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DOL Hearings: Wonkishly Stimulating

There was conflict, and it was interesting.

Although not as entertaining as, say, Megyn Kelly and the first Republican presidential debate, the three days of testimony and debate on the Department of  Labor’s conflict-of-interest proposal this week proved to be much more absorbing than your average C-SPAN broadcast.

And why not. The terms and conditions of managing $7.2 trillion in rollover IRA money are getting hashed out.

The webcast hearings, which end at mid-day today, have involved the testimony of over 100 witnesses, including financial industry advocates, attorneys, law and finance professors, consumer rights activists, at least one martyred whistleblower and a couple of just-folks insurance agents from the farm-and-ranch belt. 

The DOL grouped the witnesses into 25 panels of three or four each, often pairing natural antagonists in a way that prevented imbalance and monotony. There were boring patches where witnesses simply read written statements. But these patches were typically followed by a wonkishly stimulating Q&A period in which a panel of DOL officials, led by Deputy Assistant Secretary of Labor Tim Hauser, probed, prodded and sometimes provoked the witnesses. 

The hearings made one thing clear: The DOL specifically wants its proposal to close a 40-year-old “loophole,” written before the invention of 401(k)s and IRAs, that allows advisers considerable discretion in deciding when the legally-binding burden of “fiduciary” conduct applies to their conversations with and recommendations to clients. It was equally clear that advisers don’t want to surrender that discretion.

Overall, the DOL maintains that its proposal—now more than five years in the making—aims to lower costs and raise transparency in transactions involving tax-deferred savings, without unnecessarily restraining trade. Those likely to be most affected by the proposal—those who earn commissions on selling variable annuities and mutual funds to IRA owners—say it won’t work. 

Is the DOL naïve?

Will the proposal accomplish the DOL’s goal? It depends on the workability of the compromise at the heart of the regulation, which would allow brokers and agents to keep using the third-party commission compensation model as long as they sign a pledge to act “in the best interest” of the client “without regard” to their own compensation.

At the hearing, even the DOL seemed to have doubts whether such a compromise is practicable. At one point, Hauser asked Mark Smith of the Sutherland Asbill law firm if the DOL was “naïve” to believe that such a compromise could work. Smith said, “No.”

Yet most of the industry representatives who testified said brokers and agents couldn’t operate within the confines of this compromise. Tom Roberts of the Groom Law Group said, “The best interest standard is incompatible with any selling model that I have seen. It is exclusively in the interest of the [advice] recipient.”

Steve Saxon, also of Groom Law Group, said, as he has said before, that the proposal’s “without regard” clause, which requires advisers to promise to turn a blind eye to their own compensation when formulating advice, was too absolute, and would create too much legal liability for advisers.

One after another, industry representatives called the proposal “unworkable.” The changes in reporting responsibilities necessitated by compliance with the proposal would break their IT budgets, they said, and having a different standard of conduct for managing IRA money and taxable retail money would just confuse clients.

Addressing that last point, the DOL’s Hauser said,  “Congress created a statute that said there should be a special regulatory regime created for tax-preferred accounts, and we’re it. We do not want to make the broker model impossible. We agree that not everyone needs an ongoing advisory or RIA relationship. We just want to tamp down the conflicts.”

As for the accusation implicit in the DOL proposal that the industry has problems that require new regulation, no industry witness acknowledged the existence of problems. Indeed, the industry advocates and attorneys offered no direct response to the assertions by consumer activists and academics who, in their testimony, claimed that brokers’ recommendations are often determined more by a desire to enhance their own or their firms’ compensation than by the clients’ needs or interests.   

There was, in fact, considerable evidence to that effect. Mercer Bullard of the Business Law Institute at the University of Mississippi described in detail the way compensation dominates sales behavior in broker-dealers. His testimony was unique in laying bare brokerage compensation practices that appear designed to maximize sales. 

Arthur Raby of Rutgers, Jonathan Reuter of Boston College, Michael Finke of Texas Tech and others cited various studies that showed that commissions lead advisors to recommend sub-optimal investments or insurance products.

“Economic incentives matter. When a person or firm has chance to get much higher compensation, the allure of the higher compensation nearly always wins, to the disadvantage of consumers,” said Ron Rhoades of Western Kentucky University. Antoinette Schoar of MIT described a 2012 study where mystery shoppers sent to brokerages were steered away from index funds and encouraged to believe in the wisdom of chasing returns.

Several consumer advocates opposed the plank of the DOL proposal that sends client-broker disputes into mandatory binding arbitration. Joe Peiffer, president of the Public Investors Arbitration Bar Association, argued that the arbitration system is biased in favor of advisers. Consumer advocates also pointed to the ineffectiveness of disclosures in providing the transparency that clients need from brokers and financial advisers. 

