For Your Consideration

OK, as of today, the Fed has said to Lehman, “NO SOUP FOR YOU!“, and they are now at the mercy of a bankruptcy court. Merrill Lynch ceases to exist as an independent investment bank and will be swallowed up by Bank of America.

Now, we are witnessing the potential of the bankruptcy of AIG, American International Group. This potential collapse is so breathtakingly overwhelming it is difficult to find the words to express its impact.

As of the moment of this writing, the Fed is trying to help orchestrate a $100 BILLION DOLLAR “bridge” loan package to give AIG time to sell assets to stave off bankruptcy and it is EXACTLY this moment that we come to understand the magnitude and utter failure of AIG management who should not have allowed things to escalate to this point. I think in the future there will be entire business management classes and curricula devoted to the study of events surrounding this epic failure.

But the talking heads are missing the point. It doesn’t matter if/how financing for AIG gets arranged today or tomorrow, the damage is done. Credit analysts in the bond markets have marked AIG’s bonds to junk status and the rating agencies have put AIG on “credit watch negative”, which is a precursor to severe ratings downgrades. In essence, perception is reality and many smart people do not expect AIG to survive as it exists today.

But the biggest problem doesn’t rear its ugly head until January 1, 2009 when AIG’s reinsurance treaties expire. Reinsurance is essentially insurance for insurance companies. If the company cannot negotiate renewal of its reinsurance treaties, it  cannot survive as an insurer and will be forced to terminate all in-force policies, citing loss of reinsurance. This is the insurmountable issue as I see it today.  The question of the day is: What reinsurance companies will be willing to “belly up to the bar” for AIG?

Prudence dictates that individuals AND businesses review their exposure to AIG. This is not just an academic exercise. I would urge a review of insurance policies in force as soon as practicable. For individuals that may mean annuities provided by American General, life insurance policies and/or auto policies with 21st Century or AIGDirect. These matters and questions should be reviewed and discussed with your agent. For corporate risk managers or financial controllers: I would direct your insurance broker(s) to provide an assessment of exposure and immediately begin the remarketing of coverage in the event the unthinkable occurs.

That being said, there probably is only ONE person alive who has the gravitas with regulators, capital markets, and reinsurers to “right” the AIG ship: the deposed ex-Chairman of AIG, Maurice “Hank” Greenberg. I believe that only his direct stewardship will assuage these parties. Let’s see if the AIG board has the brass b@lls to bring him back.  Of course, that exposes another long term personnel risk management issue for AIG: life after Hank. But that is an issue for another day. Today is the day AIG needs its Chairman back.

These are truly momentous times. I, for one, will keep my eyes on January 1, 2009 and hope for best (but plan for the worst).

Quick Update as of 4:45PM EST: It appears that Mr. Greenberg has been rebuffed by AIG management (video in link). In this interview today, Mr. Greenberg (who was ousted from AIG over 3 years ago) was asked what “went wrong” and from his perspective, “what happened?”

Mr. Greenberg replied, “I think several things. I think risk management controls either disappeared or were weakened. There wasn’t attention being paid to the accumulation of risk. I felt there was a determination to grow without the right controls in the financial sector of the business. Many things went wrong.”

OK, today let me drop a little insurance strategy on you to help you “evaluate your insurance premium savings quantitatively by increasing your risk retention”.

Got that? That’s a real “fancy-pants” way of saying, “save money by increasing your deductible”, but now you can sound important-like and impress your insurance-geek friends. Just one word of caution: don’t try that one at a party unless you’d rather be alone.

OK, bad insurance humor aside, it’s commonly known that by increasing your deductibles will generally lower your cost of insurance. But today, I’ll give you a strategy to analyze the premium savings to see if it makes sense to take on more risk.

It’s important to understand that insurance is provided by an insurance company on a “cost plus basis“. What that means is that very smart mathematics types (known as “actuaries”) figure out the dollar amount of the frequency and severity of losses that the insurer is likely to have to pay for the risks they assume. Think of this number as just the “pure” loss amounts, without any expenses associated with them. Let’s call that number “X”.

