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The One True Path to Income

Posted on May 16, 2014 by Kerry Pechter -

Every May, when the lawn grows green and shaggy again and the John Deere roars to life after its six-month snooze, the word-scapers here at Retirement Income Journal return to one of their favorite subjects: Income annuities.

Last week we tried to deconstruct the “crowding out” effect of Social Security on retail income annuities. This week we’ll examine that old-made-new product, the deferred income annuity, or DIA.

From a negligible sales base in 2011, when New York Life wrote the first modern DIA contract, DIA sales jumped to $1 billion in 2012 and then more than doubled, to $2.2 billion in 2013, according to LIMRA’s Secure Retirement Institute. By comparison, sales of immediate annuities (SPIAs) grew by $600 million in 2013, to $8.3 billion.

Eleven insurers now offer DIAs in the race. (See today’s cover story.) The sales leaders tend to be mutual companies (which like asset-liability matched products) with stellar strength ratings that assure clients that they’ll still exist in 40 years. New York Life accounts for about half of annual sales. Northwestern Mutual, MassMutual and Guardian Life are in pursuit. But MetLife, Principal, and other publics just getting started.

Career agents sell 57% of DIAs, according to LIMRA. Full-service national broker-dealers sell 40% and banks sell the rest. Though those numbers hide it, New York Life, MassMutual, Guardian and Principal Financial are reported to be selling DIAs with great success through Fidelity’s annuity platform.

AIG and Principal DIAs are currently quoted and offered for sale on the Income Solutions web platform operated by the Hueler Companies, and other brands will soon join them, according to CEO Kelli Hueler. Established to give 401(k) plan sponsors with a direct, open-architecture, low-cost “out of plan” SPIA option they can offer to participants at retirement, Hueler now wants to offer DIAs as well.

Today’s DIAs, which typically start providing income five to 15 years after issue, are a hybrid of two earlier types of DIAs that never got much traction in the marketplace: the flexible premium annuity and “longevity insurance.”

People used those more traditional DIAs to buy future income at a steep discount. The discounts were funded by long years of compounding and by mortality pooling. But these products had little appeal in the marketplace because they lacked liquidity and, just as importantly, exposure to the equity premium.

The new breed of DIA is a more palatable compromise. The deferral period is usually just long enough to allow insurers to back them with longer and slightly riskier bonds, but the income doesn’t seem hopelessly distant. The latest designs remove the biggest barriers to sales.

Add a death benefit to allay fears of forfeiture and the product lends itself to the type of “best of both worlds” framing that helps producers close sales among retiring Baby Boomers who are looking for pension-like income. DIAs, along with fixed indexed annuities with income riders, may also be absorbing some of the demand left by the diminished supply of variable annuities with generous guaranteed lifetime withdrawal benefits.

The monthly payout of a single-life DIA purchased with a $100,000 premium by a man at age 59½ with a 10-year deferral and a cash refund of unpaid principal on death is comparable to the guaranteed payout of a variable annuity with a GLWB that offers a 10-year, double-your-benefit-base deferral period and a 5% payout at age 69.

The highest current DIA payout for such a contract would be $990.80 per month, according to Cannex, which provides the most up-to-date DIA quotes. The hypothetical GLWB payout would be $1,000 a month for life. The GLWB, whose underlying assets would include equities, would have more upside potential than the DIA, but it would also have higher costs.

DIAs have an advantage over SPIAs. A 55-year-old investor who wanted to protect himself from sequence of returns risk during the run-up to retirement could, as an option, put money into a 10-year fixed annuity and wait until age 65 to decide whether to buy a SPIA. To provide liquidity, the insurer would have to back the product with short-term, high quality bonds.

The same investor could get a somewhat larger income stream with a DIA, all else being equal. “The mortality credit drives about a quarter of the difference and the rest comes from our ability to take advantage of the yield curve,” an actuary at one of the DIA issuers told RIJ. “Besides going a little longer in maturity, to 10 or 15 years, we can also take some calculated credit risk. We’re not talking about anything exotic, just double or triple Bs.”

One obstacle to buying a DIA is that they tend to require planning ten or more years in advance of retirement, which most people don’t do. People who are considering buying a DIA qualified money, such as rollover IRA assets, should probably start thinking about the decision before age 60.

That’s especially true for people buying a DIA with qualified money. Several DIA issuers set the latest purchase age at 68, 68½ or 69, for qualified premiums, because the payouts must begin before age 70½, when required minimum distributions begin. People who are trying to leverage the higher mortality credits at older ages might find that restriction a bit confining.

Those who are buying a DIA with non-qualified, or after-tax money, face no such restrictions. Maximum-issue ages for these assets are as high as age 95. For such clients, DIAs can also help spread the income tax due on the interest earned on the principal over a period of many years. Once all principal has been distributed, however, the payments are 100% taxable as ordinary income.

DIAs are a useful new arrow in the product quiver of SPIA manufacturers. While SPIAs are mainly purchased by people in their late 60s or older, DIAs give issuers a product that they can offer to people in their 50s, thus broadening their market. Like SPIAs, DIAs can be positioned as a way for retirees to reduce risk in one part of their portfolios so that have more freedom to take risk with the rest of their assets.

As a risk-averse person approaching retirement without a defined benefit pension, I find the DIA concept appealing but the payouts still underwhelming. Low interest rates aren’t the only reason for the unimpressive payout rates. Adverse selection—the tendency for healthy people to buy annuities and vice-versa—inflates the contract price by about 10%.

I try to rationalize the low-interest rate problem by telling myself that low rates have driven equity prices up. Ergo, if I sell inflated equities to buy my DIA, I’m not hurt by the low rates. It’s a comforting thought, but not very.

I also tell myself that complaining about low rates is just a way of dodging the reality that I just haven’t save enough. Many of us still seem to expect growth and appreciation, as opposed to sheer saving (and the sacrifices it entails), to painlessly fund our retirements. That may turn out to be true for some, but you can’t count on it.

Piketty and the Zeitgeist

Posted on May 16, 2014 by Dani Rodrik -

I get the same question these days wherever I go and from whomever I meet: What do you think of Thomas Piketty? It’s really two questions in one: What do you think of Piketty the book, and what do you think of Piketty the phenomenon?

The first question is much easier to answer. By sheer luck, I was among the earliest readers of the English-language version of Capital in the Twenty–First Century. Piketty’s publisher, Harvard University Press, had sent me the pre-publication galleys, hoping that I would contribute a blurb for the back cover. I did so happily, as I found the scope, depth, and ambition of the book impressive.

I was of course familiar with Piketty’s empirical work on income distribution, carried out jointly with Emmanuel Saez, Anthony Atkinson, and others. This research had already produced startling new findings on the rise of the incomes of the super-rich. It had shown that inequality in many advanced economies has reached levels not seen since the early part of the twentieth century. It was a tour de force on its own.

But the book goes far beyond the empirical work, and narrates an intriguing cautionary tale about the dynamics of wealth under capitalism. Piketty warns us not to be fooled by the apparent stability and prosperity that was the common experience of the advanced economies during a few decades in the second half of the twentieth century. In his story, it is the un-equalizing, destabilizing forces that may be dominant within capitalism.

Perhaps more than the argument itself, what makes Capital in the Twenty-First Century a great read is the sense of witnessing a superb mind grapple with the big questions of our time. Piketty’s emphasis on the political nature of the distribution of income; his subtle back-and-forth between the general laws of capitalism and the role played by contingency; and his willingness to offer bold (if, to many, impractical) remedies to save capitalism from itself are as refreshing as they are rare for an economist.

So I would have liked to claim that I was prescient in foreseeing the huge academic and popular success that the book would have upon publication. In truth, the book’s reception has been a big surprise.

For one thing, the book is hardly an easy read. It is almost 700 pages long (including the notes), and, though Piketty does not spend much time on formal theory, he is not beyond sprinkling an occasional equation or Greek letters throughout the text. Reviewers have made much of Piketty’s references to Honoré de Balzac and Jane Austen; yet the fact is that the reader will encounter mainly an economist’s dry prose and statistics, while the literary allusions are few and far between.

The economics profession’s response has not been uniformly positive. The book’s argument revolves around a number of accounting identities that relate saving, growth, and the return to capital to the distribution of wealth in a society. Piketty is very good at bringing these abstract relations to life by hanging real numbers on them and tracing their evolution over history. Nevertheless, these are relationships that are well known to economists.

Piketty’s pessimistic prognosis rests on a slight extension of this accounting framework. Under plausible assumptions – namely that the wealthy save enough – the ratio of inherited wealth to income (or wages) continues to increase as long as r, the average rate of return to capital, exceeds g, the growth rate of the economy as a whole. Piketty argues that this has been the historical norm, except during the tumultuous first half of the twentieth century. If that is what the future looks like, we are facing a dystopia in which inequality will rise to levels never before experienced.

