Investment of Life Insurance Funds [Reprint 2016 ed.] 9781512817928

Table of contents :
Preface
Contents
List of Tables
Chapter I. Introduction
Chapter II. Factors in The Demand for Capital Funds
Chapter III. The Supply of Saving
Chapter IV. Management of The Life Insurance Investment Portfolio
Chapter V. Government Securities
Chapter VI. Real Estate Mortgages
Chapter VII. Corporate Debt
Chapter VIII. Corporate Debt (Continued)
Chapter IX. Real Estate and Other Property
Chapter X. Preferred and Common Stocks
Chapter XI. The Valuation of Assets
Chapter XII. The Influence of Government
Chapter XIII. A Century of Life Insurance Portfolio Management
Chapter XIV. A Century of Life Insurance Portfolio Management (Continued)
Appendix I. Experience with Use of Market Prices for Valuation, 1929-1948
Index

Citation preview

INVESTMENT OF LIFE INSURANCE FUNDS

T H E S. S. HUEBNER FOUNDATION FOR INSURANCE EDUCATION David McCahan, Editor

Lectures LIFE INSURANCE: TRENDS AND PROBLEMS THE BENEFICIARY IN LIFE INSURANCE LIFE INSURANCE TRENDS AT MID-CENTURY INVESTMENT OF LIFE INSURANCE FUNDS

Studies AN ANALYSIS OF GOVERNMENT LIFE INSURANCE AN ANALYSIS OF GROUP LIFE INSURANCE THE ECONOMIC THEORY OF RISK AND INSURANCE

INVESTMENT OF LIFE INSURANCE FUNDS Edited by

David McCahan, Ph.D. (G.L.U.) Executive Director The S. S. Huebner Foundation for Insurance Education

Blip® 11®

Philadelphia UNIVERSITY OF PENNSYLVANIA PRESS LONDON: GEOFFREY CUMBERLEGE OXFORD UNIVERSITY PRESS 1953

Copyright

1953

UNIVERSITY OF PENNSYLVANIA PRESS Manufactured

in the United States of America

Library of Congress Catalog Card Number 53-6951

THE

S. S. H U E B N E R INSURANCE

FOUNDATION

FOR

EDUCATION

T h e S. S. Huebner Foundation for Insurance Education was created in 1940, under the sponsorship of t h e American Life Convention, the Institute of Life Insurance, and the Association of Life Insurance Presidents (now the Life Insurance Association of America). Its primary purpose is to aid in strengthening insurance education on the collegiate level. It functions along three principal lines: 1. Providing fellowships and scholarships to aid teachers in accredited colleges and universities of the United States and Canada, or persons who are contemplating a teaching career in such colleges and universities, to secure preparation at the graduate level for insurance teaching and research. 2. Building u p and maintaining a research service center in insurance books and other source material which will be available through circulating privileges to teachers in accredited colleges and universities desirous of conducting research in insurance subjects. S. Publishing research theses and other studies which constitute a distinct contribution directly or indirectly to insurance knowledge. Financial support for the Foundation is provided by more than one h u n dred life insurance companies which contribute on the basis of their ordinary insurance in force. T h e program of activities is under the general direction of a Board of Trustees representing t h e life insurance institution, which Board has broad powers, including that of determining means for filling vacancies thereon. Actual operation of t h e Foundation and of its affairs has been delegated to the University of Pennsylvania u n d e r an administrative plan submitted by the University and approved by the Foundation Trustees. In accordance therewith the University has established an Administrative Board consisting of seven officers and faculty members of the University of Pennsylvania and two faculty members of other universities. It has also appointed an Executive Director. BOARD OF TRUSTEES Thomas I. Parkinson, President, Equitable Life Assurance Society of the U.S. (Chairman) Harrison L. Amber, President, Berkshire Life Insurance Co. Harold J. Cummings, President, Minnesota Mutual Life Insurance Co. Ernest M. Hopkins, Chairman of the Board, National Life Insurance Co. Leroy A. Lincoln, Chairman of the Board, Metropolitan Life Insurance Co. Edmund M. McConney, President, Bankers Life Co. William M. Rothaermel, Altadena, California Adolph A. Rydgren, Chairman of the Board, Continental American Life Insurance Co. Frank F. Weidenborner, Vice President, Guardian Life Insurance Co. of America ADMINISTRATIVE BOARD S. S. H u e b n e r , Honorary Chairman Harry J . Loman, Chairman David McCahan, Executive Director C. Canby Balderston Edison L. Bowers Roy F. Nichols Ralph H. Blanchard C. A. Kulp Edwin B. Williams

PREFACE

Life insurance companies rank among the great institutional investors of America. In the process of providing indemnity for lost life values, of writing annuities, and of furnishing many collateral services, they have accumulated billions of dollars in capital funds. These funds have been directed into numerous channels where they play an important part in strengthening the country's productive capacity, building national defense, and ultimately making possible an infinite variety of goods, services and satisfactions. T h e ways in which these funds are applied through investment are of great significance to policyholders who are dependent for their contractual benefits upon the safety and profitability of securities purchased. But they are also of great significance to the public generally whose standard of living has been raised by increases in, and improvement of, the capitalistic tools of production. Hence, an examination of the principles, practices, trends and problems associated with the investment process appears well warranted. That concept inspired this volume. T h e presentation of a volume such as this is in conformity with the policy established by the Administrative Board of T h e S. S. Huebner Foundation for Insurance Education, which places considerable emphasis upon the publication of material that will be especially useful to college or university teachers of insurance in their instructional work. As elsewhere stated, this publication policy has been influenced by the following primary considerations: (1) The conviction that every teacher who keeps faith with the ideals of his profession wants to be fully informed on all matters of consequence in the realm of his specialty. (2) The realization that college and university instruction in insurance has already reached, and will continue to reach, far more students in the broad domain of economics, government, vii

viii

PREFACE

sociology and their subdivisions than in such specialized vocational subjects as insurance law, actuarial science and insurance medicine. (3) The recognition that a teacher in the social science subjects must obtain a broad comprehension of the life insurance institution as a whole in its social setting. This must be an "over-all" view which not only includes the structure, functions and services of this institution but also its manifold interrelationships with other institutions which make up American life today. (4) The realization that analysis and thorough study of all the technical literature in life insurance is a time-consuming process which is frequently prohibitive for the teacher whose duties require that he have an equally broad grasp of other important economic and social institutions. T o keep himself conversant with all the developments and the new ideas which are presented in the journals of the actuarial societies, the medical directors, the agency executives, the insurance lawyers, the life underwriters, etc., and to be reasonably well informed on matters of importance which have not been there presented, is no small task. Thus far, the Foundation has undertaken the issuance of two series of volumes, known as "Huebner Foundation Lectures" and "Huebner Foundation Studies," the first series comprising a compilation of addresses on selected insurance topics and the second presenting the results of thorough research in specific areas. This is the fourth volume in the "Lectures" series. As was the case with its predecessors, it contains a series of lectures given under the auspices of the Foundation at the University of Pennsylvania. Each of the lectures in the present series was delivered at a dinner meeting attended by fellows and scholars of the Foundation and teachers from the Insurance Department faculty. In following this procedure, members of the Foundation's Administrative Board had in mind the desirability of enabling these present and future teachers of insurance to enjoy the privilege of hearing outstanding authorities, with a background of broad experience in the life insurance field, discuss the subjects assigned to them. The primary directing principle followed in the selection of the speakers was their capacity to make a worthwhile contribution to the thinking of this teaching group. Publication of these manuscripts was authorized by the Ad-

PREFACE

ix

ministrative Board of the Foundation with the sincere hope, and in the confident belief, that their range of usefulness might be extensively widened through making them available to other teachers and students of insurance who could not hear the original presentation. It was felt that such publication would be in full accord with the policy above set forth. As was the case with the first three volumes of lectures, this one is of significance, not alone because of the high standing in the life insurance world of those who have made it possible and the inherent quality of their respective contributions to it, but because it reflects the continuance of an organized effort to provide a literature especially intended for teachers in the broad field of the social sciences. Conscious as these teachers are of the complexities and ramifications of the subjects with which they deal and the frequent inconclusiveness of the researches therein, they are nevertheless zealous to broaden their understanding and enrich their teaching. T o them this volume is dedicated. Through them it is hoped that research may be stimulated. From them will be welcomed substantial participation in the subsequent studies, monographs and other materials which are published under the auspices of this Foundation. T o Dr. G. Wright Hoffman, Dr. James J. O'Leary and Dr. Charles R. Whittlesey who made helpful suggestions on the topics to be included and potential authors; to each of the various lecturers whose name appears in the Table of Contents and in the specific chapter which he prepared, and who has helped to make this volume possible by his gracious, competent and generous participation; and to Miss Mary Drever who has rendered valuable editorial assistance, the editor acknowledges his deep indebtedness and hearty appreciation. It should in no wise detract from the quality of the volume to point out that expressions of opinion which may appear in publications of the Huebner Foundation are those of the authors and not of the Foundation itself. D.McC. Philadelphia January 1953

CONTENTS

CHAPTER

FACE

PREFACE

I

Ή

INTRODUCTION,

1

by David McCahan

How Life Insurance Generates Saving Hedging Debts Against Debts Basic Investment Problems A Brief Review II

FACTORS IN THE DEMAND

FOR

1 4 6 7 CAPITAL FUNDS,

by

Simon S. Kuznets

9

Introduction T h e Longevity of the Asset or User Internal Savings and External Funds Long-Term Debt and Equity Problems of Measurement III

9 10 16 22 25

T H E SUPPLY OF SAVING, by R a y m o n d W . G o l d s m i t h Sources of Information on Supply of Saving Current Series Historical Series Characteristics of the Supply of Saving Since 1900 Changes in Total Supply Distribution Among Saver Groups Significant Changes in Forms of Saving Share of Life Insurance in Personal Saving

IV

MANAGEMENT OF THE L I F E PORTFOLIO,

INSURANCE

31 35 34 41 44 44 46 48 54

INVESTMENT

by Robert B. Patrick

Investigation and Analysis of Investment Opportunities Of Securities Of Mortgages and Real Estate Acquisition of Securities From Investment Bankers By Direct Negotiations xi

56

57 58 60 62 63 65

xii

CONTENTS

CHARTE»

PACE

By Competitive Bidding Through Financial Correspondents Disposal of Securities Diversification Capital Gains Analysis of Investment Results

V

G O V E R N M E N T SECURITIES, by

67 68 72 74 75 77

Willis J. Winn

T h e Significance of the Government Bond Portfolio General Characteristics of Government Securities U. S. Government State and Municipal Foreign T h e Investment Attributes of Government Securities U. S. Government State and Municipal Foreign Life Insurance Company Investment Operations in Government Securities U. S. Government State and Municipal Foreign T h e Investment Problem VI

R E A L E S T A T E M O R T G A G E S , by L .

Douglas Meredith

Life Insurance Mortgage Holdings Changes in Mortgage Lending Advantages of Mortgage Loans as Investments Disadvantages of Mortgage Loans as Investments Review and Appraisal Possible Improvements in Mortgage Lending

VII

CORPORATE DEBT,

by Arnold R. La Force

Suitability of Corporate Debt for Life Insurance Investment Availability of Corporate Debt for Investment Broad Trends of Corporate Bond Investment by Life Insurance Companies from 1921-51 Prosperity Decade-1921-30 Depression Decade-1931-40 World War II Period-1941-45 Postwar Period—1946-51

VIII

CORPORATE DEBT

(Continued), by Arnold R. La Force

Relative Characteristics, Importance, and Outlook of Different Types of Bond Investments

78 78 80 80 83 84 85 85 87 89 89 91 94 95 95 100

100 102 104 108 112 113 H7

119 121 135 136 140 144 145 151 151

xiii

C O N T E N T S CHAPTER

PACE

Railroad Bonds Public Utility Bonds Industrial Bonds Equity Capital Problem Direct Placements Conclusions

IX

151 152 154 157 163 167

R E A L ESTATE AND O T H E R PROPERTY,

by John G. Jewett 173

Types of Real Estate Available for Investment Types of Leases Available "Sandwich" Lease Long-Term Net Lease Legislation Real Estate Investment Portfolio Investment in Transportation Equipment Summation X

PREFERRED

AND

COMMON

STOCKS,

by

174 175 176 177 181 182 184 185 G.

Wright

Hoffman

186

T h e General Pattern of Investment Some Background Facts Principles of Life Insurance Investment T h e Position of Preferred Stock Background Characteristics of Prefcrreds T h e Position of Common Stock Background Some Arguments in Favor of Common Stock Some Arguments Against Common Stock Comment—Pro Comment—Con Some Quantitative Evidence Experience of the Eighteen Largest Life Companies Experience of Seven New England Companies Investing for a Widow Problem of When to Buy Summary—Outlook

XI

T H E V A L U A T I O N OF A S S E T S ,

by Sherwin

C.

