Archives: Articles

IssueM Articles

Flood into foreign equities bodes ill: TrimTabs

Posted on March 5, 2013 by Editor Test -

An estimated $55.1 billion poured into global equity mutual funds and exchange-traded funds in January and February, the biggest two-month inflow on record, according to TrimTabs Investment Research.

“Bulls should be concerned” that in-flows into foreign stock funds have been so heavy this year, said David Santschi, TrimTabs CEO. “Big inflows from fund investors often occur near market tops.”

Global equity mutual funds and exchange-traded funds received an all-time record $34.4 billion in January, according to TrimTabs note to clients. While inflows subsided to $20.1 billion in February, last month’s inflow was still the second-highestsince October 2007.

“It’s remarkable that U.S. investors are convinced the grass is greener offshore even though global equities have been underperforming,” said Santschi. “The average U.S. equity fund is up 6.2% so far this year, more than double the average global equity fund’s 2.4% gain.”

TrimTabs reported that U.S. equity mutual funds and exchange-traded funds issued $5.9 billion in February, down from $32.0 billion in January. Bond mutual funds and exchange-traded funds issued $17.2 billion in February, down from $33.5 billion in January.

“Inflows into U.S. stocks slumped dramatically last month,” said Santschi. “But global equity funds raked in more than $1 billion daily in fresh cash, and inflows didn’t slow much as the month progressed.”

The previous two-month record for inflows into global equity mutual funds and ETFs was $49.1 billion in January and February of 2006 amid growing enthusiasm over investments in emerging markets and China, in particular, TrimTabs said.

Stable Value Funds: Performance to Date – Part I

Posted on March 3, 2013 by David Babbel and Miguel Herce -

Stable Value Investment Funds (SVIF) are offered in almost half of all defined contribution (DC) plans in the USA, with more than $800 billion dollars worth of assets under management. Historically, they have been one of the two most popular asset classes for people enrolled in such plans.

Unlike stocks, bonds, and many other asset classes, they are generally not susceptible to large fluctuations in value, but accrue attractive interest over time while providing necessary liquidity at book value. Therefore, they may be especially suitable as people approach retirement and are also useful after retirement.

Their stable value allows a person to transition into retirement without any late-inning unwelcome market surprises that can devastate a retirement plan. After retirement, for those plans that allow participants to retain a portion of their assets in SVIF, the availability of funds at book value is important when extraordinary expenses are incurred.

In three related studies[1] conducted over the past seven years, we have examined SVIF performance relative to six other major asset classes, including U.S. large stocks, small stocks, long-term government bonds, corporate bonds, intermediate-term government and corporate bonds, and money market funds.

Our evidence suggests that going back to their inception in 1973, SVIF have dominated two (and nearly three) major asset classes based on a historical analysis and that they often occupy a significant position in optimal portfolios across a broad range of risk aversion levels.

We discuss the factors that contributed to stable value’s remarkable performance and whether it can continue to maintain it into the future. Our various studies used three methods to examine historical performance:

Mean-variance analysis
Stochastic dominance analysis
An enhanced multi-period utility analysis

In Part I of this report, we will briefly discuss the mean-variance results. Part II will summarize the performance results using the other methods.

What are Stable Value funds?

SVIF offer principal protection and liquidity to individual investors, and steady returns that are competitive with intermediate-term bond yields. However, over ensuing one-to-three-month intervals, the guaranteed rate of return moves much more slowly than intermediate-term bond yields.

This is achieved by having a process that allows the provider to smooth market volatility through amortizing gains and losses over the duration of the portfolio. This smoothing is effected through the rate re-set mechanism and insulates against day-to-day volatility. Consequently, SVIF provide investors with positive returns of very low volatility. This combination of bond-yield-like returns and low volatility generates contract or book value accounting of the investment.

The underlying investment portfolios of SVIF are comprised of high quality, short maturity corporate and government bonds, mortgage-backed securities, and asset-backed securities. In all but a few pre-specified circumstances, investors in SVIF are able to transact (make deposits, withdrawals, transfers) at book or contract value, which is deposits plus accrued interest, less any past withdrawals.

While SVIF do not require a set holding period but provide full access to the participant’s principal and accumulated interest, they are subject to the general restrictions within the overall plan. For example, many plans restrict participants from the direct transfer to a competing short-duration bond or money market fund by requiring that money transferred out of SV be first invested in a non-competing (e.g., stock or long-term bond) fund for a short period such as 30-90 days to eliminate arbitrage.

This rule, together with the fact that plan participants do not act in concert regarding the allocation of their funds, allows the investment contract protections to be provided for a fraction of what it would cost if interest arbitrageurs dominated the pool and were revising their allocations aggressively.

Mean-variance analysis

From an investor’s viewpoint, SV funds operate like a passbook savings account. They accrue interest at a pre-specified crediting rate that is generally updated every one to three months to slowly incorporate changing market conditions. Below are compared the relative yields of stable value and money market funds in the stressful post-crash period.

SVIF also fared well over a longer time period. The SVIF returns shown are net of all fees. Note that over the twenty-one-year period shown below, there were only two brief intervals lasting a month or two each when the money market fund average yield exceeded the stable value average.

Despite shortcomings, the mean-variance approach is a popular analytical tool and provides useful insights into the ability of SV investments to dominate other asset classes.

The historical record provides evidence that, even as stand-alone investment, SV funds have been superior in the mean-variance sense to money market and intermediate-term government/credit bond funds.

Based solely on historical returns, when included in optimal mean-variance portfolios, SV funds contribute significantly to the portfolio, to the exclusion of money market, intermediate-term government/credit bonds, long-term corporate bonds and even large stocks.

