Topics: Start spending, Roth 401(k) preferred, financial industry trends, growth in life insurance? FL hurricane insurance, CPP+DB are target benefit??? retirement age=80? age impact on CPP benefit, public pension plan watershed? panic is rational, sustainable spending, quantitative inadequacies, SROs? document protection, national well-being, betting or hedging? “winner effect”.
Personal Finance and Investments
“Quit saving and start spending” Ted Rechtshaffen discusses the difficulty many retirees who have after spending a lifetime saving for their retirement, can’t turn the switch to start spending even if they have sufficient assets to allow them to do so. “The main issue is that there are items on their bucket list that they never consider checking off because of the cost. You only live once. The cost of putting off that safari trip to Africa may be never getting there. Even worse, if you have family overseas, and you put off seeing them because the flight is too expensive, you may never see them again. The missed life opportunities from saving for a rainy day can become very significant.” He has a list of suggestions as to what to do with the money if you expect to have an estate in excess of one million, among them are: “make a bucket list”, “look at your relationships with family and friends” are there opportunities to improve them or help them, and others.
In Bloomberg’s “The retirement savings move tax pros love” Carla Fried writes about some reasons why (American) tax-pros like Roth rather than traditional 401(k); the reasons include: required traditional 401(k) distribution can push you into higher marginal tax bracket as well as reduce the net value of your Social Security benefit and increase your Medicare costs.”
In BusinessWire’s “Vanguard CEO Bill McNabb: Investors are driving change in global fund industry” Vanguard CEO indicated that the investor driven “four broad trends that will shape the global fund industry are… regulatory schemes, advisory fee structures, and advice models, along with the growing demand for low-cost exchange-traded funds”.
In InvestmentNews’ “Life insurance-not annuities- is the next area for growth” Darla Mercado reports that the dwindling interest in annuities, fixed due to low rates and variable due to insurance companies’ exposure to a ‘bad event’, is driving insurance companies to refocus on life insurance as the next growth opportunity; more term for those still working and (whole)life coupled with (LTCI-like) option to tap policy without having to die “under certain health circumstances”.
In the WSJ’s “Florida worry season starts” Leslie Scism writes that after six hurricane free years the Florida “state hurricane-insurance system is in good shape, but a big storm is concern”. Specifically a hurricane of the scale of Andrew in 1992 would force the state-run insurance entities to sell billions of dollars worth of bonds, which might be very difficult under current circumstances. This is even though Citizens property (the largest) has $6B in reserves and spent $750M on private reinsurance.
In BenefitsCanada’s “The problem with big CPP” Fred Vettese is unhappy with the renewed push (by Ontario and others) for a “modest, phased-in expansion of the CPP”. While I don’t resonate with most of his arguments I take particular issue with the argument that current DB plans (like the CPP?) are not really Defined Benefit plans as they operate in reality more like Target Benefit plans. (Most private (and public) sector DB plans always came with very strictly defined contractual benefit obligations, and they were never intended to have the flexibility not to deliver on already earned benefits. So to say that private sector DB plans were like the CPP, just target benefit plans (because many companies did not deliver anyway on their contractual obligations), I would call revisionist history. However, it is true that the CPP was always effectively a target benefit plan as the federal/provincial governments had (and used) the unilateral power to change contribution or benefit levels. But I do agree that Canada’s DB plans are in systemic failure and have frequently not delivered on contractual obligations partly due to inherent flaws in the DB plan design, but mostly due a combination of incompetence/stupidity/self-interest of regulators, actuaries, investment managers and employer/administrator boards and executives who failed to deliver on their fiduciary and professional responsibilities prior to an employer bankruptcy, and the inadequate legal protection of pensioners’ rights after bankruptcy.) By the way, Mr. Vettese proposes instead of an expanded CPP, a wait and see approach to see whether the PRPP might work. (That is unlikely given what we know today about the PRPP. I also have reservations about an expanded CPP, but only on the basis of Canadians putting too many eggs in one CPPIB basket; it should be very simple to use the existing CPP administrative infrastructure to minimize incremental administrative cost of an expanded CPP, but place the incremental required/voluntary contributions into other asset pools managed by a different entity built on a similar governance construct as the CPPIB, OMERS and other large non-profit pension plan schemes in Canada and the world.)
According to InvestmentNews’ “80 the new 65? Retirement age needs radical adjustment, says AIG boss” AIG CEO Robert Benmosche “said Europe’s debt crisis shows governments worldwide must accept that people will have to work more years as life expectancies increase… Retirement ages will have to move to 70, 80 years old”. (Are you ready for another 15 years in the harness?)
