The Investment of Life Assurance Funds

By F. S. JAMIESON

'I do not see the attraction to any Insurance Company in the . . . Debenture Stock

• . . seeing that in the current year its price has ranged between 112 and 1164.. (1909) 'The question now is not, as it used to he, "Dare we put more than 10% in ordinary shares?" It is, "Dare we leave more than 50% in fixed interest investments?"' (1957) EACH of the above quotations comes from a paper on investment matters, delivered in the year indicated by a life assurance official. They represent somewhat extreme viewpoints, but I have selected

them to emphasise the great change in policy and outlook in regard to the investment of life as- surance funds which has taken place during the Past fifty years.

Broadly speaking, the two main changes are as follows :

1. At the end of last century only 25 per cent. of life assurance funds were invested in Stock Exchange securities, the remaining 75 per cent. being in other types of asset, mainly mortgages on property. Today the position is almost exactly reversed, about 75 per cent. of assets on the average being invested in Stock Exchange securities. 2. Fifty years ago life offices had virtually no hold- ings of ordinary shares in their investment portfolios, while today these shares on the average probably constitute about 25 per cent. of the total.

What are the reasons behind these major Changes in investment policy and to what extent

are the trends they indicate likely to be continued in the future?

The first change is partly due to the much greater supply today of suitable Stock Exchange

securities. Its main cause, however, lies in a

change in outlook by the managements of life offices. Fifty years ago it was deemed a necessary quality of a good investment that its capital value should not only be basically secure, but should

also (as indicated in the first quotation above) be immune from temporary fluctuations. This emphasis on capital security was, on the face of it, extremely commendable; and at that time, When companies were smaller and younger and had not had the time or opportunity to amass the inner reserves which they possess today, even a temporary depreciation could have awkward con- sequences when it came to presenting the year's 1.tecounts. Security of capital is, however, not in Itself a complete guarantee of solvency, since life assurance premiums are calculated on the assump- tion that the life office will earn a certain rate of interest and, if that rate is not earned, the office may not be able to meet its obligations, however secure the capital value of its invest- ments.

shift recent years there has been a tendency to the emphasis from capital to income. The liabilities of a life office are long-term ones, but

mortgages on property (which, as stated earlier, formed a large part of the investment portfolio y Years ago) are normally short-term assets— they are liable to be repaid, or the rate of interest

on them altered, at relatively short notice. Some greater long-term security of income is desirable and this can be better provided by long-term or irredeemable fixed-interest securities. It is true that these will fluctuate in market value as the level of interest rates varies, but, if the securities are basically sound, such fluctuations cannot affect the solvency of a life office, provided its assets are 'matched' as to duration with its liabilities—since in such a case interest rate changes affect the real values of assets and liabilities alike.

This 'matching' of assets and liabilities has been the subject of considerable discussion in life assurance circles in recent years and is now generally looked upon as a desirable investment objective. Because of this, mortgages, far from regaining their former status as life assurance company investments, will probably continue to fall in importance.

The second change deals with ordinary shares. Life offices started to buy these to any extent in the late 1920s and purchases were continued on a moderate scale during the 1930s. Since the end of the Second World War, however, the pace of investment in these shares has quickened con- siderably.

A great deal has been written recently about the fact that ordinary shares provide a hedge against the effects of inflation and are superior to fixed-interest securities on this account. Infla- tion is not, however, a danger to life assurance companies, except to the minor extent of its effect on their expenses of management, since they deal in money contracts and not in goods.

What, then, is the reason for this trend towards ordinary shares? In the first place, companies want to earn as good profits as possible for their policy holders who hold 'with profits' contracts, and also (in the case of proprietary offices) for their shareholders; and if, without endangering the basic security behind all their contracts, they can arrange their investments so that these profits rise in times of currency depreciation, they can, in regard to those entitled to share in these profits, temper the wind to the shorn lamb—a highly desirable objective.

In the second place, the case for investment in ordinary shares does not rest entirely on the inflation argument. Indeed, too much publicity• has, in my view, been given to this argument. It is too often assumed that, because life assurance companies and other institutional investors buy ordinary shares, they are necessarily convinced that inflation will always be with us; and the man in the street, on being told that this is the view of the experts, tends himself to act on this

assumption, which makes it all the more diflicult for the authorities to restore stability to the currency.

Even without the effects of inflation, ordinary shares should, over a period, show better results on the average than fixed-interest securities. Their prices, however, are liable to fluctuate more violently than those of fixed-interest securities and also the performances of different ordinary shares vary between themselves to a very great extent. Fifty years ago companies did not have inner reserves sufficient to enable them to meet a substantial depreciation in market value, nor were they large enough to spread their ordinary share investments sufficiently widely to ensure that they attained at least an average result. Today the position is quite different in both these respects, and companies with substantial holdings of ordinary shares cannot be considered as taking unjustifiable risks and, whether or not further inflation occurs, should be in a favourable posi- tion as regards their future profits.

The trend into ordinary shares now appears to be an established one. The extent to which it will continue depends in some degree on the terms on which ordinary shares can be purchased relatively to other types of investment. If the demand for ordinary shares rises to such an extent that their prices are forced up to a level at which their growth prospects are over-discounted, the professional investors, who handle life assurance funds, will naturally tend to avoid them.

This leads, finally, to the consideration of a question which any reader of this article may reasonably ask—'What will be the effect on life office investments and investment policy of any substantial extension of State pensions, such as, for example, is envisaged in the recent Labour Party pamphlet on National Superannuation?' The proposals in this pamphlet might, in the first place, lead to a slowing down in the rate of increase of life assurance funds, or even to their reduction. Secondly, they would introduce the State (in the persons of the trustees of the National Superannuation Fund) as a competitor in the stock market, and in particular, in the ordinary share market.

Whenever in the past there has been an exten- sion of State life assurance and retirement bene- fits, it has been feared at the time that the effect on life assurance companies would be adverse. These fears have, however, always proved ill- founded and life assurance companies have gained, rather than lost, through the increased public interest -aroused thereby in life assurance and pension matters. The present proposals are, of course, more far-reaching and past experience in this case may be a faulty guide. Nevertheless, I doubt whether life office managements will, or should, at this stage make any changes in invest- ment policy on this account—there is as yet no good basis for calculating such adjustments.

Will the entry of the State into the ordinary share market raise prices to such an extent as to make these shares no longer attractive as long- term investments? It is impossible to give a reasoned opinion on this point. But, in consider- ing it, it should be remembered that a vast amount of new industrial finance will be required over the balance of this century; and also, that State funds have an incurable habit of never growing as fast as expected—the temptation to use them to finance current expenditure is too great.