Key Takeaways
– A participating policy (also called a “with‑profits” policy) is a life‑insurance contract that may pay annual dividends to the policyholder based on the insurer’s financial experience and surplus.
– Dividends are not guaranteed; they depend on insurer earnings (investment returns, mortality experience, expenses) and are usually paid annually or left to accumulate.
– Common dividend uses: reduce/cover premiums, take as cash, leave to accumulate interest, or buy paid‑up additions to increase coverage and cash value.
– Participating policies tend to carry higher initial premiums than comparable non‑participating policies because the insurer charges conservatively and intends to return excess as dividends.
– Mutual insurers typically issue participating policies; stock insurers more often issue non‑participating policies (they pay profits to shareholders).
What is a participating policy?
A participating policy is a life‑insurance policy that allows the policyholder to share in the issuer’s profits through dividend payments. The insurer builds conservative assumptions into pricing (mortality, interest, expenses) and may return part of the surplus to participating policyowners when actual experience is better than those assumptions. Because the dividend is treated as a return of excess premium by the IRS rather than ordinary income in most cases, it has favorable tax treatment when it simply reduces cost basis or is a return of premium (see IRS Publication 550) (Investopedia; IRS).
How participating policy dividends are determined
– Sources of dividend: primarily insurer investment returns, favorable mortality (fewer claims than expected), and lower expenses.
– Variable components: interest rates, mortality rates and expense experience change over time; insurance companies periodically adjust dividend scales and formulas based on experience.
– Timing and guarantees: dividends are typically paid annually but are not guaranteed. The insurer’s dividend scale can be changed; whole life dividends are adjusted infrequently, while some participating universal life dividend components can change more often.
Types of life insurance that can participate
– Whole life: the most common participating contract. Dividends can increase cash value and death benefit.
– Universal life: some forms may be participating, but dividend behavior and crediting may change more frequently.
– Term life: usually non‑participating (no dividends) because premiums are low and there is no cash value to distribute.
Participating vs. non‑participating policies (practical comparison)
– Cost: Participating policies generally have higher initial premiums because they include an element intended to be returned as dividends. Non‑participating policies typically have lower premiums up front.
– Profit sharing: Participating policyholders share in insurer surplus via dividends. Non‑participating policyholders do not; profits go to shareholders (in a stock company).
– Cash value growth: Participating cash‑value policies can accumulate additional value via dividends and paid‑up additions, potentially reducing net long‑term cost. Non‑participating permanent policies must rely on guaranteed interest and credited interest for cash value growth.
– Risk sharing: Participating policies shift some risk to policyholders (they share both upside and the lack of dividends if experience is unfavorable).
Why insurers price participating policies higher initially
Insurers use conservative assumptions when pricing participating policies to ensure solvency under stress. If actual experience is better, the insurer returns part of the surplus as dividends. The IRS treats dividends as a return of excess premium rather than taxable income (subject to rules), which affects tax treatment (Investopedia; IRS).
Pros of participating policies
– Potential dividend income that can lower net premium costs over time.
– Ability to increase cash value and death benefit via paid‑up additions.
– Generally stable long‑term cost structure (conservative pricing).
– Favorable tax treatment for dividends that are treated as return of premium (within limits).
Cons and why a participating policy may not be right for you
– Higher initial premiums than non‑participating alternatives.
– Dividends are not guaranteed; future payments depend on insurer performance.
– Complexity: dividends, scales, illustrations and non‑guaranteed elements require careful review.
– If you want simple low‑cost protection for a limited time horizon, term (non‑participating) is usually cheaper.
Are mutual insurers limited to participating policies?
In many U.S. states, mutual life insurance companies traditionally issue participating policies because policyholders are the owners and thus share in surplus. Stock companies more often issue non‑participating policies and pay profits to shareholders. State law and company charter dictate what kinds of policies a company can issue (Investopedia; state insurance guides).
Tax treatment overview
– In many cases, dividends from a participating policy are treated by the IRS as a return of excess premium (a reduction in basis) rather than taxable income, up to the amount of premiums paid; consult IRS Publication 550 for details and limits.