Once that’s done, the financial bean-counter guys and gals get together and add in the costs the company must bear to administer their customers’ losses, such as employing people and costs of adjusting and paying for the losses. Let’s call that number “Y”.

Then finally, once that’s done, the management types (you know, the one’s dressed in suits) add a cost which represents the percentage of profit they want to make. Let’s call it 10%. So the cost of insurance is figured like so: (X + Y) * 1.10.

Sounds too simplistic? It’s closer to reality than you think.

OK, so let’s go back to our generally misunderstood actuary friends (they need love, too). They know that if you take a $100 deductible instead of a $1000 deductible, their frequency of loss will increase, because you’ll be tempted to put in that $250 loss claim now. If you had chosen a $1000 deductible, they’d never see the claim. So, what do we learn from this?

By choosing low deductibles, you are trading today’s insurance premium dollars for future potential claim dollars.

The reason and logic should be clear from the example above: the company has to charge more to pay for its increased likelihood of loss, which also includes the very real and expensive loss adjustment expenses. And because you are paying premiums on a “cost-plus” basis, this is generally speaking a bad deal for the consumer because you are not only “prepaying” your small claim but you’re also paying for the insurance company’s costs and profit-margin targets.

If I haven’t lost you yet, here’s a very simple method of evaluating whether or not increasing your deductibles is a good “buy” for you. It assumes that you have the financial capacity to pay that deductible if/when the loss occurs- Remember: the fundamental rules of personal risk management dictate that we do not take on more risk than we can handle and we never risk a lot for a little.

So with those caveats aside, here it is: If today’s premium savings can “pay for” the difference in deductibles within 3 years, it’s probably a good idea to increase the deductible (assume more risk) and take the premium savings.

Say you have a policy with a $250 deductible that costs you $1000 per year. Your agent advises that the premium would decrease to $750 if you chose a $1000 deductible. So your out of pocket premium savings is $250/year (nice!), but your out of pocket risk has increased $750 (not so nice). Since the annual premium savings of $250 * 3 = the difference in our deductible ($750), it’s generally a good strategy to increase the deductible.

Of course, if you do have suffer a loss within 3 years, you’ve “lost the bet” so to speak, but it’s sting is tempered by your retaining the first year’s premium savings. On the other hand, any loss 3 or more years in the future has paid for itself. Actually, and then some, since premiums tend to rise more or less, every year. The percentage rate increase will be less with a $1000 deductible for example, than a $250 deductible, in keeping with our example.

Now that you got this down, call your agent, save some money (if appropriate) and then go treat yourself to something nice (some chocolate, an ice cream, maybe a new car…) because you’re now a much more savvier purchaser of insurance than you were mere moments ago.

Can’t get enough of this scintillating material, don’t forget to click here for more fun.

Well, just a flurry of activity today, isn’t it? I’m going to be away on vacation until late April/early May so I wanted to commit a few ideas that I’ve been mulling over lately to the site before I either forget them or get caught up in other things. Some concepts I have “in development” as of today that’ll have to wait for my return:

1. A line item breakdown of variable annuity costs - OUCH!

2. Why stock market timing is a bad (but pervasive) idea;

3. A discussion of “senior” seminars and the art of the “sale” - beware the siren call of the “free” steak dinner!;

4. The allure of fixed index annuities and when they are suitable;

5. Long Term Care Insurance Objections (and rational responses);

6. Within every small business owner lies the soul of risk manager;

7. Moral and ethical obligations of a fiduciary;

8. Legal considerations of the sale of securities by “captive” financial advisors/insurance agents;

9. Exploration of the concept of “Personal” Enterprise Risk Management;

10. How to reduce health insurance premiums through exposure analysis;

11. Matching bond fund durations to meet a 1-5 year financial need;

12. “If investing *isn’t* boring, you’re doing it wrong”; and

13. An exploration of personal risk control techniques.

Just a little “light” reading, huh? Also, if you haven’t already done so, please consider registering your email address (or send me an email at md at marcd.com and I’ll register for you!) so that the site updates will be forwarded automatically to you by email. Consider referring a friend to the site - we need more friends! Thanks again for your support and I’ll see you in about a week.

