Meaning of the Terms "Divisible Surplus" and "Dividends"

Having ascertained, the amount of surplus for all policies, the company may next set aside out of this amount a so-called "contingent reserve." The balance of the surplus fund may be considered as "dividend" or "divisible" surplus, the terms having reference to that part of the surplus which the management of the company decides may be returned with safety to its policyholders. The sums thus returned are commonly designated as "dividends" or "profits", although these terms as used in life insurance should not, as is the case in business generally, convey the idea that the amounts returned represent the "chance element in production. Instead, we have already seen that, with the possible exception of excess interest earnings, surplus in life insurance consists of salvages, and dividends to policyholders therefore represent essentially the return of that portion of their premium payments which the experience of the company shows to be unnecessary for the payment of claims and the maintenance of reserves.

While the companies may, in the absence of legislation, use their discretion in determining the amount of surplus to be distributed there is a tendency to regulate this matter by statute. Thus, as a result of the New York insurance investigation of 1906, that state limited the amount of surplus which a company may withhold from policyholders, the limit varying from 20 percent, of the reserve liability in the case of smaller companies to 5 percent, of the reserve where the same exceeds seventy-five millions of dollars. The purpose of this legislation was to prevent the company from retaining more surplus than is necessary to offset the factors, such as fluctuations in the mortality rate and in interest earnings, which are apt to interfere with the payment of uniform dividends. It was felt not only that life insurance is not subject to unusual losses such as are experienced in fire insurance, and that the aforementioned limits are therefore conservative, but that a large surplus furnishes a constant temptation for the misuse of funds and for extravagance in the conduct of business.