Meaning of the Term "Surrender Value"

It was explained in The Reserve that the level-premium plan involves the charging during the early years of the policy of a net premium which is larger than necessary to pay for the insurance in those years, with a view to accumulating a fund sufficiently large to enable the company to meet the cost of insurance in the later years of the life of the insured when the net premium is insufficient to pay for the current cost of protection. These overcharges, we saw, are credited to the policy from year to year at an assumed rate of interest and constitute the reserve. The manner in which this reserve accumulates was illustrated (here) in connection with a $1,000 ordinary life policy at age 45, issued on the basis of the American Experience table and 3 percent, interest. It was seen that the net annual premium of $29.67 on this policy results in a reserve of $19.61, at the end of the first year, and that thereafter the accumulation to the credit of the policy continues to increase until, at the end of the fifty-first year of the contract, or the extreme limit of the insured's life according to the mortality table, it equals the face value of the policy.

Now what shall be done with this fund in case the insured wishes to surrender his policy or fails to pay his premium when due? It is clear that under such circumstances the company, since its future liability under the policy ceases, no longer requires the reserve the accumulated overcharges in the net premium for the purpose originally intended. Experience has shown that it is not necessary for the protection of the company or the other policyholders to insist that the insured upon failing to continue his premium payments shall forfeit the entire reserve value of his policy. It has therefore become a universal practice of the companies to permit the insured, in case he surrenders or lapses his policy after it has been in force for several years, to receive all or a designated percentage of its reserve value. This allowance constitutes the so-called "surrender value" of the policy; while the portion of the reserve which the policyholder forfeits is known as the "surrender charge".