Thursday, May 09, 2013

Buying Service Credit Can Be A Slam Dunk

One of the most consistent requests I receive from new educator clients (as well as other government employees) is to run an analysis to see if it makes sense for them to buy (or repurchase) service credit.

It used to always make sense, but today there are fewer purchase options and in most cases the cost has increased to the point where they would be better off saving in a 403(b).  But not always.  I still come across situations where it not only makes sense to make the purchase, it would be crazy not to.

I use several different models to determine whether the buyback makes sense, but the easiest to understand is the one that tells the client "how long do I have to live to break even?"  Break even being the number of months one would receive income from a pool of money, earning a specific interest rate and that pool becoming exhausted.  There is no right number of months, it really depends on the client, but believe it or not, I've come across some service credit purchases that allow the client to make back every dollar in just over four years of retirement, assuming no interest (longer with different interest assumptions).

Recently, I ran a scenario for a client who had already decided against the buyback.  I won't give away the state where this plan resides and we'll name my client George.  George had less than four years that could be purchased for about $28,000.  He thought this to be too much money.  However, the annual increase in benefit was just over $7,500.  I didn't have to run any numbers to determine this was an incredible deal, but I ran them anyway.

I wanted to see what rate of return George would need if he invested the money on his own and then provided the same income (adjusted for a similar inflation benefit) to himself and lived to about normal life expectancy.  Using 86 as normal life expectancy I calculated that George would have needed a return of almost 21% annually (with no fluctuation in that return) to provide the same benefit the buyback of service credit would provide.  This became the biggest buyback slam dunk I've ever encountered.  Not buying back the service credit would be leaving potentially hundreds of thousands of dollars on the table.  Not only was it worth it, but the client should certainly borrow if they didn't have the funds.

I should state that I rarely run into these "slam dunk" service credit purchases anymore and when I do they are usually of the "repurchase" variety - meaning the client had taken money out of the system many, many years ago and is eligible to re-purchase those years.  Normally, when a person takes a distribution of their defined benefit balance after leaving an employer, it is only their own contributions plus earnings that they receive - not the employer contributions.  So when they ask to repurchase the credit, they have the employer contributions restored, lowering the cost of the buyback.

Buying service credit can be a smart idea, even if the payback period or internal rate of return is not great.  But generally I like to see a payback period under 12 - 15 years (depending on if it's a single life or joint life) and an internal rate of return to average life expectancy over 5%.  Client risk profile is very important in this decision, so my numbers will vary with the client.

If you are eligible to repurchase past service credit, you should look into it.  If you are eligible to purchase years of service credit for which you were eligible, but didn't work - get the data and have someone run the numbers.  While "airtime" is becoming more rare and not usually worth it anyway, you might also look to see if it makes sense for you.

Be careful who you ask to run the calculation, a product salesperson has a vested interest in you NOT doing the buyback.  A buyback can be like found money, don't leave it on the table.

Scott Dauenhauer CFP, MSFP, AIF

Tuesday, May 07, 2013

Conflicts in Fixed Annuities: Incentives Part II - The Trips, The Amazing Trips!

Do you know what incentives lurk behind the products our nation's educators are sold in their retirement programs?

It doesn't take much time searching the internet to find some of these incentives.  I receive e-mails everyday detailing where I can go if I sell enough of XYZ product.

One major conflict of selling most fixed annuities is insurance agents may be incentivized to sell products of a single company (or several products from a single Insurance Marketing Organization) in order to qualify for special perks.

These perks might be exotic trips, cash or even Apple products. 

There is no law against offering special perks and insurance companies are within their right to offer agents big incentives to sell their products.  However, it's my opinion that this is a major conflict of interest that should be disclosed and potentially even banned.

Fully paid for vacations to exotic locales could certainly persuade an agent to sell one annuity product or another or to sell an annuity when another financial product would be more appropriate. Educators should be aware of the incentives behind products sold to them. In a perfect world there would be no incentives, only the best interest of the client and a fully disclosed compensation scheme separate from the recommendation.

Qualifying for exotic trips is one of the biggest lures for getting insurance agents to sell the products of an insurance company or from an Insurance Marketing Organization (or IMO, an entity that essentially wholesales annuity products).  Sell enough of a certain product or of a collection of products and the agent may end up with a trip to any number of locations.

Many companies offer trips and other perks as incentives to sell their products.