In other words, optimal mean-variance portfolios based on past data contain only SV funds, long-term government bonds and small stocks in proportions that naturally vary with the expected return (or, alternatively, the expected volatility) of the optimal portfolio.

(Looking forward, we would expect long-term government bonds to be excluded from the set of efficient portfolios because their historical returns benefitted from a significant drop in yields, producing huge capital gains. We cannot expect such a significant drop in yields going forward, so their future returns relative to other investment classes cannot benefit from the capital gains.)

For example, over the past 23 years, from January 1989 through January 2012, SV returns exhibited both a higher mean and lower volatility than either money market or intermediate-term government/credit bond returns. This feature can be seen in the figure below, where we plot two efficient frontiers, one including all seven asset classes in our study and one that excludes the value-weighted SV (VW-SV) funds. The plot extending back to 1973 looks about the same.

While not shown here due to space constraints, we observed that no optimal mean-variance portfolio along the efficient frontier included money market instruments, intermediate-term bonds or long-term corporate bonds. Not even large US stocks were included. We also observed that SV funds predominated in the lower portion of the expected return range, where one would conventionally anticipate seeing money market and intermediate-term bond investments.

The Sharpe ratio, commonly used in performance measurement, measures excess return per unit of risk. It measures how well an investor is compensated per unit of risk taken. Higher ratios denote greater return for the same level of risk.

The Sortino ratio focuses more on the downside risk. It is based on the Sharpe ratio, but penalizes for only those returns that fall below the target return, which in our case is the average riskless rate of return over the period of analysis. It gives the actual rate of return in excess of the risk-free rate per unit of downside risk.

The Sharpe and Sortino ratios for quarterly net return data from 1989-2011 are reported in the table below.

	Large Stocks	Small Stocks	Long-Term Corporate Bonds	Long-Term Government Bonds	Intermediate-Term Gov’t/Credit	Stable Value	Money Market
Mean	2.21%	3.27%	1.99%	2.15%	1.38%	1.41%	0.87%
Std. Deviatn	8.19%	11.68%	4.78%	5.46%	1.84%	0.38%	0.59%
Sharpe Ratio	0.16	0.20	0.23	0.24	0.29	1.69	N/A
Sortino Ratio	0.24	0.33	0.44	0.46	0.52	25.77	N/A

Note that the Sharpe ratio values for five of the asset classes are mostly clustered together, but that for SV it is about six times greater than the highest of the other asset classes. This pattern is even more pronounced for the Sortino ratio. The extremely high ratio for SV funds results from the fact that throughout the period under consideration, the risk-free rate exceeded the SV credited rate only for only a few months and by small amounts. Hence, there were only a few, small observations that factored into the denominator.

The Value Proposition, Challenges and Future Prospects

The positive evidence shown above also holds true over the entire 40-year period of existence for traditional and synthetic forms of SVIF. It raises two questions: What has been the value proposition that allowed these returns to be achieved? Should we expect this kind of performance over the future?

The value proposition has two facets. On the asset side, some of the return above money market yields comes from investing at durations sufficient to capture the term premium that has been traditionally available. The funds also are able to take on a very small amount of credit and convexity risk and thereby gain additional spread. They also invest in some less liquid securities and Guaranteed Investment Certificates (GIC), which provide higher spreads than the most liquid assets.

The first two of these factors help explain why SV returns have generally outpaced money market yields, but do not explain why they also have outpaced intermediate-term government/credit returns. For that we must turn to the liability side of fund management.

On the liability side, the contribution to performance derives from behavioral finance factors. SVIF have contingent liquidity that FASB and GASB define as “benefit responsive.” From the point of view of participants, SV has liquidity similar to money market funds. Banks, insurers or other financial institutions that issue the investment contracts take on the transfer/liquidity risk as well as the investment/market risk that everyone will not withdraw at the same time, since the underlying portfolio has to be less than contract value to cause the investment contract to make up the difference.

SV providers mitigate their risk largely by being astute at predicting and underwriting participant behavior. Providers know that SV investors tend to use less liquidity than they think they need. They know that the vast majority of participants, because of tax penalties, equity wash requirements that inhibit interest rate arbitrage, and simple investor inertia, tend to leave their money in stable value options for a fairly long time. Providers are willing, therefore, to guarantee a fixed rate for a traditional GIC or a minimum zero percent crediting rate each quarter for a synthetic GIC. This allows “wrap” providers to offer their guaranties at lower prices than otherwise would be the case.

Going forward, SVIF will need to be able to continue earning term premia, liquidity premia, and credit spreads while investors will need to continue to behave as they have over the past 40 years for it to continue to be a widely sought investment vehicle for accumulation and decumulation.

David F. Babbel, professor emeritus, The Wharton School, Univ. of Pennsylvania, is a Senior Advisor to CRA (Charles River Associates) and leader of its Insurance Economics practice. Miguel A. Herce, Ph.D., is a Principal at Charles River Associates.

[1] Our previous studies were published in the Working Papers Series of the Wharton Financial Institutions Center website (Babbel and Herce, 2007-#21, 2009-#25, 2011-#1). http://fic.wharton.upenn.edu/fic/papers.html These studies provide references to the literature that explain the details.

Ten Questions about Quantitative Easing

Posted on February 28, 2013 by Nouriel Roubini -

Most observers regard unconventional monetary policies such as quantitative easing (QE) as necessary to jump-start growth in today’s anemic economies. But questions about the effectiveness and risks of QE have begun to multiply as well. In particular, ten potential costs associated with such policies merit attention.

