Sunday, December 3, 2023
Home Authors Posts by Charlie Gipple, CFP, CLU, ChFC

Charlie Gipple, CFP, CLU, ChFC

Charlie Gipple, CFP®, CLU®, ChFC®, is the owner of CG Financial Group, one of the fastest growing annuity, life, and long term care IMOs in the industry. Gipple’s passion is to fill the educational void left by the reduction of available training and prospecting programs that exist for agents today. Gipple is personally involved with guiding and mentoring CG Financial Group agents in areas such as conducting seminars, advanced sales concepts, case design, or even joint sales meetings. Gipple believes that agents don’t need “product pitching,” they need mentorship, technology, and somebody to pick up the phone… Gipple can be reached by phone at 515-986-3065. Email:

Long Term Care Linked Benefit Products: Too Good To Be True?

One of the goals that I have as I work for my agents across the country is to guide them on which is the best product for their client’s situation. Impartial and unbiased product knowledge and strategies is what agents want. Needless to say, I analyze a lot of annuity, life, and long term care products. The point is, of a large universe of these products, there are two areas that really excite me today when it comes to product innovation. What are those two areas that excite me the most? It would be a tie between annuities and the topic of this article—linked benefit long term care products.

Too good to be true?
Linked benefit products have gotten so good that many times I get the responses of “Are the benefits really guaranteed?” or “It seems too good to be true.” Skepticism is warranted, because when people think of long term care insurance, they think of traditional LTCI. And with traditional LTCI, many folks have experienced significant premium hikes as the years have gone by. Plus, with traditional LTCI, if you don’t use the benefit, you lose the benefit and the premium you paid. Therefore, the fact that many linked benefit products have 100 percent guaranteed benefits and also have a death benefit and cash value, this creates skepticism among the clients. In this article I wanted to spend a couple minutes discussing why and how the benefits are not “too good to be true” and are indeed sustainable for the insurance carriers to offer. By the way, Traditional LTCI, I believe, is more sustainably priced than previous generations for reasons I will discuss.

First, what is a linked benefit?
A linked benefit long term care product is a subcategory of the broader “Hybrid/Combination Long Term Care” category. What differentiates a linked benefit product from just the products with accelerated benefits (AOB) is that the linked benefits also have a “Continuation of Benefits Rider” or “Extension of Benefits Rider,” depending on the vernacular the carrier uses. Example: Many life insurance policies have AOBs on them where the death benefit—and only the death benefit—can be accelerated for chronic illness or long term care purposes. Conversely, a linked benefit product has the death benefit that can be accelerated (via the AOB) but then, once the death benefit is fully depleted, there is a COB or EOB that kicks in to provide additional long term care benefits. So, with linked benefits you can get multiples of the death benefit in long term care benefits if we are talking a life insurance linked benefit product. With linked benefit annuities you can get multiples of the accumulation value in long term care benefits. The presence of the COB/EOB is what makes a linked benefit product a linked benefit product.

Back to the Question:
Are these products too good to be true? No, they are awesome products but the actuarial logic that goes into these products make them very sustainable to create and price. The semi-actuarial reasons are:

1) Interest rates: This not only goes for linked benefits, but also for traditional long term care insurance. We all know that when an insurance company takes the premium, they put it into their general account, which hopefully grows in value so that the carrier can dip into their general account to pay claims. The higher interest rates are for the carrier, the easier it is to pay claims over time all else equal. Today, interest rates are much higher than they were just one or two years ago. This helps the carriers pay claims! However, this rate environment may not last forever so it also comes down to what are the long term interest rate projections that the carrier is assuming as they price today’s products? Today, carriers have much more reasonable long term projections of interest rates than they did a couple of decades ago. A couple of decades ago carriers assumed fairly high interest rates which allowed for low premiums, at least until interest rates substantially decreased. At that point, the clients got love letters from the carrier saying that their premiums on their long term care policies were going to increase! Today, carriers are much more rational with their long term interest rate projection. So, whether it’s traditional long term care or linked benefits, I believe that premiums are much more sustainable going forward. Besides, with most linked benefit products, the premiums are rock solid 100 percent guaranteed.

2) Lapse assumptions: The best thing that can happen for the carrier with traditional LTCI or linked benefits is that the client pays premium for quite a while (long enough for the carrier to offset the acquisitions costs plus profit) then stops paying the premium and the policy lapses without the carrier ever paying a claim. Once upon a time carriers had lapse assumptions of over five percent. Oversimplified Example: At a five percent lapse assumption, the policies that are written this year will be completely off the carrier’s books over a 20-year period of time. This means that the carrier would be free of any claims on the policies written this year because “all” the policies would be lapsed by year 20!

These overzealous lapse assumptions did not happen! Folks that had LTCI generally held onto their insurance until they went on claim. Even after carriers increased the premiums, clients generally did not lapse their policies. In actuarial terms, the “shock lapse” did not meet the carriers’ expectations. Policy owners were extremely resilient in continuing to pay the premiums, which is a testament to how the consumers valued their policies! So, because very few clients lapsed their policies relative to what was projected to lapse, unfortunately some carriers imploded from their inability to pay claims. Today, carriers are generally assuming that consumers continue their policies until there is eventually a claim and are pricing policies accordingly. This helps with the sustainability of premiums for traditional LTCI and helps the insurance carriers remain financially strong.

3) High deductible: Linked benefit products are very sustainable because they are very similar to high deductible health plans. What do I mean by that? Whether that linked benefit product is an annuity that has an accumulation value or a life insurance policy that has a death benefit, the long term care benefits paid are reducing the client’s accumulation value or death benefit first. The first dollars come from the client’s pocket! For example: Assume a client has a $100,000 death benefit on their linked benefit life policy. They also have a long term care pool of $200,000. If the client goes on claim, the first $100,000 in long term care benefits will reduce the death benefit to essentially zero (residual DBs are usually a part of these policies). That means that if the client were to pass away, then the life insurance policy will not pay out a death benefit at that point (or a very small one). But overall, the client wins because they get up to $200,000 in long term care benefits. Another example: If a consumer has a linked benefit annuity with $100,000 in accumulation value but a long term care benefit of $300,000, the first $100,000 in long term care benefits comes from the client’s accumulation value. Although not technically a “high deductible health plan,” it has a similar trait that allows the carrier to better price this product type.

4) Consumer behavior: With traditional long term care, it is a use it or lose it proposition. Therefore, if the client so much as stubs their toe, they may try to go on claim. A bit of an exaggeration I know. But the clients are very inclined to try to use their policy when they can so they get something out of it. Conversely, with linked benefit products, the client is using their own money at first. This leads to lower claims experience at the insurance carrier for linked benefit products.

Opportunity exists when there is a gap in the need that a consumer has and how much of that need has been addressed. I won’t bore you with statistics around long term care that we all know. What I will say is, when you compare the number of people that will need long term care insurance to those that currently have it, the opportunity for you, the financial professional, is huge.

I hope this article provides you with some confidence and knowledge on traditional LTCI, AOB riders, and linked benefit products. It is now up to you to broach this conversation with your clients.

ChatGPT And I Discuss Estate Planning And Living Benefits: What Grade Would I Give AI?

Created by OpenAI, ChatGPT is one of a few different platforms that people are talking about today. This is a chatbot where you can punch in questions and it will answer you back. This is a class of artificial intelligence that uses “Machine Learning.” Machine learning is where the system basically “learns” and collects data as time goes by. Think of a chess game. If you are a veteran chess player, the history of the moves that the other person takes as well as your predictions on what they will take usually informs us of what our next move should be, based on our history of success with making that next move. If you are a newbie to chess, you don’t have much intuition about your competitor’s previous moves and you have very little prediction powers on next moves. Well, “machine learning” has an almost infinite capability of remembering the past patterns and then drawing inferences into the future. ChatGPT does this not with chess, but with almost any question you throw at it.

What is my verdict on if AI is going to replace the financial professional anytime soon? I will opine on that at the end of this article. But first, feel free to eavesdrop on a conversation between me and AI (ChatGPT).

