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The Columbia University Libraries reserve the right to refuse to accept a copying order if, in its judgement, fulfillment of the order would involve vioiatlon of the copyright law. Author: Barnett, Samuel ■ m mm ■ Life insurance accounting Place: Louisville, Date: 1909 MASTER NEGATIVE i COLUMBIA UNIVERSITY PRESERVATION DIVISION BIBLIOGRAPHIC MICROFORM TARGET ORIGINAL MATERIAL AS FILMED - EXISTING BIBUOGRAPHIC RECORD P ! | ij,.v. - ^j.'>5g'*r'» -yi-y.!-:^ ■ - ■ -M Barnett , Sanual 'N|?y&8tiyattoe field c 01909^ tables »'for]BS. RESTRICTIONS ON m' TECHNICAL MICROFORM DATA Fluyi SIZE: T^mm REDUCTION RATIO: /5X IMAGE PLACEMENT : lA ^ IB IIB DATE RLMED: MQ-QS INITIALS: TRACKING * : FILMED BY PRESERVATION RESOURCES, BETHLEHEM, PA. > CP 00 ■ o 3 3 0> o > — ♦» o 05.0 Is go •-'—I "^:< 00 IM O CaI CJI 3 3 IS (/> ^ I— t- ^ ^ :::d N c/) OOM iD O V CJI 3 3 > 00 o m CD O "vj O o ?C0 N M e 3 i Ul AX ^^^^ 8 V l^lils I .An 2.0 mm ABCOEFGHUKLMNOPQRSTUVWXYZ alicddihiiMinnopqntaJVWxyzl234S6^ ABCDEFGHIJKLMNOPQRSTUVWXYZ abcdefghiiklmnopqrstuvwxyz 123456^ 4r ABCDEFGHIJKLMNOPQRSTUVWXYZ ^ ^ abcdefghiiklmnopqrstuvwxyz 2.5 mm 1234567Bd0, m H 9 O O -o m -o 0 L, "o > C CO 1 ^ r> P 00 > 3D O -0^ 4v Ul 3 3 b i i si si o ro CJI 3 3 CD 0, O o m (D O OQ X X < ^ .ta,... a/ 1HE LIBRARIES , - ^ . ' ^ \ ^\ V i ^^^^ V - - ^ 1 4* ' It.'^* ^ ' a' ' 'y 4* T V .r-t GRADUATE «»«><»^ OF BUSINESS .3' / « i " ■' If*'* *- A LIFE INSURANCE ACCOUNTING By SAMUEL BARNETT CONSULTING ACTUARY ATLANTA, GEORGIA THE INSURANCE HELD UXnSVBXE. KENTUCKY COPYRIGHT, 1909 wr SAMUEL BARIOTT. ! Table oi Contents. Chapter L INTRODUCTION. (general Idea of Accounting S LegBl Accounting • Separate Parts of AoeaaoXtm < Plan of This Work T Cbapter IL LIFE INSURANCE BOOKKEEPING. General Idea 8 Peculiarities of Life Insurance Bookkeeping S Ust of Books 11 General Journal 12 Application Register 1 , 14 Policy Register 15 IndiTldiial Policy Ledger Cards i If Agent's Policy Memorandum Ledger ; 19 Agent's Note Memorandum Book 21 The Agent's Journal • 22 The Agency System in General 22 The Pranium Joonua M .The Inyestment Journal' If The Expense Journal 37 The Insurance Terminated Journal ' 41 Hie IMTldend Joarma » 4f The Annuity & SupplND^ary Contract Joonal . «^ 50 The General Ledger ^ 50 Bank and Cash Account 51 Agenf ■ Pemcmal Ledger 52 Record of Classifled Insurance S2 Beeerret and Dividend Records SS Mortality and Lapse Records 56 Completing the Records and Balancing the Books 57 Chapter m. OONGLUSIONS FROM THE FACTS. Legal ReaervM ft The Contingency Reserve (2 Proportional to Fluctuations 62 The Standard of Safety 63 Oontlngraey Reennra Tabic M Calculation of ContiagMicy Reaorve IS Maximum Insurance on Sinf^e Life 67 Probable Fluctuations 68 Natnre of the Contingency Reserve 69 How Created, Uaed and Bedistrlhvfted tt « Gkupter IV. DIVIDEND CALCULATIONS. Regulated by Law ^ RMnttiiig Tniats " Elements Entering into Dividend Calcttlatioii* '* The Duty of Dividend Calculations "^^ Incidence of Expenses and Profits ^ BxpeniM • Prengdmn CJollection General Administration ^ Taking Care of the Funds Interest ^ MortaUty • • J* Lapses and Surrender Medical Selection, I^apses and Surrenders 82 Legal Classifications ^ Formulae tor Dividend Galeatetiaas 8S AppHeatkms of the Formulae •' Tie Aggregate Divisible Surplus Practical Method of Dividend Calculations W Ctastor STATSMENTS. - go General Explanations "* Form of Statements ■ , . . • . 99 How to Make Out StatemenU • • Oftin and Lees BzMMt • Chapter VI. EXAMINATIONS AND VALUATIONS. Their Object Net VahMtfoin and liegal Bewnren 101 Defects of Net Valuation^ 1*^1 Effect of Rapid Growth .'. • • Natural Accounting and Vahwtioiui i CondflMed Stntenent tor Porpoees of. YaMkm 105 SoiTODcy and inatAreaej 10" Equalization Savings ; Life Insurance Accounting CHAPTER I. INTRODUCTION. The ultimate object of Accounting k to determine the rights of th« various jmrties connected with the business. . The right to call for an Accounting is vested in the Stoekheilders and Policyholders. The duty of Accounting rests upon the Companies. And yet in many respects correct legal Accounting is more important to the Companies than to the Policyholders. In fact, it is oft^ more important to perform a duty than, to insist upon a right. Strange to say, the subject of Life Insurance Accounting has been little studied. The rights of the Policyholders and of the Stockholder^ are vay had^ defined and, in fact, scarcely defined at all. And, of course, conversely, the duties of the Companies are very badly defined and, in fact, scarcely defined at all. As a consequence, there are no very definite rules for examining the Companies and no very- definite forms for Companies' Statements. How a Company is to account is left pretty much to the Company. Still, there are some rigid legal requirements. Requirements which are too rigid in some particulars and too lax in others. Requirements which seem unjustly to favor some Companies and to bear very harshly on other C-ompanies. In our opinion it will greatly benefit the Companies, particularly the young Companies, more closely to study the subject of Accounting and to devise correct and fair methods of examinations and complete and cor- s roct forms of Company's Statements, and more thoroughly to understand tlie i^tiye rights of Stockholders and Policyholders. LEGAL AGOOmiTIlie. All rights are determined by Law. The Law must, therefore, ovtliae the general method of Accounting. But to arrange and classify the facts in soeh a way as the Law niaj apply, is the work of the Actuary and of the expert Insoraiiee Book- keeper. Under general rules of Law the Actuary must make calcnlatioiis so as to ascertain under the rules of Law the rights of the parties ia doUars and cents. By Legal Accounting we mean such Accounting as will be sanctionfid by a Court of Law and Equity, anywhere. We do not mean mere «»- formity to some local statute. The Accounting must, therefore, be legal and the law mnst ghre general direction to everything that is done. THE SEPARATE PiJtTS OF ACCOUHTISG. first Record of facts. The facts cannot be wdl lecwded without first being properly classi- fled, caaasificatimi mnst be nade with the main «Kl in view ;to-wit: the r^ts of the paitieB as determined by legal mles. The expenses must be dassifled, before recorded, from a legal stand- point with r^eraace to who ate to pay the expenses, or npon whimi the expenses are t» fall in the legal method of Accounting. J%t saTings and profits must be dasrified, before recorded, with ref- i9Biee to the legal qncstSon as to i^um they b^ong, considering the sources whoice thqr emanated. It is clear, therefoi^ Aat the record of and prior classifications of the facts mnst be made in enbordination to the main end la wkm, and this constitvtes the first step in Accounting. Lif^ Insurance Accountkig siKNild, therefofe^ presmt a complete ^s- tem of double entry bookkeeping, arranged in the best way for determin- ing the rights of the parties cqiUMeted with the badness. Second. Mathematical deductions from the facts. From the f^cts j^op^ly recorded, must be calculated the I^gal Be- sprre which the Company should carry ; the Cont^jOMy Bowrro wsfuifed c by the standard expressly or impliedly set up; the aggregate amount of profits or fBayings to be paid or credited to the Pc^cyholders and the pro- portions in which these sayings are to be distributed to the separate classes and indiyidual Policyholders and Stockholders. Valuations have for their object to determine how wdl the Ck>mpany is carrying out the contracts and what are the dangers of insolvency and what are the probable pn^ts or savings that the Company may make in the future and what its future is likely to be. Third. Conclusions of Law. After, in conformity to general rules of law, the facts have been properly classified and recorded and after, under these rules of law, the proper mathematical calculations have been made and the mathematical results ascertained, the law pronounces final judgment and determines the rights of the parties. This renders the Accounting complete and establishes the ends aimed at. FLAM OP IBIS WORK. This work, therefore, sets out first a complete system of double entry bookkeeping, giving all the forms necessary and explaining their use. The book then gives a complete treatment of the subject of the Con- tingency Reserve and explains its object and the nature of a standard of safety and how to determine the Contingency Reserve for any Company. The book then takes up the subject of Dividend calculations and shows how under legal rules the Company ought to divide out profits to the Policyholders, and what are the relative rights of Policyholders and Stockholders. The Book then takes up the subject of valuations and the subject of real and artificial insolvency and the correct method of testing the prog- ress of the Company. As a part of the general subject the book gives a complete form of Statement arranged with reference to the great end in view; to-wit: to ascertain the rights of the parties connected with the business. The form is complete, though not very long, and gives the things that are needed in order to ascertain the rights of the parties. 