How are dividends distributed in a participating life insurance policy?

Dividends in a participating life insurance policy are distributed as a return of excess premium based on the insurer's performance. Participating policies are designed to allow policyholders to share in the insurer's profits. When the insurer performs well—typically measured by favorable investment returns, lower-than-expected claims, and efficient management—this surplus can be returned to policyholders in the form of dividends.

These dividends are not guaranteed and can vary from year to year, depending on the financial performance of the insurance company. This is a key feature that distinguishes participating policies from non-participating policies, which do not offer dividends. In contrast, the other answer choices do not accurately represent how dividends are structured. For instance, dividends are not fixed annual payments, nor are they automatic increases in the death benefit or deferred tax-free lump-sum payments. Each of these incorrect options omits the importance of the insurance company's performance and how it directly influences the dividends received by policyholders.