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Comment: Goodbye, Mature Market Institute

Posted on December 24, 2013 by -

The year 2013 cannot be allowed to end without a brief requiem for the MetLife Mature Market Institute. The respected in-house retirement think tank, which MetLife created in the late 1990s, was itself retired at the end of last May.

The decision to shut the MMI surprised few people, given MetLife’s overseas acquisitions and its pullback from domestic retirement businesses since 2010. But many were puzzled that the company would close a program that delivered so much bang for the buck, and at a time when the old-age boom is arguably still in its infancy.     

The MMI and its staff had lots of friends, and they were sorry to see it go. “It’s a big loss,” lamented Cindy Hounsell, the president of the Women’s Institute for a Secure Retirement (WISER), in a recent conversation with RIJ. “They did a lot of things that nobody else did.”

The staff of the MMI worked for 15 years out of a 10-person office in Westport, Conn. They sponsored dozens of non-partisan research reports, establishing a “Retirement IQ” and a “Retirement Readiness Index.” Their monthly newsletter, QuickFacts, was distributed to MetLife executives, sales team, brokerages that sold MetLife products, the national media, academics, legislators and retirement-related advocacy groups.  

The MMI’s last big report, published last May, was a 39-page write-up of a survey of Americans born in 1946, titled, Healthy, Retiring Rapidly and Claiming Social Security: The MetLife Report on the Oldest Boomers. (The MMI website is still up, and many of its reports are still available for download. But nothing new has been posted for six months.)

Though they knew they weren’t a profit-center, members of the MMI staff felt that they earned their keep by stoking good-will toward the corporate parent, scoring thought-leadership points, and burnishing the MetLife brand with the kind of positive press coverage that money can’t buy.

“We generated 60% of the PR for MetLife in the retirement space, even though we were a very small part of the budget. We did some things on the Hill and worked with the MetLife legislative department. We were quoted in the New York Times and Wall Street Journal,” said Sandra Timmermann, Ph.D., who had been executive director of the MMI.   

“We gave MetLife a chance to take the high road and not always be talking about products,” she told RIJ recently. “We had a constituency with the media and the external wholesalers. Some of the sales people in the retirement income area liked what we did. Our material was something they could use that was not transactional.”

John Migliaccio, the director of research at the MMI until last May, told RIJ, “This has been a topic of much thought and conversation, inside and outside of the MMI. Sandra and I received such an outpouring of incredulity and concern and dismay from hundreds and hundreds of people. I couldn’t keep up with all the emails. People were saying, ‘How could they be doing this?’”

MetLife’s reasons

Pessimists might be tempted to regard the MMI as a canary in the coalmine (or perhaps, given MetLife’s long association with Peanuts cartoon characters, the “Woodstock” in the coal mine). Just as the establishment of the MMI 15 years ago helped plant the MetLife flag in the Boomer retirement space, and helped define and promote the retirement space, so the end of the MMI might signal a loss of confidence in the potential of that space.

Since the MMI began, MetLife has tested the profitability of just about every product line within the Boomer retirement space—and eventually retreated from each of them, partly or entirely. (It was certainly not alone in doing so, but MetLife is a bellwether.) In the wake of the financial crisis, MetLife backed out of the reverse mortgage, the LTC, and the in-plan annuity businesses. After suddenly ramping up its variable annuity business with rich options in early 2011, it quickly downsized its sales targets for that business once the risks of big blocks of VAs with living benefits became clear. 

One prominent casualty in mid-2012 was Jody Strakosch, the firm’s popular National Director of Retirement Products. She had led MetLife’s ambitious “SponsorMatch” initiative, a co-venture with BlackRock that would have brought deferred income annuities to the 401(k) world. Plan sponsors weren’t interested, and BlackRock subsequently proceeded with a much different program called LifePath.

Given its frustrations with these businesses, the discontent of its shareholders and equity analysts, and the Fed’s debilitating (for insurers) low interest rate strategy, it’s not surprising that MetLife decided to look for financially greener pastures. In 2010, the company went through what analysts called a “transformational” change when it bought Alico and other global insurance properties.

With those acquisitions, MetLife’s estimated share of revenue from outside the U.S.—in Asia, Latin America and Eastern Europe—jumped to 40% from 15%. As management’s attention naturally shifts in that direction, however, it implies that it no longer considers the Boomer retirement market as the best growth opportunity for a U.S. life insurer—especially not for a publicly held life insurer with impatient shareholders.

“No life insurance company is not going to not sell to the retirement market,” said Timmermann, who earned her doctorate in education and gerontology at Columbia Teacher’s College. “But MetLife said they’re looking at other priorities. They’re going global. They’re also looking at selling to younger markets, and the new product sets are not necessarily geared to retirees—like life insurance and employee benefits.”

Magma from a volcano

Is this an omen that the low interest rate environment in fact has permanently hobbled the Boomer income opportunity for life insurers? Migliaccio, for one, doesn’t think it should be. “I’m not mystified about their decision [to close MMI] at the tactical level,” he said. “But at the strategic level it just doesn’t add up.” For him, the retirement wave is still just getting started.

“This is not something where you can say, ‘Oh well, the time is past. Let’s look at another demographic here or overseas.’ The retirement wave is happening everywhere. It’s like magma coming out of a volcano. You can’t stop it. The oldest of the Baby Boomers are just now moving into this arena,” he said.

“There are trillions of dollars in 401ks, even with half of the people not having an opportunity to save that way. Loaded on top of that, you have the $11 trillion intergenerational transfer between the Boomers and their parents. To say, ‘We’re not looking at that market anymore’—that baffles me.”

His concern is that a tilt away from the U.S. retirement business by a giant like MetLife might create a vacuum that non-insurers will gladly inhabit. “You might see a new species coming in. It will probably be the investment companies. A Fidelity or Vanguard or someone else on the brokerage side. They don’t have the same regulatory pressures or the reserve requirements that the insurance companies have,” Migliaccio told RIJ.

At least one blogger who listened to MetLife’s third-quarter analysts call suspected the company of doubting not just the near-term prospects of retirement-related businesses but of the U.S. economy itself. He took it as a bad sign that CEO Steve Kandarian told analysts not to expect earnings guidance from MetLife in the foreseeable future.

“To me this means that MetLife is very unsure of what the future holds,” wrote David White on the SeekingAlpha blog. “It means that it sees a considerable chance for a downturn in its business and in the overall US and world economies.”

So, is the shutdown of the MMI a sign of dire trends, or just part of the creative destruction that’s going on at MetLife? One thing is clear: a lot of people in the retirement industry are sorry to see the MMI close up shop.  

© 2013 RIJ Publishing LLC. All rights reserved.

A Crash in Late 2014?

Posted on December 24, 2013 by -

One year ago, in a year-end column for 2012, I predicted that the easy-money bubble would continue inflating through 2013, which should be a good year for asset prices, but that 2014 would be more problematic.

Having been “right so far” with this prediction, I thought it worth re-examining to determine whether the crash will indeed occur in 2014, as I then predicted, or whether investors may be able to enjoy another good year before doom hits. My crystal ball is more clouded than it was a year ago, and the first half of 2014 looks good, but I wouldn’t be too certain about the fourth quarter.

I was certainly right to be pretty optimistic for 2013. The Standard & Poor’s 500 Index is up today 25% from Dec. 31, 2012, and the Dow Jones Industrial Average is up 21%. On the other hand, the MSCI World Ex. U.S. Index is up only a more modest 12% and gold is sharply down, by about 26%.

I confess an expensive error in the last area – it seemed to me (and still seems) that with Japan having joined most Western economies in mad monetary stimulus, gold had to rise sharply—indeed I suggested a price of $3,000 an ounce. Instead, all the money seems to have gone into Bitcoin—a sad commentary on the downfall of solid values in modern life. Still, overall, I was right for 2013 and am tempted to repeat the prognostication for next year.

Well, let’s have a look, shall we? If next year is an exact replica of this year, the S&P 500 Index will end at 2,224 and the Dow Jones Industrial Average will end the year at 19,232. Gold, on the other hand, will end the year at $912. Hmm.

I have to say that combination looks pretty unlikely. I could indeed see gold at $912, which would imply that monetary stimulus had been scaled back and that the inflationary psychology had been eliminated from the markets—including those in India and China from where the majority of today’s incremental demand for gold arises. Perhaps we would have had some actual deflation in the West, with prices declining, thus removing gold’s psychological advantage as an inflation hedge.

In that case, real interest rates would have risen, since at least long-term rates can’t fall below zero. Corporate profits would surely have fallen and much of the bubble psychology would have been wrung out of the stock market. In other words, the S&P 500 Index would most likely be chasing the gold price down toward 900.

Conversely, to get the S&P 500 index up to 2,224, corporate profits would have to show considerable further oomph beyond today’s level, which is already an all-time high in terms of U.S. Gross Domestic Product. To get profit margins rising like that money would still have to be very cheap and inflation would have to have ticked up a bit. In that case, gold would surely be chasing the S&P 500 Index up beyond $2,200.

