Archives: Articles

IssueM Articles

More Boomers + fewer advisors = robo-advice?

Posted on December 31, 2015 by Editorial Staff -

With financial advisors retiring as fast as Boomers, it’s little wonder that robo-advisors and related “digital advisory solutions” have sprung up to fill the growing gap between the supply of retirement planning advice and the potential demand for it.

This trend apparently has been underway for some time. The number of U.S. financial advisers fell for the fifth straight year as the industry suffers a continuing wave of retiring veteran advisers, according to a report this week by the Boston-based research group Cerulli Associates.

There were roughly 285,000 financial advisers in 2014, a 1.9% drop from 2013, according to Cerulli. The industry has lost more than 39,000 advisers, roughly 12%, since peaking at 325,000 advisors in 2008.

The decrease held steady from 2013, when adviser headcount also fell by 1.9%, but researchers say attrition through retirement will continue to shrink the industry. Nearly half of all financial advisers are over the age of 55. Over the next decade, Cerulli expects nearly 100,000 more brokers to retire.

Cerulli’s data comes from surveys of 7,000 advisers across banks, brokerages, insurers and other investment firms. The research firm has tracked adviser population figures since 1992.

Only two types of advisors—registered investment advisors (RIAs) and “hybrid advisers”—saw their sales force increase in recent years. RIAs are independent wealth managers who collect fees as a percentage of client assets. Hybrid or dually-licensed advisors collect fees on a client’s assets as well as commissions on securities trades. Cerulli Associates’ Kenton Shirk said he expects the numbers of RIAs and hybrid advisors to continue growing over the next five years.

‘The Big Short’ Is No Tall Tale

Posted on December 30, 2015 by Kerry Pechter -

“The Big Short,” the just-released film based on Michael Lewis’ nonfiction bestseller about the 2007-2008 mortgage bond meltdown, doesn’t blame the financial crisis on Fannie Mae or Freddie Mac. Or Bill Clinton or on the community activists at ACORN, as several histories of the Great Recession do.

This reality-based drama instead blames the crisis mainly on stupidity, herd-mentality and moral hazard among Wall Street bankers and traders. Neither the book or the movie has a hero, only winners—the raffish hedge fund types who got nine-figure rich by convincing complacent bankers to take the other side of a very large bet against mortgage-backed securities.

To the extent that the movie divines the ultimate source of the global financial crisis, its Patient Zero is Lewis S. Ranieri. If you have a long memory, you may recall that Ranieri was the legendary Salomon Brothers bond trader who invented mortgage securitization during the topsy-turvy 1980s. He played a big role in Lewis’ first book, Liar’s Poker.

But what of Fannie Mae and Freddie Mac, the government-sponsored entities (GSEs) whose purchases of subprime mortgages were central to the crisis? A lot of smart people believe that overzealous government lending policy, mediated by the GSEs, caused the crisis. In Fragile by Design, for instance, their excellent 2014 book on the crisis, Charles Calomiris of Columbia and Stephen Haber of Stanford pin the tail on a “political bargain” between the big banks and the Association of Community Organizations for Reform Now, or ACORN.

Their version of the crisis, which has wide currency, goes like this: In the 1990s, big banks wanted to merge. ACORN’s activists, armed with the 1977 Community Redevelopment Act (CRA), threatened to torpedo the mergers unless the banks channeled $850 billion in credit through community organizations and committed an “additional $3.6 trillion in CRA lending to underserved areas or low-income communities” between 1992 and 2007.

The activists then pressured Congress to mandate Fannie and Freddie to buy the sub-prime loans made to credit-unworthy individuals or in depressed communities. The GSEs bundled up the loans, divided the bundles by seniority, and marketed the tranches with the highest seniority to global institutions at triple-A prices. Soon the big banks got involved, and their demand for sub-prime loans took on a momentum of its own. Mortgage bond fever became the 21st century version of tulipmania.

An equally persuasive book, Black Box Casino, by Robert S. England, supports this version of the story. England traces the crisis to 1992 legislation, known as the “GSE Act,” which gave Fannie Mae and Freddie Mac too much autonomy and lending power with too little oversight. In England’s telling, the nitro and the glycerin that produced the crisis were first combined at Fannie and Freddie when Congress mandated them to commit most of their lending to poor people while setting their capital requirement for MBS at a mere 0.45% (a 222 to one leverage ratio) and insuring their liabilities.

“Congress basically created the framework for what would become the world’s two largest hedge funds,” England wrote.

It is this version of the story that “The Big Short” rejects, largely by ignoring it. Instead, Lewis paints a scenario where a trifecta of fraud, ignorance and stupidity in the financial industry pumped an otherwise garden-variety housing boom into an epic catastrophe. (Though slightly didactic, the movie does a particularly good job of dramatizing the anxieties of dealmakers, including the ironic moment when the Big Shorters realized that a successful bet on the end of the financial system might never pay off.)

Having read The Big Short, and lots of other books and scholarly articles that support its version of the crisis, I find its anti-banker version of the crisis more credible than the anti-government version. The idea that community activists had the power, even with allies in the government, to blackmail huge banks seems preposterous. It contradicts much of what I’ve seen first hand.

For instance, in my own community during the 2000s, I saw cornfield after cornfield replaced by the printed circuits of tract mansions. In my own mailbox, I received an endless series of glossy, four-color junk mail solicitations for pre-approved six-figure loans with no money down and three-figure monthly payments. Clearly, something rotten was afoot.

If the government were in fact forcing money into poor neighborhoods, I would expect to have seen low-income housing projects blossom, and observed homeowners replace renters in poor and middle-class neighborhoods. But the opposite occurred. We saw the construction of thousands of McMansions on rural land and a rise in renter-occupied houses in middle-class urban neighborhoods.

Indeed, in the small city where I used to live, real estate brokers were buying up rowhouses and renting them to poor people. (My once 100% owner-occupied rowhouse neighborhood deteriorated in this way.) We eventually moved to the country. In my new neighborhood, one large home has stood empty for five years because the doctor-nurse couple who owned it, along with two other homes, defaulted on their loan).

Government policies or rules may well have provided conditions necessary for the crisis to germinate, but they were not sufficient. Common sense dictates that the crisis also required the massive exploitation of the loopholes by those who had the most to gain from exploiting them. That would be the mortgage brokers and asset securitizers.

Tellingly, Calomiris and Haber reveal in Fragile by Design how the original low-income housing program morphed into a McMansion program. Once Fannie Mae and Freddie Mac enabled the lowering of mortgage underwriting standards, those lower standards “applied to everyone,” they wrote.

Thus, by 2006, “46% of first-time home buyers put down no money at all, and the median first-time buyer put down only 2% of the purchase price… The result [of such “inconceivably lax” rules] was the rapid growth of mortgages with high probabilities of default.” Had lending been confined to the poor, we wouldn’t have had nearly as big a boom—or as big a bust.

Vanguard keeps dominating fund flows

Posted on December 30, 2015 by Editorial Staff -

Is it the ultra-low expense ratios? The Internet-friendly direct sales model? The focus on passive investing? The lack of conflicts of interest in its inimitable ownership structure, which sprang from Jack Bogle’s head 40 years ago?

No one knows for sure.

But statistic-junkies know this: Through the end of November, Vanguard mutual funds received more net inflows than the next nine mutual fund companies combined. According to Cerulli Associates, the source for all data here, Vanguard is also the top retail mutual fund manager, with $2.33 trillion under management and a 20% industry market share.