Let’s first get this out of the way: flood insurance suffers from what the insurance industry calls “adverse selection”, which means that for the most part *only* those people that need to buy flood insurance coverage (as required by their lender), in fact do. Some (closer to “most”) people assume that it’s already covered under their homeowners, renters or condo policies (it isn’t) or figure the risk of flood too remote to affect them. Accordingly, the law of large numbers cannot work properly. I’ve outlined 5 forgotten (or unknown) flood insurance concepts that everyone should know:

1. The primary supplier of coverage is the federal government.

It’s true- it’s called the NFIP, which stands for the National Flood Insurance Program. The government contracts with insurers to provide the coverage to you, but the costs (including claims paid) are funded by the U.S. taxpayer.

2. The definition of a flood zone: EVERYWHERE

There’s *nowhere* in the United States where a flood cannot occur. Just because your home is not in a designated flood “zone” should not give you any comfort. In fact about 30% of all flood losses occur OUTSIDE a designated flood hazard area.

3. Flood coverage includes losses from mudslides or mudflow.

If I had a dollar for everyone who told me, “I live on at the top of a hill (or on a hill) - I don’t need flood insurance”. Ask people who live in the hilly areas of California who’ve lost their homes to mudslides if they don’t need flood insurance. Remember, land subsidence (which is for the most part a fancy term for a mudslide) isn’t covered under a standard homeowners/renters/condo policy.

4. There is VERY-limited coverage for basements.

Contents of a basement is NOT covered, nor is any improvements such as finished walls, floors or ceilings. What *is* covered are things like: foundation elements, utility connections, heaters, A/C units, unfinished walls and clean-up. That big screen TV and stereo system you have in the basement is there at your own risk only!

5. Increased Cost of Construction is included (sub-limited).

This is a nice addon and automatically included for most regular flood policies. Basically, the government (through the insurer) will help you pay for building upgrades (post-loss) to reduce the likelihood or severity of a future loss. Amount of coverage available: $30,000. It’s a shame we don’t pay enough attention to prevention or mitigation pre-loss!

Now that we’re conversant with the 3 general types of risk, it’s instructive to understand the basic tenets, or “truths”, of risk management. They may seem simple in concept but you’d be amazed at how many people don’t stop to consider, forget, disregard or plainly ignore them in their daily lives.

• Don’t take on more risk than you can handle (afford to lose);

• Don’t risk a lot for a little gain;

• Consider the odds of the risk you’re taking; and

• Don’t confuse, mistake or substitute insurance for proper risk management and risk control.

Remember that many of the pure risks (risks where there only is a chance of loss) we face in our daily lives are easily handled by insurance. When I consider these tenets, I think back to an experience I had with a trucking company owner who operated a small fleet. During my initial meetings with him and review of his current insurance plan, I noticed that most of the vehicles were being insured for liability only. He explained that as a matter of policy, he took off collision and comprehensive coverages once the loans were paid off and he was no longer required to maintain the insurance coverage.

Seemed reasonable enough, but it’s important to know that many of these trucks (he had about 8 at the time) were still worth in excess of $20,000 *each* and I think we can all agree that a very large financial loss would be suffered should even a *single* truck get totaled in an accident. So, I asked the owner to explain his thought process. He shared that it was his experience that none of his trucks were ever totaled in an accident and he had saved a substantial amount of money in insurance costs throughout the years.

We got to talking more about this. I asked about where the vehicles were kept overnight. He explained that he would back them up into the warehouse dock at night and over the weekend. I asked if he considered what would happen if he woke up one morning to find that the warehouse suffered a fire and 6 of the 8 trucks were destroyed because they were so close to the building itself. He thought about it for a moment…

“I would probably be out of business“, was the response.

