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Fidelity offers bonuses for IRA contributions

In a stunt that echoes the $600 bonuses that TD Ameritrade and E*Trade offer for big-ticket IRA rollovers, Fidelity announced today that it will match a percentage of a person’s contributions to his or her IRA for three years after he or she opens a Fidelity IRA with a lump sum of $10,000 or more.

The matches on the three annual follow-on contributions range from as small as one percent if the new IRA is opened with a deposit of $10,000 to $50,000, to as large as 10% if the new IRA is opened with at least $500,000.

Here’s how a Fidelity release described the new offer:

  • The match is available to new or existing customers who transfer a Roth, Traditional or Rollover IRA to Fidelity.
  • When this occurs, and an individual makes contributions to the IRA over the next three years, Fidelity will match the annual contribution up to 10%.
  • Direct rollovers from a 401(k) or 403(b) plan are not eligible.
  • If a customer transfers $500,000, he or she will earn 10% on future contributions.
  • If a contribution of $5,500 is made in the first year, that customer will receive a $550 match.

There’s a 1.5% match for three annual contributions made after an initial deposit of $50,000 to $100,000, 2.5% for contributions made after a deposit of $100,000 to $250,000, and 5% for contributions made after a deposit of $250,000 to $500,000, Fidelity said in a release. 

DoL won’t ban commissions: Wagner Law

The Wagner Law Firm, which specializes in pension law, offered the following report this week:

The White House and the U.S. Department of Labor (“DOL”) have released new information concerning the DOL’s highly anticipated proposal to revise its fiduciary definition under ERISA.  The DOL proposal has not yet been published, but the Obama Administration has arranged this coordinated release of information as part of its ongoing efforts to promote the proposed rule change.

Broader Fiduciary Definition. Updated information concerning the DOL fiduciary proposal was circulated through a newly released fact sheet from the White House as well as FAQs posted on the DOL’s website.  As discussed in these releases, the DOL proposal would indeed broaden the definition of “investment advice,” which in turn would broaden the scope of advisors to plan clients who would be viewed as fiduciaries for ERISA purposes. 

New fiduciary standard and exemption.  Under the proposed rule, advisors under the new fiduciary definition would be required to put their client’s best interest first.  However, the proposed rule would not require advisors to eliminate their conflicts of interest.

Instead, the proposal would include a prohibited transaction exemption that would merely require advisors to mitigate their conflicts and also disclose them.  The new exemption would be “principles-based” (i.e. based on general principles rather than detailed “rules-based” requirements), providing advisors with the flexibility to adopt appropriate practices and adapt them over time. 

Although the applicable releases do not explicitly reference the Investment Advisers Act of 1940 (the “Advisers Act”), based on the description of the new fiduciary standard and exemption, it appears that the DOL fiduciary proposal would impose a set of principles-based requirements on advisors to plan sponsors and participants that would be analogous to those found under the Advisers Act.

No ban on commissions or non-fiduciary education. The applicable releases state that the DOL remains committed to ensuring that all common forms of compensation, including commissions and revenue sharing, would still be permitted under the proposal. Thus, it appears that the new exemption under the DOL proposal would permit the receipt of “variable compensation” so long as the conflict is mitigated under the advisor’s practices and fully disclosed. The releases also state that advisors would continue to be able to provide general education on retirement savings across plans and IRAs without triggering fiduciary status.  For example, when providing guidance on the mix of stocks and bonds that a person should have based on his or her expected retirement date, the advisor should be able to provide such guidance in a non-fiduciary capacity.

Next steps for DOL fiduciary proposal. Although the DOL proposal has not yet been published, Labor Secretary Thomas Perez has informally stated that the proposed rulemaking is being submitted to the Office of Management and Budget (“OMB”).  Following a standard interagency review at OMB, which is expected to be completed within 90 days, the DOL proposal would finally be made available to the public.  

CEA Report on Conflicted Advice.  In addition to the releases described above, the White House Council of Economic Advisers (“CEA”) released a report analyzing the economic cost of conflicts of interest.  The report makes the following conclusions:

  • Conflicted advice lowers investment returns by roughly 1 percent annually.
  • The aggregate annual cost of conflicted advice for IRA assets is roughly $17 billion each year.
  • A retiree receiving conflicted rollover advice will lose roughly 12 percent if the savings are drawn down over 30 years.

The focus of the CEA report suggests that the DOL fiduciary proposal will include significant restrictions on advisors seeking to provide rollover advice to participants. Presumably, the CEA report will be used to support the DOL’s required economic analysis for its proposed rulemaking, quantifying the costs of conflicts and the expected impact of the rule. 

Additional resources

http://www.whitehouse.gov/the-press-office/2015/02/23/fact-sheet-middle-class-economics-strengthening-retirement-security-crac

http://www.dol.gov/featured/protectYourSavings

http://www.whitehouse.gov/sites/default/files/docs/cea_coi_report_final.pdf

Year-over-year changes in 401(k) fees are minimal, new book shows

The average total plan cost for a small retirement plan (50 participants/$2,500,000 assets) remained flat at 1.44% over the past year, while underlying investment fees declined, according to the newly released 15th Edition of the 401k Averages Book.

“Although total plan costs remained flat or increased by a basis point for the majority of plan sizes, we saw a year-over-year decline for eight of the nine investment categories we track,” said David Huntley, the book’s co-author.

“For example, Large US Equity fees declined from 1.40% to 1.38% and Target Date Funds from 1.35% to 1.32%,” he said, noting that participants’ exposure to equities and target date funds has grown as 401(k) balances reach new highs. “Traditionally US equities, target date funds and international have higher expenses than fixed income and stable asset so the shift from one to the other resulted in total plan costs remaining flat.”

For large retirement plans (1000 participants/$50,000,000 assets), total plan costs were flat at 1.03% and underlying investment fees declined. The study shows Large US Equity fees declined to 1.03% from 1.05% and Target Date Funds to .96% from 0.98% for large retirement plans.

“Plans have been successful at driving down investment expenses by changing share classes or prudence in the selection process,” said Joseph Valletta, Huntley’s co-author.  

Wide range between low- and high-cost providers

Total plan costs on a small plan range from .43% to 1.88%, while large plan costs range from 0.31% to 1.38%.   

The 15th Edition of the 401k Averages Book can be purchased for $95 by calling (888) 401-3089 or online at www.401ksource.com.

Plans offer automated advice to disengaged participants: Cerulli

Advice in defined contribution (DC) plans is mainly delivered automatically today and is often administered without any action from the plan participant, according to Cerulli Associates, the global analytics firm.

“Plan sponsors have increasingly embraced auto-features, which were once thought of as radical, in an attempt to boost plan participation and employee contributions,” said Jessica Sclafani, senior analyst at Cerulli, in a release. “This shift in perception is in response to the overall lack of participant engagement.” 

“Retirement advice begins with auto-enrollment, which informs employees they should save for retirement. Auto-enrollment is a crucial first step in auto-advice that captures the most vulnerable population of the workforce that isn’t saving at all,” the release said. 

According to Cerulli’s 2014 Plan Sponsor Survey, 73% of plan sponsors have incorporated automatic features into their plan design. Nearly 90% of plans use auto-enrollment, with the majority of flows directed toward target-date funds. 

“While widespread adoption of auto-enrollment is a step in the right direction, a deferral rate of less than 5% salary is inadequate and will not translate to retirement security,” the release continued.

Because the participant bears the most responsibility for saving, Cerulli said, it views the implementation of auto-features as a “realistic versus paternalistic” approach to plan design.   

Betterment receives $60 million in new private equity

Betterment, the automated investing service, has announced the close of a $60 million round of growth funding. Private equity firm Francisco Partners led the financing, which includes investments from previous investors Bessemer Venture Partners, Menlo Ventures, and Northwestern Mutual Capital.

Launched in 2010, Betterment manages more than $1.4 billion of assets in tax-efficient, personalized portfolios for more than 65,000 customers and considers itself the largest automated investment service, by size of customer base.

Peter Christodoulo of Francisco Partners has joined Betterment’s board of directors, the company also announced. Francisco Partners has made previous investments in Prosper Marketplace, eFront, PayLease, Paymetric, Avangate and Hypercom, among others.

In the past year, Betterment has introduced new features, including Tax Loss Harvesting+ and Tax Impact Preview. The company also recently unveiled Betterment Institutional, a digital solution for financial advisors. 

Northwestern Mutual revenues reach record $26.7 billion

Northwestern Mutual posted record levels of revenue, assets and surplus for 2014, as well as a dividend payout to policyowners for 2015 that is expected to exceed $5.5 billion, a record, the company said in a release.

In 2014, Northwestern Mutual’s revenue ($26.7 billion), total assets ($230 billion), operating gain before dividends and taxes ($6.1 billion), and total surplus ($22.6 billion) all reached record high levels.

In addition, the company said it increased its life insurance in-force to $1.5 trillion (five percent over 2013) and managed more than $87 billion in client investment assets (12% over 2013).

The $5.5 billion of total dividends Northwestern Mutual expects to distribute to policyowners in 2015 includes record dividends on traditional permanent life insurance ($4.8 billion), disability income insurance ($320 million), term life insurance ($150 million), and variable life insurance ($105 million). “We also expect to pay $45 million on fixed and variable annuities,” the release said.

