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10-year Treasuries could yield 5% in three years: BNY Mellon

Posted on July 8, 2013 by Editor Test -

The “normal cyclical rise” in interest rates is now emerging after a long delay caused by the financial crisis, the recession and the Fed’s yield suppression campaign, said BNY Mellon chief economist Richard Hoey in a recent Economic Update.

“The aftermath of the three-decade-long decline in interest rates is likely to be labeled a secular bond bear market, but we prefer to view it in the context of the cyclical normalization of interest rates that we expect over a half-decade period,” Hoey said in a BNY Mellon release.

“If we are correct to expect real GDP growth of 3% or more for the next three years, 10-year Treasury bond yields are likely to eventually normalize at about 5% at the end of a half-decade-long process of interest rate normalization,” he said.

The economic impact of an interest rate rise is very sensitive to the cyclical stage of monetary policy, which ranges from “aggressively stimulative” to “aggressively restrictive,” he added, noting that the Fed plans a gradual move from aggressively stimulative to merely stimulative.

Is non-fundamental, second-hand investing killing capitalism?

Posted on July 8, 2013 by Editor Test -

Momentum investing had become dominant over fundamental investing, both for short-term gain and short-term risk reduction, and it is the main cause of bubbles and crashes, according to Paul Wooley, chairman of the Paul Wooley Centre for the Study of Capital Market Dysfunctionality at the London School of Economics.

“The choice between these two strategies, rather than the length of holding period, is the key to understanding short-termism,” he said at an event at St. James Palace in London. “Principal-agent problems and a flawed theory and understanding of finance are bringing capitalism to its knees,” he added. His comments were reported in a recent issue of IPE.com.

A team at the Wooley Centre has developed a model of finance that tries to explain mispricing, momentum, bubbles and crashes. While savers fuel the finance sector, institutions such as pension funds determine how that capital is allocated, Wooley said.

“Immediately, there is a problem,” he said. “Astonishingly, the bulk of investing by pension funds and other savings institutions is now conducted without reference to fundamental value.”

Pension funds use academic finance theory to select benchmarks, control risk, choose strategies and write contracts with managers, Wooley said, but that theory assumes investors invested directly in securities. Instead, they delegate. But delegation creates principal-agent problems, he said, with the agents having better information and different objectives, and the principals being unsure about the competence and diligence of the agents.

“The new theory explains mispricing, momentum, bubbles and crashes and other long-standing puzzles, such as value and growth, under- and over-reaction and why, perversely, high-risk stocks offer a lower return than low-risk stocks,” he said.

The model showed that momentum could only be justified for investors with short horizons, and that fundamental investing won out in both the medium and long run.

“It shows that almost everything practitioners and policymakers are currently doing is diametrically wrong and both privately and socially damaging,” he said. Funds adopting these strategies will be rewarded with higher medium- and long-run returns, irrespective of what other funds are doing, he claimed.

Boomers may be two generations in one: IRI

Posted on July 8, 2013 by Editor Test -

The youngest Boomers will face added challenges and will be less prepared financially to overcome them than older Boomers, largely because of their different “workplace experiences” and “employee benefit histories,” according to new research from the Insured Retirement Institute.

“We need to start segmenting the Boomer cohort,” said Cathy Weatherford, IRI President and CEO in a release. “Those on the back end of the generation have worked most their careers during the defined contribution plan era. As a result they will be more self-responsible for their retirement income security. At the same time, late Boomers have less saved for retirement.”

Forty-two percent of Boomers between ages 61 and 66 believe they have enough savings to live comfortably throughout retirement, but only 25% of Boomers between ages 50 and 55 believe they have enough. According to the latest IRI research:

47% of late Boomers report less than $100,000 in retirement savings, compared to 32% of early Boomers.
43% of late Boomers cite a defined contribution plan as a major source of retirement income, compared to 36% of early Boomers.
Insufficient savings is the most common reason late Boomers are uncertain as to when they retire, as stated by 27%. The most common reason for the uncertainty among early Boomers, as stated by 20%, is that they enjoy working.
31% of late Boomers say they struggle to pay their rent or mortgage and 34% percent are financially supporting an adult child, while only 20% and 21% of early Boomers, respectively, say so.
80% of late Boomers remain in the labor force, compared to 43% of early Boomers.

Greater Yield through Closed-End Funds?

Posted on July 8, 2013 by Russell Wild -

For some, it’s a necessity. For others, it’s driven by a fond remembrance of yields past. Whichever. A desperate search for yield has gripped older investors. And that in large part explains the recent surge in closed-end funds.

Both the number of new closed-end funds (CEFs) launched and the money going into closed-end funds are at record highs. In one month (March) alone there were four launches. “The CEF industry market size has increased to $288 billion, dispersed among 583 funds that are managed by 103 different asset managers,” according to a June report from Cerulli Associates.

Of course, we all know that finding yield, even in today’s low-interest environment, is not really very hard. If you want a 12% return right now, you can buy 10-year bonds from the government of Greece. But there’s a catch. With high return comes high risk. Do CEFs, some of which offer yields similar to Greek bonds, offer any lesser risk?

Unlikely. Markets tend to be efficient. But that’s not to say that closed-end funds are bad. Just move in with eyes wide open. The risk of buying Greek sovereign bonds is readily apparent (huge government deficits, riots in the streets, the potential for default). There’s no free gyro lunch.

And there’s no free lunch in closed-end funds, either, although the risks are not always so visible. As with any fund, open or closed, you assume whatever risks are inherent in the asset class. So if you buy a high-yield bond CEF, for example, you risk that the underlying high-yield bonds may default en masse or, alternately, plummet in value should interest rates rise. You are also subject to managerial risk, as CEFs tend to be quite actively managed. And your account value is subject to the management fees of CEFs, which tend to be significantly higher than those of open-end funds.

Then there are the subtler dangers:

The discount factor. Because CEFs issue a fixed number of shares, demand may drive the share price higher than the net asset value (NAV) of the underlying holdings. That’s called a premium. Conversely, if the fund owners throw an IPO party and no one comes, the share price may dip below street level. That’s called a discount.

If you buy shares at a premium, or even at a modest discount, you risk seeing those share values fall, regardless of how the underlying holdings perform. According to my Morningstar Principia software, about 120 CEFs currently sell at a premium, and many others are near par. Beware.

Leverage. Many CEFs (about two-thirds, or 400, per Morningstar) borrow money to create leveraged positions. That’s often how certain funds deliver great yields. But, of course, leverage magnifies losses as well as yield and performance. Many of the leveraged high-yield CEF bond funds now selling at a premium, largely for their juicy 10% to 12% yields, took enormous hits in 2008. In some cases, those hits exceeded the 40% or so loss that stocks suffered.

Cannibalism. Consuming capital to raise yield is something that rarely happens in the mutual-fund world, and when it does, it is clearly brought to investors’ attention. Vanguard, for example, has three funds with the words “managed payout” in the name. In the world of CEFs, “managed payouts” are not trumpeted. Check carefully to see whether the “distribution rate” includes a return of capital. If it does, your cherished yield may be little more than smoke and mirrors.

Russell Wild, MBA, is the author of Bond Investing for Dummies and Exchange-Traded Funds for Dummies. He recently bought shares of The Central Fund of Canada Limited (ticker CEF), a closed-end fund that invests in precious metals. The management fees are low. He bought it at a discount. The fund is not leveraged. There is no return of capital. And the yield is negligible.

Mitigating Behavioral Risk

Posted on July 8, 2013 by Alison F. Salka -

People face many risks with respect to their retirement planning, and the industry has spent a considerable amount of time trying to quantify and explain them to consumers. Most of us are familiar with the perils of longevity, inflation, and investment risk. Much has been done to raise awareness and design solutions that address these risks. But there is another risk that is not as well recognized and is particularly difficult to plan for: behavioral risk. This risk relates to how people make financial decisions and the biases that can handicap their decision-making.

Behavioral finance is a field of research that combines psychology and economics to try to understand how and why people make decisions that are not always economically “rational.” It looks at our natural biases — including the tendencies toward inertia in decision-making, discounting the future, and the aversion to loss — all in an effort to see how they affect our financial decisions. It is important to consider these propensities when designing and marketing retirement income products to ensure they are as effective as possible.

Behavioral finance has already provided insights that changed the way many people currently save for retirement. For example, by recognizing an individual’s tendency toward inertia in retirement planning, researchers identified an opportunity: retirement plan automation. Automatically enrolling employees in a retirement plan and automatically increasing their savings rate annually make inertia work for people instead of against them. They only need to take action if they want to opt out and stop saving. The fact that very few people actually do opt out makes a tangible difference in the retirement outcome of millions of retirement plan participants.

