Archives: Articles

IssueM Articles

No Retirement Account Left Behind

Posted on May 19, 2016 by Kerry Pechter -

Fintech, aka robo-finance, is scaring the bejeezus out of the financial industry’s old guard. Barbarians from Silicon Valley, with their gleaming algorithms, have disrupted traditional business models. The mice are scaring the elephants—at least until the elephants acquire the mice outright.

But fintech doesn’t always originate in California, and it doesn’t always threaten the status quo. Sometimes it sprouts from within, and aids, the retirement business, especially when it’s applied to one of the retirement industry’s inefficiencies—like the “leakage” from 401(k) and other qualified plans, for instance.

Spencer Williams, the president and CEO of Retirement Clearinghouse (RCH), was in Washington, DC, last week to explain his company’s proposed technology solution to leakage—most of which occurs when people liquidate their tax-deferred accounts in the course of changing jobs.

The solution is called “auto-portability.” When a worker with a small retirement account quits a job at a company in the auto-portability network, RCH will try to find them at their next employer’s plan and consolidate their old account with their new account. RCH and similar companies perform this “roll in” service today, but on a manual, piecemeal basis; auto-portability would robo-ize and scale it.

The technology for auto-portability involves “electronic records matching.” That’s the identification and verification process that facilitates the use of credit cards in retail transactions. But the success of auto-portability will need more than financial technology.

“First, you have to get all the recordkeepers onboard. That’s no mean feat,” Williams told about 130 professionals who gathered for the Employee Benefit Research Institute (EBRI) Policy Forum on May 12. “The other requirement for a clear path forward is assistance from the Department of Labor.” [To watch a video of the presentation, click here.]

Auto-portability needs the DOL’s blessing, because it will work only if plan participants can be auto-enrolled by default—by not actively refusing to be included in the system. RCH has asked the DOL for an Advisory Opinion confirming the legal basis for default enrollment in an auto-portability program.

RIJ has reported several times on RCH’s auto-portability initiative since 2013. Since then, Williams and Tom Johnson, both of whom worked as retirement executives at MassMutual in the mid-2000s, have met with plan sponsors, recordkeepers, Washington officials and trade association reps to assemble the cross-industry cooperation that auto-portability will require.

If auto-portability takes off, RCH will run the technology, charging $59 for each account that passes through the system. (RCH charges $79 per account to do this manually today, and will continue to be in that business.) “When people look at the damage done by leakage and understand the benefits of auto-portability,” Williams told RIJ this week, “they become engaged.”

The leakage problem

If you were designing an employer-sponsored retirement savings system from scratch, you’d probably build in a method that allows people to transfer money from their previous plans to their new ones when they change jobs, so that the nest egg keeps growing and compounding tax-deferred. Indeed, it’s said that rollover IRAs were created in anticipation of this need.

But merely allowing rollover IRAs didn’t solve the leakage problem, in part because the system has generated so many tiny accounts. Given the high rate of job turnover in the U.S., millions of people aren’t in a 401(k) plan long enough to develop large balances. When they change jobs, they tend to cash out those accounts (“leakage”) or abandon them.

About 53% of job changers take the cash. Of those, “37% take the money because they need it for an emergency. The other 63% take it because it’s much simpler to say, ‘ Send me money,’ and to pay the taxes and penalties on the withdrawal,” rather than execute a do-it-yourself transfer of assets to an IRA or to their next plan, said Williams: “We take the DIY out of it, and put in a mechanism where we do it for them.”

Pension law allows plan sponsors to transfer orphaned accounts that are worth less than $5,000 to safe harbor IRAs, or SHIRAs. The biggest 401(k) plan providers, like Fidelity and Vanguard, operate their own SHIRAs. Independent SHIRAs absorb the rest of the flow. SHIRAs try to find the missing owners, but the process, as noted above, is slow.

System-wide, leakage starts as tiny drips but swells into a flood of dissipated savings. According to EBRI data, 12.5 million leave DC plans each year. Of those, five million have accounts worth $5,000 or less. People with accounts of that size have a 28% job turnover rate, changing employers once every 3.5 years on average.

An estimated $8.8 billion in small account balances falls out of the DC system this way each year; the total annual leakage, according to EBRI, could be 10 times that amount. While these losses represent a tiny percentage of the multi-trillion-dollar DC industry, they compound over a 35- or 40-year career cycle into a significant sum. According to the Center for Retirement Research at Boston College, leakage reduces the aggregate DC savings of the nation’s 60-year-olds by 25%.

How auto-portability works

Williams said that his firm’s version of auto-portability works by “push” rather than “pull.” The process begins when the employee’s account gets pushed out of the old plan. This may occur long after the former participant has changed jobs. Then the system tries to match the participant with the new plan. In a “pull process,” the new plan sponsor’s recordkeeper would initiate the process after a new employee joins the plan.

Here’s a step-by-step explanation of the auto-portability process:

A participant who has been defaulted into the auto-portability program leaves his or her job and leaves behind a DC account.
The plan sponsor informs the participant that he’s eligible for the auto-portability roll-in process. After an initial notice and waiting period, the account goes to a safe-harbor IRA, or SHIRA. After the SHIRA account is opened, the records are sent to Retirement Clearinghouse.
Using the “electronic record matching” technology, Retirement Clearinghouse looks for matches between the owners of accounts in the SHIRAs and the millions of participants in plans whose recordkeepers use the auto-portability program.
When a match is confirmed, RCH completes the forms required for rolling the account assets into the participant’s new plan account. These participants will receive a postcard notifying them of the transaction.
The safe-harbor IRA account is closed and the balance is rolled-in to the participant’s new employer plan. The money is automatically invested according the participant’s current investment elections, or in the retirement plan’s default investment option. The participant receives a final notice.

‘Ah-hah’ moment
Williams, a US Naval Academy graduate, became more interested in auto-portability relatively recently. Back in 2007, he was headhunted away from MassMutual to help turn around Rollover Systems, a Charlotte, NC-based SHIRA owned by Robert Johnson, the founder of Black Entertainment Television, or BET.

Williams replaced Reggie Bowser, a former Lending Tree executive who started the firm in 2001 to capitalize on the provision in the first Bush tax cut (“EGTRRA”) that allowed and encouraged plan sponsors to force the small 401(k) accounts of separated employees into safe-harbor IRAs, and spawned the assisted rollover business.

In 2010, a Rollover Systems client, a 250,000-employee company that Williams declined to identify, asked Williams if Rollover Systems could, in addition to transferring the small accounts of departed employees to safe harbor IRAs, also help its new employees merge previous retirement accounts into their new plan. Williams had an epiphany.

“It was an ah-ha moment. We asked ourselves, ‘If we can do an assisted rollover for job changers, could we do an automatic roll-in?’ The answer is yes. We find that there are all kinds of circumstances for consolidation. There are plans that are terminated. There are companies that are sold. Every job change turns into a series of consolidations. Our mission is to create a new automatic path to consolidation,” he told RIJ in 2013.

Flash forward to 2016: “This is not just a concept,” Williams said this week. “This is in practice in our client base today, with the ERM technology already at work. We’re working with a very large employer and its recordkeeper. We find that the average account balance in the employer plan increases by about 45% when we do this. We have about 1,500 people whose old accounts we have matched up and moved into their new accounts. The account value almost doubles, proving the utility of the process.”

Not all of the issues have been resolved. One objection: A person’s new 401(k) plan may have higher fees or worse investments than their old one. Companies that solicit IRA rollovers from job changers might not like auto-portability, but rollover companies aren’t likely to care about the tiny accounts that RCH is talking about.

If they build it, will participants buy into it? Research by Warren Cormier of Boston Research Technologies, using auto-enrollment behavior as a proxy, has given RCH a glimpse of how people would respond to auto-portability, Williams said.

“As people get used to using this mechanism, as it gets into their heads that this will be done for me, there’ll be an ever-decreasing number of cash-outs,” he told RIJ. “With the status quo, we estimate there will be $320 billion in cash-outs over the next generation. If we eliminate leakage, we can cut that number in half.” He’s hoping to receive DOL’s blessing this summer.

How The British Save More for Retirement

Posted on May 19, 2016 by Kerry Pechter -

RIJ’s cover story this week describes “auto-portability.” This is a newly conceived process, based on a repurposed bit of financial technology, that would automatically consolidate your old “stranded” 401(k) accounts into your active 401(k) account, assuming you have one.

If it were practiced universally, auto-portability could rescue old accounts from the dead letter office of the retirement system and forward them to a participant’s latest address. This would improve the current non-system, which encourages people to cash-out small accounts and squander the money on, stereotypically, flat-screen smart TVs.