Funds sponsored by the Malvern, PA-based fund company received $139.3 billion in the first 11 months of 2015 and $7.87 billion in November. The next nine companies received about $118.7 billion in the first 11 months and about $6.7 billion in November.

Four of the top five funds in flows in November were Vanguard funds: the Total International Stock Index Fund, the Total Bond Market II Index Fund, the Total International Bond Fund Index and the Total Stock Market Index Fund. The remaining top-five fund (in third position) in November was the PIMCO Income Fund.

Vanguard’s strength, as reflected by Cerulli’s data, is clearly in its market-wide index funds, that form the core of many investment strategies, to which more specialized “satellite” funds are typically added for diversification. (The underlying funds in the asset allocations of the leading robo-advisor, Betterment, are Vanguard index funds.)

Thanks to several big equity index funds, Vanguard is the top equity fund advisor, with assets of $1.26 trillion. Its Total Stock Market Index Fund had the most flows in November, with $1.02 billion, and it had five of the top six funds in terms of net inflows YTD: the 500 Index fund, Total Stock Market Index fund, Mid-Cap Index fund, Institutional Index fund and Small-Cap Index fund.

As of the end of November, Vanguard was also the top manager of taxable bonds ($518.3 billion, 19.5% market share) and tax-exempt municipal bonds ($122.2 billion, 21% market share). In the taxable category, its Total Bond Market II fund had the highest flows in November ($1.29 billion) and its Total International Bond Index fund has the highest flows YTD ($19.3 billion). In the tax-exempt category, its Intermediate-Term Tax-Exempt bond fund had the highest flows in November ($435.7 million) and YTD ($3.81 billion).

RIJ’s 20 Top Events for 2016

Posted on December 30, 2015 by Kerry Pechter -

AICPA Advanced Personal Financial Planning Conference, January 18-20, 2016, Bellagio, Las Vegas, NV.

T3 (Technology Tools for Today) Advisor Conference, February 10-12, 2016, Marriott Harbor Beach Resort, Fort Lauderdale, FL

Morningstar Institutional Conference, March 3-4, 2016, JW Marriott Desert Ridge Resort and Spa, Phoenix, AZ.

Society of Actuaries, 2016 Investment Symposium, March 14-15, 2016. New York Marriott Downtown.

NAPA 401(k) Summit, April 17-19, 2016, Music City Center, Nashville, TN.

IMCA Investment Consultants Conference, February 1-2, 2016 Sheraton New York Times Square Hotel, New York

IRI Marketing Summit, March 20-22, 2016, PGA National Resort and Spa, Palm Beach Gardens, FL

IMCA 2016 Annual Conference Experience, April 17-20, 2016, Hyatt Regency Orlando, Orlando, FL

Money Market Institute, 2016 Annual Convention, April 20-21, 2016, Marriott Marquis, Washington, DC.

FPA Retreat 2016, April 25-28, 2016, The Wigwam, Phoenix, AZ.

SOA/LOMA LIMRA Secure Retirement Institute Retirement Industry Conference, May 4-6, 2016, The Westin Copley Place, Boston, MA.

69th CFA Institute Annual Conference, May 8-11, Palais des Congres de Montreal, Montreal, Quebec, Canada.

SOA Life & Annuity Symposium, May 16-17, 2016, Nashville, TN.

NAPFA Spring Conference, May 17 – 20, 2016, Sheraton Phoenix Downtown, Phoenix, AZ.

Boulder Summer Conference on Financial Decision Making, May 22-24, 2016, St. Julien Hotel, Boulder, CO.

NAIFA Congressional Conference, May 24-25, 2016, Washington, D.C.

Morningstar Investment Conference, June 13-15, 2016, McCormick Place, Chicago, IL.

Vision: IRI Annual Meeting 2016, September 25-27, 2016, Broadmoor, Colorado Springs, CO

Money Market Institute 2016 Fall Solutions Conference, October 18-19, 2016, The Westin Copley Place, Boston, MA.

NAPFA Fall National Conference, October 11 – 14, 2016, Hyatt Regency Crystal City, Arlington, VA.

Here come the new Boomers (sans Beatles)

Posted on December 30, 2015 by Editorial Staff -

Here’s a look at six of the strongest financial trends among Millennials and a preview of what to expect from Millennials in 2016, courtesy of Northwestern Mutual:

There will be an influx of Millennials in the workforce. According to the Bureau of Labor Statistics, in 2016 Millennials will represent the largest generational segment. They will have more disposable income as they reach management positions.

Millennials are socially conscious investors. Socially-conscious funds play to Millennials’ inclination to “give back.” In 2001, investment in these models totalled $3.1 trillion; by 2014 this had jumped to $6.6 trillion.

Weddings will become even more expensive. In 2014, the average price of a wedding rose to $31,213, a 4% increase from 2013, according to The Knot’s annual survey. Many couples already choose to wed later due to student loan debt and unstable financial situations.

The average student loan debt will continue to increase. As of 2015, U.S. students carry $1.2 trillion in debt. In 2014, average loan debt was $28,950, up 2% from 2013, among 70% of students who graduated. Student-loan debt helps explain the number of Millennials living at home and the tendency among young adults to delay home-buying. TheMintGrad.org, Northwestern Mutual’s online resource for Millennials, offers tools to help pay down student debt

Millennials will skip the gym, but not the exercise. Wellness remains a top priority among Millennials, with 88% saying they exercise. But a Mintel survey shows that 72% of Millennials say gym memberships are too expensive. So they have been cutting their gym expenses and instead paying for community exercise programs, fitness apps, classes and other nontraditional workouts.

Millennials travel, but spend less per trip. Millennials are willing to make sacrifices, like forgoing hotel stays for hostels, to cut down travel expenses. According to a Yahoo! Travel Survey, 68% of Millennials are more likely to spend less than $1,000 per trip versus 33% of the population surveyed who said they would spend $1,000 to $4,999 on a vacation.

“Millennials tend to follow their hearts,” says Emily Holbrook, director of the young personal market at Northwestern Mutual. “Their financial decisions are reflective of their personal values, beliefs and lifestyles.”

Stick to a Plan? Few Retirees Do: Hearts & Wallets

Posted on December 30, 2015 by Editorial Staff -

Advisors preach “safe withdrawal rates” to their retired clients, but many retirees ignore strict financial guidelines and spend erratically. And it’s not uncommon for retirees to designate the same pot of money for legacies and longevity insurance—a practice that keeps their would-be heirs in suspense.

These insights and many more are revealed in two new studies by the research firm Hearts & Wallets. The studies are Funding Life After Work: Impact of Parenthood & Wealth Transfer on Retirement Solutions for Baby Boomers and Portrait of U.S. Household Wealth.

Funding Life After Work explores a variety of Boomers’ attitudes about money that might interest advisors, including:

Sources of income in retirement
Decisions about whether to tap into capital
Sources of advice
Robo-advisors
Most important financial needs

The study found, for instance, that many retirees practice a “chunk or nothing” spending pattern, consuming from 0% to 9% or more of principal annually rather than drawing down savings at sustainable rates. This behavior is thought to spring from a conflict between shame about spending capital and a desire to do so, or to occur among parents who worked longer than non-parents to provide for their children’s education.

