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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.

Managed-vol funds added to JeffNat’s Monument Advisor VA

Posted on December 6, 2013 by -

Jefferson National said it has added 23 new investment options, including managed-volatility funds, to its Monument Advisor variable annuity, which is targeted to registered  investment advisors and other fee-based advisors who want to trade alternative investments on a tax-deferred basis and have no interest in living benefit riders.

 

Sales of Monument Advisor have exceeded $1 billion over the past 20 months, Jefferson National said in a release.

 

The latest additions to Monument Advisor’s 400-option fund roster include 14 investment options from American Funds. Among them are five funds that incorporate Milliman’s short-futures volatility management technique. The technique moves the hedging strategy from the insurer’s balance sheet into the fund itself, financing it with part of the shareholder’s own assets.

 

Additional options with embedded risk management include Federated Managed Tail Risk Fund II, and Goldman Sachs Variable Insurance Trust Global Markets Navigator Fund, a managed volatility fund. Jefferson National also added six asset allocation funds from SEI, one of the first companies to offer “Manager-of-Managers” investment programs. The last of the new funds is the Gold Bullion Strategy Portfolio from Advisors Preferred Trust. 

 

Jefferson National cited Cerulli research showing that in five years the use of alternative strategy funds could increase more than 245%.The high turnover of such funds generates a lot of short-term capital gains tax, thereby making it advantageous to hold them within a tax-deferred variable annuity wrapper within minimal insurance costs.

 

The fear that a fiscally-challenged, revenue-hungry U.S. government might try to raise capital gains tax in the future is also believed to be driving sales of investment-only VAs like Monument Advisor and Jackson National’s Elite Advisor.

© 2013 RIJ Publishing LLC. All rights reserved.

Aegon reduces longevity risk exposure in Netherlands

Posted on December 6, 2013 by -

Aegon has completed a second capital markets transaction to reduce its risk from future improvements in longevity in the Netherlands, the company said in a release.

The transaction is the latest step in Aegon’s strategy to open new capital markets outlets to lay off longevity risk and further strengthens its leadership in the Dutch pension market. The impact on Aegon’s earnings is limited as this transaction was done at an attractive cost of capital.

The transaction has a maturity of 20 years with a commutation covering exposures that run longer than 20 years. It covers underlying longevity reserves in the Netherlands of €1.4 billion. The transaction is the second undertaken by Aegon to reduce longevity risk in Aegon’s pension business in the Netherlands, following a longevity hedge on €12 billion of reserves completed in January 2012.  

Aegon’s partners in the transaction are Société Générale in the role of intermediary and Risk Management Solutions as modeling agent. The risk is assumed by third-party investors and reinsurers, including SCOR, the world’s fifth largest reinsurer. SCOR is a €32.6 billion reinsurer operating in 31 countries, with three main business, SCOR Global Life, SCOR Global P&C and SCOR Global Investments.

© 2013 RIJ Publishing LLC. All rights reserved.

Five fat years may be followed by five lean ones: T. Rowe Price

Posted on December 6, 2013 by -

Be careful, investors. The global investment environment is approaching “an inflection point.” So said T. Rowe Price investment pros at the company’s Investment and Economic Outlook event in New York recently.

Given that what goes up must come down, they suspect that the gains of the last five years—U.S. stock indices are 160% of their lows in 2009 and touching new nominal highs—won’t be matched over the next five.  

“The U.S. bull market is aging,” said Bill Stromberg, T. Rowe Price’s head of equity. “International investments, especially in emerging markets, represent the best long-term value from here in fixed income and equity.”

The taper caper. Expect the U.S. Federal Reserve to reduce its bond purchases in the next three to six months, they said. The Fed will move slowly while unemployment is high, but the tapering could “lead to volatile conditions in global equity and fixed income markets.”

“The impact of political uncertainty in Washington should be less than it was this year, once we get past the January sequestration talks and the focus turns to elections,” said Alan Levenson, T. Rowe Price chief economist.

Europe and beyond. Europe’s economic recovery is still in its early stages, which could give European stocks more room to run than their U.S. counterparts. In Japan, ineffective corporate governance and dated labor and regulatory rules will hamper government reform efforts. In emerging markets, equity valuations appear to be below historical norms.

“The macroeconomic environment has transformed from an end-of-the-world scenario and fears of a Eurozone break-up to a story of improving confidence, modest recovery, and improving company fundamentals,” said Dean Tenerelli, portfolio manager of T. Rowe Price European Stock Fund. 

Munis on the mend. Global fixed income markets are vulnerable to interest rate increases, but emerging market debt has potential, they said. Credit fundamentals are rising for many states and municipalities, helping U.S. municipal bonds. Revenues are increasing, due to economic improvement and tax rate hikes, and budget gaps are shrinking.

