Policy Loan Utilization Factors in Dividend Distribution Formulas

Abstract

This article presents the results of a study of dividend distribution formulas that recognize either individual policy loan activity or class policy loan activity. Redistribution measures are developed to measure the intraclass redistribution of surplus that would be required if the individual loan dividend formula were used instead of a class loan formula or one that does not reflect policy loan activity. This article extends the results of a previous study of dividend distribution into the area of policy loan utilization [7]. The possibility of including in dividend distribution formulas a variable that recognizes policy loan activity on a particular policy or group of policies has been discussed, sometimes heatedly, in the insurance literature [ 1, 2, 3, 5, 9, 10]. The primary purpose of this paper is to describe and evaluate the major ways in which dividend distribution formulas might be altered to reflect this loan activity. Dividend Formulas Recognizing Policy Loan Variables Three basic approaches to recognizing this activity have been suggested. The first, and simplest, would pay dividends that vary with the interest rate in the policy loan provision. The second would vary the dividends according to individual policy loan experience. The third would calculate dividends that reflect class policy loan experience. Dividends Varying with the, Policy Loan Interest Rate Separating policies into dividend classes by recognizing differences in the contractual policy loan interest rates is one possible basis for dividend refinement. These new classes would permit greater equity' among policies with different policy loan interest rates than a structure that treats all policies with other similar characteristics as a single class. A dividend refinement recognizing differences in contractual policy loan interest rates would credit the interest gain based on the investment earnings attributable to each class. The investment experience for all policies with the same contractual loan rate would be combined and would include earnings from policy loans. Thus, the dividend interest rate would reflect the average Norma L. Larsen is an Assistant Professor of Finance and Business Economics at the University of Southern California. She has a Ph.D. from the University of Pennsylvania. ' For an extensive discussion of alternate definitions of equity, see [6].