Do You Need Longevity Insurance?

Most of us probably pay too much for insurance.

This is not as startling a statement as it might appear. The huge financial fortunes that have created companies such as Prudential; Metropolitan Life; and Berkshire Hathaway have been based on the idea that most of us are willing to pay to protect ourselves against events that either have a low probability of occurring or may never happen.

We all have homeowners' insurance, for example, even though statistically the odds of a house burning down any particular year is extremely remote. The prospect of losing everything in a fire is, for most people, too devastating to take a chance.

When it comes to insuring against events in our old age, however, both we and the industry are still evolving. For example, long term care insurance was really not needed a generation or two ago since most people simply didn't live long enough to need it.

Another idea whose time might be coming is longevity insurance.

The idea here is pretty simple, according to an article written by Tara Siegel Bernard in Tuesday's New York Times:

You can agree to begin collecting the insurance at a much later date in the future, like your 85th birthday. So if you live past your life expectancy, you’re covered. And since most people don’t know when they’re going to die, this allows you to spend down your retirement savings more liberally because you know your payments will kick in later. The big risk, of course, is that you won’t see a dime because you die before you can collect.

http://bucks.blogs.nytimes.com/2011/06/28/longevity-insurance-buying-down-the-risks-of-living-too-long/?emc=eta1

Ms. Bernard goes through some numbers later in the article, based on a new policy offered by New York Life. I need to spend more time on the math, but on the surface the idea makes some sense.

I do have a couple of concerns, however. First, this is still a fairly new product, which means that the industry is still not clear on how to price longevity insurance. And, second, it is also possible than an individual might be be better off by simply taking the premiums that they would have paid the life insurer and invest in the market themselves.

Still, a worthwhile read.

Thoughts on Software from Brent Thill at UBS

There's been lots of talk in the press about a new tech bubble, especially in the software area.

Much of this chatter relates to the huge valuations attached to companies like LinkedIn and Pandora Media when they have been brought public in recent weeks. Private estimates now value Facebook at around $100 billion even though Facebook's revenues in 2010 were just over $2 billion.

When Google tried to buy Groupon for $8 billion a few months ago, Groupon turned it down flat. Many tech observers thought that company management was crazy, but now it appears that the private market value for Groupon is twice Google's offer.

This is concerning, especially for a group that is producing prodigious top line growth but very little in the way of profits.

I just heard UBS software analyst Brent Thill today at lunch. Brent is a first-rate analyst, in my opinion, and has been following the group for more than a decade.

Brent said that the IPO pipeline for software companies is a robust as he's seen it in 10 years. Small tech companies, it seems, are rushing to the public market while prices are generous, and investor demand for new concepts in social media and cloud computing appears insatiable.

All this makes Brent uneasy. It gives Brent pause when industry leaders like Larry Ellison of Oracle say that their deal activity has slowed due to excessive valuations.

Brent noted that in the past, Oracle has paid anywhere from 0.5x to 4.0x Enterprise Value/Revenues for acquisitions. But when I glanced down the list of the stocks that Brent covers, exactly one of them (Microsoft) trades below 4x EV/Rev.

More typical is VMWare, which now trades at a cool 50x P/E, or 10.5x EV/Revenues. Virtualization is a crucial part of today's tech world, but this is a very full valuation for VMW.

Brent still sees some upside for the group - there's too much cash chasing too few names - but it seems that we are in the late innings for stock performance for the group, especially for the newer "concept" stocks.

The ROI of College is 2x the Stock Market

I posted a note last week discussing the (very) high cost of college education.

As it turns out, Dave Leonhardt had a column in yesterday's New York Times opinion section that made a very good case for colleges.

Mr. Leonhardt notes that only about 1/3 of high school graduates go on to college, while another 10% get a degree from a two-year program. And while it is true that higher education is expensive:

The evidence is overwhelming that college is a better investment for most graduates than in the past. A new study even shows that a bachelor’s degree pays off for jobs that don’t require one: secretaries, plumbers and cashiers. And, beyond money, education seems to make people happier and healthier.

“Sending more young Americans to college is not a panacea,” says David Autor, an M.I.T. economist who studies the labor market. “Not sending them to college would be a disaster.”

And for people like me, who work in the investment world, there is this:

...the returns from a degree have soared. Three decades ago, full-time workers with a bachelor’s degree made 40 percent more than those with only a high-school diploma. Last year, the gap reached 83 percent. College graduates, though hardly immune from the downturn, are also far less likely to be unemployed than non-graduates....