First, while a purely “Austrian” response (that is, austerity) to bursting asset and credit bubbles may lead to a depression, QE policies that postpone the necessary private- and public-sector deleveraging for too long may create an army of zombies: zombie financial institutions, zombie households and firms, and, in the end, zombie governments. So, somewhere between the Austrian and Keynesian extremes, QE needs to be phased out over time.

Second, repeated QE may become ineffective over time as the channels of transmission to real economic activity become clogged. The bond channel doesn’t work when bond yields are already low; and the credit channel doesn’t work when banks hoard liquidity and velocity collapses. Indeed, those who can borrow (high-grade firms and prime households) don’t want or need to, while those who need to – highly leveraged firms and non-prime households – can’t, owing to the credit crunch.

Moreover, the stock-market channel leading to asset reflation following QE works only in the short run if growth fails to recover. And the reduction in real interest rates via a rise in expected inflation when open-ended QE is implemented risks eventually stoking inflation expectations.

Third, the foreign-exchange channel of QE transmission – the currency weakening implied by monetary easing – is ineffective if several major central banks pursue QE at the same time. When that happens, QE becomes a zero-sum game, because not all currencies can fall, and not all trade balances can improve, simultaneously. The outcome, then, is “QE wars” as proxies for “currency wars.”

Fourth, QE in advanced economies leads to excessive capital flows to emerging markets, which face a difficult policy challenge. Sterilized foreign-exchange intervention keeps domestic interest rates high and feeds the inflows. But unsterilized intervention and/or reducing domestic interest rates creates excessive liquidity that can feed domestic inflation and/or asset and credit bubbles.

At the same time, forgoing intervention and allowing the currency to appreciate erodes external competitiveness, leading to dangerous external deficits. Yet imposing capital controls on inflows is difficult and sometimes leaky. Macroprudential controls on credit growth are useful, but sometimes ineffective in stopping asset bubbles when low interest rates continue to underpin generous liquidity conditions.

Fifth, persistent QE can lead to asset bubbles both where it is implemented and in countries where it spills over. Such bubbles can occur in equity markets, housing markets (Hong Kong, Singapore), commodity markets, bond markets (with talk of a bubble increasing in the United States, Germany, the United Kingdom, and Japan), and credit markets (where spreads in some emerging markets, and on high-yield and high-grade corporate debt, are narrowing excessively).

Although QE may be justified by weak economic and growth fundamentals, keeping rates too low for too long can eventually feed such bubbles. That is what happened in 2000-2006, when the US Federal Reserve aggressively cut the federal funds rate to 1% during the 2001 recession and subsequent weak recovery and then kept rates down, thus fueling credit/housing/subprime bubbles.

Sixth, QE can create moral-hazard problems by weakening governments’ incentive to pursue needed economic reforms. It may also delay needed fiscal austerity if large deficits are monetized, and, by keeping rates too low, prevent the market from imposing discipline.

Seventh, exiting QE is tricky. If exit occurs too slowly and too late, inflation and/or asset/credit bubbles could result. Also, if exit occurs by selling the long-term assets purchased during QE, a sharp increase in interest rates might choke off recovery, resulting in large financial losses for holders of long-term bonds. And, if the exit occurs via a rise in the interest rate on excess reserves (to sterilize the effect of a base-money overhang on credit growth), the ensuing losses for central banks’ balance sheets could be significant.

Eighth, an extended period of negative real interest rates implies a redistribution of income and wealth from creditors and savers toward debtors and borrowers. Of all the forms of adjustment that can lead to deleveraging (growth, savings, orderly debt restructuring, or taxation of wealth), debt monetization (and eventually higher inflation) is the least democratic, and it seriously damages savers and creditors, including pensioners and pension funds.

Ninth, QE and other unconventional monetary policies can have serious unintended consequences. Eventually, excessive inflation may erupt, or credit growth may slow, rather than accelerate, if banks – faced with very low net interest-rate margins – decide that risk relative to reward is insufficient.

Finally, there is a risk of losing sight of any road back to conventional monetary policies. Indeed, some countries are ditching their inflation-targeting regime and moving into uncharted territory, where there may be no anchor for price expectations. The US has moved from QE1 to QE2 and now to QE3, which is potentially unlimited and linked to an unemployment target. Officials are now actively discussing the merit of negative policy rates. And policymakers have moved to a risky credit-easing policy as QE’s effectiveness has waned.

In short, policies are becoming more unconventional, not less, with little clarity about short-term effects, unintended consequences, and long-term impacts. To be sure, QE and other unconventional monetary policies do have important short-term benefits. But if such policies remain in place for too long, their side effects could be severe – and the longer-term costs very high.

Prudential Enters DIA Space with All-Bond VA

Posted on February 28, 2013 by Editor Test -

Having noticed the success that other life insurers have had in selling deferred income annuities (DIAs), Prudential Annuities has rolled out a new offering designed to compete in that product category.

The new product is a variable annuity with a living benefit called Prudential Defined Income. It invests all client assets in a long-duration bond fund, held in a separate account, and offers an annual compound 5.5% roll-up in the benefit base for every year the client delays taking an income stream.

For instance, a 65-year-old man could invest $100,000 and begin taking an annual lifetime income of $8,540 ten years later. That amount is based on a 5% payout rate for a 65-year-old and an income base of $170,814 ($100,000 compounded at 5.5% for 10 years.)

That payout rate is much less than the payout rate from the leading deferred income annuity, New York Life’s Guaranteed Future Income product. According to New York Life, it would allow a single man who invested $100,000 at age 65 to take an income of more than $12,000 at age 75.

