Methods of Distributing the Surplus According to the Time of Distribution

Dividends may be paid either annually or on the deferred-dividend plan. The annual-dividend plan is now most generally used by companies issuing participating policies, and in certain states is required by statute. The dividends, as will be shown later, may be used to reduce premiums, to purchase paid-up additions, etc. In nearly all the well established companies these dividends gradually increase from year to year because the increasing reserve value of the policy results in an increasing surplus through the operation of the excess interest factor.

Deferred dividends, as distinguished from annual dividends, refer to those which, according to the terms of the policy, are not payable until the close of a stipulated number of years, such as five, ten, fifteen or twenty years. Policies providing for payment of dividends in this manner are commonly called "deferred-dividend", "accumulation", "distribution", or "semi-tontine" policies. The underlying principle of the plan is that those policyholders who fail to continue premium payments to the end of the designated period because of death, surrender or lapse, lose the dividends which they would have received under the annual-dividend plan, and that the dividends thus lost revert to those policyholders who continue their premium payments throughout the deferred-dividend period. The system as used at present must not be confused with the so-called "tontine" plan, which was at one time extensively used in the United States and which provided for a forfeiture of both dividends and policy value upon failure to pay a premium, the entire forfeiture accumulations being divided among the persisting policyholders at the close of the designated dividend period. As distinguished from this plan, the deferred-dividend system applies the forfeiture idea to dividends only, and thus reduces the chance of large gains being derived from the surrender or lapse of policies.

But even in its present form the deferred-dividend plan seems to be losing favor with the public and is being superseded by the annual distribution system. The latter plan, it is argued, is not only well adapted to the policyholder who wishes to keep his annual premiums to the lowest possible figures, but also serves the purpose of making the company economical in the management of its business since extravagance will at once be revealed by a reduction in the annual-dividend distribution. The deferred-dividend system, on the other hand, has met with much opposition in recent years, although the plan has also many able supporters. Briefly outlined, the arguments advanced against and in favor of the plan are the following:

Against the plan it is argued:

1. That it is the reverse of insurance, the fortunate survivors benefiting at the expense of those who die.

2. That the plan is frequently not understood by the insured at the time the contract is issued, or, if understood, its significance is not properly appreciated.

3. That the plan furnishes a temptation towards .extravagance in that it gives the company possession of large unassigned surplus funds. This is especially true where an accounting to policyholders is deferred until the end of the dividend period, whereas under an annual distribution plan such extravagance would not be likely to occur since it would come to the immediate notice of policyholders. It is for this reason that some of the companies using the plan give an annual accounting to their policyholders of the amount of surplus standing to their credit, thus enabling them to judge whether the company is properly managed.

4. That the plan has been responsible in the past for extravagant estimates on the part of agents as to the amount of dividends that would be realized by policyholders who would continue premium payments to the end of the dividend period. In fact much of the opposition to the system was occasioned by the fact that the estimates made far exceeded the results obtained, thus causing many policyholders to labor under the impression that they had been deceived by the companies.

In favor of the plan it is argued:

1. That it represents an understanding between the insured and the company which is clearly set forth in the contract and which should be known to the insured at the time the contract is issued. It follows that the plan is not morally wrong and works no injustice to the policyholder since he has the right to have his dividend payments deferred and conditioned upon the payment of premiums during the whole of the stipulated dividend period.

2. That with reference to a company's solvency the plan is more advantageous than the annual distribution system in that it enables the company to retain control of a large fund which is free from any definite liability and which will serve as a protection against the depreciation of the company's assets in time of financial panic or business depression. The shortcoming of the annual distribution system, it is argued, lies in the fact that the company, owing to the strenuous competition prevailing in the business, may possibly endanger its solvency by too liberal a distribution of its surplus funds.