by Dr. Mark H. Shapiro
"There are worse things in life than death. Have you ever spent an evening with an insurance salesman?"... ...Woody Allen.
Commentary of the Day - January 26, 2004: Doing the Texas Two-Step.
As any regular reader of Molly Ivins knows, the great state of Texas is a top-notch incubator of crazy public policy schemes. According to an article in yesterday's Los Angeles Times by staff writer Scott Gould, the latest of these is a clever variation of the "dead peasant" scam that is being foisted on the Texas Teacher Retirement System by none other than former Texas senator Phil Gramm, who now works for the UBS Investment Bank of New York. Alert readers of The Irascible Professor might recall that Phil Gramm's wife Wendy Gramm, while Chair of the Commodity Futures Trading Commission, played a key role in pushing through key regulatory exemptions that allowed Enron to game the electricity trading market without government oversight. (At the same time Phil Gramm was collecting six-figure campaign contributions from Enron.)
For those of you who might not be familiar with Russian history, the "dead peasant" scam refers to the practice of buying the ownership rights to dead serfs then selling those rights before the buyer becomes aware of the fact that the serfs are dead. Under the variation of the scheme being promoted by Phil Gramm and Texas governor Rick Perry, the state of Texas would float a bond issue using Gramm's employer -- UBS Investment Bank -- as the underwriter. The proceeds from these bonds then would be used to buy annuities through UBS PaineWebber Inc. The annuities would be used to pay the premiums on life insurance policies that would be taken out on members of the Texas Teachers Retirement System. These life insurance policies would not provide any benefits to the members or their families. Instead, upon the death of an insured member, the proceeds from the life insurance policy would be used to retire the bonds, and if anything is left over it would go to the Texas Teachers Retirement System health fund. The fund currently faces a major long-term shortfall owing to a $30 million loss they suffered when Enron went into bankruptcy and the poor investment climate from 1999 to 2002, as well as to changes in the system put into place to help cover the deficit in the Texas state budget.
On the surface the Perry-Gramm scheme seems to be better than sliced bread. Except for the underlying gouhlish nature of the idea of betting on the longevity of retired teachers, everyone would appear to win. Various UBS subsidiaries would collect millions of dollars in fees and commissions, and the Texas Teachers Retirement System health fund presumably would net a tidy sum.
However, as any serious investor knows, when something sounds too good to be true it usually is. The catch in this scheme is a subtle one. Life insurance companies are not run by fools. The insurers are in business to make money. They do that by investing premiums conservatively, and by making sure that they pay out less in benefits than they make on their investments. They employ armies of actuaries to make sure that they won't be caught short if there is a sudden spike in the mortality of the people they insure. The bottom line is that life insurance, when viewed as an investment, is a lousy one. The typical rate of return is less than 4%.
Remember that to buy the annuities to pay those insurance premiums, Texas will have to float bonds. The investors who buy bonds also are not fools. They, in effect, will be loaning Texas money. They want two things in return. The first is a decent rate of return on their loan, and the second is the eventual return of their principal. The current rate of return on high quality tax-exempt bonds is right around the 4% level. So at best one could hope to break even if the Perry-Gramm scheme is adopted. But, that does not take into consideration the commissions and management fees that will have to be paid to UBS. Those are likely to add another one or two percent in costs. The net effect likely will be that the insurance payments fall short of what is needed to service the bonds, the retirement system health fund gets nothing, and the Texas taxpayers end up holding the bag because in order to get that low 4% bond rate they would have had to back them with the state's credit.
The best solution, of course, to meet the shortfall in the retirement system health fund would be a temporary increase in taxes. From an economic point of view it always makes more sense to fund current expenses out of current income. But, given the penchant of Republicans like Perry to avoid taxes, the next best solution would be for Texas to issue relatively short-term bonds to cover the immediate needs of the retirement system health fund. The improving investment climate should allow the state to pay off these bonds from gains in retirements system investments without having to pay the exorbitant fees and commissions associated with the Perry-Gramm scheme.
It should be noted that the Perry-Gramm scheme is a take-off on similar private-sector plans. Large corporations such as Wal-Mart have been using the payouts from similar life insurance policies on their rank-and-file employees to fund health care and other benefits for current employees. These private sector schemes also have come under fire from critics who note that they work only because of the tax breaks that accrue to the companies when they buy the life insurance. In effect, the companies are using the taxpayers to fund their benefit programs rather than using their corporate profits.
It doesn't take much imagination to realize that if the Perry-Gramm scheme is adopted, the Texas taxpayers will end up footing the bill not only to shore up the retirement system health plan, but also to pay millions of dollars in commissions and fees to UBS.
© 2004 Dr. Mark H. Shapiro - All rights reserved.