Much behavioral research has focused on understanding how people can save adequately and invest appropriately for retirement. While decisions made during the accumulation phase are certainly critical, they are no less crucial than the decisions that occur at and after retirement — including defining a retirement income strategy. Decisions made at this stage are particularly important; if people make bad economic decisions, they have less time and ability to make up any financial losses. This may, in part, explain why retirees are particularly loss averse. Carriers and producers can better meet the needs of this group by recognizing that their loss aversion has an emotional component, as well as a financial one.

Most people are loss averse. Kahneman and Tversky (1979) were the first to point out that losses hurt us more than gains please us. Emotionally, it’s estimated that the pain of a loss has twice the impact as a win; it takes a $1,000 win to have the same emotional resonance as a $500 loss. This propensity influences many investment decisions. Sensitivity to loss often leads people to opt for a smaller certain gain over a potentially higher gain. This helps explain why, at a time of market volatility when the potential for extreme gains and losses is higher, people who adjust their portfolio tend to seek safety in fixed income investments. Investors will “sell low,” but then likely “buy high” later on.

More recent research has found that loss aversion is even stronger among retirees. In fact, they seem to weigh losses about 10 times more heavily than gains. This “hyper loss aversion” seems to apply beyond economic loss as well. According to Eric Johnson of Columbia University, perception of loss of control over assets can be another facet of loss aversion. It was initially assumed that loss aversion would, in fact, predispose retirees to prefer products that provide guaranteed income. Interestingly, Johnson’s research found the opposite. Retirees averse to loss did not favor products with additional protection and guarantees.

This may seem irrational or counterintuitive, but this type of irrationality is endemic to human nature. Johnson’s research suggests that there is an emotional component to loss aversion; in this case, it takes the form of the loss of control. Product manufacturers and distributors need to take these inconsistencies into account when explaining and marketing guaranteed products. This is where framing, or how the issue is presented, can be helpful. If retirees see guaranteed products in terms of gains and control (the gain of certainty and control over income), then it may help overcome some of their discomfort.

Framing also affects the perceived attractiveness of income solutions. Consider that most people seem comfortable with the idea that they can live on 70 or 80% of their pre-retirement income. People seem a lot less comfortable, however, when asked about their planned spending reduction of 20 or 30%. Framing can also affect income choices. While LIMRA found that using the term “annuity” to describe an annuity (versus calling it a “financial product”) doesn’t seem to affect their appeal, how it is described does matter. Annuities are perceived as more attractive when they are viewed from a “consumption” frame; more people viewed an annuity favorably when it was presented as a specific monthly paycheck for life. When it was presented as an investment paying a certain return for life, it was less popular. Clearly, context matters here.

Consumers can be irrational. This means that they do not always act in ways that are consistent with their self- interest, which poses a risk to their retirement security. However, people tend to be irrational in some common, predictable ways. This “predictable irrationality” lets us better identify where people go wrong and help steer them toward better retirement decisions. Mitigating “behavioral risk” is every bit as important as mitigating the other types of retirement risk. Those who can successfully address it, along with the traditional retirement risks, will have stronger, more productive relationships with their customers.

Anatomy of AXA’s New VA Buy-Back Offer

Posted on July 8, 2013 by Kerry Pechter -

Its generous variable annuity living and death benefits made AXA Equitable Life the top seller of VA contracts for 2007, when the so-called VA arms race was near its height. Now the unit of France’s AXA Group wants to buy some of those rich guarantees back from their owners.

On July 1, AXA Equitable filed an N-4 registration statement with the Securities and Exchange Administration describing the terms of an exchange of cash for the surrender of GMIB (guaranteed minimum income benefit) rider on in-force Accumulator VA contracts, including the Plus, Elite and Select versions of the product.

The offer is voluntary, according to the statement. It is aimed at contract owners with GMIB riders that are “in the money.” These would be in-force riders where the amount of money that can be used to buy a life annuity (known as the “benefit base”) is larger than the current cash value of the contract.

Judging by the hypothetical examples provided in AXA Equitable’s SEC filing, contract owners who accept the buyout could receive up to roughly half the difference between the benefit base and the account value in cash. For instance, if the contract’s benefit base is $150,000 and the account value is only $90,000, the owner could exchange the guarantee for a payment of about $30,000 (for a new account value of $120,000).

The riders on VA assets generate fees; the fees apparently do not, in the view of AXA Equitable management, justify the level of reserves the riders require or the cost of the derivatives—options, futures, swaps and swaptions—required to hedge the equity and interest rate risks implicit in the guarantees. Today’s low interest rates make hedging more expensive and they reduce the insurers’ revenue on their fixed income investments.

Hence the logic of at least trying to buy back some of the benefits—benefits that the company wouldn’t be trying to buy back unless they were valuable to the contract owner. It’s difficult for a VA issuer to estimate its exact exposure on such riders, since no one knows exactly how the contract owners might allocate their assets or exercise their rider options in the future, or how the equity and fixed income markets might behave in the future. It’s unknown if, 30 years from now, VA riders will turn out to be a net gain or net loss for an insurer. In the meantime, however, the carrying costs can be onerous.

The July 1 filing is only the latest move by AXA Equitable to trim some of the risk off its VA book. In 2012, the Company suspended the acceptance of contributions into certain Accumulatorcontracts issued prior to June 2009 and initiated a limited program to offer to buy back from certain policyholders the guaranteed minimum death benefit (“GMDB”) rider in their Accumulator contracts. The Company also took steps to limit and/or suspend the acceptance of contributions to other annuity products.

This morning, an AXA Equitable spokesperson sent RIJ this statement: “Following on the strong contractholder interest in our previous offer, we have decided to make our voluntary program available to a broader customer base. This voluntary, opt-in, no-fee program allows contractholders the option to cancel certain features of their contracts in exchange for an increase in their account value. Our commitment to meeting our promises to policy- and contractholders is unchanged. We will continue to offer and develop variable annuity products that provide retirement savings and financial protection solutions for our customers.”

Framed as a ‘win-win’

So far, AXA Equitable, Transamerica/Aegon and The Hartford have made VA rider buy-back offers. (Both Transamerica/Aegon and AXA Equitable have European-domiciled parents, and U.S. life insurers with foreign parents have been under special pressure to de-risk or even abandon the VA business in the wake of global financial crisis that began in 2008.)

Although the fine print in the contracts is designed to give the insurers the flexibility to reduce the generosity of their products and to make buy-back offers, such moves have been controversial. A buy-back offer can suggest quiet desperation on the part of the insurer—not what a guarantee provider wants to suggest—and could put the advisor who sold it in the complicated, potentially conflicted position of reversing a previous recommendation to a client. It raises questions about the safety of the guarantee and the insurer’s ability to price its guarantees. It could potentially harm the insurer’s brand.

AXA Equitable is framing the buy back offer as a potential win-win, especially for people who planned to surrender their contracts or drop the rider anyway. “You would benefit because you would receive an increase in your contract’s account value and your Guaranteed Benefit charges would cease,” says the N-4 filing. “We would gain a financial benefit because past market conditions and the ongoing low interest rate environment make continuing to provide these Guaranteed Benefits costly to us. Providing the lump sum payments will be less costly to us than the amounts we are currently setting aside to guarantee the benefits.”

The insurer is treading carefully. It may be mindful of the negative publicity triggered by The Hartford’s May 1 announcement of its intention to allow current VA contract owners to keep their living benefit riders only if they accepted new reductions in their range of investment options and to cancel the living benefits if the contract owners didn’t respond to the announcement within a certain period of time. The “negative option” tactic was seen as a heavy-handed move that The Hartford couldn’t have risked had it not already sold its de novo annuity business to Forethought.

Irresistible riders

Back in 2007, some of the riders on the Accumulator VAs were virtually irresistible. Starting in May 2007, a 6.5% “roll-up”—an annual increase in the benefit base—was offered on the GMIB and the GMDB. The roll-up lasted until age 85. What’s more, a contract owner could withdraw an income of up to 6.5% of the benefit base from the contract each year without reducing his or her right to annuitize an amount no less than the initial purchase premium.

These features helped AXA Equitable—at whose predecessor firm, Equitable Life, a group led by Jerry Golden had originated the GMIB in 1996—attract about $15.5 billion in VA premia in 2007. But then the crash and the long interest rate drought converted those VA contracts from a mother lode to a millstone.

AXA Equitable had $96.7 billion in VA assets at the end of the first quarter of 2013, according to Morningstar. As of last 2013, the total account value and net amount at risk of the hedged VA contracts were $39.583 billion and $5.966 billion, respectively, with the GMDB feature and $22.689 billion and $2.099 billion, respectively, with the GMIB feature, according to AXA Equitable’s latest 10-Q filing. Because these programs don’t qualify for hedge accounting treatment, their losses are recognized in net investment income and can hurt earnings.