The company also expanded its Portfolio Income Annuities to the non-qualified market in 2014, fueling annuity sales. Total annuity sales reached a record $2.4 billion, up four percent over 2013. In 2015, the company plans to introduce the Accelerated Care Benefit, a new optional benefit available with its permanent life insurance to help meet long-term care needs.

A new 1.1 million sq. ft. expansion of Northwestern Mutual’s corporate headquarters in downtown Milwaukee, Wisconsin, is under construction. The company expects to add 1,900 jobs by 2030. In 2015, it expects to add more than 450 employees, many of them in information technology.  

© 2015 RIJ Publishing LLC. All rights reserved.

UBS Looks at Longevity and Annuities

At the Investment Management Consultants Association’s annual conference, held in midtown Manhattan on a wet, windy day in early February, a UBS executive gave a presentation titled “Planning for Longevity Risk Certainty.” (The strikethrough was his, and it was intentional.)

Michael W. Crook’s slides weren’t exactly what you expect to see in that type of venue. The wealthy clients of IMCA members usually don’t run out of money in retirement, unless they’re reckless. And wealth managers at wirehouses like UBS aren’t known for their interest in things like longevity risk or annuities.      

Crook, the head of portfolio and planning research at UBS Financial Services, never did mention annuities in his IMCA presentation. But the fact that he addressed longevity risk at all, and that IMCA asked him to speak to its members about it, hints at a growing interest in lifetime income where it once hardly existed.

“Clients and prospects have been asking about it,” Crook told a few hundred investment managers, mostly men in business-casual. He spoke in a hotel ballroom just north of Times Square, where TV screens the size of tennis courts poured sensational images, colors and ad slogans down on phone-wielding tourists from Asia and Europe, like hot oil on barbarian invaders.

Times are changing.  In addition to tax minimization and estate planning, high-net-worth clients, especially those without pensions, recognize a need for guaranteed lifetime income. And even the wirehouses—UBS, BoA Merrill Lynch, Morgan Stanley Smith Barney and Wells Fargo—have begun talking the longevity talk.   

The wealthy have more longevity risk

The wealthy in particular should worry about longevity risk because they tend to live the longest, Crook pointed out. As couples, they live even longer. His father, a smoker, died in his 60s, he said, but his mother, a retired teacher, is still alive in her 90s. (The wealthiest 55-year-old Americans can expect to live about 10 years longer on average than the poorest, according to the Brookings Institute.) Major risks to wealth in retirement

“Keep in mind that the people you’re working with aren’t average,” Crook said.

People who live the longest, no matter how much rich or poor they are, can eventually face frailty and isolation. Recognizing this, Crook said, UBS urges its advisors to ask clients three simple non-financial questions: Who will change your light bulbs? Where will you get an ice cream cone? Who will you have lunch with?

These questions help clients focus on three major challenges in retirement: coping with physical limitations, relocating to a more convenient residence, and maintaining an adequate social network. While the questions don’t directly address finance, they all involve needs—home maintenance, transportation, and recreation—that could entail financial decisions.

Like other retirement experts, Crook talked about the threat of sequence of returns risk for retirees. This is the risk that a retiree will be forced to sell depressed assets in order to generate income, especially in the 10-year “red zone” that’s centered on the retirement date. One way to protect yourself from this type of volatility or market risk, he said, would be to “manage both sides” of the household balance sheet and to live on borrowed money if the market drops while you’re in the red zone.

In fact, UBS has created a “securities-based lending program” to facilitate such a strategy. Using creditworthy clients’ investments at UBS as collateral, the bank offers credit lines of $55,000 or more to clients at a maximum interest rate of LIBOR plus 5.5%. It would serve as an alternative to holding enough cash to cover a year or two worth of living expenses, or to securing a source of income, perhaps from an annuity, that’s immune to market volatility. 

Besides helping clients avoid losses during downturns, leverage can help increase returns during upturns, Crook said at the IMCA conference. “You can get a one percent larger return on your assets with the appropriate amount of leverage,” he said. “The prudent use of leverage is not that risky. There’s a clear tactical opportunity between the costs of the debt and the return on assets. It’s a simple way to take advantage of both sides of the balance sheet.”

Bucket list

“Bucketing” is a popular if somewhat controversial approach to investment management in retirement, and one of Crook’s slides showed his version of it. The slide referred to a conservative “liquidity” bucket “dedicated to preserving lifestyle over the next 3-5 years,” a balanced/growth “longevity” bucket “dedicated to achieving lifetime consumption goals,” and a growth or speculative “legacy” bucket with “excess assets not necessary for lifetime consumption.”

Michael CrookCrook (left) used “longevity” as the label for an income-generating bucket during retirement, as opposed to the label for a bucket whose assets are a hedge against longevity risk.  He showed a rough schematic of each bucket’s content at three different ages: 35, 65 and 85.

During the working years (age 35), the liquidity bucket would be tiny, the longevity bucket growing, and the legacy bucket empty. At age 65, the longevity bucket would be the largest of the three buckets. At age 85, the liquidity bucket would be the same size it was at age 65, the longevity bucket would have shrunken to roughly the size of the liquidity bucket, and the legacy bucket would dwarf the other two.

Asked after the conference where annuities might fit into this scheme, Crook said, “The annuity question is a tough one. There’s pretty conclusive evidence that they have a role to play for some households, and that people like annuitized income when it is endowed to them (pensions, etc). However, it’s a hurdle for many investors to purchase something with a negative expected value (like all insurance).”

But there are signs that UBS interest in individual retail annuities may be growing. Last fall, UBS advertised on LinkedIn for someone to fill a vacancy for an Annuity and Insurance Specialist to support financial advisors and promote the UBS Retirement Platform to financial advisors. Also last fall, the company’s CIO Wealth Management Research division dedicated the quarterly issue of its magazine, “Your Wealth & Life,” to “Navigating Longevity.”

An annuity executive at UBS confirmed to RIJ that his company is encouraging its advisors to become more familiar with indexed annuities—an insurance product whose strong sales in the insurance channel many broker-dealers and wirehouses are no longer able to ignore.

“They recognize that, on the whole, there’s value in that type of product,” Steven Saltzman, of Saltzman Associates, which conducts roundtable discussions where distributors from many different companies can talk frankly about product trends.

“They see indexed annuities as effective vehicles for income riders, and they see a need to educate and inform their advisors about them. Only a few years ago, these advisors were selling against indexed annuities. Now that there are better product choices available, they feel that it’s incumbent on them to provide education.”Three questions from UBS

In an email to RIJ, Crook expressed interest in CDAs, or contingent deferred annuities. These products are a lifetime income rider, sold by an insurance company, which registered investment advisors can wrap around portfolios of mutual funds. If the value of the portfolio goes to zero as a result of withdrawals or market depreciation, the insurer pays a monthly income for life. In essence, the product (sometimes known as stand-alone living benefit or SALB) is a variable annuity guaranteed withdrawal benefit that’s unbundled from the variable annuity.

But the product, championed by Prudential as a way for insurers to sell a product to the annuity-resistant RIA channel but descried by MetLife as a source of uncontrollable risk, has been slow in coming to market. (See ARIA Retirement Solutions, as an exception.) The National Association of Insurance Commissioners has been studying the product to determine whether it is or isn’t an insurance product, and how it should be regulated. 

© 2015 RIJ Publishing LLC. All rights reserved.

Are the Bears Crying Wolf?

Remember protractors? Those six-inch plastic half-moons that helped you pass high school geometry? I still have one, and it helps me decide if stocks are overvalued. That’s right. When the angle of the rise in the S&P 500 Index exceeds 67.5%, I back away from equities.  

Call it “poor man’s technical analysis.”

When this homespun methodology starts telling me that equities are no longer a bargain, I don’t necessarily sell shares; I just stop buying more. To be sure, I’ve missed more than half of the current rally. But I don’t feel terribly alone, because serious technical analysts seem to share my belief that stocks are too dear.   

Chart watcher Brad Lamendorf, for instance, is chief information officer at the Lamendorf Market Timing Report and sub-advisor to the Advisor Shares Ranger Equity Bear Exchange Traded Fund. In the February issue of his report, he writes, “At the present time EVERYTHING is overvalued.” Protractor

“From a historical perspective,” Lamendorf concludes, “equity markets are exceedingly expensive. Investors have become far too over-confident, as evidenced by the sentiment gauges highlighted in this issue of LMTR.”

Of course, bear fund advisors like Lamendorf, John Hussman and others have been calling for a crash for many months or even years. But when I showed Lamendorf’s charts to Doug Short, a technical analyst who writes the Financial Life Cycle blog at AdvisorPerspectives.com, he didn’t dismiss Lamendorf as just another bear crying wolf.

“[Lamensdorf’s] conclusions match spot-on the conclusions I reach in the indicators I track monthly,” Short told RIJ this week. “An amplifying concern I have is the magnitude of margin debt. The concern is that we could potentially see a sudden liquidity problem in the event of a major downside shock.”

Jim Otar, a Toronto-area advisor, writer and creator of the Retirement Optimizer, takes it for granted that we are headed for a setback, but he doesn’t know when it will occur. “I think [equities are] a little bit overvalued but not stratospheric considering where bond yields are and current, excessive political/social risk present throughout the rest of the world,” Otar told RIJ. “I am sure there will be some correction of 20%-40% some time during the next three years, but that is nothing unusual.”

