A.H. Bailey’s Principles of Life Insurance Investment

Principles of Investment as laid down by A.H. Bailey

A.H. Bailey was actuary of the London Assurance Corporation. He contributed a paper in 1862, which was published in Journal of Institute of Actuaries, Vol. X.

The principles are commonly known as ‘Bailey’s Cannons’ which remain as much applicable to insurance business today as they were in 1862.

However, their mode of application can be changed with the changing conditions. His principles of investment are summarised as below:

(i) That the first consideration should invariably be the security of the capital.

(ii) That the highest practicable rote of interest be obtained, but that this principle should always be subordinate to the previous one, i.e., the security of capital.

(iii) That a small proportion of the total funds (the amount varying according to the individual circumstances of each case) should be held in readily convertible securities for the payment of current claims.

(iv) That the remaining and much larger proportion may be safely invested in securities that are not readily convertible.

(v) That as far as possible the capital should be employed to aid the life insurance business.

Comments on A.H. Bailey’s Principles

1. The presentation of the principles shows that Bailey was fully aware of the safety, profitability and liquidity principles but he presented in an exemplary way which did not reveal all scheme of a picture. He would have presented it in a simple way.

2. He was extra cautious with the negative relationship between the safety and profitability. But there are certain securities where the safety and profitability principles are fully applicable simulatenously.

In gilt-edge securities and postal certificates or national defence bonds may achieve both security of capital and maximum return.

Moreover, Investment Fluctuation Fund may be created for meeting losses on investments.

3. He put undue stress on liquidity. Liquidity, at least for established concerns, are not very essential because a vast fund inflows daily to the business in form of premium, return on investment and other sales proceeds.

4. He discussed the principle of diversification in his second, third and fourth principles which can be given only under one principle of diversification because the diversification may also be according to profitability and liquidating besides according to class, character and geographical locations.

Usefulness of Bailey’s Principles

Bailey’s principles are as much useful today as were in his time.

1. Security of Capital

As he thought, security of capital is very useful today also, because of fiduciary relationship of the insurer and insured. Therefore, he pointed out first principle of security in his cannons.

2. Profitability

He suggested the second principle only after the first one because he was aware of the negative correlation between high security and high profitability.

It is correct in most of the cases even today.

He tried to establish happy balance between the first and second principles. Therefore, he suggested that a fund should be invested in safe security first and in profitable securities, later on. At least the assumed rate of interest must be earned to avoid losses.

3. Liquidity

The negative correlation between liquidity and profitability was fully known to him. Therefore, he suggested that a larger portion of funds should be invested in non-liquid securities and a smaller part in the liquid securities , i.e., which can be easily converted into cash.

4. Social Objective

His fifth rule to increase life insurance business is now gaining more importance because of awareness of the government towards Social objectives.

He suggested that life insurer should make investment in social institutions such as municipal boards, hospitals, housing societies, health centres and schools because these will help in reducing mortality which will tend to reduce premium rates.

The life business will increase, consequently.