Life insurance and Annuity selling by Wade Pfau?

[aja8888]

If one wants an insurance payment to be a non-taxable payout for a surviving spouse or heir, why not buy straight term insurance at a much lower cost?

(why screw around with whole life policies)??

 

[mathjak107]

straight term may not stay in effect long enough . besides in this case being discussed it is to be left to heirs which means term is likely long gone by that age or so expensive at that age it would be insane.

 

[2017ish]

There is an active Boglehead thread on this article (personal finance, noninvesting). Wade Pfau put a post in and is coming back later to answer some questions, including the whole life matter. He noted that the underlying white paper gets into the nitty gritty that had to be omitted from the forbes article.

 

[pb4uski]

That works in the case of an isolated company that fails for an isolated reason (malfeasance, uniquely poor decisions, etc). It does nothing but spread the damage and force other teetering companies over the edge in the case of a systemic problem. The weight of the increasing number of companies falling into the pit assures even the strongest companies will be drug under. 2008 is far from as bad as things can get, I'm sure most people here are structuring their affairs to weather such a storm. And yet, during that time, insurance companies were not sanguine about their ability to withstand the gale, instead approaching the government for help. It's all "solid as a rock" when selling policies to people, some companies (and their trade groups) didn't sound that way behind the scenes when push came to shove. We can all choose which version to believe today.

I couldn't disagree more. In 2008 there were a handful of insurers who were indeed nervous, but the issues in the insurance industry were minute compared to the banking industry, where banks were failing seemingly every other day. Only two insurers, Lincoln and Hartford, accepted TARP money and in both cases they repaid less than a year after they received it.

If it ever gets so bad that insurers are unable to perform on their contracts, then the banking industry and stock and corporate bond markets will be in tatters.

 

[Independent]

I am trying to see where he missed something, but I can't find it.

I think that's important. He uses a 3.5% SWR rate which allows for inflation driven increases, then he compares that to a non-indexed SPIA.

Investment management fees and asset allocation before retirement are probably bigger deals.

He assumes that our 35 year old couple is so naive regarding asset allocations that they need to pay 75 bp to an adviser to get them into the right mix of stock and bond funds. And, that adviser buys funds with average expenses of 84 bp. (Those are his Target Fund expenses.)

But, when that couple buys a WL policy, they suddenly get so sophisticated that they can run their own asset allocation strategy that involves annually offsetting the bond allocation with the WL cash values. This increases their equity allocation in the WL scenario, helping to produce nearly as much at-age-65 401k balance when they save $9,000 per year as when they save $14,281.

I don't buy it. They are either sophisticated in both cases or naive in both cases.

 

[mathjak107]

this is true

 

[Independent]

nope , that is the smallest "IF " of them all. even 2008 did not effect one annuity or life policy. in fact agg's insurance business was unscathed.

then you have various state guarantees . states require insurers to just absorb failed companies.

This would be true if Pfau were using the guaranteed values in his comparison.

He isn't. He is using the illustrated values. So, he assumes that our couple can stop paying the $4,500 annual premium at age 65 because by then the dividends will be sufficient to cover the premium.

And, he is using the illustrated death benefit (presumably including dividend-funded additional insurance) when he buys the SPIAs and when he calculates the "legacy value".

Since he has "Actuarial Science" in the title to his paper, and since this is funded by OneAmerica, it might be good if he talked to the actuaries responsible for those illustrations and disclosed the interest and mortality in the guaranteed values and the expenses, interest, and mortality in the illustrated values. Then the readers might guess something about the uncertainty in the illustrations.

 

[samclem]

Only two insurers, Lincoln and Hartford, accepted TARP money . . .

True, but not the whole point. What CNN said at the time (emphasis added)

Treasury Department spokesman Andrew Williams said Allstate, Ameriprise Financial, Hartford Financial Services Group Inc., Lincoln National Corp., Principal Financial and Prudential Financial Inc. have qualified for TARP money.
"These life insurers met the requirements for the Capital Purchase Program because of their bank holding company status and each applied for CPP capital investments by the deadline of November 14, 2008," Williams said.

Allstate, Principal Financial, Prudential--these are companies we've all heard of, not bit players. They all asked for government bailouts, some later turned them down. If/when they paid 'em back, or if they took the money at all isn't the point--when the chips were down, these supposed bedrocks of stability were so unsure of their future financial strength that they begged the government (taxpayers) for help. So, what are we to believe today about the safety of these and other companies? And a few decades from now?

