Sec. 15. Rhythmic changes in weather and in crops. A psychological movement, once started, accumulates force and momentum up to a certain point where a reaction begins. This rhythmic movement as it appears in the capitalization of enterprises is favored and magnified, we have seen, by the wide use of credit and by the constantly changing technical and physical conditions of industry. These call for constant revaluations of the sources of incomes, thus destroying customary and habitual valuations. But why should the cycle begin or end at one point of time rather than at another; and what determines the length of the cycle? Some of the new dynamic forces such as inventions and growth of population are distributed pretty regularly along the line, so that their influences are nearly equalized. But occasionally some large impulse may serve to start a swing and if this impulse is somewhat regularly repeated, it may serve to keep up the rhythmic motion. True, the lack of coincidence in the impact of various influences which occur accidentally, such as political changes, wars, and the rapid opening of new routes of transportation, would serve to hasten or to retard, perhaps for a time quite to alter, what would otherwise be the rhythm of the cycle. That there is nevertheless, a noticeable degree of regularity in the recurrence of crises may be due to the presence of one dominating factor.

Alternation of good and poor harvests has always seemed to be favorable to business prosperity. In America since about 1865, farm products have constituted the larger part of our exports, so that a succession of large harvests has usually acted to stimulate exports (one of the features of a period of prosperity), to give us a larger credit balance in international trade, and to reduce the rate of exchange. Large harvests of the staple agricultural crops in America have been known to be closely related to the amount of rainfall in the three most important growing months. Recently, it has been shown that the rainfall of the Ohio Valley occurs in cycles of about eight years, and in a larger cycle of thirty-three years. The cycle of yield per acre of the nine principal crops is shown to correspond closely with the cycle of pig iron production (one of the best single indices of growing business) dated one to two years later.[14] As the cycles of rainfall and of harvests are not coincident in different countries, it will require further study to adjust to these observations the fact of the world-wide extent of the great financial crises. But a better understanding of objective conditions of this kind will give fuller meaning to the psychological interpretation of crises.

Sec. 16. Remedies for crises. The financial crisis must be looked upon as an economic disease which brings many evils in its train. The need is not merely to mitigate the severity of the brief period of crisis, but also to smooth out the curve of the business cycle so as to reduce periodic unemployment, the lottery element in profits, and the number of unmerited failures in business. Several measures may aid toward this end. In the past the crisis has been more severe in America than in Europe because of certain well-recognized defects which now have been largely remedied in the Federal Reserve Act.[15] The provisions whereby any one may get credit on good commercial assets should make it impossible for a crisis to degenerate into a panic. This legislation has provided springs to reduce the jolt of the change from a higher to a lower level of prices.

Probably other improvements may be made in our banking laws. Competent students of the subject have urged that the payment of interest on deposits not subject to notice before withdrawal should be made unlawful, because demand deposits constitute the greatest danger at critical times. In principle this objection is sound, tho experience may show that this evil has been practically remedied by other features of the Federal Reserve Act. Moreover, bankers could, by pursuing a more conservative policy, discourage speculative methods of enterprise. The strong public disapproval of stock-market speculation on margins may some day be able to express itself effectively in ways that will not injure healthy business. Greater stability in our tariff policy would remove a constantly disturbing factor in prices, as would likewise the stabilizing of the standard of deferred payments. In the attempt to remedy the great evil of unemployment, public works of every kind might be planned and distributed in time so as to better equalize the demand for labor and materials. Finally, much better commercial statistics are needed, and for collecting them and reporting the outlook, government organization is required comparable in range and methods to the weather bureau.

It cannot be expected, however, that financial crises, in the sense of general readjustments of prices downward from time to time, ever can be completely abolished. There will always be changes in general industrial conditions calling for reevaluation of the existing sources of income; and in this process there will always be a tendency to rhythmic swing like that of a river, which carries the stream of prices now on this side of the valley, now on that. But this fluctuation of general prices surely can be so greatly moderated in magnitude and in evil results as to make the word "crisis" almost a misnomer. It is toward the attainment of this irreducible minimum of uncertainty and disaster in business that efforts should be directed.

[Footnote 1: On the way these affect private profits see Vol. I, pp. 340, 341 (and references there given in note), 348 ff. and 361 ff. There are thus good reasons for discussing crises in connection with profits, as well as with money and banking.]

[Footnote 2: See Vol. I, pp. 51, 154, 300-302.]

[Footnote 3: See below, ch. 15, sec. 5, on the tariff legislation at this time.]

[Footnote 4: See ch. 8, sec. 1.]

[Footnote 5: See ch. 6, sec 5.]

[Footnote 6: See diagram of business failures 1890-1914, in Vol. I p. 364.]

[Footnote 7: In the first annual report of the United States Commissioner of Labor is given a long catalog of theories that have been suggested, many of them quite fantastic.]

[Footnote 8: See Vol. I, ch. 38, on Abstinence and Production. Believers in the glut theory usually condemn efforts to encourage frugality among the masses, calling it the "fallacy of saving."]

[Footnote 9: See Vol. I, ch. 37, secs, 6 and 9.]

[Footnote 10: See e.g., Vol. I, pp. 271. 335, 365 367.]

[Footnote 11: See Vol. I, p. 304.]

[Footnote 12: See above, ch. 6, on the standard of deferred payments.]

[Footnote 13: See note on tariff legislation and business crises, end of ch. 15.]

[Footnote 14: In both cases there is what is called in statistics a high degree of correlation (viz., .719 and .800), indicating that there is that percentage of probability that there is some causal relation between the two sets of figures.]

[Footnote 15: See above, ch. 9, secs. 5, 6, 8.]



CHAPTER 11

INSTITUTIONS FOR SAVING AND INVESTMENT

Sec. 1. The nature of saving. Sec. 2. Economic limit of saving. Sec. 3. Commercial bank deposits of an investment nature. Sec. 4. Investment banking. Sec. 5. Savings banks in the United States. Sec. 6. Typical mutual savings banks. Sec. 7. Postal savings plan. Sec. 8. Advantages of the postal savings plan. Sec. 9. Collection of savings and education in thrift. Sec. 10. Building and loan associations. Sec. 11. The main features. Sec. 12. The continuous plan. Sec. 13. The distribution of earnings. Sec. 14. Possible developments of savings institutions.

Sec. 1. The nature of saving. The motives actuating the different classes of lenders may, for our present purpose, be reduced to two: to postpone the consumption of income, and to obtain a net income from wealth (or investment). Saving always is relative to a particular period and is for more or less distant ends. The child saves its pennies to go to the circus next week, the working girl saves her dimes for a new hat next spring, the earnest high school pupil saves to go to college next year, and the provident man saves for his family's future needs and for his own old age. But always, to constitute saving, there must be for the time a net result: the excess of income over consumptive outgo in that period. This is easily distinguishable from various forms of pseudo-saving of which many persons that are really spending all their incomes are very proud. Such forms are: planning to buy a particular thing and then deciding not to do so, but buying something else; finding the price less than was expected, and thereupon using this so-called saving for another purpose; spending less than some one else for a particular purpose, such as food, but off-setting this by larger outlay for another purpose, such as clothing; spending all one's own income but less than some one else with a larger income. We may define saving as the conversion, into expenditure for consumptive use, of less than one's net income within a given income period.

Saving goes on in a natural economy both by accumulation of indirect agents and by elaboration so as to improve their quality.[1] It goes on to-day by the replacement of perishable by durative agents, as in replacing a wooden house by one of stone or concrete, and by producing wealth without consuming it, as in increasing the number of cattle on one's farm. But saving has come to be increasingly made in the form of money (or of monetary funds), and in this chapter we shall consider some of the ways in which this can now be done.

