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‘Asset-intensive’ annuity reinsurance has NAIC’s attention

In the six years from 2018 through 2023, U.S. life/annuity companies ceded over $600 billion in reinsurance—essentially reducing their liabilities by a similar amount and potentially reducing their capital requirements by billions of dollars, according to AM Best.

An unknown amount of those liabilities are now covered by reinsurers in Bermuda, where U.S. regulators can’t necessarily see all the assets backing them. What does that mean? Does the reinsurance make a life/annuity issuer stronger or weaker? How should insurance regulators respond?

Since last winter, the Life Actuarial Task Force (LATF) of the National Association of Insurance Commissioners (NAIC) has been working on a response. It has produced a draft for a new “guideline” that “establishes additional safeguards… to ensure that the assets supporting reserves continue to be adequate.”

On October 24, the LATF met again to talk about the guideline, hosting a public Zoom meeting. Interest was high: 239 people were on the call. No conclusions were reached, but the task force expects to have a guideline in hand in 2025.

The LATF produced a detailed, 56-page backgrounder for the call, including input from the American Council of Life Insurers, the American Academy of Actuaries, and members of the public.

Many reinsurance transactions are unremarkable. Life/annuity and property/casualty insurers routinely use it to share or off-load risks to specialized reinsurers in order to re-deploy scarce capital to different ventures—or to underwrite more annuity business.

But reinsurance—in the view of economists at the Bank for International Settlements, the Federal Reserve, and others with financial fragility concerns —has been increasingly manipulated since 2013 to reduce the cost of writing annuity business—in ways that were once frowned upon. Large asset managers have bought life insurers, gathered revenue through the sale of fixed deferred annuities, set up their own reinsurers in Bermuda or the Cayman Islands, and moved liabilities to them, freeing up capital.

It’s not clear how much of the $600 billion in reinsurance (see below) was involved in this “Bermuda Triangle” strategy, as RIJ has dubbed it.

Source: AM Best.

When reinsurers are offshore, however, U.S. regulators have a harder time seeing, analyzing, and evaluating the assets. When the annuities are “asset-intensive”—more like investments than insurance—ensuring the safety and performance of the underlying assets becomes more urgent for regulators.

Here’s how the LATF laid out the issue in preparation for its October 24, 2024 meeting:

“State insurance regulators have identified the need to better understand the amount of reserves and type of assets supporting long duration insurance business that relies substantially on asset returns. In particular, there is risk that domestic life insurers may enter into reinsurance transactions that materially lower the amount of reserves and thereby facilitate releases of reserves that prejudice the interests of their policyholders.”

The LATF has been enhancing its regulations to detect under-reserving with weak assets by offshore affiliated reinsurers. The task force is considering:

From https://www.theactuarymagazine.org/thinking-beyond-price/

“Enhancements to reserve adequacy requirements for life insurance companies by requiring that asset adequacy testing use a cash flow testing methodology that evaluates ceded reinsurance as an integral component of asset-intensive business (emphasis added; see sidebar).”

Morgan Stanley, whose equity analyst, Bob Jian Huang, covers publicly-traded life/annuity companies, issued a research brief on offshore reinsurance on October 23. “Regulators likely want to have better line of sight into the reinsurance agreements for offshore entities. Further ability to have comfort around these reinsurance relationships is also critical,” the brief said.

According to Morgan Stanley, “The use of reinsurance to derisk and free up capital has become increasingly popular in recent years. Reserve credits taken at an industry level are up 65% over the last five years, and modified coinsurance reserves are up 76% for the same period. Specifically, credits ceded to non-US reinsurers have more than tripled since 2018, while credits taken to US-based reinsurers are up 31%, comparatively. Favorable reserve requirements, investment flexibility and tax efficiencies are among a few reasons driving this trend towards offshore reinsurance.”

“Regulators hope to have a guideline by the end of 2025, and the Life Actuarial (A) Task Force, the task force which put forth this proposal, is on the preliminary agenda for the National NAIC Fall meeting, taking place on November 16-19,” Morgan Stanley said.

© 2024 RIJ Publishing LLC. All rights reserved.

Honorable Mention

Gainbridge, RetireOne to offer non-tax-deferred MYGA for RIAs

Gainbridge Life has issued the annuity industry’s first non-tax-deferred annuity product and is partnering with RetireOne, the no-commission annuity sales platform for registered investment advisors (RIAs), to distribute it, according to a release.

That will make RetireOne the first outsourced insurance desk with a non-tax-deferred annuity product among its offerings to clients, the release said. FastBreak allows clients to withdraw funds prior to retirement without the early withdrawal tax penalty associated with traditional MYGAs. Owners are taxed annually on interest earned.

RetireOne will distribute two Gainbridge MYGA contracts: FastBreak, which is not tax-deferred, and SteadyPace, which is tax-deferred. Both offer fixed rates as high as 5.50% annual percentage yield (APY) for the longest terms, according to the release.

Gainbridge, which offers fixed annuities for RIAs, is owned by Group 1001, which also owns Delaware Life. Serving the commission-paying annuity market, Delaware Life issued $2.73 billion worth of MYGAs and $970 million worth of deferred fixed indexed annuities in the first half of 2024.

Started in 2011, RetireOne offers no-commission annuities from multiple “A” rated companies to more than 1,200 RIAs, who access the fiduciary platform at no additional cost to them or their clients. RetireOne said it currently services over $1.8 billion of retirement savings and income investments.

Because FastBreak earnings are not tax-deferred, owners will not owe a 10% tax penalty if they withdraw interest before age 59½. If they make withdrawals from or surrender their contract before their investment term, a withdrawal charge and a market value adjustment will apply to an amount over the 10% annual free withdrawal amount.

The FastBreak multi-year guaranteed annuity product with form number ICC23-D-NTDMYGA-BASE, and SteadyPace™ multi-year guarantee annuity product with form number ICC22-D-MYGA-BASE, or variations of such, are issued by Gainbridge Life, a Delaware-domiciled insurer headquartered in Zionsville, Indiana.

Income Lab launches new income planning tool

Income Laboratory, Inc. (Income Lab), maker of retirement income planning software, has launched a tool with annuity modeling, comparison, and stress-testing capabilities for financial advisers and their clients, the company said in a release.

The new offering will help “illustrate how annuities work, to compare annuity options, and to evaluate how annuities affect how much clients can spend in retirement and the security of that spending,” the release said. Income Lab’s CEO is Johnny Poulsen. [You can read a past article in RIJ about Income Lab here.]

The new tool integrates with Income Lab’s existing suite of retirement planning tools, will allow advisers to:

  • Create personalized retirement income scenarios that incorporate annuity income alongside other sources of retirement income, such as Social Security and investment portfolios, to see if an annuity is right for the client.
  • Assess the impact of annuities on overall retirement risk by stress testing how an annuity would impact a plan during some of the worst times in history.
  • Evaluate different annuity options head-to-head to see which performs better in which environments.
  • Help clients identify what type of annuity may (or may not) fit their retirement goals and risk tolerance.

Income Lab software was named “Best in Show” at the 2022 & 2023 XYPN Advisor Tech Expos, was the “Highest-Rated Retirement Distribution Planning Tool” in the 2023 T3/Inside Information Advisor Software Survey, was named a “Stand-Out in Retirement Distribution Planning,” and was rated highest in satisfaction and value by the “Kitces.com Report: The Technology that Independent Financial Advisors Actually Use (And Like).”

For more information about the new annuity features or to explore Income Lab’s full suite of retirement planning solutions, visit IncomeLab.io.

Schroders polls plan participants on appetite for private assets

More than one-third (36%) of participants in a 401(k), 403(b) or 457 workplace retirement savings plan would invest in private equity and private debt investments if their plans offered them, according to the Schroders 2024 U.S. Retirement Survey.

Of participants surveyed, 80% of these participants said access to private investments would lead them to contribute more to the plan. Of those interested in private investments:

  • 52% said they would invest less than 10% of workplace retirement assets in private assets.
  • 34% would invest between 10-15%.
  • 8% would invest more than 15%.
  • 6% are unsure how much they would invest in private assets

“Alternative investments such as private equity and private debt have long served as important portfolio diversifiers in defined benefit plans. Given the evolution of the asset class in recent years, it’s a matter of when, not if, these investments will become more common in defined contribution plans,” said Deb Boyden, Head of US Defined Contribution, Schroders, in a release.

Half of all plan participants (51%) surveyed said they don’t understand the benefits of adding alternatives to their retirement portfolio, and 64% said alternative investments sounded risky to them. More than half of participants (52%) said they don’t know how to manage risk in their retirement portfolio and 59% want more investment guidance from their employers.

The Schroders 2024 US Retirement Survey was conducted by 8 Acre Perspective among 2,000 US investors nationwide ages 28-79, including 780 Americans who currently participate in a workplace retirement plan (e.g. 401k, 403b, or 457 plan). The survey was conducted from March 15 to April 5 in 2024.

Protective enhances its flagship variable annuity

Protective Life Corporation, a subsidiary of Dai-ichi Life Holdings, Inc., has enhanced its Protective Aspirations variable annuity, which has been issued by its principal subsidiary, Protective Life Insurance Company, since 2022.

Product enhancements include:

  • New advance payout options added to the SecurePay Protector benefit: In addition to SecurePay Protector’s standard, guaranteed lifetime income payout option, 3-, 5-, 8- and 10-year advance payout options are now offered to provide more choice and control to when customers can begin receiving income.
  • SecurePay NH withdrawal rate cap increased to 15%: The SecurePay NH benefit, a nursing home enhancement available with both income benefits in Protective Aspirations variable annuity, has been improved from 10%, now providing up to a 15% withdrawal rate.
  • New maximum daily value death benefit: Available up to age 77, the new death benefit provides the greater of contract value, premiums less withdrawals, or the greatest daily value up to the deceased owner’s 83rd birthday.

Protective Aspirations variable annuity is issued by Protective Life Insurance Company (Nashville, TN) in all states except New York under policy form series VDA-P-2006. SecurePay Investor benefits issued under rider form number VDA-P-6063. SecurePay Protector benefits issued under rider form number VDA-P-6061. SecurePay Nursing Home benefits issued under form number IPV-2159. Policy form numbers, product availability and product features may vary by state.

Variable annuities are offered by Investment Distributors, Inc. (IDI), the principal underwriter and distributor for registered products issued by Protective Life Insurance Company, its affiliate.

© 2024 RIJ Publishing LLC. All rights reserved.

Bermuda Shorts

Private credit sector growing fast: Financial Times

A headline in the Financial Times from October 7 read, “Why private credit’s gung-ho growth needs proper monitoring.”
Citing projections by Morgan Stanley, JPMorgan and the International Monetary Fund (IMF), an FT reporter wrote:
“Whether you take the IMF’s view that this is a $2tn-a-year industry, or JPMorgan’s that it tops $3tn, experts seem to agree on one thing: the growth pattern of recent years is only going to accelerate.

“After expanding by 50% over the past four years…, the [private credit] sector is set to balloon by 90% over the next four. Private capital giant Apollo said last week that it aimed to double its assets under management to $1.5tn by 2029, powered by an annual $275bn of private credit.”

The collaboration between banks and private equity companies on lending to companies was demonstrated by the recent announcement that “Apollo and Citigroup would collaborate on $25bn of lending. Earlier deals involved Oaktree and Lloyds; Brookfield and Société Générale; AGL and Barclays; Centerbridge and Wells Fargo; the list goes on.”

The article added, “The recent push by big asset managers, including BlackRock, State Street and Invesco, into the private capital space, making easy-access private credit exchange traded funds available to retail investors, adds another layer of systemic concern.”

Addressing the possibility of greater financial instability, FT wrote, “the positive view is that the shift of loans away from banks is exactly what regulators sought with their post-2008 rules to make banks safer.” But “ever since regulators began chasing risk out of the banking system a decade and a half ago, they have acknowledged a need to monitor where it is going, without properly doing so.”

Venerable launches its own line-up of variable annuity insurance trusts

Venerable Investment Advisers, LLC, an investment adviser and wholly-owned subsidiary of Venerable Holdings, Inc., has launched “an initial line-up of mutual funds comprised of approximately $9.9 billion in assets under management,” according to a release.

The mutual funds in the launch, and subsequent funds, serve as investment options for insurance company separate accounts and bring the management of the mutual funds underlying Venerable Insurance and Annuity Company’s variable annuity business in-house.

Venerable Advisers engaged investment advisory subsidiaries of Russell Investments and Franklin Resources, Inc. (“Franklin Templeton”) to provide sub-advisory services with respect to Venerable Variable Insurance Trust (“VVIT”).

Venerable is a privately held company with business operations based in West Chester, Pennsylvania; Des Moines, Iowa; and New York, NY. Venerable owns and manages legacy variable annuity business acquired from other entities.

Venerable was created by an investor group led by affiliates of Apollo Global Management, Inc., Crestview Partners, Reverence Capital Partners, and Athene Holdings, Ltd. Venerable Investment Advisers, LLC, was established in 2023 and manages the mutual funds underlying Venerable Insurance and Annuity Company’s variable annuity business.

© 2024 RIJ Publishing LLC. All rights reserved.

How ‘Demutualization’ Changed Everything, Part II

The “demutualization wave” of the late 1990s was a watershed for the U.S. life/annuity business. It was the outcome of forces building up for two decades. It would have profound effects, simultaneously good and bad, on the life/annuity business in the new millennium.

While demutualization was happening, the controversy surrounding it focused on insurance policyholders and whether they would be paid fairly for surrendering their ownership interests in mutual insurance companies. But the companies that went public experienced much bigger changes.

Demutualization gave U.S. life insurers new strengths and new vulnerabilities. They could gobble up other insurers, but they could also be gobbled up. They escaped the tyranny of interest-rate risk but became victims of equity-market volatility. Instead of quiet policyholders, they got noisy, impatient shareholders.

With demutualization, a life insurer goes from being a cooperative aimed at providing its owner-customers with insurance “at cost,” to being a diversified financial corporation aimed at maximizing value for its shareholder-owners. That’s a fundamental change. Demutualization changed the products that stock life/annuity companies sold, how they dealt with financial or biometric risk, their management “styles,” their distribution partners, the regulators they faced, and the accounting regimes they used.

There are infinite numbers of ways to connect historical dots. Causation and correlation can be hard to tell apart. It’s difficult to identify the tipping point that starts a trend until the trend is under way or even over. Today, blessed (or perhaps cursed) with hindsight, we can get a clearer look at the drivers of demutualization (covered in RIJ’s October issue) and its consequences.

The consequences of demutualization

The changes that insurance companies underwent when they demutualized were too subtle for the casual observer to recognize. That was true in part because the changes were already underway at the time of conversion. It was also true because few people had ever understood what happened behind the scenes at life insurers.

Let’s look at a few of the major consequences of demutualization.

From insurance to investments

Coincident with demutualization, the late 1990s saw a “historic shift in life insurers’ overall product mix toward annuities” and away from life insurance sales. (Obersteadt) Although still called life insurance companies, non-mutual insurers and private equity–led life insurers were now primarily annuity companies. (In the U.S., only life insurers can sell annuities.)

After becoming stock companies, life/annuity companies increasingly focused on selling annuities that resembled investments more than insurance and whose returns were correlated more with the stock indices than with interest rates. From 1997 to 2009, non-mutuals focused on sales of variable annuities. Later, their sales focus shifted to index-linked annuities.

Variable annuities are diversified bundles of mutual fund–like investments whose gains aren’t taxed until withdrawn. Fixed indexed annuities (FIAs) and registered index-linked annuities deliver gains only when equity (or hybrid) indexes go up. All are “deferred” annuities; despite their optional income riders, they are used more to generate “protected growth” before retirement rather than to produce lifelong income during retirement.

By contrast, mutual life insurers prefer to sell life insurance, deferred fixed rate annuities—whose yields are determined mainly by prevailing interest rates—and either immediate or deferred “income annuities,” whose sole purpose is to provide guaranteed income for life.

