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Posted on May 21, 2015 by -

Lincoln officially announces QLAC status on deferred income annuity

Lincoln Financial Group announced that it enhanced its Lincoln Deferred Income Solutions  annuity with Qualifying Longevity Annuity Contract (QLAC) status for IRA rollovers.   

With QLAC status, qualified funds from an IRA used to purchase this annuity will be exempt from standard Required Minimum Distribution (RMD) rules. When opening a QLAC with a Lincoln Deferred Income Solutions Annuity, clients can invest the lesser of $125,000 or 25% of their total IRA assets in Lincoln’s QLAC and defer receiving income payments to a future date.

The dollar amount invested into a QLAC is excluded from the RMD calculation that determines the amount an individual must begin withdrawing from a qualified retirement account at 70½ , potentially at a time when a client does not have an income need. The QLAC can defer the impact of RMD-related income taxes and guarantee a future income.

With QLAC status on the Lincoln Deferred Income Solutionsannuity, payments may be deferred until age 85. Beneficiaries will receive the full return-of-premium death benefit if the policyholder passes away before receiving any QLAC distributions or, if the QLAC distributions have started, they receive a return of premium death benefit reduced by all previous payments. 

New York Life announces executive movements

John Y. Kim, 54, the vice chairman of New York Life, has been elected president of the company, succeeding chairman of the board and chief executive officer Ted Mathas, 48, who has been president since 2007. Kim continues reporting to Mathas, who remains chairman and CEO.

Kim also retains the role of chief investment officer of New York Life, as well as overall responsibility for the Investments Group and enterprise-wide technology. The company’s largest business unit, the Insurance & Agency Group, has been added to his responsibilities.

Before joining New York Life, Kim had been president of Prudential Retirement, where he led its defined benefit, defined contribution and guaranteed products businesses, and before that he was president of CIGNA Retirement and Investment Services. Kim earned his Bachelor in Business Administration degree from the University of Michigan and holds an MBA degree from the University of Connecticut.

New York Life also announced that Chris Blunt, 53, will return to Investments to run the Group as its president, reporting to Kim. Blunt joined the company in 2004 as head of New York Life Investments’ Retail Investments strategy, where he was successful in growing Investments’ sales of mutual funds through all of its distribution partners. Blunt most recently headed the Insurance & Agency Group with co-president Mark Pfaff, who plans to retire at year-end after 30 years of service.

In a separate announcement, New York Life said that Yie-Hsin Hung, 52, has been named chief executive officer of New York Life’s asset management subsidiary, New York Life Investment Management LLC (NYLIM), effective immediately. Hung reports to Chris Blunt, president of the Investments Group, which includes all of New York Life’s asset management businesses, totaling more than $500 billion in assets under management. 

Hung was previously co-president of NYLIM. As CEO, she replaces Drew Lawton, 56, who will retire at the end of this year.  He is now a special advisor to Blunt. Stephen Fisher, formerly co-president of NYLIM, is now president of NYLIM and reports to Hung. Fisher continues as president of the MainStay Funds.

US and Canadian institutions look to Europe for illiquidity premiums

North American institutions are planning long-term investments in foreign infrastructure and are pumping billions of dollars into Europe, according to a new report from Armstrong International based on a survey of 305 North American institutional investors in the first quarter 2015.

The combination of low bond yields, high U.S. equities prices and the strong U.S. dollar, many investors are “embarking on what some economic commentators are describing as ‘a 21st Century land-grab’ across Europe in an attempt to add value to their portfolios,” the report said. Investors were said to be increasing allocations to private equity, real estate, infrastructure and, to a lesser extent, hedge funds.

Four in five (78%) respondents said that they are actively investing or planning to increase their allocations in Europe.  Of the remainder, three quarters said that they are actively considering European investments. They included public pension funds, public universities, private foundations and endowments in the U.S. and Canada with assets of $1 billion to $200+ billion.

 “It feels very much like a land grab,” said Martin Armstrong, chairman of Armstrong International, in a release. “After a tepid decade, this level of investment enthusiasm implies that Europe is a re-emerging economy.”

The report finds that Institutional investors believe that illiquid assets can deliver a high income at a time when other traditional fixed income yields are at historic lows.

The government of China has been a substantial investor in infrastructure beyond its borders, including Europe. A rush to Europe by North American investors could be “a harbinger of future international bidding wars between the two trading superpowers,” according to one commentator who was surveyed.

Asia and Sub-Saharan Africa, respectively, are the second and third-place destinations for foreign investment, the Armstrong International survey showed. Two thirds of those investing in Asia are planning to add to their portfolios. Only 22% currently invest in Africa, but 37% of the respondents said they plan to increase their allocations to this region over the coming next three years.

DOL extends comment period on fiduciary definition 

According to a DOL statement released Friday, May 16, 2015, a forthcoming issue of the Federal Register will announce the extension of the deadline for comments on the definition of a fiduciary with respect to IRAs to July 21, 2015 (i.e., or an additional 15 days). In accordance with its original plan, the DOL will hold a public hearing within 30 days of the close of this initial comment period, as so extended.  After the hearing, the comment period will reopen for an additional 30 to 45 days.

New DTCC service processes liquid alt trades in days, not weeks

A new service from the Wealth Management Services unit of the Depository Trust & Clearing Corporation is designed to help broker-dealers process internal account transfers for alternative investments more quickly and easily, according to a release from DTCC, which manages data on the global financial industry’s trades. 

The new Alternative Investment Products Service (AIP) service automates account transfers for non-traded real estate investment trusts (REITs) and business development corporations (BDCs), helping broker/dealers to re-register accounts and internally transfer investors’ shares between closing and opening accounts.   

Currently, account transfer transactions often take broker/dealers several weeks to complete because operational processes are largely manual—incurring paper trails, multiple registrations and numerous inter-departmental hand-offs. The AIP enhancement  processes transactions, straight-through, in a single day. Broker/dealers can transmit data over a secure network, reducing risk and increasing efficiency and scalability.  

WMS and its AIP service are offerings of DTCC’s National Securities Clearing Corporation (NSCC) subsidiary. Today, there are 382 clients – representing fund administrators, funds, broker/dealers and custodians – benefitting from the AIP service. 

Pershing introduces Subscribe Annuity Analytics Dashboard

Under the new Department of Labor conflict-of-interest proposal, brokers selling variable annuities and insurance agents selling fixed index annuities would have to ensure that purchases of those products are in the “best interest” of their clients.

If so, they and insurance carriers will have to monitor their sales more closely. A new service from Pershing, the BNY Mellon-owned clearinghouse and multi-function platform provider appears designed to help them do that.

The service is an annuity data, reporting and presentation tool called the Subscribe Annuity Analytics Dashboard. According to Pershing release, the dashboard will provide Pershing clients with “an integrated, efficient solution for managing annuity sales flows and more transparency of new and existing business.”

“Annuities contracts and purchases are being examined more closely. As a result, monitoring of these products has become increasingly important for firms,” said Rob Cirrotti, head of retirement solutions at Pershing.

The dashboard is available through Pershing’s Subscribe service, which carries firm-specific annuity business information, and can be accessed through NetX360, Pershing’s technology platform. The dashboard technology is provided by Albridge Analytics, an affiliate of Pershing.

Using information from more than 50 individual insurance carriers, the Subscribe Annuity Analytics Dashboard allows distributors to evaluate the annuity business of their financial advisors using a number of factors, including annuity type, transaction type, IRS qualification and detailed attributes about the annuity owner. The dashboard can also assist firm management and marketing professionals identify offices or advisors that may need additional support.   

The dashboard includes information on both networked and non-networked positions across two modules:

  • A positions module, sortable by carrier, plan type, issue and surrender date, owner or advisor. It is available for both networked and non-networked positions sent to Pershing by carriers. Data includes date of issuance, surrender date, current value, owner/annuitant demographic information and all advisor information. 
  • An order module, containing data associated with new and subsequent premium transactions, which can help firms better understand carrier concentrations, monitor exchange activities and regulatory detail in the event of a FINRA audit or regulatory visit. Detail in this module includes identifying 1035 exchanges and qualified transfers, product type, issuing carrier, state of solicitation, qualified vs. non‐qualified and advisor information.

Data from both modules can be filtered, sorted and exported to Excel.

Gen X: More vulnerable than proactive

Gen X’ers (Americans ages 35-49) worry about their finances but don’t take much action to improve them, according to the 2015 Northwestern Mutual Planning and Progress Study.
“Of four generations surveyed, Gen X was found to have the poorest financial habits. In addition to comprising the majority of ‘informal’ planners, Gen X has more spenders than savers compared to other generations and is the least likely to have more savings than debt,” the study found. 

Among the study’s findings:

  • 37% of Gen Xers say they do not “at all feel financially secure.” This is more than any other generation, including Millennials.
  • 23% are “not at all confident” that they will achieve their financial goals.
  • 66% expect to have to work past traditional retirement age due to necessity, with 2 in 10 (18%) believing they will never retire. 
  • 82% of Gen Xers who anticipate needing to work past the age of 65 feel they will need to do so because they didn’t save enough.
  • 44% live with children under 18 and over a quarter have a parent or other relative in the household. Balancing personal financial priorities with the added demands of dependent care is likely to have implications on decision-making.
  • 66% of Gen X respondents acknowledge that their financial planning needs improvement and less than one in 10 (9%) consider their generation “very financially responsible.”
  • Gen X’ers are the generation most likely to say they would pay down debt if they had a windfall of $10,000, the least likely to have sought guidance from an adviser. 
  • 34% do not know how much income they need to retire.
  • 47% have not discussed retirement planning with anyone. 

The 2015 Northwestern Mutual Planning & Progress Study was conducted by Harris Poll on behalf of Northwestern Mutual and included 5,474 American adults aged 18 or older (including 813 Gen Xs age 35-49) who participated in an online survey between January 12, 2015 and January 30, 2015. 

© 2015 RIJ Publishing LLC. All rights reserved.

England Swings (Away from Annuities)

Posted on May 14, 2015 by -

You think you know England, don’t you? Well, you don’t know Union Jack. There’s more to the merry olde UK than lurid tabloids, Downton Abbey, heavy food, the ForEx market and royal babies. At the moment, its £3.9 trillion ($6.16 trillion) retirement market is in a state of disruption.   

As of April 6, defined contribution participants in the U.K. are no longer under any pressure to buy life annuities at retirement or any other time. Because of that, McKinsey & Co. expects the percentage of DC savings going into life annuities to drop from 75% to between 30% and 40%. An estimated £10 billion leaves DC plans each year.

