The Prosperity Blog

A Financial Powershift Toward Insurance Companies?

The assessment of Dr. Nikolaus von Bomhard, CEO of Munich Re, the world’s biggest reinsurance company, in an October 15, 2008 Reuters article by Christian Kraemer states: “The credit market crisis will shift the balance of power within the finance industry towards insurers and away from banks because insurance companies have a better business model.”

Located in Germany, Munich Re has subsidiaries throughout Europe and North America. After observing the challenges affecting banks and mortgage institutions both at home and abroad, von Bomhard is confident Munich Re “is stable and well-capitalized – despite the market turmoil.” In fact, von Bomhard believes that most insurance companies “will emerge stronger from the crisis.”

According to von Bomhard, there are two reasons insurance companies should continue to survive – and thrive – in tough economic times.

First, insurance companies have a superior track record when it comes to evaluating investment risk. In the Reuters article, von Bomhard stated that many banks’ business models were based on unrealistic profit expectations, and in an attempt to meet those expectations, some institutions took more risks. But because banks did not have appropriate risk management systems in place to accurately assess their investments, they “blindly relied on the judgment of outside credit agencies.”

A second factor that favors insurance companies is what von Bomhard calls “sustainability.” The emphasis for insurance companies is long-term returns within the context of being able to pay claims. “Insurance is a promise for the future,” says von Bomhard. “Its business model is built on fulfilling obligations from insurance contracts on a durable – in other words, sustainable – basis.” In contrast, von Bomhard sees banks as too often oriented toward short-term results.

In an October 8, 2008 press release following the fallout from the financial crisis, von Bomhard said “major losses or crises like the present one are also a test for our business model. And we are passing this test.” While von Bomhard has an obvious interest in trumpeting the strength of insurance companies, his comments have some academic support as well. In his 2006 book Money, Bank Credit, & Economic Cycles, Spanish economist Jesús Huerta de Soto provides the following assessment of life insurance companies relative to banks:

The institution of life insurance has gradually and spontaneously taken shape in the market over the last two hundred years. It is based on a series of technical, actuarial, financial and juridical principles of business behavior which have enabled it to perform its mission perfectly and survive economic crises and recessions which other institutions, especially banking, have been unable to overcome.

By the way: As an example of the way things might be different if this financial shift occurs, von Bomhard said, “In my view, life insurance is going to experience a renaissance because it is secure.” De Soto concurs, calling life insurance “a form of perfected savings.

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Life Insurance

Life insurance isn’t the sexiest financial topic, but as an aspect of risk management, it remains a foundational component in every financial plan. And, in its own way, the life insurance industry has some interesting developments. What follows are three life insurance items worth noting.

Note #1: If you are serious about life insurance, get expert assistance.

The purchase of life insurance is rarely a “once-in-a lifetime” thing. Surveys about customer preferences and behaviors may vary in their specifics (what type of policy was purchased, the amount, etc.) but one aspect of their findings seems constant: People who buy life insurance will buy several policies during their lifetime.

In the industry, a typical comment is that people buy seven life insurance policies during their lifetime. Some of the details of this statement are fuzzy (if you buy a policy on your child, does it count as one of their seven policies, or one of yours?), but even if the number is three or four instead of seven, it still means that life insurance is not a “set-it-and-forget-it” financial decision. However, even with seven policies during your lifetime, it’s not like buying life insurance is something you do on a regular basis. Consequently, many people are less than informed when it comes to the status of their life insurance program. What’s worse, there are indications that some “financial professionals” aren’t much better informed than the typical policyholder.

Errold F. Moody, Jr., operates and maintains what he claims is “the largest and most comprehensive planning site on the Internet” (www.efmoody.com). For more than two decades, Moody’s major interest has been “individual fee financial planning.”  It is Moody’s contention that the best way to retain the services of a financial professional is by paying for their advice as opposed to buying their products. Except when it comes to life insurance. Moody observes that many fee-based planners don’t seem to know much about insurance. Besides personal experience, he quotes a 1999 Journal of Financial Planning article which stated:  “…many planners were not looking at, or least not emphasizing enough, the entire area of risk management – not just life insurance, but also disability, health, long-term care and liability coverage.”

