by KD » Sun Aug 15, 2010 02:55 am
I recently was told that my father had a life insurance policy he intended to go to his six children from his first marriage. His third and last wife told my brother that the policy was cancelled and we would receive nothing. I suspect, if there was a policy, she may have changed the beneficiary to herself shortly before my father died. He was quite ill before he passed. Is there any way we can find out if a policy did exist and do we have an legal rights to contest it?
Posted: Fri Sep 17, 2010 12:45 am Post Subject:
I give up! What's the source of your definition? I could make up anything I wanted to support my contention, but I chose a nationally-recognized textbook instead.
Maybe there's a reason the government has chosen to "treat [a dividend] as a return of excess premium for tax purposes."
But in the final analysis, a mutual insurance company's "earnings" come from only two sources: premiums and interest on invested reserves. As previously discussed, the taxes on interest (gain) are paid by the company as part of its expenses. The gain is not distributed to policyowners as a return on equity (aka: equitable portion), only the premiums are returned to avoid the tax implication.
That's what makes life insurance products different from mutual funds and other investments.
Now to take this just one step further, let's say the mutual insurance company decided it wanted to close up shop -- not due to insolvency, just a desire to go out of business. And, for argument's sake, no other insurance company could be found to buy its policies and assets. What would happen?
Each policyowner would receive the full cash value of their policy, and an "equitable portion" of the company's assets. As with dividends, that equitable portion would be based on the relationship of individual premiums paid to the sum total of all premiums paid -- one's percentage of ownership, so to speak. How would that be taxed -- as income or capital gains?
Be careful how you answer, because it might affect your definition of a dividend.
Posted: Fri Sep 17, 2010 02:43 am Post Subject:
I give up! What's the source of your definition?
It is the same definition that is used by several large mutual insurers.
only the premiums are returned to avoid the tax implication.
This is only true until the total dividends are higher than the total premiums. Based upon the current dividend scale, if a 25 year buys a $1,000,000 policy and takes all dividends in cash, when he's 70, he will have received more back in dividendends than he has paid into the policy. At this point, why would the dividends be taxable if all that they are is a return of excess premium? If he dies at 90, he'll have received about $450,000 in dividends more than he paid. If this was simply "excess premiums" being returned, why is this taxable income.
It's taxable income because Congress says that it is.
Posted: Fri Sep 17, 2010 02:57 am Post Subject:
But in the final analysis, a mutual insurance company's "earnings" come from only two sources: premiums and interest on invested reserves
It can come from premiums and invested reserves and from money that is invested above its reserves and from other products. For instance, an insurance company can use profits from its non-participating UL policy to pay participating WL owners.
What if we use a crazy example? ABC company does not make enough money from their whole life policies to pay a dividend. However, they make an absolute killing on their term insurance. They use the profit from the term insurance and pay it as a dividend to the owners of the company, the people who onw participating whole life policies.
These dividends, from a tax standpoint, are treated like a return of excess premium. However, The reality is that there isn’t any excess premium to be distributed to their policy holders since the premiums are only enough to cover obligations. Yet, there is still a dividend. How can this be? There is a profit in the company as a whole and the dividend distributions can accurately be described as, “an equitable portion of the company’s earnings.”
Posted: Fri Sep 17, 2010 02:01 pm Post Subject:
A little clarification about my use of the term "invested reserves". This is not only the Valuation Reserves (and actual policy cash values) as required by law, but the remaining General Account Reserves, and all of it together is what many companies call their "portfolio". So 'return on investments' comes from all sources.
And here's an explanation from one very large, well known, but quiet mutual insurer from the northwestern part of the US:
It is important to note that the dividend scale interest rate, which reflects the performance of the company’s investments, is just one element that determines the actual dollar amount of dividends. The other important factors include mortality charges (representing the cost of death benefits paid to survivors) and expense charges. In fact, about 60 percent of the expected 2010 payout is attributable to favorable expense and claims experience. It is also important to note that (name withheld) goal is to pay the highest possible policyowner dividends consistent with maintaining a strong financial position. Since (name withheld) is a mutual company, it has no stockholders and, thus, no dividends to be paid to stockholders. All the money earned over and above what is needed to pay benefits to policyowners, to run the operation and to keep the company on a solid financial footing, is returned to policyowners as dividends.
