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Goldman Touches the FIA Market

Posted on October 4, 2013 by Kerry Pechter -

Bermuda-based Global Atlantic Financial Group, a multiline insurer and reinsurer whose principal owner is Wall Street powerhouse Goldman Sachs, is expanding its footprint in the life insurance industry by acquiring privately-held Forethought Financial Group Inc., which offers variable annuities, fixed annuities and fixed indexed annuities, as well as funeral insurance.

By buying Houston-based Forethought, Global Atlantic, which until last April 30 was Goldman Sachs Reinsurance Group, captures The Hartford’s former annuity business; Hartford stunned the industry by selling its once-vaunted life and annuity business to Forethought in 2012.

Global Atlantic also owns Commonwealth Annuity and Life (the former Allmerica Life), which Goldman Sachs bought in 2005. And, just two days ago, regulators approved Commonwealth’s acquisition of $10 billion in Aviva USA life insurance assets from Athene Re (not Aviva Life and Annuity in its entirety, as the box below misstates).

The Aviva and Forethought deals prompted the rating agency A.M. Best to affirm Commonwealth’s A-minus (Excellent rating) and removed the insurer from “under review with negative implications.”

Goldman Sachs, a partnership that went public in the late 1990s and morphed into a bank holding company during the financial crisis, acquired Bermuda-based Ariel Re in 2012, which is now part of Global Atlantic’s property-casualty segment. These transactions give Global Atlantic total assets of about $31 billion. Its chairman and CEO is Allan Levine (right), former CEO of Goldman Sachs Reinsurance Group. Forethought’s CEO, John Graf, will join Global Atlantic’s board as a non-executive vice-chairman of the life and annuity business.

In response to an inquiry by RIJ, Mark Kollar of Global Atlantic’s public relations firm, Prosek Partners, said Global Atlantic wasn’t yet giving interviews on the deal. It could not be confirmed if ownership of Epoch Securities, the small Massachusetts-based broker-dealer that distributes Commonwealth Annuity’s variable annuities, has transferred from Goldman Sachs to Global Atlantic.

Fixed indexed annuity due next year

Forethought already has at least two fixed indexed annuity contracts (Bonus Advantage and Forethought Income 125) and Commonwealth expects to introduce one. Goldman Sachs owns a reported 23% (this is anecdotal but the source was in a position to know) of Global Atlantic Financial Group. The companies are said to be still working out how Forethought and Commonwealth will fit into Global Atlantic’s structure.

“The acquisition [of Aviva’s life insurance business] will provide Global Atlantic with new sources of earnings diversification, as this acquisition will enhance its product lines and distribution channels,” A.M. Best said in an October 2 release. “[The acquisition of Forethought] will provide additional product diversification to Global Atlantic, including its pre-need insurance.”

Like other recent purchases of domestic life insurers by other private companies, Global Atlantic’s purchase of Forethought has triggered a burst of conversation, speculation (and anxiety, in some quarters), especially in the fixed indexed annuity part of the life business, where total sales are currently running at an all-time high of about $9 billion a quarter.

“The established FIA companies are very frustrated and feel that they can’t compete,” said one industry watcher. Others are more sanguine.

“I’m in favor of the deal,” fixed indexed annuity authority Jack Marrion told RIJ this week regarding the Global Atlantic-Forethought deal. “Global-Commonwealth wants to get bigger in this area and Forethought was looking for more capital.” As a consultant to the companies involved, Marrion said he couldn’t comment further.

Market share triples since 2008

Other private companies that have taken advantage of the divestitures and depressed values of annuity and life insurance assets in the wake of the financial crisis include Guggenheim Partners (owner of Equitrust, Security Benefit, Sun Life Assurance), Apollo Global Management (owner of Athene Re, purchaser of Aviva plc’s US business and purchaser of Presidential Life) and Harbinger Group Inc., which in 2011 bought the U.S. life and annuity businesses of Old Mutual plc.

These companies—particularly Security Benefit—have shaken up the status quo in the fixed annuity business by, in some cases, offering higher sales commissions and/or richer bonuses, payout rates and riders and climbing the sales rankings. They’ve taken advantage of the popularity of the fixed indexed annuity category—popular among risk-averse investors who are disappointed with CD returns or are looking for guaranteed retirement income—and, some say, invigorated an already strong product category.

The private company share of fixed indexed annuity sales has tripled in five years. According to industry sources, in second quarter 2008 private companies had an 8% market share. By second quarter of 2013, they had a 23% share. FIAs appeal to private companies in part because sales are strong, because less-than-A-rated companies can sell them, and because they’re not SEC-regulated are less transparent than securities products. They also involve a lot of financial engineering, a presumed strength of private equity firms.

“There’s skepticism about these companies—and a lot of it is unfair,” said one life insurance industry watcher this week. A retirement industry insider said: “These new investors in the life insurance industry are experienced managers of insurance assets—80% of the assets were outsourced to them anyway—and they’ve put extremely fit management in place.”

Commitment questioned

But regulators (Ben Lawsky in New York State), rating agencies, the more conservative (bank channel and broker-dealer) distributors and established competitors in the life insurance and annuity field have raised a lot of questions about the short-term, risk-on reputations of the private company entrants, some of which have less than A ratings from A.M. Best. Equitrust is B+ and Security Benefit is B++, for instance. Athene’s Aviva Life and Annuity was downgraded today to B++ from A-minus by A.M. Best.

“We’re just not sure about their commitment to the industry,” said one competitor, referring to the possibility that the private companies might be pumping up sales of fixed annuity issuers in hopes of selling them in a few years—an unwelcome trend in an industry where companies boast about their 19^th century provenance, if they have even the most tenuous justification for doing so.

“I have to assume that Global Atlantic’s motivations are similar to the other private companies that have come into this space,” said a person who follows the FIA business. Because of the low interest environment, they can get a great deal on the life and annuity assets. Forethought is known for its funeral policies or ‘pre-need life insurance.’ That could be part of the motivation.”

The same observer was troubled about upward trends in the share of FIA business going to companies rated less than A-minus by A.M. Best, the amount of business going through proprietary channels (“where life insurer A works with distributor A only”), and about the higher commissions that lower-rated companies were paying in order to boost sales.

Average commissions for FIAs have come down from a peak of about 9% before the financial crisis to about 6% today, but some private equity-owned companies tend to be above average. Equitrust (B++), a Guggenheim property, offers an 8.5% commission on its Market Power Bonus Index and Market Twelve Bonus products. Fidelity and Guaranty Life (owned by Harbinger) pays 8% on at least two products. Athene Life (B++) offers 7%.

By contrast, higher rated companies tend to pay lower commissions. American General (A) pays a 3.5% commission on its AG Horizon Index 9 product. Lincoln National (A+) offers 4.5% on its OptiPoint 10 and New Directions 8 products. (All ratings are by A.M. Best.) That gives them an edge in the bank channel but not so much in the independent agent world, where most FIA sales originate and always have.

How do they do it?

The frequent question about the private companies is: how do they pay for the richer sales percentages and more attractive product features? There are lots of answers: They save on taxes and reserves by using captive offshore reinsurers; they earn management fees on the assets they acquire; they take greater credit risk on their fixed income portfolios; their people are smarter than yours.

Matt Hutton, a life insurance specialist at Deloitte in New York, put it this way: “First, they get the assets at a good price. Second, they don’t have ‘analyst fatigue.’ Third, they manage the investments a bit better. Fourth, unlike the public companies that have to face the analysts every quarter, they can take a long-term view regarding volatility.”

Another New York-based analyst agreed with the idea that the most successful private equity firms do tend to make smarter bets, not just riskier ones. “Frankly, they’re smarter than most of the institutional people. There’s a reason why investors demand more from them and pay them more. They wouldn’t be in business if they had no track record of beating the markets, especially the credit markets,” he said.

“When you’re talking about a spread-based business, it’s almost 100% commoditized,” he added. “Then it comes down to, Who are the smarter guys in the room? Whether its asset selection, leverage or timing, if they can generate even a modest incremental portfolio yield versus the typical investment grade bond portfolio, it makes a big difference. In this business mix, every basis point counts.”

‘Not close to the end’ of this trend

As for the question of mortgage-backed securities (MBS), which privately-owned life insurers are said to be loading up on, he believed that the private equity fixed income specialists are good at distinguishing between securities that are cheap because they’re trash and those that are true bargains.

“This asset class has gotten painted with a broad brush. But when you dig beneath the surface, you find many important nuances that many people, including most of the media, don’t get. For instance, it matters at the end of the day whether you were assessing the value of a fixed or floating rate instrument, a callable or non-callable instrument, or a package of 2006-or-prior vintage mortgages versus mortgages packaged in 2007-2009,” he told RIJ.

“If you were smart and had the cash and were willing to invest for the long-term, then you could find good, lower-risk assets that were priced the same as the lousy assets,” he added. “You weren’t throwing the baby out with the bathwater. And especially at the private equity firms, there’s a lot of leverage they could put on those bets.”

The shape of the annuity space will continue to evolve, he predicted. “Apollo is on the record as saying that they would take Athene [Life and Annuity] public by the end of 2015, so we will see more disclosure from them,” he said.

