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Helicopter Money Is in the Air

Posted on September 22, 2016 by Robert Skidelsky -

Fiscal policy is edging back into fashion, after years, if not decades, in purdah. The reason is simple: the incomplete recovery from the global crash of 2008.

Europe is the worst off in this regard: its GDP has hardly grown in the last four years, and GDP per capita is still less than it was in 2007. Moreover, growth forecasts are gloomy. In July, the European Central Bank published a report suggesting that the negative output gap in the eurozone was 6%, four percentage points higher than previously thought. “A possible implication of this finding,” the ECB concluded, “is that policies aimed at stimulating aggregate demand (including fiscal and monetary policies) should play an even more important role in the economic policy mix.” Strong words from a central bank.

Fiscal policy has been effectively disabled since 2010, as the slump saddled governments with unprecedented postwar deficits and steeply rising debt-to-GDP ratios. Austerity became the only game in town.

This left monetary policy the only available stimulus tool. The Bank of England and the US Federal Reserve injected huge amounts of cash into their economies through “quantitative easing” (QE) – massive purchases of long-term government and corporate securities. In 2015, the ECB also started an asset-buying program, which ECB President Mario Draghi promised to continue “until we see a sustained adjustment in the path of inflation.”

QE has not been a magic bullet. While it helped stop the slide into another Great Depression, successive injections of money have yielded diminishing returns. The ECB’s announcement of its policy narrowed the gap in bond yields between Europe’s core and periphery. But a study by Thomas Fazi of the Institute for New Economic Thinking emphasizes QE’s lack of influence on bank lending, the increase in non-performing loans, and the dire output and inflation figures themselves. Moreover, QE has undesirable distributional consequences, because it gives money to those who have already have it, and whose current spending is little influenced by having more.

Policymakers should have been alert to the likelihood of this mediocre outcome. When central banks try to reduce inflation by pumping liquidity out of the system, their policy is subverted by commercial banks’ ability to pump it back in by making loans. In today’s deflationary environment, the reverse has happened. Central banks’ attempt to pump in liquidity to stimulate activity is subverted by commercial banks’ ability to pump liquidity out by augmenting reserves and refusing to lend.

That leaves fiscal policy. The logic of current economic conditions implies that governments should be taking advantage of ultra-low interest rates to invest in infrastructure projects, which would both stimulate demand and improve the structure of the economy. The problem is the climate of expectations. As the Oxford economist John Muellbauer says, treasuries and central banks have been “hammering into the consciousness of the private sector the importance of reducing gross government debt relative to GDP.”

This orthodoxy arises from the idea that borrowing is simply “deferred taxation.” If the private sector believes that taxes will have to rise to pay for government borrowing, according to this view, people will increase their savings to pay the higher taxes, thus destroying any stimulative effect. The orthodoxy mistakenly assumes that government spending cannot generate any extra income; but so long as it prevails, debt-financed fiscal policy is ruled out as a means to revive economic growth.

As a result, analysts and policymakers have started mooting ideas for unconventional fiscal policy to supplement unconventional monetary policy. In particular, they are debating variations of so-called helicopter money, following a famous thought experiment by Milton Friedman in 1969, in which “one day a helicopter… drops an additional $1,000 in bills from the sky.” Former Federal Reserve Chairman Ben Bernanke, among others, has offered influential support for “helicopter drops” to revive flagging economies.

Helicopter money comes in two forms, which could (and should) be dropped together. The first is to put purchasing power directly into the hands of consumers – for example, by issuing each voter or citizen with smart cards worth $1,000 each. The Swiss economist Silvio Gesell, who originally proposed a scheme of “stamped money” at the start of the last century, added a stipulation that balances unspent after a month should be taxed, to discourage hoarding.

Alternatively, helicopter money could be used to finance infrastructure spending. The advantage of such “monetary financing” is that such spending, while adding to the deficit and leading to a permanent increase in the money supply, would not increase the national debt, because the government would “owe” the money only to its own banker. This would eliminate the offsetting negative expectation of higher taxes.

Surely, issuing debt that never has to be repaid is too good to be true, right? There is indeed the obvious danger that governments might easily become addicted to monetary finance to pay for private and public spending, which is why it is unlikely to be tried openly unless economic conditions worsen significantly. But the political risk of doing nothing if we stumble into another recession (as seems quite likely) is worse. Like it or not, unconventional fiscal policy could well be the next game in town.

Anecdotal Evidence

Posted on September 22, 2016 by Kerry Pechter -

Expect the DOL rule to apply to taxable accounts

At the Financial Planning Association’s annual conference in Baltimore last week, RIJ asked ERISA attorney Marcia Wagner, who is a kind of defensive coordinator for firms wishing to ward off potential class action lawsuits under the DOL fiduciary rule, if she thought the ethical standard established by the rule would eventually apply to taxable accounts as well as IRAs and 401(k) plans.

Yes, she said, she believes it will, regardless of what the SEC does or doesn’t do. Others have noted that it will be difficult or impractical for advisors to apply a suitability standard to the taxable part of a client’s portfolio and the fiduciary standard to the tax-deferred part. That may be true. But multiple standards will continue to exist. The protections that apply to hedge fund customers, for instance will presumably continue to be different from the protections for less wealthy investors.

If the DOL rule applies to all advisors and all types of accounts, we can expect to see an even faster and more extreme shift among advisors to AUM compensation models and to the use of robo-advice for younger investors and smaller accounts.

Put guardrails around your four percent withdrawal: Vanguard

For planners and advisors who like to tell their clients to spend about four percent of their assets in retirement—as opposed to those who prefer “bucketing” or partial annuitization as their income-generation tools—Vanguard has created a new formula for calculating a safe rate of withdrawal from savings.

In a white paper published this month, “From assets to income: A goals-based approach to retirement spending,” a Vanguard team recommends a compromise between two versions of the 4% rule: one (“A”) that calls for spending an inflation-adjusted 4% of the original balance and another (“B”) that calls for spending 4% of the current real balance.

Each of those alternatives has a drawback. The first is too rigid, the second too flexible, in the face of market volatility to provide sufficiently predictable and sustainable income. Splitting the difference, Vanguard’s decumulation experts call for using the second alternative but putting upper and lower limits on annual spending.

Supposed, to use the classic example, that a new retiree has $1 million in savings and, conveniently, a need to spend $40,000 in the first year of retirement. He takes Vanguard’s advice and, in the following years, promises not to give himself a raise of more 5% or to tighten his belt by more than 2.5%.

Here’s how the hypothetical numbers play out. At the start of the second year, after earning a 10% return and spending $40,000, the retiree has $1.06 million. Under version B of the 4% rule he could spend $42,400 (.04 x $10.6 million). But since his upper limit is $42,000, that’s all he spends. Conversely, if the market gone down that year, he would have spent no less than $39,000 ($40,000 – ($40,000 x .025)).

Since retirees often disregard their recommended spending limits, this might seem like a labor-intensive exercise in false precision. It gets even more complicated when you factor in variables like asset allocation and portfolio choices, and even more so when you try to obey the rules of tax-efficient decumulation.

Still, Vanguard’s method adds nuance to the 4% rule. Advisors can also point to research like this to show that they did their homework before recommending a withdrawal rate.

Bad day at Wells Fargo, good day at BlackRock

One of America’s great financial services brands was sullied this week when Wells Fargo’s over-zealous sales practices, which reportedly included the creation of false accounts by more than 5,000 employees who hoped to reach or were compelled to reach big, hairy aggressive sales goals, became front page news.

“A brand is a promise kept over and over and over,” a consultant once told me. That’s a variation on the truism that it takes a long time to achieve trust but a short time to lose it. Wells Fargo may yet emerge whole from this episode. Consumers have short memories. And, just as many voters hate Congress but admire their own district’s representative, the ubiquitous bank’s retail relationships will probably survive.

But the incident indicates the pressure at publicly held companies to stoke earnings and please shareholders—even if it means throwing customers under the bus. That may sound harsh, but this fundamental conflict of interest tinges every public company’s product design, compensation, sales practices and even the wording of its advertising and communications. In the extreme, it results in incidents like those at Wells Fargo.

By contrast, BlackRock and its CEO, Laurence D. Fink, received almost unalloyed praise from the New York Times last weekend. BlackRock, formerly Blackstone, has grown dramatically through acquisition (absorbing Merrill Lynch’s funds in 2006 and Barclays Global Investors in 2009) and its share price has soared.

In the retirement income market, its primary product entry seems to be CoRI target-date bond funds. These are long-term bond funds that track the proprietary CoRI Index, which reflects the fluctuating price of $1 of lifetime income on your retirement date, as determined by prevailing immediate annuity prices, which also follow long-term bond returns.

The concept relies on asset-liability matching. The CoRI Index and the value of CoRI funds, like immediate annuity prices, move in the opposite direction of long-term interest rates. As rates rise, your fund will lose value, but immediate annuity prices will fall too, so that your CoRI fund will always buy the same income (in proportion, of course, to your investment in the fund).

But if you never intend to buy an annuity, the long maturities of the CoRI funds entail a lot of interest rate risk. And the funds aren’t cheap. According to page 3 of the CoRI 2017 prospectus, there’s a front-end Investor A share load of 4% for purchases under $1 million, and an annual fund expense ratio of 83 basis points (58 basis points for institutional shares requiring an investment of $1 million or more).

The cost could potentially be much higher. The prospectus explains that the annual operating cost is 2.06%, of which BlackRock has waived 1.23%. A footnote adds, “the Fund may have to repay some of these waivers and/or reimbursements to BlackRock in the following two years.” Such ambiguity makes the value of the CoRI funds proposition hard to assess.

Jackson offers no-load VA for fiduciary era

Posted on September 22, 2016 by Editorial Staff -

As rumored at the FPA annual conference last week, Jackson National Life has launched a fee-based variable annuity. Called Perspective Advisory, it offers the same investments and optional benefits, for an additional charge, as Perspective II, Jackson’s flagship commission-based variable annuity, the company said in a release today.