– If dividends exceed basis or are left to accumulate interest, different tax consequences may apply; consult a tax advisor for your situation.
Is a participating policy right for me?
Consider a participating policy if:
– You want permanent coverage with cash‑value accumulation.
– You value potential dividends to reduce long‑run net costs or to grow cash value.
– You prefer the mutual‑type structure where policyholders share surplus.
Consider alternatives if:
– You need short‑term, low‑cost protection (term life).
– You prefer simpler contracts with guaranteed elements and lower premiums.
– You distrust relying on non‑guaranteed dividends for long‑term planning.
Practical steps to evaluate and buy a participating policy
1. Define needs and goals: death benefit target, time horizon, desire for cash value, willingness to pay higher early premiums.
2. Compare policy types: get illustrations for both participating whole life and comparable non‑participating whole life or universal life, and compare term options for basic protection.
3. Request dividend history: ask the insurer for at least 10–20 years of dividend scale history and recent dividend payouts for the product.
4. Review policy illustrations carefully:
– Look at both guaranteed and non‑guaranteed columns.
– Check how dividends are credited and various dividend option illustrations (reduce premium, cash, accumulate, paid‑up additions).
5. Ask for projected cash‑in and surrender values: understand penalties, surrender charges, and how dividends affect cash value.
6. Check financial strength and ratings: review ratings from AM Best, Moody’s, S&P, and consumer complaint records.
7. Ask about expense charges, rider availability and costs (e.g., waiver of premium, LTC riders), and policy loan terms.
8. Compare total cost long term: run scenarios (conservative dividend, average dividend, no dividend) to understand downside and upside.
9. Confirm tax implications with a tax advisor: how dividends affect basis, taxable interest on accumulated dividends, and taxation on policy loans/surrenders.
10. Consider independent advice: consult a fee‑only financial planner or life insurance specialist to interpret illustrations and compare options.
Questions to ask the insurer or agent
– Is this policy participating? If so, how frequently are dividends paid and how are they determined?
– Can you provide the dividend scale history for this product (past 10–20 years)?
– What are the guaranteed vs. non‑guaranteed values in the policy illustration?
– What dividend options are available and how do they affect death benefit and cash value?
– What fees, charges, surrender penalties and loan interest rates apply?
– How will dividends be treated for tax purposes?
– What is the company’s capitalization, investment strategy and ratings?
Practical example of dividend uses
– Reduce premium: dividends are applied to pay part or all of the next premium.
– Cash payment: dividends taken as cash provide periodic income.
– Accumulate at interest: dividends left on deposit earn interest, boosting cash value.
– Paid‑up additions (PUAs): dividends buy additional small amounts of fully paid life insurance that increase both death benefit and cash value.
When to re‑evaluate
– Review your policy periodically (every 3–5 years) or after major life events to ensure it still meets goals.
– Revisit if dividend scales decline or insurer ratings change materially.
The bottom line
A participating policy shares insurer surplus with policyholders in the form of dividends. It’s a long‑term, cash‑value life insurance strategy that tends to cost more initially but can reduce net lifetime cost or increase savings through dividends. Whether it’s right for you depends on your goals (permanent coverage, cash accumulation vs. low initial cost), your tolerance for non‑guaranteed elements, and the insurer’s dividend track record and financial strength.
Sources and further reading
– Investopedia. “Participating Policy.” https://www.investopedia.com/terms/p/participation_policy.asp
– Internal Revenue Service. Publication 550, Investment Income and Expenses. https://www.irs.gov/publications/p550
– Insurance Information Institute. “What are the Principal Types of Life Insurance?” https://www.iii.org
– Texas Department of Insurance. Life Insurance consumer guides. https://www.tdi.texas.gov
– MassMutual. “What Goes Into Whole Life Insurance Dividends?” (company materials)
– Equitable. “Common Questions About Life Insurance.” (company materials)
– Wisconsin State Legislature. Chapter 632 – Insurance Contracts in Specific Lines. (state statute reference)
Editor’s note: The following topics are reserved for upcoming updates and will be expanded with detailed examples and datasets.