In other words, 2014 can’t be like 2013. It will therefore have to be different. Polish the old crystal ball, and let’s estimate in which direction the differences might arise.

One factor that should make us bearish is that everyone else is bullish. The top-ten Wall Street banks, polled by Marketwatch, all think the market will be higher at the end of 2014 than it is today. They forecast rises in the S&P 500 Index ranging from 4% to 17%—all of them short of the “naïve” forecast of 25%, let it be noted. That’s not definitive. You could get a net rise of 10% on the year with a market that rose 50% and then turned round and fell 27%, in which case the net 10% rise would pretty clearly be the harbinger of dark days ahead in 2015.

However, the overall optimism of Wall Street pundits does suggest that most of the buyers are in the market already, which you’d expect in a market up 25%. Those who were out—or who like me bet on the sectors of precious metals and emerging markets that have performed worst this year—have to feel pretty stupid right now. 

Ben Bernanke’s decision last week to reduce the amount of bond purchases undertaken by the Fed is bullish for the long term—at least as it avoids one form of catastrophic risk—but it clouds the picture in the short term, although the market’s initial reaction was euphoric.

According to Bernanke, we can expect a gradual further decrease in bond purchases, perhaps with a $10 billion decline at each Fed meeting in 2014 so that by the end of the year purchases would have halted altogether and the Fed balance sheet would have stabilized at $4.5 trillion. That’s a much more tolerable situation than we would have been facing if Bernanke hadn’t tapered: expanding the Fed’s balance sheet until it swallowed the U.S. economy.

The global economy is nowhere near capacity, which leads me to suspect a further lengthy period of recovery before the next recession hits. You’d expect recovery to continue fairly slowly in the rich Western countries, as wages continue equalizing between the West and emerging markets.

On the other hand, there seems no reason why Africa should not continue to get rich rapidly. Indeed, while Chinese growth has slowed and India, Brazil and Russia have all in their different ways run into problems, sub-Saharan Africa is so much poorer than other emerging markets (at around $1,400 per capita GDP compared with $9,600 in Latin America) that it should have a decade or so of rapid growth ahead before the inevitable constraints of its poor government and infrastructure really begin to bind.

Nevertheless, between the two extremes of an early crash and a stock-market boom that goes on and on, there seems to be a likely outlook somewhere in the middle. At the extreme case, it would seem very unlikely that the current market boom can last until the end of 2015, even if the Fed does indeed hold short-term interest rates near zero for the whole period.

For one thing, long-term interest rates have risen substantially in spite of the $85 billion of monthly bond purchases. So reduction of the pace of bond purchases should cause the rise in rates to continue, or otherwise accelerate. In the long run, that has to cause a market decline as corporate profits will be affected.

At the other extreme, the Fed still will be purchasing $50 billion or more of bonds monthly until the middle of next year, which should limit the rise in long-term rates in the next six months. Only when Fed purchases taper toward zero, in the second half of 2014, does the current market euphoria seem likely to lessen.

In the meantime the market will have gone much higher—it is rising at far more than the average market prediction of 10% a year—because of the flood of money into it, and should continue doing so.

On balance, therefore, we can guess at a market peak sometime between Sept. 2014 and June 2015, at a level much higher than the current one. We can, however, be pretty sure that once the market has peaked, its fall will be both prolonged and steep. Long-term interest rates will rise, so corporate profits will decline. The mass of malinvestment caused by the last five years of zero short-term interest rates will be a massive overhang on the market.

The outlook for investors is thus difficult. The opportunity to make money will extend for only a few more months, after which there will be a period, possibly as long as 3-4 years, during which any foray into the market will be rewarded by massive losses. Sell too early and you could miss not just the last 10% of the run-up, but the last 30-40% if it extends into 2015. Sell too late and your invested capital will spiral into the abyss.

In any case, bears can be comforted by one thing: the higher the market climbs, the harder it will fall.
© 2013 Prudent Bear, Martin Hutchinson.

IRI publishes a look back at 2013 and look forward to 2014

Posted on December 19, 2013 by -

The Insured Retirement Institute, a lobbying organization for manufacturers and distributors of annuities, has issued a review of the events of 2013 and a preview of its expectations for 2014 in the areas of annuity products, sales, and regulation.

The “State of the Insured Retirement Industry” report offers a comprehensive appraisal of the annuity industry, with special attention to reasons for optimism: rising bond yields, aging Baby Boomers, innovative annuity products, and support from the Obama administration for guaranteed lifetime income tools.

On the issue of social media, the report notes that “the financial services industry lags behind other industries in using social media.” One problem: broker-dealer face an estimated social media startup cost of $50 per month per registered rep just for “regulatory monitoring and archiving expenses.”

The report introduces a relatively new acronym, “GOVA.” It stands for “growth-oriented variable annuities,” and refers to contracts with low fees, numerous investment options and no lifetime income benefits.

In a linguistic gesture that may dismay some fund companies, the report refers to “volatility funds” when describing managed-volatility funds, which use some combination of dynamic asset allocation and derivatives strategies to protect investors from extreme market fluctuations.

© 2013 RIJ Publishing LLC. All rights reserved.

Fitch sees stability for life insurers in 2014

Posted on December 19, 2013 by -

The release of Fitch Ratings’ “2014 Outlook: U.S. Life Insurance” report this week was upstaged by the Federal Reserve’s indication yesterday that it would taper its monthly bond-buying policy slowly over the course of 2014 and keep interest rates low for the foreseeable future.   

While the equity markets loved the Fed’s reassurances, which sent the Dow up almost 300 points on Wednesday, the life industry might have preferred something different. According to the Fitch Outlook, a 50 to 100-basis point uptick in rates would “have positive implication for our outlook on U.S. life insurers.” 

But Fitch acknowledged that the Fed’s low-rate policy has helped life insurers in two ways. It has buoyed equities, which help fund variable annuity guarantees and raise fee revenue. It has also helped revive the economy, which in turns has stabilized the bond market.

Overall, Fitch’s near-term outlook for the life insurance industry is “stable,” assuming no major interest rate spikes, no international crises and a continuation of the weak recovery, modest GDP growth and high unemployment.

A sustained interest rate spike would be an increase of 500 basis points or more, the report said. A jump of that magnitude would instantly reduce the value of the insurers’ bond portfolios and cause flight from products with low fixed crediting rates.

A rate spike wouldn’t be all bad, Fitch said. It would make payout annuities, long-term care insurance and universal life products with no-lapse guarantees more attractive.

Fitch mentioned three areas of concern for life insurers: the continued drag on profitability from legacy variable annuity business, uncertainty over the possibility of new regulatory structures, and “macroeconomic shocks,” such as a decline in the creditworthiness of U.S. sovereign debt. 

The new year could bring an increase in mergers and acquisitions in the life insurance industry, Fitch noted. More European insurers are expected to divest U.S. life subsidiaries, partly in reaction to Solvency II capital requirements. Also, private equity firms are expected to continue to look for opportunities to pick up assets at bargain prices and to establish a footprint in the ever-growing retirement market.

© 2013 RIJ Publishing LLC. All rights reserved.

W&S FGD introduces managed-risk investment strategy to GLWB rider

Posted on December 18, 2013 by -

The guaranteed lifetime income benefit rider on variable annuities offered by Integrity Life and National Integrity Life is now linked to a managed-volatility investment strategy, according to a release from W&S Financial Group Distributors, Inc., the wholesaler of annuities and life insurance issued by companies in the Western & Southern Financial Group. 

The new managed-volatility investment options are:

  • American Funds Insurance Series Managed Risk Asset Allocation Fund
  • Fidelity VIP Target Volatility Portfolio
  • TOPS Managed Risk Moderate Growth ETF Portfolio

Investors electing the strategy may allocate among the options in any combination, including up to 100% to a single option.

In addition, six new investment options are available to owners of the AdvantEdge, AnnuiChoice and Pinnacle variable annuities issued by Integrity Life or National Integrity Life.

The new funds are available within the “self-style” investment strategy of Guaranteed Lifetime Income Advantage, the GLWB rider. (To use the self-style strategy with the GLWB, investors must keep at least 30% of their assets in bonds. Those who use the managed-vol strategy are exempt from the 30% bond requirement).    

The six new options include:

  • American Funds Insurance Series Global Growth Fund
  • American Funds Insurance Series Growth Fund
  • American Funds Insurance Series Growth-Income Fund
  • American Funds Insurance Series Managed Risk Asset Allocation Fund
  • American Funds Insurance Series New WorldFund
  • Fidelity VIP Target Volatility Portfolio

 © 2013 RIJ Publishing LLC. All rights reserved.

Time, money, age and advice: They’re all connected

Posted on December 18, 2013 by -

When people decide either to seek investment advice, manage their money themselves, or just ignore their finances, they’re acting more rationally than you might think. Consciously or not, they do a mental cost/benefit analysis of the situation—weighing the value of their time, their own abilities and the amount of money they have.

