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The rates of return earned in the Canadian general insurance industry Kenning, David Wayne 1973

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• c! THE RATES OF RETURN EARNED IN THE CANADIAN GENERAL INSURANCE INDUSTRY by DAVID WAYNE KENNING B. Com., University of British Columbia, 1971 A THESIS SUBMITTED IN PARTIAL FULFILMENT OF THE REQUIREMENTS FOR THE DEGREE OF MASTER OF BUSINESS ADMINISTRATION in the faculty of Commerce and Business Administration We accept this thesis as conforming to the required standard THE UNIVERSITY OF BRITISH COLUMBIA April, 1973 In presenting this thesis in partial fulfilment of the requirements for an advanced degree at the University of British Columbia, I agree that the Library shall make it freely available for reference and study. I further agree that permission for extensive copying of this thesis for scholarly purposes may be granted by the Head of my Department or by his representatives. It is understood that copying or publication of this thesis for financial gain shall not be allowed without my written permission. Department of COMMERCE AND BUSINESS ADMINISTRATION The University of British Columbia Vancouver 8, Canada Date APRIL 11. 1973 ii Abs tract Since the introduction of the Little Report which looked at the re lationship between prices and profits in the property and liability insurance industry, there has been extensive discussion in the Journal of Risk and Insurance and elsewhere on the important issue of calculating the profitability of property and liability insurance companies. Much of this discussion has centered on defining the appropriate measures of risk and return in order to determine the insurance industry's profitability relative to that of other industrial groups. It is generally agreed that such inter-industry comparisons must be set within a risk-return framework. However, the emphasis placed on the conceptual problems of defining and measuring risk has resulted in a good deal of arbitrariness in,^calculating rates of return. To be specific, none of the studies published in the Journal of Risk and Insurance employ the same rate of return measure. These variations arise in part from the differing approaches adopted in arriving at a comparative measure, but they also reflect an attempt to develop a more precise method of measurement. This study investigates the underlying difficulties that are associated with these previous studies. It is felt that many of these difficulties can be circumvented by analyzing the rate of return that is earned within the insurance industry, ignoring a comparison of returns with other industries. This allows the risk dimension to be dropped from the analysis. In arriving at a accurate measurement procedure, it is explained that profit should be related to net worth rather than total assets, investable funds, or some other measure. The reason is that the return on net worth considers only those funds which management has under its control for al ternative uses. It is then explained that net worth is best measured iii indirectly as the difference between total assets and liabilities at one point in time. However, there are several adjustments that must be made to the statutory asset and liability figures before they can be used. Assets, which consist primarily of financial assets, should be valued at market prices, because market values are a more realistic valuation of assets at a point in time than book values. Non-admitted assets should also be included in the total asset figure. Liabilities require sub tracting a realistic value of the "equity" from the unearned premium reserve. Care must also be taken not to classify such items as unauthorized reinsurance reserves, investment and contingency reserves, etc. as liabilities because they are really a part of the net worth of the company. It is then explained how an accurate calculation of the return on net worth can actually be made. In this area, special consideration must be given to the quarterly payment of dividends, the payment of income taxes, any additional capital that is raised during the time period, and to tax or tax credits relating to any unrealized profits or losses that are to be included in the return measure. A brief explanation of how the population and sample were chosen is presented along with other various empirical procedures that were followed. This study then presents the results of the empirical work. Several rates of return were calculated including the rate of return before and after tax for the industry as well as for three generally defined size classes of the industry. The latter was done to determine if there are any economies of scale in operation. The rate of return was then defined to originate fromthree sources. These sources are investment income, mainly consisting of rents, interest and dividends received, underwriting profit, and other or residual income mainly comprised of unrealized capital gains or losses. iv The 'tax shield effect relating to the difference between underwriting profits calculated on a statutory basis and on an incurred basis was also determined. On the other hand, the tax shield effect associated with unrealized capital gains and losses was not calculated because no capital gains tax were evident in Canada during the time period studied. Finally some conclusions are presented along with mention of further study and research that could be undertaken in light of the results of this study. The general conclusions are that the insurance industry return during this period was not excessive. It was also concluded that after a certain volume of insurance business is reached, some economies of scale seem to exist. Finally, investment income (rents, interest, and dividends received) accounted for most of the industry rate of return before taxes because underwriting and residual income (unrealized capital gains and losse were generally within the - 1 percent to + 1 percent range on net worth duri the time period of the study. V TABLE OF CONTENTS Page LIST OF TABLES ix ACKNOWLEDGEMENT xi CHAPTER 1. INTRODUCTION 1 The Purpose of the Study 1 The Justification for the Study 1 The United States SituationThe Canadian Situation 2 The Outline of the Study 3 2. A SUMMARY AND CRITIQUE OF THE LITERATURE WRITTEN ON THE PROFITABILITY OF THE GENERAL INSURANCE INDUSTRY 6 Studies on the Profitability of American General Insurance Companies 6 The Little Report on Prices and Profits in the Property and Liability Insurance Industry by Arthur D. Little Inc 6 The Rate of Return Measure 7 Technical Difficulties 10 The Risk Measure 11 Profitability in the Property and Liability Insurance Industry by Richard Norgaard and George Schick 14 The Rate of Return Measure 14 Property - liability Profits: A Comparative Study by James S. Trieschmann 17 The Rate of Return Measure 17 The Risk Measure 20 vi TABLE OF CONTENTS (Continued) CHAPTER Page Studies on the Profitability of Canadian General Insurance Companies 20 ' Calculation of Rates of Return on Invested Capital of Canadian General Insurance Companies by Peat, Marwick, Mitchell and Co. and Price, Waterhouse, and Co 20 3. AN APPROACH TO CALCULATING THE RATE OF RETURN IN THE GENERAL INSURANCE INDUSTRY 26 The Rate of Return on Net WorthThe Explanation for Using the Rate of Return on Net Worth 26 The Steps Performed to Calculate the Return on Net Worth 8 Step 1 - Making the Required Adjustments to the Statutory Asset and Liability Accounts 28 Assets 21. Investments 28 2. Non Admitted Assets ... 29 Liabilities 30 1. Unearned Premium Reserve 30 2. General, Investment and Contingent Reserves 34 3. Reserve for Reinsurance Ceded to Unregistered Companies 35 4. Loss Reserve 36 A Summary of Required Asset and Liability Adjustments 37 Step 2 - Making the Actual Rate of Calculations 40 Allowing for transfers or Additions of Capital 41 vii TABLE OF CONTENTS' (Continued) CHAPTER Page Allowing for Periodic Payments of Dividends 42 Allowing for Taxation of Unrealized Gains 42 Step 3 - The Choice of the Weighting System 43 4. THE EMPIRICAL PROCEDURES 7 The Population Defined 4The Population Stratified 7 The Sample Selected 48 The Data CollectedThe Adjusted Net Worth Calculated 48 The Rate of Return CalculatedThe Sources of Return 49 5. THE RESULTS 52 The Industry Rate of Return 5The Industry Rate of Return Before Taxes . 52 The Industry Rate of Return After Taxes .. 54 The Industry Rate of Return Before Taxes by Industry Class or Size 58 The Industry Rate of Return After Taxes by Industry Class or Size 9 Other Results Concerning the Rate of Return 61 The Sources for the Industry Rate of Return ... 64 Investment Income 6Underwriting Income 6 The Tax Shield Effect 68 viii TABLE OF CONTENTS (Continued) CHAPTER Page Underwriting Profit/Net Premiums Earned 70 Residual or Other Income 2 The Tax Shield Effect 73 6. CONCLUSIONS 74 BIBLIOGRAPHY 8 APPENDIX 81 ix LIST OF TABLES Table Page I. A Summary of the Results of the Peat, Marwick, Mitchell & Co. and Price, Waterhouse & Co. Study 22 II. A Summary of the Asset and Liability Adjustments Required to Arrive at the Actual or Adjusted Net Worth 39 III. The Industry Rate of Return Before Taxes 53 IV. The Yearly Industry Rate of Return Before Taxes (weighted using the adjusted net worth figure) 5V. The Industry Rate of Return After Taxes 55 VI. The Yearly Rate of Return After Taxes (weighted using the adjusted net worth figure) 55 VII. The Average Tax Effect on the Industry Rate of Return 56 VIII. The Industry Rate of Return Before Taxes by Industry Size 8 IX. The Industry Rate of Return After Taxes by Industry Size 59 X. The Average Tax Effect on the Industry Rate of Return by Size Class 60 XI. Investment Income/Adjusted Net Worth 65 XII. Adjusted Underwriting Profit/Adjusted Net Worth 67 XIII. The Underwriting Tax Shield Effect on the Rate of Return on Net Worth (10 year Arithmetic Averages) 70 XIV. Statutory and Incurred Underwriting Profit/ Net Premiums Earned 71 XV. Residual or Other Income/Adjusted Net Worth 72 X LIST OF TABLES (Continued) Table Page Tables XVI to XXXII of the Appendix, are in many instances, enlargements of tables given in the text of the thesis XVI. The Random Sample of Canadian General Insurance Companies Used in this Study 82 XVII. The Expense Ratio Used for the Unearned Premium Reserve 83 XVIII. The Industry Rate of Return Before Taxes (on adjusted net worth) 84 XIX. The Industry Rate of Return After Taxes (on adjusted net worth) 87 XX. The Industry Rate of Return Before Taxes by Industry Size (on adjusted net worth) 90 XXI. The Yearly Adjusted Net Worth 92 XXII. The Yearly Dividend Payout 8 XXIII. The Yearly Additional Capital Paid In 104 XXIV. The Yearly Income Taxes 110 XXV. Investment Income - Industry and by Size Class 116 XXVI. The Yearly Investment Income 118 XXVII. Actual or Incurred Underwriting Profit - Industry and by Size Class 124 XXVIII. The Yearly Overstatement in the Unearned Premium Reserve and the Statutory and Incurred Underwriting Profit 126 XXIX. The Effect of the Tax Shield and the Unearned Premium Adjustment on the Underwriting Result (1961 - 1970) 135 XXX. Statutory Underwriting Profit to Net Premiums Earned 136 XXXI. Incurred Underwriting Profit to Net Premiums Earned 137 XXXII. Summary of Results - Industry and by Size Class 138 Acknowledgement I am especially indebted to: Dr. Gerald M. Dickinson for his constant encouragement, patient guidance and continuing direction during the writing of this study. 1 Chapter 1 Introduction The Purpose of the Study The purpose of this study is to examine the rates of return earned by a random sample of general insurance companies operating in Canada. The companies included in the sample are Canadian companies or Canadian subsidiaries of British or American companies. Rates of return are calculated for the years 1961-70, the latter year being at the time of writing the latest year figures were available. The Justification for the Study The United States Situation Over the last five years in the United States there has been over a dozen articles written on the rate of return earned by the property and liability insurance industry. The starting point for these series of articles can be traced back to November 1967, when a report by Arthur D. Little Inc. was presented to the American Insurance Association.^^ The author, Dr. Irving Plotkin concluded "that the risk related rate of return in the insurance industry is significantly below that which other industries (2) earn." Plotkin found the rate of return for his sample to average 4.4 percent over the period 1955-65. A second study done by the same author in June 1969 resulted in a 3.6 percent rate of return for the insurance industry while the other industries averaged a 10.7 percent rate of return. Many of the other articles written during this five year period concur with these results. However, there are also other articles that do not agree with these results. 2 The Canadian Situation Two chartered accountant firms working jointly have produced the only study in Canada on the rate of return earned by general insurance companies (4) operating in Canada. This study presented a large number of accounting rates of return but did not reach any conclusions on the level or adequacy of the rate of return. In light of the number of articles that have been written in the United States it is rather surprising that only one attempt has been made in Canada. Furthermore, when it is noted that in many instances conflicting results were reached, this fact becomes even more surprising. In the opinion of the author of this study, this is in itself enough justification for the time spent on this study. However, there are further underlying implications that are just as important. In the first place, the insurance industry has used the results of many of these studies to convey to the public and regulatory authorities the unprofitable position they are in when compared to other industries. The insurance industry claims they are in a very vulnerable position because the low rate of return will result in the industry's inability to attract capital from the investing public who are seeking the highest rate of return for a given level of risk. Similiarly, investors will feel that the capital already invested in the insurance industry is inefficiently employed and therefore will flow out to other industries that offer a higher rate of return. The outcome is that the insurance companies feel if they are to maintain the service they provide, there must be approval of rate increases in the price of insurance or even removal of price regulation by the statutory authorities. Of course, any price increases have implications for most of the population because of the large number of insurance policies held. As a result of continuing price increases, some provincial governments in Canada have or are in the process of taking over and running certain segments of the insurance industry. One only has to look at the heated debate over 3 automobile insurance premium increases and the pending government takeover in British Columbia to gain a feeling of the importance that this topic has in our society today. The Outline of the Study The next logical question is are the claims of the insurance industry valid? Is the insurance industry underearning as determined by the various studies that have been done? Chapter 2 will present a summary and critique on some of the literature that has been written on the rate of return earned by the property and liability insurance industry. The emphasis will be on the Little Reports of November 1967 ^"^ and June 1969,^^ because these two reports have managed to stir up more controversy than the other studies. However, emphasis will also be placed on the Canadian study done jointly by Peat, Marwick, Mitchell, and Co. and Price Waterhouse and Co.both because it is the only study in Canada and because of the similiar purpose of this study. A brief analysis will also be presented of articles written by Richard Norgaard and George Schick and James S'. Trieschmann. (9) Dr. Plotkin concluded that it is the inbecent structure of present insurance operations and not actuarial or accounting phenomenon which produce the current unsatisfactory rate of return in the industry.(10) Similiarly, in the only Canadian study to date it was stated that "adjust ments have not been made in the calculation of equity for possible excesses in the reserves for unearned premiums and unsettled claims.On the other hand, Long and Gregg stated that "because statutory regulations require insurance companies to present financial data on a statutory or solvency basis it is necessary to look beyond the statutory results to determine the (12) true financial position and earnings record of an insurance company." 4 This study concurs with Long and Gregg. Chapter 3 will explain that assets will have to be restated to include non-admitted assets and unrealized investment gains among other asset .adjustments. Liabilities will also be restated to eliminate various reserves that are merely appropriations of surplus, overstatements in the unearned premium reserve, etc. It will be explained that the overstatement in the unearned premium reserve is created by an accounting mismatching of revenues and expenses. The purpose of Chapter 3 will be to arrive at the increase or decrease in the shareholders net worth through the period by attempting to adjust the statutory shareholders net worth to reflect the various adjustments made to the statutory assets and liabilities. Recognition must also be given to such things as the difficulties that are encountered when the adjusted shareholders net worth for the individual companies are aggregated into one return for the industry as a whole. Specifically, the determination of a weight for each company must be determined. Chapter 4 will explain the empirical procedures that were used. This includes such procedures as how the sample was chosen, what were the data sources, how the actual adjustments from the published data were made, etc. Chapter 5 will then present the results. The rate of return for the industry will be analysed on a before and after income tax basis. Companies were then broken down into three size classes to determine if there were any differences in the rate of return earned by companies of differing size. The total rate of return was also broken down into the components that make up this rate of return. These components, three in number, were defined as underwriting results, investment income (interest, dividends, and rent), and other income that mainly consisted of unrealized capital gains or losses. Also included in the results will be an analysis of the tax shield effect associated with the conservative statutory accounting 5 procedures used to determine underwriting profit. Finally, Chapter 6 will restate the purpose of this study, present a summary of the more important findings, and suggest what further studies could be undertaken that might arise from this study. FOOTNOTES 1. Arthur D. Little Inc., "Prices and Profits in the Property and Liability Insurance Industry", Report to the American Insurance Association, November 1967. 2. ibid., p. 129. 3. Arthur D. Little Inc., "Rates of Return in the Property and Liability Insurance Industry 1955 - 1967", Report to the National Association of Independent Insurers, June 1969. 4. Peat, Marwick, Mitchell, & Co. and Price, Waterhouse & Co., "Calculation of Rates of Return on Invested Capital of Canadian General Insurance Companies", Report to the Superintendent of Insurance, January 1967. 5. Arthur D. Little Inc., op. cit., November 1967. 6. Arthur D. Little Inc., op. cit., June 1969. 7. Peat, Marwick, Mitchell, & Co. and Price, Waterhouse & Co., op. cit., January 1967. 8. Richard Norgaard and George Schick, "Profitability in the Property and Liability Insurance Industry", The Journal of Risk and Insurance, Vol. XXXVII, No. 4, December 1970, pp. 579 - 587. 9. James S. Trieschmann, "Property Liability Profits", The Journal of Risk and Insurance, Vol. XXXVIII, No. 3, September 1971, pp. 437-453. 10. Irving H. Plotkin, "Rates of Return in the Property and Liability Insurance Industry", The Journal of Risk and Insurance, Vol. XXXVI, No. 3, June 1969, pp. 173 - 200-11. Peat, Marwick, Mitchell, & Co. and Price, Waterhouse & Co., op. cit., p.2. 12. John D. Long and Davis W. Gregg, Property and Liability Insurance Handbook, Richard D. Irvin, Inc., Homeward Illinois, 1965, pp. 937. 6 Chapter 2 A Summary and Critique of the Literature Written on the Profitability of the General Insurance Industry The purpose of this chapter is to present a summary and critique of some of the more significant articles written about the rate of return earned in the property and liability insurance industry. The emphasis will be placed on the rate of return measure that was used in each study, though a brief explanation will also be given to the risk measure where applicable. This chapter will begin with a summary and critique about certain articles written in the United States by Arthur D. Little Inc., Richard Norgaard and George Schick, and James S. Trieschmann. Separate emphasis will then be placed on the only Canadian study to date, that is the study prepared jointly by the two chartered accountant firms of Peat, Marwick, Mitchell, and Co. and Price, Waterhouse and Co. Studies on the Profitability of American General Insurance Companies The Little Report on Prices and Profits in the Property and Liability Insurance Industry by Arthur D. Little Inc. As stated in Chapter 1 of this study, this Little Report reached the following principal conclusion: that the risk related rate of return in the insurance industry is significantly below that which other industries earn.(l) The report stated that the rate of return for the insurance industry sample averaged 4.4 percent from 1955 to 1965. 