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dougwarrenclu-blog · 8 years ago

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Case Study 017: Third Meeting

Third Meeting Preparation

With regards to preparation for the third meeting it was more difficult than what I normally do at this stage with a new client.

Frank and Shelly’s situation is far from typical primarily because they have so many variable annuity contracts, all purchased at different times and they have a fairly singular objective which is to find the best way to provide a continuation of income for Shelly after Frank dies.

Normally when I meet with a new client, the direction we go in will either be annuities or life insurance. I may start with annuities and later discuss life insurance with a client. But normally I am trying to solve two different problems. It is very unusual for me to suggest that either product might represent a different way of solving the same problem or meeting the same objective.

In Frank and Shelly’s case they could use annuities or life insurance or a combination of the two to solve the problem. Until we meet next I don’t have much of a feel for the option that they might be viewing as the best.

I did get some valuable feedback.

During the review of the spreadsheets relating to VA contract 9923 where the surrender penalty period ended in a few weeks and VA contract 4926 that was already out of the surrender penalty period, Frank made a comment about how using the accumulated values in these contracts to purchase something that would provide a continuation of income for Shelly was a “no-brainer”.

In addition, he made a few favorable comments about both options 2 and 3 but I got the feeling that for whatever reason he was not finding option 1 that attractive.

But other than this I had no clear direction as to any specifics regarding what he and Shelly might want to do.

Even though I was not expecting to transact any business during the third meeting I always try to be prepared just in case the client might want to move faster then what I am anticipating.

To do this for Frank and Shelly’s meeting, I would need to be prepared to complete paperwork for at least two different annuities and I would need at least one life insurance policy.

Option 1 Annuity

The first annuity would be needed if Frank and Shelly decided that option 1 would be best. Remember, with this option we would be replacing one or more of Frank’s variable annuities with an annuity that had an income rider providing a joint life income payout.

To get ready for this possibility I again used the Rider quote tool from Annuity Rate Watch.This tool allows me to select up to three annuities and run a detailed report.

I find page five of this of this report particularly useful. It provides a side-by-side comparison of the payout amounts from each of the annuity’s income riders.

Note that in the spreadsheets that presented to Frank during the second meeting, I consistently discussed the amounts if Frank activated his current annuities GMWB riders at ages 65, 67 or 69. My reason was that Frank has always been somewhat vague as to when he might want to start income in the future. He was pretty certain that he would not start income any earlier than age 65, or any later than age 70.

By using this page of the report I can continue to be consistent and show the income amounts that would be provided on a joint life basis if started for any of these three replacement annuities at either age 65, 67 or 69.

Notice that when I ran this report I chose to assume an amount of premium of $1,000,000. I did not necessarily do this because I was thinking that Frank might want to replace all of his current annuities. At this stage I really don’t know the amount that might be appropriate. But $1,000,000 is a round number that is easily divisible. In other words, if Frank wanted 50 percent of the income payout amounts shown in the report it is easy to understand that this would require $500,000 of premium.

To be really prepared, I would want to make sure I had the applications and all the necessary paperwork for all three annuities so no matter which one Frank and Shelly might select I would be ready. However, I usually think that I could narrow it down to at least two of the three so I only prepare for those.

In fact, depending on the amount of premium ultimately involved, I might suggest that the client divide it among two or more annuities.

With every client where my recommendation centers on annuities, I almost always give the client a choice of at least three different products. The reason is simple. When an advisor only shows one product the perception is that the advisor is “selling” that product. However, when an advisor shows three products the perception is that the advisor is helping the client to “buy” a product. Most people hate to be sold something but most people enjoy buying something.

Option 3 Annuity

I would prepare exactly the same way for the annuity that might be used if Frank and Shelly selected option 3. I would prepare a report using Annuity Rate Watch that I could use to compare the income amounts from three different annuities. And I would have the applications and necessary paperwork I would need to complete if one were selected.

The primary difference is that to get rider quotes for this option, I change the assumption from a joint life income payout to a single life payout for Shelly.

Option 2 Life Insurance

My approach to preparing for option 2 is different. Here I will select only one product that I feel might best be suited for their circumstances. In Frank and Shelly’s case, I believe that what will be the best fit for their objectives is a product with a guaranteed premium amount and a guaranteed death benefit. I do not want the continuation of the death benefit to be dependent on anything other than the guarantees in the contract. In other words, when we look at a typical indexed UL product illustration, we usually see two primary columns containing a projection of values based on certain assumptions. One column bases the projections on guaranteed maximum COI (cost of insurance) and guaranteed minimum earnings. With many IUL products you will see a lapse occurring at around the 20 year point if only these guarantees are achieved. The other column shows much better results but it is based on non-guaranteed assumptions. If the COIs stay low and the stock market index performs in some positive manner these projects “might” hold true. But if they don’t the policy could be in jeopardy of lapsing.

Relying on this type of an IUL product might be fine when it is being used for the purpose of generating future tax advantaged income (through cash value loans), but that is not the objective with Frank and Shelly. For them, I need to be certain that the death benefit is guaranteed to always be maintained as long as they pay the premium.

I know of a very good product that meets this criteria so I run an illustration based on a $1,000,000 death benefit. The annual premium that would be required to be paid to maintain this death benefit for as long as Frank might live is a little over $20,000.

As with the annuity quotes, I pick the amount of $1,000,000 because it is easily divisible. I can show this illustration to Frank and if they should decide they only need $500,000 of death benefit, it will be obvious that the premium would be half of $20,000.

Above I stated that people hate to be sold but love to buy. And that the advantage of giving people a choice of three products as opposed to showing them only one is either the positive perception of helping a customer buy (when you provide a choice) or a negative perception of selling something (when you only offer one product).

It may seem a contradiction that I am choosing to prepare to only show Frank and Shelly one life insurance product. So let me explain how I would be intending to proceed should Frank and Shelly want to pursue the direction of the life insurance option.

First, I will tell them that it will be important for us to find a very specific type of life insurance product that we know will guarantee the continuation of the death benefit as long as the premiums are paid. I will then make the point that there are some very good products available that meet that category and that I am prepared to show them an illustration of one of these products. I would then stress that they need to understand that because I am showing this illustration, it does not necessarily mean that this is the product that I would end up recommending. Last, I will make the point that I really can’t find the best product for meeting their specific objective until we first go through a basic underwriting process to get a better idea of how any insurance company might view Frank’s health and insurability.

Regarding this last point, what I am trying to suggest is that I will be looking at multiple life insurance products to find the best one for them but before I can do this accurately we have to see if Frank might qualify as a preferred risk, standard risk or be rated to some degree. Once we pin that down then I can more accurately search for the best option.

Stating this is much more in line with the perception of helping them buy as opposed to selling something. I am showing them only one illustration from one insurance company but only as an example. Other products might be better or worse. The premiums for the same coverage might be higher or lower. But they will not be dramatically different than what is reflected in the $1,000,000 illustration requiring a $20,000 annual premium. And, I know from experience that this product will likely be very competitive.

So my plan is that I show them the illustration, if they like what they see then I will suggest we submit an application and go through this company’s underwriting process. There will be no cost to Frank and Shelly, no premium required at this point and they are under no obligation to accept the policy if it is offered. Once we know how this company rates him we will have a pretty good idea as to how other companies will likely rate him. Once I know the rating I can shop around to see if we can do better than the initial product.

This is often the process I use when dealing with clients who have a need for life insurance.

I could instead prepare three illustrations for three different life insurance products and show them to Frank and Shelly during the upcoming meeting just like I am planning to do with the annuity options. Life insurance illustrations are much more complicated than annuity illustrations and my fear would be that they might get confused.

In addition to this illustration I also brought along an application just in case they might want to move forward at the next meeting.

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dougwarrenclu-blog · 8 years ago

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Case Study 017: Second Meeting

Second Meeting Preparation

Again, the primary concern that we are trying to help Frank address is how to protect Shelly’s financial security if Frank predeceases her. During the phone call with the company rep that issued Frank’s variable annuity contracts, we learned that there were no options available for changing the income riders from a single life to a joint life payout. So the options that I can see would be the following:

Option #1 – Would be to replace one or more of Frank’s current annuities with some other type of annuity that would provide a joint life income payout. Based on the information I got from the insurance company I can estimate the amount of single life income any of Frank’s contracts might provide in the future depending on when he might activate the rider. I can then get quotes of joint life income from annuities offered by other insurance companies. Frank could then compare the larger single life payout from the existing VAs, to the lower joint life payout offered by any replacement annuities in order to make a judgement as to if this option might best accomplish his objective.

There are two ways to consider this option. Once is to take the current net surrender value that would be available if a VA contract was replaced and use that amount as the premium for any new annuity. A second would be to wait until the VA contract had reached the end of its surrender penalty period and wait until that time to replace the VA with another annuity.

Regarding these two alternatives as to the date of the replace the latter has the potential advantage of allowing Frank to avoid any surrender penalties. However, I know that Frank is not planning on starting income for at least a few years so the disadvantage is that there would be less growth in the income base of the new annuity. The result of waiting could be less income.

The only way we will know which timing alternative might best benefit Frank and Shelly is be projecting the VA contract’s income and comparing it to the income from any new annuity based on if the VA contract was surrendered and replaced immediately or if we waited to do the replacement.

Option #2 – With this option Frank keeps the VA contracts and eventually activates the GMWB rider’s single life payout. Frank then purchases life insurance with the death benefit being used to replace any lost income on Frank’s death (from the single life annuity payout) to Shelly.

We can assume that under the first option (replacing the VA contracts with new annuities providing a joint life payout), that the single life payout will be larger than any joint life payout. In other words, Frank will enjoy less income during his life if he switched to annuities with a joint life payout. If he keeps the VAs with the single life payout he will enjoy more income during his life. So the degree of any value from the life insurance option should be apparent when we compare the cost of the life insurance premiums to the additional income that Frank would receive from his VA’s single life payout. This means that we will have to come up with an amount of death benefit we want life insurance to provide in order to adequately protect Shelly and then determine the required premium to fund that life insurance.

Option #3 – Another option that I thought of but did not mention to Frank during our first meeting might be for Frank to keep all but one or two of his VA contracts with the idea of eventually activating the GMWB’s single life payout from those contracts and replacing the others with a new annuity with an income rider that would also provide a single life payout but on Shelly’s life. My thinking with this option is that Shelly would defer the activation of the income rider on this new annuity for a long period of time. At least ten years or longer. The idea would be to find an annuity with an income rider that had a strong growth of the income base over long periods of deferral so that when she did ultimately activate the rider the amount of resulting income would be large.

This might mean that a relatively small amount of money devoted to the new annuity could provide a large amount of future income for Shelly. The majority of the accumulated values that could then remain in Frank’s current VA contracts might then still provide adequate income when he activated their GMWB rider single life payouts. At Frank’s death, Shelly activates her annuity’s single life income rider to offset any lost income from Frank’s VA single life payouts.

At first glance it might seem that using this approach would be risky because we of course have no way of knowing when Frank might die. The strategy would seem to require that Frank live a long time in order for Shelly’s annuity’s income base to have a long time to grow. And it might appear that the sooner Frank might die the greater the risk that Shelly’s annuity wouldn’t have the time need to grow her income to a sufficient level. But the risk of Frank’s possible early death would likely be offset by the fact that the sooner Frank might die the fewer the GMWB withdrawals he has taken from his VA contracts. This should mean that we could expect that there would be more accumulated value remaining in his VA contracts at his death that would then pass on to Shelly.

For advisors new to these contracts it might help to dig a little deeper into this subject.

When any annuity’s income rider (in this case Frank’s VA contract’s GMWB rider) is activated, each income withdrawal is deducted from the accumulated value. When the policy owner dies the remaining accumulated value is paid to the beneficiary (Shelly in this case). After years of income withdrawals it is reasonable to assume that the accumulated value will get smaller and smaller meaning that the longer the policy owner lives the less accumulated value we should assume will remain that can be passed on to the beneficiary. If the policy owner lives long enough, it is reasonable to assume that at some point the entire accumulated value will have been exhausted and nothing will remain to be passed to the beneficiary. But conversely if the sooner the policy owner dies after activating the income rider, the greater the accumulated value we can expect will remain for the beneficiary.

So while it is true for us to expect that with this option if Frank dies relatively soon there might not be much growth in Shelly’s annuity’s income base, the resulting smaller income would be offset by what is reasonable to assume will be a larger remaining accumulated value that she will inherit from Frank’s VA contracts.

Option #4 – There is at least one other option that we should at least consider. Instead of activating his VA’s GMWB (Guaranteed Minimum Withdrawal Benefit) to generate a single life income to Frank, he could use the annuitization provisions that exist in these contracts to provide some form of joint life payout. (Again, for readers unfamiliar with these contracts and provisions there are major differences between how a GMWB or income rider works and how annuitization works. The GMWB rider in Frank’s contracts only allow a single life payout. But the annuitization options in his contracts allow for either a single life or joint life payout.)

However, Frank and I briefly discussed annuitization during our first meeting and Frank gave me the impression that he was not comfortable with the restrictive nature of annuitization as it related to its impact on the contract’s accumulated value. For this reason, unless something changes during a future meeting I am not going to consider annuitization as a serious option. Having decided on the best options to present to Frank I now need to figure out the best way to communicate these options at our next meeting. Presenting multiple options to any client can be very effective because it compels the client to perceive the advisor as taking on the role of being a true advocate. Clients would much rather work with someone who they feel is their advocate as opposed to someone they perceive more as a product salesperson.

But with all the advantages of working this way there is a potential disadvantage that is dangerous to ignore. It is that the more options a client is presented with the greater the danger a client will become confused. And the easiest decision for a confused client to make is to do nothing.

Because of this I spend a great deal of time preparing for how I am going to communicate any options I decide to present to a client.

In order for Frank to be in a position where he can evaluate these options I need to prepare an Excel spreadsheet show him some numbers. Before structuring this spreadsheet I need to decide how I want to present these options. The fact that Frank has multiple VA contracts complicates things. The question I struggled with was did I want to try to combine all of the annuities when I showed each option or did I want to show the impact that each option might have on each individual VA contract?

I decided that the simplest way to do this would be to develop a separate spreadsheet for each VA contract. But I needed to come up with a format so that each spreadsheet was essentially the same.

Below is a screen shot of the spreadsheet I prepared for each of the nine annuities.

Spreadsheet #1 (4270)

Note: This contract’s income base (benefit base) growth is based on the highest level achieved by the accumulation value. Because there is no way to know future performance, for my projections I have chosen to assume that there is no growth in the income base.

Spreadsheet #2 (9923)

Spreadsheet #3 (6498)

Note: This contract’s income base (benefit base) grows at an annual rate of 6 percent for the first ten years. Spreadsheet #4 (4211)

Note: This contract’s income base (benefit base) grows at an annual rate of 6 percent for the first ten years. Spreadsheet #5 (2073)

Note: This contract’s income base (benefit base) grows at an annual rate of 6 percent for the first ten years. Spreadsheet #6 (7499)

Note: This contract’s income base (benefit base) grows at an annual rate of 6 percent for the first ten years. Spreadsheet #7 (1722)

Note: This contract is out of surrender penalty period in a matter of a few weeks. It does not have an income rider. Spreadsheet #8 (6722)

Note: This contract is the only one with an income rider set up to provide a joint life payout. Spreadsheet #9 (4926)

Note: This contract is out of surrender penalty period. It is a fixed rate annuity with no income rider.

If you refer to the first spreadsheet (4270) you will see that column “J” contains an estimate of the income amounts generated from the GMWB riders available with each of the current VA contracts (that contain GMWB riders). On all spreadsheets I am showing the projected rider income if activated at age 65, 67 or 69. For example, if Frank activated the GMWB (income rider) for contract 4270 at his age of 65, I have estimated that the single life payout lifetime income will be $13,080. Note that because this particular contract’s income base does not grow on a guaranteed basis but instead is based on the growth of the accumulated value, I have chosen to assume that the income base will not increase the longer Frank waits to activate the income rider. In other words I am projecting that the payout amount will be the same $13,080 whether he activates the rider at his age 65, 67 or 69. This may or may not be realistic. I may be undervaluing the potential future income that can be achieved by deferring the activation of the income rider but I chose to base any projections I make on guarantees. I will make sure that when I present this to Frank I stress this point. The reason I chose these three rider activation ages is because when I discussed with Frank how long he intended to wait before wanting income he indicated that at the earliest it would be at his age 65 and that he saw little value in waiting until he was 70 or older to start income. Option #1

In column “M” (labelled Option 1) you see an estimate of the projected income that would be generated by replacing this particular VA with an annuity that had an income rider that provided a joint life payout. For easy of comparison these joint life incomes are also shown at starting ages of 65, 67 and 69.

In cell I3 you see the current cash surrender value from each of the VA contracts. Remember, I got this value during the telephone conversation with the issuing insurer’s service rep.

The joint life income amounts shown in column M are based on the assumption that it is the current cash surrender value ($200,000) from the VA would be used as the premium for the purchase of the new annuity providing the joint life payouts (Column M).

To obtain the joint life payout amounts (Column M) I used a third-party quote engine that is a favorite tool of mine available from Annuity Rate Watch (AnnuityRateWatch.com). Members of this site have many tools available.

The tool I used for this case preparation was their income rider comparison tool.

To obtain quotes of joint life payout amounts I enter Frank and Shelly’s current ages.

Then I entered the premium amount. Again, this is the available cash surrender value from Frank’s VA contract 4270.