"All the money earned" includes premiums paid. Dividends, when paid, are a reflection of a policy's accumulated cash value. Premiums paid are one thing, investment returns another. And all of the expenses of the company (mortality [aka: claims] and general expenses) are the final component.
To simplify, money in minus money out equals gain (or loss). Most insurance companies do a very good job of managing their invested monies, mostly in fixed income and other interest-bearing items. So there is always going to be some income -- more in some years than others, obviously. When you look at this same insurance company's portfolio valuation above statutory reserves, it, too, is affected by the general performance of the markets/economy. And the "current dividend scale" varies accordingly.
So we'll give the insurance company its ability to invest and earn a very respectable rate of return, both year to year and over the long haul. But, when calculating premium rates to cover the mortality and expenses, the actuaries must use a very conservative approach, and use a straight-line rate, probably around 4%-6% at most companies. The formula remains the same: Mortality minus Interest plus eXpenses equals rate (M-I+X=rate).
If the actuaries nail the long term mortality costs and expenses, the real variable is the interest earnings, which cannot be guaranteed. But the company quoted here even admits that 60% of the dividend is attributable to lower than anticipated mortality and expense factors.
The actuaries did their job, being very conservative. The underwriters did their job, selecting better than average risks than the actuaries expected. The investment managers did their job and earned a respectable rate of return, exceeding the actuaries predictions. And company management did its job in controlling expenses in ways the actuaries could not imagine. And policyowners paid their premiums as calculated by the actuaries.
When the actuaries calculate rates conservatively, they are somewhat higher than would be needed if things worked out exactly as the M-I+X formula demands, because the actuaries usually also add in a small amount of extra expense for profits, just in case.
The actuaries know what most of us also know: the world is not a perfect place, and unanticipated events can occur. More deaths than expected, huge increases in other expenses pop up, revenue declines temporarily (or worse). That's why they establish rates (at all companies) to be more than necessary in a perfect world. It might be said that actuaries think in terms of a "worst case scenario" -- how much do we need to collect to be able to pay for everything that could happen and still eke out a small profit?
So everyone pays a bit more for their insurance than they perhaps need to pay -- and all of it, combined, generally results in profitable years for almost all life insurance companies. Stock insurers may share those excesses with their shareholders. Mutual insurers may share those excesses with their policyowners.
Some of us know that death claims are not paid using (long-term) invested money, but are paid first with present income (new premiums being paid). And all other current expenses are also being paid with present income. When present income is insufficient to overcome these expenses, then income from investments is siphoned off to balance the books. As long as all the investment income has not been used to cover expenses, there is "surplus" that can be shared with stockholders or policyowners.
We don't care about stockholders, they know that their dividends are being generated by other people's money, and will have to pay tax on that income.
In a perfect world, all insurers could charge the exact amount of money necessary to cover their liabilities. In which case, there would never be a surplus. "Current Assumption" policies attempt to do this, but they are generally behind the curve, not on top of it or ahead of it, and it can (and often does) result in poor performance.
So most insurers allow the actuaries their conservative numbers and charge the premiums they do. In a mutual company, when all things are said and done, when they are giving their surplus profits back to policyowners, they are, effectively, recognizing the fact that they have overcharged the policyowner.
"We didn't need all the money you paid us to do what we did this year, and we even made some extra, so here it is coming back to you." is how I explain it to my students. Simplistic? Perhaps. Dishonest? No.
And, yes, that's the way the IRS sees it, too. It is not the way the insurance company tends to portray it in its marketing materials.
Fact is, if they charged less money, the dividends would be smaller, right? If they charged the precise amount of money needed, the dividends would be zero, right?
So, the whole business of dividends can be complex -- I think we're all in agreement with that. Do they result from/come from "surplus"? Yes. But no one interested in purchasing life insurance, other than perhaps an actuary, wants a detailed explanation of dividends, and nobody really cares where they come from. People just want them. But why?
The company's marketing materials, or the sales presentations of the agents, lead some people to believe that they just magically appear every year to people who buy this company's products.
And that's my only complaint. There has to be an explanation for them. And there is. I've presented it above (and I'm going to prove it below). Agents don't usually explain it that way, which is entirely up to them, not me. Is it a misrepresentation? Only if there is communication that leads someone to believe they are guaranteed.
