Brokered CD Survivor Option

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Brokered CD Survivor Option

Postby archbish99 » Fri Apr 05, 2013 5:51 pm

I've been thinking about the Survivor Option on brokered CDs. I've read in a couple different instances that these can be useful for older account holders, and it seems like it provides a once-in-a-lifetime opportunity (well, once after a lifetime, really) for a slightly higher yield. Assuming that the portfolio was being left to a spouse, that one's life expectancy was reasonably limited, and that the funds aren't needed during the owner's lifetime, what would be the best way to take advantage of this feature?

Is it simply to say that it reduces/eliminates term risk, and someone in that position should simply buy bonds with the highest possible yield-to-worst regardless of duration? Or should one instead look for bonds selling well below par and expect to redeem at par? The put doesn't change the issue that rates could rise, and better yields could have been had with a shorter investment followed by reinvesting at higher rates; however, when rates do rise, the put at par limits how low it could actually be expected to go, meaning a CD already below par will turn a predictable profit.

This is largely theoretical, since my father's life expectancy isn't known to be limited to a certain period of time, but odds are good that he'll go before my mother does, so I expect it will be applicable at some point while I'm managing their portfolio.
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Re: Brokered CD Survivor Option

Postby john94549 » Fri Apr 05, 2013 7:17 pm

You'll have to show me the math.
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Re: Brokered CD Survivor Option

Postby archbish99 » Fri Apr 05, 2013 7:50 pm

john94549 wrote:You'll have to show me the math.

Okay, a couple simple examples of how this works.... The fixed-income portion is currently a 7-year CD ladder. If I were rolling over a rung right now, 7-year CDs are yielding up to 2.15%. (That's actually for a 6-year CD that happens to have higher yield.) Per $1k of face value, I would pay $1100 now; the account would receive $20 every six months for six years, and then get face value of $1000 when the CD matures in 2019.

Instead, if I knew that the account owner's life expectancy was approximately seven years or less, I could purchase a CD that matures much further out. The current best has a 2032 maturity and a 3.26% yield. Per $1k of face value, I would pay $998.75 now; the account would receive $16.25 every six months, and then get the face value of $1000 when the account owner dies. You effectively get a 30-year CD's yield on a CD held for seven years.

Alternately, if I knew that the account owner's life expectancy was much shorter, I could go for steepest discount. There is a CD for sale currently maturing in 2022 whose price per $1k face value is $974.50; the CD would pay $8.75 every six months, but that's not the main point. It redeems at face value upon the account owner's death -- if that's six months from now, the yield on the CD is a whopping 7%. If a year from now, a still-respectable 4.38%.

Obviously, this isn't a strategy that makes sense for someone who expects to need the money during their lifetime, but it seems like a useful structure for fixed-income investments targeted at being left to a spouse or other heirs.
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Re: Brokered CD Survivor Option

Postby Bob's not my name » Fri Apr 05, 2013 8:29 pm

I did this. Have you read my prior posts on the topic? I've been meaning to write a comprehensive piece on it. There are a lot of options to discuss, such as buying 10-year non-callables vs. 30-year callables with acceptable no-call periods. Regarding weighing discount vs. rate, I used a bond yield calculator to compare yields of the offered CDs in 1-, 2-, and 5-year scenarios, and I also diversified by picking some that would pay the highest yield at the 1-year end and some that would be highest at the 5-year end. I can also tell you a lot about actually exercising the death puts. Since you're not in a rush I hope you can wait for my write-up :)

Here are some old threads. I didn't review them to see if I still agree with everything I wrote at the time:

viewtopic.php?f=1&t=95896&p=1385346

viewtopic.php?f=1&t=113568

viewtopic.php?t=45781

If interest rates ever rise there might be a terrific opportunity to buy today's low rate, long term CDs at steep discounts on the secondary market.
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Re: Brokered CD Survivor Option

Postby archbish99 » Fri Apr 05, 2013 9:53 pm

I'd read two of them. They convinced me that this is an option to examine further, but left me with some questions on specific strategies. Do brokered CDs have a minimum holding period or purchase time before death, for example, other than presumably needing to have settled by then? Could someone hypothetically do a large death-bed purchase of steeply discounted CDs, or would they need to be purchased months ahead?

