more than roughly comparable, the results would be at best approximate because, as Webb points out, "This comparison ignores any differences in dividend payout between the insurance stocks and the industrial stocks during the period covered."

In addition, the best method for a study of this sort is not to assume that the investor bought stock at the beginning of the period and held it to the end of the period. Rather one should randomize the time of purchase and/or sale. For example, one could assume the investor to buy at a random time during the period covered, and to hold until the end of the period. Or one could choose the time of purchase on the basis of a study of the average length of time one investor holds one company's stock.

The Philo Smith, Landstreet & Co. adjustment method

Philo Smith, Landstreet & Co. applies three major adjustments to property-casualty income statement and balance sheets. The first provides for a 25% tax on unrealized capital gains, as Plotkin did. The second brings the bonds shown on the balance sheet from book to market value. Plotkin, Sharp, and Webb all ignored this adjustment, because it is extremely cumbersome to calculate and its effect is minor. The third is the acquisition expense adjustment, which was described in the Quarterly Insurance Stock Review of June 9, 1967:

For property and casualty insurance companies, Philo Smith,
Landstreet & Co. adjustes the statutory balance sheet by
multiplying unearned premiums by the ratio of acquisition
expenses to net premiums written. These acquisition expenses,
which the Insurance Expense Exhibit reports on an incurred
basis, are commission and brokerage expenses plus premium
taxes, licenses, and fees. This adjustment technique produces
the unamcrtized balance of acquisition expenses charged off.
In order to match income and expenses for the period, the
year-to-year change in that balance is deducted from the
amount of commissions and premium taxes charged to the
tatutory gain and loss statement.

Some analysts make these calculations on the basis of fixed ratios of 35% for casualty business and 40% for property lines, or on the basis of the ratio to net premiums written of total operating expenses. Such techniques tend to overstate earnings, because the general overhead expenses which are included in total expenses should be charged to the operations of the period as they are in other businesses.

Unlike the data assembled by Plotkin, Sharp, and Webb, who were relying on industry data published in Best's Aggregates and Averages, the calculation of adjusted earnings and adjusted net worth by Philo Smith, Landstreet &

Co. and other security analysts is based on detailed analysis of convention statement data. The table below shows for a sample of leading companies the ratio of adjusted net income to adjusted net worth for the last four years, as calculated by Philo Smith, Landstreet & Co. These ratios are lower than rates of return because the definition of adjusted earnings excludes both realized and unrealized capital gains, while the adjusted net worth includes both types of gains. In addition, the bonds to market adjustment is made for adjusted net worth only. Each year's adjusted net income is divided by the adjusted net worth at the end of the previous year.

ADJUSTED NET EARNINGS/ADJUSTED NET WORTH
for leading property-liability groups

Arguments over measurement of property-liability industry profitability will probably never be finally decided. Such issues as adjustment of equity in unearned premium reserve, allowance for taxes on unrealized appreciation, and choice of a time period, will continue to cloud the discussion of return on net worth. In addition, questions will continue about the relevance of figures on average rate of return. More relevant would be an extensive study of actual investor profits in the stock market.

Those who are interested in aggregate profitability will be gratified to note that the range of disagreement has narrowed significantly since two years ago. Arthur D. Little is willing to settle for 7%; Dean Sharp feels the correct figure is more like 9%; Bernard Webb's figure is 10.9%.

Those who feel that investor profits in the industry have been inadequate or excessive would be interested in the historical study of insurance stock performance suggested by Hofflander and Mason. Those who feel that automobile and other specific insurance rates have been inadequate or excessive should concentrate, not on aggregate profitability studies, but on the economic structure of the industry, including pricing structure and policies. From these points of view the profitability debate is a tempest in a teapot.

39-280 71 pt. 17A - 68

From the Journal of Commerce, Nov. 7, 1968

LACK OF PRECISE ACCOUNTING Data Called INSURANCE FIELD ROADBLOCK

Lack of precise accounting data is probably the greatest obstacle industry must overcome in adequately measuring profitability, according to an Indiana University professor.

"Accounting really does not and cannot have the precision which most of us would like it to possess and, in fact, impute to it," said Prof. John D. Long, chairman of the insurance department at Indiana University.

This is particularly true where liabilities of property-casualty insurance companies are concerned, he told the 23rd annnual meeting of the National Association of Independent Insurers.

Looking at the reserve for losses, for example, Prof. Long noted that the amount which a settlement of a particular claim ultimately will require is a matter of judgment, “at best an educated guess."

"Despite the order in the universe," he said, "the loss adjustment environment changes too fast to allow fuil confidence to be placed in the amount listed as payable at some date perhaps far in the future in the discharge of a particular claim.

OVERSTATED CLAIMS

"Thus, claims in the best of faith may be grossly overstated or grossly understated as of any point in time and the misstatement may not become apparent until months or years later. At one extreme, a company might be insolvent with its officials or anyone else being aware of the fact.

"At the other extreme, a company apparently insolvent might, in fact, be sound. I am not asserting that the extremes occur often; merely that they can occur. At the very least, the fact is plain that loss reserves are estimates and that the estimates need not be made consistently from one insurance company to another, and certainly not in the same way that a non-insurance company estimates its liabilities.

"The unearned premium reserve calculated, say, on a semiannual basis, is a culprit which has heaped untold woes upon the insurance industry. It perhaps needs little elaboration except to observe that, while its calculation is not the subject of as much variation from one company to another as is the loss reserve calculation, it is significantly removed from the reality of revenues and expenses."