“Inflation caused the development of a series of investment products lodged within life insurance companies’ variable life and annuity products. The converting [demutualizing] life insurers are more active in the separate accounts market than the non-converting insurers” and “increase their separate accounts activity significantly after conversion, indicating the possibility that they are able to expand their separate accounts activity once they have access to capital markets.” (Erhemjamts and Leverty)

Annuity sales in the U.S. have exceeded life insurance sales every year for at least the past 20 years, according to LIMRA. In 2004, U.S. life insurers sold $183 billion worth of the annuities and $121 billion in life insurance. In 2021, sales tallied $237 billion and $164 billion, respectively. In 2023, according to iii.org, life insurance premiums were roughly one-third of annuity premiums ($121.5 billion vs. $360.7 billion).

Focus on fees rather than “spreads”

Anecdotally, stock analysts prefer financial companies whose income is steady from quarter-to-quarter and throughout the years. Analysts are hesitant to recommend the shares of stock life insurers whose earnings are sensitive to movements in interest rates—which haven’t been steady for decades.

Traditionally, life insurers earned their profits from the spread—the difference between what they earned on their bond portfolios and the interest rate (internal or explicit) return promised to policyholders or contract owners. But deferred variable annuities are long-term products that generate steady asset management fees for fund companies and income rider fees for the life insurer.

When a mutual insurer’s own internal investment management team managed the company’s bond investments and held bonds to maturity, the company enjoyed little or no opportunity to earn asset management fees or trading profits. But large, aggressive, alternative asset managers like Apollo, KKR, Blackstone and Ares now own annuity-issuing life insurers. They can earn high-fee revenues from managing their life insurers’ assets. The asset managers, formerly known as buyout firms, also create customized high-yield debt, bundle and securitize it, and sell tranches of the bundles to various clients around the world—including their own insurers.

From buying “biometric” risk to dealing in investment risk

Life insurers are called life insurers because they employ actuaries who specialize in estimating the life expectancies of individuals and groups. Traditionally they sell protection against dying too soon (i.e., sell life insurance) or against living too long (sell income annuities or annuity riders). Through risk-pooling, asset-liability matching, and buying-and-holding the safest corporate bonds to maturity, they can afford to provide protection from a cluster of investment and biometric risks much more cheaply than the average person’s cost of  “self-insuring” against them.

Publicly-traded life/annuity companies have steadily de-emphasized the purchase of biometric risk. Over the years, in fact, they have pulled back from the purchases of any risk. Owners of variable annuities bear virtually all of the volatility risk of their contracts’ account values. Owners of fixed-rate annuities pay surrender fees and market value adjustment fees that eliminate much of the insurers’ interest rate risk. Owners of FIAs bear the opportunity cost of receiving zero yield when the equity indices their contracts are tracking go down during specific crediting periods. They “pass on to the customer the risks and the benefits of the investment management process.” (Friedman)

Traditional mutual insurers focus on managing the risk of their liabilities—i.e., the risks of paying large, unanticipated claims—and sometimes buy reinsurance to protect themselves from extreme claims. Publicly-traded life insurers and private equity–controlled life insurers increasingly focus on managing the risks of their assets—i.e., investment risk—and use reinsurance structures to sell their investment risk to institutional investors, such as pension funds and endowments.

From buying public-market bonds to buying securitized private credit

 The trillion-dollar asset management firms—also known as private equity firms, buyout firms, and loan originators or alternative asset managers—began creating large numbers of “leveraged loans” for high-risk small and mid-sized companies. Banking regulations (Dodd-Frank) after the Great Financial Crisis made it more costly for bank syndicates to lend to such firms. Wall Street firms filled the vacuum with this private credit.

Highly-rated corporate bonds still account for most of the assets in life insurers’ general accounts, but life insurers, led by the private equity–led insurers, hold increasing amounts of private credit in the form of tranches of bundled and securitized leveraged loans.

These tranches typically have slightly higher yields than corporate bonds with similar credit ratings. Although life insurers do not buy leveraged loans directly—individually they’re too risky—insurers help finance the private credit business when they buy tranches of bundled loans.

Some observers have been worried by the resemblance between these securitizations, known as collateralized loan obligations and the collateralized debt obligations that fueled the over-creation of credit that preceded the Great Financial Crisis.

From career (“captive”) sales forces to independent agents

A mutual life insurance company relies on a different type of sales force to sell its products than a stock life insurance company. Mutual insurers traditionally employ their own dedicated salespeople—known as career or captive agents—who sell only their employer’s products. Captive agents were the sales people who typically sat down with young married couples at their kitchen tables and coaxed them into buying life, home, and retirement products from the same mutual insurance company.

But the process of hiring, training, and retaining such a force—a standing army of salesmen, in a sense—was expensive. When mutual companies became stock companies, many cut costs by either shrinking or eliminating their captive forces. Instead, they engaged individual insurance agents (for fixed annuities) and brokers (for variable annuities) indirectly, through insurance marketing organizations or brokerage firms, respectively.

These wholesaling organizations contracted with, trained, and supervised the people who actually sold the product. They also selected the menu of products that the agents and brokers could sell. The life/annuity companies paid commissions on the sales, with the lion’s share of the commission going to the agent or broker and a smaller portion going to the intermediary organization. Thus they turned a fixed cost into a variable cost that could be built directly into the sale of the product.

“Third-party distribution now represents 52% of sales in life and 81% in annuities. As the competition among insurers in third-party distribution continues to intensify, strategic distribution relationships are becoming closely intertwined with insurers’ success,” according to McKinsey’s January 2024 report, Redefining the Future of Life Insurance and Annuities Distribution.

In handing over the responsibility for managing salespeople, however, life insurers also hand over some of the control. Their reliance on distributors for sales inevitably gives distributors power over them—power to make the annuity manufacturers compete against each other for the agents’ and brokers’ loyalty, which they may once have been able to count on more easily, if not taken for granted.

As a result, “Distributors are demanding more from insurers in the form of personalized bonuses, proprietary products, API integration capabilities, and more. Distribution partnerships also increasingly require insurers to make significant investments in product differentiation, sales incentives, servicing, and technology. These investments can be quite costly to insurers.”

More complex regulation

Demutualization brought more life insurers into clashes with federal regulators. Under the McCarran-Ferguson Act of 1945, life insurers, their products, and the sellers of their products, are regulated by state insurance commissions. But publicly-traded life insurers, like other publicly-traded companies, must report to the Securities and Exchange Commission (SEC) and submit new variable annuity products, which include securities, to the agency for approval. Reporting to the SEC is no small burden or expense for life insurers.

As publicly-traded life insurers create more annuities whose performance is tied to the rise or fall of equity indexes (like the S&P 500 Index), there’s ambiguity as to whether these products should be regulated as securities or as insurance products.

Index-linked products with variable returns (RILAs) are regulated by the SEC and sold by brokers, but index-linked products with fixed returns (FIAs) are regulated by 50 different state insurance commissions. In 2007, the SEC tried to regulate FIAs as securities, but failed because the courts ruled that FIA’s no-loss guarantee made them insurance products.

Multiple conflicts of interest

The most subtle but perhaps most significant effect of demutualization may be that it created a conflict of interest between the companies’ shareholders and their customers—the policyholders and contract owners. No one can serve two masters equally at all times.

Insurers are not alone in this. All publicly-traded companies face conflicts of interest to varying degrees. But in the case of mutual life insurers, the fact that policyholders were also dividend-earning owners—they owned “a piece of the Rock,” as Prudential used to boast—created an imperfect but powerful network of loyalty and trust. Shares are much easier to trade away than insurance policies, annuities, jobs, and policyholder rights.

When publicly-traded life insurers became more reliant on commissioned, independent agents and brokers to sell their annuities, the conflict between the clients’ interest and the brokers’ or agents’ interests was added to the mix, creating room for another layer of mistrust between the public and insurance companies.

Bottom line

In the early 2000s, professors at UMass-Boston and Northeastern University studied 11 major U.S. life insurers that fully demutualized (bought out their policyholders with cash or stock) between 1997 and 2001. They found that “demutualization promotes efficiency in the life insurance industry as well as in the capital markets and hence can be viewed as socially desirable.” (Chugh and Meador, 2006)

“Management in these companies has successfully implemented a strategy that is based on higher growth, greater profitability, improved cost efficiency, and innovations in product offerings. These firms take more risk in managing their portfolio assets. The stock form of organization increases transparency in reporting and governance, and provides opportunities for firms to engage in mergers and acquisitions. In addition, the demutualized firms offer new securities for investors and unlock the value lying dormant in the mutual policyholders’ surplus. For these reasons, the long-run market returns of demutualized companies have outperformed various market indexes, including the NASDAQ Insurance Company Index, creating economic value.” (Ibid.)

There’s a case to be made that demutualization has led to a split between life insurers and some of the academics who do retirement research. Academics have written countless books and papers on the benefits to retirees of owning immediate income annuities—the type of annuities that publicly-traded life insurers are least likely to sell. This contributes to confusion in the public’s mind about the value of annuities.

A quarter-century after the stampede, one could argue that demutualization backfired, even as it achieved several of its tactical goals. Though, as stock companies, life insurance companies could use shares as mergers & acquisition currency to acquire other life insurers. They also made themselves into acquisition targets. In that sense, demutualization may have hastened the consolidation of the industry. As stock companies, they also could accept billion-dollar infusions of equity capital from European firms like ING and AXA, only to see that capital take flight after the Great Financial Crisis.

Demutualization clearly made life insurers more vulnerable to financial turbulence. The U.S. stock market crash in 2008 reduced the value of the investments backing the lifetime income guarantees of variable annuities by tens of billions of dollars. It did variable annuity issuers little good that the investments were in separate accounts, under the contract owners’ control, or that the investments were likely to (and did) recover their value long before the issuers would need to pay most of the claims on those guarantees. (Obersteadt)

The market crash created the equivalent of a margin call for life insurers, like The Hartford, which had written those lifetime income guarantees and under-hedged the market risks associated with them. The Hartford, for instance, needed an emergency $15 billion loan from Allianz Life of North America. It later sold its retail annuity business to Goldman Sachs. Meanwhile, insurers that remained mutual, such as New York Life, Guardian, Northwestern Mutual, experienced stress during the 2009–2022 low interest-rate famine but survived.

In retrospect, some life insurers appear to have followed the herd into demutualization without fully understanding the exposures, hazards, shareholder demands, and bad press they would face in the sharp-elbowed world of stocks. It’s not that they weren’t warned.

“Many of the companies that are becoming public are doing so with a general lack of the necessary years of experience that it takes to manage a company optimally on a GAAP basis as a public company”:

    • “Your financials are open to public scrutiny, and, depending on the situation, they could be scoured and challenged. [The public will be] digging into the numbers and comparing your company to other companies.
    • Quarterly financials are required…for a public entity and will be subject to the same level of scrutiny as year-end financials.
    • Another consideration is the pressure to maintain growth and profit patterns… When dealing with insurance products, we are dealing with long-tailed liabilities. Many companies with a mutual company perspective have been used to very long-term management time frames. But now, if you are a public company with a publicly traded stock, your income statement has to be very solid and predictable in current periods as well as in long-term trends.
    • You should be able to forecast earnings accurately, and you don’t want volatility or negative trends, even if you believe that long-term gains will result. Anything like that would tend to have an adverse effect on your stock price.” (SOA 1999)

Demutualization radically changed the character of many life insurance companies. The differences between stock and mutual companies aren’t just “inside baseball” topics, with relevance to only to quantitative analysts (“quants”), actuaries, securities analysts, and academics.

Consumers of financial products—such as retirees who might be exploring annuities as supplements to their Social Security income—need to understand these distinctions.

Potential purchasers of annuity products should understand the behind-the-scenes sorting process that, depending largely on the business model of the insurer, determines which products they see or don’t see, which type of agent or adviser deals in a particular set of products, which products certain agents or advisers will never show them, and how well they will be served by the insurer, agent or adviser after buying—or not buying—the product.

© 2024 RIJ Publishing LLC. All rights reserved.

Sources

Balasubramanian, Ramnath, et al. “Redefining the Future of Life Insurance and Annuities Distribution,” McKinsey & Co., January 2024.

Chugh, Lal, and Meador, Joseph. “Demutualization in the Life Insurance Industry: A Study of Effect.” Financial Services Forum Publications. Fall 11-2006.

Erhemjamts, Otgontsetseg and Leverty, J. Tyler, The Demise of the Mutual Organizational Form: An Investigation of the Life Insurance Industry, Journal of Money, Credit and Banking, February 24, 2010. ( https://ssrn.com/abstract=1558536 or http://dx.doi.org/10.2139/ssrn.1558536)

Friedman, Stephen J. “The U.S. Life Insurance Industry: The Next Five Years,” Pace Law Faculty Publications, January 1990.

“Generally Accepted Accounting Principles: Implications for Mutual Insurance Holding Companies and Demutualizations,” Society of Actuaries, Record, Vol. 25, No. 1, Atlanta Spring Meeting, May 24-25, 1999.

“Mutual Insurance Holding Company Conversions: Lessons Learned,” Society of Actuaries, Record, Vol. 24, No. 1, Maui I Spring Meeting, June 15-17, 1998.

Obersteadt, Anne, et al. “State of the Life Insurance Industry: Implications of Industry Trends,” National Association of Insurance Commissioners and Center for Insurance Policy and Research. August, 2013.

© 2024 RIJ Publishing LLC. All rights reserved.

An Odd Couple: Trump Visits My Half-Latino Town

Donald Trump came to Allentown, PA—my home for many years—last Tuesday night. He delivered his 85-minute, invective-filled, vainglorious and by now familiar stump speech to a capacity crowd in a 10,000-seat hockey arena/concert venue built with a public bond issue.

A few days earlier, at a Trump rally in Madison Square Garden, an insult-comic called Puerto Rico “a floating island of garbage.” Allentown’s population is 54% Latino, including many Puerto Ricans.

Otherwise, Tuesday was a sunny, peaceful day here, interrupted by a small counter-demonstration by neighborhood Hispanic groups. The local newspaper’s feature writer described the scene on Tuesday afternoon in Allentown—famous for Billy Joel’s 1982 lament—with his usual eye for vivid detail:

“The center of Allentown was awash in red Tuesday, loud with pop and country music and the cries of merchandise hawkers whose wares bore the likeness of Donald Trump in any number of guises: gun-toting Rambo, knight in armor, bird-flipping tough guy taunting would-be assassins that he has proven to be bulletproof.”

Although the crowd at the arena, called the PP&L Center, appeared to be majority-white, the city’s population of 125,000 is only 38% white, according to the U.S. Census bureau. The city’s households have a median income under $50,000, or about two-thirds the average median income of the surrounding Lehigh Valley.

The region has always been populated by migrants, in waves dictated by the economy. The Pennsylvania German population—farmers and tradesmen with formidable names like Lichtenwalner, Fenstermacher and Diefenderfer—of the 18th century were joined in the 19th century by Central and Eastern European coal miners and iron workers, who raised families (as I did) in dense but tidy “rowhouse” neighborhoods. With the decline of the economy in the 1990s, thousands of low-income Hispanic parents arrived from New York City, searching for cheap housing and a safer environment for their children (including a future Philadelphia Eagles running back named Saquon Barkley).

Middle- and upper-middle class migrants have streamed out of the city and into the surrounding suburbs. Priced out of the market for single-family homes in New Jersey, these families been drawn by an expanding regional economy epitomized by McMansion subdivisions in former cornfields and million-square-foot white warehouses clustered at the nexus of interstate highways I-78 and I-476.

I’ve lived in this area for more than half my life. I’ve seen Bethlehem Steel corrode, watched most of Mack Truck’s jobs drained away, and observed four-story knitting mills converted to apartments. Hess’s, the city’s anchor department store and symbolic heart, was razed. Once nicknamed the Little Apple, Allentown, despite its “revitalized” core, is no longer a mini-Manhattan.

Poor people are concentrated in Allentown because they can afford to live here. A disquieting 63% of family households are headed by only one parent. Sixty-two percent of the population identifies as either Hispanic, African-American or mixed race, according to the U.S. Census. Half of the population speaks a language other than English at home. Almost 20% of the population is identified as having disabilities.

At the PP&L Center (Pennsylvania Power & Light owns the arena’s naming rights), Trump clearly wasn’t speaking to that audience. His red-capped audience almost surely came from outside the city. In his speech, he showed little familiarity with the local economy, other than to reference the petroleum industry that was born in 1859, when Col. Edwin Drake’s wooden derrick struck a gusher in Titusville, Pa. “Frack, frack, frack,” Trump promised the crowd. “Drill, drill, drill.”

