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Comparing Dividend and Interest-Crediting Rates in Life Insurance

In this article, I am going to explain the differences and similarities of Whole Life Dividends and Indexed Universal Life Interest Crediting. Comparing dividend and interest-crediting rates is important because rates aren’t always comparable

Goal 

The primary goal of this article is to show that differences in methodology will result in different rates, but the overall returns on Policies are roughly the same. Both Whole Life Dividends and IUL Crediting Rates represent the allocation of Insurance Company investment gains to Individual Policies based on their relative cash value.

I’m going to start off by covering the basics, or what I call “Life Insurance 101”. For more basics, check out the resources at the bottom of the page.[1] Then I’m going to address comparability. I’ll explain the different ways whole life dividend rates can be calculated. I’ll also cover the mechanics of IUL Interest Crediting.

Understanding the Basics 

In this discussion, let’s first grasp the fundamentals of life insurance policies. These policies serve primarily for benefit protection, transferring risk from the insurer to the policy owner. A portion of premiums goes towards building the cash value, which is invested by the insurance company in secure debt instruments.

Basic anatomy of a life insurance policy

It’s important to realize that the cash value of a life insurance policy is really just the owner saving up the death benefit. The insurance company uses the saving to eventually transfer risk from the Insurance Company back to the insured.

It’s important to realize that this money does not sit idle. The insurance company invests in secured debt instruments like bonds, mortgage-backed securities, and preferred stocks. The net returns from these investments is allocated to every policy. That is the Dividend.

Diving into Dividends 

Whole life policies pay dividends. It is important to realize that dividends are essentially allocations of the insurance company’s investment gains to individual policies based on their cash value. That means that  dividends are not a return on premiums but on the cash value portion (after deducting all fees).

Dividend rates of Whole Life policies are not always comparable. Some companies net out the cost of insurance and other mortality expenses. Others might show a higher dividend rate, but then show a separate line item expense for the cost of insurance.

Examining Interest Crediting in IUL 

On the other hand, indexed universal life policies don’t credit dividends. IUL policies use interest crediting based on the movement of various stock market indices. What happens is that the insurance company takes the funds that they would have used to pay a dividend and they use them to hedge in the Index Options market. They are purchasing options that will capture the largest possible movement in the Index.

The goal of an IUL is for the crediting to capture a premium over what they would have paid as a dividend. Many people incorrectly think that IUL policies invest directly in the market. They do not.

Comparing Policy Performance 

Since dividend and interest crediting rates are not always directly comparable, it is important to focus on overall policy performance. You should realize that the overall performance of policies tends to be fairly comparable. Insurance companies invest in very similar assets and use the same mortality tables. Insurance companies have a vested interest in maximizing cash value returns, regardless of the method used. IUL policies, because of the hedging, should be higher over the long run. Therefore, the focus should be on forward-looking rates that reflect actual performance expectations, rather than solely relying on historical rates.

A good reference for current bond market yields and trends is FRED.

Key Takeaways 

1. Dividend and interest crediting rates may not be directly comparable due to variations in calculation methods.

2. Today’s dividend or interest crediting rate may not accurately reflect future performance and should be used cautiously for forward-looking projections.

3. Understanding the mechanics of policies and how insurance companies allocate gains is essential for making informed decisions about life insurance products.

In conclusion, whether you’re exploring whole life or indexed universal life insurance, it’s essential to look beyond dividend and interest crediting rates and focus on understanding the underlying mechanics of policy performance. By doing so, you can make more informed decisions to meet your long-term financial goals.


[1] For more life insurance basics, check out:

How Life Insurance Works

Life Insurance 101

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