We recently came across this article called “Help your client understand par policy dividends,” – it caught our eye since the true operational details are considered proprietary. Participating life insurance is the most misunderstood, misrepresented, oversold, and over-pitched product. It is a good policy, but it will never look as good as the illustrations.
It’s impossible to know how these policies will look in the long run so to that end, we wanted to share our comments on a few points from this article:
“Based on a par policy’s profits, annual dividends may be issued to policyholders. These dividends can be used to increase a policy’s cash value and death benefit over time.”
The dividends have nothing to do with the profits. All of my clients who purchased these products in the mid to late 80s are receiving no dividends (and haven’t for the past 4 years) yet the fund is highly profitable from a returns perspective. Dividends are issued when returns beat the assumptions underlying the calculations of the dividends. When your policy meets and/or beats the assumptions, a dividend is issued. I cannot take this chart seriously when my clients are not getting dividends.
“The formula for calculating policy dividends is called the ‘dividend scale,’ which is based on a number of factors, including a par policy’s investment returns, policy lapses, claims and expenses, said Steve Krupicz, AVP, advanced sales and actuarial consulting, with Manulife Financial Corp. Specific weightings by each insurer are proprietary, he said.”
It is not just the weighting, all the foreword-looking assumptions are considered proprietary. Therefore it’s impossible to make accurate predictions and therefore realistic illustrations.
“Portfolio returns are a major component of a par policy’s profits, accounting for 60%–70% of the dividends paid over the policy’s lifetime, Krupicz said. The dividend scale interest rate (DSIR) is used to calculate the proportion of dividends attributable to portfolio returns.”
If portfolio returns are a major component and get more important as years go by, then why do I have clients not getting dividends? They invested in the 80s and returns since then have been incredible. This is my MAIN concern with this sort of product, I have questions and am given no answers.
“Insurers use “smoothing” — amortizing gains and losses over several years — to help keep the DSIR stable over time. For example, Sun Life Financial Inc.’s average annual DSIR was 7.54% for the 25 years ended in 2019, with a standard deviation of just 0.77%. By comparison, 10-year Government of Canada bond returns averaged 4.26% annually over the same period with a standard deviation of 1.82%, and the S&P/TSX composite index’s average annual total return was 8.32%, but with a standard deviation of more than 16%.”
This is simply not a relevant comparison. If I had $100 in bonds I would expect a check for $4.26 in this example. However, how do I calculate what my dividend is with a reported DSIR of 7.54%? What does that mean? They provide no backup accordingly. Comparing returns to a DSIR is comparing apples to nothing.
“An insurer could experience relatively poor portfolio performance but benefit from mortality gains or cost-cutting, said Peter Wouters, director of tax, retirement and estate planning services with Empire Life Insurance Co.”
The extent of each is “proprietary” so we cannot really know.
“Still, persistently low interest rates remain an important factor for policy dividends. ‘Every insurance company is telling advisors there’s downward pressure on their dividend scale interest rates as a result of lower bond rates,’ Krupicz said.”
They say there is downward pressure and continue to show examples illustrating current returns. Brokers may bastardize it but insurance companies offer no guidance and are the source of the problem.
Buyer beware!! You are being over-promised and the dividends will under-perform.