Tag Archives: life & annuity

Retirement: Why Worry?

Some friends and associates may pass over my periodic posts here thinking they are not relevant to them, which is why I am focusing on retirement: why worry? You see, regardless your situation, well prepared or ill prepared, knowing more and acting on it with respect to your retirement is entirely relevant for each of you.

First, some context on where things stand.
Americans are astonishingly ill prepared for retirement, and Social Security is no panacea. You truly do have to invest in your retirement, and the leaner things are now, the smarter you need to be about it.
We are way behind: Ready to get serious about saving for retirement? Here’s what you need to do.
Compound interest helps: Ask a financial planner: ‘What is compound interest?’
Managing your investments does not end when you retire: 3 Reasons it’s important you continue investing long after you retire
Healthcare remains the elephant in the room: These 5 charts predict what retirees will pay for healthcare over the next 10 years Near retirees can expect $400K in health care costs
We continue to live longer, so the old rules no longer apply: We’re living longer – get ready to pay for it 4% Retirement Rule: Why It Might Not Work for You, and What You Should Do About It Managing your retirement nest egg and making it last as long as you do

Now that you have a sense for things, what can you do about it right now?

I realize I seem to have a one track mind, retirement. That’s because it is how I best feel able to help each of you. Now, though, here are some other, thought provoking articles.
You may have read about this AI from Google beating the world class Go player. It is said to be quite a feat, and this article expands on this. Most interestingly, the article delves into the ‘what-ifs’ around AI given this one’s ability to think of things a human would not consider. Fascinating. Google just proved how unpredictable artificial intelligence can be
As you think of desirable traits for a President, predictability has to be pretty high on the list. Admittedly most campaign promises go by the boards, but you hope the candidate is truthful and sticks to their core beliefs (as outlined during the election). Incredibly, The Economist has taken a strong stand on our current election cycle. What do you think of this? ‘President Donald Trump’ in Top Ten Risk Events for Global Economy

Understanding Longevity Risk

Understanding Longevity Risk
Then a quick note on US economic recovery and some fun things, too

Being right about your longevity is the real key to retirement planning:
Yes, I focus a lot on costs and compounding when talking retirement, but it really comes down to how long you will be living, doesn’t it? That’s your longevity risk. My focus is right because you want to get the most bang for your savings, but still, how much should you have? Plan for a Long Life When Saving for Retirement
I have mentioned these several times before, but I am not the only one thinking “longevity annuities” will be the big push in 2015 after Treasury approved them inside your 401(k) or IRA. ‘Longevity’ in annuities could be the big 2015 focus
The good news is you should expect … and push for … your retirement plan to show you just how much income you can expect from your savings. Lifetime Income Estimates Would Boost Retirement Savings Rate, Study Finds
Lest we forget, fees matter, but here is a completely different perspective, shareholder fees matter most according to this article, makes sense. The great mutual fund expense ratio lie

One interesting article about the US economy:
This helps explain the discrepancy between rosy figures on the economy and the persistent malaise at the local level. Only 2% of counties have fully recovered! Much of America Still Hasn’t Recovered from the Recession

Interesting reading from around the web:
Two articles this week on Google’s changes to Google Translate. If you head overseas this is a real win Google Translate Update May Save You a Lot of Money and even a demo Watch Google Translate decipher foreign signs in real time (could have used that once or twice!)
This one gives you an infographic on what Apple products drive revenue. Where Apple’s Money Comes From
Beware the consequences of exceeding your free bag limit on airlines. What Airlines Don’t Tell You About That Free Bag

The Fallacy of Cost of Capital continued

Friday I teed up the frequent breakdown in implementation of cost of capital constructs. Today I will give an example illustrating the downstream cost of this oversight. While this is, by no means, limited to the life & annuity space – the lessons are broadly applicable; I will continue the life & annuity company example, assuming a few things:

  • Indexed annuity product with a target/expected 12% ROE
  • $3 billion of annual production
  • 10% total compensation paid at issuance
  • Nominal cost of capital of 8%
  • 10 year amortization schedule (straight line for simplicity sake)

Today, with generally flush capital structures, there is little concern about layering in new business in this product. The horns of the dilemma are that in leaner times, say 2009, it would be difficult to authorize more volume despite returns beating corporate targets. A fully executed cost of capital construct would ‘charge’ the business 8% for invested capital, incentivizing the business to find a more efficient capital structure, releasing capital for redeployment (business development, shareholder returns, capital investment, etc.) and easing capital strain.

Here is a comparison of acquisition costs with and without the cost of capital (CoC) charge:

with CoC without CoC Variance V%
Required Capital/Cash (Issue Year) $300.0 $300.0 $0.0 0.0%
Est. GAAP Expense (Issue Year) 43.0 30.0 (13.0) (43.3%)
Total Capital Cost (Over 10 Years) 410.2 300.0 (110.2) (36.7%)

Not applying an explicit cost of capital charge obscures the true cost of running this business, by understating issue year GAAP expense by 43% and total cost by 37%. This is true for any business, not just life & annuity, for any capital cost.

