Tuesday, August 28, 2012
An annuity product is a formal contract promising a certain payment stream. Simply, for a price, you can buy a specified stream of payments, usually from an insurance company. You trade a lump sum (or, in some cases, multiple payments) for a promised payment stream. The stream could be a specified number of years or it could be your “lifetime.” In fact, it is often your “lifetime” and/or the “lifetime of your spouse.” Sometimes, the amount is decreased to your surviving spouse.
The issuer of an annuity – usually an insurance company or pension plan - faces a lot of uncertainty. An actuary is a trained mathematician in these specialized calculations. He or she looks at your age and gender to estimate how long you (and/or your spouse) will live. Once they estimate the duration of payments, they estimate the investment pool necessary to pay them. Today’s retirement lifespan can last 30-35 years, and that’s a lot of uncertainty.
To protect the issuer, an actuary needs reliable estimates for both longevity and investment earnings. If they pay you too much or too long, then the issuer loses money. For a pension plan, this mistake means that the company sponsor will need to add more money to the plan. For an insurance company, that deficit comes out of reserves or profits. Neither of these options are acceptable, so actuaries tend to be (need to be) conservative in making estimates.
What’s this mean to you or me? Partly, it means that we are likely to do better than those estimates. Estimates are necessarily based on the conservative end of a conservative spectrum of investment returns. That’s how actuaries protect the issuer.
There’s a strong chance we can do better. Why? First, we can use a broader pool of investments for our portfolio. Second, we can adjust the portfolio as conditions change (the actuary has to estimate the future today). Third, there’s no margin built into our model for insurance company profit.
In the end, the residual of these factors – any amounts accumulated over the above the actuary’s estimate – may be passed on to our beneficiaries. Remember, most annuity products are exhausted after the annuitant (or annuitants) dies. There is no surplus to the buyer when an actuary overestimates longevity or underestimates investment returns.
That brings up another really important point. An annuity’s stream of payments is inflexible. Should an emergency – or an opportunity – arise, there is no way to interrupt the payment stream. This lack of flexibility is a huge issue for today’s typical retirement horizon.
Another related point is that inflation wreaks havoc on long-term annuity payments. Think back to your salary in 1987. Would you like to live on that amount today? Could you live on that amount today? Now, leap ahead to 2027; how much will today’s monthly annuity payment buy in tomorrow’s world? Avoid any annuity product that doesn’t include an annual Cost of Living Adjustment (COLA). It will reduce the early payments, but add genuine value down the road.
My last point is also important. Don’t buy an annuity product without comparing prices. Every insurance company uses their own actuaries and estimates. These can vary quite a bit at any point in time. Any buyer, especially those with larger sums to invest, should seek quotations from several highly-rated insurers. Most local insurance agents represent just one company, and I’d always recommend a second opinion before buying.
Dan Danford, CFP® is Principal/CEO of Family Investment Center in St. Joseph, MO. The firm offers commission-free investment services for families, businesses, and nonprofit groups.
Tuesday, August 21, 2012
Recent years seem to have brought more bad investment news than good, so it’s nice to enjoy some positive markets. Sometimes we have to remind ourselves that good years are normal and that recent bad years are abnormal!
Bob Siemens, one of my early mentors, used to remind us that a market bottom is the “point of maximum pessimism” and that a top is a “point of maximum optimism.” He also used to say that a rising market “climbs a wall of worry.”
I share these thoughts because I’m fairly confident we have passed the point of maximum pessimism, and that 2012’s stock market is certainly climbing a wall of worry. Both points create some enthusiasm for investing over the next few years.
What about the presidential election? What about the Federal Reserve’s artificial low interest rates? What about the European debt crisis? What about geopolitical issues in the Middle East or Asia or Africa? Troubling, all, but not devastating for investors.
The most influential factor for investors today is noise. Stupid, senseless, loud, relentless, and insulting market noise. You can’t escape it and it creates a false sense of urgency about finance and investing. Noise blares from every television, computer, magazine, newspaper, and billboard. There’s a Crisis Everywhere … crisis … crisis … crisis. Mostly, it’s absurd.
Stop the madness! We are going to continue doing what has worked best in the past and we expect it to put money in our collective pockets. Our process and policies are based on facts, studies, and proven techniques. We aren’t responding to crises, or whims, or screeching monkeys on television. We are carefully selecting managers and/or securities to meet the specific needs of your portfolio and family.
Our promise when we started in 1998 was simple. We would invest client money using the same principles, strategies, securities, and safety that we use for ourselves. In other words, we treat your family in exactly the same way we treat our own. It’s still true and it’s still our promise.
Our goal in 1998 was also simple. We wanted to build the premier investment management firm in this region. Frankly, we welcome your questions and ideas. Anyone on our team will be pleased to talk with you by telephone, email, or in person. We are proud to serve your family, and we are happy to explain things or discuss alternatives. Every discussion makes us better!
Monday, August 13, 2012
With many parts of the world experiencing financial crisis, what has backed the money for all these years?
In the video below, Dan Danford, CFP®, Founder and Chief Executive Officer of Family Investment Center, explains what is backing our currency, the currency of other nations, and why it all doesn't just fall apart when countries face perilous economic issues. Danford also addresses the functions of monetary and fiscal policies, which were created to help in times of a financial crisis.
Tuesday, August 7, 2012
An interesting article was published recently addressing the security of traditional pension plans. Liz Weston's MSN Money article "Is Your Pension Safe" provides some eye-opening statistics:
• Nearly 80% of the private pension plans covered by the Pension Benefit Guaranty Corp., or PBGC, are underfunded, to the tune of $740 billion. The news is even worse among the nation's largest companies. Only 18 defined benefit pension plans offered by companies in Standard & Poor's 500 benchmark are fully funded.
• More than 1,400 companies shut down their pension plans in fiscal year 2011, compared with 1,200 in 2009, according to the PBGC. An additional 152 plans failed, meaning they were terminated without enough money to pay promised benefits and were taken over by the PBGC. The PBGC itself, which is funded by employer-paid insurance premiums, is running a $26 billion deficit.
• Public pension funds are underfunded by at least $1 trillion, according to a report by the State Budget Crisis Task Force. To close the gap, 35 states have reduced pension benefits for their employees, and half have increased worker contributions to their plans, according to a report released in March by the U.S. Government Accountability Office. Three states -- Georgia, Michigan and Utah -- have implemented hybrid plans that include defined contribution plans, similar to 401k's, that shift some investment risk to workers.
• Even fully funded retirement plans aren't exempt. General Motors, once considered the model for running a solid pension plan, shocked its salaried retirees by announcing it was offloading their pensions to Prudential Financial. About 42,000 retirees had to make the difficult decision whether to take a lump-sum settlement or trust Prudential to send them monthly checks.
Most importantly, Weston discusses what pension participants need to know to protect their benefits, some of which include personal savings in addition to the pension, the extent to which many benefits that have already been earned are protected, and the need to closely monitor the plan. Click here to read the entire article.