The Prudential product offers more liquidity, however. Subject to a surrender fee (for seven years, starting at 7%), the Prudential investor could access the money in his account. The New York Life investor could not access his money during the deferral period. His beneficiaries would receive a cash refund, however, if he died during the deferral period. A refund of unpaid principal is also paid at death.

The Prudential product offers a return of premium death benefit (net of withdrawals and fees) during the deferral period and a return of the remaining account value, if any, if death occurs after income payments begin.

Prudential’s deferred income offering is available to policyowners ages 45 to 85, and requires at least a $25,000 premium. All assets are invested in the AST Long Duration Bond Portfolio. The income benefit and the roll-up are not optional; they are part of the contract. The policyholder cannot drop the benefit.

The all-in annual costs are 2.74%, including a mortality and expense risk fee of 95 basis points, investment fees of 84 basis points, a Defined Income benefit charge of 80 basis points and an administrative fee of 15 basis points.

Advisors and potential investors should take note that the payout rate from the Prudential Defined Income annuity is based on the client’s age when he or she purchases the contract, not when he or she begins taking income. The payout rates of most variable annuities with living benefits are typically based on the age at which income is first taken.

Bruce Ferris, senior vice president of sales and distribution for Prudential Annuities, said this practice gives the company a better idea of what its future liability will be—even though it cannot know exactly when each client will begin taking income.

“One of the difficulties in designing variable annuities is that we’re still in the early stages of understanding client behavior or behavioral finance, regarding when they will take income or restart income. This helps us significantly in pricing a product that allows for a higher level of initial income than our Highest Daily Lifetime Income rider, but without the opportunity of the Highest Daily feature,” Ferris told RIJ.

“The annuity space is book-ended at one end by the single premium immediate annuity, which offers the highest level of initial income, and at the other end by the variable annuity with a guaranteed lifetime income benefit, which offers upside opportunity. Our new product resides somewhere in the middle. We wanted to combine the features and benefits of both,” he added.

“[New York Life, Guardian Life] have become leaders in the deferred income annuity space, which was once called ‘longevity insurance,’ and they’ve brought out products with terrific market appeal. [With Prudential Defined Income] we’re bringing another version of that.”

Pacific Life announces new pension de-risking product

Posted on February 28, 2013 by Editor Test -

Pacific Life has added a new product, Pacific Secured Buy-In, to its suite of “pension de-risking” products, the Newport Beach, Calif., company said in a release.

The product is intended to enable plan sponsors “to de-risk their pension obligations and stabilize their corporate balance sheets and income statements without affecting plan termination, said Richard Taube, vice president, Institutional & Structured Products for Pacific Life. He recommended it “for plan sponsors who want to de-risk… without recognizing settlement losses.”

Pacific Secured Buy-In allows the plan sponsor to transfer all future obligations to Pacific Life by converting its plan to a Pacific Transferred Buy-Out contract at any time and at no cost, the release said.

Pacific Life’s risk-transfer products also include Pacific Insured LDI, a “guaranteed alternative to best-efforts liability-driven investing strategies.” Launched last year, it guarantees plan sponsors a match between plan assets and plan liabilities without requiring an up-front payment like a buy-in or buy-out product, and without triggering settlement losses.

Europe evaluates incentives for working longer and subsidies for saving more

Posted on February 28, 2013 by Editor Test -

European pension policies should promote “active aging,” using a “modern tax and benefit system” to incentives for longer participation in the labor market, said László Andor, European Union’s commissioner for employment social affairs and inclusion.

Speaking at a conference on tax issues for pensions in Brussels, Andor referred to the last year’s Pensions Adequacy Report, which stressed that increasing working life would be key to pension adequacy in the future.

“This requires active aging strategies, investments in life-long learning of all age groups, the adaption of workplaces to the needs of older workers and new forms of labor-force participation,” he said.

The tax system could incentivize active participation in the labor market until the statutory retirement age is reached, or even beyond that stage, he said, adding that “it may be necessary to increase taxation in other areas, such as value-added taxes, green taxes and property taxes” to offset the reductions in taxes on earned income.

The commissioner conceded that tax increases, if not properly designed could backfire, and that shifting taxation from labor to other sources might affect the financing of social protection.

“This is a risk particularly in countries where social protection is primarily based on social insurance contributions,” he said. “However, the financing of social protection could be preserved by earmarking a portion of revenues for this purpose, as done for instance by Germany for VAT.”

Andor also stressed that, as part of the EU’s plans to cut costs, member states will have to look at the cost of promoting funded second and third-pillar pensions through tax exemptions and other subsidies.

“They will have to examine whether fiscal incentives offered to pension savers and to pension funds yield enough value in terms of pension provision,” he said. “They will also have to consider whether similar or better results can be achieved through other or complementary means.”

The key argument for subsidies through tax exemptions, according to Andor, is that second and third-pillar schemes are voluntary. Therefore, economic incentives are necessary to motivate employers and individuals to defer consumption into the future and build extra entitlements through complementary savings, he said.

“Yet, even with high subsidies, it has been impossible in some member states to raise coverage above 50%,” he added, noting that some authorities were now trying the regulatory approach of auto-enrolment instead.

Public authorities might need to look at the idea of mandatory private pensions, he noted. “Making it mandatory need not mean we abolish or even reduce fiscal incentives,” he said. “But it would mean we have more room to consider how much we subsidize and with which distributional profile.”

