#194 | 2020 Whole Life Dividend Rate Recap

‘Tis the season for the much-anticipated, much-speculated, much-hyped dividend interest rate announcements from mutual companies. The headline is that not a whole lot happened this year in terms of dividend rate changes. New York Life, Northwestern Mutual and PennMutual held their DIRs stable, while MassMutual and Guardian both dropped by 20bps. This year was hardly the bloodbath that some folks were predicting due to the slide in earned rates throughout the year, which is exactly why it’s instructive. This year is a little window of insight into the ways that mutual insurers are changing to meet the challenges of seemingly permanent low interest rates and why some of the old thinking about DIRs no longer applies.

Imagine that the Whole Life market in the US is completely dominated by two insurers of roughly equal size, Southeastern Life and MaineMutual. These two companies employ different strategies about how to run their businesses. Southeastern is a classic mutual company that exclusively sells participating Whole Life insurance policies. To maximize its competitive position, Southeastern underwrites judiciously, ruthlessly cuts expenses and invests aggressively. Southeastern’s core philosophy is that sticking to its knitting will produce the best, and most consistent, dividends to policyholders and that these happy policyholders will stick around, which will keep the enterprise humming for generations.

MaineMutual shares Southeastern’s philosophy that happy policyholders will stick around to keep the enterprise running forever, but has a different (and much more entrepreneurial) strategy. MaineMutual looks at its massive balance sheet, sparkling home office and talented workforce as assets that can be deployed into a host of potential businesses. MaineMutual is a top 3 seller of fixed annuities, writes boatloads of auto insurance, has a reinsurance company, runs a large institutional asset management business and sells huge amounts of group insurance. MaineMutual is far less concerned with strict expense and mortality management than it is with feeding its various businesses with sufficient capital that will, hopefully, produce stellar long-term earnings to be paid out in the form of a dividend to the Whole Life policyholders who provided all of that capital in the first place.

But there’s an interesting twist to the story playing out right now. Life insurers become far more leveraged to their business strategies when rates are low. Let’s assume that Southeastern can reliably earn slightly higher spreads on invested assets but MaineMutual earns an extra $500M from its other businesses. In a high interest rate environment, the net effect is that Southeastern’s DIR is 0.25% higher than MaineMutual’s, but the difference on a percentage basis is small. An extra quarter of a percent doesn’t mean much when baseline rates are 10%. In a low interest rate environment, the opposite happens – MaineMutual’s extra $500M of earnings translates into 0.5% of extra yield on the block whereas Southeastern’s ability to earn larger spreads doesn’t count for much in a low rate, low spread environment. An extra 50bps on DIR counts for a whole heck of a lot in a 5% baseline rate environment, especially when you consider the fact that the discretionary part of the DIR increases by 50% when a company goes from 5% to 5.5% (subtracting out the 4% guaranteed crediting rate).

Increasingly, life insurers in the real world have turned to the MaineMutual playbook. Witness New York Life’s acquisition of Cigna’s group life and annuity businesses, just to name one prominent and recent example. The big conversation in the Whole Life world over the last few years is about how major mutual companies will “cope” with a low interest rate environment. Well, there’s your answer. Mutuals aren’t going to just buckle down and try to survive by cutting expenses and underwriting more judiciously. There are natural limits to both of those strategies. They also can’t push too hard on edgy investment strategies because of NAIC capital requirements, but investment prowess is also a game with limits. Every insurer is trying to find a niche in the capital markets that looks a lot like what every other life insurer wants too. Those assets are scarce and prized. So what options do a mutual companies have other than to build up ancillary businesses? In my view, not many.

That makes comparing real-world companies and their DIRs increasingly difficult. If every company looked more or less like my fictional Southeastern, as was true many years ago, then we’d be able to do apples-to-apples comparisons because the companies would actually be comparable in their strategies. That’s why there’s a legacy of thinking about DIR as an equal metric across life insurers, which was never really true anyway because every carrier quotes their DIR differently. But if every company follows my fictional MaineMutual, then they will all necessarily look different because they are all making different bets. One real-world company might decide that it wants to build a huge annuity business. Another one might rely on an institutional or retail asset manager. Another one might be big in the group space. Another one might have a diversified set of businesses. Another one might go international. Still another one might decide to write a bunch of risky life and annuity products. At time zero, they all look pretty similar. How different they look in the long run will be a function of interest rates. If rates stay low, they’re going to look really different. If rates dramatically increase, they’re going to look more similar than not.

I covered some of these same arguments recently in a surprisingly popular post on Whole Life where I wrote, basically, that illustrations in Whole Life should be mostly ignored and the right thing to focus on is the company writing the product. The same goes for the DIR. Please, for goodness sake’s, don’t view a company’s DIR as the indication of the company’s quality or performance. Every single Whole Life company could dramatically increase its DIR right now by cutting surplus, ceasing capital investments and stopping new business. Any and all of those things would produce a huge pop in distributable surplus that would be funneled to the dividend and produce a huge DIR. Do you want that? Didn’t think so. Every company is trying to balance current payouts with investing in building businesses to bulletproof its future. In a weird way, if I were you, I might be asking for a lower DIR so that the life insurer can allocate adequate capital to things that will produce future earnings streams. That’s the playbook for thriving in a low interest rate environment. What you should care about is the next 30 years of DIR, not the next 12 months.

But there’s just one little problem – are life insurers actually any good at buying or building these other businesses? The track record is, shall we say, checkered. Let’s take MassMutual for example. Mass was quick to tout their successful acquisition, management and extremely profitable disposal of Oppenheimer Funds. Much less known is their similar success in running Barings, an institutional asset manager based in my home town of Charlotte. But what about Mass’s much-touted direct-to-consumer arms Haven Life and Velora Life? It’s not hard to see that, from a pure P/L standpoint, both of those were abject failures. Every other company has its story of successes and failures in ancillary businesses as well and there will be many more as mutual companies increasingly focus on non-core lines. In the long-run, will the MaineMutual strategy produce better returns than the Southeastern strategy? Only if these non-core businesses end up being profitable on a risk-adjusted basis. Inevitably, therefore, some companies will win and some will lose relative to the baseline. Maybe the tried-and-true Southeastern playbook isn’t so bad after all.

Ah yes, and speaking of risk, remember AIG Financial Products? That little, tiny, rounding-error of a non-core businesses managed to bring a global AAA rated life insurer to its knees in the matter of weeks. You never have to worry about that with a company selling just participating Whole Life. But a company that suddenly sticks its fingers in all sorts of businesses that it doesn’t really understand? Well, that’s a different story.