Saturday, July 30, 2016

Increased Monthly Annuity Payments

This post has gotten way too long. So I am writing the end here at the beginning [and rewriting what was below on how I got here in the next post].

How can increased monthly annuity payments reduce total benefits (payout)? Because the first payment is 10, 20, 30, 40, and 50% lower than the not increased monthly benefit rate, and the calculator “interest rate” needed to schedule the ever-increasing payments is not great enough to catch up (Chart 20).

The annuity calculator for setting the fixed no benefit rate (that works perfectly) begins to drift off course as the marketed increased payment rate rises from 1% to 5%. The calculator is the perfect model for setting the fixed rate (Chart 19).

It duplicates the chart in the marketing brochure (Chart 16).

The mystery was solved when I realized the same calculator was being used for both monthly payment rates: fixed monthly payment benefit rate and the five increased monthly payment rates. I could now use the calculator to explore the behavior of trying to match lower starting monthly payments to increased monthly payments.

Chart 20 shows that the total payout drops very little with a 1% and a 2% increased monthly payment. No problem here. At 3%, the calculator “interest rate” needed to maintain a 3% increased payout is a bit more than 3%; at 4% it is 5%; and at 5% it is 7.5% with the fixed rate calculator still failing badly when used in this way; nearly $7,000 off track.

Charts 21 and 22 show how it goes off track. The marketing is good. Get a 5% increased monthly payment each year. I believed it. Why question? I then asked Excel to show me the actual increase in relation to the marketed increase. What a surprise!

The claim that the increased payment is 1% or 2% is good. At 3% there is a gentle decline of about 0.5%; not an increase. There is about a 1% bonus at the start of the 5% claim followed by a drop of over 2% by the end of the 20-year contract. Not enough money is paid out during those last high monthly payment years. The result is a $6945 loss in monthly payments for the illustrated contract in relation to the fixed rate monthly payment contract we are buying (please see the next post if you are interested in the details). 

Valid comparisons between contracts (annuities and CDs) must show the amount in the pot, the duration of the contract, and the total payout. I need these three values to work through a reinvestment scheme in a new post.

The marketing from the 10% personal bank loan (in the next post) to the 5% increased payment annuity does not count with one exception. My fixed rate annuity calculator generates an interest rate that can be compared to simple interest (CD interest) as a common denominator, if I have that last increased payment from the increased payment contract.

Sunday, July 24, 2016

Annuity Payment Increase Benefit

Our financial advisor warned us not to take the “Annuity Payment Increase Benefit”. It would take much more money in the pot then to have equal payments. This sounded strange to me. If we reduce the initial years of payments, it seemed to me, there would be more money for later payments at no additional costs. There are situations where this makes sense such as the fear of inflation.

The brochure states, “This benefit will automatically increase your annuity payments each contract year.” Then several lines about how the calculation is done with the section ending with, “These annual increases will continue until the annuity payments end.” The word “increase” appears six times in this marketing copy.

At the bottom of page 12 it states, “It may take some time before your annuity payments will equal or exceed the annuity payments under a contract without this benefit. Please see the chart on the next page.” (There are 6 increases to one whoops: promotion with one partial truth in advertising.)

The chart on page 13 (Chart 16) is not what I was expecting. It is what I call a “tourist” quality presentation. It gives you the idea but lets you seek out the specifics after you have arrived at the spot. Here we have to deal with the tradition of buying something and then having 10 days to return it if not satisfied.

The fulcrum in this chart is not in the center, but at about 13 years. But more disturbing is the area below the $500/month line, where we would be giving up money, which is much larger than the area above the $500/month line, where we would be getting back money.

What is entirely missing, but alluded to above, is the total payout for each option. Only the rate of the last payment is listed. This “benefit” has a cost that is not listed.

I need to sum the payments for 20 years for each benefit option. I have only the starting point and the ending point from the inaccurate artistic chart. My first trial was to draw a straight line between start and end rates (Chart 17). This is also simple interest. It is not a good fit. The fulcrum is at about 12 years. It is not at 10 years, half way from start to end of the contract.

I need to fit a sagging curve; not a straight line. Compound interest develops a sagging curve (Chart 18). The fulcrum is now at about 16 years and has long sagging lines leading up to something that looks about right.

[One day later] It occurred to me to put the starting values in the Pot to annuitize. Adjust the interest rate to span the gap between starting and ending values. The fit was almost perfect. The required interest rates ran from 0.85 for 1% to 7.5 for 5% benefit using my calculator.

Chart 20 is a complete surprise to me. The more that is given in the beginning years, to get an “increased payment” in later years, the smaller the total payout. Chart 20 estimates that it would cost about $7,000 to experience a 5% increased benefit on the illustrated $100,000 contract.

