The privatization of any social program always brings a hot debate between conservatives, liberals and, well, anyone in the middle. Many free market minded individuals think Social Security should be privatized while liberals say no way. Who is right and is it even possible to privatize such a huge chunk of the Federal pie?
First, let’s answer whether or not Social Security could be privatized. The answer is simple, it cannot be and privatization will never, ever happen. Why? Anyone who has been alive for more than 15 years knows that the federal government takes a nice chunk of your paycheck for FICA, basically Social Security and Medicare/Medicaid, but what they do not know, usually, is that the Social Security portion does not go where you might think. There is no actual account for your Social Security benefits instead you build up credits and your payout is determined by what age you retire. The size of your check will vary some depending how long you have worked and who much you put into the system. This is a very 30,000 foot view.
You receive credits into your Social Security account and not a “cash balance” report because there is no cash actually in your account. Believe it or not the government borrows against Social Security assets all the time and gives you an I.O.U. instead – the Social Security Administration is now cashing in some of those I.O.U.’s because they are now broke. You should know this because it means that if the cash flow into Social Security was ever stopped the whole house of cards would come crashing down. In effect, your entitlement program is the largest Ponzi Scheme in the history of scams. It is for that very reason Social Security will never be privatized because all of the lies would be exposed. But, what if we could privatize it?
Is it a good idea to privatize Social Security? That is a complex question and I am inclined to say yes, but with severe limitations. I do not think it is a great idea to put it into an account with only equities because people do dumb things when equities are involved. In my opinion I believe that using a deferred income annuity product would be the best option or some other type of account that has guarantees attached to it. An income Annuity would give the investor much higher lifetime income than you might think. I am also inclined to believe that insurance companies would create a product that would create a greater stream of lifetime income than what Social Security could ever provide.
However, I think some products should never be considered as an investment option. On my list I believe products that involve higher fees should be excluded such as equity index annuities and variable annuities. I am a believer in Variable annuities, but I feel that the current product fees are too prohibitive to make them a suitable option, a new one would have to be created. I am not a believer in equity index annuities, call me crazy but monthly or daily averaging which intentionally lower the rate of return is not a good idea and then throw on caps, yields or spreads and you have a product that is just not good. I am sure someone will disagree with me about indexed annuities, but that is their opinion and I have not seen a product I actually like. Plus when you exclude the dividends for these products it will drastically underperform the market rate of return. In short, these types of insurance products, which I am sure are valuable, are just too complex for a self directed Social Security account and I do not have faith in the government to choose the best products if they were allowed.
I think a hybrid product with a living benefit, which would payout 5% for as long as the owner lives regardless of account value, might be a decent option. They have a lower cost compared to a variable annuity, but provide similar lifetime income guarantees. These accounts also would mandate an asset allocation model that would have to be adhered to or all guarantees are off. Contrary to belief, asset allocation did work throughout the market crisis. Yes, you took a loss even in a diversified portfolio, but a balanced fund only lost 19% and has a standard deviation of 12.7, not bad.
If this were to happen, privatization of Social Security, it would lead to bad products being created since the government has no sense of what is and what is not a good investment for people. It would also lead to great confusion by investors since many have no idea how any type of guaranteed products work or their drawbacks. There is also the possibility that if/when we have another meltdown in the markets the losses incurred by investors would bankrupt insurance companies or whoever is offering guarantees. It is clear that traditional pension funds have not worked, the taxpayer is already making good on those guarantees, which leads me to believe that any type of equity investment options are simply a bad idea.
The only feasible option for privatizing Social Security would be using a traditional income annuity. The risk is manageable and the returns are predictable as well. However, this is all a moot point because it will never, ever, happen simply because if the government did not receive that income from your paycheck they would fold. While I think some investors would benefit from this the larger population would not and the only real winner would be Wall Street, as usual.
Those are words you will never hear in Washington because, from what I gather, they have no idea how a calculator actually works. I just started reviewing this new bill, you know, the one so popular that the phone lines to Congress were jammed all week long, and it does not add up. I shouldn’t say that it does not add up, I should say that the assumptions are ridiculous.