But Titusville is 300 miles from Allentown, in the woodsy northwestern corner of the state. Shell Oil owns the old Quaker State and Pennzoil brands. The anthracite coal mines, integrated steel mills, textile factories, cement plants, zinc smelters, and railroads that once employed tens of thousands of blue-collar workers are mostly gone. The word “Pennsylvania” means Penn’s Woods, but nearly the entire state was deforested, temporarily, by the end of the 19th century. The wood became furniture, construction materials, and fuel.

Mining and logging employed only 23,100 out of the 6.56 million workers in the state in September 2024, according to the Bureau of Labor Statistics. The most worker-intensive industries in the state are now education; health care; trade; transportation; utilities; professional services; and government. One of the more geriatric states, Pennsylvania ranks 35th in economic activity. The Allentown-Bethlehem-Easton area—the “Lehigh Valley”—is the third largest metropolitan area in Pennsylvania, after Philadelphia and Pittsburgh. Pennsylvania has 19 electoral votes, the most of any of the states that are in play for the election. It’s been reported that a few thousand voters in Pennsylvania—about half as many as were in the PP&L Center (for Pennsylvania Power & Light, which bought the naming rights) to see Trump—will decide who controls the White House and therefore, to a degree, who controls the Earth.

This part of Pennsylvania has voted a blue streak in recent years. The local congresswoman, Rep. Susan Wild, both U.S. Senators, Bob Casey and John Fetterman, and the governor, Josh Shapiro, are all Democrats. But much of Pennsylvania is rural. Beyond the near suburbs, Trump signs line the country roads and cornfields.

Ryan Mackenzie, the Republican state representative hoping to unseat Wild, warmed up the crowd for Trump last Tuesday. To check the appropriate local demographic boxes, and to flesh out the dais, the Trump campaign had to go farther afield. Zoraida Buxo, a female Republican “shadow senator” from distant Puerto Rico, and Wesley Hunt, an African-American U.S. Representative from Houston, made brief appearances. The crowd saw a glimpse of Sen. Marco Rubio (R-FL). The man once dismissed as “Little Marco” and a “lightweight” by Trump, rushed up to the podium to announce that Joe Biden had called Trump supporters, “Garbage.”

What goes around comes around.

I don’t understand the magnetism of the-former-guy or the appeal of his agenda to many of my neighbors—or to my readers. Annuity sales will top $400 billion this year, an all-time high. The Dow Jones Industrial Average is at an all-time high. The Fed performed a neat trick by raising interest rates without sinking equities. What’s not to like? The evergreen sore points—the “issues”—in this election cycle are inflation, immigration, taxes, government regulations. But, with gasoline prices down, so is the annualized CPI.

If Trump gets his chance to deport hundreds of thousands of undocumented migrants, many will no doubt be arrested in Allentown. But it will be wildly expensive, time-consuming, divisive, and unproductive to deport masses of people, on either a local or national scale. Such a move will be challenged by human rights advocacy groups in courts throughout the land. Our southern border is under siege because parts of Latin America have become unlivable for families and because low-wage agricultural and “hospitality” jobs in the U.S. go begging.

As for taxes and regulations, I see no glaring reason for the retirement industry to complain. Even though most of the products that life/annuity companies sell today are more investment-like than insurance-like, and though only a handful of large life insurers remain policyholder-owned, the insurance industry retains government blessings. It still enjoys the tax-deferred or tax-free buildup inside its products and, on the retirement side of the business, the massive tax expenditure that incentivizes long-term saving. Are those subsidies taken for granted?

Yes, Trump’s return would end Gary Gensler’s aggressive enforcement policies at SEC. It would pull the plug (again) on the DOL fiduciary rule. But regulations cut both ways. Without a sense of regulatory protection, the public’s faith in the financial system, already low, will slip farther away.

As a member of the media, I stand ashamed of it. It has largely abandoned its post in this election cycle. It has given Trump a nearly free pass on the low-character question, which has always been hiding in plain sight (where the truth usually hides).

Despite the felony convictions, the coziness with dictators, the flagrant lies, the ignorance of law, economics and history, the stiffing of creditors, the two impeachment trials, the overt threats of violence, the self-enrichment, the appointment of family members to critical policy positions and, above all, the encouragement of the deadly riot and busted coup at the Capitol in January 2021, the media have said remarkably little about Trump’s many self-disqualifications for public office.

Why write this? Why take an unnecessary, perhaps foolish, professional risk? Silence is just not an option anymore.

© 2024 RIJ Publishing LLC. All rights reserved.

Middleware is Central to In-Plan Annuities

People talk about software and hardware. They talk about firmware. But they haven’t talked as much about “middleware.” Yet, if or when the integration of annuities into 401(k) plans makes the leap from novelty to normal, we’ll thank the middleware providers for it.

Middleware is a type of software. It bridges the gaps between the databases where plan recordkeepers, insurance companies, and investment companies store confidential participant or policyholder information. It lets those databases communicate in “the Cloud” using APIs (application programming interfaces).

When annuities were common only in 403(b) plans, a plan recordkeeper and an annuity issuer might arrange an exclusive, bilateral exchange of information. But middleware is a hub-and-spoke operation. It lets plan sponsors switch life insurers easily and inexpensively, if needed. It furnishes the annuity “portability” that most 401(k) plan sponsors will insist upon before they add annuities to the investment menus of their plans.

The three most prominent middleware providers in the DC space today are said to be Toronto-based Micruity (about whom RIJ has written), SS&C Technologies, a global tech company with some $2 trillion under administration, and the Investment Provider Xchange, or IPX Retirement, a former 403(b) recordkeeper based in Centennial, CO.

iJoin provides the UI and UX

Recently, RIJ had a chance to talk with Bill Mueller, CEO of IPX, and Steve McCoy, CEO of iJoin, a managed account provider that gives plan sponsors a turnkey interface for messaging and educating participants about converting part of their savings to guaranteed income streams at retirement. income solutions.

The two firms are currently partnering with Allianz Life of North America on Allianz Lifetime Income+, Allianz Life’s in-plan solution for 401(k) plan participants. When auto-enrolled participants get close to retirement age, the solution starts funding an Allianz fixed indexed annuity with an option, income-providing guaranteed lifetime withdrawal benefit.

Steve McCoy

“Our technology spans the full plan-size spectrum, from startup plans to jumbo or mega-plans,” McCoy told RIJ. “Our direct customers are the plan providers, but the indirect customer are the plan advisors. A lot of our technology supports their objectives.

“Forward-thinking advisors don’t want to be boxed in. They want choice, optionality, and flexibility. Our strategy is to build out a marketplace of solutions for more personalized advice,” he said. In iJoin’s case, that means providing a managed account.

Like target date funds, managed accounts are “qualified default investment alternatives,” which means that under the Pension Protection Act of 2006 participants can be defaulted into them. Managed accounts, which compete with TDFs as vehicles for annuities within 401(k) accounts,  can incorporate a participant’s personal data—a spouse’s income, assets outside the plan, real estate—into its algorithms, or what McCoy calls iJoin’s “advice equation.”

“Our first carrier partner was Allianz. We’ve also partnered with Annexus, Athene and Nationwide. We’re working on TIAA’s Secure Income program for the defined contribution market. We’ll be announcing a relationship with Capital Group to provide a personalized target date fund. We have a relationship with T. Rowe Price through an insurer.”

IPX provides the ‘connectivity’

Where iJoin builds the online user-interface that determines the plan participants’ user-experience, it partners with IPX to tie the interface to the other plan service providers. IPX divested its 403(b) recordkeeping business last March in order to stake its future on the 401(k) annuity opportunity.

“We’ve developed a platform called Retirement Edge,” IPX CEO Bill Mueller told RIJ. “It provides connectivity between the recordkeeper, the custodian, and the insurance carriers.” The connections are product-agnostic. Retirement Edge currently accommodates fixed income annuities, collective investment trusts (CITs) with income riders, or qualified longevity annuity annuities.

Bill Mueller

“QLACs” are deferred income annuities whose assets, according to a 2014 Treasury Department action, can be excluded from retirees’ required minimum distribution calculations until age 85. Retirement Edge can execute the data exchanges for both “in-plan” annuities (which are funded during the accumulation stage) “out of plan” annuities (which aren’t funded until the participant leaves the plan).

“On the back end, we’re ‘cashiering’ the transaction,” Mueller said. “Cashiering” is one of the more complicated steps in the 401(k) annuity digital machinery. It occurs when a participant is either purchasing a small amount of future income benefits with each paycheck, or buying an annuity with a lump sum at retirement.

The middleware provider coordinates the liquidation of all or part of the participant’s account value and the purchase of an annuity contract with the recordkeeper, the custodian of the money, and the annuity provider. “IPX is the only middleware player that has cashiering capability for the client,” McCoy told RIJ.

Plans offer multiple income options

Each firm involved in these chains of transactions gets incremental shares of the compressed fees that 401(k) plan providers and their fiduciaries have been allowed to charge in the wake of several court rulings during the wave of “breach of fiduciary duty” class action lawsuits brought by participants and plaintiffs’ attorneys in the 2010s. Mueller nonetheless has faith in the future of the 401(k) annuity market.

“Since we divested our recordkeeping business, we are solely focused on DC,” Mueller said. He believes that there’s “no question” that the 401(k) annuity trend has legs. “Two years ago when we talked to recordkeepers, they’d say they weren’t sure about how they would approach this market. But now the conversation is, ‘We’ll do this. We’re just not sure when.’”

IPX is preparing for a future where 401(k) plans will offer not one but a choice of several lifetime income options to their participants. With that in mind, “we set out to create a marketplace,” he said. “In addition to providing portability, we think it will standard for plans to provide more than one flavor. That’s why we currently support a fixed income annuity and a QLAC. Our TDF-style annuity is a work-in-progress.”

© 2024 RIJ Publishing LLC. All rights reserved.

How T. Rowe Price Approaches the ‘401(k) Income’ Market

Several of the major target-date fund (TDF) providers, in their quest to equip defined contribution (DC) plan participants with tools for “pension-izing” their savings (and to retain assets in the plan), have embedded deferred annuities into their popular funds-of-funds.

Their expectation is that plan sponsors will default auto-enrolled participants into the TDFs, that participants will automatically start contributing to the deferred annuity at about age 50, and that when participants retire, some will choose to switch on the annuity’s lifetime income rider.

  1. Rowe Price is taking a different approach with its retirement business. The $1.61 trillion asset manager, which record-keeps more than 8,400 retirement plans and manages about $464 billion in TDFs across those plans, isn’t defaulting participants into anything. It believes plan sponsors prefer it that way.

The Baltimore-based asset manager decided several years ago to focus on non-guaranteed “managed payouts” as an optional income solution for auto-enrolled participants. Starting this year, it is offering an enhanced managed payout program called “Managed Lifetime Income.” It includes a deferred income annuity that guarantees payouts until the annuitant dies.

In the jargon of 401(k) income solutions, MLI offers an “out-of-plan” annuity (funded at or after retirement) rather than “in-plan” annuity (notionally funded before the participant retires). T. Rowe Price will offer MLI initially to the DC plans that it administers.

Multiple income solutions needed

Last September, T. Rowe Price’s senior global retirement strategist, Jessica Sclafani, explained her company’s initiatives to the ERISA Advisory Council (EAC), a 15-person panel representing various stakeholder-groups in the retirement industry and the public at large.

Jessica Sclafani

The panel was hearing witnesses and gathering testimony for the Department of Labor about Qualified Default Investment Alternatives, of which TDFs are one, and whether regulations governing QDIAs should be tweaked to reflect their use as vehicles for annuities in 401(k) plans.

“There are several solutions in the marketplace today where contributions are allocated to an annuity-like asset class that would allow for the future purchase of guaranteed income,” Sclafani told RIJ in an interview after the EAC meeting.

Instead, she added, “We believe that ultimately retirement income will be implemented through an array of investment options. We don’t think that one solution will meet the majority of participants’ needs.”

In 2017, T. Rowe Price started offering participants in its plans a mutual fund with a managed payout program that’s offered to participants over age 59½ and retirees. In 2019, it introduced a collective investment trust (CIT) with the same feature. The target (but not guaranteed) payout rate was 5% of an amount based on the participant’s final TDF balance, subject to a “smoothing” mechanism that makes the income stream less volatile. In an email to RIJ, Sclafani described the payout calculation:

The total calendar-year distribution amount is determined each year by calculating 5% of the average net asset value (NAV) of the participant’s fund or CIT over the trailing five years. The fund/trust automatically makes 12 equal monthly dividend payments to investors each calendar year. The amount to be paid each year is reset annually as a means to balance these competing goals and risks.

The 5-year look-back serves to smooth potential volatility in the amount paid out. Also, the participant chooses how much to invest in the “Price Managed Payout Investment.” They could allocate their entire balance or just a portion. In this way they can influence the amount of the payout, even though it is set at 5%.

“That solution is currently available only on our recordkeeping platform,” Sclafani said. We’re looking to work with a middleware provider to launch it on third-party recordkeeping platforms.”

The company’s new Managed Lifetime Income (MLI) program bundles a managed payout process with a type of deferred income annuity called a Qualified Longevity Annuity Contract (QLAC).

[Established in 2014 by the U.S. Treasury Department, QLACs are deferred income annuities with a twist. Savings in a QLAC aren’t subject to the Required Minimum Distribution rules, which require withdrawals from IRAs, 401(k) and other qualified accounts starting at age 73.]

“We know that a certain cohort of participants will benefit from a QLAC, so we’ve paired QLAC and managed payouts,” Sclafani said. “You choose either at retirement or in retirement how much to put into Managed Lifetime Income.”

At retirement, participants who are invested in TDFs must decide whether to opt-into the MLI program or not. If they do, part of their money stays in a liquid managed payout account in the 401(k) plan. The rest is applied to irrevocable purchase of the QLAC.

For example, a 65-year-old might decide to receive a managed payout for 15 years, until age 80.

At that point, income from the QLAC would begin and would last for as long as the retiree lives.   (If retirees die before receiving all of their QLAC income, their beneficiaries receive the unpaid balance.)

Significantly, the QLAC could boost a retiree’s income by 50% a year relative to the annuity-less managed payout program, T. Rowe Price estimates. “There’s a roughly 7.5% payout of the managed payout portion over 15 years. The QLAC is sized to offer the same payment that the retiree had been receiving before.”

Although the money used to buy the QLACs would move over to the general account of the annuity provider from the retired participants’ 401(k)s, the present value of the annuity would still be visible on the retirees’ account statements.

“We made sure that participants would still have a holistic view into MLI as a solution,” she said. “Participants have worked hard to achieve a desired balance. It shouldn’t look like they’re giving up a chunk of it when they buy the annuity.” [T. Rowe Price has not yet identified the life insurer providing its QLAC.]

From “A Five-Dimensional Framework for Retirement Income Needs and Solutions,” T. Rowe Price. May, 2024.

The future of 401(k)s and annuities

Large plan sponsors now actively ask for information about income-generating tools rather than simply listen to pitches about it, Sclafani said. “More DC plan sponsors are taking meetings proactively. We’ve moved from the 10,000-foot level to the implementation stage.” A slight language barrier still impedes communication, however. “As an industry we lack a standard taxonomy for discussing retirement income,” she said. “That’s a barrier to future implementation.”

No one should expect the 401(k) income market, still in its infancy, to reach instant maturity, she said. “If you think you’ll see 20% of eligible participants use the solution, that’s a recipe for disappointment. We see 5% to 10% adoption rates among participants,” Sclafani told RIJ. Among T. Rowe Price’s 8,400 plans, the managed payout solution is offered to about 400. Of those, 60 currently use the managed payout solution.

  1. T. Rowe Price research foresees defined contribution plans offering not one but multiple income tools to their participants. “Our research suggests that it’s a fallacy that you should offer one [income] solution,” Sclafani said. “Participants have diverse needs, so you need more than one solution. We would like to see participants opt into a retirement solution, and then streamline the process by limiting the number of decisions they have to make.”

The solutions don’t have to be embedded in QDIAs. “Adding a retirement income solution to a DC plan is already a complex decision,” she added. “We’re not doing ourselves any favors by attaching it to a QDIA. The industry is conflating two decision points that are already monumental by themselves. That’s just making it harder for plan sponsors.”

© 2024 RIJ Publishing LLC. All rights reserved.