The impact: an opportunity for global asset managers to step in and offer non-annuity alternatives that provide volatility control and systematic payouts. So far, Barclays and AllianceBernstein have responded. A spokesperson for indexing giant Vanguard, which is currently an investment-only DC provider in the UK, said her company is watching the situation but not responding yet.

McKinsey, the consulting firm, has been tracking the evolution of the U.K. retirement market, which “is undergoing profound change across all dimensions: regulations, technology, competitive dynamics and customer preferences,” according to a report the firm released in April, In the Eye of the Storm: Transformation in the UK Retirement Market.

“The result is an opportunity for capturing market share that is unique in the broader European asset management landscape, and which has prompted an unprecedented level of strategic debate among the asset managers, insurers, pension providers, platforms and distributors that operate in the sector,” the report said.

But McKinsey also noted that “the time window for action is limited – strategic initiatives launched in the next six to twelve months will likely set the course for years to come.

Last fall, AllianceBernstein, which manages about $1.6 billion in target date funds for DC plan participants in the UK, introduced a new non-annuity, non-guaranteed lifetime income product for retirees called “Retirement Bridge.” Designed to create a seamless transition for retirees from DC plans, it measures out a monthly income from a TDF.

The income amount matches the payout the retiree would have received from a single-premium immediate annuity, drawing on principal if necessary. At age 75, the retiree can buy a life annuity or stay in the TDF. Income from the TDF from that point onward would consist only of earnings, while preserving principal.

The cost of Retirement Bridge would “depend on the administration provider,” said Sebastian Kadritzke, an AllianceBernstein spokesperson, in an interview. One provider currently offers it for a combined annual investment and administration fee of 85 basis points.

BlackRock, the $4.8 trillion asset manager that administers DC plans in the UK, has just begun offering its 300,000 British participants in 195 workplace plans a systematic withdrawal plan. While SWPs are offered by about half of U.S. 401(k) plans, according to PlanSponsor magazine, they’re relatively new to England.

On April 27, the BlackRock Retirement Income Account was announced. The firm characterized it as an “income alternative to annuities” that “aims to provide a low-cost and straightforward option for retirees… following new pensions freedoms introduced on 6 April.

“We have seen a raft of new fund launches within the industry to cater to new pensions freedoms, but we believe this innovation provides our members with a simple, flexible and cost-effective way of moving from the accumulation phase of workplace pension saving to decumulation,” said Paul Bucksey, head of UK Defined Contribution at BlackRock, in a press release.

According to the release, “Account holders will be able to access a multi-asset core fund, LifePath Flexi, but can also create their own personal portfolio from a range of around 100 investment funds from BlackRock and other leading managers… The annual management charge to use the core fund, LifePath Flexi, is 0.41% of funds under management.” The all-in cost is 50 basis points a year, a BlackRock spokesperson told RIJ.

In 2013, BlackRock introduced a new retirement income concept in the U.S. called the CoRI Index, a benchmark based on current prices for single-premium immediate annuities that shows pre-retirees the estimated cost of a dollar of lifetime income starting at age 65.

By investing in corresponding BlackRock CoRI long-term bond funds that are based on the CoRI Index, a near-retiree can build predictable retirement income but not guaranteed, lifetime or mortality-pooled income. The CoRI funds have an annual expense ratio of 2.04%, compared to 0.12% for Admiral shares of the Vanguard Long-Term Government Bond Index Fund.  

The end of compulsory annuitization in the UK, effected by the Cameron administration, has been a disaster for UK annuity issuers. The old law gave many Britons, especially those not at risk of running out of money in retirement, some flexibility in spending their tax-deferred savings.

Annual withdrawals were subject to a cap, but annuitization could be postponed until age 75 and they could take out up to 25% of their savings tax-free. Most middle-class workers bought single-premium immediate annuities with their DC savings when they retired, to avoid the significant tax costs of doing otherwise.  

Those days are over. This week, Just Retirement, a British private-equity-backed annuity issuer, reported a 59% drop in sales of “medically underwritten annuities,” which are sold to people with medical problems and priced lower than typical life annuities, and a 22% drop in overall sales in the nine months after June 30, 2014. But the company has seen a big increase in its purchases of pension liabilities from corporations.

Total retirement assets in the UK are estimated at £3.9 trillion, according to McKinsey, compared with about $24.7 trillion in the U.S., which is the latest estimate from the Investment Company Institute.

“Annual assets in motion [in the UK are] about £155 billion currently, including contributions to workplace and personal pensions, and assets moving from pensions into decumulation products,” McKinsey’s report said. “Given the various market changes (e.g., auto-enrolment, pension freedom, shifts in customer preferences), this value is expected to grow to about £180 billion by 2020.”

Most British pre-retirees don’t realize exactly what has happened in the retirement space or what it will mean to them, surveys show. But sooner or later they’ll need systematic ways to draw down their money in retirement, either direct from their DC plan or from Self-Invested Personal Pensions (SIPPs), which are similar to traditional IRAs, as well as for financial advice (including “robo”) that meets recently-established UK standards for low cost and transparency.

© 2015 RIJ Publishing LLC. All rights reserved.

Offer Life Annuity and Whole Life in Tandem: Pfau

Posted on May 14, 2015 by -

Does whole life insurance make sense for income-hungry retirees? In a paper written for mutual life insurer OneAmerica and released this week, retirement planning expert Wade Pfau (below left) claims that it can—not just for the sake of producing a big legacy but also to enhance income.    

Thanks to its tax advantages, life insurance has long served as an estate-planning tool for wealthy investors. But most contemporary heads-of-households elect to “buy-term-and-invest-the-rest,” and then drop their term coverage at retirement, when the parental nest is empty and there’s not much human capital left to replace.Wade Pfau

In the past, a few advisers, notably Burlington, Iowa-based Curtis Cloke, have designed custom retirement solutions that combine income annuities, life insurance and investments. Now comes Pfau, a co-editor of the Journal of Personal Finance and professor at The American College, to test the desirability of such a strategy.     

His conclusion is that a household’s breadwinner can, starting at age 35, increase his family’s income at age 65 by a median 40% and increase his legacy by as much as 228% by using a combination of investments, a whole life policy and a single-premium immediate annuity, relative to the income and legacy accruing from investments and term life insurance coverage alone.

To find out how he arrives at those numbers, you’ll have to read the whitepaper that he produced for OneAmerica. But we’ll try to summarize his two hypotheticals: one involving 35-year-old Steve and Susie, and the other involving 50-year-old James and Julie.

In the first case, Steve is working and Susie is a homemaker. They have $65,000 in their 401(k) and they can afford to save $15,000 a year. Steve has three options:

  • Scenario 1. He can buy term-life and invest $14,281 a year in his 401(k) with the intention of taking 3.5% inflation-adjusted systematic withdrawals at age 65 or
  • Scenario 2. He can buy term-life and invest $14,281 a year in his 401(k) with the intention of buying a single-premium, joint-and-survivor life income annuity with $738,000 of his 401(k) accumulation, dropping his term coverage, and taking 3.5% inflation-adjusted systematic withdrawals at age 65 or  
  • Scenario 3. He can buy whole-life for a taxable $6,000 per year and invest $9,000 a year in his 401(k) with the intention of buying a single-premium single-life income annuity with $738,000 at age 65 and taking 3.5% inflation-adjusted systematic withdrawals at age 65.

Pfau ran Monte Carlo simulations and found that the strategy in Scenario 1 would produce median income of $58,556 from SWPs at age 65 while Scenarios 2 and 3 would produce median income of $81,434 and $82,034, respectively, through a combination of SWPs and income annuity payments.

Looking at the median legacies under the three strategies, Pfau found, not surprisingly, that Scenario 2, where the term insurance was dropped at retirement, lagged. If Steve were to die at age 66, he would leave $1.69 million under Scenario 1, $940,551 under Scenario 2 and $1.46 million under Scenario 3. If he were to live to 100, those numbers would be $649,780, $217,897 and $2.13 million, respectively.

In a second hypothetical, Pfau considers James and Julie, two 50-year-olds who plan to retire in 15 years. Even though their time horizon is shorter than Steve and Suzie’s, they experience the same benefits—higher income thanks to the SPIA, and higher legacy thanks to the life insurance.

Much of this is intuitive. Life annuities characteristically enhance annual income, relative to SWPs with average returns. Whole life insurance enhances legacy values, especially compared to a legacy without life insurance. But don’t the cost of whole life and the slow growth of the cash value combine to create a lot of drag on the potential investment accumulation?

Not as much as you might think, Pfau explains. That’s because the investor rebalances his 401(k) in favor of equities to offset the bond-like character of the whole life cash value. “The 401k piece is more aggressive when whole life is used,” he told RIJ. “This is explained in the article because it is an important point.” Therefore the median accumulation, based on Monte Carlo projections, is higher. Perhaps more importantly, the presence of the whole life policy allows Steve to buy a single life instead of a joint-life SPIA at age 65, thus raising the payout rate for the same premium by 17%.

Pfau suggests that the inclusion of whole life in a retirement income plan has psychological value: it can make the purchase of a single premium immediate annuity more palatable.      

“Behaviorally, Scenario 2 presents a difficult strategy for many retirees to accept. Despite potential improvements to their retirement income, retirees generally do not like to annuitize their assets in such a way. Meanwhile, Scenario 3 uses a single-life SPIA and maintains a death benefit with life insurance, which can essentially protect or “refund” the assets used for the annuity purchase,” Pfau writes.

“This combination should be more palatable for retirees. And when we compare Scenarios 2 and 3, we can observe that the available income is similar, while the legacy value is substantially different. The lack of a death benefit with Scenario 2 means that legacy assets are substantially less. Psychologically, many retirees will find it easier to contemplate adopting Scenario 3 over Scenario 2.”

Fee-based advisers who are not accustomed to selling insurance products may not even consider this type of strategy. If nothing else, it would deprive them of billable assets. But that doesn’t mean the strategy isn’t smart, says Curtis Cloke. “When you are not biased to a product type or to how financial professionals are paid (fee vs. commission),” he told RIJ, “it becomes obvious that the true “best in class” planning solutions cannot be created efficiently without the inclusion of both insurance based and traditional investment product allocations.”

© 2015 RIJ Publishing LLC. All rights reserved.

