Insuring
Investments
For nervous investors, an
insurance policy
on your mutual funds may retire your worries
By Heidi Rafferty
Dips
and turns in the recent bear market have been so stomach-churning that
many investors may wonder what, if anything, will be left for them in
their golden years.
In your 20s or 30s? You may be wondering whether your 401(k), IRA and
mutual funds will eventually reap enough to sustain you beyond
whatever is left of Social Security. Getting ready to take the
retirement plunge? You may be worried about insuring your nest egg for
your long-term care — and making sure there is something left over
for your heirs after you’re gone.
The life insurance industry, eager to capitalize on the latest market
fluctuations, has teamed up with some brokerage firms to market
insurance products for mutual funds. Policies only pay out when the
customer dies.
While the sellers of these plans tout them as win-win prospects for
skittish investors, industry watchers caution that they require
scrutiny. Although they may be a viable option for older folks, young
people could lose more in years of accumulated compounded interest
over what they otherwise might pay in insurance premiums, industry
watchers say.
If people playing the market continue to follow basic rules of
long-term investing, they should feel safe that a plump retirement
cushion will be there for them, regardless of market downturns.
“We have 20- and 30-year-olds who are putting money in money market
funds for fear of the market. It’ll come back,” says Andrew
Culpepper, owner of Culpepper Investment Group in Kinston.
“As long as you believe in the capitalistic economy we operate in,
these stocks will do well. If a mutual fund is reasonably well-managed
and diversified, most will average 10 to 12 percent a year over a long
period of time.”
Preserving What’s Left
But what about those who may have already taken huge losses and are
trying to preserve what’s left so they can retire within a few
years? Generally, you need to replace 70 to 80 percent of your current
income in retirement.
The oldest of the 67 million baby boomers are now in their 50s, and a
strong majority say they have given a lot or at least some thought to
their retirement years, according to a 1998 research study by the
American Association of Retired Persons.
The national survey shows that six in 10 boomers are counting on money
from savings and investments as retirement income. Forty-eight percent
say they are counting on Social Security, but just 36 percent say they
feel confident it will be around when they retire. Seven in 10 say
they don’t want to depend on their children during retirement.
Couple those concerns with the market’s plummet, and it’s easy to
see why insurance policies that preserve funds for a person’s
beneficiaries might be attractive to a lot of folks right now.
“My gut feeling is that if you’re 50 or older, you’re facing
retirement. You don’t have much time to recover,” says Stephen
McDavid of Edward Jones in Fayetteville.
Edward Jones sells products for Putnam Investments of Boston, which is
offering the insurance plans on all its mutual funds in all share
classes, including regular accounts and IRAs. The plans were first
offered in March 2000 in conjunction with Allstate Life Insurance Co.
Other companies that also have been at the forefront of the death
benefit insurance programs include American Skandia, whose product is
called AS Goodwill; SunAmerica, which has the Asset Protection Plan;
and Prudential Insurance Co. of America, whose plan is dubbed
PruTector.
The products are offered by so few companies that the Securities and
Exchange Commission does not have records of how many are out there.
Even the insurers say that with the newness of the programs, they have
not tracked whether more people have used them during the market
downturn.
“It doesn’t seem like a widespread practice right now,” says
John Nester, spokesman for the SEC’s Office of Investor Education.
He says the SEC regulates each product on a case-by-case basis. State
insurance departments might also regulate the products, depending on
how they are packaged, he says.
How the Insurance Tool Works
Generally speaking, here’s how the insurance tool works, using the
Putnam Allstate Insurance Investor plan as an example:
If the market dips, the original investment is guaranteed, and the
investor also receives a 5 percent return on his or her one-year
anniversary.
If the market improves, the value of the investment locks in at the
highest price. Some companies place a cap on how much they will pay
out; for example, the Putnam plan has a $2 million cap.
Say you put down $10,000 as your initial investment. If the market has
dipped during the year, then on your anniversary, you automatically
receive another $500 (5 percent). You are guaranteed $10,500.
If the market improves and your investment shoots to a high of $12,000
but then later goes down, say to $9,000, your investment value still
locks in at $12,000.
SunAmerica’s Asset Protection Plan provides for a 4 percent minimum
annual growth rate, up to a 200 percent maximum.
Under that plan, if you make an initial investment of $100,000 and you
die three years afterward, your investment value would equal $112,486,
SunAmerica says.
But if your investment had declined to $95,000 on your death date, the
death benefit would be $17,486 (representing $5,000 for the loss on
the initial investment, plus $12,486 at the ensured 4 percent annual
growth rate). Your heirs would also be entitled to the actual market
value of your account.
On the other hand, if the mutual fund account is greater than the
death benefit value, there is no death benefit, but the heirs receive
the full worth of the funds.