The launch is directly linked to the Department of Labor’s so-called fiduciary rule, which will makes the sale of a variable annuity to an IRA owner a “prohibited transaction” unless the seller signs a contract promising to act in the client’s best interest.

“The company’s entrance into the fee-based space is designed to meet increased market demand for products compatible with fee-based accounts and platforms as a result of the U.S. Department of Labor (DOL) fiduciary rules, released in April 2016,” according to a release from Greg Cicotte, Jackson’s executive vice president and chief distribution officer.

“In today’s heightened regulatory environment, many of our distribution partners are choosing this type of product to serve their clients who are seeking strategies for retirement planning,” the release said. “The legal and compliance costs, as well as additional disclosure requirements related to managing a commission-based platform under the DOL mandates, have set the stage for utilizing fee-based variable annuities.”

Perspective Advisory also gives Jackson a product for advisory distribution channels where insurance products historically have not been widely utilized, such as the Registered Investment Advisor market.

Perspective Advisory’s key features include:

Compensation structure: Advisor compensation is fee-based, rather than commission-based.
Minimum initial premium: $25,000.
Product cost: 0.30% annually for mortality, expense and administration costs.
Surrender period: Three-year withdrawal charge schedule of 2%, 2%, 1% and zero.
Investment options: More than 90, ranging from 56 to 219 basis points in annual fees.
Additional options: AutoGuard and LifeGuard Freedom living benefits, ranging from 80 to 160 basis points in annual fees, and death benefits ranging from 30 to 100 basis points in annual fees.

With eye on DOL, IRI hires Milliman to survey annuity comp

Posted on September 22, 2016 by Editorial Staff -

To help financial services firms and financial professionals comply with the reasonable compensation standard under the Department of Labor’s fiduciary rule, the Insured Retirement Institute will survey current compensation practices regarding sales of annuities and other investment products, IRI announced.

Milliman, Inc., the global consulting firm, will conduct the survey for IRI. Financial firms have until the end of 2017 to fully comply with the rule, which was issued last April.

The survey aims to help firms demonstrate their existing reasonable practices, rather than to reveal non-compliant practices, according to IRI CEO Cathy Weatherford.

“While we believe our members’ have always strived to design their compensation practices in an appropriate and reasonable manner,” she said in a press release, “demonstrating compliance with this new legal requirement is another matter.”

The new rule’s Best Interest Contract (BIC) Exemption or amended Prohibited Transaction Exemption (PTE) 84-24 allows firms to recommend variable or fixed indexed annuities and accept commissions or variable third-party compensation on the sale only if the compensation is reasonable.

According to the IRI release, the survey is necessary to establish industry compensation benchmarks because the DOL didn’t define “reasonable,” or offer examples or so-called safe harbor suggestions, except to say that compensation should follow “a market based standard.”

MassMutual, Envestnet enhance fiduciary services

Posted on September 22, 2016 by Editorial Staff -

MassMutual and Envestnet Retirement Services (ERS) are expanding their Fiduciary Assure program, through which ERS helps Mass Mutual institutional retirement clients maintain compliance with their ERISA fiduciary obligations, the insurer announced this week.

“Our new services are complemented by our new Fiduciary Support Analyzer, which can help retirement plan sponsors determine their relative risk and need for fiduciary support, and our new tracking guide,” said Tina Wilson, senior vice president, Investment Solutions Innovation, in a news release.

Earlier this year, MassMutual and ERS, a registered investment advisor, added “3(21)” service to their Fiduciary Assure program. Now, as an expansion of the program, MassMutual and ERS are offering a “3(38) service.

Both the 3(38) and 3(21) services are available at no additional cost to retirement plans with less than $5 million in recordkeeping assets, according to Wilson. Larger plans pay a fee of two basis points for either service, she said.

Under the 3(38) service, sponsors can allocate certain fiduciary investment responsibilities to ERS. ERS or the plan sponsor develops the investment lineup from a pre-approved list of investment options. ERS monitors the investment performance and directs MassMutual to adjust the investment lineup as needed in order to meet core asset class requirements.

With the 3(21) service, sponsors share their fiduciary investment responsibility with ERS. Sponsors retain the ultimate decision-making authority provided their investment lineup includes at least one investment option in each of four core asset classes (cash equivalent, domestic bond, domestic equity and foreign equity) from a pre-selected list provided by ERS.

Or, sponsors can opt for a pre-selected investment lineup. Sponsors are responsible for making ongoing investment line-up changes in order to maintain the core asset class requirements.

As part of the enhancements, Fiduciary Assure provides sponsors and advisors digital access to critical reporting information, MassMutual said. Separate websites enable sponsors and advisors to monitor fiduciary compliance by providing “fingertip access” to reporting that is specific to each retirement plan. Sponsors’ fiduciary investment reports are housed within an online data vault.

MassMutual is introducing a digital fiduciary planning guide and calendar that helps advisors and sponsors track key fiduciary filing dates for both defined contribution and defined benefit plans. The guide contains key dates that plan fiduciaries should be aware of related to plan filings, notices, distributions, testing and reporting requirements.

Advisors to retirees shouldn’t neglect the ‘household balance sheet’

Posted on September 22, 2016 by Editorial Staff -

For advisers active in recommending rollovers from defined-contribution plans to IRAs, the DOL’s new fiduciary rule might appear at first to have little impact. That’s because clients may roll over only a couple of times in their careers, and because many advisors are already fiduciaries.

But, across the advice industry, the impact of the rule could be much greater than might first appear, according to the MacroMonitor, a publication of Strategic Business Insights (SBI).

For one thing, the fiduciary standards will shift tens of billions of dollars into the pockets of IRA owners. Second, advisors are at risk of underestimate how much broader their fiduciary responsibilities will be to clients who have entered retirement.

On the first point, the fiduciary standards could save IRA owners over $40 billion in ten years, SBI research shows. “Even narrowly applied, the impact could affect about seven million households and nearly $600 billion that rolls over into IRAs annually—the numbers are rising,” this week’s issue of the MacroMonitor said.

On the second point, fiduciary standard of advice to a retiree may mean a shift in the focus of advice from the narrow field of investment management to the more comprehensive management of each client’s “household balance sheet.”

The household balance sheet includes the sum total of the household’s assets and debts, and includes the interests, if applicable, of a spouse, children and perhaps other stakeholders, MacroMonitor said.

“A complete understanding of the household’s requirements and resources is necessary to apply a fiduciary standard effectively in both the accumulation and disbursement phases” because “the purpose of advice is to create and maintain a secure income (such as cash flow) during retirement.”

Expertise in mutual funds alone will not be sufficient for the fiduciary retirement advisor. “Providing good retirement advice requires knowledge about all retirement resources, retail investments, debts, and all forms of protection held; most households have a variety of them all,” the report said.

“Recent-rollover households more likely than all households to own all types of retirement accounts—IRAs (Roths, Simples, Traditional), 401k’s, 403b’s, 457’s, and individual annuities—and at least one household head is also more likely than all household heads to have a defined-benefit pension plan.”

Other demographic and financial characteristics of recent-rollover households make the task of providing good advice complicated and difficult. Near-retirement household hold more debt than all other households combined.

The report noted, however, that rollover clients are receptive clients. “The good news is that rollover households frequently secure advice before making major investment decisions,” the MacroMonitor said. “They are more likely than all households to use most types of financial institutions and intermediaries, and they tend to trust these firms and professionals. Many already have a written financial plan and wills in place.”

Flight from active equity funds continues: Morningstar

Posted on September 22, 2016 by Editorial Staff -

Investors continued to exit actively managed U.S. equity funds in August, according to Morningstar’s monthly report on U.S. mutual fund and exchange-traded (ETFs) asset flows. Active U.S. equity funds lost a net $25.4 billion in August, compared with a negative $32.9 billion in July.

Passive U.S.-equity funds persisted in attracting investor money, with an estimated inflow of $16.4 billion in August, about half of July’s $33.8 billion intake. (Morningstar estimates net flow for mutual funds by computing the change in assets not explained by the performance of the fund and net flow for ETFs by computing the change in shares outstanding.)

Highlights from Morningstar’s report about U.S. asset flows in August:

Total international-equity asset flows for August consisted of an estimated $7.3 billion outflow from developed markets and a $6.2 billion inflow to emerging markets.
Taxable and municipal bond funds accumulated flows, reflecting investors’ preference for a steady income stream: $27.8 billion and $7.4 billion, respectively. Commodity funds saw a trend reversal in August with a$1.0 billion outflow from passive funds.
The diversified emerging-markets category has consistently been on the top-flowing list for the past few months; in August, total flows were $5.5 billion. Factors such as stronger currencies, diminishing worries about China, and young populations driving more potential for growth going forward, are top contributors.

The top Morningstar category remains unchanged from July: intermediate-term bond. The bottom five categories were also little changed from last month, with large growth, world allocation, and Europe stock sustaining the largest outflows. WisdomTree Europe Hedged Equity and its Deutsche counterpart, Deutsche X-trackers MSCI Europe Hedged, continued to suffer outflows.

Of the top 10 U.S. fund families, only Vanguard, State Street and T. Rowe Price saw positive flows into active strategies in August. American Funds continued to suffer for the third consecutive month, seeing $1.5 billion in outflows in August.

Vanguard continued to lead the way for passive inflows, gathering $20.7 billion in August. The highest inflow to a passive fund went to Vanguard Total Stock Market Index Fund, which took in an estimated $4.6 billion last month.

PIMCO saw two of its funds on the top-flowing list in August. PIMCO Income Fund, which has a Morningstar Analyst Rating of Silver, led flows into active funds with an estimated $1.4 billion.

Could You Be Sued Under the New DOL Rule?

