Hidden Cameras and Annuity Salesmen

I've been fielding a lot of questions lately about equity-indexed annuities. Someone here in Dallas is advertising an annuity product that he says guarantees a 7 percent annual return with no downside risk.

Of course, that oversimplifies what the product actually is, which is an insurance contract with a payout value tied to a stock market index like the S&P 500. Equity-indexed annuities are really no better than their close cousins, variable annuities, and they're sold in much the same way.

Set aside for a moment that there are much better investment vehicles out there. My biggest problem with these annuities is the way they're sold. These products are frequently on the SEC and FINRA watch lists because they're aggressively sold to inappropriate investors, especially seniors.

Chris Hansen, the Dateline reporter famous for his hidden-camera investigations, recently focused on the annuity business. What he found is disturbing, awful, and not at all surprising.

See for yourself:

http://www.msnbc.msn.com/id/21134540/vp/24108012#24108012

Play close attention to the way these guys give themselves fancy titles that don't mean anything and make promises that just aren't true. Also check out the "Annuity University," where salespeople are taught how to hit seniors' fear, anger and greed buttons and how to deflect questions about the products' liquidity and safety.

What disturbed me most, though, is how these scumbags try to buy credibility. They can pay $2,500 to have their name and photo printed on a book they didn't write. They can have their picture on the cover of a fancy-looking magazine, right beside Fed Chairman Ben Bernanke. And they can read a script for a phony national radio show and give out the audio CDs to potential customers.

This obviously struck a nerve with me, as I have a book coming out in October (which I did write myself), numerous articles on the web and in print (ditto), and a real radio show where we're live and taking calls from real people almost every week.

The ways these guys distort the truth to convey a sense of credibility show why the industry has such a bad reputation. If these guys will lie to you about their credentials, what else do you think they'll lie about?

People want to know who they're really dealing with. They want truth and honesty. If you're a commissioned salesperson, fine -- tell me that up front so I know what I'm getting into. The problem with the financial services industry is that there's so much incentive for advisors to confuse and mislead their investors. People deserve much more respect than that.

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Kim Snider is the President and Founder of Snider Advisors, an SEC Registered Investment Advisor, focused on teaching individual investors a sensible, long-term investment approach focused on maximizing cash flow. For more information on Snider Advisors or the Snider Investment Method and how to stop enriching your investment advisors at your expense, please visit snideradvisors.com. Her book, How to Be the Family CFO: Four Simple Steps To Put Your Financial House in Order, will be in bookstores October 1, 2008.

Snider Advisors makes no representation that the information and opinions expressed are accurate, complete or current. The opinions expressed should not be construed as financial, legal, tax, or other advice and are provided for informational purposes only. Call 866-952-0100 to request the Snider Investment Method® Owner's Manual, which includes a description of the Snider Investment Method, investment objectives, risks, suitability and other information. Please read and consider carefully before investing. All investments, including the Snider Investment Method™ are subject to risk, including possible loss of principal.

 

Guarantees and Generalizations

This week, I want to do things a little differently. Instead of writing my usual article, I sat down with newsletter editor (and radio show sidekick) James Pecht and discussed some feedback we received from our recent "Red Flag" articles. It's an audio file about 14 minutes long, and you can download it to listen from your computer or move it to your mp3 player.

Click here for the audio Kimmunique (Hi - 128k | Lo - 24k)

Notes:
0:00 Introduction
2:00 What we mean by the statement "If a financial advisor constructs a portfolio with an expected return of less than 10 percent, that's a red flag"
4:40 Why that statement did not reflect a guarantee but rather a goal
5:45 Generalizations in the articles -- why I use inflexible rules
8:25 About the information session scheduled for Saturday, May 31. (After my talk, we'll head over to Boston's the Gourmet Pizza on 635 and MacArthur in Irving to broadcast the weekly radio show live on location. Then we'll stick around to answer questions and talk to folks one-on-one.)
10:45 New virtual office hours -- a twice-weekly conference call.

Details on the office hours: 

• Wednesdays 5 p.m. - 6 p.m. Central Time
• Thursdays Noon-1 p.m. Central Time

Ask anything that's on your mind about the Snider Method, personal finance, the economy -- you name it! We have a special toll-free conference call line -- you can call in and ask your questions, or just listen in to what others are asking. The office hours have an online component, too -- the technology we're using allows me to show you calculations, visit websites, etc. It's like you're sitting right beside me, looking at my computer screen together.

To join me, here's what you do:

1. Call 1-888-617-3400 and enter the access code 791564.
2. (Optional) Go to https://www1.gotomeeting.com/join/597893666.Please note: Attendance is limited for the online component, and you may be prompted to download some software the first time you log on.

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Kim Snider is the President and Founder of Snider Advisors, an SEC Registered Investment Advisor, focused on teaching individual investors a sensible, long-term investment approach focused on maximizing cash flow. For more information on Snider Advisors or the Snider Investment Method and how to stop enriching your investment advisors at your expense, please visit snideradvisors.com. Her book, How to Be the Family CFO: Four Simple Steps To Put Your Financial House in Order, will be in bookstores October 1, 2008.

Snider Advisors makes no representation that the information and opinions expressed are accurate, complete or current. The opinions expressed should not be construed as financial, legal, tax, or other advice and are provided for informational purposes only. Call 866-952-0100 to request the Snider Investment Method® Owner's Manual, which includes a description of the Snider Investment Method, investment objectives, risks, suitability and other information. Please read and consider carefully before investing. All investments, including the Snider Investment Method™ are subject to risk, including possible loss of principal.