Present System of Valuation a Hybrid Four Unpredictable Factors T h e Valuation Problem of Direct Placements Recommended Principles Some Significant Facts

Badger

186 187 190 191 191 192 193 193 194 195 196 199 200 200 204 207 210 211 213

214 215 217 219 222

CONTENTS

χίν CHATTE*

PACE 224 225

Valuation of Stocks Progress Made XII

T H E INFLUENCE OF GOVERNMENT, by J a m e s J. O ' L e a r y Historical Framework of Life Insurance Company Investing Federal Reserve Policy and Life Insurance Company Investments Treasury Policy and Life Insurance Company Investments Influence of Housing Policy of the Government Some Policy Questions at the Federal Level with Respect to Life Company Investments Conclusion

227

The

ΧΙΙΙ

A CENTURY OF LIFE INSURANCE PORTFOLIO MANAGEMENT, by George T. Conklin, Jr. Factors Conditioning Life Insurance Investment T h e Economic Forces at Work in O u r Economy T h e Accumulation of Capital T h e Demand of O u r Economy for Capital—Dynamic Growth Free Enterprise and Competition Regulation State Regulation Present Insurance Laws Federal Regulation Internal Characteristics of the Life Insurance Industry A Guaranteed Fixed Interest R a t e on Policy Reserves Competition and Free Enterprise in the Life Insurance Industry Growth and Stability of the Industry—Long-Term Predictable N a t u r e of Liability Trusteeship Summary

XIV

229 232 233 235 244

246 246 246 246 247 248 249 250 251 254 255 255 258

and

A CENTURY OF LIFE INSURANCE PORTFOLIO MANAGEMENT (Continued), by George T. Conklin, Jr. Portfolio Changes Over a H u n d r e d Years Life Insurance Investment Around 1850 Premium Notes, Defen-ed and Outstanding Premiums, Policy Loans Cash Mortgages Real Estate United States Government B o n d ·

227

258 258 261

262 262 262 263 265 266 270 271

CONTENTS CHAPTEÄ Municipal Bonds Corporate Bonds Railroad Bonds Public Utilities Industrial Bonds (All Other Bonds) Stocks Conclusion

XV PACE 274 276 276 279 282 284 285

APPENDIX I—EXPERIENCE WITH USE OF MARKET PRICES FOR VALUATION, 1 9 2 9 - 1 9 4 8 INDEX

289 »5

CHARTS: T h e Growth of Net National Saving Distribution of Net National Saving Among Main Saver Groups Cumulative Change in Outstanding Long-Term Public and Private Debt, by 5-Year Intervals 1920-1950 Selected Annual Rates of R e t u r n on Cost for the Combined Investments of the 18 Largest U. S. Life Insurance Companies, 19291950

PAGE 47 49 189

202

LIST OF TABLES

TITLE PAGE

Comparison of Private Long-Term Debt with Privately Held Durable Assets in the Country, U.S.A., 1900-48 Sources and Uses of Corporate Funds—Totals for 1947-51 Quarterly Estimates of Total Personal and Personal Liquid Saving, 1947-51 Personal Saving Estimates of Department of Commerce and Securities and Exchange Commission

21 26 35 38

Main Components of Non-Farm Individuals' Saving; Current Values (Percent of Total Non-Farm Individuals' Savings) Life Insurance Company Investment Yields 1945-50

50 106n

U. S. Net Public and Private Debt, End of Calendar Year. 1921-50

122-123

Growth of Representative Forms of Individual Savings 1910-50

128-130

Sources and Uses of Corporate Funds for Five Years 1946-50 Inclusive (Excluding Banks and Insurance Companies)

132

U. S. Life Insurance Companies' Holdings of Corporate Bonds

134-135

New Money Financing, All United States Corporations

138-139

U. S. Net Corporate Long-Term Bonds and Notes Outstanding

153

Profits, Dividends and Undistributed Profits of American Corporations

159

Comparative Trend in Debt-Equity Ratios during Postwar Period for Manufacturing Companies and Electric Companies

160

T h e 22-Year Average Annual Rate of Return on Cost of Selected Types of Securities for the Combined Investments of the 18 Largest U. S. Life Insurance Companies, 1929-50 Current Return on the Combined Common Stock Holdings of Seven New England Life Insurance Companies, Annually, 1939-50

206

Annual Dividend Yield Based on Original Cost of Investment for Widow

208

xvU

203

CHAPTER I

INTRODUCTION By

How

DAVID

MCCAHAN*

L I F E INSURANCE GENERATES SAVING

T h a t the operations of life insurance companies in the twentieth century should generate a substantial volume of saving is inevitable. T h e r e are a n u m b e r of underlying reasons for this but foremost among them is the very elementary b u t highly significant fact that the probability of death rises with an increase in age. Were this not so, life insurance could be written on m u c h the same general basis as fire insurance or numerous other forms of property a n d casualty coverage. T h e procedure would be essentially one of spreading over the many the losses of the few through the "magic of averages." And the principal capital f u n d s arising from the process would be from premiums paid in advance, incurred losses not yet paid out, or those funds which are contributed directly or indirectly to guarantee that losses will be met in the event that the spreading should not function smoothly. I n other words, the aggregate capital funds incident to the business would, with respect to the volume of risk assumed, probably be on about the same scale as we associate with certain other lines of insurance. But when we start with this rising rate of mortality a n d then couple with it the understandable reluctance on the p a r t of the public to pay a premium that would, after age 10, continuously increase with age until it would reach prohibitive levels, we realize that the level premium plan is the only practical way in which life insurance can be written for individuals on any substantial scale. * Professor of Insurance, Wharton School of Finance and Commerce, University of Pennsylvania; President, American College of Life Underwriters; Executive Director, T h e S. S. Huebner Foundation for Insurance Education. 1

2

INVESTMENT OF LIFE INSURANCE FUNDS

T h e writing of annual renewable term policies on separate lives may be theoretically possible and have some uses of limited application, but as a general solution for providing life insurance coverage it is impractical. Group contracts constitute an extremely important exception but do so only because the conditions under which the group is composed and the manner in which the cost is spread over employer and employees tend to minimize lapsation, cut the expenses of operation, and conceal (at least from the mass of employees) the effect of the rising mortality cost. In substance, the operation of a group life plan, with minor exceptions, does give participants not only a fixed premium, but one which for older employees is fixed at a level under actual cost. Level premiums actuarially related to a rising mortality rate obviously involve a charge which during early years will be greater than the actual mortality cost. This excess must be retained and kept safe for policyholders. Moreover, life insurance companies must set up as a liability on their books a reserve which can be popularly thought of as representing this excess even though it is measured with reference to the obligations of the future rather than the experience of the past. Because of the state legislation respecting the basis for constituting this liability, it has come to be known as the "legal reserve." Although the amount of life insurance reserve for any given company in proportion to the face value of its outstanding contracts will necessarily vary with a number of different factors, of which the type of contract is an exceedingly important one, the aggregate becomes substantial with the passage of time and the growth in volume of business. Parenthetically, it should be noted that the excess payments incident to the level premium system, to which reference has been above made, also give rise to certain nonforfeiture values on the part of the policyholder. A schedule of such values, based upon certain mortality, interest and expense assumptions, is incorporated into his contract at issuance. T h e options which he is given of receiving extended term insurance, taking a fractional paid up policy or surrendering for cash are, as is also the case with the right to borrow, related to the excess that he has paid in premiums over and above what is necessary to meet the costs up to the time that such a right is exercised. T h e worth of these pre-maturity

INTRODUCTION

3

rights has been widely recognized by policyholders, especially in times of emergency. T h e accumulation of saving inherent in the process of providing insurance protection is accentuated by single or limited premium payment methods under which the policyholder pays for his contract in one sum or makes payments during a period which is shorter than that for which his insurance runs. T h e development and utilization of contracts—such as endowment insurance or retirement income insurance—that emphasize the building up of funds for meeting some living need of the policyholder himself, as well as providing death benefits, further contributes to the saving as does the exercise of certain dividend options granted by participating companies. T h e settlement options that have become so popular with the insuring public during recent years do not, it is true, directly foster the accumulation of saving but they do retard the liquidation thereof so that in the aggregate the amounts of policyholder savings held by the life insurance companies have grown more rapidly than would otherwise be the case. In fact, numerous features of modern life insurance that have been devised to meet more conveniently and effectively the financial problems both of survival and of death have stimulated the generation of saving through life insurance. But life insurance companies also write annuity contracts. As respects some of these, such as single premium immediate annuities, the function of the company is not one of accumulation but of systematic liquidation with reference to life contingencies. T h e funds which it has received in payment have been accumulated elsewhere and transferred to it. But with respect to many, such as annual premium deferred annuities, the function may be primarily one of accumulation for many years until the contract reaches the "pay out" stage. Even group annuities, under which some participants have begun to draw benefits, will normally involve an accumulation that takes place much more rapidly than any liquidation. T h e net effect in the aggregate of the annuity business written by life insurance companies has therefore been one of growth in saving. T h e trio of functions—indemnification, accumulation, and liquidation—that are reflected in the life insurance and annuity business are closely interrelated. They may be combined in an

4

INVESTMENT

OF LIFE INSURANCE

FUNDS

infinite number of ways to produce a variety of contracts with multiple useful and attractive features. In these combinations, sometimes applied concurrently and at other times consecutively, they can be flexibly adapted to meeting varied and often changing needs both of policyholders and of their dependents. And the greater the extent to which the life insurance institution and its representatives show their ingenuity and initiative in applying these functions for the service of the American public, the greater the probability that the effect of their joint operation will be a continued and substantial generation of savings. HEDGING DEBTS AGAINST DEBTS

As has been previously implied, the measure of a life insurance company's liability to its policyholders for the saving that has been created is ascertained prospectively rather than retrospectively. T o put this another way, the actuaries proceed to calculate the present value of future claims on all of the many and varied contracts outstanding and then to subtract from it the present value of future premiums. Probabilities of death and survival, interest and expenses all enter into these calculations at one point or another, the fundamental objective being to get at a figure which, with the addition of future premiums and interest, will enable the company to satisfy all claims as they come due. This reserve, as it is called, is obviously a group concept representing, as it were, the company's aggregate liability to all of its policyholders. The quality of the company's selection and underwriting as well as mortality, interest and other assumptions, will necessarily have a bearing upon its accuracy. There are of course other liabilities on a company's balance sheet but the reserve for any established company is so predominantly important (representing normally from 85 to 90 per cent of all liabilities, special reserves, capital and surplus combined) that its very nature governs the legal requirements and practice pertaining to investment of assets. This is not the place to discuss either the state laws respecting the types of investments that a life insurance company can purchase, the distinctive characteristics of the investments actually held, or the trends in company investment policy. Various phases of these subjects in addition to many other subjects will be covered fully in subsequent chapters. All that we need to recog-

INTRODUCTION

5

nize now is that both by legislative mandate and company practice the emphasis has traditionally been upon investment in interest bearing liens or debts through the instrumentality of bonds and mortgages. Only in recent years have equities had any place of consequence in the investment portfolio and even today that place is relatively small. T w o general observations at this point, however, are warranted. One is that in the eyes of legislators and company executives, the investments of life insurance are in the nature of a trust f u n d and should be handled in accordance with fiduciary principles even though the relationship between a company and its policyholders is that of debtor-creditor rather than trustee-beneficiary. T o put this a different way, despite the fact that the rights and obligations of the parties arise from a contract and not from a trust, and are accordingly subject to contract rather than trust law, there is a quasi-trust philosophy that permeates and determines investment administration. T h e second observation is that the process of purchasing liens or debts which appear on the asset side of the balance sheet to offset the debts due to policyholders that are comprised in the legal reserve and related obligations on the liability side is in substance hedging debts against debts. Obviously, to the extent that the liabilities have been accurately stated, it is important that the counterbalancing assets be equal in volume, but it is also important that in their safety, stability of value, diversification, maturity distribution, yield and other qualities they show good promise of meeting over a period of time all of the requirements growing out of the peculiar characteristics of the liabilities that the company has assumed. T h i s process is, of course, a continuing one, with frequent changes both in assets and liabilities. T o the degree that assets offset capital, surplus, or special reserves that constitute earmarked forms of surplus, it can be argued that the debt-hedging concept above outlined is not applicable and that life insurance companies should be permitted to own types of assets other than liens. T h e provision of some state laws permitting purchase of common stocks in an amount not to exceed the company surplus is probably founded on such a belief. But policyholders have a vital interest even in this excess since it provides the cushion to assure the soundness of their contracts in case

6

INVESTMENT OF LIFE INSURANCE FUNDS

of unexpected losses or contingencies. Hence, speculation with it would not be warranted irrespective of the fact that it does not constitute a liability. T h e directions in which it can be applied in our economy are therefore not without limitations. BASIC INVESTMENT PROBLEMS

The magnitude and rate of growth in investments that have come into the hands of life insurance companies as a result of the processes heretofore outlined pose numerous and intricate problems. Many of these are economic since the funds placed in private enterprises must be employed in a productive manner to yield goods and services out of which interest and principal repayment will be assured. Even those loaned to government must be backed by potential revenue from taxes or other sources that will enable the lender to rely on the promises in the bonds it has received. Some are social. Fortunately, economic and social soundness are frequently to be found in the same investments so that the life insurance companies which apply appropriate economic tests in the disposition of their funds have found that their action more or less automatically redounds to the welfare of the public. Nevertheless, there are times when a proposed investment may be fully eligible on economic grounds but companies may decide that it has dubious social values that would result in public criticism. And there are other times that proposed investments have within them the possibility of yielding worthwhile social values but not on a sound financial basis. T o purchase them would mean "robbing Peter to pay Paul" inasmuch as the policyholders who would lose by this would suffer an impairment in the social values for which they had been buying life insurance. And then there are political problems. The very size of life insurance company portfolios constitutes a temptation to some who are politically minded. They have seen within it infinite and potent possibilities for vote-getting. Moreover, economic planners who think in a different set of principles than those that have characterized the private enterprise life insurance system would like to fit this institution into their own orbit. The prevailing Federal political philosophy of the past two decades has naturally tended to focus attention on this conflict of ideologies. Problems of the type to which allusion has been made prompted

INTRODUCTION

7

the preparation of this volume. They suggested the desirability of marshalling the facts on what had been done, of studying the principles on which the companies have operated, of understanding the environment in which life insurance investing has functioned, of visualizing the difficulties that have been confronted, and of interpreting the trends. These will be discussed in the following chapters by authorities who are exceptionally well qualified in their respective fields. At this point it will suffice to sketch briefly the thinking that underlies the organization and arrangement of the subject matter. A

BRIEF REVIEW

T h e savings accumulated through life insurance are of primary concern in the supply side of the equation that determines the condition under which savings will be used and the rate of return they will yield. But they are only one part of that supply. Moreover, life insurance investing is not conducted in an economic vacuum. Capital funds are subject to demand as well as supply forces that affect all other units that may have a use for them. Hence, the nature of these forces and the extent to which they are susceptible of measurement are of basic concern to insurance economists and investment officials even though they are broad in scope, often intangible in character, and normally do not point to precise solutions of immediate problems. T h e next two chapters have to do with the factors in the demand for capital funds and with the supply of saving. Their very nature suggests the wide range of influences that impinge upon life insurance in its operations as an important, constructive and closely integrated segment of our entire American economy. Depicted as it were against this broad economic background, and coming next in order is the management of the life insurance investment portfolio. Techniques of acquisition and disposal are presented, with the pros and cons of controversial procedures outlined. Then follows, in four succeeding chapters, a discussion of the important areas of debt in which the big bulk (over 86 per cent at the end of 1951) of life insurance assets is invested. They are three in number, (a) government (including Federal, state, municipal and foreign), accounting for 20 per cent of all assets; (b) real

8

INVESTMENT OF LIFE INSURANCE FUNDS

estate mortgages (both farm and urban), accounting for 28.3 per cent; and (c) corporate (railroads, utilities and industrial), accounting for 38.1 per cent. In view of the growing interest and activity during recent years in equities as a possible outlet for life insurance funds, two chapters are devoted to the principal developments and problems. One has to do with ownership of income producing real estate and other property; the second with common stocks. A considerable portion of the latter is concerned primarily with "commons" and with the problems incident to fitting them into the framework of investment principles that presumably should constitute the tenets of sound investment policy. The valuation of assets comes next. This is a subject with many ramifications, not the least of which is its effect upon the direction of investment flow. With cash income normally exceeding outgo, with maturity of liabilities spread widely over a period of time, and with receipts from interest, amortization and principal repayments predictable and dependable, the surplus of a life insurance company can for all practical purposes be relatively small in relation to liabilities. But much depends upon the basis on which assets are valued for balance sheet purposes. The critique of valuation methods here presented is instructive and thought provoking. Then comes a chapter on the influence of government, with particular focus upon that of the Federal Government during recent years. The tremendous burgeoning of Federal power, and the objectives and practices associated therewith, could not have transpired without having some significant effects on life insurance investments. Accordingly, this chapter should challenge the thinking of those who are deeply concerned with the direction in which political forces have been attempting to move our economic and social institutions. But let it speak for itself. And finally, for a broad view of portfolio movements over a long period of time, are two chapters which show the mobility of life insurance funds and their adaptability to the economic needs of the country. Reflected in the results are the dynamic and competitive efforts of many different individuals who have been studying the past and scanning the future in their efforts to make wise decisions.

