Dividend Paying Permanent Life Insurance - In addition to protection and the ability to build cash value, many whole life insurance policies often offer a special feature that many policyholders find attractive: dividends.
But this feature, while it sounds simple, actually involves some complexity and comes with caveats. Hence, it is important to understand the ins and outs of dividends in order to appreciate the overall benefits that a whole life insurance policy can bring you.
Dividend Paying Permanent Life Insurance
First, dividends are not guaranteed. The total dividend amount and individual dividend payments are subject to change based on the insurance company's operating experience in any given year. Generally, when an insurance company does well in a given year, its policyholders receive a share of its distributable surplus.
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Second, the policy must be "participatory," that is, a type of insurance or other financial product designated by the insurance company as eligible for dividends.
Although dividends are not guaranteed, most insurance companies attempt to pay them on a consistent basis to eligible participating whole life insureds. MassMutual, for example, has consistently paid dividends since the Civil War. And as the company has grown, so has the total annual dividend payout, as shown in the chart below. (Learn more about MassMutual's latest dividend announcement here.)
Source: Massachusetts Mutual Life Insurance Company Annual Report, Year End, Summary of Operations, Dividends to Policyholders. These numbers reflect the dividends paid to policyholders. Dividends paid equal to the amount paid to eligible participating policyholders plus any increase in liabilities.
In general, insurance companies make money from policyholders' premiums. They are required by law to keep a certain amount of this amount in reserve to cover their long-term liabilities to the insured. Insurance companies generally invest these reserves in very conservative assets, such as high-quality bonds and commercial mortgages.
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Every year, the insurance company calculates the amount of its surplus that is allocated to the participating policyholders in the form of dividends. This is called a divisible surplus. It is the amount paid after the carrier has set aside the necessary funds to meet all contractual obligations, especially the reserve requirements for its policies, as well as what it expects to cover operating expenses, contingencies and general business purposes.
Dividends are declared and paid annually. However, since the Company cannot guarantee that a distributable surplus will be achieved each year, dividend payments cannot be guaranteed. It depends on the company's performance in these three areas.
The mortality component is based on actual death experience rather than the insurance company's estimated policy and premiums paid.
Performance in this area reflects how well an insurance company calculates and selects risk in underwriting operations. A company that is careful with whom it agrees to write life insurance and how it rates policy premiums is likely to have a more positive mortality experience over time. So at the policy level, the mortality component of the dividend is based on the policyholder's age, gender and underwriting class (their health and habits such as smoking) as well as the net sum assured. (face value minus cash value) in that year. (Related: How a Personal Health Record Can Lower Your Costs)
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In addition, an insurance company, like any other business entity, incurs costs while operating, from administrative costs to investment fees and salaries. As mentioned above, the company estimates premiums based on these costs and allocates funds to cover them.
The dividend expense component reflects the difference between the actual costs incurred in writing and servicing policies compared to the costs incurred in setting premiums over time.
Therefore, any increase in costs or decrease in efficiency will also be subtracted from the gross margin. So those considering a whole life insurance policy may want to examine the insurance company's corporate performance over time to see how well it has controlled costs over time. (Related: MassMutual's Financial Strength)
The third important element in determining dividends is return on investment. It is based on actual investment results for the insurance company that are more favorable than those required to support policy reserves and guaranteed cash value.
Vanishing Premium Definition
In determining premiums and guaranteed elements, insurers use conservative assumptions (guaranteed interest rates and mortality rates) to ensure that the company will collect enough money to pay all benefits in the future, even in unfavorable financial scenarios. Favorable investment results occur when the return on the company's actual investment exceeds the guaranteed interest rate required to meet the contractual obligations to the policyholder.
This is largely based on the trader's financial portfolio, which usually consists of bonds, stocks and other types of market investments.
That's why it's important for those buying whole life insurance to study the insurance company's holdings and investment philosophy, especially in terms of risk and stability. For example, MassMutual's investment objective is to generate competitive long-term results while maintaining the ability to withstand downturns in financial markets.
The chart below is MassMutual's holdings, which consist primarily of high-quality fixed income securities, but also invest in stocks, commercial mortgages, real estate and other assets.
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In addition to financial instruments, an insurance company can also achieve returns by investing in related areas of business, third party businesses and other ventures. Profits from these types of investments and operations can also add to a company's total surplus.
For example, MassMutual offers a variety of insurance products in addition to whole life insurance, such as annuities. Revenues from these areas help increase their surplus. MassMutual has ownership stakes in global asset management companies and wealth management operations, giving it access to the profits generated by those teams.
These types of business lines and investments can not only directly increase the company's surplus, but can also diversify the sources of income. This can soften the blow of other types of investment or business downturns.
The total return on the investment portfolio and other trading profits help support the company's dividend yield (DIR).
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, which is established annually by the company's board of directors. The investment component of the dividend is the difference between the DIR and the policy's guaranteed interest rate. So, hypothetically, if this guaranteed rate is 4 percent and the investment component is added to 2 percent, then the overall DIR will be added to 6 percent.
There is a temptation to compare life insurance dividends with other types of financial instruments, such as US Treasuries or corporate bonds. While such comparisons can be interesting and informative about relative performance, they are not quite "apples to apples".
For example, the chart below shows MassMutual's DIR compared to three common fixed income measures over the long term. Each measure reflects specific calculations for that measure. For example, policyholder mortality is not a factor in determining the US Treasury rate.
MassMutual's DIR is determined using the portfolio average method, which reflects the portfolio's return on all assets backing our participating permanent life insurance and participating annuity blocks. Each portfolio consists of investments acquired over a number of years, so changes in the interest rate on new money gradually affect the DIR. The stabilizing effect of the portfolio averaging method over time is one of the reasons MassMutual and many other insurers use this approach to determine dividend rates.
Dividend Paying Life Insurance
MassMutual's dividend yield refers to the MM business block, which comprised Massachusetts Mutual Life Insurance Company and the former Connecticut Mutual Life Insurance Company prior to the 1996 merger. According to the 2012 dividend schedule, there is one dividend interest rate for all blocks.
Moody's performance on experienced Aaa corporate bonds for all industries, with the dividend yield quoted for the previous year; For 2023, this is the average monthly rate from January to September of the previous year. Moody's Aaa rates through December 6, 2001 are the average of Aaa utility and Aaa industrial bond rates. As of December 7, 2001, these rates are averages for Aaa industrial bonds only.
The market yield on a constant maturity 10-year US Treasury note quoted at the dividend yield shown for the previous year; For 2023, this is the average monthly rate from January to September of the previous year.
The market yield on US Treasury securities with a 1-year perpetual maturity at the dividend interest rate quoted for the previous year; For 2023, this is the average monthly rate from January to September of the previous year.
Infinite Banking Concept
As mentioned at the beginning, those who purchase eligible participating whole life insurance policies can receive a dividend. The size of each policyholder's payout depends on how much their policy contributed to the company's surplus. Therefore, long-term policies with large death benefits will usually receive larger dividends than smaller policies taken recently.
Dividends are an important part of the overall value offered by permanent life insurance. But it is important to know how dividends are determined
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