Sen. Warren Speaks Up for ‘Fiduciary Rule,’ Puts Down Annuity Sales Perks

U.S. Senator Elizabeth Warren (D-MA) has just attacked the life/annuity industry at the most sensitive spot in its organizational anatomy—its reliance on flashy sales incentives for the marketing organizations and insurance agents who distribute and sell its bread-and-butter products.

Warren, a long-time, persistent scourge of the financial services industry recently published a white paper, “Cancun, Cruises and Cash: How the Department of Labor’s New Retirement Security Rule Would End Insurance Industry Kickbacks that Cost Savers Billions.”

While criticism of gifts, high commissions and hard sales tactics in certain parts of the annuity industry is old news, the whitepaper has a fresh peg. Warren timed it to appear on the date—September 23, 2024—when the Biden Department of Labor hoped that the latest iteration of its “best interest rule” would go into effect. A judge blocked its progress last July.

The “best interest rule” required that insurance agents, instead of trying to persuade clients to buy annuities (especially fixed indexed annuities) with rollover IRA money, adopt a more selfless “fiduciary” ethical standard and only recommend products to IRA owners that would be in their best interest.

Introduced at the end of the Obama administration, the first version of the fiduciary rule ran into a wall in 2018 when, in a 2-1 decision, the Fifth Circuit Court of Appeals reversed a lower court decision (overruling the dissent of its own chief judge) and vacated the rule on the grounds that the DOL had no authority to put special hurdles between insurance agents—whose activities are regulated by state insurance commissions, not the DOL—and the savings in IRA accounts.

(The DOL regulates the investments in 401(k) plans, but its jurisdiction has never been explicitly extended to include the rollover IRAs into which so many plan participants transfer their 401(k) savings when they change jobs. The Fifth Circuit judges ruled that only Congress could do that, and it hasn’t.)

The initial lawsuit against the rule was brought not by injured citizens—the rule appeared to be popular—but by the American Council of Life Insurers, whose members could lose sales as a result of it, with support from the U.S. Chamber of Commerce. The lead attorney, Eugene Scalia (son of the late Supreme Court Justice Antonin Scalia) had represented the industry before. The following year, President Donald Trump appointed Scalia to be U.S. Secretary of Labor.

When the Biden administration succeeded Trump, the DOL started work on a new and more challenge-proof version of the fiduciary rule.

Much of Warren’s white paper is devoted to documenting the many kinds of sales incentives that annuity issuers advertise to annuity wholesalers and insurance agents. Warren’s argument is that these incentives, rather than the clients’ best interests, drive the agents’ recommendations to older Americans.

Her white paper concludes, “The annuity industry’s efforts to obscure its pervasive use of kickbacks and perks reveal why the DOL’s Retirement Security Rule is needed—and how it will protect consumers. The industry’s secret kickbacks hurt consumers by incentivizing agents to sell certain products because they will earn a bigger cash bonus or fancier vacation, not because they are in their client’s best interest.”

© 2024 RIJ Publishing LLC. All rights reserved.

Test Your ‘401(k) Annuity’ Math Skills

Actuaries and math puzzle-solvers, here’s a question. Several novel target date funds (TDFs) have come to market in which deferred annuities are embedded as one of the investment sleeves. These TDFs are intended to be distributed through 401(k) plans as qualified default investment alternatives (QDIAs) for auto-enrolled participants.

Here’s how they work: When participants who are auto-invested in the TDFs reach age 45 or 50, increasing percentages of their contributions begin to spill over into the deferred annuity sleeve. At age ~65 or so, the participant must decide whether or not to convert the amount in the annuity sleeve to guaranteed lifetime income.

Like safe drivers’ car insurance?

The conundrum concerns the asset-based fee on the contents of the deferred annuity sleeve during accumulation. Starting at age 50, the participant might pay as much as 100 bps/year on the assets in the sleeve; in return, typically, the annuity issuer sets a floor under the sleeve’s accumulation. But the floor (as I understand it) is contingent on the participant’s decision at age 65 to convert the sleeve assets to guaranteed income.

If there’s no conversion, the floor vanishes and the participant has only the amount in the sleeve. Some people have worried that participants who have paid the annual 100 bps for 15 years but never opt into the annual lifetime income stream (~5% – 6% of an amount no less than the floor) may feel robbed of the fee (which may have eroded their accumulations along the way).

But one witness at a meeting of the ERISA Advisory Council this week suggested that those participants might be like people who buy car insurance but never have accidents: they shouldn’t feel robbed of their premium.

So, is the 100 bps drag on the TDF sleeve an unfair charge for participants who don’t opt into the annuity at retirement? Or does it have value either way? What if the participant could see that her account balance was higher than the floor, and so declined the income benefit because it wasn’t “in the money.” Did her 100 bps have insurance value? Was it like an call option that served its purpose and died?

Some actuarial wisdom is needed here, perhaps. Future plaintiffs’ attorneys may examine this question carefully. BTW, this is not a new problem. Living benefit riders on individual annuities have posed similar ambiguities. Now the 401(k) world is about to experience it.

Is the fee fixed or variable?

Here’s another question for those with high numeracy quotients. Suppose an insurance wrap fee during accumulation is fixed at 100 bps for the participant in the TDF. (Ignore whether the whole TDF or just a sleeve is wrapped, and the age when the billing starts.)

If the wrapper offers a floor, and resets the future minimum benefit every year, will the wrap provider (the annuity issuer) need to change the crediting rate in response to changing interest rates and the participant’s rising age? (In a multi-insurer lifetime income benefit auction system, each insurer’s appetite for a piece of the business may also affect its crediting rate bid.)

Is changing the crediting rate each year or month tantamount to changing the product fee? I don’t know. If it is, fiduciaries may need to justify that uncertainty. What might happen to crediting rates if the next financial crisis brings a new ZIRP?

Clearly, it is difficult to draw general conclusions about in-plan annuities, since features vary so much and the benefit can be variable.

Out-of-plan annuities are usually fixed, simpler, not linked to QDIAs, and provide less (or no) liquidity. They entail fewer fiduciary issues. But they’re much harder to get participants to use.  I review out-of-plan annuities (and in-plan QLACs) in this and future editions of Retirement Income Journal.

© 2024 RIJ Publishing LLC. All rights reserved.

Private assets, reinsurance pose systemic risks, research warns

Even as the “Bermuda Triangle” strategy stokes this year’s sharp rise in U.S. fixed deferred annuity sales—by enabling life insurers to reduce capital requirements with reinsurance—the strategy keeps attracting criticism from financial governing bodies.

In mid-September, economists at the Bank of International Settlements (BIS) in Basel, Switzerland, following the Federal Reserve and the International Monetary Fund, warned about the systemic risk posed by private equity firms that “have funneled investment into private markets by acquiring insurance portfolios through affiliated reinsurers.”

In a paper entitled, “Shifting landscapes: life insurance and financial stability,” four BIS analysts show through data and commentary that:

  • Insurance risk is now backed by fewer, less liquid and riskier assets.
  • Cross-border risk-sharing arrangements among or within large (re)insurance companies and their connections with PE firms [has made] supervisory monitoring more complex.
  • The higher tail risk of PE-linked insurers, coupled with greater investment in less liquid assets, suggests that these firms could prove more vulnerable than peers in difficult market conditions.
  • Life insurers’ increased exposure to more risky and illiquid assets raises the risk of losses and vulnerability to sudden liquidity needs, while growing reliance on AIR [asset-intensive reinsurance] raises concerns about interconnectedness and complexity.
  • In sharp contrast to the diversification benefits derived from conventional life reinsurance by pooling mortality and longevity risk, returns on invested assets could prove highly correlated in the event of widespread market downturns.
  • PE-linked life insurers in the United States had ceded risk to affiliated insurers equivalent to almost half of their total assets (or nearly $400 billion) by the end of 2023, compared to less than 10% of total assets for other US life insurers.
  • About two thirds of the risks ceded by PE-linked life insurers were assumed by affiliate reinsurers with links to PE located in offshore centers.
  • In the U.S., major life insurers had ceded reserves of about $2.1 trillion at end-2023, no less one quarter of their total assets, and up from ~$500 billion in 2017. About 40% of ceded risks were assumed by reinsurers in offshore centers, nearly triple the 2017 share. reported in 2017.
  • In 2022, life insurers managed total assets of about $35 trillion, around 8% of global financial assets, up from $14 trillion two decades ago.

The global mission of the BIS, according to its website, is to “support central banks’ pursuit of monetary and financial stability through international cooperation, and to act as a bank for central banks.” Established in 1930, the BIS is owned by 63 central banks in countries that together account for about 95% of world GDP.

The new paper’s authors are Fabian Garavito, Ulf Lewrick, Tomas Stastny, and Karamfil Todorov. Like economists at the Federal Reserve, the BIS analysts offer the standard disclosure that their report doesn’t necessarily reflect an official position of the BIS or the International Association of Insurance Supervisors.

The analysts’ description of the life/annuity industry in the U.S. aligns closely with RIJ’s descriptions of what we call the “Bermuda Triangle.” This is the three-cornered partnership between fixed deferred annuity issuers (i.e., life insurers), private credit originators (i.e., private equity firms) and Bermuda- or Cayman-based reinsurer—all three of which are often affiliated in both synergistic and conflicted ways.

The BIS report diverges slightly from RIJ in leaving the impression that the Bermuda Triangle life insurers are still selling multiple-premium insurance products that offer protection against mortality risk and longevity risk.

RIJ’s reporting has shown that PE-controlled life insurers sell mainly single-premium products that offer protection against investment risk, and make their money mainly from asset-management fees rather from the difference between the yields they promise policyholders and what they earn on safe, hold-to-maturity bonds.

© 2024 RIJ Publishing LLC. All rights reserved.

The Feeling Was De-Mutual

Ironically, the bankruptcies of multi-billion dollar life insurers owned by publicly-held Baldwin-United (in 1983), First Executive (1991), and First Capital Holding (1991) didn’t scare major mutual life insurance companies away from changing into stock companies. On the contrary.

Starting with The Equitable in 1992, a wave of household-name mutuals would “demutualize” in the 1990s and early 2000s. From then on, they would be owned by investors and not, as they had been, by the people who bought their life insurance policies and annuities.

As stock companies, they could do what mutual insurers couldn’t: Hold an initial public offering, sell shares, and raise billions of dollars in fresh capital. In doing so, they hoped to compete in a rapidly consolidating financial services industry where scale would be the price of survival.

The watershed year was 2000 when, after Congress repealed the Glass-Steagall Act, a dozen large mutuals, including Prudential and MetLife, celebrated the end of the old millennium by becoming either stock insurance companies or “mutual holding companies” that owned stock insurance companies.

What few recognized, then or even today, is that stock life insurance companies are fundamentally different from mutual life insurance companies. To varying degrees, and with good as well as regrettable consequences, demutualization changed a company’s priorities, products, profit requirements, relationships with customers, and even their corporate cultures.

What is ‘demutualization’?

There are three types of life insurance companies: stock, mutual, and fraternal. We’re interested in the first two; fraternals tend to be small. Mutual life insurers play two important but narrow roles in the economy. Owned by their customers—the policyholders—they’re tasked with providing those owners (or “members”) with life insurance and annuities at the lowest possible cost.

All life insurers support the overall economy by lending to businesses. That is, they buy mostly corporate bonds and hold them to maturity. The profitability of mutuals depends mainly on the difference (the “spread”) between the yield on their bonds and the benefits they’ve promised to policyholders.

If a mutual earns more on its investments than it needs, it pays dividends to its policyholders, thus lowering their cost of insurance even more. Since mutuals are akin to non-profits, and provide a public good, all life insurers in the U.S. enjoy favorable tax treatment of their products and relatively light regulation by state insurance commissions.

The strength of mutuals is also their weakness. Gibraltar is impossible to move; for the same reason, it’s not very nimble. A mutual insurer can’t raise large amounts of fresh capital overnight or seize new opportunities in fast-changing times. But since they don’t have investors to cheer on that kind of behavior, they have no incentive to do so—unless or until their survival is at stake.

Stock companies are fundamentally different creatures. They are owned by their shareholders, who include individuals and institutions like pension funds and endowments, not by their customers.  Unlike policyholders, who seek relief from risk, investor-shareholders seek risk and its ability to deliver wealth. Where mutuals rely on the spread for their profits, stock life insurers prefer to rely on asset management fees.

From the Panic of 1837 to the turn of the 20th century, most U.S. life insurers had been stock companies. After the Armstrong Committee’s exposure of stock insurance company mischief in 1905, many became mutuals. But the 1970s would change the financial game. The abandonment of the gold standard and unprecedented inflation in 1971, which led to the soaring interest rates of the early 1980s, disrupted the entire U.S. financial services industry.

To compete in a rapidly diversifying and consolidating financial service industry, many mutual life insurers felt they needed more resources and flexibility. Conversion to the stock company model, in a legal process opaquely called “demutualization,” presented a path to growth, independence, and higher profits. Once a few large mutuals showed the way, the herd followed.

Between 1997 and 2001, five of the 15 largest U.S. life insurers demutualized. Ten other major life insurance companies, with total assets in 2003 of $775 billion, demutualized over the same time period [Meader and Chugh]. Of the 1,470 life insurance companies that were in business in the United States at the end of 1999, only 106 were still mutual companies, or 7% of the total. But they included giants like MassMutual, New York Life, and Northwestern Mutual Life. Mutuals accounted for 21% of the total industry assets, 17% of premium income, and 36% of life insurance in force. [Smallenberger].

Drivers of Demutualization

Many factors drove demutualization. As a business strategy, demutualization was seen as a company’s route to increase competitiveness and profits as a one-stop shop for all kinds financial services. But macroeconomic forces, like globalization, government spending, and the aging of the Boomer generation also contributed to the trend. Pressure to demutualize or not varied, of course, by company.

Insurers needed capital to compete

In the freewheeling financial industry of the late 1990s and early 2000s, before the reality check of 2008, mutual insurers looked over-specialized and under-financed relative to the competition. The industry landscape and outlook was described in 2000 by executive James Smallenberger of AmerUs Group (acquired by British insurer Aviva plc in 2006) in a 2000 Drake Law Review article.

Smallenberger predicted “continued consolidation within the life insurance industry and convergence of the life insurance industry with… banks, securities firms, and mutual fund companies. Many life insurance companies will need to gain significant economies of scale through acquisition or internal growth in order to cost-effectively invest in new products and technologies to meet changing insurance and investment needs and customer service expectations…”

“Mutual insurers do not have sufficient organizational flexibility to participate in the emerging integrated financial services market” [Butler, et al]. Smallenberger believed that “companies unable to achieve the necessary economies of scale will be gobbled up by larger competitors.” [Smallenberger].

Managerial self-interest

Consumer advocates, especially in New York, charged that executives at mutual insurers might use demutualization as an opportunity to appropriate the general account surplus—the owners’ equity—for themselves. This was a murky area, and, in the patchwork system of insurance regulation in the U.S., the rules varied by state.

In a mutual insurer, the surplus belongs to the policyholders. In a stock company, it belongs to the shareholders. To the extent that executives could choose to reward shareholders—of whom executives were likely to be among the largest—the path to self-enrichment was certainly there. In the collapse of First Executive Corp., parent of Executive Life, insiders did in fact engineer control of a large share of the failed company’s assets.

Few policyholders knew they had rights to a portion of the equity. Rules for securing, quantifying and transferring those rights varied by state, if they existed at all. Prudential’s demutualization in 2001 showed one way in which the pie could be sliced among its then-approximately 11,000,000 policyholders. [IRS, Demutualization-Revised]

“Management gave 454.6 million shares to the policyholders directly and in addition sold 110 million shares to the public at $27.50 per share. Part of the $3 billion in proceeds was paid to cash-out small policyholders and to other policyholders who chose not to receive shares of stock in the new company.” [Meador & Chugh]

Foreign firms’ interest the U.S. life/annuity market

Large European insurers were naturally eager to enter U.S. market. According to a May 1999 Bloomberg News report, the U.S. “accounts for more than half the world’s retirement savings market,” which Intersec Research of Stamford, Conn., predicted would grow 39% to $15.4 trillion by 2003. (That number reached $40 trillion in 2024, according to the Investment Company Institute.) To accept foreign investment, however insurers needed to be stock companies. The Equitable’s demutualization in 1991 was driven by the prospect of a $1 billion capital infusion from French insurance giant AXA [International Herald Tribune].