If it ever gets so bad that insurers are unable to perform on their contracts, then the banking industry and stock and corporate bond markets will be in tatters.

It works the other way, too: If the banking industry, stock and corporate bond markets are in tatters, the insurance companies will be unable to perform on their contracts. So, I'd prefer to just cut out the middleman (and all their fees, costs, and huge HQ buildings) and invest in the underlying assets.

 

[hnzw_rui]

True, but not the whole point. What CNN said at the time (emphasis added)

Allstate, Principal Financial, Prudential--these are companies we've all heard of, not bit players. They all asked for government bailouts, some later turned them down. If/when they paid 'em back, or if they took the money at all isn't the point--when the chips were down, these supposed bedrocks of stability were so unsure of their future financial strength that they begged the government (taxpayers) for help. So, what are we to believe today about the safety of these and other companies? And a few decades from now?

That the government will bail them out again to prevent total economic collapse?

I'm finding current government debt to be a bigger concern...

 

[mathjak107]

to much worry about this stuff . aig insurance was fine , allstate does not sell life and annuities and prudential didn't need the bailout.

until we have a modern day failure to pay i wouldn't give this two thoughts. we have zero to date.

 

[samclem]

That the government will bail them out again to prevent total economic collapse?

I'm finding current government debt to be a bigger concern...

Related issues, right? The bailout worked last time because the world still clamored for US bonds as a safehaven when the sky was falling. Increasing USG debt and decreased US economic growth could make that less likely next time.

 

[brewer12345]

I couldn't disagree more. In 2008 there were a handful of insurers who were indeed nervous, but the issues in the insurance industry were minute compared to the banking industry, where banks were failing seemingly every other day. Only two insurers, Lincoln and Hartford, accepted TARP money and in both cases they repaid less than a year after they received it.

If it ever gets so bad that insurers are unable to perform on their contracts, then the banking industry and stock and corporate bond markets will be in tatters.

Whatever the next crash turns out to be, it will be different than the last one. I would make no assumptions about how stable the insurers are in the next crisis. What if the states sign off on principles based reserving in the interim and the insurers all get their fox-in-the-henhouse freak on big time?

 

[Independent]

to much worry about this stuff . aig insurance was fine , allstate does not sell life and annuities and prudential didn't need the bailout.

until we have a modern day failure to pay i wouldn't give this two thoughts. we have zero to date.

But, once again, the gov't is not going to bail out their illustrated values. And, Pfau is using illustrations.

 

[mathjak107]

i would still believe the insurers would likely stand up a whole lot better than your portfolio would if that was the case.

as far as pfau's numbers and assumptions there are lots of skewed things going on . but odds are a base of guarantees and your own investing should produce better results .

i just can't say how much better.

 

[pb4uski]

..... Allstate, Principal Financial, Prudential--these are companies we've all heard of, not bit players. They all asked for government bailouts, some later turned them down. If/when they paid 'em back, or if they took the money at all isn't the point--when the chips were down, these supposed bedrocks of stability were so unsure of their future financial strength that they begged the government (taxpayers) for help. ....

They did not ask for bailouts as you claim and they definitely were not begging the government for help. There was a lot of uncertainty at that time with the financial system as a whole and there was no real cost for applying for TARP so many of them applied in case things got worse even though they had no real need at the time. Given how crazy things were at that time there was no reason not to apply just in case. As it turned out, once the feds stabilized the banking system and financial markets, there was less uncertainty and other than The Hartford and Lincoln they decided that they wouldn't need additional capital and even The Hartford and Lincoln only needed it for a short period of time.

 

[mathjak107]

if i had to bet on whether it was the insurers failing to pay on an annuity or these low rates and high stock valuations hurting many of us more likely , it would be no contest .

 

[samclem]

He assumes that our 35 year old couple is so naive regarding asset allocations that they need to pay 75 bp to an adviser to get them into the right mix of stock and bond funds. And, that adviser buys funds with average expenses of 84 bp. (Those are his Target Fund expenses.)

He's been caught stacking the deck before. Remember the high advisory expenses and fees he built into his projections for individual retirees?
He did it in this paper.
Reaction here and here.
Sure, if a retiree gives away 1% (or more in advisory fees, etc), then he might only be able to take home 3% safely. But the withdrawal rate was still close to 4%--it's just that Wade and others got to spend it.

 

[Independent]

Let's look at the illustrated values.
At age 65, the illustrated cash surrender value is $257,337.