What follows are the destinations for this year and the last few years for those who qualified for one big name insurance company:

2014 Hayman, Great Barrier Reef; Sydney, Australia

2013 Big Apple Bonus - New York City

2013 The Ritz-Carlton, Key Biscayne Florida

2012 Fairmont Orchid Resort, Kohala Coast, Big Island of Hawaii

2011 Riviera Maya, Mexico

2010 Florence, Italy

Another insurance company has a “Leaders’ Club,” which awards a Mediterranean cruise for those who produce enough annuity premium. The cruise is on the Crystal Serenity Ship and cruises to Italy, Greece and Turkey from April 20th to May 7th, 2014!

This company also had a qualifying trip for 2013 to the Four Seasons in Lanai, Hawaii, not bad.

I’ve attached various documents I’ve found from Insurance Marketing Organizations below. It's a cornucopia of great vacation locales:


Ritz Carlton in Hawaii

Puerto Rico



Alaskan Cruises



The list never ends.

Here's a link from an e-mail I just received, check out the headlines:

Silverado Resort and Spa in Napa ValleyExplore all that the Napa Valley has to offer in your limousine wine tasting excursion. Later, you can unwind with a soothing fireside massage or full service spa.
Pebble Beach LodgeEnjoy this world-renowned resort, while indulging in two rounds of golf at the infamous Pebble Beach courses.

All of these trips are achieved by selling annuities to our nation’s educators.  I think it's reasonable to ask if this is appropriate.  The issue has certainly been addressed before in the financial services industry.

Back in 2003 the National Association of Securities Dealers (NASD), now the Financial Industry Regulatory Authority (FINRA) fined Morgan Stanley $2 million dollars for conducting sales contest that “offered or awarded various forms of non-cash compensation to the winners, including tickets to Britney Spears and Rolling Stones concerts, tickets to the NBA finals, tuition for a high-performance automobile racing school, and trips to resorts.”

That was over a decade ago, yet a similar practice in the fixed annuity industry is not only allowed, but seemingly encouraged (Morgan Stanley never admitted or denied the charges). Why is this okay?

Why are our nation’s educators retirement savings being invested by such conflicted sales agents? In my opinion,  this is not acceptable. The industry answer is a disclosure document that is light on disclosure, does not disclose incentives behind the sale and misses the point entirely.  An industry spokesperson from ASPPA/NTSAA was recently quoted:
“We maintain that improving transparency is a far better approach to improving the 403(b) marketplace, than taking away public school employees retirement choices.”
How convenient. Parade around a confusing disclosure document that doesn’t actually disclose pertinent items like exotic trips and whether or not the agent is acting as a fiduciary rather than addressing the actual problem.  Having said that, I think that insurance companies, insurance agents and insurance marketing organizations should be transparent about what incentives are behind the sales of their products.

Since fixed annuities are insurance products, they are regulated at the state level - they are not securities and thus out of the purview of the SEC or FINRA. Perhaps the Consumer Financial Protection Bureau should get involved. For what it’s worth, I’m calling on the fixed annuity industry to make changes to the sales incentives they offer.

I call on all insurance companies that offer products to our nation’s educators to do the following immediately: 

Stop offering additional incentives for the sale of your products

Stop offering your products through IMO’s who offer such incentives

Set commissions on a level basis and disclose them fully

Don't allow agents who sell your products to represent themselves as advisors

Insurance agents, you are not innocent in this - I call on you to do the following:

If possible, stop doing business with companies who offer exotic trips in exchange for recommending their annuities.

If offered a special incentive, kindly decline

Disclose to clients the existence of such incentives

Make your voice known on this topic

I’m willing to bet my e-mail inbox will be silent.

I want to make clear that not all insurance agents are evil, greedy, commission and perk hungry.  I've met many qualified agents whom I respect and even refer my clients to when appropriate.  A good insurance agent can be very valuable (though less so in the fixed arena).  But if you are in education and the person selling you something is licensed to only sell you that product, you might look elsewhere.  As the saying goes, when all you have is a hammer, everything looks like a nail.

I’ve listed links to a bunch of the documents I found on the internet referring to special trips. The links are likely to be dead soon (if they aren’t already), I’ve pdf’d the documents and made them all available to you using my own host. All the documents were obtained on the open internet - no passwords, no firewalls, the information was freely available to anyone.

Scott Dauenhauer CFP, MSFP, AIF
The Teacher's Advocate

 Chairman’s Club 2014

 Champions 2013



 Leaders Club

 Miscellaneous Trips

Thursday, May 02, 2013

Farewell, About Time and WTF?