The Hamilton Project, a research group in Washington, has just finished a comparison of college with other investments. It found that college tuition in recent decades has delivered an inflation-adjusted annual return of more than 15 percent. For stocks, the historical return is 7 percent. For real estate, it’s less than 1 percent.

College Degrees Are Valuable Even for Careers That Don’t Require Them - NYTimes.com

Interesting counterpoint to my Friday post.

Is College Worth It?

Faithful reader Steve Plouffe suggested I post a comment about college tuition costs:

I have a son who will be a junior at Wesleyan University. You have to be a pretty good student to gain acceptance at Wesleyan, according to the Wesleyan Argus:

...admission for the Class of 2014 was the most selective it has been in the University’s history. Out of 10,656 applicants, the University admitted 2,125, translating to a 20 percent admission rate. In contrast, the rate two years ago was 27 percent. The University hopes to enroll 745 students....

Still, Wesleyan is not cheap, and tuition costs keep rising. Tuition for the 2011-12 school year will rise by 3.8%, which is roughly in line with increases for prior years.

But, according to the New York Times, Wes is not alone in raising its tuition:

Tuition and fees at private nonprofit colleges and universities will increase by an average of 4.6 percent — about $1,228 — for the next academic year, according to the National Association of Independent Colleges and Universities. The average tuition increase was 4.5 percent last year and 4.3 percent the previous year, down from average annual increases of 6 percent in the decade before the economic downturn.

Private College Costs Rising 4.6 Percent - NYTimes.com

College education, it seems, is one of those rare commodities where demand rises along with cost. Like fine wine, the more something costs, the higher the cost of tuition the strong the demand for admittance.

But is it worth it?

Well, to my wife and I, this is a no-brainer: we were mostly concerned about getting our son into the best school possible, regardless of cost.

But not everyone agrees. Bill Gross of Pimco - arguably the best bond manager of our generation, and manager of the largest bond fund in the United States - writes about college tuitions in his most recent monthly newsletter.

And, to Mr. Gross, college is fast becoming somewhat of a scam:

Fact: College tuition has increased at a rate 6% higher than the general rate of inflation for the past 25 years, making it four times as expensive relative to other goods and services as it was in 1985. Subjective explanation: University administrators have a talent for increasing top line revenues via tuition, but lack the spine necessary to upgrade academic productivity. Professorial tenure and outdated curricula focusing on liberal arts instead of a more practical global agenda focusing on math and science are primary culprits....

Conclusion to ponder: American citizens and its universities have experienced an ivy-laden ivory tower for the past half century. Students, however, can no longer assume that a four year degree will be the golden ticket to a good job in a global economy that cares little for their social networking skills and more about what their labor is worth on the global marketplace.

http://www.pimco.com/EN/Insights/Pages/School-Daze-School-Daze-Good-Old-Golden-Rule-Days.aspx

I don't know when this cycle will change - I can remember the same complaints about tuition costs when I was going to Michigan in the 1970's - but it does seem logical that at some point there will be a point where students and their families will say: Enough.

Still, I think this point may be further away than perhaps Mr. Gross thinks. Once my son completes his four years at Wesleyan, I doubt that Mrs. RG and I will be as concerned about tuition cost as we are today.

Are the Emerging Markets A Better Bet than US Stocks?

Richard Bernstein was formerly chief market strategist for Merrill Lynch. Rich made a number of very good market calls over the years he was at Merrill, including a prescient call advising investors to switch from tech stocks to oil stocks back in 2000.

Rich has since left Merrill to start his own investment advisory shop, and now manages money for mutual funds as well as individual accounts.

However, Rich still gives a number of presentations, and he usually has some pretty good observations.

For example, I saw this short piece in Financial Analysts magazine. Here's an excerpt:

U.S. investors might not know it, but the Standard & Poor's 500 Index has now outperformed the BRIC nations' equity market for almost 3 1/2 years, Richard Bernstein told attendees today at the second annual Innovative Alternative Strategies Conference in Chicago.

Rich continues to more bullish on US stocks than the emerging markets sector, bucking the consensus that says you should always invest in countries with the highest growth rates:

Challenging the conventional wisdom, Bernstein said that he considered U.S. small-cap companies to offer more potential than any other asset class in the next decade. "The projected earnings growth rate of U.S. small-cap companies is 50% higher than that of Chinese companies," he said.

S&P 500 Beats BRICs For 3-Plus Years, Bernstein Says

There's one other point that I would add to Rich's comments. Based on data from Ned Davis Research, the volatility of the emerging markets is nearly twice that of the US large cap markets.

