When it comes to evaluating whole life insurance dividends and whole life insurance yields it’s important to keep an eye on the investment results of a company’s general account. The general account is the collection of assets the company holds under management to support most of its fixed insurance products.
Since investment return is one of the three main components of whole life insurance (or any permanent life insurance) design, ignoring a company’s investment performance would be a critical error.
Whole life insurance is based on three main components:
Since today’s topic is focused on that second point, we’ll only briefly address numbers 1 and 2. Mortality cost is the expected value (stated as a cost) for the policy in a given year. For those without a profound love or understanding of probability theory, expected value is merely the value or cost of a given event based on the probability of a given outcome (i.e. if the probability of winning a lottery for $1 million is 1 in 10 million, than the ticket has an expected value of 10 cents).
Expense is the loading component of a life insurance policy. It’s the ability of the insurance company to add additional cost to the policy to cover operational expenses. These expenses are regulated by state insurance commissioners so the insurance company can’t simply load an indefinite amount of extra cost to policies.
The investment component is the return the insurance company assumes that it will earn on the money that it collects.
From a regulatory point of view, the investment return is guaranteed by the company. The technical purpose behind this is for reserve building. The precise details on what that means are best left for separate article, just understand that as we mentioned in the introduction to whole life article, the company takes on the guarantee of building collected premium to be a cash account that eventually equals the death benefit.
Whenever the insurance company experiences actual operational results that are better than the guarantees offered by a policy, a dividend is traditionally paid to share in the higher than anticipated profitability of the collected premiums.
Because the insurance company has limited room with respect to varying mortality and expenses, investment return typically represents the largest opportunity to generate revenue. As a result of this, it’s not surprising to learn that investment yield also makes up the largest component of participating whole life’s dividend, and this is why so much time is spent discussing the dividend interest rate.
Since we spend so much time talking about the use of whole life insurance as an asset class, we use this metric to evaluate the overall health of a company and use it as one of many metrics to help make inferences about where dividend rates may go in the future.
For example, since most companies guarantee a 4% annual return on whole life policies issued under the 2001 CSO, we want to see companies that maintain an average of at least 4% for the past 5 years. Though it may seem like a somewhat short period of time, the 5 year period helps keep results closer to actual economic conditions rather than being influenced by old results that were produced by assets that the company likely no longer holds.
Since the 4% rate is the benchmark on which company pricing is based, the larger the margin between actual performance and that 4% the higher the revenue earned by the insurance company. The higher the revenue, the more likely we’ll see higher dividends.
There is one common mistake that agents and company marketers make, which is to incorrectly draw a direct connection between the dividend interest rate and the total investment return. Dividends on a whole life policy are paid somewhat similarly to dividends paid on any item, a pool of money is determined and that pool is paid out to each participant based on some formula to distribute those dividends. The rate is merely determined afterwards to act as a way to quantify the relative payout.
We took the top 14 insurance companies well known for their whole life products and evaluated their 5 year total return on investment assets. The average for the entire industry is 4.62%, which speaks volumes about the complaints we’ve been hearing from insurers about low fixed assets yields. One potential ray of sunshine for insurers is the fact that the newest CSO has dropped the statutory required rate of return to 3.5%, bad news for everyone else is that this means premiums could go up.
As you can see from the table, some insurers are currently performing comfortably above the 4% mark (in fact, we’d suggest anyone who beats 5% s doing pretty well). There are some who have fallen dangerously close to a 5 year average of 4%, which is not in and of itself good news, but it’s not all by itself a reason to reject a company as a potential option.
Life insurers have often used the 10 year note as a benchmark for performance. With a 5 year yield below the 4% guarantee under the 2001 CSO, we can also see why several insurers have bemoaned the current interest rate environment. Since it’s a benchmark, though it’s below the guaranteed return rate, it’s also helpful in evaluating performance of each company relative to this benchmark. Good news is, everyone beats it.
While the investment return is an important aspect to company performance, especially when we’re selecting a policy to use as a low risk asset in our portfolio, it’s not the only factor. We also have to remember that sometimes people make mistakes in a given year that will continue to affect their average yield in these sorts of comparisons.
So while this information is helpful, it’s not the only metric one should consider when choosing between companies.
Still I’d suggest this consideration is one of slightly more considerable weight when compared to certain other factors (i.e. net income, return on equity, operating expenses to net revenues, etc). If you’re interested in reviewing more of the year by year data for a specific company, feel free to reach out to us, and we’ll be happy to send it along. Since whole life insurance dividends are the central focus when we look at this product as an asset class, it’s important that we spend some time reviewing this component at the company.
Brandon launched the Insurance Pro Blog in July of 2011 as a project to de-mystify the life insurance industry. Brandon was born in Northern New England, and he currently calls VT home. He attended Syracuse University and graduated with a triple major in Economics, Public Administration, and Political Science.