Special guest Dan Foley, CLU (Vice President of Marketing Technology at Security Mutual Life Insurance Company of New York) joins Dr. Tom and John McFie to share how dividends work in a whole life insurance policy with a mutual company. Discover why dividend rates vary from company to company and the best ways to compare the performance of insurance products.
Tom: Welcome to Wealth Talks where we talk about solutions, money and other things that create wealth in your life. It’s good to be back after a nice vacation in the snow, John, and we’ve got a special guest this morning.
John: Yes, we sure do. Today, we have Dan Foley who is the Vice President of marketing technology at one of the insurance companies that we represent, Security Mutual New York, and he can tell you a little bit more about the company. But Dan Foley, he graduated with a major in Math and a minor in Computer Science and he started work 35 years ago in the actuarial department at the insurance company making sure that they had adequate reserves to cover the products that they were selling.
Tom: All right.
John: It’s an important function to make sure they have enough money to cover what they’re doing there. And now he’s moved over to marketing technology, he’s the Vice President of that. He does a lot of products support, training, case work, and he’s also what’s called an Illustration Officer, which means that he signs off, he’s one of the people that signs off on the illustrations verifying that they comply with all the regulations, the areas where they sold.
Tom: Well, we’re really excited to have down today to all you listeners out there because there’s a question that always comes up when we’re making an illustration and that is the dividends. How are they figured, what are they and what really do they do. And so it’s exciting to have Dan with us this morning because we’re going to delve into that aren’t we, John?
John: Yes, we sure are. So I just want to take a moment and say welcome, Dan. Thanks for joining us today.
Dan Foley: Oh, it’s my pleasure. I’m delighted to be part of your podcast.
Dan Foley: Thank you for inviting me.
John: It’s a pleasure to have you. You know, we were talking a few weeks ago about the dividends question, and one of the things that I asked you is where exactly is the dividend rate coming from? What, where, you know, we see the dividend column and we look at an illustration, how exactly does that tie in with the guaranteed value? Is it added on top? What does the dividend rate the insurance company publish every year? What does that mean? So can you get started on that topic?
Dan Foley: Sure. Absolutely. The dividend, dividends are an important part of a Mutual Life Insurance company’s experience. When we price our products, our whole life products, we’re looking at long periods of time into the future. And you mentioned that I’ve been with the company for 35 years which seems like a long, long time and it’s passed very quickly. But when we’re planning, we’re looking at long windows of time, we’re planning not just for this generation but for the next generation and the next generation. So when we price our products, our whole life products, we’re looking at windows of time that extend for, depending on the issue age, over a hundred years. So we need to be very careful in setting the prices. So when we do calculations, we make assumptions about mortality, about what life expectancy is going to be. We make assumptions about what kind of earnings the company is going to get on its investments, the premiums that we collect, we need to invest in and generator earnings in order to be able to pay future claims. And we also make assumptions about what expenses we’re going to incur. And generally, the assumptions that we make are going to be fairly conservative because we need to be able to make sure that we hit those benchmarks that we were going to be able to earn what is needed in order to pay the future claims. And again, we’re talking about long periods of time here.
So when we make these conservative assumptions, we certainly hope and we certainly expect to have experience that really exceeds those assumptions, that we’re going to be able to earn more on our investments than what’s needed just to meet the minimum guarantees, that we’re going to have proper underwriting scrutiny of each applicant didn’t get better than expected mortality results. And likewise, we’re going to control our expenses and manage our expenses in a prudent way to be able to get the best – the lowest expenses possible so that we can benefit our policy owners. And we are a Mutual Life Insurance companies which means that we’re owned by our policy owners. So we want to do the best that we can for them.
John: Well, Dan –
Dan Foley: When we develop a dividend – I’m sorry.
Tom: Dan, I just want to kind of butt in here and say that Security Mutual has done a really, really good job of doing that historically because you have offered a dividend to your policyholders for how many years straight now?
Dan Foley: Well, we’ve been in business for a 130 years, and for the last 125 years, we’ve paid dividends.