Moody follows with some commentary of his own. (As you read this, keep in mind that for the past 22 years, Moody has been a professor at the University of California at Berkley and Irvine, taught classes for Professional Designation in Financial Planning, and from 1995-2004, he was an Insurance instructor for various licenses and continuing education programs.) “Insurance is, in my mind, one of the most difficult of all planning areas. While it is easy to get information about mutual funds and other investments from the likes of Morningstar or Value Line, it is almost nigh on to impossible to obtain objective and intensive analysis of a life insurance product. Therefore, since the analysis is hard, and since very few planners have the capability to do such analysis, they simply have decided to effectively eliminate planning for that area in total. Therefore, while somebody may have limited the conflict of interest in regards to commission, they simply have paid an hourly or flat fee for an incompetent, unknowledgeable adviser who has effectively breached its fiduciary obligation to a client.”

Thus, Moody concludes the only effective way to buy life insurance is from a knowledgeable agent. Moody acknowledges that “while it is unquestionably true that commissions can taint the planning process, it is not a universal fact.” The real issue is the financial professional’s knowledge of insurance, their ability to accurately transmit that information to the consumer, and then deliver the appropriate products. Because of the variety and complexity of insurance contracts, you need to work with someone who is immersed in the business.  And the most likely “expert” is an insurance agent, commissioned or not.

“The problem is that no matter what you think of insurance, past problems, future difficulties, etc., risk management still is a mandatory element of financial planning.” – Errold Moody

Note #2: Guess who’s buying life insurance?

People over 70. Here’s something that actuaries might not have anticipated: Increasing numbers of people over 70 are buying more life insurance.  According to its PR material, Towers Perrin is “a global professional services firm that helps organizations improve performance through effective people, risk and financial management.” One of the reports that Towers Perrin produced in 2005 was the Tillinghast Older Age Mortality Study (TOAMS), which uncovered interesting trends in the use of life insurance among older individuals. In February 2008, Tower Perrin released TOAMS 2, and the updated data was, in a word,
“overwhelming.”

Quoted in a February 12, 2008 Business Wire release, Mike Taht, a principal at Towers Perrin noted “an overwhelming increase in sales activity at the very high issue ages. ” Specifically, Taht reported that “…for some companies, sales at issue ages over 70 represent 30% of all universal life premiums sold – a statistic unheard of five years ago.” Other research from TOAMS 2 found that 2007 life insurance sales were up 4.3% over 2006 for ages 60 and older, while sales among the 45 to 59 age group declined. The TOAMS 2 suggested that this significant increase in older individuals owning life insurance could compel insurers to adjust their prices, underwriting practices and mortality assumptions.

Why are older people buying more life insurance?

Some possible answers:
Greater longevity = lower prices. Many life insurers have repriced their products (or developed new ones) based on longer life expectancies. This has resulted in more affordable premiums at higher ages. Reality turns out to be different than theory. Remember the conventional financial wisdom that says most people don’t need life insurance in their old age? It turns out people either want or need life insurance in their “golden years,” for a variety of reasons. Their retirement resources (pensions, investments, etc.) may not be as great as anticipated. Rising health care costs, especially those from a final illness, may put surviving family members at financial risk. There may be a desire for certainty and guarantees in inheritance bequests or the settling of other financial issues – and life insurance is particularly well-suited to meet these objectives.

The emergence of life settlements as an alternative final transaction.

Through life settlements, policy owners have a secondary market for their life insurance policies – they don’t have to be held until death for there to be a payoff from the insurance benefit. Although some forms of life settlement have come under ethical and legal scrutiny, there are plenty of legitimate and creative ways for policy owners to leverage the financial value of a life insurance policy before one’s death.

Note #3: A Presidential Campaign rescued by a life insurance policy?

In the fall of 2007, Senator John McCain’s presidential campaign was in serious financial
trouble.
Just months away from the start of presidential primaries, McCain was broke. Laying off staffers and abandoning his quest for the Republican Party nomination seemed inevitable. So the McCain campaign, like many other struggling enterprises, went looking for a loan. In November, the Fidelity & Trust Bank of Maryland lent McCain $3 million.  According to a February 14, 2008 Wall Street Journal editorial, “there’s no doubt the November cash infusion helped Mr. McCain survive long enough to compete and win in New Hampshire (one of the early state primaries), and ultimately to become the GOP’s presumptive nominee.”

It is not unusual for candidates for elected office to borrow to finance their campaigns. But what got the attention of the Wall Street Journal was the collateral McCain offered in exchange for the $3 million.  According to the Journal, it was McCain’s demonstrated ability as a fund-raiser that convinced the bank he was worth the money – regardless of whether he would eventually win the nomination. But in addition, The Journal noted that “Mr. McCain also put up a life insurance policy and other campaign assets.” Although the article provided no further details, the essence of the transaction could be evaluated thusly: Fidelity & Trust was banking on McCain’s unique personal ability to raise money – and on the policy that insured his life.

