How Guardian Calculates Dividends - 2011

To: From: Subject: Date:

All Field Associates Jess Geller, FSA, Vice President & Actuary How Guardian Calculates Individual Life Dividends November 18, 2010

Background Guardian was founded in 1860 and became a fully mutual company in 1925. As a mutual life insurance company, Guardian has no outside stockholders and is chartered to operate in the best interests of its participating policyowners. Owners of participating life insurance policies share in Guardian's actual financial results through annual dividends.

During 2011, Guardian will distribute approximately $740 million in dividends to participating individual life insurance policyowners.

This memorandum explains key terms, describes the calculation of policy dividends, and provides a sample dividend calculation. Note that dividends are not guaranteed as they are declared annually by Guardian's Board of Directors.

Contribution Principle Guardian allocates the dividend fund to policies in accordance with the contribution principle. This principle is designed to allocate dividends to each participating policy in the proportion that the policy contributed to Company earnings. This principle is the accepted standard of practice for mutual insurance companies in the United States. Guardian is a well-diversified company. Profits from other lines of business play an important role in determining dividends that are passed through to policyowners.

Direct Recognition Guardian uses the Portfolio Direct Recognition method of calculating dividends for policies issued since 1983 (and older policies that have accepted an on-going update offer). Investments are classified as "non-loaned" assets (including fixed income securities, equities, real estate, etc.), and "loaned" assets, which consist of policy loans secured by policy cash values. These two types of asset classes may perform differently.

The loaned portion of the policy's cash value receives a dividend interest credit that is linked to the policy loan interest rate. The non-loaned portion of the policy's value receives an interest credit that will vary with Company investment experience. Direct Recognition links policy performance to each individual's decision whether to take a policy loan, and thus eliminates cross-subsidies that would otherwise occur.

The Guardian Life Insurance Company of America (Guardian), New York, NY

Page 1 of 4

Dividend Substitution and Pegging Guardian's current practice is to pay a dividend that is higher than the basic dividend formula amount when certain conditions apply. The practice is called Substitution if it applies in the first three policy years and Pegging if it applies thereafter. The intent is to add an extra degree of stability to policies. These adjustments apply to basic policy dividends only and do not apply to dividends on paid-up additions. This practice is not guaranteed as it is approved each year by the Board of Directors.

Substitution In an environment of a declining dividend scale, Substitution smoothes performance for the second and third policy years by eliminating dividend reductions that would otherwise occur. For policies illustrated in 2011, the basic non-loaned policy dividend that will be paid at the end of policy years two and three will not be less than the basic dividend amount illustrated at the time the policy was issued. Substitution does not affect the dividends on paid-up additions.

Pegging Beginning with the non-loaned basic dividend paid at the end of policy year four, Guardian currently employs a strategy called Pegging. Pegging allows for a smoother transition from year to year in a declining dividend scale environment. Pegging does not guarantee that the dividend will increase from year to year, but does "soften" the decline in the dividend that would otherwise occur if only the dividend formula was used.

Dividend Calculation The example shown below is based on a L121 Whole Life policy, insuring a male who was age 35 at issue and qualified for Guardian's most favorable risk classification. The face amount is assumed to be $1 million. The policy is assumed to be in its 20th year.

Non-Loaned Interest Component During 2011, the non-loaned dividend interest rate is 6.85%. The dividend interest rate reflects a contribution from other Guardian lines of business. The excess of the non-loaned dividend interest rate over the interest rate underlying the dividend fund, which is 4.00% for this policy, is applied to the policy's reserve at the beginning of the year. In our example, this reserve is $240.04.

Interest Return

= (6.85% - 4.00%) x $240.04 = $6.841

Mortality Component Guardian's actual mortality experience is better than the guaranteed mortality. Excess mortality charges are returned to the policyholder through the dividend. The mortality return is the excess of the guaranteed mortality rate over the dividend mortality rate multiplied by the net amount at risk, which is the policy's face amount less the end-of-year reserve. In the calculation below, the end-of-year reserve is $245.35.

