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Ch 16 SURPLUS—AN INSURANCE COMPANY'S CAPITAL

Terms in this set (41)

Illustrative dividend calculation for a $100,000 ordinary life policy issued to a male aged 32 (reserve basis: full net level premium reserves, 1980 CSO Male Table, and 5.5% interest).

(1) Gross premium: $12.51 × 100 + $50 policy fee $1,301
(2) Net level premium: 100 × 8.51 851
(3) Loading: (1) - (2) 450
(4) Mortality contribution to 10th-year dividend
(a) 9th-year terminal reserve 7,653
(b) 10th-year terminal reserve 8,671
(c) Tabular cost of insurance:
{[100,000 - 4(b)]/1,000} × 3.29 301
(d) Mortality charge: 0.695 × 4(c) 209
(e) Return of tabular mortality: 4(c) - 4(d) 92
(5) Interest contribution: (0.0625 - 0.055) × [(2) + 4(a)] 64
(6) Loading contribution
(a) Expense charge: 0.115 × (1) + 35.00 + 20.00 205
(b) Return of loading: (3) - 6(a) 245
(7) Total dividend for the 10th-year: 4(e) + (5) + 6(b) 401

The steps in the calculation are as follows:

The gross premium for the policy in this example is $12.51 per $1,000, plus a policy fee of $50. This premium is the net level premium ($8.51 per $1,000), computed using mortality from the 1980 CSO Male Table and 5.5 percent interest, plus loading.
The loading—developed in Table 13-1 of chapter 13 and used in this example—is 16 percent of the gross premium, plus $2 per $1,000, plus the policy fee
of $50.

The mortality contribution to the 10th-year dividend is the tabular cost of insurance minus the actual mortality charge for the 10th year.

The tabular charge in this example is the net amount at risk, multiplied by the 1980 CSO Male Table rate at age 41, 3.29 per 1,000, which yields $301.

The actual mortality charge is the percentage of actual to expected mortality for age 41 multiplied by the tabular cost of insurance.
The rate of mortality used in the calculation of an actual dividend varies by attained age and reflects the
company's own mortality experience during recent years. If we assume the actual rate of mortality at age 32 is 65 percent of the 1980 CSO Male Table
rate and that the percentage increases by one-half point for each year of attained age, the assumed actual rate of mortality at age 41 would be 69.5
percent of the rate reflected in the table.

The mortality saving at attained age 41 is 30.5 percent of the tabular rate.
Therefore, the mortality charge would be $209, which, deducted from $301, gives a mortality saving for the year of $92.

The interest contribution at all durations is calculated by multiplying the initial reserve for the year in question plus the net level premium by the difference
between the assumed rate of interest and the so-called dividend rate of interest.
While the latter will bear a close relationship to the actual rate of interest the company earned in recent years, it might deviate in either direction in any particular year.

In the illustration, the dividend rate of 6.25
percent produces an excess interest factor of 0.75 percent when compared to the assumed rate of 5.5 percent.

Applying this factor to the sum of the initial reserve of $7,653 produces an excess interest contribution of $64 for the year.

The loading in our example is 16 percent of the gross premium, $2.00 per $1,000 of insurance, and a per-policy expense of $42.
Of this, 2.4 percent of the gross premium, $1.25 per $1,000 of insurance, and $3.00 per policy were
included intentionally to provide future dividends.

The difference between actual expenses and the policy's loading for our $100,000 example policy
provides a savings of $245. This amount is available for dividend distribution, a portion of which may well have been included in the loading formula for that
specific purpose.
The assumptions described in this dividend illustration result in a total dividend of $401—that is, $92 from mortality savings plus $64 from excess interest, plus $245 from expense savings
Such a test combines a given set of gross premiums, surrender values, and dividends with realistic assumptions about mortality, interest earnings, expenses, and voluntary policy terminations. The result shows whether the accumulated asset shares for the various plans, ages at issue, and durations meet the requirements of both adequacy and equity.

An existing dividend scale should be tested periodically to assure that it meets
the same objectives.

Over the life of any block of policies the aggregate dividends distributed will be somewhat less than the amount contributed to surplus.
This is necessary if the company is to accumulate and maintain a contingency reserve sufficient to protect it from its liabilities.
That is an objective of well-managed companies. As reserves increase, whether from the sale of
new policies or the natural progression under old policies, the absolute size of the contingency reserve must also increase.
Apart from interest earnings on the contingency reserve or "free surplus,"65 the only source of
such funds is the current earnings from policies. Therefore, even over the long term, something less than the net additions to surplus from all blocks of
policies will be returned to policyowners as dividends. Equity demands that each group of policies bear a share of this cost.
This is just another way of saying that a policy's asset share should eventually exceed the reserve and
that management expects each policy to make a permanent contribution to the company's surplus.