Sec. 2. Economic limit of saving. There is an economic limit to saving, as judged from the standpoint of each individual.[2] The ultimate purpose of every act of saving is the provision of future incomes, either as total sums to be used later or as new (net) incomes to be received at successive periods. The economic limit of saving in each case is dependent upon the person's present needs in relation to present income and conditions, as compared with the prospect of his future needs in relation to his future income and conditions. Each free economic subject must form a judgment and make his choice as best he can and in the light of experience. There is no absolute and infallible standard of judgment that can be applied by outsiders to each case. Yet there is occasion to deplore the improvidence that is fostered and that prevails, especially among those receiving their incomes in the form of wage or salary. Considered with reference to the possible maximum of welfare of the individuals themselves, the apportionment of their incomes in time is frequently woful. It is uneconomic for families of small income to save through buying less food than is needed to keep them in health; but it is likewise uneconomic to spend the income, when work is plentiful and wages good, for expensive foods having little nutriment and then, for lack of savings, to go badly underfed when work is slack and wages are small. There is for each class of circumstances a golden mean of saving. The saving habit may develop to irrational excess and become miserliness, but this happens rarely compared with the many cases where men in the period of their largest earnings spend up to the limit on a gay life and make no provision for any of the mischances of life—business reverses, loss of employment, accidents, temporary sickness, permanent invalidity, or unprovided old age. Despite the development of late of new agencies and opportunities for saving there is need of doing more toward popular education in thrift.[3]

Sec. 3. Commercial bank deposits of an investment nature. If a commercial bank pays no interest on demand deposits there is no motive for the depositor to keep a balance larger than he needs as current purchasing power. When his bank account increases beyond that point, it becomes available for a more or less lasting investment to yield financial income. If the sum is small or if the owner is at all uncertain as to his plans or if he is not in a position to find another attractive form of investment, the offer by the bank of a small rate of interest on special time deposits (2 to 3 per cent is not an unusual rate in such cases) will suffice to cause him to leave such funds in the bank. Since about 1900 the practice has been greatly extended of paying interest even on "current balances" of regular checking accounts (demand deposits). If the new 5 per cent rule[4] as to reserves against time deposits operates to cause commercial banks generally to pay a rate ranging from 2-1/2 to 3-1/2 per cent on time deposits, their amount will doubtless increase greatly. But still, in the future as in the past, those depositors having funds that can be invested for considerable periods will seek a higher rate of interest than can be obtained from commercial banks.

In their loaning function the "commercial" banks (as the adjective indicates) serve mainly the special needs of the commercial elements of the community—business men borrowing for short terms to carry out particular transactions. Loans made on short-time commercial paper (quick assets) are very suitable to the needs of a bank that has its liabilities largely in the form of demand deposits. Time deposits can be more safely loaned on the security of real estate and for longer periods.

Despite their limitations in this respect, the commercial banks must be recognized as of growing importance in the work of encouraging and collecting small savings, which in many cases are better invested in other ways. In 1916, the centenary of the beginning of savings banks in this country, a nation-wide propaganda was undertaken by the American Bankers' Association for the encouragement of savings.

Sec. 4. Investment banking. Enormous amounts of securities issued by governments or by corporations (railroad or industrial) are now on the market and to be bought conveniently by private investors. Through special bond houses some bonds are to be had in denominations as small as $100 and $500. The regular brokers on the stock exchanges buy and sell, for a small commission, the regular bonds and investment stocks. Several large statistical and financial expert agencies[5] in return for an annual subscription, offer advice to investors regarding general market conditions and special securities.

For a large number of investors the personal examination and selection of sound securities is too difficult a task. To serve their needs many bonds and trust companies have of late developed special departments for investment banking. Through these agencies the banks are constantly placing as relatively permanent investments securities which they have bought or have aided "to float" or which they handle only as commission agents. In any case the real investment banker is bringing to his task special training and a high sense of his professional obligations, and is employing the services of statisticians, financial experts, and of practical engineers to determine exactly the fundamental conditions of each investment. Investment banking promises to increase steadily in amount and importance.

Sec. 5. Savings banks in the United States. For the increasing number of wage-earners, salaried employees, and persons following professions, investment as active capitalists is impossible.[6] Their savings must take the form of passive investments. But there are few good opportunities for lending money in small amounts, without great risk, and the requirement of skill, time, and labor to look after the loans and to collect the interest is prohibitive to a small lender. To provide a place where small sums could be kept with safety and so as to yield a moderate rate of income, the first modern savings bank in the United States was instituted in New York in 1816 after a plan already developed in England.

In form these banks are mutual, having no capital stock on which dividends are to be paid. The boards of trustees are self-perpetuating and receive only fees for attending meetings. In their legal aspect these banks have a philanthropic character. Their investments are limited by law to specified, conservative classes of securities and loans on real estate. The total increase from investments is, after paying the expenses of operation and setting aside a surplus, distributable to the depositors at regular periods. In the United States the number of such institutions reported in 1914 was 2100.[7] They have over 11,000,000 depositors, deposits to the amount of $5,000,000,000, an average deposit of $444 per depositor, or of $50 per capita of the whole population. These figures are very unequally distributed geographically, the divisions ranking as to total deposits in the following order: the Eastern Middle, New England, Middle Western, Pacific, Southern, and Western divisions. The first two of these groups of states have about 75 per cent of all the deposits, the Southern states hardly 2 per cent, and the Western (North Dakota to Oklahoma) only 1/4 of 1 per cent.

Sec. 6. Typical mutual savings banks. About one third of these banks are on the mutual plan, having no capital stock (most of them in the East) and these contain about four fifths of all the deposits. The stock savings banks have individual deposits of over a billion dollars, and have outstanding capital stock to the amount of about $90,000,000 (about 9 per cent of their deposits). These stock savings banks to a much greater extent than do the mutual banks transact also a commercial business.

The banks on the mutual plan are therefore the most important, the typical savings banks. The average rate of interest they paid to depositors in 1914 was 3.86 per cent. About one half of their resources are invested in loans, mostly to small borrowers on the security of real estate, and most of the remainder consists of bonds and other securities of the safer kinds.

Savings banks are subject to the supervision and inspection of the banking departments in the several states, a fact that exerts a salutary effect though not insuring absolutely against either mistaken judgment or dishonesty on the part of the bank officials.[8]

Savings banks seek to keep invested as large a part as possible of their assets, keeping only in ready cash enough to meet a possible temporary excess of withdrawals over deposits. In contrast with the policy of commercial banks with their demand deposits, the sound policy for savings banks is to reserve the right to require notice of intention to withdraw. The period of such notice varies from a minimum of ten days to a maximum of about sixty days. In ordinary circumstances it is not needful or usual for a bank to exercise this right, but it is a needful safeguard in times of commercial crises. This requirement of notice is greatly to the advantage of depositors collectively and thus of the community as a whole. It is not an undue limitation of the rights of the individual depositor. It is unfair for the individual, in a period of financial stress, to seek his own safety in a manner which is impossible for all, and thus to endanger the interests of all.[9]

The mutual savings banks in 1914 had (on the average) but six tenths of a cent of actual cash (and "checks and cash items") in their tills for every dollar of deposits, but in addition they had for every dollar of deposits four cents due on demand from state and national (commercial) banks. In the aggregate these demand deposits amounted to the large sum of $172,000,000, a large part of which bore a low rate of interest.

The depositors in savings banks have a direct legal claim on the bank as a corporation. The bank's only means of payment are its assets, consisting of claims upon the owners of such wealth as houses, factories, railroads, electric light plants, good roads, and school buildings. Thus virtually the depositors have by their savings made possible the building and equipping of these actual forms of wealth, and have an equitable claim upon the usance of them, which claim is met by the payment of interest and dividends to the savings banks. Viewed in this way the great social importance of the savings function appears, and the importance of developing the savings institutions.