Anyone who has taken a license exam, insurance or securites, and who has been asked the question about dividends, knows that the correct answer is (or is related to) "Dividends are a refund of excess premiums paid and are not taxable."
Any other discussion (or realization) of dividends in excess of basis, for the vast majority of policyowners, rarely comes up in the life of their policy, and if it even does it happens very late in the life of the policy (but as I mentioned, very high face amounts and very high premiums can produce different, earlier results). For most, it never happens, because those dividends are being used to add value to their policy in the form of paid up additions, or some or all of it is being used to pay future premiums, reducing or eliminating a policyowner's out of pocket expense to continue the policy. Possibly even both. I have no quarrel with that. Never have, never will.
But here's how I'm going to prove that dividends are a refund of excess premiums paid once and for all.
Relying on the "Overview of (name withheld) Financial Results" -- the first page of the 2009 Annual Financial Statement of the same insurance company I've already quoted -- their surplus increased about $800 million, dividends increased $200 million ($600 million of surplus obviously retained to "keep the company on a solid financial footing"). Fine, good move. Company is in great financial shape. Total dividend paid = $4.7 Billion. Terrific! One more consecutive year of dividends, according to their marketing materials, since 1872. But, as Paul Harvey used to say, "And, now, the rest of the story . . ."
Premium revenue for 2009 . . . $13.1 Billion (-4% from 2008)
Net investment income for 2009 . . . $7.8 Billion (-1% from 2008)
Difference = $5.3 Billion
If the dividend is $4.7 billion, how much does that leave for future invested reserves? $600 million.
How much was of earned surplus was permitted to go to invested reserves? $600 million.
Where did it really come from?
As the company states in its financial report:
Dividends can be declared and credited, at the Board of Trustees' discretion, when current experience in general account investment earnings, mortality, morbidity, and expenses is more favorable than the original assumptions used to establish policy premiums. (Name withheld) has paid a dividend every year since 1872. Future dividends are not guaranteed.
"More favorable than the original assumptions used to establish policy premiums" translated into common English layman's language: refund of excess premiums not required to produce a profit or cover a net loss. We know this to be true from this financial statement because premiums are almost double net investment income.
Case closed.
Posted: Fri Sep 17, 2010 05:56 pm Post Subject:
And here's an explanation from one very large, well known, but quiet mutual insurer from the northwestern part of the US:
I guess that we should start by having you invest in a map of the US.
Posted: Sat Sep 18, 2010 01:17 am Post Subject:
But here's how I'm going to prove that dividends are a refund of excess premiums paid once and for all.
Relying on the "Overview of (name withheld) Financial Results" -- the first page of the 2009 Annual Financial Statement of the same insurance company I've already quoted -- their surplus increased about $800 million, dividends increased $200 million ($600 million of surplus obviously retained to "keep the company on a solid financial footing"). Fine, good move. Company is in great financial shape. Total dividend paid = $4.7 Billion. Terrific! One more consecutive year of dividends, according to their marketing materials, since 1872. But, as Paul Harvey used to say, "And, now, the rest of the story . . ."
Premium revenue for 2009 . . . $13.1 Billion (-4% from 2008)
Net investment income for 2009 . . . $7.8 Billion (-1% from 2008)
Difference = $5.3 Billion
If the dividend is $4.7 billion, how much does that leave for future invested reserves? $600 million.
How much was of earned surplus was permitted to go to invested reserves? $600 million.
Unfortunately, Max, along with being Geographically challenged, you are also mathematically challenged. Using incorrect math concepts isn’t going to help with your case. You may know how to subtract, but you have to know WHEN to subtract.
Why would you subtract Net investment income from premium revenue? The difference in those numbers is not relevant. That is not your starting point. Those numbers need to be added together to get to their total revenue number. (“Other revenue” should also be included.) It is this $21 Billion that is the starting point.
Just in case, you have any doubt about me being correct, let’s look at how you calculated the numbers, but make a change in the actual numbers:
Premium revenue for 2009 . . . $13.1 Billion
Net investment income for 2009 . . . $11.8 Billion
Difference = $2.3 Billion
If we use your calculations, an increase in investment income would mean that less money is available for dividends when in fact, it should be obvious that more income should equal more money available to pay dividends.
