ERROLD F. MOODY JR.

February 13, 2006

National Underwriter

33-41 Newark St.

Second Floor

Hoboken, New Jersey 07030

RE: January 9th, What are Proper Investments for Retirement, Blazzard and Hasenauer

Gentlemen,

I have enjoyed Bazzard and Hasenauer articles for some time and even used one of their quotes in my book. But I take considerable exception to the above article. I too act as an expert witness but primarily act as a personal financial planner and educator. I have taught literally all the securities licenses, real estate courses, continuing education for CFP's attorneys, brokers and insurance agents and much more. The enclosed resume speaks for itself. I would add that I am one of about 35 Life and Disability Insurance Analysts in California- those able to charge a fee for insurance advice. As such, I believe I can add a level of real life application that is lost in the article commentary.

First and foremost is the fact that if a client acts solely on their own, then they are generally on their own- the reference if they buy a variable annuity directly from Vanguard, Fidelity or the like (though even here there can be problems). But I start to ‘wonder' about the bulk of the sales by reps who rarely are trained to know what they are doing or selling- yet have to accept the responsibility thereof. Or, more likely, with their broker dealer firm and/or the insurance company.

The article states that a variable annuity is for living too long, not just about dying when the stock market is down. That, in my mind, coincides with his second comment that an initial allocation could be construed as "unsuitable". However, I submit the question is not about hindsight- it is about the responsibility that the agent et al is taking with that initial offering, allocations and risk and whether there was adequate knowledge aforethought. Doubtful. That's because any plan must start with a comprehensive budget- see below.

The article states that some "statistical analysis" exists which can level the volatility of the risks. Sure- just use bonds. But as you do so, you reduce returns. As such, the article states that retirees may find, at some point, that their assets are insufficient for their income. How will they find that out? Ouija Board? HP12c? The first more so than the latter. Assuming that they do take on unacceptable risk against the advice of the agent and in view of a proper plan, the client may have little recourse in a subsequent claim of additional losses (and justifiably so), but it is also the issue of how definitive and valid the initial advice was. And we now have hit the most critical planning element for retirees- the budget. More definitively, a specific retirement budget. There is just no way to figure out risk and suitability unless you can reasonably and rationally innumerate how much the client needs for retirement. While I certainly submit that an explicit budget can be "off" even at the beginning of retirement, nevermind over a period of 20/30 years, it is mandatory that a solid attempt be made for this number. It does no good to apply any suitability characteristics unless you know- via a budget analysis- just how much was needed (Social Security excluded). With that, and effectively only that, can an adviser determine the risk necessary for a lifetime (caveats added addressed further). For example, if the client needs $40,000 a year at retirement, inflation is 3.5%, investment returns are 7% and the actuarial lifetime is 25 years, the "kitty" needed is $670,000 (rounded). Perhaps some retirees have that effective kitty and are relieved that they will "make it". But these statistics are based on a flat rate or return- which has no bearing to real life.

No period of time has seen a 7% flat rate annual return. If I see that, game over. Volatility dominates. Somebody, some entity at some official/professional level has to be knowledgeable that such presentation will not hold up under most past history.

The prominent comment on page 19 is, ‘the planning function calls for assistance of a retirement professional who can assist retirees in finding the ‘proper' investments for their needs". I repeat, no formal budget, no ‘proper' investments or allocations. Therein is the crux of the plaintiffs complaint. Just what was done? Certainly a plan had to incorporate exactly what risk is.

Unfortunately, the bulk of plans by almost every firm have ‘confused' risk with standard deviation and show that ‘risk' declines over time. True, standard deviation does go down. But the longer securities are held, the greater the risk of a loss. Actually an investor can expect about 50% less funds than anticipated. I submit that there is a fiduciary duty to provide this material to clients. But it is not done. Why? Well, first and foremost, the fundamentals of investing have never been taught to brokers. A series 7 rep has not been taught diversification, beta, alpha, correlation, standard deviation and on and on. I have a great difficulty in looking at an agent and its firm when they are woefully negligent in the knowledge necessary to understand risk. If you do not know diversification, you cannot determine risk. If you do not know risk, you cannot determine suitability. Really simple actually. Worse yet for a plaintiffs claim, I have never even yet met a securities attorney who knew what diversification was by the numbers. Not one. Not one who understood risk. It's not available with a law degree. None of this has been presented to arbitrators either. I repeat, if you do not know the definition of diversification by the numbers, you cannot determine risk. If you cannot determine risk, you cannot determine suitability. What about CFPs? Still no good. They have been presented some of the elements of risk, but never the true statistical relevance of standard deviation nor the associated formula showing a risk of loss. Designations and degrees might look good on paper, but the underlying competence remains suspect.

From here we go to the house of Monte Carlo. Most recognize this a statistical method of analyzing the odds of success. I am going to have to see this in order to know whether the odds of success of a portfolio have been addressed. It is generally conceded that a withdrawal rate of about 4% would allow the assets to last to a level of 95%.

