The case can be made that miscommunication is at the root of most of our problems. The better we, humans, organizations and countries, can communicate with one another, the less chance of misunderstanding. Unfortunately, there are several terms in the life insurance lexicon that do not communicate very well. The three that we will look at today are dividends, loans and paid up policies.
While called dividends, the IRS considers distributions by mutual insurance companies a partial return of premium, and hence does not tax them until they exceed the basis in the policy. Treasury Reg. §1.72-11(b)(1) Since this differs markedly from the manner in which dividends from a corporation are taxed, I believe communication would be improved if distributions from mutual insurance companies had a different name. I have no suggestions other than “partial return of premium” which seems a bit unwieldy.
“Loan” is another ambiguous term as it relates to life insurance policies. Two aspects differentiate policy loans from any other type of loan. First, a job isn’t necessary to obtain a “loan” from your insurance policy (cue the sub-prime jokes). Second, it need not ever be repaid; if it is still outstanding at death, the death benefit will simply be reduced by the unpaid loan. It seems to me that “lien” would be a much more accurate term to describe such a transaction.
The media (and others) often refer to a policy that requires no further out of pocket premiums to keep it in force as “paid up.” However, “paid up” is a technical term used to describe a policy that cannot accept any more premiums. Usually, it is the design of the policy, such as a policy paid up at age 65 or a 20 pay policy, but it can also be elected as a non-forfeiture provision.
The preferred term for policies that currently require no more premiums but can still accept them is “premium offset.” That is because the premium is being offset by dividends, but the owner can still pay the premium should she so desire. It also means that future premiums could be required if the dividend scale were to decrease. This used to be referred to as the “vanishing premium” concept, but regulators now frown on that term.
The better we can communicate with our family, friends, co-workers and neighbors, the lesser the chance for a misunderstanding. And so it is in business. Unfortunately, there are several ambiguous terms used in the life insurance industry that, in my opinion, hinder communication. Hopefully, this will help your understanding when you come across these terms.