And they have. According to the 10-Q, “changes in free-standing derivatives, in the fair value of GMIB reinsurance contracts, and changes in VA rider reserves” reduced AXA Equitable earnings by $1.924 billion in the first quarter of 2013. The same factors created a loss of $2.724 billion for the first quarter of 2012 and a loss of $826 million for all of 2012.

Stock analysts, of course, keep a close eye on such things. AXA ADRs (American Depositary Receipts), valued in U.S. dollars, were traded on the New York Stock Exchange from June 25, 1996 to March 25, 2010, when AXA delisted. Since March 26, 2010, AXA ADRs have been traded in the U.S. over-the-counter (OTC) market and are quoted on OTCQX. AXA Equitable has an A+ rating from Standard & Poors’, an Aa3 rating from Moody’s and an AA- rating from Fitch.

AXA Equitable is still very much in the VA business. But over the past two years it has shifted its product focus to the Structured Capital Strategies variable annuity. This so-called “buffered” product works much like an indexed annuity but is registered as a security product with the SEC. At last month’s IRI Government, Legal and Regulatory Conference, SEC staff members mildly criticized the issuers of buffered products (MetLife also offers one) for presenting them as risk-mitigating products when in fact the contract owners have potentially large risk exposure during deep market downturns. The SCS product has garnered well over $1 billion in sales.

A.M. Best issues life/annuity M&A trend report

Posted on June 27, 2013 by Editor Test -

From a new A.M. Best report on M&A in the life/annuity industry:

For many companies considering M&A, product mix has shifted to those that are less capital intensive as well as product designs with less generous benefits. Lines of business such as traditional fixed annuities, long-term care, banking, group medical and Medicare supplement have been de-emphasized by some industry players in favor of international expansion (largely through acquisition), fixed indexed annuities, indexed life, employer stop-loss and voluntary benefits sold through the worksite.

A.M. Best continues to see industry managers focused on core product lines, leading to decisions to exit product lines, which may lead to legal entity dispositions or reinsurance of certain business segments. For those transactions that include products such as level premium term insurance or universal life with secondary guarantees, disentangling from the often complex reserve financing that is in place presents unique challenges and require new solutions to be in place for successful execution. Systems integrations also represent a challenge.

Uncertainty in regulation continues to be a key challenge for the industry. Many of the regulatory issues that were on the horizon entering 2012 continue to be unresolved or yet to be implemented. This includes IFRS accounting, principles-based reserving, the NAIC Own Risk and Solvency Assessment (ORSA), Solvency II and the potential effects of the non-bank SIFI designation. Consequently, A.M. Best believes that life/ annuity companies will face significant costs of compliance, accounting volatility and likely greater capital requirements in the near to medium term.

Specifically, regulatory challenges, perceived or actual, are clearly driving dispositions of assets by international players and presenting opportunities for acquirers that were not previously present. This concern was certainly a driving factor for insurers looking to shed their banking assets. Some European-based organizations are feeling pressure to divest operations, largely driven by the impending capital requirements of Solvency II. Similarly, Canadian companies have also exited U.S. operations/business lines, largely driven by stringent domestic capital requirements.

The economy is also a factor driving recent activity. The prolonged low interest rate environment makes market/interest sensitive lines unattractive as margins are squeezed and capital costs rise. Into this arena have entered private equity asset management specialists who believe margins can be improved through perceived superior income generation and credit analysis skills.

These asset aggregators have grown rapidly and have caused some critics to question the long term value proposition and commitment offered to consumers and to the industry. Historically, plans included an exit strategy of five to seven years, either through an IPO, sale or run-off.

A strategy focused on investment acumen and to some extent, exploiting market inefficiencies, will need to be time tested to prove its effectiveness as an appropriate long-term strategy for the life insurance and annuity sector. A.M. Best remains cautious about the ability to fully integrate and extract long-term value from these blocks of business given the size and complexity of some of these recent transactions. A.M. Best will also evaluate the ability of private equity asset managers to effectively integrate management teams.

Potential for higher earnings and revenue growth is leading some domestic carriers to expand internationally through acquisition. Targets have included asset managers, distributors as well as insurance companies. However, foreign regulation may limit full ownership/control and necessitate accepting a minority ownership position instead. Not having full control of a foreign operation can present operational and managerial challenges. On the other hand, some U.S. carriers have abandoned certain international markets in favor of domestic opportunities focused more on mortality and morbidity risks, which generally exclude embedded guarantees.

Traditional factors also continue to drive M&A activity. In some of the cases cited above, geographic expansion was the main driver of an acquisition. In this case, a simple shell purchase can suffice if a company already has a built in distribution network in place or is looking to open up into a new market and only needs state licenses to broaden its strategy. In other cases, adding scale to an existing product platform or the opportunity to gain greater product diversification offer a compelling reason for a transaction. Finally, for smaller companies, divestitures were used to facilitate succession planning, unlock shareholder value, or as part of overall tax strategies, especially in 2012.

The Bucket

Posted on June 27, 2013 by Editorial Staff -

Genworth launches online training for producers on indexed products

Genworth has launched The Index Institute, a virtual community for producers. The Index Institute contains index life insurance and index annuity training, market insights, presentations, product information and sales ideas.

According to a Genworth release:

Index Universal Life (Index UL) insurance has grown to a $1.5 billion market in 2012 from $330 million in 2006.Sales rose 42% in Q4 and improved 36% for the year, representing 30% of total UL premiums and 12% of all individual life insurance premia.
Fixed index annuities (FIAs) have turned in five consecutive record-breaking years of growth, finishing 2012 with $33.9 billion in sales.

The Asset Builder Index UL, a flexible life insurance solution that offers a death benefit, cash accumulation and an optional accelerated benefit rider for long term care services (ABR), is Genworth’s latest index UL product. The ABR, which is available at an additional cost, allows the policy owner to access the death benefit to pay for covered long term care services.

Among Genworth’s FIAs are the SecureLiving^® Index 5, Index 7 and Index 10 Plus products.

Retirement needs vary more widely than thought: DFA

Conventional thinking on retirement savings is overly simplistic and is limited in its usefulness for most investors. Many standard savings plans fail to take into account personal circumstances, changing income levels and assets accumulated over time, according to new research from Dimensional Fund Advisors. The study modeled realistic income patterns based on data from thousands of households.

For example, a single saving rate recommendation fails to recognize that it may be easier for households with income of $50,000 per year to maintain their current lifestyles in retirement than households making over $100,000 per year. The reason lies with a variety of factors, including the amount of income that needs to be replaced during retirement, the increased revenue contributed by social security in lower income groups and the larger impact of employee 401(k) matches on savings.

The new study, “How Much Should I Save for Retirement?,” is a companion to 2012 research by Dimensional, “How Much Retirement Income Is Enough?” which examined the level of income that people need in retirement. That study challenged the conventional wisdom that investors need to replace 75% to 85% of their income to live comfortably in retirement. Dimensional found that the range was broader, varied greatly based on individual circumstances and using one common number was an overly simplistic approach.

American General launches Lifestyle Income Solution for GUL policies

American General Life Companies has announced the Lifestyle Income Rider, which can be teamed with AG Secure Lifetime GUL(Guaranteed Universal Life Insurance) policies to create the Lifestyle Income Solution.

“This new rider can effectively turn an American General life insurance product into a guaranteed stream of retirement income,” said James A. Mallon, president and CEO, Life Insurance, AIG Life and Retirement, in a release.

“It is… for those who need the option to purchasing life insurance to help meet their family’s financial needs if the worst should happen, while guaranteeing another source of retirement income if the best should happen,” he said.

Tim Heslin, vice president, product strategy and implementation for American General, said, “Our Lifestyle Income Solution features guaranteed monthly withdrawal benefits after as few as 15 years, regardless of the cash surrender value within the policy.

“Further, clients have the flexibility to transform a portion of their life insurance benefit while they are still living to help supplement their retirement income. Customers can choose this living benefit and then stop it during payout if they decide they no longer need it and want to maintain a life insurance benefit. If they stop the living benefit, they can restart it at a later date.”

The Lifestyle Income Solution on AG Secure Lifetime GUL is available for issue ages 18-70 in specified amounts of $100,000 to $10,000,000 (conditions and limitations apply; see your agent for details). The Lifestyle Income Solution, which has its own premium, must be issued in conjunction with the Terminal Illness Rider on AG Secure Lifetime GUL.

Northern Trust report offers details on DC plan asset flows

Participants in employer-sponsored defined contribution retirement plans reduced their U.S. equity holdings and increased their fixed income holdings in 2012, thus missing out on at least part of last year’s equity market gains, according to a report by the Defined Contribution Solutions group at Northern Trust.

On the other hand, plan participant diversified overall into international equities and increased their allocations to target date funds, two trends that Northern Trust found healthy. Northern Trust is a DC plan service provider.

