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Edward Jones to pay $20 million SEC fine

Posted on August 13, 2015 by Editorial Staff -

St. Louis-based brokerage firm Edward Jones and the former head of its municipal underwriting desk have agreed to settle charges that they overcharged customers in new municipal bonds sales, the SEC announced this week.

In the SEC’s first case against an underwriter for pricing-related fraud in the primary market for municipal securities, the firm also was charged with separate misconduct related to supervisory failures in its review of certain secondary market municipal bond trades.

An SEC investigation found that instead of offering bonds to customers at the initial offering price, Edward Jones and Stina R. Wishman took new bonds into Edward Jones’ own inventory and improperly offered them to customers at higher prices. Municipal bond underwriters are required to offer new bonds to their customers at what is known as the “initial offering price,” which is negotiated with the issuer of the bonds.

In other instances, Edward Jones entirely refrained from offering the bonds to its customers until after trading commenced in the secondary market, and then offered the bonds at prices higher than the initial offering prices.

The firm’s customers paid at least $4.6 million more than they should have for new bonds. In one instance, the misconduct resulted in an adverse federal tax determination for an issuer and put it at risk of losing valuable federal tax subsidies.

Edward Jones agreed to settle the case by paying more than $20 million, which includes nearly $5.2 million in disgorgement and prejudgment interest that will be distributed to current and former customers who were overcharged for the bonds. Wishman agreed to pay $15,000 and will be barred from working in the securities industry for at least two years.

According to the SEC’s order instituting a settled administrative proceeding against Edward Jones, the firm’s supervisory failures related to dealer markups on secondary market trades that involved the firm purchasing municipal bonds from customers, placing them into its inventory, and selling them to other customers often within the same day. Because of the short holding periods, the firm faced little risk as a principal and almost never experienced losses on these intraday trades. The SEC’s investigation found that Edward Jones’ supervisory system was not designed to monitor whether the markups it charged customers for certain trades were reasonable.

Edward Jones consented to the SEC order without admitting or denying the findings and undertook a number of remedial efforts and now discloses the percentage and dollar amount of markups on all fixed income retail order trade confirmations in principal transactions. Wishman consented to a separate SEC order without admitting or denying the findings.

Conflict of Interests

Posted on August 6, 2015 by Kerry Pechter -

Three and a half days of hearings on the DOL’s controversial fiduciary proposal, which will be available to viewers worldwide through a live webcast, begin at 9 a.m. next Monday morning at the Francis Perkins Building, a stolid limestone cube on Capitol Hill.

I will watch from home on my laptop, hoping for spectacle but prepared for something more like a C-SPAN speech-athon. (Click here for a link to the schedule.)

Given the stakes, and the underlying emotion, this hearing would, in less polite society, turn into a melee. The DOL’s proposal, in its current form, would disrupt the funding mechanism of the sales and distribution of load mutual funds and variable annuities to rollover IRA owners. The industry that relies on that mechanism, and any intermediary who receives third-party compensation for advising retail clients, would suffer financially if it becomes the regulation of the land.

Brokers, agents and certain investment advisers would probably either have to accept a smothering new layer of recordkeeping tasks and compliance chores, or get out of the vendor-financed advice business. This way of delivering financial products and services, they believe, works better than any alternative. But it is now threatened by digital advice, fee compression and the Obama administration’s zeal to reform it.

It’s a turf war, and the turf is very valuable. The DOL believes that the $7.2 trillion in rollover IRAs is 401(k) money that went AWOL; in a perfect world, it should be treated with the same forbearance that applies to ERISA plans as long as it stays tax-deferred. Ideally, in the DOL’s world, it would be used to buy lifetime income.

The financial services industry believes that the rollover IRA money is, aside from the nuisance of tax deferral and required distributions, no different from the money in ordinary after-tax retail accounts. Neither side is right, and neither side is wrong. The status of rollover IRA money is ambiguous. Hence the struggle.

Neither side has a good solution to a very complicated problem with an ad hoc and opportunistic history. Both appear to be in denial. The DOL doesn’t recognize what a huge expensive mess that its proposal would create in the financial services world. The industry doesn’t admit to the deception that’s implicit in its third-party payment regime.

The saddest part is that both sides seem to think that it’s possible to “manage” conflicts-of-interest. It isn’t. The conflicts are embedded in the product designs, the compensation schemes and even in the business models of the financial service industry. Unless those change, the conflicts (and the effects of the conflicts) that the DOL frets over will still exist.

These hearings haven’t gotten much attention outside of the financial industry, even though the proposal’s impact would be huge. The New York Times’ Maureen Dowd didn’t even mention it in her recent review of President Obama’s campaign of regulatory activism. Most of the world finds the retirement business boring, I guess.

So, while I’m hoping for fireworks, the hearings will probably be sedate and bureaucratic. About 100 witnesses, most of them representing companies, institutions, and advocacy groups, will testify. Department of Labor panelists will ask questions. If the witnesses just read the comments that they posted on the EBSA website, I may surf over to C-SPAN for relief.

How to Build an ‘Income-Oriented’ Portfolio

Posted on August 5, 2015 by Editorial Staff -

Before the financial crisis, many affluent retirees relied on a “total return” approach to income generation. A diversified, age-adjusted and risk-adjusted stock-bond portfolio, they figured, could generate enough interest, dividends and/or capital gains to meet their needs.

But the income stream from a total return portfolio can be uneven, forcing retirees to tighten or loosen their belts unexpectedly. In the jittery post-crisis world, more risk-averse retirees are said to be looking for a portfolio that will give them income that’s both robust and predictable.

Writing in the Spring 2015 issue Journal of Portfolio Management, David Blanchett and Hal Ratner of Morningstar Inc. propose a framework for building what they call “income-oriented portfolios” to meet that demand. On paper, at least, they were able to create the desired portfolios by tapping the riskier regions of the bond universe.

To see how total-return and income-oriented portfolios differ at the extremes, check out the pie charts below, reprinted from the research paper (“Building Efficient Income Portfolios”). At left is the total-return portfolio. At right is the income-oriented portfolio. Both hypothetical portfolios are built to deliver a 7.5% expected average annual return (based on historical returns for the selected asset classes from 1997 to 2014). Both also use a fair amount of high-yield bonds to achieve it.

But in reaching for an ambitious overall return, the two portfolios use the rest of their risk budgets differently. The total return portfolio opts for small-cap value stocks and U.S. real estate, while the income-oriented portfolio looks for similar levels of risk and return in emerging market debt and long-term investment grade corporate bonds.

The payoff from using that particular all-bond asset allocation is a higher, more predictable income. “The income return for the total-return portfolio is 140 basis points below that of the income portfolio,” write Blanchett (head of retirement research at Morningstar) and Ratner (head of global research).

“When looked at from traditional efficiency metrics, such as Sharpe ratio or total return-to-CVaR ratio, the total-return portfolio is more attractive,” they write. “But in this case, the income investor is indifferent to total-return efficiency and more concerned with income predictability.”

What are the trade-offs? Less chance for capital gains, for one. Within limits, the income-oriented investor can ignore fluctuations in the prices of his bonds. The total return investor relies on opportunistic asset sales for part of his income. Taxes are another trade-off. The income-oriented investor faces a larger tax bill, mainly because interest is taxed as ordinary income at up to 35%.

Taxes being a bigger problem for wealthy retirees and income sufficiency being a relatively bigger problem for the middle class, Blanchett and Ratner’s conclusion that “less-wealthy investors in comparatively low income brackets with relatively little risk capacity will derive the greatest utility from an income-oriented strategy” comes as little surprise.

Annuities where annuitants share longevity risk

The prospect of longevity gains creates a significant financial risk to insurance companies that issue annuities. Here’s a suggested alternative for issuers: deferred life annuities that adjust to rising longevity by delaying the start of payments, according to an index of longevity gains in the larger population.

This is proposed in an article by European finance professors M. Denuit, S. Haberman and A.E. Renshaw, “Longevity-Contingent Deferred Life Annuities,” in The Journal of Pension Economics and Finance, 14 (3) 2015.

The article, heavy on equations, is aimed more at economists and actuaries than annuity product developers. But this concept for annuity redesign, which offers clients the benefit of lower premiums to compensate for uncertainty about the income start date, is already past the development stage. Some countries with aging populations, like Germany, have already applied it to their social security systems. “Considering the difficulties that have been experienced in issuing longevity-based financial instruments, this might well be an efficient alternative to help insurers to write annuity business,” the authors venture.

