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Comment: Oracle and Others Sued by Schlichter

Posted on February 2, 2016 by -

In this post, we will address all of the recent lawsuits filed by Schlichter, Bogard & Denton, the 800-pound Gorilla in this space. The most recent was filed last week against Oracle. The case against Anthem has received a lot of attention. But one that has slipped through the cracks a bit is against Reliance Trust and one its clients.

This case may the first of its kind on this scale to go after an outsourced fiduciary who is not related to the plan sponsor. Finally, the case against BB&T will be familiar to readers as involving claims of a provider’s own in-house plan.

Troudt v. Oracle Corp.

On January 22, 2016, an excessive fee lawsuit was filed against Oracle Corp., a Fortune 100 company based in Redwood City, California. Troudt v. Oracle Corp. was filed in the District of Colorado and alleges that the plan’s fiduciaries allowed excessive recordkeeping fees to be paid to Fidelity.

The complaint alleges that Oracle allowed Fidelity to be paid between $68 to $140 per participant rather than a reasonable per head fee of $25. The plan’s participant count increased from 38,000 in 2009 to about 60,000 today. Over that same time period, the plan’s assets increased from $3.6 billion to over $11 billion.

The complaint also alleges that the following funds underperformed and should not have been selected:

  • The Artisan Small Cap Value Fund
  • PIMCO Inflation Response Multi-Asset Fund
  • TCM Small-Mid Cap Growth Fund

This is not the first time a major client of Fidelity has been sued, which includes cases such as Tussey v. ABB and previously dismissed lawsuits against John Deere, Exelon, and Unisys. Notably missing from the lawsuit are allegations that cheaper share classes were available but not used, as is alleged in the lawsuit below.

Bell v. Anthem

On December 29, 2015, an ERISA lawsuit was filed against Anthem Inc. in the Southern District of Indiana federal court.  This is the first time, to our knowledge, that a plan sponsor has been sued on this scale where Vanguard has been the recordkeeper and their funds have made up the lion’s share of the core options available.

The allegations in the complaint included:

  • The plan’s fiduciaries caused Vanguard to be paid excessive recordkeeping fees. Not until 2013 were more expensive share classes of the plan’s funds replaced with cheaper alternatives. This reduced the recordkeeping fees paid to Vanguard through the revenue sharing generated from the funds.
  • Cheaper share classes were available much earlier than selected, even as far back as the late 1990s. This failure caused $18 million in losses to the plan.
  • Artisan Mid Cap Value Fund and the Touchstone Sands Capital Growth Fund were imprudently included in the plan because they were excessively prices as compared to similar Vanguard funds, in addition to more expensive share classes being used until 2013.
  • Failed to use separate accounts for these two funds and collective trusts for the Vanguard target date funds in the plan instead of mutual funds and that this changes would have resulted in less fees paid by participants.

The excessive recordkeeping fees alleged by plaintiffs was between $80 and $94 per participant until 2013 when Anthem negotiated a flat per head fee of $42. This is based on a plan that had between $3.3 and $5.1 billion during the time period in question in the lawsuit.

The plaintiffs also allege that the $42 is too much and was excessive by at least 40%. Finally, the complaint alleges that the plan should have included a stable value fund instead of a money market fund.

Pledger v. Reliance Trust

On December 22, 2015, Pledger v. Reliance Trust Company was filed in the Northern District of Georgia federal court. The issues raised in this complaint are unique to this case and should be carefully studied by any service provider offering outsourced 3(21), 3(38), or 3(16) services.

The lawsuit was filed by participants in a plan sponsored by Insperity Inc., a professional employer organization (“PEO”). As a PEO, Insperity provides outsourced human resources and business solutions to small and medium sizes businesses. Typically, these outsourced employees are co-employed by Insperity as well as the client business. They become part of a 401(k) plan sponsored and administered by Insperity rather than the client company.

The plaintiffs claim that:

  • Insperity used the plan’s asset to seed a 401(k) recordkeeping business it started to supplement its core business functions. Previously the plan was with another industry recordkeeper. After Insperity started its recordkeeping division, the plaintiffs claim the plan was moved to it without a competitive bidding process.
  • The plan’s $1.9 billion in assets represented 95% of Insperity’s recordkeeping assets. It is also worth noting that Insperity had a different plan for its corporate workforce and that it was also recordkept by Insperity.
  • Insperity derived excessive compensation from the recordkeeping activities and that Reliance Trust Company, also a defendant, was part of the scheme. It alleges that Reliance was hired as the plan’s 3(38) fiduciary investment manager as well as a discretionary trustee.
  • Insperity received between $119 and $142 per participant per year in recordkeeping fees.
  • The more expensive share classes of the Reliance collectives were selected to generate additional revenue sharing to benefit Insperity. They also claim the target date funds had terrible performance that caused losses to the plan of between $41 million and $56 million.
  • Reliance selected “untested” and “newly-established” target date funds it managed as collective trusts. Plaintiffs claim that Reliance was charged a sliding scale for managing these assets.

Essentially, the plaintiffs accuse Insperity and Reliance of a quid pro quo that allowed Reliance to pick its own investments for the plan, such as the target date funds selected, which then allowed Reliance to select funds that generated excessive revenue sharing that went to Insperity. 

It’s unclear from the complaint if Insperity selected the collective trusts and simply hired Reliance as an investment manager or whether all investment decisions were outsourced to Reliance and it then selected its own products for inclusion. The plaintiffs claim it is the latter.

In what may be the most troublesome allegation in the complaint, plaintiffs claim that the Insperity corporate plan, which had only $208 million in assets, had the same investment lineup but used cheaper share classes than the $2 billion plan in six instances. They also claim that the corporate plan was offered a stable value fund where the plan for the outsourced employees was not, in violation of ERISA.

Smith v. BB&T

On October 8, 2015, current and former employees of BB&T Corporation filed a lawsuit in the Middle District of North Carolina federal court alleging self-dealing by BB&T with regard to its own in-house 401(k) plan.

Plaintiffs allege that BB&T has benefited at the expense of plan participants by using BB&T’s own funds which also include those managed by its wholly owned subsidiary Sterling Capital Management. The plan is alleged to currently have about $2.93 billion in plan assets.

According to plaintiffs, until 2009, the plan only had BB&T mutual funds, but since then non-proprietary funds have been added. BB&T has also been the plan’s recordkeeper in addition to the primary asset manager of the plan.

Plaintiffs allege that through this setup, BB&T profited at the expense of the plan’s participants by allowing the plan to generate excessive revenue sharing which went to BB&T and not engaging in an arm’s length RFP process to find a different recordkeeper.

Like other lawsuits filed by the Schlichter firm, they claim these funds are also imprudent when compared to a lineup of Vanguard fund or if separate account or collective trusts had been used rather than mutual funds.

The complaint also alleges that many of the BB&T funds in the plan were poorly performing, including Sterling Capital International Fund. It also attacks the use of a BB&T money market type product rather than a stable value fund, as well as the unitized structure of the BB&T company stock fund in the plan, an issue that has been litigated in previous cases.

A separate lawsuit has been filed against BB&T by a different plaintiffs firm. That suit, Bowers v BB&T, will be litigated along with Smith v. BB&T.

Our thoughts

The cases against Oracle and Anthem do not involve allegations of self-dealing under ERISA. Such allegations have been the linchpin of trial decisions and settlements in the recent successes by the plaintiff’s ERISA bar. Instead, the claims attack the process and substance of the fiduciary decision-making by the defendants.

The cases against Reliance/Insperity and BB&T both involve allegations of self-dealing. The case against BB&T has a familiar pattern and is similar to ones previously filed against Ameriprise and Fidelity.

Pledger v. Reliance Trust may be the first case to address the common practice of outsourced investment managers using their own products/solutions as substitutes for more mainstream target date funds. This is become a more common thing to see in the form of model portfolios and collective trusts.

It will be important to pay close attention to the way in which the relationship was established by Reliance and Insperity, as there is definitely a right way to do it and a wrong way.  

Having an outsourced fiduciary provider in most instances will not stop a plan sponsor from also being sued. In Pledger v. Reliance Trust, the complaint states that Reliance was selected as the outsourced investment manager and discretionary trustee.

Yet Insperity was still sued and it is alleged that they are as much responsible for the claims involving investments as is Reliance, the outsourced fiduciary. While I understand that Insperity has its own independent claims against it, it is worth emphasizing that Insperity as the plan sponsor still needs to fight its way out of this lawsuit, like any other plan sponsor who might get sued would.

While a plan sponsor in another situation, or Insperity here, may be able to show that all responsibility over investments was that of the outsourced fiduciary, the time and expense of defending a lawsuit is very real and many times may be more or as much as the ultimate damages that a court could find against them.

The ultimate conclusion here is that, for a plan sponsor, outsourcing a fiduciary role to a service provider is not a total insulation from risk. And this lawsuit provides a nice example of that. Instead, there should be other valid reasons (of which there are many) for outsourcing fiduciary roles to service providers.

© 2016 FRAplantools.com 

Legal Defenses

Posted on February 1, 2016 by -

The Department of Labor’s proposed fiduciary rule is well-intended: the government wants to protect the millions of inexperienced investors who are rolling money from 401(k) plans to IRAs from exploitation by self-interested brokers and agents.

But, unless amended, the rule would also expose brokers and their firms to new legal liabilities, in the form of tougher arbitration hearings or perhaps an expensive wave of litigation in federal courts.    

It’s not clear if the DOL intended to terrorize broker-dealers with its proposal. But by explicitly granting investors new rights to sue advisors, it has. Greater legal liability isn’t the only possible consequence of the rule that worries advisors—they also fear costly IT overhauls and a chill on sales of commissioned products—but it’s high on the list.

Their fears are not unrealistic. Broker-dealers have seen what happened in the 401(k) space, where St. Louis plaintiffs’ attorney Jerry Schlichter has won a series of big-ticket damage awards against 401(k) plan providers and sponsors for breaching their fiduciary duties to plan participants. The same, they fear, could happen to them and their businesses.

Here’s the twist that really bugs the industry: The DOL will rely on plaintiffs’ attorneys to enforce the rule by using it in federal class action suits against broker-dealers. Labor can regulate 401(k) and IRA advice, but it can’t enforce the rules it issues (only the IRS can).

Efforts to derail the rule so far haven’t worked. Bills filed by industry-friendly legislators (two more were marked up this week by the House Committee on Education and the Workforce) have gotten nowhere, and face a sure presidential veto if they did. A Trump or Cruz victory in November would certainly kill the rule, but no one seems to bank on it. The DOL itself might yet soften the wording of rule and make it less disruptive for the industry. But hopes for that are waning.

One defensive option is left: Sue the DOL and ask the U.S. District Court of Appeals to block the rule. This strategy worked when the indexed annuity industry sued the SEC and got Rule 151A annulled in 2010, and some think it could work again. (“Remember, 151A was a promulgated rule before we defeated it,” boasted the fixed indexed group, Americans for Annuity Protection, in a January 11 e-mail blast.) 

To learn more about a possible lawsuit, RIJ consulted several pension and securities law attorneys: Bruce Ashton of Drinker Biddle & Reath, Mercer Bullard of the University of Mississippi School of Law and PlanCorp, Tom Clark of Wagner Law Group, and Steve Saxon of Groom Law Group. Here are our questions and their answers.

A legal challenge? On what grounds?

There are hints that a financial industry trade group might file a lawsuit against the DOL this year if, as expected, the final rule still contains the Best Interest Contract Exemption. The BIC or BICE requires advisors to IRA owners to promise to act solely in their client’s best interests. It’s the same “fiduciary” standard that advisors to pensions and defined contribution plans have to meet.   

Steve Saxon of the Groom Law Group in Washington, D.C., which represents industry clients, described a lawsuit as possible. “Generally speaking, and focusing just on various segments of the retirement services industry, there’s a possibility that litigation will be brought. That’s an arrow in the quiver that people are considering.”

He’s not alone. “The going thought is that a lawsuit is a long shot, but certain people are gung ho about it,” said Tom Clark of the Boston-based Wagner Law Group and a blogger at Fraplantools.com.

