The Business Insurance Zone Day 3: Whole Life Dividends

Whole life dividends are a commonly misunderstood topic.  This is due in large part to the sometimes intentional convoluted nature of whole life insurance.  That's not an attempt to knock it down.  Whole life insurance is certain a powerful and worthy insurance contract for your financial needs, and as an asset it certainly complements portfolios as a low risk and/or alternative investment choice.

 

Return of Premium

We've all heard it before.  Whole life dividends aren't real dividends as they are just return of excess premium.  A.L. Williams used to love taking this point way too literally (of course, he had term insurance to sell whole life insurance policies to replace).

It's true, dividends are a refund of premium.  There's no debating this fact.  I'll go one further and give termites one more goody to extrapolate to the nth degree and misapply to reality.  Participating policies are legally allowed more expense loading purely to return it as a dividend–sounds scandalous.

What am I turning on whole life insurance?  Hardly.   I personally own, and have written life insurance policies that have cash values in excess of the premium paid to the policy.  And a big driving factor behind that fact (which continues to happen) is the payment of dividends.  So even though we give the company more money than we need to, they earn an incredible return on that extra money (30 year average yield on General Account assets within the insurance industry is 9%) and return to the policy holder through a dividend.  When that dividend is used to purchase participating paid-up additions, it compounds the cash value growth.

Comparing Dividend Interest Rates

A big problem within the industry is the tendency for agents to compare the dividend interest rates of companies to infer who is better.  This is a rookie's mistake.  Dividend interest rates are based off the policy's reserve not the cash surrender value.  The reserve is the money that would be required to pay the premium due for the entire period of the policy, and the balance of this reserve is dependent on the age of the reserve and the age of the policy (typically it is less than the cash surrender value) and it varies among carriers.

We cannot take the stated dividend interest rate of one company and compare it to the dividend interest rate of another company and suggest that because one company states their rate is a larger number they will in fact pay more dividends.

Whole Life vs. Universal Life

If we look at the historical rates and the historical internal rates of return, we'll note that whole life competes very favorably with universal life insurance.  At the same time, for the same reason that we cannot compare dividend interest rates among whole life carriers, we cannot compare dividend interest rates to universal life insurance crediting rates.  Universal life crediting rates are based off the cash surrender values whereas whole life dividend interest rates are based off the server.  To be clear, universal life insurance reserves are the cash surrender value (unlike whole life).  We commonly refer to universal life as unbundled and since the cash value (reserve) is on the client, they get to know exactly what it is.

Dividend Rates in Dramatic Interest Rate Increases

We know a lot of people who really want to see higher interest rates.  And the insurance company would love higher interest rates.  But, a spike in interest rates could spell trouble for the industry and for dividend interest rates in the immediate future.

This isn't to say that rates will be at a huge disadvantage (especially since life insurance companies will do whatever necessary to avoid dis-intermediation)  but they won't spike with market rates quite as much as some might assume.

Ultimately, participating whole life insurance is the only product on the market that has a legal requirement with the most specificity with regard to how dividends must be paid.  In fact, some companies have issued participating policies and failed to pay legally required dividends and later had legal suit brought against them, resulting in dividends being paid to all policy holders when the divisible surplus occurred.

In the world of personal finance, there are few financial products that rival the stability and relative yield of whole life dividends.

 


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