a 10 year plan, for instance, cannot exceed 4.45% per year. The lower loads in subsequent years result in the investor who is in the plan the full ten years ultimately paying approximately the same total sales load he would have paid had he invested directly in the underlying mutual fund shares.

On a 10 year, 120 payment, $25.00 per month plan, the 50% front end load would typically equal $150.00. It is important to realize that only about half of this amount goes to the salesman who actually talks to the customer and makes the sale. The balance is applied toward other expense, such as recruiting, training and supervision of sales personnel, advertising, and home office overhead. On these small amount plans sponsors consistently report a loss in the first year.

THE FRONT END LOAD IN LIFE INSURANCE

For any life insurance company licensed in New York State the first year commission paid to the agent on a sale of a "whole life", permanent life insurance policy is typically 55% of the first year's premium.

For companies not licensed in New York the commission paid to the selling agent on an individual whole life insurance policy typically is 65% and sometimes is as much as 80% of the first year's premium. The renewal commissions to the agent are typically 5% a year for 9 years.

This commission to the life insurance selling agent is net to that agent. There are in addition other direct selling expenses such as incentive overrides to field sales managers and assistant managers or to general agents, advertising and home office sales expense. Total selling expense on a whole life individual policy sold by a company doing business in New York will customarily run as high as 100% of the first year's premium and for companies not doing business in New York will run as high as 120% of the first year's premium.

It is a familiar fact to any purchaser of life insurance that an individual whole life policy will typically not acquire any cash surrender or loan value during the first year after he takes it out and that such cash surrender value will be small in relation to the amount paid in for several years after the original issue of the policy. The cash surrender value represents the current savings element of a life insurance policy which is available to be withdrawn or borrowed by the policyholder.

The cost of providing the pure death benefit on a year-to-year basis-i.e., the mortality cost-in a permanent life insurance policy is remarkably low-far lower than most people realize. For a whole life policy issued to a man aged 40 at standard rates by a typical large life insurance company, this pure mortality cost entirely aside from loadings, expenses, taxes and profit-is only $1.20 per $1,000 of coverage in the first policy year. For this policy the mortality cost is only $4.40 per $1,000 of coverage in the 10th policy year when the man is age 50. The premium for this policy is $20 per $1,000 of coverage each year. Since there is no cash value at the end of the first year 94% of the gross premium is available for expenses, including commissions, and for taxes and profit. Actually more than this 94% of the gross premium on the policy involved is typically used, even by conservative life insurance companies, for first year expense. To meet total first year expense, which will often be over 100% of the first year premium, the company in effect borrows more money from its surplus or from the pool of funds built up by older policies. As a result, and because of the lapse factor, a life insurance company often will not recoup its investment in a new policy for periods ranging from six to twelve years.

Most of this first year expense is selling expense. The reason I emphasize the willingness of even the most conservative life insurance companies to invest so much in selling expense, is to show that in the life insurance business the front end load principle is universally accepted as essential.

THE REASON FOR FRONT END LOADS IN BOTH CONTRACTUAL PLANS AND LIFE

INSURANCE

Certain worthwhile products, particularly in the area of financial protection, do not sell themselves.

Over the past hundred years tens of millions of Americans have purchased individual life insurance policies. The overwhelming majority of these people or their families have been better off for the purchase of these policies. Practically none of these policies sold themselves. They were sold by agents or, as they prefer to be called, by life underwriters. It is a truism in the life insurance business that a prospect never comes into the office asking to buy a policy.

Efforts have been and are still being made from time to time to merchandise individual life insurance by mail or by newspaper and magazine ads without a person to person confrontation between salesman and prospect. But these efforts have on the whole been notably unsuccessful.

Long ago the life insurance industry found that if the policy contracts are to be sold salesmen must go out and make the sales and these salesmen must be adequately paid for doing so. They found that these salesmen cannot wait for two or three or four years to receive their commission for making the sale. They must receive most of it the first year if they are to have an incentive and to make a living. That is the reason for the front end load-and for 55% commissions to life insurance agents the first year with renewal commissions thereafter often only four or five percent.

Exactly the same is true of selling contractual plans.

These plans are not set up for the person with substantial capital or large discretionary income who can come up with lump sums to buy mutual fund shares. They are set up for people who can be sold on putting aside some of their monthly income on a regular basis to buy mutual fund shares rather than spending the money for something else.