Problems with Viatical and Life Settlements

Warning: Long-Post

 

I have received several questions in recent weeks asking for my opinion on a life settlements. Rather than continuing to answer these questions piecemeal, it seems to make more sense to put the whole thing in writing so I can point people to a more thorough treatment of the subject than I can sometimes give on the radio or in a Q&A session.

 

The topic is a big one, so I will tackle it in several parts. To begin with, what exactly is a life settlement? What are the risks? - There must be some because we know there is no such thing as a risk free return in excess of what U.S. Treasuries will pay. They are not obvious but they are significant. Finally, do I like them as an investment?

 

What is a life settlement?

 

A life settlement is when the owner of a life insurance policy sells the policy for more than the surrender value but significantly less than the death benefit because they no longer need the policy, can't afford the premiums, or need the cash. The purchaser pays the premiums and becomes the beneficiary of the policy. When the insured dies, the new policy owner gets the proceeds rather then the insured's heirs.

 

Typically, the policy is bought by a viatical settlement provider. That company may hold the policies as an asset in their investment portfolio. More often, they securitize a group of policies and sell an interest in the pool of policies to investors - much like the mortgages that were pooled into collateralized mortgage obligations and all those other various acronyms you read about in the paper these days. In this case, they are a broker-dealer of life settlements.

 

Example

 

A policyholder sells a policy with a $100,000 death benefit for $50,000. The settlement provider or broker-dealer would take $50,000 of the money raised from investors and use it to pay the policyholder. When the policy holder dies, the settlement company receives the $100,000.

 

On the other side of the transaction, the company sells an interest in the policy to investors at some discount greater than the discount offered to the insured. For example, the broker-dealer offers the interest to investors at a 28% discount. The broker-dealer collects $72,000 from the investor and uses $50K to pay the seller of the policy, pocketing the difference. Some of that is paid as commission to the sales agent and the rest goes into company coffers.

 

When the insured dies, the insurance company pays money to the settlement provider, who then distributes the $100,000 proceeds to the investors. If the insured had a two year life expectancy and died on schedule, the investor would receive the full 28% return indicated by the discount. If the insured lives beyond the two year life expectancy, for six years say, the investor still receives the 28% holding period return, but because of the increased number of years to earn the return, the annualized return is reduced to 3.5%.

 

Brief History

 

Life settlements sprang up in the 1980s in the form of viatical settlements - the sale of a life insurance policy by a terminally ill policy holder. The price paid for the policy was/is discounted from face value based on the anticipated life expectancy of the person selling the policy - the longer the life expectancy, the steeper the discount.

 

Viaticals became big business - and big news - in the 1990s because of the AIDS epidemic. The industry was largely unregulated and rife with fraud.

 

Advances in AIDS treatments eventually undermined the viatical industry, which was based on the certain and imminent death of the insured. Advances in medical technology soon had AIDS victims living longer and some went into remission altogether. The same thing started happening with cancer patients. Seeking greener pastures, the industry moved on to life settlements, also sometimes known as senior settlements.

 

The difference between viaticals and life settlements

 

A search of the web finds the term viatical settlement is defined, in conventional usage, as the sale of a policy where the insured is terminally ill and anticipates death within 24 to 36 months. A life settlement is the sale of a policy on an insured who is generally over the age of 65, not terminally ill, but whose mortality is predictable based on standard actuarial methods.

 

What returns can an investor expect?

 

It is hard to find any marketer of life settlements promising less than double digit returns. In a report by the Conference for Advanced Life Underwriting, the author notes, "Presumably, high current returns reflect an immature market, where uncertain regulation, doubtful liquidity and high risk of deception or outright fraud require a premium on the investment yield, and will revert to more conservative norms as the market matures."

 

Risks of investing in viaticals or life settlements

 

Federal and state regulators consider life settlements to be securities. That means the person selling them must be licensed to sell securities. It also means they must provide you with a full and fair disclosure of all material facts, including a discussion of the risks, in the form of a prospectus or other similar document.

 

Liquidity risk - unlike stocks, bonds or other highly liquid securities, you probably cannot readily convert a life settlement into cash if you need it. This means you may not get any money from the investment until the insured dies and the claim is paid. It is possible the insured could live much longer than expected, or even outlive you. There are plenty of cases where that has happened. Can you afford to lock your money up until the insured dies?

 

Longevity risk - "There's an old saying, `The only sure things in life are death and taxes' and viatical salesmen play on that," said Denise Voigt Crawford, Texas securities commissioner. "They tell investors that because death is a sure thing, viaticals are too. But the only sure thing with viaticals are the large commissions some brokers get, making it even tougher for investors to get the returns they're promised."

 

The Florida Department of Financial Services, which regulates securities in the state of Florida, says in their pamphlet on life settlements, "Be cautious of any person that represents these investments as guaranteed or low risk." The life expectancy of the insured is just a guess. Those stubborn insureds and their doctors aren't in any hurry to make your investment pay off. They can and do live longer than the life expectancy estimate.

 

Longevity risk is particularly relevant in IRAs and other retirement savings vehicles because they produce no income and are not liquid. This is a serious problem if the insured outlives the life expectancy estimate and you need retirement income. It is exacerbated if you reach the age of required minimum distributions and can't make them.

 

Variability of return - If the insured dies within the estimated timeframe, your return will be high. If they don't, your return will be low. Beyond the ghoulishness of waiting around for some poor soul to die so you can profit from their demise, the variability of returns is a risk. It isn't the slam dunk the salesperson often portrays.