T. Rowe Price favors revenue-backed municipal bonds, especially in areas such as public utilities, transportation authorities, and hospital systems, most of which operate as monopolies within their local markets.

“Despite headlines created by the situations in Detroit and Puerto Rico, municipal bonds still provide a high-quality, time-tested way to earn tax-free income,” said Hugh McGuirk, head of municipal bonds.

“Munis have evolved away from being a predominantly interest-rate sensitive market to a more credit-driven market, which places a premium on strong internal credit research.  Underfunded pensions continue to represent a critical challenge for state and local governments.”

© 2013 RIJ Publishing LLC. All rights reserved.

PacLife launches fixed annuity with GLWB and roll-up

Posted on December 6, 2013 by -

On December 2, Pacific Life introduced Pacific Income Advantage, a single-premium fixed deferred annuity with a lifetime withdrawal benefit option and an annual 6% simple increase in the benefit base until any withdrawal—including a required minimum distribution—is taken, for up to 10 years.

The product, which may be unprecedented, merges the most popular annuity options with the most basic annuity chassis. It’s a little like opting for heated leather seats, turbo and a Pandora radio link in a Hyundai Accent.

In addition to the GLWB and the roll-up, the product provides the features common to multi-year-guarantee fixed deferred annuities. That includes preservation of principal, interest rate guarantees, tax deferral and a death benefit. One industry observer suggested that, from the manufacturer’s point of view, the product’s deferral bonus might be looked at as an expression of the mortality credit and the interest accrual.

The Income Advantage requires a single premium of at least $25,000, according to the manufacturer’s fact sheet. Guaranteed interest rate terms can vary from one to 10 years. The cost of the income rider is 75 basis points (a maximum of 95 bps) for both the single and joint life options. The roll-up is equal to 6% of the purchase payments received within 60 days of contract issue.

The payout rate from age 65 to 69 is 5.25% for single life and 4.75% for joint life. It’s a half a percentage point lower for those ages 59½ to 64 and a half a point higher for those ages 70 to 79. At age 80, the payouts jump to 6.75% for single life and 6.25% for joint life.

The product is a bit like a SPIA with liquidity and a lower payout. For a premium of $100,000, a 65-year-old couple could, after 10 years, turn on a guaranteed lifetime income of at least $8,400 a year (5.25% of $160,000). Exact payouts would vary by contract, depending on changes in interest rate term or interest rate at reset. 

A product like this offers more liquidity and legacy value (via the death benefit) but probably less income than a deferred income annuity (DIA). A cash-refund DIA purchased by a 65-year-old couple today for $100,000 would, after 10 years, pay about $11,400 a year, according to Cannex data. Certain fixed indexed annuity contracts today would provide roll-ups as high as 8.5% for 15-year and a 6% payout for a 75-year-old couple.

Roll-ups have been a key selling point of deferred annuities with living benefits over the past five or eight years. At a time when money market funds earn less than the inflation rate, a roll-up of 5% or more looms large in the public imagination.

Indeed, anecdotal evidence shows that many if not most annuity owners (and even some advisers) perceive the roll-up is the equivalent of guaranteed growth rate. The roll-up, of course, doesn’t increase the surrender value of the contract; it merely increases the size of each payment. The manufacturer can also offset the impact of a roll-up by reducing the payout percentages.      

At the end of the guarantee period of the new Pacific Life product, the owner has a 30-day window to renew at available rates without risking a market value adjustment. The product can be sold to annuitant/owners up to age 85. The option to annuitize the contract can’t be exercised after age 95.

A withdrawal charge is assessed for the length of the guarantee period, for up to seven years. For partial withdrawals over 10% of the contract value in any given year, a market value adjustment will be assessed. The product is not available in New York.

There’s a curious comment in the press release on this product. It says “Guaranteed Withdrawal Benefit annual credits increase the protected value and will be treated as earnings when withdrawn.” That’s a bit puzzling. The annual credit—the roll-up—enhances the benefit base, not the account value.

The roll-up merely increases the rate at which the client withdraws his own money; why count it as “earnings”? The point is probably moot for contracts purchased with fully-taxable qualified money, but it may be significant for contracts purchased with after-tax money.

© 2013 RIJ Publishing LLC. All rights reserved.