Northern Trust’s Defined Contribution Tracker analyzes data on 1.5 participants in 85 U.S. retirement plans with $190 billion in market value. The tracker confirmed the contradictory state of affairs in 2012—equity values were rising even as many investors seemed to be the equity markets—that some explained by pointing to substantial corporate buyback programs during the year.

In 2012, the tracker showed, participants shed domestic equities even as the Russell 3000 Index of U.S. stocks gained 16.4% for the year. U.S. equities remained the largest asset class at 31.1% of holdings but fixed income saw net positive inflows of 9.2% for the year, despite low yields.

Assets held by target retirement date funds in DC plans tracked by Northern Trust grew to 14.6% from 11.9% of participant allocations during 2012. International equity, meanwhile, grew from to 7.6% from 5.9% of allocations in the tracker universe.

“Target retirement date funds have benefited from the increased adoption of auto-enrollment and other automated features,” said Susan Czochara, senior product manager in Defined Contribution Solutions at Northern Trust.

The Defined Contributions Tracker will be published annually using year-end data aggregated from DC retirement plans with daily valued assets under custody at Northern Trust.

Northern Trust has approximately $214 billion in DC assets under custody. Its global custody unit works closely with the asset management team to provide comprehensive integrated solutions for DC plans, including daily valuation, multi-manager unitization, Defined Benefit-DC integration, performance measurement and cross-border pooling.

Baucus/Hatch letter to Congressional colleagues

Next Steps on Tax Reform
Chairman Max Baucus and Ranking Member Orrin Hatch, U.S. Senate Committee on Finance
June 27, 2013

Dear Colleague,

We write today to ask you for your input as the Finance Committee moves forward with comprehensive tax reform. America’s tax code is broken.

The last major reform of the tax code was the Tax Reform Act of 1986, which is considered by many as the gold standard for tax reform. However, since then, the economy has changed dramatically and Congress has made more than 15,000 changes to the tax code. The result is a tax base riddled with exclusions, deductions and credits. In addition, each year, it costs individuals and businesses more than $160 billion to comply with the tax code. The complexity, inefficiency and unfairness of the tax code are acting as a brake on our economy. We cannot afford to be complacent.

Over the past three years, the Finance Committee has been working on tax reform on a bipartisan basis. We have held more than 30 hearings and have heard from hundreds of experts on reforming the code—how to make it simpler for families and businesses and spark a more prosperous and competitive economy. In addition, over the past three months, we have issued ten bipartisan options papers totaling more than 160 pages that detail reform proposals we are considering in every area of the tax code. The full Committee has met on a weekly basis to discuss these options papers and how to put plans into action. We are now entering the home stretch.

Colleagues, now it is your turn. We need your ideas and partnership to get tax reform over the finish line. In order to make sure that we end up with a simpler, more efficient and fairer tax code, we believe it is important to start with a “blank slate”—that is, a tax code without all of the special provisions in the form of exclusions, deductions and credits and other preferences that some refer to as “tax expenditures.”

This blank slate is not, of course, the end product, nor the end of the discussion. Some of the special provisions serve important objectives. Indeed, we both believe that some existing tax expenditures should be preserved in some form. A complete list of these special tax provisions as defined by the non-partisan Joint Committee on Taxation can be found at https://www.jct.gov/publications.html?func=select&id=5.

But the tax code is also littered with preferences for special interests. To make sure that we clear out all the unproductive provisions and simplify in tax reform, we plan to operate from an assumption that all special provisions are out unless there is clear evidence that they: (1) help grow the economy, (2) make the tax code fairer, or (3) effectively promote other important policy objectives.

Today, we write to ask you to formally submit legislative language or detailed proposals for what tax expenditures meet these tests and should be included in a reformed tax code, as well as other provisions that should be added, repealed or reformed as part of tax reform. In order to give your proposals full consideration as we work to craft a bill, we request these submissions by July 26, 2013. We will give special attention to proposals that are bipartisan.

To help inform your submissions, we asked the nonpartisan Joint Committee on Taxation and Finance Committee tax staff to estimate the relationship between tax expenditures and the current tax rates if the current level of progressivity is maintained. While Members of the Senate have different views on whether the revenue raised from eliminating tax expenditure or other reforms should be used to lower tax rates, reduce the deficit, or some combination of the two, we believe that everyone should understand the trade-offs involved when adding tax expenditures back to the tax code.

The blank slate approach would allow significant deficit reduction or rate reduction, while maintaining the current level of progressivity. The amount of rate reduction would of course depend on how much revenue was reserved for deficit reduction, if any, and from which income groups. However, as shown in the chart below, every $2 trillion of individual tax expenditures that are added back to the blank slate would, on average, raise each of the seven individual income tax brackets by between 1.3 and 2.2 percentage points from what they would be under the blank slate.

Likewise, every $200 billion of corporate tax expenditures that are added back to the blank slate would, on average, raise the top corporate income tax rate by 1.5 percentage points from what they would be under the blank slate. These estimates demonstrate that the more tax expenditures we allow in the tax code, the less we will be able to reduce tax rates or reduce the deficit. As we work to craft a tax reform bill, we will bear these trade-offs in mind.

While we believe that taking a hard look at every income tax expenditure is an essential part of tax reform, we also encourage you to examine other aspects of the tax code. For example, many provisions of the income tax that are not considered tax expenditures could be greatly simplified. In addition, almost half of federal tax revenues come from sources other than
income taxes. The tax reform process will therefore involve much more than just income tax expenditures.

Our tax code is bloated and outdated. The income tax was established a century ago, in 1913. And it has been a generation since our last tax reform in 1986. As Chairman and Ranking Member of the Finance Committee, we are determined to complete tax reform this Congress. We look forward to your ideas and to working together to accomplish this historic goal.
Average Effect on Tax Brackets of Adding Back Tax Expenditures, Maintaining the Current Level of Progressivity.

These estimates represent an average effect because the effect on tax rates of adding back, for example, $1 trillion in individual tax expenditures is not as large as the effect of adding back a second $1 trillion in tax expenditures. Put differently, it becomes increasingly costly to lower the tax rates as the tax rates go down through base broadening. The current level of progressivity means the level of progressivity in 2017. Certain tax expenditures are excluded from the analysis where doing so is necessary to maintain the current level of progressivity. The income ranges for the current tax brackets are for married taxpayers filing jointly.

Cost of elderly care in 2011 was >$400bn: CBO

Posted on June 27, 2013 by Editor Test -

The total value of long-term services and supports for elderly people, including the estimated economic value of informal (or donated) care, exceeded $400 billion in 2011, according to a the Congressional Budget Office report released June 26.

Expenditures for institutional care—provided in skilled nursing facilities, nursing homes, and nursing facilities located in continuing care retirement communities—totaled $134 billion in 2011, or about 31% of all expenditures for LTSS (long-term services and supports) expenditures. Expenditures for home- and community-based service providers, such as home health and personal care agencies and adult day care providers, totaled $58 billion.

Informal care, usually provided by family members and close friends, accounts for more than half of the total economic value of long-term services and supports. The economic value of informal care in 2011 was about $234 billion, CBO estimates.

Choosing to provide informal assistance to a frail elderly person may entail a substantial sacrifice of free time on the part of a caregiver; more than half of all informal caregivers work full time in addition to providing such care, and the burdens for caregivers who do not work full time may also be substantial.

By 2050, one-fifth of the total U.S. population will be 65 or older, up from 12% in 2000 and 8% in 1950. The number of people age 85 or older will grow the fastest over the next few decades, constituting 4% of the population by 2050, or 10 times its share in 1950. That growth in the elderly population will bring a corresponding surge in the number of elderly people with functional and cognitive limitations.

On average, about one-third of people age 65 or older report functional limitations of one kind or another; among people age 85 or older, about two-thirds report functional limitations. Functional limitations are physical problems that limit a person’s ability to perform routine daily activities, such as eating, bathing, dressing, paying bills, and preparing meals. Cognitive limitations are losses in mental acuity that may also restrict a person’s ability to perform such activities.

One study estimates that more than two-thirds of 65-year-olds will need assistance to deal with a loss in functioning at some point during their remaining years of life. If those rates of prevalence continue, the number of elderly people with functional or cognitive limitations, and thus the need for assistance, will increase sharply in coming decades.

LTSS expenditures for elderly people now account for an estimated 1.3% of gross domestic product (GDP).

That share is likely to rise in the future as the population ages. To explore the potential implications of the growing elderly population, CBO developed three alternative scenarios regarding the future prevalence of functional limitations among the elderly, holding constant other factors affecting those expenditures, such as growth in prices for LTSS, changes in family structure that could affect the provision of informal care, and changes in how services and supports are delivered.

