Chapter III of this work briefly described the coverage given by the three forms of employers' liability poli- cies, which are in common use and have there indi- cated the methods adopted for the determination of premium. In Chapter IV we have discussed those pro- visions of employers' liability policies not referred to in Chapter III. COMPENSATION INSURANCE RAPIDLY SUPPLANTING EMPLOYERS' LIABILITY IN- SURANCE. — The business of employers' liability insurance in the United States is rapidly dwindling. At the present time compensation acts are effective in forty-two states and three territories. It is only a ques- tion of time, and a comparatively brief time, until all of the states will have passed compensation laws. The natural result will, of course, be the practical elimina- tion of the business of employers' liability insurance. It will not disappear entirely for the reason that many of the compensation laws now cover only certain haz- ardous employments or exclude certain employments. Nearly all of the acts specifically provide that they shall not apply to farm or ranch labor or domestic servants. Many of them provide that they shall not apply to an employer who has less than a stated number of em- ployes. The great majority of them provide that either the employer or employe may elect not to become sub- ject to the law. Ordinarily an employer making such election is deprived of his three common law defenses. On the other hand, if the employe elects not to become subject to the act, the employer who has not made such 148 THIRD PARTY INSURANCE election may avail himself of these defenses. Because of these and similar provisions contained in the various compensation acts employers' liability insurance will continue to be written to a limited extent. PREJUDICE AROUSED AGAINST INSURERS OF EMPLOYERS' LIABILITY.— Prior to the pass- age of the compensation acts the need for insurance against employers' liability had been pretty generally recognized and a large volume of this business was written in the United States. As we have already shown, the third party companies issued policies under which they obligated themselves to settle claims made by employes against employers on account of occupa- tional injuries or to defend suits brought to enforce such claims. The evils which we have described as incident to the old system of liability gave rise to much bitterness between the employing class and wage earners. While a majority of these claims were settled, the settlement usually left a feeling of mutual dissatisfaction and where litigation followed intense hostility frequently ensued. By reason of the fact that third party companies in effect stepped into the shoes of the employer and became at least indirect parties to these controversies a distinct and far reaching prejudice against these insurers was aroused among the work- ing classes. In many instances this enmity was unde- served and unfortunately in some cases it was justified. The whole system was wrong and as a consequence its application gave rise to many evils. The claim ad- justers of the companies, being always on one side and having frequently to defend non-meritorious claims, WORKMEN'S COMPENSATION 149 came, to some degree, to regard all claims with suspicion and to consider themselves as engaged in a constant warfare in which the end justified the means. In short their viewpoint became distorted and their perspective limited. EFFECT OF COMPENSATION ACTS IN ELIMINATING PREJUDICE.— The passing of the old and long established methods of determining em- ployers' liabiHty and the substitution therefor of the compensation innovation has had a very profound and far reaching eflFect on the business of third party insurance. The effect has been to radically soften the prejudices previously aroused in the minds of the working classes against third party insurers. While these deep seated and long existing animosities have not entirely disappeared much satisfactory progress has been made to that end. When one stops to con- sider the serious results in the way of legislation and otherwise which flow directly or indirectly from a situ- ation such as previously existed, the beneficent effects of the compensation acts from the standpoint of third party insurers can be appreciated. BULK OF COMPENSATION INSURANCE WRITTEN BY PRIVATE CARRIERS.— The com- pensation laws have revolutionized the whole business of third party insurance. The passage of these laws may be well regarded as the most important event in its history. All of the compensation acts require the employer to give some sort of guarantee of his ability to make payments of the indemnities provided for. Under most of the acts two alternative methods are 150 THIRD PARTY INSURANCE prescribed. The employer must carry compensation insurance in an authorized private carrier or he must submit evidence to the Industrial Board or other state authority that his financial condition is such as will enable him to carry his own insurance. In those states where state funds exist the employer is given a third alternative, namely, to insure in the state fund. It should be understood that seven of the states have monopolistic state funds and, in such states, the em- ployer must either give evidence of his financial responsibility or insure with the state fund. Experi- ence has proven that the employing classes generally are sufficiently intelligent to recognize the inadvis- ability of attempting to carry their own insurance irrespective of their financial resources. Hence the great majority of employers have not taken advantage of the second alternative above indicated. Therefore, in those states where there is no competitive state fund, the vast majority of employers carry compensa- tion insurance in private companies. Also private com- panies have been uniformly successful in their com- petition with state funds and in most states where state funds exist the bulk of the business is written by the private carriers. The result is that whereas only a part of the employing class carried employers' lia- bility insurance, the majority of employers in compen- sation states now carry compensation insurance with private companies. EMPLOYERS' LIABILITY RATES WERE IN- ADEQUATE. — Prior to the passage of the compen- sation acts there existed a very active competition WORKMEN'S COMPENSATION 151 among third party companies for employers' liability business. There was no state regulation of rates and the efforts made by the companies to establish uniform rates and to secure adherence by the various carriers to such rates were generally unsuccessful. The result was that employers' liability rates were, for the most part, entirely inadequate and during the decade pre- ceding the compensation era third party companies with a few notable exceptions lost a great deal of money in the conduct of this business. Those which were poorly managed or had small financial resources went under. The entire business came into more or less disrepute. COMPENSATION RATES NOW ADEQUATE. — All this has been changed by the passage of the compensation acts. In many states adequate rates are established by law and in the others the companies have at last succeeded in bringing about a sufficient degree of co-operation to do away with cut-throat rate wars. It is true that at the beginning the companies had great difficulty in establishing scientific rates for compensation insurance. They of course had no statis- tics developed in this country and those which had been compiled in England and on the continent were not only inadequate but, because of different con- ditions misleading. The result was the companies were obliged to proceed very largely in the dark and they, of course, made many mistakes. For a time the compensation business proved very unprofitable. A number of companies whose management was not effi- cient or who wrote more of this business than their 152 THIRD PARTY INSURANCE resources warranted failed and others voluntarily with- drew from the line. With the growth of the business to its present immense proportions, experience on an enormous volume of pay roll has been collated, and the time has or soon will come when compensation rates may be fixed in accordance with sound actuarial principles. CAUSES CONTRIBUTING TO BRING ABOUT RATE ADEQUACY.— Credit for the pioneer work which has been largely responsible for the present satisfactory condition of compensation rates must be given to the National Workmen's Compensation Serv- ice Bureau of New York City. We shall give further consideration to it in a subsequent chapter. Also it must not be forgotten that abnormal conditions brought about by the war have assisted materially in tiding the companies over the critical period in the compensation business. Wages have increased enorm- ously and premiums based upon wages have nat- urally increased correspondingly. At the same time the maximum benefits provided by the compensation laws have remained practically stationary. The re- sult has been that the premiums received have been larger than the carriers had any reason to expect at the time the rates were determined and, in conse- quence of this condition, profits have been recently made which have served to offset losses incurred dur- ing the experimental years. COST OF COMPENSATION INSURANCE SHOULD BE KEPT AT MINIMUM.— There can be no question but that the compensation business WORKMEN'S COMPENSATION 153 partakes of a public interest and that considerations of public policy require that employers should be pro- vided with insurance at the minimum cost consistent with safety and efficient service. Third party com- panies are, almost without exception, fully sensible of this fact and have no desire to make undue profit out of the business. They appreciate the insurance, being compulsory and involving so many considerations of public policy, must be carried by them at a minimum profit if they are to remain, as they are now, the principal carriers of this liability. It is, therefore, gen- erally conceded that the companies should be per- mitted to make only a small underwriting profit. The consensus of opinion is that this profit should be in the neighborhood of 1% of premiums written. In addition to this, the companies, of course, will receive their so-called banking profit ; that is to say the inter- est on deferred payments. COMPENSATION RATES NOW IN PROCESS OF RE-ADJUSTMENT. — For reasons above indi- cated compensation rates are now in process of a downward revision to the end that the companies may receive only the comparatively small profit to which they are entitled. This re-adjustment involves the solution of many difficult problems. It is recognized that in the United States the cost of compensation insurance has not yet arrived at its peak. Experience in Europe and in those states which were pioneers in installing the compensation system has demonstrated that it takes a certain period of time for the pubHc to become educated to the possibility of recovery under 154 THIRD PARTY INSURANCE compensation acts. Therefore, rates which are ade- quate during the first year or two that an act is in force later become inadequate. Another perplexing question arises in connection with the determination of the permanency of the present wage level. As we have already shown, wages have increased enormously without any corresponding increase in maximum limits under the compensation laws. If wages remain at their present level the companies will be justified in materially reducing compensation rates. If such re- duction is made and is followed by a shrinkage in wages, rates will then become inadequate and large losses will result. The future of the compensation business from the standpoint of third party companies therefore depends, in a considerable measure, upon the exercise of correct judgment in the determination of these difficult problems. COMPENSATION POLICY FORMS.— The forty- five compensation acts which are at the present time in force in the states and territories of the United States are in no sense uniform. On the contrary, they vary in many vital and material respects. From the standpoint of the compensation insurer this situation gives rise to many difficulties. The acts of many of the states pro- vide that the compensation policy forms must be ap- proved by the insurance commissioner or the industrial board. In other states where there is no such statutory requirement commissioners or industrial boards have seen fit to insist upon the submission of policy forms for their approval. Many of the compensation acts indicate specifically certain provisions which must appear in WORKMEN'S COMPENSATION 155 compensation policies. While a comparison of the re- quirements of the various acts in this respect indicates a general similarity, they vary to a considerable extent. Some of the states, with or without express statutory authority, have insisted that companies doing com- pensation business within their borders must use a special state standard policy form and these standard forms as promulgated have, in some instances, been poorly drawn by men unfamiliar with all of the intri- cacies incident to the practical handling of compensa- tion insurance, thus occasioning to the companies much inconvenience and annoyance. Incidentally these so-called standard forms as drafted by the vari- ous state authorities have not been at all uniform, but vary not only in those respects made necessary by differences in the laws but also with the peculiar idiosyncrasies, whims or prejudices of their draftsmen. THE UNIVERSAL STANDARD WORKMEN'S COMPENSATION POLICY FORM.— Until recently the companies have, therefore, been obliged to prepare and use a large number of different compensation policy forms. The lack of uniformity in these forms has given rise to much confusion in the handling of the detail work incident to the conduct of this busi- ness. Aside from this, such procedure has involved very considerable expense in the way of printing and keeping track of this plethora of contracts. This de- cidedly unsatisfactory condition has led the companies to attempt to so standardize the policy form that it may be used in all of the compensation states in con- junction with a special state rider to take care of 156 THIRD PARTY INSURANCE special statutory enactments of such character that they are not susceptible to standardization. Mr. W. G. Cowles, Vice-President of the Travelers' Insur- ance Company, has been particularly active in this connection and due to his untiring efforts this much to be desired result has been practically attained through what is known as the universal standard workmen's compensation policy form, which has now been approved for use in all but two of the compensa- tion states. CHAPTER VI PUBLIC LIABILITY NEGLIGENCE. — Under all systems of jurispru- dence, ancient or modern, it has been recognized that the freedom of individual action is subject to limita- tion and that no person has a right to indulge in any individual activity the result of which is to injure another in person or property. The obligation lies upon everyone to exercise reasonable care to avoid such injuries to others and if the failure to exercise such care is the proximate cause of injury to another the wrongdoer is responsible in damages to the in- jured person or his representatives. Every person is liable to respond in damages in the event that his fail- ure to exercise reasonable care, which failure is known as negligence, causes injury to another. CONTRIBUTORY NEGLIGENCE.— To this basic liability there is one generally recognized exception, namely, that the wrongdoer is not responsible to the injured person if such person is himself guilty of negligence and such contributory negligence is one of the causes proximately bringing about his injury. We have pointed out in the preceding chapter that the special relationship of master and servant has given rise to other qualifications known as the doctrines of assumed risk and fellow servant. These doctrines have no application to the determination of liability in cases 157 158 THIRD PARTY INSURANCE not involving a controversy between master and serv- ant. When the parties are strangers and under no such contractual relationship the liability of one on account of injury done to the other depends upon the determination of two propositions. Has the person causing the injury failed to exercise reasonable care? If so, he is responsible unless it appears that the in- jured person has also been negligent and his con- tributory negligence one of the causes of his injury. BURDEN OF PROOF.— It is fundamental that one seeking to recover damages from another has at the outset to establish as a prima facie proposition that the person accused has been negligent and that his negligence caused the injury. Also if he is to prevail the plaintiff must establish his contentions by the greater weight of the evidence. This conception is ordinarily expressed by the statement that upon the one claiming damages rests the burden of proof. Under the common law and most statutory enact- ments, it is also necessary for the one seeking damages to establish that he himself has not been guilty of con- tributory negligence. This is a part of the burden of proof which rests upon him. Therefore, in an ordinary suit brought to recover damages alleged to have been occasioned by negligence, the plaintiff must allege and prove by the preponderance of evidence that the defendant was guilty of negligence which caused in- jury to the person or property of the plaintiff and that the plaintiff was free from negligence, i. e., at the time the injury was received was exercising reasonable care for his own safety. PUBLIC LIABILITY 159 STATUTORY MODIFICATIONS OF COMMON LAW RULES. — We have already shown that some of the employers' liability acts have laid down the doc- trine of comparative negligence. They provide that an injured employe may recover from the employer even though guilty of contributory negligence if it appears that the employer was guilty of gross negli- gence and that the contributory negligence was slight. Under these acts it is commonly provided that the jury may take into consideration the comparative negligence of the two actors and may bring in a ver- dict arrived at by giving due weight to these factors. This same doctrine of comparative negligence has, by statutory enactment in some of the states, been made applicable to cases not involving the relationship of master and servant. Also in some states the legis- latures have modified the common law rules relative to burden of proof. Under such enactments it is pro- vided that the burden of establishing contributory negligence is upon the defendant and that the injured person makes out a prima facie case by introducing evidence tending to indicate that his injury was occasioned by the negligence of the defendant. To this prima facie case the defendant is permitted to set up and prove contributory negligence as a matter of defense. In jurisdictioris where this rule is in force the burden of establishing contributory negli- gence rests upon the defendant, which means that the defendant must establish contributory negligence by the greater weight of the evidence. These departures from common law rules have not met with general 160 THIRD PARTY INSURANCE approval and in nearly all the states the principles of law applicable are those which we have described in the preceding paragraphs. PUBLIC LIABILITY INSURANCE.— From the foregoing it will be apparent that an individual, firm or corporation engaged in any sort of a business enter- prise is likely at any time to be called upon to respond in damages on account of injuries to members of the public occasioned by reason of the conduct of such enterprise. This situation has given rise to a demand for various kinds of public liability coverage. This need has been met by third party insurers and as new situations have arisen new forms of coverage have been devised to meet the exigencies of the particular case. Naturally because of the various conditions under which public liability may arise it has been found impossible to cover all of these contingencies under one policy form. We have heretofore in Chapter III listed fifteen separate forms of public liability cov- erage which have come to be generally recognized. We have also there described the insuring clauses of these various policies and the methods by which pre- miums are determined. In Chapter IV we have made a comparative analysis of those provisions of these policies not referred to in Chapter III. It will, there- fore, not be necessary for us to give any further de- tailed consideration to public liability policy forms. DEVELOPMENT OF PUBLIC LIABILITY IN- SURANCE. — In the previous chapter we have called attention to the fact that the need for employers' liability insurance has only existed for a comparatively PUBLIC LIABILITY 161 short time. The development of modern industry has been responsible for the concurrent development of employers' liability insurance. What has been said in that connection is very largely true of the business of public liability insurance. As a matter of fact this business is of more recent origin than that of em- ployers' liability, which, as we have seen, was first written in the United States in 1886. Public liability insurance is in reality an enlargement or extension of employers' liability. A third party company having issued its policy to an employer under which it agreed to indemnify the insured against liability imposed by the law on account of injuries to employes would naturally be called upon by some of its assured to extend the coverage to indemnify against liability im- posed by reason of injuries to persons other than employes. This is precisely what happened. Out of the extension of employers' liability policies grew the practice of issuing separate policies of public liability insurance. As the insurers became experienced in this line and as the demand for this coverage grew the various policy forms now in general use were evolved. PUBLIC COVERAGES WHICH LOGICALLY ACCOMPANY EMPLOYERS' LIABILITY AND COMPENSATION. — There are certain public cover- ages which are customarily issued as supplementary to employers' liability or compensation insurance. As we have already seen workmen's compensation is simply a new form of employers' liability and one or the other of these coverages is customarily carried 162 THIRD PARTY INSURANCE by employers. When, therefore, a policy of compen- sation or employers' liability insurance is issued to a manufacturer or a contractor, it is customary to also issue a manufacturers' or contractors' public liability policy running for the same period. Such public policy serves as a supplement to that protecting against in- juries to employes in that it provides indemnity against liability arising on account of injuries to per- sons who are not employes. As already indicated, the premium for these two public policies is arrived at in the same manner as the premium for the com- pensation or employers' liability policy. It is based upon the payroll of the same employes and premiums vary with the same occupational classifications. MAINTENANCE AND OPERATION OF BUILDINGS AND ELEVATORS.— A somewhat different situation exists as regards general and ele- vator public liability. The premium for neither of these policies is based upon payroll, but upon area and frontage in the one case and upon an individual charge for each elevator in the other. Persons engaged in the maintenance or operation of buildings or eleva- tors have certain insurance needs which are in one sense the reverse of those of a manufacturer or con- tractor. As a general proposition, the primary liability against which a manufacturer or a contractor must seek protection is that incident to the injury of em- ployes. These employers are engaged in enterprises which involve the services of a number of employes. In most cases the public hazard is only an incident. On the other hand, one who is engaged in the main- PUBLIC LIABILITY 163 tenance or operation of a building or elevator is ordi- narily concerned principally with his possible liability on account of injuries to members of the public. Such an enterprise does not usually involve the employment of more than a few persons and the principal hazard is that arising by reason of injury to members of the public who may be upon the premises. In many instances the assured under these policies are not sub- ject to the compensation laws. In most cases the hazard has little or no relation to the payroll of employes since it is not one which primarily arises from the activities of employes, but rather from the inherent dangers incident to the use or maintenance of the subject matter of the insurance. For these reasons while manufacturers' and contractors' public policies are usually purchased as a matter of course by one who takes out employers' liability or compen- sation insurance, the general liability and elevator policies are handled as individual and distinct prop- ositions. GENERAL LIABILITY WRITTEN MOSTLY IN THE LARGE CITIES.— The great bulk of gen- eral liability insurance is written in a few of the larger cities. The public generally is only just commencing to realize its value. In rural districts and in smaller cities and towns very little of this owners', landlords' and tenants' insurance is issued and that whicli is written is confined almost entirely to the coverage of stores, theatres, hotels and other buildings where the public is accustomed to gather in large numbers. Therefore, the companies have as yet only scratched 164 THIRD PARTY INSURANCE the surface in so far as the possibilities of premium income to be derived from this business are concerned. A general campaign of education is being carried on and throughout the country the owners, landlords and tenants of buildings are gradually coming to appre- ciate the desirability and even the necessity of carry- ing this form of insurance. The business as a whole has been profitable to the companies and offers many attractive future possibilities. UNSATISFACTORY CONDITIONS WHICH EXISTED IN NEW YORK CITY.— In some of the larger cities and particularly in New York City it is customary for the owners and tenants of practically all buildings to insure against the liability which may be imposed upon them on account of injuries to mem- bers of the public while upon or about the premises. This practice has arisen out of a real necessity brought about by the peculiar conditions existing in the large centers of population. Perhaps the most important factor in educating the general public as to the possi- bilities of recovery on account of personal injuries due or alleged to be due to acts of negligence in connection with the maintenance or upkeep of buildings has been the activity of a certain class of attorneys. In certain densely congested districts in New York City the possibilities of making money by the prosecution of such claims have been taken advantage of by un- scrupulous claimants and dishonest attorneys to such an extent that the companies have been forced to establish prohibited areas in which they will not write general liability insurance. Where the claimant's PUBLIC LIABILITY 165 conscience is sufficiently elastic and he acts under the guidance of a crooked attorney, familiar with the principles of law applicable, it is very easy to collect considerable sums on fictitious claims. Such claims are easy to make and hard to disprove. Particularly where the claimant is a woman the jury is usually inclined to be liberal with the defendant's money. These conditions became so bad in New York City that the companies writing general liability insurance lost a great deal of money. It was discovered that the business of collecting on fictitious claims of this character was conducted on a wholesale basis and made possible by fraudulent and criminal conspiracies existing between claimants, lawyers and physicians. In some cases it was found that the assured was also a party to the conspiracy. Certain radical steps have been taken by the companies to correct these evils. Experience in the various districts has been carefully collated, rates have been materially increased and certain districts placed on the prohibited list. Also steps have been taken to ferret out and prosecute habitual claimants, crooked attorneys and doctors. As a consequence of the work which has been done in this connection by third party companies in New York City, conditions have materially improved and it is now possible to make a reasonable profit out of this business if it is carefully and efficiently conducted. TEAMS' INSURANCE.— Prior to the development of the automobile industry, the business of insuring against public liability arising by reason of the use and maintenance of vehicles was confined to teams' 166 THIRD PARTY INSURANCE public and property damage insurance. Outside of the large cities very little of this business is written. The danger of injury to members of the public through the use and maintenance of team-drawn vehicles in rural communities is, of course, not great. There does, however, exist a hazard which should be taken care of by insurance and the fact that such hazard is mate- rially less than that incident to the operation of teams in closely settled sections is reflected in the premiums charged. The situation as regards this insurance is quite similar to that which we have described in our discussion of general liability. For the reasons there indicated it may confidently be expected that there will continue to be a substantial increase in the volume of this insurance. Much yet remains to be done to bring about a scientific and dependable method of determining rates for teams' insurance. However, a relatively large experience is now available in such form that the actuaries may derive from it the prin- ciples which will enable them to fix correct rates. AUTOMOBILE INSURANCE.