RetiremEntrepreneur: Lou Harvey

Posted on December 4, 2013 by -

Dalbar copy blockWHAT I DO:  Dalbar has been characterized as a ‘policeman’ of the financial services community. There are three areas of service that we focus on. First, we’re well known for tracking investment behavior and activities related to financial services. Second, we perform qualitative and quantitative evaluations of business processes. The third area is certification.  Our most closely followed report is the Quantitative Analysis of Investor Behavior, or QAIB. We do tracking reports for customer service, investor statements, websites and, most recently, for mobile devices. We’ve also issued reports covering fee disclosure, fiduciary changes, target date funds and asset allocation practices. As for our name, the ‘Dalbar’ brand name was arbitrarily invented. The name had to be unique, not offensive, not too long, not too short, easily spelled and pronounced.

WHO MY CLIENTS ARE: Our clients are, on one hand, financial institutions, and on the other hand, the advisors and suppliers to financial institutions. We work with investment firms, 401(k) record keepers, broker-dealers and insurance companies. If the company’s brand name is generally known, then it is most likely a client of Dalbar’s.

WHY PEOPLE HIRE ME: We intelligently combine quantitative and qualitative work. That’s what makes us unique. Another factor is the process that we use. In order to achieve results for clients, we have technology that brings a lot of variables into a common platform, which then arrives at an evaluation. Technology is central to what we do. Our reputation, our brand and our history also make us unique.

WHERE I CAME FROM: I was born in Puerto Barrios, Guatemala, in 1942 and then moved to Jamaica, where I received a degree in physics from the University of the West Indies. Then I moved to New York. After a couple of months I got a card in the mail inviting all those ‘interested in planning your financial future’ to a meeting. At the meeting, a man started talking about mutual funds and diversification and investment management. I was wide-eyed. I was a scientist by education and a technical person by nature. I talked to him about getting involved in the business and that’s how I got started. Dalbar was founded in 1976. I was able to fund my start-up through sufficient personal capital for the first few months, and never looked back after that. I got my spirit of entrepreneurship from my mother. She had many wise sayings, the most memorable being, “You don’t have to be rich to be independent.” As for being a person of color, it has not affected the course of my career. If I suffered from racial discrimination, I was not aware of it. If I had access to set asides or affirmative action privileges, I have never used them.

HOW I GET PAID: We sell a variety of different products. There are some studies that we do gratis. We also do studies where firms pay a fee to participate and receive a copy of the study, as well as studies that firms request. Fees for evaluations also vary. We may do evaluations for a single firm, or we may syndicate our evaluations. Our evaluations of client statements, for instance, are syndicated valuations. The third bucket includes the certifications. For that we charge a uniform fee, which is a critical part of our credibility. Everybody pays the same fee, win, lose or draw. Dalbar is a private partnership.

MY RETIREMENT PHILOSOPHY: I am having so much fun working that I won’t quit until I can’t get up in the morning. I do have a strong senior management team in place that can operate without me. There is an exit plan for the business. As for annuities, I have no objection to them. They can play a critical role in retirement. But, I personally don’t have a need for an annuity’s benefits. It comes down to personal strategy. Unfortunately, most people aren’t so lucky as me. They don’t enjoy what they do. Also, hundreds of millions of people have suffered a disservice. They’ve been led to believe that if they save 5% or 6% of their income and invest it for 45 years, they can retire at 65 years of age at some level of comfort. Most researchers know that that’s not true. People need to save three to four times as much as they’re currently saving. Instead of putting money away for comfort in retirement, people are living too high on the hog today. It’s not about moving financial chess pieces around. It’s about saving more money. That, I think, is the only solution to this retirement problem.

© 2013 RIJ Publishing LLC. All rights reserved.

Four Fallacies of the Second Great Depression

Posted on November 28, 2013 by -

The period since 2008 has produced a plentiful crop of recycled economic fallacies, mostly falling from the lips of political leaders. Here are my four favorites.

The Swabian Housewife. “One should simply have asked the Swabian housewife,” said German Chancellor Angela Merkel after the collapse of Lehman Brothers in 2008. “She would have told us that you cannot live beyond your means.”

This sensible-sounding logic currently underpins austerity. The problem is that it ignores the effect of the housewife’s thrift on total demand. If all households curbed their expenditures, total consumption would fall, and so, too, would demand for labor. If the housewife’s husband loses his job, the household will be worse off than before.

The general case of this fallacy is the “fallacy of composition”: what makes sense for each household or company individually does not necessarily add up to the good of the whole. The particular case that John Maynard Keynes identified was the “paradox of thrift”: if everyone tries to save more in bad times, aggregate demand will fall, lowering total savings, because of the decrease in consumption and economic growth.

If the government tries to cut its deficit, households and firms will have to tighten their purse strings, resulting in less total spending. As a result, however much the government cuts its spending, its deficit will barely shrink. And if all countries pursue austerity simultaneously, lower demand for each country’s goods will lead to lower domestic and foreign consumption, leaving all worse off.

