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Here come the new Boomers (sans Beatles)

Posted on December 30, 2015 by -

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

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

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

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

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

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

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

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

© 2015 RIJ Publishing LLC. All rights reserved.

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

Posted on December 30, 2015 by -

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

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

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

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

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

Parent traps

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

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

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

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

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

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

Income, advice and needs

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

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

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

© 2015 RIJ Publishing LLC. All rights reserved. 

American Financial sells LTCI book to focus on FIAs

Posted on December 30, 2015 by -

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

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

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

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

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

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

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

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

© 2015 RIJ Publishing LLC. All rights reserved.

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

Posted on December 24, 2015 by -

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

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

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

Defined contribution plans

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

Individual Retirement Accounts (IRAs)

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

Technical notes

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

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

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

© 2015 Investment Company Institute.

The Perils of Fed Gradualism

Posted on December 23, 2015 by -

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

© 2015 Project Syndicate.

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

Posted on December 23, 2015 by -

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

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

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

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

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

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

Uneven impact

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

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

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

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

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

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

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

US Total Retirement Market

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

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

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

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

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

© 2015 RIJ Publishing LLC. All rights reserved.

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

Posted on December 23, 2015 by -

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

The briefing said:

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

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

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

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

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

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

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

© 2015 RIJ Publishing LLC. All rights reserved.

Seniors’ home equity reaches $5.76 trillion

Posted on December 23, 2015 by -

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

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

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

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

© RIJ Publishing LLC. All rights reserved.

New ERISA Advisory Council members appointed

Posted on December 23, 2015 by -

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

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

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

The newly appointed members and the constituencies they represent are:

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

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

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

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

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

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

© 2015 RIJ Publishing LLC. All rights reserved.

Bob Pozen Knows Retirement

Posted on December 22, 2015 by -

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

RIJ: Thank you, Bob.

© 2015 RIJ Publishing LLC. All rights reserved.

Fed raises target overnight rate by quarter-percent

Posted on December 17, 2015 by -

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

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

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

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

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

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

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

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

© 2015 RIJ Publishing LLC. All rights reserved.

A near-retirement breakup calls for financial advice: MacroMonitor

Posted on December 17, 2015 by -

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

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

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

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

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

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

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

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

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

© 2015 RIJ Publishing LLC. All rights reserved.

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

Posted on December 17, 2015 by -

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

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

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

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

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

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

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

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

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

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

© 2015 RIJ Publishing LLC. All rights reserved.

Significantly, pension risk-transfer goes Dutch

Posted on December 17, 2015 by -

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

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

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

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

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

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

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

© 2015 RIJ Publishing LLC. All rights reserved.

Unsolved mystery: Where are the missing participants?

Posted on December 17, 2015 by -

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

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

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

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

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

Specifically, EBRI found:

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

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

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

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

© 2015 RIJ Publishing LLC. All rights reserved.

No-Nonsense Income Planning

Posted on December 16, 2015 by -

If you’re a registered investment advisor you may feel compelled to steer retirees away from annuities. If you’re an insurance agent you may naturally want to sell your clients annuities with ample commissions. Jim Otar, a Toronto-area advisor, prefers to let the his clients’ funded status—green, yellow or red—dictate his recommendations.  

For almost two decades, Otar has presented his commonsense, no-nonsense “Zone” method of retirement income planning to thousands of advisors at countless events. Although he claims to be “slowing down,” he gave yet another of those presentations at the recent IMCA retirement conference in Scottsdale.

A mechanical engineer by training, Otar designs retirement plans the way engineers design bridges: To bear the peak stress, not just the average stress. Bengen’s 4% rule does much the same thing, but Otar has added nuance, detail and flexibility to that hoary heuristic. He readily shares his methods, and doesn’t give a hoot if you buy into them or not. That’s part of what makes him so credible. 

“Zone” theory

At 20, Otar emigrated to Canada from Istanbul. He earned BS and MS engineering degrees at the University of Toronto. In the 70s,  he started managing his own money. Then he managed money for his relatives, and by the mid-1990s had become a CFP. He’s also licensed to sell insurance in Ontario. He documented his methods in the 2009 book, “Unveiling the Retirement Myth.”

Otar may be known best for his “Zone” matrix, which serves planning as well as practice management purposes. He categorizes clients as Green, Yellow and Red. Green zoners have enough money to fund their spending needs indefinitely; they and their advisors can afford to focus on estate planning. Red zone clients need (or want) more income than their savings can safely muster. Yellow clients fall in between.