Sec. 7. Postal savings plan. In many countries of the world the governments have not only authorized private, corporate, and trustee savings banks, but have provided public agencies where it is possible for the citizens to deposit small amounts. Thus municipal, and what are called communal, savings banks are operated by many European cities; but the most effective and widely used agencies for the purpose are the national post-offices. Postal savings banks, or postal savings systems as divisions of the postal service, are now found in all the larger countries of the world, and in many smaller ones. The United States of America was almost the last civilized country to establish such a system, which was authorized by act of Congress in 1910, and went into operation in a few designated cities in January, 1911. The number of offices at which it was in operation was rapidly increased, and the number in 1914 was about 10,000.

Any one ten years of age may become a depositor. Deposit must be made always in multiples of one dollar. Not more than $100 will be accepted for deposit in any one calendar month, and nothing after the total balance to the depositor's credit is as much as $1000, exclusive of accumulated interest. However, amounts less than one dollar may be saved for deposit by purchasing a ten-cent postal savings card and affixing ten-cent postal savings stamps until the nine blank spaces are filled. Such a filled card will be accepted as a deposit of one dollar either in opening an account or in adding to an existing account.

Deposits are not entered in a depositor's book, as is the usual practice of savings banks, but are evidenced by certificates issued in fixed denominations of $1, $2, $5, $10, $20, $50, and $100. These bear interest, from the first day of the month next following that in which the deposit is made, at the rate of 2 per cent per annum for a whole year (interest is not paid for any fraction of a year). Interest is not compounded, unless the depositor withdraws the interest and redeposits it, but simple interest continues to accrue annually on a certificate so long as it is outstanding, without limitation as to time.

By the end of the first year (1911) of operation the savings system held a balance to the credit of depositors of nearly $11,000,000; in the next year (1912) there was added to this about $17,000,000; in the next year (1913) about $12,000,000; and this average rate of one million dollars a month net addition to deposits has continued to the present (1916). These funds are deposited in banks belonging to the federal reserve system, which must deposit with the Treasurer of the United States designated kinds of bonds (national, state, and municipal) as security and pay interest at the rate of 2-1/2 per cent on the amount of the deposits. The one-half per cent difference between this rate and that paid to individuals goes far toward paying the expense of operating the system.

Provision is made for the issue of postal savings bonds in exchange for certificates issued in sums of $20 or multiples thereof up to $500. These bonds bear interest at the rate of 2-1/2 per cent payable in semi-annual instalments, January 1 and July 1. These bonds are not counted as a part of the $500 maximum of deposits allowed to one person, and there is no limit to the amount of bonds which may be acquired by one depositor. Postal savings bonds are exempt from all kinds of taxes, federal and local. These bonds are issued only on the surrender of postal savings deposits, but may be sold by the owner at any time. Three years after the law went into effect, there were $4,635,820 of postal savings bonds outstanding.

Sec. 8. Advantages of the postal savings plan. As compared with corporate savings banks the postal savings system has certain advantages.

(a) It protects the small depositors from the danger of dishonest private bankers who have preyed upon the immigrants in the larger cities. To foreigners, accustomed to the postal savings plan in their home countries, it is especially useful.

(b) It gives to every depositor the greatest safety possible, as "the faith of the United States is solemnly pledged" for the repayment of depositors.

(c) It brings a savings institution to many a small town and rural place formerly entirely lacking in facilities for small depositors. The benefit of this has not immediately appeared to be great, but may in time prove to be.

(d) It pays interest from the first of the month following the date of deposit whereas the usual practice of savings and commercial banks is to pay only from the beginning of the quarter year or half year.

(e) It provides for the exchange of deposits for bonds bearing a higher rate of interest—a unique feature greatly simplifying for the small saver the process of buying bonds for more lasting investment.

In some respects, however, the postal savings system falls short of the advantages of the regular savings banks. These usually accept for deposit as small an amount as ten cents; they pay interest either quarterly or semi-annually; they pay on the average (at present) almost double the rate of interest, and the interest is credited to the depositor's account at stated intervals and automatically compounded. The postal savings system, as the law now stands, may be looked upon, therefore, as supplementing the regular savings banks rather than competing with them.

Sec. 9. Collection of savings and education in thrift. Small savings have been encouraged in many places by penny provident funds, dime savings banks, and school savings funds, which have been conducted at public schools, social settlements, and factories, by school officers and by charitable and educational societies acting through canvassers. These plans all call for much personal effort and cost, which must be provided by volunteer services and private gifts. These plans being undertaken mainly as a means of education in thrift and in the related moralities, their results are not to be measured merely by the magnitude of the sums collected. They are not rivals of the ordinary savings banks, but rather auxiliary methods of encouraging their use. The funds collected by these agencies are usually deposited in local savings banks, and depositors are encouraged to open individual accounts there, whenever they have considerable sums saved.

In Germany the public schools have been furnished with automatic stamp vending machines, from which savings stamps in as small denominations as ten pfennigs (2-1/2 cents) may be had by dropping a coin into a slot.[10] This method could be used very effectively in connection either with the postal savings system or with a local savings bank. It ought to be made easy to deposit funds at every school house, at every post-office, at every factory counter on pay day, and wherever people pass in numbers. Allurements to foolish expenditures meet old and young at every turn; to spend the dime is made all too easy, whereas to save it and deposit it in a safe place too often calls for wasteful and discouraging efforts from the person of small means.

Sec. 10. Building and loan associations. Building and loan association is the name applied to a cooeperative organization of persons with the purpose of collecting regularly from members small sums which are loaned to some members for the purpose of building or paying for homes.[11] The first association of this type was organized in Frankford, Pennsylvania, in 1831. It and others of its kind have made Philadelphia notable among all the larger cities as "the city of homes." The number of such associations has almost steadily increased in the United States. Pennsylvania continues to rank first in respect to amount of total assets, with Ohio a close second, and New Jersey third (the ranking first in proportion to population). Associations of this type have been hardly second in importance in America to the savings banks as institutions for savings for persons of moderate means. The number of their members (nearly 3,000,000) is about one-fourth of that of savings bank depositors, and the amount of their assets (1-1/4 billion dollars) is about one-fourth that of the reported savings banks. But their relative influence in educating and encouraging to thrift is doubtless much greater than these figures indicate. There are more than three times as many of them as of reported savings banks, their management is much more democratic than is that of the banks, and many of their members attend and participate in the meetings and understand how they are conducted. Moreover, the savings made through these associations are constantly passing on into the houses that are fully paid for, and which continue to yield their incomes to their owners. Each year these associations collect from their members as dues and in repayment of loans (made to build houses) the sum of over half a billion dollars, which is twice as much as the annual increase in the deposits of the reported savings banks.[12]

Sec. 11. The main features. A building and loan association is organized by a group of persons in a neighborhood, uniting to form a corporation under the laws of the state, every member to subscribe for one or more shares. The officers elected all serve without pay excepting the secretary-treasurer, who receives a small fee for his services. All official meetings are open to all members. The shares vary in denomination from $25 to $200; the larger figure being common under the serial plan and $100 being usual under the continuous (or permanent) plan, described below. Whenever there is a sufficient sum it is loaned to one of the members for the purpose of building a house. The borrower must subscribe for shares to the par value of his loan.

The receipts of the association are of several kinds.

(a) Interest is received from members, usually at the rate of 6 per cent, and from banks at a lower rate on the small working cash balances kept on deposit. Usually the loans made are large enough to cover a large proportion of the cost of the house, but the land on which the house stands must be free from all incumbrance, and its value gives a margin of safety to the association. Then by the method of payment of dues the debt is, from the first month, steadily reduced and the security for the loan therefore grows constantly better.

(b) Premiums are collected in addition, sometimes in the form of a higher rate of interest, but the practice of charging premiums has been mostly abandoned and the total amount of premiums now constitutes less than 1 per cent of all payments from members.

(c) Fines for delinquency also are less commonly imposed now and constitute a small fraction of 1 per cent of total payments.

(d) Deductions are made on account of withdrawal before the maturity of the shares; under these circumstances it is usual to pay a portion but not all of the accumulated profits, sometimes a proportion increasing as the shares approach maturity.