On my LinkedIn page (have you “followed me” yet?) I recently discussed a bit of a case study where a client came to me and said his dad wanted to either “gift” the farm to him now or wait until after he (the dad) dies to pass the farm on via inheritance. I think this is a great topic to discuss with ChatGPT because it is very nuanced in that there are many things to take into consideration; estate taxes, stepped up cost basis, gift taxes, Medicaid, etc. So, let’s see if the system can hang with us mere mortals.

Without boring you with the nuances of this exact case, my preliminary recommendation without speaking with his dad—as we will—is that the land will likely be better passed on after death rather than via gifting, largely because of the stepped-up cost basis tax treatment. Don’t know what that is? ChatGPT will tell us in a bit.

Now, in hindsight, let’s take the above example and see if my client could have received the same advice that I gave him by using ChatGPT.

My question to ChatGPT:
“Should I gift my assets, or should I wait until I die?”

ChatGPT answer (cut and pasted):

“Deciding whether to gift your assets during your lifetime or to wait until you pass away is a personal decision that depends on your individual circumstances and goals. Here are some factors to consider:

  1. Estate taxes: If your estate is large enough to be subject to estate taxes, gifting assets during your lifetime can help reduce the taxable value of your estate and minimize your estate tax liability. However, it’s important to consult with a qualified estate planning professional to ensure that your gifting strategy is structured in a way that is tax-efficient and meets your long term financial goals.
  2. Medicaid planning: If you anticipate needing Medicaid benefits in the future, gifting assets during your lifetime can help reduce the value of your assets and make you eligible for Medicaid sooner. However, there are rules and restrictions around gifting for Medicaid purposes, and it’s important to consult with an experienced elder law attorney to ensure that your gifting strategy is structured in a way that is compliant with Medicaid rules and regulations.
  3. Control over assets: Gifting assets during your lifetime means that you are relinquishing control over those assets and transferring ownership to someone else. If you want to maintain control over your assets and continue to manage them, it may be better to retain ownership of them until your death.
  4. Gift tax: If you gift assets during your lifetime, you may be subject to gift tax if the value of your gifts exceeds the annual gift tax exclusion amount. However, there are ways to structure your gifting strategy to minimize or avoid gift tax liability, such as using the lifetime gift tax exemption or making gifts to a qualified charitable organization.

Ultimately, the decision to gift your assets during your lifetime or wait until you pass away depends on your individual circumstances and goals. It’s important to consult with a qualified estate planning professional to assess your options and develop a comprehensive estate plan that meets your needs.”

I would give ChatGPT’s response a grade of about a D. Afterall, it didn’t even discuss the notion that when one inherits property upon death, the cost basis “steps up,” which can ultimately lead to less taxes later on. However, if you ask ChatGPT specifically about “stepped up cost basis,” it does a very good job of explaining what it is.

I do like that it brought up Medicaid planning! If assets are gifted today, then the dad may be able to qualify for Medicaid later on. Of course, there is a five-year lookback to take into consideration but at least ChatGPT showed us Medicaid as an item to take into consideration. I also like the fact that it teased on the “annual gift tax exclusion” as a way to gift assets!

My verdict? I want to split my verdict into three areas:

  1. Recommendations: When a client wants to get down to brass tacks on recommendations, the system does not (yet) cover all the bases that need to be taken into consideration. The peripheral vision when it comes to financial advising is not on par with a seasoned professional. Again, for our purposes, I would give it a D grade.
  2. Fine Details: When I asked the system, “What is stepped up cost basis?” it knocked the ball out of the park. Like I mentioned, it does a very good job of explaining what something is, but so does Google. However, I did ask the system about other topics like estate taxes, etc., and it did OK. In this area, I give the system a B+. As time goes on, the “machine learning” will make it more precise.
  3. General Knowledge/Marketing: For this, I give it an A! Not an A+, but an A. I think ChatGPT makes a good living/breathing brochure! This is where you—the financial professional—can save a significant amount of time via articles, blogs, teasers, social media posts, etc. I have begun to do this with my clients while always making it clear that the article was “Powered By AI.”(Sidenote: I do fear that AI will make the writings in our world less “genuine.”)

Anyway, you be the judge of its effectiveness below as I take a random topic of living benefits on life insurance. Is this an article you would find worthy for general education? I think so!

My question to ChatGPT:

“What are living benefits on life insurance?”

ChatGPT answer (cut and pasted):

“Living benefits on life insurance are features that allow the policyholder to access a portion of the death benefit while they are still alive, in certain circumstances. These benefits can provide financial assistance to policyholders who experience a qualifying event that impacts their health and ability to work. Here are some examples of living benefits on life insurance:

  1. Accelerated death benefit: This benefit allows the policyholder to access a portion of the death benefit if they are diagnosed with a terminal illness that is likely to result in death within a certain timeframe. The accelerated death benefit can be used to cover medical expenses or other costs associated with end-of-life care.
  2. Critical illness benefit: This benefit allows the policyholder to access a portion of the death benefit if they are diagnosed with a critical illness, such as cancer, heart attack, or stroke. The funds can be used to cover medical expenses or other costs associated with the illness.
  3. Chronic illness benefit: This benefit allows the policyholder to access a portion of the death benefit if they are diagnosed with a chronic illness that results in the inability to perform a certain number of activities of daily living, such as bathing, dressing, and eating. The funds can be used to cover long term care expenses or other costs associated with the illness.

Living benefits on life insurance can provide policyholders with greater financial flexibility and security during challenging times. It’s important to review the terms and conditions of your life insurance policy to understand what living benefits are available and how they can be accessed. Additionally, it’s important to consult with a qualified insurance professional to determine if living benefits are appropriate for your individual situation.”

Overall, I still feel very secure in my job not being replaced anytime soon, while having the ability to leverage AI instead of competing against it.

Converting A GLWB Annuity To A Roth: What Value Is Taxed?

With the hundreds of billions of dollars that are currently sitting in annuities that have guaranteed lifetime withdrawal benefits that are also IRA money, I think it’s important that I point something out that many financial professionals are unaware of. It has to do with Roth IRA conversions. It also has to do with required minimum distributions.

Let’s use an example and say that “John” rolled over $100,000 of IRA money into an annuity 10 years ago. That annuity has a GLWB benefit base that has grown to $200,000 because of the guaranteed roll ups. However, John’s annuity contract value is only $120,000. If he were to trigger the GLWB this year, he could get around $15,000 per year, just as an example. Wouldn’t it be a great concept if he could convert that IRA to a Roth IRA prior to taking that income that would later come in tax free? Before we answer that question, we should also ask the question, ”What value is it that he is taxed on when he converts the entire IRA to a Roth IRA?”

Let’s use an extreme—and slightly ridiculous—example. Extreme examples help demonstrate the point. Let’s say the benefit base has grown to $1 million. And if John were to trigger the income after that 10th year, he would get $70,000 per year, even though his contract value was only $120,000. Wouldn’t it be a fabulous idea if he can convert that entire traditional IRA into a Roth IRA and only be taxed on his $120,000 contract value, and then get $70k per year tax-free? Of course, that would be a great idea. So great that the IRS has already addressed this with a rule back in 2006 that many people are unaware of. However, as Roth IRA conversions become more prominent, I believe many folks will become more aware of this. Since you are reading this article, you will certainly be aware of the “IRS Entire Interest Rule.”

What is the answer?
So, let’s get back to the question. What value is it that determines the amount that is taxable to John in the year that he makes the Roth IRA conversion? It is neither the contract value, nor the benefit base. It is the “fair market value” of the annuity. The fair market value equals the accumulation value plus the net present value of future additional benefits (GLWB income) on that annuity. The IRS has not given carriers much guidance on the actual calculation of the net present value other than that the carrier should abide by the “reasonableness standard.” That fair market value is then put into a letter that the carrier will send your clients every year. It is usually called a “Fair Market Value Letter.” Very original, I know.

If the Roth IRA scenario sounds kind of far out and that Charlie is just doing mental gymnastics for no reason, I promise you that you will come across it eventually. Either by the Roth IRA scenario I mentioned previously or the other two scenarios below:

  1. Required Minimum Distributions: That “fair market value” which is usually larger than the contract value is also what determines the required minimum distributions on a policy that has a GLWB! Not the contract value and not the benefit base. (Note: there are a couple of exceptions to the use of the “fair market value” rule. One such example is, if the present value of the additional benefit does not exceed the contract value by 20 percent or more, then it can be disregarded.)
  2. “What the heck is this letter I received?” Eventually a client will call you up and say, “I got a fair market value statement in the mail and what does that mean?” They might be very happy because that fair market value statement will show a number larger than their current accumulation value.

