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Charlie Gipple, CFP, CLU, ChFC

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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: cgipple@cgfinancialgroupllc.com.

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

Charlie Gipple, CFP, CLU, ChFC
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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?

Charlie Gipple, CFP, CLU, ChFC
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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?

Charlie Gipple, CFP, CLU, ChFC
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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!

TABLE 1

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.

TABLE 2

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

Charlie Gipple, CFP, CLU, ChFC
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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.

“If I Don’t Sell That Product, It’s A Bad Product”

Charlie Gipple, CFP, CLU, ChFC
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“If I Don’t Sell That Product, It’s A Bad Product”

A while back, I posted something on LinkedIn about how to assist consumers that desperately need help get qualified for Medicaid. As you know, Medicaid can pay for long term care (nursing home care primarily), if a consumer is deemed financially incapable. It is not a replacement for long term care insurance, but it can help consumers that did not prepare. And now those consumers are in a time of distress and need. Afterall, this is what we do as an industry—help folks in their time of need. After posting these Medicaid planning tips that leveraged “Medicaid Compliant Annuities,” there were several positive responses from agents who wanted to learn more.

However, as with any social media post that gets thousands of views, there were a few negative posts—although a tiny percentage of total responses. I would divide these negatives into four different camps:

  1. An attorney: All the attorney had to say was that all financial professionals should hire an attorney if they choose to help clients with this, and it’s ridiculous that I should even comment on Medicaid because I am not an attorney. Basically, only attorneys are smart enough to cover this topic.
  2. Fee-Only Advisor: This guy had nothing to say other than annuities are bad and include a lot of “fees,” which was ironic to me. (By the way, single premium immediate annuities for Medicaid purposes generally have no fees!)
  3. The life insurance guy that downplayed Medicaid: Because if everybody owned life insurance with a chronic illness rider, the client would never be in that position in the first place. (PS. I am a “life insurance guy” myself but disagreed with him bashing the client in hindsight.)
  4. My Favorite: The guy that must’ve viewed my post as taking away from his long term care insurance sale. This guy wanted to criticize me because I called it “Medicaid planning,” like the rest of the world—including the CFP Board! (He didn’t realize that I am a significant fan of long term care insurance.) He took the opportunity to plug his designation course for all that were viewing. LOL. Consumers are destitute because of long term care expenses, and we are quibbling over terminology?

My social media post—believe—is an unfortunate microcosm of what can take place in this wonderful industry. All four individuals above viewed that scenario of helping clients who previously failed to plan as taking from their paychecks. I am sure they would not admit that, but that is where the negativity came from. Any proposed solution that was outside of how they got paid in their own world is a bad solution. To the Chevy guy, there is not a Ford on Earth worth anything and vice-versa. This mindset does our collective industry no good. It is OK to be cheerleaders for products and strategies that are different from what we offer and still make great money! There is about $30 trillion in financial assets that Americans own currently. There is enough to go around.

In politics, if you listen to the commentary from our “leaders” on both sides of the aisle, there is never anything that the other side does that is any good. If one party comes out and says, “We cured cancer,” the other party will discuss how that “horrible development” will put a strain on pharmaceutical sales and the industry will collapse. Therefore, those politicians stand on the platform of negativity, as if that will help their party’s cause. What about the “Party” of the American People? Why not just view it all as one party—The American People Party?

I like the social media example above because of the amount of irony. I use attorneys every single week. I am pro attorney. I am also an “investment advisor” that charges fees on securities assets. I am a part of that “party.” As many of you know, I love life insurance and I especially love the chronic illness riders. What about long term care? If everybody in America owned an LTCI product, consumers would be in better shape. I am pro LTCI.

My point is not about how bad social media, or our industry, is, my point is about how we as professionals need to think beyond our immediate paycheck because the “partisanship” in financial services does nothing good for our business as a whole. For instance, is there anybody in our business that thinks Ken Fischer has done anything good for our industry and the reputation of financial professionals? This is the guy who says he would die and go to hell before selling an annuity. Where is he today as the stock market is down over 20 percent and the bond market down 15 percent? Do you think he has turned a few consumers away from our business because of his messaging? Absolutely. I am sure there are consumers that have not saved much in retirement dollars—whether in annuities or with Ken Fischer—because of Ken Fischer’s messaging.

There was actually a fifth camp in my social media post. It was one gentleman that effectively said that he was previously interested in the medicaid planning topic but not so much anymore because of the “partisanship” and confusion. I agreed with him!