Different plans have been and still are followed in respect to the method of issuing the shares. Under the terminating plan all the shares begin and mature at the same time (for all members that continue to the end). Whereupon the association dissolves or starts anew. The chief difficulty in this plan is that the association has too few funds to loan at the beginning of its career, and a surplus of unloanable funds as it nears the maturity of the series. It is therefore necessary to encourage or to compel the withdrawal of non-borrowing members on the payment of estimated profits to date.

The better to remedy this difficulty the serial plan was devised, by which new series of stock are issued at intervals—yearly, half-yearly, quarterly, and even oftener.

Sec. 12. The continuous plan. A further development is the continuous plan (usually called the permanent or the Dayton plan), by which much greater flexibility is attained in the organization. Shares of stock may be subscribed for at any time, each man's separate subscription of shares being treated as a separate series, and maturing each at its own time. There is thus, after an association has been for some time in operation, a continuous stream of new members (or new subscriptions) flowing into the association, and a continuous outflow of shareholders whose shares have matured. The maturing shares of borrowing members discharge their indebtedness to the association; the maturing shares of non-borrowing members are paid in money, or may (if the association has use for the funds) be left as an interest-bearing loan.

Additional funds are obtained when needed by issuing paid-up stock to non-borrowers. This is convenient at the beginning of an association and when the movement in building is more active than usual. But if an association has funds that cannot be loaned, outstanding paid-up stock may be called in. In practice a large part of the paid-up stock as well as of the running stock is subscribed for and held not by large capitalists but by persons of small means, especially "the more frugal element in the working classes." Non-borrowing members desiring to withdraw may do so at any time under certain conditions; but to safeguard the association, the laws usually require that thirty days' notice of intention to withdraw shall be given, that not more than one half of the funds received in any one month shall be paid on withdrawals, and that withdrawing shareholders shall be paid in the order of the notices of intention to withdraw.

The most intelligent and prudent workers were formerly deterred from subscribing by the fear that sickness, unemployment, or other mishap might make it impossible to keep up regular payments. Now, however, fines for late payment have been almost entirely done away with. On the other hand, extra payments may be made at any time by borrowing members, to hasten the date when their shares mature and their debt be discharged. These privileges are possible because of the method of distributing earnings which will now be described.

Sec. 13. The distribution of earnings. Every six months is ascertained the amount of the gross earnings which, under this plan, consist almost entirely of interest paid on loans. From this amount are deducted expenses (and in some states 5 per cent of the total is placed in a "loss fund" to meet possible losses) and the rest is divided in proportion to the amount standing to the credit of each member, being credited to the account of running stock and paid in cash to holders of paid-up stock.

The payment of dues is correspondingly simple. The dues at twenty-five cents a week amount to $13 a year per share of $100. This is the whole bill; there are no extras. The interest at 6 per cent (the usual rate) is $6, and the rest, $7, is credited upon the stock. Thus at the end of the first six months the member has $3.50 to his credit, and is entitled to his share of the net earnings on that amount. Thus his share of the earnings is steadily increased by compound interest, and if he keeps up his regular payments the shares mature in about sixteen years. This means in most cases that a prudent tenant can become the owner of a house in sixteen years while paying no more than the rent would be. As the active investor he becomes his own rent collector and uses the house with less need of repairs, thus dispensing with services and costs which are included in contractual rents.[13]

These associations are properly made subject to supervision and examination by state officials, in the manner of that exercised over banks. They have been favored by exempting the shares of members and the mortgages held by the associations from all state and municipal taxation. As the houses built or paid for are taxed, this is of course but just, but it is an exception to the rule of the illogical general property tax.[14]

Sec. 14. Possible developments of savings institutions. The social importance of increasing and improving the agencies of savings for the masses is being more fully recognized, but much more might be done in these directions. Some possible changes have been suggested above, and a few words more may be added.

Probably the greatest developments in the near future will be through the savings departments of commercial banks (favored by the reserve rules of the Federal Reserve Act) rather than by the increase in the number of special banks for savings. The initial expense and risk of starting a savings bank is considerable, and outside of cities of some size this is prohibitive. Whereas a savings department, with its funds and reserves separated, can be easily and cheaply operated in connection with a general bank. It is much to be desired, however, that a larger measure of popular cooeperation might be made possible to the depositors, both for its educational value and to reduce the real evil of the autocratic or the plutocratic centralization of the money power in the small communities.

Savings banks usually limit the amount of an account to $3000. It is desirable that depositors should be able easily to convert their savings-bank deposits over certain amounts into good bonds, bearing a higher rate of interest (after the method of the issue of postal savings bonds). There is need of a central market in each community where such bonds can be bought and sold at any time; and the savings banks might easily serve to buy and sell for their customers in this way in the larger bond market. This would be of benefit also to the states and municipalities which issue bonds for such purposes as schools, roads, and public utilities, by creating a more open and regular market to small investors than now is provided for such securities. This might somewhat reduce the rate of interest and there would be a gain divided between taxpayers and lenders.

The general plan and principles of local building and loan associations might well be extended to groups of rural cooeperators, enabling them to make loans to their members; and to groups of small investors, permitting them to hold real estate mortgages and bonds and stocks of corporations, free from taxation other than that paid on the wealth itself. Members of such organizations could get a higher income on their investments than a savings bank could pay, and with greater security than if each attempted to save and invest by himself.[15]

Savings institutions are necessarily also lending institutions. In this chapter they have been looked at mainly from the saver's (the lender's) standpoint, though their service to the borrower is of cooerdinate importance. In the case of building and loan associations this feature is most apparent. Later, the problem of the agricultural borrower will receive further consideration.

[Footnote 1: See Vol. I, chs. 9 and 10.]

[Footnote 2: See Vol. I, pp. 285-290 for the analysis of saving from the individual standpoint; and pp. 482-499 for its relation to general economic conditions.]

[Footnote 3: See Vol. I, p. 484.]

[Footnote 4: See above, ch. 9, sec. 7.]

[Footnote 5: E.g., Babson Statistical Organization, Brookmire Economic Service, Moody Manual Co., Moody Corporation Service.]

[Footnote 6: See Vol. I, p. 318.]

[Footnote 7: Report of the Comptroller of the Currency. Not all of these are mutual. Statistics, moreover, include in some cases (e.g., California) the savings deposits of commercial banks but not the number of such banks, and in other cases (Michigan) some banks that do chiefly a commercial business. The line of demarcation between savings banks and savings departments of commercial banks cannot be sharply drawn. The Comptroller of the Currency reported in 1914 in a different form the amount of savings deposits and of time certificates of deposits in all kinds of banks as the enormous sum of $8,675,000,000.]

[Footnote 8: In the last twenty-three years, on the average, seven savings banks a year have failed, the annual excess of liabilities over assets being about $200,000, or about $30,000 for each failing bank. The total loss has been about 1/5 of 1 per cent of total deposits.]

[Footnote 9: The Federal Reserve Act, by making it possible for loans to be had at any time (through member banks) on good security, should reduce the danger of runs on savings banks.]

[Footnote 10: The author saw in operation a new machine of this kind which had been installed in a German public school as early as 1910.]

[Footnote 11: See Vol. I, pp. 290, 297-298, 484, and 486.]

[Footnote 12: The figures here given and the description of methods apply to the "local" building and loan associations. The success of this kind led to the organization of other associations which took the name "National" building and loan associations, to carry on a business in a larger field. The number of these has always been comparatively small, and their operation is less simple, democratic, and economical than the local associations. They have borne more of the nature of ordinary profit-making enterprises. They should not be confused with the local associations.]

[Footnote 13: On these economies, see Vol. I, p. 298.]

[Footnote 14: See ch. 17, sec. 4.]

[Footnote 15: Since this was written the Federal Rural Credits Act has been passed, embodying the main idea here described.]