“I don’t think we’re anywhere close to the end, in terms of private equity-sponsored insurance companies’ interest in the fixed and fixed indexed annuities space. We’ll see over time if that evolves into some interest in the variable annuity space.” But that may have to wait until their strength ratings improve.

Drew Carrington joins Franklin Templeton’s DCIO business

Posted on September 26, 2013 by Kerry Pechter -

Retirement industry veteran Drew Carrington will join Franklin Templeton Investments as senior vice president and head of Defined Contribution – Institutional, based in San Mateo, Calif., the mutual fund company announced this week.

Carrington will report to Scott Lee, head of Franklin Templeton’s institutional sales team, and will “focus on shaping and executing the firm’s sales and service strategy within the growing defined contribution investment-only (DCIO) segment of the US institutional market,” a release said.

In the past, Carrington has served as head of the Defined Contribution and Retirement Solutions Group at UBS Global Asset Management and was a principal at Mercer Investment Consulting. He holds Chartered Financial Analyst® (CFA)¹ and Chartered Alternative Investment Analyst (CAIA) designations and holds a bachelor of arts from Harvard University.

Fidelity to raise equity allocations in target date funds

Posted on September 26, 2013 by Kerry Pechter -

Fidelity Investmentssaid it will tweak the glide path for its Freedom Fund target date funds based on information gleaned from investor demographics and behaviors, updated capital market assumptions and “an enhanced approach to evaluating loss-recovery and risk-aversion,” the Boston-based financial services giant said in a release.

Fidelity is the largest provider of target date funds with more than $170 billion under management on behalf of approximately 6.5 million investors in its Fidelity Freedom Funds product line (Fidelity, Fidelity Advisor, Fidelity Index and VIP).

Over the next several months, Fidelity expects to increase equity allocations across most of the dated portfolios, with a proportional decrease in other asset classes, notably short-term debt. The target asset allocations for Fidelity Freedom 2020 Fund, for example, will be modified along the following lines:

The target for domestic equity funds will rise to 43% from 39%.
The target for international equity funds will increase to 18% from 14%.
The target for bond funds will decrease to 32% from 39%.
The target for short-term funds will decrease to 7% from 8%.

Fidelity said the glide paths of its target date portfolios seek to provide inflation-adjusted retirement income equal to about half of an investor’s final pre-retirement salary. “These assets should be combined with other complementary sources of income (e.g., Social Security, defined-benefit plan benefits and personal savings) to achieve Fidelity’s overall retirement planning target of income replacement equal to 85% of final salary,” the company said in a release.

Jackson National dominates annuity flows in first half of 2013

Posted on September 26, 2013 by Kerry Pechter -

Jackson National Life, a U.S. subsidiary of Britain’s Prudential plc, was the healthiest U.S. annuity issuer in terms of net cash flow in the first half of 2013, according to the Analytic Reporting for Annuities, a service of Insurance & Retirement Services of the National Securities Clearing Corp., a subsidiary of DTCC.

Jackson National was ranked first in inflows and first in net flows, with $8.4 billion (18.9% market share) and $6.1 billion, respectively. Three Jackson variable annuity products—Perspective II 05/05, Perspective II L-Series and Elite Access—were all among the five best-selling annuity products.

The first-half report showed that there was about $85 billion worth of annuity transactions processed by 112 insurance companies, involving 128 distributors and encompassing 3,236 different annuity products.

The statistics do not include captive agent sales. One of the most popular annuity products in the first half, deferred income annuities, are manufactured mainly by mutual insurers and sold mainly by captive agents.

Overall, the annuity industry saw first half net cash flows down by 46% compared with the first half of 2012 and 20% lower than net flows posted in the second half of 2012.

Inflows into annuity products processed in the first half of 2013 totaled almost $45 billion, increasing by nearly 4%, or $1.7 billion, compared to the first half of 2012. Outflows totaled almost $41 billion, up over 13% from the first half of 2012.

Of the annuity inflows, it’s not clear how much is new money coming from the public and how much is transfers from other annuity issuers. Similarly, it’s not clear how much of the outflow leaves the annuity industry through withdrawals or surrenders and how much is exchanged into other annuities. companies.

Outflows totaled almost $41 billion, increasing by over 13%, or $4.8 billion, compared to the first half of 2012. The resulting net cash flows totaled $3.6 billion, declining by over 46% compared to the first half of 2012. Compared to the second half of 2012, inflows in 2013 increased by 6%, out flows increased by 9% and net flows declined by just under 20%.

Ten insurance companies/holding companies accounted for $15 billion in net flows and 17 more companies shared an additional $2 billion in net flows. Sixteen companies experienced a total of $13 billion in negative net flows, with one unidentified company accounting for a $5 billion net outflow. MetLife and AXA SA were on the top-ten list for inflows but not on the top-ten list for net flows.

Of the 3,236 fixed and variable annuities tracked, net flows were concentrated within a relative handful of products. Five variable annuities had more than $1 billion in net flows, the top 10 variable annuities totaled $13 billion in net flows. An additional 64 products had net flows more than $100 million. They were among 610 products that showed positive net flows of almost $35 billion. The remaining 2,624 products showed negative net flows of about $31 million.

Distribution remains concentrated in the top 10 companies, who accounted for 68% of all sales of annuities in the U.S. in the first half of 2013, or an average of $5.7 billion each. The top 20 distributors, none of whom were named, accounted for 82% of sales, or an average of about $3.5 billion. That left 108 distributors sharing 18% of $85 billion, or about $141 million in gross sales each.

Ten states, led by California with 8%, accounted for about 45% of all U.S. annuity sales in the first half of this year. The other nine were Florida, New York, Texas, Pennsylvania, Ohio, New Jersey, Michigan, Illinois and Massachusetts.

A retirement income guide for the perplexed plan sponsor

Posted on September 26, 2013 by Editorial Staff -

The report might be called, “Everything You Wanted to Know about Turning DC into DB But Were Afraid To Ask.”

The Society of Actuaries (SOA) and the Stanford Center on Longevity have released the research report, “The Next Evolution in Defined Contribution Retirement,” which describes of the options currently available for helping employees convert 401(k) savings into a retirement paycheck. If you want to come up to speed fast on the DC-to-DB dialogue, this report should help.

Retirement experts are worried that millions of Baby Boomers might mismanage their 401(k) savings when they retire and run out of money prematurely, and they want more plan sponsors to start giving plan participants the information and the tools they need to create guarantee lifetime income.

A tiny minority of plan sponsors share this concern and have taken steps to provide access to in-plan annuities or bridges to out-of-plan annuities, which the report calls Retirement Income Generators, or RIGs. But the great majority are hesitant about taking responsibility for their ex-employees’ long-term financial security. Many of them are uncomfortable with the fiduciary liabilities they already bear in sponsoring a retirement savings plan.

The report aims to show them what their options are. It provides plan sponsors with an outline to help them design a retirement income program and a checklist of questions to ask retirement income providers. It also includes information on administrative and design considerations, issues with offering default retirement income solutions and discussion points on fiduciary liabilities from prominent Employee Retirement Income Security Act (ERISA) attorneys.

Three percent GDP growth for next three years: BNY Mellon

Posted on September 26, 2013 by Editorial Staff -

Monetary easing—both past and ongoing—in the world’s wealthiest countries should continue to increase the pace of economic growth worldwide in 2014, according to the September 2013 Economic Update from BNY Mellon’s chief economist.

“Fears of a developing market crisis appear overdone and continued expansion at a moderate rate can be anticipated in most of them,” wrote economist Richard B. Hoey, adding that there will be a mixed pattern among emerging market countries.

According to his Update:

The U.S. outlook. We believe the U.S. economy has moved into the second half of what we expect will be seven consecutive years of economic expansion. U.S. real GDP has grown at about 2% over the past four years, but we expect an acceleration to three years of 3% real economic growth in 2014, 2015 and 2016. This should be due largely to the fading of several drags, such as the federal fiscal drag and the state and local downsizing drag. The U.S. is not very inflation-prone, so monetary policy can remain stimulative. The dovish stance of monetary policy was reinforced by the Fed’s recent decision to postpone the first taper of QE3.

The outlook for Europe. Europe entered 2013 in a double-dip recession which was caused by the slow pace of financial stabilization in Europe. Aggressive policies and promises from the European Central Bank have, with a lag, calmed these financial stresses. Our view has been that the European recession would end by mid-2013 and be followed by a very weak economic expansion. Recent data have supported that thesis. The swing from a double-dip recession to a modest economic expansion in Europe should contribute to faster global economic growth in 2014 and beyond.

On the East Asian front. The Japanese economy has been stagnating for two decades, but Abenomics has brought about a dramatic change to a more stimulative policy. Despite uncertainties about the hike in the value-added tax planned for the spring of 2014, confidence and economic activity have improved in Japan, led by a very strong gain in corporate profits which should contribute to future strength in investment spending and wage income.

There was a cost-of-capital shock to many emerging market countries due to volatility in the perceptions of U.S. monetary policy. For countries whose policies are regarded as appropriate, these stresses should calm overtime.

China is a separate case. With its capital controls, financial conditions are dominated by domestic decisions rather than by the spillover effects of U.S. economic policy. China is not experiencing a temporary cyclical slowdown. Rather, it is adjusting down to a slower pace of sustainable growth. There has been mal-investment and an accumulation of vulnerable loans in China, but we believe that the Chinese government has both the financial resources and the will to amortize these losses over a number of years, rather than permitting a contagious financial meltdown. We expect an orderly deceleration of trend growth in China.