Posted on September 21, 2016 by Kerry Pechter -

Will tort lawyers use the Best Interest Contract of the new Department of Labor fiduciary rule to turn financial advice into the next asbestos-related, or tobacco-related, or defined contribution fee-related federal class action legal bonanza?

Are small-scale independent advisors at risk of getting sued by disgruntled clients? Are employee-advisors at risk if their deep-pocketed broker-dealer employers get sued? Will clients sue insurance marketing organizations for ethical lapses by the agents they run?

These questions were on the minds of the Certified Financial Planners—many of whom are also licensed to sell securities and insurance products to IRA owners and some of whom are advisors to 401(k) plans—in Baltimore’s Inner Harbor last week at the Financial Planning Association’s annual conference.

The answers, as heard during breakout sessions that hundreds of CFPs attended, ranged between the extremes of “Be afraid, be very afraid” to “Honest advisors have nothing to fear” and a number of positions in between.

At least four speakers at the conference addressed the DOL’s rules legal implications. They included Marcia Wagner, the Boston-based ERISA lawyer; Tim Hauser, the DOL attorney and lead author of the fiduciary rule; Ron Rhoades, law professor at Western Kentucky University; and Doug Lennick, a CFP and founder of think2perform.com, who preaches a gospel of mindfulness.

In the end, “Will I get sued?” may not be the most urgent question. From the financial industry, the battle over the DOL rule may be less about ethics than about pricing. The DOL appears to have focused on the provision of conflicted advice, but its real targets are high-priced products. And in trying to make products cheaper for retirement clients, it—intentionally or not—roils the delicate economies of the entire industry, from advisor to broker-dealer to fund company or insurer.

So, the more load-bearing questions may be: How will manufacturers and distributors adapt to the rule? Will they voluntarily reduce prices and cut costs (perhaps by replacing human intermediaries with robo-advice)? Will they stop taking non-transparent third-party payments? Will they conduct business as usual until someone sues them, and then fight the DOL rule in the courts? Will they assume that the DOL rule will soon apply to taxable accounts? At least until the DOL begins issuing a list of clarifying FAQs, there are more questions than answers.

The next ‘asbestos’?

Wagner, who counsels companies how to avoid ERISA violations, believes that the DOL rule is going to engender a lot of class action litigation. She compared the coming wave of lawsuits to the mesothelioma and tobacco litigation that kept plaintiff’s attorneys busy for decades, as well as to the recent wave of lawsuits against defined contribution plan sponsors and providers for violations of their fiduciary duty to seek lower costs for participants.

The potential liability is clear. The DOL rule gives retirement clients the right to participate in class action suits, without agreeing to forced arbitration, against advisors or broker-dealers who have violated the rule’s so-called “Best Interest Contract,” which requires them to recommend products or services that are in the “best interest” of the client, as opposed to the seller’s interest.

Advisors, broker-dealers and other intermediaries don’t need to sign the so-called BIC, and accept that type of accountability, unless they receive so-called “differential” or “variable” compensation—i.e., commissions or revenue sharing fees that they receive from product manufacturers—when selling to 401(k) or IRA owners.

One way to continue accepting third-party payments without becoming vulnerable to lawsuits, Wagner said, might be to charge a flat rate to product manufacturers whose products they sell. “If it’s all levelized, it stops all prohibited transactions from happening in the first place,” she said. “It’s a de facto exemption” from the rules against prohibited transactions.

Levelization, in this sense, would mean having the broker-dealer determine any source of variable compensation and embed all of those fees in a single price, so that the all-in third-party revenue for a product category would be, for instance, a flat 50 bps. “That’s what much of the industry is engaged in and that will change payout grids [substantially,” she told a gathering of perhaps 250 CFPs.

[A broker-dealer executive disputed that assessment. “Receiving a flat rate would allow us to avoid the conflicts that are created from revenue sharing and omnibus fees, but it’s only a partial solution,” the executive told RIJ.

“First of all, everyone would have to pay the same amount, which means you would have to eliminate companies like Vanguard from your platform since they don’t pay revenue sharing. Second, you would have to set the amount low enough so that every company could afford to pay it. That would mean some companies would pay more than they currently do, but most of the big firms would pay much, much less. In short, you can only replace a portion of what a firm is getting now.”]

Rollovers are slippier

Then there’s the matter of rollovers. Independent advisors who act as fiduciary advisors to 401(k) plans with assets of $50 million or more may become vulnerable to violations of the new rule when trying to convert retiring participants to new rollover clients—which is often the reason why advisors work with 401(k) plans in the first place. The DOL regards this practice, a type of so-called cross-selling, as an opportunistic way to increase revenue from those clients by moving them from an institutionally-priced plan to a retail account.

“Cross-selling practices create potential conflicts of interest, and capturing rollovers is a classic example of cross-selling,” Wagner said. “It’s easy to see the potential to sell products to the sponsors of a plan after years of developing relationships with them. It used to be that if you weren’t a fiduciary to a plan, you could cross sell, but that’s over. Now, if you want to engage a rollover client and get variable compensation, you will need the ‘full-blown’ BIC with all of the disclosures.”

For the independent planner who sometimes sells insurance and/or investment products for commission, perhaps the best way to demonstrate bona fides to clients and regulators is to avoid one-off product sales and wrap the products in the context of a carefully-considered financial plan developed in concert with clients.

“You may want to consider strategic use of financial plans. Quality financial plans force the advisor to consider the whole picture and demonstrate that the advisor’s recommendations are being done in the client’s best interest and the conflicts are being mitigated,” Wagner said.

Either way, advisors need to practice a new level of circumspection in consultations with clients, she added: “Loose lips sink ships. You need to be careful discussing matters with your clients in this brave new world.”

‘Pernicious’ conflicts of interest

The DOL’s Hauser said that the client’s right to use the courts as a remedy against violations of the DOL rule, calling it an “important incentive to compliance.” But he reiterated the DOL’s position that the rule was intended to close an old loophole in the antiquated “five-part” test of fiduciary duty required of pension advisors, not to create a new window for plaintiff’s attorneys.

As for the possibility of enforcement actions by the DOL, a grace period will probably extend well into 2018. That’s judging by Hauser’s statements during a Q&A session at the FPA conference.

“This is major reform. These are significant changes. The DOL is aware of that,” Hauser conceded. “So, in the near term, our aim is to help firms toward compliance. Between April and December, we’ll help people comply. As of April 2017, if [your actions] meet the definition of conflicted transactions, you’ll have to meet the basic exemption [from the prohibition on conflicted transactions] or refrain from those transactions. If you want revenue sharing and 12b-1 fees, you can do that.

“But in exchange you need to enter into a [best interest] contract with the retail customer and set up a website explaining what you’re doing. Starting January 1, 2018, you must begin executing the Best Interest Contracts. We’ll help people comply between April and December. If you’re trying to get things right, the department’s aim is to help you, and that will be true for some time after December 2017.

“The idea that we’re ‘creating law’ by enforcing regulations, I want to remind people, isn’t true. I also often hear that the rule is very complex. I don’t think so. The current fee structures and industry practices are complicated. Trying to hang onto those structures brings a certain amount of complexity to the compliance effort,” he said. A list of answers to “Frequently Asked Questions” about the DOL will appear this fall “on a rolling basis,” he added.

Don’t ‘complify’ matters

“I’m seeing some firms that are attacking this problem and building new advice platforms and new compensation schemes, who are getting ready for the DOL rule even before the 2017 deadlines,” said Rhoades. “Some have their heads in the sand. They’re saying, ‘This can’t be happening.’ Others are waiting. But this will transform the way firms operate. We will see the proportion of fee-based accounts move to 60% or 70% of the advisory business from 40% in a relatively short period.

“Some firms and advisors think they can continue to do what they’re doing—that is, they can live with the BIC and still sell high commission products. You have a duty to justify client expenditure of funds. I have heard people say they will use the same process for choosing investments. That’s not going to fly,” he added.

“It’s one thing to say your fees are reasonable, but now you will need to benchmark your fees. When it comes to investment policy you have the duty to select the strategy prudently. You can’t do it ad hoc. When choosing products, it’s a fight for basis points. In the 401k suits, for example, one action said the plan sponsor should have chosen a fund with two less basis points.”

Rhoades and Doug Lennick both put forward the idea that advisors who never put themselves in conflicted positions or engage in self-dealing can consider themselves safe from litigation. “When you do everything right, you don’t worry about liability,” he said. “You’re more likely to have liability when you have conflicts of interest.”

“The DOL is giving the client the opportunity to take action against advisors or firms,” said Lennick. “This may create class action suits. A lot of people in our industry ‘complify’ instead of simplify. But if you’re profoundly simple, if you practice empathy, if you prepare your clients for the ‘certainty of uncertainty,’ then you will always be in a defensible position. Your clients will not sue you. They will give you a referral.”

Guiding Clients Through the Medicare Maze

Posted on September 15, 2016 by Kerry Pechter -

If you’re an advisor and you’re not helping guide your 65-year-old clients through the Medicare maze, maybe you should reconsider. Multi-licensed young retirement advisors like Ash Toumayants are only too happy to lever the Medicare opportunity to pry your clients away.

The 34-year-old founder of Strong Tower Associates in State College, Pa., Toumayants brings an outsider’s perspective to financial advice. Arriving in the U.S. from Cairo with his parents only 14 years ago, this grandson of refugees from the 1915 Armenian genocide appreciates entitlements like Social Security and Medicare as perhaps only an émigré can.

“Armenia is a poor country. So is Egypt,” he told RIJ recently. “Social benefits are meager. You have to pay for everything yourself. The strength of the public system here is incredible to me. You guys have it made, but you don’t give much thought to making the most of what you have.”

After graduating from Penn State with an industrial engineering degree and digressing into insurance and financial services through a temp job, Toumayants is now establishing himself. He’s affiliated with Retirement Wealth Advisors and FormulaFolios, two Michigan-based RIAs founded by Jason Wenk, who gained some renown a few years ago as an iconoclastic annuity blogger.