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One of Those Details That Needs Regular Attention

Perhaps you noticed an item from the week of December 3, 2007 that appeared in the major wire services…

A wealthy London widow who had outlived both her husband and lone son, repaid the kindness shown to her by a family that owned a Chinese restaurant by leaving them a $21million inheritance. The woman, Golda Bechal, had stated in a 1994 will that she wanted Kim Sing Man and his wife, Bee Lian to be the beneficiaries of her estate upon her death.

Sad and alone following the deaths of her husband and son, Ms. Bechal became close friends with the couple that operated a Chinese restaurant in her neighborhood. The three of them not only met regularly at the restaurant and Ms. Bechal’s apartment, but also traveled together on vacations to other countries. When Ms. Bechal died at age 88 in January 2004, her five nephews and nieces contested the will, asking the British courts to declare it invalid, claiming Ms. Bechal suffered from dementia. However, after more than three years of deliberations the court awarded the inheritance to Kim Sing Man and his wife, saying, “it was not irrational to leave the bulk of her estate to Mrs. Man, the daughter she would dearly wished to have had, and her husband.”

You may never have $21 million to pass on, but the above story illustrates the challenges of settling an estate, especially when significant assets are involved. While it is possible to contest almost every will, there are several things you can do to make it less contestable.

Have it drafted by a professional. A hand-written will, although it may be valid, is not recommended. A handwritten will is called a “holographic will.” It is valid in about 25 states so long as all material provisions and clauses are entirely handwritten. However, because most handwritten wills are not as in-depth as a professionally drafted will and because they are oftentimes not properly written, they are not recommended. Courts can be unusually strict in determining whether a holographic will is authentic.

Have all changes and updates prepared by a professional. A will may often contain a provision or schedule, listing specific assets and their intended beneficiaries. Some people may try to amend this section by hand at a later date. In general, any handwritten annotation is much easier to challenge, even if witness signatures are present. Revisions (generally called codicils or amendments) should be made with the same care and attention to procedure as was given the original document.

Make a will review a regular part of your financial check-up. If it’s on the list, you’ll get used to doing it. If you do it regularly, it won’t take much time.

Checklist:

  • Have your will drafted by a professional.
  • Have all changes and updates prepared by a professional.
  • Make a will review a regular part of your financial check-up.
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Financial Pep Talk ('cause you might need one right now)

Remember Eeyore? You know, the pessimistic, depressed, grey donkey from the “Winnie the Pooh” stories? (If you do, you’re probably trying to impersonate Eeyore’s voice from the Disney cartoons, aren’t you?) From Eeyore’s perspective, things were always heading for disaster. Even when things were looking up, Eeyore was sure that it was only setting the stage for something worse.

As you read the financial headlines, there are moments where you might wonder if everyone writing or speaking about financial topics had suddenly become Eeyores. All the bad news means only more bad news: rising oil prices, dropping stock market values, defaulting mortgages, declining earnings, downsizing companies and outsourcing jobs. As Eeyore might say, “Oh my, it’s all bad news. ”When the bad news starts to cascade, it seems the conditioned response is to adopt a bunker mentality – pull back, pull out and hole up. Cut your losses, cut your expenses, cut up your credit cards. But maybe now is not the time to cut and run.

Read this excerpt from “Killing Sacred Cows” by Garrett Gunderson:

I’m constantly amazed at how much financial advice I hear boils down to cutting expenses. Now, am I saying that cutting expenses is inherently bad, or that it is not useful in the proper context? No. But to enjoy better results, instead of asking, “How can I cut my expenses” we should ask “How can I be the most productive in this moment?”

How can I be most productive in this moment? Isn’t that a good question on which to base your financial decisions?

Much of the macro-level economic fallout is the result of poor decisions by institutions and large groups of individuals. But if you’ve been making good financial decisions, it’s possible you are well-positioned to take on some outstanding opportunities – at very favorable prices.

If that’s the case, now is the time to act, not pull back. Even if some of your financial
history isn’t that great, are your problems going to be solved simply by tightening your
belt? Put it this way – what’s going to pay off that home-equity loan faster – an extra
$100 each month, or a $1,000 increase in monthly income? As Gunderson says, “we
should produce more than we consume, and the best way to do that is usually to focus
more on increasing our production as opposed to focusing on decreasing our consumption.”