They decided the best way to go was to raise the Medicare tax “only” on individuals making over $200,000 a year and couples making over $250,000 a year. The income tax increase is .9% for the Medicare tax, this will be in addition to the other coming tax hikes coming at the end of this year, and there is now an unearned income Medicare tax. So, if you make a lot of money and have dividends or interest you will have to pay an additional 3.8% tax on those investments, so much for investors buying dividends stocks.
Here is the problem, the Democrats claim this tax hike will raise $210B paying for roughly 20% of this bill. Are these people for real? Why would investors hold income producing investments if they will lose 3.8% on the interest earned? They will not because they will buy a variable annuity or growth stocks that pay nothing in dividends. That blows that $210B figure right out of the water, but the Medicare income tax hike is hard to get around. Unless you can control how much you are getting paid you will have to pay that tax, but it will surely have repercussions.
For the first time ever we have an administration who is going to impose one of the largest tax increases on Americans during a recession. I take that back, this did happen twice before, the 1930’s and the 1970’s and both decades were terrible. I can hear many of you now, it is only on the rich! Well, I got news for you first, there has never been one estimate from Congress on taxation, revenue generated and cost that has ever been right. Second, there is no way that only people making over $299K a year can pay for this program, it is impossible. That $200K number will trickle down to, my guess at least, to the sweet spot of $150K for individuals and $175K for couples which is a lot of people I might add.
Insanity does not begin to describe what is happening right now. I mean, sure the President signed an $18b jobs bill today and is about to urge the passing of a trillion dollar spending bill, do you see something wrong with that? It is a bit disproportionate and, frankly, right now the country needs jobs. At this point I just hope we have a real up or down vote on this bill so we know where our Congressional member stands and we do not go through with this sneaky backdoor deemed to pass vote.
I cannot wait to read the full bill, but, unfortunately, I will not have time until well after it is passed. I do know that ultimately this is bad news for all of the country because it was not put together properly. All the people wanted was for Congress to start over and do this the right way, no one is in the “do nothing camp.” Unfortunately, that is not to be and we are on the verge of expanding upon already existing failed programs. Essentially, it is like taking Medicare, which is almost broke, and giving it to everyone, good idea! Actually, that is Alan Greyson’s idea right now, Medicare for all is what he says, but, as most lawyers are, he is illiterate to just how ugly the balance sheet of the government or Medicare really is. Good luck!
What no one wants to talk about, ever, in terms of retirement planning is the sequence of returns and the impact on retirement planning. I am bringing this up now as we wrap up the worst 10 year period ever in the S&P 500 we have ever had. In fact, technically, this is the only official 10 year period of time the S&P 500 has ever been negative. I say officially because the 10 year period is subject to interpretation, but regardless we are looking at a period of time wrapped by 2 of the worst periods ever to invest in the equity markets. In other words this decade had the mother of dumbbell negative returns ever.
What the impact of this 10 year period has had on retirees will be felt for the next couple of decades. Essentially, many retirees or pre-retirees have been wiped out or will have to drastically alter their lifestyles in order to make their money last. While I could easily blast the likes of Scott Burns, Suze Orman and a million other drive by financial advisor writers for dispensing horrible advice that they likely did not even follow themselves, I will not. They simply told people what they believed to be true because they used flawed logic and ridiculous assumptions that normal financial advisors would have dismissed as idiocy, not that they are innocent either, but they were the targets of these writers inept ridicule for long enough.
The simple fact is this, everything has a cycle whether we are talking about the Earth, the moon or the markets they all of a cycle. When we look at market returns sometimes the cycle shows an unmanaged index does substantially better than managed money while at other times managed money does better than the unmanaged index. Over the past 15 years we saw the unmanaged index do better than managed money, but will that trend continue? Unlikely. That cycle has run its course from my point of view, sure there will be stand out sectors, but that is it. If you go back in time to the 1970’s it is fair to say that this theory of mine pans out and managed accounts did better than the unmanaged indexes, but you know me, let’s not let the facts get in the way of what they pawn off as the truth.