The UK has taken a stab at DC account consolidation, but the effort has been a victim of politics and industry opposition. Last year the British authorities proposed instituting a policy called “pot-follows-member.” It would make sure retirement accounts follow people from job to job. But there’s no British counterpart to our rollover IRA, which is essential to the process.

The British out-do the US in one aspect of their defined contribution system, in my opinion. Their form of tax-deferral is arguably better than ours. When a DC plan participant in the UK contributes to a tax-deferred plan, the government adds the participant’s “tax relief” to his retirement account.

To understand this, you have to look inside a paycheck. Assume that a hypothetical Briton has a £5,000 monthly salary and a 25% income tax rate. The government withholds £1,250 in taxes each month. If he contributes 10% of pay (£500) to a DC plan, the government credits 10% of his tax (£125) to his plan account. His plan balance after one month is £625. His take-home pay is £3,250.

In the U.S.—please correct me if I’m wrong about this—it works differently. Assume that a hypothetical American has a $5,000 monthly salary and a 25% income tax rate. If he contributes 10% of pay ($500) to a DC plan, the federal government withholds $1,125 in tax on the remaining $4,500 in his paycheck. His savings balance after one month is $500. His take home pay is $3,375.

The Briton saves 25% more each month than the American. The difference in savings adds up to a lot over the hundreds of months in a work-life. Ignoring investment gains or losses, the Briton in my example saves £7,500 in the first year; the American saves $6,000. Over a lifetime of tax-deferred saving and compounded returns, the Briton will end up with a lot more savings than the American.

How much more? I consulted two well-known retirement experts about the best way to calculate the difference in long-term results. It’s not very complicated, said Wade Pfau of The American College. If the U.S. DC system switched to the British method of tax-deferral, participants in American would save 1 x (1 + 0.25 tax rate) as much as they do now, or an additional 25%. In my hypothetical, that would mean an extra $110,000 or so for the American retiree if he saves for 35 years and has a 4% rate of return. (For simplicity, we’re ignoring inflation, etc.)

Alternatively, Moshe Milevsky of York University suggested that if Americans kept their current system but chose to invest their tax savings in their tax-deferred accounts (and invested the tax savings on the reinvestment of the initial savings), they would save 1/(1 – 0.25 tax rate) as much as they do now, or an additional 33%.

Somewhere, the gods of behavioral finance must be howling with laughter, or in frustration. Both participants chose to contribute 10% of pay to their DC accounts, but one of them has significantly more savings at retirement. It means that changing the design of our system could, without asking participants to change their habits or preferences, make millions of Americans much more secure in retirement.

As a nation, the Britons are at different stage in their transition from defined benefit pensions to defined contribution pensions. And the process isn’t going very smoothly, according to what I read at IPE.com. But I admire the way they designed their tax-deferred savings system. By comparison, our method endows us with tax-deferred growth, but lets the tax savings on contributions slip away. (Another attractive feature of their system: retirees can withdraw 25% of their tax-deferred savings tax-free.)

The British system may have another advantage, although it’s difficult to quantify. Their policies might produce a greater sense of shared purpose between the public and the government regarding retirement savings. If Americans saw their government, in effect, contributing directly to their retirement accounts, the government’s demands for minimum taxable distributions at age 70½ might not seem so perplexingly intrusive.

I think we can agree that our retirement system offers many opportunities for improvement. We change jobs frequently and cash-out or leave unvested employer matches on the table; we may drop out of the system entirely for a few years here and there; our employers don’t always offer plans, let alone matching contributions; fees can reduce our rate of return by 25% or more over a lifetime; volatility slows down the accumulation process; taxes come due during retirement; and we’re prone to dumb investing mistakes along the way. With so many pitfalls along the road to a well-funded retirement, it might help if the system defaulted us into saving, not spending, the tax break on contributions.

UBS to partner with SigFig, a robo-advisor

Posted on May 19, 2016 by Editorial Staff -

In the latest partnership between a major asset manager or wirehouse and a robo-advisor, UBS Wealth Management Americas announced this week that it has formed a strategic alliance with SigFig, an independent San Francisco-based digital advisory service.

UBS is taking an undisclosed equity stake in SigFig and will develop investing technology alongside it, according to news reports.

UBS said in a release that it will use SigFig’s technology to automate some of the middle-office chores of its 7,000 wealth managers (“B2B” robo) rather than using SigFig to create a digital advisory channel with individual clients (“B2C” robo), as direct providers like Vanguard and Schwab have done. B2C works either by itself or with the support of a financial advisor via phone or Skype.

The SigFig “digital platform will improve the ability of UBS advisors to efficiently provide advice on assets held at UBS and other institutions, a critical factor in providing truly personalized financial advice across the complete range of client needs,” UBS said.

According to the release, UBS and SigFig will create a joint Advisor Technology Research and Innovation Lab, where “UBS financial advisors, product experts and technologists” can work with SigFig’s experts on new wealth management tools.

In the first quarter, UBS’s average financial adviser had $147 million of invested assets and $1.06 million in revenue, according to the New York Times. What follows appeared in the Times this week:

The technology will allow the advisers to spend more time talking to clients and less time constructing investment portfolios and other activities that lend themselves to automation, said Tom Naratil, the president of UBS Americas. “It’ll make them more effective in helping clients to make better choices,” he said.

But unlike some other brokerage firms, which are developing products for retail customers, UBS will not take a robo-adviser service directly to its wealthy customers, Mr. Naratil said in an interview. “We’ll give them some tools, but we’re not going down the self-serve route,” he said.

Last month, SigFig announced its first agreement with a bank, the $3.2 billion Cambridge Savings Bank outside Boston.

Despite DOL rule, A.M. Best raises outlook for indexed annuity issuer

Posted on May 19, 2016 by Editorial Staff -

A.M. Best has revised the outlooks to positive from stable and affirmed the financial strength rating (FSR) of A- (Excellent) and the issuer credit ratings (ICR) of “a-” of the members of Athene Group:

Athene Annuity & Life Assurance Company
Athene Annuity & Life Assurance Company of New York
Athene Annuity and Life Company
Athene Life Insurance Company of New York
Athene Life Re Ltd.

Athene Group is the consolidating rating unit for the U.S. operating companies, which is focused on the fixed indexed and fixed annuity market segments, along with Athene Life Re Ltd. (ALRe) (Bermuda), its affiliated reinsurance company.

Concurrently, A.M. Best has revised the outlook to positive from stable and affirmed the ICR of “bbb-” of Athene Holding Ltd. (AHL) (Bermuda). AHL operates as the holding company for the U.S. and Bermuda operations.

The outlook revision for Athene Group is based on strong risk-adjusted capitalization, which was further enhanced by additional cash capital contributed to the company in 2015, a trend of generally strong profitability following its acquisition of Aviva, and recent sales growth through retail initiatives.

A.M. Best considers any potential remaining integration issues relating to the Aviva acquisition as unlikely and immaterial to the company’s future financial performance. The company is led by a strong management team with proven ability to grow capital both organically and through new capital generation, a trend that has not abated since the company’s inception.

The company’s strong trend of earnings and capital growth has enabled AHL and its operating companies to strengthen their balance sheets while providing sufficient capital support for retail growth and new product development.

A.M. Best also notes that the quality of the group’s capital is high, as the capital structure currently employs no financial leverage. The company recently filed an S-1 registration statement with the Securities and Exchange Commission regarding a planned future initial public offering.

Partially offsetting these positive rating factors are the pressures associated with managing assets in an extended low interest rate environment, as well as the embedded exposures present in changing credit cycles. Additionally, the pending Department of Labor fiduciary rule has the potential to result in higher compliance costs and may provide a sales headwind going forward, particularly for fixed indexed annuities.

Positive rating actions could occur if the company diversifies its product offerings into more creditworthy product lines, resulting in sales growth in products other than fixed indexed annuities. Continued positive trends in top-line and bottom-line earnings could also result in a positive rating outcome.

Negative rating actions could occur if the company experiences operating losses through poor investment performance or if the company holds lower levels of risk-based capitalization at the group or operating entity level, which could in turn lower A.M. Best’s view of the company’s capital adequacy.

Platform plays matchmaker between fiduciary advisors and prospects

Posted on May 19, 2016 by Editorial Staff -

GuideVine Technologies, Inc., an online platform that helps consumers find a right-fit financial advisor, announced an alliance with the National Association of Personal Financial Advisors (NAPFA).

GuideVine, which was founded by former McKinsey & Co. consultants and software entrepreneurs, said in a release that it can serve as a digital marketing partner for financial advisors, enabling them to:

Reach prospects through the platform.
Get help crafting marketing messages and content.
Outsource digital marketing chores.

Participating NAPFA advisors can obtain onboarding services at a discounted rate. These include developing messaging for videos and shooting the videos to be included with the advisor profile, as well as discounted annual platform fees.

