UNIVERSITY OF ILLINOIS LIBRARY JUN 14 1915 A REPORT ON FIRE INSURANCE RATES ENG LELINGIS BY MAURICE H. ROBINSON, Ph. D. _ PROFESSOR OF INDUSTRY AND TRANSPORTATION ji UNIVERSITY OF ILLINOIS PREPARED FOR THE EFFICIENCY AND ECONOMY COMMITTEE CREATED UNDER THE AUTHORITY OF THE FORTY-EIGHTH GENERAL ASSEMBLY STATE OF ILLINOIS SENATORS WALTER I. MANNY, CHAIRMAN” - MT. STERLING W. DUFF PIERCY - - - - MOUNT VERNON LOGAN HAY - - - - - - SPRINGFIELD CHARLES F. HURBURGH =- - - GALESBURG REPRESENTATIVES CHARLES F. CLYNE, SECRETARY - - AURORA SPEAKER WILLIAM McKINLEY - - CHICAGO JOHN M. RAPP - - - - - FAIRFIELD EDWARD J. SMEJKAL - . - . CHICAGO JOHN A. FAIRLIE, DIREcTOR - ° > URBANA INTRODUCTION During the investigation by the Efficiency and Economy Com- mittee of the administration of the laws for the supervision of cor- porations and business under public regulation, and while considering plans for the organization of the several State offices and commissions dealing with these several matters into a single executive department, there arose the question of the powers that the Commissioner should be clothed with over insurance companies and the further question as to whether the present State laws were adequate. In this general dis- cussion many questions arose, among them the question of fire in- surance rates. Properly to arrive at a just conclusion, the Committee determined to have prepared a general survey of the fire insurance business, including the matter of fire insurance rates. The Committee did not have funds sufficient to make any extended investigation of insurance companies; and it was therefore, suggested that the reports of the various State commissions and commissioners of insurance be used in the preparation of the paper. In accord with this suggestion, the Committee requested Professor Maurice H. Robinson to prepare a short history of fire insurance and also a brief report on fire insur- ance rates. The study made in accordance with this request and the suggestions of the Committee is herewith presented. Therefore, this study of Professor Robinson’s is not an exhaustive original investigation of the subject. As the Committee had sug- gested, he has used the data set forth in the reports made by special commissions and State Insurance Commissioners in other states. While this report was prepared, some months previous to the report of the present Insurance Superintendent of this State, and was founded on the reports as suggested, it is in full accord with the special findings of Superintendent Potts that fire insurance rates in this State are inequitable and excessive; that fire insurance rates are controlled by a combination of insurance companies; and that such rates should in some way be regulated and controlled by the State. On the question of how to deal with insurance companies in the matter of rates there is ample room for a just difference of opinion. It should be noted, however, that the recommendations in the report herewith appended are in direct agreement with the recommendations of the Special Com- mittee of State Insurance Commissioners appointed by the Insurance Commissioners of the United States’ in their annual convention, of which Committee Insurance Commissioner Ekern of Wisconsin was a member. As a result of its investigations, the Committee decided to limit its recommendations to changes in administrative organization under existing laws and not to propose changes in the substantive law. This determination was reached, not only because of the question as to its authority in the latter class of matters, but also because the plans for administrative reorganization involved as much as could be carefully 1004 EFFICIENCY AND ECONOMY COMMITTEE considered in time for the Committee to report to the Forty-ninth Gen- — eral Assembly. The recommendations in this paper were not in all respects concurred in by all the members of the Committee. However, they do meet with the approval of some of the members. This report is printed and submitted for the valuable information it contains on the subject of fire insurance and fire insurance rates. WALTER I. MANNY. A REPORT ON FIRE INSURANCE: RATES IN ILLINOIS. BY PROFESSOR MAURICE H. ROBINSON, UNIVERSITY OF ILLINOIS. HISTORICAL DEVELOPMENT. Fire Insurance as an important factor in business affairs dates from the great fire in London, in 1666, when over eighty-five per cent of the buildings in that city were destroyed. The next year, one Nicholas Barbon opened an office for the purpose of insuring buildings against fire. This venture was so successful that in 1680 the business was enlarged and a partnership formed under the name of “The Fire Office.” In 1681 an attempt was made to establish a department of the city government for the purpose of underwriting risks by the city. This project was abandoned after two years experience. The business steadily grew in importance, and in 1681, the first of the mutual companies was formed and began operations under the name of “The Friendly Society,” an organization which lasted for one hundred years. Thus it will be noticed that within a period of fifteen years, 1666-1681, all the important methods of carrying on fire insurance, viz.—stock, state and mutual were operated in London side by side as a direct result of the greatest conflagration, relatively speaking, which history records. For the first one hundred years after the great fire, the growth of fire insurance was slow. Beginning about 1800, the busi- ness of insuring buildings against the ravages of fire began to develop more rapidly and during the last seventy-five years the growth has been both extensive and intensive, until at the present time every civ- ilized country has a fairly well developed fire insurance system cover- ing a large proportion of the fire risks. It is not possible to determine the exact amount of insurance in force in the United States at the present time. This results from two conditions: (1) Only a part of the insurance actually carried is reported to the various: state insurance departments,’ and (2) there is nO Organization that makes it a business to collect and publish all the insurance actually in force in the several states. It is, however, possible to reach an approximation that is fairly accurate. Each state published the total amount of the insurance car- ried by the several companies authorized to operate within its jurisdic- tion. . All of the more important companies operate in the larger states and while there are many small companies operating locally, the total bulk of such insurance is relatively small. Taking the companies reporting to the State of New York, it is found that on December 31, 1912, such companies had a total of $51,202,402,351 of fire insurance in force. To this must be added insurance carried by unauthorized companies and by companies operating in other states? but not in New York. If we may assume that the companies operating in the State of New York carry seventy-five per cent. of the total carried in the United States, then the total amount covered by insurance would be approximately seventy billion dollars ($70,000,000,000). From these 1Report of the Commissioner of Insurance, Wis., 1914, p, 15. *N, Y, Insurance Report, 1913., pt, 1, p. Ixv, 1006 EFFICIENCY AND ECONOMY COMMITTEE. approximations it would seem that the risks subject to destruction by fire are fairly well covered by fire insurance.® The reason for the rapid growth of fire insurance during the last seventy-five years is not difficult of explanation. The property of each individual owner is subject to destruction by fire at any time. For the whole United States the annual fire loss has averaged about $225,000,000 for the past ten years, and in one of these years, viz., 1906, the total loss by fire was over $500,000,000. This annual loss must be borne by someone. Formerly it was borne by the owner. Now most property owners prefer to pay an annual fire insurance tax and be relieved from the risk of a partial or total loss. Fire insurance is, in fact, a great cooperative institution, all those insured contrib- uting to a common fund, and all the insured who suffer fire losses drawing out an amount equal in general to their individual losses. The annual contribution of each is small in comparison to the individual’s income from which it is drawn. A fire loss when it comes is liable to represent a substantial portion of the savings of a lifetime. The sum of all the contributions is nearly double the actual losses, but so much more serious is a total or nearly total loss to any individual when considered from the standpoint of his economic well-being than a series of comparatively small ones, that society could well afford to pay even more than it does now rather than dispense with the pro- tection afforded by fire insurance. It follows from this that fire insurance rates might be raised con- siderably above their present level and still the individual members of society would find it to their advantage to carry insurance. Why then do not insurance companies raise their rates? : There is some competition