As we know, many traditional investment-focused advisors are aging out of the profession, and a new generation is emerging. If Toumayants is at all representative of them, they’re more holistic and more retirement-minded than their predecessors. In a telephone conversation, he talked with RIJ about Medicare, annuities, robo-advice, the Department of Labor’s fiduciary rule and his business model, among other things.

Panicky 64-year-olds

When Toumayants (at right) was temp-ing in college, making outcalls for a Medigap writer, he was dismayed not just by the level of panic that the Medicare decision inspires in 64-year-olds, but also by their ignorance of the program and the lack of support that investment advisors offered in that area. He smelled opportunity.

“Ask any 64-year-old and you’ll hear that every week they get 20 pounds of mail about Medicare supplements,” he said. “It makes them really panicky. There are Medicare supplements, Medicare Advantage plans, prescription drug plans—and people don’t know which is which. This decision is even more stressful than the rollover decision. You can always stay in your 401(k), but with Medicare you’re forced to make a decision.”

Investment advisors, perhaps because they didn’t have health insurance licenses and/or because there isn’t much money in it, didn’t seem to be helping these people much. This mystified Toumayants

“I was shocked by the number of people I met whose financial managers had no idea how Medicare worked,” he said. “How can you be sure that your clients will have enough income for life if you don’t know what arguably their biggest retirement expense will be? Medicare is its own animal. It’s hard to understand and most advisors don’t bother.”

What’s so hard about Medicare? For one thing, because neither Medicare A or B (hospital coverage and physician coverage) covers all health expenses. So new enrollees face the responsibility to top up their coverage by choosing either a Medigap plan or a Medicare Advantage Plan.

In theory, this decision should feel familiar to anyone who has ever had to choose between a fee-for-service health insurance plan (like Medicare supplement insurance or “Medigap” coverage), which lets them to visit any doctor, and an health maintenance organization or preferred provider network (like Medicare Advantage), which claims to offer lower costs for patients willing to use only doctors or hospitals in a given network.

In practice, 65-year-olds typically face a flurry of mail and telephone solicitations from insurance agents who work from lists, they often face a hodge-podge of familiar and unfamiliar insurers, and the pressure of an enrollment deadline booby-trapped with rare but scary penalties.

The dilemma is having to choosing between the monthly premiums of a government-standardized Medigap plan plus a separate drug plan—or yield to the seduction of a zero-premium bundled Advantage plan, usually with co-pays and an annual cap on out-of-pocket costs. (All Medicare recipients pay at least $121 a month for basic Medicare, usually as a deduction from their Social Security checks. If you choose a Medicare Advantage plan, Medicare pre-pays the insurer a fixed amount to cover you.)

Toumayants often recommends Medigap. “It’s more predictable,” he said. “You know what you will pay. There are no co-pays, no networks to worry about. They cover you anywhere in the country. Any hospital or doctor will accept them. If you’re someone who wants to travel in retirement and see all 50 states, you should get Medigap.”

Building a tower

Merely selling Medicare supplements isn’t a career—a trail commission might be $100 per year per in-force policy—but Medicare counseling, as a kind of loss leader, can be an excellent prospecting tool, especially for advisors who are positioning themselves as retirement specialists, Toumayants has learned. Medicare advice establishes his bona fides as a financial advisor, and bona fides, in the wake of the DOL rule, is gaining value.

Toumayants considered various business models before deciding to get his Series 65 license, become an investment advisor representative of an RIA, and start Strong Tower (whose name refers to Luke 14: 28-30). “I tried the brokerage model. I didn’t like it. It’s too expensive and too cumbersome. With the insurance model, you have to do product training and get new certification and pass a test to sell a new product. With the RIA model, I can charge an AUM fee or an hourly fee for planning,” he said. His annual AUM fee is one percent for the first $100,000 under management; the fee drops to 75 basis points for amounts above $1 million.

For guaranteed income, Toumayants recommends fixed indexed annuities with guaranteed lifetime withdrawal benefits and roll-ups rather than immediate or deferred income annuities.

“Even though the income stream is less than from a SPIA, The FIA roll-up creates predictability for a 55-year-old who wants to start income in 10 years. Even though the income stream may be less than you’d get from buying a SPIA in 10 years, that 20% haircut is worth it because people know exactly what they will get. I also like the death benefit feature,” he told RIJ.

“I’m not a big fan of longevity insurance. If you’ve structured your guaranteed income properly and set other assets aside, mainly for inflation protection, you shouldn’t need it. We also have to make sure, for people who still have money when they die, that that money will go to the kids. I know that there’s a shift under way, with Boomers saying, ‘I will take care of me first,’ but your kids are really going to need that money,” he said, given the high housing costs and low investment returns that the future appears to have in store for them.

As for investment management, Toumayants outsources that to the RIA, Retirement Wealth Advisors, which uses a managed account program called FormulaFolios, which in turn is monitored by a proprietary system called WealthGuard that automatically sells off risky assets when a client’s portfolio balance threatens to break through an agreed-upon floor.

“I tell clients, ‘I don’t have time to meet with you and manage your money,” he said. I could do that if I had 10 clients with $10 million each. Or if I simply did ‘buy and hold’ investing. But if that’s all I were doing, it would be hard to justify the AUM fee.”

On the insurance side, he said, “I wish I could give people all the insurance guidance they need for a flat $300 a year and not take any commission on product sales. But in Pennsylvania that business model doesn’t exist. I can’t go to an insurance company and say, ‘I have these clients who want to sign up for your plan, can’t you give them commission-free pricing?’”

Strong opinions

Regarding the tectonic forces that are affecting advisors today—the DOL fiduciary rule and the rise of robo-advice—Toumayants doesn’t feel threatened by either. RIAs aren’t necessarily immune to the effects of the DOL rule—they need to sign a Best Interest Contract to sell indexed annuities, for instance—but they aren’t in the DOL’s cross hairs.

“I don’t know what will happen, or what the outcome will look like, but I’m not worried about it. I know that if I’m doing what’s right and fair for my clients, I’ll be fine,” he told RIJ. “Any time legislation passes, there are more documents to sign and the applications get a little bigger. That’s all. It’s hard to regulate something like this.”

As for robo-advisors, he doesn’t regard them as serious competition to his high-touch managed account services. “I’ve surveyed my clients and people over 50 don’t have any interest in it. Robo-advisors offer rigid fixed portfolios of index funds and a rebalancing service. There’s hardly any tactical management,” he said.

His managed account service delivers more, he said. “FormulaFolios is not just a rigid mixture of 60/40 through thick and thin. And we don’t need 100% percent of upside. All we want to capture is 80% of the market’s gains and absorb no more than 40% of the losses. We think it will deliver better average performance than you can get by riding the market up and down. Robo-advisors are only going to attract people over 50 who think they know more than I do.”

Toumayants believes he’s taking the long view—the view of a young advisor who may still be practicing in the year 2050. “I’m 34. I want to stay in business. I don’t want to be like the Blockbuster owner who wakes up one day and has no customers coming into his store,” he said. “I have strong opinions on this stuff,” he added, “and it aggravates me that most advisors don’t think about it and don’t sit down and develop a perspective on what they’re doing.”

The Cost of Retirement Age Uncertainty

Posted on September 15, 2016 by Kerry Pechter -

As if we didn’t have enough retirement-related risks to hedge against, a group of economists now point to a new one—uncertainty about one’s retirement date—and their findings point out a structural weakness of the Social Security system.

In a new paper, “The Welfare Cost of Retirement Uncertainty,” Frank N. Caliendo and Aspen Gorry of Utah State University, Maria Casanova of Cal State-Fullerton, and Sita Slavov of George Mason suggest that many Americans spend less and save more during their lifetimes in the belief that a layoff or illness might force them to retire a few years earlier than they expected.

Despite the advisability of thrift in general, the authors don’t believe such behavior is necessarily efficient. In other words, retirement timing uncertainty is a large enough risk to consider insuring, and the authors go so far as to put a rough price on it.

“Our conservative estimates of the standard deviation of the difference between retirement expectations and actual retirement dates range from 4.28 to 6.92 years,” the paper said. “This uncertainty implies large fluctuations in total wage income. We find that individuals would give up 2.6%-5.7% of total lifetime consumption to fully insure this risk and 1.9%-4.0% of lifetime consumption simply to know their actual retirement date at age 23.” I’m not sure how to translate that into dollars, but it sounds like equivalent of $1 out of every $25 to $50 of personal spending.

Precise knowledge of one’s retirement date, of course, is a luxury that vanished with defined benefit pensions, gold watches and retirement parties. You might suppose that Social Security buffers the risk of unexpected early retirement, because it offers enrollment across an eight-year age band (62 to 70). But the economists argue that the Social Security not only fails to take the sting out of this risk, it can make it worse.

That’s because Social Security exacts a price for early retirement, regardless of whether it’s voluntary or involuntary, according to the paper. If someone retires involuntarily at age 62 instead of age 65, for instance, they lose three years of earned income and the opportunity to make what might have been their biggest-ever payroll tax contributions. Whether they claim Social Security at 62 or wait until later, they are likely to have lower benefits than they otherwise would have.

“While current programs in the U.S. (Old Age and Survivors Insurance and Social Security Disability Insurance) may appear to offer protection against this risk, in fact they do not,” the paper said. “Social Security does just the opposite because of the positive relationship between benefits and earnings, making it ineffective at providing timing insurance: individuals who suffer early retirement shocks have low average earnings and benefits while individuals who retire late have high average earnings and benefits.”

The paper, which was published this month by the National Bureau of Economic Research, was based on data about 3,251 men who participated in the Health and Retirement Study, a biennial study of 7,700 U.S. households. The authors reviewed data from 11 waves of the study, between 1992 and 2012, and included men who were ages 51 to 61 during the first wave, 14 years ago.