So posits a new article Olivia Mitchell of the Wharton School, Raimond Maurer of Goethe University, and Hugh Kim of Seoul-based SKK University,called, “Time is Money: Life Cycle Rational Inertia and Delegation of Investment Management” (NBER Working Paper 19732).

The article offers some potentially valuable marketing insights. It ambitiously tries to quantify what has hitherto been difficult to quantify, such as the value of financial advice. And it makes some interesting observations about age-specific investor behavior.      

At any given life stage, the authors say, people tend to manage their investments in one of three ways: by doing nothing (“inertia”), by doing it themselves (“self-management”) or by consulting a financial advisor (“delegation”).

The young don’t have a lot of money yet and they’re too busy building up their professional skills to pay much attention to their finances. They tend to let inertia have its way until they enter their 30s. That’s unfortunate, because getting professional advice “from the beginning of the lifetime boosts welfare by 2.5%,” the authors suggest. By “welfare,” they mean consumption.

Evidently, as people enter their 40s and 50s, they have more savings, more street-smarts and are more secure in their careers, so they have the means, motive and opportunity to manage their own finances. “The middle-aged are more active, since this group is the most efficient in terms of financial decision-making.” It takes them only about 3% of their time to manage their money, which they can easily afford. “Still, however, almost 85% of the middle-aged group does not change portfolio allocations.”

The willingness to self-manage tends to rise as people retire and have more free time. “The fraction of self-managing investors jumps from 15% to about 30% at age 65,” the paper says. Then, as mental agility begins to decline with age, so does the urge to self-manage.

Just as people sleep a big chunk of their lives away, so they spend most of their lives not paying much attention to money management. Even though investors change their portfolio management approaches 6.58 times during their lifetimes—which sounds like a lot—they spend an average of 66.44 years doing nothing, the paper said. They self-manage for an average of 13.56 years, and begin self-management, on average, about 30.87 years after they enter the work force.   

The paper has good news overall for advisors. It claims that access to an adviser “boosts wealth more than 20% across all age groups,” mainly because people with advisers hold more equities and because outside advice lets people devote more time to climbing the career ladder. Professional advice is associated with a 2% increase in consumption, starting at age 50 and continuing through retirement. 

© 2013 RIJ Publishing LLC. All rights reserved.

Czechmate: New government will end auto-enrolled DC plan

Posted on December 18, 2013 by -

The Czech Republic’s incoming coalition government says that it intends to close down that country’s recently-created “second-pillar” pension system by the beginning of 2015, IPE.com reported. Only 83,753 Czechs had joined the plan as of the end of November.

The coalition, led by the Social Democrats, will merge existing second-pillar accounts with the voluntary “third pillar” defined contribution plans. It’s not clear what will happen to the thousands of second-pillar members without an existing third-pillar account.

The second pillar plan was introduced in 2013 by the former government of Petr Nečas. It was funded by diverting 3% of the nation’s 28% social contribution (similar to our payroll tax), plus 2% of wages from members. The system was voluntary, but employees were auto-enrolled in it and participation, once begun, was irrevocable.

Parts of the second pillar program were unpopular, such as the requirement for workers to contribute an additional 2% of pay and their lack of access to their money before retirement. The low, legally capped commission that financial intermediaries would receive from pension companies also reportedly weakened support for the second-pillar plan.

Since 1996, the Czech Republic has had a universal pay-as-you-go “first pillar” old age pension funded by a mandatory 21.5% employer contribution and a 6.5% employee contribution. The earnings base on which pensions are assessed is 100% up to CZK 8,400 per month, 30% between CZK 8,400 ($417) and CZK 20,500 ($1,019), and 10% above this sum.

This pension could be supplemented with a voluntary defined contribution plan (the third pillar), and participants could choose between a state asset manager and private investment management. At the beginning of this year, the former government created a second pillar, characterized by auto-enrollment, and the third pillar was closed to new accounts and contributions.

The move to shut down the second pillar had been expected. Bohuslav Sobotka, chairman of the opposition Social Democrats (CSSD) and leader of a three-party coalition, had said that his party would scrap the system if it won the next election, scheduled at the time for 2014.

The Social Democrats didn’t have to wait that long. Nečas resigned in June following a series of scandals. The interim leader, Jiří Rusnok, lost a confidence vote in August, precipitating an early general election last October.

The change would have a minimal impact on Czech finances, unlike Poland’s current second-pillar overhaul.

“My expectation of this outflow is CZK800m (€29m) in 2014, slightly more than 0.2% of the state budget for pensioners,” said Pavel Jirák, chief executive and chairman of the board at KB Pension.  

“It was more of a political than an economic issue. The change is expected from the beginning of 2015. None of the participants would lose their second-pillar money through the merger, in accordance with the Czech constitution,” he added.

“We are still convinced the creation of the second pillar was the right step towards diversifying financial sources for retirement, and a good long-term solution given the unfavorable demographic trends and their negative impact on state pension financing,” he added.  “So we are against this merger – but without any power to stop or influence it,” he added.

According to Pensionfundsonline.co.uk:

  • The minimum age at which payments can be received from a Czech pension fund is 60, provided a minimum number of contributory years, which is regulated by each pension fund.
  • If money is withdrawn from the account before this age, the state matching contributions have to be repaid and there is additional taxation. Generally, money can be withdrawn as a lump sum or in the form of regular installments.
  • The state matches employees’ contributions depending on their level of contributions. For member contributions between CZK 100-199, the state adds CZK 50 plus 40% of the member contribution above CZK 100.
  • If the pension plan member contributes between CZK 200 and 299, the allowance is CZK 90 plus 30% of the sum above CZK 200. The allowance gradually increases with the highest allowance (CZK 150) for members contributing more than CZK 500.
  • Employers can deduct their contributions from their tax base up to 3% of an employee’s assessment base. Employer contributions of up to 5% of their wages are exempt from income tax for the employee.

© 2013 RIJ Publishing LLC. All rights reserved.

RetiremEntrepreneur: Robert Klein

Posted on December 18, 2013 by -

Robt Klein text box

What I do:  I’m a retirement income planner who develops and manages strategies for creating and optimizing retirement income. I recommend and implement conservative retirement income planning, management, and protection strategies that aren’t available, and often aren’t discussed, in traditional stand-alone investment advisory firms. I help my clients maintain their independence and dignity, and increase their opportunities to provide for a legacy for their family, heirs, and charitable organizations, if that’s their goal. To me, it’s extremely exciting to do this work because this part of the business is relatively new. We’ve been doing retirement planning forever, but the last several years it became retirement asset planning vs. retirement income planning. It’s a thriving, growing field and I feel like a kid again, starting over in this niche.

Who my clients are:  Retirement Income Center’s clients are generally successful higher net worth individuals who are approaching, or are in, the retirement phase of their life. They understand that retirement income planning is complex and requires expertise and experience to help them achieve their financial goals and have peace of mind. Initially, many of my clients come to me when they have a problem. Some are looking to sell a business, or are contemplating the sale of real estate or stock, and they need help with a large lump sum of money. They want to translate that into an inflation-protected lifetime income stream while minimizing tax consequences.

Why people hire me:  My clients appreciate the independent, comprehensive, personal touch I bring to the table. They understand that my attention to detail and responsiveness is second-to-none, and allows them to sleep better at night. Last, but not least, my clients know that I always place their needs first and that I value and respect my professional relationship with them. For our initial meeting, I request that prospective clients don’t bring in financial information. I want to get to know them, and allow them a chance to get to know me.

How I get paid:  Retirement Income Center, unlike other financial services firms, isn’t tied to a single compensation model that it depends on for the majority of its revenue. Our initial retirement income planning analysis and recommendations are generally provided on a fixed-fee basis. All subsequent services are delivered using traditional financial services compensation methods. These include investment advisory services for which we use an assets-under-management fee schedule. I also offer fixed income annuity and other insurance strategies, including life, long-term care, and disability, as a licensed insurance agent appointed with multiple highly-rated life insurance companies who pay me commissions in connection with sales of their products.

Where I came from:  I grew up in New Jersey, received a B.A. in Economics from Rutgers College, an MBA in Accounting from Rutgers Graduate School of Management, and an M.S. in Taxation from Golden Gate University. After obtaining my CPA license and working for CPA and financial planning firms in New York and New Jersey, I earned my CFP designation. I moved to California in 1986 and founded the CPA financial planning firm, Robert Klein, CPA in 1989, which continues to provide income tax and accounting services to its clients. I got my entrepreneurial spirit from my father. When I was growing up, my father had his own insurance business, and his independence rubbed off on me. I saw the benefits of doing things yourself and accomplishing things on your own terms.

My view on annuities: Although I’ve seen a change in recent years, I feel that annuities are often misrepresented and misunderstood by the public. The annuities that I include in my recommendations are fixed income annuities, which provide sustainable lifetime income. I own fixed income annuities, and a lot of the things I recommend to clients, I’ve done personally. I always try to put myself in my client’s place. In a way, I can say ‘I’ve been there, I’ve done that and I know that it makes sense for you.’