Banks’ desire to access insurance assets

Mutual insurers could see that financial conglomerates were encroaching on their turf. Banks, which sell fixed-rate annuities today, were as interested in diversifying into insurance as insurers were to diversify out of it. [Stephen Friedman, “The Next Five Years.”] “On the demutualization debate, the proposal for demutualization comes not from the life insurance companies, which are very happy being mutual companies, but from the banks, because the banks want to demutualize the life insurance companies and then buy them. That is more than a sidelight on this discussion, I think, because it reflects a worldwide trend. If I can coin a double cliche, I would call that trend the ‘globalization of the homogenization of financial institutions.’”

Financial Megatrends

The growth of the U.S. financial sector in the 1990s could not have occurred without a growing money supply. An increase in deficit spending by the U.S. government after 1980 provided that supply.

The national debt is the difference between what the federal government has spent into the economy since the founding of the country and what it has taxed out of the economy. In 1980, the accumulated  difference was $908 billion.

The Reagan Administration criticized the debt as a drag on the economy. But rather than reduce it by cutting spending and raising taxes, the administration cut taxes and increased military spending. Over the next decade, the debt rose to $3.23 trillion. Those new trillions cascaded through government contractors, banks, businesses, employers, the financial markets, and American households.

The national debt reached $5.67 trillion in 2000 and then more than doubled, to $13.56 trillion by 2010 as a result of the bailout of the financial system after 2008. Today, the debt stands at more than $33 trillion. The national debt troubles many people. They believe that U.S. taxpayers will have to pay down the debt someday, impoverishing themselves in the process. Reasonable economists disagree [Fiscaldata.treasury].

Evolution of life insurers into investment companies

Even before they converted to stock companies, mutuals were already creating “variable” or “indexed” life insurance and annuity products that offered potential for investment growth along with their usual insurance-related benefits. “The spike in interest rates at the beginning of the 1980s “caused the development of a series of investment products lodged within life insurance companies’ variable life and annuity products. These products pass on to the customer the risks and the benefits of the investment management process.” Also, “many large life insurance companies have bought large investment management firms. Alliance Capital, for example, with more than $40 billion under management, is a subsidiary of the Equitable… The life insurance business itself has become an investment management business.” [Friedman]

An unprecedented bull market

By demutualizing, life insurers were following the flow of the 1990s. The flow was into stocks. The deregulation of telecom industry, the mass ownership of personal computers, the Internet, and the dot-com boom gave investors plenty of opportunity to invest. It was the period of index funds and discount brokerages, when “Main Street met Wall Street.”

The technology-heavy NASDAQ was 458 at the start of 1990, and 4,798 in March 2000, before the inevitable shake-out of 2001. The S&P 500 was 813 in 1990 and 2,756 in March 2000. The DJIA was 2,560 at the beginning of 1990 and 11,390 at the beginning of 2000. If life insurers wanted to join this party, and hold onto customers, they would have to become part of the securities world.

Changing regulations

Changes in federal tax law helped shape the evolution of the life/annuity business in the 1980s and 1990s. The Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) eliminated a loophole in the use of variable annuities, along with many other tax breaks. But despite TEFRA, the variable annuity allowed wealthy investors to delay taxes on the growth of their investments until they retired.

In 1984, the passage of the Deficit Reduction Act (DEFRA) limited the deductibility of policyholder dividends paid by mutuals as a way to “allocate taxes more equitably between mutual and stock life insurers” [McNamara and Rhee]. In 1988, a New York law ended a 66-year prohibition against demutualization and “served as a model for demutualization statutes in other states” [Battilani and Schröter].

The demutualization trend, already well under way, was eventually codified and sanctified by legislation at the end of the Clinton administration. “With the passage of the Gramm-Leach-Bliley Financial Services Modernization Act in 1999, the Depression-era barriers that blocked cross-industry mergers and product sales among banks, securities firms, and insurance companies have been removed. This reform will clear the way for these firms to move increasingly into each other’s businesses, thereby forcing each firm to become more efficient, more creative, and more customer-focused than ever” [Smallenberger].

During the 1990s and early 2000s, 37 major life insurers demutualized. Of those, the estimated number of policyholders was reported for only 15 companies was available. They had an estimated 29,713,000. Of that total, Prudential and MetLife had combined 22,200,000 policyholders.

Boomer saving in tax-deferred 401(k) plans

The macro-trend arguably driving all of the financial micro-trends of our recent history is the maturation of the Baby Boomer Generation. By 1990, the entire Boomer generation (born 1946 to 1964) was old enough to be in the workforce. They had married, created families, set up households. They were beginning to save in large numbers in hundreds of thousands of relatively new 401(k) plans.

U.S. savings in tax-deferred defined contribution savings plans (e.g., 401(k)s and 403(b)s) was only $874 billion in 1990. By 2000, it was $2.958 trillion, According to the Investment Company Institute. In 1990, $636 billion was in individual IRAs.

By 2000, that figure was $2.629 (reflecting the growth of “rollover IRAs,” which contain money saved in defined contribution plans but later “rolled over” to individual IRAs). In 1997, when I went to work at The Vanguard Group (now “Vanguard”), a kind of cooperative, it managed about $250 billion worth of mutual funds. In 2024, Vanguard managed $7.2 trillion.

This is the first part of a two-part article on demutualization. The second and final part, covering the opposition to, the impact of, and the long-term implications of demutualization, will appear in the November issue of Retirement Income Journal.  

Sources

Battilani, Patrizia, and Harm G. Schröter. “Decumulation and Its Problems,” Quaderni – Working Paper DSE N° 762.

Butler, Richard J., Yijing Cui, and Andrew Whitman, “Insurers’ Demutualization Decisions,” Risk Management and Insurance Review, 2000, Vol. 3, No. 2, pages 135-154.

Friedman, Stephen J. “The U.S. Life Insurance Industry: The Next Five Years” (1990) Pace Law Faculty Publications. https://digitalcommons.pace.edu/lawfaculty/115

“Historical Debt Outstanding,” FiscalData.treasury.gov https://fiscaldata.treasury.gov/datasets/historical-debt-outstanding/historical-debt-outstanding

Malkin, Lawrence, and Jacques Neher. “French Insurer to Put $1 billion into Equitable: AXA Buys Stake in U.S. firm,” International Herald Tribune, July 19, 1991.

McNamara, Michael J., and S. Ghon Rhee. “Ownership Structure and Performance: The Demutualization of Life Insurers.” The Journal of Risk and Insurance, Jun., 1992, Vol. 59, No. 2 (June, 1992).

Smallenberger, James A. “Restructuring Mutual Insurance Companies: A Practical Guide Through the Process,” Drake Law Review, Vol. 49, 2001.

© 2024 RIJ Publishing LLC. All rights reserved.

Lessons from Britain’s national ‘NEST’ egg program

Aimed at helping workers in low-pay, high-turnover jobs save for retirement, Britain’s national defined contribution plan, known as NEST, is barely a dozen years old. Most of its participants are young and have small accounts. It’s too soon to say how they’ll “draw down” their “pension pots” in retirement.

But Will Sandbrook, director of NEST Insight, the program’s in-house research group, expects that retired NEST participants will take systematic withdrawals from their accounts for the first 10 or 15 years of retirement, then switch to a late-life deferred income annuity.

Will Sandbrook

Sandbrook spoke at a September 18 webinar sponsored by the National Institute for Retirement Security (NIRS) in Washington and entitled “What the U.S. Can Learn from the U.K.’s National Employment Savings Trust.” (That’s NEST’s full name.) He was interviewed by Tyler Bond, research director of NIRS.

“In the future, we think the best default income process will be a hybrid approach, with ‘drawdown’ [systematic withdrawal] in the first part of retirement and a guaranteed solution in the later part,” Sandbrook said. Today, he added, “most of the people in NEST who are reaching retirement today have small pension pots [accumulations] that they take as cash.”

Annuities for ‘long-tail’ risks

While NEST faces no immediate pressure to design a decumulation strategy for its participants, corporate sponsors of large 401(k) plans in the U.S. are. Asset managers and life/annuity companies have begun dunning them with a variety of proprietary draw-down products.

Those products and processes come in a variety of shapes and sizes, with a few that fit the model that NEST imagines its members using in the future. Principal Financial currently offers a program that lets 401(k) participants lock-in credits toward a qualified longevity annuity contract (QLAC) during the accumulation period. They decide at retirement whether to commit to it or not. T. Rowe Price is preparing to roll out a strategy where the participants decide at retirement whether to allocate money to a QLAC or not.

NEST envisions its members waiting until age 75 or so before they move part of their NEST assets into a late-life annuity, Sandbrook said. Five or ten years later, they would start receiving annuity payments that will last as long as they (or their spouses) are living.

“Annuities were never designed to be 30-year products,” he said. “Better to have draw-down and then an annuity to deal with the larger long-tail risks.” Income annuities cost least, any actuary can tell you, when payouts start in advanced old age. That’s when you’re both least likely to be still alive and most likely to have run out of money. To make that strategy work, you just have  to make sure that your liquid savings don’t hit zero before your monthly annuity checks start arriving.

There’s also behavioral drawback to buying an “immediate” life annuity that starts producing income at the beginning of retirement, Sandbrook said. NEST may want to “put some conditionality in the draw-down”—that is, “encourage people to tighten their belts in some years” rather than, say, liquidate depressed assets during a market downturn and lock in a permanent loss. But with a “30-year immediate annuity you take away some of that discretion.”

Interestingly, the type of decumulation strategy favored by NEST, Principal, and T. Rowe Price resembles the one that Jason S. Scott of Financial Engines prophesied in a 2007 research paper.

Partly because interest rates were so low for so long, these late-life annuities, also known as deferred income annuities (DIAs), have not offered payout rates high enough to be popular. They accounted for only 1.2% of U.S. annuity sales in the first half of 2024, at $2.5 billion. But DIA sales were up 30% in first-half 2024 over first-half 2023, apparently benefiting from the higher bond yields that lifted sales of most fixed annuities.

Replacing pre-retirement income

Inaugurated in 2012 with start-up funding from the U.K. government, NEST now has about 13 million members. It was designed for people previously not well-served by the pensions sector, including those on low-to-moderate incomes, working for smaller employers, or with higher likelihood of job turnover. NEST also draws members from large employers in sectors with lower income levels and higher job turnover.

Sandbrook estimated that a stunning 25 million people in the U.K., or more than a third of the U.K.’s population of 67 million, live in households where at least one source of income is “volatile.”

The U.K. has a “flat-rate” state pension that equals about 30% of the average pre-retirement earnings of a median worker starting at age 66, Sandbrook said. NEST started out with the stated goal of enabling lifelong participants in the program to eventually replace an additional 15% of pre-retirement income, with retirees relying on personal savings for the rest of their retirement income.

NEST participants contribute a minimum of 8% of pay to their accounts—the current default minimum contribution rate for all employers/pension plans under the auto-enrollment regulations in Britain. Since 2012, U.K. law has required all employers in the U.K. to offer access to an auto-enrolled retirement savings plan. NEST makes it easy for small employers to fulfill that obligation.

The U.K. state pension contrasts with that of the U.S., where Social Security benefits are based on payroll tax contributions, up to a salary cap. Benefits in the U.S. are “progressive” rather than flat. As percentages of pre-retirement income, they’re higher for low-income workers than for high-income workers.

Financial whack-a-mole

Sandbrook’s job—his title is executive director of NEST Insight—gives the Oxford-educated social scientist a window into the financial lives of low- and middle-income couples. A survey of 50 families showed them constantly moving money between checking, savings, and credit accounts to try and pay bills on time and avoid penalties. One couple made 150 transfers in a single month. “They were just moving money from one account to another,” he said via Zoom from London.

Tyler Bond

This modern, smartphone-enabled game of financial whack-a-mole doesn’t leave much money for retirement saving or much time for retirement planning. “It creates a massive focus on today,” Sandbrook said. “Low-income people are capable money managers in the short-term. But it exhausts their capacity for long-term planning. Imagine the cognitive load that that uses.”

“People try to save. Some households belong to savings circles, where five households might contribute to a fund, and each household receives the whole pot every fifth month. The degree of innovation that people go through to make ends meet is amazing,” the NEST research director said.

That evidence was furnished by the Real Accounts project, a long-term study by NEST Insights of U.K. households’ financial lives. The project, according to its website, “uses first hand stories and digital transaction tracking to build an in-depth, in-the-moment understanding of households’ income, spending and money management strategies over time.”

The Real Accounts project was inspired by the U.S. Financial Diaries project, a joint venture of  the Financial Access Initiative at the NYU Wagner Graduate School of Public Service, The Center for Financial Services Innovation (now the Financial Health Network), and Bankable Frontier Associates.

One of the lingering questions about auto-enrolling low-income workers in retirement plans is whether or not nudging them to make salary deferrals every month might backfire and drive up their use of credit cards. NEST has gathered enough data on that issue to reach a tentative answer.

“We saw a small increase in debt for those auto-enrolled,” Sandbrook said. “We can hypothesize about the mechanism for this, that if you live day-to-day, and someone takes a bit of money out of your pay check, you just run out of money a bit sooner and adjust through credit.”

“It’s easy to see how pushing on one part of the household balance sheet affects another part, without them having any real choice. But they didn’t opt out of NEST. Those who design pension plans need to know this about people.”

© 2024 RIJ Publishing LLC. All rights reserved.

Briefs from the ‘Bermuda Triangle’

US insurers hold more private equity, but income on PE drops

U.S. insurers experienced a second straight year of declining income on their private equity investments, which dropped to $7.7 billion in 2023, down from $10.2 billion in 2022, according to ratings agency AM Best.

A new Best’s Special Report notes that U.S. insurers’ private equity holdings rose 10.8% to $146.2 billion, up from $132 billion in 2022; this followed growth of 3.3% in 2022 and 37% in 2021.

That increase in 2023 was driven by $7.4 billion from new investment acquisitions or additional investments in current holdings, with the book value of current holdings increasing by approximately $6.8 billion.

Nearly all of that growth was generated by life-annuity (L/A) insurers, which account for over three quarters of the insurance industry’s private equity investments.

Investments in private equity remain concentrated in a few large insurers, according to the report. Fifteen companies, almost entirely L/A carriers, account for just over 60% of private equity holdings, with allocations averaging only 5% of invested assets. “The ratio of these holdings to capital can be a better guide for determining potential exposure,” said David Lopes, senior industry analyst, AM Best.

The report notes that the average exposure for capital & surplus (C&S) among the top 15 holders of private equity investments is 40.2%. However, more than half of AM Best’s rated companies with private equity investments have exposures amounting to less than 10% of their C&S.

Demand for private equity investments had slowed in 2022 compared with 2021, due to a rise in interest rates and concerns about a potential recession, but private equity investments again rose in 2023, as insurers sought higher yields with alternative options.

“Understanding the performance and risks of the private equity firms that investors choose to invest in requires comprehensive due diligence,” Lopes said. “Most insurers investing in private equity have larger sophisticated in-house investment management teams. Also, most insurers prefer experienced money managers with a solid history.”

Insurers use private equity to diversify investments and achieve higher yields versus other asset classes, but the small percentage allocations of invested assets point to generally more conservative investment strategies and lower levels of risk tolerance, according to the report. Insurers are also wary of the effects of private equity investments on capital models. Investments in common equity vehicles such as limited partnerships are subject to higher capital charges than rated debt or preferred equity.

State Street sued again for recommending Athene in PRT deals

Two new federal class action lawsuits were filed in September against State Street Global Advisors Trust Co., as a pension adviser, and against pension plan sponsors who followed SSgA’s recommendations to replace their defined benefit pensions with group annuities underwritten by Athene Annuity & Life.

In recommending Athene, both lawsuits claim, SSgA failed in its fiduciary duty to recommend only the “best available annuity,” as required by the Employee Retirement Income Security Act of 1974 (ERISA). Athene is not, however, named as a defendant in either case. Similar suits, filed on behalf of pension plan beneficiaries, were filed earlier in 2024.

The first of the latest two cases, filed September 3 in U.S. District Court, Southern District of New York, involved the 2019 transfer of more than $2 billion in pension plan assets of pharmaceutical giant Bristol-Myers Squibb to Athene. The second case, filed September 4 in U.S. District Court, District of Colorado, involved the 2021 transfer of $1.4 billion in pension plan assets of Lumen Technologies to Athene.

