As if low interest rates and volatile stock markets haven’t done enough damage to clients’ investment portfolios, these negative forces are taking a growing toll on the returns clients are earning in the cash value of their life insurance policies, as well.
Dividends on participating (“par”) life insurance policies have been trending lower in recent years. So far in this year alone, dividends are down by more than 10% at some insurers as low interest rates punish the returns that insurance companies are earning on investments within their par accounts.
The trend may mean difficult conversations for some financial advisors, as their clients are forced to adapt to lower returns across all aspects of their investment portfolios.
“Existing policyholders will need to lower their expectations over what was perhaps illustrated to them in the past,” says Jeff Blain, insurance consultant for Ottawa-based MD Financial Management Inc.
In the past year, poor stock market performance combined with low interest rates hit par accounts at some insurers especially hard. At sister companies Toronto-based Canada Life Assurance Co. and London, Ont.-based London Life Insurance Co., for example, 2016 par policyholder dividends decreased by an average of 12.6% and 11.7%, respectively, compared with the amount that would have been paid this year if no changes had been made.
The reductions were triggered by decreases in those insurers’ dividend scale interest rates – the rates used to calculate the investment component of par policy dividends – of 50 basis points (bps) and 60 bps, respectively.
“A low interest rate environment, combined with negative returns on the common stock component of the par account, is what drove the reduction in the dividend scale,” says Saundra Edwards, assistant vice president of business development and solutions at Canada Life, London Life and Winnipeg-based Great-West Life Assurance Co. (Great-West Life also dialed back its dividend interest rate by 25 bps for the 2016 calendar year.)
The market conditions have forced other insurers to make downward adjustments to their dividends, as well. Toronto-based Manulife Financial Corp., for example, reduced its dividend scale by 25 bps for certain par policies effective September 2015.
Most insurers’ dividend scale interest rates now are in the 5.3%-6.75% range, compared with rates of around 12% in the early 1990s.
“[The reduction] has been a gradual decrease,” says Byren Innes, senior strategic advisor, financial services consulting and deals, with PricewaterhouseCoopers LLP in Toronto. “Essentially, it’s just a continuation of the prolonged interest rate environment that we’re in.”
The premiums collected on par insurance are pooled into a participating account, which typically is managed conservatively with heavy weightings of bonds, mortgages and other fixed-income instruments. The level of dividends paid out to policyholders is reassessed by insurers each year, taking into account the performance of these investments, as well as policyholder mortality experience and operating expenses.
“[Insurers] try to pay out as much as they can, but they still have to have the [reserve] fund backing all of the policies,” says Innes. “So, [insurers] have to be very prudent in how they manage those assets, so that they can pay out future death claims and future cash values, et cetera.”
Although improvements in policyholder longevity have had a positive impact on insurers’ par accounts, the poor investment performance has outweighed other factors. Insurance companies typically maintain healthy surpluses in their par accounts to smooth out returns to avoid dramatic swings in dividends.
However, given the prolonged low interest rate environment, Edwards says, insurers have no choice but to dial back dividends.
Volatile equities markets
“There’s no indication that the low interest rate environment or the volatility in equities markets is going to change, or that [the reduction in dividend scale rates] is just a short-term blip,” Edwards says. “There is a belief that this [investment climate] is going to last a little while longer, and so we need to reflect that in the dividend scale that we credit policyholders.”
The fact that insurers are making these adjustments should reassure policyholders that the reserve fund backing their policies will remain healthy in order to pay all future benefits, Edwards says: “[The dividend reductions] show that we are managing the par account [prudently] and ensuring that it continues to remain strong going forward for policyholders.”
Some clients will feel the impact of the dividend adjustments more than others because the actual dividend rate on each policy varies based on factors such as the year the policy was issued and age of the policyholder. Clients who rely on their policy’s dividends to offset premiums are likely to feel the greatest impact because they may be forced to resume making out-of-pocket premium payments as dividends decline.
Assuming your clients have been properly prepared for the inevitable fluctuations in par policy dividends, Blain says, the declines shouldn’t come as a surprise – particularly considering the state of markets.
“What we’re seeing right now is very reflective of the markets,” Blain says. “If good planning has been done up front with our clients, and good conservative projections have been done, then the impact of these lower returns is not as hard felt – and certainly shouldn’t be a surprise.”
The declines in dividends do not appear to be deterring clients from buying par policies. Sales of whole life insurance have been outpacing other life insurance product categories in the past few years, Edwards says, and par policies have been driving much of that growth.
Adds Edwards: “We continue to see, year over year, solid sales and growth in sales.”
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