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pipes, etc. Similarly, under the''rent clause'' the insurance company agrees to make good the loss of rents caused by fire and actually sustained by the insured on occupied or rented portions of the premises which have become untenantable during the time that is required to restore the premises as they were before the fire. Companies also, under the "livestock clause" insure horses, cattle, and other live stock against death by lightning while in the described premises. On the other hand, certain clauses specifically limit the amount of the insurance under a given policy which is applicable to a given item of the property described, as where, for example, "not more than 15 per cent of the amount of this policy shall cover on pattern cards, drawings, designs, lithographic stones, and negatives.''
Various clauses also provide for the proper maintenance of fire-protective appliances. Thus the "signaling system clause'' stipulates that in view of the described premises being fully equipped with a perfect automatic fire-alarm system, etc., a reduction is made in the premium of the policy, but on the understanding that if the apparatus is at any time removed at a later date, or becomes inoperative, the company shall at once receive notice of the fact, and a prorata proportion of the reduction in the premium shall be refunded to the company for the unexpired term of the policy. Likewise the "automatic sprinkler clause" provides for due diligence on the part of the insured to maintain such equipment in complete working order during the term of the insurance; and the "perfect fire-protection clause" makes similar provision.
THE REINSURANCE RESERVE
The nature and purpose of the reserve in fire insurance becomes apparent if we take into account the manner in which a company earns its premium. Thus let us suppose that a company issues an annual policy for a premium of $120. This premium is payable in advance, and since the policy has a year to run, it is clear that the company has not yet earned this sum, but will become entitled to it only in the proportion that the policy reaches its maturity. At the end of the first month one twelfth of the term has elapsed, and the company can rightfully consider that part of the premium, or $10, as earned. Eleven twelfths of the premium, however, or $110, must be considered unearned, since the company has not yet furnished protection for the eleven months remaining in the term. At the end of six months one half of the premium, or $60, is earned, and the other half unearned. It is not until the end of the twelfth month that the company has furnished the full year's insurance, and is, therefore, entitled to the full premium.
This unearned portion of the premium constitutes the reserve. It must be regarded as a sum held in trust by the company for its policy-holders. Although paid to it in advance the company cannot claim this sum as its own property. It belongs to the policy-holders, and must be earned by the company before it can be used for its own purposes. The reinsurance reserve may thus be defined as "the unearned premium"; or as the liability of the company to its policyholders for that portion of the premium already collected, but not yet earned.
It should be stated here that the term "reinsurance reserve, '' so generally used in insurance terminology, is a misnomer, and does not convey a true idea of the purpose for which a reserve exists. Certainly an insurance company does not start in business with the idea of winding up its affairs and reinsuring its business in another company. And even where a company reinsures its business, it does not at all follow, as some have argued, that the reserve should contain only that sum which would be required to reinsure its old business. Innumerable instances of reinsurance contracts exist where one company assumed the business of another company, and was willing to take considerably less than the unearned premium as the price for carrying the policies to maturity. Vice versa, where the company, desiring to cease business, is known to have been careless in the underwriting of its risks, the reinsuring company might demand much more than the unearned premium as the price for carrying the reinsured policies to the end of their term.
Whatever the standards may be that are advanced for the existence of a reserve, and there have been many, it will be found upon examination that all are untenable except that which regards the reserve as consisting of a sum equal to the unearned portion of the company's premium income, to be held by it in trust for the exclusive benefit of the policyholders. In case a company becomes insolvent, the receiver or assignee would take this view of the case, and would consider each policy-holder a creditor for the unearned premium on his policy. Even in case the company reinsured its business in another company, it by no means follows that the policy-holders must consent. They can decide to withdraw, and are entitled to the unearned premium on their policies. If the company chooses, it may decide to retire from business, and no objection can be raised provided the company makes a settlement with all its policy-holders by returning to them the unearned portion of the premium. In fact, with or without giving a reason, either party to the insurance contract may decide to cancel it, and in such a case the company must have on hand the unearned premium, because every fire-insurance contract provides that "if this policy shall be canceled as hereinbefore provided, or become void or cease, the premium having been actually paid, the unearned portion shall be returned on surrender of this policy, or last renewal, this company retaining the customary short rate, except that when this policy is canceled by this company by giving notice, it shall retain only the pro-rata premium.''
From the foregoing it is evident that the maintenance by every company of a fund equal to the unearned premiums on all its policies in force should be a necessary requirement for its financial solvency. It is only natural, therefore, that the several states have enacted laws requiring all companies to maintain such a reserve, and making it the duty of the insurance commissioner to determine annually their financial condition. These laws are of the greatest importance, and upon their strict observance depends, very largely, the security of policy-holders. The law of Pennsylvania with reference to the determination of the reserve and financial solvency of the companies resembles, in its general outline, the law of other leading states, and is as follows:
"For every company doing a fire insurance business in this state, the insurance commissioner shall calculate the reinsurance reserve for unexpired fire risks, by taking fifty per centum of the premiums received on all unexpired risks that have less than one year to run, and a pro rata on all premiums received on risks that have more than one year to run; and in marine and inland insurance he shall charge all the premiums received on unexpired risks as a reinsurance reserve.
"Having charged against the company the reinsurance reserve, as above determined, for fire, inland, and marine insurance, and adding thereto all other debts and claims against the company, he shall, in case he finds the capital stock of the company impaired to the extent of twenty per centum, give notice to the company to make good its whole capital stock within sixty days; and, if this is not done, he shall require the company to cease to do new business within this state, and shall thereupon, in case the company is organized under the authority of this state, immediately institute legal proceedings, as required in this act, to determine what further shall be done in this case. Any company receiving the aforesaid notice of the insurance commissioner, to make good its whole capital stock within sixty days, shall forthwith call upon its stockholders for such amounts as will make its capital equal to the amount fixed by the charter of said company; and in case any stockholder of said company shall neglect or refuse to pay the amount so called for, after notice personally given or by advertisement in such time and manner as the said commissioner shall approve, it shall be lawful for the said company to require the return of the original certificate of stock held by such stockholder, and in lieu thereof to issue new certificates for such number of shares as the said stockholder may be entitled to in the proportion that the ascertained value of the funds of the said company may be found to bear to the original capital of the said company"
In its strictest sense, we have seen that the reserve of a fire-insurance company should consist of the unearned portion of all premiums collected. But when it is remembered that policies vary in their term all the way from a short period to five years, and that more policies are written at one time of the year than at another, it is apparent that it would be a difficult task to examine the thousands of policies of a large company individually with the view to determining the unearned portion of the premium for each. For all practical purposes a short cut rule may be adopted for the approximate ascertainment of this unearned fund. The law of Pennsylvania, already quoted, and generally applied throughout the United States, furnishes such a rule. It provides that the insurance commissioner "shall calculate the reinsurance reserve for unexpired fire risks by taking fifty per