But in the above example defined the investor, by what reason is anything going to work? If the 4% statistic has merit, the retiree will need $1,000,000 in order to have an acceptable retirement ($40,000 excluding Social Security). Few retirees will have the extent of those assets. If the adviser did NOT address the proper assets and risk for and the retiree got caught in a bad period of the economy, is it the retirees fault for it all going wrong? Or attempting a higher risk when the "trusted" plan falls flat? Actually, the flat rate of return plan was a fraud- the retiree would was rarely going to make it. Certainly if the assets were distributed into a fixed annuity and other parts into life insurance, the retiree is really behind the eight ball.

Sure the retiree may have done something beyond acceptance, but the adviser has to have presented the caveats of investing. Yet none- at least very few- have ever defined the risk of LOSS. Per Investments by Bodie Kane and Marcus, "the impact of a one time standard deviation over the entire portfolio could reduce the amount anticipated by almost 50%." So now what if the retiree takes on extra and unacceptable risk? Was it the retirees fault that they were never told about the risk? No- it was the advisers lack of knowledge, competency and fiduciary duty.

This statement is corroborated by 2000- 2002 (actually planning for past history). Most "advisers" want to state that the 44% losses sustained during that period were merely reflective of the economy and a bad market. Nope- they were consistent with the economy and the losses sustained in a similar period of 1973- 1974. What was indicated to retirees regarding an initial wholesale slaughter of their retirement assets? If one is a professional adviser, it is mandatory to address risk. And it is necessary to adjust the allocation to reflect what devastation might occur.

Assume $670,000 with an initial $40,000 withdrawal indexed for inflation

Year S&P 500 Loss/gain Total Addition (Reduction) Remaining

1973 -17.37 (-116,000) ($156,000) 514,000

1974 -29.72 (-153,000) (194,000) 319,600

1975 31.55 100,000 57,000 376,000

1976 19.17 72,000 28,000 404,000

1977 -11.50 (46,000) (92,000) 312,000

1978 1.06 3,000 (44,000) 268,000

1979 12.31 33,000 (16,000) 252,000

1980 25.77 65,000 15,000 267, 0000

1981 -9.73 (26,000) (77,000) 190,000

In 9 years, the portfolio has shrunk $480,000. Even if the portfolio then returned a flat 7% rate, it would last just about another 5 years. No matter how you run the numbers, the assets will be gone roughly 10 years before the retiree is ‘scheduled' to die. Is the rationale and defense merely an unacceptable past history? Or that the ‘market always comes back?' No- training and presentation of risk is mandatory by the adviser PRIOR to 2000- 2002. After all, the inverted yield curve in early 2000 was so obvious with its risk projection , no one could have missed it with a brick. But is this historical position presented in any courses- including those for CFPs? Nope. The sophomoric defense commentary that "gee, everyone knows the market goes up and down" and "the market always comes back" are illogical and almost wrong for most retirees. It is whether or not the retiree's MONEY will ever come back. Big difference.

This commentary could go on and on. But the point is clear- all of these issues have to be addressed if an adviser can relinquish the responsibility to a investor/client/retiree. There is limited defense if a formal budget was not done. A percentage of current expenditures is rarely satisfactory. There is very limited defense in the use of a flat rate of return. There is some offset with a Monte Carlo analysis- but that is generally a computerized plan that, while it does indicate volatility and risk, does nothing to help ameliorate the economic scenario such as 2000- 2002. A plan has to incorporate far more than stay the course during financial devastation.

Putting assets into various allocations serves no purpose unless the risk of success is identified with real life applications. Advisers knew or should have known of the implications of 1973/74 and had a duty to acknowledge same to retirees. Also to reflect what they would do should such scenario happen again. Otherwise they and their firms are liable. That a "plan" cost only $500 or $250 or whatever and that the retiree should have known they weren't going to get much for that price has no validity as a defense. Retirees- effectively all clients- are novices as to risk. Further, they "trusted" the adviser.

If an adviser wants to use a variable product, it is not about having money to last a lifetime. A variable product (actually the agent) MUST account for economic changes by adjusting the portfolio to reflect new risk. Losing 44% in a variable annuity does what? Nothing. That you can get income for life with a lowered asset base that will not provide enough money for retirement serves no purpose. The adviser got paid for developing a plan and allocation. If one lives forever, maybe the conformist presentations will work. But real life applications clearly show that the knowledge base of the planners and their firms limits the competency and capability of the adviser to properly counsel the retiree. MPT, modern portfolio theory, is only valid at the time it is presented. It does not address future occurrences. That does not mean that the adviser has to have a crystal ball. But it does mean they have to clearly and unequivocally present the entire case for risk and reward up front so the clients/retirees are fully informed what can happen and what will be done. If that is not done, the agent and firm are liable for breach of duty.

Very Truly,

Errold F. Moody Jr.