The next-gen adviser: Half person, half machine

Posted on May 14, 2015 by -

The traditional broker-dealer/adviser business model continues to come under pressure. Zealous regulators and disruptive robo-advisers are compressing fees. The old rationale for personalized fee-based advice—“the advisor makes money when you make money”—makes less sense when people are spending down assets.

Many advisors have been able to gain economies of scale and accommodate low-margin middle-income clients by outsourcing more and more chores to platforms and software. But there are clear signs that the balance is starting to tip—with advisors supporting the digital channel rather the digital channel supporting the advisors.   

This is the brave new world of hybrid advice that’s described in a new report, Gold at the End of the Rainbow: Using Automation to Profitably Serve the De-Accumulating Investor, from Celent, the Boston-based research firm. The report, according to a Celent release, “examines the degree and form to which automated forms of delivery might be used to profitably serve the de-accumulation needs of retirement investors.”

The insight that the spectrum of paid financial advice will range from packaged products, algorithms and do-it-yourself online tools for the mass affluent, lavish hand-holding for the very wealthiest (and a combination of the two for people in between) was made in the middle of the past decade by a number of observers, notably Francois Gadenne at the Retirement Income Industry Association.

Celent validates that forecast, offering a map of the “The De-accumulation Opportunity by Delivery Channel (see below). It reassures advisers, arguing that, if anything, retirement income clients need custom solutions that no robo-adviser seems to be able to handle—at least not yet. But Celent points out that adviser have been slow to recognize the import of these demographic and technical trends.

Celent De-Accumulation Opportunity

“De-accumulation, which encompasses downside protection and wealth transfer as well as the drawdown of assets, is a topic advisors have tended to avoid in light of its inherent sensitivity and the challenge of monetizing advice around it,” said a summary of the report, released this week.

“Today, however, considerations are evolving under the weight of demographic trends as well as economic and regulatory imperatives… Denial and resistance to automation already are ceding ground to understanding and acceptance. In fact, the scope of the de-accumulation opportunity suggests that it will not be long before the advisor becomes a flag carrier for the blended model.”  

“Although automated delivery is disruptive to the standard advisory model, its impact should not be measured in terms of the disintermediation of the real life advisor,” the report said. “Decisions around de-accumulation are sufficiently complex (How best to transfer money to my children?) and emotionally freighted (Will I have enough to live on for the rest of my life?) as to demand face-to-face counsel, at least for the foreseeable future.”

Clients, too, are increasingly preoccupied with the challenges of funding a multi-decade retirement period (with its attendant healthcare costs), especially given systemic risks to longstanding retirement programs such as Social Security, corporate pensions, and even 401(k) plans.  

“Advisors and the brokerage, advisory, and insurance firms that employ them are starting to explore the automated delivery of advice as a way to rationalize their high-cost sales structures,” Celent said in a release. “As such, automated delivery tools geared toward serving the post-work investor (and the investor planning for retirement) will be deployed at the service of the advisor, and not in his stead.

“Celent believes that this blending of virtual and physical distribution models increasingly will take place with the tacit support (if not the encouragement) of advisors eager to reach an expanding pool of mass affluent and Millennial clients.”

© 2015 RIJ Publishing LLC. All rights reserved.

Worth the Wait? More Delaying Social Security Past 62

Posted on May 14, 2015 by -

More U.S. retirees are waiting to claim Social Security benefits past the year they become eligible. The reasons: lower Social Security replacement rates, longer lifespans, and disappearing defined benefit plans, according to a new report by the Center for Retirement Research at Boston College.

The percentage of claims at age 62 has dropped dramatically in the last 28 years. In 2013, 35.6% of men and 39.5% of women claimed Social Security benefits the year they turned 62, according to CRR. That’s down from 51.9% of men and 63.6% of women who claimed at age 62 in 1985, according to the report Trends in Social Security Claiming.

“The good news is that more people are claiming retired-worker benefits at later ages, and this pattern is consistent with increased labor force participation at older ages and the rise in the average retirement age,” CRR director Alicia Munnell wrote in the report.

“Nevertheless, in 2013 more than a third of insured workers still claimed Social Security benefits as soon as they became eligible. The question is whether this decision appropriately reflects the individual and family circumstances of these individuals or whether they are making a mistake.”

This news should not surprise many advisers, because more of their clients are asking about the benefits of waiting to claim—so they can get the 8% increase in benefits for every year they delay until age 70.

“Over 66% of today’s beneficiaries are critically or totally dependent on Social Security to maintain their retirement lifestyle,” Brian Doherty, president of Filtech, told RIJ. “With people living longer and longer, it’s important to make the right claiming decision.”

Two to four million people make an irrevocable claiming decision every year. While the increase of defined contribution plans replacing defined benefit plans and the rising costs of healthcare play a role in claiming decisions, other factors also help explain why more people are waiting to claim.

“One factor, for example, is the cost of living adjustment (COLA) feature on Social Security,” said Doherty. “While everyone receives the same annual COLA on their benefits, when you apply that percentage to a larger amount it results in a bigger increase. “So by delaying to age 70, you not only maximize your Social Security benefit, you also lock in the biggest dollar increases possible for the rest of your life. This is something people rarely consider and it’s the only pay raise most retirees receive in retirement.”

Perhaps the message is getting through to more retirees that delaying might make sense for them and their family.

© 2015 RIJ Publishing LLC. All rights reserved.

Nationwide Life fined $8 million for pricing violations

Posted on May 14, 2015 by -

The Securities and Exchange Commission today charged Nationwide Life Insurance Company with routinely violating pricing rules in its daily processing of purchase and redemption orders for variable insurance contracts and underlying mutual funds.

Nationwide agreed to settle the charges and pay an $8 million penalty.

Pricing rules for mutual fund shares require an investment company to compute the value of its shares at least once daily at a specific time set by its board of directors and disclosed to investors.  According to the SEC’s order instituting a settled administrative proceeding, Nationwide’s prospectuses stated that mutual fund orders received before 4 p.m. at its home office in Columbus, Ohio, would receive the current day’s price.  Orders received after 4 p.m. would receive the next day’s price. 

An SEC investigation found that when regular postage mail became available for retrieval early each morning from its P.O. boxes, Nationwide arranged for the pickup and delivery of mail directed to other business units but intentionally delayed the retrieval of mail related to its variable contracts business. 

Therefore, in spite of receiving customer orders and other variable contract mail in its P.O. boxes at least several hours before the 4 p.m. cut-off time, Nationwide sought to avoid its requirement to process the orders contained in this mail using the current day’s price by ensuring this mail wasn’t delivered to its offices until after 4 p.m.

Meanwhile, Nationwide did arrange for prompt pickup and delivery of U.S. Postal Service Priority Mail or Priority Express Mail that enabled contract owners to track an order’s time of delivery to the P.O. boxes.  Those orders were assigned the current day’s price.

“For more than a 15-year period, Nationwide intentionally delayed the delivery of untracked mail containing orders from customers and processed them at the next day’s prices in violation of the law,” said Sharon B. Binger, Director of the SEC’s Philadelphia Regional Office. 

The SEC’s order finds that Nationwide instructed the post office to divide mail directed to the P.O. Box for its variable contract business from mail directed to P.O. boxes for other lines of business, and to maintain it in separate areas of the post office loading dock. 

Nationwide typically hired a private courier to collect and deliver the mail from the loading dock to its offices. Nationwide arranged for its courier to travel to the post office at 3 a.m., 5 a.m., and 7 a.m. each business day to retrieve mail for the other lines of business, but specifically instructed the courier not to retrieve variable contract mail at these times. 

Nationwide instead instructed the courier to deliver variable contract mail no earlier than 4:01 p.m. in order to deem it received when it arrived “in the building.”  If the courier arrived in Nationwide’s parking lot before 4 p.m., the instructions were to wait until 4:01 p.m. to enter the building.

Therefore, some couriers intentionally delayed their arrival time at Nationwide by stopping to purchase meals or fuel.  By contrast, priority mail related to the variable contract business was promptly retrieved by the courier and processed by Nationwide before 4 p.m. for pricing at the current day’s price.

The SEC’s order further finds that Nationwide employees complained to post office staff when portions of the variable contract mail were inadvertently mixed together with the other mail and therefore delivered to Nationwide’s offices before 4 p.m.  After one such incident, Nationwide requested a meeting with the post office and stressed that it needed “late delivery” of variable contract mail “due to regulations that require Nationwide to process any mail received by 4 p.m. the same day.”

Nationwide consented to the entry of the SEC’s order finding that the firm willfully violated Rule 22c-1 under the Investment Company Act of 1940.  Nationwide neither admits nor denies the findings, and must cease and desist from committing future violations of the rule and pay the $8 million penalty. 

A.M. Best comments on insurer stock buybacks and dividend payments

Posted on May 14, 2015 by -

In a report issued this week, the ratings agency A.M. Best noted the trend among publicly held insurance companies of returning cash to shareholders through stock repurchases and dividends. The report is titled, “Insurance Industry Buybacks: Stocks Undervalued or Opportunities Scarce?”

“Insurance companies are holding onto a much smaller portion of their net income as they returned 76% of total net income to shareholders in the form of dividends and buybacks, with buybacks representing 70% of money returned to shareholders,” the report said.

AIG completed the largest repurchase of shares in 2014, buying back over USD 4.9 billion. In terms of a total return of cash to shareholders, AIG was also the largest, with USD 5.6 billion being returned to shareholders from both dividends and repurchases.

Life insurers listed in the A.M. Best report, along with their 2014 buybacks and dividends (in millions of dollars), included (in descending order of market capitalization):

  • AIG: $4,903 in value of buybacks; $712 in dividends paid.
  • MetLife: $1,001; $1,621.
  • Prudential: $1,000; $1,027.
  • Ameriprise Financial: $1,372; $426.
  • Sun Life Financial: $0; $886.
  • Lincoln National: $650; $170.
  • Principal Financial: $205; $410.

“Insurance companies have not been particularly good at timing share repurchases. Management has been increasing repurchase activity just [when] price-to-book multiples have made this capital management activity more expensive.

“Had the companies in this review used the same amount of money spent in 2014 to buy back stock during the lows of 2008, they would have repurchased 27% more stock then they could have been purchased in 2014,” the report said.

“It would seem difficult to rationalize that in the current environment management would believe their stock prices are trading at a substantial fundamental discount, and would warrant almost 50% of net income to be spent on repurchases as it was in 2014.

“However, in an environment in which companies are faced with a combination of low interest rates and low industry premium growth, those with substantial cashflow may find they have little other choice of deploying that capital besides returning it to shareholders,” A.M. Best noted.