Lamensdorf’s lament is based on his observations of three ratios: the equity-price-to-sales ratio, the ratio of enterprise-value-to-EBITDA (earnings before interest, taxes, depreciation and amortization), and “Tobin’s q,” the ratio of the market value of a company’s productive assets to the cost of replacing those assets at current prices.

Those three ratios are at their second-highest levels ever—second only to levels seen just before the millennial tech crash, he writes. The price to sales ratio is 1.7, which is second only to the 2.1 registered in 2000, the enterprise value to EBITDA ratio is also at its second highest level, after 2000, at 11.5. Tobin’s q is 1.09—its highest level since peaking at more than 1.6 in 2000.

All of which tells him that the market is overripe. Short’s measurements point to the same conclusion. “Based on the latest S&P 500 monthly data, the market is overvalued somewhere in the range of 60% to 94%, depending on the indicator, down slightly from the previous month’s 61% to 96%,” he wrote on February 4.

“Overvaluation would be in the range of 73% to 105%, little changed from last month’s 74% to 106%. At the end of last month, the average of the four [indicators I use] is 77%, off its 80% average last month, which topped two standard deviations above the mean and was the highest average outside 46 months during the Tech Bubble from September 1997 to July 2001.”

Margin debt is one of the things that Short looks at, and his charts show that it is at all-time highs, in real terms. It spiked in March 2000 at about 280% of its 1995 value, at about 330% of its 1995 value in July 2008, and it peaked at about 360% of its 1995 value in February 2014. In current dollars, New York Stock Exchange margin debt is now just below its February 2014 zenith, at about $450 billion. 

“Leverage on the NYSE continues to hit daily highs, reinforcing the complacent nature of the market,” Short told RIJ in an email. “In our opinion, when the market turns downward its force will be swift.”

Technical analysis may or may not be valid, but it’s difficult to rely on fundamentals at a time when, as Short writes, “the markets [are] largely driven by the… Federal Reserve,” or when stock buybacks may be distorting the market indices.

Writes Lamendorf, “Earnings are being artificially manufactured rather than growing organically. Instead of funding [rising pension] liabilities, corporations have been manipulating their balance sheets by creating corporate buybacks to bolster earnings-per-share, thereby directly manipulating the PE.”

Another keen market watcher is Charles Biderman, chairman of TrimTabs Investment Research and portfolio manager of the TrimTabs Float Shrink ETF. He has been keeping track of stock buybacks.

“A lot of people think there’s a relationship between the market and the economy. But in the stock market, there’s just shares,” Biderman told RIJ. “Since 2011, the share count has been falling. As the total number of shares goes down, there’s more money chasing fewer shares. Share prices go up. There is no sustainable economic growth absent all of these tweaks and twinges.”

Biderman brushed aside suggestions that cheap money might be fueling stock buybacks or contributing to the near-record amount of margin debt, but he believes that low rates have fostered bubbles in, say, commodities. “When you cut interest rates to zero, products that you have to borrow money to buy become cheaper, and demand is pulled forward by the price cut. If Janet Yellen raises rates, the economy will crater,” he said.

We all know that market timing is a loser’s game and that the market is theoretically efficient. But if you’re a Boomer on the cusp of retirement and your vulnerability to sequence-of-returns risk is at or near its peak, statistics and statements like this can’t help but give you pause.

If stocks are in fact highly over-valued, this might be the right time to sell some long-held shares and start funding, say, a flexible-premium deferred income annuity. Annuity yields may be low, but you’ll be paying for your contract with arguably over-valued equities. 

This just in: The Treasury Department’s Office of Financial Research issued a bulletin on February 26 entitled, “Volatility Returns Amid Oil Price Declines, European Developments.” It said in part: 

“In Q3 2014, analysts had forecast 2015 earnings growth of approximately 12%; the current consensus estimate is 4%, while revenues are expected to remain flat. The principal cause of this change is the decline in oil prices, and its sizable impact on energy firm earnings. The other main cause is the stronger U.S. dollar, as roughly one-third of U.S. corporate profits are earned overseas. Meanwhile, earnings results from Q4 2014 have been mixed.

“Despite the markdown in expected earnings, broad U.S. equity prices remain near all-time highs. The forward price-to-earnings ratio is at 17, the highest since 2002 (Figure 6), while the cyclically-adjusted price-to-earnings ratio is highly elevated at 27.

© 2015 RIJ Publishing LLC. All rights reserved. 

Lockheed Martin pays $62 million to settle 401(k) fee suit

The last of the first wave of excessive fee lawsuits filed on September 11, 2006 in what many dubbed the “Schlichter Blitzkrieg” has been settled. On the eve of trial in December, the parties in Abbot v. Lockheed Martin agreed to the settlement in principle to avoid trial and now the terms of the settlement have finally been made public.

Lockheed Martin has agreed to pay $62 million and implement extensive affirmative relief. According to the settlement agreement, Schlichter, Bogard & Denton will request up to $20,666,666 in attorneys’ fees and reimbursement of up to $1,850,000 in costs, all to come out of the settlement amount above. The plaintiffs had alleged that the fiduciaries to the Lockheed Martin 401(k) plans cause the plans to pay excessive administrative fees and that the fiduciaries had imprudently managed the money market fund and company stock fund.

The affirmative relief agreed to is as follows:

(1) to publicly file with the Court the annual Department of Labor filing that discloses fees paid by the Plans (known as Schedule C to Form 5500) as well as information about the assets held in, and performance of, the Stable Value Fund and the Company Stock Funds;

(2) to confirm current limitations on the amount of cash equivalents held in the Company Stock Funds and the amount of money market equivalent assets held in the Stable Value Fund, and to file a notice with the Court if those limitations are changed;

(3) to initiate a competitive bidding process for the Plans’ recordkeeping services for the Plans, and to publicly file with the Court a notice identifying the entities that submitted bids and the selected recordkeeper;

(4) to offer participants the share class of investments that has the lowest expense ratio, provided that the share class is available and consistent with the needs and obligations of the Plans; and

(5) The terms of the Settlement will be reviewed by an independent Fiduciary.

Our Thoughts

This is the single largest settlement of an excessive fee case against one employer to date. As we’ve written about before, the substantive decisions have been swinging in favor of plan participants in recent years. If that continues, this will not be the last settlement and I would imagine we could even see a higher settlement amount.

The post Lockheed Martin Settles Excessive Fee Lawsuit for $62 million appeared first on Fiduciary Matters Blog.

 

Rising sales of “medically underwritten” group annuities reported in UK

A handful of UK life insurers are enjoying a boomlet in sales of “medically underwritten” group annuity contracts to defined benefit pension plan sponsors. Sometimes called “impaired annuities,” these contracts cost less than conventional group annuities because the pricing reflects the annuitants chronic health problems—such as diabetes, cancer or risk factors for cardiovascular disease, such as smoking, high blood pressure and obesity.

Sales of medically underwritten insurance contracts in the UK reached nearly £600m in 2014, with close to three-quarters of deals being completed in the final quarter, according to UK consultancy Hymans Robertson. Only £91m worth of such deals occurred in 2013, when the first medically underwritten transaction took place.

The market for these specialty annuities is expected to grow to £1.5bn (€2bn, $2.6bn) by the end of 2015, IPE.com reported this week. These sales are helping offset the decline in sales due to the termination of government-mandated annuity purchases with qualified savings, which takes effect in April. Click here for information on medically underwritten bulk annuities.

These recent medically underwritten deals have been pension “buy-ins.” Unlike pension “buyouts,” like the one that Prudential and MassMutual just agreed to with Kimberly-Clark in the U.S., and which transfer all responsibility for the pension to the insurer(s), a buy-in allows the plan sponsor to hold the annuity as a plan asset but shifts longevity, inflation and investment risk to the insurer.

Four UK insurers offer medically underwritten group (“bulk”) annuities: Aviva, Just Retirement, Legal & General, and Partnership, with Partnership and Just Retirement doing the majority of business.

Just Retirement has seen its annuity sales decline only 4%, event though the UK government has stopped requiring most retirees to annuitize their defined contribution savings by age 75. The company said it offset the decline in individual business with a 39% increase in bulk annuity sales, with total business peaking above £660m.

Overall, the bulk annuities market—of which medically underwritten is a tiny fraction—grew significantly over the last year. The reason: it’s cheaper for the plan sponsor to use a buy-in than to try and match its payment liabilities with UK Gilts (the British counterpart to U.S. Treasuries), because of the competitive market and rising Gilt prices.

A Hymans Robertson partner, James Mullins, said the number of bulk annuity deals completed in 2014 stood at an estimated 180, of which 22 were medically underwritten. In terms of value, the medically underwritten market accounted for just 5% of all deals. Mullins said that, in his firm’s experience, medically underwritten buy-ins were pricing around 5% below traditional contracts.

© 2015 RIJ Publishing LLC. All rights reserved.

Borzi Needs to Appreciate Retail Distribution More

The debate over the Department of Labor’s supposedly imminent re-proposal of its “fiduciary” or “conflict of interest” rule has been bothering me, almost tormenting me, since someone leaked the now-famous White House memo a couple of weeks ago. It’s a conundrum.

Let’s look at it from the DoL’s point of view. The regulators are alarmed that financial intermediaries are steering rollover IRA owners into retail products and services that are much more expensive than the ones they received as participants in ERISA-regulated employer-sponsored retirement plans.