between the standard fire insurance companies. More important, however, is the competition of the mutual companies, including town and county mutuals, factory mutu- als, the Lloyds and during the past five years the inter-insurers. The town and county mutuals are, however, not fitted by nature to undertake risks subject to the conflagration hazard. Therefore, their competition is substantially limited to country districts and the smaller towns. The factory mutuals, the Lloyds and the inter-insurers are, on the contrary, admirably fitted to undertake such risks. Con- flagrations are unlikely to occur in several cities at the same time. The factory mutuals, the Lloyds and the inter-insurers make it their policy to scatter ‘their risks and so avoid to a large extent the con- flagration hazard. Moreover, by a well-organized system of inspec- tion, the factory mutuals and to a somewhat smaller extent, the inter- insurers, have so encouraged and perfected the art of fire prevention, that their burning ratio has been phenomenally low as compared with risks insured in the usual way. As a result, fairly active competition has been maintained in many lines of commercial risks, including fac- tories, stores, warehouses and the like. Such insurance has not, how- ever, been developed to any extent among property owners of other classes in the congested districts.. In such cases, competition is gen- erally ineffective and the rates are likely to be somewhat above the average. 8See U. S. Geological Survey, Bul, 418, for other estimates, FIRE INSURANCE RATES 1007 METHODS OF CONDUCTING THE FIRE INSURANCE BUSINESS. There are three methods of carrying on the business of fire insurance : The Mutual Plan The Stock Company Plan State Insurance The Mutual Plan In the mutual plan of carrying on insurance, a group of risks are associated under an agreement, whereby each individual member agrees to bear such a portion of any loss that may come to any of the risks associated as the insured value of his property bears to the total insured value of all risks insured. Generally speaking, each insured deposits a certain stipulated premium and guarantées by a note or other evidence of his responsibility that he will bear any additional assessments that may be made by the proper authorities on account of additional losses. The premium deposited is, however, usually larger than is necessary to pay the prorated share of the losses and expenses, and any surplus is held as a reserve and finally, or at intervals, dis- tributed according to the plan adopted at the beginning among the insured. In mutual insurance the rates charged are not important. The important features are: The actual fire losses; The expenses of conducting its business ; The distribution of the burdens—that is, the share that each member finally bears. The Stock Company-Plan Notwithstanding the advantages of the mutual plan, a very large proportion of all fire insurance is conducted by stock companies or by individual insurers and partnerships for profit: The reasons for this condition are as follows: 1. The conflagration hazard is directly connected with the building of wooden structures closely adjoining one another as in the modern city. Under these circumstances it is inevitable that fires should spread. Occasionally where the conditions are favorable, con- flagrations result. Such was the case in Chicago in 1871; in Boston in 1872; in Baltimore in 1904 and in San Francisco in 1906. Unless the mutual companies are so large as to be unwieldy from the administra- tive point of view, or the risks so scattered as to make the expense of doing business prohibitory, the losses to the individual policy holder are liable to be so heavy in case of conflagrations as to make the insur- ance a burden rather than a help. On this account mutual companies generally have confined their activities to the country districts, or to villages and have left the congested city to the stock companies. : 2. The object of a mutual company is to save money to the insured by reducing the cost of insurance to the actual expenses. While it is quite impossible with the information at hand at the pres- ent time to make a comparison of any value, it is often stated that the 1008 EFFICIENCY AND ECONOMY COMMITTEE. fire insurance business is not particularly profitable.* Certainly more insurance companies have failed during the past fifty years than have made financial successes. The mutual rate is gen- erally low—due to the following reasons: (1) Much of the work con- nected with the administration is not paid for at its commercial value; and (2) the mutuality of the insurance tends to reduce the actual fire loss, where the insured are closely associated. This is best illustrated by the experience of the factory mutuals where the fire loss has been reduced by a careful inspection and the dissemination of information toa fourth and in some cases to an eighth of the former rate. 3. The difficulties connected with establishing and maintaining efficient administration of mutual companies has proved a marked obstacle to their development. This obstacle is growing less each year but is still of great importance. 4. In some states mutual companies are encouraged by appro- priate legislation; in others, the state occupies a neutral position; in still others, the state government has seemed to discourage the forma- tion of mutual companies, and to favor the stock plan. Historically speaking, Illinois seems to have adopted the policy of neutrality. It seems to the writer that the state ought to change its policy.in this respect and adopt that of encouraging the formation and operation of mutual companies in all fields of insurance. State Insurance , As stated in the historical introduction, State Insurance was tried in London as early as 1681, but was soon abandoned. . State Insur- ance has, however, been fully developed in several of the leading European countries, especially in Germany, where the government has played a leading part in undertaking industrial activities as well as in regulating those owned and operated by private individuals. It is in New Zealand, however, that State Insurance has been promoted with the greatest vigor. There it has been used as a means of regu- lating the rates of the stock insurance companies rather than of secur- ing a revenue to the government. As this report was undertaken for the purpose of comparing fire insurance rates in Illinois with those in other states, where the conditions are somewhat similar, it would be inconsistent with its purpose to enter upon a discussion of the relative merits of the three plans of carrying on the business of fire insurance.° HOW RATES ARE MADE . Competitive Rates In the earlier history of fire insurance, rates were made by indi- vidual fire insurance underwriters, entirely independent of the others in the same line. Under such conditions the rates were sharply com- petitive and for the larger risks there was active bidding. Sometimes the premiums were less than the average cost of the fire losses and still the rates were maintained on the same general level. The reason for this is evident when one considers the circumstances: (1) Any rate above the direct costs of placing the business— 4The “Spectator” in the issue of June 4, 1914, shows that the losses and under- writing expenses of 112 companies for a period of 16 years ending with 1913, exceeded the underwriitng income by over $20,000,000. 5See Gephart, State Insurance (N. Y. 1913), for a full discussion of the merits and disadvantages of State Insurance. FIRE INSURANCE RATES 1009 that is, agents’ commissions, etc.—is likely to give a clear profit, as the chances are strongly in favor of escaping without any fire, or fire losses, during the period of insurance. (2) The agents who place the insurance are primarily interested in writing insurance for the sake of obtaining commissions, conse- quently their influence is in favor of lowering the rate in special cases where the business would otherwise go to some other agent. (3) Until recent years, there was no statistical information avail- able upon which to make a rate based upon the average fire loss. As a result of the above conditions, rates tended to be high for the small owners, or for those unable to obtain mutual insurance, and low for the large owners and those able to form or take advantage of mutual companies already in existence. Competitive fire insurance rate making thus led to discrimina- tions® between risks of essentially the same general character, depen- dent upon whether the owners were able to make use of competition or not. Thus some rates were excessive and others too low. Such a condition was good neither for the companies nor the policy holders. Two general movements were inaugurated to correct the evils, one started by the policy holders, the other by the companies. We shall discuss the plan inaugurated by the companies first. Schedule Rating Schedule rating is an attempt to measure class hazards and to base the general rate on the class hazard. In addition, there is a further