Hot Off the Web- August 8, 2011

Personal Finance and Investments

Anne Tergesen reports in WSJ’s “‘Combined’ insurance policies grow” that while sales of traditional long-term-care insurance policies have decreased from 303,000 (2007) to 235,000 (2010), the sales of policies combining life insurance with LTCI rose from 15,000 (2007) to 26,000 (2010). “Such “combined” policies pair long-term-care coverage with either life insurance or an annuity. In the event the policyholder needs long-term care, the insurer typically pays funds tax-free from the linked annuity or — in the case of a policy packaged with a life-insurance contract — prepays some or all of the death benefit.” Tergesen lists some advantages of some of these combined policies such as: may allow recovery of LTCI premiums if benefits are not used, fixed price unlike risk of premium increases in traditional policies, lower underwriting standards when combined with annuities. Disadvantages include lower life or annuity payments if LTCI benefits already used”, inability to share LTCI benefits between spouses, steep upfront costs for combined policies.

Bill Husted in Palm Beach Post’s “Protect sensitive files with encryption” discusses the use of encryption to protect sensitive files on your computer or on a third party (cloud) server. He provides links to AES encryption education , source and download (free) or commercial source(fee). (Also don’t forget to figure out a scheme that allows sharing passwords to your online life with your successors in case you suddenly become unable to do so.)

Tim Cestnick in the Globe and Mail’s “In estate planning, know the hazards of joint ownership”provides a long list to consider: triggering a tax liability, a potentially unintended estate distribution, ”family or legal disputes”, loss of exclusive control over assets, creditor threat, and principal residence may become taxable.

The Financial Times’ Lex column “Equities plunge: Perspective is in order” opines that “If one was comfortable making a long-term bet on stocks back in December, much less at the April peak, then there is little reason to feel differently today unless fundamentals have changed. The likelihood that billions will be pulled out of stock funds just illustrates that the stock market is the only one in the world where customers run away during a sale.” And in the Financial Post’s “Better to hedge, than time the market”Jonathan Chevreau ask what you can do now as the market is swooning. But “for protective measures, the horse is out of the barn on this correction. Those with well diversified portfolios (including cash, bonds, REITs, commodities, gold and precious metals and quality dividend paying stocks) have little choice but to ride it out. “For those who take a balanced approach, damage has been very limited thus far,” says Dan Hallett, a director of Highview Asset Management, “Neither I, individually, nor we as a firm are panicking … We have all been singing, more loudly than usual, the virtues of balance in asset mix strategy.” “

In the WSJ SmartMoney’s “10 things your parents won’t tell you” Kelli Grant provides her list of unmentionables, such as: “we are rich”, “you’re not in the will”, “someone is taking advantage of me”, “you’re ruining my retirement”, “…just like I’m going to ruin yours” and “take my car keys”.

Real Estate

In the Globe and Mail’s “Toronto housing market cools in July” Steve Ladurantaye reports that “Resale house prices fell in Toronto in July as the number of sales dropped, but the city remains on track to have its second busiest sales year in its history. Sales were down 22 per cent and the average price fell 3.2 per cent to $459,122 in July compared to June. Year over year, however, sales were up 23 per cent in July and prices were 10 per cent higher…Vancouver posted a similar drop in sales Wednesday, and national numbers will be released August 15.”

According to the WSJ’s “Homeowners can’t hop on low rates”U.S. 30- and 15- year mortgage rates are down to 4.55% and 3.54%, respectively, but Nick Timiraos writes that it is not just risk-based fees/rates (borrower’s credit score related) charged by Fannie/Freddie and historic low mortgage rates for years have allowed refinancing before, the biggest obstacle today is qualifying (i.e. due to lower home values, lower incomes). But for those who qualify, it can be attractive, since “A rule of thumb holds that every one-percentage-point decline in rates effectively reduces home costs for buyers by roughly 10%.”

Pensions

In WSJ’s “Bondholders win in Rhode Island” Michael Corkery reports that “Central Falls, R.I., a city of 19,000 residents that filed for bankruptcy Monday, is a bondholder’s dream. Thanks to a new state law that places bondholders ahead of other creditors, Central Falls plans to pay investors the entire $635,000 it owes them in October. Retired city workers might not be so lucky. Instead of $296,000 in pension checks promised before Central Falls became the second U.S. municipality to seek Chapter 9 protection this year, the retirees could get only $196,000 in payments next month—a 34% cut….As municipalities in other states grapple with overwhelming pension obligations and debts, similar laws could catch on, partly because they will help even shaky cities and counties keep borrowing money”. (Pathetic…)

In the Financial Times’ “How to cut costs in running pensions”Pauline Skypala writes that “The fund management industry is mostly run for profit – for the owners rather than the investors. The owners of fund groups are virtually guaranteed a profit; the investors with them enjoy no such guarantee.” Canada’s model of large in-house managed pension funds e.g. OMERS is held out as a model for U.S. and U.K. pension funds; they are large, low cost, with big infrastructure, real estate and private equity investments. Also mentioned is that OMERS hopes that it “will be allowed to offer its services as a manager of a planned new pension product for Canada” the PRPP which it feels it can offer for 75-80 bp, which Skypala points out to be higher than the 50 bp U.K. Nest program to be achieved with passive products. She concludes with “Large scale plans run on a not-for-profit basis with in-house management are undoubtedly the cheapest way to look after people’s retirement savings. Governments keen to help their citizens build their own pension pots should take note.” (If the OMERS PRPP cost indicated at 75-80 bp are all-in-costs, meaning that they include administration costs, then it is beginning to be more interesting, though still much higher than the about 0..6% including annuitization option, which I consider as a reasonable starting benchmark for a large scale plan; 0.3% is my benchmark for a DC-like plan)