An interest rate of 1.8% would yield the $500/month or $6,000/year on the $100,000 pot in 20 years shown in the illustration. The total payout would be $6,000 x 20 or $120,000, without the increase benefit and the for-life options.

I would like to know if I am really right on this, or is the marketing a clue of what is, in my opinion, wrong here. To match this contract, with a 5% inflation rate, with the contract we are negotiating (10 years certain and no life insurance included), we would need to put up a pot of about double the money and lose about $14,000. I can agree with our financial advisor on this but I do not understand it. Guardian Life is a highly regarded mutual company, like New York Life, or we would not be dealing with it.

I in no way see this as a “benefit”, something of greater or increased value. A better way, that was suggested by our first daughter in law, was to select a constant rate (as we have) and, when the monthly payment is not needed, to reinvest it. Then we would hold and manage the unneeded money rather than the insurance company. It should not cost us several thousand dollars per year to do this.

Friday, July 22, 2016

Stale Tobacco Smoke Again

It is 5:20 and I am up and out of the shower. I am feeling good. My nose is clear. I checked my desk for the UPS mailing label I forgot to put away last night.

The form was overlaid with the last email from the financial advisor:  “PS. I still need your signatures to open the annuity account.” Events of last week started to make sense.

I knew I needed to send the signatures but in my mind that was linked to sending the check. That was something I would not do until I could understand how annuities worked in relation to compound interest. And figuring that out was extremely difficult because I even had to use the iPhone calculator to set decimal points in the correct location.

My math coprocessor was on the blink again as well as my entire digestive system. That is how I lived for 50 years. Singular makes possible safe trips to the bathroom.

I can look at numbers with no meaning. I can graph numbers and there is meaning.

My wife did not like for me to fly a single engine light plane. I have used that as the reason I quit flying. My reaction to aircraft engine exhaust was the real reason. It is as bad as stale tobacco smoke.

The worst case was learning to do wheel landings. I pinned the wheels to the runway from an uncomfortable distance. This is before I learned to watch for the shadow of a wheel to know I was close to the ground. I have no memory of taxiing to the hanger, getting out of the plane, or entering the office. To this day I remember the shock of stepping out of the office into the hanger space with no idea of how I got there. I had wanted to solo on my birthday.

On other landings there was no sound or feeling of the wheels skidding on the runway as they touched down. Dr. Carlton Lee, our allergist at St. Joseph, MO, many years later, called this momentary amnesia. At the moment the aircraft stalled, engine fumes come into the cabin.

In later years this was a problem at airports when jets replaces props. I could become completely disoriented not only in space but also time in the terminals.

Every so often flight instructors are checked by giving a recent graduate a check flight. I was picked. Cotton Woods forewarned me that a cross-controlled stall had been added to the check flight. I had never done one. He told me how. “Just remember that as the nose comes up into the stall, there is no way to predict how the plane will fall.”

The engine labored. The stall. The landscape was slowly spinning about a point to my upper right. I had no sense of being right side up or upside down. I stopped the spin and gently leveled out. I had no sense of falling. I also had plenty of room for the maneuver.

On return to the airport, I was puzzled that my altitude was way too high. I had set the altimeter to above sea level in error! I was asked to give the correct altitude. I could not do that. I could not subtract. We were a 1,000 feet too high over the Memorial Cemetery. I was too high and instructed to do a cross-wind wheel landing. My only hope was to do that down wind from the hanger on the next approach.

It worked. The up wind wheel was pinned solidly on the ground before the wind knocked us about after passing the hangar. He congratulated me on the landing and my flying style: Trim the aircraft to fly itself and use the controls to alter that setting. We adapt within our limitations without knowing we have them.

Last week I was at an hour meeting with smokers in a small room (with no burning cigarettes). Then we had a family gathering at the Heidelberg restaurant. My digestive track was in an uproar again, and a characteristic lower abdominal pain again appeared but not in stop-in-your-tracks intensity. After 26 years in clean air houses, the past has returned to haunt me again.

Numbers no longer made sense last week. I could set up Excel with a rough estimate of what I wanted to do with a graph. I could change numbers and watch the effect on the graph.

Now that the decision has been made and acted upon so we have an annuity to pay my wife’s memory care bill for the next 10 years, it will be interesting to see if my remaining nagging back pain will again disappear. Is it relief from caregiver’s stress, the new chair yoga, or the full exercise routine that is working here? 6:51 and time for breakfast.

Friday, July 15, 2016

Short Term and Long Term Savings

I was in high school when I figured out that I could not save enough to buy a car. So I didn’t buy one. It was not until our three kids finished high school that we actually got more done than just letting savings be a thing of interest.