Interest rates: A major spike after the 2016 national election. The Federal Reserve surprised money market participants by deciding to postpone the first taper of its QE3 program of buying $85 billion a month of Treasury and mortgage securities. One reason was that the Fed is “data-dependent” and U.S. economic data have been mixed rather than definitively strong.

In addition, the Fed appeared concerned about the risk of a fiscal shock. We believe a major motive for the adoption of QE3 in September 2012 was concern about the “tail risk” of a large year-end 2012 “fiscal cliff.” In the end, the fiscal tightening was significant but not severe. A year later, we believe that one element in the Fed’s decision not to taper in September 2013 was the “tail risk” of disorderly fiscal negotiations over funding the Federal government and the debt ceiling.

We believe that the odds of permanent damage are quite low, but there certainly could be some very tense moments between now and early November 2013, when it should all be resolved. We believe that, both in September 2012 and September 2013, the Fed was motivated in part by the desire to take out some monetary insurance against potential fiscal shocks.

We continue to expect a three-phase upward adjustment of bond yields over a half-decade period, as outlined in our report entitled “Interest Rate Normalization” dated September 12, 2013. The first phase is an adjustment to free-market levels from artificially low bond yields, which reflect an artificial scarcity of bonds due to large scale bond purchases under QE3. This adjustment is underway, but in a choppy pattern, due to the Fed’s “Hamlet syndrome” about beginning the tapering down of QE3. To taper or not to taper? That is the question.

We regard the Fed’s failure to start the taper as a leading indicator of a central bank which will eventually end up “behind the curve” in its monetary policy, slowly building up the pressure for a major upward spike in interest rates in 2017 or 2018, following the Presidential election of 2016. While the first Fed taper has been postponed, we expect the first taper to occur within the next two to six months.

Occupy QE

Posted on September 26, 2013 by Stephen S. Roach -

The Federal Reserve continues to cling to a destabilizing and ineffective strategy. By maintaining its policy of quantitative easing (QE) – which entails monthly purchases of long-term assets worth $85 billion – the Fed is courting an increasingly treacherous endgame at home and abroad.

By now, the global repercussions are clear, falling most acutely on developing countries with large current-account deficits – namely, India, Indonesia, Brazil, Turkey, and South Africa. These countries benefited the most from QE-induced capital inflows, and they were the first to come under pressure when it looked like the spigot was about to be turned off. When the Fed flinched at its mid-September policy meeting, they enjoyed a sigh-of-relief rally in their currencies and equity markets.

But there is an even more insidious problem brewing on the home front. With its benchmark lending rate at the zero-bound, the Fed has embraced a fundamentally different approach in attempting to guide the US economy. It has shifted its focus from the price of credit to influencing the credit cycle’s quantity dimension through the liquidity injections that quantitative easing requires. In doing so, the Fed is relying on the “wealth effect” – brought about largely by increasing equity and home prices – as its principal transmission mechanism for stabilization policy.

There are serious problems with this approach. First, wealth effects are statistically small; most studies show that only about 3-5 cents of every dollar of asset appreciation eventually feeds through to higher personal consumption. As a result, outsize gains in asset markets – and the related risks of new bubbles – are needed to make a meaningful difference for the real economy.

Second, wealth effects are maximized when debt service is minimized – that is, when interest expenses do not swallow the capital gains of asset appreciation. That provides the rationale for the Fed’s zero-interest-rate policy – but at the obvious cost of discriminating against savers, who lose any semblance of interest income.

Third, and most important, wealth effects are for the wealthy. The Fed should know that better than anyone. After all, it conducts a comprehensive triennial Survey of Consumer Finances (SCF), which provides a detailed assessment of the role that wealth and balance sheets play in shaping the behavior of a broad cross-section of American consumers.

In 2010, the last year for which SCF data are available, the top 10% of the US income distribution had median holdings of some $267,500 in their equity portfolios, nearly 16 times the median holdings of $17,000 for the other 90%. Fully 90.6% of US families in the highest decile of the income distribution owned stocks – double the 45% ownership share of the other 90%.

Moreover, the 2010 SCF shows that the highest decile’s median holdings of all financial assets totaled $550,800, or 20 times the holdings of the other 90%. At the same time, the top 10% also owned nonfinancial assets (including primary residences) with a median value of $756,400 – nearly six times the value held by the other 90%.

All of this means that the wealthiest 10% of the US income distribution benefit the most from the Fed’s liquidity injections into risky asset markets. And yet, despite the significant increases in asset values traceable to QE over the past several years – residential property as well as financial assets – there has been little to show for it in terms of a wealth-generated recovery in the US economy.

The problem continues to be the crisis-battered American consumer. In the 22 quarters since early 2008, real personal-consumption expenditure, which accounts for about 70% of US GDP, has grown at an average annual rate of just 1.1%, easily the weakest period of consumer demand in the post-World War II era. That is the main reason why the post-2008 recovery in GDP and employment has been the most anemic on record.

Trapped in the aftermath of a wrenching balance-sheet recession, US families remain fixated on deleveraging – paying down debt and rebuilding their income-based saving balances. Progress has been slow and limited on both counts.

Notwithstanding sharp reductions in debt service traceable to the Fed’s zero-interest rate subsidy, the stock of debt is still about 116% of disposable personal income, well above the 43% average in the final three decades of the twentieth century. Similarly, the personal saving rate, at 4.25% in the first half of 2013, is less than half the 9.3% norm over the 1970-1999 period.

This underscores yet another of QE’s inherent contradictions: its transmission effects are narrow, while the problems it is supposed to address are broad. Wealth effects that benefit a small but extremely affluent slice of the US population have done little to provide meaningful relief for most American families, who remain squeezed by lingering balance-sheet problems, weak labor markets, and anemic income growth.

Nor is there any reason to believe that the benefits at the top will trickle down. With real consumption stuck on a 1% growth trajectory, the bulk of the US population understandably views economic recovery and job security very differently from those enamored of wealth effects. The Fed’s goal of pushing the unemployment rate down to 6.5% is a noble one. But relying on wealth effects targeted at the rich to achieve that goal remains one of the great disconnects in the art and practice of economic policy.

The Occupy Wall Street movement began two years ago this month. While it can be criticized for its failure to develop a specific agenda for action, it galvanized attention to income and wealth inequality in the US and around the world. Unfortunately, the problem has only worsened.

Lost in the angst over inequality is the critical role that central banks have played in exacerbating the problem. Yes, asset markets were initially ecstatic over the Fed’s decision this month not to scale back QE. The thrill, however, was lost on Main Street.

That is precisely the point. The Fed’s own survey data, which underscore the concentration of wealth at the upper end of the US income distribution, fit the script of the Occupy movement to a tee. QE benefits the few who need it the least. That is not exactly a recipe for a broad-based and socially optimal economic recovery.

An Old Argument for Annuities, Made New

Posted on September 26, 2013 by Kerry Pechter -

Variable annuities with living benefits are no longer selling themselves, as they did before the financial crisis. So, from what I hear, a number of advisors have been checking out the deferred income annuity as a potential replacement for it in their retirement planning toolkit.

The beauty of the VA/GLWB was its irresistible storyline. It appealed to the Boomers’ congenital desire to have it all: uncapped upside, a solid floor on the downside, liquidity, and even something left over for the kids.

Unfortunately, that’s an impossible act to follow (in part because it was never possible in the first place). But what if somebody did figure out how to wrap a best-of-both-worlds, cake-and-eat-it-too story around the DIA? And provide the data to back that story up?

Someone has. Curtis Cloke, the Iowa advisor whose Thrive Income Distribution System is the subject of today’s lead article in RIJ, has refined a sales/planning process that a hybrid retirement portfolio of period certain DIAs and mutual funds can generate both more income and more final wealth with less risk than a 4% systematic withdrawal plan.

And he says he can demonstrate that it works.

The basic principle behind Thrive is not new. Almost anybody who has ever been involved in marketing retail income annuities (as I have been) has tried to make the case that, in general, typical retirees should buy enough lifetime income to cover any spending need not covered by Social Security and/or a pension, and then take as much risk (or none) as they want with the rest of their money.

David Babbel of The Wharton School made this case in a research paper commissioned by New York Life a few years ago. Wade Pfau and Michael Kitces have recently published research that supports it. To use a rural analogy: Why harness a pair of unreliable horses (stocks and bonds) to your income wagon when you can use a Clydesdale to pull the wagon and enter a thoroughbred in the Kentucky Derby?

But, in the past, that argument consisted mainly of words or numbers on a page. A homily for the converted, not a story that could win over skeptical hearts and minds. Especially in the middle of a bull market.

Cloke has refreshed that story. The Thrive Income Distribution System takes an ancient annuity marketing pitch and beefs it up enough to appeal to high net worth clients who otherwise might not spend five minutes looking at an income annuity.

Cloke has been using Thrive for almost 15 years. He and former MetLife executive Garth Bernard started marketing it nationally in 2008. Only in the past two years, however, have deferred income annuities become widely available from a range of manufacturers. Which means that more retirement advisors than ever have the tools to experiment with this strategy.