In addition, GuideVine will conduct a digital marketing consulting review to help strengthen the advisor’s various online profiles. NAPFA advisors will also be included on the new fee-only/NAPFA specific portion of the GuideVine site to further promote their fiduciary standing.
Consumers can use Guidevine to evaluate more than 250 pre-screened financial advisors from firms that collectively manage over $50B in assets. Consumers can access videos, profiles, community experiences, advisor regulatory histories and authenticated reviews from their personal network on GuideVine.com.

Robos force advisors to step up their games: Cerulli

Posted on May 19, 2016 by Editorial Staff -

Technological advances are pushing financial services providers to keep up with investor expectations, and, ultimately, be the center of their clients’ financial lives, according to the second quarter 2016 issue of The Cerulli Edge – U.S. Retail Investor Editionexamines, a publication of Cerulli Associates.

“Wealth management providers, in particular, feel pressure from technology solutions (such as digital advice), changing financial planning expectations, and the commoditization of investment management services,” said Shaun Quirk, senior analyst at Cerulli, in a release.

“The retail investor is demanding more, forcing these firms to offer a deeper client experience,” Quirk said. “Many advice providers tout a ‘holistic’ planning model to bolster their perceived value. However, this overused term in wealth management is vague and heavily focused on investment management as opposed to true financial planning.

“As financial planning opportunities become available to a broader investor demographic, providers will need to leverage technological advances to scale the solutions, and streamline everything from the onboarding and information-gathering stage to the recurring planning conversations. The providers that can take the abstract nature of financial and retirement planning and make it an engaging, tangible process will win client assets.”

Investors desire deeper online, goal-oriented resources, research, and content to satisfy their investment management and financial planning needs. But they lack the bandwidth or attention span to dedicate significant time toward their financial well-being and the multitude of investment services used, according to Cerulli.

2106 Milliman Ad

Posted on May 19, 2016 by Editorial Staff -

Three Advisor-Friendly Reverse Mortgage Strategies

Posted on May 12, 2016 by Kerry Pechter -

Financial fads run hot and cold among advisors and planners, but interest in home equity conversion mortgages (HECMs, or reverse mortgages), which allow people over age 62 to tap their home equity without leaving their homes, continues to be lukewarm.

That’s not for lack of promotion by thought-leaders in the planning world, like Harold Evensky, Barry Sacks and Wade Pfau. All have published persuasive articles in the Journal of Financial Planning that portray HECM lines of credit as a no-brainer income-generating tool for retirees—even for those in the “green zone,” with plenty of savings.

Pfau, a professor at The American College, wrote recently that those articles “could very well lead to the strategic use of home equity in a retirement income plan to become the next hot topic for client and adviser education, similar to how Social Security claiming strategies have been ubiquitous in recent years.”

If a tipping point in favor of HECMs is ever going to arrive, the time is now. The low interest-rate environment, which reduces annuity payouts, raises HECM loan amounts. Collectively, Boomers have trillions of dollars in home equity. And, as Pfau has suggested, a “loophole” in the HECM rules that currently favors HECM lines of credit (HECM-LOCs) may not stay open forever.

RIJ is agnostic on the advisability of using reverse mortgages. But it seems clear that fiduciary-minded advisors or planners who practice “life-cycle” planning, and even those who don’t, should consider every asset on “household balance sheet” when looking for sources of retirement income. And that includes home equity.

In this fifth installment of our series on HECMs, we review three HECM strategies that are tailor-made to entice advisors: the HECM-for-purchase, the “standby” HECM-LOC to supply cash after a year of negative returns, and the HECM-LOC created at age 62 but tapped only if all other sources of cash are exhausted.

A new home, financed with a HECM

We’re used to thinking about reverse mortgages as tools to help older Americans “age in place,” but since 2009 the Department of Housing and Urban Development has allowed people to finance the purchase of new FHA-approved home or condo—not a vacation home or assisted-living unit, however—with the help of a reverse mortgage.

Michael Banner, a Florida-based HECM broker, has been on a campaign to popularize HECMs-for-purchase. Via online courses sponsored by his company, AmericanCEInstitute, he said he has educated 14,000 financial advisors, real estate agents and others in the past five years about the benefits of this strategy.

Consider this hypothetical: A 65-year-old couple wants to sell a paid-off $500,000 home in the Northeast and move to a $500,000 home in the Southwest. According to Banner, they can put down about $250,000 on the new home and borrow the rest in a reverse mortgage.

The result: The couple moves into a new home with equity in the form of a $250,000 down payment (net of closing costs and real estate commissions) from the sale of the departure home. This component is excluded from capital gains tax. The other half of the purchase price is financed with a reverse mortgage, on which the couple has the option but not the requirement to make any payments.

Banner told RIJ that when he tells advisors that their clients can move into a new home without having to make mortgage payments and with half of the equity of the previous home available for any purpose they wish, advisors get excited. “When certified financial planners hear this, they say, ‘Whoa. What did you just say?’” he told RIJ recently. When the heirs sell the house and settle the HECM, he added, any remaining equity passes to the estate and any accrued interest is deductible, under current law.

In his view, a synergy between HECM brokers, real estate agents and financial advisors is waiting to be tapped. “The reverse mortgage world hasn’t gotten out and knocked on the doors of the realtors,” Banner said. “The industry has been too lazy to build rapport with them. Last year five million homes were sold in the U.S. and 14%, or 700,000, involved sellers over age 62. Of those, there were only about 2,500 HECMs for purchase.”

HECM-LOC vs. longevity risk

In an article in the Journal of Financial Planning, Wade Pfau of the American College, whose work in recent years has served as a touchstone for retirement planners, demonstrated the benefits of opening a reverse mortgage line of credit as early as age 62 and then leaving it untapped unless or until it is absolutely necessary.

This strategy, as Pfau explains, takes advantage of what may or may not be an intended aspect of the HECM law. Under the regulations, a borrower’s HECM-LOC, even if not tapped, starts with the same upper limit as a HECM loan. What’s more, the HECM-LOC’s limit grows at the same rate as a comparable loan balance would grow—currently, at about 4% a year fixed or 2.75% adjustable.

Because the upper limit is HECM-LOC is growing over time, whether the retiree dips into or not, this strategy was likely to provide the retiree with more borrowing power later in life than if he or she postponed opening the HECM-LOC until a later age. As Pfau wrote:

“The strategy that used home equity as a last resort, but which opened a line of credit at the start of retirement in order to let the line of credit grow before being tapped, provided the highest increase in success rates. Especially when interest rates were low, the line of credit would almost always be larger by the time it was needed when it was opened early and allowed to grow, than when it was opened later.”

Pfau hypothesized a 62-year-old investor with a $1 million in a tax-deferred retirement account, a $500,000 home with no mortgage, a 25% tax rate, a 50/50 investment portfolio, and after-tax income needs of $40,000 a year. He then compared the success rates (in terms of never having less than $40,000 a year from investments) and legacy outcomes (the amounts left in the client’s portfolio at death) for these strategies:

Ignoring home equity and withdrawing $40,000 (inflation adjusted) each year from investments
Waiting until portfolio depletion to open a HECM-LOC
Opening a HECM-LOC at beginning of retirement and exhausting it before tapping personal savings
Receiving a HECM in the form of a $17,972 annual “tenure payment” until death or departure from the home
Opening a HECM-LOC living expenses only to avoid distressed selling in down markets and either paying it back down or not paying it back down
Opening a HECM-LOC at the beginning of retirement, paying the closing costs out of pocket, and ignoring it unless or until other sources of income failed to provide at least $40,000 in real purchasing power.

On the basis of Monte Carlo simulations, all of these strategies provided a better-than-50% chance that the client would not run out of money if he didn’t live past age 85. But the last option—opening a HECM-LOC early but tapping it last—was the only one that offered a chance of portfolio success greater than 70%, even if the client’s retirement lasted 40 years. The best strategies for maximizing legacy value, however, were those that employed the $17,972-a-year tenure payment or the use of the HECM-LOC before tapping personal savings.

Escape from tyranny of 4%

Retirees can also use reverse mortgages as a hedge against sequence of returns risk. “Sequence” risk refers to the rapid depletion of savings that can occur if the retiree has to generate income by selling depressed assets. The risk is considered greatest during the five years directly before and after the retirement date.

Some advisors handle this risk through a bucketing strategy. They tell retiree to hold a bucket of cash or near-cash large enough so that, during a bear market, they can dip into cash rather than lock in losses by selling stocks. In 2012, Barry Sacks, Harold Evensky and others suggested in articles in the Journal of Financial Planning that a HECM-LOC could be used as a substitute for the cash bucket.

The payoff was that the retirees, immunized from sequence risk, could then afford to spend from savings at, for instance, a rate of six percent per year for 30 years, rather than at the proverbially safe rate of 4%, without increasing their risk of running uncomfortably short of money before they died.