Premiums for this service vary. Putnam, for example, offers its plan
for an annual premium of 0.3 percent of the account value on the most
recent anniversary date if you’re 21 to 70. For those 71 and older,
the annual premium is 0.5 percent.
Why insure investments?
Sellers of these plans point to the obvious protection they offer
against market volatility. They also point out that because insured
mutual fund accounts are backed by a term life insurance policy, the
death benefit proceeds paid to the beneficiaries pass directly through
probate, potentially income-tax free.
But “there’s no free lunch,” warns John Rich, chief investment
officer of U.S. Trust Co. of North Carolina in Greensboro.
“Conceptually, I can see where people might create a product and
find it attractive, but you have to step back and see what you’re
getting and what it’s costing,” he says, adding that one
alternative to insurance plans would be to have a smaller amount of
equity in your mix and a bigger fixed income allocation.
“For a younger person with a long-term horizon, they are a long-term
investor. For someone with a short-term horizon, maybe they
shouldn’t take the risk to begin with. Before you think about diving
into a product, look at the overall asset allocation.”
Ramy Shaalan is a senior fund analyst for Wiesenberger Thomson
Financial in Rock Hill, Md., which has one of the major mutual fund
databases in the country. He thinks the insurance industry only came
out with the products because of the market downturn, and cautions
younger investors to consider what they might lose in the long run in
compounded interest if they spend money on premiums instead.
“The power of compounding is more likely to add to your return other
than a fixed security,” he says.
Stick to Basic Rules
People who are investing for the long haul should not be fearful of
current market conditions, Shaalan and others say. In fact, they
should follow basic investing rules that will help them stay the
course, no matter what happens in the near future. In the end,
they’ll come out winners.
“If you believe in America, especially if you’re in your 20s . . .
if you have any opinion that the future is not dire, you have a
tremendous accumulation period ahead of you,” Rich says.
“You’ll make more money as a stock investor than a bond investor.
Having a healthy exposure to the equity market makes perfect sense.
The most important thing any young person can do is think and act like
an investor.”
John Collins, spokesman for the Investment Company Institute in
Washington, D.C., says that if people can’t stomach the market, they
should stick with certificates of deposit or money market investments.
“By and large, the mutual fund industry does not offer guarantees
that you’ll make a return or lose money,” Collins says.
“That’s actually part of the fundamental approach to it. (SEC)
rules make it a clean industry, but you can still lose your money.”
Even so, research by the institute shows that mutual fund shareholders
have not reacted abruptly to stock market setbacks and corrections in
the past. In fact, 86 percent of fund shareholders suggest they are
not concerned about short-term fluctuations, and 98 percent say they
view their fund investments as savings for the long-term.
To make your investment work for you in the future, whether it’s a
mutual fund, IRA or 401(k), here are some strategies:
 Diversify. Collins, Rich
and others agree that the best way to minimize your risk is to ensure
that your investment is not dependent on one or two “great”
stocks.
“A young person can afford to have more risk but still needs to
spread the risk around and not concentrate in a narrow sector.
Diversification is risk control,” Rich says.
McDavid of Edward Jones urges his clients to sink no more than 10
percent of their 401(k) investment into their own company’s stock.
One of his clients put a bulk of his funds with his employer,
Westinghouse. He left the company, and it was worth $298,000 at the
time, so he kept the stock for about five or six years.
It fell to a $90,000 value, McDavid says. “That’s a big issue for
people.”
Contribute the
maximum.
McDavid tells his clients to “put as much as they possibly can”
into their 401(k) plans to take the most advantage of matches from
employers.
On the other hand, don’t stick just to your 401(k). Spread the
wealth around. People who don’t look beyond their 401(k), for
example, have created a “terrible paradox” for themselves, McDavid
says.
“They’ve tax-sheltered every dollar they’ve got, which is
generally not accessible until death or retirement. They need to
invest outside of their retirement plans,” he says.
One of his clients was in such a situation and wanted access to his
money to open up a new business. He ended up paying 42 to 45 cents of
every dollar in taxes with penalties to take the money out early.
Stick with the
winners.
Culpepper notes that, “If you want to see what stocks are in a
particular fund, sometimes that gives you comfort.”
He tells his clients to always consider whether there is a strong
chance the companies in which they are invested will go out of
business.
Tried and true giants like General Electric, Exxon Mobil, Microsoft
and Pfizer may have lower stock prices today, but they will still be
around for a long time, Culpepper says.
He recalls one client who didn’t heed his advice: “During the Gulf
War, I had a client who was scared to death. The news was bad. We were
going to war, we were going to lose 100,000 people, and he had
McDonald’s stock,’’ Culpepper says.
“I said, ‘Is McDonald’s going out of business?’ As a matter of
fact, he ultimately sold it at the low, and it bounced back, not two
weeks later, when they started shipping sandwiches to our crews over
there. They didn’t like the Mideast food.”
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