Gross vs. Net Dividends
Dividends can be a challenging concept for clients to grasp—from defining a dividend to options for receiving them. Dividends also work differently with whole life insurance than they do with stocks.
So How Do You Launch a Client's Dividend Education?
It is essential to understand the distinction between gross dividends and net dividends. When mutual companies make a profit, they are required by law to distribute those profits amongst all owners. Policy owners of participating whole life insurance are considered partial owners of the life insurance company and are therefore able to partake in the distribution of dividends. Although no dividends (profits) are guaranteed, they must be paid out when they occur. The good news? Dividends have a stellar track record in the life insurance industry.
Advisors and clients alike can be tempted to compare the gross dividends of mutual companies to make an informed decision. Looking only at the gross dividends, however, is actually irrelevant in the grand scheme of things.
Here's why:
In order to run a well-managed insurance company, companies must first subtract their operating costs from any dividend rates. There are three components to these costs: death benefit costs, commission fees, and general operating costs. Once these costs have been considered, you’re left with the net dividend rate. This is the figure that matters to you and your client.
Companies will have different overhead costs, so the gross dividend of one company may look more favorable than the other…but in actuality doesn’t perform as well after costs. The net dividends represent the actual dividend rate payable to policy owners.
How Does Truth Concepts Facilitate Client Education?
In the Truth Concepts calculators, we show the net figures for you. The net dividends are most obvious when it comes to the Funding Calculator, coupled with the Life Insurance Values tool. Here’s how you can analyze the gross dividend against the net dividend:
Below is our Life Insurance Values tool. Use this to upload your desired illustration. This enables you to transfer the values to the Funding Calculator. Notice, though, the IRR (internal rate of return) displayed in the right-hand columns. These rates can be misleading because people don’t quite understand IRR.
In Life Insurance Values, the IRR indicates the account’s cumulative earnings. Taking just the Life Values IRR at face value, that -58.32% is downright terrifying. Who would choose that? And yet it doesn’t have the context to understand that early Cash Value reflects policy costs such as comissions, overhead, etc.
Fifteen years down, and the policy seems to pretty be earning a pretty steady 3% or so. And yet something is still not quite adding up. After all, at this point, the cash value actually exceeds what you’ve put into it. How could 3% ever outpace a -58 percent?
This is where the Funding Calculater comes in.
Below is the Funding Calculator. If you load in stored life insurance data and toggle on the IRR button, you’ll see that it also shows the Internal Rate of Return. However, if you also toggle the “RORs” button next to Cash and Legacy on the top bar, you’ll get an annual ROR.
The difference here is that it’s not a calculation of the cumulative value of the policy. It shows the net dividend by isolating the return for each individual year. This is what most people EXPECT and therefore think they’re seeing when they see ROR. We’ve included it in the Funding Calculator to meet those expectations.
The benefit is that it shows a much more HONEST picture of what’s happening within a life insurance policy. If you go by the internal ROR, things look pretty dismal for about a decade, because the policy has not broken even. But when you look at the annual ROR, you’ll see that the policy actually starts earning a positive sum in Year 6.
Not only that, but the policy is actually earning that 3% only 9 years out, not 20. From that point on, the policy is doing more like 4-5% annually, which accurately reflects recent dividends.
Meanwhile, the Internal ROR will always be dragged down by those early years, which skews everything.
If you’re still skeptical, copy and paste the Annual ROR column (the whole column) into the “Annual Investment Rate” box under “Alternate Account” on the right-hand side. This interpolates how an alternate account, say a savings account, with the same deposits will perform.
You’ll see that the EOY balance, if the savings account earns that same rates every year, is the same as the total Cash Value. Even though the life insurance seems to underperform in the beginning, the performance of the account is equal to the alternate account. In other words, even a savings account with “red” in the first five years will have the same results if the Annual RORs are the same.
The same cannot be said for the Internal ROR column. Plug that into the alternate account, and you’ll get a VERY different result. This is why it’s critical to understand the difference between the two.
So the Annual ROR given outlines the overall net performance of the life insurance, accurately portrays the growth of the Cash Value. This directly compares to the net dividend rate.
What it really means is that by the time the policy owner’s portion of the dividend hits their pocket, it has been reduced by the overhead cost.
The IRR can be likened mroe to the overall trajectory of the policy. This can be important information for an advisor, but rather confusing when shown to a client who might mistakenly interpret the IRR as the Annual ROR. This is one reason we do not recommend showing the Life Insurance Values tool to a client directly, and instead uploading the data into another calculator, like Funding, to make your demonstrations. (In Funding, you can even toggle OFF the IRR and leave only the Annual IRR.)
In Conclusion
Our hope is that this post will help inform future dividend discussions with your client. Gross Projections are important to the life insurance companies, but when it comes to your client, Net is more meaningful. Using the Funding Calculator, show your client the growth power of their net dividends.
For more info on the Funding Illustration and how to make the biggest impact, see our tutorial page. If a deep dive into the calculators sounds interesting, Truth Training is a LIVE 3-day event where you will learn how to show clients why much of the typical financial advice they hear is FLAWED…and what to do instead. For more info on the next session, visit our Truth Training page.