In those scenarios, LTSS expenditures were projected to range from 1.9% of GDP to 3.3% of GDP by 2050. (The combination of actual future prevalence of functional limitations and changes in those other factors could result in LTSS spending that was less than 1.9% of GDP or more than 3.3 percent of GDP by 2050. Spending could be higher, for example, if the provision of informal care fell relative to the provision of formal care as a result of a shrinking average family size.)

Projections of LTSS expenditures are subject to considerable uncertainty. In addition to estimates of the prevalence of functional limitations, they require judgments about future innovations in the delivery of care, changes in the use of services, and future rates of growth in the costs of labor and other inputs to long-term care.

A Sudden U-Turn in Bond Flows

Posted on June 27, 2013 by Editor Test -

Is it time for bond owners to panic? That may depend on why they’re holding bonds in the first place, or how they financed their bond positions.

Some people are panicking. U.S.-listed bond mutual funds and exchange-traded funds posted an all-time record net outflow of $61.7 billion in June (through June 24), according to TrimTabs Investment Research. That broke the previous record of $41.8 billion set in October 2008.

“Before June, bond funds had posted inflows for 21 consecutive months,” said David Santschi, CEO of TrimTabs. He attributed the reversal to Fed chairman Ben Bernanke’s hints in May that he might scale back the Fed market interventions that have propped up prices for bonds of all credit qualities and durations.

On June 24, San Diego financial pundit Bill Gunderson sent out an e-mail blast that said, “Here’s the one thing people do not know about the market right now: This is no time to be in bonds. At some point, Bernhanke [sic] must take away the punch bowl. And when that happens, bonds will be punished even more than the 8% decline they have suffered since the beginning of the year.”

In case words alone weren’t sufficiently scary, Gunderson also issued a newsletter with a picture of the Massacre at Little Big Horn (aka Custer’s Last Stand) and a chart illustrating the fall in share the price of Vanguard Total Bond Market Index Fund—to $80, a 5% paper loss—since May 1.

Since I (full disclosure) own shares in Vanguard Total Bond Market Index Fund, I felt compelled to fret. So I spoke with Chris Philips, a senior market strategist in Vanguard’s Investment Strategy Group. The conversation went as follows:

RIJ: I comfort myself that during periods of rising rates a bond fund’s price is supposed to recover in a time period roughly equal to its average duration, because the manager keeps reinvesting at higher yields. Is that a valid rationale?

Philips: It almost never holds up in reality because of credit-spread timing and other factors. But it’s based on a kernel of reasonable intuition and relationships over time. It’s one of those rules of thumb that [bond fund owners] can use to gauge their general risk exposure.

RIJ: Still… there’s been an 8% decline in six months. Time for a gut-check, no?

Philips: The Vanguard Total Bond Market Index Fund is down 3.2% year-to-date. Its worst year historically was negative 9.2%. Gunderson says bonds are off 8%; he might be talking about long-term Treasuries, which is the worst-case scenario. To put the risk of bonds in perspective, we would point out that during the financial crisis, housing prices dropped 50% in some places, dividend-paying stocks lost 55% and the overall market lost 50% at one point. While there are other income sources, they come with different or greater risks than bonds.

RIJ: Let’s suppose that I restrain myself from panicking, but millions of my fellow bond fund owners don’t. Won’t the bond fund manager have to start dumping bonds at big losses to cover all the redemptions?

Philips: There’s the possibility of a forced sell-off, but the amount of [negative] cash flow that would have to occur is tremendous. If you look at all of the sources of cash flow in the Total Bond Market Index Fund, including money from institutional investors and target date fund investors in 401(k) plans, the probability of everyone deciding to pull money out is small. In large funds like Total Bond Market or PIMCO Total Return, you always have a lot of securities coming to par. There’s a lot of money to work with. Even in 2010 and 2011, when we had the perceived crisis in the municipal bond market, not one of our muni-bond funds experienced forced selling.

RIJ: It’s hard to accept the fact that the 30-year bull market in bonds is actually over.

Philips: Despite all the fear about rising rates, it would be worse for yields in all income securities to remain low. In contrast to an environment of financial repression, where people who rely on certificates of deposit have been penalized not only by the Fed but also by the flight to fixed income, rising yields is a good thing. We’d rather have a market with historically normal rates than rates that are historically high or low. Ultimately, it gets down to how rising rates occur. In the period of 2003 to 2006, the Fed was very open about how and when they would raise short-term rates, and the market had a lot of room to price in the changes.

RIJ: Is there a buying opportunity here? Can you ‘buy the dips’ in bond prices as you might in stock prices?

Philips: ‘Buying the dips’ is a timing mentality, which we don’t recommend. On the other hand, if your target allocation for fixed income is 50% and you’re below that because of the share price decline and you had the cash, it might make sense. That’s where dollar cost-averaging comes in.

RIJ: Thanks, Chris.

Wharton professor challenges value of annuities

Posted on June 27, 2013 by Editor Test -

“We find that most households should not annuitize any wealth. The optimal level of aggregate net annuity holdings is likely even negative.”

So write Kent Smetters of the Wharton School and Felix Reichling of the Congressional Budget Office in their introduction to a research paper that was disseminated by the National Bureau of Economic Research this week. It is an extension of work published in 2004 by Smetters.

The authors were not immediately available for comment.

The introduction defines annuities as “investment wrappers” rather than as insurance contracts. According to a preface to the paper, they discussed its content with several members of the RIJ community, including Zvi Bodie of Boston University, Jeff Brown of the University of Illinois, and Boston-area advisor Rick Miller.

The papers offers two main arguments against tying up money in an annuity:

Illness or mishap might shorten your lifespan and/or create demand for cash to pay medical bills or make up for lost wages.
By shifting purchasing power toward the end of your life, it deprives you of spending power earlier in life, when you might value it more.

“We find that 63% of households should not annuitize any wealth, even with no transaction costs… The ‘true annuity puzzle’ might actually be that we do not see more negative annuitization [i.e. life insurance],” the authors write.

But they acknowledge that annuities have a role.

“For retirees, annuitization becomes more desirable at larger values of wealth,” they write. “After a negative survival shock, a wealthy retiree has enough assets to pay for any potentially correlated long-term care cost from the annuity stream itself… Hence, a wealthy retiree can ‘hold to maturity,’ in much the same way that a long-term bond holder is less concerned with duration risk.”

In an email to RIJ, the University of Illinois’ Brown wrote, “In spite of [Smetters’] work, I still believe [annuities] make sense as a way of ensuring that real people don’t outlive their resources.”

Declaration of independence

Posted on June 26, 2013 by Editor Test -

Going Dutch on pension reform

Posted on June 26, 2013 by Editor Test -

The Netherlands’ deadline for overhauling its rules for private pensions with a new “Financial Assessment Framework” (FTK) has been pushed back to January 1, 2015, due to the complexity of the changes. But in the meantime there’s been lots of debate over it and how it might affect workers.

Expectations for retirement have changed in the Netherlands. Dutch workers both young and old expect smaller pensions than their predecessors. But their expectations may need to drop even lower if the “tax-facilitated accrual rate” falls to 1.75% a year, according to an IPE.com report based on interviews with the VvV, or Dutch Association of Insurers.

In 2012, the Netherland’s new government announced a measure that included a reduction in tax-advantaged pension accrual rate to 1.75% per year of service and tax-facilitated pension accrual would no longer be possible above an income of €100,000, according to a report by Ernst & Young.

As a rough example, the pension of a Dutch worker who had a final salary of €50,000 (One euro = US$1.30) after 40 years would be €35,000 (1.75% x 40 x €50,000), while at 2.25% the pension would be €45,000. The highest tax-facilitated pension accrual would be €70,000 after 40 years on the job.

So far, the pensions would like a compromise between the old and new rates. The civil service scheme ABP and the unions FNV, CNV and MHP, as well as the VvV, have called on Parliament to allow for a 2% pensions accrual to ensure young workers receive adequate pensions.

Dutch employees between 18 and 35 years of age expect to receive 64% of their final average salary in retirement, according to a survey of almost 1,000 consumers by the polling firm GfK on behalf of the VvV. But they may need 74%, VvV said.

Suggested government proposals to decrease the yearly accrual rate to 1.75% from 2.25% will hit young people particularly hard, even if promised permanent compensation measures lift the new rate to 1.85%, studies have shown.

Dutch workers over 50 believe they will require 79% of their average salary in retirement, yet the VvV estimates that they will receive on average 69% at most. Among young employees, 79% said worried that their pension might be under 50% of their average salary; while 76% of older workers said this was a threat.

Both age groups expect to retire at 65.5, on average; less than 8% expect to work until 70, GfK found. But 31% of the younger generation and 25% of older workers said they would need a part-time job after retirement.

The government should not “economize” on pensions but rather reduce the civil service headcount, cut back on Social Security benefit, or reduce the mortgage interest tax break.