Five Reasons Not To Be Bearish On Stocks

It's been remarkable how quickly the prevailing mood among investors has turned sour.

It was only two months ago, in April, when my biggest concern about the stock market was the high degree of bullish sentiment.

At that time, a number of surveys indicated that nearly 75% of investors surveyed were positive on the outlook for stocks. Meanwhile, nearly the same percentage of investors were bearish on bonds - most were looking for long maturity Treasury bond yields to soar.

Then the correction came, and stocks are now off about -8% from their spring peaks. And, predictably perhaps, surveys now indicate that bearish sentiment is as high as the lows in the summer of 2010.

We all know the bearish story: Housing is still crumbling; unemployment is too high; and the federal government is gridlocked. Investors find 0.37% yields on Treasury notes preferable to stocks yielding 3% or more.

I've been telling clients a five reasons not to turn to cautious:

1. I've been using the "Cyrano Principle" argument that I have discussed earlier this week. Yes, there are lots of problems in the world, but they are always fairly well-known. In my opinion, the capital markets are already reflecting a good deal of bad news;
2. What are the alternatives to stocks? It is hard to make a long-term investment case for bonds yielding less than 2%, and money market fund yields are essentially nil.;
3. I also find it interesting that the uber-bears on the economy and stocks have no problem piling into corporate bonds; if the world is really going to implode, corporate credit will get smacked along with the stocks. Buying single-A rated corporate bonds yielding 2% (which is about where they are trading) doesn't give you much downside protection;
4. Valuations on most large cap stocks are reasonable, if not downright attractive. This morning's Financial Times notes that Apple is trading at 13x earnings, despite the fact that Apple's sales are expected to grow by 60% this year. IBM, by comparison, is also trading at the same 13x P/E ratio, but sales growth is expected to be one-tenth of Apple's.
5. The "nightmare" scenario that most of us remember - the extreme bear market of 2008 - occurred in a world that was blithely unaware of the subprime mortgage risk that was lurking in the financial system. If anything, investors today are almost entirely focused on risk;
6. Earlier this week Bloomberg noted that stocks are trading at their cheapest valuations since 1985 - is this the time to flee to the sidelines?
   

Are Euroblock Problems Already Reflected In Market Prices?

I mentioned the "The Cyrano Principle" in my blog post yesterday.

Veteran market strategist Laszlo Birinyi discussed The Cyrano Principle in last weekend's New York Times. The idea, as Mr. Birinyi was quoted saying, is:

"If the problem is as obvious as the nose on your face, the chance are the everyone else knows it, too" The markets, he said, are very good at digesting this news and adapting to it. Sooner or later, he says, "unless there is some truly dramatic surprise - and not just something the market is well aware of" - stock will resume what he expects to be a long run higher.

http://www.nytimes.com/2011/06/19/your-money/stocks-and-bonds/19stra.html?scp=2&sq=jeff%20sommer&st=cse

Which brings me to the current buzz about Greece and the euro block.

I don't know which way the Greek parliament will go today - the discussion of austerity measures has brought widespread protests among the Greek populace, who seem to like getting lots of benefits paid for by foreign creditors (no fools, these Greeks) - but I really don't think it is going to make that much different in the markets.

Moreover, I would also bet that the Greeks can continue to thumb their collective noses at the rest of Europe for the very simple reason that a Greek default would hurt the rest of Europe more than it would hurt Greece.

Jeremy Warner had a good column about the situation in last Friday's London Telegraph. Here's Mr. Warner's observation:

Give us the money, the Greeks can say, or we’ll pull the whole house down with us. As Europe’s policy elite is only too painfully aware, the cost of refusing is likely to be infinitely greater than that of coughing up, however politically unpalatable it might seem to the solvent north. Neither the IMF nor the eurozone can afford to let Greece go.

Mr. Warner goes on to write that a Greek default would inevitably lead to defaults by Ireland and Portugal, followed possibly by even Spain. And in the papers today there are several articles discussing the idea that the real problem in euro land awaits in Italy.

http://www.telegraph.co.uk/finance/comment/jeremy-warner/8581092/Greeces-ace-card-help-us-or-well-take-you-all-down.html

In short, I keep looking for events that don't seem to be already widely discounted in current market prices, and so far am coming up short.

Or, put another way, when billions of dollars are flooding in 2-year Treasury notes yielding 0.38%, it is hard to say that the world isn't already well aware of the financial storms raging in Europe right now.