Last, I indicate the assumed deferral period before the income rider from any new annuity would be activated.

This rider comparison tool then provided me with a listing of hundreds of FIAs with income riders, the dollar amount of the joint life income they would provide, and it ranks these annuities in order of the highest amount of income. That is all I had to do to get the joint income amounts that appear in column M of the spreadsheets. Notice that in my spreadsheets I have not indicated the name of the insurance company issuing the annuity providing this joint income payout. For my next meeting with Frank I do not want to discuss specific annuity products. The purpose of out next meeting will be to give him a general idea of the dollar amounts involved with each option I am presenting. For now I want to limit our conversation to more of a conceptual discussion and not get too far into the details. My hope is that I can get Frank to select one of the options and then we can devote another meeting to exploring the details of only that option. My fear would be that if we got too far into

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dougwarrenclu-blog · 8 years ago

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Case Study 017: First Meeting

Please note that the following case study is based on a series of meetings that Doug had with an actual client. However, the names and several aspects have been changed to both protect the confidentiality of the client and to enhance the educational value to the reader. In addition, it is our practice to never mention specific companies, products and product or investment account names in these case studies. The purpose of the case study is to not endorse a specific product or company. Product categories and types are mentioned in the case study. It is assumed that the reader will have access or can easily get access to many products of the type mentioned in the case study from the IMO/FMO or marketing organization that the reader is affiliated with.

Meeting Notes – Frank and Shelly Frank age 63 Shelly age 61

First Meeting - Met with Frank in his home.

Frank is a successful entrepreneur. Three years ago he sold his interest in a consumer goods export business that he had started 12 years earlier. He immediately started another business with his son whom he plans to cede control to within the next four years.

Frank’s spouse Shelly is a retired educator and did not participate in the meeting.

While we did not talk specifically about the amount of their investments and savings my initial impression was that they have about $3m or more in investable assets. In addition, Frank receives a six-figure payment from the sale of his business that will continue for another four years.

The first thing I do whenever I meet a new client is to spend a few minutes and tell them about my background and experience. I usually will give a new client a copy of one of the books I have written. I will talk a little about some of my appearances on financial television programs that have aired on PBS and will give them a copy of a DVD containing clips from these public television shows. And I might give them a copy of an article that mentions that I was quoted by Tony Robbins in his bestselling book MONEY, Master the Game.

All of this helps establish my creditability, which is one of the most important objectives for the advisor during the first meeting. It has taken me a long time and a lot of hard work to become established this way. And for the majority of years in my career I did not have this advantage but was still able to gain a degree of success. My point is that any reader who is committed to this profession should start now to find ways to add to their resume and build their credibility. Someday it can pay off enormously.

After discussing my background I always start every initial meeting by asking the new client this important question, “What do we need to discuss today in order to make this meeting of value to you?”

Essentially Frank answered as follows:

“Over the past ten years I purchased nine variable annuity contracts with a total current value of approximately $1m. Because these were purchased by a friend who is a financial advisor, I did not pay very close attention to the details. I am now starting to believe that maybe purchasing these products were not in best interest.

My interest in meeting with you is to get a second opinion.” The variable annuity contracts were on the table and based on Frank’s body language it was clear to me that he was inviting me to look at them. It is not unusual for me to meet with people like Frank who have a policy or investment statements that they want me to review. In these situations my style is to not be in a rush to touch any of these documents and instead wait until we have an initial conversation.

A mistake I often made early on in my career was to jump at the chance to look at what the client has and immediately start finding weaknesses. Over the years I have learned that it is far better to take a different approach. Also, it is not uncommon for a prospective client to tell me they are looking for a second opinion. This is a way for people to keep in control of the meeting and more or less set the parameters for the relationship. People are always worried about being sold something so asking for a second option is a very non-committal way for the client to suggest that the purpose of the meeting is not to buy something but instead only to get information.

This is fine for me and fits well into my sales process. My style is to have multiple meetings and educate clients before attempting to get them to take any action. I move slowly with all clients and I look for opportunities to communicate this early on in the initial meeting. But first I want to respond to the client’s request for a second opinion.

Doug – I would be happy to give you my opinion on your variable annuities. I would need to first take a closer look at the contracts but before I do the most important information for me to have is for you to tell me what your objective was when you decided to purchase these annuities? What was the main thing that you hoped these would do for you?

Frank– This may sound silly but I am not sure why I purchased them. At the time my entire focus was on my business. It was doing well and I was making a good income. I need some place to put this money and my advisor at the time suggested these annuities.

Doug – I understand. I have worked with a lot of successful and busy people over the years and it is not unusual that they have little time to devote to managing their investments. But without having a clear idea of what you were trying to accomplish it is very difficult for me to give you my opinion regarding these products.

I am a little different than most advisors in that I don’t necessarily look at different products or investments in the context of either being good or bad. Instead, my view is that different products are designed to meet different objectives. So the question of whether something is good or bad can best be answered in regards to how well a product does or does not meet a specific objective.

Frank– Well I guess what was most attractive to me about these annuities was that I believed that they were like a pension. I have a small pension from when I worked for a company but it is not a lot.

Doug – OK, then before I even look at your contracts I can tell you that your variable annuities will meet that objective. They will provide you with a lifetime income that can act more or less like a pension. So in regard to me giving you a second opinion, are you asking me to tell you if I think the amount of the income your current annuities will provide is more or less than what some other annuity might provide?

Frank– No. I already know what amount of income each annuity will generate. My concerns are that the annual fees are over three percent but even more important, the way they are set up the income is only paid as long as I live. Once I die the income does not continue to my wife.

Doug – Are you sure that you can’t change these annuities so that the income is based on a joint life payment?

Frank– I am pretty sure. At least that is what I was told.

Doug – Did you call the insurance company and find out directly from them?

Frank– No.

Doug – That is definitely something that you should do before you make any changes. We can talk more about this in a minute but first let’s discuss the fees you are paying in these variable annuity contracts. Assuming you are correct and the fees and they are over three percent, that is high. There are many excellent annuities available with fees of around one percent. But I am wondering if the amount of the fees is really that much of a concern to you. For a minute let’s ignore the problem of the single life, if your primary objective is a pension-like income and assuming these annuities provide that, then does it really matter to you if the fees are high or low? For example, let’s assume one of your variable annuities guaranteed a minimum income of $1,000 per month for life but with a fee of three percent, would it really make sense to switch to some other annuity where the fee was maybe only one percent but with a monthly income of $800?

Frank– I guess not but it just seems like the higher the fees, then one way or the other they have to reduce the benefit to me.

Doug – You are right. Fees will reduce some benefit but not necessarily the lifetime income. Your current fees might reduce a benefit that you really don’t care that much about. And changing to another annuity might reduce your fees but at the same time if it reduced your lifetime income then you have to ask if that would really make sense in terms of accomplishing your objectives. In a few minutes I will explain exactly how your fees impact you but first it is important to say that at this point I have no idea what income will be provided by your annuities and I don’t know if some other annuity would provide greater or less income, my only point is that the better you can define for me what your objectives are, the better position I will be in to give you a valid second opinion. If maximizing income is your primary objective my opinion of your current annuities could be completely different then if reducing fees is the primary objective. The clearer you can be in defining your objective, the more valuable a second opinion from me or any other advisor will be. Does that make sense? Frank– Yes it does. Actually I think that the real issue or concern I have is that the income won’t continue after I die.

Before continuing there are a couple of observations that are important to consider.

Most importantly is that now I am pretty sure I understand exactly where Frank’s “pain” is concerning these contracts which is the apparent single life income option. Without this understanding we could have wasted a lot of time talking about things that I might have assumed were the problem and I would have gained little traction in terms of getting Frank to really engage with me. Until he might say something that makes me think that some other issue is actually more painful, I will focus most of my attention to solving the problem of the apparent single life payout in Frank’s current annuities.

Next, I found Frank’s comment about fees interesting because over the years I have worked with many clients who have owned variable annuities and only a few clearly understood the actual amount of fees they were paying until I educated them. Usually a VA owner mistakenly thinks that the fees are in the range of about one to two percent, when in reality the actual fees are often three to four percent depending on the riders included in the contract. The fact that Frank said his fees were over three percent raised a bit of a warning flag in my mind. This understanding causes me to wonder exactly how Frank learned the amount of the fees. With most of the variable annuity contracts that I have examined, the fees are not obvious nor fully disclosed. In order for owners to have a more complete understand of the fees and charges they most also refer to the product’s prospectus. I have never met a client who claims to have read a prospectus and few have closely reviewed the annuity policy or contract.

I would be surprised if the advisor who originally sold him these VAs explained the true amount of the fees. So again the question going through my mind is how did Frank came to gain this understanding? This is an important question because to me it indicates that Frank may have discussed this with another agent or advisor. If this is true and I am competing with another advisor I want to know it as soon as possible. I also want to understand the nature of Frank’s relationship with the original advisor.

But before doing this I want to explain to Frank how I work so that he knows what to expect. I do this early on in every first meeting I have with a prospective client. In Frank’s case the explanation went something like this: Doug – Ok, we will spend a little time dealing with this issue of protecting the income going to your wife after your death but first let me explain how I work with people.

First, my approach is fairly slow and methodical. I prefer and most of the people I end up working with prefer to have a series of briefer meetings as opposed to having a long marathon session where we try to cover everything. The first meeting I have with a potential client usually lasts about 45 minutes. And, it is just like we are doing here. I ask a bunch of questions so that I understand what the issues are. And I want you to feel free to ask me anything you like. Don’t hesitate to ask if you want to know more about my experience and qualifications, or how I get paid, or anything at all.

There are only two purposes of this first meeting. One is for me to determine if I think I might be able to help with problem or issue. The second is for us to decide if we want to have a second meeting.