7 The Rate of Return Measure - The return measure used in the Little Report is referred to as the return on investible funds. For insurance companies, the return is calculated as follows: RpL = I + D + UP + (RC - T) + UC (1) S + UR + LR where = rate of return earned in the property and liability insurance industry I = interest D = dividends UP = underwriting profit RC = realized capital gains T = taxes associated with the realized capital gains UC = unrealized capital gains S = surplus consisting of capital stock paid plus surplus UR = unearned premium reserve LR = loss reserve For non-insurance companies, the return on investible funds measure is calculated by the following: %PL =NI_+FC (2) S + LD where R^-^ = rate of return earned in the non-insurance industry or industries NI = net income FC = fixed charges LD = long term debt There are many criticisms that can be levelled at the return on investible funds measure. In the first place, the numerator"in the rate of return for insurance companies contains underwriting profit. The actual 8 figure used in the Little Report is the statutory underwriting profit. This is not correct. Chapter 3 will show that when the rate of growth of insurance business written by a particular company is increasing, the statutory underwriting profit is an understatement of the actual under writing profit. The reason for this is that under statutory regulations a company cannot take credit for prepaid expenses and thus the premiums that are received and entered into a liability account called the unearned premium reserve contains an equity in it that should be allowed for the statutory underwriting result. To emphasize, the expenses associated with writing insurance contracts, and a large proportion of such expenses do occur at the time of the writing of the contracts, are written off to the income statement on a cash basis while the revenues associated with these same insurance contracts are set up as a liability and earned only on a time accrued basis. The result is that there is a mismatching of revenues and expenses in the insurance industry. This is a violation of a basic accounting principle that must be corrected in order to arrive at the true or actual underwriting profit. A second criticism of the return on investible funds measure is that it does not allow for the tax consequences of unrealized capital gains or losses included in the numerator of the formula. This ommission introduces a volatility into the risk adjusted rate of return for insurance companies that increases the apparent risk of insurance companies relative to other companies. This is likely to occur because such unrealized capital gains or losses represent a larger proportion of the rate of return in an insurance company than is true of non-insurance companies. This in turn is due to the nature of the insurance business, where investments comprise a large proportion of total assets while inventories, fixed assets and accounts 9 receivable are smaller in relation to total assets. In other words, if a tax on unrealized capital gains with credit for unrealized capital losses was accounted for, the tax would have a more stabilizing effect on the level of return among insurance companies, relative to non-insurance companies, thus reducing the risk and possibly increasing the risk adjusted rate of return for insurance companies. The third criticism of the return on investible funds measure centres on the denominator. The Little Report equates the two reserve items of insurance companies with the long term debt of other industries. The two reserve items are short term liabilities, but the Little Report treats them as a source of funds just as long term liabilities are for a manufacturing company. They are not the same. The weakness is that whereas long term debt produces a return to its suppliers in the form of debt interest, there is no such return to policyholders from the two reserve items. Debt is the result of a decision to borrow and the company has no choice but to pay the interest costs associated with the outstanding debt. These interest costs are added back onto the fixed charges item in the numerator of the return measure for non-insurance companies. On the other hand, the two reserves created are implicit, they are a necessary bi-product of the insurance process. There is essential no cost; in fact, they bear interest because they are usually invested in very secure and liquid investments by the insurance companies. Though these reserves are included in the denominator and wrongly so because they are current liabilities, there is no imputed return included in the numerator. In other words, the "fixed charges" is zero for insurance companies, but positive or plus for other industries. Hence, the return on investible funds measure for insurance companies has an inherent downward bias built into it. The return on investible funds measure is also biased against the 10 insurer that maintains a larger proportion of reserves for unearned premiums and unpaid losses in relation to net worth. The larger the proportion of reserves, the lower the rate of return. The formula does not even allow for comparisons within the insurance industry simply because nothing is added to the numerator as an imputed interest on these reserves, while varying reserve amounts are added to the denominator. In conclusion, the reserve items should not be included in the denominator. The return on investible funds is a meaningless concept which neither considers the totality of assets (the return on assets)' nor the return to the owners of the enterprise (the return on net worth). Technical Difficulties - Brief mention should be made of some of the empirical or procedural difficulties associated with the Little Report. For non-insurance industries, the report uses the Compustat Industrial (2) Tape. This manual defines the fixed charges item as follows: fixed charges represent all interest expense, the amortization of debt discount or premium and the amortization of expense (ie; underwriting, brokerage fees, advertising costs, etc.) Fixed charges also include subsidiary preferred dividends and other interest. As a result, the fixed charges item in the numerator of the return on in vestible funds measure for non-insurance industries is overstated because it includes more than just the interest paid on the long term debt amount given in the denominator. The Little Report does not state how the various industries were selected or how the companies within the industry were selected. However, the time period chosen for insurance companies (1955 - 65) was listed as one of the worst for the insurance industry's overall earnings. Furthermore, this period also differs from the time period chosen for non-insurance industries (1950 -1965). The period 1950 - 54 for insurance companies was a good period, one in which the combined loss and expense ratio was below 100 percent. 11 In other words, the time periods chosen may have helped to widen the spread between the rate of return for the insurance versus the non-insurance industry. There is also a problem involved with applying the Standard Industrial Classification that is used in the Little Report. The Standard Industrial Classification defines industries by the use of digits. For example, a one digit industry may be the entertainment industry. A two digit industry is a narrower definition of what constitutes an industry. The entertainment industry may be subdivided into sports, music or drama etc. A three digit industry is a further narrowing of the definition of an industry. Sports may be subdivided into hockey, baseball, football, etc. In short, the greater the number of digits used the more precisely a particular industry is defined. Some of the industry definitions used in the Little Report are four digit, three digit, and two digit industries. It is felt that the spatial dispersion of returns will be exaggerated by this heterogenity among industry groupings because any outside influence could have a more catastrophic effect on a narrowly defined industry than on a broadly defined industry. The Risk Measure - The definition of industry risk used in the Little Report is the average over all years of the variance of company rates of return about their mean value, these latter calculations being made for each year. Thus, this measure requires the following two steps to be performed: 1. the annual variance for each industry Var(C.t) =1 < (C.t - C.t)2 (3) N 1=1 where C^t = rate of return for company i in year t 12 where C.t = average rate of return.for all companies in the industry in year t N = number of companies in the industry in year t 2. the risk for an industry over T time periods 1 • S- Var(Cit) (4) T t - 1 where T = the number of years The Little Report concluded that by regressing the average rate of return for an industry upon the average risk of that industry the following result was obtained: that the insurance industry is not earning a rate of return commensurate with those earned in other economic activities on assets placed in similar risks. In only one case in a hundred could an industry with a risk of 10.89 units have earned the 4.4 percent or less by chance factors alone. (5) The Little Report also states: that the measure of risk is based on a cross sectional concept. As such it eliminates many of the statistical difficulties encountered by previous researchers who used measures of risk based on a time - series concept. The risk measure used in the Little Report can be termed the spatial measure of risk. As a measure of risk, the spatial measure has certain deficiencies, which like the return measure, reduce the validity of the results presented in the Little Report. In the first place, the reader should carefully consider the following example. Suppose the companies comprising an industry are earning a different return in any one year but over time each company continues to earn exactly the same rate of return. In this instance, prediction for a single company is relatively easy because there is no risk 13 in the variance of return for that single company. That is, the returns for each company are predictable and little uncertainty exists. However, the spatial measure of risk would not assign a zero value to this situation. On the other hand, if all the companies in an industry in a given year earn exactly the same rate of return, but this industry rate varies from year to year the spatial measure of risk would assign a zero risk to this situation. Of course, the most probable situation is for companies in an industry to have rates of return which vary both spatially and over time. However, it is entirely possible using the spatial measure of risk for the risk to be judged the same in this situation just described as in the first instance (where the companies earn a different return in any one year but over time each company continues to earn exactly the same rate of return.) Obviously, the two situations do not represent the same amount of risk. The reason for this result, which may seem rather unusual at first glance, is that the spatial measure of risk considers only one dimension of risk. This measure used in the Little Report measures risk across the industry at a point in time but fails to adequately consider risk over time. In short, the spatial measure considers the peculiar and specific characteristics of the individual companies in an industry such as the quality of management expertise and the size of the company, etc. These are important considerations, however, an investor is also concerned with future external factors such as fiscal and monetary policy, business cycle fluctuations, price level changes, and shifts in demand, etc. In other words, the spatial measure concentrates on factors that make companies different at one point in time but additional consideration must also be given to future factors that are going to affect the entire industry as one unit. A second criticism of the risk analysis presented in the Little Report 14 revolves around regressing the average rate of return upon the average risk for that industry. Frequently, conclusions are reached that the further the industry is above the regression line the more the industry is overearning. Likewise, the further below the regression line an industry is located, the more the industry is underearning. As stated earlier, the insurance industry was found to fall well below the fitted regression line and therefore the Little Report concluded that the insurance industry was underearning. How ever, the regression line was not a close fit and hence the tradeoff is not too accurate. Specifically, if repeated samples' were taken, it is highly likely an entirely different regression line would result from each sample. To conclude that the insurance industry is underearning based on the regression analysis presented in the Little Report is incorrect. Profitability in the Property and Liability Insurance Industry by  Richard Norgaard and George Schick This November 1969 study concluded that insurance company earnings are generally on a par or exceed those of non-insurance companies. The study also concluded that there was a suggestion of economies of scale both in terms of the size of the company and the degree of specialization within the in surance industry. The Rate of Return Measure - For non-insurance companies Norgaard and Schick used the following rate of return measure: ROM (t) = I(t) + D(t) + TMV(t) - TMV(t-l) + TS(t) + A(t) (5) NFL TMV(t-l) where ROM = the return on market value for non-insurance companies at time (t) TMV = I(t) + MP(t) MC(t) C(t) MP = market value of preferred stock at time (t) MC = market value of common stock at time (t) 15 I = interest on long term debt at time (t) D = cash dividends paid - preferred and common at time (t) C = the yield on long term debt TS = treasury stock purchases A = net debt amortized In arriving at a rate of return measure for insurance companies Norgaard and Schick made a very important assumption. The assumption is that since the market value of a firms outstanding securities must equal the market value of its package of assets and since insurance company assets are carried at market, there should be a substantial similiarity between the market value of assets and the market value of their own shares. Therefore, for insurance companies Norgaard and Schick substitute the market value of assets for the market value of their own shares outstanding. Hence, for insurance companies the rate of return measure is the following: ROM (t) = D(t) + TS(t) + TMV(t) - TMV(t-l) (6) PL TMV(t-l) where D = dividends to policyholders in case of mutual companies at time (t) TMV = terminal market value of assets In short, Norgaard and Schick compare the return on assets for the insurance industry against the return on the market value of outstanding securities for non-insurance companies. There is one large weakness associated with the Norgaard and Schick study. As stated, they used the total market value of assets £^TMV(t-l)J as the denominator or base for the return calculation for insurance companies. The numerator consisted of dividends, treasury stock purchases, plus the change in the value of total assets Qp(t) + TS(t) +A TMV(t).[[] Therefore, the rate of return can be rewritten as follows: 16 ROMTMC(t) = D(t) + TS(t) + A TMV(t) (7) iNb TMV(t-l) The key to seeing the weakness in the Norgaard and Schick study stems from recognizing a basic accounting indentity. This basic accounting identity is the following: TMV(t) = L(t) + S(t) (8) where TMV = value of total assets at time t L = value of total liabilities at time t S = value of total net worth at time t Furthermore: A TMV(t) = A L(t) + A S(t) (9) Now, by substituting the above into the rate of return measure t_ (7) 3 tne following is obtained: ROM (t) = D(t) + TS(t) + A L(t) + A S(t) (10) PL TMV(t-l) Therefore, by using the Norgaard and Schick measure the rate of return can be increased by increasing the value of the liabilities^, A L(t)J over the period. Obviously, this is not correct and results in an overstatement in the rate of return for insurance companies relative to non-insurance companies because the measure used to calculate the return to the latter uses the change in the market value of securities outstanding, not the change in the value of total assets. The two are not the same for the market value of securities outstanding reflects many more factors in addition to the change in the value of total assets. For instance, perhaps a more important consideration is the composition of the change in the value of total assets, rather than the dollar value of the change itself. To conclude, the Norgaard and Schick return measure for insurance companies is unsatisfactory and has an inherent upward bias built into the 17 numerator of the measure. Property - Liability Profits: A Comparitive Study by James S. Trieschmann The study by Trieschmann reached the conclusion that the results of the Little Report do hold. Trieschmann also noted that there was some differences in the rates of return earned among insurance companies according to their size. The study stated that large companies are able to produce a more stable return but not a higher return. The small companies had the lowest risk adjusted rate of return but the study concluded that economies of scale do not necessarily exist in the general insurance industry. The Rate of Return Measure - For the insurance industry, Trieschmann used the following rate of return measure: rit = UI + (.75)(UII) + RII +' .50(.75)(E)(UPt - UP^) - T (11) (PSt + PSt-1) / 2 where r^t = rate of return for the ith firm in year t UI = statutory underwriting income UII = unrealized investment income (capital gain tax rate = 25%) RII = realized investment income UP = unearned premium reserve at time t E = expense ratio (Trieschmann assumed that 257,, of the expense associated with the unearned premium reserve was not yet incurred at the end of a given year.) T = federal income taxes PS = surplus at time t For the non-insurance industry, Trieschmann used the following return measure: rit = NI + NRI (12) (Et.x + Et) / 2 18 where NI = net income NRI = non recurring income E = shareholders equity at time t The major criticism of the Trieschmann study centres on the denominator in the return measure. In particular, Trieschmann adds together the be ginning and ending surplus amount for each year and divides this by two to arrive at what is termed the average surplus for the year. In most instances, this is not correct. It is argued here that the denominator should be simply the surplus amount at the beginning of the year. The reason for this is that income, represented by the numerator in the return measure, normally starts to accrue from the first day of the year and then continues throughout the year. By using an average, Trieschmann implies that this is not the case. For example, in periods of a growing surplus figure, and this has been the normal situation in the past, the use of an average will result in a larger denominator and hence a lower rate of return than by simply using the beginning surplus figure. Of course, there are exceptions. Not all income will begin to arrive evenly from the beginning of the year and therefore these sources of income should legitimely be given separate treatment. Some examples include funds derived from a merger or consolidation, a transfer of funds from a parent to a subsidiary or vice versa, and funds derived from new financing. On the negative side, there is the periodic payment of dividends which usually occurs quarterly. The separate treatment referred to would require determining how long the particular funds were or were not available to the managers of the company during the year or the period under study. This would then formthe foundation for developing a new base or denominator for each of these separate or nonrecurring items. A second criticism of the Trieschmann study revolves around his imputed 19 tax (tax credit) to unrealized capital gains (losses) on financial asset holdings and also on imputing taxation to capitalized underwriting profit. Trieschmann taxed these unrealized capital gains (gave tax credit to unreal ized capital losses) at the long term capital gains tax rate in the United States of 257o. Capitalized underwriting profit was taxed at the full marginal corporate rate of 50%. Chapter 3 will show that some adjustment should in fact be made for tax in this area and that the rates given above are reasonable in the circumstances. However, the method used to incorporate this imputed taxation into the rate of return calculation results in some bias. Trieschmann, arguing the need for accounting consistency, subtracts the imputed tax from both the numerator and denominator of the rate of return ratio. The danger of making this arbitrary adjustment without considering the compound interest implications can be seen as follows: Assuming any additional capital or dividends are equal to zero for ease of exposition, the above adjustment implies: rt = Awt - Xt Wt-1 " xt where rt = rate of return earned over a basic unit of time (one year) Wfc = net worth at the end of year t - or surplus at the end of year Awt = wt - wt_x Xt = the imputed taxation in year t This can be rewritten as Wt-l(l + rt) = Wt - Xt + rt Xt; the term rtXt, which arises from subtracting Xt from the denominator is clearly redundant, and therefore results in an overstatement of the rate of return. Finally, it should be mentioned that this study did attempt to measure the return to the owners of the company, the return on net worth, something 20 the other studies mentioned in this chapter did not do. Chapter 3 will explain that the return to the owners of the company is the only meaningful measure for insurance companies. However, the approach will be different from that used by Trieschmann. The Risk Measure - Like the Little Report, Trieschmann used the spatial measure of risk. However, the temporal measure was also used in order to compare the two risk measures. The temporal measure is a measure of the variability in the rate of return over time within a single firm. Trieschmann concluded that the spatial method of adjusting for risk gives a lower risk adjusted rate of return than does the temporal measure. This study also stated that the temporal measure is more logical both because it allows one to look at individual companies and also that by using the study's sample this measure demonstrated a stronger risk-return relationship. The same criticisms of the risk measures discussed earlier under the Little Report apply here to the Trieschmann study. Each risk measure considers only one dimension of risk. The temporal risk measure does not take account of the risk across the industry at one point in time. On the other hand, the spatial risk measure fails to adequately consider risk over time. Studies on the Profitability of Canadian General Insurance Companies Calculation of Rates of Return on Invested Capital of Canadian General  Insurance Companies by Peat, Marwick, Mitchell and Co. and Price, Waterhouse  and Co. In contrast to the large number of studies written in the United States, this study is the only one that has been done in Canada. The period studied was from 1958 to 1965 and the data source for each year was the "Report of the 21 Superintendent of Insurance, Volume 1." In this report to the Insurance Bureau of Canada, the authors did not present any conclusions about the profitability of Canadian property and liability insurance companies. The report merely presents a large number of statutory accounting rates of return, all using different sources of income or a different base or denominator on which to calculate the percentage rate of return. Table 1 summarizes twenty-four rates of return, rates of return based on total equity and total assets employed. These two basis were further subdivided into year-end capital, annual average capital, year-end capital but not including gains from sale or maturity of investments, and finally annual average capital but not including gains from sale or maturity of investments. The income or numerator used for arriving at the percentage rates of return was similiarily severally based on net underwriting profit excluding investment income, total income including investment income before income taxes, and total income including investment income but after income taxes. The results of this