Participating vs Non Participating Life Insurance

Having the security of receiving a death benefit from a life insurance policy helps to know that there will be financial assistance for those we love if we were to pass away unexpectedly.

When looking into obtaining coverage, there are two different types of life insurance to choose from: Participating and Non-Participating.

Most of the time you can refer to them as whole life and term life. There is at least one case where whole life is not participating. We’ll talk about Universal life briefly later on.

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A participating life insurance policy allows the policyholder to participate in the profits of the life insurance company.

The life insurance company, like most organizations or businesses, will earn profits over the course of a financial year. The benefits of these net profits are passed on to the policyholder and are paid out in the form of dividends. The payments are most often made on an annual basis.

If you hold a participating policy, you can use the dividends in a few different ways: pay premiums due on the policy, purchase additional death benefit, or simply receive it in the form of a check to spend however you’d like.

These net profit dividends are not guaranteed. They are based on the financial performance of the insurance company.

Look at it like a bonus based on how well the business did throughout the year. The more you have invested in the business, the more dividend you receive.

A participating life insurance policy will most likely always have guaranteed benefits. More like a floor for how little the dividend will be. But, it will also have non-guaranteed benefits – this is where we project our profits to be, this is where they’ve been historically. We just don’t guarantee that.

The non-guarantee is a selling point.

Having financial protection in the form of life insurance while at the same time being able to participate in the profitability of the company is attractive to many life insurance prospects.

The safety and tax advantages of a whole life insurance policy tends to be the better option between it and term life IF it fits in your budget.

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Whole Life Insurance policies are usually the only type of policies that offers a dividend payment. This is true for an individual whole life insurance policy and for a whole life policy from a group plan, like through your employer.

The biggest of these reasons is that in a mutual life insurance company (the most common ownership structure for life insurance companies) the whole life policy holders, you and I, are actually the owners of the company.

This is why we receive that “vote by proxy” letter. Because owners get to vote.

Investopedia: a mutual company is owned by its customer or policyholders

As owners of the company, we have the right to participate in the profitability of the company. This is similar to how a stockholder of a company has the right to participate in the earnings of that company through growth and dividends.

Participating policies may cost more up front, but can actually end up costing less than non-participating policies over the long term. Let me word that another way: whole life may look more expensive but could actually be less than a term life policy that seems inexpensive.

By having this type of cash value policy, the dividend will typically increase as the policy’s cash value increases. The annual dividend will increase as you make the required premium payments.

This can be a very beneficial investment vehicle.

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From the perspective of the policyholder, whole life policies are essentially risk-free because the insurance company bears all risk.

As long as the policy premiums are paid, the death benefit will pay out, no questions.

A participating whole life insurance policy represents a very safe, stable investment vehicle, while the insurance provides valuable financial protection.

The dividend rate is responsive to market interest rates because insurance companies reinvest in safe money vehicles like bonds. When interest rates rise the insurance company makes more money, and so do you because the insurance carrier will share those profits with you in the form of dividends.

There are also tax advantages to dividend payments because they are classified by the IRS as a return of premium rather than a source of income and therefore they are not taxed.

When you account for the safety, stability, and tax advantages, a participating whole life policy is often the best choice for people who can afford to pay the higher premium.

Non-participating insurance policy, sometimes referred to as non-par or without-profit policy, does not offer any dividends or profit sharing. This type of policy provides only guaranteed benefits to the policyholder, no estimated benefits. However, these life insurance plans can pay guaranteed benefits on maturity (return of premium), and always pay on the death of the insured during the term as long as the policy was in effect.

Maturity: the moment in which a debt must be paid to fulfill the contract. 

Pure term life insurance policies are non-participating plans where you pay a premium for which you get a fixed life insurance coverage amount for a specified period of time. In case of the unfortunate demise of the insured during the policy term, the beneficiary receives the death benefit.

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Definitions (in layman's terms)

Insured: if a death benefit is paid because someone dies, that someone was the insured
Insurer: the insurance company (often confused with the agent)
Agent: the person taking your application
Policy Owner: usually the Insured but not always
Policy holder: same as the Policy Owner
Primary Beneficiary: who receives the Death Benefit
Contingent Beneficiary: who receives the Death Benefit in the event Primary is deceased

Term life insurance is your best bet if your goal is to have temporary life insurance coverage at an economical price. A term plan cushions your dependents from financial risks and helps them take care of their needs and liabilities in your absence.

The payments from term-life insurance are not based on the performance of secondary markets, it is a pure life insurance coverage, which is guaranteed. Net profits from investments of the insurance company are not shared.

Term life insurance is generally a nonparticipating policy with low premiums. It may suit the requirements of an individual interested in providing for their beneficiaries temporarily and with lower premium payments.

The term policy will expire if the insured does not pass away during the policy period (term). Term life insurance provides coverage over a specified period of time, usually 5, 10, 20, or even 30 years, or to a specified age such as 65.

Term policies only pay a death benefit to the beneficiary if the policyholder dies during the specified term and is a good choice when the policyholder needs protection for a temporary time or a specific need.

The insurance company charges enough to cover the administrative expenses (the manpower to process and underwrite the policy, plus printing and shipping costs, and other administrative costs), enough to pay the life insurance agent a commission, plus enough to for a small margin of profit.

This insurance clearly has its place in the life insurance product lineup because it is a useful and cost-effective solution for many life insurance policy owners.

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Term insurance, nonparticipating policies, has the advantage of being more affordable than permanent, participating, insurance. The death benefit amount and policy amounts are guaranteed to remain level during this time, regardless of the insured’s health status.

Although many term policies can be renewed, the premium will increase when a new term begins.

A policyholder can renew a term insurance policy at the end of the contract period without evidence of insurability as long as the premium payments are current.

There is also the option of converting a term policy into a permanent policy, such as whole life, and benefit from cash value and dividends. These premiums are higher to reflect the age of the insured and because whole life has a more expensive premium than term.

Term insurance policies can also have a Return of Premium (ROP) feature which refunds part or all of the premiums paid at the end of a level term period if death benefits are not paid out. This premium is higher than that of basic term policies.

Decreasing term insurance policies feature a decreasing death benefit, but the premium stays the same. A policyholder may use these types of policies to cover financial obligations that decrease over time, such as a mortgage or business/commercial loan.

Universal life insurance policies are permanent life insurance combining term insurance with a cash account earning tax-deferred interest. These policies have already paid interest on their cash value and are not eligible for additional dividend payments.

This is usually because of the way that life insurance companies invest the aggregate cash value in all universal life insurance policies.

It is held under a separate investment umbrella from the general account of the insurance company.

The universal life insurance policy owners are paid the market interest rate as it is defined in their policy. They are not entitled to any additional funds which is why they are considered to be a non-participating policy.

Under most contracts, premiums or death benefits can fluctuate at the discretion of the policyholder.

The policy stays in effect as long as the premium is paid either by the insured or when the cash value is sufficient to cover the cost of insurance. A policy loan can be taken against the cash value of the policy as well.

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Life insurance companies have massive amounts of cash on hand. Instead of letting the money sit stagnant, they invest this money in a portfolio of very secure fixed income securities, such as treasury bonds and notes.

The interest earned from these fixed-income assets comprises a major source of revenue for the insurance company. So when you are deciding on what kind of life insurance to purchase, weigh the pros and cons of each type of life insurance and what best fits the budget for you and your family.

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