Financial services firms might feel they have nothing to lose by creating a drawn-out legal battle, Clark said. “The industry might see the upside to a quagmire,” he said, “and file even though they can’t win it.” Bruce Ashton (right) of Drinker Biddle & Reath agreed that “a challenge of the DOL’s authority with respect to ‘regulating’ IRAs seems fairly likely.”Bruce Ashton

What would be the grounds for such a lawsuit? Clark thinks that industry lawyers might accuse the DOL of violating protocol—in effect, to try to win on a technicality. They would question not what the DOL did, but how it did it. 

“If there’s a lawsuit, it would be a challenge that the DOL overstepped their regulatory bounds and messed up the rulemaking,” he told RIJ. “They can’t do it on substance; that would involve a bigger uphill battle than a challenge on procedure.”

Saxon speculated that a suit might charge that the DOL made the definition of “an investment advice fiduciary” too broad. “It would allege that the department went too far and that their definition of a fiduciary is not supported by the statute or any other authority,” he said.

“Secondly, it would say that the BIC exemption is an application of Title 1 of ERISA—in the fiduciary duty rules under Section 404—to IRAs,” he added. “Congress made a decision, when it enacted ERISA [in 1974], not to do that. But the way in which the conditions of the BIC exemption work, that’s where we end up. You could add that having the remedy [to a violation of the rule] be a class action lawsuit is problematic as well.”

Says Bullard: “The first thing they did was to change the definition of a fiduciary. They are making more people subject to the prohibited transaction rules, and they are also extending the duty of loyalty to IRAs, which wasn’t true before. That will be the primary focus of legal challenges to the rule, because Congress decided not to apply that duty, which is just a basic prudence standard, to IRAs.

Concerns about the “Best Interest Contract”  

Neither 401(k) plans or IRAs—let alone the possibility that the rollover IRA would become the largest single repository of retirement savings in the U.S., as they are today—were contemplated when ERISA was enacted.

Section 404 of Title I of ERISA gives the DOL authority over advisor conduct in employer-sponsored retirement plans like 401(k)s. But, as Saxon noted, the law says nothing about DOL jurisdiction over advisor conduct with respect to individual IRAs.  

The “Best Interest Contract Exemption” would span the gap. It enables the DOL to exercising authority over IRA advisors without amending ERISA. If advisors want to sell products to IRA owners and receive third-party commissions from product manufacturers, they will commit a “prohibited transaction”—a punishable offense—unless they and their clients have signed the BIC and they have sworn to act in the sole interest of their clients, just as pension advisors do.

This puts brokers (or at least those brokers who mix the role of advisor with the role of sales agent) in an untenable position. They cannot safely take that oath, because, in the normal course of their jobs, they sometimes act in their own best interests. On the other hand, if they don’t sign BIC contracts, they will commit a crime every time they sell a product and accept a third-party commission.  

Steve Saxon“Right now, IRAs are not subject to Title I of ERISA,” Saxon explained. “An IRA holder can’t sue a financial institution for imprudence under ERISA. This is what this whole BIC exemption is all about. If an IRA provider is a fiduciary, and if it is were found to have failed to meet what amounts to Section 404 under ERISA—as delineated in the BIC standard, which is based on Section 404—then, if that standard isn’t satisfied, there’s no exemption and you have a prohibited transaction. It’s not actionable under ERISA, because they didn’t change [ERISA].”

That’s another twist in this tale. Even if the DOL can regulate advisor conduct with respect to IRAs, ERISA doesn’t give it the power to enforce those rules. So the proposal specifies that IRA owners who feel wronged by their advisors have recourse to the federal courts, through private class action suits. They can’t be limited to pursuing claims of misconduct in arbitration hearings, where brokers traditionally enjoy a kind of home-field advantage.

“The Department of Labor made it easier for class action lawsuits to be filed,” Saxon said. “They’ve paved the way for plaintiffs attorneys to act as substitutes for DOL. It’s a clever alternative, based on the application of a Title I-type standard of conduct to an IRA sales transaction. You broaden the definition of fiduciary to capture the advice-giver as a fiduciary, then apply Section 404 to the sales transaction. My view is that [the BIC standard] went beyond 404 and created some problems. That’s a key point in evaluating where we end up.”   

Ashton told RIJ: “The BICE is structured as it is to create a private right of action for IRA holders that doesn’t now exist, since there really isn’t an effective enforcement mechanism. The prohibition against interfering with the right to participate in a class action is in there for the same reason.”

“On the one hand, ERISA has the ‘duty of loyalty’ provision,” noted Bullard. “It applies only to advisors to retirement plans. On the other hand there is a set of ‘prohibited transaction’ rules that apply to advisors to IRAs and to retirement plans. The latter apply to IRAs and retirement funds, but the duty of loyalty applies only to retirement plans. “[The BIC] is a clever way to apply that duty to IRAs,” he added. Mercer Bullard

“They not only applied the [duty of prudence and loyalty] standard, which becomes actionable by government, they also made it privately actionable. There’s no private access under ERISA, but the contract will give you private right of action through breach of contract.”

As Clark put it, “For the rule to have teeth, [it requires the participation of the plaintiff’s bar]. That’s the linchpin.” Of course, teeth for one adversary is a bite for the other.

If challenged, would the rule be stayed?

“It’s complicated,” Saxon said. “Is there a federal judge who would be willing to stay the implementation of the effective date of the regulations? Or would the federal courts say that the US Department of Labor has the right to move forward with the finalization of the regulation and the exemptions?”

If the case went to the US Supreme Court, Saxon said, “The question would be ‘How long would that take and, in the meantime, would those of us in the retirement services space have to comply and deal with the terms of the regulation and the exemption’?

Bullard doesn’t think the case is likely to go to the US Supreme Court, which hears only a small percentage of cases. While there is a lower federal court in Washington, “This will be decided by the US District Court of Appeals, DC circuit, and the three-judge panel would probably stay the rule,” he said. “If you got a Republican panel, it would definitely be stayed. That’s because the rule would revolutionize the way [the broker-dealer systems work]. So, if there’s any risk of it not being legal, the smart thing would be not to go down that road in the first place. Once the industry implemented the necessary changes, it would be too expensive to go back.”

But that wouldn’t necessarily kill the rule, Bullard added. The DOL would likely appeal the initial panel’s decision to all 11 judges of the DC circuit, where there’s currently a seven-to-four Democratic majority, which would be more likely to uphold the rule. “But if a Republican gets elected president in the November, the rule is dead,” Bullard told RIJ.

The future

Without a Republican victory next fall, the lawyers who spoke with RIJ were doubtful that the brokerage industry could defeat the fiduciary rule.

Tom Clark“Based on the law challenging an agency’s ability to make rules, the law creates an uphill battle for challengers. Against that backdrop, it’s fair to say they will have an uphill battle,” said Clark (left).

“I’d be very surprised if a lawsuit in this area would get very far,” Ashton said. “The DOL clearly has the authority to grant class exemptions and to structure the conditions for those exemptions that deal with both plans and IRAs. I also suspect that courts will find that they have the authority to regulate rollovers, since the assets are plan assets before they are rolled over. My suspicion is that DOL has vetted their legal authority pretty well. There will likely be lawsuits but I doubt very much whether they will be successful.”

There’s still a possibility that the DOL will change the language of the rule to make it less disruptive of the current brokerage business model, which relies on the flow of commissions from product manufacturers to advisors and allows advisors to manage their acknowledged conflicts-of-interest as they see fit.

For instance, the DOL could delete the section of the proposal that forces commission-paid sellers of variable annuities—but not other annuities—to take the BIC oath. Under current law, so-called “Prohibited Transaction Exemption 84-24” allows all annuity sellers to take commissions when selling to people with retirement accounts.

“The DOL could keep Prohibited Transaction Exemption 84-24 the way it is now. They could move all annuity transactions to PTE 84-24, or they could move all of them to the BIC. But no one really knows what might happen next,” Saxon said.

“If anyone is telling you that they know what’s been happening at the Department of Labor since September 24, when the last comment period ended, that would not be reliable,” he said. “Even inside the government, things are still fluid, and they will be fluid until the regulation is finalized. In the meantime, they are not meeting with us or discussing anything with us.”

Assuming that the final rule won’t be different from the proposal, Bullard believes its biggest impact will be to empower clients in arbitration disputes with advisors, not to trigger a hail of class action suits against deep-pocketed brokerages. “There aren’t going to be class action suits,” he told RIJ. “No one believes there is significant class action exposure here.

“The single biggest effect will be an increased liability risk in arbitration,” he added. “Plaintiffs will be able to put the BIC contract in front of an arbitration panel and show that the advisors were fiduciaries. This will mean that you can make a fiduciary breach claim in arbitration. The plaintiff will still face the hurdle of having to prove that the advisor failed to do what a fiduciary should do. But there will be a real increase of liability risk for advisors, and basic changes to [advisor] compensation.”

Beyond that, the brokers will need to adapt their computer systems to new compensation regimes, compliance protocols and reporting requirements. “The costliest part for the financial firms will be changing all their systems. This will mean a total overhaul, Bullard said.”

The broader view

There’s a simple explanation for the complexity of all this. Gaps in the law engender ambiguities, and ambiguities get resolved in court. ERISA has big gaps. Its authors didn’t envision IRAs or 401(k)s. The line between advisors and brokers and agents has blurred over the years. Most importantly, rollover IRAs are inherently ambiguous: they are private retail accounts and government-subsidized mini-pension funds at the same time.

Such ambiguities provide plenty of grist for the legal mills. But it’s important to remember that the legal battle is just a sideshow to the main issue. At stake here is the $7 trillion rollover IRA market. The question is whether broker-dealers and other intermediaries will be able to serve—or exploit, in the Obama administration’s skeptical view—that rich market in the manner to which they are accustomed.   

© 2016 RIJ Publishing LLC. All rights reserved.

Betterment Wants to Build a Better 401(k)

Posted on January 28, 2016 by -

Grandly declaring that the “the era of expensive, impersonal, unguided retirement saving is over,” Jon Stein, the CEO of Betterment, announced yesterday that his New York-based, venture-cap-backed robo-advice company has officially entered the 401(k) business as a full-service small plan provider.  

In recent years, several Internet start-ups like Ubiquity and blooom have tried to build low-cost turnkey 401(k) plans for the tens of thousands of small companies in the U.S. that either have high-cost broker-sold retirement plans or no savings plans at all. Success has been elusive.

As a result, the percentage of full-time U.S. workers without a savings plan at work has remained stuck at about 50%. California and other states have taken steps to fill the vacuum with public defined contribution options, and the Obama administration has urged small employers to offer its “MyRA” workplace IRA. But none of those initiatives has momentum yet.

Now Betterment has stepped into the batter’s box. It puts new participants in managed accounts made up of exchange-traded funds (ETFs), assigning them asset allocations based on their Social Security full retirement ages. The all-in costs are similar to the costs that large plans enjoy: as little as 10 basis points for plans with the most assets under management and up to 60 basis points for plans with the least. (A 30-basis point expense ratio, for instance, generates revenue of $30,000 per $10 million in AUM.)

The 401(k) business is the newest of Betterment’s three business lines. The others are its retail robo-advice business, with 130,000 online customers and $3.2 billion in ETF assets under management, and Betterment Institutional, a version of the Betterment retail platform that advisors can license and brand as their own customer-facing digital advisory channel.      

Betterment says it already has about 50 401(k) customers. One of the first was Boxed, a privately-held 80-employee firm whose HR director, Elena Krieger, describes it as a “mobile-first e-commerce” company. Founded in 2013, it takes phone-mediated orders for Costco-sized amounts of food and household items and delivers them from its own warehouses to individuals and businesses throughout the lower 48 states. The two companies share a common investor and a fondness for digital disruption.

“There was a cultural fit between us and Betterment. That was what was interesting to Boxed from the get go,” said David Taft, vice president of communications at Boxed. Elena Krieger, the firm’s HR director, said, “Betterment had a similar philosophy. We’re both mobile-first e-commerce.” Boxed had no existing retirement plan, she said. She disagreed with the conventional wisdom that small business owners tend not to bother sponsoring retirement plans unless a highly incentivized broker shows them how much they can reduce their own taxes by doing so. 

“I would say its more common than not in companies at our stage of growth to offer a 401(k) plan now,” Krieger told RIJ. “The 401(k) is not seen only as a management enrichment tool. The people we hire are asking us, ‘Where’s the 401(k)?”