study (Table 1) generally show that the average return has not been high and that the average investment income accounts for an appreciable return to the insurance industry as a whole. The average underwriting income is negative in all instances for the time period 1958 -1965. However, there are some criticisms that can be advanced about these calculated rates of return. One criticism is underlined in the following statement taken from the report itself: adjustments have not been made in the calculations of equity for possible excesses in the reserves for unearned premiums and unsettled claims ^ ' This study did recognize that the accounting information was presented on Table 1 A Summary of the Results of the Peat, Marwick, Mitchell & Co.. and Price, Waterhouse & Co Study (eight year average rates of return) (1958 - 1965) INCOME BASIS BASED ON YEAR-END CAPITAL net underwriting (loss), - excluding investment income total income, including investment income - before income taxes total income, including investment income - after income taxes CAPITAL BASIS TOTAL ASSETS EQUITY EMPLOYED 7o ONLY % (0.92) (2.62) 2.98 8.47 2.24 6.37 BASED ON AVERAGE ANNUAL CAPITAL net underwriting (loss), - excluding investment income (0.97) (2.72) total income, including investment income - before income taxes 3.12 8.78 total income, including investment income - after income taxes 2.35 6.60 BASED ON YEAR-END CAPITAL AND EXCLUDING  GAINS FROM SALE OR MATURITY OF INVESTMENTS net underwriting (loss), - excluding investment income (0.92) (2.62) total income, including investment income - before income taxes 2.53 7.21 total income, including investment income - after income taxes 1.80 5.11 BASED ON AVERAGE ANNUAL CAPITAL AND EXCLUDING GAINS FROM SALES OR MATURITY OF INVESTMENTS net underwriting (loss), - excluding investment income (0.97) (2.72) Table 1 (Continued) A Summary of the Results of the Peat, Marwick, Mitchell & Co. and Price, Waterhouse & Co. Study (eight year average rates of return) (1958 - 1965) INCOME BASIS CAPITAL BASIS TOTAL ASSETS EQUITY  EMPLOYED 7, ONLY % BASED ON AVERAGE ANNUAL CAPITAL AND EXCLUDING  GAINS FROM SALES OR MATURITY OF INVESTMENTS total income, including investment income - before income taxes 2.66 7.48 total income, including investment income - after income taxes 1.88 5.30 24 statutory basis which stresses solvency and some adjustments were made on the liability side of the balance sheet for investment, general and contingency reserves and on the asset side for non-admitted assets. However, this was not carried far enough. Chapter 3 will explain that further adjustments are required in order to arrive at a meaningful rate of return. It has already been shown that there are difficulties when using an average figure in the denominator of a percentage rate of return. The discussion in regard to the Trieschmann study on this area equally applies to this Canadian study. To emphasize, and in conclusion, it is important to realize that to arrive at the real rate of return for general insurance companies requires a study to consider all sources of income and loss over a given time period, to adjust the statutory or reported accounting data where needed to reflect this, and to calculate a rate of return based on the return to the owners of the company. The purpose of Chapter 3 will be to present an accurate measurement procedure which will be used to arrive at the real rate of return earned by Canadian property and liability insurance companies from 1961 to 1970. FOOTNOTES 1. Arthur D. Little Inc., "Prices and Profits in the Property and Liability Insurance Industry", Report to the American Insurance Association, November 1967, pp. 129. 2. ibid., p. D - 7 . 3. Standard and Poors Corporation, The Compustat Information Manual, August 1966, pp. 5-12. 25 FOOTNOTES - (Continued) 4. J.D. Hammond and N. Shilling, "The Little Report on Prices and Profits in the Property and Liability Insurance Industry", The Journal of Risk and Insurance, Vol. XXXVII, No. 4, March 1969, pp 129 - 145. 5. Arthur D. Little Inc., op. cit. , p. 35. 6. . ibid., p. 35. 7. Peat, Marwick, Mitchell, & Co., and Price, Waterhouse & Co. "Calculation of Rates of Return on Invested Capital of Canadian General Insurance Companies", Report to the Insurance Bureau of Canada, January 1967, p. 2. 26 Chapter 3 An Approach to Calculating the Rate of Return in the General Insurance Industry The objective of this chapter is to present a method or an approach that will arrive at the real rate of return earned in the property and liability insurance industry in Canada. The Rate of Return on Net Worth The Explanation for Using the Rate of Return on Net Worth Chapter 2 has explained that previous studies have used different return measures and yet all of these studies have referred to the particular measure that was used the rate of return to the insurance industry. The Little Report used the return on investible funds measure. As explained, this was a meaningless measure because it measured neither the return on the total assets invested in the industry nor the return to the owners or shareholders of the various companies. Norgaard and Schick used the return on total assets. However, in the case of the insurance industry, the return on assets is also a rather meaningless measure because this industry does not represent the normal situation where all the assets are financed from equity or through normal debt sources such as bondholders, etc. A large percentage of the funds are provided by policyholders, not bondholders, who are purchasing a service and transfering risk to the insurance company. The main concern of the policyholder is the cost of the service to him and as a result he is not investing in the insurance company in the normal sense of the word. The rate of return on net worth is the only meaningful measure for general insurance companies. The measure could be defined to include returns to long term suppliers of capital, but general insurance companies do not raise 27 funds via long term debt, therefore, leaving only shareholders as suppliers of long term capital. It is felt that only shareholders or owners of the various insurance companies are interested in the rate of return earned on their investment. Trieschmann recognized this and did attempt to calculate the rate of return on the investment by the owners. The approach that he used was through the income statement. This approach basically consisted of taking the final net income figure and adding back certain specified deductions that had been made in the statutory figures in-order to arrive at an accurate numerator for the rate of return measure. This approach is not entirely valid for the general insurance industry because the published statement are stressing solvency at the expense of presenting a true and accurate profit picture. The income statement simply does not include all the information that is needed to arrive at the actual or true rate of return on net worth. In order to take account of the various statutory requirements in the insurance industry, the balance sheet statement also becomes a source of information. The balance sheet must be analyzed in conjunction with the income statement and the statement of- underwriting profit. This approach through the balance sheet makes use of the following fundamental accounting identity. At Lt + Wt (1) where A assets at the end of year t liabilities at the end of year t net worth at the end of year t Rearranging terms: (2) 28 Furthermore: A At - ALt = Awt (3) In words, equation (3) states that by examining the changes in the asset and liability accounts, the change in net worth can be determined. However, because of legal statutory reporting requirements certain adjustments must be made to the asset and liability accounts before this change in net worth can be determined. The remainder of this chapter will present a step by step approach to calculating the rate of return on net worth for Canadian property and liability insurance companies. The Steps Performed to Calculate the Return on Net Worth Step 1 - Making the Required Adjustments to the Statutory Asset and Liability  Accounts - The adjustments made to reported assets will be discussed first, followed by the adjustments made to the reported liabilities. Assets - the statutory or legal reporting requirements in general, require companies to value assets conservatively. As mentioned earlier, the stress is on solvency and the accounting formats are designed to answer the question what would these assets realize in the market place if they had to be sold at short notice. To be specific, there are three areas where assets require readjustment. Two of these are explained below, the third will be discussed later in conjunction with the required liability adjustments. 1. Investments In most insurance companies, investments represent a large percentage of the total asset value of the company. The regulatory powers require these investments to be shown at book value. However, if the total market 29 value of such investments is less than the total book value, the lower market value amount must be used as the valuation for the investments. On the other hand, if the total market value of the investments is higher than the total book value, the lower book value not the market value must still be used. This principle, known as the lower of cost or market basis of val uation, has an inherent downward bias built into the statutory valuation of investments. In particular, all possible losses must be provided for, but any possible gains are not permitted until they are realized through sale. In order to arrive at a fair valuation of investments, an adjustment must be made. This adjustment consists of adding to the statutory investment or total asset figure, an amount that represents the difference between the total market value and the total book value of investments when the market value is higher than the book value. This eliminates the inherent bias built into the statutory reporting requirements by treating gains and losses in the same manner. 2. Non-Admitted Assets Legislation states that only assets which are readily realizable in cash may be included in the assets of an insurance company for statutory reporting requirements. These are known as admitted assets. Other assets are termed non-admitted assets. For example, any premium which is over ninety days due is considered a bad debt and therefore a non-admitted asset, ir-regardless of the net worth of the person or corporation who owes the premium. Office furniture is also considered a non-admitted asset. These two items are not excluded from the total asset figure of companies in other industries. At the most, a small percentage is set aside each year as an allowance for bad debts or as a provision for depreciation. In a vast majority of cases these are sound assets and should be recognized 30 as such and included as admitted assets. As a result, an adjustment must be made to add the non-admitted assets to the statutory total admitted asset figure. As explained, a third asset adjustment, cash and securities deposited by reinsurers will be discussed in conjunction with the liability adjustments which follow. Liabilities - The adjustments that are required for liabilities are greater in number, and in the case of one adjustment more complex. The basic difficulty is that some of the statutory liabilities are in whole, or in part, not liabilities in the true sense of the word. That is, they do not represent a future obligation that must be paid out of company funds. Therefore, since the statutory reporting requirements stress solvency this means there is an overstatement of the actual liabilities. Four liability adjustments will now be discussed. 1. Unearned Premium Reserve There is a legal requirement that premiums received from policyholders are earned only as a function of time. For example, for a pre-paid three year policy, the company must evenly spread the revenue earned from that policy over the three years. That is, over each month 1/36 of the premium received is earned or 1/3 is earned each year. The premiums are usually paid in advance and the portion of the premium that is unearned must be set up in a liability account called the unearned premium reserve. However, for the most part, the expenses associated with the premium received arise in the first month or so of the contract period. This is due to such factors as the prepayment of commissions to a broker or salesman, premium taxes that must be paid at the time of the writing of the insurance 31 contract, and general office expenses in typing up the insurance policy, etc. The legal requirement in regard to these expenses is that they must be written off against income in the time period that they occur. Unlike revenues, there can be no deferral of expenses. That is, the companies are not allowed to match expenses against the revenue earned over the life of the contract period. In short, revenue is being earned on a time accrued basis while expenses are incurred on a cash basis; there is no matching of revenues and expenses. The necessity of showing a liability equal to the pro-rata unearned gross premium is not realistic. Granted, for a company with a stable volume of business and a stable expense ratio, this particular requirement makes little difference. However, the normal situation is for the volume of premiums received or written to be changing from year to year. Further more, during recent years, it would be expected that the trend would be towards a larger volume. Then the result of the statutory requirement will be to understate underwriting profit currently and to overstate it in those years when premium volume declines. However, it is likely for premium volume to continually grow from year to year because of inflationary increases and general expansion of business and hence there is a continual underestimation of underwriting profit. The extent of the understatement in underwriting profit depends upon the rate of expansion of business written. The faster the expansion rate the larger the amount of underestimation in underwriting profit. Therefore, the unearned premium reserve is usually overstated and the underwriting profit understated; thus an adjustment is required. The best approach to this complex adjustment is to look at the United States situation first because the adjustment is simple and will lend understanding to the adjustment required in Canada. In the United States, the entire premium 32 received must be set up as a liability at the effective date of the insurance contract. Let the unearned premium reserve be designated by the symbol released over time. However, a major proportion of the expenses, designated by et, are incurred at the time the policy is written. It is reasonable to use the ratio of expenses, excluding subsequent adjustment expenses, to the net premiums written, pt (both on a yearly basis) as an accurate approximation of the percentage of the premiums absorbed in expenses. To arrive at a proper matching of expenses and revenues, credit should be allowed in the unearned premium reserve for the expenses incurred in respect of these outstanding or unearned premiums. This can be done by subtracting unearned premium reserve. Furthermore, the amount of understatement in the actual underwriting profit in a typical year will be Aut )• In Canada, the adjustment is more complicated because the insurance companies are allowed to take expense credit for 20 percent of the premiums received. Therefore, the unearned premium reserve at the end of the year is not 100 percent of the premiums outstanding, but 80 percent. In other words, the statutory authorities in Canada do recognize that a proportion of the expenses, are incurred at the time the insurance contract is written, but the maximum credit allowed is only 20 percent. An adjustment must still be made because it is highly unlikely that the actual expense ratio e f-is 20 percent. The first step in arriving at a correct figure for the unearned premium reserve is to gross up the Canadian statutory reserve Ut. As more business is written, Ut decreases and the earned revenue is Pt 33 Ut to represent an unearned premium reserve without any credit for expenses. This first step is done as follows: TjC/100) . that is, we now have a reported unearned premium reserve that is identical to the one in the United States. Taking this further, it can now easily be seen that the true unearned premium reserve can be represented by u9 fi?-P- ] / l-et ). In other words, the adjustment is the difference between the statutory liability and the actual liability, i.e. rearranging terms, the adjustment can be expressed as The above formulation says that if the actual expenses associated with writing the premiums is greater than 20 percent, the adjustment c f 100 / et\\ Uf 1 - 1 will be positive. This in turn, means that the actual c A°°¥ er\ unearned premium reserve Ut [~on 111- - j will be smaller than the statutory unearned premium reserve U^ On the other hand, if the actual expenses associated with writing the premiums is less than 20 percent, the adjustment will be negative. There fore, the actual unearned premium reserve will be larger than the statutory unearned premium reserve. In this case, it is necessary to add the adjustment to the statutory reserve. The third situation that could occur is if the actual expenses associated with writing the premiums is exactly equal to 20 percent. The adjustment -_E Jl is now zero and so the actual unearned premium reserve is Pt// equal to the statutory unearned premium reserve. It can be appreciated that this third situation would only occur in exceptional circumstances and that an adjustment of some amount would normally be required. However, the above adjustment is biased to some extent. In particular,  prem: 34 it shows that the companies with the highest expense ratios will get the most favourable treatment though the greatest downward adjustment of the unearned premium reserve. Obviously, it is inaccurate to reward these companies with the highest expense ratio, because a high expense ratio normally reflects inefficiency in their operations. To bypass this undesirable bias that is built into the above adjustment, the following adjustment will be used for all companies in this study: P where e = the average expense ratio for the ten largest companies - in each year as determined by their net premiums written. The reason for making this modification in the required adjustment is two fold. In the first place, since expenses vary with the composition of business, an average of the largest companies would provide a good representation of the aggregate expense ratio. Secondly, by taking the average expense ratio of large companies, given there are expense economies in the industry, one is more likely to obtain a better estimate of the "expense credit" that a reinsurer would offer if an insurance business was sold. 2. General, Investment, and Contingent Reserves All three of these reserves are classified as liabilities under the statutory reporting requirements in Canada. However, they are not liabilities in the true sense of the word because in the majority of cases they do not represent a future payment obligation. They are merely an appropriation of surplus or of net worth made through the following illustrative journal entry: Debit Surplus XXXX Credit Investment or other reserve XXXX 35 The adjustment that is required is to transfer the reserve amount from the liabilities to net worth or surplus. In particular, this requires sub tracting the amount of the three reserves from the statutory total liability figure and then adding this same amount to the surplus or net worth. 3. Reserve for Reinsurance Ceded to Unregistered Companies Reinsurance is the assumption by one insurance company of all or part of a risk undertaken by another insurance company. The company .buying the reinsurance is called the ceding company or the reinsured and the company selling it is called the reinsurer. The important thing is that in performing this function the reinsurer assumes a part of the reinsureds responsibility to maintain the reserves that are required. In particular, under laws in Canada, a Canadian insurance company must maintain reserves for business ceded to companies not registered under the Canadian and British Insurance Companies Act. That is, an account called a "reserve for reinsurance ceded to unregistered companies" must be set up as a liability. Once again, the liability is not a true liability. In nearly all cases, these unregistered companies are very secure companies operating overseas in countries like Germany or Switzerland or secondly in the United States. These unregistered companies are basically impossible to distinguish from those foreign companies that are registered to transact business in Canada. In short, the probability that a Canadian primary insurer would have to back up business reinsured or ceded to these un registered companies is extremely low. Therefore, an adjustment is required that consists of subtracting the "reserve for reinsurance ceded to unregistered companies" from the statutory total liability figure and then to add this same amount to the surplus or net worth. Because of this legal requirement to maintain this reserve, Canadian 36 primary insurers will usually request that these unregistered companies deposit, in trust, some cash and liquid securities with the reinsurer (the Canadian primary insurer) in order that the Canadian company can earn a return on this cash and liquid securities. This return represents a return for for feiting the use of their own funds that are tied up in the reinsurance reserves. An account called "cash and securities deposited by reinsurers" is entered on the Canadian company's balance sheet both as an asset and a liability for the same amount. In a strict sense, this is neither a true asset or lia bility. It is merely a book entry that is required because the Canadian company does have possession of the cash and securities, though of course, it does not own them. Though this asset-liability account has no effect on net worth, an adjustment will be made to subtract the amount of the cash and securities deposited by reinsurers from both the statutory total asset and total lia bility figure in order to arrive at a realistic value for assets and liabilities. 