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VOLUNTARY RESERVES

In addition to the legal reserve, which is held to meet specific policy obligations, life insurance companies set aside various voluntary reserves, some of which may serve a special purpose and some of which may simply be another name for surplus. Special-purpose reserves may be set up to cover future declines in the market value of nonamortizable securities, to smooth out mortality fluctuations, to meet expenses under supplementary agreements, and the like. A general-purpose reserve is likely to be called a contingency reserve. In some companies the contingency reserve is the balancing item between assets and liabilities, and no surplus is shown. Since all of such special reserves are voluntary in nature, they can be used to meet any of an insurance company�s obligations.

In some states the amount of voluntary reserves, including surplus, that can be accumulated by a mutual life insurance company is limited by law. The purpose of such a limitation is to insure that the major portion of surplus earnings will be currently distributed to policyowners in the form of dividends. The accumulation is usually limited to 10 percent of the legal reserve as computed by the insurer. Therefore the more conservative the basis on which an insurer computes its policy liabilities, the larger the surplus or special reserves it can accumulate.

NOTES

The first part of this statement is not applicable to term insurance.
The number of deaths begins to decline after the 44th policy year because of the shrinking number of survivors; the death rate, of course, continues to increase.
It might be argued just as validly that through the 28th policy year interest on the accumulated fund makes a net addition to the policy reserve, depending on whether the cost of insurance is assumed to have been charged to net premiums or interest.
The general formula for the calculation of prospective reserves is as follows:
ktVx:n = Ax+t:n-t - kPx:n�x+t:k-t
V = full net level premium reserve
x = age of issue
k = number of years in premium-paying period
t = number of years elapsed since date of issue
n = number of years in policy period
A = net single premium
P = net level premium
� = present value of a life annuity due of $1
The notation n is used only in connection with term and endowment insurance contracts and temporary life annuities. A whole life policy is known to run to the end of the mortality table, so it is not necessary to show n values for it. If it is the ordinary life form, the k values can likewise be omitted from the formula since it is known that the premium-paying period is coterminous with the policy period. Thus the prospective reserve formula for an ordinary life policy can be expressed as follows:

tVx = Ax+t - Px�x+t

The reserve for any block of policies is usually calculated on the same basis no matter how long the policy remains in force. Therefore it is common for life insurers to have blocks of policies based on different mortality tables and different interest rates. For example, an insurer may have 12 blocks of whole life policies issued at age 30 based on the 1941 CSO Table, 20 blocks of policies issued at age 30 based on the 1958 CSO Table, and 10 blocks of policies issued at age 30 based on the 1980 CSO Table.
The determination of the effect on reserves that would be brought about by a change in mortality assumptions poses a mathematical problem of extreme complexity. For a discussion of the problem and the mathematical techniques, see C. Wallace Jordan, Jr., Life Contingencies (Chicago: Society of Actuaries, 1952), pp. 114-20; and E. F. Spurgeon, Life Contingencies (London: Cambridge University Press, 1947), pp. 112-16 and 188-90.
This is not true of term and other types of insurance policies whose reserves do not increase continuously to the date of expiration or maturity.
The valuation net premium is the net premium used in the calculation of the company's policy reserves, whether they are computed on the net level premium basis or in accordance with one of the modified systems.
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