The owner never considered that possibility/peril and it changed the whole equation and perception of risk in his mind. Well, I don’t know about you, but I consider going out of business for a peril we can prevent or reduce to be an undesirable and wholly unacceptable outcome.

Premiums on truck collision and comprehensive coverages are *heavily skewed* to the collision portion, meaning the cost of collision coverage was about 4-5 times more expensive than the cost of comprehensive coverage. I explained that for about $300 per year, per truck, we could add on comprehensive coverage only which would cover the vehicles for “just about” every physical peril, including fire- with the exception, of course, of colliding with another object. He said his current insurance broker never had this kind of discussion with him or offered comprehensive separately.

So how does all of this relate to the basic risk management tenets? Clearly, the business owner was unwittingly taking on more risk than he could afford to take and was risking a lot for a little premium savings. He didn’t consider the odds of the risk because he didn’t even *consider* the risk! But once presented, the responsible action was clear.

And no, tenet #4 was not ignored: We discussed moving the trucks away from the building as a loss control measure, but he was concerned about vehicle theft issues and the lighting in the truck-yard was sketchy. Since it was a leased building, there were landlord issues which did not allow him to add more lighting. So, while we didn’t confuse insurance with controlling the risk, we *used* insurance as a risk transfer technique because it was economically reasonable to do so given the circumstances.

The business owner was also happy to learn that comprehensive coverage would also pay in the event one of his trucks was stolen. He said it was always a concern, but one “he lived with”. As you can imagine, his warehouse wasn’t exactly in the best part of town.

You know, I *really* don’t have an obsession with the Bear Stearns implosion, but it’s so chock-filled with cautionary tales I just can’t resist! For those who want to know the basic financing “hows” of the Federal Reserve - JPMorgan Chase deal, this is a nice, easy to understand one page illustration:

Bloomberg graphic

I think it’s fair to say that one of the areas traditional risk management gives short-shrift to is the area of “personal” risk management. Sure, major corporations employ risk managers and teams of experts to assist them survive the myriad of risks present to the “enterprise” but where’s the love for individuals?

Even the risk management educational material I’ve reviewed focuses almost entirely on corporate risk management (I guess it’s because that’s where the money is). This lends credence to my point of view, but my position isn’t set in stone. If there is a wealth of personal risk management educational material available that I’ve somehow missed, let me know. When the data change, so do I.

Let’s face it, the general public depends on insurance salespeople to act as risk managers because:

• A. The general public (and most insurance salespeople) thinks “risk management” is the same thing as “insurance”; and
• B. Most people, who are busy living their lives, don’t consider risk management concepts and techniques.

Professional risk managers wince and take a real dim view of the perception that “risk management = insurance”. They’ll tell you that insurance has a role to play in risk management, but as a financial tool to be used, nothing more. If you can only solve risk management problems with insurance, you ain’t much of a risk manager!

There’s a problem, though - insurance salespeople aren’t particularly versed in risk management techniques. (There, I said it.) They can talk to you all day about life insurance, car insurance, house insurance (you get the point), but to have an intelligent discussion on how to apply risk management techniques to *your* LIFE is not one you’re likely to be engaged in any time soon.

There are exceptions of course, but not many. While a person can obtain a Masters degree or Ph.D in insurance, they’re usually relegated to academia (or locked away, somewhere far away!). These are not your garden-variety insurance salespeople types. The industry attempts to compensate for this education gap, in part through designations such as CPCU, CLU, CIC and CRM. Admittedly, it’s a confusing alphabet soup for the general public.

I would urge you when choosing your next insurance broker or representative, strongly consider those people who have passed the rigorous education and testing requirements required to obtain the designations shown above. You’re much more likely to be able to have a conversation on risk management concepts and techniques if you do.

This brief comic video reminded me of one life insurance sales call I made years ago on a junior executive and his wife.

