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Whole Life Insurance Dividends and Interest Rates

Whole Life Insurance Dividends and Interest Rates

How are whole life insurance dividends and interest rates faring in this low interest rate environment? Is today’s long stretch of low interest rates a bad sign for whole life insurance in the future?

Today, we’re having a candid conversation about today’s interest rate environment, the impact on bond rates and prices, and how that impacts whole life insurance dividends.

If you want to know how your whole life insurance will weather any environment… tune in now!

The Role of Bonds on Insurance

Bonds play a significant role in the dividends you receive as a policyholder. This happens because life insurance companies invest heavily in conservative bonds. So rising interest rates should lead to higher declared dividend rates. Similarly, a falling Federal interest rate will likely result in a decreased dividend rate. 

Are there long-term effects of a low interest rate environment? Well, not to spoil things completely, but life insurance has been around for a long time. It has survived many low-interest rate environments, paying dividends through wars, depressions, recessions, and much more. 

We’re going to dive deeper into why this is, and how life insurance is still one of the safest choices for your money. 

How Do Insurance Companies Invest?

When you pay premiums, the insurance company doesn’t just throw that money into a savings account and wait. They actually put the money to work. Some of this money goes into securities, however, it’s a minuscule amount. Many companies have anywhere from 0.58% to 2.49% of their portfolio in common stock. 

The much more significant portion of life insurance company’s investments is in bonds—either corporate bonds or treasury bonds. Bond investments often range from 60.2% to 75.5%. 

Then, there are preferred stocks, which work similarly to bonds because it produces interest. Additionally, preferred stock means that stockholders get paid before anyone in the common stock gets paid. This means preferred stockholders have low liability. The range for preferred stocks is about 0.25% to 1% of the company’s portfolio.

The next biggest investment in an insurance company’s portfolio is going to be mortgage-type investments. Companies allocate anything from 0% to 16.3% of their portfolio to mortgages. To reduce risk, they invest in high equity mortgages. Real estate investments, separate from mortgages, range from 0.33% to 1% of the investment portfolio. 

What About Policy Loans?

The last kind of “investment” life insurance companies make is contract loans. And these are the loans that insurance companies offer to policyholders. Contrary to popular belief, when you take a loan, you’re not taking a loan from yourself. The life insurance company is giving you the money because your cash value is backing the loan. This also means that when you pay interest, you’re paying interest to the life insurance company, not yourself. 

Life insurance loans make up anywhere from 2% to 7.24% of an insurance company’s portfolio. 

Policy loans, even in a low-interest rate environment, are great for insurance companies, and by extension you, as the policy owner. It all comes down to the way mutual companies are structured and the dividends they pay. In a low interest rate environment, with many loans fixed at about 5%, this is actually some of the greatest returns companies get during such times. Plus, they can take comfort knowing all loans are backed by cash value. 

This is beneficial to you, the policy owner because you want your insurance company to do well. You partake in the profits of the company, so it’s a boon to you and all other policy owners.

Life Insurance Companies Invest Conservatively

The insurance companies have a lot of responsibility on their shoulders. They invest conservatively because they have contractual obligations to millions of people to pay out a death benefit. Permanent insurance, unlike term, is guaranteed to pay out so long as the policyholder keeps the insurance in force. This means there’s a higher standard that companies who offer permanent insurance must adhere to. 

Mutual insurance companies specifically cannot invest recklessly because of this responsibility. There’s a lot of capital management happening behind the scenes, and to assume that a dividend is solely “return of premium” doesn’t capture the whole picture. 

Not only is there a chief officer in charge of capital management at the life insurance company, but there’s also an entire team, an entire strategy, and structure.

How Do Bonds Work?

Bonds have an inverse relationship to interest rates and their value. The following is a hypothetical example to explain how bonds work. Say you buy a 10-year treasury bond at what’s called “par value,” or $1,000. You lock in the interest rate when you buy the bond. So say the interest rate is 1.5%, you’re going to earn that rate every year for ten years. 

If the interest rate goes up while you own that bond, you still only earn 1.5%. While the rate of your bond hasn’t technically decreased, the value decreases because it’s technically underperforming. However, the inverse is also true, and this is the power of those bonds. 

If the interest rate were to decrease while you own the bond at 1.5%, the inherent value of your bond increases. This happens because your bond is now earning more than the new bonds are earning. 

Then, let’s say someone wants that higher-earning bond and they offer you more money for it. If, for example, you bought a bond at 6% and rates decreased to 5%, someone may offer you $1,100 for your bond. That offer is actually a 10% earning, which may be a 4% spread, but is a 66% increase from what you were working with. 

In an environment that interest rates go down, current bonds are at a premium.

What a Portfolio of Bonds Means for Insurance Companies

Insurance companies determine profit by taking all the gains from investments and subtracting costs. Costs usually include death claims, wages, commissions, etc. Companies then take this profit, which is proprietary information, and declare a dividend. The higher the profit, the higher the dividend. 

Unfortunately, one of the most difficult things that can happen is what we’ve seen in the last ten years or so. Not only did interest rates go down, but they’ve stayed relatively flat. So insurance companies are still getting yields on their bonds, but they’re not able to sell them. And this is one of the greatest sources of profit. 

However, because bonds still earn that locked-in rate, companies are still doing well. This is why they declare a lower rate, so the financials can stay balanced in times where there isn’t as much profit. So while it may feel stagnant as a policyholder, this is the type of strategy that allows companies to thrive in the future. 

Additionally, bonds are stable because of the way they continue to pay steady interest over the allotted time period. It may not be as exciting as the stock market, yet in a low interest rate environment, it is a “sure thing” for the companies.

Why You Shouldn’t Worry About Low Dividend Rates

While low dividend rates can appear scary at first, they’re actually more significant than you’d think. When you realize that low dividend rates are actually a proactive response by insurance companies, everything shifts. 

Low dividend rates don’t necessarily mean the company is in bad shape, or that their investments aren’t doing well. On the contrary, low dividend rates allow companies to navigate low interest rate environments more conservatively. It’s a power play, which helps the company weather the low rate environment. Consequently, this allows them to come back even stronger when interest rates increase. 

It looks, perhaps, like on the surface, the highest dividend rate is going to outperform a lower dividend rate. But what we often don’t look at is the insurance companies’ responsiveness to the environment.

Because lower whole life insurance dividend rates may push away new policies, however, companies are often lowering rates to protect the company for a future when the interest rate environment changes. These are companies who are thinking of the long game, as we hope people utilizing infinite banking are thinking about the long game. 

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Rachel Marshall

Rachel Marshall is the Co-Founder and Chief Financial Educator of The Money Advantage and President of Marshall's Insurance and Financial Services. She is known for making money simple, fun, and doable. Rachel has built a team of licensed professionals (investment advisors, insurance agents, attorneys, tax strategists) to help her clients create time and money freedom with cash flow strategies, Privatized Banking, and alternative investments. Rachel is the co-host of The Money Advantage podcast, the popular business and personal finance show. She teaches how to keep more of the money you make, protect it, and turn it into cash-flowing assets.
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