liabilities Archives - Bankers Anonymous

I conducted an experiment last week to test a long-held theory. The ubiquitous funny advertisements with the green lizard have led me to believe I could save money by calling up my automobile insurance provider and asking them to reduce my costs. (FWIW I don’t use that company. I have a different one, and I’m loyal to mine.)

Long story short, it worked. At the end of my phone conversation with my provider I’ll pay $20.07 less per month. To state some obvious math, that’s $240.84 per year.

I think my choices are prudent for me, but they are not free-lunch choices. I made a series of calculated gambles based on what I know about insurance in general, my particular car, and my personal financial situation.

This all started from a conversation over coffee with a reader two weeks ago. He mentioned that since the 1980s he’d declined to pay for collision insurance on his car, and that he calculates having saved at least $30,000 since then as a result. That got my attention. I realized I haven’t deeply studied the different components of auto insurance. Maybe you haven’t either. Now’s your chance to get a little nerdy with me.

For starters, auto insurance is required by law in every state. The required part of auto insurance is liability insurance. That’s for when you damage someone else’s body, car, or property. In Texas you’re allowed to buy a minimum of $25,000 in coverage per person or car, and $60,000 per incident. I pay to insure well over the minimum amounts and I didn’t mess with this liability part of my auto insurance policy.

The second part of auto insurance – which turns out to be optional in some cases – is collision insurance. That’s the amount you’ll receive if your car gets damaged.

Here’s where insurance theory and two other personal finance theories came into play. I’ll hit you with all three theories. First, insurance is expensive, so buy the least you can while still avoiding catastrophic financial risk. Second, don’t buy too much car. Third, try to buy so little car that you can avoid having a car loan. This third part is admittedly rarely achieved, but something to strive for. Because if you can eliminate your car loan, you have more options with collision insurance.

(Not meant as an advertisement. Just the pictures was BIG!)

If you have a car loan, your lender makes you buy collision insurance, naturally, because the car acts as collateral for your loan. A smashed up car makes for poor collateral. If you don’t have a car loan, however, you can decline collision insurance.

I don’t have a car loan. I also don’t have a valuable car. In combination, that means I’m not terribly worried about losing many thousands of dollars in value if I wreck it. During this process I looked up trade-in value [LINK to Kelly Blue Book https://www.kbb.com] for my 11 year-old Hyundai Elantra with 95,000 miles and learned it’s worth $1,800 to $2,5000. I don’t expect my insurance company to shower me with much more than that amount, in the event of a total wreck. And I’m not dropping $7,000 in repairs into this automotive beauty in that event either. Both of these factors mean I should keep my collision insurance to a minimum. I declined to pay for any collision insurance this week, because that suits my particular circumstance.

A fourth rule of personal finance came into play on the issue of comprehensive coverage. The rule is that it helps to have money in order to save money.

I saved a small amount when I upped my comprehensive coverage deductible from $500 to $1000. A few definitions might be helpful to explain what this means. Comprehensive coverage protects me if something other than another motorist hits me, such as hail damage, a tree falling, or flooding. The deductible is the amount I’m on the hook for, in the event of needed repairs. My upping the deductible is really a result of being able to handle the financial hit if a bad thing happens. If I didn’t have either savings or decent lines of credit, I wouldn’t be able to responsibly increase my deductible. But I do, so it’s cool. That’s the “it takes money to save money” thing.

A few other fine-print things I considered during my auto insurance conversation.

I continue to pay for vehicle damage if I’m hit by an uninsured motorist, although I lowered my coverage to the Texas state minimum of $25,000. As I mentioned, my car ain’t worth $25,000, so I’m probably over-covered there.

I continue to pay $1.65 per month for towing and labor. Between a history of dead batteries and flat tires, it feels like I need a tow or jump start more than once a year. So I’m getting my full money’s worth there, if history is any guide.

