Final answer:
The policy that may pay dividends to policyholders is known as a participating policy, which is associated with mutual insurance companies. These dividends are paid from surplus funds when the company's performance is better than predicted, and are distributed to policyholders in various forms, differentiating it from stock dividends.
Step-by-step explanation:
The type of policy that may pay a policyholder a dividend when there is a surplus is a participating policy, commonly found in life insurance. Participating policies are offered by mutual insurance companies, rather than stock insurance companies. With these policies, the policyholder is entitled to a share of the company's profits, which are distributed as dividends. The dividends can be taken as cash, left to accumulate at interest, used to reduce premiums, or used to purchase additional insurance. In contrast to participating policies, non-participating policies do not pay dividends.
It's important to note that dividends are not guaranteed and are paid out of the insurer's surplus funds. Surplus arises when the actual life insurance experience in areas such as investment earnings, mortality and expenses are more favorable than the insurance company predicted in setting its premiums. As such, dividends are issued as a partial refund of the premium paid and thus differ from stock dividends, which are paid out from a company's profits to the shareholders based on the number of shares they own.