© 2015 RIJ Publishing LLC. All rights reserved.

Managed accounts gain ground against TDFs as default investment: Cogent

Posted on May 14, 2015 by -

The proportion of “mega” 401(k) plans ($500 million or more in assets) offering managed accounts instead of target date funds as their plan default investment option increased to 18% in 2015 from 5% in 2014, according to the annual DC Investment Manager Brandscape, a Cogent Reports study by Market Strategies International.

According to the report, mega plan sponsors indicated a strong interest in offering ETFs within managed accounts to their plan participants and cited “retirement income product offerings” as a reason for selecting a managed account provider.Cogent Brandscape 2015

“While target date funds continue to serve as the most widely preferred default investment option among most plans, this increased usage of managed accounts among Mega plans signals a growing desire in the industry to offer a more personalized solution for plan participants,” says Linda York, vice president of Cogent Reports.

“This shift echoes the rise in popularity of these robo-advice retirement vehicles that are customized for each individual investor and highlights new opportunity for investment managers to secure a place on the investment lineups of these larger plans as managed account providers.”

The report identifies the top investment managers that plan sponsors would likely consider for managed accounts and target date funds as well as other investment products. Among the larger plan segments, eight firms rank in the top ten for both managed accounts and target date funds.

Within this competitive set, Vanguard earns the greatest consideration potential as a target date fund provider, while Charles Schwab Investment Management claims the lead position for managed accounts.

LPL to pay at least $11.7 million for range of abuses

Posted on May 7, 2015 by -

LPL Financial LLC, America’s largest independent broker-dealer, has been censured and fined $10 million by the Financial Industry Regulatory Authority (FINRA), the self-policing agency for broker-dealers.

LPL, which had revenues of $1.1 billion in the first quarter of 2015, was charged with “broad supervisory failures in a number of key areas.” The broker-dealer consented to the entry of FINRA’s findings without admitting or denying the charges.

A FINRA release said LPL didn’t properly supervise the sale of complex products. LPL also failed to monitor and report trades and deliver to customers more than 14 million trade confirmations, the release said.

LPL will also be required to pay about $1.7 million in restitution to certain customers who purchased non-traditional ETFs. The firm may pay additional compensation to ETF purchasers pending a review of its ETF systems and procedures.

FINRA found that, at various times spanning multiple years:

  • LPL failed to supervise sales of certain complex structured products, including ETFs, variable annuities and non-traded REITs.
  • With regard to non-traditional ETFs, the firm did not monitor the length of time that customers held these products in their accounts, did not enforce its limits on the concentration of those products in customer accounts, and failed to ensure that all of its registered representatives were adequately trained on the risks of the products.
  • LPL failed to supervise its sales of variable annuities, in some instances permitting sales without disclosing surrender fees.
  • In connection with certain mutual fund “switch” transactions, LPL used an automated surveillance system that excluded these trades from supervisory review.
  • LPL also failed to supervise non-traded REITs by, among other things, failing to identify accounts eligible for volume sales charge discounts.

According to FINRA, LPL’s systems to review trading activity in customer accounts were plagued by multiple deficiencies. For example, LPL’s surveillance system failed to generate alerts for certain high-risk activity, including low-priced equity transactions, actively traded securities and potential employee front-running.

The firm used a separate, but flawed, automated system to review its trade blotter that failed to provide trading activity past due for supervisory review, FINRA said, and the firm failed to deliver over 14 million confirmations for trades in 67,000 customer accounts.

According to other FINRA charges:

  • Due to coding defects that remained undetected for nearly six weeks, LPL’s anti-money laundering surveillance system failed to generate alerts for excessive ATM withdrawals and ATM withdrawals in foreign jurisdictions.  
  • LPL failed to report certain trades to FINRA and the MSRB, and failed to ensure it provided complete and accurate information to FINRA and to federal and state regulators concerning certain variable annuity transactions.
  • LPL failed to reasonably supervise its advertising and other communications, including its registered representatives’ use of consolidated reports. LPL did not monitor the creation or use of consolidated reports, and failed to ensure that these reports reflected complete and accurate information.

© 2015 RIJ Publishing LLC. All rights reserved.

Wells Fargo used “pernicious” and “illegal” sales tactics: LA city attorney

Posted on May 7, 2015 by -

The Los Angeles city attorney filed a civil complaint this week against Wells Fargo & Co., charging one of America’s largest full-service financial services firms with coercing its employees to drum up new business and, in the process, defrauding an untold number of Wells Fargo retail customers. 

Wells Fargo sent RIJ the following statement: “We will vigorously defend ourselves against these allegations. Wells Fargo’s culture is focused on the best interests of its customers and creating a supportive, caring and ethical environment for our team members. This includes training, audits and processes that work together to support our Vision & Values and our commitment to customers receiving only the products and services they need and will benefit from.”

The complaint, initiated after a Los Angeles Times investigation, claims that Wells Fargo units “victimized their customers by using pernicious and often illegal sales tactics to maintain high levels of sales of their banking and financial products.” 

The company, as part of its “Gr-eight” growth initiative, put extreme pressure on its employees to sell each Wells Fargo customer eight “solutions” or financial products, ranging from credit card services to savings accounts to insurance products, the complaint said.

Wells Fargo bank logos are a familiar site in many parts of the U.S. According to its website, the company’s 265,000 employees serve 70 million customers at more than 8,700 locations with more than 12,500 ATMs.

The company considers itself the top retail mortgage lender in the U.S., the top minority and low-income mortgage provider, the top new and used car loan provider, and the largest provider of student loans among banks.

Various surveys have ranked the company #2 in annuity sales in 2014, #3 in providing full-service retail brokerage services, #4 in 2014 in providing wealth management services to accounts of $5 million or more, and #6 in providing IRAs in the U.S. in the third quarter of 2014.

Wells Fargo was charged with engaging in at least three types of conduct that the prosecutor called “gaming.” These included:

  • “Sandbagging,” the practice of failing to open accounts when requested by customers, and instead accumulating a number of account applications to be opened at a later date. Specifically, Wells Fargo employees collect manual applications for various products, stockpile them in an unsecured fashion and belatedly open up the accounts (often with additional, unauthorized accounts) in the next sales reporting period.
  • “Pinning,” the practice of assigning, without customer authorization, Personal Identification Numbers to customer ATM card numbers with the intention of… impersonating customers on Wells Fargo computers, and enrolling those customers in online banking and online bill paying without their consent.
  • “Bundling,” the practice of incorrectly informing customers that certain products are available only in packages with other products such as additional accounts, insurance, annuities and retirement plans.

Wells Fargo, which has about $1.7 trillion in assets under management, made no secret of its ambition to win a bigger share of its clients’ wallets, and to take advantage of its diverse product lines to cross-sell and up-sell.

At its website, the company said it would pursue these opportunities:

  1. Investments, brokerage, trust and insurance. We want to be the nation’s most respected provider of wealth, brokerage and retirement services. Only seven of every 100 of our retail banking customers have purchased an IRA through Wells Fargo or have a brokerage relationship with us. Only eight of every 100 buy insurance through Wells Fargo. We want all our wealth management, brokerage and retirement customers to bank with Wells Fargo. We want all our banking customers to think of us first for all their wealth management needs.
  2. “Going for gr-eight.” Our average retail banking household has about six products with us. We want to get to eight . . . and beyond. One of every four already has eight or more. Four of every 10 have six or more. The average banking household, for example, has about 16 products. Our average wholesale bank relationship has six products with us and our average commercial bank relationship, eight. Our wealth management, brokerage and retirement customers lead the pack with an average of 10 products per customer.
  3. Commercial bank of choice. We want to satisfy every financial need of commercial customers, large and small (including working capital, insurance, real estate financing, equipment leasing, trade finance, investment banking and international banking), and have more lead relationships than any competitor in every market we serve.
  4. Banking with a mortgage. We want all our mortgage customers to bank with us and all our banking customers who need a mortgage to buy it from us. We have some real opportunities here. Only about one of five of our banking households that has a mortgage has it with us, and only about a third of our mortgage households have a banking relationship with us.
  5. Wells Fargo cards in every Wells Fargo wallet. Every one of our creditworthy customers should have a Wells Fargo credit card and debit card. Only one of every three of our banking customers has a credit card with Wells Fargo. Nine of every 10 have a Wells Fargo debit card.
  6. Be our customers’ payment processor. We must be our customers’ first choice for payment processing.

© 2015 RIJ Publishing LLC. All rights reserved.

Dutch gov’t to drop forced DC annuitization—but not this year

Posted on May 7, 2015 by -

While life insurers in the U.S. promote the idea of defaulting 401(k) participants into an annuity, the Dutch government is moving in the other direction—preparing to follow the UK’s lead by lifting its annuitization requirements for defined contribution (DC) plan participants.  

But the Dutch aren’t going to relax their rules right away. Legal proposals to allow Dutch DC plan participants to postpone the purchase of an annuity have been put on hold, IPE.com reported this week. Today, the Dutch must convert their entire DC savings to a life annuity when they reach the official state pension age.

The Dutch government was expected to allow savings to remain invested beyond the pension age. But Jetta Klijnsma, state secretary for the Social Affairs Ministry, said the government needed more time to work out the responsibilities of pensions providers towards DC members who opted for such arrangements.

Both Parliament and the pensions industry urged the state secretary to introduce legislation as soon as possible, as low interest rates are leading to low pension incomes for retiring workers as they convert to an annuity.

But adjusting the framework for DC plans raised complicated questions about the implementation of some legal aspects, including asset managers’ scope of duty towards members, and who would be responsible for investments, Klijnsma said

She added that standardization would be needed to prevent volatility in pension outcomes, and that the government would focus on elaborating DC contracts that allowed for variable benefits, in order to limit complexity and speed up implementation.

However, she did not specify whether the new alternatives would or wouldn’t feature “collective risk sharing” for pensioners. The planned introduction of new legislation would be postponed by six months to July 1, 2016, she said, and another round of consultation was a possibility.

The UK recently removed restrictions on DC savers, scrapping the need to force an annuity purchase entirely. Before April 6, 2015, UK DC savers had to purchase an annuity if their savings fell between £18,000 (€24,000) and £310,000, with the average size around £25,000, or about $38,111 at current rats.

However, unlike the Netherlands, Britain allowed savers to postpone an annuity purchase with the balance of their DC assets until they reached age 75; they could remain invested until then.