7 CHAPTER n. LIFE IKSOSAIKX B00EKBSPIX6. A correctly arranged double entry system ol life InsuraiMie htnA» constitutes an object lesson showing the practical worldiig of the Cfm- pany. No doubt the best education the stodent of Lifte Inamaee can obtain is carefully to study well arranged doable entry book form 9mA to follow the successive entries in the different books. In the forms here given, the headings are so arranged as to snggest the forms of entries needed. A study of the fcMrm will explain how to make the entry. The forms are sufficient for the most complicated and largest busiBess, and yet substantially the same forms are needed for every bustuess no matter how small. Of course the forms may be slightly varied. In certain instances cards may be preferred rather than permanent books, but no matter w hat variations are made the main divisions if the records are complete must remain substantially as here given. PECULIARITIES OF LIFE INSURANCE BOOKKEEPING. We give here three keys which virtually unlock the whole system of Life Insurance Bookkeeping. They are as follows: First The contiBgeiit nature of the facts. When a Company issues a p<^icy of Life Insurance the Company beeomes liable In effect the Company has issued a bills payable, but this bills pi^able is subject to future unknown contingencies. In the iadlYidnal case it is impossible to teU how these contingencies will turn OBt Tlie party may live 70 yeaia. He may die tomorrow. Ill the indi- vidaal ease the Company does not know what its liability is. Tils coiitiiifeiit nature of the facts is the controlling peculiar^ of Life Imsaiaiice, or of Insaiaiiee in genml. As a fwnlt paratory to the facts that are to go into the Insurance records proper. The application for instance is not a contract, but is merely a pro- posal for a contract The Poliqr Bister when the poli^r is first issued does not repre- sent a contract actually formed;, but merely a inenorandum of a policy which may or may not be delivered and thvm Buiy or may not go into force. And so with other Auxiliary books. Second. The system of Special Journals. The facts in Insurance fall into a few distinctly marked classes such as the receipt of premiums, the receipt of interest, the payment of expenses, the payments to Policyholders, etc. These classes are so well marked and the typical entry in each is so well marked that it is convenient to keep each in a separate Journal. It will be noted too that the receipts of premiums and of interest and the payment of expenses and the payments to Policyholders are definite facts, certain, free from contingencies, and such as may be en- tered at once upon the books and cannot like contingent transactions be kept off the books. In Life Insurance P>ookkeeping, we therefore, keep the Special JiNumals hereafter named. Third. The Agency System. The Agency system is an integral and exceedingly important part of Life Insurance. In fact, it is the life of the whole business. Yet the Agency system is simply a means to an end. The Agency books as a rule are auxiliarj- and not part of the books proper. Yet the Agency system is so important that it needs to be separately provided for. If the above distinctions are constantly borne in mind it is easy to »ee the identity between Life Insurance Rookkeeping and other forms of bookkeeping, and the tgrstem becomes veiy eaagr. « LIST OF BOOKS. • We gire here a genml oiitlme of tke books needed in a cntraet Books. Income. Disbursements. . Machinery , (8) Agent's Journal. (9) The General Ledger. AUXIUART BOOKa (1) Application Register. (2) Policy Register. (3) Individual Policy Ledger Cards. (4) Cash and Bank Memorandum Book. % (5) Individual Stock Book. (6) Agency Ledger. ( 7) Personal Ledger. (1 (2 (3 (4 (5 (6 (T (8 (9 OmnnBHIBllCBS. Classified Insurance Written Books. Reserve and Dividend Calculation Books. Actual to Expected Mortality Calculation Books. Agent's Policy Memorandum Ledger. Agent's Note Account. Bills Receivable Memorandum Book. Bills Payable Memorandum Book. Investment Diary and Interest and Rent Book. Alphabetical indexes of Declined and Reduced Risks. 11 No confiision need arlae firaiii fceepiag several Journals any more tlian making differoit Joomal entries cn different pafee of tlie same Jonmal. If a Journal entry is made on the wrong Jonmal no harm is done exc^t that it is inconyeni^t. The entry will find its way to the I.«dger all the same. Looee-Leaf books will he found most conyaurat for Insnranee records. We will take up in detail each of the foregoing books in the simplest osier for practical explanation and use. THE GEHERAL JOURH AL. On the General Journal should be entered all the facts at the be- ginning of the business and all the closing entries at the end of the jear, or at the end of the business, and if desired, the monthly aggregates of all entries on the Special Journals. On the General Journal will also be entered all the facts that do not properly fall in any of the Special Journals. The ruling of the General Journal will be the same as the ordinary tloumal in any other business; thus: OBHXBAL JOOTOTAL. Doaerfpttona « Debits. Credits. * Otherwise the- following form of Ckmeral Jonmal. is sometimes prc- f tarred : OENEBAL JOUKNAL. Debits. Descrlptkms. Credits. * 1 12 This is a partial adoption for the Ctoneral Journal of what is known as the Columnar method, which we will extaisivdy use. The numbo* of columns maj be increased as much as we please, ac- cording to the extent we widi to dassify, as Gash, Bank, ^Agent's Bal- ances, Personal AecountSy etc., etc, to be written at the head of the Columns. The op^ng entry, indicating the beginning of bumness, will be made upm iht Q^eral JoumaL ^le Assefts of the C nnged accofdii^ to Agents. (Indexed by Agents.) We give here the form of the Agent's Policy Memorandum Ledger. We transcribe from the Poli<*y Begkter directly to the Agait'a P<^ icy MaDoraBdnm Ijedger. Tlie Policj MeoMxraiidnm Ledger is a mere Mesmorandiim. It doea aot before tiie Premium is coUected represent a charge against Hie Agent, bat r^resoits merely that the Policy has been sent to the Agent for the Agent to collect the Preminm and deliver the Poli<7 and lemik the Premium to the Cktmpany when the Preminm is cc^lected. The Agent owes nothing nnti! the Preminm is collected. The case is exactly analogons to Hie Gdm^any^s soidfaig a note to the Bank to be eoHeeted, with the inirtnictioiis to send the prooeeds as soon as eoQeeted hack to the Company. The Bank owes solftiBg until the note ii eok- leetedL If the Agent collects the Premiioi and fails to reiait it tiie AgessA will owe the Preminm to the Ckimpany, bat not nntO then. Whoi the Preminm is paid by the Policyholder to the Agent and the Policy deliyered, the contract goes into effect The Company then becomes bound as between the Company and the Pcdicyholdery and the Preminm must be at cmee altered cm the Preminm Journal whether the Agent remits to the Company or not If he fails to ronit he must be charged the amount AGENT'S POLICY MEMORANDUM LEDGER. Vmmm of Am^t- DcBcriptloiui. Debits. Premhuns. Date. Number. Kind. Insured. Amount Policy. Date. e o c. u IK & Q Sundries. Short. C a 3 « Interest. Totals. ♦J De.scription.s. Sundries. Dividends. Commissions. c 1-1 Cash. Notes. Not taken. Total. i 1 1 1 20 From the Premium Journal we transcribe directly to the Agaifs Policy Memorandum Ledger. The debit side of the Agent's Policy Memorandum Ledger (Trans- cribed from the Policy Register), thus shows the sending the Poliqr to the Agent for him to deliver the Policy and collect the Premium, and the credit side^ (transcribed from the Pronium Journal) shows the set- tlement. From the Agent's Policy Memorandum Ledgar we find the Policies in the Agoit's hands unreported on. THE AGENT'S NOTE MEMORANDUM BOOK: The Agent is eonsidared by the Ccmipany as in effect an oidorser * >^ te. •4-* c o o e o c H o %* o Due. t Pol o z intio nt. 1 e Z %-i Iptlo; nt. « o o O O O o u 3 O Dat el ■4-< CC 6 d K V 6 c 6 « E Q Q Z Z p < Z Z a -< 1 iim^miiiffii ■llHlB' PATHBNT ON MOVBS. n Whenever a note is received bj tlie Company from tlte Afoit it Is transcribed on the debit side of the Agent's Note Aeconnt, indiesthig a possible liability on the part of the Agent in respect to the note. When the note is paid, or when there is a partial payment the iMt should be transcribed on the credit side of the Agent's Hote Mtanoran- dum Book. When two sides balance the Agent's Note Account is clear. The Agent's Note Memorandum Book is a mere m^orandnm. It is merely a re-arrangement of the list of Bills Beceiyable (Pxeminni Notes) by Agencies. THE AGENT'S JOUSHAL. If the Company deals extensively through its Agents, particnlarly if it keeps a running account with its Agents, it will be advisable to keep a special Agent's Journal. We give here the form of such a Journal. This Journal is a book of original entry. The Agent's Balances only, as shown at the foot of the columns, will be carried forward to the General Ledger, as these aggregate results are all that belong to Insurance Books proper. But collaterally we will transcribe to the Agent's Individual Ledger. DSBITS. CBEDFTS. Date. Descriptions. Agent. Casli. l^anli. Interest. Bills Uecelvable. Sundries, Descriptions. Agent. Cash. Bank. Interest. Bills Receivable. Sundries. II 1 1— The Agent's Individual Ledger thus gives itemized particulars of vhich the Agent's balance in the General Ledger is the aggregate. 