The lead attorney in the Bristol-Myers Squibb case is Edward Stone of New York. The lead law firm in the Lumen case is Schlichter Bogard LLP of St. Louis. Both firms have filed similar lawsuits in the past alleging violations of U.S. pension law in pension risk transfer deals involving SSgA and Athene. Schlichter filed suits in March and May of this year, regarding SSgA’s advice for plan sponsors AT&T and Lockheed-Martin.

The Bristol-Myers Squibb suit alleges that:

“Bristol-Myers, The [pension] Committee, and State Street breached their duty of prudence by selecting an unsuitable annuity provider and breached their duty of loyalty by favoring their own corporate interests over the participants’ interests in a secure retirement. Bristol-Myers’ and The Committee’s goal was to save Bristol-Myers money and State Street’s goal was to further its line of business that recommends Athene as an annuity provider. Consequently, their search and selection of Athene was biased in favor of the lower-cost provider and neither objective nor sufficiently thorough or analytical, thereby breaching their duty of prudence.”

According to the Lumen suit:

“Defendants did not select the safest possible annuity available to ensure the continued, long-term financial security of Lumen retirees and their beneficiaries. Instead, Defendants selected Athene, whose annuity products are substantially riskier than those of numerous other traditional annuity providers. Athene structures its annuities to generate higher expected returns and profits for itself and its affiliates by investing in lower-quality, higher-risk assets rather than in quality assets that would better support its future benefit obligations. In transferring Plaintiffs’ pension benefits to Athene, Defendants put Lumen retirees’ and their beneficiaries’ future retirement benefits at substantial risk of default without appropriate compensation. Because the market devalues annuities when accounting for such risk, it is also likely that Lumen saved a substantial amount of money by selecting a group annuity contract (or group annuity contracts) from Athene instead of the actual safest annuity available.”

Both suits make reference to Athene, a life insurer created by private equity firm Apollo Global Management in 2009 for the purpose of selling annuities to older Americans, reducing the capital requirements that come with those sales through offshore “financial reinsurance,” and investing a portion of the annuity premium in loans originated by Apollo. Retirement Income Journal has tagged such a business model, since copied by many other U.S. life insurers, as the “Bermuda Triangle strategy.”

State Street and Apollo to partner on distribution of private assets

State Street Global Advisors (SSgA), the wealth management firm, and Apollo Global Management, Inc., manager of alternative assets and issuer of Athene fixed deferred annuities, has announced a partnership to bring private assets to a wider audience of investors.

“This relationship of a market-leading, global asset manager and a market leading originator of private assets is designed to open the door to investing in private markets and expand access to a wider investor base,” the two firms said in a September release.

As of June 30, Apollo reported more than $145 billion of asset origination in the prior twelve months, through its credit business and “origination ecosystem spanning 16 standalone platforms.”

At the end of 2023, SSgA was the world’s fourth-largest asset manager with assets under management of $4.37 trillion, according to the Pensions and Investments Research center. That figure includes (as of June 30, 2024), $1.394 trillion in its proprietary SPDR exchange-traded funds, of which $69.35 billion was in gold assets.

Oceanview launches ‘Topsider’ fixed indexed annuity

Oceanview Life and Annuity, a fixed deferred annuity issuer affiliated with Bayview Asset Management, and Simplicity Group, a financial products distributor, have brought a new fixed indexed annuity to market: Topsider FIA.

The Topsider FIA’s “Gain Control Option” allows clients to potentially increase their participation in market gains by applying a portion of their annual index credits towards a higher participation rate for the following year. “This feature aims to capitalize on market recovery cycles,” an Oceanview release said.

Oceanview Holdings Ltd. provides retail annuities and asset-intensive reinsurance solutions through its subsidiaries. On a consolidated basis, Oceanview had over $12 billion in assets as of year-end 2023. It holds an A (Excellent) strength rating from AM Best.

The Topsider FIA’s features include (beside the standard FIA features of tax deferral and protection from market loss):

Allows clients to increase participation rates using a portion of their annual index credits.

Includes crediting strategies tied to the S&P 500 Daily Risk Control 10% Excess Return Index.

Allows clients to modify their Gain Control Option percentage each contract anniversary.

Is available exclusively through Simplicity Group’s distribution network.

Oceanview has the structure of companies that use what RIJ has called the “Bermuda Triangle” strategy. This structure includes an alternative asset management firm, a U.S. issuer of fixed-rate or fixed indexed annuities, and reinsurers in Bermuda or the Cayman Islands—all of which are under the same corporate umbrella.

In 2018, Bayview Asset Management, led by David Ertel, funded Oceanview Holdings Ltd with $1 billion raised from institutional investors, according to AnnuityAdvantage.com. Oceanview Holdings then purchased Alabama-domiciled Longevity Insurance and renamed it Oceanview Life and Annuity Company.

Oceanview Asset Management LLC, a wholly-owned subsidiary of Bayview Asset Management, LLC, is Oceanview Life and Annuity’s investment manager.

In April 2018, Oceanview Holdings established Oceanview Reinsurance in Bermuda. In 2021, Oceanview Bermuda Reinsurance was formed, with 75% ownership by Oceanview Reinsurance and 25% ownership by Overview Holdings. In June 2024, Oceanview Holdings Ltd. announced the establishment of Oceanview Secure Reinsurance Ltd., in the Cayman Islands.

Munich Re wants to take longevity risk out of life insurers’ PRT deals

Munich Re North America Life is now offering “longevity reinsurance” to help clients “accumulate assets while transferring biometric risk,” a release said. This “pension risk transfer” (PRT) product will allow clients to “convert uncertain future pension or annuity payments to a fixed cash flow stream.”

“Likely clients are insurance companies involved the PRT deals and also asset reinsurers which are often private equity companies buying blocks from insurance companies in order to reinvest assets,” said Munich Re Second Vice President and Actuary, Longevity Reinsurance, Ben Blakeslee.

“There was ~$45b of PRT transactions in the U.S. in 2023 across 21 insurers, and these figure have been rapidly growing over the past 10 years,” he added, citing data from Aon, the consulting firm. “Despite this, longevity reinsurance has been rarely used, so these insurers are retaining substantial longevity risk. We expect reinsurance capacity will become increasingly valuable to support this quickly growing market.”

“We believe there is significant, untapped demand for longevity reinsurance in the US and Canada markets,” said Mary Forrest, President and CEO of Munich Re North America Life, in a statement.

Clients will be able to lock in mortality assumptions and a fee at inception, according to the statement. “With the increased reserve and capital requirements for longevity risks, and further changes coming in the US, insurers and asset reinsurers can leverage Munich Re’s strong balance sheet and deep mortality expertise,” the release said.

The pension risk transfer market has grown alongside elevated interest rates in recent years. Meanwhile, insurers are seeking to balance mortality and longevity risks. Under these conditions, longevity reinsurance “can complement a variety of risk management strategies,” Munich Re said.

Munich Re North America Life includes Munich Re Life US and Munich Re, Canada (Life), which have served the U.S., Canada, Bermuda and Caribbean markets for 65 years.

Munich Re Life US, a subsidiary of Munich Re Group, is a leading US reinsurer. Munich Re Life US also offers “tailored financial reinsurance solutions to help life and disability insurance carriers manage organic growth and capital efficiency as well as M&A support to help achieve transaction success.”

LeMay and Bickler to co-lead Individual Markets at Global Atlantic

Global Atlantic Financial Group, a life/annuity subsidiary of asset manager KKR, has appointed Emily LeMay, its chief operations officer and Jason Bickler, its chief distribution officer, as co-heads, Individual Markets, effective immediately. LeMay and Bickler will report to Rob Arena, co-president of Global Atlantic.

LeMay joined Global Atlantic seven years ago. She began her career at MetLife, rising to Operations and Customer Experience Strategy for the U.S. and Latin America. She currently serves as vice-chair of the Insured Retirement Institute’s (IRI’s) Digital First Initiative.

Bickler has been with Global Atlantic for 10 years. He began his career as an actuary at Allstate, assuming roles of increasing leadership responsibility including product design, relationship management, direct sales and sales leadership.

© 2024 RIJ Publishing LLC. All rights reserved.

Honorable Mention

GAO investigators go ‘undercover’ to study conflicts of interest

Over the course of several months, 102 financial professionals in the U.S. received phone calls from General Accounting Office researchers posing as a fictitious 60-year-old who wanted advice about what to do with about $600,000 in IRA and 401(k) accounts.

Acting more as mystery shoppers than as sting operators, the GAO investigators documented 75 completed encounters in which the “financial professionals described their role and the nature of the relationship with the client and discussed the client’s financial profile.”

Here’s how the GAO, in a report published in July and released last week, described what its researchers did:

We steered the conversations toward subjects that would help us learn about potential conflicts of interest that might exist in the relationship. We brought up subjects conversationally, without using uniform language. In most cases, we explicitly asked about conflicts of interest, because regulators suggest doing so.

In most cases, we discussed the term fiduciary, because it helped establish the nature of the relationship, facilitated a discussion of the investor protection standards that would be applicable, and because the definition of a fiduciary was the subject of DOL’s 2016 rule regarding conflicts of interest…

We discussed variable compensation to financial professionals, because earning more from recommending one product, service, or company over another can be a source of conflicts of interest… We analyzed call transcripts for information obtained about conflicts of interest, including responses to questions about conflicts of interest, fiduciary protections, and variable compensation.

GAO’s undercover calls revealed that when investors ask professionals about conflicts of interest, their questions “may not always produce helpful information.” While “firms’ disclosures of conflicts are available to investors… investors may not review or understand these documents.” In other discoveries:

  • “In 18 of our undercover conversations, financial professionals described ways that other financial professionals are compensated, such as through sales and fees that can lead to conflicts of interest. Twelve financial professionals recommended ways retirement investors can protect themselves from conflicts of interest or made statements about general products or firm types to avoid.
  • “Four of those discussed product types to pay attention to with regards to conflicts of interest. For example, financial professionals discussed avoiding certain investment products because of the compensation a financial professional would receive for selling them, including annuities, load mutual funds, and proprietary products.95 Six of the 12 financial professionals discussed compensation models a retirement investor should pay attention to for conflicts of interest.”
  • “Fifteen financial professionals told us that recommending insurance products, such as annuities, would constitute fiduciary advice, and three financial professionals told us that recommending insurance products would not constitute fiduciary advice. One financial professional explained that with the purchase of an annuity, our 60-year-old retirement investor would not be exiting the fiduciary relationship but would potentially be exiting a fee-based relationship. Another financial professional said he could not act as a fiduciary when recommending an annuity because he could earn commission from that product.
  • As of September 2023, 83% of non-wealthy RIA clients were with firms that were registered as or affiliated with a type of broker-dealer and 63% were clients of investment advisers who were also doing business as an insurance broker or agent or affiliated with an insurance company or agency. Financial professionals may provide one recommendation as an RIA and another as a broker-dealer or insurance agent, which may not be apparent or meaningful to a retirement investor.
  • Our undercover investigation found that financial professionals often used the term “best interest” when describing “fiduciary” duties. Of the 70 financial professionals who we talked to about the term “fiduciary,” 41 said it meant acting in the client’s “best interest.” One financial professional was reportedly a fiduciary under FINRA.84 Another said a financial professional has a fiduciary responsibility to make sure he is selling the right products.

The GAO concluded:

Whether a fiduciary standard applies can vary based on context. As a result, it may not always be apparent whether a financial professional has a fiduciary obligation to the retirement investor or not. Financial professionals can have multiple roles, such as registered representative of a broker-dealer of securities and insurance agent, and retirement investors may not fully understand the conflicts associated with each role.85 Most financial professionals we spoke to (49 of 75) were both. registered representatives of broker-dealers and investment adviser representatives, which meant they could act in either capacity.

Based on our disclosure review and our undercover phone calls, conflicts can be numerous, complex, and dynamic, which can make it challenging to completely convey them all, and their implications, through a real time conversation with a retirement investor. Retirement investors have a stake in understanding conflicts of interest in their relationships with their firm and financial professional because conflicts of interest may be associated with lower investment returns.

Conflicts of interest are a common part of many financial transactions involving products recommended to retirement investors. The mechanisms in place to help identify or explain conflicts of interest, such as required disclosures and discussions with financial professionals, may not fully explain the risk and challenges posed by conflicts of interests. Despite obligations to mitigate and eliminate certain conflicts, conflicts of interest persist and can negatively impact retirement investors.

SEC charges six major ratings agencies with record-keeping lapses

The Securities and Exchange Commission has charged six nationally recognized statistical rating organizations, or NRSROs, for significant failures by the firms and their personnel to maintain and preserve electronic communications.

The firms admitted the facts set forth in their respective SEC orders, an SEC release said. They “acknowledged that their conduct violated recordkeeping provisions of the federal securities laws; agreed to pay combined civil penalties of more than $49 million, as detailed below; and have begun implementing improvements to their compliance policies and procedures to address these violations.”

  • Moody’s Investors Service, Inc. agreed to pay a $20 million civil penalty;
  • S&P Global Ratings agreed to pay a $20 million civil penalty;
  • Fitch Ratings, Inc. agreed to pay an $8 million civil penalty;
  • HR Ratings de México, S.A. de C.V. agreed to pay a $250,000 civil penalty;
  • A.M. Best Rating Services, Inc. agreed to pay a $1 million civil penalty; and
  • Demotech, Inc. agreed to pay a $100,000 civil penalty.

Each of the credit rating agencies, with the exception of A.M. Best and Demotech, is also required to retain a compliance consultant.

A.M. Best and Demotech engaged in significant efforts to comply with the recordkeeping requirements relatively early as registered credit rating agencies and otherwise cooperated with the SEC’s investigations, and, as a result, they will not be required to retain a compliance consultant under the terms of their settlements.

“We have seen repeatedly that failures to maintain and preserve required records can hinder the staff’s ability to ensure that firms are complying with their obligations and the Commission’s ability to hold accountable those that fall short of those obligations, often at the expense of investors,” said Sanjay Wadhwa, Deputy Director of the SEC’s Division of Enforcement. “In today’s actions, the Commission once again makes clear that there are tangible benefits to firms that make significant efforts to comply and otherwise cooperate with the staff’s investigations.”

Each of the six firms was charged with violating Section 17(a)(1) of the Securities Exchange Act of 1934 and Rule 17g-2(b)(7) thereunder. In addition to significant financial penalties, each credit rating agency was ordered to cease and desist from future violations of these provisions and was censured.

The four firms ordered to retain compliance consultants have agreed to, among other things, conduct comprehensive reviews of their policies and procedures relating to the retention of electronic communications found on their personnel’s personal devices and their respective frameworks for addressing non-compliance by their personnel with those policies and procedures.

How the commercial real estate bust could affect US life insurers

Recognizing U.S. life insurers’ “significant exposure” to commercial real estate (CRE), and “pressure on commercial property values” from “lower demand for office space as well as higher interest rates,” at the Chicago Fed recently analyzed “life insurers’ CRE exposures and their implications for financial stability.”

The Fed’s researchers published their findings in Economic Perspectives, No. 5, August 2024. They reported that:

  • At $600 billion (as of 2022:Q4), commercial mortgages were the third-largest asset calls in life insurers’ portfolios, accounting for about 16% of the insurers’ total investments and about 14% of general account assets.
  • Life insurers are also exposed to CRE through their $170 billion CMBS holdings. About 80% of life insurers’ CMBS holdings are senior (AAA-rated) tranches; life insurers rarely invest in below investment-grade CMBS tranches.
  • Given their significant CRE exposures, life insurers could potentially experience significant losses if CRE prices deteriorate.
  • Despite investing in highly rated CMBS tranches, life insurers could potentially incur losses from their CMBS holdings.
  • Current and at-origination loan-to-value (LTV) ratios are low for CRE mortgages compared to those for residential mortgages.
  • Life insurers would suffer a $10 billion loss from their commercial mortgage portfolios. The average loss is about 1.1% of capital, with more than one quarter of life insurers experiencing no losses. With few exceptions, insurers’ losses are less than 10% of their capital.
  • We do not find evidence that exposure to CRE affected life insurers’ stock returns in two periods of heightened concerns about CRE.
  • In a severe shock, five large insurers—insurers with $10 billion assets or more—could experience losses of more than 20% of their adjusted capital, and several insurers may face heightened regulatory scrutiny and have to raise capital.
  • Most insurers with large estimated losses have only a small share of runnable liabilities, mitigating concerns about potential runs triggered by CRE-related losses.
  • The life insurance sector as a whole could face combined losses of about $36.3 billion from direct and indirect exposures to CRE.
  • Some individual large life insurers face significant losses of up to 34% of their capital. However, the largest losses are concentrated in life insurers with limited run risk.
  • Stocks of publicly traded life insurers with large CRE exposure did not exhibit abnormal negative returns after the failure of SVB or the earnings announcement of NYCB, suggesting that market participants did not anticipate life insurers experiencing outsized losses related to CRE.