There is a possible solution, the paper said. Adding a benefit to Social Security that isn’t earnings-dependent would make involuntary early retirement less of a lose-lose, the authors suggest. It seems to work in other countries.

“In some public pension systems such as Japan, the UK, Spain and other European countries, part of retirement benefits is independent of the individual’s earnings history. In other words, a component of retirement benefits is fixed regardless of when retirement occurs. This feature can mitigate up to one-third of the welfare costs of retirement timing uncertainty.”

The hazard of such a benefit is that it might encourage people to leave the workforce early by choice, the authors warned, and that would be counter-productive at a time when working longer may be more advisable. So it looks like Americans have another retirement risk that they need to hedge: the risk of starting retirement earlier than they thought because of a late-life layoff.

Positive Words about Negative Rates

Posted on September 15, 2016 by Ben Bernanke -

Nominal interest rates are very low, and in a world of excess global saving, low inflation, and high demand for safe assets like government debt, there’s a good chance that they will be low for a long time.

That fact poses a potential problem for the Federal Reserve and other central banks: When the next recession arrives, there may be limited room for the interest-rate cuts that have traditionally been central banks’ primary tool for sustaining employment and keeping inflation near target.

That concerning possibility has led to calls for a new monetary policy framework, including by Fed insiders like John Williams, president of the San Francisco Fed.

In particular, Williams has joined Olivier Blanchard and other prominent economists in proposing that the Fed consider raising its target for inflation, currently 2 percent.[1] If the Fed targeted a higher average level of inflation, the reasoning goes, nominal interest rates would also tend to be higher, leaving more room for rate cuts when needed.

Few fans of negative rates

Interestingly, some advocates of a higher inflation target have been dismissive of the use of negative short-term interest rates, an alternative means of increasing “space” for monetary easing. For example, in a recent interview in which he advocated reconsideration of the Fed’s inflation target, Williams said: “Negative rates are still at the bottom of the stack in terms of net effectiveness.”

Williams’s colleague on the Federal Open Market Committee, Eric Rosengren, also has suggested that the Fed may need to set higher inflation targets in the future while asserting that negative rates should be viewed as a last resort. My sense is that Williams’s and Rosengren’s negative view of negative rates is broadly shared on the FOMC.

Outside the United States, Mark Carney, governor of the Bank of England, has expressed openness to targeting nominal GDP (which essentially involves targeting a higher inflation rate when GDP growth is low), but has also made clear that he is “not a fan” of negative interest rates.

As I explain below, negative rates and higher inflation targets can be viewed as alternative methods for pushing the real interest rate further below zero. In that context, I am puzzled by the apparently strong preference for a higher inflation target over negative rates, at least based on what we know now.

Yes, negative interest rates raise a variety of practical problems, as well as political and communications issues, but so does a higher inflation target. In this post, I argue that it’s premature for policymakers to emphasize the option of raising the inflation target over the use of negative rates. Pending further study about the costs and benefits of both approaches, we should remain agnostic about whether either or both should be part of the Fed’s policy framework.

Comparing a strategy based on a higher inflation target with the use of negative rates is natural because, as just mentioned, they work through the same channel. Economic theory suggests that aggregate demand (consumption and investment) responds to the real rate of interest, which is the nominal (market) interest rate minus the public’s expected rate of inflation.

As I noted in my earlier post on negative rates, the Fed has routinely set the real federal funds rate at negative levels (i.e., with the nominal funds rate below inflation) to fight recessions. However, with the inflation target at its current level of 2 percent, and assuming that the Fed does not set its policy rate lower than zero, the Fed cannot reduce the real policy rate below -2 percent, i.e. a zero nominal rate less 2 percent expected inflation.

History, including the experience of the past few years, suggests that—in the absence of a robust fiscal response—that may not be enough to deal with a bad recession. To reduce the real policy rate further, the Fed would either have to lower the nominal interest rate into negative territory, raise expected inflation (by raising the inflation target), or both.

Since negative nominal rates and a higher inflation target both serve to reduce the lower (negative) bound on the real interest rate achievable by monetary policy, they are to some extent substitutes.

The argument for negative rates

Which approach is preferable? Without trying to be exhaustive, I’ll briefly compare them on four counts: ease of implementation, costs and side effects, distributional effects, and political risks. I find that negative rates are not clearly inferior to a higher inflation target and may even be preferable on some dimensions.

Ease of implementation. Negative interest rates are easy to implement. In practice, central banks in Europe and Japan have imposed negative short-term rates by deciding to charge (rather than pay) interest on bank reserves, an action that is clear, concrete, and essentially instantaneous.

Experience suggests that the effects of imposing negative rates on reserves also spread fairly quickly to other interest rates and asset prices. Like other central banks, the Fed pays interest on bank reserves and presumably could use a similar approach—essentially charging banks to keep reserves at the Fed—to enforce a negative policy rate.

In contrast, while the Fed could announce at any time that it is raising its inflation target, the announcement would not increase the Fed’s ability to lower the real interest rate unless the public’s inflation expectations changed accordingly.[2] But, as the Japanese experience has shown, inflation expectations may adjust slowly or incompletely to announced changes in target, especially if actual inflation has been very low for some time.

The public might also have reasonable doubts about the Fed’s ability to reach the higher target or about the willingness of the Congress or future Fed policymakers to support a higher inflation goal, both of which would reduce the credibility of the new target and thus its ability to influence expectations.

Which approach provides, potentially, more policy “space” for the Fed? Some advocates of a higher inflation target, such as Blanchard, have proposed increasing the target to as much as 4%, which would allow a real policy rate as low as -4 percent, if the nominal rate is zero.

The extent to which rates can be pushed negative, in contrast, is constrained by the fact that households and businesses can always choose to hold cash, which pays a zero nominal interest rate, rather than securities. To date we have not seen policy rates below -0.75% (Switzerland), equivalent to a -2.75% real policy rate if expected inflation is 2%. That comparison favors a higher inflation target, obviously.

On the other hand, it is not clear that an inflation target as high as 4% would be politically tenable and hence credible in the U.S. or other advanced economies, whereas arguably feasible institutional changes, some as simple as eliminating or restricting the issuance of large-denomination currency, could expand the scope for negative rates. The question of which approach creates more policy “space” is thus still somewhat open. Of course, nothing rules out using some combination of the two strategies.

Costs and side effects. Negative rates and a higher inflation target both have costs and side effects. As I discussed in my earlier post, negative rates can create problems for money market funds, banks, and other financial institutions, costs that would have to be managed if rates remained negative for very long. These concerns are legitimate, since effective transmission of monetary policy requires a properly functioning banking and financial system.

For what it’s worth, the effects of negative rates on banks’ net interest margins in Europe appears to have been moderate thus far. There are also means by which central banks can limit the effects of negative rates on bank profits—by charging a negative rate only on a portion of bank reserves, for example, as the Bank of Japan has done.

Higher inflation has costs of its own, of course, including making economic planning more difficult and impeding the functioning of markets. Some recent research suggests that these costs are smaller than we thought, particularly at comparatively modest inflation rates. More work is needed on this issue.

Higher inflation may also bring with it financial stability risks, including distortions it creates in tax and accounting systems and the fact that an unexpected increase in inflation would impose capital losses on holders of long-term bonds, including banks, insurance companies, and pension funds.

In comparing the costs and side effects of the two tools, a difference worth keeping in mind is that negative rates would be in place only in periods when they were needed (i.e., when the zero lower bound on interest rates would otherwise be binding), while higher inflation (assuming it could be achieved) would be a permanent condition, affecting the economy in good times as well as bad.

Changing the inflation target also carries the risk of being perceived as opportunistic, which could result in inflation expectations becoming unstable. Less-anchored inflation expectations would make inflation harder to control and give the Fed less scope to use monetary policy to offset fluctuations in employment.

Distributional effects. Either policy would give the Fed more scope to fight recessions and keep inflation near target, potentially providing broad benefit. On the margin, though, the two approaches would differ in their distributional implications, with the net effects difficult to assess.

The most direct costs of higher inflation are borne by holders of cash, and, again, with a higher inflation target those costs would be experienced at all times, not just during recessions. More generally, less wealthy people may find it more difficult to protect themselves from inflation. In contrast, negative rates would probably most affect more financially sophisticated and market-sensitive firms and households. In particular, banks would probably not pass on negative rates to small depositors, with whom they want to maintain profitable long-run relationships, but instead would more likely impose negative rates on “hot money” investors who place less value on longer-term relationships.[3]

The transition to a higher level of inflation would hurt holders of bonds and other non-indexed assets while providing a windfall for debtors, including mortgage borrowers. In the medium term, nominal returns to saving (including the investments of pension funds, life insurance companies, etc.) would be higher with a higher inflation target, but the real (net of inflation) returns received by savers would be similar under either regime.

Political risks. Both negative rates and a higher inflation target would be politically unpopular, possibly leading to reduced support for the policies of the central bank and for its independence. In particular, as already noted, the credibility of a higher inflation target could be reduced if political support for it were seen to be tenuous. Political viability is thus an important concern in judging these policy options.

In the political sphere, the fact that negative rates would be temporary and deployed only during severely adverse economic conditions would be an advantage. Like quantitative easing, which was also unpopular in many quarters, a period of negative rates would probably be tolerated by politicians if properly motivated and explained.

We have some evidence on this point: Negative rates are disliked by many in Europe and Japan but central banks have been willing and able to use them without facing high political costs, at least so far.

In contrast, a higher inflation target would be a permanent, or at least very long-lasting change, not restricted to an emergency; and it would raise questions about the flexibility of the Fed’s legal mandate to achieve price stability. It thus might need explicit approval or at least some sort of review from Congress.

A possibility, recently proposed by a comprehensive study on monetary policy options, would be to set up a commission to assess potential changes in the Fed’s policy regime and to report to Congress and the public.

