Insurance companies earn profits by taking in more money in premiums than they pay out in claims to policyholders. Any excess profits earned by the insurer are referred to as a surplus.
Identification
Insurance companies are required by state laws to hold a certain amount of funds in reserve to ensure they always have enough money on hand to pay claims. A surplus is any amount over and above the reserve level.
Sources
Insurance companies can accumulate a surplus is a number of ways. Examples include interest and dividends earned on investments, surrender charges gained from cashed-in policies, sales fees and lower claims payouts than anticipated.
Significance
A large surplus is often a sign that an insurance company is profitable and in good financial health. Some insurance companies will use a surplus to award shareholders or policyholders in the form of dividends. It could even elect to lower premiums as a way to attract and retain policyholders.