Beyond protection and the ability to build cash value, whole life insurance is typically participating, meaning policyowners are eligible to receive dividends. While this feature can seem complicated, it’s worth understanding, as whole life insurance dividends can potentially provide a significant benefit to clients.
A participating whole life insurance policy must be designated by the insurance company as eligible to receive dividends. Even among participating policies, however, dividends aren’t guaranteed. The amount of the dividend payout in a given year depends on the operating experience of the insurance carrier in that year.
Choosing the right carrier for an insurance policy can matter when it comes to dividends. To know what to look for in a carrier, it’s important to understand what funds eventually become available for distribution as dividends—an amount known as a “divisible surplus.”
The Primary Components of a Divisible Surplus
Insurance companies take in money through premiums from policyowners. They are required by law to keep a certain amount of that money in reserve to cover their long-term commitments to policyowners. Insurance companies generally invest these reserves in very conservative assets like high-grade bonds and commercial mortgages.
Initial premiums are determined using conservative assumptions (guaranteed interest rates and mortality rates) to ensure the company collects enough money to pay all benefits in the future, even under adverse financial scenarios. Company surplus is primarily the result of favorable operating experience with respect to investment results, mortality (death claims) savings and expense savings. Divisible surplus is the portion of company surplus that is set aside to be paid or applied as policy dividends in the following year. In order to pay dividends, divisible surplus must be achieved. This is one reason why the payment of dividends on any particular eligible participating policy is not guaranteed. Generally, dividends are declared and paid annually and are subject to change.
Each eligible participating policyowner receives that policyowner’s equitable share of the divisible surplus as a dividend that results when the overall actual experience of these components (investment, mortality and expenses) is better than the experience that was originally assumed in setting premiums and guaranteed elements for that policy. Although MassMutual has paid dividends every year since 1869, dividend payments are not guaranteed.
The divisible surplus of funds that a carrier can pay out for dividends in a given year depends primarily on three main factors:
1. Mortality Experience (Death Claims)
If the insurance company ends up paying out less in actual death claims is less than the conservative mortality assumptions used in setting the premiums and guaranteed elements in a given year, that money saved contributes to the company’s potential divisible surplus.
Performance in this area reflects how well an insurance company calculates and selects risk in its underwriting operations. A company that has sound underwriting and prices premiums properly is likely to have a more positive mortality experience over time.
The expense component of the dividend reflects the difference between the actual expenses that were incurred in issuing and administering policies over time versus the expenses that were assumed in setting the premiums.
Like any other business, it costs money to operate an insurance company. These include administration costs and other expenses. Companies typically price premiums based on those costs and set aside funds to cover them. A spike in costs or a decline in efficiency may reduce overall surplus. Clients considering a whole life policy can research an insurance carrier’s corporate performance to see how well it has controlled costs over time.
Insurers invest the net premiums they collect using conservative assumptions that support their ability to pay guaranteed interest rates and mortality claims, even under adverse financial scenarios. When the company’s actual investment returns exceed the funding required to meet its contractual obligations to policyowners, that excess contributes to a potential divisible surplus.
This component can come from a conventional portfolio of bonds, stocks, and other types of market-based investments. An insurance carrier can also achieve returns by other methods. For example, a carrier may invest in related business lines, third-party businesses, and other enterprises. Profits from those types of investments and operations can also add to a company’s divisible surplus.
Your clients may want to examine insurance carriers’ holdings and investment philosophy, especially with regard to risk and stability, to find the carrier whose investment approach most mirrors their own. It’s also a good idea to look for carriers whose other business lines and ownership stakes add to the potential size of the divisible surplus. Understanding how a particular carrier’s dividends are funded can help your clients choose policies most likely to yield the returns they’re looking for.
The Dividend Calculation
When a company has divisible surplus, the size of each individual policyowner’s dividend payout depends on how much their policy has contributed to it. As a result, long-standing policies with large death benefits will generally receive larger dividend payouts than smaller policies put in place more recently.
Because an insurance company cannot predict its performance in the three components that make up divisible surplus, it cannot guarantee that it will be able to pay dividends in any given year. But clients can always check a carrier’s record to see whether they’ve consistently paid dividends in the past.
How to Use Dividends
Clients holding eligible participating whole life insurance policies who receive dividends have a choice to make. For example, they can receive dividends in cash, use them to reduce next year’s premium payment or accumulate interest by leaving the funds on deposit. Many policyowners choose to use their dividends to purchase additional paid-up whole life insurance, an option which can increase the policy’s death benefit and cash value.
Dividends are an important part of the overall value that participating whole life insurance offers. It’s important for clients to know how dividends are determined and what factors affect their issuance so they can make informed decisions when choosing a plan and a carrier.
The decision to purchase life insurance should be based on long-term financial goals and the need for a death benefit. Life insurance is not an appropriate vehicle for short-term savings or short-term investment strategies. While the policy allows for loans, you should know that there may be little to no cash value available for loans in the policy’s early years.
The information provided is not written or intended as specific tax or legal advice. MassMutual®, its subsidiaries, employees and representatives are not authorized to give tax or legal advice. Individuals are encouraged to seek advice from their own tax or legal counsel.
The products and/or certain features may not be available in all states. State variations will apply.
Whole Life Legacy series policies ((Policy Forms: MMWL-2018 and ICC18-MMWL in certain states, including North Carolina)/ (MMWLA-2018 and ICC18-MMWLA in certain states, including North Carolina)) and MassMutual Whole Life series policies on the digital platform (Policy Forms: WL-2018 and ICC18WL in certain states, including North Carolina) are level-premium, participating, permanent life insurance policies issued by Massachusetts Mutual Life Insurance Company (MassMutual), Springfield, MA 01111-0001
Reprinted from Wealth Management, [insert date]. Used with permission.
FOR FINANCIAL PROFESSIONAL USE. NOT FOR USE WITH THE PUBLIC.