Although commissions can serve important public purposes, proponents of a higher inflation target should be careful what they ask for. In the United States, as in Europe, there is a substantial element of public opinion (well represented in legislatures and even in the central banks themselves) that holds that central banks should concern themselves only with inflation, and that efforts to use monetary policy to stabilize employment are illegitimate or impractical.

These views have manifested as opposition to the Fed’s accommodative policies in recent years, and even in legislative efforts to eliminate the employment part of the Fed’s dual mandate. Holders of this perspective would be unimpressed by the cost-benefit analyses of the Keynesian proponents of a higher inflation target.

To the contrary, they would strongly oppose choosing higher inflation in order to give the Fed more room to respond to employment fluctuations, and indeed might seek a lower target. In their efforts they would be aided by the public’s money illusion (the tendency to confuse general inflation in both wages and prices with changes in real wages). Whatever the abstract merits of a higher inflation target, if it is not politically achievable then it is of no benefit.

Conclusion. It would be extremely helpful if central banks could count on other policymakers, particularly fiscal policymakers, to take on some of the burden of stabilizing the economy during the next recession. Since that can’t be assured, and since the current low-interest-rate environment may persist, there are good reasons for the Fed and other central bankers to consider changes in their policy frameworks. The option of raising the inflation target should be part of that discussion. But, as I have argued in this post, it is premature to rule out alternative or potentially complementary approaches, including the possibility of using negative interest rates.

Financial Engines prepares to roar

Posted on September 15, 2016 by Editorial Staff -

When an executive from Financial Engines shared the stage with Department of Labor Secretary Tom Perez as he announced the publication of the DOL’s fiduciary or “conflict of interest” rule last April, many people understood the significance.

No other private sector company took direct part in that historic—skeptics might say infamous—moment in the history of U.S. pension regulation. The message seemed clear: The Obama administration’s DOL approves of the way Financial Engines delivers advice to people with tax-deferred savings.

This week, it was NASDAQ-listed Financial Engines’ turn to make a couple of announcements. The provider of online managed accounts and financial guidance at about 690 companies, said it would rebrand 120 former The Mutual Fund Store locations nationwide—purchased by Financial Engines in 2015 for $560 million—as “Financial Engines Advisor Centers.”

In a media blitz yesterday, Financial Engines executive vice president Kelly O’Donnell explained to reporters that the move involves than a superficial name-change. Financial Engines intends to begin offering in-person advice along with robo-advice, and it plans to begin serving not just the 401(k) market but also the rollover IRA market and the aggregated taxable and non-taxable accounts of families, both before and after retirement.

“We’re broadening our focus beyond retirement,” O’Donnell told RIJ in a phone interview yesterday. “We’ve learned that retirement isn’t the only financial goal that people have. People have told us loud and clear that they need help with the big picture. Not just retirement but also college savings and health care, and putting it all in perspective.

“So we’re bringing to market a new offer. We’ll provide a dedicated advisor to the workplace participants we serve. We’ll continue to have online service and professional managed accounts for 401(k) participants, but we’re also offering relationships with advisors who will focus on aggregated accounts—not just 401(k)s but also IRAs and spouse’s accounts. We’ll put all of it together in a comprehensive plan. These are services that used to be reserved for the high net worth clients.”

The DOL rule will, arguably, force some asset managers and distributors who are already in the rollover IRA space to lower their fees to DOL-friendly levels and add scalable robo-advice to their offerings. To move to the rollover IRA space and the broader advice space, Financial Engines already has those elements, but has only recently added the necessary human advisors by buying The Mutual Fund Store.

O’Donnell thinks that, of those two camps, Financial Engines is better positioned. “The DOL broadened 401(k) protections to the IRA, and we’re uniquely positioned to provide that help. We’re one of the only providers that can manage your 401(k), your IRA and your taxable accounts. And, unlike retail advisors who can only make money through the rollover, we’re agnostic [as to whether the client rolls over or not],” she said.

Financial Engines needs to be agnostic on rollovers, because otherwise conflict with some of its partners in the 401(k) business might occur. According to O’Donnell, her firm contracts directly with plan sponsors in about half of its 401(k) business and works with the recordkeepers on the other half. Some of those partners may prefer to see money stay in a plan when a participant leaves the company or retires, while others may prefer to encourage a rollover.

In any case, Financial Engines will not be necessarily competing with the wirehouses for high net worth rollovers. The wirehouses trawl for accounts worth $250,000 or more, but Financial Engines mainly serves the middle or affluent market.

“We’re targeting and working with different customer than most other companies,” O’Donnell said. “Our average balance is $123,000 and our median balance is only $55,000. “Our founding mission was to work with people who don’t otherwise have access to professional financial services. We use scale to reach people who aren’t typical financial service customers.”

The Mutual Fund Stores’ median client account balance was $223,000, O’Donnell said, describing the stores as modest offices without the “mahogany desks” or high-rent urban locations of large financial institutions. As for pricing and products, O’Donnell said that Financial Engines will be offering non-proprietary, institutionally-priced funds and modest advisory fees.

“At this point, we’re not getting into specifics on pricing, because we’re still testing. But we will be coming to market with something that’s one-third or one-half of the 150 to 200 basis points that you might see elsewhere. There will be no account balance minimums,” she said.

Income Plus, which is Financial Engines’ systematic withdrawal service for retirees, will be available to clients in 401(k) plans and clients of The Mutual Fund Store,” she added. About 10 years ago, Financial Engines emerged as an advocate of using systematic withdrawals for retirement income between the ages of about 65 and 85, and then relying on a longevity annuity for subsequent income, if needed.

But when Income Plus was rolled out in 2011, the annuity was left out except as an out-of-plan option. That was mainly because plan sponsors in general resisted the inclusion of annuities in workplace plans, and still do. Going forward, “we will advise on life insurance,” O’Donnell said, “but otherwise we won’t have sales capability on insurance products.” Annuities don’t appear to be in the picture.

A.M. Best report defines VA issuers’ dilemma

Posted on September 15, 2016 by Editorial Staff -

Although marketplace demand for variable annuities continues as near-retirees look for lifetime income products, many VA issuers may not necessarily able to take advantage of that demand, according to the ratings agency A.M. Best.

According to “Variable Annuity Sales Decrease Amid Regulatory Changes,” a new Best’s Special Report, “The continued low interest rate environment and recent equity market volatility have pressured policyholders’ VA returns. This has also pressured insurers’ ability to manage large blocks of in-force VA business, many of which have richer guarantees than are currently underwritten.

“Risk management strategies, including the use of hedges, have helped mitigate these concerns, yet A.M. Best continues to see some market-driven volatility in earnings stemming from Statutory VA reserving requirements, including Actuarial Guideline 43, as well as some recent GAAP charges related to policyholder behavior.”

VA sales were down 18% in the first quarter of 2016 compared with the same prior-year period and down 16% from the fourth quarter of 2015. Decreases in VA sales have not been uncommon in recent years, as companies have looked to de-emphasize market-sensitive products and reduce the generous guarantees seen in prior years, Best said.

However, the decrease in the first quarter of 2016 also relates to equity market volatility and the looming U.S. Department of Labor (DOL) fiduciary rules changes. While equity markets are up in the second quarter of 2016, it is possible the industry will continue to see VA sales wane as policyholders look toward more stable returns from fixed and indexed products.

A.M. Best said it has already seen more money going toward equity-indexed products, including fixed-indexed annuities. Overall, there continues to be a strong and increasing need in the market for retirement and wealth management products as the U.S. population ages. Prudent investment returns have also been harder to come by.

Going forward, qualified VA’s will be affected by the DOL fiduciary rule changes, which will include additional fee disclosures and more level compensation structures. Approximately 58% of separate account direct premium written in 2014 was related to qualified business. A.M. Best does not expect this allocation to change significantly as there is a great need in the marketplace for tax-advantaged products.

A.M. Best also expects that companies could apply the new DOL fiduciary rule changes to both their qualified and non-qualified businesses. The rule changes will also greatly impact companies that utilize the Independent Marketing Organization for sales as they look to update systems and products for these changes.

Overall sales and separate account value growth have slowed for the industry. While there was strong growth in separate account individual annuity reserves from 2011 to 2013, this growth slowed from 2014 to 2015 as companies scaled back their VA sales and the equity market volatility for the period negatively affected account values.

Separate account individual annuity premiums and deposits also decreased 5% from 2014 to 2015, and withdrawals remained relatively high compared to historical amounts after increasing for five straight years from 2010-2014. Furthermore, surrenders and withdrawals outpaced premiums and deposits in each year from 2011 to 2014. Given the current environment for 2016, A.M. Best expects the trend would continue.

Jackson National and the Rolling Stones. Of course.

Posted on September 15, 2016 by Editorial Staff -

Jackson National Life will serve as the official U.S. sponsor of “Exhibitionism — The Rolling Stones,” a traveling exhibit that offers comprehensive insight into the Rolling Stones through an immersive and interactive tour highlighting the band’s iconic artistic legacy.

According to a Jackson release, “Exhibitionism” is “the largest touring experience of its kind and the first time in history the band has unlocked their vast private archives. Previously housed at the Saatchi Gallery in London, Exhibitionism will make its North American debut in New York City in November at the iconic Industria, West Village.”

Barry Stowe, chief executive officer and chairman of Prudential plc’s North American Business Unit, said the sponsorship is “a natural fit for the company, and a defining project in enhancing Jackson’s brand identity.”

“Exhibitionism is a once-in-a-lifetime celebration of the history of true rock ‘n’ roll legends,” Stowe said in the release. “Like the Stones, Jackson’s history began in the early ‘60s, a time that brought the onset of an era of dramatic change. Focused on helping the generation that led this change plan for the next phase of their lives, Jackson is pleased to be able to sponsor a world-class exhibition focused on an artistic and cultural phenomenon that helped define and shape the baby boomers and generations to come.”