attempt by a system of credits and demerits to fix the rate on each individual risk according as it is better or worse than the class to which it belongs. The first attempts to work out a system of schedule rating dated from the period just following the Civil war. One of these originated in Philadelphia, another in St. Louis. Neither of these systems, how- ever, was much used. Each proved to be so much more equitable to all parties that a general movement was inaugurated under the general direction of Mr. F. C. Moore, to prepare a schedule that might be used by all the companies. A ‘committee was appointed representing the leading fire insurance companies and as a result of their work the Mercantile Schedule was formulated and adopted. Since about 1890 it has been in general use in eastern states and includes some of the leading cities in the eastern central states. (1) The Mercantile Schedule: This schedule is based upon two central ideas: (1) A standard city and a standard building, and (2) a system of charges and credits for deviations from the estab- lished standard.” The base rate for a standard building in a standard city was fixed at twenty-five cents. To obtain the key-rate for a stand- ard building in any other city, additions were made on account of deficiencies as to water works, fire departments, building laws, narrow streets. To the key-rate for any city, charges are added to find: the rate for individual buildings on account of deficiencies from the speci- fications of a standard building. ®*Zartman, Discrimination and Co-operation in Fire Insurance, Yale Readings in Fire Insurance. TMoore, Fire Insurance and How to Build; The Mercantile Schedule. 1010 EFFICIENCY AND ECONOMY COMMITTEE. (2) The Analytical Schedule: Soon after the Mercantile Schedule was formulated, Mr. A. F. Dean of Chicago began working on a schedule constructed on different lines. In the first place, the Dean or Analytical Schedule® classifies cities into six classes—depen- dent upon water protection, fire departments, etc.; and in the second place, the deductions and additions are on a percentage basis rather than a fixed amount. By dividing cities into classes, the work of rating individual risks is somewhat simplified; by making the charges on account of individual defects or excellences, a percentage of the origi- nal base rate, the principle of relativity is adopted, viz., that a defective flue in an inflammable home is a greater hazard than an equally defec- tive flue in a fire proof building—that is, each added defect makes the original defect worse. The principle of schedule rating is a sound and equitable one. Rate-making thus becomes scientific in character and as the experience of the various companies becomes wider and as their records become more complete and extensive the schedule rates become more and more equitable,—as between different.classes of risks and different individ- uals insured. It is evident, however, that schedule rating in itself gives no protection against a high level of rates. Cooperative Agencies With the general adoption of schedule rating it became desirable for the companies to cooperate for the purpose of making the basic schedules, and having entered into such cooperation it was of course natural to observe the rates thus made. For the United States there are two important rating associations, the Western Union and the Western Insurance Bureau. The Western Union was formed soon after the Dean Schedule was formulated and embraces the states of the northern portion of the Mississippi Valley, west of Pennsylvania, north of Alabama and east of Colorado, Wyoming and north to the Canada line. The member- ship is made up of officers and agents of -stock companies and it has — jurisdiction over rates and commissions for all those who are members of the Union. Its administration is entrusted to a committee, but the important rules and regulations are made by the Union in the regular way—a nine-tenths vote being necessary to establish new regulations or modify old ones. All members must observe the tariff of rates established by the Union. The actual work of making individual rates is performed by local boards and inspection bureaus. For Illinois, the Illinois Inspection Bureau operating under the supervision of the Western Actuarial Bureau and subject to the control of the Western Union has charge of the Dean Schedule and keeps it up to date. A rating book is pub- lished for each of the cities and villages, and the agents representing the companies belonging to the Union are required to observe the rates as published. The Western Insurance Bureau: Until about four years ago there were a considerable number of companies that for various rea- sons did not belong to the Union. Such companies, called ‘‘Non- ®Hess. The Philosophy and Method o@f Operation of the Analytic System, Chi- cago, 1909. FIRE INSURANCE RATES 1011 Board Companies,” generally followed closely the Dean Schedule of rates, but in many cases were paying their agents a higher rate of © commission. In June, 1910, a large portion of the non-board com- panies organized the Western Insurance Bureau and established a uniform rate of commission, varying from fifteen to twenty-five per cent., except in certain preferred risks where the commission is as high as forty per cent. In April, 1912, the Union and Bureau entered into a combination for the purpose of establishing a uniform rate of commission for both organizations. While there is no agreement to that effect, the result of this combination has been to secure the adoption of a uniform rate of premiums for writing insurance by both organizations. At the present time competitive rate-making between stock fire insurance companies in fire insurance is, generally speaking, a thing of the past. Whatever competition exists is between the mutuals, the Lloyds, the inter-insurers and the companies comprising the Unions. Since the mutuals are by their nature, and to a certain extent by law, prevented from entering into competition in centers of population where there is danger of conflagrations, a considerable part of the fire insurance business is not subject to competitive conditions. STATE REGULATION OF INSURANCE While the companies have been establishing cooperative agencies for the purpose of making and enforcing non-competitive rates, the several states have been creating State Departments of Insurance and authorizing such departments to supervise the activities,of the com- panies and more and more.to regulate and control the rates promul- gated by the rate-making associations. In Illinots The State law under which the insurance business is conducted in Illinois has two principal objects: to prevent insolvent insurance com- panies, associations, etc., from undertaking risks, and to secure a revenue from the insurance business. The law covers these two objects in a satisfactory way. The Insurance Superintendent is given ample power and is provided with an office force sufficiently large to enforce the law fairly well. The Insurance Superintendent is, however, not directly authorized to exer- cise any supervision over either rates or rate-making associations. Attention should, however, be called to two clauses, one of which gives the Superintendent power to classify risks and the other to secure and publish information as to the actual rates in force. Section 21 (paragraphs 37, 38, 40) of Chapter II of the Insurance Laws (Edition of 1911) provides: It shall be the duty of the Insurance Superintendent to establish a classifi- cation of risks into any number of classes, not less than four, according to the degree of hazard of such risks; and the Insurance Superintendent shall require said companies, as a part of the aforementioned statement (the annual statement required by law) to give the number of policies in force covering property embraced in each class and the aggregate amount at risk upon property in each class. The Insurance Superintendent is hereby authorized and empowered to address any inquiries to any insurance company or the secretary thereof, 1012 EFFICIENCY AND ECONOMY COMMITTEE. in relation to its doings or condition, or any other matter connected with its transactions, and it shall be the duty of the company so addressed to promptly reply in writing to such inquiries. It shall be the duty of the Superintendent of Insurance to cause to be prepared and furnished to each of the companies, printed forms of the state- ments required by this Act; and he may, from time to time, make such changes in the form of such statements as shall seem to him best adapted to elicit from the companies a true exhibit of their condition in respect to the several points hereinbefore mentioned. . It shall be the duty of the Insurance Superintendent to cause the informa- tion contained in the statements required by this section to be arranged in a tabular form and printed in his biennial report. It will be noticed that the Insurance Superintendent is to establish a classification of risks into any number of classes, not less than four, according to the degree of