Yet extrapolation is dangerous in economics, and the evidence that Piketty adduces to support his argument is hardly conclusive. As many have argued, the return to capital, r, may well start to decline if the economy becomes too rich in capital relative to labor and other resources and the rate of innovation slows down. Alternatively, as others have pointed out, the global economy may pick up speed, buoyed by developments in the emerging and developing world. Piketty’s vision needs to be taken seriously, but it is hardly an iron law.

Perhaps the source of the book’s success should be sought in the zeitgeist. It is difficult to believe that it would have had the same impact ten or even five years ago, in the immediate aftermath of the global financial crisis, even though identical arguments and evidence could have been marshaled then. Unease about growing inequality has been building up for quite some time in the United States. Middle-class incomes have continued to stagnate or decline, despite the economy’s recovery. It appears that it is now acceptable to talk about inequality in America as the central issue facing the country. This might explain why Piketty’s book has received greater attention in the US than in his native France.

Capital in the Twenty-First Century has reignited economists’ interest in the dynamics of wealth and its distribution – a topic that preoccupied classical economists such as Adam Smith, David Ricardo, and Karl Marx. It has brought to public debate crucial empirical detail and a simple but useful analytical framework. Whatever the reasons for its success, it has already made an undeniable contribution both to the economics profession and to public discourse.

Dani Rodrik is Professor of Social Science at Princeton’s Institute for Advanced Study and author, most recently, of The Globalization Paradox: Democracy and the Future of the World Economy.

Prudential launches new SPIA

Posted on May 16, 2014 by Editorial Staff -

As part of a broad effort to diversify its risk exposure away from the equity markets and issue products that tie up less capital, Prudential Annuities has introduced a single-premium immediate annuity (SPIA) with an optional cash refund feature and a one-time option to access future payments in a lump sum (under the life with period certain income option).

“We’ve had SPIA products for many years, but this is an updated version,” said Bruce Ferris, president, Prudential Annuity Distributors, in an interview with RIJ this week. “We had a SPIA that hadn’t been refreshed in terms of administration or marketing for many years, and it wasn’t available on Cannex, where most SPIAs are illustrated and quoted. [Getting the product on Cannex] was part of our motivation for reissuing the product.”

From an enterprise risk perspective, SPIA sales also have the potential to help balance Prudential’s heavy weighting toward equity-linked products. “This launch is reflective of a broader strategy of growth through diversification. We want a broader, complementary solution-set that fits the company’s capital deployment strategy,” Ferris said.

“A SPIA is an asset-liability matching product. The behavioral risks associated with it are much lower than with the variable annuity, for several reasons. The contract owner is giving up access to the money, and the company doesn’t need to try to predict when the contract owner might draw income.”

Prudential managers have said in the past that as a stock company Prudential Financial has to deliver profits that excite shareholders—the types of profits that are more likely to come from selling equity-linked products. SPIA and the relatively new Prudential bond-based deferred income product don’t deliver those types of returns, but they do help diversify risk. Although new sales of Prudential variable annuities with living benefits have declined steeply from their peak, the VA book of business still delivers huge revenues, thanks to fees that are linked to the booming equity values of the subaccounts in its existing contracts.

Whether Prudential is now selling bond-linked products instead of, as opposed to alongside, equity-linked products, Ferris could not say. But he noted, “We’re taking a different approach from competitors. Some of our competitors seek success by controlling supply. We seek success by managing risk. That’s why you see diversified products from us—the SPIA, the Prudential Defined Income product, our traditional variable annuity with a living benefit, and our investment-only variable annuity, which is intended to be a tax-deferred accumulation vehicle.”

Reinsurance once again available to VA issuers: Fitch

Posted on May 16, 2014 by Editorial Staff -

Improved pricing and less aggressive investment guarantees are leading to a re-opening of the reinsurance market in the variable annuity space, giving writers of VAs a risk mitigation alternative to in-house VA hedging programs, according to a new report from Fitch Ratings.

But “it is unclear how much of an impact this will have on the risk profile of VA writers,” a Fitch release said. “It could result in a reduction in the industry’s exposure to VA risk or, conversely, it could simply allow insurers to sell more VAs than they otherwise would. Fitch expects the ultimate answer to lie somewhere between the two extremes.”

Like the equity markets, the supply of VA reinsurance market has been volatile in recent decades, Fitch said. It was very active in the 1990s, dried up after the correction in 2000-2002, sprang back to life in 2006-2007, and dried up again after the 2008-2009 financial crisis.

Fitch said it has seen an increase in reinsurance transactions involving VA risk. CIGNA, previously a reinsurer of variable annuity risk, entered into a reinsurance transaction in February 2013 with a subsidiary of Berkshire Hathaway on an in-force book of variable annuities.

In the fourth quarter of 2013, Lincoln National Corp.’s (LNC) largest insurance operating subsidiary entered into a reinsurance treaty with Union Hamilton Reinsurance, Ltd., a Bermuda-domiciled subsidiary of Wells Fargo & Co. This transaction was particularly notable in that the reinsurance agreement involved future new business. Under the terms of the treaty, Union Hamilton will reinsure the living benefit guarantee on 50% of new VA sales from Nov. 1, 2013 through Dec. 31, 2014, up to $8 billion of new living benefit guarantee sales. LNC will retain 100% of the product cash flows, excluding the living benefit guarantee.

Fitch believes that more VA writers are exploring potential opportunities to cede a portion of the risk associated with their VA guarantees, but no other significant announcements of such treaties have yet emerged.

Investors rotate from growth to value; REITs outperformed the S&P

Posted on May 16, 2014 by Editorial Staff -

A “massive” rotation out of growth stocks and into value stocks occurred this spring, according to TrimTabs Investment Research. Growth-oriented U.S. equity exchange-traded funds have redeemed $5.6 billion (4.6% of assets) since the start of April, while value-oriented U.S. equity ETFs have issued $3.9 billion (2.6% of assets).

“Fund flows have shifted dramatically beneath the market’s calm surface,” said TrimTabs CEO David Santschi, in a release. “While most major U.S. stock market averages were little changed in recent weeks, investors showed an overwhelming preference for value over growth.”

The shift in flows has occurred across the size spectrum. Small-cap growth ETFs have redeemed $750 million (5.9% of assets) since the start of April, while small-cap value ETFs have issued $150 million (1% of assets). Large-cap growth ETFs have redeemed $4.6 billion (4.9% of assets), while large-cap value ETFs have issued $2.6 billion (2.5% of assets).

“These flows mark a huge change in trend,” Santschi said. “Investors were favoring growth over value for most of the past year.”

TrimTabs believes the Federal Reserve’s “tapering” and the disappointing performance of recent technology and biotechnology IPOs are probably driving investors to re-evaluate the prospects of growth companies. It also suggested some investors may want to start taking advantage of the sell-off.

“Our liquidity indicators are bullish almost across the board, and ETF investors tend to be poor market timers,” noted Santschi. “While plenty of social media, cloud computing, and biotechnology firms are still grossly overvalued, stock pickers may want to consider scooping up other growth names that have been dumped along with the tech and biotech highflyers.”

NAREIT’s May 2014 REIT market update

U.S. REIT returns outpaced the S&P 500 in April and outperformed the broader equity market in the first four months of the year. Almost all sectors of the U.S. REIT market delivered double-digit total returns for the first four months of 2014. Self-Storage was the industry’s top-performing sector for the year-to-date, delivering an 18.83% total return.

On a total return basis, the S&P 500 was up 0.74% in April, but the FTSE NAREIT All REITs Index was up 2.88%, the FTSE NAREIT All Equity REITs Index was up 2.99%, and the FTSE NAREIT Mortgage REITs Index was up 1.86%.

For the first four months of the year, the S&P 500 was up 2.56%, but the FTSE NAREIT All REITs Index was up 11.70%, the FTSE NAREIT All Equity REITs Index was up 11.76%, and the FTSE NAREIT Mortgage REITs Index was up 13.23%.

Among other REIT market sectors in the first four months of the year, Health Care was up 16.84%; Apartments were up 16.40%; the Home Financing segment of the FTSE NAREIT Mortgage REITs Index was up 15.36%; Office was up 13.61%; and Retail was up 12.62%, led by Regional Malls, up 13.10%.

At April 30, the dividend yield of the FTSE NAREIT All REITs Index was 4.05%, and the dividend yield of the FTSE NAREIT All Equity REITs Index was 3.57%. The dividend yield of the FTSE NAREIT Mortgage REITs Index was 9.80%, with Home Financing REITs yielding 10.81% and Commercial Financing REITs yielding 7.11%. By comparison, the dividend yield of the S&P 500 was 2.07% Five individual equity REIT market sectors produced dividend yields over 4%: Free-Standing Retail (6.07%); Health Care (5.08%); Mixed Industrial/Office (4.643%); Diversified (4.48%) and Manufactured Homes (4.14%).