4. Loss Reserve A loss reserve is an appropriation of surplus or net worth set up to meet outstanding claims. These outstanding claims are defined to include anticipated claims as well as claims that have been incurred but not yet paid. The anticipated claims are subjective estimates usually based on the company's previous claim experience. The estimates are done by the managers of the respective companies. In this area, the principal difficulty is that a precise method for determining how accurate the company's estimate of loss reserve requirements is has not yet been determined. The required reserve is defined as "one that will be adequate to cover for a reasonable period of time any losses and (1) expenses larger than those predicted and any declines in asset values" 37 When the loss reserves for a given calendar year are underestimated, there is a direct effect, incurred losses for that calendar year are reduced and the rate of return is increased. However, when the claims associated with these loss reserves are settled in later years, the effect of the past practice of underestimating loss reserves will be noticeable in terms of increases in incurred losses and a reduced rate of return. Of course, the opposite situation, an initial overvaluation of loss reserves required could occur with opposite subsequent effects taking place. Could these errors in estimating loss reserve requirements cancel them selves out? John L. Anderson concluded : "that the effects of setting up loss reserves in excess of true reserves for the liability appears to be relatively minor. Furthermore, this can be expected because considerable penalties or benefits to calendar year results and the rate of return can only arise if a company changes its reserve policy from conservative to less conservative or vice versa1. It is the rate and the amount or extent of changes in the reserve policy that is the important element. Rafal J. Balcarek also concluded: "that reserve margins have an insignificant effect on calendar year results is basically correct if one takes a significantly long period of time. However, if one confines himself to the more usual period of time like one calendar year the impact of reserve margins becomes more pronounced."(3) With the previous discussion in mind, no adjustment will be made to the loss reserve estimate since this study covers a period of eleven consecutive years. This is based on the assumption that the period studied is long enough to cancel out any particular changes made in the overvaluation or undervaluation of loss reserves that would effect the rate of return cal culation. A Summary of Required Asset and Liability Adjustments - At this point of the 38 study, a table summary of the preceding discussion would be helpful to the reader before turning attention towards the actual rate of return calcul ation. Table II lists the adjustments made in this study. Table II A Summary of the Asset and Liability Adjustments Required to Arrive at the Actual or Adjusted Net Worth Adjusted Assets = statutory assets as reported + the difference between the market value and book value of investments if the market value of these investments is greater than the book value + non-admitted assets - cash and securities deposited by reinsurers MINUS Adjusted Liabilities = statutory liabilities as reported - unearned premium adjustment - reserve for reinsurance ceded to unregistered companies - cash and securities deposited by reinsurers - investment, general, and contingent reserves EQUALS Adjusted Net Worth 40 As the table shows, the purpose of these extensive adjustments to statutory assets and liabilities is to arrive at an adjusted net worth figure for each company and for each year of the study. These adjusted net worth figures will be used as the basis for the rate of return cal culations to be discussed below in step 2. (4) Step 2 - Making the Actual Rate of Return Calculations - Ignoring taxes and transfers or additions of capital for the present, the net profit earned over a period of a year can be written as: Wt - Wfc_1 + dfc (5) Wfc = adjusted net worth at the end of year t (after taxes paid) d^ = dividends paid during year t This dollar rate of return can be rewritten as: A Wt + dt (6) where Aw,. = W - W , t t t-1 This net profit can then be expressed in percentage terms by putting the equation (6) over the adjusted net worth at the beginning of the year. That is: Awt + dt (7) Wt-1- ;, Formula (7) represents the rate of return that is earned over a typical year t by one typical company. However, it may be more informative to rewrite (7) as Wt-1 (1 + rfc) = Wt + dt in order that one can see the compound interest assumption that underlies the use of a profit ratio; rt is the rate of return earned over the year. 41 Allowing for Transfers or Additions of Capital - Equation (7) does not allow for an increase in net worth over the year from such things as new funds raised from shareholders. If new funds are in fact raised during the year, an allowance must be made for this because applying (7) would clearly over state the return earned in the year. Specifically, it is highly unlikely that new capital would always be raised at the beginning of the year. th Therefore, if new capital, Ct, is raised (1 - $) way through year t, then formula (7) can be extended as follows: It w(__1(l + r ) + C(;(l + rt) = wt + dfc t = 1,2, . . . , n 0 < 3t £ 1 (8) or wt_1(l + rfc) + ct(l + Itrt) = wt + dt t = 1,2, . . . , n since (1 + = 1 + 3Btrt if rfc and higher powers of rfc are ignored (9) Therefore, the return ratio can be rewritten as: Awt + dt - ct " * rt""wt_1 +3tct t = 1,2, n (10) In this study it is assumed that new capital was raised half-way through the year CBt = 1/2). This assumption seems appropriate because information on the exact date of new capital raised by particular companies is not readily available. It is worth noting here that in none of the published studies discussed in Chapter 2 do their authors make an allowance for new additions of capital. This means that these authors are assuming that any new capital raised, is done so entirely at the end of the year, which is unlikely. 42 Allowing for Periodic Payments of Dividends - To this point in the analysis it has been assumed that dividends are paid at the end of the year or period of measure. Of course, this is the exception rather than the rule. Normally, companies pay some dividends through the year. An allowance for this can be done in much the same manner as was done for situations where there were new additions of capital. The formula can be extended thus: wt-l^ + rt> + ct(1 +:Btrt) = wt + dt(l + <*trt> t = l>2> • • • > n Therefore, the return can be rewritten in ratio form as: AW,. + d. - c*. rt = A t t t = 1,2, n (12) wt-l+3ct-*|it In this study it was assumed that dividends were paid quarterly and in even amounts throughout the year. Therefore, it was possible to set at = 5/8 for all t. This represents the average time the funds, as represented by the dividends, were not available to the company during the year for earning additional profits. Allowing for Taxation of Unrealized Gains - It was argued earlier that un realized capital gains and losses should be included in the rate of return ratio. Therefore, it follows that some tax adjustment should be made to these unrealized capital gains and losses that are included in the ratio. Similiarily, tax should also be imputed on the capitalized underwriting profit. In arriving at a correct procedure, two points must be observed. Firstly, the double taxation of these gains must be kept to a minimum; and secondly, explicit recognition should be given to the deferred aspect of the tax, because to assume that it is paid at the end of each year tends 43 to understate the average rate of return over a period of time. The procedure which meets these two conditions is to subtract the imputed tax on the total net unrealized gain earned over the entire period of measure ment from the terminal adjusted net worth. Thus: wfc_1(l + rt) + ct(l +3trt) = dt(l ta^r,.) + wt t = 1,2, ..., n-1 (13) Wn-l^1 + rn> + cn(l + ^nrn) = dn(1 +cthrn) + wn " xn (14) where xn = tax imputed to total net unrealized gains over the n years The average rate of return over the n years is now obtained by taking the unweighted geometric mean of (1 + rt) for t = 1,2, n. The weighting procedure is the subject of the next step. (4) Step 3 - The Choice of the Weighting System^ '- To this point in the dis cussion the analysis has been limited to arriving at the correct rate of re turn on net worth for one company over one year. The final step in arriving at a meaningful return measure for the entire industry is to answer the question of what type of weighting procedure should be used in aggregating over companies and over time. Weighting across companies to get an aggregate rate of return figure is one issue. If the rate of return for the industry or a subset of the industry is required, as is the case in this study, then a weighted arithmetic mean, weighted by net worth, is the correct procedure. All published studies to date have used a weighted average procedure and there seems to be little argument on this point. The second issue relating to weighting procedure is what method should be used for measuring the average rate of return over a period of time. In 44 previous studies, most of the authors have not made explicit the weighting procedure they have used. In fact, it seems that a different procedure for weighting across time was used in each study. To determine the correct weighting procedure, it is necessary to analyze the relationship between the annual rate of return ratios and the underlying compound interest rate assumption. The rate of return ratio, assuming the simplest case where dividends and new capital are zero is again the following A w rt =-^n <15> or wt-l^ + rt^ = wt *• = • • • , n (16) Substituting backwards for "i? = 1,2, n, the following is obtained: wQ(l + r]_) (1 + r2) ... (1 + rn) = wn (17) It is easy to see the direct correspondence between this and wQ(l + r) = wn where r is the average annual compound rate. Similiarly, it is clear from this that the correct weighting of the yearly rates of return is to take the n 1/n unweighted geometric average of the yearly rates ( TT (1 + r.) -1 as i=l a close approximation to r. This will always be feasible because (1 + rt)>-even in the years in which there are large unrealized capital losses. Finally, in the more general case: wfc_1 (1 + rt) + ct(l +3trt) = wfc + dfc(l + oq.r,.) t = 1,2, ..., n (18) 45 And substituting backwards for t = 1,2, n, the following is obtained: n wQ(l + rx) (1 + r2) .... (1 + rn) +t|1ct(l +aJtrt)Rt n - wn + Jl dt^1 + «trt)Rt n . where Rfc =i=^"+ l (1 + for t=l,2, n-1 (19) and R = 1 n Again an unweighted geometric average of (1 + rt) (t = 1,2, n) provides a good approximation to the average compound rate 1 + r: w0(l + r)n+ £ ct(l +Str) (1 + r)n-t= wn + J dt(l + <*tr) (1 + r)n" t=l t=l 0 <3t < 1 ct > 0 O.f o(t <1 dt » 0 (20) This completes the theoretical analysis on how the rate of return should be calculated for the Canadian general insurance industry. The next chapter will present a brief explanation of the empirical procedures performed in this study. Following this, Chapter 5 will present the actual results that were arrived at through using a random sample of insurance companies. FOOTNOTES 1. State of New York Insurance Department, "Report of the Special Committee on Insurance Holding Companies", Report to the State of New York Insurance Department, February 1968. 2. John L. Anderson, "Financial Accounting Practices of Property and Liability Insurance Companies", The Journal of Risk and Insurance, Vol. XXXIX, No. 2, June 1972, pp. 201 - 213. FOOTNOTES - (Continued) 3. Rafal J. Balcarek, "The Effect of Loss Reserve Margins on Calendar Year Results", Proceedings of the Casulty Actuarial Society, Vol. LIII, 1966, pp. 1 - 16. 4. Gerald M. Dickinson "Calculating the Profitability of Non-Life Insurance Companies. Some Clarifying Comments", Working Paper. 47 Chapter 4 The Empirical Procedures This chapter will present a brief description of the procedures that were performed in the empirical area of this study. The Population Defined The first step was to define the population of insurance companies from which a random sample could be selected. The defined population excluded the following: 1. Foreign companies that operate through branch offices in Canada, but the population includes subsidiaries of foreign companies. 2. Mutual insurance companies. 3. Companies that only offer insurance to specialist groups such as farmers, etc. 4. Companies that were not operating in Canada prior to 1955. The last restriction was imposed to eliminate small companies which would be expected to be unprofitable at the outset of their operations. In other words, the population consisted of stock companies that were: 1. Canadian in origin or subsidiaries of foreign companies operating in Canada and 2. operating prior to 1955. The addition of the constraint concerning specialist groups reduced the population to 52 companies. The Population Stratified The second empirical step that was performed was to stratify the population into segments. This was done on the basis of the total admitted assets in the reported statements in the last year of the study. The 48 population was divided into three groups: those companies which have total admitted assets greater than $20,000,000; those with assets be tween $10, 000, 000 and$20,000,000; and those under $10,000,000. These groups will be referred to in the study as large, medium and small companies respectively. The Sample Selected The next step was to select from each of these three groups, a sample of twelve companies using a random number table. Table XVI in the appendix is a listing of the thirty-six companies comprising the sample along with their reported total admitted assets in 1970. The Data Collected The data source for this study was the Report of the Superintendent of Insurance.From this source all the data needed to calculate the adjusted rate of return on net worth for the ten years (1961 - 70) was collected. The Adjusted Net Worth Calculated The next step was to calculate the adjusted net worth amount for each company and for each of the eleven years. As explained in depth in Chapter 3, this step entailed making adjustments to the statutory reported assets and liabilities. Table XVII in the appendix is a presentation of the actual expense ratios used in the unearned premium reserve adjustment. In particular, the expense ratio for each year is an average of the ten largest companies as defined by the volume of the net premiums written. The Rate of Return Calculated The adjusted net worth figures fojsm the basis for the calculation of 49 the rates of return as described in Chapter 3. Several rates of return on net worth were actually calculated: 1. The yearly return, before and after taxes, for each company in each year. The main purpose here was to show the effect of income taxes. 2. The yearly average return, before and after taxes, for each of the three size groups (small, medium and large) in each year. The same was done for the entire industry by using a weighted return. The main purpose here was to determine if any economies of scale exist in the insurance industry. 3. The unweighted geometric and arithmetic averages of the nine and ten year return, before and after taxes, for each of the three defined size groups. The nine year return was calculated when it was realized that the first year of the study was an exceptionally good year for the insurance industry. The main purpose here was to omit the first year's influence on the overall return in order to see what affect this year had on the average rate. 4. The unweighted geometric and arithmetic average of the nine and ten year return, before and after taxes for the entire industry. The determination of the weights used has been explained in Chapter 3. The Sources of Return The final step was to break down the rate of return on net worth after taxes into its three component parts in order to determine the relative importance of each component. These components can be viewed as the sources for the earned rate of return. The three sources of the return on net worth are the following: 50 1. Investment income which mainly consists of interest, dividends, and rents received less all investment expenses. This source of return is not difficult to determine because the amount is given in the Report of the Superintendent of Insurance. In this instance, no adjustment is made to the statutory figure. 2. The actual underwriting profit or loss which must be dis tinguished from the statutory underwriting profit or loss. As explained in Chapter 3, this involves accounting for the degree of overstatement in the unearned premium reserve. An estimate was also made of the tax shield effect which companies derive from using an accounting method which understates underwriting profit (or exaggerates underwriting losses). A common way of expressing underwriting results is as a percentage of net premiums earned. An analysis of incurred or actual and statutory underwriting profit or loss to net premiums earned was made to determine what effect there would be on this ratio by using the higher actual underwriting figure. 3. The residual or other income which mainly consists of gains or losses from changes in the difference between the cost and market value of investments. An imputed tax (tax credit) to unrealized capital gains (losses) was not calculated because there was no capital gains tax in Canada during the time period of this study. The next chapter will present the detailed results of this study. Chapter 6, the final chapter, will present a summary of the results, present conclusions, and then suggests what extensions could be made to this study that would enable more research to be undertaken on the rate of return 51 earned in the general insurance industry. FOOTNOTES 1. Superintendent of Insurance. "Report of the Superintendent of Insurance  For Canada 1960 - 1970", Vols. I & II, Information Canada, Ottawa. 52 Chapter 5 The Results The purpose of this chapter is to present the results and offer an analysis or an explanation for these results. The Industry Rate of Return The Industry Rate of Return Before Taxes Under this heading the underlying purpose is to show what the insurance industry earned during the period, ignoring the effect of income taxes. The reader will remember that it was decided in Chapter 3 that the correct return measure is the unweighted geometric average of the yearly rates of return. It should also be remembered that these yearly rates of return are weighted arithmetic averages of the three size classes (large, medium, and small) using the adjusted net worth figure at the beginning of each year from each class as the basis for the weighting procedure. However, an unweighted arithmetic average over time will also be calculated in this study because it is the measure many of the other studies have used. This will permit this study to compare the results of this unweighted arithmetic average with the correct measure, the unweighted geometric average. Furthermore, a nine year rate of return was also calculated because of the high rate of return that occurred in the first year of the study ( 1961 - 22.75%). TableIllpresents the nine and ten year industry rate of return before taxes based on both an unweighted geometric and arithmetic average. 53 Table III The Industry Rate of Return Before Taxes 1961 - 1970 1962 - 1970 Unweighted Geometric Average 9.57= 7.57. Unweighted Arithmetic Average 9.77, 8.37, The averages in Table III are calculated from the weighted yearly returns given in Table IV. Table IV The Yearly Industry Rate of Return Before Taxes (weighted using the adjusted net worth figure) 1961 - 22.757o 1962 - 5.38% 1963 - 7.237, 1964 - 7.477, 1965 - 7.117, 1966 - 4.847, 1967 - 14.047, 1968 - 21.277, 1969 - 00.347, 1970 - 6.70% 54 In the author's opinion, Table III shows that the insurance industry as a unit has not earned a high before tax rate of return. On the contrary, the return could be considered to be relatively low in the majority of the years under study. Table IV shows that in only three years (1961, 1967, 1968) did the insurance industry earn what could be considered a high rate of return. The other years represent a mediocre return at best. In fact, one year (1969) resulted in an extremely low rate of return. Later in this chapter it will be shown that the three high rates of return can be attributed mainly to increases in the market value of investments held, though variation in the underwriting results also played some part. Table III shows that by using a geometric average as opposed to an arithmetic average has a relatively minor effect in a downward direction on the rate of return. This is to be expected because by definition a geometric average is always less than its corresponding arithmetic average. However, by excluding the high return earned in 1961, the average rate of return by either averaging procedure is decreased significantly. This tends to stress the importance of the three high returns that were earned. Without these three good years, the average return would drop considerably below its already modest level. The Industry Rate of Return After Taxes The underlying purpose in this section is to show what effect the income taxes had on the rate of return earned by the general insurance industry. Table V is the unweighted geometric and arithmetic industry average after taxes, both calculated on a nine and ten year period. 