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Déjà vu? Assolutamente non!Article added by Michael Pinkans, CFA on August 8, 2011
Mike Pinkans

Michael Pinkans, CFA

Freehold, NJ

Joined: July 18, 2011
The Hidden Truth About the Affordable Care Act
In economics, delta means change and “I” stands for interest rates. Our goal is to provide you with solid economic news that can help explain changes in the economic environment not only affecting your business, but providing you opportunities to take advantage and stand apart from your competition.

In the final days of the debt ceiling debate, politicians, along with television and radio pundits, warned of financial Armageddon if a debt deal wasn't reached. The public was told that the stock market would immediately drop at least 1,000 points and interest rates would skyrocket, costing the American public hundreds of billions more in debt payments.

However, after reaching a debt deal this past Tuesday, the market continued to fall along with interest rates. What is going on and how does this impact our business?

Over the past few days, the Dow Jones Industrial Average (DJIA) has dropped more than 1,000 points, easily erasing all the gains experienced thus far in 2011, and then some, as the market has fallen more than 15 percent now.

Are we experiencing déjà vu from the fall 2008 financial meltdown? Assolutamente non (Italian for absolutely not)!

Unlike the fall of 2008, this is not a financial crisis. Markets are functioning, governments are borrowing and large companies can borrow money very cheaply. Volatility in the marketplace is still pretty tame compared to 2008. Economies are slowing, not falling. However, storm clouds are forming on the horizon.

There are three principal reasons for the worldwide stock market drop.

First, the Eurozone rescue package for Greece and Ireland really didn't do much to solve long-term economic issues for many southern European economies. Ireland and Greece are still in serious financial trouble and Italy, Spain and France are not far behind.

Italian 10-year government bond yields yielded 6.12 percent on August 3, 2011 compared to 4.87 percent on July 1, 2011. While Prime Minister Silvio Berlusconi has led an interesting lifestyle (to say the very least) while in office, he may not survive the next few months, leaving Italy in a political vacuum.

Spanish 10-year bonds yielded 6.26 percent on Aug. 3 and Spain's prime minister has already rushed back to Madrid after starting his vacation earlier this week as Spain is due to sell up to $5 billion of 3- and 4-year government bonds next Thursday into a jittery marketplace. Even French debt yields have doubled recently compared to stable European leader Germany as France has been slow to cut a chronic deficit. We may be witnessing the beginning of the end of the Euro.

Second, the U.S. debt ceiling debate brought out the sheer scale of the fiscal challenges in the world's largest economy. The debate wasn't pretty and portrayed politicians on both sides in a bad light. While Congress just left for a four week vacation (perhaps patting themselves on the back for finally coming to an agreement on the debt ceiling), their work isn't done. In fact, the current deal has merely put a Band-Aid on a large gash that really requires many stitches. Not only does the current deal involve making tough decisions on cutting certain expenditures before Thanksgiving (when automatic cuts go into effect), but trillions more in cutbacks or revenue increasers must be made over the next few years.

Third, the developed world is reporting anemic economic growth. What you see continuing in the U.S. is happening in many advanced economies. Higher unemployment, businesses hoarding cash rather than investing in new equipment and personnel, and consumers cutting back on spending is causing the world's economies to slow down, making future government austerity spending plans even harder to attain.

As a result, instead of interest rates increasing in the United States, money is flooding into the safety of U.S. debt instruments. The 10-year Treasury has fallen from 2.90 percent just a few days ago to close at 2.45 percent recently. It may even begin to approach 2.25 percent.

Why is the money coming here? While we know we have economic issues in the United States, they are still less severe than in other advanced economies. We still have the financial might to fix our problems compared to other countries and without the corruption rampant in countries such as Russia. If anything, we should remain optimistic about the U.S., because the rest of the world certainly seems to be, based on their continued purchases of our debt.

However, the low interest rate environment is causing other issues. Recently, Bank of New York said that customers that have deposited more than $50 million into their accounts since the end of July will face an annual fee of at least 0.13 percent of the excess deposits. Can it really be true that a bank will now charge depositors for the privilege of depositing their money? Bank of New York says they have been forced into this position as companies and investment managers continue to hoard cash and with basic reserves costing the bank 0.10 percent, it can't afford to hold the excess cash with short term investment options being so low. Not many customers have $50 million, but the trend of banks charging for the privilege of doing business with them will increase.

How does this affect our industry? On the annuity side, guaranteed multi-year interest rates are plummeting; guaranteed income rider rollup rates and SPIA payout rates are dropping as well. On the life insurance side, a depressed interest rate environment will force term and guaranteed universal life rates to increase again. These changes are occurring even as you read this.

What's the opportunity? Don't be like Congress and take a four week vacation. Call your customers immediately. There is still time to lock in solid, fixed annuity rates or income rider rollup rates. You literally have days to lock your clients into these higher guarantees.

For those who have been presented with an insurance proposal and are "thinking about it,” help them understand that the significant drop in interest rates will impact insurance pricing and crediting rates now and for the foreseeable future.

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