Comparisons of withdrawal strategies, from Wade Pfau

Retirement expert Wade Pfau of The American College, whose work we cite regularly in Retirement Income Journal, has three more articles that will interest advisers:

“Making Sense Out of Variable Spending Strategies for Retirees” (March 2015) compares 10 drawdown alternatives for spending wealth over the 30 remaining years of life, based on client’s preferences. He looks at everything from the Required Minimum Distribution schedule to an annuitized floor with aggressive discretionary spending to his own and other prominent decision rules.

“Reduce Retirement Costs with Deferred Income Annuities Purchased before Retirement” (Journal of Financial Planning, July 2015) examines annuities with a short-term deferral to hedge against bear markets and longevity risk. A short-term deferral, if the annuity is purchased prior to retirement, can be used to fund retirement spending at a lower cost.

“The Cost of Retirement with Different Income Tools” (Journal of Financial Planning, April 2015) compares sustainable spending rates under various portfolio designs.

Stepping stones to bigger Social Security checks

It’s smart to delay claiming Social Security benefits until age 70. The monthly payout, after all, is 75% higher than at age 62. And if you want to retire before age 70, use your investment portfolio to bridge the income gap.

In his paper, “Bridges to Social Security” (Journal of Financial Planning, April 2015), Jonathan Guyton shows how to fund this gap at the beginning of retirement without increasing longevity risk at the other end of retirement.

The client, he says, should take a lump sum from savings that’s equal to the cumulative amount she would have received from Social Security during the delay period (from age 66 to age 70 in this example). That money should be invested conservatively, and then liquidated in a manner that replaces the foregone income from Social Security (including cost of living adjustments).

Over those four years, she can supplement that income by withdrawing from her remaining savings at the rate of 4.5% per year. Then, when she reaches age 70, she can live on the higher payments from Social Security and 4.5% a year from savings. This segmentation strategy works better, on an after-tax basis, than simply spending 6.5% a year from savings starting at age 66 (to meet 100% of income needs) and reducing that rate (to make room for full benefits from Social Security) at age 70. Guyton describes all this in a brief, not a full journal article, so not all of his assumptions are visible.

Aging aside, retirement can be good for your health

Is retirement good for your health or bad for your health? Of course, it depends on a lot of variables. In studying unhealthy retirees, researchers have had difficulty determining if they’re unhealthy because they retired or if they retired because they weren’t healthy enough to work.

Aspen and Devon Gorry of Utah State University and Sita Slavov of George Mason University tackle that question in a new study, “Does Retirement Improve Health and Life Satisfaction?”

Their answer: Retirement doesn’t make you unhealthy. On the contrary. The researchers use data from a survey of Americans over age 50 that asks people questions about their health and daily activities (Sample question: Do you agree or disagree with the statement, “In most ways my life is close to ideal”). They conclude that retirement does improve life satisfaction. Over time, it even improves health, they posit, which can help reduce health care expenditures.

How much does America spend on medical care for those age 65 and over?

Not long ago, the Employee Benefit Research Institute and Fidelity Investments released estimates that Americans should be saving at least $250,000 just for expected medical expenses in retirement.

Fear over the possibility of high medical bills, especially the expense of long-term residential care, is known to drive a lot of saving behavior, especially by those too wealthy to qualify for coverage by Medicaid.

Given the natural infirmities of old age, older Americans use much more health care than younger people. In 2010, medical bills for those aged 65 or older were 2.6 times the national average, according to government data, and accounted for over one third of all U.S. medical spending.

A new report, “Medical Spending of the U.S. Elderly,” takes a closer look at these costs. Written by Mariacristina De Nardi of the Federal Reserve Bank of Chicago, Eric French and Jeremy McCauley of University College London and John Bailey Jones of the University of Albany, it’s based on an analysis of government data for the period from 1995 to 2010.

Among their findings:

Medical expenses more than double for those between ages 70 and 90, with most of the increase coming from nursing home spending.
The top 10% of all spenders are responsible for 52% of medical spending in a given year.
Those currently experiencing either very low or very high medical expenses are likely to find themselves in the same position in the future.
The government pays for 65% of the elderly’s medical expenses; the expenses that remain after government transfers are even more concentrated among a small group of people.
The poor on average consume more medical goods and services than the rich, but are responsible for a much smaller share of their costs.
While medical expenses before death can be large, on average they constitute only a small fraction of total spending, both in the aggregate and over the life cycle.
Medicare covers well over half of the elderly’s medical expenditures. Private health insurance, Medicaid, and out-of-pocket expenditures each cover between 11 and 13% of the total.
In 2013 personal health care expenditures in the U.S. amounted to $2.5 trillion in 2014 dollars, representing 14.7% of GDP.
Low-income people consume more medical resources per year. The higher spending on the poor consists mostly of greater expenditure on nursing homes. When nursing home care is excluded, the income gradient is much less pronounced.

RetirePreneur: Bo Lu

Posted on August 5, 2015 by Jenna Gottlieb -

What I do: I am the co-founder and CEO of FutureAdvisor, an investment advisory firm based in San Francisco that helps people manage their long term investments. We manage multiple goals for individuals including retirement planning and college saving. Our software helps those that are looking at how to set everything up correctly as they enter their retirement phase, and also to assist saving for college on behalf of their grandchildren.

The software takes less than two minutes to get started and there is free portfolio analysis for users and recommendations. The software also helps minimize investment fees. We work with Fidelity and TD Ameritrade in managing accounts. We have a relatively straightforward custodian relationship with Fidelity and TD—very similar to what they have with thousands of advisors. Bo Lu copyblock

Who my clients are: Our average client is 42 years old and has $150,000 in assets being managed by us. That number represents the majority of their liquid net worth, so we would define clients as middle class, middle America families who are looking for investment help.

My business model: Just like every other investment advisor, we are fee-based. We charge half a percentage point on the assets we manage annually, not including college savings assets, which are managed for free. We change half or less than half of what a local advisor would charge and we start at a minimum of $10,000 in investable assets, which is much lower than many other advisors.

Where I came from: I’m the lead investment advisor for FutureAdvisor and I hold a Series 65 license. Before co-founding this company, I earned a degree in computer science from the University of Illinois Urbana-Champaign with a minor in technology and management. Jon Xu, FutureAdvisor’s other co-founder, is the chief technology officer who previously worked at Microsoft.

My entrepreneurial spirit: For me, the major motivation to solve this problem was that it was a problem worth solving. I saw a problem that was so stark. Rich families have financial advisors and that’s it, many in the middle class and poor families don’t have that same opportunity. I felt that my duty to the world was to fix this problem. It’s so obvious that every single person in the country deserves access to quality, unbiased financial management. The poor care just as much, but they don’t have the tools or money.

The most challenging part of starting and growing a business: When you have something you’re truly passionate about, the actual work and execution of that idea are a pleasure and exciting. At the start, the most challenging part was the things you don’t go into it thinking about – things like incorporating, and getting registered with the SEC. Things like finding office space and accounting and setting up phones. At the start, it was surprising how much more time the operational aspects of the business took than I expected. As you continue to grow the biggest challenge becomes finding the right people. Especially early stage, the people you choose to work with are paramount to your success – finding those people in a crowded marketplace can be a challenge.

What I see ahead for retirement income: I think that there’s good news ahead. What I see for the future of retirement income is that everyone will have a team managing their assets for them. Quality, unbiased, affordable retirement planning will not be reserved for only the wealthy. There are people who rather than spend their time looking at the markets, want some help, but may not be able to afford pricier advisory services. I hope, and our mission is, that more people will be able to go out and enjoy their lives, and worry less about the future, because a team is managing retirement assets for them.

The best retirement income plan for most people: The reason why this company was started was because the best financial income plan does not exist for most people. People have different situations and varying degrees of risk tolerance. It’s so different for each person. The problems are personal therefore the solutions must be personal.

My view on the robo-advisor label: We have been called a robo-advisor. But it’s really bigger than the term. Software has an ability to help those who do not qualify for high-quality expensive financial management. That said, we couldn’t imagine that in 10 years time, that software will play a smaller role. Software is here to stay and we believe in a mix of licensed CFPs to answer questions and the use of software. It’s reasonable to incorporate software into retirement planning. Advisors who don’t incorporate software will get left behind.

