#243 | Rethinking Whole Life Dividends

One of the things I’ve been hearing a lot recently, especially from folks on the independent side of the business, is some variant of the argument that low interest rates are going to crush dividend scale interest rates (DSIRs) on Whole Life in short order because they are “unsustainable” at their current levels. Everyone knows that portfolio yields are down. Everyone knows that companies are under pressure. How is it that Whole Life seems to be largely unperturbed, the safe harbor in the midst of the storm? The answer is that either the mutual companies are universally playing nefarious and temporary games with their financials and products in order to prop up their stories – or they have a structural advantage that is only just now coming into play in a low rate environment.

In my experience, the folks making the argument about Whole Life dividends are coming at it from the paradigm of dealing with stock companies selling Universal Life policies. From that lens, Whole Life certainly does look unsustainable, but that’s not the right way to look at it. Whole Life isn’t Universal Life. Whole Life is a participating product. It is, effectively, equity in the operations of the mutual company. The DSIR for any particular company is a reflection not of current interest rates but of the net income that will be funneled back to policyholders, who own the company. Interest rates, of course, impact net income available for distribution, but it’s hardly the only factor.

Prior to this year, anyone trying to get a feel for where a particular company’s dividend comes from would have been somewhat at a loss. The books were just too messy. Statutory filings reported net income and dividends by product line, so all Individual Life products at a particular company were aggregated into a single operational category. But in 2019, the filing standards changed and now life insurers have to break out operational results by product category. For Whole Life, this means that, for the first time, we can see the net income directly attributed to Whole Life right next to the dividend directly paid to Whole Life. Combined with the Analysis of Reserves, which is also newly broken out by product category, can give you some pretty interesting insights into how these Whole Life blocks really work.

Take, for example, the seemingly simple metric of Net Investment Income (NII). In 2019, New York Life averaged $74.9B in Whole Life reserves and attributed $4.3B of NII to the block, which is a yield of 5.73%. MassMutual rings in at 5.34%, Guardian is at 5.06% and Northwestern rounds out the list at 4.88%. It’s probably not a coincidence that the DSIR at each one of the insurers follows the same ranking, with the exception of New York Life and MassMutual, which are flipped and separated by just 0.1% in DSIR. If you compare the Whole Life NII against each company’s Universal Life NII then the rates are closer, with MassMutual at 5.06%, Guardian at 4.93% and Northwestern at 4.75%. New York Life is the outlier at 4.37%, but their UL is written through their stock subsidiary, New York Life and Annuity (NYLAC).

I bring up the topic of NII because it illustrates one of the key things that sets Whole Life apart from Universal Life. Whole Life is the flagship product for all of these companies and it undoubtedly gets the choicest assets. At Pacific Life, for example, Whole Life NII yield is just 12 basis points higher than UL NII yield. But these blocks are also huge and stable, which means their portfolios are more protected against swings in premium inflows or benefit outflows. If you look at a ratio of premiums paid minus benefits and expenses paid out as a percentage of the total reserves for the block, the net premium flow is between 0.7% (NYL) and 2.94% (Guardian) for all of the Big 4 insurers. For Pacific Life’s Indexed UL block, that same metric is a whopping 11.6%. Minnesota Life’s IUL block stands at 10%. A low interest rate environment is certainly going to impact net investment earnings for mutual companies with large Whole Life blocks, but it’s just going to happen in slow motion compared to everywhere else. And it might just give them enough time to ride it out until things turn around, if that ever happens.

But the real story, of course, is the final dividend payout. In the new statutory filings, we can clearly see the relationship between the net income created by the Whole Life block and the dividend paid to the policyholders in that same block. It’s a test – does Whole Life work the way it’s supposed to work? Do companies really flow statutory Net Income back to policyholders in the form of a dividend? The answer is a resounding yes. That’s exactly what happens and you can see it in the statutory filings. Take a look at the table below.

MassMutualPennMutualNew York LifeNorthwestern MutualGuardian
Whole Life Net Income1,161,261,23474,067,0241,818,324,6064,943,389,348983,870,394
Whole Life Dividends1,644,479,27595,613,2941,918,058,1185,073,858,981965,337,720
Dividend / NI Ratio141.61%129.09%105.48%102.64%98.12%

In fact, in every case except for Guardian, the life insurer pays more in dividends than the block earns in net income. Where’s the extra amount coming from? Things like expense control, solid mortality experience, stellar investments and successful business lines create distributable net income. And for mutual companies, that means it all goes to policyholders either in the form of a dividend payout or capital augmentation.

The perennial question about mutual companies is whether or not they actually do a good job of managing their businesses for the benefit their policyholders. Recall the notorious Boston Globe article from 2015 which essentially made the case that mutual companies mostly existed for the benefit of the people running them, not the policyholders. Let me play the Devil’s advocate for that argument. If you look at general insurance expenses assigned to Whole Life as a percentage of total Whole Life reserves, the expense ratio is 1.96% for New York Life*, 1.65% for MassMutual and 1.55% for Guardian. To put it another way, with a lower expense ratio at these insurers there would be a clear benefit to actual dividend payouts, but life insurers choose not to operate that way. There could be a lot of legitimate reasons for spending money, including in ways that ultimately benefit policyholders in the long run. Spending money isn’t bad if it’s being spent productively.

