Participating Policy

A participating policy is an insurance contract that pays dividends to the policy holder. Dividends are generated from the profits of the insurance company that sold the policy and are typically paid out on an annual basis over the life of the policy. Most policies also include a final or terminal payment that is paid out when the contract matures. Some participating policies may include a guaranteed dividend amount, which is determined at the onset of the policy. A participating policy is also referred to as a "with-profits policy."

Participating policies are typically life insurance contracts, such as a whole life participating policy. The dividend received by the policyholder can be used in several different ways. First, the policyholder can apply the dividend proceeds to the insurance policy's premium payment. Second, the dividend can be kept with the insurance as a deposit in order to generate interest much like a regular savings account. Finally, the policyholder can simply receive the dividend payment in cash, much like a dividend payment on a stock

Insurance companies charge premiums that are estimated to meet their expenses. Non-participating premiums are usually lower than premiums for participating policies. Insurance companies charge higher premiums on participating policies, based on conservative projections, with the intent of returning the excess. This has implications for the policy's tax treatment. The IRS has classified the payments made by the insurance company as a return on excess premium instead of dividend payouts.

For example, an insurance company will base premiums on higher operating costs and lower rates of return than are actually expected. By operating from conservative projections, an insurance company can better protect against risk. In the end, this is better for the individual policyholder because it helps offset their insurance company's insolvency risk, resulting in lower long-term premiums. Participating policies are essentially a form of risk sharing, in which the insurance company shifts a portion of risk to policyholders.

Though the interest rates, mortality rates and expenses that dividend formulas are based on change year to year, an insurance company will not vary dividends that often. Instead, they will alter dividend formulas periodically based on experience and anticipated future factors. These statements apply to whole life insurance. Universal life insurance policy dividend rates can adjust much more frequently, even monthly.

Participating policies can cost less than non-participating policies over the long term. With cash value policies, the dividend will typically increase as the policy’s cash value increases. From the perspective of the policyholder, whole life policies are essentially risk-free because the insurance company bears all risk – although with participating whole life policies, the insurance company shifts some risk to the policyholder.

However, the question of whether participating policies are superior to nonparticipating policies is a complex one and depends largely on individual needs. 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 with less payments. But individuals interested in earning regular dividends from their policy in their lifetime may opt for a participating policy.