Are first real savings was having our first house paid for before the first kid went off to college. We never rented again.

Now we are renting an apartment in a residential care site. I have yet to figure out just what justifies the monthly payment. Selling the house came first. So now I need to review short term (simple interest) and long term (compounded interest) as a background for understanding the way monthly annuity payments are calculated that will help pay our residential care bill.

Annuity calculators on the Internet produce different results. In general, an expected annuity payment of $2000/month for 10 years certain requires a pot of money in cash around $224,000. Now $2,000/month for 10 years is a total of $240,000. The total profit is only $16,000 or $1,600/year when removed each year and not reinvested.

The rate of 0.0071 or 0.71% [($16,000/$224,000)/10 years] simple interest must be adjusted to the fact that the insurance company is only holding the full pot on the first month and holding an empty pot after the last month. On average the company is holding half of the pot. The resulting interest rate is then twice that above [($16,000 to me/$112,000 average pot)/10 years] or 0.014 or 1.4% on average. That is $130.67 interest ($112,000 x 1.4%) and $1869.30 principal is in, on the average (fifth year), annuity payment of $2000.

The annuity returns our money in even monthly payments, Add annuity payments to SS and MO pension and we expect to have the residential care bill about paid each month for 10 years if we ignore inflation.

Can we do better managing the money ourselves? CDs are currently paying 0.7% or 1/2 the rate of 1.4% from the insurance company. Only CDs are government insured.

The insurance company, holding the annuity, is reinvesting the interest each year (compound interest). The first few years, I found, show a straight line characteristic of simple interest (Chart 13).

The difference between simple and compound interest is therefore very small in the short term..

The traditional compound interest rate of 6% generates impressive returns compared to the present government managed rates of below 1% for government insured accounts (Chart 14). I think that 6% is purely marketing today if you are seeking low risk to manage high short term current bills.

Long term holdings average out financial bumps plus long term adds the earning power of compounding for the insurance company.

In summary, we can do the compounding calculations on the principal each payment, or, on the interest rate and the starting pot (Chart 15). At 1% it takes five years to gain a dollar on a $1,000 CD by compounding the interest. Compounding by year (Principal x Rate x Year) yields the same return as compounding the rate [Pot * ((1 + rate)^Year) -1]. It is this last formula for compounding by interest rate that I need to make sense of annuities.

Friday, July 8, 2016

Second Person Pricing

Provision Living at Columbia has been open 9 months (memory care, 21 beds on the first floor). Mill Creek Arbors has been open 3 months (memory care, 17 to 23 beds). Provision Living has 3 beds empty; Mill Creek Arbors has 6-9 beds empty. The two sites are meeting market needs about equally.

Currently these spaces are rented at about the same all-inclusive price for single memory care occupancy: Provision Living, $6,000 and Mill Creek Arbors, $6,400. The differences in price for two people, in the prior post (Chart 11), did not show this fact. All-inclusive at Mill Creek Arbors includes a furnished apartment, but you can bring your own furniture.

What is new is that both have two couples occupying, separate independent living and memory care apartments, or, one person receiving independent living services, as a second person, in a memory care apartment (different services in one apartment).

[Looking back at our experiences of the past 6 months, my best location would still be the clean air house we just sold last month on a high market. We must now make the best of residential care for my wife who really needs such care.]

We have lived a month in this memory care apartment, with the same furniture that was in the 3-room, 2-bed, independent/assisted living apartment (except for two chairs and the bed headboard), We receive improved services with far less staff time. We have about the same useable space. And it cost a bit less. The second person independent living fee is applied to assisted living and memory care (Chart 12).

Mill Creek has pricing for all three levels of care. Chart 12 puts these into perspective. When we first looked into residential care, we looked at independent living priced of $3,100/mo. I included a charge for more than one meal a day. The included second person fee was $700/mo. Only Lenoir Woods had such a low entry fee for a couple.

If we had qualified for assisted living at Mill Creek, the charge could have been $5,600/mo for the two of us. Assuming a 25% discount on the second person, I plotted this as $3,200 and $2,400 for the first and second person (Chart 12).

The price for combined independent living and memory care at Mill Creek Arbors is about the same if both persons use one large room or each person uses a smaller room (Chart 12). The concept of a second person fee does not exist past independent living. It is replaced with a discount for purchasing more than one space.

The room layout (studio) and how things can be arranged in them at Provision Living allows for a second person without having to purchase a second space. This seems to be on a case-by-case basis. In our case, it was a verbal agreement in August last year; several months before we were moved in in December.