How we train our algorithms to think more like people: Computers are completely logical. They take the most mathematically correct actions, even when those actions aren’t particularly intuitive. When the impact of those actions is relatively small, and where an investor might assume something is broken/wrong when seeing them, we have trained our algorithm to not make them.

For example, the algorithm might want to sell a particular ETF in your IRA and then buying the same ETF in your taxable account. Even to the saviest investor, this might seem like an error, and cause distrust or even fear that the system is broken. Causing that type of alarm just isn’t worth the .0001% extra efficiency that the algorithm is capable of. There are a lot of little things like that, which don’t have a measurable impact on performance, but which could cause undue stress or unnecessary churn in users’ portfolios.

What the retirement income industry can do better: Help needs to be more accessible to the masses. If you look at what the industry’s impact has been as a percentage of the country it’s embarrassing. Incentives are misaligned, and the people who need help the most are precisely the ones who have been viewed as “too small to spend time on.” It’s why we are focusing so heavily on providing more advice digitally. It lets us throw the status quo on its head, and give everyone the attention and advice they deserve.

My retirement philosophy: I think the thing we think about is that people should not worry, but be cognizant of their financial future earlier rather than later. I would encourage people who are younger to do that. Our median client is not 50 but in their early 40s and are actively engaged in planning for their own future. If you are actively engaged and planning, you would be a person well served.

John Hancock Retirement to offer HelloWallet robo-advisor

Posted on August 5, 2015 by Editorial Staff -

Starting in the fourth quarter of 2015, John Hancock Retirement Plan Services intends to offer Morningstar, Inc.’s HelloWallet financial wellness tool to its plan sponsors, for use by plan participants through John Hancock’s Total Retirement Solution platform.

HelloWallet is a web-based and mobile application. It helps people manage their finances by integrating financial information, thus making it potentially easy to “create budgets, analyze spending and savings trends, and track progress toward goals,” John Hancock said in a release.

The technology engine uses findings from behavioral finance and industry experts to help guide people toward making smart financial choices in easy and incremental steps,” the release said.

“Financial stress is a major factor in many people’s lives, and retirement is almost an irrelevant topic if people have too much debt and not enough savings,” said Patrick Murphy, president of John Hancock Retirement Plan Services, in a prepared statement. “By offering HelloWallet, we’re helping people figure out how to alleviate their immediate financial stresses and enable them to save for a comfortable retirement.

Morningstar, Inc. is a global provider of independent investment research, and a leader in managed account solutions for plan participants. Morningstar acquired HelloWallet Holdings, Inc. in 2014. HelloWallet, LLC, a subsidiary of HelloWallet Holdings, is the provider of the HelloWallet software tool noted here.

John Hancock Financial is a division of Manulife, a Canada-based financial services group with principal operations in Asia, Canada and the United States. Assets under management by Manulife and its subsidiaries were C$821 billion (US$648 billion) on March 31, 2015.

Symetra rides new FIAs to record quarterly sales

Posted on August 5, 2015 by Editorial Staff -

Symetra Life Insurance Company exceeded $1 billion in quarterly annuity sales for the first time during the second quarter 2015. Symetra’s fixed indexed annuities (FIAs) posted the highest quarterly production figures since the product launched in April 2011.

Sales were driven by the March 2015 introduction of the Symetra Edge Plus Fixed Indexed Annuity and the Symetra Edge PremierFixed Indexed Annuity.

“New product launches and our continued expansion and increased penetration of the bank and broker-dealer distribution network” accounted for the record sales,” said Dan Guilbert, executive vice president of Symetra’s Retirement Division, in a release. “Indexed annuities were the quarter’s growth engine.”

The Symetra Edge Premier FIA’s indexed account options include the JPMorgan ETF Efficiente 5 Index, which provides interest crediting options based on indexes composed of diverse asset classes, including domestic and foreign equities and others. Symetra’s Retirement Sales team has added six wholesalers since January 2015, four of whom are focused on broker-dealers as part of the division’s ongoing expansion in the channel.

Guardian enhances 401(k) portal

Posted on August 5, 2015 by Editorial Staff -

The Guardian Insurance & Annuity Company, Inc., has enhanced its website, 401k.guardianlife.com, to allow small businesses, third-party administrators and participants to better administer and manage their Guardian defined contribution plans.

New features include a dashboard with access to key retirement plan performance statistics, enhanced reporting options, easier navigation and a resource library.

A key enhancement is the Guardian IncomeConnect Calculator. It projects current savings into retirement income and provides a real-time gap analysis. If it detects a shortfall in savings, the calculator will suggest educational tools and resources to help the plan participant close the gap.

Individuals are likely to contribute more to their 401(k)s if they know how much their current contributions will provide in future retirement income, according to the recently released Guardian Small Plan 401(k) RetireWell Study 2.0: “What’s Working and Not Working for Small Plan Participants.”

The new website is intended to reduce the administrative burden on financial professionals, TPAs and plan sponsors by allowing them to review plan data and indicators for a snapshot of the plan at any point in time. The website also offers eDelivery for plan sponsor summary statements and participant quarterly statements.

If It Ain’t Fixed Indexed, It’s Broken

Posted on July 30, 2015 by Kerry Pechter -

Except for fixed indexed annuities, sales of all annuities declined in the first quarter of this year. You might say that, if it ain’t an FIA, it’s broken.

A survey of 15 broker-dealers by the Insured Retirement Institute shows that fixed indexed annuities remain a niche product, representing only about 10% of annual annuity sales, but that the niche has grown, with the equity-linked insurance products finding a home at independent broker-dealers.

To be sure, sales of variable annuities still dominate. They account for two-thirds of total annuities sales, the survey showed, and about two-thirds of those are sold lifetime income guarantees. But sales of variable annuities fell to a five-year low in the first quarter of 2015.

FIAs are the only annuity category that grew in 1Q2015 (by 3%). They have helped fill the VA vacuum for registered reps who, too new to have developed a large enough book of business to support a fee-based revenue model, rely heavily on commissions.

The retreat of variable annuities has puzzled some observers. Rising equity prices have provided a reliable tailwind for VA sales in the past. But not this time, for several reasons:

A number of once-major issuers have stopped making VAs, and fewer contracts are 1035-exchanged (because new contracts aren’t as rich as the older ones). More than a few advisers say they still feel betrayed by the contract buyback offers tendered by a few insurers, who were desperate to shrink their exposure to the unknown-unknown liabilities lurking in their VA books.

In addition, the shift by some life insurers toward selling low-cost IOVAs (investment-only VAs) has made some broker-dealers skittish. They say it’s difficult to demonstrate to their in-house watchdogs that it’s suitable to sell an insurance product without insurance features. (IOVAs are built for tax-deferred trading, and typically have no death or living benefit.)

B/D FIA sales growing

An FIA is a structured insurance product. Most of the purchase premium is used to buy bonds, but a small percentage used to buy options on equity indexes. If equity indexes rise, the value of the options rises and the gains are credited to the contract. If equity indexes fall, the options are worth nothing but the underlying bonds grow enough to support a principal guarantee.

Despite their indirect exposure to equity risk, FIAs are not securities; the courts established that in 2009 after SEC commissioner Chris Cox, alarmed by media reports of predatory sales practices, tried to put them under federal jurisdiction. As insurance products, they’ve been distributed mainly through state-regulated insurance marketing organizations and sold by insurance agents.

But FIA sales through b/ds have been growing. Some b/ds, such as Edward Jones and Ameriprise, continue to keep FIAs off their product shelves. Others, like Commonwealth Financial Network, have embraced them.

In 2012, independent insurance agents accounted for 84% of $32 billion in FIA sales, while b/ds sold only 4%. In 2013, those numbers were 78%, 4% and $36 billion, and in 2014 independents agents sold 66% and b/ds sold 15% of $48 billion.

Almost all of the growth in the b/d channel has been among the independent b/ds, according to the Saltzman Associates, a Charlotte, NC-based consultant. In the first quarter of 2015, 87% of the $1.52 billion in FIAs sold in the b/d channel was at independent b/ds, with only $67 million at the national and regional broker dealers and $164 million at the wirehouses (Morgan Stanley, Merrill Lynch, UBS and Wells Fargo).

