When you go into the market to buy life insurance products, you will come across two insurance variants – direct recognition life insurance and non-recognition life insurance.
Unfortunately, many people don’t understand the difference between the two and how it suits their needs. This article is about a comparison between direct recognition and non-recognition variants.
What Is Direct Recognition Insurance?
Today insurance policies are not taken only for coverage; they are also used as collateral to borrow money. Insurance companies pay a dividend to policyholders, and the dividend rate changes every year. You can use a direct recognition insurance policy to take a loan, and the insurance company will acknowledge these loans and pay dividends accordingly.
In most cases, the insurance companies do not pay a regular dividend rate for any borrowed money. However, experts understand that insurance companies have an unpublished rate for any borrowed money.
What Is Non-Direct Recognition Insurance?
Non-direct recognition insurance policies have the same dividend rule irrespective of whether you have borrowed against the insurance policy. However, the dividend paid for non-recognition insurance policies is generally lower than direct recognition insurance.
Companies declare dividends on their insurance products differently. Hence, it lures many people with high dividend payouts on direct recognition life insurance policies. However, it would be constructive for you to consider other factors like paid-up additions and the age of your policy that can affect whether your dividend projection will be low or high.
Is Direct Recognition Insurance better than Non-Direct Recognition Variants?
There is no forthright answer as many factors are involved. For example, some people think direct recognition insurance is inferior due to low interest and dividends. However, it would be practical to look at the other side of the picture.
A direct recognition insurance company has unique dividend pools. One dividend pool will have collateralized funds for non-borrowed money, while the other will have funds for borrowed money. The separate dividend pools allow insurance companies to pay lower dividends against borrowed cash while you get a higher reward for an unutilized cash value of your insurance policy. While you get a lower dividend for borrowing against insurance, you also get lower interest on loans that help you save money in the long run.
How Does It Work?
Understanding Cash Value
You may not understand the working of direct recognition insurance until you understand cash value in the context of insurance policies. Cash value refers to interest you earn from the policy that you can withdraw during emergencies. Generally, only permanent life insurance policies offer a cash value option.
The insurance policy’s cash value is collateral under a direct recognition insurance loan that directly affects the interest rates. In non-direct recognition insurance, the insurance policy’s cash value is not affected even after borrowing against it. The downside of non-direct recognition insurance is that even if you have not taken a loan against the cash value, you will still receive lower dividends.
Which Is Better for You?
If you make a head-to-head comparison, neither is superior to the other. However, experts believe direct recognition insurance offers more benefits as you don’t get lower dividends due to others taking loans. Once you repay the cash loan, you start getting higher dividend rates for the cash value.
Now that you know the difference between these two options, you can decide which one best suits your needs.