In a very interesting short C.D. Howe Institute paper “Comparing nest-eggs: How CPP reform affects retirement choices” Laurin, Milligan and Shirle examine the impact of changes in “adjustment factors” which determine the penalties/rewards for those who choose to start CPP before/after age 65. They examine the impact in three situations: before tax (and no GIS), after-tax (no GIS) and after-tax (with GIS). They then plot the “Discounted present value of CPP benefits by age of retirement”. They conclude that “The new pension adjustment factors have moved in the right direction, but still fall short of offering many Canadians who retire at different ages the same value for their CPP benefits. In particular, those affected by the GIS clawbacks continue to face substantial financial disincentives to working longer.” (The calculation likely were done based on life expectancy of 65 year olds, but of course half the 65 year olds live past life expectancy (median age of death) by definition. See the benefits of adding a pure longevity insurance payout option in the CPP might help middle income Canadians protect themselves from running out of money in my Pure longevity insurance payout option in CPP would reduce retirees’ longevity risk; the power of such an option would be further enhanced if benefits enhanced by delayed CPP would be transferable to survivor benefits.)
There is a wave of public and private sector pension plans in Canada and the US which are starting to tackle their growing pension problems. In the Globe and Mail’s “New Brunswick tackles its pension pickle” Jeffrey Simpson writes that “public authorities are scratching their heads (as private employers have been doing) about how to respond. Public sector unions are understandably anxious that benefits be protected. Critics insist the answer lies in clawing back benefits, raising employee contributions or some combination of the two.” In WSJ’s “As costs soar, taxpayers target pensions of cops and firefighters” Michael Corkery writes that “Since the recession, dozens of state legislatures and city councils across the U.S. have scaled back benefits and jobs in an attempt to plug gaping budget holes… The initiative would force current city workers to either contribute more to keep their promised benefits or accept a more modest pension. It would also give the city the right to temporarily suspend cost-of-living raises that retired workers now receive. Anxiety among U.S. voters over unemployment, lower housing values and investment losses have emboldened government leaders to roll back pensions of even the most popular government workers.” And WSJ’s “California’s pension watershed” reports “Government reformers notched several victories on Tuesday, including two in California, of all places. Voters in San Diego and San Jose—the state’s second and third largest cities—overwhelmingly approved two of the most aggressive pension reforms the country has seen in recent years by a more than two-to-one margin.” The cities had to lay off workers due to pension cost. Voters passed DC plans for new workers and reduced benefits or increased contributions for existing DB beneficiaries.” In WSJ’s “Recall bid fails in Wisconsin” Belkin, Nelson and Porter write that Governor “Walker insisted that limits on public-employee bargaining rights, as well as requirements in the law that most government workers pay for more of their pension and health-care benefits, were needed to help close a $3.6 billion gap in the state’s budget.” He won in the recall election this week suggesting to “Republican lawmakers across the nation that challenging government unions could pay political and fiscal dividends”. (Looks like tectonic shifts are under way in the US, but I hope that already earned benefits will be sacred.)
Also in the WSJ, Sharon Terlap reports in “GM acts to pare pension liabilities” that GM, in an effort to reduce its pension obligations, is handing “over all assets and obligations of its salaried retiree pension program and management responsibility to Prudential Financial through the purchase of a group annuity contract. Prudential could begin making pension payments starting next year. GM said retirees’ payments won’t change.” By this move GM is reducing its future pension risk (longevity and return rates), yet it is unclear how GM plans to save money given that “it will spend roughly $29 billion to get Prudential to take over $26 billion in pension obligations. GM also estimated the pension buyouts will cost around $3 billion”. (According to “Group annuity plans” there appear to be three different types of group annuity contracts. The article did not indicate which type applies in the GM situation and what risks are carried by whom, though “immediate participation guarantee” appears to be the closest of the three.)
Things to Ponder
In the Financial Times’ “Panic has become all too rational” Martin Wolf looks at the forces in play in the Euro crisis under way, the risks associated with potentially wrong moves by policy makers (of course we will truly know what was a wrong move in retrospect) and potential damage that may be inflicted on the world economy. He writes that he never understood how the events in the 1930s could happen until now; the recipe is simple- “fragile economies, a rigid monetary regime, intense debate over what must be done, widespread belief that suffering is good, myopic politicians, an inability to co-operate and failure to stay ahead of events”.