For rank and file people it isn't easy to make and stick to a decision to put aside some of the paycheck every month. Developing and bringing about such a decision-for both life insurance and contractual plan salesmen-requires individual solicitation and follow up. It requires time and work for the salesman and he deserves to be compensated for it.

THE GROWING ROLE OF LIFE INSURANCE COMPANIES IN SELLING MUTUAL FUNDS

If the front end load for contractual plans is abolished or scaled down and spread out, as proposed by the pending legislation, it will mean that many contractual plan companies will no longer be able to attract salesmen to sell their product and many salesmen of contractual plans will not be able to stay in business. On a $25 a month contractual plan, for example, if a first year loading of only 20% is decreed, the salesman would be getting $30 in first year commission. This would be his first year compensation for all of his prospecting work, for all the visits which did not result in any sale, for the two or three interviews which would be customary for each sale actually made, and for the paper work and followup. This isn't enough compensation to keep the salesman going.

There is an ironic aspect in this threat to the contractual plan business. If the contractual plan companies are, because of new legislative restrictions, unable to have field forces of salesmen, it does not mean by any means that there will not be large numbers of salesmen going around, reasonably compensated, selling mutual funds to the rank and file public. Who will this alternative group of salesmen be and how will they receive adequate compensation? The answer is that they will be salesmen primarily interested in selling life insurance but also offering to sell mutual fund shares in combination with life insurance policies or as door openers for selling life insurance.

Dozens of life insurance companies-including some of the largest ones-are acquiring control of mutual funds or forming their own, or offering another type of federally regulated investment company product, the variable annuity. As of September last year the authoritative Best's Insurance News showed that, of the 100 top life insurance companies in the United States, 55 now have at least one equity product (either a variable annuity or a mutual fund) or are planning to have one soon.

There are no federal restrictions—and quite properly so on the sales loads and the commissions permissible on sales of life insurance policies themselves. The strong and growing interest of the public in equity products has caused the life insurance companies and agents, to a rapidly increasing degree, to include mutual fund shares in their kit of products. Since these agents have the healthy commission structure from life insurance available to make it possible for them to succeed financially, they will not have to be concerned with the restricted level of loadings available from the mutual fund sales alone.

In a full page ad, in the March 1969 issue of Best's Review, a large stock exchange member firm offers by mail for $385 a training course for life insurance salesmen in selling mutual funds and life insurance in combination with mutual funds.

This, I submit, is the reason why the life insurance companies are not appearing in these hearings except on the limited issue of funding of qualified pension

and profit sharing plans. Many have been amazed at the fact that they are not here. It is known to all that they are moving into the offering of mutual fund shares and individual variable annuities. One not familiar with the realities of the situation might wonder why they are not expressing their concern with the direct threat to the front end load on these additional products their agents will be selling. However, when it is realized that many of these life insurance companies and agents will actually be offering their mutual funds and variable annuities as door openers for the sale of life insurance or as part of combination plans with life insurance-perhaps even in some cases as "loss leaders" for the sale of life insurance-it can be understood why they are not concerned as the contractual plan companies must be with the threat to the front end load.

I do not for a moment wish to raise doubts about the skill and training of life insurance agents. They are, as a profession, an outstanding group of men with great interest in knowing their products and doing a responsible job for their prospects. However, the conventional life insurance policy will continue to be their main interest and their breadwinner. Can it be assumed that they will acquire the same knowledge about and provide the same detailed explanation of their mutual fund and equity products as they provide for their life insurance policies? Would the public, in fact, be well served by (a) largely eliminating one group of salesmen of periodic payment purchases of mutual fund sharesthe salesmen of contractual plans-and (b) substituting another group of salesmen who are primarily interested in selling a different product?

The front end load in life insurance and the resulting sales commission structure is sound and fair and fully justified. But its availability should not be used as a means of forcing the contractual plan salesmen out of the picture and leaving the field to another group of salesmen who can afford to go out and see the mutual fund prospects.

Senator PROXMIRE. Thank you, gentlemen, very much.

I think this has been most helpful. We certainly had a balanced presentation.

The committe will reconvene tomorrow at 10 o'clock to hear six additional witnesses.

(Whereupon, at 1:20 p.m., the hearing was adjourned, to be reconvened at 10 a.m., Friday, April 18, 1969.)