My personal retirement philosophy:  I believe, first and foremost, you should always be striving to grow as a person and obtain the experiences in life that allow you to do this. Planning for retirement is part of this evolution and needs to consider lifestyle as well as financial issues. A retirement income planning mindset should be adopted as early as possible to give us the freedom, flexibility, and ability to choose when, where, and how we want to retire and to continue to live the life we want to live. Finally, when the day comes when we’re physically and/or mentally limited in our ability to sustain the life we’ve cherished, we need to have a plan in place for protecting the assets and income we’ve accumulated without physically, financially, and emotionally burdening our family and other loved ones.

© 2013 RIJ Publishing LLC. All rights reserved.

What Fools These Mortals Be

Posted on December 18, 2013 by -

Here’s an offer you can easily refuse: Send me $100,000 in cash today, and let me keep it for at least three months. At the end of that time, I will give you $250… and maybe a bunch of commission-free online trades to boot.

Attractive? No, not really. But a significant number of day traders or would-be day traders must be vulnerable to this sort of temptation. Why else would serious companies like Merrill Edge, TDAmeritrade, and E*Trade offer nearly identical variations of it?

You’ve seen the ads in glossy magazines or on television. The three companies named above all promise “up to $600” to anyone who funds a new brokerage account with money that’s new to the firm. 

After seeing a few of these ads, I thought it would be edifying to go online and read the fine print behind these teasers. As you might suspect, the offers aren’t nearly as generous as the headlines suggest.      

Merrill Edge

Merrill Lynch pitches a “Simply a Great Offer”: Up to $600 when “you enroll, open and fund a new Merrill Edge investment account or IRA.” But you have to move at least $200,000 in cash or securities to Merrill Lynch in order to qualify for $600.

If you bring between $25,000 and 49,999 to Merrill Edge, you get $100. Bring $50,000 to $99,000 and you get $150; bring $100,000 and you get $250; to get $600, you must bring $200,000 or more. The money must come from outside Merrill Lynch and Bank of America (including Merrill Lynch 401(k) plans), must arrive within 30 days of the opening the account, and must stay for at least 90 days.

Even then, you don’t get your bonus right away. “Please allow up to 45 days for the cash reward to be credited to your account,” the footnote said. I called Merrill Lynch’s customer service line to ask if my account would bear interest. The phone rep said yes: at the rate of one basis point per year (0.01%). If I put my money in a money market account it could earn 1.15% per year, he said, but I wouldn’t be able to trade in and out of that account.

The Merrill Edge offer came with 300 commission-free equity, ETF or options trades, which had to be executed within 90 days. In addition, anybody who maintains a balance of at least $25,000 at Merrill Edge gets 30 commission-free trades a month, every month.

TD Ameritrade

TD Ameritrade’s bonus offer was slightly different. There, the account must be opened by December 31, 2013, and funded within 60 days with $2,000 or more. To receive a $100 bonus, the account must be funded with $25,000 within 60 days; to receive $300, it  requires $100,000 or more; and to receive the maximum $600 bonus, the account must be funded with $250,000 or more within 60 days of account opening.

Regarding the amount of time your money must be deposited, TD Ameritrade is more demanding than Merrill Lynch. “The Account must remain open with minimum funding required for participating in the offer for nine months, or TD Ameritrade may charge the account for the cost of the cash awarded to the account,” the disclaimer on the firm’s website said. (Emphasis added.)

The TD Ameritrade program comes with 500 commission-free online trades of equities, ETFs or options. They must be used within 60 days of opening an account.

E*Trade

This online discount brokerage, whose hard-boiled toddler-spokesperson is as familiar as GEICO’s green-and-yellow gecko, demands more skin-in-the-game than the others. New accounts must be funded with at least $10,000. But the top bonus is $2,500, not a mere $600. Like TD Ameritrade, E*Trade offers 500 commission-free trades, available during the first 60 days after the account is funded.

To get the full $2,500 bonus, you have to deposit $1 million at E*Trade. People who deposit $500,000 to $999,999 get $1,200; people who deposit $250,000 to $499,999 get $600; those who deposit $100,000 to $249,999 get $300; those who deposit $25,000 to $99,999 receive $200.

Please note that not all $600 bonuses lead to the same service. Merrill Lynch can afford to offer a slightly less attractive bonus because its flat online trading fee is just $6.95, compared with $9.99 for TD Ameritrade and $7.99 at E*Trade (for people who trade 150 to 1499 times a quarter).

OK, I get it. These three firms compete strenuously for the loose cash of over-confident amateur traders (many of whom might just as well apply their animal spirits to slot machines, the Lotto or bingo at the Odd Fellows lodge). In a hyper-competitive market, you need a sexy teaser just to lure eyeballs to your website. If one brokerage firm promises a bonus, the others have little choice but to match it.

But it’s tacky, frankly, to offer cash—and so little cash, relatively speaking—to potential investors. It also seems vaguely unsuitable to solicit hundreds of thousands of dollars from people without knowing if they can afford to put that much at risk. As for meeting a fiduciary standard, forget it. If day trading is a losing game, as everyone knows it to be, no fiduciary could recommend doing it. 

It’s surprising that such promotions are even legal. A few years ago, after repeatedly watching the talking E*Trade baby imply that anybody with a sippy cup, a highchair and a smartphone can succeed as a day trader, I called FINRA to ask why or how such an ad could elude the compliance police. I was told that because E*Trade provides an investment service, not an investment product, none of the usual rules against promissory claims applied.

I find it a little scary to think that a retiree or job-changer could roll his or her entire 401(k) nest egg into a discount brokerage IRA account, invoke the spirit of Jim Cramer, and start betting on short-term volatility.

© 2013 RIJ Publishing LLC. All rights reserved.

Is There a Retirement Crisis or Not?

Posted on December 18, 2013 by -

Is there or isn’t there a retirement crisis in the United States? It depends on what you read, and which retirees or near-retirees you have in mind. Two recent reports by well-known organizations arrive at very different conclusions on the wellbeing of the American retirement system and American retirees.

On the one hand, a respected academic group, the Center of Retirement Research at Boston College, whose National Retirement Risk Index is sponsored by Prudential Financial, claims that more than half of American households are headed for a drop in living standards after they retire.

On the other hand, three retirement industry groups—the American Council of Life Insurers, the Investment Company Institute, and the American Benefits Council—just released a study claiming, “workers generally maintain their standard of living when they retire.”

How could two groups reach such different conclusions? Partly by using different data, partly by opting to favor averages over medians or vice-versa, and partly by having different goals: to shake up the status quo or to protect it.

The dim view

The Center for Retirement Research at Boston College, with funding from Prudential publishes an update of its National Retirement Risk Index every few years. It offers a rather grim view of Christmas Future for retirees.

In a recent study, “Will the Rebound in Equities and Housing Save Retirements?,” a CRR research team asserted that “half of today’s working age households are unlikely to have enough resources to maintain their standard of living once they retire.”

“As of 2010, even if households worked to the age of 65 and annuitized all their financial assets… 53% of American households were at risk,” wrote Alicia Munnell, Anthony Webb and Rebecca C. Fraenkel.

Despite the equity market’s rebound since 2010, the retirement outlook remains dire for many, the CRR believes. That’s because most people don’t own stocks and because home values—the basis for reverse mortgages, which are factored into the NRRI—are still depressed.

“While stocks are slightly higher than their pre-crisis peaks, house prices are still substantially lower in real terms than in 2007,” the CRR report said.   

Stock ownership is also highly concentrated, so even an ongoing equity boom wouldn’t change the fact that more than half of today’s households won’t have enough resources to maintain their standard of living once they retire.

“Equities are only a miniscule amount of the wealth of low-income households and only % percent of the wealth of those in the middle- income group; only for the top third of the income distribution are equities a significant portion of total wealth.”

Evidently, if you have a large portfolio and a lot of home equity, you’re likely to be well prepared for retirement. For the rest, the best way out of this predicament is to save more and work longer, according to CRR.

The sunny view

And now, for something completely different.

A joint research report from the ABC, ACLI and the ICI had a decidedly rosier evaluation in a report that was largely a defense of the voluntary, tax-deferred employer-based retirement savings system, exemplified by the 401(k) plan.

Their report, Our Strong Retirement System: An American Success Story, found that Americans’ retirement prospects have improved greatly over time, with near-retirees averaging about $360,000 in their defined contribution and IRA assets.

The report found that retirement assets constitute a major share of household savings and investments, which it said speaks to the health of the investment industry, and investors’ confidence in the retirement system.

“The saving and investments held in the retirement system represent the largest component or share of American households’ total accumulated financial wealth,” said the report.

“At the end of June 2013, total retirement assets of $20.9 trillion, as tabulated by ICI, represented 34% of $61.9 trillion in all household financial assets in the United States.” Of that amount, about half is in employer-sponsored retirement plans and IRAs. The rest is in private defined pension plans, annuity reserves and government retirement plans. 