The Thrive Income Distribution System won’t have universal appeal among distributors and producers. Fee-only advisors may pass because it reduces billable AUM. Commission-addicts may find it too labor-intensive. But open-minded advisors who have been casting about for a more compelling way to present annuities to clients may find it truly enlightening.

Selling Income Annuities on Greed, Not Fear

Posted on September 26, 2013 by Kerry Pechter -

Burlington, Iowa is a small, fading river town where Mississippi steamboats and mighty railroad lines once traded freight. Adrift in an ocean of cornfields, it’s an unlikely place to find what may be the future—perhaps even the salvation—of the income annuity business.

But that possibility is what drew me and a dozen other people to Burlington one morning last August. We had enrolled in Thrive University, the fancy name for the workshops where Curtis Cloke teaches his Thrive Income Distribution System for using deferred income annuities (DIAs) in retirement.

For a day-and-a-half, we sat classroom-style in a fluorescent-lit room and heard Cloke, a large, enthusiastic man of 50, talk through hundreds of slides about Thrive’s recipe for creating mosaics of annuities, mutual funds and permanent life insurance and solving the major risks of retirement: longevity, volatility, inflation, tax, shortfall and legacy.

“Thrive believes in making the impossible possible,” said Cloke. He delivers about a dozen of these workshops at different places around the country each year, charging up to $1,300 a seat for a taste of the Thrive secret sauce. “We buy income and invest the difference. We maximize the amount of money that’s unfettered to income needs.”

With a two-inch loose-leaf binder of material to cover and less than 18 hours to cover it, Cloke has to talk fast. Observations, anecdotes, calculations and data points come in torrents. The details can be dizzying. “I get a little deeper into the weeds than most people care to get,” he said. “But you have to get your mind around the flexibility of these products.”

Unexpectedly rapid sales of deferred income annuities since mid-2011 has gotten a lot of people interested in Cloke and Thrive Income. That’s why, along with financial advisors, the Thrive University class in Burlington in August also attracted people from higher up the annuity food chain.

There was Jay Robinson of Financial Independence Group (FIG), an insurance marketing organization that uses Thrive principles in its “Booming Income” program for producers; Cliff Kitchen of Guardian Life, which intends to use Cloke’s ideas to help its agents sell its deferred income annuities; and Gary Baker from Cannex, which provides income annuity pricing data to IMOs and broker-dealers. The Thrive Income method has even gotten the blessing of The American College, which includes it in the curriculum for its Retirement Income Certified Professional designation.

Don’t be an “asset hugger”

Cloke’s Thrive Income method is a process, not a product. It follows the time-honored philosophy that retirees should use income annuities to cover any income need not covered by Social Security or pensions and to invest the rest of their money in risky assets—to maintain liquidity, protect against inflation, meet emergency needs or establish a legacy.

That’s the same philosophy espoused by authorities as varied as the Retirement Income Industry Association, by Tom Hegna, the popular lecturer and author of “Paychecks and Playchecks,” and by any number of marketers at companies that issue income annuities. It’s a natural extension of the idea that people—and especially retirees—should gamble only with money they can afford to lose.

But Cloke takes this argument up a notch. He may be the first person to come up with data in support of the counter-intuitive idea that annuities provide more liquidity and more legacy potential than a retirement income program based on systematic withdrawals from a risky portfolio of stocks and bonds. In other words, annuities aren’t just for fear-driven retirees. They’re for greed-driven ones, too.

Instead of presenting annuities as pure defense, Cloke gets aggressive with them. He makes them un-boring. In his cosmology, it’s retirees who don’t annuitize that are timid. He calls them “asset huggers” who allow all of their money to become “hostage” to income production, and therefore not truly free for risk-taking, or emergencies or heirs.

How is this possible? It’s possible if you use sequential or overlapping inflation-adjusted deferred income annuities with periods certain or cash refunds for retirement income and invest the rest of your money in growth-oriented mutual funds. The Thrive method generates customized, precisely documented retirement income plans using combinations of deferred income annuities (for income), life insurance (for legacies) and mutual funds, and to squeeze any efficiencies (tax advantages, mortality credits, higher yields) from them that he can.

Thrive clients don’t have to worry that they might get “hit by a bus” in early retirement and lose a bunch of money. Since they have a safe income to live on, they can ignore market volatility. They can afford to let their equity investments compound until they die. They don’t know how large their legacy will be, but they know there will be one.

“The process is not unique to him, but he does it in a way that’s elegant. And he’s created some complex tools to illustrate income,” said Kitchen, who runs the Living Balance Sheet platform at Guardian Life, where agents learn how to structure annuity portfolios. He made the pilgrimage to Burlington in August. “Two of our leading reps went to Thrive University and told me, ‘Cliff, you have to go out there. This guy has his finger on the pulse of this stuff.’ He’s the best at what he does.”

Fun with Dick and Jane

During the workshop, Cloke offered up several hypothetical examples of a Thrive solution to a retirement income puzzle. One simplified case involved Dick and Jane, an imaginary couple ages 60 and 59 respectively. They wanted to retire in six years.

A mass-affluent couple, Dick and Jane had about $504,000 in non-qualified savings and each had about $95,000 in qualified savings. In addition, Dick expected to receive a monthly pension of $1,100. Both expected Social Security benefits.

The couple needed about $1,800 a month from their savings to reach their spending goal. They also wanted a 3% annual inflation adjustment. To achieve that for the first five years of retirement, Cloke used $121,000 of their non-qualified money to buy a five-year period-certain deferred income annuity with a 3% annual inflation adjustment that would start paying out in six years, when Jane reached age 65.

At the same time, he used $282,000 of their non-qualified money to buy a 20-year period certain DIA with a 3% annual inflation adjustment, starting in 11 years when Jane reached age 70. The two DIAs, in sequence, cost a combined $403,000 and produced the $2,000 a month inflation-adjusted income that Dick and Jane said they needed.

As for their remaining $291,000 in savings (including the assets in both IRAs and the rest of the non-qualified money), Cloke invested it in mutual funds for long-term compound growth at an expected rate of 5%. If Dick and Jane took no withdrawals from it for splurges or emergencies, it could be worth about $1 million in 25 years.

Is this strategy better than a traditional 4% systematic withdrawal strategy from a balanced portfolio? Cloke, who has done the cash flow comparisons, would argue that the inflation-adjusted DIAs yield more income with zero market risk. The instinctive answer is that it probably fares better in unfavorable markets, for highly risk-averse clients, and for advisors who like insurance products.

Let’s make a crude, back-of-the-envelope analysis: If Dick and Jane used a 4%, inflation-adjusted withdrawal strategy, they could take 4% of $890,000 (the estimated value of their nest egg in six years, according to the Department of Labor’s calculator). That’s almost $3,000 a month to start.

Doesn’t that beat Thrive’s $1,800-a-month annuity payout? Yes and no. As Cloke likes to say, the entire nest egg is “hostage” to income. Dick and Jane can’t dip into their savings without cannibalizing their income stream or their legacy fund. Moreover, their portfolio would likely require a higher bond component in order to match the safety of the annuity strategy.

A more apples-to-apples comparison might call for Dick and Jane to set aside $291,000 for long-term growth, as Thrive would have them do, and then take 4% from the rest of their assets (worth about $500,000 when they retired, according to the DoL) for an estimated income of $20,000 per year or $1,667 per month. At first glance, that strategy looks comparable to the DIA approach.

When you factor in the potential differences in fee drag (the annuity income is net of costs), the tax treatment of the income streams (a portion of the DIA income is excluded from income tax because it was purchased with non-qualified money), the transparency that comes from using period-certain annuities and the peace-of-mind that comes from the guarantees, the Thrive method looks even better, Cloke claims. His numbers are compelling enough, he says, to produce a 95% closing rate in six months with retirement income clients.

“We can compete with investments every day of the week because of the efficiencies of this system,” he said. “I know that’s not the view of the [investment] industry. But I’ll annihilate them on the fees on the assets held hostage to income. An asset manager who can’t have a conversation about insurance [products] can’t compete with us.”

The Dick and Jane scenario offers, as mentioned earlier, a simplified version of the Thrive process. Other hypothetical cases that were presented at the workshop in Burlington, using high-net-worth clients, suggested that the Thrive method can yield even greater efficiencies for people with challenging tax situations, cash flow needs, or legacy desires.

Thrive goes national

Cloke’s personal story is of the jeans-to-Brooks Brothers variety. His grandfather was a family farmer in Iowa who had lost the farm. As a kid, Cloke would ride on the tractor seat beside him as he plowed other people’s land, listening to the elder’s advice about hard work, thrift and charity. “Save 10%, give 10% and live on 80%,” he recalls.

Out of high school, Cloke became an underground miner, working 600 feet below the surface of the earth in central Iowa’s vast Jurassic-period deposits of gypsum, the chalky mineral that’s used in wallboard, plaster and cement. A serious mine injury landed him on Social Security disability. By that time he had a house and a family but not much of a future.

Then, a mentor materialized, a local insurance agent who told him, “You could do what I do.” In 1987, Cloke became a Prudential representative. He struggled. He landed a big contract. He began to prosper. In 1999, he discovered a product that Prudential didn’t sell publicly—a five-year deferred income annuity—and started using it in retirement income plans. “That’s how Thrive Income was born. I’d been laddering bonds and I realized that this was the perfect bond,” he said.

