Understanding Your Life Insurance Policy: Why the Dividends Matter
In a few weeks, Penn Mutual will be declaring our annual dividend to our policyholders-something we’re very used to doing! In fact, we’ve paid a dividend every year since we were founded in 1847, a history we’re proud of. Life insurance dividends are much more than just money given back to policyholders, and I think their importance to both the policyholder and insurance company is often overlooked.
Here’s why the dividends on your participating life insurance policy matter:
Dividends are distributions refunded back to you when our performance exceeds expectations. You get money back because it didn’t cost as much as we expected to provide you insurance.
The three components of dividends at Penn Mutual are:
- Interest, or how well the firm managed its investments;
- Mortality, how it managed its risk by good solid underwriting;
- Expense, how it managed the cost of acquiring new business, maintaining existing policies, and growing its distribution.
You pay premiums to the company, and the dividend is concrete evidence of how well it made use of those premiums.
Dividends are the best measure of the performance of a mutual insurance company. The more in dividends a company can pay to its policyholders is a reflection of the quality and performance of the company. Dividends are directly correlated to the returns of the company, but sometimes the actual dividend could vary, reflecting the company’s performance vs. the market.
Dividends are a good reason why you should buy life insurance from a mutual company. A mutual insurance company has only one key stakeholder–its policyholders. On the other hand, a public or stock insurance company has two stakeholders–first in line are its shareholders, and then its policyholders. And these two stakeholders have competing interests at times. Shareholders have a very short-term perspective–usually quarter to quarter. But policyholders have a long-term interest–10, 20, 30, even 40 years or longer. If you want a permanent insurance policy that has the potential to more quickly accumulate cash value, a mutual company is the way to go, because mutual companies pay dividends to their policyholders, while public companies pay dividends to their shareholders.
The conflict for public companies is that insurers routinely put 20-, 30-, 40-year liabilities on their books, and over that course of time there will be many economic cycles, both up and down. Mutual companies can weather the storms of the economy because our balance sheets are inherently less risky than those of public insurance companies. Here’s why: We don’t have to try and get a higher return for shareholders. A mutual company may operate at a 7 Return on Equity (ROE) expectation, while a public insurance company generally runs at 13 ROE. Since mutual companies and stock companies deal with the same economic environment, the same interest rates, and offer similar products, one of the ways for public companies to get 6 more ROE turns out of their business is to carry more investment risk on their balance sheets.
Four things you can do with the dividend from your life insurance policy
When you get a dividend from your life insurance company, there are four things you can do with it:
- You can take the dividend and spend it. We will simply write you a check. The money is tax-free, because we are refunding your money to you.
- You can use the dividend to reduce the premiums you have to pay on your policy. We call this “premium offset”, and if your policy is in force long enough, you could get to a point where the dividend completely covers the premiums of your policy, subject to the fact that dividends are not guaranteed.
- You can let your dividends accumulate and grow in the policy. If you continue paying your full premium and don’t take the dividend, then the cash value of your insurance policy will grow even faster.
- You can purchase paid-up additional permanent life insurance coverage on your policy. This additional insurance allows policy death benefits and cash values to grow to meet needs or to satisfy dreams.
There is no one right answer for how to use your dividends. My experience is that people take different approaches over the life of their policy depending on their stage of life or what they’re looking to accomplish. Some use the dividend to supplement their income, others to offset their premium, and others to build cash value and death benefits. It’s not a once-and-done decision, because you can change your mind at any time depending on your personal situation.
There is something I always say about Penn Mutual’s history of paying dividends: “We work hard at keeping our story boring, and we’re committed to it.” After 167 consecutive years of paying dividends, I imagine it can seem boring. But our job is to be here for the long-term, and, while dividends are never guaranteed, we see it as an important measure of how well we are serving our policyholders. You won’t hear us changing our strategy, or talking about the next hot investment. We focus on managing our business for the long-term.
Our story is a story of consistency over 167 years-and that story has paid us dividends over the years.