Regarding the ability of savings to provide retirement income, the report cites Internal Revenue Service data showing that “income from wages, Social Security benefits, employer-sponsored retirement plans, and IRAs, net of taxes and adjusted for inflation, on average remains fairly stable in the year individuals first claim Social Security benefits and for three years thereafter. For three-quarters of these individuals, income in the year in which they retired equaled 87% or more of their income in the prior year.”

Why the difference?

It’s not easy to measure how well Americans in general are prepared for retirement, or what percentage of Americans are on track to be financially secure in retirement. There are blind spots and inconsistent benchmarks in the data. The definition of “Maintenance of pre-retirement standard of living” seems like a hard thing to gauge.

It’s easy to see, however, how two different organizations are able to find evidence that supports opposing conclusions about retirement readiness. It’s true that Americans as a whole have saved a lot for retirement and own a lot of securities, much of it through their 401(k) plans. It’s equally true that the savings is concentrated at the successful end of the income spectrum.

For example, the March 2013 National Compensation Survey showed that 59% of all full-time private industry workers were participating in a retirement plan. But only 20% of part-time workers were. Comparing union with non-union workers, the participation rates were 86% and 45%, respectively. Comparing the top 25% of earners with the bottom 25%, the numbers were 78% and 18%.

Like the person whose head is in the oven and feet are in the freezer, the U.S. body politic will have very different experiences in retirement. But, on average, you could say that we’re doing all right.

© 2013 RIJ Publishing LLC. All rights reserved.

Everybody wants to be a wealth manager

Posted on December 12, 2013 by -

“The Future of Practice Management,” a study by the Financial Planning Association Research and Practice Institute done in collaboration with New York-based Advisor Impact, suggests that few advisors have business or retirement plans for themselves and that “wealth manager” is the position that many advisers and planners hope to attain.

Among the survey findings in the study:

  • 50% of financial advisers do not have a written business plan.
  • 46% of financial advisers do not have a retirement plan for themselves, yet 40% are planning to retire within the next 14 years.
  • Only 25% of financial advisers have a succession plan in place to ensure their business transitions appropriately when they retire – the percentage with a formal plan increases slightly to 31% at age 60-64 and 41% at age 65+.
  • 76% of “money managers” indicate they will change the positioning of their practice.
  • Of those who plan on changing, 44% will transition to “wealth managers,” who work on complex executive compensation and estate planning issues.
  • 72% of “investment planners” indicate they will change.
  • Of those who plan on changing, 46% will transition to Wealth Managers
  • 53% of “financial planners” indicate they will change. Of those who plan on changing, 62% will transition to wealth managers.
  • Only 30% of wealth managers plan to change.
  • Only 25% of advisers have a formal definition of their ideal client, i.e., the best candidates for their services.
  • Only 38% of advisers who have defined their ideal client say 75% or more of their current clients fit their definition.
  • Advisers are more likely to set an asset minimum (43%) than to have a definition of their ideal client.

A full report of The Future of Practice Management study is available from FPA and includes additional details on these issues and other areas of business operations.

© 2013 RIJ Publishing LLC. All rights reserved.

Great-West Financial launches low-cost VA with income rider

Posted on December 12, 2013 by -

Great-West Financial has introduced Great-West Smart TrackII, a variable annuity that levies a lifetime income rider fee (currently 1%; 1.50% maximum) only on assets that are moved to an income sleeve. 

There are no administration or distribution fees, and total costs are lower than the average variable annuity with similar features, according to a Great West release.

While contract owners can put money in the investment sleeve in a wide variety of fund options, there is apparently only one fund option in the income sleeve: a Great-West SecureFoundation Balanced Fund, Class L. Such two-sleeve variable annuities have been offered by other companies in the past. 

There’s an annual ratchet, which increases the benefit base if the account value reaches a new high. The contract offers income growth potential by linking the payout rate to the 10-year Treasury rate, as some other VA riders do.

For instance, for contract owners ages 65 to 69, the annual payout rate under the living benefit rider is 4% as long as the 10-year Treasury yield is under 4%. (Today it is under 3%.) But if the 10-year rate is between 4% and 4.99%, the payout rate goes to 4.50% a year. If the 10-year rate is 5% to 5.99%, the payout rate jumps to 5.50%, and so on. The maximum payout rate is 8%, which occurs only if the 10-year rate is 8% or higher.

According to the prospectus, the contract owner can choose to take the amount that is outside the living benefit income sleeve and annuitize it on a variable basis, with or without a guarantee period. Variable annuitization, though not common, has been shown to produce favorable long-term results, when back-tested against historical market performance. The first payment from the variable income annuity in this contract is calculated by assuming an interest rate (an “AIR”) of 2.5%.

Depending on the death benefit selected, Great-West Smart Track II’s mortality and expense charge is 1.00% (or up to 1.20%, depending on the death benefit selected). Fund charges range from 0.46% to 1.70% of assets. 

The contract also offers the possibility of inflation protection if the benefit base is stepped up to a new level, following a new high water mark in the account value or an increase in the10-year Treasury yield.

Great-West Smart Track II is a commission-based offering that’s available through banks and independent broker dealers. The new offering complements Great-West Smart Track, a fee-based offering, that’s available through registered investment advisers.

© 2013 RIJ Publishing LLC. All rights reserved.  

So far, fee disclosure hasn’t moved the fee-awareness dial

Posted on December 12, 2013 by -

The LIMRA Secure Retirement Institute (SRI) reported the results this week of a series of consumer surveys asking DC plan participants about their retirement plan fees, as an assessment of the effectiveness of the Department of Labor’s 2012 regulations requiring greater fee disclosure.

A 2012 LIMRA survey, conducted prior to the initial participant disclosure, showed that 50% of retirement plan participants do not know how much they pay in fees and expenses. LIMRA’s 2013 follow-up survey, as reported by Tom Dennis and Cecilia Shiner of the SRI, has shown:

  • The disclosures have had little impact; there is no noticeable difference in participant knowledge of the fees they pay.
  • Half of participants do not currently know how much they pay in fees and expenses. 
  • Nearly 4 in 10 still believe that they do not pay any fees or expenses.
  • 64% of plan participants feel that the fees and expenses they pay are reasonable.   

“When asked about how much they pay in fees, only 12% of DC plan participants were able to estimate a percentage,” the LIMRA report said. “One third of these participants believe they pay over 10% in total plan fees.” 

Previous SRI research found that one in five consumers contributing to DC plans or IRAs say they rarely or never read retirement plan disclosures. Only one in three spends more than five minutes reading disclosures.

Most participants apparently use fee information only when making investment changes or examining statements beyond a quick account balance check.

 “It will take time for the long-term impacts of fee disclosure regulations to emerge. Retirement plan service providers are making the effort, but participant inertia and industry complexities are making it difficult to initially see positive results,” the LIMRA release said. 

© 2013 RIJ Publishing LLC. All rights reserved.

Deconstructing Warren

Posted on December 12, 2013 by -

Warren Buffett has moved into my neighborhood. To be more precise, Berkshire Hathaway HomeServices’ For Sale signs have sprouted on lawns in my neighborhood, supplanting signs once posted by Prudential Fox & Roach, the curiously named regional real estate brokerage that Buffett’s flagship firm recently acquired.

For me, as for many investors, the Oracle of Omaha is an object of speculation—not in the investing sense but in the sense of wondering how and why he’s been able to master the markets for so long. Even when the market eluded him, as it did in the late 1990s, it soon came running back to him with its tail-risk between its legs. It, not he, had failed.

Many have tried to explain Buffett’s record of outperformance. Roger Lowenstein, the longtime Wall Street Journal columnist, wrote a superb biography of Buffett nearly two decades ago. Last month, three quants from AQR Capital Management in Greenwich, Conn., published a research paper in which they claim to have deconstructed Warren’s wizardry.

“Buffett’s returns appear to be neither luck nor magic, but rather reward for the use of leverage combined with a focus on cheap, safe, quality stocks,” write Andrea Frazzini, David Kabiller, and Lasse H. Pedersen in “Buffett’s Alpha” (NBER Working Paper 19681).

These authors take stock of Buffett’s technique and track record, as an owner of a publicly traded company, Berkshire Hathaway, and as an investor in public and private companies. The record speaks for itself: a dollar invested in Berkshire Hathaway in November 1976 would have been worth more than $1,500 at the end of 2011. That entails an average annual return 19% over the riskless T-bill rate, compared to 6.1% for the general stock market.

“Buffett’s Alpha” is a technical paper, but the takeaways are fairly straightforward. The authors attribute the success of the folksy Nebraskan—an apparently uncomplicated man of occasionally liberal views who enjoys Coca-Cola and cheeseburgers—to a combination of three factors:

  • Selection of safe, high-quality, cheap stocks. Buffett uses the principles of fundamental analysis that he learned at Columbia University directly from the source, Ben Graham. Berkshire Hathaway’s portfolio companies and stock holdings includes household names like GEICO, Benjamin Moore, Dairy Queen, Fruit of the Loom, Wrigley, Heinz, Dow Chemical and so on.
  • The use of leverage in the purchase of stocks. The authors estimate Buffett’s average leverage at 1.6%, which by itself would magnify the market’s historic return to about 10%. More important, he has had a “unique access to stable and cheap financing.” His leverage has been financed by premia from his insurance and reinsurance companies at an average annual cost of only 2.2%.
  • Buffett’s deep pockets and captive financing have allowed him to weather market storms without resorting to asset fire sales. Though Berkshire Hathaway lost 44% of its value during a 20-month stretch at the end of the 20th century (while the overall stock market was gaining 32%), his “impeccable reputation and unique structure as a corporation allowed him to stay the course and rebound as the Internet bubble broke,” the authors write.

