Meaning of Surplus and Sources from Which Derived
Life-insurance policies may be classified either as "non-participating"
or "participating". Non-participating policies are those which definitely
guarantee the premium and the sum insured and do not entitle the insured
to receive any other benefits than those expressly set forth in the contract.
Participating policies, on the contrary, usually require the payment of
a premium considerably larger than necessary to meet the company's liability
under the contract, and as a consequence the insured is allowed from time
to time to "participate" i.e. to receive a portion of the surplus earnings
of the company. This surplus may be defined as that sum which the company
has on hand after deducting the reserve value of its policies and after
paying its current expenses and annual death claims.
To understand the sources from which a company derives its surplus, it
is necessary to recall the nature of life-insurance premiums. Net premiums,
we saw, are calculated on the assumption that a certain rate of interest
can be earned and that death claims will occur as indicated by a given mortality
table. If, therefore, the rate of interest actually earned and the mortality
actually experienced are just equal to the assumptions, and if all policies
remain in force until maturity, net premiums will prove just sufficient
to enable a company to meet the benefits guaranteed under its contracts.
But to the net premiums the companies must add a loading to cover expenses
and contingencies. It is thus clear that in the regular conduct of its business
a life-insurance company might derive a surplus- from three principal sources:
(1) a higher return on investments than the rate assumed for premium and
reserve computations, (B) a lower death rate than that indicated by the
mortality table employed, and (3) a saving in the loading because total
expenses are less than the total loadings. Although the sums derived from
all three sources are usually called surplus earnings, it should be noted
that the last two are really in the nature of a salvage and that only the
first interest earnings on investments in excess of the assumed rate may
be truly characterized as a profit. A few minor sources of surplus, such
as gains from the surrender or lapse of policies and from non-participating
business, should also be mentioned, but these sources are usually of much
less importance than the other three.