55 Table V The Industry Rate of Return After Taxes 1961 - 1970 1962 - 1970 Unweighted Geometric Average 7.3% 5.570 Unweighted Arithmetic Average 7.5%, 6.2%, The averages in Table V are calculated from the weighted yearly returns given in Table VI. Table VI The Yearly Industry Rate of Return After Taxes ( weighted using the adjusted net worth figure ) 1961 - 18.71% 1962 - 3.96% 1963 - 6.89% 1964 - 6.71% 1965 - 5.34% 1966 - 1.50% 1967 - 8.48% 1968 -17.13% 1969 -00.80% 1970 - 4.18% 56 Table IV and Table VI taken as a unit show what effect income tax had on the weighted yearly rates of return. It appears that income taxes had a large effect on the before tax rate of return in only two years of the study. The 1966 return is now very low, similiar to the return earned in 1969. The 1967 return is now no longer a high return because a large proportion of this return before tax has simply been reduced by income taxes. Table VII presents the effect income taxes had on the rate of return earned over the period studied. Table VII The Average Tax Effect on the Industry Rate of Return + 1961 - 1970 * % change Unweighted Geometric Average 2.2% 23% Unweighted Arithmetic Average 2.2% 23% + 1962 - 1970 * % change 2.0% 27% 2.1% 25% where + = the industry rate of return before taxes minus the industry rate of return after taxes * = the industry rate of return before taxes minus the industry rate of return after taxes divided by the industry rate of return before taxes. This table shows that on the average, insurance companies have tended to pay a relatively low rate of tax over this period either because their actual pre-taxable earnings have been low and/or the statutory reporting requirements have tended to understate true earnings. It is generally 57 expected to find large profitable companies approaching the fifty percent tax bracket. Table V shows that by using the arithmetic average instead of the correct geometric average results in a relatively minor distortion of the industry return in a upward direction. This is expected because the same thing was found to occur with the before tax rate of return. How ever, the nine year rate of return was again significantly below the ten year rate of return. To emphasize, the two or three good years play a very large role in keeping the average return over this period from falling significantly below its present level. Generally speaking, investors are concerned with the after tax rate of return, what accrues to them after the various governments have taken their share. Is the 7.3 percent geometric average a satisfactory rate of return? For the most part, this decision has to be left with the in dividual investor who has his own preferences. However, some thoughts can be put forward by looking at the promised federal bond yield over the same time period. This latter type of investment is usually considered to carry the lowest degree or amount of risk. On Canadian government bonds the long term promised yield has ranged from slightly below 4 percent in 1961 to almost 8 1/2 percent in 1968 to 1970. The return on provincial and municipal bonds, generally paralleled the federal long term bond yield, though the. yield or return was 1 percent to 1 1/2 percent higher. The upper limit of the provincial or municipal bond yield therefore approaches the after tax rate of return earned in the insurance industry over the same time period. All this is saying is that if management of the insurance companies had put the funds that were under their control, as represented by the net worth, into government bonds, they may have earned a higher rate of 58 return. The author feels it is relatively safe to conclude that the average rate of return on net worth earned by the insurance industry over this time period was not excessive and indeed would be considered to be somewhat on the low side if compared to average returns earned by other industries. The Industry Rate of Return Before Taxes by Industry Class or Size Under this heading, the underlying purpose is to determine if there are any economies of scale operating in the general insurance industry. Specifically, are there any differences in the before tax rate of return earned by small, medium and large size companies? Table VIII is a presentation of the before tax unweighted geometric and arithmetic average return by size class, both on a nine and ten year basis. Table VIII The Industry Rate of Return Before Taxes by Industry Size 1961 - 1970 1962 - 1970 Small Companies Unweighted Geometric Average 7.9%, 6.1% Unweighted Arithmetic Average 8.0% 6.9% Medium Companies Unweighted Geometric Average 7.0%, 5.0%, Unweighted Arithmetic Average 7.4% 5.97, Large Companies Unweighted Geometric Average 9.77, 8.17, Unweighted Arithmetic Average 10.8% 9.2% As can be seen, on a before tax basis, the small size companies did earn a slightly higher rate of return than the medium size companies. It is quite possible that the small companies not wanting to spread themselves too thinly over many lines of insurance business, have as a result, concentrated o 59 one or two insurance lines that were either more profitable, or this has allowed such companies simply to maintain better control over the various expense of running an insurance business. The large companies have done appreciably better than either the small or medium size companies. This does suggest that there is some evidence of economies of scale in the general insurance industry. Large companies are able to take advantage of management expertise, labour specialization in performing a single function, and other various cost economies. In short, it seems that medium size companies suffer because they are either too large to be able to concentrate their effects on one or.two profitable lines and or too small to take advantage of the cost economies and management expertise that the large companies possess. The Industry Rate of Return After Taxes by Industry Class or Size The purpose here is to see if income taxes have any effect on the differences in the rates of return earned by the three different size classes. Table IX is a presentation of the after tax unweighted geometric and arithmetic average return by size class, both on a nine and ten year basis. Table IX The Industry Rate of Return After Taxes by Industry Size 1961 - 1970 1962 '- 1970 Small Companies Unweighted Geometric Average Unweighted Arithmetic Average 5.2% 5.3% 3.7% 4.2% Medium Companies Unweighted Geometric Average Unweighted Arithmetic Average 5.6% 5.8% 3.7% 4.3% Large Companies Unweighted Geometric Average Unweighted Arithmetic Average 8.0% 8.2% 6.1% 6.9% 60 Table X shows the effect income taxes had on the rate of return earned by the three different size classes. Table X The Average Tax Effect on the Industry Rate of Return by Size Class + 1961 - 1970 * % change + 1962 - 1970 * % change Small Companies Unweighted Geometric Average 2.7% 34% 2.4% 39% Unweighted Arithmetic Average 2.7% 34% 2.7% 39% Medium Companies Unweighted Geometric Average 2.4% 34% 1.3% 26% Unweighted Arithmetic Average 2.6% 35% 1.6% 27% Large Companies Unweighted Geometric Average 1.7% 18% 2.0% 25% Unweighted Arithmetic Average 2.6% 25% 2.3% 25% where + and * are as defined under Table VII except that the size class percentage return is substituted for the industry percentage return. Table IX and Table X do present some mixed or rather conflicting results but some information can still be extracted from these two tables. It seems that the small size companies paid a greater amount of income tax as a percentage of pre-tax earnings such that this reduced their after tax rate of return to that of or even below that of the medium size companies. The large companies rate of return remained appreciably above that of either the small or medium size companies as these large companies seem ingly paid less taxes as a percentage of their pre-tax earnings. One 61 reason for this may be that the large companies received a higher proportion of their return in the form of realized or unrealized capital gains which are not taxable. This statement will be supported later when the three sources of the rate of return are discussed. A second reason why large companies paid less taxes as a percentage of their pre-tax earnings stems from the possibility that the large companies grew at a faster rate than the small or medium size companies. This becomes a more distinct possibility when it is remembered that the companies were divided into the three size categories based on their total admitted assets at the end and not the beginning of the time period. Specifically, a faster growth rate would allow the large companies to capitalize more of their underwriting profits into the unearned premium reserve. Table XXIX in the appendix supports this viewpoint because it shows that it was for the large companies that the unearned premium adjustment had the largest effect on the statutory underwriting result. The unearned premium adjustment expressed as a percentage of the statutory underwriting profit is a good representation of the amount of hidden profit in the statutory underwriting results. The percentage was 26.4 percent for large companies and only 17.3 percent and 13.4 percent for the small and medium companies, respectively. The related tax shield effect (Table XXIX), which will be discussed later, presents the same picture because the tax shield is largest for the large companies. Other Results Concerning the Rate of Return The reader can refer to the various tables in this chapter or to the tables in the appendix in order to find support for the following remarks. The Low and High Rates of Return Experienced by Each Size Class - The 62 medium-size companies experienced several years in which there was a negative rate of return. The large-size companies did not experience any negative rates of return while the small companies experienced such a return in only two years. Both the small and medium-size companies experienced several years in which they received a positive but low rate of return. Again, the large companies did appreciably better because a low return was experienced in only two years (1966 and 1969). On the other hand, the small companies had a high rate of return in only two years (1961 and 1968) while the other two size classes received a relatively high return in three years (1961, 1967, and 1968). To emphasize, it seems that the large size companies did better because of their ability to use certain economies of scale and the possibility that they were not held back by the lack of management expertise or by other limited resources,etc. But it is also necessary to stress that these economies seemingly do not begin until a certain size of insurance operation is reached. Dividends, Additional Capital, Income Taxes, and Adjusted Net Worth Divided by Size Class - Table XXI in the appendix presents the adjusted net worth amount for each company and the total amount for each size class along with the total yearly change in this figure. This will give the reader some idea of the difference in size composition of each of the three classes, as defined by the amount of the total adjusted net worth. It will also lend understanding to the weights that were used for each size class in arriving at the industry yearly rates of return. Table XXII in the appendix shows the dividends paid by each company and the yearly total for each of the three size classes for the ten year period. It is interesting to note that the small size companies paid 63 none or very little in the way of dividends, while the companies that rare classified as large almost always paid a dividend in each year. As would be expected, the medium-size companies fell somewhere inbetween. Table XXIII shows that the opposite situation exists when examining the additional capital that is inserted into the industry during the period under study. Specifically, additional insertions of capital were a frequent occurrence in small and medium size companies, but this was rare for the large-size companies. A possible explanation is that large companies have sufficient retained earnings on which to draw from to finance their expansion. This may also be an explanation for their high dividend payout. Table XXIV in the appendix gives the income taxes that were paid by each company with totals for each of the three size classes. It shows that large companies have had to pay some income tax in the majority of years. On the other hand, the small and medium size companies have not paid income taxes in several of the years of the study and have, in fact, enjoyed the benefits of a refund of income taxes through loss carry forward provisions. At the same time, it has already been explained why these taxes paid by the larger size companies represent a smaller percentage of their pre-tax earnings. There are two or three reasons why the small and medium size companies did not pay tax in several of the years of the study. First, and the most obvious one is the negative rates of return or losses that were incurred in some of the years. This in turn, permitted the companies to take advantage of the loss carry forward provisions of the tax act where these losses could be offset against subsequent income. Many of the small or medium size companies might have been new companies that could take advantage 64 of higher capital cost allowances or other tax incentives. Finally and along the same lines, these mediumNor small size companies are probably not as diversified as the large companies and hence suffer more from business cycle fluctuations and trends in the economy. This of course means there will be years in which the returns will be low with subsequent low income tax liabilities. This completes the discussion relating to the rate of return that was earned in the insurance industry and by the different groups of that industry, both on a before and after tax basis. Attention will now be turned towards a different viewpoint of the rate of return. Specifically, what are the sources for the rate of return that was earned or received? The Sources for the Industry Rate of Return There are basically three sources of return earned by general insurance companies. These are the following: 1. investment income 2. underwriting income or profit 3. residual or other income (mainly consisting of unrealized capital gains) The remainder of this chapter will discuss these three income sources. I. Investment Income Investment income consists basically of interest, dividends, and rents received. Table XI is a summary of the investment income earned by the three size classes and by the entire industry. The figures in this table and for subsequent tables in this chapter are unweighted arithmetic averages for the three size groups and a weighted arithmetic average across the industry using the same weighting procedure as described earlier for the industry return figure. 65 Table XI Investment Income Adjusted Net Worth 1961 - 1970 1962 - 1970 Entire Industry 9.01% 9.12% Industry Segments or Classes Small Companies Medium Companies Large Companies 7.60% 10.00% 9.08% 7.70% 10.17% 9.18% Several things are worth noting here. The industry investment income for the ten year period (9.01%,) accounts for almost the entire industry before tax rate of return while the nine year investment income (9.12%,) does in fact account for more than the entire industry rate of return before taxes. Table XI also shows somewhat surprisingly that the medium size companies earned a higher investment income than either the small or large size companies. What accounts for this situation is difficult to determine. It is quite possible that the smaller companies lacked management expertise in investment policy while the larger companies, though they had this management expertise, were just too large to keep abreast or to be in constant touch with all facets of their investment program. Expressing this in another way, the medium size companies have both adequate investment man agement and the ability to continually evaluate their investment policy. Furthermore, managers of small companies may be far more risk conscious than other managers, and therefore desire to remain in liquid investments, retain a shorter investment horizon, etc. all of which would contribute to a lower investment income. Finally, another possible reason why medium companies have higher investment income is because they have larger under writing losses (see Table XII). Since underwriting losses can be offset 66 against investment income, medium companies may have put more in high coupon bonds; hence, resulting in higher investment income. On the other hand, the large and small companies with better underwriting profits, may go for discount bonds; hence, resulting in lower investment income but some capital gains on maturity, which are non-taxable. Table XXV in the appendix presents as a percentage, the overall average and yearly investment income for each of the three size classes. The same table also shows the overall average and yearly weighted arithmetic average for the entire industry. Table XXVI in the appendix expresses basically the same thing but in dollar amounts for each company along with totals for each of the three size groups. These tables show that the investment income earned increased rather slowly but steadily over the time period. There were no wide fluctuations from year to year in the income received. This would be expected as the companies hold a large volume of long term bonds. II Underwriting Income The second source of the rate of return for general insurance companies is underwriting income. Table XXVII in the appendix presents as a per centage, the overall average and the yearly underwriting income for each of the three size groupings. The same table also shows the overall average and the yearly weighted arithmetic average for the entire industry. Table XXVIII in the appendix shows the amount of overstatement in the unearned premium reserve, or in other words, the degree of understatement in the true or incurred underwriting profit. The yearly change in this figure is then calculated in order to arrive at the required adjustment which is then added to the statutory underwriting figure in order to arrive 67 at the incurred or actual underwriting income for each size class. The information presented in these two tables is summarized in Table XII. Table XII Adjusted Underwriting Profit Adjusted Net Worth Entire Industry Industry Segments or Classes Small Companies Medium Companies Large Companies 1961 - 1970 0.07% 0.36% •3.53% 0.91% 1962 - 1970 -0.49% 0.04% •3.75% 0.39% As can be seen, over the ten year period, the small and large size companies experienced a small underwriting profit. Over this same period the industry profit was similiarly small. However, over the nine year period the industry suffered a small loss, though both the small and large size companies still experienced a small profit. The surprising result about Table XII is that the medium companies did appreciably worse with an under writing loss of 3 1/2 percent to 3 3/4 percent on their net worth. This loss is sufficient to offset the higher investment income gains discussed earlier so that the overall return to the medium companies is smaller than that for the small and large companies. As mentioned earlier, the under writing and investment returns may be related because the underwriting result may be a determining factor in deciding to invest in high coupon or low coupon discount bonds. This also tends to confirm the earlier hypothesis that these medium size companies are not large enough to take advantage of any economies of scale like the large companies can nor are they forced like the small companies because of limited resources to specialize in only a small number of insurance lines and hence to gain 68 expertise in these insurance lines. Table XXXVII in the appendix also shows that the underwriting result varies from year to year. There may be a good underwriting profit in one year only to be cancelled out by a large underwriting loss in the following year. This is in contrast to the investment income source which was fairly constant over the time period studied. Specifically, relatively poor underwriting years (expressed as a percentage of net worth) occurred in the following years: a) small companies - 1962, 1963, 1964, 1965, 1969, 1970 b) medium companies - 1961, 1962, 1963, 1964, 1965, 1969, 1970 c) large companies - 1962, 1963, 1964, 1965, 1969, 1970 It is interesting to note that from the above there is only one year (1961) that was not listed as a poor underwriting year for all three size classes. On the other hand, relatively good underwriting years are few in number. They are the following: a) small companies - 1966, 1967, 1968 b) medium companies - 1966, 1967 c) large companies - 1961, 1966, 1967 The Tax Shield Effect - The difference between underwriting profits cal culated on a statutory basis and on an actual or incurred basis should also be taxed as the difference represents profits capitalized by statutory accounting procedures when premiums are growing. Such gains would be subject to tax when realized. The amount of the tax shield effect is the difference between the tax that \wa s actually paid and the tax that would be paid if the understatement in the underwriting result was accounted for in making the tax calculation. The reader must remember that the rate of change in the adjusted unearned premium reserve represents the 69 difference between the statutory and the incurred underwriting result. In this study a 50 percent tax rate is assumed; therefore the amount of the tax shield is one-half of the difference referred to in the preceding sentence. Normally, the tax shield effect would be a positive amount because the unearned premium reserve is usually overstated due to growing premiums, inflation, etc. The amount of the tax shield effect can be expressed in percentage terms by dividing the amount of the tax shield by the tax that was actually paid. The following results were obtained: a) small companies: 12.1% b) medium companies: 15.47, c) large companies: 18.57= The above ratio shows that if account was taken of the underestimation in underwriting profit stemming from the overstatement of the unearned premium reserve, the income taxes would be appreciably higher than what they are under statutory reporting requirements. The differences in the ratios for the three size companies shows that the tax shield effect is largest for the large companies, then the medium companies, and finally the small companies. This is as expected when it is remembered that the tax shield effect can be attributed to the faster rate of growth of the large companies as represented by the faster rate of growth in their premiums received and in the rate of expansion in the unearned premium reserve. What effect did the tax shield have on the rate of return on net worth? Table XIII shows the average tax shield effect on the average after tax rate of return on net worth. The averages used are ten year arithmetic averages. 70 Table XIII The Underwriting Tax Shield Effect on the Rate of Return on Net Worth (10 year arithmetic averages) (1) (2) (1) - (2) After Tax Return After Tax Return /if tax had been based J CUsing Actual Tax Paidj Tax Shield \. on adjusted earnings,/ Adjusted Net Worth Adjusted Net Worth Adjusted Net Worth *S.C. 5.3% 00.347o 4.967, *M.C. 5.87o 00.427. 