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The Bucket

Posted on March 28, 2013 by -

New York Life promotes Matthew Grove 

New York Life has promoted Matthew Grove, a force behind the firm’s billion-selling deferred income annuity, to senior managing director, responsible for the Retail Annuities business, including product development, product management, marketing, in-force business and annuity service operations.  He reports to Senior Managing Director Drew Lawton.

Grove joined New York Life in 2009 to lead the company’s effort to establish guaranteed lifetime income as an asset class, and he was also responsible for the distribution of mutual funds and annuity products through Registered Investment Advisors (RIAs). 

In 2011, Grove played a central role in developing and marketing the Guaranteed Future Income Annuity (GFIA), a deferred income annuity. Attracting $1 billion in premium in its first 18 months on the market, it is the most successful new annuity product in the company’s history, New York Life said in a release. 

Before joining New York Life, Grove was the chief marketing officer of Jefferson National, an insurance company focused on serving the needs of the RIA market.  At Jefferson National, he was responsible for developing and marketing the leading annuity product distributed through the RIA channel. 

Earlier, Grove ran his own technology consulting firm focused on building enterprise software for financial services firms. He has an MBA from Columbia University and a BS degree in computer science from the University of Pennsylvania.   

Curian Capital iPad ‘app’ for managed account proposals             

To enable financial advisors to generate on-the-spot proposals for their clients, Curian Capital LLC has launched the Curian Select Portfolios iPad application, or app. The app lets advisors:

  • Create proposals directly from the iPad anywhere, even without Internet access
  • Review presentation materials with clients in an attractive and easy-to-understand format
  • Select from 25 different account types and six different managed Select Portfolios
  • Capture client information and offer clients the option to sign proposals electronically 

The Curian Select Portfolios iPad app has many of the same features available for the Select Portfolios on Curian’s existing proposal generation system, allowing advisors to seamlessly transition to the new iPad version.

In addition, the app provides investor-facing educational messages and informational videos, including details on Curian’s asset management process used in generating its new Select Portfolios.

The Curian Select iPad app is a free download for financial advisors authorized to do business with Curian, and is available via the Apple iTunes Store, under “Curian Select.”

Genworth sells wealth management business for $412.5 million

Genworth Financial, Inc. has agreed to sell its Wealth Management business, including Genworth Financial Wealth Management and alternative solutions provider, the Altegris companies, to a partnership of Aquiline Capital Partners and Genstar Capital.

The sale price is expected to be about $412.5 million. The company will record an after-tax loss of approximately $40 million related to the sale with approximately $35 million recorded in the first quarter of 2013 and the remainder upon closing. 

The sale is expected to close in the second half of 2013, subject to customary conditions and regulatory approvals.  Net proceeds from the transaction will be used to address the 2014 debt at maturity or before. 

Goldman, Sachs & Co. and Sullivan & Cromwell LLP advised Genworth on this transaction.

© 2013 RIJ Publishing LLC. All rights reserved.

Deficits at largest pension funds keep growing: Milliman

Posted on March 28, 2013 by -

Pension funds continue to suffer from the low-rate environment, according to Milliman’s 2013 Pension Funding Study, which cover the 100 largest US corporate pension plans. These plans ended 2012 with a $388.8 billion deficit—a $61.1 billion increase over 2011.

Since the end of 2010, declining discount rates (4.02% at year-end 2012) have widened the pension funding deficit by more than $150 billion, driving record deficits in each of the last two years, Milliman said in a release.

The pension funding ratio stood at 77.2% at year’s end, down from 79.2% at the end of 2011. The deficit increase and reduced funding ratio in 2012 occurred despite plan sponsors’ efforts to halt the decline through de-risking and despite rising stock prices. 

 “There was no fighting the inevitable gravity of these low interest rates, as the 100 pension plans in our study saw a cumulative deficit increase in excess of $60 billion. All this in spite of strong asset performance that exceeded the expectations of most plan sponsors,” said John Ehrhardt, Milliman consulting actuary and co-author of the study.

“Pension funding status will continue to be tied to interest rates. If rates stay low—and all indications are that they will through 2014—these pension plans will struggle to fill their funding gap.”

Major pension stories for 2012 include:

De-risking results in shakeup at the top of the Milliman 100. IBM’s plan replaced General Motors’ in 2012 as the largest in the Milliman 100, after GM sold much of its obligation to Prudential. Other large plan sponsors, including Ford and Verizon, also pursued de-risking. Across the entire Milliman 100, de-risking by at least 15 plan sponsors resulted in a cumulative $45 billion reduction in plan obligations.

Asset increases and $61.5 billion in contributions were not enough to close the deficit. With an 11.7% investment return in 2012, the Milliman 100 pension plans performed better than they expected but not enough to offset the ballooning deficit. Nor were contributions in excess of $60 billion.

Record contributions in 2012—but not at the level expected. While the $61.5 billion in contributions during 2012 was significantly greater than most prior years, it exceeded the 2011 total by only $6.3 billion and the 2010 total by only $1.8 billion. Many plan sponsors apparently changed their contribution strategy after the MAP-21 interest rate stabilization legislation passed.  

Another record year for pension expense. Following a $38.5 billion charge to earnings in 2011, the Milliman 100 pension plans again set a new record for total pension expense, with a $55.8 billion charge to earnings. The $17.3 billion increase in pension expense is consistent with the prediction of $16 billion reported by last year’s study. This year’s study predicts a $7.6 billion increase in pension expense in 2013.

Asset allocations relatively stable. In 2011, plan sponsors decreased their equity allocation by more than 5%. In 2012, the equity allocation dropped just 0.2% (to 38% from 38.2%), as the move toward liability-driven investments (LDI) slowed. In 2012, the bull market favored plans with relatively higher equity allocations.

What to expect in 2013. With the Federal Reserve Board indicating its intention to keep interest rates low through 2014, pension obligations will remain high. The bull market has continued into 2013, and de-risking may continue this year. But the pension funding deficit is likely to last until interest rates rise.

© 2013 RIJ Publishing LLC. All rights reserved.

Most middle-income Americans ignore longevity risk: Bankers Life

Posted on March 28, 2013 by -

Although one in four of today’s 65-year olds will live past age 90, 87% of Americans don’t discuss longevity risk, according to a new study, Longevity Risk and Reward for Middle-Income Americans, from Bankers Life’s Center for a Secure Retirement (CSR).   

Ironically, those surveyed for the study accurately estimated the average life expectancy of American adults.  On average, respondents with a median age of 65 said they think they will live to age 86, irrespective of gender, income or health.

Two-thirds say that genetics (65%) is the determining factor in how long they will live. Fewer linked longevity to eating right (46%), exercising (44%) or smoking (37%). 

The survey also showed that:

  • Middle-income Americans, ages 55 to 75, tend to believe that wisdom arrives at about age 56, but old age doesn’t necessarily start until age 78.
  • 60% middle-income Americans age 55 and older say their best years are ahead of them.   
  • For the 40% who report that their best years are behind them, they attribute the realities of aging, their health and an overall negative outlook as the primary reason.

© 2013 RIJ Publishing LLC. All rights reserved.

 

Bloomberg publishes new edition of ERISA: The Law and the Code

Posted on March 28, 2013 by -

Bloomberg BNA has published the 2012 edition of ERISA: The Law and the Code, Annotated, a desktop reference that provides updated text of the Employee Retirement Income Security Act (ERISA) and relevant portions of the Internal Revenue Code (Tax Code) and Public Health Service Act (PHSA).

The latest edition provides comprehensive updates on:

  • Changes to the pension funding rules for single-employer defined benefit plans
  • Additional information required in the annual funding notice that defined benefit plans must provide to participants and beneficiaries, labor organizations, and the Pension Benefit Guaranty Corporation (PBGC)
  • Increased PBGC premiums as the result of the Moving Ahead for Progress in the 21st Century Act

This treatise provides the complete “before” and “after” picture of changes enacted by the Patient Protection and Affordable Care Act (PPACA). The PPACA mandates that group health plans and health insurance issuers providing coverage to group health plans must comply with certain provisions of the PHSA and that these PHSA provisions will prevail over any conflicting ERISA or Tax Code provisions. Part 3 of ERISA: The Law and the Code, 2012 Edition, Annotated, provides the PHSA sections as amended by the health care reform laws, and Part 4 includes relevant sections of the PHSA prior to PPACA and other amendments.

This reference also features “Recent Amendment” notes that provide a complete history of every amendment made to each reprinted section of ERISA, tracks all of the changes made to the Tax Code sections back to the Economic Growth and Tax Relief Reconciliation Act of 2001, and supplies the history of each reprinted section of the PHSA (post-PPACA), all in an easy-to-follow format. Amendment notes also track relevant non-amending legislative material helpful to understanding ERISA and the Tax Code.