Just as important to me is the power of one’s word. When people realize that you are a “partisan” that cheerleads only about your product/strategy, then all of your words ring hollow from there. This is why nobody believes what politicians say, especially when they are speaking about the other party.

When you are a “partisan” in financial services, your recommendations will be scrutinized heavily and your constructive criticisms will be discounted. And when your words become hollow to your prospects and/or clients you will not achieve full potential. Because of this, I do believe in transparency and calling out bad actors and bad strategies. For those close to me, you know that is my style. When my 15-year-old asks me how I thought he did in his basketball game, he knows what he is going to get whether good or bad. But, he is all ears and takes my feedback seriously. He doesn’t even ask my wife (his mother) how he did because she will invariably tell him “Great Honey!” every single time because she is such a positive and wonderful human being. In short, honesty is important but just because some person or some strategy was not in the same “Party” as you does not make them a “bad actor” or their options “bad strategy.” Our words need to mean something.

I listened to a podcast a while back where Neil deGrasse Tyson—an astrophysicist—was talking. He was discussing the deepest part of Earth’s surface and also the highest part of Earth’s surface. He stated that the Mariana Trench in the Pacific Ocean is the deepest—being over 30,000 feet deep. That is about six miles deep! Additionally, the tallest point on Earth is Mt. Everest at around 30,000 feet high. Almost six miles high! These are huge peaks and valleys to us small Earthlings. However, if you were a giant that was holding planet earth that was now about the size of a cue ball, you wouldn’t even feel that valley or that peak. In other words, in relative terms, the Earth is as smooth as a cue ball when you think “big enough.” This makes sense because twelve miles of difference between the deepest part and the tallest part is nothing compared to the overall size of the planet which is almost 8,000 miles in diameter!

Now I am not saying that our industry is as perfect as the surface of a cue ball. What I am saying is that I think it is important that we “think big picture” when it comes to our industry. Are there peaks and valleys when it comes to some products and some strategies? Absolutely. However, by more consumers being involved in our industry, those consumers and the world will be a better place. Partisanship does not help that cause.

GLWBs, Step-Ups, And Other Random Annuity Thoughts

Charlie Gipple, CFP, CLU, ChFC
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GLWBs, Step-Ups, And Other Random Annuity Thoughts

A few weeks ago I was preparing an indexed annuity illustration for one of our agents who had a client that wanted guaranteed lifetime income. So, I was running one of my favorite indexed annuities with the GLWB rider. As I looked at the printout, I came across something that I hadn’t seen in years. It was a “step up!” It had been such a long time since I’ve seen one of these, at least on this type of a GLWB rider, that I was confused until I realized what was happening and why it was happening: The 11.5 percent S&P 500 “cap” was outpacing the GLWB rollup rate. Now that is not something you saw when caps were at five percent!

Over the last few weeks I have also had a few questions from agents asking me, “Can you explain what is happening in this illustration?” So, I felt the topic to be worthy of a column along with a few other random thoughts on GLWBs.

A couple decades ago I was with a very large company that was a leader in the variable annuity space. At the time, the hot item with variable annuities was “guaranteed lifetime withdrawal benefits”(GLWBs), and its predecessor, “guaranteed minimum income benefits” (GMIBs). These were very popular because, on the back end of the dotcom crash, consumers were looking for guarantees to protect them from the turmoil they had just experienced. The GLWBs separated themselves from the GMIBs in that the GLWBs did not require annuitization, just “withdrawals.” Hence, with the GLWBs, the company did not require the client to lose control of their account value by locking it into a perpetual income stream.

At that time our hot VA product story was that the client had a “benefit base” that was guaranteed to grow by seven percent every year, regardless of what the actual account value did on that variable annuity. Even if the account value lost 50 percent, again, the client had that baseline guarantee that they can eventually take income based off of. Furthermore, the variable annuity world marketed an additional benefit, and that benefit was “step-ups.” The notion of a step-up was that if, at the end of the year, the actual account value is higher than the benefit base—meaning that the account value increased by more than what the seven percent rollup percentages had done—the client’s new benefit base would “step up” to what that account value was in that year. And then the ongoing seven percent roll up percentages would generally apply to that higher value. Later on came quarterly step-ups, monthly step-ups, and then daily step-ups. Then the economy crashed in 2009, interest rates plummeted, and these robust variable annuity benefits “stepped down”…but I digress.