CHAPTER 12

PRINCIPLES OF INSURANCE

Sec. 1. Chance, unavoidable and average. Sec. 2. Uneconomic character of gambling. Sec. 3. Borderland of gambling. Sec. 4. Insurance: definition and kinds. Sec. 5. Insurance viewed as a wager. Sec. 6. Insurance as mutual protection. Sec. 7. Conditions of sound insurance. Sec. 8. Purpose of life insurance. Sec. 9. Assessment plan. Sec. 10. The reserve plan. Sec. 11. The mortality table. Sec. 12. The single premium for any term. Sec. 13. Level annual premiums and reserves. Sec. 14. Different features of policies. Sec. 15. Insurance assets and investments as savings. Sec. 16. Excessive costs of insurance operation.

Sec. 1. Chance, unavoidable and average. Every action and every movement in life has in it some element of chance. There are what may be called natural chances, arising from the uncertainties of the seasons, or from rainfall, heat, hail, storm, flood, lightning, or land-slides. Such chances must be taken both by the small enterpriser and by the large. In earlier conditions of society natural chance dominated industry, and it still remains and must always remain important. There is the chance of unexpected political events, such as war, riot, and legislation on money, tariffs, credit, and business relations. These things are caused, it is true, by the action of men, but it is a collective action out of the control of the individual. There is the chance of human carelessness causing fire, explosions, and wrecks on misplaced switches. There is the chance of physical or mental collapse, as the sudden insanity or the sudden death of one performing responsible duties. There is the chance of sickness that often wrecks the plans and the fortunes of a whole family. There is the chance of economic alterations in methods of production and of transportation, in fashions and demand in this direction or for those materials.

Some of these chances are more connected with money-lending, others with manufacturing, some with agriculture, others with commerce; but all are present in some degree in every industry. Some events are unique in nature and seem unlikely ever to occur again; others are of a kind occurring so irregularly that no reasonable prediction can be made as to the time and frequency of their occurrences. Still others occur frequently and to many different persons; but no individual can tell when and how they will occur to him. A general average of chances in different lines of business causes some to be called safe, others extra-hazardous. Chance has its favorable as well as its unfavorable aspects. Chances are averaged and added algebraically to the profit or loss in an industry, for an extra-hazardous enterprise must in general afford a higher average of profit in order to induce men to engage in it. It is folly to take a risk without ascertaining its degree so far as general experience enables one to choose. But inasmuch and in so far as the gains and losses fall unequally upon different individuals, income depends upon chance.

Sec. 2. Uneconomic character of gambling. This prevalence of chance sometimes tempts men to say that business is "a gamble." But a distinction in principle must be made between gambling and legitimate risk-taking. The chances enumerated above are not sought, but avoided as far as possible; yet they must be borne by some one if productive enterprise is to continue, and the burden must somehow be distributed throughout the community. Gambling is, however, a kind of risk-taking which has a very different economic and moral quality. Gambling creates the hazard, making the gain or loss of income depend on an event that is not a necessary part of productive enterprise. Typical gambling is the transfer of wealth on the outcome of events absolutely unpredictable, so far as the two gamblers are concerned. Examples are the shaking of unloaded dice or the honest dealing of a pack of cards, and the betting on prices in so-called "bucket-shops" by persons having no connection with the market of real things, and seeking to get something for nothing as a result of mere chance.

Cheating is not a necessary mark of gambling, altho the cruder forms of dishonesty, such as the loading of dice or the collusion of horse-owners or of horse-jockeys to deceive the betting public, are so common that they seem often to be an essential feature. Gamblers recognize fair as opposed to unfair methods. Fair gambling is a kind of minor morality within the immoral field of gambling, like the honor found among thieves. The chance-taking in gambling has no useful purpose or result outside itself. Betting and gambling do not produce wealth, but merely shift the ownership of existing wealth. The gamblers constitute themselves a little fictitious economic circle, and they transfer gains and losses on the turn of events that have no practical objective result within their circle except to determine the direction of the transfer. Even when fairest, gambling must, in its average results, be uneconomic. In any economic trade each trader gains by getting goods that are, on the marginal principle, to him more valuable than the other kinds of goods he gives up.[1] But in gambling the winner gets all, the loser gets nothing. If two men of like incomes gamble the additional desires that the winner is able to gratify are (by the principle of decreasing gratification) less in amount than the desires which the loser must forego. As a result the loser is often depressed and seriously injured by the loss of his income, the winner makes reckless and extravagant use of his winnings. Easy come, easy go, is the rule of gamblers.

Moreover, gambling reduces the amount of wealth by relaxing the motives of economic activity, diverting energy from productive enterprise, tempting men into dishonesty to offset their losses, and leading them into speculation and embezzlement.

Sec. 3. Borderland of gambling. Ranging between the extremes of unavoidable risk-taking and of gambling are a number of cases of a mixed nature. In nearly all wagers, judgment in some degree influences the choice of sides. One man bets on a horse whose pedigree and performances he knows thoroly; another judges by the horse's appearance as it comes upon the track. The professional bookmakers have the latest possible and most exact information on which to base their bids.

In the bets made on one's own prowess, as on speed in running, the chance-taking is still on the uneconomic side of the borderland, certainly if the running is for the sake of the wager, not for pleasure or for a useful purpose. A premium won by a runner for speed in delivering a message of economic importance presents an essential contrast to the winnings in a wager.

Finally, the very borderland of difficulty is reached in the purchase and sale of goods in the market with a view of profiting by chance changes in price. The purchasing and holding of land, lumber, grain, cattle, and other tangible and useful things, that need to be stored, held for buyers, or taken to market, must be judged liberally. The quality of gambling depends somewhat on the motive as well as on the ability of the trader. The enterpriser dealing with real wealth, and fitted to take the risks both because of his resources and of his exceptional knowledge, needs the motive of gain in such cases, and in a sense can be said to earn socially what he gets. The motive of the uninformed must be a blind trust in luck, and a hope to gain from a rise in prices which they are quite unable to foresee or to explain.

Sec. 4. Insurance: definition and kinds. The large element of luck in industry due to unavoidable chances has something of the same evil character as gambling. It brings unearned prizes to some and to others unmerited losses. It must therefore be a benefit to the community, if this element of unavoidable chance cannot be reduced as a whole, at least to regularize it and make it exactly calculable for any individual. In this way each may be encouraged by the more certain prospect of receiving a reward proportionate to his efforts and abilities. This desirable condition has in many respects been accomplished by means of insurance.

Insurance is the act of providing a guarantee of indemnity against a financial loss that will result if an event of a specified kind occurs. The person seeking some surety against the possible loss is the insured; the person contracting to indemnify against the loss is the insurer; the written contract of insurance is the policy; and the price paid by the insured in fulfillment of his part of the contract is the premium; the amount paid when a loss has been incurred is the indemnity; and the person to whom the indemnity is paid is the beneficiary (who may or may not be the insured).

The insurance with which we are here concerned is that which gives financial indemnity. This is given for loss of expected net income, when by chance either receipts are less or costs are more than average. The two main classes as regards kinds of loss are property insurance and personal insurance. Property insurance is that which indemnifies for loss of one's possession in specified ways, such as by fire, by the elements at sea (marine), by hail, lightning, or cyclone, by death (of valuable animals), by robbery, and by breakage (of window glass). Personal insurance is that which indemnifies the beneficiary for loss of income as the result of various happenings to persons, the chief being death, accident, sickness, invalidity, old age, and unemployment. The principle of insurance is being constantly extended to new subjects[2] and it is capable of further development in a variety of directions.

Sec. 5. Insurance viewed as a wager. Insurance, without question a highly useful thing, appears, paradoxically, to be in its outer form a bet. The large merchant with many vessels used in many kinds of business had in the days before marine insurance an advantage in distributing his losses over a number of voyages. Antonio, the wealthy merchant, is made thus to express his security:

"My ventures are not in one bottom trusted Nor to one place; nor is my whole estate Upon the fortune of the present year. Therefore my merchandise makes me not sad."