I'm ashamed to say it didn't even occur to me that as interest rates climb, CDs below par will become far more easily available, making this strategy both more feasible and more profitable....
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Re: Brokered CD Survivor Option

Postby Bob's not my name » Sat Apr 06, 2013 4:04 am

There's no minimum holding period, but the hyperbolic scenario is unlikely, because of course there are other things to do near the death, even for the well-prepared non-family trustee. It does take up to a few months to liquidate after death -- I doubt this ever presents a problem, because you're still earning the long-term interest rate. Even if you bought steeply discounted, low rate CDs, it's still likely the rate of the long term CD will be better than the money market rate the funds will earn after liquidation and before distribution. In a falling rate environment the rate will be exceptionally good. Four years ago I had 6% callables and 5% non-callables after the death. I sold the non-callables at good premiums (the effective annualized yields were double digit) and played out the call period on some of the callables.
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Re: Brokered CD Survivor Option

Postby john94549 » Sat Apr 06, 2013 6:26 am

Tell me more. My Mom is 97, pushing 98, and has a rather tasty conventional CD (at 3.8%) maturing in about 4 years. It is currently "co-trusteed", so I can re-invest when the time comes. Retail CDs, the longest I've found is ten years, and the yields are pretty lame.

One issue that springs to mind is whether a co-trustee CD (in a trust) would qualify. I've wondered how USAA would treat my Mom's death, should she die before the CD term is up. Would it be my option? The interest is reported on her SSN, but I am technically a co-owner, I guess.

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Re: Brokered CD Survivor Option

Postby Bob's not my name » Sat Apr 06, 2013 6:41 am

john94549 wrote:Retail CDs, the longest I've found is ten years, and the yields are pretty lame.
Right now you can buy 3.25% 20-year brokered CDs at just under par and 2.5% 15-year CDs at a 1% discount. For a trustee with a very elderly grantor, an FDIC-insured 3.25% CD is a pretty unimpeachable choice. For a grantor who has a terminal illness, the discounted 2.5% is probably better. The trustee's job is to safeguard the estate, so more aggressive investments are ill-advised.
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Re: Brokered CD Survivor Option

Postby john94549 » Sat Apr 06, 2013 6:49 am

3.25/20 would work. Where do you see this (for future reference, if necessary)? Vanguard?

Worst case scenario is I'm saddled with the 3.25 for the balance of the term, but that arbitrages, in any event.
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Re: Brokered CD Survivor Option

Postby Bob's not my name » Sat Apr 06, 2013 6:54 am

Yes, at Vanguard. Look up the commission schedule for your status, since commissions obviously affect yield. Beware small lots, since there is a minimum commission.

Sorry, I wasn't careful enough. The 3.25% has a call date next month, so the expectation may be a call, even at that rate. I also see a 3.00% asking 99.5 with a September call date. If either of these is called, you will have made better than 3% on a short-term CD.
Last edited by Bob's not my name on Sat Apr 06, 2013 6:59 am, edited 1 time in total.
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Re: Brokered CD Survivor Option

Postby john94549 » Sat Apr 06, 2013 6:59 am

Bob's not my name wrote:Yes, at Vanguard. Look up the commission schedule for your status, since commissions obviously affect yield.


Thanks much. Making a mental bookmark.

Now, write that paper.
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Re: Brokered CD Survivor Option

Postby Bob's not my name » Sat Apr 06, 2013 7:00 am

I was editing as you wrote. Just want to point out that I added a second paragraph to my above post.
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Re: Brokered CD Survivor Option

Postby john94549 » Sat Apr 06, 2013 7:11 am

I suspect the "best of all possible" would be a non-callable. I further suspect the "apples-to-apples" is the 30-year Treasury, which I am prepared to hold, if need be. Mom needs the best current yield. Our estate is ambivalent.
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Re: Brokered CD Survivor Option

Postby archbish99 » Sat Apr 06, 2013 1:29 pm

Commissions at VBS have simplified a good bit.... No minimum, to start with. Commission to buy new issues or to sell is zero; for secondary market purchases, you pay $1 (Flagship or Voyager Select) or $2 (Voyager or Investor) per $1k of face value, with a $250 maximum if you're making a truly massive purchase.
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Re: Brokered CD Survivor Option

Postby john94549 » Sat Apr 06, 2013 2:34 pm

Thank you kindly. Going ultra-long on a brokered CD with a death benefit (if I might be crass) never crossed my mind. It should have been obvious, but who knows?

One wonders at the esoteric financial products which might be available to seniors 85 years plus (and thus not in the market for SPIAs).
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Re: Brokered CD Survivor Option

Postby Bob's not my name » Sat Apr 06, 2013 4:48 pm

john94549 wrote:I suspect the "best of all possible" would be a non-callable.
Not necessarily. Callables typically pay a higher rate and are typically available at longer terms, which also provides a higher rate.