We all know that GLWBs on indexed annuities came from the variable annuity world. The first GLWB was put on an indexed annuity chassis around the year 2006, after the variable annuity business had been running with the concept of GLWBs and GMIBs for years. This made sense to the indexed annuity market because the VA business had used these riders with huge success. The VA business was a good business to copy because the VA business at the time was about six times the size of the indexed annuity business. 2006 VA sales were $160 billion and indexed annuity sales were around $25 billion.

Over the last two decades these riders have evolved like everything else. I now discuss that there are two different categories of GLWBs in general: a) Performance-Based (the newer breed); and, b) Guaranteed Rollup Riders (the traditional breed).

The performance-based riders generally have minimal (sometimes none) “rollup rates.” These riders largely rely on the account value to increase in order to have the benefit base (and eventual income) increase. An example of one of these GLWBs may be, your benefit base will increase by two times what the amount of credit/performance was in your account value.

The performance-based riders are a good option for the clients/agents that believe that the performance of the underlying index may enable the benefit base to grow faster than what a guaranteed rollup rider may be able to do. These riders effectively rely on “step-ups” like what I discussed with the variable annuities.

The other category—at least how I categorize them—is “Guaranteed Rollup Riders.” These are the traditional seven percent, 10 percent, etc., benefit base rollup rates. These GLWBs are for the clients/agents that want straight guaranteed income without any reliance on the account value. These are the riders that have been on indexed annuities since the beginning.

Generally, the “performance-based” riders will show “non-guaranteed” income that is higher than the guaranteed-rollup riders, at least based on the illustration. However, from a guaranteed income standpoint, the guaranteed rollup riders will generally show the highest guaranteed income.

With the guaranteed rollup riders, something odd is starting to happen with interest rates having spiked the way they have, and that is the potential to receive a step-up on the benefit base… If the indexed annuities in the early years had much potential for “step-ups” back then, then I certainly don’t remember it. If there was ever much potential then it only lasted until the financial crisis, when interest rates really started to plummet.

Why no step-ups? Two primary reasons:

  1. Low interest rates: Because caps and par rates on these products were so low that the odds of having the accumulation value outpace the “benefit base” was almost nothing. (Caveat: There are some “volatility-controlled indexes” that show very high “backcasted rates” that have been able to show a step-up, but that has not been the norm.)
  2. Bifurcation of objectives: Another reason that you have not seen step-ups on this flavor of GLWB is because the GLWB focused annuities are “generally” watered down from an accumulation standpoint relative to the same company’s accumulation focused annuities. If you compare the cap rates, par rates, etc., on a product that provides very good guaranteed income, you will find that the tradeoff is “usually” the lack of accumulation performance. (Note: There are exceptions to this rule in that there are products that have the same cap as their “accumulation focused” counterpart. Hence, the product I used in the first paragraph.)

With interest rates having increased the way that they have, and by choosing a product that also has great accumulation potential, there may be opportunities to show the consumer the potential for an occasional step-up on their indexed annuity. But be cautious of rosy illustrations.

One last point on income focused products that also have great caps, par rates, etc. Even without a “step-up,” a great income focused annuity represents less of an “opportunity cost” to the client—versus a purely accumulation product—when that income focused annuity also has great accumulation potential.

Why Focus On Social Security?

Charlie Gipple, CFP, CLU, ChFC
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Why Focus On Social Security?

A while back an agent of mine was calling out to confirm social security seminar attendees from a marketing campaign that we conducted for him. At the time, he had around 20 registrants and was calling out to these prospects to confirm their attendance for the upcoming seminar. While he was doing this, he sent me a text message that said, “I have feedback on the calls that I have been making and observations, if you would like to hear them?” Although it sounded somewhat ominous to me I said, “Of course.” Later that day he called me. As I picked up the phone, I must admit that I was somewhat cringing because, again, his previous text sounded ominous. I was hoping that his feedback was not outside of the normal observations that I and my numerous other agents have experienced. I thought, “Maybe his geographic area does not care about Social Security” or, “I wonder if he is not able to get a hold of the registrants and he is unhappy.” Etc. So I was dying to hear his feedback.

When our phone conversation turned to the seminar and his call outs, he went into what his observations were. He said in a surprised voice, “I am amazed that almost everybody I spoke to did not treat me like a cold caller, but rather they were actually looking forward to the seminar because they want to learn more about Social Security!” He also said that many of the consumers had questions for him on their particular situation while he was on the phone with them. He had to tell them, “We are going to cover that in the seminar.”