hazard; he is further authorized to inquire into the “doings” of all insurance companies ; he may change or modify the form adopted by the legislature whenever in his judgment such changes would better secure the desired information, and finally he is required to publish such information in his annual report. In view of the above provisions of the law it is evident that the Insurance Superintendent is not only empowered, but it is made his duty to secure full publicity of fire insurance rates, by establishing classes of risks and securing information in regard to the number of policies in each and the aggregate amount at risk upon property in each class. That such information would prove of the very greatest value hardly needs argument. It has all the merits of proper publicity. Its chief value would lie in its discouragement of discriminations in rates against certain classes of property. It is possible that such information would have little effect upon the general schedule of rates. It would, how- ever, facilitate a comparison of rates in Illinois with rates on similar classes of risks in other states, and thus tend toward an equalization of rates in general. In Other States Up to the present time sixteen states have enacted legislation providing for a greater or less supervision of fire insurance rates. These states in the order in which the legislation was enacted are as follows: New. Hampshire” cee oes 1899 Kentucky. 20.4 3.2005. 1912 Montara. ? ee ne eee ead the Arkansas 0.00.6 5 as 3 a 1912 SouthvG@arntinall er. eine ea. ee 1904 New: Jersey 2.00.0... cee 1912 Oklahnmatcc bit. Gain eee: 1907 North Garolisa: <,:. 1... lee Kidsrsagir' ic. 4 Satie Sue a ees 1 Oo New: Yotk? eas onsale eee 1913 Louisiana (Repealed 1912).... 1910 "TOXASy vgn’: von [a Bie tl Sele dele Reena Massachusetts 007.54 ht ete le Washington 2.0. s,s .'... ys 1913 In the fourteen states where state regulation of rates is now in force the power of the State through the courts or Department of Insurance varies very greatly. Some merely prohibit discriminations ; some require all rates and schedules to be filed and made public rec- ords; some authorize certain authorities to hear complaints; some authorize the insurance department to change rates on complaint after an investigation; and one provides that the rates and schedules shall be made by a state commission. FIRE INSURANCE RATES 1013 Anti-Discrimination Montana in 1903 enacted an anti-discrimination law, which pro- vides: (Chapter 112, Laws of 1903)—“No insurance company organ- ized under the laws of this state, or doing business in this state shall make or permit any discrimination or distinction in favor of individ- uals between insurants or property of the same class in the amounts of premiums or rates charged for policies or in the dividends or other benefits payable thereon.”’ Agents violating this provision are made guilty of a misdemeanor. Companies and officers are liable to a fine of not exceeding $500 for each violation, to be recovered by an action in the name of the state. Further, the State Auditor is required to revoke the license for one year of any company found guilty of disobeying the law. Oklahoma has a similar provision in the anti-trust law, and the State Insurance Commissioner has ruled that the section applies to fire insurance corporations. Rates To Be Filed Fight states, viz., Kansas, Kentucky, Arkansas, New Jersey, New York, North Carolina, Washington and West Virginia, require rates and schedules to be filed and, generally speaking, to be open to public inspection. Hearing Complaints Massachusetts and New Hampshire provide that any person or company aggrieved by any rating of any insurance company may file a complaint with the insurance commissioner. In Massachusetts the complaint is heard by a board composed of the Insurance Commis- sioner or a special deputy appointed by the commissioner and two citi- zens appointed by the Governor, sitting as a board of appeal for fire insurance rates. After due hearing the board is authorized to make a finding “as to whether the rate is excessive, unfair or discriminatory, and shall make a recommendation.” ‘The finding and recommendation in each case is a public record, open to inspection, but is not obligatory upon the companies. In New Hampshire the commissioner is author- - ized to conduct the hearing and if the rates appear to him to be exces- sive, he may fix a reasonable rate, which must be adhered to by the companies. Refusal to insure property at the rate fixed by the com- missioner after a hearing is punishable by a fine of $200 for each offense. Rate-Making Associations Authorized The latest development in state legislation concerning fire insur- ance is connected with the authorization and regulation of rate-making associations. This movement seems to have originated in Missouri in 1911. Under the Missouri Act the companies operating in that state formed the Missouri Actuarial Bureau and employed a force of expert raters and the necessary clerical help, under the general direction of Mr. H. M. Hess, one of the leading authorities on the Dean Schedule. Before the work of this Bureau was completed, the legislature of 1913 passed additional legislation making it illegal for any company to use any rates prepared by any rating association. While the former 1014 EFFICIENCY AND ECONOMY COMMITTEE. legislation was thus negatived and the work of the Actuarial Bureau rendered useless for the time, the idea was adopted in New Jersey, New York, North Carolina and Washington and seems likely to spread over a wide territory in the immediate future. The New York legislation is the most comprehensive and there- fore its principal features will be described as an illustration of this type of regulation. The New York Act provides that every corpora- tion, association, bureau or person that maintains a bureau or offices for suggesting, approving or making rates to be issued by more than one underwriter for insurance on property or risks in the state must: (1) file with the Superintendent of Insurance a copy of the articles of agreement, etc., and such other information in regard to its organiza- tion as may be required by the Superintendent; and (2) submit to examinations by the Superintendent of Insurance as often as he deems expedient, and in any case at least once in every three years. The Super- intendent is required to make public the results of such examinations in his annual reports and to report to the legislature on the methods of operation of such organizations. The records of such organizations are made public records and the companies or bureaus are required to furnish the Superintendent any schedule of rates or other information that he may demand. Such bureaus may not discriminate between members nor may they make rates conditioned upon the whole or any part being placed at such rates or with subscribers to the rating organization. This legislation is the most important step in the right direction that has been taken in recent years in the supervision of insurance rates. The making of scientific rates cannot be undertaken by indi- vidual companies on account of the enormous expense. It must, there- fore, be done either by the companies through cooperating rating bureaus or by the states. From the scientific point of view the rates should be made by experts and the expense should be borne by the companies that are profiting by the business. Cooperation in making insurance rates, however, prevents competition between the companies and, therefore, such rates naturally become monopolistic in their char- acter. Consequently such rates should be under the supervision of some public authority. This condition has been recognized in the New York legislation and the proper supervision of such rates pro- vided for in the law. State Fire Insurance Rate-Making On the sixth of September, 1910, the State of Texas enacted the first general State Fire Insurance Rating law within the limits of the United States. Under this act a general schedule of rates based upon the Mercantile System was promulgated. In 1913 the Act of 1910 was repealed, and a new act along the same general lines, but giving the state board more complete control, was substituted in its place. The Act of 1913 provides: 3 (1) For a State Insurance Commission composed of the Com- missioner of Insurance and Banking and two commissioners to be appointed by the Governor by and with the advice and consent of the Senate; FIRE INSURANCE RATES ra POLES (2) The State Insurance Commission shall exclusively fix and promulgate maximum rates of fire insurance premiums to be charged and collected in the State. Companies writing insurance in the state are not permitted to charge rates higher than the rates promulgated in the schedule, nor to charge less in any case unless they make such lesser rate applicable to all risks of the same class situated in the same community. Under the authority of this act and its predecessor, the State Insurance Commission was created and organized in Texas in 1910 and promulgated its first schedule of rates on