Retirement Clearinghouse to help find missing participants

Posted on May 16, 2014 by Editorial Staff -

To help fill a “gaping hole” left by the discontinuation of two government programs, Retirement Clearinghouse LLC (RCH) has introduced a search service to locate missing retirement plan participants, the Charlotte-based company said in a release this week.

The Social Security Administration and the Internal Revenue Service have both decided to stop operating a “letter forwarding program” that helped plan sponsors locate participants who have gone missing due to address changes and other circumstances, the RCH release said.

An estimated 9.5 million defined contribution plan participants change jobs each year, and many leave their accounts behind in former employers’ retirement plans. RCH said the cost to plan sponsors of resolving these accounts is an estimated $48 billion over 10 years.

RCH said it has combined searches of national change-of-address records and commercial databases with Internet tracker and social media search capabilities. It also validates and updates participant data, oversees mailings to last known addresses, and locates missing participants when possible. The service helps plan sponsors meet fiduciary responsibilities.

Is Social Security Unsociable to Annuities?

Posted on May 8, 2014 by Kerry Pechter -

If Uncle Sam began making and selling an inexpensive national automobile—a people’s car analogous to the minimalist Volkswagen beetle of the 1930s—would it “crowd-out” demand for privately manufactured automobiles?

The logical answer might be: Sure, but only among people who drive the cheapest, most basic privately-manufactured cars; people who drive luxury cars like a Lexus, Cadillac or BMW wouldn’t be affected at all.

Here’s a related question: Does the availability of Social Security benefits displace or “crowd out” the demand for individual income annuities among U.S. retirees?

On the one hand, the Boomer retirement wave has clearly stoked demand for retail guaranteed income products. Annual sales of income annuities (immediate and deferred) breached the $10 billion barrier for the first time in 2013. Sales of fixed indexed annuities with living benefit riders also boomed last year.

But while interest in annuities is seasoning slowly, like hickory-smoked barbecue, interest in Social Security has suddenly caught fire. Advisers and their clients are talking about “claiming strategies,” and using new-fangled calculators to “optimize” their benefits. Experts like Alicia Munnell at the Center for Retirement Research at Boston College have recommended “buying an annuity from Social Security” by delaying benefits until age 70 and living on other savings in the meantime. (Today’s low risk-free interest rates and high Social Security deferral “credits” are helping create an arbitrage opportunity, in a sense.)

The Social Security crowd-out question has no single or simple answer. Lots of factors impinge on demand for private annuities besides Social Security. But it seems safe to say that annuity issuers who want to forecast the potential market for guaranteed income, as well as policymakers who are trying to decide how best to alter Social Security, should all be wondering to what extent our public and private sources of retirement income work in concert—or compete.

Yes and no

The short answer to the crowd-out question is “Yes, but not entirely.” The longer and unsurprising answer is, “It depends.” It depends partly on whether you’re emphasizing Social Security’s relative “replacement rate” or the absolute size of the benefits.

Social Security replaces more of the pre-retirement income of middle and low-income workers than of high-income workers. In that sense, like income tax rates, it’s “progressive.” Depending on the yardstick you use, Social Security, when claimed at the full retirement age, replaces 57-65% of a low-income worker’s pre-retirement income, 42-48% of a middle-income worker’s pre-retirement income, and 35-40% of the income of a worker at the top of the Social Security wage scale, according to the Center for Retirement Research at Boston College. Conventional wisdom calls for a 70% to 80% income replacement rate in retirement, so Social Security fulfills at least half of that.

You might conclude that Social Security satisfies most of the average person’s need for so-called income flooring in retirement, just as the pre-war VW bug fulfilled the average person’s vehicle needs. But what about the many advisors’ clients who earn much more than the FICA limit ($117,000 in 2014)? For workers accustomed to grossing $20,000 to $50,000 per month, and expecting to need 80% in retirement ($16,000 to $40,000 per month), Social Security income might replace only part of their need for safe income. The amount would depend on perceived need, debt load or risk tolerance.

“There’s no question that the presence of Social Security crowds out some of the demand for private annuities that would exist in the absence of Social Security. But the replacement levels are sufficiently low that it shouldn’t completely crowd out private annuities, especially for people in the upper and even the middle part of the income distribution,” said Jeff Brown, a University of Illinois economist.

“Public social security (SS) systems, providing mandatory annuitized benefits, crowd out private markets,” wrote Israeli economist Eytan Sheshinski in his 2007 book, The Economic Theory of Annuities. “However, the SS system in the United States provides replacement rates (the ratio of retirement benefits to income prior to retirement) between 35% and 50%, depending on income (higher rates for lower incomes). This should still leave a substantial demand for private annuities.”

Present value of Social Security

But if you ignore the replacement percentages and focus on two other numbers—the maximum benefits under Social Security and the estimated present value of those benefits—it’s hard to imagine anyone needing more annuitized wealth than can be gotten from Social Security.

For instance, a middle-class couple, claiming at ages 64 and 70, might easily receive $4,000 in monthly Social Security benefits, or $48,000 a year before taxes and Medicare B premiums. As a retail joint-life annuity, even without inflation protection, that income stream would be worth about $800,000, according to immediateannuities.com. If that’s equal to or greater than the couple’s total household wealth, do they really need to annuitize more?

That’s how an economist or an advisor who looks at the entire “household balance sheet,” might see it. “I’m not sure I would use the phrase ‘crowd out,’ to describe Social Security’s effect on demand for guaranteed income,” said Moshe Milevsky, the York University finance professor who writes, consults and teaches retirement finance.

“But I certainly agree that many Americans are over-annuitized because Social Security is such a large portion of their income and balance sheet, and it’s hard for the private sector to offer a real inflation-indexed annuity at the same prices.”

Other economists who have studied and written about retirement finance for many years suggested in a recent paper that Social Security is probably why most middle-class households don’t buy retail annuities.

“Old age insurance benefits from Social Security are the major source of retirement income for most retired households,” wrote Raimond Maurer of Goethe University in Frankfurt, one of three authors of a paper published in the March issue of Review of Finance. They found the Social Security spousal benefit to be generous; Germany’s old age pension offers no such feature, Maurer told RIJ. In Maurer’s description, Social Security in the U.S. sounds less like a pre-war Beetle and more like a 2014 Audi.

“In practice, [Social Security] benefits… which are comparable to a joint and survivor annuity, are well balanced for a couple and provide relatively generous survivor benefits in the range of one-half to two-thirds of the previous income. … For retired couples with moderate financial wealth, purchasing additional annuities in the private market only provides marginal welfare gains. This might explain why so few households participate in the private annuity market and therefore—at least in part—the annuity puzzle,” the German economists wrote.

Like a nice restaurant

Some believe that the availability of Social Security crowds out private annuities in another way—by making them more expensive. “The equilibrium price of annuities is about 14% more than it would have been otherwise in the absence of Social Security,” writes Arizona State University economist Roozbeh Hosseini in a paper published on March 20.

In his view, Social Security drives up the cost of private annuities by worsening the effect of “adverse selection”—the tendency for healthier, longer-lived people to buy private annuities. Because Social Security is mandatory, Hosseini writes, and requires all American workers, regardless of health status or life expectancy, to participate, it reduces its own vulnerability to adverse selection.

But by satisfying the need for guaranteed income among less healthy (and often lower-income; unfortunately the two go together) people, it only shifts that problem to the private annuity market, he claims. “In the presence of Social Security, 47% of the population (those with higher mortality) are not active in the market. These individuals get more annuitization than they need from Social Security.

“On the other hand, individuals with lower than average mortality, expecting longer life spans, accumulate more assets and have higher demand for annuities. These individuals purchase annuities in the market. However, since higher mortality types (good risk types) are not in the market, the equilibrium price of annuities is about 14% percent higher than it would have otherwise been in the absence of Social Security.”

Not everyone agrees, at least not entirely. “Perhaps those ‘low life expectancy retirees’ would decide not to buy an annuity,” Milevsky told RIJ. For them, voluntary private annuities are, on average, even more expensive than they are for people with high life expectancies. Even without considering the possible effect of Social Security, retirement experts like Wade Pfau of The American College, and George A. (Sandy) Mackenzie, editor of The Journal of Retirement, have estimated the implicit load on private income annuities to be 10% to 15%, thanks to costs and adverse selection.

(That’s not a reason to avoid income annuities, Mackenzie wrote in his 2006 book, Annuity Markets and Pension Reform. Just as relatively expensive fire insurance is still much cheaper than the cost of replacing a burnt-down house, even an expensive life annuity is still much cheaper than self-insuring against longevity risk.)

Social Security is “clearly a substitute” for private annuities, and therefore crowds them out, says economist Eugene Steuerle, a senior fellow at the Urban Institute. But Social Security has also stimulated demand for private annuities, he believes.

More so than defined benefit pensions, Social Security created the modern concept of retirement for middle-class Americans, Steuerle told RIJ. Before Social Security, millions of people reached age 65 with nothing in the bank, so they kept working. Social Security enabled them to retire. The larger supply of retirees naturally generated more demand for additional sources of retirement income, such as private annuities.

