Negative Interest Rates and the Mafia Annuity

     Rocco "Quick Sauce" Corleone wants to set up a Mafia Annuity for five elderly capos, and he tells Vito "Beancounter" Borrellione to do the math.  The Mafia Annuity is the one where you have a capo depart, don't ask how, at the end of every five year period, but on the last day of each plan month all capos get a black satchel filled with cash for as long as they remain undeparted.  The final satchels delivered to the soon-to-be departeds (offed right then and there mostly) get returned to Quick Sauce, along with everything in the departed's pockets and his bling, so there's no need for management fees, especially with the bling.  Monthly satchels are tossed out a limo window by the largest of six or seven goons in a drive-by, tailed once every five years by a marinara delivery truck carrying the Corleone clean-up crew.

     Quick Sauce tells the capos they're putting up three big ones each as lump sum payment for their generous and affordable policies, and Beancounter spreads the numbers, showing up at The MacDougal Post for review by our in-house CPA, who gives the spreadsheet the kind of meticulous attention to detail accountants reserve for financials like this in trying to keep their shinbones from being attacked by baseball bats.

     The printout is correct.  $15 million gross lump sum payment, $3 million apiece from 5 annuitants, 900 total satchels out the limo window, 60 a year in years 1 through 5, 48 per in years 6-10, 36 per in years 11-15, 24 in years 16-20 and 12 in years 21-25.  Gross lump sum divided by total satchels equals $16,666.67 a satchel, or $200,000 a year.  

     Not bad, for everyone involved, overlooking an actuarial detail or two.  Okay, five actuarial details if you're following this closely.  CPA wonders what an annuitant would get if he didn't join the death pool and instead set up a $3 million 25 year plan like this for himself.  Answer is....$10,000 per satchel, or $120,000 each year.  Mafia Annuity turns out to be much better, aforementioned actuarial detail(s) overlooked.  Problem here begins in the 26th year, the geezer-outlives-his-money-thing that financial advisers occasionally place a distant second to their hands (both usually) in your aging pockets too.

     CPA notes that Quick Sauce isn't assuming any return on that gross lump sum.  Zilch.  No return at all.  The don has obviously considered the impact negative interest rates are likely to have on the insurance industry.  Quick Sauce ain't gonna pay no bank no money to buy no bond.  He'll hold up the joint first.

     Google "Mafia Annuity" and you might get googled yourself at the local FBI office, only they've got better google than you, so CPA decides not to do that.  Instead he compares that $3 million 25 year individual plan with no investment return with the same exact thing returning 7% a year - that is, each and every single year for 25 of them, you earn 7% on the principal.

     That $10,000 a month, or $120,000 a year with no investment return at all, more than doubles if you get 7% on your money, a number often cited as the historical return on common stock investments, becoming $21,203 a month, or 
$254,441 annually.

          Before the Financial Apocalypse of 2007-08, major insurance companies were held in the highest regard by Wall Street.  Industry leaders understood their books and backed prudently-calculated liability estimates with gilt-edged investments across the entire risk window, assuring that appropriate financing would be there whenever needed.  People had reason to believe that these operations would continue to run like clockwork for as far as a seer's eye could see.  The knowledgeable investor had at least a couple of life and/or property and casualty outfits in the portfolio, maybe a dash of reinsurance and broker/agency exposure as well.

     Then came the AIG bailout and, with it, this new thing called a derivative, throwing in some really scary counter-party risks through what struck us as the surprise emergence of seemingly thousands of crazy-ass speculators embedded inside our money markets, for goodness sakes, and the insurance business-model just seemed to blow up in The Street's face, like all of a sudden too.

     Since then, we've been watching another weapon of mass destruction creep silently into position for a second colossal smackdown: negative interest rates.  Only recently has the potential catastrophic impact of this central planning fiasco fallen into our intermediate term forecasts, so we're compelled to pass along our thoughts to you.

     And we just did.  The unknowns are formidable here, and the only numbers we can draw on come from that non-existent Mafia Annuity example.  It's clear to us the insurance industry may have to make some big changes, the nature of which we can only surmise, hence that's unpublishable for now.  Is a switch from bonds to direct real estate investments in the works?  How about buying up corporations to hold and manage them a la Warren Buffett.  Will policies become far more expensive in the future?  Will contracts have to be rewritten?  We don't pretend to know the questions here, let alone the answers.

     Finally, remember the Mafia Annuity structure?  You know, where Rocco "Quick Sauce" Corleone had an annuitant depart, don't ask how, at the end of every five year period.  That's an Ordinary Annuity, and for those of you who went ahead and asked how anyway, the don can just as easily draw up an Annuity Due, where an annuitant departs at the beginning of every five year period.

     Lets hope Quick Sauce didn't find out you asked.