Parent traps

The Portrait of U.S. Household Wealth study focuses on 5.2 million households ages 53–70 with $500K to $5 million in investable assets who control about $10 trillion of the estimated $21 trillion in total Boomer savings.

Hearts & Wallets surveyed three consumer groups that make up 82% of these households and control 84% of the assets. The groups are “Non-Parents” (1.8 million households with no children who have about $3.5 trillion), “Parents Spend All” (1.0 million households headed by parents who plan to spend all their assets in retirement and have about $1.7 trillion), and “Parents Leave Inheritance” (1.5 million households headed parents who plan to leave a legacy and have about $3.1 trillion.

“Parents who plan to leave a legacy aren’t necessarily more generous than those who plan to spend it all,” Laura Varas, Hearts & Wallets co-founder and principal, said in a press release. They like to say that they’re putting money aside for their children, but simultaneously they see that money as a potential emergency fund for themselves, if they need it.

Consciously or unconsciously, this form of double-think serves a purpose. “To them, leaving an inheritance is the ultimate insurance policy,” Varas said. “They may plan to leave only a couple of $100,000 or so, but having that goal reins in their spending and guides their retirement funding decisions.” It also has a downside, she added: “They could afford to be a little less frugal and risk averse if they had sources of advice or solutions that acknowledged this fear.”

The “Parents Leave Inheritance” is primarily concerned with how much money they have and the location of important documents and paperwork, the studies found. The “Parents Spend All” group expresses equal concern for their children, but worries that a pre-determined inheritance might make children irresponsible. Retirees without children have a different problem altogether: they tend to worry about not having anyone to help them when they become frail.

“Non-parents more often say they are unsure who will help them when they become infirm. It’s not so much about the money, but about having a trusted caretaker to take them to the doctor and help with bill-paying. Parents often see children in these roles,” Varas said.

Income, advice and needs

All segments express frustration with the low-interest rate environment that forces them to take more financial risk than they would like to. Even if they own annuities, they may be unsure about when to take annuity income or how annuities affect their Required Minimum Distributions (RMDs).

In other findings: Boomers look to advisors, accountants or estate planners for answers. Finding the right professional is challenging for them, especially given their perception that advice will be “free.” Good advisors continue to encounter the mistrust generated by advisors who didn’t meet clients’ expectations. Few older investors even know about “robos.”

In terms of financial services, the survey participants wanted help with investment selection, optimizing income and minimizing taxes, charitable giving and estate planning, and long-term care expenses. The “Parents Spend All”and “Non-Parents”groups were equally interested in income and tax optimization solutions, because of their low wealth transfer needs and willingness to spend principal. A clear majority of those surveyed said they are willing to pay someone to tell them how much they can afford to spend and to advise them on tax-smart charitable giving and estate planning.

American Financial sells LTCI book to focus on FIAs

Posted on December 30, 2015 by Editorial Staff -

American Financial Group, Inc., has completed its sale of United Teacher Associates Insurance Company and Continental General Insurance Company, which contain almost all of its run-off long-term care insurance business, to HC2 Holdings, Inc.

The deal “allows us to provide continued focus on our [fixed and fixed-indexed] annuity business,” said Craig Lindner, AFG’s co-CEO. “The sale is expected to create between $110 and $115 million of excess capital for AFG by mid-2016 (due to the timing of tax benefits to be received), in addition to the $700 million of excess capital reported at September 30, 2015.”

HC2 paid approximately $15 million in proceeds. AFG may also receive up to $13 million of additional proceeds from HC2 based on the release of certain statutory reserves of the legal entities sold by AFG.

To obtain regulatory approval for the transaction, AFG agreed to provide up to $35 million of capital support for the insurance companies, on an as-needed basis to maintain specified surplus levels, subject to immediate reimbursement by HC2; this agreement expires five years after closing. In exchange for this agreement, AFG received warrants to purchase two million shares of HC2 common stock.

In the first quarter of 2015, AFG recorded an after-tax non-core loss of $105 million in connection with this transaction; an additional after-tax non-core loss of up to $10 million may be recorded after closing, reflecting updated valuations of expected proceeds to be received and net assets disposed.

Due to a significant tax benefit from the sale, AFG expects to receive total after-tax proceeds of $110 to $115 million from the transaction (including the tax benefit but before any potential future proceeds).

With the completion of this sale, AFG will retain only a small block of 1,700 polices totaling approximately $33 million of reserves.

Philip Falcone, HC2’s chairman, president and CEO, said in a release, “We believe this acquisition provides a strong base on which to grow our insurance vertical and also offers further diversification for HC2.”

Schlichter law firm sues Insperity over high plan fees

Posted on December 24, 2015 by Editorial Staff -

Retirement assets dip to $23.5 trillion in 3Q2015: ICI

Posted on December 24, 2015 by Editorial Staff -

Total U.S. retirement assets were $23.5 trillion as of September 30, 2015, down 4.3% from the end of June, according to just-released data from the Investment Company Institute.

The new estimate of $24.5 trillion for June reflects a slight downward revision based on new information. Retirement assets accounted for 34% of all household financial assets in the United States at the end of the third quarter of 2015.

Assets in individual retirement accounts (IRAs) totaled $7.3 trillion at the end of the third quarter of 2015, a decrease of 4.8% from the end of the second quarter. Defined contribution (DC) plan assets fell 4.1% in the third quarter to $6.5 trillion. Government defined benefit (DB) plans—including federal, state, and local government plans—held $5.0 trillion in assets as of the end of September, a 3.9% decrease from the end of June. Private sector DB plans held $2.8 trillion in assets at the end of the third quarter of 2015, and annuity reserves outside of retirement accounts accounted for another $1.9 trillion.

Defined contribution plans

Americans held $6.5 trillion in all employer-based DC retirement plans on September 30, 2015, of which $4.5 trillion was held in 401(k) plans. In addition to 401(k) plans, at the end of the third quarter $504 billion was held in other private-sector DC plans, $842 billion in 403(b) plans, $255 billion in 457 plans, and $426 billion in the Federal Employees Retirement System’s Thrift Savings Plan (TSP). Mutual funds managed $3.5 trillion, or 54%, of assets held in DC plans at the end of September.

Individual Retirement Accounts (IRAs)

IRAs held $7.3 trillion in assets at the end of the third quarter of 2015, down 4.8% from the end of the second quarter of 2015. Forty-seven percent of IRA assets, or $3.4 trillion, was invested in mutual funds.

Technical notes

The Investment Company Institute’s total retirement market estimates reflect revisions to previously published data. Revisions to the Financial Accounts of the United States, published by the Federal Reserve Board, resulted in a substantial downward revision to assets of annuities held outside of retirement plans for the past 10 to 15 years, with smaller revisions going back to 1992; and minor, mostly upward, revisions to estimates of 403(b) plan and IRA assets at life insurance companies from 2007 through 2015:Q2.

In addition, newly released U.S. Department of Labor (DOL) Form 5500 data for 2013 were incorporated, resulting in slight downward revisions to DC plan assets (both the “401(k) plans” and the “other private-sector DC plans” categories) and private-sector DB plan assets beginning in the first quarter of 2013.

The reported assets of federal pension plans for the first, second, and third quarters of 2015 are adjusted for U.S. Treasury financing activities undertaken in anticipation of hitting the legal limit on federal government borrowing. These actions have reduced the amount of Treasury securities reported on the balance sheet of federal government DB plans, an effect that we anticipate will be fully reversed in the fourth quarter of 2015.