“It’s like what happens when a restaurant opens in a nice neighborhood without restaurants. Other new restaurants follow, and they benefit from each other,” Steuerle told RIJ this week. At the same time, the growth of retirement savings in 401(k) plans and rollover IRAs has given millions of people the wherewithal to buy additional income. And while only 10% or 20% of them might actually buy annuities, “Twenty percent of a big pile is more than 20% of a small pile,” he added.

DB pensions leave a vacuum

What will happen when defined benefit pensions finally disappear, and no one enters retirement with a DB annuity? Will people buy private annuities to supplement Social Security instead? Annuity manufacturers may hope so, but the market dynamics are not so simple.

For people who have DB pensions, familiarity with guaranteed income evidently tends to foster demand for more. “Our research suggests that the presence of guaranteed income creates demand rather than suppresses it,” said Ross Goldstein, a New York Life managing director, told RIJ.

New York Life, the leading seller of income annuities, paid out more than $1 billion to about 129,000 contract owners in 2013. The average monthly payment was $682, with 60% receiving under $500 a month, 24% receiving $500 to $1,000 a month, and 16% receiving over $1,000. About half the $1 billion went to people ages 80 and older, over 30% to people ages 70 to 79 and nearly 20% to people ages 65 to 69. “It looks a lot like the distribution of income in the United States,” Goldstein said.

As an example of a typical prospect, Goldstein suggested a couple with $500,000 in savings and $40,000 in Social Security and/or pensions, who might boost their guaranteed income to $45,000 or $50,000 a year buying an income annuity with a chunk of savings. The move would reduce principal, but in a single, deliberate coup. It would also reduce the future temptation or need for piecemeal or panicky withdrawals from the remainder.

The disappearance of DB pensions could open up demand for retail annuities. But it would also reduce the number of people who have first-hand knowledge of the rewards of guaranteed income, Goldstein suggested. Most 401(k) participants will need to be taught to think of turning their savings into annuities, an educational process that has barely begun.

Even if the absence of DB pensions does inspire the public to buy retail annuities—an idea that annuity marketers constantly pitch—the substitution rate “won’t be dollar for dollar,” Brown told RIJ. Steuerle agreed. “The decline of DB pensions might help but it won’t be a one-to-one substitution,” he said in an interview.

That leaves the ultimate question: What happens if Social Security benefits shrink, either through means-testing, or less generous indexing, or in terms of replacement ratios, as a result of declining payroll tax revenue? Will that compel millions of people to convert at least part of their IRA or 401(k) money to retail or institutional annuities? Annuity manufacturers are praying for just such an outcome.

One source of rising inequality: Power couples

Posted on May 8, 2014 by Editorial Staff -

Everyone knows that when two doctors marry, or two lawyers marry, or when a doctor and a lawyer marry, they can afford to hire a live-in nanny to shepherd and chauffer the kids while they work 12 hour days.

Researchers have documented an increase in “positive assortative matching,” which is a fancy way of saying that “likes marry likes.” And some believe that the rise of professional couples with two high-powered salaries has helped fuel the wealth-concentration that pundits so often write about and debate over.

The paper, “Marry Your Like: Assortative Matching and Inequality,” was written by a cosmopolitan quartet of economists: Jeremy Greenwood of Penn, Cezar Santos of the University of Mannheim, Georgi Kocharkov of the University of Konstanz, and Nezih Guner of Barcelona-based MOVE (Markets, Organizations and Votes in Economics). It has just been published by the National Bureau of Economic Research.

Here are hypothetical cases used by the authors to illustrate the evolution of the link between marriage choices and financial status over the past half-century:

“In 1960 if a woman with a less-than-high-school education (HS) married a similarly educated man their household income would be 77% of mean household income. If that same woman married a man with a college education (C) then household income would be 124% of the mean.

“Alternatively, in 2005 if a woman with post-college education (C+) marries a man with a less-than-high-school education their income would be 92% of mean household income. This rises to 219% if her husband also has a post-college education. So, at some level, sorting matters for household income.”

To the extent that those examples reflect the new norms, then a husband’s education is still the primary determinant of a couple’s future income, but women are evidently bringing more to the household balance sheet than they used to. If so, it’s an idea that rings true.

Before the 1970s, positive assortative matching—call it PAM—was less common simply because women weren’t as much like men, in terms of education or earning power. Women weren’t attending law, medical or dental schools in today’s large numbers, and they hadn’t yet achieved an equal (or almost equal: the pay differential and “glass ceiling” persist) presence in professional or managerial ranks.

Just as importantly, women aren’t quitting work when they get married and have children, as they used to. In the last 30 or 40 years, the “working mother” phenomenon became the norm. (Working Mother magazine, still going strong, was founded in 1979.) “For positive assortative matching to have an impact on income inequality married females must work. Married females worked more in 2005 than 1960,” the researchers wrote.

The paper doesn’t explore PAM’s implications for retirement, but they’re easy to see. Income and wealth patterns that exist during the working years must certainly persist into retirement, since higher-income workers are more likely to be working in companies with generous retirement plans, more likely to save and likelier to have high Social Security benefits. A power-couple in their early 60s today who delay Social Security until age 70 can expect to receive as much as $6,000 per month, or $72,000 a year, when benefits begin, and regular cost-of-living increases from then on.

It’s 2024. Do You Know Where Your Industry Is?

Posted on May 8, 2014 by Kerry Pechter -

By the year 2024, how will the retirement industry have changed from the way it looks today? The wide-ranging responses of two dozen retirement industry experts to multiple variations of that speculative question have been compiled into a new report.

The 96-page document, entitled “Expert Interviews on the Future of the Retirement Market,” is based on the results of a series of interviews conducted last winter by The Diversified Services Group, Inc. (DSG), a Philadelphia-area consulting firm, and the research firm Mathew Greenwald & Associates (MGA), based in Washington, DC.

RIJ, as a participant in the interview process, received a summary of the results, and we can offer highlights. The report isn’t scientific, it doesn’t reach any kind of consensus on the likely shape of the future and it includes, inevitably, many extrapolations of current trends. The experts’ comments also tend to be rather sober, with references to rising inequality, rising costs, and dysfunctional government.

Its main value, according to DSG’s introduction, is to render a kind of transcript of a high-level brainstorming session, and to stimulate more brainstorming. The interviewees “point out some potential areas for long-term opportunity,” the introduction says. DSG advises readers to “carefully consider some initial actions to gain competitive advantages in these areas.”

Some of those potential opportunities were implied by predictions like these:

Cities should prepare to welcome an influx of Boomer retirees. Warm climate retirement spots will give way to more diverse urban areas that offer retirees cultural opportunities. Seniors in suburban and rural areas will need transportation solutions.
New ways of delivering affordable financial advice will be needed. Most people will not be able to afford comprehensive financial planning services, but piecemeal advice won’t be very useful unless it leads to more comprehensive services.
Architects and contractors may be needed to help convert some of today’s large single-family homes into inexpensive residences or assisted-living facilities for groups of unrelated single retirees. Many full-service nursing homes will close. The long-term care financing puzzle remains unsolved, and government-financed solutions may be necessary.
Hospitals will compete directly with insurance companies to assume the insurance and cost risk.
The size of the Boomer retiree market will force politicians on the left and right to come together and provide support. Opportunities may exist for those who can harness the Boomer energy and apply it in Washington.
- Employers’ unwillingness to go much beyond financial education in preparing employees for retirement presents an opportunity for advisors or plan service providers who can fill this gap with assistance, advice, and income solutions.
- Beyond auto-enrollments and auto-escalation, there is a need for new methods of encouraging additional saving for retirement in employer-sponsored plans.

The interview subjects included retirement experts selected from a variety of fields and areas of expertise. They represented life insurers, financial advisory firms, non-profit research groups and consulting firms. They included such bona fide experts as Dallas Salisbury of the Employee Benefits Research Institute, Mark Warshawsky, currently at the American Enterprise Institute, Wade Pfau of The American College, Michael Kitces of Pinnacle Advisory Group and Christopher Raham of Ernst & Young.

One of the interviewees predicted, “We will be shocked by how little has changed.” But if you asked someone had made that comment in 2004, how wrong they would have been. If recent history is any guide, it seems safer to strap ourselves in and get ready for a bumpy ride.

DSG’s “Expert Interviews” report represents the fifth phase of a planned six-part series of syndicated studies. The annual multi-sponsor research series is entitled, Retiree Insights Research Program. The final phase of the research, a consumer survey, is still in process.

A conference to review the entire research results with the sponsoring organizations is planned for mid-June. Subscriptions for copies of the entire series of research reports are available for purchase, said Borden Ayers, a principal in the DSG organization. Interested parties should contact either DSG or Greenwald & Associates.