The government cannot spend money it does not have. This fallacy – often repeated by British Prime Minister David Cameron – treats governments as if they faced the same budget constraints as households or companies. But governments are not like households or companies. They can always get the money they need by issuing bonds.

But won’t an increasingly indebted government have to pay ever-higher interest rates, so that debt-service costs eventually consume its entire revenue? The answer is no: the central bank can print enough extra money to hold down the cost of government debt. This is what so-called quantitative easing does. With near-zero interest rates, most Western governments cannot afford not to borrow.

This argument does not hold for a government without its own central bank, in which case it faces exactly the same budget constraint as the oft-cited Swabian housewife. That is why some eurozone member states got into so much trouble until the European Central Bank rescued them.

The national debt is deferred taxation. According to this oft-repeated fallacy, governments can raise money by issuing bonds, but, because bonds are loans, they will eventually have to be repaid, which can be done only by raising taxes. And, because taxpayers expect this, they will save now to pay their future tax bills. The more the government borrows to pay for its spending today, the more the public saves to pay future taxes, canceling out any stimulatory effect of the extra borrowing.

The problem with this argument is that governments are rarely faced with having to “pay off” their debts. They might choose to do so, but mostly they just roll them over by issuing new bonds. The longer the bonds’ maturities, the less frequently governments have to come to the market for new loans.

More important, when there are idle resources (for example, when unemployment is much higher than normal), the spending that results from the government’s borrowing brings these resources into use. The increased government revenue that this generates (plus the decreased spending on the unemployed) pays for the extra borrowing without having to raise taxes.

The national debt is a burden on future generations. This fallacy is repeated so often that it has entered the collective unconscious. The argument is that if the current generation spends more than it earns, the next generation will be forced to earn more than it spends to pay for it.

But this ignores the fact that holders of the very same debt will be among the supposedly burdened future generations. Suppose my children have to pay off the debt to you that I incurred. They will be worse off. But you will be better off. This may be bad for the distribution of wealth and income, because it will enrich the creditor at the expense of the debtor, but there will be no net burden on future generations.

The principle is exactly the same when the holders of the national debt are foreigners (as with Greece), though the political opposition to repayment will be much greater.

Economics is luxuriant with fallacies, because it is not a natural science like physics or chemistry. Propositions in economics are rarely absolutely true or false. What is true in some circumstances may be false in others. Above all, the truth of many propositions depends on people’s expectations.

Consider the belief that the more the government borrows, the higher the future tax burden will be. If people act on this belief by saving every extra pound, dollar, or euro that the government puts in their pockets, the extra government spending will have no effect on economic activity, regardless of how many resources are idle. The government must then raise taxes – and the fallacy becomes a self-fulfilling prophecy.

So how are we to distinguish between true and false propositions in economics? Perhaps the dividing line should be drawn between propositions that hold only if people expect them to be true and those that are true irrespective of beliefs. The statement, “If we all saved more in a slump, we would all be better off,” is absolutely false. We would all be worse off. But the statement, “The more the government borrows, the more it has to pay for its borrowing,” is sometimes true and sometimes false.

Or perhaps the dividing line should be between propositions that depend on reasonable behavioral assumptions and those that depend on ludicrous ones. If people saved every extra penny of borrowed money that the government spent, the spending would have no stimulating effect. True. But such people exist only in economists’ models.

© 2013 Project Syndicate.

 

Use These Maps to Find Boomer Wealth

Posted on November 28, 2013 by -

In addition to the ever-growing forest of white papers and surveys that document Americans’ failure to save enough for retirement, there exists a less voluminous but more upbeat lumber pile of literature that shows how much Americans have saved. And it’s a lot—on paper at least.

Two recent surveys, one by Cerulli Associates (of 401(k) participants) and the other by the Investment Company Institute (of IRA owners) throw some fresh, crunchy numbers onto the pile.

Taken together, the two reports shed light on a pivotal question: Which type of account will most Boomers draw their retirement incomes from? Will it be rollover IRAs, 401(k)s, annuities or “All of the above”? The answer will help determine the market shares that different types of intermediaries—investment advisors, fund companies or insurance companies—are likely to enjoy as the Boomers move through retirement.

‘Evolution of the Retirement Investor’

Cerulli’s report, “Evolution of the Retirement Investor 2013,” is proprietary, but a summary is made available to the press. One of the charts, titled “Distribution of RIO Households’ Investable Assets by Investable Assets and Age Range 2012E,” is a prism that reveals the five underlying color-bands of the “ROI,” or retirement income opportunity.   

What’s immediately observable is the sheer amount of money saved by households headed by people ages 55 to 69. This group of about 30 million Americans has saved about $15 trillion, of which about $6 trillion is in retirement accounts. The Cerulli data shows not only how much wealth exists in America, but also how concentrated it is.