— Next to the in- auguration of the new system of liability imposed by compensation acts the development of the automobile industry has had the most profound effect upon the business of third party insurance. Both compensation and automobile insurance have developed during the present century and almost over night have come to be of the utmost importance to third party companies. We are not here interested in the early vicissitudes experienced in perfecting motor vehicles to a point where they became an important commercial factor. PUBLIC LIABILITY 167 This because the necessity for this form of insurance did not arise until that time. Automobile construction was first undertaken in the United States in the early nineties, but the industry had not developed to an extent where insurance became necessary until the beginning of the present century. Some idea of the possibilities in the way of premium income from auto- mobile insurance may be derived from the considera- tion of the fact that at the present time it is conserv- atively estimated that there are over six million auto- mobiles in use in the United States. DIFFICULTY IN DETERMINING AUTOMO- BILE RATES. — In previous chapters of this work we have described the various forms of automobile insur- ance and the methods by which premiums are deter- mined. By reason of the rapid development of this business and the absence of dependable statistics the companies have been confronted with many perplexing problems in their efforts to fix scientific rates. The situation has been further complicated by the difficulty of establishing any uniform rating system which will take care of the varying hazards which are presented. Rating systems which are applicable to certain of these hazards cannot be applied to others and so many factors enter into each that it is difficult to devise any well balanced system which will give proper weight to all pertinent considerations. PECULIAR HAZARDS INCIDENT TO OP- ERATION OF AUTOMOBILES.— Automobiles are powerful mechanisms and their operation involves certain new and serious hazards to the general public. 168 THIRD PARTY INSURANCE The use of these vehicles has increased so rapidly that the law-making bodies have been unable to keep abreast with the legislation necessary to properly regulate that use. So many vital public interests are involved that it is certain that the next few years will witness the development of a great amount of legisla- tion designed to put such limitations and restrictions upon the operation of motor vehicles as may be neces- sary to safeguard the public. It is true that much has already been done. Legislative thought, which has not as yet been crystalized into law, has also been brought to bear in many states and a number of proposed laws are now under consideration. Logic- ally the first step taken has been to provide for the registration and licensing of automobiles and the placing of certain speed limits upon their operation. There are in practically all states various state and municipal laws applicable in this connection. Not- withstanding these regulations the number of acci- dents due to the use of automobiles and occasioning fatal or serious bodily injuries is appalling. COMPULSORY INSURANCE.— One of the legis- lative conceptions which has already taken firm root is that owners of automobiles should be required by law to give some assurance of their ability to pay damages for which they may become responsible by reason of personal injuries occasioned by the operation of such automobiles. There are, of course, certain classes of motor vehicles which are used for purposes making this requirement peculiarly imperative. Of these the most conspicuous are automobiles which are PUBLIC LIABILITY 169 used as public carriers. In certain sections of the country so-called jitney buses are customarily used for the purpose of transporting passengers for hire. These jitneys have regular routes, the fare charged is small and to a large extent they perform the same function as street cars. In the rapid development of this business many persons of little or no financial responsibility became engaged in it. There being no regulation many evils developed. The vehicles were operated carelessly, were overcrowded and a great number of serious accidents, involving injuries to passengers and pedestrians, occurred. Inasmuch as in a majority of cases the owner or operator of the jitney had no financial responsibility, it was impossible for injured persons or their representatives to recover damages suffered by reason of the negligent operation of these common carriers. A remedy was immediately sought in the passage of municipal ordinances, which, among other things, required the owners of jitneys to carry insurance. These ordinances have been followed up in a number of states by statutes to the same effect. EXTENSION OF COMPULSORY INSURANCE REQUIREMENTS TO VEHICLES OTHER THAN COMMON CARRIERS. — The same reasons which have given rise to the insurance requirements above referred to are applicable in a modified degree to all classes of motor vehicles. Automobile accidents are so frequent and so many persons receive serious in- juries in consequence thereof that it has come to be generally recognized that certain very definite in- terests of public policy are involved. It seems clearly 170 THIRD PARTY INSURANCE within the police power of the government to require persons operating these dangerous instrumentaHties to provide adequate protection for those who may be so unfortunate as to receive bodily injuries while in the exercise of due care for their own safety. As a consequence of the realization of the necessities of this situation, there have been presented to many legislatures within the last few months bills designed to require the owners of all classes of motor vehicles to make provision for the payment of damages on account of injuries occasioned by their use. INTELLIGENT LEGISLATION REQUISITE. ■ — For the most part these proposed laws have been hastily drawn by draftsmen who have not devoted sufficient attention to the subject to enable them to prepare adequate and equitable laws. For this reason most of these proposed bills have not been enacted into law. In a few states statutes have been passed affecting certain classes of motor vehicles, notably the jitneys already mentioned. The entire subject is at the present time a very live one and there can be no question but that much more comprehensive legisla- tion is in immediate prospect. The acts which have been thus far proposed are in no sense uniform and for the most part are not predicated upon any adequate knowledge of the best methods by which the desired result may be attained. It is scarcely necessary to say that the subject is sufficiently important to war- rant the most careful investigation and that it is eminently desirable that this legislation be made as uniform as possible. Unwise and illconsidered legis- PUBLIC LIABILITY 171 lation may do irreparable harm. If the protection is to be given it must be given in such a way as to be real and adequate. The draftsmen of the legislation should be guided by the lessons of experience with the special and predominant aim of preparing a law that will bring about the greatest possible benefit to all persons concerned, including not only those mem- bers of the public for whom the protection is desired but also the owners of automobiles. DEFECTS IN PROPOSED LAWS.— In nearly all cases it seems to have been assumed that the method best calculated to protect the public is to require all automobile owners to file a bond with some state or municipal officer. As a practical prop- osition the filing of a bond is a very unsatisfactory method of accomplishing the desired result. If per- sonal sureties are allowed, and under most of the bills such sureties are permissible, the protection is always doubtful. If the alternative method be adopted and the law require the surety to be a corporation duly authorized to do a surety business, there remain many forcible objections. A bond is not a contract of indemnity and does not protect the automobile owner at all. He must, in the first instance, become his own insurer and if financially able to do so must stand the loss, which may be irreparable, if a large judgment is rendered. The obvious solution is to require an indemnity contract which would protect the owner of the motor vehicle as well as the person injured. Such contract should, of course, be required to provide that judgment may be collected from the insurer in 172 THIRD PARTY INSURANCE the event of the insolvency of the assured. Some of these bills eliminate any requirement as to bond or insurance in the event that the automobile owner is able to establish his financial responsibility to the satisfaction of some designated state or municipal authority. Theoretically, this is a reasonable prop- osition. Practically it is a farce. The fact that the owner of an automobile may be solvent at any par- ticular time does not constitute the slightest guarantee that he will be solvent when it comes time to pay a judgment. Everyone knows that litigation of this character is in the courts for years. Obviously a protection of this kind is ridiculously inadequate. Aside from this, it would be impossible for any ofScial to intelligently determine financial responsibility in the great number of cases that would be presented to him. It is safe to say that in almost every instance the function would be performed in a perfunctory and slip-shod manner. SUGGESTIONS AS TO PROPER FORM OF THIS LEGISLATION.— Every purpose of public policy underlying the legislation which we have just discussed may be attained and every objection which we have pointed out eliminated by the passage of a law which provides in substance: 1. Every applicant for Hcense must file with a designated state, county or municipal official an indem- nity contract of Hability and property damage insur- ance running for a period of not less than the term for which the license is issued and written by an insurer authorized to do business in the state. PUBLIC LIABILITY 173 2. Such contract must provide to indemnify the assured within adequate limits, against all liability which may be imposed upon him by law on account of injuries to persons other than employes of the assured occasioned by the operation, maintenance or use of the licensed motor vehicle. 3. Such contract must further provide that in the event a final judgment is recovered against the assured in a case covered by the policy, such judgment must, subject to the limits of the policy, be immediately paid by the insurer direct to the plaintiff. LIABILITY WITHOUT FAULT.— A very inter- esting and radical suggestion has recently been made, namely, that the owners of motor vehicles, without regard to negligence, be made liable in fixed amounts for injuries occasioned by the operation of such vehicles. This rather startling innovation, it will be observed, would have substantially the same effect upon the public liability of the owners of motor vehicles that the compensation laws have had upon the liability of employers. The owner of an auto- mobile would be obligated to pay for every injury occasioned by its operation without reference to and entirely irrespective of negligence or contributory neg- ligence. On the other hand, the payments to be made by him would be fixed along somewhat the same lines as have been followed in the drafting of the compensation laws. It is obvious that this innovation would have some decided advantages. It would do away with a mass of litigation which has already clogged the courts in some measure to the same extent that the old em- 174 THIRD PARTY INSURANCE ployers' liability litigation did. It would bring about immediate payments to persons injured in automobile accidents or their dependents. It would also eliminate to a very considerable extent the cost of collection of damages incident to the present system. Most of these public cases are handled by attorneys who because of the difficulties and delays consequent upon litigation are obliged to charge considerable fees and who in many instances charge unconscionable fees. Desirable as all this would be it may well be doubted whether such a law would stand the test of constitutionality. In order to sustain such a law the courts would have to go much further than they have already gone in sus- taining the compensation acts. It is barely possible that an ingenious court could evolve some theory upon which to predicate a finding of constitutionality. It may, however, be predicted with considerable assur- ance that there are practically insurmountable diffi- culties in the way of such legislation. PROPERTY DAMAGE.— Among the recognized public coverages listed in Chapter III are automobile and teams' property damage. What we have said in this chapter pertaining to the automobile and teams' public business is largely applicable to the two forms of property damage. There is little differ- ence between an agreement to indemnify an assured against liability imposed by law on account of personal injuries occasioned by his operation of a vehicle and an agreement to indemnify on account of damage to the property of others so occasioned. The responsi- bility of the assured is determined by the application PUBLIC LIABILITY 175 of the same legal principles and the problems pre- sented to the insurer are practically identical. One distinction between the public and the property damage coverages arises out of the difference in the amount of damages for which the assured is likely to become responsible. It is quite apparent that in the great majority of cases accidents due to the opera- tion of vehicles are not likely to result in large prop- erty damage loss. For this reason the premium for public coverage is very much higher than that charged for property damage and it is customary for the companies to place a correspondingly low limit upon their liability. As we have already seen, the standard limit for property damage is $1,000.00 on account of one accident. There are, of course, certain rather remote possibilities of the assured becoming respon- sible in a large amount on account of property damage occasioned by the use of a motor or other vehicle. Among these is that arising by reason of the possi- bility of a fire being occasioned by the negligent operation of such vehicle and occasioning large prop- erty loss. Cases of this character are, however, so rare that it is not customary for the insuring public to require more than the standard limit for property damage insurance. COLLISION INSURANCE A DEPARTURE FROM THIRD PARTY PRINCIPLES.— ColHsion insurance, of course, constitutes a radical departure from the general theory of third party insurance. It involves a direct contractual relationship between the insurer and the person whose property is damaged 176 THIRD PARTY INSURANCE and hence the problems presented to the insurer are of a special and unique character. The company issu- ing this coverage does not indemnify its assured against a liability to a third person, but agrees to pay the assured for loss suffered by him. The form of contract which has been created for this purpose and the methods of determining premium have already been described. The carrier is obligated under its contract to pay for actual damage to the insured car brought about by a collision with a moving or stationary object. Having received notice that an accident has occurred it devolves upon the claim department to identify the car, make careful estimate of damage done and replace or repair the automobile as economically as possible. As might be expected a decided moral hazard is involved in this form of insurance. The companies have experienced much difficulty in limiting their payments to the actual damage sustained for the reason that there is a marked disposition on the part of the insuring public to make excessive claims. By this we do not mean that fic- titious claims are frequent, but there is a general tendency among assured whose cars have been dam- aged by collision to endeavor to secure repairs other than those necessitated solely by reason of the col- lision. For this reason and because of the excessive cost brought about by present abnormal conditions the business in recent months has been decidedly unprofitable. The foregoing remarks are applicable particularly to collision insurance on cars of the private passenger type. Experience on commercial PUBLIC LIABILITY 177 vehicles has been much more satisfactory, presumably for the reason that assured are not so particular as to the appearance of these vehicles, are not incHned to present claims for accidents involving scratches and other trivial injuries and are far more reasonable and more easily satisfied in connection with the making of repairs. DEDUCTIBLE COVERAGE.— As previously indi- cated, collision insurance is written in two forms ; one known as full coverage and the other as deductible coverage. The writing of deductible coverage grew out of the desire to devise some means to eliminate the moral hazard. At the outset the deductible con- tract provided that the insurer should be liable only for damage in excess of $25.00. Experience proved that the amount retained by the assured as his own risk was not sufficient and that in actual practice there was a tendency on the part of the assured to increase claims sufficiently to take care of the liability rest- ing upon them. Also in the stress of competition some of the companies made a practice of ignoring this retention and of paying claims in full. A few months ago the principal carriers engaged in this business agreed to write three forms of collision insur- ance — ^full coverage, $50.00 deductible and $100.00 deductible. Very little of the latter form has been issued and the relief hoped for has not been secured. Apparently the only solution is to eliminate the writ- ing of full coverage entirely and issue only deductible coverage. The amount to be retained by the assured should not be less than $100.00. It is believed that by 178 THIRD PARTY INSURANCE thus entering into a contract of co-insurance the moral hazard which has had so much to do with the unsatis- factory experience will be largely eliminated. The assured as a co-insurer will naturally be much more careful and if the retention is fixed at an amount sufificiently large the petty claims which in the aggre- gate make up the great bulk of collision losses will be done away with. It is in connection with these claims that most of the difficulties incident to the business have arisen and their elimination should make it possible to place the business upon a reason- able profit basis. OTHER PUBLIC COVERAGES.— In this Chapter we have now discussed all of the recognized public coverages listed in Chapter III with the exception of the two contingent or protective forms — owners' and contractors', the physicians' and surgeons' and the druggists' public liability policies. These coverages have been devised to meet certain peculiar situations and they are relatively unimportant from the stand- point of volume. Inasmuch as we have in Chapter III described the insuring clauses of these policies, the methods by which premium is determined and the circumstances under which they are issued, further comment here is unnecessary. CHAPTER VII UNDERWRITING THE UNDERWRITING DEPARTMENT.— The proposal for all forms of insurance comes to the insurer in the form of a written memorandum and it relies largely upon the facts so presented in deter- mining whether a policy is to be issued and, if so, upon what terms. Various methods have been devised by the companies to verify statements made in the proposal and to supplement the information therein contained. The department in charge of all of this work is quite universally known as the underwriting department. This name is, in a sense, a misnomer. The term "underwriter" was first applied to those individual insurers who wrote their names under con- tracts of marine insurance and assumed individual responsibility for certain carefully restricted portions of the general insurance undertaking. The employes of an insurance company who perform the very im- portant work of determining what risks shall be accepted and the other questions incidental thereto are, in reality, not underwriters, i. e., they are not insurers and do not undertake any individual or other insurance responsibility. In a correct sense the com- panies are themselves the underwriters as it is they who subscribe the contract and become bound thereby. Inasmuch, however, as it is the universal practice to 179 180 THIRD PARTY INSURANCE designate the department whose functions we have above set forth as the underwriting department, we shall do likewise. GENERAL PROCEDURE.— The procedure fol- lowed by the underwriting departments of third party companies involves no substantial departure from methods in general use by all insurers. Proposals come daily from the production or agency department to the underwriting department. That department checks the proposals as to rates, classifications and technical makeup. Search is made to ascertain whether the risk has been previously carried by the company and if so whether previous experience has been satis- factory or otherwise. Investigation is also made to ascertain whether the company has on file any record that the particular risk has ever been cancelled or re- jected by another company or that another company has paid claims on same. After going through these various processes if it is found that the risk as submitted conforms to the rules and rates in use, if the class of business is satisfactory, if neither the company to which the proposal is made or any other carrier has had unfavorable experience, the risk is approved. If technical mistakes have been made, it falls upon the underwriting department to correct them. If the risk is obviously one which is objectionable it is imme- diately rejected. If questionable such further investi- gation is carried on through correspondence and otherwise as may be necessary to gather all available information and final decision is made on the basis of facts so disclosed. UNDERWRITING 181 POLICY WRITING.— The procedure followed by the underwriting department varies with the practice of the particular company as to policywriting. Ordi- narily policies are not written at the home office. Policywriting supplies are placed in the hands of the company's agents or branch offices depending upon whether it operates on a general agency or branch office system. Ordinarily when the proposal is re- ceived by the home office the policy has already been written and the proposal is simply a copy of the schedule of the policy which has been issued. If the underwriting department determines that the risk is undesirable it requests the branch office or policy- writing agent to effect cancellation. If mistakes have been made in classifications or rates or in any other respect, the underwriting department takes such steps as may be necessary to bring about correction. Inas- much as the great bulk of the business of any insur- ance company is not written at the place where the home office is located this work is done largely by correspondence. In those cases where the producer of the business is not given policywriting privileges, policies are written at the home office under the super- vision of the underwriting department and sent to the producer for delivery. PROHIBITED AND QUESTIONABLE RISKS. — The experience of the companies has indicated that there are certain risks which are either entirely unin- surable or can be profitably written only under certain special conditions. These risks are of two kinds; those which are engaged in extremely dangerous 182 THIRD PARTY INSURANCE work and those involving a moral hazard. Of the two the latter is the more objectionable. Risks falling within the so-called hazardous classifications are in- surable. Where a moral hazard is involved in con- nection with any sort of an insurance coverage an element of uncertainty is injected which makes it impossible to fix a scientific rate. This because it is impossible to enter into any satisfactory contractual relationship unless both parties deal fairly with one another and live up to the mutual obligations imposed by the terms of the contract. This factor of uncer- tainty is not presented to a company issuing a policy to an honest assured irrespective of how hazardous his business may be. The objection to such a risk is the possibility of a catastrophe loss, which may seriously impair the solvency of the insurer. There are occupations of such character that an accident causing injury or death to a number of persons is likely to occur at any time. The cost of such an accident to an insurance carrier may run into many thousands or even hundreds of thousands of dollars. A conservative company is naturally reluctant to jeopardize its future by issuing policies to risks of this kind. Of course, in the last analysis, the laws of average are applicable and if a company has a suffi- cient volume of this business to enable these laws to operate and resources adequate to eliminate the danger of one loss bringing about an impairment there is no reason why the business cannot be written. Under such circumstances the rate will take care of the loss and the company will make up a catastrophe loss from UNDERWRITING 183 the profits made on other similar risks. As we shall subsequently show, this situation is approximated by companies of limited resources by means of reinsur- ance. MORAL HAZARD.— The so-called moral hazard is incident in some degree to every kind of insurance. This term has come to mean that intangible danger which accompanies the assumption of the liability of an assured who is dishonest, reckless or indififerent to contractual and other obligations. The presence of this hazard may be indicated by the experience of one or more companies on a particular risk or by such experience in connection with a general class to which the particular risk belongs. When a company has carried a risk and has found that unwarranted claims are made, that demands for more than is due are presented or that difficulty is experienced in collecting premium, it is safe to assume that the undesirable tendencies so indicated are likely to continue and unfavorably affect the loss ratio. Quite frequently a proposal is received from an assured on whom the particular company has carried no previous insurance. It may happen, however, that by means of the clear- ing-house system described in Chapter II, which, in one form or another is maintained by practically all companies, the carrier to which application is made may ascertain that some other company has had an unsatisfactory experience. Such risks, irrespective of the source from which previous history is derived, are generally considered uninsurable because of moral hazard. 184 THIRD PARTY INSURANCE VARIATIONS OF MORAL HAZARD.— The fact that a risk is determined to belong, to this class does not necessarily mean that the assured has been actually guilty of dishonesty, or that his claim experi- ence has been unsatisfactory, but may only mean that he has proven himself to be reckless or careless or indifferent to the rights of the insurer or of third parties. It may be that the assured has indicated a disposition not to comply with the terms of his con- tract relative to the payment of premium or failed to co-operate with the insurer in the handling of claims. While ordinarily the existence or non-existence of a moral hazard is determined with reference to a par- ticular risk, there are classes of business which the companies have found to be generally undesirable. The majority of those engaged in certain occupations have been found to be undesirable from the standpoint of an insurer and not being able to weed out the good from the bad the companies are forced to consider all persons engaged in such occupations as uninsurable. It frequently happens that risks involving a moral hazard also involve a catastrophe hazard. This is particularly true with reference to certain dangerous industries for which the premium rates are high. This fact has, in many instances, led assured engaged in these occupations, as a class, to adopt various expe- dients to avoid the payment of the high premium which the hazardous character of their operations makes necessary. Again there are territories in which the experience of the companies has been so generally bad that they have been forced to take the position UNDERWRITING 185 that all risks in such territories involve a moral hazard and have therefore established definite areas in which they will not write business. ATTEMPTS TO ELIMINATE MORAL HAZ- ARD BY CO-INSURANCE. — Various expedients have been adopted by insurance companies to elim- inate the moral hazard. One of the schemes which has been tried most frequently is to enter into some kind of a co-insurance agreement making the assured responsible for a certain percentage of each loss. The so-called deductible coverage is of course simply one form of co-insurance. We have already seen that in writing automobile collision insurance the companies issue contracts which provide that they are to have no liability unless the loss exceeds a designated amount and in that event the amount retained by the assured is to be deducted from the total loss, the insurer paying only the amount in excess of the assured's retention. When a contract of this character is issued the assured has a direct interest in avoiding an accident. Further than this, petty claims are eliminated and the company becomes responsible only in the event that the accident is sufficiently serious to cause a substantial loss. This same principle has been applied in writing other forms of insurance and has met with some success. Satisfactory results can- not be attained if the assured is given the option to purchase full coverage or deductible coverage. This is largely true because in such case there is a selection against the company in that a dishonest assured will invariably carry the full coverage. It is also unsatis- 186 THIRD PARTY INSURANCE factory unless the amount retained by the assured is substantial, otherwise there will be a disposition to increase claims sufficiently to enable the assured to collect not only his actual loss but a sufficient addi- tional amount to take care of his own retention. It must also be remembered that in the third-party busi- ness where the insurers protect the assured against claims made by strangers the moral hazard ordinarily does not directly affect claim payments. About all that can be accomplished through the issue of a deductible coverage contract by a third party company is to make it to the interest of the assured to exercise care in the prevention of accidents. OTHER DEVICES ADOPTED.