David H. Kinder, RFC®, ChFC, CLU
Understanding Life Insurance Dividend Payout Announcements
Updated: Jan 20
This is about the time of the year when all the major mutual insurance companies announce their annual dividend rate or payout. I just got an email from [company name omitted] about theirs (which is being reduced by 50 basis points) and I've been hearing about other companies and their announcements. What is a dividend from a mutual insurance company? A dividend is sharing in the profitability of the insurance company. As a participating policyholder, you are entitled to dividends if a dividend is declared.
What are the major components that make up the dividend?
There are three major factors:
General investment account performance
Mortality claims processed (if better or worse than actuarily projected)
Overhead operating expenses
(Note: #3 for overhead operating expenses... is why it's in the client's best interest that agents are paid by commission - by finding favorable risks to purchase insurance and are only compensated after they source that business.)
Dividends are not guaranteed.
This is mentioned in all the literature, disclosures, and illustrations. It is the non-guaranteed parts of the illustration because we don't know what will happen in any given year. Dividends may be more or less favorable.
Dividends are NOT a Rate of Return!
It's unfortunate that there are agents that say "Look, our policies pay 6%" (or whatever) as though you're going to get that credited to your policy every year. Unfortunately that's not how it works. I was also quoted extensively in this article on Ethics.net about these kinds of practices: https://www.ethics.net/articles/misrepresentation-and-ignorance-a-dangerous-blend-for-ethics
The Insurance Pro Blog guys put out a very good whitepaper titled: "What You Need To Know About Life Insurance Dividends: Why the Dividend Rate is only Part of the Story" In it, they discuss that the % means nothing without knowing the actual amount to be divided. After all: 8% of $100,000 ($8,000) is far less than 4% of $5,000,000 ($200,000).
Not all policies receive will equal dividend treatment
New policies with little to no cash values will get very little dividends. Look at your illustration for the column on dividends. They start small and then grow over time (assuming the dividend scale remains constant). Dividends are distributed based on:
- Age of policy
- Funding level of the policy (minimal funding gets less dividends than max funding) - Underwriting classification. Standard gets the LEAST dividends while "ultra preferred" and "rated" policies get better dividend treatment!
The secret the IRS doesn't want you to know about dividends: Dividends have been classified as a "return of overcharged premium" because the company didn't need it (it was profitable). Critics of whole life insurance claim that makes it a ripoff because you're being "over-charged". Here's the deal: Keep looking further down that column of dividends. Won't there be a point when the dividends EXCEED what you paid into the policy? If dividends were limited ONLY to the amount you were "over-charged"... wouldn't the dividends stop after you got your money back? But they keep going!
David, that's great, but why do some companies show less of a dividend reduction than others? Why are some being more level and some are reducing their dividend? Can you explain that? Yes, I can. And we simply have to look at their policy structures. In short, if a company is keeping their dividend rate more level... then they aren't paying much of a dividend on their newer policies. While the companies who are reducing their dividend are probably paying SOMETHING on their newer policies. Let's consider one large mutual insurance company (without naming names). They are projected to barely touch their dividend rate. However, they recently stopped issuing a 10-pay life policy in favor of a 12-pay and a 15-pay. (In fact, they changed their 10-pay policies to make them MEC (Modified Endowment Contracts) so they LOSE their tax benefits!) Now, if you stretch out the premium payment period for a similar death benefit, won't the payment go lower? Won't that reduce the amount of dividend to be paid out in the early years? It's simply a matter of understanding their policies and how they are being used. [Name omitted] may have a reduced dividend, but they are still very competitive as a policy for the strategic use that we use them for our clients. Other companies may be playing the "dividend % rate" game... but I won't. Dividends may not meet illustrated expectations, but I still want a quality company committed to paying dividends, doing quality business, and helping our clients to solve the problems that we can help them solve. Quite frankly, dividend rate percentages have very little to do with it.