Homegrown recordkeeping 

One of the most difficult aspects of offering a 401(k) plan is the recordkeeping function. The recordkeeper accepts transaction requests, processes and allocates contributions and updates participant records when transactions are settled. It’s a complex, low-margin business that has seen rapid consolidation in recent years, with firms like JP Morgan and New York Life selling their recordkeeping businesses to Great-West and Manulife, respectively. 

Recordkeeping grows in complexity when a plan uses revenue-sharing, which bundles the all of the costs of a plan into the expense ratios of the funds. In such cases, the recordkeeper must keep track of “how much money [the plan] keeps and how much money [the fund managers] keep,” said Tom Clark, an ERISA attorney at the Wagner Law Firm who serves on Betterment’s advisory board. Tom Clark

Recordkeepers often find themselves doing that for a multitude of plans sponsors using funds from different asset managers, whose funds may have multiple share classes, each of which might entail different payment terms. “You can imagine how complicated it can get,” Clark (right) added.

Betterment leapfrogs those complexities by not using revenue-sharing in the first place and by offering only ETFs, rather than the mutual funds whose share classes facilitate revenue-sharing. Since revenue-sharing tends to be non-transparent and introduces conflicts of interest among the various parties, no revenue-sharing means a lower likelihood of fiduciary breaches and lawsuits. 

Cynthia Loh, who runs Betterment’s 401(k) business, said that the company’s decision to use ETFs without revenue sharing made it necessary to build its own recordkeeping system. “We’d been speaking to different recordkeepers, and we found that 401(k) recordkeepers don’t support ETFs. The whole 401(k) system has been set up for mutual funds. They do it that way so companies can use revenue sharing. And there’s no incentive for them to get out of mutual funds,” she told RIJ.

“With mutual funds, you can add different share classes, and then share revenue in different ways. It’s not transparent, and you can’t do that with ETFs. The 401(k) ecosystem was built on the idea that brokers get paid, administrators get paid, and the participant suffers. You couldn’t have that scenario with ETFs. That’s not how ETFs work at all. You couldn’t have that scenario,” she added.

Cynthia LohOther 401(k) companies do offer ETFs, but almost all of them turn their ETFs into mutual funds to accommodate revenue sharing, she said. “Except for Schwab, what we’ve seen from the other recordkeepers is that they repackage the ETFs as mutual funds. They’re technologically not capable of using [pure] ETFs. So we had to build our own.” Since Betterment’s retail business already used ETFs, “we didn’t have that much more to build on top of our existing system,” Loh (at left) told RIJ.

Betterment uses about 30 of the 1,600 or so ETFs on the market. It generally selects either a Vanguard or iShares ETF as the primary investment choice for each asset class in its managed accounts. “Whatever ETF we’ve chosen for each asset class is the default purchase if a customer needs to purchase that asset class. We have secondary and tertiary tickers for tax-loss harvesting purposes (to avoid wash sales),” a Betterment spokesman said.

Plain vanilla for small plans

But by simplifying its offering, Betterment may be limiting itself to the small plan market. Small sponsors are often willing to accept a one-size-fits-all solution, but large sponsors want customized solutions, said Rob Foregger, the former Fidelity Investments executive who co-founded NextCapital Group, a digital advice provider.

NextCapital’s customers are large enough to have their own research departments that produce their own investment methodologies and their own capital market assumptions, which NextCapital converts into scalable web-based participant advice. “Betterment can afford to take a more plain-vanilla approach because they’re going after the micro market. Having said that, I have a lot of respect for Betterment and Jon Stein and I wouldn’t underestimate their long-term capabilities.”

Moving into the 401(k) space “is a logical extension of Betterment’s business model,” Foregger added. “Winning in the retail space, in the long run, requires winning in the defined contribution space. The retirement market is just too big to ignore. And the DC market is perfect for scalable advice,” he told RIJ. “The Department of Labor is also going to make digital advice the de facto solution in the coming decade. But people who think you can just take a retail robo platform and put it in the DC market are sadly mistaken.” 

Veterans of the 401(k) business agree that the small plan segment is tougher than it looks. “The movement of the money itself is getting easier,” said one executive who spent many years at a major retirement plan provider. “But then you have all the legal and regulatory requirements for changing ownership of a piece of property. The problem is that you have 300,000 small plans and they all have their peculiarities. Once you go into all the permutations, and the individual circumstances and the beneficiary designations, it gets complicated. I can show you easy cases. I can show you horror stories. But no doubt Betterment does have ‘leapfrog’ advantages.”  

© 2016 RIJ Publishing LLC. All rights reserved.

Retirement Crisis? Not for Educated Couples

Posted on January 28, 2016 by -

Along with the question of whether a climate crisis exists or not, the less dire question of whether a retirement crisis exists in the U.S. or not has bedeviled pension-minded academics for several years. 

The Center for Retirement Research at Boston College has a National Retirement Risk Index that puts 52% of households at risk for seeing “a drop in living standards” in retirement. The Employee Benefit Research Institute and the Investment Company Institute have said that fewer than 20% of older Americans will “run short of money” in retirement, with long-term care expenses the deciding factor for many. 

A new study from the RAND Corporation suggests that there is not as broad a crisis as some previous studies have suggested. It also confirms the fact that well-educated married couples rarely end up poor in retirement and that poorly educated single women (not widows) often do. That’s not a new development.

The study, “Measuring Economic Preparation for Retirement: Income versus Consumption,” was written by Michael D. Hurd and Susann Rohwedder of RAND and NETSPAR, Europe’s Network for Studies on Pensions, Ageing and Retirement. They looked at the shortcomings of using the Income Replacement Rate—household income immediately following retirement divided by income immediately before retirement—as a measure of retirement savings adequacy.

Instead, they used measurement techniques that they thought better reflected the availability of defined contribution plan and IRA savings (earlier measurement only looked at Social Security and pensions), that also distinguished between single people and couples in a more realistic way than did previous methods, and that focused on consumption in retirement rather than income.

Earlier methods, for instance, allowed distortions to creep in. Poorer people or singles sometimes looked better prepared for retirement than married or high-income people, but only because their pre-retirement incomes were so much lower and they had less income to replace.

Also, some earlier methods didn’t account for the economies of scale enjoyed by couples, or the fact that couples on average have three times as wealth as singles (not twice as much), or the fact that spending and consumption in retirement isn’t a direct reflection of wealth or income.  

Here’s the bottom line. Hurd and Rohwedder determined that when they used the traditional Income Replacement Rate method were used, only 35% of U.S. singles and 34% of couples would have a retirement income at least 70% of their pre-retirement income. If savings in IRAs were taken into account, those numbers would rise to 46% each. Those numbers would suggest a severe retirement crisis.

But the researcher’s “consumption-based method,” using the same data, found that 59% of single Americans and 81% of couples are prepared for retirement. When sex and educational attainment were factored in, a wider range of outcomes emerged. About 29% of single women with less than a high school education and 90.2% of married women with at least a college degree education were prepared for retirement.

In describing their methodology, Hurd and Rohwedder wrote that “[our] consumption-based measure of economic preparation, takes into account the complexities of the modern post-retirement income stream and the ultimate consequences for the retirement-to-death consumption path…

“[It] finds whether a household has, with high probability, the resources to finance a trajectory of spending from shortly following retirement until death (in the case of a single person) or until death of the surviving spouse (in the case of a couple).

“[It] accounts for uncertainty about the date of death, differential mortality, taxes, spending out of assets, marital status, and the consumption path (across time as well as persons) [as well as] heterogeneity by age, sex, marital status, education, and initial economic conditions.”

Does this study mean that Americans don’t need to worry about retirement as much as they thought they did? It would probably be wrong to read it that way. The current problem, not addressed in the study, is that Americans are entering retirement with no experience or training in how to distribute their defined contribution savings wisely over their final ten, 20 or 30 years of life, or to how to achieve their goals with the assets they have.     

© 2016 RIJ Publishing LLC. All rights reserved.

The Global Economy’s Marshmallow Test

Posted on January 28, 2016 by -

The world economy is experiencing a turbulent start to 2016. Stock markets are plummeting; emerging economies are reeling in response to the sharp decline in commodities prices; refugee inflows are further destabilizing Europe; China’s growth has slowed markedly in response to a capital-flow reversal and an overvalued currency; and the US is in political paralysis. A few central bankers struggle to keep the world economy upright.

To escape this mess, four principles should guide the way. First, global economic progress depends on high global saving and investment. Second, saving and investment flows should be viewed as global, not national. Third, full employment depends on high investment rates that match high saving rates. Fourth, high private investments by business depend on high public investments in infrastructure and human capital. Let’s consider each.

First, our global goal should be economic progress, meaning better living conditions worldwide. Indeed, that goal has been enshrined in the new Sustainable Development Goals adopted last September by all 193 members of the United Nations. Progress depends on a high rate of global investment: building the skills, technology, and physical capital stock to propel standards of living higher. In economic development, as in life, there’s no free lunch: Without high rates of investment in know-how, skills, machinery, and sustainable infrastructure, productivity tends to decline (mainly through depreciation), dragging down living standards.

High investment rates in turn depend on high saving rates. A famous psychological experiment found that young children who could resist the immediate temptation to eat a marshmallow, and thereby gain two marshmallows in the future, were likelier to thrive as adults than those who couldn’t. Likewise, societies that defer instant consumption in order to save and invest for the future will enjoy higher future incomes and greater retirement security. (When American economists advise China to boost consumption and cut saving, they are merely peddling the bad habits of American culture, which saves and invests far too little for America’s future.)

Second, saving and investment flows are global. A country such as China, with a high saving rate that exceeds local investment needs, can support investment in other parts of the world that save less, notably low-income Africa and Asia. China’s population is aging rapidly, and Chinese households are saving for retirement. The Chinese know that their household financial assets, rather than numerous children or government social security, will be the main source of their financial security. Low-income Africa and Asia, on the other hand, are both capital-poor and very young. They can borrow from China’s high savers to finance a massive and rapid build-up of education, skills, and infrastructure to underpin their own future economic prosperity.

Third, a high global saving rate does not automatically translate into a high investment rate; unless properly directed, it can cause underspending and unemployment instead. Money put into banks and other financial intermediaries (such as pension and insurance funds) can finance productive activities or short-term speculation (for example, consumer loans and real estate). Great bankers of the past like J.P. Morgan built industries like rail and steel. Today’s money managers, by contrast, tend to resemble gamblers or even fraudsters like Charles Ponzi.

Fourth, today’s investments with high social returns – such as low-carbon energy, smart power grids for cities, and information-based health systems – depend on public-private partnerships, in which public investment and public policies help to spur private investment. This has long been the case: Railroad networks, aviation, automobiles, semiconductors, satellites, GPS, hydraulic fracturing, nuclear power, genomics, and the Internet would not exist but for such partnerships (typically, but not only, starting with the military).

Our global problem today is that the world’s financial intermediaries are not properly steering long-term saving into long-term investments. The problem is compounded by the fact that most governments (the US is a stark case) are chronically underinvesting in long-term education, skill training, and infrastructure. Private investment is falling short mainly because of the shortfall of complementary public investment. Shortsighted macroeconomists say the world is under-consuming; in fact, it is underinvesting.

The result is inadequate global demand (global investments falling short of global saving at full employment) and highly volatile short-term capital flows to finance consumption and real estate. Such short-term flows are subject to abrupt reversals of size and direction. The 1997 Asian financial crisis followed a sudden stop of capital inflows to Asia, and global short-term lending suddenly dried up after Lehman Brothers collapsed in September 2008, causing the Great Recession. Now China is facing the same problem, with inflows having abruptly given way to outflows.

The mainstream macroeconomic advice to China – boost domestic consumption and overvalue the renminbi to cut exports – fails the marshmallow test. It encourages overconsumption, underinvestment, and rising unemployment in a rapidly aging society, and in a world that can make tremendous use of China’s high saving and industrial capacity.