In case you are wondering about the correct calculation to come up with your approximate $5.3 billion number it is as follows:
Total Revenue minus total benefits and expenses:
Total Revenue = Premium revenue + net investment income + other income = $21.3 Billion
Total benefits and expenses = Policy owner benefits paid + increase in benefit reserves + commissions and expenses= 6.8 +7.1 + 2.4 = $16.1 Billion
$21.3 Billion - $16.1 Billion = $5.2+ billion. It is from this $5.2 + billion that dividends can be paid.
By the way, your math only works because of a combination of coincidence and lack of understanding. The change in dividend comes nowhere in any calculation. It is the dividend that matters and not the change from one year to the next. You used this number to make the rest of your calculation make sense. The reserves didn’t increase by $600 million. They increased by $8 Billion.
Posted: Sat Sep 18, 2010 01:35 am Post Subject:
Here’s more to show you why “dividends are a return of excess premium” Isn’t a correct definition and is simply used to make understanding easier and has to do with the tax status.
1) Regardless of how infrequently it happens (and I don’t believe that it’s infrequent), when dividends received are greater than one’s cost basis, they are no longer a tax free return of excess premium. How can Joe’s dividend be a “return of excess premium” and Tim’s dividend be a taxable gain? The source of the dividend hasn’t changed. All that has changed is how the IRS is treating this dividend. The IRS changing the treatment of it doesn’t make it something else. For both Joe an Tim, the dividend is “an equitable distribution of earnings”.
2) From a tax standpoint, it’s not just dividends that are considered a return of premium. It is all money that is removed from a policy up to the basis. Ex. Joe buys a $1,000,000 policy that costs 10,960/year. The policy never pays a dividend. 30 years into the future, he has paid a total of $328,800 into the policy and it has a cash surrender value of $418,000. Any money that he takes out up to $328,000 is considered a return of premium and is tax free. Yet, there is no dividend involvement at all.
Posted: Sun Sep 19, 2010 02:39 pm Post Subject:
along with being Geographically challenged, you are also mathematically challenged.
Well, that's a hoot! :D
Milwaukee, WI not in the northwest? They must be lying about where they're located. They're absolutely north and west of Chicago. Just trying to drop a hint so you could find the company and look at their numbers.
Why would you subtract Net investment income from premium revenue? The difference in those numbers is not relevant. That is not your starting point. Those numbers need to be added together to get to their total revenue number. (“Other revenue” should also be included.) It is this $21 Billion that is the starting point.
Well, that's the whole point. The company has explained in it's "overview" everything there is to know about its gains, but only when you look to the rest of the financial report can you see the way the numbers play out. The math is the math, and subtracting net gains from gross premiums, irrespective of "other income", is correct math at the correct time, in the context of the discussion of where the EXCESS comes from.
And as for the numbers themselves, when you look at their more complete financial report, under REVENUE, there are only three things listed (in $ millions):
(1) Premiums $13,062
(2) NET invested income 7,772
(3) Other income 532
You can make up all kinds of hypothetical numbers and you can try to explain them any way you want, but from an accounting perspective, your premise holds no water. These are the real numbers from a real financial statement. "Other income" may include policy loan interest received and the sale of real estate or other assets (and in this case it is almost insignificant, even though it is $532,000,000).
Knowing when to subtract? Knowing when to add? It's all about knowing what is profit and what is loss, and what is surplus and what is deficit. So let me give you a little lesson in accounting, using the same financial statement that you should have looked at before making up your own set of numbers.
After revenue on the financial report comes expenses (again, in $ millions):
Policyowner benefits paid $6,807
Increase in benefit reserves 7,138
Commissions and expenses 2,189
Total benefits and expenses 16,134
Gain before dividends and taxes 5,232
Policyowner dividends 4,715
Gains before taxes 517
Income tax expense (benefit) 42
Net gain from operations 475
Net realized capital gains (losses) (154)
Net income 321
The company put some $7.1 billion into policy reserves (cash value), and paid almost $2.2 billion to agents as commissions along with other expenses. All of this in addition to $6.8 billion, mostly in death claims ("policyowner benefits" can also equal surrenders, loans, and withdrawals). Gains before dividends and taxes is subtracting expenses from revenue. Premiums are 61% of revenue, gains 36%, and other income barely 3%.