 

Quality of life expectancy estimate - The life expectancy estimate is the key to return. If the company or its consultants improperly evaluate life expectancy, or worse, misrepresent the life expectancy, promised returns go out the window. Like all pooled investments, there is no transparency. It is difficult for the investor to really know what they own and the reputation of the parties involved. Considering the dodgy history of the industry, this lack of transparency is particularly troubling.

 

Credit risk - There are significant activities and associated costs incurred while the policy is outstanding. These include paying the premiums, tracking the insured, monitoring the health of the insured, filing a claim when the insured dies, and distributing the proceeds to investors. The credit worthiness of the life settlement issuer is a major issue. Who will pay these costs if the broker-dealer goes out of business of is otherwise unable to pay these costs?

 

There is also credit risk in the insurer as well. Viatical investment promoters commonly assure investors that issuing life companies have a high credit rating and are unlikely to fail. That is not necessarily true. Regulators seized Confederation Life in 1994, when it was rated B++ and had been rated A+ (superior) only the year before. For those unfamiliar with the company, it was the single largest life insurance company to fail in North America, with total losses in the billions.

 

Legal risk - Because the heirs lost out on whatever return the investors and issuer made, they can and often do challenge the change of ownership in the policy, tying up the proceeds in legal proceedings and incurring additional legal fees.

 

Again, transparency is an issue insofar as you could lose the entire investment if the settlement provider, issuer, broker-dealer, agent or others involved encounter financial trouble or are involved in fraud. Life insurance companies have two years to investigate and rescind policies obtained using fraudulent information. They may also sue for damages.

 

Many applications, for example, ask the applicant whether they intend to sell the policy. If the insured says no, at the time, and then later sells the policy, there is potential grounds for rescission. Other potential pitfalls involve policies that contain intentionally misleading information from the insured, known as "cleansheeting." This is when an insured or agent deliberately leaves relevant information off the application. If you think this doesn't happen, think of all the fraudulent mortgage applications that were filed in the last few years.

 

Another scheme that could cause you to lose money is known as "wet ink." This is where the policyholder obtains a life insurance policy for the specific purpose of immediately reselling it. Some are even encouraged by unscrupulous life settlement providers to repeat the practice over and over again.

 

Regulatory risk - Given that the SEC, FINRA and state regulators have deemed life settlements to be securities, the question of suitability comes into play. In the case of a life settlement, it is not just suitability of the investment for the buyer, but in this case, also for the seller. If the seller was allowed to sell a policy when it was not in his or her best interest, or the best interest of the heirs, as is often the case, regulators could take action.

 

The SEC recently filed their first case involving life settlements, going after a hedge fund for improper disclosure. This firmly establishes the SEC's intent to claim regulatory jurisdiction over life settlements, something they had not done until now.

 

Legislative risk - Life insurance is tax advantaged in that the value is allowed to build up tax deferred and no income or capital gains is due on the death benefit. This special treatment was due to the role life insurance is supposed to play in caring for a family after the death of the breadwinner.

 

Congress, which is faced with large budget deficits, has been licking their chops over the cash buildup in life insurance policies for quite awhile now. Life settlements, which threaten to turn life insurance policies into nothing more than an investment, may be the excuse Congress has been looking for to tax life insurance policies.

 

What is my opinion on life settlements?

 

I have covered the risks at length. Personally, I am much more comfortable with market risk. There is also just the general idea, which I find repugnant. I don't care how much they pay.

 

"The psychology of investing in viaticals is different than investing in other types of instruments, and people need to consider that going in," said Bradley Skolnik, Indiana securities commissioner and chair of NASAA's enforcement section. "The risk is high with viaticals, and investors need to ask themselves if the potential reward is worth the burden of hoping someone will die quickly so they can maximize their return."

 

Beyond those two things, I am a cash flow investor. I believe that today's investor has to be most concerned with matching up cash outflows to cash inflows. Life settlements offer no cash flow and no liquidity. Combining them with a traditional cash flow investment, like bonds or an immediate annuity, drops the return to an unacceptable level for the person who has to make a bare minimum of 10% a year (.04 + .04)/(1-.25) to cover a 4% withdrawal rate, minimum of 4% inflation and an assumed 25% marginal tax rate.

 

My take is life settlements are another great product for the commissioned salesman selling them but a bad idea for you. You can do better.

 

SOURCES:

 

1. Rothberg, Ed, Viatical and Life Settlements: Investing Without a Safety Net. CALU Report (Conference for Advanced Life Underwriting, 2005) http://www.calu.ca/publicationDetails.asp?x=&y=EHQ-7142005-3382&i=308&d=1&z= (accessed April 9, 2008,).

 

2. “NASD Warns on Viaticals,” Financial & Tax Fraud Associates, Inc. http://www.quatloos.com/viaticals.htm (accessed April 9, 2008,).

 

3. Viaticals and Life Settlements, (Florida Department of Financial Services: Office of Financial Regulation) http://www.fldfs.com/Consumers/literature/Viaticals2.pdf (accessed April 10, 2008,).

 

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Kim Snider is the President and Founder of Snider Advisors, a SEC Registered Investment Advisor, focused on teaching individual investors a sensible, long-term investment approach focused on maximizing cash flow. For more information on Snider Advisors or the Snider Investment Method and how to stop enriching your investment advisors at your expense, please visit snideradvisors.com. Her book, How to Be the Family CFO: Four Simple Steps To Put Your Financial House in Order, will be in bookstores October 1, 2008.

