Smart guys question 4% SWR strategy

[Independent]

As I had explained, it's a comparison. In the case of financial difficulties, the insurers may still claim from the reinsurers, whereas most other private companies do not have this additional layer of protection.

You've said a couple things I can agree with. One is that insurers can use mortality pooling to add value to people who want income for exactly as long as they live. Another is that some retirees might benefit from a planning strategy that separates their spending into "needs" and "wants", and then target a very high probability of success for the "needs", while going further out on the risk/return curve when funding the "wants". (That's my re-wording of the strategy that I think you're promoting.) Those comments make sense to me.

But I've disagreed with statements like the quote above.

I've pointed out that typical reinsurance contracts don't make payments because of "financial difficulties". If there is a general recession with a lot of bond defaults, causing stress for insurers who have invested in bonds, reinsurance payments don't suddenly go up. Insurance companies can buy credit insurance just like anybody else, but reinsurance doesn't give them something better.

I'll try an analogy. If a manufacturer has factories in one country but sells a lot in other countries, it will have some currency risk. It might hedge this risk with some sort of currency derivatives. Suppose it wants to issue public bonds and get a bond rating. The rating agency will note that it has this currency risk, then look at the hedging program. The hedging will be recognized as part of the rating.

A bond salesman who says "This company is actually stronger than its rating, because it has a currency hedging program." is misleading the customer. He's implying that the rating agency ignored the hedging program.

I understand that ratings aren't perfect. But any insurance salesman who says "This company is actually stronger than its rating because it has reinsurance programs." is misleading the customer. The salesperson is in no position to claim that the rating agency isn't using the reinsurance in its rating, but that's what he is saying.


On the CPI issue, I made that comment before I realized that you aren't in the US. Here in the US, we not only have CPI-linked bonds, but also CPI-linked annuities (see the Vanguard site). In fact, in the US everyone already has a CPI-linked annuity through Social Security. A financial adviser who thinks a client might be a candidate for a private SPIA should first recommend that the client maximize his/her SS monthly income by deferring the benefit start date. It's plausible that a lot of people who agree with your strategy of having a solid base of "insured income" would conclude that SS meets that need.

 

[brewer12345]

I understand that ratings aren't perfect. But any insurance salesman who says "This company is actually stronger than its rating because it has reinsurance programs." is misleading the customer. The salesperson is in no position to claim that the rating agency isn't using the reinsurance in its rating, but that's what he is saying.

I'll go you one further. Not infrequently, companies with lots and lots of reinsurance are actually weaker credits than those with less. Why? Because the heavily reinsured company is using reinsurance to make up for the fact that they don't really have the necessary equity capital to support all of the business they have written. If something happens or they have a dispute with one or more reinsurers, it often isn't pretty.

 

[AdventuresAddict]

You've said a couple things I can agree with. One is that insurers can use mortality pooling to add value to people who want income for exactly as long as they live. Another is that some retirees might benefit from a planning strategy that separates their spending into "needs" and "wants", and then target a very high probability of success for the "needs", while going further out on the risk/return curve when funding the "wants". (That's my re-wording of the strategy that I think you're promoting.) Those comments make sense to me.

But I've disagreed with statements like the quote above.

I've pointed out that typical reinsurance contracts don't make payments because of "financial difficulties". If there is a general recession with a lot of bond defaults, causing stress for insurers who have invested in bonds, reinsurance payments don't suddenly go up. Insurance companies can buy credit insurance just like anybody else, but reinsurance doesn't give them something better.

I'll try an analogy. If a manufacturer has factories in one country but sells a lot in other countries, it will have some currency risk. It might hedge this risk with some sort of currency derivatives. Suppose it wants to issue public bonds and get a bond rating. The rating agency will note that it has this currency risk, then look at the hedging program. The hedging will be recognized as part of the rating.

A bond salesman who says "This company is actually stronger than its rating, because it has a currency hedging program." is misleading the customer. He's implying that the rating agency ignored the hedging program.

