If you're considering an insurance product that includes an investment feature, consider the following two examples of why you might want to say no.
Mass Mutual. On Nov. 15, 2012, the SEC sued Massachusetts Mutual Life Insurance Company in an administrative proceeding (an agency process somewhat like a court case, although conducted within the SEC instead of in a court). Mass Mutual settled without admitting or denying the SEC's charges. The essential accusation the agency leveled against Mass Mutual was that it didn't adequately explain to customers how withdrawals from variable annuities under certain circumstances could drain their accounts of value. (See the SEC's press release at http://www.sec.gov/news/press/2012/2012-230.htm.)
Variable annuities involve the customer making periodic payments for a number of years and directing how the money is invested in a tax sheltered annuity. Eventually, the invested amounts can be used to purchase an income stream from the insurance company. The investments may do well or poorly. To ameliorate the potential for poor investment returns, Mass Mutual offered an optional rider that, for an additional premium, gave customers a GMIB, or Guaranteed Minimum Income Benefit. The GMIB guaranteed a minimum value that customers could use eventually to purchase an income stream, regardless of how poorly their investments did.
The GMIB could increase by 5% or 6%, depending on the rider. Mass Mutual capped the level of the GMIB (through a somewhat complex formula). Once the cap was reached, the GMIB wouldn't increase. Mass Mutual also allowed customers to make withdrawals from their annuities before they converted the investment value into an income stream. If they made a withdrawal before the GMIB reached its cap, the withdrawal would reduce the GMIB value (and the value of the invested assets as well), but wouldn't prevent the GMIB from continuing to increase. However, after the GMIB reached its cap, withdrawals would decrease the GMIB and it wouldn't increase the next year. Thus, making withdrawals after the GMIB reached its cap could permanently shrink the GMIB--under some potential circumstances, to zero. According to the SEC, Mass Mutual didn't clearly explain how the GMIB, which might be thought by customers to be a guaranteed minimum value, wasn't guaranteed if the customer made withdrawals after it reached its cap.
Got it? Pretty simple, right? To be sure, after it was nabbed by the SEC, Mass Mutual did the right thing and eliminated the cap on the GMIB. But if you furrowed your brow over the details of this annuity (and we've just summarized them--read the SEC's press release and order cited above for a gorier rendition), you should think twice--and then three times--and then four times--and then five, six, seven and many more times before investing in a variable annuity.
Universal Life. The other example is in today's Wall Street Journal (Nov. 17-18, 2012, P. B9), which reports that low interest rates may require universal life insurance policy holders to pay higher premiums or face the cancellation of their policies. Universal life is a form of permanent life insurance that allows customers to have life insurance coverage for long periods of time (i.e., longer than the perhaps 20 years allowed in term life coverage), often with flexibility in the amounts of the premiums paid. Universal life also has an investment feature, and customers can use money from the investment account to help cover the cost of their life insurance. As customers age, the cost of life insurance coverage naturally increases. But today's low interest rate environment has been detrimental to investment returns, including those of universal life policies. Many universal life customers are facing the need to pay increased premiums, or see a reduction of their life insurance coverage or even the cancellation of their policies. Large numbers of universal life policies were sold years ago, before the Federal Reserve declared war on positive interest rates. So the current low rate environment and its consequences for universal life policies probably come as a surprise to many customers.
Insurance products like variable annuities and permanent life insurance can sometimes put customers into the middle of the complexities of the financial markets. You're subject to many of the same risks as professional investors and traders. But you probably don't have the same level of knowledge, experience, and information as they do. Sophisticated insurance products can be labyrinthine mazes of risk shifting, and it's possible to run into the Minotaur. Traditional insurance, which consists of the pooling of risks, can offer sensible protections. But stick to policies that are easy to understand, because then you'll know what you're getting into. Term life and fixed annuities can be useful for many people. Super dooper, turbo-charged complex insurance products that also invest your savings, pick up your dry cleaning and get the oil changed in your car are to be viewed cautiously, and then skeptically.