Rollover IRA contributions reached $321.3 billion in 2012: Cerulli

Posted on May 8, 2014 by Editorial Staff -

The regulators call it “leakage” but for broker-dealers it’s a veritable gusher. As Americans change jobs or retire, they frequently transfer their savings from low-cost, high-regulated 401(k) plans to rollover IRAs, where the rules and regulations, for better or worse, are much looser.

Cerulli Associates, the Boston-based global analytics firm, follows these asset flows. In a proprietary new study, “Retirement Markets 2013: Data and Dynamics of Employer Sponsored Plans,” Cerulli reports that contributions to rollover IRAs rose 7.3% in 2012 to $321.3 billion. Figures for 2013 were not yet available.

In the report, Cerulli examines the size and segmentation of public and private U.S. retirement markets, including defined benefit (DB), DC, and IRA. The report is the eleventh in an annual series.

Most of the rollover money originates 401(k) plans, and Cerulli advises plan providers—the biggest include Fidelity Investments, Vanguard, ING U.S. Retirement, Great-West Financial, Principal Financial and others—to reach out to departing participants and try to retain the assets before it is rolled over to an IRA at other fund firm or to a broker-dealer.

There’s usually an interim in which to do that. “Participants do not necessarily roll over their assets immediately after leaving their employer,” said Bing Waldert, director at Cerulli. “Some take action months or even years after their departure.”

Other findings from the report, only a portion of which was released to RIJ this week:

59.4% of 401(k) assets are investment-only, 41.7% are proprietary and the remaining 8.8% is made up of self-directed brokerage assets, company stock and other.
In 2014, Cerulli estimated that 32.1% of U.S. retirement assets will be in IRAs, 23.4% will be in public DB plans, 21.7% will be in private DC plans, 14.4% in private DB plans, and 8.4% in public DC plans. In 2002, the IRA share was 26.7%.
In 2012, there were an estimated 45,010 defined benefit plans in the U.S., of which more than three-fourths had fewer than 100 participants and less than 10% had 100-999 participants. Only 701 DB plans had more than 10,000 participants.
Only 24,400 of the nation’s 307,623 financial advisers (7.9%) received more than 40% of their income from work with defined contribution plans in 2012. More than half of the 24,400 were in the insurance channel, and about 20% were in the independent broker dealer channel. Advisers in the insurance channel. Almost 42,000 advisers “dabbled” DC plans, receiving less than 20% of their income from work with plans.

Initial funding granted for Connecticut’s public IRA plan

Posted on May 8, 2014 by Editorial Staff -

The Connecticut General Assembly announced Wednesday that it will invest $400,000 to begin creation of a state-level public IRA plan, open to all private sector workers. The funds were approved in the FY 2014-2015 budget passed by legislators on May 3.

The money will finance the Connecticut Retirement Security Board, which will be “conducting a market feasibility study and developing an implementation plan” for a state-sponsored, workplace-based payroll deferral program for the state’s 740,000 workers who lack access to an employer-based plan, according to a release from Retirement for All CT, an advocacy group that supports the program.

“The Board, chaired by the State Treasurer and State Comptroller, is expected to report back to the General Assembly their findings and a plan for implementation by 2016. Funding included in the state budget is expected to be used to hire the necessary consultants and staff to ensure the Public Retirement Plan will be self-sufficient and compliant with all federal regulations,” the release said.

Detroit municipal retirees to take 4.5% pension cut

Posted on May 8, 2014 by Editorial Staff -

Working through federal bankruptcy mediators, the City of Detroit and the Detroit Retired City Employees Association (DRCEA) have agreed on the treatment of pension and healthcare benefits under a proposed Bankruptcy Plan of Adjustment.

Under the agreement, the city retirees will take a 4.5% cut in current pension benefits and lose cost-of-living-allowances. The benefits can be restored depending on the performance of the General Retirement System under the Plan of Adjustment.

Retirees were also promised a “meaningful voice” in governance of the planned General Retirement System and of a Voluntary Employees Beneficiary Association (VEBA) that is to be established.

The DRCEA is the Detroit’s largest employee association with almost 8,000 members, or about 75% of Detroit’s eligible general retirees.

The Retired Detroit Police and Fire Fighters Association (“RDPFFA”), composed of about 6,500 members or more than 80% of Detroit’s police officers and firemen, reached a similar agreement with the city on April 15.

The “income message” isn’t getting through: EBRI/MetLife survey

Posted on May 8, 2014 by Editorial Staff -

As hard as the Department of Labor and insurance companies try to convince American workers to frame their 401(k) balances in terms as monthly income instead of lump sums, the effort doesn’t seem to be winning many hearts or minds.

Eight-five percent of respondents to a recent survey of 501 retirees and 1,000 workers contributing to employer-sponsored retirement plans described an income projection similar to the type produced by the Department of Labor’s Lifetime Income Estimate Calculator as “useful.”

But there was no evidence that the tool will encourage significant numbers of plan participants to think about converting their savings to income at retirement.

That’s reassuring news for mutual fund companies eager to retain plan participants’ assets after they retire. But it’s not what issuers of income-producing annuities hope to hear.

The survey, part of the 2014 Retirement Confidence Survey, was conducted by Greenwald & Associates, underwritten in part by MetLife and commissioned by the Washington, D.C.-based Employee Benefits Research Institute.

The illustration tool estimates monthly lifetime income based on a participant’s current account balance, contributions to their account and the projected value of their account balance at retirement, according to an EBRI release.

Just over half of current workers contributing to plans (54%) provided estimates about their own balances and contribution rates when they were asked how the calculator’s income projections compared with their own expectations for future income from their defined contribution (DC) savings.

Only 17% of those who answered the questions said the projections would cause them to increase their contributions to their plan. Among the 27% of those who said their estimate was “much” or “somewhat” less than expected, just over a third indicated they would increase their contributions.

Why? “The main reason cited by workers at all income levels… is the need to pay for day-to-day expenses, particularly since many are living paycheck-to-paycheck,” said Roberta Rafaloff, vice president, Institutional Income Annuities at MetLife.

Current retirees say they rely primarily on Social Security (62%) and defined benefit (DB) pensions (36%) as major sources for retirement income. But more than two-thirds of workers expect future Social Security benefits to be weaker than today’s, according to the release.

Only 33% and 29% of workers believe major sources of their retirement income will come from Social Security and DB pensions, respectively. While only 19% of retirees say employer-sponsored retirement plans such as a 401(k) are a major source of income in retirement, 42% of current workers do.

Thirty-percent of those surveyed didn’t know if their current plan offered an annuity option or not. Only one in five believed he or she had access to an annuity through their plans.

The Bucket

Posted on May 8, 2014 by Editorial Staff -

Rising VA account values boost Prudential operating income in 1Q 2014

Prudential Financial, Inc. reported after-tax adjusted operating income for its Financial Services Businesses of $1.137 billion ($2.40 per Common share) for the first quarter of 2014, compared to $1.072 billion ($2.27 per Common share) for the year-ago quarter.

Net income for the Financial Services Businesses attributable to Prudential Financial, Inc. was $1.225 billion ($2.59 per Common share) for the first quarter of 2014, compared to a net loss of $735 million ($1.58 per Common share) for the year-ago quarter. Information regarding adjusted operating income, a non-GAAP measure, is provided below.

“Our Annuities, Retirement, and Asset Management businesses are benefiting from sustained growth of account values and assets under management, driving strong underlying earnings momentum,” said Chairman and Chief Executive Officer John Strangfeld, in a release.

Adjusted operating income was not calculated under generally accepted accounting principles (GAAP), Prudential said. It provided a reconciliation of adjusted operating income to the most comparable GAAP measure.

The U.S. Retirement Solutions and Investment Management division reported adjusted operating income of $945 million for the first quarter of 2014, compared to $769 million in the year-ago quarter.

The Individual Annuities segment reported adjusted operating income of $388 million in the current quarter, compared to $372 million in the year-ago quarter. Current quarter results include a charge of $21 million and results for the year-ago quarter include a benefit of $62 million, in each case reflecting an updated estimate of profitability for this business driven largely by market performance in relation to our assumptions.

Excluding the effect of the foregoing items, adjusted operating income for the Individual Annuities segment increased $99 million from the year-ago quarter, primarily reflecting higher asset-based fees due to growth in variable annuity account values.

The Retirement segment reported adjusted operating income of $364 million for the current quarter, compared to $228 million in the year-ago quarter. The increase reflected a $123 million greater net contribution from investment results.

“We estimate that returns on non-coupon investments in the current quarter were about $80 million above average expectations. The remainder of the increase in Retirement segment adjusted operating income reflected higher fees associated with growth in account values,” the release said.

The Asset Management segment reported adjusted operating income of $193 million for the current quarter, compared to $169 million in the year-ago quarter. The increase was driven by higher asset management fees reflecting growth in assets under management, net of expenses.