 

Snider Advisors makes no representation that the information and opinions expressed are accurate, complete or current. The opinions expressed should not be construed as financial, legal, tax, or other advice and are provided for informational purposes only. Call 866-952-0100 to request the Snider Investment Method™ Owner's Manual, which includes a description of the Snider Investment Method, investment objectives, risks, suitability and other information. Please read and consider carefully before investing. All investments, including the Snider Investment Method™ are subject to risk, including possible loss of principal.

 

Take Care of You First, Then the Money

On March 20, I shared the story of Jane, a Snider Investment Method™ workshop graduate who ran into an unfortunate situation when her mother passed away unexpectedly. Jane wrote me today to tell me the situation had been resolved and to share what she learned:

 

I just got good news this morning.  Wachovia got Hartford to give us a new  free look period on that variable annuity so my dad is going to get  the money back plus a $2000 gain.  The man who investigated our complaint found that the first papers my dad signed were only to surrender the annuities that came due at my mothers death.  We thought that was the "investment" contract.  The variable annuity contract wasn't signed until three weeks later when the money arrived in the bridge account.  I wasn't there then and Daddy did not receive a copy of the contract.  This was well after the agent knew that we wanted to disclaim the money.  That discrepancy made the bank see our point and it acted quickly. 

 

Thanks for your advice.  I hope my problem helps others see that most things can wait awhile after someone dies.  You don't have to act right away and probably shouldn't.  AND you should get a copy of every piece of paper you sign! I had thought I was smarter than signing papers without asking specific questions but you don't know how you will act when you are shell-shocked and grieving. 

 

That is good advice. I want to thank Jane for sharing so others could learn.

 

Sometimes fortunately, and sometimes unfortunately, life is full of changes. Financial planners call these transition events and they include: marriage, retirement, career change, divorce, loss of a spouse or parent, a windfall or settlement, the sale of a business and inheritance. Almost all of these events will have both a financial and an emotional component.

 

You must take time to deal with the emotional component before dealing with the financial. I was mentored for awhile by a psychologist who worked with traders at hedge funds. He told me, "Whatever unresolved issues you have in your life will play themselves out in your trading."

 

At the time, I dismissed his statement as a bunch of psycho-babble. Probably because I had unresolved issues I couldn't face at the time! Imagine that! But years later, I was able to see that he was absolutely right. And it wasn't just in my trading, it was how I handled every aspect of my money - from the investments I chose, the house I chose to live in, the car I drove, even the people I chose to hang out with.

 

When we face a life transition, such as the death of a spouse or death of a parent, there are always going to be a tangled mess of unresolved emotions immediately following. You will probably feel hurt, grieving, angry, confused or needy. Who knows. Emotions are a complex thing. But you need to take care of those first, before making any decisions about advisors, investments, gifts or purchases.

 

Also, and this is going to sound cynical, beware of anyone who suddenly "appears" in your life after a transition event, especially one that involves a lot of money. Long lost friends and relatives who suddenly appear can only have one thing in mind - to get something from you.

 

Same thing with new relationships. We often try to fill holes in our life, especially freshly created holes, by stuffing something or someone in them. Give yourself the gift of time.

 

A good rule of thumb is six months. Try not to make any decisions about anything, for at least that long, if you can possibly help it. If that means money sits in a bank account or a money market fund for awhile, so be it. If that means you stick close to old friends and loved ones for awhile, that is probably a wise move. Decisions made within that six month window have a high likelihood they'll be bad ones.

 

Only after you take care of you, will you be in a place where you can take care of the money.

 

Kim Snider, Kim Snider Financial Communications, Chronim Investments and/or Snider Advisors make no representation that the information and opinions expressed are accurate, complete or current. The opinions expressed should not be construed as financial, legal, tax, or other advice and are provided for informational purposes only. Call 866-952-0100 to request the Snider Investment Method™ Owner's Manual, which includes a description of the Snider Investment Method, investment objectives, risks, suitability and other information. Please read and consider carefully before investing. All investments are subject to risk including possible loss of principal.

 

Getting Out Of Variable Annuities

I recently did an online workshop titled "Why Annuities Stink." We wanted to use a bit stronger word than stink but people send me emails telling me they get offended when I use the word sucks. (It's a generational thing that I frankly don't get. It doesn't mean THAT anymore!)

 

After outlining the slew of problems with variable annuities, we went to the question and answer session where one of our Snider Investment Method alumni gave an account of a situation with her deceased Mother that illustrates some of the abusive sales practices that occur routinely with annuities.

 

Jane's mother died suddenly at Christmas. Just after the funeral, her financial advisor contacted Jane saying her Mother had an investment that needed to be "rolled-over." When the paperwork arrived, it turned out the investment was a variable annuity. Further investigation revealed this same advisor had sold her Mother another annuity just months before she died, with a long surrender period.

 

There are very few situations where a variable annuity makes sense and the older you are, the less sense they make. The only person who should have a variable annuity is a very young person, earning a very-high income, who has maxed out all other tax deferred alternatives, and knows they won't need the money for many years.

 

That is not the way they are sold - at all.

 

The North American Securities Administrators Association (NASAA) reported that between 2004 and 2005, 26% of the 3,635 state enforcement actions dealt with the financial exploitation of seniors; and 34% of all “successfully concluded enforcement actions” involved either variable or equity-indexed annuities. Patty Struck, administrator of the Division of Securities in Wisconsin, said last month that within the last year, 44% of the complaints securities regulators have received came from seniors.

