and 70 percent of total income as table 2 shows after making allowance for estimated future losses on acquired properties and notes. If this operation were a commercial or industrial enterprise, or even a casualty insurance business, such an examination's conclusion would be fairly warranted. If the fund were underwriting short-term risks, insuring against events which can be expected to occur in say, the next year, at the end of which a new contract would again be written, the annual net income of the fund would indeed be enormous. For short-term insurance operations of this kind, income is just about balanced off by claims and expenses plus some return on invested capital. But the fund is underwriting a long-term risk, insuring against events which can be expected to occur any time between the origination of the insured mortgage and its maturity. The fund is writing long-term contracts of insurance. The term can be as much. as 30 years. To the extent that current income is not expended for claims or losses and expenses, the excess part of its income is accumulated against future events, i.e., future losses and expenses, or future liabilities.

103, 043, 069 1,829, 814

Miscellaneous income.

286
1, 484, 822
628, 923

783, 850
473, 415

725, 343 88,857

ANALYSIS OF INSURANCE RESERVES

1 Includes $54,132,767 in participations distributed from group accounts prior to July 1, 1954.

How much of this net income should be accumulated or reserved? A valuation of reserve liabilities is designed to answer such a question. The adequacy of the insurance reserves of a fund to cover its future contingent losses and related expenses can be established by a valuation of such future losses and expenses. In the practice of life insurance organizations such valuations measure reserve liabilities not only for the purpose of establishing whether a fund is solvent but also for the purpose of determining how much of earned surplus may be available for distribution to policyholders or stockholders. With mortality experience well established, expected mortality-one of the major elements in the valuation of reserve liabilities can be predicted reasonably well. Consequently, the reserve liabilities of life organizations can be determined with a fair degree of accuracy and are the expected future liabilities.

There is a noteworthy difference between the reserve liabilities of life organizations and that of the mutual mortgage insurance fund. The future losses and expenses which the liabilities of this fund measure are principally contingent upon a general deterioration of business conditions-a development which does not readily lend itself to prediction. Since the incidence of an economic reversal cannot readily be predicted, the most conservative basis for reserve valuations for such future losses and expenses is to assume that adverse economic conditions of approximately depression magnitude might develop immediately. The reserve valuations are designed to measure the liabilities resulting from the development of such a contingency. Thus. the liabilities of this fund are contingent liabilities.

The risks which the fund underwrites are in the nature of a catastrophe hazard which may be characterized as economic in nature and cyclical in pattern. The events insured against do not occur in substantial proportions except under the contingency of a depression. In this sense, FHA's reserve liabilities are not designed to measure the solvency of the fund according to its accepted meaning in the underwriting of conventional risks. To emphasize this distinction, the reserve liabilities of this and other mortgage insurance funds are described as "estimated reserve requirements." They are thus the amounts of reserves which an insurance fund requires to cover the insurance losses and administrative expenses which the fund might incur if an economic reversal of approximately depression magnitude were to develop immediately. It is this reserve valuation approach which Professors Fisher and Rapkin reviewed and approved in addition to the assumptions on foreclosures and losses.

Distinct from the reserve requirements are the "insurance reserves,' i.e., the earned surplus which an insurance fund has accumulated from its operation. A balance status for a fund exists when its insurance reserves are equal to or greater than the estimated reserve requirements. When a balance status is attained, the fund has sufficient resources to meet such future insurance losses and expenses as might be incurred in the event that adverse economic conditions of approximately depression magnitude were to develop immediately.

The comparative reserve position of a fund is thus determined by changes in insurance reserves and reserve requirements. Insurance reserves of a fund are principally affected by the net income it earns during an accounting period. Reserve requirements are affected by the volume of new insurance written, the aging of the insurance con

tracts in force, and terminations of the insurance contracts in force. A substantial increase in the amount of new insurance written has the effect of raising significantly the reserve requirements, for the reason that reserve requirements are at their highest level for new insurance. Aging of the insurance in force lowers reserve requirements for the reason that reserve requirements for contracts in force become progressively lower the longer the insurance has remained on the books. Terminations of insurance, of course, reduce reserve requirements.

One of the principal purposes served by the excess of insurance reserves over reserve requirements is to protect the reserve position of the fund from a more rapid increase in the volume of new insurance than that for insurance reserves. In the case of the mutual mortgage insurance fund, another purpose served is in the allocations from this fund's net income to the participating reserve account from which participation payments are distributed to eligible mortgagors upon the termination of mortgage insurance.

Another noteworthy feature of the reserve requirements is that they take into account the fact that when a claim under mortgage insurance is paid by an insurance fund, the mortgage insurance fund acquires a property in exchange for its debentures. As properties are sold, the proceeds of sales are used to redeem the fund's debentures. It is the expected future acquisitions and their expected future losses on sale, among other things, that are reflected in the reserve requirements when they are valued with respect to the mortgage insurance contracts in force. Some of the other items which are included in the determination of reserve requirements are expected future premiums, investment income, and administrative expenses.

The mutual mortgage insurance fund (the first of the funds to be established and the largest in terms of insurance in force) is authorized by statute to distribute part of its earned surplus to eligible mortgagors upon the termination of mortgage insurance. Reserve requirements for this fund are used, as in life insurance practice, to determine how much of surplus may thus be distributed. That part of the earned surplus which is available for distribution is in the statutory reserve called the participating reserve account. This account is authorized to receive allocations from the net income of the fund which are made in accordance with sound actuarial and accounting practice.

Valuations of estimated reserve requirements of the mutual mortgage insurance fund are made semiannually. Table 3 shows the results of the most recent valuation as of June 30, 1960, and, in addition, previous semiannual valuations going back to December 31, 1953. Perhaps the most noteworthy facts to be observed in this table are, first, the gradual attainment of the balance status of the fund with the December 1954 valuation. It took this fund approximately 20 years to accumulate a sufficient amount in the way of earned surplus to match or exceed its estimated reserve requirements. The favorable economic climate was an important contributing factor, for insurance losses up to that time had been negligible. On the other hand, if insurance losses and the related expenses in that intervening period had been substantial, it would have taken a longer time for this fund to have attained a balance status.

A second fact meriting attention is the buildup in the excess of insurance reserves over reserve requirements to over $90 million at

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