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The basics of insurance dividends

Receiving money from your insurance company often means that something bad has happened to you. But some insurers do pay you under good circumstances. These payments are known as dividends.

 

Policy dividends are a "return of premium," which means that if your insurer had an overall good year, it will give you back part of the premium you paid for your insurance policy.

 

But not all insurance companies pay dividends, nor do all insurance policies. Here's a look at how you can find out whether you can expect a dividend check from your insurance policy, and how much you might get.

Your money back — but not guaranteed

Which dividend is which?

 

The word "dividend" is often thrown around so loosely that its meaning gets confusing. Thus it is important to note the difference between a policy dividend and a stock dividend.

 

A policyholder dividend pays a return of premium back to the policyholder if the company has strong financial results and a lower-than-expected number of claims. These are paid by mutual insurance companies, in which ownership lies with policyholders.

 

A stock dividend is declared by a publicly traded stock company. Insurance companies generally issue stock dividends to stockholders to compensate for when the company is not growing at astronomical rates, according to Michael Snowdown, a faculty member at the College for Financial Planning in Denver. "If you don't have a good plan to grow, you have to declare a dividend," he says. "Otherwise, people are going to drop your stock."

 

Thus, in order to receive a stock dividend from an insurance company, you must be a stockholder, but you don't have to be a policyholder. You can be both, but it means buying stock as well as a policy.

Whether or not you receive a dividend on your insurance policy depends on three factors:

  • Loss experience: An insurance company anticipates how many claims it will have in a given year by examining its claim history. If your insurer pays out fewer claims than expected, you have a better chance of receiving a dividend.
  • Investment performance: Your insurance company invests the money it saves for reserves and other contract obligations. If the investments perform well, you have a better chance of receiving a dividend.
  • Expenses: Expenses include everything associated with the cost of selling insurance, from agent commissions to advertising to office expenses. If your insurance company spends less than anticipated, you have a better chance of receiving a dividend.

If the insurance company has an "off year," meaning that its financial performance in those areas is poor, it likely will not pay a dividend. However, it does not need favorable results in all areas to pay a dividend. For example, the insurer still may pay a dividend if its expenses were higher than anticipated but its investments posted record results. Snowdown says insurers also take revenues into account, but revenue is a lesser factor because it is not as easy to predict as expenses, investment returns, or loss experience.

Insurers pay dividends not only to pass on savings to policyholders, but also to get a substantial tax break. Karen Horvath, vice president at A.M. Best, an insurance ratings company based in Oldwick, N.J., says that dividends are subtracted from a company's income, thus lowering the amount of taxes it must pay.

Who gets dividends

Paying back policyholders

The top five insurers paying the most policy dividends in 1999.

Insurer (property/casualty)

Dividends paid (in millions)

United Services Auto Assoc.

$454.6

Nuclear Electric Insurance Ltd.

$400

Lumbermens Mutual Casualty Co.

$331.1

California State Auto Assoc.

$231.9

New Jersey Manufacturers Insurance

$213.9

Insurer (Life)

Dividends paid (in billions)

Teachers Insurance and Annuity Assoc.

$4.04

Northwestern Mutual Life Insurance Co.

$2.86

Prudential Insurance Co. of America

$2.71

Metropolitan Life Insurance Co.

$1.76

New York Life Insurance Co.

$1.36

Source: A.M. Best Co.

To receive a policy dividend, you must be a policyholder on the date your insurance company declares a dividend. So if you bought a policy from your insurer in August, and the insurer declared a dividend in June, you should not expect to get a check. Most insurance companies pay dividends to policyholders just before their renewal dates comes up.

Mutual insurance companies — those owned by policyholders — pay dividends on policies. Non-mutual insurance companies, such as publicly traded stock companies and mutual holding companies, also may pay dividends on "participating policies," which are contracts that pass on surplus money to policyholders. For example, if an insurance company calculates its premiums with the assumption that it will earn 3 percent interest on its reserves, and it actually earns 7 percent, participating policyholders may receive a dividend (assuming other factors, including losses and expenses, are favorable).

 

Robert Hartwig, vice president and chief economist for the Insurance Information Institute (III), says stock companies may issue dividends to give policyholders an incentive to drive more safely (for auto insurance), take more precautions with home safety (for home insurance), or live healthier (for life insurance).

 

Whether dividends are a true incentive remains a question, because they can be quite small. According to the III, mutual insurance companies selling property/casualty insurance (which includes, auto, homeowners, and workers compensation insurance) have paid dividends totaling 2 percent to 3 percent of premiums paid over the past 10 years. For all companies (including stock companies), that figure is only 1 percent to 2 percent.

 

If you are insured by a mutual insurance company, keep in mind that you may not receive dividends if you are insured by one of its stock subsidiaries. For example, State Farm Mutual Automobile Insurance Co. pays dividends on auto insurance policies, but State Farm Fire and Casualty Co. — a stock subsidiary — does not pay dividends on homeowners policies, according to Dick Luedke, a State Farm spokesperson.