I can tell you right now that there is no way I will be able to make any recommendations and I doubt I will be able to give a valid second opinion during the remaining 30 or 40 minutes we spend together today. I feel that what I just said is extremely important and something I always say right away during every initial meeting I have with a new client. When most people first meet with a new advisor they are afraid that the advisor will try to sell them something right away. People put their “guards up” to avoid this. I know from experience that if I am meeting with a married couple for the first time, the chances are good that just before we meet one spouse will say to another something like “whatever we do, let’s make sure we don’t buy something today!” I want these people to relax during our first meeting. The last thing I want them to feel is any pressure that I might try to convince them to take some action before they are ready. To do this I try to make it clear that this will not happen during this meeting. If we do decide to have subsequent meetings, then my goal will be to provide you with various options for addressing your issue. My attitude is and my experience has proven to me that there won’t be any option that I can come up with or that any advisor can come up with that will be prefect. I will give you several options and each will have its own strengths and weaknesses. One option will be to make no change at all and continue with your current annuities. This is something that obviously must be considered. And ultimately it might prove to be your best option. But even if it does, it won’t be perfect. Here is the way I view my job. It is simply to examine every option for meeting a specific objective that my education and experience cause me to believe is worth considering. Explain each option to you, including both its strengths and weaknesses. My goal is to give my clients enough information so that they can make an intelligent decision as to what is best for them. In order for me to do a thorough job, it will take time and several meetings. This is ok with me because I am not in a hurry. Is it ok with you? I always pause here and wait for my client to answer. Most often they will say yes. And in my experience they are relieved to know that I am not a typical salesperson who will try to push them into buying some product. Doug – One other thing that is important for me to understand is if you are working with any other advisors. Are you still in contact with the person who originally recommended these annuities? Frank – Not really. I have not spoken to him for several years. Doug – You seem to be fairly knowledgeable on these variable annuity contracts. Was that because the original advisor was so through in explaining fees and other aspects or can I ask if you have discussed these contracts with anyone else? As was my suspicion, Frank explained that he had talked to another financial advisor about these contracts. That advisor was the one who explained the fees and more importantly had discovered that seven of the variable annuities had income riders that provided only a single life payout. Frank had not spoken to this other advisor for over a year and he told me that he did not do any business with him because he never really trusted him. If this had been an issue and there was another advisor involved, at some point I would want to deal with it by getting some kind of a verbal commitment from the client. Usually the appropriate time for this would be towards the end of the first meeting. Between my first and second meeting I am going to be doing something like preparing quotes or in Frank’s case I will be evaluating his current VAs and developing options for him to review. If there were another advisor involved, before doing the work to prepare for the second meeting I would simple say something like… Before we close this meeting let’s spend a minute and talk about your relationship with this other advisor. I am more than willing to spend time evaluating your current annuities and come up with options for you to consider. And certainly I would have no problem if you decided not to act on any of the options I present. But I would have a problem if I did all of the work and you decided to go forward with one of my recommendations but you actually did the business with the other advisor. Is that something I need to be concerned about?” If a person tells me that they have some reason why they might want to do business with the other advisor because perhaps he or she is a relative or close friend, then I will thank them for their honesty and not schedule any additional meetings. In Frank’s case this won’t be an issue because he has indicated to me that no other advisor is involved. At this point it will be a good time for me to take a look at his variable annuity contracts. But what is going through my mind is that my objective is by the end of this first meeting I want Frank to agree to allow me to take his annuity contracts with me so that I can do a more thorough evaluation. The process of Frank or any other person becoming my client will occur in steps or stages. In the early part of my career I often would attempt to close a sale at the first meeting. While this worked for smaller transactions and with some products, I learned over the years that it was too big of a step, too soon for most people to take. Now my process is much longer. I guide or help my clients to take a series of small steps that culminate in the actual transaction. This is not only a more effective approach, it is necessary because I now work with more clients with a higher net worth and the transactions are larger. Some of these steps are simply going from one meeting to the next meeting. I know that each time a prospective client agrees to meet that he or she is getting more comfortable with me and my recommendations. But there are other important steps that I can help my client make as well. One is to get a client to trust you with his statements or in Frank’s case his actual contracts. This may not seem like such a big deal for you or I because we know that even if I was dishonest there is no way that I could extract any value from the contract. But Frank may not really understand this and he has only just met me. Before I even begin to look through his contracts I know that my ultimate objective is to leave the first meeting with those contracts in my possession. For this and other reasons I do not want to do a thorough examination at this time. In other words, the more detailed I get examining the contracts now, the less reason I have for taking the contracts with me for a thorough examination. Instead I want to only take a brief look at each contract. The question is what should I focus on as I look through Frank’s contracts? I could look at the fees, or try to get an idea as to the amount of income each might provide. But remember, early on in this meeting I spent time trying to learn what was Frank’s primary issue or concern regarding this contracts. In other words, through questioning I discovered where Frank’s pain was. He told me that it was the fact that the income riders provided only a single life income option that could jeopardize his wife’s future financial security. If I am correct and this is his major source of concern or “pain”, this is where my focus should be in this initial review of his annuity contracts. Like most annuity contracts that I have examined that contain income riders, in the back of Frank’s there was a multiple page section devoted to an explanation of the income rider. Every carrier’s description pages will be different but fortunately in the case of Frank’s contracts it was easy to find what I was looking for because in large bold letters at the top of the page it was stated Guaranteed Lifetime Withdrawal Benefit – Single Life. What made things easier was that eight out of the nine annuity contracts were purchased from the same carrier and were formatted similarly, allowing me to somewhat easily find what I was looking for, which was to discover if the income rider was set up for a single life or a joint life payout. After looking at all nine contracts what I concluded was that what Frank had was a little different than what he thought he had. Six of the contracts where VAs, containing an income rider that were set up to provide a single life payout to Frank. One contract was a VA, containing an income rider that was set up to provide a joint life payout to both Frank and Shelly. One contract was a VA, without an income rider that was owned by Shelly. And the remaining contract was not a variable annuity. Instead it was a fixed rate annuity that did not contain an income rider. In addition, all contracts had a ten year term. And they had all been purchased at different times over the past 12 years. The oldest contract could be surrendered without penalty. Within a few months the second and third oldest could be surrendered without penalty. And the remaining contracts had two or more years before they reached the end of the surrender charge period. I briefly explained all of this to Frank. He was surprised and somewhat relieved that at least one of the contract’s income provided a joint life payout. One point that I emphasized to Frank was that I was not comfortable in relying solely on my brief examination of the contracts to conclude that there were no options for changing the income rider’s single life payout to some form of a joint life payout. I stressed that what needed to be done was for he and I to get on the phone at some future time and call the insurance company and ask them if there were any such options. I told Frank that I needed to be on the phone because I knew the right questions to ask to truly flush this out. By Frank’s response I could tell that he wanted to do this. I also felt that he was starting to value my expertise and input. Including me on a future phone call to the insurance company is again a small but important step that will move Frank closer to becoming a client. Often when I have a first meeting with a client who has a variable annuity contract I will want to call the insurance company during that first meeting. However, the typical pain that people have with VA contracts relates to the fees. Often, people simply do not believe that they are actually paying fees as high as is often the case with many VA contracts. So one purpose of calling the issuing company during the first meeting is so that the client can hear what the fees are directly from the company and not have to rely on my assessment. Frank did bring up the high fees in his VA contracts but again this was not his primary concern. Plus, he already believes he has a problem with most of his annuities, the single life payout, which he wants to resolve. There is no need to phone the issuing company at this point. And in my mind there are more important things I want to accomplish in the time remaining in our first meeting. My next step will be to spend a little time educating Frank about annuities in general. And specifically I want to make sure that he understands the fundamental way that income riders work. This will be important regardless of whether he keeps his current contracts or decides to go with some other option I might present at a future meeting. Anytime I discuss annuities with a new client I will fairly consistently go through the same presentation. You can see my standard annuity presentation by watching the video tutorial that accompanies the FIA software I typical use. This video tutorial and software can be found on the AdvisorGrid website. In Frank’s case I am going to deviate in some ways from my standard annuity presentation and instead focus more on the issue of annuities which can be used to provide permanent lifetime income. Again, this is what I was able to flush out as Frank’s primary objective early in our meeting. Even though Frank appears to have above average knowledge of annuities, I do not want to bypass this step. I find that most people really do not understand income riders or annuitization and for years I have successfully used variations of the following explanation to clear up confusion. Doug – There are a few options that are immediately apparent to me that I think should be considered. I will share them with you in a moment but first I think it is important to spend a few minutes so that I can be certain that you understand how annuities work and what their strengths and weakness are. My first question to you concerned what your objective was when you purchased these annuities. What I heard you say was that primarily it was to provide a pension-like income during retirement. As long as that really is your primary objective then generally speaking an annuity is not only appropriate but it is really your only option. This is because by definition an annuity is the only financial instrument that can guarantee a lifetime income. In other words, if a contract guarantees to pay you an income for the rest of your life, then it is considered to be an annuity. I am not saying that your variable annuities are your only option, or even the best option for a lifetime income. Instead I am talking generally about what an annuity is. Actually when we say the word “annuity”, that represents a pretty large umbrella and there are a lot of products under that umbrella. I am not going to describe every type of annuity to you but instead let’s talk about the four major categories of annuities that most products will fall under. First, I will start with what are commonly referred to as fixed rate annuities. Remember, we found that that one of Frank’s annuities was a fixed rate annuity. I pointed to this contract an explained that this annuity was in this category. All annuities provide at least one option for providing lifetime income. And while that is true of fixed rate annuities I don’t really recommend this product category to clients. If it is important then we can discuss my reasons later. But for now, I will say that in my view a fixed rate annuity is best used as an alternative to a certificate of deposit. In some ways fixed rate annuities are similar to a CD. You decide on a term that you are willing to commit your money to and the insurance company agrees to pay you a fixed interest rate over that term. Once the term ends you either commit the money for another period or you take the money and do something else with it. While insurance companies will provide guarantees to safeguard your money, it is important to understand that no annuities are FDIC insured. So the financial strength of the company behind your annuity becomes very important. I am often asked my opinion as to if I think fixed rate annuities are good or bad. And my answer typically is that generally speaking I don’t believe any product or investment should be thought of in terms of if it is good or bad. Instead, you need to tell me your objectives for the money you put into this annuity (I point to Frank’s fixed rate annuity). Then I can tell you if it does a good job or perhaps not such a good job in achieving those objectives. If, for example, you say that when I bought this fixed rate annuity I was just trying to protect the money from stock market volatility. Or, if you said I was just trying to defer taxes. Or, perhaps some other reason my answer would be that I believe it did a good job in meeting that objective. Was there some alternative that might have done a better job? Perhaps, but the important point is that the better you can define your objectives for this particular sum of money, the better I am able to present you with the best options to meet that objective. You have made it clear that your primary objective was a lifetime income. Again, any annuity, including your fixed rate annuity will provide you with options for accomplishing that. It is called annuitization. Whether annuitization is a good or bad option will depend on your objectives. At this point I picked up Frank’s fixed rate annuity contract and flipped to the pages that provided information on the contracts annuitization option. Every commercial annuity contract regardless of whether it is a fixed rate annuity, a variable annuity, a fixed indexed annuity or any other form of annuity will contain pages describing annuitization options. If a contract does not offer these options then it is not an annuity. (For readers who are newer to annuities it is important to understand that annuitization is different than using an income rider to provide your client with a guaranteed lifetime income.) Doug – This annuity, as with all of your annuities, allows you to convert the accumulated value in the contract into a stream of income payments that will be guaranteed to last for a defined period of time or for your lifetime. I then flip to the page in Frank’s contract that describes an annuitization option that will provide a joint life income last as long as either Frank or his wife is alive. Doug – You might be pleased to know that one of your options that this contract provides is for a joint life payout. This means that if you take this option then the resulting income would be guaranteed by the insurance company to be paid as long as either you or Shelly were alive. Of course this means that if your primary objective and concern regarding these current annuities is to protect Shelly with a lifetime income payout, then you do have this option and you don’t need to make any changes to this contract. Understand, I am not saying that it might be your best option, only that it is an option that is available in the contract. But before you should consider it, you need to clearly understand what annuitization means. Like everything it has its strengths and weakness. In a future meeting we can get into all of the details but for now let me just say that there is one possible weakness of annuitization that we should talk about. Generally speaking, in order to get a lifetime income you are giving up access to the annuity’s accumulated or cash value. In other words you are essentially exchanging your principal for an income stream. Usually you will have some options with annuitization that will guarantee that the income payments will last for a specified period of time in case you died too soon after you annuitize. Again, we can get into more details at a future meeting if it turns out that you might want to consider using the annuitization options in your current annuities. I can tell you that in my experience most people view giving up control of principal as a pretty drastic step. I think it is because they worry about the consequences if they change their mind in the future. So these restrictions might be viewed as one of, if not the most significant weakness of annuitization. What is its strength? You could say that it is the fact that it can provide exactly what you are looking for, permanent lifetime income. But there are ways to get that from an annuity without annuitization, which I will explain in a minute. The real strength of annuitization is that generally speaking it will provide the greatest amount of lifetime income. The reason that the insurance company can provide greater income under this option is simply because you are giving up control of your principal. It is a mistake to think of annuitization as either being good or bad. Instead you should think of it as an option which will be like any option you have in that it will have its own strengths and weaknesses. My job, is to learn what your objectives are, present you with any option I think is valid, and point each options strengths and weaknesses so that you are in the best position to make an intelligent decision. Does that make sense? Doug – There are three other main categories under this annuity umbrella that I want to briefly describe. The next is an annuity typically referred to as either an immediate annuity or a deferred income annuity. As the name implies, one version would typically provide income that starts right away while the other one might be used when the income isn’t needed to start until sometime in the future. Like the category we just discussed, these annuities typically use annuitization to provide the permanent income. This means that if someone does not like the requirement of giving up control of their principal then they probably would not like either an immediate or deferred income annuity. The third category of annuities are variable annuities. Just like the eight contracts you already own. Variable annuities are unique in a couple of ways. One, you are already familiar with. The accumulated value inside each of your contracts is more or less invested in the stock market. As the market goes up, your cash value can go up right along with it. But, when the market drops, your cash value also drops right along with it. Another thing that is unique to variable annuities are the fees. There are several different types of fees that will typically be found in a variable annuity. They have names like the mortality and expense free, administration fee and because they provide a choice of different investment options, that are similar to mutual funds there is typically what is referred to as a fund fee. Like all annuities, your variable annuities provide you with the option of annuitization. Like we have discussed this would allow you to more or less give up control of the contract’s cash value in exchange for a lifetime income. Let me ask if at this point you have any opinion on using annuitization to provide income? Frank – I would need to think about it but I am not sure I would feel comfortable giving up control of the money. Doug – That doesn’t surprise me. Fortunately, with seven of these contracts you do have another option that can provide permanent, lifetime income. You have this option because at the time you purchased these annuities you added what is often referred to as an income rider. At a future meeting we need to get into the details of exactly how your income riders work. Again, like everything they are not perfect. They have their strengths and weaknesses. For now let me say that a strength of a typical income rider is that they provide a way to get permanent lifetime income but without annuitization. In other words they provide the ability to retain more control of the contract’s accumulated value even after you start receive a lifetime income. Frank – That sounds good. Doug – Yes. It can be good. But these income riders are not perfect. One of the reasons your fees are high on these contracts is because there is an annual charge for this income rider. At this point I don’t know exactly what it is, and it will be important for us to find, but my guess is that the charge is about one percent per year. This added to the other charges that are typical of variable annuities is how your fees have gotten above three percent. There are annuities with income riders where the total amount of fees can be far less. That takes us to the last category I will describe which is typically referred to as fixed indexed annuities. (Insert drawing) Unlike your variable annuities, with indexed annuities the cash value is not invested directly in the stock market or in any type of mutual fund. Instead, the insurance companies create a structure where growth is linked to the performance of a stock market index like the S&P 500. But there are a couple of major differences. One is that when the stock market index goes down these contracts protect you from market losses. So unlike your variable annuities which generally speaking will fully expose you to market losses, the indexed annuity provides guarantees that when the market goes down the worst that will happen is that your cash value will not earn any interest. That protection from volatility is a basic difference that is often very appealing to many people especially when it comes to their retirement funds. But again, nothing is perfect and neither are these annuities. What is their major weakness? Certainly one is that you typically don’t get all of the gains when the market is up. (Insert drawing of up and down line with the stair step) For example, let’s say that this line represents the stock market index. When the index goes up, instead of realizing all of the gains, you only are credited with a portion of the gains. In exchange for limiting the gains, you don’t suffer any market losses during the inevitable periods when the index goes down. When the index is up, you are credited with a portion of the gains. When the index goes down, those prior gains are protected from market volatility. Index goes up, you get part. Index goes down, you are protected. This is kind of like walking up a set of stairs, where once you reach one level you can’t go down because of market losses. Whether or not this type of structure will be a good match for someone really depends on how they feel about market volatility. This is not anything that we have discussed so far. How comfortable are you with the inevitable ups and downs of the stock market? Frank – I am not really sure. When I was younger I had my 401k in the market and some other stocks. I didn’t like it when the market was down but I was always fairly confident that eventually it would go back up. I have been fairly happy with the results. But now I am at a point in my life when I really don’t want to take much risk. In recent years I have moved money out of the market. Doug – Where did you move that money to? Frank – I have most of it in CDs. I certainly took note of this and will most certainly dig deeper into these CDs at a future meeting but I don’t want to get off track from our current conversation so I continued this way: Doug – Can I assume that the reason was to keep this money protected from volatility? Frank – Yes. I will continue to receive money from the sale of my previous business. And the new company that my daughter and I started is doing well. But you never know what might happen with either one of these, so I just felt it was better to start moving money into CDs even though they aren’t paying much interest. Doug – I think that is smart in your situation. No sense in taking on so much risk your retirement is jeopardized. Are you thinking that it might make sense to move some of the variable annuity money into something without market volatility? Frank – Maybe. But I do think that I have enough in CDs. I am not sure I need more safety. Doug – Are you saying that you might be comfortable with the exposure to market volatility with your variable annuities? Frank – Well, I am not really concerned about it too much. I guess what I don’t understand is what how any income from my variable annuities would be impacted if the market dropped a lot. Doug – That is certainly something important to understand. And I need to take a real close look at the contracts before I would feel comfortable in providing a detailed explanation but at this point I am pretty confident in saying that these current variable annuities would provide plenty of protection with regards to your income continuing even if the markets dropped dramatically. Again, I really need to spend some time reading the contracts to know for sure. I think that we are at a point when it might be at a good idea to wrap this meeting up and talk about how to move forward. You do have some options that I will be glad to talk about, but before telling you what they are let me restate what I believe you have told me are your concerns and objectives. And it is import for you to tell me if I have these wrong or if there is anything that should be added. You bought these annuities primarily so that they would provide you with a pension-like income during retirement. And more than the fees, market volatility or anything else, you pretty much now have a singular concern with them which is that seven of them apparently only provide a single life income payout which does not continue to your wife. Is this the correct way for me to look at this? Frank – Yes. That pretty well sums it up. Doug – Good. Then based on this I can tell you that I already know that there are at least three options, maybe more, that you should consider. We can spend a few minutes talking about them but understand that I am not in a position to make any recommendation. I simply do not know enough at this point to know which might be the best option. First, you could keep your some or all of your existing annuities. You do have one where the income rider was set up to provide a joint life income payout. And as important, until we talk to the insurance company and ask them the right questions about the income riders in the other contracts we won’t know for sure if they might be able to be modified in some way so that they also could provide a some form of a joint life income payout. At this point I have no way of knowing how good this option might be. To find out there are two things I would have to do. One is to really spend some time reviewing these contracts. I know that after I did this I would still have some questions that only the insurance company could answer so the second thing would be to call them. A second option would be to look at the potential advantages and disadvantages of replacing one or more of your current annuities with some other type of annuity that would provide a joint life income payout. Frank – Are you saying to cancel them and pay a penalty or wait until I can cancel them when there is no penalty? Doug – At this point I don’t know the answer. It would depend upon the amount of the penalty and the amount of benefit some new annuity might provide. I would have to really look into the details before I could give you a better answer. However, I will tell you one thing right now. You have told me that you are certain you are paying fees of over three percent per year. That means you could pay over 10 percent in fees over the next three years. If you have an annuity that charges a five percent penalty to surrender now, then depending on the fees of anything you might replace it with, there could be a net advantage. Again this is something that needs to be looked at in much greater detail. There is at least one other option that I might suggest we consider but before I explain, can I ask you about your health? Are you being treated for any illness or dealing with any medical conditions like diabetes, high blood pressure? Frank – No. I am in pretty good health. No problems that I am aware of. Doug – Good. Then you might want to consider using life insurance to protect Shelly’s income if you die first. In other words, maybe it would make sense to keep at least some of the variable annuities, start a single life income payout from the existing income rider and then rely on the life insurance death benefits to offset any loss of income that Shelly might experience at your death. Frank – That’s interesting but at my age I would expect that life insurance would be pretty expensive. Doug – Well there is no question that there would be an expense involved but the way that I would suggest looking at the cost of this option is more on a bottom line basis. In other words, since a pension-like income is your primary objective, what is the net amount of income you would be left with after paying the cost of the life insurance under this option? If it is greater than what would be provided by any other option we might come up with then it is worth considering. I just don’t know at this point if it would be or not. In fact, I think this is the bottom line for this meeting. You have made it clear as to what your concerns are and what you are trying to accomplish. As I have said, my job is to come up with multiple options for addressing those concerns and meeting your objectives. If you trust me enough to allow me to take these contracts with me then I can do the review. But I already know that the issuing company won’t answer my questions about your contracts unless you give your permission. The way that works is that we would both need to get them on the phone, they would ask for your authorization to disclose information to me, and once you provided that then they will answer any questions I have. We could either make this call at our next meeting or we could do a conference call some time when you are at your office and I am at mine. But let’s not worry about this now. Before I even know what question I will want to ask them I need time to examine the contracts. Are you comfortable trusting them with me if I give you a receipt for them? Frank said yes. First Meeting Observations and Comments The next step with Frank will be to call the issuing insurance company because I know I will need to ask some questions. But first I need to review each of the contracts in order to know what questions I may need to ask. I could do this with Frank at the second meeting but my expectation is that I will need time after we talk to the insurance company and before it makes sense to have a second meeting. Because of this, the way I left it with Frank was that we scheduled a time for a phone call one week later. During that call I would conference in the insurance company so that we could ask questions. After that call and depending on what we learned we would schedule a time for our second face to face meeting. During this first meeting the majority if my focus was on annuitization and the income riders that were part of Frank’s variable annuities. I pretty much downplayed fees and the risk of stock market losses that these contracts exposed Frank to. The reason I did this was because I felt that these were really not primary issues that Frank was concerned about. Over the years I have had a lot of joint appointments with other agents and advisors and a mistake that I see being made consistently is when advisors focus on the wrong things. This can easily happen when an advisor doesn’t really listen or take the time to discover where the client’s true pain is. Instead many advisors talk about feature and benefits of the product they are pushing. Many advisors who favor FIAs have an attitude that variable annuities are horrible products. While I often recommend FIAs, I don’t share the attitude that VAs are bad. Again, they are different products designed to do different things and my view is that it is a mistake to view them or any product as being either good or bad. It is fairly typical that when an advisor who favors FIAs meets with a new client who owns a VA to immediately attack the VA. This can lead to a first meeting where the advisor is stressing that his fees are lower or better protects the client from market risk. While these positions might be accurate the point is that they might not be very meaningful if the client is not concerned about fees or market volatility. Believe me, if Frank’s primary concern was market volatility my presentation and talking points would have been much different. This is why the first thing I always do when meeting with a new prospective client is to spend time in trying to flush out where that person’s pain is. The more effective I can be at doing this the more I can discuss things that are truly meaningful with that individual. This leads to clients viewing me more as their advocate and less as a product salesperson. Then when I ultimately present options that will minimize or altogether remove that person’s pain, it will be much easier for me to make them my client.

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dougwarrenclu-blog · 9 years ago

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Case Study 021: Fourth Meeting

Conclusion

Meeting Notes – Nancy and Chuck Nancy Age 66 Chuck Age 63

Fourth Meeting Preparation

As I prepared for the next step, my expectation is that I will likely need two or perhaps even three more meetings with Nancy before any purchases are made or accounts opened.

The process I am taking with her may seem drawn out. It is but that is my intention. Remember that Nancy is still months away from having access to any lump sum pension amounts. This means that no matter when Nancy may be ready to move forward, we can’t until this money is available. So for this reason I am intentionally looking for reasons to keep engaging with her as we move closer to her retirement date.

If Nancy had immediate access to all of her retirement funds, I would be scheduling our meetings four to seven days apart. I know from working with many clients over the years this is a good pace to build momentum towards and eventually come to a conclusion. But with Nancy, I have been scheduling meetings two to three weeks apart. I don’t normally like this because the longer period of time that elapses between meetings, the more clients forget what has been previously discussed. And worse, all sorts of things might happen that could interfere with turning a prospect into a client. But I feel that I have little choice but to run that risk with Nancy because again her funds are not currently available.