Nearly 70% of surveyed young workers said it made little sense for them to carry on working until the age of 72, assuming the Dutch Cabinet’s plans on the retirement age are embraced by Parliament.

Generational conflict

The Dutch pension system has another problem that prevents the government from overhauling it: younger plan members subsidize older members by means of an average contribution rate. So said professor emeritus Jean Frijns at a recent conference in Amsterdam.

“The average contribution methodology is the elephant in the room,” he said. “And, so far, everybody has been giving it a wide berth. This is a relic from the past. It amounts to a considerable chunk of pay-as-you-go financing hidden in our system of capital funding.”

Young plan members presently pay higher contribution premiums, which he said could be seen as pay-as-you-go subsidies to older scheme members. “The moment a scheme is closed to new members, this creates a pension deficit for older workers,” he said.

“I don’t see how they can close that cap in the 10-15 years that remain for them before retirement. This is a tremendous risk we are depositing at the doorstep of a particular group of workers.”

Government plans to limit fiscally facilitated pension savings are now bringing the problem into sharper focus. “This means 20% of pension funds are being closed off,” he said. If the proposed FTK favors current retirees, older active plan participants would be at a disadvantage.

“Pension funds have implicitly promised to treat all scheme participants equally, so the problems caused by this average contribution methodology must be solved together, with the pain borne by pensioners, older workers and younger workers alike,” he said.

Measuring You for an ERISA Suit

Posted on June 26, 2013 by David Lindorff -

Across America, providers of ERISA-regulated retirement are lowering their fees for defensive and proactive reasons. Some want to avoid being sued by participants for not being good fiduciaries of the plan. Some may want participants to accumulate more money at retirement. And, in some cases, they may simply not have realized until recently that they had a problem. “A lot of plan sponsors just never really thought about fees before,” said Alicia Munnell, director of the Center for Retirement Research at Boston College.

But they think a lot about them now. Just this week, Cigna Corp. and Prudential, which bought Cigna’s retirement business in 2004, reached a $35 million settlement in the case of Nolte v. Cigna, filed in 2007. It was alleged that participants were overcharged for proprietary investment options, that plan assets were misused and that Cigna used plan assets and revenue to pump up the value of its retirement business in the sale to Prudential.

Targets on our backs

Plan sponsors, providers and sponsors have been on alert since March 2012, when Missouri Federal District Judge Nanette Laughrey awarded $36.9 million to the plaintiffs in Tussey v. ABB. The plaintiff’s attorney in that case, like the Cigna case and other similar cases, was the St. Louis law firm of Schlichter, Bogard & Denton.

Judge Laughrey ruled that ABB, a construction firm, and its 401(k) plan provider, Fidelity Management Trust Co., breached fiduciary duty by providing services to management at participants’ expense, shifting plan assets from Vanguard Wellington Fund to the proprietary Fidelity Freedom Fund, and, on Fidelity’s part, profiting from the “float” on plan contributions and distributions. ABB management and Fidelity have appealed Laughrey’s ruling to the Eighth Circuit Court of Appeals.

Courts have made conflicting decisions in such fee cases, which means that one or more of them is bound to wind up before the Supreme Court. Meanwhile, however, the fact that substantial damages are being awarded by some courts has many plan sponsors looking to see what their potential liability could be, and what they can do now to minimize the risk.

“I’m starting to have conversations with plan sponsors who say, ‘We look like we have a target on our back. We want to just go to the lowest cost provider for our 401(k) plan,’” said Jason C. Roberts, founder and CEO of the Pension Resource Institute in Manhattan Beach, Calif. “That’s dangerous, though, because if you cut fees, you could get stuck with even more liability, because the cheap plans don’t do the advisory work you need.”

Besides, he adds, if you suddenly cut your fees, your employees might scrutinize what you were charging before. There are “people out there” who are “running algorithms to spot good targets for excessive fees lawsuits,” he told RIJ.

Industry-wide risk: large, unknowable

“It’s hard to put a number on the plans that are at risk of lawsuits over excessive fees. But being conservative as we are here, I would say that the number is very high,” James Holland, director of business development at Millennium Investment and Retirement Solutions in Charlotte, NC, told RIJ. “Remember, 80% of the cost of most of these plans comes from the investments. And, especially in the smaller space, any time the plans are product-driven, you’ve got a problem. Brokers who sell these plans are driven by commissions, so I’d say the risk in plans is pretty high.”

David Witz, managing director of FRA PlanTools, said, “No one knows the scale of the excessive fee problem. Without knowing the services rendered, we can’t know if the fees charged are excessive. [But] “if you [as a plan sponsor or provider] have a relationship that is five or more years old, you’re vulnerable” simply because the potential damages involved can be so large.

“The perception of the industry is that the plaintiff attorneys in these cases are just ambulance chasers. I think that assessment is off-base,” Witz added. “These attorneys do a lot of research before that will take a case, and won’t bring one unless they think they have a good chance to win. The marketplace doesn’t get this.”

Referring to the recent Cigna settlement, he says, “That is a huge win for the plaintiffs, and the message is that this isn’t going away.” He notes that the first audits of current year plans subject to the new 408(b)(2) rules will be coming out late this year or early next year, and he predicts “a wave of lawsuits over excessive fees next year.” Witz’ firm has a site, ERISA Litigation Index, that tracks the trend.

Marcia Wagner, a partner at the Wagner Law Firm in Boston, says the problem of excessive 401(k) fees is “gradually going to be resolved going forward, because of litigation, and because of new disclosure rules.” But she believes the existing retirement industry is rife with examples of such excessive fees. “I’d say at least half the plans out there have excessive fees,” she said. “Right now you’re seeing these lawsuits against the big guys, but it’s even more of a problem with the smaller plans.”

Excessive fees will also need to be addressed in the 403(b) plans offered in the public education and not-for-profit sector, she added. “I’ve seen plans where the fees are extremely excessive,” she said, but adding that because the DoL’s transparency rules don’t apply to 403(b) plans, high fees are harder for participants in those plans to spot.

Statute of limitations

ERISA’s statute of limitations on 401(k) fees is complex. Participants can sue within up to three years after they first learn of an alleged fiduciary violation by a plan sponsor or provider. But they can also sue within up to six years after the last action that arguably represented a breach in fiduciary behavior, even if it was unknown to participants at the time. Damage awards can therefore reach back a number of years.

One takeaway for plan providers and broker-dealers: You need to be aware of the risk that your own intermediaries, who sell plans to plan sponsors, might be named as co-defendants in an ERISA suit. If an advisor knows that he or she is selling a retirement plan with excessive fees, or knows of any self-dealing between the plan sponsor and the plan provider, “the advisor shouldn’t touch it ,” cautioned Gretchen Obirst, a plaintiff’s attorney at Seattle-based Keller Rohrback. “If the fees are too high, you could be in trouble even if you disclosed them.”

If you need a sign that plan sponsors and providers are concerned about recent fee-related court cases and the possibility that participants might sock them with a multi-million dollar federal class action lawsuit, the director of Boston College’s Center for Retirement Research, Alicia Munnell, has one.

Less than three weeks ago, she told RIJ, Boston College’s 403(b) plan provider, TIAA-CREF, reduced its plan fees by introducing an institutionally priced share class of its CREF Equity Index and closing the retail share class. The retail shares had cost only 42 basis points a year—hardly predatory—but the institutional shares cost a miniscule seven basis points.

Plan providers like TIAA-CREF are lowering their plan fees for defensive and proactive reasons. They want to avoid being sued by participants for not being good fiduciaries of the plan. They want participants to accumulate more money at retirement. And, in many cases, they didn’t know until recently that they had a problem. “A lot of plan sponsors just never really thought about fees before,” Munnell said.

Editor’s note: A TIAA-CREF spokesperson responded to Munnell’s comments, saying: “TIAA-CREF works closely with plan sponsors and consultants to determine the most economical mutual fund share class for institutional clients. In line with industry standards, TIAA-CREF offers lower-priced mutual fund share classes when plan economics allow.”

Cigna, Prudential settle ERISA lawsuit for $35 million

Posted on June 24, 2013 by Editor Test -

Cigna Corp. and Prudential Retirement Insurance and Annuity Co., have agreed to pay $35 million to settle a six-year-old fee-related federal class action lawsuit, Nolte et al. v. Cigna Corp., et al., according to a release by Schlichter, Bogard & Denton, the St. Louis law firm that represented the plaintiffs.

The initial complaint was filed in 2007 in the U.S. District Court for the Central District of Illinois. Cigna sold its retirement plan business to Prudential Financial for $2.1 billion in 2004, and the lawsuit claimed that Cigna improperly used plan assets to enhance its revenue from the sale.