CHAPTER II

FACTORS IN T H E D E M A N D CAPITAL FUNDS

FOR

By SIMON S. KUZNETS* INTRODUCTION

Capital, as the term is used in the title of this chapter, implies a minimum length of time for which the f u n d s are committed or tied up, by intention. T h e m i n i m u m period that distinguishes short- from long-term, or current from capital, funds is partly a matter of judgment; and prevalent practice does not seem to be uniform. But there is little need for fine distinctions here; and it may be sufficient to suggest that by long-term we mean a period well over a year or two, and perhaps a m i n i m u m of five years. 1 Funds, in the present context, imply means of purchase advanced to the user by another party. Long-term "financing" may, of course, be undertaken by the user of a capital asset out of his own means. But we are concerned here with the demand for other people's funds, and would have used the term "loan" except that the latter implies debt not ordinarily associated with funds advanced by the purchase of stock. If demand for long-term funds means any and every desire to borrow, without obligation to repay the principal for years to come, it far outruns at any given time the volume of long-term funds that can be expected to materialize. For unless charges are • Professor of Economics and Statistics, Wharton School of Finance and Commerce, University of Pennsylvania; Director of Study on "Capital Formation and Financing in the American Economy" sponsored by the Life Insurance Association of America and conducted by the National Bureau of Economic Research. The author expresses his indebtedness to Messrs. Raymond W. Goldsmith, Leo Grebler, and James J. O'Leary for comments that made for significant improvements in the original draft of this paper. 1 In Private Long-Term Debt and Interest in the United States (National Industrial Conference Board, 1933), p. 2, Leonard Kuvin defines long-term debts as those running for a period of at least five yean. 9

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INVESTMENT OF LIFE INSURANCE FUNDS

so high that the funds are in fact repaid within a short time, most borrowers of short-term money would prefer long-term funds—which would free them of the obligation to repay, or at least to prove the capacity to repay, for a long time to come. It would only confuse the discussion if we were to consider all possible desires for long-term funds without limiting them to cases that have sufficient economic justification to warrant their serious consideration by would-be lenders, i.e., to those uses in which the prospective borrower reasonably can be expected to meet all the conditions of the loan. Hence, in dealing with factors determining the demand for long-term funds our emphasis is on such cases, granted the limitation of the available supply of such funds. In that sense, our examination becomes one of the economically justifiable needs for long-term funds. 2 T H E LONGEVITY OF THE ASSET OR USER

In general, the tying up of funds is economically justified when the asset that absorbs the funds is itself long lasting, i.e., possesses economic longevity in that it continues in use and yields returns for a long period. Such longevity of the asset may arise out of different sources, the distinction among which is important for a glimpse of the factors that determine the demand, in our sense of the term, for capital funds. If an asset remains physically intact in the process of economic use without suffering rapid obsolescence, and only loses value quite gradually, then it, being tangible and separable from the user, can serve as security, and the longevity of the user himself may become a secondary consideration. We may then have a realistic demand for long-term funds, whether or not the user himself is long-lived—provided that he is not among the exceptions who introduce a risk of economic loss where it otherwise does not exist. But demand by short-lived users (e.g., individuals) for funds to finance short-lived assets (e.g., food) or even long-lived but intangible assets (e.g., education of free men in 2 This is an oversimplification since, as a matter of fact, many long-term capital investments have been financed by a succession of short-term borrowings. In reality, there is no sharp line between economically justifiable bases for long- and for short-term funds. Yet one must be drawn for analytical purposes, on the assumption—always subject to check—that even a rough model conveys the main features of the real situation.

FACTORS IN DEMAND FOR CAPITAL FUNDS

II

our society, but not that of slaves in a slave society) provides no justifiable economic basis for long-term financing by outside funds. However, if the user possesses the virtue of economic longevity, it may not matter that the individual asset, or even a specific group of assets, is short-lived; longevity is assured by the characteristics of the user, rather than of the physical asset. If it may be assumed that a business corporation—one which is not just a cloak for an individual or family business—lives forever, regardless of how short the life of its machines or of specific items of its inventory, any and all assets of the corporation, i.e., anything that may be considered tools necessary for the functioning of the corporation as a living economic entity, becomes a basis for an economically justified demand for capital funds. That demand may not necessarily be met, and will not be met in all cases. However, past experience shows that corporations have used capital funds to finance acquisition of some types of assets that could not have been financed by individuals or unincorporated business by long-term funds. T h e longevity of the asset may then arise not only out of its physical characteristics but out of the life characteristics of its user. We view a business corporation as a viable economic unit, whose function is to provide service payable in terms of profit, so that the earning of profit becomes a testimony of the serviceability and hence vitality of the unit. It follows, therefore, that all outlays that do not carry with them a sufficient return, not only of the principal but also of some adequate earning, are inimical to the life of a corporation; and if so, they cannot become a justifiable basis for demand for capital funds. This, of course, explains the aversion to the use of long-term (and for that matter any) funds for business expenditures that cannot be demonstrated to be profit yielding and hence assuring the economic longevity of the user unit. But there are legal entities that are not in business, in the sense that their function is not to earn profits, and their services are judged by other criteria. T h e success of these units, the non-profit corporations and particularly the governments, is not tested on the market; they are expected to render services, and to gather the means for them by fees, contributions, or taxes (overt, or

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I N V E S T M E N T OF LIFE INSURANCE FUNDS

in the case of inflation, hidden). They may need capital funds, either because they need costly durable assets, or sometimes, particularly in the case of governments in times of emergency, because there is a sudden rise in current outlays that cannot be met by current revenues. In either event, in determining whether the demand for capital funds is justifiable, it is not a question of whether the funds are intended for acquisition of long-lived real assets or for current expenditures, but rather one of the longevity of these institutions, both as performers of the basic services they are designed to render and as collectors of fees, donations, taxes, or any other current revenues. Here the longevity of the asset, if one can refer to an asset at all, lies not in the life of its physical embodiment nor in that of the user as a profit-making solvent business unit, but rather in the longevity of the public entity as a performer of recognized basic services and as a dominant claimant to sources of current revenue adequate to discharge future obligations. These elementary distinctions among the sources of longevity of an asset help us to understand some of the major factors that determine the demand for capital funds. In a growing economy such as ours, the demand for long-term funds, whether internal or external to the user, would grow because of: (a) increase in population, and continuous changes in the patterns of technology of production and in modes of life reflected in ultimate consumption. These all may, and do, spell increasing needs for tangible long-lived durable assets—houses, producers' and consumers' equipment, roads, etc.—regardless of the length of life of the individual user of these assets; (b) increasing scope of activity of business corporations, vis-à-vis unincorporated business, which provides a basis for long-term financing even of assets physically short-lived or intangible; (c) increasing scope of activity under the auspices of nonbusiness legal entities, of which some, notably the Federal Government, may call for extensive capital funds to cover current outlays rather than acquisition of capital goods. T h a t there has been a marked rise in the absolute magnitudes under these three heads is obvious and needs no documentation. But what are their magnitudes relative to some measure of economic activity? If we agree to use national income or net national product (I use the two terms interchangeably), a measure of the

F A C T O R S IN DEMAND F O R CAPITAL FUNDS

13

total net output of the economy, as a yardstick, some comparisons can be made. For the tangible durable assets listed under (a) we may take structures, producers' durable equipment, consumers' durable goods, and land. T h e value of these assets, in 1929 prices, was estimated by Raymond W. Goldsmith to be roughly $150 billion at the end of 1896, $360 billion at the end of 1928, and $384 billion at the end of 1948. These values are net of accumulated depreciation, which partly explains the mild rise in the totals from 1928 to 1948; and they exclude stocks of military equipment and military construction by the Government. We can calculate national income, also in 1929 prices, as roughly $27 billion for 1896-97, $84 billion for 1928-29, and $123 billion for 1948-49. T h e ratio of total tangible durable assets to income has thus declined, from about 5i/¡ to 1 at the end of the 19th century, to 4.3 to 1 in 1928, to 3 to 1 in 1948. Part of the decline is due to the relative stability, since the end of the 19th century, of the land component. T h e value of durable assets excluding land is $86 billion in 1896, $254 billion in 1928, and $305 billion in 1948; and their ratio to national income is 3.2, 3.0, and 2.5 respectively, still showing a secular decline but milder than that in the ratio based on durable assets including land. Thus, while there has been a spectacular and enormous increase in the domestic stock of tangible durable assets, and hence in the basis for long-term funds (internal and external), it has not been as great proportionately as in national income. 3 There are some indications, however, that the growth in reproducible durable assets was more than proportional to the growth in national income during the latter part of the 19th century, so that the ratio of their stock to national income increased. T h e decline in the ratio thus came largely in the 20th century. 4 T h e reasons 3 T h e figures on value of tangible durable assets are from Raymond W. Goldsmith's paper, "A Perpetual Inventory of National Wealth," Studies in Income and Wealth, Volume Fourteen (National Bureau of Economic Research, 1951). particularly Table 1, pp. 18-19. T h e estimates of national income are rough annual approximations underlying the decade averages given in the author's National Product since 1869 (NBER, 1946). * Structures and equipment (excluding land and consumers' durables) in 1929 prices increased from about $30 billion at the end of 1878 to about $863 billion at the end of 1898 (National Product Since 1869, Table IV-11, p. 230). Net national product, again in 1929 prices, averaged $13.6 billion in 1874-83 and $29.8 billion in 1894-1903 (ibid., T a b l e II-16, p. 119). T h e ratio of the

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INVESTMENT OF U F E INSURANCE FUNDS

for this decline cannot be discussed here, for they would take us too far añeld. But it may be noted that many capital-intensive industries, such as the public utilities, have been turning out more net product with the same or smaller stock of durable capital goods; that the proportion in national income of various types of services not requiring large fixed capital has increased; and that the rise in the share of the Federal Government in national income in recent years has not been accompanied by an equal rise in its share in the stock of durable capital. On the extension of the relative scope of corporations in the national economy, listed under (b), our data are even more scanty. We know that the proportion of corporations in the nation's economy grew rapidly during the late 19th century, but quantitative data are not at hand. A rough approximation to the share of corporations in national income is given by Willford I. King, who sets it at 39 per cent in 1899 and 44 per cent in 1909.® For recent years, the Department of Commerce has apportioned national income totals by legal form of organization." The figures show that income originating in corporate business in 1929 was about 58 per cent of income originating in all business and about 52 per cent of national income; the corresponding percentages for 1950 were 63 and 55 respectively, thus indicating a slight rise in the share of corporations in both. T h e bearing of these figures upon the question of interest here—the share of corporations in those nondurable or intangible assets that might provide the basis for capital funds when handled under corporate auspices and could not when handled by individuals or unincorporated business—can only be conjectured. But it is legitimate to infer that the proportions in the areas we are trying to guess at must have increased rapidly during the last quarter of the 19th and perhaps the first quarter of the 20th century, and only slowly thereafter. stock of durable assets to national income increased, therefore, from 2 2 to 1 to 2.9 to 1. The ratio for the later date is lower than that derived by Dr. Goldsmith, partly because consumers' durable commodities are excluded here and partly because Dr. Goldsmith revised the allocation between land and structures, assigning a higher ratio to the latter. * See The Wealth and Income of the People of the United States (Macmillan, 1915), Table XLII, p. 211. • See the 1951 National Income Supplement to the Survey of Current Business, Table 12, pp. 156-7.

FACTORS IN DEMAND FOR CAPITAL FUNDS

15

On point (c), the increased scope of non-profit agencies, particularly governments, the major item of quantitative evidence is, of course, the public debt. Our specific interest is in the long-term debt contracted to cover current outlays, rather than to acquire any tangible assets—the particular basis upon which governments and the like can demand and receive capital funds, and individuals and business units cannot. But we shall perhaps commit only a minor error by assuming that the debt of the Federal Government, most of which originated in war outlays, financed current expenses that did not represent any marked additions to tangible real assets. The debt of the Federal Government (gross) was somewhat over $2 billion in the 1870's when national income, in current prices, ranged about $6.5 billion; declined to about $1 billion (either gross or net) in 1915-16, when national income was about $37 billion; rose to well over $20 billion (net) as a result of World War I, and in 1946, after World War II, stood at $230 billion (net), when national income (according to the Department of Commerce definition) was about $180 billion. 7 T h e increase in the amount of capital funds absorbed by government in connection with current outlays, resulting largely from World War II, has been proportionately much greater than that in total net output of the economy. If the three groups of data could be added we could ascertain whether, in the long run, the bases for long-term financing, internal or external—in the form of tangible durable assets, other assets under corporate auspices, and governmental demand for current outlays not met out of current revenues—increased more than national income. Such a comparison would be doubly significant: first, because national income provides a gauge of overall activity; and second, because it is also the source of savings which provide the financing. But the scattered measures cited overlap in scope (e.g., growth of all durable assets and growth of corporations, or the former and growth of government debt), and direct addition is out of the question. Yet by combining the findings, one may reasonably infer that the huge growth in the absolute magnitude of the bases for long-term financing was at least 7 For gross federal debt see Historical Statistics of the United States (Bureau of the Census, Washington, 1949), Seríes Ρ 132, pp. 305-6. For net public debt since 1916 see estimates by the Department of Commerce in the Survey of Current Business, October 1950.