Prudential expands its reinsurance strategy

Prudential Financial, Inc., has agreed to reinsure a portion of its guaranteed universal life block with Wilton Re, resulting in approximately $350 million of expected proceeds, post-closing, according to a release last month.

Wilton Re will reinsure ~$11 billions of reserves backing guaranteed universal life policies issued by Pruco Life Insurance Company Arizona (PLAZ) and Pruco Life Insurance Company of New Jersey (PLNJ). The deal covers policies written through 2019 and represents ~40% of Prudential’s remaining guaranteed universal life statutory reserves.

In March 2024, Prudential reinsured a $12.5 billion guaranteed universal life block with Somerset Re. Upon closing, Prudential will have achieved an approximately 60% reduction in its exposure to guaranteed universal life.

PGIM Portfolio Advisory, PGIM’s multi-asset solutions affiliate, will manage all the assets supporting the block and will also receive additional assets to manage from Wilton Re. After two years, Prismic, the Bermuda-based reinsurance company created by Prudential and Warburg Pincus, will have an option to reinsure 30% of the block from Wilton Re on substantially similar terms.

Prismic (not to be confused with the web development software company) was created by Prudential and Warburg Pincus last September, with an additional group of investors agreeing to make equity investments in it. At that time, Prudential expected to reinsure to Prismic a block of structured settlement annuity contracts with reserves of ~$10 billion. Prudential’s obligations to the holders of these annuities will remain unchanged following the reinsurance arrangement and Prudential will continue to administer the contracts.

Prudential aims for Prismic to be a strategic reinsurance partner with the ambition to grow their reinsurance relationship materially in years to come. PGIM and Warburg Pincus will provide asset management services to Prismic. Through expanded reinsurance capacity, Prudential expects Prismic will allow the company to provide more people with access to its life and annuity products.

The group of global investors that has agreed to make equity investments in Prismic, alongside Prudential and Warburg Pincus, will give Prismic a combined initial equity investment of $1 billion from Prudential, Warburg Pincus and a group of global investors.

Prudential and Warburg Pincus will initially own 20% and 15% of the equity in Prismic, respectively. Prismic’s board will include two independent directors. Prudential, Warburg Pincus, and the group of investors will each nominate one director.

  • Prismic will leverage PGIM’s and Warburg Pincus’ global investment management capabilities across public and private markets, including public fixed income, private credit, private real estate, and private equity. Prismic will become a client of PGIM Portfolio Advisory, a newly established affiliate within PGIM that combines asset-liability management expertise with portfolio strategy and asset allocation to deliver integrated solutions across public and private asset classes.The Wilton Re reinsurance transaction is structured on an “indemnity coinsurance basis” and contains significant structural protections, including over-collateralization and investment guidelines, the release said.

    Prismic is led by Amy Kessler, a 30-year financial services industry veteran, who will serve as CEO. Kessler was the founding leader of Prudential’s international reinsurance business.

    Upon closing of the Wilton Re deal, Prudential anticipates a decrease in total after-tax annual adjusted operating income of ~$35 million. The earnings impact will be finalized at closing. Prudential expects to incur one-time transaction expenses of ~$25 million in the quarter of closing, primarily due to the extinguishment of certain financing facilities and other closing costs.

Nassau issues new FIA with 18% bonus

Nassau Financial Group has introduced Nassau Bonus Annuity Plus, a bonus fixed indexed annuity designed to give people confidence that they can reach their retirement goals.

Issued by Nassau Life and Annuity Company, Nassau Bonus Annuity Plus is a single premium accumulation-focused fixed indexed annuity that helps increase retirement savings with an up-front premium bonus as well as total accumulation potential from powerful growth options and enhanced control over contract value.

Nassau Bonus Annuity Plus includes several enhanced features, including Nassau’s highest premium bonus of up to 18%, a free withdrawal rollover feature, and an early return of premium surrender benefit. These features are made possible by an enhanced benefit fee applied during the surrender charge period, which is 10 contract years in most states.

The enhanced premium bonus of up to 18% creates a larger base to help contract holders grow their retirement savings and increase accumulation potential over the long term.1

Contract holders also receive enhanced liquidity features, with the ability to withdraw up to 5% penalty-free annually or roll over the withdrawal option for up to five contract years to receive up to 25%2. Also, with the early return of premium surrender benefit, after the fifth contract year contract holders can receive a cash surrender value of at least their single premium less prior gross withdrawals and enhanced benefit fees.

Nassau Bonus Annuity Plus provides powerful, tax-deferred growth potential to help contract holders catch up or get a head start on their nest eggs, all while protecting the principal from market downturns3. It offers indexed accounts linked to indices like the S&P 500® and Nasdaq-100®.

1Bonus is not available for immediate withdrawal and the bonus amount and associated earnings are subject to a vesting schedule. The bonus amount may vary by age and state and is not intended to meet short-term financial goals.

2Withdrawals of any kind (including Required Minimum Distributions) will cause the free withdrawal amount to revert back to 5% on the next contract anniversary. Withdrawals exceeding the free withdrawal amount may be subject to surrender charges, recovery of non-vested premium bonus amounts, Market Value Adjustment, and pro-rated fees. See the Product Summary and Product Disclosure for more information.

3The principal is protected against market losses and guaranteed under the base contract. Applicable fees will be deducted from the contract value, and this could potentially result in a loss of principal if the contract has had interest credits less than the fees.

Nassau was founded in 2015 and has grown to $24.3 billion in assets under management, $1.5 billion in total adjusted capital, and about 374,000 policies and contracts as of June 30, 2024.

Voya tops $100bn across multiple employer solutions

Voya Financial, Inc., announced today a milestone growth advancement as the firm surpassed $100 billion across various multiple employer solutions. Further highlighting Voya’s experience and commitment to Multiple Employer Plans (MEPs), Pooled Employer Plans (PEPs), Employer Aggregation Programs and other customized solutions, the firm continues to drive growth in this important market segment, with total assets increasing 15% since the same time period last year.

To support its growth and commitment to the multiple employer plan space, Voya recently announced the addition of newly created positions to support sales growth in this important market segment. These roles, which have been focused on driving growth and engagement with both advisors and plan sponsors, are dedicated to helping facilitate the creation of new solutions and adding adopting employers into existing solutions.

Voya’s growth across the abundance of multiple employer arrangements has been driven by flexible programs designed to provide optimal support for clients of all sizes. As a result, Voya has experienced significant growth specifically within its Wealth Solutions business, with 34% of total employer-sponsored DC plans participating in a multiple employer plan solution.

Last year, Voya also announced it is serving as the recordkeeper for first 403(b) Pooled Employer Plan following the SECURE Act 2.0 legislation. The PEP is designed to provide a pooled plan option for 501(c)(3) nonprofit organizations and health care related entities, expanding retirement plan access for employees in these industries.

American Life & Security launches new FIA

American Life & Security Corp., a six-year-old, Nebraska-based insurer (B++ by AM Best), has launched the American Life MaxGrowth 10 Fixed Indexed Annuity (FIA). MaxGrowth has a contract term of 10 years with annual point-to-point, monthly sum, and “performance-triggered” options. The annuity allows for additional premium contributions within the first 6 months and offers a 5×5 Annuitization option for accessing the full Contract Value over 5 years after 5 years.*

The contract offers these crediting strategies:

  • The S&P Market Agility 10 Index (S&P Market Agility 10 TCA 0.5% Decrement Index): The S&P Market Agility 10 Index is an equity-bond index that measures the performance of equity and fixed income component indices that each take long or short positions based on momentum and volatility indicators in response to changing market conditions. RBC Capital Markets is the hedging partner for the index.
  • The Schroders Global Compass Index: The Schroders Global Compass Index is a global multi-asset index that uses a dynamic allocation to seek positive return opportunities amid changing market conditions. The Index uses a rules-based approach to allocate across multiple asset classes, including global equities, government bonds, and energy commodities.

MaxGrowth is Distributed through American Life’s IMO partners, MaxGrowth is currently available in  Arizona, Colorado, Florida, Georgia, Illinois, Iowa, Kansas, Kentucky, Michigan, Nebraska, Nevada, New Mexico, North Dakota, Oklahoma, South Dakota, Utah, and the District of Columbia.

*5×5 Annuitization is only available if no withdrawals other than RMDs have previously been taken. Additionally, MaxGrowth includes a Nursing Home Benefit rider for those who may need nursing home care.

© 2024 RIJ Publishing LLC.

US life/annuity insurers cede $1.74 trillion to reinsurers, 2016-23

Fueled by strong annuity growth on higher interest rates, U.S. life/annuity (L/A) insurers have doubled their ceded reserves to $1.74 trillion between 2016 and 2023, with an increasingly larger portion headed offshore, according to a new AM Best report.The Best’s Market Segment Report, “Strong Annuity Growth Continues Shift to Bermuda Reinsurers,” is part of AM Best’s look at the global reinsurance industry ahead of the Rendez-Vous de Septembre in Monte Carlo.

According to this report, nearly 47% of ceded L/A reserves were transferred offshore in 2023, after climbing steadily from the 26% level in 2016. AM Best believes this growth is likely to continue, as more companies may look to reinsurance to manage growth and capital levels. “With new company formations, partnerships, and private capital entering the market, the reinsurance market remains competitive and a larger share of business is being ceded to affiliates,” said Jason Hopper, associate director, AM Best.

The report notes that the vast majority of $103.2 billion in ceded reserves stemming from the 10 largest transactions of 2023 involved offshore transactions. Bermuda accounted for over a third of all in-force business, as well as 60% of new business, in 2023. Many private equity-owned insurers have started creating offshore reinsurance entities in recent years; approximately two-thirds of reserves ceded offshore go to affiliates. Companies with asset manager/private equity sponsors account for almost 44% of reserves ceded to offshore affiliates.

Bermuda and the Cayman Islands have gained in popularity due to their stable political and economic environments and regulatory landscapes, as well as access to talent (mainly legal and financial professionals). They also have flexible accounting regimes and can choose which system works best, whether that involves IFRS 17, GAAP, modified GAAP, or even a statutory approach.

Life/annuity reinsurance companies have benefited from higher interest rates and favorable mortality trends, an earlier AM Best report says. But firms backed by alt-asset managers or large private equity firms have intensified the level of competition in that niche.

The Best’s Market Segment Report, “Life/Annuity Reinsurers Face Growing Competition as Conditions Improve,” is part of AM Best’s look at the global reinsurance industry ahead of the Rendez-Vous de Septembre in Monte Carlo.

Other reports, including AM Best’s ranking of top global reinsurance groups and in-depth looks at the insurance-linked securities, Lloyd’s, health and regional reinsurance markets, will be available during August and September.

New capital continues to flow into the reinsurance segment, primarily via reinsurers owned by investment managers focused on annuity business, AM Best analysts write. These newer entrants have sought to coinsure assets that can be rolled into high-yielding positions, mainly in public, private or alternative fixed income products.

“These reinsurers also can offer attractive ceding commissions based on higher anticipated investment returns once the transferred assets are rolled into a wider set of investment opportunities,” AM Best said.

Overall, L/A reinsurers are well-capitalized and their risk-adjusted capitalization is expected to remain healthy through 2025, despite risks that remain in investment portfolios and elevated mortality for some. Reinsurers owned by asset managers benefit from their parent companies’ expertise in structured products, mortgages, private credit, and other alternatives.

“How newer entrants will alter their strategies over the long term depending on macroeconomic trends, availability of deals and regulatory changes remains to be seen. But by all indications, this ‘new capital’ is here to stay, with billions more committed but on the sidelines waiting for the next opportunity,” said Ed Kohlberg, director, AM Best.

Historically, the U.S. life reinsurance market had been pressured as primary insurers transferred less risk to third-party reinsurers, which led to a long decline in cession rates. More recently, rising interest rates led to robust annuity sales, which has motivated some primary carriers to reinsure incremental business.

While annuities are a very capital-intensive product, asset managers have thus far supported rapid growth by providing the needed capital and not constraining growth with material dividends.

Bermuda, and to a lesser extent, the Cayman Islands, have gained popularity based on the stable economic environment and regulatory landscape, as well as political stability and access to legal and financial talent. They also have flexible accounting regimes and can choose which accounting system works best.

“The notable annuity growth is likely to continue, and more companies may look to reinsurers to manage growth and capital levels. With new company formations, partnerships and private capital entering the market, the reinsurance market remains competitive with a larger share of business ceded to affiliates and third-party reinsurers,” said Stratos Laskarides, senior financial analyst, AM Best.

© 2024 RIJ Publishing LLC. All rights reserved.

Why 401(k) Plan Sponsors Remain Wary of Annuities

The SECURE Act’s safe harbor for 401(k) annuities was presumably well-intended. But it may be a case of too little, too soon. Let me explain.

Asset managers and life/annuity companies, of course, are more than ready to pitch income-generating products to the $7.4 trillion 401(k) plan market. They’ve been ready since IncomeFlex (Prudential) and SponsorMatch (MetLife and Barclays Global Investors) were born almost 20 years ago.

But, based on what I hear and read, most plan sponsors and their advisers still aren’t ready to agree to have so-called “in-plan” annuities embedded in their plans as Qualified Default Investment Alternatives. They have a lot of questions that the SECURE Acts don’t answer.

After talking to 401(k) industry veterans, including executives and business owners, I’ve created a list of issues whose lack of resolution makes even large-plan sponsors, those with the best advisers and consultants, cautious about contracting in-plan annuity fever. It’s a long list.

Softness of the SECURE Act. Safe harbors, in the literal sense, are typically walled in by granite and limestone jetties. The legal “safe harbor” for annuities in the SECURE Act of 2019 offered nothing so reassuring.

Written to admit the widest range of options, it doesn’t give plan sponsors much guidance in sifting through the many types of annuities and their often-complex product designs. With minimal direction from lawmakers, plan sponsors can only proceed slowly and with caution.

“The safe harbor provision basically requires that the insurer must have complied with state financial reporting and solvency requirements for the last seven years,” the American Academy of Actuaries wrote in 2020. “Some would view this safe harbor definition as being too low a bar by sweeping in all insurers who are eligible to operate within the state. The safe harbor does not include any criteria to distinguish financially strong insurers from those that aren’t as strong but are still in compliance with the safe harbor.”

Tablecloth too small for table. Policymakers should have addressed the retirement plan coverage shortfall long before passing the SECURE Act. At any given moment, about half of Americans lack access to a retirement plan at work. Some states have mandated auto-enrolled Roth IRAs, but that doesn’t solve the job turnover/leakage problem. (See below.) Data showing the average or median number of years that Americans spend participating in a retirement plan before they reach retirement would be useful. Yes, SECURE 2.0 increased incentives for small and mid-sized employers to sponsor new 401(k) plans; perhaps that’s beginning to move the needle on coverage.

Can’t win for losing. At age 65, the median savings (50th percentile) for a Vanguard participant, according to Vanguard’s annual “How America Saves” survey, is about $90,000. The average savings (representing the 75th percentile) is about $275,000. “Nudges” won’t increase the savings capacity for low-income workers at small plans, and employers have no incentive to contribute to the accounts of high-turnover workers. Assuming that many people will need to keep at least half their DC savings more or less liquid in retirement, there won’t be enough left to buy a meaningful guaranteed income stream.

Not all 401(k) plans are equal. No one talks about this. Great companies have great DC plans (i.e., low expenses, employer matches and, if you’re lucky, discretionary employer contributions). Small company plans often have none of that. Retirement security often depends on working for a great company, getting paid well, and participating in a generous plan for many years. But it’s hard to get a secure job in a great company.