ERISA: The Law and the Code, 2012 Edition, Annotated, may be purchased from Bloomberg BNA, Book Division, by phone or online.  

© 2013 RIJ Publishing LLC. All rights reserved.

Customers are people, British asset managers remind themselves

Posted on March 28, 2013 by -

In a story that sounded like a parody from The Onion, the CEO of Britain’s Investment Management Association (IMA) was reported to have admitted that his industry’s clients are real people—presumably with flesh, nerves, brains and emotions.

Speaking at a conference organized by the University of Warwick and the Financial Services Knowledge Transfer Network, the IMA’s Daniel Godfrey admitted that his industry had a tendency to forget that, IPE.com reported.

“What we have to do as asset managers, and a responsibility we have, is to look through that transmission chain and say, yes, our client may be a pension fund, our client may be a life company, but at the end of that chain is a real person that is relying on us to do something that is very, very important to them,” he said.

Godfrey’s comments followed a mea culpa of sorts from David Norman of TCF Investment, who alleged that the asset management industry was “negligent, incompetent and systematically corrupt.” He cited specific instances where fees had not been disclosed fairly, to the detriment of retail investors.

If the asset management industry recognized its importance to “real people,” it could then begin to address a number of concerns, Godfrey said. “If we are going to fulfill this purpose for real people, whether they are direct customers or at the end of some transmission chain, [the first step] is to have excellent fiduciary standards and operating practice,” he said.

“I don’t mean fiduciary standards in some legal sense,” he added. “I’m thinking about fiduciary standards more as a moral code, a way of behaving, a form of conduct – so that you understand what you are supposed to do in any given circumstance, by being aligned to an understanding of what your purpose is.”

A new standard of conduct could drive down costs, improve client outcomes, and build trust among consumers, he suggested.

“If you base your conduct around trying to always improve your standards of fiduciary excellence, you will look for ways in which you can bear down on costs for your clients,” he said. That “can bring costs down, and have a very big impact on long-term outcomes.”

As costs were addressed and made clear and transparent, it would allow his industry to enter a “trusted partnership” with financial regulators, politicians and consumer groups, which could lead to “a regulatory and tax regime that helps asset managers do a great job for their customers.”

To foster transparency, he suggested that costs could be expressed both in sterling and percentages, and providers could disclose how much an investor’s unit has appreciated in value, measured in pounds, along with the fee cost that went towards bringing about this increase.

We want “to see if there is a way through this quagmire of suspicion and smoke to try to get something that helps people understand what’s happened in their fund and what the costs have been,” Godfrey said.

© 2013 RIJ Publishing LLC. All rights reserved.

Customers are people, British asset managers remind themselves

Posted on March 28, 2013 by -

In a story that sounded like a parody from The Onion, the CEO of Britain’s Investment Management Association (IMA) was reported to have admitted that his industry’s clients are real people—presumably with flesh, nerves, brains and emotions.

Speaking at a conference organized by the University of Warwick and the Financial Services Knowledge Transfer Network, the IMA’s Daniel Godfrey admitted that his industry had a tendency to forget that, IPE.com reported.

“What we have to do as asset managers, and a responsibility we have, is to look through that transmission chain and say, yes, our client may be a pension fund, our client may be a life company, but at the end of that chain is a real person that is relying on us to do something that is very, very important to them,” he said.

Godfrey’s comments followed a mea culpa of sorts from David Norman of TCF Investment, who alleged that the asset management industry was “negligent, incompetent and systematically corrupt.” He cited specific instances where fees had not been disclosed fairly, to the detriment of retail investors.

If the asset management industry recognized its importance to “real people,” it could then begin to address a number of concerns, Godfrey said. “If we are going to fulfill this purpose for real people, whether they are direct customers or at the end of some transmission chain, [the first step] is to have excellent fiduciary standards and operating practice,” he said.

“I don’t mean fiduciary standards in some legal sense,” he added. “I’m thinking about fiduciary standards more as a moral code, a way of behaving, a form of conduct – so that you understand what you are supposed to do in any given circumstance, by being aligned to an understanding of what your purpose is.”

A new standard of conduct could drive down costs, improve client outcomes, and build trust among consumers, he suggested.

“If you base your conduct around trying to always improve your standards of fiduciary excellence, you will look for ways in which you can bear down on costs for your clients,” he said. That “can bring costs down, and have a very big impact on long-term outcomes.”

As costs were addressed and made clear and transparent, it would allow his industry to enter a “trusted partnership” with financial regulators, politicians and consumer groups, which could lead to “a regulatory and tax regime that helps asset managers do a great job for their customers.”

To foster transparency, he suggested that costs could be expressed both in sterling and percentages, and providers could disclose how much an investor’s unit has appreciated in value, measured in pounds, along with the fee cost that went towards bringing about this increase.

We want “to see if there is a way through this quagmire of suspicion and smoke to try to get something that helps people understand what’s happened in their fund and what the costs have been,” Godfrey said.

© 2013 RIJ Publishing LLC. All rights reserved.

Buybacks are Buoying the Bull

Posted on March 28, 2013 by -

The stock market surge seems to have stalled a bit lately. There’s Cyprus, a slowing global economy and nervousness by portfolio managers as the quarter comes to a close. But for as long as the Fed keeps creating billions of fake money daily and companies keep shrinking the number of shares outstanding, there is little doubt that more money chasing fewer shares has to inflate stock prices to new nominal highs, at least for the near term.

Why do I speak of nominal highs? The fact is that if we adjust stock prices for the asset-inflation bubble created by the Fed, stocks are not at real highs. Even Fed Chairman Bernanke admitted that at his most recent press conference. And there’s every indication that the Fed will keep inflating this asset-price bubble.

For example, the Fed will keep creating $4 billion in fake money daily to buy back its previously created fake money. And as the new fake money enters the system, there is more money available to buy the same number of assets. That is a classic definition of inflation. So everything else being equal the Fed’s fake money creation results in inflated stock and bond prices.

But there is more bullish stuff happening on top of that, also as a result of the Fed’s zero interest rate policy. Over the past seven weeks, since the start of February, companies have been reducing the total number of shares outstanding by $120 billion.

There are two ways the number of shares shrink: buybacks and cash takeovers. No surprise, then there has been a record number of buybacks announced since the start of February. There has also been a bumper crop of new cash takeovers.

The number of shares grows when companies and or insiders sell new shares. Bottom line, since the start of February the trading float of shares has shrunk by $120 billion. That translates into an annual rate of over $900 billion and that would compare with $248 billion in total float shrink for all of 2012.

Here’s why this is such a big deal. In essence, over the last seven weeks companies have given shareholders $120 billion in cash in exchange for shares. Compare that $120 billion with just $50 billion of new money going into all equity mutual and exchange traded funds so far for all of 2013.

Remember, 80% of US stocks are held by institutions. Institutions typically have a constant rate of cash holdings, whether 1% or 5%. When the number of shares held by institutions shrinks by $100 billion, or around 80% of $120 billion, that means those institutions have more money with which to buy the fewer shares available in the equity markets. Therefore, the price of the remaining shares should go up.

Yes, some self-styled market gurus poo poo buybacks and even claim they are a contrary indicator. That might be so if you only look at buybacks. However add in float shrink and the track record is much better.

Looking back, I started tracking supply and demand of stock and money in 1995. Since then, the market has gone up 11 of the 13 years that the trading float has shrunk. Moreover, the stock market has gone down three of the five years the trading float has grown. In other words, float shrink by itself has correctly predicted market direction in 14 of the last 18 years. In the other four years, demand for shares overwhelmed the impact of float change.

Bottom line, all there is in the stock market are shares of stock and the money available for investment.

Charles Biderman is chairman of TrimTabs Investment Research and portfolio manager of the TrimTabs Float Shrink ETF.

© 2013 RIJ Publishing LLC. All rights reserved.

Income-Generating Annuities Prospered in 2012

Posted on March 28, 2013 by -

The end-of-year 2012 results for fixed annuity sales are in, and, despite a few bright spots, they suffer from the effects of the Fed’s equity-friendly rate-suppression policy. Here are the important news headlines for fixed annuities, according to the latest Beacon Research Fixed Annuity Premium Study:

  • Total fixed annuity sales fell 6.5% in 2012, to $66.8 billion from $75.6 billion in 2012. Fourth quarter sales were down 2.2% from the previous quarter.
  • Allianz Life was the top fixed annuity seller for calendar 2012, but Security Benefit Life was the top seller in the fourth quarter. Its Total Value Annuity, a fixed indexed annuity, broke into the ranks of the five top-selling fixed annuity products in the fourth quarter.
  • Indexed annuities with guaranteed lifetime withdrawal benefits—a product with features that can help mitigate market risk, inflation risk and longevity risk—continued to thrive, with sales up 3.7% to an annual record $34.2 billion.
  • Sales of income annuities grew 8.5% to $9.2 billion in 2012, with deferred income annuities (DIA) accounting for all of the gains. DIA sales increased 150% from the first to fourth quarters and surpassed $1 billion by year-end.
  • Sales of fixed-rate non-MVA (market-value adjusted) annuities, their yields suppressed by Federal Reserve policy, saw a 33% drop in 2012 compared to 2011, falling to $18.8 billion from $28.1 billion.