Despite his wife’s protestations, the guy was convinced life insurance was a waste because he wouldn’t “get anything out of it”. This type of response, while being ridiculous on its face, is a fairly common objection to owning life insurance. Not rational, but common. Of course, life insurance is not for the person being insured, but for the survivors. I explained that it was for his wife and 5 minor children, to help take care of them financially when he wasn’t around to do it. Not a particularly difficult concept to grasp, but he wasn’t having it.

I then reminded him that he had just taken a $685,000 mortgage and I was curious as to how he thought it was all going to work out for his family if he should die during the mortgage term. He answered that he never thought about it because “it wasn’t going to happen“.

It then hit me. He felt the coverage was worthless because he rationalized in his own mind that he wasn’t going to die anytime soon. Not really worrying about the sale at this point, I forced him to verbalize this more and called him on it. I told him I understood his perspective. I said, “Ray, I get it. You’re not going to die” and smiled wide. He leaned back in his chair and smiled back at me as if he won something. He responded, “That’s right“.

Since there’s no use arguing with the wind (or a cat), I could only tell him that he’d “be the first“.

Yes, I updated the site’s “look and feel” to make it a little more easy to read. I also tweaked a few words here and there. Sorry for the lack of posts, I’ve been busy attending at my first Certified Risk Management professional designation course in Windsor CT last week. I look forward to sharing some of that experience in the coming days.

Look, before we begin understand that a homeowner’s policy is a complex document. Remember, an insurance policy is a legally binding contract, so of course, it’s complex and not easy to read. It’s designed that way.

And just so we’re clear, I’m not your agent and I have no idea your particular coverage or circumstance. But writing the post just prior to this one got me thinking: Many people who bought their homeowners coverage in the last 48 months are in all likelihood paying for coverage they’ll never get to use - but think they will. Here’s the skinny, but a point of clarification first:

One of the coverages included in your homeowners policy covers the “dwelling”. In fact, in all probability, your policy declarations page will show just that: “Dwelling” and then a dollar amount indicating the limit of coverage purchased/provided. Assuming you bought replacement cost coverage (you *did* buy replacement cost coverage, didn’t you?), this limit is there (in the best cases) to accurately and adequately reflect the cost to replace the “dwelling” (or “structure”) of the home in the event of a total loss.

In many cases over the last four years, however, people had been forced by their lender(s) to purchase a dwelling limit in an amount that equaled the purchase price of the home. This amount has no bearing to the amount of coverage available under the policy. You see, the “fine print” of most homeowners policies states that the insurance company will pay the dwelling limit amount shown on the policy, but only up to the actual loss sustained! Let’s look at a brief example to help illustrate:

A hypothetical NY/NJ metro single family home, 2000 sf, owner-occupied, would currently have a dwelling replacement value of about $250,000 to $350,000 (anywhere between $125 - $175 per square foot depending on age and build quality). Let’s split the difference and go with $300,000 replacement value. The market value (pre-August 2007) of this home is: $650,000.

Here’s where the lenders missed a turn in the road and their borrowers are paying for it: The policy dwelling limit should reflect $300,000 and not $650,000, even though the mortgage amount is greater than $300,000! (It’s probably around $585,000, assuming a 10% down payment). Because the premium on a homeowners policy is based in large part on the dwelling limit, the homeowner is paying about TWICE what he should because he/she was forced into buying a $650,000 dwelling limit instead of $300,000.

AN IMPORTANT POINT: a homeowners insurance policy does not pay off the mortgage in the event of a loss- it pays the replacement value of the home ONLY, irrespective of your mortgage amount! So, don’t bother torching the home, it won’t pay off your mortgage unless the mortgage amount is LESS than the replacement value of the home - then you’ll get what’s left over after the mortgage is paid.

