Tag Archives: financial advisor

Long-term Care Costs Fall Heavily On Women

The Cost of Long Term CareMy Comments: This was written nearly 5 years ago but the message since then has only gotten louder. As more of us get older, and we stay alive, where the money comes from to keep us alive is increasingly in question. We joke about it often, but unless we are willing to let people starve to death, which we aren’t, then food, shelter, clothing and care has to be provided.

Increasingly, companies that offered what we call Long-Term-Care policies are no longer offering contracts. Those that do are rapidly increasing their premiums. There are no simple remedies.

BTW, I’ll be out on a business trip for a few days so you may not hear from me again until next week.

Ruthie Ackerman / AUG 30, 2010

Because women live longer, require more care and tend to be the primary caregivers in their families, long-term care falls disproportionately on their shoulders.

Yet according to a recent survey by Genworth Financial women face challenges talking to their families about putting together a financial strategy to deal with long-term care.

Genworth’s survey found that 72% of women said that the biggest barrier to starting this conversation is the concern about upsetting family members, compared with 57% of men that voiced the same worry.

Needless to say, seven out of 10 will need long-term care in their lifetime.

Despite the difficulty in having these tough conversations, long-term care is a hot button issue given that it is likely to be the greatest retirement expense facing Americans today. And as individuals continue to live longer the issue will only get worse.

The number of persons aged 65 or older is expected to double in the next 20 years; there will be 110% more people 80 or older, according to the U.S. Census Bureau.

The U.S. Department of Health and Human Services report that at least 70% of people over age 65 will require some long-term care services at some point and more than 40% will need care in a nursing home.

The truth is that the cost of long-term care has skyrocketed as well, increasing for the sixth consecutive year, with most of these increases outpacing inflation, according to Genworth Financial’s Cost of Care Survey conducted in April 2009. Genworth found that the national average median cost of one year in a private nursing home room is $74,208.

Yet families often think that health insurance and Medicare will cover these costs. But they cover almost none of the cost of nursing homes, assisted-living facilities or in-home care.

In fact, Olympic Gold Medalist Wendy Boglioli, who is now a spokeswoman for Genworth, said in a phone interview last week that not having long-term care insurance can be a real danger for women.

Women already take 11 years out of the workforce, she said, to take care of children and families, which means their retirement savings tends to be smaller, putting them at risk for outliving their retirement. And 90% of women will be solely responsible for their finances at some point in their life.

That is why it is important for advisers to talk to women about the options available to them to pay for long-term care costs. Boglioli said the options are: count on family, welfare (for the indigent and poor), self-insurance, and a long-term care policy.

“What I have seen in my experience in this industry is that families are either brought together or ripped apart by these decisions,” said Biglioli. “Having a long-term care strategy in place and having it in writing gives a family more resources. Without a strategy you are voluntarily putting your family at risk to make huge decisions financially, physically and emotionally.”

Ruthie Ackerman is the online editor of Financial Planning magazine, a SourceMedia publication.

My source: http://ebn.benefitnews.com/news/long-term-care-costs-fall-heavily-on-women-2684150-1.html#Login

The Unraveling Is Gathering Speed

man+umbrella+globalMy Comments: Yesterday, I posted an article that suggested what you might expect over the next six years if you are a generic investor. You have money positioned here and there across the globe in traditional investments. Today I post an article that posits further evidence that we have structural problems that need resolution.

The dilemma facing those who find themselves in charge of the national debate is that no amount of prayer is going to help. I’ve said before that HOPE is not an effective investment strategy, and by the same measure, PRAYER is unlikely to result in economic stability for future generations. Couple this with global warming and we’re looking at a tough road to hoe.

Charles Hugh Smith / Mar. 19, 2015

Does anyone else have the feeling that things are not just unraveling, but that the unraveling is gathering speed?
Though quantifying this perception is more interpretative than statistical, I think we can look at the ongoing debt crisis in Greece as an example of this acceleration of events.

The Greek debt crisis began in 2011 and reached a peak in 2012. The crisis was quelled by new eurozone/IMF loans to Greece, and European Central Bank chief Mario Draghi’s famous “whatever it takes speech” in late July 2012. The Greek debt crisis quickly went from “boil” to “simmer,” where it stayed for almost two and a half years. But no one with any knowledge of the gravity and precariousness of the situation expects the latest “extend and pretend” deal to patch everything together for another two years. Current deals are more likely to last a matter of months, not years.

We can discern the same diminishing returns in Federal Reserve/central bank interventions, as the initial rounds of quantitative easing pushed stock and bond markets higher for years at a time, while the following interventions generated lower returns.

What factors are reducing the positive effects of intervention and causing increased volatility? Let’s start with the engine behind every central bank/state intervention and every “save” of the status quo: debt.

Debt Brings Forward Consumption & Income
Debt has one primary dynamic: borrowing money to consume something in the present brings forward consumption and income. Economists describe trading future income for consumption today as bringing consumption forward. And since debt must be repaid with interest, bringing consumption forward also brings income forward.