In its early form marine insurance was the attempt of smaller ship-owners to distribute their losses (as could the wealthy merchant) over a number of undertakings, lucky and unlucky. It became customary for a ship-owner to bet with a wealthy man that the ship would not return. If it did come back, the owner could afford to pay the bet; if it did not, he won his bet and thus recovered a part of his loss. Gradually there came about a specialization of risk-taking by the men most able to bear it. They could tell by experience about what was the degree of uncertainty, and could lay their wagers accordingly. When several insurers were in the same business, competition forced them to insure the vessel and cargo of the ordinary trader for something near the percentage of risk involved. The insurance thus tended to become a mutual protection to the ship-owners; what had to be paid in premiums to cover risk came to be counted as part of the cost of carrying on that business.

Every legitimate form of insurance exhibits substantially the same characteristics; it reduces loss at the margin where it is felt most keenly. The difference between insurance and gambling, thus, lies primarily in the purpose of insurance, which is not to increase artificially the risk that any individual runs, but to neutralize or offset an already existing chance. The insurance bet is what is called a "hedge." The difference lies further in the collective method of insurance, which combines the chances scattered among a number of persons. Insurance does not increase the total of risks and of losses, but merely combines, averages, and distributes them equally among all the insured. This eliminates the chance element to the individual by converting it into a regular cost.

Sec. 6. Insurance as mutual protection. Modern insurance is conducted either by enterprisers for profit, or by mutual companies; but in any case in large measure the losses in insurance are mutually shared, as the premiums (plus interest earned) equal the total losses plus operating expenses and profit, if any is made. Each insured gets a contract of indemnity for the payment of a sum that will help cover the losses of others. Such an exchange is mutually beneficial. The premium comes from marginal income; the loss if it occurs would fall upon the parts of income having higher value to the insured. The less urgent needs of the present are sacrificed in order to protect the income that gratifies the more urgent needs of the future. In insurance each party gives a smaller value for a greater; each makes a gain. The greater security in business stimulates effort. This effect is quite the opposite of that of gambling.

Sec. 7. Conditions of sound insurance. To be economically sound, insurance must have to do with real productive agents, and with a group of occurrences which, as a whole, are approximately ascertainable in advance—however irregularly they may fall upon individuals. The beneficiary must have an incurable interest in the property or person insured; that is, the beneficiary must actually suffer a loss by the occurrence insured against. Finally, the amount of the indemnity must not be greater than the loss incurred. Some of the greatest difficulties in insurance arise from the absence of these essential conditions. When there is no insurable interest or when the indemnity is greater than the loss that may be incurred, the beneficiary may and sometimes does find it to his interest to bring about the socially injurious event insured against. He artificially increases the loss against which insurance was taken. When the insured sets fire to his own buildings, he makes an illegitimate use of insurance. Constant efforts are made by insurance companies to guard against these "moral risks," the least calculable of any. Merchants whose stocks have been mysteriously burned two or three times find difficulty in getting further insurance. Formerly insurance was not paid in case of death by suicide; but now usually no such limitation is contained in a policy after a period of one or more years. As men rarely plan suicide years in advance, death by one's own hand some years after taking life insurance is regarded as coming under the ordinary rules of chance. Yet it is to be feared that this liberal policy serves as a temptation at times to crime and to self-destruction.

Sec. 8. Purpose of life insurance. Property insurance is mainly an aspect of enterpriser's cost, whereas personal insurance is more closely connected with the object of saving.[3] We shall in the rest of this chapter limit the discussion to the one most important form of personal insurance, that called life insurance (sometimes called survivors' insurance).

Life insurance is that form of insurance in which partial indemnity is provided for survivors against the financial loss incurred by the death of the insured. Usually the insured is the breadwinner of the family and the beneficiary is a member of his family, but in an increasing number of cases the beneficiary is the surviving business partner, a creditor, or a business corporation with an insurable interest in the life of one of its employees.

Life insurance has been much used by persons mainly dependent on labor incomes[4] rather than on incomes from capital, by those receiving salaries, professional fees, and by active business men. It has of late been extended rapidly, as "industrial insurance" to wage earners, in policies never exceeding $1000, but averaging very much less, and often being for no more than enough to pay funeral expenses. The premiums on such policies are usually collected weekly and by agents making personal visits. The cost to the insured is, therefore, necessarily very high in proportion to the amount of insurance.

Sec. 9. Assessment plan. Life insurance plans may be distinguished, with reference to the time and method of collecting the premiums, as assessment and reserve insurance.

In the simple form of assessment insurance originally the losses were paid by contributions taken after the losses occurred, each member paying an equal share without regard to age. In a slightly improved plan the assessments are made at the beginning of the year, based upon the expected mortality for the year. The sum just sufficient for this purpose (omitting expenses) is called the natural premium. The cost of such insurance is closely related to the average age of the members. The rates are very low in a new organization with a membership of young men; but each year the average age, and therefore the mortality of the membership, rises and the annual assessments must be increased. By constant additions of young members, this rise of cost may be retarded. But when these members grow older, a still larger addition of young members is required to keep down the average, and the mathematically inevitable result is an increasing rate of assessment. This keeps young men from entering, and finally results in failure or in some form of "reorganization" that drives out the older members. The assessment plan carries with it the seeds of its own decay.

To meet these difficulties in part, various modifications of the flat-rate assessment plan are employed, such as classification by age at entry, so that each member pays a flat-rate according to age at entry; or large initiation fees at entry which form a temporary "reserve" to offset increasing mortality in late years. Finally, the policies may be issued on the natural premium plan, by which the members of each age class pay exactly what the insurance costs for the year. Under this plan the company will remain solvent, but with this and all the other expedients the surviving members are forced to drop the insurance in later years.

Assessment insurance is sold by business companies organized for profit, by fraternal orders, and by various types of mutual organizations. The business companies have had a dismal history of hardship to surviving members and of eventual failure. They are disappearing under the influence of hostile legislation resulting from a better popular knowledge of insurance principles. The fraternal orders combine insurance with other objects of a benevolent and social character. With good management, a favorable death rate, and very low expenses, some of them have provided protection at very low rates for many years. Others have failed with disappointment and disaster to the older members. Still others are struggling with difficulties that presage dissolution. Many now have some form of reserve accumulations, and some have so improved their methods that they closely resemble reserve companies. The assets of all the assessment companies are now $1.37 per $100 of insurance in force, while the legal reserve companies have $22.66. The assessment companies now get 10 per cent of their total incomes from their funded investments, as against 24 per cent for the old-line companies. Even with the favorable conditions under which the fraternal orders conduct their insurance business they are doomed to failure unless they adopt rates and policies based upon adequate reserve accumulations. Many thousands of present members are paying for insurance at rates which will not suffice to meet the future losses. The assessment plan fails to eliminate the one great risk, that of leaving the survivors without insurance in advancing years.

Sec. 10. # The reserve plan.# The reserve plan, if honestly administered, gives complete protection against the difficulties just indicated. The essential purpose of the reserve plan is to collect during the earlier years of the insurance policy when the mortality is less, a sum larger than is needed to meet the current losses. This sum, the reserve, is kept invested and accumulating an income, sufficient to offset the increase in losses as years advance. In reserve insurance, therefore, the premium never increases from year to year, altho it may be so arranged as to diminish or to cease entirely sometime within the term for which the insurance continues.

The premium must always be fixed in advance. The calculations for determining the premiums on different kinds of insurance policies are many and complex, but all conform to a few general principles. The three factors assumed are an average mortality table, a rate of interest (or yield on investments), and an expense rate in proportion to the premiums or outstanding insurance. Insurance on the reserve plan is often called "scientific insurance" because, upon the basis of these assumptions resulting from experience, it makes exact mathematical calculations of the premiums and reserves needed for insurance of any particular kind in respect to age of insured, number of payments, method of paying the beneficiary, and any other conditions. The premium thus fixed is, however, only a maximum, and usually is reduced as the result of conditions more favorable than those assumed.