My intention for the upcoming meeting is to primarily devote it to exploring options for providing the amount of permanent income required so that along with their Social Security, the $5,000 target income is achieved.

The two primary options for generating income to fill any gap are to use her pensions or to purchase an FIA with an income rider. In part, this is why I ended the prior meeting by stressing the importance of Nancy completing her homework assignment of finding out the details of her pension options.

Until I have that information, all I can do is to obtain quotes of the lifetime income amounts that could be provided by the annuities. I want to give Nancy three annuity options to look at during our next meeting. The advantage to providing a client with quotes from multiple products is that from the client’s perspective, this is more consistent with helping him or her purchase something as opposed to appearing as if you are trying to sell them something, which is more the perception anytime the advisor focuses only on showing one product. The disadvantage of presenting multiple products is that unless the advisor is careful with the way he or she does this, there is a greater risk of confusing the client.

Anytime I am presenting multiple fixed index annuities with income riders I like to use the rider quoting tool from Annuity Rate Watch. This tool allows me to print a report that includes a single page that contains the rider income amounts of up to three annuities, side-by-side. This makes it very simple for the client to focus on what I believe is the single most important aspect when it comes to selecting one of these annuities, which is the amount of lifetime income guaranteed by each of the issuing insurance companies.

Because I know that the amount of income needed to fill any gap in Nancy and Chuck’s target $5,000 income, it is easy to use the Annuity Rate Watch rider quoting tool to come up with a selection of companies that might best meet that objective.

The gap is $1,560 per month. This is their $5,000 target minus their $3,100 of Social Security and minus the $340 that Nancy would receive if she activated the income rider from her existing annuity. (Earlier I had called the insurance company that issued this contract to confirm this amount.)

What complicates this is that I am not sure if at this point I want to base the annuity quotes on the income rider providing a single life payout or a joint life payout. The indication I have gotten from Nancy whenever we spoke about her pensions was that she was thinking that if she did take a lifetime income she would select the option that provided a 75 percent continuation of the pension income to Chuck if she died first.

I intend to position the fixed index annuities as an alternative to taking any lifetime income option from her pension. I can’t structure any fixed index annuity’s income rider so that it would provide a 75 percent continuation to a surviving spouse. I could use multiple fixed index annuities, some with a single life payout and some with a joint life payout in a combination that would come close to matching a 75 percent continuation, but at this stage this could become far too confusing for Nancy.

What I decide is to base my quotes on a single life payout, make this clear to Nancy at the time I present this option, and tell her that I am sure I can find a way to address protecting Chuck in the event of her prior death.

To do my search I set the “Solve For” filed to “Premium Required” and enter $18,720 as the annual amount of lifetime income needed to fill the income gap (monthly gap = $1,560 X 12).

I click the “Continue” button and instantly I have the amount of premium required to generate that rider income from hundreds of fixed index annuities.

All I do is pick the three annuities I want to use and then click a button to generate the report containing the quotes.

When I am reviewing this option with Nancy I can turn to one page in the report to see a side-by-side comparison of the income riders involved.

Depending on the circumstances, with some clients I use this report to show how much lifetime income would be provided by each insurance company assuming the premium was the same amount.

In Nancy’s case the approach is different. We know the gap we are trying to fill, what we don’t know is how much premium she must allocate to each company to fill that gap. In other words, for the report I prepared for Nancy the lifetime income amount is the same $18,720 (the annual gap) for all three annuities. What will vary when we look at the annuities side-by-side is the premium required.

I also printed a single page Vital Signs report for each of these three annuities.

This is the same report I prepared and showed Nancy at the prior meeting when we discussed annuities for secure growth.

My process is that after she and I review the report showing the premiums required by each of the three insurance companies, I can then use these reports to discuss the ratings and financial strength of each of the companies involved.

By doing this and discussing other aspects of each annuity, like surrender penalty period, the amount of penalty free withdrawals, fees and other factors, I am suggesting that the decision as to which annuity to choose should not necessarily be based solely on the premium required or the amount of income provided by an annuity. For example, annuity A might provide slightly more income but annuity B might be issued by a company with much greater financial strength. Some clients may be willing to sacrifice a small amount of lifetime income in exchange for greater financial strength, smaller fees, a shorter surrender penalty period or some other consideration that may be more important to them.

For years I took a different approach and typically only showed prospective clients a single product without providing many options. It was a simpler approach that brought me success.

Today I prefer and actually enjoy this process of providing multiple options. Readers should pick the approach that works best for them.

Another thing I did to get ready for the upcoming meeting was to prepare some information regarding some securities portfolios that would fit Nancy’s risk profile based on her answers to the questions from out last meeting.

And last, as I always try to do, I brought applications and necessary paperwork with me in case Nancy might want to move faster than I am anticipating.

Fourth Meeting

Years ago I stopped being surprised when meetings went differently than I had expected.

When I asked Nancy if she had been able to do her homework for this meeting she answered yes and then told me the following:

Nancy – I got all of the information on each of the pensions and Chuck and I have decided what we want to do. The lump sum amounts for the four pensions are:

Pension #1 - $158,377

Pension #2 - $75,000

Pension #3 – $246,128

Pension #4 - $55,362

We want to take the lifetime income from pension #1. The amount will be $857.65 per month for as long as I am alive and then $643.24 for Chuck, as long as he is alive. As soon as I retire I would also like to start receiving income from the annuity I already have

And we have decided to take the lump sum amounts for the other three. We need to figure out the best way to invest this money and the $80,000 in my 401k.

What do you think about us taking about $100,000 of this money so that you can help us invest it in the stock market and taking the rest and putting it in one of those annuities you showed me before?

I had thought and prepared for what I had expected to be a conversation primarily devoted to considering the options of using either her pensions or an FIA with an income rider or a combination of the two to provide for a gap of $1,560. From what Nancy just told me, she was much further ahead of me in that she and Chuck had made decisions that would result in them becoming clients and transacting a fairly large amount of business.

The reader might think this is great and it certainly is but there are some things I feel I still need to do before we go down this road but I have to be careful that I don’t do those things in a way that might give Nancy any reason to change her mind.

My first concern is that the income they will receive from pension #1 is only $858 a month which is well short of the $1,560 gap that needs to be met to reach their target.

I discussed this with Nancy and she said that Chuck would likely continue working for another five or possibly ten years. If not full time then part time. And as a nurse she was confident that she could get part time work if she needed to. So they really weren’t worried about having enough income. It was clear from what she said that it was far more important that they preserve the lump sum amounts in her remaining pensions.

I understand her and Chuck’s attitude about their income needs and their approach to meeting those needs and it made sense to me.

Now the question remaining is if I should broach the topic of if it might be better to purchase another FIA as an alternative to her plan of taking income from pension #1.

I decide not to discuss purchasing another annuity for lifetime income because I wasn’t sure it would be in her best interest and I see other challenges as well if took this approach. One is that using fixed index annuities with income riders to match the income from pension #1 is complicated by the fact that the pension also provides a survivor income for the benefit of Chuck. Again, this makes it more difficult but not impossible to come up with some combination of fixed index annuities to do the same. More importantly, I am positive that using fixed index annuities would require that Nancy allocate more than the $158,377 lump sum amount she would receive from pension #1 if she took the fixed index annuity alternative. Certainly there are advantages as well as disadvantages to using fixed index annuities as an alternative, but regardless of the approach it would be difficult to present the fixed index annuity alternative as being far superior. Plus it was apparent that Nancy felt somewhat comfortable in having at least some income provided by her pensions.

For these and other reasons I never showed her the report containing the fixed index annuity quotes that I had prepared for this meeting.

Instead, Nancy and I spent the remainder of the meeting discussing investment options consistent with her risk profile for that portion of the money she wanted to allocate to a direct investment in the stock market. We also dug deeper into the details of the fixed index annuity structured more for secure growth for the other portion of the funds. This was made easier by the fact that at a prior meeting she had given me an indication that the fixed index annuity with the seven year term was the one she had favored. Because of this, I only had to focus on that product as we discussed things such as the crediting method this annuity used to determine gains as well as the other details of that product.

By the end of the meeting the course was clear as to what would be done. However, because Nancy was still many weeks away from having access to her retirement funds I set another meeting for the purpose of answering additional questions and completing the necessary paperwork.

Conclusion

There were no more surprises. Everything went as expected from this point on.

While Nancy and I did have additional meetings and conversations I don’t believe that there is anything I could add that the reader would find instructive, with the following important exception.

As an advisor, it is difficult if not impossible to know for sure why a person ends up becoming a client and transacting business. While we can only guess, in Nancy’s case I am fairly confident that I know what a very important key was at least.

I believe it was that Nancy and I spent time during most of our meetings talking about that a large component of her dream retirement was spending time with her granddaughters. And more specifically having the money so that she could take them on trips and cruises.

One example was that when we discussed the money she was allocating to securities and the fixed index annuity for the purpose of growth I spent considerable time explaining her ability to access this growth to fund these vacations. I explained that by limiting any withdrawals to only the earnings, she would be able to preserve the principal so that it could be passed on to her granddaughters if she did not need this money during her lifetime.

But here is what I believe was an important part of these discussions. I took this further and said something like:

Doug - Certainly it would be great to preserve all of this money so that one day you could pass hundreds of thousands to your granddaughter. But maybe a better option is to use some of this principal during your life so that instead of limiting these trips to one every few years, you are able to take them more frequently. Certainly this could mean a smaller inheritance but think of all the great memories you would leave them with.

I then asked Nancy to think about her own childhood and the things that now as she looks back are the most important.

Doug - My guess is that possibly what is truly important to you like many of us, are memories of spending time with your family and perhaps with your grandparents. If you were fortunate enough to have fond memories of this, my guess that those are far more valuable than any inheritance you might have received from them.

Early in my career I made the mistake that many advisors do in approaching every client as providing some “numbers” solution to some “numbers” problem.

The longer an advisor stays in the business the more he or she learns that the value brought to a client goes far beyond what is expressed by the numbers involved.

#021meeting4

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dougwarrenclu-blog · 9 years ago

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Case Study 021: Third Meeting

Meeting Notes – Nancy and Chuck Nancy Age 66 Chuck Age 63

Third Meeting Preparation

I won’t have a clearer idea of the specific recommendations that I might make to Nancy until after the third meeting. Before I do I need to pin down the amount of any income gap she will have at retirement. This can’t be done until I know what her monthly expenses are and the amount of income she and Chuck will received from Social Security.

Because of this, the purpose of the third meeting will be to dig deeper into growth instruments.

All along Nancy and I have discussed allocating resources to first make sure that she has a source or sources of permanent income sufficient to meet the target income she wants or needs.

Because of her four pensions and existing annuity (an FIA with an income rider) It appears that some would have more than enough permanent income by just using these resources.

The question will be if it is better to take a lifetime income from her pensions or use some or all of the money that would come if she elected a lump sum from these pensions to possibly purchase additional annuities with income riders.

The advantage of doing this is that any remaining accumulated value in these annuities would be available to pass on to her granddaughters at her death. However, realistically if she lived long enough it isn’t reasonable to expect that much accumulated value would be remaining.

The disadvantage of purchasing additional FIAs with income riders to replace the pension income is that the payout from the pensions will be less than the lifetime withdrawal amounts from the annuities.

This is due to the fact that her pensions have the full advantage of something typically referred to as mortality credits. All annuities that offer lifetime income provide the benefit from mortality credits but single life pensions and true annuitization of a commercial annuity provide the most benefit. Because the lifetime income provided by fixed index annuities is typically in the form of the income rider, not by annuitizing the contract, fixed index annuities will receive less benefit from mortality credits.

For those readers who may not be familiar with the concept of mortality credits, I have included the following excerpt from my book How to Avoid a High Wire Retirement.

And as it relates to the amount of lifelong income, the second element that annuities share with Social Security and pensions is that only these three instruments are able to provide you with something that other financial instruments can’t: mortality credits.

Just as Jack was able to use magical beans to grow a beanstalk much higher than an ordinary beanstalk, mortality credits can boost lifelong retirement income.

Fortunately, the power of mortality credits doesn’t come from magic; it comes from math.

The best way to understand mortality credits is to use an example:

Assume there are 10 people who each have $10,000 to invest. They pool their money, and invest it in some financial instrument that pays two percent interest for one year. At the end of that year, there will be a total of $102,000 in the pool.

If divided equally, each of the ten would receive $10,200. Their profit would be $200 each.

Now let’s assume that one member of this group died before the distribution, and the members had previously agreed that only the surviving members would share in the pool.

The $102,000 now divided among only the nine survivors would provide each with total of $11,333. Almost magically, the profit is boosted to $1,333 each.

This means that instead of two percent, each survivor received a payout rate of more than 13 percent. The difference between the two percent and 13 percent is the mortality credit.

Jeffrey R. Brown, assistant professor of finance at the University of Illinois, offers another explanation of mortality credits. (Except he calls them a “mortality premium.”):

The extra rate of return that a life annuity can pay is sometimes called a “mortality premium” because it is essentially an extra rate of return that annuitants can earn in return for giving up their claim on their assets at death. To illustrate this concept in a simple, hypothetical example, suppose that at the beginning of the year 100 people each invest $1 in bonds earning 5 percent interest, and that 95 of them are still alive at the end of the year. Each of the 95 survivors would have $1.05 to consume, while the five decedents would leave $1.05 to each of their estates. If instead, each of these 100 individuals had pooled his or her money through an annuity contract, each of the 95 survivors would receive $105/95 = $1.10 to consume. Thus, the annuity contract provides an extra 5 percent rate of return – the mortality premium – in exchange for reducing the resources available for a bequest.

I know that many readers are likely thinking: “Mortality credits are great, but only if the person lives long enough to collect them.” The point is valid, because in their purest form, annuities require that a person give up control of his or her principal, and this money is lost at the person’s death.

But before going further, it may be important to consider that many annuities offer options that provide some level of protection against losing all of the money if a person dies earlier than might be expected. A joint life annuity protects a spouse by providing the continuation of a payout for the lifetime of both the annuitant and the surviving spouse. Lifetime income annuities with 10 years, 15 years or an even longer number of years of certain payments are another choice. These annuities provide for the continuation of the payout for a minimum certain number of years even if annuitant has died. But again, no matter how long the person lives, the income will continue.

Some insurance companies offer cash refund annuities where at the death of the annuitant (or the annuitant and spouse in the case of a joint life annuity) a lump sum is paid to the beneficiary in an amount that equals the initial premium paid, minus the total of all of the income payouts received prior to death.

While there are many options available that can serve to effectively limit the potential losses the owner’s estate might have from an early death, it is important to recognize that the use of any of these options will reduce the amount of mortality credits that a person will receive. In other words, you would expect the payout rate, in terms of the amount of monthly income, to be more if it was only provided during the life of the annuitant, and less if it was provided during the life of the annuitant and a surviving spouse.

The great thing about mortality credits is that they can make it unnecessary to select financial instruments from higher up on the risk vs. reward pyramid in an attempt to boost the amount of your monthly income. You don’t need to find bonds paying higher interest rates, guess which stocks have the best growth potential, or search for a better performing mutual fund. None of this is necessary because income annuities are not at all like the typical do-it-yourself retirement plans that require you to figure out how to generate a reliable and consistent income that you are certain will last for as long as you live.

As is often the case, with Nancy I am attempting to figure out the best way to accomplish multiple objectives that somewhat conflict with each other. One the one hand she needs permanent lifetime income and on the other she wants to preserve some portion of her wealth to pass on to her granddaughters.

The simplest and perhaps best solution in dealing with this conflict is often to have the client purchase life insurance with a death benefit in an amount that matches her legacy objective. That way she can devote all of her remaining resources to providing permanent income for the rest of her life.

Unfortunately, what came out in a prior discussion with Nancy is that due to some health issues I was fairly certain that any application for life insurance would be declined.

For all of the above reasons, at this point I continue to lean in the direction of Nancy taking the income option from some of her four pensions and a lump sum from the reminder. Possibly some of the lump sum along with her 401k might be allocated to purchasing an FIA with an income rider. Another portion of the remaining money could be allocated to either securities or an FIA structured more for secure growth or a combination of the two.

Before I know what might be best I need to try to learn more about the level of volatility that Nancy might be comfortable exposing her money to.

For these reasons I have two primary topics that I want to discuss with Nancy during our third meeting. I want to get into a more in-depth discussion of both direct investments in securities and secure growth fixed index annuities.

My goal for this first topic is to end by completing a risk profile that I must do before making any specific securities related recommendations.

To give readers who may not be familiar with a risk profile, below are two pages of 12 page form I use.

The red numbers to the left of each question represent a score that you add based on the answer the client selects.

When done, you total the score and the result allows you to place the client in a category designed to indicate if that client has a low, moderate or high tolerance for risk.

The more someone might score at in the range of having a low tolerance for risk, the more I would likely encourage them to consider either a very conservative securities portfolio or perhaps an fixed index annuity for secure growth. And the higher the score is towards a high risk tolerance, the more aggressive the choice of investments.

However, as experienced securities advisors know, many clients answer the same questions differently depending on the environment at the time. When markets are going strong a person’s answer can reflect that they have a higher tolerance for risk then if the same person had answered these questions during a recession.

My other goal for this upcoming meeting is to present Nancy with some actual fixed index annuity products that I feel might be appropriate when the objective is secure growth.