These definitions help guide Otar’s annuity recommendations. Clients who start out in the red zone, for instance, can move to yellow or green, for example, by reducing their spending rate or buying guaranteed income. Otar says that red clients buy income annuities “for insurance reasons,” as protection from longevity risk. Green clients, on the other hand, buy income annuities for “investment reasons”: to take more risk with their other assets.    

The zone strategy also helps frame the annuity discussion. “It gives you a precise guideline about when risk must be exported to create a lifelong income,” Otar said. For instance, an advisor and client can easily see that a $500,000 life annuity that pays out $30,000 a year would benefit someone who needs $30,000 but can only withdraw $20,000 safely from investments. On the other hand, someone who needs only $18,000 a year from $500,000 can take or leave the annuity.Otar Safe Withdrawal rates

Withdrawal rates should vary depending on how the income will be used, Otar believes. Other advisors might divide a retiree’s assets into risky, low-risk and risk-free buckets, or they might segment savings into one-year, five-year and ten-year buckets, and then use a uniform 4% withdrawal rate. Otar uses a different prism in his approach.

The more indispensable the income, the lower the safe withdrawal rate. Otar divides expenss into “essential” (survival), “basic” (lifestyle) and “discretionary” (aspirational). While a retiree could prudently spend 4.7% a year from a discretionary account (in an example Otar uses), he might be prudent spending only 3.9% a year from a lifestyle account and only 3.2% and calculates a different withdrawal rate (based on different risk tolerances) for each spending category. (See chart at right.)

Factors like age, market levels at the time of retirement, sequence risk and inflation also guide Otar’s withdrawal rate recommendations. Someone who retires at age 60 and/or when the equity price-to-earnings ratio is 25, for instance, should spend much more cautiously than someone who retires at age 70 when the P/E ratio is seven. Assuming a 30-year retirement, which Otar does, means that inflation can blow up the best-laid plan. “A bad sequence of inflation, he said, “can cut portfolio life up to 40%.”   

Fat tails and discontinuities

As a third insight, Otar (after reading William Bernstein) recognized the limits of Monte Carlo simulations. “Many in our business think that Monte Carlo simulations adequately represent the luck factor. But Monte Carlo assumes random fluctuations around an average growth rate. It assumes a Gaussian distribution. Markets don’t work that way. Even if you add ‘fat tails,’ Monte Carlo doesn’t simulate black swans efficiently,” he says. (For more on the non-Gaussian behavior of stocks, see the late Benoit Mandelbrot’s “The (Mis)Behavior of Markets.” Basic Books, 2002.)

Instead of using Monte Carlo simulations, Otar created a method he calls “aftcasting” to test the adequacy of a retirement portfolio. In an aftcast, he can see how each portfolio would have behaved starting in every year since 1900. His method incorporates actual performance sequences over 30-year periods, which reflect the interdependencies and feedback effects of various market variables. Aftcasting reveals the true frequency of market “discontinuities,” Otar has written.

If you’re an advisor, you may find yourself agreeing with Otar’s approach but unable to implement it. Your business model may not allow it. Advisors in fee-only practices, for instance, may never be able to recommend an income annuity, no matter how deep in the red zone a client may be, because it would reduce their AUM.

On the other hand, an advisor who relies on commissions, such as an insurance agent or a fledging broker-dealer advisor, might naturally lean toward recommending a large annuity purchase , no matter how deep in the green zone a client may be; it’s the only way he or she is rewarded. Otar makes a point of not putting himself, or his clients, into either of those boxes. 

© 2015 RIJ Publishing LLC. All rights reserved.

Quartzite’s Most Famous Pianist

Posted on December 16, 2015 by -

What happens if you don’t save enough for your retirement?

You might spend your golden years in the desert, nearly naked but deeply tanned, living hand-to-mouth, peddling plastic-wrapped pulp fiction, and banging out boogie-woogie on an old piano for curious French video-bloggers.

In short, you could be 72-year-old Paul Winer, aka Sweet Pie, the retired musician and current proprietor of the Reader’s Oasis Bookstore in Quartzite, Arizona, a sun-bleached pit stop on I-10, mid-way between Phoenix and Los Angeles.