Rolling Stones

The exhibition will include 500 unseen artifacts from the band’s personal archives and take visitors through the band’s 50-year history, from living together in a small apartment to headlining stadium concerts, and embracing “all aspects of art and design, film, video, fashion, performance and rare sound” associated with the band.

The exhibition includes original stage designs, dressing room and backstage paraphernalia, guitars and instruments, iconic costumes, rare audio tracks and unseen video clips, personal diaries and correspondence, original poster and album cover artwork and unique cinematic presentations.

Exhibitionism is promoted and presented by Australian company International Entertainment Consulting (iEC) with the participation of Mick Jagger, Keith Richards, Charlie Watts and Ronnie Wood. Collaborations and work by Andy Warhol, Shepard Fairey, Alexander McQueen, and Ossie Clark to Tom Stoppard and Martin Scorsese will be included.

The exhibition includes nine different rooms, each with its own distinctly designed environment. Starting with an introductory “Experience,” visitors will look back at the high points of the band’s career through a new film, with a high-octane soundtrack. Visitors will then be taken back to the Stones’ beginnings and on the remarkable journey that made them one of the most successful rock ‘n’ roll bands in the world.

Lincoln Financial enhances VA income rider

Posted on September 15, 2016 by Editorial Staff -

Lincoln Financial Distributors (LFD), the wholesale distributor of Lincoln Financial Group, said it has enhanced the Lincoln Market Select Advantage, an optional living benefit rider available for a fee of 1.25% (1.50% for joint and survivor policies) with Lincoln’s American Legacy and Lincoln ChoicePlus Assurance variable annuities.

The “enhanced option features five percent guaranteed growth to the Income Base during accumulation, flexible income alternatives and access to asset allocation funds, including risk managed options,” according to an LFD release.

“Before we launched this rider, we had Linc 2.0,” Dan Herr, vice president, annuity product management, told RIJ in an interview this week. Consistent with what was in market at the time, it required the use managed-risk investment options. Then we introduced Market Select Advantage, which didn’t have the managed-risk requirement but offered a lesser benefit. You had to delay your first withdrawal for at least five years.

“The latest enhancement brings together both features,” Herr said. “This version allows the use of some asset allocation funds that are not managed-risk, and if you wait three years—or reach age 70, if that’s in less than three years—before taking a withdrawal, you get a higher withdrawal percentage. The 5% rollup starts at purchase and runs for 10 years. It applies only in years when there’s no withdrawal and there’s a hard stop at 10 years from purchase. It’s geared for someone who wants to start income in three years or more.

“For those who want income right away, we have i4Life, our flagship income rider. That’s geared to immediate and rising income,” he added. [i4Life is a immediate variable annuity; when the value of the assets in the separate account appreciate, monthly payouts rise and vice-versa.]

“We’ve enhanced the investment flexibility of that rider and made some product tweaks that bolster the upside story. With the earlier version of i4Life, there was a 4% Assumed Interest Rate,” Herr told RIJ. [With a variable income annuity, the company calculates the size of the first payment by assuming that the account earns 4% in the first period.]

“We lowered the AIR to 3%, which increases the likelihood that there will be a rising income. We also have a managed risk version of i4Life, where the AIR stays at 4%. Our deferred variable annuities offer i4Life as a payout option. A contract owner could choose to take part of the assets as immediate variable income and keep the rest liquid. We’re the only commercially available immediate variable annuity that is liquid. “

Herr was asked why Lincoln was sharpening its variable annuity value proposition at a time when VA sales continue on a downward trend—for reasons described in today’s RIJ article on the latest A.M. Best annuity report.

“As we think about the value proposition of annuities, especially around guaranteed income, we’re looking at what the investment world will look like over the next five to 10 years,” he said. “We’ve had a great bull market. Stocks are at an all time high. Analysts say we’re likely to see muted investment returns over the next 10 years, in the 4% to 6% range for equities and 2% for fixed income, and we ask, ‘How could it not be in the best interests of clients to offer a guaranteed income stream?’ A small segment of producers already understands this. We have to make sure we reach the rest of the advisor world with the message that there’s a product that can help their clients offset the risk of running out of money.”

The Essence of Goal-Based Investing

Posted on September 7, 2016 by Kerry Pechter -

It was July 15, only a day after the horrific truck attack on a crowded seaside esplanade in Nice, France. Lionel Martellini, the director of the EDHEC Risk Institute in Nice, appeared slightly uncertain as he approached the lectern in a conference room on the mezzanine of the Grand Hyatt in midtown Manhattan.

The 48-year-old Martellini admitted that he was shaken by the terroristic event in his hometown. But, after assuring the audience of two-dozen or so pension economists that his family and friends in southern France were safe, he plunged into the third session of a three-day seminar blandly called “Advances in Asset Allocation.”

RIJ first reported on Martellini’s work, which is far from bland, last March. Since then, he’s been campaigning for a financial services “revolution” that will make the management of individual retirement accounts more like managing pensions: More goal-based, reliant on the sophisticated risk management tools, and focused on delivering retirement income.

That revolution is necessary, he believes, because the shift from defined benefit to defined contribution plans makes middle-class people responsible for creating their own pensions. So, even though Martellini’s audience at the Grand Hyatt consisted of pension wonks, his work is relevant to investors and their advisors.

If you’re an advisor who’s familiar with the curriculum of the Retirement Management Analyst or the Retirement Income Certified Professional, the following may sound familiar. If you’re a more traditional investment advisor who’s curious about goal-based investing, this report on Martellini’s recent seminar may reveal a new way to look at saving for retirement.

What ‘goal-based’ means

Listening to Martellini, a contrast emerges between conventional and “goal-based” investing (“liability-driven” investing, in the language of pensions). Goal-based investing is more than just a form of mental accounting that assigns labels like “house,” “college” or “retirement” to different pots of money.

A switch to goal-based investing, for instance, changes the way advisors assess their clients’ risk capacity. Instead of asking new clients how far they could stand to watch the value of their accounts drop without panicking, a goal-based advisor measures a client’s risk “capacity” or risk “budget” by calculating how much of their savings clients can afford to put into risky assets without jeopardizing the achievement of their savings goals.

“Risk aversion is irrelevant,” Martellini said. “We need to understand loss aversion, relative to goals, not risk aversion.”

In practice, different clients will have different risk capacities. It won’t depend on their fortitude in the face a market downturn. It will depend on the differences between their savings rates, their time horizons, and the amount of savings they’ll need to fund their retirements.

“You can’t decide what the client’s essential goals will be. But with your help, the client will be able to calculate his floor. After that, your job will be to show clients the different opportunity costs”—what you might miss by being too conservative, for instance, or how much more you might have to save—“between different routes to his goals,” Martellini said.

Establishing a “floor” is central to goal-based investing. A traditional investor hopes or expects that his advisor or fund manager will outperform a market benchmark using stocks and bonds. A goal-based investor relies on his advisor to act more like a pension fund manager—using a conservative “goal-seeking” portfolio to fund an essential level of income in retirement and a “performance-seeking” portfolio of risky assets with upside potential that will finance discretionary spending in retirement.

A goal-based advisor’s job

It’s the synergy between those two portfolios that makes goal-based investing interesting. Martellini likes to use automotive analogies. As he puts it, clients face different routes to their retirement savings goal—straight and smooth, uphill and down, or carved by hidden curves. Goal-based dvisors apply the only three risk management techniques at their disposal—diversification, hedging or insurance—to help clients reach their goals safely, on time, and fuel-efficiently (i.e., with the least contributions).

When it comes to managing risk (i.e., volatility) during the accumulation period, traditional advisors and goal-based advisors take very different approaches. A traditional advisor might periodically rebalance a client’s portfolio by selling winners and restoring the original asset allocation. Goal-based advisors (or their fund managers), are more inclined to do the opposite, with a kind of stop-loss strategy.

Using what’s known as dynamic asset allocation, they might practice daily rebalancing between the client’s goal-seeking portfolio and the performance-seeking portfolio. Instead of selling risky assets that have appreciated, they might sell losers before the losses can break through the client’s pre-determined floor. Somewhat counter-intuitively, they buy back risky assets as their value recovers.

That particular type of dynamic asset allocation is called Constant Proportion Portfolio Insurance (CPPI). It protects the goal-seeking portfolio to fulfill its mission. It’s more momentum-based than contrarian, and it’s more defensive than aggressive. Like other forms of goal-based investing, it values accuracy over distance.

“Dynamic asset allocation reacts to changes in market conditions,” Martellini said. “It lets you go faster when the road is straight and slows you down when the road is windy. You’ll never reach your goals if you go too slowly. The question is, how much of the portfolio can the client afford to allocate to risky assets and still be safe?

“The client is in the driver’s seat,” he added. “But advisors have to be smart about how they spend the client’s risk budget. Their skill is all about implementing the efficient use of diversification, hedging, and insurance. The client makes his own decisions, the market does what it will, and the advisor tries to get the best possible outcome.”

Putting GBI into practice

Many advisors and investors already use products to practice goal-based investing, perhaps without being aware of it. When people buy a fixed index annuity, for instance, 95% of their money goes into a goal-seeking portfolio of bonds that preserves the principal and 5% goes into a performance-seeking portfolio of options on an equity index that will appreciate if the index goes up.

Similarly, when people buy the Even Keel managed-risk mutual funds, part of their investment pays for a Milliman short-futures strategy; the futures gain value if and when the underlying equities lose value. When people bought Prudential’s variable annuity with the Highest Daily living benefit a few years ago, most didn’t realize that Prudential was practicing CPPI with their money.

In an interview, Martellini had admiring things to say about Dimensional Fund Advisors’ target date funds, which emphasize the funding of an income-generating portfolio of Treasury Inflation-Protected Securities (TIPS) by the retirement date. He also likes BlackRock’s CoRI Index, which shows people how much inflation-adjusted lifetime income their savings would produce starting at age 65, based on their current age, current level of savings and prevailing bond prices.