I have no intention to try to get her to make any decisions during our third meeting. My objective is more to see how she reacts to the idea of investing in stocks and/or using fixed index annuities for secure growth and what her preference might be.

I find that preparing for meetings when I intend to present secure growth annuities is more difficult than getting ready to present fixed index annuities with income riders.

Anytime I am recommending fixed index annuities with income riders a primary objective will be lifetime income. In my view, when this is the objective then I can simply use a quote engine to search for products that provide the highest income. I can and will screen products depending on factors like the financial strength of the insurer and their reputation for providing good service but I many other things like bonuses, rollup rates, crediting methods and other factors can serve more as a distraction that can get in the way of what is most important to many clients in this situation which is the amount of lifetime income.

It’s different and less clear cut when the objective is secure growth. There is much more to consider and it is difficult, if not impossible to make direct comparisons between one product and another. This is important because I always want to present multiple products and give my clients a choice.

Again, people hate to feel they are being “sold” something but they love to “buy” things. A difference in the perception of selling something to a client as opposed to helping that client buy something is the difference in offering a choice of multiple products instead of just one.

So to prepare to present secure growth fixed index annuities, I find that I must rely on the literature, consumer pieces and illustrations provided by each carrier. Instead of presenting one page showing income amounts side-by-side from three different annuities as I can when the objective is lifetime income, I now must deal with multiple marketing pieces that are all formatted differently.

This forces me to be selective as to what I will use because if I am not I can easily leave the client hopelessly confused.

It is our practice with these case studies to not promote or mention specific products so we will not discuss or show the marketing pieces or illustrations that I presented to Nancy. But in general terms we will try to provide insights as to my product selection process and summary of the details I suggest that the client pay particular attention to.

To start, I want to give my clients the choice of three different surrender penalty periods. I usually pick one fixed index annuity where the surrender penalty period ends after six years, one that ends after seven or eight years and a third that ends after 10 to 12 years. So I prepared three illustrations, one for each product term I would be presenting.

Last in my preparation, I printed a copy of I report called Vital Signs, a product produced by EbixExchange.

This is a single page report that is devoted to providing information relating to the financial strength of an individual insurance company. I print one for each annuity that I will be presenting.

I only briefly review these with clients and typically focus largely on ratings that company has been given by the various rating agencies and the information regarding that company’s total surplus.

What is great about using these single page Vital Sign reports is that they are all formatted the same way which makes it easy to compare information regarding one insurer with another.

Third Meeting

As I always do, I started this meeting by asking Nancy if she had any questions or things she wanted to discuss since our last meeting.

She did have a few but nothing that would be instructive to add here.

I then provided a brief review of what we discussed during our prior meeting. During this review I paid particular attention to the allocation model we had discussed that suggested that after setting aside an emergency fund, the most important thing was to allocate resources in order to have permanent income and then allocate remaining resources for growth.

Next, I asked Nancy if she and Chuck had done their homework and completed the budget form I had given her during the last meeting and gone online to get their updated Social Security retirement benefit statements.

They did. Nancy gave me copies, which we discussed for a few minutes. The bottom line for this was that the amount of target income that they wanted was in fact very close to the $5,000 that she had estimated during our previous meetings. And, the total Social Security retirement benefits that both would receive was $3,100. This assumed that they waited to their full retirement age to file.

This was important information for me to have because now I could more accurately calculate the amount of the gap between the target income and their other income sources in order to come up with options for closing that gap. However, this is something I would need to prepare to do for our next meeting. The purpose of this meeting was to discuss options for any of Nancy’s retirement money that might be allocated for the objective of growth.

Again, it is clear to me that Nancy will have sufficient resources to generate the target retirement income she and Chuck will need, with money left over that can and should be allocated in a way that accomplishes an objective of growth.

To this end, I started a conversation with Nancy regarding the value of and various ways to invest in the stock market.

Nancy had made it clear to me in both our prior meetings that she was comfortable having some amount of her money devoted to direct stock market investments. Whenever this was mentioned she talked in terms of limiting this to around $100,000.

I was glad she felt this way because I believe that for many people this is important.

I have my series 65 securities license and encourage all advisors to obtain a securities license. We know that many readers of these case studies are not securities licensed. For this and other reasons we have chosen not to include specific details of securities related conversations in these case studies. However, you will find general points and comments regarding some of what Nancy and I discussed during this portion of the meeting.

1. We briefly discussed some of the differences between active and passive investing.

2. Annuities are great but not perfect. Stocks as an investment is great but not perfect. My belief is a combination of the two is the best direction for many people.

3. I explained that I work with clients in two different ways depending on their preference. Some of my clients prefer to pick their own stocks and mutual funds, or they might have other advisors that they trust for managing their portfolios. These clients might want to only have me assist them with annuities. And if that is what the client wants I am perfectly happy limiting my role just to that. Other clients want me to help them with everything. This is what I prefer because I believe that it is important to try to have everything coordinated in such a way that it is all working towards meeting the objectives of each client.

At this point Nancy made some comments that indicated she was feeling comfortable in our relationship and wanted me to help her with everything.

4. I told her that before I could make any specific recommendations that the first thing I needed to do was to have her complete a “risk profile”. I explained that this was a series of questions that I needed to ask for the purpose of getting a better idea as to the type of portfolio that might best line up with the degree of volatility or risk she was comfortable taking.

5. We completed the risk profile.

The securities portion of this meeting ended with me telling Nancy that I wanted to discuss her situation with the securities team that I worked with and that I would be prepared to make some specific recommendations at out next meeting.

We then moved on to the second part of this meeting during which we discussed using FIAs for the purpose of secure growth.

I started by setting the illustrations for the three annuities that I had prepared in front of Nancy. I put them side by side and said something like:

Doug – All of these annuities do a great job of protecting you from stock market losses. The insurance companies can only do this if they know that you will leave the money with them for a long period of time. They all will charge very hefty penalties of you take all of your money out before the end of the term. Annuities will all have different periods of time or terms when penalties will apply on excess withdrawals.

This first one has a term of six years. The word “term” as it relates to these annuities is may be different than you are used to. It doesn’t mean that this annuity ends after six years. Instead, it means that once you reach six years, from that point on you can withdraw as much money as you might like without any penalty.

This second annuity has a seven year term. The idea is the same but now you must wait one year longer to reach the point when you can withdraw as much as you like without any penalty.

And, this third annuity has a ten year term so you have to wait even longer before the penalty period ends on this one.

As we look closer at each one of these annuities you will see that they each provide you with the ability to withdraw a certain amount without any penalty. So I don’t want you to think that there is no liquidity. Just that if you exceed these limits the penalties can be very severe.

Again, we will get into the details as we look closer at each of these annuities. But before we leave the topic of the term or period when penalties might apply, here is what is important to keep in mind about these different terms. The basic idea is that the longer the term, the more benefit that the product should be able to provide. If you don’t feel that you are getting any more value from an annuity with a ten year term then you probably would be better off with something where the term was shorter.

The value we are looking for with all three of these annuities is “secure growth”. This is different than the annuity that you already have, which in my mind is structured for lifetime income.

All three of these annuities do provide options for lifetime income, but if that was the objective I would not have shown you these specific annuities. Again, nothing is perfect. I would be great if I could find an annuity that provided superior lifetime income and superior growth potential. My job would be much easier. But there is no annuity that does a great job at both. Generally speaking, the stronger an annuity might be for lifetime income the weaker it will be for secure growth and vice versa. I have selected these three because I like them for secure growth.

All three, regardless of the term provide the same security or protection from market losses. So the major difference is the degree of potential each offers to capture as large a portion of the index gains as possible when the index is up.

Does that make sense?

Nancy seemed to understand so I continued by providing a fairly brief review of each product’s illustration. As experienced advisors know, most annuity illustrations will contain a series of projections based on different scenarios. One scenario is typically projections based on the annuity’s guaranteed values which assume zero growth. Then a second and third scenario is included in the same illustration which shows projections based on the performance of the index over some historical period. For example, one seven year term fixed index annuity that I like to use for secure growth provides an illustration that shows hypothetical rates of return based on the worst, best and most recent seven year period of index performance.

I showed Nancy the results for all three periods from each of the three annuity illustrations.

I again suggested that she consider that unless an annuity with a longer term provided something of value above what a shorter term annuity might provide, then there was little sense in tying up money for the longer period. Oftentimes products will be able to afford to provide the customer with a more generous crediting method structure when the term of the contract is longer. If so, that should at least start becoming apparent when we examine hypothetical projections found in the illustrations. In other words, the longer the term, the greater the potential for growth that should be present. If it is not present to a sufficient degree when the term of the contract is longer, then again what is the point of the client tying his or her money up for a longer term?

As I explained these and other things to Nancy I often referred back to our prior discussion of the advantages and disadvantageous of a direct investment in securities. The bottom line to the securities discussion is along the lines of “Investing in the stock market is great. But nothing is perfect. A primary strength of securities is that they provide a great potential for long-term growth. A primary weakness is that you must be prepared to endure volatility before you can realize the growth.”

I then suggest that the less comfortable people are with volatility, the more we might want to consider the alternative of an fixed index annuity for secure growth. The bottom line to the secure growth discussion is along the lines of “ fixed index annuities are great for secure growth. But nothing is perfect. A primary strength of fixed index annuities is that because they provide protection against stock market losses they eliminate the negative part of volatility. A primary weakness is that any gains are limited.”

Because I am encouraging Nancy to more or less view the hypothetical growth rates contained the illustrations as they relate to the term required by each contract, I believe that it is extremely important to also state the following:

Doug – It can appear that these hypothetical rates of growth are realistic because they are based on historical performance. You have heard the disclaimer that past history is not a representation of the future. And this is definitely true in the case of these annuities. I think it is important to take the highest historical numbers and bring them down by one or two percent or even more. Part of the reason that you are considering using an fixed index annuity for growth as opposed to a direct investment in the stock market is because you are concerned the market may not going to perform all that well in the future. And if that is the case, then we shouldn’t look at the highest hypothetical growth rates in these annuities as being realistic because in order for those rates to be achieved in the future, it would require that the stock market performs well. In other words, the more we believe that stocks will go up in the future, the more logical the choice to invest directly into stocks. That way you aren’t limiting your gains as you will with any indexed annuity. Remember, with these annuities you are trading some of the potential upside for protection against stocks going down in value. If we don’t think there will be this downside, then get all the upside by being in the market. But if I am understanding you correctly, you feel that the stock market might be in for a pretty rough ride going forward. And if that is your attitude, it is a mistake to look at the hypothetical growth rate in the FIA illustrations based on a past period of good performance in the stock market and assume that you will get those same rates going forward.

The point I am trying to make to Nancy is that some of these fixed index annuity illustrations can show some very attractive hypothetical rates of growth based on the assumption that the stock market index performs very well. But, it really isn’t logical or realistic to suggest to Nancy or any client who isn’t convinced that the stock market will perform well in the future, that an fixed index annuity can provide the really attractive growth rate that might be found in an illustration. The more attractive the rate in any illustration the better the stock market would have had to perform to deliver that rate.

Again, I believe that Nancy has an objective of growth for at least some portion of her money. And anytime the objective is growth I will often talk about the options of either a direct investment in securities or an fixed index annuity structure for secure growth during the same meeting.

I think it is very important to give my clients choices. When the objective is growth, some clients may choose securities. Some may choose an fixed index annuity. My typical recommendation is to use a combination of the two. I attempted to communicate this to Nancy by saying something like:

Doug - The reason for allocating a portion of your retirement funds to both is primarily because there is really no sure way know what will happen in the markets in the future. If we are wrong and instead of the markets declining, they go up. Then we win with a combination of fixed index annuities and securities because in a really strong market the securities might provide double-digit or better returns. Because the fixed index annuities place a limit on the up-side potential, we can expect they will never do as well in up markets. During those periods when everything appears to be going well, it is easy to start getting greedy and say darn it I wish I had everything in securities instead of these fixed index annuities. But if the markets are in for a rough road then the securities could be down by double-digits or more. Depending on the way the market moves, sometimes fixed index annuities can provide modest gains even when the result is the markets go down. Any such returns can offset the losses of our securities. Even if the markets go down so severely that the fixed index annuities provide no return, we likely will be very glad we choose to have some of our money allocated to them because we know that at worse they are protected from market losses.

After reviewing the three illustrations with Nancy I set the Vital Signs for each issuing insurance company on top of each illustration. I told Nancy that it was also important to consider the financial strength of each carrier. I then spend a few minutes and highlight each company’s ratings and surplus.

I spent a few minutes talking about the protections provided by the legal reserve system imposed on the insurance industry and provided reasons why I felt that any money that she might put into an annuity would be amply protected.

Nancy also said some things that gave me a strong indication that she liked the idea of limiting the amount of money she would have invested in the stock market and using the ten year term FIA I had presented for a larger portion of the money allocated for secure growth.

I told her this was valuable feedback because it would allow us to spend more time at our next meeting in digging deeper into those topics. However, I told her that I felt the most important thing we needed to address was how we were going to meet the primary objective of permanent retirement income. The obvious options were that she could either take a lifetime income from her pensions, or take the lump sum from the pensions and use this money to purchase additional annuities similar to the one with the income rider that she already owned.

I asked her to think about this between now and our next meeting and that I would also do some research in this direction to see which annuities might be best for that purpose in case that was the direction.

Last, and most importantly I gave Nancy another homework assignment. It was critical that we have as much detail as possible concerning her pension options. I asked her to contract the personnel office or whoever was in charge of employee benefits. They should be able to provide her with specific information concerning her options with each of the four pensions.

Nancy agreed to contact her employer do what she could to obtain this information before our next meeting.

#021meeting3

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dougwarrenclu-blog · 9 years ago

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Case Study 021: Second Meeting

Meeting Notes – Nancy and Chuck Nancy Age 66 Chuck Age 63

Second Meeting Preparation

I try to define my objectives for each meeting beforehand, because this will guide me as to how I need to prepare but more importantly it will force me to stay disciplined through the course of that meeting to limit my discussion to only the topics that will best advance me to accomplish my objective.

Early in my career I was guilty (and occasionally still am) of talking too much and about too many different things. People in our business are generally good communicators who enjoy talking. It can be surprisingly difficult for us to restrain ourselves in this regard. And it can make it even harder if we don’t have a clear understanding of precisely what we want to accomplish during each and every meeting we have with a client.

My primary objective for this second meeting with Nancy is to review her existing annuity. In addition I want to educate her on the topic of fixed indexed annuities with income riders because at this point I think that this could be a logical option for her to consider.

The way I educate clients on these products is generally the same, so I do not need a lot of preparation.

Because it will be important for me to review her current annuity I want to make sure she has located the contract. To this end I instructed my assistant Lynne that when she called to confirm our meeting she reminded Nancy that she need to have that contract available if at all possible.

And, with regards to Nancy’s existing annuity I know that I am going to want her to appoint me as the agent of record. I try very hard to do this with every prospective client I meet who has an existing annuity or life insurance policy. In fact, I make an even greater effort to do this with those prospective clients who decide not transact any business with me during our initial series of meetings.

Over the years this has benefited me greatly. I know that no matter how good of a job I might do when I first meet with a prospective client, that many people are not ready to do any transactions at that point in time. The mistake that many advisors make and one that I made early in my career is to assume that because someone didn’t transact business when during your initial meetings, it means that they will never transact business.

The reality is that nothing could be further from the truth when the advisor does a decent job during the initial meetings. Again, the time may not have been right for the prospective client at that moment.

Smart advisors will keep a record of all prospective clients they have dealt with in the past and continue to stay in touch with them in hopes that when the client is ready to make a change or transact some business, the advisor will be remembered.

But an even more powerful way to accomplish this is by becoming the agent of record on existing accounts. When this is done the client starts looking at the advisor as his or her agent and someone the client will contact with questions or advice concerning the policy. Better still, being appointed as the agent of record gives the advisor a great reason to contact the client periodically in order to do a review of the policy.

One of the smartest advisors I know once did close to $50 million dollars in personal production in a single year. If you ask him how he did such a mind-boggling amount of business, he will tell you that it was largely due to the fact that over prior years he had worked just as hard to get “control” of prospective client’s assets, as his effort to transact business at that particular time.

Normally I wait to discuss becoming the agent of record more towards the end of my series of initial meetings with a new client. With Nancy I think it is appropriate to try to do this at the second meeting.

Much of my reason for this timing is simply based on a feeling that I got from our first meeting from Nancy that she seemed very positive about me helping her. Asking her to decide to appoint me as the agent of record would be a small and easy step for her that could help cement our relationship.

In order to transfer the agent of record to a new agent, many insurance companies will accept a simple letter of instruction signed by the client.

I prepared this letter to bring with me to our next meeting.

Second Meeting

I met with Nancy at her home.

I was able to meet her husband Chuck, but he did not participate in the meeting because he was studying for a work related exam he had to soon take.

I always prefer to have both spouses involved when working with a married couple. To this end I chatted with Chuck for a few minutes and made an effort to get him to participate. He declined by saying that he really needed to study and that this was Nancy’s money and she didn’t need his help in deciding what to do with it.

What was interesting was that Nancy told me later that while Chuck was in the other room the entire time she and I met, he was listening closely to our conversation and evidentially told Nancy that he though I knew what I was talking about and encouraged her to take my advice.

As soon as Nancy and I sat down I could see that she had located her annuity contract and it was ready for my review.