Of the five groups that the chart encompasses, the least wealthy and most wealthy are both probably—or very different reasons—outside of the retirement market per se.  The least wealthy are by far the most numerous (17.3 million) but they have average retirement savings of only $8,900 each. All but invisible to financial services companies or advisers, they will likely rely on Social Security, family members and income from part-time jobs in retirement.

At the other extreme are the 457,000 older heads-of-households who have $1.07 trillion in retirement savings, or about $2.34 million each. Because their retirement savings represent only about 22% of their total investable wealth, however, retirement may not represent a challenge or even a milestone that will drive them to seek new sources of advice or assistance. 

Cerulli sees “an opportunity for independent and direct providers” in the lowest of the middle three groups. This group is large (6.3 million) and not so wealthy ($960 billion in retirement assets; $1.54 trillion in other investable assets) that its members won’t need help in trying to stretch their savings over 20 or 30 years of retirement.

This mass-affluent group is currently “underserved” by the financial services industry, the report says. The group’s retirement assets represent a big share (62%) of its total investable wealth. With average retirement savings of only $154,000, this group will be financially “constrained” in retirement. Since their longevity risk will be high, they could be potential annuity purchasers. 

‘The Role of IRAs’

The Investment Company Institute (ICI) report, “The Role of IRAs in U.S. Households’ Saving for Retirement, 2013,” looks at the IRA side of the retirement savings picture—especially rollovers. Rollover IRAs are the subject of much scrutiny these days; while nest eggs are usually laid in 401(k)s, they’re increasingly likely to hatch in rollover IRAs.

While the IRA may originally have been intended as a way for the millions of people without employer-sponsored retirement plans to save for retirement on a tax-deferred basis, it hasn’t exactly worked out that way. Americans mainly use IRAs as the default havens for the tax-deferred savings that they voluntarily or involuntarily transfer (“roll over”) from a former employer’s plan. Most of the $5.7 trillion in IRAs today came from rollovers, not from piecemeal contributions.

That’s a boon for the retirement industry. The savings that finds it way into retail rollover IRAs is available for a much wider range of investment options than savings in Department of Labor-regulated workplace retirement plans, while remaining tax-deferred. That worries the Department of Labor, which would prefer that retirement assets continue to grow in an institutionally-priced environment with a fiduciary standard of conduct.      

Rollovers, which in about three out of four cases are triggered by a job change, have arguably made IRAs a much larger phenomenon than they would otherwise be. Although there’s roughly an even split between owners of IRAs with and without rollovers, there’s about twice as much money on average in rollover-funded IRAs ($173,000 vs. $90,000).

The median amount of former 401(k) money in IRAs is 70%, and 49% of IRA owners say that 75% or more of their IRA assets are rollover money, according to the ICI. The most common reason (72%) cited for executing a rollover was to preserve tax deferral—an answer that makes sense only for the 46% who said they were forced to move money out of their former employers’ plans.

IRA ownership tends to be a marker for greater household wealth and education, according to the ICI. IRA-owning households have more than double the household income and eight times as much financial assets as non-IRA households, on average. Decision-makers in IRA households are twice as likely to have a college or graduate degree. 

Once people set up rollover IRAs, fewer than half seem to contribute to them in a given year—either because they are contributing to a 401(k) at work or because they are retired or because they don’t have extra money to save. (It stands to reason that, without the automatic payroll deferral of a 401(k) plan, people are less likely to contribute to a tax-deferred account.)

Retirees who have IRAs don’t seem in a hurry to dip into them unless they have to. The vast majority of IRA withdrawals are taken after age 70½, when annual minimum distributions are required to begin. Most people of RMD age withdraw the minimum amount required under tax law. Many people evidently experience the annual RMD simply as the occasion for an unwelcome tax bill, especially if they intend to reinvest the withdrawal rather than spend it.   

Compare and contrast

It’s interesting to compare the answers that IRA owners and 401(k) participants gave to a question about their primary source of financial advice. Sixty percent of IRA owners in the ICI survey said a “financial adviser” was their most common source of advice on “creating a retirement strategy.” In the Cerulli survey of participants, the largest single share (26.9%) named “401(k) provider” as their primary source of retirement advice.

That might suggest that as long as people have most of their money in 401(k) plans, they’re most likely to rely on the provider’s recommendations. That might be good news for major 401(k) providers like Vanguard and Fidelity. But after a rollover, people seem more likely to rely on advisors, which would appear to be good news for brokers and financial advisers. The data isn’t definitive either way, however. Even among participants, 15.7% name “financial advisor” and an additional 8.4% name “financial planner” as their primary source of advice.