Example: As I mentioned, five years ago you could buy new issue 10-year non-callables paying 5% or 20-year callables paying 6%, with a one-year no-call period. I bought both types for a grantor with a terminal illness. Interest rates fell (contrary to all predictions), so the non-callables could be sold for a good premium instead of exercising the death puts. Had interest rates risen, there would have been no premium, and the callables would have paid better because they had the higher rate. So the callable 6% was the sure thing, and the non-callable 5% was a bet on interest rates falling.

Another example: I bought same for a second grantor, elderly and poorly, but without a terminal illness. Lasted five years. The 6% callables were called, but some not for three years, so I made 6% on 1- to 3-year CDs. I re-invested by buying 30- and even 40-year callables paying 4%, and because interest rates continued to fall those were also called. Meanwhile, the 5% non-callables were fetching significant premiums, so I sold them. I re-invested by buying 2.5-3.5% callables and non-callables at discounts on the secondary market, and liquidated these by death put.

Over the five-year period, the annualized returns I made on FDIC-insured CDs ranged from 12% (best) to 4% (worst).
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Re: Brokered CD Survivor Option

Postby john94549 » Sat Apr 06, 2013 5:40 pm

Going forward, I suspect it's sausage ("wurst").

But an interesting challenge.
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Re: Brokered CD Survivor Option

Postby archbish99 » Sat Apr 06, 2013 8:44 pm

For my parents, I'm thinking I may start rolling over the CD ladder rungs to very long maturities in the next couple years, and if Dad outlives the ladder's intended duration I'll be thrilled for non-financial reasons. At any point where we know he's getting terminal, I'll pull in reserves from other investments to buy the deepest discounts I can find, which will hopefully be plentiful and deep by that point.

With the requirement for separate letters and death certificates per issue, though, that suggests a stronger preference for larger quantities of individual CDs -- some rungs of the ladder are spread to many different issues because the best yields happened to be on smallish lots.
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Re: Brokered CD Survivor Option

Postby mak » Fri Jan 10, 2014 12:45 am

And someone figured out how to scale this and make serious money:

http://money.cnn.com/2013/09/20/news/economy/terminally-ill-fraud/
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Re: Brokered CD Survivor Option

Postby archbish99 » Fri Jan 10, 2014 2:45 pm

Yes, through fraud as the URL and title emphasizes:
Kenneth Israel, director of the SEC's Salt Lake regional office wrote:The Stapleses deceived brokerage firms and bond issuers by casting themselves as survivors of a joint ownership situation when the deceased had no legal ties to the bonds at all.

The deceased, in this case, had opened a joint brokerage account with the scammers before death, but signed documents relinquishing all ownership interest in the account. The scammers then funded the accounts and bought bonds, but claimed the deceased as the actual owner.

It's a worthwhile distinction -- this is a valid technique in an account funded and owned by an elderly or terminal person, who is leaving the account to his/her heirs. That's true even if the person making investment decisions in the account isn't them, but an agent or trustee. But purchasing assets in someone else's name with your own money and while retaining control of the money, but trying to cast them as the owner to take advantage of the survivor option? That's fraud.

Interestingly similar to what some people try to do with UTMA accounts, putting money in their kids' names for the tax savings, but thinking it's still theirs and they can take it back later.
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Re: Brokered CD Survivor Option

Postby mak » Fri Jan 10, 2014 3:18 pm

Right now there are many CDs with low coupons like 1.5%, 2.0%, or the floating coupons tied to some complex formula based on the difference between 5.0% and 6 mo LIBOR times some factor, with a floor of 1% APY minimum, all for sale on the secondary market at steep discounts to par. I found one today at 84c for example. Because of the screwy coupons, people have little interest, and the owners just want out, they didn't realize what they bought a few years now the coupon is 1%. But they have survivor options. A valid strategy for someone with an aging relative with at most a life expectancy of 5 years, who has money lying around with no plan except to leave to heirs, and no interest in taking risk, is to buy these up, ignore the low coupon rate, and hold to death. Buy at 84c, collect par at death. No one can buy life insurance with serious health problems at an advanced age, this is effectively a life insurance policy being offered to anyone with no underwriting, with FDIC insurance.
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Re: Brokered CD Survivor Option

Postby MooreBonds » Fri Jan 10, 2014 10:42 pm

I pursued this strategy with my grandmother's portfolio, from roughly 2004-2011 (when she passed on). Some of the CDs were paying very generous rates, and all of the ones I purchased for her account had the death-put/estate feature. I diversified her portfolio, and had up to 25 at the time of her passing. Back then, the rage of the day were 'spread CDs', where the interest rate was often fixed for the first 6 or 12 months, and afterwards, the interest earned was a multiple of the spread between 2 rates (like the 30 year constant maturity treasury yield minus the 2 year constant maturity treasury yield) times 4%. But there were also some conditional CDs (pays out x% as long as LIBOR is Below a certain level), and other variants.