OTHER PROBLEMS

Lack of precise accounting data, Prof. Long said, poses similar problems when any type of company or industry attempts to measure its assets and net worth, or tries to match expenses and revenues.

"All of this sounds hopeless," he commented. “and would be except for two facts. The first is that some accounting decisions, such as how to depreciate a computer, "wash out" over time. The second is that approximations, even rough ones, will serve most of our purposes, provided we remember that they are rough, and provided further that we take into account the differences in prevail

ing accounting practices from one firm to another and from one industry to another for which financial comparisons are being made."

Prof. Long listed other difficulties in adequately measuring profitability as the required use of samples, the relatively of most measurements, and the fact that any study of profitability calls for some sort of value judgment.

REPORTING UNITS

On the subject of sampling, he explained that normally there are too many reporting units for all of them to be included in a comparative study.

"How safe is it to generalize to the respective universes," he asked, "and what qualifications should be imposed?

"Statistical inference provides a very useful and quite dependable technique for making such generalizations from even fairly small random samples, provided we remember the caveats with which such generalizations should be used. Too often we become too enthusiastic and forget the caveats. I recall the old saying that goes: "All Indians walking in sing.e line at least the one I saw did."

Commenting on the relativity of studies, Prof. Long said "The rub" comes in choosing the base against which profits are measured. The decision to be made, he pointed out, is whether the base should be sales, total assets, fixed assets, total liabilities, net worth or something else. He added the answer lies in the purpose for which the study is being made.

"If we wanted to compare from one industry to another the profitability to owners," he said, "we might feel justified in measuring profit against net worth and in ignoring differences in the degrees of leverage as between the industries. If we wanted to compare the efficiency with which assets were used in each of two industries, we might decide to express profits as a percentage of total assets or of total assets minus current liabilities. If we were involved in a study of concentration of income, we might want to measure profit in terms of the number of owners and express the result as profit per owner."

Virtually any study, such as a study of profitability, calls for some sort of value judgment, Prof. Long remarked. He said those making the study and those using the results normally cannot escape coming to grips with the question of what is the normative conduct.

"What is the measure of acceptability?" he asked. "What is the standard of good and bad? How much is enough, too much, too little? Thinking again of profitability, what is the ethics of profit? What, if anything, is wrong with a 60 per cent rate of return? What, if anything. is wrong with a 2 per cent rate of return? What is the generally accepted standard which can be used in making value judgments? Actually, there isn't any.

"One technique in comparing profitability of industries is to measure for, the time span under consideration, the average annual rate of return for each sample firm in the industry, and then measure the result against figures similarly derived for each of several other industries," he said.

STATEMENT OF VESTAL LEMMON, PRESIDENT, NATIONAL ASSOCI ATION OF INDEPENDENT INSURERS, CHICAGO, ILL.; ACCOM PANIED BY GEORGE DeWOLF, ASSISTANT GENERAL COUNSEL

Mr. LEMMON. Thank you, Mr. Chairman.

I am Vestal Lemmon, president of the National Association of Independent Insurers. Seated with me to my right is our assistant general counsel, Mr. George DeWolf.

Our association consists of more than 350 stock and mutual companies writing over half of the automobile insurance in the United States today. We appreciate this opportunity to make a statement before your committee.

We are entirely in accord with the objective of preventing insurance company insolvencies and cushioning their effect on individual members of the public. However, we are resolutely opposed to the creation of a Federal Insurance Guaranty Corporation for three reasons:

First, it would be inherently so cumbersome and expensive that the supposed cure would be out of proportion to the problem.

Second, it would result in Federal takeover of an area of regulation which the States are quite competent to handle, contravening the trend to return regulatory authority to State and local governments wherever feasible.

Third, it ignores the fact that the States and the insurance industry are taking very adequate steps to further reduce insurance company insolvencies and their consequences to the point of insignificance.

At the outset, I would like to dispel any doubt about who would regulate the property and liability insurance business if S. 2236 is enacted. It would mean Federal regulation of insurance, lock, stock, and barrel. Some may not wish to recognize this inevitable conse quence, and may picture the Federal insurance examiner as a cooperative partner of the State regulatory authorities. The Advisory Committee on Economic Regulation to the Department of Transportation, relative to S. 2236, put this palliative in true perspective when it said:

Inevitably, the Federal agency, to protect the integrity of the fund it must administer, will find it has to reach further and further in the exercise of the powers conferred upon it or to seek even more powers.

Financial supervision is the primary purpose and function of insurance regulation. The needs of financial regulation pervade the legal controls imposed upon insurers. Ultimately, it is inconceivable that the Federal agency charged with faithful administration of a fund derived from people in every state, will be able to tolerate significant discrepancies among the states in capital and surplus requirements, in investment laws, in rate administration, and in examinations of insurers. Comprehensive Federal control will, indeed must, follow Federal financial responsibility.

We support State regulation of insurance as we would support State or local regulation of any function where the job can be done efficiently at a level of government closer to the people. Because we do have 50 State insurance departments, the automobile assigned risk plans and FAIR plans can be tailored to meet the needs of the people in each State. The standards for entry into the business for both companies and agents can be set to reflect local needs and conditions. New innovations in coverage and forms can be developed to meet local needs. Experimentation with various policy forms, rating procedures, experience