 

Jane signed the contract rolling over the annuity based on what she said was pressure from the salesman "at a very bad time" when she was, obviously, distraught about her mother's passing and, I am guessing, not thinking real clearly. Notice I used the word salesman, not financial advisor or banker, even though this guy worked for one of the largest banks in the Southeast.

 

When Jane met with the estate attorney later that day about her Mother's estate, he told her they could have disclaimed the assets if she hadn't signed the contract. Jane is supposed to get a 15 day period in which she can change her mind. But when she called the advisor to tell him she no longer wanted to roll-over the annuity, he told her the contract had "already been Fed-Ex'd and it was too late!

 

So Jane's question was what to do with these annuities now that she was in them? This is a common question. I find that people experience buyer's remorse with variable annuities more than anything else. Not surprising since they are terrible investments.

 

There are three choices if you are in a variable or equity index annuity and want to get out. To understand the pros and cons of each, you must remember three things about these annuity contracts:

 

1. Variable annuities usually have a surrender fee that is gradually reduced over some period of time. Seven years is typical. Some go as long as ten. And the penalty is substantial. For example, a 7% charge might apply in the first year, 6% in the second year, 5% in the third year, and so on until the eighth year, when the surrender charge no longer applies.
2. Variable annuities are tax-deferred which means you are subject to a 10% early distribution tax if you take the money out before age 59 1/2.
3. The fees on variable annuities are very high. Those fees will eat up performance making them (did I already mention this?) terrible investments.

 

With those "gotcha's in mind, you have three choices for dealing with the "Hotel California" of investment products:

 

The first is to just wait until the surrender fee goes away. Often, contracts will allow you to withdraw part of your account value each year – 10% or 15% of your account value, for example – without paying a surrender charge. The pros of waiting are you avoid the surrender charge. The downside is you are stuck in a lousy investment because they have trapped you there. Generally not a good plan.

 

Second, is to do a 1035 exchange to a very low-cost, no bells and whistles annuity. This is basically an annuity roll-over. The steps are: 1) Pick a new annuity company - preferably a bare-bones, low cost one; 2. Contact that company for an application and 1035 exchange paperwork; 3) fill it out and they will take care of the roll-over.

 

There are several low-cost annuity providers including Fidelity and Vanguard. Unfortunately, one of the best no-load mutual funds, TIAA-CREF, has stopped accepting new investors. If you do a 1035 exchange, you are still liable for surrender charges with the old annuity but there will be no early withdrawal penalty if you are under 59 1/2 since you are rolling the money from one tax-deferred account to another. You also don't lose the tax-deferral. Be aware, the surrender charge clock will start all over again, though.

 

Your final option is to say "Screw it!", and cash it out. This is my preference. Yes. You are going to take the tax hit if you are under 59 1/2. Yes. You are going to pay a surrender charge. But I just don't believe in staying in a bad investment because they have trapped me in it. As far as I am concerned, you chalk that loss up to tuition and vow to yourself you'll never make that mistake again.

 

I think the real lesson here is not to buy a variable or equity indexed annuity in the first place. But if you do, you should know that you have options.

 

SOURCE: (direct quotes are indented and highlighted)

 

1. "Group Think." Investment Advisor March 2007.

http://www.investmentadvisor.com/magazine.php?issue=300075

 

2. "Variable Annuities: What You Should Know." United States Securities and Exchange Commission March 20, 2007.

http://www.sec.gov/investor/pubs/varannty.htm

 

Kim Snider, Kim Snider Financial Communications, Chronim Investments and/or Snider Advisors make no representation that the information and opinions expressed are accurate, complete or current. The opinions expressed should not be construed as financial, legal, tax, or other advice and are provided for informational purposes only. Call 866-952-0100 to request the Snider Investment Method™ Owner's Manual, which includes a description of the Snider Investment Method, investment objectives, risks, suitability and other information. Please read and consider carefully before investing. All investments are subject to risk including possible loss of principal.

 

Variable Life Insurance & Annuities: Investment Scandals in Waiting

The following is from Steve Selengut, portfolio manager and author of "The Brainwashing of America". He put it up as a comment to my post, "NASD continues probe into abusive sales practices of variable annuities." I thought it was worthy of its own post. See what you think.

 

 

We humans are as creative on the "Dark Side" of commercial activity as we are in developing beneficial new products and services. In the face of huge financial benefits, however, some corporate executives can't resist taking an extra dessert even before their shareholders have finished dinner. Some scandals have more of an impact on investors than others, and most produce unwarranted layers of government regulation and control that stifle honest creativity.

 

Plain vanilla fraud and theft are less worrisome to me than situations where the general acceptance of misinformation or "business as usual" practices allows inherently bad product ideas and blatant mismanagement to become accepted by regulatory authorities, financial professionals, and myopically gullible consumers. Here are some candidates for future "Blockbuster Scandal Awards" (B S Awards, if you will): Variable Life Insurance & Annuities, Wrap Fee Managed Investment Accounts, Portfolio Window Dressing, Asset Allocation Mutual Funds, and Obscene Executive Compensation.

 

1) Variable Insurance and Annuities: Variable products are a relatively new thing in the insurance industry, circa 1980 or so. Before that, the conventional wisdom labeled the Shock Market much too risky for Life Insurance Policy and Annuity Contract guaranteed benefits. In fact, these benefits had been "guaranteed" for so long that it became a generic expectation of anyone in the market for either. So why did the State Insurance departments cave in to the Variable Product lobby? And what is not emphasized as these products are marketed to potential insureds and annuitants?