Let’s say we want to buy a vehicle with cash, and it will take five years to save up the lump-sum purchase cost. We forego current consumption to save for future consumption.

If we get a 100% auto loan now, we get the use of the vehicle (present-day consumption), and in exchange, we sacrifice some of our income over the next five years to pay back the auto loan. We brought consumption forward, and in essence, took future income and brought it forward to pay for the consumption we’re enjoying today.

We can best understand the eventual consequence of this dynamic with a simplified household example. Let’s say a household has $2,000 a month in net income, i.e. after taxes, healthcare insurance deductions, etc., and rent (or mortgage payments), basic groceries and utilities consume $1,000 of this net income. That leaves the household with $1,000 in disposable income.

At the risk of boring finance-savvy readers, let’s briefly cover the difference between net income and disposable income. Net income can be earned (wages, salaries, net income from a sole proprietor enterprise, etc.) or unearned (dividends, interest income, rents, etc.) It can only rise by making more money or reducing taxes. There are limits to our control of these factors. In a stagnant economy, it’s tough to find better-paying jobs and harder to demand higher wages from employers. Since governments’ expenditures are rising, taxes are also going up; it’s difficult for most wage earners to cut their total tax load by much.

Disposable income is more within our control, as it is fundamentally a series of trade-offs between current consumption and future income/savings: if we choose to consume now, we have less income to save for future consumption or investments. If we sacrifice consumption today, we have more money in the future for consumption or investing. If we borrow money to consume today, we’ll have less future income, because a slice of our future income must be devoted to pay down the debt we took on to consume today.

If our household borrows money to buy a vehicle and the payment is $500 per month, the household’s disposable income drops from $1,000 to $500. If the household takes on other debt (credit cards, student loans, etc.) with payments of $500 per month, the household’s disposable income is zero: there is no money left to dine out, go to movies, pay for lessons, etc.

In effect, all of the future income for years to come has been spent.

The Only Trick To Expand Debt: Lower Interest Rates

There are only two ways to support additional debt: either increase net income, or lower the rate of interest on new and existing loans to free up disposable income. Suppose our household refinances its auto loan to a much lower rate of interest, and transfers its credit card debt to a lower-interest rate card. Huzzah, each monthly payment drops by $100, and the household has $200 of disposable income to spend on current consumption or on more loans. Let’s say the household chooses to buy new furniture on credit with the windfall. This new consumption brought forward pushes the monthly debt payments back up to $1,000.

This additional debt-based consumption profits two critical players in the economy: the state (i.e. all levels of government) and the financial sector. The state benefits from the higher taxes generated by the sales, and the financial sector profits from transaction fees and the interest earned on the new loans.

The household’s consumption and debt rose as a result of lower interest rates, but there is a limit on this dynamic: lenders have to charge enough interest to service the loan, reap a profit and compensate shareholders for the risk of default.

If lenders fail to properly assess the risk of default, they will be unprepared to absorb the losses incurred as marginal borrowers default en masse. This places the lender’s own solvency at risk.

Using this trick to enable further expansion of debt thus creates a systemic risk that borrowers will over-borrow and lenders will not have sufficient reserves to absorb the inevitable losses as marginal borrowers default and other borrowers suffer declines in disposable income that trigger further defaults.

In other words, the trick of lowering interest rates yields diminishing returns: the more debt that is enabled, the thinner the margins of safety, and thus, the greater the systemic risks rise in direct correlation with rising debt loads.

The Trick To Increase Consumption: Punish Savers
While lowering interest rates increases disposable income and enables an expansion of debt, it also generates a disincentive for households to forego current consumption by saving disposable income rather than spending it. Near-zero interest rates actively punish savers by reducing the interest income earned on low-risk savings accounts and certificates of deposit (CDs) to near-zero. Savers are pushed into either investing in high-risk markets that benefit the financial sector, or into spending rather than saving – a choice that benefits the state, as more spending generates taxes for the state.

The Global Expansion Of Debt Has Increased Systemic Risks
These are the basic dynamics of the entire global economy: interest rates have been pushed to near-zero to punish savers and encourage the expansion of debt-based consumption. But this inevitably leads to a reduction in disposable income and current consumption, as debt brings forward both consumption and income.
Once the borrowers have maxed out their borrowing power, there is no more expansion of debt or additional debt-based consumption. This is known as debt saturation: flooding the financial sector with more credit no longer boosts borrowing or brings consumption forward.

Those who brought their consumption forward can no longer add to present consumption, as their future income is already spoken for. That’s where the global economy finds itself today. This vast expansion of debt on the backs of marginal borrowers and the expansion of risky investments has greatly increased the systemic risk of losses from defaults arising from over-extended borrowers.

No wonder every attempt to further expand debt-based consumption is yielding diminishing returns: net income is stagnant virtually everywhere in the bottom 95% of the populace, and further declines in interest rates are increasingly marginal, as rates are near-zero everywhere that isn’t suffering a collapse in its currency.

The diminishing returns manifest in three ways: the gains from each round of central bank tricks are declining, the periods of stability following the latest “save” are shrinking and the amplitude of each episode of debt crisis is expanding.