The beginning of this decade should have been the warning sign for those following the advice of the financial rags who themselves have never ran money or witnessed what it is really like to lose someone money. Instead they blast brokers for making money and tell you to buy an index fund because over the long-term “nothing outperforms the S&P 500,” how’s that working out for you? Simply put, they did not know their history and they over simplified a very complex thing, your retirement planning. Retirement planning is complicated and deeply personal and no one, I really mean this by the way, should ever take their retirement planning advice from the TV or newspaper.
With hindsight on my side, unfortunately, it is now clear that these people did not know what they were talking about. Not only that, but their intentions are now out for everyone to see. One person mentioned already, who always advocated Vanguard index funds, opened an RIA firm and will gladly manage your money for a small fee, even though he said brokers were crooks before, unless he is the broker I guess. The other person sells binders for $50 or $100 that you can buy at Staples for $10 or $20, but since they are branded with their logo or some other nonsense they are worth more, I am still trying to figure out why that is. Either way, to their legions of devoted followers their betrayal means nothing or they will continue to mindlessly follow them, which is astounding to me, even though they destroyed their wealth. Here is what I mean.
The sequence of returns is the timing of returns, either good or bad, and the impact on your portfolio. This is the most important aspect of investing and the biggest ‘Black Swan’ there is because it is out of your control. This is why asset allocation is so important when you are talking about your serious retirement money. I have a larger portion of play money that I speculate with, but you better believe that my real money, my retirement money, is not in some E-Trade account with my finger on the buy/sell button all day long. I have a plan with my real money and I do tinker with it occasionally, but only when I feel the need to be more conservative or more aggressive, but it is professionally managed, not by me, to keep my emotions out of the game. However, the sequence of returns is always ignored by most gurus I read or listen to and it will devastate you if you are not careful.
If you invest and instantly lose 10% for the first couple of years it takes you a very long time to regain those losses or exceptionally high returns for a few years. It is even worse if you are taking income from your portfolio which is the case for many retirees, unfortunately. I am going to concentrate on those taking income from their portfolios in this example, just 5% income I might add, because many Boomers retired either in 2000 or in the last few years, either way you will get the point. I am not even going to show you the double whammy of the dumbbell negative returns because that is so depressing it is not even funny. In fact, this will be and is such a serious problem I am not sure what can be done about it because literally millions of Boomers are in serious trouble now.
Here we see someone who decides to retire and rolls over his 401K and listens to a buy and hold indexing guru. They decide to invest into a generic fund and let it all ride thinking that 5% withdrawals should suit them just fine, since he is told the market averages 10% over the long-term, another farce I might add. Unfortunately for this investor he got suckered into a bad time to invest and the market fell 10% for the first 2 years he owned his fund, but no problem writes the financial guru, just hold on and everything will be fine, really? Well, you tell me if everything looks fine to you.
Exhibit 1-1
Keep in mind, I am not showing any other negative returns, not even a negative 1%, and I am showing +8% returns for every other year in this illustration. I am also showing a straight 5% withdrawal rate, not ever a little more for the grand kids, to pay the taxes or medical bills, just 5%. This person runs out of money in about 20 years with 2 negative years right off the bat and they did not even look that bad, 10% market declines are, well, normal right? That is just one illustration of the sequence of returns and how they can impact the investor, not imagine if I put in the 2008 50% decline in there, there would not be anything left. I also ran this with 6% withdrawals, but the only difference is it gets uglier faster.
There is nothing you or I can do about the sequence of returns, but I have never seen something so important ignored before. While we are wrapping up the worst decade on record for stocks don’t you think we should talk about this stuff a little bit, especially since Boomers are about to retire in droves, well they were at least. Frankly, those bond funds everyone is slamming right now, do you know why they are so popular, not that I agree with it I might add, but they are so popular because they have positive returns on the 5 and 10 year benchmarks. Look at equity portfolios, most funds look horrible, except some managed funds I might add, but in comparison investors are saying, well sure this fund only did 5%, but it is better than the -3% I did over 10 years, so buy it.