Martellini and his colleagues at the EDHEC Risk Institute, which was founded at France’s School of Advanced Business Studies (EDHEC) in 2001 to do research on pension risk management, have their own project underway. They want to “encourage the adoption of cost-efficient retirement solution that would have defined benefit-like qualities,” he told RIJ.

Their solution would involve dynamic asset allocation between two low-cost, high-liquidity exchange-traded funds (ETFs): a bond ETF leading to a bond ladder that would provide income from about age 65 to age 85, and a balanced ETF invested in EDHEC’s proprietary smart-factor indices that would provide upside potential. Martellini believes that smart-beta or smart factor indices provide better risk-adjusted returns than conventional capital-weighted indices. Income after age 85 might be provided by a longevity annuity.

Ultimately, Martellini envisions the “mass-customization” of such a solution. (Within the next few days, he’ll be presenting a paper on the topic at a Retirement Investing conference in Oxford, England, co-sponsored by Oxford University, EDHEC Risk Institute and the Journal of Investment Management.)

He feels strongly that millions of defined contribution participants worldwide will need customized, goal-based savings strategies in order to enjoy a secure retirement. But he knows it won’t necessarily be easy. “Mass customization is made harder by the facts that people have different ages and different dates of retirement as well as different amounts of savings,” he told RIJ. “They also have different streams of future contributions and different essential and aspirational goals. We know how to do it. We just have to make it happen.”

Chile’s Pension Crunch

Posted on September 7, 2016 by Andrés Velasco -

Defined benefit pension plans are under pressure. Changing demographics spell trouble for so-called pay-as-you-go (PAYG) systems, in which contributions from current workers finance pensions. And record low interest rates are putting pressure on funded systems, in which the return from earlier investments pays for retirement benefits. The Financial Times recently called this pensions crunch a “creeping social and political crisis.”

Defined contribution, fully-funded systems are often lauded as the feasible alternative. Chile, which since 1981 has required citizens to save for retirement in individual accounts, managed by private administrators, is supposed to be the poster child in this regard. Yet hundreds of thousands of Chileans have taken to the streets to protest against low pensions. (The average monthly benefit paid by Chile’s private system is around $300, less than Chile’s minimum wage.)

Chile’s government, feeling the heat, has vowed to change the system that countries like Peru, Colombia, and Mexico have imitated, and that George W. Bush once described as a “great example” for Social Security reform in the United States. What is going on?

The blame lies partially with the labor market. Chile’s is more formal than that of its neighbors, but many people—especially women and the young—either have no job or work without a contract. High job rotation makes it difficult to contribute regularly. And it has proven difficult to enforce regulations requiring self-employed workers to put money aside in their own accounts.

Moreover, the legally mandated savings rate is only 10% of the monthly wage, and men and women can retire at 65 and 60, respectively—figures that are much lower than the OECD average. The result is that Chileans save too little for retirement. No wonder pensions are low.

But that is not the end of the story. Some of the same problems plaguing defined-benefit systems are also troubling defined contribution, private account systems like Chile’s. Take changes in life expectancy. A woman retiring at age 60 today can expect to reach 90. So a fund accumulated over 15 years of contributions (the average for Chilean women) must finance pensions for an expected 30 years. That combination could yield decent pensions only if the returns on savings were astronomical.

They are not. On the contrary, since the 2008–2009 global financial crisis, interest rates have been collapsing worldwide. Chile is no exception. This affects all funded pension systems, regardless of whether they are defined benefit or defined contribution schemes.

Lower returns mean lower pensions—or larger deficits. The shock and its effect are large. In the case of a worker who at retirement uses his fund to buy an annuity, a drop in the long interest rate from 4% to 2% cuts his pension by nearly 20%.

The rate-of-return problem is compounded in Chile by the high fees charged by fund managers, which are set as a percentage of the saver’s monthly wage. Until the government forced fund managers to participate in auctions, there was little market competition (surveys reveal that most people are not aware of the fees they pay). A government-appointed commission recently concluded that managers have generated high gross real returns on investments: from 1981 to 2013, the annual average was 8.6%; but high fees cut net returns to savers to around 3% per year over that period.

Those high fees have also meant hefty profits for fund managers. And it is precisely the disparity between scrawny pension checks and managers’ fat profits that fuels protest. So, more challenging than any technical problem with Chile’s pension system is its legitimacy deficit.

To address that problem, it helps to think of any pension system as a way of managing risks—of unemployment, illness, volatile interest rates, sudden death, or a very long life span. Different principles for organizing a pension system—defined benefit versus defined contribution, fully-funded versus PAYG, plus all the points in between—allocate those risks differently across workers, taxpayers, retirees and the government.

The key lesson from Chile is that a defined contribution, funded system with individual accounts has some advantages: it can stimulate savings, provide a large and growing stock of investible funds (over $170 billion in Chile), and spur economic growth. But it also leaves individual citizens too exposed to too many risks. A successful reform must improve the labor market and devise better risk-sharing mechanisms, while preserving incentives to save. It is a tall order.

Chile’s system already shares risks between low income workers and taxpayers, via a minimum non-contributory pension and a set of pension top-ups introduced in 2008 (as Minister of Finance, I helped design that reform). Subsequent experience suggests that those benefits should be enlarged and made available to more retirees. But the Chilean government has little money left, having committed the revenues from a sizeable tax increase two years ago to the ill-conceived policy of free university education, even for high-income students.

In response to the recent protests, the government has proposed an additional risk-sharing scheme: some (thus far undecided) part of a five percentage-point increase in the mandatory retirement savings rate, to be paid by employers, will go to a “solidarity fund” that can finance transfers to people receiving low pensions.

The goal is correct, but, as usual, the devil is in the details. In the medium to long run, it seems likely that wages will adjust, so that the effective burden of the additional savings will be borne by employees, not employers. One study estimates that workers treat half of the compulsory savings as a tax on labor income, so too-large an increase (especially in the funds that do not go to the worker’s individual account) could cause a drop in labor-force participation, a shift from formal to informal employment, or both. Chile’s economy does not need that.

There are no easy answers to the pensions conundrum, whether in Chile or elsewhere. Chilean legislators will have to make difficult choices with hard-to-quantify tradeoffs. Whatever they decide, irate pensioners and pensioners-to-be will be watching closely.

Labor Department acts on state-sponsored workplace IRAs

Posted on September 7, 2016 by Editorial Staff -

The Department of Labor’s Employee Benefits Security Administration has published a final rule that will make it easier for states to create IRA programs for workers who don’t otherwise have access to tax-deferred savings plans at work, the DOL reported.

The agency said it has also published a proposed rule that would, by clarifying federal labor laws, help some cities and local governments establish similar payroll-deduction IRA programs.

So far, eight states have passed legislation requiring private-sector employers that don’t offer retirement plans to auto-enroll their workers in state-administered, payroll-deduction IRAs. Other states have created marketplaces where employers can buy plans from private plan providers.

But uncertainty over the application of the Employee Retirement Income Security Act’s “preemption provisions”—which establishes ERISA’s authority over all retirement plans in the U.S.–has discouraged more states from creating such programs.

To remove that obstacle, the DOL has issued a final rule providing a safe harbor that would reduce the risk that state IRA plans would be subject to ERISA rather than to state laws. The rule also allows workers to opt out of state auto-enrollment arrangements. The rule will go into effect 60 days after its publication in the Federal Register.

The proposal to expand the safe harbor to include a limited number of larger cities and counties in response to comments received from members of the public will be open for 30 days of public comment after its publication in the Federal Register.

Publicly-traded U.S. life insurers see 19% income decline: Fitch

Posted on September 7, 2016 by Editorial Staff -

The 15 publicly traded U.S. life insurers rated by Fitch Ratings saw their pretax operating income decline 19% in the first half of 2016, the result of “declining interest rates, volatile equity markets and unfavorable macroeconomic headwinds,” a Fitch release said.

“Unfavorable mortality and competitive pricing continue to hurt individual and group life insurance segments while volatile financial markets impacting the variable annuity, retirement plan and asset management segments,” said Dafina Dunmore, director, Fitch Ratings, in a statement.

Industry results were also adversely affected by large reserve adjustments, particularly for MetLife, Inc., and Prudential Financial, Inc. Average aggregate operating return on equity declined to 10.4% in first-half 2016 compared with 13.0% in the prior-year period for Fitch’s rated universe.

The likelihood of interest rates remaining lower for longer was enhanced by the UK vote to withdraw from the European Union (EU), Fitch said, noting that the “Brexit” vote led to a material decline in interest rates in the second quarter of this year. Fitch expects low reinvestment rates to continue to be an earnings headwind in the second half of 2016.

AXA wins excessive fee litigation suit

Posted on September 7, 2016 by Editorial Staff -

After five years of litigation and a 25-day trial in New Jersey federal court, AXA US has been found not guilty of receiving excessive compensation for managing and administering certain of its mutual funds, as alleged in Mary Ann Sivolella v. AXA Equitable Life Insurance Company and AXA Equitable Funds Management Group, LLC and Sanford et al. v. AXA Equitable Funds Management Group, LLC (Civil Action No. 3:11-cv-04194 (D.N.J.).

In a 159-page opinion, Judge Peter G. Sheridan ruled that the plaintiffs failed to prove that AXA Equitable’s Fund Management Group had charged “exorbitant fees” while delegating “all of the services” to sub-advisers or a sub-administrator for a “nominal amount.”

According to an AXA release, the decision “vindicates FMG LLC’s ‘manager-of-managers” structure, whereby FMG LLC provides essential services to the funds and at its own expense and engages third-party service providers to provide certain limited investment and administrative services.”

The AXA US case is the first Section 36(b) excessive case to go to trial since 2009 and is the first of the numerous cases that recently have been filed challenging the manager-of-managers structure, the release said.

Expect the DOL rule to apply to taxable accounts

Put guardrails around your four percent withdrawal: Vanguard

Bad day at Wells Fargo, good day at BlackRock

Data Connection

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