Variable annuities as lightning rod

In the hearings, variable annuities received special attention. At least two consumer advocates cited instances where an adviser recommended that clients roll over 401(k) assets from low-cost institutional funds to high-fee variable annuities, to their detriment. At the same time, several industry advocates cited instances where buying a VA protected clients from market volatility and longevity risk.

VAs, perhaps because of their opaque fees, multiple moving parts and high commissions, have been singled out for special treatment in the DOL proposal. The proposal selectively requires commissioned sellers of VAs to take the “best interest” pledge that the industry finds unacceptable, while allowing fixed annuities to continue being sold under the long-standing and more flexible Prohibited Transaction Exemption 84-24.

Another contentious area involved the question of whether the proposal would backfire by reducing the access of small investors to advisory services. From the industry’s perspective, third-party commissions incentivize brokers to serve people who don’t have enough assets to interest fee-based advisers or who are unwilling to pay out-of-pocket for advice. In other words, these low-balance clients benefit from what might be called vendor financing.  

Consumer advocates rejected this as illogical. Since clients pay indirectly for such vendor financing without knowing it, they said, they clearly can afford to pay for advice in a more transparent framework. Sheryl Garrett of the Garrett Planning Network dismissed the idea that the proposal would deprive the middle-market of advice, pointing to advisors in her network who currently provide conflict-free advice to thousands of middle-income clients. 

She and others refuted arguments that taking away brokers’ incentives to advise the middle market meant the middle market would go without advice, or pay much more because the only alternative was wrap accounts. “We would categorically reject the idea that conflicted commission-based advice is always cheaper than non-conflicted fee-based advice,” said Christopher Jones, chief investment officer of Financial Engines, which provides web-based managed account services to retirement plan participants and retirees.

What happens next? After the hearings, the DOL will invite further comment, and then incorporate the new comments into the next draft—perhaps the final draft—of the proposal. Although Hauser said that the DOL wants to accommodate industry concerns, one witness, Caleb Callahan, representing the Association for Advanced Life Underwriting, made a surprise comment that the DOL’s mind is already made up about what it will do next.

Callahan referred to a letter from Secretary of Labor Tom Perez to Missouri Congresswoman Ann Wagner stating that the DOL is ready to move to a Final Rule. RIJ obtained a copy of the letter from a Wagner staff member. At one point, the letter says: “We will move forward towards issuing a Final Rule that balances the input we have received.”

The letter concludes, “We continue to welcome input on how to refine and streamline this Proposal so that when we publish a Final Rule, we can all be sure it is reflective of relevant input and achieves its desired goals.”

Two advisors have suggested to RIJ, somewhat darkly, that the Obama administration is deliberately circumventing Congress with the DOL proposal in order to achieve some narrow or partisan gain.

“The idea of using the Department of Labor to regulate our entire industry is a strong-arm tactic by the current administration,” one advisor told RIJ in an email yesterday. “I can’t stand this overreach of government regulation, just because some people are angry about how other people get paid. That’s honestly what this entire thing is about.”

© RIJ Publishing LLC. All rights reserved.

Summer issue of Journal of Retirement is released

The Journal of Retirement, vol. 3, no. 1, Summer 2015, is now available online, according to the journal’s publisher, Institutional Investor Journals. The articles in the new issue include:

  • “Illustrating Retirement Income for Defined Contribution Plan Participants: A Critical Analysis of the Department of Labor,” by Mark J. Warshawsky.
  • “A Glide Path for Target Date Fund Annuitization,” by Moshe A. Milevsky, Huaxiong Huang, and Virginia R. Young.
  • “Dynamic Choice and Optimal Annuitization,” by David Blanchett.
  • “Social Security’s Individual Value and Aggregate Burden,” by Liqun Liu, Andrew J. Rettenmaier, and Thomas R. Saving.
  • “Minimizing the Risk of Opportunity Loss in the Social Security Claiming Decision,” by Brian J. Alleva.
  • “Retirement and the Great Recession,” by Alan L. Gustman, Thomas L. Steinmeier, and Nahid Tabatabai.
  • “Financial Literacy and Economic Outcomes: Evidence and Policy Implications,” by Olivia S. Mitchell and Annamaria Lusardi.
  • “Financial Planning and the Reality and Requirements of Retirees with Private Pensions,” by Liam Foster.

© 2015 RIJ Publishing LLC. All rights reserved.