Showing posts with label life insurance. Show all posts
Showing posts with label life insurance. Show all posts
Sunday, November 18, 2012
Sunday, September 23, 2012
Costs of Quantitative Easing
The law of unintended consequences haunts economic policy. The Federal Reserve's quantitative easing program, now in its third phase, is meant to provide economic stimulus. However, it also drags on the economy. Let us count the ways.
Reduced Interest Income. Hundreds of billions of dollars of interest income have been lost because of the Fed's longstanding campaign to drive down borrowing costs. Losses of this magnitude undoubtedly have dampened consumer demand. Even though QE likely sprung loose some personal income by providing lower mortgage rates for homeowners to refinance, tight standards applied by banks making mortgage loans have limited the refi impact of lower rates.
Reduced Retirement Savings. As bond yields shrivel up like corn in today's drought-ridden Midwest, many retirements look bleaker. Even though the stock market has boomed, large numbers of shell-shocked savers abandoned stocks after the 2008-09 market crash and haven't participated in the gains. Instead, they ducked into bonds. Although the improbable bond rally of the past few years generated capital gains for many bond holders, the basic return sought by bond investors comes from interest paid. That has been paltry. As retirements look bleaker, many workers cut back on current consumption in order to save more.
Pension Pain. Despite appearances from some recent press coverage, pension funds cannot take large risks, overall, with their portfolios. However much publicity pensions' alternative investments may generate, a large part of pension assets must be invested in high quality bonds. As returns on these puppies shrink, employers corporate and municipal confront the necessity for greater contributions. Workers may be laid off, citizens may receive fewer public services, state and local taxes may be raised, shareholders may endure lower returns, and those workers still employed may have to make greater pension contributions. All of which would further discourage current consumption.
Insurers Backpedal. Insurance companies' returns on their investments are falling. This means policies that depend on long term returns, such as annuities and long term care policies, become more expensive or even impossible to buy. Or else, they offer fewer benefits. Policy holders suffer. Those people who want to provide for themselves, through long term care policies, annuities, whole life and similar products, have a harder time. More people end up having to rely on government programs like Social Security, Medicaid and so on. That's not good in an age of serious federal deficits.
Yield Curve Flattens Bank Incentive to Lend. Back in the days when they made loans, banks would borrow short term (usually through demand deposits, interbank loans via the fed funds market, and savings accounts) and lend longer term. The difference between short term interest rates (historically lower) and longer term interest rates (historically higher) provided profits for the banks. But the yield curve (the graph of interest rates from short to long) has been flattened by the Fed's monetary policies. There isn't that much difference any more between short and long term rates. Potential profitability for banks has been squeezed. Banks have less incentive to lend, and fewer loans means less potential for economic growth.
The Fed has sworn on a stack of printed money to keep short term rates darn near invisible until at least mid-2015. It may achieve some of its objectives. But it will also create unintended consequences. The impact of these opposite reactions to the Fed's actions may be greater than the central bank foresees. There are few real life experiments in economics. But if we look at the most obvious example of the impact of a central bank squashing interest rates for years at a time, we can see that Japan has remained moribund for two decades since its financial and real estate crashes in the early 1990s. The Bank of Japan has ruthlessly stamped out any positive upswings of interest rates in that nation. But that hasn't produced the spark needed to revive Japan's economy.
It now looks like the Fed will keep rates unnaturally low for the better part of a decade. Given Japan's experience, one wonders what is in the Fed's playbook. If it's a sensible fiscal program from Congress and the White House, the next question would be what is the Fed smoking? But if the Fed is acting on the reasonable assumption that we will have fiscal dysfunction for the foreseeable future, only the arrival of Godot, it would seem, would offer reason for optimism.
Reduced Interest Income. Hundreds of billions of dollars of interest income have been lost because of the Fed's longstanding campaign to drive down borrowing costs. Losses of this magnitude undoubtedly have dampened consumer demand. Even though QE likely sprung loose some personal income by providing lower mortgage rates for homeowners to refinance, tight standards applied by banks making mortgage loans have limited the refi impact of lower rates.