82 ASSaSTS INDIVIDUAL LEDGER. An Agent's Ledger of the mnial f<»ni may be he^ showing the indi- vidual aecoants, which aceonnts represent the itendied partievlan that appear as goMral Agenf s Balances on tiie Gawral Ledger. THE A6BKCT SYSTEM IN ^NBRAL. The Company thus deals with the Agent in three distinct ca- pacities: as a Banker to collect the Premiums, as a quasi endorser on the Notes sent in by the Agent, and personally in his individual capacity. First. The Agent's Policy Memorandum Ledger. This shows the dealing with the Agent in the light of a Banker to collect the Premiams for the Company and to remit to the Company. The debit side of the 'Agent's Policy Memorandum Ledger (trans- cribed from the Policy Register), shows the number and descriptions of the Policies sent to the Agent to collect the Premiums. The credit side, rtranscribed from tlie Premium Journal), shows the settlements. The Account thus shows also what is unsettled for by the Agent. This is thus an Account with the Agent as the collecting Banker of the Company. Second. The Agent's Note Memorandum Book. This Book deals with the Agent as the quasi endorser of the premium notes sent in to tlie Company by the Agent and upon which the Agent may become actually liable to the Company. It is thus the Agent's Contingent Liability Note Account. Third. The Agent's Personal Account. This Account deals with the Agent as an actual ddl>tor or creditor. The actual adTances to the Agent and all actual moneys paid to the Cknapany on the Asaifs Ac- count will come in the Agent's Personal Account. The Agent's Policy Memorandum Ledger matures into an actual Personal Account as soon as 4he Agent collects the* Premium and fiiils to remit. The Agent's Note Memorandum account matures into an actual per- sonal account as soon as the note matures and is unpaid. Suppose we wish to know the standing of an Agent at any time: We first examine his Personal Account to see what are his actual debits e at once eatmi wkMm tbe Agent lias ranitted tbe money or not, and no matter how the aie- connt stands hetwem the Company and the Afent. The commimkm liability, whether certain or contingent, attaches at once agaimaithe Com- pany and mnst be at t, To |75 First Preminm Pure. 25 Load. 50 AgeaaL CoUateraUy we will transcribe to the Individnal Policy Ledger Card the full settlenient of the flOO Preminm. On the back of the card we win transcribe the lien oi f25, and the Preminm Kote of f75. Collaterally also we will transcribe the settlonent to the Ag^t's Polity Memorandnm Ledgi». We will also transcribe the note of $75 to the Agent's Note Account as a memorandnm. When the Agent's Note Account shows that the |75 note is paid the Agent's C o c ■i Premium Notes. Interest. Rents. Profit and Loss. First. Renewals. 2 Renewal. 1 It is not neeeamy furtiiar to iUnstrate tbeme simple entries. Any- one ovdinarity familbff witii DoaUe Entry Bo(d±eeping will ind no difltenlty in tills branch of tlie subject. Tbe postings to the O^ieral Ledg^ will be the numthly footings of the different cohmms. The Sundries colnnin, of coarse^ mnst be separately posted to the Cteneral Ledger. This posting of the aggregates to the Gteneral Ledger^ coupled with the collateral transcribing as memoranda to the individual accounts in the Auxiliary Bo(^ completes the entries. We need to be careful not to omit any of the collateral transcribing. But even if we were to omit the collateral transcribing, our main boohs would still balance and be correct. We might be put to a good deal of inconvenience, however, in mak- ing out the Individual Accounts. Suppose, for illustration, a First Premium note is paid, on which the Agent is considered liable. We need to enter Cash to Premium notes in the Investment Journal. We need to transcribe the payment of the note on the Individual Policy Ledger Card. We need to transcribe the payment on the Agent's Note Account. We need to cancel the note on the Bills Beceivable Book. To omit any one of these may cause annoyance and delay in making out personal accounts in the future and yet there would be no mistakes in the aggregate Insurance Books proper. All mortgages, collateral loans, bonds, stocks, policy loans, premium notes, bills receivable, etc., will, of course, be entered in order of date recdved in the Journals. In order to keep the run of the due dates and an alphabetical list, abstracts of each note or other evidences of debt should be made on loose- leaf sheets about 5x8, one original and one carbon copy being made of each, or if preferred, one original and two carbon copies. The abstracts should show all particulars needed. It is not necessary to give the form. Hiese copy abstracts may be filed, one set according to due date, one set alphabetically and if a third set is desired, this third set may be filed according to the date of the papers. The latter, however, is suiBciently covered by the Journal entry. These loose-leaf abstracts in the above orders should be kept in loose-leaf books. The securities themselves may most conveniently be k^t filed ac- cording to due date. In addition to the above eacli hmg-time security such as a mort- gage note or long-time loan should have a separate special Ledger ac- count upon which separate columns should be provided for interest pay- ments and the payments on principal, for fire insurance and for leats and repairs, etc. As these forms have nothing peculiar to do with insurance we refer the reader to Keal Estate Mortgage Loans Companies, Beal Estate Com- panies and Banks for the best forms. The forms are simple and the reader's ingenuity may easily suggest suitable forms for the purpose. These may be considered diflferent forms of the Bills Beceivable and BiUs Payable Books. THE EXPENSE JOURNAL. We com^ now, to the subfect of disbursm^ts. The chi^ diiAmrsements Ml into two great classes, expenses and piQrmentB to PoliigrhoMen. The object of aU Aeconnting, and therefore the object of all classifi- cations for tiie purposes of record, is to ascertain the rights of the par- S7 ties interested in the basiiiesB. The clasdileatioiis of expenses, therefoxe, should be guided by the question, whom tiie expenses are to fall on. Without going into detail, it is plain that cinunisslons ought to fall on the premium in reqpect to which the eommissioiis are charged and thus on the 'Po^eyhoHkit who has to pay the premium. Expenses of Premium Collection in general, which relate^ so far as we know, not to any indiyidual premium, but to all premiums alike^' diould be charged against all premiums as a percentage and thus fall on the premium-paying Policyhtddors as a class. After the premiums are completely paid, the Poli^holder should be charged nothing further for the expenses of Premium collection. Expenses which relate to the Company as a whole and which, so far as we know, do not relate to any indiyidual thing or Policyholder or class rather than to any other, may appropriately be called Expenses of General Administration and should be charged against all Policy- holders in the Company. Expenses of handling the funds should be charged against the funds and will thus reach the indiyidual Policyholders in proportion to their lespectiye reseryes, as it should. The Expense Journal is, tlierefore, divided into three parts: 1st. The expenses of preiniiini collection, 2d, The expenses of general administration, 3d, The expenses of taking care of the funds. These three. classes of expenses should be kept in a loose-leaf journal with tabs indicating the locality of each class, Tlie subject of proper classifications of expenses will be more care- fully considered under Dividend Calculations. The expenses of premium collection should include commissions, agency salaries, rents for agency pur]>oses, agency supervision, agency traveling expenses, agents' licenses and other agents' expenses. Medical expenses are not properly chargeable against premiums or in proportion to premiums. But Medical expenses, like commissions on first premiums, belong to first year's expenses and do not belong to the general yearly running expenses of the Company . The Medical expenses may thus be considered as a tax upon the first premiums and the prac- tical results in dividends to Policyholders will be practically the same I as if charged against all Policyholders alike. We, therefore, put Med- ical expenses as part of premium collection. Under the expenses of general administration will fall the salaries of home and branch officers, rents for general purposes, furniture and fixtures, general licenses to do business, g^eral insurance taxes, traTei- ing for general purposes, postage, telegrams, express charges, exchange, messages, printing, stationery, adyertising, Stockhold^ dlTideada, Di- rectors' expenses, general legal expenses and all expenses that r^te to the Company as a whole or that cannot be related to any partiealar person or thing or class. The expenses of taking care of the funds include taxes, on real es- tate and other funds, repairs, trayeling expenses ftw lo 60 OQ « s 0) u a X 00 s oi (« Eh 0) M) Id *j oo o >> B O OS -o E bO B B « 2 o sz u o 00 n 0) CO S A X "5 « n s 5 B 0) OS -d E 03 60 E M) ■w n > B U c4 h *> B O O >> ed <.