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Author: KluverBucy One star, 50 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 76406  
Subject: Re: Retirement, college, and Obamanomics Date: 1/3/2013 1:31 AM
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Rayvt,

It requires some pretty serious back-peddling to go from your orignal statement of:

"The market paid a dividend and SOMEBODY received it, and if it wasn't you then it was the IUL company."
......to.....
"The holder of a call indeed doesn't directly collect the dividend, true. But he does, however, indirectly get the dividend by the fact that the price of the option is lower than it would be if the stock didn't pay a dividend"

Nobody was claiming that options pricing isn't affected by whether the underlying security pays a dividend. But your original claim that the insurance company was actually pocketing the dividend payments was simply false.

However, the "discounted" cost of the option does directly relate to my previous question: "do the insurance companies truly use all of the available funds generated by the fixed income securities to create these call spreads or are they skimming some of the income off the top?" For this sytem to work best(provide the highest possible cap) for the policy holder, you want to use all of the funds generated by the fixed income securities and buy the call options as cheaply as possible, so that you only need to sell a really far out of the money call option - thereby giving you the maximum cap possible.

Your recent post states: "The contract says that the policy holder is paid based on what the index does. It says nothing about how the company invests the money. They could buy calls, they could buy gold, they could buy Mongolian yak milk futures. How they make their profit is their problem, not the consumer's. All the consumer cares about is that he gets paid what he is supposed to -- he doesn't care how the company got the money."......Actually having read several IUL policies, I am pretty sure they state that they invest the money using the bull spread option strategy. And it most certainly is of concern to the potential investor how it is invested. If they claim to be using a bull spread options trade, but are actually investing in yak milk futures, this is fraud and may wind up blowing up like a ponzi scheme - not a company that I would invest with.

Next, Dave provided an answer to my above question stating that:" Allianz Life's general account yield is approximately 6.5% They acknowledge taking an 80 bip haircut off the top before applying a 5.7% credit to the IUL contracts, from which the client can choose to keep all the 5.7% yield as a fixed credit, or apply any portion (up to all of it) toward a cap spread with a floor as low as 0% to a ceiling as high as 19%".....Now, that actually confirms one of my concerns with these products - on top of the loads, fees, and insurance underwriting profits, the company is also skimming 0.8% of the fixed income. That is a lot of friction to overcome to obtain decent returns.

Now, let's put all of the dividend and yak milk nonsense behind us. I acknowledge that the returns are reduced by the lack of dividends and I hope you can accept that the company is truly doing a bull spread with the options. You did some nice back of the envelope calculations showing that simply buying the S&P index and collecting the divdends beats the IUL strategy with a 0% floor and 15% cap (I know Dave disagrees with this, but I think your numbers are reasonable). To that I posed the question: "What is better an 8% tax free gain or a 10.5% gain being taxed as a combination of capital gains and dividends?" And here the answer really will vary from one individual to the next. However, I suspect that there at least some individuals that would be better off with the 8% tax free gain. So the logical next question is: are they better off enough to offset the loads, fees, and cost of insurance? Again this seems to be a question that would require a lot of individulized information to correctly answer. But, by getting to this last question what is really being debated is whether IULs are an optimal, fair, or suboptimal investment option - whichever they be, clearly they are not the financial equivalent of a perpetual motion machine or a money merge account.

KB
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