That the unraveling is speeding up is not just perception – it’s reality.

My source: http://seekingalpha.com/article/3012436-the-unraveling-is-gathering-speed?ifp=0

Retiree Health Costs And Employee Ignorance

retirement_roadMy Comments: This article appeared recently in a weekly summary of articles designed for advisors whose clients are typically small businesses. At this point you need to ask for a definition of “small business”.

It depends. About 30 years ago I qualified to attend an insurance conference. I was roomed with a fellow advisor from Pittsburgh and we were talking about an idea appropriate for a “small business”. I suddenly asked him what he meant by a “small business”. His response was a company with annual revenue of from $25M to $100M. He said there were hundreds of them where he lived.

In 1985, here in Alachua County, there might have been one private employer whose annual revenue exceeded $50M. My definition of “small business” was a company with from 3 – 25 employees with revenue of maybe $1M per year. No wonder I never qualified for the annual trips.

Meantime, here we are in 2015 and wondering how we are going to finance the health care costs in our respective retirements. It’s not a pretty picture.

by Richard Stolz / MAR 16, 2015

How many of your employees will be short of money in retirement if they ignore the prospect of requiring long-term care? Answer: All of them.

Many employees, already under the gun to save enough to pay for nonmedical expenses in retirement, are in even worse shape when anticipated future medical costs are factored in.

For example, nearly half (48%) of consumers believe that the total amount they’ll need to spend on healthcare in retirement won’t exceed $50,000. Moreover, only 15% of pre-retirees have even estimated the level of health care costs they will face in retirement. The average 65-year-old couple retiring today, meanwhile, can expect to need $220,000 to cover medical expenses, not including long-term care.

The findings come from research of 500 employers and 1,005 consumers conducted by Alegeus Technologies, the consumer health care funding platform, and a third-party research firm.

HSA misconceptions
The survey also revealed that consumers have a lot of misconceptions about health savings accounts. For example, 65% seem to confuse HSAs with health reimbursement accounts, believing that they would forfeit any un-spent HSA funds at the end of the year, as is the case with HRAs. That might not be surprising, because 71% of those polled “are not enrolled in any tax-advantaged benefit accounts,” according to Alegeus.

HSAs can only be offered in conjunction with a high deductible health plan. But the definition of “high” today isn’t very high – a deductible exceeding $1,300 for single coverage, and $2,600 for family coverage.

HSAs, Alegeus suggests, can serve as a very effective long-term saving and investment vehicle to help employees prepare for health costs in retirement. The key is for employees not to tap too deeply into their HSAs to pay for health costs prior to retirement.

HSAs are funded with pre-tax dollars, and aren’t taxed when used to pay medical expenses. That makes them superior to 401(k)s and IRAs, which are taxed at the back end.

Avoiding penalties
As with IRAs and 401(k)s, funds withdrawn too soon from HSAs (assuming it’s for a non-medical purpose) face a penalty tax – 20%, plus regular income tax. That penalty disappears after age 65. Unlike retirement accounts, HSAs have no minimum annual distribution requirements.

Today’s annual HSA contribution limits are $3,350 for employees with single coverage, and $6,650 for family coverage, suggesting that employees who save aggressively in HSAs can put a big dent in their future health cost needs.

That is rarely done, however. According to Employee Benefit Research Institute data, only 15% of HSA owners make the maximum annual contribution. Employees would be wise not to, however, if they had not already contributed up to the maximum amount in their 401(k) that is eligible for an employer match.

Barack Obama’s Gamble on the Future of Iran

Nixon+ChinaMy Comments: I must confess to being tired of all the crap going on in politics, whether its local, state, national or international. Increasingly my opinions, concerns, fears, hopes, expectations, etc., seem irrelevant. The temptation is to walk away and try to ignore it.

That’s an emotional response and there’s a parallel with my universe as a financial planner. I’ve preached that “hope” is not a valid investment strategy. To be successful, you have to be proactive and alert and overcome emotion. And there’s still a chance you’ll fail. The alternative is to roll over and die. Which is not going to happen.

With respect to Iran, I don’t see a reason not to try and work with them. We hated China, and we are now friends. We hated Japan, and we are now friends. We hated Germany, but are now friends. Hell, if you go back far enough, we hated the French. At some point, someone has to reverse course and I see no reason to favor war without first trying to establish a negotiated truce. For that to happen, you have to at least talk with them.

Edward Luce March 15, 2015

At stake is the idea that talking to your worst enemies makes sense

President Barack Obama is poised to take the biggest foreign policy gamble of his presidency. Ignoring opposition at home, and near unanimous dissent in the Middle East, he looks likely to push ahead with an Iran nuclear deal in the coming days. His bet is that the world’s most hardline theocracy can be induced to change for the better. Over time Iran’s silent majority will gain sway over their ayatollahs.