The prospect of managing the Boomers’ trillions is galanizing, to be sure. But it’s worth remembering that those are still mainly paper trillions, and the assets could deflate at almost a moment’s notice. The jury is still out on whether and by how much the sales of securities by Boomer retirees might depress market values, and whether or not the U.S. economy will be strong enough to keep security prices high in coming years. 

© 2013 RIJ Publishing LLC. All rights reserved.

VA Issuers Limit Inflows in 3Q: Morningstar

Posted on November 28, 2013 by -

The third quarter of 2013 showed modest activity. Last quarter’s “house cleaning” meant most carriers already made their impactful product adjustments. So changes to the nuts and bolts of products and structures were minimal this quarter. The biggest movement related to access to products, with AXA Equitable making a buyout offer, a group of carriers limiting subsequent payments to their products, and Jackson National expanding access by reopening the availability of living benefits for its joint life products.

Hartford continued to execute on its reallocation requirements. Several carriers including MetLife, Nationwide, and Prudential (via a cap) managed exposure by limiting subsequent payments to contracts and benefits. Carriers have a number of ways they can limit exposure. Much of the heavy lifting in this area was done last quarter via fee increases, limits to step ups, and reductions in with- drawal rates. This quarter, carriers triggered their option to limit inflows to earlier, more generous versions of contracts in order to control liability.

Low interest rates continued to put pressure on carriers and hampered any ability to ratchet benefit levels back up.

During the third quarter, carriers filed 84 annuity product changes compared to 182 product changes in the second quarter of 2013 and 106 in the third quarter last year.

Q3 Product Changes

Allianz rolled out a hybrid VA (Index Advantage). This contract costs 1.25% as a B share and has no living benefits. Funds can be invested in three subaccounts or tied to two interest crediting strategies based

on indexes from S&P, Nasdaq, or Russell. The first “protection” cred- iting strategy bumps up the account value by a predetermined percentage if the index gains value after a year. The credit percentage changes every year (it is currently 4.5%) and will never be less than 1.5%. A second “performance” crediting strategy either steps up the account value (subject to a cap) or reduces the benefit base (offset by a buffer that never changes over the contract life). Losses worse than the buffer reduce principal.

Released in July, Allianz Investment Protector is a Guaranteed Minimum Accumulation Benefit that covers a 10-year protection period and offers return of premium or, if higher, 80% of the highest anniversary value during this period. Its fee is 1.30%.

Also in July, AXA filed a buyback offer to owners of certain living benefits for the Accumulator series of contracts issued between 2004 and 2009. The buyback was executed in September. The offer
asks the client to terminate either the Guaranteed Minimum Income Benefit rider or enhanced earnings rider in exchange for a credit to the account’s value. The calculation factored in multiple values and credited an amount to the contract owner’s account.

As of September 13, 2013, and for a limited time, AXA offered an increased account value to owners of certain Accumulator
contracts who have elected the Guaranteed Minimum Income Benefit. If accepted, the Guaranteed Minimum Income Benefit, optional death benefits, and standard death benefit will terminate and only the account value will be payable upon death. Contact the carrier for details.

AXA closed the Accumulator 11.0 Series (B, C, CP, and L shares) in September.

In September, Jackson National re-released the joint versions of its living benefits after a hiatus. The joint versions of the LifeGuard Freedom 6 and the LifeGuard Freedom Flex are available again. The Freedom 6 offers an age-banded guaranteed withdrawal (currently 4.5% for a 65-year-old). The three standard step ups are available: highest anniversary value; a 6% fixed step up for 10 years of no withdrawals; or a doubling of the benefit base after 12 years. Its fee is 1.60%. The LifeGuard Freedom Flex offers an age-banded guaranteed withdrawal (currently 4.5% for a 65-year-old), and a fixed step up of 5%, 6%, or 7%—one of which is chosen by the client. The step up chosen then determines the rider fee range (from 1.35% to 1.60%). The other two step up options (highest anni- versary value and deferred benefit base) are similar to the Freedom 6.

MetLife limited subsequent payments in its GMIB Max series of riders as of August.

As of July 15, 2013, Nationwide limited subsequent payments into its lifetime withdrawal benefits (5%, 7%, and 10% Lifetime Income Options).

Principal changed the age bands on its lifetime withdrawal benefit (Guaranteed Minimum Withdrawal Benefit). The single-life version consolidated from five age bands to three. The withdrawal rate for a 65-year-old dropped from 5.25% to 5%. Principal also reduced the number of age bands on its Income Builder series (Income Builder 3 and Income Builder 10). It reduced the Income Builder 3 age bands from eight to five and from seven to four for the Income Builder 10. The withdrawal rates for a 65-year-old did not change.