5.38% *L.C. 8.2% 00.50% 7.70% * = Small Companies - Medium Companies - Large Companies Though the tax shield effect did have an effect on the amount of taxes paid, Table XIII shows that it does not have much effect on the average after tax rate of return on net worth. The amount of the tax shield expressed as a percentage of net worth ranged from 1/3 of 1 percent to 1/2 of 1 percent. Expressing the tax shield effect in a different way, that is, as a percentage of the calculated after-tax return, the effect is only about 6 or 7 percent. Underwriting Profit/Net Premiums Earned - Frequently, in the insurance literature, the underwriting result'is expressed as a percentage of the net premiums earned and not as a percentage of net worth. Table XIV expresses both the statutory and incurred underwriting profit as a percentage of the net premiums earned. This is done on a weighted basis for the industry and on an unweighted basis for each of the three size classes. The averages are arithmetic averages. The underlying purpose of Table XIV is to show what effect the adjustment to the statutory underwriting result has on this commonly quoted ratio as representing the profitability of insurance 71 operations. Table XIV Statutory and Incurred Underwriting Profit Related to Net Premiums Earned 1961 - 1970 1962 - 1970 Industry Statutory -01.03% -01.40% Incurred -00.29% -00.29Small Companies Statutory -00.71% -01.02% Incurred 00.01% -00.40Medium Companies Statutory -03.37% -03.60% Incurred -02.86% -03.05Large Companies Statutory -00.25% -00.67% Incurred 00.57% 00.12As can be seen, the effect of the adjustment expressed as a percentage of net premiums earned is small, generally less than 1 percent. This can probably be attributed to the fact that even though the adjustment is large in relation to the tax actually paid or to the statutory underwriting profit the net premiums earned denominator is much larger; the total premiums range from 156 to 380 million over the period. As a result, any adjustments expressed in this way has a small effect on the final underwriting result. This would also be expected if such a comparison was based on the adjusted net worth at the beginning of each year. The reader will remember that this study expressed the incurred or actual underwriting profit as a per centage of the adjusted net worth at the beginning of the year (see Table XII) 72 III Residual or Other Income This residual source of the rate of return mainly consists of un realized capital gains. Failure to include these gains as a profit source tends to underestimate the rate of return of insurance companies. Of course, if unrealized capital gains are considered, consistency demands that unrealized capital losses must also be included. Table XV expresses the residual income as a percentage of the adjusted net worth. Once again, the averages used are arithmetic averages, weighted in the case of the industry source. Table XV Residual or Other Income Adjusted Net Worth 1961 - 1970 1962 - 1970 Entire Industry 00.62% -00.33% Industry Segments or Classes Small Companies 00.04% -00.84% Medium Companies 00.93% -00.52% Large Companies 00.81% -00.39% As can be seen, the income attributable to this source was relatively significant in most instances. The above source for the 10 year period represents about 10 percent of the total return over the period. The small size companies did not do as well as either the medium or large size companies. Writers who object to the inclusion of unrealized capital gains and losses do so not because of the results given above but because of the volatility of financial asset prices from year to year. Table XXXII in the appendix does indeed illustrate the fluctuation in this source of 73 return from year to year. And it is for this reason that insurance company profitability can only be measured meaningfully over a fairly long time span and even then attention must be focused on the economic conditions present at the terminal dates used in the calculation. For example, note the differences in the income above by the delation of 1961, a year in which the market prices of investments held rose sharply. The Tax Shield Effect - When calculating net profits, there was the question of whether these unrealized profits and losses should be taxed. It was pointed out in Chapter 3, that it is more accurate to impute some taxation to these profits with offsetting tax credits for losses, since such gains and losses would be subject to tax when realized. Specifically, a capital gains tax would help to reduce any capital loss because a portion of that loss could be deducted from other income. Of course, it would also reduce a capital gain by the amount of the tax. As was stated in Chapter 4, an adjustment for the tax shield effect associated with unrealized capital gains and losses was not made in this study because insurance companies in Canada did not pay a capital gains tax in the period under study, (1961 - 1970). Finally, it is interesting to note that if a capital gains tax was accounted for; whether it would or would not have an effect on the income from this source (which represents 107„ of the rate of return over the 10 year period) depends on what, the capital gains tax rate would have been. The last chapter, Chapter 6, will present a summary of these results and give some conclusions relating to the profits earned by the Canadian general insurance industry. 74 Chapter 6 Conclusions This study, which is the first study of any sophistication in Canada, has examined the rates of return earned by a random sample of property and liability insurance companies. The rates of return were calculated for a ten year period, 1961 - 1970. This study reached the following main conclusions: 1. The rate of return earned on net worth is the only meaningful measure for insurance companies. Many of the previous studies have not recognized this. However, certain adjustments must be made to the statutory asset and liability accounts in order to arrive at the true rate of return earned on net worth. These adjustments usually involve correcting for understatements in asset accounts and overstatements in liability accounts. 2. Many of the previous studies have examined only the income statement in calculating a rate of return. Given the data available and the statutory reporting requirements, the balance sheet must also be analyzed in addition to the income statement. 3. The rate of return earned during this period was not considered to be excessive though the return did fluctuate widely from year to year. Furthermore, on the average, income tax accounted for only about 25 percent of the before tax rate of return. 4. The large-size companies, as measured by admitted asset size in 1970, did better than medium or small size companies both on a before and after tax basis. It was concluded that after a certain volume of insurance business is reached, some economies of scale may exist. On a before tax 75 basis, the small companies earned a slightly higher rate of return than the medium size companies did. It was suggested that this might reflect the limited resource capibility of. small insurers, thus forcing them into choosing fewer but more profitable insurance lines. 5. In most years, the small companies did not pay any dividend. Onthe other hand, the large companies almost always paid a dividend. The medium companies fell somewhere inbetween. Any additional capital that was raised during the period of study was raised by the small and medium sized companies. Large companies tended to finance their higher rate of expansion through retained earnings. This might imply that the large companies were the better managed companies because they grew at a faster rate than the smaller companies without the need for external financing. 6. The rate of return before taxes comes from three generally de fined sources; investment (interest, dividends, and rents), underwriting, and other or residual income (mainly consisting of unrealized capital gains). 7. The investment income accounted for most of the industry rate of return before taxes. In terms of this source of return, the medium size companies had a higher investment income on net worth than the larger companies and appreciably better than the smaller companies. This is likely due to the type of bond purchased. The medium size companies purchased high coupon bonds because their underwriting losses could be applied against the investment income received, in order to reduce the amount of income taxes payable. On the other hand, the large and small companies purchased discount bonds in order to receive a non-taxable gain at maturity because they did not have a large amount of underwriting losses that could be offset against 76 investment income. In all instances, the income earned from this source increased slowly but rather steadily throughout the period. 8. In terms of the underwriting income or profit, the medium size companies did appreciably worse than either of the other two size groups. This lower underwriting result (loss) suffered by the medium size companies was large enough to offset their higher investment income discussed above. The tax shield effect associated with the underwriting adjustment involving the overstatement in the unearned premium reserve had little effect on increasing the rate of return although it did have an effect on the taxes actually paid. 9. Income from other sources, mainly consisting of unrealized capital gains and/or losses, accounted for almost 10 percent of the rate of return earned over the period. A tax shield associated with unrealized capital gains and losses was not calculated because during the period of the study there was no capital gains tax in effect in Canada. The reader can refer to Table XXXII in the appendix for a detailed summary of the results of the study. This study has made several adjustments to overcome some of the deficiencies of the conservative accounting system used by the property and liability insurance companies. For example, this study included all unrealized capital gains and losses into the rate of return measure. An adjustment was made to the un earned premium reserve to more accurately reflect the amount of the liability. However, even with an allowance for such adjustments, the property and liability insurance industry was found to be earning a reasonable but not monopoly profits. At the same time, this does not necessarily mean that companies are operating in a perfect market and therefore because of this reasonable rate, are necessarily on 77 average efficient. We have also shown that there are some economies of scale in the non-life insurance industry. Questions which demand further attention are at what level of operation do economies of scale exist and how great are these economies? If significant economies do exist, this may suggest that legislation should be introduced to encourage a greater degree of concentration within the industry in order to reap these economies. This in turn might result in some lowering of the premium rates paid by policyholders. A second area ripe for investigation relates to the present investment regulation. In particular, some companies appear to be holding the statutory maximum of 25 percent of their assets in common stock and this would seem to suggest that these companies may prefer to hold more of such assets. An easing of these investment restrictions may permit companies to earn higher profits by taking more risk and this also may help to keep prices down. 78 BIBLIOGRAPHY A. BOOKS Li, Jerome C.R., Numerical Mathematics, Edwards Brothers, Inc., Ann Arbor, Michigan, 1966 Long, John D. and Davis W. Gregg, Property and Liability Insurance Handbook, Richard D Irwin, Inc., Homewood, 111., 1965 B. ARTICLES Anderson, Dan Robert,"Effects of Under and Overvaluations in Loss Reserves", The Journal of Risk and Insurance, Vol. XXXVIII, No. 4, December 1971 Anderson, John L., "Financial Accounting Practices of Property and Liability Insurance Companies", The Journal of Risk and Insurance, Vol. XXXIX, No. 2, June 1972 Bailey, Robert A., "A Review of the Little Report on Rates of Return in the Property and Liability Insurance Industry", The Proceedings  of the Casulty Actuarial Society, Vol. LVI, 1969 Balcarek, Rafal J., "Effect of Loss Reserve Margins on Calender Year Results", The Proceedings of the Casulty Actuarial Society, Vol. LIII, 1966 Dickinson, Gerald M., "The Rate of Return Earned by U.K. Insurance Companies in the U.S." The Journal of the Chartered Insurance Institute, 1973 Dickinson, Gerald M. , "Calculating the Profitability of Non-Life Insurance Companies: Some Clarifying Comments", Working Paper Ferrari, J.R., "The Relationship of Underwriting, Investments Leverage, and Exposure to Total Return on Owners' Equity", The Proceedings of the  Casulty Actuarial Society, Vol. LV, 1968 Forbes, Stephen W., "Growth Performances of Non-Life Insurance Companies 1955 - 66", The Journal of Risk and Insurance, Vol. XXXVII, No. 3, September 1970 Forbes, Stephen W., "Rates of Return in the Non-Life Insurance Industry", The Journal of Risk and Insurance, Vol. XXXVII, No. 3, October 1970 Goddard, Russell P., "Total Earnings From Insurance Operations - The Investors Viewpoint", The Proceedings of the Casulty Actuarial Society, Vol. LV, 1968 79 B. ARTICLES Hammond, J.D., E.R. Melander, and N. Shilling, "Economies of Scale in the Property and Liability Insurance Industry", The Journal of Risk  and Insurance, Vol. XXXVIII, No. 2, June 1971 Hammond, J.D. and N. Shilling, "The Little Report on Prices and Profits in the Property and Liability Insurance Industry", The Journal of Risk  and Insurance, Vol. XXXVI, No. 1, March 1969 Hammond, J.D. and N. Shilling, "Some Empirical Implications of the Return on Investible Funds Measure of Profitability", The Journal of Risk and  Insurance, Vol. XXXVII, No. 4, December 1970 Hofflander, Alfred E. and R. Hal Mason, "Prices and Profits in the Property and Liability Insurance Industry", The Journal of Risk and Insurance, Vol XXXV, No. 2, June 1968 Long, John D., "The Property - Liability Insurance Industry", Business  Horizons, Vol. XI, No. 1, February 1968 Long, John D., "Comments on the Plotkin Paper", The Journal of Risk and  Insurance, Vol. XXXVI, No. 3, June 1969 Norgaard, Richard and George Schick, "Profitability in the Property and Liability Insurance Industry", The Journal of Risk and Insurance, Vol. XXXVII, No. 4, December 1970 Plotkin, Irving H. , "Rates of Return in the Property and Liability Insurance Industry: A Comparative Analysis", The Journal of Risk and Insurance, Vol. XXXVI, No. 3, June 1969 Trieschmann, James S., "Property - Liability Profits: A Comparative Study", The Journal of Risk and Insurance, Vol. XXXVIII, No. 3, September 1971 C. PUBLICATIONS BY GOVERNMENT AND OTHER ORGANIZATIONS Arthur D. Little Inc., "Prices and Profits in the Property and Liability Insurance Industry", Report to the American Insurance Association, November 1967 Arthur D. Little Inc., "Rates of Return in the Property and Liability Insurance Industry 1955 - 67", Report to the National Association of Independent Insurers, June 1969 Canada.Canadian and British Insurance Companies Act. R.S.C., 1970, C.I - 15 Canada. Superintendent of Insurance. Report of the Superintendent of Insurance  for Canada. 3 Vols, 1960 - 70 C. PUBLICATIONS BY GOVERNMENT AND OTHER ORGANIZATIONS Peat, Marwick, Mitchell and Co. and Price Waterhouse and Co. Calculation of Rates of Return on Invested Capital of Canadian General  Insurance Companies. Report to the Insurance Bureau of Canada, January 1967 Standard and Poors Corporation. The Compustat Information Manual. Standard and Poors Corporation, New York, N.Y. August 1966 State of New York Insurance Department. Report of the Special Committee on  Insurance Holding Companies. Report to the State of New York Insurance Department, February 1968 APPENDIX 82 Table XVI The Random Sample of Canadian General Insurance Companies Used in this Study LARGE COMPANIES GREATER THAN $20,000,000 1. Western Assurance $70,041,000 2. British America 55,473,003. Canadian Indemnity 45,783,004. Dominion Insurance 38,886,005. General Accident of Canada 37,224,000 6. Dominion of Canada General 36,141,007. Guardian Insurance of Canada 27,954,008. Canadian Reinsurance 26,520,000 9. Canadian General 25,725,0010. Wellington Fire 24,905,0011. Canadian Surety 23,749,0012. Halifax 21,497,00MEDIUM COMPANIES $10,000,000 - $20,000,000 1. Canadian Accident & Fire $17,552,000 2. London & Midland 17,247,003. Acadia 16,836,004. Federal Fire 15,894,005. Consolidated Fire 14,215,000 6. General Security of Canada 14,193,007. Quebec 13,166,008. Globe Indemnity 12,926,009. Merit 12,407,0010. Guarantee Co. of North America 11,645,000 11. Mercantile & General of Canada 11,189,0012. Hudson Bay 11,317,00SMALL COMPANIES LESS THAN $10,000,000 1. Stanstead & Sherbrooke $8,155,002. Missisquoi & Rouville 8,051,003. Canadian Home 8,010,000 4. Fidelity Insurance 6,945,005. Great Eastern 6,903,006. Fire of Canada 6,557,007. Canadian Health & Accident 6,274,000 8. Federation 6,189,009. Scottish Canadian 5,353,0010. Reliance of Canada 4,968,0011. Commonwealth 4,906,000 12. London - Canada 4,693,0083 Table XVII* The Expense Ratio Used for the Unearned Premium Adjustment (1) (2) (3) (4)- (2) YEAR EXPENSES** NET PREMIUMS WRITTEN EXPENSE RATIO $ $ % 1960 38,769,384 103,342,279 37 1961 39,159,740 102,622,067 38 1962 41,690,753 105,435,439 39 1963 43,467,600 111,967,724 39 1964 46,476,054 123,277,978 38 1965 50,974,992 139,280,688 37 1966 56,619,185 158,171,369 36 1967 66,104,067 181,079,873 37 1968 68,981,510 183,514,885 38 1969 77,148,705 207,832,583 37 1970 84,124,803 231,727,504 36 * - the amounts presented here are for the ten largest companies as determined by the volume of net premiums written in each year * - expenses include salaries, commission and brokerage, premium taxes and other expenses but excluding adjustment expenses Table XVIII The Industry Rate of Return Before Taxes (on adjusted net worth) Small Companies height Net Worth - Small Companies Net Worth - Industry X Yearly Rate of Return % Weighted Rate of Return % Medium Companies 'eight Net Worth - Medium Companies Net Worth - Industry X Yearly Rate of Return % ' Weighted Rate of Return % Large Companies feight Net Worth - Large Companies Net Worth - Industry X Yearly Rate of Return % Weighted Rate of Return 1961 18,455,492 133,005,182 17.86 02.48 27,175,828 133,005,182 20,80 04.25 87,373,862 133,005,182 24.38 16.02 1962 20,751,201 155,958,525 -00.98 -00.13 31,929,806 155,958,525 -02.54 -00.52 103,277,518 155,958,525 09.11 06.03 1963 19,924,737 160,607,224 07.42 00.92 31,101,550 160,607,224 01.44 00.28 109,580,937 160,607,224 08.84 06.03 1964 20,774,439 169,073,653 09.06 01.11 31,795,400 169,073,653 00.12 00.02 116,503,814 169,073,653 09.20 06.34 1965 22,757,390 186,532,144 05.38 00.66 36,967,570 186,532,144 08.76 01.73 126,768,793 186,532,144 oc -p-06.94 04.72 Small Companies eight Net Worth - Small Companies Net Worth - Industry Table XVIII (Continued) The Industry Rate of Return Before Taxes (on adjusted net worth) 1966 25,377,946 198,724,823 1967 25,200,742 197,489,060 Yearly Rate of Return % Weighted Rate of Return 7> Medium Companies sight Net Worth - Medium Companies Net Worth - Industry X Yearly Rate of Return 7> Weighted Rate of Return 7, Large Companies sight Net Worth - Large Companies Net Worth - Industry X Yearly Rate of Return 7> Weighted Rate of Return 7> 06.44 00.81 41,517,015 198,724,823 06.29 01.31 132,050,418 198,724,823 04.09 02.82 04.09 00.53 43,346,363 197 , 489 , 060 14.05 03.08 128,764,751 197,489,060 15.99 10.43 1968 1969 1970 27 ,281,631 219,036,029 31,536,273 255,110,827 31,415,915 248,887,942 19.97 02.49 01.90 00.23 09.40 01.19 47,495,153 219,036,029 59,462,745 255,110,827 56,400,875 248,887,942 24.43 05.30 -02.25 -00.52 03.03 00.69 144,250,134 219,036,029 164,111,809 255,110,827 161,071,152 248,887,942 20.47 13.48 00.98 00.63 07.45 04.82 M Table XVIII (Continued) The Industry Rate of Return Before Taxes (on adjusted net worth) Industry Rate of Return Before Taxes %, 1961 1962 22.75 05.38 1966 1967 04.84 14,04 Unweighted Geometric Average (10 years) - 9.5% Unweighted Geometric Average ( 9 years) - 7.5%, Unweighted Arithmetic Average (10 years) - 9.77, Unweighted Arithmetic Average ( 9 years) - 8.37, 1963 1964 1965 07.23 07.47 07.11 1968 1969 1970 21.27 00.34 06.70 OO ON Table XIX The Industry Rate of Return After Taxes (on adjusted net worth) Small Companies eight Net Worth - Small Companies Net Worth - Industry X Yearly Rate of Return % Weighted Rate of Return % Medium Companies aight Net Worth - Medium Companies Net Worth - Industry X . Yearly Rate of Return % Weighted Rate of Return % Large Companies sight Net Worth - Large Companies Net Worth - Industry X Yearly Rate of Return % Weighted Rate of Return 7„ 1961 .18,455,492 133,005,182 15.19 02.11 27,175,828 133,005,182 18.60 03.80 87,373,862 133,005,182 19.48 12.80 1962 20,751,201 155,958,525 -02.75 -00.37 31,929,806 155,958,525 -02.10 -00.43 103,277,518 155,958,525 07.19 04. 76 1963 19,924,737 160,607,224 06.07 00.75 31,101,550 160,607,224 01.86 00.36 109,580,737 160,607,224 1964 20,774,439 169,073,653 07.54 00.93 31,795,400 169,073,653 00.05 00.01 165,563,814 169,073,653 1965 22,795,781 186,532,144 02.43 00.30 36,967,570 186,532,144 06.95 01.38 126,768,793 186,532,144 08.47 08.37 05.38^ 05.78 05.77 03.66 .Table XIX (Continued) The Industry Rate of Return After Taxes (on adjusted net worth) 1966 1967 Small Companies eight Net Worth - Small Companies 25,157,390 25,377,946 Net Worth - Industry 198,724,823 197,489,060 X Yearly Rate of Return 7, 02.64 -00.16 Weighted Rate of Return % 00.33 -00.02 Medium Companies eight Net Worth - Medium Companies 41,517,015 43,346,363 Net Worth - Industry 198,724,823 197,489,060 X Yearly Rate of Return 7, 04.02 08.91 Weighted Rate of Return 7, 00.84 01.95 Large Companies eight Net Worth - Large Companies 132,050,418 128,764,751 Net Worth - Industry 198,724,823 197,489,060 X Yearly Rate of Return 7, 00.50 10.05 Weighted Rate of Return 7= 00.33 06.55 19 68 1969 1970 271,290,842 219,036,029 31,536,273 255,110,827 31,415,915 248,887,942 16.02 01.97 -00.20 -00.02 06.52 00. 82 47,495,153 219,036,029 59,462,745 285,110,827 56,400,875 248,887,942 21.84 04.73 •03.07 00.72 01.15 00.26 144,250,134 219,036,029 164,111,809 255,110,827 161,071,152 248,887,942 15.81 10.41 00.16 00.10 04.79 ° 03.10 Table XIX (Continued) The Industry Rate of Return After Taxes (on adjusted net worth) Industry Rate of Return After Taxes 7, 1961 1962 1963 1964 1965 18.71 03.96 06.89 06.71 05.34 1966 1967 1968 1969 1970 01.50 08.48 17.31 00.80 04.18 Unweighted Geometric Average (10 years) - 7.37, Unweighted Geometric Average ( 9 years) - 5.57 Unweighted Arithmetic Average (10 years) - 7.57, Unweighted Arithmetic Average ( 9 years) - 6.27 00 Table XX The Industry Rate of Return Before Taxes by Industry Size Class (on adjusted net worth) 1961 1962 (Percent) 1963 1964 1965 1966 1967 1968 1969 1970 nail Companies 17.86 -00.98 07.42 09.06 05.38 06.44 04.09 19.97 01.90 09.40 adium Companies 20.80 -02.54 01.44 00.12 08.75 06.29 14.05 24.43 -02.25 03.03 arge Companies 24.38 09.11 . 