I understand that ratings aren't perfect. But any insurance salesman who says "This company is actually stronger than its rating because it has reinsurance programs." is misleading the customer. The salesperson is in no position to claim that the rating agency isn't using the reinsurance in its rating, but that's what he is saying.


On the CPI issue, I made that comment before I realized that you aren't in the US. Here in the US, we not only have CPI-linked bonds, but also CPI-linked annuities (see the Vanguard site). In fact, in the US everyone already has a CPI-linked annuity through Social Security. A financial adviser who thinks a client might be a candidate for a private SPIA should first recommend that the client maximize his/her SS monthly income by deferring the benefit start date. It's plausible that a lot of people who agree with your strategy of having a solid base of "insured income" would conclude that SS meets that need.

Hi, before I reply, let's read an interesting article regarding how the 'regulation' layer of assurance plays a part in ensuring the continuity of s reinsurer during potential crisis (not necessarily due to stock market crash):

Reinsurance crisis may spark more takeovers - Jacksonville Business Journal:

Monday, July 17, 2006
Reinsurance crisis may spark more takeovers

Jacksonville Business Journal

Florida regulators are warning that Florida Select Insurance Co. might be just the first of several property insurers they will take control of this summer because of reinsurance problems.
Following last year's heavy losses on hurricanes, many reinsurance companies that share risk with insurers are offering less coverage or are raising rates on insurers' residential and commercial property business in Florida.
On June 30, the Florida Office of Insurance Regulation received a state court order to put Sarasota-based Florida Select Insurance Co. into rehabilitation and a receivership under the Florida Department of Financial Services.
Florida Select, the state's 20th largest home insurer, has about 70,000 homeowners' policies.
As of July 11, the DFS was allowing Florida Select to renew policies, but not write new ones.
The OIR is monitoring several other insurers that, like Florida Select, do not have sufficient reinsurance to help pay potential claims if hurricanes cause damage to properties they insure, OIR spokesman Bob Lotane said.
He would not provide a number of companies or any names. The OIR has licensed and approves rate increases for about 150 companies that write homeowners insurance.
State laws permit the OIR to ask for receiverships for insurers that do not have adequate reinsurance, in addition to capital, in relation to their premiums and the insured value of policies.
The OIR usually will give companies "some slack" when quarterly deadlines pass and grant them several extra weeks to renew reinsurance contracts or sign new ones, Lotane said.
But when hurricane season began June 1, the OIR decided to strictly enforce that rule for at least several months.

The above is a real story of how the regulators would take action whenever they detect some potential problems.

Regarding my point that reinsurer may indeed decrease the risk of loss of annuity payout, let me use a simple illustration which I think makes things easier to understand. Again, I am comparing this Annuities Portfolio described vs Balanced Portfolio (including stocks and bonds to derive SWR) for the Survival Income portion.

A typical annuity-issuing insurer would be reinsured by a few reinsurers. This makes the nature of risk----carrier-risk-----diversified. For example, at a customer's level, his annuity may be divided into 5 proportional parts insured by the original insurers and 4 other reinsurers. And since each individual reinsurer must again be regulated, it makes the scenario in which the insurer itself plus all the reinsurers it's reinsured with being unable to honor the retirement income payout less likely. Less likely not than risk-free govt Bonds, but than the Balanced Portfolio which consists of these:
1) big-cap stocks
2) small-cap stocks
3) emerging mkt stocks........
4) govt bonds
5) corporate bonds.......

Let's understand that financial crises happen at different levels. What you mentioned is the worst case one, which does not occur so often. But even if it occurs, the regulators are likely to step in to make a decision that is fair all all sides.

During a crisis like the above, the regulators of insurance may take over the insurers and reinsurers temporarily or they may make some new rules, etc. But for most other private companies, the regulators would just allow the directors to do the insolvency paperwork if they want. With the Diversified Annuities Portfolio, the additional benefit is that our portfolio is protected with an additional layer of regulators' protection from Swiss, Singaporean, etc regulators. I'd heard that, in Switzerland, not a single insurer had failed to meet its obligations for 150 years (that's longer than any living human being's lifespan)!