 

As if the 8% sales commission on Straight Life Annuities wasn't enough, the addition of Mutual Fund bonuses made the Variable Annuity irresistible... to financial professionals. Similarly, this product is so lucrative for the companies that they manipulate their rates to become more competitive. Since the introduction of variable benefits, there have been more insurance company failures and scandals, and not just a few disappointed recipients of reduced annuity payments. What's in your retirement plan?

 

2)Wrap Fee Investment Accounts: From the very beginnings of wealth, the very wealthy employed Investment Managers to protect and to grow their portfolios. Most Investment Managers had just a few huge clients that they tended to while the rest of the fledging financial industry focused on property protection and estate creation through life insurance. Most of today's (salaried) Investment Managers are employed by Financial Institutions to supervise thousands of Mutual Funds for millions of investors of all financial shapes and sizes. There are more Equity Mutual Funds than there are individual Equities on the New York Stock Exchange. Most investors today will employ many Investment Managers and never actually speak to any of them.

 

Enter the personally managed investment portfolio product offered by most major Financial Institutions. For a single fee, you receive the personal services of a professional Investment Manager, and a portfolio specifically designed for you. Except, of course, that you get neither. You get precisely the same portfolio as everybody else, and all at once regardless of price... a Mutual Fund with individual statements. But of course, you can speak to the manager any time you like, change your asset allocation, set aside a reserve for an upcoming expenditure, etc. Yeah, sure you can!

Note that "Flat Fee" managed accounts are quite different and may actually be separately and personally managed.

 

3)Portfolio Window Dressing: Every quarter, every year, we hear about the adjustments that portfolio managers are making as they attempt to look smart to their largest clients. Now in a discipline (Investing) that they all officially recognize as a long-term commitment to some specific strategy or plan, why do the Masters of the Universe spend so much time manipulating their short-term performance numbers? And why is this considered business as usual instead of common fraud?

 

4)Asset Allocation Mutual Funds: I look at Asset Allocation a bit differently than most professionals seem to and I regulate and monitor a portfolio's structure using the cost basis of securities rather than their Market Value. But how, logically, can a one-size-fits-all Mutual Fund be the right mix for all investors? Here's a definition found on the Internet: "A mutual fund that rotates among stocks, bonds, and money market securities to maximize return on investment and minimize risk". And a definition of Asset Allocation from a similar source: "The practice of distributing a certain percentage of a portfolio between different types of investment assets, such as stocks, bonds, mutual funds, cash, real estate, options, etc. By diversifying an individual's asset base, one hopes to create a favorable risk/reward ratio for a portfolio".

 

In reality, Asset Allocation is a structure-planning tool that determines what percentage of an Investment Portfolio is to be invested for Growth in Equity securities and what percentage is to be invested for income production. The proper allocation is a function of the investor's age, marital status, financial position, employment status, retirement plans, expenditure needs, risk tolerance, family responsibilities, etc. Diversification occurs within the two (just two) asset classes. One size fits all... who's kidding whom?

 

5) Corporate Executive Compensation: I strongly believe that everyone has the right to become filthy rich, legally of course. I respect anyone who gets there honestly because their success creates jobs, opportunities, wealth, and a higher standard of living for everyone. But, once they sell shares of their successful enterprises to the public, they have a responsibility to share future profits and growth. Obscene executive suite compensation (right down to the chauffeured limousines) is simply stealing from shareholders.

 

With every new Scandal, a voracious Media and a hypocritical Congress exacerbate the fear of shocked investors and call for more regulation of the very entities whose success, freedom, viability, and competitiveness they should be nurturing. Ironically, politicians are always the most outspoken critics... probably because of their familiarity with cover-ups and improprieties. But no one ever questions the integrity of the Financial Institutions that invent, produce, price, and promote products and services that do far more long-term harm than the few (albeit serious and sensational) incidents of corporate wrong doing.

 

Four of the five candidates for this year's Blockbuster Scandal (B S) Award were created on Wall Street. The fifth is ignored by it. Which one bothers you most?

 

Your thoughts and comments are welcome, as always. Please leave them below.

 

Kim Snider, Kim Snider Financial Communications, Chronim Investments and/or Snider Advisors make no representation that the information and opinions expressed are accurate, complete or current. The opinions expressed should not be construed as financial, legal, tax, or other advice and are provided for informational purposes only. Call 866-952-0100 to request the Snider Investment Method™ Owner's Manual, which includes a description of the Snider Investment Method, investment objectives, risks, suitability and other information. Please read and consider carefully before investing. All investments are subject to risk including possible loss of principal.

Annuities: Fixed or Variable, Immediate or Deferred?

I began questioning how many people understand the difference between different types of annuities after I received an email this week from one of my Snider Investment Method™ Workshop graduates. Annuities come in a thousand different flavors and colors. No two are exactly alike.

 

I think most people lump them together without understanding the difference. Or maybe they just think I automatically think all annuities are bad. That is not true. I think MOST annuities are bad and the rest have very limited application.

 

Annuities are basically either fixed or variable and either immediate or deferred. Beyond that, the permutations become endless. That is one of their drawbacks. They are very complicated, almost impossible to compare apples to apples, and very few people understand what they are buying when they buy them. Nowhere in the investment world is buyer's remorse more prevalent, in my experience, than with buyers of annuities.

 

A fixed annuity is an insurance contract that promises you, or you and your spouse, a predetermined income for as long as you live--no matter how long that might be. For example, you pay the insurance company a lump sum of $100,000, say, and they promise you $3,000 to $6,000 a year for the rest of your life.