Tom: That’s –
Dan Foley: So we paid them – yeah, we’ve paid them during very difficult times, during periods of depression, during times of war and difficulty for our nation. And as I said, I mean, we really need to plan for the long haul. And so – and operate with some eye towards the near term, as well. So we need to take a lot of things into account in order to meet the guarantees and exceed them and pay dividends. So the dividend formula is going to have three major components that contribute to the dividends, and those components are going to be the company’s investment earnings, the company’s claims or mortality experience, and the expenses that the company incurs. Most of the time, when we talk about dividends, people are going to say, well, tell me what your dividend rate is,or what’s your dividend interest rate, or which is sometimes known as a dividend distribution rate as well. And that dividend interest rate generally is going to address the investment earnings – the investment earnings component of the dividend formula.
Now, each carrier has a unique formula that reflects not only their experience but also their pricing philosophies. Some carriers may charge a little higher premium but then they’ll get a little bit higher dividends. Others may charge a more modest premium or a minimal premium and have minimal dividends kind of thing. So those kinds of things need to be considered when you’re comparing different companies. But people tend to gravitate toward the dividend interest rate because they can relate to dividend interest or to interest rates in general. It’s very difficult to relate to mortality or expenses, I mean we don’t have anything in our lives that allow us to really judge those things. I mean, you may say well, you know, running my household gets more expensive every year or, you know, I’ve got taxes and that kind of thing. So, maybe the expenses – maybe have a feel for it, but to equate that to a dollar amount or a percentage every year is not necessarily easily done. But people will do .understand interest rates, they understand that they have an interest rate on their mortgage, they understand that they earn interest on maybe a savings account, a passbook savings account, or that they pay interest on a credit card or on a mortgage. And so, they have some sense of what the interest rate – what an interest rate is. So that’s where the focus goes, I think. Probably really immediate disservice to the policy owner because – or the applicant or client, it may be a disservice because if you overlook the other two elements, you may be overlooking a big, big piece of the formula.
John: I certainly agree with that because so often, we’ll get a prospect or a client that’s been with another agent and they’ll say, “Well, you know, because my dividend rate is six percent and my policy loan rate is only six percent, I’m breaking even.” And can you explain why that’s not really reality?
Dan Foley: Yeah, absolutely. And that’s a great question because people will – they’ll hear a dividend interest rate and it may be three, four, five, six, seven percent, and then they want to know what does that mean? I mean, do they take my premium and do I get six percent on the premium or am I earning, you know, six percent on the cash value or how does that work? And so often when you go to do the math, and, you know, as John mentioned, I was a math major and, you know, I would look at a number and say, “Okay, well, okay. This is my premium and that’s your six percent and I can do the math and oh wait a minute, that’s not what the dividend should be. We’ll make it six percent of – maybe a six percent of the cash value,then I do that and say, wait a minute, I’m not getting six percent over there either. And now I’m looking at my, you know, my age and my advisor and saying six percent, I mean, I can do math. This isn’t turning out to be six percent. What’s really going on here?” And the difficulty is that that six percent really is embedded in the dividend formula, and again, it relates to the investment earnings. And by the way, when some carriers will report that number and they’ll include in there or they’ll fail to recognize investment expenses, so you may see wide swings in the rates. I mean, you may see some carrier that might have a seven percent rate and yet the internal rate of return on their premiums doesn’t come anywhere near seven percent, and you ask why, and they say, well that’s seven percent. It does not reflect investment expenses, so that could be as much as 200 basis points.
Dan Foley: So that could be really fairly substantial. So really I think what we need to do is look not so much at the dividend interest rate but maybe look at what’s the internal rate of return. And by that, I mean, what interest rate would I need to earn on each premium paid in order to total up to the cash value, the total cash value, which is a guaranteed cash value, plus the cash value of any dividends. Likewise, you can do the same thing with the death benefit. Look at what rate would I need to earn on the premiums to equate to the total death benefit that benefit as a basic policy.
Dan Foley: Any riders and any dividends. And that gives you really a better picture of what the return on your premium dollars would be. But to isolate the interest rate in the dividend formula and to compare it to the policy loan interest rate that really – you’re really, you know, you’re comparing apples and – I don’t even know if you’re comparing apples and oranges, you’re comparing apples and, you know.