The scenario in bullet point #2 is likely what you will run into the most; your clients will get these letters. At the end of last year, a client of mine called in because he got a fair market value letter stating he had a fair market value of almost $230,000. He was ecstatic because the year before he put $185,000 of IRA money into his indexed annuity. He was surprised because the stock market had been horrible, and he didn’t know how he received so much growth. I explained to him that the $230k value didn’t apply to him yet because: 1. He will not be converting it anytime soon; and, 2. He is 10 years away from his first required minimum distribution. I also told him that the present value of the GLWB benefits must have been around $45,000 ($230k minus $185k).

The last thing I mentioned to him was that the $230,000 number is nothing to get excited about, just as we should not jump for joy when the county sends us a large “assessment value” on our house. The fair market value on an annuity and the assessment value on a house are very similar and for similar purposes. Taxes.


My title is tongue in cheek of course but there is truth to it. There are a lot of acronyms and terminology that can make one’s head spin. So, I wanted to write a quick article discussing the meaning of some of these things, differentiate between a few areas of the long term care business, and also explain correct terminology.

I believe that the long term care opportunity for you, the financial professional, is too large to ignore. So, if you are not really familiar with the long term care space, this article may shed a little light on the topic.

Stand Alone LTCI
Although the stand-alone long term care insurance marketplace has gone through some significant “de-risking,” these policies are still superior to what they were when first offered as they are loaded with various features that did not exist previously. For instance, when first offered in the late 70s by the handful of carriers that offered it, LTCI only covered expenses associated with nursing home/skilled nursing facilities. This is in contrast to the policies today that also offer coverage for in-home care, adult day care, and assisted living facilities.

The old label of “nursing home insurance” is no longer appropriate. As a matter of fact, based on many studies as well as my experience at long term care carriers, anywhere from 50 to 75 percent of first time long term care claims are for in-home care versus nursing home and assisted living facilities. These numbers are important because they demonstrate the flaw in the notion that long term care insurance is “nursing home insurance.” It is important to discuss with clients that LTCI is insurance that can actually allow you to stay out of the nursing home and allow you to have more options than if you were otherwise on Medicaid.

To discuss some features of these products, some traditional LTCI policies today have return of premium options that address the “use it or lose it” concern that many consumers have had about LTCI. One can choose among a handful of benefit periods and also a handful of inflation options. One can also choose a shared care feature that allows you to use your spouse’s benefit pool if yours depletes. The list of features goes on…

What about the huge premium increases that have happened over the last couple of decades? I believe that, with updated interest and lapse assumptions on new offers, the prices will be more stable than they have been in decades. No longer are carriers estimating overly optimistic long term interest rates along with six percent lapse assumptions! (Note: For carriers, an aggressive lapse assumption can be dangerous and overly rosy because that means they are assuming they will not have to pay claims on those policies that lapse. Consumers have held on to their long term care policies and carriers have reflected this in their new lapse assumptions.)

Combination/Hybrid Products
Combination products are an alternative to the traditional LTCI we just discussed. Because many people discuss “combination products,” “acceleration products,” and “linked benefit products” as if these terms are synonymous, I would like to spend some time differentiating the terminology as these terms are not synonymous.

Combination/hybrid products are the broad category of products that can be on a life insurance chassis or an annuity chassis. Thus, a combination/hybrid product is an annuity or life insurance policy that has some form of long term care benefit, usually in the form of a rider. These products can be life insurance with accelerated death benefit riders, annuities with long term care riders, or they can be true linked benefit products that we will discuss in a bit.

With what has happened in the stand-alone LTCI marketplace, today around 90 percent (Milliman 2021 Long Term Care Insurance Survey) of the long term care marketplace is combination products versus stand-alone LTCI. Clearly the flexibility of these combo products is very appealing to financial professionals and consumers. Combo products will only continue to grow in popularity.

Below are two subcategories that make up the larger combo products/hybrid products category:

  • Acceleration of Death Benefit Products. (Note: the AOB is technically a rider added on to the base policy.)
  • Linked Benefit Products

Accelerated Death Benefit Type Products
This is a subcategory of the broader combination product/hybrid world. These are usually life insurance-based products where the death benefit (and no more than the death benefit) can be accelerated for the purposes of a long term care event or a chronic illness.

When I present this product/rider I like to point out that the life insurance of the old days typically had one “trigger” in order to access the death benefit—death. However, today’s products many times have a chronic illness rider or long term care rider that allows for the acceleration of the death benefit. These AOB riders are the mechanism that allows the insured to get enjoyment out of the product during their lifetimes rather than having to die. Again, the two prominent rider types offered within this category are chronic illness riders and long term care riders. Again, AOB riders will generally allow for just the death benefit to be paid out for long term care, nothing more. What if you want more of a long term care pool? That is where linked benefits might come in.

Linked Benefit Products
Linked benefit products are the second subcategory of the broader combination product/hybrid world. What separates a linked benefit product from just a normal life policy with the death benefit being available for acceleration? It is the COB rider (continuation of benefits) or EOB rider (extension of benefits). With just an AOB rider (acceleration of the death benefit) that we previously discussed, the maximum amount that is accessible is the death benefit, period! However, when you add a COB/EOB to a product that also has an AOB, you get access to multiples of the death benefit when it comes to long term care. A lot of acronyms, so allow me to give you an example.

Example: John bought a linked benefit life insurance policy for a single premium of $100,000. The death benefit on this life policy is $200,000. Should he need long term care, the acceleration of benefits rider allows him to access all of this death benefit. What if he continues to need care even after his death benefit is depleted? Well, fortunately, because this is a linked benefit product, he has a COB/EOB rider that allows for an additional two times (example) his death benefit, or an additional $400,000 in the long term care pool. That COB/AOB that piggybacks on the base product and the AOB is what makes a linked benefit product a linked benefit product. Once his AOB is depleted, the COB/EOB can kick in. What if he died before depleting all of his death benefit? The remaining death benefit will go to a beneficiary.

(Note: One of my favorite products is actually a linked benefit annuity product that triples the clients premium for purposes of long term care, with relatively minimal underwriting. The client gets access to their annuity accumulation value if they need long term care, plus they have a COB/EOB that is an additional two times their accumulation value!)

Which Long Term Care Option Is The Best?

To immediately squash the suspense, you are not going to read this article and see that one type of long term care policy is better than the others. It is solely dependent on what the consumer is looking for that will determine their “best” choice. As I will show you in the included table, each of the three product areas that I will be discussing excels in one area where the other two may not. It is all a matter of what the consumer is looking for.

The purpose of this article is to compare a few of the various options from a numerical standpoint so that, whether you are a financial professional that is not yet “long term care savvy” or a consumer that is looking to address this very prominent risk (long term care), this article is for you.

I will not get into the weeds a whole lot in this article with things like reimbursement, indemnification, shared care, tax deductions, partnership, etc. In this article I wanted to show you how I usually start my analysis of the various long term care options that exist today which, again, is largely about numbers. Usually, after I look at the numbers is when I will drill down from there and get into “the weeds”—which is beyond the scope of this article.

The obvious main reason that people buy long term care insurance is so the insurance company pays a benefit—usually identified as a daily benefit or monthly benefit—if that person can no longer take care of themselves. Common triggers for these benefits to be paid out are: To be unable to perform two of the six activities of daily living for a 90-day period of time or to have severe cognitive impairment.

Although the above reason for purchasing long term care insurance may seem obvious, choosing one long term care product over another usually has to do with much more than just what the long term care benefit is. For instance, one consumer may be concerned about the policy being a “use it or lose it” proposition. Meaning if the consumer just dies without ever needing the long term care benefit, then what would the beneficiary get if anything? Another consumer may be concerned that they may want to change their minds ultimately and not pay for long term care insurance anymore. Can they change their minds without losing everything they put in?

Because of the above concerns by consumers, as well as historically low interest rates for the longest time that have forced insurance carriers to think outside the box, we have had huge product innovations in the long term care insurance space. These innovations are indeed wonderful but could also be confusing to a consumer looking at the various options. Furthermore, financial professionals are oftentimes confused with the various long term care options that exist today. So, this article is to give everybody ideas on how to compare long term care options, at least at a high level. Future articles might get in “the weeds” a little more.