Puly Loy OTS 4 Lbs Texas Basic Schedule, in accordance with the principles of the Mer- cantile Schedule: ; Defines a standard city and provides by a system of charges and credits or deviations therefrom. The application of the charges and. credits gives the key-rate for a town; Makes a classification of buildings based upon the character of the con- struction and defines a standard building in each class, with a series of charges and credits for deviation from the standard ; Provides an occupancy table for various commodities ; Makes specifications of charges and credits for various kinds of expo- sure; and Describes a large number of special hazards with the appropriate rates for the same. ‘The Board schedules are contained in a book of 354 pages and are supplemented from time to time with amendments. Changes in any of the foregoing provisions are modified by order of the com- mission. RATES IN ILLINOIS In a paper read before the National Convention of Insurance Commissioners, held at Burlington, Vermont, in July, 1913, the Hon. F. W. Potter, then Insurance Superintendent of Illinois, stated® that he had called upon the stock fire insurance companies doing business in the State of Illinois, Kansas and Texas, for a statement of their fire premiums, fire losses and expenses for a five-year period ending December 31, 1912. During this period there was no supervision exercised over rates in Illinois. In Texas the State Rating Board had been in exist- ence for about two years; and in Kansas, the State Insurance Super- intendent had been exercising authority over rates for a period of four years. ! The results of this inquiry, according to Mr. Potter, showed that ninety-seven companies doing business in Texas had suffered an under- writing loss of $3,435,745 and of approximately $500,000 in the State of Kansas. Mr. Potter planned, he stated, to communicate the results to the State Legislature, with a recommendation that the state law be amended in such a way as to clothe the State Superintendent of Insur- ance “with sufficient discretion to refuse a license to companies desir- ing to do business in Illinois, and admitted to these unprofitable states, where by the terms of the law or its necessary effect, the rate-making function is taken away from the insurance companies.” *Proceedings National Convention of Insurance Commissioners, 1913, p. 57. 1016 EFFICIENCY AND ECONOMY COMMITTEE. Instead of carrying out his original intention, Mr. Potter pre- sented the matter to the National Convention of Insurance Commis- sioners, chiefly on the ground that it was a matter concerning all the. State Insurance Departments and ought, therefore, to be first dis- cussed by that body. The paper of Mr. Potter was extensively dis- cussed, but no action was then taken. Later a Committee on Rates was appointed and the Honorable Herman L. Ekern, Commissioner of Insurance of Wisconsin, was made Chairman. This Committee has been carrying on an investigation, but has not yet published its report.?° Mr. Potter very properly contends that no State should, by act of legislation, attempt to get its fire insurance at less than its share of the total cost for the country as a whole, and that where a state persists in so doing it may become desirable for the other states to take concerted action to remedy the situation. His first proposal, that of excluding companies doing business in a losing state from transacting business in a profitable state, has so many disadvantages that it cannot be seriously considered until other methods have been tried. The tendency at the present time is to per- mit companies to join together for purposes of making scientific sched- ules and specific rates and give the insurance department the power to prevent discriminations between individual risks within the same class. . If after such regulation has been in operation for a period sufficient to give it a thorough test, rates as a whole are unduly high, then it may become both wise and necessary to clothe the state departments with the power to raise or lower general schedules as in Kentucky and Kansas. The statement of Mr. Potter was intended to prove that the busi- ness of insuring property risks is more profitable in some states than in Others in certain years. The tables published by the various insur- ance departments show, however, that while certain companies con- duct business at a loss in certain states during certain years, the com- bined business is usually fairly profitable, especially for the larger and better established companies. To find whether the insurance is unduly profitable it becomes necessary to compare the net savings with the capital invested and at a risk. The New York Report'? made an investigation of the actual earnings on capital for—, Class 1. The six largest U. S. companies Class 2. The six medium U. S. companies Class 3. The six smallest U. S. companies Class 4. Six new companies. Class 5. Six foreign companies. The results were as follows: Per cent. Class.1-—20 wears 4.6 scsi cwr't Average rate of earnings 10.1 Class. 2-20 years yc jcbisse hb eielobiblccmate spe tte ae 6.6 19At the annual convention of the Insurance Commissioners held at Asheville, N. C., Sept. 15-18, 1914, the special committee on fire insurance rates and rate-making reported progress, and asked that the report be deferred until the December meeting. At the December meeting, a preliminary report was presented with a statement that the full report would be presented and distributed at an early date. 11Report of the Joint Committee, 1911, page 55 et seq.— FIRE INSURANCE RATES £017 Ee a a oa UE = Ai INE a er a ip te 4.5 , aso OL ANY Ly os icc ees e eitlea uae tie se 28.5 SEC ARL VE: Masten estat aiccs Meets Sie ch io Ale — 2.3 SOMIpan ye Cen ks ok Fa pes alah apie | RAR (OaN ee ETS © etna cathe a aarsPRe ute) Cape ean alee — 2.6 ME UTOIAT Wr ie Rh ne ete gM ey Merk ae ke 8.7 RRGHDatly velar mese cere ec tan ae hi Ne Blog = EG BN eSP OW OINDAN Lie ei acini hiner) multi uddls os CZ OTA PIAN) Voge Etta Gaia eer, Peat Mt eae eu lt — 4,7 AOUUIIAN VS ere ys Wicd ceekcda ek IA, Pi seet ia el tie 6.7 DOM Dan virciee kr nace teat Cir lt Aah hy : 5.1 CREAT T Gaye CIT ED AR be eens eet er Fe — ll WOULD AN: ime, Ce Mens VPS, Space. —14.8 (— indicates a loss.) Attention may be called at this point to the expense ratio. The New York Report shows” that for every dollar received in premium 38% cents is paid out for expenses, and that of this amount 21.5 cents is paid to agents in the form of commissions. While it is not within the scope of this report to investigate the proper expense ratio for an insurance company, it may be pointed out that the fire insurance busi- ness as conducted at the present time does not necessitate an extensive system of salesmen and solicitors as is the case with life insurance; nevertheless the ratio of expense to premiums is much higher in the case of life insurance business. The question of especial interest to the citizens of this State is: Are the rates relatively higher in Illinois than in the United States as a whole or in other states similarly situated and with approxi- mately the same hazards? This question is not easy of solution with the information available under present conditions. A comparison of rates—that is, the premium paid per $100 worth of property insured— is obviously of little or no value in this connection. It is well known that fire insurance rates in European countries are exceedingly low when compared with those in force in the United States. This condi- tion is due chiefly. to the comparatively small fire loss in European countries. This small fire loss again is due chiefly to two causes: Building Construction and Fire Protection Frame construction is almost unknown in European cities.1* In the United States it is the rule, except in restricted areas in certain of the cities. Fire protection in many of the cities in the United States is comparable with that afforded in Europe. But in other cities the protection afforded is entirely inadequate considering the risks involved; as a result, the conflagration hazard, as well as the annual fire loss, is small in European cities and relatively large in the United States. The Moral Hazard The moral hazard is the title given to all classes of hazards that arise out of circumstances which make it possible for persons to profit from the burning of insured property. For example, wherever there 12Page 91. 18), S. Geological Survey, Bul. 418, pp. 16-21. 