Provision Living at Columbia 21 Memory Care Apartments

Mill Creek Arbors makes optimum use of the common space by eliminating hallways. The remaining three empty private rooms (1, 9, and 15) are also the three rooms that exit into the three short hallways that exit the building or go to the common area.

Mill Creek Arbors 17-23 Memory Care Beds

Price is a strong factor in selecting one of these sites for a couple (Chart 12). The overall layout and appointments are an equally strong factor for a single person. The same reasoning applies here as in buying a car or a house. If cost is within an acceptable range (after you get over the initial sticker shock), other factors are more important in making a choice.

In our case Provision Living opened shortly before we needed it; with no waiting list. Mill Creek opened shortly before we acquired a new financial advisor to sort out insurance and money. Insurance must match licensing.

We visited several residential care sites more than once to figure out which one would fit best now and in the future (as health needs changed). Out first choice of independent living, with memory care as daycare, was not good after a few months even with all services within one building.

Things are going much better with my independent living services in my wife’s memory care apartment. She can now come and go as she needs (likes at the moment, including naps). I still spend much of my time in the assisted living area: breakfast, noon meal, exercising. The Internet in the library connects me to this blog.

[Chart 12 was transferred from the PC side of this MacBook Pro to the Mac side using an iPhone. Recent updates have made some of the software incompatible, not operable, or just missing. Windows 10 may fix part of the problems.]

Thursday, July 7, 2016

How long will the money last? - How long will we live?

I must now get ready to work with a financial advisor. The idea being marketed is to find a way to "never outlive your money".

It is easy to calculate the answer to how long the money will last: Take the total pot and divide by the rate of withdrawal: $500,000/$10,000/month = 50 months or 4.2 years.

We expect to live longer than that. We also do not have $500,000 cash in hand. We also do not know what future expenses may be.

If we go broke after 4 years and are not eligible for Medicaid, we must depend upon relatives to support us. That is not good planning.

Currently in Columbia, MO, just a residential care bill can exceed $10,000/month at all four full care sites!

If we add our SS, my tax free MO pension, and our minimum required distributions to the mix, $500,000 will last 3 more years or 7.2 years.

The financial advisor does not want to wait 7.2 years for all the money to be in the pot. He needs the money up front. And he needs to know how long we will live. This problem is covered by insurance that pools the risk. He can estimate our age at death from life expectancy tables.

If we expect to live longer than the average, we receive a longer, lower, monthly payout. If we expect to live shorter than the average, we receive a shorter, higher monthly payout. This of course is gambling.

To produce a marketable product, most annuities insure a minimum payout of 10 years to us or our beneficiaries, or until we die. We cannot outlive the payments but that does not insure that all our bills will be paid.

So, how long will my wife and I live? At 85, one prediction is 7 more years for me; the same time the money runs out. At 79, the same prediction for my wife would put her at 86 and me at 92, on average. That is being right half the time for living that long.

The financial advisor must now turn a fixed amount of money into a stream of payments for an uncertain amount of time. He must not lose the money. It is not government insured. He must make his salary or commission plus a return for his investors.

Further, he must match the average life expectancy with the average return he can get when investing the $500,000. He has several ways to win and to lose. 

Casinos always win by taking a percentage (such as 1 penny/dollar) from the total pool. Players only win if they are in the top half of the distribution of players. Long term on average always beats specific short term players over time. The same has been found to hold for hedge fund managers.

The financial advisor can then balances short term needs (a ten year, or more, payout) with long term investments (30 year bonds).

Now for the other side of the game. The highest payout is to gamble with no protection. (1) When we die, the monthly payments stop. The insurance company wins the rest of our pot.

(2) Next, when we die, the monthly payments stop but the remaining portion of the pot goes to our beneficiaries.

(3) When we die, monthly payments to our beneficiaries continue for a period of time (10 years seems to be popular for several reasons).

(4) Monthly payments continue past 10 years until we die. There are no payments to beneficiaries. We have won a portion of the insurance pooled pot. 

As I understand all of this, an annuity is then not an investment but an insurance contract (a gamble) based on the number of years we will live and the investment success of the insurance company.

Each level of protection requires insurance that costs more at each higher level. Age 85 seems to be the limit on getting that insurance.

The insurance company starts with no risk as we must put up the pot of $500,000. It also owns the money. CDs are ours and can be cashed in anytime (with a low penalty).

(I keep using $500,000 as it and a million dollars are popular reference points for immediate annuities. We actually have a delayed annuity of $25,000 with a 2% interest guarantee and  a current performance over 3%. That money equals 3 months in residential care.)

Is then an immediate annuity better than laddered long term CDs in the predicted 10 year financial market? Can the insurance company out perform CDs enough to pay the expenses of providing the annuity?