I also learned that our household auto insurance premiums won’t jump in six months when my eldest gets her learner’s permit. But they will jump in 1.5 years – quite a bit – when she gets her full license. I could hear the empathetic pain over the phone in the auto insurer representative’s voice when I told her my daughter’s age.

So that will be a future auto insurance cost increase. In the meantime, I was happy to squeeze out a bit in savings while I could.

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scary_pension_liabilites — You want to see something really scary?

The headline is from The Twilight Zone movie, from when I was about 10 years old. As for the rest of the movie after that first moment, I experienced it as an audio-only event. I just stared down at my feet, too freaked out to look up above the seat in front of me.

I thought of the line this morning when I read an ordinary-seeming Wall Street Journal article about a legislative move to allow companies to continue to underfund their pensions.

Corporate pension-funding, analogous to long-term retirement planning or college funding for individuals, really comes down to small choices that we make today that have extraordinary consequences thirty years in the future.

This is the kind of thing which we – and our leaders – should worry about late at night.

Instead of course we focus on strategizing about which reality TV star ought to release a sex tape to revive her career, or which NFL player’s ongoing pattern of domestic abuse will cause a ‘distraction’ to his team during Sunday’s game.

I guess I’m just saying we’re typically not spending enough time worrying about the really scary things, like under-funded pension liabilities.

The WSJ article details that Congress passed, and Obama signed, a transportation bill that happens to contain a provision to allow companies temporary relief from fully funding their pension obligations. In the fine print of the article we learn that the pension-funding obligation comes from calculations of current interest rates, which are extraordinarily low. What companies wanted, and our leaders delivered, was a pension-funding formula that took into account interest rates of the last 25 years, rather than the last 2 years. This is a key difference.

Here’s how I assume it works: If you observe that prevailing interest rates of, say, 10 year bonds are at 2%, then you have to make the assumption that all money invested in bonds for the next ten years will return just 2% per year. That’s reasonable. And from there you can calculate how much money you’ll have in 10 years, using compound interest. (see how I always work in a link to that idea?)

The problem is that if you assume only a 2% return on your money, then you need to invest a lot more money today in order to actually have enough to meet the future obligations of your pension plan.

If you could instead assume a bond rate of return of 6% – because that was the average interest rate over the past 25 years – then you need a lot less money to fund your pension plan. Problem magically solved. Companies are happy. CEOs are happy. Workers who depend on pensions eventually are unhappy. But hey! As Meatloaf says, 2 out 3 ain’t bad.

As I’ve written previously, the low returns of bonds are a major drawback of a low interest rate environment, when you have to have enough money for the long run. Endowments and charities and pensions that previously depended on a healthy bond portfolio to kick out 5-6% returns every year are stuck either generating less money for the long run, or they’re going far out onto the risky end of the investment spectrum (over-allocating to stocks or more exotic risks) to make the numbers work.

Or, as we saw yesterday, just pretend you can get the returns on bonds that we got over the past 25 years. Ignore our actual historically low interest rates now with magical-thinking assumptions.

By the way, what happens when companies underfund their pensions?

If a company disappears or goes bust, the federal government (and therefore you and me, via taxes) picks up the unfunded pension liability through an agency known as the Pension Benefit Guaranty Corporation. Just as the FDIC guarantees bank deposits (up to a certain size) and insurance regulators guarantee insurance payouts (when an insurance company fails), so does the PBGC pick up pension obligations when a private company with a pension goes bust. In 2010 for example, 147 companies with pension failed, and the PBGC paid our $5.6 Billion in liabilities to pensioners.

A big factor in the GM and Chrysler bankruptcy and bailouts of 2008, for example, had to do with the government pension guaranties.

For some time before 2008, GM and Chrysler had morphed from car manufacturers with large pension plans into giant pension-liability companies that also happened to make some cars (that not enough people actually buy anymore.)

I can’t claim to know the details of the agreement signed into law yesterday, but using tricks like a 25 year average on historic interest rates, rather than current interest rates, should keep us up all night, rather frightened.

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