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It's November and that means it's time for most major U.S. life insurer who have any significant focus on whole life insurance sales to announce anticipated dividends for next year. We've already heard from a few life insurers and we are awaiting announcements from the others.
We figured we'd take a moment to discuss what these announcements mean, as well as offer up some commentary on the state of whole life insurance dividends going into 2019.
How Life Insurance Dividends Work, a Quick Review
As many of you already probably know, whole life insurance dividends come from three primary considerations for the life insurer:
- Investment performance on managed assets
- Insurance Profitability
- Administrative Expense
Experience at the life insurance company over the past year that exceeds expectations for these three categories result in money available to pay a dividend.
At the end of the policy year, the board of directors at each life insurer looks at these three components, and determines the dividend payable to policyholders.
At the same time, a so-called dividend interest rate is normally established and some (but not all) life insurers publicly announce the effective dividend scale with the latest dividend payout anticipated for the following year.
The dividend interest rate has long been a tool used for good and evil.
The Dividend Interest Rate
The dividend interest rate specifically speaks to the portion of the dividend payment attributable to the investment performance of assets held by the insurer on the behalf of the insured. In other words, is the portion of the dividend payable by “alpha” created by the life insurer with the money that the policyholder holds at the life insurance company (aka the cash value of his/her insurance policy).
For years, various people actively engaged in marketing life insurance to the general public have played a bit fast and loose with what exactly the dividend scale represents.
In some instances, some suggest that the dividend interest rate is a rate of return policyholders achieve on the money paid to the insurance policy, which is wrong.
In other cases, others suggest that the dividend interest rate represents a return on the policy (undefined beyond this point) that shows who among all the life insurers pays a higher return to policyholders, this is also wrong.
And in some circumstances, suggestions are that the dividend interest rate is the rate of return policyholders achieve on their cash values, also incorrect, but the closes to correct among the group.
The dividend interest rate is simply a variable within a more complex calculation that determines the dividends payable to each policyholder. So knowing the dividend interest rate means you know one (out of several) variables used to calculate the dividend owed to each policyholder.
So why so much fascination over the dividend scale if it's only one component to a much more complicated calculation? Because for years, the dividend interest rate represented the largest variable that affected the dividend payout–and this is still the case for most U.S. life insurers.
To paint a picture that I want to make clear by no means represents the reality of the life insurance industry and is merely numbers plucked from the air to make a point, imagine a calculation that involved 5 different input variables. Imagine also that one of the five will make up 90% of the output result. If we know the value of that one variable that makes up 90% of the result and only that value, we have a pretty good understanding of what is going on in terms of direction of the output without even looking at the other variables.
Best Use of the Dividend Interest Rate
We've mentioned numerous times on this blog that the best application of the dividend interest rate–in our eyes–is on tracking the movement of the dividend over time at one specific company.
For example, if we look at the dividend interest rate at New York Life over a 10 year period, we can use the declared dividend interest rate to determine if the dividend has mostly trended up, down, or flat. We cannot, however, take the dividend interest rate at New York Life this year, and compare it to Northwestern Mutual's dividend interest rate and declare one company superior to the other.
We also cannot take the dividend interest rate at New York Life and use it in any meaningful way to calculate the exact dividend owed to a policyholder. We can, however, get somewhat close if we are really good at understanding insurance minutia. But this pursuit is mostly for Friday night spreadsheet fun and has little application beyond that.
Declining Dividend Interest Rates
For many years, insurers have mostly announced declining dividend interest rates. We've reported on this through various analysis on this web site (the latest you can get as a download from the homepage). The driver behind this declining dividend interest rate is declining interest paid on debt instruments due to low market interest rates.
Insurers assume a guaranteed rate of return achieved on assets held for policyholders and returns beyond that guarantee support a dividend payout. Sadly for the life insurance industry, it's primary investment option, debt, has boasted mostly paltry yields for over a decade.
This simply leaves less money left over since life insurers achieve investment returns that are drawing close to the guaranteed return assumptions. Case in point, the average return on assets among the six life insurers we regularly track for dividend analysis was 4.4% for 2017. The guaranteed rate of return on the majority of the policies issued by these six companies is 4%.
Until interest rates trend up for a sustained period of time, life insurers will continue to experience declining investment returns which in turn will most likely result in lower dividend interest rates.
But, declining dividend interest rates doesn't always mean declining dividend payouts.
The Other Dividend Factors
While investment returns usually play the largest role in dividend payouts for policyholders, other factors do matter. Life insurers who experience better than anticipated claims (i.e. fewer people who held policies died than anticipated) can and do use this additional profitability to pay dividends in the years the experience is better than expected.
In addition, insurers can, and do, cut costs to help support the cause for maintaining a strong dividend payout to policyholders.
Lastly, insurers are free to use business activities that fall outside of regular whole life policies to pay support the dividend payout. Insurers who own subsidiary businesses or who maintain other insurance business lines, are free to use the profitability of those businesses or lines to support the dividend to participating policyholders.
Announcements to Date
As of the publication of this blog post and podcast, we've officially received work from three companies that we normally track for dividend performance. One announced an increase in the dividend interest rate, while the other two announced no change in the 2019 rate over the 2018 rate.
For the remaining companies that have yet to announced, we could only speculate at this point on what they will likely do (and we will forgo that opportunity).
The news so far has been largely positive, and we aren't anticipating any big surprise announcements from the remaining life insurers (but we'll have to wait and see what ultimately happens).
We don't anticipate any major increases to occur this year or next year in terms of dividend interest rate. Given the stability of insurance company practices, we also don't foresee any major increase in dividends payable under other considerations (claims experience and administrative cost containment).
We are planning a much more in-depth and specific to each company blog post once all announcements are public.
Great article. A must read for all.