Adjustable Premium

  

Categories: Insurance, Tax, Regulations

You buy a hamburger for $5. Then, two bites in, the cook comes over and says "you know what, I just got a call that the price of meat went up. You owe me another dollar for those next few bites." That's basically the gist of the adjustable premium, except with insurance policies instead of food.

An insurance policy where the price can fluctuate over time has what's called an "adjustable premium." In these situations, the contract has stipulations allowing the insurance company to change what the policyholder is paying. There are limits (it's not as bad as the hypothetical hamburger we outlined above). The amount that the premium can change is set out in the initial contract. So it's not totally predatory and random. But it's mean.

The key? Stay healthy.

Related or Semi-related Video

Finance: What is Adjustable Rate Preferr...15 Views

00:00

Find it a la shma What is adjustable rate preferred

00:06

stock Okay let's start with the basics preferred stock and

00:11

yes we have a whole video on this one as

00:12

well Preferred stock generally pays a dividend and is often

00:17

convertible into common stock at a premium to where it

00:21

was issued So preferred stock is kind of bond like

00:26

and kind of equity Like fish Most preferred stocks get

00:30

issued some set dividend like a base rate of say

00:33

six percent or something like that And note that it's

00:36

called a dividend in the case of preferred stock not

00:41

an interest payment subtle but very important difference here because

00:45

interest on bonds is tax as ordinary income and dividends

00:49

on equities are qualified meaning that their tax at long

00:54

term gains rates or dividend tax rates anyway these preferred

00:58

pay six percent no matter what the price at which

01:02

one preferred unit trades will fluctuate like a stock or

01:06

bond But that thousand dollars par preferred will just continue

01:11

to pay its sixty bucks a year in dividends until

01:14

the preferred shares are bought back by the company you

01:17

know at some premium or until the shares convert into

01:20

being common stock or the company goes bankrupt in armageddon

01:24

scenario one starring ben affleck jr But in the case

01:28

of adjustable rate preferreds it's not always the six percent

01:32

that gets paid or whatever the initially stated rate wass

01:36

in the case of these equities and yes preferred stocks

01:39

considered equity even though it acts like a bond Sometimes

01:42

in this case the dividends will very with some set

01:45

indexed like t bills or live or where the preferred

01:50

dividend might be set on a say a trailing four

01:53

quarter bases to be two hundred basis points Mohr interest

01:58

that it pays than the average t bill reign as

02:02

of blah blah blah blah time frame Well why would

02:05

you want this adjustable feature with preferreds Well you can

02:09

imagine a scenario in a low interest rate environment where

02:13

we have preferred stocks paying five percent and the prevailing

02:16

rates are three percent for very high quality dead teo

02:20

top notch blue chip companies But then we get inflation

02:25

and that three percent for the best borrowers goes to

02:28

six percent and a given preferred stock would then need

02:32

to pay more like eight percent to be trading around

02:35

The thousand dollars par value it was issued at So

02:38

said another way if that piece of paper is on

02:41

ly giving investors fifty bucks a year when a very

02:45

similar piece of paper gives investors eighty bucks a year

02:49

investors will want charity They will sell down than thousand

02:54

dollar piece of paper giving only fifty bucks to price

02:57

low And so that when it's bought it pays eighty

03:02

bucks a year in charity right that thousand dollars going

03:05

to sell down to nine hundred eight hundred seven hundred

03:08

until whatever you pay for it pay the same interest

03:10

rate is that eighty dollars year thing Thank you Inflation

03:13

specifically In this case a thousand dollars preferred paying fifty

03:17

bucks a year would have to sell for six hundred

03:21

twenty five bucks teo yield eight percent meaning that the

03:26

thousand dollars par value that investors bought in a five

03:29

to ten years ago would drop dramatically by three hundred

03:32

seventy five dollars a unit to be six hundred twenty

03:36

five dollars To be quote at market unquote and that's

03:40

a problem a big risk that investors will hate Hence

03:44

the invention of the adjustable feature here Adjustable rate preferred

03:49

Stock Great inventions So in this case if it preferred

03:53

was adjustable if rates went up a cz were describing

03:56

here then it is extremely likely that the t bill

04:00

or live or rates would go up similarly as they

04:03

generally follow inflation grids over time And in this scenario

04:08

if the rate of the dividend on the preferred stock

04:11

at just's then it's always going to be something like

04:15

t bill ray plus three hundred basis points or something

04:18

like that so that if there really is big inflation

04:22

and federal funds rates go from three percent to six

04:25

percent The return on these preferreds would go up about

04:29

the same amount making the security much more appealing to

04:33

investors Got all that well let's Just hope that if

04:36

anything else is in need of getting adjusted those investors

04:39

will take care of it in private nia do that

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