A participating policy is an insurance contract that pays dividends to the policyholder. Dividends are generated from the profits of the insurance company that sold the policy and are typically paid out on an annual basis over the life of the policy.
Most policies also include a final, or terminal, payment when the contract matures. Dividends from a participating policy are not guaranteed and depend on the annual performance of the insurance company. This type of policy is also referred to as a “with-profits policy.”
Key Takeaways
- A participating policy pays dividends to the policyholder, sharing a portion of the insurer’s profits.
- Policyholders have various options for their dividends: receiving them in cash, keeping them on deposit to earn interest, or using them to lower premiums.
- Non-participating policies, such as term life insurance, do not pay dividends but may offer lower initial premiums.
Understanding Participating Policies
Participating policies are typically life insurance contracts, like whole life participating policies. The dividend received by the policyholder can be utilized in several ways: it can pay the insurance premium, be left with the policy to earn interest, or be withdrawn as a cash payment.
Participating Policies vs. Non-Participating Policies
Insurance companies set premiums based on multiple factors, including expenses. Initially, non-participating policies usually have lower premiums than participating policies because there is no dividend expense. Participating policies charge more with the intent of returning the excess through dividends, impacting the policy’s tax treatment. The IRS classifies these payments as a return on excess premium.
For example, an insurance company may base premiums on higher operating costs and lower expected rates of return. Operating from conservative projections helps mitigate risks, potentially protecting the policyholder against the insurer’s insolvency risk, resulting in lower long-term premiums.
Note
Participating policies represent a form of risk sharing, shifting part of the risk burden to policyholders. However, dividend formulas, which depend on factors like interest rates and expenses, may not change frequently—typically adjusting periodically based on experience and projections. For cash value policies, dividends generally grow with the policy’s cash value, offering additional funds for premiums or savings.
Is a Participating Policy Right for Me?
Deciding between participating and nonparticipating policies depends on individual needs and preferences. Term life insurance, usually nonparticipating, gives basic coverage at low premiums. It may be suitable if you aim for lower costs while ensuring coverage for beneficiaries.
Permanent life insurance can be either type. Nonparticipating permanent policies may offer lower initial premiums but lack the dividends and profit sharing of participating policies. Participating policies, although initially pricier, provide dividends that can reduce long-term costs or build savings.
The type of insurance company also plays a role. Mutual life insurers typically offer only participating policies, sharing premium returns with policyholders, making these nontaxable. In contrast, stock life insurers usually provide nonparticipating policies, allocating profits to shareholders instead.
Why Choose Participating Over Non-Participating Life Insurance?
A participating policy, or “with-profit” policy, lets policyholders share in the insurer’s profits through dividends. These can offset premiums, stay in the policy to earn interest, or be taken as cash. Non-participating policies, lacking dividends, do not share profits but might have lower initial premiums.
Why Might a Participating Policy Not Be for You?
Participating policies tend to cost more initially, as premiums are set higher to cover potential dividend payments. These returns are considered a return of excess premium by the IRS and thus tax-free, unlike regular dividend payouts.
Do Mutual Life Insurance Companies Issue Participating Policies?
By law in most U.S. states, mutual life insurers can only offer participating policies. They provide regular dividend refunds to their policyholders.
The Bottom Line
A participating policy offers dividends from the insurance company’s profits, typically paid annually. While possibly more expensive initially, these policies may be beneficial through shared dividends, helping manage premiums or build savings over time. Choosing the right policy requires considering your needs, the type of insurer, and how you wish to leverage potential dividends.
Related Terms: Non-Participating Policy, Whole Life Insurance, Term Life Insurance, Cash Value Policies, Mutual Life Insurance Company.
References
- Dundas Life. “What Is Participating Life Insurance?”
- MassMutual. “What Goes Into Whole Life Insurance Dividends?”
- Internal Revenue Service. “Publication 550 (2022), Investment Income and Expenses”.
- Texas Department of Insurance. “Life Insurance Guide”.
- Insurance Information Institute. “What are the Principal Types of Life Insurance?”
- Wisconsin State Legislature. “Chapter 632 - Insurance Contracts in Specific Lines”.
- Equitable. “Common Questions About Life Insurance”.
- American Safety Council - Florida Insurance Licensing Association. “1.5.2 Mutual Insurers”.
