two years, and in all states a surrender charge is permitted. This charge is often established by law, such as 24 per cent or 3 per cent of the insurance; in other cases it is 20 per cent of the reserve on the policy. The reason for establishing a surrender charge is that the insured has contracted with the company, that is, with the other members of the group, to remain in the organization until the close of the period of this contract, that is, for life or for a given number of years. The company has been at considerable expense in taking the insured into the group. He has been solicited to join; he has been examined by a physician, and the granting of the policy occasions extra expense and, as has been shown, his first premium leaves practically nothing after these initial expenses are paid. Life insurance is a coöperative arrangement to protect against contingencies which occur over a long series of years. If absolute freedom of withdrawal were permitted it might well happen that many risks would often withdraw. A penalty on withdrawal is thus established by the surrender charge, which is assumed to cover, in part at least, the expense of securing a new member to take the place of the withdrawing member.

Paid-up Insurance. The Paid-up Insurance Value is the amount of insurance which the cash surrender value will as a single premium purchase at the attained age of the insured. Since the cash surrender value depends upon the reserve, so the paid-up insurance also depends upon it. This results from the fact that the insured sometimes neglects or is unable to pay his premiums, although he may not voluntarily withdraw from

the company. Paid-up insurance may also be granted at the close of the period of an endowment policy, but it then also depends upon the cash value which is in turn dependent upon the accumulated reserve. The paid-up insurance is manifestly a larger sum than the cash or surrender values, since the latter sum is to remain with the company to draw interest to provide for the amount of insurance granted.

Extended insurance is also another result of the valuation policies. Extended insurance is that number of years and months beyond the date when the policyholder lapses his policy during which the policy as a whole still remains in force. If it is later matured by death, the company pays the sum assured minus any past debts with interest due to the company. The time of the extension depends upon the cash value of the policy at the time of the lapse, and results from the fact that the policyholder under the level premium plan has been paying premiums in excess of the cost of the insurance which has been accumulating with their interest

as a reserve.

REFERENCES

Dawson, Miles M. The Business of Life Insurance, Chaps. V, XIX.

Smith, G. W. Notes on Life Insurance, Chaps III, VII.

Yale Readings, Vol. I, Chap. XIII.

Report of Joint Committee of Senate and Assembly of New York, pp. 378-388, 418-429.

Insurance Guide and Handbook, Fifth Edition, Chaps. XIII, XIV. Practical Lessons in Actuarial Science, Miles M. Dawson, Vol. II. pp. 122-204; Vol. I, pp. 204-250.

CHAPTER IX

THE SURPLUS AND DIVIDENDS

THE methods of valuation discussed in the preceding chapter determine the legal solvency of an insurance company. But the test thus applied, if just met by an insurance company, is not a safe basis for operating the company. Any marked increase in the mortality or the expense or a depreciation of the investments would bring the company into bankruptcy. It is the practice, therefore, of all insurance companies to maintain a sum in excess of this minimum legal requirement. This excess is called a "surplus,' "the undivided surplus," "the contingency reserve," or unassigned funds."

The Surplus. "L The term surplus" is used in two leading senses when applied to the insurance business: first, that sum which remains at the close of any calendar year after death claims and the current expenses of conducting the company have been paid; second, the sum remaining after current expenses, annual death claims, and the reserve are deducted. It does violence to the ordinary meaning of the word "surplus" to apply the first definition. A somewhat parallel example would be for a person to borrow $32,000 to engage in a business. Suppose he pays $30,000 for the business, $2000 for equipment, and at the close of the year finds

that he has $3000 as a result of his operation. He would not be justified in claiming that he has a surplus of $1000 because he has $1000 remaining after he pays for his equipment. Nor would $500 be his surplus, if he allowed $500 for his services, for he owes $32,000 for the business with the interest thereon. Just so the life insurance company cannot call a surplus all that sum which remains after the current year's expenses and death claims are paid. A sum equal to the aggregate reserve on all policy obligations must be set aside.

Origin of the Surplus. Let us again consider the net premium in order that we may understand the composition and origin of the surplus. It will be recalled that a company assumed that a certain rate of interest could be earned and also assumed from the mortality tables that a certain number of claims would fall due. It was able then to calculate the sum which it would need to collect. To this sum, the net premium, it made certain additions, called loading, for the purpose of covering expenses and contingencies. There would thus be three main sources from which a surplus might be secured, namely, interest, mortality, and loading. That is to say, a saving might be effected from any one or all of these sources.

A fourth source of the surplus may be from the excess of the policy reserve over the surrender values on such policies when they are discontinued.

Surplus Interest. The rate of the interest which the insurance companies assume that they can earn on their assets has always been conservative, and in actual practice they have been able to earn more than the

assumed rate. The rates now most generally assumed are 3 per cent and 3 per cent. The expenses incurred in investing the assets are charges against the interest income. Since these investment expenses may amount at least to one half of 1 per cent on the assets, it is necessary to earn sufficient to cover the investment expenses in addition to the interest at the assumed rate before there is any surplus from interest. Many of the old policies now in force on the books of insurance companies were issued on a 4 per cent interest assumption, and on the reserve of such policies, 4 per cent interest must be earned in addition to the investment expenses before there is any surplus for these policies from interest.

In the later years of a policy when the reserves are large, the gain or saving from interest become important. Mortality Savings. The company has assumed a certain death loss, and if the actual mortality is below the expected, a saving will be effected. The importance of this saving may, however, be easily overemphasized. If the company had based its premiums on a mortality table of the general population, the mortality saving might constitute a permanent addition to the surplus, provided it had used care in selecting the persons for insurance. But the tables of mortality now in use are based on the experience of insured lives after the benefit of selection has disappeared. The actual results are therefore likely to approach through a long series of years the calculated results, although by a careful selection of new insurants the actual experience may be kept below the assumed. If, however, a very favorable