But first, as I always do I started by asking Nancy if she had any questions or comments concerning our first meeting. She did not. I then briefly reviewed what we had discussed. I did this by saying something like the following:

Doug – Let’s start today’s meeting by taking a few minutes to review what we talked about last meeting and what struck me at least so far as what you are trying to accomplish. It will be very important that you let me know if I have any of this wrong, or you can say anything that will help me to better understand your objectives. Again, my job is to give my clients the best options for accomplishing their objectives. Until I am clear about your objectives, any options I propose likely won’t do you much good.

Your primary concern is that you will soon have to make a decision regarding what to do with your pensions. Your choices are to take a permanent lifetime income that will provide you with a monthly check for as long as you live and also provide Chuck with a smaller income for the rest of his life if he outlives you, or you can take a lump sum amount. You like the idea of the permanent income if you take the first option but the big disadvantageous you see is that once you take this income the lump sum amount more or less is gone. You like the idea of taking the lump sum, in part, because it could one day become a substantial inheritance that you could leave your granddaughters. One of the disadvantages if you do take a lump sum is you then would have to figure out how to invest it, and you are at least somewhat fearful of the volatility of the stock market because of what happened in 2008 with the financial crisis.

Is that a fairly accurate summary?

Nancy – Yes very accurate.

Doug – Good. Is there anything you can add to help me better understand your objectives?

Nancy – Not really. But I have thought about what we talked about and I am starting to think that really don’t want to take the pension income. I think I should take the lump sum.

Doug – Ok. What is making you feel that way?

Nancy – I am pretty sure that if I don’t take the lump sum at some point I will really regret it. I thought more about what you said about doing things like taking my granddaughters on a cruise. I really want to do those kinds of things. If I give up the $500,000 lump sum then I am afraid it will be harder to do.

Doug – I understand. And I never try to encourage clients from using their money to do the things that are really important to them. But, I think that it might be good for you to not make in decisions right away and keep an open mind to any options that we might come up with. You and I are still early in the process of working through this so it is hard to know what might be best.

Are you ok with that?

Nancy – Of course.

Before continuing it might be helpful to the reader to address the benefits of starting each meeting with I summary like I did with Nancy.

The advisor’s ability to provide an accurate summary of a prior meeting will depend on doing two things. First, the advisor has to carefully listen to what the client says during that meeting. Listening is a skill that is gained by conscious effort. Like a lot of advisors, I was not very good at it during the early part of my career but even though I am now much better at it, it’s something that I still must consistently remind myself to do during just about every meeting. The second thing that the advisor must do is get in the habit of taking good notes both during and after each meeting.

When I do joint work with advisors they are consistently amazed at the level of detail that I put in my notes. It is not unusual for me to have several pages of typed notes covering the details of each client meeting. During the actual meeting I am only noting the important items but I usually end each work day at home or in my office adding volumes of detail while it is still somewhat fresh in my mind.

I have found that if I wait even a day or two to do this I run the risk of forgetting a lot.

I can then refer to my detailed notes prior to the next meeting so that I have a very clear idea of what I have done and what I still need to accomplish with this client.

And there are even greater benefits to being able to accurately summarize a review of the prior meeting to a client. It makes them feel that you are really listening to them and that you take their concerns very seriously. This can’t help but to give the client confidence that you will help them.

I can’t over stress how important this is.

After my review I took a closer look at Nancy’s annuity. It was a fixed indexed annuity contract with an income rider that I was very familiar with and had even recommended the same to some of my clients.

I complimented Nancy on making a good choice and asked her how well she undertood her annuity.

She said she really didn’t know very much about it.

This put me in a position that I really like to find myself in. I can explain her annuity to her and since it is similar to what I might ultimately recommend that she purchase as an option to meet her objectives, I will at the same time be providing a general explanation of a new annuity.

Anytime I have a client who already owns an annuity that I think does a good job in meeting that client’s objectives, I almost always take the same approach. I explain their current annuity in depth before I propose any new annuity.

If instead I ignored their current annuity, or worse if I told them their current annuity was bad because I wanted to replace it, in my view I am making a mistake that I see many advisors making.

Think about a situation where an advisor criticizes a client’s current annuity solely because the advisor wants to replace that annuity to earn a commission. Aside from the fact that it could be unethical or even worse, it isn’t very smart. Remember, when the client purchased the original annuity the salesperson told him it was great. Now a new salesperson is in effect saying the original salesperson was either ignorant or he lied when he said the original annuity was so good. And that new salesperson is telling the client to switch to a new annuity that is great. How does the client know that the new salesperson isn’t ignorant or lying as well?

I am not trying to suggest that there aren’t valid reasons for replacing one annuity with another. Clearly, there are times when it is in the client’s best interest to do so. Only that It is a weak strategy to view every existing product as an opportunity for replacement and to approach it by always bad-mouthing what a client got from another advisor.

Again, in this case I feel that the annuity Nancy has is a good one for her especially if she bought it for the purpose of permanent income that I know this product excels in providing.

As I pointed out a few things about this annuity it became clear to me that the original advisor who recommended it focused primarily on how it would protect Nancy from stock market losses. And this was attractive to her because again, at the time she purchased it she had just lost a lot of money due to the financial crises.

She did have a recollection about how the annuity would provide her future income but was very vague on the details.

To provide Nancy with a quick education on how indexed annuities with income rider work I used a different section of the same fixed index annuity software that I had used during our first meeting.

My explanation pretty much followed the script that you will find in this software’s user guide but I did modify it to better relate to Nancy’s circumstances.

I started by saying that the advisor who recommended this annuity was absolutely correct that the money you put in would be protected from stock market losses. But did he explain or do you still understand how this is accomplished?

Nancy – Not really.

That’s ok, the general idea is fairly simple. Let’s say that this black line represents the stock market. It goes up and down like the stock market does.

With the stocks that you owned in 2008, when they went up in value, you went right along with them, mean your portfolio balanced increased. And, as you know, when they sent down, the value of your portfolio went down right along with them as well.

This is what we expect to happen when we are “directly” invested in the stock market.

But with your annuity, your money is never in the stock market. Instead the insurance company uses a method to link to a stock market index in a way that allows you the annuity to be credited with a portion of any gains. In your case, your annuity is linked to the S&P 500 Index.

(Click button #1) Because of the way they do this, when the index goes up, instead of realizing all of the gains, you only are credited with a portion of the gains.

(Click button #2) In exchange for limiting the gains, you don’t suffer any market losses during the inevitable periods when the index goes down.

It is exactly because of this that the advisor recommending this annuity was able to assure you that your annuity’s accumulated value would never decline because the stock market dropped.

(Click button #3) When the index is up, you are credited with a portion of the gains.

(Click button #4) When the index goes down, those prior gains are protected from market volatility.

(Click button #5) Index goes up, you get part.

(Click button #6) Index goes down, you are protected.

(Click button #7) This is kind of like walking up a set of stairs, where once you reach one level you can’t go down because of market losses.

(Click button #8) Because of the kind of annuity it is, your annuity is very effective at eliminating market volatility but it’s not perfect. Like everything, it has its own set of strengths and weakness.

(Click button #9) First, the insurance companies need time to make this work. That is why your annuity, like all annuities, would charge you a pretty stiff penalty if you decided to take all of your money out before you had completed an initial ten year period. Different annuities have different periods where a penalty will apply but all are fairly long-term and the ten years with your annuity is not out of the ordinary.

(Click button #10) But one advantage of your annuity, like many annuities, you can withdraw up to 10% each year without a penalty. You only pay a penalty if you withdraw more than 10% and only if that withdrawal occurs in the first ten years of the contract.

Clear so far?

Nancy – Yes.

(Click button #11) We have already talked about the fact that you aren’t going to get all of the gains when the stock market really goes up. You are, in effect, accepting a limit on any gains in exchange for protection from market losses.

(Click button #12) And your annuity like most annuities that have an income rider, which I will explain in a minute, has an annual fee. The fee you are paying is 1.05 percent. This is in line with what you will pay with many good annuities.

I then used the pull down menu at the top to advance to the next section.

Again, I am taking the opportunity of using Nancy’s annuity contract to educate her on how FIA’s with income riders work. Because of this I want to modify my presentation to better fit her existing contract. Since she purchased her contract with a $50,000 premium, that is the premium I want to use in my example. So I enter $50,000 in the in-put field at the top left of the screen.

Doug - A major strength of your annuity and any annuity in my option, is that it is the only financial instrument where the insurance company makes a guarantee that income will continue for life. And where this guarantee is backed by the full ability of that company to pay their claims.

The kind of annuity that you have has two parts. Maybe it helps to think of it as a double-sided coin. You have a guarantee (from the issuing company) of permanent income on one side of the coin, and you have something that is typically referred to as “accumulation value” on the other.

It is important to keep these two parts separate and not confuse one for the other.

The accumulated value is the side to focus on when you want to know how much you will get if you quit (surrender your annuity) after the end of this contract’s initial ten year term.

But what I believe will be more important to you is that whatever remains in your annuity’s accumulated value is what your granddaughters will get when you die.

It is important to understand that neither you nor your granddaughters will ever get the “Income Base”. This amount is never paid to your beneficiary if you die nor is it a value you can ever receive if you cancel the contract. So the question is, what is the purpose of the income base? It only has one, which is to calculate the amount of the permanent income that the FIA will provide if and when you activate the lifetime income feature.

And you are at a point with this contract that you can activate your lifetime income at any time you want. You could do it now, next year or anytime.

(Click button #1) Since you haven’t yet activated the lifetime income feature, an important question is, how each side can potentially grow over time?

(Click button #2) Let’s start with the Accumulation Value side. As I mentioned earlier, your gains are linked to the performance of a stock market index. When the index goes up you get a portion of the gains. When the index goes down there are no market losses.

Because potential gains are linked to the performance of a stock market index, no one can tell you the amount of growth that might occur in the future because no one knows how the index will perform in the future.

The only thing we know for sure is that the accumulation value will not be impacted in a negatively if the index goes down in value, you just won’t be credited with any gain.

As I mentioned, your annuity does have a fee of 1.05 percent. That is 1.05% of the value of the income base. This is in line with similar annuities that provide a guaranteed lifetime income. This fee is deducted from the accumulation value annually. This means that you will see your accumulated value go down in any year where there are no gains credited. And this is due to the fee.

(Click button #3)

Again, during my presentation I am trying to use Nancy’s annuity as an example. I know that her contract has a rollup rate of 7 percent for the first ten years. So I change the in-put field in the top-left section of the screen to 7 percent.

Doug - While the growth in accumulation value side is not predictable, the income base side of your annuity is very predictable. During the period while you are waiting to activate the lifetime income feature, your annuity’s income base will grow by a guaranteed rate of 7 percent during the first ten years.

Nancy – Wow!

Doug – Yes, that is a great rollup rate. You did a great job when you decided to purchase this annuity.

Also, what is great is that this 7 percent for ten years is written in the terms of your contract and can’t be changed by the insurance company.

At this point I picked up her contract and showed her the page which specified the rollup rate. I did this because I wanted her to know that we were talking about contractual guarantees in the event that at some point I would be suggesting the option of her purchasing another FIA with an income rider. Again, I am using the power of explaining her existing contract to showcase the value of possibly purchasing another.

Doug – Because we know the amount you initially put into this annuity ($50,000) and we know the amount of the rollup rate (7 percent), it is easy to calculate the growth of the income base.

But, you also received another benefit when you started this annuity which will make this value even greater. Do you remember your agent talking about a bonus?

Nancy – Yes, I do.

Doug – At the time you purchased your annuity the insurance company was crediting an 8 percent bonus. That means that you added $50,000 and they added $4,000.

At this point I changed the input field at the top-left of the screen from the $50,000 that I had originally entered to $54,000.

Doug – This bonus was added both to the accumulated value side and the income base side. Which has meant that you not only had a guaranteed compound growth rate of 7 percent on your income base but that rate was applied to a much larger starting amount of $54,000.

Because of this, after just five years, because of this growth, your income base should be about $75,738.

I would need to see your most recent statement to know for sure what the actual values are of your income base and the contract’s current accumulation value.

Do you have a copy of your last statement?

Nancy – If I do, I don’t know where it is.

Doug – That is ok for now. We can always check directly with the insurance company. But this brings up something we should talk about before continuing.

I believe that you told me that you were living in Texas when you purchased this annuity and you haven’t spoken to the agent since that time. Is that correct?

Nancy – That’s right.

Doug – It is really important that you have someone assigned to this contract that can stay on top of things and keep you informed of things that you really should be doing on a regular basis.

For example, we have talked about how any growth in the accumulated value is linked to the performance of S&P 500. But it is actually more complicated than that. You have several choices as to exactly how the gains are calculated. More importantly, each year you have the ability to change from one calculation option to another.

It is the job of your agent to help you with this and to keep on top of this. In your case this is very important because it is the remaining accumulation value that will go to your granddaughters at your death.

Nancy – I wouldn’t even know how to get in touch with the agent.

Doug – Even if you could I am not sure that would be the best idea because he is so far away. You actually have the right to change what is referred to as the “agent of record” on your annuity. You can appoint just about anyone as long as they have the proper license. This is a service I provide many of my customers who purchased an annuity from an agent who is no longer active in the business or who now lives too far away.

Nancy – You mean I could make you my agent on this annuity?

Doug - Yes. As a matter of fact I have done a lot of business with this company and I am very familiar with their products.

This is something we can talk more about later. For now, there is a lot more you need to understand about your annuity.

Let’s talk more about activating the lifetime income.

Doug - For example, assume you are ready to start your permanent income after five years, if the rollup rate was 7 percent, the income base would have grown to $75,738.

To determine your lifetime income amount, we need to know what the withdrawal percentage is. We can find this in the contract.

At this point I picked up Nancy’s contract and turned to the page containing the table of withdrawal percentages. I showed Nancy that in her case the percentage would be 4.25 percent. Then I used the up arrow in the green withdrawal percentage input field to change the rate to 4.25 percent.

Doug - The insurance company takes the income base of $75,738 and multiples it by 4.25 percent to determine the income about of $3,219. And as long as you never exceed this withdrawal, the insurance company guarantees the income will continue in this amount for the rest of your life, no matter how long you live.

Just remember that the sole purpose of the income base is to determine the amount of your lifetime income. It is not what will pass to your granddaughters when you die.

They get only the amount remaining on the accumulation value side.

And we have no idea how much this will be in the future because we have no way of knowing the amount of growth. That will be based on the performance of the index.

If you had your last annual statement we could see exactly what your accumulated value was as of that date. But again, we can find that out later.

For the purpose of this explanation, let’s just assume that your income base after five years was a hypothetical amount of $63,000. Again, this is not a guess or an estimate, we are just using this number as an example. And further, assume the accumulated value after three years was $319,000. Again this is an entirely hypothetical example.

Note that the program will automatically calculate an accumulation value that is approximately 50% less than any increase in the income base. The software does not allow you to change this. Again, you are only trying to provide an example.

(Click button #4)

Doug - It might help to think of this $63,000 of accumulation value as a bucket of money.

(Click button #5) It is also very important to understand that any withdrawals, including your lifetime income withdrawals will come out of this bucket. Plus, the fee that is charged will also be deducted every year from the amount that is in this bucket.

Any potential gains that are credited linked to the performance of the index will continue to be added to this bucket.

This means that after you start taking withdrawals of income, there will be money flowing out of this bucket (to cover those withdrawals and any fees) as well as the possibility of money flowing into the bucket due to the performance of the stock market index and the crediting method you have chosen.

Again, your annuity provides you with different options as to how any potential gains are calculated when the index goes up. And you can change the option used each year if you like.

That’s why I think it is a good idea to set me up as your agent so that I can help you stay on top of this. If we do a good job there might be the possibility of a little more money eventually passing to your granddaughters at your death.

But because I mentioned the possibility of money passing to your heirs, it is important to explain something about this annuity.

I have told you that I think you made a great choice by purchasing it. But that opinion is based on one important assumption. And that is that your objective when you purchased it was to get a lifetime income. As long as that is what you were trying to accomplish, this annuity will do a great job. But it is not perfect. It can’t do a great job for accomplishing every objective. Nothing can. So what are the weaknesses? Or, I should say what doesn’t it do such a great job of accomplishing?

I do not view it as a great growth vehicle. There are other financial instruments that can do a better job of that. Including other annuities that in my view are designed to perform better when the objective is growth but where you also want protection from stock market losses.

And, what may be even more important in your case is that I don’t think your annuity is a great choice when the objective is leaving an inheritance. Again, there are other instruments, including other annuities that I believe can do a much better job at that.

However, products designed more for growth and leaving an inheritance certainly aren’t perfect either. Typically, their weakness is that they likely wouldn’t do as good of a job as your annuity when it comes to the objective of providing a lifetime income.

This should only make sense. It would be too much to expect that any instrument could both provide you with a lot of income over your lifetime and also provide a big inheritance to your granddaughters at your death.

Does that make sense?

Nancy – Yes. But are you saying that when I die there won’t be anything left in my annuity?

Doug – Not necessarily. What I am saying is that the longer you might live, the less I would expect would remain.

Actually, when it comes to how much might remain at your death, there are really only three possibilities.

I use the pull down menu at the top-left of the screen to advance to the next section.

Doug - Again, what happens to the accumulated value balance in the future will depend on the potential flow of money going into the bucket and the flow coming out.

