As much of the business taken on by companies was very long-term, they did not need to keep all the reserves in the bank. Investments in Government securities, property and shares were made, and these helped to increase the surplus achieved. As the presence and predictability of the surplus was recognised, companies split their policies into two classes, those participating and those not participating in profits, with different rates of premium. What the companies were saying, in effect, was that according to the necessarily conservative assumptions of the actuary, suchand-such a rate of premium was necessary at such-and-such an age.
This would be the non participating rate.
Those prepared to pay a higher rate of premium for the same sum assured would, however, be allowed to share in the surplus achieved.
This surplus would arise first from the investment of the extra premium paid by the participating policyholders, and from any surplus arising on non-participating business as a result of the conservatism of the assumptions made by the actuary in setting premium rates; secondly from any reduction in mortality rates over the period; and thirdly from any reduction in operating expenses below those anticipated.
From this it might seem that non-participating (or nonprofit) policyholders were getting a raw deal, but this is not the case.
The actuary's assumptions proved conservative on two accounts.
First, mortality declined.
It has done so fairly steadily for over a century, and, though we now know this has happened, actuaries cannot simply extrapolate and assume the trend will continue, since to do so would lead, among other things, to the conclusion that humans would all become close to immortal within a few hundred years. Premium rates have therefore to be set on the basis of historical mortality statistics, so as mortality improves there is a tendency for each generation of policyholders to "subsidise" the next through the accumulation of surpluses due to greater longevity. Secondly, the actuary may have regard to historical experience in assuming a future rate of interest to be earned on the funds. So long as money values and interest rates are fairly stable, this presents no problem, but in the past 25 years, for example, the general trend in interest rates has been one way - up - so that interest-rate assumptions have in almost every case been proved very much lower than those actually achieved. The funds have therefore earned far more than expected, and a larger surplus has accrued.
Planning a Scheme
The actual operation of a modern life insurance company is extremely complex, involving all the aids of modern technology and especially, of course, the computer. But the essential principle is simple. Let us assume that we were planning a scheme whereby 1,000 men all aged 45 would agree to pay into a common fund each year of their lives enough to pay out £111,000 to the dependants of any of them who died during any year. From Table 1 on p. 3, it is possible to determine fairly precisely just how many of the 1,000 will die in any year. In Year 1, on the basis of the mortality... see: Insurance and Investment