In their 2012 article, Barry H. Sacks and Stephen R. Sacks published “Reversing the Conventional Wisdom: Using Home Equity to Supplement Retirement Income.” Searching for an answer for retirees who resisted living within an annual budget of 4% of savings but who didn’t want to increase their longevity risk, they suggested that the clients use a reverse mortgage.

But instead of using the reverse mortgage as a last resort (if and when the clients ran out of money), or as a first resort (before spending a cent from savings), they suggested that retirees only tap their lines of credit during the years that followed a year of negative returns.

Evensky and his co-authors John Salter and Shaun Pfeiffer, also writing in 2012, took a slightly different approach. Unlike the Sackses, they suggested that the retirees apply some of their returns during the profitable years to the HECM-LOC, thereby protecting the equity in their home for their heirs.

David Peskin, president of Reverse Mortgage Funding LLC of Bloomfield, NJ, told RIJ that, as it stands today, hundreds of thousands of retirees are opening conventional home equity lines of credit today to supplement their incomes. If they used HECM-LOCs instead, which he claims to be able to set up for about $1,000, they’d have the option of not making any payments on it.

“Advisors should find this more and more appealing because it puts their clients in complete control of their finances,” Peskin told RIJ. “The reverse mortgage used to be marketed as a no-payment product but it’s really a flexible payment product. The unused portion continues to grow, and it’s guaranteed. It can’t be taken away from you in a financial crisis.”

What’s not to like?

Despite the logic behind these three uses of HECMs, only a small minority of advisors seems to be pursuing them. Peskin said that if he conducts a HECM seminar with 500 advisors, only about 10% request further information. Similarly, Pfau said his columns about HECMs on the Forbes magazine website attract only about a tenth as many views as his other columns do.

Regarding Pfau’s untapped HECM-LOC strategy, he believes that the Department of Housing and Urban Development may eventually change the HECM-LOC rules to preclude a scenario where interest rates have risen, housing prices have fallen, and the upper limit of an untapped HECM-LOC has been allowed to grow for 20 or 30 years. A borrower could use HECM-LOCs to bet against the housing market, and engineer his or her own miniature “big short.”

“I think this was unintended. It sounds too good to be true. I expect the government will put an end to it at some point, especially if the line of credit strategies become more popular,” Pfau told RIJ. “I don’t think these strategies were anticipated. Also, I don’t think it was anticipated how these strategies become that much more attractive in a low interest rate environment.”

At the same time, HECM lenders have little to gain from creating empty HECM-LOCs. Most of them make their money reselling the loans, and an empty HECM-LOC gives them nothing to sell. “If it turns out that planners and consumers are putting them in place and never using them, we’d have to rethink that strategy,” Peskin said. “So far that hasn’t been the case. People are using it to supplement living expenses.”

Regarding the problem that advisors often don’t see a clear path to compensation for recommending a HECM, Peskin hopes advisors don’t look at it that way. “If it was my financial planner,” he said, “I’d like them to look at every available option, even if they don’t make money on it.”

The Wealthier, The Quicker to Sell in a Downturn?

Posted on May 12, 2016 by Kerry Pechter -

Part of the debate over the Department of Labor’s fiduciary rule and the related debate over “robo” financial advice has focused on investor behavior during periods of extreme market volatility—like the ones we all endured back in 2008-2009.

Critics of the fiduciary rule argued that it would eliminate commission-based advisors. And skeptics of digital advice predicted that, if it replaced advisors and brokers, middle-class investors wouldn’t have any options (other than, say, to a Vanguard or Fidelity phone rep) when the VIX spiked and they needed someone to talk them out of dumping equities.

These arguments puzzled me, because I thought that ordinary savers—retirement plan participants, for instance—were more inclined to inertia than panic during market upheaval. It was all the more puzzling because I also assumed that rich people—the upper 5%—are too smart to sell in a panic. On the contrary: I assumed they were scooping up bargains (as did the Sage of Omaha back in 1975).

But if both those assumptions were true, then who is responsible for the panicky selling? In a new research paper, entitled “Who Sold During the Crash of 2008-2009? Evidence from Tax Return Data on Daily Sales of Stock” (NBER W22209), a group of Big Ten economists and an IRS analyst say that wealthy people and older people are the most likely to sell in scary market downdrafts.

Older people, I can understand. Wealthy people? That’s somewhat surprising. It contradicts the conventional wisdom that they have financial advisors who can pull them away from the TV and Internet and calm them down.

The jittery ‘one percent’

But no. “We find that, starting in September 2008, the share of sales volume attributed to the top 0.1% of income recipients rises sharply until the beginning of 2009. More generally, we find that high-income taxpayers have a greater propensity to sell during periods of market tumult,” the six authors of the study wrote. Four were economics professors at the University of Michigan, one was an Ohio State University economist, and the sixth works for the Internal Revenue Service.

“Sales volume rises much more strongly with lagged VIX changes for the top 95-99, 99-99.9, and 99.9-100 income percentiles than for other income groups over the period 2008 to 2009,” they continued. The same was true for people over age 60. “In multi-dimensional analysis, both high income and age over 60 are associated with a strongly positive sales volume-VIX relationship, as are income and receipt of Social Security income.”

High-net-worth and older investors were more likely to sell equity mutual funds than individual stocks. They weren’t more likely to sell financial stocks than other stocks, but they were less likely to sell consumer-durable stocks than stocks in other sectors. While high wealth levels tend to overlap with higher ages, the researchers saw separate effects for age and income.

“Younger high-income investors were also selling much more than younger, lower-income investors,” co-author Daniel Reck of the University of Michigan told RIJ in an email. “Basically, we see strong relationship between age and crisis sales at all income levels, and also a strong relationship between income and crisis sales at all age levels. So we conclude that the income relationship isn’t driven purely by the fact that high-income investors are older.”

“Other aspects of investors—gender, marital status, region and state of residence, presence and amount of a mortgage interest deduction, and 2007 zip-code-level house price growth—are not related to the volatility sensitivity of stock sales,” the paper said.

The study was based on data from federal tax returns with the names removed. The economists matched asset sales reported for capital gains taxation purposes with some demographic information on each taxpayer. Asset purchases were identified indirectly, from dividend receipts and a supplementary brokerage account data set “suggesting that individuals with high levels of gross sales are also, to a substantial extent, net sellers of stocks,” the authors wrote.

The study didn’t cover trading in tax-deferred accounts, such as IRAs and employer-sponsored retirement plans, because it was based on IRS data and trades in tax-deferred accounts don’t leave a tax trail.

Reasons for selling

The tendency of high-income investors to sell in high-volatility episodes, the authors wrote, could exist because:

They tend to pay greater attention to their portfolios.
They perceive themselves better able to time the market.
They are more likely to own stocks on margin, which potentially multiplies their losses.
They blame their money managers for stock market losses and withdraw their funds in response.
They lose trust in financial intermediaries in response to market turmoil.

“Some investors may be forced to sell due to constraints on their risk-bearing capacity (e.g., leverage constraints, liquidity shocks), some may be less tolerant of short-run risk than the average investor (e.g., close to retirement), some may perceive themselves to be better informed than others and anticipate a further price decline, and some investors may lose trust in the stock market altogether and perceive it as a rigged game,” the paper said.

“Individuals trading in mutual funds as opposed to individual stocks are likely more risk-averse and thus more prone to reduce the risk in their portfolios during the crisis by moving their wealth from mutual funds to something safer. Mutual fund investors could also be less confident in their own ability to pick winning stocks, which could make them more likely to sell off in tumultuous times than investors who are confident enough to pick individual stocks.”

The researchers added, “The greater sensitivity of older investors is consistent with the idea that investors close to retirement (with less opportunity to make up losses through future labor income) should be particularly sensitive to a perceived rise in risk.”

The researchers couldn’t rule out the possibility that plan participants and IRA owners were trading just as frequently as the top 5% during volatile markets. They noted that high-income and older people hold a higher share of their wealth in taxable accounts “perhaps due to the limits on contributions to tax-deferred retirement accounts. The same is true of older individuals.” Overall, the researchers found it easier to understand why older people sell in choppy markets than to understand why the wealthiest do.

The authors of the paper included Jeffrey Hoopes of Ohio State University, Stefan Nagel, Daniel Reck, Joel Slemrod and Bryan Stuart of the University of Michigan, and Patrick Langetieg of the IRS.

Athene Holdings, a major fixed indexed annuity issuer, registers for IPO

Posted on May 12, 2016 by Editorial Staff -

Athene Holding Ltd., one of the offshore, private-equity-backed insurers that injected fresh competition—and controversy—into the fixed indexed annuity market after the financial crisis, filed with the U.S. Securities and Exchange Commission (SEC) for a proposed initial public offering of its Class A common shares.

