New York Insurance Law is an instance of this. (See Appendix D.) In order that you may be sure that the securities have not been borrowed for the purpose of exhibiting them to the examiner or for temporary purposes, it is well to satisfy yourself that the company's title to the securities is the result of an actual purchase. This evidence will be exhibited to you either in the shape of the receipted bills from the vendor or, if you desire more affirmative information, you can obtain it from an inspection of the entries in the cash book, supplemented by an inspection of the cheques or vouchers themselves. CHAPTER V Difference Between Bonds and Stocks - Danger in Stock Investments - Preferred, Common and GuarStocks Collateral Loans "Window anteed In my talk to you the other day I pointed out that, although there might be some differences in the extent of security behind it, a bond was a definite promise to pay; to-day I wish to refer to this in order that you may realize the difference between a bond and a certificate of stock. A certificate of stock is merely an evidence of the holder's equity in a corporation: it indicates that he is a partner in the business: there is no promise to pay any sum at any time and until the company is liquidated or the stock retired, there is no chance for an investor to receive the principal of his investment. An insurance company is a semi-public corporation and you can readily appreciate the danger to it of an investment in the capital stock of another corporation. If the funds of the policyholders are to be used for the purpose of purchasing a partnership in a different kind of business, the policyholder should be prepared to experience the penalties of a losing venture in the same way that he will benefit by a profitable one. I have in mind the case of a life insurance company which purchased a number of shares in a casualty company. The latter's business was not conducted along proper lines, and in consequence the stockholders had to meet an assessment on their stock in order that the casualty company might remain solvent and be permitted to transact business in the various States. As the life insurance company was a stockholder, it, with all the others, had to contribute to this additional payment. As a result the life insurance policyholders have invested many times the amount of their original purchase in the capital stock of the casualty company, and it is almost unnecessary for me to point out that this is an entirely improper channel of investment for the funds of the policyholders. You will appreciate this danger by stopping to consider the manner in which the stockholders of national banks are regarded. If for any reason the funds of a national bank become seriously impaired, not only do the stockholders lose all of their investment in the capital stock, but under the National Banking Law they are liable for an assessment equal to the par value of their stock holdings. If an insurance company, for instance, had $100,000 of the capital stock of a national bank and through poor investments or defalcations the affairs of the bank became involved, the insurance company would have to protect the depositors not only to the extent of its original investment of $100,000, but also to the extent of an additional $100,000 if it were needed. It is pertinent that at this time I should call your attention to the fact that from our viewpoint there is a difference between a life insurance company and a company transacting other forms of insurance. The policy contracts of a life insurance company may run for a long term of years, and it is no unusual thing for policies to be in force forty, fifty or sixty years from their dates of issue. The continued success, therefore, of a life insurance company depends upon the safe investment of its funds in such a way that they will earn the rate of interest assumed in the calculation of the premiums. The contracts of other insurance companies run for shorter terms as compared with the policies of a life insurance company, and the premium rates are not predicated upon the investments earning a definite rate of interest. I mention this fact in order that you may see the direct bearing it has on the point to which I am now going to refer, viz., that if the corporation, the stock of which the insurance company holds, is not successful, no dividends are payable upon the stock and therefore the earning power of the investment is crippled; while this might be a very serious matter to a life insurance company, you will see that it will not have the same effect upon companies transacting other forms of business. In the State of New York at the present time, life insurance companies are not permitted to invest in or loan upon the stock of any corporation (see Appendix E); the exception noted in the statute relates to the stocks of a municipal corporation, which are more in the nature of bonds, and the criticisms noted above cannot properly be applied to them. The two forms of stock which will probably come to your attention in the examination of insurance companies, are preferred and common, either of which may be guaranteed. The preferred stockholders of a corporation are entitled to a distribution of the earnings of the corporation before any dividends are declared upon the common stock, and in some cases are entitled to priority in the event of liquidation. After the interest on the bonded indebtedness and the other fixed charges have been met, the preferred stockholders are entitled to a dividend if in the judgment of the directors such a payment be advisable. A preferred stockholder's certificate does not entitle him to a definite payment, but merely to an equity in the earnings. As a usual thing, on preferred stocks the dividend is limited to a certain amount, although the preferred stockholders in some corporations are entitled to an additional dividend after the common stockholders have received their dividend. The common stock of a corporation entitles its holder to the profits which are apportioned by the directors; it is quite evident that before the common stockholders can receive any dividends, the interest on the bonds, the fixed charges and the dividends to the preferred stockholders (if any preferred stock has been issued) must be paid. When a railroad corporation leases its lines to another corporation, one of the terms of the lease may provide that the lessee shall pay dividends at a certain rate upon the outstanding capital stock of the lessor. These shares thereby become "guaranteed stocks," but it must be evident to you that their security depends upon the earning power of the road which has assumed the operation of the leased lines. In examining an insurance company which holds certificates of stock among its assets, it is necessary to observe whether the certificates stand in the name |