 

The advantage of a fixed annuity is that it provides you with a guaranteed cash flow indefinitely - provided, of course, the insurance company remains solvent. If you live a long time after buying the annuity, you may even receive more in payments than you put in. The second advantage is its consistency. You know exactly how much you are going to get. The amount does not fluctuate with market conditions or interest rates.

 

The downside is, when you die, the remainder of your initial payment belongs to the insurance company. Your heirs get nothing. Another disadvantage is that most fixed annuities are just that - fixed. The amount you receive each year remains constant so the purchasing power is eaten away, over time, by inflation. Finally, it is highly likely that even a conservative investor can get far better returns than the annuity.

 

When is a fixed annuity appropriate? The only time a fixed annuity makes sense to me is for an extremely risk-averse investor. An example would be someone who has almost no retirement savings, no other sources of income, and for whom the loss of even a single dollar would be catastrophic. Even then, the problem I have is you can do so much better with just a smidgeon of extra risk using CDs and bonds.

 

A variable annuity, on the other hand, is very different. The initial investment is invested in a range of investment options, usually mutual funds, called subaccounts. The amount of money you receive is, as the name implies, variable, and is based on the performance of the investments.

 

Variable annuities are generally reviled by all but those who sell them. The problems are legion and I won't go into them here. If you are interested, you can check out my previous posts on the subject, my interview with Gary Schatsky, chairman emeritus of the National Association of Financial Planners on the subject, or get a quick run down of the problem from two good articles here and here.

 

I never, ever, ever recommend a variable annuity. Bring on the angry email from the insurance salesmen. I don’t care. You can’t convince me otherwise.

 

The other characteristic of annuities is immediate versus deferred. An immediate annuity begins paying out immediately.

 

A deferred annuity has an accumulation phase and a payout phase. During the accumulation phase, you contribute to the annuity and hopefully give the principal time to grow. When you reach retirement age, you can elect to annuitize the principal, in which case you would begin receiving regular periodic payments, like a fixed annuity, or you can request a lump sum distribution.

 

While I admit there may be specific scenarios in which an annuity makes some sense, my general advice is, be they fixed or variable, immediate or deferred, annuities are an investment you can probably do without.

 

Kim Snider, Kim Snider Financial Communications, Chronim Investments and/or Snider Advisors make no representation that the information and opinions expressed are accurate, complete or current. The opinions expressed should not be construed as financial, legal, tax, or other advice and are provided for informational purposes only. Call 866-952-0100 to request the Snider Investment Method™ Owner's Manual, which includes a description of the Snider Investment Method, investment objectives, risks, suitability and other information. Please read and consider carefully before investing. All investments are subject to risk including possible loss of principal.

09-27-2006: Items of interest for the Family CFO

Yet another example that no one can predict the future direction of stock prices and reading the news on those stocks will cause you to buy when you should be selling and sell when you should be buying. Take a look at the news headlines from 1995-97 about Apple. (Tip of the hat to Barry Ritholtz of The Big Picture for this one.)

 

Health insurance continues to be the x factor in the future standard of living for many Americans. The New York Times (free subscription required) says the cost of insuring a family rose 7.7% last year. That is double the cost from seven years ago. It is also double the rate of wage increases and inflation.

 

Walter Updegrave, senior editor at Money Magazine (and previous guest on my radio show) lays out some of the reasons you should avoid annuities in 3 Retirement Deals You Can Do Without. He gives the sales pitch for equity indexed annuities, IRA rollover annuities and annuity swaps. Then he does a nice job of telling you what the pitch leaves out. (Thanks to Snider Investment Method™ graduate Taylor Stevens for the heads up on this one.)

 

Paul Farrell, of MarketWatch.com, illustrates one of the fundamental problems with investing: we are human. Being human, our brains play all sorts of dastardly tricks on us. One such trick is filtering out information that doesn't support our point of view. We all do it. It is one of the reasons why I say, when it comes to investing, we are our own worst enemy. We think we are being logical when really we make decisions in a totally illogical way, most of the time.

 

If you see something you think would be of interest to other Family CFOs, please pass it on. You can email it to me: kim (at) kimsnider.com. As always, your thoughts on these or any other topics are welcome. Leave them below.

 

Kim Snider, Kim Snider Financial Communications, Chronim Investments and/or Snider Advisors make no representation that the information and opinions expressed are accurate, complete or current. The opinions expressed should not be construed as financial, legal, tax, or other advice and are provided for informational purposes only. Call 866-952-0100 to request the Snider Investment Method™ Owner's Manual, which includes a description of the Snider Investment Method, investment objectives, risks, suitability and other information. Please read and consider carefully before investing. All investments are subject to risk including possible loss of principal.

Ditch your money manager

Everybody focuses so much time and attention on minimizing taxes. But guess what? Taxes aren't the biggest drain on your returns. It's the fees and commissions being collected by those same advisors who are talking about all those nasty taxes. The fact is you'll pay four times more to your fund manager than you will to Uncle Sam in taxes. How, you might ask?

 

This is how: suppose you and your wife don't have any dependents when you reach retirement and you're at that 1 million mark and you decide you can live off $40,000 a year. And suppose the $40,000 is ordinary income so you'll have to take the standard deduction. The government gets around $4000 but your money manager will get four times that amount.

 

You see the fund industry gets about 1.60 percent in expenses from you - the consumer - in order to pay for things like marketing, taxes, tools and the occasional piece of advice. You and your spouse will be paying your friendly fund manager $16,000 every year based on your million dollar portfolio. That's four times what you're paying in federal taxes! And for what? Certainly not for performance since two-thirds of all actively managed funds under-perform the benchmark indexes.