Not all 401(k) income products are equal. Too much is being asked of plan sponsors. The SECURE Act “does not specify which annuity products could be offered within a defined contribution plan; consequently, there is a full spectrum of possible products,” according to the American Academy of Actuaries whitepaper. “If the goal of plan sponsors is to provide their employees with options for lifetime income, they need to know that some of the options they add to their plans may meet this goal better than others. [Emphasis added.] Annuities that have additional investment-based guarantees attached or that mix investments with insurance add complexity to the education process and may be less effective in providing lifetime income than simpler products.”

The friction of liquidity. In the retail annuity market, a portion of a deferred income annuity’s yield comes from its illiquidity; its issuer holds bonds to maturity and avoids the inefficiency of holding short-term liquid instruments. If liquidity reduced yield by 100 basis points per year (an actuary’s estimate), from a net 5% to a net 4%, on $100,000, starting at age 50 with a $5,000 annual contribution, the accumulation by age 65 would be ~$284,000 instead of ~$321,000. That’s a $37,000 cost of liquidity.

“Most people don’t use the liquidity when it exists. At least not during their working lives. They may want to use it at retirement. So if you an amass an extra 10% of assets, even if the surrender fee is 2.5%, you are still way better off using the less liquid version. These folks end up paying thousands of dollars for an unused feature!” a long-time industry actuary told RIJ.

Loss due to leakage.  “Leakage” from tax-deferred savings during job changes reduces lifetime accumulations dramatically. The median job tenure for Americans is only 4.1 years. One industry veteran told me that 75% of 401(k) plan participants won’t be in their current plan when they reach retirement age.

Gender offender. Despite the fact that women on average live a couple of years longer than men, all else being equal, lifetime payout rates for 401(k) annuities must be gender neutral—i.e., the same for both. This could incentivize men to look for an annuity outside the plan. It could also create a communication challenge for plan sponsors.

The burden of providing education. Unless plan sponsors, plan advisers and plan providers invest money and effort in educating participants about retirement income planning, a lot of participants who have been defaulted into annuities will opt-out of them at retirement or before. It’s not even clear how to educate participants. If the best way to use a living benefit is to switch on the income payments immediately, but the annuity issuer would prefer that contract owners delay payouts, who will be candid with participants?

Possible blowback from benefits paid for but not received. “We have ongoing conversations with plan sponsor clients and other fiduciaries, about what is referred to as the potential for ‘unrealized benefits,” said Kelli Hueler, whose online platform, Hueler Income Solutions, enables participants nearing, at, or in retirement to shop for and buy low-cost income annuities. She’s referring to benefits that auto-enrolled participants may have paid for during the accumulation period but that—either because they change jobs or opt out of the annuity at retirement—they never receive. “It’s a serious issue that’s being discussed by astute plan sponsors and their consultants. They’d like to see lifetime income product designs that prevent this from happening.”

Soft assumptions. “Some of the recent TDF in-plan income products appear to rely on positive cash flow assumptions into the investment fund in order to provide guaranteed par value withdrawals into the future for retirees” Hueler told RIJ. “Importantly, it’s an assumption that hasn’t yet been tested.” Given that the products are designed for older participants who will take withdrawals relatively soon, the assumption seems questionable to her and some plan fiduciaries. For many years, Hueler also ran a company that collected data on stable value funds, including historical cash flow statistics, for fund evaluation and reporting to plan sponsors and other fiduciaries. Morningstar purchased that business in 2020.

Conflicts of interest. It strikes me as inherently challenging for plan fiduciaries, whose loyalty to plan participants is supposed to be undivided, to act in the participants’ best interests when choosing products that are designed, simultaneously, to serve the interests of a providers’ shareholders. The incentives and responsibilities are mismatched. Such conflicts of interests have consistently proven to create situations of “asymmetrical information” that disadvantage the clients. Clients typically don’t read, heed or understand verbal or written disclosures.

Paradox of QDIA annuities, Part I. Providers of in-plan 401(k) annuities need to be able to auto-enroll participants into qualified default investment alternatives (QDIAs such as TDFs, managed accounts or stable value funds) because they don’t believe that many participants will actively choose to invest in an annuity. Yet they seem to expect inertia or a newfound respect for annuities to propel these participants into actively choosing the annuity at retirement. I don’t understand this.

Paradox of QDIA annuities, Part II. Because retirement income planning involves long-term and sometimes-painful trade-offs, and because it requires discussions of both death and taxes, it requires substantial engagement on the part of a future retiree. But auto-enrolled participants are often the least-engaged participants. When, how and why will they engage?

Paradox of QDIA annuities, Part III. The smartest, best-paid participants, who are the ones most likely likeliest to reach retirement with the largest accumulations, are also the ones most likely to select their own investments. To the extent that that’s true, QDIA annuities will miss the largest, juiciest fruit on the 401(k) tree.

Portability issues still unsolved. The last time I checked, the folks at Retirement ClearingHouse were still making progress on its auto-portability initiative, which would forward the 401(k) assets of job-changers from their old plan to their new plan. I’m still trying to understand portability issues. It’s complicated. But it’s still a work in progress.

Patchwork regulation. The ongoing legal battle over the DOL’s “best interest” rule suggested to me that every player entering the defined contribution game would prefer to use their own playbook. They aren’t in the same book, let alone on the same page. Asset managers want to play by SEC rules, insurers want to play by state regulatory rules, employees rely on the Labor Department’s protections—and the judicial system appears vulnerable to gaming. Meanwhile, plaintiffs’ attorneys are waiting for plan sponsors to mess up. I’m not optimistic.

The ‘black box’ of insurance. Once insurers lock themselves into a guarantee, they must leave themselves some wiggle-room in which to manage their risks. At times, as I understand it, that can mean adjusting the costs or the benefits of a product in order to avoid a loss. Plan sponsors and participants may not be able to see into the “black boxes” where these adjustments are made. Yet fee transparency has to be a sine qua non for adoption by plan sponsors; they’re terrified of lawsuits.

Participants need more choices. Given the uniqueness of each retiree’s household balance sheet, and each one’s future income needs, it seems odd that a plan’s participants would not have several income-generating options at retirement. These might include non-guaranteed systematic withdrawal plans, for instance, as well as annuities.

“Any one in-plan income solution would be a mistake,” a DC plan veteran told me recently. “No one in-plan solution can accommodate that diversity of needs and goals. And, any two or more in-plan income solutions would add complexity far beyond what plan sponsors want to deal with, or everyday workers can use—without an advisor.”

Underwhelming demand from plan sponsors and participants. Despite what their proprietary surveys say, the sell-side of the 401(k) annuity market is still more interested in bringing this trend to fruition than the buy-side—i.e., the plan sponsors and participants. That’s to be expected, since the benefits to the sell-side are immediate and tangible, while the benefits to the buy-side are more remote and incalculable.

The takeaway

The push for 401(k) annuities may very well serve the business goals of DCIO (defined contribution investment-only) TDF providers. They partner with insurers to preserve assets-under-management levels in 401(k) plans and slow down the rollover-driven hemorrhage of TDF balances at retirement. But it’s not fair or efficient to use sponsors and participants as guinea pigs, or expect that, after a long shakeout period, the market’s invisible hand will deliver an optimal solution.

If the past is any guide, a few large asset managers and life insurers will try to impose a regime that serves their needs but not the public’s. That’s OK for hula-hoops or even computer operating systems, but this is a national program that participants finance and taxpayers subsidize. Too little has been done to address fundamental issues, leaving most plan sponsors not ready to commit.

© 2024 RIJ Publishing LLC. All rights reserved.

‘If you’re not talking about it, you’re not winning’

Mark Fortier is an actuary who worked on AllianceBernstein’s pioneering 401(k)/annuity at United Technologies [now RTX] over a decade ago. He sees JPMAM’s initiative in the context of the DCIO (defined contribution investment-only) market, where it competes against other asset managers that distribute products (funds, TDFs, ETFs, CITs, etc.) through 401(k)s but don’t own their own proprietary retirement plan businesses.

With its DCIO/TDF competitors chasing the 401(k) income trend, J.P. Morgan can’t ignore it. “Retirement income has always been a popular topic of discussion for plan sponsors, advisors, and consultants,” said Mark Fortier. The theory is that if you are not talking about it, you’re not winning. So the topic of retirement income is a relevant discussion for them to have, even if it doesn’t turn out to be a big asset gatherer for them.”

Among the leading TDF issuers, JPMAM has a couple of competitive disadvantages. Having sold its retirement plan business to Empower in 2014, it doesn’t have the kind of captive pool of 401(k) participants that, for instance, Vanguard and Fidelity have.

Its TDFs also contain actively managed funds, which means that the fees are higher than those of the all-passive TDF providers. “Target date funds fees have fallen each year, driven by fee litigation and a shift to passive. The pure passive providers such as Vanguard, Blackrock, and State Street Global Advisors have been the winners of this trend,” Fortier told RIJ.

The TDF sector’s flattening growth curve is likely to be a challenge for all TDF issuers. “The growth of the TDF market has always been organic,” he said. “It was based on the fact that contributions exceeded distributions because ‘savers’ outnumbered ‘spenders.’ But ‘money out’ is starting to equal ‘money in,’ so the days of double-digit organic growth are ending.”

“As a DCIO player in the 401(k) business, J.P. Morgan fears irrelevance,” Fortier said. His personal assessment is that the 401(k) income opportunity has remained frustratingly out of the grasp of TDF manufacturers. “They’re doing a lot of work just to bet on the chance that participants will voluntarily convert their savings to an annuity,” he said. “But so far that has been a losing bet.”

Another executive, who has tried to market income products to plan sponsors for many years, told RIJ, “I’m skeptical. “Most employers and plan sponsors scratch their heads. No one is clamoring for it. Industry insiders are still cautious about the uptake so far.

“The hype is there, but I haven’t seen anything to justify it. Think of the things people could be pushing for, like the best way to claim Social Security or how to choose between Medigap and MedicareAdvantage plans. We’re all being told it’s the next big thing. But I don’t think the momentum is there.”

© 2024 RIJ Publishing LLC. All rights reserved.

 

J.P. Morgan Asset Mgt Joins the 401(k) Annuity Race

J.P. Morgan Asset Management (JPMAM) has followed its target-date fund (TDF) competitors into the newborn 401(k) “in-plan” annuity market, partnering with A-list life insurers Equitable and Prudential on a new TDF/annuity product line called SmartRetirement Lifetime Income.

The new series, announced August 15, is based on the $2.9 trillion asset manager’s existing SmartRetirement TDF series. It will compete for plan sponsor clients against similar TDF/annuity hybrids from BlackRock, State Street Global Advisors and AllianceBernstein.

For those new to this phenomenon: The SECURE Act of 2019 encouraged 401(k) plan sponsors to offer annuities, issued by life insurers, to their participants, either as savings vehicles during their working years and/or to be purchased for immediate income at retirement.

Several large asset managers and insurers have since grafted annuities onto TDFs which, with $3.5 trillion in assets industry-wide, are the most common 401(k) savings vehicle. TDFs, like managed accounts, are admitted as qualified default investment alternatives (QDIAs) in 401(k) plans by the Department of Labor.

Participants who don’t choose their own investments can therefore be defaulted into a TDF.  Once invested in a TDF/annuity hybrid that can generate lifelong income throughout retirement, participants are likelier to leave their savings in the plan instead of rolling them over to an IRA.

“By offering in-plan lifetime income, the product design aims to mitigate the need for rollovers by giving participants access to institutional-quality products and pricing and helping the plan sponsor, recordkeeper, and J.P. Morgan retain in-plan assets,” JPMAM head of retirement Steve Rubino told RIJ in an email.

“We’re focusing on the larger plan universe of U.S. defined contribution plans eligible to invest in collective investment trusts (CITs), initially targeting large and mega plans as their QDIA [qualified default investment alternative],” Rubino wrote. (CITs are an increasingly popular vehicle for TDFs; they entail less paperwork and lower costs than mutual funds.)

The income guarantee

One of investment sleeves inside the SmartRetirement Lifetime Income TDF will be a stable value fund (SVF), a type of low-volatility bond fund often used in 401(k) plans for capital preservation, and in which about $870 billion in defined contribution plan assets are currently held.

Ten years prior to a participant’s target retirement date, some his or her savings will begin migrating to the SmartRetirement Lifetime Retirement Income Fund, which “ will invest in group annuity contracts issued by unaffiliated insurers to finance the optional lifetime income feature during the participant’s retirement spending phase.”

“In the accumulation phase, the TDF will make purchases of a stable value fund as part of the participant’s fixed income allocation,” Keith Namiot, head of institutional markets at Equitable, told RIJ in an interview. “That is, a portion of what would have been in bonds will be in stable value.

“The target allocation at retirement is 25% of the account value,” he added. “A ‘synthetic GIC’ (guaranteed investment contract) provided by us and by Prudential will wrap around the SVF during the accumulation period. Participants can elect guaranteed income for life at retirement,” he added. Participants will be able to move money out of the SmartRetirement Lifetime Income TDF if they wish—pension law requires that 401(k) assets be liquid for the participant.

Pulling the trigger

Though defaulted into the TDF, participants cannot be defaulted into the annuity. They must actively choose it. “At retirement the participants can choose to buy a guaranteed withdrawal benefit for life and make withdrawals that are linked to the life expectancy of the policyholder and possibly the spouse. Participants must actively choose to trigger the lifetime income benefit; they can’t be defaulted into it. They can increase their payment by delaying the commencement of benefits.

The TDF/annuity concept is still too new for anyone to know what percentage of participants who reach retirement will pull that trigger. A lot will depend on how well that decision is supported by the plan sponsor and product providers. “When there’s education at moment of retirement, there’s a noticeable difference in the take-up rate,” said Equitable’s Namiot.

To educate participants, JPMAM said, “We are designing an intuitive digital experience, ‘My Retirement Income Planner.’ It is intended to provide education that plan participants can use in their decision-making, including whether to opt into the lifetime income feature. There will not be any additional fees—for plan sponsors or participants—for accessing this digital education.”

Given the participant’s account value, years of life expectancy when income starts, and the anticipated growth rate of the SVF, the insurer will be able to calculate not only the monthly payments during retirement, but also project the date when the account will be depleted.

“Usually, in a variable annuity with a GWB, the payment is a percentage of the guaranteed income base, Namiot said. “Due to market volatility, it is not possible to know what year the account will be depleted. For this product, the guaranteed payment is based on mortality and the payments are designed to deplete the account value at a specific date in the future.  We adjust the payment each year based on the net-of-fees performance of the account.”

If retirees die before reaching that date, their beneficiaries will receive what’s left in the account. If retirees outlive their life expectancies, one of the life insurers will continue paying them by purchasing a life-contingent, single premium immediate annuity (SPIA). “At a certain date in the future that is known to us and to the participant, if still living, Equitable will begin making guaranteed payments to the policyholders in amounts equal to their last monthly payout check,” he told RIJ.

The SPIA is financed by the annual insurance fees that the participants start paying as soon as they opt into the program at retirement. Retirees will continue to pay investment fees on the 75% of their savings that remains in the 401(k) plan, under JPMAM management. Specifics about these fees were not available to RIJ at deadline. The current fee for the JPMAM SmartRetirement Income Fund, the most final fund in its TDF series, is 69 basis points (or 88 bps without the current waiver).

The annuity features known as “guaranteed withdrawal benefits” have been around for more than 25 years, initially as riders on deferred variable annuities and later on other types of deferred fixed, fixed indexed, and registered index-linked annuities. The value proposition sounds like a win–win: the monthly payout can’t be less than a certain minimum, and retirees can always take out more than that for unplanned or unforeseen expenses.

But that type of “withdrawal benefit” has always presented a trap of sorts for retirees, no matter which insurer offers it. The minimum withdrawal rate is, in effect, also a maximum withdrawal rate. If retirees over-withdraw from their accounts, they could, depending on how much they withdraw, forfeit past fees and receive proportionately smaller monthly payments until they die. Since their “excess withdrawal” would reduce the providers’ asset-based fees, that makes sense.

At retirement, participants in the SmartRetirement program also have an opportunity to choose a non-guaranteed distribution service, JPMAM’s “Flexible Retirement Income Fund. JPMAM’s website describes it as “a balanced portfolio of stocks and bonds that offers higher growth potential and supports a flexible withdrawal strategy.”

© 2024 RIJ Publishing LLC. All rights reserved.