so far to dictate the policies of both the great political parties that their old-time controversies are forgotten and they are merged in attacks upon the business of the country, is a prejudice that is based upon two false assumptions: first, that the men of great affairs are lacking in integrity, and, second, that the men of small affairs are oversupplied with it. I shall not say that the reverse is more nearly true, but I do say that almost every instance of great success in this country is an example of a combination, in the man who has accomplished it, of scrupulous honesty, great frugality of personal expenditure during the years of struggle, and unbounded industry; while as a commentary upon general good conduct of the masses as such, it is a pertinent remark that if during the last few years one of our largest street railway systems could have gathered into its treasury all the fares that were passed up to its conductors, together with all the fares for which it gave rides but for which the passengers had contrived to omit to pay, it would not now be in the hands of receivers.

The loss to traction lines in all principal cities by the evasion and the dodging of passengers, and by the misconduct of conductors, is estimated at from 5 to 10 per cent. of their gross earnings. The aggregate loss to shareholders of traction companies throughout the country must amount to a great many millions of dollars annually.

Now, gentlemen, a few words more about The American Association. That Association voted at its last meeting to accept the invitation of The Pennsylvania Institute of Certified Public Accountants to hold its next annual meeting at Atlantic City, in this State, in October. It is understood that the Certified Public Accountants of the State of New Jersey and The New York State Society of Certified Public Accountants are to join with The Pennsylvania Institute of Certified Public Accountants in making the strongest host The American Association of Public Accountants, or, indeed any other gathering of public accountants in this country, has ever had. The Committee on Annual Meeting 1908 is very much alive to the needs of that occasion, and is already actively engaged in plans that promise much for our enlightenment and entertainment.

I thank you for your attention.

The Journal of Accountancy

Published monthly under the auspices of The
American Association of Public Accountants

EDITOR

JOSEPH FRENCH JOHNSON

ASSOCIATE EDITOR

W. H. LOUGH, JR.

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EDITORIAL.

Life Insurance and Valuations.

The life insurance companies have during the recent financial disturbances been much exercised in regard to the valuation of their bonds, or fixed-term securities, in which a large part of their funds is invested. They are opening their eyes to the false and unphilosophical system which has been carelessly followed in the past, and it is believed that a scientific and logical method will be introduced. The companies are especially in a hard position from the fact that they are subject to the supervision of as many insurance commissioners as there are States in the Union, to say nothing of their foreign business. These officials must pass upon the solvency of the companies: that is, whether the assets which they hold are sufficient to meet in due time the liabilities for which they have pledged themselves, and which mature as deaths occur. As these officials, guided by their State laws and their own judgment, may greatly differ, it is possible for a company to be pronounced insolvent in some states and entirely solvent in others: a case analogous to that result of our dual system of government whereby a man who is single in Dakota is married in New Jersey, or sane while in Virginia, but insane as soon as he comes into New York. To add to the perplexity of the case, it may be said with

moderation that not every one of the gentlemen in office is a trained insurance expert and accountant.

The trouble arises from setting up an absolutely false and unreliable standard of solvency, one based upon guess rather than upon facts, the so-called market value of securities having a fixed term and a fixed rate of interest.

If you had a contract with an employee to work for you for ten years at $1,000 a year, would you consider the expense as only $800, because you know a man who would work for that? This would be the same kind, of absurdity involved in supposing that a bond which will certainly pay you 4 per cent. for thirty years to come has shrunk in its value to you because, through the result of circumstances, you could now buy it at a price which would pay 6 per cent.

There are two different causes working to shift the values of term securities up and down. The first is the efflux of time, by which the value approaches nearer and nearer to par as the principal comes nearer to maturity. The second cause is fluctuation in the force of interest, whether especially as to the particular form of investment or a general, universal rise or fall. The resultant of the time factor combined with the entering cost is a regular curve, mathematically ascertainable, passing from original cost at the time of making the investment to par at maturity. Those are facts, and from them can be deduced the exact corresponding value at any point. The aberrations caused by the shifting rate of interest transform the curve into an irregular series of sinuosities, now above and now below the line of the curve, but really governed by it. As the point of rest is approached, the oscillation diminishes and the normal line of the curve becomes predominant.