John: Granola bars.
Dan Foley: Yeah, yeah. Well, you know, chocolate pies. I mean, it could be anything. You’re really mixing things that are not all comparable. But, you know, we do tend to gravitate toward those things that we know, and often I’ll be asked by one of our agents that, you know, the client has been, you know, has been consulting maybe a CPA or some other trusted advisor and that advisor saying, “Well, tell me what the dividend interest rate is.” And I can tell you what that number is but it’s not really of any great benefit because you’re overlooking other pieces of the formula.
John: Yes. When we were talking about the –
Dan Foley: People tend to gravitate business.
Tom: Yes, they do.
John: They do tend to gravitate towards it. And when we were talking, you said even within Security Mutual, there is a conversation about what your dividend rate should be, different people within the company have different ideas as to what that number is. Isn’t that right?
Dan Foley: Absolutely. Absolutely. And yes, so our dividend interest rate depending on how you want to report it, there’s no uniformity required to report these things in the same way. And because each company has its unique formula that represents not only their experience but their philosophies and many unique attributes that they have, it really is difficult to make comparisons to specific elements. So, you know, we have our corporate actuary, one point said to me, “Well, our dividend interest rate is three point two percent but you could easily say that it could be five point two percent because if you wanted to consider the investment expenses.” And, you know, the fact is, either number is defendable.
Dan Foley: And either number is accurate but it’s, you know, if you claim that you’re one or the other, it’s not like someone can say, “Well, show me how that, you know, how that works into two different pieces,” because in other words, if you use the 5.2, you say, “Okay, we’re going to go ahead and calculate the dividend and part of that means I’m going to take the 5.2 and then I’m going to subtract out the investment expenses, which brings me down to 3.2 and then you continue on with the formula.” So the point is that when you look at individual elements of the formula, you can make faulty conclusions. And it sort of reminds me of a story that I was talking to John about the other day, and it’s an old story and it’s been told and retold many times and the variations of it are many and that’s the story of the blind men who are asked to describe what an elephant is. So the blind men are positioned around the elephant at different points and they’re able to reach out and touch the elephant just exactly where they’re standing and then they’re supposed to report back, “Can you describe to me what an elephant looks like?” And one of the men is standing there near one of the elephant’s legs and he reaches out and he feels and it’s cylindrical and solid, and he said, “Well, this leg is more like a pillar or, you know, something that’s very sturdy. Maybe it’s a tree trunk, so it’s like that kind of thing.” And another man who’s standing near the tail of the elephant reaches out and grabs the tail and says, “No, no, no, no. Elephant is like a rope.” He’s holding the tail and it’s bendable and he, you know, feels and it’s got a little roughness like some rope does. He says, “No, an elephant is clearly like a rope.” And then a third man is standing near the ear and he grabs and he says, “Wait a minute, no, an elephant is more like, it’s more like a fan. It seems like a big leafy fan that you might use.” So, I mean, you can see where I’m going, I won’t go through all seven men, but the point is none of them are wrong in their observations. And yet the totality of the elephant is not really described.
Now, this story will go on, the parable will go on to different ends, in some they collaborate, and they come up with an actual picture of what the elephant is like and in others, it turns violent because everybody is just making their, you know, making their own experience just exactly what the elephant is and they disagree. But the point is in our situation, if I’m reaching to the dividend interest rate and saying well, that’s the most important thing and I totally neglect to consider the mortality or expense elements, I’m maybe the guy standing near the tail saying that the elephant is like a rope and I’m just not correct.
So that’s sort of, I mean that may be a little bit of a stretch of analogy as to what’s happening here but you kind of get the idea that really in order to get the full picture, you need to consider all the elements and that’s very difficult to do, as I said, because the mortality piece is not really known. I mean as someone who has worked in an actuarial department and who has looked at mortality tables, and I don’t know whether either of you have ever done this, but, you know, they start out with a population of 10 million lives at age zero and they win all those down over time to a point where there are no more lives there to consider, that’s not something that’s easily grasp in any way, and as I said, I mean, I was a math major and I was trying to, you know, you can’t get a visual picture for what this means.