1018 EFFICIENCY AND ECONOMY COMMITTEE. is an opportunity to recover from the insurance companies compensa- tion in excess of the value of the property burned a moral hazard emerges. For this reason the valued policy is universally opposed by insurance companies as tending to create an artificial and unnecessary moral hazard. For this reason also the coinsurance principle with the usual eighty per cent. clause is generally favored. In this connec- tion it may be noted that the valued policy is unknown in Europe, and the coinsurance principle is practically a universal one. On this account the fire losses due to the moral hazard are less in Europe than in the United States. There is still another factor of large importance. It is well known that every building situated within a few hundred feet | from a burning building is under considerable risk from the so- called exposure hazard. The exposure; hazard - varies with the inflammability of the building and contents, the distance from the burn- ing building, the direction and velocity of the wind, and the fire pro- tection afforded by the fire department. It is of course true that the exposure hazard is independent of the original cause of the fire. The incendiary who. burns his own building for the sake of the insurance | may involve a city in an extreme conflagration. The man who care- lessly drops a lighted cigarette butt in a lot of inflamable material, as in the case of the Asch building in New York on the 24th of March, 1911, when 143 working girls lost their lives, is equally as dangerous and ought to be legally responsible. The European countries have rec- ognized this danger and have attempted by appropriate legislation to lessen the hazards arising therefrom. This result is partially accom- plished by laws making every individual responsible for loss of life or property caused by his own gross carelessness and neglect. As a result of the less inflammable buildings, more adequate fire protection, and the reduction of the moral hazards by appropriate legislation, the fire loss in European countries is relatively small and the rates for fire insurance correspondingly low. The following table, compiled by the Geological Survey and the Bureau of Manufactures, shows the fire loss per capita for cities of the same size in the United States and Europe.** Po pulation. iS, Europe 4D ver ViS0000G We tikes evan eR Ree 65 100,000 300 O00 eae ae Site ee ee tone Le ter ha eer ae OF 50,000 2100;000 (iD ee ee 47. 1.67 30,000 9250, 00053 i ath ee S28 Pee eee eee a 10,000 = 30/000 ii eas he iets pee 81 Under — 10,000 . BA/i For certain cities of ADDLOxIMately the s same size, , the comparison s as follows :"® —e Loss per capita. . Loss per cari 1 hParis) (1904) aoe eee oe ae 47... Chicago >(.1907). in. ee 1.43 2. St. Petersburg (1904) ....... 1.42....Philadelphia (1907) . 1.45 3. Birmingham, Eng. .(1904) .... .41...; Baltimore- (1907) 32.) (ape 1.66 4... Shefheld,: Eng. (1904) >... 2° 318.4, Cleveland (1907). vat) ae 1.12 5.) Frankfort, ‘Ger, (1904). 00.2. 31. 2.Gincinnatis (1907) 3,00. '.7 2: ae 5.70 6. Bremen, Ger. (1904) ......... 38; 62)St./ Paul (C1907) o5 0. ee + 2.56 7. Toulon, France (1904) ....... 55 Atlanta £1907) | oe eee 2.15 14U. S. Geological Survey, Bul. 418, p. 24. 15Tbid p. 24. FIRE INSURANCE RATES i LOLS The National Board of Fire Underwriters gathered statistics for 1910, relating to a considerable number of cities, with the following results: Cities. Population. Loss per capita. Mentteds States oO sv 207 29,996,720 $ 2.39 PAICIANG eee ener thy fe 11 2,335,847 44 Berenice: tates evil | go 3! ed 8 4,392,529 92 VOT IN ALI Ves yi Pe oes oad Pek 13 5,616,822 .99 Brolandee ne: |; See ee oe to 2 657,680 45 BROEIVA Vie oa, elegy te 1 244,000 [ao The average annual loss by fire in the United States for the past ten years has been approximately $225,000,000,'® or about $2.50 per capita. The average annual loss in the European countries during the same period is stated by Mr. Roger W. Babson’ to be less than fifty cents per capita, or approximately one-fifth that of the United States. No comparison of rates prevailing in United States with those prevailing in European countries is of practical importance unless taken in connection with fire losses. A comparison of rates to be of value must then take cognizance of conditions, and compare states and cities similarly situated with respect to the fire hazard, or failing that, to make corrections for the risk involved. While the conditions vary in the several states, it may prove of value to make some comparisons, carefully noting in connection with the rates, the relative hazards as shown by the annual fire losses. For this purpose the following states have been selected: Illinois, Iowa, Massachusetts, Michigan, New Jersey, New York, Texas and Wisconsin. To show rates and losses in an area chiefly urban composed largely of slow-burning or fire-proof construction, and protected by a well-equipped and efficient fire depart- _ ment, the District of Columbia is included. Table I shows for the selected states and the District of Columbia: 1. The total insurance written (a) for each of the years from 1909 to 1913, (b) for the five year period 1909-1913, and (c) for a period of approximately forty years—that is, from the first year for which the statistics were gathered to the year 1913 inclusive. Z. The total premiums received for the corresponding periods ; and— 3. The total losses on account of fire for the same period. From this data the following rates have been calculated: (a) The average premium rate in dollars per hundred dollars insured ; (b) The average burning rate in cents per one hundred dollars insured. (c) The-ratio of losses to premiums, expressed as a percentage. 16Tbid p. 138. 17N, Y. Times, Mar. 24, 1912. 1020 Year Risks Premiums Losses b Rate 1900 ........ $ 1,778,804,044 $ 22'160,892 $ 9,963,255 $1.24 19LOf aie 1,853,261,576 22,589,580, 10,871,966 1.22 LOTT es eek We, U lide Seas 24,396,372 12,244,0159 > eee 19 Zire ere 2.102,364,885 25,369,047 12,867,136" “T21 LOLS See ann. 2,268,882,603 26,011,348 14,277,051 1.14 1909-13 ........ $10,020,692,811 $120,527,239 $ 60,223,423 $1.20 1869-13 ........ $46,398,382,602 $547,704,869° $264,034,929° $1.15 IOWA d L909 0 Wek tS 4s. Ae $ 8927f $ 2,501 f $1.83 NHS GN ge eae a 540.7 7,464 3,186 1.38 1693 Leama ty 585.2 7,479 4,026 1.27 AS Pee Rey a Fe 480.4 5,549 3,240 1.16 IWBAGs. Acre: 652.5 7,012 4,327 1.07 OOO TBS rns ea eed AOSD $ 36.431 $17,280 $1.21 1870-13: 2.0.2... $21,207.1 $175,266 $75,781 $1.66 MASSACHUSETTS & LOUD ic ths IOS $ 12,905 $ 6,585 $. .99 yA 6 ben, eae 1,354 13,085 7,014 .96 DRPIOS ae. 1,391 13,457 FAT? 97 TS 1,410 14:154 7,884 1.00 1943) 4..: 1,479 14,534 9;191 .98 1909-13 ........ 6,917 68,135 37,791. 98 1872-13 4....... 39,065 397,960 206,351 1.01 MICHIGAN? 1909 $ 679:7 $ 7,998 $4,218 $1.17 19.10 © Ae eke: 872.25 8,203k 4,404 .93 10,8781 TOA Pee a 854.7 8,649 5,201 1.04 1912 1,142.87 9,236k 4,998 Miz 12,818/ AK ee Crores © 1,320.87 9;245k 5,037 1.01. 13,359/ 1909-130 ce) oe 4,870.2 53,702 23,888 m0 1S7O-V50w) we on ee Opes: 196. 101. itz EFFICIENCY AND ECONOMY COMMITTEE. EABLE I ILLINOIS a °?°® @Statistics from Ill., Ins. Reports, 1910-1914 ¢ Loss Ratio bIn Dollars per $100 at risk In Cents per $100 at risk adInsurance Age, October, 1914 éIn Millions of Dollars in all tables except Illinois. YIn Thousands of Dollars in all tables except Illinois. Cedi and by States, 1914 - Boston fire not included. ’ Ratio of Loss to Premiums 55 40.4 58 47.2 60 50.2 61 50.7 62 54.8 “60 49.9 37 Tate 51 28.8 at 42.6 64 53.8 66 57.9 65 61.7 62 ee 66 438 51 51.2 52 53.8 52 52.9 56 65.7 62 63.4 SAS 2 cies 53 51.8 59 58.7 50 50.7 58 61.3 54 53.0 54 60.3 552. 55, 64 51.9 eee ee eee ae 1910 .... 1911 1911 © 6 ef 0s Je 10.6 S56 8 6 © 6 0.8 NEG Sapa (7 SS eae 1909 1910 eee ee wee eee ere eee BE atv, os. 2 ate A J! (LS 1 ar 1865-13 6 0/8) 0) 8. oo) 6. ae ae > Se ee M22) i ar tReport Insurance 6) fe) 6.8) 6.6 @ ce @ 66's 258 Commissioner, 1910-1914 jGross Amount at risk kNet Premiums _ lGross Premiums mStatistics from Insurance Age, Oct. 1914, unless otherwise noted. nAverage of yearly average burning ratio Premiums FIRE INSURANCE RATES Losses NEW JERSEY m $ 10,000 — $ 3,500 10,000 4,750 10,700 4,330 11,300 6,250 11,500 6,000 53,500 24,830 184,000 90,000 NEW YORK $ 43,500 $19,750 45,500 21,000 44,000 25,750 46,750 26,000 48,000 23,000 227,750 ‘115,500 1,102,000 567,750 TEXAS $ 8750 — $ 6,500 8,750 6,000 8,750 6,000 9,500 8,250 10,000 5,500 45,750 32,250 159,250 99,500 TEXAS 0 $ 9,840 $8,450 10,000 5,200 19,840 13,650 WISCONSIN $ 7,000 — $ 3,000 6,750 3,750 6,750 3,333 7,250 2,750 8,000 2,500 35,750 15,333 187,500 93,000 oTexas Ins. Board—Combined Classification totals. Loss Ratio 1021 Ratio of ‘Losses to ‘Premiums 1022 EFFICIENCY AND ECONOMY COMMITTEE. DISTRICT OF COLUMBIA 109 «sig ode $ 133 $ 670 $ 200 {O10) CAR Nbaeelyas 670 250 101TH RE 18S 650 440 1012.) San: 130 630 300 isn eee 142 710 290 {00013 Aare 678 3,330 1,580 lcs ccna a Gaina: 15,000 5,890 ¢ 50 15 48 18 7 32 48 30 49 20 $ 49 23 $ 59 23 In order to show more clearly the fire insurance rate situation in Illinois, three tables have been prepared from the information con- tained in Table I. These tables are: Table IJ, which shows the burn- rate for each of the geographical areas, and the relative position occu- pied by Illinois in the group. Table III, which shows the premium rate in each area, and Table IV, which shows the profits to the com- panies derived from the insurance written in each of the areas. TABLE II CENTS BURNED PER $100 INSURED 31 42 53 57 64 65 66 96 63° 1913 1909-1913 Period Approx. 40 yrs. 1. Dist. Col. 20 1. Dist. Col. 23.2. 