If all the securities of a company were at par and bore 4 per cent. interest, there being no doubt of punctual payment of interest and principal, and the premiums on the policies were adjusted on a 4 per cent. basis-allowing for expenses-can there be any question that this company would at every moment be solvent: that is, in position to pay every claim as it matured? How could the ups and downs of the Stock Exchange dealings in that kind of security (even supposing them always bona fide) possibly affect the fact that the company will have a dollar in hand every time it has to meet a dollar of liability?

This is of course an ideal hypothesis; but the principle is true that to the company purchasing the security at a price which makes it yield a certain rate of interest, that is the rate, which can not be varied except by actually selling.

Buying a security above or below par is merely discounting a number of future cash payments. Let us discard the idea of a distinction between interest-cash and principal-cash, for it all looks alike. A ten year 6 per cent. bond for $1,000 is the right to receive twenty sums of $30 each at intervals of six months and the further right to receive a lump sum of $1,000 at the end of the tenth year; or we might say, nineteen sums of $30 and one sum of $1,030. To buy this bond you must discount these payments at some rate or other; none of the $30 payments is worth $30 now; the $1,000 payment is not now worth $1,000. If the rate of discount is exactly 6 per cent., the sum of all the sums receivable will be just $1,000. But if the rate of discount differs at all from 6 per cent., then the price of the bond differs from par. We must then discard the idea of the $30 payments being payments of interest. As each of these matures, if the rate of discount is 4 per cent. the $30 is partly the original discounted valuc and partly interest thereon at 4 per cent.

If the rate of assured income is sufficient together with the insurance premiums to make good the face of each policy at maturity, the company is solvent, irrespective of the fact that a profit or a loss would be made by liquidating on the last day of December, in the current year.

It is surprising that the insurance companies ever allowed their assets of this kind to be rated otherwise than on the basis of the productive rate which was established by the purchase of them. With their skilled mathematicians in the actuarial department, who have elaborately computed their chief liability, that is, the reserve" necessary to be maintained, it would seem as though equal accuracy should have been attained on the other side of the balance sheet.

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Mr. John Tatlock, an eminent actuary and now president of the Washington Life, recently read an able and interesting paper on this subject, in which he pointed out this peculiarity of the actuaries. Presumably they have not cared to trespass on the province of the treasurer; but in reality the treasurer ought to be

enough of an actuary to handle such a problem or else call upon the actuarial department for its help.

We believe that, if the question of valuation had been submitted to a jury of professional accountants, it would have been worked to the proper solution.

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Mr. Tatlock considers that the market-value method, which has become traditional since State supervision of insurance was first introduced in New York and Massachusetts, was adopted from a false analogy with a banking concern, whose liabilities are practically immediate; it is required, from the nature of its business, to provide for possible liquidation within a short space of time. The liabilities of a life company, on the other hand, are provided by contract to mature over a period of a long term of years; the amount of liabilities requiring settlement within a given period, or at a given time, can be determined in advance with a high degree of accuracy, and good management can, and does provide that assets are in hand when needed, irrespective of the ups and downs of market trading in such assets in the meantime."

Besides the mental confusion which Mr. Tatlock thus points out there is another cause. Without clearly perceiving that there are two separate forces at work as stated above, there was an obscure feeling that the value always fell or rose from original cost to par at maturity, and the conclusion was jumped at that its track followed the serpentine windings of market value through whose convolutions one could not discern the ideal curve which it would have followed but for the vagaries of interest-rate.

In this last year-end when the market did not exist and market values had disappeared, the life companies were in a sad plight. Having prepared thoroughly to meet all liabilities, they were still in danger of insolvency on paper. Something had to be done. Grotesque plans were suggested; to value everything on a 4 per cent. basis, irrespective of truth; to consider the market of 1907 to be like that of 1906, though everyone knew it was not: to value all unlisted securities, not publicly quoted, ad libitum, at any price necessary to produce solvency.

In spite of the remonstrances of Mr. Tatlock and Mr. M. M. Dawson, one of the most eccentric of these methods was adopted, that of averaging the thirteen valuations from December 31, 1906, to December 31, 1907, inclusive, adding them all together and