Dan Foley: In my life at a one, you know, one person, one policy kind of level. So, anyway. So that’s I think where we get to some of the confusion and some of the difficulties with dividend interest rates. One thing I will say, there is a value to looking at the dividend interest rates for a particular carrier to see what the trend might be over a period of time because then you have some idea well, okay, I see that the interest rate has changed in this kind of fashion over a long period of time. And certainly if we looked over the last 20 years or 30 years, we’ve seen interest rates have generally been on a trend that has gone down. I mean, when I first started here 35 years ago, interest rates were really lofty and I can remember working on an annuity and a new single premium deferred annuity that had a minimum guaranteed interest rate of four and a half percent. And at the time, interest rates were double digits. I’m thinking I can’t even imagine a time when an interest rate would be of a four and a half percent would apply. Obviously, I was a young man at the time and I didn’t have much life experience, but I don’t know that even someone with a great life experience could have predicted the trend that we’ve seen since then.
Now, a four and a half percent interest rate on annuity, you’d be looking up and you’d, you know, you would have people beating a path to your door for that kind of rate.
Dan Foley: I mean, it’s lofty by today’s standards. But anyway –
Tom: Well, I think that that’s incredible to see companies like Security Mutual who have been able to have an earnings portfolio that pays a dividend over such a long period of time because I remember when, you know, I was going to school 35 years ago and someone got a home loan for 17% on a variable rate mortgage and they thought they got a great deal. So to be able to work through those volatile times of the market and where the interest rates have really just bottomed out to sometimes even negative levels, I think it’s an incredible company like Security Mutual can continue to pay dividend.
Dan Foley: Yeah, you’re right, Tom. I mean, you know, we need to take a long view because we need to be there for our policy owners and for their families and businesses. And it is a challenge. There’s no question about it. I mean there are great pressures on carriers now in order to meet their minimum interest rate guarantees. And it’s really evident on the Universal Life side of the house where again, we have products that have four and a half percent interest rate guarantees and I know other carriers have high guarantees as well and some carriers have gone out and said, “Okay, well, wait a minute, this is a high rate, we have to be able to pay these rates.” And then they pull a different lever, they look at maybe the cost of insurance and see if well, can we justify some kind of an increase on that side of the house? And that gets to be very difficult.
Dan Foley: And it would be bad result for the consumer. I mean, the whole life, of course, you don’t have that situation at all because we make the conservative assumptions upfront, we price the products, we use low interest rates and, you know, in factoring with those premiums are going to be, and then we hopefully a better experience and pay the dividends that we have for 125 years, so.
Tom: That’s so important, too. I’m glad you brought that up because when we talk to prospects and clients and fees always do come up, you know, the nice thing about whole life is the fees are already fixed in the premium cost and we’re not having to worry about what they’re going to be in the future because they’re guaranteed for life.
Dan Foley: Absolutely. I’m not going back to any a customers this year and saying, “Oh, we’re going to increase your premiums by X percent.” Not happening. Not happening on the whole life.
Tom: I’m just reading Jack Bogle’s book Don’t Count On It and he talks about how fees and service charges and penalties really destroyed the investment world and how the investment world has come more round to his philosophy now after he’s plugged away since 1974 when he started the Vanguard Group. A mutuality is what Vanguard was built on. And that was really shocking to me but mutuality works.
Dan Foley: Absolutely. Absolutely. And the tricky part about some of those fees is that they seem relatively small and when you look at them, you know, for a period of, you know, a period of a year well, okay, well,that’s only a quarter of a percent. But you look at a quarter of a percent over a long period of time and wow.
Tom: Yes. It’s –
Dan Foley: It can make a big, big difference.
Tom: I listened to Steve Forbes on Money Watch one time and he said, you know, on a two percent fee, you’re going to lose 60% of your profits over your lifetime of investing.
Dan Foley: Yeah.
Tom: And people – again, you know, we talked about people are familiar I would say what an interest rate, but sometimes they don’t understand what a compound in interest rate is going to do like for them.
John: Or against them.
Tom: Or against them.