When he was done giving me his feedback on his first experience with Social Security seminars, I breathed a sigh of relief and told him what I will tell the readers of this column: Consumers are passionate about learning more about their Social Security. This is because there are very few credible places for them to go to get feedback/advice on their Social Security.

To me, one of the greatest ironies about the financial services business is the fact that Social Security is not a large part of our industry’s education apparatus. To demonstrate, If I were to pile up the books that I had to read in order to get my CLU® designation, CHFC® designation, CFP® designation, my life insurance license, my Finra Series 7 license, and also my Finra Series 66, it would be a stack probably two to three feet high. However, the total pages in all of those books that are dedicated to teaching us—the financial professional—about Social Security would probably amount to not much more than 100 pages, if that. There is no exaggeration in that statement.

This is ironic because Social Security represents the largest asset for many of the folks that we work with. As many know, over a couple’s lifetime, it is not uncommon to get $1 million in Social Security payments.

So you have an asset that is the largest asset that many households have, while at the same time it is one of the most complex assets that they have. And our industry has not educated these consumers on how to maximize that asset. That is ironic.

The good news is, that irony also represents opportunity for those financial professionals that wish to take advantage of it. As I laid out in the first paragraph, the opportunity is not some theoretical conclusion that I arrived at but rather a true need that these consumers have. I hear the questions from consumers everyday and I see the results from agents helping consumers with Social Security everyday. It is a huge need that you can help these consumers with and also make a great living with if you make sure you do a few things:

  1. Learn Social Security: It is complex but it is worth the trouble, I promise.
  2. Plug into a program that will get you in front of those consumers that need help and are qualified prospects. (Note: You do not have to spend $4,000, $5,000, $6,000 to get in front of 20+ people in a seminar room!)
  3. If you are not comfortable in front of people, get a mentor/partner that will do the seminars for you and also teach you how to do them.
  4. Use the right tools/software to help you with the backend implementation of the consumers’ Social Security maximization. Once the seminar is done, you need to help the attendees. How do you do it? By having the right tools and the right knowledge.
  5. Partner with an IMO that will help you, guide you, and mentor you on all of the above, from getting you in front of prospects all the way through joint Zoom calls with the prospects after the seminar.

One misperception that I hear a lot is, “But people that attend Social Security Seminars usually are not very affluent and therefore not an ideal client of mine.” I beg to differ. Of course socioeconomic factors are also a function of the profiling you conducted in your target marketing, but my experience says that if you have a room of 20 attendees that want to hear about Social Security, a few of them in the room will actually be millionaires.

Another misperception I hear about Social Security seminars is, “There is no way for an agent to make money when helping with Social Security optimization.” There are indeed ways to make a significant amount of money by helping consumers with Social Security. Afterall, much of maximizing Social Security from an after tax standpoint has to do with other assets that the client plans to draw from in retirement. Coordination between Social Security and those assets is of paramount importance. And those other assets are where the opportunity lies for financial professionals. And I would argue that if a consumer is given a choice on who to manage the assets between, a) ABC Brokerage Firm that doesn’t even know how to spell Social Security, and, b) a financial professional that just showed them how to get an additional $200k in Social Security benefits over their projected lifetime, that consumer will choose “b” almost every time.

Buckle Up! We Are Going To Create An Indexed Annuity!

Charlie Gipple, CFP, CLU, ChFC
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Buckle Up! We Are Going To Create An Indexed Annuity!

Get out your financial calculators, spectacles, and your pocket protectors because we are going to have some fun with this column. We are going to create a product. Of course I am being somewhat facetious because there’s much more that goes into “creating a product” than just the numbers, such as: Non-forfeiture requirements, state filing, illustration parameters, surrender charges, MVAs, utilization rates, etc. I do not pretend to be an actuary, but I am about as “actuarial” as a sales guy can be. My wife tells me that’s like being the tallest elf.

Regardless, this elf is going to show you the not-so-basics of creating an indexed annuity with a “cap” based on today’s (October 7, 2022) interest rates and options prices. The purpose of this is to not make everybody into actuaries but rather to enable you to easily answer many questions about these products by having a deep understanding of how they are created.

Here is the product we—the insurance company—are going to create. This will be a 10-year indexed annuity that utilizes an annual reset S&P 500 strategy. This strategy has a “cap” that we will need to figure out based on today’s interest rates and options costs. This product will have a seven percent commission to the agent. Furthermore, we—the carrier—have shareholders that require a “return” on the company’s capital to the tune of eight percent (more on this later).