In InvestmentNews’ “Why you should invest for sustainable spending” Rob Arnott writes that “Although people tend to measure wealth in terms of the dollar value of a portfolio, we believe it is better to measure wealth in terms of the real spending that the portfolio can sustain over the entire life of the obligations served by the portfolio. In 2004, we coined the expression “sustainable spending,” to gauge this true value of a portfolio…(so) bull markets are actually very bad news for those who are net savers, building a portfolio to fund future needs, because it costs more to buy the same real income stream… We’re better off only if we’re spending from the portfolio immediately, not saving more for the future!” And in 2009 the situation was exactly the opposite.”… bear market drawdowns have little impact on sustainable spending (unless you are no longer saving, i.e. are retired). Indeed, these sell-offs provide opportunities to increase our sustainable spending through disciplined rebalancing between asset classes or within asset classes, especially volatile ones like equities… Ben Graham liked to distinguish between a temporary loss of value and a permanent loss of capital. The former is a rebalancing opportunity; the latter is a disaster.” Looking at the even greatest bear markets since 1912 with greater than 30% real drawdowns, “The peak to trough decline in real dividend distributions was a scant 3% drop, on average. Even in the Great Depression, real dividend distributions fell by “only” 25%… Massive market corrections disproportionately impact market prices versus spending power.” (All true if you are not yet retired, you are still in the accumulation part of your lifecycle and are not yet spending your capital…but if you are the story is somewhat different.)
Gillian Tett in the Financial Times’ “Our volatile age defies spreadsheet strategy” discusses the inadequacy of quantitative models, however she opines that “what really matters now in places ranging from Finland to Greece are non-quantitative issues such as political values, social cohesion and civic identity” and reminds readers that mid-last century bankers understood that credit risk could not be assessed without addressing “character” of the borrower (individual, company or country)
There is considerable current discussion on the appropriate regulatory model for financial industry advisors (whether they are (transaction compensated) brokers, (commission sales compensated) ‘advisors’, insurance sales persons), the standards of duty (fiduciary or not), and the nature of the regulator (SRO or SEC/government). Much of the discussion in the CFA Institute report “Self-regulation in today’s securities markets- outdated system or work in progress” , even though published in 2007, provides a great background for those interested in the trade-offs between self and government regulated financial markets. The report explores the history (started with guilds), the range of regulation (from none to self to government), the pros (access to expertise, buy-in, etc) and cons (conflicts of interest, starving the regulator, barriers to entry, etc). The article quotes Howard Davies former chairman of UK FSA on regulatory structure: “The one piece of advice which I would offer to any country reviewing its regulatory structure, is that it should ask very carefully whether the self-regulatory mechanisms in place are sufficiently robust to be left alone? Is there a genuine community of interest, on which robust self-regulation can be built? Are there appropriate sanctions which can be used to punish miscreants? Does the system retain the confidence of those whom it is intended to protect? Where the answers to these questions are no, then it is time to consider putting a statutory framework in place”. (In Canada for example there is not even a discussion on the appropriate regulation pertaining to financial advisors, but testing against Howard Davies’s criteria, many would argue that changes are necessary.)
In WSJ’s “Protecting vital documents” Ellen Schutz looks at ‘cloud’ storage options for scanned copies of your important documents (birth certificates, marriage, mortgage docs, etc). Options mentioned include Dropbox, Skydrive, Google Drive and iCloud. And if you are looking for encrypted cloud-based storage VaultWorthy ($12.95/mo) covers up to 50 documents and includes access for up to five “trustees”.
The Financial Times’ “Betting versus hedging: the wagers war” explains in simple terms the current debate on the Volker rule and the difference between hedging (protecting yourself) and betting (trying to make a profit). The article points out that all hedges are ‘bets’ but there is a grey area when you must take an original position, e.g. “an airline must buy jet fuel” to operate but a bank can just invest excess deposits in Treasuries.
The Economist’s “The wealth of nations” shows “an alternative approach to measuring national well-being” developed by the OECD called the “Better-Life” Index rather than the GDP; it measures “11 key aspects of life – not just income and jobs but their housing, environment, social network, work-life balance, personal security, education, health, whether they feel part of the democratic process and their level of satisfaction with life in general”.
And finally, in the National Post’s “Risk perverse” you can read Melissa Leong’s interview with John Coates author of “The House Between Dog and Wolf: Risk-taking, Gut Feelings and the Biology of Boom and Bust” (which sounds interesting, but I haven’t read as yet) discussing what happens to ”sensible traders transform into manic money-makers…was it greed or something deeper- molecular even?” Coates attributes the “winner effect” which apparently well known phenomenon in the animal (and human athlete) world where they “found that an animal that has won a fight or a competition for turf is statistically more likely to win the next competition it enters…The mechanism driving this winner effect was rising levels of testosterone. It increases your lean muscle mass and increases your hemoglobin and thus your blood’s capacity to carry oxygen. But it also affects the brain. It makes you more confident, it makes you take more risk… As their testosterone levels rise, they (animals) go out in the open too much, they pick too many fights, they neglect parenting duties and they patrol areas that are too large and as a result, they suffer from increased rates of predation… It’s also viewed in politics, in sports, in war. This winner effect provides the physiological explanation for this classic, tragic process of hubris.”