> B 4) E a> ft a 3 m CREDITS. OD B O 00 0) 00 b •O B 3 OQ 00 B 40 XZFBH8E8 OF TAXXVO GABB OF THE FUVBS. DEBITS. CREDITS. Date. Descriptions. Sundries. Taxes. Repairs. Traveling Expenses. Legal Expenses. Profit and Loss. Other Expenses. Descriptions. Sundries. Cash. M a as » Real Estate. Other Funds. THE INSURANCE TERMINATED JOORKAI.. Haying considered Disborsem^ts 1 %. O « Q 1 Po'lcy number. 1 Kind. E 3 E «• u Insured. Address. Age at Issue. Date terminated. 1 olicy year. Fraction. Original amount. ' Additions. 1 Deductions. Amount of policy. Reserve, Surrender value. Date. De.ecrlptlons. X b •o c 3 1 1 gg B o 1 o 9. 1 « U 1 Sundries. Bank. Sundries. Debts Cancelled Used to Pay Premiuims. 1 Policy liens. 1 Folicy leans. 1 Premium notes. Deferred Prem*. Sundry Ins. Paid up additions. Paid up Ins. Extendhd Ins. Annuities. .Supplementary Contracts. 1 Uevived. 1 ■ We also note ccrfumns for the Bes^ve and Bumaider Values. The ratio between the aggregate Surmader Value and the aggregate Bm&nre shows the percoitage of Surrmder Value to the R e s cnn ^ and thus the proit by the Company from Surrenders and Lapses. The entries on the Insurance Terminated Journal must be in regu- lar Bookheqiing form, as on all the Journals. If there is no Burraider Value and, thanefofe, nothing paid to the Policyholder, still tiie Insurance Tmninated should be entered at its proper place, notwithstanding the fact that the dclrit and credit columns will remain empty with respect to this entry. The debit side on the Insurance Terminated Journal will be either ii Death Loss or a Matured Endowment oir a Surrend^ Value. The credit side will be a check equivalent to cash, or it will be Debts cancelled, such as Bills Beceiyable, Policy Loans, Policy Liens, Pranimn Notes or Deferred Premiums, or it will be Surrender Values used as Premiums to purchase other Insurance, or it will be combinations of Uu-se. 42 If surrender values are used to purchase Paid-Up or Extended In- surance or Annuities we have a "Change" from one form of Insurance to another and this means the termination of the one kind and the iflauaufi^ of another kind of Insurance. The transaction is thus double and for completeness should be Al- tered on both the Insurance Terminated Journal and the Pi«nium Journal. Only the aggregate footings at the end of the month will go forward to the General Ledger. But we transcribe to the Individual Accounts as usual when desired. We will give a few illustrations of entries in the Insurance Termi- nated Journal: # Suppose a Whole Life Policy issued at age 30 f.)r |!10,000, Ordinary Life Plan, terminates by death after ten annual Premiums have hem paid; and suppose that |10,000 is paid in full settlement. ' We first get the Policy Ledger Card and then turn to the Insurance Terminated Journal general division, "Whole Life," and to the sub- division "Terminated by Death" and fill in the Descriptive columns. The Policy ye^r will be 10 and the fraction 1, showing that the annual Pre- mium has been paid in full. On the debit side we put Death losses 110,000 and on the credit side under Bank |10,000. *10,000 Death Losses. Dr. To 110,000 Check on Bank. After making the entry in the Insurance Terminated Journal we transcribe the Termination to the Individual Policy Ledger Card, giv- ing the date and cause of death and the settlement. We file the PoUcy Ledger Card in the Terminated Insnrunee for the year. Again, suppose a Twenty-Pay Life at age 40 for 110,000. Suppose this terminates by death the Twelfth Policy Year, after the third quar- terly Premium payment has been made. Suppose the quarterly Premium is |100. We get the Policy Ledger Card and turn to the Insurance Termi- nated Journal, "Whole Life" Insurance, Tmina4«d by Death, the same ns before, and fill in the Descriptions. Under Policy Year we put 12, and under Fractions showing that only % of the annual Premium it is paid, and that the remaining 14 Deferred Premium remaining as a debt due the Company. Under debits we put Death loss |10,000, and under credits Debts cancelled, we put flOO for the Deferred Premium, and check |9,900 to balance : 110,000 Death losses. Dr. • To |9,900 Check on Bank. 100 Deferred Premium Cancelled. We transcribe the Termination upon the Policy Ledger Card, giving . the date and cause of Death and settlement. We file the Policy Ledger Card in the Insurance Terminated Cabi- net for the year. Again, suppose a Twenty- Year Endowment for |10,000 at age 55, matures at the end of twenty years, during the life of the Insured, and suppose a Policy loan of |3,000 matures at the same time: We turn to the Insurance Terminated Journal, division "Endow- ments'' and to the sub-division "Maturity" and fill in the Descriptions and enter upon the debit side matured Endowments |10,000 and enter upon the credit side under Policy loans ^,000, and under Bank f 7,000 check for the balance: 110,000 Matured Endowment Dr. To 17,000 Check on Bank. 3,000 Policy loans cancelled. Again, suppose a Term Insurance of $5,000 expires at the end of ive years, during the life of the insured : We turn to the Insurance Terminated Journal Term Insurance, un- der the sub-division "Expiration/' and enter the d^ails in the Descrip- tion columns. The debit and credit er. To 1130 Premium. We may keep a separate Policy Ledger Card of this extended insu- rance, or we may enter the extension <»i the original card to repntmt the extended term insurance. Again, suppose a Twenty-Pay Life at age 45 for $1,000 terminates the fifteenth year, the Keserve being $500, surrender value |450. Suppoieie a lien under a general contract exists for $100 and a policy loan evidenced by a note for $100, leaving $250 available balaneew Sup- pose this $250 is used to purchase paid-up insurance. We obtain the Policy Ledgra* Card, turn to the Insurance Termi- nated Journal, Whole Life surrendered, and aft^ fllling in the descrip- tive columns make the entry as fmikmn: f45d Surrender value. Dr. To $100 Policy liens. 100 Policy loans. 250 Surraider values used to pay j^wmiunw for paid-up inmiranee. If preferred we may oiter the $250 smender value credit in red ink and also on the debit side $250 in red Ink and $200 In black Ink, the red ink to re^eeent memmanda and not book entries, or we may leave the $25a blank ratiiely and put $300 debH and $200 credit We transcribe to the PoU^ Ledg^ Card as usual. We turn to the Premium Journal under the head of Changed, paid^ up insurance, and enter: 1^ Surrender values, Br. To 1250 Premium, and collaterally transcribe as usual to the Policy Ledger Card, either a new card or we retain the old card for the purpose. Again, suppose a Fifteen-Pay Life Policy at age 40 lapees at the end of the tenth policy year with a Reserve of $440, and surrender value of $400, and suppose extended insurance is granted. We obtain the Policy Ledger card as usual and turn to the Insu- rance Terminated Journal, Whole Life Lapsed and aftw filling in the descriptive columns make the entry : 1^00 Surrender values. Br. To $400 Surraider values used to purchase ext^ided Insn- ance. We may put the $400 debit and $400 credit In red ink if desired as before, or leave blank after filling in the descriptitm. We transcribe the entry to the P value; Br. To $400 Premium. We either make out a new card ext^ded Insurance and enter on the new card or retain the old card for the purpose. Suppose now that within the time aUowed for levlval and whHe the extended insurance is in foiwe, the policyholder bAm a revival and pro- duces satisf actoiy evid^ce of good health. The extended term insurance which is now in existence must be can- celled on the Insurance Terminated Journal and the original policy revived. ^ j As usual we obtain the card for the extended Insurance, either the new card made for ^t purpose or the old card to which the extended iiumrance attaches, and turn to the Insurance Terminated Journal Term Insurance Surrendered and after filling in the descriptive columns and ascertaining that, say $50, has already been consumed in carrying 47 the Extended Term Insnranee to date, leaving |350 as a balance surren- der value, our entiy will be : |350 Surrender value. Dr. To ^350 Surrender value used to re- vive old insurance. As before, we may enter the $350, both debit and credit, in red ink or leave these columns blank after filling in the descriptive columns. We transcribe to the Policy Ledger Card as usual. We turn to the