Agenda:

  1. Determine how much we, the insurance company, can get in yield when we invest that client’s money.
  2. Based on our IRR requirements from the shareholders, how much of a “spread” do we shave off the top of the yield that we are getting in bullet point number one above.
  3. We then take what is left of the difference of number one and number two above and that determines our call option budget.
  4. We take our call option budget, and we buy and also sell call options based on today’s option prices. Based on the pricing of call options, you and I will be able to identify what cap rate a person can get in today’s environment. Sounds pretty cool huh?

1: How Much Yield Do We Get?

First off, when a carrier takes a client’s $100k (example), that carrier will invest almost all of that money in the bond market. Although a lot of folks use the 10-year treasury as “the benchmark” for the yield rate, a better benchmark is the Moody’s Baa bond yield. This is because carriers generally invest more in corporate bonds than they do in Treasury bonds. Why? Because corporate bonds provide a higher yield. For instance, an index of “investment grade” corporate bonds might represent a 5.99 percent yield. This is much better than the 10-year Treasury bond that is currently yielding 3.88 percent. Thus, the reason corporates are favored over Treasuries.

Now that the insurance company knows that it can invest their money and earn approximately six percent on this money that is going into their “general account,” the carrier needs to allocate that money between the bonds and the call options. The bonds will be purchased to guarantee the money grows back to $100,000 every single year, regardless of what the S&P 500 does. This is how the carrier is able to support the policy guarantees. The call option chunk will give the indexed annuity the “link” to the stock market in the up years. Again, Bonds=Guarantees and Options=Upside.

2: The Carrier’s Cut

Before we calculate how much money goes to bonds and how much money goes to the call options, the carrier takes their cut… This is where the “carrier spread” comes in. That is, the carrier shaves a little off the top of that six percent (technically 5.99 percent in our example). That “spread” is how the carrier makes money. How much spread does the carrier require? It depends…

Our carrier has shareholders that require them to make a certain amount of money on the carrier’s capital. And make no mistake that putting a case on the books costs a carrier capital. Afterall, the carrier has to pay for the administration, paperwork, and the big one, agent commission. This is why if you have ever seen a carrier grow “too fast” they will shut off new sales.

There are various measurements on the amount of money the carrier makes off their investment, such as Return on Investment (ROI) and Internal Rate of Return (IRR).

To simplify this, let’s say that we, the carrier, pay $7,000 to put our $100,000 on the books, or seven percent. This is simplified because our agent commission is seven percent and there are technically more expenses than that but bear with me! If the carrier shareholders demanded an eight percent internal rate of return over the 10-year life of our product, what annual income would be required for the carrier to achieve that? If you put this in your financial calculator, it would require $1,043 per year to the carrier (PV=-7,000, N=10, %=8, FV=0, solve for PMT). In other words, by the carrier “investing” $7,000 of their own money, in order to get an eight percent return over the 10-year life of the product, that carrier would need 1.043 percent ($1,043) off the top of our six percent. Hence, a spread of 1.043 percent. (Note: In corporate finance you learn that if the IRR is greater than the carrier’s “cost of capital,” it is a project that is worthwhile. Hence, if a carrier borrows money at six percent and gets an IRR on that money/capital at eight percent, that is a product that has a positive “Net Present Value” and is good!)

For our example, let’s simplify the above and say that the carrier’s yield is six percent and the carrier spread that is required to keep the shareholders happy is simply one percent. No need to get crazy here with the decimals.

3. Calculating the Call Option Budget

After the carrier takes its one percent off the top, we have five percent to play with for our client and their $100,000. This is where we need to divide the money between the bonds and the call options. The bonds need to guarantee $100,000 at the end of every year to—again—support the policy guarantees. So, what dollar amount needs to go into the bonds—earning five percent—so that those bonds in the general account grow back to $100,000 at the end of the year? Hint: The correct answer is not $95,000! The correct answer is $95,238. Thus, if you add five percent to $95,238, you will get $100,000. So, if the insurance carrier is investing $95,238 in bonds, what are they doing with the other $4,762? Call options. We have arrived at our call option budget.

Review:
What have we done so far? So far, we have designed the commission level on the product at seven percent. We also calculated how much the carrier needs in spread to make the shareholders happy, and we have also arrived at our call option budget of 4.76 percent that will soon determine the cap. (Note: All of these calculations revolve around the interest rate of six percent—technically 5.99 percent. This is why indexed annuity pricing has gotten better over the past year.)

