Archive for the Other Investment Management Topics Category

Life Settlements – a Good Investment or no?

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Life Settlements - a Good Investment or no?A life settlement is the sale of a life insurance policy by the owner to a third-party, typically for cash in an amount greater than the surrender value (why else would a person sell their life insurance policy?). The buyer assumes ownership and pays the premiums necessary to keep the policy solvent. Upon the death of the insured, the buyer of the policy receives the death benefit.

Generally speaking, life settlements are an option for policy owners of high net worth who are over 65. Independent estimates report that one in five policies in this group has a market value exceeding the cash value offered by the insurance carrier.

The market for life settlements started out on a rational basis. The original business plan for life settlements was to purchase unwanted or unneeded policies as an institutional investment from policyholders over 65 whose health had deteriorated more rapidly than the aging process would indicate. This primary factor established the mortality arbitrage necessary to make the purchase price higher than the policy’s surrender value.

Are life settlements a viable investment?

There are a number of pitfalls policyholders must consider before selling their policies, but if you are in the market to purchase life settlements, it’s important to consider a few details. First, the life settlement market has become quite active, indicating that the industry has convinced itself these life insurance policies are mispriced. As the industry has developed, it’s begun eying the policies of healthy insured individuals and labeling them as attractive targets as well.

Life settlement brokers have begun purchasing policies and repackaging them. These packages are then sold to small institutional and individual investors with the original message: these are unwanted policies from policyholders who are at least 65 years old and in unexpectedly deteriorating health. Unfortunately, all of the packaged policies may not adhere to the investment model.

This is what some in the industry refer to as ‘dumb money’ because the investors don’t know how to analyze the investment potential and they don’t understand that an accurate assessment of life expectancy is critical to this particular investment’s success.

Our Conclusion?

While the life settlement businesses started out as a worthy secondary market for limited situations, the market has gotten out of control. Huge, often hidden, fees and commissions have been assessed to these life settlement package investments. Add that to the misplaced understanding that these policies are all great investments and you have a poor reason to invest. In many cases, the insureds should not be selling their policy until it is about to terminate, and investors shouldn’t become owners of another person’s life insurance policy.

Funding College – should you go private or federal?

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Funding college - should you go private or federal?An unlikely change resulting from the recent Health Care and Education Reconciliation Act of 2010 relates to the federal student loan program. Beginning the first of July, 2010, all student loan lending through the Federal Family Education Loan Program (FFELP) will originate from the federal government’s Direct Loan program. This means that private banks will no longer be able to make government-backed loans to students and their families. The intent is to streamline the process, which was often confusing and sometimes misused by dishonest lenders.

What difference will the changes make?

The process of applying for college loans is now simplified into a single system. You won’t have to shop around to find a lender offering the most competitive rates and loan rate terms. Remember the 2007 student loan scandals, which revealed that lenders were providing university kickbacks to be on a ‘preferred lender’ list handed out to students and parents? Well, those are long gone.

It’s important to remember too that private educational loans also often came with variable interest rates, no caps, high origination fees, and less flexible repayment terms – all features the Stafford loans were designed to eliminate.

So what’s the College Loan Process now?

The process won’t change – students and parents will fill out the Free Application for Federal Student Aid (FAFSA) to apply for Stafford loans, which are unsubsidized loans made directly with the federal government. Interest rates are fixed at 6.8% (the same as in 2009-2010) and no credit check is required.

Stafford loans have limits:

  • freshman can borrow no more than $5,500

  • sophomores can borrow no more than $6,500

  • upper-class undergrads can borrow no more than $7,400

  • the lifetime cap remains at $31,000

When your student reaches these limits, parents can apply for a Parent PLUS loan, which is also available through the FFELP (the federal government). The rules on PLUS loans are slightly different, however. Parents are required to pass a credit check and sign a promissory note. The interest rates on PLUS loans is now fixed at 7.9% (reduced from the previous 8.5%), which is great for parents.

How does Repayment work now?

The new health bill also contains some provisions for future repayment of college loans that will help low-income borrowers. Borrowers taking out student loans on or after July 1, 2014 can choose a repayment plan that is income-based, with an accelerated duration of 20 years instead of 25.

2010 Graduate – current repayment rules
$40,000 in student loans
standard 10-year repayment schedule
6.8% interest rate
= Graduate pays $460/month

Post 2014 Graduate – new repayment rules
$40,000 in student loans
standard 10-year repayment schedule
6.8% interest rate
married with a child
earning less than $27,000 (150% of poverty level)
= Graduate pays $160 per month and any unpaid balance is forgiven after 25 years.

Note! These changes do not affect current borrowers.

Should You go with a Private Loan?

It depends. First, many parents expect their children to assume some of the debt related to their higher education and, in that case, your student should fill out the FAFSA which will entitle them to Stafford Loans and their relatively easy terms.

After that, if you want to borrow in your own name, you should generally consider the PLUS loans because of the relatively low interest rate (7.9%). If you prefer to borrow educational funds for your children from a bank where you have a personal relationship, you may be able to get a better interest rate than those offered by the PLUS loan program.