Fourth quarter sales 

Total fixed annuity results were $16.2 billion in fourth quarter, down 6.5% from a year ago and 2.2% sequentially. Annual sales fell 11.6% to $66.8 billion. Large losses in fixed rate annuity sales were responsible for the annual decrease. Most issuers of these products chose to lose sales rather than cut prices further, Beacon said. 

Fourth quarter’s income annuity results of $2.4 billion were up 7.2% from a year ago and 0.3% from the prior quarter. It was the third consecutive quarterly improvement. Indexed annuity sales were $8.5 billion in fourth quarter, 1.2% above a year ago but 3.2% below the prior quarter.

Looking ahead, Beacon Research CEO Jeremy Alexander said, “We think that 2013 will be another record year for indexed and income annuities. But we don’t expect overall fixed annuity sales to change significantly.”

The surprise success of deferred income annuities on the part of New York Life has inspired other carriers, including MetLife, MassMutual, Guardian and others to either step up sales of existing products or enter the market for the first time.

Several years ago, these products were called Advanced Life Deferred Annuities. The typical ALDA was envisioned as longevity insurance, since it wouldn’t pay out until or unless the owner lived past age 85. Given mortality rates and a long deferral period, such coverage could be purchased cheaply.  

But that was how academics and actuaries envisioned DIAs (or ALDAs). In practice, babyboomers in their late 50s and early 60s have been buying the latest generation of DIAs for income beginning around 10 years after purchase. As one life insurer put it, people are buying them as “personal replacement” rather than as longevity insurance.   

Estimated Fixed Annuity Sales by Product Type (in $ millions)

 

Total

Indexed

Income

Fixed Rate

Non-MVA

Fixed Rate

MVA

Q4 ‘12

16,200

8,452

2,381

4,369

999

Q3 ‘12

16,570

8,735

2,374

4,434

1,026

% ∆

-2.2%

-3.2%

0.3%

-1.5%

-2.6%

Q4 ‘12

16,200

8,452

2,381

4,369

999

Q4 ‘11

17,330

8,352

2,221

5,409

1,346

% ∆

-6.5%

1.2%

7.2%

-19.2%

-25.8%

YTD 2012

66,810

34,198

9,197

18,840

4,584

YTD 2011

75,570

32,978

8,481

28,117

5,996

% ∆

-11.6%

3.7%

8.5%

-33.0%

-23.6%

 

Allianz was the top fixed annuity company in 2012, followed by New York Life, Aviva, American Equity and Security Benefit Life, a first-time annual top-five company. In fourth quarter, Security Benefit Life moved up from fourth place to take the lead for the first time. Fourth quarter results for the top five Study participants were as follows:

Fixed Annuity Sales ($000), 4Q 2012

Security Benefit Life

1,398,773

Allianz Life

1,247,064

New York Life

1,122,196

American Equity

1,068,853

Lincoln Financial Group

908,694

Source: Beacon Research, March 27, 2013.

 

In specific product sales, New York Life’s Lifetime Income Annuity was the fourth quarter’s best seller, as it was for all of 2012. Indexed annuities from Allianz and American Equity remained top products, with the Allianz Endurance Plus rejoining the top five in third place. Security Benefit Life’s indexed Total Value Annuity joined the top five for the first time. 

Top selling fixed annuities products, 4Q 2012

Rank

Company

Product

Type

1

New York Life

NYL Lifetime Income Annuity

Income

2

American Equity

Bonus Gold

Indexed

3

Allianz Life

Endurance Plus

Indexed

4

Security Benefit Life

Total Value Annuity

Indexed

5

Allianz Life

MasterDex X

Indexed

Source: Beacon Research. March 27, 2013.

 

In the fourth quarter, Security Benefit Life jumped from 14th place to take the lead in bank channel sales. Jackson National regained #1 status in the independent broker-dealer channel. Lincoln Financial Group was the new leader in fixed rate non-MVAs. The other top companies in sales by product type and distribution channel were unchanged from the prior quarter.

Security Benefit’s formula

Some people in the annuity industry have been wondering how Security Benefit, which is owned by private equity firm Guggenheim Partners, has been able to offer such rich benefits and to achieve unprecedented sales levels. Judith Alexander, director of marketing at Beacon Research, said she did not know the answer, but she was willing to speculate.

“There are two possible answers,” she told RIJ. “They may have made some investments that have seen high returns and they are using those returns to back the liabilities and to offer generous rates and rollups. Or they are willing to price the business at a lower margin than the more traditional carriers. They can do that because they’re not publicly held companies. They may have a business plan that calls for taking lower margins in order to grab a larger market share. Both of those things could be true. They’re not mutually exclusive.”

Security Benefit has an A- strength rating from Standard & Poor but only a B++ strength rating from A.M. Best, Alexander said. Traditionally, products with less than an A rating couldn’t make it onto the shelf of broker-dealers and banks, she said, so it surprised her that Security Benefit was able to become the top fixed annuity seller in the bank channel.

“I have heard that banks and broker-dealers are a little less stringent in their financial strength requirements than they used to be,” she said. “In a more normal rate environment you might have needed an A from both A.M. Best and S&P to get in. Now it appears that you need an A- from one of them. Banks are desperate to get some higher-crediting fixed-rate products on their shelves.”  

If insurers elect to buy slightly lower-quality bonds or longer-term bonds in order to earn a bit more yield than is otherwise available, they run the risk that ratings agencies will reduce their strength ratings. But some insurers might be willing to sacrifice a notch of their ratings in order to offer customers more competitive interest crediting rates—especially if the strategy doesn’t disqualify them from distribution by banks and broker-dealers, Alexander explained.

© 2013 RIJ Publishing LLC. All rights reserved.

The Best Retirement Research of 2012

Posted on March 26, 2013 by -

The retirement financing challenge is a worldwide phenomenon. Almost every advanced nation has its Boomer generation, its massive debt and its rising retiree-to-worker ratio. Many emerging nations have no safety net at all for their aged. Governments, companies, families and individuals from Singapore to Honduras, from Germany to Australia, all feel the pain.

Not surprisingly, the search for solutions to this complex demographic, political and financial problem has elicited a river of academic research. Each year, social scientists use the latest survey techniques and mathematical models to illuminate different aspects of the problem and to test potential solutions. 

For the second consecutive year, Retirement Income Journal is honored to bring some of the leading English-language research in this area to your attention. We asked researchers to identify their favorites among the research that they first read during 2012 (even it did not appear in published form until 2013). They recommended the 16 research papers that we describe below (with some links to webpages or pdfs).

Here you’ll find research that emanates from Croatia, Denmark and Germany, in addition to the U.S. There’s research from at least 20 different universities. There are papers that apply to advisors of individual clients and to sponsors of institutional retirement plans. There’s research for annuity issuers and for distributors of annuity products. At least one paper calls for a major change to U.S. retirement policy. As a group, the papers shed light on many of retirement financial challenges that individuals, financial services providers, and governments face today.

 

A Utility-Based Approach to Evaluating Investment Strategies

Joseph A. Tomlinson, Journal of Financial Planning, February 2012.

In exploring the often-overlooked “utility” or insurance value of annuities, this actuary and financial planner ventures where few others care to tread. He rejects the popular notion that an annuity represents a gamble with death. “Immediate annuities are often viewed as producing losses for those who die early and gains for those who live a long time, whereas I am portraying no gain or loss regardless of the length of life,” he writes. “This is an issue of framing or context. If one thinks of an annuity as providing income to meet basic living expenses, both the income and the expenses will end at death.” He also asked 36 people how much upside potential they would require—i.e., how much surplus wealth at death—to justify a retirement investment strategy that carried a 50/50 risk of depleting their savings two years before they died.

 

Spending Flexibility and Safe Withdrawal Rates

Michael Finke, Texas Tech University; Wade D. Pfau, American College; and Duncan Williams, Texas Tech. Journal of Financial Planning, March 2012.

The “4% rule” is a needlessly expensive way to self-insure against longevity risk, this paper suggests. “By emphasizing a portfolio’s ability to withstand a 30- or 40-year retirement, we ignore the fact that at age 65 the probability of either spouse being alive by age 95 is only 18%. If we strive for a 90% confidence level that the portfolio will provide a constant real income stream for at least 30 years, we are planning for an eventuality that is only likely to occur 1.8% of the time,” they write. They also show that a mixture of guaranteed income sources and equities burns hotter and more efficiently than a portfolio of stocks and bonds: “The optimal retirement portfolio allocation to stock increases by between 10 and 30 percentage points and the optimal withdrawal rate increases by between 1 and 2 percentage points for clients with a guaranteed income of $60,000 instead of $20,000.”

