With all of the attention the life insurance industry has been receiving lately, it's easy for policyholders to overlook two important factors: 1) few investments, if any, meet the safety of life insurance and, 2) few investments offer the advantages of tax-free accumulation of cash values and tax-free death benefits. Whether you own a traditional whole life insurance policy, or an interest- or investment-sensitive policy, it is important to have some familiarity with how your policy earnings are determined.
While insurance is generally purchased with the death benefit in mind, a large number of the policies purchased today permit the policyholder to share in the insurance company's "experience." The life insurance premiums that you pay depend on a variety of factors that influence your company's experience generally and your policy's experience in particular. The important elements affecting a company's experience are mortality, expenses, and investment earnings.
For example, if over time, your insurance company experiences lower expenses and mortality rates, but higher investment results than those it assumed when it set the premiums for your policy, it will be able to pass some of these savings along to you in the form of dividends. While your status as a policyowner also means you share in any experience losses, most insurance policies are based on fairly conservative assumptions. If your insurer meets the assumptions that it built into your policy's premiums, it will be able to pay you the dividends that were illustrated when you bought your policy.
In fact, this conservative pricing structure has meant that most companies have historically been able to pay their policyholders higher than illustrated dividends. It is the job of the insurance company's board of directors to determine how much of the company's overall surplus should be retained and how much should be used to pay policyholder dividends. While most companies try not to deviate from their dividend projections, companies sometimes must decide between the competitive advantages of matching past dividend projections and the need to add to their surplus to ensure it is able to meet its claims obligations.
It must be remembered that not all life insurance policies work the same way. In the case of universal life insurance, expense and mortality charges are subtracted from premium payments and your resulting cash value is credited with a specified interest rate determined on a company by company basis. While most companies guarantee to credit your cash value at a minimum interest rate, the actual credited rate is generally in excess of the guaranteed rate.
Unlike traditional or even universal life insurance, with variable life insurance, your policy earnings are based on the performance of the investment accounts that you, as a policyholder, decide to allocate your policy cash values. The increasing cash values of life insurance make it more appealing as an accumulation choice for funding college education, retirement, or even second homes. And of course, in the event of a policyholder's death, a family or business can receive the necessary funds to help continue without the complication of a financial crisis.