One measure of the success of this strategy, the authors point out, is that Berkshire Hathaway stock has a higher Sharpe ratio (a measure of risk-adjusted performance; it is calculated by subtracting the risk-free rate from a portfolio’s rate of return and dividing the result by the standard deviation of that return) of any U.S. stock or mutual fund continuously traded for at least 30 years since 1926.

Speaking of Buffett’s insurance and reinsurance holdings: According to Berkshire Hathaway’s 2013 third-quarter report,

“In 2013, life and annuity premiums earned in the third quarter and first nine months of 2013 increased $340 million (46%) and $663 million (33%), respectively over premiums earned in the comparable 2012 periods. Premiums earned in the third quarter of 2013 included $470 million from one annuity reinsurance contract, which was partially offset by a decrease in life reinsurance premiums earned. In the first quarter of 2013, premiums of $1.7 billion were earned in connection with a new reinsurance contract under which BHRG (Berkshire Hathaway Reinsurance Group assumed certain guaranteed minimum death benefit coverages on a portfolio of variable annuity reinsurance contracts that have been in run-off for a number of years.”

With all due respect to the authors of this academic paper, who themselves are the creators of investment models like Betting-Against-Beta and Quality-Minus-Junk, they failed to mention two Buffett advantages that Lowenstein related in Buffett: The Making of An American Capitalist (Random House, 1995).

First, Buffett was fortunate enough to have a father who was a successful stockbroker and a U.S. Congressman; he arguably stood on taller shoulders than most of us groundlings ever will. Second, almost 40 years ago, the champion of buy-and-hold finessed the mother of all market-timing moves.  

After doing very well in the go-go 60s Buffett liquidated his portfolio in 1969. He sat on his mountain of cash until October 1974 when, with the Dow Jones Industrial Average at 580, he decided to start buying blue chips. How do you feel? a Forbes reporter asked him at the time. “Like an oversexed guy at a whorehouse,” Buffett replied. “This is the time to start investing.”

The rest, as they say, is history.

© RIJ Publishing LLC. All rights reserved.

Nationwide Ties New VA Income Rider to Managed-Vol Funds

Posted on December 12, 2013 by -

Pending SEC approval, Nationwide Life Insurance Company is expected to announce a new living benefit rider on its Destination 2.0 variable annuity contract. Selection of the rider, called Lifetime Income Capture, requires investment in one or more of five “managed volatility” portfolios. Its annual deferral bonus is linked to the 10-year Treasury rate.

The deferral bonus or roll-up is the sum of 3% simple interest plus the nominal rate of the monthly 10-year Treasury constant maturity (currently 2.86%). The crediting period lasts until the first lifetime income payment or up to 15 years. The roll-up can’t be less than 4% or more than 10%, according to the prospectus.

The expense ratio of the Income Capture rider is 1.20% (1.50% maximum) for a single person, and an additional 0.30% for a joint contract. The mortality and expense risk charge is 1.10% on the B-share, which has a seven-year, 7% surrender schedule. The administrative charge is 0.20%. Death benefit options are extra. The annual payout rates and age bands that apply to Income Capture are not included in the current filing, which is dated effective December 16, 2013.  

In addition to the lifetime withdrawal benefit, other payout options include: systematic withdrawals, annuitization or a lump sum payment equal to the current lifetime withdrawal amount multiplied by an age-related factor.

Contract owners who choose Income Capture have five investment options:

  • American Funds Insurance Series – Managed Risk Asset Allocation Fund (Class P2)
  • Nationwide Variable Insurance Trust – NVIT Cardinal Managed Growth & Income Fund (Class II)
  • Nationwide Variable Insurance Trust – NVIT Cardinal Managed Growth Fund (Class II)
  • Nationwide Variable Insurance Trust – NVIT Investor Destinations Managed Growth & Income Fund (Class II)
  • Nationwide Variable Insurance Trust – NVIT Investor Destinations Managed Growth Fund (Class II)

The expense ratios of these funds do not appear readily accessible in the prospectus. The NVIT Cardinal Managed Growth & Income Fund has an expense ratio of 1.02% (1.31% without the temporary waiver), according to Nationwide’s website.

Regarding the impact of required minimum distributions at age 70½, the prospectus states:

“Contract Owners subject to minimum required distribution rules may not be able to take advantage of the Lifetime Withdrawal Percentages available at higher age bands if distributions are taken from the contract to meet these Internal Revenue Code requirements. Contract Owners who elect not to take minimum required distributions from this contract, i.e., they take minimum required distributions from other sources, may be able to take advantage of Lifetime Withdrawal Percentages at the higher age bands.”

The NVIT Cardinal Managed Growth & Income Fund’s Volatility Overlay, which BlackRock manages, is described on Nationwide’s website as follows:

The Volatility Overlay is designed to manage the volatility of the Fund’s portfolio by using stock index futures to hedge against stock market risks and/or to increase or decrease the Fund’s overall exposure to equity markets.

The Volatility Overlay also invests in short-term fixed-income securities (or Underlying Funds that themselves invest in such securities) that may be used to meet margin requirements and other obligations of the Fund’s futures positions and/or to reduce the Fund’s overall equity exposure.

When volatility is high, the Volatility Overlay will typically seek to decrease the Fund’s equity exposure by holding fewer stock index futures or by taking short positions in stock index futures. A short sale strategy involves the sale by the Fund of securities it does not own with the expectation of purchasing the same securities at a later date at a lower price. When volatility is low or stock market values are rising, the Volatility Overlay may use stock index futures with the intention of maximizing stock market gains.

These strategies may expose the Fund to leverage. Therefore, even though the Core Sleeve allocates approximately 50% of its assets to equity investments, the Volatility Overlay will be used to increase or decrease the Fund’s overall equity exposure within a general range of 0% to 65%, depending on market conditions.
Nationwide Fund Advisors (“NFA“) is the investment adviser to the Fund and is also responsible for managing the Core Sleeve’s investment in the Underlying Funds. BlackRock Investment Management, LLC, the Fund’s sub-adviser, is responsible for managing the Volatility Overlay, including the fixed-income securities it holds.

The American Funds’ Managed Risk Asset Allocation Fund that’s available to Income Capture clients is sub-advised by Milliman. The Milliman Volatility Overlay is described as follows on the American Funds website:

The fund employs a risk-management overlay referred to in this prospectus as the protection strategy. The protection strategy consists of using hedge instruments—primarily short positions in exchange-traded futures contracts—to attempt to stabilize the volatility of the fund around a target volatility level and reduce the downside exposure of the fund during periods of significant market declines.

The fund employs a sub-adviser to select individual futures contracts on equity indexes of U.S. markets and markets outside the United States that the sub-adviser believes are correlated to the underlying fund’s equity exposure. These instruments are selected based on the sub-adviser’s analysis of the relation of various equity indexes to the underlying fund’s portfolio. In addition, the sub-adviser will monitor liquidity levels of relevant futures contracts and transparency provided by exchanges as the counterparties in hedging transactions…

The sub-adviser will regularly adjust the level of exchange-traded futures contracts to seek to manage the overall net risk level of the fund. Even in periods of low volatility in the equity markets, the sub-adviser will continue to use the hedging techniques to seek to preserve gains after favorable market conditions and reduce losses in adverse market conditions.

In situations of extreme market volatility, the exchange-traded equity index futures could significantly reduce the fund’s net economic exposure to equity securities. The fund’s investment in exchange-traded futures and their accompanying costs could limit the fund’s gains in rising markets relative to those of the underlying fund, or to those of unhedged funds in general.

To get a wider range of investment options, contract owners can take the Nationwide Lifetime Income Track rider. Though it has no roll-up, investors who wait at least five years before starting income get an extra half-percent annual payout. This rider currently costs 0.80% of the benefit base per year.

The Nationwide Lifetime Income Track option has two sets of payout bands. One band is for single people who take income within five years of purchase. It pays 4% a year to those ages 59½ to 64, 4.5% to those ages 65 to 74, 5% to those ages 75 to 80, and 5.5% to those ages 81 or older. Another band, for single people who wait at least five years before taking income, pays, as mentioned, a half-percent more in each age band.

For joint contracts, the payout rate is 0.25% less than the rate for single lives in each age band mentioned above. For instance, the payout for a 65-year-old couple, after a five-year waiting period, would be 4.75% per year. The current additional charge for the joint option on the Income Track rider is 0.15%.