Reduced Retirement Savings. As bond yields shrivel up like corn in today's drought-ridden Midwest, many retirements look bleaker. Even though the stock market has boomed, large numbers of shell-shocked savers abandoned stocks after the 2008-09 market crash and haven't participated in the gains. Instead, they ducked into bonds. Although the improbable bond rally of the past few years generated capital gains for many bond holders, the basic return sought by bond investors comes from interest paid. That has been paltry. As retirements look bleaker, many workers cut back on current consumption in order to save more.
Pension Pain. Despite appearances from some recent press coverage, pension funds cannot take large risks, overall, with their portfolios. However much publicity pensions' alternative investments may generate, a large part of pension assets must be invested in high quality bonds. As returns on these puppies shrink, employers corporate and municipal confront the necessity for greater contributions. Workers may be laid off, citizens may receive fewer public services, state and local taxes may be raised, shareholders may endure lower returns, and those workers still employed may have to make greater pension contributions. All of which would further discourage current consumption.
Insurers Backpedal. Insurance companies' returns on their investments are falling. This means policies that depend on long term returns, such as annuities and long term care policies, become more expensive or even impossible to buy. Or else, they offer fewer benefits. Policy holders suffer. Those people who want to provide for themselves, through long term care policies, annuities, whole life and similar products, have a harder time. More people end up having to rely on government programs like Social Security, Medicaid and so on. That's not good in an age of serious federal deficits.
Yield Curve Flattens Bank Incentive to Lend. Back in the days when they made loans, banks would borrow short term (usually through demand deposits, interbank loans via the fed funds market, and savings accounts) and lend longer term. The difference between short term interest rates (historically lower) and longer term interest rates (historically higher) provided profits for the banks. But the yield curve (the graph of interest rates from short to long) has been flattened by the Fed's monetary policies. There isn't that much difference any more between short and long term rates. Potential profitability for banks has been squeezed. Banks have less incentive to lend, and fewer loans means less potential for economic growth.
The Fed has sworn on a stack of printed money to keep short term rates darn near invisible until at least mid-2015. It may achieve some of its objectives. But it will also create unintended consequences. The impact of these opposite reactions to the Fed's actions may be greater than the central bank foresees. There are few real life experiments in economics. But if we look at the most obvious example of the impact of a central bank squashing interest rates for years at a time, we can see that Japan has remained moribund for two decades since its financial and real estate crashes in the early 1990s. The Bank of Japan has ruthlessly stamped out any positive upswings of interest rates in that nation. But that hasn't produced the spark needed to revive Japan's economy.
It now looks like the Fed will keep rates unnaturally low for the better part of a decade. Given Japan's experience, one wonders what is in the Fed's playbook. If it's a sensible fiscal program from Congress and the White House, the next question would be what is the Fed smoking? But if the Fed is acting on the reasonable assumption that we will have fiscal dysfunction for the foreseeable future, only the arrival of Godot, it would seem, would offer reason for optimism.
Wednesday, June 29, 2011
Defensive Financial Planning
One aspect of financial planning that receives little attention is avoiding an unexpected depletion of your assets. It involves dull, boring stuff like insurance and taking care of yourself. Far more exciting are graphs showing the exponential growth of compounded savings and glossy magazines featuring lifestyles of those retirees who planned well. But in financial planning, a good defense can preserve the wealth you took so much effort to build. Consider the following.
INSURANCE. Okay, few things in life are as nauseating as insurance. Most of us would rather see the dentist than review our insurance coverage. But insurance protects our finances when bad things happen.
Health insurance provides the means to get medical care. Health problems, not credit card craziness, are the number one reason why people end up in bankruptcy. Insurance doesn't necessarily prevent bankruptcy, but it makes it much less likely. A good health insurance policy also opens doors at the emergency room, and ensures that you get good care. Your recovery may be faster and you suffer less stress over availability and quality of care.