The right policy is to channel China’s high saving to increased investments in infrastructure and skills in low-income Africa and Asia. China’s new Asian Infrastructure Investment Bank (AIIB) and its One Belt, One Road initiative to establish modern transport and communications links throughout the region are steps in the right direction. These programs will keep China’s factories operating at high capacity to produce the investment goods needed for rapid growth in today’s low-income countries. China’s currency should be allowed to depreciate so that China’s capital-goods exports to Africa and Asia are more affordable.

More generally, governments should expand the role of national and multilateral development banks (including the regional development banks for Asia, Africa, the Americas, and the Islamic countries) to channel long-term saving from pension funds, insurance funds, and commercial banks into long-term public and private investments in twenty-first-century industries and infrastructure. Central banks and hedge funds cannot produce long-term economic growth and financial stability. Only long-term investments, both public and private, can lift the world economy out of its current instability and slow growth.

© 2016 Project Syndicate.

$100 million for retirement pilot programs in Obama budget proposal

Posted on January 28, 2016 by -

The management of Retirement Clearinghouse, LLC, a Charlotte-based technology company, has spent more than a year promoting automatic, electronic 401(k)-to-401(k) transfers of small account balances for job changers, for which it built, operates and markets a proprietary platform.

Efforts in that area got a presidential endorsement this week boost when President Obama unveiled his fiscal 2017 budget, which included funding for pilot programs to test “auto-portability” concepts.

The 2017 budget package “will propose a $100 million grant pilot program to determine how best to reach self-employed or those with stop-and-start work patterns, as well as a pilot program to encourage states to develop their own private-sector programs to increase access,” Pensions & Investments reported this week.

Retirement Clearinghouse said that it is not in line for any federal funding, which is expected to be directed to non-profit groups. But executives said that the pilots could raise public awareness of auto-portability and, potentially, help make it a standard feature of the defined contribution system.

By preventing the cash-outs of small accounts that often occur when plan participants change jobs, such programs could reduce “leakage” from retirement savings plans. A significant number of participants lose track of their accounts when they change jobs.

Under the Retirement Clearinghouse program, accounts worth $5,000 or less are automatically moved to a “safe harbor” (regulation-compliant) rollover IRA at Retirement Clearinghouse when participants leave a plan without taking action on their accounts. If and when the employee enrolls in another 401(k) plan, the money transfers to that plan.   

Retirement Clearinghouse is majority-owned by Robert L. Johnson, founder of Black Entertainment Television, and led by CEO Spencer Williams, a former MassMutual executive. Beginning in 2014, they have talked to officials at the Labor and Treasury Departments, legislators, industry associations, financial services companies and plan sponsors about the ability of their product to contribute to the public policy goal of reducing leakage and promoting retirement security. 

In a press release, Johnson thanked “the bicameral group of Congressional members, led by Senator Patty Murray (D-Wash.), who in November urged the Employee Benefits Security Administration to issue guidance on auto portability for employers.”

According to the release:

“Retirement Clearinghouse has been working with the Departments of Labor and Treasury, legislators on Capitol Hill, industry associations, financial services companies and plan sponsors to deliver portability solutions to large and small employer, said Spencer Williams, President and CEO of Retirement Clearinghouse.

“Beginning in 2014, Retirement Clearinghouse has been engaged in an open and collaborative dialogue with a group of the largest retirement services providers about implementing, on a national scale, a utility model which has all the elements of a cooperative structure, enabling workers to seamlessly and automatically move their 401(k) accounts from employer to employer—through a safe harbor IRA—when they change jobs. Through its experience in the field, and guided by feedback from key stakeholders, Retirement Clearinghouse has come to understand that such a structure provides the most benefit to participants, plan sponsors, retirement service providers and other stakeholders in the U.S. retirement system.

Funding for auto-portability pilot programs was one of several retirement-related efforts in the President’s proposed budget, which must be approved by the Republican-led Congress. The budget also included “new rules that would make it easier for small businesses to join together to form 401(k) retirement plans for their workers, even if the businesses are in different industries.”

© 2016 RIJ Publishing LLC. All rights reserved.

Bank of Montreal introduces Smart Folio, a robo-advice solution

Posted on January 28, 2016 by -

Facing competition from independent online advice startups and the approach of stronger fee disclosure requirements this summer, the Bank of Montreal has become the first of the major Canadian banks to offer a “robo-adviser.”

Called “SmartFolio,” the financial advice service, developed in-house at BMO, directs online customers to a portfolio of exchange-traded funds depending on their income, investment horizon and tolerance for risk. 

The other four big Canadian banks—Royal Bank, Toronto-Dominion, Bank of Nova Scotia and Canadian Imperial Bank of Commerce—are expected to develop their own robo-advice solutions, but BMO is first on the market.

The target customer for SmartFolio is someone who is ready to start investing, but not yet prepared for a full-fledged financial plan.  Prospective clients access SmartFolio through a computer, tablet or smartphone. They fill out an online questionnaire that gathers information about their investment goals, their time horizon and their tolerance for risk.

After some online explanations of volatility and the relationship between risk and reward, the client is enrolled in one of five model portfolios made up of BMO’s own exchange-traded funds, or ETFs. More options may be available in the future, according to Charyl Galpin, head of BMO Nesbitt Burns, a part of BMO Wealth Management.

Customer support is provided via live chat, email and telephone. The minimum account size for SmartFolio is $5,000 and fees are charged as a percentage of assets under management, starting at 70 basis points for the first $100,000 and gradually moving lower to 40 basis points for amounts above $500,000.

For a $5,000 account, which is the minimum to invest, the annual fee comes out to $60, according to an online calculator featured on the SmartFolio site. There may be additional management expense ratio fees on the ETFs offered.

Although BMO is touting the service as low cost, its fees are somewhat higher than those offered by some of the independent Canadian robo-advisors. There are numerous standalone robo-adviser services in the Canadian market, including WealthSimple, NestWealth and WealthBar.

Wealth Simple and WealthBar offer free accounts for those investing less than $5,000. At WealthSimple, clients whose accounts are between $5,000 and $250,000 pay 50 basis points, while WealthBar charges 60 basis points.  

The arrival of fee transparency in Canada is also driving the development of robo-advice offerings. Beginning July 15, Canada’s investment brokers and dealers will have to itemize the annual costs of the service fees, embedded commissions, and referral fees and report them to their clients.

Galpin says BMO started SmartFolio as a way to fill a “gap in the market.” She estimates the demand for online portfolio management will reach $300 billion a year in North America by 2020.

© 2016 RIJ Publishing LLC. All rights reserved.

Better times ahead for U.S. active equity funds: Cerulli

Posted on January 28, 2016 by -

Managers of active U.S. equity funds face negative factors in 2016—including a potential ‘risk-off’ stance in the run-up to the quadrennial election, more interest rate hikes, and the mixed blessing of high P/E ratios—but there are some positives, said Cerulli Associates in the latest issue of The Cerulli Edge – European Monthly Product Trends edition.

The prospect of a rising dollar should make U.S. equities attractive to Europeans, and investors will expect active strategies to perform better than passive funds in volatile markets, Cerulli analysts said in a release.

For instance, the S&P 500 was flat in dollar terms last year and underperformed European benchmarks. But in euro terms, it rose 20% for year ending November 30, 2015. Allianz’s Ireland-domiciled US equity fund, investing in standard names such as GE, returned 18.7% despite trailing the benchmark.

“Fed hikes may well further strengthen the dollar, making U.S. exports less competitive, which held back some companies in 2015. However, for a European investor in a US fund, there is compensation in a strong dollar, if the product is unhedged,” said Barbara Wall, Europe managing director at Cerulli.

Cerulli is bullish on the U.S. Its analysts noted that domestic investment in infrastructure would help domestically focused industrial names. “A strong U.S. economy will help to generate sustainable corporate profits, dividends, strong M&A activity, and share buyback programs,” Wall said in a release, conceding that China-inspired turmoil may see further outflows in equity funds in the early months of 2016.

Then there’s the expectation that active funds do better in difficult times. “Stock-picking may be key if investors are to realize upside, while limiting downside if the market goes as badly wrong as some fear. Firms with well-established track records, that have been selling reasonably well, can hope to make further gains, especially if the turmoil sees some fall by the wayside,” Gorman said in a release.

“The recent pullback has made many companies look considerably cheaper,” he added. He pointed to T. Rowe Price’s Luxembourg-domiciled U.S. Blue Chip equity fund and MFS Investments’ actively managed U.S. Value Fund as two steady performers. 

“U.S. equity funds with decent records of picking the right stocks can hope to sell in Europe, given the lack of alternatives. The upside potential is clear, while the better funds can mitigate the losses during the tougher times. Managers should be using established channels to extol the virtues of U.S. equity funds, as well as pushing to appear on the growing raft of self-directed platforms,” said Wall in the release.

© 2016 Cerulli Associates.

Five lessons for advisors from Vanguard CEO

Posted on January 28, 2016 by -

Advisors shouldn’t fear but rather should take advantage of the demographic, technological and consumer-oriented regulatory factors that are roiling their industry, said Vanguard CEO Bill McNabb in an address at ETF.com’s Inside ETFs Conference in Hollywood, Fl., this week.

Vanguard’s large family of ETFs and index mutual funds, its low-cost, direct-to-consumer business model and its hybrid robo/human advice services have made it a beneficiary of current trends. According to Morningstar, Vanguard captured more fund flow in 2015 than the next nine mutual fund companies combined. 

“Financial advice is having a moment,” McNabb said in a release. “The rise of more technology-based solutions has made advice part of a national conversation in the financial press and in the popular media. The best advisors are seizing this moment to tell their story.”

McNabb offered five concepts for advisors to consider:     

We are in a low-cost revolution. Today’s investor expects to pay less for investment funds and services. Robo offerings are creating a new pricing floor. A traditional advisory firm can provide the in-person, individualized services that a robo advisor cannot. However, traditional advisors cannot hang their hat on that fact alone.

Advisors must adapt to a changing industry. Financial advice is evolving and technology is part of that evolution. Most advisors have been using financial technology tools for years. How can advisors further automate routine elements of their practice and digitize and mobilize some of the client experience?

In some ways, the world is not as complex. Investments are becoming more commoditized. Portfolio construction also is becoming commoditized. These functions can now be largely automated through model portfolios and even through target-date funds. That’s no longer a differentiated selling point for advisors.

In other ways, the world is not as simple. For most investors entering retirement, advice is the answer. And with the Baby Boom generation now entering retirement, demand for advice is great. The questions retirees face are increasingly complex.  Rules of thumb and single-product solutions rarely provide a complete answer.        

Advisors must tell their story. To differentiate themselves, advisors must explain their value proposition. http://www.vanguard.com/pdf/ISGQVAA.pdf

Vanguard has published research showing how advisors can add up to 3% in net portfolio returns over time for their clients with Vanguard Advisor’s Alpha, a wealth management framework that focuses on portfolio construction, behavioral coaching, asset location, and other relationship-oriented services.
Vanguard offers 68 low-cost ETFs in the U.S., with more than $483 billion in assets, up 13.2% from year-end 2014. The firm manages the $57.4 billion Vanguard Total Stock Market ETF (VTI), the $40.4 billion Vanguard S&P 500 ETF (VOO), and the $34.5 billion Vanguard FTSE Emerging Markets ETF (VWO).

© 2016 RIJ Publishing LLC. All rights reserved.

More Than a Nice Interface?

Posted on January 21, 2016 by -

Fidelity’s office tower soars over downtown Boston, and Vanguard’s corporate campus sprawls near Malvern, Pa. Betterment, the “robo-advisor” that yearns to compete with those direct-to-investor giants, rents three post-industrial lofts in a landmark building with a white cast-iron façade on W. 23rd St. in New York.

Though still relatively small (about 130,000 clients and $3.5 billion under management) venture capital-backed Betterment has big ambitions. Its 35-year-old CEO, Jon Stein, a HarvardAB/ColumbiaMBA grad and son of Dallas urban planners, aims to disrupt the conventional financial services industry—not just at the individual level but at the advisory platform and institutional levels as well.

RIJ talked with Stein (above) for an hour recently at Betterment headquarters (below, right). The offices were open-plan, factory chic. Clusters of Millennials sat at screens on workbench-type tables under exposed ventilation ducts. No isolation-enforcing cubicles, no sound-absorbing carpets. Commuter bicycles mounted on the walls. It was lunchtime, so the bearded, tattooed chef—recruited from a posh Manhattan restaurant, Per Se—could be seen behind trays of hot shepherd’s pie at the far end of the room. 