Or a skeptic might say that these companies are padding their own pockets with policyholder money. That’s certainly what the Boston Globe article seems to say. I remember making (and immediately regretting) a joke a decade ago when a bus full of agents from one of the major mutual companies unloaded at one of the finest restaurants in DC about whether or not their policyholders had approved the expense. It’s a joke that’s not really a joke. Any dollar spent at a mutual company is a dollar not paid in a dividend. That philosophy is why Northwestern Mutual has long touted its fierce expense management and the proof is in the pudding – their expense ratio is just 0.55% and their raw attributed expenses ($954M) are lower in absolute than MassMutual ($1.02B) and New York Life ($1.47B). In a low rate environment, you can bet your bottom dollar that mutual companies are going to start following Northwestern Mutual’s lead on expense management.

But there’s another angle on how to generate value for policyholders that goes well beyond the basics. Mutual companies are in the business of more than just selling Whole Life. Some of them are multi-faceted financial institutions with several significant lines of business. The profits from all of these lines of businesses also flow back to the participating policyholders in the form of dividends and can substantially increase the net payout. That’s the true equity component of Whole Life dividends. Prudent Whole Life block management is effectively a refund of overpayments. The policyholders equity position is in their own product. But if profits come from elsewhere in the business, then suddenly that equity position is a lot more than just a refund – it’s true equity. And that can count for a lot.

MassMutual provides a prime example because Whole Life is basically the only participating product they sell (DI also participates and receives a small dividend). Life Insurance excluding Whole Life actually had negative net income in 2019 (about -$100M), but Group Annuities and Individual Annuities combined for a total net income of $700M while Disability kicked in about $100M. All in, that’s a net benefit of $700M from other businesses within MassMutual, none of which are participating. Where does all of that money go? Well, some went to capital ($220M, plus a $240M tax credit on WL) but the rest went to dividends on participating Whole Life. That, my friends, is exactly how it’s supposed to work. And it does.

PennMutual has a similar makeup, with Individual Annuities kicking in $70M into the pool, which offsets some of the losses on Individual Life (particularly Guaranteed UL). At Guardian, about a third of the company’s total net income is generated from non-Whole Life activities, but Guardian chose to redirect the funds towards bolstering its capital base by 6%. Every company tells a different story. Every company has a different structure. But because these are participating policies, those differences matter. Whole Life is, in a sense, part fixed income and part equity. In a high interest rate environment, the equity component isn’t nearly as noticeable. It gets washed away in the flood of high net investment yields. But today, the earnings from the equity component can make a pretty big difference.

The question I posed at the beginning of the article was whether Whole Life companies are playing games or if the product actually has a structural advantage that is rising up from beneath the surface of low interest rates. The answer, based on the arguments above, is pretty clear – Whole Life actually has a structural advantage because it has embedded equity exposure in the mutual company profits. You can easily see it in the way the money flows in the statutory filings. All else being equal, an overfunded Whole Life policy should outperform – potentially handedly outperform – a Universal Life policy because of its embedded equity exposure. There are always tradeoffs, of course. Whole Life isn’t as flexible as Universal Life. Universal Life offers more transparency. Universal Life can be tailored to more specific sales scenarios. If you’re thin-funding and only concerned with low-cost death benefit, Universal Life is the better chassis. Universal Life offers more crediting options. But what Whole Life lacks in these dimensions it makes up for in a structural performance advantage, which is going to become increasingly important in today’s low rate environment.

One final note. I am not at all making the argument that dividend interest rates aren’t going to drop. Low rates are absolutely exerting pressure on dividend interest rates. All else being equal, lower net investment yields mean lower dividends. For some companies and some products, it might even mean negative contributions of investment yield to the dividend because the guaranteed rates in the policies are greater than the earned rate. When you’re illustrating Whole Life, you should probably shave off some of the DSIR in the same way that you should shave off the illustrated returns of any other portfolio yield product, including Indexed UL. What’s different about Whole Life, however, is that it’s possible that Whole Life can still generate solid dividends in a low rate environment by earning profits from other lines of business, ruthless expense management or flawless underwriting experience. There’s just more to the story. Generalizing about Whole Life is hard. A fair statement would be to say that, all else being equal, lower interest rates will result in lower dividend interest rates – but nothing is ever held equal and certainly not in Whole Life.

*New York Life uses a managerial system for its career agent system, which means that all of the expenses for branch management roll up to New York Life and are therefore presumably listed as general insurance expenses rather than commissions. Based on sales data and commission payouts, I’d ballpark managerial expenses at somewhere around $180M. Backing that out of the overall general expenses pushes down New York Life’s expense ratio to 1.72% – still the highest but not by quite as wide of a margin.