In 2007, he received a phone call from a MetLife executive and actuary named Garth Bernard. Bernard, a gregarious income annuity enthusiast with a big Rolodex, thought Cloke was onto something huge. In April 2008, Bernard quit MetLife to go into business with Cloke. They took the Thrive Income Distribution System national.

The financial crisis interrupted their entrepreneurial plans. Bernard eventually left the business and moved abroad, but not before introducing Cloke to his network and bringing Thrive Income to the attention of the wider retirement income industry. In the wake of the crisis, with Boomers looking for financial safety and more than a dozen insurers marketing or developing DIAs, Cloke found himself to be in the right place at the right time.

The Thrive Income method is now a modest juggernaut. It reaches financial advisors and insurance agents either directly or indirectly through Cloke’s advisory partnership, Two Rivers Financial Group, through Thrive University workshops, through proprietary software and training programs, and through a video that’s part of the curriculum for the Retirement Income Certified Professional designation at The American College.

Its principles are also disseminated through the “Booming Income” platform that FIG maintains for its producers, through the Living Balance Sheet platform used by Guardian Life agents, and through a spinoff group called Precision Retirement by Design, which other advisors consult for income solutions.

Relationships with organizations like The American College have given Thrive Income a growing legitimacy, at least in circles that don’t reject income annuities out of hand. “Our curriculum tries to include many voices, and Curtis is an important voice,” said David Littell, an attorney, CFP and co-director of the New York Life Center for Retirement Income at The American College.

“A lot of the usual conversation about using income annuities for ‘flooring’ focuses on the safety of it. The academics tend to focus on the ‘utility function.’ But Curtis is saying that his method is actually a cheaper way to create retirement income,” Littell added.

‘Take this and run with it’

A few weeks after the Thrive University workshop, I called some of the people who attended to get their impressions of it. One was Denny Zahrbock, a Minneapolis-area financial advisor and an insurance celebrity of sorts. He is currently chairperson of the exclusive Top of the Table of the Million Dollar Round Table, an elite club of hyper-successful insurance agents and financial advisors.

“In some client situations that certainty of income would be appealing. But I wouldn’t be as confident selling this as Curtis is. He’s so confident that you buy right into it,” Zahrbock told RIJ. “The biggest negative is that it’s not mainstream yet. That’s the problem for any pioneer.”

Another Thrive University alumnus, Steve Goldstein of Dakota Wealth Solutions in Moorestown, N.J., said he likes Cloke’s method because, once the annuities are purchased, the client’s assets grow rather than shrink over time. “You’re never running a negative cash flow,” he said. Goldstein wrote the software for the simplified form of Thrive Income that FIG offers its agents.

“The right people will take this and run with it,” he said, adding, however, that most investment-driven advisors and even most insurance-minded advisors will shy away from it, either because it’s too strange or too labor-intensive. “A lot of investment professionals aren’t open-minded in looking at what the insurance industry has to offer. And not every insurance agent will want to spend the time to concentrate on this. But the top-level agents will.”

Kitchen of Guardian Life sees Thrive as effective, but a niche phenomenon. “What he does is revolutionary, but it’s not going to start a revolution because there are so many competing voices out there. And there’s a huge difference in compensation” [between income annuities and other, higher-commission products that intermediaries can sell], he said.

More bullish is Robinson of FIG, which is the first insurance marketing organization to promote the Thrive Income Distribution System to its producers. “There’s going to be a huge market for DIAs,” he said. “You’ll see the direction of the industry moving away from the variable annuity to the fixed indexed annuity with a living benefit and the DIA.” To help its agents sell those DIAs, FIG is counting on Curtis Cloke and Thrive.

Will Obamacare Undermine Employer-Provided Health Insurance?

Posted on September 23, 2013 by Editorial Staff -

The American Action Forum has estimated that 43 million Americans could lose access to employer-sponsored health insurance after the Affordable Care Act, widely known as Obamacare, goes into effect on October 1.

But three health economists at the University of Michigan call that estimate much too high. According to their analysis, published in the September issue of Health Affairs, the net effect of the ACA on coverage will range from a 1.8-percentage point decline in coverage to a 2.9-percentage point increase.

Which estimate is correct? According to the Michigan analysts, the answer depends on whether low-income workers who currently have affordable workplace coverage will want to drop that coverage to qualify for the ACA’s subsidized coverage for uninsured workers, and whether their employers will stop insuring them so they can do so.

The paper argues that there’s no evidence that this will occur, in part because low-income workers are often or usually in the same health plan as higher-income workers. The authors cited several surveys of employers:

In a 2013 survey, 98% of very large firms (those with more than 1,000 employees, which account for about half of the workforce) said that they expected health benefits to be an important component of compensation three to five years from now.
A survey by the International Foundation of Employee Benefit Plans found that the share of employers reporting that they will definitely offer coverage in 2014 jumped from 46% percent to 69% over the past two years.
In March 2013, 84% of employers reported that they were still studying the ACA. Only two-thirds of large employers said that they were “familiar” with the shared- responsibility penalty.
Among firms with 50–100 employees, 71% reported that they would be more likely to participate in the SHOP exchanges if a large choice of plans were available at the employer’s targeted benefit level.

The authors suggest in their conclusion that, in terms of health care economics, it doesn’t matter whether people buy group health insurance through exchanges or through employers. They also say that the availability of non-employer sources of health insurance may reduce “job lock”—the tendency for people to remain in jobs purely for the health insurance benefit.

America’s Labor Market by the Numbers

Posted on September 23, 2013 by Mohamed A. El-Erian -

Politicians and economists now join investors in a ritual that typically takes place on the first Friday of each month and has important consequences for global markets: anticipating, internalizing, and reacting to the monthly employment report released by the United States Bureau of Labor Statistics (BLS). Over the last few years, the report has evolved in a significant way – not only providing an assessment of the economy’s past and current state, but, increasingly, containing insights into its future as well.

Think of the BLS’s employment report as a comprehensive monthly check-up for the American labor market. Among its many interesting statistics, it tells you how many jobs are created and where; how earnings and hours worked are evolving; and the number, age, and education of those seeking employment.

Despite the data’s richness, only two indicators consistently attract widespread attention: net monthly job creation (which amounted to 169,000 in August) and the unemployment rate (7.3% in August, the lowest since December 2008). Together they point to a gradual and steady improvement in overall labor-market conditions.

This is certainly good news. It is not long ago that job creation was negative and the unemployment rate stood at 10%. The problem is that the headline numbers shed only partial light on what may lie ahead.

The figure for monthly job creation, for example, is distorted by the growing importance of part-time employment, and it fails to convey the reality of stagnant earnings. Meanwhile, the headline unemployment rate does not reflect the growing number of Americans who have left the work force – a phenomenon vividly reflected by the decline in the labor participation rate to just 63.2%, a 35-year low.

To get a real sense of the labor market’s health, we need to look elsewhere in the BLS’s report. What these other numbers have to tell us – about both the present and the future – is far from reassuring.

Consider the statistics on the duration of unemployment. After all, the longer one is unemployed, the harder it is to find a full-time job at a decent wage.

In August, the BLS classified 4.3 million Americans as long-term unemployed, or 37.9% of the total unemployed – a worrisome figure, given that the global financial crisis was five years ago. And, remember, this number excludes all the discouraged Americans who are no longer looking for a job. In fact, the more comprehensive employment/population ratio stands at only 58.6%.

The teenage-unemployment rate is another under-appreciated indicator that is at an alarming level. At 22.7%, too many American teenagers, lacking steady work experience early in their professional careers, risk going from unemployed to unemployable.

Then there are the indicators that link educational attainment and employment status. Most notable here is the growing gap between those with a college degree (where the unemployment rate is only 3.5%) and those lacking a high school diploma (11.3%).

Rather than confirming the paradigm of gradual and steady improvement, these disaggregated numbers attest to a highly segmented, multi-speed labor market – one with features that could become more deeply embedded in the structure of the economy. If current trends persist, the BLS’s report will continue to evolve from a snapshot of the past and present to a preview of the future.

Undoubtedly, the US labor market’s uneven recovery has much to do with the structural and policy gaps exposed by the 2008 global financial crisis and the recession that followed. The economy is still struggling to provide a sufficient number of jobs for those who were previously employed in leverage-driven activities that are no longer sustainable (let alone desirable).

Moreover, US schools, particularly at the primary and secondary levels, continue to slip down the global scale, constraining Americans’ ability to benefit from globalization. Meanwhile, existing and newly created jobs provide less of an earnings upside. And political polarization narrows the scope for effective tactical and structural policy responses.

This combination of factors is particularly burdensome for the most vulnerable segments of the US population – particularly those with limited educational attainment, first-time labor-market entrants, and those who have been out of work for an extended period.

So while net job creation will continue and the unemployment rate will maintain its downward trajectory – both highly welcome – the labor market’s evolution risks fueling rather than countering already-significant income and wealth inequalities, as well as poverty. Overburdened social support mechanisms would thus come under even greater pressure. And all of this would amplify rather than attenuate political polarization, placing other urgent policy priorities at even greater risk.

If this interpretation is correct, the heightened attention given to the monthly BLS headline indicators needs to be accompanied by a broader analysis and a different mindset. After all, the report is much more than a scorecard on America’s performance in confronting a persistent economic, political, and social challenge; it is also an urgent call for a more focused corrective effort involving both government and business.