In the NYT’s “Muddying the budget waters with Social Security”Tara Siegel Bernard discusses that the difficulties that U.S. government had with the when and how much to cut, is nothing compared to the hardest decisions to still come about which programs will be cut! Social Security is on the table and the changes proposed appear benign on the surface, e.g. changing cost of living adjustment to a new index. One proposal is a switch to CPI-U which based on historical evidence could result in a 9.2% cut over 30 years, and the proposed change is being ‘sold’ by some as not “to save money” but because the CPI-U is “more accurate” ( J ).

And then there is the Canadian Federation of Independent Business VP Dan Kelly’s Financial Post article “Early retirement can still be possible for some” in which he rips into the differences between public and private sector pension plans and their availability. (While many won’t disagree with many/most of his points, others might find that his views overly partisan and thus decrease their effectiveness.)

Jonathan Chevreau‘s “Pooled pension plans could be very simple”discusses PRPPs; the points are not new, but they bear repeating. “Ottawa should continue with PRPPs and consider at least a modest expansion of the CPP, as it has already indicated. Whatever it does, it should make sure lower-cost passive options are included. It must remind the financial industry it exists to serve future retirees, not vice versa.” (Still, PRPP as tabled so far doesn’t give anyone outside Mr. Flaherty’s office, any warm and fuzzy feelings. Furthermore, the PRPP will delay the still necessary ‘real pension reform’. Time will tell.)

Things to Ponder

In the September 2011 CFA Institute’s conference proceedings “Advances in risk management and risk governance” Leslie Stahl writes that the answer to the question “What is risk?” is not standard deviation or risk-adjusted return. “Risk is the possibility of a bad outcome in the real world; it is not a purely mathematical concept. “ “When problems occur, what happens first mathematically is that correlations go to 1 or –1. Yet, how many investment managers actually stress test correlations going to 1 or –1? …Different types of stress tests can be used. One approach is to use individual facts and assumptions, such as interest rates rising or falling, credit spreads narrowing or widening, correlations changing, or equity prices going up or down. Another approach is to use historical stress scenarios, such as the financial crises in 1987 or 1994, the Asian flu crisis, or the dot-com crisis. Another approach is what I call “management nightmares.””

Jack Hough in WSJ SmartMoney’s “How much more could stocks drop?” writes that “further stock market declines are entirely possible” as “Corporate earnings are the highest they’ve been relative to worker wages (including benefits) since just before the Great Depression. High earnings are usually a good thing for stock investors, but in the past, when earnings have gotten too high relative to wages the result has been an earnings plunge. Workers are also customers, after all, so if they’re not participating in the boom, the boom is unlikely to last.”

Laurence Kotlikoff writes in Bloomberg’s “Generational balance, not budget balance”that “Whatever you think of the House Republicans, they understand that our country is broke. But they have no idea how broke. They are pushing hard for a balanced-budget amendment. What we need is not budget balance, but generational balance. If we are going to amend the Constitution, let’s prohibit today’s adults from leaving tomorrow’s generations with higher lifetime net tax rates. A Generational Balance Amendment would specify that, absent prolonged states of emergency, each generation would pay the same share of its lifetime labor earnings in taxes, net of benefits received. Stabilizing lifetime net tax rates isn’t just a matter of fairness. It’s critical to our country’s long-term economic survival.” (Well worth reading, it explains why even a balanced budget and no debt can still leave massive cross-generational inequities; i.e. you can end up forcing your children to pay for your retirement via taxation. So there is a ‘free-lunch’ after all, but what is free to me might be paid by my children.)

In the Financial Times’ “’Best-ideas’ funds come out on top” Steve Johnson writes that “Highly concentrated “best-ideas” funds may be able to consistently outperform traditional, highly diversified active funds.” The article then weakens its thesis by indicating that this appears to be case in UK and France, but unclear in the US and incorrect in Germany. “The findings tie-in with some academic research. A paperby Randy Cohen, Christopher Polk and Bernhard Silli released in 2008 found that the typical fund manager has a small number of good ideas that outperform the index, while the rest of their portfolio typically adds no value…(Some argue that ) more concentrated funds benefited from higher quality managers. “Only good fund managers get to run these portfolios. People have got to think a lot of you to give you money to run in a concentrated portfolio…(but) concentrated funds could be more volatile and could struggle to invest in small or mid-cap companies if they attracted too much money. Given the capacity constraints of concentrated funds, Mr Millard believed more diversified funds, which allow fund houses to gather more assets, and therefore gather more management fees, would continue to dominate the industry, irrespective of the findings.”

And finally, a history lesson in Bloomberg’s “Default 400 years ago leaves scars” in which Christophe Chamley looks back at “Spain’s default in 1575. What events more than 400 years ago suggest is that it’s easy to ignite a dangerous chain reaction in financial and credit markets and inflict lasting damage on the economy…(and concludes with) What’s the message for the House Republicans today? First, don’t overestimate your power. Second, history stays with us. Spain’s default is 424 years old, but its story is still being told and may, to this day, be affecting that nation’s perceived creditworthiness and cost of capital.”