The Numbers: Live, Die, or Quit
The spectrum that I compare the various long term care options on is the “live, die, or quit” spectrum. In analyzing products, I will plot out—whether mentally or on a spreadsheet like the included chart—the values of each policy across three different objectives.

  1. Live: If the client lives and needs care, what is the total long term care benefit that can be paid over the client’s life and also the maximum monthly benefit that the consumer can get access to if he/she triggers the benefits?
  2. Die: What if our client dies without ever needing long term care benefits? Did they waste their premium or is there a death benefit? Example, traditional LTCI has historically been known to be a “use it or lose it” proposition.
  3. Quit: What if the client wants to quit? For whatever reason he/she no longer wants the policy. Is there a surrender value that he/she can get access to, or was it all for nothing?

I plotted out three different product types across my Live, Die, Quit spectrum. The product types are:

  • Traditional Long Term Care Insurance
  • Hybrid Life/Long Term Care Product
  • Hybrid Annuity/Long Term Care Product

The Lazy Money Scenario
When I ask consumers that do not have long term care insurance how and from what source they will pay for their long term care if they need it (which is very probable), they will usually point to their savings account or certificates of deposit. That is a natural inclination because that is money that is generally more “liquid” than their IRAs or 401ks. That is when I will show them the power of moving that “lazy money” (that is likely not earning much interest) over to one of these products. By doing so, they can oftentimes get more interest on their money, more death benefit, and/or use the power of leverage when it comes to long term care buying power. Their money is now working for them instead of being lazy! Allow me to explain.

The chart assumes a single premium moving into each of our three products. There are no more premiums that our consumer needs to pay in this scenario. This is the simplest scenario to look at when differentiating products because it easily shows the long term care leverage per dollar of premium, the death benefit leverage per dollar of premium, and the liquidity per dollar of premium. I could have also made a chart with “ongoing premiums,” because not everybody has $100,000 laying around and may prefer to spread the premiums out. However the overall story on the long term care leverage and death benefit leverage would also apply to the ongoing pay scenarios, just to a different extent. (Ongoing premium example, the same benefit on a traditional LTCI policy that is paid for life would only be around $5,000 per year, versus a lump sum of $100,000.)

It is important to point out some details before jumping into the chart. The annuity is very rigid in that it has limited options in benefit periods. This product triples the consumer’s money for purposes of the total lifetime long term care pool. Again, the money is working immediately! Now, if one needs care, they cannot take the $300,000 (triple of our $100k) out all at once. It has to be spread over 72 months. In other words, the benefit period is 72 months, which makes the maximum monthly long term care benefit $4,167 ($300,000 divided by 72). For these long term care annuities, this 72-month benefit period is a common design although there are some annuity offerings where you can choose other benefit periods. My point is, although the traditional LTCI and the life/long term care hybrid can have shorter benefit periods—which means higher monthly maximums—I illustrated all of these products to have a 72-month benefit period. I wanted to keep it as “apples to apples” as possible. I also kept it simple without choosing inflation options on the benefit.

Who Wins in What Scenario?

  • Traditional LTCI: Traditional long term care insurance has the most long term care leverage of any of these products, as represented by the green highlight. This product will give our 60-year-old female a benefit pool of almost $600k and a monthly benefit of $8,220. If it is purely long term care leverage without regard to other bells and whistles, traditional LTCI wins. Now, although there are sometimes return of premium options on traditional LTCI that can potentially give a beneficiary a death benefit, I did not illustrate it here because I wanted to demonstrate the significant long term care leverage that traditional LTCI can provide. That leverage gets watered down when you add the ROP. The “Live” scenario is where LTCI shines! Also, traditional LTCI is very modular as far as various benefit periods, inflation options, shared care, etc. Again, let’s keep this bearable!
  • Life/LTC Hybrid: Because this is whole life insurance at its foundation, you can guess that the “Die” scenario is where this generally beats the other two options. The death benefit is the highest at $179,122 for our 60-year-old female. It also provides cash value that grows on a guaranteed basis. As you can see, the cash value is only $75,952 in year one, but it grows throughout the life of the contract (assuming no withdrawals or claims). If she “Quits” the policy in year 15, although not advised, she would get back $111,699. This particular policy pays benefits on an indemnification basis versus reimbursement but, again, let’s not go there for now.
  • Annuity/LTC Hybrid: Because this is on an annuity foundation, the consumer’s money has the ability to grow, even after the monthly long term care charges. Thus, this product generally wins the “Quit” scenario. This annuity pays an interest rate of 4.5 percent (as of this writing) in year one and can adjust thereafter. If she “quits” in year one, she can get out $95,015 after surrender charges. (Note: This product is a nine-year product.) If she “quits” in year 15, she can get back $162,217, assuming the 4.5 percent remained constant up to that point and no withdrawals or claims were paid. The “Die” scenario is very good as well as her beneficiaries will get back the accumulation value that is free of surrender charges at any point in time should she pass away. This policy has the lightest underwriting of any of them, but again…

As you can see, there are various reasons for various consumers to choose any one of the products. Not any one is “the best” until the financial professional knows what the consumer is looking for.

New Annuity Caps Better Than Renewal Caps. Do I Replace?

Carriers have better pricing horsepower for annuities than they have had in over a decade. By “pricing horsepower” what I am referring to is interest rates. We all know that the 10-year Treasury Bond yield has increased substantially over the last couple of years. However, a better benchmark to pay attention to for what carriers largely invest in is corporate bonds. Carriers like the additional yield that corporate bonds provide over Treasury Bonds, while maintaining “investment grade” quality. Hence, my favorite benchmark, the Moodys Baa Corporate Bond yield.

Chart 1 shows the interest rates–minus the carriers’ spread–can be viewed as the call option budget for indexed annuities, which ultimately determines the caps and participation rates. Clearly, at the time of this writing with the rate being 5.59 percent, the carriers are able to purchase caps and participation rates that are very high, at least relative to recent history.

For many agents, these rising rates and the rising rates’ impact on annuities is new territory. Because of this, I have recently had conversations with agents about the disconnect between the caps/par-rates on new policies versus renewal caps/par-rates on existing policies.

For example: I recently saw a renewal statement on a client’s policy where the renewal participation rate was 185 percent. Although that seems very high, what was the participation rate on new policies for new clients that want to purchase that same annuity today? Almost 300 percent! Naturally, this disconnect has generated questions from the agents. Let’s discuss a couple.

First, is the carrier trying to “rip off” our clients that are in the old policies?

No. Allow me to explain.

Annuity caps are based on “new money rates” that the carrier is able to invest their dollars in at the time the annuity was issued. And to simplify, the cap on the annuity will remain somewhat tied to those original rates, although there will be some ebbing and flowing as interest rates adjust and also as call option costs ebb and flow. With existing annuities, you see relatively low deviation among the caps/par-rates at issue versus caps/par-rates on renewal. The important thing to note with annuity/new money pricing is, when prevailing interest rates increase, annuity caps on new issues are very quick to respond—like what we have seen over the last year. The downside here is, as interest rates have increased and new issues are looking great, the renewal rates on seemingly identical older policies are not keeping up! Why is this? Because, remember, new money pricing “kind of” anchors the annuity pricing to the original bond rate from when the policy was originally purchased X years ago.

Annuity/New Money Pricing is in contrast to “Portfolio Pricing” that carriers often use with life insurance. With portfolio pricing, the blended rate of the insurance carriers general account (or large “tranches” within the general account) is what determines the cap/par rates on IUL, whether those IULs are new IULs or renewal IULs. Over time, that multi-billion-dollar chunk of investments will slowly go up and down with prevailing interest rates. The overall interest rate of the general account is very slow to respond because the carrier’s general accounts are so large. Those general accounts always have bonds that come to maturity and are being replaced, but only a relatively small chunk at a time.

Furthermore, with the life insurance general account pricing, the carriers are generally able to keep new issue caps/par-rates in lockstep with the renewal cap rates on existing policies, at least for the same generation of product. (Note, it is a common practice for carriers to launch new generations of products where the carriers can more easily disconnect the renewal-caps/par-rates from the new-issue cap/par-rates, but that is a conversation for another day.)