 

Should You Buy an Annuity from Social Security?

Steven A. Sass, Center for Retirement Research at Boston College, Research Brief, May 2012.

In a financial version of “The Charlie’s Angels Effect,” Social Security went from misbegotten child to Miss USA last year. Returns on low-risk investments were lower than the step-up in Social Security income that comes from postponing benefits to age 66 or even 70. It thus made more sense for a 62-year-old retiree to delay Social Security and consume personal savings than to hoard his own cash and claim Social Security benefits. “Consider a retiree who could claim $12,000 a year at age 65 and $12,860 at age 66—$860 more,” the author writes. “If he delays claiming for a year and uses $12,860 from savings to pay the bills that year, $12,860 is the price of the extra $860 annuity income. The annuity rate—the additional annuity income as a percent of the purchase price—would be 6.7% ($860/$12,860).”

 

Lifecycle Portfolio Choice with Systematic Longevity Risk and Variable Investment-linked Deferred Annuities

Raimond Maurer, Goethe University; Olivia S. Mitchell, The Wharton School, University of Pennsylvania; Ralph Rogalla, Goethe University; Vasily Kartashov, Goethe University. Research Dialogue, Issue 104, June 2012. TIAA-CREF Institute.

Deferred income annuities—often purchased long before retirement—are in vogue. To offset the risk that a medical breakthrough could lift average life expectancies, annuity issuers could raise prices. But that would suppress demand. The authors of this study propose a “variable investment-linked deferred annuity” (VILDA) that might solve that problem. The owner would assume the risk of rising average life expectancy by agreeing to a downward adjustment in the payout rate should average life expectancy rise. In return, he would enjoy a lower initial price. Access to such a product, perhaps through a 401(k) plan, could increase the annuity owner’s income at age 80 by as much as 16%, the researchers believe.

 

Retirement Income for the Financial Well and Unwell

Meir Statman, Santa Clara University and Tilburg University, Summer 2012.

In this paper, the author of What Investors Really Want calls for a mandatory, universal workplace-based defined contribution plan in the U.S. that would make Americans less dependent on Social Security for retirement income. “It is time to switch from libertarian-paternalistic nudges to fully paternalistic shoves,” the author writes. He argues that automatic enrollment, which has been shown to increase 401(k) participation, is not strong enough a measure to make a difference in the amount of retirement savings available to most people. He recommends tax-deferred private savings accounts similar to 401(k) and IRA accounts but mandatory and inaccessible to account owners before they reach retirement age.

 

Harmonizing the Regulation of Financial Advisers

Arthur B. Laby, Rutgers University. Pension Research Council Working Paper, August 2012. 

In this paper, a law professor analyzes the debate over harmonized standards of conduct for advisors. On the problem of principal trading, he writes, “Any broker-dealer that provides advice should be required to act in the best interest of the client to whom the advice is given [but] imposing a fiduciary duty on dealers is inconsistent, or not completely consistent, with the dealer’s role. A dealer’s profit is earned to the detriment of his trading partner, the very person to whom the dealer would owe a fiduciary obligation.” He identifies three obstacles to harmonization: the difficulty of analyzing its costs and benefits, the presence of multiple regulators, and the question of whether advisors should have their own self-regulatory organization.

 

A Framework for Finding an Appropriate Retirement Income Strategy

Manish Malhotra, Income Discovery. Journal of Financial Planning, August 2012. 

No two retirees have exactly the same needs, and advisors need a process for finding the best income strategy for each client. The author has created a framework that advisors can use to tackle this challenge. His framework includes two “reward metrics” (income and legacy) and three “risk metrics” (probability of success, the potential magnitude of failure, and the percentage of retirement income safe from investment risk). “Using this framework, advisers can incorporate a variety of income-producing strategies and products, and decisions about Social Security benefits, into their withdrawal analyses—lacking in much of the past research focused purely on withdrawals from a total return portfolio,” Malhotra writes.


An Efficient Frontier for Retirement Income

Wade Pfau, Ph.D. September 2012 (Published as “A Broader Framework for Determining an Efficient Frontier for Retirement Income.” Journal of Financial Planning, February 2013.

Just as there’s an efficient frontier for allocation to risky assets during the accumulation stage, so there’s an efficient frontier for allocation to combinations of risky assets and guaranteed income products in retirement, this author proposes. He describes “various combinations of asset classes and financial products, which maximize the reserve of financial assets for a given percentage of spending goals reached, or which maximizes the percentage of spending goals reached for a given reserve of financial assets” and asserts that “clients can select one of the points on the frontier reflecting their personal preferences about the tradeoff between meeting spending goals and maintaining sufficient financial reserves.”

 

How Important Is Asset Allocation To Americans’ Financial Retirement Security?

Alicia H. Munnell, Natalia Orlova and Anthony Webb. Pension Research Council Working Paper, September 2012.

Asset allocation may be important when it comes to building a portfolio, but “other levers may be more important for most households,” according to this paper. “Financial advisers would likely be of greater help to their clients if they focused on a broad array of tools—including working longer, controlling spending and taking out a reverse mortgage,” the authors write, claiming that decisions in these areas can have a bigger impact on retirement savings than merely transitioning from a typical conservative portfolio to an optimal portfolio. “The net benefits of portfolio reallocation for typical households would be modest, compared to other levers,” they write. “Higher income households may have slightly more to gain.”

 

The Revenue Demands of Public Employee Pension Promises

Robert Novy-Marx, University of Rochester; Joshua D. Rauh, Stanford. NBER Working Paper, October 2012.

The cost of fully funding pension promises to state and local government workers is startlingly large, according to these authors. Assuming that pension assets earn only a risk-free real return of 1.7% (the yield of TIPS in 2010) and that each state’s economy grows at its 10-year average, government contributions to state and local pension systems would have to rise to 14.1% of own-revenue to achieve fully funded systems in 30 years, the authors say, or $1,385 per household per year. “In twelve states, the necessary immediate increase is more than $1,500 per household per year, and in five states it is at least $2,000 per household per year,” they calculate, adding that a switch to defined contribution plans would cut the pension burden dramatically.

 

What Makes Annuitization More Appealing?

John Beshears, Stanford; James J. Choi, Yale; David Laibson, Harvard; Brigitte C. Madrian, Harvard; and Stephen P. Zeldes, Columbia. NBER Working Paper, November 2012.

When offered an annuity or a lump sum at retirement, many defined benefit plan participants choose the lump sum. While this behavior obeys the principle that “a bird in the hand is worth two in the bush,” it can be shortsighted for healthy people who need to finance a long retirement. How can policymakers help cure this form of myopia? These researchers surveyed DB plan participants and found them more willing to choose annuitization if they could annuitize part of their savings instead of 100%, if their annuity income were inflation-adjusted, and if they could receive an enhanced payment once a year, in a month of their own choosing, rather than identical amounts every month. 

 

Home Equity in Retirement 

Makoto Nakajima, Federal Reserve Bank of Philadelphia; Irina A. Telyukova, University of California, San Diego. December 2012.

The retirement savings crisis notwithstanding, many older Americans reach the end of their lives with too much unspent wealth, rather than too little. Some academics call it “the retirement savings puzzle.” The authors of this study think they’ve solved the mystery. Much of the unspent wealth is home equity, they believe. “Without considering home ownership, retirees’ net worth would be 28% to 53% lower,” they write. A number of homeowners tap their home equity by downsizing, purchasing reverse mortgages or simply neglecting to invest in home maintenance as they get older. But retired homeowners rarely downsize unless an illness or death of a spouse occurs, the study says.   

 

Active vs. Passive Decisions and Crowd-Out Retirement Savings Accounts: Evidence from Denmark

Raj Chetty, Harvard University and NBER; John N. Friedman, Harvard University and NBER; Soren Leth-Petersen, University of Copenhagen and SFI; Torben Heien Nielsen, The Danish National Centre for Social Research; Tore Olsen, University of Copenhagen and CAM. National Bureau of Economic Research, December 2012.

Are tax subsidies the best way to encourage retirement savings? Not in Denmark, say these authors. “Each [dollar] of tax expenditure on subsidies increases total saving by one [cent],” they write, because 85% of Danish retirement plan participants are “passive savers” who ignore tax subsidies. If employers simply put more money into retirement plan participants’ accounts, it would do much more to raise retirement readiness, the authors assert, finding that every additional [dollar] added by employers enhances savings by 85 cents. Though their study is based on Danish data and Danish currency, the authors suggest that the results cast doubt on the effectiveness of America’s $100-billion-a-year tax expenditure on retirement savings.

 

Wealth Effects Revisited: 1975-2012

Karl E. Case, Wellesley College; John M. Quigley, University of California, Berkeley; Robert J. Shiller, Yale University. NBER Working Paper Series, January 2013.