According to a 2011 amended complaint, Cigna “invested more than $1 billion of Plan assets directly into [its] General Account, even though that investment imposed excessive and undiversified risk upon the Plan; and (5) used Plan assets in [its] business by placing more than $2.4 billion with Defendants as assets under management so as to increase the ongoing revenues and profits, including the eventual sale price, of CIGNA’s retirement business to Prudential while not accounting to the Plan for such use.”

A spokesperson at Prudential Retirement declined to comment.

Part of the settlement, which remains to be approved by Judge Harold A. Baker, will go to plan participants’ accounts and part will compensate the plaintiffs’ law firm, which has made a specialty over the past several years of suing plan sponsors and providers for alleged breach of their fiduciary duty to protect plan participants against excessive fees. In 2012, the same law firm won a $36.9 million judgment in a fee-related class action lawsuit, Tussey vs. ABB. The plan provider in that case was Fidelity.

According to the release:

“The case involves disputes over the handling of the Cigna 401(k) plan, the prudence and level of fees of certain plan investment options, and the sale of Cigna’s retirement business to PRIAC… The Nolte plaintiffs allege, among other things, that the fiduciaries responsible for overseeing the plan breached their legal duties by allowing the plans to pay excessive investment management and other fees while allegedly benefiting Cigna and that Cigna improperly benefited from the sale of Cigna’s retirement business.

“The defendants dispute these allegations and assert that the plan has always been appropriately managed to offer a menu of sound options for participants’ retirement savings. Cigna and PRIAC maintain that they have fully complied with the Employee Retirement Income Security Act of 1974, which covers such plans…

“As part of the settlement… Cigna has agreed to continue not to include in the plan’s investment lineup any investment options managed by it or its affiliates and has agreed to continue to exclude retail class mutual funds from the plan’s lineup—as it has since the 1990s.”

Equity correction a buying opportunity: Prudential

Posted on June 24, 2013 by Editor Test -

Stocks are likely to continue to struggle and volatility remains high in the near term as investors worry about Fed QE “taper,” uncertainty about further Bank of Japan stimulus efforts to re-flate Japan, global growth concerns, and continued political tensions in Turkey, says John Praveen, chief investment strategist at Prudential International Investments Advisers LLC.

In his July 2013 strategy report, Praveen therefore says he is reducing his equity market overweight “on a tactical basis.” But he sees the dip in equity values as a buying opportunity. According to a summary of his report:

Strategically, global equity markets remain supported by:

Low interest rates and plentiful liquidity;
Improving global growth;
Improving risk appetite as Euro-zone continues to re-stabilize with resolution of the crises in Italy and Cyprus;
Healthy earnings rebound; and
Valuations have become more attractive with the recent correction.

“We see the equity correction as a buying opportunity,” Praveen writes. The equity rally is likely to resume as the liquidity and policy uncertainties ease with the Fed reassuring about QE buying continuing through late 2013, Abe-Kuroda deliver the next tranche of stimulus and policy measures in Japan, and global growth picks up.

Praveen also observed:

We raise bonds to Neutral as yields are likely to remain range bound with upward pressure on yields from QE taper fears, easing of Euro-zone risks and improving growth offset by low inflation in the developed economies and continued central bank buying, even with QE taper.
Among global stock markets, we reduce overweight in Japan as market likely to remain volatile until fresh Bank of Japan stimulus and Prime Minister Shinzo Abe outlines “third arrow.” Reduce Euro-zone to neutral on Fed taper fears. Remain Neutral on EM stocks with sluggish growth and slow rate cuts. We raise U.S. to Neutral status; it is likely to be a defensive hedge amidst increased volatility.
Among global bond markets, we remain Overweight in Euro-zone bonds as the economy remains in recession and inflation remains low. Raise U.S. Treasuries to modest Overweight on Q2 GDP slowdown and low inflation. Remain Neutral on JGBs. Remain Underweight U.K. Gilts.
Among global sectors, we are Overweight on Financials and Information Technology; Modest Overweight on Industrials, Healthcare and Telecoms; Neutral on Consumer Discretionary; Underweight on Energy, Materials, Consumer Staples and Utilities.
Among currencies, the U.S. dollar is likely to strengthen against the yen and be range bound against the euro. Further Bank of Japan stimulus and Abe government’s reform measures should push the yen back above ¥100/$.

Investing in Gold: Does It Stack Up?

Posted on June 24, 2013 by Knowledge@Wharton -

Gold has a timeless allure—especially if you worry about stock market volatility, inflation, a decay of ordinary currency or the collapse of civilization. Yet not everyone agrees that gold offers the safe haven its promoters describe. After soaring for a dozen years, it has plummeted in 2013.

After all, while gold has some practical uses in electronics and a few manufacturing processes, most of it ends up as jewelry on people’s wrists and necks—or rests quietly as stacks of ingots in rooms with thick doors and strong floors. How reliable can demand be for a commodity that very few people actually need? What is the proper role for gold in an investment portfolio? Why has its price been falling?

“People call it an insurance policy. I call it a very expensive insurance policy,” says Wharton finance professor Jeremy Siegel.

“I would never recommend a specific investment in gold,” adds Kent Smetters, professor of business economics and public policy at Wharton, who adds that investors have better ways to hedge against inflation—one of gold’s presumed benefits.

A spotty record

There is no denying that gold has held value for humans for thousands of years. It is found in the graves of the elite all over the world. The search for it drove much of the exploration of the New World. Treasure hunters risk their lives pursuing chests of it lost at the bottom of the sea.

But its record as a store of wealth is spotty. From early 2001 to late summer 2011, the price of gold soared from just under $300 an ounce to nearly $1,900, confirming gold proponents’ view that the metal is a terrific investment. But there have been long periods of disappointment, too. Gold peaked just shy of $700 an ounce in 1980, then fell and did not again hit that level for 27 years. It started this year at $1,657, and has fallen about 18% to around $1,355, while the Standard & Poor’s 500 Index has gained about 18%.

The cause of these ups and downs is always open to debate. When the price of steel rises or falls, the reason can usually be found in the pace of world economic growth. Grain prices are heavily influenced by the weather. But gold rides waves of emotion.

Most gold becomes jewelry. In fact, among the largest consumers of gold are jewelry buyers in India, says Wharton finance professor Franklin Allen. “India has not been doing well, so that may be a factor” driving gold prices down, he notes. “There may also be some selling by central banks and hedge funds that we aren’t aware of.” Big sales, perhaps to raise money for economic stimulation, would increase gold supply, undercutting prices.

Gold prices are also affected by the ebb and flow of demand for other investments. If stocks look good, some investors will switch from gold to stocks, and falling demand will help drive gold prices down. Gold’s fall this year coincides with a fast climb in stock prices. “Gold and silver are suffering because people are moving money to the stock market,” Smetters says.

Siegel maintains a long-run chart of real returns for various asset classes—returns adjusted for inflation. Because of inflation, a dollar acquired in 1802 would have been worth just 5.2 cents at the end of 2011. A dollar put into Treasury bills at the same time would have grown to $282, or to $1,632 had it gone into long-term bonds. Held in gold, it would have grown to $4.50. True, that’s a gain even with inflation taken into account. But the same dollar put into a basket of stocks reflecting the broad market would have grown to an astounding $706,199.

As an investment, gold has some flaws. Anyone who owns it in significant quantity would be wise to ante up for secure storage, which creates a cost that drags on the return, says Siegel. And, unlike bank savings, bonds or dividend-paying stocks, gold does not provide income. “It’s a very volatile asset with no yield,” according to Allen.

Nor does gold provide rights to share in corporate profits—a perk enjoyed by any stockholder. Investors who want safety can use government bonds, knowing the government can use its taxing power to make good on its commitments to bond owners. No one stands behind the price of gold.

Paying a ‘big price’

In a period of hyperinflation, when currency becomes virtually worthless, or a time of great distrust in the economy or banking system, gold may indeed become a safe haven, Siegel notes. “There isn’t anything that’s clearly better if you’re concerned about those sorts of events.” But he adds that people who turn to gold tend to be “overly concerned” about catastrophe. Putting a large portion of one’s wealth into gold would therefore mean sitting on the sidelines waiting for an unlikely event while other assets, such as stocks, produced better long-term returns. “I think you would be paying a big price,” Siegel says.

Currently, inflation is very low, which eliminates that factor as an immediate reason to hold gold, Smetters points out. Investors who want a guaranteed hedge against any future inflation have better options in inflation-indexed U.S. savings bonds, he adds. I-bonds guarantee a modest return on top of the inflation rate, while also insuring against loss due to deflation, or falling prices.

According to Smetters, there is another option: Treasury inflation-protected securities, or TIPS. These U.S. government bonds provide annual interest earnings plus a rise in principal, or the face value of the bond, tied to the inflation rate. (TIPS are best held in retirement accounts like IRAs and 401(k)s to avoid annual tax on “phantom income” from the inflation adjustments, Smetters notes.) Allen agrees. “I would say TIPS are a better strategy [than gold] to protect against inflation, unless things are very bad indeed in the U.S. Swiss francs would also be a good bet.”