If you think about it (and who does, unless you’ve got much too much time on your hands), this all makes sense. You don’t want the value of the land to be included in the dwelling limit, that’s just silly. Remember, the land will still be there, even if the home isn’t. It’s doubly silly when I tell you of another “fine point” you’ll find in most homeowners policies… “Land” is EXCLUDED from coverage! Ah, those insurance company types.

In my years as a retail insurance agent, I can’t tell you how many times a lender strong-armed the borrower to insure the property to the purchase price (or at the very least, the mortgage amount). They simply would not fund the loan unless this was done. Well, times are a little tougher for the lenders these days and you just might be able to get them to see it “your way” now.

Talk to your agent and see if you can reduce your cost of insurance today.

This is great quote. Read it and just let it sink in for a moment….

“The entire real estate debacle is the fault of everybody that was involved. And it was all about greed and speed,” said Rachel Dollar, a Santa Rosa attorney who represents lenders in fraud and other cases. “The brokers wanted their commission. The lenders wanted their premiums. The borrowers wanted their homes.”

(Emphasis added by me). The direct source of the quote.

I love the way Ms. Dollar (sometimes this stuff just writes itself!) uses the word “everybody”…. Let me add some more people who need to be included in the “everybody” category…

• Real estate attorneys received payment for their closings;
• Newspapers received increased real estate advertising revenue;
• Home appraisers received payment for their (ahem) valuation reports;
• Home inspectors received payment for their services;
• Homeowners insurance companies received premiums (and still continue to get paid) based on inflated real estate values (which were required by the lender to fund the loan);
• We can add insurance agents/brokers to the line above as commissions in large part are based on the gross premium paid by the homeowner;
• Many local and state governments benefited (and continue to benefit) from inflated real estate values;

I could go on, but you get the point. In short, it’s turned out to be a big turd sandwich in which we will all now have to take a bite.

Almost every investor has a money market account (MMA) or a bond fund. Almost everyone knows these accounts are not ordinary bank accounts and thus are not insured by the FDIC. Of course, FDIC “insurance” is a bit of a canard, as there is nowhere near enough money in reserves to pay everyone who has an FDIC insured account in the event of a sufficiently large enough U.S. banking crisis.

What most people are blissfully unaware of is that a MMA is essentially a very short term bond fund. A bond is essentially a “promise to pay” a certain sum tomorrow (over time) for a certain sum today. There are many websites that explain bond funds in hyper detail (go here for a great primer) - this is the most stripped down explanation I could think of! Bonds can be offered by many entities (corporations/governments, etc.) and are used for many purposes (capital expenditures/cash flow/reserves, etc). “Short term” refers to what is essentially a bond’s duration (which is essentially it’s “repayment period”). The duration of a MMA is usually less than 1 year. Short term bond fund duration as of this writing is about 2 years. Intermediate term bond fund duration is about 5-7 years and long term bond fund duration is 7+ to 3o years.

Let’s consider ABC Company, which needs money to manufacture a new plant. It decides to sell bonds (backed by its ability to repay) to meet its needs. It becomes the bond’s “issuer”. It will pay the bond owner interest for the use of the bond owner’s money today over the duration of the bond. But consider that ABC Company is not in the best of financial shape and would have to pay an interest rate much higher to attract an investor (who is concerned with ABC Co’s ability repay its debt, which is commonly referred to as “default risk”).

So ABC Company decides to pay to have its bonds insured with a monoline bond insurer for a fee, essentially “lending” its own credit rating to ABC Company’s bonds. Without the bond insurance, ABC would (in this hypothetical example) have to pay 8% interest on its bonds, but now that the bonds are “insured”, an investor might only be able to get 5% interest from ABC Co. since the risk of default is (allegedly) far less. ABC Company “pockets” the 3% difference, less the cost of the fee to the bond insurer.

So far, everybody’s happy, right?

• ABC Company is happy, it’s paying 5% interest instead of 8%;
• The investor is happy because the bond is “guaranteed” by a triple AAA rated bond insurer; and
• The bond insurer is happy because it charged and collected the bond insurance premium.