The Perils of Fed Gradualism

Posted on December 23, 2015 by Stephen S. Roach -

By now, it’s an all-too-familiar drill. After an extended period of extraordinary monetary accommodation, the US Federal Reserve has begun the long march back to normalization. It has now taken the first step toward returning its benchmark policy interest rate—the federal funds rate—to a level that imparts neither stimulus nor restraint to the US economy.

A majority of financial market participants applaud this strategy. In fact, it is a dangerous mistake. The Fed is borrowing a page from the script of its last normalization campaign—the incremental rate hikes of 2004-2006 that followed the extraordinary accommodation of 2001-2003.

Just as that earlier gradualism set the stage for a devastating financial crisis and a horrific recession in 2008-2009, there is mounting risk of yet another accident on what promises to be an even longer road to normalization.

The problem arises because the Fed, like other major central banks, has now become a creature of financial markets rather than a steward of the real economy. This transformation has been under way since the late 1980s, when monetary discipline broke the back of inflation and the Fed was faced with new challenges.

The challenges of the post-inflation era came to a head during Alan Greenspan’s 18-and-a-half-year tenure as Fed Chair. The stock-market crash of October 19, 1987—occurring only 69 days after Greenspan had been sworn in—provided a hint of what was to come. In response to a one-day 23% plunge in US equity prices, the Fed moved aggressively to support the brokerage system and purchase government securities.

In retrospect, this was the template for what became known as the “Greenspan put”—massive Fed liquidity injections aimed at stemming financial-market disruptions in the aftermath of a crisis. As the markets were battered repeatedly in the years to follow—from the savings-and-loan crisis (late 1980s) and the Gulf War (1990-1991) to the Asian Financial Crisis (1997-1998) and terrorist attacks (September 11, 2001)—the Greenspan put became an essential element of the Fed’s market-driven tactics.

This approach took on added significance in the late 1990s, when Greenspan became enamored of the so-called wealth effects that could be extracted from surging equity markets. In an era of weak income generation and seemingly chronic current-account deficits, there was pressure to uncover new sources of economic growth.

But when the sharp run-up in equity prices turned into a bubble that subsequently burst with a vengeance in 2000, the Fed moved aggressively to avoid a Japan-like outcome—a prolonged period of asset deflation that might trigger a lasting balance-sheet recession.

At that point, the die was cast. No longer was the Fed responding just to idiosyncratic crises and the market disruptions they spawned. It had also given asset markets a role as an important source of economic growth. The asset-dependent economy quickly assumed a position of commensurate prominence in framing the monetary-policy debate.

The Fed had, in effect, become beholden to the monster it had created. The corollary was that it had also become steadfast in protecting the financial-market-based underpinnings of the US economy.

Largely for that reason, and fearful of “Japan Syndrome” in the aftermath of the collapse of the US equity bubble, the Fed remained overly accommodative during the 2003-2006 period. The federal funds rate was held at a 46-year low of 1% through June 2004, before being raised 17 times in small increments of 25 basis points per move over the two-year period from mid-2004 to mid-2006. Yet it was precisely during this period of gradual normalization and prolonged accommodation that unbridled risk-taking sowed the seeds of the Great Crisis that was soon to come.

Over time, the Fed’s dilemma has become increasingly intractable. The crisis and recession of 2008-2009 was far worse than its predecessors, and the aftershocks were far more wrenching. Yet, because the US central bank had repeatedly upped the ante in providing support to the Asset Economy, taking its policy rate to zero, it had run out of traditional ammunition.

And so the Fed, under Ben Bernanke’s leadership, turned to the liquidity injections of quantitative easing, making it even more of a creature of financial markets. With the interest-rate transmission mechanism of monetary policy no longer operative at the zero bound, asset markets became more essential than ever in supporting the economy. Exceptionally low inflation was the icing on the cake—providing the inflation-targeting Fed with plenty of leeway to experiment with unconventional policies while avoiding adverse interest-rate consequences in the inflation-sensitive bond market.

Today’s Fed inherits the deeply entrenched moral hazard of the Asset Economy. In carefully crafted, highly conditional language, it is signaling much greater gradualism relative to its normalization strategy of a decade ago. The debate in the markets is whether there will be two or three rate hikes of 25 basis points per year—suggesting that it could take as long as four years to return the federal funds rate to a 3% norm.

But, as the experience of 2004-2007 revealed, the excess liquidity spawned by gradual normalization leaves financial markets predisposed to excesses and accidents. With prospects for a much longer normalization, those risks are all the more worrisome. Early warning signs of troubles in high-yield markets, emerging-market debt, and eurozone interest-rate derivatives markets are particularly worrisome in this regard.

The longer the Fed remains trapped in this mindset, the tougher its dilemma becomes—and the greater the systemic risks in financial markets and the asset-dependent US economy. It will take a fiercely independent central bank to wean the real economy from the markets. A Fed caught up in the political economy of the growth debate is incapable of performing that function.

Only by shortening the normalization timeline can the Fed hope to reduce the build-up of systemic risks. The sooner the Fed takes on the markets, the less likely the markets will be to take on the economy. Yes, a steeper normalization path would produce an outcry. But that would be far preferable to another devastating crisis.

Stephen S. Roach, a former chairman of Morgan Stanley Asia and the firm’s chief economist, is the author of Unbalanced: The Codependency of America and China (Yale University Press, 2014).

Damage Assessment: Who’s Hurt by New Fiduciary Rule?

Posted on December 23, 2015 by Kerry Pechter -

The perennial wave of rollovers from 401(k)s to IRAs won’t be thwarted by the Department of Labor’s soon-to-be-issued “conflict of interest rule,” but the rule could foil some of the existing synergies in the IRA business, according to the latest issue of the Cerulli Edge, Retirement edition.

In the report, analysts at Cerulli Associates, a global consulting firm, said that they believe the proposed rule, which would extend the DOL’s jurisdiction over retirement plans to include retail rollover IRA accounts, will “be implemented with only minor revisions in spring 2016.”

And even though the DOL has made clear that it would rather see less money migrating from relatively low-cost, closely regulated 401(k) plans to potentially higher-cost retail IRA accounts, Cerulli doesn’t think that’s likely. The firm expects the rollover tsunami to keep rising. By 2020, it estimates the annual volume of rollovers will reach $517 billion.

“Tsunami” in this case is justified hyperbole. As more Boomers reach retirement age or leave their employers, more of them roll their employer-sponsored plan accounts to IRAs. Rollover IRA assets, now at about $7.3 trillion, exceed the assets in defined contribution plans.

Cerulli cited two reasons why the rollover wave will continue unabated: First, the big broker-dealers whose advisors have largely switched to a fee-based, fiduciary compensation model already, so their most important advisor-client relationships won’t necessarily change.

Second, most 401(k)s aren’t set up for flexible distributions, so retirees are virtually forced to roll assets over to IRAs. “Just 21% of large plan sponsors report having adopted an in- plan guaranteed income product,” Cerulli reported. “Only 10% of plans allow participants to take ad hocpartial distributions.”

