“Pretend you are driving a car in the middle of a thunderstorm, and you happen upon three people on the side of the road. One of them is a frail old woman, who looks on the verge of collapse. Another is a friend who once saved your life. The other is the romantic interest of your dreams, and this is a once-in-a-lifetime opportunity to meet him or her. You have only one other seat in the car. Who do you pick up? There’s a good reason to choose any of the three. The old woman needs help. The friend deserves your payback. And clearly, a happy future with the man or woman of your dreams will have an enormous long-term impact on your life. So, who should you pick? The old woman, of course. Then, give the car keys to your friend, and stay behind with the romantic interest to wait for the bus!”1
We are all individually surrounded by people we can help, people who can help us specifically, or people who we know could benefit from meeting someone else we know. Our success in life depends on how well we build relationships, and the extent to which we establish reputations for making other peoples’ lives better.
In this article I am simply attempting to expand our appreciation for the art of networking.
Networking, defined: “Networking is the exchange of information and ideas among people with a common profession or special interest, usually in an informal social setting.”2
Throughout my career I have regularly attended networking events. Initially, I viewed this as my best way to let people know that I existed and what it was I did for a living. (Notice the ridiculous hero of that sentence: I, my, I, I.) As I matured, the idea of networking transformed into more of a means of meeting influential people. Later on, the approach I took in networking was to discover who in my relationship circles could prove helpful to people pursuing their dreams.
My ultimate networking goal: To make connections between people who had needs and those who could meet those needs.
Frail Old Woman
In the story above, told by Shane Snow, there is a category of person who we can help, who, in return, can literally do nothing to further our own success. We all have a natural human tendency to act mainly out of self-interest. Those of us who lead organizations (for-profit, or non-profit) generally seek to build relationships with people who can help our organizations in some way.
Someone once said, “When you give a luncheon or a dinner, do not invite your friends or your brothers or your relatives or rich neighbors, in case they may invite you in return and you would be repaid. But when you give a banquet, invite the poor, the crippled, the lame, and the blind. And you will be blessed, because they cannot repay you.”3 Imagine seeking to serve people and extend hospitality to them, not because of what’s in it for us, but because of what’s in it for them.
Personal Illustration #1
I had an appointment in downtown Cincinnati. Traffic was slower and heavier than usual because of a downpour of rain. The interstate had three lanes of traffic moving toward town. I was in the middle lane about to merge into the right lane in order to exit. That is when I spotted a car parked ahead on the right berm, and the woman standing and looking at her car’s flat tire. Standing in pouring rain.
I had a decision to make. I was running late to an appointment with a highly influential and wealthy prospect. This was before I carried a cell phone. It was not possible for me to alert the prospect concerning the delay. Yet, here was someone in dire need. What to do. I pulled off the highway, stopped my car, and walked back to the woman. I urged her to get into her car and out of the rain. I wore a white dress shirt, tie, suit pants and good shoes. It took me about 15-20 minutes to jack up her car, replace the tire, and load the damaged tire into her trunk. Off she went. I walked back to my car.
I drove into the city, valet parked my car at a hotel near the offices of my prospect, found a public bathroom, cleaned the black tire smudges off my arms and hands, straightened my wet tie, dried my shoes, donned my dry jacket, and took the elevator up to the offices where I was now thirty minutes late. My only thought: “I blew this one. No chance he is ever going to meet with me, a life insurance agent, after being thirty minutes late without notification.”
The elevator arrived at his floor and the doors opened into an open reception area. The man’s name was there on the wood paneled wall in large letters above a wide desk where a woman sat ready to receive guests. The woman sitting there was–guess who–the same woman I had helped.
Yes! The appointment could not have gone better!
Point: When we serve someone who cannot benefit us in any way, we are providing the highest level of service we can. Maybe, just maybe, we might be blessed precisely because they cannot repay us.
A Friend Who Once Saved Your Life
All of us have achieved our success, in part, due to the actions and influences of other people. Rarely has the other person actually saved our life. They most certainly helped us move up, advance forward, expand our reach, or achieve the next level.
In an article for “Investopedia” written by Julia Kagan and published in June 2022, Ms. Kagan wrote:
“Once you join a networking group, it’s important to become a contributing member. Rather than just using the association to further their own goals, people who use networking effectively look to offer something of value to other group members.”4
How can we benefit others or add value?
Consider these examples:
- Help others to widen their circles of acquaintances.
- Help people discover fresh opportunities.
- Help people increase their awareness of news and trends in their fields.
Point: What we have we did not create except through the combined efforts of many other people. What we have is intended to be shared.
