Participating whole life insurance (par) is one of the most popular life insurance solutions in Canada. Advisors have to help clients navigate the choice of many providers’ par products. That means evaluating different and sophisticated product designs, as well as the underlying asset management philosophies of different par funds. Top advisors typically keep these six questions in mind as they help clients make an informed decision:
#1 – Is the method used to set the dividend scale sustainable?
Participating life insurance is over a century old. Its continuing strength stems in part from its unique product design, in which providers share their risk with their policyholders. Because policyholders share risk, they also share in the profits when performance is better than expected. This sharing is passed to policyholders through dividends.* Dividends are distributed based on actual experience versus key assumptions. These include investment returns, mortality, expenses, taxes, inflation and lapses.
While it may be tempting for advisors and clients to focus on the current dividend scale interest rate of a par product, that rate affects only a portion of what clients may receive as the dividend. When choosing a product, it’s important to look at other factors, including the method that companies use to set their dividend scale. Doing so can give a strong indication of future performance. Insurance providers who consider current and historical experience when setting a dividend scale may provide a more sustainable rate because they know how their fund has performed in the past through different market conditions. If a provider sets its dividend scale by looking at future expectations alone, its projection could be too optimistic, leading to more unexpected volatility in its rate in the future.*
#2 – Could any of the features included in the product design introduce risk?
Par is different from other products. With non-participating products, providers are on the hook for any risk they introduce against their guarantees. With par, any risk introduced by the provider affects the policyholders too. If that risk impacts the dividend performance, the policyholders may lose out. Advisors often watch out for product features like rating reduction programs or those that allow large payments at any time without underwriting. Such features can result in healthy policyholders subsidizing unhealthy policyholders. This can further introduce negative mortality experience into a par block, and potentially lower future dividends.
#3 – How old is the par fund?
Providers with older par funds may have more experience managing investments through economic upturns and downturns. Older funds also carry the opportunity for enhanced returns because they have assets invested from periods where markets were performing well. These assets likely return higher yields.
But the age of the par fund is not the only issue. Advisors also consider the average duration of the assets. Providers that take bets on interest rates by investing too short can depress the dividend scale interest rate in low-interest rate environments and will also drive dividend scale interest rates down quickly if low-interest rates persist.
#4 – How are the par fund investments managed?
A provider’s risk management philosophy is also important. Using a total-rate-of-return investment approach helps mitigate some of the usual business cycle volatility, as providers must strike a balance between managing risk and achieving solid returns. Investing in high-quality assets and using research-based investing also helps ensure a balanced portfolio. A significant proportion of assets invested in private fixed income (PFI), real estate and investment-grade holdings are signs of a strong par account. Private fixed income alone offers average returns of 150 basis points greater than corporate bonds with a similar rating. Real estate holdings help protect against low-interest rates and have the opportunity to hedge against inflation with both capital appreciation and rental income.
#5 – How much does the provider rely on reinsurers?
A provider that retains the mortality risk of its clients has more potential to pass back dividends to policyholders. By minimizing the use of reinsurance, the provider is not locked into fixed rates payable to those reinsurers. Minimizing the use of reinsurance can also maximize the opportunity for mortality gains to be passed back to clients. When reinsurance is used, it should be to optimize capacity so that companies can accept larger policies without too much concentration risk to the block.
#6 – What does the illustration really show?
Choosing a par product based solely on an illustration has many limitations. In most illustrations, the cash values and death benefit values between alternative dividend scale interest rates can vary less in the first few years and more in later years. The stability of a par fund over time can be a better predictor of success than the dividend scale interest rate that was set in the first few years. Comparing the standard deviation of the dividend scale interest rate can show how stable a par fund has performed historically and can provide confidence that future performance may be stable as well.*
The answer to most of the questions about par
At the end of the day, much of the decision on which company’s par product to choose is a dividend management story. Providers can improve the likelihood that positive experience will be passed to clients in the form of dividends. They can take less risk with product design, use a sound management philosophy, retain mortality risk and use a sustainable method to set their dividend scale.
*Dividends are not guaranteed, and past performance is not an indicator of future performance.