Premium Journal under the head of Revived Insu- rance and assuming that the back premiums to be paid in cash amount to $100 in addition to the $350 surrender value, for the Extended Term Insurance, our entry will be: $100 Cash. 350 Surrender value. Dr. To $450 Premium. We transcribe to the Ledger Card as usual. In the column headed Reserves in the Insurance Terminated Jour- nal we must put the Reserves upon each Policy Terminated, and in the column headed Surrender Values we put the entire Surrender Value provided in the Policy without regard to any of the liens or loans or debts due by the Policyholder to the Company. The aggregate footing of the Beserve column will show the aggre- gate Reserves. The aggregate footing of the Surrender columns will show the Sur- render Values allowed. The difference between these shows the profit realized by the Company from Lapses and Surrender. The Insurance Terminated Cards, after the termination Insurance f^ntries have been made on all the books, will be placed aside in the In- mnance Terminated Card ealnnet for the year, and will there remain to tlie end of the year. At the end of the year all the Terminated Cards will be taken from Terminated cabinet and will be classified. First AoeoidiBg to kind of Inmmoieey and aeccHidy according to nfwatoitry. Tkgm terminations will then be entered in this order on the Insn- mmee C^Maifteil Booka, wkiek we will eiplain ]at». 48 TBE DiVlDBRD JOURHAL. The Dividend Journal also represents payments to Pt^i^holdera. We give here a convenient form for this Journal. As in all the Journals the entries must be in r^^ar Double Entiy form. Where the Dividend is used in reduction of Premiums the entire entry should be made on the Premium Journal, as we consider the Premium Journal the controlling Journal. However, columns are pro- vided to enter Dividends in reduction of Premiums on the Diyidend Journal, if desired. If, however, the Dividend used as a Premium is ^tered upon the Dividend Journal it should be transferred to the Premium Journal so as to keep the Premium Journal complete. The facts would thus be shown on both the Dividend Journal and the Premium Jonmal. but the debit and credit on the Dividend Journal being the same would cancel each other. Othen»vise they may be entered in red ink in the DiTide^d Journal as memoranda only. All cash Dividends will naturally come on the Dividend JoumaL Thus: $50 Dividends. Dr. To $50 Cash, would go immediately upon the Dividend Journal and would be col- laterally transcribed to the Individaal Poliq^ Ledger Card. DIVIDEND JOURNAL. DDBCRIPTIONB. DBUiTS. CRBDfTB. Date of Policy. Number. Kind. Premium. Issued. Original Amount. Additions. Deductions. Amount of Policy. Age at Issue. Policy Year. Fraction. Dividend Rate. Amount of Dividend. Date. Description. Sundries. Dividends. Desoriptiong. Sundries Bank. Used as Premiums. Reduction of Premiums. I'aid Up. Annuities. 4t Again, a $25 dividend paid in reduction of Premiuiris had best go directly upon the Premium Journal, but we may enter it on the Divi- dend Jonmal as follows (in red ink, as a memorandum only, if pre- ferred): |25 * Dividend. Dr. To |25 Dividend, used in reduction of Premiums. Tile debit and credit of Dividends on the Dividend Journal cancel each other, and we then make the regular entry upon the Premium Jonmal : |25 Dividend. Dr. To 125 Premium. ANNUITY AND SUPPLEMENTARY CONTRACT JOURNAL. This Journal also represents pfQrmeiitB to PoliejholderB. We here give the form of the Ammity and Bappleaimisary Contract Journal. It is intended to cover paymmtM to Policylioldm on Annuities and on contracts that hare matored into claims, bnt which are being paid annually or being diseha^ by Siq^piisietttaiy Contniets. The entries npon this Journal, as upon all the o4to Jonmals, are in ffl^r DonMe Entry Hom. AXVUZT7 An SOmjOnVTABT OOVTBAOT JOUBVAL. Kind of Policy mmcBiFTHyHB. DKB1T8. CtUfiOlTS. f Date. Policy Number. Kind of Policy. Insured. Address. Amount. a Q Descriptions. Sundries. Descriptions. Bank. Sundries. Thus, suppose an Annuity Certain for twenty years is being paid in discharge y Life and for all Endowments and for all Term Polieica and for all other Policies. • If the Policy is increased or decreased in «monnt, still rraudnlng of the same class, such as a Premium Addition Policy, we may leaye two lines for each PoUej Tfomdng the d s s & Eh "5 t Mean Bbcposures During Tear. Reserve Rates. Terminal Reserves. At Rislc TWndar. M«dl«L By Death. By Lapse and Sur. Rate. Expected Loss. Rate. Jmtl Expected Loss. II 56 * coMPLsmro the recor]>s axd balaxchig the woosa. In Life Insurance, as in all other businesses, the opening entry is made by putting the assets on the left, in the debit column, and the liabilities, including stock and surplus, on the right in the credit column- At the end of every year the books should be balanced and into the new year there should be brought forward nothing except the assets and liabilities, leaving Profit and Loss, etc., behind, in the same way as if the Company were entering upon a new business the new year. After a Life Insurance Company begins business there will arise certain classes of assets and liabilities which appertain to Life Insu- rance only. Among the assets will appear Policy Loans, Policy Liens, Premium .Notes, Agent's Balances, etc. And among the liabilities will appear Legal Reserves, Surplus to Policyholders, etc. During the year the Company will collect Premiums and Interest. These constitute the two sources of income. And as these sources of iiicntingency Beserve. Br. *f o Profit and Loss, and the new Goniangency Bteenre, the amount of which will he cal- culated by the Aetnaiy, will be l»ought into existence on the books an entry of the form: Profit and Loss. To New Contingency Besarve. Similarly, the old Legal Reserve will be balanced into Profit and Loss by an ^tiy of the fofm: Old Legal Beserve To Profit and Loss, and the new Legal Beserve^ the amount of which will be calculated by the Actuary, will be brought into existence on the hookB by an entry of the form; Profit and Loss. To New Legal Reserve. Thus, the new Ccmtingency Beserve and the new Legal Resttrve coma forward as liabilities. Stock dividends and other payments due to Stockholders are properly chargeable as expenses of General Administration and thus come for- ward in effect as liabilities against the Company and in favor of tha Stockholders. The Contingency Reserve entries will have consumed as much of the profit or savings as is necessary for a Contingency Beserve and the en- tire remaining profit and loss is then Divisible Surplus to be paid or credited to the Policyholders. We thus finally balance profit and loss into divisible surplus which is brought forward as a liability. We open the new books, therefore, for the new year in exactly the same way as we open the books at the beginning of the business. The assets on hand at the beginning of the year are charged to the liabilities on hand at the beginning of the year and all accounts that do not represent assets or liabilities are left behind on the old books. Sf CHAPTER m. CONCLUSIONS FROM THE FACTS. The facts having been ascertained, classified and recorded the next thing is to draw conclusions. These conclusions consist of mathematiciil calculations and conclusions of law. Among the most important mathematical calculations are the Legal Reserve, the Contingency Reserve, the Net Divisible Surplus and those fundamental ratios which constitute the basis of dividend calculations. The conclusions of law consist in determining the rights and li- abilities of the parties upon the facts thus disclosed. LEGAL RESERVES. When a Life Insurance Company signs a Policy the Company be- fomes liable. But what this liability at the present time is in dollars and cents 'on this particular policy, nobody can tell; for nobody can tell Iww long the Policyholder will live, nor how soon he may die, nor when tiie Company will have to pay the claim. Thus in Life Insurance Bookkeeping, as we have seen, this Policy is not entered at once upon the books as a bill payable, but the liability is apparently left off the records until the death actually occurs. But the liability is only apparently left off the records. The Li- ability really appears on the records in another form disguised in the Rhape of the Legal Reserve liability. The Legal Reserve laws artificially convert a future contingent un- known liability into a present certain known artificial liability. The L^al Reserve liability upon any policy at any time is arti- ficially defined by law to be the net single premium that will be required to purchase the contract at the present age of the insured, less the pres- ent value of future net preoiiums, by the interest rate and mortally table fixed by the law. It will be thus seen that by conventional rules more or less artificial an artificial value is put upon the Policy ; to-wit : the single premium at the interest rate and mortality table fixed by the law, and the Company is charged this amount, but the Company is at the same time