Sec. 11. The mortality table. When large numbers of men are taken as a group, a certain proportion of those at each age may be expected to die. A mortality table starts with a group of persons, as 100,000, at a given age, as 10 years, and shows the number who die and the number who survive at each year of age until all are dead. The table most widely used in the United States is the American Experience Table of Mortality, constructed by Sheppard Homans in 1868. The figures of this table, at different years, are given below:

Age Number Living Deaths each year Death rate per 1,000

10 100,000 749 7.49 20 92,637 723 7.80 30 84,441 720 8.43 35 81,822 732 8.95 40 78,106 765 9.79 50 69,804 962 13.78 60 57,917 1,546 26.69 70 38,569 2,391 61.99 80 14,474 2,091 144.47 90 847 385 454.54 95 3 3 1,000.00

The actual number of deaths of any group of insured will not correspond exactly with the figures of any mortality table. But this is not an essential defect of a table so long as the figures of the table are approximately correct and are at least as great in the earlier years as the actual mortality. For any excess of premium thus collected but increases the safety of the insurance and reduces later payments. In fact the mortality in nearly all companies in the United States is much below the figures of the American Experience Table, partly because of the influence of medical selection on the recently insured and partly because of the decided improvement in longevity since the table was constructed.

Sec. 12. The single premium for any term. It is evident that the natural assessment premium payable at the beginning of the year for $1000 of insurance for that year is expressed by the death rate, e.g., at age 35, the payment of $8.95 by each of the 81,822 living at the beginning of the year will provide the $732,000 needed to pay the losses.[5]

In the same manner would be determined the natural assessment premium for each year of insurance. Now, when it is possible to invest the premiums so as to yield a minimum rate of income it is a simple matter to determine the amount of a single premium, at any age, that is adequate to pay for insurance covering any selected number of years (term insurance) up to the entire period of each insured person's life (full life). It is necessary only to apply the formula of present worth and that of compound interest on investments.[6] Thus the expected losses of any year according to the table of mortality, divided by 1 + rate of yield on investments raised to the power of years distant, equals the present worth of insuring the entire group for that year. The sum of the discounted cost of insurance for all the years of the term divided by the number living at the beginning of the period, gives the single premium for each of the insured. Let P be the present worth of all the policies for a group of the same age, p the present worth of one policy, X the total insured at the beginning of the period, f the natural assessment premium this year, or the natural premium required for any year. Then

f f1 f2 fn P = + + + (l + r) (l + r)^2 (l + r)^3 (l + r)^n

P p = X

The payment in advance of the single premium for any selected period provides a reserve fund sufficient, on the assumptions made, to carry all the insurance without further payments. Each year there is added to the fund the income earned on investments, and there is subtracted the amount of the losses for the year, until the death of the last member of the insured group. If the deaths in the earlier years are fewer than were expected in the mortality table, this will be offset eventually by more deaths at the advanced years; but in the meantime a reserve larger than was expected is yielding income, thus providing a larger sum than is needed to pay all the policies at maturity. This surplus might be distributed as so-called "dividends" from time to time to those surviving, or be added pro-rata, at intervals, to the amount of the policies as accumulated dividends.

Sec. 13. Level annual premiums and reserves. It is a matter of no very abstruse mathematics (in principle) to find the equivalent of this single premium in any one of many other forms of premium payment. The processes are mainly but variations of present worth and compound interest calculations. Such calculations, however, lead into many complexities of practical detail difficult to explain in brief compass, and are the special task of the actuary (the mathematical expert dealing with such problems in the insurance business). The most useful actuarial equivalent of the single premium is the level annual premium for any period (term or life). Almost all policies now written have the level annual premium as a feature. The amount of the level annual premiums at first is greater than the losses; this causes for a time the steady accumulation of a reserve which yields income. Then, as the losses grow, they overtake and finally surpass the amount of the annual premiums. Therefore, the total reserve for any group of insured increases year by year to a maximum and then declines until it reaches zero with the payment of the last claim. The individual reserve for each policy not yet matured increases steadily the longer it is in force. The total reserve is essential to the solvency of the company and the payment of all the policies as they fall due. The companies which issue policies on the level premium plan or reserve plan are known as "old line" companies, or as "legal reserve" companies, because the state laws require every company of this type to maintain the reserves calculated on the basis of a certain rate of yield. The growth of the legal reserve companies in recent times constitutes one of the financial marvels of the age.

Sec. 14. Different features of policies. The premiums thus far discussed are "net premiums" estimated as just sufficient to meet the actual payments required by the contracts in the policies. To provide for the expenses of management an addition is made to the net premium called the "loading." The entire premium is called the "gross premium."

Reserve insurance is still carried on by a few stock companies, but of late some stock companies have been transformed into mutual companies, which are the prevailing type. The mutual company legally belongs to the policyholders. The gross premiums in reserve insurance are, for the purpose of safety, fixed at a figure larger than the expected cost of the insurance, and normally the earnings from interest are higher, the mortality is lower, and expenses are less than those on which the calculation of rates is based. From the excess of income resulting, the company sets aside a surplus and then divides the rest among the policyholders. These returns, virtually but the refund of excess premiums, are called "dividends" (a somewhat misleading term, not to be confused with dividends on corporate stock). The policies that receive dividends are called "participating" and are said to participate in the earnings. Formerly the majority of policies paid "deferred" dividends after 5, 10, or 20 years, according to various tontine and semi-tontine plans, the survivors to these periods receiving their dividends plus those of the other policyholders who had died or had withdrawn from the company. This form of payment having been found objectionable, it was made illegal in New York and other states, and in most cases dividends are now paid annually. The stock company, organized for profit, frequently charges lower premiums for "non-participating" policies, and then retains such profits as may result from keeping expenses below receipts.

The most popular policies are term policies (usually for 5, 10, 15, or 20 years); ordinary life policies with annual premiums; limited payment life policies (the policy payable at death, with premiums fully paid up after 10, 15, or 20 years); and endowment policies (the face of the policy payable after 10, 15, or 20 years if the insured is still living). An endowment policy must be understood to be a regular term policy of insurance for the specified number of years, plus a plan of regular annual savings, which at compound interest, accumulate to the face of the policy. Many persons are attracted to endowment insurance by the oft expressed thought that "you don't have to die to beat it." But this is a mistaken thought. For the premium in endowment insurance is much higher than that for life insurance alone during the same period, so that the endowment is merely a pretty convenient but somewhat costly plan of saving, hitched on to an insurance policy, with which "actuarially," it has no essential connection. In "scientific" insurance the insured pays its full actuarial cost for each additional feature of the policy that he buys. The various policies issued by a company are approximately equivalent actuarially, on the basis of the assumptions made, but they are of very different degrees of desirability, in view of the circumstances of the insuring individual. The choice of policies deserves a more careful investigation than it usually received. Moreover, carelessness and ignorance in the choice of a company is responsible for widespread loss and suffering.

Policies differ in respect to the mode of payment. The payment usually takes the form of a lump sum payment at death or at the maturity of the endowment. In recent times there has been a growing use of optional forms of payment which give to the beneficiary annual or monthly installments for a definite number of years or for life.

Sec. 14. Insurance assets and investments as savings. The discussion of savings institutions in the last chapter left unmentioned insurance, which probably is destined to be the most important of all. The assets of life insurance companies in the United States have already attained the enormous sum of $5,000,000,000, a sum equal to the reported savings bank deposits. In the last twenty years life insurance assets have more than doubled in each decade, and are now increasing by about a quarter of a billion dollars every year.[7] These great funds, which in equity nearly all belong to the policyholders, form already approximately one thirtieth of all the private capital of the country. They are invested in many ways, in real estate, in loans secured by mortgages on real estate, in bonds—municipal, railroad, and industrial. The problem of wise legislation for these organizations, of their competent and honest management, and of their relation to the social, business, and political life of the nation, is certain to be of ever-increasing importance. We are hardly more than emerging from the experimental stage of life insurance, hardly more than at the beginning of its development.