Disability insurance provides income when you can't work. More often than you might think, people suffer from disabilities. Social Security disability isn't easy to qualify for, and the process takes a long time. Private disability coverage is often easier to qualify for and more generous.
Life insurance protects your family if you're no longer around to provide for them. Not everyone lives to 75, 80 or older. Life insurance feels like the biggest waste of money imaginable, unless your family needs it. Term life is usually the best choice. Permanent, whole, or universal life typically involve high commissions and other costs. Most people are better off buying term coverage and saving for retirement in other financial vehicles.
Auto insurance is required by law, but the amount of coverage you have to buy is often pretty low. Boosting your liability coverage will make sense as soon as you have any sort of respectable net worth. Without good liability coverage, a single accident can wipe out a lifetime of saving.
Homeowners/renters insurance provides liability coverage, and in the case of homeowners coverage, the funds to rebuild if your house burns down. Get a flood rider if there's any significant chance of flooding (and not just from a river, but also from sewer backups and the drainage ditch in the back yard). Buy earthquake coverage if you're in a high risk zone.
Umbrella policy. An umbrella policy provides liability coverage above and beyond your auto and homeowners policies. You can buy protection up to $10 million and perhaps even more. Umbrella coverage becomes a good idea once your net worth reaches a level you wouldn't be embarrassed for others to know about. Remember, a single car accident can wipe out a net worth of $500,000, $1 million or more, even if you have $300,000 of liability coverage from your auto policy. The umbrella policy puts a lot more protection over your head, and is worth thinking about if you start to get attached to your six or seven figure net worth.
Business liability coverage may make sense for those who are self-employed and work in circumstances where a customer or other person might be injured. For example, if you operate a catering business out of your kitchen, buy some insurance that covers the possibility of customers getting food-borne illness from your products. Accidents happen.
MAINTAIN YOUR HEALTH. As mentioned above, the single most common reason for personal bankruptcy is a health problem. Health insurance doesn't cover all expenses, and significant health problems can prevent you from working. Even if your uninsured health care expenses are modest, you still confront the mortgage, grocery bills, gas expenses, etc. So exercise, eat a balanced diet and avoid/quit smoking. Keeping your health as good as possible can make a real difference in your financial well-being.
INSURANCE. Okay, few things in life are as nauseating as insurance. Most of us would rather see the dentist than review our insurance coverage. But insurance protects our finances when bad things happen.
Health insurance provides the means to get medical care. Health problems, not credit card craziness, are the number one reason why people end up in bankruptcy. Insurance doesn't necessarily prevent bankruptcy, but it makes it much less likely. A good health insurance policy also opens doors at the emergency room, and ensures that you get good care. Your recovery may be faster and you suffer less stress over availability and quality of care.
Disability insurance provides income when you can't work. More often than you might think, people suffer from disabilities. Social Security disability isn't easy to qualify for, and the process takes a long time. Private disability coverage is often easier to qualify for and more generous.
Life insurance protects your family if you're no longer around to provide for them. Not everyone lives to 75, 80 or older. Life insurance feels like the biggest waste of money imaginable, unless your family needs it. Term life is usually the best choice. Permanent, whole, or universal life typically involve high commissions and other costs. Most people are better off buying term coverage and saving for retirement in other financial vehicles.
Auto insurance is required by law, but the amount of coverage you have to buy is often pretty low. Boosting your liability coverage will make sense as soon as you have any sort of respectable net worth. Without good liability coverage, a single accident can wipe out a lifetime of saving.
Homeowners/renters insurance provides liability coverage, and in the case of homeowners coverage, the funds to rebuild if your house burns down. Get a flood rider if there's any significant chance of flooding (and not just from a river, but also from sewer backups and the drainage ditch in the back yard). Buy earthquake coverage if you're in a high risk zone.
Umbrella policy. An umbrella policy provides liability coverage above and beyond your auto and homeowners policies. You can buy protection up to $10 million and perhaps even more. Umbrella coverage becomes a good idea once your net worth reaches a level you wouldn't be embarrassed for others to know about. Remember, a single car accident can wipe out a net worth of $500,000, $1 million or more, even if you have $300,000 of liability coverage from your auto policy. The umbrella policy puts a lot more protection over your head, and is worth thinking about if you start to get attached to your six or seven figure net worth.