Sure, the investments are more expensive. But why? They’re often most expensive when the costs of distribution are embedded in the fee structures. In the case of certain variable annuities share classes, for instance, the insurance carrier earns back the one-time commission it pays for distribution by charging the client a big annual mortality and expense risk fee.

The DoL might therefore be misidentifying the problem. It seems to be acting on the presumption that manufacturer incentives are causing intermediaries to steer rollover IRA owners into expensive investments. If that’s true, the solution might appear to be to ban the incentives. But it might not be true. Or it might be true for reasons that the DoL doesn’t appreciate.

The real problem might simply be that it is much more expense to distribute financial products and services to individual IRA owners than it is to distribute to participants in retirement plans. Since individuals are clearly averse to paying the cost of distribution directly, the intermediaries sell them products whose expenses include the distribution costs.

If that’s true, a strict new DoL proposal, if it becomes the law of the land, could destroy a system—flawed but functional—that finances the distribution of financial products and services to millions of middle-income Americans, leaving a vacuum in its place. This, in fact, is what the financial services industry seems to argue.

Unfortunately for the industry, it doesn’t have a foundation of trust on which to build its case. It has become an over-compensated, entrenched vested interest, and it has pretended that sales and distribution costs are “advice” or “active management” to better justify them. To hide its conflicts of interest, it sacrifices transparency. In some cases, the incentives themselves are high enough to inspire corruption or attract corrupt people.

So the argument over whether there should be a fiduciary standard or a suitability standard misses the point. This is about the cost of distribution, not about ethics. Maybe we should think of ways to make sales and distribution (and advice and asset management) nearly as efficient in the retail rollover world as they are in the wholesale institutional world.

But wait. Using the Internet, that’s what Fidelity, Schwab, Vanguard, the ‘robo-advisors,’ the latest advisor platforms and services like Hueler’s Income Solutions are already trying to do. Digital technology will have a much bigger impact than regulation.

© 2015 RIJ Publishing LLC. All rights reserved.

The Fed Stays in ‘No Man’s Land’

Based on the newly-published minutes of the Federal Reserve Board of Governors January 27-28 Open Market Committee meeting, the Fed “is not sounding like an institution that is ready to raise its benchmark interest rate in June,” a New York Times article said today.

Which means that the Fed’s policy of keeping prevailing interest rates very low by buying securities—a policy that in 2009 one insurance executive told RIJ his company could tolerate for about five years—will move into its seventh year.

Here are a few relevant excerpts from the minutes:

  • “Many participants indicated that their assessment of the balance of risks associated with the timing of the beginning of policy normalization had inclined them toward keeping the federal funds rate at its effective lower bound for a longer time.”
  • “Many participants regarded dropping the “patient” language in the statement… as risking a shift in market expectations for the beginning of policy firming toward an unduly narrow range of dates. … Some expressed the concern that financial markets might overreact, resulting in undesirably tight financial conditions.”
  • “The Committee agreed to maintain the target range for the federal funds rate at 0 to 1⁄4 percent and to reaffirm the indication in the statement that the Committee’s decision about how long to maintain the current target range for the federal funds rate would depend on its assessment of actual and expected progress toward its objectives of maximum employment and 2 percent inflation.”
  • “The Committee also decided to reiterate its expectation that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run.”

The Fed’s policy has buoyed the stock market by allowing investors to borrow cheaply to invest in equities and by assuring investors that any change in rate policy will be gradual and telegraphed in advance. It has helped bondholders by keeping the prices of existing bonds of questionable value high.

But it has also driven up the cost of retirement dramatically. It has been a disaster for near-retirees and retirees who were hoping to get decent yields from safe investments in certificates of deposit, fixed-rate annuities, municipal bonds, Treasury bonds and income annuities. It has also been fatal for some pension funds, hiking their degree of underfunding overnight. No Mans Land Posterj

The silver lining in the Fed’s playbook, for Baby Boomers on the verge of retirement, is that the low-interest policy has helped maintain the value of the equity investments that represent a large chunk of their savings. But that’s arguably cold comfort. There’s a lot of risk implicit in the stock market these days and, in the opinion of some, not much risk premium left.

If the Fed raises rates, will the stock market move down? Will a small downward movement in the stock market trigger margin calls, distressed sales and even lower prices? To me, those are the important questions. Some experts say this isn’t how the equity prices and interest rates interact. If not, why does The Street get conniptions when the Fed hints at an end to quantitative easing?

My nightmare scenario is that when rates go up, equity prices will fall, and millions of Boomers will wish they’d sold their stocks at the peak and bought income annuities with the proceeds.

In 2001, a tense anti-war movie about the Bosnian conflict, called “No Man’s Land,” presented a lose-lose situation where the combatants on one side have booby-trapped the body of a fallen enemy soldier with a powerful land mine. The mine is set to explode when the soldier’s comrades, having retreated, return and attend to his body.

But the booby-trapped soldier was merely unconscious, not dead. When his comrades come back, they can’t help him, because moving him will trip the mine and kill the rescuers. A TV crew films the scene, and the media falsely reports that the soldier has been saved. The movie ends with the fully conscious soldier alone and abandoned with a land mine on his chest.

The Fed’s dilemma—our dilemma—somehow recalls that movie. 

© 2015 RIJ Publishing LLC. All rights reserved.

Prudential and MassMutual in Deal to De-Risk Kimberly-Clark Pension

Another S&P 500 company has taken steps to de-risk its defined benefit pension plan, and Prudential, this time in partnership with MassMutual, has bagged another billion-dollar pension risk transfer deal.

Kimberly-Clark, the $21 billion maker of Kleenex tissues, Huggies diapers and Scott toilet paper, among other consumer products, has announced the purchase of group annuity contracts from The Prudential Insurance Co. of America and MassMutual Life.

Existing Kimberly-Clark DB pension assets, a 2015 contribution to the plan of $100 million, and an anticipated $400 to $475 million debt-financed addition to pension plan will financed the annuities. Responsibility for paying retirement pension benefits to about 21,000 U.S. retirees will shift to the two insurers.

The move will reduce Kimberly-Clark’s projected pension benefit obligation by about $2.5 billion, the Irving, Texas-based paper products giant said in a release. While Prudential will be the annuity administrator, Prudential and MassMutual will each pay half of each retiree’s benefit. Kimberly-Clark products image

Prudential has been a leader in the pension risk transfer business, executing deals with General Motors, Verizon in the past, and signing agreements in 2014 to annuitize the pension assets of Motorola Solutions and pharmaceutical giant Bristol-Myers Squibb.

The Newark, NJ-based insurer has also done longevity risk insurance deals with firms in the U.K. A Bloomberg report last fall quoted MetLife CEO Steven Kandarian as saying that MetLife has bid on pension risk transfer deals but at the same time is hesitant to take on long-term liabilities.

“MetLife and Prudential are the largest companies who have been aggressively bidding for pension risk transfer, and Prudential has won all of them. Prudential is evidently underpricing MetLife, but it’s very difficult to tell the risk in their pricing because the disclosure is so poor. Are they underpricing to gain market share?” Rob Haines, senior insurance analyst at CreditSights in New York, told RIJ.

“This is not necessarily a bad business to be bidding on, but it’s inherently risky, especially with the low rate environment. The question is, can they earn sufficient income to cover the liabilities associated with these deals? It’s hard to say, given the lack of disclosure. With insurance companies, you get a lot of exposure about assets. They tell you the CUSIP of every asset they own. But from the liability perspective you get very little,” Haines added.

“MassMutual’s capacity to take on this risk is better than Prudential’s, because it’s a mutual company and its overall risk profile is lower. Whether these are good decisions or bad decisions, we won’t be able to judge for several years,” he said.

The Dallas Business Journal reported this week that in 2014, Kimberly-Clark had about $6 billion in pension assets and $7 billion in total pension obligations. “The $2.5 billion in savings may help buoy the company’s financials after Kimberly-Clark reported net income of $1.52 billion for full year 2014. That’s down 29% from $2.14 billion in 2013, primarily due to currency fluctuations in Venezuela,” the newspaper reported.

Prudential will begin making benefit payments and providing administrative services to the affected retirees on June 1, 2015, according to the release. Retirees will receive the same monthly benefit they received from Kimberly-Clark. 

The decision to use two insurance companies was driven by fiduciary and risk-management concerns. State Street Global Advisors (SSGA), representing the interests of the affected retirees as the independent fiduciary, determined that a transaction split between Prudential and Mass Mutual was the safest available annuity structure to provide retiree benefits.   

As a result of the annuity purchases, Kimberly-Clark expects to recognize a non-cash pension settlement charge of $0.8 billion after tax ($1.3 billion before-tax) in the second quarter of 2015. This charge will be excluded from the company’s 2015 adjusted results.

Deutsche Bank and Towers Watson served as strategic advisors to in this transaction.

Other DB sponsors eye annuity purchases

Almost two-thirds of defined benefit (DB) plan sponsors surveyed expect to act in 2015 to curb Pension Benefit Guaranty Corporation (PBGC) premium costs down the road, with most likely to elect settlement strategies, according to a new report from benefits consultant Aon Hewitt.

Of defined benefit (DB) plan sponsors surveyed by Aon Hewitt:

  • Nearly one-quarter (22%) are very likely to offer terminated vested participants a lump sum window in 2015.
  • 19% of employers plan to increase cash contributions to reduce PBGC premiums in the year ahead
  • 21% are considering purchasing annuities for a portion of their plan participants.