RIJ: It seems like the Vanguard and Fidelity are more like the integrated steel mills that employed tens of thousands of people and produced millions of tons of steel, and Betterment is like the automated mini mills that came along in the 1980s. Would that be an accurate analogy? 

Stein: Ironically, we do think of ourselves as more like the vertically integrated steel mill. We are a full-stack solution. That’s our competitive advantage. We’ve rebuilt the plumbing, rebuilt the banking APIs [application programming interfaces], the trading, the recordkeeping, and the back-end infrastructure. That gives us efficiency advantages. We also have the user-experience advantages, like Apple. Because we make the products we sell, we can provide a better user-experience. So we have both. We do more than you think we do. 

RIJ: How would you describe the business you’re in?

Stein: We think of ourselves as having several businesses. One is the retail business. We have retail customers who are solicited to sign up, usually at the recommendation of a friend or family member. They tell us about their goals, and we create and manage their portfolios. That’s the retail business. We also have the institutional business. We’re selling to registered investment advisors. We have over 200 firms on the Betterment platform. That’s a white label product, with the advisor’s name on it. Schwab doesn’t offer that. TDAmeritrade doesn’t offer that. Betterment HQ in NYC

RIJ: So, a company like Envestnet would be a competitor? 

Stein: Yes, we compete with an Envestnet, or a Charles Schwab, in that space. Then we have the 401(k) business. We built the first recordkeeper that combines recordkeeping with ETFs. 

RIJ: People with experience in the 401(k) business tell me that building a recordkeeping system from scratch is sort of an IT nightmare. 

Stein: I guess I’m a glutton for punishment. Actually, recordkeeping is easier with ETFs. And the whole thing is easier because we have no legacy systems. We’ve been investing in recordkeeping on the retail side for eight years.

RIJ: But you outsource a lot of what the big fund companies do internally, right? You use APEX, for instance, for clearing and execution.

Stein: APEX doesn’t do much for us. We send trades through them.

RIJ: What functions do you do in-house?

Stein: We’re the custodian. We manage the funds. We do the accounting, the statements, the confirmations, and all the regulatory functions. We’re not outsourcing any of that. We manage the money. It sits with Betterment. It’s true that we don’t offer anything like a Vanguard Windsor II Fund [an actively-managed large-cap value fund]. We provide a simpler, streamlined solution. But it’s still end-to-end, and the advice is more sophisticated than Vanguard offers.

RIJ: OK. I had the impression that your core competency was the way you on-boarded new customers—that you applied the kind of frictionless interface that works for an Uber or an Airbnb to the investment business. You’ve got sophisticated ways of keeping track of prospects, and automated e-mail programs that nudge new clients through the enrollment and payment process. I thought that was your key distinction.

Stein: The on-boarding is just the tip of the iceberg. We make it easier to fund your account. You can fund your account same day that you open it. You can’t do that with anybody else. To make that on-boarding experience better, we have the only e-signed paperless rollovers in the industry. You can rollover from 401(k) to a Betterment IRA with an e-signature and a click. We couldn’t do those things if we hadn’t built all the plumbing ourselves.

RIJ: But it’s still true that you’re benefiting in major ways from the accomplishments of companies that went before you. If custom asset allocation hadn’t become a commodity, you wouldn’t be here.

Stein: It’s true that we couldn’t be building this business without the help of two things: The reduced cost of building information technology today, and the emergence of exchange-traded funds. Today you can get a globally diversified portfolio through an ETF, using one API—through one pipe—and you can go to any vendor [ETF manager] to get it. That’s good for us. We have access to one connection who gives us access to the whole world of ETFs, without any additional build and without any special distribution agreements. We can use iShares or Vanguard or Schwab ETFs. The money is spread out among multiple ETFs and multiple providers. With open architecture, we get the lowest costs and the most liquidity.

RIJ: Then there’s the arrival of the smartphone. That changed everything.

Stein: We now get 60% percent of our log-ins from our mobile app. What’s happening with phones is like the early stage of what happened with desktops. Everything moved to websites. Now everything’s moving to mobile.

RIJ: Let’s talk about fintech and the regulatory environment. The Secretary of Labor himself has said he welcomes the robo-advice industry and thinks it’s good for Baby Boomers who need help managing their retirement money. Some in the fintech industry have said the Department of Labor’s fiduciary proposal can only help their type of low-cost, unbiased advice. Have you personally spoken with people at the DOL about synergy between robos and regulation?

Stein: We have had meetings with policymakers and at DOL and we’ve written a letter supporting their initiative. I wouldn’t say there’s been ‘frequent’ communication between us and the Department of Labor.  I’m not a policymaker. I don’t read the proposals or the bills; I rely on smart people for that. The gist of it is that the DOL wants to simplify things. Their goal, whether you think they’re going about it in the right way or the wrong way, is that anybody who gives advice to retirement investors should have their interests well-aligned with the client’s interests. I think that’s a noble ambition. 

RIJ: Where do you think all of this is headed? The conventional wisdom is that there will be a convergence that combines robo-advice with a human touch. You already offer phone support, right?

Stein: We’ve got a dozen people answering the phones. We have customer support seven days a week, 12 hours a day. We’re recognized by Consumer Reports as having the best customer service. I think that’s a testament to the fact that we’re putting people first.

RIJ: Yes, but do you foresee combining your technology with in-house human advisors, the way Vanguard has.

Stein: I don’t see a big distinction between the human role and the role of technology. People have always used technology to give advice. I can’t imagine any investment advisor working without technology. We have advisors using our technology today. It’s a big deal for them because of our investments in a better customer experience. We don’t see ourselves as replacing human advisors. Our customers get great advice from talking to our phone team. But they also don’t have to talk to anyone if they don’t want to. I think we do a better job, even without an expensive call center.

RIJ: What about the status quo do you think isn’t working, and what are you trying to fix?

Stein: On average, Americans have a real problem with saving enough for retirement. Today, only 10% to 15% of retirement spending comes from personal savings. A third comes from Social Security. Some comes from working in retirement and the rest comes from personal savings. In the system we’ve designed, most people are at a loss for how much they should be saving. We’ve done a disservice to our population. The way we designed the 401(k) system—it’s like we said to people, ‘You can have access to any medicine you want, but there’s no doctors and no pharmacists.’

RIJ: Speaking of retirement spending, I noticed that you have a retirement income program that calculates monthly withdrawals that vary with the ups and downs of the market. But the example on the website uses a 20-year life expectancy for a hypothetical 65-year-old woman. A lot of planners are now using a 30-year life expectancy. 

Stein: Even with a 20-year timeline, we set it up so that you could live for 99 or 100 years, and even when you get there, it’s likely that you will still have significant savings left over. It’s almost too conservative. You could probably spend more than we recommend. I don’t worry about anyone who uses our method running out of money.

RIJ: What’s your exit strategy for you and your venture cap backers? Are you planning to take Betterment public?

Stein: We want to go public. That’s the ambition of the company. 

RIJ: Do you think there’s any danger that going public might hurt your relationships with your customers? The current version of the DOL’s fiduciary proposal requires advisors to act ‘solely’ in the interests of their clients. But public companies have to put the shareholder first. Do you see a potential conflict there?

Stein: Not at all. An IBM or a General Motors or an Apple couldn’t succeed if they didn’t have their customers’ interests in mind. When companies stop putting their customers first, the world punishes them. The capitalist system isn’t perfect, but it produces great things. We all rely on it.

RIJ: I was wondering where the name ‘Betterment’ came from.

Stein: The name came from an old-fashioned word for making things better. I liked the idea and liked the name. I probably heard it at home because my parents used it. They were city planners in Dallas, where I grew up, and they would talk about the ‘betterment’ of public streets. 

RIJ: What led you into finance?

Stein: I happened into financial services, and I was appalled at what I saw. I was frustrated by the products that the banks were building. I thought, ‘There’s got to be a better way.’

RIJ: You could have made millions on Wall Street, and then quit to do anything you wanted.

Stein: It’s true that I’m not making as much money as I could be right now, but I’ve got the best job in the world.

RIJ: Thank you, Jon. 

© 2016 RIJ Publishing LLC. All rights reserved.

The January sell-off in stocks—a delayed reaction to the Fed?

Posted on January 21, 2016 by -

Any possibility of a causal link between the Federal Reserve’s quarter-point rate hike in mid-December and the 10.7% correction in equity markets since the start of 2016 seemed to be eliminated by the fact that equities did quite well during the last two weeks of the year.

But a Morningstar analyst remarked in a report this week that the $16.8 billion net flow into U.S. equity funds in the month of December—the most in two years—seemed to be a “cyclical phenomenon that probably has more to do with year-end rebalancing” than with optimism about equities.

Overall, equity funds experienced negative flows after two years of inflows. The exception was international-equity funds. They led all category groups in terms of highest inflows for the calendar year, collecting $207.6 billion.

Asked if year-end re-balancing might have delayed an equity sell-off until January 4,  Morningstar’s Alina Lamy told RIJ, “It is possible. The trend we’ve repeatedly observed is that managers tend to rebalance in December. The challenge they’re facing is that they rebalance in December regardless of whether market conditions are favorable or not. So it is possible that we could have seen outflows from U.S. equity funds in December were it not for the year-end rebalancing trend.”

The inflow into U.S. equities in the last month of the year also belied the fact that the S&P500 Index finished the year down 1.4%. “In general, flows tend to follow performance,” Lamy wrote in the Morningstar report, “but such a strong inflow into a category that delivered a negative return for the year seems to indicate that investors are looking more toward the future.

“With the Federal Reserve raising rates for the first time in 10 years and the European Union maintaining its quantitative-easing measures, investors seem to believe there is higher potential for growth in Europe and Asia than in the United States. The high inflow to international equity therefore appears more like an anticipatory move at this point.

“Another trend is that a large portion of flows tends to come from funds-of-funds, particularly retirement plans, target-date, and target-risk funds, and these plans have been increasing allocations to international equity. A majority of these large international-equity flows we’ve seen come through the retirement channel. Vanguard is just one example; they have been enhancing diversification for their target-date funds by increasing their international equity exposure.”

Taxable-bond funds sustained the worst outflows by category group in December, $29.0 billion, most of them driven by the high-yield category, which saw outflows of $11.2 billion for the month—the third-largest monthly outflow since 1993.

Third Avenue Management’s announcement that it would liquidate its high-yield bond fund, Third Avenue Focused Credit, without allowing investors to redeem their shares right away, along with falling oil prices, helped ignite the selling. 

With only a few exceptions, passive funds gained at the expense of active funds in December and in 2015 overall. Indeed, two of only three firms with inflows to their actively managed funds in December were passive shops—Vanguard and State Street.

Franklin Templeton suffered heavy outflows in December, with two of the firm’s fixed-income offerings among the active funds with the highest outflows. Templeton Global Bond and Franklin Income had outflows of $2.2 billion and $1.7 billion, respectively.

© 2016 RIJ Publishing LLC. All rights reserved.

Advisors Provide Icing, But Retirees Need Cake

Posted on January 21, 2016 by -

After a quarter-century of designing and building retirement planning software, I find myself nearing my own retirement. It’s time to ponder lessons that I have learned or failed to learn.  One thing I’ve learned, the hard way, is that most financial services companies and advisors don’t especially want to change the way they serve (or under-serve) most retirement clients, or to radically change the software they do it with.  

Lesson One. For most people, retirement planning is not about investments, taxes, estate planning, or even retirement income. It’s about other stuff. It’s about where to live, what to do, what relationships to pursue or drop, and how to solidify their legacies. It’s about focusing on what matters and, surprisingly often, it isn’t money.

True, people pursue their non-financial goals in ways that are enabled or constrained by money. So if advisors weren’t engaged in the financial minutiae of retirement planning, we’d miss important details. But in most cases those details are secondary or even irrelevant. 

And we can’t work magic. Most people, when they retire, already hold all the cards they can ever play. The present value of their net worth and their probable future income streams are more or less determined. We can advise them to add risk or exercise more caution at certain times, but the success of those strategies depends on what cards their opponent (i.e., Fate) plays. There are no guarantees, just probabilities.