Once-in-a-Lifetime Opportunity
In the mid 1990’s, American television host, Jimmy Fallon, was a Computer Science major at the College of Saint Rose in Albany, New York. While a student there he obsessed about the comedy industry and occasionally performed comedy at small clubs. Fallon sent an audition tape to a former boss named Peter Iselin. Mr. Iselin passed on Fallon’s tape to an entertainment agent named Randi Siegel working in Los Angeles. Ms. Siegel had connections to “Saturday Night Live” and worked with clients like David Spade and Adam Sandler.
Although she found Fallon’s tape to be charmingly amateur, Ms. Siegel called him. To her amazement, Fallon knew who she was. (He was a student of the comedic industry.)
“He was so dead-set on joining SNL that he dropped out of school one semester shy of graduating.”5
Fallon bombed his first audition at SNL. He was able to eventually get a second audition. He was hired as a cast member in 1998.
Randi Siegel handed Jimmy Fallon a once-in-a-lifetime opportunity.
Point: We may be the one who can offer someone else a once-in-a-lifetime opportunity. Just as possible, someone we meet just may be able to introduce us to a once-in-a-lifetime opportunity. If we are willing to be generous and open handed with our relationships many of us can end up being the person in the middle and simply connect one person with a dream to another person who can help bring the dream closer. (Like Peter Iselin in Fallon’s story.)
Personal Illustration #2
I have two friends who like the same kinds of experiences and adventures that I do. Recently we discovered that a coming Friday was wide open on each of our calendars. We met mid-morning and headed to downtown Hamilton, Ohio.
Our first stop was at a women’s health facility called “Pathway to Hope.” We knew people who volunteered there and wanted to see firsthand what it was like and gain an understanding of the services they offered. The director gave us a personal tour. We made two networking accomplishments there:
- The hallway walls were barren of artwork. One of the three of us is an artist/photographer. He volunteered to donate several framed pieces of his work as gifts to be hung on the blank walls.
- The facility shared the space with another organization that was moving to new headquarters. They were leaving behind bulky wood furniture that must be removed. We three have a friend that takes unused, unwanted old wood furniture and turns it into new, highly utilitarian pieces. We took photos and texted them to our friend who expressed interest in taking the pieces off their hands. For free.
Our second visit was to a one-room museum dedicated to honoring the children’s book writer and illustrator, Robert McCloskey. Mr. McCloskey was born and raised in Hamilton. He was famous for his book Make Way for Ducklings, published in 1941. He received two Caldecott Medals from the American Library Association, and the U.S. Library of Congress named McCloskey a “Living Legend” in 2000.
The curator of the museum is an older man named Jim Schwartz, and he was very generous with his time and answered our questions. We came to find out that Mr. Schwartz had other interests. He wrote three books about an important Ohio manufacturing company named Cincinnati Milacron, and biographies of its founder (Frederick A. Geier) and the founder’s heir and successor.
The three of us jumped into networking gear! We happen to know a man who built and sold a highly successful machine tool company and who has a personal museum of historic Cincinnati Milacron machines. He is a fanatic about the industry and Milacron’s important place in it.
We connected our friend with Jim Schwartz and came to discover that our friend owned and has read all three of the latter’s books! Both men were delighted to make one another’s acquaintance and they look forward to sharing their knowledge with one another.
Point: We run into people every day, inside and outside of our work, related or sometimes unrelated to our normal lives, and yet, in a small world, we can often make connections between new friends and those we know well.
Summary
In life and in business we cast out our nets in order to find new opportunities, to meet new people, and to increase our influence in the world. In the process we can help those who cannot return the favor, begin to repay people who have blessed us, and find ways to connect ourselves and others with once-in-a-lifetime opportunities.
In particular, through networking, we can:
- Gain insights that only come from viewing a situation with fresh eyes.
- Develop and nurture not only professional relationships, but also strong and long-standing friendships.
- Build invaluable social skills and self-confidence.
- Open the door to new perspectives, suggestions and guidance.
- Create access to new and valuable information sources.
- Help other people to receive introductions to potentially relevant people.
- Improve our own reputations as being knowledgeable, reliable, and supportive.
- Sow the seeds for reciprocal assistance.
After reading the above, and as an independent financial professional, how would you answer this question:
How well is your net working?
Footnotes:
- Smartcuts: How Hackers, Innovators, and Icons Accelerate Success, by Shane Snow, Harper Business, September 2016, ISBN: 0062560751.
- https://www.investopedia.com/terms/n/networking.asp.
- Luke 14:12-14 (NRSV), Oxford University Press, August 15, 1991, ISBN-10:0195283805.
- https://www.investopedia.com/terms/n/networking.asp.
- https://www.businessinsider.com/jimmy-fallon-networking-key-to-success-2014-11.
Image by Paul C Lee from Pixabay
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: 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?
What we have just done is created an indexed annuity that:
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?.”