4. Buying and Selling Call Options to Arrive at Our “Cap”

So, we have $4,762 to buy call options that link our client’s $100,000 to the S&P500. That is a call option budget of 4.76 percent of our $100,000. So, the first thing we want to do is look at the prices of call options on the S&P 500 (SPX). We want this call option to give us all of the upside of the S&P 500 between now and 12 months from now, because our product is an “annual reset.” (Note: My discussion is going to be largely about percentages. The exact dollar amounts to link the client’s $100,000 would be just a function of buying multiples of what we are talking about below. The exact dollar amounts are not important. The call option budget percentages are important.)

Table 1 represents five rows—out of hundreds of rows—that represent today’s (10/8/22) option prices for an S&P 500 option that expires approximately one year from now. Because we want this option to give us growth on our client’s money from where the market is today (3,639), we need to find the “strike price” that is close to that number. In other words, we want to buy an “at the money” call option. So, we need to see what options sellers are “asking” for these options. It appears that we can buy an option for $432.10 on a S&P 500 value of 3,625. This call option represents a whopping 11.92 percent (432.10 divided by 3,625) of the “Notional Value” that is linked to the market! We have a problem here because our options budget is only 4.76 percent.

No fear, there is a solution here. That solution is that we can buy this option but then immediately sell another option that will give us back approximately 7.16 percent. This will ensure that our net options cost is only 4.76 percent. In other words, by us buying an option for 11.92 percent and selling one for 7.16 percent, our total net cost will be our options budget of 4.76 percent (11.92 percent-7.16 percent=4.76 percent).

So above, let’s buy the “at the money” option for 11.92 percent of the “notional value.”

Selling a Call Option
As you can see in the options pricing tables, the higher the “strike price” on call options, the cheaper they are. It is because the “strike price” represents the point in time where the option purchaser actually starts making money. Hence, “in the money.” So, if we are selling a call option, we want to go as far down the “strike price” as we can. This is because when the market increases to that number, that is the point that we will be giving the upside to somebody else! Ideally, we would just purchase the option that we already did above and not have to sell a call option. However, we don’t have the large call option budget to do that, therefore we must sacrifice some upside. So, let’s go down the list and see what we need to sell. We need to produce about $259.55 (7.16 percent of 3,625) so that we net out to our 4.76 percent budget.

We found something close! We can sell an option for $257.20 at a strike price of 3,950. What does this mean?

  • We netted out to a cost of $174.90 (Paid $432.10—Sold $257.20). This represents something very close to our call option budget—4.82 percent (174.90 divided by 3,625)
  • We just created a product with an approximate “cap” of nine percent. This is because we are participating in the upside of the market starting at 3,625 and handing off the upside “participation” in the market once it crosses over 3,950. 3,950 is approximately nine percent (8.97 percent technically) higher than 3,625.

What we have just done is created an indexed annuity that:

  1. Guarantees the client’s money will never be lost. This is because the carrier has the bonds that grow back the money to $100,000 every year, assuming rates stay the same.
  2. Gives the shareholders their IRR, assuming rates stay the same.
  3. Gives the carrier a 4.76 percent call option budget to buy the call options after they expire every year, assuming rates stay the same.
  4. Gives the carrier upside potential of nine percent that they can pass through to the client in the form of a “cap.”
  5. Pays the agent a seven percent commission.

Although my calculations are my own calculations and not specific to a carrier, the product I just explained with those caps, commission rates, etc, really does exist today. So, those calculations are not pie in the sky.

Technically, one of my favorite products is the same as what I laid out here, except the A-rated carrier just announced a cap increase to 10.5 percent for premiums over $100k! How can they do that? Numerous ways. Maybe the carrier is demanding less spread for themselves. Or maybe the carrier is able to get investments at higher yields than my six percent. Both of these would mean more call option budget.

I am fully cognizant that this was a three-coffee article for you to read, but I promise you, if you are serious about indexed products, this article will help you in the future when it comes to answering questions about “How do the carriers do it?.”

The Best Time To Use A CRM Was 20 Years Ago—The Second-Best Time Is Now!

Charlie Gipple, CFP, CLU, ChFC
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The Best Time To Use A CRM Was 20 Years Ago—The Second-Best Time Is Now!

I know, I know! That is not exactly how the old Chinese proverb went, but it was something like that! It was actually, “The best time to plant a tree was 20 years ago but the second-best time is now.“ What that proverb gets at is the power of investing time today with the foresight that you will ultimately get a benefit out of it. That awesome shade tree we sit under today was because somebody took the time 20 years ago to plant it.

