How Life Insurance Dividends work

Under the Hood: How Life Insurance Dividends Work

Have you ever wondered how Life Insurance Dividends work? Or where the money comes from for Life Insurance Dividends? Or how are Dividends calculated? The goal of this article is to answer these questions.


Before I explain how Life Insurance Dividends work, it’s important to understand some of the basics of a Life Insurance policy. The purpose of the Cash Value is to help the Insurance Company reduce risk in the policy. Unlike Term Insurance, Permanent Life insurance is going to pay a death benefit someday. The Cash Value is simply the savings mechanism that the Insurance Company uses to displace that risk over time.

It is important to realize that the Death Benefit includes the cash value. This means that the beneficiary DOES NOT receive both the Cash Value and the Death Benefit. The policy premium includes a portion that will go into the Cash Value.

How Life Insurance Dividends Work

The idea is that the Cash Value will grow and ultimately displace all of the risk to the Insurance Company. The chart above shows the death benefit and Cash Value for a policy on a 45-year-old with a $1 Million Death Benefit. You can see that the Cash Value starts off small but ultimately grows to equal the Death Benefit around age 115. It’s important to understand that the gap between the Cash Value and the death benefit is the Net Amount at Risk to the Insurance Company. This means that the Net Amount at Risk shrinks every year as the Cash Value  grows and displaces the risk.

What is the Insurance Company Doing With The Cash Value? 

They invest it in conservative debt securities. A key reason insurance companies can safely offer participating Whole Life Dividend and IUL interest crediting is their conservative approach to investing the premiums and reserves backing these policies.

By law, insurers must maintain a core portfolio of low-risk, investment-grade fixed-income holdings like bonds, mortgages and alternatives like real estate and private equity. These high-quality, income-producing assets provide stable returns.

Insurers allocate only a limited portion of the general account to equities and other more volatile investments. This disciplined asset allocation and emphasis on capital preservation allows insurers to consistently pay Dividend and interest credits that smooth out market cyclicality.

Realize both whole life and indexed universal life policies utilize the same types of invested assets for their reserves. While the dividend and interest crediting mechanisms differ, the insurance company facilitates both through a professionally-managed, diversified pool of reserves. This reserve pool aims for long-term growth and stability. The insurer invests the reserves conservatively to provide steady returns that fund future claims obligations.

At the end of the year, the Insurance Company allocates the net gains from their investments to each policy.

How Life Insurance Dividends Work 

A Dividend is simply an allocation of the net gains on the company’s reserves to each policy based on the relative amount of Cash Value. With a participating Whole Life Insurance policy, you are essentially a partial owner in the operations of the Insurance Company through your policy. The company generates revenue from premium payments and investment returns on their reserves.

After netting out expenses, the insurance company distributes any remaining surplus or net income back to eligible policyholders as dividends. These Dividend represent your share of the insurer’s profits for that year.

Dividend allocations follow a precise actuarial formula based on factors like policy type, size, Cash Value, and reserves. Policies with higher Cash Values generally receive larger dividend payments proportional to their contribution to the company’s reserve pool.[1]  

You can opt to take Dividend in cash, purchase paid-up additions to increase death benefit and Cash Value, or let them accrue interest. Leaving Dividend to compound is a powerful way to turbocharge long-term Cash Value accumulation.

IUL Interest Crediting 

For an Indexed Universal Life (IUL) insurance policy, there are no divisible “profits” paid out as annual Dividend.  However, as noted above, the reserves of the company are still invested in the same kind of assets. But instead of paying a Dividend, the Insurance Company uses the money to safely hedge with options on various stock market indices. The goal of this hedging is to capture as much movement in the market index as possible. The Insurance Company credits interest to your policy’s Cash Value based on the performance of this hedging program.

It is critical to understand that the goal of this hedging is not to perfectly replicate the index’s returns. Many people incorrectly believe that the performance is intended to match that of the underlying index. That is not the case! Instead, the goal is to simply credit more in interest than they would have credited with a Dividend. They are looking for a premium over “The Debt Market” rate of return.

The interest crediting rate is calculated using formulas involving index returns, current cap rates, participation rates, spreads and minimum floor rates defined in the contract. These levers provide downside protection while allowing upside participation in the index performance. The insurer credits interest to your Cash Value based on the performance of an external index like the S&P 500, subject to caps, participation rates, and floors.


The goal of this article was to explain how Life Insurance Dividends work. I wanted to explain what Dividends are, why they exist, and the mechanisms how they work. For more information, check out the Life Insurance 101 eBook or schedule a call with me.

[1] Maximum Over-funded policies will have the most Cash Value and will thus earn the most in Dividend. Click the link to learn more about maximum over-funded policies.