Protective rolled out a new Lifetime Guaranteed Minimum Withdrawal Benefit called SecurePay 5. It offers a 5% lifetime withdrawal and two step ups: a highest anniversary value and a 5% fixed step up for 10 years. The rider has a nursing-home provision that doubles the withdrawal percentage if the contract owner is confined to a nursing home. There is also a medical-condition provision that increases the withdrawal percentage between 0.25% and 2% if the contract owner’s medical condition qualifies. The fee is 1.20%.

Prudential tweaked the withdrawal rates on its relatively new Defined Income benefit, which guarantees lifetime withdrawals now ranging from 3.35% for age 45 to 7.35% for ages 85+. A different percentage applies for each issue age between 45 and 85. Contracts issued prior to September 13, 2013 ranged from 3.15% to 7.15%, while contracts issued prior to July 15, 2013 ranged from 3% to 7%. Prudential also increased the step up to 6% from 5.5% (single and joint versions).

Prudential limited subsequent payments into some of its HD Lifetime Income benefits to a $50,000 annual maximum on additional purchase payments. The change was effective July 29, 2013 (August 8, 2013 for employer-sponsored qualified retirement plans). This applies to HD Lifetime Income, Spousal HD Lifetime Income, and HD Lifetime Income with Lifetime Income Accelerator.

Security Benefit updated its EliteDesigns. The new C share contract has 275 subaccounts including alternative asset classes and offers a return of premium death benefit. The cost is 1.45%.

SunAmerica closed the Polaris Advantage, Polaris Advantage II, and Polaris Preferred Solutions bonus contracts in the third quarter.

Pipeline

Hartford set an October 4, 2013 deadline for owners of the Director M lineup to reallocate their investments or face losing the Lifetime Income Builder rider. Contract owners are required to place a minimum of 40% of assets in fixed-income investments and a risk- based asset allocation model. This follows a first quarter cash buyout offer to owners of the Lifetime Income Builder II rider on the Director M series and the Leaders series.

As of October 25, 2013, Jackson National stopped taking applications for 1035 exchanges or qualified transfers of assets. Transactions involving contracts with living benefits will not be accepted unless they are submitted through a Jackson National affiliated broker/ dealer. The company is planning to lift this restriction beginning December 16 of this year.

Minnesota Life released a contract for Waddell & Reed. The Advisors Retirement Builder II contract carries a series of four lifetime Guaranteed Minimum Withdrawal Benefits. Each is set up with a separate fee, step up, and withdrawal percentage. The suite of benefits includes: withdrawals for a 65-year-old ranging from 4% to 5.25%; steps ups from zero to 6%; and fees from 0.45% to 1.40%. The B share costs 1.30% and offers 29 Ivy Funds subaccounts.

Transamerica is readying an O share filing. More info is to come in a future product change summary.

© 2013 Morningstar, Inc.

First you’re retired, then you’re not

Posted on November 28, 2013 by -

You’ve heard of the revolving-door syndrome. Now a “Revolving-Retired” syndrome has been identified.

According to a recent edition of The MacroMonitor, a publication of SRI Consulting-Business Intelligence, Revolving-Retired households are those with a primary head age 55 or older who has gone from full-time to part-time work, or has retired and returned to the workforce, or has retired and plans to return to the workforce. Heads of households with less than $100,000 in savings and investments and those who rely on Social Security for most of their retirement income are most likely to fit this description.

Revolving Retirement Graphic

This may represent a new market niche. According to SRI-BI, “A gap exists between the products and services that financial institutions offer to pre-retired and retired households and the needs of Revolving-Retired households. As retirement evolves into a more flexible yet complicated life stage, financial services providers could benefit from understanding the multiple stages of retirement better.”

Some Revolving-Retired households, as well as households preparing for retirement, continue to support dependents; households with dependent children no doubt postponed forming families in their thirties, The MacroMonitor said.

© 2013 RIJ Publishing LLC. All rights reserved.

 

When unemployment goes up, so does number of ‘partially-retired’

Posted on November 28, 2013 by -

Over the half-century from 1960 to 2010, the fraction of the overall white male labor force represented by “partially retired workers” rose from virtually zero to about 15% for 60-62 year olds, and the average length of spells of “partial retirement” has steadily increased.

This finding was reported in “Macroeconomic Determinants of Retirement Timing,” an NBER working paper by Yuriy Gorodnichenko of the University of California at Berkeley, Jae Song of the Social Security Administration and Dmitriy Stolyarov of the University of Michigan.

Hoping to estimate how variations in unemployment rates, inflation and housing prices affect the timing of retirement, they determined that “flows into both full and partial retirement increase significantly when the unemployment rate rises,” especially for workers close to normal retirement age.

