Life Insurance Premiums, Dividends, and Policy Values
Premium components
A gross premium equals the net premium (mortality minus interest) plus loading (expenses, contingencies, profit). Mortality charges rise with age; interest assumptions reduce the premium. A participating policy pays dividends; a nonparticipating policy does not. Dividends are a return of divisible surplus, not guaranteed and generally not taxable until they exceed premiums paid.
Dividend options
Owners may take cash, reduce premium, accumulate at interest, purchase paid-up additions, or buy one-year term. Paid-up additions are popular because they increase both death benefit and cash value without new underwriting.
Policy values
Cash value grows over time and is available for loans, surrender, or nonforfeiture options. Policy loans accrue interest and reduce the death benefit if unpaid. Surrender forfeits coverage for the cash value. Reserves are the insurer's liability for future claims and are not the same as cash value.
Traps
Questions confuse (1) dividends with guaranteed interest; (2) reserves with cash value; (3) the tax status of loans (generally not taxable unless the policy lapses or is surrendered with gain); and (4) the effect of a loan on the death benefit. Also remember that the cost of insurance rises with age in universal life, so a level premium may not sustain the policy.
Rule of thumb
Track the money: premium in, expenses and mortality out, and the remainder becomes cash value and reserve. Anything labeled "guaranteed" must appear in the contract, not just the illustration.
Worked example
A $250,000 participating whole life policy earns a $2,000 dividend. Electing paid-up additions raises the death benefit and cash value; taking cash reduces the policy's growth. Neither choice is guaranteed to repeat.