Mortality Return

= (.00550 -.00188) x ($1,000.00 ? $245.35) = $2.732

Loading Component The Loading Component recovers the Company's expenses, including taxes, and assesses a contribution to policyowner's surplus, a profit charge.

The Loading Component for this sample policy is negative $3.153.

The Guardian Life Insurance Company of America (Guardian), New York, NY

Page 2 of 4

Putting It Together The dividend at the end of policy year 20 is:

Dividend

= Interest + Mortality + Loading = $6.841 + $2.732 + (-$3.153) = $6.42 for each $1,000 of policy base face amount

Policy Loans Policy loans affect dividends. The adjustment to the dividend depends on the

? amount of the policy loan, ? prevailing non-loaned dividend interest rate, ? policy loan interest rate 1 and ? age of the insured and of the policy

The adjustment reflects the number of days during a policy year that a loan was outstanding and is applied only to loaned cash values.

The difference between a policy's loan interest rate and the interest rate credited to loaned dividends is called a loan spread. The table below shows the loan spreads used in the 2011 dividend scale:

Policy Loan Tier 1 2 3

Policy Years 1 ? 20

After 20 policy years but before attained age 60 After 20 policy years and at least attained age 60

Loan Spread 2011 Scale

0.75% 0.25% 0.10%

For the 2011 dividend scale, there will be a positive adjustment to the dividend on loaned amounts. For loan tiers 1 and 2, the adjustment will be 0.65%. For loan tier 3, the adjustment will be 0.90%.

Since the sample policy in this memo is assumed to be in its 20th year, the loan interest rate is 8.00%, the loan spread is 0.75% and the adjustment is 0.65%. The loaned dividend interest rate is equal to the loan rate plus the loan adjustment minus the loan spread.

Loaned dividend interest rate = 8.00% + 0.65% - 0.75% = 7.90%

7.90% is 1.05% higher than the non-loaned dividend interest rate of 6.85%.

In this example, a $20,000 loan (net of loan interest) is assumed to occur at the beginning of policy year 20. Loan interest at the rate of 8.0%, or $1,600, is payable in advance. The Direct Recognition adjustment that is applied to the loan substitutes the 7.90% loan dividend interest rate in place of the non-loaned dividend interest rate of 6.85%

1 Policy loan interest rates are fixed by contract and vary by policy form. For policies written since the 1997 form, the contractual loan rate reduces from 8.00% to 5.00% at the later of attained age 65 or beginning of policy year 21.

The Guardian Life Insurance Company of America (Guardian), New York, NY

Page 3 of 4

Loaned Dividend = Non-loaned dividend minus Direct Recognition adjustment

= $6,420 ? ($20,000 x (6.85% ? 7.90%)) = $6,420 ? (-$210) = $6,630 loaned dividend

In this example, the Direct Recognition adjustment increases the dividend by $210, which is equal to 1.05% times the loan. As a result of direct recognition, the cost of borrowing decreases from $1,600 to $1,390 or from 8.0% to 6.95%.

If the non-loaned dividend interest rate is less than the loaned dividend interest rate, which is the case in the example above, the Direct Recognition adjustment results in a larger dividend than if there had been no policy loans outstanding. The reverse would be true if non-loaned dividend interest rate exceeded the loaned rate. Please note that, because policy loan interest is payable, loans generate an additional cost, which does not apply to policies that do not have loans. Therefore, loans do not enhance policy performance.

Properly managed, policy loans are an excellent way for policyowners to access policy cash values. Assuming that the policy is not a Modified Endowment Contract (MEC), and will not become a MEC within a two-year period from when the loan was taken, the policy loan will not be taxed if the policy is held until death.

I hope you have found these disclosures useful. Please contact me for more information on this topic.

2010-11136 The Guardian Life Insurance Company of America (Guardian), New York, NY

Page 4 of 4

 ................
................

In order to avoid copyright disputes, this page is only a partial summary.

Google Online Preview   Download