Small plan participants pay as much as 1.97% in annual fees

Posted on February 28, 2013 by Editor Test -

If the average 401(k) small plan participant is earning an investment return of 6% a year, he or she is losing about 25% of that to fees. For the average large plan participant, the fee bite on a 6% return would be about 16%.

That’s based on the latest data from the 13th Edition of the 401k Averages Book, which shows that the average total plan cost for a small retirement plan (up to 50 participants and $2,500,000 in assets) is 1.46% (down slightly from 1.47% over the past year), with a range of .38% to 1.97%. For a large retirement plan (1,000 participants/$50,000,000 assets), the average total plan cost is 1.03%, down from 1.08% over the past year.

Investment expenses for small plans declined to an average of 1.37% from 1.38% while the large plan average investment expense declined to 1% from 1.05%. The Department of Labor’s 408(b)(2) disclosure regulations were cited as putting downward pressure on fees.

Although “401k fees have been trending down over the years, the Department of Labor’s fee disclosure regulations helped bring a great deal of attention to 401k plan fees,” said Joseph Valletta, co-author of the 401k Averages Book.

The average target date fund expense in a large plan is .98%, while the balanced fund average is 1.12%. The average target date fund expense for a small plan is 1.37%, while the balanced fund average is 1.45%.

The 13^th Edition separates the costs of target date funds from the costs of traditional balanced and risk-based funds for the first time. Published since 1995, the 401k Averages Book is available for $95.

Debate continues over capping 401(k) tax break at 28%

Posted on February 28, 2013 by Editor Test -

The executive director/CEO of the American Society of Pension Professionals & Actuaries (ASPPA), Brian H. Graff, issued a statement rebutting a recent suggestion from a Brookings Institution scholar that the federal budget deficit could be reduced by $40 billion over 10 years by reducing the maximum tax break on retirement plan contributions at 28%.

The suggestion was made by the Brookings Institution Karen Dynan in her essay, “Proposal 6: Better Ways to Promote Saving Through the Tax System,” which was part of a report from Brookings’ Hamilton Project, “15 Ways to Rethink the Federal Budget.” Her proposal has been favored by the Obama Administration.

There’s been a rising chorus of academic and governmental voices suggesting that at least part of the annual “expenditure” on retirement plan tax deferral (estimated at $50 billion to $70 billion by the Center for Retirement Research at Boston College) is wasted because it offers incentives to wealthy people who would save even without the incentive.

Under the “28% cap” proposal, a small business owner in the 39.6% marginal tax bracket would reduce his federal income taxes by a maximum of $14,000 on a maximum deferral of $50,000 into a 401(k) plan, rather than the potential $19,800 tax savings under current law.

Only adjusted gross income over $400,000 for single filers ($425,000 for heads of households and $450,000 for couples filing jointly) is taxed at the highest marginal rate, and only about one percent of Americans earn that much. But many of them, some would argue, are business owners who base their decision to sponsor or not sponsor a retirement plan on the size of the tax benefit to themselves.

ASPPA CEO Brian H. Graff is in that camp. He has publicly maintained that incentivizing savings isn’t the only benefit of the tax break for high earners. It also incentivizes high-earning small business owners to sponsor a retirement plan in the first place, he has argued. Reduce their benefit, and they’ll shut down their plan or never start one in the first place. In his latest prepared statement on the topic, Graff said:

“Brookings Hamilton Project has proposed placing a 28% cap on the ‘rate at which deductions and exclusions related to retirement saving reduce a taxpayer’s income tax liability.’ Because the tax incentive for retirement savings is a deferral, not a permanent exclusion, the proposal would more accurately be described as double taxation of contributions to retirement savings plans for anyone with a marginal tax rate of over 28%.

You won’t expand coverage by penalizing small business owners for offering a 401(k) plan. Retirees already pay ordinary income tax on distributions from retirement savings plans. If this proposal went through, a small business owner in the 39.6% bracket would pay an 11.6% tax on contributions made to the 401(k) plan today, and pay tax again at the full rate when they retire.

The Hamilton Project paper acknowledges that individuals subject to this double taxation may decide to put their savings somewhere other than in the 401(k) plan. What it fails to acknowledge is when that double-taxed person is a small business owner and it no longer makes sense for the owner to have a 401(k) plan, that owner probably won’t offer a 401(k) plan to the employees, either.

ASPPA strongly supports expanding coverage through proposals such as automatic enrollment IRAs. But we think those proposals should be a step up for workers who have no access to workplace retirement savings. Not a step down for workers that had a 401(k) plan before their employer got hit with a double tax on their own 401(k) contributions. ”

Dynan’s proposal includes the following recommendations:

Cap the rate at which deductions and exclusions related to retirement saving reduce a taxpayer’s income tax liability at 28%
Increase the tax credit that small businesses can take for startup pension plan expenses.
Establish an automatic IRA program.
make the saver’s credit refundable and easier to understand
Remove obstacles to firms establishing expanded savings platforms that would allow employees to save for both retirement and nonretirement purposes.

Life and annuity companies will face reckoning in 12-14 months: Conning

Posted on February 28, 2013 by Editor Test -

A new report from Conning on the global insurance industry suggests that the life and annuity sector continues to be plagued by three main problems: a slow economy, low interest rates, and regulatory advancement.