 

[cute fuzzy bunny]

I hope you guys are cutting and pasting this stuff and not typing it all out by hand...

 

[Nords]

I hope you guys are cutting and pasting this stuff and not typing it all out by hand...

I was just thinking that we're gonna have to bring back the 5000-word limit to posts.

Wasn't it Peter Lynch who said that you should be able to explain a concept [-]in posts of less than 1000 words[/-] on the back of a napkin-- otherwise it's not worth risking your money?

 

[cute fuzzy bunny]

So I guess the penultimate investment would be in napkins?

"There...thats it!"

 

[W2R]

This has been done. One name is "assumption reinsurance". See assumption reinsurance Note that it's "uncommon", not the typical type of reinsurance.

You may be wondering because you remember news stories from some years ago. There was a flurry of activity in which companies were transferring the direct policyowner liability without the policyowner's approval. This seemed wrong for exactly the reason you mention.

I believe that regulators got involved and started requiring policyowner approval. Since some people would always say "no", that made the transaction less attractive.

Good! Thank you. I can understand why the policyowner would not approve, if he had spent time carefully selecting a company that he thought would still be solvent (and exist) in forty years. This is reassuring.

 

[Independent]

Hi, before I reply, let's read an interesting article regarding how the 'regulation' layer of assurance plays a part in ensuring the continuity of s reinsurer during potential crisis (not necessarily due to stock market crash):

The above is a real story of how the regulators would take action whenever they detect some potential problems.

Regarding my point that reinsurer may indeed decrease the risk of loss of annuity payout, let me use a simple illustration which I think makes things easier to understand. Again, I am comparing this Annuities Portfolio described vs Balanced Portfolio (including stocks and bonds to derive SWR) for the Survival Income portion.

A typical annuity-issuing insurer would be reinsured by a few reinsurers. This makes the nature of risk----carrier-risk-----diversified. For example, at a customer's level, his annuity may be divided into 5 proportional parts insured by the original insurers and 4 other reinsurers. And since each individual reinsurer must again be regulated, it makes the scenario in which the insurer itself plus all the reinsurers it's reinsured with being unable to honor the retirement income payout less likely. Less likely not than risk-free govt Bonds, but than the Balanced Portfolio which consists of these:
1) big-cap stocks
2) small-cap stocks
3) emerging mkt stocks........
4) govt bonds
5) corporate bonds.......

Let's understand that financial crises happen at different levels. What you mentioned is the worst case one, which does not occur so often. But even if it occurs, the regulators are likely to step in to make a decision that is fair all all sides.

During a crisis like the above, the regulators of insurance may take over the insurers and reinsurers temporarily or they may make some new rules, etc. But for most other private companies, the regulators would just allow the directors to do the insolvency paperwork if they want. With the Diversified Annuities Portfolio, the additional benefit is that our portfolio is protected with an additional layer of regulators' protection from Swiss, Singaporean, etc regulators. I'd heard that, in Switzerland, not a single insurer had failed to meet its obligations for 150 years (that's longer than any living human being's lifespan)!

Most of your post is about regulators. I'm not disagreeing about them.

I am disagreeing regarding your claims for reinsurance. In your example, if the transactions are big enough I expect a rating agency to notice what's going on and take that into account in their rating. Your argument amounts to saying that rating agencies are systematically giving ratings to insurers that are too low because they don't give enough weight to reinsurance. That is, you understand reinsurance better than they do. I don't see any reason to believe that.

 

[ESRBob]

Unless I am not doing it correctly, the Vangard site offers single life at around 5% (CPI-U adjusted) for a 53 year old male. With survivorship (at 100%) it's 4.3%.