Lesson Two. Most of the advice our industry offers won’t help people who are already headed for financial trouble. They need to add to the value of their financial resources, relative to expected expenses. Moving money around won’t do that reliably. Often it just adds risk and strengthens Fate’s hand.

Most retirees can improve their financial situation in only two ways: By working more and/or slashing expenses. That is the unappetizing two-layer cake upon which our fancy planning serves merely as icing. The icing has value, but the millions of people who are approaching retirement need to find more cake or go on a diet.

Lesson Three. There’s no market for the kind of planning software that would address this problem.

In 1991, I began imagining software that could give people exactly what they need. It would deal with every financial issue retirees face, with particular emphasis on those with the biggest impact. It would deal with these issues in an integrated way and produce a coherent plan. The software would support complexity, but be simple to use.   

Fifteen years later, I had a prototype and took it on the road. But the big financial services companies didn’t want it. The software either required actual cooperation among their silos, or they didn’t offer all the same products and services that the software encompassed.   

Financial advisors didn’t want to deal with it either, it turned out. The software either did too much for them, they said, or it operated in unfamiliar ways, or required new workflows. I believed in it because it worked for my clients and myself. But the product’s success began and ended there. 

Employers, plan sponsors or other organizations weren’t seriously interested either. A few considered licensing it, but they were reluctant to endorse (and be held liable for) what they didn’t understand. And they didn’t understand it.

Finally, I began offering it to individuals. Many of them have liked the software, and some have renewed it year after year to keep their plans on track. But without a campaign to drive consumer awareness—an effort that only big companies like Apple can afford—I couldn’t generate enough demand.

The Bottom Line. Naturally, it bothers me that my small company reaped only thousands of dollars in sales after spending millions on product development. But my frustration runs deeper than that. Fifteen years ago, I was certain that, if given the right software, the retirement industry would embrace it, and use it to address the non-investment needs of the mass market. In other words, I believed the industry would change. Since 2007, I’ve learned why software like mine hasn’t been widely adopted. The industry, for reasons of its own, has little desire to change.   

© 2016 RIJ Publishing LLC. All rights reserved.  

Fed to roll over Treasuries as they mature

Posted on January 21, 2016 by -

About $216 billion in U.S. Treasury securities will mature in 2016, but according to a speech this week by New York Fed president William C. Dudley, the Federal Reserve will roll them over rather than let its $2.4 trillion inventory of Treasuries shrink.

The reinvestment policy is designed to be interest-rate neutral. While the Fed won’t increase its overall Treasury holdings, it will still be acting as a buyer of Treasuries, thus maintaining demand, establishing a desired price floor and preventing upward pressure on yields. 

Addressing the Economic Leadership Forum in Somerset, NJ, last Sunday, Dudley said:

“As we noted in the December FOMC statement, we anticipate that we will continue reinvestment ‘until normalization of the federal funds rate is well underway.’

“I think this policy makes sense not only because the decision to end reinvestment will represent a further tightening of monetary policy, but also because it is difficult to assess ahead of time the impact of such a decision on financial market conditions given the lack of historical experience.

“I also believe that continuing reinvestment until the federal funds rate reaches a higher level makes sense. We want to ensure that we have the ability to respond to adverse shocks by easing monetary policy by lowering the policy rate. Having more ‘dry powder’ in the form of higher short-term interest rates seems more desirable than less dry powder and a smaller balance sheet.

“My view is that we should not set a numerical tripwire for ending reinvestment. If the economy were growing very quickly and the risks of an early return to the zero lower bound for the federal funds rate were deemed to be low, then I could see ending reinvestment at a relatively low federal funds rate.

“In contrast, if the economy lacked forward momentum and the risks of a return to the zero lower bound were judged to be considerably higher, I would want to continue reinvestment until the federal funds rate was higher.  

“In my view, good monetary policy-making requires ongoing assessment and judgment, not the adherence to mechanical rules. I know market participants desire certainty, but in the uncertain world in which we live, that desire is not consistent with the policy that would best achieve our objectives.”

© 2016 RIJ Publishing LLC. All rights reserved.

Danish bank offers retail robo-investing in ETF portfolios

Posted on January 21, 2016 by -

A Danish financial institution, Saxo Bank, has launched what it calls a “large-scale, truly digital investment solution for retail investors.” The web-based service is called SaxoSelect and offers three prefab portfolios built with iShares ETFs from BlackRock.

Saxo Bank clients can choose between a Defensive, Moderate, or Aggressive ETF portfolio. The portfolios are managed by Saxo Bank and are available in selected currencies—initially euros and sterling—and charge an all-in service fee of 90 basis points per year.

“Technology will profoundly change the asset management industry,” said Saxo Bank CEO Kim Fournais, in a press release. “Access to technology, demand for transparency, and focus on performance will change the way individuals manage their savings.”

“The growth of the European ETF market shows no sign of abating, but it is paramount that these tools are delivered to investors in a way that complements their digital habits,” said Michael Gruener, co-head of iShares EMEA Sales at BlackRock.

The Saxo Bank Group is an online, multi-asset trading and investment specialist offering trading and investment technologies, tools and strategies. Founded in 1992 and headquartered in Copenhagen, Saxo employs 1,450 people in 26 offices in five continents.

At December 31, 2015, BlackRock’s AUM was $4.645 trillion, including more than $1 trillion in over 700 iShares funds. The firm has about 13,000 employees in over 30 countries and a presence in North America, South America, Europe, Asia, Australia, the Middle East and Africa.   

© 2016 RIJ Publishing LLC. All rights reserved.

Bank annuity sales dip 2.5% in first three-quarters of 2015

Posted on January 21, 2016 by -

Income earned from the sale of annuities at bank holding companies (BHCs) amounted to $2.62 billion in the first three quarters of 2015, down 2.5% from the $2.69 billion in the first three quarters of 2014, according to Michael White Associates (MWA), Radnor, Pa. 

Wells Fargo & Company (CA), Morgan Stanley (NY), Raymond James Financial, Inc. (FL), JPMorgan Chase & Co. (NY), and Bank of America Corporation (NC) led all bank holding companies in annuity commission income. 

Third-quarter BHC annuity commissions were the sixth-best quarterly annuity commissions in history at $888.5 million. They were down 0.8% from $893.0 million in second quarter 2015, however, and down 0.3% from $888.5 million earned in third quarter 2014.

Of the 583 bank holding companies surveyed:

  • 49.1% (286) participated in annuity sales activities during the first three quarters of 2015.
  • Their $2.62 billion in annuity commissions and fees constituted 17.6% of their total mutual fund and annuity income of $14.84 billion.
  • The $2.62 billion represented 39% of total BHC insurance sales volume (i.e., the sum of annuity and insurance brokerage income) of $6.71 billion.

Of the 6,270 banks, 876 or 14.0% participated in annuity sales activities, earning $594.8 million in annuity commissions or 22.7% of the banking industry’s total annuity fee income. Bank annuity production was down 2.5% from $644.4 million in the first three quarters of 2014.

Top 10 Bank Holding Companies in Annuity Sales

“Of 286 large top-tier BHCs reporting annuity fee income in the first nine months of 2015, 180 or 62.9% were on track to earn at least $250,000 this year,” said Michael White, president of MWA and author of the study, in a release. Of those 180, 81 BHCs or 45.0% achieved double-digit growth in annuity fee income.

“That’s a 7.2-point decrease from the same period of 2014, when 93 institutions or 52.2% of 178 BHCs on track to earn at least $250,000 in annuity fee income achieved double-digit growth. This decreased double-digit growth in annuity revenues among large BHCs demonstrates the continued weakening of the bank annuity sector.”

Over two-thirds (68.4%) of BHCs with over $10 billion in assets earned third quarter year-to-date annuity commissions of $2.49 billion, constituting 94.8% of total annuity commissions reported. This was a decrease of 2.5% from $2.53 billion in annuity fee income in the first three quarters of 2014.

Among this asset class of largest BHCs in the first three quarters, annuity commissions made up 17.4% of their total mutual fund and annuity income of $14.35 billion and 41.2% of their total insurance sales revenue of $6.04 billion.

Banks with $1 billion to $10 billion

Banks in the next tier didn’t fare as well. With 45.2% participating in annuity sales, BHCs with assets between $1 billion and $10 billion recorded a decrease of 18.4% in annuity fee income. Sales fell to $128.9 million in the first three quarters of 2015 from $158.0 million in the first three quarters of 2014 and accounted for 19.3% of their total insurance sales income of $667.0 million.

Among BHCs with assets between $1 billion and $10 billion, leaders included:

  • Santander Bancorp (PR)
  • Stifel Financial Corp. (MO)
  • Wesbanco, Inc. (WV)
  • National Penn Bancshares, Inc. (PA)
  • First Commonwealth Financial Corporation (PA)

The smallest community banks, those with assets less than $1 billion, were used as “proxies” for the smallest BHCs, which are not required to report annuity fee income. Leaders among bank proxies for small BHCs were:

  • The Oneida Savings Bank (NY)
  • Sturgis Bank & Trust Company (MI)
  • The Security National Bank of Sioux City, Iowa (IA)
  • Bank of Springfield (IL)
  • Bank Midwest (IA)

These banks with assets with less than $1 billion generated $50.9 million in annuity commissions in the first three quarters of 2015, down 6.7% from $54.5 million in the first three quarters of 2014. Only 10.6% of banks this size engaged in annuity sales activities, which was the lowest participation rate among all asset classes.

Among these banks, annuity commissions constituted the smallest proportion (18.7%) of total insurance sales volume of $271.4 million.

Among the top 50 BHCs nationally in annuity concentration (i.e., annuity fee income as a percent of noninterest income), the median year-to-date Annuity Concentration Ratio was 5.60% at the end of third quarter 2015.

Among the top 50 small banks in annuity concentration that are serving as proxies for small BHCs, the median Annuity Concentration Ratio was 16.04% of noninterest income.

The findings are based on data from all 6,270 commercial banks, savings banks and savings associations (thrifts), and 583 large top-tier bank and savings and loan holding companies (collectively, BHCs) with consolidated assets greater than $1 billion operating on September 30, 2015. Several BHCs that are historically insurance or commercial companies have been excluded from the study.

© 2016 Michael White Associates.

Christie nixes state-run IRA in favor of private marketplace

Posted on January 21, 2016 by -

Twelve hours after New Jersey’s governor Chris Christie vetoed a bill creating a state-administered retirement plan for private-sector workers, the state assembly voted to cooperate with him and settled on a compromise plan, NAPANet reported this week. 

The original bill, similar to legislation in California, Illinois and other states that creates tax-deferred workplace retirement savings plans for American workers whose employers don’t offer one, would have required New Jersey small employers with 25 or more workers to set up an IRA plan funded by payroll deduction.

But Christie, a Republican, objected to the mandatory nature of the plan and expansion of state government and rejected the bill. So the Democratic-controlled legislature authorized the creation of a “small business retirement marketplace,” modeled after one established in Washington state last year. A marketplace was one of three options outlined in an Interpretative Bulletin the Labor Department issued in November at the direction of President Obama.

The new legislation is now called the New Jersey Small Business Retirement Marketplace Act, to be aimed at firms with fewer than 100 qualified employees (ERISA eligibility) at the time of enrollment. A majority of New Jersey workers work in such firms.

The bill Christie vetoed—which had been sponsored by the Democratic leaders in both houses of the state legislature—would have created a Secure Choice Savings Program. Businesses with fewer than 25 employees could choose to offer the plan to their workers. While administered by a seven-member board of state officials, the program would not have been guaranteed by the state or require state funding, though the Garden State would initially have had to cover start-up costs.

Christie referred to the mandatory nature of the retirement plan, similar to programs taking shape in California and several other states, as a reason for his decision to veto legislation that would have enabled it.

“I believe that the approach taken by the Legislature — mandating participation under a threat of fines for not participating — is unnecessarily burdensome on small businesses in New Jersey,” Christie said.

Specifically, he expressed concern that the state would have borne the initial cost of the program and that “the bill creates yet another government bureaucracy to oversee and implement the program, while there are plenty of private sector entities with particular expertise that can perform this function instead.”  