Since April, UK savers have been able to access their DC savings in a variety of ways including drawing down cash or investing in income drawdown products.

© 2015 RIJ Publishing LLC. All rights reserved.

Retirement Clearinghouse reaches $3 billion in ‘roll-ins’

Posted on May 7, 2015 by -

Automatic enrollment took the 401(k) industry by storm in the ‘90s, but the next big thing might be automaticaccount consolidation, aka “roll-ins.”

More plan sponsors are facilitating roll-ins of accounts as a cost-effective way to improve plan performance metrics, as well as retirement outcomes for participants.

Companies like Retirement Clearinghouse hope it’s a growing trend. The Charlotte, N.C., company automates two-way flows of assets into and out of retirement plans. It promotes the practice as a way to raise average account balances and reduce plan expenses.

Retirement Clearinghouse said it has consolidated over 113,000 retirement savings accounts totaling more than $3 billion in assets into existing IRA or 401(k) accounts. It claims to be the only independent party that consolidates assets into active 401(k) accounts through plan-to-plan transfers.

“More plan sponsors are promoting and facilitating roll-ins of accounts as a cost-effective way to improve plan performance metrics, as well as retirement outcomes for participants,” said Spencer Williams, the firm’s president and CEO.

Roughly 9.5 million individuals who participate in defined contribution plans change jobs every year, according to data from the Employee Benefit Research Institute. Most striking is that every year an estimated 33% of these job changers choose to cash out of their retirement plan instead of rolling their balances into their new employers’ plans.

That leaves a lot of room for improvement. EBRI has estimated that a 50% reduction in cash-outs across the system would add $1.3 trillion to individuals’ retirement savings over a 10-year period. Widespread retirement account consolidation could save consumers $40 billion in administrative and recordkeeping expenses over a 10-year period, according to data from Cerulli Associations.

Among those who don’t cash out, the ownership of multiple accounts is common. After changing jobs several times over a period of decades, more than two-thirds of workers who haven’t cashed out have multiple retirement accounts, according to Retirement Clearinghouse. The balances of about 40% of these retirement plans were below $10,000 in 2012.

Plan sponsors benefit as well from roll-ins. Account consolidation significantly reduces cash-outs by creating a new default for participants when they change jobs—keeping their assets invested and cutting their administrative fees.

© 2015 RIJ Publishing LLC. All rights reserved.

The Bucket

Posted on May 7, 2015 by -

LIMRA LOMA taps Transamerica’s Kent Callahan as new chairman

The LIMRA LOMA Secure Retirement Institute has chosen Kent Callahan, president and CEO of Transamerica’s Investments & Retirement division, as its next chairman. He will succeed David Levenson of Edward Jones.

The chair helps guide the organization’s research and education agenda. LIMRA LOMA has conducted research on a wide range of topics, including finances for the affluent, debt and retirement savings decisions, in-plan income guarantee options, usage of variable annuities and issues pertaining to IRAs.

As head of Transamerica’s Investments & Retirement division, Callahan is responsible for the variable annuity, mutual fund, and U.S. institutional retirement plans businesses. The division has 25,500 plan sponsors representing 5.4 million participants with $295 billion of revenue-generating investments.

Additionally, Aimee DeCamillo was elected as vice chair. She will succeed Callahan in 2016. DeCamillo is vice president and head of T. Rowe Price Retirement Plan Services, which serves 3,500 retirement plans, representing approximately 2 million participants with roughly $155 billion of assets. DeCamillo also served as the Financial Literacy Committee Chair in the LIMRA LOMA’s inaugural year.

David v. Goliath: Active fund manager warns against index funds

Investors keep pouring money into index equity funds but they may be putting themselves at risk, according to a new report from New Jersey-based Wintergreen Advisers, which sponsors the actively managed global value-oriented no-load Wintergreen Fund.

Index fund hype creates an illusion of safety, which can lead ordinary investors to take on a dangerously high concentration of risk in their investment portfolios, the report said.

For instance, the automatic investment in index funds by retirement plan participants means that they buy stocks without considering whether they are over-valued or under-valued. It also means that a few large index specialists are accumulating a high percentage of America’s savings.

 “We believe that one consequence of this is that billions of dollars of value created by American companies are being diverted to a select few executives while ordinary investors, distracted by ‘low fee’ hype, are subjected to dangerous risk concentrations in their retirement portfolios,” said David Winters, CEO of Wintergreen Advisers, in a statement.

The massive assets of index fund giants like Vanguard Group, BlackRock and State Street make them the largest block of shareholders in America’s largest publicly traded companies, holding an average of 16% of the shares outstanding of the top 25 companies in the S&P 500.

Over the past five years, Wintergreen found that, 89% of the time, those three firms voted in favor of proposed executive equity compensation for CEOs at the 25 largest companies in the S&P 500, and opposed executives’ pay packages less than 4% of the time. They withheld or cast votes against directors 4% of the time.

As of March 31, the $1.2 billion Wintergreen Fund had an 87% stock allocation. At 20.8% of assets, tobacco was its largest sector play. Its top ten holdings included Reynolds American, the parent of R.J. Reynolds Tobacco (7.3%), British American Tobacco plc (6.8%) and Altria Group, the parent of Philip Morris USA (4.7%), along with the Swatch Group AG and the Coca-Cola Company. Only 37.5% of its assets were invested in U.S. The fund’s Investor Share class has an annual expense ratio of 1.89% and a one-year return of minus 6.71%.

Transamerica names new retirement appointments

Transamerica Retirement Solutions has named Bill Noyes to the newly created position of senior vice president of retirement plan operations. Noyes previously served as senior vice president of client relationship development.

Additionally, Kevin Edwards, who currently serves as vice president of client compliance and consulting services, has moved into the role of national director of institutional markets client management.

The positions were created because of growth in retirement-related sales, according to the firm. Transamerica’s retirement division, which has more than 25,000 plan sponsors representing 5.4 million participants, topped $100 billion in assets under management in 2013, and continues to grow. Numbers for end of year 2014 were unavailable by press time.

Retirement and investment sales were $16.8 billion in 2013, up 47% compared to 2012 and deposits were $21.2 billion, up 12% from the previous year.

The firm made a few additional appointments. Blake Bostwick, the current chief marketing officer, has been appointed as the division’s chief operating officer. Bostwick replaces Alice Hocking, who recently left the firm. 

© 2015 RIJ Publishing LLC. All rights reserved.

Six Ways to Dress Up QLACs

Posted on May 6, 2015 by -

From the time he reached age 70½ until he died at 84, a retired auto executive (we’ll call him Bill Clemens) deeply resented the IRS compulsion to take a distribution from his half-million dollar 401(k) plan each year. 

Living easily on an executive-level pension and Social Security, with no mortgage or car payments, he and his wife didn’t need the extra $20,000 or so in RMD income. They liked the accompanying bump up in annual income taxes even less.

If Bill had had access to a Qualified Longevity Annuity Contract, he would probably have leapt at the chance to cut his annual RMD by up to 25% for up to 15 years. Today, QLAC issuers and distributors are hoping that lots of retirees like Bill will do exactly that. 

Last week, we wrote about the issuers of QLACs and some of the websites that promote these deferred income annuities. This week, we’ll look at QLAC sales and marketing strategies that issuers and distributors intend to use.

So far, the most popular (but not the only) hook for selling QLACs is as a tool for postponing RMDs and taxes on up to $125,000 in qualified money until as late as age 85, especially for healthy people who don’t rely on their RMDs for current income. But is the potential tax savings great enough to justify the loss of liquidity on an eighth of a million dollars for 15 years? Inquiring minds want to know.     

A remedy for RMDs

Almost as soon as QLACs were announced by deputy Treasury Secretary Mark Iwry last July, advisors and manufacturers talked about marketing QLACs as a way to cut RMDs. They would appeal to America’s Bill Luckabaughs, and spin the QLAC as a way to stop Uncle Sam from reaching so deeply into their pockets at age 70½.  

Thrivent and Pacific Life, for instance, are two QLAC issuers who are stressing the RMD angle. Pacific Life’s QLAC announcement led off with a headline about RMDs. At Thrivent, annuity vice president Wendy McCullough intends to lead with the RMD angle.

“We say, ‘Look, if you have more required minimum distribution than you need in income, invest the difference in a QLAC. The QLAC is for people who do need their 401(k) for income but who don’t need their entire RMD,” McCullough told RIJ during a recent interview.

 “Another thing we see happening: New retirees have more and more qualified than non-qualified assets,” she added. “Up until now, they couldn’t get longevity protection at later ages. It was never an option. With the QLAC, you’ll reduce your tax bill and get longevity protection at the same time.”QLAC story box 5-7-2015

One of the slides in a Pacific Life QLAC webinar this week showed an estimate of potential cumulative tax reduction of $41,409 from the purchase of a $125,000 maximum purchases of a QLAC of $41,409 between ages 70½ and 84, assuming an average annual growth rate of the IRA assets during that period of six percent. (Click on Pacific Life chart, below at left.)

The Pacific Life example assumed a 65-year-old man paying income tax at the rate of 30%. A retiree with a 30% tax rate has an annual pre-tax income north of $200,000, however. People with that kind of money may have more ambitious tax reduction strategies and probably have no fear of ever running out of money.

Not all manufacturers recommend leading with the RMD angle. One doubter is Dan Herr, vice president, Annuity Product Management, at Lincoln Financial, which has rolled out QLACs to the MGA (managing general agent) channel and is preparing to distribute them through its wholesaler, Lincoln Financial Distributors, and broker-dealer, Lincoln Financial Network.

Lead with longevity protection

“I struggle a little with the idea that the RMD deferral is the main reason you buy it,” Herr told RIJ. “If I don’t need that future income, if I’m just getting it out for the RMD exclusion, the benefit is fairly small. There’s a large proportion of retirees who need assistance with lifetime income, and that’s where our focus is going to be. That’s where the real need for education is. I don’t want to minimize the RMD. It’s an added benefit. And there’s a benefit in having clarity. But we’re in the business of providing income guarantees.

“We’ll position the QLAC the same way we positioned the DIA: as a tool to help clients and advisors address longevity income needs by deferring income up to age 85. It contains an element of tax deferral, but its main purpose should be to provide an efficient way to manage longevity risk. That’s the heart and soul of what a longevity annuity should be,” Herr said.