Uneven impact

The DOL proposal will hurt some financial industry players, leave some more or less alone, and have a mixed effect on others, according to Cerulli. It’s difficult to isolate the likeliest points of pain, however. That’s because advisors often wear multiple hats (insurance and investments), broker-dealers have mixed business models (commissions and asset-based fees), and properly licensed and certified intermediaries can act as planners at one moment, brokers at another and insurance agents at another. Here’s how Cerulli expects the new “playing field” to unfold:

Insurer-owned broker-dealers: They could get hurt the most, Cerulli says. Their business model—where advisors often sell proprietary products like variable annuities on commission—is inherently conflicted. Insurer-owned B/Ds faced problems even before the DOL’s campaign to reform the IRA rollover industry began.

Firms with existing client relationships: Plan participants tend to stick with the provider they know. Depending on the size of the plan, that provider might be a registered rep, an insurance agent, a recordkeeper, or a full-service provider like Fidelity or Vanguard. It’s no coincidence that Fidelity, the largest plan provider, is also the largest IRA provider, with 14.7% ($1.1 trillion) of the IRA market. (Fidelity’s “Bring Us Your Old 401(k)s” ads seem to be everywhere.)

Wirehouses: As registered investment advisors, most wealth managers at wirehouses (Merrill Lynch, Morgan Stanley, UBS, Wells Fargo) are already fiduciaries, so they already comply with the DOL’s anticipated new rule. Also, their high net worth clients (>$250k in investable assets) tend not to purchase commissioned products, which DOL believes are inherently conflicted. “Cerulli believes that large-balance investors and rollovers will be the least impacted by the new rules because these investors will value holistic advice on their entire portfolio,” the report said.

Advisors at broker-dealers affiliated with investment banks that underwrite securities: “To be a fiduciary, these B/Ds must ensure that investors receive best execution or the most favorable price on any securities they purchase. It should be noted that this largely applies to buying individual equities or bonds,” the Cerulli bulletin said. In other words, investment banks might have difficulty pressuring their broker-dealers to push their issues.

Advisors or broker-dealers that receive revenue-sharing payments from companies that provide products on their shelves: “A key source of revenue for many B/Ds is revenue sharing from product manufacturers, which is another potential conflict of interest, albeit for the B/D rather than the advisor. Seeking client acknowledgment of revenue sharing may be yet another pain point for advisors,” according to Cerulli.

Recordkeepers: “Many recordkeepers provide IRA education while participants still have assets within defined contribution plans to help facilitate rollovers,” Cerulli’s report said. “While investors may be getting the consultation they seek in these scenarios, the proposed Department of Labor Conflict of Interest Rule has the potential to change this dynamic with more stringent regulation of the IRA rollover process.” The DOL has said publicly, however, that generic rollover information by recordkeeper call center operators won’t be considered to be advice under the forthcoming rule.

Editor’s note: In the discussion over the details of the conflict-of-interest proposal and its disruptiveness for broker-dealers, the context of the rule is often lost or obscured. For instance, it’s been said, somewhat opaquely, that the DOL wants to “expand the definition of fiduciary.” Essentially, the DOL wants to change an antiquated definition of fiduciary status that allows some broker-dealer reps to be refs and players at the same time—that is, to serve as trusted, objective advisors to retirement plans and also use the plans as sources of retail rollover prospects.

The DOL hopes to end this game, especially when a client’s costs go up as a result. The ultimate goal is to reduce the costs that retirement investors pay. The DOL focus on costs rankles the retail financial industry because it appears to imply that their services add no value. Retirement industry leaders have also claimed that, as a practical matter, brokers will sell far fewer 401(k) plans to small businesses if there’s no potential for them to secure future retail business.

Some broker-dealers believe that the DOL rule will chill the sale of all commissioned products, including income annuities and the hot-selling fixed indexed annuities. If that happens, they have argued, the DOL initiative will backfire by eliminating services for middle-income clients (who are the primary purchasers of commissioned products) and reducing the availability of guaranteed income products.

The industry resents the “one size fits all” solution to conflicts-of-interest in the IRA world that the DOL appears eager to impose. Rather than make surgical changes to its rules, the DOL chose to use a blanket approach and require advisors who want to make inherently conflicted transactions—sell on commission, accept revenue sharing, or sell proprietary securities—to sign a legally-binding Best Interest Contract (BIC) and promise to act in the sole interest of the client. Many in the rollover industry have found the BIC requirement to be, in their words, “unworkable.” But the IRA business is so varied and complex that anything other than a principles-based solution may have been impractical.

The DOL proposal does make at least one surgical change to the regulations. It distinguishes variable annuities from fixed annuities, making sellers of VAs on commission subject to the BIC pledge requirement while allowing fixed annuities to continue to be sold under an existing indulgence (i.e., “exemption from prohibited transaction”). As a result, selling VAs may be more difficult going forward. But it may not matter much: VA sales are shrinking anyway.

Fed hike will have “no immediate impact” on insurers: A.M. Best

Posted on December 23, 2015 by Editorial Staff -

In a new briefing, entitled “Insurers Hope Fed Move a Sign of Things to Come,” the rating agency A.M. Best said, “The Federal Reserve’s first interest rate increase in nearly a decade does not symbolize a ‘lift off’ scenario for interest rates. Subsequent moves by the Fed will involve an uncertain and measured approach with multi-year rate increases following what had been an unprecedented monetary easing.”

The briefing said:

“A.M. Best sees no immediate impact to its view of the U.S. property/casualty, life or health insurance industries, or any individual rating units as a result of the 0.25% increase in the Federal Funds Rate. While the overall industry has been juggling falling portfolio yields and limited reinvestment opportunities, life/annuity companies in particular have also been facing spread compression. In the short-term, the Fed’s rate hike will primarily impact the shorter end of the interest rate term structure, which doesn’t impact insurers with predominantly longer-term bond holdings. This initial move also doesn’t ease the pain for older spread-based products with higher guaranteed crediting rates.

“Although investment portfolio yields would eventually benefit from any increasing interest rate scenario, A.M. Best is more watchful of the increased credit risk accumulating for the industry from its effort to attain higher investment returns.

“Overall, however, a continued measured rise in rates is a net positive for the life/annuity industry as product spreads improve, investment portfolio yields increase, and other side benefits accrue to the industry, such as having a positive impact for those carriers with underfunded pension plans.”

In a second briefing, entitled “Rating Outlook Remains Stable For U.S. Life/Annuity Industry But Challenges Persist,“ said A.M. Best “is maintaining its stable outlook on the U.S. life/annuity industry for 2016, supported by the benign credit and interest rate environments and in the face of various challenges, in particular, the overall economic climate and its potential impact on interest rates, and, to a lesser extent, credit risk.”

“The life/annuity industry has seen absolute and risk-based levels of capitalization improve. In addition, asset impairments remain low and operating performance is up modestly as compared with 2014,” the briefing said.

But the assessment was mixed. “Slow premium growth for life products, driven in part by the industry’s inability to effectively access the middle market, remains an industry-wide dilemma, and when coupled with low interest rates, leads to moderate revenue and operating earnings,” A.M Best said.

“A shift to a negative outlook could result from an overall negative transition in the U.S. economy, which, for example, could drive a sudden spike in interest rates. In addition, a material increase in credit risk resulting in investment impairments would also potentially drive an unfavorable change in outlook.”

Seniors’ home equity reaches $5.76 trillion

Posted on December 23, 2015 by Editorial Staff -

An estimated $147 billion increase in the aggregate value of homes owned by seniors drove their share of home equity to $5.76 trillion, according to the National Reverse Mortgage Lenders Association.

