South Carolina Life Insurance Practice Exam

From what type of insurer did the insured purchase a policy that paid a nontaxable dividend one year and nothing the next?

1. Foreign

2. Alien

3. Domestic

4. Mutual

The correct answer is: Mutual

The correct answer is that the insured purchased a policy from a mutual insurer. Mutual insurance companies are owned by their policyholders. One of the distinguishing features of such companies is their ability to pay dividends to policyholders. These dividends can be a result of the company's underwriting gains or investment performance. When a mutual insurer does well, it may distribute a portion of those profits back to policyholders in the form of dividends. These dividends are generally considered nontaxable income for the insured. However, dividends are not guaranteed; if the insurer does not perform as well in a given year, policyholders might receive no dividends at all. Hence, it is entirely normal for a policyholder to receive a nontaxable dividend one year and nothing the following year, as these payments depend on the insurer's profitability. In contrast, foreign and alien insurers refer to the jurisdiction in which the insurer is domiciled. Domestic insurers are those whose operations are based within the state where they are doing business. Although these different types of insurers can also pay dividends, the specific characteristic that describes the situation in the question — the issuance of dividends based on policyholder ownership rather than performance guarantees — is unique to mutual insurers.