I did the quote on Vanguard's site and I think there may be something different in your details, but not much. I used 100% survivorship for a male 53 and a spouse 51, with CPI adjustments for life. A 500k initial payment would yield $19,580 per year (inflation-adjusted) or 3.9%. No guaranteed payout period-- you both die next month, your heirs lose. There was also a 13k "Exclusion Amount" -- not sure what that is.

For me the rub is this: I can probably get myself a 3.9% inflation-adjusted SWR for life, and still have the money at the end. With an annuity, you get a guaranteed 3.9% inflation-adjusted SWR but they keep your money.

Still it isn't so far off 4%. Maybe by running the numbers with 53 year-olds it gets friendlier. I ran it years ago and it was much lower down in the 3%s. I guess that is one benefit of growing older!

 

[ERD50]

I did the quote on Vanguard's site and I think there may be something different in your details, but not much. I used 100% survivorship for a male 53 and a spouse 51, with CPI adjustments for life. A 500k initial payment would yield $19,580 per year (inflation-adjusted) or 3.9%.

...

For me the rub is this: I can probably get myself a 3.9% inflation-adjusted SWR for life, and still have the money at the end. With an annuity, you get a guaranteed 3.9% inflation-adjusted SWR but they keep your money.

The vanguard calculator says a 53M/51F has a 50% chance of one making it 37 years (90 YO Male). A 3.9% SWR - 93% historical success for 37 years.

And 12% chance of one making 45 years. 3.9% SWR - 90% historical success for 45 years (98 YO Male).

One way to view it, rather than the opportunity to leave heirs/charities big bucks - what are the odds you will be asking the heirs to support you? Purely mathematical - for the 37 year period:

50% survival times 7% chance of portfolio bust = 3.5% chance of needing support at 37 years (remember that some of those failures happened much earlier (~ year 30).

12% survival times 10% chance of portfolio bust = 1.2% chance of needing support for the 45 year period.

-ERD50

 

[RockOn]

The vanguard calculator says a 53M/51F has a 50% chance of one making it 37 years (90 YO Male). A 3.9% SWR - 93% historical success for 37 years.

And 12% chance of one making 45 years. 3.9% SWR - 90% historical success for 45 years (98 YO Male).

One way to view it, rather than the opportunity to leave heirs/charities big bucks - what are the odds you will be asking the heirs to support you? Purely mathematical - for the 37 year period:

50% survival times 7% chance of portfolio bust = 3.5% chance of needing support at 37 years (remember that some of those failures happened much earlier (~ year 30).

12% survival times 10% chance of portfolio bust = 1.2% chance of needing support for the 45 year period.

-ERD50

Where are you getting the SWR %'s?

 

[ERD50]

Where are you getting the SWR %'s?

That was just the number that ESRBob threw out, because that is the number that a Vanguard annuity would provide. If you pulled that same SWR as the annuity provides, those are the numbers you get.

Unless the provider defaults. And I have trouble assuming solvency for 45 years, though the risk is probably pretty low.

-ERD50

 

[RockOn]

That was just the number that ESRBob threw out, because that is the number that a Vanguard annuity would provide. If you pulled that same SWR as the annuity provides, those are the numbers you get.

Unless the provider defaults. And I have trouble assuming solvency for 45 years, though the risk is probably pretty low.

-ERD50

I'm still confused, but that's not new.

 

[RockOn]

For me the rub is this: I can probably get myself a 3.9% inflation-adjusted SWR for life, and still have the money at the end. With an annuity, you get a guaranteed 3.9% inflation-adjusted SWR but they keep your money.

That seems to keep coming up. I think you really need to look at the IRR of an investment and not put so much weight on that fact. If they paid you 50% a year for life, you wouldn't care if they kept your money, would you? At some price, the fact they keep your money shouldn't matter, you can always reinvest the money they pay you if you don't want to spend it. Unless of course, you really think you are going to die soon, then I'd be concerned. The question really is whether the guarantee (if there is such a thing) is worth the cost.