Of the 15 b/ds polled by IRI, six said sales were growing “significantly” and six said sales were growing “modestly.” The remaining three said sales were “steady.” About one in three expected sales to grow significantly in the future, and seven of 15 expected FIA sales to represent a higher percentage of their annuity sales in the future.

FIAs were found to displace sales of other annuities at b/ds—mainly cannibalizing VAs with lifetime income benefits and traditional fixed annuities. According to the survey (see chart below), executives at four of 15 b/ds said that FIA sales “significantly” displaced sales of each of those two products. Three b/ds said FIAs significantly displaced sales of certificates of deposit.

Of the many crediting strategies that FIAs offer—and which make the product confusing to some people—the b/ds clearly preferred some to others. Asked to consider 13 different strategies, b/ds ranked “annual point-to-point,” “monthly point-to-point,” “monthly averaging,” “multiple index strategies,” and “fixed with multi-year” as the most popular.

The least widely used crediting strategies were “daily averaging,” “inverse annual point-to-point,” “term end-point,” “multiple point-to-point” and “fixed with an equity kicker,” according to the survey.

Most b/ds work with five or more FIA suppliers. Some work directly through FIA issuers, some through IMOs and some with both IMOs and issuers. The top manufacturer of FIAs has historically been Allianz Life, with Security Benefit Life rising into second place since its purchase by Guggenheim Partners, the private equity firm.

A product for all interest rate climates

IRI asked b/ds what factors they believe would drive FIA sales in the future. The factors most frequently mentioned were higher interest rates, the availability of lifetime income riders, “concern that lifetime income benefits might be less generous in the future,” “value of principal protection with some upside potential,” and, ironically, “persistent low interest rates.”

“Both higher interest rates and persistent low interest rates were cited as potential sales drivers, which seems paradoxical but in fact is simply viewing the product from two different perspectives,” the IRI survey said.

“In a persistent low interest rate environment, sales are boosted by the product being an attractive alternative to low interest products such as CDs. As rates rise, index options become less expensive and FIAs are able to provide more upside potential, making the product more attractive from a growth standpoint.”

Part of the appeal of selling FIAs has traditionally been the high commissions paid by manufacturers. According to the IRI survey, 64% of FIAs pay gross up-front commissions of 5% or less, but 36% pay 6% or 7%. Invented at Keyport Life in 1995, FIAs were marketed aggressively during the low-interest period after the 2000 dot-com crash by Allianz Life of North America, under then-CEO Robert W. MacDonald.

The products have thrived during the two periods of historically low interest rates since 2000. At such times, they can provide safety with more upside potential than fixed deferred annuities or certificates of deposit. The addition of lifetime income riders to FIAs has helped boost their appeal and their sales in recent years.

Is It Time to End Tax Deferral?

Posted on July 30, 2015 by Kerry Pechter -

Blame it on tax deferral.

Like a park ranger who blocks the road to a million acres of resource-rich wilderness and warns loggers and the miners that they shall not pass, the Labor Department’s Phyllis Borzi is standing in front of the $7.2 trillion in America’s IRAs and telling commission-driven brokers and agents: Back off!

The chief of the Employee Benefit Security Administration is doing it because of tax deferral. The government has hundreds of billions of dollars worth of tax expenditures invested in IRAs. Tax deferral is supposed to help Americans’ retirement accounts grow faster and fatter. The DOL doesn’t want to see its investment consumed by unnecessary commissions and fees.

(You may believe that most of those commissions and fees aren’t useless at all, and that they pay for products and services that enhance investors’ and retirees’ financial security. The DOL doesn’t appear to share that belief.)

Notice that the government has no beef with the treatment of taxable accounts. The trillions of dollars in those accounts are up for grabs. But retirement accounts are different. The DOL evidently thinks that as long as the money in rollover IRAs remains tax-deferred, it should be as closely regulated as the money in ERISA-regulated plans (whence almost all of it came).

Ergo, DOL proposal haters, be careful what you wish for. An argument against the spirit of the proposal is an argument for ending tax deferral for retirement savings. If you want to keep tax deferral, it might make sense to accommodate some of the DOL’s concerns.

A nest of ambiguities

We tend not to see the situation in those terms because the role of tax deferral has been fogged over with ambiguities.

Tax deferral means different things to different people. Not everybody agrees that tax deferral is a subsidy. Not everybody believes that tax deferral should achieve a public policy goal. Not everyone believes that tax deferral is a “tax expenditure,” or even that such a phenomenon as tax expenditures exist.

The nature of the rollover IRA is also ambiguous. Is it a personal pension fund—a kind of trust accounts—or is it like any other retail brokerage or mutual fund account, aside from the nuisances of penalties for early withdrawal and required minimum contributions at age 70½? Answer: It’s both.

The purpose of the 401(k) itself is ambiguous. Created by the private sector, it was first seen as a tax management device, then as a supplemental savings plan, then as a replacement for defined benefit pensions, and now as a de facto incubator for retail rollover IRA accounts. The government didn’t create the phenomenon and never had a clear goal for it, so why should it care to regulate it more closely?

Because of tax deferral.

There’s a good reason why we don’t recognize the tax deferral on savings as a direct federal subsidy. In the UK, they encourage savings differently. The government directly credits the participant’s retirement account with an amount equal to the tax reduction. Here, we get a tax refund, which we don’t necessarily have to save. There’s no government-funded sleeve in our retirement accounts. So when the DOL says it wants to regulate our IRAs, we can accurately say, “But it’s our money.”

A modest proposal

It would seem, then, that everyone is right—and wrong. The DOL has a legitimate claim that rollover IRA money should be regulated like an ERISA plan, and the financial services industry has an equally legitimate claim that rollover IRA money should be treated the same (except for the penalty before 59½ and the RMDs at 70½) more like other retail money. Hence the battle. (The hearings on the conflict-of-interest proposal start August 10 in Washington.)

All I am saying here is that, the more strongly and successfully the industry presses its case, the easier it will be for enemies of the $100 billion annual tax expenditure for retirement savings to say: Go ahead, brokers, have your way with rollover IRAs, and even 401(k)s for that matter. But you have to give up tax deferral. A subsidy without rules is a recipe for moral hazard. You can’t have it both ways.

This strikes me as the issue at the heart of the current controversy—the issue we duck and dodge, while pretending that it’s all about “advice.” Perhaps it’s time to reconsider tax deferral, and replace it with tax-free withdrawals from retirement accounts. Think how much simpler life might be.

FINRA Sides with Brokers against DOL Proposal

Posted on July 30, 2015 by Kerry Pechter -

FINRA, the securities industry’s in-house watchdog, is urging several changes in the Department of Labor’s proposed “fiduciary rule” for retirement accounts, including a change that would create a single “best interest standard,” based on current securities laws, for both retirement and non-retirement accounts.

The recommendation was one of several that FINRA (Financial Industry Regulatory Agency) made in a 21-page letter sent to the DOL on July 17 in response to the DOL’s request for comments on the proposal. It is posted in the public comments section of the DOL’s website.

Many of FINRA’s recommendations are consistent with those made by other members of the industry that it both serves and polices. In its letter, FINRA asked the DoL to clarify its best interest standard, or “BICE,” and to “harmonize” the standard of conduct for commission-paid brokers and fee-based advisors, in addition to harmonizing it for retirement and non-retirement accounts.

Otherwise, the proposal’s “fractured approach will confuse retirement investors, financial institutions, and advisers,” said the FINRA letter. The letter provided the chart below to show that the DOL proposal would create the potential for six different sets of rules for any product a financial advisor might offer:

FINRA Chart DOL Proposal comment 7-15

FINRA also asked the DOL to eliminate the proposal’s requirement that financial institutions maintain public web pages, updated at least quarterly that:

“show the direct and indirect material compensation payable to the Adviser, Financial Institution and any Affiliate for services provided in connection with each Asset (or, if uniform across a class of Assets, the class of Assets) that a plan, participant or beneficiary account, or an IRA, is able to purchase, hold, or sell through the Adviser or Financial Institution, and that a plan, participant or beneficiary account, or an IRA has purchased, held, or sold within the last 365 days, the source of the compensation, and how the compensation varies within and among Asset classes.”