Farewell, But Not Goodbye

It was announced a few days ago that Julia Durand, Director of Defined Contribution Solutions at the California State Teachers Retirement System (CalSTRS) would be leaving to accept a position as the Deferred Compensation Manager at the San Francisco City and County Employees' Retirement System.

This is a bittersweet announcement for me as I've had the pleasure of working with Julia since 2008 and she has become a real 403(b) Advocate (and friend).  Given that there are so few 403(b) advocates, it's tough to lose one.  But I know she'll continue to be vocal in support of the things that matter to those in government defined contribution programs.

Julia was in charge of all the major defined contribution programs at CalSTRS and they all grew under her tenure.  The 403(b) industry is not the easiest to deal with, but she approached it with a zeal and a poise that disarmed those who would oppose her.

The Pension2 program at CalSTRS has come a long ways and all the staff at CalSTRS should be proud of this accomplishment.  I'm highly biased, but I believe it to be the best 403(b) program available in California and a role model for the country.

CalSTRS will soon be conducting a search to determine who will take Pension2 and the other Defined Contribution programs into the future and I'm confident a new 403(b) Advocate will rise to the occasion, like Julia did.

We will miss you Julia, don't be a stranger!

About Time 

Plansponsor recently ran an article focusing on those who were critical of the PBS Frontline documentary "The Retirement Gamble."  As I was reading through I found an interesting quote from the head of ASPAA/NTSAA (National Tax Sheltered Account Association) that made me do a double take.  The quote in question, as follows (emphasis mine):

“We need to expand coverage to those without a plan at work. We need to make it seamless for workers to save through greater utilization of auto-enrollment. And we need to make sure we focus on outcomes so the system produces the retirement results reasonably expected by both plan sponsors and participants.”
I'm a big advocate of auto-enrollment, in fact I just finished a four-part series titled "Make It Automatic" which you can find here, here, here and here. One of the biggest opponents I've encountered to auto-enrollment is the NTSAA organization, which is part of ASPPA (for a bit of irony, read this).  The NTSAA believes that individual insurance agents and registered representatives should enroll people and that there should be an unlimited number of products available for 403(b) plans - the exact opposite situation needed for auto-enroll.

So when the head of an organization that actively lobbies to defeat any chance of auto-enroll in 403(b) retirement programs says "We need to make it seamless for workers to save through greater utilization of auto-enrollment." I have to wonder whether he was misquoted.  I actually agree with his whole quote, in fact it sounds like something I would say, what gives?

My suspicion is that the current head of ASPPA is no longer in a dual role as head of NTSAA.  This allows him the freedom to push the goals of ASPPA which might differ from the goals of NTSAA.  It seems odd to me and counterproductive to have an organization whose underlying members represent diametrically opposing viewpoints.

The question really becomes this, "Does the NTSAA stand behind the ASPPA director's viewpoint on auto-enrollment as it applies to government employees?"  Furthermore, will the NTSAA work to spend money to stop auto-enroll while ASPAA spends money to push for auto-enroll?  Can these two organizations really stay under the same umbrella given their divergent belief systems?

At this point, I'll take it as a win and say that ASPPA/NTSAA now supports my viewpoint that auto-enroll is critical to the success of helping those in education retire comfortably.

WTF (Why The Face) 

Financial Advisor magazine ran the following headline:

The relevant quotes are as follows:

“We’re getting more than 2 percentage points of fees from the assets that are part of our annuity business,” Mark Grier, Prudential’s vice chairman, said at a Citigroup Inc. financial-services conference in Boston today. “In your businesses, you probably would dance in the street over 40 or 50 or 60 basis points.”

“The quantitative evidence is that that pricing is sustainable in the market,” Grier said today. “People want to pay for the features that these products provide and they’re willing to pay those kinds of prices.”
Now you know what makes insurance companies dance, but are they overcharging?  It seems that if the pricing were enough to cover the risks and a reasonable profit, nobody would be dancing, just reasonably happy.  This guy sounds downright giddy.  Is it possible that the benefits now offered on most annuity products are so benign as to not represent a real cost to the insurance provider and thus the extra fees really are gravy?

Only time will tell.  After the next financial crisis we'll find out whether this guy was just another idiot AIG fellow or a company genius who helped design products that really didn't do anything, except overcharge clients.

Scott Dauenhauer, CFP, MSFP, AIF
The Teacher's Advocate