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INVESTMENT OF LIFE INSURANCE

FUNDS

proportionately as great as the growth in national income, and most probably greater. This assuredly seems true for the last quarter of the 19th century, and may also be true for the 20th century if we include the World War II period. INTERNAL SAVINGS AND EXTERNAL FUNDS

T h e discussion thus far has touched upon factors that determine economic need for long-term financing, whether such need is satisfied from the user's savings, or by funds provided from the outside. However, the very definition of at least one case implies provision of external funds—that of government borrowing to cover current outlays, usually of the emergency type. Hence, whatever has been said about government borrowing applies pari passu to the demand for external funds. The only comment that should, perhaps, be added is that our definition reflects practices customary in our type of society and is not in any sense a logical necessity. Theoretically, it would be possible for a government, even as distinct from government enterprises run on a business-like basis, to amass internal savings, i.e., claims of the type accumulated by individuals for purposes of meeting emergencies or expanding needs. Our society does not countenance such a practice because it is unwilling to permit the state executive the discretion that would be granted by the existence of accumulated funds available for use without current check by elected legislatures. In other words, we prefer discretion to remain with the elected legislative bodies and allow current revenues of government to exceed current outlays only for some approved specific and immediate use—acquisition or construction of real assets (buildings, roads, etc.), reduction of debt, or provision for expected payments (Social Security funds, etc). It is also possible for a government to finance emergency expenditures by fiat money, a practice far from unknown in the past and approximated, in fact, by a bond issue when bond holdings are permitted to become a basis for expansion of circulating media. But here again, for obvious reasons, governments under control of the people usually prefer to acquire long-term funds from wouldbe buyers of government bonds, in the hope that any surplus income and savings might be kept from flooding the economy and causing inflation.

F A C T O R S IN D E M A N D F O R CAPITAL FUNDS

17

A genuinely new, genuinely corporate business unit is another case, implied although not clearly stated in our earlier discussion, where the basis for long-term financing necessarily calls for external funds—this time by the logic of the definition, rather than as reflection of social practices. Where such a unit is organized, not by merger or re-organization of existing corporations nor as a cloak for an individual or family business continuing to operate as of old, the funds involved must be external in the sense that no past accumulation of savings by the unit itself is possible. T r u e , the resources thus mobilized may be either real assets transferred from some antecedent unincorporated business, or funds contributed in monetary form. In the former case, the resources while employed in the past need not have involved any external financing; and if they did, it was most probably short-term. Yet with the transfer of these resources, a block of external funds assumes an overt form—available for further circulation in the investment markets. Where the resources mobilized by the new corporate unit are in the form of money savings contributed by purchasers of shares, they may have previously served as longterm funds; but they also may have been, and most likely were, used for short-term loans (e.g., bank deposits), or were even taken from idle balances (i.e., hoards). Whenever genuinely new corporate business units are formed, implicit in the process is the demand for (and partly creation of) external capital funds. What has been said above about the growth of the corporate sector as a factor in providing bases for long-term financing is relevant here so far as that growth takes the form of creation of new corporate units. In all the other cases covered in the earlier discussion, where assets are sought either by ultimate consumers, by individual business firms, or by already established business corporations (and even by some public units), long-term funds can, and often do, come from accumulated savings of the user rather than from external sources. An individual buying a house or some durable consumer good, can, theoretically, finance it out of current income or accumulated balances without creating any demand for external capital funds; and an existing corporation can pay for new equipment out of its own funds. We are not concerned here with repercussions of such actions elsewhere in the economy, with

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INVESTMENT OF LIFE INSURANCE FUNDS

the effects on the availability of long-term funds elsewhere, say, of a withdrawal by an individual or a business unit from bank balances. Our attention is exclusively on the acquisition of assets as a possible basis for demand for external capital funds; and from this standpoint, the cases just mentioned, where an economic basis for long-term financing is given, present the problem of the choice between internal savings and external funds. One may ask why, given the choice, there should be any demand for external funds, since they are necessarily more expensive and more dangerous to the user than his own accumulated savings. The question is naïve, but in trying to get at the function and significance of a complex phenomenon like the flow and use of capital funds, it is best to raise even naïve questions explicitly. For both the ultimate consumer and the business unit the answer is the same: demand for external capital funds exists because gross returns from using them in addition to internal savings are expected to cover all calculable costs and yield a net return with a margin for uncertainties. The grounds for such expectations may naturally differ among various categories of would-be users. T o an individual who considers borrowing on a mortgage to buy a house, the important factor is often the disparity in timing between the life cycle of savings and the life pattern of the need for the house. Many people can have accumulated enough to buy a house outright only by the time they may expect to live but another few years. Yet any reasonable estimate of the return from the use of an owned house, compared with the cost of a rented one, might be much greater than the total cost, direct and indirect, of contracting a mortgage obligation. For a business corporation planning to market a bond or a stock issue to finance expansion of its productive facilities, the reason for the demand is most often the disparity between the long-term resources necessary to exploit an immediately available economic opportunity and the amount that can be diverted from current or accumulated own balances. The above statement is obviously a gross oversimplification. People who borrow in order to purchase a house are motivated in part by the belief that owning with a mortgage debt is cheaper than renting. But there may also be a strong element of preference for and pride in owning a house, which can in a sense be

FACTORS IN DEMAND FOR CAPITAL FUNDS

19

interpreted as a greater return from an owned house justifying higher money costs—but only in a special sense. A business corporation in choosing between borrowing and internal financing may be strongly motivated by the advantages of the former in reducing the corporate income tax via deduction of interest payments, which, while also a consideration that could be brought within the meaning of costs and returns, is rather a special case. Yet with all such complexities and ramifications the demand for external funds still remains a matter of balancing returns against costs; like all demand, it is like a pair of scissors, one blade of which is the expected yield and the other the cost of the supply. Two important corollaries follow. First, demand for external capital funds cannot be defined unless the multiplicity of elements involved in the cost of such funds—not merely the rate of interest and other payments—is considered. While it may be true that the demand for capital funds is inelastic with respect to some of the less important if more easily perceived elements of cost, e.g., the interest or the yield rate, it may be quite responsive to other components in the terms. It would be unrealistic to assume that changing practices in advancing money on residential housing have had little effect on the demand for it, relative to the equity money that went into owner-occupied housing; or that the terms offered by the investment market for money in the form of equity stock have not had a sizable effect on the demand for external funds. It follows that such demand is in large part a function of the characteristics of the supply, and one cannot but be impressed by the extent to which they have been influenced by the ingenuity and social invention involved in adapting the supply of long-term funds to the varieties of potential demand. Of the devices used, the corporate form of organization and the associated development of the public investment markets were major inventions that provided the bases for the demand for long-term funds and mobilized savings to satisfy this demand. And anyone who only glances at the complex and diversified organization in the investment markets and observes the rapidity with which new forms of financing have followed new emerging needs or modifications of old types of demand, becomes aware of the extent to which demand for external capital funds is a creation of factors on the supply side—in the sense that the latter

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extended the economic basis for the demand for external capital funds to areas where no such base existed before. T h e second corollary relates to problems of measurement. Clearly, if demand for external capital funds is a function not only of returns but also of costs, to measure it we need what economists call the "demand schedule," viz., the amount of capital funds for which there would be demand, at a given time, under different conditions of costs of supply; and a single figure measuring that demand would be possible only if we agreed on some specific cost level and a whole complex of institutional practices as a point of reference. Demand so defined is measurable theoretically, but the difficulties involved are enormous. For we would need a survey of all bona fide intentions for use of external capital funds, accompanied by indications of amounts contingent upon some sequence of terms converted into strictly comparable costs; and then, to express the demand in some single figure, we would have to decide upon one cost level for which to calculate the corresponding demand volume. Obviously, a survey of intentions associated with various contingent costs, and even the conversion of the various components of the terms into some comparable cost series, are tasks so difficult as perhaps to be beyond our powers of economic observation. At any rate, I know of no study that would even approximate it. Granted that measurement of demand for external capital funds, in the strict meaning of the term "demand," is well nigh impossible, it would be feasible, and of interest, to measure the volume of funds actually provided. But even for the latter, an attempt to secure a picture of long-term nationwide trends is impeded by lack of the data in sufficient detail to permit the kind of analysis of sources and uses and funds discussed briefly in the concluding section of this paper. We can, however, on a nationwide scale, compare private long-term debt with durable assets in private hands (Table I). Unfortunately, the external funds covered in Table I are limited to fixed debt, and do not include equity securities—common and preferred stock. What is even more important, changes in outstanding fixed debt cannot be compared with changes in durable assets held even if the latter are reduced to constant price valuation. Changes in outstanding debt are a balance of repay-

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ments and gross new issues, and during different periods may represent different combinations of withdrawals and gross new issues. Hence, all one can learn from a comparison like that given in Table I is whether the ratio of outstanding debt to the volume of durable assets shows any distinct secular trend. TABLE COMPARISON

I

O F P R I V A T E L O N C - T E R M D E B T W I T H PRIVATELY H E L D D U R A B L E ASSETS IN T H E C O U N T R Y , U . S . A . ,

1900-48

(Values in Billions of Dollars) Private Current Values Year 1900 1904 1908 1912 1916 1920 1924 1928 1932 1936 1940 1944 1948

(1) $ 60 75 95 113 149 242 238 280 202 225 251 303 481

Durable

Assets

Depreciated Original Cost (2) $ 58 72 90 106 126 173 196 244 211 211 222 239 328

Private Long-Term Debt

(V $ 18 23 30 37 43 55 67 86 88 75 77 72 104

Ratios (3)to(l)

(3) to (2)

C)

(V

0.30 0.31 0.32 0.33 029 0.23 0.28 0.31 0.44 0.33 0.31 0.24 022

0.31 0.32 0.33 0.35 0.34 0.32 0.34 0.35 0.42 0.36 0.35 0.30 0.32

Col. 1. Total national wealth, excluding: inventories; monetary gold and silver; consumer durables; all public items; and net foreign assets. See Part A of T a b l e 1 in R. W. Goldsmith's, "A Perpetual Inventory of National Wealth," Studies in Income and Wealth, Volume Fourteen (National Bureau of Economic Research, 1951), pp. 18-19. Col. 2. Same as Col. 1, Part C of Goldsmith's Table, plus current value of land. Col. 3. Net corporate long-term debt plus individuals' mortgages, given for 1916 and later years in the Survey of Current Business, October 1949, T a b l e 1, p. 8 a n d September 1951, T a b l e 1, p. 21, extrapolated by Leonard Kuvin's estimates in Private Long-Term Debt in the United States (National Industrial Conference Board, 1936), T a b l e 10, p. 36.

N o such trend is revealed over the half-century covered. Whatever marked changes in the ratios are observed are due primarily to the more rapid movement in current values of assets (cf. the rise in the ratio in 1932 and the drastic decline in 1944 and 1948). It appears that somehow a long-term consilience is attained in movements of the stock of durable real assets in private hands

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I N V E S T M E N T OF L I F E INSURANCE F U N D S

and the volume of private long-term debt outstanding; and the ratio remains at a roughly constant level throughout the halfcentury. 8 LONG-TERM D E B T AND EQUITY

T h e following brief discussion of the choice between obtaining external capital funds in the form of equity issues and of longterm debt obligations (bonds, mortgages, etc.), is not intended to deal with such technical factors as leverage, maximization of market value of stock versus maximization of net earnings, effects of income taxes, and the like. T h e r e is neither room here to discuss these issues, nor sufficient competence on my part to deal with them properly. It seemed more appropriate to consider the broader aspects of that choice, from the standpoint of the national economy as a whole. Only within a relatively narrow area, in fact, is a choice between long-term debt and equity financing possible—even if we make the artificial assumption that the amount of external capital funds required is invariant to the form of financing. For ultimate consumers, i.e., the individuals and families in their private capacity, and for governments, both of which have large shares in total capital funds, the question of equity financing does not arise at all. T h e reason is obvious: equity financing offers incentives to the would-be purchasers of stock by promising participation in the economic fortunes of the issuing unit; and, offsetting the risk, there is a chance of substantial profits. A person who needs 8 T h i s conclusion would not be significantly changed were we to include privately held inventories under real assets. Furthermore, it is possible that in the future, provided the price rise ceases, the volume of debt outstanding will rise sufficiently to make for a return of the ratio in Col. 4 to its secular level. Several recent studies of external and internal financing by business corporations which cannot be discussed here, should be noted: for 1921-39, Albert R . Koch's The Financing of Large Corporations ( N B E R , 1943), particularly p. 103; for 1923-41, George Terborgh's The Bogey of Economic Maturity (Chicago, 1945), particularly pp. 145, 240-46; and for 1915-41, Sergei P. Dobrovolsky's Corporate Income Retention, 1915-43 ( N B E R , 1951), particularly pp. 68-81. T h e current study of long-term trends in capital formation and financing, initiated at the National Bureau of Economic Research in 1950 at the request of the Life Insurance Association of America, promises to yield statistical estimates of external and internal financing for several important capital using sectors of the economy (agriculture, mining and manufacturing, public utilities, residential and related housing, and others).