At stake is the idea that talking to your worst enemies makes sense. Mr Obama’s bet on diplomacy could hardly differ more from George W Bush’s world view. Yet they share a weakness — the belief that one inspired move can transform the game. Mr Bush thought he could implant democracy in the Middle East by toppling its most brutal autocracy. Mr Obama hopes to create stability by engaging its most dangerous regime. In American football they call this a ‘Hail Mary’ pass. Will Mr Obama’s fare any better?

The more you listen to Mr Obama’s critics, the more you sympathise with his approach. From Israel’s Benjamin Netanyahu to Saudi Arabia’s rulers and nearly every Republican in the US Senate, Mr Obama’s detractors believe Iran’s word is not worth the paper it is written on. At best, Mr Obama is naive. At worst he is un-American. Making deals with a rogue regime betrays US values.

In fact, such trade-offs are very American. For the greater good, Franklin Roosevelt struck an alliance with Joseph Stalin, one of history’s most prolific mass murderers. Richard Nixon made peace with Mao Tse Tung, who killed even more people than Stalin. Jimmy Carter and Ronald Reagan backed Afghanistan’s mujahideen. By these standards, Iran’s transgressions are small potatoes.

Furthermore, Iran poses no threat to America’s universal values. Communists claimed to speak for all mankind. Iran only appeals to about 2 per cent of it — the world’s Shia population. As Mr Obama was fond of quoting John F Kennedy: “If you want to make peace you don’t talk to your friends, you talk to your enemies.”

Mr Netanyahu says no deal is better than a bad one. Here again, Mr Obama is more grounded in reality than his critics. If the choice is between a bad deal or war, the former is far better. Others glibly talk about bombing Iran. In an ideal world, Mr Obama would have persuaded Iran to dismantle its civil nuclear programme, rather than capping its resources at a low ceiling. The deal would hold indefinitely rather than for 10 to 15 years. Iran’s “nuclear breakout time” would last for ever, rather than just a year. Tehran would end its support for Hizbollah, Syria’s Bashar al-Assad and others, rather than pledging to do nothing. It would also be legally binding, rather than a political document. Alas, no such terms are realistic. Mr Obama is not permitting the perfect to be the enemy of the good.

So what could go wrong? The flaw in Mr Obama’s logic is that Tehran will pay no real price for breaking its word. Compared with five or 10 years ago, it is negotiating from a position of strength. If it implements the deal, Mr Obama will gradually relax economic sanctions. If it breaks its word, they will be reimposed. Iran’s worst case scenario would mean reverting to today’s status quo. What does it have to lose? This is where Mr Obama’s innate reasonableness can count against him. His administration insists that “all options remain on the table” — including military strikes. But Mr Obama makes no secret of the fact that he would never exercise that option.

His hope is that Iran’s moderates, led by Hassan Rouhani will gain popular support as growth picks up with the gradual lifting of sanctions. Domestic backing for the deal would therefore rise. In turn, Iran will dilute its sponsorship of the Shia militias and terrorist groups in the region. Moderate Sunni regimes will also pull back. The logic of economics will replace the lure of sectarianism. Mr Obama would have converted today’s vicious circle into a virtuous one. It is an optimistic vision that is worth pursuing. No one has any better ideas. But it needs a plan B and Mr Obama does not seem to have one.

His approach has two further drawbacks. First, the US-led war on the Islamic State of Iraq and the Levant is largely being fought by Iran and its Shia allies in Iraq and Syria. Mr Obama is relying on an unspoken alliance with Iran to do most of the fighting. Mr Obama’s reluctance to put US boots on the ground has increased Iran’s leverage.

Second, America’s Sunni allies, led by the Saudis, Egypt and Turkey, believe Iran will bide its time before abandoning the deal. It will first pocket the rewards. They have little faith in Mr Obama’s grasp of Iran’s internal dynamics. Ayatollah Khamenei’s declining health adds another imponderable. The danger of a Middle East nuclear arms race has never been greater.

Mr Obama risks sharing another legacy with his predecessor. Mr Bush tried to install democracy at the point of a gun. In practice he created a vacuum that was filled by Iran. Baghdad became a satellite of Tehran, which is what it remains today. Iran was the largest beneficiary of Mr Bush’s blunders in the Middle East. Its power has continued to grow during the Obama years. It would be an irony if the impending deal were only to cement that trend.

5 Annuity Questions With Rational Answers

Piggy Bank 1My Comments: Every year, many BILLIONs of dollars flow from the pockets of Americans into a financial contract called an “annuity”. Originally, the idea was to give an insurance company some of your money, and they would agree to send it back to you, with interest, over time.

Over the years, the sophistication of these contracts has grown exponentially and they come in more flavors than seems possible. The latest have features that appeal to many of us who are increasingly older, fully understand the temporary nature of life, and are unwilling to simply curl up in a ball and hope for the best.

They are not always cheap, ie the internal costs can be serious, but we both know that most good things in life are not cheap. But you have to either know how to evaluate what you are paying for or find someone you trust to help you. The fact that so much money is flowing into them suggests there is are rational reasons to use them. (I’ve edited this slightly since it was written for advisors and not the general public.)