credited all future net pr^iums; the value ol which is determined in tlie same artificial manner. In speaking of the Legal Beame laws as artificial and conventional, no disrespect' is. meant In the abs^ce of an artificial or eonyentional mle there is no way to convert a future conting^t unknown liabilil^ into a present certain known liability. But in Accounting it is of the utmost importance that the true arti- ficial and conventional nature of the Legal Reserve method of Valuati 'U abonld be fully admitted and apj^iated. OOerwise Accounting wlU be more or less deffectiva The object of artificial conventional rules should be to fit the facts and arrive at truth in tpe simplest, easiest way. If artificial conven- tional rules do not fit the facts and do not yield the truth they are of little value. i.nltss the true nature of the Legal Reserve laws are appreciated And unless they are applied in the ri^t way and qualified in the right way th^ may produce a great deal of harm and perhaps more harm than good. The Legal Bmme laws require that each Cany should ascertain yearly the tabular net mortality losses ( Insurance less Reserve), on each Policy and from this should de- duct the Policy's pro rata share of the actual losses for the particular age, Policy year and class of Policy. The result is the dividend for the year. If the class at the particular age, Policy year and class of Policy is too small to obtain reliable averages the Company must resort to the proper means to determine these averages. Experience shows that in general medical selection has the effect the first year of reducing mortality by nearly .50, the second year .40, the third year .30, the fourth year .20, and the fifth year .10. After the fifth the mortality is normal. Medical selection, therefore, has two effects. A temporary effect and a permanent effect. The temporary effect wears off in about five years. After five years the permanent strength of the Policyholder's constitution shows itself and the mortality savings thereafter will be more nearly a uniform percentage. The best way to determine mortality savings is, therefore, to de- termine the savings after the fifth year and for the first, second, third, fourth and fifth years to add .50, .40, .30, .20, and .10, or .40, .30, .20, JO and .00. The above is the general experience of nearly all Companies and will produce better results tlian tlie Company's own experience unless the Company is a very large one. If, in calculating dividends the Company classifies its mortality riaks geographically ast 1^ oeei^tiana or by character of riaka or otherwise, the Company should so specify in its Statement and should assign to each class the savings in that class according to the foregoing rules. LAPSES ASD SURHETOiaUS. The Company should calculate yearly the lapse and surr^ider rates for different ages. Policy years and classes of Policy. The dividends assignable to any Policy for the year on account of lapses and surrenders should be determined as follows : The actual lapse and surrender rate of the Company at the particu- lar age, policy year and class of policy should be multiplied by the per- centage of Reserves saved by the Company at the particular age. Policy year and class of Insurance, and the result multiplied by the Reserve on the Policy should be the dividend assignable to the Policy. If the class at the particular age. Policy year and class of Policy is too small to obtain reliable averages the lapse and surrender rates may be taken to be the experience of Companies generally; to-wit: in the fol- lowing proportions: .20 the first year; .12 the second; .08 the third; .05 the fourth, down to nothing the twentieth Policy year. Otherwise the Company may average the results of a good many years. MEDICAL SELECTION LAPSES Ain> SURRENDERS. We ghre bdow wluit may be called Hie ayimge myings rate« from tlie tempofaiy cffeet n o w 5 -1° -on s| . 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The facts and classifications are given immediately in the Journals and Ledgers. » In the Ledger and as far as possible in the Jourdal should be kept separate accounts, pages, columns or divisions with the sub-divisions of premiums, interest, sources of profit and all other classifications named in the Statement. Of course this does not include the modes of payment along the top of the various diagrams. From the Ledger the total columns should be filled in and the analysif as to how payments were made should be taken from the Journals. In filling out the schedule of premiums the amounts paid in divi- dends, commissions, cash, notes and liens and surrender values will be taken from the Premium Journal and the totals from the Ledger and the .sundries column will be used to balance. Similarly with other such sched- ules. Third. Deductions from assets. Here, also, the totals should be first taken from the Ledger. The analysis of tlie payments to Policyholders will be taken from the Insurance Terminated Journal or Ledger. The schedule of premiums and the schedule of payment? to Policy- holders may be checked against each other. Thus, premiums that are paid by dividends in the premium exhibit will also appear in the payments to Policyholders exhibit as dividends used to pay premiums, etc. In the exhibit of payments to Policyholders we note supplementary contracts appear in the schedule to the left and also in the list of how paid at the top of the schedule. This is evidently necessary, as the following instance will show : Suppose the proceeds of a death claim used to purchase a life an- nuity on the beneficiary. It must be entered opposite death claims under suppl^entacy contracts. 96 When now these yearly annuities are paid to the beneficiary in cash they must be entered opposite supplementary contracts and under cash. Fourth. Assets. If to the Ledger assets at the banning of the period we add the ad- ditions and subtract the deductions we should obtain the assets at the end of the period. The easiest way to check the work and to secure a balance is to use the trial balances at the beginning of the period and at the end of the period. At the beginning of the period, which should be the beginning of the year, the trial balance should consist of nothing but assets on the left and liabilities on the right Reserves. Assets at the beginning : - Liabilities. Surplus. Daring the progrew of the business the assets will be increased as follows: Premiums. Interest. Profit on sales and maturities. Profit from changes in book values. ^ Increase in liabilities. During the progress of the business the assets will be diminl i rfwd as follows: Death claims. Matured endowments. Annuities. Dividends. Surrender values. Expenses. Losses on sales and maturities, liosses in book values. Decrease in liabilities. If we take the trial balance at the end of the year and analyse it according to the above aekeme and put in one place the increase in assets and in anoth^ place the decrease in assets and in another the asac^ at Increase in Assets: Dimunition of Assets. the «id of the period and at another the liabilities at the end of liie period and compare the aflsets and liahilitiea at ti^ ead with the aaaeto and lia- bilities at the beginning, we ray eaaity «^e a balance by emnpariaoii with the trial balances a* tiie beginning and at the end. Fifth. Liabilities. Just as the ateets are divided into Ledger assets and Ncm-Ledg» as- sets the Liabilities may conyeniently be diirided'in the same wy. Sixth. Contingency Besocre. The standard pf safety adopted by the Ck>mpany and the amount of Contingency Reserve on account of amets and om acconnt of BMHFtalKy respectively should be given in the Statemoit. ^ Seventh. Fluctuations. The fluctuation rates are necessary for the propar determination of the Contingency Reserve. Eighth. Exhibit of Policies. The exhibit of policies is not strictly necessary for the purposes of Accounting, but of course is of very great intoest and is in fact the baals of the whole business. Ninth. Classification of Assets. This is another way of exhibiting how the a«3ets grow frwn their original state at the beginning to their final state at the end of the period. It is not strictly a part of the Accounting, but is an interesting and nsefol achibit. The foregoing exhibits give the Statement proper of the Company. The Gain and Loss Exhibit exhibits the same facts nnder diff^nt ar- i-angements and in different lights. GAm AND LOSS EXHIBIT. First. Expenses. The Gain or Loss from ^qttfises is the gain or loss from the loading. The loadings are intended to pay expenses. In the StateBMmt the loadings are included in the premium receipts on the credit side. In the Statmait the expenses of Premium Collection and expenses of Q^ieral Administration appear on the debit side. The difiference be- tween the loadings and these expenses constitutes the aggr^ate dividend from the Expense Account But this aggregate expense saving is in itself of little value. The in- dividual expense ratios are the things that are of importance. The Oain and Loss Exhibit should show as is