Dan Foley: Sure. Sure.
John: So, going back to the dividend rates a little bit, what I heard you saying through all that, Dan, is that the carriers could have widely different interest rates, but we cannot use those rates at all to compare them to each other, only to their own performance, is that right?
Dan Foley: You’re spot on. Yeah, because they’re different and you don’t have all the pieces, you can really only make faulty conclusions.
Tom: So we’re just about to the end of our time here, Dan and I wanted to just ask you one question, you’re talking now to a group of consumers that are shopping insurance and one is working with a large company that’s saying, we pay an eight percent dividend, the other one is saying well, our dividend is three point two, five percent, or something. How would you advise that person to compare those different illustrations that they’re looking at?
Dan Foley: Well, I think that the dividend interest rate really as I’ve said is really immaterial. I think that you have to kind of put that out of your head. It’s an interesting point, not really much I can do with it. What I can do something with is look at what I’m putting into the contract, what premiums I’m paying and what I’m getting out of it. And I described the internal rate of return earlier, I think that that’s a very good way to compare different policies because of the fact that different policies have different premiums and it’s like well how do I cut through all this to see what return I’m getting, what kind of value I’m getting for what I’m paying into the contract. So I would suggest that that is best done by calculating the internal rates of return. Now many illustrations or sales presentations will include those things. If they don’t, then they certainly can be calculated. It’s not necessarily an easy calculation but it certainly is done routinely and I think that that’s a good question to ask. And by the way, you’ll see that the internal rates of return will vary over time. You know, generally, it takes a little bit for the policies to get going to start to build their cash value to recover all of your premiums and then start to earn, take some time. I think if you look at maybe some different benchmarks and say, okay, well, tell me what’s the internal rate, and we’re talking about long term situations, what’s my internal rate of return after 10 years or 15 years or 20 years, and see how do these compare. Then you can say to the company well, okay, because I will defy the company that’s got the seven or eight percent dividend interest rate, to show where that shows up in a sales presentation in terms of the value that I’m getting for what I paid into it.
John: And when we were talking the other day, you were mentioning how a lot of companies will cut their guarantees way back so they can pay those higher dividends. Takes pressure off the company.
Dan Foley: Well, yeah, that goes to – no question about it, no question about it. Some carriers are in a position where they use, you know, maybe a captive field force and they rely on the company’s reputation to say hey, you know, we pay dividends. And the way that they do it is by charging a relatively high premium by promising a relatively low guarantees and then by paying what looks to be a healthy dividend.
Dan Foley: In that kind of pricing philosophy, the internal rate of return kind of cuts through that because it takes into account the fact that you’re paying a higher premium right from get go.
Dan Foley: And again, that’s something that internal rate of return number is something – I mean that’s math, that’s math and you can do the math on any carriers, illustrations and ledgers and policies. I mean, you can do that math. So now, you know, we do need to remember as we’re looking at those internal rates of return, they are going to be taking into account not only the base policy and its guarantees, but it’s also going to be taking into account the dividends and the dividends are not guaranteed. However, you can get to a point where, okay, this is what the return is at this point in time, in January of 2017, this is how this measures up and this is how these carriers compare and then you can make your own conclusions.
John: There we go. Yeah.
Tom: Well, I would just like to conclude with saying, you know, it’s good to hear someone in your position to say what I’ve confirmed and doing thousands of illustrations and comparing them with other companies. And what we do here at Life Benefits is we focus on the guaranteed numbers because the dividend is like icing on the cake and it’s going to make everything better. And then we stick with companies that have had a consistent dividend year after year after year like Security Mutual because we do want the icing on our cake.
John: That’s right.
Dan Foley: Yeah. Absolutely.
John: Well, Dan, thank you very much for joining us, this has been great.
Tom: It’s been very, very informative. Thank you so much and I know that our listeners are going to be obligated to your time that you spent with us today. Thank you very much.
Dan Foley: Well, you’re most welcome and it’s been my pleasure.
Tom: Have a great day.
John: All right, we’ll be back next week here on Wealth Talks where we talk about solutions, money and other things that create wealth in your life. Have a great evening.