But were premiums alone sufficient to pay all of the expenses AND put more money into policy reserves as required by law? NO. With the help of net investment gains, they were able to cover all the expenses for the year. However, it could be said that if premiums are 61% of revenue, they account for 61% of the pretax gain. $5,232,000,000 x 0.61 = $3,191,520,000 (which would leave about $2,546,750,000 from investment returns and "other income").
The increase in "benefit reserves" and the "gain" before dividends and taxes can, in your mind or mine, come either from investment returns or unnecessary premiums. It doesn't matter how it is accounted for, but in reality, it probably comes from investment gains (since the investment managers are not going to "withdraw" that money for the purpose of paying money out to policyowners unless forced to, they are going to shift it into the accounts that are used to hold statutory and cash value).
But you're probably thinking that the dividends are being paid from investment gains. Which is, in all likelihood, incorrect.
Dividends are going to come from the source of funds least likely to be impacted by the stock market . . . premiums. The Chief Financial Officer would probably tell you that, from his perspective as an accountant, that the excess of premiums is what accounts for the dividends, not the gains from invested money. But he'll also admit that they are interconnected. Without BOTH, the Board of Directors would face the possibility that dividends might not be possible.
And so the numbers are the numbers. If actual premiums were lower, certainly the dividends would be lower. If there was no investment gain, there would be little or no dividends. In the final accounting is it simply a matter of MONEY IN (from all sources, as shown on the financial statement) and MONEY OUT (in all ways, also as shown).
After all, that's why it's called a balance sheet. When all is said and done, the books must balance, to the penny.
In a mutual company, if there were no dividends paid to policyowners, where would the money go? To reserves and investments, to higher commissions, to higher salaries, to who knows what? To avoid the possibility of having all that extra money, and not wanting to look like executives were benefitting at the expense of policyowners, the easiest solution would be to LOWER PREMIUMS, would it not?
What allows the company to pay dividends? Profitability. Investment returns. Premiums paid. They are all intertwined. Eliminate one or more, and the dividends must go with them. So when you look at the income, where is the bulk of it coming from? Premiums.
And, the simplest way to explain it all is, "We're giving you back a portion of the premiums you've paid over all the time you've been paying premiums."
And again, when it comes to dividends in excess of basis, you're going to have to come up with more than speculation about how much and how often. I can't find anything to substantiate one position or the other. But in my mind, and in my limited experience managing large face amount corporate life insurance policies that were being paid dividends, that probably means it is a relative non-issue, otherwise there would be tons of discussion about it.
And I'm sure we would be seeing threads complaining of it, too.
This is just going to be one of those discussions that has no perfect resolution. Which is why I labeled it as "philosophical".
As for being math challenged, you are the one who misrepresents the subject in your hypothetical experiment by making the numbers up.
Premium revenue for 2009 . . . $13.1 Billion
Net investment income for 2009 . . . $11.8 Billion
Difference = $2.3 Billion
The subtraction is correct, but you've conveniently omitted the rest of the equation. Where are the rest of your mythical numbers? Where are the expenses, where are the dividends paid? What is the balancing math?
This is the same kind of shoddy accounting that leads the government to tell us that paying $974 billion in new expenses not directly offset by new revenue will save $140 billion in actual dollars (actual discussion of Obama's health care plan over the first 10 years). If you believe that, then you'll believe anything.
You have your point of view, and I have mine. I do not discount your right to your opinion, I'm just offering a socratic discourse on why I believe your premise is faulty. Argument, rebuttal, that's what it's all about. Keep it coming! I think it's enjoyable, and do not take any offense at anyone's remarks in the least.
Posted: Sun Sep 19, 2010 08:38 pm Post Subject:
Well, that's a hoot!
Milwaukee, WI not in the northwest? They must be lying about where they're located.
Max, Milwaukee is 2000 miles from the Pacific Ocean and is East of the Mississippi River.
I'm disappointed that you that you can't see that your math is irrelevant. It's the total income that matters. What portion is from premiums and what comes from investment gains has no bearing on how much in dividends will be paid. If the bulk of the income came from investment gains instead of from premiums, the results could have been identical and they still could have paid the exact same dividend...unless they used your math.
Posted: Sun Sep 19, 2010 08:43 pm Post Subject:
Milwaukee is in the Northwest to the same extent that New Orleans is in the Southwest. Who would have thunk that we could have so much flooding in the New Orleans desert.
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