The 70+ page proprietary report, titled “U.S. and Global Insurance Industry Outlook: Economic, Capital Markets, and Regulatory Challenges Continue—Nothing to Be Gained by Waiting for Things to Get Better,” makes the following points about the life and annuity business:

The life and annuity sector has more asset leverage than the property-casualty and health sectors and “a more uniform national perspective as opposed to significant variability in product and market characteristics at the state level.”
The low interest rate environment has a negative effect on investment income and on policyholder behavior, and exacerbates the mismatch of asset and liability durations.
Performance margins are hurt by relatively low sales of discretionary products and spread compression of investment yields compared with guaranteed credited rates.
Companies continue to seek ways to de-risk interest rate exposures and income guarantees, but the extended environment with little near-term chance for reversion to “normal” levels makes this increasingly problematic.
Falling surrender rates are increasing the effect of net spread compression and forcing increases in statutory reserves.
Operating margins on net premiums are half pre-financial crisis levels.

According to report, “life and annuity products may be seen as discretionary purchases that may be broadly constrained in times of financial stress. Individual annuities, both fixed and variable, will continue their decline in premium from shifting policyholder behavior, while indexed annuities and group annuities are doing well.”

Regulatory challenges are affecting solvency and risk management approaches, investment and hedging capital charges, reserving for contingencies and policyholder behavior, and distribution strategies.

Major differences “between regulators and companies on the degree of conservatism in reserving may swing toward the regulators’ position if the low interest rate environment is seen as extending beyond the next couple of years,” the report said.

Strategies pursued by life insurance companies include:

Increased divestitures of blocks of business and noncore operations (including bank and savings and loan affiliates).
Aggressive investment in infrastructure improvements.
Alternative distribution strategies and more focused market approaches
Broader ranges of investment alternatives.

As for companies that are adopting a “wait and see” attitude, the report said that strategy might work if normal conditions return in the next 12 to 14 months, but not if “sluggish conditions” and “intensifying regulatory challenges” persist.

The Best Retirement Research of 2012

Posted on February 28, 2013 by Kerry Pechter -

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.”

The Online 401(k) offers $200 for successful leads

Posted on February 21, 2013 by Editor Test -

As a publicity stunt, the Online 401(k), a low-cost provider of retirement plan services to the very smallest of small businesses, is offering a $200 reward for any lead that results in a sale.

“By instituting the referral incentive, we are hoping to debunk common myths about retirement plans and help Americans at businesses of all sizes effectively save for their retirement,” the company said in a release.

Only about 8% of small businesses with between two and 20 employees offer any type of retirement savings plan to their employees. The Online 401(k) is hoping the new referral program will be an incentive for concerned citizens to direct their friends and family that work for small businesses to its affordable, easy-to-use retirement plan.

“Small businesses are the least likely to offer a 401(k) plan to their employees,” says Chad Parks, CEO and founder of The Online 401(k). “By offering this program, we hope more small businesses will realize there are plans out there designed for them and their employees. Combined with the fact that the government wants to pay us to save, we hope the light bulb will go off.”

The Online 401(k) offers plans that are web-based and flat-fee: The company offers four retirement plan options, which conform to ERISA contribution limits:

Single(k): Designed for a single proprietor business, it allows a maximum investment of up to $50,000 per individual.
Starter(k): Serves businesses that have between one and 100 employees. It allows for a maximum savings potential of up to $5,000 per year or $6,000 for employees who are 50 or older.
Express (k): A low-cost 401(k) for a business with up to 50 employees. There is a maximum investment potential of up to $50,000 per individual.
Custom(k): Designed for a business with up to 50 employees, there is a maximum investment potential of up to $50,000 per business.

The referral reward program applies to anyone who refers a business to the firm that eventually results in an opened plan. The program comes on the heels of the company’s cross-country road trip in 2012 to publicize the lack of retirement savings in America that will eventually be turned into a documentary called “Broken Eggs Film: The Looming Retirement Crisis in America.”

Quote of the Week

Posted on February 21, 2013 by Editor Test -

Variable Annuity Carriers ‘Mix It Up’ in Q4

Posted on February 21, 2013 by John McCarthy -

Variable annuity product development activity this quarter was healthy. Carriers filed 101 annuity product changes in the fourth quarter of 2012. This compares to 106 new filings during the third quarter of 2012 and 130 in Q4 of last year.

New product development was modest. Carriers filed very few new contracts and a small number of new benefits. Most of the activity this quarter centered on fee changes to existing products and revisions to step ups and withdrawal percentages.

Interestingly, activity flowed in both directions, as Allianz and VALIC made their benefits more generous, while a host of carriers trimmed benefit guarantees and raised fees. We may be at an inflection point, with the first carriers beginning to tweak products in small ways for competitive advantage despite the ongoing low interest rate environment.

The list of carriers attempting to pare their risk exposure continues. In addition to selling its VA distribution business earlier in the year, Hartford this quarter announced an annuity buyout effective in 2013. In November, Jackson National suspended exchange inflow activity for approximately one month. Similar moves were made earlier in the year by Transamerica and AXA, in addition to last quarter’s host of carriers that limited additional contributions to existing contracts and benefits, including Allianz, AXA, MetLife, John Hancock, Prudential and Transamerica.

(Click here for the original pdf of this article, with charts.)

Innovations of note

Forethought Financial is on the board with a new VA filing for Q1 2013. Nationwide figured out a creative way to provide benefit portability. They launched a new contract called Destination Income in December available for rollovers from Nationwide qualified plans that offered living benefits. This contract allows the living benefit from the qualified plan to be carried over as-is to an individually owned contract. This addresses the portability problem and is a leader in this category.

More to come

What may be even more interesting is the pipeline activity for Q1 2013. The hits keep coming as far as limiting exposure for carriers. SunAmerica limited the contributions considered for its Lifetime GMWB benefits to the first year instead of the first

two years. SunLife sold its U.S. variable annuity business to Delaware Life Holdings, owned by Guggenheim Partners.