So what happens when the bond insurer goes belly-up? It’s a reasonable question these days and while it hasn’t happened (yet) don’t mistake the improbable for the impossible.

You see, the bond insurers have taken a bite of the sub-prime mortgage mess and the losses in this market segment may cause these insurers to lose their AAA rated credit status and even worse, may bankrupt them.

So in answer to my own question, very bad things would happen. Existing bonds would lose their insured status. New bonds would not be able to become insured, increasing borrowing costs for issuers.  Investors would, in many cases, lose money (principal)  on existing bonds that go into default. The shockwaves are so vast that it’s difficult to get your head around it. Our economy relies so heavily on credit that almost every industry will be effected by this in one way shape or form. Of course, as businesses are negatively impacted, employment will be as well.

The best primer I’ve found to help explain this potential meltdown can be found here. You can’t put your head in the sand on this one.

From wikipedia, “The yield spread premium (YSP) is the cash rebate paid to a mortgage broker based on selling an interest rate above the wholesale par rate that the borrower qualifies for”. What that means in plain language: YSP is a mark-up on the interest rate charged to you over and above the rate a lender would be willing to receive.

Lenders provide rate sheets to mortgage originators (including mortgage brokers). If the originator closes your loan at a rate higher than shown on lender’s rate sheet, the lender pays a percentage of that amount (overage) back to the originator. This is over and above any other fees the originator may charge such as appraisal fees, underwriting fees, etc.

In a prepared statement to Congress in 2002, Professor Howell E. Jackson of Harvard Law School noted in relevant part that the “study indicates that the vast majority of borrowers pay yield spread premiums - on the order of 85 to 90 percent of all transactions” and that “the average amount of yield spread premiums is quite substantial, on the order of $1,850 per transaction, making these payments the most important single source of revenue for mortgage brokers.”

It’s reasonable to suspect the “substantial” YSP amount of $1,850 in the Professor’s study is woefully antiquated. Since this testimony was prepared before the housing bubble, let me give you an updated example for your review, using some reasonable NY/NJ real estate values.

• Hypothetical loan amount: $400,000
• Lender’s par rate per their rate sheet (the rate the lender would accept): 5.50%
• The rate you closed at: 6.25%
• YSP paid to originator: $12,000
• Difference in the total amount of interest paid by borrower on 30 year loan: $69,016.61.

The rule of thumb is for every 25 basis points (0.25) paid by the borrower over the par rate, 1% of YSP is created. So in the example above, about 3% YSP is created. Following the math, $400,000 X .03 = $12,000 would be paid to the loan originator.

As I understand it, there currently is no legal obligation to disclose the loan YSP to borrowers except on the final settlement statement at closing, when it is often too late to do anything about. I believe it is a moral and ethical duty to disclose prior to closing, but since greed trumps morality almost every time, I would urge you request this information before the closing date on your next mortgage.

Further, with many borrowers who bought homes in the bubble years 2003 - late 2007 looking for someone to blame, I wonder what would happen if they looked at the mortgage originator and lender as a prospective target? Perhaps an argument could be made that the lender/originator was “unjustly enriched” for failing to disclose YSP prior to closing. I have to believe that insurers writing mortgage brokers and lenders professional liability (malpractice) coverage are concerned with this. It wouldn’t take many of these actions to start an avalanche of litigation, especially for those in the most “bubbly” real estate markets of California, Nevada, Florida and New York. I’m certain there are litigators who wouldn’t mind trying.

Of course, where the YSP was disclosed and agreed to by the borrower prior to closing, I have no issue. I wonder just “how many” disclosures occurred prior to closing…

I do have one final question, but it is admittedly rhetorical: How can we objectively review borrowers’ legal counsel’s role here? While the closing documents are in preparation, this information is available. What action(s) did borrower’s counsel undertake to explain YSP to their clients? Yes, I know. This line of questioning is a slippery slope with no answer.

Think this post is over the top?  Check out this link.

