Reasons Justifying a Surrender Charge

Three prominent reasons have been advanced why the company during the earlier years of the policy should make the surrender allowance less than the full reserve. The most important of these relates to the initial expense incurred by the company in securing and issuing a policy. This expense to-day considerably exceeds the amount allowed for expenses in the first year's premium, and the company expects to reimburse itself out of the margin for expenses in the future premiums which the insured is expected to pay in accordance with the terms of his contract. Unless the policy therefore remains in force for several years it will actually prove a source of expense, instead of advantage, to the company. To allow the return of the full reserve to a policyholder who lapses or surrenders his policy in the early years would be an injustice to remaining policyholders since they would be obliged to reimburse the company for the amount it expended in securing the policy in question and which it failed to get from the insured because of his early withdrawal. Justice to remaining policyholders, it is argued, requires the application of some form of penalty for early withdrawal, and this penalty we have seen assumes the form of a complete forfeiture of the reserve in case of lapse or surrender before the payment of the first two or three premiums, and as regards the great majority of companies, the retention, following the payment of the second or third premium, of a decreasing surrender charge during the next ten, fifteen or twenty policy years. Obviously, as the policy grows older more liberal surrender values may be granted. Not only has the company had time to reimburse itself for the original cost of obtaining the policy, but the contract is now self-supporting. Furthermore, the policyholder has become sufficiently accustomed to paying his premiums to warrant the belief that he will continue the policy to its maturity. It should here be stated that by far the greatest number of lapses and surrenders take place during the first and second policy years.

Another reason advanced in favor of not allowing the insured to obtain the full reserve on the policy at pleasure is the possibility that during periods of financial stringency-or business depression so many policyholders may avail themselves of the privilege of surrendering their policies as to greatly weaken the financial standing of the company to the detriment of remaining policyholders. In commenting on this phase of the subject, Mr. Edward B. Fackler states:

In times of business depression, such as this country has seen more than once, even the best securities will suffer serious depreciation though their certainty of payment remains unquestioned. Such a financial crisis is just the time when policyholders, in need of cash, are most likely to demand surrender values from the company, thus not only reducing its premium income, but also forcing the sale of securities at less than their true value, and perhaps crippling the company. In such a case the persons exercising these options should purposely not be allowed a greater proportion of the reserves on their policies than the company is able to realize on the true value of its securities sold to provide cash for retiring policy-holders. This matter, however, cannot be regulated by any set of rules, but depends on the amount of the company assets, the character of its business and investments, and the form of its organization.

Such statements have in view the fact that, unlike the restrictions imposed by savings banks on the withdrawal of deposits, most life-insurance policies now outstanding do not provide for the right on the part of the company to defer payment in time of financial stringency. Within recent years, however, many companies have reserved the right in their contracts to defer payment of the cash value, or the making of a loan except for the purpose of paying renewal premiums, for a period not exceeding sixty or ninety days.

Still another argument in favor of a surrender charge, although some writers question its correctness or importance, refers to the "adverse mortality selection" which it is assumed will be brought about by the allowance of very liberal surrender values. The position taken by the supporters of this view is as follows: A life-insurance policy is a unilateral contract to which the company must always adhere but which the insured may break at any time by simply discontinuing his premium payments. Whenever, therefore, the payment of premiums seems a hardship, the healthy policyholder, not feeling the immediate need for insurance, will have no hesitancy in lapsing his policy. Policyholders in poor health, on the contrary, will appreciate fully the value of their insurance and will exert themselves to the utmost to pay the premium. Hence, according to this view, the good risks are likely to lapse on a large scale if surrender values are liberal, while impaired risks will stay with the company. The result is a great reduction in the average vitality of the policyholders remaining with the company. It is therefore argued that retiring policyholders should forfeit a portion of the reserve value of their policies in order to provide a fund to meet the higher death rate among the poorer risks that remain.