Valuation and Surplus, 1800-1952

The need for a valuation of life assurance liabilities arose with the introduction of the regular premium whole-of-life assurance policy. Level premiums for an increasing risk implied that a portion of the premiums received in the policy’s early years must be reserved to fund the larger frequency of claims that was expected to occur in later years. A liability valuation determined how much needed to be reserved. This was well-understood by James Dodson in his original designs of whole-of-life assurance in the mid-1750s. What he did not anticipate was that by the end of the century a test of whether adequate reserves were being held would be necessary for two distinct purposes: to determine if the fund was solvent (i.e. if it had sufficient assets to meet its contractual liabilities); and to determine how much surplus could be distributed to the with-profit policyholders (and how the distribution should be equitably allocated across different policyholders).

Through most of the near-150-year period between the Napoleonic Wars and end of the Second World War, the prudent with-profit premium rates of the established British life offices had led to an embarrassment of riches. The demonstration of solvency with respect to life office’s contractual liabilities could be done with relative ease and was not a particular focus of actuarial minds. The other side of this coin was that significant surpluses were being generated that had to be distributed to with-profit policyholders, at least in part.

With-profit funds were a form of pooled investment vehicle. There were no set rules on how the earned surplus should be distributed between current policyholders and the ‘estate’ of the office; or, once the policyholders’ allocated surplus was determined, how it should be distributed across the different generations of current policyholders. Questions such as these featured prominently in the thinking of the British actuarial profession from the 1850s onwards, and triggered some of its most impassioned debates. Fundamentally, two distinct tasks arose in determining with-profit bonuses: determining how much surplus had arisen over a period by measuring the changes in the values of assets and liabilities; given the determination of the surplus, decide how much to distribute to existing policyholders and how to distribute it amongst them. We will return to methods for distributing the surplus at the end of this section. First we consider how actuarial thinking developed on how the size of surplus was determined through the valuations of assets and liabilities.

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