The annual premium is $4,500. I'll make some guesses about what happens to the premium. 100% of the FY premium goes to acquisition expenses (agent commission, other field expenses, HO marketing, underwriting, and physical policy issue). After the first year, $540 (the term premium) covers death benefits, annual administration, and profit goals. 2% of the difference between $4,500 and $540 goes to premium taxes. The rest of the premium is invested in bonds and eventually accrues to $257,000.

The company needs to average 4.7% on those bonds to hit that target. Pfau apparently believes that is plausible. But, his median return on bonds available to the 401k saver starts at 1% and eventually gets to 4% after 30 years. (page 26) It's no surprise that the WL looks better than the mutual fund.

Once again, I don't think he is apples-to-apples in his assumptions.

 

[pb4uski]

Whatever the next crash turns out to be, it will be different than the last one. I would make no assumptions about how stable the insurers are in the next crisis. What if the states sign off on principles based reserving in the interim and the insurers all get their fox-in-the-henhouse freak on big time?

Obviously if the regulatory scheme changes significantly then the conclusions might also change. My remarks are based on the current regulatory environment and how the insurers weathered the 2008 financial storm much better than banks and others.

As is however, the likelihood of "the system" failing to pay any guaranteed benefits is very remote even under some pretty bad economic conditions based on history.

When I was working in the industry I recall it being frequently stated that no life insurer had ever defaulted on any guaranteed benefit...ever. I never got any clarity as to whether that was for life contracts or also included annuity contracts and I was never able to find a source so in my mind it is a bit of an urban legend.

 

[samclem]

There was a lot of uncertainty at that time with the financial system as a whole and there was no real cost for applying for TARP . . .

There was a cost, and there should continue to be one--the loss of their "rock solid" public reputations and the diminution in the value of their "guarantees." When things looked cloudy, they turned to me (the taxpayer) for money to make good on promises they had made. If they didn't think that would shake my (our) confidence, they were wrong. If they realized that they were risking their reputation but applied for TARP anyway, then I'd say they were pretty scared. Either way, it does not inspire confidence.

 

[brewer12345]

Obviously if the regulatory scheme changes significantly then the conclusions might also change. My remarks are based on the current regulatory environment and how the insurers weathered the 2008 financial storm much better than banks and others.
QUOTE]

Well, there is the rub. If one keeps their assets in a traditional portfolio, it is easy to make changes. If you instead choose to follow Dr. Pfau's bullpucky advice, you are wedded to whatever insurers you chose for the long haul. I think cases like UnumProvident and (especially) Phoenix are very much worth keeping in mind when you consider buying an expensive guarantee.

 

[pb4uski]

There was a cost, and there should continue to be one--the loss of their "rock solid" public reputations and the diminution in the value of their "guarantees." When things looked cloudy, they turned to me (the taxpayer) for money to make good on promises they had made. If they didn't think that would shake my (our) confidence, they were wrong. If they realized that they were risking their reputation but applied for TARP anyway, then I'd say they were pretty scared. Either way, it does not inspire confidence.

Ok, other than full faith and credit instruments and FDIC insured bank accounts, name a safer place to put your money.

 

[haha]

I've just come from the SS discussion, where the consensus is unclear to me, but it certainly does not seem overwhelmingly in favor of taking SS at 70. Yet SS, and by extension the additions to SS that one gets by waiting are easily the best annuities available to garden variety Americans. Yet this thread seems to have at least some potential commercial annuity fans. And some of these people have already stated that they do not favor taking SS late.

If annuities dominate bonds, and indexed annuities dominate unindexed ones, and government payers dominate private insurance companies, and if private indexed annuities are rare anyway, I really don't see anything to be unsure about.

Either you hate the annuity concept, or you realize that US government indexed annuities with right of survivorship are a flaming bargain, far better than anything offered in a competitive market.

Ha

 

[ETFs_Rule]

What are insurance products? LONG-term commitments. You have to hold these policies for LIFE! Over long time periods a diversified portfolio doesn't lose money. During the modern era the worst you would have done over any rolling 20 year time period is like 5.3%. That makes these "guarantees" pretty pointless. You're not gonna lose money anyway.

 

[samclem]

Ok, other than full faith and credit instruments and FDIC insured bank accounts, name a safer place to put your money.

Well, I'm not sure why we'd rule those out. And it all depends on the definition of "safe". Pfau is pushing these annuities for "must have" returns to support basic needs. That means they can't lose ground to inflation--but these non-inflation adjusted annuities are very likely to do so. Over long periods, a diversified portfolio never has. So, we are left to wonder which approach is truly safer.