1s. Dist) Gor 23 2. Wisconsin 30 2. New York 35.7. 2. New York 3. New York 32 3. New Jersey 42 3. New Jersey 4. New Jersey 41 4. Wisconsin 46 4. Massachusetts 5. Michigan 54 5. Massachusetts 548 5. Illinois 6. Massachusetts 62 6. Michigan 55 6. Michigan 7. Illinois 62.9 ~- 7. Illinois 60 7. Wisconsin 8. Iowa 65 8. Iowa 62 8. Iowa 9. Texas 73 9. Texas 96 9. Texas The United States, 1890-1907.a TABLE III CENTS PAID PER $100 INSURED 1913 1909-1913 Period Approx. 40 yrs. 1. oper Col. 49 1. Dist. Col. 49 1. Dist. Col. 2. New York 67 2. New York 77 2. New York 3. New Jersey 90 3. New Jersey 91 3. New Jersey 4. Massachusetts 98 4. Massachusetts 98.7. 4. Massachusetts 5. Wisconsin 98 5. Wisconsin 107 5. Illinois 6. Michigan 101 6. Michigan > 110 6. Michigan 7. Illinois II4 7. Illinois 120 7. Wisconsin 8. Texas 130 8. Iowa 133 8. Texas 9. Iowa 174 9. Texas 137 9. Iowa The United States, 1890-1907, a TABLE IV. CENTS SAVED PER $100 RECEIVED 40 year Period 1913 1909-1913 (Approx. ) 1. Wisconsin 66.9 1. New Jersey 1. Dist. Col. 2. Dist. Col. 59 2..lowa 532s. Lowe 3. New York 51.8 3. Wisconsin . po} 3. Illinois 4. New Jersey 48.4 4. Dist. Col. 52.6 4. Wisconsin 5. Illinots 45.2 5. Illinois 50.1. 5. New York . 6. Texas 443 6. New York 49.2 6. Massachusetts 7. Michigan 39.7. 7. Michigan 45 7. Michigan 8. Iowa 38.3 8. Massachusetts 44.77 8. New Jersey 9. Massachusetts 36.7°, 9. Texas 30 9. Texas The United States 1890-1907.a KobhhRRU mH & GSURSSSE SS DO OO NUR OON aHess, H. M. Philosophy and Method of Operation of the Analytic System, p. 15. — : _ FIRE INSURANCE RATES eLO2S From an examination of Tables II, III and IV it will be noted: 1. For the forty-five years during which the insurance statistics have been gathered in the state, 57 cents worth of property has been burned and paid for by the insurance companies for every $100 insured. That. for the last five years 60 cents worth has been burned and paid for; and that for 1913 the burning ratio was 62.9 cents per $100. This showing is better than the average for the United States, 1890-1907, but compares unfavorably with the fire loss in the District of Columbia, New York, New Jersey and Massachusetts, for the total period, and with District of Columbia, New York, New Jer- sey, Wisconsin, Michigan and Massachusetts for the past five years. From these tables it would seem that the fire loss-in the state is unnecessarily high and steps should be taken to ascertain the causes and apply the proper remedy or remedies. 2. The average rate paid for insurance for the 45-year period is $1.15 per $100 insured. It will be noticed that Illinois occupies a middle position in the selected group, and the same relative posiffon in rates that it does in the fire loss. While, however, the fire loss is on the average a little below that of the United States, the average rate is somewhat higher. In the face of a steadily increasing fire loss, it is of course unlikely that the premium rate will fall by voluntary action of the companies writing the insurance. While other states have been gradually reducing their fire loss, or burning ratio, and as‘a result their average premium rate, Illinois shows an increasing burning rate, and a stationary premium rate. For the last five yeays and for the year 1913, in both burning ratio and premium rate, Illinois has dropped to seventh place, only Iowa and Texas showing a more unfavorable condition. en ~ 3. Table IV shows the proportion of the premiums received which have been retained by the companies. It may be desirable to note in this connection that out of the premiums received the insurance companies pay——first, the fire losses, and, second, the expenses of carry- ing on the business. Whatever is left after paying the fire losses and expenses goes to the proprietors of stock companies in the form of increased surplus and dividends, and to policy holders of mutual com- ~ panies as surplus or in return premiums, often erroneously called divi- dends. For the whole United States, during the period 1887-1907, for every dollar paid into the insurance companies, 56 cents was burned and 44 cents was retained by the companies. The 44 cents was used to pay expenses, accumulated a “safety fund” and the remainder was paid out in dividends. According to the report of the Joint Committee of the Senate and Assembly of the State of New York,’® published in 1911, the 44 cents was divided up as follows: Page 91. 1024 EFFICIENCY AND ECONOMY COMMITTEE. Salaries, rent and general administration ........ 7.5 cents Commissions to agents ..... yo bl b ale'e oe 4.903 0 nr Famesiti< pe bea otha. Se rs a sai irvtas » 6 olbcade SORE a Special agents—salaries and expense .......... 2 » Sale Inspections—local boards .............. .. lk pel Printing—postage). «+ ..4. dur jeedi oe ee ee sb otalPexperrseii...icicuat seein on . bo 2 a ae oe a Totaly burning 37) .).0. & soaks ee 56.0507 5 04 SDs Net-underwriting profitcrse. co. n een . wig SOLO —_———_—— This net profit is, it should be observed, a net saving out of every dollar received in premiums. To find the rate of profit on the capital invested, it is necessary to compare the total net annual savings with the capital invested. For the forty-five year period the rates enforced by the fire insur- ance companies in Illinois, uncontrolled by the State, show a saving from the premiums received considerably above the average for the United States for the shorter period 1890-1907. And in only two of the selected areas, viz., District of Columbia and Iowa, have the insur- ance companies been saving a larger proportion of the premiums received. For the five-year period, as well as for the year 1913, Illinois occupies the middle position, four areas being more profitable to the insurance companies and four less so. In general, the State of Illinois has been tending to become a less favorable field for insurance com- panies, not because of a decrease in the premium rate, but owing to a steady and persistent increase in the fire losses. This is a serious situation and merits the attention of all property owners, fire insur- ance companies, the state legislature and the state officials, especially the Department of Insurance and the State Fire Marshal’s office.*® COINSURANCE Coinsurance is best defined by a quotation from the old French clause relating to that feature of insurance. It states that: If at the time of the fire the value of the objects covered by the policy is found to exceed the sum total of the insurance, the assured is considered as having remained his own insurer for that excess, and he is to bear, in that character, his proportion of the loss. 1°The writer desires in this connection to call attention to the exceedingly un- satisfactory condition of fire insurance statistics in) the various States and to suggest that the State Superintendent of Insurance be urged to use his influence with the State Commissioners at their next general convention in favor of securing uniformity in the reports of the insurance companies in the several States and especially in the method of compiling the results in each State for the summaries generally presented. Owing to the lack of uniform methods among the several States, to say nothing of the variations that are often found from year to year in the same State, the writer has little confidence in the tables he has compiled, except as showing tendencies and positions of the several States in a most general way. A specific example may be cited to illustrate: The State of Michigan usually presents statistics showing the net amount at risk written each year. For the years 1910, 1912, 1913, the gross amounts only are reported. Wor the years 1909 and 1911 the net amounts only are given. This makes it impossible to obtain the burning ratio, and the premium rate obtained by comparing the gross amounts written with the gross premiums is not likely to be identical with that found by comparing the net amount of risks with the net premiums received. By the concerted action of the State Insurance Commissioners, it would be comparatively easy to provide for uniformity in the reports of Insurance Companies and consequently of securing statistics that would be of value for com- parative purposes, . . - FIRE INSURANCE RATES * 1025 The European countries generally have written insurance from the earliest times under the coinsurance principle. The practice in the United States, on the contrary generally follows the opposite practice, and in some of the states coinsurance is prohibited by law. The effect of coinsurance is to make the owner a coinsurer with the insurance _ company, wherever the property is only partially insured. When, how- ever, the property is fully covered, the entire risk is undertaken by the company whether the loss is partial or complete. Thus, suppose A insures his property worth $10,000 for $5,000 and the policy contains the coinsurance clause. If the loss is total A recovers $5,000, the face of the policy. If, however, the loss is only $500 the company is responsible for that proportion of the actual loss denoted by the relation of the face of the policy to the value of