(Click button #1) The first possibility is that the index could perform in such a way that more money flows in than what flows out from any withdrawals taken for income and to cover any fees. If this consistently happens then over time the accumulated value would grow.

While possible, this is extremely unlikely. Remember, the accumulation value in your annuity provides the potential of being credited with only a portion of the gains when the index goes up.

This means that the growth potential is limited. This annuity was designed to provide a lot of lifetime income so you have a situation where what is flowing into the bucket is limited while what is flowing out of the bucket is a relatively large amount.

(Click button #2) A second possibility is that the gains credited to your annuity’s accumulated value roughly match any withdrawals taken for income and to cover any fees. If this consistently happened, then over time the cash value would stay approximately the same.

While this is also a possibility, I think it is best to expect that this is unlikely as well.

(Click button #3) A much more realistic expectation is that the gains credited, on average, will be less than what is withdrawn. If this consistently happens, then over time the accumulated value would decline. And if you live long enough, you could reach a day when there would not be any accumulated value remaining.

This is why it is so important to know what you really want to accomplish. If it is to preserve money to pass to your granddaughter this annuity might be not so good for that purpose because if you die with no accumulated value, those heirs would get nothing. However, if the objective is lifetime income this annuity works great for one extremely important reason.

(Click button #4) The way your annuity works is that even if you live so long that all of the accumulated value has been drained out, this will have no impact on the continuation of your lifetime income.

You have a contractual guarantee from this insurance company that as long as you don’t exceed the set amount of lifetime income withdrawals, that those payments will continue to you for as long as you live.

That is great for you as long as your objective was income. But not so great for your granddaughters if your objective is instead to preserve this money for them.

Nancy – I understand but now I don’t know what I should do because I know I will need income but I do want to leave something for my granddaughters.

Doug - I don’t think you need to worry about it because I do think that if you plan right you might be able to do both. The key is to properly allocate your resources.

Doug – Remember that at our last meeting we talked about the right way to allocate? The first thing to do is make sure you have an emergency reserve that is always kept in some liquid account. Then we take what is left and use it to fill in gaps between the targeted amount of income we need or want. And then, once we know that we have our income needs met we have the freedom to take whatever remains and allocate those assets for growth so that we can accomplish other objectives.

My point is that I think you have enough resources to provide yourself with the income you’ll need with enough left that we can try to grow so that it can provide for any other objectives. Which for you, would be to leave money to your granddaughters.

I think this annuity is great for providing some of the permanent income you’ll need. With that, your Social Security and possibly taking lifetime income from one or two of your pensions, my guess is you’ll have the income you want, or close to it.

That leaves the other pensions that you could take as a lump-sum payout and allocate that money along with your 401k to accomplish the objective of growth.

If this money does grow you can use it if you might need to because of inflation. Or perhaps you could use some of it to take those vacations with your granddaughter that you told me you have dreamed about.

Then after you have passed away, if there is any money left, you can leave it to your granddaughters.

Nancy – I really like this.

Doug – I think we can make it work but there is a lot left to do before I will know for sure.

We have covered a lot this meeting and I think we should bring it to a close.

At this point I think the best thing for us to do is set another meeting to continue the education process. Next meeting I want to talk more about the stock market, certain annuities and options for that portion of your funds that might be allocated to achieve growth as opposed to lifetime income.

I also want to give you some homework to do before we meet again. First, I need you to get statements from the Social Security website showing the monthly retirement income amounts for both you and Chuck.

I made sure that Nancy new how to do this and told her that if she had any questions or problems that she could phone my assistant Lynn who would walk her through the process.

Doug – Second, I want you and Chuck to sit down and together and complete this budget worksheet.

Doug - It will be important for us to be really clear about the amount of income you will need after you retire because the whole key to any recommendations I make will be contingent on our ability to set the right income target. Having an accurate idea of your expenses today is critical.

When you do this, I don’t want you to try to figure out how your expenses might reduce after you retire. I can help you with this after I see what you are spending today.

And, don’t think that you need to have every expense down to the penny. Really all we need is a rough estimate. If it takes you longer than 45 minutes then you are trying to get too detailed.

It is fairly typical that I will ask new clients to provide me with information concerning their expenses. Depending on the client and circumstances, often I will ask for only a rough estimate of a total amount as opposed to asking the client to break down each expense as is reflected in the above form. In Nancy’s case I am asking for more detail because in the prior meetings she as given me the impression that she thinks her income needs at retirement will be around $5,000 per month. I am a little concerned that this figure might be low because of the high cost of living in California.

In my experience, people hate going through this process of listing expenses which is why I made the point to Nancy that she only needs to provide estimates and it shouldn’t take longer than 45 minutes.

Nancy promised that she would do this homework so we ended by scheduling the date for our next meeting.

I tried to set a time when Chuck could participate but because of his work schedule the only time we could do this is in the evening. Over the years I have had many evening appointments but at this stage of my career I rarely do anymore so I made the decision to meet with Nancy alone at the hospital where she works.

Second Meeting Observations and Comments

Nancy did sign the letter that I had prepared to have me appointed as the agent of record on her current annuity.

Regardless of what I said to Nancy at the close of the meeting about possibly taking a lifetime income from some of her pensions and a lump sum for the others, I am still not sure what I will ultimately propose to her.

It is apparent that she has a strong desire to preserve money that she can pass on to her granddaughters. This objective might argue against taken a lifetime income from any of her pensions.

Again, at this point I am not sure as to the best direction to take.

-END Second Meeting-

#021meeting2

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dougwarrenclu-blog · 9 years ago

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Case Study 021: First Meeting

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Meeting Notes – Nancy and Chuck Nancy Age 66 Chuck Age 63

First Meeting - Met with Nancy at her place of employment.

Nancy is a nurse who will be retiring in four months. She has one daughter and four granddaughters. She recently married her second husband Chuck. They keep all of their finances separate. (My feeling was that Chuck did not have that much in the way of savings.)

In 2006, she believed that she was in fairly good shape financially. She and her first husband had a home with over $500,000 of equity and a second piece of rental property that they had purchased as an investment. They both had well-paying jobs. Nancy worked for a hospital that provided a pension and her husband had accumulated about $300,000 in his 401k plan. With approximately ten years of work before they were planning to retire, their plan was to max-out their 401k contributions and make extra payments on their home mortgage and the mortgage on the rental property with the goal of having both balances paid in full by retirement.

At the time their daughter was living in Texas and she and her husband had just started a family.

Nancy and her first husband had also considered that when they retired they might sell both their home and rental property and move to Texas to be closer to their daughter and because the cost of living would be considerably less than in California.

An unfortunate series of events changed those plans and eroded the finances. First, Nancy’s husband passed away unexpectedly. Soon after Nancy decided to quit her job, sell the properties and move to Texas.

She purchased a smaller home near her daughter’s family. Her intention was to find a nursing job in Texas but at that time her son-in-law was starting a new business. Nancy decided to go to work for him and to invest some of the proceeds from the sale of the properties and her deceased husband’s 401k in to this new business venture.

After a few years the business failed, Nancy lost quite a bit of her money and her daughter and son-in-law got divorced.

Then in the midst of the 2008 / 2009 financial crisis, both Nancy and her daughter decided to move back to California. Nancy took a loss when she sold her Texas home and another substantial loss on stocks that she had invested a large portion of her remaining savings.

Nancy is very resilient and by the time of our first meeting she had put much of this past turmoil behind her. She also had got her job back with the hospital she had worked for before she left and was able to get a certain amount of pension credit due to her past employment.

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All of this helps establish my credibility, which is one of the most important objectives for the advisor during the first meeting. It has taken me a long time and a lot of hard work to become established this way. And for the majority of years in my career I did not have this advantage but I was still able to gain a degree of success. My point is, that any reader who is committed to this profession should start now to find ways to add to their resume and build their credibility. Someday it can pay off enormously.

Nancy answered as follows:

“I will retire in a few months. The hospital retirement plan allows me to choose to either take a pension income that would be paid to me for the rest of my life or I can take a lump sum. I am trying to decide which would be the best choice.”

Doug – I see. Over the years I have worked with quite a few people faced with having to make the same choice. I know it can be a difficult decision.

Nancy – I am worried I will make the wrong choice and then spend the rest of my life regretting it.

Doug – Have you received all of the information you need to make the decision? I mean do you know what the amount of the income is if you take the pension or the lump sum amount if you don’t?

Nancy – I have a general idea as to the amounts but I have to wait until I complete the separation paperwork to know for sure.

Doug – Well, if you like we can have a general conversation today based on what you know now and then if we decide to work together we would have more specific discussions.

Nancy – Can I ask you how much you charge?

Doug – I hate to answer your question this way but it really depends on what I am dealing with and we would need to talk more before I can give you a better answer. But there isn’t any charge for us to have a general conversation today. And by the end of that conversation I promise you I will give you a better answer to your question. Is that fair?

Nancy – Yes.

Doug – Before we talk about the dollar amounts involved with your two choices, I am sure that you have already given this some thought. Could we spend a few minutes and talk little about what you are thinking so far?

Nancy – Well, I like the idea of taking the pension but my understanding is that once I do I can never take the lump sum amount. The lump sum buyout should be close to $500,000. I am not sure if I want to give up all of that money.

Doug – Why would it be important to hold on to that money? I mean what would you do if you didn’t take the pension and instead received this money?

Nancy – I guess I would invest it.

Doug – Do you know where?

Nancy – Probably the stock market. I am not sure.

Doug – Do you own stocks now or have you in the past?

Nancy – Not now but I used to.

This is when she then told me the details about her first husband dying, moving to Texas and losing a lot of money.

Doug – The stocks you owned in the past, did you select them yourself or did you work with an advisor?

Nancy – I picked them. But given what happened, I am not sure I did such a good job.

Doug – Well, I don’t think you can base much on what happened in 2008 and 2009 because most stocks didn’t do well.

But I think what is important as it relates to the decision you have to make is if you would be comfortable taking the lump sum payout and investing it in the stock market? No one knows if we will ever see a repeat of how bad things were during that financial crisis but it is pretty safe to say that the stock market will always go both up and down in the future.

Let me ask you to really try to imagine something. Let’s say you took a $400,000 lump sum payout, you put it in the stock market and a year later your stocks were only worth $320,000?

Nancy – I would feel pretty bad.

Doug – That would represent a 20 percent drop, which is the typical definition of what is often called a bear market. Now we haven’t had one since 2008 but on average a bear market happens about every five years.

I am not saying this because I don’t think you should put money in the stock market. Instead I am only saying that if you do, you have to be prepared for this kind of volatility. As you probably know the drop in 2008 was much, much worse.

Nancy – I know. And that is part of the problem. I really don’t know where would be the best place to invest the money if I did take the lump sum. Where do you think?

Doug – I get asked that question all of the time. And I always answer it the same way. You have to first tell me as specifically as you can what you are trying to accomplish before I can tell you the best way to accomplish it.

Everyone is searching for the “best” product or investment. But there is no such thing. Different products are good for doing certain things. But they are bad when it comes to doing other things.

For example, I am a big believer in the stock market. I think stocks are great but my view is that they are great when the objective is growth. I am not so sure how great they are when people have other objectives like income. The one thing I know for sure is that they aren’t perfect. Because nothing is. Every product or investment that you or I or anyone else has it’s own set of strengths and weaknesses.

People typically look at investing or picking the right products for their retirement planning as being really complicated. My view is that it doesn’t need to be. The key is to really spend some time thinking about exactly what you are trying to accomplish, then it becomes easier to look at the strengths and weakness in all the choices and pick the ones with strengths that match up well with your objectives.

Does that make sense?

Nancy – Yes it does.

Doug – Good. But I will tell you that people typically find that it isn’t so easy trying to figure out what they want to accomplish. This is because we all want our money to do a lot of different things. It would be easy if we only had one objective but it’s more typical to have multiple objectives.

What I mean is that let’s say I want you to make a list of all of the things that you would want to find in the perfect investment for the $400,000 from your pension. What would you put on that list? We talked about stocks and how they can be great for growth so would you put “growth” on your list?

Nancy – Sure, I want the money to grow.

Doug – Yes, everyone does. What else would be on the list? What about liquidity? Would you want an investment that allowed you to take the money out if you needed it without any penalty?

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Nancy – Yes.

Doug – What else?

Nancy – Well, I would need income.

Doug – OK. We would put income on the list. What else?

Nancy – I am not sure.

Doug – How about safety or protection from losses? Some investment would start sounding almost perfect if you could get unlimited growth potential but where the money was safe, it generated income and was totally liquid so that you could take as much money out as you might need at any time. Right?

Nancy - Yes, that would be great.

Doug – We’re not done. Remember, we are creating a list of all the things we would want in an investment so we can put anything on the list. What about tax advantages? What if this same investment was tax free?

Nancy - That would also be great.

Doug – Of course, there is just one problem. Do you know what it is?

Nancy – I don’t think anything like that exists.

Doug – You’re right. While it is easy to come up with a list of things that would make a product or investment perfect. No product or investment will have each and every one of the things on our list.

But doesn’t it make sense that some products or investments might have more of the things on the list then others? And when it comes right down to it some of the things on the list really aren’t nearly as important as other things.

So it all comes back to defining your objectives. The clearer we are on that the better position I will be in to suggest options that will best accomplish those objectives. But I will tell you right now that I will never come up with the perfect option because one doesn’t exist.

Let me explain how I work with my clients and how I view my role.

Most of my clients are fairly intelligent people. They don’t need me to tell them what to do when it comes to their retirement planning. Instead what they need is for someone who is knowledgeable to tell them their options. And because nothing is perfect, to tell them both the strengths and weakness of each option. That is exactly how I work. I help a client really figure out what they are trying to accomplish, then I present every option that I think makes sense, tell them the strengths and weakness of each and let them decide what is best for them.

Does that make sense?

Nancy – Yes. It makes a lot of sense.

Doug – Great. Let me ask you a question then. If instead of a lump sum you could take a pension and receive an income for the rest of your life. How does knowing that you would have a source of income guaranteed for as long as you live rank in terms of your objectives?

Nancy – It is important. This is why I keep going back and forth with trying to decide what I should do.

Doug – No, I get it. It isn’t easy. What is the amount of income if you take the pension income?

Nancy – I have been told that it will be about $2,900 a month and when I die that Chuck would get 75 percent of that.

There is one other thing that I should mention. I actually have four different pensions and the $2,900 would be the income from all four.

Doug – You mean four pensions from this same hospital?

Nancy – Yes. I don’t really understand all of the details but it has to with some changes over the years with the hospital. It was affiliated with one group of hospitals and that changed to another group and then because I left employment in 2006 and then came back later it all ended up where I have four different pensions.

Doug – Do you know if this means that you might be able to take a lump sum from one or more and also take the pension income from the others?

Nancy – Yes. I am almost positive I can do that.

Doug – That will be important for us to explore, but for now I think it is best for us to just continue to talk about your objectives in general terms.

Basically the choice is that you can take a lump sum of $500,000 or an income of $2,900.

I think the first thing to consider is how much income you will need when you retire and any other sources of income you might have.

Have you ever heard of the term “asset allocation”?

Nancy – Yes but I really don’t know what it means.

Doug – Usually it is used in the context of what is the appropriate mix of investments to achieve certain objectives consistent with a certain level of risk. The actual definition isn’t important here. I mentioned it only because it is my view that there is another way to look at asset allocation when someone is preparing for retirement and trying to make the decision you are facing with regards to your pensions.

At this point I launched the fixed index annuity software tool that is included with your premium membership at AdvisorGrid.com. I often use this tool to go through an entire annuity presentation with a client, but I also often use only parts of the software when it is more appropriate to communicate a single concept. For Nancy, there is a concept that I think is very important for her to understand before we go any further.

I can quickly communicate this concept by using the pull-down menu at the top-left of the screen to navigate to the “Allocations” section of the software. Then I pretty much said the following to explain the concept to Nancy.

Doug – Because you are getting ready to retire you have to decide on the best way to allocate all of your resources, including your pensions to accomplish your objectives.

(I click the first button at the top.)

When I help people with this, the first thing I want them to make certain of is that they allocate or set aside enough money in some highly liquid account so that it will always be available in case it is needed for some unexpected event or emergency.

This is important because it does little good to structure a really good long term retirement plan buy end up having to undo everything because your roof blew off your house and you need money to replace it.

I typically suggest that allocating six to 12 months of your monthly expenses for the purpose of liquidity. And with regards to where to put this money, we have to first consider what the objective is for this money. Since the primary objective is liquidity it should be deposited in a short-term bank account or perhaps a money market fund. These instruments won’t provide much growth. But growth isn’t the objective for this money, it’s liquidity.

Does that make sense?

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Nancy – Yes but I am not sure what a money market fund is.

Doug – I promise you we will get to that at the appropriate time. I will layout all of your options and explain the advantages and disadvantages of each. But for now I think it’s best to keep our conversation general.

Are you ok with that?

Nancy – Of course.

(I click the second gray button at the top.)

Doug – Once we have an emergency fund established, the next objective is to allocate the remaining resources for the purpose of income. It is my view that permanent income is perhaps the single most important objective for retirement. It is very difficult to enjoy yourself and feel secure if you don’t have a secure source of income.

We don’t really need to get in the details of your situation right now, but for the purpose of this example do you have any idea as to the amount of monthly income you will need or want after you retire?

Nancy – I really don’t know. That is something that I have wanted to spend some time and figure out.

