Note: Asset figures used by Norgaard and Schick are from Best's Consolidated Statement which includes some life insurance companies. that same statement:

Change in Total Liabilities (1965-1966)

Change in Policyholders' Surplus (1965-1966)

+ 33.897
28.880

From

PROFESSOR RICHARD L NORGAARD'S WORKSHEET

CONTINENTAL CASUALTY COMPANY

End of Year

1966

1965 1964 1963 1962 1961 1960 1959 1958 1957 1956 1955

1954 1953

1952

.443 .126 .319 .176 .230 .238 .029 .082 .202 .471 .197 .284 Market Value of Securities

Market Value

= .162 which equals the 15-year average return reported by Norgaard and Schick (p. 8) for

t=52

the Continental Casualty Company.

NS-30

Source:

Best's Insurance Reports Fire and Casualty, 1967, pp. 282-285.

NS-31

APPENDIX C

"Kemper Executive Refutes Claim
Of Companies' High Profit Rates"

BEST'S INSURANCE NEWS

(December 1968, p. 98)

Reproduced with the kind permission of Alfred M. Best Company, Inc.

Kemper Executive Refutes Claim
Of Companies' High Profit Rates

THE KEMPER INSURANCE Group
has questioned the validity of the
conclusion of Professors Richard L.
Norgaard and George G. Schick of
the University of Southern Cal-
ifornia that the fire and casualty in-
surance companies "are producing
extremely high rates of profit."

The professors had submitted a critique of the Arthur D. Little study in testimony before Philip A. Hart's antitrust and monopoly subcommittee of the Senate Judiciary Committee. The Little study concluded that the property and liability insurance industry as a whole has a "comparatively low rate of return." R.D. McClure, assistant actuary of the Kemper Insurance Group, released the content of a letter dated October 18, which he had addressed to Professors Norgaard and Schick.

In his letter, Mr. McClure challenged the Norgaard-Schick claim that the 15-year average rate of return for insurance companies ranged from 8% to 41.5%. Mr. McClure said, "The flaw, we think, is a faulty assumption which you made with respect to insurance companies and which renders your conclusions of dubious value."

Mr. McClure referred to the professors' formula used to arrive at insurance company rates of return: ROI(t) = [DC(t)+TS(t) + TMV IMV] IMV. In this formula, ROI(t) means return on investments, this year (t); DC, common dividend paid; TS, treasury stock purchased; TMV, terminal value of assets; and IMV, initial value of assets.

Mr. McClure pointed out, "What you say, then, is that if dividends and treasury stock transactions are ignored, an insurance company's return on investment (or profit) is the same as the company's growth in assets.

"This approach fails completely to take into account the changing nature of the liabilities. Your paper does prove that insurance company assets grow at a pretty good pace. But even a company headed for fail.

ure usually shows increases in assets right up to the day of bankruptcy."

Mr. McClure provided some examples to prove the fallacy of the Norgaard-Schick formula:

A company at the end of 1966 had assets of $10 million and at year-end 1967, $12.5 million. At the end of 1966, reserves were $7 million; capital, $1 million; and surplus, $2 million. At year-end 1967 reserves were $10.5 million; capital, $1 million; and surplus, $1 million. The company had a bad year. Reserves had to be increased 50% and surplus cut in half to meet the deficiency. Yet, explained Mr. McClure, the Norgaard-Schick formula produces a profit of 25%.

In his second example, Mr. McClure described a company which had assets at the end of 1966 of $10 million and at year-end 1967, $6 million. At the end of 1966 reserves amounted to $7 million; capital, $1 million; and surplus, $2 million. At year-end 1967, reserves were $3 million; capital, $1 million; and surplus, $2 million. This company ceased writing business on January 1, 1967 and just ran off its reserves preparatory to going out of business. The initial reserves were somewhat low, but the investment income made up the difference so that no profit or loss was realized. However, by the Norgaard-Schick formula, the company suffered a 40% loss.

Finally, Mr. McClure described a company formed January 1, 1966 with a capitalization of $500,000. No business was transacted in the year. On December 13, 1966, it was decided that more capital was needed to launch the venture, and an additional $500,000 was put up. According to the Norgaard-Schick formula, this company had a 100% return on investment for the year.

Mr. McClure also reported that in a reply to his letter, Professor Norgaard appeared to concede that using assets as a measure of insurance company profits raises some serious problems for which he, Norgaard, ¡does not have the answer.

NS-33

Best's Insurance News
December, 1968