“A growing number of plan sponsors anticipate increasing pension plan costs due to recent changes to the Society of Actuaries longevity models and rising PBGC premiums,” said Ari Jacobs, Aon Hewitt’s Global Retirement Solutions leader, in a release.

More than one-third (36%) of pension plan sponsors said they are “increasingly adjusting plan assets to match liabilities.” Another 31% are “very likely” to do so in the year ahead.

“Pension plan sponsors… are taking actions now to better position themselves to manage volatility in their pension plans,” said Rob Austin, director of Retirement Research at Aon Hewitt.

In other survey findings:

  • 74% of the companies surveyed have a DB plan; Of those:

    • 35% have an open, on-going pension plan
    • 34% have a plan that is closed to new hires
    • 31% have a frozen plan
    • 45% of companies surveyed recently conducted an asset/liability study. Of those that haven’t, 25% are somewhat or very likely to in 2015.
    • 18% of companies performed a mortality study in 2014; 10% plan to do so in 2015.
    • 26% of companies currently monitor the funded status of their plan on a daily basis, up from12% in 2013.

© 2015 RIJ Publishing LLC. All rights reserved.

A product that ‘no one likes’ sold over $235 billion in 2014

Record sales of indexed and income annuities helped raise overall annuity sales volume to $235.8 billion in 2014, a three percent increase over the previous year, according to LIMRA Secure Retirement Institute’s Fourth Quarter 2014 U.S. Annuity Sales Survey.

Fourth quarter annuity sales were $58.1 billion, 6% lower than in the fourth quarter of 2013. The drop was attributed to lower interest rates.

LIMRA 4th quarter 2014 annuity sales

While variable annuities still accounted for about 60% of total annuity sales in 2014, VA premiums fell 4%, to $140.1 billion—their lowest annual sales since 2009. VA sales, which occur mainly in the federally regulated broker/dealer channel, were $34.2 billion in the fourth quarter, down 6% percent from prior year.

Indexed annuity sales, which are sold in the state-regulated insurance channel, reached $48.2 billion in 2014, up 23% ($9 billion) over 2013, accounting for more than half of all sales of fixed annuities for the first time. Indexed annuity sales were $12.2 billion in the fourth quarter, up three percent from the year-ago quarter.

Overall fixed annuity sales were $95.7 billion in 2014, up 13% from 2013. In the fourth quarter, total fixed annuities fell 5%, to $23.9 billion.

Immediate income annuity sales rose 17% in 2014, to $9.7 billion, but fell 12% in the fourth quarter, to $2.3 billion, compared to the fourth quarter of 2013. LIMRA Secure Retirement Institute analysts attribute the fourth quarter decline to lower interest rates.

“In the run up to the fourth quarter of 2013 interest rates were trending upward, reaching over 3% at year-end,” a LIMRA release said. “In the fourth quarter of 2014, [benchmark] interest rates dropped a third of point, falling to 2.17% at the end of 2014.”

Sales of deferred income annuities (DIAs) reached a record $2.7 billion in 2014, a 23% gain from 2013. Like immediate annuities, DIAs suffered from falling interest rates in the fourth quarter. DIA sales were $680 million in the fourth quarter 2014, 4% below 2013.

Sales of fixed-rate deferred annuities (Book Value and MVA) rose one percent in 2014, to $29.7 billion.  Fixed-rate deferred annuity sales fell 14% in the fourth quarter, to reach $7.3 billion.

Top twenty rankings of total, variable and fixed annuity writers will be posted in mid-March after the last earnings call of survey participating companies. LIMRA Secure Retirement Institute’s fourth quarter U.S. Individual Annuities Sales Survey represents data from 96%.

© 2015 RIJ Publishing LLC. All rights reserved.

Bird? Plane? No, It’s a New MetLife VA Rider

MetLife has recovered some of its appetite for variable annuities. The giant publicly-held insurer is hoping that an innovative new VA living benefit rider, called FlexChoice, will help it increase its overall retail annuity sales by about 50% in 2015.

“We’ve been in the variable annuity business for a long time of course, but we had a de-risking and, since then, we’ve focused on designing a product that was more competitive,” Elizabeth Forget, the executive vice president of MetLife’s Retail Retirement and Wealth Solutions business, told RIJ in an interview this week. “We are ready for growth again, in a measured way, in a way that meets our profitability and capital requirements.”

“We’ve stated publicly that our goal for 2015 is to increase total retail annuity sales by at least 50%,” she added. “We sold $8.2 billion in 2014. We believe that a lot of that growth will come from [FlexChoice], along with the Investment Portfolio Architect investment-only variable annuity and our product with Fidelity, which has a GMAB [guaranteed minimum accumulation benefit] rider.”

After leading all life insurers with more than $20 billion in retail annuity sales in 2011, MetLife decided to pull back. According to LIMRA’s third-quarter 2014 annuity sales report, MetLife ranked eighth in fixed annuity sales at $2.1 billion and $4.74 in variable annuity sales.

FlexChoice doesn’t require purchasers to choose between single or joint life coverage at the time of issue. Most VA contracts create a dilemma for couples, forcing them to pick either the higher benefits and lower costs of single coverage and sometimes requiring them to guess which spouse will live longer. With FlexChoice, singles and couples (as long as the spouse are no more than 10 years apart in age) pay the same fee for the rider and get the same payout rate when the income period begins. Flexchoice investment chart

The decision to choose single or joint-life coverage comes later. If and when the account value goes to zero and the contract is in-the-money, and both spouses are alive, they must accept a lower payout rate if they want guaranteed income for as long as both are living.

“When we were designing this product, our research and showed that people are looking for flexibility. The fact that people had to decide at issue whether they wanted single life or joint life was very restrictive, because you have the lower income and higher fee if you pick joint coverage,” Forget told RIJ.

“With this product, they can take income at a level they want for either one or two lives. Later, if and when the account value goes to zero and the MetLife benefit kicks in, then they can decide whether to take it for one or two lives.” Contract owners who use FlexChoice get a conditional account balance guarantee: They can lapse the rider on the fifth or tenth anniversary, or any subsequent anniversary, and get at least their premium back.

For people who want flexibility in the size of their income stream, FlexChoice offers two payout regimes, “Level” and “Expedite”. For people who start withdrawals between ages 65 and 75, for instance, “Level” payouts start at 5% then drop to 4% for joint coverage if the account zeroes out. “Expedite” payouts start higher—at 6% for both singles and couples—but if the account goes to zero before the contract owners reach age 80, the new single rate is 4% and the new joint life rate is 3%. (The age of the older spouse is used when determining age of first withdrawal.)

Roll-ups were and remain a key driver of sales of variable annuities, and FlexChoice offers a 5% compound increase in the benefit base (the notional amount to which the withdrawal percentage is applied) for the first 10 years (in years when no withdrawal is taken). That’s well below the double-your-money-after-10-years pre-financial crisis offerings. But clients like to think of a roll-up as a guaranteed growth rate—though the two are not comparable—and 5% sounds like an oasis in the ongoing yield drought.  

Given the cost of this product and the restrictions on investments, contract owners aren’t likely to see benefit base gains in excess of 5%. Although the FlexChoice offers optional step-ups when the account value reaches a new high on a contract anniversary, few accounts are likely to grow fast enough to overcome both the expense ratio (about 4% all-in) and the 5% annual roll-up.

The FlexChoice rider fee is 120 basis points. That goes on top of a 105 basis-point mortality and expense ratio for the MetLife variable annuity contract, a 25 basis-point administration charge, an optional 65 basis-point FlexChoice death benefit and fund fees that range from 52 to 190 basis points. Assuming an average fund fee of 100 basis points, the whole package costs over 4% a year.  

Even with that level of fees, a contract owner doesn’t have complete investment freedom. He or she must invest at least 80% of the contract assets in a combination of managed-risk funds, and the remainder in balanced funds. The combination of insurance fees and reduced-risk funds creates two levels of risk mitigation for the issuer and two hurdles to appreciation for the contract owner.  

“We have heard the ‘belt and suspenders’ objection from advisors, so we made the investment restrictions a bit more flexible,” Forget told RIJ. “We tried to do whatever we could, but it’s very expensive to offer these guarantees. We also try to make it as clear as possible that these funds are meant to be more conservative.” MetLife has a third level of risk mitigation available for FlexChoice contracts: On new contracts, it can reduce the roll-up rate or the withdrawal rate during periods of market stress.

It’s interesting to compare the anticipated income rates from the new FlexChoice rider to the latest payout rates for the deferred income annuity that MetLife introduced in 2014. The payout from the MetLife DIA for a 65-year-old couple with a $100,000 premium and a 10-year deferral rate is currently $882 a month for the lives of both spouses, according to Cannex.

If the same couple invested the same premium and chose the same deferral period for a MetLife VA with FlexChoice, the premium would compound to at least $162,900 in 10 years. It would pay out $814 a month for life under the Expedite option but only $679 a month under the level payment option. If account zeroed out before both spouses had died, income for both lives would drop to $407 under the Expedite option and about $340 a month under the level option.   

Difference clients and advisors place different values on the added liquidity that’s available under a VA contract. Some will prefer the higher income of the DIA; others will choose the flexibility of the annuity. By offering a range of products, MetLife reduces the likelihood that potential clients will ever need to go elsewhere to find what they need.