Sumitomo Life buys Symetra for $3.8 billion, a 32% premium

Sumitomo Life Insurance Co. will acquire all of the outstanding shares of Symetra Financial Corp., which is part owned by Warren Buffett’s Berkshire Hathaway and former Buffett company White Mountains Insurance Group, Symetra announced this week.  

The total combined transaction consideration of $32.50 per share is approximately $3.8 billion in aggregate and represents a 32% premium over Symetra’s average stock price of $24.64 for the 30 days ending August 5, 2015. Symetra will give Sumitomo Life its first significant operational platform in the U.S.

Symetra’s President and Chief Executive Officer, Thomas M. Marra, and the current management team will continue to lead the business from Symetra’s headquarters in Bellevue, Washington. Symetra will maintain its current brand, employees, distribution channels and product mix.

Symetra shareholders will receive $32.00 per share in cash at closing, plus a previously announced special dividend of $0.50 per share in cash, payable on August 28, 2015 to Symetra shareholders of record as of August 10, 2015. The amount of the special dividend was established in connection with the determination of the total combined transaction consideration.

Sumitomo Life, founded in 1907, is a leading life insurer in Japan with multi-channel, multi-product life insurance businesses. It provides traditional mortality life insurance, nursing care, medical care and retirement plans through sales representatives, insurance outlets, the Internet and bancassurance.

As of March 31, 2015, Sumitomo Life had $229 billion in assets, approximately 6.8 million customers and 42,000 employees.

Symetra, founded in 1957 and based in Bellevue, Washington, provides employee benefits, annuities and life insurance through a national network of benefits consultants, financial institutions and independent agents and advisors. As of June 30, 2015, Symetra had $34 billion in assets, approximately 1.7 million customers, and 1,400 employees nationwide.

Symetra’s largest shareholders, White Mountains and Berkshire Hathaway, representing approximately 18% and 17% ownership of common shares, respectively, have agreed to vote in favor of the transaction.

Warren E. Buffett, Berkshire Hathaway chairman and CEO, said, “Tom and his management team have done a good job running the company and have executed a great deal for shareholders. I wish them the best for future success under their new owners.”

The transaction is expected to close late in the first quarter or early in the second quarter of 2016 and is subject to the approval of Symetra’s shareholders and regulators, and to other customary closing conditions. Morgan Stanley & Co. LLC is acting as financial advisor and Cravath, Swaine & Moore LLP is acting as legal advisor to Symetra.

© 2015 RIJ Publishing LLC. All rights reserved.

Tax-efficient fund management pays off, study shows

Tax-efficient funds have tended to outperform other funds in before-tax and after-tax returns, according to “Tax-Efficient Asset Management: Evidence from Equity Mutual Funds,” a paper by Clemens Sialm of the McCombs School of Business at the University of Texas at Austin and Hanjiang Zhang of Nanyang Technological University in Singapore.

The authors hoped to find out whether or not tax-efficient fund management might in fact hurt after-tax returns by constraining the fund managers’ investment strategies. They found the opposite.

Shareholders of taxable mutual funds pay an average of about 1.12% of the value of their fund holding each year in dividend and capital gains taxes, the authors found. The annual tax burden rivals fund expenses and management fees, whose impact receives far more attention.

The authors examined U.S. equity mutual funds from 1990 through 2012, based largely on information from the CRSP Survivorship Bias Free Mutual Fund database that tracks fund returns, dividend and capital gains distributions, total net assets, fees, flows, and investment objectives.

On average, mutual funds that followed tax-efficient investment strategies generate better after-tax returns for taxable investors than funds that do not, the researchers found. Funds in the lowest tax-burden quintile over the prior three years exhibited excess returns net of taxes of -0.19% over the subsequent year. Funds in the highest tax-burden quintile, by comparison, exhibited excess returns of -2.29% after taxes. In other words, tax-efficient funds impose relatively less fee drag on the raw index returns.

The pre-tax return on funds in the lowest tax-burden quintile over the previous three years averaged 0.91 percentage points higher, in the subsequent year, than funds in the highest tax-burden quintile. Tax-efficient funds did not perform worse than their peers with regard to pre-tax returns.

An investment in 1990 of $10,000 in mutual funds in the highest tax burden decile would have compounded in 2012 to $55,800 before taxes and to just $37,800 after taxes. On the other hand, an equivalent investment in mutual funds in the lowest tax burden decile would have compounded to $58,900 before taxes and to $48,800 after taxes over the identical time period. Thus, investing in tax-efficient funds would have increased the final wealth of a typical taxable investor by more than $10,000.