© 2013 RIJ Publishing LLC. All rights reserved.

The Ghost of VA Contracts Past

Posted on December 12, 2013 by -

The Ghost of Contracts Past haunts the VA market this holiday season. The living benefit story—guaranteed income plus liquidity and legacy—still has legs, but many advisors find today’s contracts are Scrooge-like compared with the rich contracts of years past.    

“Managed-volatility” funds or funds-of-ETFs are a point of contention. Only if insurers require investors to use such funds, which react defensively when equity volatility kicks up, can insurers—those still in the VA/living benefit game, that is—offer those enticing 6% or 7% deferral bonuses.

The managed-vol story is, in a sense, yesterday’s news. Everyone knows that it “saved” the VA industry (at a price), yadda yadda. But on the conference circuit this fall, people were still talking about this loosely defined risk management method, which seems to have no formal benchmark.

Actuary Ken Mungan of Milliman, whose risk-management technique sits quietly inside many managed-vol funds, promoted it in presentations from New Orleans to Washington, D.C. Nationwide Life applied to the SEC for a new managed-vol living benefit rider. AllianceBernstein boasted that it’s bringing its private-wealth dynamic asset allocation tool to the masses.

On the distribution frontier, however, advisors grumble. Asked about managed-vol funds in VAs at an industry roundtable, a roomful of broker-dealer managers fell silent for a moment. The last thing they want is more investment restrictions, which managed-vol funds entail. Finally, SEC officials demurred that managed-vol funds may make VA guarantees redundant. 

Nonetheless, managed-vol funds are selling, both inside and outside VA wrappers. Fed by demand from VA manufacturers, sales of managed-vol funds have been one of the bright spots of the post-financial crisis era. Sales rose from just $30.9 billion at year-end 2006 to $200.1 billion by mid-2013. About 64% of the assets, or $127.9 billion as of mid-year 2013, was in variable annuity separate accounts and the rest available as taxable funds or ETFs.

B/Ds are hard to please

At a recent industry roundtable discussion, for instance, senior representatives of broker-dealers expressed disappointment with them. “They handcuff you a bit,” said one b/d annuity manager. “We all understand the need for risk management in a variable annuity. But we’re not in love with them.”

The grumbling springs from two sources. First, volatility management cuts both ways. The same strategies that buoy these funds in down markets can hamper them in up markets. That’s simply their nature, but it doesn’t endear them to advisors during rallies, like the one that investors have enjoyed in 2013.

For instance, the TOPS Managed Risk Growth ETF, available in Ohio National, Securian VA contracts, which has an equity allocation of about 75%, has grown by 13.8% this year. That’s not far behind, say, Vanguard’s target-risk LifeStrategy Growth fund-of-funds (18.7% YTD), which allocates about 80% to stocks. But it’s less than half the S&P500 Index’s 29% return YTD, which is the headline rate that advisors’ clients see on CNBC.

Second, managed-vol funds in a variable annuity can make advisors feel like Houdini, roped in iron chains, locked in a trunk and submerged in the Hudson River. Advisors once hoped—and were encouraged to believe—that the VA living benefit rider alone, with few or no investment restrictions, would serve as investment insurance. Now they wonder why they also need to pay for another layer of protection through the mandatory use of managed-vol funds if they want a GLWB with a roll-up.

“It’s a belt-and-suspenders strategy,” said one broker-dealer. “Except that the client wears the belt and the insurers wear the suspenders.” In other words, the client may pay extra (with a portion of the managed-vol fund assets) for a risk management technique that mainly reduces the insurer’s balance sheet risk.

Regulators share some of the advisors’ wariness of managed-vol funds in VAs. The SEC has discouraged the use of the word “protected” to describe the funds, requiring at least one fund manager to take the word out of its brand name. And the SEC shares the advisors concern about the shifting risk-reward proposition. 

“These contracts are sold on the basis of a living benefit rider that focuses on downside protection,” said William Kotapish, assistant director of the SEC’s Division of Investment Management, at an American Law Institute conference last month. “If I paid for that kind of rider. I would want my equity funds to shoot for the moon.

“That’s why I bought the protection in the first place. A fund that is managed with reference to an insurance company’s obligations under its rider raises significant conflicts of interest and fiduciary issues.”

Another and perhaps more important matter is that “managed-volatility,” like “target date,” can mean many things. Fund managers and sub-advisors evidently use a range of hands-on and computer-driven tools to manage volatility. They may or may not use derivatives and/or leverage. They use different ways of measuring volatility, and maintain very different asset allocations.

Miracles of financial engineering

That’s the glass-half-empty view. VA manufacturers, asset managers and actuarial firms see managed-vol as a miracle of financial engineering. It brings a strategy that “once was available only to $100 million pension funds to people with $5,000” and they “saved” the VA industry, said one fund manager who asked for anonymity.

Managed-vol enables even conservative mutually owned life insurers to keep offering a product—the VA with a 10-year, double-your-money roll-up and a 5% lifetime income guarantee—for which there is undeniable demand, in a repressive interest rate environment that would otherwise stop them from offering any GLWB at all.  

One managed-volatility fund manager conceded that managed-volatility funds alone can eliminate “95% of the risk of a person running out of money,” assuming the same withdrawal rate restrictions as a GLWB. “But people are saying, ‘I don’t care, I want 100% protection and I’ll pay the extra 1.30% [for a living benefit rider] to get it.’ ”

Advisors wouldn’t object to the use of managed-volatility funds in VAs, he added, if they weren’t compelled to use them: Compulsion elicits resistance.   

At conferences, Milliman’s Mungan, whose company now manages or sub-advises on over $20 billion in some 30 managed-vol funds, has asserted that managed-vol is a win-win for insurers and consumers.

For insurers, he says in his presentations, the strategy allows for “lower and more stable reserves and capital,” which gives them more capacity to offer richer VA riders. At the same time, he argues, the strategy can provide “improved risk-adjusted returns for the policyholder” over the long haul.  

“Income Capture”

In the meantime, the big asset managers clearly see managed-vol funds as a sales opportunity. AllianceBernstein has adapted its own Dynamic Asset Allocation service from Bernstein Global Wealth Management to offer a managed-vol solution in the VA space.

Mike Hart, managing director of insurance services at AllianceBernstein, said his firm’s manager-driven solution reacts more spryly to market changes than managed-vol solutions that run on auto-pilot.

“Our concern about algorithmic solutions is that they look with equivalency at market environments that are vastly different,” Hart told RIJ recently. “For instance, if market volatility in March 2008 was the same as in March 2009, their view of the risk would be the same.” The company’s Private Client page boasts that its process is designed to “mitigate the effects of extremes in the market…without sacrificing long-term returns.”

If the low interest rate environment compels VA owners to share more risk with insurers, so be it, Hart said. “Insurers are saying, we have a unique ability to produce guaranteed income. But because of balance sheet issues, there are parameters. It’s a reasonable way of approaching the business,” he said.

AllianceBernstein’s Global Dynamic Allocation Portfolio is one of the managed-vol options in MetLife variable annuities. According to one product (broadside sense??), it has a “10% equity volatility cap (including emerging market and high yield debt).” Judging by the wording of the literature, the fund managers have a very free hand.

Nationwide has a managed-vol strategy (the algorithm was written by Nationwide, and the trades will be executed by BlackRock, RIJ is told) for people who buy the forthcoming Income Capture lifetime withdrawal benefit on its Destination 2.0 variable annuities. Purchasers of Income Capture must invest in a suite of five funds (or funds-of-funds) that includes a managed-vol offering from American Funds and four from Nationwide. That new rider is discussed in greater detail in today’s issue of RIJ (see “Nationwide”).

It will take a few more market cycles before we know if managed-vol funds can actually deliver the win-win—lower risk and higher long-term returns—that they promise. But, given investors’ level of risk-aversion since the global financial crisis (and assuming that bonds alone can’t offset equity risk as well as they once did), the supply of and demand for managed-vol funds—both inside and outside variable annuities—seems only destined to grow.

“Based on what I’ve heard, the growing trend of having risk-managed strategies inside variable annuities with living benefits is not going away anytime soon,” Hart said. “It will be fundamental to product development. There will be next-generation products, maybe involving more active management or alternatives or factor investing.”

© 2013 RIJ Publishing LLC. All rights reserved.

The Long Short Run

Posted on December 6, 2013 by -

Before 2008, I taught my students that the United States was a flexible economy. It had employers who were willing to gamble and hire when they saw unemployed workers who would be productive; and it had workers who were willing to move to opportunity, or to try something new in order to get a job. As bosses and entrepreneurial workers took a chance, supply would create its own demand.

Yes, I used to say, adverse shocks to spending could indeed create mass unemployment and idle capacity, but their effects would be limited to one, two, or at most three years. And each year after the initial downturn had ended, the US economy would recover roughly 40% of the ground between its current situation and its full employment potential.