The new figures boosted the NRMLA/RiskSpan Reverse Mortgage Market Index (RMMI) to a record in Q3 2015 of 200.19, from 195.42 in Q2, even though mortgage debt held by seniors increased slightly, to $1.46 trillion from $1.45 trillion during that period.

The Q3 numbers are based on data from the 2013 American Community Survey and the Federal Reserve’s Z.1 Release to estimate the value of aggregate senior home equity underlying the RMMI.

“The recalibrated index uncovered something we didn’t expect to see, which was that senior housing values outperformed the general population. In metro areas hard hit by the Great Recession, for example, senior home values were more resilient to declines. It’s great news for seniors who are considering tapping their housing wealth to support their retirement planning,” said NRMLA President and CEO Peter Bell in a release.

New ERISA Advisory Council members appointed

Posted on December 23, 2015 by Editorial Staff -

U.S. Secretary of Labor Thomas E. Perez has appointed five new members to the 2016 Advisory Council on Employee Welfare and Pension Benefit Plans, known as the ERISA Advisory Council. Perez also appointed current member Mark E. Schmidtke as incoming council chair and Jennifer Kamp Tretheway as the incoming council’s vice chair.

Schmidtke is a shareholder with the law firm Ogletree, Deakins, Nash, Smoak & Stewart, P.C. in Valparaiso, Indiana. Tretheway retired recently as a trust company executive with Northern Trust.

The 15-member council provides advice on policies and regulations affecting employee benefit plans governed by the Employee Retirement Income Security Act of 1974.

The newly appointed members and the constituencies they represent are:

Beth A. Almeida, representing the general public, is principal researcher with the Center on Aging at the American Institutes for Research, where she writes on employee benefits, transitions to retirement, and long-term care.

Patricia M. Haverland, representing employers, is vice president, Pension Fund Management for Siemens’ North American operations.

Tazewell V. Hurst III, representing employee organizations, is a senior research economist with the International Association of Machinists & Aerospace Workers.

Cynthia J. Levering, representing actuarial counseling retired from Aon Consulting as a senior vice president and consulting actuary in 2009.

Stacy R. Scapino, representing investment counseling, is a partner and global leader for Mercer Investments’ Multinational Corporate Consulting activities.

By law, council members serve for staggered three-year terms. Three members are representatives of employee organizations (at least one of whom represents participants in a multiemployer plan). Three members are representatives of employers (at least one of whom represents employers maintaining or contributing to multiemployer plans). Three members are representatives of the general public. There is one representative each from the fields of insurance, corporate trust, actuarial counseling, investment counseling, investment management and accounting.

Bob Pozen Knows Retirement

Posted on December 22, 2015 by Kerry Pechter -

Few people in the financial services industry have been as productive and influential in so many ways as Bob C. Pozen. The 69-year-old Harvard-and-Yale-educated lawyer has served as president of Fidelity Investments, as chairman of MFS Investments, as a presidential adviser and SEC official, as a research fellow at the Brookings Institution and, currently, as a lecturer at MIT. He has written books on topics both macro (the mutual fund business, the Global Financial Crisis) and micro (personal time management).

Back in October, Pozen moderated a panel on Innovative Retirement Products at the 2015 Fall Journal of Investment Management conference at the MIT Sloan School of Management. The panelists included Peggy MacDonald of Prudential Financial’s pension risk transfer business and Tom Reid of Sun Life Financial of Canada.

During the panel discussion, Pozen spoke favorably about the usefulness of annuities in mitigating longevity risk. In a recent phone conversation with RIJ, he expanded on some of his views regarding retirement.

RIJ: Greetings, Bob. Ten years ago, I bought your book, The Mutual Fund Business. And I know that the second edition of your book, The Fund Industry: How Your Money Is Managed, came out in early 2015. So it’s a privilege to talk with you in real time. Judging by your comments at the JOIM conference, you sounded like a fan of annuities.

Pozen: I didn’t say I liked all annuities. I said I like the concept of longevity annuities. What’s good about them is that payouts don’t start until you’re 80 or 85 years old, which makes them relatively inexpensive. They also serve a planning need. It’s easier to create a financial plan that stops at age 80 than to plan for an unknown lifespan. And, the way the Treasury rules work now, you can also get a pass on the RMD rules up to about $125,000 when you buy a longevity annuity with tax-deferred savings.

RIJ: You’re talking about the Qualified Longevity Annuity Contract, which the Treasury Department introduced in 2015. Some people think the cap on QLAC contributions of $125,000 doesn’t offer upper-income people a large enough tax incentive to give up so much liquidity, while the cap of 25% of qualified savings won’t let middle-income people buy a meaningful amount of income with their smaller IRA balances. What do you think of those concerns?

Pozen: Despite what economists may say about the high value that people place on optionality, putting 25% in a longevity annuity seems like a reasonable insurance policy while still leaving you with flexibility.

RIJ: There’s been a lot of debate over whether the U.S. is experiencing a retirement “crisis.” The Center for Retirement Research at Boston College says that 52% of American households are at risk of not being able to maintain their current lifestyle in retirement. But the Investment Company Institute and others say that income from 401(k)s has been underestimated or overlooked in official statistics, and that most retirees will do just fine. Do we have a crisis?

Pozen: There is a retirement-related set of problems. Whether there’s a crisis or not is a different question. For some income groups, there is not a crisis. There are others who will depend entirely on Social Security for their retirement income. Then there’s a middle ground made up of people who have not saved enough for retirement. It’s clear that some of them should save more. But how much more, we don’t know. We have all these people who say they want to save more but don’t.

RIJ: Why do you think they don’t save?

Pozen: A lot of them don’t have a 401(k) plan at work and they don’t set up their own IRAs. Roughly half of employees in the United States don’t have retirement plans at work and inertia seems to prevent them from saving on their own. We also know there are lots of employers choosing not to participate in that system. Some are small employers, some are in the agriculture and retail sectors.

RIJ: The Obama administration recently went live with its MyRA program of workplace IRAs that use existing payroll systems without requiring the employer to sponsor a full-blown retirement plan. And a few states, including California, are in the process of setting up state-sponsored retirement plans with mandatory participation by most employers and automatic enrollment of workers. What do you think about those state “public option” plans?

Pozen: I’m in favor of the automatic IRA. As for the state plans, I think it would be better to have a federal system than to have three states doing it.

RIJ: Another of today’s big public policy issues involves the Department of Labor’s proposed “conflict of interest rule” that will extend DOL jurisdiction to rollover IRAs and raise the standard of advice on IRA money to a fiduciary level. Have you looked at that issue?

Pozen: I’m not very familiar with the details of that, so I can’t comment.

RIJ: When George W. Bush was president, you advised his administration on Social Security policy. What were your ideas for reforming Social Security?

Pozen: I came up with a plan called “progressive indexing.” The thrust of it was that Social Security benefits are growing faster than the Consumer Price Index because they’re linked to wage growth. Wages on average rise about one percent faster than prices. My proposal was to link the growth of benefits of the upper third of earners to CPI growth while letting the benefits of the lower third of earners continue to rise with the wage index. This strategy would cut the program’s long-term deficit somewhere in half.

RIJ: Wouldn’t that introduce a form of “means-testing,” which might not be very popular?