Changes in housing wealth have a much bigger effect on consumption than changes in stock market wealth, the authors assert. During the housing boom of 2001-2005, the value of real estate owned by households rose by about $10 trillion, and “an average of just under $700 billion of equity was extracted each year by home equity loans, cash-out refinance and second mortgages,” the authors write. In 2006-2009, real estate lost $6 trillion in value, reducing consumption by about $350 billion a year. “Consider the effects of the decline in housing production from 2.3 million units to 600,000, at $150,000 each. This implies reduced spending on residential capital of about $255 billion,” they note. The paper builds on a 2005 paper by these authors, which remains the most downloaded article on the B.E. Journal of Macroeconomics website.

 

Optimal Initiation of a GLWB in a Variable Annuity: No Arbitrage Approach

Huang Huaxiong, Moshe A. Milevsky and Tom S. Salisbury, York University. February 2013.

Most owners of variable annuities with in-the-money guaranteed lifetime withdrawal benefits  (GLWBs) should activate their contract’s optional income stream sooner-rather-than-later and later-rather-than-never, these authors recommend. “The sooner that account can be ‘ruined’ [reduced to a zero balance] and these insurance fees can be stopped, the worse it is for the insurance company and the better it is for the annuitant,” they write, noting that even the presence of a deferral bonus or “roll-up” feature in the product doesn’t justify postponing drawdown. With over $1 trillion in GLWB contracts in force, the paper suggests, the behavior of contract owners will have major implications for them and for the annuity issuers. 

 

Empirical Determinants of Intertemporal Choice

Jeffrey R. Brown, University of Illinois at Urbana-Champaign; Zoran Ivkovic, Michigan State University; Scott Weisbenner, University of Illinois at Urbana-Champaign. NBER Working Paper, February 2013).

Croatia’s bloody war of independence from Yugoslavia in the 1990s yielded a natural experiment in behavioral finance. To save money from 1993 to 1998, the Croatian government began indexing pensions to prices instead of wages. After the war, the courts ordered the government to reimburse pensioners for the reduction. In 2005, about 430,000 Croatians were offered either four semi-annual payments—totaling 50% of the nominal amount owed—or six annual payments—totaling 100% of the nominal amount owed. Seventy-one percent chose the first option. “As one might expect,” the authors write, “those with higher income and wealth were more willing to accept deferred payment from the government.”

© 2013 RIJ Publishing LLC. All rights reserved.

No surprise: Most Americans still not saving

Posted on March 21, 2013 by -

Less than half of U.S. workers are taking the steps necessary to prepare for retirement, according to the 23rd annual Retirement Confidence Survey from the Employee Benefit Research Institute and Mathew Greenwald & Associates, a survey firm.

Among workers surveyed, 57% reported less than $25,000 in total household savings and investments (excluding the value of their primary homes and any defined benefit pension plans).

The report adds additional evidence to the well-known facts that a significant percentage of America’s full-time workers don’t have access to a workplace retirement savings plan and only a small minority of those who do are on track to save enough to retire on—now estimated to be as much as 10 times their final salaries.

Some people can’t win for losing: 55% of workers and 39% of retirees report high debt loads. According to Matt Greenwald, “Only about half of workers and a comparable number of retirees say they could definitely come up with $2,000 if an unexpected need arose within the next month.”

Among the other major findings in this year’s RCS:

Job uncertainty falling. Thirty percent of workers and 27% of retirees say “job uncertainty” is their biggest problem, down from 42% of all workers a year ago. 
Savings prevalence declines.  Sixty-six percent of workers report that they and/or their spouses have saved for retirement, down from 75% in 2009.
Those who have workplace retirement plans use them.  Eighty-two percent of eligible workers say they participate in such a plan with their current employer; and another 8% of eligible workers report they have money in such a plan, but are not contributing.
Daily expenses hurt savings. Forty-one percent of eligible workers say they don’t contribute or don’t contribute more to their plans because of the “cost of living” and “day-to-day expenses.”  
Health care costs are a worry. Sixteen percent of workers are “not at all confident” about their ability to pay for basic expenses, 29% were concerned about medical expenses and 39% were concerned about long-term care expenses. 
Many ignorant about retirement needs. Forty-five percent of workers guess at how much they will need to accumulate for retirement; 18% did their own estimate, 18% asked a financial advisor, 8% used an on-line calculator and 8% read or heard how much was needed.
Few seek or take professional advice. Just 23% of workers and 28% of retirees report obtaining investment advice from a professional financial advisor who was paid through fees or commissions. Of those, 27% followed all of it, 41% followed most and 27% followed some. 
© 2013 RIJ Publishing LLC. All rights reserved.

Lump sum DB payouts represent rollover opportunities: Cerulli

Posted on March 21, 2013 by -

The number of separated defined benefit (DB) plan participants has been rising since 2004, and the lump-sum distributions they received represent asset acquisition opportunities for advisors and IRA providers, according to Cerulli Associates. 

“The number of separated participants in private DB plans totaled more than 12.4 million at the end of 2011, up from 10 million in 2004,” Kevin Chisholm, associate director at Cerulli Associates, said in a release. “It is likely plan participants will select a lump sum rather than a monthly payout,” he added.

DB plans, DB plan participants and lump-sum distribution trends, including de-risking, are the main topics of the first quarter 2013 issue of The Cerulli Edge–Retirement Edition.

IRA providers and advisors should develop marketing plans to reach separated participants in private DB plans, Cerulli suggested. These individuals are not retired, and may be contributing to a defined contribution plan that could create additional rollover opportunity in the future.  

Direct channel grabs market share from advisors  

The U.S. retail direct channel is growing at the expense of advisor-sold channels, according to a new report from Cerulli, The Retail Investor Product Usage 2012.

“Assets in the direct channel grew from $3.4 trillion in 2010 to $3.7 trillion in 2011,” said Roger Stamper, a senior analyst at Cerulli. “As direct providers continue to increase their advice and guidance services, they have been able to acquire and retain clients who may have sought advice in the advisor channel,” he added.

Cerulli director Scott Smith said, “Direct providers were largely unscathed by reputation issues facing their advisory counterparts during the market downturn, and therefore have not faced the same level of client distrust.

“Compared to advisory firms, direct firms are more advanced in their client portals as well as online and mobile client access. Direct clients are able to complete the majority of their requests and transactions online or over the phone themselves, which provides an advantage in maintaining a greater number of client accounts.”

Institutional investors account for 57% of equity ETF assets

Posted on March 21, 2013 by -

Institutional investors dominated the equity exchange-traded fund (ETF) market in 2012, holding roughly one-half of total equity ETF assets, according to Strategic Insight’s new report, “ETF Trends by Channel and Investor Type.”

Within international equity ETFs, institutions accounting for an estimated 57% of total assets, while individual investors and their financial advisors own the rest. ETFs give investors quick exposure to liquidity in emerging wealth regions, said Dennis Bowden, Assistant Director of U.S. Research at Strategic Insight.

Within the core U.S. equity ETF space, institutional market segments accounted for an estimated 46% of ETF assets, but a larger share of aggregate activity in 2012. Institutional investors deposited an estimated net $33 billion into US equity ETF strategies during the year (led by $26 billion into S&P 500 Index ETFs). Demand for core U.S. equity ETFs within the retail space was estimated at about $10 billion.    

Retail investors dominated aggregate holdings in the bond ETF space, however, accounting for 70% of assets as of the end of 2012, with institutional investors owning 30% of bond ETF assets.

Overall, 58% of ETF assets were held in the retail marketplace at the end of 2012, compared with 42% held by institutional investors. The Private Bank channel held the largest ETF asset total at the end of 2012 with roughly $276 billion, and gained $46 billion in 2012 flows. The RIA channel followed with approximately $267 billion of aggregate ETF holdings and an estimated $28 billion in 2012 net inflows.

Strategic Insight based the research on the new intermediary-sold fund distribution data transparency contained in the Simfund Pro, 7.0 database, which encompasses asset and net flow information (updated monthly) for roughly $7 trillion of open-end stock and bond mutual fund and ETF assets across over 900 distributors and nine distribution channels.

© 2013 RIJ Publishing LLC. All rights reserved.

The Bucket

Posted on March 21, 2013 by -

Strong start for MassMutual’s Retirement Services Division in 2013

MassMutual, which acquired The Hartford’s retirement plans business in 2012, announced that its Retirement Services Division’s sales in the first two months of 2013 were 25% ahead of plan.  

About 71% of the overall sales pipeline is with large broker-dealer firms, but sales through independent firms has increased, the company said. In the emerging markets (under $5 million in assets), 80% of new plans are coming through third-party administrators (TPAs).  