Tax efficiency depends in part on the investment style of the fund. For example, small-cap funds may be forced to liquidate holdings in a company whose market capitalization gets too big, and vice-versa for a large-cap fund. Tax burdens also tend to be higher on funds that hold stocks paying high dividend yields and on funds that see high rates of redemptions and volatile investor flows.

© 2015 RIJ Publishing LLC. All rights reserved.

Study alleges fund “favoritism” in bundled 401(k) plans

Do 401(k) participants sometimes get second-rate proprietary mutual funds from their bundled 401(k) providers, and does that hurt their ability to save enough for retirement? New research from the Center for Retirement Research at Boston College suggests as much.

“Where mutual fund companies serve as plan trustees—indicating their involvement in the management of the plan—additions and deletions from the menu of investment options often favor the company’s family of funds,” the August 2015 research brief said.

“This bias is especially pronounced in favor of affiliated funds that delivered sub-par returns over the preceding three years. And participants do not shift their savings to undo this favoritism, especially the favoritism shown to subpar affiliated funds. … [and] the lackluster performance of these sub-par funds usually persists.”

The study was based on plan data from 1998 to 2009, so the sample predates the possible reformative effect of recent federal class-action suit judgments against major plan providers and plan sponsors for failing to minimize fund expenses. It was written by Veronica Pool, Clemens Sialm and Irini Stefanescu of Indian University, the University of Texas and the Federal Reserve, respectively.

The data was culled from SEC Form 11-K filings and Form 5500 filings of 2,494 plans with about nine million participants. Three-quarters of the plans had trustees that were affiliated with mutual fund companies. Most of the plans offered proprietary funds as well as outside funds.

“The bias in favor of affiliated funds is particularly pronounced for poor performers,” the authors wrote. “Plans remove just 13.7% of affiliated funds in the lowest performance decile, dramatically less than the 25.5% deletion rate for unaffiliated funds in the lowest performance decile.”

© 2015 RIJ Publishing LLC. All rights reserved.

BlackRock now manages $123 billion in Japanese savings

BlackRock, the world’s largest fund manager, was the biggest beneficiary of a move by Japan’s Y137tn ($1.14 trillion) Government Pension Investment Fund (GPIF) to ramp up its exposure to domestic and foreign equities, IPE.com reported.  

Raising the assets it runs for GPIF and other public defined benefit pension plans in Japan to Y13.8tn from Y9.4tn, BlackRock became Japan’s second-largest manager of DB assets after Sumitomo Mitsui Trust, according to the Japan Pensions Industry Database.

The overhaul of the GPIF’s assets, announced last October, came after two years of pressure from Prime Minister Shinzo Abe, who wanted GPIF to take on more investment risk in hopes of meeting rising pension liabilities and to help end years of deflation.  

Sumitomo Mitsui Trust lost Y718bn of assets over the 12 months ending last March 30, but held the top spot in pension assets. BlackRock moved up to second spot from third position after increasing its total Japan assets to Y15.4tn ($123.1 billion). The other three top-five spots went to Mizuho Trust, State Street Global Advisors and Diam, respectively.

© 2015 RIJ Publishing LLC. All rights reserved.

Edward Jones to pay $20 million SEC fine

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.  

© 2015 RIJ Publishing LLC. All rights reserved.

Conflict of Interests

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.

© 2015 RIJ Publishing LLC. All rights reserved.

 

    

How to Build an ‘Income-Oriented’ Portfolio

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.

 Blanchett pie charts cover 08062015

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.

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.

© 2015 RIJ Publishing LLC. All rights reserved.

RetirePreneur: Bo Lu

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.

© 2015 RIJ Publishing LLC. All rights reserved.

John Hancock Retirement to offer HelloWallet robo-advisor

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.

© 2015 RIJ Publishing LLC. All rights reserved.

Symetra rides new FIAs to record quarterly sales

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 Premier Fixed 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.

© 2015 RIJ Publishing LLC. All rights reserved.

Guardian enhances 401(k) portal

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.

© 2015 RIJ Publishing LLC. All rights reserved.

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

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.

IRI FIA sales displacement chart

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.

© 2015 RIJ Publishing LLC. All rights reserved.  

Is It Time to End Tax Deferral?

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.

© 2015 RIJ Publishing LLC. All rights reserved.

FINRA Sides with Brokers against DOL Proposal

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.”

© 2015 RIJ Publishing LLC. All rights reserved.

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

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.

© 2015 RIJ Publishing LLC. All rights reserved.

Switcheroo: New FIA credits benefit base, not account value

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.

© 2015 RIJ Publishing LLC. All rights reserved.

The SoA’s new logo is “impossible”

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.

© 2014 RIJ Publishing LLC. All rights reserved.