“MetLife is committed to the retirement space. Americans need help with retirement,” Forget said. “But we’re still focused on our core strategy, which includes growth overseas and reduced reliance on capital-intensive products. Our strategy has evolved and we feel good about where our annuity business is.”

© 2015 RIJ Publishing LLC. All rights reserved.

Questions & Answers about: Medicaid Annuities

What is a Medicaid annuity, exactly? A Medicaid-compliant annuity is a “restricted” period-certain annuity that couples can use if one of them is going into a Medicaid-covered nursing home. The healthy spouse can buy a payout annuity with assets that would otherwise have to be spent before the patient could qualify for Medicaid nursing home coverage. The income from the annuity does not count as income for Medicaid purposes. 

Who uses Medicaid annuities? The typical clients are in their 70s or 80s, with $200,000 to $300,000 in savings, according to Michael Denton, COO and president of Clarke Financial Group, an Irvine, Calif.-based insurance marketing organization. “They are at the point where they didn’t buy long-term care insurance and they have no other means to pay for long-term care costs,” he told RIJ. When one spouse enters a nursing home, the care without insurance might cost $7,000 to $9,000 a month. Instead of paying those bills with savings, “they can put money into a restricted annuity and start an income payout for the healthy spouse. That income doesn’t count toward Medicaid,” Denton said.

How do they work? As a rule, the Medicaid annuity must be a period-certain contract with the healthy spouse as the owner and annuitant, and the term equal to the healthy spouse’s life expectancy. The healthy spouse is the sole payee and state Medicaid department is the primary beneficiary. If the healthy spouse dies before the annuity term is up, the state would recover its costs from the remaining assets and the balance, if any, would go to secondary beneficiaries.

“This saves the healthy spouse from being destitute,” Denton said, with no assets other than the amount allowed by the state. For example, a wife with $230,000 in assets might live in a state where she can keep up to $120,000 for herself without disqualifying her husband, who is in a nursing home, from Medicaid. If she uses the excess $110,000 to purchase a Medicaid annuity, she would receive a monthly income for the length of the term and her husband would qualify immediately for Medicaid nursing home coverage.  

Why are Medicaid annuities important? “It’s making more and more sense for a lot of people,” Denton said. “A lot of people have never had the opportunity to buy, or just never bought, long-term care insurance. The saddest part is that people accumulate what they consider a lot of money and they watch it disappear when a spouse needs long-term care. No one thinks it’s going to happen to him or her. This is an opportunity to protect assets and protect the healthy spouse.”

What pitfalls should advisors and clients look out for? “It’s always important to use a local eldercare attorney in this process,” Denton said, “because each state has different nuances. When there are any problems, it’s usually when an advisor sells an ordinary immediate annuity to the couple and not a restricted one. With the new rules [from the Deficit Reduction Act of 2005] you have to name Medicaid as the beneficiary. The income has to be actuarially sound and payments must be made in equal amounts—no deferral or balloon payments.”

“This can only be done as the ill spouse is entering or is already in the nursing home,” he added. “It doesn’t work to do in an advance. In the past, there were insurance agents who would say, ‘Buy this immediate annuity because it will help you qualify for Medicaid in the future,’ but that didn’t work. But an eldercare attorney can do the planning in advance and have the restricted annuity start on the same day that the person goes into the nursing home. That’s the best of all possible worlds.”

Who sells Medicaid annuities? Only a handful of U.S. insurance companies are reported to sell Medicaid annuities. They include Allstate, Allianz Life, ELCO Mutual Life & Annuity, Genworth Financial, Nationwide and MetLife. 

Medicare and Medicaid nursing home care

© 2015 RIJ Publishing LLC. All rights reserved. 

U.K. life insurers to suffer as forced annuitization ends

Last spring, the British government officially ended the nation’s mandatory annuity purchase policy, and the effects are expected to become evident as UK life insurers begin reporting their 2014 results in the coming weeks.

Britain’s Chancellor of the Exchequer, the equivalent of our Treasury Secretary, last year surprised the life insurance industry with plans to end the policy of requiring many workers to buy a life annuity by age 75 with any remaining money in their tax-deferred defined contribution savings accounts. The new policy goes into effect this April.

Many working-class Britons simply bought a life annuity at retirement age from their DC plan provider, without even shopping for the best price on an exchange, and the annuity sales were a big source of income for insurers. (The law allowed for some flexibility. People who could demonstrate that they weren’t at risk of outliving their money generally had more leeway in the disposal of their tax-deferred savings.)

The disappearance of that requirement now threatens what was a £12 billion ($18.55 billion) market.  Even though the changes don’t take effect for several weeks, some annuity providers told Reuters a few months ago that sales were down 50% to 60%. Analysts estimate the drop off could now be more than 80%.

The major life insurers are expected to be profitable, according to Thomson Reuters data, but profits at Aviva, Friends Life and Legal & General are expected to be flat year-over-year instead of rising. Profits at annuity specialist Partnership Assurance are seen taking a sharp hit, according to the data.

Insurers and asset managers say the proposals do create opportunity for new product sales, such as “drawdown pensions enabling pensioners to decide how much they want to withdraw each year.” But those products are not as profitable as life annuities.  

“An annuity is about 10 times as profitable as a pension,” Gordon Aitken, analyst at RBC, told Reuters, adding that the changes could take a few years to have a deep impact on profits. The changes are likely to reduce the industry’s aggregate profit potential, according to Credit Suisse analysts.

Those hardest hit are expected to be annuity specialists such as Partnership Assurance and Just Retirement. There’s been speculation that the two private equity-backed firms might be put up for sale. Partnership Assurance reports its results on March 3. Just Retirement issues half-year results on Feb 24. Aviva took action to strengthen its position with the $8.8 billion planned acquisition of Friends Life late last year. These two firms report annual results on March 5.

L&G is increasing its focus on bulk annuities, taking on the risk of defined benefit corporate pension schemes, and this month entered the market for lifetime mortgages. Standard Life, which just purchased the financial advisory firm, Pearson Jones, reports annual results this Friday. Prudential plc, owner of Jackson National Life in the U.S. (and no relation to Prudential Financial), which has a stronger focus on Asia than on Britain, is due to report on March 10.

© 2015 RIJ Publishing LLC. All rights reserved.

Giant banks are “systemically-important” for different reasons

Five of the eight U.S. banks that are considered globally systemically-important (G-SIB)— Citigroup, JPMorgan, Morgan Stanley, Bank of America, and Goldman Sachs—have high “contagion index” values, according to a new report from the Treasury Department’s Office of Financial Research.

A bank’s contagion index indicates the likelihood that its financial problems might infect other banks. The contagion index combines what the paper called a “connectivity index” with a bank’s size and leverage levels. According to the report:

  • The higher the bank’s leverage, the more prone it is to default under stress
  • The larger it is, the greater the potential spillover if it defaults
  • The greater its connectivity index, the greater is the share of the default that cascades onto the banking system

Of the eight U.S. G-SIBs (those named above plus Bank of America, Bank of New York Mellon and State Street), seven had high financial connectivity index values, the paper said. Bank of New York Mellon and State Street were high on both dimensions despite their relatively smaller sizes.

A bank that has large foreign assets and large intrafinancial system liabilities is a potential source of spillover risk, according to the paper. Five banks had large foreign assets (exceeding $300 billion) and Citigroup and JPMorgan had large figures for both foreign assets and intra-financial system liabilities. Four of the six largest banks were net borrowers from the financial system. Bank of New York Mellon and State Street, which run large securities lending businesses, had large negative net positions.

Over-the-counter derivatives positions, which contribute to the complexity of the financial system and helped trigger the financial crisis of 2007-2008, were particularly high at Morgan Stanley and Goldman Sachs. Morgan Stanley’s positive OTC derivatives values accounted for almost 30% of its total exposures, the paper said. For Goldman Sachs, the figure was about 15%. 

Banks can also become systemically important if they dominate a specific business sector. Bank of New York Mellon Corp., State Street Corp., and Northern Trust Corp. (NTRS) have large operations as custodian banks. Goldman Sachs and Morgan Stanley have large underwriting businesses. Deutsche Bank Trust (DB), a U.S. subsidiary of the largest German bank, has a high level of payment activity.  

Although the world’s largest banks satisfy international standards for risk-based capital, including a new capital buffer, they have relatively low leverage ratios (calculated as Tier 1 capital divided by total exposures) compared to smaller banks, according to the OFR paper.   

Last December 9, the Federal Reserve proposed a draft rule implementing the G-SIB buffer for U.S. bank holding companies that could result in some banks holding larger capital buffers than those proposed by the Basel Committee.

The higher the Tier 1 leverage ratio, the more stable the bank. The Tier 1 leverage ratio is calculated by dividing Tier 1 capital ratio by the firm’s average total consolidated assets. The Tier 1 leverage ratio is an evaluative tool used to help determine the capital adequacy and to place constraints on the degree to which a banking firm can leverage its capital base.

[To be adequately capitalized under federal bank regulatory agency definitions, a bank holding company must have a Tier 1 capital ratio of at least 4%, a combined Tier 1 and  Tier 2 capital ratio of at least 8%, and a leverage ratio of at least 4%. To be well-capitalized, a bank must have a Tier 1 capital ratio of at least 6%, a combined Tier 1 and Tier 2 capital ratio of at least 10%, and a leverage ratio of at least 5%.

