A participating life insurance policy is any policy eligible to earn dividends payable by the insurance company that issued the policy. While a policy may have participating status, it is not guaranteed to necessarily receive dividends. Many financial resources confuse the definition of participating by claiming that it means the policy will earn dividends. This is inaccurate. Participating merely means the policy has the ability to earn dividends if the policy block has profits generated to pay dividends. I'll explain the nuances of this throughout this article specifically in the context of the three major types of life insurance. All three of which, I assure you, can be participating.
Participating versus Non-Participating
Life insurance policies all fall into two broad categories, participating and non-participating. As we covered, participating policies are eligible to receive dividends. Alternatively, non-participating policies will never earn dividends regardless of how profitable the block of insurance business is to the life insurer.
Life insurers disclose participating status in the policy contract. You can also check before you buy to determine of the policy you plan to buy is participating or non-participating.
Participating Whole Life Insurance
The most common type of participating life insurance is whole life insurance. This product is commonly synonymous with dividends–though there are several non-participating whole life policies available.
Whole life policies that earn dividends generally do so annually at the policy anniversary date. The insurance company will determine the dividends payable to each policyholder based on a formula it sets once per year. Some insurance companies publicly announce a major variable in their formula, the dividend interest rate, once the board of directors approves the dividend-paying plans for the coming year.
Participating whole life policies may also earn terminal dividends. These are dividends paid upon the termination of a policy for its cash value or at the death of the insured.
Participating Universal Life Insurance
While universal life insurance products more commonly fall into the non-participating category, several mutual life insurers do issue participating universal life insurance policies. As a reminder, participating status does not necessarily mean the policy owner will receive dividends.
It's common for participating universal life insurance policies to pay irregular dividends. A dividend payment happens most often due to above expectations profitability over a certain time period.
Participating Term Life Insurance
Much like universal life insurance, term life insurance is much more commonly issued as non-participating life insurance. But some mutual life insurers do issue participating term insurance and a few even have a history of paying dividends on older term life insurance policies.
Is the Dividend Paying Policy always Better?
Owning a participating policy can result in a lower net cost of buying the insurance. The value created by the dividends may lower your out-of-pocket cost substantially. Older whole life policies can earn enough dividends to pay the entire premium due, which effectively reduces the policy owner's cost to zero.
It's extremely unlikely that a participating universal or term life policy will ever earn dividends sufficient enough to cover the entire premium. That said, dividends paid on either of these policy types certainly bring the net cost of the policy down.
You will, however, generally pay more for a participating policy in the earlier years. Whether it's worth it to pay the additional upfront cost of a participating policy and then let dividends bring the cost back down is dependent on the buyer's unique circumstances.
Some Policies Never Pay Dividends
Some insurance companies issue participating policies that never earn dividends. The reasons for this vary but usually involve mutual insurers who have a practice of issuing nearly all policies with the possibility of one day earning a dividend–no matter how unlikely.
It's important to understand that if a company issues one type of life insurance that it pays dividends on, that does not necessarily mean it will pay dividends on all the other types of insurance policies it issues.
To revisit something I mentioned at the beginning of this blog post, participating simply means the policy has the ability to earn a dividend. Simply being a participating policy does not guarantee that the policy will ever earn a dividend.
If you are wondering about the likelihood that a policy you are reviewing will ever earn dividends, here's how you can go about figuring it out.
First, you can simply ask about the dividend-paying history on the specific policy you are considering. The insurer can verify that it paid dividends to this policy type and can usually give you a roughly estimated amount through the sales illustration insurers create to help potential buyers better understand policies before purchasing them.
Keep in mind that having paid dividends in the past does not guarantee that the insurer will pay dividends in the future. It is unheard of for an insurer to stop paying dividends to a policy to which it paid dividends in the past, but the possibility does exist.