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funds to finance the purchase of a house is obviously not a business unit that can earn substantial profits, or incur substantial losses; nor can governments or other legal entities charged with public interest (the former in particular concerned with setting the conditions for free private markets), participate in these private markets as legitimate business units whose success is tested by the net profits realized. Nor is there any genuine choice for unincorporated business units. The dependence of each on the life or activity of one or a few individuals means that long-term debt is possible only if there are some long-lived assets to provide the necessary security; and equity financing on a broad basis is impossible, since too much of the control of the business is in the hands of the individual proprietors or partners. Under such conditions, equity funds are supplied either on the basis of personal relations between lenders and borrowers (friends, members of the family, etc.), or by some partnership arrangement—a practice that was of paramount importance before the development of the modern corporation. Today these practices are relatively unimportant compared to equity financing, associated with open, public investment markets. We are left, then, with a choice between debt and equity only for business corporations of a structure and size that make them distinctly different from individual proprietorships or partnerships. Yet even here the choice is far from free. The financing of any sizable proportion of capital needs by long-term debt is warranted only if the business corporation is assured a minimum level of gross income over the long-run, so that it can meet the schedule of interest payments without recourse to expensive emergency means, and meet the obligations to repay or refinance the principal, when due, without costly embarrassment. This assurance is a matter not only of stable markets and stable costs for the corporation's product; it is also a matter of freedom from the type of obsolescence induced by competitive pressure, either within or outside the industry, that might, in the long run, reduce the corporation's economic position. Such conditions are partly a matter of size, since only a corporation that constitutes an economic giant is likely to dominate the industry, to be relatively free of destructive threats of com-

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INVESTMENT OF LIFE INSURANCE FUNDS

petition, and to have sufficient economic reserves to meet the pressures of fixed debt obligations. A related and perhaps even more important source of such conditions is a monopolistic position, where the only threat may be competition by substitute products in other industries. But where there is monopoly, there is likely to be government regulation; and where such regulation affects, as it eventually does, price setting, capital valuation, and levels of permitted or "fair" net returns, a situation naturally develops in which the choice between debt and equity is beset with compulsory elements. Railroads, for example, are prohibited by many states from selling stock below par value. In general, where payment of interest on debt is treated in one way and returns on equity share in another—not only for tax purposes but in consideration of permitted rates—the choice between debt and equity is heavily biased, if not necessarily completely forced. One may thus argue that public utilities are outside the area of relatively free choice between debt and equity, not because, like government and individuals, they are necessarily limited to the former, but because the legal elements reflecting the broad view that society takes of these industries are quite important. In the light of these general considerations, a comparison between the total amount of mortgages and bonds outstanding (with maturities over one year) and the book value of stocks (common and preferred) is revealing. At the end of 1946 the total value of fixed debt and capital stock reported by all nonfinancial corporations was about $101 billion, of which $33.7 billion were bonds and mortgages and $67.4 billion stocks. However, in the public utilities sector, the total for bonds and mortgages was $21.5 billion, and for stock $23.9 billion; and the ratio of the former to the latter was 90 per cent whereas it was 50 per cent for all nonfinancial corporations. For all nonfinancial corporations exclusive of public utilities, of some $55.6 billion of fixed debt and stocks, only $12.2 billion were fixed debt and $43.4 billion were stocks, the former accounting for only about a fifth of the total. Finally, among nonfinancial, nonpublic utility corporations classified by size of assets, units with assets of $100 million or over had $18.7 billion of fixed debt and stocks, of which $4.4 billion, or slightly less than a quarter, were in bonds and mortgages; whereas for the smaller corporations, with assets of less than $100

FACTORS IN DEMAND FOR CAPITAL FUNDS

25

million, of the combined total of $36.9 billion, only $7.9 billion, or about a fifth, were accounted for by bonds and mortgages.® The limited importance of debt relative to equity in external financing for all but public utility corporations is partly recent in origin; a somewhat greater recourse to long-term debt was probably characteristic of the early years of the century. But it is nevertheless true that a genuine choice between debt and equity is possible for only a limited sector of the economy that accumulates capital goods and exercises demand for capital funds; and that even within this limited sector the choice is circumscribed by both economic and noneconomic factors. The conspicuous difference in the distribution between public utilities and other industrial sectors is evidence of the importance of certain inexorable economic and legal factors that limit the choice. PROBLEMS OF M E A S U R E M E N T

As already indicated, demand for capital funds is the result of a variety of situations in which prospective returns to borrowers from the use of external long-term funds are weighed against the assumed costs of the latter. The measurement of demand of capital funds, as thus defined, is hardly feasible unless the number of possible situations is reduced by a set of specifying restrictions and a survey of intentions of would-be borrowers under these specifications, is set up. The task is perhaps truly impossible since it requires the expression in concrete terms of a variety of hypothetical situations that may yield only vague notions. Granted the potentialities of survey-of-intentions techniques beyond their present embryonic beginnings, existing data, and those for years to come, can be expected to measure only the amount of capital funds actually supplied to their users—what might be called "satisfied" demand or "realized" supply, the two necessarily being identical. And there are grave difficulties even in measuring this volume in a way that would shed most light on the factors at play and on the major problems which face the institutions directly engaged in the field. These difficulties already »Statistics of Income for 1946, Part 2, Tables 4 and 6. It should be noted that book values of stocks, used in these reports, often difTer widely from market values, which is generally not the case for fixed debt. However, the broad results of the comparison for 1946 are not likely to be affected much by this consideration.

26

INVESTMENT OF LIFE INSURANCE FUNDS

suggested above may perhaps be best indicated by considering the recent data that provide the most effective measurement. Table II summarizes for 1947-51 the sources and uses of funds by all corporations in this country except banks and insurance companies. It is based upon the valuable work at the Department of Commerce under the direction of Irwin Friend. As it stands, Table II tells a rather interesting story. External TABLE II SOURCES AND U S E S O F C O R P O R A T E F U N I » T O T A L S FOR

1947-51

(Billions of Dollars) Sources or Uses of Funds Uses: 1 Plant and equipment outlays 2 Inventories (change in book value) 3 Change in receivables and other current assets 4 Change in cash and U.S. Government securities 5 Total uses

6 7 8 9 10 U 12 13 14 15 16

Sources: Internal: Retained profits and depletion allowances Depreciation allowances Total internal External: Change in trade debt Change in federal income tax liability and other current liabilities Change in bank loans Change in mortgages Net new issues Total external Total sources Discrepancy (sources less uses)

The Economic Report Table B-37, p. 203.

Amount for 1947-51 $ 88.6

23.1 26.7 14.1 S 152.5

$ 54.4 34.4 Í 88.8 $ 12.3 18.8 7.8 3.9 24.7 $ 67.5 $156.3 + 3.8

of the President, January 1952 (Washington, 1952),

capital funds, defined as mortgages and new issues (bonds and stocks), were roughly $28.6 billion during the last five years. Since total gross additions to plant and equipment, the durable assets whose financing is the raison d'être for capital funds, were $88.6 billion, external capital funds accounted for only about threetenths of these durable asset additions. However, net additions to the latter, i.e., net capital formation, amounted to about $54

FACTORS IN DEMAND FOR CAPITAL FUNDS

27

billion; and of that amount, external capital funds accounted for somewhat over a half. Some important questions that arise can perhaps be answered by means of the detail underlying these estimates; others must for the time being remain unanswered. The first set of questions relates to the use of net figures for sources. Net new issues are obtained by subtracting retirements from all issues of bonds and stocks; and financial institutions engaged in providing capital funds are interested in whether a net issue total arises from a large gross issue and a large volume of retirements, or from a small gross issue and no retirements. As an extreme illustration, consider two cases: in the first, one of two corporations uses the proceeds of a new issue to retire an old one, and the other does not appear on the capital market at all; in the second, one of two corporations places a new issue and the other retires an old issue of equal amount. In both cases, net new issues are zero; but in the first, the financial institutions have no functions to perform except perhaps in an advisory capacity, whereas in the other case they may have to act both as recipients of idle funds resulting from redemption of the issue by one corporation and as providers of funds for the new issue by the other. T h e more detailed estimates of sources and uses of funds in the March 1948 issue of the Survey of Current Business show that in 1946 net new issues of $2.3 billion were derived from $7.2 billion of gross issues and $4.9 billion of retirements; whereas in 1947, a larger net, $4.1 billion, was derived from a smaller volume of gross issues, $6.6 billion, and a much smaller volume of retirements, $2.5 billion. For mortgages, unfortunately, only net changes are given. A second set of questions stems from the practice of aggregation, unavoidable in the publication of the data since full detail would be practically impossible. T h e aggregation runs in two directions: aggregating the information for the thousands of individual corporations included, and aggregating for distinct entries, on both the sources and uses side. From our standpoint, the more important one is the aggregation of the large number of firms into totals, inevitable even if tables like the one presented are prepared for distinct industrial groups. If the total includes several firms, a firm in which net additions to plant and equipment are fully or more than fully covered by net new issues or

28

INVESTMENT OF LIFE INSURANCE FUNDS

net change in mortgages may very likely be grouped with one in which an equally large addition to plant and equipment is accompanied by no net addition (or possibly diminution) in sources associated with external capital funds. Yet to understand the factors that make for demand for capital funds, such a distinction is of the utmost importance. For how many of the firms subsumed in this table does the ratio of net external capital changes form about half of net additions to plant and equipment, for how many is it zero or negative, and for how many is it more than one? And what characteristics and conditions of these firms explain the differences in "satisfied" demand for external capital funds? These questions could be explored only by study of individual firms. The study cited here had to rely heavily on the assembled aggregates of corporate balance sheets and income accounts published by the Bureau of Internal Revenue. A third set of questions stems from the difficulty of tying specific types of uses to specific types of sources. We compared external capital sources with plant and equipment outlays, on the ground that the latter provide the rationale for the former. But our earlier discussion indicated that long-lived entities like corporations can use capital funds even for assets that are physically short-lived. We could, therefore, have compared external capital funds with the total of additions to plant and equipment and inventories; or even, perhaps, with the total of all uses. Indeed, in the article in the March 1948 Survey of Current Business, Mr. Friend allocates $5.5 billion of the total new issues for 1946 and 1947 to plant and equipment and $2.3 billion to "working capital." T h e fact of the matter is that, without knowledge of the specific managerial decisions involved in a given addition to external capital funds, the association between the latter and any specific use may be an arbitrary imputation. Any source can be associated with almost any use since funds are fluid and lose their identity when put into a general pool. All these questions and difficulties beset the measurement of the "satisfied" demand for capital funds regardless of the source from which such funds are supplied. T h e demand for capital funds from a specified group of financial institutions, such as insurance companies, is further affected by shifts in the flow of savings through various channels—a consideration which intro-

FACTORS IN DEMAND FOR CAPITAL FUNDS

29

duces an entirely new set of factors. It cannot be discussed here. T h e limitations on aggregative statistical measurement of demand for capital funds, illustrated above, are even greater for estimates that go further back in time and that are less revealing than the source and use analysis available for corporations since 1946. Even for corporations, let alone other large groups of capital fund borrowers, earlier series are largely in terms of net changes in outstandings; or, if in terms of gross and net issues, are unaccompanied by measures of other sources or of uses. Net changes in outstandings, even corrected for revaluation when necessary, are net to a point where the distinction between total issues and withdrawals and retirements is impossible. Absence of data for other sources or for uses enhances the possibility of significant error and reduces the chances for meaningful analysis. These questioning remarks are not intended to rob aggregative statistical analysis of value or promise. On the contrary, much of its value lies in providing an orienting framework for the economy as a whole, and indicating the rough order of magnitudes within which the economy operates. Its promise is even greater than its contribution so far, since statistical work in the field is in its very beginning. Significant studies like those by W. Braddock Hickman at the National Bureau of Economic Research on corporate bond financing and by Raymond W. Goldsmith on the volume and types of savings—both covering the period from the beginning of the century—are nearing completion, and the very cumulation of results, even in terms of broad groups and aggregates, will provide valuable insight into the response of the economy to changing conditions affecting its need and demand for capital funds. Our remarks are intended rather to suggest that statements concerning excesses or inadequacies of such funds are more in the nature of intuitive judgments, and that the statistical evidence now available does not permit unequivocal assertions as to the validity of such judgments. 10 In such a situation clarity 10 Such judgments are not necessarily wrong; the difficulty is rather that they cannot be tested unless some meaning, other than that used here and clearly understood by both the author of the statement and the readers, is assigned to the term "demand." My own feeling is that such statements most often refer to "need," not to "demand." For example, if there is a "need" for X million new houses, and correspondingly a "need" for Y billion dollars of capital funds at cost levels that are considered acceptable; and if the Y billion dolían are not available at such cost levels, then we can say that there is a

30

INVESTMENT OF LIFE INSURANCE FUNDS

of concepts, a firm view of the basic functions of financial flows in economic society, and respect for empirical evidence are preconditions of a clear realization of the significant things we know and do not know—a realization that should compel policy decisions to utilize all relevant knowledge and to recognize the areas of ignorance. shortage of capital fundi or an excess of "demand." It would help greatly to clarify our consideration if more explicit definitions of terms were earnestly sought.

CHAPTER III

T H E By

SUPPLY

RAYMOND W .

OF

SAVING

GOLDSMITH*

T h e supply of funds can be ascertained from one side of what has become known as a sources-and-uses-of-funds statement. Such a statement shows for a business enterprise, a household or government, or for a group of them, the cash or equivalent derived during an accounting period from both internal sources (capital consumption allowances deducted in arriving at net profit; retained net profit) and from external sources (borrowing; sale of own securities; reduction of assets). Sources-and-uses-of-funds statements are not yet generally available to the student of finance nor can they be easily derived from published balance sheets and income accounts. T h e only statements available on a comprehensive basis are those for non-financial corporations prepared by the Department of Commerce for the period since World War II. 1 If we are interested in the long-range picture and want to include not only corporations but also households and governments—and this is essential for any thorough analysis of the capital market—we must deal with the supply of saving instead of the supply of funds. T h e two concepts differ mainly in two respects. First, the supply of saving is a net concept—saving by some units and in some forms is offset by dissaving of other units or in other forms; and receipts and outflows of funds in one and the same account are netted, repayments of mortgages, for instance, being treated as an offset against new mortgage loans. Second, the supply of saving deals with the ultimate suppliers of funds, and does not trace all the crossflows, particularly those through financial intermediaries. T h e study of these crossflows is as yet an almost uncultivated although important and promising field * Director, Saving Study, Life Insurance Association of America. 1 See Table II discussed by Dr. Kuznets, page 26.