A well-diversified investment portfolio can also help guard against inflation, says Smetters. “I generally believe in a multi-part investment process that starts with a safe layer of bonds, internationally diversified.”

Another option, of course, is stocks, which, as Siegel’s data show, have a good long-term track record against inflation. A key reason: Companies can increase prices for goods and services as inflation drives up costs of raw materials and labor. Inflation can also lift customers’ incomes, enabling them to pay higher prices.

Real estate investment trusts, or REITS, also offer an inflation hedge, Allen adds. REITS are a form of mutual fund that own residential, commercial or industrial real estate. Property values and rents generally rise with inflation, making REITS a good hedge. For those worried about a collapse in the stock market, he suggests “put options,” which hedge against loss by giving their owners the right to sell at a guaranteed price a block of shares or a broad index, like the S&P 500. To minimize costs—the premium paid for an option—the investor can buy “out of the money” puts. These are cheaper because they require the investor to accept some loss before the protection kicks in—similar to getting an insurance policy with a very large deductible.

Investors who worry deeply about other asset classes can put a small portion of their holdings into gold for peace of mind, so long as they are willing to pay a price in storage costs and weak returns, Siegel says.

Buy the mine

Most experts caution against investing in jewelry and collectable coins, because it’s hard to assess the artistic or collectable value that comes on top of the value of the raw gold. Professional investors trade gold on the futures market—but this is very complex, and futures are generally used for short-term bets rather than long-term investments.

As a compromise, investors can buy stocks in gold mining companies, says Allen. These stocks give shareholders the right to share in cash flows, and they tend to benefit when gold rises, though investors must also assess the quality of management, the firm’s competiveness in the market and any other factors typically involved in a stock purchase.

To avoid the cost of storing gold, investors can buy shares in exchange-traded funds (ETFs) that own physical gold kept in vaults in places like Switzerland. ETFs are a kind of mutual fund that trades like stocks, making buying and selling of gold very easy. They are a good way of speculating on spot prices, or holding gold for the longer term to diversify a portfolio. Gold ETFs might not be so good, however, as a hedge against financial, social or political chaos, because ETF trading depends on the financial markets, and the gold itself is inaccessible.

What’s a better remedy than gold for investors worried about social crisis? “For those worried about social chaos, a move to Canada might be advisable,” Allen quips.

Evaluating Retirement Advisor Designations

Posted on June 24, 2013 by Editor Test -

With more than 50 certification programs based on the withdrawal phase of the planning lifecycle, advisors are faced with a paralyzing choice about which designation provides the most valuable curriculum. The issues surrounding withdrawal planning differ starkly from those encountered during the accumulation phase.

An April 2013 report by the Consumer Financial Protection Bureau highlighted the consumer confusion over this issue. This confusion undoubtedly extends to financial advisors as well. Let’s look at which programs are best positioned to allow advisors to guide their clients through retirement. I will highlight three of the more prominent and rigorous programs aimed at building knowledge about retirement income.

These include the International Foundation for Retirement Education’s (InFRE) Certified Retirement Counselor® (CRC®), The American College’s Retirement Income Certified Professional® (RICP®), and the Retirement Income Industry Association’s (RIIA) Retirement Management Analyst^SM (RMA^SM).

Full disclosure: I am personally involved with two of these designation programs. I am employed by the RICP® sponsoring organization and contribute to its curriculum. I am a former curriculum director for the RMA^SM, and I still participate in educational programs.

(To read further, go to: http://advisorperspectives.com/newsletters13/Retirement_Income_Designations.php)

How to court Gen X and Gen Y clients

Posted on June 24, 2013 by Editor Test -

Most do-it-yourself, affluent 20- and 30-somethings are open to future relationships with financial advisors. But the technology savvy of young investors can create challenge for advisors, according to the Boston-area research firm, Hearts & Wallets.

The firm’s latest report shows financial service providers and advisors how to connect with this market segment. It describes Gen X & Y’s financial goals, their reasons for seeking financial advice and the ways they use technology.

“Gen Y and the younger Gen X… can perform investment selection and retirement planning tasks that could only be done with an advisor just a few years ago,” said Chris Brown, Hearts & Wallets principal, in a release. As a result, they expect more from a financial advisor.

Eighty percent of investors ages 21-29 and 68% of investors ages 30-39 say they “make decisions and manage money on my own,” according to the Hearts & Wallets 2012/2013 Investor Quantitative Panel, an annual survey of more than 5,400 U.S. households.

The Hearts & Wallets report, “Generations X & Y Won’t Be DIY Forever: Managing the Intersection of Advice and Technology to Gain Favor with the Young Affluent,” includes the results of focus groups with investors ages 25-39 with “good savings habits and/or a minimum of $100,000 in investable household assets.”

The focus groups included “Peak Accumulators,” who were defined as good savers who engage to varying degrees in six financially responsible behaviors. They represented 40% of households led by members of Generations X and Y.

Across all affluent young investors, three main financial goals repeatedly surfaced:

The need for an emergency fund.
The need to save for the costs of college educations
Retirement

More affluent investors cited additional goals:

Paying off a mortgage early
Saving for specific situations, such as the arrival of a new baby

Opportunities for advisors

Younger affluent investors (“Emerging Peak Accumulators”) look for unbiased advise, often from family, friends, co-workers and bloggers, the report said.

“They use information sources from workplace providers, online brokerages and media sources to friends and family. Only occasionally will they use professional advisors,” said Laura Varas, Hearts and Wallets principal. “[But] certain key moments open the door for the advisor relationship.”

While young investors often seek advice when buying a home or buying life insurance after the birth of a child, heavy-handed life insurance sales tactics can sour them on financial professionals. Banks don’t necessarily provide an optimal experience during the home-buying experience or may not offer investment or retirement products.

“To attract Gen Y and X clients, lead with a message of competence and credibility, and then deliver that competence and credibility,” Varas said.

12 best practices for web-based advice and apps

The Hearts & Wallets’ 12 best practices for web-based advice and apps:

Strategy

Include your firm’s mission statement
Explain what differentiates the firm’s offering
Offer a score or report card to help users gauge their progress

Marketing

Consider offering different tools for users based on financial sophistication
Use mobile technology (iPhones, tablets, etc.) in app/web imagery; have a professional look
Include many categories of life events, not just the basic ones

Service model/pricing

Offer various support channels (online chat, phone assistance, email)
State pricing clearly and explain how the firm offer differs from the competition; consider offering a fee comparison relative to competitors
Offer new users a free trial

Technology functionality

Offer both app(s) and a web tool(s) and differentiate functionality appropriately (quick/on-the- run vs. work)
Offer users the option to include other accounts in the firm’s app/tool to view their entire portfolio, but don’t require it
Include an automatic withdrawal/savings option

DTCC launches ‘Producer Management Portal’

Posted on June 24, 2013 by Editor Test -

A new service that will allow insurance carriers and distributors to “share, track and verify state-mandated annuity training completions by their agents and brokers” has been launched by the Insurance & Retirement Services unit of the Depository Trust & Clearing Corp. (DTCC).

The Producer Management Portal, or PMP, as the new service is called, is a response to a new National Association of Insurance Commissioners (NAIC) rule that requires producers to complete two levels of training—one specific to the annuities class of insurance and the other for the carrier-specific product the producer sells.

“The tool supports insurance industry participants as they navigate this increasingly complex web of regulations and agent training requirements that differ across states and product lines,” said a DTCC release.

Within the annuity industry, the frequent failure by intermediaries to understand the details of the complex annuity products they sell has often been cited as a contributor to unsuitable sales, to bad publicity, and lack of wider acceptance by the public.

“While legislation has not drastically shifted on suitability requirements nationwide, the insurance industry is seeing a rapid rate of adoption for NAIC model legislation that outlines suggested producer training requirements for annuity products. Twenty-two states have already implemented regulation based on the model, with another ten on the horizon,” says a notice on the DTCC website.

PMP’s centralized database, consisting of information from insurance carriers and education vendors, is intended to help eliminate redundant manual processing and unauthorized sales, enable better compliance with state-mandated rules, and provide secure access to confidential data.

I&RS will add license and appointment (LNA) data management and authorization service to PMP’s functionality in the next development phas. LNA automates and standardizes the flow of producer management information between insurance carriers and distributors, according to the DTCC release.

Genworth launches online training for producers on indexed products

Retirement needs vary more widely than thought: DFA

American General launches Lifestyle Income Solution for GUL policies

Northern Trust report offers details on DC plan asset flows

Baucus/Hatch letter to Congressional colleagues

Data Connection

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