Earlier this month, a friend and I were motoring west from Phoenix on I-10 en route to Joshua Tree National Park, where we planned to hike and camp before I attended the IMCA 2015 Retirement & Decumulation conference in Scottsdale later in the week.

We stopped for gas in Quartzite, a tiny town that blossoms in January and February when regiments of rock hounds arrive in RVs for one of the nation’s largest rock and gem fairs. We passed Sweet Darlene’s Restaurant & Bakery, an open-air junk-and-rock shop, and a used bookstore with, curiously, a parking lot big enough for tour busses.

As red flowers attract hummingbirds, used bookstores attract me. Kim, a friendly, honey-haired clerk, welcomed me into the dark, non-climate-controlled store, which was as much Bedouin tent as conventional four-walled structure. When my pupils adjusted from the outside glare to the inner shade, I noticed a small framed photograph of a thin, brown, half-naked man seated at a piano. A moment later, that same man scurried by me between two tables stacked with books, each one protected by plastic wrapping from the invasive desert sand. 

“Is that you in the picture?” I superfluously asked. He confessed that it was. He wore a black wool sweater, a black hat covered with buttons, a thong, sunglasses and sandals. The hat, sunglasses, and a free-range moustache and beard hid most of his face, but his thin beef-jerky legs were fully exposed. He appeared to have no buttocks or body fat.

Paul Winer (pronounced with a long “i”), it turned out, is not shy about revealing either his body or his personal history. “I’ve had 68 court cases filed against me and I won every one of them,” he told me. Really?  I asked. For nudity? For obscenity? “Yes, for all them,” he said. I soon learned that he hails from New England, that he knew Johnny Winter but not Paul Butterfield and that his home is the only one in Quartzite with a mezuzah on the doorjamb.

As “Sweet Pie,” Winer performed barrelhouse piano on the college concert circuit in the U.S. and Canada during the Blues Revival of the late 60s and early 70s. His specialty: Performing naked but for a codpiece. Later, he moved to Arizona to be near his aging parents. His father died recently at age 90-something. His daughter, he mentioned in passing, died when she was eight years old.

“Count Basie told me that I had the best left hand on the piano that he had ever heard, beside himself. But I never studied music,” Winer told me, as he tells hundreds of people who pass this way each year. We stood outside in the unusually cool December sunshine.Winer

“I invented the phrase, ‘F— ‘em if they can’t take a joke,’ he continued. “Everyone thinks Bette Midler invented it. But I used it first at Brown University and she used it for the first time a month later. I’m famous on the Internet but we’re just making room and board here.” Two women in down parkas approached us from the parking lot. “Excuse me for a moment,” he said.

Winer’s international fame then became evident. The two women, a videographer and sound technician, said they worked for a French TV station. Like many Europeans, they knew about Winer from the “Roadside America” website, and knew that he was one of the few tourist attractions between Taliesen West (Frank Lloyd Wright’s former home and architectural studio in Scottsdale, AZ) and posh Palm Springs, CA.

On the one hand, there’s only one conventional way to prepare for a secure retirement: You amass a big pile of securities or real property in advance. On the other hand, there’s no limit to the range of inventions that older Americans will employ that will allow them to at least muddle through—and perhaps even enjoy—their final decades even when they haven’t saved “enough.”

Let’s count the ways: Some people move to cheap digs in places like Nicaragua or Portugal; some share homes with people they meet through the Green House Project; some take to the road in Airstream trailers; some earn $10 an  hour handing out canapes to shoppers at Wegman’s Markets; some move in with their adult children; some offer their children’s bedrooms on Airbnb. There will always be a “retirement savings gap,” and older people will always build bridges across it—even if it means going naked and opening a bookstore in the desert.

The French journalists had asked Winer to sing and play the piano for them while they videotaped and recorded him. To prepare for his photo op, Winer mounted an adult-sized tricycle and pedaled out of sight. He returned in a new outfit: a red holiday sweater, red socks and a seasonal codpiece: a small, red, upside-down Santa’s cap with a white pom-pom at the tip. Then he led the French women to a baby grand piano inside the store. He sat down and played an original composition, “A Little Nothing.” You can listen to it here. (Video courtesy of Jeffrey Schell.)

Before my friend and I departed for Joshua Tree, I bought a copy of Winer’s 1971 “Lost Tapes” CD for $15. It seemed like the least I should spend in return for an hour’s amusement.  As we drove west, however, I remembered his comment about the daughter he’d lost. An under-funded retirement can test a person’s resourcefulness, but some things are almost beyond endurance. 

