What Is an Annual Dividend (Insurance)?

In the insurance industry, an annual dividend is a yearly payment paid out by an insurance company to its policyholders. Annual dividends are most commonly distributed in conjunction with permanent life insurance and long-term disability income insurance policies.

Insurance companies may pay their customers an annual dividend when the company's revenues, investment returns, operating expenses, claims experience (paid claims), and prevailing interest rates in a given year are better than expected. Dividend amounts can change year to year and are not guaranteed. Dividends are most common among mutual insurers, as publicly-traded insurance companies often pay dividends to their shareholders instead of policyholders.

Key Takeaways

  • An annual dividend is a yearly payment granted to an insurance policyholder, often of a permanent life insurance or long-term disability policy.
  • The dividend amount depends on factors such as profits made by the insurance company, investment performance, and the amount of money paid into the policy.
  • Annual dividends can be received as cash, to purchase more insurance, or else applied to premiums to reduce overall payments going forward.

Understanding Annual Dividends in Insurance

Annual dividend calculations are based on the individual insurance policy's guaranteed cash value, the policy's annual premium amount, the company's actual mortality and expense costs, and the dividend scale interest rate. Insurance companies need to make sure that they earn enough in premiums each year to cover their expenses, reserves, and contingencies, but they may choose to share a surplus with their customers.

Policyholders also need to closely consider the credit rating of the insurance company itself and judge for themselves how sustainable dividends may be, moving forward. Most insurance companies are rated A or better by major credit agencies, but those below an A rating may warrant a closer investigation to determine whether the insurance is sufficient or not.

Policyholders who have borrowed against their policies may receive reduced annual dividends while the loan is outstanding.

How Policy Dividends Are Paid

Annual dividends can be taken in several forms, with the policyholder able to choose or modify how they are received. Cash payments work similarly to dividend payments by stocks to shareholders, where they receive a check each year in the amount of the dividend due.

However, the insurance dividend may also be applied to help pay for the policyholder's annual premiums in order to reduce the customer's cost of carrying the policy. They can also be applied to increase the policy's value through the purchase of additional insurance, known as paid up additions (PUA). PUAs increase the policy's death benefit as well as its living benefit by increasing the policy’s cash value. If the insured has a loan taken out against the value of the policy, the dividend can be used instead for repayment of the policy loan. Indeed, if the dividend is large enough, it can continue to cover the cost of a policy loan indefinitely.

Annual Dividends and Whole Life Insurance

Many whole life insurance policies pay dividends. In many ways, these dividends resemble traditional investment dividends that represent a share of a public company’s profit. The dividend amount often also depends on the amount of money paid into the policy.

For instance, a policy worth $50,000 that offers a 3% dividend will pay a policyholder $1,500 for the year. If a policyholder contributes another $2,000 in value during the subsequent year, they will receive $60 more for a total of $1,560 next year. These amounts can increase over time to sufficient levels to offset some costs associated with the premium payments.

Whole life insurance dividends may be guaranteed or non-guaranteed, depending on the policy terms. This is just one reason why it's very important to carefully read through the details of a plan before purchasing a policy. Oftentimes, policies that provide guaranteed dividends have higher premiums to make up for the added risk. Those that offer non-guaranteed dividends may have lower premiums, but there also may not be any premiums in a given year.

Other types of insurance can also pay dividends to policyholders, including universal life (UL) and certain types of long-term disability insurance (LDI).