A better mix of fiscal and monetary policies and sustained measures to enhance productivity and competitiveness remain necessary conditions for addressing America’s labor-market challenges. But they are not sufficient.

Both the public and private sectors – individually and through scalable and durable partnerships – need to think much more seriously about labor retraining and retooling programs, enhanced labor mobility, vocational training, and internships. President Barack Obama’s appointment of a “jobs czar” would also help to enhance the credibility, accountability, and coordination required to overcome today’s significant and rising employment challenges.

Yes, the headline numbers will continue to signal overall improvement in the labor market. The urgent task now is to ensure that lasting progress is not undermined by the worrisome compositional trends that the BLS’s report highlights month after month.

The Liability-Driven Retirement Portfolio

Posted on September 23, 2013 by Kerry Pechter -

The premiere issue of The Journal of Retirement, the scholarly quarterly that’s published by Institutional Investor Journals and edited by Sandy Mackenzie, arrived in my mailbox a week or two ago.

The first article that caught my attention was the last one in the issue. Written by two analysts and an asset allocation expert at Russell Investments, it was titled, “Optimizing Retirement Income: An Adaptive Approach Based on Assets and Liabilities.”

The method described here, one that Richard Fullmer (then at Russell, now at T. Rowe Price) wrote about in 2009 and which was one of the topics of the 2012 book, “Someday Rich,” takes the principle of liability-driven investing from pension funds and applies it to retirement portfolios. An annuity drives the action without being part of it… not unlike the role of the ghost in Hamlet.

An advisor using this method would monitor his or her client’s portfolio balance during retirement to see whether it was growing larger or smaller in relation to the portfolio’s liability. The liability in this case is defined as the cost a life annuity, purchased at age 85, that could generate an adequate income for the rest of the retiree’s life.

If the markets cooperated and the portfolio experienced a big surplus, the advisor could adapt by raising the portfolio’s equity component exposure (according to a formula charted by the authors). If the portfolio experienced only a small surplus, the advisor could protect it by shifting the asset allocation toward fixed income. If the value of the portfolio fell below the value of the liability, the advisor and retiree would have a difficult choice. They could either raise the equity allocation—a risky approach—or spend less until the liability became fully funded again.

This method can get quite complicated—with frequent course corrections—but for the purposes of the article the authors reduced it to a simplified example using only one asset allocation change, at age 75. In that example, a 65-year-old couple with $1 million sets aside $460,000 in cash to cover living expenses ($46,000 per year) until age 75. They invest the remaining $540,000 in a conservative 30% equity/70% bond portfolio. Their advisor simultaneously calculates that the couple would need about $380,000 at age 85 (assuming they live that long) to buy a joint annuity that would pay $46,000 per year for life.

At the end of 10 years, the now 75-year-old couple reviews their portfolio. If the markets were favorable from 65 to 75 and produced a surplus (relative to the cost of the annuity), they can switch to a 70% stock portfolio for the next 10 years. If the markets had been generally unfavorable, however, they’d stay with the conservative 30% stock portfolio until age 85.

The method doesn’t call for the couple to actually buy an annuity at age 85. Rather, it uses the cost of the annuity as a yardstick to gauge the “funded status” of the couple’s portfolio at any point from age 65 to age 85 and to guide adjustments in equity allocations.

This “adaptive approach” is more likely to produce safe outcomes for retirees, the authors contend, than drawing down income from a fixed equity/bond allocation (with rebalancing) or from a buy-and-hold portfolio. One strength of this approach is that it defines a “successful” portfolio as one that provides an adequate income for life—not one that merely maintains a positive account balance for life.

Also to be found in the first issue of The Journal of Retirement:

“Analyzing an Income Guarantee Rider in a Retirement Portfolio.” In this article, Wade Pfau of The American College shows that VAs with GLWBs can help risk-averse people resist the urge to invest too conservatively in retirement. At the end of a 30-year retirement, he calculates, a person would (on average) end up with a higher account balance if he held a VA/GLWB with a 70% stock allocation than if he held an unguaranteed portfolio with a stock allocation of 40% or less, all else being equal. Pfau points out shortcomings of the VA/GLWB—the fee drag and the product’s low likelihood of yielding an inflation-adjusted income in retirement—but he suggests that the value of a lifetime income guarantee is rising, given current market valuations. Pfau expects significantly lower average rates of investment return in the future than in the past.

“The Economic Implications of the Department of Labor’s 2010 Proposals for Broker-Dealers.” The authors of this article, all from the Center for Retirement Research at Boston College, claim that the DoL’s fiduciary proposal (currently being revised after strong industry opposition) wouldn’t have much impact, even if it went through in its original form. Because the proposal bans only 12b-1 fees (not sales commissions or the sale of actively managed funds), it would reduce broker-dealer revenues by only a small fraction of the total, the CRR report said. Of the $247.8 billion that broker-dealers reported as revenue in 2010, the authors said, only about $9.5 billion came from 12b-1 fees (25 basis points or less) and only about $2 billion came from 12b-1 fees assessed on IRAs (because only about 20% of all mutual fund assets are held in IRAs). As a bolder alternative to the 2010 DoL proposal, the authors recommend applying the ERISA regulations that govern 401(k) plans to rollover IRAs.

“Be Kind to Your Retirement Plan—Give It a Benchmark.” “A well-engineered DC [defined contribution] plan should be experienced by the participant much like a DB [defined benefit] plan, providing predictable in-retirement income and having very little risk,” write the authors of this paper. They have created a benchmark for decumulation portfolios against which retirement plan sponsors can measure the risks and rewards of all other proposals for retirement income generation. For a 65-year-old retiree, their benchmark portfolio would consist of a 20-year ladder of annually maturing Treasury Inflation-Protected Securities coupled with a life-contingent income annuity providing income from age 85. They suggest that plan sponsors who enable retiring employees to invest in such a portfolio would be fulfilling their fiduciary duty.

Allianz Life Launches an “Indexed Variable Annuity’

Posted on September 19, 2013 by Editorial Staff -

Calling it a “new breed of variable annuity,” Allianz Life Insurance Company of North America (Allianz Life) has launched a fixed indexed annuity/variable annuity hybrid that claims to offer more upside potential than a traditional FIA and more downside protection than a traditional VA.

The product is called Allianz Index Advantage, and is described as an Indexed Variable Annuity (IVA). It lets contract owners choose between two strategies, Index Performance and Index Protection. Investors can divide their premium between the two strategies in any proportion. Transfers between the two are allowed on any contract anniversary.

The Index Performance strategy is a fixed indexed annuity, but with higher caps on the interest crediting rate than a traditional FIA can offer. The trade-off is that Allianz absorbs only the first 10% loss in the contract value instead of guaranteeing no losses, as a traditional FIA would.

The three index options are S&P 500 Index, NASDAQ 100 Index and the Russell 2000 Index. The initial caps are 13%, 11% and 14%, respectively. Caps for new business change monthly, and the caps for in-force business can be re-set on any contract anniversary, but can’t go below 1.5%. There’s an annual product fee of 1.25%.

The Index Protection strategy is more conservative. The only index option is the S&P500. If the index return is flat or positive at the Index Anniversary (the anniversary of the day the money was first assigned to the index option), the client receives the amount of potential annual interest that may be credited during that year (the Declared Protection Strategy Credit). The amount of the credit is currently 4%. It is subject to change annually on the Index Anniversary and will never be less than 1.50%.

When the index return is negative, nothing is credited, and the contract value is reduced by the annual product fee of 1.25%. It’s calculated as a percentage of the charge base, which is the contract value on the preceding quarterly contract anniversary (adjusted for subsequent purchase payments and withdrawals).

As an alterative to index crediting, contract owners can invest in Allianz Life mutual funds. Variable options include the AZL Money Market Fund, AZL MVP Balanced Index Strategy Fund and AZL MVP Growth Strategy Fund. Transfers to the variable options are allowed every sixth Index Anniversary.

The Bucket

Posted on September 19, 2013 by Editorial Staff -

Two Toronto firms ally as Cannex buys The QWeMA Group

Cannex, a major provider of financial product data to distributor groups in the U.S. and Canada, said it will purchase The QWeMA Group, a consulting and software company founded by Moshe Milevsky of York University. Both firms are based in Toronto, Ontario, and both are active in the retirement income space.

Among other things, Cannex provides up-to-date pricing data on immediate income annuities and deferred income annuities. Cannex was founded in 1983. Its CEO is Lowell Aronoff. QWeMA stands for Quantitative Wealth Management Analytics.

Gary Baker, U.S. president of Cannex, told RIJ, “QWeMA was an early client of Cannex and the two have had a collaborative relationship for some time.” The two companies both serve insurance product distributors, with one providing the data and the other providing tools to manipulate and analyze it with.

Cannex will gain QWeMA’s personnel, technology and intellectual property in the deal, whose value was not disclosed. That will include QWeMA’s valuation tools and product allocation support technology, Baker said.

The valuation tools allowed advisors to determine, for instance, the option value of a guaranteed lifetime withdrawal benefit on a variable annuity contract, which an advisor could use to decide when or whether to activate the income benefit, he said.