Indeed, the maximum annual tax savings is less than $1,000. The current limit on contributions to a QLAC is the greater of $125,000 or 25% of tax-deferred savings. By excluding that amount from the calculation of the RMD, a retiree would reduce his taxable distribution by about $4,900 according to current tables and his annual income tax bill by about $1,000.

PacLife QLAC slideThis raises questions about the logic of selling on the basis of RMD reduction. If high net worth clients can afford to give up access to $125,000 for up to 15 years, would they care about reducing taxes by $1,000 to $2,000 a year, especially if they are essentially just “kicking the can down road,” as one Pacific Life presenter conceded in his webinar.  

Conversely, if a $500,000 (or smaller) IRA represents someone’s entire retirement savings, and he or she needs the entire RMD for current income, will that person be able to afford a QLAC? Not least, there’s the question of whether the tax savings is worth the loss of $125,000 in potential liquidity and the potential growth on that amount.

“An advisor’s best luck would be to lead with the tax piece. That’s where we’re headed with it,” said Matt Carey, a Wharton MBA candidate and co-founder of Abaris, a DIA and (soon-to-be) QLAC sales site based in Philadelphia.

“But when you explain to people what it is, you find that [the tax savings] it’s not that big a deal. I have a lot of clients—and speaking as a ‘client’ myself—it would be pretty nice to have a smaller RMD at age 70½. But the tax piece alone isn’t enough. You’ve got to do both.”

A ‘bob and a lure’

“For those who can afford to buy the maximum QLAC, $125,000 is not that much money,” said Sean Ruggiero, founder of an IMO in Coeur d’Alene, Idaho, as well as an educational website called Safemoneysmart. “Even some of the union workers out here are retiring with $1 million in retirement savings, or $1.3 million. We did a calculation, and the tax savings is not earthshaking. Especially when you consider the fact that you can’t touch the money for 10 or 15 years.”

But effective producers often need only the slimmest of conversation-starters in order to establish a relationship with a prospect, and Ruggiero thinks the QLAC’s RMD aspect can easily do that. Producers can use it as a “bob and a lure” to attract attention and pave the way to the sale of another insurance product.

One advocate of that approach is Eric Estrada (aka “Thetaxfreeninja”), the marketing director of Synergy Annuity, an IMO in Houston. “You can earn more trust and bring in more assets by explaining that this is a smart tax move. Ninety percent of high net worth clients want the adviser to make recommendations about taxes, but only 10% do,” he told RIJ.

“One producer and I wrote QLAC with 25% of the 401(k) and put the balance into a fixed indexed annuity. Then, because the client was healthy, we took the RMDs and bought a life insurance policy.  The death benefit from the life insurance will recoup all the taxes and the distributions that were taken out. That was two annuity sales and maybe a life policy sale from one strategy.”

But Estrada leads with the RMD angle. “We love the QLAC for RMD planning. It’s hugely overlooked. We have a long history of working with advisors who partner with tax professionals, and the biggest complaint is around RMDs. RMDs tend to get overlooked,” he said.

“Everyone is on the Social Security bandwagon, or talking about decumulation. That’s the right thing to be doing. But we also have to talk about the money that’s on the sidelines in qualified accounts. Clients typically have no idea what to do with it. And until now, they haven’t had a solution for preserving it.” Estrada and others pointed out that some retirees look at their IRAs as their legacy or “leave behind” money, and they resent RMDs for whittling away at it every year.

Asset retention strategy

One of drawbacks of QLACs for commission-paid agents and fee-based advisers involves compensation. The typical commission on a QLAC will be only about half the commission (3% vs. 6%) that a producer can earn selling an equivalent FIA. For a fee-based adviser, recommending a QLAC means “annuicide”: a reduction of assets under management. If $125,000 leaves an investment portfolio and goes into a QLAC, a fee-based adviser charging one percent of assets loses $1,250 in annual revenue.

Carey believes he can show fee-based advisers that QLACs are a net gain for adviser and client. “We think fee-based advisors will eventually drive most of our sales,” he told RIJ. The logic is that, if you have a client who is afraid of outliving his or her money, even if it means five or 10 or 15 percent less assets-under-management for you, this will help you establish credibility and trust with the client, and, in the long run, help you keep the rest of their assets.”

More ways to position QLACs

Brainstorming sessions have produced other ideas for positioning QLACs. Although some people regard the QLAC’s mandatory return-of-premium death benefit (a cash refund during the income stage is an option some issuers offer) as a necessary evil (it protects heirs but reduces the income payment), it can be a plus.

If you accept the premise that annuities sell best when positioned as win-win protection and not as a potential sunk cost, then QLACs with both death benefits and cash refunds might be the most appealing: If the client doesn’t live long enough to get the income, his beneficiary gets a nice lump sum. The opportunity cost associated with loss of liquidity might be seen as a small price to pay for guaranteed higher consumption or a guaranteed legacy.

[One issuer noted that a QLAC without a cash refund during the income period makes no sense, because it creates an unacceptable scenario. Beneficiaries of a person who died a day before the income start date would receive the premium but beneficiaries of a someone who died a day after the income start date would receive nothing.)    

QLACs may also be a hedge against the risk of rising out-of-pocket medical costs in old age. “I’ve been approached by people in elder law who are interested in this as an alternative to long-term care insurance,” Matt Carey told RIJ. “We’re still in the early stages of thinking about DIAs and QLACs as alternatives to LTCI.”

While “it would be really expensive to buy a longevity annuity to pay for nursing home costs,” he noted, it would provide cash for any type of medical expense, including home health care. He also sees an opportunity, if and when partial annuitization becomes available, to market QLACs to people whose pensions have been terminated and paid out as lump sums.

“The good thing about it is that it provides cash [that you can use for any type of medical expense]” Carey added that when pensions are terminated and employees get offered a lump sum, if there’s ever a provision for partial annuitization, that might present a window of opportunity to offer a QLAC.

Finally, a QLAC with a flexible start date could, like a DIA, serve to offset the loss of income for couples when one spouse dies and the survivor has to live on one Social Security payment. By the same token, either a QLAC or DIA could be positioned as a way for retirees who already taken the minimum Social Security benefit at age 62 to fix their mistake and “add back” the late-life income they forfeited by not waiting until age 67 or age 70 to claim.

In a perfect world, advisers and producers could recommend annuities based on their fundamental strengths—a guarantee of lifelong income and a mortality credit. But because so many affluent annuity prospects worry more about taxes than outliving their money (and because low interest rates don’t compensate them for inflation risk and liquidity features dilute the mortality credit), the primary basis for marketing annuities will be tax deferral.  

© 2015 RIJ Publishing LLC. All rights reserved.

Moshe Milevsky on Tontines

Posted on May 6, 2015 by -

Tontines are investment vehicles that combine features of an annuity and a lottery. In a simple tontine, a group of investors pool their money together to buy a portfolio of investments, and, as investors die, their shares are forfeited, with the entire fund going to the last surviving investor. For example, in an episode of the popular television series M*A*S*H, Colonel Sherman T. Potter, as the last survivor of his World War I unit, was entitled to open the bottle of cognac (and share it with Hawkeye Pierce et al) that he and his fellow doughboys brought back from France.

Similarly, imagine that you and nine friends each throw $1,000 into a pot, and the last one to die gets to keep all $10,000. That’s a type of tontine; and so long as you and your friends all have similar life expectancies and none of you has murderous intentions, it’s what we call a “fair bet.”

In a fascinating new book, King William’s Tontine: Why the Retirement Annuity of the Future Should Resemble Its Past, York University Professor Moshe A. Milevsky takes us through the grand history of tontines and explains how tontines can be used to design a wide variety of financial products today—from investment funds to annuities and pensions.

The story, like Col. Potter’s, begins in France. Back in the 1600s, the French and the British couldn’t get enough of fighting with each other. But wars are expensive, and the divine kings of the time needed to raise money to pay for them. Along came Italian financier Lorenzo de Tonti (1602-1684), who proposed the idea of a tontine to King Louis XIV—and for whom tontines are named.

Here’s the basic idea: Instead of selling bonds that pay 6% interest to the lenders, a government sells subscriptions in a tontine fund that entitles all surviving investors to receive, say, a 10% dividend each year while they are alive, but nothing at all after they die. When the last investor dies, the debt is gone—finito—in effect, amortized over the lives of the investors. You can see the benefit to the government. But is it a fair bet for the investors?

To answer that question, Professor Milevsky’s book focuses on King William’s tontine, the first of its kind. King William (of Orange) persuaded the English Parliament to enact the Million Act of 1693. The Act invited 10,000 Englishmen to contribute £100 each to a tontine scheme so that King William could have £1,000,000 to finance his war with France. In exchange for each £100 share, the government promised to pay a high dividend on the tontine until the last investor died (10% a year for the first seven years and then 7% a year until the last investor died).

Unlike bondholders, however, deceased investors could not bequeath their shares to their children or friends. Instead, the dividends on their shares would be forfeited to the investors who were still alive. When the last investor died, however, King William’s tontine would end, and the government would keep the £1,000,000 principal.

Milevsky’s book entertains us with stories about King William, about the tontine, about the lives (and deaths) of the investors who bought into that first government tontine, and even about Edmond Halley—the astronomer-mathematician who advised investors about the tontine.

From there, the book also offers a witty and pleasurable romp through the history of tontines, from the 1600s to the present. Along the way, Alexander Hamilton, our first Secretary of the Treasury, contemplated issuing tontines— rather than bonds—to pay off the United States’ Revolutionary War debt. But other Founding Fathers apparently hated the idea, and it was never enacted. That should not surprise us. Can you imagine our politicians agreeing to pay off our $13 trillion public debt over the next 30 years (much as homeowners routinely do when signing 30-year mortgages)?

Professor Milevsky is an engaging author, and the past 350 years of tontine and government-finance history come alive in his book. Of equal importance, however, is his discussion about how the tontine principle could be used to improve today’s annuities and pensions.

The trick is to use the tontine principle—the idea that the share of each investor, at death, will be enjoyed by the survivors—to design tontines so that they benefit multiple survivors, not just the last survivor. Remember those ten friends who each threw $1,000 into a pot? Instead of waiting until nine die to pay the $10,000 to the last survivor, a tontine fund could be designed to make distributions each time a friend dies. For example, when the first friend dies, the other nine should each get $111.11 ($111.11 = $1000/9); and so on. Better still, if you could recruit new investors to replace those who die, a tontine fund could be perpetual.

Tontine funds could even be run by low-fee discount brokers, not life insurance companies. After all, the investors just need a custodian to hold (and invest) the contributions and to divide the contributions of those who die among those who survive.