“Workers who are partially retired show a differential response to a high unemployment rate,” they found. “Younger workers increase their partial retirement spell, while older workers accelerate their transition to full retirement. We also find that high inflation discourages full-time work and encourages partial and full retirement.” Changes in housing prices had no significant impact on retirement timing.

© 2013 RIJ Publishing LLC. All rights reserved.

Harbinger details annuity sales results for fiscal 2013

Posted on November 28, 2013 by -

Major changes are underway at Fidelity & Guaranty Life, the insurer that was purchased by the Harbinger Group in the wake of the financial crisis.

In late August, FGL filed for an IPO. On November 1, the company said it would “re-domesticate” from Maryland to Iowa. This week the parent company announced its consolidated results for the year ending last September 30, including results for its insurance division.

“Operating income in our Insurance segment has performed strongly and grown to $522.9 million due to a more favorable economic environment and our solid market position,” said HGI president Omar Asali, in a release.

The firm reported these financial highlights for its insurance segment for fiscal 2013:  

  • Annuity sales, which for GAAP purposes are recorded as deposit liabilities (i.e. contract holder funds), for fiscal 2013 of $1.0 billion, compared to $1.7 billion for fiscal 2012.
  • Annuity sales fell because of pricing changes and because of relatively high sales during the same period last year from the launch of new products. The pricing changes were made to maintain target profitability and target capital ratios.
  • Indexed universal life sales grew by 16%.
  • Net income was $350.2 million, up from $344.2 million for fiscal 2012.  Operating income was $522.9 million, up from $159.9 million for Fiscal 2012. Bond sales and adjustments to amortization and reserves (to reflect updated assumptions related to interest rates and option costs based on the current market environment) significantly improved during Fiscal 2013.
  • Adjusted operating income (“Insurance AOI”) rose by $163.5 million (pre-tax), or 282.4%, to $221.4 million from $57.9 million for Fiscal 2012.
  • Annual changes made to assumptions about the surrender rates, earned rates and future index credits that are used in the FIA embedded derivative reserve calculation drove the increase. They caused a reserve decrease of $86.5 million during the fourth quarter of Fiscal 2013, net of related DAC and VOBA amortization and unlocking impact.
  • Also contributing to the increase: immediate annuity mortality gains of $36.3 million during Fiscal 2013 caused by large case deaths and the absence of an $11.0 million charge for unclaimed death benefits, net of reinsurance, recorded in Fiscal 2012 and a reconciliation of adjusted operating net income before taxes to the Insurance segment’s reported net income before taxes below.

FGL had approximately $17.4 billion of assets under management as of September 30, 2013, compared to $17.6 billion as of September 30, 2012. As of September 30, 2013, HGI’s Insurance segment had a net GAAP book value of $1.2 billion (excluding Accumulated Other Comprehensive Income (“AOCI”) of $112.9 million). As of September 30, 2013, the Insurance segment’s investment portfolio had $305 million in net unrealized gains on a GAAP basis. FGL’s statutory total adjusted capital at September 30, 2013 was approximately $1.136 billion.

On November 1, 2013, FGL announced that it would move from Maryland to Iowa to leverage Iowa’s “deep insurance talent pool, sophisticated regulatory approach to indexed products, and strong business climate.” In addition, on August 29, 2013, FGL filed for a U.S. initial public offering.

© 2013 RIJ Publishing LLC. All rights reserved.

Does threat of layoffs make workers work harder?

Posted on November 28, 2013 by -

Worker productivity in the U.S. rose during the Great Recession. Although the aggregate number of hours worked fell 10.01%, output dropped only 7.16%. Social scientists wondered whether this occurred because companies fired less-productive workers or because the retained workers worked harder.

In their paper, “Making Do With Less: Working Harder during Recessions (NBER Working Paper No. 19328),” researchers Edward P. Lazear and Kathryn L. Shaw of Stanford and Christopher Stanton of the University of Utah found evidence that employees worked harder.

In a review of computer-tracked daily productivity data for 23,000 workers at a large tech company between 2006 and 2010, they found a 5.4% increase in productivity, 85% of which they attributed to employees working harder.

The tech company had operations in states with high unemployment rates, like Florida, and states with relatively low unemployment rates, like Kansas. Worker effort rose the most in areas with higher unemployment rates. Workers whose productivity had previously been below-median boosted their productivity the most.

There was little evidence that less-productive workers had left the firm. Those newly hired during the recession were 1.5% more productive than all the other workers, but their impact on total productivity was small because they made up only 30% of the workforce. They accounted for only 0.68 percentage points of the overall 5.4% boost in productivity.

© 2013 RIJ Publishing LLC. All rights reserved.