— The companies have sought to eliminate the moral hazard arising by reason of the disposition of the assured to avoid the payment of full premium by making frequent audits, by the installation of special bookkeeping systems and other similar methods. These various plans have, in the main, proven unsatisfactory in that the assured have generally found a way to counteract them. The carriers have also, from time to time, made efforts to select particular risks out of an objectionable class or in an objectionable territory and to that end have relied upon their inspection departments to cull out the wheat from the chaff. While some degree of success has been attained, these efforts have, for the most part, also been unavailing. In conclusion, it may be stated, as a general proposition, that a risk involv- ing any degree of moral hazard is absolutely unin- surable. UNDERWRITING 187 CATASTROPHE HAZARD.— While a risk which carries with it any element of moral hazard must ordinarily be regarded as uninsurable, this proposition does not hold true at all as to those risks which involve what we have termed a catastrophe hazard. As above indicated, all such risks are insurable provided the carrier has adequate resources and that sufficient volume can be written to enable the laws of average to operate. It is also true that there are many varia- tions of such risks and, from the standpoint of an individual carrier, the problem presented is simply to select only those which present a catastrophe hazard not out of proportion to the volume of business which the company is writing. Also the underwriting department must take into consideration the problem of collective hazard. It is apparent that if a numbei of hazardous risks are located at one point the chance of catastrophe loss is greatly increased whereas if such risks are scattered over a wide territory the possibility of an overwhelming calamity is done away with. This general principle is, of course, applicable to risks other than those which are generally regarded as carrying with them catastrophe possibilities. The company which exercises underwriting wisdom will always endeavor to keep its risks scattered as much as possible so that a conflagration, a tornado, an epidemic or other unusual and devastating calamity which may affect any one territory may not bring to the company an overwhelming financial loss. RISKS INVOLVING CATASTROPHE POSSI- BILITIES THROUGH THE HAPPENING OF 188 THIRD PARTY INSURANCE ONE ACCIDENT.— Risks which are designated by the term "catastrophe" are of many kinds. The class to which this term is particularly applicable includes occupations of such character that an accident causing injury or death to a large number of persons is defi- nitely possible. Of these occupations the most notable are coal mining, the manufacture of explosives or of products containing explosives, the operation of large ships or vessels, building moving, raising or wrecking, the transportation of passengers by common carriers and the maintenance and operation of amusement halls or parks. It is common knowledge that these occupations are so inherently dangerous that there always exists a real possibility of a catastrophe involv- ing very large financial responsibility. It is quite obvious that no company is in a position to issuej coverage on such risks unless it has almost unlimited financial resources or is able to secure adequate reinsurance, retaining for itself only such liability as it may be able to meet without serious disturbance. While it is true that if risks are carefully selected and proper attention paid to safety requirements the pos- sibility of overwhelming loss is rather remote, such possibility always exists. Further than this, in order to get a proper insurance average, it is neces- sary for the company writing any of these lines to secure a sufficient volume to enable the laws of average to operate and if a large volume is secured, there must be taken into account not only the possibility of one catastrophe loss but also of a series of such losses. CATASTROPHE LOSS POSSIBLE ON MANY UNDERWRITING 189 RISKS NOT ORDINARILY CONSIDERED AS HAZARDOUS. — The possibility of catastrophe loss due to one accident is by no means confined to the particularly hazardous classifications just mentioned. It exists in connection with many risks which are not ordinarily considered as falling within the hazard- ous classifications and for which the premium rate is small. The best illustration of what we now have in mind is the so-called loft risk. This is a term applied to assured conducting manufacturing operations involving the employment of considerable numbers of people in buildings which are commonly referred to as loft buildings. In many large cities where lack of space makes congestion necessary, such operations are carried on in large buildings, frequently on floors at a considerable height above the ground where the means of egress are inadequate. Losses of this kind are usually brought about by a fire or a collapse of the building. In a general way this or similar danger is inherent to a greater or less degree in every case where a large number of persons are congregated at one place under such circumstances that an assured may be held responsible, as an employer or otherwise, in the event of a disaster. RISKS PRESENTING POSSIBILITY OF FRE- QUENT SERIOUS INJURIES TO LIMITED NUMBER. — The foregoing considerations apply in a modified degree to the underwriting of many kinds of business of such character that while a calamity involving injury to a considerable number of persons is not probable, there are likely to be frequent acci- 190 THIRD PARTY INSURANCE dents causing serious injury or death to one or to a limited number of persons. As illustrative of such risks may be mentioned saw mills; stamping opera- tions; junk yards; chimney construction; window cleaning; threshing; corn shredding; operations involving the use of electricity; cotton compressing and ginning; steeple and tower building; structural iron and steel erection; the operation of ambulances; fire engines, police patrols, vehicles used for trans- porting baggage, mail, newspapers and periodicals, sight-seeing cars, emergency or trouble cars. In these various operations accidents occasioning serious injuries to one person or to a few people frequently occur. By reason of such accidents the assured may become responsible to employes or to members of the public. Such risks are questionable not because they ordinarily involve the possibility of one overwhelming loss but because of the frequency of comparatively serious accidents. For this reason a high premium must be charged which, in some cases, is almost pro- hibitive. Premiums are so high that there is constant pressure brought upon the companies to reduce them and a general disposition on the part of the assured to avoid full payment where possible. Aside from this last mentioned consideration, which in reality raises an issue of moral hazard, there is no reason why the business cannot be written profitably if adequate rates are charged and if a sufficient volume is done. However, the difficulty of securing adequate rates and enough volume to get a proper insurance average, coupled with the moral hazard sometimes present. UNDERWRITING 191 has led most of the companies to place all or a large portion of these risks upon their prohibited lists. EMPLOYERS' LIABILITY AS DISTIN- GUISHED FROM PUBLIC LIABILITY.— A review of the questionable classifications referred to in the preceding paragraphs will indicate that as to some of them the principal danger arises in connection with the liability which may be imposed by reason of injury to employes while as to others the hazard is principally a public one. It frequently happens that a risk of this character may be regarded as one to whom employers' liability or compensation insurance may be safely granted whereas it would not be in accord- ance with good underwriting principles to issue public coverage and vice versa. Thus, for illustration, there is little danger of injuries to the public being occa- sioned by the operation of coal mines; cotton gins; saw mills; threshing machines, or the business of window cleaning. On the other hand, the public hazard is the important one to be considered when it comes to the coverage of amusement parks and halls; fairs; automobile speed contests; ambulances; fire engines ; police patrols ; sight seeing cars ; trouble cars; taxi cabs and vehicles used for the transfer of baggage, newspapers and other periodicals. There- fore, in the one case a company may be willing to write public liability but unwilling to issue either employers' liability or compensation and, on the other hand, be willing to assume the liability of the assured to employes though refusing to cover public liability. Some of these risks carry both hazards to a marked 192 THIRD PARTY INSURANCE degree as, for illustration, the manufacture of explo- sives or of products containing explosives. PASSENGER HAZARD.— The law imposes upon a common carrier of passengers certain extraordinary responsibilities. While such a common carrier is not an insurer he is required under the law to exercise a very high degree of care. When one becomes a passenger he ordinarily places himself almost entirely at the mercy of the carrier. There are certain inherent dangers incident to the operation of all vehicles, par- ticularly those which are propelled by some form of mechanical power. Further, the operation of such vehicles ordinarily requires a special knowledge and ability and more than an ordinary degree of prudence. In most cases the passenger has absolutely no control over the operation of the vehicle and must rely entirely upon the skill and caution of the carrier. For this reason the mere happening of an accident occasioning injury to a passenger is ordinarily to be regarded as indicating prima facie that the carrier is responsible. Excluding those cases where injuries occur while entering upon or alighting from a public conveyance, it is only in rare instances that the injured passenger is guilty of contributory negligence, relieving the carrier of liability. This situation naturally presents an exceptional opportunity for the successful prosecu- tion of non-meritorious or excessive claims and the ambulance-chasing lawyer has not overlooked this fertile field for his activities. Cases involving alleged injuries to women due to jolts and other minor acci- dents are exceedingly difHcult to defend. Even where UNDERWRITING 193 claims are meritorious there exists a general prejudice against many carriers of passengers which is fre- quently reflected in excessive verdicts. INSURERS ORDINARILY REGARD PASSEN- GER HAZARD AS UNDESIRABLE.— For all these reasons the coverage of passenger hazard is looked upon with much dislavor by most of the companies. It is, of course, true that there are marked variations in these risks. Many companies do not hesitate to cover passenger hazard on livery vehicles or hotel omnibuses for a responsible assured. This is partic- ularly true as to risks located outside of the large cities. Most of the companies, however, absolutely refuse to insure jitneys, taxi cabs and sight seeing cars. While these risks are written by a few com- panies and while some of them undoubtedly may be written at a profit, the majority of conservative and successful underwriters consider these experiments as playing with fire and are content to let this business go to the few companies which are willing to write it. Of this class of risks the most objectionable are rail- ways and street car lines. The possibility of serious accidents, the probability of unfounded or exaggerated claims and the pronounced prejudice of the public against these carriers have led practically all the companies to consider them as uninsurable in so far as liability to passengers is concerned. ROUTINE HANDLING OF PROHIBITED RISKS. — Upon receipt of the proposal the underwrit- ing department has little difficulty in determining whether the risk should be considered as a prohibited 194 THIRD PARTY INSURANCE one. It soon formulates definite rules pertaining to those risks which, from the standpoint of the particular carrier, are to be considered as uninsurable. As a matter of fact, the production department is ordinarily familiar with the attitude of the underwriting depart- ment and seldom submits a proposal on a risk of this character. Therefore, it is only rarely that the under- writing department finds it necessary to decline a proposal on this ground. Of course, such cases will arise and in its daily routine the underwriting depart- ment examines, in a preliminary way, all proposals received and either rejects those of the character just mentioned or, if a policy has been written, orders same cancelled. Naturally there are exceptions to all rules and occasionally a risk falling within the general class regarded as prohibited will, because of some special merit or some peculiar combination of circumstances, be accepted. It is the custom to make special pre- sentation of such cases to the underwriting department and not to cover them without its express authori- zation. UNDESIRABLE RISKS IN ACCEPTABLE CLASSIFICATIONS.— What we have just said applies to those risks which either because of their peculiar individual characteristics, or the fact that they belong to an objectionable class or are located in a prohibited territory, are considered as uninsurable. Very frequently, however, proposals are rejected not because of the considerations just mentioned but for the reason that the carrier to which the risk is pre- sented or another company has had some sort of UNDERWRITING 195 unfavorable experience on the particular risk. The underwriting department may ascertain in one way or another that the previous claim experience has been bad, that the applicant has indicated a disposition to avoid the payment of full premium, has failed to co-operate with his insurer in connection with previous claims, is of bad moral character, addicted to the use of intoxicants or drugs, or reckless or indifferent to the rights of others. Such a risk, though it may belong to a very desirable class, is regarded as uninsurable. CLAIM EXPERIENCE.— The mere fact that the loss ratio on a particular risk has been bad in the past does not necessarily indicate that such risk is undesirable. The primary function of insurance is to protect against misfortune not due to the misconduct of the assured. A company issuing policies to a thou- sand very desirable risks would naturally expect to pay some claims and the fact that several members of the group are unfortunate enough to suffer the casualty insured against does not indicate that such members are either better or worse than the balance of the group. The underwriting department may find that an applicant for automobile public insurance has been unfortunate enough to kill a pedestrian by the oper- ation of his car and that his previous insurance carrier has been obliged to pay the limit of its policy. In such a case it is material to inquire as to the circumstances of the accident. If it develops that the assured has not been guilty of any particular misconduct indicating a general reckless disposition and that the case is sim- ply one of those inevitable accidents incident to the 196 THIRD PARTY INSURANCE operation of automobiles, the risk is accepted without question. The same proposition holds true as to all forms of third party insurance. ACCIDENT FREQUENCY.— The thing that the underwriting department is most interested in is acci- dent frequency. It may find that there have been a number of trivial accidents which, in the aggregate, have cost little and that the loss ratio on the risk has been good. Nevertheless, the accident frequency if above the average for the particular class of risk is significant as indicating the probability that something is wrong. The trouble may be due to the fact that an automobile owner has a reckless chauffeur or that he is himself careless. It may be that a building upon which general liability insurance is carried is not in good repair or that the tenants are dishonest and inclined to present fictitious claims. It may be found that a manufacturer carrying compensation insurance has a careless foreman or that his machinery is not properly guarded or that his employes are unskillful or of an undesirable class. It may develop that a large majority of such employes are minors or that the employer is penurious and unwilling to pay sufficient wages to secure a high grade of help. In short, any one of a thousand explanations is possible. In considering the real significance of accident frequency, the character of the risk must, of course, be taken into consideration. If the operations are such as would ordinarily bring about a number of minor accidents and the accident frequency on the particular risk is approximately the average which would be expected on one of its kind, UNDERWRITING 197 it is accepted without question. If, upon the contrary, the underwriting department is able to determine by reason of its famiUarity with all kinds of risks that the accident frequency is too high, then the risk must be rejected unless it is possible to ascertain and correct what is wrong. IMPROVEMENT OF BAD RISKS.— The prob- lem of making a bad risk into a good one is one of the most important that the underwriting department must solve. It is very easy to accept only those risks which are letter perfect and to reject every risk not coming up to this standard. A narrow policy of this kind will unduly handicap the production department and seriously interfere with the growth of the com- pany. Therefore, one of the most important functions of the underwriting department is to search out and eliminate the cause of preventable accidents. To do this eflSciently requires resourcefulness, intelligence, painstaking industry and wide knowledge of all phases of the business. POLICY FORMS.— The underwriting department, upon receipt of a proposal, determines, first, whether the risk belongs to a class which it regards as insur- able. If that question is decided in the aiifirmative, it then makes its investigation as to the desirability of the risk on its individual merits. Having availed itself of the various sources of information which have been referred to, if the underwriting department finds no objection to the risk or is able to overcome to its satis- faction existing objections, it then becomes its duty either to issue a contract in proper form or if the policy 198 THIRD PARTY INSURANCE has been issued to satisfy itself that it has been issued correctly. Inasmuch as third party companies find it necessary in the conduct of their business to use a great number of poHcy forms and riders supplement- ing, modifying or extending such forms, the task is no light one. If the policy is to be actually written under the supervision of the underwriting department, it must, out of the twenty distinct forms listed in Chapter III, select that which is appropriate to the particular risk. Further than this, it must select the particular edition of that form which it is permissible to issue in the state where the risk is located. In many states, where a special form is not required, it is necessary to attach a special rider modifying the particular form to comply with the statutes of the state or the ruling of the insurance department or of the department in charge of compensation insurance. COMPENSATION POLICY FORMS.— At the present time the Universal Standard Workmen's Com- pensation policy form has been approved for use in every compensation state with the exception of Colo- rado and Massachusetts. There is, however, a special endorsement for each state which must be attached to the policy when issued in that state. It is to be hoped that in the comparatively near future the universal form will be approved for use in all states and by such action made universal in fact. It is a part of the duty of the underwriting department, if the policy is written under its supervision, to use the correct form and endorsement. If, as is generally the case, the policy is written by the producer, the underwriting department UNDERWRITING 199 must check the proposal which shows in appropriate places the form numbers of the policy and of any- attached endorsements. If mistakes have occurred corrections must be made. PUBLIC AND EMPLOYERS' LIABILITY FORMS. — The state of Iowa is the only one which has refused to approve the public policy forms in gen- eral use by third party companies. These carriers have, therefore, found it necessary, in order to do business in Iowa, to prepare a complete set of public policy forms which are used only in that state. Public policy forms are required by law to be submitted to the insurance department for approval in Colorado New Hampshire Iowa Vermont Nebraska In other states the filing of these forms is required by ruling of the insurance departments although there is no law to that effect. The states just referred to are Idaho New Jersey Kansas Rhode Island Kentucky Oregon Montana Washington In the rest of the states neither the law nor the rul- ings of the insurance departments require public policy forms to be filed or approved. There are, in a few of these states, statutes which require modification of some of the public policy provisions now in general use. In such states the necessary modification is made by the attachment of a rider. The form of the em- ployers' liability policy is not now of importance in 200 THIRD PARTY INSURANCE states where compensation laws are in effect. It is not necessary to secure approval of this form in any of the states wiiere compensation laws are not now in effect. The underwriting department must, of course, be familiar with all of these details and do the various things necessary to insure that each risk is covered by a policy which conforms to the law of the state in which the risk is situated. SPECIAL ENDORSEMENTS.— There are certain conventional endorsements which third party com- panies customarily attach to their policies. As cases necessitating the use of such endorsements arise fre- quently the forms are standardized and printed. It often happens, however, that a particular risk pre- sents certain exceptional underwriting problems and in such event it becomes necessary to prepare special typewritten endorsements conforming to the exigencies of the special case. While the manuals in use by the companies prescribe definite rules applicable to the ordinary case, certain assured have peculiar require- ments which can be met only in this manner. The preparation of these special endorsements requires an intimate familiarity with basic principles and the ability to apply these principles to extraordinary situ- ations. It is incumbent upon the underwriting depart- ment to solve these problems correctly as they arise and to prepare suitable endorsements. This work must be done carefully and intelligently since if an endorse- ment be hastily drawn or prepared by one who is not thoroughly grounded in the principles applicable, it UNDERWRITING 201 may impose upon the company a liability which it ought not to assume. ESTIMATED PAY ROLLS.— As previously indi- cated, the premium for many of the third party cover- ages is based upon the pay roll of the employes of the issured. As an initial proposition the assured estimates to the company the pay roll which will be expended in connection with the classifications covered by the pol- icy and pays an advance or deposit premium based upon such estimate. The contract provides that the premium is to be finally determined by means of audit of the assured's pay roll records made by the insurer. Policies of this character are written on an annual, semi-annual, quarterly or monthly audit basis. This means that the audit is to be made either at the end of the year for which the policy is written or at the end of intermediate periods of six months, three months or one month. The advance or deposit premium naturally varies with the pay roll period upon which the estimate is based. ADEQUATE ESTIMATES NECESSARY.— It is of the utmost importance that the pay roll be estimated honestly and with as much accuracy as possible. If the estimate is inadequate the company does not re- ceive the proper initial premium. Under such circum- stances, it is unable to make any accurate approxima- tion of its loss ratio prior to audit and is deprived for a considerable period of the interest on the premium to which it is entitled. In addition to this, the com- pany takes the chance of losing a considerable portion of the premium due in the event that the assured be- 202 THIRD PARTY INSURANCE comes financially irresponsible during the period inter- vening between the inception of the risk and the date when the additional premium disclosed by audit is payable. For all of these reasons, it is essential that the insurer exercise due care to avoid issuing policies for which advance premium is paid on the basis of a gross under-estimate of pay roll. The underwriting department must, therefore, examine the proposal carefully, take into consideration the work which the assured is doing, the number of employes and other factors disclosed by answers to interrogatories con- tained in the proposal which enable it to approximate, with some degree of accuracy, the probable amount of pay roll which will be earned. GENERAL RULES APPLICABLE IN FIXING THE AMOUNT OF ADVANCE OR DEPOSIT PREMIUMS. — The average assured is naturally dis- posed to under-estimate his pay roll. By so doing the assured retains the use of his money for a considerable time. Under stress of competition agents are also prone in soliciting business to hold out this possibility as an inducement. Therefore, the underwriting depart- ment must be constantly on its guard and exercise extreme vigilance to the end that this evil be eliminated in so far as may be possible. In actual practice none of the companies receive the full advance premium to which they are entitled and they know- ingly permit a certain degree of under-estimation. Different companies have different rules applicable to this situation. The conservative companies decline to accept estimates which they have reason to believe are UNDERWRITING 203 grossly inadequate. Whenever the underwriting de- partment determines that the estimate falls sub- stantially below the standard fixed, it must insist upon the payment of an additional advance premium. It is customary for the companies to supplement the in- formation which is obtained by the underwriting department by an investigation which is made by the inspection department. The form on which the in- spector's report is made calls for an estimate as to the probable pay roll to be expended during the policy term. This furnishes an additional reason why there must be close co-operation between the uhderwriting and inspection departments since otherwise the in- formation obtained by the inspector would not be brought to the attention of the underwriting depart- ment. SCRUTINY OF EXPERIENCE ON LIVE RISKS. — The mere fact that the policy has been cor- rectly issued and that the underwriting department has exercised due care in the various ways we have described does not relieve it of responsibility. It must watch each risk carefully in order to detect unfavor- able developments. It is, therefore, the custom of well managed companies to establish a special branch of the underwriting department ordinarily referred to as the experience department whose duty it is to review the experience on live risks from time to time during the policy term. At fixed intervals this department determines such experience as to each risk which is in force. It computes the premium earned and ascer- tains the loss ratio by a comparison of earned premium 204 THIRD PARTY INSURANCE to losses paid plus an estimate of liability on claims outstanding. An apparently unfavorable loss ratio is frequently due to an under-estimation of pay roll and when the experience department determines that the loss ratio on any particular risk is unsatisfactory, it customarily calls for a pay roll statement from the assured. If an inadequacy is disclosed the assured is required to pay the proper additional premium. If the review of the experience department indicates an ab- normal accident frequency steps are taken to eliminate the cause. If this is found to be impossible the risk is cancelled. No well managed company waits to lock the barn after the horse is stolen. The work done by the experience department discloses not only definitely bad results but also unfavorable tendencies. In this manner it is frequently possible to prevent serious loss by prompt cancellation. RENEWALS. — The underwriting department cus- tomarily reviews experience on all risks prior to their expiration for the purpose of determining whether such experience warrants renewal. This is necessary because renewal policies are frequently written and delivered by the producer before the expiration of the old policy. It is much easier to decline to renew an old policy than to insist upon the cancellation of a new one. The difficulties with which the underwriting department is confronted in its consideration of an entirely new risk are, to a considerable degree, non- existent when it comes to the renewal of an existing policy. Actual experience is a safe guide and the underwriting department is not required to depend UNDERWRITING 205 solely upon its judgment, but is able to avail itself of the lessons taught by such experience. MODIFICATION OF RATES DURING POLICY TERM. — Under existing rating systems it is per- missible, as to some forms of insurance, to decrease premium rates during the policy term in the event that the assured makes improvements or installs safe- guards. For illustration, the basic compensation rates as shown in the companies' manuals are subject to modification by the application of schedule rating. In fixing the initial rate, such rating system is applied on the basis of the condition of the plant at the time the rate is determined. In many instances a debit increasing the rate is imposed because of defective plant conditions. In other cases the assured is not given the benefit of a possible credit which could be obtained by compliance with safety requirements. As a matter of service to their assured, third party com- panies follow up these matters very carefully through their inspection departments and advise their assured in detail as to how the premium may be reduced by compliance with safety recommendations. While it is the business of the inspection department to make the recommendations and ascertain whether they have been complied with, it is the duty of the underwriting department, upon being advised that the credit is due, to see to it that an endorsement is attached to the policy properly modifying the rates at which it was originally written. EXCESS LIMITS— REINSURANCE.