Doug – I know. It isn’t easy. I might be able to help you with that but for the purpose of this conversation it really isn’t important for now.

(I enter $5,000 in the field at the top-right portion of the screen.)

Let’s say that for planning purposes we identify a target amount of income that is desired of $5,000 a month.

This is the goal or objective. And it is such an important objective, that my view is that you want to allocate all of the resources you can to meet this objective. If you didn’t have any resources to allocate there would be a gap of $5,000 between what you have and what you need?

Fortunately you do have resources.

Is it correct for me to assume that both you and Chuck are eligible for Social Security retirement benefits?

Nancy – We went online and checked about a year ago and it was about $1,600 for me and I think Chuck’s was a little less but I don’t remember the exact number.

Doug – Do you remember if those amounts were if you started collecting at age 66 or earlier?

Nancy – Mine was at age 66. I don’t remember with Chuck but he is planning on working until he is 65 or 66 so I think his income was based on that.

Doug – That’s close enough for now.

(I enter $3,000 in the Social Security field at the top-right of the screen.)

Doug – Let’s assume that your total Social Security is $3,000. That cuts the gap to only $2,000.

And, we know that you have the option of a pension, which will reduce it further. How about Chuck? Will he have a pension?

Nancy – No. But he is contributing to a 401k at work so he has that. And I also have a small 401k plan at work. So we can get income from those.

Doug – Yes, you could get income from the 401k plans but let’s talk about something that I think is very important for you to consider. And that is the difference between “permanent” income and “maybe” income.

I put income from things like Social Security, pensions and annuities as being permanent income because they provide guarantees that your income checks will come month after month for as long as you live.

Income from most things, like 401ks and IRAs, generally speaking, is less certain. Unless the 401k is rolled over to an IRA and then funded with an annuity, there is no assurance that the income will continue for as long you live.

When allocating for income I ask my clients to carefully consider if they want to base their retirement on permanent income or if they are ok with basing it on maybe income.

Does that make sense?

Nancy – Yes. Also, I forgot to tell you that I have an annuity.

Good – I think that is great because that is just another resource you have that you can count on to provide permanent income.

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Let me ask you, when you do annual reviews with the advisor you worked with to get this annuity what was the most recent figure he or she gave regarding the amount of income you would receive from this annuity?

It is important to break here from the conversation with Nancy and explain why I asked this question in this way. First, anytime I am dealing with a prospective client who has an annuity, I know that at one time or another there was an advisor or agent involved. So one thing I want to try to figure out right away is how close of a relationship the client currently has with the advisor. Second, in the event that I am meeting with a prospective client who has an active relationship with another advisor I may find myself competing for this client.

The way that most advisors compete is by attacking the other advisor. I learned a long time ago that if you are not careful, the more you attack a client’s current advisor the more the client will defend that advisor. Think of it this way, the client made a decision to work with the other advisor. If I attack the other advisor I am also attacking the client’s decision.

There is an old saying in this business that it is a mistake to call someone’s baby ugly. Meaning you might be right but it certainly won’t get you anywhere.

A better approach to competing with another advisor is to say things in such a way that it isn’t you that is saying that the advisor isn’t doing such a great job, but instead the client is reaching that conclusion on his or her own.

For example, I could ask Nancy if she regularly meets with her advisor and if she says no I could attack that advisor by suggesting that any “good” advisor will make sure he meets at least once each year with their clients. And if I took this approach I wouldn’t be surprised for Nancy to say something like “oh, he has offered to meet with me but I haven’t thought it was necessary”. And the more I might press along these lines the more I might force Nancy to defend the current advisor and say something like “actually he is a very nice man and he has been very helpful.” Once she hears herself saying something like that she might be thinking “why am I talking to Doug, I should be talking to my advisor.”

You can counteract this possibility by wording questions like these:

You say - “When you do your annual reviews what does he tell you with regards to…”

The client thinks - “He has never contacted me about doing a review. I wonder why?”

You say - “When your advisor projected your expenses, adjusted for inflation over the next 20 years and then matched them against your future income, did he or she see any reason to be concerned?”

The client thinks - “He never did that. It would have been helpful if he had?”

You say - “When your advisor projected the different start ages for Social Security what was his recommendation as to how to maximize your benefits?”

The client thinks - “He never did that. It doesn’t sound like he really doing much for me. Maybe I should change to another advisor? Doug seems to be pretty thorough.”

In Nancy’s case it turns out that she had purchased this annuity when she lived in Texas and had not spoken to the advisor since. She did say that she wasn’t expecting the income to be large because she only put $50,000 into it.

So our conversation continued pretty much as follows:

Doug – It will be important for us to know exactly the amount of income this annuity will provide because whatever the amount, because it is permanent and guaranteed by the company to last the rest of your life, it is an extremely important source of income. If you like I can review the contract at a future meeting.

For now let’s ignore the annuity and focus on the other source of permanent income that we know you would have available, assuming you decided to take the lifetime income from all of your pensions.

(I enter $2,900 in the Pension field at the top-right of the screen.)

Doug – Adding that full pension income means that you would no longer have a gap. Instead you have $900 more income then the $5,000 target. And this isn’t even considering your current annuity. Even if it only provides an extra couple hundred of permanent income in this example you would still have over $1,000 more each month than the target.

Nancy – Actually I think $5,000 is close to what we will need.

Doug – I am certainly not saying that having more permanent income than would you need is a bad thing. How much permanent income a person wants or needs to use as their target is entirely up to them. However, I will tell you that when I am working with a client who doesn’t have a large pension, my only option as to a recommendation for an instrument that can provide permanent lifetime income is an annuity.

Pensions and annuities are great for providing permanent income. But they are not perfect. Again, nothing is. They have their strengths and weakness. The strength of both pensions and annuities is what we have already talked about. They can be counted on to provide a check month after month, no matter how long you live. But they also have some weaknesses.

They aren’t very good at providing liquidity, they aren’t very good if your objective is to leave money to your children or grandchildren and they are not typically designed for growth.

Nancy – I would like to leave something to my granddaughters.

Doug – It is good for me to know that. The more important the objective of leaving money to them, the less taking a permanent income from your pensions will match up with that objective.

In other words, if you said Doug, my sole objective for this money is to ensure I have an income the rest of my life then that objective points you to your best decision which would be to take the permanent income from those pensions. But if you said Doug, my sole objective for this money is to preserve it so that it can be passed on to my grandchildren, then that objective points you to the decision to instead take a lump sum.

If we are to work together I will want to take a lot of time at another meeting exploring the best way to meet the objective of passing money to your granddaughters, but before we go too deeply into that subject lets continue with this allocation model.

As I was saying, pensions and annuities are great for income but not so good for other objectives. One big weakness they have is growth. And this can present a big problem when we consider what inflation can do to someone’s retirement.

A target income of $5,000 might get the job done today in terms of providing the money needed to pay bills and have some fun. But what about 20 years from now?

To deal with inflation we need growth.

Do you know if there is any sort of future cost of living adjustment providing by your pensions?

Nancy – I know that there is not. The $2,900 stays the same for as long as I live.

Doug – That is not surprising. Most pensions don’t have any cost of living adjustment.

And while it is only a guess at this point, I would be very surprised if after reviewing your current annuity we found that it provided for any cost of living adjustment as well. Most annuities don’t.

Again, this is why growth is so important. And this is the typical weakness of most pensions and annuities.

It is also an important reason why I usually recommend allocating only the amount of resources to filling any gap in target income without exceeding that income.

Instead, I prefer to take any excess and allocate that for the growth needed to combat future inflation.

The fact that you have multiple pensions that will allow you to use some for a lifetime income and take a lump-sum from the others might be a real advantage.

For example, for simplicity’s sake let’s say that instead of taking a lifetime income of $2,900 from all four of your pensions, you could turn two of them into a smaller amount of lifetime income and take a lump sum from the other two.

(I now reduce the $2,900 I had entered earlier in the pension field to $1,700.)

This leaves a gap of $300. But we also have your current annuity. And as I said earlier, annuities are a great way to fill any gap.

We aren’t sure at this point how much lifetime income your annuity will provide but for now let’s assume that it is $300. This would mean that between your Social Security, your annuity, and only two of your pensions (in this example), there would be no gap between your target income and what is provided.

But we still have not addressed how we are going to deal with inflation.

(I click the gray button at the top.)

Doug - Again, to combat inflation we need growth.

Since we only needed to allocate two of your pensions (in this example) to meet your target income, the lump sum amounts from the other two, along with any other resources you have could be allocated for growth.

The place that we typically go when the objective is growth is the stock market. Historically stocks have provided superior growth. This is the strength of investing in stocks. But because nothing is perfect they also have a weakness. One that you experienced first-hand in 2008. Their weakness is volatility. Stocks go up but they also go down.

In order for stocks to be a good fit for any investor he or she has to be prepared for volatility.

From what you have told me, it sounds like when the financial crisis hit you felt you had to sell your stocks because you couldn’t risk losing any more value.

Nancy – Yes. It was a very bad time for me. I had already lost a lot of money by investing in my son-in-law’s business and then when my stocks dropped I got to a point where I felt I couldn’t afford to lose any more.

Doug – You weren’t alone. A lot of people felt that way and did exactly what you did.

But let me tell you a quick story that you might find interesting.

Years ago I had a client who was a Colonel in the Marine Corps. In fact, he was in charge of what was called the NCO academy, where every couple of months a group of non-commissioned officers from all over the US came to go through a six week training course. He invited me to come in and spend an hour talking about basic financial planning, which I did for years.

It was a great experience, I met a lot of great people and some of them even became my clients.

As is the case with many people who make a career of the military, many retire at a fairly young age with a pension but continue working in a second job where they end up with a second pension as well.

I have a client who lives in my town who after retiring from the military, was a pilot for another 20 years with a major airline that provided a great pension. This person, like many others in this situation have more than enough permanent income to meet the target income they set for their retirement.

It was interesting to me the difference in the ways that people dealt with the financial crisis of 2008. I know people who had plenty of savings and investments but not much permanent income and the financial crises took a tremendous toll on them. Even those with so much money that they could afford to take losses were affected deeply. They would cancel vacations, cut down on going out to eat and more or less stopped spending money. Again, for some people this was necessary but what I am trying to say is that I saw even very wealthy people go through the same thing.

But I saw a major difference in the attitudes of people that had a lot of permanent income. I would visit with clients like the airline pilot I just described and for him and his wife the crisis was horrible, it really didn’t have much of an impact on them personally. They still went on vacations, they still went out to dinner and they continued to spend money pretty much as they had before the crisis.

The difference was that they felt they could because they knew that each and every month they would receive a check no matter how bad things got.

A lot of people who didn’t have permanent income felt they could rely on, sold their stocks in the midst of the crisis because they felt there was simply too much at stake if they didn’t sell and the value of their stocks continued to fall.

But what I observed during this period was the more permanent income a person had, the more reluctant they were to sell their stocks.

Does that make sense?

Nancy – Yes. In my case not only had I lost money when my son-in-law’s company went broke but I was also out of a job.

Doug – It is understandable that you sold your stocks even though you probably felt that eventually the chances were good that one day they would go back up.

The point is that if someone follows this model that I just took you through where you allocate your resources to first provide your target income, because your income is now secure maybe you are in a better position to allocate some money to the potential growth of the stock market. If you do, we know it is almost certain you will have to endure period where your stocks will go down in value. But with sufficient permanent income, you are probably in a better position to ride out the bad times.

Nancy – That makes sense.

Doug – Great, but it is important to make a point here. Even though it might “feel” that as long as you had enough permanent income that you could better face the ups and downs of the stock market, the reality is that some people find that they can’t or don’t want to deal with it no matter how much permanent income they have.

Everyone is different with regards to how much risk they can tolerate.

It is a principal of investing that the greater the opportunity for growth, the more volatility we will likely be forced to experience.

But here is an important thing to know. There are products and investments designed for growth but where the volatility is less.

There are even some products, like some annuities that can delivery growth but with no risk of market losses.

Sounds great. And it might be. But it isn’t perfect. Everything has strengths and weakness. So if the strength is that we can get growth without any chance of stock market losses, what is the weakness? One is that the growth potential is limited.

It all comes back to the same thing. Nothing is perfect. You won’t find a perfect answer when trying to decide if you should take an income from your pensions or take a lump sum and allocate that money for growth or some other objective. Each choice will have its advantages and disadvantages.

The best way to deal with the decision you have to make as well as all the other financial decisions you will need to make as you transition into retirement, is to always ask first yourself the question of exactly what you are trying to accomplish. Is it liquidity, is it income, growth, leaving an inheritance or something else?

The problem is that it is rare that people have a singular objective. Instead there are a number of things that most people want to try to accomplish when it comes to their money.

This is why it is too bad that there isn’t some magical product or investment that can do a great job at everything. But of course nothing is perfect. That is why I believe that the best approach is to view your money as being divided between a number of different “buckets” and then have a specific objective for each bucket.

For example, we talked about the importance of having an emergency fund. Let’s assume that you decided that the appropriate amount to allocate to this objective was $30,000. Now that we know the objective it becomes easy to find the best instrument for that objective. You just deposit it in a bank account. Again, you won’t earn much interest but that is ok because that is not the objective.

I would suggest that you look at your four different pensions as four different buckets. Then ask, what the most important thing is for each of these buckets to do for you. The answer for one might be permanent income. The answer for the second might be growth. You might want to allocate the third for passing on to your granddaughters. The fourth might be to provide you with fun money so you can travel.

Nancy – I have always dreamed of taking my granddaughters on a cruise with me.

Doug – Maybe you can. My job as an advisor is to try to help my clients make their dreams come true.

I didn’t always feel this way. In the early part of my career I thought it was right to spend my time helping clients find the best investments or products. But over the last few years, I guess as I have become older, I realize that all of those things are really just a “means” to an “end”. We spent all of this time working and saving money for retirement. The real purpose of all this sacrifice shouldn’t just be so that we can buy groceries after we retire. The real objective should be to live out our dreams as best we can.

Nancy – I haven’t thought of it that way.

Doug – This meeting has run longer then I usually like to spend the first time I meet with people. Let’s wrap this up and talk a little about how we might proceed.

I certainly am not prepared at this point to make any recommendations. There is still a lot more I need to know about your situation before I would feel comfortable doing that.

Let me tell you how I usually work with people. First, I prefer and most of the people I work with prefer not to have long marathon sessions where I give them a lot of information to digest. Instead I believe it is better to have a series of briefer meetings and limit the topics discussed at each meeting. I would need to spend another meeting with and really get a good understanding of your pensions, your 401k, Chuck’s 401k any other assets you have and I would want to review your annuity contract.

Then we would likely have another meeting or two devoted to suggesting different options that I think you should consider to meet your objectives. Again, nothing is perfect so I can tell you right now I will never come up with an option that doesn’t have weaknesses. So we will need to spend time so that I can thoroughly explain not just the strengths but the weakness of each option.

Once you decide what is the best option for you we would need another meeting to implement the options.

The bottom line is that I am not in a hurry. I am slow and methodical and I encourage my clients to be the same.

I trust that you don’t have a reason to be in a hurry for any of this?

Nancy – Only that I am supposed to tell the hospital what I want to do with my pensions 30 days before I separate from service.

Doug – If you’re planning on retiring in four months then you should have plenty of time and we don’t need to hurry.

Let me answer your initial question about how I get paid and then we can decide what to do next.

What I am paid and who pays me depends on what my client might do. For example, let’s say I have a client who needs permanent income and decides to purchase an annuity. In that case, the insurance company pays me directly. And they don’t subtract what I am paid from the money my client puts into the annuity. But let’s say that I have a client whose objective is growth and decides to put money in an investment portfolio that I purpose. Then I am paid a fee each year that is deducted from my client’s balance. Those are the two basic ways that I am paid. And since we don’t know at this point what options might be best for meeting your objectives, it is hard for me to be more specific than that.

However, there is one thing that I can be very clear on. You will never receive a bill from me for anything I might do for you unless you knew well in advance that this might happen, exactly what it would cost and had ample opportunity to decide if you wanted to go in that direction.

Is that fair?

Nancy – Yes.

Doug – Great, then let’s set up a time for our next meeting.

First Meeting Observations and Comments

Usually when scheduling follow up meetings I want them to be no longer than about a week apart. Again, my process is such that I typically am not doing any transactions until the fourth meeting. At this point I have no reason to expect that it would be any different with Nancy if she decided to become a client.

Normally I get concerned if too much time passes between appointments because there is a certain momentum that can be lost. However, with Nancy I have a little different concern. Any the proceeds for any transaction that might involve her decision to take a lump sum amount from one or more of her pensions won’t be available for probably six months. If I complete my process with her too quickly then she will still be months away from declaring to her employer what she wants to do concerning her pension.

I realize that I might be making a mistake but with Nancy I decide to drag the process out and my plan will be to schedule each subsequent meeting about two or three weeks apart.

The reader will note that during this meeting I did not directly discuss the option of taking a lump sum from one of the pensions and using the proceeds to fund an annuity with an income rider. While I do think that this will be an option I want Nancy to consider, there did not seem to be much value in bringing that up now.

At this stage in the process I think it is more important to stress the importance of permanent income, which I think I did. Later, I can help Nancy understand the pros and cons of using the pension option versus an annuity to best accomplish the objective of permanent income.

It is my view that during any first meeting with a new prospective client, I am not selling anything except myself and a need for another meeting.

Download this entire case study in a pdf file format from the prior screen.

-END First Meeting-

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