SI

32

INVESTMENT OF LIFE INSURANCE FUNDS

of research. But analysis of the supply of saving by itself is of great significance for a study of the capital market, and on an even broader plane for that of economic development, for it shows the final sources of funds which finance economic growth; and it may also indicate the channels through which and the forms in which the funds are made available to those who demand and invest them. Saving is generally defined by economists as the excess of current income over current expenditures, and in this case the definition fortunately seems to correspond roughly to the popular usage of the term. It is important to note, however, that appropriate capital consumption allowances are included in current expenditures, as are distributions to owners in the form of profit withdrawals and dividends. More importantly, economists generally exclude realized as well as unrealized capital gains and losses, in particular inventory profits and losses from their definition of saving. This, in accounting terms, is a measurement from the income account. Thanks to the formalism of double-entry bookkeeping, saving so defined can also be derived from the balance sheet of every economic unit. In that case it is measured as the net result of changes, excluding valuation changes, in all types of assets and liabilities including paid-in capital among the latter. T h e numerical results of the two measurements of saving are necessarily identical if consistent methods of accounting are employed. Hence, saving of some economic units calculated from their income account can be combined with the saving of other units measured from their balance sheet without danger of gaps, overlaps or discrepancies. National saving is the result of the combination of saving, or dissaving, of all saver groups. As a rule three main groups are distinguished, (a) households, which, if possible, are further divided into farm and non-farm households, and include trust funds, private non-profit institutions and usually unincorporated business enterprises; (b) corporations; and (c) the Federal, state and local governments. The saving of each group is the result of the combination of the accounts of all units belonging to it. T o attain the flexibility required for economic analysis it is often necessary to use variants of this basic saving concept. The most important of these are variants including or excluding sav-

T H E

SUPPLY

OF

SAVING

33

ing through consumer durables and military assets; calculating depreciation allowances on the basis of either original cost or replacement cost; and including or excluding inventory profits and losses. Economists are often inclined to operate with a concept of saving which excludes consumer durables. T h i s is justified when interest is centered in the durable reproducible productive equipment of the economy, but in that case consistency would require the exclusion of saving represented by residential real estate and through most types of governmental structures. I n an analysis of the changes in national wealth and its financing, on the other hand, all forms of saving are of importance. Inclusion or exclusion of saving through durable military assets depends on whether military expenditures are regarded as a normal part of the economic process. T h e choice between the use of original cost or replacement cost as the basis of depreciation allowances is one between adherence to the customary methods of business accounting or the deviation from them in the interest of better comparability of a given year's income and expenditures. T h e situation is similar with respect to elimination or inclusion of inventory profits and losses. Business accounting methods as yet do not call for the elimination of such gains and losses, but the tendency of social accounting to eliminate all valuation changes demands the omission of inventory profits or losses. T h e remainder of the discussion will be divided into two sections. T h e first is intended to present the data now available on the supply of saving, both on a current basis and for a long look backward. In the second section a summary will be given of a few important quantitative characteristics of the supply of saving during the last fifty years, on the basis of preliminary estimates taken from a study sponsored by the Life Insurance Ass'n of America, in which I have been engaged for the past few years. I . SOURCES OF INFORMATION ON S U P P L Y O F SAVING

T h e r e are two basic approaches to measuring the supply of saving. T h e first utilizes time series on income and expenditures, or assets and liabilities of different groups of economic units; the second is based on sample surveys. Both have been developed only in the last ten to fifteen years to the stage where they provide, each within its limitations which will be discussed presently, a

34

I N V E S T M E N T O F LIFE INSURANCE F U N D S

fairly comprehensive and reliable picture of the supply of saving in the American economy. This information may be used for two purposes. T h e first is the current observation of changes in the supply of saving. This forms an important part of the short-term analysis of the capital market and business fluctuations. T h e second purpose is the analysis of the basic forces which determine the total volume of saving as well as its distribution between saver groups and forms of saving. For the first purpose up-to-date figures at not more than quarterly intervals are required. T h e second purpose, on the other hand, calls for long historical series, and as a rule requires considerably more detailed information than is necessary for current observation, but normally is satisfied with annual data. Current

Series

For the observation of current changes in the supply of saving we have at our disposal two quarterly and two annual series. Of the quarterly series one is prepared by the National Income Division of the Department of Commerce, and the other by the Securities and Exchange Commission. Both become available about two months after the end of the calendar year quarter to which they refer. T h e Department of Commerce's quarterly estimates of saving cover without further breakdown all households, unincorporated business enterprises, farms, and private non-profit organizations. No comparable figures are made available for either the Federal, state and local governments or for business corporations, although it is possible to derive from series published by the Department of Commerce a current estimate of corporate saving which is conceptually similar to the series for personal saving. T h e main characteristic of the Department of Commerce's estimate is that it is obtained as a residual, i.e., by subtracting total estimated consumption expenditures from total personal income. Minuend and subtrahend in turn are built u p from a large number of component series, some of which are based on current statistics of a high degree of sensitivity and reliability, whereas others necessarily represent not much more than rough preliminary estimates. This method of derivation makes it unavoidable that even relatively small errors in personal income or consumption expendi-

T H E SUPPLY OF SAVING

35

tures may lead to very large errors in personal saving since saving generally amounts to only 5 to 10 per cent of minuend or subtrahend. An error of only 1 per cent, but in different directions, in either personal income or consumption expenditures—and a TABLE I Q U A R T F R I Y ESTIMATES OF T O T A L PERSONAL AND PERSONAL L I Q U I D

SAVINC: 1947-51

(Billions of Dollars) Total Personal Saving (Department of Commerce) As first estimated·>

As revised After 1 yearb by 1951*

Seasonally

1947

1948

1949

1950

1951

I II III IV I II III IV I II III IV I II III IV I II III IV

Adjusted

Personal Liquid Saving (Securities and Exchange Commission') As first estimated

After 1 year*

Unadjusted

(i)

(2)

0)

0)

(V

$3.2 2.8 3.2 2.8 3.2 3.1 3.8 4.6 5.3 4.0 3.3 2.7 4.7 2.8 1.6 4.0 25 5.3 5.6 5.1

$2.9 1.0 2.4 2.4 2.9 2.7 3.8 3.8 3.7 2.5 1.6 1.6 3.7 22 li 42 2.0 4.7 5.2 5.3

$1.5 .1 1.0 1.3 1.3 2.6 3.3 3.3 2.6 1.7 1.2 .9 3.1 22 12 4.2

$1.4 2.4 2.9 —.4 2.5 .9 3.1 1.8 .6 1.0 1.7 .8 .6 .6 .1 2.6 .1 3.2 5.7 4.2

$1.4 2.0 3.0 —.6 1.7 .8 2.8 15 .9 .8 1.4 .0 .0 .0 .8 1.6 .1 3.0 5.3 5.0

» National Income, 1951, p p . 208-9. b Survey of Current Business, various issues, c Securities and Exchange Commission releases. ~f liquidity than is generally recognized. 7 First, the pattern of mortgage loans now offered by life insurance companies provides for self-liquidation as a result of monthly 7 "Liquidity: A Growing Attribute of Mortgage Loan Portfolios," Journal of Commerce, Vol. V, No. 4, December, 1950, pp. 316-323.

The

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INVESTMENT OF LIFE INSURANCE FUNDS

payments on principal and interest, which differs greatly from the loan pattern of twenty-five years ago under which a borrower procured a loan for three to five years with no regular reductions on principal. Second, an active real estate market greatly contributes to the seeming liquidity of mortgage loans, for as properties are sold, loans tend to be paid off. Third, mortgage loan liquidity also is enhanced by insurance of loans by the Federal Housing Administration and by guaranty of loans by the Veterans Administration. These endorsements and the marketability of FHA debentures assure that in the event of foreclosure, the lender can expect an early recovery of cash without the complicated problems of real estate liquidation which resulted from farm loans in the 'twenties and from urban property loans in the 'thirties. Fourth, the development of Federal agencies with more or less authority to buy mortgage loans augments greatly their real or potential marketability. The Home Owners' Loan Corporation and the Federal Farm Mortgage Corporation set an example in this type of activity by refinancing defaulted loans and demonstrating a commendable experience with them. Though vague assumptions fail to constitute sound investment collateral, it is hard to believe that some phases of HOLC activities would not be renewed in the event of extensive loan defaults or that the Reconstruction Finance Corporation would not enter the market. Fifth, the use of mortgage loans by the owning institution as collateral for loans at commercial banks or the Federal Reserve Banks affords another possible source of liquidity and there always is the likelihood of sale of loans. Finally, development of FHA loans resulted in the evolution of an over-the-counter market for loans which market prior to 1935 had not existed. Mortgage loan investments of life insurance companies serve very useful social purposes. They aid the acquisition of homes and make multifamily housing possible; they finance buildings essential to the productive capacity of the nation; and they assist in production of the world's food supply through the financing of farm operations. DISADVANTAGES OF MORTGAGE LOANS AS INVESTMENTS

These somewhat glowing advantages of mortgage loan investments in no way should be allowed to conceal significant di$-

REAL E S T A T E MORTGAGES

109

advantages of such investments which, unless expertly coped with, can reduce or eliminate entirely their appeal. T h e purchase of mortgage loan investments entails at the outset heavy acquisition expenses. T h e active purchase of mortgage loans may be effected (1) through branch offices maintained and operated by the company; (2) through mortgage bankers who serve as loan correspondents; or (3) a combination of these methods. In any case, an active field organization must be maintained to originate (and to service) loan applications. This organization procures applications, investigates applicants, appraises the security, and puts the application in proper form for submittal to the home office. If the application is approved, the field representative closes the loan, making certain that all conditions imposed by the home office have been fulfilled. But the field organization, whether branch office or correspondent, comprises only part of the personnel necessary to the origination of loans because a well-trained organization at the home office to supervise field activities is a vital necessity. Economic trends in lending areas must be studied; relationships with correspondents must be maintained in order to obtain business and to make certain that field and home office appraisals at least follow similar patterns; loan inspectors or review appraisers must be kept acquainted with the lending territories, modern construction trends, and construction costs; and personnel must be available to assist in the management and liquidation of foreclosed real estate when and if it is acquired. A continuing volume of new loan purchases is essential for economic justification of such a welltrained and competent home office staff. T h e servicing of mortgage loans also involves considerable expense. Skilled personnel is required to cope with the myriad details which cannot be avoided. This work, like that of origination, also falls into two natural categories: in the field and at the home office. In the field, it involves receipt of regular payments and their pursuit if not promptly made. It also requires adequate accounting records, the handling of any trust funds which accumulate for taxes and insurance premiums, and the payment of the latter items as they fall due, with complete periodic reports to the home office. It is customary to allow the correspondent a participation in the interest ranging from 1/16 of 1 per cent to

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INVESTMENT OF LIFE INSURANCE FUNDS

1 per cent, depending upon the size of the loan and the rate of interest, to compensate him for this service. T h e home office staff, in turn, must review these reports, account for the funds, check insurance premiums and tax payments, and urge correspondents to press for collections. In event of seemingly hopeless default, the home office usually prosecutes the foreclosure. Rapid strides have been made during recent years in procedures that have served to simplify the servicing operation. T o the extent that economies result, the return on loans improves accordingly. These improvements include machine and punch-card accounting, the elimination of receipts for monthly payments unless requested, and simpler methods of handling various steps of the servicing process. One of the attributes of mortgage loans which contributes materially to their liquidity is their comparatively short life which previously has been mentioned. However, at the same time that this reveals an obvious advantage, it creates a great disadvantage by aggravating the problem of reinvestment. Short-lived investments present special problems in a period of declining money rates because higher yielding investments evolve into cash at a time when the proceeds can be reinvested only at lower rates. Also, under such circumstances, a portfolio is subject to "raiding" or refinancing by other lenders. T h e relatively short lives of mortgage loans are less disadvantageous in a period of rising interest rates because it then becomes possible to reinvest loan proceeds at improving rates of return. One of the greatest disadvantages of mortgage loans ensues from the problems of foreclosure likely to be encountered. The few foreclosures of the past fifteen years (which have been kept at record low figures by a housing shortage, easy mortgage credit and a severe inflation) tend to submerge into oblivion the gravity of the foreclosure problems which arose prior thereto. Three very serious problems always arise in connection with the foreclosure of a loan by a life insurance company. One is the costs incident to foreclosure, the second is the adverse public relations, and the third is the liquidation of the real estate acquired. T h e costs of foreclosure vary widely from state to state. New York and Illinois have been somewhat notorious for years because of their high foreclosure costs, whereas Texas, Virginia, and other states

REAL E S T A T E M O R T G A G E S

111

have very low costs. T h e expenses of foreclosure not only involve court and legal fees, but loss of interest and possible damage to or neglect of the property during the period of foreclosure. T h e latter, of course, depends upon the attitude of the borrower and the length of time which intervenes from the time action is instituted until the property is acquired. T h e public relations incident to foreclosures can become very complex. One hardly expects to make friends by evicting or threatening to evict people from their homes, but the responsibility of a trustee in dealing with a delinquent borrower allows no choice. When foreclosure results in property acquisition, a problem of real estate management and liquidation immediately arises. Absentee ownership of real estate presents many problems ranging from those of assessment to those of vandalism. When an investor purchases a block of bonds he receives a pretty clear indication of a not distant date upon which the bonds will be ready for purchase and by which time his cash must be available. T h e purchase of mortgage loans on the other hand necessitates the issuance of a commitment letter to purchase a loan (unless it is a loan on existing property) at a future indeterminable date after construction of a building, demonstration of adequate title, and endorsement of any FHA insurance or VA guaranty. T h e period of time required to complete these steps will depend upon the efficiency of the builder, the availability of materials, weather conditions, and congestion in title offices and the offices of the FHA and VA. If the commitment was made subject to sale of the property to a satisfactory purchaser, additional time may be required. Furthermore, some commitments always tend to expire unused for a variety of reasons, all of which compounds confusion for the investment officer planning a program for the use of funds likely to become available for investment. It is no novel experience to plan upon remittance on a large loan and then be notified that payout will be deferred thirty or more days. T h e establishment of expiration dates in commitment letters and the imposition of standby charges help to provide at least a small degree of control over this problem, but sometimes, especially when the demand from investors for loans is great, the imposition of penalties becomes exceedingly difficult.