— The reader is already familiar with the fact that compensation 206 THIRD PARTY INSURANCE policies are ordinarily issued without any limit upon the liability of the insurer. Most companies have spe- cial reinsurance arrangements protecting them against loss in excess of the limit which they are in a position to carry themselves. The leading stock companies have created what is known as the Workmen's Compensa- tion Reinsurance Bureau and the members of this Bureau are automatically protected against liability under compensation policies in excess of $25,000 on account of loss due to any one accident. All of the member companies pay a certain percentage of their compensation premiums into a common pool. The fund thus created has already become sufficiently large to take care of almost any conceivable catastrophe or series of catastrophes. The companies not members of this Reinsurance Bureau usually make reinsurance treaties with companies engaged in the business of reinsurance, or with Lloyds, which apply auto- matically to all policies issued. The reinsured pays a certain percentage of its premium to the reinsurer, the reinsurance applying to all policies issued and reported on bordereau to the reinsurer. When auto- matic arrangements of this sort are in existence, the underwriting department need give itself no concern in so far as compensation policies are concerned. This statement is subject to this qualification. The protec- tion afforded by the Workmen's Compensation Rein- surance Bureau does not apply to certain prohibited lines. The same prohibitions are ordinarily contained in blanket reinsurance treaties. If the character of the risk is such that the blanket reinsurance does not apply UNDERWRITING 207 the underwriting department must negotiate a special reinsurance relieving the initial carrier of its liability in excess of the amount which it is willing to retain. ASSOCIATED COMPANIES.— The fact that the Workmen's Compensation Reinsurance Bureau does not cover certain extremely hazardous classifications has led a number of the larger stock companies to enter into a pool for the purpose of handling such risks, which is known as "The Associated Companies." This pool was designed primarily to take care of coal mine compensation business but has been extended to certain other hazardous lines, both compensation and public. The agreement into which the companies have entered is substantially as follows : The company which secures the risk is called the "proposing com- pany" and signs the policy as agent for all companies, the obligation being joint and several. The proposing company collects premium, pays commissions, handles claims, etc., at its own expense. Policies must be issued and countersigned at the home office of the pro- posing company. A limit is placed upon total acqui- sition cost and upon commissions paid to agents. The proposing company retains a certain percentage of all premiums to cover its cost of handling the risk and the balance of the premium is divided equally between all companies, including the proposing company, and each company pays an equal proportion of all losses. The associated companies employ at their joint ex- pense a supervising mine inspector, and such assistants and clerical help as may be necessary. 208 THIRD PARTY INSURANCE REINSURANCE OF EMPLOYERS' LIABILITY AND PUBLIC POLICIES.— Employers' liability and the various forms of public policies ordinarily contain the standard Hmits of $5,000 for loss due to one person injured and $10,000 for loss occasioned by one acci- dent. In many cases, however, the assured desires excess limits. Most of the companies have certain fixed limits beyond which they are unwilling to assume liability without reinsurance. Unless the initial carrier has a blanket reinsurance agreement automatically applicable to all policies issued, it is necessary for the underwriting department to effect special reinsurance treaties applicable to any risk carrying limits in excess of the amount which the company is willing to carry at its own hazard. CHAPTER VIII RATES AND RATING BUREAUS PREMIUMS BASED UPON UNIT OF EX- POSURE. — Third party insurers have fixed upon cer- tain units of exposure and the total premium for any policy is computed by multiplying the appropriate rate per unit of exposure by 'he number of such units pre- sented by the particular risk. These so-called units of exposure vary with different divisions of the busi- ness. In selecting the measure of exposure the com- panies have endeavored to choose that which most accurately reflects the hazard and which, from a prac- tical standpoint, is the most convenient. Thus we have seen that a unit of $100.00 of total payroll earned by all employes engaged in covered operations is used in determining premium for employers' liability, workmen's compensation, manufacturers' and con- tractors' public liability policies. Similarly the meas- ure used in determining premium for the contingent policies is a unit of $100.00 of cost of work covered. The unit ordinarily used in writing general liability is floor area and street frontage, although, if such policy is issued to cover a theatre, the premium is based upon the number of seats and if issued to cover certain shows or exhibitions is based upon each $100.00 of gate receipts. The premium for an elevator policy depends upon the number of elevators covered. S 20v 210 THIRD PARTY INSURANCE likewise does the premium for a teams' policy, the number of teams being ascertained by dividing total payroll of drivers by the average wage of one driver. In determining premium for the various automobile coverages adaptations of many of the foregoing methods have been used. For illustration, the unit of exposure may be one car insured for twelve months or one named driver for a period of twelve months or a unit of $100.00 of payroll of employes or of livery earnings. RATES. — Thus far we have not attempted to dis- cuss rates as distinguished from premium. We have described the various units of exposure and the methods whereby the premium for any policy is de- termined by applying rates to such units. We shall now enter upon a discussion of the manner in which the rate to be charged for any given unit is ascertained. It should be understood that it is not within the scope of this work to attempt any elaboration of the technique of rate making. This would require us to enter the domain of higher mathematics and actuarial science. One desirous of mastering this subject must, of neces- sity, devote himself to the study of the many scientific treatises bearing upon its various phases which eluci- date the intricate processes involved in so far as they have yet been perfected. We shall here confine our- selves to broad statements of basic principles cal- culated to inform the reader in a general way as to fundamentals. LAWS OF AVERAGE. — In determining the proper rate for any form of insurance, it is first neces- RATES AND RATING BUREAUS 211 sary to ascertain the laws of average which are applicable to the particular hazard against which the insurance protects. These laws can only be determined in the light of experience. Therefore, no insurance carrier can intelligently determine the proper premium rate for any given hazard unless there is available to it a record indicating at least approximately the fre- quency with which the casualty insured against has occurred in the past and the cost of loss so occasioned. This past experience is of significance only in the event that it pertains to a definite and measurable exposure. It is also essential that the exposure upon which the experience is based be sufficiently large to enable the laws of average to operate. It has been demonstrated that events which as to the individual are apparently entirely fortuitous are in fact governed by the immut- able laws of average. The larger the exposure on which experience has been collated the more authori- tative is that experience for the purpose of rate making. JUDGMENT RATES. — Whenever an insurance company is possessed of statistics pertaining to a suffi- ciently large exposure to make it certain that they in- dicate correctly the laws of average applicable, the fixing of rates becomes a comparatively simple matter. Even under such circumstances it is necessary to take into consideration the possibility that the conditions existing during the period to which such statistics per- tain have changed or may change in the future. It then becomes necessary for the rate maker to determine the modifications which should be made. 212 THIRD PARTY INSURANCE No man can definitely foretell the future and any such modification must depend largely upon the element of human judgment. It also frequently happens that the rate maker may have reason to believe that the statis- tics with which he is furnished are in some respect inaccurate. The more recent the experience the more valuable it is in the sense that it indicates that its results are predicated on conditions similar to those existing at the time that the rates are determined. On the other hand, there exists a greater possibility of inaccuracy. This is particularly true with reference to many of the third party coverages. Many accidents covered by these policies which, when first reported, appear to be of little consequence, develop into serious and expensive claims. If the rate maker has before him the recent experience under a compensation act the claim cost is made up of two items, payments which have been actually made and payments which must be made in the future. This means that the experience is not a final one and that an important element in it is predicated upon fallible human judg- ment. In comparing a completed experience with one in which an estimate of outstanding losses is a factor, it has been found that such losses have been almost invariably underestimated. The rate maker must, therefore, again use his judgment as to the allowance which should be made on this account. DIFFICULTIES IN DETERMINING RATES FOR NEW COVERAGES.— As we have seen, many of the third party Hues are of very recent origin. In fact, the two most important branches of this business. RATES AND RATING BUREAUS 213 workmen's compensation and automobile, have been developed almost entirely within the past decade. When the companies began writing these hnes they had available no dependable statistics. They, there- fore, were confronted with a problem of the utmost difficulty, i. e., the determining of rates for coverages of great complexity and diversification without the almost indispensible requisite of statistics based on past experience. At the outset, therefore, these rates had to be determined largely as a matter of judgment. The rate makers relied, to some extent, upon European experience and that developed in connection with analogous lines such as employers' liability, work- men's collective and teams' insurance. To a large ex- tent, however, they had to go forward blindly, groping their way among many pitfalls and patiently waiting for the light of experience. MODIFICATION OF BASIC RATES.— A basic rate is that which reflects the average experience of a large number of risks. There are, of course, many variations between the individual risks comprising the group on whose experience the average rate is based. Some are very much worse and some very much better than the average. The basic rate reflects the aggregate experience of the group. This means that the risk which is better than the average is penalized by reason of the presence of bad risks which in turn obtain a better rate than they would receive were the entire group made up of risks similar to them. In order to do away with this obvious injustice it has become necessary to supplement the general rating plan by 214 THIRD PARTY INSURANCE some form of rate modification which will adjust the basic rate to correspond with the hazard of individual risks. The method whereby this result is accomplished is ordinarily referred to as merit rating. Merit rating as applied in the third party business is divided into schedule and experience rating, the first system being predicated upon the merit of the assured from the standpoint of ascertainable physical hazards and the latter reflecting the moral or intangible hazard indi- cated by experience. Inasmuch as the carrier must receive an aggregate premium from any given group which reflects the hazard of all risks in that group, whether good, bad or indifferent, the application of merit rating should not either increase or decrease the total premium. Logically merit rating should decrease premium paid by the risks which deserve it and cor- respondingly increase the premium received from bad risks to the end that the insurer may receive from the group the same aggregate premium which it would have received without the application of merit rating. MERIT RATING HAS REDUCED AGGRE- GATE PREMIUM.— As a matter of fact, the merit rating systems in use at the present time have resulted in a decrease of aggregate premium and hence it is obvious that they are defective. Pending the perfec- tion of the merit rating systems the companies have corrected this defect by increasing the average rate. In other words to the average rate they have added a loading calculated to equalize the discrepancy. In this connection, there must also be given considera- tion to the fact that the practical effect of the merit RATES AND RATING BUREAUS 215 rating systems is to improve the group as a whole. The possibility of securing a reduction in rate operates as a persuasive incentive to induce individual risks to improve physical and moral conditions, thus decreas- ing the claim cost. Hence our statement to the effect that the insurer must receive the same aggregate premium which it would receive were no merit rating applied is subject to the qualification that such ag- gregate premium may be reduced to the extent that the group as a whole is improved through the use of merit rating. FACTORS ENTERING INTO THE DETERMI- NATION OF RATES.— There are two items which enter into the determination of any rate ; the loss cost per unit of exposure and the loading on the loss cost requisite to pay expenses and profits. The first of these items is ordinarily referred to as the pure premium, being the amount which available experience indi- cates to have been the claim cost for each unit of exposure. In computing such cost there must be added to actual disbursements an estimate of the probable cost of outstanding claims. Because of lack of sta- tistics or the probability of a change in conditions, it is frequently necessary for the rate maker to exercise his judgment in modifying the pure premium used in determining the rate, i. e., to allow a pure premium factor different from that indicated by past experience. For this reason, the pure premium ascertained on the basis of past experience is frequently referred to as the experience or indicated pure premium and the pure premium as so modified is termed the established pure 216 THIRD PARTY INSURANCE premium. The so-called loading is the amount which is added to the pure premium to take care of all expenses and to provide a profit for the insurer. This item is made up as follows: commissions to agents plus other expenses incurred in soliciting business, the aggregate of the two being known as acquisition expense; general administration expense; taxes and licenses; and allowance for profit. COMPENSATION RATES.— We are not here particularly concerned with the history of compensa- tion rate making. We have already commented on the difficulties with which the carriers were confronted at the outset because of the absence of dependable statistics. In bringing about the present satisfactory status of compensation rates the companies and all others concerned have experienced many vicissitudes which can readily be imagined and which have fre- quently been eloquently described elsewhere. We assume that our readers are at this time primarily interested not in a dissertation upon this interesting subject but rather desire to be informed as to the methods now used for determining compensation rates. CLASSIFICATIONS. — Rates, of course, vary greatly with the hazard incident to various kinds of operations. As an extreme illustration, it is quite obvious that a rate adequate to cover the compensa- tion liability of an employer of bank clerks would be grossly inadequate to cover the liability of an assured engaged in the business of operating a stone quarry. Therefore, one of the first steps in compensation rate making was to classify all sorts of occupations and RATES AND RATING BUREAUS 217 industries. The principle just referred to is also applicable to various kinds of work carried on by the same assured. Thus any given assured may have employes engaged in clerical work, as salesmen, drivers, chauffeurs, machine operators, etc. It is, therefore, necessary not only to classify the various basic industries but also to properly subdivide and classify the operations incident to each. In arriving at these classifications, it has been necessary to limit their number to avoid unimportant shadings and unnecessary refinements and, at the same time, to provide enough classifications to give effect to ac- tual and substantial variations in hazard. It is apparent that too many classifications based upon fine distinctions must give rise to endless confusion and ultimately defeat their purpose. On the other hand, it is essential that there be sufficient classifications so that operations involving a real difference in hazard may be segregated and a proper rate applied thereto. CLASSIFICATIONS BECOMING STANDARD- IZED. — These principles were recognized at the out- set by compensation carriers and, with the develop- ment of the science of compensation rate making, these classifications are gradually becoming standard- ized. Consequently there is now available a very con- siderable volume of experience segregated by classi- fications and, on the basis of such experience, it is possible to scientifically determine the proper rate applicable to each $100.00 of pay roll earned by em- ployes engaged in operations falling within any such classification. Where there is not sufficient experience 218 THIRD PARTY INSURANCE under any given classification, it becomes necessary for the rate maker to take into consideration the experience under analogous classifications and to modify pure premium indicated by the limited experi- ence by the application of individual judgment. VARIATIONS IN LIABILITY IMPOSED BY COMPENSATION LAWS.— There exists a wide divergence between compensation laws as to benefits payable thereunder. Hence a rate for any given classi- fication which may be adequate in one state may be grossly excessive in another and in still another en- tirely inadequate. This situation has given rise to great difficulties in the compilation of experience and in fixing rates for the different states. Until recently it has been assumed, as a general proposition, that the relation between the hazard of the various classifica- tions is the same in all states and also that any given classification will produce the same accident frequency and severity in all states. As a matter of fact, this assumption is not entirely correct because the number, character and cost of work accidents under the same classification depend, in a measure, upon climatic, physical and social conditions, the character of the workmen, the prevailing sentiment of those intrusted with the determination of controverted cases, etc. Hence, although the theory above referred to has been generally applied, it has been necessary in fixing rates for the same classification in various states to give individual treatment to certain classifications when local conditions are such as to clearly so require. RATES AND RATING BUREAUS 219 EXPERIENCE UNSAFE GUIDE UNLESS BASED ON WIDE TERRITORIAL EXPOSURE. — While it is fundamental that the experience upon which an insurance rate is to be predicated must not only be large in volume, but also have been incurred over a wide territorial area, there has been recently observable a tendency among a few of the larger in- dustrial states in determining rates to be charged by insurance carriers within their borders, to give undue weight to their individual experience. Such action is obviously unwise and unscientific. The business of compensation insurance is nation wide. A large ex- perience based upon nation wide exposure is now available and will continue to increase in volume. Under such circumstances it would be unfortunate if any one state should unnecessarily disregard the experience incurred in other states and such procedure would be contrary to the basic principles of insurance rate making. No one would think of fixing life insur- ance rates upon the basis of mortality incurred in one state no matter how large that mortality experience might be. While it is true that accident frequency depends in a measure upon local conditions, the gen- eral laws of average cannot be determined accurately except from an experience incurred under all sorts of conditions and comprising within its scope the largest possible area. It is permissible to take into consider- ation, in modifying pure premium determined from an extensive and wide spread experience, abnormal local conditions which have been definitely ascertained. Provided undue weight is not given to this factor, it 220 THIRD PARTY INSURANCE is a proper one. To go beyond this and attempt to fix rates on the basis of an experience incurred in a re- stricted territory would be to fly in the face of recog- nized and well established fundamental principles. LAW DIFFERENTIALS.— When the first basic manual was prepared in 1914 the largest and most dependable experience available was that which had been incurred under the compensation act of Massa- chusetts effective in 1912. The loss cost per unit of exposure under that act was, therefore, taken as a basis. It was assumed that the laws of average gov- erned the relative character of accidents if applied to a sufficiently large number of accidents. In other words, it was taken for granted that if out of a very large number of accidents it could be determined just how many resulted in death, in various dismemberments and in total and partial disabilities of varying dura- tion, an equal number of accidents happening in the future would produce the same approximate results. Proceeding upon this theory the so-called standard accident table was prepared. The purpose of this table is to assist in calculating the relative distribution of accidents in accordance with those classifications of disabilities for which indemnities are provided by American compensation laws. In preparing this table all available statistics, both American and European, were taken into consideration and on the basis of such statistics a hypothetical table was prepared showing what the available statistical evidence indicated to be the relative distribution of one hundred thousand acci- dents divided into such classifications. By the use of RATES AND RATING BUREAUS 221 this table it is possible to determine the cost of each kind of injury under the Massachusetts act as com- pared with the cost under any other act. The table indicates the number of fatal cases, of various sorts of dismemberments, of total and partial disabilities which may be expected out of one hundred thousand acci- dents. The benefits provided by the Massachusetts act for each kind of accident were compared with the benefits provided by the acts of other states for the same kind of accidents. The percentages indicating this comparison were determined and a weighted aver- age of such percentages computed. The resultant per- centage indicated the cost of claim payments under the act of any given state as compared with Massachusetts. If, for illustration, the cost in a given state was found to be 5 per cent greater than that arising under the Massachusetts act, a diflferential of 105 was estab- lished for that state. This is known as the law differential. OTHER EXPERIENCE MADE AVAILABLE BY THE USE OF THE LAW DIFFERENTIAL.— At the time the first basic manual was prepared there was little experience aside from the Massachusetts experience. It was, however, possible by the use of the law differential to reduce such experience to the Massachusetts level and to thus ascertain the loss cosi per unit of exposure which would have resulted if the entire experience had been incurred in Massachusetts. By this method it was possible to secure a much larger volume of experience and to fix a basic pure premium for Massachusetts in conformity therewith. 222 THIRD PARTY INSURANCE This basic pure premium can be converted for use in any other state by the use of the particular law differ- ential applicable. During the period which has inter- vened since the promulgation of the first basic manual this method has been used very extensively. At the present time plans are being perfected which involve somewhat radical modifications of methods hereto- fore in use. It is proposed to substitute pure premium incurred under the New York compensation act on 1917 business in lieu of the old Massachusetts experi- ence. It is also contended that the accumulation of large volumes of experience in individual states makes it possible and proper to give greater effect, in de- termining the rates for any given state, to the experi- ence incurred within its own borders. While, as we have previously shown, this suggestion, subject to cer- tain very definite qualifications, is sound, any method of rate making calculated to give undue weight to the experience of a single state is fundamentally defective. STATE MULTIPLIERS.— While the law differ- ential is the principal factor in determining rate vari- ations for the different states, it has been necessary to take into consideration many other factors. To give effect to all of them, the pure premium under the original Massachusetts law has been taken as the basis and to it applied what are known as state multi- pliers. In addition to the law differential, the factors which enter into each multiplier are as follows: (1) Underestimate of outstanding losses. (2) Increasing cost due (a) To the age of the act. RATES AND RATING BUREAUS 223 (b) To abnormal industrial activity. (3) Industrial diseases. (4) Variations due to merit rating. (a) Schedule rating. (b) Experience rating. (5) State experience. (6) Catastrophe hazard. (7) Management expenses and taxes. (8) Profit. EXPLANATION OF THE FOREGOING FACTORS. — (1) We have already commented upon the effect of the under-estimate of outstanding losses. (2) Experience has demonstrated that the cost of com- pensation under any act increases with the age of the act. The principal reasons are as follows : It takes time for employes to fully realize the possibilities of recovery ; the courts and administrative bodies in- trusted with the construction of the compensation laws have proved to be very liberal in their interpretations and as broad interpretative precedents are established, the cost increases. Of course any abnormal industrial activity also has a profound effect upon loss cost. (3) In establishing basic pure premium under the Massachusetts act the cost of industrial diseases was eliminated for the reason that few compensation laws include this coverage. Therefore, in determining the multiplier for any state where the compensation law covers such diseases, proper allowance must be made. (4) We have already explained why it is necessary to make allowance for the inadequacy brought about by the application of merit rating. (5) We have hereto- 224 THIRD PARTY INSURANCE fore indicated the reasons why a factor is inserted to give effect to the actual experience in a particular state. (6) The very nature of compensation insur- ance makes overwhelming catastrophes possible, and, as we have seen, it is customary for carriers to assume unlimited liability. No experience yet available is suf- ficiently large to show the average effect of catas- trophes and hence a special judgment loading must be added. (7-8) Inasmuch as management expense, taxes and profit must be paid out of premium received an adequate loading must be added. SCHEDULE RATING.