People purchase life insurance policies because they understand the existence of risk. In other words, they will, at some time, pass away and no one knows when it will happen. As such, they rely on having this risk managed by a company that will not only return their investment, at a future time (pay the beneficiaries), but that they would also pay any additional money that the policy may have earned.
Insurance companies are known as risk managers. They get money from their policy holders, in the form of premiums paid. The companies typically invest these premiums to earn more and increase profits, as long as the accounts are properly managed by them or their fund managers.
Failure to properly manage the invested premiums is one of the big reasons, along with devastating natural disasters, why some insurance companies go bankrupt and are no longer able to pay the claims of their policy holders.
There are insurance companies that give out or distribute dividends, to their policy holders, when they do get surplus profits. Insurance companies that distribute profits to their policy holders are known as mutual companies.
These insurance companies consider their policy holders to be like their stockholders, because it is through them that they get the premiums which are then invested. Most companies do not, however, guarantee the payment of dividends, as this is very dependent on how well their investments do in the various markets. Dividends are paid when a surplus of funds exist.
These surplus funds come from the company’s investment earnings, mortality savings and their operational savings. Mortality savings happen when the premium or life insurance package, taken by the insured, is more than the actual death claims paid by the company.
Insurance companies are required to maintain reserves for death benefit claims. When the profit they get from their investments is more than the required reserves, then they earn savings. The operational savings happen when the insurance company spends less in terms of the costs necessary to operate.
Insurance companies pay or distribute dividends to their policy holders, not because of sheer generosity, but because it also entitles them to a tax break, since the dividends are subtracted from their income. With lesser income, the insurance companies will be paying less tax.
Insurance dividends are different from stock dividends in that insurance dividends are considered to be a return of premiums paid by the policy holder, while stock dividends are issued by corporations to their stockholders, when they can share profits.
Publicly listed corporations typically issue dividends to their stockholders to keep them satisfied and to keep them from cashing out their stocks.
Once the insurance company declares a dividend, the policy holder can choose to convert his/her dividends into cash, allow them to accumulate, use them to pay the premiums or pay any existing policy loans. Insurance dividends are generally exempted from income tax, except when the dividends received are more than the premiums that have been paid or if it is converted into cash.
Many insurance companies distribute dividends by sending dividend certificates to their policy holders. Most often, these dividends are so small that it would be more practical to simply have the money accumulate and let it be withdrawn when the policy has matured. However, there are still many policy holders who prefer to convert their dividends into cash, believing that they had better spend their money while they still have the opportunity to do so.
Many insurance agents that you run into are not really trained well in certain areas of the insurance policy, such as dividends and the dividend certificates. Some do not even know what to do with dividend certificates. This is one of the reasons that we always recommend that a person try to learn as much as possible before signing any insurance contract.
The more you know about the insurance policy that you are getting, the better able you will be to maximize any benefits that you could be receiving through your policy. As always, we hope that you will contact your independent insurance agent for help with these choices. He/she is typically more knowledgeable, because they work with multiple companies and can better advise you of the options available to meet your specific set of needs.