Direct Recognition is a feature in some life insurance policies where the policy’s dividend and interest payments are adjusted based on any loans taken from the cash value. If you take a loan, the insurer may reduce or increase your dividends for the portion attributed to loaned money. If the loan rate is above the dividend rate, then your dividends on the borrowed cash value will increase since you are paying what’s considered an “above market” rate. If the loan rate is below the dividend rate, then your dividends on the borrowed cash value will decrease since you are getting a “below market” loan rate.
It’s worth noting that mutual companies offering Non-Direct Recognition loans will pay the same dividend on both the loaned and non-loaned portion of cash values. In theory, that means that non-borrowing policyholders will essentially subsidize any “below market” loans, and borrowers taking “above market” loans subsidize the dividends for all non-borrowers by paying a higher rate. However, Non-Direct Recognition companies either nimbly adjust their loan rate accordingly and/or pay lower ongoing dividends to all policyholders to subsidize the excess cheap money borrowing.
Learn more about Direct Recognition vs. Non-Direct Recognition here.