When policyholders have what is called a participating policy from a mutual insurance company, they are eligible to receive dividends based on the company's financial performance.
When claims are low and the company's investments perform well, dividends tend to rise. On the other hand, when claims are high and investment returns slump, dividends are likely to fall.
The dividends on a participating policy aren't guaranteed, so they may not be paid every year. Unlike the dividends paid to a company's shareholders, participating policy dividends are considered a return of premium. As a result, the dividends are not taxed as income.
Dividends may typically be paid out as cash, as additional insurance coverage, or may be used to reduce policyholders' premiums or repay policy loans. Rules vary from company to company.
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