indicated the commis- sion rates on first and renewal prmiums and the ad valorem percentage charge per premium for the general expenses of pr^inm collection and and also the g^^ral administration ratio for expenses of General Admin- istration. It will be remembered that only future net or pure uncollected and deferred premiums are admitted Assets (the Legal Reserve liability in foct assuming that these premiums have been paid). But unpaid loadings are not admitted assets, nw are expaises paid in advance. Second. Interest The intmst payments induding r^ts and profits appear in the Btatement on the credit sidci, Apparently in the Statement there is no corresponding charge against the intent by which the profit and loss is to be asc^tained. But the intmst charge is merged in and disguised in the Legal Re- serve liability. The Legal Reserve liability is in ftict a charge covering ex- pected interest and e^qvected mortality. Thus, the real basis of profit or loss is the actual interest earned com- pared with the interest charged in the Legal Besme. Thus, tiie diffof^ce betwe^ the net interest actually earned hy the Company and the interest required to maintain the Reserve constitutes the aggr^ate profit or loss from interest This aggr^te interest profit or loss must be individnaliaed and ap- portioned to the individual policyholders as a basis of Dividend calcula- tions. The obvious method is to average tlie n^ interest earnings o?er a suffici^t number of years to obtain uniformity. The diif^^ce between Ihe rate allowed, for the year and the rate to maintain the Beser?e is the pniftt or loss rate, which multiplied by the Policyholder's Reserve gives his profit or loss. Third. Mortaliiy Account In the Statement the actual death losses, matured endowments, an- nuity payments, etc., appear on the debit side. As in the case of int^^st, so in the case of mortality, theate is appar- ently no corresponding charge on the liabilily side by comparison with which to determine gain or loss. n But as in the case of interest, so in the ease of mortality, this liabil- ity is merged in and disguised in the JjtgBl Ses^ve liability. The Legal Reserve liability includes liabUity fbr expected mortality according to the table. Thus, the difference between the actual and expected net mortality losses constitutes the aggregate savings frwn mortality. These must be individualiaed for different policy years and if we wish, for different ages and kinds of insurance as a basis for Ditideod calculations. Fourth. Surrender Account. In the Statement will be shown on the debit side the »urrwider val- ues allowed to Policyholders who lapse or surrender. Just as in the case of interest and mortality, so in the case of sur- render values, the corresponding liability with which actual surrender pay ments are to be compared is merged in and disguised in the Legal Be- sen e. The Company is charged the amount of the Legal Reserve and settles this liability for, in most cases, a smaller surrender value. Thus, the aifterence between the Keserve liabilities and the surrender values gives the gain or loss from surrenders. We need also to individualize these savings to show how much is as- signable to policies in the first, second and third policy years, etc., and if we wish for different ages and kinds of policies as a basis of Dividend calculations. 100 CHAPTER VI. EXAMINATIONS AND VALUATIONS. Examinations and Valuations should be looked upon as part of the Accounting of the Company to the Stockholders and Policyholders and should have two objects : 1st. Solvency, to see whether the Company can carry out its con- tracts at all. 2d. Dividends, to see what profits have arisen or are likely to ari.se. NET VALUATIONS AND LEGAL RESERVES. There are two ways in which the Legal Reserve Net Valuation laws may be looked upon : Ist As a substitute for all Life Insurance Accounting. 2d. As conditions with which Life Insurance Accounting must con- form. The marked tendency has been to look upon the Legal Reserve Net Valuation laws as substitutes for all Life Insurance Accounting. In our opinion incalculable injury has been done the cause of Insu- rance by what seems to us this false construction of the Legal Re.serve laws. Let us see exactly what Net Valuation is; what it covers and what it does not cover. The typical statute passed by nearly all the, states establishing the Legal Reserve is about as follows : "The net value of a policy at any time shall be taken to be the single net premium which will at that time effect the insurance, less the value at that time of the future net premiums called for by the table of mortal- ity and rate of interest designated." Here the policy discounted by mortality and interest is charged as a liability against the Company. Here also the Company is credited the present value of future net premiums. This in effect allows future net premiums as admitted assets. 101 But the loading on the premiums, whieh OH the ayerage is about 25 per cent, is not included in Net Valuations. Thus, though the Company is charged substantially the full valne of the policy it is allowed credit for only about 75 per cent of the premiums. As Net Valuation takes no account of future loadings, so of necessity it takes no account of those liabilities that are expected to be paid out of future loadings and this is the vital defect in Net Valuations considered i's a substitute for all Accounting. It leaves out a large part of the as- sets and a large part of the liabilities. It is thus only about one-half the Accounting. Let us note some of the things omitted. A Company grants a large territory to a General Agent. The Agent bpends large sums or money developing the territory and establishing an Agency Force. This benefits the Company as much as if the Company had spent the money itself. In return the (^)mpany grants renewal com- missions on future premiums. Under the present Net Valuation system none of these things enter into the Accounting or into the Statement of the Company, although materially affecting future dividends. Again, in return for services rendered a Company grants special or board "contracts creating future contingent charges agaiu.^t the future business of the Company. These contracts materially affect future divi- d^ds and yet none of these transactions appear in the Company's Ac- eoonting or in the Company's Statements. Again, a financing Company advances money to put a young Com- pany on its feet, and takes in effect liens on future loadings. These liens, of course, diminish future dividends, but these transactions do not appear in the Accounting or in the Statements. These and other similar omissions necessarily follow from the Net Valuation plan, for if the assets out of which all these things are ex- pected to be paid are omitted, to-wit : future loadings, of course the lia- bilities themselves must be omitted. The Net Valuation plan does not pro- pose to take account either of the^^ie assets or liabilities. Again, in passing judgment upon the expenses, interest, mortality and snrrender values erf a Company, Accounting requires that we take accoimt of the age^ rise and rate of growth of the Company, for under equally good manacoiient these vary greatly with the age, size and rate of 102 erowth of the Company. The expose ratios diminish as the Company increases in size. The following table shows the average graduated expense ratios of Ckwapaniwi of different riies; AVERAGE GRADUATED EXPENSE RATES OF LIFE INSUR- MMOm CXnCPANIES CLASSIFIED BY SIZES OF THE COMPANIES. Size of Gompaiiy First Years Commissions General Premium Chnrg" Administration Ratio per $1000 Insurance Pins 25 MilUon 60 .150 2.53 60 50 .135 B.4S 7» 50 .lae 8.84 100 60 . 120 2.26 200 60 .103 2.06 300 " 50 .090 1.91 400 «• 50 .080 1.88 600 60 .072 1 75 600 60 .066 1.70 700 " 60 .063 1.65 800 ** 50 .088 1.60 900 60 .061 1.65 One BUlion 50 .060 1.50 By the use of the above tahle and by the method oi dividaid calcnlatioiis we can eamij ealenlate how much an iuaeam in the siie ^ the Company will or oiif^t in the fature to diminic^ exp&mut latios and increase the fatme dividends of the diffmit WHeyhM&m in tiie Com- pai^. We can thus easily calculate how much each PolicyhcMer can affoid to pay for new bnsiness. It is s^-evident that the Policy h<^dm camiot afftn^ to pay much, for th^ will not be in the Gompany long raongh for the dimlniafaed expense ratios materially to affect thdr dividesds. 