This option is similar to the premium reduction option except that the dividends are applied as additional premiums while the policyowner continues to pay the full annual premium. Under this option, the policyowner is essentially converting what is an ordinary level premium whole life policy into a form of increasing premium limited pay policy. After a number of years, the policy will be entirely paid-up and the policyowner will require no further premiums to keep the full face amount in force for the remainder of the insured’s life. In other words, if the assumptions are met the premium “vanishes”. (Of course, if the level of dividends projected is not met, it will take longer than anticipated for this to occur.) Once the policy reaches paid-up status, policyowners typically use additional dividends to buy paid-up additions, but they generally may apply the additional dividends under any of the other dividend options.
Although it would be unusual, if a policyowner applies dividends as additional premiums, it is theoretically possible for dividend payments to reach a sufficiently high level soon enough to violate the modified endowment contract (MEC) rules. Because having the policy classified as a MEC would have adverse tax consequences, policyowners and their advisers should take some care when this dividend option is selected to assure that premiums do not exceed the MEC levels.
Reproduced with permission. Copyright The National Underwriter Co. Division of ALM