Business liability coverage may make sense for those who are self-employed and work in circumstances where a customer or other person might be injured. For example, if you operate a catering business out of your kitchen, buy some insurance that covers the possibility of customers getting food-borne illness from your products. Accidents happen.
MAINTAIN YOUR HEALTH. As mentioned above, the single most common reason for personal bankruptcy is a health problem. Health insurance doesn't cover all expenses, and significant health problems can prevent you from working. Even if your uninsured health care expenses are modest, you still confront the mortgage, grocery bills, gas expenses, etc. So exercise, eat a balanced diet and avoid/quit smoking. Keeping your health as good as possible can make a real difference in your financial well-being.
Wednesday, June 6, 2007
Aaaaagh!!!!! Insurance!!
Given a choice between visiting a dentist and buying insurance, most people would opt for the dentist. At least, you can get novocaine for the worst moments.
But if you’re serious about building wealth, it's important to protect yourself from risk. We’re not talking about investment risk. You know that stocks, real estate and other assets can decrease, as well as increase, in value. We’re talking about personal risks, and risks to your property.
What happens to your finances if you’re seriously injured and can’t work for months? What if a guest slips and falls in your home? What if you or your spouse dies, and leaves you to raise the kids alone? What happens if the next Katrina heads your way and turns your house into a pile of kindling? These are all examples of situations that could drain away your savings. How do you protect yourself?
1. Get health insurance. The most common reason people declare bankruptcy isn’t reckless spending. It’s unmanageable medical expenses. If you’re uninsured, do your best to get coverage. Be willing to sacrifice a lot of lifestyle in order to be protected. If you’re uninsured and have a health crisis, you won’t have a lifestyle. If you have trouble finding coverage, contact your state health authorities. Some states have programs to assist residents to get coverage.
Also, take care of your health. Avoiding a health problem is better than treating one, even if you have to eat some fruits and vegetables.
2. Get disability insurance. According to the Social Security Administration, something like 8.6 million workers and their dependents received Social Security disability payments in 2006 (www.ssa.gov/OACT/STATS/OASDIbenies.html). This figure doesn’t include people who received private disability payments, but no Social Security. Disability is a fairly common problem. Look for a policy that defines disability as your inability to work in your field or profession (and, indeed, your specialty within your field or profession). A policy that defines disability as your inability to do any kind of work (flipping burgers, anyone?) doesn’t provide much protection.
3. Get homeowners insurance. Make sure the policy limit is high enough to cover the current cost of reconstructing your home. Also have plenty of liability coverage, in case a guest slips and falls on your property--$300K is not too much. And think about whether you should get optional flood coverage--you don't need a Katrina to have a flooding problem (a sewer backup is all it takes).
4. Bulk up your auto policy. Make sure you have plenty of liability coverage--$1 million is rational in these litigious times. And don’t overlook the property damage coverage. Some luxury cars today cost over $100,000. Having $100,000 of property damage coverage isn’t a bad idea.
4. Consider life insurance. If you have dependents, life insurance may be a good idea. There’s no fixed rule of thumb for how much you need. Add up your other financial resources (savings, Social Security survivors’ benefits, any employer’s benefits for survivors, and your spouse’s income if he or she would work even if something happened to you), and then figure out how much insurance you’d need to get the little ones through college. Increase the amount if you want your spouse to stay home and take care of the kids.
5. Consider an umbrella policy. An umbrella policy provides additional liability protection, above and beyond your auto and homeowners’ policies. You can buy millions of dollars of coverage. It’s a good idea if your net worth is six or seven figures.