Jefferson National adds more alternative funds to its low-cost VA

In an ongoing effort to help registered investment advisors and other fee-based advisers trade liquid alternatives on a tax-deferred basis, Jefferson National has added eight new investment options, including six alternative strategies, to its low-fee Monument Advisor deferred variable annuity.

The new options include Tortoise VIP MLP & Pipeline Portfolio, PIMCO All Asset All Authority Portfolio, along with Direxion VP Indexed Managed Futures Strategy Fund, Goldman Sachs Variable Insurance Trust Multi-Strategy Alternatives Portfolio, Oppenheimer Diversified Alternatives Fund/VA, and Legg Mason BW Absolute Return Opportunities, a non-traditional bond fund. ⁴

Jefferson National’s suite of Dimensional Funds now includes with DFA VA Global Moderate Allocation Portfolio. The new lineup also includes the actively managed, socially responsible Calvert VP SRI Balanced Portfolio. and social responsibility factors.

In late March, Jefferson National launched the JNF SSgA Retirement Income Portfolio, a managed volatility fund.

T. Rowe Price launches new “unrestrained” high-yield bond fund

Calling all fixed income investors with an appetite for higher returns and a tolerance for higher risk (but not much appetite for fixed indexed annuities).

T. Rowe Price, which manages $26.6 billion in so-called junk bond funds, has launched the Credit Opportunities Fund, a high-yield bond fund whose managers will have “few restraints” in bond selection and looking for “opportunities in credit that extend beyond traditional fixed rate bonds,” the Baltimore-based no-load fund company said in a release.

The fund will be managed by Paul Karpers, who also serves as portfolio manager for the T. Rowe Price Institutional High Yield Fund for U.S. institutional investors and the T. Rowe Price Funds SICAV–Global High Yield Bond Fund for non-U.S. institutions domiciled in qualifying jurisdictions.

Karpers will have considerable latitude to invest across a range of securities and credit situations:

No limits on below investment-grade or unrated bonds. These may include distressed or defaulted securities.
Up to 50% of assets in bank loans. These floating rate securities, with periodically resetting coupons, typically involve borrowers with significant debt loads and can offer the potential for high yields.
Up to 20% in securitized instruments backed by a pool of assets, such as residential or commercial mortgages and loans.
Up to 10% in equities or equity-like securities, typically with a focus on deep-value situations and credit themes.
Up to 10% in trade claims—outstanding obligations of companies in bankruptcy. Investors can purchase these claims from creditors, often at a deep discount.
May purchase both U.S. and non-U.S. issuers, including emerging markets securities.
Up to 50% in nondollar-denominated securities (although holdings denominated in other currencies are expected to typically be hedged back to the U.S. dollar).
May use derivatives, such as credit default swaps and options, to express a positive or negative view of an issuer’s credit quality.

Investors can access the strategy through Investor Class shares of the fund, Advisor Class shares (PAOPX), or the Institutional Credit Opportunities Fund (TRXPX). The net expense ratio is estimated to be 0.90% for the Investor Class shares, 1.00% for the Advisor Class shares, and 0.65% for the institutional fund. The minimum initial investment in the Credit Opportunities Fund is $2,500, or $1,000 for retirement accounts or gifts or transfers to minors (UGMA/UTMA) accounts. The Institutional Credit Opportunities Fund generally requires a $1 million minimum initial investment.

Correction

Posted on May 1, 2014 by Editorial Staff -

In our cover story two weeks ago about Nationwide Financial’s New Heights indexed annuity, our calculation of a hypothetical return under one of the product’s two-year crediting methods was over-simplified. To annualize a two-year return, we divided by two instead of taking a square root. We blame deadline pressure and age-related innumeracy for the error.

Our calculation

To annualize a hypothetical two-year gain of 30%, we divided by two to get 15%. We then multiplied that number by the participation rate (60%) and got 9%, from which we subtracted the annual spread (1.85%) for an annualized return of 7.15%. For simplicity’s sake, we ignored the extra return generated by participation in a fixed account with a one percent annual return, which would have added about 0.40%.

The right calculation

According to Nationwide, we should have multiplied the two-year index return (30%) by the participation rate (60%) to get (18%). Then we should have multiplied the compound two-year return of the fixed rate account (1.01 squared minus 1 = 2.01%) by its participation rate (40%) to get 0.804%. We should then have combined the 18% and the 0.804% to get a total two-year return of 18.804%.

To find the annualized return, we should have taken the square root of 18.804% (the square root of 1.18804 minus 1) to get 8.997%. Finally, we should have subtracted the annual spread (1.85%) to arrive at a total annual credit under the contract of almost 7.15%. The client would receive the square of that amount, or 14.8% for the two years.

Ten Images that Explain Retirement

Posted on April 30, 2014 by Kerry Pechter -

Longevity risk, Social Security maximization, diversification—these concepts are fundamental to conversations between advisers and their older clients. But they can be hard to explain in words alone, without an illustration or diagram.

You’d think it would be easy to find such images. Tons of relevant charts and graphs can be found on most financial services company websites. And financial planning software can generate multitudes of colorful retirement projections in a flash.

But just as the department stores are filled with beautiful clothes but no one looks especially well dressed, images that produce a shock of financial recognition in clients’ brains evidently aren’t so plentiful. A while ago, we asked retirement advisers to share some of their most effective visual aids with us. The most common response: “When you find some, let us know!”

So we searched for some, and we found ten examples that you and your clients might find useful and entertaining. There’s no magic pill here to banish client confusion; adviser input will still be needed. But, according to Catherine Mulbrandon, author of An Illustrated Guide to Income in the United States and founder of Visualizingeconomics.com, that’s the most you can hope for.

“A well-designed graphic will help people find the patterns in the data and highlight the out-liers,” Mulbrandon told RIJ recently. But “its true power is how it can be used in a conversation between the expert and the person unfamiliar with the subject by making the data clear and accessible.”

Inflation: Postage stamps tell a story

With today’s e-mail and texting, postage stamps are one of the buggy-whips of the information age. But many older people will remember, as children, collecting rare stamps in glassine sleeves or peeling the foreign stamps from airmail letters.

You can’t lick old stamps when it comes to illustrating inflation. David Laster, director of Investment Analytics at Merrill Lynch, shared a slide of vintage stamps (right) at the Retirement Income Industry Association conference last March. By showing clients that the price of a first-class stamp tripled from 1975 to 2005, he gives them an idea how much the price of most things could rise during their lifetimes.

Inflation is central to any retirement income discussion. Pre-retirees and retirees worry as much about inflation as they do about health care, surveys show. Advisors know that inflation protection is a big reason for retirees to own equities. If you decide to use the stamp method, try creating your own progression of old stamps (search for “commemorative stamps” at Google Images). For more precise inflation estimates, use this calculator.

Prioritizing: Maslow’s pyramid

Wealthy clients (unless they remember the Depression) don’t always differentiate between needs and wants, advisers are known to say. Even their necessities are luxurious. They tame snowy roads with BMW X-5s, even if Toyota Highlanders will do. Bosch D-Ws clean their dishes, even when a high-end Kenmore would suffice. And the habit may extend right into retirement.

Retirement usually requires budgeting, however. A retirement income planner’s typical first chores include helping clients identify their baseline expenses or needs (often to calculate the amount of safe or guaranteed income they’ll need). Another important step is to help clients prioritize their goals (and figure out how to finance them).

To illustrate his theory about the hierarchy of human needs, the 20^th century psychologist Abraham Maslow created a pyramid (a simplified version is at left). It’s been adapted for many purposes, including financial advice. New retirees or near-retirees may feel strong but vague needs for security and fulfillment; advisers can use the multi-colored pyramid as a prism to help clients get more specific. You can design your own pyramid, leaving the layers blank so that clients can ink in their own personal hierarchy of needs and goals.

Savings adequacy: Otar’s zones

The Toronto-area adviser and public speaker Jim Otar doesn’t like to waste time finding out if prospective clients have enough assets to retire on. He has a system. It involves simple but mathematically explicit diagrams. He asks clients to divide their total assets ($1 million, say) by their first year withdrawal during retirement. This number is the Client Asset Multiplier, or CAM.

The CAM can help people determine whether they don’t have enough money even to buy an inflation-adjusted life annuity large enough to pay for their basic retirement needs (Red Zone), if they have more than enough money, even without the safety net of an annuity (Green Zone) or if they are somewhere in between (Gray Zone).

This little diagram, Otar says, can tell the adviser which emotion he or she needs to focus on when talking to clients (hope or fear), whether the client can afford to retire with what he or she has now, and whether an income-generating annuity should be part of the discussion.

Asset inventory: Bachrach’s “Financial Road Map”

Bill Bachrach of Bachrach & Associates is a successful adviser who successfully trains other advisers. His online store sells items that other advisers can use in their practices. Among the items is a 17” x 22” piece of heavy stock printed in money-ish green and black on both sides and called “Financial Road Map for Living Life on Purpose.”

