Dividend Options (Participating Policies)
Participating policies (also called "par" policies) are eligible to receive dividends from the insurance company. Policy owners can choose from several options for how to use these dividends.
What Are Policy Dividends?
Policy dividends are distributions of the insurance company's surplus to participating policy owners.
Important Characteristics
| Feature | Description |
|---|---|
| Not guaranteed | Dividends are not promised; depend on company performance |
| Return of premium | Considered a return of excess premium |
| Not taxable | Generally not taxable until they exceed total premiums paid |
| Declared annually | Board of directors determines dividend amounts |
Sources of Dividends
Dividends result from favorable experience in:
| Source | Explanation |
|---|---|
| Mortality | Fewer claims than expected |
| Expenses | Lower operating costs |
| Interest | Higher investment returns |
Exam Tip: Dividends are NOT guaranteed. They represent a return of overcharged premium based on the company's favorable experience.
Cash Payment Option
The cash payment option pays dividends directly to the policy owner in cash.
How It Works
| Feature | Description |
|---|---|
| Payment | Check or electronic deposit |
| Timing | Typically annually |
| Policy effect | None—policy unchanged |
| Use | Policy owner uses for any purpose |
Advantages
- Immediate access to funds
- No restrictions on use
- Supplements household income
Disadvantages
- No growth in policy value
- No increase in death benefit
- No premium relief
Reduction of Premiums Option
The reduction of premiums option (also called premium reduction) applies dividends toward paying the policy premium.
How It Works
| Feature | Description |
|---|---|
| Application | Dividend offsets next premium due |
| Timing | At premium due date |
| Out-of-pocket | Reduced by dividend amount |
| Policy effect | None—same coverage continues |
Example
| Item | Amount |
|---|---|
| Annual premium | $2,000 |
| Dividend | $300 |
| Amount due | $1,700 |
Advantages
- Reduces out-of-pocket cost
- Automatic—no action needed
- Policy stays fully in force
Disadvantages
- No additional benefit accumulation
- No cash in hand
Accumulation at Interest Option
The accumulation at interest option leaves dividends with the insurance company to earn interest.
How It Works
| Feature | Description |
|---|---|
| Location | Dividends held by insurer |
| Interest | Credited at declared rate |
| Access | Can withdraw anytime |
| Death benefit | Accumulated amount added to death benefit |
Tax Considerations
| Item | Tax Treatment |
|---|---|
| Dividends | Not taxable until exceed premiums paid |
| Interest earned | Taxable as ordinary income annually |
Advantages
- Funds grow with interest
- Accessible when needed
- Increases death benefit
- Conservative, safe growth
Disadvantages
- Interest is currently taxable
- Lower returns than other investments might offer
Paid-Up Additions Option
The paid-up additions option (PUAs) uses dividends to purchase additional paid-up whole life insurance.
How It Works
| Feature | Description |
|---|---|
| Purchase | Small amounts of paid-up whole life |
| Death benefit | Increases by amount purchased |
| Cash value | Additions build their own cash value |
| Underwriting | No evidence of insurability required |
| Dividends | Additions may earn their own dividends |
Advantages
| Advantage | Explanation |
|---|---|
| Increasing coverage | Death benefit grows over time |
| Cash value growth | Additions have cash value |
| No medical exam | No underwriting required |
| Compound growth | PUAs can earn dividends that buy more PUAs |
Example
| Year | Base Death Benefit | PUA Death Benefit | Total Death Benefit |
|---|---|---|---|
| 1 | $100,000 | $1,500 | $101,500 |
| 10 | $100,000 | $20,000 | $120,000 |
| 20 | $100,000 | $55,000 | $155,000 |
Exam Tip: Paid-up additions is often considered the best dividend option for growing both death benefit and cash value over time.
One-Year Term Option (Fifth Dividend Option)
The one-year term option (also called the fifth dividend option) uses dividends to purchase one-year term insurance.
How It Works
| Feature | Description |
|---|---|
| Coverage type | One-year term insurance |
| Amount | Usually equal to cash value |
| Purpose | "Fills the gap" between cash value and death benefit |
| Renewal | Automatically renewed each year with that year's dividend |
The Gap Concept
In whole life, as cash value grows, it becomes part of the death benefit:
| Component | At Death |
|---|---|
| Pure insurance | Face amount minus cash value |
| Cash value | Included in death benefit |
| Total | Face amount |
One-year term fills this gap so beneficiaries receive face amount PLUS cash value.
Example
| Item | Amount |
|---|---|
| Face amount | $100,000 |
| Cash value | $25,000 |
| One-year term purchased | $25,000 |
| Total death benefit | $125,000 |
Advantages
- Maximizes death benefit
- Low-cost term coverage
- Protects cash value for beneficiaries
Disadvantages
- No cash value accumulation
- Coverage depends on dividend amount
- Term insurance expires each year
Comparison of Dividend Options
| Option | Death Benefit | Cash Value | Cash Access |
|---|---|---|---|
| Cash | No change | No change | Yes |
| Premium reduction | No change | No change | No |
| Accumulation | Increases | Increases | Yes |
| Paid-up additions | Increases | Increases | No (unless surrender) |
| One-year term | Increases | No change | No |
Key Takeaways
- Dividends are not guaranteed and represent a return of excess premium
- Cash option pays dividends directly to policy owner
- Premium reduction applies dividends to lower premiums due
- Accumulation at interest leaves dividends to earn interest (interest is taxable)
- Paid-up additions purchases additional paid-up whole life coverage
- One-year term (fifth dividend option) purchases term insurance equal to cash value
- Paid-up additions often provides the best long-term growth in death benefit and cash value
Policy dividends are:
The dividend option that uses dividends to purchase additional whole life insurance without evidence of insurability is:
The one-year term dividend option is designed to:
11.3 Settlement Options
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