The number of shares to be offered and the price range for the proposed offering have not yet been determined. The IPO was announced last fall and then postponed. Renaissance Capital IPO Center estimated that Athene Holding would try to raise up to $1 billion and said that underwriters have not been chosen.

In 2015, one of its subsidiaries, Athene USA, was the fifth biggest seller of indexed annuities in the US, with $2.55 billion in sales and a 4.8% market share. It trailed Allianz Life, American Equity, Great American, and AIG.

Most indexed annuities are sold by commissioned independent insurance agents and about two-thirds are funded with tax-deferred savings. This business model is widely expected to be adversely affected by the Department of Labor’s fiduciary rule, issued in early April. The rule will make it tougher to justify the sale of products with high commissions to IRA owners.

Athene Holding Ltd. (Athene) is a $86 billion in GAAP(and $59.9 in invested assets)insurance holding company whose operating subsidiaries’ business is primarily issuing and reinsuring retirement savings products, including fixed annuities and funding agreements, according to the Athene website.

Not long after the financial crisis, private equity firms, including Guggenheim Partners, Harbinger and Apollo, swept into the life insurance business, buying depressed companies, hoping to capitalize on rising demand for retirement income products, and confident that they could raise the firms’ profitability.

Athene was founded in 2009 by James Belardi, former president of SunAmerica Life Insurance Company and now CEO of Athene Holding Ltd., and Chip Gillis, former head of Bear Stearns’ Insurance Solutions Group and now CEO of Athene Life Re.
The Pembroke, Bermuda-based company was founded in 2008 and booked $2.6 billion in sales for the 12 months ended December 31, 2015. It plans to list on the NYSE under the symbol ATH. No pricing terms were disclosed.

Athene was purchased in 2012 by Apollo Global Management, the private equity firm co-founded by Michael Millken and Leon Black in 1990. Apollo had been managing assets for Athene before buying it. Apollo subsequently paid $2.6 billion for Aviva USA, the Des Moines-based life insurer issuer, renaming it Athene USA and divesting its life insurance business. Athene’s largest shareholder is AP Alternative Assets, a publicly traded investment vehicle controlled by Apollo, according to Bloomberg.

The products offered by Athene include:

Retail fixed and equity indexed annuity products;
Co-insurance and reinsurance arrangements with third-party annuity providers; and
Institutional products, such as funding agreements.

Athene’s principal subsidiaries include Athene Annuity & Life Assurance Company and Athene Life Insurance Company, Delaware-domiciled insurance companies, Athene Annuity and Life Company, an Iowa-domiciled insurance company, Athene Annuity & Life Assurance Company of New York and Athene Life Insurance Company of New York, New York-domiciled insurance companies, Athene Deutschland, a Germany-based life insurance company, and Athene Life Re Ltd., a Bermuda-domiciled reinsurer.

Conning study assesses pension risk transfer (PRT) market

Posted on May 12, 2016 by Editorial Staff -

“Pension Risk Management Market: Key Opportunities and Challenges,” a new proprietary research study from Conning Inc., analyzes the pension risk transfer market in the U.S. and U.K., and provides details on the insurers in the U.S. market and the issues insurers face in this developing market.

The study also examines key liability-driven investment concepts. It is available for purchase from Conning by calling (888) 707-1177 or by visiting the company’s web site at www.conningresearch.com.

Conning analyzed data from the 20 largest U.S. corporate DB plans that accounted for 43% of aggregate DB plan assets of the 238 U.S. corporate DB plans with $1 billion or more in assets.

“With the improvement in funding status in 2015 for these companies, plan sponsors broadly experienced a smaller impact on their balance sheets, long-term financial obligations, and contributions than in 2014,” Conning said in a release.

But that improvement hasn’t removed the pressure on DB plan sponsors. “Plan sponsors have a continued interest in pension risk management, which stems from the ongoing funding volatility and resulting negative impact on balance sheets, long-term financial obligations, and contributions,” said Scott Hawkins, Director, Insurance Research at Conning, Inc., in a prepared statement.

“Plan sponsors’ chief financial officers face uncertainty in planning future funding obligations, and the underfunded defined benefit liabilities are yet another form of long-term financial obligations. Significant funding status volatility can directly affect both credit ratings and the cost of capital.”

“Insurers and asset managers are well-positioned to help plan sponsors remove or mitigate their pension risk and the funding volatility that creates cash-flow and other management issues,” said Steve Webersen, head of Insurance Research at Conning. “Insurers have the expertise to assume a plan’s pension liabilities through pension risk transfers using annuity buyouts or annuity buy-ins.

“Asset managers, meanwhile, can help plan sponsors develop and implement liability-driven investment solutions that can reduce funding status volatility for the plan sponsor that chooses to retain the risk. Our analysis finds continued growth and interest in both solutions.”

But insurers do face limitations on the amount of longevity risk they can assume in PRTs. “Longevity risk may be a future issue for U.S. insurers since they currently do not incur a longevity charge under RBC,” Hawkins told RIJ in an email. “However, the NAIC is looking into the possibility of including such a charge. Should that happen, some insurers may reduce their PRT appetite to maintain RBC levels, or seek out longevity reinsurance deals as U.K insurers have done.”

UK investors more open to robo-advice than Americans

Posted on May 12, 2016 by Editorial Staff -

Most wealthy people “recognize the potential of robo-advisors and automated investment services to add value to their wealth management services,” according to Investors’ Attitudes towards Robo-Advisors – Evidence from the US and the UK , a new report from MyPrivateBanking Research. The report is based on interviews with 600 affluent and high net worth individuals in the US and the UK.

In the US, Charles Schwab Intelligent Portfolios is the brand investors associate most with robo advice (43%). In the UK, Nutmeg leads the field, also with 43% brand recall, a MyPrivateBanking release said.

Rich investors evidently like their wealth managers to use digital channels. According to the release, more than 70% of those surveyed think that such tools can “positively influence their wealth manager’s advice and decision-making process and that automated advice potentially speeds up onboarding processes such as registration and account opening, making these processes more efficient and convenient.”

Possibly because they’re more engaged with investing, “the adoption of automated wealth advice is happening faster in the high-net-worth segment than mass affluent, with current usage of online wealth management tools at 43% and 17%, respectively,” said Carmela Melone, analyst at MyPrivateBanking Research, in a statement.

Only 34% of those surveyed consider robo-advisors are “not trustworthy,” but 56% worry that advisors who use or offer robo tools to clients might over-rely on them, and fail to think and do research on their own. Half of the respondents rated the quality of human based advice as unmatched by robo’s.

Overall, UK and US investors have similar attitudes toward automated/robo advice, with some differences. UK investors would pay 10 basis points more on average for robo (and human-only) advice. In the US, 28% of those surveyed said they don’t think they will use robo advice tools in the future, compared with only 12% in the UK.

MyPrivateBanking offered these conclusions and recommendations for wealth managers:

Offer the right tools: Financial planning and tax optimization wizards are the most important.
Know your target segments: The youngest discretionary investors are the early adopters of robo, but automated services also appeal to self-directed middle age clients.
Use multiple channels: Face-to-face, telephone and e-mail still dominate contact methods but use of social media is increasing.
Look for opportunities to automate any link in the chain, from onboarding new clients to delivering specific advice.

Extra, extra! It’s a real-time event-based API!

Posted on May 12, 2016 by Editorial Staff -

In the future—no, make that the present—you won’t have to ask for the financial news that’s most important to you. Your phone will tell you that it is ready for your inspection.

Barchart, a provider of financial market data and technology, has released a “real-time event-based API,” a new managed service that allows firms to integrate event-based alerts, that use market data and related information, into their websites, software, mobile apps and internal systems.

According to Barchart:

A firm can use the API (application programming interface) to build its own interface with the service which then monitors user specified conditions in real-time and notifies the user via SMS, email and/or push notification when the condition is met.

Alerts can be sent when the price or volume of a financial instrument crosses a specified level, or when news on a company is released. More sophisticated conditions can be created using technical and fundamental data or by stacking conditions together, the Barchart release said.

The cloud-based service is built upon Amazon Web Services (AWS) infrastructure. “It offers a complete managed service for financial data monitoring and alerting that is auto-scalable, resilient and redundant throughout multiple AWS availability zones,” the release said.

“The storing, monitoring and sending of the event based alerts are managed by Barchart inside of AWS,” said Eero Pikat, president of Barchart, in a release. “We also supply the underlying market data, news, fundamental or technical data required, though we can also integrate and apply your own set of data. The service is designed to be extremely robust and scalable, as it is fully leveraging the power of cloud computing.”