© 2015 RIJ Publishing LLC. All rights reserved.

Waiting on the Fed

Posted on December 10, 2015 by -

Barring a sudden sell-off on Wall Street, higher short-term interest rates are coming soon. But don’t expect more than a tiny hike. And don’t expect long-term rates to budge. That kink in the life insurance industry’s air hose isn’t going away soon.

According to the Treasury Department’s own Office of Financial Research, movements in foreign equity and fixed income markets imply a 75% chance of a 25-basis point increase in the Fed Funds rate (currently about 0.12%) at the Fed’s December 15-16 meeting. The perceived likelihood of a hike was 40% after the September Fed meeting and 60% after the October meeting.

Because emerging markets are sensitive to U.S. interest rates and exchange rates, their movements can indicate expectations of changes in those rates. Since early November, broad emerging market equity indexes have fallen about 3%, sovereign and corporate bond spreads have widened by 20-to-30 basis points, and oil-linked currencies have depreciated by between 4% and 8%, said the OFR report. Mutual fund investors have resumed selling emerging market equities and bonds. OFR Chart 12-10-2015

While there’s now a consensus that the Janet Yellen-led Fed will make a cautious move next week, a return to historically “normal” interest rates in the foreseeable future is not predicted. (In point of fact, there may be no normal rate. As this St. Louis Fed chart shows, rates trended generally up from 0.83% in 1954 to 19.10 in 1981, and then generally back down to 0.12% last month, with intermittent spikes before recessions.) 

Any inclination toward higher rates is expected to be “very gradual.” “Recent Fed communications also focused on the path of policy following liftoff and reinforced expectations for a gradual pace of rate increases over the next year. The market is currently pricing in two-to-three 25 basis point rate hikes in the 12 months after the first increase,” said the OFR report.  

So much for short-term rates. But what about yields on 10-year Treasury bonds, which give insurance companies fuel for income annuity payout rates and variable annuity hedging strategies? Philippe Combescot, managing director, Global Equity and Commodity Derivatives, BNP Paribas, predicted recently that the yield curve in the near future will be flat, with long-term rates not moving much in response to several small hikes in short-term rates.    

“Our prediction is that the long end of the curve will stay stable but the front end of the curve will go up, so that we’ll have eventually have 2.5% at the short end and a long end between 2.5% and 3%,” Combescot said in a presentation at the Society of Actuaries EBIG (Equity-Based Insurance Guarantees) Conference in Chicago last month.

“Some analysts are saying that the period of low rates might stay for longer than we thought, and as long as globalization keeps a lid on wages, that situation could remain for a long time In Japan, they’ve had one-percent rates on 20-year bonds for 25 years,” he added, noting that the Fed might decide to raise short-term rates to 1.5% and stop there for awhile.

BNP Paribus Interest Rate expectationsLong-term rates will stay low because investors are “more worried about low inflation outcomes than high inflation outcomes,” Combescot said. He noted that the 10-year Treasury prices have produced a negative yield for the past three years, but that investors pay those prices on the chance that a future flight to Treasuries might drive prices even higher. “Investors and some economists are pricing in a 25% chance of recession. The Fed is not,” he added.

“When the Fed raised rates in 1994, the GDP growth rate was 5%. Today we are talking about something closer to 2%,” he said. “Financial conditions have tightened and that has done most of the work that the Fed is supposed to do. Zero [short-term interest rates] may not be far from where it should be.”

The equity markets are pricing in a “very benign” hiking cycle, because the sluggishness of the economy and the lack of inflation doesn’t warrant anything more. Historically, the stock market has fallen 10.5% on average in response to every one percent increase in interest rates. according to W. Michael Cox, director of Southern Methodist University’s O’Neil Center for Global Markets and Freedom.

Cox told advisors at the IMCA 2015 Winter Institute Conference on Retirement and Decumulation in Phoenix last week that, there’s been a significant sell-off in stocks within three to six months of the beginning a hiking cycle. He blamed the current high valuation of the stock market on the Fed’s “methamphetamine” interest rate policy.  

Not everyone believes the Fed dictates interest rates today. Also speaking at the IMCA retirement conference, Michael Finke of Texas Tech argued that the aging-related global savings glut has pumped up demand for, and prices of, both stocks and bonds. The supply of bonds has actually risen, Finke said, but the demand for bonds has risen even more, driving high bond prices and low yields.