I’m not going to try to talk you into it. I’ve heard all the objections and reasons for not buying private disability insurance. None of them any good. If you don’t mind NOT having an income when you’re not able to work, you’re right, you don’t need disability coverage.

If however, having a ready income stream when you can’t work is important to you (heck, maybe it’s even a necessity with that mortgage you have and car payment and let’s not forget the insurance and …), you’d be wise to consider it. Premiums are about 3% of gross income per year.

But this post isn’t about buying disability coverage. It’s about buying it BEFORE you start your own business.

You see, no one thinks about disability insurance before they start their new business. Truth is, it’s next to impossible to get it once you begin self-employment. This is due to the financial underwriting process the company will undertake, where you will have to prove the financial “need” for the coverage by providing copies of your W-2 (or similar documentation) for review.

See the problem already? You won’t be able to prove financial “need” because you probably will not have a salary at opening day- OR you will have a greatly reduced salary at start-up, which will severely limit the amount of coverage you will be able to qualify for.

There’s also the bit about employment history. Disability underwriters want to see 2+ years at a job (or at least job function). You won’t have that at start-up either. It’s not difficult to understand why. Offering a policy to someone in a new business has the very real increased potential for claim written all over it. Not doing well in your new venture? No problem! You’ve got a disability policy that’ll pay!

So, before you leave that cushy job (with group long term disability coverage), budget for a disability policy on yourself while you can qualify for it!

My good friend Phil has always said that a very smart insurer could make a killing by offering “End of the World” coverage. The idea is that people would buy insurance to cover themselves from the peril of Armageddon and the “End of the World”. In case you weren’t aware, insurance policies as a general rule specifically exclude the peril of war (there are some exceptions).  In the event of a claim, people could send in their proofs of loss to a mailbox or post office box for review (and prompt payment, ostensibly).

If any underwriter at Lloyds of London thinks this is a good idea for a new product and can get 100% subscription, call me.

Some subjects just lend themselves to exciting writing: politics, religion and of course, the current media-created sensation du jour, Britney Spears. Let’s face it: writing about insurance is kind of like trying to make paint drying exciting and inspires as much enthusiasm as the thought of watching grass grow.

Well, no argument here. In fact, after spending close to 20 years in my chosen profession, it’s absolutely true that people want to know about their coverage exactly on two occasions: when their premium is due and when it comes time to file a claim. This should not exactly surprise anyone.

The industry is vast and complex and it’s not surprising to get (at least) 2 different answers to any one question asked. Even alleged “experts” disagree on fine points of coverage (ask a victim of Hurricane Katrina if their loss was a result of a flood or wind damage) and in many occasions, the court system is relied upon to tell us what the definition of is is. And so goes the insurance industry’s delicate dance with the legal system. It’s sometimes impossible to imagine one without the other.

Personal financial risk management is not for the timid or weak of heart. The best insurance people find reasonable solutions to the very real risks faced by their clients. When things go well, the work goes mostly unnoticed, due to the intelligent risk management design of an insurance professional.

There is a subtle, yet real difference between the terms customer and client – they are not interchangeable. Essentially, a customer is a Wal-Mart shopper: the active party in a transaction. A client is generally defined as one who is “under the protection of another”. Usage of the term “client” conveys an active professional standard and duty of care, which may be why the term has fallen out of favor.

Over the past decade, insurers have come under increasing pressure to become more a “financial services firm that happens to do insurance” than what most people think of as the traditional financial risk transfer role of insurers. With this subtle transition, and much to my dismay, insurers have been quietly exiting the “client” business.

Of course, the insurers are not solely to blame, as they will stress that they are only reacting to consumer demand. There’s truth to it: One cannot get through an evening without seeing at least one TV commercial with an animated character espousing the ability to quote, bind and print auto insurance policies online within minutes.

The subtext is clear: The burden of being “correct” has shifted to you from the insurer (or its representative) . Regrettably, the choices made will not be known to be adequate until AFTER an incident. Let’s be careful out there!