Wealth management firms, brokers, exchanges, trading software providers and fintech start-ups can use the service, which can monitor price data, news, public company financials and ratios, and technical data like moving averages and stochastics. It can monitor price data on stocks, futures, options, forex, mutual funds, ETFs and indexes.

The service can also be configured to monitor real-time, delayed or end-of-day data. As a web services based solution, the API is compatible with any operating system, such as Windows, Linux, iOS or Android, and any programming language, such as Java, PHP or ASP.NET.

The ‘Kosher’ Reverse Mortgage (IV)

Posted on May 5, 2016 by Kerry Pechter -

“Kosher,” or “kashrus” in Hebrew, means clean or pure. It refers to food and food preparation that’s consistent with Jewish dietary laws. But kosher is also established in several languages as a synonym for legitimate, suitable, proper, and aboveboard.

Which brings us to reverse mortgages. Jack Guttentag (below right), an emeritus professor of Penn’s Wharton School and a reverse mortgage authority, has a website where he promotes relatively low-cost “kosher” reverse mortgages and warns against the non-kosher, allegedly over-priced HECMs that are advertised on television and online.

In Guttentag’s view, the growth of the reverse mortgage market is held back in large part by its lack of price transparency, which hides inefficiencies—i.e., middleman profits—that in a more competitive market would be arbitraged away. Through his website and publications, he’s led a campaign to shed light on HECM pricing. Jack Guttentag

As he and others explained to RIJ, a kosher reverse mortgage lender will share some of profit that he or she makes when selling the loan on the secondary market with the end client by reducing or waiving the origination fee, which HUD caps at the greater of $2,500 or 2% of the first $200,000, plus 1% of the amount more than that, up to a maximum of $6,000.

A non-kosher lender, he says, will charge the highest possible origination fee and keep the “mark up” or profit on the resale of the loan. If the lender’s costs are high—from employing hundreds of call center employees and buying ads on TV and the Internet—those higher profits help cover the costs.

“The lenders on my site will offer rebates, but a firm like AAG [American Advisors Group, the largest HECM company, with a 25% market share] will spend money on television commercials, so they’ll charge the maximum origination fee on every loan, on top of the higher interest rate, which lets them sell the loan balance for a higher price,” said the 92-year-old Guttentag, who is known online as “the Mortgage Professor.”

Not surprisingly, the leader of the HECM lender’s advocacy group differs. “I don’t agree with a lot of things that Jack says,” said Peter Bell, the executive director of the National Reverse Mortgage Lenders Association. “He’s made a lot of comments about calculators. I think his comments have been way off base. I don’t know anyone who is charging the full origination fee. Most are in $2,500 range. I see very few instances where people are paying the full amount.”

Less-than-transparent pricing isn’t solely responsible for the state of the HECM market, in Guttentag’s opinion. “The market ought to be ten times larger than it is,” he told RIJ. “It’s small because you’re dealing with the elderly, because their home is their most prized possession, and because the instrument is complex. All of these factors generate anxiety.

“To top it off, the press has been pretty negative for reasons that are hard to understand. That has begun to change, fortunately, because the need is growing by leaps and bounds.” While three million homeowners reached age 65 in 2015, he estimates, only about 60,000 HECM loans were written. For a list of HECM lenders, click here.

Caveat emptor

Unless the borrower, or the borrower’s financial advisor, does the proper homework, and finds a mortgage broker with better pricing, they run the risk of paying many thousands of dollars more for their loans than they should. (Even when they do shop around, they discover that cost of a fixed-rate reverse mortgage—the kind that appeals to consumers but pose risks to HECM lenders—offer only about half the payout of a variable or an adjustable rate reverse mortgage.)

In short, a buyer-beware ethical standard prevails in the HECM world. It naturally breeds mistrust among the sophisticated, and it persists even though the lenders are insured against loss by government guarantees. Because seniors don’t know exactly who to trust in the HECM market, many avoid the category entirely.

“What Guttentag said is true. Pricing in reverse mortgages is extremely opaque,” concedes Shelly Giordano, author of the 2015 book, What’s The Deal with Reverse Mortgages? “That’s why people have to get proposals from several brokers or banks and then try to get them to drop their prices. There’s no substitute for doing your homework. If you just call one [lender] they’ll hit you with everything they can. It’s just human nature.”

Another prominent participant in the HECM market, who asked not to be identified, told RIJ, “I don’t like it at all, the fact that the TV/Internet folks often quote a higher interest rate and, sometimes, the maximum HUD allowable origination fee. But I do understand why they may do it.”

Reverse mortgages “have always had a black eye [with consumers and financial advisors] because the cost to the consumer has been high,” said Cliff Auerswald of AllReverse, a 10-employee firm in Orange County, California that approves about 30 reverse mortgages per month—far less than the 1,000 mortgages that the industry leader underwrites.

“The fees have come down a bit since FHA reorganized its insurance premiums. But the atmosphere is still dominated by companies that run huge call centers and teach their reps to keep the cost up. They can do that because they are selling the most loans. AAG and others by default charge the maximum origination fees. They come down only when they find that the consumer is comparison-shopping. That’s the biggest problem.”

In an e-mail statement, AAG told RIJ:

“The cost to close a HECM loan varies upon by each individual’s situation and the specific loan they choose. During the process, we cover with them their ability to meet the financial obligations associated with the selected loan.

“Borrowers are also required to undergo independent third-party reverse mortgage loan counseling to discuss the pros and cons, process and anticipated costs associated with their loan.

“We offer competitive pricing. During the loan process, if borrowers state they received a better price from a competitor, we’ll review the competitor quote with them and the loan option selected. Closing costs are an included part of the conversation.

“We’re the leader in reverse mortgage lending by over two times the volume, and the reason why is based on our best efforts to ensure borrowers are informed about how home equity can help supplement their retirement income.

“We firmly believe that without the level of investment we make to build awareness about the product, fewer seniors would understand about HECM loans and the market would be smaller than it is today.”

Kosher v Mainstream HECM Chart

Kosher mortgage math

At AllReverse, Auerswald applies part of his profit on the sale of a HECM on the secondary market to the origination fee and closing costs. He described a hypothetical kosher adjustable-rate reverse mortgage loan. “Let’s say the client was born in 1940 and had a home worth $500,000,” he told RIJ. If the house had no existing mortgage, that 76-year-old could borrow up to $306,000. Up to $181,000 would be available at closing. The rest would be available 12 months after closing. (A younger borrower would not be able to borrow as much because he or she would have more years of life expectancy and, consequently, a more distant payoff date).

The mortgage insurance premium (MIP) would be 0.5% the loan amount ($950) if the borrower took no more than $181,000 at closing. If the borrower took more—if he or she needed to pay off a $200,000 existing mortgage, for instance—the MIP would be rise to 2.5%, or $4,750. If the client wanted a fixed-rate HECM, he or she could probably borrow only about $150,000 against a paid-off $500,000 home. That’s because the lender would bear the risk that interest rates might go up dramatically in the future.

Under federal rules, the origination fee on a $306,000 loan could be as high as $5,060. But lenders don’t have to charge that much. If the client were opening a line of credit and “not drawing any funds,” Auerswald said, “we would be likely to charge $3,500 to originate the loan. It might cost $7,500 in total closing costs. But if you drew $50,000 at closing, we’d waive the origination fee. And if you borrowed $100,000 or more, we’d cover all costs.”

Auerswald can afford to pay the $7,500 costs himself because, depending on interest rate spreads, he can sell the borrower’s $100,000 IOU on the secondary market for well over that amount. (He didn’t wish to be quoted on the markup, which varies.) The margin exists in part, he said, because the loans are bundled into highly marketable securities and are insured by the Government National Mortgage Association, or GNMA.

“Securitization has made the pricing so favorable that almost all of the lenders could live with no origination fee,” Auerswald told RIJ. “Counselors will tell people to shop around, but it is up to the consumer to do it. “The largest HECM lenders don’t lower their prices, he added, because “they might have as many as 1,000 employees inside their call centers. Their cost per acquisition is high and that’s why they have to be costly to consumers.”

Give the complexities of the HECM, most 70-something retirees arguably face them at their peril, and need a trustworthy guide. On a large loan, a client could save $10,000 in mortgage insurance premiums by taking less than 60% of the loan value at closing, and save an additional $7,500 in origination fees and other costs by working with a “kosher” HECM lender.

“At certain interest rates,” Auerswald said, “I have customers who can save $20,000 in closing costs alone by using us.”

Referring to Guttentag’s kosher mortgage numbers, Don Graves, the president of the HECM Advisors Group in Wyncote, Pa., said, “I think Jack’s analysis of the fees of the major call center-based lenders is observable in some cases. But the vast majority of HECM funds are fair to the customer and the company.

