EXHIBIT 5C

COMPARISON OF RATES OF RETURN IN COMMON STOCKS

TO RETURN IN THE PROPERTY AND LIABILITY INSURANCE INDUSTRY

1955

1956 1957 1958 1959 1960 1961 1962 1963 1964 1965

Year

Sources: L. Fisher and J.H. Lorie, "Rates of Return in Common Stocks the Year-by-Year Record, 1926 65, The Journal of Business, July, 1968, Table 1A, for the New York Stock Exchange statistics.

Property and Liability Insurance Industry statistics develuped by Arthur D. Little, Inc. from Bisaggregates and Averages, 1956 1966, N4/D2 measure of return.

-34

APPENDIX

ADJUSTMENTS FOR

MARKET VALUE ACCOUNTING

IN

PROPERTY AND LIABILITY INSURANCE COMPANIES

-35

Differences in accounting techniques among industries often make it difficult to construct unbiased comparisons. Because the property and liability insurance industry values some of the assets on its book at current market value and most industries carry assets at cost, we made certain adjustments to conventional rate of return calculations. These adjustments reflected in the income of insurers any changes in asset values. Specifically, for the insurance companies we added to both the numerator and denominator of the rate of return fraction the unrealized capital gains on the assets they hold. However, we did not include the unrealized capital gains as income or asset items in the industrial corporations' calculations.

As stated in the ADL Report (p. 29), this treatment was necessitated because the particular bookkeeping system employed by the insurance industry is at variance with that employed by industrial firms. In reporting the insurance industry at current value (i.e., taking into account the unrealized capital gains), we actually tended to overstate, rather than understate, its rate of return relative to returns at original

cost. To illustrate this point we consider a simplified and extreme example.

Table I presents two companies (A and B) identical in every way except their accounting methods. Both companies have, in essence, a nondepreciating asset (a machine) which costs $100 and yields the operating profits indicated in the second column of their Table I. While Company B carries the machine on its books at original cost ($100), Company A marks up the value of its asset to market. market value is assumed to increase $10/year.

From this table, one may be tempted to conclude:

This

"The last column of Table I shows that the profit of
company A relative to the profit of company B quickly
deteriorates over time. Since both companies use the
same machine and receive the same profits the differ-
ence in relative profit is a result of the different
methods used in accounting. Company A represents in-
surance companies who are required by law to keep
their book assets at market value (except for bonds
at amortized value); whereas, company B represents
all others who must use book values in order to comply
with income tax regulations. If insurance company
managers measure their profits on a book basis relative
to other companies they quickly come to the conclusion
that they are earning sub-normal profits when in fact
they may be earning normal profits."

-36

I. Book value of A's machine - Profit/capitalization rate = 10/.10 = $100 in year 1. In year 2, Value = 11/.10 $110.

II.

Rate of return Profit from machine/book value of machine.

III. Book value of B's machine is a constant $100 since it is based on original cost.

However, in measuring the insurance industry ADL adjusted the profit figures of these "Company A-like" firms to reflect the increases in values reported on their books; that is, we added to operating income all investment incomes, including realized and unrealized capital gains. Following the procedure we used in our insurance study, the adjusted profit stream and rates of return for Company A would be those indicated in the following tabulation:

Clearly the adjusted returns for Company A are greater than those for Company B. In our analysis we treated the insurance industry like Company A and other industries like Company B.

Therefore, contrary to what one's initial impression may be, the impact of ADL's comparing the insurance industry at current value and the other industries at original cost is to overstate the insurance industry's rate of return. Accordingly, when our study indicates that on the basis of these measures the insurance industry has the lowest rate of return, we are doubly assured in concluding that this is a disadvantaged rate of return.

-38