Paid-Up Additions (PUA's) – What are they, and how do they work?

Briefly, on Whole Life insurance (WL):

The WL used by us is “Participating, non-direct recognition Whole Life”, issued by a mutual company. To buy a policy is to become an owner of the (“mutual”) company. We do not use “public” companies, and not all WL policies work as we need them to.

When you buy a policy, you pay for it through premiums. Part of the premium buys Paid-Up Additions (PUA’s).

PUA’s are little additional pieces of death benefit added to the policy. These are paid-up for life (one-time cost).

At year-end, the insurance company’s annual profits are distributed to company owners (here aka policy owners). Those profits come in the form of “dividends” and those dividends may be handled (by the owner) a number of ways, such as a payment out, maybe used to pay premiums, but commonly dividends are used to buy Paid-Up Additions (PUA’s).

Where do the profits come from, to be distributed as dividends?

1)    The “general account” where investments are handled for the company. Investments include bonds, commercial real estate, etc.  Normally conservative investments. Profits roll into the “DIVIDEND POOL”.

2)    Savings on budgeted expenses. For example, the company knows that in 2020, it will cost $1,000,000 to open the doors for business, and budgets accordingly. At year-end, only $900,000 was spent. The difference, $100,000, rolls into the DIVIDEND POOL as profit.

3)    The “Business Model” is to sell insurance, collect premiums, and pay on claims. Presumably, and by regulated efforts (by the states in which the company does business), the difference is a profit and that rolls into the DIVIDEND POOL.

 To be clear: to receive the dividend is to participate in the profitability of the company as an owner. This is not reliant on the stock market.

 Again, when the dividend is issued, the most common design is to allow the dividend to purchase “Paid-Up Additions” (PUA’s), which are little additional pieces of death benefit added to the policy.

 These PUA’s are:

1)    Intrinsically valuable. They represent a future cost to the company. The day the insured (named in the policy) dies, the company has to pay a death claim. Those PUA’s represent a future cost…the company can (and does) determine what the current “value” is.  Think of it this way: if you said to the company “If I give back that collection of PUA’s you’ve given to me over the years, what’s it worth to you?” The company, in order to get out of the future liability of that cost/claim will tell you what it’s worth. You can do just that, give PUA’s back to the company and receive the current value. BUT…

2)    Also a factor in the subsequent year’s dividend calculation. Dividends grow and the previous year’s amount will help to determine the next. Other factors are size of policy, cash value, premium, death benefit, and PUA’s. The best way to grow the policy, with cash value, death benefit, and subsequent dividends is by accumulating PUA’s. These will accumulate in true “compounding” fashion, unlike stocks, bonds, and funds.

In summary, part of a premium pays the company for the risk it takes on you, the insured. Part of the premium goes to buy PUA’s and to thereby grow the death benefit. Dividends also buy PUA’s.  The PUA’s grow your cash value, and the overall growth is somewhat “circular” as the factors tie together.

Back to “Participating, non-direct recognition Whole Life.”

 Participating means you, as policy owner, participate in the profitability of the company.

“Non-direct recognition” refers to the fact that if you are using the policy for access to cash (here in the form of loans, using your policy as collateral), your dividends are not negatively affected. This is a huge factor with large purchases (e.g. for your business or college funding) or with retirement funding.  Oh, and repayment of any loans is entirely on your schedule, not the company’s.

A key point:

The responsibility for success here is squarely on the shoulders of the company.  Not the stock market. The companies used for this have been consistently profitable (and paying dividends) for a minimum of 100 years without missing a beat.

As the world becomes more turbulent, I see this as an increasingly important consideration.