In our business, slowing down and taking time to “plant trees” can be exceedingly difficult. I know that you know the feeling: You are going through the day trying to keep all of your customers happy while at the same time trying to bring in new customers, while at the same time putting out fires, while at the same time in meetings, while at the same time getting calls from wholesalers, etc., etc. Just merely coming up for a breath can be difficult. Then when you throw on top of it the time you should set aside to do extra reading, studying, working out, staying healthy, watching the Chiefs play (Steve?), etc., there are simply not enough hours in the day! Again, I know the feeling of having to focus on what is important while letting other things go. However, sometimes those “other things” can be trees that you should be planting…

With that said, there is one task that has become non-negotiable for me. This is a tree planting ceremony that I no longer sacrifice in the name of being “too busy.” This task has become just as important as taking breaths, because I have seen it pay off many many times. That is, entering customer and case data into my company’s CRM (Customer Relationship Management) system.

As a marketing organization that processes and manages the business of scores of agents, needless to say, a CRM system is important. However, even if you are a one man/woman shop, it should be important to you as well. I know this because I do personal production myself and have found that in my “personal production” role, I can’t live without it.

Many of you might be saying, “Duh Charlie! Of course, CRMs are important. All financial professionals should have their customer and policy data in an easily accessible program.” My response is twofold: 1. I would guess that it is not a large majority of agents that actually have a CRM; 2. Most importantly, I am not referring to just the basic common-sense stuff like client names, addresses, and policy information. I am also referring to certain “events” that take place over the life of an annuity or life insurance policy.

Annuity Events
When an agent writes an annuity case with my company, we will code into my CRM system what month, day, and year that annuity comes to the end of its term. We also have a running report that is automatically emailed to me–from my CRM–of the annuities that are hitting those dates over the next 60-days. Why one should do this is obvious. At the end of those periods, the clients will need help doing something else with that money. And you also get paid again. For instance, if a two-year multi-year guaranteed annuity was issued today, then 60 days prior to November 2024 I will be notified by my CRM that you, the agent, have X dollars coming up for renewal. I feel like Santa Claus sending the agents those emails. If it is an indexed annuity written, we will code into the CRM system when the end of the surrender period is.

Now that we are in an interest rate environment where short term annuities look very appealing, you will find that a two-year or three-year MYGA comes to the end of its surrender period surprisingly quick. Two or three years is a blink of an eye. So, plant that tree today so you can enjoy its shade when your CRM (or your IMO’s CRM) provides you with that renewal report.

Another area for annuities that we code into the system is when the guaranteed lifetime withdrawal benefits were illustrated to be activated. Of course, a good agent that does reviews every year will be able to know when the client would like to take their money, but sometimes annual reviews go by the wayside for some agents. By taking time to code these items in your CRM, or partner with a marketing organization that does this for you, you are planting a tree that will be very profitable in the future. RMD dates are important as well!

Life Insurance Events
If you sell term insurance, there is no better time to contact your clients than when they are about to lose their convertibility privileges.

To back up a bit, most term insurance policies allow a client to convert to a permanent policy later on at the health rating that they originally got on the term policy. So, even if the consumer got sick along the way but wants to “upgrade” to a permanent policy, they are still classified as “super preferred“ if that’s what the term insurance rating was. Imagine how many people during the “term“ of the term life insurance policy get sick prior to the end of the convertibility period. Well, when you or the marketing organization has that “end of conversion period date” coded into the system, which generates a report 60 days prior, imagine the opportunities there. On several occasions I have come across consumers that told me, “I recently learned that I could’ve switched to a permanent product a while back with my old health rating. I did not know this and missed the deadline.” Needless to say, these were not my clients that missed that deadline. My clients do not miss this deadline.

IUL Death Benefits and Values
IUL is often illustrated with an increasing death benefit (Option 2) that turns to a level death benefit (Option 1) sometime in the 23rd century. Sarcasm. Is that a point in time that you may want a reminder email from your CRM or your partner IMO? You bet!

In addition to the above, some CRM systems will allow you to code into the system the various policy values you illustrated by the end of the fifth year, tenth year, fifteenth year, etc. This is something that I have recently begun to do. This will allow my agents to have great conversations with their clients as these policy anniversaries approach. If the policy has actually performed at a rate beyond what was illustrated, that is an enjoyable conversation to have with clients!