 

[youbet]

For me the rub is this: I can probably get myself a 3.9% inflation-adjusted SWR for life, and still have the money at the end. With an annuity, you get a guaranteed 3.9% inflation-adjusted SWR but they keep your money.

Depends what you mean by "probably." At 100% success and 45 years, you're SWR will be less than 3.9%. And there will be many instances of "close calls" where your portfolio is almost depleted or diminished significantly in real terms.

Not trying to defend annuities, don't have one and don't plan to, just saying that when you up the success rate from 95% to 100% and extend the time period to 45 years, you won't get a 4% SWR. And there will be many outcomes where the ending portfolio value is well below the beginning portfolio value. Your use of the term "probably" is a little optimistic.

 

[cute fuzzy bunny]

I'm not sure thats such a hard and fast rule.

Basically if your SWR strategy survived the depression and the 60's-70's sideways/stagflation periods, you'd need an event worse than those to have a failure. The time period (30, 40, 50 years) isnt as relevant as the number and severity of the major events. Usually the difference between a 100% SWR and a 95% one are those two periods of time.

Whats more likely to create a failure is wading 7-8 years into a bad market, seeing that your portfolio is drawn down to under 50% of its original size, and jumping into action to "do something" and then missing the rebound.

It also depends greatly on your willingness and ability to draw down spending in bad times, what your asset allocation is, and may be improved by "bucketing" strategies. Its also been shown that one of these major events very early in the retirement period can finish you off, while one 10-15 years post-retirement generally wont hurt too much.

But yeah, a 60/40 TSM/TBM port, taking the 4% inflation adjusted every year whether you need it or not, spending it like clockwork, and the future investment returns and scenarios mimic the past...4% may or may not work.

A CPI adjusted annuity for 40 years where the CPI understates the annuitants personal inflation rate by a half percent or so every year would also fail pretty nicely. Just very slowly and not obvious at first.

 

[youbet]

Basically if your SWR strategy survived the depression and the 60's-70's sideways/stagflation periods, you'd need an event worse than those to have a failure. .

I must be doing something wrong with FireCalc runs. When I solve for a 4% WR I keep getting several percent failure rates. Plus a bunch of stressful near-misses.

I understand those outcomes and accept the risk and have planned accordingly. But am I entering something wrong? So many seem to feel you can withdraw an inflation adjusted 4%, never have a failure and wind up with much more than you started with, guaranteed. And, of course, as you say, if the future is no worse than the historical data.

Edited to add: Oh yeah, deltas between the CPI and your own personal inflation rate would impact annuities and SWR plans similarly.

Not trying to defend annuities, just trying to keep the facts straight ref FireCalc runs.

 

[haha]

Not trying to defend annuities, just trying to keep the facts straight ref FireCalc runs.

Naughty boy!

Ha

 

[ESRBob]

That seems to keep coming up. I think you really need to look at the IRR of an investment and not put so much weight on that fact. If they paid you 50% a year for life, you wouldn't care if they kept your money, would you? At some price, the fact they keep your money shouldn't matter, you can always reinvest the money they pay you if you don't want to spend it. Unless of course, you really think you are going to die soon, then I'd be concerned. The question really is whether the guarantee (if there is such a thing) is worth the cost.

Good point. So that is an interesting question to throw out:

What would be your tipping point -- the point at which you'd say, "fine, I'll take the plunge and buy the annuity" for say, half of my savings in order to lock in a secure, inflation-adjusted return for life. It depends on your age, of course, but let's just keep with this example and assume you're in your mid-50s. Assume it's a reputable company, too. Would 3.9% do it for you? 4.5%? 5% or more? What would get people off the dime to send in a check for a big chunk of your life savings in exchange for an immediate annual CPI-adjusted payment for life, with all the risks and ups and downs we all know about?