New York Life agents sold $1.6 billion worth of income annuities in 2012   

New York Life’s primary distribution channel of 12,250 agents in the U.S. posted a second consecutive year of record sales in 2012, the large mutual life insurer said in a release.

Individual recurring premium life insurance sales through agents were up 4% over 2011. Life insurance policies sold through agents also rose 4% in 2012, with 45% of the company’s new life insurance policies produced by agents serving the African-American, Chinese, Hispanic, Korean, South Asian, and Vietnamese markets in the U.S.

Agents also sold $4.7 billion of annuities of all types in 2012, a 9% increase from 2011. Sales of guaranteed lifetime income annuities through agents, including the new deferred income annuity, jumped 20% over 2011, reaching a record $1.6 billion.

Sales of mutual funds through agents rose 34% in 2012 over the prior year, to $807 million. The company’s investment boutiques in both income oriented and capital appreciation funds remain in high demand from customers.

Barron’s named New York Life’s MainStay funds the #1 fund family for the 10-year period in its annual ranking of mutual fund families. MainStay ranked in the top three for the 10-year period for the fourth consecutive year.

Fitch affirms stable outlook for Hartford

Fitch Ratings has affirmed all ratings for the Hartford Financial Services Group, Inc. (HFSG) and its primary life and property/casualty insurance subsidiaries. The Rating Outlook is Stable.  

Fitch’s rating action incorporates HFSG’s near-term capital management initiative, announced in February 2013, which reflects the company’s focus on its property/casualty, group benefits and mutual funds businesses.   

HFSG’s recent sale of its individual life business to Prudential Financial, Inc. and its retirement plans business to Massachusetts Mutual Life Insurance generated a positive net statutory capital impact to Hartford life of approximately $2.2 billion. This is comprised of an increase in U.S. life statutory surplus and a reduction in the U.S. life risk-based capital requirements.

As a result, the company’s U.S. life subsidiaries paid approximately $1.5 billion to the holding company in the first quarter of 2013. This included a $1.2 billion extraordinary dividend from its Connecticut domiciled life insurance companies, primarily Hartford Life and Annuity Insurance Company (HLAIC).

The company also dissolved Champlain Life Reinsurance Co., a Vermont-based captive subsidiary of HFSG, and returned approximately $300 million of surplus to the holding company.

HFSG expects to use this capital for approximately $1.0 billion of debt repayments over the next year, including maturities in July 2013 ($320 million) and March 2014 ($200 million). This should help the company to reduce its financial leverage and improve its debt service, Fitch said.

HFSG also anticipates returning capital to shareholders through a $500 million multi-year share repurchase program that expires at Dec. 31, 2014.

Fitch expects HFSG to maintain a financial leverage ratio at or below 25% following the successful execution of the company’s capital management actions. HFSG’s financial leverage ratio (excluding accumulated other comprehensive income [AOCI] on fixed maturities) increased to 27.2% at Dec. 31, 2012 from 22.5% at Dec. 31, 2011, due to additional debt issued to redeem the company’s 10% junior subordinated debentures investment by Allianz SE.

HFSG’s operating earnings-based interest and preferred dividend coverage has been reduced in recent years, averaging a low 3.5x from 2008 to 2012. This reflects both constrained operating earnings and increased interest expense and preferred dividends paid on capital over this period.

The key rating triggers that could result in an upgrade to HFSG’s debt ratings include a financial leverage ratio maintained near 20%, maintenance of at least $1 billion of holding company cash, and interest and preferred dividend coverage of at least 6x.

The key rating triggers that could result in a downgrade include significant investment or operating losses that materially impact GAAP shareholders’ equity or statutory capital within the insurance subsidiaries, particularly as they relate to any major negative surprises in the runoff VA business; a financial leverage ratio maintained above 25%; a sizable drop in holding company cash; failure to improve interest and preferred dividend coverage; and an inability to execute on the company’s strategic plan.

Tom Johnson appointed senior advisor at Retirement Clearinghouse    

Retirement Clearinghouse, LLC has appointed E. Thomas Johnson Jr. as a senior advisor. Johnson “will promote RCH solutions that enable sponsors of 401(k) and other retirement plans to help employees when changing jobs,” the company said in a release.

Johnson has been an executive in the retirement savings and retirement income industries with Federated Investors, MassMutual Financial Group and, most recently, New York Life Insurance Co. 

“Tom, whose late father is known as the ‘godfather’ of the 401(k) for his role in creating the first 401(k) plan, will use his unique combination of experience, commitment and relationships to raise awareness of the challenges facing our retirement system and to elevate our brand in the marketplace,” said J. Spencer Williams, president and CEO of RCH.  

NPH announces record full-year results

National Planning Holdings, Inc., the large network of independent broker-dealers, reported record revenue of $837.2 million in 2012, up 6.3% over 2011. NPH’s total product sales rose almost 2% over the prior year to more than $16.6 billion, representing record volume for the firm.

NPH 2012 Results: Year-Over-Year Comparison

                                             FY 2012                                     FY 2011                                  % Change

Revenue                           $837,191,813                           $787,839,218                                    6.3%

Sales                            $16,629,239,440                        $16,314,874,804                                 1.9%

No. of Reps                              3,540                                         3,636                                        -2.6%

The NPH network consists of INVEST Financial Corporation (INVEST), Investment Centers of America, Inc. (ICA), National Planning Corporation (NPC), and SII Investments, Inc.

Protective announces new FIA  

Protective Life today announced the release of the Protective Indexed Annuity, a fixed indexed annuity with a range of withdrawal charge schedules and three interest crediting strategies. It also has available principal protection.

In addition to a fixed interest crediting strategy, the Protective Indexed Annuity offers two indexed interest crediting strategies, annual point-to-point and annual tiered rate. The latter credits an interest rate enhancement when index performance meets or exceeds a pre-determined performance tier.

The product also offers access to contract value for unforeseen circumstances, such as unemployment, terminal illness and nursing home confinement.

© 2013 RIJ Publishing LLC. All rights reserved.

 

 


Was That a Prohibited Transaction?

Posted on March 20, 2013 by -

A thickset man in an open collar shirt, who advises a small-plan 401(k) sponsor, approached the microphone stand during the Q&A portion of a breakout session on ERISA litigation at the recent ASPPA/NAPA Summit at Caesar’s Palace in Las Vegas.

His question was this: Twenty years ago, he sold his client a retirement plan. The plan was worth $300,000 at the time, and his one percent annual fee yielded $3,000. He considered himself paid fairly for the hours he put in.   

Since then, the plan assets have swollen to $2 million, and his 1% now yields $20,000 a year. He feels a responsibility to tell the plan sponsor that it could buy the same services elsewhere for $5,000, but that would reveal the fact that he was being overpaid.

Should he inform the sponsor? he asked the panel on the dais, which included David Cohen of Evercore Trust, Michael Kozemchak of Institutional Investment Consulting and David Wolfe of Drinker, Biddle & Reath.  

“Well, it goes against human nature,” observed Wolfe. “But it makes sense.” Laughter burst from the audience, helping to relieve a perceptible buildup of tension in the room.

Such is the type of dilemma in which many professionals in the retirement plan industry find themselves since the Labor Department’s Employee Benefits Security Administration began crusading for greater fee transparency and higher fiduciary standards among providers.        

Several anecdotes in the spirit of the one related above could be heard at the ASPPA/NAPA conference. It didn’t take much digging to elicit ERISA war stories from attendees, who spoke on the assumption that their names wouldn’t appear in print.  

For instance, after the same breakout session, a somewhat distressed plan advisor from Tennessee approached one of the panelists and began telling a complex tale that had no obvious beginning, middle or end but was compelling nonetheless.

The young man had just begun advising a plan sponsor who several years ago had bought a group variable annuity from a registered rep associated with a major life insurance company. A few years later, the rep exchanged the annuity for a new contract, netting a $45,000 commission.

The plan sponsor wasn’t happy with the new contract, and asked the rep if the company could back out of it. The rep reported that a surrender charge would apply.

The new plan advisor and his client are both unhappy with the situation. Part of the problem is that neither the plan sponsor nor the advisor fully understands the exact costs or benefits of the contract.

They are under the impression that even the youngest participants are locked into a lifetime of fees for a lifetime income guarantee. They also don’t know whether or not the new contract was better than the old one, or if it might even be valuable enough to hang onto. (It was purchased before the financial crisis, when VA riders were rich.)

The point here is that neither the plan sponsor nor advisor knows what to do next.  

Here’s another tale, this one from a worried 401(k) broker. Like many of his brethren, he often used creativity to help close a deal. Given the new environment, he’s wondering if he may have transgressed in the past. 

For instance, he described a negotiation where he offered the plan sponsor certain discounts on services if the plan sponsor would let him run the plan’s money and some of the sponsor’s corporate money as well. Is that OK, he asked?