It’s really just a large worksheet with blank tables embellished with just enough map-like imagery to give clients a sense of planning a trip. There’s plenty of space for advisers and the clients to document the clients’ current cash reserves, debt, investments and insurance policies. There’s also space to list personal goals, along with blank cells for noting the date targeted for achieving the goal, the estimated cost of achieving the goal, the priority of the goal and two or three words that describe how the client will feel when the goal is reached. “The Financial Road Map” isn’t fancy, but its potential for helping advisers make clients feel more comfortable about sharing sensitive personal financial information is obvious. Packs of 30 can be purchased at Bill Bachrach’s website.

Asset diversification: Callan’s “periodic table” of investment returns

Some images produce enlightenment without much explanation. Callan’s annual “periodic table” of returns, which ranks the performance of 10 stock and bond indices for each of the previous 20 calendar years, is one of them. It’s a vivid wake-up call for clients who don’t fully grasp the volatility of market returns or the importance of diversification. “The Table highlights the uncertainty inherent in all capital markets,” says Callan’s caption.

The rankings are relative, not absolute. For instance, the Barclays Aggregate Bond Index returned only 5.24% in 2008 and the MSCI Emerging Markets Index returned 79.02% in 2009, yet they stand shoulder-to-shoulder as the performance leaders for their respective years. A printable copy of the periodic table is available at www.callan.com.

Behavioral economics: Carl Richard’s line drawings

Some advisers just use a pencil or a pen and a legal pad to illustrate financial concepts to their clients.

Anybody can draw a simple cross-section of a descending staircase, for instance, with steps showing the drop in income when a wife stops working, and when a husband stops working. The now-common income graph that almost every computer-generated retirement planning workup uses probably started out as a back-of-the-envelope drawing or a sketch on a legal pad.

The guru of simple Sharpie drawings is Carl Richards, a certified financial planner, author of The Behavior Gap, and New York Times columnist. He’s responsible for at least hundreds of simple graphs and Venn diagrams drawn on napkins or blank pieces of paper, each dedicated to illustrating a home truth about investing. One of the simplest and most direct is at left. You can see many of his drawings at behaviorgap.com, and buy high-res copies of any of them for $99 each. Or you can try drawing your own.

Time-segmentation: Macchia’s pillars

Few of us are CPAs but behavioral economists say that most of us practice “mental accounting.” We divide our wealth into notional categories. We distinguish between “play money” and “pay money,” or “college savings” and “retirement savings” and so forth.

That may explain the popularity of “bucketing” and “time-segmentation” as retirement income planning methods. The technique of designating different chunks of wealth for use soon (cash), later (bonds) or much later (stocks), or for necessary or discretionary purchases, etc., can lend a reassuring architecture to the fog of retirement. Ladders of bonds or income annuities also qualify as forms of bucketing. Purists call bucketing an illusion (especially if it implies that stocks are safe in the long-run). But illusions can help get clients through the night.

Creating an illustration of bucketing—perhaps as a cascade of periodically rebalanced accounts—is as easy as clicking-and-dragging pictures of buckets from a free graphics website onto your desktop. If you’re not a do-it-yourselfer, you can take advantage of images like the one above, which Wealth2K, creator of the Income for Life Method, uses to illustrate a time-segmentation method.

The complexity of decumulation: Pfau’s bulls-eye chart

Retirement income planning involves a lot of moving parts. There are as many potential solutions to the income challenge as there are retirees. Accumulation was so much easier. The bulls-eye chart developed by Wade Pfau, Ph.D., a professor at the American College and widely-published retirement researcher, can serve as a mental organizer for all those moving parts.

“The Retirement Income Challenge” is the title of his copyrighted chart, which consists of a circle in the center labeled “PROCESS: Combine Income Tools to Balance Goals and Risks” surrounded by three concentric rings labeled, from outermost to innermost: “Income Tools” (containing 20 sources of income), “Risks” (14 hazards) and “Goals” (six basic financial goals). Pfau posts a pdf of the chart on his blog.

Product allocation: Cloke’s glidepath

The retirement glidepath chart is now almost universally used by retirement planners. The x-axis of these columnar charts represents the years of retirement and the y-axis represents cash flow. Designs vary, but it’s common for the columns, like a row of test tubes, to be filled with the amount of income the client will receive each year. Different sources of income are typically represented by different colors.

The Burlington, Iowa adviser Curtis Cloke uses the chart at left to illustrate his proprietary retirement income method, known as Thrive. This particular chart includes both the accumulation and decumulation years. It uses the color green for the protection products, yellow for cash reserves and red for equities. Glidepath charts, which many financial planning software products can generate, are often able to speak more clearly to clients than spreadsheets can.

Glidepaths are easy to abuse, however. Depending on the underlying assumptions about investment returns and spending rates, they can easily be manipulated to give clients the reassuring impression that they will have far more wealth at the end of retirement than when they started.

Social Security claiming: The Impact Technologies grid

Ever since someone realized that the annual deferral bonus for delaying Social Security from age 62 to age 70 is far higher than the return on any other low-risk asset, there’s been unprecedented excitement around the much-maligned Old Age and Survivors Insurance program. A lot of advisers now use Social Security claiming strategies as a hook for client meetings and prospecting seminars. Software vendors have come up with a variety of Social Security maximization tools.

The Social Security Explorer software from Impact Technologies Group in Charlotte, N.C., uses a color-coded, nine-by-nine grid to make the claiming process more transparent. Each square represents a combination of ages (62-70) when spouses can choose start benefits.

Depending on the couple’s inputs, the software considers seven Social Security claiming strategies and executes 567 calculations for 81 age combinations. Then it puts a star in the box that represents the best ages for them to start benefits, and explains how to file. The grid, in blue, greens, magenta and beige, lends visual interest to a potentially dry task.

Websites referenced in the story, plus a few more:

RetirePreneur: Stan Haithcock

Posted on April 30, 2014 by Jenna Gottlieb -

What do you do? The name, ‘Stan The Annuity Man,’ speaks for itself. I sell only annuities, and only fixed annuities. I do not believe that annuities should be considered as market growth products. I don’t think you can have your cake and eat it too. If you want growth, buy growth. Not an annuity.

This belief puts me on an island. Annuities should be owned for four things—principal protection, income for life, legacy and long-term care. If you don’t need one or more of those four things, you don’t need an annuity. But too many people buy the dream, pushed by some agents, that they can have all the upside and none of the downside, or that one annuity can address all of their needs. Stan Haithcock R-Preneur box2

Why do clients hire you? I’m brutally honest and abrasively factual. I’ve been called the walking-middle-finger-of-annuity truth. I love that description and I embrace that role. Most agents use ridiculous catch-phrases to sell annuities. It’s not right. Annuities aren’t for everyone, and I’m not afraid to say that. I tell the good, the bad and the truth about these products. I’m Clark Howard, Ralph Nader, and Jim Kramer rolled into one… but angrier, bigger, louder, and more outspoken.

Where did you come from? Both my parents were basketball coaches, and I played for the University of Central Florida. Professionally, I was a wirehouse brat. I started out with Dean Witter, which was absorbed by Morgan Stanley. Then came Paine Webber, which was purchased by UBS. I took some time off and was kicking around and stumbled upon annuities. A friend suggested that I take a serious look at them because of my ‘to the point’ personality. At first I thought, ‘Give me a break.’

But then I got serious about it. I hired a PR branding specialist. We talked about names and held focus groups. My parents named me after ‘Stan the Man’ Musial, the St. Louis Cardinal Hall of Famer, so ‘Stan the Annuity Man’ stuck. I started speaking to large groups about annuities and writing articles for Marketwatch. I tell people that my ‘Stan the Annuity Man’ writings are actually me speaking, but without the cuss words. My articles and my new book, The Annuity Stanifesto, reflect that tone.

What’s next for the annuity business? Eventually, the consumer will tell to the industry, ‘Please, stop. We want simple, transparent products that we can understand.’ That will put pressure on the agent/advisor business. In the not too distant future, I predict, most annuities will be sold direct. We’ll see a shift toward simplistic products that you could explain to a nine-year-old. The consumer will demand it.

What is your own retirement philosophy? One word comes to mind—lifestyle. Lifestyle means different things for different people, but annuities can help provide the lifestyle people want through a contractually guaranteed transfer of risk. Baby Boomers and retirees need to stop chasing yield and growth and figure out how much income they need and just go live their life. The contrarian in me feels like I’m screaming into a hurricane with this simplistic message. Sometimes I feel like I’m one-of-none.

In 2013, Jackson National Broke Sales Records; VA Industry Broke Even

Posted on April 30, 2014 by Editorial Staff -

New variable annuity sales rose 1.1% in the fourth quarter of 2013, to $35.2 billion from $34.8 billion in the third quarter, a 1.1% increase. But year-over-year sales were off 1.5%, to $141.2 billion from $143.4 billion in 2012, according to the most recent Variable Annuity Sales and Asset Survey from Morningstar, Inc.

