A central feature of these policies is the dividend. Understanding how these dividends work is key to evaluating whether a participating policy aligns with your financial goals.

What is a Participating Policy?

First, it’s essential to distinguish a participating policy from its counterpart, the non-participating policy. A participating policy is a contract where the policyholder is entitled to receive dividends, which are a return of excess premiums. A non-participating policy has fixed premiums and benefits, with no dividend payments.

When you pay a premium for a participating whole life policy, a portion covers the pure cost of insurance, administrative expenses, and contributes to the policy’s cash value. The premium is typically set at a conservative, higher rate than the insurer’s current best estimate of future costs. If the insurance company performs better than its conservative assumptions—through investment returns, mortality experience (fewer claims than expected), and operational efficiency—a surplus is generated. This surplus is the pool from which dividends are paid to participating policyholders.

Understanding Dividends:

They Are Not Guaranteed

A critical point is that dividends are not guaranteed. The insurance company’s board of directors declares them annually, based on the company’s actual performance. While many mutual insurance companies (which are owned by their policyholders) have a long history of paying dividends, they are not an obligation. They should be viewed as a non-guaranteed, potential return of premium.

Sources of Dividend Surplus:

Actual death claims are lower than anticipated in the premium calculations.

The insurer’s general investment portfolio earns more than the conservative rate assumed when pricing the policy.

The company operates more efficiently than projected, lowering administrative costs.

How Can Policyholders Use Dividends?

When a dividend is issued, policyholders typically have several options for its use, offering flexibility in managing the policy:

Receive the dividend as a direct cash payout. This provides immediate liquidity but removes the funds from the policy’s long-term growth potential.

Apply the dividend to offset the next premium due. This effectively lowers your out-of-pocket cost for maintaining the policy.

Leave the dividend with the insurance company to earn interest in a separate account. These funds remain accessible for withdrawal or to pay future premiums.

This is often considered the most powerful option. The dividend is used to buy additional, fully paid-up whole life insurance coverage. This increases the policy’s total death benefit and its cash value on a guaranteed basis. These PUAs themselves can also earn future dividends, creating a compounding effect.

Use the dividend to buy one-year term insurance, temporarily increasing the death benefit.

The Impact on Policy Performance

The use of dividends, particularly through the purchase of Paid-Up Additions, can significantly enhance a policy’s long-term value. Over decades, this can lead to:
* Substantial growth in cash value beyond the guaranteed minimum.
* A meaningful increase in the total death benefit.
* The potential for the policy to become self-sustaining, where dividends eventually cover the entire premium cost.

Key Considerations for Buyers

* Long-Term Horizon: Participating policies are designed for long-term financial planning. The dividend mechanism’s benefits compound most effectively over many years.
* Company Strength and History: Research the insurer’s financial strength ratings (e.g., from AM Best, Standard & Poor’s) and its historical dividend performance. While past performance doesn’t guarantee future results, a consistent track record is a positive indicator.
* Illustrations Are Hypothetical: Agents provide policy illustrations that project future values using current dividend scales. These are not promises. Scrutinize the guaranteed values (which are low but certain) versus the illustrated values (which use non-guaranteed dividends).
* Tax Treatment: Dividends are generally considered a return of premium and are not taxable as income until the total dividends received exceed the total premiums paid into the policy. Consulting a tax advisor is always recommended.

Conclusion

Dividends in participating life insurance policies represent a mechanism for policyholders to share in the favorable financial experience of the insurer. They offer valuable flexibility to enhance cash value, increase coverage, or reduce out-of-pocket costs. However, they are a non-guaranteed feature, making the choice of a strong, well-managed insurance company paramount. For individuals seeking permanent life insurance with the potential for growth and flexibility over a long period, a participating policy with a thoughtful dividend utilization strategy can be a powerful component of a comprehensive financial plan. As with any significant financial product, careful analysis and consultation with a qualified financial professional are essential steps before purchasing.