— This form of merit rating is designed to give effect to the individual physical characteristics of each risk upon the theory that it would be unfair to penalize a good risk because of the deficiencies of other risks or, on the other hand, to enable a poor risk to profit at the expense of a good one. In practical operation, the schedule rating sys- tem is applied by the inspection departments of the various companies. Certain standards of safety have been established and the risk is credited or debited dependent upon whether or not it measures up to such standards. Inasmuch as schedule rating depends upon the ascertainment of existing physical conditions it is not possible to apply it to risks which do not have a permanent location. Thus schedule rating cannot be applied to a contracting risk because there is no fixed place at which operations are carried on and safety conditions vary at each location. At the present time the compensation schedule is applicable only to manu- facturing risks. Schedule rating is not used in de- RATES AND RATING BUREAUS 225 termining rates for the various forms of public liability. This statement is subject to the qualification that a modified schedule rating plan is applied in determin- ing the rate to be charged for theatre public liability policies. EXPERIENCE RATING.— Inasmuch as schedule rating depends entirely upon observable physical con- ditions, it, of course, gives no effect whatsoever to moral or intangible factors although everyone knows that two risks having precisely the same physical characteristics may produce a radically different experience. In the one case the workmen may be intelligent, the supervision capable and the general morale good. In the other conditions exactly the con- trary may prevail. In order to give effect to these divergencies, so-called experience rating plans have been devised. To some degree, they constitute a de- parture from fundamental principles of insurance rate making, which, as we have said, depend primarily upon averages and do not take into account individual elements in an aggregate experience. For illustration, in fixing the premium charge for a personal accident policy no variation is permissible because of the experience of the carrier in connection with one indi- vidual. Such an individual is either insurable or unin- surable and if acceptable the average rate is charged. It may be that one individual has been fortunate or unfortunate but no account is taken of this fact in fixing premium. Such action would be unsound in that it would permit the element of chance or luck to enter into what should be a scientific determination of the 226 THIRD PARTY INSURANCE law of average applicable. It is, of course, true that a succession of misfortunes frequently indicates a defect in the risk. Thus if an individual carrying a policy cov- ering public liability on an automobile should present ten claims in a year, that fact would tend to indicate him to be an incompetent or careless driver. On the other hand, if, under the same circumstances, an assured should report no accident, that fact would be of no significance whatever. JUSTIFICATION FOR EXPERIENCE RAT- ING. — While the advocates of experience rating con- cede the applicability of the generalities above set forth and make no contention that experience rating should be applied to determine the premium for the ordinary insurance risk, they contend that where the risk is sufficiently large so that even if good it may be expected to produce some accident frequency, it must be considered to present an experience not dependent entirely upon chance or contingency, from which a law of average imperfect but significant may be derived. Their theory is that under such circumstances the individual experience of such a risk should not be dis- regarded, but should be taken into consideration in connection with the general experience of the class to which it belongs as at least indicating a trend. Certain minimum requirements as to the size of the risk and the period of exposure are imposed and a formula has been worked out which may be applied to the basic rate in fixing premium for those risks which qualify. There can be no question but that there is merit in the theory upon which experience rating is RATES AND RATING BUREAUS 227 predicated provided it is possible, as a practical propo- sition, to determine with reasonable accuracy the rela- tive w^eight of class experience and individual risk experience. The experiment now being made will therefore, be watched with great interest by those interested in the science of insurance rate making. Experience rating at the present time is applied in connection with the writing of compensation business and also in determining premium for automobile risks where a number of cars are covered. AUTOMOBILE RATES.— In a general way the same problems which have had to be solved by com- pensation carriers in fixing scientific rates have been presented to the insurers of the various kinds of auto- mobile liability. Indeed because of the diversity and complexity of the automobile coverages the problems presented have been even more difficult. In the com- pensation business the unit of exposure, namely, $100.00 of pay roll of employes engaged in covered operations, is uniform. On the contrary, it has been necessary in determining automobile rates to adopt a number of different units since it is impossible to select one adapted to the peculiar needs of each branch of this business. As a matter of fact, automobile rate making is not yet on a scientific basis, but is in a process of evolution. Many of the methods now in vogue are still purely experimental. There have re- cently been many changes and it is to be expected that in the future frequent modifications will have to be made until such time as proper standards may be determined and sufficient statistics compiled on the 228 THIRD PARTY INSURANCE basis of such standards. This business was first writ- ten about the beginning of the present century. The first manuals which contained rules and classifications for the rating of automobiles were issued about 1901. These rules and rates pertained only to public liability and in the absence of any statistics were based upon rates which had previously been charged for teams' public insurance. Many of the difificulties which the companies are now experiencing are due to the fact that at the beginning no standardized system of com- piling and reporting experience was adopted. The first uniform statistical plan based upon an actuarial analysis of the situation was promulgated by the National Workmen's Compensation Service Bureau to take effect January 1, 1917. FACTORS TO BE CONSIDERED IN DETER- MINING AUTOMOBILES RATES.— The most cur- sory investigation of the subject will indicate that there are many factors which enter into the problem of determining rates for automobile insurance. It is not a difficult matter to determine what these factors are, but is exceedingly difficult to devise a plan which will correctly measure and give effect to each. It is obvious that the number of miles that a car is driven has a direct bearing upon the accident frequency which may be expected. The exposure on a car which is driven continuously is necessarily greater than that presented when an automobile is used only part of the time. However, it has as yet been impossible to perfect any device which will insure the correct measurement of mileage and eliminate the possibility of fraud. It is RATES AND RATING BUREAUS 229 also apparent that the purposes for which an auto- mobile is used must be given consideration. Again the probability of accident is greatly increased if the automobile is operated at a place Where the traffic is dense. It requires no special knowledge to perceive that the rate which must be charged for an automobile which is operated in a center of dense population like New York City must be much higher than that which is charged for coverage on a car which is driven in a rural district. The loss cost incident to the operation of automobiles also depends to a considerable extent upon the character of the laws and traffic regulations in force at the place where the cars are operated and upon the manner in which such laws and regulations are enforced. Similarly, consideration must be given to the general character of the population in so far as that character is reflected in a disposition to litigate or to press exaggerated or unfounded claims. Along with this, weight must be given to the prevailing sentiment toward automobile owners since such sentiment has a direct effect upon the size of verdicts. Naturally the hazard varies with the physical characteristics of the insured automobile. Among these the most important is the motive power. A car propelled by electricity is less hazardous than one whose motive power is de- rived from gasoline or steam. The weight and size of the automobile have a direct bearing upon the ease of control and upon the impact and consequent dam- age which may be expected from a collision. The speed which an automobile is capable of attaining also affects the hazard incident to its use. Climate, topog- 230 THIRD PARTY INSURANCE raphy and road conditions have an influence upon acci- dent frequency and severity. PRIVATE PASSENGER CARS.— In Chapter III we have briefly described the methods now used for determining premium for various kinds of automobile coverage. It is advisable to here call specific attenjbion to the relation between the methods previously described and the hazard factors referred to in the preceding paragraph. Because of the variations in hazard due to the type of car and the purpose for which it is used all cars as we have seen are roughly divided into four classes — private passenger, com- mercial, public, manufacturers and dealers. Private passenger cars are again divided into groups, largely dependent upon list price, on the theory that the list price reflects, in a general way, the momentum which is dependent upon speed and weight. The various other factors referred to in the preceding paragraph are given effect in so far as is practically possible by the setting up of definite territorial divisions and by rate variations dependent upon the person by whom the car is driven. The lines of demarkation between these territories must of necessity be, to a large extent, arbitrary and dependent upon individual judgment. Inequities must inevitably occur because there is in reality no fixed and definite place where a territory of one character is immediately contiguous upon one of an entirely differ- ent character. Thus it happens that an assured resid- ing on one side of an imaginary line must pay a larger premium than a more fortunate assured on the other side although conditions under which both cars are RATES AND RATING BUREAUS 231 operated are very nearly identical. It will perhaps be possible in the future to establish zones by means of which different territories may be gradually merged into one another by easy gradations. COMMERCIAL CARS.— As we have seen, the premium for commercial cars varies with the territorial schedule and, in this respect, the methods adopted foi fixing commercial premium are the same as those ap- plied to private passenger cars. Here the similarity ceases since the premium for commercial cars is pri- marily dependent upon the business in connection with which they are used. Until recently the rate makers in fixing commercial premium have given no considera- tion whatever to the factor of relative momentum. In other words, the same premium has been charged for all commercial cars in the same territory used for the same purpose. As this book goes to press our atten- tion is called to certain new rules just adopted, which are calculated to give effect to this most important consideration. Under these rules an additional sub- division of commercial cars is made, depending upon load capacity. Cars with a load capacity of one ton or less are placed in what is called the "light" class. Those with load capacity of more than one ton up to and including three and one-half tons are placed in a "medium" class. All cars with a load capacity in ex- cess of three and one-half tons are included in a class designated as "heavy." The minimum rate is, of course, applicable to the light class and increases with load capacity. This innovation corrects a serious de- fect in the methods which have been used for rating 232 THIRD PARTY INSURANCE commercial cars and is a decided step in the right direc- tion. PUBLIC AUTOMOBILES.— Here again effect is given to many of the hazard factors which we have mentioned by the establishment of territorial divisions. With livery vehicles the element of relative momentum is disregarded and premium is paid at a fixed rate, varying only with the territorial classification. Hotel omnibuses and taxi cabs are handled in the same manner. In fixing rates for other public automobiles an attempt is made to reflect the factors of momentum and group exposure by varying the rate with the passenger carrying capacity of the vehicle. MANUFACTURERS' AND DEALERS' AUTO- MOBILES. — The same territorial divisions are taken into consideration in fixing the rates for these cars. No method has been devised, for giving any effect to the factor of momentum. Various units of exposure are used, including units which are used in connection with rating private automobiles, namely, one identified car insured for twelve months or one named driver for a period of twelve months. Also an adaptation is made of the methods which have been described in connec- tion with our discussion of compensation rates and the rate is applied to a unit of $100.00 of pay roll earned by employes or to each $100.00 of livery earnings. ELEMENTS OF AUTOMOBILE PREMIUM.— What has been said in this Chapter and in Chapter III will be sufficient to give the reader a general idea of the methods now used in determining premiums for the various automobile coverages. It is not here pos- RATES AND RATING BUREAUS 233 sible to go into further detail and no attempt has been made to enter into refinements or to make specific reference to all variations. The elements which enter into the automobile premium as finally determined are the same as those which enter into the compensation premium. There must first be determined the pure premium and to this must be added the loading requi- site to pay expenses and profits. Having once estab- lished a definite statistical plan the principles which have already been described in connection with our discussion of compensation rates become applicable. Experience must be compiled indicating the loss cost per unit of exposure. Judgment variations must be made to the end that such experience pure premium may be modified to take into account the underestimate of pending claims and expected changes in conditions. TERRITORIAL DIFFERENTIALS.— This modi- fied pure premium must be determined for each of the units of exposure which are used in connection with various kinds of automobile coverage and for each classification for which the same unit is used. In the first instance such premiums are determined for the United States as a whole. The next problem pre- sented is to translate them into premiums applicable to each territorial division. This means that the estab- lished pure premium for all classifications using the same exposure unit, in a given territory, must be com- pared with that for the United States as a whole. The differential thus determined is then applied to each sep- arate classification and the rate for such classification for each territory is fixed in this manner. It is assumed 234 THIRD PARTY INSURANCE that the relative hazard for all territories is the same as regards all classifications and that it is unnecessary to enter into the refinement of classification experi- ence for each territory. It has not yet been established definitely that this assumption is warranted and hence it is customary to check up classification rates so determined with actual classification experience for individual territories. Where serious discrepancies occur, judgment modifications are made. STANDARD LIMITS. — The reader is already familiar with the fact that workmen's compensation is the only third party line which is customarily writ- ten without a definite limit upon the insurer's lia- bility. The standard limits for all of the automobile public coverages and also for the other forms of public liability are $5,000.00 on account of one person injured in one accident, and, subject to the same limit for each person, $10,000.00 on account of more than one person injured in one accident. Therefore, the experi- ence from which pure premium is determined is an experience arising, for the most part, under policies containing these limits and all of the standard units of exposure to which we have referred are predicated upon them. However, a small percentage of policies issued provide for larger limits and experience arising under such policies is reported in as many different groups as there are different first or individual limits. No separation of experience with respect to the second or collective limit is made. Thus far no adequate and authoritative experience is available arising under policies providing excess limits. The manuals in use RATES AND RATING BUREAUS 235 contain a table indicating the percentage of increase to be charged for various excess limit combinations and to a large extent these percentages have been determined arbitrarily and hence are not actuarially sound. In fixing these percentages, the rate makers have been prone to play safe and hence they are undoubtedly, for the most part, excessive. NEED FOR REVISION OF EXCESS LIMIT RATES. — With the growing demand for larger limits, due to the decreasing value of the dollar which has resulted in larger settlements and higher verdicts, the time is fast approaching when it will be necessary for the companies to revise the limit tables now in use and experience is now being collated to that end. In the past the need for excess limits has been felt principally by those engaged in the maintenance and operation of elevators, large department stores and other enterprises where there is a collective hazard. There is, however, an increasing demand from the own- ers of automobiles brought about by conditions just referred to. This situation has prompted some of the carriers to consider the advisability of issuing automo- bile public coverage without any limit whatsoever and this question is now being given serious consideration. Certain difificulties which must be overcome will prob- ably delay the universal adoption of unlimited auto- mobile public coverage, but it is quite probable that in the comparatively near future, it will be generally written. RATES FOR OTHER THIRD PARTY COVER- AGES. — It would serve no good purpose to take up 236 THIRD PARTY INSURANCE further space by a detailed description of the methods used in determining rates for third party coverages other than compensation and automobile. The prin- ciples which are applied in fixing rates for them are equally applicable to the other lines and what we have said in our discussion of compensation and automobile rates will be sufficient to familiarize the reader with the general process of determining third party rates. In all cases the loss cost for the particular unit of exposure must be determined and subjected to judg- ment modification based upon the considerations we have previously indicated. Suitable dififerentials or multipliers must be determined and applied to the basic pure premium for the purpose of fixing rates in different territories. To the selected pure premium as finally determined must be added an adequate loading for expenses and profits. The rate having been thus fixed it becomes a simple matter to ascertain premium by applying the given rate to each unit of exposure. CO-OPERATION IN RATE MAKING — RA- TING BUREAUS.— The necessity of co-operation in rate making has long been recognized by all kinds of insurance carriers. No one company, no matter how large, is able to ascertain the laws of average from a consideration of its own experience. In order to determine these laws with any degree of accuracy, the aggregate experience of many carriers must be taken into account. Actuated by this obvious truth, insurance companies have, from time to time, devised methods whereby the experience of all may be merged RATES AND RATING BUREAUS 237 into a common pool. For the most part this end has been accomplished by the establishment of so-called rating bureaus to which each company reports its individual experience. One of the functions of a rating bureau is to collate and analyze the experience of all for the benefit of each. ELIMINATION OF SUICIDAL RATE COM- PETITION. — Another exceedingly important duty of such a bureau is to eliminate, in so far as may be possible, unintelligent and cut-throat rate competition. The insurance business is peculiar in that it is very easy for an overly optimistic or an inefficient manage- ment to err seriously in determining at any given time the actual financial condition of a company. The business is so complex that mistakes in accounting frequently occur and can be avoided only by the utmost care exercised by trained actuaries and account- ants. Large sums are collected in premiums to cover future contingencies. If it happens that a company is fortunate and for a time experiences a very favorable loss ratio, there is frequently a disposition to take it for granted that such experience will continue and to forget that in the long run the operation of the laws of average will inevitably bring about the loss indi- cated by the aggregate experience of the past. As we have seen, in many of the third party lines, the obligation of the carriers need not be met immediately, but is payable in installments which are sometimes extended over long periods. The experience of the best managed companies has indicated that there is a constant tendency to underestimate the cost of out- 238 THIRD PARTY INSURANCE standing claims. This situation is rendered more acute by the stress of competition and agency pressure. Hence one of the principal functions of a rating bureau is to bring about adherence to uniform and adequate rates by all of its members. NATIONAL WORKMEN'S COMPENSATION SERVICE BUREAU. — The third party companies doing business in the United States recognized the necessity of co-operation at an early date and, in 1896, when the business first became securely established, an association of companies, known as the Liability Conference, was formed. In 1910 a compulsory com- pensation law was enacted in New York and a com- mittee of stock companies writing business in that state was organized for the purpose of formulating practices and rates for the new business. This com- mittee subsequently developed into a co-operative organization of all of the leading stock companies which was known as the Workmen's Compensation Service and Information Bureau. The old Liability Conference was merged into it. In 1913 its name was changed to the Workmen's Compensation Service Bureau and in 1916 again changed to the National Workmen's Compensation Service Bureau. This Bureau has played an exceedingly important part in the development of the compensation and liability business. The work which it has done has redounded not only to the benefit of its members but to that of all companies writing these lines. It has been the pioneer in collating statistics and to it must be given the principal credit for bringing about the stabilization RATES AND RATING BUREAUS 239 of the compensation business and the determination of compensation rates in accordance with sound actu- arial principles. The rating methods which we have previously described were originally conceived and put into practical effect by this Bureau. BRANCH BUREAUS AND RATING OFFICES. — The compilation of statistics, the preparation of manuals and all of the work incident to the creation of the various rating systems has been done at the principal office of the National Workmen's Compensa- tion Service Bureau in New York City. Its activities, however, have been by no means confined solely to this work. It has not only prepared manuals, pro- mulgated basic rates and created the merit rating systems which we have described, but has also been active in their practical application. To this end it has established rating offices and branch bureaus in the various states. The rating offices are controlled entirely by the National Bureau. Branch bureaus are organized around a body of local representatives of the companies and exist by virtue of charters granted to them by the National Bureau. To these branch bureaus and rating offices are delegated certain admin- istrative duties, but the determination of general principles and rates is retained by the National Bureau. In a general way, branch bureaus are intrusted with the duty of determining the proper manual classifica- tions applicable to any given risk and of modifying the basic rates so assigned by the application of schedule and experience -rating. While a considerable portion of this work is done by the companies thern- 240 THIRD PARTY INSURANCE selves, it is subject to verification by the local branch bureau or rating office. It many states it is necessary for companies which are members of the National Bureau to submit copies of the schedules of policies issued by them to the branch bureau or rating office for approval. If inspection indicates that the policies have been correctly written, the schedule is stamped "approved" and returned to the company, otherwise it is disapproved and steps are taken to bring about correction. STATE RATING BUREAUS.— The laws of some of the states provide that compensation rates are sub- ject to the approval of the insurance commissioner or other state official. In several of the states specific provision is made for the establishment of independent state bureaus. In others there are no provisions for the machinery which the state official must have in order to put his powers into practical effect. In such cases state rating bureaus have frequently been established by the companies at the request of the official vested with the power to supervise rates. In practically all such cases this work has been accomplished through the local rating offices and branch bureaus above referred to. As a matter of fact, the service performed by these branch bureaus and rating offices in states where there is no official supervision of rates is equiv- alent to that performed by independent state bureaus. In those states where independent state bureaus exist, they have co-operated to a very considerable extent with the National Bureau and have availed themselves RATES AND RATING BUREAUS 241 of the statistics compiled and rating methods devised by it. NATIONAL COUNCIL ON WORKMEN'S COMPENSATION INSURANCE. — In 1915 the Workmen's Compensation Service Bureau undertook a general revision of rates. For many obvious reasons it was desirable that all persons interested in the problem of compensation rate determination should participate in the revision. A meeting was, therefore, called of representatives of the Massachusetts Rating and Inspection Bureau, the Compensation Inspection Rating Board of New^ York, the Workmen's Com- pensation Service Bureau and also of other insur- ance departments and industrial commissions which were interested. As a result of this conference a representative committee consisting of certain state insurance departments, state funds, stock and mutual companies was appointed, which was known as the Standing Committee. In order to bring about stand- ardization, all interests concerned agreed to submit to the Standing Committee changes in rules, classifica- tions and rates for consideration and advice before taking final action upon them. From this beginning, by a process of evolution, there has come into exist- ence what is known as the National Council on Work- men's Compensation Insurance. The constitution of this body was adopted in September, 1919. Its object is to co-operate with rating organizations and public officials in all states in the determination of equitable premium rates for workmen's compensation insurance. Any rating bureau having jurisdiction over workmen's 242 THIRD PARTY INSURANCE compensation insurance rates is entitled to member- ship and practically all of the important rating bureaus have already availed themselves of this privilege. The work of the Council is carried on through represent- ative committees. The establishment of this council marks an epoch in the development of the compensa- tion business. Its influence will have a far-reaching and beneficial effect upon the business as a whole. In its organization there are represented stock com- panies, mutuals, state funds and reciprocals. Its organization is workable and it will undoubtedly be able to finish the great task, already so well begun, of placing the compensation business on a stable basis by the determination of correct rates for all classifica- tions in all territories. This means in the first place that injured workmen will not be deprived of the benefits to which they are entitled under compensation acts through the insolvency of carriers brought about by inadequate rates. It means further that employers will be assured that the rates paid by them are not excessive and, last of all, that the carriers themselves may be certain of receiving the reasonable profit to which they are entitled. CHAPTER IX INSPECTIONS AND AUDITS INSPECTION DEPARTMENT. — All insurers must have some means of investigating risks which are submitted to them. The proposal which is received from the applicant sets forth most of the material information which it is necessary for the underwriting department to have in order to determine intelligently whether the risk should be accepted, and, if so, the rate which should be charged and the form of policy which should be issued. It is, of course, impossible to require the applicant to set forth in minute detail all facts with which the underwriting department should be familiar. It is further essential that the statements made in the proposal be verified. Third party com- panies make this supplementary investigation through their inspection departments. It is also incumbent upon the inspection department to examine risks to which schedule rating is applicable for the purpose of ascertaining those physical conditions which are taken into account by such rating system. Inspectors are provided with appropriate printed forms on which they report conditions as found by them. On the basis erf such report proper debits and credits are fixed and the basic rate adjusted accordingly. It is also the duty of the inspection department to ascertain what improvements in physical conditions are possible 243 244 THIRD PARTY INSURANCE and to place before the assured definite recommenda- tions indicating observed defects and pointing out how they may be corrected, thus accomplishing the double purpose of serving the assured by bringing about a reduction in his premium and also eliminating, in so far as may be possible, hazards which are likely to bring about injuries. QUALIFICATIONS REQUISITE.