The premium in personal insurance (life, accident, sickness, invalidity, old age pensions) is in almost all cases paid out of some current income. The premium paid is just so much subtracted from the amount available for present direct use and applied to the purchase of future incomes for one's self or family. The insurance method differs from the method of depositing savings by its contingent nature, the resulting income of any individual being possibly much greater than the amounts actually saved (e.g., when the insured dies or is injured soon after taking insurance), and possibly less or nothing at all. A very desirable kind of insurance which is yet little developed is that for a term ending with the usual retirement age (say 65 years) combined with an old-age pension for life thereafter.

It is probable that abstinence will more and more express itself not in accumulating large capital sums to provide for one's old age or for survivors, but in providing insurance for survivors, and invalidity and old-age pensions for the insured and others, payable as terminable annuities. In any case the results to be expected in the changing forms and magnitude of private fortunes are certain to be great.

Sec. 15. Excessive costs of insurance operation. So beneficent is insurance that the enormous cost of transacting the business under present methods is much to be regretted. A very large part of the premiums paid by the insured is retained by the companies.[8] In the case of reserve life insurance a considerable part of what is not returned is, however, set aside as reserve virtually held in trust for the policyholders. In the case of the other kinds of insurance, nearly all of the amount not returned is either cost of operation or profits, tho it must be recognized that a part of the cost of some kinds of insurance is for real services, such as inspection and fire prevention. It is remarkable that the percentage returned by the life insurance companies, accumulating, as they do, large reserves in trust for the policyholders, is greater than it is for the other kinds of companies (fire, marine, casualty, surety, liability, accident, and health insurance).

It is a striking evidence of the importance of the marginal principle[9] that insurance at such a cost should still be desired by men. The use of insurance would be much wider and its benefits greater if this "tare and tret" of doing the business could be reduced. It seems a reasonable hope, now that the experimental stages are passed, that this may be done. In the case of all kinds of insurance as yet a large expense for agents has been necessary to educate men to see the value of insurance and to purchase it, as well as for many other competitive expenses. It has been found that much of this expense can be saved by insurance in groups (for all employees in an establishment), by compulsory insurance (as of all working men), and by central state administration serving to regularize and unify the organizations. This important question will be further considered in connection with "social insurance" as a measure to benefit the working classes.

[Footnote 1: See Vol. 1, ch. 5, sec. 7.]

[Footnote 2: The Jeffries-Johnson prize-fight was insured, against rain, for $30,000. Frequently, race-horses, the fingers of pianists, the lives of ball-players, and the throats of singers, are now insured. Summer hotels in England regularly insure for large sums against more than so many days of rain per season.]

[Footnote 3: On the former, see Vol. I, pp. 365 and 374; and on the latter, below, sec. 14.]

[Footnote 4: See Vol. I, labor-incomes, in Index.]

[Footnote 5: There is an appearance of a slight discrepancy due to the omission of fractions of cents. If premiums are collected at the beginning of the year and losses are paid at the end of the year, and if interest can be earned meantime at the rate of 3-1/2 per cent, the natural premium for a one year term policy is about $8.64, that being the present worth of $8.95 due a year hence, interest being 3-1/2 per cent. In these calculations there is no allowance for expenses, the necessary "loading," on which see below, sec. 14.]

[Footnote 6: See Vol. I, p. 279.]

[Footnote 7: The following are the chief statistical facts regarding the life insurance business in the United States, Jan. 1, 1914, showing separately legal reserve and assessment companies, and the total. Number of Policies Insurance Companies in force in force Legal reserve .. 260 38,206,000 $20,256,000,000 Assessment ..... 605 8,789,000 10,023,000,000 Total .......... 865 46,995,000 30,587,000,000 - Premium Total Per cent income income income from premiums Legal reserve .. $715,000,000 $946,000,000 75.6 Assessment ..... 138,000,000 153,000,000 90.2 Total .......... 853,000,000 1,099,000,000 77.6 Payments to Assets Assets for each policyholders 100 insurance in force Legal reserve $470,000,000 $4,659,000,000 $22.66 Assessment .... 106,000,000 195,000,000 1.37 Total ....... 576,000,000 4,854,000,000 15.87 ]

[Footnote 8: In 1913 the total premiums collected by all kinds of insurance companies reported (Statistical Abstract of the U.S., 1914, pp. 549-557) were about $1,512,000,000, and the amount returned to policy holders the same year was $918,000,000, or about 61 per cent of all premiums, the amount not returned ($584,000,000) being 39 per cent.

Premiums received Returned to policyholders Amount Percent

Life insurance reserve companies ..$715,000,000 $470,000,000 67 assessment companies 138,000,000 106,000,000 76 Other kinds ......... 659,000,000 342,000,000 52 ——————- —————- — Total ........... $1,512,000,000 $918,000,000 61 ]

[Footnote 9: See above, secs. 2 and 5.]



PART IV

TARIFF AND TAXATION



CHAPTER 13

INTERNATIONAL TRADE

Sec. 1. Political and trade boundaries. Sec. 2. Benefits of international trade. Sec. 3. Choice of the more advantageous occupations. Sec. 4. Persistence of differences between nations. Sec. 5. Doctrine of comparative advantages. Sec. 6. Equation of international exchange. Sec.7. Balance of merchandise movements. Sec. 8. Cancellation of foreign indebtedness. Sec. 9. Par of exchange. Sec. 10. International monetary balance and price-levels.

Sec. 1. Political and trade boundaries. By international trade is meant, in general, trade between persons resident in different countries; comparatively rare is the case in which one of the two parties to a trade is a whole nation acting through its government as a unit (e.g., in the purchase of munitions of war in neutral countries). Outside of a communistic group such as the family, trade is a necessary accompaniment of division of labor. As territorial division of labor began between neighboring tribes,[1] international trade was the earliest kind of regular interchange of goods. Indeed the very word "market" meant originally the boundary between tribes. Thus, from primitive times when wandering savages gave bits of flint or copper in return for salt or fish, individuals have sought to adjust their goods to their desires through trade with men of other political groups. With the progress of the world in the means of communication and transportation, international trade has widened in extent and grown in volume.

Economic relations never have been coextensive with political relations. The economic groupings of men connected by a network of trades never have and never will correspond very nearly with political groupings of men bound together by common citizenship in particular states. Indeed it is not uncommon for many of the residents in two adjoining states to trade far more with each other than they do with their own fellow citizens. Lawmakers and rulers from the beginnings of formal governments have constantly tried to hinder this kind of trade. They have done this chiefly because of their belief that they could strengthen their states in political and economic ways, and could favor some of their citizens, by confining economic relations within political boundaries—if not exclusively, more closely than when trade was left to take its natural course, guided by individual motives. The regulation of international trade, therefore, has always constituted an economic problem of great importance in the field of political action.

Sec. 2. Benefits of international trade. Now, bearing in mind that international trade is carried on by individual traders in any two countries, we may ask what motive impels men to trade across the political boundaries of a state. The simple answer is that each trader has something to give and desires to get something in return. Each is seeking to get something that has to him a greater value than the thing he gives, and believes he can do this in trade with a foreigner better than by trading at home. In any trade, both parties gain, or think they are gaining.[2] In international trade there is the same chance for mistake as in domestic trade, but no more. In a single transaction in either domestic or foreign trade one party may be cheated, but the continuance of trade relations is dependent upon continued benefits. The once generally accepted maxim that the gain of one in trade is the loss of another is now generally rejected, but often still it is assumed to be true of international trade. The starting point for the consideration of this subject is in this proposition: Foreign trade is carried on by individuals, for individual gain, with the same motives and for the same benefits as are found in other trade.