08.84 09.20 06.94 04.09 15.99 20.47 00.98 07.45 1961 - 1970 geometric average 1962 - 1970 geometric average 1961 - 1970 arithmetic average 1962 - 1970 arithmetic average nail Companies 7.9 6.1 8.0 6.9 sdium Companies 7.0 5.0 7.4 5.9 arge Companies 9.7 8.1 10.8 9.2 O nail Companies sdium Companies arge Companies nail Companies =dium Companies arge Companies Table XX (Continued) The Industry Rate of Return After Taxes by Industry Size Class (on adjusted net worth) (Percent) 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 15.19 -02.75 06.07 07.54 02.43 02.64 -00.16 16.02 -00.20 06.52 18.60 -02.10 01.86 00.05 06.95 04.02 08.91 21.84 -03.07 01.15 19.48 07.19 08.47 08.37 05.38 00.50 10.05 15.81 00.16 04.79 1961 - 1970 geometric average 1962 - 1970 geometric average 1961 - 1970 arithmetic average 1962 - 1970 arithmetic average 5.2 3.7 5.3 4.2 5.6 3.7 5.8 4.3 8.0 6.1 8.2 6.9 Table XXI The Yearly Adjusted Net Worth (dollars) Small Companies COMPANIES 1960 1961 1962 1963 1964 1965 London - Canada $ 1,178,799 $ 1,517,658 $ 1,473,642 $ 1,425,965 $ 1,517,643 $ 1,528,479 Commonwealth 407,283 451,986 406,591 422,927 445,156 425,175 Reliance of Canada 1,162,925 1,455,222 1,346,803 1,206,760 1,830,125 1,933,197 Scottish Canadian 1,067,036 1,321,818 1,292,679 1,449,155 1,643,985 1,791,698 Federation 1,036,739 1,125,449 998,521 975,787 922,497 890,158 Canadian Health & Accident 5,158,313 5,318,653 5,212,443 5,400,028 5,846,844 5,902,228 Fire of Canada 1,233,498 1,426,667 1,166,980 1,362,647 1,152,383 3,136,643 Great Eastern 854,814 731,139 774,034 943,434 1,036,054 1,149,349 Fidelity Insurance 1,799,655 2,193,157 2,072,573 2,304,835 2,560,473 2,691,707 Canadian Home 1,258,530 1,354,163 1,208,607 1,349,781 1,517,755 1,334,624 Missisquoi & Rouville 1,600,238 1,818,416 1,831,054 1,988,636 2,292,373 2,391,922 Stanstead & Sherbrooke 1,697,662 1,836,873 1,940,810 1,944,484 2,030,473 1,982,210 TOTAL ADJUSTED NET WORTH CHANGE IN ADJUSTED NET WORTH $18,455,492 $20,751,201 2,295,709 $19,924,737 - 826,464 $20,774,439 849,702 $22,795,781 2,021,342 $25,157,390 2,361,609 Table XXI (Continued) The Yearly Adjusted Net Worth (dollars) Small Companies COMPANIES 1966 1967 1968 1969 1970 London - Canada $ 1,503,365 $ 1,606,094 $ 2,022,077 $ 2,198,095 $ 2,343,162 Commonwealth 308,674 281,964 325,510 565,826 687,622 Reliance of Canada 2,101,504 2,307,425 2,948,708 2,457,081 2,737,014 Scottish Canadian 1,705,689 1,934,699 2,118,429 2,118,003 2,225,387 Federation 926,657 1,015,794 1,188,381 1,196,825 1,308,995 Canadian Health & Accident 5,452,262 5,500,243 6,087,186 6,043,765 5,497,496 Fire of Canada 3,503,749 3,272,257 3,447,464 2,554,712 2,610,347 Great Eastern 1,112,323 1,262,740 1,392,472 1,367,214 1,635,310 Fidelity Insurance 2,785,162 3,333,514 4,165,805 4,574,633 4,400,928 Canadian Home 1,659,941 1,897,673 2,410,767 2,715,031 2,801,643 Missisquoi & Rouville 2,290,150 2,623,748 3,130,499 3,379,752 4,671,136 Stanstead & Sherbrooke 2,028,400 2,152,591 2,298,975 2,244,978 2,641,738 TOTAL ADJUSTED NET WORTH CHANGE IN ADJUSTED NET WORTH $25,377,946 220,556 $27,290,742 1,912,796 $31,536,273 4,245,531 $31,415,915 -120,358 $33,560,778 2,144,863 Table XXI (Continued) The Yearly Adjusted Net Worth (dollars) Medium Companies COMPANIES 1960 1961 1962 1963 1964 1965 Hudson Bay $ 3,356,053 $ 3,763,415 $ 3,705,495 $ 3,883,315 $ 4,112,754 $ 4,056,386 Mercantile & General of Canada 2,262,967 2,439,778 2,917,872 2,532,327 2,550,847 2,614,904 Guarantee Co. of North America 3,098,849 3,341,493 3,215,256 3,723,025 3,516,960 3,625,170 Merit 5,151,261 5,524,311 4,.882,529 4,031,056 3,473,598 3,446,639 Globe Indemnity 2,811,533 3,304,536 3,193,145 3,289,818 3,474,143 3,456,320 Quebec 450,680 586,003 549,222 1,671,547 1,796,939 1,766,091 General Security of Canada 127,296 1,252,069 1,150,966 1,116,237 1,268,087 1,487,364 Consolidated Fire 1,484,484 1,839,430 1,833,975 2,004,314 3,660,273 4,273,664 Federal Fire 1,601,562 2,004,743 1,969,137 1,972,758 4,378,871 4,644,088 Acadia 3,816,792 4,332,799 4,019,256 3,996,850 4,157,480 4,372,650 London & Midland 943,076 691,319 802,692 960,198 1,125,881 1,862,917 Canadian Accident & Fire 2,071,275 2,849,710 2,861,915 2,663,960 3,451,737 5,910,822 TOTAL ADJUSTED NET WORTH CHANGE IN ADJUSTED NET WORTH $27,175,828 $31,929,806 4,753,978 $31,101,550 ^-828,256 $31,795,400 693,850 $36,967,570 5,172,170 $41,517,015 4,549,445 4> Table XXI (Continued) The Yearly Adjusted Net Worth (dollars) Medium Companies COMPANIES 1966 1967 1968 1969 1970 Hudson Bay $ 3,776,000 $ 3,871,671 $ 4,318,104 $ 4,146,324 $ 4,243,519 Mercantile & General of Canada 2,404,984 2,700,211 3,319,232 3,566,546 4,093,309 Guarantee Co. of North America 3,734,999 3,898,025 4,407,316 4,175,002 3,534,191 Merit 4,494,059 5,896,444 5,861,289 5,338,436 5,268,372 Globe Indemnity 3,179,841 3,383,594 4,129,995 4,133,699 4,434,183 Quebec 1,660,127 1,620,640 5,883,071 5,561,940 5,722,673 General Security of Canada 1,684,046 2,194,924 2,481,408 2,056,134 2,085,130 Consolidated Fire 4,388,266 4,547,784 4,880,424 4,964,653 5,343,665 Federal Fire 5,165,079 5,387,151 5,818,304 5,915,589 6,379,342 Acadia 4,119,744 4,315,082 5,476,559 5,135,385 5,531,137 London & Midland 2,953,584 3,686,220 6,218,004 5,395,458 10,655,208 Canadian Accident & Fire 5,785,634 5,993,407 6,669,039 6,011,709 6,092,432 TOTAL ADJUSTED NET WORTH CHANGE IN ADJUSTED NET WORTH $43,346,363 1,829,348 $47,495,153 4,148,790 $59,462,745 11,967,592 $56,400,875 - 3,061,870 $63,383,161 6,982,282 Table XXI (Continued) The Yearly Adjusted Net Worth (dollars) Large Companies COMPANIES 1960 1961 1962 1963 1964 1965 Halifax $ 7,554,877 $ 8,650,180 $ 8,734,537 $ 8,682,314 $ 8,986,522 $ 9,034,358 Canadian Surety 4,460,428 5,127,434 5,237,611 5,322,069 5,793,428 6,279,194 Wellington Fire 2,396,283 3,028,389 2,946,942 2,963,136 5,425,205 6,199,436 Canadian General 5,815,403 7,086,173 7,243,553 7,611,112 8,446,391 8,907,194 Canadian Reinsurance 5,676,131 5,259,767 5,540,230 6,096,228 6,782,622 6,777,059 Guardian Insurance of Canada 5,694,129 8,225,334 7,863,172 8,559,210 7,942,500 8,011,620 Dominion of Canada General 6,185,616 7,226,153 7,119,798 7,872,054 8,565,659 9,148,394 General Accident of Canada 7,775,602 9,478,768 9,320,337 10,511,232 12,259,204 12,943,829 Dominion Insurance 3,526,341 4,664,498 4,522,955 4,554,286 4,930,611 6,842,612 Canadian Indemnity 4,271,736 5,075,442 9,964,572 10,328,141 11,148,916 11,622,713 British America 15,315,867 18,504,207 18,806,748 20,104,154 21,430,995 21,316,192 Western Assurance 18,701,449 20,951,178 22,250,482 23,889,878 25,056,740 24,967,817 TOTAL ADJUSTED NET WORTH $87,373,862 $103,277,518 $109,580,937 $116,503,814 $126,768,793 $132,050,418 CHANGE IN ADJUSTED NET WORTH 15,903,656 6,303,419 6,922,877 10,264,979 5,281,625 VO ON Table XXI (Continued) The Yearly Adjusted Net Worth (dollars) Large Companies COMPANIES 1966 1967 1968 1969 1970 Halifax $ 8,994,333 $ 9,809,150 $ 10,978,708 $ 10,790,915 $ 10,623,418 Canadian Surety 6,844,022 7,125,091 7,904,283 7,791,131 7,979,066 Wellington Fire 6,588,819 7,018,420 7,751,355 8,145,094 8,665,149 Canadian General 8,674,231 8,890,700 8,980,395 8,804,595 7,573,342 Canadian Reinsurance 5,937,872 5,469,681 5,830,604 6,154,604 6,573,078 Guardian Insurance of Canada 8,167,169 8,117,260 9,290,734 8,533,745 8,440,238 Dominion of Canada General 9,037,787 10,283,735 12,613,358 13,017,270 14,722,855 General Accident of Canada 12,061,365 13,431,509 15,555,459 13,975,990 14,450,176 Dominion Insurance 7,493,679 13,800,811 16,056,650 15,461,901 15,294,525 Canadian Indemnity 10,771,550 11,339,750 12,574,785 12,599,016 13,716,130 British America 20,199,149 22,269,981 25,495,513 25,013,418 25,143,692 Western Assurance 23,994,775 26,694,046 31,169,985 30,783,213 30,912,597 TOTAL ADJUSTED NET WORTH $128,764,751 $144,250,134 $164,111,809 $161,071,152 $164,094,266 CHANGE IN ADJUSTED NET WORTH -3,285,667 15,485,383 19,861,675 -3,040,657 3,023,114 Small Companies COMPANIES London - Canada Commonwealth Reliance of Canada Scottish Canadian Federation Canadian Health & Accident Fire of Canada * Great Eastern Fidelity Insurance Canadian Home Missisquoi & Rouville Stanstead & Sherbrooke TOTAL DIVIDENDS Table XXII The Yearly Dividend Payout (dollars) 1960 40,000 12,500 $52,500 1961 40,000 18,750 1962 40,000 18,750 1963 32,013 40,000 18,750 1964 32,013 50,000 1965 32,013 50,000 94,794 $58,750 $58,750 $90,763 $82,013 $176,807 Small Companies COMPANIES London - Canada C ommo nwe a1th Reliance of Canada Scottish Canadian Federation Canadian Health & Accident Fire of Canada Great Eastern Fidelity Insurance Canadian Home Missisquoi & Rouville Stanstead & Sherbrooke TOTAL DIVIDENDS Table .XXII (Continued) The Yearly Dividend Payout (dollars) 1966 32,013 50,000 1967 32,013 60,000 25,000 1968 51,220 60,000 25,000 1969 64,850 75,000 25,000 1970 87,500 25,000 $ 82,013 $117,013 $136,220 $164,850 $112,500 VO Table XXII (Continued) The Yearly Dividend Payout (dollars) Medium Companies COMPANIES Hudson Bay Mercantile & General of Canada Guarantee Co. of North America Merit Globe Indemnity Quebec General Security of Canada Consolidated Fire Federal Fire Acadia London & Midland Canadian Accident & Fire TOTAL DIVIDENDS 1960 1961 $ 73,328 $105,409 33,436 90,000 95,000 27,500 24,000 94,000 94,000 80,000 110,000 $388,828 $437,839 1962 1963 1964 1965 $105,410 $105,409 $105,409 $187,903 46,802 26,744 40,116 95,000 95,000 95,000 178,000 60,000 94,200 94,000 47,000 47,000 94,000 150,000 150,000 40,000 50,000 $491,212 $397,409 $374,153 $644,219 Medium Companies COMPANIES Hudson Bay Mercantile & General of Canada Guarantee Co. of North America Merit Globe Indemnity Quebec General Security of Canada Consolidated Fire Federal Fire Acadia London & Midland Canadian Accident & Fire TOTAL DIVIDENDS Table XXII (Continued) The Yearly Dividend Payout (dollars) 1966 1967 80,232 110,000 102,000 1968 1969 80,232 45,000 66,000 120,348 408,100 160,000 78,000 120,348 160,000 240,000 67,750 188,000 188,000 150,000 300,000 188,000 300,000 188,000 300,000 1970 $208,527 $142,073 $ 164,988 $ 183,320 $ 219,984 40,116 170,000 240,000 188,000 150,000 $838,759 $815,305 $1,419,436 $1,259,418 $1,008,100 Table XXII (Continued) The Yearly Dividend Payout (dollars) Large Companies COMPANIES 1960 1961 1962 1963 1964 19 65 Halifax $ 50,000 $ $ 100,000 $ 200,000 $ 200,000 $ 200,000 Canadian Surety 85,000 85,000 85,000 85,000 85,000 85,000 Wellington Fire 48,000 Canadian General 90,000 90,000 90,000 90,000 90,000 90,000 Canadian Reinsurance Guardian Insurance of Canada 172,500 230,000 275,000 275,000 Dominion of Canada General 171,751 171,751 171,751 171,751 171,751 171,751 General Accident of Canada 70,000 87,500 105,000 Dominion Insurance 24,000 24,000 24,000 24,000 24,000 24,000 Canadian Indemnity 140,000 160,000 360,000 360,000 381,000 420,000 British America 425,000 440,000 440,000 440,000 440,000 935,000 Western Assurance 500,500 523,600 523,600 523,600 523,600 947,100 TOTAL DIVIDENDS $1,706,751 $1,724,351 $2,069,951 $2,239,351 $2,002,851 $2,977,851 Table XXII (Continued) The Yearly Dividend Payout (dollars) Large Companies COMPANIES 1966 1967 1968 1969 1970 Halifax $ 250,000 $ 250,000 $ 300,000 $ 300,000 $ 300,000 Canadian Surety 85,000 85,000 85,000 85,000 85,000 Wellington Fire Canadian General 90,000 270,000 525,000 400,000 157,000 Canadian Reinsurance 187,500 187,500 187,500 187,500 187,500 Guardian Insurance of Canada 350,000 400,000 Dominion of Canada General 209,637 252,575 303,090 394,017 454,635 General Accident of Canada 140,000 140,000 140,000 140,000 140,000 Dominion Insurance 24,000 24,000 24,000 24,000 24,000 Canadian Indemnity 480,000 540,000 600,000 600,000 600,000 British America 1,215,000 600,000 850,000 1,115,000 1,300,000 Western Assurance 1,247,400 616,000 893,200 1,124,200 1,309,000 TOTAL DIVIDENDS $3,928,537 $2,965,075 $4,131,790 $4,769,717 $4,557,635 Small Companies COMPANIES London - Canada Commonweal th Reliance of Canada Scottish Canadian Federation Canadian Health & Accident Fire of Canada Great Eastern Fidelity Insurance Canadian Home Missisquoi & Rouville Stanstead & Sherbrooke TOTAL ADDITIONAL CAPITAL Table XXIII The Yearly Additional Capital Paid In (dollars) 1960 1961 1962 2,750 1963 1964 $ 100,000 400,000 300,000 180,000 19 65 68,242 2,149,960 100,000 $ 2,750 $ 100,000 $ 880,000 $2,318,202 Small Companies COMPANIES London - Canada Commonwealth Reliance of Canada Scottish Canadian Federation Canadian Health & Accident Fire of Canada Great Eastern Fidelity Insurance Canadian Home Missisquoi & Rouville Stanstead & Sherbrooke TOTAL ADDITIONAL CAPITAL Table XXIII (Continued) The Yearly Additional Capital Paid In (dollars) 1966 1967 1968 1969 1970 $ $ $ $ $ 75,000 300,000 300,000 8,250 10,450 169,550 2,326,920 750,000 $ $2,326,920 $ 383,250 $ 310,450 $ 919,550 Medium Companies COMPANIES Hudson Bay Mercantile & General of Canada Guarantee Co. of North America Merit Globe Indemnity Quebec General Security of Canada Consolidated Fire Federal Fire Acadia London & Midland Canadian Accident & Fire TOTAL ADDITIONAL CAPITAL Table XXIII (Continued) The Yearly Additional Capital Paid In (Dollars) 1960 1961 150,000 21,110 1962 330,355 1963 415,000 1964 500,000 100,000 2,009,750 2,519,500 400,000 1965 250,000 250,000 300,000 1,764,857 $ 171,110 $ 330,355 $ 415,000 $5,529,250 $2,564,857 Medium Companies COMPANIES Hudson Bay-Mercantile & General of Canada Guarantee Co. of North America Merit Globe Indemnity Quebec General Security of Canada Consolidated Fire Federal Fire Acadia London & Midland Canadian Accident & Fire TOTAL ADDITIONAL CAPITAL Table XXIII (Continued) The Yearly Additional Capital Paid In (Dollars) 1966 1967 1968 1969 1970 $ $ $ $ $ 33,750 2,858,193 250,000 1,306,666 1,000,000 850,000 6,000,000 $1,000,000 $1,100,000 $2,891,943 $ $7,306,666 Large Companies COMPANIES Halifax Canadian Surety Wellington Fire Canadian General Canadian Reinsurance Guardian Insurance of Canada Dominion of Canada General General Accident of Canada Dominion Insurance Canadian Indemnity British America Western Assurance TOTAL ADDITIONAL CAPITAL Table XXIII (Continued) The Yearly Additional Capital Paid In (dollars) I960 1961 1962 1963 1964 19 65 $ $ $ $ $ $ 2,511,375 425,000 165,000 484,731 1,000,000 1,500,000 $ 744,731 $1,000,000 $ $2,511,375 $1,500,000 Large Companies COMPANIES Halifax Canadian Surety Wellington Fire Canadian General Canadian Reinsurance Guardian Insurance of Canada Dominion of Canada General General Accident of Canada Dominion Insurance Canadian Indemnity British America Western Assurance TOTAL ADDITIONAL CAPITAL Table XXIII (Continued) The Yearly Additional Capital Paid In (dollars) 1966 1967 1968 1969 $ $ $ $ 5,419,174 1,463,786 1,485,048  $ $5,419,174 $1,485,048 $1,463,786 Small Companies COMPANIES London *< Canada Commonwealth Reliance of Canada Scottish Canadian Federation Canadian Health & Accident Fire of Canada Great Eastern Fidelity Insurance Canadian Home Missisquoi & Rouville Stanstead & Sherbrooke TOTAL INCOME TAX Table XXIV The Yearly Income Taxes (dollars) 1960 192 89,008 56,645 4,000 1961 $ 7,198 -831 172 166 391,502 317,741 34,490 75,134 50,886 $541,519 $484,784 1962 1963 1964 1965 $ 16,914 $ "986 $-23,883 190 130 174 88 54 59 143,673 304,510 314,302 223,333 39,400 - 39,889 99,009 - 11,163 1,876 32,099 92,988 61,297 4,180 $364,717 21,966 - 7,848 $266,779 27,566 163 $320,198 83,478 263,463 $695,449 Small Companies COMPANIES London - Canada Commonwealth Reliance of Canada Scottish Canadian Federation Canadian Health & Accident Fire of Canada Great Eastern Fidelity Insurance Canadian Home Missisquoi & Rouville Stanstead & Sherbrooke TOTAL INCOME TAX Table XXIV (Continued) The Yearly Income Taxes (dollars) 1966 1967 1968 1969 1970 $ 155,850 $ 124,630 $ -3,350 $ 101,847 $ 143,344 59,190 100,082 220,180 16,627 35,000 85,000 6,000 -12,000 314,328 292,929 357,978 152,890 275,738 -468 18,725 231,996 80,000 211,843 90,052 116,000 110,735 265,653 24,000 -20,868 243,000 158,862 112,000 161 156 192,000 - 127,086 139,929 69,000 198,509 162,500 $ 946,263 $1,119,029 $1,073,802 $ 660,454 $ 903,394 Table XXIV (Continued) The Yearly Income Taxes (dollars) Medium Companies COMPANIES 1960 1961 1962 1963 1964 1965 Hudson Bay $153,574 $163,131 $ 39,155 $-39,155 • $ $ 43,626 Mercantile & General of Canada -1 200 Guarantee Co. of North America 38,000 15,063 20,415 Merit - 155,029 -155,029 9,448 -9,448 Globe Indemnity 127,928 133,601 19,216 -19,216 Quebec -27 General Security of Canada 485 490 458 528 840 Consolidated Fire 134,462 118,586 -118,624 -1,301 139 148 Federal Fire 140,297 115,548 -118,675 188 140 148 Acadia 17,307 109,833 - 73,052 2,147 London & Midland Canadian Accident & Fire 128,795 105,370 110,777 -110,000 235,729 TOTAL INCOME TAX $857,877 $591,530 - $140,746 -$128,836 $ 24,990 $684,458 Table XXIV (Continued) The Yearly Income Taxes (dollars) Medium Companies COMPANIES 1966 1967 1968 1969 1970 Hudson Bay $ 183,030 $ 226,475 $ 194,500 $ 75,224 $ 148,823 Mercantile & General of Canada 68,000 42,821 228,505 Guarantee Co. of North America 7,317 8,860 2,069 Merit 116,600 "116,600 Globe Indemnity 131,237 284,420 96,980 30,954 110,896 Quebec 169,738 52,396 92,022 208,744 General Security of Canada 580 592 20,443 -•6,701 378 Consolidated Fire 94,670 386,454 86,920 99,848 298,241 Federal Fire 102,800 420,266 90,394 118,856 340,653 Acadia 169,000 231,740 -181,829 45,510 London & Midland 9,914 -708,773 Canadian Accident & Fire 424,041 572,723 394,701 82,980 558,947 TOTAL INCOME TAX $ 943,675 $2 ,229,669 $1,246,068 $ 479,635 $1,117,393 Table XXIV (Continued) The Yearly Income Taxes (dollars) Large Companies COMPANIES 1960 1961 1962 1963 1964 1965 Halifax $ 16,000 $ 123,730 $ 93,000 $-82,001 $ 4,813 $ 4,127 Canadian Surety 261,125 107,939 84,000 72,500 244,834 572,315 Wellington Fire 210,379 180,138 -190,248 632 386 370 Canadian General 263,000 370,500 234,000 -•82,256 37,268 284,318 Canadian Reinsurance Guardian Insurance of Canada 600,000 350,000 -261,202 1,740 Dominion of Canada General 537,261 563,282 23,830 --46,316 1,991 17,592 General Accident of Canada 45,000 138,001 -18,902 "12,795 275,000 17,000 Dominion Insurance 242,455 "173,497 64,394 "64,486 60,000 Canadian Indemnity 206,265 297,899 86,825 101,076 105,899 475,806 British America 438,709 513,270 1,086,038 228,616 170,667 261,785 Western Assurance 695,877 1,772,216 767,010 286,192 125,708 271,834 TOTAL INCOME TAXES $3,516,071 $4,243,478 $1,968,745 $402,902 $966,646 $1,965,147 Table XXIV (Continued) The Yearly Income Taxes (dollars) Large Companies -COMPANIES 1966 1967 1968 1969 1970 Halifax $ 3,668 $ 410,000 $ 520,000 $ -95,000 $ 803 Canadian Surety 900,009 664,869 517,165 -390,000 Wellington Fire 90,610 520,757 68,823 117,482 397,250 Canadian General 307,538 632,563 616,244 218,733 -220,000 Canadian Reinsurance 2,427 221,803 338,984 280,044 63,186 Guardian Insurance of Canada 30,000 850,000 700,000 - 460,000 -45,848 Dominion of Canada General 648,778 720,000 707,186 340,000 1,337,303 General Accident of Canada 300,000 335,000 75,000 - 85,000 - 383 Dominion Insurance 67,744 480,817 756,832 -189,209 - 494,000 Canadian Indemnity 592,401 714,123 254,332 505,313 940,334 British America 775,795 921,985 1,015,911 538,249 950,816 Western Assurance 942,955 1,219,800 1,075,679 543,373 1,272,609 TOTAL INCOME TAXES $4,661,925 $7,691,717 $6,646,156 $1,323,985 $4,202,070 Investment Income Table XXV - Industry and by Size Class Small Companies 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 * Weight .1387 .1330 .1240 .1228 .1222 .1265 .1285 .1245 .1236 .1262 X + Investment Income 06.68% 05.98% 06.28% 06.68% 06.71% 07.31% 08.10% 09.25% 09.05% 09.92% = Weighted Return 00.93% 00.80% 00.79% 00.82% 00.82% 00.92% 01,04% 01.15% 01.12% 01.25% 1961-1970 arithmetic average - 07.60% 1962-1970 arithmetic average - 07.70% Medium Companies * Weight .2043 .2047 .1936 .1880 .1981 .2089 .2194 .2168 .2330 .2266 X + Investment Income 08.49% 07.52% 08.11% 08.15% 09.32% 10.50% 11.57% 11.92% 11.75% 12.69% = Weighted Return 01.73% 01.54% 01.57% 01.53% 01.85% 02.19% 02.54% 02.58% 02.74% 02.88% 1961-1970 arithmetic average - 10.00% 1962-1970 arithmetic average - 10.17% t-1 h-1 ON Table XXV (Continued) Investment Income - Industry and by Size Class 1961 1962 1963 1964 1965 1966 .6569 .6622 .6622 .6890 .6796 .6644 Large Companies * Weight X + Investment Income 08.197= 07.52% 07.40% 07.58% 08.05% 08.93% = Weighted Return 05.38% 04.98% 04.90% 05.22% 05.47% 05.93% 1961-1970 arithmetic average - 09.08% 1962-1970 arithmetic average Industry Return 08.04% 07.32% 07.26% 07.57% 08.14% 09.04% 1961-1970 arithmetic average = 09.01% 1962-1970 arithmetic average 1967 .6520 10.23% 06.67% 09.18% 10.25% 09.12% 1968 .6585 10.66% 07.02% 1969 .6432 10.37% 06.67% 1970 .6471 11.90% 07.70% 10.75% 10.53% 11.23% For Each Size Class: * The weight is Adjusted Net Worth - Size Class Adjusted Net Worth - Industry + The rate of return is Total Investment Income (Table XXVI) - Size Class  Adjusted Net Worth at the beginning of the year - Size Class Table XXVI The Yearly Investment Income (dollars) Small Companies COMPANIES 1961 1962 1963 1964 1965 London - Canada $ 68,172 $ 76,637 $ 78,695 $ 81,233 $ 90,836 Commonwealth 20,666 21,261 21,244 20,964 18,118 Reliance of Canada 103,357 113,838 116,681 124,980 128,847 Scottish Canadian 74,466 80,515 88,082 98,322 110,502 Federation 76,905 66,459 41,806 37,256 51,724 Canadian Health & Accident 160,970 142,808 151,010 155,038 106,916 Fire of Canada 95,432 99,680 105,005 150,113 173,313 Great Eastern 76,411 74,375 77,901 87,772 113,506 Fidelity Insurance 126,444 120,477 106,535 150,133 151,323 Canadian Home 96,122 107,153 114,163 127,714 134,701 Missisquoi & Rouville 101,183 109,996 116,152 124,056 139,363 Stanstead & Sherbrooke 114,523 119,424 120,731 143,373 187,579 TOTAL INVESTMENT INCOME $1,114,651 $1,133,223 $1,138,005 $1,300,974 $1,486,728 Table XXVI (Continued) The Yearly Investment Income (dollars) Small Companies COMPANIES 1966 1967 1968 1969 1970 London - Canada $ 92,817 $ 78,511 $ 141,112 $ 212,946 253,545 Commonwealth 23,761 20,068 30,818 27,077 78,809 Reliance of Canada 162,383 209,357 277,557 334,664 316,390 Scottish Canadian 125,158 133,547 149,960 165,404 184,304 Federation 58,137 57,265 80,137 83,683 103,889 Canadian Health & Accident 252,148 259,524 278,275 297,327 318,970 Fire of Canada 275,128 380,827 425,036 424,792 392,847 Great Eastern 130,522 153,632 187,742 211,307 235,538 Fidelity Insurance 180,253 202,168 230,135 254,251 273,282 Canadian Home 135,623 164,439 225,254 275,132 296,063 Missisquoi & Rouville 161,319 186,530 204,886 256,468 325,569 Stanstead & Sherbrooke 222,755 261,728 283,303 304,872 332,814 TOTAL INVESTMENT INCOME $1 ,820,004 $2,107,596 $2,514,215 $2,847,823 $3,112,020 Table XXVI (Continued) The Yearly Investment Income (dollars) Medium Companies COMPANIES 1961 1962 1963 1964 1965 Hudson Bay $ 232,450 $ 243,472 $ 255,697 $ 281,108 $ 312,729 Mercantile & General of Canada 206,593 216,466 225,974 255,696 298,073 Guarantee Co. of North America 238,658 234,160 246,733 251,865 292,390 Merit . 