Experts offer three possible approaches to equitable treatment of a withdrawing policyowner. Each approach produces different costs for the insurance. At one extreme, the policyowner receives no refund of any amount. According to this view, the function of life insurance is viewed solely as providing benefits upon the death of the insured. Those who "drop out" of the venture forfeit all payments and all interest in the contract. This view generally has not been accepted since the early days of life insurance.

At the other extreme, it might be argued that terminating policyowners should receive a refund of all premiums paid, plus interest at the contractual rate, less a pro rata contribution toward death claims and the premium loading. A contract with such generous surrender values implicitly assumes that expenses occur evenly throughout the policy�s premium-paying period and that the premium is sufficient to absorb expenses that arise each year. A separate process to find surrender values is not needed; withdrawing policyowners receive exactly the reserve under the policy. When higher expenses occur in early policy years, this approach leaves persisting policyowners to pay those costs that remain unpaid when a policy ends during its early years.

Supporters of this view argue that the healthy growth of a company benefits all policyowners and therefore the cost of acquiring new business should be charged to all policies. Strictly applied, this approach charges all acquisition expenses to the entire body of policyowners. A modified approach charges existing policyowners some acquisition costs of new policies.

The third and prevailing approach holds that a withdrawing policyowner should receive a surrender benefit�either cash or some form of paid-up insurance�approximately equal to the amount contributed to the company, minus the cost of the protection received, minus the expenses of establishing and maintaining the policy. Ideally, a policyowner�s withdrawal should neither benefit nor harm continuing policyowners. The maximum benefit to a withdrawing policyowner would be a pro rata share of the assets accumulated by the company for the block of policies�that is, by definition, the policy�s asset share. The actual surrender benefit should be reduced below the asset share, however, for several reasons.

A company will usually reduce the surrender benefit to an amount less than the asset share of a surrendered policy. Five possible explanations for this include the following:

In addition, it could be argued that surrender benefits may need to be limited to prevent their payment from threatening the solvency of the insurance company.

Over the years actuaries have speculated about the effect of voluntary withdrawals on the mortality of those persisting in the insured group. Some actuaries maintain that most voluntary terminations result either from a reduced need for insurance protection or from a change in the insured�s financial circumstances. They reason that termination occurs with little regard for the state of the insured�s health, and they see little adverse mortality selection in withdrawals.

Other actuaries argue that persons in extremely poor health are not likely to surrender their policies and will instead borrow to maintain their protection. Many believe that those who do surrender are, on the average, in better health and can be expected to live longer than those who do not surrender. If surrender values are too high, the accumulated funds may not be sufficient to pay the death claims of the remaining policyowners. In view of a lack of conclusive data on the subject, some companies withhold a small portion of the asset shares from surrendering policyowners in order to offset any adverse selection that might occur.

It has been observed that many terminations, particularly cash surrenders, tend to increase sharply during periods of economic crises and depressions. In addition, many cash surrenders occur when market interest rates are higher than those provided on life insurance cash values. Terminations reduce the inflow of cash to the company and, if cash is demanded, increase the outflow of cash. A company may be adversely affected (1) if it has fewer funds to invest at what might be an attractive rate of interest, and (2) if it is forced to liquidate assets at depressed prices. The policyowner�s right to demand the cash value of a policy at any time forces the company to maintain a more liquid investment portfolio than would otherwise be necessary. This reduces the yield on the portfolio. Most companies charge terminating policyowners with the resulting loss of investment earnings by reducing surrender values below what would be otherwise available.

Sound life insurance management demands that each group of policies ultimately pay its own way, including a provision for adverse contingencies like wars and epidemics. Newly issued policies depend on prior accumulations to provide these protective margins. Later those same policies leave the company with something less than the actual accumulations as a surrender value.

The difference between a policy�s accumulation and its surrender value varies with the size of the company. The law of large numbers tells us that predictability increases with greater numbers. Applying the law of large numbers to contingency reserves means that a larger contingency reserve is needed per policy on a small block of business than would absorb the same financial variation in a larger block of business. The primary objective, as always, is safeguarding the security of the policies remaining in the group.

Little needs to be said on this point, except that in a stock company, a deduction may be made from the asset share of the surrendering policyowner to compensate stockholders for the risk borne by capital funds. The size of the deduction varies depending on the level of profits already distributed to stockholders.

All companies incur expenses to process the surrender of a policy. Some companies estimate aggregate expenses for surrenders and include them as part of the loading in the premium for all policies. Other companies charge the cost of the transaction to the particular policies involved by deducting it from the surrender value that would otherwise be available. Under the latter practice, the cost of surrender is a deduction from the asset share.

In practice, surrender benefits must be limited if their payment might impair the security of remaining policyowners. When balancing the interests between terminating and continuing policyowners, conflicts are resolved in favor of continuing policyowners. Placing higher priority on the interests of continuing policyowners is consistent with general contract law. The party to a contract who is willing to continue under its original terms is not made to suffer through the inability or unwillingness of another party to honor the contract.

On the other hand, modern insurance contracts include surrender value as part of the policy�s benefits. A policyowner who chooses to withdraw the surrender value arguably acts within the terms of the contract as much as the policyowner who keeps a policy in effect until it matures. Nonetheless the argument justifies favoring policyowners who wish to continue under the original terms of the contract.