In addition, FINRA called for the limit that the DOL wants to place on the range of assets that financial institutions can sell to IRA owners. The current version of the proposal defines the permitted assets as:

“bank deposits, CDs, shares or interests in registered investment companies, bank collective funds, insurance company separate accounts, exchange-traded REITs, exchange-traded funds, corporate bonds…, insurance and annuity contracts (both securities and non-securities), guaranteed investment contracts, and equity securities” but not “any equity security that is a security future or a put, call, straddle, or any other option or privilege of buying an equity security from or selling an equity security to another without being bound to do so.”

Price-fixing suit names Goldman, 21 other primary Treasury dealers

Posted on July 30, 2015 by Editorial Staff -

In a federal class-action lawsuit, Boston’s public employees pension fund has accused 22 large financial institutions of using their privileged positions as primary dealers of U.S. government debt to manipulate the Treasury auction market and boost their own profits at investor’s expense.

All of the institutions entrusted with underwriting and distributing Treasury debt—Bank of America’s Merrill Lynch unit, Citigroup, Credit Suisse, Deutsche Bank, Goldman Sachs, HSBC, JPMorgan Chase, UBS and 14 others—were named in the suit, which State-Boston Pension Fund filed July 23 in U.S. District Court, Southern District of New York.

The State-Boston Pension Fund manages $5.4 billion for more than 20,000 active and more than 14,000 retired employees of all city departments and agencies as well as the School Department, the Boston Redevelopment Authority, the Boston Housing Authority, the Public Health Commission, and the Boston Water & Sewer Commission.

The suit was filed about a month after Bloomberg News reported that the U.S. Department of Justice (DOJ) was investigating possible misconduct in the $12.7 trillion Treasury market, where primary dealers operate with little oversight and where tiny fluctuations in spreads represent millions of dollars gained or lost.

The plaintiffs linked the alleged manipulation with the similar manipulation of the benchmark LIBOR (London Interbank Order Rate) in 2012. The Treasury “conspiracy ultimately collapsed around the time DOJ secured a plea agreement from UBS Securities Japan Co. Ltd. in connection with its investigation of LIBOR in or around December 2012—a scandal involving similar manipulative conduct that would ultimately engulf several of the same Defendants, their parents, or affiliates,” the State-Boston suit said.

The suit claims that traders at the 22 firms conspired via Internet chatrooms and text messages to widen their spreads, or profit margins, on trades of government debt. Primary dealers typically sell government securities “short” prior to a Treasury auction, and then cover their positions by buying debt instruments from the U.S. Treasury.

Sharing information on order flow before the auction, the suit said, the traders agreed to charge investors such as pension funds and other investors a slightly higher, “supra-competitive” price for Treasury bills, notes and bonds, then conspired to pay a slightly lower, less competitive price on their own purchases from Treasury.

Because the prices and yields that are set during the Treasury auction become the benchmarks for prices in related markets, the effects of the manipulation included mis-pricing of Treasury futures and options, the lawsuit said. The New York law firm of Labaton Sucharow represents the plaintiffs.

According to the suit:

Using “electronic methods of communication, Defendants’ Treasury securities traders employed a two-pronged scheme to maximize the spread between their short positions in the when-issued market and their acquisition costs of obtaining Treasury securities at Treasury Department auctions.

“First, Defendants’ traders agreed to artificially inflate the prices of Treasury securities in the when-issued market through coordination of bid-ask spreads. Defendants communicated with each other during the when-issued market to ensure that prices of when-issued Treasury securities would stay at supracompetitive levels.

However, because Defendants are primary dealers—and thus were required to bid at Treasury Department auctions—Defendants, individually and collectively, generally maintained short positions in the when-issued market. Defendants needed to be able to cover these positions profitably. Thus, they needed to fix the prices at which they bought Treasury securities from the Treasury Department.

And that’s exactly what Defendants did. Defendants coordinated their bidding strategies at the Treasury Department auctions to artificially suppress the prices they would pay for their bids. This had the effect of benefiting the short positions they maintained in the when-issued market by allowing Defendants to cover their positions with low-cost Treasury securities purchased at auction.

By artificially increasing the spread between prices of Treasury securities in the when-issued market and at auction, Defendants were able reap supracompetitive profits— essentially shorting (selling) Treasury securities artificially high in the when-issued market and then buying them at artificially low prices in the Treasury Department auction to cover their short positions.

Through Defendants’ unlawful conduct, they were able to keep the spread between when-issued and auction prices at supracompetitive levels that would otherwise not have been possible in a competitive market.”

The lawsuit seeks class-action status on behalf of investors in Treasury securities, including futures and options, from 2007 to 2012, and unspecified triple damages.

Reuters sought responses from the primary banks named in the suit but said it did not receive any.

Switcheroo: New FIA credits benefit base, not account value

Posted on July 30, 2015 by Editorial Staff -

Fidelity & Guaranty Life, the Baltimore-based insurer that was purchased by Harbinger Capital from Old Mutual plc in 2011, has a new fixed indexed annuity designed to provide income payments for retirees, called FG Retirement Pro.

F&G described the product as unique in allowing the “benefit base” (the notional amount guaranteed minimum withdrawal benefit’s monthly payment gets calculated), rather than the account value, to grow through an interest crediting mechanism determined by the appreciation of equity index options.

Meanwhile, the account value (the cash value of the contract) grows by an annually declared fixed interest rate. In states that allow it, the contract also offers an optional 7% premium bonus that vests over time, a 13% cap on annual point-to-point increases in the benefit base, and an income multiplier (200% for single annuitants and 150% for joint annuitants) for contract owner who become ill.

Asked to comment on this type of product design, a consulting actuary who is not familiar with the product offered this observation by e-mail:

“The cost of a GLWB [to the issuer] is somewhat proportional to the gap between the cost of the withdrawal path vs. the account value/surrender path. A proxy for the withdrawal path is the benefit base (BB), although the true cost is the present value of the withdrawal income and the exercise probabilities.

“Some products have tried to manage this gap by having the BB grow in some way that is related to interest crediting. For example, there is “stacked” BB crediting consisting of a constant plus credited interest. Basically, it is good to keep the BB and the AV from diverging too much.

“With hedge budgets being fairly low, it may be that BB growth based on credited interest is generally, on average, lower than a competitive fixed roll-up rate. If F&G has become aggressive on hedge budgets/interest crediting, the gap between a fixed roll-up and this may be narrow.

“With roll-ups where they were, step-ups were a rarity. They had minimal financial impact. If the case is that the AV and the BB both grow by credited interest, then there never would be a step-up; however, that would have minimal financial impact.

“On the surface, this F&G product seems to add nothing for the customer (unless I am missing something) except some simplification by eliminating a much misunderstood roll-up rate.”

“The design of FG Retirement Pro puts strong indexing opportunity into the income feature. The product’s “innovation lies in its income potential,” said Brian Grigg, vice president of annuity distribution at FGL. Any agent who has sold indexed annuities clearly understands the upside potential of index credits tied to a well-known index, such as the S&P 500. FG Retirement Pro takes it to the next level and builds a benefit base on indexing. And, the caps have the potential to be very strong.

“The competitive arena for FIAs for many years now has been with income. Early versions provided a fixed roll-up rate as a way to grow a benefit base. FG Retirement Pro combines the fixed rate with the potential of a higher overall roll-up rate through indexed interest credits to the benefit base.”

FG Retirement Pro is available for sale immediately. A call requesting comment from FGL was not returned by deadline.

The SoA’s new logo is “impossible”

Posted on July 30, 2015 by Editorial Staff -

As part of an overall brand refresh, the Society of Actuaries (SOA) has adopted a new logo. The logo design is based on the Penrose “impossible triangle,” which itself was partly inspired by the famous drawings by M.C. Escher that employed ambiguous shadows and perspectives to depict objects that couldn’t exist in three-dimensional space.

The SoA says, however, that the new logo represents infinity, like a Mobius strip, which some people believe is the original inspiration for the ancient symbol of infinity, ∞. According to one source, if “a line is traced around the Penrose triangle, a three-loop Mobius is formed.”

“The infinity symbol communicates how the organization is continually evolving to provide forward-thinking research, education and opportunities for our community and the professionals within it,” the SOA said in a release.

