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David – I read somewhere (eg not sure if this is true) that while principal is guaranteed in a mutual insurance company contract, the dividend rate is not guaranteed… a fancy way of saying that if Bernanke continues to manipulate interest rates, many of these contracts allow the insurance company to reduce (and if needed eliminate) the dividend on policies.
1) Is the above true?
2) In the “no such thing as a free lunch” department, how can an insurance policy pay fixed rates that are 200-300 basis points higher than investment grade bond funds? I know you mention the “deserved skepticism” — but I don’t believe in free lunches and somewhere (like a clause in contract that allows them to cut dividend rates) these insurance companies must be covering themselves… are they are being incredibly aggressive on mortality assumptions?
I ask because several insurance companies that used to be known for very conservative underwriting have in recent years become rather creative under new management (examples withheld to protect the guilty)
Insurance dividend scales are never guaranteed. If pre-dividend profits change, so do dividends. That said, the actuaries of the firm have to justify their decisions so that they can show that they are not being discretionary in their decisions, but show that policyholders are being rewarded in proportion to pre-dividend profits.
2) It is difficult to say without more data, but:
a) some companies use past good decisions to subsidize the present.
b) some companies use high rates, but then have expense charges, mortality charges, surrender charges, etc., that erase much of the advantage of the high rates.
c) sometimes the high rates are a “tease,” and can be adjusted down.
There is no free lunch, at least, not permanently. Thanks for writing.