So, which is the superior method of treating dividends when there’s an outstanding policy loan?
Are the “purests” correct when they point to non-direct recognition as the only way a company should approach whole life policy loans?
Or, does direct recognition have an advantage by “not subsidizing the policies with loans with the ones without them” as the companies that issue direct recognition contracts are quick to point out?
The Non-Direct Approach
As we’ve said, non-direct recognition does not adjust the dividends paid on a policy when there is an outstanding policy loan. For a long time, this has been regarded as a superior feature. We’ve covered the notion that policy loans do not come out of the policy.
And, in truth, whether the policy is direct recognition or non-direct recognition, something still gets paid on the cash values that are pledged as loan collateral.
This feature has been the catalyst behind numerous marketing packages mentioned in the non-direct recognition post. The addition of non-direct recognition augments this benefit, or so the claim goes.
But, one question non-direct recognition adherents often fail to address is that there is no fix-all.
The likes of MassMutual, New York Life, Ohio National, and MetLife (some big names in the non-direct arena) do not have access to a magic well from which to pull money.
So, while it’s very nice that they don’t adjust dividends, there has to be something that they give up in order to make that benefit a reality.
The Direct Approach
Direct recognition, as we know from the last post, was introduced as a way to combat rising interest rates that made whole life insurance policies of the day appear to dramatically lag behind other fixed income-based assets.
Direct recognition companies are quick to point out that their non-direct counterparts are subsidizing policies with loans with policies that do not take loans. In other words, they are dragging down the dividend they could be paying non-loaned policies to prop up the loaned policies.
This seems like a fair criticism, but some non-direct recognition companies would counter that the practice of “subsidizing” the dividend with other business units is a prevalent practice among all companies.
For example, a company may derive a significant amount of income from a non-participating block of insurance business.
Profitability on this block is not shared with policy owners and instead is part of the company’s surplus goes towards whole life dividends.
Traditionally, direct recognition has been criticized by its opponents for reducing the dividend rate when a policy loan is outstanding.
However, since fixed loan interest rates on some policies are currently higher than insurance companies are earning on their general account investments, direct recognition has turned into a feature that increases dividends paid on loaned portions of policies.
Keep in mind that whole life is a product issued mostly by mutual life insurers who seriously consider participating policyholders as owners and that the company works to deliver the best benefits to its owners.
It’s important to note that this practice (increasing dividends) does not enhance policy performance by virtue of taking a loan as there is still a spread between loan interest and the dividends paid.
It does, however, offset what in current conditions might seem like very high interest rates.
It’s Really No Contest
When it comes down to it, one is not superior to the other. All this talk about direct recognition vs. non-direct recognition is a game of smoke and mirrors used to keep your focus away from the really important stuff.
In the fight among insurance companies, there is no magic, but there are plenty of magicians.
I’ve talked about the Blease projected income report, which is done every year by Blease/Full-Disclosure (edit: Blease Research is no longer updated due to the passing of its founder, Roger Blease, in 2013).
This report solves for death benefit based on a specified base premium for several companies and then solves for projected income. If you want to read the article on the Insurance Pro Blog, it can be found here.
Here’s an image taken from the current report that shows us all of the participating companies and their results:
Click on the Picture to Enlarge
Now, if non-direct recognition were the ultimate feature, then the non-direct recognition companies should consistently report higher incomes, but that’s not the case.
Ohio National (a non-direct recognition company) does take second place, but Penn Mutual (a direct recognition company) wins top prize.
Also note that we have to cut through Security Mutual, the Guardian, and Country Financial (all direct recognition) before we get to another non-direct recognition company: Lafayette Life.
It is noteworthy that both Mass Mutual and New York Life are missing from this list. We suspect Mass could give Penn Mutual a run for its money. New York Life, on the other hand, probably isn’t going to win this fight.
Details, Details, Details
I said it at the beginning of this post, and I’ll say again – there’s more to a whole life contract than its dividend recognition.
The total package is important, so if you’re looking at one product simply because it is or isn’t non-direct recognition, you may be under the influence of a magician.
Direct recognition is more prevalent but can also have some pitfalls (note that the worst performers tend to be direct recognition contracts).
Life insurance contracts can be robust. Be sure to consider wealth accumulation and retirement income strategies when making a life insurance purchase as opposed to getting hung up on whether the contract is direct or non-direct recognition.
Feel free to reach out to us if you have any questions. We can help you objectively evaluate which policy will work best for you using our own proprietary analysis.