The positive side to “Portfolio Pricing” that most life carriers use is when interest rates are rapidly decreasing. When this happens, there is a significant lag in the amount of time it takes for that giant portfolio to get watered down by the lower rates. For instance, for the longest time we saw IUL caps on new IUL policies hold “relatively” stable while the annuity caps on new issues plummeted because of dropping interest rates. Now the inverse is happening with annuities. Rates are spiking up and new-issue annuity caps are as well. But agents are left wondering why the annuity renewal caps are not increasing as well. It all has to do with the “New Money” pricing that annuities use. So, the answer is , the carriers are generally not playing games by purposely keeping renewal caps low relative to new issues.

Now, with what I just said about annuities, many agents are wondering if it would make sense to “surrender” old annuities to get the better pricing. The answer is, it depends on the scenario. Also, it depends on the carrier. Many carriers have rules such as, “As long as the net loss (after premium bonus is taken into consideration) is less than two percent or three percent, then we will allow you to use our annuity to replace the old annuity.” Of course, that is me paraphrasing.

Also remember, this interest rate environment that we are in is exactly why “Market Value Adjustments” on annuities were created—to insulate the carrier from the bond losses they would have if your clients cashed out their annuities after interest rates have increased. It is no coincidence that the MVA formula in most policies is a similar formula as the formula for bond pricing. With bonds that the carriers are buying, as interest rates increase the value of their bonds decreases. With an annuity, as interest rates rise, the client’s surrender value decreases, all else being equal. The MVA is the mechanism the companies use for passing through bond losses or gains to the clients, at least if the clients are going to cash out their annuity prematurely.

We have all read about the failed Silicon Valley Bank that had to liquidate treasury bonds at a severe loss, which accelerated their demise. This loss in their treasury bond portfolio was because of one thing—rising interest rates that diluted the bonds’ values. If the bank had a way to pass on those losses to consumers, it may have helped. Alas, that is not how bank products work. With annuity contracts however, insurance companies have the luxury of having “MVAs” that provide some insulation against interest rate risk (the risk of rising rates).

So, if you are considering surrendering a client’s annuity to go into a new one, understand that there is a lot to take into consideration such as:

  • Market Value Adjustments
  • Carriers’ rules on “replacements”
  • Losing a “benefit base” that may be very high on the old policy
  • Losing an enhanced death benefit
  • Fees on the new policy versus fees on the old policy
  • Comparing new guaranteed income levels to that of the old policy
  • Premium Bonuses on new policies to offset surrender charges on the old

On the last point about Premium Bonuses: There are great premium bonus products out there that may help put the client in a better position than what the client currently owns. These premium bonuses can often offset surrender charges and MVAs. But, there are also premium bonus products that may be inferior to the existing product the client currently owns. Premium bonuses are rarely given because the carrier just wants to be nice. That pricing is always made up elsewhere in the product.

Silicon Valley Bank: Are Annuity Companies Next And What Does This Mean For Annuities?

What happened to Silicon Valley Bank—along with Signature Bank—that represents the two largest bank failures since the financial crisis? Silicon Valley Bank failed because of six primary reasons, among other things:

1. Deposits were drying up relative to in the past and relative to SVB’s expectations. Because SVB’s customers were largely startup companies and because the economy had been rough on those startup companies, that meant these customers needed their cash back from the bank (SVB). Furthermore, with deposit interest rates being less than other places that startups can put their money, deposits left SVB.

2. Because of the above loss in deposits, the bank needed to raise capital in order to meet reserve requirements that banks have to abide by. They did this by selling long-term bonds that were not yet at maturity. Many of these bonds were Treasury bonds that they had to sell at significant losses. These losses were because of the fact that interest rates have risen so much over the last couple of years.

3. Because of the concerns of these losses that Silicon Valley Bank was now recognizing, there was a good old-fashioned “run on the bank.” These startup companies swarmed to the bank to take out their deposits, which further exacerbated the issue.

4. The run on the bank happened because the average account balance at Silicon Valley Bank was well into the seven-figures versus the $250,000 that FDIC covers. As a matter of fact, somewhere around 90 percent of the $175 billion that the bank had in deposits was “uninsured,” meaning that those dollars were above the $250,000 threshold.

The FDIC was created back in the great depression (1933) to provide consumers with this protection and to avoid runs on the bank. However, when you have more than $250,000 at a bank, the FDIC insurance does little to keep you from “running to the bank” to get your money. Hence, in the SVB scenario, the government later rushed in to make an exception and back-stop all deposits, regardless of the size. The reason being, this was “systemically important” because of the dollar size we were looking at and the potential “contagion.” (Note: I believe that large banks having a blank check by the government will unfortunately direct the flow of capital away from smaller regional banks to those large banks. The big will get bigger. But I digress.)

5. Asset/Liability Duration mismatch: In my college banking classes, one of the most basic things we learned is that assets’ and liabilities’ duration should be matched to each other as much as possible. This is another reason that SVB failed. The liabilities—which were deposits—had a very short “duration“ relative to the assets backing them. The liabilities were not very sticky (obviously). The assets backing those liabilities were largely long-term bonds that needed to be liquidated. That in turn created significant losses, as interest rates have skyrocketed over the last year. To oversimplify, in a perfect—and impossible—world, the assets being liquidated would have been right at maturity when the deposits were fleeing, which would have avoided losses.

6. The inverted yield curve (brought on by the Fed) hasn’t helped banks either. Because banks usually borrow money short term and lend money long term, banks’ “net interest income“ has been suboptimal. (Note: Insurance companies generally borrow money long term and buy bonds that are long term. Asset duration=Liability duration.)

Are Annuity Companies Next?
I do not believe that annuity companies will follow the same path as Silicon Valley Bank (and other banks to come). There are two primary reasons for this:

1. Annuities with surrender charges and market value adjustments are significantly “stickier” to insurance companies than what bank deposits are to banks. Therefore, carriers being forced to raise capital because of “runs on insurance companies” is not likely. Even if that did happen, carriers have the ability to pass-through bond losses via market value adjustments—at least with annuities. MVAs were created for times like this and are a good thing in this type of environment because they insulate carriers from interest rate risk that pummeled SVB.

Because of the inability of consumers to easily access their annuity money, the matching of duration on assets versus liabilities is much easier for insurance companies, which helps everybody—the companies and the consumers that rely on the financial stability of the companies.

2. Insurance carriers do not practice “Fractional Reserving” that banks utilize. “Fractional Reserve Banking” is a fancy term for, “If you deposit $10 at a bank, that bank only needs one dollar on hand and can lend out or invest the other nine dollars.” Of course that example assumes a 10 percent “reserve requirement” as set by the Federal Reserve. “Fractional Reserving” is leverage.

To oversimplify, this means that the $100,000 that you see on your bank statement is backed by only $10,000 that the bank has on hand! Needless to say, this can create significant “asset sales” when the customers want their deposits back, as we saw with SVB. The banking regulators’ justification for the “Fractional Reserve System” is that the FDIC is “usually” there to back the deposits if the bank cannot. Plus, fractional reserving does create more money in an economy, which can be a good thing. Can be a bad thing too.

Insurance companies are not able to use “Fractional Reserving” but rather abide by a “Legal Reserve” system. This means that one dollar that customers have at an insurance company is backed by at least one dollar that the company can access. This might create less profit for insurance companies versus banks in good times, but it also means less drama than the banks in the bad times!

Now, a risk that insurance companies do face is: What if the bonds that the carrier purchased were bonds issued by one of these failing banks? This is indeed a risk that insurance carriers face, especially if this “crisis” gets worse. However, the reports that I have read show that the largest exposure to SVB by an insurance company was nothing of consequential size.

Contagion—in addition to direct exposure—is also a risk for insurance companies, at least if this crisis gets worse. An example of contagion might be where an insurance company is exposed to a bond that was issued by a customer of the banks that went belly-up. Or, a bond that was issued by a bank of a customer that is a customer of a bank that went belly up.

Counterparty risk can also be a concern. A “counterparty” would be one of the banks where insurance companies buy their hedges/options. If one of these banks go belly-up, the insurance companies would be left holding the bag on indexed products, or other areas in their portfolio where they have “hedged” certain risks. I don’t view counterparty risk as a huge concern at this point because insurance companies usually use the mega banks as counterparties. As mentioned, the mega-banks may actually get more “mega” as a result of what is happening.

