SURPLUS WHENCE DERIVED. In the conduct of a life insurance company, profits or salvages may be made in all or at least in some of three ways, viz. : higher returns from investments than at the rate of interest assumed in computing net premiums and reserves, a lower amount of mortality claims than was expected, according to the table employed, and expenses and disbursements less in the aggregate than the load ings of the premiums received.
But one of these, the excess of returns from invest ments over interest at the required rate, is genuinely a profit. Both the others are really salvages. Yet the three are usually grouped together and called surplus earnings.
A due regard for prudence dictates that the rate of in terest assumed in computing net premiums and reserves shall be so low as to assure that it can be realized through a long term of years, and that the mortality table shall represent mortality which may reasonably be expected by the average company, operating under like conditions, with a moderate margin for safety. These precautions make it all but certain that, for a time at least, there will be gains from excess interest and salvages on the expected disbursements for death losses. In other words, net pre miums, when so computed, are certain to be slightly re dundant.
Originally, one of the declared purposes in loading participating premiums was to provide for a definite bonus or dividend to be returned to the insured, in addi To' tion to other gains and salvages. This is still true in Great Britain and some other countries; but, owing to competitive conditions in• the United States as to agents' first-year commissions, it was until recently deemed that a company did well to keep its expense disbursements just within the aggregate loading, even though the business were large and on the full-participating plan. A few companies saved a fair percentage of the loading by con tenting themselves with a very moderate new business. As has been shown, however, unless preliminary term or some substitute for it has been adopted, the expense in curred the first year of insurance is greatly in excess of the loading on the first year's premiums. This excess alone absorbs the margins in the loadings on renewal pre miums, if new insurances, equal to about one-third the insurances in force at the beginning of the year, are se• cured at the then prevailing rates of commissions. The rates of commissions payable under the restrictions of the Armstrong laws would admit of nearly one-half being written, if all the margins of old and new premiums could be and were so applied.
The difference between the aggregate "costs of insur ance" that is, the sum of the net tabular mortality costs of the actual insurance and the actual death losses, less reserves released at death, is accounted a clear gain or salvage. This salvage is sometimes called suspended mortality, meaning that all must die some day; payment is merely deferred.
The assumption involved in calling the salvage on mortality a true gain is this : The lives which complete the year, no matter if there have been fewer losses than as per the table during the year, have as good vitality and as good chances of life as the persons at their attained ages, from whose lives the experience was taken which made up the mortality table. Therefore, their future 102 premiums, with their present reserves, assure the payment of their claims; and the premiums which have been re ceived in excess of the needs of the past and of the rein surance reserve, may therefore be considered a true sur plus.
Another source of gain to individual policyholders, but at the cost of others, which was once paraded as likely to yield very large returns, is from forfeitures and sur render charges. Estimates of enormous profits, based
upon conditions as to lapsation that were passing away, were indulged in a few years ago. Usually these esti mates were honestly made, and were not larger than at the time appeared, both to prudent business men and to experts in life insurance, to be reasonable. Thus the first figures employed by one of the leading companies which issued these "tontines" were submitted to the lead ing American actuary of that day, Sheppard Homans, and were endorsed by him as conservative; though in the event they proved to be preposterously high.
The gains were of this nature : The reserves of poli cies which were terminated by lapse during a term of ten, fifteen or twenty years, which had been selected by the insured in advance, were forfeited to the persistent policyholders. These gains proved to be much smaller than was expected, partly because interest was not at so high a rate as was anticipated, but chiefly because the gains from forfeitures were much smaller and were, per haps, almost wholly offset by the increased expense in curred in procuring applications for policies which were subject to so harsh conditions. The accumulated gain from forfeitures in some instances, as to which detailed statements were furnished, added but two or three per cent. to the total accumulations of surplus.
The harsh and unfair character of the "full tontine" insurance provisions was relaxed after a time as regards 103 new policies; and the condition was substituted that only the surplus, if any, over the reserves should be forfeited, 'liberal surrender values being allowed from the reserve. The deceptive nature of gains from forfeitures is suffi ciently indicated by the fact, attested by the managing actuary of one of the largest companies, that of two policies of the same kind, age of insured and year of issue, the one with full tontine provisions completed its twenty-year term with a smaller accumulation of surplus than the one which provided for forfeiture of surplus only.
The disappointing character of the tontine gains actu ally realized was soon so far forgotten that certain com panies, organized for the purpose, were able for a time to make representations that accumulated profits of from 661 per cent. to Poo per cent. could be realized on en dowments maturing in ten years, because of gains from forfeitures; whereas the largest gains, under more favor able conditions, both as to interest and economy of man agement, had been only from one-third to one-half of the lowest of these percentages. The actual returns on poli cies sold by these representations were about 10 per cent.
Under accumulated surplus plans, as applied to endow ment insurances, with the distribution term the same as the endowment period, the accumulation, including re serve, exceeds the sum insured during the last years of the period, so that there is a positive gain to the sur vivors because of deaths during these years. In com parison with plans where surplus is withdrawn annually or is applied to increase the sum insured, there are such gains in event of death at any time, for the surplus that would have been paid to the deceased policyholder dur ing his lifetime or to his beneficiaries in increased benefits is forfeited to the survivors.
The reason these gains were illusory, even when they should have been considerable, is that they were fully absorbed by the larger expenses incurred by the com panies, largely in the form of wasteful expenditure to se cure new business.