Tuesday, February 27, 2018

Direct Recognition vs Non-Direct Recognition (Does It Matter?)

Does it matter if your life insurance policy is a direct versus a non-direct recognition policy? Here, I'm going to break down what the difference is between these two types of policies. Then, I'm going to answer the question, does it matter?

The Difference Between Direct Recognition vs Non-Direct Recognition

A whole life policy allows the option to ask for loan against the value of your policy. A policy loan, may reduce the dividend you receive when it's paid. If your policy is a direct recognition policy, you'll receive a lower dividend than if you didn't have a loan. If it's a non-direct recognition policy, your loan has no impact on the dividend you'll receive.

On the surface, you'd guess that a non-direct recognition policy would be a better deal. The insurance company will ignore your loan and pay you the normal dividend.

But, that might not be the case.

Let's walk through why not.

Dividend Rates Don't Matter, Actual Values Do

Let's say one insurance company pays a dividend of 6% and another  pays a dividend of 5%. Which insurance company is a better deal for you?

If you said the company that pays a 6% dividend, that would seem like a good answer but may not be the right one.

The reason is that the company paying the 6% dividend may be more expensive than the one paying 5%. Their administrative cost, cost of insurance and other expenses may be higher.

The net effect?

You could actually see less money in your policy from the company with the higher rate.


The internal costs of the policy eat up the difference.

Here's a report on dividend rates from some insurance companies.

Use an Illustration to Compare Policies

Insurance companies don't make it easy to figure out which company is the better deal. But you can get a good idea of which company might give you better values.

You can request an illustration for each policy and look at the projected values in the future. While it will be hard to make an apples to apples comparison, you can get close.

With an illustration, you can compare what the projected future values might be. The one with higher values could be the better performing company.

I say could be for a couple of reasons.

First, dividends aren't guaranteed. You don't know what dividends will actually be.

Second, the internal costs of the policy could always change inside the policy down the road. Since the contract allows the insurance company to change costs inside the policy, you may never know until years later the impact that will have on your values.

So, I limit my comparison to the guaranteed values in the contract to see which company is better.

If on a guaranteed basis, one company performs better, I'll likely go with the company that guarantees me a better deal.

Avoid Direct Recognition with High Fixed Interest Loan Rates

I'd avoid policies that have a high fixed interest rate and are direct recognition. That's because you'll not only get a reduced dividend, you'll also pay more interest on top of that.

Look at Dividend History and Company Performance

Since dividends are a return of premium, you want to focus on the strength of the insurance company. Is the company a solid performer? Does it have a strong history of paying dividends?

Focus more on the strength of the company rather than whether it's a direct or non-direct recognition policy.


If you plan on taking out loans, the interest rate you pay may be a bigger factor than whether a policy is direct or non-direct recognition.

What matters most is which company performs better and returns that performance to you the policyholder.

Let me know if you have any questions in the comments below.

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Michael is a champion of guaranteed issue for employees in the workplace. He's been an insurance agent since 1992 and has worked with thousands of employees.