“ The shield represents a foundation, bound by a set of principles, that advances the interests of our profession and cultivates outstanding, trusted professionals. The Penrose triangle (impossible triangle), among other mathematical related symbols, served as inspiration. The logo is blue, a color of trust.”

The new logo will be featured on SOA.org and in the organization’s magazine, The Actuary.

“The SOA brand is changing, though our principles endure as we serve the public, advance the profession, credential and educate actuaries, and build strong actuarial communities,” said SOA President Errol Cramer, FSA, MAAA, in a statement. “This brand refresh reflects the essence of the SOA. We are trusted to advance knowledge through actuarial research. We are trusted to nurture and educate our candidates.”

The SOA’s ancestry can be traced to the formation of the Actuarial Society of America in 1889. When the ASA merged with the American Institute of Actuaries in 1949, the SOA was born. The SOA will continue to use its traditional seal for official documents.

When entertaining ideas for a new logo, the SOA surveyed members and other audiences on the messages and brand identity. The brand campaign was developed by the SOA and an outside vendor. The SOA Board of Directors approved the new logo in October 2014.

Time for Boomers to rebalance: Fidelity

Posted on July 30, 2015 by Editorial Staff -

Fidelity Investments’ latest quarterly analysis of its 401(k) accounts and Individual Retirement Accounts (IRAs) showed that the bull market that started in 2009 has made Boomers richer on paper—but perhaps more heavily allocated to equities than they should be.

In a report released this week, Fidelity shared these statistics:

Account balances. The average 401(k) balance dipped slightly at the end of Q2 to $91,100 from $91,800 at the end of Q1, and is nearly flat from the end of Q2 2014 average of $91,000. However, IRA balances increased to $96,300 at the end of Q2, up from $94,000 at the end of Q1 and $92,500 one year ago.
Contributions. Individuals and their employers remain committed to saving in 401(k) accounts and total contribution rates are reaching record levels. The average 12-month total savings amount, which combines employee contributions and employer contributions (such as a company match), increased from $9,840 at the end of Q1 to $10,180 at the end of Q2 – the first time the total savings amount has surpassed $10,000. The average IRA contribution dipped to $2,690 at the end of Q2 from $3,150 at the end of Q1, primarily due to the significant number of people making contributions to their IRA in Q1 to meet the IRS tax deadline.
401(k) loans. While average balances have increased over the past several years, higher savings balances could be contributing to increased loan activity among 401(k) account holders. While the percentage of people initiating a loan (10.1%) and the percentage of loans outstanding (21.9%) have remained steady over the last several quarters, the average 401(k) loan amount continues to increase. For the previous 12 months, the average loan amount reached $9,720 at the end of Q2, up from $9,630 at the end of last quarter and $9,500 a year ago.

Many Boomers top-heavy on stocks

While a rising stock market is one reason the average 401(k) balance is up 50% in the last five years, this has led to an increased percentage of equities within many 401(k) accounts, which can add increased exposure to the negative impact of a market downturn.

Many older 401(k) account holders, including Baby Boomers close to retirement age, had stock allocations higher than those recommended for their age group.

Fidelity compared average asset allocations to an age-based target date fund and found 18% of people 50-54 had a stock allocation at least 10 percentage points or higher than recommended, and for people ages 55-59, that figure increased to 27%.

An additional 11% of people ages 50-54 had 100% of their 401(k) assets in stocks, while 10% of people ages 55-59 had all of their 401(k) assets in stocks.

Would the DoL Proposal Deny Advice to the Masses?

Posted on July 23, 2015 by Kerry Pechter -

The financial services industry’s most common criticism of the Department of Labor’s conflict-of-interest proposal has been that middle-class Americans would lose access to valuable advice about retirement investing if the proposal were enacted in its current form.

Several financial services trade associations mentioned this possibility in the reports they submitted to the DoL during the public comment period on the proposal, which ended this week. The cost of all the disclosures required by the proposal, said the Bank Insurance & Securities Association:

“Will require enormous effort on the part of financial service providers, at great expense. Conceivably, this could force all but the largest financial institutions to leave the retirement plan and IRA business, inhibiting the ability of average investors to obtain the advice they require.”

But is that true? Would the Labor proposal backfire, and ruin an imperfect but functional market for advice in a quixotic attempt to purify it? Or is the industry’s concern for the average investor mainly just a talking point, tailored to neutralize the DoL message and gain public sympathy?

The jury’s still out. A review of the comments on the DoL/EBSA website, and a look at related reports and studies, suggest that the proposal in its current form would be highly disruptive. In the UK, advisor numbers dropped by almost 25% after most commissions were banned.

But the proposal may not as disruptive to the delivery of advice per se as to the delivery of products. The advisors who will be most affected will be those who are directly involved in the sales and distribution of high-cost mutual funds and variable annuities; these are products that don’t sell themselves, and which require the incentives that the DoL clearly targets. The proposal may or may not limit a client’s access to advice; it would almost certainly limit an advisor’s access to clients.

The economics of advice

Part of the economic argument against the DoL proposal is the assumption that vendor financing—mainly in the form of manufacturer-paid commissions on the sale of mutual funds and annuities—helps drive the provision of financial services to middle-class people who wouldn’t actively seek or pay for advice alone.

According to this line of thinking, if you encumber the commission-model with over-regulation, advisors will move to the fee-based model that, almost by definition, caters primarily to people with enough wealth to make a percentage of assets-under-management arrangement attractive for the advisor.

“If, as we predict, the proposed rule will cause all compensation models to move to one-size-fits-all pricing, advisors are likely to determine that they cannot afford to work with small clients,” wrote Scott Stolz, president of the Raymond James Insurance Group, in his comment to the DoL.

In support of that idea, he pointed to a hypothetical client with a $25,000 IRA. “Assuming a common asset charge of 1%, advisors are unlikely to enter into a fiduciary relationship that requires essentially a 24-hour a day, seven-day-a-week care for just $250 a year.”

Even if the advisor charges a commission, it still wouldn’t be enough, Stolz argued. First of all, “the compression of commissions and trails… will provide compensation to the advisor roughly equal to the $250 he or she would receive under a fee-based agreement,” and the advisor “will most likely not serve the client because the costs and liability [entailed by the BIC standard] will likely exceed the compensation received.”

Defenders of commissioned sales also argue that one-time commissions on product sales can be cheaper in the long-run than asset-based fees that are assessed every year. But it’s difficult for a layperson to make apples-to-apples comparisons in such cases, because products often entail their own automatic annual fees, and an asset-based fee might cover financial planning services that commissions don’t.

Will ‘robos’ fill the gap?

Even assuming that middle-class investors are disenfranchised by regulations that discourage commission-based sales, they increasingly have the option of seeking investment advice online. Robo-advisors like Wealthfront, Betterment and others, as well as traditional B2C providers like Vanguard and Fidelity, along with advisors who adopt a hybrid model that blends in-person and automated advisory services, are confident that they can pick up the slack.

In his official comment to the DoL proposal, submitted this week, Rob Foregger, the co-founder of robo-advisor NextCapital, wrote, “The emergence of low-cost, automated services will directly help alleviate the concerns of decreased access to advice.

“In general, digital advice firms target those investors who may be underserved by traditional advisors. With the increased adoption rate of new technology, access to automated financial advice will only continue to grow and ultimately benefit lower-income investors.”

At the recent InVest conference in New York, executives from robo-advice firms praised the DoL proposal. One even suggested that the DoL timed its proposal to take advantage of the robo-advice phenomenon. Secretary of Labor Tom Perez mentioned the availability of Wealthfront and other robo-advisors when asked in a House subcommittee hearing about the potential for an advice-gap to open up in the wake of a hard-line DoL rule.

No advice gap in fiduciary states

In one of the few academic studies on this topic, Michael Finke of Texas Tech University and Thomas Langdon of Roger Williams University looked for evidence that holding agents to a fiduciary standard changes the composition of their client base—shifting it away from the middle-class—but they couldn’t find any.

“The [financial services] industry is likely to operate after the imposition of fiduciary regulation in much the same way it did prior to the proposed change in market standards that currently exist for brokers,” they wrote in their 2012 paper, “The Impact of the Broker-Dealer Fiduciary Standard on Financial Advice.”
Exploiting the fact that some states already impose a fiduciary standard on advisors, Finke and Langdon surveyed advisors in states with and without the standard to see if there was a significant difference in the average incomes of their clients.