6. Consider a long term care insurance policy. This type of insurance covers nursing home expenses and other long term care costs (including some care at home). Medicare doesn’t cover most of these expenses. Medicaid does, but you need to spend down your savings to qualify for Medicaid. Long term care insurance is a way of protecting your savings. It could make sense if you have a six or seven figure net worth. Look for a policy with level premiums and an inflation adjustment in the amount of coverage. This stuff is expensive if you wait until your 60s (we’re talking thousands a year). If it seems to make sense for you, buy as early in your life as you can because it's much cheaper if you start when you're younger.
Okay, enough already about insurance. Here’s the story for your inner artist if you’re thinking of a career change. http://www.cnn.com/2007/SHOWBIZ/05/31/lego.artist/index.html.
But if you’re serious about building wealth, it's important to protect yourself from risk. We’re not talking about investment risk. You know that stocks, real estate and other assets can decrease, as well as increase, in value. We’re talking about personal risks, and risks to your property.
What happens to your finances if you’re seriously injured and can’t work for months? What if a guest slips and falls in your home? What if you or your spouse dies, and leaves you to raise the kids alone? What happens if the next Katrina heads your way and turns your house into a pile of kindling? These are all examples of situations that could drain away your savings. How do you protect yourself?
1. Get health insurance. The most common reason people declare bankruptcy isn’t reckless spending. It’s unmanageable medical expenses. If you’re uninsured, do your best to get coverage. Be willing to sacrifice a lot of lifestyle in order to be protected. If you’re uninsured and have a health crisis, you won’t have a lifestyle. If you have trouble finding coverage, contact your state health authorities. Some states have programs to assist residents to get coverage.
Also, take care of your health. Avoiding a health problem is better than treating one, even if you have to eat some fruits and vegetables.
2. Get disability insurance. According to the Social Security Administration, something like 8.6 million workers and their dependents received Social Security disability payments in 2006 (www.ssa.gov/OACT/STATS/OASDIbenies.html). This figure doesn’t include people who received private disability payments, but no Social Security. Disability is a fairly common problem. Look for a policy that defines disability as your inability to work in your field or profession (and, indeed, your specialty within your field or profession). A policy that defines disability as your inability to do any kind of work (flipping burgers, anyone?) doesn’t provide much protection.
3. Get homeowners insurance. Make sure the policy limit is high enough to cover the current cost of reconstructing your home. Also have plenty of liability coverage, in case a guest slips and falls on your property--$300K is not too much. And think about whether you should get optional flood coverage--you don't need a Katrina to have a flooding problem (a sewer backup is all it takes).
4. Bulk up your auto policy. Make sure you have plenty of liability coverage--$1 million is rational in these litigious times. And don’t overlook the property damage coverage. Some luxury cars today cost over $100,000. Having $100,000 of property damage coverage isn’t a bad idea.
4. Consider life insurance. If you have dependents, life insurance may be a good idea. There’s no fixed rule of thumb for how much you need. Add up your other financial resources (savings, Social Security survivors’ benefits, any employer’s benefits for survivors, and your spouse’s income if he or she would work even if something happened to you), and then figure out how much insurance you’d need to get the little ones through college. Increase the amount if you want your spouse to stay home and take care of the kids.
5. Consider an umbrella policy. An umbrella policy provides additional liability protection, above and beyond your auto and homeowners’ policies. You can buy millions of dollars of coverage. It’s a good idea if your net worth is six or seven figures.
6. Consider a long term care insurance policy. This type of insurance covers nursing home expenses and other long term care costs (including some care at home). Medicare doesn’t cover most of these expenses. Medicaid does, but you need to spend down your savings to qualify for Medicaid. Long term care insurance is a way of protecting your savings. It could make sense if you have a six or seven figure net worth. Look for a policy with level premiums and an inflation adjustment in the amount of coverage. This stuff is expensive if you wait until your 60s (we’re talking thousands a year). If it seems to make sense for you, buy as early in your life as you can because it's much cheaper if you start when you're younger.
Okay, enough already about insurance. Here’s the story for your inner artist if you’re thinking of a career change. http://www.cnn.com/2007/SHOWBIZ/05/31/lego.artist/index.html.
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