I may sound bitter, but this is serious stuff that people just take so lightly and it drives me nuts. CNBC is now all about entertainment, not about serious news anymore which is a shame. The personal financial gurus are all about selling their latest book rather than helping people do real things, but maybe it is the peoples fault when you have to have a segment called can I afford this. People, if you have no money in the bank, in debt up to your eyes, make $50K a year, then no you cannot afford a $700K house, it is common sense. However, even though they are getting calls like this it does not justify giving out poor advice, ignoring history, not understanding the sequence of returns, the basics of asset allocation, vilifying brokers, picking on products – yes folks a variable annuity turned out to be the best product in the world to buy in 2000, and simply recommending index funds because they are index funds – a monkey could do that.
There is good news and bad news to this mess. The good news is it is almost over and the bad news is that is it is almost over. No matter what side of the fence you are on the one thing I can assure you of is that it is going to pass tomorrow morning. Even though I can also assure you that it is a budget buster, see the Republican CBO inquiry today for proof, and you should all know by now that the CBO is garbage in, garbage out group. What I mean is that if you feed it the sequence of data you want results for you are certain to get the desired results you want.
The real unbiased results were from the actuary that submitted his results a couple weeks ago, sorry, but actuaries know insurance and are key to determining costs, risks and results. His report shows that the costs for premiums will go sky high, I guarantee that to be the case as well, I know a thing or two about insurance as well. Basically, we have lawyers writing a bill that is math intensive and that is a major mistake, for proof look at Medicare deficits, Social Security, National Flood Insurance or any other government run program. For those who think this bill will reduce health insurance premiums ask yourself this one question, how can it is they did not take out the federal anti-trust exemption for insurance companies?
Seriously, without taking out that one exemption it is next to impossible to lower insurance premiums because it restricts citizens from buying policies across state lines. That means that insurers who have a lock on some states will still have a lock on those states, give me a break. Not only that, but now these same insurers must add millions of sick people to the roles and cannot charge them higher premiums, specifically, so that means all of our premiums will go up. This bill is the greatest gift to the insurance industry ever created. The only government gift to the private industry that was better, and it was not even close, was the no bid contracts to Halliburton under Bush. If this thing passes, buy insurance companies because for the first time in history the Federal government will mandate that citizens will be forced to buy a product from private companies to the tune of a trillion dollars over the next 10 years, give or take a few billion.
Because premiums will go sky high and our brilliant elected officials are incapable of doing simple math the subsidized premiums we will have to pay will blow those sweet deficit reducing estimates right out of the water within 3 to 4 years. If the administration and Congress decided to work with the industry, people like me who are truly impartial, they could have built a real reform bill, but since they think they know everything they have just put the final nail in the coffin of the US, from a fiscal point of view. Medicare will be insolvent or eliminated much faster than currently projected and the budget deficits will be through the roof by 2016 as the new taxes make people rethink how much money they want to earn. Oh, I am also assuming that we are actually in a recovery I might add, but if we are not in a real recovery, which the housing numbers today shows that without government help we are still in trouble, then the trouble comes much earlier.
What is that you say, AARP and the AMA support this bill so it must be OK? Let me tell you something about those organizations, in my opinion, they would sell their grand kids for an extra dollar and I am not kidding. AARP had a Medicare Advantage plan that they endorsed pulled from the market because it was so bad. They endorsed the product, it got pulled from the market and I can assure you that Medicare Advantage contract was a lot shorter than 2,100 pages long so it is highly unlikely they even know what is in the health care reform bill, but they know they can profit from it somehow. They hate variable annuity contracts, but love immediate annuity contracts because they have a GA contract with NY Life. Basically, if they can profit from it they will endorse it, period.
The AMA, who knows what they see in it except that they probably think they will get a permanent Doc Fix Bill passed or they like the idea of mandatory private insurance much better than a public option. Let’s face it, $26 per office visit from Medicare must stink versus the $50 or $90 per visit from private insurance. If you combine that an additional 30M new patients, or 40M depending who you listen to or where you get your uninsured number from, that equals some major money for the AMA and its members.