 

It's worth noting that not all mutual insurance companies pay dividends. Bob Sohovich, a spokesperson for Nationwide Mutual Fire Insurance Co., says his company instead will charge lower premiums if it nets favorable results. "Whatever savings that we experience, we reflect it in our rates," he says.

Auto and home insurance dividends

Dividends in the 1990s: property/casualty insurance

The following represents the amount of policy dividends paid since 1990 from property/casualty insurers.

Year

No. of insurers paying dividends

Dividends paid (in billions)

1990

512

$3.33

1991

521

$3.26

1992

534

$3.17

1993

526

$2.96

1994

531

$3.73

1995

546

$4.02

1996

534

$3.25

1997

552

$4.18

1998

585

$5.66

1999

600

$3.97

Source: A.M. Best Co.

The cash you receive on an auto or home insurance policy is proportionate to how much premium you have paid. The more cars you have on a policy, the more you'll get in dividends. Many companies calculate their dividends on a state-by-state basis. If an insurance company has better financial and claims results in a given state, it may pay more in dividends to policyholders in that state.

 

Your individual claim record will not impact the company's decision to issue a dividend to you. For example, a person who had two accidents and a speeding ticket would receive the same dividend as a person with a pristine driving record.

 

However, Luedke of State Farm says a person who is moved from a mutual company into a stock subsidiary because of his or her driving record before a dividend is declared would not receive a dividend. For example, if you get into three auto accidents in March and State Farm moves you from the mutual company, which has "preferred" customers — those with good driving records — into State Farm Fire and Casualty Co., which insures "standard" customers — those with poorer driving records — you will not receive a dividend.

Life insurance dividends

Life insurers also classify their policyholders, and the amount you pay in premium and the amount you receive as a dividend depends on what class of policyholders you are in.

Policyholders are placed in rating classes according to physical characteristics, including age, sex, and medical history. If your life insurer has to pay out a higher-than-expected number of death claims in your class, you are less likely to get a dividend.

Dividends in the 1990s: Life insurance

The following represents the amount of policy dividends paid since 1990 from life insurers.

Year No. of insurers paying dividends Dividends paid (in billions)

1990

534

$15.74

1991

499

$15.72

1992

503

$15.50

1993

481

$15.88

1994

481

$16.99

1995

467

$18.36

1996

451

$18.75

1997

449

$17.70

1998

439

$19.42

1999

419

$19.78

Source: A.M. Best Co.

You might assume that younger folks would receive more in dividends than seniors because younger people are less likely to die. However, James Reiskytl, vice president of tax and financial planning at Northwestern Mutual Life Insurance Co., says premiums are calculated such that older people pay more in mortality and expense (M&E) fees — the cost the insurer charges you to assume the risk of insuring you — and thus get back a higher dividend because they pay more in premium. Thus, older people have the same chance of receiving the amount younger people receive, he says.

 

Still, it's possible that some policyholders will receive dividends when others won't, regardless of how much a particular group pays in M&E fees. Life insurers "don't want to reward a class [of policyholders] if there are a lot of unknowns and they have a poor track record," says Michael Bartholomew, senior counsel for the American Council of Life Insurers.

 

Those who own whole life and universal life insurance policies may receive dividends, while people who own term life insurance policies will not. That's because the cash value in a whole or universal life insurance policy is a fixed rate guaranteed by the insurer and funded through money in the company's reserves. In turn, the investment return on its reserves is one factor that determines whether the insurer will pay a dividend. Term life insurance policyholders do not receive dividends because there is no underlying cash value that earns interest.

 

Variable life and variable universal life insurance policyholders may receive dividends if there are a lower-than-expected number of death claims in their rating class and the insurer managed to keep down its expenses. However, these policyholders are less likely to receive dividends than whole or universal life insurance policyholders because earnings on the cash value — one factor life insurers use to determine whether they will pay a dividend — are not fixed or guaranteed. Instead, the cash value in variable policies is based on the performance of subaccounts, which are investment options that may include mutual funds.

Dividends and taxes

If your insurer issues you a dividend, you can take it in cash, buy additional insurance coverage, or apply the money toward your premium. For life insurance policies, you also can pay off loans you may have taken against your whole life policy.

 

In most cases, your dividends won't end up in Uncle Sam's pocket. Dividends from auto and homeowners insurance policies are tax-free.

 

Life insurance policy dividends are taxable only when the amount you receive in cash exceeds the amount of premiums you have paid. The dividends are taxable only if you take them in cash. If you use your dividends to buy paid-up additions to your policy, they are not taxable. Dividends also may be taxable if your life insurance policy is a modified endowment contract, which is a policy that's overfunded in order to build up greater cash value. Dividends on modified endowment contracts are taxable unless the money is used to buy paid-up additions to your policy.

An incentive to stay

Insurance companies often pay dividends to keep customers from defecting to other insurers, says Hartwig of the III. Insurers think a check at the end of the contract year — no matter how small — is incentive enough for policyholders to renew their coverage and not seek lower rates or better coverage elsewhere.

 

"At the end of the year, the last thing a person sees from their insurer is a check," he says. "That can go an awful long way in keeping that customer."

 

Last Updated Oct. 12, 2000
 
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