The marketplace will offer three options: a SIMPLE IRA, a payroll deduction IRA and a MyRA. Firms participating in the marketplace will have to offer at least two investment options, including a target date fund, or similar fund, and a balanced fund.

Participating employers will not be assessed an administrative fee or surcharge, and the program is directed not to charge enrollees more than 1% in total annual fees.

The new bill directs the State Treasurer’s office to:

  • Establish a protocol for reviewing and approving the qualifications of all participating financial services firms;
  • Design and operate a website that includes information on how eligible employers can voluntarily participate in the marketplace;
  • Develop marketing materials about the program; and
  • Identify and promote tax credits and benefits for employers/workers related to participating in the program.

© 2016 RIJ Publishing LLC. All rights reserved.

The Bucket

Posted on January 21, 2016 by -

MetLife’s strength and credit ratings placed “under review” by A.M. Best

A.M. Best said it has placed the financial strength rating of A+ (Superior) and the issuer credit ratings (ICR) of “aa-” of the primary life/health insurance subsidiaries of MetLife, Inc., “under review with developing implications.”

“The actions follow MetLife’s public announcement on Jan. 12, 2016 that it will pursue the separation of a substantial portion of its U.S. retail segment and is evaluating structural alternatives for this separation. These alternatives include a public offering of shares in an independent, publicly traded company, a spin-off or a sale,” an A.M. Best release said.

“The ratings will remain under review until A.M. Best receives more definitive direction from the management of MetLife on the final separation strategy to be pursued, as well as the ultimate capital structure and allocation between the organizations,” the release said.

 “The new retail focused company would maintain the more capital intensive lines of business, including variable annuities with living benefit riders and universal life with secondary guarantees, which would result in a significant amount of exposure to market volatility and interest rate risk. However, at this time the level of capitalization for this company has not been set,” the release continued.

“A.M. Best acknowledges that MetLife will maintain its industry leading position in the group insurance market and will continue to focus on growing its corporate benefit funding segment, which includes structured settlements and pension risk transfer business. The company will also focus on increasing its international presence in which it holds several market leading positions in both mature and emerging markets.”

The ratings agency also placed the ICR of “a-”, as well as all issue ratings of MetLife, under review with developing implications, along with the FSR of A (Excellent) and the ICRs of “a+” of MetLife’s property/casualty companies.

The P/C companies include Metropolitan Property and Casualty Insurance Company, seven fully reinsured subsidiaries and a separately rated subsidiary, Metropolitan Group Property and Casualty Insurance Company (together referred to as MetLife Auto & Home). 

Canadian pension funds gain access to China’s capital markets

The Ontario Pension Board (OPB) and the Canada Pension Plan Investment Board (CPPIB) have become the first pension funds to gain access to China’s capital markets under the more flexible of the country’s two main licenses for foreign institutional investors, IPE.com reported this week. 

The two boards have been granted Renminbi Qualified Foreign Institutional Investor (RQFII) status. The China Securities Regulatory Commission (CSRC) approved their licenses in December and announced on Thursday, according to Charles Salvador, director of investment solutions at Z-Ben Advisors.

The $272.9bn (€249bn) Canadian Pension Plan is already active in China. In December, it invested RMB3.2bn (€460m) in Postal Savings Bank of China, one of China’s largest retail banks.

The announcement of the RQFII licenses for the Canadian funds comes after a torrid start to the new calendar year for Chinese markets, with stocks down amid high volatility and the renminbi depreciating. 

Under the RQFII program, investors can invest directly in China’s capital markets. The program resembles the Qualified Foreign Institutional Investor (QFII) platform but it is much less restrictive.

The RQFII provides easier access to the Chinese interbank bond market, doesn’t require investors to allocate at least half of their quota to equities (A-shares), and allows investors to use offshore renminbi or other major currencies to fund their quota. QFII is strictly a US dollar-based program.

The approval of the licenses for the Canadian pension funds signals a change in the approach that pension funds will take to investing in Asia, Salvador told IPE.com.

“If they’re looking to gain direct exposure to A-shares, then they’ll have to think twice about going through the QFII platform,” he said. “They’ll have to think about RQFII, and then they also have the option of the Connect platform.” Connect links the Hong Kong and Shanghai stock exchanges, letting investors invest in eligible Shanghai-listed securities. 

Until now, asset managers, banks, securities companies, insurance companies and hedge funds have used the RQFII program. GIC, Singapore’s sovereign wealth fund, received an RQFII license early last year, but it is unclear if this was granted to it in an asset management capacity.

Voya urges DOL not to encourage state-based defined contribution plans

Voya Financial, Inc. has submitted a letter to the Department of Labor (DOL) commenting on the DOL’s proposal to exempt state-sponsored IRA savings programs from the Employee Retirement Income Security Act of 1974 (ERISA).

The letter acknowledged that “millions of American workers lack access to workplace retirement savings plans, disproportionately those who work for small employers,” and that “Voya agrees there is an urgent need to expand access to workplace retirement savings plans to address the retirement savings gap.”

But the DOL proposal “would enable a 50-state patchwork of government-administered retirement savings vehicles with inconsistent state and local regulations, low annual contribution limits, no opportunity for employer contributions and limited access to retirement planning and advice,” Voya said.

“This patchwork will be difficult, if not impossible, to dismantle once built, and, if other layers of systems or requirements are added at the federal level in the future, there will be an even more confusing ‘50 plus one’ patchwork of state and federal standards, rather than a single, streamlined standard.”

“Automatic enrollment, sufficiently high limits for employee contributions, flexibility for employers to match contributions, access to high quality retirement planning advice and availability of an appropriate range of investment alternatives” would be preferable to the DOL solution, Voya said.

Voya asked the DOL to withdraw its proposal, and instead “seek a uniform federal solution that encourages employers to offer 401(k) and similar retirement savings plans.” The firm urged the DOL to “work with legislators, private industry and other stakeholders to craft an appropriate federal framework… to address the retirement savings gap rather than creating a new state-based system.”

Protective acquires Genworth blocks via re-insurance

Protective Life Insurance Co, a subsidiary of Protective Life Corp., which is a unit of The Dai-ichi Life Insurance Co., Ltd., has acquired via reinsurance certain blocks of business from Genworth Life and Annuity Insurance Co., Richmond, Va., Protective Life Corp. announced this week.

The transaction, announced last September 15, was Protective’s first acquisition since becoming part of Dai-ichi Life and the second largest acquisition in Protective’s history, according to a prepared statement from John D. Johns, Protective’s Chairman and CEO. “We continue to have substantial available capital, and we are ready to pursue other acquisition opportunities,” the statement said.

Liberty Mutual becomes Chile’s biggest P/C insurer

Liberty Mutual Insurance has named Fernando Cámbara Lodigiani as CEO of its Chile operations following its acquisition of 99.6% of Compañía de Seguros Generales Penta Security S.A. Together with its existing company, Liberty Compañía de Seguros Generales S.A., Liberty Mutual Insurance is now the largest provider of property and casualty insurance in Chile.

Private passenger automobile insurance is the single largest line of business for Liberty Mutual’s International operations, which insures more than 5.9 million autos worldwide outside the U.S. The Chilean property/casualty market is estimated at US$3 billion.

Cámbara, the CEO of Penta Security, will lead a unified management team comprised of executives from both companies. Penta Security is the fourth largest non-life insurer in Chile. Its products are consistent to those offered by Liberty Seguros, which has grown substantially in the ten years since Liberty Mutual Insurance first entered Chile.

 In 2014, Liberty and Penta Security generated CL$171 billion and CL$226 billion of direct written premiums, respectively.
The acquisition in Chile adds to Liberty Mutual’s International local business operations that sell to individuals and businesses in three geographic regions: Latin America, including Brazil, Colombia, Ecuador, and Chile; Europe, including Spain, Portugal, Turkey, Ireland and Russia; and, Asia, including Thailand, Singapore, India, Malaysia, China (including Hong Kong) and Vietnam. Private passenger automobile insurance is the single largest line of business for Liberty Mutual’s International operations, which insures more than 5.9 million autos worldwide outside the U.S.

© 2016 RIJ Publishing LLC. All rights reserved.

Video: Income ‘Roundtable’ at The American College

Posted on January 14, 2016 by -

When it comes to naming the essential elements of a retirement portfolio, there are as many opinions as there are financial advisors. Equities, insurance, annuities and reverse mortgages—each of these product categories has its advocates and adversaries.

Mastering just one of these categories can be a challenge, and many advisors focus on only one or two. But, given the endless variety of risks and resources that older clients bring to advisors, retirement specialists ideally need to be conversant in all four. 

Last November 11, four people who teach in the Retirement Income Certified Professional (RICP) designation program at The American College for Financial Services in Bryn Mawr, Pa., gathered to talk about all these product types, plus Social Security claiming strategies, in a two-hour videotaped roundtable discussion.

The quartet of experts included David Littell, JD, professor of taxation at the College, Wade Pfau, Ph.D., director of the College’s New York Life Center for Retirement Income, Jamie Hopkins, the Center’s co-director, and Curtis Cloke, a Burlington, Iowa, based advisor who teaches an RICP online course. (Richard M. Weber moderated the roundtable, which The American College of Financial Services and the Society of Financial Service Professionals co-sponsored.)  

You can link here to the video, which is part of the RICP curriculum. Highlights from the video are also described below.

Reverse mortgages: the Pfau perspective

People either love or ignore reverse mortgages as a retirement income tool, and both positions are defensible. Millions of middle-class Baby Boomers are under-saved. As a group, they hold trillions of dollars in home equity. Surveys show that most of them would like to “age in place.” Many experts, including Nobelist Robert Merton, think reverse mortgages need to be part of almost any middle-class retirement strategy.    

Many advisors assume that their high net worth clients, no matter how long they live, will never be desperate enough to need a reverse mortgage. But in the RICP roundtable, Pfau argued that even wealthy clients can benefit from using a reverse mortgage line of credit as a handy source of liquidity during market downturns.

“The conventional wisdom is that the HECM (Home Equity Conversion Mortgage) line of credit becomes a logical option only at the end of life,” Pfau said. “But the new strategy is to get it early in retirement and only use it to avoid selling assets at a loss. It protects you against sequence of returns risk. You can use a cash buffer for the same purpose, but that can create a drag in performance.”

If you open a HECM LOC at age 62, your loan capacity begins growing right away and keeps growing throughout retirement. (Why does loan capacity grow? When people take out a HECM loan, they make no payments toward it and the loan balance grows until they die or sell the house. To assure parity between HECM loans and HECM lines of credit, the program allows the line of credit’s limit to grow at a rate similar to that of the loan balance.)

Annuities as part of an investment strategy: the Cloke technique

Like reverse mortgages, income annuities have long been regarded as appealing mainly to those who don’t have enough savings to cover their retirement needs. In other words: for retirees who can’t afford to live on an inflation-adjusted 4.0% or less for at least 30 years. But that’s not necessarily so, claims Curtis Cloke, who teaches an RICP course in his proprietary “Thrive” retirement methodology.

Just as Pfau argued that reverse mortgage should appeal to a retiree’s desire to stay largely invested during downturns, Cloke explained that high net worth retirees can maintain high equity positions without losing sleep if they buy enough guaranteed income to cover their basic or even their basic-plus-discretionary expenses.  

In the November roundtable, Cloke describes an actual case (using pseudonyms) of a 64-year-old husband and 63-year-old wife with assets of $3.1 million, combined Social Security at full-retirement age of $56,000, and a pension (husband’s life only) of $35,000 a year. They wanted an income of $11,000 per month for living expenses, adjusted upward by 3% per year, plus $500 per month for medical insurance, increasing at the rate of 5% per year, for a total real income of $138,000 per year.

Cloke recommended a combination of strategies and products, including the delay of Social Security until age 70, the purchase of inflation-adjusted, cash refund Qualified Longevity Annuity Contracts for income starting at age 85, conversion of traditional IRAs to Roth IRAs, and the use of deferred income annuities with cash refund features.

A lot of advisors might consider it simpler just to cover this client’s income needs with Social Security, pension and a 3% systematic withdrawal from a diversified investment portfolio. But Cloke rejects what he calls an “assume and consume” approach to retirement income, and claims that his method creates enough gains through lower taxes, lower asset management fees, mortality credits and increased equity exposure to more than cover the cost of commissions and insurance product-related costs.