the property. In this case the company is responsible for one-half the loss, or $250. If the policy does not contain the coinsurance clause the company is responsible for the total loss up to $5,000. The coinsurance clause is, therefore, of importance only where the loss is partial; but most losses are partial. The New York Report has an interesting com- pilation bearing upon this subject. For a certain class of buildings, for-every $100 worth of property insured, On the average, out of every 100 fires— 82 average $2 loss, or a total of $164 6é 66 66 666 cc ‘ce 84 6 14 3 66 25 ce oe 23 66 (73 es 2 66 35 ‘6 66 66 66 66 70 1 66 45 6é CG) 6e 66 66 45 1 66 55 66 6c OSG 66 6c 55 1 6c 65 66 6c 6 6é 66 65 1 66 75 66 tC 166 66 66 75 al 66 85 66 6c OS 66 66 85 2 66 99 66 Seuree 66 6c 198 100 A total of $916 If all these houses had been insured for their full value—$100 each—the loss to the companies would have been $916, or 9.16 per cent. of the face value of all the policies issued. If, on the other hand, each one had been insured for $10 the total amount at risk would have been 10 times $100, or $1,000, and the losses to the insur- ance companies would have been: 82 losses at $2 equals $164 Lae geese .1 Dic cath 180 $344 or 34.4 per cent. of the amount at risk. That is, without coinsurance the rate should be a degressive one, increasing as the amount carried on any property decreases. The rate of degression, worked out on the basis of actual experience, is, accord- ing to the New York investigation, as follows :?° : 20Report of Joint Committee, Feb. 1, 1911, p. 85. 1026 EFFICIENCY AND ECONOMY COMMITTEE. Insurance 10% of value Rate — 34% 20 hee 46 . 66 24 OG 30 cé 6é 6¢ é cé 20 ce 4O 6é (73 6¢ ce (77 17 c¢ 50 é c¢ c¢ 6é ce 15 ce 60 ¢é &¢ €¢ 6s ce 13 ce 70 cé 6¢ (f4 ce igs TZ cé 80 cé €¢ €é ce ceé 1} ce QQ ‘6 ce 6é ¢é cé 10 6é 100 (<9 ce t¢ 6é ¢é¢ 9 ce In other words, in order to get an equitable adjustment of the burdens of the cost of insurance, the rate should be based upon the two following principles: 1. It should vary with the hazards of each building insured ; 2. It should also vary with the amount of insurance carried, unless the coinsurance principle is adopted. In Illinois as a general principle the coinsurance clause is not in use, neither is there any provision for a degressive rate varying with the amount of insurance carried. The result is to favor the wealthy man and the larger corporations. Both of the latter can afford to take’a certain share of the risk themselves. The poor man and the smaller business cannot afford to take such risks. Consequently the first two classes insure less fully and are in most cases—that is, in 82 out of every hundred—amply protected, and, carrying less insurance, their expense on account of fire protection is smaller. The last two classes ought to, and probably do, carry fuller protection and, paying the average rate, their expense for protection against the fire hazard is necessarily heavier. The coinsurance system ought to be provided for by legislation, but since there seems to be an unwarranted prejudice against this equitable principle, the companies should be required to make their rates degressive, increasing as the face of the policy decreases, the rate of degression to be determined on the basis of actual experience of the state in regard to partial and total losses. It may be noted in connection with coinsurance that it is the normal method in European countries and it is probable that this condition partially accounts for the greater attention to fire protection, the lowed burning ratio and the reduced cost of insurance. SUMMARY AND CONCLUSIONS Fire insurance and insurance covering property risks generally is a business that requires cooperative action for rate-making purposes on the part of the companies undertaking to carry the various hazards and properly to protect the property owners. Otherwise the rates are unstable and discriminatory, and changes in rates and discriminations are likely to handicap unduly the small property owner and favor those who are better able to protect themselves. Moreover cooperation in rate-making is a very great economy, since one “book of estimates,” as the rate schedules are often called, _may be used by all the companies. Indeed it is practically impossible for the small companies to undertake to enter the business of writing FIRE INSURANCE RATES 1027 - insurance where they are obliged to prepare their own rate books. But rate-making by cooperative action permits and encourages monopolis- tic rates. This is especially true of commercial districts, where mutual companies generally find it undesirable to operate. On this account cooperative agencies should be recognized by law and required to _ Operate under the supervision of the State Insurance Superintendent. The primary object of schedule rating is to adjust the premium to the risk. Where this is scientifically done there is no discrimination in rates. Each property owner pays the average rate for his class of property risks. The law, therefore, should assist the cooperative rating agencies by prohibiting discriminations and authorizing the Insurance Superintendent to make investigations and order changes wherever it is found that discriminations actually exist. Whether the State Insur- ance Superintendent should be given the power to raise or lower rate schedules as a whole is as yet a controverted question. The Kansas law, enacted in 1909, has recently been sustained by the Supreme Court,”* and such power may, therefore, be legally granted. It may, therefore, be concluded: First: The average rate paid for fire insurance in the State of Illinois is higher than in the United States as a whole and higher than in some states even where the fire loss has been relatively greater. Second: The burning rate in Illinois, while higher than it ought to be, has been lower than in the United States as a whole and lower than in some of the states where building construction is of the same general character. Third: Rates have been made in Illinois for many years by cooperative associations without any supervision by the Insurance Department. | Fourth: Rate-making by cooperative associations of companies writing insurance in a given state is not only desirable, but necessary for the economical making of rates; and such rate-making is essential for equity as between individual risks or between similar classes of risks, unless the rate-making function is delegated to the Department of Insurance, as in Texas. Fifth: Rate-making by the state through the Department of Insurance is as yet in the experimental stage. If the state should make rates for insurance companies it ought also to make rates for railroad corporations and all forms of public utilities. Regulation of rates rather than the making of rates seems to be the wiser course at the present time. Sixth: Rate-making associations. are controlled by insurance companies. They should be required to report to the State Insurance Department and should be subject to regular examinations as insur- ance companies are. Seventh: Such associations by whatever name called should be prohibited from making discriminatory rates: (a) discriminating between risks of the same character in the State of Illinois; 22German Alliance Insurance Co. vs. Ike Lewis, as Superintendent of Insurance for State of Kansas, April 20, 1914. 1028 EFFICIENCY AND ECONOMY COMMITTEE. (b) discriminating between classes of the same general character in the State of Illinois; or (c) discriminating against Illinois risks, where compared with risks of the same general character in other states. Eighth: The State Department of Insurance should be clothed with sufficient power by an amendment to the insurance law to enforce effectively the above recommendations. Ninth: Since the department would be clothed with considerable discretionary power, it would probably be wise to put the general super- vision of rates under a commission, whose chairman should be the chief executive officer, or the Insurance Department should be united with the other regulating departments for purposes of control, retain- ing the Insurance Superintendent as executive officer. Tenth: Coinsurance should be permitted by law; and where policies are written without coinsurance the rates should be adjusted as explained in the section on coinsurance, so that persons protecting their property most fully would be required to pay the lowest rate, the rate progressing as the amount of the insurance carried grows less. In order to prevent the emergence of the moral hazard, as the amount at risk approaches the value of the property insured, the rate ought to be degressive until approximately eighty per cent. of the value of the property is covered, and after that point is reached the rate should become a fixed one, or increase in some geometric ratio as the face of the policy approaches the value of the property. ea : 1 : . \ ‘ s 7 ; f { rm i . Ee i x ‘ # / 4 a : ‘ ¢ ’ ‘ s t ? , ' 3 i a} : ' ‘ / A . , . * f Py r ‘ } * ~ ‘ + “ \ . 4 ; % , ‘\ y ’ : ‘ ' ~ f . 7 y s ‘ © RACs a 3) ) rou