Pozen: It’s not means-testing. Means-testing would mean that you’d get nothing from Social Security if you are among the high earners. My plan is more like “means-tilting.” I’d be reluctant to suggest that the people in the top third get nothing from Social Security. That would undermine popular support for the program.

RIJ: But your idea wasn’t incorporated into the Bush administration’s Social Security reform plan, right?

Pozen: For a while, my idea had a lot of traction. President Bush linked it to Social Security privatization, which became his administration’s main policy recommendation. But the ideas are separate, if by privatization you mean a carve-out of Social Security taxes where you divert, say, 5% of the FICA tax into private accounts. But if you diverted FICA taxes you’d have to put all of the money into Treasuries, or the program would be too risky. It’s hard to get good deals on investments.

RIJ: Some conservatives have recommended raising the full retirement age, or FRA, as a way to close the Social Security funding gap. What do you think of that type of reform?

Pozen: There are a lot of difficult issues associated with raising the FRA. There’s an issue involving people who can no longer do physical work. If they have to wait longer for Social Security benefits, will there be suitable jobs for them while they’re waiting? Another issue is that a lot of lower earners won’t get that much from Social Security anyway because of the big longevity gap between upper earners and lower earners. My proposal is more income-based than retirement age-based. To me, it goes to the heart of the problem. We’re already moving to age 67 for the FRA, but if we go to age 70 a lot of workers would get nothing. Raising the FRA may sound attractive at first but we have to be careful.

RIJ: Some liberals have recommended increasing in the level of income that’s subject to payroll taxes, currently set at $118,000. Do you think that’s a good idea?

Pozen: I’ve seen proposals to raise the FICA limit to $200,000, but that’s really whacking certain people. That’s putting a big new tax on people who don’t consider themselves wealthy. I would rather see a 2% surcharge on all income above the current FICA limit.

RIJ: The next time we have a public debate on the future of Social Security, the question of whether the “trust fund” is real will undoubtedly come up again. Is the trust fund “real”?

Pozen: That’s a false question. The Treasuries in the trust fund are IOUs from one part of the government to another. It’s a trust fund that’s filled with intra-governmental obligations. When it’s time to cash out those special Treasuries, the money will have to come from the federal budget. So Congress would need to appropriate the money but then probably have to borrow it. It’s kind of circular.

RIJ: Switching to another topic entirely, what do you think of the rise of the robo-advisors?

Pozen: I’ve had some experience with robo-advisors, and I think they do a good job with smaller amounts of money. From $50,000 to $100,000, say. But they don’t offer customization, at least not in the way that some people think they do. They do serve a purpose, however.

RIJ: Robo-advice seems to me to be just another name for an Internet-driven trend toward disintermediation of advisors and direct distribution of investment products and services. One survey showed that when people are asked which robo-advisors they know of, they mention direct providers like Fidelity, Vanguard and Schwab.

Pozen: Robo-advice is more than direct distribution. It’s direct distribution in a particular way. And I think Vanguard was very smart to start its own robo-advisor.

RIJ: You’ve worked in a Republican administration and you’ve been associated with the liberal-leaning Brookings Institution. You’ve also been a senior executive of large financial services companies. That makes it tough to place you on the political spectrum. Where would you place yourself?

Pozen: I’m a moderate Democrat, which means that I’m fiscally conservative and socially liberal.

RIJ: Thank you, Bob.

Fed raises target overnight rate by quarter-percent

Posted on December 17, 2015 by Editorial Staff -

Choosing to take minimal action before events force it to take drastic action, the Federal Open Market Committee “decided to raise the target range for the federal funds rate by one-quarter percentage point, bringing it to 0.25% to 0.50%,” Federal Reserve chairman Janet Yellen said at a press conference yesterday.

“This action marks the end of an extraordinary seven-year period during which the federal funds rate was held near zero to support the recovery of the economy from the worst financial crisis and recession since the Great Depression,” Yellen read from a prepared text.

The Fed Funds rate is the annual rate at which Federal Reserve member banks lend reserves to each other overnight. Yellen added that the Fed raised two other rates that it uses as tools to push the Fed Funds rate up into the target range.

“Specifically, the Board of Governors raised the interest rate paid on required and excess reserves to 0.5%, and the FOMC authorized overnight reverse repurchase operations at an offering rate of 0.25%. Both of these changes will be effective tomorrow,” she said.

As for the future, Yellen’s forward guidance wasn’t nearly as specific as Alan Greenspan’s when he began raising rates by predictable amounts and predictable intervals in 2004.

“The median projection for the federal funds rate rises gradually to nearly 1.5% percent in late 2016 and 2.5% in late 2017,” she said. “As the factors restraining economic growth continue to fade over time, the median rate rises to 3.25% by the end of 2018, close to its longer-run normal level.”

Anticipating questions about why the Fed had decided to raise rates even though it thinks the U.S. economy is relatively tepid, Yellen said:

“We recognize that it takes time for monetary policy actions to affect future economic outcomes. Were the FOMC to delay the start of policy normalization for too long, we would likely end up having to tighten policy relatively abruptly at some point to keep the economy from overheating and inflation from significantly overshooting our objective. Such an abrupt tightening could increase the risk of pushing the economy into recession.”

A near-retirement breakup calls for financial advice: MacroMonitor

Posted on December 17, 2015 by Editorial Staff -

For older couples, marital stability may be the best predictor of financial security in retirement. That’s especially true for women. If two can live as cheap as one, going solo can cost double.

In short, divorce is highly disruptive of the finances of adults nearing retirement. And these autumnal, change-of-life, empty-nest-transition, loss-of-vitality divorces are occurring more often.

That spells opportunity for financial services providers, according to a new report in the MacroMonitor, a publication of the Princeton, NJ-based Consumer Financial Decisions Group of Strategic Business Insights, an international business consulting firm.

“In 1992, the number of divorced households with heads age 50 and older was lower than for younger heads (younger than age 50),” the report said. “In 2014, the number of divorced heads age 50 and older is three times that for households with younger divorced heads (12 million versus 4 million households),” the report said.

“Also notable is the significantly higher number of divorced women age 50 and older (7.1 million) than men of the same age (4.5 million).”

Men are more likely than women to remarry, according to MacroMonitor. Although incidences are small, men age 50 and older are twice as likely as women age 50 and older to expect to remarry in the next year.

There are about 20 million divorced or separated households in the U.S; about 15.5 million are divorced and 4.4 million are separated. Between 1992 and 2014, the overall proportion of US divorced households has remained at about 12%.

“The effects of divorce and separation on finances are immediate and often long lasting,” the report said. “Financial relationships, financial product and service ownership, and assets suffer effects, and changes in cash flow are immediate. The results of divorce may be more profound for mature households than for younger households because of impending retirement.”

Divorce affects older women differently from men because women tend to live longer, have lower lifetime earnings, and serve as caregivers throughout their lives, the MacroMonitor said. Large numbers of women didn’t enter the work force until the 1970s, so many older women didn’t learn to manage finances on their own. As a result many lack experience and confidence.

Cash-outs, loans and rollovers fuel the flood from 401(k)s: Cerulli

Posted on December 17, 2015 by Editorial Staff -

Nearly $81 billion disappeared from retirement accounts in 2014 as a result of cash-outs and loan defaults, according to Cerulli Associates, a global analytics firm. Such events are the source of the so-called “leakage” that undermines retirement savings and will likely create financial shortfalls later in life.