“I have seen certain larger lenders starting with a product mix that is consistent with their costs of customer acquisition, which may involve a slightly higher interest rate as well as a higher origination fee. But the mortgage insurance premium and third party charges will not change from lender to lender. Origination fees will typically be based on secondary market factors and the interest rates of associated programs.”

NEXT: Innovations that Could Spark a Bigger HECM Market

The Fed’s Risky New Mandate

Posted on May 5, 2016 by Alexander Friedman -

“In this world, there are only two tragedies,” Oscar Wilde once wrote. “One is not getting what one wants, and the other is getting it.” As the US Federal Reserve inches closer to achieving its targets for the domestic economy, it faces growing pressure to normalize monetary policy. But the domestic economy is no longer the Fed’s sole consideration in policymaking. On the contrary, America’s monetary authority has all but explicitly recognized a new mandate: promoting global financial stability.

The US Congress created the Fed in 1913 as an independent agency removed from partisan politics, tasked with ensuring domestic price stability and maximizing domestic employment. Its role has expanded over time, and the Fed, along with many of its developed-country counterparts, has engaged in increasingly unconventional monetary policy – quantitative easing, credit easing, forward guidance, and so on – since the 2008 global financial crisis.

Now, the unconventional has become conventional. A generation of global market participants knows only a world of low (or even negative) interest rates and artificially inflated asset prices.

But the Fed’s dual mandate remains in force. And while the Fed’s recent rhetoric has been dovish, the fundamentals of the US economy – particularly those that supposedly matter most for the Fed – indicate a clear case for further rate hikes.

Consider, first, the Fed’s employment mandate. The unemployment rate is down to just 5%, job growth is strong and consistent, and jobless claims have been on a clear downward trajectory for several years.

As for the price-stability mandate, the oil-price collapse has naturally affected headline figures over the past year, but the trend in core inflation (excluding the energy component) suggests that the Fed is falling behind the curve. Core CPI is at a post-crisis high, having risen 2.3% year on year in February, and 2.2% in March.

Moreover, inflationary pressures will likely mount as the year progresses. With the household debt-to-asset ratio now approaching levels last seen in the 1990s, consumers have plenty of capacity to ramp up their borrowing. At the same time, the cost drag on inflation is set to diminish as the oil price stabilizes, and the dollar’s recent softness implies further inflationary pressure.

But this domestic progress puts the Fed in a difficult position. As a result, the Fed is effectively trapped between a US economy that increasingly justifies normalization of monetary policy and the interest of fragile global markets – in which about 60% of the world’s transactions are dollar-denominated – in further dovishness.

Messaging from financial markets increasingly influences the Fed’s decision-making. Any suggestion that the Fed will hike faster or sooner than anticipated leads to fears of tighter financial conditions, and violent risk-off moves. After a multi-year bull market in equities and fixed-income securities, stimulated by the very monetary policies the Fed is trying to leave behind, there is no valuation support to dampen the reaction. In the absence of genuinely robust global growth, which is unlikely in the near term, financial markets are relying on extremely loose monetary policy to prop up prices.

The Fed’s rate decision in March, and Fed Chair Janet Yellen’s commentary, was a case in point. The Fed apparently could not stomach the sell-off in global financial markets in January and February, which was driven largely by concerns about further tightening.

This is odd, because effects on consumption from changes in financial wealth (stocks and bonds) are small. What matters far more are changes in house prices, which have not deteriorated. Similarly, changes in the cost of capital, including the equity cost of capital, have a minor impact on business investment.

In other words, from the standpoint of its dual mandate, the Fed should not be terribly concerned about market volatility, even of the magnitude seen in January and February. But every signal sent from Yellen and the Fed was that policymakers were very concerned about exactly this. And the rally in markets that came after the Fed backpedaled on the pace of rate increases has only served to strengthen the feedback loop between the probability of US interest-rate hikes and global market volatility.

The loop has become calcified into a new mandate for the Fed, with other global policymakers becoming increasingly overt in referring to it. China’s deputy finance minister recently praised Yellen for her communication and cautious approach, which “takes us into consideration.”

The implications of this are worrying. If Yellen and the Fed feel beholden to financial markets, the risk of sharper rate hikes further down the road, as the Fed increasingly falls behind the inflation curve, will rise.

Beyond this, there are important longer-term considerations. Given the low base, and the Fed’s obvious caution, nominal interest rates are unlikely to climb too far by the next US recession. With a lack of traditional rate-cutting firepower, the next downturn could be longer than usual, compelling further reliance on unconventional monetary policy – even beyond the negative nominal interest rates now being pursued in Europe and Japan.

Indeed, Yellen’s predecessor, Ben Bernanke, recently addressed such possibilities, notably the potential for a permanent increase in the money supply (so-called helicopter money). This could take a number of forms: quantitative easing combined with fiscal expansion (for example, higher infrastructure spending), direct cash transfers to the government, or, most radically, direct cash transfers to households.

Such extreme policies are still only theoretical, and implementing them would most likely spur heightened congressional scrutiny. Nonetheless, the pressure to support global financial markets and other external economies suggests why the issue is being debated.

With the Fed deciding in their just-concluded April meeting, yet again, to hold rates, their dilemma is set only to intensify this year: normalize monetary policy in line with domestic fundamentals, or cede to the pressures of global financial markets. The former is sure to usher in a highly volatile future; the latter would further entrench the Fed’s new mandate – one that undermines any semblance of central-bank independence.

The Latest from an RIJ Competitor

Posted on May 5, 2016 by Kerry Pechter -

The Spring 2016 edition of The Journal of Retirement, the quarterly magazine published by Institutional Investor Journals, edited by Sandy Mackenzie and underwritten by Bank of America Merrill Lynch, arrived in mailboxes this week, bringing its usual mix of scholarly articles about retirement.

Financial advisors might be especially interested in Nancy Foster-Holt’s article on the transition to retirement for small business owners and in the piece on Social Security claiming for widows and widowers by Social Security gurus William Reichenstein and William Meyer.

Several of the articles are aimed at public policy wonks. The articles on longevity annuities, on “in-plan” annuities, and on defined benefit plans all involve suggestions for government action that would resolve some of the obstacles to the use of products and strategies whose popularity with academics is not matched by success in the marketplace.

Here’s a list of the articles in the new issue, along with brief descriptions:

The Market for Longevity Annuities. In the past three years, longevity annuities, aka deferred income annuities (DIAs), which provide income beginning more than a year after purchase, have become a multi-billion dollar business. Yet demand for DIAs, as for all income annuities, is still relatively weak.

In this article, Katherine G. Abraham of the University of Maryland and Benjamin H. Harris, a former deputy director of the Retirement Security Project at the Brookings Institution, propose ways to “remove obstacles to a robust market for longevity annuities.” Among their suggestions:

“Issuance of a new financial security graphic,” modeled on the old Department of Agriculture food pyramid, reminding Americans to include annuities in their financial planning.
Federal certification and favored tax treatment for certain financial products, including longevity annuities;
Allowing longevity annuity issuers to advertise the presence of state guaranty programs;
Offering longevity annuities in the federal Thrift Savings Plan;
Encouraging use of DIAs in employer-sponsored retirement plans;
Creating longevity-protected bonds or mortality indices allowing insurers to hedge against unexpected increases in human lifespans.

Regulatory Recommendations for the Department of Labor to Facilitate DC Lifetime Income, Robert J. Toth Jr. and Evan Giller. The authors of this article, both attorneys, would like to see a resolution of the legal uncertainty that prevents most 401(k) plan sponsors from offering an annuity option to participants. They recommend that the DOL and Treasury Department create an online “clearing house” for information about annuity products and providers and “how to use annuities in DC retirement plans.”

U.S. Corporate DB Pension Plans—Today’s Challenges.Two attorneys,Martin L. Leibowitz and Antti Ilmanen “examine why so many [defined benefit] plans have closed and/or shifted to more conservative asset/liability allocations [and] discuss the challenging balancing act for underfunded plans when making their asset class allocation, duration-matching, and contribution choices.”

Financial Illiteracy Meets Conflicted Advice: The Case of Thrift Savings Plan Rollovers, John A. Turner, Bruce W. Klein, and Norman P. Stein. This article, whose research involved mystery-shopping into the advice that participants in the ultra-low-cost federal Thrift Savings Plan receive about rolling over their money to an IRA at a higher-cost bank, fund company or broker-dealer, concludes that participants are often urged into rollovers that will result in increased annual fees, and that participants as well as advisors underestimate or disregard the impact of fees when making a rollover decision.

Addressing the Retirement Savings Crisis in the United States: The Role of Employer-Provided Financial Education, Barbara A. Smith. This economist in the Social Security Administration’s Office of Retirement Policy reviews recent research on the effectiveness of financial education at the workplace. She concludes that its effect “will be greater in workplaces with younger, less-educated workers who have fewer retirement savings options.”

