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Dividend payments are a feature of whole life insurance policies.  The dividend payment is a way for whole life policy owners to take part in the money an insurance company makes.  This is especially important for owners of policies with mutual life insurance companies, as the policy owners are also the owners of the company.

The dividend payment can be thought of as interest earned for keeping cash value in a whole life insurance policy.  Dividend payments are made once per year to policy owners, who have different options regarding how to utilize these payments.  The size of the dividend payment depends on a number of factors, but the amount is mostly influenced by the amount of cash value in a policy and the life insurance company’s financial performance during the year.  The dividend payment is usually made on the policy anniversary.

Factors Influencing Size Of Dividend Payment

The dividend payment is calculated based upon a number of factors, which can vary slightly from company to company.  Generally there are a few common factors taken into account when determining the dividend payment for any given policy.

  • Year beginning cash value of policy (net of loans).
  • Year end cash value of policy (net of loans).
  • Actual mortality and expense rates experienced by the company over the course of the year.
  • Company financial performance.
  • Amount of profit the company decides to retain in cash reserves for the year.
  • Prevailing interest rates (which influence company performance significantly).

Policy Cash Value Effect On Dividends

When determining the dividend payment, the higher the cash value of a policy the more the dividend payment will be, all else being equal.  The insurance company will take into account any loans against the policy value when calculating the dividend payment, so beware of the effect of loans. Generally more growth of policy value through premiums also leads to a higher dividend payment.

Mortality Rates Experienced Effects on Dividends

The mortality and expense charges experienced by the life insurance company reflect the quality of underwriting accuracy over time.  Severely misjudging risk is one of the greatest impediments to the long term financial stability of a life insurance company.  Every year the company can expect a certain percentage of their insured persons to pass away, resulting in death claims.  If fewer people pass away than statistically expected based on underwriting risk class and expected mortality rates for each class, the company will end up retaining more money than they expected.  Owning a policy from a company with strict underwriting standards and a favorable mix of risk classes can lead to actual mortality rates being lower than anticipated.

A lower than expected mortality rate will lead to a higher dividend payout, all else being equal.

Financial Performance of Company Effect on Dividends

The financial performance of the company ultimately plays a major role in the size of dividend payments.  Financial performance is influenced by multiple factors, which include factors that are part of the dividend calculation.  Financial performance depends upon the amount of money paid out in claims over the course of a year, the sales of the company, the amount of premiums paid to the company compared to the amount expected to be paid, and prevailing interest rates as these strongly effect the amount of money earned on company reserves, which are massive in terms of total assets.

All else being equal, higher company performance will lead to higher dividend payments made to policy owners.

Amount of Money Retained In Reserves Effect on Dividend Payments

Life insurance companies are required by law to keep a certain amount of money in cash reserves.  This minimum is called the reserve requirement, and these calculations are very complex.  Insurance companies are required to keep this large cash reserve base in case death claim payouts are much higher than expected over a given time period, due to a large scale disaster or poor underwriting for instance.  The reserve helps ensure that the company will be able to stay in business and meet all claim obligations over time.  A company may decide to retain more money than required by law in reserves.

Generally if a life insurance company decides to keep a higher amount of money in cash reserves for the year dividend payments will be lower with all else being equal.

Prevailing Interest Rates Effect on Dividend Payments

This can ultimately effect the dividend payment in two ways.  The first is higher interest rates lead to higher returns on the cash reserve account.  If cash reserves are earning more than needed, the surplus can be paid out in the form of dividends to policy holders.

The second way interest rates effect dividend payments are from a competitive standpoint.  If prevailing rates are high, but the amount earned on the cash reserve account is comparatively very low, people will be less likely to invest in a whole life insurance policy.  To some extent, life insurance companies must keep dividend rates competitive given the current interest rate environment in order to retain and attract new business.  Life insurance companies must also keep dividend rates competitive compared to other industry competitors.

Higher dividend payments will be paid when interest rates are higher, generally speaking, though life insurance dividend rates are notoriously slow to adjust both higher and lower which is in part a reflection on the duration of their bond holdings in the cash reserve account.

Uses For Dividend Payments

A policy owner has three options for directing their dividend payment.  Each option has merits and drawbacks, and may effect both the long term rate of return on a whole life insurance policy as well as the death benefit ultimately paid to beneficiaries.  Every owner should consider their options, the effect on the policy, and the tax consequences of their decision closely.  These are the three options for dividend payments.  The way a dividend is used can usually be changed easily by the policy holder at any time.  Check with your insurance company regarding rules for changing dividend options.  For an in depth discussion of the investment implications of various dividend choices, look at our discussion of life insurance as an investment.

Paid Directly To Owner

A dividend payment may be paid directly to a policy owner each year as a check.  This can be used to supplement income or retirement income and to realize an investment return from the policy without accessing cash value.  This is a taxable distribution which is taxable in the year in which it is paid.  This option makes the most sense after premium payments are no longer due for a life insurance policy and there is no need to increase the death benefit through the purchase of additional paid up coverage.

Used To Reduce Premium Payments

The dividend can be directed towards reducing premium payments.  As the dividend payment grows over time, the owner will be obligated to pay less and less for premium payments.  Eventually the dividend payment can usually pay the entire premium and the policy becomes self sustaining.  At this point the excess (if any) over the premium payment due can be used to purchase paid up additional death benefit or be paid out the policy owner.  Using this option makes sense for people looking to reduce their costs who do not need the additional death benefit.  If used to pay premiums directly the dividend is not taxable at time of payment.  This is another tax efficiency of life insurance.

Used To Buy Paid Up Additional Life Insurance

Finally, the dividend payment can be directed towards the purchase of additional paid up whole life insurance.  This has the duel advantage of both increasing the death benefit available for beneficiaries, and increasing the growth rate of the dividend payment through the higher guaranteed minimum cash value growth (paid up whole life insurance still has guaranteed cash value growth).  Some owners elect to do this for the duration of the policy, and others elect this option for a period of time to achieve higher future dividend payments and insurance coverage and then direct the dividend payment to other uses.  While the paid up additions are increasing cash value, it is still tax deferred growth.  In other words the dividend payment is not taxable when paid if used to purchase additional coverage, only the additional cash value is taxable if withdrawn.

Dividends Make Whole Life Insurance Extremely Valuable

As can be seen, the payment of dividends from whole life insurance makes whole life an attractive product for those people looking for long term coverage.  Dividends are useful in a number of ways, and when managed properly can provide substantial tax deferred growth in policy value as well as provide a high supplement to the income of the policy owner without effecting the death benefit of the policy.

To compare the cost of a whole life insurance for yourself or another, use the Life Ant quote comparison tool.