— Inasmuch as they are dealing with all sorts of mechanical appli- ances, it is essential that the men who are intrusted with the work described in the preceding paragraph should have some technical education. They must be familiar with at least the elementary principles of engineering and mechanical science. Theoretical and scholastic knowledge alone is not sufficient and it is necessary that the inspector also have a wide and varied practical experience. Until recent years most of this work has been done for third party companies by practical mechanics with little preliminary tech- nical education. At the present time, it is the practice of the companies to employ young men who have had some technical education and to train them under the direction of men who have had the necessary practical experience. ELEVATOR INSPECTIONS.— Schedule rating is not applicable to modify premium charged for elevator coverage. Hence the inspection of elevators has no eflfect upon rates. The purpose is to ascertain the physical condition of the insured elevator since a defect may occasion serious accident imposing upon the carrier a large liability. There are a great variety of INSPECTIONS 245 elevators and their mechanism is complicated, pre- senting many danger points to which careful attention must be given. A competent elevator inspector must be particular to note the character and apparent ability of the operator, as a careless or inefficient operator presents a distinct source of danger. The fact that an inspection made at the time a carrier assumes liability indicates the insured elevator to be in good mechanical condition, constitutes no guarantee that such condition will continue during the life of the policy. It is, therefore, customary to follow up the preliminary inspection by subsequent periodical inspections made at monthly or quarterly intervals. For this reason, the relative expense of making ele- vator inspections is higher than that incurred in connection with any of the other third party lines,. In this respect it resembles the steam boiler and fly wheel business. FACTORY INSPECTIONS.— This branch of the inspection department's work requires a very wide range of knowledge on the part of the inspector. It is most important that his work be done efficiently. All sorts of appliances must be examined and ever varying conditions taken into consideration. It is necessary to observe and record those physical char- acteristics which must be taken into account in the application of schedule rating. Ample opportunity is presented for constructive work in the way of accident prevention. The inspector must give his attention to buildings, sidewalks, yards and elevators, as well as to boilers, engines and machinery of all kinds. He 246 THIRD PARTY INSURANCE must examine stairways to ascertain whether the treads are in good condition and the stairs properly handrailed. He must determine whether all possible safeguards have been adopted to prevent catastrophe loss due to fire, and, in this connection, must determine whether fire escapes, fire signals and exits are ade- quate. It becomes necessary to investigate the con- dition of yards, railroad tracks, overhead bridges, passage ways, etc. While ordinarily an inspector does not make a special examination of the condition of boilers, it is his duty to find out whether this work is attended to by a regular boiler inspector and to observe the date of the last inspection. He must also investigate for the purpose of determining whether the boilers are in charge of competent men. The same general consideration must be given to the condition of engines, engine rooms, drive wheels, fly wheels, gears, belts, pulleys and shafts. It would be impos- sible to mention all of the various matters of this character to which attention must be given. The foregoing will indicate in a general way the wide scope and variety of the work which must be attended to by the factory inspector. INSPECTION OF CONTRACTING RISKS.— For reasons which have already been explained, schedule rating is not applicable to risks of this kind. A contractor's policy does not ordinarily limit the coverage to one designated location but rather to a territory such as a city, county or state. Many con- tractor risks are not inspected at all for the reason that their work is so varied and performed under INSPECTIONS 247 conditions which change so frequently that an inspec- tion of one small job would have little, if any, signifi- cance and the attempt to inspect every job would involve a prohibitive expense. If, for illustration, a policy is issued to cover a painting contractor who is engaged in the general business of doing interior decorating of apartment buildings, it would be futile to attempt to make an inspection. Theoretically, it might be advisable to examine his equipment in the way of ladders, ropes, scaffolds, etc., but this equip- ment is so simple, is used under such ever varying conditions and is subject to such frequent replacement that a single inspection would be of little benefit. Where it is known that a contractor is engaged on any large job, or where the nature of his work is such that it may be expected that he will engage in substantial operations at one place, it is customary to make an inspection. As illustrative of the matters to which attention must then be given may be mentioned the condition of hoisting and conveying apparatus, stag- ings, platforms and other similar equipment. It is also important to ascertain not only physical condi- tions, but also general methods employed in the direction and supervision of the work. The inspector must know whether explosives are properly handled and stored and whether blasting is done by men skilled in this particularly dangerous work. Most large con- tracting operations involve excavation work and it is the business of the inspector to find out whether approved methods are adopted in the carrying on of this work and all suitable precautions availed of. It 248 THIRD PARTY INSURANCE is important for the inspector to determine whether overseers and foremen are intelligent and exercising proper interest in the protection of workmen by using good methods of signaling, refraining from overloading hoisting apparatus or floors and adopting proper measures to prevent workmen from doing reckless and foolhardy things. Where public liability is carried, it is also essential that the inspector should see to it that sidewalks, streets and passage ways are kept clear and to insist upon the contractor complying with all applicable laws and ordinances. GENERAL LIABILITY INSPECTIONS.— As we have seen, general liability policies are issued to cover all sorts of buildings where manufacturing operations are not carried on, such as office buildings, hotels, stores, theatres, etc. With the exception of theatre risks, schedule rating is not applicable to this class of business. While the hazards presented are ordi- narily much less serious than those involved in con- nection with the other lines which have been referred to in this Chapter, it is customary to make an inspec- tion of all buildings which are covered by general liability policies. Inspections are not made where risks are small and inaccessible and the cost of inspection would be out of proportion to the premium received. Thus it is not absolutely essential that a small grocery store which is covered by a general liability policy should be inspected particularly when located in a rural community where the company has little similar business. Usually risks of this character if they appear to be satisfactory on the basis of the INSPECTIONS 249 information contained in the proposal, are inspected only when it is possible to do so economically by reason of having sufficient inspection work in the vicinity to warrant the inspector in making a special trip. What we have already said with reference to factory inspection is here applicable. The work of general liability inspection is, of course, much simpler in that the machinery hazard is ordinarily negligible. It is important to ascertain the condition of stairways, of roofs, floors, sidewalks and adjacent ways. De- fective coal hole covers, worn stairway treads, im- perfect floors and other similar conditions are prolific sources of costly accidents. These and other similar matters must, therefore, be given attention and if defects exist they must be corrected. It is very important also that the inspector ascertain the general character of the tenants of the covered building. As we have already seen, there are certain districts which experience has demonstrated must be considered as absolutely prohibited for the reason that the inhab- itants of such districts are prone to make fraudulent or excessive claims. Wherever the character of the tenants is such that the inspector feels that an element of moral hazard is presented, the risk must ordinarily be declined. Where the risk is of the type which presents a collective hazard, of which the best illustra- tion is a theatre risk, the inspector must be careful to ascertain whether all proper precautions against the consequences of fire have been adopted. MINING INSPECTIONS.— It is quite apparent that a mining risk presents certain special hazards 250 THIRD PARTY INSURANCE which are in many respects peculiar to it. For the most part the inspection of mining risks is done by mining experts who devote their entire attention to this work. To do it efficiently requires not only a very considerable degree of technical knowledge, but also a wide and varied practical experience. The catastrophe hazard is present to a greater or less extent in connection with all mining risks, and, as the results of a catastrophe are overwhelming, the pos- sibility of its occurrence must be guarded against by every practical device which has been developed in the mining industry. Some of the factors having an important bearing upon catastrophe possibilities are geological formations, the condition of tunnel roofs and the methods used for timbering. It must be determined whether the mine is one which produces explosive or noxious gases and consideration must be given to the ventilation and lighting systems and other devices used to eliminate danger incident thereto. The inspector must ascertain how and where explo- sives are stored and the general methods of handling same. He must investigate the condition of hoisting appliances, engines and boilers. The foregoing are only illustrative of the various matters to which atten- tion must be given by the mine inspector. MISCELLANEOUS INSPECTIONS. — The in- spection departments of third party companies are chiefly concerned with the inspection of the classes of business previously referred to in this Chapter — elevator, factory, contractors', general liability and mining risks. Their activities, however, are not nee- INSPECTIONS 251 essarily confined solely to them. While it is not the ordinary practice to inspect automobile and teams' risks when policies cover one or a very limited number of cars or teams, it is advisable to inspect large risks of this character. Theoretically, it would be well to inspect every such risk, but the expense is prohibitive. When a policy is issued covering a number of teams, the inspector looks over the equipment in use and ascertains the general character of drivers, makes a check upon the business for which teams are used as stated in the proposal, etc. It is wise to make the same sort of survey when a policy is issued covering a number of automobiles. The underwriting depart- ment also frequently calls for special reports of various kinds. Thus it may suspect without having definite knowledge that an applicant for automobile public coverage on a single car is undesirable. It turns to the inspection department for the necessary investiga- tion. Again very large limits may be desired and the underwriting department may consider it wise to have a definite knowledge of the assured's character and the purposes for and conditions under which the car is used. In a general way, therefore, the inspection department acts as the eyes and ears of the company, making all those investigations necessary to the care- ful conduct of its business. INSPECTION SERVICE RENDERED BY NATIONAL WORKMEN'S COMPENSATION SERVICE BUREAU. — In the first instance, the solicitor must determine the form of policy appropriate for the coverage of any given risk. He must also 252 THIRD PARTY INSURANCE primarily, with the assistance of the manual, select those classifications which aptly describe the character of the applicant's operations. In setting forth these classifications in the proposal, the solicitor must use the manual wording. In some cases, particularly in connection with the compensation business, it is not easy to determine just what classification should be used and ample opportunity for mistake and mis- classification is presented. Where the information contained in the proposal is not sufficient to enable the underwriting department to judge whether the risk has been correctly classified and when it has reason to suspect the possibility of misclassification, it calls upon the inspection department to supply it with the necessary information. All of the leading stock companies are members of the National Work- men's Compensation Service Bureau and, in a general way, the classification of all risks written by a member company is subject to the supervision of that Bureau acting through its rating offices and branch bureaus. This is particularly true as regards the compensation business. For the purpose of exercising this super- vision, the National Bureau has in its employ a corps of inspectors who operate under the immediate super- vision of its branch bureaus or rating offices. If ques- tions as to classifications arise, they are determined largely on the basis of information furnished to the local rating office or branch bureau by such Bureau inspectors. APPLICATION OF SCHEDULE RATING SYS- TEMS. — Schedule rating is applied to modify the INSPECTIONS 253 premium charged for theatre policies and that charged for certain compensation coverage. Ordinarily the company inspectors obtain information upon which theatre rating is based and submit that information to the local rating office or branch bureau, which, in turn, modifies the manual rate by the application of the theatre schedule. In some cases the rate making inspection of theatre risks is made by a Bureau in- spector. For the purposes of applying schedule rating to compensation risks, such business is divided into two classes, new business and renewals. The term "new business" is applied to any risk which has not carried compensation or employers' liability insurance with a conference company during the preceding sixty days. The term "renewal business" is applied to all other risks. INSPECTION PROCEDURE WITH REFER- ENCE TO COMPENSATION BUSINESS.— When a Bureau company desires to insure a new risk, it is privileged to issue a policy in conformity with manual classifications at full rates. If the risk is susceptible to schedule rating the company must call upon the branch bureau or rating office to make an inspection and to determine the adjusted rate on the basis thereof. No company is permitted to modify rates on new business on the basis of inspection made by its own inspectors. After having issued a compensation policy at rates modified by the schedule rating system and promulgated by the Bureau, the carrying company is required, not less than fifteen days prior to the expira- tion or anniversary date of the policy, to file with the 254 THIRD PARTY INSURANCE local branch bureau or rating office an inspection report containing the data pertinent in determining the application of the schedule rating system. It is also required to file a rating sheet showing the adjusted rate as determined on the basis of its inspection. This inspection report and rate computation are checked and if found to be correct, the resultant rate becomes the authorized renewal rate available for use by the carrying or any other Bureau company. INSPECTION ROUTINE.— Proposals pertaining to risks which require inspection are so stamped by the underwriting department. An inspection card on which appears information which the inspection department must have is made up, forwarded to the inspection department and serves as the basis for its routine operations. The company inspectors, under the supervision of the home office inspection depart- ment, make inspections and forward reports to the home office. On the basis of these reports recom- mendations are made up and sent to the assured. These recommendations indicate in detail those defects in the risk which should be corrected and also indicate if the risk is susceptible to schedule rating what effect such correction will have upon the rate. The assured is requested to advise as soon as recommendations have been complied with. Upon such advice, a re- inspection is made and, where circumstances warrant, the assured is given the benefit of premium adjustment. EDUCATION IN ACCIDENT PREVENTION.— The science of accident prevention does not deal solely with mechanical safeguards. There may be installed INSPECTIONS 255 in any given plant all of the latest mechanical devices calculated to prevent accidents. This is not sufficient. The human element must be given consideration. The workmen and those who direct their operations must be educated to appreciate the importance of accident prevention work and must all co-operate if satisfactory results are to be attained. It does no good to provide a workman with goggles to prevent eye injuries unless he wears them. No matter how mechanically perfect a safety device may be it cannot guard against the dangers incident to ignorance, carelessness and indif- ference on the part of workmen or superintendents. The personal equation is vital. A realization of this obvious truth has led the inspection departments of third party companies to carry on safety campaigns for educational purposes and many novel and in- genious methods have been adopted. In many large plants it is customary to emphasize the importance of the safety first movement, to graphically illustrate the consequences of preventable accidents and the precise way in which they could have been prevented, by means of moving pictures specially prepared with a view to the conditions which exist in the particular plant. Safety meetings addressed by foremen and company inspectors are called. Interesting literature with appropriate illustrations is circulated among -employes and bulletins in various languages posted at conspicuous places. One of the most difficult prob- lems with which those in charge of these safety cam- paigns have been confronted has been the large and diverse element of foreign help employed in many 256 THIRD PARTY INSURANCE industrial enterprises. Frequently as many as a dozen different languages are spoken by employes engaged at work in the same plant and they are neither able to understand one another or the foremen who super- vise their work. While this condition can be remedied to some extent by the posting of bulletins and the circulation of literature printed in various languages, it can only be eliminated entirely by educating work- men to read and understand the English language. CARE OF INJURIES.— From the standpoint of the inspection department of a third party company, the first objective is to prevent the happening of acci- dents and the next to minimize their consequences. Trivial injuries if not promptly and properly attended to frequently have most serious results. Thus infec- tion often follows slight cuts and abrasions causing in many instances serious disability and even loss of limb or life. Eye injuries, no matter how slight, are always dangerous and should be given expert atten- tion. While the ultimate responsibility for the handling of injury cases, in so far as that responsibility rests upon an insurance company, falls upon its claim department, the inspection department exercises an important function in seeing to it that adequate facil- ities are provided for first aid treatment. Certain credits are allowed under the schedule rating system for the installation of properly equipped first aid cabinets, dispensaries and emergency hospitals. Third party inspectors have adopted a very broad policy in this connection and do all that is possible to the end that proper equipment be installed for giving neces- AUDITS 257 sary first aid and that steps be taken to insure that such equipment is fully utilized by injured workmen. At the suggestion of the inspection department fore- men are instructed to insist that workmen under their charge not only protect themselves by the use of safety devices but also in the event that injury occurs, not- withstanding such precautions, that the workmen take advantage of the provisions which are made for their benefit. AUDITS. — The reader is already familiar with the practice adopted, as to those third party lines premium for which is based upon payroll of employes, of deter- mining the initial or deposit premium on the basis of an estimate of the payroll which will be earned during the period to which the estimate pertains. We have seen that it is the duty of the underwriting department to exercise all possible care to the end that these estimates be adequate. Having done this the obliga- tion of the underwriting department ceases and it devolves upon the audit department, at the expiration of the monthly, quarterly, semi-annual or annual period, to examine the records of the assured for the purpose of making the premium adjustment which is provided for by the policy. Proper records must be kept to the end that the audit department's attention may be called to the date on which audit should be made on every policy outstanding on the company's books. The actual work of making audits is done by auditors who, in the first instance, must be qualified accountants capable of intelligently examining the several bookkeeping and accounting systems in use 258 THIRD PARTY INSURANCE by the various assured. It is also necessary that these auditors be thoroughly familiar with the provisions of the policy and with the methods used by the com- pany in determining classifications and rates. Not only must these auditors be possessed of such qualifi- cations, but they must be men of such maturity, per- sonality and experience as to creditably represent the company and exercise a reasonable degree of diplo- macy in their dealings with assured. They must be able to intelligently explain to an assured the pertinent provisions of his policy, to satisfy him that the audit has been made correctly and that payroll has been properly distributed among the classifications covered by the policy. AUDIT ROUTINE.— The auditors who do this work are provided with appropriate printed forms on which are copied the classifications which appear in the policy and the rate applicable to each. Using this form as a guide, the auditor examines the books and records of the assured for the purpose of ascer- taining the entire payroll earned by all employes engaged in covered operations and of properly dis- tributing that payroll by classifications. Upon com- pleting his investigation payrolls as determined are written by the auditor opposite the appropriate classi- fication and the assured or his bookkeeper requested to sign same as indicating that it is correct. This report is returned to the company by the auditor and is carefully checked at the home office. If mistakes are discovered, steps are taken to correct them. In some instances, it is necessary to require a re-audit. AUDITS 259 If, as is almost always the case, an additional premium is due, it is charged to the assured and billed in due course, ordinarily through the agent. In those cases where the audit shows that the advance premium was excessive, the assured is given proper credit and the excess payment is returned. DIFFICULTIES IN SECURING CORRECT AUDITS. — While the procedure above briefly outlined is apparently a simple one, many difficulties are ex- perienced in securing correct audits. Where proper bookkeeping and accounting methods are followed by the assured, the problem is greatly simplified. Even under such circumstances the bookkeeping system used does not ordinarily take into consideration the special and various classifications of work as set forth in the policy and the auditor, in order to get an approximately correct distribution of payroll, must exercise a considerable degree of judgment and in- genuity. In many instances, however, the auditor finds that the assured has no definite and scientific method of keeping track of payroll expenditures, par- ticularly as to divisions of such expenditures between classifications. In fact many assured whose operations are conducted on a small scale keep no written record. In such cases the auditor has to use his judgment and avail himself of the experience acquired in handling similar cases. He must diplomatically interrogate the assured and determine whether he is disposed to be frank or evidences a disposition to reduce his premium by convenient lapses of memory. The auditor must ascertain what work has been done by the assured 260 THIRE) PARTY INSURANCE during the audit period and his experience enables him to make a fairly accurate estimate as to the labor cost incident thereto. He must examine check stubs and such scattered memoranda as the assured is able to produce and make the best adjustment possible under the circumstances. MANIPULATION OF RECORDS NOT INFRE- QUENT. — The auditor must be ever on the alert to detect fraudulent manipulation of records made for the purpose of reducing premium. The foregoing characterization is perhaps to some extent unchar- itable. It, however, frequently happens that an as- sured who ordinarily conducts his business along correct lines and pays his obligations, develops a moral obliquity in his dealings with a payroll auditor. For some inconceivable reason many assured seem to feel that they are engaged in a sort of a game or test of skill and that to the victor belongs the spoils. We do not intend to intimate that these remarks are applic- able to the majority of assured. There is unfortu- nately a considerable percentage, however, whose methods vary between what may be termed a lack of frankness and deliberate fraud. In some instances assured have gone so far as to install a double set of books — one of which is specially prepared with a view to submitting same for examination by the pay- roll auditor. Further than this, there always exists the distinct possibility of overlooking some item of expenditure or some diversification in classification with the resultant loss of considerable premium to the company. Indeed, it may be safely asserted that in the AUDITS 261 aggregate, notwithstanding all the care that is exer- cised, the companies receive a premium which is materially less than they are entitled to on those branches of their business the premium for which is determined on the basis of wage expenditure. In order to reduce this loss to a minimum it is essential that the audit department be in all respects efficient and that its employes be selected with much care and careful attention paid to their training. CHAPTER X CLAIMS, SUITS AND RESERVES THIRD PARTY CLAIMS.— We have, in Chapter II, outlined the general processes applied in adjusting claims arising under insurance policies. In the third party business the insurers do not indemnify against direct loss suffered by the assured but against loss due to liability imposed upon the assured by reason of injuries in person or property suffered by third persons. For this reason the methods used in adjusting third party claims differ in many material respects from those applicable to the adjustment of claims arising under policies idemnifying the assured against direct loss. The carrier becomes liable only to the extent that the assured is responsible to the third party. Negotiations pertaining to adjustment are, therefore, carried on with the third party and pay- ments are made to him. In the event of litigation the insurer defends in the name of the assured suits which are brought against him. The claim departments of third party companies must, therefore, possess a knowledge of the principles of law involved in the determination of the assured's liability and must make careful investigations for the purpose of definitely determining the facts upon which such liability rests. This work must be carried on by men whose experi- ence and training are of such character as to enable 262 CLAIMS 263 them to judge the value of these claims intelligently and to effect settlements where possible on a proper basis, thus avoiding the expense and objectionable complications incident to litigation. Inasmuch as every claim of this kind is, in reality, an embryonic lawsuit, those handling the claim must, from the outset, have in view the possibility of litigation and so conduct their investigation as to provide the legal department of the company with such evidence of the facts as may enable it to properly present at a trial any defenses that the assured may have. CLAIM DEPARTMENT ROUTINE.