LSAs: Recipe For Disintermediation

Some years ago I served for a period of time on our local “Better Business Bureau” board of directors. At one time during my years of service, the main complaints we were receiving were being directed at health spas and physical fitness centers. Most of the complaints centered on the way they were handling membership fees. Typically, a member would sign up for a year at a stipulated fee per month. The member actually was signing a promissory note, which the spa promptly sold to a bank. If the member, after a few weeks of exercising, decided to drop out of the plan, the individual then discovered he or she still owed the balance of the note, and the banks insisted upon payment. Shock turned to anger, which resulted in a complaint to the BBB.

Because of the bad report we issued on all of these organizations, their business suffered and a group of them asked for a hearing to plead their side of the case. The request was granted and they pointed out that engaging in physical exercise was difficult for most people and unless there was a strong incentive to continue the program, most would drop out after a short time and their health would suffer as a consequence. The incentive to continue in this instance, they argued, was the loss of the money they had pledged to pay. They also produced statistics to show that pay-as-you-go plans did not work because of the high drop-out rate.

The board could see the logic of imposing some kind of discipline on a plan for physical fitness, but still, we did not like what was perceived as a deceptive way of financing the discipline. A compromise was reached, which required the spas to be more open in their dealing with their members and provide full disclosure as to the penalties involved. It worked and the complaints soon stopped.

Financial fitness, like physical fitness, also requires discipline. When I came into our business, I worked initially with middle-income families who were not unlike the families of today. They had dreams and ambitions but had done little to bring them about. It was a fact that at that time, most of their savings accounts had less than 100 dollars in them and the rate of savings was sporadic at best. Typically, I would ask a 45-year-old how much he or she had saved out of the last months pay. The answer was usually “nothing,” and then I would point out that they had only 240 such paychecks left before age 65 and 240 times nothing is still nothing. That was usually the springboard for creating an insurance plan that provided “double duty dollars”family protection, coupled with a long-term savings plan. Early termination caused the loss of insurance protection and a financial penalty thereby injecting a sense of discipline into the plan. It has worked well for millions of people who might otherwise have clung to their rollercoaster savings accounts.

Nevertheless, despite the availability of excellent savings regimes, the savings rate in this country continued to decline. To counter this, some years ago the individual retirement account was created and it offered a tax deduction to spur savings rate. People simply moved funds from a non-tax advantaged account to one that gave them such an advantage. It is, I believe, an established fact that no new funds were created. In fact, Deputy Treasury Secretary Samuel Bodman recently stated at a press conference that there has been a steep decline in personal savings.

So, now comes the latest proposal to bolster the nations savings rate. I refer to Senate Bill 2263 in support of “Lifetime Savings Accounts” (LSA), whereby a person could put up to $5,000 per year into a savings account that would accumulate, tax free and which could be withdrawn at any time without penalty. In my opinion this measure, if enacted, will do more harm than good. For a starter, I believe “lifetime savings,” as applied to this concept, is a misnomer. It wont be a lifetime accountit will last until the owner needs a new boat or a new car. It may be a boon to consumption, but without any elements of discipline, insofar as leaving the funds to grow, it wont be there when it comes time to retire.

Perhaps even more important, what kind of disruption will this create in the financial markets? If experience with IRAs has taught us anything, it is that people will simply move funds from other accounts to this new medium. What then will be the consequences of such disintermediation? Accounts with long-term discipline are sure to suffer.

The adage “you cant have your cake and eat it, too” seems appropriate here. That cake will be long gone before retirement age, because the discipline to leave it along and persevere is missing.

Reproduced from National Underwriter Edition, April 23, 2004. Copyright 2004 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.