Q4 product changes

Bucking the trend, Allianz in October raised the fixed percentage step up on the Income Protector GLWB to 6% from 5%. The simple interest is credited quarterly before the first withdrawal (or age 91). The change applies to new sales.

Fees increased on six different Genworth benefits. Increases ranged from 15 bps to 50 bps to bring all benefits to 1.25% on December 3rd. Benefits include Income Protector, Lifetime Income Plus Solution, and Lifetime Income Plus 2008.

In December Hartford filed a living benefit buyout offer scheduled to execute in the first quarter 2013. The firm will offer a cash buyout to current contract owners who have the Lifetime Income Builder II GLWB as a way to reduce exposure on their books. Investors who have not started income payments (withdrawals or annuitization) and who have a minimum contract value will be eligible for an enhanced surrender value payment to terminate their contracts. These owners will get the greater of the contract value on the surrender date, or if the account is underwater the contract value plus 20% of the benefit base (the total payout is capped at 90% of the benefit base). The payment can fluctuate with the market until Hartford receives all the appropriate documents from the client. Contracts affected include the Director M series and the Leaders series.

Jackson National dropped the joint option on its LifeGuard Freedom 6 Net and Flex benefits effective Oct. 15. This applies not only to new contracts but also to existing contracts that do not have the option elected. Jackson is also eliminating the bonus credits on contracts, which range from 2% to 5%. In addition, the Perspective Advisors II and Perspective Rewards VA contracts are closing.

Jackson National limited the sales flows from exchanges into VAs that offer optional guaranteed benefits on November 13, 2012, but began accepting flows again on December 17. The limitations did not apply to Elite Access, the alternative-fund loaded B-share.

John Hancock closed multiple contracts effective October 15th: Venture Opportunity A-Series, Venture Opportunity A-Share (national & NY), Venture Opportunity O-Series, Venture 4 (national & NY) and Venture (national & NY). In addition, subsequent purchase payment restrictions were added to multiple John Hancock Venture contracts on October 15th.

Lincoln National filed changes to the Lincoln ChoicePlus and American Legacy Fusion contracts. The fee for SmartSecurity Advantage will increase from 65 bps to 85 bps (single) and 85 bps to 100 bps (joint). In addition, the withdrawal percentages for Lifetime

Income Advantage 2.0 (Lifetime GMWB) changed for younger age bands, decreasing one-half percentage. The change became effective December 3, 2012.

Minnesota Life rolled out the MultiOption Guide contract (B-share and L-share). The contract will be marketed by Securian and costs 1.35% (B-share; 1.70% for L-share) and comes with a Lifetime GMWB and a GMIB. The withdrawal benefit (1.20% for single and joint versions) offers an age-banded withdrawal (5% for 65 year old single; 4.5% for joint) and the three standard types of step ups: highest anniversary value; 6% fixed step up for ten years; and a doubling of the benefit base after 10 years provided there are no withdrawals. Investments must go into one of three allocation plans. The existing GMIB (cost 95 basis points) is attached with a 5% fixed and HAV step ups and allowable 5% dollar-for-dollar withdrawals.

Nationwide launched a new I-share contract called Destination Income in December. The fee is 70 bps. The contract is only available for rollovers from Nationwide qualified plans. The contract creates benefit portability with a Lifetime GMWB that carries over the lifetime guarantee from the qualified plan; thus, withdrawal percentages vary. The benefit offers an HAV step up. The living benefit is automati- cally included for an additional 1.00%. The contract offers seven subaccounts. The contract can only be titled to one owner, but the benefit can continue for a surviving spouse.

Nationwide continues the trend toward risk-management-based subaccounts by adding four managed volatility funds to its core lineup. One of the managed volatility funds is available with the L.inc GLWB benefit.

Ohio National made changes to its GLWB Plus benefit. The step up was decreased from 8% to 7% (simple). The deferred benefit base bonus step up was eliminated. In addition, the GMAB component was eliminated on the joint version only.

On October 1st Pacific Life increased fees on multiple versions of its CoreIncome Advantage benefits. Fee increases ranged from 10 to 20 bps. The single-life version went from 60 bps to 80 bps before a step up occurs. Joint version went from 80 bps to 100 bps until a step up occurs.

Protective increased the fee for Protective Income Manager to 1.20% (1.30% under the RighTime option) effective December 10th. SecurePay R72 closed, replaced by a new SecurePay benefit with a highest anniversary value step up and no fixed percentage increase step up.

The RiverSource Accumulation Protector Benefit (multiple versions attached to different contracts) fee increased to 1.75% on October 20th. Symetra released a New York version of its True VA. The New York version contract fee is slightly higher at 75 bps (versus 60 bps), and it does not carry the enhanced death benefit rider.

Thrivent closed its Return Protection Allocation GMAB on December 20th. This affects the Flexible Premium DVA 2005, which still carries a Lifetime GMWB benefit.

VALIC decreased the fee on its IncomeLOCK 8 Lifetime GMWBs to 1.10% from 1.30%. Also, the guaranteed lifetime withdrawal percentage decreased to 4.75% (4.25% joint) from 5% (4.5% joint) for a 65 year old. After the account balance reaches zero, the remaining benefit base is paid out periodically at 4.75% (4.25% joint), or 3.75% (3.25% joint) if the age of the older owner at first with- drawal was younger than age 65. Previously, these percentages were 4% and 3%, respectively.