Image by Pavlo from Pixabay

Multiple Product Lines: The Convenience Of Walmart But The Expertise Of The Mayo Clinic

Charlie Gipple, CFP, CLU, ChFC
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Multiple Product Lines: The Convenience Of Walmart But The Expertise Of The Mayo Clinic

On a monthly basis I get automatic reports that are generated from my CRM system. These reports are sorted out by the agents that work with my IMO and show what policies are coming to the end of the term within the next 60-days. For instance, a two year multi-year guaranteed annuity that was written two years ago represents an opportunity right now for my agent. Additionally, a term life policy coming to the end of its convertibility period represents an opportunity for my agent. This is what this report shows me. From there I am able to send the agent their report so they can reach out to their client and have that conversation. I feel like Santa Claus delivering these reports to my agents.

Anyway, as I was going through my report last month on two-year MYGAs that are reaching the end of the surrender period, I observed one agent that had three cases on this report that were coming to the end of their surrender periods. The total amount of these three annuities that were “coming due” represents about $950,000. Those are three great sales meetings that this agent will be having! But that is not the interesting part. The interesting part is, 30 months ago, this agent did not even know how to spell annuities! He was almost exclusively P&C. Now however, his business has taken on a life of its own. He has policies that are rolling over and, most importantly, he knows how to sell annuities to his massive P&C book of clients. How did all of this happen? Let’s back up and I will discuss.

The number one retailer in the United States is Walmart. The number one grocer in the United States is also Walmart. Now, Walmart is usually the cheapest around which is largely the reason for dominating in both areas, but I would argue that a lot of their “multi-offering” success is about convenience as well. Consumers have a limited amount of time, and it is nice to be able to buy that car battery they need while simultaneously grabbing what’s for dinner tonight. Making one trip is better than two. Plus, at Walmart, you have some great people-watching to keep you entertained, but I digress.

I mention the above example because I often work with agents who are very good in one area—annuities, life insurance, long term care—but not good in other areas. And if they are not fluent in those other areas, they completely disregard those other product lines while having conversations with their clients. Like everybody, agents tend to have a bias where they only want to talk about what they are comfortable with for fear that they are asked a zinger question that they don’t know the answer to. This is natural. Well, perfection is the enemy of progress many times. You don’t have to be perfect to merely get the client interested in a separate product line.

If you are an agent that works with my marketing organization, you will attest that I have been imploring everybody for some time now that if they have clients, they should be able to discuss with those clients annuities, life insurance, and long term care insurance—all three. That may sound daunting to some because we only have so much room in our brains, and it is hard to be an “expert” in multiple areas. Well, with what I am talking about, the goal is to just know enough to get the clients interested in the concept. And once they are interested, bring somebody into the equation that does know that product line. I promise you that you will make a lot of money if you get out of your comfort zone and start taking that step.

In this same Broker World issue, I discuss a little bit about partnerships and what are some recommended commission split structures. If the thought of partnering with another agent and splitting your commission with them makes you cringe, just know that many times you can have an IMO as one of your “partners” where a commission split may not apply. For instance, multiple times a week I am brought into the “three-way calls” with the agent and client via Zoom to discuss the concepts, ideas, and minute details that the agent may not have known. Because it is merely a Zoom call, there are no “splits” involved and is actually the best use of my time. If there are better uses of an IMO’s time than helping consumers with financial security while simultaneously helping agents make a great living, I would like to know what that is! The broad acceptance of Zoom calls is one of the few positives that COVID has brought about. I never would have thought that the average 65-year-old client would be fine with logging onto a Zoom call, but we are there.

But is the above scenario suboptimal? Would it be more optimal if you knew everything (annuities, life, long term care) so you did not have to get a third-party “expert” involved? I don’t believe so! There is power in discussing with your clients that you are a specialist in certain areas and have a “team” of other specialists that help you with the other product areas. Afterall, this is how one of the most credible clinics in the world operates, the Mayo Clinic.

If you are providing your clients with the convenience of Walmart but expertise like the Mayo Clinic, I promise you that you will make a lot of money. It is just a matter of finding the right partners and also the courage to broach the conversations in those areas that may be foreign to you. For my P&C agency that I started this column with, it took a lot of courage to start conversations about annuities, but he did, and now he is making a significant amount of revenue from annuities. And his clients view me as a part of his “team,” as I am.

Once you jump into these other product areas and get a couple of sales under your belt, your business will start to take on a life of its own. You will become more familiar with the sales concepts and product details via the best way possible–through observing an expert communicate the story to your clients. It may not be as exciting as observing the people at Walmart, but it is certainly more profitable.

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