112

INVESTMENT OF LIFE INSURANCE FUNDS

Other minor adverse aspects of mortgage loan investments might be mentioned, but experience would indicate that mortgage loans possess such strong investment advantages that they rightly deserve a prominent place in a life insurance company portfolio. Proceeding from that point, this discussion hardly could approximate completeness without a brief review of the mortgage market and an appraisal of the outlook. This phase of the subject, like all of the others touched upon, possesses many facets. T h e emphasis placed upon housing loans, limitations currently prevailing with respect to commercial construction, and the limitations of time suggest that the appraisal be confined primarily to housing loans. R E V I E W AND

APPRAISAL

T h e housing shortage of the past decade appears obvious in retrospect. A shortage of housing at the outbreak of the war, restricted construction during the war, and a substantial shift of population from rural to urban areas resulted in a greatly curtailed supply of housing to meet the unprecedented demand for housing. Rent control held the prices of housing accommodations at approximately prewar levels, while national income soared to new heights, thus making it possible for many persons to acquire better housing accommodations than otherwise would have been the case, and greatly increasing the demand. Easy mortgage credit in the form of high ratio loans, longer loan terms, and the lowest interest rates in history, added vigor to the otherwise great demand for houses. The greatest housing boom in our history ensued. During the decade, through 1951, 6,860,300 new housing units were constructed. An all-time record of 1,390,000 units was achieved in 1950, and in each of the years 1949 and 1951 approximately one million new units were constructed. The year 1952 promises 800,000 to 900,000 additional units in spite of existing material shortages, lending restrictions, and higher interest rates. These figures suggest very clearly that the real housing shortage has been pretty well eliminated despite the statements of some observers that many millions of new units must be built in the next few years. At the same time, they further suggest that during

REAL E S T A T E M O R T G A G E S

113

the year ahead there will be a substantial volume of mortgage loans available, barring all-out war, of course. T h e greatest uncertainty arises out of the bases on which these loans will be available. T h e interest rates on conventional loans readily adjust themselves to market conditions and so long as money rates continue upward, they, too, are likely to move upward. FHA and VA rates, however, are controlled by the Federal Government and to date housing authorities have shown little or no inclination to make their interest policies conform to the anti-inflationary pattern being established by the Federal Reserve System. T h e rigidity of rates on F H A and VA loans has caused them to sell at discounts, but this presents technical complications for the buyers. Whenever these loans become drugs on the market, pressure develops for increased activity of Fanny May,8 and for further direct loans to veterans. It even has been suggested that the reserves of the National Service Life Insurance f u n d be used for this purpose. T h e life insurance companies of the nation have displayed an eager disposition to buy VA and FHA loans, but as trustees of the savings of eighty million policyholders, they hardly can be expected to purchase such loans on bases less attractive than other investments, particularly when such action would fan the fires of inflation and further impair the purchasing power of the dollars they are trying to preserve. T h e change in the money market last year brought new hope to life insurance investors, both in the encouraging prospect of procuring higher earnings and in the placing of at least a slight brake on inflationary forces. Higher interest rates also have the effect of slowing down the pace at which loans will be prepaid ahead of schedule. When a mortgage loan carries a low rate, the purchaser of a mortgaged property is more inclined to buy the equity instead of refinancing the loan. Moreover, the incentive for raiding disappears, and borrowers with surplus cash may themselves seek a higher return on their funds instead of paying off a low interest-bearing loan. POSSIBLE IMPROVEMENTS IN M O R T G A G E

LENDING

T h e long history of mortgage loans and the favorable experience with practically all types of loans during the past decade * Federal National Mortgage Association.

114

INVESTMENT OF LIFE INSURANCE FUNDS

tend to numb our senses into a kind of pleasant somnambulance of contentment with what is available and render us unconscious to the opportunities which exist for pioneering in this field. Improvements in mortgage lending in the years ahead probably will fall into one or all of three categories: (1) mortgage loan patterns; (2) mortgage loan mechanics; (3) mortgage loan servicing. That the pattern of mortgage loans may enjoy further improvement may be demonstrated by innovations of recent years. Twenty years ago, adoption of the plan of level monthly payments together with the monthly deposit of one-twelfth of taxes and insurance premiums effected an almost revolutionary change which to date has enjoyed great popularity with borrowers and lenders alike, and holds forth even greater promise in a period of less prosperous business conditions. More recently, adoption of the "packaged mortgage loan" and a wide variety of options to the borrower have made the modern mortgage loan an almost unrecognizable descendant of its forebears. The "packaged.mortgage" loan is a plan of home financing which includes major kitchen equipment within the lien of the real estate loan. The test which was applied for many years to determine whether a particular article belonged to a house or was personal property belonging to the occupant depended on whether or not removal of the particular fixture or equipment would in any way disfigure the house—that is, break the plaster, or a wall or floor. If so, it was considered part of the realty; if not, it was construed to be personalty. More recently, this concept has changed and in many jurisdictions the test is whether or not the parties entering into the transaction intended that the particular fixture should be part of the realty and whether or not it is fastened to the house in any manner at all—and thus the "packaged mortgage." Many advantages accrue from this plan. First, the payments for the equipment are spread over the life of the loan instead of the usual two- or three-year instalment purchase period. Second, the rate of interest paid for financing the equipment is the same as that paid for financing the rest of the house instead of high instalment loan rates. Third, the financing of equipment

REAL E S T A T E M O R T G A G E S

115

becomes an integral part of the over-all financial pattern and the credit position of the borrower is improved. Fourth, during the early years when his cash position is likely to be weakest, the borrower's payments are lighter than would be the case with a mortgage loan and instalment contracts. Finally, all of the financing is cared for by one instrument and the borrower deals with only one lender instead of several. Other recent innovations include a variety of options available to the lender. Many loans now provide that borrowers shall have the privilege of making payments on principal in excess of regular amortization. They also provide that the loan shall not be considered in default so long as payments on principal exceed those specified by the amortization schedule, and so long as interest, taxes and insurance premiums are paid. Many lenders permit the borrower to pay his loan in full at any time without penalty in the event the property is sold. Another provision permits the borrower to defer principal instalments of his own accord on a pattern determined by the number of years the loan has been kept in good standing. In some states borrowers, on concurrence of the lender, have the right to increase the loan without complete refinancing. Life insurance in an amount sufficient to liquidate the loan in the event of death of the breadwinner has come, in the minds of many, to be just as essential as insurance against other hazards and to bear advantages for the lender as well as the borrower. Other innovations might be cited, but these more than suffice to illustrate the point. Mortgage loan mechanics, namely origination and foreclosure, particularly from the legal angle, also clamor for processing innovations. T h e high costs of proving title and the complexities of foreclosure might readily be simplified and costs reduced to the advantage of borrowers and lenders alike. Also, in the field of mortgage servicing, unbounded opportunities for creative thought continue to knock on the doors of those who care for these processes. By way of illustration, a question is presented: W h o will be the first to demonstrate that monthly payments can be kept in even dollar amounts, thus eliminating the costly detail of accounting for millions of cents every year? Many similar questions cry for answers.

116

INVESTMENT OF LIFE INSURANCE FUNDS

In conclusion, mortgage loans have been, are, and will continue for the foreseeable future to be very significant outlets for life insurance funds. The inherent opportunities to serve policyholders and borrowers through aggressive activity in this field know no bounds. Despite their centuries-old history, mortgage loans offer an investment frontier for those seeking investment adventure and creative opportunity.

C H A P T E R VII

CORPORATE

DEBT

By ARNOLD R . LA FORCE* Corporate debt is an important source of investment for life insurance funds. However it is extremely difficult to isolate corporate bonds as a field of investment for such funds and then to proceed to gather the statistics thereon and to interpret fully a n d clearly the investment activities of life insurance companies in this one specialized field. T h e difficulty lies primarily in the fact that mere statistical recitals of trends and developments in one specialized or isolated field of investment cannot explain fully the economic causes of such trends and developments and their significant relationship to other investment, financial, and economic data. T o o often incorrect and warped conclusions are drawn where such limited statistical recitals or analyses are employed. Hence, in the presentation the author has tried to develop the subject material in as broad and relative terms as possible in the attempt to achieve a fuller and clearer understanding of the subject. Previous lectures in this series have undoubtedly emphasized that the nature or types of life insurance investment vary in response to changing economic trends and demands for capital. In very simple language, savings can be invested only if there is a demand for such funds, and broadly speaking, such demand comes from individuals, business organizations, and governments. T h i s lecture, therefore, is concerned with demand for debt capital by a particular legal type of business organization—the corporation—and the extent to which the life insurance companies are • Second Vice-President, Metropolitan Life Insurance Company. In the presentation of his paper Mr. La Force emphasized the fact that the opinions expressed on this subject are his personal observations only and hence are not to be associated necessarily with the life insurance company with which he is connected. 117

118

I N V E S T M E N T O F LIFE INSURANCE F U N D S

utilizing their reserve funds or the savings of their policyholders to satisfy such demand. It should be stressed that corporations have played the major role in the vast growth of American business in the past century and now occupy a position of great importance in the functioning of our economy. A measure of this importance is indicated by the fact that corporations now contribute three-fourths of the total national income originating within the private sector of the economy, excluding agriculture and professional services.1 Previous lectures doubtless have emphasized also that certain financial characteristics of the life insurance business determine, to a large degree, the general or broad investment policies followed by the life insurance business. For example, since the contractual liabilities of life insurance companies are long-term in nature and extend for the most part over the lifetimes of the policyholders, and, to an increasing degree, over the lifetimes of beneficiaries as well, the investments of life insurance companies correspondingly can be and usually are long-term in nature. Similarly, since the cash inflow of the life insurance companies has practically always exceeded the cash outflow, the liquidity factor is of minor importance in life insurance investing. T h e important thing to remember is that the nature of the life insurance business is such that money must be put to work immediately. T h i s does not prevent the exercise of judgment in selecting short- or long-term investments according to conditions obtaining at the time of investment, but the dollar must always be kept productive and the interest of existing policyholders must not be sacrificed or even postponed for the possible benefit of those who may be the policyholders at a subsequent date. T h e explanation for the fact that life insurance companies have been long-term investors during the past two decades lies in the fact that during this period long-term interest rates have been substantially higher than short-term rates, plus the fact that the superior liquidity of short-term investments has not been needed. In addition, longterm investments per se are more suitable than short-term investments, because they correspond in time element to the long-term contractual obligations of the life insurance business, these obli1 " T h e Business Population by Legal Form of Organization," by B. C. Churchill, Survey of Current Business, June, 1951, page 9.

CORPORATE

DEBT

119

gâtions being fixed in amount, staggered as to timing and statistically predictable. T h e importance of such a relationship in the time element between investments and contractual liabilities cannot be overemphasized, particularly from an actuarial viewpoint. Lastly, it has been emphasized, undoubtedly, that life insurance income is largely retained and reinvested at compound interest, providing an inexorable growth of capital which is most important in life insurance calculations even at low interest rates. Hence, while safety of the original principal is most important as an objective of life insurance investment, it is not the only consideration, and the regularity and reliability of income coupled with the rate of income become increasingly more significant with the passage of time. SUITABILITY OF CORPORATE D E B T FOR L I F E INSURANCE INVESTMENT

W i t h this brief introductory background let us now consider the suitability of corporate debt as a source of investment for life insurance funds, particularly in relation to the financial characteristics or requirements of the life insurance business as just summarized. In the first place it should be noted that we will be dealing with the concept of long-term corporate debt since, as indicated, life insurance companies are characteristically long-term investors. As such, corporate long-term debt possesses many attributes which qualify it as an ideal type of life insurance investment. T h u s , corporate long-term debt has a fixed maturity and generally carries a fixed interest rate representing a constant claim which must be met regularly by the issuing corporation in order to avoid insolvency. T h e s e characteristics of corporate long-term debt make it most adaptable in the actuarial end of the life insurance business where the assumption of constancy and regularity of income return is most important. Even more important, however, from the standpoint of the safety objective in life insurance investment, is the fact that corporate debt constitutes a prior claim on the assets of the corporation and is protected by the subordinate interest of others in the nature of a secondary lien and the proprietary ownership such as to provide a cushion against loss in the event of financial difficulties for the corporation. T h e history of rail-

120

INVESTMENT OF LIFE INSURANCE FUNDS

road reorganizations illustrates most emphatically the wisdom of investing in instruments having the prior claim cushioned by junior claims and the equity investment. In this connection it should be noted that this prior claim need not necessarily take the form of a mortgage bond secured by a specific pledge of assets. For example, a large proportion of industrial companies' assets usually consist of current assets and of other assets not as adaptable to pledge as are those of railroad and utility corporations. Hence, industrial debt financing commonly takes the form of debentures or promissory notes, but let there be no thought that such obligations are not adequately protected. In fact, like first mortgage bonds, these debentures actually do constitute a prior claim in most cases because of the existence of protective covenants. Thus, as set up by the lending life insurance companies, the protective covenants in such debenture or note obligations include such provisions as: (a) the assets of the borrower cannot be pledged or mortgaged without at least equally securing the outstanding debentures or notes: (b) additional long-term debt can be incurred only in limited amount; and (c) dividends or other distributions on common stock cannot be made except from future earnings. In addition, of course, there will be other provisions which seem appropriate to the facts of the individual case. This mention of protective covenants also serves to emphasize another important attribute of corporate long-term debt as an area of investment, and that is its flexibility. In other words, indenture or note terms can be tailored to fit the economic characteristics and circumstances of each individual case. T h e importance of long-term corporate debt as a field of investment will, of course, vary from one life insurance company to another. Life insurance companies make their investment decisions on a highly individualistic basis, and divergent investment policies are frequently pursued. However, the decision to employ corporate debt as a field of life insurance investment at a given time will be reached only after comparing, in terms of relative safety and net yield return, the competitive fields of investment of corporate debt, U. S. Government debt, municipal debt, real estate mortgages, direct real estate investment in the form of housing and commercial properties and corporate

C O R P O R A T E

121

D E B T

equities—i.e., preferred and common stocks. In making such a comparison of the various fields of investment it is submitted that the following attributes of corporate debt as a broad field of life insurance investment should be recognized—namely, (a) the highly impersonal nature of corporate bond investment, (b) the greater ability to recognize in terms of yield the various degrees of credit standing, (c) the superior marketability of corporate bond investments, (d) the greater simplicity of administering and supervising the investment, and (e) the flexibility of the instrument. It also should be noted, of course, that within the broad field of corporate debt itself the relative attractiveness at a given time of, for example, utility corporate debt must be examined in relation to industrial and railroad corporate debt and vice versa. AVAILABILITY