In a new report, “Evolution of the Retirement Investor 2015: Insights into Investor Segmentation and the Retirement Income Landscape,” Cerulli examines retirement decisions made by individual investors, with emphasis on 401(k) plan participants, IRAs and rollovers, and retirement income.

Leakage is of great concern to 401(k) providers who hope to retain the assets, to IRA providers who want to capture more of the assets in motion, and to policymakers who worry about potential demand for government services from underfunded elderly Americans. Cash-outs, which become possible when individuals change jobs, are the biggest cause of leakage, with loans a distant second.

The U.S. may be the only developed country where individuals can tap a tax-deferred savings program before retirement. If the cash-out amounts are small, the prospects of a slightly higher tax bill or even a 10% penalty for early withdrawal don’t act as effective deterrents. “Outside of the interaction with their recordkeeper or IRA service provider, there is really nothing stopping anyone from accessing either a terminated DC or IRA account early,” said Shaan Duggal, a Cerulli research analyst.

“Nearly every Gen-Xer who completed a cash distribution from their 401(k) ended up paying an additional 10% penalty on top of regular taxes to the IRS. When a distribution is requested, recordkeepers should spring into action, conveying the benefits of preserving the tax-deferred nature of the assets.”

“Loans are also a source of 401(k) leakage, albeit smaller, but when they are defaulted on immediately they cause a taxed and penalized event for the already cash-strapped individual,” Duggal said in a release. “Removing the entire loan function from the plan may be extreme, but restricting the amount of outstanding loans to only one will slowly do away with the idea that the DC plan is meant to be a source of short-term liquidity.”

But leakage is a sideshow relative to the rollover story. Over the past decade, millions of plan participants have, one by one, moved their retirement plan money into rollover IRAs when they changed jobs. In 2014, those over age 50 represented almost 80% of the flow, according to Cerulli. Retirement providers want to stem the outflow, while advisors and IRA providers hope to capture it.

Full-service firms like Fidelity and Vanguard, which provide retirement plans, serve as IRA custodians and sell mutual funds direct to the public, are positioned to benefit regardless of the direction of the flow. In 2014, Fidelity led the IRA industry with 14.6% of total rollover flows. When people roll over their money, they often roll it over to their plan’s provider or to a brokerage advisor.

“Advisors received the majority of rollover assets ($220 billion), followed closely by self-directed IRAs at $162 billion. Plan-to-plan rollovers were a distant third at $27 billion,” the Cerulli report said. Cerulli speculated that the Department of Labor’s pending proposed “fiduciary rule” could, when it is issued, dampen the flow from 401(k) plans to IRAs. “The DOL viewpoint is that the DC plan is often the best place to leave assets,” Cerulli writes, but it’s still likely that most people will withdraw their retirement income from IRAs, not from 401(k) plans.

Social Security is still the No. 1 source of retirement income (33.9%) for middle-class participants. Defined contribution and personal savings combined provide 32.5% of participants’ income in retirement, Cerulli reported.

Significantly, pension risk-transfer goes Dutch

Posted on December 17, 2015 by Editorial Staff -

The UK’s Legal & General insurance company, which partnered with Prudential Financial on the recent conversion of part of Philips Electronics of North America’s defined benefit to a group annuity, will reinsure €200m of the Dutch firm ASR Nederland’s pension obligations, IPE.com reported this week.

The expansion of the pension risk-transfer business beyond US, UK and Canada pension funds for the first time is a “significant milestone,” Legal & General Re chief executive Manfred Maske said in a release. It was the first deal executed through L&G Re, set up in 2014.

Prudential, active in the de-risking market both in North America and the UK, has long predicted de-risking would spread across Continental Europe. The firm’s head of longevity insurance, Amy Kessler, addressed the topic at the International Longevity Risk and Capital Markets Solutions in Lyon in September.

“Globalization is just beginning, with activity spreading quickly from the US, the UK, Canada and the Netherlands to France, Germany, Switzerland, the Nordics, Australia and beyond,” Kessler said.

James Mullins, head of risk transfer at UK consultancy Hymans Robertson, the ASR deal confirmed there was now a global market for risk transfer.

“With more choice of markets, reinsurers that are taking on longevity risk may look to increase pricing over the longer term,” he said. “But that goes against the trend we have seen for some time now of reinsurers keeping prices low. Strong competition, intense interest in the sector and appetite for deals has kept it that way.”

“The potential market for pension risk transfer in the US, UK and Europe is huge and will play out over many decades.” Kerrigan Procter, managing director at Legal & General Retirement, told IPE.com.

Unsolved mystery: Where are the missing participants?

Posted on December 17, 2015 by Editorial Staff -

Is the percentage of Americans who participate in a workplace retirement savings plan dropping, or is the method used to measure participation faulty? The Employee Benefit Research Institute raises this question in a new Issue Brief.

It’s an important and timely question. If participation is dropping, it could add weight to the argument that state-sponsored, auto-enrolled retirement savings plans are needed to make up for the lack of coverage provided by the voluntary 401(k) system.

At issue is the accuracy of the Annual Social and Economic Supplement (fielded in March) to the Census Bureau’s CPS. It is one of the most-cited sources of income data for retirement-age Americans.

The Census Bureau redesigned the income-related questions starting in the 2014 survey in response to findings that this survey has misclassified and generally under-reported income (in particular, sources of retirement income).

While the redesign of the survey did capture more income (especially pension income), EBRI notes, it also significantly lowered the survey’s estimates of retirement plan participation among those most likely to participate. Furthermore, these new CPS participation results trended downward in contrast to other surveys on retirement plan participation.

Specifically, EBRI found:

In the 2014 CPS, which provides results for 2013, both survey designs were used. Under the traditional survey design, the percentage of all workers found to be working for an employer that sponsored a plan was 50.2%, compared with 47.6% from the redesigned questionnaire, a difference of 2.6 percentage points. For full-time, full-year wage and salary workers ages 21-64 (those most likely to participate in a plan), the difference was 3.7 percentage points (60.8% traditional vs. 57.1% redesigned) and for public-sector workers ages 21-64 the difference was 3.3 percentage points.
The 2015 survey used the redesigned questionnaire, and the percentages of workers working for an employer that sponsored a plan were found to have decreased among each work force. The percentage of full-time, full-year wage and salary workers ages 21-64 working for an employer that sponsored a plan fell 2.7 percentage points from 2013 to 2014.
The percentage of full-time, full year wage and salary workers ages 21-64 participating in a plan under the traditional survey design was 53.0%, compared with 49.5% under the redesigned questionnaire, a difference of 3.5 percentage points.

The decline contradicted the findings from the Bureau of Labor Statistics’ National Compensation Survey (NCS). It found that the percentage of private-sector wage and salary workers at establishments with 500 or more employees participating in an employment-based retirement plan increased in 2014 to 77% from 76% in 2013.

“While the redesign of the CPS questionnaire achieved one of its primary goals of capturing more income—especially pension income—it also resulted in sharp declines in the estimated retirement plan participation levels of current workers,” Copeland said. “Furthermore, those most affected were those groups with the highest likelihoods of participation—those older, with higher earnings, and working for larger employers.”

The full report, “The Effect of the Current Population Survey Redesign on Retirement-Plan Participation Estimates,” is published in the December 2015 EBRI Notes and online at www.ebri.org.

Data Connection

Lists*