470,849 448,570 393,785 428,613 457,490 Globe Indemnity 210,219 217,457 226,818 251,306 27 8,589 Quebec 29,224 35,594 147,074 162,718 166,940 General Security of Canada 75,283 96,286 87,070 92,447 113,767 Consolidated Fire 116,355 133,532 157,171 193,677 301,492 Federal Fire 123,559 144,330 167,052 208,395 343,093 Acadia 287,384 316,964 293,085 286,664 296,981 London 6c Midland 78,519 82,595 76,420 91,759 172,866 Canadian Accident & Fire 222,886 222,080 243,267 296,739 49 6,365 TOTAL INVESTMENT INCOME $2,291,979 $2,391,506 $2,520,146 $2,800,987 $3,530,775 Table XXVI (Continued) The Yearly Investment Income (dollars) Medium Companies COMPANIES 1966 1967 1968 1969 19 70 Hudson Bay $ 365,190 $ 386,391 $ 421,620 $ 453,980 $ 456,070 Mercantile & General of Canada 355,211 386,768 418,833 478,313 520,455 Guarantee Co. of North America 334,089 335,600 405,664 560,341 625,074 Merit 485,863 555,666 640,971 621,397 641,428 Globe Indemnity 306,742 337,056 321,625 339,182 377,818 Quebec 174,740 187,118 155,974 527,523 57 8,537 General Security of Canada 201,790 260,357 340,536 380,253 404,099 Consolidated Fire 373,706 471,702 552,100 648,828 712,043 Federal Fire 417,238 522,854 609,462 734,564 808,129 Acadia 411,534 476,520 516,859 586,270 626,888 London & Midland 323,018 388,999 541,244 647,508 822,150 Canadian Accident & Fire 609,445 715,058 805,625 908,935 973,227 TOTAL INVESTMENT INCOME $4,358,566 $5,024,089 $5,730,513 $6,887,094 $7,545,918 Table XXVI (Continued) The Yearly Investment Income (dollars) Large Companies •COMPANIES 1961 1962 1963 1964 1965 Halifax $ 487,304 $ 477,429 $ 473,714 $ 507,251 $ 505,435 Canadian Surety 363,663 400,681 441,770 476,192 533,717 Wellington Fire 190,524 201,145 227,286 287,230 444,393 Canadian General 402,103 436,463 463,853 528,346 610,511 Canadian Reinsurance 540,672 610,139 649,687 695,766 902,157 Guardian Insurance of Canada 589 , 346 685,526 712,038 747,106 814,238 Dominion of Canada General 533,871 498,557 533,943 620,834 754,359 General Accident of Canada 610,863 613,546 656,208 772,441 846,242 Dominion Insurance 199,062 246,192 276,277 301,583 353,637 Canadian Indemnity 366,987 666,357 749,189 876,539 953,602 British America 1,253,181 1,292,039 1,308,837 1,433,636 1,625,190 Western Assurance 1,565,266 1,583,108 1,519,843 1,585,781 1,744,880 TOTAL INVESTMENT INCOME $7,103,472 $7,711,182 $8,012,645 $8,834,705 $10,088,311 t-O Table XXVI (Continued) The Yearly Investment Income (dollars) Large Companies COMPANIES 1966 1967 1968 1969 1970 Halifax $ 529,378 $ 621,322 $ 656,813 $ 714,958 $ 775,410 Canadian Surety 631,333 707,875 764,540 817,995 983,685 Wellington Fire 546,582 692,658 801,838 972,893 1,016,595 Canadian General 732,069 900,532 1,009,850 1,027,111 1,089,201 Canadian Reinsurance 944,233 970,332 965,694 1,107,820 1,329,338 Guardian Insurance of Canada 873,023 1,080,150 1,136,859 1,232,415 1,294,914 Dominion of Canada General 893,277 1,020,630 1,184,754 1,351,083 1,569,232 General Accident of Canada 936,009 1,032,384 1,095,224 1,210,231 1,337,489 Dominion Insurance 435,565 871,854 1,113,692 1,258,881 1,472,404 Canadian Indemnity 1,093,036 1,377,576 1,556,877 1,703,889 1,894,357 British America 1,904,794 1,942,188 2,408,491 2,601,975 2,937,773 Western Assurance 2,059,221 2,130,315 2,498,436 2,801,329 3,137,773 TOTAL INVESTMENT INCOME $11,578,520 $13,347,816 $15,193,168 $16,800,580 $18,838,171 00 mall Companies Weight X Underwriting Imcome Weighted Return edium Companies Weight X Underwriting Income Weighted Return Table XXVII Actual or Incurred Underwriting Profit - Industry and by Size Class 1961 1387 1962 1963 .1330 .1240 1964 1228 1965 1966 1967 1968 1222 .1265 .1285 .1245 1969 1236 2043 2047 1936 1880 1981 2089 .2194 2168 2330 1970 1262 03.24% -03.93% -07.75% -05.44% -00.07% 07.76% 07.27% 05.83% -02.18% -01.11% 00.45% -00.52% -00.96% -00.67% -00.01% 00.98% 00.93% 00.73% -00.27% -00.14% 1961-1970 arithmetic average = 00.36% 1962-1970 arithmetic average = 00.04% 2266 -01.56% -08.16% -14.65% -11.08% 00.46% 06.15% 05.89% 03.79% -09.99% -06.15% -00.32% -01.67% -02.84% -02.08% 00.09% 01.28% 01.29% 00.82% -02.33% -01.39% 1961-1970 arithmetic average = -03.53% 1962-1970 arithmetic average = -03.75% K3 Table XXVII (Continued) Actual or Incurred Underwriting Profit - Industry and by Size Class 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 .6569 .6622 .6622 .6890 .6796 .6644 .6520 .6585 .6432 .6471 05.60% 00.80% -05.49% -03.42% 00.91% 05.26% 09.06% 03.75% -04.36% -03.00% 03.68% 00.53% -03.64% -02.36% 00.62% 03.49% 05.91% 02.47% -02.80% -01.94% 1961-1970 arithmetic average = 00.91% 1962-1970 arithmetic average = 00•39% 03.81% -01.66% -07.44% -05.11% 00.70% 05.75% 08.13% 04.02% -05.40% -03.47% 1961-1970 arithmetic average = 00.07% 1962-1970 arithmetic average = -00.49% For Each Size Class: * The weight is Adjusted Net Worth - Size Class Adjusted or Net Worth - Industry + The rate of return is Incurred Underwriting Profit (Table XXVIII) - Size Class Adjusted Net worth at the beginning of the year - Size Class Table XXVIII The Yearly Overstatement in the Unearned Premium Reserve and the Statutory and Incurred Underwriting Profit (dollars) Small Companies COMPANIES 1960 1961 1962 1963 1964 1965 London - Canada $ 138,196 $ 159,703 $ 162,915 $ 165,324 $ 173,724 $ 128,525 C ommo nwe a1th 23,843 26,988 28,590 26,991 30,738 36,394 Reliance of Canada 259,569 299,030 323,620 182,415 210,644 254,686 Scottish Canadian 122,367 136,018 149,648 164,275 170,370 194,682 Federation 97,243 107,100 115,230 104,495 108,255 104,558 Canadian Health & Accident 76,366 79,955 65,178 66,132 67,209 67,045 Fire of Canada 175,781 212,180 255,477 271,454 233,507 381,295 Great Eastern 115,767 123,611 131,263 159,241 182,429 218,037 Fidelity Insurance 200,321 197,673 135,325 150,905 162,683 183,290 Canadian Home 243,332 338,846 378,062 375,385 379,468 239,216 Missisquoi & Rouville 161,995 191,027 200,934 220,627 234,727 251,152 Stanstead & Sherbrooke 194,477 202,654 213,185 268,324 294,679 306,450 TOTAL OVERSTATEMENT IN UNEARNED PREMIUM RESERVE $1,809,257 $2,074,785 $2,159,437 $2,155,568 $2,248,433 $2,365,330 Table XXVIII (Continued) The Yearly Overstatement in the Unearned Premium Reserve and the Statutory and Incurred Underwriting Profit (dollars) Small Companies COMPANIES 1966 1967 1968 1969 1970 London - Canada $ 29,114 $ $ 203,250 $ 203,695 $ 219,678 C ommo nwe a1th 67,415 59,258 106,955 79,938 56,762 Reliance of Canada 280,381 358,028 422,887 280,726 315,617 Scottish Canadian 184,552 206,920 121,962 258,630 325,188 Federation 97,262 103,956 114,369 108,346 108,231 Canadian Health & Accident 70,418 64,806 66,529 66,483 62,101 Fire of Canada 493,172 582,758 587,575 518,523 445,083 Great Eastern 224,810 245,039 262,438 288,657 330,953 Fidelity Insurance 196,498 255,749 302,383 476,077 286,536 Canadian Home 293,708 345,516 430,416 435,207 514,142 Missisquoi & Rouville 276,863 297,192 356,166 375,026 391,491 Stanstead & Sherbrooke 366,358 413,752 438,835 464,399 409,951 TOTAL OVERSTATEMENT IN UNEARNED PREMIUM RESERVE $2,580,551 $2,933,774 $3,413,765 $3,555,707 $3,465,733 Table XXVIII (Continued) The Yearly Overstatement in the Unearned Premium Reserve and the Statutory and Incurred Underwriting Profit (dollars) Small Companies CHANGE IN OVERSTATEMENT IN THE UNEARNED PREMIUM RESERVE STATUTORY UNDERWRITING PROFIT INCURRED UNDERWRITING PROFIT 1960 + + 1961 $ 265,528 323,908 1962 $ 84,657 - 893,907 1963 $ 589,436 $- 809,255 $ -3,869 -1,523,315 •$1,527,184 1964 $ 92,865 -1,232,704 -$1,139,839 1965 $ 116,897 -132,433 $ -15,536 Small Companies CHANGE IN OVERSTATEMENT IN THE UNEARNED PREMIUM RESERVE STATUTORY UNDERWRITING PROFIT INCURRED UNDERWRITING PROFIT + +-1966 $ 215,221 1,716,410 $1,931,631 1967 $ 353,223 1,561,909 $1,915,132 1968 $ 479,991 1,105,300 1969 $ 141,942 -829,173 1970 $ -89,974 -258,536 $1,585,291 $ -687,231 $ -348,510 to OO Table XXVIII (Continued) The Yearly Overstatement in the Unearned Premium Reserve and the Statutory and Incurred Underwriting Profit (dollars) Medium Companies COMPANIES 1960 1961 1962 1963 1964 1965 Hudson Bay $ 370,319 $ 415,824 $ 447,468 $ 462,697 $ 477,416 $ 49 7,723 Mercantile & General of Canada 429,156 397,518 390,150 425,638 495,995 498,929 Guarantee Co. of North America 211,568 134,432 164,761 150,936 245,742 232,618 Merit 1,546,869 1,272,103 1,148,606 1,003,251 920,635 872,810 Globe Indemnity 389,219 415,824 447,466 462,697 467,261 497,722 Quebec 54,956 57,496 169,201 185,078 187,067 199,091 General Security of Canada .216,778 265,903 247,567 213,517 245,526 :304,863 Consolidated Fire 276,873 309,153 429,671 460,877 509,349 794,497 Federal Fire 297,437 331,235 460,362 493,775 545,732 411,461 Acadia 427,793 454,006 419,517 418,419 384,782 475,662 London & Midland 150,741 230,799' 43,739 98,515 202,868 177,990 Canadian Accident & Fire 375,947 510,336 565,780 547,127 622,411 857,489 TOTAL OVERSTATEMENT IN THE UNEARNED PREMIUM RESERVE $4,748,656 $4,789,629 $4,934,288 $4,922,527 $5,304,784 $5,821,155 Table XXVIII (Continued) The Yearly Overstatement in the Unearned Premium Reserve and the Statutory and Incurred Underwriting Profit (dollars) Medium Companies COMPANIES 1966 1967 1968 1969 1970 Hudson Bay $ 601,182 $ 628,346 $ 634,452 $ 628,569 $ 632,010 Mercantile & General of Canada 468,387 394,137 416,822 493,034 499,550 Guarantee Co. of North America 245,634 362,698 587,815 841,776 822,171 Merit 881,645 993,228 1,052,654 1,024,546 900,046 Globe Indemnity 501,181 471,260 483,339 470,927 47.4,008 Quebec 200,474 157,284 808,156 680,950 716,678 General Security of Canada 274,041 347,308 396,792 516,488 459,888 Consolidated Fire 611,279 686,141 831,277 821,255 802,604 Federal Fire 654,942 748,502 890,570 879,916 859,934 Acadia 636,972 718,732 816,405 858,002 887,135 London & Midland 208,674 563,585 610,223 744,682 68,788 Canadian Accident & Fire 923,056 1,026,431 1,123,390 1,220,040 1,038,515 TOTAL OVERSTATEMENT IN THE UNEARNED PREMIUM RESERVE $6,207,467 $7,097,651 $8,652,105 $9,180,185 $8,161,327 Table XXVIII (Continued) The Yearly Overstatement in-the Unearned Premium Reserve and the Statutory and Incurred Underwriting Profit (dollars) Medium Companies CHANGE IN OVERSTATEMENT IN THE UNEARNED PREMIUM RESERVE STATUTORY UNDERWRITING PROFIT INCURRED UNDERWRITING PROFIT 1960 + + 1961 $ 40,973 -462,959 $ -421,986 1962 $ 144,659 - 2,738,836 $2,594,177 1963 $ -11,761 -4,541,137 $4,552,898 1964 $ 382,257 -4,187,271 $3,805,014 19 65 $ 516,371 341,267 $ 17 5,104 Medium Companies CHANGE IN OVERSTATEMENT IN THE UNEARNED PREMIUM RESERVE STATUTORY UNDERWRITING PROFIT INCURRED UNDERWRITING PROFIT + + 1966 $ 386,312 2,169,043 $2,555,355 1967 $ 890,184 1,666,314 $2,556,498 1968 $1,554,454 266,992 $1,821,446 1969 $ 528,080 -6,394,505 $5,866,425 1970 $1,018,858 - 2,637,737 $3,656,595 Table XXVIII (Continued) The Yearly Overstatement in the Unearned Premium Reserve and the Statutory and Incurred Underwriting Profit (dollars) Large Companies COMPANIES 1960 1961 1962 1963 1964 1965 Halifax $ 724,107 $ 830,897 $ 886,977 $ 875,878 $ 900,799 $ 903,583 Canadian Surety 586,997 699,726 785,277 769,399 814,688 883,691 Wellington Fire 415,310 464,179 644,507 691,285 763,924 855,043 Canadian General 633,808 722,629 759,562 804,036 856,561 1,030,608 Canadian Reinsurance 818,988 805,429 923,339 1,013,046 941,331 891,964 Guardian Insurance of Canada 329,625 1,232,232 1,490,225 1,399,301 1,445,660 1,385,401 Dominion of Canada General 904,779 936,999 1,030,751 1,193,874 1,265,158 1,369,473 General Accident of Canada 902,478 962,157 1,029,741 1,115,299 1,095,687 1,269,464 Dominion Insurance 489,827 841,307 854,972 883,324 878,690 829,176 Canadian Indemnity 823,421 876,160 1,740,698 1,839,377 2,022,512 2,181,615 British America 1,659,887 1,863,548 1,671,862 1,824,588 1,929,785 2,072,070 Western Assurance 2,564,248 1,795,312 2,140,808 2,332,512 2,481,943 2,692,371 TOTAL OVERSTATEMENT IN THE UNEARNED PREMIUM RESERVE 10,853,475 12,031,125 13,958,219 14,741,919 15,397,738 16,364,459 ro Table XXVIII (Continued) The Yearly Overstatement in the Unearned Premium Reserve and the Statutory and Incurred Underwriting Profit (dollars) Large Companies COMPANIES 1966 1967 1968 1969 1970 Halifax $ 882,607 $ 1,096,954 $ 1,179,451 $ 1,187,434 $ 1,204,215 Canadian Surety 1,027,288 1,106,556 1,335,991 1,502,704 1,671,247 Wellington Fire 916,918 1,029,212 1,246,799 1,232,882 1,203,906 Canadian General 1,062,725 1,273,740 1,312,464 1,287,927 1,304,342 Canadian Reinsurance 738,654 712,788 757,848 920,398 1,242,797 Guardian Insurance of Canada 1,282,874 1,434,811 1,622,043 1,832,124 1,905,840 Dominion of Canada General 1,429,336 1,647,068 1,873,273 1,901,911 2,014,910 General Accident of Canada 1,327,557 1,486,430 1,627,722 1,896,633 2,113,728 Dominion Insurance 1,339,845 1,561,108 1,574,106 1,620,584 1,748,454 Canadian Indemnity 2,272,386 2,761,889 3,090,990 3,207,678 2,874,100 British America 2,018,587 2,656,443 2,879,853 2,990,140 2,808,568 Western Assurance 2,652,590 3,250,229 3,557,212 3,545,243 3,364,938 -TOTAL OVERSTATEMENT IN THE UNEARNED PREMIUM RESERVE $16,951,437 $20,017,228 $22,057,752 $23,125,658 $23,457,045 Table XXVIII (Continued) The Yearly Overstatement in the Unearned Premium Reserve and the Statutory and Incurred Underwriting Profit (dollars) Large Companies CHANGE IN OVERSTATEMENT IN THE UNEARNED PREMIUM RESERVE STATUTORY UNDERWRITING PROFIT INCURRED UNDERWRITING PROFIT Large Companies CHANGE IN OVERSTATEMENT IN THE UNEARNED PREMIUM RESERVE STATUTORY UNDERWRITING PROFIT INCURRED UNDERWRITING PROFIT 1960 + + + + 1961 $ 1,177,650 3,682,304 $ 4,859,954 1966 $ 586,978 6,234,129 $ 6,821,107 1962 $ 1,927,094 -1,105,515 $ 821,579 1967 $3,065,791 8,648,442 $11,714,233 1963 $ 783,700 -6,733,331 $-5,949,631 1968 $2,040,524 3,312,006 $ 5,352,530 1964 $ 655,819 -4,644,279 $-3,988,460 1969 $1,067,906 -8,134,884 $-7,066,978 1965 $ 966,721 187,749 $ 1,154,470 1970 $ 331,387 -5,074,198 $-4,742,811 4> Table XXIX The Effect of the Tax Shield and the Unearned Premium Adjustment on the Underwriting Result (1961 - 1970) (1) Tax Shields .5x the change in the overstatement of the unearned premium reserve (2) Tax Actually Paid (3) Tax Shield Effect (1) 7 (2) Small Companies $ 828,236 $ 6,834,869 12.1% Medium Companies 1,706,336 7,587,000 15.4% Large Companies 6,301,783 34,072,771 18. 5% (4) the change in the overstatement of the unearned premium reserve (5) Statutory Underwriting Profit (6) The unearned premium adjustment effect (4) ; (5) Small Companies $ 1,656,472 $ 9,577,595 17.3% Medium Companies 3,412,672 25,406,061 13.4% Large Companies 12,603,566 47,756,837 26.4% Table XXX Statutory Underwriting Profit to Net Premiums Earned 1961-70 1962-70 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 A. A.* A.A. * Small Companies 02.05% -05.93% -09 00% -06.68% -00.63% 07.02% 05.93% 03.48% -02.57% -00. 76% -00. 71% -01. 02% ledium Companies -01.25% -07.17% -11 55% -09.00% -00.62% 03.37% 02.39% 00.37% -07.30% -02. 92% -03. 37% -03. 60% jarge Companies 03.55% -01.00% -05 74% -03.50% 00.12% 03.59% 04.39% 01.65% -0(3. 54% -01. 98% -00. 25% -00. 67% Weighted Industry Ratio** 02.26% -02.90% -07 39% -05.09% -00.13% 03.85% 04.05% 01.54% -04.40% -02. 09% -01. 03% -01. 40% ** the weight used is Net Premiums Earned for Small Medium size class Large for each year Net Premiums Earned for the industry for each year * Arithmetic Average ON Table XXXI Incurred Underwriting Profit to Net Premiums Earned 1961-70 1962-70 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 A. A.* A.A.* Small Companies % 03.74 -05.36 -09.02 -06.18 -00.70 07.90 07. 27 05.00 -02.13 -01.02 00.01 -00.40 ledium Companies % -01.14 -06.79 -11.58 -08.18 -00.32 03.97 03.66 02.54 -06.70 -04.05 -02.86 -03.05 jarge Companies 7. 04.69 00.75 -05.07 -03.00 00.75 03.93 05.95 02.66 -03.07 -01.85 00.37 00.12 Weighted Industry Ratio** 7o 03. 21 -01.58 -06.93 -04.52 00.41 04.31 05.52 02. 88 -03.90 -02.30 -00.29 -00.68 Small ** the weight used is Net Premiums Earned for Medium size class for each year Large  Net Premiums Earned for the industry for each year * Arithmetic Average Table XXXII Summary of Results - Industry 1961 Rate of Return - After Taxes $ Rate of Return - After Taxes % Tax $ Rate of Return - Before Taxes $ Rate of Return - Before Taxes % Sources of Return Investment Income $ Investment Income % Underwriting Results $ Underwriting Results % Other Income (unrealized Capital Gains etc."^$ Other Income ^Unrealized Capital Gains etc^X 24,663,520 18.71 5,319,792 29,983,312 22.75 08.04 5,027,404 03.81 14,345,806 10.90 1962 6,138,921 03.96 2,192,716 8,331,637 05.38 1963 10,933,612 06.89 540,845 11,474,457 07.23 1964 11,351,544 06.71 1,311,834 12,663,378 07.47 07.32 07.26 •2,581,853 -12,029,713 -01.66 -07.44 07.57 •8,933,313 -05.11 1965 9,963,158 05.34 3,345,054 13,308.212 07.11 10,617,232 11,335,911 11,770,796 13,036,666 15,205,814 08.14 1,314,038 00.70 •422,425 11,733,374 8,558,952 -3,211,640 -00.28 07.41 05.01 •01.73 LO OO Rate of Return - After Taxes-$ Rate of Return - After Taxes % Tax $ Rate of Return - Before Taxes $ Rate of Return - Before Taxes 7. Sources of Return Investment Income $ Investment Income 7. Underwriting Results $ Underwriting Results % Other Income ^Unrealized Capital Gains etc!) $ Other Income (Unrealized Capital Gains etc.} 7, Table XXXII (Continued) Summary of Results - Industry 1966 1967 1968 1969 1970 2,968,207 16,852,087 37,356,665 -1,599,722 10,309,872 01.50 08.48 17.13 00.80 04.18 6,551,863 11,040,415 8,966,026 2,464,074 6,222,857 9,520,070 27,892,502 46,322,691 864,352 16,532,729 04.84 14.04 21.77 00.34 06.70 17,757,090 09.04 11,308,093 05.75 -19,545,113 -09.95 20,479,501 10. 25 16,185,863 08.13 -8,772,862 -04.34 23,437,896 10.75 8,759,287 04.02 14,125,528 06.50 26,535,497 10.53 -13,620,634 -05.40 -12,050,425 -04.79 29,496,109 11.23 -8,747,916 -03.47 -4,215,464 -01.06 vo Table XXXII (Continued) Summary of Results - Industry Rate of Return - After Taxes Rate of Return - Before Taxes Investment Income Underwriting Results Other ^Unrealized Capital Gains, etc. AVERAGES 10 year geometric average = 7.3% 9 year geometric average = 5.5%. 10 year arithmetic average = 7.5% 9 year arithmetic average = 6.2%, 10 year geometric average = 9.5% 9 year geometric average = 7.5% 10 year arithmetic average = 9.7% 9 year arithmetic average = 8.3% 10 year arithmetic average = 09.01% 9 year arithmetic average = 09.12% 10 year arithmetic average = 00.07% 9 year arithmetic average = -00.49% 10 year arithmetic average 9 year arithmetic average = -00.62% = -00.33% Table XXXII (Continued) Summary of Results - Small Companies 1961 1962 1963 1964 1965 Rate of Return - After Taxes $ 2,759,537 -567,050 1,195,125 1,578,016 574,875 Rate of Return - After Taxes % 15.19 -02.75 06.07 07.54 02.43 Tax $ 484,784 364,717 266,779 320,198 695,449 Rate of Return - Before Taxes $ 3,244,321 -202,333 1,461,904 1,898,214 1,270,324 Rate of Return - Before Taxes "L 17.86 -00.98 07.42 09.06 05.38 Sources of Return Investment Income $ 1,214,651 1,233,223 1,238,005 1,400,974 1,586,728 Investment Income % 06.68 05.98 06.28 06. 68 0,6.71 Underwriting Result $ 589,436 -809,255 -1,527,184 -1,139,839 -15,336 Underwriting Result % 03.24 -03.93 -07.75 -05.44 -00.07 Dther Income (unrealized Capital Gains, etc.)$ 1,440,234 -626,301 1,751,083 1,637,079 -300,868 Dther Income^Jnrealized Capital Gains, etc.")7o 07.94 -03.03 08.89 07.82 -01.26 Table XXXII Summary of Results Rate of Return - After Taxes $ Rate of Return - After Taxes 7> Tax $ Rate of Return - Before Taxes $ Rate of Return - Before Taxes 7. Sources of Return Investment Income $ Investment Income 7. Underwriting Result $ Underwriting Result 7> Other Income (unrealized Capital Gains, etc!} $ Other Income (unrealized Capital Gains, etc.^7, Continued) Small Companies 1966 1967 1968 1969 1970 657,230 -43,292 4,353,163 -62,544 2,045,407 02.64 -00.16 16.02 -00.20 06.52 946,263 1,119,029 1,073,802 660,454 903,394 1,603,493 .1,075,737 5,426,965 597,910 2,948,801 06.44 04.09 19.97 01.90 09.40 1,820,004 2,107,596 2,514,215 2,847,823 3,112,020 07.31 08. 10 09.25 09.05 09.92 1,931,631 1,915,132 1,585,291 -687,231 -348,510 07.76 07.27 05,83 -02.18 -01.11 2,148,142 -2,946,991 1,327,459 -1,562,682 185,291 -08.63 -11.28 04.89 -04.97 00.59 •p-Table XXXII (Continued) Summary of Results - Small Companies Ratesof Return - After Taxes Rate of Return - Before Taxes Investment Income Underwriting Results Other(Unrealized Capital Gains, etc AVERAGES 10 year geometric average = 5.27, 9 year geometric average = 3.77, 10 year arithmetic average = 5^87, 9 year arithmetic average = 4.27, 10 year geometric average = 7.97, 9 year geometric average = 6.17, 10 year arithmetic average = 8.07, 9 year arithmetic average = 6.97, 10 year arithmetic average = 07.607 9 year arithmetic average = 07.707, 10 year arithmetic average = 00.367, 9 year arithmetic average = 00.047, 10 year arithmetic average 9 year arithmetic average = 00.04% = -00 . 847, Rate of Return - After Taxes $ Rate of Return - After Taxes 7 Tax $ Rate of Return - Before Taxes $ Rate of Return - Before Taxes % Table XXXII (Continued) Summary of Results - Medium Companies 1961 $5,020,707 18.60 591,530 5,612,237 20.80 1962 $ -667,399 -02.10 -140,746 -808,145 -02.54 Sources of Return Investment Income $ Investment Income 7> 2,291,979 2,391,506 08.49 07.52 Underwriting Result $ Underwriting Result 7, Other Income (unrealized Capital Gains, etc.^$ Other Income (unrealized Capital Gains, etc^7> A = arithmetic average G = geometric average -421,986 -2,594,177 -01.56 -08.16 3,742,244 13.87 •605,474 -01.90 1963 $ 576,259 01.86 -128,836 447,423 01.44 2,520,146 08.11 -4,552,878 -14.65 2,480,175 07.98 1964 $ 17,073 00.05 24,990 42,063 00.12 1965 $2,628,807 06.95 684,458 3,313,265 08.75 2,800,987 08.15 -3,805,014 -11.08 1,046,090 03.05 3,530,775 09.32 175,104 00.46 -392,614 -01.03 Table XXXII (Continued) Summary of Results - Medium Companies Rate of Return - After Taxes $ Rate of Return - After Taxes 7, Tax $ Rate of Return - Before Taxes $ Rate of Return - Before Taxes % Sources of Return Investment Income $ Investment Income 7, Underwriting Result $ Underwriting Result 7> Other Income Unrealized Capital Gains, etc.^$ Other Income (unrealized Capital Gains, etc.) 7, A = arithmetic average G = geometric average 1966 $1,668,107 04.02 943,675 2,611,782 06.29 1967 $3,864,095 08.91 2,229,669 6,093,764 14.05 4,358,566 5,024,089 10.50 11.57 2,555,355 2,556,498 06.15 05.89 •4,302,139 -1,486,823 -10.36 -03.41 1968 1969 1970 $10,495,085 21.84 1,246,068 11,741,153 24.43 -$1,802,452 -03.07 479,635 -1,322,817 -02.25 $ 683,716 01.15 1,117,393 1,801,109 03.03 5,730,513 11.92 1,821,446 03.79 4,189,194 08.72 6,887,094 11.73 -5,866,425 -09.99 -2,343,486 -03.99 7,545,918 12. 69 -3,656,595 -06.15 -2,088,214 -03.51 Table XXXII (Continued) Summary of Results - Medium Companies AVERAGES Rate of Return - After Taxes 10 year geometric average = 5.6% 9 year geometric average = 3.7%, 10 year arithmetic average = 5.8% 9 year arithmetic average = 4. 3%, Rate of Return - Before Taxes 10 year geometric average = 7.0% 9 year geometric average = 5.0%, 10 year arithmetic average = 7.4% 9 year arithmetic average = 5.9%. Investment Income 10 year arithmetic average = 10.00% 9 year arithmetic average = 10.17% Underwriting Results 10 year arithmetic average = -03.53% 9 year arithmetic average = -03.75% Other^Unrealized Capital Gains) etc 10 year arithmetic average = 00.93% 9 year arithmetic average = -00.52% Table XXXII (Continued) Summary of Results - Large Companies 1961 1962 1963 1964 1965 16,883,276 7,373,370 9,162,228 9,756,455 6,759,476 19.48 07.19 08.47 08.37> 05.38 4,243,478 1,968,745 402,902 966,646 1,965,147 21,126,754 9,342,115 9,565,130 10,723,101 8,724,623 24.38 09.11 08.84 09.20 06.94 7,103,472 0.8.19 4,859,954 05.60 9,163,328 10.59 7,711,182 07.52 821,579 00.80 809,354 00.79 8,012,645 07.40 -5,949,631 -05.49 7,502,116 06.93 8,834,705 07.58 -3,988,460 -03.42 5,875,783 05.04 10,088,311 08.05 1,154,470 00.91 -2,518,158 -02.02 late of Return - After Taxes $ late of Return - After Taxes % Tax $ late of Return - Before Taxes $ late of Return - Before Taxes % Table XXXII (Continued) Summary of Results - Large Companies 1966 642,870 00.50 4,661,925 5,304,795 04.09 1967 13,031,284 10.05 7,691,717 20,723,001 15.99 Sources of Return Investment Income $ [nvestment Income % 11,578,520 13,347,816 08.93 10. 23 Jnderwriting Results $ Jnderwriting Results 7» )ther ^Unrealized Capital Gains etc)$ )ther (unrealized Capital Gains etc!)?0 6,821,107 05.26 •-13,094,832 -10.10 11,714,233 09.06 -4,339,048 -03.30 1968 22,508,417 15,81 6,646,156 29,154,573 20.47 15,193,168 10. 66 5,352,530 03.75 8,608,875 06.06 1969 265,274 00.16 1,323,985 1,589,259 00.98 16,800,580 10.37 -7,066,978 -04.36 -8,144,343 -05.03 1970 7,580,749 04.79 4,202,070 11,782,819 07.45 18,838,171 11.90 -4,742,811 -03.00 -2,312,541 -01.45 -p-00 Table XXXII (Continued) Summary of Results - Large Companies Rate of Return - After Taxes Rate of Return - Before Taxes Investment Income Underwriting Results Other (unrealized Capital Gains, etc.} AVERAGES 10 year geometric average = 8.07, 9 year geometric average = 6.17o 10 year arithmetic average = 8.27, 9 year arithmetic average = 6.97, 10 year geometric average = 9.77, 9 year geometric average = 8.17, 10 year arithmetic average = 10.87, 9 year arithmetic average = 9.27, 10 year arithmetic average = 09.087, 9 year arithmetic average = 09.187, 10 year arithmetic average = 00.917, 9 year arithmetic average = 00.397 10 year arithmetic average 9 year arithmetic average = 00.817, =-00.397 

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