“We find no statistical differences between the two groups in the percentage of lower-income and high-wealth clients, the ability to provide a broad range of products including those that provide commission compensation, the ability to provide tailored advice, and the cost of compliance,” they wrote.

Those findings are compromised, however, by the fact that the research was sponsored in part by the fi360, the Financial Planning Association and the Committee for the Fiduciary Standard, all of which have come out in favor of tougher standards for brokers and agents. But the data speaks for itself.

Impact of RDR in UK

In the UK, a similar proposal did in fact have a disastrous effect on advisors. After the 2008 financial crisis, authorities in the UK conducted an examination of brokerage practices, called Retail Distribution Review (RDR), and a few years later the government outlawed third-party commissions on many annuity and investment products.

At the time, many observers feared that middle-class people would be “disenfranchised” in terms of access to financial services as a result. In a sense, it did. A June 2013 study by consultants at the Cass Business School of City University London found that between 2011 and 2013, the number of advisors in the UK dropped to 31,000 from 40,000.

“The overwhelming view of most of our interviewees was that… RDR would lead to a polarization and fragmentation of the advisory market,” the Cass report said. “The consequence of this will be a reduction in the number of mass-market IFAs [independent financial advisers], which may create a ‘guidance gap’ where many consumers may find themselves without independent financial advice, despite still having a demand for it.”

But, the report continued, “Despite the concerns raised by some or our interviewees about the unattractive nature of the market for financial advice in an RDR world, 69% of the advisers in our survey suggested that they would be retaining 75% to 99% of their clients, while 17% stated that they would retain 100% of their clients.”

People were already moving away from the commission-based model anyway, the report said: “Sophisticated, computer- and financially-literate investors are already gravitating to internet solutions where fees are transparent and low. The awareness of ETFs, fundamental indices and similar ‘economical’ products is increasing exponentially.”

Metered advice

Few commenters on the DoL proposal have asked a fairly obvious question: Why can’t registered reps simply charge middle-class clients an hourly fee for advice, like fee-only planners, and avoid the conflict created by third-party compensation?

One advisor did in fact raise this issue in a comment to the DoL. “There is much talk in the media that registered reps believe that small clients, and some have even said mass-affluent clients, will not have access to advice if reps are not allowed to charge commissions on IRA,” wrote Jonathan Phelan of Algonac, Michigan.

“Apparently their feeling is that RIAs will not service such clients and the reps have no other way to earn money on a client’s IRA than a commission. Why couldn’t the reps or the RIAs simply charge an hourly or flat fee for services for such clients instead of a commission or percentage of assets under management? I know there are plenty of RIAs, including myself, that are willing to charge hourly fees. Why are registered reps unable or unwilling to do that?”

One often-heard answer is that investors would rather have a commission deducted from their purchase premium or an expense ratio deducted from their account value, than write out a relatively modest check for an hour of advice or pay a flat fee for the creation of an investment plan. Indeed, investors generally don’t question an advisor’s right to earn a commission. But surveys show that they don’t necessarily know when the advisor is receiving a commission, or whether the commission might be distorting the advice. Therein lies the problem that the DoL hopes to address.

Clearly, the government and the financial services industry have divergent ideas about what’s best for middle-class savers. Industry advocates say that the DoL proposal is a solution in search of a problem. The government says that too many investors—IRA owners in particular—are over-paying for financial products and services. The search for a shared vision of the future has proven elusive.

In the Fiduciary Fight, Key Players are Biting Off as Much as They Can Chew

Posted on July 23, 2015 by Will Trout -

Amidst the summer lull, the Department of Labor (DoL) has issued Field Assistance Bulletin 2015-02, a clarifying document that aims to open the door to the broader use of annuities within defined contribution (DC) plans.

While annuities have been allowed within DC plans for some years, a lack of guidance as to fiduciary obligations post-sale has tempered sponsor enthusiasm. The bulletin explains that while sponsors are considered under fiduciary obligation at the time of annuity selection and at each periodic review, they will not be held to this standard in the case of specific purchases by a participant or beneficiary.

This distinction is important in that it grants significant protection to sponsors, but the DoL leaves significant wiggle room as to the frequency of required reviews.

Clearly, published reports of the pending insolvency on an issuing insurer would trigger the need for a review. Otherwise, the degree of diligence that must be exercised by the sponsor post-selection will need to be evaluated on a case by case basis: First by the plan sponsor, presumably, and then by the DoL.

This may be a best-effort solution to an irreconcilable problem, but such a measured response by the DoL is unlikely to eliminate what it describes as “disincentives for plan sponsors to offer their employees an annuity as a lifetime income distribution.” Plan sponsors have little incentive, in any case, to assume the risks of offering annuities when these are readily available for purchase outside the pre-tax space, and so the DoL will need to aim higher.

What is noteworthy here is not so much the narrow scope of the little noticed bulletin, or its limited reach, but the degree to which it signals an acceleration of DoL efforts to clean up the DC business. To a large degree, this acceleration reflects a heightened jockeying for position among regulators and other industry actors with an interest in guiding reform. The recent Supreme Court case of Tibble vs. Edison International, which affirmed the nature of the fiduciary responsibility of plan sponsors to participants on an ongoing basis, appears to have brought issues of power and control to a head.

The latest guidance from DoL attempts to boost clarity around sponsor obligations pursuant to the sale of annuities. This guidance is important because to date, regulatory attention has fallen disproportionately on the accumulation side of the DC business. Helping participants to successfully manage the payout function is a noble and (as I discuss in my recent report on de-accumulation) challenging goal. Time is of the essence if the US is to forestall a doomsday scenario of retirees outliving their savings.

At the same time, it is important to keep in mind that economics are not the only consideration driving the DoL push. Rather, the newfound urgency underscores the Department’s desire to put its imprimatur on an issue that is being tackled by multiple actors (e.g. Treasury; the SEC, which announced last month its compliance-focused ReTIRE Initiative; and lobbying groups such as SIFMA and NAIFA) and from multiple standpoints. In particular, a torrent of litigation (the capstone of which was the Tibble vs. Edison verdict) appears to be shifting decision power to the courts.

Legal actions are also shining a spotlight on fees. This presents a cart-before-the-horse problem for DoL, in that excessive fees are an issue that a uniform fiduciary standard is supposed to address. Having assumed the mantle of defined contribution crusader, the DoL risks falling behind events. The pressure on DoL will only become more acute as we enter the twilight of the Obama administration.

The upshot? Look for a wave of bulletins and other forms of guidance from the DoL, particularly in the wake of the upcoming August hearings. While the fiduciary debate to date has gotten less attention than it deserves, it will rise to the top of the political agenda this fall, despite resistance from industry lobbyists. Indeed, given the weight of the government and private sector entities (among them the AARP) behind reform efforts, the end result may actually have teeth.

Today’s Dark Lords of Finance

Posted on July 23, 2015 by Alexander Friedman -

In his Pulitzer-Prize-winning book, Lords of Finance, the economist Liaquat Ahamad tells the story of how four central bankers, driven by staunch adherence to the gold standard, “broke the world” and triggered the Great Depression. Today’s central bankers largely share a new conventional wisdom – about the benefits of loose monetary policy. Are monetary policymakers poised to break the world again?

Orthodox monetary policy no longer enshrines the gold standard, which caused the central bankers of the 1920s to mismanage interest rates, triggering a global economic meltdown that ultimately set the stage for World War II. But the unprecedented period of coordinated loose monetary policy since the beginning of the financial crisis in 2008 could be just as problematic. Indeed, the discernible effect on financial markets has already been huge.

The first-order impact is clear. Institutional investors have found it difficult to achieve positive real yields in any of the traditional safe-haven investments. Life insurers, for example, have struggled to meet their guaranteed rates of return. According to a recent report by Swiss Re, had government bonds been trading closer to their “fair value,” insurers in America and Europe would have earned some $40-$80 billion from 2008 to 2013 (assuming a typical 50-60% allocation to fixed income). For public pension funds, an additional 1% yield during this period would have increased annual income by $40-50 billion.