The domain of the Keynesian (and monetarist) short run, I said, was 0-2 years. When analyzing events at a horizon of 3-7 years, one could safely assume a “classical” model: the economy would return to full employment, while changes in policy and in the economic environment would alter the distribution but not the level of spending, production, and employment. Beyond seven years was the domain of economic growth and economic institutions.

All of this is now revealed as wrong, at least for today, if not in the past or the future. Japan since the start of the 1990’s provides strong evidence that the short run can last for decades, and then be followed not by a return to the old normal, but by a transition to a new normal in which the Keynesian short run of economic depression casts a long shadow. What we have seen since 2008 is that Japan is not an exception.

The default framework for thinking about these questions is a very old one: the market-and-natural-interest-rate framework of Knut Wicksell’s Geldzins und Guterpreis (“Interest and Prices”). In every economy, the argument goes, there is a market interest rate determined by the financial system, and there is a natural interest rate – the value at which desired savings at full employment equal desired investment at full employment, and at which the economy as a whole desires neither to leverage nor to deleverage.

If the economy as a whole desires to leverage up, the result is an inflationary boom. If the economy as a whole desires to deleverage, a depression ensues. It is then the central bank’s job to intervene in the banking system in order to push the market interest rate to the natural interest rate, thereby balancing the economy at full employment without excess inflation.

The problem now is that the natural interest rate – that is, the liquid safe nominal interest rate on short-term US Treasury securities – is less than zero. Thus, the central bank cannot push the market interest rate there. Until something happens to raise the natural interest rate, we are stuck with a depressed economy.

Some blame a global savings glut for this state of affairs, and call for less thrift. But if we were at full employment, we would recognize that the world still has mammoth growth opportunities, and to sacrifice future growth for current well-being is a second-best choice.

Others blame a global investment shortfall driven by a lack of technological opportunities. But, given that this view is expressed in every deep depression, it appears to be an effect of economic stagnation, rather than a cause of it.

Still others say that the problem would resolve itself, at least in the US, if the target for annual inflation were raised from 2% to 5%, because a loss of so much of the real purchasing power that people hoard in cash would induce the needed boost in real investment. I think they are probably right, but former central bankers like Paul Volcker and Alan Greenspan would warn that a 5% inflation target is ultimately unsustainable. People can be happy with a stable 2% target (which is too low to notice), but 5% annual inflation would eventually become 10%, and 10% would eventually become 20%, and then the US would face another deep recession, like in 1982, or even more unpleasant alternatives.

Finally, according to a fourth group of economists, centered around Ricardo Caballero of MIT, the problem is a global shortage of safe assets. This view translates into policies aimed at better mobilizing society’s financial risk-bearing capacity, and that use the public sector to outwit the forces of time and ignorance that curb willingness to engage in risky investments.

So we have four theories, all advocated by smart, thoughtful, and hard-working economists. In a better world, sophisticated debate in a vibrant public sphere would inform economic policy. In the world as it is, we are all Japan in the early 1990’s, looking ahead to two or more decades of lost economic growth.

© 2013 Project Syndicate.

Unions balk at proposal to cut Illinois pension benefits

Posted on December 6, 2013 by -

As part of an effort to cut the state’s pension costs by $160 billion over 30 years, Illinois legislators have proposed lower cost-of-living increases for retirees, a higher retirement age for some employees, and a cap on pensions for high-salary workers.   

The proposal would require the state to make additional payments into the pension system until it is fully funded, no later than the end of 2044, the New York Times reported last Friday. Workers who are 45 or younger would need to work up to five years longer. Cost-of-living increases might apply only toward a portion of a person’s pension, based on job tenure.

Among the provisions laid out Friday: most pension matters would no longer be part of collective bargaining; some workers could choose to switch from a defined benefit plan to a defined contribution system, like a 401(k); and workers would be asked to contribute one percent less of their salaries to retirement.

“This does set the state on sound financial footing,” said Christine Radogno, the state Senate’s Republican leader. “It doesn’t erase the unfunded liability in one fell swoop, but it certainly puts us on a path to get it paid off in a minimum of 30 years.”

But labor leaders denounced the plan as “catastrophic.” A vote on the plan was scheduled for December 3, or one day after legislators were scheduled to learn whom they might face in their next primary election.    

“This is a grotesque taking of employees’ retirement security that seems both patently illegal and unfair,” said Daniel J. Montgomery, the president of the Illinois Federation of Teachers. “If we’re not successful in stopping this train, then our next step is litigation,” said Anders Lindall of the American Federation of State, County and Municipal Employees.

The Illinois state pension system is underfunded by an estimated $100 billion. The state has the worst credit rating in the nation. On the other hand, the Illinois Constitution prohibits pension benefits from being “diminished or impaired.”

For many state and local governments, pension costs have become a central challenge with no easy political or legal answers. Detroit officials have cited $3.5 billion in unfunded pension costs among a list of debts that has left that city seeking federal bankruptcy protection. In San Jose, Calif., Chuck Reed, the Democratic mayor, championed efforts to pass a referendum to reduce pension benefits, though city workers say the move is illegal. The mayor now says he hopes to mount a statewide ballot initiative next year that would change the state Constitution to allow cities to cut pension benefits.

© 2013 RIJ Publishing LLC. All rights reserved.

Colorado “trader” charged with duping retirees in $4 million Ponzi scheme

Posted on December 6, 2013 by -

On November 21, the Securities and Exchange Commission and the U.S. Attorney in Denver charged a self-described institutional trader in Colorado with running a Ponzi-like scheme in which he duped insurance agents into preying on elderly annuity owners.

Gary C. Snisky, 47, of Longmont is accused of employing insurance agents to sell interests in his company, Arete LLC, which he said offered a safer, more profitable alternative to an annuity based on government-backed agency bonds. 

A computer specialist who worked for Snisky, Richard Greeott, plead guilty on October 7, 2013 to mail fraud and money laundering charges, the U.S. Justice Department said in a release. As part of Greeott’s plea agreement, he agreed to make restitution of up to $4,501,887.

According to a federal grand jury indictment and Greeott’s plea agreement:

Beginning in 2010 and continuing through January 2013, Sniksy operated Colony Capital, LLC, which purported to be a private equity firm offering investment opportunities in bonds, futures trading, and other offerings. Sometime in 2011, he shut down Colony Capital and formed a similar firm called Arete, LLC.

Starting in July 2011, Snisky offered a 10-year investment model based on the purchase of Ginnie Mae bonds, which promised the investor a 10% upfront bonus and an annual return of 7%. Prior to April of 2012, Snisky began offering a five-year investment model for the Ginnie Mae bond program, which promised a 6% annual return on the invested money.

Between approximately July 2011 and January 2013, Snisky received more than $4,000,000 in investor money that was supposed to be invested in the Ginnie Mae bond program. He did not purchase any Ginnie Mae bonds.

In mid-2010, Snisky asked Richard Greeott, who was doing IT work for Colony Capital, to develop an algorithm for a fully-automated trading system for trading in the futures market. By the end of 2012, Snisky knew that Greeott was still developing the algorithm and was merely testing it by trading in a simulated environment and by making small trades in the futures market.  

[But] Snisky convinced investors, potential investors, and financial advisors that Colony Capital and Arete were using the algorithm to profitably trade in the futures market. Based on these false statements, Snisky received more than $300,000 from investors to be invested in the futures trading program. He did not invest this money as promised. 

Snisky also falsely boasted about Colony Capital’s and Arete’s success in the futures market in order to falsely bolster the companies’ overall appearance of success. The government is seeking to forfeit over $1.9 million in currency seized from Gary Snisky and related LLC accounts and a commercial real property valued at approximately $400,000.00.

According to the SEC, Snisky told annuity owners that he would use their money to buy government-backed agency bonds at a discount and use them to engage in “overnight banking sweeps.” Instead, he used some $2.8 million of investor funds to pay his salespeople and make mortgage payments on his own home, the SEC said.

In August 2011, after raising at least $3.8 million from more than 40 investors in Colorado and other states, Snisky recruited veteran insurance salespeople who would sell the Arete investment to their established client bases that owned annuities, according to the SEC’s complaint filed in Denver. The majority of investors in Arete used funds from their IRAs or other retirement accounts.

The SEC alleges that Snisky described Arete as an “annuity-plus” investment from which investors could withdraw principal and earned interest with no penalty after 10 years while still enjoying annuity-like guaranteed annual returns of 6% to 7%. Snisky’s sales pitch was so convincing that even one of his salespeople personally invested retirement funds in Arete, the SEC said.

Snisky created and provided all of the written documents that the hired salespeople used as offering materials to solicit investors.  Snisky also showed salespeople fraudulent investor account statements purporting to show earnings from Arete’s investment activity.

Following an initial influx of investors, Snisky organized at least two seminars where he met with investors and salespeople. He introduced himself as the institutional trader behind Arete’s success and hand-delivered fraudulent account statements to investors attending the seminars.   

The SEC’s complaint against Snisky seeks a permanent injunction, disgorgement of ill-gotten gains plus prejudgment interest, and a financial penalty.

© 2013 RIJ Publishing LLC. All rights reserved.