 

[youbet]

Good point. So that is an interesting question to throw out:

What would be your tipping point -- the point at which you'd say, "fine, I'll take the plunge and buy the annuity" for say, half of my savings in order to lock in a secure, inflation-adjusted return for life. It depends on your age, of course, but let's just keep with this example and assume you're in your mid-50s. Assume it's a reputable company, too. Would 3.9% do it for you? 4.5%? 5% or more? What would get people off the dime to send in a check for a big chunk of your life savings in exchange for an immediate annual CPI-adjusted payment for life, with all the risks and ups and downs we all know about?

7%

If a extremely reputable company would give me that, cola'd, at 55, I'd buy in for 50% of my stash. Since I'm figuring on a 3.5% SWR, I could live fine on the 7% of 50%. The other 50% would remain invested and if 15 - 20 years later the insurance company went belly up, I'd go live off the remaining portfolio at its then current value. If the insuranc company didn't go belly up, then the 50% + growth would be left to the kiddies.

 

[clifp]

7% sounds roughly right to me. I consider putting 1/2 my money into a 6% SWR with COLA and jump at 8%. I'd stick to 50% because even though I don't have kids I do look forward to giving away a lot when I am 80 or so.

 

[Rich_by_the_Bay]

As an alternative to COLA for those who choose a SPIA early in retirement...Skip the COLA. 5 years later check the CPI and buy a second smaller SPIA to cover inflation and repeat until you no longer need a raise or no longer need the longevity insurance.

The advantages are lower initial cost, all your add-on SPIAs will pay better per dollar spent because you're older, you keep the add-on cost in the market until you need it, you can diversify over several carriers, and if you die young you'll leave less money on the table.

Joint survivorship may require further analysis, but that's the idea.

 

[RockOn]

As an alternative to COLA for those who choose a SPIA early in retirement...Skip the COLA. 5 years later check the CPI and buy a second smaller SPIA to cover inflation and repeat until you no longer need a raise or no longer need the longevity insurance.

The advantages are lower initial cost, all your add-on SPIAs will pay better per dollar spent because you're older, you keep the add-on cost in the market until you need it, you can diversify over several carriers, and if you die young you'll leave less money on the table.

Joint survivorship may require further analysis, but that's the idea.

If one did your plan, without the COLA, Vanguard offers about 7% right now (without surviorship).

As far as what it would take me to jump, I really think 4%, COLA'd with 100% surviorship is a pretty good deal if one can assume it is safe. The SWR of 4% assumes you could be out of money anyway in 30 years, even though it is possible it could do much better than that. I do not like risk.

Being greedy, 5% with COLA and 100% survivorship, seems pretty hard to turn down. That might be possible soon if rates back up a bit but I'm not sure how fast the insurance companies would sweeten the deal.

I doubt we'll ever see 7%.

 

[youbet]

As an alternative to COLA for those who choose a SPIA early in retirement...Skip the COLA. 5 years later check the CPI and buy a second smaller SPIA to cover inflation and repeat until you no longer need a raise or no longer need the longevity insurance.

The advantages are lower initial cost, all your add-on SPIAs will pay better per dollar spent because you're older, you keep the add-on cost in the market until you need it, you can diversify over several carriers, and if you die young you'll leave less money on the table.

.

That idea has merit Rich. Of course the downside is that if the period between your initial purchase and the time to buy the additional SPIA has been one of flat or downward portfolio growth coupled with significant infaltion (1970's) that would be a little painful....... That is, the advantages you mention are true, but you do give up having the insurance company shoulder the risk of high inflation/no or negative portfolio growth.

It's hard to have it both ways! Darn it!

 

[unclemick]

Hmmm - and then there are those wise acres who read threads and post things like:

Pssst Wellesley - current yield = 4.19%. Not inflation adjusted.

Heh heh heh - I guess my annuity is called early SS. Now - post 70 1/2 in 6 yrs depending on Mr Market - will I be receptive to using some of my RMD to purchasing blocks of fixed anuities to goose income? Never say never. . So far, age 49-64, 1993 - 2008 have tap danced in the 60/40ish portfolio ballpark and survived - 1 to 6% SWR depending on the yr. Stay loose! .