What are policy dividends?

Policy dividends refer to a return of unused premiums to policyholders, which is a characteristic feature of participating life insurance policies. These policies are designed for policyholders who share in the insurer's profits. When the company performs well financially, it may exceed its expectations in premium collection and policy claims, resulting in excess funds. This surplus is then returned to policyholders in the form of dividends.

The essence of a participating policy is that the policyholder is regarded as a participant in the insurance company’s success, leading to a potential return on the premiums paid. Therefore, option B captures the fundamental nature of dividends, emphasizing that they are essentially recognized as a form of profit-sharing for policyholders.

In contrast, penalties for late payments relate to late fees or interest charges incurred by policyholders, which do not represent dividends. Annual bonuses from the insurer are generally not synonymous with dividends, as bonuses can be structured differently and often pertain to non-participating policies. Lastly, dividends are typically tax-exempt as long as they do not exceed the amount of premiums paid, making them less likely to be categorized as taxable income for policyholders. Hence, understanding the concept of policy dividends as a return of unused premiums is key for anyone studying life insurance practices.