Social Security

Social Security laws changed in November, with the federal government removing the option—some called it a loophole—that allowed workers at full retirement age to file for Social Security benefits but not take them, purely for the sake of enabling their working spouses to begin collecting spousal benefits (not the benefits they earned by working) until age 70, when they would both switch on their own earned benefits.

It was a strategy that could bring a few couples a $50,000 windfall over four years. But the government has taken it away. As David Littell explained during the roundtable, the file-and-suspend strategy ends on May 1, 2016. Until then, only workers who have already reached age 66 and have never claimed benefits can use it until then. “But [the government is] not taking these strategies away from anybody who has already started them,” he said.

Besides file-and-suspend for spousal benefits, one other Social Security option has also been eliminated. “If you were age 66 and filed and suspended, and then at 68 you found out you had cancer, you used to be able to change your mind and they would send you a check for the two years of benefits that you missed,” Littell said. “That’s also going away.”

But there are still reasons to file and suspend, he added. “If a new 66-year-old client who took Social Security at age 62 comes to an advisor and they decide that the client would be better off deferring until age 70, the client can still suspend his payments until age 70 and get credit for the extra four years of deferral,” Littell said.

Long-term care insurance

In another section of the roundtable, Jamie Hopkins, co-director of The New York Life Center for Retirement Income, discussed the fundamentals of long-term care, as well as other end-of-life issues that retirement advisors should be understand.

© 2016 RIJ Publishing LLC. All rights reserved. 

MetLife To Let VA Liabilities Go

Posted on January 14, 2016 by -

Citing its desire to avoid a SIFI designation as the motivation, MetLife, Inc., this week said it would separate from a large part of its U.S. Retail segment, including three life insurance companies and their variable annuity businesses, either selling the companies or creating an independent firm with a new public offering.

MetLife bet big on the variable annuity with living benefits in 2011, writing a record-setting $28.4 billion. Today, MetLife has VA assets of $165 billion, the most among retail VA writers and second only to TIAA-CREF’s group variable annuity assets. MetLife’s VA assets, and the hard-to-control liabilities attached to them, will move to the new entity.

The move doesn’t necessarily mean that MetLife can or will avoid designation as a Systemically Important Financial Institution, according to Fitch Ratings. “It remains unclear if the proposed restructuring will result in MetLife shedding its SIFI designation as the U.S. Financial Stability Oversight Council has not yet to provide an ‘exit ramp’ for designated firms,” Fitch said in a release this week.

But it is clear that “MetLife will no longer write new U.S. retail life and annuity business—a significant strategic shift for the firm,” the Fitch release said, as the parent company pursues “a separation of a substantial portion of its U.S. retail life and annuity business that would be subject to enhanced capital requirements under yet-to-be-announced U.S. nonbank SIFI prudential standards.”

On Wednesday, Fitch placed the financial strength ratings of MetLife Insurance Company USA and General American Life Insurance Company on Rating Watch Negative. Yesterday S&P also downgraded the financial strength ratings of MetLife Insurance Company USA and General American Life Insurance Company one notch to “A+” (5th highest), while placing the ratings on a negative outlook.

David Paul, a principal at ALIRT Research, said some distributors who have sold MetLife VA contracts have had questions about whether the restructuring will affect the safety of the guarantees.

“Nothing has changed at the life insurance subsidiaries that issued the contracts,” Paul told RIJ. “They’re just as strong or as weak as they were. All that’s changed is the implicit support from the parent. Everyone has been programmed to believe that if you have a well-branded parent, that it’s forever.

“But that’s not true,” he added. “The idea that the parent will always be there, you have to take off the table. We issue scores, which are proprietary, to eight MetLife insurance subsidiaries, and those scores range from strong to quite weak.”

ALIRT put the MetLife move in the context of several moves by other VA issuers in after the financial crisis (see chart). “We also note the recent pressure that activist investors (led by Carl Icahn and John Paulsen) are placing on AIG to separate into three operating units, for either spin-off or sale, citing in part the regulatory burdens of the SIFI-designation,” an ALIRT release said.

ALIRT metlife release chart

MetLife Executive Vice President Eric Steigerwalt will lead the new business, according to MetLife release. MetLife said it will spin off or sell MetLife Insurance Company USA, General American Life Insurance Company, Metropolitan Tower Life Insurance Company and several subsidiaries that have reinsured risks underwritten by MetLife Insurance Company USA.

“The parts of the U.S. Retail segment that would stay with MetLife are: the life insurance closed block, property-casualty, and the life and annuity business sold through Metropolitan Life Insurance Company (MLIC). MLIC would no longer write new retail life and annuity business post-separation,” the release said.   

Approximately 60% of current U.S. variable annuity account values, including 75% of variable annuities with living benefit guarantees, are in entities that would be a part of the new company. The new company would also contain approximately 85% of the U.S. universal life with secondary guarantee business.

The Company’s other reporting segments – Group, Voluntary and Worksite Benefits (GVWB), Corporate Benefit Funding (CBF), Asia, Latin America, and Europe, the Middle East and Africa (EMEA) – would remain part of MetLife.

 “Currently, U.S. Retail is part of a Systemically Important Financial Institution (SIFI) and risks higher capital requirements that could put it at a significant competitive disadvantage. Even though we are appealing our SIFI designation in court and do not believe any part of MetLife is systemic, this risk of increased capital requirements contributed to our decision to pursue the separation of the business.” An independent company would benefit from greater focus, more flexibility in products and operations, and a reduced capital and compliance burden.

“This separation would also bring significant benefits to MetLife as we continue to execute our strategy to focus on businesses that have lower capital requirements and greater cash generation potential. In the U.S., it would allow us to focus even more intently on our group business, where we have long been the market leader. Globally, we will continue to do business in a mix of mature and emerging markets to drive growth and generate attractive returns.”

The new company would represent, as of September 30, 2015, approximately 20% of the operating earnings of MetLife and 50% of the operating earnings of MetLife’s U.S. Retail segment. The new company would have approximately $240 billion of total assets, including $45 billion currently reported in the Corporate Benefit Funding and Corporate and Other segments.

The complete management team of the new company, as well as its board of directors, is to be defined over time as preparations for the transaction take shape.

Steven A. Kandarian, MetLife chairman, president and CEO, said, “At MetLife our goal is to create long-term value for our shareholders and deliver exceptional customer experiences. As a result of our Accelerating Value strategic initiative, MetLife has been evaluating opportunities to increase sustainable cash generation and is directing capital to businesses where we can achieve a clear competitive advantage and deliver a differentiated value proposition for customers. This analysis considers the regulatory and economic environment in each market where we do business. We have concluded that an independent new company would be able to compete more effectively and generate stronger returns for shareholders. Kandarian concluded, “It is important to note that this is just the first step in the process. We will provide more information as the transaction unfolds, consistent with U.S. securities laws.”

Any separation transaction that might occur will be subject to the satisfaction of various conditions and approvals, including approval of any transaction by the MetLife Board of Directors, satisfaction of any applicable requirements of the SEC, and receipt of insurance and other regulatory approvals and other anticipated conditions. No shareholder approval is expected to be necessary. Because the form of a separation has not yet been set, the Company cannot currently provide a specific potential completion date. If the separation takes the form of a public offering, the Company expects that it would file a registration statement with the SEC in approximately six months. No assurance can be given regarding the form that a separation transaction may take or the specific terms thereof, or that a separation will in fact occur.

The Company is also undertaking preparations to complete the required financial statements and disclosures that would be required for a public offering or spin-off. The completion of a transaction taking the U.S. Retail segment public would depend on, among other things, the U.S. Securities and Exchange Commission (SEC) filing and review process as well as market conditions.

© 2016 RIJ Publishing LLC. All rights reserved.

Do In-Plan Annuities Have a Future?

Posted on January 14, 2016 by -

If anything could breathe new life (and sales) into the annuity industry during a period of stubborn headwinds (the affluent are living longer and a low interest rates are here to stay) it would be the introduction of annuitization options in retirement plans.

In-plan annuities make perfect sense. Minimal distribution costs and institutional pricing could raise annuity payout rates. Participants could get used to the idea of buying future income gradually, and benefit from decades of tax-deferred compounding and interest rate diversification.

While it’s true that defined contribution plans were never designed to create income, and aren’t easy to re-purpose, they’ve inherited the job that defined benefit pensions used to do. DB pensions have found new life as fodder for pension risk transfer deals, but the creativity in that space is largely destructive of institutional income strategies.  

But such a revolution can’t happen—not on a broad scale, outside jumbo plans—without a revolution in the minds of plan sponsors. And plan sponsors have conflicted feelings about annuities. The latest evidence of their views comes to us via the “2015 Survey of Defined Contribution Viewpoints,” produced by Rocaton Investment Advisors.

[Editor’s note: This week’s announcement by MetLife that it would spin off some of its insurance subsidiaries might make plan sponsors even more skittish about the stability of in-plan annuity sellers. See today’s RIJ article on MetLife.]

The Rocaton report would seem to offer encouragement to annuity advocates. When asked to name “the one thing” they would like to change about their plan or plans in general, “include a retirement income solution” was the most popular answer (given by 24% of 100 sponsors and 28% of 199 providers).   

Further questioning showed, however, that enthusiasm for in-plan income options is bigger on the sell-side than the buy-side. Only 39% of plan sponsors mentioned “considering a retirement income solution” to be one of their three priorities for 2016. But 62% of the plan providers mentioned “retirement income solutions” when asked what new products they’d like to develop.

Chart from Rocaton 2015 DC Viewpoints study

The authors of the study remarked at the high rate of interest in DC income. They found it to be inconsistent with “the lukewarm use and reaction to retirement income solutions in other questions” in the survey. But the resolution to that inconsistency could be found in sponsors’ answers to the question: “Which retirement income options do you offer?”

Three out of four plan sponsors said they offer “educational or planning tools focused specifically on retirement income.” One in four sponsors said they offer participants access to a managed account program with a focus on non-guaranteed income—the most popular of which is Financial Engines’ Income-Plus program for retirees.

So, we can’t assume that plan sponsors who express an interest in retirement income would use in-plan annuities. About one in six plan sponsors (17%) said they offer participants access to immediate or deferred income annuities through an “annuity window” outside the plan—an apparent reference to Hueler’s Income Solutions platform, which is available, for instance, to members of Vanguard’s plans.

When asked which retirement income options they might consider adding to their plans or consider appropriate for DC plans, 71% of plan sponsors and providers referred to “education or planning tools.” Just over 40% of plan sponsors mentioned an “asset allocation option with a guaranteed income or annuity component.” That may have been a reference to the Qualified Longevity Annuity Contracts that the U.S. Treasury Department approved for use within target date funds in defined contribution plans.   

For several years, plan sponsors have hinted that they might be amenable to in-plan annuities if the Department of Labor offered a fiduciary “safe harbor.” This could be an annuity product or annuity selection process that employers could follow without fear of ever having to pay their employees in case the annuity provider failed and the employees’ state guaranty programs also failed.

But insurers should probably not hang much hope on the chance that this will happen. The Department of Labor already offers a safe harbor of sorts—“the best available annuity” language in Interpretive Bulletin 95-1–and has not expressed great interest in going farther.

In short, the Rocaton report doesn’t offer any indication that, despite their assertion that the retirement security of their employees is important to them, plan sponsors in general want to bring annuities per se into their plans. Some of the largest 401(k) plans, especially those whose sponsors provided a DB pension in the past and would like to replicate the income benefit without the liability (like United Technologies), may be the most likely to want to work directly with an insurer. Others, not as much.

One could speculate that the state-sponsored mandatory defined contribution plans that are under construction in California, Connecticut and a few other states might, depending on how they evolve, decide to offer in-plan guaranteed income options to their participants at some point. As non-profits, they might not require the same incentives or protections that private plan sponsors and providers need.

At present, annuity issuers can gain exposure to the 401(k) participant market through the Hueler Income Solutions “annuity window.” So far a number of insurers do offer immediate and deferred income annuities through that platform, but others anecdotally haven’t done so because it might compete with and perhaps under-price their retail distribution channels.

© 2016 RIJ Publishing LLC. All rights reserved.