Clearly, this whole bill revolves around money for everyone. Everyone who loves it is getting paid big time to endorse it or vote for it. However, you, the person who pays for everything, is not in favor of this bill according to every poll conducted. I wonder why you are not in favor of it? Maybe because you know your Congress person is receiving tons of money from special interest groups to push things through, check opensecrets.org to see, or that Bernie Sanders, a socialist, sold out for $10B, way to be a socialist, Ben Nelson sold out for less, and of course we have the Louisiana Purchase take II. However, you have to pay your taxes plus the health insurance premiums and Congress wonders why you don’t want this thing, incredible.
What I find interesting is that New York, who is on the verge of bankruptcy, should have held out against this thing. Where was Schumer and Gillibrand on this? Why didn’t they say no way on this bill and get out Medicaid paid for? It work for Ben Nelson and Bernie I am sure it would have worked for NY. Oh yeah, Chuck was busy making the media rounds and calling flight attendants “bitch” instead of doing is fiduciary responsibility to his home state. I dislike the Republicans, I mean abortion that is the best defense against this thing you can come up with, however I agree with them that this bill is the train wreck of the century. Why is China moving towards capitalism, but the US appears to be moving towards socialism?
Clearly socialism did not and does not work, but here we are. For those who want the socialist lifestyle I urge you to seek out the countries that live under those types of regimes. I admit the US has problems, nothing is perfect, but here is the thing most countries want what we have, not the other way around. We could fix health care the right way if we took our time and did things in the open, as Obama promised he would do, but that never happened. Instead we decided to use a sledge hammer to itch our nose and it is not going to end well. Unfortunately it will take 4 years for me to be proven correct.
I was excited to see The Hartford had turned the corner to profitability, until I realized that they only had positive earnings if you excluded the losses. I am sorry, but that is accounting profits, not actual profits. Without the losses the firm posted a whopping $1.56 per share, but including the losses the firm lost $.79 per share. Of course, no one is going to look under the hood at the balance sheet in the media, so come with me for a ride at looking at an insurance company’s balance sheet.
First, let’s take a look at this statement about these quarters’ results:
“Impairments were $536 million, pre-tax, in the third quarter of 2009. The majority of impairments were related to potential future credit losses on certain structured securities.
Net unrealized losses on investments were $5.8 billion, pre-tax, as of September 30, 2009, compared with $13.2 billion as of December 31, 2008. The improvement was driven by significant spread tightening across virtually all fixed maturity asset classes in the second and third quarter of 2009, partially offset by the implementation of new impairment accounting guidance.“
So, there is still $5.8B in losses on the books, that will have to be realized because everything is catching a bid nowadays. However, what caught my eye was new impairment accounting guidance. That is the fabled market-to-fantasy land issue that we have all been talking about. What would happen if we did not have that rule in place? I am sure you know that that $5.8B would go way up, but that must be good news, somehow.
The firm did not enjoy prosperous growth across its business lines, its P&C business was down pretty much across the board. Its variable annuity business had significant net outflows, its fixed annuities had less than $1B in net inflows. The mutual fund arm of the firm did have strong inflows of about $2.7B, but it is a low profit margin product. Its group benefits did OK with $4.4B and its individual life has margins of about 4%. Overall, it is not that strong of a report in my view as its core business were way down.
If you actually look at the balance sheet there is simply nothing to really like. Every division, except for the P&C division lost money, but had a credit from previous losses which offset the loss and made it a gain. This is a paper gain, not an actual gain at all. For example, The Hartford had a loss of ($323M) in its core life business, but Less: Net realized capital losses of $822M and what do you know, you have a profit of $499M. I know, I am being picky, why argue with a profit, right? Sorry, but a profit is something you earn, not carry forward credits or offset losses. I am not saying that The Hartford’s earnings are not legitimate, but I am saying it is just accounting.
This type of accounting realized losses were on every line of the earnings statement, which makes me think that the $.79 loss is the only number to go with here. I know we are all looking for good numbers and good news, but accounting profits are just that and not real. What happens when you have no more losses to offset anything or the rules get changed, I hope, back to mark-to-market? The Hartford is a good firm and I know they will be fine, but I do not like this quarter’s earnings at all. I do not own any long or short positions in The Hartford and I encourage you to look for yourself at the earnings report and judge it for yourself.
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