​Whole Life Policy Yield Spread Near Historic Highs

Ivan Illán  |

A very old and boring insurance contract type – the whole life insurance policy – is demonstrating some uncharacteristically unique income support opportunities. For more than 150 years, mutual life insurance companies have kept to their archaic structure, where whole life insurance policy holders (not stock holders) own the company, and thereby participate in the corporate profits through declared dividends paid to policy holders. Many analysts have argued that this makes for an advantageous corporate governance, as an aligned interest with customers as company owners. The structure has afforded these carriers many years of relative financial stability compared to other publicly traded financial institutions. In recent decades, some mutually-owned companies (e.g., MetLife (MET), Manulife (MFC), etc.) have shed their mutual status for common stock owners, however their core whole life product line remains, as does its flexible usage.

This article is not going to classify whole life insurance policies as an asset class or an investment explicitly, since they’re technically neither. However, a whole life cash value policy could be termed as a contractual asset, since it represents a legally binding agreement of an exchange of values from carrier to policy holder. And, given the excruciatingly low yields on myriad fixed income rates, whether corporates, sovereigns, or loans, investors have been forced to consider alternate asset strategies to achieve their goals. Equities have been the favored asset class for many income-seeking investors to meet their income needs gap through “homemade dividends”, but the potential cost of using this more volatile asset has yet to be experienced (i.e., a drawn-out, global stock bear market). My favorite definition for wealth is having money when you need it, without accepting compromised asset values to fund the need. By this definition, whole life cash values could play a tactical income role in an integrated asset allocation strategy and comprehensive financial plan.

So, how good an offer are these policies nowadays? Data on whole life policy dividends yields (which accumulate internally as policy cash values) and 10-Year US Treasury bond yields (risk-free, time-horizon appropriate rates), over the past quarter century, have been examined. The correlation between the industry’s average whole life dividend yields and the 10-Year US Treasury bond yields is 0.9472, which is very significant and consistent. Similarly, the statistical R-squared is 89.7%, which means the 10-Year US Treasury as comparative index explains a significant level of movement in whole life dividend yields. Even though the R-squared and correlation figures are significant, as an industry, life insurance general-account (GA) assets hold only 7.8% of their GA investments in Treasury and/or federal government bonds The vast majority (46%) of GA assets are corporate and foreign bonds. This is an important diversification fact given the credit and interest rate risk exposure within the fixed income market.

In the custom chart (above), the relationship between the 10-Year US Treasury yield versus the average whole life dividend yield since 1989 is illustrated. The orange bars represent the spread differential between the whole life yields over the Treasury bonds, while the blue line charts the progressive decline of the 10-Yr yields. There’s been some variance in the yield differentials with an increasing trend over the period, and an average whole life yield addition of 264bps. In 2016, there’s an average 353bps dividend yield advantage, which is 34% above the historical average – a metric fueled by the globally diversified and actively managed insurance companies’ GA assets. Depending on the specific carrier, the difference can be even greater (e.g., the largest spread is MassMutual at 549bps, General American is lowest at 329bps, based on 06/14/16 data on 10-Yr US Treasury yield at 1.610%). This article does not factor a comparative tax advantage over taxable bonds (whole life policy loans are generally tax-free mechanisms to access accumulated cash values).

To this point, when illustrating whole life cash values, dividend yield, and internal rate of return (IRR) projections, it takes many, many years to achieve a cash-on-cash based IRR that delivers a policy holder the maximum benefit from a declared dividend yield. The more time a policy has to mature (e.g., 10 years minimum, 20+ years preferably), the more favorable the contract’s internal cash value compounding. Measuring cash value IRR, not the dividend yield, through a taxable equivalent yield (TEY) lens can be a relevant translation, especially for investors with high effective tax rates. This takes some skill to develop, but the best life agents share this type of data routinely.

One of the most clever whole life cash value uses is meeting all or large parts of retiree household income needs by leveraging a policy’s accumulated cash value during times of market corrections or bears. This kind of dynamic, cross-asset utilization supports the overall retirement household income need in a sustainable, lower volatility – and certainly less emotionally stressful – strategy, allowing stock portfolios to recover, by allocating income burdens elsewhere, when they’re most vulnerable. Our persistently low interest rate environment is forcing alternate income strategies to the forefront. The key is choosing strategy alternates that don’t increase risk exposure (like, stock market crashes or interest rate spikes), but instead provide a haven from the inevitable storms.


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1. To determine industry average dividend yield figures, twelve whole life manufacturers (both mutual and stock companies) were reviewed, including the following carriers: General American, Guardian, John Hancock, Manulife, MassMutual, MetLife, New England Financial, New York Life, Northwestern Mutual, Penn Mutual, Phoenix, and Sun Life. Data are found in NFP’s publication at: https://internal.nfp.com/webfiles/public/insurance... Historical_Whole_Life_Dividends.pdf

2. Source on General-accounts investments: Chicago Fed Letter, Federal Reserve Bank of Chicago, April 2013, Number 309

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

Companies

Symbol Name Price Change % Volume
MET MetLife Inc. 45.77 0.42 0.93 6,300,696 Trade
MFC Manulife Financial Corporation 16.60 0.05 0.29 1,294,922 Trade

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