Jan 21, 2015 | By Chris Bartolotta

It’s no secret that there are a lot of misconceptions out there about annuity products. You make it clear that you’ve got some preconceived (and often incorrect) assumptions when you ask the following questions.

1. Aren’t fixed annuities bad for clients?

Let’s get this one out of the way first. Even setting aside the fact that there are numerous different types of annuities, and hundreds of products of each type, there is no such thing as a category of financial products that is inherently “bad.”

That’s not to say that annuities are right for everyone; that would be equally absurd. As with most things in life, the answer lies somewhere in between. What is good or bad for a client depends heavily upon their individual circumstances. The ideal client for a fixed annuity is typically at or near retirement age, has $100k or more in liquid assets, and has a low risk tolerance. Even within that subset of the population, though, there are myriad options available. Should they look at a SPIA? A DIA? An indexed annuity? Should they buy an income rider or not?

Saying that all annuities are bad is like saying all cars are bad. If you have a one-mile commute to work and don’t travel much, you probably shouldn’t be driving an SUV. If you’re a contractor who regularly hauls heavy equipment on the job, a coupe isn’t going to work well for you. The same principle holds true for annuities, or any other financial tool.

2. What’s the interest rate on this SPIA?
Somewhere, an actuary is reading this section header and laughing. Asking about the interest rate on a SPIA points to a fundamental misunderstanding of what a SPIA is and what it’s supposed to do, which makes it all the more unnerving to the annuity-savvy advisor that this question gets asked all the time.

A SPIA, shorthand for Single Premium Immediate Annuity, is what most people think of when they hear the word “annuity.” If you need to explain it in one sentence, it’s an exchange of a lump sum of cash for a stream of payments over a certain period of time, typically the client’s lifetime.

Since an insurance carrier doesn’t know the exact day you’re going to die, it would be extremely difficult — not to mention downright irresponsible — for them to try to price it for maximum earnings over the agreed-upon time period. It’s true that a carrier will sometimes try to be consistently the best in a certain client sweet spot — females aged 64 to 69, for example — but if you’re using SPIAs to try to earn tons of money, you’re not using them correctly. They should be used to cover known, fixed expenses. Accumulation of interest is best left to a deferred annuity or to investments.

3. How can I get a hybrid annuity?
The answer to this one is very easy. You can’t.

The term “hybrid” often gets thrown around by websites purporting to be about consumer advocacy, which typically tout market upside without any downside risk. While this technically does describe certain aspects of a fixed-indexed annuity, these are not “hybrid” products in any sense of the word. They are a well-defined class of annuities that are distinguished by certain features, just like any other product.

The theory these sources will claim is that, because the product is tied to a market index but protects against loss, you have a combination of the best parts of a fixed and a variable product. The reality is that while it’s true that a market index is used to determine gains in a given year, at no point is your money actually being invested into the stocks (or commodities, in some cases) in that index. They also often paint a rosy picture where the client can catch all of the booms in the market without suffering any of the busts. In reality, because it is still a fixed product, it can do better than a traditional fixed rate, but single-digit interest is still going to be the norm. This actually leads nicely into the next question you should immediately eliminate from your annuity lexicon …

4. How much should I invest in a fixed annuity?

Another easy answer here. Nothing.

That isn’t to say your clients shouldn’t buy annuities. It’s likely that some of them absolutely should. The issue here lies with thinking of fixed annuities as an investment, when in fact they are an insurance product. After all, you need a life license to sell them, not a securities license.

When your clients think of their fixed annuity as an investment, this creates the probability that they will begin comparing it to an actual investment, in which case the interest earned will start to look poor in a hurry. It behooves you to remind them that they are purchasing this product for guarantees, not to get rich. To put it another way, explain to them that fixed annuities are the mirror image of life insurance. Their life policy insures against the financial consequences of an early death; their annuity insures against the financial consequences of a long life.

5. Aren’t annuities expensive?
No trick question this time. The answer to this one is: It depends.

Annuities are often decried as being a poor choice due to the high fees involved. A base fixed annuity contract with no riders included, however, will have no fees at all.

Now, it’s true that a fixed annuity can have fees. Most indexed annuities and a handful of traditional fixed contracts have the option to add an income rider, and the vast majority of those carry an annual fee. It’s usually slightly under one percent, though some are more expensive, and some less or even free. Other types of riders, such as an enhanced death benefit option, may also be available and carry their own fees. It’s up to the agent or advisor to ensure the consumer knows what they are so they can decide if they’re worth the cost.

The White House and Hidden Retirement Fees

InvestMy Comments: It’s fairly easy to paint Wall Street as a villain in almost any article that deals with the management of money for the vast majority of Americans. After all, they typically act in their own best interest, which may or may not coincide with what’s in my best interest. But that’s the American way, isn’t it?

Here I’m reminded that if I’m bound by a fiduciary standard, as is my attorney, my doctor, my CPA, and by some of us in financial services, I have a legal, moral, and ethical obligation to do only that which is in my client’s best interest. And working hard to find ways to not disclose the fees I’m charged seems to violate what is in my best interest as a consumer.