I would not say that the current crisis that the banking industry is dealing with is a great thing for the insurance industry, but it is not necessarily a horrible thing either. Afterall, much of the money that is leaving banks is going to insurance companies, because of the ability to get higher rates on those savings. I would bet that anybody reading this article that does annuity business has had a client or two write a $100k check from their bank account to an annuity that is paying a higher rate of interest.

Additionally, because of the way the bond market works, investment grade corporate bonds’ yields have actually increased in recent days, even though the 10-year Treasury has lost 60 basis points in a short time. Hence, credit spreads have increased. These higher corporate rates help insurance companies make even better products!

Lastly, in times of turmoil, annuities do well. Annuity sales did well in the great depression, they did well during the financial crisis, and they will do well now!

GLWB Economics: Are GLWBs Even A Good Thing?

This article is somewhat of a meshing of my last couple of monthly columns. In one article I discussed the economics and the “internal rates of return” by delaying your Social Security benefits. In another article I discussed indexed annuity GLWBs versus the old four percent rule. This article is bringing both concepts together—GLWBs and internal rates of return.

First, what is a GLWB? Quite simply, a GLWB is a rider that attaches to an annuity that allows for the client to continue to receive income from that annuity beyond the point where the accumulation value (the consumer’s money) hits $0. Without a GLWB, the alternative may be that the consumer lives so long that they spend all of their money and are left with no income from that point forward. GLWBs are “longevity insurance” that can be attached to a base annuity, usually for an additional fee. That additional fee may be one percent of the “Income Value/Benefit Base” for example. The consumer’s withdrawals under the provisions of the GLWB go on for as long as the consumer lives. Now, obviously that doesn’t mean the consumer can choose whatever level of income they would like! There are maximums that are specific to the company, the product, the amount of time the consumer defers payment, and the age that the consumer is when he/she elects to activate “lifetime income.” The economics of those GLWB maximums is what we are assessing in this article.

With interest rates increasing the way they have, GLWBs have better “economics” than what they had just one or two short years ago. As a matter of fact, the guaranteed income from these GLWBs dwarf the “safe withdrawal rules of thumb” that I discuss in previous articles. However, although it sounds good to say “GLWBs will generally pay out higher income than the four percent rule,” what does that mean? What kind of returns are GLWBs expected to give consumers over a normal lifetime in exchange for that one percent or so rider fee? Are they more sizzle than steak?

The benefits that GLWBs provide to consumers are highly dependent on how generous the carrier is with pricing their GLWBs, along with a ton of other “macro” items like interest rates, consumer longevity, etc. At any one point in time, the carriers are all dealing with the same macroeconomic environment and consumer longevity. But even with that being the case, some carriers have great GLWBs, some have lousy GLWBs, some carriers do not even offer GLWBs.

My company’s job as an IMO/FMO is to identify the carriers that have great GLWBs for my agents among other things. But even if that “best” carrier is identified, the attractiveness of their GLWB can vary from situation to situation. Some carriers may have their GLWB priced the best for consumers that start their income at older ages, or younger ages, or the consumers that delay taking income the longest, or scenarios where the husband and wife want “joint income,” etc.

Think of term life insurance. There are carriers that usually have the lowest prices on term life insurance in general. However, within those top carriers, some carriers may focus on the “smoker” niche. Some may focus on the “Super Preferred” niche. Some may stand out relative to their peers with substandard health ratings. The list goes on. Many of us have seen term insurance “heat maps” where the best carriers for a bunch of different ages and situations are mapped out. Finding the right GLWB for your consumers is very similar. The following analysis is just the tip of the iceberg in what we can look at with GLWBs, but I think it does an adequate job of addressing the three goals of this article:

  1. What are the “economics” to the consumers of GLWBs?
  2. How can GLWB pricing vary from carrier to carrier?
  3. Even if we identify a “favorite carrier,” how does the GLWB attractiveness vary from scenario to scenario?

I have done research on several GLWBS. However, in order to keep this article digestible, I am only going to use a couple different examples.

One of the top products that my company offers is a product that has 10 percent simple rollups until the client activates their income. At that point in time, the “benefit base” stops receiving the 10 percent rollups and the client gets a percentage (payout factor) of whatever the benefit base is. Naturally, the fact that the benefit base is increasing year after year means that the consumer is rewarded with higher GLWB payments the longer he delays. Plus the payout factors increase with age as well, which is the case with most GLWBs. The flipside is, every year that the consumer delays is one year less that they will be taking income because they are one year closer to their death. That sounded morbid, didn’t it? So, the million dollar question is, do the increasing payments outweigh the fact that for every year that goes by, you shave off one year of income? This is where it comes down to internal rates of return and finding the product’s sweet spot. A lot like what I did with my previous Is Delaying Social Security Worth It? article.

Let’s say we have a 60-year-old male that is retiring this year. With $100,000 he is looking for income that will supplement his Social Security payments that he will get eventually. He has plenty of other money but he would like a guaranteed baseline of income that he will have for the rest of his life. Because he has other money, he has the freedom to take the GLWB income now, or delay. Whatever makes the best financial sense. So, you run the illustration on the product that I just mentioned. On the illustration, that product will show you (and him) the levels of income that he is guaranteed if he were to activate the GLWB at various ages. For this product, those numbers are represented in my green bars.

Those green bars indicate that if he wants to take income immediately, he is guaranteed $5,000 per year for the rest of his life. If he waits five years, he gets $9,750 per year. (Note: How are these numbers versus the four percent rule? I discussed that in last month’s column.)

The most interesting part of the graph is the red line. The red line represents the internal rate of return on his $100,000 premium if he chooses income at those respective ages and lives until his approximate life expectancy of age 85. For example, if he were to take his $5,000 income immediately and have that income until age 85, that is only a 2.23 percent internal rate of return. Not real great! Conversely, if he were to wait until age 65 to start taking income, you are now talking about a 5.22 percent internal rate of return. Not a bad bond alternative! To really take the scenario to the extreme, if he were to live until age 100, his IRR would be 6.79 percent.

Notice how the IRR spikes up if he delays five years instead of four years? That is because the payout factor on this product is banded at every five years and thus shoots up at age 65, age 70, etc. In other words, if our guy came to me and said he wanted to start taking income at age 64, I would be inclined to encourage him to wait an extra year.

Also note, I have seen people want to start taking income on the “contract anniversary,” without paying attention to anything else. Pay attention to ages and if there will be a birthday soon that would significantly bump up his payout factor. If so, it would behoove him to wait to get the higher payout factor!

What if he wanted “Joint Income” with his spouse that is the same age? The second chart represents the same product, just a different IRR Curve. This assumes the second spouse will “unalive” at age 92.

Now check out the next product that is completely different with a different carrier. If my couple has the additional money that allows them to defer taking income from this annuity for 10 years—until age 70—I would likely recommend this one. By delaying until age 70, they are looking at an IRR of 6.32 percent, assuming the income stops at age 92. This is a great “Joint Income Later” product that is priced at a whole 50 basis points higher than some of the other ones I have seen.

It is interesting to see the different shapes of various carriers’ IRR curves and how they price their products. Of course, there are calculators that I use that tell my agents the highest paying products for each scenario, but it is interesting putting the numbers into IRR context and comparing that to the yields that carriers are getting on their investments today.

It also raises a lot of carrier actuarial questions such as:

  • What life expectancy assumptions are carriers using? Is the 6.32 percent IRR so high only because the carrier expects everybody to die sooner than the other carriers?
  • What about lapse assumptions? If everybody cashes out their policy at the end of the surrender period, then the IRRs are a moot point. Remember the variable annuity carriers “buying out” the clients with GLWBs? This is because the IRR analysis was too high for the carriers to support paying out.
  • Future interest rate assumptions?
  • Assumptions on accumulation value growth? Afterall, a GLWB can be a moot point if consumers never ran out of their accumulation value because of stellar performance.

With scores of GLWB carriers out there and all of the possible scenarios that each GLWB can have, there are thousands of different scenarios that we can choose. By giving you a sample of a few, I hope this article at least demonstrates how every carrier and every product can vary in attractiveness depending on the exact situation. Partner with an IMO that understands the nuances.