— All third party policies require the assured to give to the com- pany immediate written notice of the happening of an accident likely to result in a covered liability. The companies provide their assured with printed notice forms designed to elicit the pertinent facts. Each notice received is considered as a separate claim, given a number and properly recorded. The first operation of the claim department is to check coverage which is done by examining the proposal for the policy under which claim is presented to ascertain whether such policy was in force at the date the accident is alleged to have occurred and covered the kind of an accident which is reported. If it appears that the claim is not covered additional investigation must be made to confirm that fact and if confirmed the assured must 1: z duly notified. If the notice indicates that the claim to which it pertains is covered, it becomes necessary for the claim department to make such investigation as may be necessary to determine the facts, thus 264 THIRD PARTY INSURANCE enabling it to intelligently estimate the liability and determine the best method of handling. Since most claims arise out of accidents which occur at various places away from the home office of the company the bulk of this work must be directed by correspondence. Through this medium the home office claim depart- ment instructs its claim representative at the place where the accident occurs as to the methods to be adopted. In turn it receives from such representative full report of his investigations, copies of statements of witnesses and other pertinent information. Just as soon as possible the home office claim department makes an estimate as to the probable cost of the claim, which is known as a reserve. The aggregate of all estimates indicates to the company approximately what its outstanding claim liability is at any given time. The claim is held open and proper reserve carried until it is finally disposed of. When a claim is settled and the company receives the proper release, the file is closed and the reserve released. CLERICAL ORGANIZATION. — The foregoing brief outline will be sufficient to indicate that there is a great deal of clerical work incident to the main- tenance of an efficient claim department. While those in charge of this work must primarily be competent adjusters, able to judge the value of claims intelli- gently, familiar with the best methods for bringing about settlement on a proper basis and thoroughly informed as to the terms of the contract under which they adjust, they must also be qualified to conduct a rather complicated clerical organization. Everyone CLAIMS 265 of the many claims which are received daily by the claim departments of the large companies must be given individual consideration and not one must be overlooked. Correspondence must be followed up carefully, outside adjusters must be required to get in their investigation reports promptly and every fact which has a bearing upon liability must be inquired into. It will not do to take things for granted or to indulge in conjecture. Written statements of wit- nesses must be secured to substantiate the position of the company as to every controverted issue of fact. OUTSIDE ADJUSTERS.— The actual work of investigation and settlement must, of course, be done by outside adjiasters located in each territory where the company is doing business. The powers which are given to these local adjusters vary, dependent upon methods followed by the particular company and the confidence which the home office has in the ability and judgment of the adjuster. Where the company is doing a large volume of business at one point, it is customary to maintain a local claim department in charge of an experienced adjuster who reports direct to the home office. In some instances such adjuster is given authority to make settlements on the basis of his own judgment within certain limits, being re- quired to consult the home office as to the amount of payment only where such amount is in excess of the prescribed limit. While ordinarily all claim adjust- ments are under the direct supervision of the home office, those companies which operate on a branch office basis frequently give to the local adjuster very 266 THIRD PARTY INSURANCE broad powers, depending almost entirely upon his judgment and not requiring advice as to details. In most cases, however, the local adjuster must send to the home office copies of all correspondence, state- ments of all witnesses and full report of investigation. The home office claim department thus keeps in con- stant touch with each claim and its file is a duplicate of the local adjuster's file. The adjuster is ordinarily furnished with blank draft forms and draws upon the company in settlement of claims. In some instances a local bank account is maintained, thus enabling him to make payment by check. Where the volume of business done in a particular territory is not sufficient to warrant the expense of maintaining a claim depart- ment, the companies usually retain attorneys to take care of their claims. Many lawyers make a specialty of this work and frequently one firm will represent most of the companies doing business in the city or town in which it is located. COMPENSATION CLAIMS.— Nearly all of the compensation acts impose meticulous requirements upon employers relative to reports which must be made to state authorities. In most states it is neces- sary for the employer to file notice of each accident on a prescribed form. In many states it is necessary to file supplementary reports at various stages of disability. In others the employer must enter into a formal written agreement with the injured employe as a preliminary to the making of compensation pay- ments and file a copy of such agreement with the official having supervision over compensation claimi CLAIMS 267 In nearly all states copies of each receipt for partial payment and of the receipt for final payment must also be so filed. As a part of their service compen- sation carriers perform all of this detail work for their assured and must maintain the organization necessary to give it prompt and accurate attention. The work incident to the handling of the average compensation claim is largely in the nature of detail which is trouble- some but not difificult. One of the most important matters is the handling of medical disbursements to which the next paragraph will be devoted. In every case the adjuster must determine whether the injury is one for which the compensation act provides in- demnity. While the great majority of these claims are covered, difificult and perplexing questions fre- quently arise and a competent adjuster must be thoroughly familiar with the terms of the compensa- tion act and with the interpretation thereof by the compensation boards and the courts. In the ordinary case, however, the duty of the adjuster is to attend to the detail matters above referred to, make payments promptly and keep sufficiently informed so that he may terminate payments as soon as the injured work- man is able to resume his work. MEDICAL PAYMENTS. — A considerable percent- age of total payments made under compensation poli- cies goes to physicians who render medical aid for which the employer is responsible. This means that a very important part of the work of a compensation claim department is the handling of these medical payments. The adjuster in charge of this work must 268 THIRD PARTY INSURANCE be acquainted with the qualifications and character of the physicians in his territory, must have experi- ence sufficient to enable him to pass upon their bills intelligently and the diplomatic ability to conduct negotiations with them in such manner as to keep the medical expense within reasonable limits. Where the company has a large risk, or a number of risks at one point, it is customary to make arrangements with a competent physician to take care of all the med- ical work at that particular place. .Sometimes these physicians are paid regular salaries or a satisfactory fee schedule may be agreed upon. An adjuster must be familiar in a general way with the customary and reasonable fee for the performance of all sorts of operations and with the charge which is proper for attendance. Even where the charge for each visit is reasonable, it is possible for a physician to unjusti- fiably increase his total bill by making unnecessary visits. Therefore, the adjuster must carefully check the number of visits. By reason of his observations in handling a great number of claims an experienced adjuster is able to judge the approximate number of visits actually necessary for the proper treatment of any designated injury. At the outset considerable friction developed between claim adjusters and the medical fraternity, but, happily, these differences have been largely reconciled. For the most patt a basis of co-operation has been arrived at which is satisfac- tory to all persons concerned. MALINGERING.— One of the principal duties of a compensation claim adjuster is to get injured work- CLAIMS 269 men back on the job as soon as their condition permits. In order to do this work effectively the adjuster must be able to apply the science of psychology. He must keep in close touch with all disabled em- ployes, acquire their confidence and friendship by fair dealing and frankness and when an injured man has sufficiently recovered to enable him to resume his employment must do everything that he can to induce the injured employe to return to work. It frequently happens, particularly where workmen are engaged in heavy physical labor that they exhibit a reluctance to go back to work even after they are sufficiently recov- ered to enable them to safely do so. This reluctance is very largely the result of a psychological condition and must be overcome in various ways adapted to the particular characteristics and personality of the work- man. A successful adjuster must exercise a reasonable discretion in this connection and must be willing to pay all that the injured man is properly entitled to. BOARD PROCEEDINGS.— As we have seen the compensation acts provide a new and simple procedure for the disposition of controverted cases. The injured workman files an informal petition and the hearing is had before an arbitrator who considers the evidence on both sides and disposes of the matter summarily by entering an award for or against the claimant. Either party may appeal to the full board and from its decision a further appeal lies to the courts on questions of law only. The foregoing is the procedure followed in most of the states although there are, of course, variations. In every case where an adjuster foresees 270 THIRD PARTY INSURANCE the possibility of a dispute he must make his investiga- tion and work up his evidence with a view to sub- stantiating his position at the hearing. Because of the general disposition evidenced everywhere to construe the acts liberally and to resolve every doubt in favor of the injured workman, an experienced adjuster will not allow a case to go to arbitration until he has exhausted every means of amicable adjustment. Arbi- tration must be reserved as a last resort and only those claims contested which are entirely without merit. PUBLIC LIABILITY CLAIMS.— Claims arising under the various public liability policies present the same general characteristics. The first essential, which cannot be too strongly emphasized, is to make prompt and thorough investigation. The liability of the assured which is assumed by the company depends almost entirely upon questions of fact. Unless the claim is settled these facts must be established by the testimony of witnesses. In any event the claim depart- ment can know the facts only by obtaining the written statements of such witnesses. Unless the facts are so known it is impossible to determine the questions of liability arising, which is another way of saying the amount that the claim is worth. Therefore a liability claim department must have an organization through which immediate and efficient investigation of all reported accidents may be made. The more promptly the investigation can be made the more satis- factory it will be. The essential thing to do is to get on the ground at once, interview all witnesses, obtain full signed statements covering all pertinent facts CLAIMS 271 while the witnesses are accessible, while such facts are fresh in their memory and before the witnesses can be tampered with by the ambulance chasing lawyer or the avaricious claimant. The individual who makes investi- gation in such cases must be grounded in the funda- mental principles of law applicable. He must under- stand that the assured's liability depends in the first instance upon whether he has been guilty of negligence and, in the second place, upon whether the injured per- son has also been negligent. The adjuster must have some familiarity with the legal conclusions as to negli- gence or contributory negligence which should be pred- icated upon any given state of facts. In other words, the adjuster must recognize the relative importance of all facts developed by his investigation and must in- vestigate every circumstance which has a bearing upon questions of liability involved. INVESTIGATION REPORTS.— Above all things the investigator must avoid the fatal mistake of distorting facts. It is his duty to report conditions exactly as they are and not as he or his company would wish them to be. If the assured, has been negligent it is essential that the company should know it. Nothing can be accompHshed by securing a state- ment from the assured which presents a picture more favorable than the circumstances warrant. Conditions must be faced squarely and an investigator accom- plishes no good end when he persuades a witness to make a favorable statement which is not in accord with facts. His superiors in charge of the final adjustment of the claim are thereby misled into a false sense of 272 THIRD PARTY INSURANCE security and the consequences are frequently most serious. The investigation of an accident resulting in a comparatively trivial injury should be conducted just as carefully as in a case where the injury is seri- ous. Injuries which are at the outset apparently incon- sequential are often followed by unfavorable develop- ments. Further than this, the liability adjuster has found that the trivial accident is the one which, if not properly investigated, is likely to cost the most money for the very reason that the failure to make a proper record of the facts may place an insured practically at the mercy of an unscrupulous claimant. ADJUSTMENTS. — The compensation laws provide a definite liability and the facts having been ascer- tained the amount due may be automatically deter- mined. The liability claim presents an entirely differ- ent situation. In the last analysis the amount to which the injured person is entitled must be determined by a jury. The factors which enter into this final determi- nation are infinite in their variety and complexity. In one case an injured person may recover a verdict of $10,000 and under precisely the same circum- stances another jury may bring in a verdict for the defendant. The amount to which any injured per- son is entitled, or rather the amount which he can recover, can, therefore, not be fixed by the application of any mathematical formula and is entirely a matter of judgment. In short, a liability claim is unliquidated and when it comes to a jury verdict one man's gtiess is as good as another's. It is safe to assume that in the average case the jury will be actuated to some degree CLAIMS 273 by sympathy. This is particularly true where the assured defendant is a corporation. One basic principle that may be laid down is that in almost every case it is cheaper to settle than to fight. Aside from the uncer- tainty above referred to an adjuster must take into consideration the very considerable expense incident to litigation. The situation may well be summed up by the homely maxim that a bad settlement is better than a good lawsuit. The adjuster must not, however, permit himself to become unduly apprehensive. He must retain his balance and perspective and refuse to submit to undue imposition. He must choose the happy medium between two extremes making settle- ments where it is possible to do so on a reasonable basis, but being prepared to fight when necessary. In such contingency no stone in the way of careful and painstaking preparation must be left unturned. FACTORS ENTERING INTO THE DETER- MINATION OF THE VALUE OF A CLAIM.— The third party adjuster in determining the value of any claim must take into account a great variety of items among which may be mentioned the following. He must weigh the evidence obtained by the investi- gator bearing upon questions of negligence and con- tributory negligence. He must not permit himself to be affected by his personal predilections, but must give effect to every item whether favorable or unfav- orable. The adjuster must consider the character of the injury. Where possible he should have the benefit of a medical examination made by a physician in whom he has confidence. In death cases the adjuster must 274 THIRD PARTY INSURANCE inquire into questions of dependency and must be familiar with the rules applicable in the particular jurisdiction in determining the measure of damages which dependents are entitled to recover. In non-fatal cases the sex, social standing, earning capacity and similar characteristics of the claimant must also be considered. Attention must be given to the character and personal appearance of witnesses for the purpose of forming an opinion as to the weight which a jury is likely to give to their testimony. For illustration, an experienced adjuster knows that a jury pays little attention to the testimony of police officers or to that given by employes of an assured corporation. If the claimant has placed his case in the hands of an at- torney it is the business of the adjuster to know what the ability of that attorney is and his personal peculiar- ities. Thus the adjuster should know whether the attorney is one who settles most of his cases or makes a practice of gambling on the result of a trial. Local prejudice must be considered since it is reflected in the size of verdicts. All of these and a thousand other factors must be taken into account in the mental oper- ations by which the adjuster determines the value of a liability claim. Having made up his mind as to the maximum amount which he is justified in paying, rather than incur the expense and uncertainty of litiga- tion, the adjuster brings to bear all of his abilities for the purpose of effecting settlement as far below his maximum limit as may be possible. METHODS BY WHICH ADJUSTMENTS ARE EFFECTED. — It is impossible to convey to the reader CLAIMS 275 more than a general idea of the various methods by which adjustments are effected. The personal equa- tion is the important factor. The adjuster must depend upon the intuition which is acquired by his experience in handling all kinds of cases and in dealing with all types of claimants and attorneys. Aside from any question of ethics, an adjuster, if he is to achieve permanent success, must be honest in his dealings with claimants. Subterfuge and deceit will, in the long run, discredit the adjuster and his company. An unscru- pulous adjuster may be able at times to take advantage of the ignorant and the weak, but, in so doing, destroys his own character and reputation and, what is worse, that of his employer. It is true that third party claims are unliquidated — that their value can be determined only by the application of individual judgment and is not susceptible to mathematical demonstration. It is entirely proper that the adjuster should, under these peculiar circumstances, make his settlements within reasonable limits, but beyond this he should not go. No definite rule can be laid down as to the manner of approaching a claimant or an attorney for the purpose of bringing about a settlement. The adjuster must be familiar with local conditions and the character and personal idiosyncrasies of the people with whom he is dealing. Ordinarily the best results are obtained by immediate and vigorous action. It is wise to settle a case before it gets into the hands of an attorney as he may be unscrupulous or avaricious and any settlement made must, of course, be large enough to satisfy the claimant and also to take care of the 276 THIRD PARTY INSURANCE attorney's fee. Further than this, many claimants are prone to brood over their injuries and to magnify them. When settlement is made the matter is forgot- ten and the injured person gets well immediately. Quick settlement is particularly desirable where minor injuries are involved. Trivial claims which can be settled cheaply and satisfactorily to all concerned immediately after the accident often become trouble- some and expensive if settlement is unduly delayed. On the other hand, there are some cases which are so bad that they cannot very well get worse and time frequently has a healing and softening effect upon them. EVIDENCE OF SETTLEMENT.— The adjuster must be particularly careful to secure from the claim- ant a valid release so drawn as to entirely relieve the assured from further liability. The companies place in the hands of their adjusters printed release forms to.be used for this purpose. In the ordinary case, it is only necessary to secure the signature of the claimant in the presence of witnesses. Where the claimant is a minor he is not bound by his release and it becomes necessary for the adjuster to see to it that proper legal formalities are complied with. Ordinarily a guardian must be appointed and the settlement must be approved by the court of appropriate jurisdiction. The adjuster must be acquainted with the legal pro- cedure necessary to effect a binding settlement in the jurisdiction where it is made and must insist that all formalities be strictly complied with. CLAIMS 277 PROPERTY DAMAGE CLAIMS.— The reader is already familiar with the fact that most of the third party coverages pertain only to personal injuries. These carriers, however, issue contracts under which they indemnify the assured against liability on account of damage to the property of others occasioned by the maintenance and operation of automobiles, teams and elevators. In a general way our comments upon the adjustment of personal injury claims are here applicable. The same rules of law are applied in deter- mining questions of liability. The distinguishing feature of property damage claims is that their value may be determined with a considerable degree of accuracy as property has a definite market value. Where property is completely destroyed it becomes necessary only to agree upon that market value at the time of the accident and, while differences of opinion may occur, there is not ordinarily room for any sub- stantial controversy. The adjuster must familiarize himself with the value of the particular property which has been destroyed and adjust the claim on the basis thereof, taking into consideration, of course, the same questions of liability which arise in a personal injury case. Where the property is not totally destroyed the actual damage must be determined and repairs effected as economically as circumstances warrant. Most prop- erty claims arise in connection with the automobile business and in a great majority of these cases it is an automobile which is damaged. It is, therefore, necessary that the adjuster have a general familiarity with the mechanism of automobiles and the value of 278 THIRD PARTY INSURANCE their »parts. He must also know the reasonable cost of repair and replacement. AUTOMOBILE COLLISION CLAIMS.— The re- marks just made relative to automobile property dam- age claims are here pertinent. As we have already pointed out, automobile collision is not a third party insurance, but involves a direct obligation to indemnify the assured against actual loss suffered by reason of damage to the insured automobile occasioned by col- lision. In the adjustment of these claims, therefore, no questions of negligence arise. If the car is cov- ered, the company is obligated to pay to its assured the loss suffered by him. It is customary for the investigator of these claims to identify the damaged car as the one which is covered. The car is described in the policy by its engine number and the investigator, therefore, examines that number and sends to the home office an identification slip evidencing that the exam- ination has been made and that the car has been properly identified. Incidentally this same procedure is followed in the handling of all automobile claims if the insured cars are specifically described in the policy. A special moral hazard arises in connection with the adjustment of collision claims in that many assured are prone to present exaggerated claims and to attempt to secure repairs at the expense of the carrier which are not made necessary by reason of the collision. These claims must therefore be scrutinized very closely to the end that the company may pay only the loss due to the casualty insured against. It is cus- tomary for the claim department to select reputable SUITS 279 concerns engaged in the business of repairing auto- mobiles and to insist wherever possible that work for which their companies are responsible be done by such concerns. SUBROGATION— Inasmuch as all third party policies contain the subrogation clause, which we have previously described, it becomes the duty of the claim department to take advantage of all rights inuring to the carrier thereunder. The possibiHty of this salvage must, therefore, be borne in mind at the time investigations are made and the investigator must be careful to secure all available evidence which may be of assistance to the company in enforcing its subroga- tion rights. Proceedings are ordinarily brought in the name of the person having the primary cause of action. If recovery be had the carrier is only entitled to reim- bursement for its own outlay and any excess recovery is paid over to the person entitled to it. The subroga- tion clause is of particular benefit to the companies which write automobile collision. Frequently the cir- cumstances are such as to warrant the insurer in mak- ing claim in the name of its assured against the owner of the automobile causing the damage for which it has paid under its collision coverage. Many of the com- panies have found it advisable to establish a subroga- tion department which reviews all claims, the pre- liminary investigation of which has indicated the pos- sibility of effecting salvage under the subrogation clause. SUITS. — The law department plays an important part in the operations of a third party company. Prac- 280 THIRD PARTY INSURANCE tically all claims present legal questions. The claim department, by reason of its experience, becomes versed in fundamental principles. It is, however, fre- quently necessary to refer difficult questions to the law department for determination and the two depart- ments must work in close harmony. Ordinarily, the law department acts only in an advisory capacity prior to the commencement of litigation. Upon receipt of summons or other process the claim file is turned over to the law department, which thereupon takes charge. A large percentage of suits are settled prior to actual trial. As to these suits, the law department becomes in effect a claim department and adopts the general methods in handling and disposing of these cases which we have described in our comments upon the claim department. If settlement is not effected, the law department must carefully prepare the case for trial and, acting through attorneys employed by it, defend the case in the name and on behalf of the assured. The general supervision of litigation, which is, of course, scattered over a wide territory, is carried on through the medium of correspondence. The law department must select in each territory where the company is doing business a lawyer competent to handle this special class of litigation. Compensation for his serv- ices is provided in various ways dependent largely upon the volume of business which the company has in his territory. Frequently he is given what amounts to a salary or a fixed annual retainer. In other cases work is done on a per diem basis in conformity with an agreed schedule. Where a company is doing little busi- RESERVES 281 ness and cases arise infrequently no definite arrange- ment is made and the reasonable value of services rendered in connection with each case is paid. The authority given to the local attorney depends upon considerations similar to those which determine the method of handling adjusters. Where a branch office is maintained or a large volume of business done at one point the attorney often devotes his entire time to the service of one company, becomes in effect a salaried employe and is given wide discretion. Even in such cases the home office law department must keep in constant touch with all pending litigation and in fact the majority of suits are handled under its imme- diate supervision and in accordance with its instruc- tions. It is scarcely necessary to say that lawyers intrusted with this important work must be experts in those branches of the law which peculiarly pertain to the business which is being conducted by the insurer. RESERVES. — An insurance company occupies a peculiar position in that it is at all times in possession of large sums of money which do not belong to it. For illustration, suppose that a stock company be organized for the purpose of doing a third party busi- ness and start issuing policies January 1, 1920. One year later it will have in its possession a considerable portion of the premium called for by policies issued within the year. It will also be entitled to take credit as an asset for ascertained uncollected premiums due it on policies taking effect within the last three months of the year. It will, of course, have dispersed a certain proportion of premiums collected to meet the expense 282 THIRD PARTY INSURANCE of its operation and the payment of claims. There will also be many claims outstanding unpaid in whole or in part. In arriving at its financial condition a com- pany must take into consideration among other things its outstanding and unpaid claim liability and must also bear in mind that a considerable percentage of the premium for which it takes credit has not been earned. In other words, it will have taken credit for premium on policies not yet expired and many accidents impos- ing claim liability upon the company will, of course, occur before such policies terminate. UNEARNED PREMIUM RESERVE.