'Hie ymng PoU47* holdm can afford to pay more, hot not more than tlieir foture diridoida will be thereby increased. Simila^, correct Aceonntii^ must take notice of the diliefiraee in the aggregate mortality rate of the young and did Gcnnpanies and the difference in sorr^dear values and lapses. lot None of these things appear in Net Legal Reserve Valuations. We should construe the Legal Reserve Net Valuation laws as conditions to which Accounting should conform and not as substitutes for Accounting. There is only one way to value all these elements and that is to in- troduce them into the dividend calculations and actually to calculate divi- dends by the l^al method for all future years and see what dividends the CompoB^ will actually earn iuihe future subject to all these conditions. Suppose tbtfe wm so Legal Beaeare Net Valuation laws. How would we fgamlae a Company and determine its solvency and probable ftitnre diTidoids? Tbe Ckmipa^y's comfracts are fotnn^ contingent and executory. Tbe bfonness depeads upon armges and thoK ayen^es are liable to fluctua- tion. lHri||Mfl|^ the Cknnpany may be eertaiidy able to cany out its con- tracts 4|^^^PMfore, proride f<»r three things: 1st f^Hmpany must maintain a fund which improved at the in- terest rate aciua]]|y ^ntka^ leallaed by the Omipany will along with future pore (net) praninms pi^ off all daims as th^ mature, according to the daath rate actually \iissst% realised by the Company. fWs is the Natural Fudky Beserve iridch flie Company should maintain. 2d. The Company must maintain a Contingency Beserve snfflcieiit ^o meet unlooked for future contingencies. 3d. Outside the Policy Beserve and the Contingency Beserve the Com- pany most provide for ezpmses to keq> Itsdf going while it is executing the contracts. If there are Legal Beserve Net Valuation laws the Company should In calculating its Beswes substitute the mortalHy and interest rates des* ignated by law in place of its own and thus maintain the Legal Policy Beserve in place of the Natural Policy Beserve. This is the only eflfeet the Legal Beserve Net Valuation laws ought to have on Accounting. Correct Accounting demands that these three things should be kept distinct and should not usurp each others' functions, but this rule is vio- lated in the methods of Accounting generally adopted. 104 Deferred dividends have been wrongfully allowed to usurp the func- tions of the Contingency Reserve. This is bad Accounting. Deferred dividends should be looked upon as dividends that have been paid to the Policyholders and by the Policyholders returned to the Com- pany and deposited with the Company as special funds. Deferred divi- dends are thus in marked contrast to and have no connection whatever with the Contingency Reserve. In another way dividends are wrongfully confused with the Contin- gency Reserve. If dividends are large the Company is tempted to allow the Contingency Reserve to become too small, expecting to replenish the (jontingency Reserve out of future dividends because it is so easy to do it. This is bad Accounting, for it throws on future Policyholders the charges that ought to fall on present Policyholders, and destroys the l^al pro- I»ortion between dividends. Again, deferred dividends have been wrongfully used to pay first year's expenses and to put up the Reserves of the young Policyholders. This is illegitimate and bad Accounting. In Non-Participating insurance savings from interest and mortality usurp the function of the expense loading. On the other hand, in Industrial insurance the defective Policy Re- serve is often supplemented by excessive loadings. All the above ways of confusing the functions of the Policy Reserve, Contingency Reserve and loading either destroy the correct proportions between dividends or produce inequities in Non-Participating premium rates. Correct Accounting requires that the Policy Reserve, the Contingency Reserve and the Loading be kept perfectly distinct. No matter how large the dividends, the Contingency Beserve should be maintained intact to its full standard, for all the savings, no matter how great, should be at once paid or credited as dividends to the particular individuals or classes and not wro^^fuUy ccMiverted into a Contingency Bes«ve. ofmsawb sTATsmr for PosFomi of valvatiov. We give here the general Omdaised fi»m of Statement for purposes of Bifidend calculations and Valuations. 105 Tlw Accountant should calculate and dyetenoine the f oUowing : 1st. The assets. 2d. The mean fluctuation rate m market value of the assets. 3d. Mean rate of interest. 4th. MesB fluctuation rate in interest rate. 5th. Actual nottaUty at diffar^t ages, pcAi^ years mad dasses of fiolicies. 6th. Policy Reserves. 7th. Liabilities certain and eontiiigeiit. 8th. The Contingency Reserve. 9th. The Divisilde surplus. l#th. CkMPBiisMOB rates cm first prpmiuina 11th. General premium exp&ue charge. 12th. The Oeoeral Administration ratio. Idth. The per cent ssvhigs in intdrest. 14th. The per coit of actual to expected oMxrtaUty at d^Eer^ ages, poIk7 yean and kinds ating or Non-Participating, by the Legal method of Dividend calculations. P»ut in a stock Comi)any the interest on Stock should go to the Stockholders, for the Stock was not ctmtributed by Policyholders. Also, the Dividends on Non-Participating insurance should go to the Stockholders. The above adjustments put the Policyholders in a Stock Company exactly where they would be in a Mutual (^ompany. The above assumes that the Stockholder's part and tlie Policyholder's part of the Contingency Reserve pay losses proportionally, but this nmy not be the practice of the Company or the agreement with the Policy- holders. The agreement may be that the Stock must be consumed before the Policyholder's part of the Contingency Reserve is resorted to. If so, the risk to which tlie Stock is exposed is the probability of its being consumed by fluctuations. This risk is calculated exactly like the Contingency Re- serve itself and for this risk the stockholder should be paid what the risk is worth. On the other hand, the agreement may be that the Policyholder's por- tion of the Contingency Reserve must be exhausted b^ore the Stock is resorted to. If so, the risk on the Stockholders is very much less. The risk is the probability of the Stock being consumed after the balance of the Contingency Reserve is consumed, and for this* small risk the Stock- holder should be paid what it is worth. Thus, there are three cases. 1st. Where the Stock and the other part of the Contingency Reserve share losses proportionally. • 2d. Whm the loss falls first on the Stock. 3d. Where the loss fidls last on the Stock. These three cases are very different. The foregoing is the theoretical, as weU as the practical, adjustment of the lelation of the Stock to Participating and Non-Participating in- sorance. The above adjustment fully answers Oie questions whether a Stock Company should write Participating business, or Participatmg and Non- Participating at the same time. Science confirms the dictates of conunon sense that theie is no reason whatever why these should not be united, provided the Legal rights of til «ic]i are protected. Tlie Compai^y the Nan-Participating Policsrholders and the Participating Policyholdm are all benefited the combination and none of th«n hnrt in any way, bat each strengthens the other, pro- Tided always that the L^;al method of Diridend calculations and of ad- justments are strictly followed. May a Mntnal Life Insnrance Ck>mpany write both Participating and Non-Participating business? This is purely a legal question and depends upon the ctmstruction jNit upon the charter. The charter will be construed under the general corporation laws of the state in which the charts was issued. These general corporation laws differ in the dHE^eiit states. The charter will, of course, also be construed by its own wording. Thus, it is probably impossibile to lay down aiiy general law whether or not a Mutual Company may legally issue Non-Participating businesiL Each case will stand on its own footing. Should a Mutual Company write both Participating and Non-Partic- ipating. business, if authorised 1^ its charter? This question is already sullleientiy answered above. If the legal methods of adjusting rights, calculating premiums and calculating divi- dends are adopted, every conmdoration is in favor of the Mutual Company writing both Participating and Non-Participating business. Each class strengthens the oth» and diminishes expouies. SAVINGS. The Legal method of dividend calculations not only determines whether a Company is solvent or insolvent in the widest sense, and not only adjusts the equities as between the various parties interested in the business, but also determines the amount of savings apportionable to each party. If the Policyholder is satisfied that the Company is solvent and treating all Policyholders fairlj', the final test of the Company for his purposes is the net cost to him of a given policy in the Company. This is the final step in the Valuation of the Company from the Policyholder's side. This final step consists in ascertaining the present value (taking everything into account) of all future legal dividends as determined by the Company's present condensed ratios. 112 v.- 5^% !. r. - ♦ . I, I ] • V*. -1» ' I I COLUMBIA UNIVERSITY LIBRARIES This book is duo on the date indicated below, or at the caipinitiaB of a drtnite pwlod after tiM date of borrowing, as provided by the Kbraij ,11 ji' • '■*>. '"^ .i# \fc •* 0 I- *l If)* I C2a(s>sa)fooM BATE DUE OATK BOMtOWBD DATK DUB ^ r J - ' ' ' * 'it ' . 4'^ COLUMBIA UNIVERSITY Ll^^^ I n Life insurance accounting I./ ■ •1. ' .4'*' ft f i A,- i 1 •' ■ JFjr "5"- ■»