July 2011

The dividend drag, 2010

Last year we wrote about the dividend drag- the effect that paying out a dividend to shareholders has on customer premiums in proprietary insurance companies. We have repeated that research, looking at dividends paid out by the larger insurers in 2010. 

On average our research shows that around 3p out of every £1 in premium paid by policyholders is lost to dividends. In effect that means that only 97p is invested, so that even if an investment returns 5% growth in a year, the policyholder will see no more than 2p growth- less once charges and tax are taken into account. 

By comparison, mutual insurers do not have shareholders. This means there is more available to invest, which in turn helps explain why mutuals typically outperform non-mutual insurers. It for example contributes to the ability of mutuals to reduce charges, raise service levels, pay more claims or to distribute products to consumers that the big insurers are not interested in.  And as we reported earlier this year, investment returns from mutuals are on average 27% higher than for non-mutuals (over a 25 year period, based on £50 per month invested in a with-profits product). 

As the chart below illustrates, six shareholder-owned insurers paid out a total of over £2.5 billion in 2010, which is 11% higher than the figures we reported for the same insurers last year: 

	gross premiums written £Ms	total assets £Ms	Total dividends £Ms	Dividends as % of premiums
Friends Life	7,541	122,154	250	3.3%
Legal and General	5,348	323,873	279	5.2%
Royal & Sun Alliance	8,448	23,104	276	3.3%
Prudential	24,568	260,806	511	2.1%
Aviva	36,274	370,107	904	2.5%
Standard Life	3,244	154,116	295	9.1%
Total	85,423	1,254,160	2,515	2.9%

 

The chart uses data from each company’s annual report, and excludes those insurance companies that are now part of banking groups, where the impact of the dividend drag is unlikely to be any less, but which is not possible to isolate in the same way. 

Of course no one doubts that dividends are important. Many wealthy investors rely on them for income, and many of the investments made by pension companies and mutuals benefit from dividends that supplement movements in share price.  Indeed much has been made of the ‘lost decade’ for shares, where a ten-year investment in the stock market would have produced a nil return based on share price movement alone, but where dividends equating to over 40% of the original investment have produced a stable if not spectacular return. 

But by the same token, that reliance on producing a good dividend means that managers of shareholder-owned insurers are focused on short-term actions that secure a high dividend.  Indeed whilst dividends have continued to grow, figures released in FSA’s Retail Consumer Risk Outlook 2011 have shown that net business flows into the life sector have fallen in recent years- and some years by as much as 20%. This means that the burden of meeting an increasing dividend payment is being covered by reducing policyholder premiums. 

Compare this to the newly emerging ‘mutual dividend’: paid by some AFM members in the recent past.  The mutual dividend recycles the excess profit back to the policyholders, to supplement investment returns or lower premiums.  So here, management focus is aligned with the interests of the customer. 

In summary, our research highlights the effects of the dividend drag: the desire to pay ever more attractive dividends means that less of a policyholder’s money is available for investment or for paying claims, and management time is diverted to securing a rising dividend in order to appease shareholders rather than satisfy customers.

 

Association of Financial Mutuals, July 2011

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