It depends, said Evercore Trust’s Cohen: “You can offer to manage the plan assets for less if the sponsor also hires you to manage the corporate assets for the regular price. But it doesn’t work the other way. You can’t offer to manage the corporate assets for less if the sponsor also hires you to manage the plan assets.”  

When brokering a 401(k) deal, which might involve a five-figure commission, intermediaries may overlook such subtleties, said one consultant who audits and advises broker-dealers on ERISA fiduciary matters. He trains brokers to recognize and avoid what ERISA regulations call “prohibited transactions.”

These are transactions that involve conflicts of interest and/or revenue-sharing arrangements that are indistinguishable from kickbacks, to use a quaint expression. Such arrangements can easily occur, for instance, in the provision of “bundled services” where there’s not always a clear and direct link between a fee and the service it covers.   

Does the typical broker have a voice inside his head, or a tiny angel who sits figuratively on his shoulder, that helps him distinguish between prohibited and fiduciary actions at such moments, the consultant was asked. No, the consultant said. Usually not.

Indeed, a broker-dealer whose reps have been mis-selling 401(k) plans for years may have hundreds of toxic contracts on its books, each of them tainted with actionable, prohibited transactions and each of them a fiduciary liability time bomb, the consultant suggested. (Under ERISA, there is a six-year and a three-year statute of limitations on such violations, depending on the situation, David Levine of Groom Law Group told RIJ. But a deal made 10 years ago, for instance, may still be questionable if a recurring payment was recently received under the terms of the deal, he said.)

It’s not all gloom and doom on the moral front, however, Most people in the 401(k) services business want to do the right thing, a woman who has worked in the retirement industry in a variety of capacities for 25 years told RIJ during a cab ride from Caesar’s Palace to McCarran Airport after the ASPPA/NAPA conference adjourned.

Many of them consciously avoid both the opportunity and the temptation to commit conflicted transactions simply by advising plans without selling products to them or selling products to them without advising them. But a few try to do both, and when deep in the weeds of a complex bundled deal they may forget that they’re working both sides of the street—and that they may be headed toward a prohibited transaction.

© 2013 RIJ Publishing LLC. All rights reserved.

401(k) Litigation: The ‘Next Asbestos’?

Posted on March 20, 2013 by -

Short-sellers and the plaintiff’s bar have a lot in common. Short-sellers attack companies they consider over-valued. Plaintiff’s attorneys file class-action suits on contingency against firms they think are committing fraud. Both can win big or lose big. Both are widely hated.

Enter Jerry Schlichter, a plaintiff’s attorney whose St. Louis worker injury law firm Schlichter Bogard & Denton last year won a judgment in federal district court against technology firm ABB and its 401(k) provider, Fidelity Management Trust.

In a March 2012 ruling that has roiled the retirement world, the court awarded plan participants at ABB $36.9 million, plus court costs and legal fees of $50 million. It was a big victory for Schlichter, who since 2006 has filed a raft of lawsuits over allegedly excessive fees charged to employees for their 401(k) plans.

Although Schlichter (at right) and other attorneys have also lost their share of excessive fee class action suits, the ABB verdict, now on appeal in the 8th Circuit, as well as hefty settlements with Caterpillar and General Dynamics, is nonetheless a shot across the bow of the 401(k) industry.

Jerry SchlichterIt warns plan sponsors large and small that they need to analyze the plans they offer their employees better and to accept their ERISA-mandated fiduciary responsibility to provide retirement plans with reasonable recordkeeping, administrative and investment fees.

Throughout the retirement industry, people are talking about the implications of Tussey et al v. ABB. Some fear it will trigger a tsunami of similar cases, creating the kind of legal boondoggle that asbestos and tobacco liability cases once provided. Others say it is headed for the US Supreme Court. Either way, it’s widely acknowledged that a new era of fee transparency, fee competition and fee compression has arrived. 

The long-term cost of fees

Why all the fuss about fees? Small differences in such fees, compounded over a lifetime, can obviously make a huge difference in the amount of savings a worker has at retirement. The Department of Labor estimates that each additional 1% in fees reduces retirement assets by 28% over 25 years.

The DoL offers this hypothetical: Imagine two young workers with 35 years until retirement each of whom puts $25,000 into a retirement fund averaging a 7% return. One worker’s plan charges a management fee of 0.5% while the other’s plan charges 1.5%. At retirement, the nest egg of the worker with the low-fee plan is $227,000. The other worker accumulates only $163,000.

These fee levels are not unusual. A BrightScope survey of 401(k) plans with assets over $1 billion found that the average expense ratio for the 30 largest plans was just 0.29%. The typical fee for plans with assets of less than $10 million was 1.45%.

As those numbers suggest, large plans with economies tend to have the lowest, but not always. For years, through so-called revenue sharing, some plan providers routinely used over-sized investment fees to cover the costs of other plan services, sometimes including specialized services—such as non-qualified plans for senior management—that most participants helped pay for but did not receive.  

When the DoL’s new disclosure rules, 408(b)(2) and 404(a)(5), went into effect last summer, many such arrangements began coming to light. Under ERISA, plan sponsors have long had a strong fiduciary obligation to assure that the plans they offer to their workers have “reasonable” fees, but the new rules have made it possible, finally, for employees to know whether that was actually happening.

Another ‘asbestos’ or ‘tobacco’?

Rules are just rules unless they are enforced, but landmark legal cases get people’s attention. Last summer’s ruling for the plaintiffs in Tussey et al v. ABB has been called “a game changer” in the retirement world. The size of the judgment and the prominence of the plan provider in the case were impossible to ignore.

In that case, Missouri Federal District Judge Nanette K. Laughrey ruled that employer ABB owed its employees a total of $35.2 million for failure to monitor recordkeeping fees charged by Fidelity and failing to negotiate rebates, as well as for shifting over participants in the plan’s Vanguard Wellington fund to the proprietary Fidelity’s Freedom Fund.

The judge also told Fidelity to reimburse employees for $1.7 million in lost float income, with the judge saying the investment firm had “used float income for its own benefit when it used interest earned from plan assets to pay for bank expenses that should have been borne by Fidelity.”

Plaintiffs’ attorneys were also awarded $50 million in court costs. Fidelity and ABB have appealed. Fidelity is appealing the separate judgment against it, which a company spokesperson characterized as a “technical violation.”

With courts in different circuits coming down differently in the complaints against 401(k) plans, it seems likely that the US Supreme Court will eventually have to consider the complex issue of employer and plan provider fiduciary responsibility and disclosure requirements for 401(k) fees.

 “A lot will depend upon which cases the Supreme Court decides to take on,” Marcia Wagner of Wagner Law Group in Boston told RIJ. “If it wants to rule in favor of fee disclosure and of upholding fiduciary responsibility, they’ll choose a case where the fiduciaries really screwed up. But this court tends to be a bit conservative, so it’s a crap shoot what they’ll do.”

If the high court waits a bit to weigh into this issue, it could have many more cases to choose from. Indeed, the plan providers’ worst fear is that Tussey et al v. ABB could trigger a wave of class action lawsuits that will be as big as the wave of asbestos litigation that started in the 1970s or the wave of tobacco litigation that followed.

“The vast majority of 401(k) funds are at risk of lawsuits over excessive fees,” said James Holland, director of business development at Millennium Investment and Retirement Advisors, a fiduciary consultancy in Charlotte, NC.

“Why? Responsible plan fiduciaries have traditionally outsourced plan management to brokers who are perceived as experts and who may be knowledgeable. However, they are not fiduciaries. They are distributors, so their ‘advice’ is product-driven. Because the costs are built into the products they recommend and are asset-based, there is an inherent conflict of interest. Thus there’s the absolute assurance that fees will sooner or later become excessive.”

[Editor’s note: A dozen attorneys from six different law firms are participating in a February 5 suit filed against Fidelity on behalf of participants of 401(k) plans at Avanade Inc., Hewlett-Packard and Delta Airlines. The suit charged Fidelity Management Trust and others with fiduciary self-dealing under ERISA in the handling of the plans’ float income. A similar suit was filed this month on behalf of the participants of 401(k) plans at Bank of America, EMC Corp., and Safety Insurance Co.]

Fee compression

But the nation’s highest court may not need to weigh in on the issue of reasonable 401(k) fees. Because of the new transparency rules, the die may already have been cast, many experts say. (The DoL itself has yet to sue a plan sponsor or plan provider for charging unreasonable fees. The agency has left that job to private attorneys like Schlichter. The DoL has filed amicus briefs in a number of these cases, however).

“There’s going to be a lot of pressure to ratchet down the fees charged for 401(k) plans going forward,” said Dan Notto, senior vice president and senior retirement plan counsel at Alliance Bernstein. “The class action suits have opened the eyes of a lot of big employers. They’re saying, ‘We’re going to have to do something to lower these fees.’ That pressure will continue whatever the Supreme Court ultimately decides.” The RIAs who run money for 401(k) plans will be equally affected, he added.

