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May 2010

The Dividend Drag

The dividend drag

money2Question- how much do insurance company dividends take out of the pockets of policyholders?

Answer- none, but only if it’s a mutual, otherwise…

Financial companies have been busy recently reporting their financial results for 2009. Across the insurance industry as a whole it is clear how tough 2009 was- ABI figures indicate that new business volumes were down over 25% in the year.

However, whilst policyholders are investing less, that has not had a similar effect on how much shareholders are taking out. New AFM research into six shareholder-owned insurers shows that £2.275 billion was paid out as dividends for 2009. Put another way, nearly 3p of every £1 premiums made by policyholders is passed onto shareholders.

afm_chart1

This is the ‘dividend drag’- the loss to policyholder value that results from being shareholder-owned. In mutual organisations the dividend drag does not exist, with 100% of premiums paid being used within the business. This helps to explain how mutual organisations typically:

  • pay higher investment returns;
  • provide better standards of service;
  • pay more claims;
  • have levels of innovation that often belie their size.

And evidence from mutual accounts published so far this year is that the sector has on the whole bucked the trend for new business volumes in 2009- with most mutuals showing impressive growth. According to a recent report on mutual insurance globally from rating agency AM Best:

“In addition to mutuals facing no pressure to return capital to shareholders, there are a number of other reasons why they generally have weathered the economic downturn better than their non-mutual rivals. Mutuals’ policyholders are traditionally communities defined by trade and/or geography, which tend to provide a more loyal customer base. Mutuals therefore generally do not churn business in the same manner as stock insurers.”

This is not to suggest criticism of shareholders- they have a valuable role in providing the capital in shareholder-owned companies, and deserve a good return for putting their money at risk. But they necessarily produce a drag on the possible returns of policyholders, and where business levels are falling more quickly than dividends paid, as the chart below shows, this has a more acute impacti.

afm_chart2

Politician in the United Kingdom have woken up to the need to preserve an effective mutual sector- to provide diversity in markets, and competition for insurers. The new government’s recently released programme promises support for the creation and expansion of mutuals. The evidence here explains how they can continue to offer a real alternative to shareholder owned companies, and indeed to public ownership.

The need for life companies to preserve dividends is understandable- but with following business volumes we have to question whether it is sustainable.

Association of Financial Mutuals, May 2010

iSource: FSA returns/ ABI projections; AFM research


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