Contents: Insured annuities-not, feedback in DC plans, longevity challenges boomer decumulation plans, more policing needed for financial planners? Florida property & casualty company practices “post-claim underwriting”, PEI’s expanded CPP proposal good but how does it solve Canadian boomers’ retirement crisis? effect of US default would dwarf Lehman impact- but it’s just a sideshow to the entitlement-driven disaster under way, banking technology tremors just precursors to earthquakes to follow, the ultimate oxymoron: value creation by Canada’s mutual fund industry, Fama: active management is for the birds and hedge funds are just an extreme form of active management.
Personal Finance and Investments
My blog post earlier this week entitled “Insured annuities? Not so fast” discusses why an “Insured annuity” based un-indexed income is typically less compelling than a systematic withdrawal of the same size from a balanced portfolio. Monte Carlo simulations suggest that based on reasonable assumptions better outcomes are achievable in terms of income and residual estate value, but of course there are no guarantees. In addition to being more flexible by having continuous access to assets throughout retirement, the balanced portfolio approach, unlike the insured annuity, doesn’t force you to trade-off longevity risk for inflation risk, and doesn’t force you to effectively lock in today’s very low interest rates with an annuity.
In WSJ’s “The great retirement income hunt” Kelly Greene explores the boomers’ challenges of turning “nest eggs into income” especially with the increasing boomer life expectancies. The article discusses the important aspect of how to provide “feedback” on the 401(k) statement which would indicate “how much monthly income their assets might provide in retirement”. Some 401(k) managers include “investors’ account balance to a projection for future contributions and earnings, factoring in any outside investments” Other go further comparing results “with the saver’s target and suggests ways of closing any gap, including changing asset allocation, increasing contributions or working longer…the tool also offers a strategy for drawing down savings, taking all sources of retirement income into account”. Others provide a quarterly score which “helps people understand whether they are on track to replace their income…” (These are all great and long overdue ideas.)
In the Globe and Mail’s “Longer lifespans demand new investing approaches” Rob Carrick also explores the decumulation stage of people’s life-cycle. The topics addressed include “what might the appropriate stock bond split (a stock allocation of (100-age) just doesn’t cut it even if updated to 110 or 120 minus age), increasing stock allocation now that bond bull market is at its perceived end, selecting an appropriate allocation according to individual circumstances (pensions, health situation, home value, debt and desire to leave an estate), one adviser suggests age-squared divided by 100 as a good percent bond allocation, others suggest annuities instead of the bond portion of the asset allocation. (Appropriate allocation to individual’s circumstances makes sense, but I am less than enthusiastic about the annuity option in general, though it may be applicable to some.)
In WSJ MoneyBeat’s “When your financial planner doesn’t tell all” Jason Zweig looks a growing number of CFPs (Certified Financial Planners) being investigated by the CFP Board with some instances when the Board removed the title from the planner. Zweig notes “these findings are a reminder that financial planners aren’t policed as closely as brokers and investment advisers are, since no government entity specializes in regulating them—and that investors can’t count on someone else to do their due diligence.” The CFP Board is not a regulator but a certification body; it can investigate but cannot subpoena. So occasionally, even if the Board withdraws the CFP title, some CFPs continue to use it.
In Fpanet.org’s “Why you should rethink savings rates, withdrawal rates, and SPIAs” Wade Pfau is interviewed by Carly Schulaka. This is a good overview of some of the current thinking/debates on retirement income accumulation and decumulation. He covers the “traditional 4% rule”, safe withdrawal rates, Zvi Bodie’s “safety first” approach, the relevance of current conditions on the expected outcomes, the importance of asset allocation, variable withdrawal rates, essential vs. discretionary spending. He recommends a 2.8-3.2% safe withdrawal rate today (referring to the traditional “4%” indexed approach). He also notes the importance of focusing on the savings rate which allows you to “take advantage of some of the mean reversion of the market”, and he believes that partial annuitization can be beneficial, even mentions “deferred income annuity” (i.e. longevity insurance) as a (relatively) new product (in the U.S. but still nonexistent in Canada) which allows you to get longevity protection at a lower cost than immediate annuities and that rather than a decreasing stock allocation glide-path in retirement perhaps the opposite will yield superior outcomes. (Thanks to VP for recommending.)