“These results are slightly better than our earlier prediction of a 2-3% drop in sales in 2013,” wrote Frank O’Connor, the project manager of Morningstar’s Annuity Research Center, in his quarterly VA sales and asset report.

Net cash flow was positive by only $1.3 billion for the year, meaning that the $141.2 billion in new sales was offset almost entirely by redemptions, surrenders and exchanges.

“Run off business from major companies that have exited the industry (notably Hartford, ING, and Sun Life) and the continued cash drain from group plans (e.g. TIAA-CREF) were responsible for net cash flow sinking into negative territory in the fourth quarter,” O’Connor commented.

“While the drag resulting from the resolution of high-liability blocks of business is temporary, expect the drag from group plan rollouts to only intensify as more Baby Boomers retire and cash out their annuity-funded plans.”

The VA industry may be starved for net sales growth but the issuers are presumably still making money on existing books of business. The surreal bull market in 2013 (surreal because the buying binge that buoyed the S&P500 by over 30% didn’t buoy the nation’s spirits much) pushed total VA assets to a record $1.87 trillion. Every 100 basis points earned on that notional sum represents $18.7 billion in revenue. The top 10 companies accounted for about 75% of total assets. Group annuity giant TIAA-CREF, which pioneered the variable annuity in 1952, alone had a 23.34% share.

In terms of their share of total annuity assets, 2013 saw significant advances by Jackson National, Ohio National, Protective, Minnesota Life and Jefferson National. The Hartford, Genworth Financial, Great-West and Cuna Mutual all saw double-digit declines in their market share of assets. Jackson National’s share of on-the-books VA assets jumped to $115.3 billion at the end of 2013 from $86.76 billion at the end of 2012.

Sales ranking were shuffled from the previous year. Prudential and MetLife ended 2013 in fifth and sixth place after finishing 2012 in first and third place, respectively. Prudential’s VA sales dropped almost 43% (to $11.4 billion) and its market share fell to 8.1% from 13.9%. MetLife’s market share fell to 7.5% from 12.4% on sales of $10.6 billion. Both companies were “grappling with ‘too many eggs in one basket’ and a need to rebalance their lines of business,” according to O’Connor.

Jackson National was the sales leader ($20.9 billion in new sales and 14.8% market share), followed by Lincoln Financial ($14.3 billion and a 10.1% share), TIAA-CREF ($13.9 billion and 9.9% share) and SunAmerica/VALIC ($12.1 billion in sales and an 8.6% market share).

Lincoln, SunAmerica, and Aegon notched 36.9%, 39.3%, and 59.3% sales gains, respectively. Prudential and MetLife were still major players with $11.4 billion and $11.0 billion in sales, and 8.6% and 8.1% of the market, respectively.

Three of Jackson National’s products were among the five best-selling contracts. Its Perspective II and Perspective L were familiar members of that group, but they were joined in the top five at the end of 2013 by the firm’s Elite Access B share, which topped a billion in sales ($1.02 billion) in the quarter, and gathered premia of $3.79 billion for the year. Elite Access B is a tax-deferred accumulation vehicle replete with alternative investment options but without a living benefit. Its success has forced other top issuers to follow its lead by creating similar products (see today’s article on the new Prudential Premier Investment VA).

On the distribution front, Jackson National was the top seller in the bank channel, the independent broker-dealer channel and the wirehouse channel. It was fourth in large regional broker-dealer channel sales. TIAA-CREF was the top-seller in the captive agent channel by a wide margin. Lincoln Financial was number one in regional broker-dealers. Fidelity was the leader in direct sales.

The top 10 variable annuity fund sub-advisors, as of year-end 2013, were: Wellington Management ($40.7 billion); T. Rowe Price ($37.8 billion); PIMCO ($34.1 billion); Quantitative Management Associates ($34 billion); BlackRock Investment Management ($31.5 billion); ING Investment Management ($29 billion); AllianceBernstein ($28.4 billion); AEGON USA Investment Management ($23.1 billion); Mellon Capital Management ($22.6 billion); John Hancock (Manulife) Asset Management ($21.1 billion).

Prudential adds an accumulation VA

Posted on April 30, 2014 by Editorial Staff -

Prudential Annuities, a unit of Prudential Financial, is the latest variable annuity issuer—Jackson National and Jefferson National paved the way—to introduce an accumulation-stage variable annuity that has no living benefit.

The product, called Prudential Premier Investment VA, is designed for tax-deferred growth rather than retirement income. This is how most VAs were designed and marketed before the advent of living benefits in the late 1990s and early 2000s.

Prudential has curtailed sales of its contracts with the Highest Daily living benefit. After selling almost $20 billion worth of that product in 2012, Prudential sold $11.4 billion in 2013, and fell from second place to sixth place in the VA sales rankings, according to Morningstar.

The new product is positioned as a hedge against potentially rising taxes. “An estimated 77% of Americans will have paid more taxes in 2013 than they did in the previous tax year,” said Bruce Ferris, president of Prudential Annuities Distributors, in a statement. “Prudential Premier Investment fills a market need by helping investors more efficiently manage their taxes and grow their wealth.”

The new VA contract will be offered in B-shares and no-surrender-period C shares. The insurance charge for the B series contract, which has a seven-year, 7% maximum surrender period, is 110 basis points per year (55 basis points for a premium-based insurance charge and 55 basis for an account value-based insurance charge). For the C series, the insurance cost is 135 basis points (67 basis points for the premium-based insurance charge and 68 basis points for the account value-based insurance charge). The contract has an optional return of purchase payments death benefit.

Contract owners can use either a “managed,” “guided,” or “customized” investment approach. The managed approach allows the investor to choose from among eight pre-built portfolios. In the guided approach, Prudential provides the asset allocations for five portfolios, ranging from conservative to aggressive, but the investor picks the specific portfolios. The customized option gives the investor free rein in choosing investment options.

The investment options include portfolios advised or sub-advised by: AQR, BlackRock, ClearBridge, Cohen & Steers, Franklin Templeton, Goldman Sachs, Herndon, Jennison, Loomis-Sayles, Lord Abbett, MFS, Neuberger Berman, PIMCO, QMA, T. Rowe Price, Western Asset Management and others. Portfolio operating expense ratios range from 59 basis points a year for the money market portfolio to 148 basis points a year for one of the asset allocation portfolios.

In one of the collateral documents on the new contract, a disclosure warns prospective policyholders about the potential consequences of investing in portfolios that owners of Prudential’s Highest Daily variable annuities with lifetime income riders might also be investing in. Some of the same portfolios are offered to purchasers of both types of contracts.

The disclosure said that because of the dynamic asset allocation formula that Prudential uses to manage risks in its contracts with lifetime income riders:

“the operation of the formula… may result in large-scale asset flows into and out of the underlying Portfolios through a series of transfers. In addition to increasing the Portfolios’ expenses, the asset flows may adversely affect performance by (i) requiring the Portfolios to purchase or sell securities at inopportune times; (ii) otherwise limiting the sub-adviser’s ability to fully implement the Portfolios’ investment strategies; or (iii) requiring the Portfolios to hold a larger portion of their assets in highly liquid securities that they otherwise would hold.”

Prudential advised owners of the new Premier Investment variable annuities to “consider the impact the formula will have on each Portfolio’s risk profile, expenses and performance” and to “work with your financial professional to determine which Portfolios are appropriate for you.”

New issue of The Journal of Retirement appears

Posted on April 30, 2014 by Editorial Staff -

The Spring 2014 issue of The Journal of Retirement appeared this week, with articles by Moshe Milevsky, Jeffrey Brown, Richard Fullmer, Jack Vanderhei and other prominent retirement researchers.

The following articles were listed in the table of contents:

Defined Contribution Plans as a Foundation for Retirement Security, by Jeffrey R. Brown and Scott J. Weisbenner.
Can Collars Reduce Retirement Sequencing Risk? by Moshe Milevsky and Steven E. Posner.
Retirement Adequacy through Higher Contributions: Is This the Only Way? by Michael Drew, Pieter Stoltz, Adam Walk and Jason West.
Evaluation of Target-Date Glide Paths within Defined Contribution Plans, by Richard K. Fullmer and James A. Tzitzouris.
Why Does Retirement Readiness Vary: Results from EBRI’s 2014 Retirement Security Projection Model, by Jack Vanderhei.
Retirement Income Research: What Can We Learn from Economics? by Gordon Irlam and Joseph Tomlinson.
Why Don’t People Annuitize? The Role of Advice Provided by Retirement Planning Software, by John A. Turner.
A review of “Retirement Income: Risks and Strategies,” by Journal of Retirement editor George A. (Sandy) Mackenzie.

Rising VA account values boost Prudential operating income in 1Q 2014

Jefferson National adds more alternative funds to its low-cost VA

T. Rowe Price launches new “unrestrained” high-yield bond fund

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