How can I be most productive in this moment?
When you first process that question, you may think of it primarily in terms of generating more income through your work, business, or investment opportunities that you already know about. But answering the question doesn’t have to be a solo project. Now might be the ideal time to ask the financial professionals that serve you for their insights as well.

An old Hebrew proverb says there is wisdom in a multitude of counselors. So it seems logical that having two or three other people helping you become more productive can only work to your benefit.

The economic bad news you hear and read shouldn’t be dismissed; some things are not going well, some companies are in trouble, and some people are struggling. But while economic bad news may give you information to adjust the specifics of your financial circumstances, it shouldn’t change your outlook.

Whatever the situation, the best response is:
How can I be most productive in this moment?

“PRODUCTIVITY TRUMPS ACCOUNTING”

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The Ugly Math of One Bad Year

Here’s an easy riddle:

Up.
Down.
Down some more.
Up.
Down in a hurry.
Up.
Up again.
Down, then up in the same day.

Who am I?

    • A) A Bipolar mood disorder

 

    • B) The stock market

 

    • C) A roller coaster

 

    • D) All of the above

    Those answering A) may want to consider professional help. Those answering C. are having more fun than the rest of us. But for all those who quickly identified with B., keep reading. You may not be aware of the exact numbers, but you probably understand stock markets have been somewhat erratic in the past few months. They move up, they move down; there’s no significant trend. Combined with the fall-out from the sub-prime mortgage situation, some people warn that investors may be on the verge of sustaining some substantial losses.

    Historically, loss would not be an unusual occurrence. Recessions, depressions, and bear markets have been a regular part of the financial landscape just as much as upward trends, booms and bull markets. History suggests that even with the ups and downs, the long-term returns are worth it so we have been conditioned to accept some losses along the way. But that doesn’t mean that financial losses from any financial decision are trivial things. Losing money is a concept that perhaps doesn’t get as much attention as it should in financial programs, but in many ways, the losses you incur may have a greater impact on your total wealth than the gains you make. There are a number of mathematical examples to illustrate this idea.

    Here’s a simple illustration.

    Suppose you have $10,000 in some non-guaranteed financial vehicle (i.e., the account values may fluctuate). For three years in a row, the account delivers a 10% annual return. At the end of the third year, your account would have grown to $13,280. Here’s the progression:

    Beginning balance: $10,000 Annual Return
    End of Year 1: $11,000 + 10%
    End of Year 2: $12,100 + 10%
    End of Year 3: $13,310 + 10%

    So far, so good. But let’s assume that in the fourth year you experience a loss, which while not desired, was not wholly unexpected. The loss is 10%. Your account balance drops to $11,979.

    Beginning balance: $10,000 Annual Return
    End of Year 1: $11,000 + 10%
    End of Year 2: $12,100 + 10%
    End of Year 3: $13,310 + 10%
    End of Year 4: $11,979  (10%)

    Three out of four years you gained 10%, right? But consider the impact of the one bad year: The average annual return was more than halved. Through the first three years, the average annual return was 10%. But the one bad year reduces the average annual return for the four-year period to just 4.62%! In order to get back to averaging 10% a year, your investment must earn over 34% in the fifth year! Look at the math. Here’s what comes from five years of steady 10% annual returns:

    Beginning balance: $10,000 Annual Return
    End of Year 1: $11,000 + 10%
    End of Year 2: $12,100 + 10%
    End of Year 3: $13,310 + 10%
    End of Year 4: $14,641 + 10%
    End of Year 5: $16,105 + 10%

    But if there’s a blip in the fourth year, making up for it in one year requires a steep increase.
    Beginning balance: $10,000 Annual Return
    End of Year 1: $11,000 + 10%
    End of Year 2: $12,100 + 10%
    End of Year 3: $13,310 + 10%
    End of Year 4: $11,979  (10%)
    End of Year 5: $16,111 + 34.5%

    Even if you don’t try to recover the loss in one year, it would take six years of earning 13.5% each year to average 10% for 10 years, all because of one bad year.
    Beginning balance: $10,000 Annual Return
    End of Year 1: $11,000 + 10%
    End of Year 2: $12,100 + 10%
    End of Year 3: $13,310 + 10%
    End of Year 4: $14,641 + 10%
    End of Year 5: $16,105 + 10%
    End of Year 6: $17,716 + 10%
    End of Year 7: $19,487 + 10%
    End of Year 8: $21,436 + 10%
    End of Year 9: $23,579 + 10%
    End of Year 10: $25,937 + 10%