Investors have responded to near-zero interest rates with unprecedented adjustments in the way they allocate assets. In most cases, they have taken on more risk. For starters, they have moved into riskier credit instruments, resulting in a compression of corporate-bond spreads. Once returns on commercial paper had been driven to all-time lows, investors continued to push into equities. Approximately 63% of global institutional investors increased allocations in developed-market equities in the six months prior to April 2015, according to data from a recent State Street survey – even though some 60% of them expect a market correction of 10-20%.

Even the world’s most conservative investors have taken on unprecedented risk. Japan’s public pension funds, which include the world’s largest, have dumped local bonds at record rates. In addition to boosting investments in foreign stocks and bonds, they have now raised their holdings of domestic stocks for the fifth consecutive quarter.

These allocation decisions are understandable, given the paltry yields available in fixed-income investments, but the resulting second-order impact could ultimately prove devastating.

The equity bull market is now six years old. Even after the market volatility following the crisis in Greece and the Chinese stock market’s plunge, valuations appear to be high. The S&P 500 has surpassed pre-2008 levels, with companies’ shares trading at 18 times their earnings.

As long as the tailwinds of global quantitative easing, cheap oil, and further institutional inflows keep blowing, equities could continue to rally. But at some point, a real market correction will arrive. And when it does, pension funds and insurance companies will be more exposed than ever before to volatility in the equity markets.

This overexposure comes at a time when demographic trends are working against pension funds. In Germany, for example, where 20% of the population is older than 65, the number of working-age adults will shrink from about 50 million today to as few as 34 million by 2060. Among emerging markets, rapidly rising life expectancy and plunging fertility are likely to double the share of China’s over-60 population by 2050 – adding roughly a half-billion people who require support in their unproductive years.

If the combined effect of steep losses in equity markets and rising dependency ratios cause pension funds to struggle to meet their obligations, it will be up to governments to provide safety nets – if they can. Government debt as a percentage of global GDP has increased at an annual rate of 9.3% since 2007.

In Europe, for example, Greece is not the only country drowning in debt. In 2014, debt levels throughout the eurozone continued to climb, reaching nearly 92% of GDP – the highest since the single currency’s introduction in 1999. If pensions and governments both prove unable to provide for the elderly, countries across the continent could experience rising social instability – a broader version of the saga playing out in Greece.

The new Lords of Finance have arguably been successful in many of their objectives since the financial crisis erupted seven years ago. For this, they deserve credit. But, when an emergency strikes, large-scale policy responses always produce unintended consequences typically sowing the seeds for the next full-blown crisis. Given recent market turmoil, the question now is whether the next crisis has already begun.

MetLife launches retail QLAC

Posted on July 23, 2015 by Editorial Staff -

MetLife’s Guaranteed Income Builder deferred income annuity (DIA) is now available as a qualifying longevity annuity contract (QLAC) for individual clients, the publicly-held insurance giant announced this week.

In late May, MetLife introduced a similar annuity, called Retirement Income Insurance, for the retirement plan market. The institutional product offers unisex pricing, while the retail product offers higher payouts for men than women because of women’s higher average life expectancy, all else being equal.

In an interview with RIJ, Elizabeth Forget, executive vice president of MetLife Retail Retirement & Wealth Solutions, said that the product would be distributed through MetLife’s affiliated Premier Client Group affiliated advisors as well as its “traditional third-party distributors,” such as broker-dealers.

The product isn’t planned to be distributed by insurance agents via state-regulated insurance marketing organizations, in part because, unlike the broker-dealers, they don’t necessarily assume responsibility for assuring the suitability of each sale, she told RIJ.

Asked if she thought that the Department of Labor’s fiduciary proposal, if enacted in its current form, might favor the sale of fixed annuities, Forget said, “The proposal differentiates between fixed and variable annuities, but it’s hard to translate what the proposed rule will mean in certain instances.” Under the current proposal, sellers of variable annuities would have to meet a new, more stringent standard of conduct by signing a “Best Interest Contract” (BIC) with the client.

QLACs help protect against the risk of outliving one’s savings. But, like several other insurers that market QLACs, MetLife is positioning its QLAC as a tax-reduction tactic. By purchasing a QLAC, IRA owners can exclude up to 25% of their tax-deferred savings (but no more than $125,000) from the calculation of their required minimum distributions until age 85, thus potentially lowering their annual tax bill by 25% for up to 14 years. Taxable annual distributions from the rest of their tax-deferred savings must begin in the year after the year the owners reach age 70½.

“By allowing clients to defer payments from their IRAs, Guaranteed Income Builder as a QLAC gives them a significant level of flexibility to manage both their assets and tax obligations—further enhancing their ability to retire with confidence,” Forget said in a release.

Lockheed Martin’s $62 million ERISA settlement approved

Posted on July 23, 2015 by Editorial Staff -

Chief U.S. Judge Michael Reagan of the Southern District of Illinois has given final approval for a $62 million settlement in favor of Lockheed Martin employees and retirees in their suit against their employer, the plaintiffs’ law firm said in a release this week.

The eight-year-old case, Abbott v. Lockheed Martin, alleged excessive fees in two of Lockheed Martin’s 401(k) plans, as well as imprudent management of certain investment options offered to employees, according to the St. Louis firm of Schlichter, Bogard & Denton.

Jerome Schlichter, the firm’s managing partner, specializes in leading class action suits against 401(k) plan sponsors and providers on behalf of plan participants and retirees, often focusing on their failure to protect participants from high investment or recordkeeping fees, in violation of their fiduciary duties under the Employee Retirement Income Security Act of 1974.

“The settlement is the largest ever for a case of this kind against a single employer,” observed Thomas E. Clark Jr. of the Wagner Law Group. Lockheed Martin’s plan, with over $27 billion in assets and 180,000 current and former employees, is the fifth largest 401(k) in the United States.

The plaintiffs had charged that Lockheed Martin, a defense contractor, invested plan participants’ retirement savings in funds that charged excessively high fees, diminishing returns. They also claimed that Lockheed Martin allowed excessive recordkeeping fees, and allowed too much of participants’ assets to be held in low-yielding money market funds.

Lockheed Martin denied the allegations and said it followed the law and that the fees were reasonable. The case was originally scheduled for trial in the Southern District of Illinois last December, but the parties reached a settlement just before then.

Schlichter said his firm also recently won a unanimous 9-0 decision in the United States Supreme Court on behalf of employees and retirees of Edison International in their 401(k) plan, which is the first 401(k) excessive fee case decided by the Supreme Court.

Fred Reish et al comment on DOL proposal’s impact

Posted on July 23, 2015 by Editorial Staff -

If enacted in its current form, the Department of Labor’s fiduciary (or “conflict-of-interest”) proposal would have “a significant impact on the sales practices of insurance agents and brokers, according to a new report from attorney Fred Reish and colleagues at the law firm of Drinker Biddle.

Under the current language of the proposal, insurance advisors would have to comply with the existing exemption (PTE 84-24) in order to be earn manufacturer-paid commissions on sales of fixed annuities to IRA owners and 401(k) plan participants, but must meet a new “best interest” or “BICE” standard on sales of variable annuities to IRA owners.

Sales of variable annuities, which are securities and insurance products, are regulated by the SEC and FINRA. Sales of fixed annuities—fixed deferred, fixed income, and fixed indexed annuities—are regulated by the states as insurance products.

One insurance company executive speculated at the recent IRI regulatory conference that, if the fiduciary bar is set higher for variable annuities, fixed annuities would have an advantage in the IRA market.

That could have a big impact on annuity sales. Recent estimates show that the amount of savings in IRAs, including traditional and rollover IRAs, now exceeds $7 trillion. Sales to IRA owners currently account for a large share—nearly half for some products—of overall annuity sales.

There’s some overlap between the BICE and PTE 84-24 standards, and some important differences. Under both standards, advisors have to act in the best interest of the client when selling to IRA owners. But the BICE rule requires advisors and clients to enter into a contract in which the advisors pledge to make their sales recommendations “without regard” to their own remuneration.

The phrase “without regard” is receiving particular scrutiny by critics of the proposal. In its public comment on the DOL proposal, the Insured Retirement Institute, which advocates for the interests of the annuity industry, said “the definition of the term “Best Interest” in the Proposed Amendment to PTE 84-24… should be revised to make clear that advisers and financial institutions must always put their clients’ interests first, but would not be required to completely disregard their own legitimate business interests.”

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