The product allocation support technology, developed by Milevsky, is used by distributors to create models for optimally allocating client assets to annuities and mutual funds. The underlying principle is that life annuities can protect retirees against longevity risk, variable annuities with living benefits can protect against sequence of returns risk, and mutual funds can provide retirees with liquidity and inflation protection.

Leave MM funds in retirement plans alone, SPARK Institute tells SEC

In a letter submitted last Monday, a lawyer for The SPARK Institute urged the Securities and Exchange Commission not to force money market funds in retirement plans to abandon the traditional maintenance of a $1 per share price and switch to a floating rate.

“The changes being considered by the SEC, if adopted, …could result in the limited availability, or elimination, of money market funds from such plans,” wrote Larry Goldbrum, The SPARK Institute’s general counsel, in response to the SEC’s proposal to let the NAV float as a way to prevent runs on money market funds, which occurred during the Global Financial Crisis.

Retirement plan service providers could switch to a floating NAV, but it would involve “costs and complexities,” he wrote. Even if there’s a retail funds exemption to the Floating NAV Alternative, “in the absence of certain changes it is unlikely that service providers will make such funds available through their investment platforms and systems.” The Investment Company Institute came out against the floating NAV idea last June.

But the presidents of the Federal Reserve Banks believe that the floating NAV idea would prevent panic. According to their September 14 letter to the SEC, reported a Wolters Kluver blogger, “If properly implemented, … a floating NAV requirement could recalibrate investors’ perceptions of the risks inherent in a fund by making gains and losses a more regularly observable occurrence.

“The floating NAV alternative reduces investors’ incentives to redeem by tempering the ‘cliff effect’ associated with a fund ‘breaking the buck.’ The first mover advantage is reduced, they explained, because redemptions would be processed at a NAV reflective of the market-based value of the fund’s underlying securities.”

The SPARK Institute also recommended that the SEC modify the retail funds daily redemption limitation so that it does not apply to:

(1) Any redemption request made by a participant in connection with an account held in a participant-directed tax-exempt retirement plan; and

(2) Any redemption request made by the plan sponsor in connection with removing a money market fund from a participant-directed tax-exempt retirement plan’s investment options, with mutually acceptable advance notice.

Retirement plans do not pose the destabilizing threats to the financial system that the SEC is attempting to address, because so few participants have big money market fund balances, the letter said. Only 1,536 (.00005 or .005%) of the 32.3 million plan participants in the U.S. held more than $1 million in a single money market fund, as of June 30, 2013, according to SPARK.

SPARK also opposes the SEC’s other idea for preventing mass redemptions from money market funds: the Standby Liquidity Fees and Gates Alternative. This would allow money market funds “to maintain a stable NAV under normal conditions, but require a fund to impose a redemption fee the following business day if its liquidity falls below a certain threshold, and also permit the fund to impose a “gate” for a period of time (i.e., suspend all redemptions),” according to a SPARK release.

“Most retirement plan service providers’ systems are not capable of being adjusted overnight with respect to an individual fund in order to impose redemption fees or restrict redemptions when the fund falls below required liquidity levels on a given business day, and then immediately remove such restrictions when fund liquidity levels recover,” wrote Goldbrum. “Plan service providers will be unable and unwilling to accept such responsibility and risk with respect to the funds.”

The comment letter also urged to SEC not to adopt a “combined alternative.”

Nationwide Funds acquires 17 funds, $3.6 billion in assets from HighMark Capital

Nationwide Financial has acquired 17 equity and fixed-income mutual funds from HighMark Capital Management, Inc., in a transaction that brings about $3.6 billion in new assets to Nationwide Funds, Nationwide Financial’s mutual fund business, according to a release.

Nationwide Funds, based in the Philadelphia area, now has more than $52 billion in assets under management.Terms of the transaction are not being disclosed.

The acquired mutual funds include five funds that have four or five-star ratings. Several are included in model portfolios and recommended lists at their partner firms. All 17 funds will be available for trading beginning Tuesday, Sept. 17.

HighMark Capital will be the subadviser to nine of the new Nationwide Funds. The other eight will continue to be subadvised by either Bailard, Inc., Geneva Capital Management, Ltd., or Ziegler Lotsoff Capital Management, LLC.

Cambridge International Partners, Inc. was engaged as financial adviser to Nationwide Financial, and Stradley Ronon Stevens & Young, LLP was retained as its legal counsel. HighMark Capital Management and Union Bank engaged Berkshire Capital Securities, LLC as their financial adviser and Bingham McCutchen, LLP as their legal counsel.

ING U.S. introduces low-cost shares for retirement plans

ING U.S. Investment Management said it has introduced no-load “R6” shares for nine of its affiliated mutual funds. The new share class is designed for defined contribution and defined benefit retirement plans as well as other institutional clients, such as endowments and foundations.

The new R6 shares are initially available for nine key funds, including the ING Small Cap Opportunities Fund, ING Mid-Cap Opportunities Fund, ING Large Cap Growth Fund, ING Large-Cap Value Fund and ING Intermediate Bond Fund. Additional funds may be added in the months ahead.

The R6 shares have no front-end sales charge, no 12b-1 fees and no third-party service fees. There are no minimums for investors in retirement plans. Certain non-retirement accounts will require a $1 million minimum investment. ING U.S. Investment Management has more than $30 billion in DCIO (defined contribution investment only) assets under management.

“This new share class responds to the needs of the marketplace and to our DCIO business,” said Paula Smith, vice president and head of DCIO products at ING U.S. Investment Management, in a release. “The shares support registered investment advisors who are seeking to best service their retirement plan clients as well as our institutional business broadly. R6 shares are lower cost and respond to the Department of Labor’s ‘service provider’ fee disclosure requirements.”

Defined contribution plans such as 401(k)s, 403(b)s and 457s are eligible for R6 shares, which are also available to existing ING “Fund of Funds.” Ineligible are Individual retirement accounts (IRAs), Simplified Employee Pensions (SEPs), Savings Incentive Match Plans for Employees (SIMPLEs) and individual 403(b) accounts.

Advisor headcount to shrink through 2017

Posted on September 19, 2013 by Editor Test -

The number of financial advisors, including brokers, agents and investment advisors, will shrink through 2017 as the industry continues to shed older advisors and marginal producers, according to Cerulli Associates, the global analytics firm based in Boston.

“By 2017, the industry will shed more than 25,000 advisors, down to just over 280,000,” said Sean Daly, a Cerulli analyst, in a release. “This reduction is largely due to retirement without sufficient backfilling of new advisors, and to a lesser extent, trimming of advisors with insufficient production. Headcount losses will accrue from the wirehouse, independent broker/dealer, bank, and regional channels.”

Cerulli’s most recent U.S. report, Intermediary Distribution 2013: Managing Sales Amid Industry Consolidation, focuses on financial products and distribution, including market-sizing, advisor product use, and asset manager sales forces.

“The insurance channel accounts for the largest portion of the advisor population. The registered investment advisor and dually registered channels were the only sources of headcount growth in 2012, but together they amount to only 15% of the industry’s advisors,” Daly said. “The independent broker/dealer channel experienced the largest market-share change over the last few years.”

Since peaking in 2005, the industry has shrunk by a net 32,000 advisors. Some simply aren’t needed. Competition and “underwhelming” client demand have caused firms to lower the supply of advisors, according to Cerulli.

DC participants should contribute 15% of pay for 40 years: Schroders

Posted on September 19, 2013 by Editor Test -

Retirement plan participants should be required to contribute at least 15% of salary for 40 years or they’ll risk an inadequate standard of living in retirement, according to a global study of defined contribution (DC) pension funds by Schroders Global Strategic Solutions.

Even in countries where employees must contribute to plans, contributions tend to be too low, with Sweden a notable exception, said the authors of the 44-page report, “Lessons Learnt in DC from Around the World.” Two-thirds of final salary was Schroders’ benchmark for an adequate retirement income level. A 3.5% discount rate was assumed. Achieving even half of final salary would, with a 3.5% return, require four decades of 11% contributions, Schroders said.

Even in Australia, where the obligatory rate will rise to 12% by 2019, a report by the country’s largest accounting body, CPA Australia, warned this may not allow citizens to give up work at the current retirement age.

To reduce volatility of returns, Schroders recommends diversification by pension funds into assets outside their domestic market. The firm criticized most collective DC fund managers for failing to target real returns of at least 3%. “You can’t eat relative returns,” said Lesley-Ann Morgan, head of Global Strategic Solutions in London.

This story was originally reported by IPE.com.

Stanford biz professor to host online course on retirement and pensions

Posted on September 19, 2013 by Editor Test -

Stanford Graduate School of Business will launch its first Massive Open Online Course (MOOC) in October, The Finance of Retirement and Pensions, led by finance professor and pension expert Joshua Rauh.

The eight-week course, which starts October 14, 2013, will help participants make better decisions about their own retirement portfolios and about related government programs and policies. To register for the course, go to: http://online.stanford.edu/course/rauh-finance.

“Our goal is to help people make better decisions about their own retirement portfolio and investments, and to shed light on U.S. policies that have important implications for retirees and taxpayers,” Rauh said in a release.

The course is aimed at anyone planning for his or her own retirement, for finance professionals in the retirement fund space, and taxpayers who want to learn more about the sustainability of government-funded retirement programs like Social Security.