I had an account for her at both Vanguard, as well as a CD broker up in Maryland (FISN). The market seems to have dried up a bit now, as rates have plummeted and banks have an easy source of cheap money from the Fed.

When it came time to exercise the death put, it wasn't too difficult, it usually is redeemed at the next scheduled interest payment. Since her account had so many positions, I had to send a death certificate for each CD she had. There was actually one CD that I ended up taking ownership of and selling rather than redeeming, since it's market value was above par.

Just one caveat to keep in mind with the estate feature: buried in the prospectus (which I read on each one), there is usually a clause which the bank has the option to limit the total par value of CDs that can be redeemed for a death put to maybe 1% or 2% of the total issue per year. If there happened to be a large chunk already redeemed ahead of you, there's a small chance you might get delayed in being able to redeem it.
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Re: Brokered CD Survivor Option

Postby mak » Fri Jan 10, 2014 10:52 pm

Thanks for this info. I mentioned earlier a CD paying (5%-6 mo libor)*1.2, floor rate 1%, listed as "death put", trading at 84c. I did some research on that CUSIP and was shocked to find buried in the prospectus that the death put is only applicable if the owner dies, was the owner at his death, and was also the owner at original issue. It specifically says the option to redeem without penalty is not available to those who purchase in the secondary market. Also, it mentions the total redemptions cannot exceed 10% of principal of all CDs originally issued. I didn't go farther to find out what happens after the 10% limit is hit, perhaps no one can redeem. These are 20 year CDs, with 18 years left to run. So clearly not ideal to purchase in the secondary market, even though they are listed as "death put". Caveat emptor. (Currently the CD pays around 6%, which is great, but as an "inverse floater", the yield will decline as libor rises, getting down to a floor of 1% if libor exceeds around 4%. Maybe not something to be locked in.)

I didn't know there were prospectuses on the normal bank-issued fixed rate brokered CDs, I got one CUSIP and tried to do some research but found nothing. This was a simple bank CD, 3%, 20 year, brokered CD. I'm worried now about a similar rule, that the death put only applies if you were the original purchaser!
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Re: Brokered CD Survivor Option

Postby MooreBonds » Sat Jan 11, 2014 10:18 am

mak wrote:I didn't know there were prospectuses on the normal bank-issued fixed rate brokered CDs, I got one CUSIP and tried to do some research but found nothing. This was a simple bank CD, 3%, 20 year, brokered CD. I'm worried now about a similar rule, that the death put only applies if you were the original purchaser!


Yes, they typically do have prospectuses on them, and is a good idea to read them. Congrats on doing your research - I can't recall at this point if many of the CDs I purchased for my grandmother had the similar clause that you had to be the original purchaser or not (it was several years ago), but the CDs she purchased were always at the initial issue with the broker or at Vanguard.

I do question about the "original purchaser" clause - I have no evidence of this, but I would expect that it's one of those fine-print details that may not always be exercised by the bank, since it would be a pain to track and look-up. Kind of like it's there as insurance and they don't bother if they have just a few % of people redeeming, but if they start getting a flood of redemptions, then they start checking. But like I said - just a feeling, no evidence whatsoever. The reason why I think this is that the CD is held by your broker - people change brokers and move securities from one broker to another or one account to another, or retitle accounts (marriage/divorce/death), so the issuer can't simply just go by the original brokerage account info at purchase.

If it were a CD that has some convoluted equation like the LIBOR one you referenced, and if rates rose it would pay out essentially nothing, then I wouldn't try gambling on the "original purchaser only can redeem" clause...but if it's a straight-forward CD (i.e. just a flat rate CD or a step-up rate with 1 rate for the first few years, and another flat rate for the later years) and if the rate isn't THAT bad where you could grin and bear it for holding another 5-10 years to maturity, I might gamble buying it with just a small position, and in the event they deny the death put, you simply hold it to maturity.

And actually, now that I think about it - this is an excellent way to reduce one's estate if you're above the $5+ million estate credit!!! Just buy bonds with small coupons at low prices now (might have to go out 7-15 years), and if the person passes on when the bonds are still low-priced, it reduces the value of their estate. Then, the heirs hold them to maturity, when the prices rise up. Of course, this requires the bond buyer to be able to tolerate the low current yield to maturity on the bonds....but if the time to maturity isn't excessive, and if the price of the bond is right, you can really do well in reducing your estate value, and converting that bond increase in value to capital gains (taxed at 15%), instead of the estate tax taxed at 35%-40%!
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