Many Exotic CDs and Structured Notes Involve High Costs and Serious Risks


With interest rates stuck at record lows, and retirees or those on the brink of retirement looking are for higher yields, Wall Street has capitalized on this dilemma by selling an array of alternative products like “structured notes” that promise higher yields but come with higher (often undisclosed) risks, and by marketing dividend stocks as alternatives to bonds, when, in fact, they are riskier than bonds.

A recent article in the Wall Street Journal by columnist Kelly Greene highlighted another such alternative investments: bonds and certificates of deposit with “death puts.” Wall Street is marketing them as a way to allow investors to achieve higher yields without taking on significantly more risk (“Retirees: Pump Up Those Yields,” by Kelly Greene, Wall Street Journal).

Death puts simply allow heirs to redeem bonds and certificates of deposit at face value, meaning they get back all the money that originally was invested. The fee paid for that feature is 0.125%.

The death put is supposed to give a senior investor the comfort to buy longer-term, higher-yielding notes and brokered CDs that otherwise might not repay their heirs the entire principal invested, if the heirs sought to redeem them prior to maturity. It should be noted that it is only the heirs, and not the investors, who can use the death put feature. If an investor needed to cash out of a bond or CD with the death benefit feature before maturity, he or she would only get market value, which could be lower than face value if interest rates increase.

The biggest risk is that the issuer of the death put may default on the payments. Most of the issuers of bonds with death puts are financial-services companies, some of whom are on shaky financial ground. The bankruptcy of Lehman Brothers brought home this risk to many purchasers of its “100% Principal Protected” structured notes, which lost almost all of their principal value.

A second risk is the fact that many such notes and CDs are callable prior to maturity, which exposes the investor to interest rate risk should the bond be called and they have to reinvest the proceeds at a lower interest rate.

A third set of risks involves restrictions placed on the availability of the death put. Some bonds must be held for at least six months before the death put can be used. Others limit the amount that a bondholder can redeem at one time or on the number of redemptions allowed in a given year. Most companies, including GE Capital and Goldman Sachs, have a six-month restriction.

Another potential downside is the fact that the death put might not be worth anything if interest rates remain as low as they are now. As the article explains, “if you died tomorrow, your heirs probably wouldn’t need to use a death put to redeem bonds at par value, because prices are so high that the bonds likely would be worth at least the face value in the open market.”

About $12 billion in bonds with death puts have been issued each year for in the past three years. The number is expected to grow about 10% in 2012. They are typically sold through brokerages including Merrill Lynch, Charles Schwab and Fidelity Investments. Death puts are most commonly used on brokered CDs ? called a “survivor’s option.”

As with all bells and whistles that are added to plain vanilla investments, there is a price for death puts and the price is determined by an actuary or other expert employed by the issuer, who uses sophisticated mathematical formulae to set the price. Unless the investor has, or is able to employ, the same expertise, it will impossible for the investor to tell whether or not the death benefit feature is a good deal or a rip-off. The investor will have to trust Wall Street. Unfortunately, a number of Wall Street firms have repeatedly demonstrated that they put their own interests ahead of their clients and are not worthy of trust.

Page Perry is an Atlanta-based law firm with over 170 years of collective experience maintaining integrity in the investment markets and protecting investor rights.