In Florida in the Sun-Sentinel’s “Universal agrees to $1.26M fine” reports that Florida’s second largest property and casualty insurance company was fined for “‘post-claim underwriting’ (which) resulted in some policyholders having unpaid claims or having coverage canceled without sufficient notice” according to the state Office of Insurance Regulation. It appears that Universal, often years after a policy has been in force, would reject a claim due to supposed inaccuracies in the policy application. (Is this not the same as the practices of some Canadian emergency travel health insurance providers?)
Pensions and Retirement Income
In Benefit Canada’s “P.E.I. pushes for CPP expansion” Craig Sebastiano discusses last week’s PEI proposal for an enhanced CPP. The specifics are starting at $25,000 annual earnings contributions are increased from 9.9% to 13.0% up to $51,000, then from $51,000 to $102,000 contributions are increased from 0% to 3.1%, increases shared equally between employee and employer. The increases would start in 2016 and would be phased in over three years. (It’s a good proposal, even if it is not clear to me how the benefits will change. It is good because it: increases savings, makes them mandatory, assets would be managed professionally, the costs associated with the incremental assets will likely be <1% and benefits are paid as indexed annuities which could start as late as age 70. The problem is that: it will hardly dent boomers’ retirement income needs (given that the benefits will likely have a pre-funded requirement as they should, it will take decades to build up to expected benefit levels, if funds will be managed by CPPIB this will further increases dependency on CPPIB for to an even larger portion of Canadians’ assets.)
Things to Ponder
In Bloomberg’s “A U.S. default seen as catastrophe dwarfing Lehman’s fall” Yalman Onaran writes that the financial disaster resulting from the Lehman collapse was nothing compared to the never seen before economic calamity the U.S. government default. Some of the dire predictions include: worldwide devastation of stock markets, borrowing cost going through the roof, potential depression, etc. (Scary article, but difficult to believe that a default would be allowed to occur.) But Niall Ferguson in WSJ’s “The shutdown is a sideshow” opines that the real threat is “An entitlement-driven disaster looms for America, yet Washington persists with its game of Russian roulette.” The real issues is that “even as discretionary expenditure has been slashed, spending on entitlements has continued to rise—and will rise inexorably in the coming years”, so even though the federal deficit has decreased from 10% on 2009 to 4% this year, the CBO projects annual 6% deficit by 2038 resulting in federal debt rising to 100% of GDP and 200% by 2078. He thinks that “Only a fantasist can seriously believe “this is not a crisis”. Current interest payments on debt of 8% of federal revenues will increase to 20%, 30% and 40% by 2026, 2049 and 2072 respectively.
In the Financial Time’s “Tremors warn of technology quake in banking” Tom Stabile reports that IT/software glitches/ tremors in US banks are just precursors of major earthquakes that might follow. An example of a tremor is sending letters of individuals’ “net worth, holdings, risk tolerance and other personal data” to the wrong people. The root cause of the tremors is “mix of old, creaky infrastructure built for simpler times and newer, complex technologies that may not yet be reliable”, which will inevitably lead to people having to “increasingly suffer data losses, account freezes, botched transactions, errant charges and other “minor” calamities”; are more major ones to come?
And finally, in the “how pathetic is this or they’re just grasping at straws” The Conference Board of Canada “Making sense of Canada’s mutual fund industry- An economic impact analysis” tries to twist the parasitic wealth destruction by Canada’s mutual fund industry into a virtue by calling it a value creator. I was going to call it entertaining (if it didn’t make you angry) but laughable is more appropriate. (Thanks to Ken Kivenko for recommending.) By the way in InvestmentNews’ “Eugene Fama reiterates opposition to active management, high fees” Fama is not only opposed to active management and high fees (major “value adds” of Canada’s mutual fund industry?), but adds that he can’t figure out why people invest in hedge funds which are just “an extreme version of the same”. (Interestingly, Fama even suggested that “less emphasis on balancing global asset allocations” might be needed given that “the U.S. market is so well diversified already”.)