Nothing is guaranteed in a tontine fund, so there is no need for insurance. The custodian bears no risk. No money would need to be set aside for insurance company reserves, risk-taking or profits. That means that tontine funds could provide significantly higher benefits to investors than commercial annuities and other commercial insurance products. And that’s why, as Milevsky demonstrates so well, the retirement annuities of the future should resemble the tontines of the past

Jonathan Barry Forman is the Alfred P. Murrah Professor of Law at the University of Oklahoma in Norman, Oklahoma. He is the author of Tontine Pensions, 163(3) University of Pennsylvania Law Review 755-831 (2015) (with Michael J. Sabin).

© 2015 RIJ Publishing LLC. All rights reserved.

RetirePreneur: Lowell Aronoff

Posted on May 5, 2015 by -

What I do: I run a company that facilitates the sale of financial products. In the U.S. we have focused on the annuity markets. CANNEX provides a surveying service for immediate income annuities. Each participating carrier provides us with its unique pricing method. We re-program these algorithms onto our server and then provide distributors and advisors with apples-to-apples comparisons of prices. Each price is specific to the adviser’s customer, we show only those carriers that the advisor is licensed with, and each quoted carrier guarantees its annuity quote.  We provide similar guaranteed surveys of the single-premium deferred income annuity market. We also provide a variety of analytical tools to help advisers calculate and explain retirement income needs. These include a product that calculates an optimal allocation between three classes of retirement income generators—managed accounts, annuities with guaranteed living benefit riders and income annuities.L Aronoff copy block

My clients are: Primarily insurance companies and distributors, – including broker-dealers, insurance marketing organizations and banks. We avoid working directly with consumers because we do not want to compete with our distributor clients who are in a better position to offer personalized advice.

Where I came from: I started my career in Montreal working in Prudential of England’s actuarial department. I found myself drawn to programming actuarial functions so I took a job with a start-up organization called CANNEX that was still a few months away from launching its first product—a method to instantly survey the income annuity market. 

To me, entrepreneurship means: Pursuing an idea or dream. This involves trading some financial security for more control of your destiny.

What made me strike out on my own: At the time I had a fabulous opportunity. The concept/product was needed and I was confident that it would make a difference. I was young enough that I had no personal or financial commitments. I could put all my time and energy into the company without needing to draw a salary for more than two years.

Who owns CANNEX: The three principal owners are Alex Melvin, Moshe Milevsky and me. Most of the other shareholders are family and friends who helped us out when Alex and I bought the company from the founding shareholders. The rest are employees who have purchased shares over the years.

My business model: Fundamentally, we charge everyone who benefits from the service. Our flagship product is an income annuity exchange. Carriers pay to be included and distributors pay for the illustrations they receive from the service. By charging both carriers and distributors we can keep our fees lower.

My biggest obstacle at the beginning: CANNEX started before personal computers were popular and the World Wide Web had not yet been envisaged. At the time, getting technology into the hands of advisors to allow them to communicate with our mini-computer was an issue, as was gaining trust and getting acceptance for a start-up organization that changed the way annuities are sold. 

How we changed the way annuities are sold: Before CANNEX, advisors would typically lug telephone-book-sized rate books to each client’s home where they would discuss the client’s need, and then do a different calculation by hand for each insurance company based on a few numbers found in each insurance company’s rate book in order to figure out how much each company was prepared to offer their client.

Why we expanded to the U.S.: It was working in Canada, and there was no U.S. competitor. The service was needed and we had experience expanding to Australia. We eventually sold our Australian operation because distance made management difficult. The U.S. was and is a natural market, with similar needs, the same time zones, and largely the same opportunity as our Canadian service.

Our biggest ongoing challenge: Keeping experienced, excellent staff happy, challenged and motivated.  This involves absorbing the input of very capable individuals in setting the company’s priorities. When people become overworked, which happens when you grow quickly, it’s important to find creative ways to split the overworked person’s job in two. Another challenge in running a two-country company is determining priorities. Our software development resources are not split between the two countries. The same person will work on a U.S. project one week and a Canadian project the next.

My retirement philosophy: I don’t think retirement is a good idea for people who are healthy and thoroughly enjoy their work. I’m lucky enough to fall into both those categories. Like most people, I have a hard time planning more than five or 10 years out, so I have no plans to retire in the foreseeable future. If and when I do retire I would buy an income annuity—but not for the usual reasons. I am constitutionally a saver, so whether I buy an income annuity or not, there is no real danger that I would run out of money. However, there is a risk that I would spend far below my means. A guaranteed check that I know will be there every month for the rest of my life would help counter my natural tendency to avoid spending.

© 2015 RIJ Publishing LLC. All rights reserved.

Who’s Doing What with QLACs Now

Posted on April 30, 2015 by -

Which of the following hashtags is trending on Twitter:

#awristwatchwhosetimehascome?

#weneverpromisedhillaryarosegarden?

#qualifyinglongevityannuitycontracts?

If you guessed the third one, you’re probably in the insurance business. By all accounts, few people outside the annuity industry have heard of QLACs. Fewer know what QLACs let retirees do: defer taxable distributions from up to $125,000 in qualified money until as late as age 85.        

But a subset of the annuity world is fairly jazzed about QLACs, and for good reason: They could open up billions of rollover IRA dollars to sellers of deferred income annuities.

To date, seven life insurers have issued QLACs, with more to come. Home offices and IMOs (insurance marketing organizations) have begun acquainting agents and producers with this strange new acronym and the product behind it.    

In this article, and in an article next week, we’ll tell you about:

  • Life insurers that issue QLACs.
  • Independent websites that promote them.
  • Strategies for selling them. (Coming next week in RIJ.)

Clearly, this product (which has also been cleared for use in 401(k)-type plans) is in its earliest stages. But many people feel that curiosity about the tax benefits of QLACs will open the door to broader conversations about other guaranteed lifetime income products with people who may not have known about any of them before. And the potential market—some $25 trillion in qualified savings—is irresistible.

Life insurers that issue QLACs

In July 2014, the Treasury Department announced specific guidelines for QLAC designs—e.g., no premium greater than 25% of qualified savings (up to $125,000) and a mandatory return of premium death benefit in the deferral period. So QLACs don’t vary much from issuer to issuer. Some contracts offer more income start-date flexibility than others. Prices will obviously fluctuate with interest rates and carrier appetite.   

AIG. AIG’s American General unit issued its American Pathway QLAC last December. Contract owners who choose a cash refund option can accelerate or delay their income start date by up to five years, and have several inflation-adjustment options.

Americo Financial Life and Annuity. This final-expenses specialist filed an applied for approval to issue its DIA as a QLAC last September. “We have had a DIA for many years, and quickly made the adjustments to meet QLAC requirements,” said Todd Adrian, Americo’s senior marketing manager, product development. “Our DIA is pretty straight forward with no special features or flexibility beyond Treasury requirements.”

First Investors Life. Carol Springsteen, president of this unit of The Independent Order of Foresters, told RIJ recently,“We will be endorsing our current deferred income annuity contract to facilitate a QLAC version. We plan to endorse our new Flexible Pay Longevity Annuity product to be a QLAC as well.”

Lincoln Financial. “We launched our DIA in November 2013, and added the QLAC status in February 2015,” said Dan Herr, vice president, annuity product management. “We released it on a limited basis, in certain firms—mainly in the MGA (managing general agent) channel—where it was an easy rollout. The national rollout will be in mid-May. Our contract can be offered with or without the return of premium after the income start date.”

Pacific Life. The company with the humpback whale logo introduced its QLAC on April 6. Christine Tucker, vice president of marketing in Pacific Life’s Retirement Solutions Group, said in a release that the company is offering the resources of its Retirement Strategies Group and Advanced Marketing Group to help “financial professionals examine the application of QLACs in a variety of financial strategies.”

Principal Financial. The Principal announced its QLAC on February 3. The Principal’s DIA and its QLAC include a return-of-premium death benefit if the contract owner(s) die during the deferral period. A return of unpaid premium rider for the income period is optional. 

Thrivent Financial. “We were able to launch on January 16,” vice president Wendy McCullough told RIJ. “It was a little bit onerous because we had to build processes for remedying excess contributions, among other things, in ways that the IRS would accept.  Now we’re rolling it out to our captive force. We’ve noticed that the newer retirees have more qualified than non-qualified assets, and up until now they couldn’t get longevity protection at later age. With QLAC, they have that option.”      

Issuers in the wings. The biggest DIA issuers haven’t announced QLACs yet. New York Life, which has a 42% share of the DIA market, and Northwestern Mutual, have each filed for state approval of their QLAC and expect to launch products this summer. A MassMutual spokesman said, “We continue to actively evaluate” as an option for IRA owners and retirement plan participants.”A Guardian Life spokesperson said “Guardian is planning to launch its first QLAC later this year.” MetLife “has yet to enter the market but we hope to soon,” a company spokesman told RIJ recently.   

Websites that promote QLACs

So much for the manufacturers; what about the distributors? QLACs are insurance products, so captive (for the big mutual company QLACs) and independent agent channels will account for most sales. A number of insurance and annuity websites have begun offering calculators, educational material, FAQs, and quotes about QLACs, along with connections to live licensed agents via toll-free numbers.

Go2income.com Jerry Golden, who created the world’s first guaranteed minimum income benefit rider while at Equitable Life in the late 1990s and sold a retirement income planning tool to MassMutual in the mid-2000s, has since launched a venture called Golden Retirement LLC. A beta version of its proprietary QLAC payout quote tool can be seen at go2income.com. “The QLAC is going to open up a lot of people’s eyes to the benefits of income annuities in general,” Golden told RIJ this week.

Immediateannuities.com. Through this site, insurance executive-turned-web- entrepreneur Hersh Stern and his licensed agents has been providing quotes and selling SPIAs directly to the public for many years. A couple of years ago, he added indexed annuities. He is now offering QLACs as well. There’s a QLAC education page on the website, a payout calculator, a QLAC FAQ page, and a video of Christina Benz, Morningstar’s director of personal finance, about QLACs. 

IncomeSolutions.com. This website, created by the Hueler Companies, is an open-architecture platform where participants in certain retirement plans (Vanguard plans, for instance) and others can get competitive bids on immediate and deferred income annuities when they change jobs or retire. In April, Income Solutions started offering QLACs from The Principal and AIG, two publicly held insurers that use third-party distribution.