    Beginning balance: $10,000 Annual Return
    End of Year 1: $11,000 + 10%
    End of Year 2: $12,100 + 10%
    End of Year 3: $13,310 + 10%
    End of Year 4: $11,979  (10%)
    End of Year 5: $13,626 + 13.5%
    End of Year 6: $15,500 + 13.5%
    End of Year 7: $17,631 + 13.5%
    End of Year 8: $20,055 + 13.5%
    End of Year 9: $22,813 + 13.5%
    End of Year 10: $25,950 + 13.5%

    In the conventional paradigm, the opportunity for increased return comes with increased risk. Thus, you could argue that increasing your annual return to 13.5% from 10% means increasing the risk by 35%. Remember, this is all the result of one bad year! Frankly, there’s very little market appeal to loss prevention. High rates of return grab headlines. (In today’s economic climate, how interested would you be in an accumulation vehicle that averaged only 4.62% over four years?) But if you really care about maximizing your wealth, you should expend some planning energy on avoiding losses. The fewer setbacks, the less you have to catch up.

    If you’d like to work with advisors who understand the importance of not losing money, contact Partners for Prosperity today. We never knowingly put our clients dollars at risk! Investors who work with us aren’t glued to stock market reports and staying awake at night, because we utilize alternative investments and proven guaranteed, accelerated saving solutions.

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  • Outside-the-box Idea: Using 72(t) to make an "asset transfer"

    For those who have most of their savings in tax-deferred retirement accounts, but are intrigued by the idea of buying a retirement home now, there may be a tax-effective way to execute the transaction. Internal Revenue Code IRC Section 72(t) allows individuals to access their IRA accounts penalty-free at any time if the withdrawals are taken as a series of substantially equal periodic payments over the life of the participant. This means you can begin drawing a regular stream of “retirement income” from your IRA at any age. While the income received is taxable, no additional penalty tax is applied.

    In order to be considered “substantially equal periodic payments,” the distributions must meet the following criteria:

    • Withdrawals must be on a regular basis, most often monthly, and at least annually.
    • Withdrawals must conform to one of three IRS approved calculation methods.
    • Withdrawals must continue for at least five years or until you reach 59½, whichever is longer.

    Depending on the size of your IRA and the cost of the property, these monthly distributions could be used to make the mortgage payment on the vacation home. For many individuals, the additional IRA income may largely be offset by the tax deduction for the additional mortgage interest paid, especially in the early years of the mortgage. The end tax result: more taxable income to report, but also more tax deductions.  By spending some of the IRA now, you lose the growth that could have occurred if the money had stayed in the account. But in this example, the IRA distributions are being used to build equity in the new home. Overall, your net worth is still growing, only the growth is in home equity instead of the IRA. And instead of delaying gratification, there’s some immediate enjoyment.

    Note: Not all tax-deferred retirement plans allow for 72(t)-type distributions. Additionally, the calculations required to be sure this “early retirement income” conforms to the law are complex. Do not attempt a distribution of this type without seeking some expert assistance.

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    Using a Reverse Mortgage to Stop Foreclosure

    Reverse mortgages are touted as a way for elderly retirees to create additional income by
    borrowing against the equity in their homes without having to take on another payment.

    Instead, the amount borrowed by the homeowner is due only when the home is sold, or the borrower dies. Since the terms of a reverse mortgage are based in part on the age of the borrower (the older the borrower, the more favorable the deal), a reverse mortgage can be a profitable strategy for supplementing one’s retirement lifestyle.

    But a December 26, 2007 Wall Street Journal article turned up another use for reverse mortgages: Staving off foreclosures for senior citizens, especially those whipsawed by declining or fixed incomes and rising payments from adjustable rate mortgages. The strategy, used by an increasing number of legal-aid advocates, isn’t suitable for everyone. But in the right circumstances, it can be a financial life-saver. A typical scenario: A senior couple with significant home equity needs cash. Attracted to the favorable terms of an adjustable-rate mortgage (low initial interest rate, minimum payment options), they take on a new mortgage, one they can theoretically afford. Over the next few years, interest rates increase and so do monthly payments. Perhaps because of health issues, increased living costs, or decreased income, the seniors find themselves unable to meet the mortgage obligation, and facing foreclosure. Even though they cannot meet their monthly mortgage obligation, the couple still has substantial equity in their home. With the assistance of a reverse-mortgage expert, the couple uses the remaining equity to negotiate a settlement on the existing mortgage. While they receive no cash out from this arrangement, the settlement eliminates the monthly mortgage payment, and keeps them in their home.

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