— This re- serve is sometimes called the reinsurance reserve because theoretically it is the amount which the com- pany, if it should go out of business, would have to pay to another company to assume its future liability under unexpired policies. It is not a claim reserve although in a sense it may be so considered since a portion of unearned premium must be devoted to the payment of future claims arising under existing poli- cies. In every state the law now requires the insurer to set aside as a reserve the total of such unearned premium. This reserve is ordinarily computed as of the close of business the 31st of December each year. The common method of calculating it is to take 50 per cent of the gross premiums for policies, in force at the date of the computation, issued for a term of twelve months or less. If the company's volume is distributed evenly throughout the year it is apparent that while some policies may, at the date of the computation, have been in force for less than one day and others for RESERVES 283 almost one year, all policies have, on the average, been in force for six months. Therefore, roughly, 50 per cent of the premium on such policies has been earned. Hence, ordinarily, this method of computation is, for practical purposes, sufficiently accurate. If, however, the business has been written unevenly, it may bring about an incorrect result. Thus if the bulk of the business is written in the early part of the year, more than one-half of the premium for the total year's busi- ness is earned on December 31st. On the other hand, if the situation be reversed, less than one-half is earned on that date. Nearly all third party policies are written for a twelve months' period and the method of deter- mining unearned premium just referred to is com- monly used. Where policies are issued for a longer term, a pro rata amount of premiums is taken as, for illustration, three-fourths of premiums on contracts having a term of two years, etc. CLAIM RESERVE.— This term is used to indicate the reserve which must be maintained to enable an insurer to pay claims outstanding at the date compu- tation is made. Various methods are adopted for determining this liability. An individual judgment estimate may be made of the probable cost of each pending claim. An experienced adjuster is able to judge with approximate accuracy the probable aggre- gate cost of a large number of pending claims. He will, of course, make serious mistakes as to individual cases, but under-estimates and over-estimates will equalize each other and, on the average, will be disposed of within the limit set. Of course, if the adjuster is 284 THIRD PARTY INSURANCE inexperienced or unduly optimistic the aggregate estimate will be inadequate. Mistakes of this sort have, in the past, proved serious, but it has been demon- strated that this method when honestly applied by experienced men to a sufficiently large number of claims will produce a result which is approximately correct. Another way of determining pending claim liability is to ascertain the average cost which the company has incurred in disposing of similar claims in the past and to multiply such average cost by the total number of pending claims, deducting, of course, any amounts already paid on such claims. Still an- other method is to ascertain the percentage of claim payments to earned premiums as indicated by past experience. This percentage is then applied to premiums earned on policies issued during a given period. From the amount so determined are deducted payments made under such policies and the result is taken as the claim reserve necessary to dispose of outstanding claims arising under policies issued dur- ing that period. LEGAL RESERVES.— Third party companies are everywhere required to maintain the unearned premium reserve to which we have referred. Prior to 1901 the companies doing business in the United States were not required by law to maintain any claim reserve. Each company was privileged to set up any claim reserve that it might see fit, determined in any manner that it desired. Some companies took ad- vantage of this situation for the purpose of making a fictitious financial showing and others, through ignor- RESERVES 285 ance, maintained inadequate reserves. As a conse- quence a number became seriously impaired and some completely insolvent. In order to eliminate these evils, laws have been passed requiring the companies to maintain adequate claim reserves. At the outset these laws were not sufficiently drastic to accomplish their purpose. Without going into the history of this legis- lation it is sufficient to say that at the present time there are in force in many states reserve laws which are reasonably adequate. The law now in force in the state of New York is one of the best and most of the companies maintain reserves in conformity with its provisions. It may, therefore, properly be used as an illustration of the most scientific method which has yet been devised for determining claim reserves. NEW YORK RESERVE LAW.— We shall not attempt to set forth this law verbatim as it appears in the New York statutes and is readily accessible to those interested. In substance, subject to certain qualifications and definitions, which it is unnecessary to here consider, it provides as follows : an individual estimate of each outstanding claim other than com- pensation and liability must be made and a reserve equal to the aggregate of these estimates maintained. The insurance superintendent is given the discretion to require additional reserve. The reserve for claims under employers and public liability policies is deter- mined on a suit basis as to policies written more than three years prior to the date of computation. The law requires that, for each suit, a specific amount be set up, varying with the year that the policy under 286 THIRD PARTY INSURANCE which the suit arises was written. The reserve for policies written during the three years immediately preceding the computation is fixed at 60 per cent of the earned premium on such policies less all loss and loss expense payments. Compensation claims arising under policies written more than three years prior to the date of computation are treated individually and given their present value assuming 4 per cent interest on determined and estimated future payments. For such claims under policies written within the three years, the reserve is fixed at 65 per cent of earned premiums less all loss and loss expense payments. The superintendent of insurance is also given discre- tion to require additional liability and compensation loss reserves. THEORY OF RESERVE LAWS. — The New York and other similar reserve laws are based, in so far as they pertain to liability claims, upon the assumption that all claims arising under policies issued more than three years prior to the date of com- putation are either already settled, in suit, or abandoned. In this connection consideration is given to the fact that under the statutes of limitation in force in most of the states claims of this sort are outlawed unless legal proceedings have been commenced. Therefore, as to such policies, it is only required that a reserve be maintained to take care of pending suits. The specific amount which must be set up for each of these suits has been determined on the basis of experience furnished by the carriers. Such experience has indicated that the cost of a suit increases with its RESERVES 287 age. This is probably due to the fact that the most serious cases are the ones which are the most strenu- ously fought. As to policies written during the three- year period, it is assumed that an individual estimate is not sufficiently accurate and that the real liability can best be reflected by the application of a percentage to earned premiums. Such percentage has been also determined on the basis of past experience. As com- pensation payments extend over long periods it would be erroneous to indulge in the assumption first above indicated as to claims under compensation policies written prior to the three-year period. It is taken for granted that sufficient time has elapsed for all such claims to be presented and for their true character to have been developed. The companies are given the benefit of the interest which they can earn on deferred installments. As to compensation claims under policies written within the three-year period, the percentage method is applied for the same reason that it is applied in determining reserve for liability claims. Index to Contents CHAPTER I Coverages Which Have Been Devised to Meet Various Insurance Needs 7-32 Accident Insurance Unaffected by Compensation Laws 22 Accident Insurance 19 Accidental Death Insurance 19 Automobile Collision Defined... 24 Automobile Lines by Fire Com- 15 Automobile Lines by Marme Companies 14 Automobile Lines Originated by Marine Companies 14 Automobile Property Damage and Collision 14 Average, Laws of 7 Basic Principles of All Insurance 11 Banking Function of Life Com- panies 17 Bonds, Fidelity and Surety 31 Burglary and Theft Insurance.. 22 Casualties Causing Loss of Earn- ing Power 20 Casualty Branches 18 Casualty Insurance 18 Compensation Laws Not Affect- ing Accident and Health Insur- ance 22 Credit Insurance 27 Death from Accident 19 Direct Loss Covered Occasion- ally 10 Distinguishing Life from Marine and Fire -.••- 16 Division of Casualties Causing Loss of Earning Power Illog- ical 20 Fidelity and Surety 30 Fire Companies and Automobile Lines 15 Fire Insurance 14 Fly Wheel Insurance 26 Health Insurance 21 PAGE Health Insurance Unaffected by Compensation Laws 22 Insurance, Casualty 18 Insurance defined 8 Insurance, Fire 14 Insurance, General Principles... 11 Insurance, Life 16 Insurance, Marine 12 Laws of Average 7 Life and Accident not "Third Party" Insurance 9 Life Companies do Banking Business 17 Life Insurance Development 16 Life Insurance Distinguished from Other Lines 16 Life Insurance, Peculiar Char- acteristics of 17 Life Policy Non-cancellable 18 Live Stock Insurance 24 Marine Insurance 12 Marine Insurance, Coverage 13 Meaning of "Third Party" In- surance 8 Origin of Insurance 8 Other Forms Distinguished from "Third Party" 10 Plate Glass Insurance..., 23 Principles of Insurance, Gener- ally Applicable 11 Sprinkler Leakage 25 Steam Boiler Insurance 25 Surety 3C Title Insurance Defined 29 Title Insurance, How Conducted 2t "Third Party" Distinguished from Other Forms If "Third Party" Insurance De- fined 8 "Third Party" Lines and Life and Accident 289 290 CONTENTS CHAPTER n Characteristics Common to All Forms of Insurance. .33-S2 PAGE Accident and Health Claims 57 Accident Prevention Benefits the Public 49 Accounting Department of Com- panies 52 Accounting of Companies 52 Agents Necessary 42 Application for Insurance 43 Binders 51 Characteristics Common to all Forms 33 Claim Department 54 Claims, Life, Accident and Health 57 Claims, 'Third Party" 58 Competition Among Companies. 42 Contracts, forms of 50 Contracts of Insurance, Con- struction of 45 Death Claims 57 Determining Premium 48 Exaggerated Claims Experience, Statistics of-. Form of Policies Forms Prescribed .... 55 .... 53 .... 50 .... 50 Health and Accident Claims 57 Information, Clearing House of. 46 Information Required by Com- panies 43 Insurance Carriers 34 Inter-Insurers Zl Investigation of Risks 47 Law Department of Insurer 60 Law of Representations, etc 44 Laws Related to Insurance 33 Legislation, Need for Uniform.. 34 Lloyds Associations 38 Lloyds, Operations of, in the U. S 39 Loss, Claims for Property 57 Marine and Fire Underwriting.. 46 Mutual Insurance Companies... 35 Mutuals, Different Kinds of ^ Need for Uniform Legislation.. 34 Notice of Claim 54 Over-Payment of Claims 55 Parole Contracts 51 Physical Hazards Considered 48 Premiums, How Determined 48 Prescribed Forms 50 Prevention of Accidents 49 Proof of Loss 54 Property Loss Claims 57 Reciprocals 37 Reserves, Estimated 56 Reserves for Claims 56 Reserves for Contingent Liabili- ties 56 Risks, How Investigated 47 Solicitation, Why it is Essential 43 State Insurance 40 Statistics of Experience 53 Stock Insurance Companies 34 Subrogation Clause 59 Tendency to Under-Insure 43 Third Party Qaims 58 Underwriting Department 45 Underwriting, Marine and Fire. 46 Unjust Claims 55 Warranties and Representations 44 CHAPTER in The Various Third Party Coverages Audit of Payrolls 67 Automobile Collision 86 Automobile Property Damage... 86 Automobiles, Commercial 83 Automobiles, Dealers' and Man- ufacturers* 84 Automobiles, Private Passenger 82 Automobiles, Public 84 Automobile Public Liability 81 «3-»7 Collision, Automobile 86 Commercial Cars 83 Compensation Contract 68 Compensation Insuring Qause.. 69 Construction, Demolition, Re- pairs and Explosives 74 Contractor's Contingent Public Liability 92 CONTENTS 291 FACE Contractors' Employers' Liabil- _>ty 68 Contractors' ProtSctive Public Liability 92 Contractors' Public Liability Contrasted with Manufactur- ers' Public Liability 72 Dealers' and Manufacturers' Automobiles 84 Demolition, Kepairs, Construc- tion and Explosives 74 Druggists' Public Liability 96 Elevator Property Damage 79 Elevators and Other iloisting Devices 74 Elevator Public Liability 78 Employers Liability 65 Explosives, Demolition, Con- struction and Repairs 74 Fly Wheel 65 General Liability 76 Landlords' Liability 76 Liability, Teams Public 87 Manufacturers' and Dealers' Au- tomobiles 84 Manufacturers Employers' Li- ability Policy 66 Manufacturers' Public Liability 71 Manufacturers' Public Liability Contrasted with Contractors' Public Liability 72 PAGE Owners Contingent Public Lia- bility 89 Owners' Liability 76 Owners' Protective Public Lia- bility 89 Payrolls and Audits 67 Peculiar Provisions of Compen- sation Policies 70 Physicians' and Surgeons' Pub- lic Liability 93 Premium on Manufacturers' Em- ployers' Liability 66 Private Passenger Cars 82 Property Damage, Automobiles. 86 Property Damage, Teams 89 Public Automobiles 84 Repairs, Construction, Demoli- tion and Explosives 74 Steam Boiler 65 Surgeon's and Physicians' Pub- lic Liability 93 Teams' Property Damage 89 Teams' Public Liability 87 Tenants' Public Liability 76 Theatre Public Liability 80 Third Party Lines, List of 64 Various Third Party Coverages. 63 Vessel Employers' Liability Pol- icy 68 Vessel Public Liability 75 Workmen's Compensation 68 CHAPTER rV Staadard Provisions of Third Party Policies M-131 Accidents Occuring when Prem- ises not yet Completed 116 Actions 122 Agent's Knowledge not held to Effect Waiver 130 Alterations 128 Assignments 128 Assured Must Notify of Acci- dent 106 Assured's Obligations ., 105 Automobile Collision, Exceptions in 118 Automobile Property Damage, Exceptions in 118 Automobile Public, Exceptions in 117 Bankruptcy of Assured 123 Cancellation Clause 120 Claims and Litigation, Control of 107 Clause, Cancellation 120 Contractors and Sub-Contrac- tors 113 Cooperation of Insurer and As- sured -107 Defense of Suits. Under Third Party Contracts 100 Defense provided extends to "Groundless Suits" 101 Direct Interest of Third Party.. Ii23 Emplo:^es Under Age Limit 114 Exception Causes 108 Exclusion Clause in Compensa- tion Form Ill 292 CONTENTS PAGE Exclusion of Liability Under Compensation Acts 109 Forfeiture Clause 105 Injuries by Vehicles or Draft Animals "^15 Insolvency of Assured 123 Inspection Clause 128 Insurer Controls Claims and Lit- igation 107 Investigation and Defense Fur- nished by Insurer 102 Investigation of Accidents 99 Liability of Insurer Limited 104 Liability to Assured 122 Liability Under Compensation Outside that Specifically Con- tracted for 112 Liability Voided Unless Payroll Premium Paid HO Limit of Liability 104 Limitations, Action Clause 124 Minimum premiums 121 Non-Assignable Contract 129 Notice of Accident 106 Obligations of Assured 105 PAGE Other Insurance 126 Over-Insurance 126 Payroll Premium, Unpaid HO Premiums, Minimum 121 Property Damage, Exceptions Proposal, Copy of 131 Right of Inspection 128 Right to Settle Reserved to Insurer 102 Schedule, Included in Policy 131 Short Rates 131 Standard Provisions of Third Party Policies 98 Subrogation Clause 125 Surgical Aid 103 Teams, Injuries by 115 Teams Public, Exceptions in 119 Uncompleted Premises, Acci- dents in case of 116 Vehicles or Draft Animals, In- juries by 115 Verbal Agreement Cannot Effect Waiver 130 Violation of Law, Persons Em- ployed in 114 CHAPTER V Employers' Liability and Workmen's Compensation 132-15fi Alternatives of Employer 150 Appeals 144 Approved Standard Compensa- tion Form 155 Arbitrator 144 Awards 144 Bureau, National Workmen's Compensation Service 152 Causes Affecting Adequate Rates 152 Claimants' Expense 144 Collection Costs 144 Common Law System, Defects of 139 Comparative Negligence, Doc- trine of 138 Compensation Acts Dispel Prej- udice 149 Compensation Board 143 Compensation Form, Universal Standard 155 Compensation Insurance by Pri- vate Carriers 149 Compensation on Profitable Basis 151 Compensation Partakes of a Public Interest 152 Compensation Rates and Wages. 154 Compensation Supplanting Em- ployers' Liability 147 Conditions Under Employers' Liability i 148 Confusion of Decisions 139 Controversies Under Modem Conditions 133 Controverted Cases .144 Contributory Negligence 133 Defects in Common Law System. 139 Defects in Present System 145 Delays in Court Procedure 140 Development of Employers' Lia- bility Law 134 CONTENTS 293 PACE Elements Affecting Compensa- tion Rates 153 Employers' Liability Act of 1880.. 137 Employers' Liability Acts 137 Employers* Liability in the U. S.146 Employers' Liability Law 132 Employers* Liability Resulted in Bitter Controversies 148 Employers' Liability Supplanted by Compensation 147 English Decisions 146 Evolution of Employers' Liabil- _ity 135 Experience on Compensation 152 Forms, Compensation Policy 154 Guarantee by Employer 149 Improvements in Compensation Under New System 143 Industrial Board 143 Iniquities Incident to Court Pro- cedure 140 Law of 1884, Workmen's Compen- sation 142 Law of Employers' Liability 132 Laws of Workmen's Compensa- tion 142 Legislation Affecting Employers' Liability 137 Liberality of Boards Toward In- jured Employe 145 Modern Industrial System 135 PAGE Negligence 133 New Jersey Law of 1911 142 Occupational Diseases Included.. 145 Policy Forms, Compensation 154 Prejudice Against Employers' Liability Insurers 148 Private Carriers or State Funds. 150 Procedure in Controverted Cases. 144 Profits Not Desired, Excessive,. 153 Provisions of Compensation Acts 143 Rates for Compensation, Ade- quate 151 Rates for Compensation De- crease 153 Rates for Employers' Liability Inadequate 150 State Funds 150 Standard Policy Forms 155 Supervision of Policy Forms 154 Underwriting Profit Small 153 Universal Standard Workmen's Compensation Policy Form 155 "Vice Principal Doctrine" 139 Wages and Compensation Rates. 154 Workmen's Compensation, De- velopment of 141 Workmen's Compensation Laws of 1884 142 CHAPTER VI Public LiabUity 157-178 Automobile Insurance 166 Automobile Insurance Compul- sory 168 Automobile Owners' Fixed Lia- bility 173 Bonds of Automobile Owners... 171 Buildings and Elevators 162 Burden of Proof 158 Co-Insurance on Collision 178 Collision Co-Insurance 178 Collision Insurance 175 Comparative Negligence 159 Compulsory Automobile Insur- ance 168 Conspiracies, Crooked 165 Contributory Negligence 157 Deductible Coverage 177 Defects in Proposed Laws 171 Difficulties of Intelligent Rating for Automobiles 167 Development of Public Liability. 160 Elevators and Buildings 162 Employers' Liability and Public Liability 161 Extension of Compulsory Insur- ance Requirements to Vehicles Other Than Common Carriers. 169 Fictitious Claims 164 Fix Liability for Owners 173 General Liability 163 294 CONTENTS PAGE Indemnity Contract 171 Intelligent Legislation Re qui site. 170 Jitney Busses 169 Landlords' Liability 163 Legislation Affecting Motor Ve- hicle Operation 168 Liability Without Fault 173 Motor Vehicle Legislation 168 Negligence 157 Negligence, Comparative 159 New York City Conditions 164 Operation and Maintenance of Buildings and Elevators 162 Owner's Liability 163 Personal Sureties 171 Premium on Building and Ele- vator Operation 162 Private Passenger Cars Collision Unprofitable 176 PAGE Proper Legislation 172 Property Damage 174 Proposed Legislation 171 Public Carriers 169 Public Liability and Employers* Liability 161 Public Liability, How Developed.160 Public Liability, How Occa- sioned 160 Rates on Automobile Insurance.. 167 Smaller Towns, Lines Writ- ten in 163 Statutory Modifications of Com- mon Law Rules 159 Suggested Legislation 172 Sureties, Personal 171 Teams Insurance 165 Tenants* Insurance 163 Uniform Legislation Desired. .170 CHAPTER VII Underwriting 179-208 Accident Frequency 196 Agency Correspondence 181 Associated Companies 207 Audits 186 Audits of Pay Rolls 201 Bad Risk Improvement 197 Bookkeeping Systems 186 Cancellation 181 Catastrophe Hazard 184 Catastrophe Hazard and Law of Average 187 Catastrophe Hazards, Kinds of.. 188 Change of Rate During Policy Term 205 Claim Experience 195 Co-Insurance and Moral Hazard. 185 Collective Hazard 187 Compensation Policy Forms 198 Dangerous Risks 181 Deductible Coverage a Safe- guard 185 Deposit Premium 202 Employers' Liability and Public Liability 191 Employers' Liability Forms 199 Endorsements, Special 200 Estimate of Pay Roll 201 Estimate Should Be Adequate... 201 Excess Limits 205 Experience Department 203 Improvement of Risk Reduces Rate 205 Individual Risk Experience 195 Individuals and Their Accident Record 196 Inspection of Pay Roll 203 Liability of Public Passenger Conveyances 192 Livery Vehicles 193 Loft Risks 189 Modification of Ra,tes During Policy Term i205 Moral Hazard 182 Moral Hazard and Co-Insurance. 185 Omnibuses, Hotel 193 Passenger Hazard 192 Pay Roll Audit 201 Pay Rolls, Estimated 201 Policy Forms, Public and Em- ployers* Liability 199 Policy Forms, Selection of 198 Policy writing 181 Premium, Advance 202 CONTENTS 295 PAGE Premium, Advance or Deposit... 202 Preventable Accidents 197 Procedure in Underwriting 180 Prohibited Risks 181 Public Liability and Employers' Liability 191 Public Liability Forms.. !!!!!! !!!l99 Questionable Risks 181 Railways 193 Recommendations to Assured 205 Reduction of Rate for Improve- ments 205 Reinsurance 205 Reinsurance of Employers' Lia- bility and Public Policies 208 Renewals 204 Resources and Reinsurance 188 Review of Experience on Indi- vidual Risks 204 Risks Judged by Individual Ex- perience 195 PAGE Risks Presenting Possibility of Frequent Accidents Injuring a Few Persons 190 Risks, Prohibited 181 Routine Handling of Prohibited Risks 193 Selection of Policy Forms 197 Street Cars 193 Taxi Cabs 193 Under-Estimating Pay Roll 202 Underwriting Department 179 Underwriting Procedure 180 Undesirable Classes of Occupa- tion 184 Undesirable Risks in Acceptable Classification 194 Workmen's Compensation Rein- surance Bureau 206 CHAPTER Vm Rates and Rating Bureaus. .209-242 Aggregate Premium Reduced by Merit Rating 214 Automobile Rates 227 Basic Rates 213 Branch Service Bureaus 239 Classification of Occupations 216 Commercial Use Cars 231 Compensation Laws and Various Liabilities Imposed 218 Compensation Rates 216 Considerations in Rate Making. .215 Co-Operation in Rate Making. ..236 Dealers, Automobile 232 Distribution of 100,000 Accidents. 220 Excessive Optimism 237 Excess Limits 235 Experience Pure Premium 215 Experience Rating 225 Experience, Record of 211 Experience Sometimes Unsafe Guide 219 Factors Affecting Automobile Rates 228 Factors Entering Each Multi- plier 222 Functions of Branch Bureaus... 23P Indicated Pure Premiums 215 Individual Treatment to Certain Classifications 218 Inspection Departments Apply Schedule Rating 224 Judgment Rates 211 Justification for Experience Rat- ing 226 Law Differentials 220 Laws of Average 211 Load Capacity Groups 231 Loading Required on Loss Cost. 215 Loss Cost Per Unit of Exposure. 215 Manufacturers' and Dealers' Automobiles 232 Massachusetts Act 221 Merging of Experience 236 Merit Rating Reduces Aggregate Premium 214 Modification of Basic Rate 214 Multipliers, State 222 National Council on Workmen's Compensation 241 National Workmen's Compensa- tion Service Bureau 238 296 CONTENTS PAGE Needed Revision of Excess Limit Rates 235 New Coverages, Rates for 212 New York Compensation Act 222 Occupations Classified 216 Other Experience Made Avail- able by Use of the Law Differ- ential 221 Permanently Located Risks 224 Premiums Based on Unit of Ex- posure 209 Price Groups 230 Private Passenger Cars 230 Public Automobiles 232 Pure Premium 215 Rate Competition Eliminated... .237 Rate Making 212 Rates Applied to Unit of Ex- posure 210 PAGE Schedule Rating 224 Standard Accident Table 220 Standardizing Classifications 217 Standard Limits 234 State Multipliers.. 222 State Rating Bureaus 240 Table, Standard Accident 220 Territorial Area Important 219 Territorial Diflferentials 233 Theatre Public Liability Rate.... 225 Theory of Experience Rating 226 Under-Estimating of Claims 237 Units of Exposure 209 Unlimited Automobile Public Coverage 235 Variations in Liability Imposed by Compensation Laws 218 CHAPTER IX Inspections and Audits 243-261 Accident Prevention Instruction. 254 Application of Schedule Rating System 252 Assured's Accounts 259 Assured's Attitude to Pay Roll Auditor 260 Audit Routine 258 Auditors, Qualifications of 257 Audits 257 Authorized Renewal Rate 254 Care of Injuries 256 Contracting Risks, How In- spected 246 Difficulties in Securing Correct Audits 259 Education in Accident Preven- tion 254 Elevator Inspections 244 Factory Inspections 245 Features Considered by Inspec- tors of Mines 250 Features to Be Noted in Factory Inspections 246 First Aid Provision 256 Fraudulent Manipulation 260 General Liability Inspections 248 Individual Insurer Cannot Mod- ify Rate 253 Inspection Department 243 Inspection of Contracting Risks .246 Inspection Routine 254 Inspectors, How Trained 244 Inspections of Miscellaneous Risks 251 Inspection Service by the Na- tional Workmen's Compensa- tion Service Bureau 251 Medical Attention 256 Mining Inspections 249 "New Business*' 253 Physical Conditions, Inspected.. 243 Recommendations and Re-In- spections 254 Recommending Improvements to the Assured 244 Remote Isolated Risks 248 "Renewal Business" 253 Safety Campaigns 255 Surgical Aid 256 Training of Inspectors 244 Treatment of Injuries 256 CONTENTS 297 CHAPTER X Claims, Suits and Reserves. Accuracy of Report by Investi- .f?tor 271 Adjustments 272 Apparently Simple Injuries! ]!!!!272 Appeal to Compensation Board. 269 Arbitration a Last Resort 270 Attorney Compensation 280 Automobile Collision Claims 278 Board Proceedings 269 Calculation of Unearned Pre- mium Reserve 282 Claim Reserve 283 Clerical Organization 264 Compensation Claims 266 Determining the Value of a Qaim 273 Economy in Quick Settlements.. 276 Embryonic Lawsuits 263 Employer and Injured Employe. .266 Employers Required to Make Reports 366 Estimating Claim Liability 284 Evidence of Settlement 276 Factors Considered in Valuing a Claim 274 Facts Essential 271 Getting Injured Workmen Back to Work 269 Honorable Dealing by Adjusters. 275 Immediate Action by Adjusters. 275 Independent Adjusters 265 Knowledge of Legal Principles.. 262 Legal Actions 279 Legal Principles and Claim De- partments 262 Legal Requirements as to Re- serves 284 Legal Reserves 284 Local Claim Departments 265 Local Legal Service 280 Malingering 268 Medical Disbursements 267 Methods by Which Adjustments Are Effected 274 Negligence, Question of 271 New York Reserve Law 285 Notice of Accidents 263 Outside Adjusters 265 Physicians 268 Powers of Adjusters 265 Powers of Insurance Superin- tendent 285 Prompt Investigation of Public Liability Claims 270 Property Damage Claims 277 Public Liability Claims 270 Relationship of Law and Claim Departments 280 Release by Claimant 276 Reluctance of Injured Workmen to Resume Work 269 Reserve for Claims 264 Reserve Law of New York 285 Reserves, How Developed 281 Retained Attorneys 266 Routine of Claim Departments.. 263 Salaried Physicians 268 Salvage Under Subrogation Clause 279 Seriousness of Trivial Accidents .272 Subrogation 279 Suits 279 Tampered Witnesses 271 Theory of Reserve Laws 286 Third Party Claims 262 Unearned Premium Reserve 282