Plan sponsors should simply offer employees index funds instead of actively-managed funds, attorney Schlichter suggests. “You have all these Nobel Prize winners saying that, over time, active management can’t beat the market, yet companies keep putting actively-managed plans with high fees in their 401(k)s,” he told RIJ. But he doesn’t rely on that argument in court. Faith in fund manager expertise is so widespread, he said, “No judge in America would buy it.”

Notto doesn’t expect plan sponsors to make a wholesale shift from active funds to low-fee index funds. Noting that his own company offers actively-managed funds and believes in their merits, he said, “I don’t think plan sponsors will just throw up their hands and go to index funds. The big funds that have experts may still try to retain actively-managed investments. But the active managers will have to prove that they are earning their fees.”

Wagner agrees. “I think plan providers can still justify higher fees, but they will have to justify them. And fee-sharing is going to be sharply reduced.” She expects fees to decline overall. “You’re going to see massive margin compression as competition pushes all fees downward. Why? Competitors will know what other firms are charging, so people will undercut each other. It will be like the airlines in the ’80s when they were deregulated. The minimum fee will get a lot more minimum, so the industry will have to figure out how to provide services that people will still want to buy,” she told RIJ.

Devil incarnate?

David Witz, managing director of Fiduciary Risk Assessment, a Charlotte-based consulting firm, said that the ball is now in the court of the plan sponsors. “The service providers are now providing sponsors with the required fee disclosures. Now the burden is on plan sponsors to compare disclosures to the regulations and secure the exemptions that the regulations provide.”

The problem, he said, is that far too few plan sponsors have enough in-house expertise to evaluate the disclosures. “And so far, unfortunately, most of them are not retaining the right expertise to do it.”

While many of the larger employers “are assuming that their corporate counsel has everything under control,” Witz thinks otherwise. So does Heath A. Miller of the Boston ERISA law firm Shepherd Kaplan LLC.

“Plan sponsors can’t use corporate counsel alone. They need to hire a plan counsel,” he said. “It’s not just a matter of expertise. Corporate counsel can have a conflict of interest in dealing with matters involving a 401(k) plan.”

In defending themselves against 401(k) fee litigation, plan sponsors can’t simply argue that their fees are low in comparison to some benchmark or to another sponsor’s fees, said Witz, who was an expert plaintiff’s witness in Tussey et al v. ABB.

“The courts aren’t going to get put into the position of deciding whether a fee is high or low,” he said in an interview. “They’re looking at process. Judges want to know what process the sponsor used in evaluating a provider’s fees. Fiduciaries will be given the benefit of the doubt if they use a reasonable procedure to evaluate the fees.”

To some degree, the 401(k) fee controversy brings to mind the adage, “Be careful what you wish for.” Defined contribution plans were supposed to be a lighter burden for employers than defined benefit plans. But employers are finding that they do bear serious responsibilities as sponsors of DC plans, including the responsibility to demonstrate that plan fees are reasonable. Plan providers, meanwhile, are seeing unprecedented pressure on their profits.

Attorney Jerry Schlichter deserves some of the credit—or blame, depending on your point of view—for altering the paradigm. “There are many fine attorneys who work in the law,” Witz said, “but very few who actually change the law. Schlichter is one of those—and that’s high praise for a guy who some in the industry have called the devil incarnate.”

© 2013 RIJ Publishing LLC. All rights reserved.

The Opposite of Austerity

Posted on March 20, 2013 by -

With much of the global economy apparently trapped in a long and painful austerity-induced slump, it is time to admit that the trap is entirely of our own making. We have constructed it from unfortunate habits of thought about how to handle spiraling public debt.

People developed these habits on the basis of the experiences of their families and friends: when in debt trouble, one must cut spending and pass through a period of austerity until the burden (debt relative to income) is reduced. That means no meals out for a while, no new cars, and no new clothes. It seems like common sense – even moral virtue – to respond this way.

But, while that approach to debt works well for a single household in trouble, it does not work well for an entire economy, for the spending cuts only worsen the problem. This is the paradox of thrift: belt-tightening causes people to lose their jobs, because other people are not buying what they produce, so their debt burden rises rather than falls.

There is a way out of this trap, but only if we tilt the discussion about how to lower the debt/GDP ratio away from austerity – higher taxes and lower spending – toward debt-friendly stimulus: increasing taxes even more and raising government expenditure in the same proportion. That way, the debt/GDP ratio declines because the denominator (economic output) increases, not because the numerator (the total the government has borrowed) declines.

This kind of enlightened stimulus runs into strong prejudices. For starters, people tend to think of taxes as a loathsome infringement on their freedom, as if petty bureaucrats will inevitably squander the increased revenue on useless and ineffective government employees and programs. But the additional work done does not necessarily involve only government employees, and citizens can have some voice in how the expenditure is directed.

People also believe that tax increases cannot realistically be purely temporary expedients in an economic crisis, and that they must be regarded as an opening wedge that should be avoided at all costs. History shows, however, that tax increases, if expressly designated as temporary, are indeed reversed later. That is what happens after major wars, for example.

We need to consider such issues in trying to understand why, for example, Italian voters last month rejected the sober economist Mario Monti, who forced austerity on them, notably by raising property taxes. Italians are in the habit of thinking that tax increases necessarily go only to paying off rich investors, rather than to paying for government services like better roads and schools.

Keynesian stimulus policy is habitually described as deficit spending, not tax-financed spending. Stimulus by tax cuts might almost seem to be built on deception, for its effect on consumption and investment expenditure seems to require individuals to forget that they will be taxed later for public spending today, when the government repays the debt with interest. If individuals were rational and well informed, they might conclude that they should not spend more, despite tax cuts, since the cuts are not real.

We do not need to rely on such tricks to stimulate the economy and reduce the ratio of debt to income. The fundamental economic problem that currently troubles much of the world is insufficient demand. Businesses are not investing enough in new plants and equipment, or adding jobs, largely because people are not spending enough – or are not expected to spend enough in the future – to keep the economy going at full tilt.

Debt-friendly stimulus might be regarded as nothing more than a collective decision by all of us to spend more to jump-start the economy. It has nothing to do with taking on debt or tricking people about future taxes. If left to individual decisions, people would not spend more on consumption, but maybe we can vote for a government that will compel us all to do that collectively, thereby creating enough demand to put the economy on an even keel in short order.

Simply put, Keynesian stimulus does not necessarily entail more government debt, as popular discourse seems continually to assume. Rather, stimulus is about collective decisions to get aggregate spending back on track. Because it is a collective decision, the spending naturally involves different kinds of consumption than we would make individually – say, better highways, rather than more dinners out. But that should be okay, especially if we all have jobs.

Balanced-budget stimulus was first advocated in the early 1940’s by William Salant, an economist in President Franklin Roosevelt’s administration, and by Paul Samuelson, then a young economics professor at the Massachusetts Institute of Technology. They argued that, because any government stimulus implies higher taxes sooner or later, the increase might as well come immediately. For the average person, the higher taxes do not mean lower after-tax income, because the stimulus will have the immediate effect of raising incomes. And no one is deceived.

Many believe that balanced-budget stimulus – tax increases at a time of economic distress – is politically impossible. After all, French President François Hollande retreated under immense political pressure from his campaign promises to implement debt-friendly stimulus. But, given the shortage of good alternatives, we must not assume that bad habits of thought can never be broken, and we should keep the possibility of more enlightened policy constantly in mind.

Some form of debt-friendly stimulus might ultimately appeal to voters if they could be convinced that raising taxes does not necessarily mean hardship or increased centralization of decision-making. If and when people understand that it means the same average level of take-home pay after taxes, plus the benefits of more jobs and of the products of additional government expenditure (such as new highways), they may well wonder why they ever tried stimulus any other way.

© 2013 Project Syndicate.

America needs, but isn’t getting, more female advisors: Pershing

Posted on March 18, 2013 by -

Although women now make up nearly two-thirds of the U.S. workforce, only about 30% of investment advisors are women and the numbers are dropping, according to a new study from Pershing LLC, a unit of BNY Mellon.

According to The 30% Solution: Growing Your Business by Winning and Keeping Women Advisors, several factors account for the decrease in women advisors:

  • More than a third of advisors today are less than 10 years from retirement.  
  • Women advisors earn just 58% of what their male peers earn, a gap that can cost women an average of $1.25 million each over a 35-year career, according to the Department of Labor.
  • More than half of respondents at Fortune 500 companies said that developing women executives was not on their agenda, according to a University of North Carolina Business School study.

According to the study, female investors are significantly more likely to engage advisors than men (46% vs. 34%). Additionally, nearly two-thirds of female millionaire investors and 82% of female ultra-high-net-worth investors prefer working with an advisor.  

A copy of the study is available at http://www.pershing.com.

© 2013 RIJ Publishing LLC. All rights reserved.