Social Security Claiming Strategies for Widows and Widowers, William Reichenstein and William Meyer. “Many financial advisers are not aware… that for many clients their Full Retirement Age for retirement and spousal benefits is earlier than their FRA for retirement and spousal benefits,” write the authors, and this article goes on to show that Social Security claiming strategies for widows and widowers may vary, depending on the age of the surviving spouse.

The Retirement Preparedness of the Business Owner. Nancy Folster-Holt. America’s small business owners tend to be well off, in the aggregate, but “worlds collide,” writes this professor at the Husson University College of Business in Bangor, Maine, when a “business owner must exit a business as well as prepare for retirement.” The business can become a trap, she finds, and too many business owners “continue to answer ‘Never’ when they are asked, ‘When do you intend to retire?’”

Book Review: Retirement on the Rocks: Why Americans Can’t Get Ahead and How New Savings Policies Can Help. George A. (Sandy) Mackenzie, the editor of The Journal of Retirement, reviews Christian E. Weller’s 2016 book describing our flawed retirement system and prescribing remedies for what ails it. Weller, a professor at the University of Massachusetts–Boston and fellow at the Center for American Progress, recommends establishing a minimum Social Security benefit of 125% of the federal poverty line for workers who have contributed 30 years, auto-enrolling workers without workplace plans into state-sponsored savings plans, and limiting options in IRAs to low-cost, low-risk investments. The book, writes Mackenzie, “is an excellent review of the thesis that the U.S. does confront a retirement crisis, and its proposal deserve serious consideration.

FINRA fines MetLife $20 million for VA replacement misconduct

Posted on May 5, 2016 by Editorial Staff -

MetLife Securities, Inc. (MSI) has been fined $20 million by the Financial Industry Regulatory Authority and ordered to pay $5 million to customers for “making negligent material misrepresentations and omissions on variable annuity (VA) replacement applications for tens of thousands of customers,” a May 3 FINRA release said.

“Each misrepresentation and omission made the replacement appear more beneficial to the customer, even though the recommended VAs were typically more expensive than customers’ existing VAs,” a FINRA release said. The following statements were issued by FINRA.

MSI’s VA replacement business constituted a substantial portion of its business, generating at least $152 million in gross dealer commission for the firm over a six-year period.

In settling this matter, MSI neither admitted nor denied the charges, but consented to the entry of FINRA’s findings.

From 2009 through 2014, FINRA said, MSI “misrepresented or omitted at least one material fact relating to the costs and guarantees of customers’ existing VA contracts in 72% of the 35,500 VA replacement applications the firm approved, based on a sample of randomly selected transactions.”

For example:

MSI represented to customers that their existing VA was more expensive than the recommended VA, when in fact, the existing VA was less expensive;
MSI failed to disclose to customers that the proposed VA replacement would reduce or eliminate important features in their existing VA, such as accrued death benefits, guaranteed income benefits, and a guaranteed fixed interest account rider;
MSI understated the value of customers’ existing death benefits in disclosures mandated by Reg. 60.

Replacing one VA with another involves a comparison of the complex features of each security. Accordingly, VA replacements are subject to regulatory requirements to ensure a firm and its registered representatives compare costs and guarantees that are complete and accurate. For investors in New York, a firm also must adhere to the disclosure requirements set forth in Regulation 60 (Reg. 60).

FINRA also found that MSI failed to ensure that its registered representatives obtained and assessed accurate information concerning the recommended VA replacements, and did not adequately train its registered representatives to compare the relative costs and guarantees involved in replacing one VA with another.

MSI’s principals did not consider the relative costs and guarantees of the proposed transactions. The firm’s principals ultimately approved 99.79% of VA replacement applications submitted to them for review, even though nearly three quarters of those applications contained materially inaccurate information.

FINRA further found that MSI failed to supervise sales of the GMIB rider, the firm’s bestselling feature for its VAs. The rider was marketed to customers (many of whom were already holding MetLife annuities) as a means of providing a guaranteed future income stream.

The GMIB rider is complex and expensive—annual fees during the relevant period ranged from 1% to 1.5% of the VA’s notional income base value. A frequently cited reason for MSI’s recommendation of VA replacements was to allow a customer to purchase the GMIB rider on the new VA contract. Nevertheless, MSI failed to provide registered representatives and principals with reasonable guidance or training about the cost and features of the rider.

In addition, FINRA found that since at least 2009, firm customers have received misleading quarterly account statements that understate the total charges and fees incurred on certain VA contracts.

Typically, the quarterly account statements misrepresented that the total fees and charges were $0.00 when, in fact, the customer has paid a substantial amount in fees and charges.

AXA and BlackRock make news, separately, in the UK

Posted on May 5, 2016 by Editorial Staff -

AXA is negotiating with unnamed companies to sell its remaining life insurance and savings business in Britain, including its SunLife unit, after a strategic review, the French insurer, which has a large presence in the U.S., said in a release this week.

AXA also agreed to sell its portfolio advisory business, known as Elevate, to Standard Life for an undisclosed amount as part of an exit from the life insurance business in Britain.

In April, AXA agreed to sell its offshore investment bonds business, which is based on the Isle of Man, to Life Company Consolidation Group.

AXA’s operations in property and in casualty, health and asset management are not part of the discussions.

AXA said that it expected to receive 650 million pounds, or about $952 million, if it is able to sell its life insurance and savings units in Britain. The sale of the businesses would result in AXA’s losing 400 million euros, or about $462 million, in income.

Any deal to sell the company’s remaining life and savings businesses in Britain would be subject to regulatory approval.

By buying the portfolio advisory business, Standard Life would gain more than 160,000 customers and about £9.8 billion in assets under administration.

After that transaction, Standard Life would have 350,000 customers and £36.4 billion in assets under administration.

“This acquisition is a clear sign of our continued commitment to lead the U.K. adviser platform market,” David Tiller, the head of adviser and wealth manager propositions at Standard Life, said in a news release.

BlackRock divests DC administration

BlackRock has sold part of its UK defined contribution (DC) business to Aegon, deciding to focus on investment management over administration, IPE.com reported. No sale price was disclosed, but BlackRock said in a statement the financial impact of the deal was “not material.”

The asset manager said it agreed to sell its DC platform and administration business, which has £12bn (€15.3bn) in assets under management, to Aegon, boosting Aegon’s DC platform to £30bn.

Paul Bucksey, head of DC at BlackRock, will become managing director of the new combined workplace business, while BlackRock will remain focused on its DC investment management capabilities, where it is responsible for £65bn, according to a statement by the company.

David Blumer, head of BlackRock EMEA, said the changes to the UK pensions landscape over the past five years—such as the end of mandatory annuitization and the resulting focus on drawdown products—had led to its decision to sell part of its business.

“BlackRock believes Aegon’s broad retail product and digital capabilities will best serve the increased demand from employers for holistic retirement solutions in the future,” Blumer said. “[It is a] perfect partner to deliver on our DC platform and administration clients’ growing needs.”

Free e-book from Society of Actuaries covers diverse aspects of retirement

Posted on May 5, 2016 by Editorial Staff -

A free e-book with more than a dozen chapters on retirement risks and various aspects of income planning and public policy is now available from the Society of Actuaries.

The “Diverse Risks Essay Collection” “explores the diverse risks associated with defined contribution plan risk management strategies; decumulation strategies for retirement; and long-term care financing,” according to the SOA.

The book includes essays that won prizes from SOA:

First prize: “The ‘Feel Free’ Retirement Spending Strategy,” by R. Evan Inglis (First Prize). This essay provides a rule of thumb for decumulation with a range attached to it. The author keeps it fairly simple and provides some analysis as to why this rule is reasonable.
Second prize: “Retirement: Choosing Between Bismarck and Copernicus,” by Krzysztof Ostaszewski (Second Prize). This essay suggests an entirely different view of retirement— as in retirement is when you can’t work anymore.

Four third prize articles:

“Thinking About the Future of Retirement,” by Anna M. Rappaport. This is a “big picture” approach, focusing on retirement ages as well as a range of issues related to DC plans.
“Longevity Insurance Benefits for Social Security,” by John A. Turner. This essay on longevity insurance proposes a change to Social Security to better achieve this goal and then focuses on how that will link to decumulation.
“Designing and Communicating Retirement Plans for ‘Humans’” and “Portfolio Approach to Retirement Income Security,” both by Steve Vernon. The first paper proposes a design for a better retirement plan.

Vernon revisits behavioral finance issues and uses them to make recommendations about structuring employee (DC) benefit plans to offer good support for decumulation. The other paper presents a portfolio approach to retirement income security that is built on research sponsored by the SOA with the Stanford Longevity Center.

Data Connection