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A Stocks and Shares ISA can be a great asset for passive income investors. Not having to pay tax on dividends can be hugely valuable, especially over the long term.
Legal & General (LSE:LGEN) have been falling and the dividend yield has reached 9% as a result. So does that make the FTSE 100 insurer a no-brainer for investors?
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Gilts
The main reason the stock has been falling recently is the bond market. Concerns over the UK economy have led to a drop in the price of 30-year government bonds (gilts).
That’s good news for anyone who wants to buy bonds, but not for anyone who owns them. And it’s especially not good for insurance companies like Legal & General.
Insurers have to meet Solvency II capital requirements, which are designed to make sure they can cover their potential obligations. And falling bond prices are an issue here.
Declines in their bond portfolios can leave insurers short of solvency requirements. I don’t think this is a danger with Legal & General, but there’s a different issue.
Dividends
Since 2022, Legal & General has consistently paid out more in dividends than it has brought in as earnings. That’s something investors should take note of:
| Company | Earnings per share | Dividend per share |
|---|---|---|
| 2022 | £0.13 | £0.19 |
| 2023 | £0.07 | £0.20 |
| 2024 | £0.03 | £0.21 |
The rest of the dividend has come from the excess capital the firm has above its Solvency II requirements. There’s nothing wrong with this and a lot of insurers do something very similar.
Legal & General ended 2024 with a £10.8bn surplus, which is a lot in the context of a firm that distributes around £1.25bn a year in dividends. But falling bond prices might cut into that.
The value of its bond portfolio falling is likely to mean the company’s Solvency II surplus falls. And investors should think about this in the context of the reliability of that 9% dividend.
Is a dividend cut on the way?
Legal & General doesn’t disclose publicly exactly how much of its assets are held in 30-year gilts. That’s entirely reasonable – this kind of information is commercially sensitive.
This does, however, make it virtually impossible to assess accurately the effect of falling bond prices on the firm’s Solvency II surplus. And that in turn creates uncertainty around its dividend.
It’s worth noting that gilt prices haven’t fallen evenly across the board. Bonds with shorter durations have been more resilient, which is probably a good thing for insurance companies.
Given this, I think it would be a surprise if a dividend cut is imminent for Legal & General shareholders. But there are definitely other dividend stocks I’m more confident about at the moment.
A no-brainer buy?
A 9% dividend yield is high, even in the context of Legal & General shares. And in that sense, now is an unusually good time to consider buying the stock.
Investors, however, need to be careful. Falling bond prices are a bad thing for the company and they directly affect the amount of cash it has available to pay dividends with.
As I see it, the stock is a long way from being a no-brainer. In fact, investors might well think the amount of brainpower required to assess that risk accurately is prohibitively high.