Capital acts as a buffer or cushion against losses, and the authors of the report say that

higher risk-based capital requirements for the largest global systemically important banks (G-SIBs) “could enhance the resilience of the financial system” by acting as a buffer or cushion against losses.

The report, entitled, “Systemic Importance Indicators for 33 U.S. Bank Holding Companies: An Overview of Recent Data,” was written by Meraj Allahrakha of George Washington University, Paul Glasserman of Columbia University, and H. Peyton Young of Johns Hopkins University.

© 2015 RIJ Publishing LLC. All rights reserved.

Staying married and avoiding nursing homes can trim your retirement shortfall risk: EBRI

America’s overall retirement savings gap is $4.13 trillion for all households headed by those between ages 25 and 64, but the gap per household varies widely depending on factors like gender and marital status, according to the Employee Benefit Research Institute (EBRI).

If Social Security benefits are cut in the future, the aggregate gap will widen. “With the program’s trust fund projected to be exhausted by 2033, the retirement deficit will increase to $4.38 trillion at that time if no additional funding is provided” and Social Security benefits are reduced, EBRI said in a release.

If Social Security were to suddenly disappear this year, the aggregate national retirement deficit would increase by almost 90%, to $7.87 trillion, the research group found. EBRI’s new analysis is based on results from its proprietary Retirement Savings Projection Model (RSPM), and estimates the size of the deficits that households are simulated to generate in retirement, or Retirement Savings Shortfalls (RSS).

Among the study’s findings:

Nursing home expenses create shortfalls. People who live the longest are most likely to need nursing home care; they face retirement shortfalls that are 14.8 times larger on average than those with the shortest lifetimes, EBRI estimates. If projected nursing home and home health care costs are excluded, America’s aggregate RSS would drop by 74%.

Married couples are safest from shortfalls. For those on the verge of retirement (Early Baby Boomers), retirement savings shortfalls vary from $19,304 (per individual) for married households, increasing to $33,778 for single males and $62,734 for single females.

Shortfalls are concentrated in half of households. Less than half of the simulated “lifepaths” modeled by EBRI are considered to be “at risk.” In those situations, the average expected shortfalls for the oldest Boomers are $71,299 (per individual) for married households, $93,576 for single males and $104,821 for single females.

A lifetime of 401(k) participation will help Gen-Xers. The longer they can participate in defined contribution plans, the better off the post-Boomer generation will be in retirement, EBRI data showed. Gen-Xers who never get a chance to work for a company that offers a workplace savings plan face an average expected shortfall of $78,297. That shortfall drops to $52,113 for those with one to nine years of future eligibility, to $32,937 for those with 10–19 years, and to only $16,782 for those with 20+ years.  

The full report, “Retirement Savings Shortfalls: Evidence from EBRI’s Retirement Security Projection Model,” appears in the February EBRI Issue Brief.  

© 2015 RIJ Publishing LLC. All rights reserved.

Citing long-term care exposures, A.M. Best lowers Genworth’s strength ratings

The ratings agency A.M. Best has downgraded the financial strength ratings of three key life/health subsidiaries of Genworth Financial Inc. to A- (Excellent) from A (Excellent) and the issuer credit ratings (ICR) to “a-” from “a”.

The three subsidiaries are Genworth Life Insurance Co. (GLIC), Genworth Life Insurance Co. of New York, and Genworth Life and Annuity Insurance Co. 

A.M. Best also downgraded the ICR to “bbb-” from “bbb” of Genworth and its existing debt ratings by one notch. The ratings had been under review with negative implications since Dec. 18, 2014. The outlook assigned to all ratings is stable.  

Driving the downgrade, A.M. Best said in a release, was the opinion that Genworth’s long-term care insurance (LTC) business “is likely to exhibit volatility going forward due to the limited credibility of claims data (particularly with later-stage claim duration data), the profile of its in-force block and the challenge of achieving regulatory approval for actuarially justified rate increases.”

A.M. Best noted the continued poor performance of the acquired block (i.e., business acquired before 1996). Additionally, roughly one-third of Genworth’s older vintage organically written LTC contracts, amounting to $1.1 billion, have lifetime benefits. (Genworth has slightly more than $2.5 billion of total in-force LTC premium.) A.M. Best believes that it is important for Genworth to take actions to reduce this tail risk, such as policyholders accepting reduced benefits in lieu of higher premiums.

On the plus side, A.M. Best said it “believes future positive rating actions could occur if LTC profitability substantially improves, GLIC’s risk-adjusted capital is maintained at or above current levels and operating performance of the mortgage insurance operations continues to trend favorably.”

But further negative ratings could occur “if a material weakness in internal controls is identified, if GLIC’s risk-adjusted capital falls below A.M. Best’s expectations, or if another significant reserve charge on the in-force LTC block is taken.”

According to the A.M. Best release:

“In the near to medium term, the company is unlikely to experience growth in sales of life insurance, annuities or long-term care, which may pressure operating results in this segment. Genworth may also face additional challenges within the U.S. mortgage insurance (USMI) segment regarding its ability to execute one or more reinsurance transactions to comply with the yet-to-be finalized Private Mortgage Insurance Eligibility Requirements (PMIERs) capital standards.

“While the performance of USMI recently has been trending favorably, it will likely take a few years for the business to contribute significant dividends. Genworth’s Canadian and Australian mortgage insurance operations continue to generate solid cash flows that the holding company will rely on primarily to service its debt obligations.

“As management has committed to refraining from taking dividends from the domestic life/health companies in the near to medium term, A.M. Best will monitor Genworth’s ability to source healthy dividends from the mortgage insurance operations if a sell-down of either Australian and/or Canadian operation is undertaken.

“A.M. Best notes that Genworth plans to allocate new money to slightly lower credit quality assets over the long term. This concern is mitigated by the organization’s seasoned investment management team, its sound risk-adjusted capital position at the life/health entities and good financial flexibility at the holding company, with more than $1.1 billion of cash and liquid assets.

“Additionally, A.M. Best views favorably Genworth’s plans to repatriate the LTC business currently at its Bermuda affiliate, Brookfield Life and Annuity Insurance Company Limited. Moreover, A.M. Best recognizes Genworth’s favorable history of achieving premium rate increases on its in-force blocks.

“The ability of the company to successfully obtain state regulatory approvals for rate actions, achieve expense savings from the corporate consolidation and divest non-core operations and unprofitable blocks of business are key factors driving the firm’s future profitability.

The ratings downgrade followed Genworth’s reporting of fourth-quarter 2014 results, which reflected the substantial completion of its long-term care insurance (LTC) active life margin review. Additionally, management confirmed its intention to conduct a thorough review of Genworth’s businesses, encompassing holding company debt reduction and a multistep restructuring plan to streamline operations.

© 2015 RIJ Publishing LLC. All rights reserved.

Ken Mungan elected Milliman’s chairman of the board

Kenneth P. Mungan, an actuary who led the development of Milliman’s short-futures risk management strategy for variable annuity portfolios and the EvenKeel mutual funds, has been elected chairman of the board of the privately-held global actuarial consulting firm by its principals.

Mungan founded Milliman’s Financial Risk Management practice in 1998, the firm said in a release. That group has become a leading provider of hedging services to the retirement savings industry, working with $140 billion in assets on behalf of insurers, variable annuities, 401(k)s, and retail mutual funds.

Mungan succeeds Bradley M. Smith, who died in October. Smith had announced his retirement prior to his passing, and the chairman selection process was already underway.

In making the announcement, Milliman president, CEO, and interim chairman Steve White said, “Ken Mungan is an innovator and entrepreneur and has built a global consulting practice dedicated to tackling retirement security issues.”  

Founded in 1947, Milliman is among the world’s largest providers of actuarial and related products and services. The firm has consulting practices in healthcare, property & casualty insurance, life insurance and financial services, and employee benefits. 

© 2015 RIJ Publishing LLC. All rights reserved.

At Second-and-Goal in Retirement, What’s Your Play Call?

When the Seattle Seahawks had possession of the football at the New England Patriots’ half-yard line with a minute left in Super Bowl XLIX, their coach had to choose between a safe but predictable play or a risky, less-predictable play—at a point in the game when the wrong move could prove fatal.

In hindsight, the emerald-clad Seahawks chose wrong and lost the game—although no one knows for sure if the risk they took was foolish or calculated, or if the observant Patriot defenders simply read an “unpredictable” play and adjusted brilliantly. 

Retirees and near-retirees who are entering their own personal retirement “red zone” and choosing a portfolio “glide path” are a little like the Seahawks on February 1. At a time when a financial mistake might throw them for a big loss, they have to decide whether to pass (read: stay invested in equities) or run (shift toward bonds) during retirement.

(Of course, for retirees and football teams alike, it depends partly on whether they’re leading or trailing and by how much—but let’s assume they’re somewhere in between.)       

In an article in the February issue of the Journal of Financial Planning, Morningstar’s David Blanchett calculates that most retirees would be better off raising their allocation to bonds during retirement than raising their allocation to stocks—especially if they have a lot of savings and if they hope to leave a bunch of money to charity or heirs. 

Sounds reasonable. But in finance as in football, reasonable people can disagree. Readers of Blanchett’s new paper might notice that it refutes a 2013 Journal article by Michael Kitces and Wade Pfau, in which those two friends and colleagues of Blanchett promoted a rising equity glide path in retirement.  