Since alternative solutions do have a cost, not explicitly applying the cost of capital stymies business unit motivation to be more capital efficient. Since we embed our program costs, there is little difference, with or without the cost of capital charge:

with CoC without CoC Variance V%
Required Capital and Cash (Issue Year) $26.4 $26.4 $0.0 0.0%
Est. GAAP Expense (Issue Year) 27.5 26.4 (1.1) (4.2%)
Total Capital Cost 397.2 390.1 (7.1) (1.8%)

Viewed together, you see the economic value of an explicit cost of capital charge:

with CoC without CoC
with Program without Program Variance V% with Program without Program Variance V%
Required Capital and Cash (Issue Year) $26.4 $300.0 ($273.6) (91.2%) $26.4 $300.0 ($273.6) (91.2%)
Est. GAAP Expense (Issue Year) 27.5 43.0 ($15.5) (36.0%) 26.4 20.0 $6.4 32.0%
Total Capital Cost 397.2 410.2 ($13.0) (3.2%) 390.1 300.0 $90.1 30.0%

Only inception costs remain constant, as others, which play out over time, rise. Failing to account for carrying cost masks parent level benefits obtained by seeking alternative capital structures. Here you see that the parent gets the most efficient use of capital by reflecting the cost of capital in business unit financials and incentivizing innovation. The business unit sees lower cash and capital demand in the issue year, lower GAAP expense in the issue year and lower total GAAP expense over the amortization period, all likely forgone without that explicit recognition of the cost of capital.

Call or email me to discuss this interesting insight, learn how it may inadvertently hamstring your growth and to talk about our innovative solutions.

Improve your retirement and leadership

Improve your retirement and leadership
Then, learn some cool stuff, too

Some overdue looks at great reads on leadership:
It’s easy to forget, but you never should: successful strategy is all about execution. Strategy Execution: A Short Checklist That Helps
You never can be a good enough negotiator. Here are some more tips from Wharton:
13 negotiating techniques taught at the Wharton School of Business
Speed up your decision-making process, and improve it. Too much to expect, well, at least read the ideas, they may ring true. 5 ways to make better, faster leadership decisions

A weekly dose of retirement guidance:
A noted economics professor and prize winning author on why people don’t buy more annuities … even though they should Jeff Brown: Retirement Researcher, Model & Mentor
A really interesting article on how to market time, without the risk of market timing. It’s worth the free sign-up to a great site. Simple and Effective Market Timing with Tactical Asset Allocation
Another reason to sign up for Seeking Alpha, a great tool for picking ETFs. Plus, they’ve got a great iPad app, too! ETF Hub
An interesting review of actual 401(k) balances vs. theoretical ones Why aren’t 401(k) and IRA balances bigger?

Better than average weekly diversions:
Despite having read the book Krakatoa, and visited Indonesia on several occasions, this slipped from my radar. It’s astonishing. The Sound So Loud That It Circled the Earth Four Times
This was not the first, and won’t be the last, article I have read about how the developing world holds the key to arresting climate change – in fact dig around on The Week site, they have a couple more. Why India is the key to the world’s climate future
You won’ learn anything from this, but you’ll be amazed. Photo of Earth from the Curiosity Rover on Mars

The Fallacy of Cost of Capital

The Fallacy of Cost of Capital in the Life & Annuity Industry


As a longtime business leader with GE, American Express and Ameriprise Financial, I came to expect the inevitability of cost of capital in annual planning and product development conversations. While the number generally had little discernible relationship with the true borrowing cost for the corporate parent, the construct made perfect sense: each P&L bears a reasonable cost for the invested capital carried on its balance sheet. As an independent advisor, I have come to realize that often times this cost is more implicit than explicit. Cost of capital appears most often in the guise of a hurdle rate. Whether considering new product design or a major technology investment, running a spreadsheet against the hurdle rate is a prerequisite. Once implemented, though, how does the cost of capital manifest itself in business unit financials? In an annuity or life business level P&L, for example, where significant issuance costs are capitalized and amortized; is the business charged a carrying cost at the cost of capital? Is there a journal entry from the parent, ultimately eliminated, mind you, reflecting the opportunity cost of this investment? Often not, which stifles creativity and confounds analysis of alternative capital structures. The parent is happy with a nominal 10% or 12% or 15% return. Have they accounted for the true cost? As businesses firm up the 2015 planning cycle, perhaps it is time to reflect on the efficacy of cost of capital execution and the downside risk of not fully accounting for the true cost of investment in business units. This recalibration may yield better corporate results by incentivizing scrutiny of invested capital, freeing up capital for long deferred investment projects. Call or email me to discuss this interesting insight and learn how it may inadvertently hamstring your growth.