Methods of Apportioning the Surplus

Having outlined the sources from which the surplus is derived we may next pass to its apportionment among policyholders. The plan now generally used in the United States is known as the "contribution plan", or some modified form of that system. As its name implies, this plan aims to credit to each policy that proportion of the company's total surplus which the policy in question has "contributed". According to the plan "the surplus is rebated back to the insured precisely as it is considered that his policy has contributed it. Thus if the mortality has not been so high as was assumed, there is put into his dividend the proportionate saving on his own tabular cost of insurance. In like manner, if the expenses and contingencies have not absorbed all the aggregate loading on the premiums, there is given him in his dividend the proportionate part of his loading that has not been required for expenses and contingencies. If the average interest returns upon the mean assets have exceeded the rate assumed, he receives in his dividend interest at the additional rate upon the funds belonging to his. policy". Stated in the form of a debit and credit account, the policy is credited under this plan with (1) the terminal reserve at the end of the previous year, (2) the premium paid under the policy, and (3) the interest actually earned.on these two items minus investment expenses; and is debited with (1) actual expense of conducting the business, (2) cost of insurance as shown from the actual experience of the company, and (3) the terminal reserve of the policy at the end of the year. The difference between the two sides of the account is regarded as the surplus contributed by the policy under consideration.

Although regarded as theoretically sound in principle, numerous difficulties arise in the application of the plan and many modifications of the system are therefore found in actual practice. In applying the system some companies employ the "two-factor method" some use three factors, and a few even four. Under the two-factor method the surplus is usually divided into the following two parts: (1) that derived from surplus interest and (2) that derived from all other sources combined the gain from interest being distributed in proportion to the reserves and the balance of the surplus in proportion to the loadings. Where three factors are used, the elements referred to are saving from loading, saving from mortality and gain from excess interest. In the case of deferred dividend policies (those which defer the distribution of surplus to the policyholder until the end of a stipulated number of years) the dividends are usually computed in the following way: (1) the actual dividends which the policy would have received had it been on the annual dividend plan are ascertained; (2) these annual dividends are accumulated at compound interest up to the end of the dividend period; and (3) the accumulated amount of these annual dividends is then increased by a percentage in order to recompense the policyholder for the risk which he assumes under the deferred dividend system, and which is not assumed under an annual dividend plan, of losing the accumulated surplus through death, surrender or lapse during the distribution period.

The assessment of expenses probably presents the greatest difficulty connected with the distribution of surplus. By far the greatest part of the expenses of a life-insurance company is the initial expenditure incurred for the procurement of new business. With respect to this large initial expense some hold that it should be assessed against the new business, while others maintain that the new business is for the benefit of the company as a whole and that the initial expense should therefore be assessed against the company's entire business. Furthermore, many expenses, such as rent, office supplies, salaries, office expense, advertising, postage, etc., are of a joint nature and it is difficult to identify the same for the purpose of assessing them upon the numerous individual policies and groups of policies carried by an insurance company. This difficulty of properly assigning expenses to individual policies has been the subject of much discussion in recent years. Mr. Daniel H. Wells, for example, has suggested the following plan as the best method of most nearly attaining the equity which it is the aim of the contribution method to give: " Assess upon the investment income all investment expenses, upon premiums such expenses as are determined by the premiums, and upon the death cost, or what is technically called the cost of insurance, all other expenses". Yet this rule, as is probably also true of any other general rule that can be devised, still leaves the difficulty of identifying each of the numerous expenses of a company with reference to each individual policy. In his discussion of this complex question Professor Gephart is forced to the conclusion that "absolute definiteness cannot be secured, for the best devised principles for assessing insurance expense will meet many difficulties when the attempt is made to apply them".