One other point in connection with the subject of risks deserves brief consideration. While it is the purpose of insurance to reduce the burden which chance losses bring upon society, one of its consequences is an increase in the actual amount of loss. This is due to the effect of in surance upon the mind of the insured. An hon est man may become less careful in protecting Lis property. a dishonest man may even seek to destroy his for the sake of obtaining the insur ance. The danger of the loss through the careless ness or misconduct of the insured is commonly referred to as 'the moral risk.' It constitutes one element in every risk that the insurance com pany assumes, and one which in general it is very difficult to estimate. It is for the interest of the company to reduce the danger as much as possible, and it is contrary to public policy to allow them to increase it unnecessarily. Vari ous forfeiture provisions are inserted in polieieS for the purpose of compelling greater careful ness and reducing misconduct. The chief re liance, however, must be on the strict applica tion of the principle of insurable interest. It may even be practically advantageous to limit the amount of insurance to a certain percentage of the insurable interest in order to create a positive incentive to carefulness and honesty. It would at least be expected that the insurance companies would use all diligence to detect ex tra hazardous 'moral' risks and avoid them. That they did not always do so in the past the History of marine insurance abundantly proves. How far they come short of doing it today can be inferred from the following statistics com piled from the annual reports of the Massachu setts State Fire 211arshal to the Insurance Com missioner.
In the report for 1S96 forty per cent. of the in surance-defrauding, fires are said to have been the work of parties with a record, that is. who had previously collected or attempted to collect insurance from one to eight times on fires of a suspicious character. Of 143 insuranee-de frauding fires mentioned in the report for 1897, 10 were set by persons who had had one or more previous fires, one of whom had had Ifs Of 111 such fires in the report for 189S. IS were set by persons who had had one or more previous fires, one of whom had bad Cs Of 154 such fires mentioned in the reports for 1901 and 1902. one of the insured had had six previous fires. one had had five. two had had three. two had had two, and 25 had had one. The apparent increase in the later years in the proportion of these fires set hy iiersons with a record may lie due to greater activity on the part of the fire marshal and his assistants. but there is certainly no indi cation of any improvement in the practice of the insurance companies.
Such a state of things speaks for itself. The chief sourve of the trouble is undoubtedly to be found in the agency system, which makes the income of the agents depend upon the amount of business they write. regardless of its character.
The Premium.—The amount paid to the insur ance company by the insured is called the pre minim It consists of two parts, the 'natural pre mium' and the 'loading.' The amount of the nat ural premium is determined by the risk, or, to speak more precisely, it equals the risk. The loading is the amount added to the natural pre mium to cover the cost of insuring the risk. In other words, the natural premium pays the losses and the loading pays the expenses. The insured in any company must pay all the losses and all the expenses of the company, interest on the capital invested in the business included.
This cost of administration is distributed among all the insured, each contributing a certain pro portion of his natural premium.
It is interesting to consider what part of the entire premium is natural premium. and what part is loading. In life insurance natural pre miums are actually calculated and loadings added to them. In many forms of insurance, however, no such division is made in practice, but the whole premium is estimated together. In such eases the proportion of loading (MI be discovered only by an examination of the expense account, which will reveal what part of the receipts from premiums has been returned to the policy-holders and what part has gone for expenses. It will be found that the proportion of loading varies a great deal from one kind of insurance to another, and from one company to another. In some cases the loading does not exceed 20 per cent. of the nat ural premium. in others it is as high as 100 per cent. The high expense account of the insurance companies is a great social burden. It enhances the cost of insurance and thins retards its growth. By far the largest single item in the expense account is usually under the head of commissions to agents, the generosity of which is defended on the grimly] that large commissions are necessary to promote the extension of the business. Thus for the purpose of persuading more or less unwilling persons to insure, the cost of insurance to the entire body of insured is in creased. It would be an experiment worth try ing whether among people familiar with the practice of insurance a company could not be operated• at a cost so nmeh below that of the present system that it could offer insurance at rates with which existing companies could not compete, at least without radical changes in methods of management.
While from the social point of view the load ing represents the cost of insurance, for a per son seeking insurance the entire premium eon stitutes its price. Ile is consequently interested in the question whether the competition of insur ance companies may be relied on to reduce the price to the lowest point consistent with abso lute safety. It is evident that the competitive principle would operate in this field at a tre mendous cost. Competition works through the elimination of the least efficient. The failure of an insurance company. however. may entail a far greater loss on the insured than it does on the insurers. The severity of the process of elimina tion has been greatly mitigated by the action of legislatures, ninny of which have provided for the compulsory winding-up of the affairs of a com pany on the appearance of certain indications of danger, while the company is still able to take care of the insured by reinsuring, its risks. Further more, the very uncertainty which constitutes an essential element of the insurance business makes unrestricted competition particularly dan gerous. During a series of good years, when losses ran below the average, there would be an almost irresistible tendency to reduce the price of insurance to the level made possible by the prevailing favorable experience. If years of unusually high losses followed, as they natural ly would follow, the company would Lind itself hard pressed to meet its obligations. Thus there is always the danger that competition would re duce the cost of insurance below the margin of saf? lv.