If we wanted to get even more complicated, we could use the IRR analysis of these GLWBs in conjunction with the IRR analysis on delaying Social Security! If we only had the financial flexibility to delay taking income from one of those two sources, which one would I take income from first, Social Security or the GLWB? It depends on the IRR tradeoffs between the two…

Is Delaying Social Security Worth It?

This article is intended for financial professionals that have the wise business practice in helping consumers plan for Social Security, and also for consumers.

For folks that may not be interested in number crunching or those that are not real familiar with financial calculators and cash flow analysis, this article may shed light on if delaying Social Security benefits is worth it. For the layperson, it may sound good when one hears, “If you delay Social Security Retirement Benefits from age 67 until age 70, you will get 24 percent more in income by waiting those extra three years.” Well, is that a good deal or a bad deal taking into consideration “Time Value of Money?” Let’s discuss.

Time Value of Huh?
The concept of “Time Value of Money” is that $100 today is generally better than $100 received in the future, which is a large reason why around 50 percent of folks take Social Security early.

Taking it further, what would you prefer to have—$100 today or $103 one year into the future? That is a more difficult calculation because it depends on what prevailing interest rates are in the economy and if you could turn that $100 today into more than $103 one year from now by investing your $100 today. My personal choice would be to have $100 today because I know that I can invest that into something that would give me a guaranteed rate of almost six percent (Guaranteed Rate Annuity). That means that I could turn my $100 into $106 in a year. (Note: I am not taking into consideration taxes in my example.)

With Social Security analysis, we need to view what we are foregoing today—also known as “opportunity cost”—in order to get X in the future as this: What you are foregoing today is the “investment” in order to get X as the payoff in the future. The lost opportunity—or “opportunity cost”—is an economic term that much of the financial world revolves around.

In other words, if I were to invest $100 today and get $103 back one year from now, then that means the internal rate of return on my money was three percent. That means that if you are given a choice between $100 today and $103 in a year, but can only get three percent on your money, then the $100 today is exactly equivalent to $103 one year from now. Again, simplified because we are not considering taxes on the growth. The decision between $100 and $103 is a toss-up if you can only get three percent.

Another decision that is a toss-up is, if you were offered $100 today versus $106.09 two years from now. Why is that a toss-up? Because if you could invest $100 today at a rate of three percent per year, you would have exactly $106.09 two-years from now after compounding. So again, $100 today is equivalent to $106.09 two-years from now, at least if you could only get three percent on your money. Three percent is the “discount rate” that makes $106.09 two-years from now equivalent to $100 today. It is no coincidence that if you punched into a financial calculator that you are investing $100 and getting back $106.09 two years from now, that the internal rate of return will come back at three percent. Well, again, if I can get a six percent internal rate of return on my money, instead of three percent, then I will choose to take the $100 today. That $100 today can grow to $112.36 two years from now at a six percent rate.

That is how “time value of money” works.

Case Study:
Now let’s get to Social Security. With Social Security analysis, we will use the same logic as above except we are not trading one small payment today for one small payment in the future. We are trading a series of dollar amounts over a number of years for a larger series of dollar amounts in the future. So, the math is more complicated but it is utilizing the same logic.

Let’s take Rob, who has a Social Security “full retirement age” of 67. Rob’s full SS benefit—also known as his primary insurance amount—is $20,000 per year. He has a choice: Does he take his Social Security benefit today at age 67, or delay?

By my 67-year-old delaying filing until age 70, he is giving up total income of more than $60,000 over the next three years. I say “more than” because technically that $20,000 that he would receive today—at full retirement age—is generally increased with inflation. So this year Rob may be giving up $20,000, but next year he may be leaving $20,700 on the table by not filing—assuming a hypothetical 3.5 percent inflation rate.

But what is his tradeoff? The positive tradeoff in waiting until age 70 is that after three years his Social Security payments would amount to $24,800 per year—not including inflation adjustments—instead of the original $20,000 per year. This is because he would have received eight percent per year in “delayed retirement credits” that the Social Security Administration gives us for delaying, which amounts to an additional $4,800 in yearly benefits. Again, it would actually be more than $24,800 because it would technically be inflation adjusted. We will reflect on inflation in a bit.

So, we understand that he would get roughly $4,800 more in Social Security payments, but for how long? And most importantly, is that a good deal? Our 65-year old male has a life expectancy (per the Social Security Tables) of approximately 15 years. Therefore, we can plan on our “approximately” $4,800 in additional Social Security payments going for 15 years.

As we analyze the question of “is it worth it?” think of the scenario as the following analogy: Rob would be paying into an “annuity” for three years to the tune of $20,000 per year plus inflation. That is the “opportunity cost” of delaying. We will assume a 3.5 percent inflation rate because that is the historic long-term average. That “annuity” will start providing lifetime payouts in the fourth year of the additional $4,800 per year that is adjusted for inflation every year. That last point is important. Rob is not “just” getting an additional payout of $4,800 per year. We are getting an additional inflation adjusted $4,800 per year!


In (Table 1) I laid out the cash flow of our scenario. The parenthesis represents the lost opportunity of $20k per year for three years, which adjusts for inflation each year. Then, at age-70, the benefit that our retiree gets starts rolling in. As mentioned, the $4,800 is adjusted each year for inflation as well. With inflation of 3.5 percent, our $4,800 today will “inflate” to $5,321 three years from now, and so on.

Our ultimate question is this: In our “annuity” analogy, what would the rate of return be on this annuity where we paid in over $60k in return for the additional income? What “internal rate of return” does delaying Social Security provide, at least based on our 67-year-old male, this lifespan assumption, and this inflation assumption? 5.66 percent. Not a bad rate, especially if Rob is receiving his Social Security tax-free. If Rob was in a 22 percent tax bracket, then that is a “taxable equivalent” rate of return of 7.26 percent. Can Rob get that kind of return elsewhere? If he can, then maybe taking Social Security at “full retirement age” is the best option.

\Table 1 is merely some quick IRR analysis of Rob’s decision using certain assumptions. Technically, there are other variables and factors that he should look at as well before making his decision, but we will discuss a few of those in a bit.


Rob Lives Longer than “Life Expectancy”
One such “variable” is, what if he lives shorter or he lives longer?

Let’s assume he lives an additional five years beyond life expectancy. (Table 2) is our new cash flow table that shows our internal rate of return as being 8.10 percent! That is a taxable equivalent of 10.38 percent, assuming his 22 percent tax bracket. If Rob has good genetics, he may want to consider delaying!

Other Factors:

  1. Different Inflation Assumptions: If you think inflation is going to be higher than my 3.5 percent, then the internal rates of return will increase relative to my examples above and vice versa.
  2. Taxes: If your Social Security is being taxed, as almost 50 percent of recipients’ are, then my “taxable equivalent yield” goes out the window. However, many times, delaying Social Security to age 70 helps the tax situation because you are generally “spending down” your pre-tax dollars in those “bridge years” from age 67 to age 70. This can lead to less reliance on pre-tax dollars at age 70+ that can otherwise add to your Social Security taxation. Said differently and to exaggerate, if you spun down all of your pre-tax dollars from age 67 to age 70, then you would not be taking any of those pre-tax dollars in the years you are taking your Social Security. This means possibly less taxes on your Social Security because your provisional income would be relatively less! Furthermore, by spending pre-tax dollars in your bridge years you are reducing what you will ultimately have to take in required distributions at age 73.
  3. It’s not just about Rob: Stats say that one of a couple that is in their mid-60s will live until age 92. So, if Rob has the higher SS payment between he and his wife, she will ultimately inherit his benefit. And if she lives until 92, for example, then my IRR number is even larger. The internal rate of return on Rob delaying until age 70—and assuming that his wife lives until age 92—is 8.94 percent, or a taxable equivalent IRR of 11.46 percent.
  4. Annuity Payments: Let’s say Rob has an annuity where he can start taking lifetime income. Many annuities “reward” you if you delay, like Social Security. So, if at age 67 Rob is deciding among delaying his SS into the future and activating annuity benefits right now or taking SS now and delaying activating his annuity payouts into the future, that could be some interesting analysis. For example, if the IRR on delaying an annuity payout is greater than the IRR on delaying the Social Security payout, he may want to consider taking Social Security now.