“Yes, I think it’s a fair interpretation,” Pfau told RIJ when asked if the new Blanchett paper runs counter to his paper with Kitces. “As a general rule of thumb, he concludes in favor of declining glide paths, at least from a starting point of today’s market conditions.”

The Kitces-Pfau article attracted a lot of attention 18 months ago. It contradicted the conventional wisdom that says you should hold your “age in bonds.” It argued that, as a default strategy, equity allocations should briefly drop during early (to minimize exposure to sequence of returns risk in the “red zone”) and then rise steadily.

“The optimal equity exposure for a portfolio over an accumulation/decumulation lifetime may look less like a slow and steady downward slope, and more like the letter U, in which the stock allocation is the lowest at the point when lifestyle spending goals are most vulnerable to absolute losses in wealth (the retirement transition itself), but greater in both the earliest years and also the latest,” they wrote.

That paper inspired Blanchett to test the equities-in-retirement conundrum using a lot more variables than Kitces and Pfau used. “If I ran their analysis with their assumptions, I’d probably get the same results. But I used different assumptions. I assume that interest rates will increase over time. I use a utility model. I incorporate a bequest preference, where they focus on income for life,” he told RIJ.

“Where they tested only two scenarios, I tested over 6,000. And I found that a decreasing equity allocation was best most of the time. But I also found that an increasing glide path was best in about 10% of the scenarios. And I left out things like allocations to annuities. There isn’t one single glide path that’s good in all cases,” he added.

Blanchett considers his results highly robust. He ran 1,000 Monte Carlo simulations (some people might consider 1,000 too few) on the outcomes of various combinations of nine different glide paths, three different average equity allocations over retirement (20%, 40% and 60%), three withdrawal rates (3%, 4% and 5%), as well as different scenarios for inflation, life expectancy, shortfall risk, and importance of residual wealth.

Blanchett also acknowledged the elephant in the room—the Fed’s zero interest rate policy—and assumed that bond yields will gradually rise in the years ahead.  

Which brought him to a conclusion that was different from Pfau’s and Kitces’, though not absolute. “Glide paths where the equity allocations decrease during retirement,” Blanchett’s paper says, “appear to be more efficient when compared to the other three changing glide paths considered, as well as a constant equity glide path.” The strategy of rapidly decreasing equity allocations in retirement turned out to be success in 75.2% of the scenarios considered—the best results of the nine glide paths he tested.

Blanchett tested three different rapidly declining equity paths over a 40-year retirement (80%-40%, 60%-20% and 40%-0%) and three slowly declining equity paths (70%-50%, 50%-30%, and 30%-10%). The 30%-10% and 40%-0% paths were the safest, especially when the withdrawal rates were 4% or 5%. The relatively least-safe path was an increase of equity allocation to 60% from 20% over 40 years, with a 5% withdrawal rate.

Rising equity glide paths were more beneficial than decreasing equity glide paths for certain types of retirees, however. “The increasing fast glide path will become considerably more attractive for retirees… where there is a large Social Security benefit [relative to income needs], a higher withdrawal rate, and a higher initial equity allocation,” the paper said.

It would be “considerably less attractive… where there are lower nominal returns or a bequest preference,” it continued. “An analysis that focuses on metrics like the probability of success, which ignores bequests entirely, is likely to find the ‘increasing fast’ glide path more optimal… [It does well in scenarios that with] “no bequest preference and low withdrawal rates.”

These outcomes are based on an assumption of rising rates. “The relative benefit of a decreasing equity glide path can at least be partially attributed to the return model used for the analysis, which directly takes into account today’s low bond yields but assumes yields eventually drift higher over time,” Blanchett wrote. He also assumes that the equity risk premium over bonds will stay in its historical range and not widen.

Wade Pfau concedes that his paper with Kitces made different assumptions about bonds. “Michael and I did look at three different sets of capital market expectations, two of which did [assume] lower bond yields. But we didn’t use capital market expectations that allow bond yields to rise over time, which is something that David and I are both now using in our newer work. So that could be a factor. I should try re-running the analysis with the newer capital market expectations I’ve been using. I wouldn’t want to conclude that this is the reason for the difference without testing it.”

What if the U.S. enters a Japanese-like era of negligible yields? That wouldn’t be good, Blanchett says. “If interest rates stay this low, then [most] recommendations are too optimistic. We’re at a unique place for the risks of stocks and bonds. There’s never been a time when yields were so low and stocks were so high,” he told RIJ, adding that cash is no refuge. “If you’re in cash right now, you’re actually earning a negative two or three percent a year. That’s destructive of wealth.”

© 2015 RIJ Publishing LLC. All rights reserved.

Tax Corporations Less, and Capital Gains More?

In his budget proposal, President Obama would raise capital gains taxes as a way to finance middle class tax relief. Along with many Republicans, he also supports tax rate cuts for business and efforts to prevent multinational corporations from avoiding U. S. taxation. 

This raises an intriguing possibility. Why not pay for at least some corporate tax cuts with higher taxes on individuals on their receipts of capital gains or similar returns? In effect, as it becomes increasingly difficult to find a workable way to tax profits of the largest businesses, largely multinational companies, why not tax shareholders directly?   

Most proposals to deal with the complexities of international taxation wrestle with how to tax corporations based on their geographical location. But as Martin Sullivan of Tax Notes said years ago, what does it mean to base taxes on a company’s easily-reassigned mailing address when its products are produced, consumed, researched, and administered in many places?  

By contrast, individuals usually do maintain residence primarily in one country. Thus, reducing corporate taxes while increasing shareholder taxes on U.S. residents largely avoids this residence problem. Indeed, many proposals, such as a recent one by Eric Toder and Alan Viard, move in this direction. While such a tradeoff is not a perfect solution, it makes the taxation of the wealthy easier to administer and less prone to today’s corporate shelter games. 

Many have made the case for why cutting corporate rates is sound policy. On what policy grounds can Obama’s plan for raising taxes on capital gains fit into this story?  

Much of the publicity about taxing the rich focuses on their individual tax rate. But many very wealthy people avoid paying individual taxes on their capital income simply by never selling stock, real estate, or other assets on which they have accrued gains. That’s because, at death, the law forgives all capital gains taxes on unsold assets. 

The very wealthy, moreover, tend to realize a fairly small share of their accrued gains and an even smaller share than those who are merely wealthy. It makes sense: the nouveaux riche seldom become wealthy unless they continually reinvest their earnings. And when they want to consume more, they can do so through means other than selling assets, such as borrowing.  

Warren Buffett was famous for claiming that he paid lower tax rates than his secretary, alluding in part to his capital gains rate versus her ordinary tax rate on salary. But Buffett doesn’t just pay a modest capital gains tax rate (it was 15 percent when he made his claim and about 25 percent now). On his total economic income, including unrealized gains, it’s doubtful that his personal taxes add up to more than 5 percent. 

At the same time, many of the wealthy do pay significant tax in other ways. If they own stock, they effectively bear some share of the burden of the corporate tax. Real estate taxes can also be significant and not merely reflect services received by local governments. Decades ago I found that more tax was collected on capital income through the corporate tax than the personal tax. Today, the story is more complicated, since many domestic businesses have converted to partnerships and Subchapter S corporations, where partners and shareholders pay individual income tax on profits. 

The President would raise the capital gains rate and tax accrued gains at death. This would encourage taxpayers to recognize gains earlier, since waiting until death would no longer eliminate taxation on gains unrealized until then. The proposal would effectively capture hundreds of billions of dollars of untaxed gains that forever escape taxation under current law. 

Trading a lower corporate tax rate for higher taxes on capital gains could also result in a more progressive tax system since many corporate shares sit in retirement plans and charitable endowments. It would reduce the incentive to hold onto assets—in tax parlance, lock-in—and the incentive to engage in tax sheltering. There’s also a potential one-time gain in productivity, to the extent that the proposal taxes some past gains earned but untaxed, as such taxes would have less effect on future behavior than the taxation of current and future returns from business. 

Tough issues would remain. Real reform almost always means winners and losers. For instance, how would a proposal deal with higher capital gains taxes for non-corporate partners and owners of real estate? Toder and Viard, for instance, would apply higher individual taxes only on owners of publicly-traded companies.

Still, some increase in capital gains taxes could help finance corporate tax reform without reducing the net taxes on the wealthy. It is exactly the type of real world trade-off that both Democrats and Republicans must consider if they are serious about corporate tax reform. 

Eugene Steuerle is the Richard B. Fisher Chair at the nonpartisan Urban Institute. He is also a former deputy assistant secretary of the Treasury. 

Coming next week: a new VA income option from MetLife

MetLife plans to the launch a new guaranteed lifetime withdrawal benefit (GLWB) rider called FlexChoice next week. The rider will be available on the company’s line of variable annuities.

According to a preliminary announcement in advance of next Tuesday’s official announcement, FlexChoice is going to be the only available GLWB rider that doesn’t require clients to elect coverage of one person or two spouses at the time of issue. Clients will also be able to start and stop withdrawals at any time without losing their ability to receive lifetime income, cancel the rider if their needs change, and receive a return of premium, minus withdrawals. There’s also a death benefit option.   

Look for more information about this product in next week’s issue of RIJ.

© 2015 RIJ Publishing LLC. All rights reserved.