Vol 9 No 2		February 2007

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Rejoinders and Rebuttals

A Rejoinder to Leimberg's Recent Newsletter on Premium Financing:

Steve Leimberg publishes a useful and often informative email newsletter dealing with a myriad of tax and financial product issues (http://www.leimbergservices.com). Unfortunately, he sometimes offers up commentary from various sources about life insurance that carries considerable baggage for the industry and its agents, such as the infamous 419 plans. Though Mr. Leimberg hasn't welcomed my observations about these commentaries I have grown weary of reading pieces, in my area of expertise, from life insurance sellers and marketers whose biased views do not provide critical judgments.

Leimberg's February 5, 2007 commentary by an ING Vice President dispassionately treats three types of premium financing as if they are all legitimate, when two of them are not. Financing that borrows both principal and interest is dangerous, and so called non-recourse loans, mostly associated with investor-initiated life insurance, is so disgraceful they have major life insurance groups and regulators trying to put them out of business. The legitimate interest-only financing method carries a high probability of loss, which can only be understood when an appropriate mathematical analysis is provided. This is not found in Leimberg's piece.

I invite you to read my column about interest-only premium financing in the July 2004 issue of the Journal of Financial Planning, An Analysis of Premium Financing . To read about investor-initiated premium borrowing please see my column in the May 2006 AAII Journal, Why You Should Avoid Investor-Initiated Life Insurance.

Letters and Rebuttal concerning Annuities Column

To follow are letters to the editor critical of my Journal of Financial Planning, November 2006, column The Good, Bad, and Ugly of Annuities.

To Peter Katt: After reading your article on "The Good, Bad, and Ugly of Annuities" in the November 2006 issue of Journal of Financial Planning, I had to write to you not only as a fellow CFP but most importantly as a consumer.

First of all, did you forget the market decline we had in 1999-2000? My husband and I lost over $500,000 in equity because I did not want to liquidate and pay the capital gains tax. Like most people, I never dreamed the market would lose so much value. I learned a valuable lesson from that experience. Never would taxes be my primary concern!

Second, you say that we planners use the "bells and whistles" as a "distraction." What you call bells and whistles I call financial security. There is no other product that allows one to participate in upside gains with downside protection. My husband and I personally own over $1 million in various variable annuities and I sleep very well knowing that we will never have less than we invested and in some cases those gains are locked in annually. Also as a side benefit, I can rebalance my investments quarterly if I want, with no tax consequence.

Third, the average annuity mortality and expense charge is approximately 1.5 percent. Add annual step features and the fee will be around 2 percent. I would gladly pay 5 percent annually if I could have all of the gain back that we lost.

Finally, I fully disclose to my clients all of the expenses and they love this product, especially the ones with 15 years or less to retirement. (By the way, some of my clients are CPAs and attorneys.)

Variable annuities are one of the best products available to financial planners today. Financial planning is more than mathematics. And as a financial professional, I believe you do your clients a big disservice by thinking that tax planning should be the primary focus and by not offering variable annuities as a valuable tool. Betty Pentola, CFP, CLU, LUTCF

To Peter Katt: Mr. Katt paints with a broad brush. To say that variable annuities are flawed because of the capital gain issue is very closed minded and unprofessional. I have clients, who were in certificates of deposit because of the fear of market risk, whom I put in VAs with living benefits. They've gone up 80 percent in the last four years. I guess they will just have to pay the taxes.
Jon Williams, CFP®, CLU, CSA

Author's response: My November 2006 column reviewed the entire annuity landscape and contained brief comments about variable annuities with guaranteed living benefits (GLBs), which provoked critical letters and several nasty e-mails. My column noted that conventional VAs may be ideal for aggressive traders and market timers but that the cost of GLBs and the conversion of capital gains into ordinary income didn't seem to justify their use. What I didn't comment on in my column, but will here, is the potential risk associated with GLBs.

What I hadn't contemplated in thinking and writing about these "heads-I-win-tails-I-break-even" products is that sellers may be viewing them as the predominant or only investment for clients. Rather, I was thinking about equity investments as part of an overall portfolio. Based on comments from several investment advisors I discussed this with, I believe this issue exposes again the problem of financial planners, as one advisor put it, "who practice financial planning based on a path of least resistance sales strategy while avoiding the more difficult task of educating the client about investment choices."

It is hard to take seriously a debate with a CFP certificant who "…never dreamed the market would lose so much value" and "would gladly pay 5 percent annually" for protection against equity losses, so let me address the critical issue this debate exposes. Variable annuities with GLBs invite product sellers to move clients' money into an "upside with no downside" product without sufficient attention to a cost/benefit analysis, appropriate diversification, and disclosure of risk.

Citigroup Smith Barney did a study of "The New Variable Annuity" (3.87MB) in September 2004. This study points out that GLBs are more risky than the VAs with death-benefit guarantees that caused havoc at Allmerica Financial and American Skandia in 2002. The most popular and commonly selected GLB is the minimum withdrawal benefit, which the study says is the riskiest of the three. It appears that the strongest finger in the GLB dike is hedging, but experience tells us that such complex strategies always have blind spots within the universe of most-likely scenarios and are inadequate protection if we enter into historically unique circumstances whose probabilities are treated as very remote in hedging models. An insurance company turned sideways because of aggressively promising "upside with no downside," VAs could face reserve-strengthening requirements that exceed their free surplus, the definition of insolvency. They would be seized by state regulators. It is questionable whether the state guarantee funds would cover such losses. If they did, it would be limited to $100,000 and this problem could be so widespread that guarantee funds could quickly be depleted. A feasible result would be that many investors would be stuck with their actual VA balances without the guarantees. This would be a real problem for an investor who had committed, say, 20 percent of their portfolio to a variable annuity with GLBs, but it would be a disaster for someone persuaded to place all of their investment funds in such a product based on the pitch that it was fully guaranteed. For those of you who think insurance executives wouldn't be so foolish as to expose their companies to such risk, please look up Baldwin United, Executive Life, Mutual Benefit, Prudential, Confederation Life, Kentucky Central, and Mid-Continent Life.

This response to my critics is quite unlikely to cause sellers of VAs with GLBs to lose their zeal, but they should at least alert potential buyers to the reality that these guarantees could fail so they can make a more informed decision.
Peter C. Katt, CFP, LIC

These letters have been reprinted with permission by the Financial Planning Association, Journal of Financial Planning, Volume 20, Issue 2, February 2007.