Historically, low current bond yields presage low future total bond returns, Finke said, and high CAPE ratios (or Shiller ratios) presage low equity returns. When the CAPE or Shiller ratio is high—yesterday it was 25.88—future 10-year annualized equity returns have been about 6%, he said. The future will be characterized by below average returns on financial assets, which Finke believes will make the supposedly “safe” withdrawal rate of 4% per year from savings during retirement too aggressive.

© 2015 RIJ Publishing LLC. All rights reserved.      

Why Roofers Retire Earlier than Professors

Posted on December 10, 2015 by -

The terms “blue collar” and “white collar” have lost their once-literal significance in the workplace, but it’s still true that certain occupations are more physically taxing than others and that workers in those jobs tend to retire earlier—and claim Social Security earlier—than people in less strenuous jobs. 

Awareness of the link between occupation and retirement age tends to grow during the country’s periodic public debates over the health of the Social Security program. Raising the full retirement age (FRA), for instance, has been suggested as a way to improve the program’s finances. But a higher FRA could harm people who must retire early because their jobs require younger minds or bodies.

In an attempt to add more precision to the conventional wisdom about physically demanding jobs and early retirement, a team of researchers at the Center for Retirement Research at Boston College has developed a “Susceptibility Index” that assigns ratings, on a scale of one to 100, to different occupations. The ratings, based on research data, indicate the susceptibilities of people in those occupations to age-related impairments that can lead to early retirement. (See chart on today’s RIJ homepage.)

The researchers, Anek Belbase, Geoffrey T. Sanzenbacher, and Christopher M. Gillis, found that physical and cognitive skills required for historically blue-collar occupations, such as food service work, do not decline with age, while abilities required for others, like roofing, do decline. By the same token, certain white-collar occupations, such as detective work or licensed practical nursing, require skills that often decline with age. 

Certain physical attributes, such as flexibility and “explosive strength” (the ability to jump, for instance), decline rapidly, according to the paper, but physically active individuals tend to experience relatively slow declines in stamina and endurance with age.

“Active individuals in their 60s have similar stamina as inactive individuals in their 30s,” the researchers wrote. “Workers who use stamina in their jobs on a daily basis (e.g., dancers, firefighters) are unlikely to experience the declines with age that may be common for less active individuals,” the researchers wrote.

Among cognitive skills, “fluid” skills, such as acquisition of new information and reaction time, tend to deteriorate in mid-life. But “crystallized” knowledge, based on education or experience, can persist into old age. Exercise, it was noted, slows the decline of cognitive skills while cardiovascular diseases such as diabetes and strokes can accelerate cognitive decline. 

The researchers looked at the percentages of different groups (by ethnicity, sex, occupation and years of schooling) that fell into either the top or bottom half of the Susceptibility distribution.

People in the top half of the distribution, for instance, were almost twice as likely as those in the bottom half of the distribution (9.5% vs. 5.4%) to claim disability benefits. About 70% of those in the top half of the distribution were retired before age 65, while only about 65% of those in the bottom half were retired by then. 

Men, not surprising, made up about 60% of the upper half of the distribution and about 40% of the bottom half of the distribution, with reverse results for women. In terms of education, 58% of those in the bottom half of the distribution had at least a college degree, while about two-thirds of those in the top half of the distribution had a high school degree or less. 

African-Americans were about twice as likely to be in the more-susceptible half of the distribution than the less-susceptible half (21% vs. 10.7%), as were Hispanic Americans (10.8% vs. 4.6%). Average earnings for those in the top half of the distribution was $35,000, compared with $49,800 for those in the bottom half. 

Among the overall conclusions of the paper:

  • Some white-collar occupations, such as police detective and designer, are as susceptible to declines in the abilities required for work as are blue-collar occupations and may have similar difficulty responding to FRA increases.
  • The Susceptibility Index is a significant predictor of early retirement. Workers in occupations in the 90th percentile of the Index are 5.7 percentage points more likely to retire by age 65 than workers in the 10th percentile.
  • While the commonly used categorization of blue- or white-collar has no additional explanatory power in a model of early retirement, blue-collar occupations are especially susceptible to early ability declines, so workers in these occupations are less likely to be able to work to the FRA as it increases to 67.

© 2015 RIJ Publishing LLC. All rights reserved.