Don’t expect this effort to remedy the problem to come from politicians who are in bed with Wall Street firms.

By Matt Levine February 24, 2015

The way that a lot of retirement investing advice goes is that you go to your broker and ask him what you should invest in, and he says, “Oh Fund XYZ is great, put all your money in Fund XYZ,” and the reason he does that is not that he loves Fund XYZ in his heart of hearts, but rather that Fund XYZ writes him a big check for steering you its way. I’m sorry, but that is the way it works. I mean maybe he also loves it in his heart of hearts, but that is not observable; the check is. As is Fund XYZ’s subsequent underperformance versus its benchmark.

A lot of people think that that is a bad system, and how could you blame them really? When I put it like that it just sounds terrible. U.S. President Barack Obama’s administration, in particular, seems not to like this system, and today the White House released this fact sheet (“Middle Class Economics: Strengthening Retirement Security by Cracking Down on Backdoor Payments and Hidden Fees”), and this report from the Council of Economic Advisers (“The Effects of Conflicted Investment Advice on Retirement Savings”), explaining how bad some retirement advising is. (Some: The administration also has high praise for the “hardworking men and women” who work as fee-only investment advisers.) New Labor Department rules are coming that would, if not quite outlaw these practices, at least make them more awkward, and part of the point of today’s releases is to justify those rules.

More On Legal & Compliance from The Advisor’s Professional Library
• Differences Between State and SEC Regulation of Investment Advisors States may impose licensing or registration requirements on IARs doing business in their jurisdiction, even if the IAR works for an SEC-registered firm. States may investigate and prosecute fraud by any IAR in their jurisdiction, even if the individual works for an SEC-registered firm.

• Trading Practices and Errors When SEC-registered investment advisors conduct annual audits of firm policies and procedures, they should pay close attention to trading practices. Though usually not required to, state-registered advisors should look at their trading practices and revise policies that do not fully protect clients.

We don’t have the rules yet, though there is already a rather enormous literature on what they will or should or won’t or shouldn’t say. But we do have the Council of Economic Advisers report, and it is pretty interesting! The main conclusion is that “conflicted investment advice” costs Americans about $17 billion a year.

The math here is:
— There’s about $1.7 trillion in individual retirement accounts invested in funds that pay brokers to recommend them.
— The people who invest in those funds could improve their performance by about 1 percentage point a year by switching to other funds that don’t pay brokers.

Pages 17-18 of the report walk through the second point in some (stylized) detail. The report assumes an employee who invests in a low-cost index fund through her employer’s 401(k) plan. The expected gross return on the index fund is 6.5 percent, but the employee pays trading and administrative costs of 0.5 percentage points, for a net return of 6 percent. But then she quits her job, and an unscrupulous adviser recommends that she roll over her retirement fund into a new individual retirement account — and that she invest the IRA in a fund with a similar expected return, but with 1.5 percentage points of costs. She gets a net return of 5 percent, and the adviser and the mutual fund split the extra fees among themselves.

This math looks a little familiar. The Vanguard Group will cheerfully compare expense ratios of its funds against other funds, because Vanguard largely markets itself as the popularizer of low-cost index funds. Here for instance is a little thing from Vanguard’s description of its Total Stock Market Index Fund:

Vanguard feesI highlighted the 1.08 percent average expense ratio of “similar funds,” which is 1.03 percentage points higher than Vanguard’s advertised expense ratio. The Investment Company Institute finds an average expense ratio of 0.89 percent for actively managed equity funds, versus 0.12 percent for equity index funds, or a 0.77 percentage point difference. Also the actively managed funds tend to underperform the passive funds even before taking out fees, though that is a sensitive topic.

So you might conclude that somewhere between three-quarters and all of the costs of “conflicted investment advice” are really just costs of actively managed mutual funds. In other words, all the stuff about “backdoor payments” and “hidden fees” and “fiduciary duties” is a non-load-bearing distraction. Most or all of the work in the CEA paper is done by the difference in costs between actively managed mutual funds and passive indexing. The conflicts of interest boil down to: It is in the financial industry’s interest to steer investors into high-fee active funds rather than low-fee passive funds.

I don’t really know what to make of that. It would be weird if the White House put out a fact sheet called “Strengthening Retirement Security by Cracking Down on Active Investing.” And obviously that’s not quite what it’s going for with this paper. But it’s close. The world view underlying this report seems to be that a lot of what the financial industry does is extract unproductive fees for itself from ignorant consumers, and that you can crack down on the fees — and save consumers money — without reducing the incentives for any socially productive activity. This, it goes without saying, is a hugely popular theory. I feel like it is generically wrong, but there may be many, many places where it is specifically correct.

In my more dictatorial moods I think people should get to choose one of two options for their retirement investing:
1. You can invest only in a list of pre-approved, low-cost, fee-capped, diversified, probably mostly passive portfolios run by reputable managers, and if you lose money everyone will nod sympathetically and tell you it’s not your fault.
2. You can sign the omnibus liability waiver and invest in whatever you want, just go nuts, but if you lose all your money it’s a felony to complain.