A word of caution, however: many private student loans have typically held variable interest rates in the past. While some private lenders are returning to the incentives they abandoned during the credit crisis, it’s important to understand the terms before you sign the loan agreement.

Of course, it’s important to remember that saving for your child’s education comes after saving for your own retirement and security needs. Losing sleep over how to pay for college pales in comparison to losing sleep over how to pay for your own retirement.

So, the most important rule is to take care of your own needs first.

It’s Your Funeral…

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There are few things in life that are inevitable. One thing is certain. Unfortunately it’s your funeral. Amazingly enough, we spend little time planning about the one thing in life that is certain. After you or a loved one has passed on and the burden is upon those left behind the financial stress can sometimes be unbearable. When my father passed away it put undue tension on our family because death preparations hadn’t been made. This tension could have been avoided if there had been a simple planning session put together beforehand and arrangements made.

In one study, the cost to bury a loved one in 1993 it would have cost that person $2,900. The same expense in 1995 it would have cost $7,100. That’s a 145% price increase.  That was a decade and a half ago. Obviously prices haven’t increased 72.5% per year since 1995, but the price has increased dramatically nonetheless. There is a financial weight to be carried. So how can one go about planning a funeral?

First, preplan, don’t prepay.  Tell your loved ones exactly how and where you would like to be buried or cremated. Decline offers to pay upfront costs in case situations change. In many states there is no requirement for funeral homes to put your money in a safe investment or refund it if you switch venues.  There is also no guarantee that your investment will yield enough to pay for a casket entirely.

Second, just like any large expense in life it’s always wise to shop around. Get a feel for prices and find the best quality for your money. Prices for funeral services and caskets vary by thousands of dollars within the same metropolitan area. Even though you may be familiar with a funeral home nearby don’t settle until you feel comfortable with all the details.

Lastly, even though a death of a loved one is a physically, emotionally, and mentally draining make sure to take the proper amount of time to think things through clearly. Use your predetermined plan and follow it. Let it be your road map. If the proper amount of caution is taken beforehand, the funeral services will go smoothly and there will be less chance that you will be taken advantage of by those that monetize the business of funerals. And more importantly there will be less stress when the day of the funeral comes.


Inflation–The Real Monster

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1984 stampThe United States is running up record high levels of debt. In fiscal 2009, we will increase the debt by more than we did during the last five years combined. We have essentially four ways to service the debt:

1. Spend less
2. Tax more
3. Default on the debt
4. Encourage inflation

In recent memory, there has not been an administration that has even remotely come close to reducing annual operating budgets. Despite the empty promises we hear ever four years, even the most conservative Republicans find ways to spend more and more of our money. So, we can cross the first option off the list, there is no way we are going to pay down the debt by spending less than we currently spend.

Most readily agree increased taxation in one form or another will be in the future. There still is some debate as to what type and how much increase will exist but it certainly seems inevitable. Unfortunately, even with higher taxes it does not look like that will be enough to pay off the increasing debt load.

Defaulting on our debt is not really a viable option. Not only would the US’ defaulting on our debt completely destroy modern banking, finance, and trade on a global scale, it would also likely lead to a war between China and the US.

Inflation makes servicing debt easier because future dollars are not worth as much as today’s dollars. Additionally, in inflationary environments, people need more money to buy goods and services. Salaries typically rise to meet this demand, creating increased tax revenue for the government. So, not only will the government be paying back debt with lower-valued US dollars, but they will have more of them to do it with.

Due to our current national debt, our future will include some combination of increased taxes and inflation, neither of which is ideal, but both of which are inevitable. While it may not seem like it, taxes are somewhat controlable. Inflation, however, is not.

When policy makers want some inflation, like they do now, they use powerful but crude tools to create it. The problem is they are not always able to control how much inflation they get and often overshoot–meaning prices prise higher than they intended. Not bad for our national debt, but it will dramatically impact your quality of living unless you plan accordingly.

Most conservative financial pundits plan on an average of 3% annual inflation. This translates to prices doubling on average every 25 years. Recall the price of a stamp 25 years ago ($0.20) versus the price of a stamp today ($0.44), and you’ll see that on average the 3% inflation rate has held. However, during the United State’s worst inflationary periods prices have doubled every five years. A far cry from countries like Zimbabwe where last year prices doubled, at times, each day, however even a five year 100% increase in prices could have a heart-stopping affect on retirement plans beacuse a 100% increase in prices is equal to a 50% reduction in your investments.

In 2008, we learned that projections of acceptable long-term market risk and return include some painfully difficult years. Many have now redefined long-term from 10-20 years to 3-5 years. As noted in a separate posting, we need to learn from 2008 by reevaluating our allocation of investment approaches and asset classes, our perspective of long versus short-term, and our willingness to accept appropriate levels of market risk. However, we cannot drive forward by looking in the rear-view mirror. If we do, we risk hitting inflation potholes that can wreak even further havoc to retirement plans.

In this post, we outlined the inevitable inflationary push that will occur at sometime in the future. The questions of how should this eventuality be addressed, what asset types are inflation resistant, and which ones are to be avoided will be posted shortly.