Myabaris.com. Matt Carey, a licensed insurance agent and MBA candidate at the Wharton School, who once worked on retirement issues at the Treasury Department, has started a business that specializes in the sale of DIAs and, starting in June, QLACs. “The QLACs we can sell right now are from AIG, Lincoln Financial, Pacific Life, and Principal,” Carey told RIJ. He and a partner are acting as agents for individuals and for advisers who otherwise don’t handle insurance sales. They hope to make buyer-behavior data available to the carriers they represent. 

Safemoneysmart.com. Coeur d’Alene, Idaho insurance wholesaler Sean Ruggiero created this website for his business, but plans to convert it to a non-profit educational site to help insurance producers learn more about retirement income, including QLACs. “QLACs are a big deal. They will have a big impact on clients and advisers—but not immediately,” Ruggiero told RIJ.

Stantheannuityman.com. The sponsor of this site, Stan Haithcock, is well known in the insurance world as a speaker, a producer and a promoter of annuities as income products rather than accumulation products. He has also written an instant book about QLACs, which he makes available on his site.

Synergyannuity.com.  “We love the QLAC. RMD planning is hugely overlooked,” said Eric Estrada, the product and marketing guru at this Houston-based IMO. “Right now, everyone is on the Social Security planning bandwagon. But clients have no idea about what to do with money on the sidelines in qualified accounts.” 

Qlacs.com. Someone had to claim the “qlacs” domain. The owner is Alternative Brokerage, an IMO whose founder is Bob Phillips, a former chair of the National Association of Fixed Annuities.

Fidelity.com. The retirement giant, which has an online platform where consumers can compare and purchase deferred income annuities from Guardian, MassMutual, MetLife, New York Life and The Principal, will soon offer QLACs. (Only one of its DIA issuers—The Principal—has announced a QLAC yet.) “We don’t have them right now, but we anticipate offering them in the second half of the year,” a Fidelity phone rep told RIJ this week.

Next week: How to Market QLACs.

© 2015 RIJ Publishing LLC. All rights reserved.

America’s Risky Recovery

Posted on April 30, 2015 by -

The United States’ economy is approaching full employment and may already be there. But America’s favorable employment trend is accompanied by a substantial increase in financial-sector risks, owing to the excessively easy monetary policy that was used to achieve the current economic recovery.

The overall unemployment rate is down to just 5.5%, and the unemployment rate among college graduates is just 2.5%. The increase in inflation that usually occurs when the economy reaches such employment levels has been temporarily postponed by the decline in the price of oil and by the 20% rise in the value of the dollar. The stronger dollar not only lowers the cost of imports, but also puts downward pressure on the prices of domestic products that compete with imports. Inflation is likely to begin rising in the year ahead.

The return to full employment reflects the Federal Reserve’s strategy of “unconventional  monetary policy”—the combination of massive purchases of long-term assets known as quantitative easing and its promise to keep short-term interest rates close to zero. The low level of all interest rates that resulted from this policy drove investors to buy equities and to increase the prices of owner-occupied homes. As a result, the net worth of American households rose by $10 trillion in 2013, leading to increases in consumer spending and business investment.

After a very slow initial recovery, real GDP began growing at annual rates of more than 4% in the second half of 2013. Consumer spending and business investment continued at that rate in 2014 (except for the first quarter, owing to the weather-related effects of an exceptionally harsh winter). That strong growth raised employment and brought the economy to full employment.

But the Fed’s unconventional monetary policies have also created dangerous risks to the financial sector and the economy as a whole. The very low interest rates that now prevail have driven investors to take excessive risks in order to achieve a higher current yield on their portfolios, often to meet return obligations set by pension and insurance contracts.

This reaching for yield has driven up the prices of all long-term bonds to unsustainable levels, narrowed credit spreads on corporate bonds and emerging-market debt, raised the relative prices of commercial real estate, and pushed up the stock market’s price-earnings ratio to more than 25% higher than its historic average.

The low-interest-rate environment has also caused lenders to take extra risks in order to sustain profits. Banks and other lenders are extending credit to lower-quality borrowers, to borrowers with large quantities of existing debt, and as loans with fewer conditions on borrowers (so-called “covenant-lite loans”).

Moreover, low interest rates have created a new problem: liquidity mismatch. Favorable borrowing costs have fueled an enormous increase in the issuance of corporate bonds, many of which are held in bond mutual funds or exchange-traded funds (ETFs). These funds’ investors believe – correctly – that they have complete liquidity. They can demand cash on a day’s notice. But, in that case, the mutual funds and ETFs have to sell those corporate bonds. It is not clear who the buyers will be, especially since the 2010 Dodd-Frank financial-reform legislation restricted what banks can do and increased their capital requirements, which has raised the cost of holding bonds.

Although there is talk about offsetting these risks with macroprudential policies, no such policies exist in the US, except for the increased capital requirements that have been imposed on commercial banks. There are no policies to reduce risks in shadow banks, insurance companies, or mutual funds.

So that is the situation that the Fed now faces as it considers “normalizing” monetary policy. Some members of the Federal Open Market Committee (FOMC, the Fed’s policymaking body) therefore fear that raising the short-term federal funds rate will trigger a substantial rise in longer-term rates, creating losses for investors and lenders, with adverse effects on the economy. Others fear that, even without such financial shocks, the economy’s current strong performance will not continue when interest rates are raised. And still other FOMC members want to hold down interest rates in order to drive the unemployment rate even lower, despite the prospects of accelerating inflation and further financial-sector risks.

But, in the end, the FOMC members must recognize that they cannot postpone the increase in interest rates indefinitely, and that once they begin to raise the rates, they must get the real (inflation-adjusted) federal funds rate to 2% relatively quickly. My own best guess is that they will start to raise rates in September, and that the federal funds rate will reach 3% by some point in 2017.

Martin Feldstein is a professor of economics at Harvard University and president emeritus of the National Bureau of Economic Research. 

© 2015 RIJ Publishing LLC. All rights reserved.

On the Road with RIJ: Penn’s Archaeology Museum

Posted on April 30, 2015 by -

RIJ is reporting this week from the Museum of Archaeology at the University of Pennsylvania, where the Wharton School’s Pension Research Council is holding its annual symposium. Right now, David Tuesta, chief economist of BBVA Research in Madrid, Spain, is presenting slides on the pros and cons of investments in infrastructure by pension funds worldwide.

This event’s attendees perennially include a high concentration of pension experts who are well known in the retirement field, especially in the academic wing of the business. There’s no red carpet here, but the luminaries I’ve spotted so far include Stacy Schaus of PIMCO, Amy Kessler of Prudential, Raymond Maurer of Goethe University in Frankfurt, Gary Mottola of FINRA (formerly of Vanguard), consultant Jodi Strakosch (formerly of MetLife Retirement) David John of AARP and, of course, Olivia Mitchell, the director of the Pension Research Council—just to name the ones I saw while grabbing a croissant, coffee and cantaloupe slices at the breakfast buffet.

The speaker who follows Tuesta is Peter Fisher of Tapestry Networks, a corporate governance consulting firm. He’s describing an  international organization, the Insurance Governance Leadership Network, where non-executive directors from global insurance companies talk with regulators about high-level insurance and accounting issues. It’s something I probably should have known about already. Its members, according to one slide, include Liberty Mutual, Lincoln Financial Group, MetLife, the National Association of Insurance Commissioners, Moody’s Investors Services, Travelers, and the Federal Reserve System. Heavy, stratospheric stuff; it will require further investigation. (At right, a Greek coin from the museum’s collection.)

Fredrik Axsater of State Street Global Advisors, followed up these two speakers with a commentary on their presentations. He observed that there are obvious conflict-of-interests associated with investments by a national pension plan in the same country’s infrastructure projects. (In the U.S., much of the local infrastructure is financed with municipal bonds or federal dollars.)Greek coin from penn

Investments in infrastructure also tend to be illiquid, he noted, so they will be hard to offer within defined contribution plans as long as those plans involve daily valuations and trading. Those issues aside, he favored pension investments in infrastructure. (During a Q&A period, there was some debate about whether the biggest barriers to pension fund investment in infrastructure is regulation, or the high fees associated with private equity firms that often broker big infrastructure deals, or the complexity of infrastructure projects, or the risk-averse nature of pension fund boards. The answer is probably, “All of the above.”) 

The low-yield environment is perhaps the biggest danger for retirement savers, Axsater said. According to State Street calculations back in 2007, Americans who saved and invested 11% of their income per year would be able to replace 65% to 80% of their final incomes in retirement.

Given the latest predictions for lower investment returns in the future, however, State Street now believes that an 11% savings rate would only produce a 45% replacement rate. “I call that a shock to the system,” he said. To close that gap, his firm believes that people may have to retire a few years later, somehow squeeze an extra 50 more basis points of yield from their portfolios, and/or buy a life annuity that starts paying income at age 80.

Webinar on DOL proposal

Yesterday at 4 p.m., ERISA super-lawyer Marcia Wagner presented a webinar on the new DOL conflict-of-interest proposal. The webinar was mainly a recitation of the major points of the proposal, but Wagner also provided some of expert commentary—which is what we were all waiting for. You can find a copy of the slides here.

In brief, Wagner believes that the “DOL proposal will affect substantially all advisors because of reach to IRA assets,” that it will be “costly for broker-dealers and insurance agencies,” that the so-called Best Interest exemption disclosures “appear to significantly exceed 408(b)(2) fee disclosures,” and that the proposal will have “little or no impact on RIAs, but certain advisors may decide to join or become RIAs.”

© 2015 RIJ Publishing LLC. All rights reserved.

Annuity CEOs receive disclosure demands from Sen. Warren

Posted on April 30, 2015 by -

U.S. Senator Elizabeth Warren (D-MA), the crusader for consumer financial protection and scourge of the financial services industry, has sent identical letters to executives at 15 different life insurance company executives asking for an inventory of their annuity sales incentives, if any.

A ranking member of the Senate subcommittee on Economic Policy and at one time a candidate to lead the Consumer Financial Protection Bureau, Warren asked the executives to provide the information by May 11, less than two weeks from now.

Chief executive officers at AIG, Allianz Life, AXA Equitable, AVIVA [now Athene], American Equity Investment Life, Transamerica, TIAA-CREF, AIG, RiverSource Life, Prudential Annuities, Pacific Life, New York Life, Nationwide Financial, MetLife, Lincoln Financial Group, and Jackson National Life received the letters.

© 2015 RIJ Publishing LLC. All rights reserved.