OF CORPORATE D E B T FOR

INVESTMENT

No matter how suitable or attractive for life insurance investment the field of corporate debt may seem, the $64 question still is how much is available or how large is the supply? T h e principal causal factor affecting the supply or availability of corporate long-term debt as a source of life insurance investment is the long-term economic growth or expansion trend of the nation, which, of course, is subject to the shorter-term influences of the ups and downs of the business cycle with all of its psychological overtones. In other words, the long-term economic growth trend of the nation will determine the needs of business corporations for plant and equipment and for more permanent financing of working capital requirements. Thus, the capital demands of business (and, hence, the supply of longterm corporate debt) will reflect such influences as (a) the level of consumer demand, both currently and as projected for the relatively near future; (b) competitive forces and improving technology; and (c) the movement of the general price level. Of course, there may be abnormal influences, such as tensions and unsettled political conditions throughout the world, which might require increased productive capacity for armaments. This definite correlation between the demand for capital funds and the supply of long-term corporate debt apparently is due to the fact that corporate managements generally desire to

122

I N V E S T M E N T OF L I F E INSURANCE FUNDS TABLE I U . S . N E T P U B L I C AND PRIVATE D E B T , END O F CALENDAS Y E A * ,

1921-50·

(Billions of Dolían)

1921 1922 1923 1924 1925 1926 1927 1928 1929 1930 1931 1932 1933 1934 1935 1936 1937 1938 1939 1940 1941 1942 1943 1944 1945 1946 1947 1948 1949 1950

Total Net Public and Private Debt

Total Public

$135.8 140.0 146.4 153.1 162.7 169.0 177.5 186.2 191.1 191.4 182.6 175.7 169.7 172.6 175.9 181.4 183.3 180.8 184.5 190.8 212.6 260.7 314.3 371.6 407.3 398.8 419.5 435.3 445.6 484.0

$ 29.6 30.5 30.0 30.0 30.3 29.9 29.7 29.8 29.7 30.6 34.0 37.9 41.0 46.3 50.5 53.9 55.3 56.5 58.9 61.3 72.6 117.5 169.3 226.0 266.5 243.3 237.7 232.7 236.7 239.1

Total Corporate Total Individual and Long-Term and Short-Term Non-Corporate Í 49.2 50.9 53.8 55.9 59.7 62.9 66.6 70.3 72.6 71.6 65.1 57.7 51.8 50.8 50.6 51.4 52.1 51.0 52.0 54.0 565 51.5 49.5 39.8 55.5 62.0 72.9 84.8 945 109.9

% 57.0 58.6 62.6 672 72.7 76 2 81.2 86.1 88.9 89.3 83.5 80.0 76.9 75.5 74.8 76.1 75.8 73.3 73.5 75.6 83.4 91.6 95.5 94.1 85.3 93.5 108.9 117.8 114.7 135.0

• Source: Survey of Current Business, October, 1950, and September, 1951. « Having original maturity of one year or more and including corporate mortgages. b Excludes corporate mortgages.

finance at least some part of capital requirements for expansion by the creation of long-term debt. The validity of this stated correlation is indicated clearly by an analysis of Table I showing the U. S. Net Public and Private Debt Outstanding at the End of Each Calendar Year 1921-50, inclusive. It will be noted that during the prosperous expansion

CORPORATE TABLE I L ' . S. N E T

DEBT

123

-(Continued)

P U B L I C AND PRIVATE D E B T , E N D O F CALENDAR Y E A R ,

1921-50*

(Billions of Dollars)

Total Corporate Long-Term Debt» 1921 1922 1923 1924 1925 1926 1927 1928 1929 1930 1931 1932 1933 1934 1935 1936 1937 1938 1939 1940 1941 1942 1943 1944 1945 1946 1947 1948 1949 1950

$33.8 34.4 36.2 38.5 39.7 41.7 44.4 46.1 47.3 51.1 50.3 49.2 47.9 44.6 43.6 42.5 43.5 44.8 44.4 43.Ï 43.6 42.7 ' 41.0 39.8 38.3 41.3 46.1 52.5 55.4 58.2

Total Corporate Long-Term Bonds and Notesb

Life Ins. Companies' Holdings of Corporate Bonds and Notes

N.A. N.A. N.A. N.A. N.A. N.A. N.A. N.A. $41.7 45.4 44.6 43.8 43.7 40.6 39.8 38.8 39.7 41.0 40.4 39.6 39.6 38.7 37.2 36.0 34.3 36.9 41.0 46.6 48.9 50.7

$ 1.9 2.1 2.3 2.7 3.0 3.4 3.9 4.3 4.5 4.9 5.0 5.0 4.9 5.0 5.3 6.0 6.5 7.3 7.9 8.6 9.6 9.7 9.8 10.0 9.9d 11.5

6.4) 6.5)

6.8)

8.9) 10.4)

Ili) 12.6) 14.0) 14.5) 14.9) 15.4)

16.1) 16.7) 17.4) 18.1) 18.3) 18.2)

.15 .47 .95 1.44 251 3.20 6.14 15.05 27.36 40.36 48.18 49.78 52.05 55.05 56.71 58.02

0.3) 0.9) 1.7) 2.4) 3.5)

4.7) 8 ί> 16.7) 24.0) 28.3)

28.6) (27.0) (265) (26.4) (26.0) (25.7)

.25 .33 .45 56 .68 .83 .99 1.17 1.43 1.67 1.93 2.18 2.42 2.67 2.92 3.37 4.04 5.98 7.60 958 11.87 16.71

( M)

28.12

(31.2) (38.9) (43.7) (44.7) (43.7) (43.9) (44.5) (44.3) (43.9)

44.33 62.33 75.25 80.35

86.12 92.72 96.68 99.19

( 1.3) ( 1.6)

( I·») ( 2.0) ( 2.2) ( 2.5)

( 2.6) ( S O) ( 3.4)

( 3-8) ( 4-5) ( 55)

( 6.1) ( 6.4) ( 6.8) ( 7.7)

(10.6) (12.8) (15.0) (17.3)

(22.1)

Note: T h e items in this table obviously do not include all forms of savings and the total presented is not to be construed as total savings. T h e series shown are chosen chiefly by reason of their availability over a long period of years. Corporate securities, business plant and equipment, residential structures and public improvements are some of the other forms of savings (or perhaps more accurately, investment) which would have to be added (with duplications eliminated) to obtain a complete account of savings.

CORPORATE DEBT TABLE

129

11—(Continued)

GROWTH OF REPRESENTATIVE FORMS o r INDIVIDUAL SAVINGS 1 9 1 0 - 5 0

(Billions of Dollars)

Commercial Banks

1910 1911 1912 1913 1914 1915 1916 1917 1918 1919 1920 1921 1922 1923 1924 1925 1926 1927 1928 1929 1930 1931 1932 1933 1934 1935 1936 1937 1938 1939 1940 1941 1942 1943 1944 1945 1946 1947 1948 1949 1950 Ρ

(*)

(%)

3.78 4.12 4.46 4.52 4.85 5.68 6.56 7.12 7.87 9.52 10.71 11.26 12.48 13.87 15.28 16.57 17.51 18.96 19.76 19.19 19.01 15.37 13.63 11.02 12.21 13.17 14.05 14.78 14.78 15.26 15.78 15.88 16.35 19.22 24.07 30.14 33.81 3555 35.80 36.15 36.31

(35.9) (36.7) (»7-2) (36-2) (36.9) (39.4) (41-2) (41.8) (42.1) (45.0) (45.2) (44.7) (45.2) (45.4) (45.3) (44.6) (43.5) (42.9) (41.5) (39.2) (37.6) (31.8) (29.3) (25.2) (26.4) (26.8) (26.9) (26.2) (24.9) (23.9) (23.0) (21.0) (18.1) (16.9) (16.9) (17.9) (18.4) (18.0) (17.2) (16.6) (16.0)

Mutual Savings Banks (f) (%) 3.36 3.48 3.64 3.79 3.88 4.02 4.26 4.37 4.55 4.95 5.34 5.61 5.96 6.38 6.82 7.22 7.68 8.27 8.77 8.84 9.42 10.01 9.93 9.49 9.74 9.87 10.06 10.17 10.28 10.52 10.66 10.53 10.66 11.74 13.38 15.39 16.87 17.75 18.39 19.27

20.01

(31.8) (31.0) (30.3) (30.4) (29.5) (27.9) (26.8) (25.6) (24.3) (23.5) (22.6) (22.2) (21.6) (20.9) (20.2) (19.4) (19.1) (18.7) (18.4) (18.1) (18.6) (20.7) (21.3) (21.7) (21.1) (20.2) (19.2) (18.0) (17.3) (16.5) (15.6) (13.9) (11.8) (10.3) ( 9.4) ( 91) ( 95) ( 9.1) ( 8.8) ( 8.8) ( 8.8)

Postal Savings Systeme (%) (f) .01 .03 .04 .06 .08 .11 .14 .16 .16 .15 .14 .13 .13 .13 .13 .14 .15 .15 .16 54 .60 .90 151 151 1.20 1.26 157 155 158 1.30 1.31 1.42 1.79 2.34 2.93 358 3.42 3.33 350 2.92

(05) (0.3)

(0-5) (0.6) (0.6) (0.8) (0.9) (0.8) (0.6) (0.6) (0.5) (0.4) (0.4) (0.3) (0.3) (0.3) (0.3) (0.3) (0.5) (15) (1.9) (2.8) (2.6) (2.4) (2.4) (2.3) (2.1) (2.0) (1.9) (1.7) (1.6) (1.6) (1.6) (1.7) (1.8) (1.7) (1.6) (1-5) (1.3)

Total

(*)

7.14 7.61 8.13 8.35 8.79 9.78 10.93 11.63 12.58 14.63 1650 17.01 18.57 20.38 2253 23.92 25.33 27.38 28.68 28.19 28.67 25.98 24.46 21.72 23.16 2454 25.37 2652 26.31 27.06 27.74 27.72 28.43 32.75 39.79 48.46 53.96 56.42 57.52 58.62 5954

Deposits (7c) (67.7) (67.7) (67.7) (66.9) (66.9) (67.9) (68.6) (685) (67.3) (69.3) (68.4) (67-5) (67.3) (66.7) (65.9) (64.3) (62.9) (61.9) (605) (57.6) (56.7) (53.7) (52.5) (49.7) (50.1) (49.4) (48.5) (46.5) (44.3) (42.4) (40.5) (36.6) (31.5)

(28.8) (27.9) (28.7) (29.4)

(28.8) (27.6) (26.9) (26.1)

* Figures consist of reserves, plus dividends unpaid and left to accumulate, less p r e m i u m notes a n d loans. *> Government pension and trust fund figures, which include all types of Government assistance, prior to 1939 were obtained from "Hearings before the T N E C . " Estimates for 1939-50 are based on data of Securities a n d Exchange Commission. « Includes both amounts redeposited in banks and a m o u n u not so redepoeited; excludes amounts at banks in possessions.

130

INVESTMENT OF LIFE INSURANCE FUNDS TABLE 11—(Continued) G R O W T H O F R E P R E S E N T A T I V E F O R M S o r INDIVIDUAL SAVINGS

1910-50

(Billions of Dolían)

1910 1911 1912 1913 1914 1915 1916 1917 1918 1919 1920 1921 1922 1923 1924 1925 1926 1927 1928 1929 1930 1931 1932 1935 1934 1935 1936 1937 1938 1939 1940 1941 1942 1943 1944 1945 1946 1947 1948 1949 1950 Ρ

Savings ir Loan Associations* (%) (f) .66 ( 6.3) .72 ( 6.4) .79 ( 6.6) Λ7 ( 7.0) .95 ( 72) 1.03 ( 7-2) 1.11 ( 7.0) 153 ( 72) 1.32 ( 7.1) 1.48 ( 7.0) 1.74 ( 7.3) 1.97 ( 7.8) 2.21 ( 8.0) 2.63 ( 8.6) 3.15 ( 9 5) 3.81 (10.3) 4.38 (10.9) (11.4) 5.03 5.76 (12.1) (12.8) 6.24 6.30 (12.5) 5.92 (122) 5.33 (11-5) (10.9) 4.75 4.46 ( 9-6) 4.25 ( 8.7) 4.13 ( 7.9) 4.02 ( 7.1) 4.01 ( 6.7) 4.06 ( 6.4) 427 ( 6-2) 4.65 ( 6.1) 4.91 ( 5.4) 5.49 ( 4.8) 6.31 ( 4.4) 7.37 (4.4) 8.55 ( 4.7) 9.75 ( 5.0) 10.96 ( 5.3) 12.47 ( 5.7) 14.04 ( 62)

Total (t) 7.80 8.33 8.92 922 9.74 10.81 12.04 12.86 13.90 16.11 17.94 18.98 20.78 23.01 25.38 27.73 29.71 32.41 34.44 34.43 34.97 31.90 29.79 26.47 27.62 28.49 29.50 3024 30.32 31.12 32.01 32.37 33.34 3824 46.10 55.83 62.51 66.17 68.48 71.09 7328

Banks

(%) (74.0) (74.1) (74.3) (73.9) (74.1) (75.1) (75.6) (75.4) (74.4) (76.3) (75.7) (75.3) (75.3) (75.3) (752) (74.6) (73.8) (73.3) (72.3) (70.4) (692) (65.9) (64.0) (60.6) (59.7) (58.1) (56.4) (53.6) (51.0) (48.8) (46.7) (42.7) (36.9) (33.6) (32.3) (33.1) (34.1) (33.8) (32.9) (32.6) (32.3)

Grand (f) 10.54 1124 12.00 12.48 13.15 14.40 15.92 17.06 18.69 21.10 23.68 2520 27.59 30.55 33.77 37.16 4029 4422 47.65 48.90 50.59 48.37 46.52 43.75 4622 49.06 5228 56.40 59.43 63.72 68.54 75.68 90.19 113.94 142.64 168.58 183.57 196.11 208.34 217.99 226.47

Total

(%) (100) (100) (100) (100) (100) (100) (100) (100) (100) (100) (100) (100) (100) (100) (100) (100) (100) (100) (100) (100) (100) (100) (100) (100) (100) (100) (100) (100) (100) (100) (100) (100) (100) (100) (100) (100) (100) (100) (100) (100) (100)