The class is comprised of two 45-minute online teaching modules each week. Each modules is divided into 5- to 7-minute segments that can be viewed at any time.

The course will include assignments, quizzes, a team project, interactive webinars, forums led by Stanford GSB alumni, and weekly updates from Rauh. Participants can expect to spend at least four hours a week on all of the course elements.

A symposium on public pensions in January 2014

The Finance of Retirement and Pensions will conclude with an interactive symposium about the challenges of U.S. pension systems. Called “Innovative Ideas for the Future of U.S. Public Sector Pensions,” the symposium will be held in January 2014 at the Stanford Graduate School of Business in Palo Alto, Calif.

The event will feature representatives of the MOOC teams with the five most promising ideas for pension reform. They will present their proposals to a panel of faculty and experts in finance and public policy. Expenses will be covered by Stanford GSB in collaboration with the Hoover Institution.

Big outflows from bond funds persist

Posted on September 19, 2013 by Editor Test -

Redemptions from bond mutual funds and exchange-traded funds reached $20.3 billion in September through Friday, September 13. September’s outflow is already the fifth-highest in any month on record. Bond funds have redeemed $138.4 billion since the start of June, TrimTabs said.

While the monthly outflow has been huge, it is still a recent phenomenon. The year-to-date net outflow of $28.4 billion reverses only a tiny fraction of the inflows from 2009 through 2012, which totaled $1.20 trillion.

“We’ve seen unprecedented redemptions from bond funds since the start of the summer,” said David Santschi, chief executive officer of TrimTabs. “The outflow of $68.6 billion in June was the biggest ever, and the outflow of $37.4 billion in August was the third-biggest ever.”

“The yield on the 10-year Treasury note has jumped 120 basis points since the end of April, which is an enormous move,” said Santschi. “We think the backup in yields has been driven partly by repayment of cheap European Central Bank loans that were used to buy Treasuries and partly by investor fears of ‘tapering’ by the Federal Reserve.”

TrimTabs argued that bond fund redemptions have been so large and so swift because retail investors commonly regard bond funds as safe.

“Many investors who loaded up on bonds in recent years didn’t fully understand the risks of what they were buying,” said Santschi. “Now that they’re suffering losses in funds they thought were low-risk, they want out fast. The exodus suggests ‘tapering’ could be more disruptive than Wall Street thinks.”

Britons debate best way to consolidate DC accounts

Posted on September 19, 2013 by Editor Test -

Retirement policy wonks in the U.K. have been discussing ways to ensure that workers don’t lose track of their various retirement accounts as they move from job to job (and DC plan to DC plan) over the course of their careers.

This issue has become especially important in the U.K. with the advent of universal automatic enrollment in defined contribution plans. More workers are expected to participate in more plans over the course of their lifetimes.

Many U.K. workers, like U.S. workers, leave small DC accounts behind and forget about them when they change jobs. (See RIJ stories, “Zombie 401(k) Accounts” and “Roll Over, Rollovers: ‘Roll-ins’ Have Arrived.”) That creates inefficiencies in the system. In the U.S., it also creates opportunities for companies that aggregate forced rollovers of small retirement accounts whose owners have vanished.

Some in the U.K. suggest the creation of a nationwide non-profit “pension-pot clearinghouse.” Similar to the Pensioenregister in the Netherlands, it would maintain a record of all the plans a person has contributed to and how much has been accumulated, as well as providing an estimate of how much income participants can expect to receive in retirement.

Others within the U.K. government favor a policy that would simply roll forward a person’s current DC assets into his or her next plan, a program known as PFM or “pot follows member,” if the account is smaller than the equivalent of $16,000.

In the pro-registry camp is Michael Johnson of the center-right Centre for Policy Studies in London. In a new paper, he wrote:

“Consumers should have online access to easy to use, secure, retirement savings information windows (“portals”) that, ultimately, display all their sources of retirement income. This would include their State Pension accrued rights as well as private provision. Annual charges and fees should also be disclosed, and the portal should allow the user to project his expected weekly retirement income, based upon a user- determined retirement age and life expectancy.

“Crucially, the portal should enable the user to transfer retirement assets, including occupational pension pots, between industry providers and aggregators, using a paper-free process. This functionality would encourage consumer engagement with saving, and ultimately lead to higher retirement incomes.”

Johnson proposed the launch of a national clearing house – PensionsClear – which, once operational, could help with the automatic transfer of pension pots, as well as provide custody services or ease the complete transfer of one occupational fund’s assets to a qualifying aggregator.

The not-for-profit company’s set-up costs could be financed directly by the industry or potentially through a levy imposed by the U.K. Department of Work and Pensions – with participation mandatory if the industry fails to cooperate.

The European Commission is in favor of a pan-European pension tracking system and earlier this year asked providers in the Netherlands, Finland and Denmark – which has run its national service, PensionsInfo, since 1999 – to explore how such a system might work.

Morten Nilsson, chief executive at Now Pensions, talked up the potential of the portal approach to improve consumer engagement. “Whatever route is ultimately adopted, the costs to the industry both in terms of time and money are going to be significant, which is why it’s critical all transfer mechanics be thoroughly considered and assessed,” he said. “A rushed solution could prove an extremely costly mistake, which would prove even more costly to undo.”

America’s Bond Market Blues

Posted on September 19, 2013 by Editor Test -

The market for United States Treasury securities is one of the world’s largest and most active debt markets, providing investors with a secure stock of value and a reliable income stream, while helping to lower the US government’s debt-servicing costs.

But, according to the US Treasury Department, overseas investors sold a record $54.5 billion in long-term US debt in April of this year, with China slashing its holdings by $5.4 billion. This dumping of US government debt by foreign investors heralds the end of an era of cheap financing for the US.

As it stands, the US government holds roughly 40% of its debt through the Federal Reserve and government agencies like the Social Security Trust Fund, while American and foreign investors hold 30% each. Emerging economies – many of which use large trade surpluses to drive GDP growth and supplement their foreign-exchange reserves with the resulting capital inflows – are leading buyers of US debt.

Over the last decade, these countries’ foreign-exchange reserves have swelled from $750 billion to $6.3 trillion – more than 50% of the global total – providing a major source of financing that has effectively suppressed long-term US borrowing costs. With yields on US ten-year bonds falling by 45% annually, on average, from 2000 to 2012, the US was able to finance its debt on exceptionally favorable terms.

But the ongoing depreciation of the US dollar – which has fallen by almost half since the Bretton Woods system collapsed in 1971 – together with the rising volume of US government debt, undermines the purchasing power of investors in US government securities. This diminishes the value of these countries’ foreign-exchange reserves, endangers their fiscal and exchange-rate policies, and undermines their financial security.

Nowhere is this more problematic than in China, which, despite the recent sell-off, remains by far America’s largest foreign creditor, accounting for more than 22% of America’s foreign-held. Chinese demand for Treasuries has enabled the US to increase its government debt almost threefold over the last decade, from roughly $6 trillion to $16.7 trillion. This, in turn, has fueled a roughly 28% annual expansion in China’s foreign-exchange reserves.

China’s purchases of American debt effectively transferred the official reserves gained via China’s trade surplus back to the US market. In early 2000, China held only $71.4 billion of US debt and accounted for 8% of total foreign investment in the US. By the end of 2012, this figure had reached $1.2 trillion, accounting for 22% of inward foreign investment.

But China’s reserves have long suffered as a result, yielding only 2% on US ten-year bonds, when they should be yielding 3-5%. Meanwhile, outward foreign direct investment yields 20% annually, on average. So, whereas China’s $3 trillion in foreign-exchange reserves will yield only about $100 billion annually, its $1.53 trillion in foreign direct investment could bring in annual returns totaling around $300 billion.

Despite such low returns, China has continued to invest its reserves in the US, largely owing to the inability of its own under-developed financial market to generate a sufficient supply of safe assets. In the first four months of this year, China added $44.3 billion of US Treasury securities to its reserves, meaning that such debt now accounts for 38% of China’s total foreign-exchange reserves. But the growing risk associated with US Treasury bonds should prompt China to reduce its holdings of US debt.

The US Federal Reserve’s announcement in May that it may wind down its quantitative easing (QE) program – that is, large-scale purchases of long-term financial assets – by the end of this year has sparked fears of a 1994-style bond-market collapse. Concerns that a sharp rise in interest rates will cause the value of bond portfolios to plummet have contributed to the recent wave of foreign investors dumping US debt – a trend that is likely to continue to the extent that the Fed follows through on its exit from QE.

Yields on ten-year U.S. bonds are now 2.94%, a 58% increase since the first quarter of this year, causing the interest-rate gap between two- and ten-year bonds to widen to 248 basis points. According to the Congressional Budget Office, the yield rate on ten-year bonds will continue to rise, reaching 5% by 2019 and remaining at or above that level for the next five years. While it is unlikely that this will lead to a 1994-style disaster, especially given that the current yield rate remains very low by historical standards, it will destabilize the US debt market.

For China, the benefits of holding large quantities of US dollars no longer outweigh the risks, so it must begin to reduce the share of US securities in its foreign-exchange reserves. Given that China will reduce the overall size of its reserves as its population ages and its economic-growth model shifts toward domestic consumption, a substantial sell-off of US debt is inevitable – and, with it, a large and permanent increase in America’s financing costs.

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