The committee met, pursuant to recess, at 10 a.m., in room 5302, New Senate Office Building, Senator William Proxmire, presiding. Present: Senators Proxmire, McIntyre, and Bennett. Senator PROXMIRE. The committee will come to order.

Our first witness this morning is Prof. Henry Wallich, professor of economics of Yale University and a very distinguished economist. We are very happy to have you, Mr. Wallich. Go right ahead.

STATEMENT OF HENRY C. WALLICH, PROFESSOR OF ECONOMICS, YALE UNIVERSITY

Mr. WALLICH. Mr. Chairman, my name is Henry C. Walich. I live at 88 Cold Spring Street, New Haven, Conn. I am a professor of economics at Yale University, but I am appearing in a purely personal capacity.

Nothing has happened since extended hearings before your committee were held on this legislation in 1967 that would fundamentally affect one's judgment concerning the intrinsic usefulness of mutual funds in the American financial scene. They confer significant benefits upon their stockholders as well as upon the economy in general. To the small investor, they give a convenient device for investing in common stocks. In an age of inflation, they provide him with a means of protecting his savings. They can provide him with risk protection via diversification, although the risks assumed by some funds are increasing sharply today. For the economy as a whole, mutual funds spread the ownership of capital. By increasing, very probably, the overall demand for common stocks, they help reduce the cost of equity capital to business. Thus they contribute to productive investment and economic growth.

The growth of mutual funds conforms to the general tendency in the American capital market, toward more "intermediation." This is the counterpart in the stock market, as yet only incipient, of the institutionalization that has occurred in the bond market. Bonds today are held, very predominantly, by intermediaries-commercial and savings banks, life insurance companies, pension funds. Common stocks are still predominantly held outright by ultimate beneficiaries. But the trend is toward more intermediation, partly through pension funds

and life insurance companies, and very importantly through mutual funds. There are reasons for thinking that equity ownership via intermediaries is more efficient-better selection, better diversification, potentially lower costs of handling of securities, as well as greater convenience to the saver. But these benefits depend, in important degree, on the conduct of the intermediaries. If the intermediaries are highly speculative, if their charges are unreasonable, the benefits can be lost. Since the trend toward intermediation is probably irreversible, the law should provide a framework within which this trend can evolve constructively.

What mutual funds should offer to the small saver is the equivalent, in the equity field, of a savings bank. The small saver needs an equity bank. That is the service a good mutual fund can supply. Aside from the selection of assets, the mutual fund should offer a convenient and cheap means of investing money and withdrawing it. The fund should pass through to the saver as large a part of its current and capital gains income as possible, with the smallest possible deduction for

expenses.

These considerations would point toward a no-load fund with a minimal advisory fee. Under conditions of competition, one would expect the forces of the market to lead toward arrangements of this sort. Competition in the mutual fund market, however, is far from perfect. It would be imperfect even if section 22-d did not provide for retail price maintenance. Furthermore, there are certain considerations of public policy that suggest that the purely competitive result may not be the ideal solution in this particular case.

It is frequently said that mutual funds are sold, not bought. Hence, there needs to be, it is said, an allowance for the cost of selling. How large a percentage of total mutual fund shares are in fact "sold" rather than "bought" nobody can say. If the industry should argue that the percentage is very high, it would raise questions about how strong the demand for its product really is. It would raise questions about the desirability, from a social point of view, of widespread fund ownership.

Nevertheless, as I have tried to point out, there are many reasons for considering widespread ownership as desirable. This is so despite the possibility that overly aggressive salesmanship may lead to some purchases that are not in the interest of the buyer. Hence, it is necessary to weigh two competing objectives: (1) cheap and efficient "equity banking" through mutual funds, and (2) widespread ownership. To gain more of the latter, some sacrifice will have to be made in terms of cheapness and efficiency. One of the purposes of the legislation before your committee is to decide where to draw this line. I turn to the sales charge.

The standard sales charge of 9.3 percent obviously differs sharply from the ideal of an efficient equity bank. It seems meaningless to me to compare this charge with the cost, to a small investor, of buying a diversified portfolio in minimal lots. The obvious standard for measuring the appropriateness of this charge is the fact that there are no-load funds that survive quite comfortably, and that closed-end funds can be bought at normal stock exchange commissions.

Nor can a defense be made for the 9.3-percent sale charge on the grounds that it is customary. There is nothing sacred about the status