 

Now let's pretend you and your spouse have an investment advisor in addition to your mutual fund manger and he's convinced you to wrap up your retirement assets in a high-commission insurance product like a variable annuity. Remember that expense ratio of 1.60? Well, it could climb to as much as 2.50 percent or more!

 

Now you and your partner are paying an outlandish $25,000 a year to your fund manager and advisor to manage a portfolio that could be managed by you, with better results, for next to nothing. $25K is over HALF of what you've taken out to live on every year. I don't know about you, but retirement is supposed to be fun and engaging and I can have a lot more fun on $65,000 than I can on $40,000.

 

The saddest part is that's about $20,000 more than what you really have to pay. So why do brokers and financial advisors continue to harp on taxes and never on fees? It doesn't take a rocket scientist to figure that one out, does it? It's a canard - a smoke screen - and we fall for it!

 

Now look, I'm not pointing fingers at you. Many of you know that I went from rags to riches back to rags again in less than two years because I didn't know what was going on in my portfolio. Like many of you, I trusted my broker to handle my money partly because I believed he was more qualified than I was to do it. That assumption cost me a whole lot of money.

 

The fastest way to improve the returns in your portfolio without taking on one ounce of additional risk is to lower your fees. The best way to lower your fees is to ditch your money managers. You don't need them, and in spite of what you might think, you don't have to spend countless hours to do manage your own money.

 

Let me know if you agree or disagree. Do you think your money managers are worth what you pay them? Do you really know how much you pay them? Leave your thoughts and comments below.

 

Kim Snider, Kim Snider Financial Communications, Chronim Investments and/or Snider Advisors make no representation that the information and opinions expressed are accurate, complete or current. The opinions expressed should not be construed as financial, legal, tax, or other advice and are provided for informational purposes only. Call 866-952-0100 to request the Snider Investment Method™ Owner's Manual, which includes a description of the Snider Investment Method, investment objectives, risks, suitability and other information. Please read and consider carefully before investing. All investments are subject to risk including possible loss of principal.

Financial Advisor Symposium: Choosing Which Retirement Account to Tap First

Choosing Which Retirement Account to Tap First

2nd Annual Financial Advisor Symposium - Las Vegas, NV

Saturday, April 28, 2006

 

 

David Carter, President, Carter Asset Management, Inc.

 

There is NO one formula that fits everyone's solution.

 

Some Deciding Factors in Choosing Which To Tap First

Qualified accounts and tax sheltered annuities will be taxed as ordinary income

Dividends and long term capital gains are taxed at 15%

Tax on social security benefit

Roth IRA money is not taxable

Is client over 70 1/2 and into required minimum distributions

Is client under 591/2 and taking 72(t) distributions

Clients desire to reduce income for their decedents

Clients desire to leave an estate for charity or heirs

 

Some people are really resistant to taking RMD's but if you look at the tables, the amounts are really very low that you are required to withdraw

 

Fredrick Adkins, CEO, Arkansas Financial Group

 

What's deducted?

What's taxed?

How is it taxed?

 

The problem with tax deferred accounts is they convert long term capital gains and dividends to ordinary income that could be taxed as high as 35% in the top tax bracket. Variable annuities do the same thing. Tax deferral is a "sucker bet"

 

Asset classes that were shunned in the accumulation phase are now favored in the distribution phase.

 

Peter Lynch, years ago, got a lot of press for suggesting that you should never own bonds in an investment portfolio. When you got to distribution, you just took capital gains and lived on those. Anyone who followed that advice was devastated in 2000 - 2002.

 

If you put qualified versus non-qualified on a pie chart and equity versus fixed income on another chart, the closer those two charts match up, the easier distributions are. Ideally you would prefer equities in the non-qualified and fixed income to match up to the qualified.

 

Bond interest is tax neutral - it is taxed the same whether it comes form qualified or non-qualified accounts. (True of Snider Method income as well.) That is not true with equities. Rule of thumb is to take fixed income assets first and move towards equity.

 

Gregory Sullivan, President, Sullivan, Bruyette, Speros & Blayney, Inc.

 

There is a world of difference between a plan that assumes linear returns, in other wrods, just takes the average return and running it out to some estiamted longevity number. In the scenario Greg showed, using the average return, the client could live to 95 and still have 1.2M left.

 

But if you run a Monte Carlo simulation, which takes into account volatility, or non-linear returns, there is a very real possibility that same client could run out of money, even while achieving the average assumed in the linear. As I demonstrate in all my speeches and information sessions, this is the hidden cost of risk.

 

If you simply look at taxes, you may get the wrong answer. It is a broader question than tax. Letting tax rule the decision making could run the client out of money.

 

If you have a $1M IRA and a $1M taxable account, you cannot have the advisor withdraw the fees for both from the IRA. IF the fee was $10K per, and you withdrew $20K from the IRA, $10K of it would be considered a withdrawal. In the other hand, you could take all $20K from the taxable to pay fees on both. It goes one way but not the other.

 

Interesting side note, all three speakers were adamantly opposed to the use of variable annuities.

 

Kim Snider, Kim Snider Financial Communications, Chronim Investments and/or Snider Advisors make no representation that the information and opinions expressed are accurate, complete or current. The opinions expressed should not be construed as financial, legal, tax, or other advice and are provided for informational purposes only. Call 866-952-0100 to request the Snider Investment Method™ Owner's Manual, which includes a description of the Snider Investment Method, investment objectives, risks, suitability and other information. Please read and consider carefully before investing. All investments are subject to risk including possible loss of principal.