Reversing the process of calculating distributable dividends on an entire life insurance policy is almost impossible given the unique nature of life insurance companies. With that said, we can use several pieces of information to at least create an estimate of the accuracy of the dividend received for an entire life policy during a particular insurance year. <! – ->
The fastest and easiest way to do this is to use the life insurance illustration. The general ledgers in the illustration normally project the distributable dividend during all insurance years, we can simply use it to reconcile the dividend earned during a specific insurance year.
The dividend can change, and if it does, the original illustration is no longer correct. What do we do now? <! – ->
We simply request a valid illustration that uses the recently declared dividend rate and uses this going forward to refer to the dividend paid. We must do this every time the dividend changes at the insurance company.
The second way to do this is much more complicated and before we dive into the process of tackling this method, let's spend some time understanding the components of the dividend and the information we will have (at least some ) access that allows us to try reverse engineering of the dividend calculation. Caution, this process is not for the faint of heart and the above process will ALWAYS be the easier way to approach this issue.
What is a dividend on a comprehensive policy?  A dividend paid for an entire life policy is the mechanism that life insurance companies use to share the profitability of their business with the policyholders. This is an obvious question. <! – ->
Why would life insurers want to share their profits with policyholders?
Many do not. And they usually do not.
But some life insurance companies in the United States operate as mutual life insurance companies (or pseudo mutual life insurance companies, which is a topic for another day). These insurers place the ownership of the company in the hands of the people who buy insurance from the company. These types of life insurance companies have a legal requirement to produce profits for their owners (ie the policyholders) and they do this through dividends.
Technically, dividends officially function as a repayment of premiums paid by the insurer. . This is a unique tax classification that gives life insurers and life insurers a significant tax break / benefit. <! – ->
The three components of a life insurance dividend
Entire life insurance dividends are deducted from three sources:
- Insurance profits
- Investments return
- Administrative costs
Insurance profits will be an insurance company. This usually happens when fewer people claim (ie die) than the insurance company expected. Predicting deaths among a large group of people is surprisingly easy, so life insurance companies rarely money on this variable.
The return on investment drives the cash value accumulation component of a life insurance contract. Insurers try to generate investment income that is at least sufficient to cover the guaranteed provisions of the agreement. The majority of life insurers successfully generate investment income that exceeds the guaranteed contract functions. Income generated in addition to these contractual obligations is profit that is entered into the dividend. This variable generally plays the largest role in the total dividend payment and is the focus of the often mentioned dividend interest rate.
Administrative expenses are the tedious daily expenses that the life insurer faces as compared to the regular expenses of all business faces. This includes things like office supplies, renting office space, electricity bills, salaries, etc. When life insurance companies work under budget for these expenses, that surplus can go towards the dividend. <! – ->
The entire life insurance dividend interest rate
Many insurance companies that issue whole life insurance policies announce the dividend interest rate when they announce the dividend for the year. While many assume that they understand what the dividend rate says to them, the truth is very few people really understand what this data point conveys.
The dividend interest rate simply tells us the initial value that the insurer uses when calculating the actual dividend on an entire life insurance policy. It is a variable of … at least … three (see above for the other two).
Further complicated issues concerning the dividend rate, there is no standardized protocol for arriving at and publishing a dividend rate. So the assumptions a company can make that make them declare a dividend interest rate of 6.95% can vary considerably from the assumptions that another company makes that make them declare a dividend interest rate of 7.05%. For this reason, it is very wrong to assume that you can compare the nominal interest rates declared by each insurance company to be able to quickly assess who is paying the higher dividend. The case is much more complicated.
So the dividend rate simply tells the number that the insurer will connect to a much larger equation to calculate an insurer's dividend for the year. But there is something else that the speech tells us. <! – ->
The dividend rate gives us a sense of how much value the insurer returns to each policyholder in addition to the guaranteed functions. of the contract. Dividend interest rates include the guaranteed accumulation rate for the policy, which is currently between 3.5 and 4%. So a 6% dividend rate means that the insurer's dividend paid on investment income generated by the assets held by the insurer is 200 points above the guaranteed accumulation rate – provided that the entire life contract has a guaranteed accumulation rate of 4%.
We can use this knowledge to make the reverse construction of the dividend payable. dividend interest and a guaranteed accumulation rate of 4% leave us with 2% as the variable we use to control the dividend paid by the life insurer. These 2% are paid on the insurance reserve, which is a complex subject but which is usually very similar to the accumulation value of the contract.
If we take the current cash value of the policy and multiply it by 2%, we arrive at a number that will be very similar to the dividend on the policy. There will almost certainly be some deviation, and this is driven by three main factors: <! – ->
First, adjustments made to the second major variable mentioned above (eg insurance gains and administrative costs) are not included in this calculation. The larger these variables affect the distributable dividend, the less accurate this calculation will be.
Second, the reserve is not identical to the cash repurchase value, so this may cause the distributable dividend to differ from the results we obtain from this calculation. .
Third, somewhat linked to the first factor and usually only at stake during the very early and very late years of a policy, various cost assumptions may play an important role in adjustment of the dividend. For example, most life insurance companies use a cost assumption for the entire life policy, which in the industry is called a modified reservation system. This effectively treats entire life policies as if they are term policies for the first year or two of a lifetime's existence. This dramatically reduces the reserve requirements that an insurer must meet for an entire life policy, and it is the main explanation behind why many ordinary auxiliary policies do not pay a dividend to the insurer during the first few years of insurance. Analyzing the dividend will never have great precision insofar as it will never work perfectly and certainly now allows us to unite the insurance company's mathematics. It will enable us to draw conclusions about an entire life policy.
If the product of this calculation is a number greater than the distributable dividend, we know that the insurer either had higher costs under the other two variables that caused a negative adjustment to the dividend or some other cost justification is allowed that allows the insurer to take a loss on the insurance during this insurance year.
If the product of this calculation is a number smaller than the distributable dividend, we know that the other variables in games (insurance gains and / or administrative costs) potentially increased the total dividend and / or reserve is greater than the insurance cash value.