But that is not the system we have now. It’s almost the reverse: The people with the least money and expertise, who really want and ought to have simple low-cost generic retirement savings, are at high risk of being steered into weird expensive stuff. It seems reasonable enough to try to nudge them back toward simplicity.

1. The White House fact sheet has some general (and tendentious) description of the new rules. Here is Bloomberg News, the Wall Street Journal, InvestmentNews, a Vox explainer. Here is Sifma expressing unhappiness, and more from Sifma on the topic. Here is a memo from Debevoise & Plimpton for the Financial Services Roundtable, also opposing the rule. Here is an FAQ from the Labor Department, and here are all the comment letters on the fiduciary-duty rule that the Labor Department proposed in 2010 and then withdrew because it was too drastic.
Since I have you here, two generic things that I think about fiduciary standards are:
1. It is impossible to make all broker-dealers fiduciaries, and trying to do so is a category mistake: Dealers are principals, and if you are selling someone something that you own, you can’t be asked to put her interests above your own. You would prefer a high price, she would prefer a low price, and making you give it to her for free because you are her fiduciary makes no sense at all.
2. There is an argument of the form, “If we couldn’t scam people quietly, we couldn’t afford to provide them the services that they need.” This argument is distasteful, but that doesn’t make it wrong. There are probably places where it is right. Arguably being sold on an expensive bad retirement plan is better than not being sold on any retirement plan and forgetting to save for retirement.
That said, I weakly think that neither of these things apply to retirement-plan brokers. They’re not acting as principal, so there’s no category-mistake problem in making them fiduciaries. And if you’ve got a retirement plan anyway — the new rules seem to be mostly about recommending rollovers and changes in allocations in existing 401(k)s and IRAs — then being sold a bad plan is probably not going to improve your situation. In that vein, the CEA report describes one mystery-shopper study:
The study finds that advisers recommend a change to the current investment strategy in about 60 percent of cases when the client had a return-chasing portfolio and in about 85 percent of cases in which the client had a diversified low-fee portfolio. The authors conclude that advisers “seem to support strategies that result in more transactions and higher management fees,” even when clients appear to hold the optimal portfolio.
Yeah that doesn’t seem like an improvement. (Try the Debevoise memo for a persuasive case the other way; Question 8 in the Labor Department FAQ is a good rebuttal.)
2. The fact sheet characterizes this as “$17 billion of losses every year for working and middle class families,” which is just plainly not true. The $17 billion number is for all “load mutual funds and annuities in IRAs,” or individual retirement accounts, as you can tell from page 19 of the report. Presumably a lot of IRAs are held by people who are not “working and middle class.” Mitt Romney has a notably large IRA, though I guess it’s not invested in load mutual funds.
Incidentally the report notes that “more than 40 million American families have savings of more than $7 trillion in IRAs,” meaning that that $17 billion comes to about $425 per year, per family with an IRA.
3. The stylized version is different from the actual version, which cites academic studies finding a wide range of underperformance. The report hangs its hat mostly on one study finding 113 basis points of underperformance.
4. As I’ve disclosed before, a lot of my money is in Vanguard funds (mostly though not all index funds), and I am personally a fan of their work.
5. Vanguard’s footnote cites to Morningstar for that average.
6. Also an interesting one. Here is a good post from Josh Brown, which we’ve discussed previously. Some amount of active underperformance is driven by specific market circumstances: For instance, active managers tend to favor certain factors that underperformed in 2014. Some of it is arithmetic: Everyone can’t be above average, and if everyone in the equity markets is a professional (not true, but becoming more true), then most professionals can’t be above average either.
7. Is this one? Well, what is “this”? It seems obvious to me that some amount of active allocation of equity capital to businesses is socially desirable, so rules that strongly disincentivize active management would be bad. But you don’t need rules to disincentivize it: Active management is more expensive than passive management, so the market should more or less discourage people from paying for it. The question is how to subsidize it, if it’s socially desirable. (I mean, not really, but something like this; we’ve discussed this topic recently.)

It is less obvious to me that the things the White House is explicitly objecting to — conflicted payments for investment advice, basically — are socially desirable, though again there is an opposing argument. Also note that these conflicted arrangements might be one way to subsidize active management, although actively allocating capital on behalf of bamboozled principals doesn’t seem socially optimal either.

— To contact the author on this story: Matt Levine at mlevine51@bloomberg.net

Long-Term Care and Who Will Pay For It

Pieter_Bruegel_d._Ä._037My Comments: Selling long-term care insurance has been a tough sell for me. It’s less appealing than life insurance and statistically, it’s less likely to happen than death. It’s an emotionally charged issue that’s hard to deal with rationally.

The major player in the long-term care insurance policy world is Genworth Financial. They’re on the hook for billions of dollars of benefits and are running out of money. You can argue emotionally that they should have known better, but rationally, if the money’s not there to pay benefits, they don’t have the ability to print it.

This possible outcome puts more pressure on all of us to better understand the dynamics of this and to make the best possible decisions about our personal future financial freedom. Find someone skilled to help you make a decision that it’s your best interest.

