I received a memo from Jess Geller, Vice President & Actuary at The Guardian Life Insurance Company of America (Guardian), New York, NY. The memorandum explained key terms, described the calculation of policy dividends, and provided a sample dividend calculation. While it may be tedious and mind-numbing, as with much of “actuarial” topics (for me, anyway), I am sharing this technical and informational post with clients who have an analytical bent. Here it is.
Contribution Principle: Guardian allocates the dividend fund to policies in accordance with the contribution principle. This principle is designed to allocate dividends to each participating policy in the proportion that the policy contributed to Company earnings. This principle is the accepted standard of practice for mutual insurance companies in the United States. Guardian is a well-diversified company. Profits from other lines of business play an important role in determining dividends that are passed through to policyowners.
Direct Recognition: Guardian uses the Portfolio Direct Recognition method of calculating dividends for policies issued since 1983 (and older policies that have accepted an on-going update offer). Investments are classified as “non-loaned” assets (including fixed income securities, equities, real estate, etc.), and “loaned” assets, which consist of policy loans secured by policy cash values. These two types of asset classes may perform differently.
The loaned portion of the policy’s cash value receives a dividend interest credit that is linked to the policy loan interest rate. The non-loaned portion of the policy’s value receives an interest credit that will vary with Company investment experience. Direct Recognition links policy performance to each individual’s decision whether to take a policy loan, and thus eliminates cross-subsidies that would otherwise occur.
Dividend Substitution and Pegging
Guardian’s current practice is to pay a dividend that is higher than the basic dividend formula amount when certain conditions apply. The practice is called Substitution if it applies in the first three policy years and Pegging if it applies thereafter. The intent is to add an extra degree of stability to policies. These adjustments apply to basic policy dividends only and do not apply to dividends on paid-up additions. This practice is not guaranteed as it is approved each year by the Board of Directors.
Substitution: In an environment of a declining dividend scale, Substitution smoothes performance for the second and third policy years by eliminating dividend reductions that would otherwise occur. For policies illustrated in 2010, the basic non-loaned policy dividend that will be paid at the end of policy years two and three will not be less than the basic dividend amount illustrated at the time the policy was issued. Substitution does not affect the dividends on paid-up additions.
Pegging: Beginning with the non-loaned basic dividend paid at the end of policy year four, Guardian currently employs a strategy called Pegging. Pegging allows for a smoother transition from year to year in a declining dividend scale environment. Pegging does not guarantee that the dividend will increase from year to year, but does “soften” the decline in the dividend that would otherwise occur if only the dividend formula was used.
Dividend Calculation: The example shown below is based on a L121 Whole Life policy, insuring a male who was age 35 at issue and qualified for Guardian’s most favorable risk classification. The face amount is assumed to be $1 million. The policy is assumed to be in its 20th year.
Non-Loaned Interest Component: During 2010, the non-loaned dividend interest rate is 7.00%. The dividend interest rate reflects a contribution from other Guardian lines of business. The excess of the non-loaned dividend interest rate over the interest rate underlying the dividend fund, which is 4.00% for this policy, is applied to the policy’s reserve at the beginning of the year. In our example, this reserve is $240.04.
Interest Return = (7.00% – 4.00%) x $240.04= $7.201
Mortality Component: Guardian’s actual mortality experience is better than the guaranteed mortality. Excess mortality charges are returned to the policyholder through the dividend. The mortality return is the excess of the guaranteed mortality rate over the dividend mortality rate multiplied by the net amount at risk, which is the policy’s face amount less the end-of-year reserve. In the calculation below, the end-of-year reserve is $245.35.
Mortality Return = (.00550 -.00198) x ($1,000.00 – $245.35)= $2.656
Loading Component: The Loading Component recovers the Company’s expenses, including taxes, and assesses a contribution to policyowner’s surplus, a profit charge. The Loading Component for this sample policy is negative $3.127.
Putting It Together: The dividend at the end of policy year 20 is:
Dividend = Interest + Mortality + Loading= $7.201 + $2.656 + (-$3.127)= $6.73 for each $1,000 of policy base face amount
Policy Loans: Policy loans affect dividends. The adjustment to the dividend depends on the amount of the policy loan, prevailing non-loaned dividend interest rate, policy loan interest rate 1 and age of the insured and of the policy. The adjustment reflects the number of days during a policy year that a loan was outstanding and is applied only to loaned cash values. The difference between a policy’s loan interest rate and the interest rate credited to loaned dividends is called a loan spread.
Properly managed, policy loans are an excellent way for policyowners to access policy cash values. Assuming that the policy is not a Modified Endowment Contract (MEC), and will not become a MEC within a two-year period from when the loan was taken, the policy loan will not be taxed if the policy is held until death.
I hope you have found these disclosures useful. Please contact me at (808)216-4147, for more information on this topic. Aloha!