Retirement Income Software is Invaluable!
This article reflects just a few variables and components of hundreds. Therefore, each consumer should work with a financial professional that has the planning software that will project how much each filing scenario will give them over their lifetime, on an after-tax basis and after inflation basis. Then and only then will a consumer feel confident that they made the right choice. It’s better than flying by the seat of our pants. If you are a financial professional and want to learn more about software (or Social Security in general), feel free to contact me.
If done correctly and in a manner that reflects “time value of money,” you will see that the difference between filing correctly and filing incorrectly can be a difference of tens or even hundreds of thousands of dollars.

Annuities Versus The Four Percent Rule

I recently saw somebody write about how we should not compare annuities to the four percent rule. Although I agree that there needs to be additional disclosures and education in the annuity part of the conversation, I disagree with not comparing the two.

Re-Anchor Clients in Reality, Not Fairy Dust
I believe that consumers tend to “anchor” their retirement income expectations on the wrong thing and therefore should be “re-anchored” in reality. For instance, consumers should be educated on the fact that William Bengen’s study in 1994 showed that in order to sustain a stock/bond retirement portfolio for 30+ years in retirement, the consumer should take out no more than four percent of their retirement account balance that first year in retirement, adjusted each year thereafter for inflation. Consumers should also be aware of the new updated studies that show “rules of thumb” of 2.3 to 2.8 percent. (Note: When using these comparisons versus annuities, it is important to discuss that annuities generally do not have “inflation adjustments” the four percent rule incorporates. More on that in a bit.)

This “re-anchoring” is important because many consumers know that the S&P 500 has gone up double digits on average for the last century and therefore overestimate what withdrawal rate they should utilize. They have seen the glorification of the stock and bond markets and have likely seen the mountain charts like the Ibbotson SBBI Chart. You know what charts I am referring to; those that show that the stock market has done double digit returns forever and that their $1 invested back when Adam met Eve would be worth enough to purchase their own private island today.

Thus, if a consumer has in their brain that stocks and bonds have always performed seven percent, eight percent, 10 percent, 12 percent, then they will tend to believe that their retirement withdrawal rate is beyond the four percent that the research shows. Even if a consumer has heard of the four percent withdrawal rule, they may have not had the math laid out for them yet that is specific to their situation. It is important to explain to those that love their stocks and bonds—as I do—that even though the S&P 500 could average 10 percent over the coming years, it does not mean they will not run out of money by taking only four percent of the retirement value from their stock and bond portfolios! How is this possible? Because of the sequence of returns risk that the stock portion can subject the client to and the low interest rates (still) that affect the bond portion. And because of these two risks a client should not overestimate what their portfolios can do as far as withdrawal rates. If you would like a graphic that helps you explain the sequence of returns risk to your clients, email me.

To demonstrate my points in the previous paragraphs, I want to cite a study by Charles Schwab. In their 2020 Modern Retirement Survey they asked 2,000 higher net worth pre-retirees and newly-retired retirees about how much money they had saved for retirement and also how much money they expected to take from their retirement portfolios. The answers from the participants were that they had $920,400 in retirement savings on average, that they planned on spending $135,100 per year from those portfolios on average, and that they were generally confident in those dollar amounts allowing them to live the retirement they would like.

I would argue that a 14.68 percent withdrawal rate ($135,100 divided By $920,400) defies any retirement research I have seen! Naturally, Schwab then points out that—contrary to these participants’ beliefs—a $920k portfolio will run out in only seven years (obviously not including interest/appreciation). Clearly, these consumers should have the math explained to them. Even if the consumers understand the new rules of thumb, they may be experiencing cognitive dissonance that should be addressed by the financial professional. By doing so, you will “re-anchor” their expectations to the new realities of 2.3 percent, 2.8 percent, or four percent withdrawal rates, which will set you up for the annuity conversation that we’ll discuss.

I am not suggesting an agent go into a big dissertation on these individual studies. I just believe that going over the simplified math—specific to the client’s portfolios—based on these new rules of thumb should be done in order to show the power of annuity GLWBs. Although generous, using the old four percent rule of thumb will suffice in explaining the annuity value proposition. By demonstrating this math to the clients, you will be re-anchoring their expectations to realistic numbers. And only then do I believe they will realize the true power of GLWB Riders.

The GLWB Conversation
Here is what my conversation looks like that I will walk our hypothetical client through:

Let’s say our 63-year-old has $100,000 in a stock and bond portfolio. I start by discussing how this 63-year-old may have the expectation that her $100k grows by five percent or so per year between now and retirement in two years. Well, based on her $110,000 (not including compounding) value at that point, what withdrawal should she take in her first year of retirement? This is where I discuss the four percent withdrawal rule, which usually surprises them because their anchoring is off. I also discuss the reasons for the withdrawal rate being only four percent. But then I will show her $100k growing to $110k in two years at retirement. If the client wants us to assume a 20 percent return over two years, fine! I will do that instead. The math still works.

By the end of the two years, her $100k has grown to $110k. That is when we figure the first-year withdrawal, which comes out to $4,400. Again, that $4,400 is supposed to increase with inflation, per the four percent rule.

That $4,400 is assuming everything goes correctly. That is, that she gets 10 percent appreciation between now and age 65, and also the four percent being indeed sustainable over her 30-year retirement.

That is when I will switch to the annuity. On one of the industry’s top annuities/GLWB riders right now, her $100,000 will generate a $7,800 payment starting two years from now, guaranteed. That payment will go on forever. This GLWB payment is 77 percent higher than what our four percent withdrawal rule will provide. And you don’t have the “hoping and praying” with the annuity. Usually at this point in the discussion, the responses are in three different areas:

  1. Seems too good to be true! How can the company do that? (This is a topic for another article.)
  2. What if everybody lives forever? Will the company go out of business? (Again, a topic for another article.)
  3. But what about inflation? The four percent rule includes inflation, and the annuity does not.

Let’s discuss.

Level Annuity Payment Versus Four Percent with Inflation
Although I believe we are being generous to the situation by using the four percent rule instead of the more updated and lower rules of thumb, it would be disingenuous to not explain the lack of inflation on the level payout GLWBs. (Note: There are some GLWBs that have increasing income, but let’s leave the conversation to level income for now.)

This objection about annuities not having inflation included, versus the four percent rule, is a reasonable objection as inflation adjustments can be crucial. As a matter of fact, the “inflation rule of 72” says that a 3.5 percent inflation rate—for example—will chop the purchasing power of a dollar in half in only 20.5 years (72/3.5=20.5 years). Meaning that $7,800 would only have the purchasing power of $3,900 in 20.5 years assuming 3.5 percent inflation.

So then what provides the highest cumulative income, our GLWB or the four percent rule example? Above is a graph from a spreadsheet I created to show what provides more income—the $7,800 (GLWB) without inflation adjustments or the $4,400 (four percent rule) with inflation adjustments. (Note: For the inflation adjustments, I assumed 3.5 percent.)

As you can see above, the inflation adjusted four percent rule annual income crosses over to where it is more than the $7,800 in the 18th year. You can see the two lines crossing over. The dollar amounts represented by the lines are in the right axis.

More important however is, what is the cumulative income from each strategy over a period of 30 years? That is represented by the bars and the left axis labels. As you can see, the Cumulative GLWB Income (black bar) stays higher than our cumulative four percent rule all the way through the 30-year retirement. Furthermore, this does not incorporate “time value of money” of the amount of excess GLWB payments we got above and beyond the four percent rule. Technically, those excess dollars reinvested would equate to even more than what our “cumulative” black bar is showing.

Clearly, there are other scenarios that we could run that can benefit or degrade the story on either one of the two solutions. For instance, we could run the four percent rule assuming a much higher return than 10 percent over two years—for example 20 percent. In that case, the “cumulative withdrawals” on the four percent rule overtake the annuity in the 27th year. But then we could also apply the “time value of money” to the excess annuity payments. We could also use the 2.8 percent withdrawal rule. Or, one could add different inflation rates, etc.

In the end and with all of this said, the story should be that consumers need to anchor their expectations reasonably and also that annuities have a great place in many consumers’ portfolios with or without inflation.