Variable Life Insurance & Annuities: Investment Scandals in Waiting
By Steve Selengut
We humans are as creative on the "Dark Side" of commercial activity as we are in developing beneficial new products and services. In the face of huge financial benefits, however, some corporate executives can't resist taking an extra dessert even before their shareholders have finished dinner. Some scandals have more of an impact on investors than others, and most produce unwarranted layers of government regulation and control that stifle honest creativity.
Plain vanilla fraud and theft are less worrisome to me than situations where the general acceptance of misinformation or "business as usual" practices allows inherently bad product ideas and blatant mismanagement to become accepted by regulatory authorities, financial professionals, and myopically gullible consumers. Here are some candidates for future "Blockbuster Scandal Awards" (B S Awards, if you will): Variable Life Insurance & Annuities, Wrap Fee Managed Investment Accounts, Portfolio Window Dressing, Asset Allocation Mutual Funds, and Obscene Executive Compensation.
1) Variable Insurance and Annuities: Variable products are a relatively new thing in the insurance industry, circa 1980 or so. Before that, the conventional wisdom labeled the Shock Market much too risky for Life Insurance Policy and Annuity Contract guaranteed benefits. In fact, these benefits had been "guaranteed" for so long that it became a generic expectation of anyone in the market for either. So why did the State Insurance departments cave in to the Variable Product lobby? And what is not emphasized as these products are marketed to potential insureds and annuitants?
As if the 8% sales commission on Straight Life Annuities wasn't enough, the addition of Mutual Fund bonuses made the Variable Annuity irresistible... to financial professionals. Similarly, this product is so lucrative for the companies that they manipulate their rates to become more competitive. Since the introduction of variable benefits, there have been more insurance company failures and scandals, and not just a few disappointed recipients of reduced annuity payments. What's in your retirement plan?
2)Wrap Fee Investment Accounts: From the very beginnings of wealth, the very wealthy employed Investment Managers to protect and to grow their portfolios. Most Investment Managers had just a few huge clients that they tended to while the rest of the fledging financial industry focused on property protection and estate creation through life insurance. Most of today's (salaried) Investment Managers are employed by Financial Institutions to supervise thousands of Mutual Funds for millions of investors of all financial shapes and sizes. There are more Equity Mutual Funds than there are individual Equities on the New York Stock Exchange. Most investors today will employ many Investment Managers and never actually speak to any of them.
Enter the personally managed investment portfolio product offered by most major Financial Institutions. For a single fee, you receive the personal services of a professional Investment Manager, and a portfolio specifically designed for you. Except, of course, that you get neither. You get precisely the same portfolio as everybody else, and all at once regardless of price... a Mutual Fund with individual statements. But of course, you can speak to the manager any time you like, change your asset allocation, set aside a reserve for an upcoming expenditure, etc. Yeah, sure you can!
Note that "Flat Fee" managed accounts are quite different and may actually be separately and personally managed.
3)Portfolio Window Dressing: Every quarter, every year, we hear about the adjustments that portfolio managers are making as they attempt to look smart to their largest clients. Now in a discipline (Investing) that they all officially recognize as a long-term commitment to some specific strategy or plan, why do the Masters of the Universe spend so much time manipulating their short-term performance numbers? And why is this considered business as usual instead of common fraud?
4)Asset Allocation Mutual Funds: I look at Asset Allocation a bit differently than most professionals seem to and I regulate and monitor a portfolio's structure using the cost basis of securities rather than their Market Value. But how, logically, can a one-size-fits-all Mutual Fund be the right mix for all investors? Here's a definition found on the Internet: "A mutual fund that rotates among stocks, bonds, and money market securities to maximize return on investment and minimize risk". And a definition of Asset Allocation from a similar source: "The practice of distributing a certain percentage of a portfolio between different types of investment assets, such as stocks, bonds, mutual funds, cash, real estate, options, etc. By diversifying an individual's asset base, one hopes to create a favorable risk/reward ratio for a portfolio".
In reality, Asset Allocation is a structure-planning tool that determines what percentage of an Investment Portfolio is to be invested for Growth in Equity securities and what percentage is to be invested for income production. The proper allocation is a function of the investor's age, marital status, financial position, employment status, retirement plans, expenditure needs, risk tolerance, family responsibilities, etc. Diversification occurs within the two (just two) asset classes. One size fits all... who's kidding whom?
5) Corporate Executive Compensation: I strongly believe that everyone has the right to become filthy rich, legally of course. I respect anyone who gets there honestly because their success creates jobs, opportunities, wealth, and a higher standard of living for everyone. But, once they sell shares of their successful enterprises to the public, they have a responsibility to share future profits and growth. Obscene executive suite compensation (right down to the chauffeured limousines) is simply stealing from shareholders.
With every new Scandal, a voracious Media and a hypocritical Congress exacerbate the fear of shocked investors and call for more regulation of the very entities whose success, freedom, viability, and competitiveness they should be nurturing. Ironically, politicians are always the most outspoken critics... probably because of their familiarity with cover-ups and improprieties. But no one ever questions the integrity of the Financial Institutions that invent, produce, price, and promote products and services that do far more long-term harm than the few (albeit serious and sensational) incidents of corporate wrong doing.
Four of the five candidates for this year's Blockbuster Scandal (B S) Award were created on Wall Street. The fifth is ignored by it. Which one bothers you most?
About the Author
Professional Portfolio Management since 1979
Author of: "The Brainwashing of the American Investor: The Book that Wall Street Does Not Want YOU to Read", and "A Millionaire's Secret Investment Strategy"
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First thing Monday morning I'm going to march into my boss's office and demand a pay cut so that I'll be in a lower tax bracket next year.
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