March 3, 2015 • Bloomberg News

Here’s an uncomfortable question: who’s going to pay for mom or dad’s nursing home bill — or yours, for that matter?

The answer, for about 1.2 million Americans, is Tom McInerney. McInerney, 58, is the chief executive officer of Genworth Financial Inc., the beleaguered giant of long-term care insurance.

McInerney is in a tight spot, and it’s getting tighter. Long-term care policies written in past decades have turned into a black hole for the insurance industry. Executives misjudged everything from how much elder care would cost to how long people would live. Result: these policies are costing insurers billions.

Genworth is struggling to contain the damage and on Monday warned of a “material weakness” in some of its accounting. To cope with mounting costs on the policies, Genworth has been raising premiums again and again. Some policyholders are furious.

“I was mad as hell,” says Arthur Mueller, an 83-year-old former real estate executive who lives in Dallas. Over the past 15 years, his annual Genworth premium has roughly doubled to $6,879.

There’s no quick or easy fix for Richmond, Virginia-based Genworth, which has posted two straight quarterly losses. The stock fell by more than half in the past 12 months, including a 5.4 percent slide Monday after disclosing the accounting weakness.

Genworth and other insurers have had to contend with the confluence of three powerful forces. The first is the rising price of elder care. Nationwide, the median cost of a private room in a nursing home is now more than $87,000 a year, after annual increases of 4 percent over the past five years, according to Genworth.

Bond Yields

Adding to the problems, interest rates have plunged to record-low levels. Insurers need to invest funds for decades before paying out on long-term care claims, so low rates hit profits from those policies particularly hard.

The third challenge boils down to demographics: America is graying. Nearly a quarter of Americans were born between 1946 and 1964, the typical definition of the baby boom generation. That’s more than 75 million people. By 2050, when the youngest boomers will be in their 80s, long-term elder care will devour about 3 percent of the U.S. economy, up from 1.3 percent in 2010, the Congressional Budget Office projects.

Given that, you might think more people would be opting for long-term care insurance, which typically covers nursing home costs and home health aides. But just the opposite is happening. Sales are falling, and big insurers like MetLife Inc. and Prudential Financial Inc. have stopping writing new policies.

Market Failure

“What’s happened over the last five, six years is an example, frankly, of market failure,” said Howard Bedlin, vice president for public policy and advocacy at the National Council on Aging. “There was a slew of pretty significant premium increases.”

Still, Genworth executives like McInerney, who joined in 2013, have said they’ll get it right eventually.

“While the product and the market has had its challenges, somebody is going to figure this out,” said Chris Conklin, a senior vice president at Genworth. “We’re sure going to try hard to have us be the ones that do it.”

But time is short. And it’s unclear if anyone can figure out long-term care insurance, at least in its current form. A.M. Best says that long-term care policies are among the riskiest products that life and health insurers offer. Standard & Poor’s and Moody’s Investors Service both downgraded Genworth’s debt ratings to junk in recent months, citing the pressure from long- term care policies.

Family Assistance

Genworth says that even with higher premiums, its old products are a good deal for customers. Despite his higher costs, Mueller says he’s sticking with his policy, given his age, the amount he’s already spent in premiums, and what nursing-home care could end up costing. His main concern, he said, is whether Genworth will still be strong enough to pay for a nursing home if he ever needs one.

Fact is, long-term care insurance might make little sense for many people. More than half of all elder care tends to be provided informally by family members. Government programs cover much of the rest.

Such insurance works best for people who want more costly care than is covered by Medicaid, according to Jeff Brown, a professor at the University of Illinois.

Karen Marshall said she’s learned how costly care can be without the insurance. She took leave from a high-paying job as an attorney at Dewey & LeBoeuf when she was in her 30s to take care of her mother in her final months of battling cancer. Soon after her mother died, Marshall’s father’s health deteriorated, and she left the firm.

‘Daunting Problem’

Marshall, 40, was spending her weekends driving back and forth from Washington to the home where she grew up in southern Virginia. Working as a corporate lawyer wasn’t an option.

“I just kind of felt like I had my back against the wall,” she said. “I spent so much time worried about dropping the ball for someone, whether it be my dad or work.”

Her father is now in an assisted-living facility that costs more than $2,500 a month, and Marshall says he’ll eventually have to move to a nursing home that would cost twice as much. Marshall, who takes on legal work to pay the bills, and started a nonprofit to aid other caregivers like herself, has been helping cover the costs. She says her dad will eventually end up on Medicaid.

Policy makers have been trying to figure out how to cope with the nation’s elder-care bill but so far have come up with few answers. A plan for long-term care insurance tied to the Affordable Care Act was scrapped by the government.

Genworth says insurance is just part of the solution to paying for long-term care. The company is exploring new products that could have more limited benefits and cost less, and ideas like government partnerships.

“It’s a daunting problem for the whole country, really,” Genworth’s Conklin said. “We at Genworth have really committed to try to come up with better solutions for people.”