VALIC also made changes to its IncomeLOCK 6 benefits. Fees dropped 20 bps and now range from 1.10% (single) to 1.35% (joint). For a 65 year old, lifetime withdrawals range from 5% to 6.5% (single) (4.5% to 6% joint), depending on the asset allocation options chosen. Once the account value reaches zero, the withdrawal percentage drops to 3% on some versions, 4% on others. For all versions, the withdrawal percentage is 4% if the age of the older owner at first withdrawal was younger than age 65 and there is a highest anni- versary value step up after age 65. The benefit maintains its three step ups: a highest anniversary value; a fixed 6% simple each year; or 200% of the benefit base after 12 years of no withdrawals.

Pipeline Q1 2013

Forethought Financial is issuing its first variable annuity contract, the ForeRetirement VA (B-, C-, and L-shares). These are the first filed under the new Forethought registrant and the targeted launch date is March 4th, 2013. Forethought purchased the new VA business capa- bilities of Hartford in mid-June of 2012. Forethought now strikes out on its own with new contracts, which unsurprisingly look similar in structure to the old Hartford Personal Retirement Manager series.

Lincoln National filed a new contract called Secure Retirement Income (Versions 1–4). The target launch date is end of Q2 2013.

Nationwide is increasing the withdrawal percentage of the joint version of its Lifetime GMWB benefit called “7% Lifetime Income Rider” on January 14th. It is also increasing the fee to 1.50% from 1.20%. A 65-year old will now get 4.75%, up from 4.5%.

Pacific Life is increasing the fee on its CoreIncome Advantage 5 Plus Joint rider. The fee increases to 1.35% from 1.00% on February 1st.

SunAmerica limited the purchase payment calculation to only include first year purchase payments, down from the first two years of payments. This applies to the Income Plus-Dynamic Options 1–3 and the custom option (Lifetime GMWBs).

SunAmerica changed its name to American General; however, the Polaris line of contracts is still being marketed under the SunAmerica name.

SunLife sold its U.S. variable annuity business to Delaware Life Holdings, owned by Guggenheim Partners. Guggenheim is clearly growing their footprint in the annuity spaces as this move follows prior annuity acquisitions that include Security Benefit, Standard Life of Indiana, EquitTrust Life, and the U.S. fixed annuity business of Industrial Alliance Insurance and Financial Services of Quebec. The proposed sale includes Sun Life’s U.S. domestic variable annuity, fixed annuity and fixed index annuity products.

In Off-Year for Annuities, FIAs and DIAs Shine: LIMRA

Posted on February 21, 2013 by Editor Test -

Six years ago, deferred income annuities (aka longevity insurance) offered great payout rates, but no one was interested in them—partly because minimum distribution requirements made them awkward to buy with qualified money.

Now, with the RMD problem amended, those products, whose income start date is typically about ten years after purchase, are selling well for the handful of companies that issue them—despite much humbler payout rates. Their overall market share is still tiny, however.

Sales of deferred income annuities (DIA) reached $1 billion in 2012, according to LIMRA’s fourth quarter 2012 U.S. Individual Annuities Sales survey, which represents data from 95% of the market. Fourth quarter DIA sales reached $390 million, up almost 150% from the first quarter ($160 million), but still less than one percent of fourth quarter total annuity sales.

“We anticipate these products will continue to have remarkable growth,” said Joe Montminy, assistant vice president and director of LIMRA annuity research, in a release. “We see new companies entering this market and existing players launching new products, targeting younger boomers looking to create an income stream when they retire.” Consumers age 45-59 have almost $10 trillion in financial assets, he said.

Overall, annuity sales were $52.6 billion in the fourth quarter, down 8% from the previous year. For the year, annuity sales dropped 8%, tallying $219.4 billion. Variable annuity (VA) sales decreased 8% in the fourth quarter, to reach $35.0 billion. VA sales totaled $147.4 billion in 2012, down 7% from 2011.

Variable annuity sales generally rise with equity prices, Montminy said, but in 2012 they declined while equity prices rose. That was a result of pullbacks by some of the major issuers, notably MetLife.

“Unlike historical trends, VA sales did not follow equity market growth, which increased 13 percent in 2012,” he noted. “VA sales performance in 2012 was clearly influenced by companies’ strategic management of their books of business – removing some products from the market, limiting additional contributions into existing contracts, and revising features/pricing on GLB riders.”

Total fixed annuity sales hit a 12-year low of $72.0 billion in 2012, down 11% from 2011. Sales were $17.6 billion in the fourth quarter, down 7% from the year-ago quarter.

In 2012, indexed annuity sales hit a record high of $33.9 billion — up 5% compared to 2011. Indexed annuity sales grew slightly in the fourth quarter, reaching $8.5 billion, an increase of two percent over one year ago. However, this was two percent lower than third quarter sales. Product innovations introduced by new entrants in the FIA space, namely Apollo Global Management, Guggenheim Partners and Harbinger Group, helped boost sales.

Most FIA purchasers opt for contracts with guaranteed lifetime withdraw benefit (GLWB) riders. A record 73% of consumers elected a GLWB rider, when available. LIMRA estimates that 87% of indexed annuities sold offer GLWB.
Punished by low interest rates, fixed-rate deferred annuity sales (book value and market value adjusted) were down 20% in the fourth quarter and down 27% for the year. Annual fixed-rate deferred product sales were $25.7 billion in 2012, the lowest since 1998.

Book value sales declined 21% in the fourth quarter to $4.9 billion; Market-value adjusted (MVA) sales were $1.0 billion, down 17%. For the year, book value and MVA declined 29% and 13% respectively.
Single premium immediate annuities (SPIAs) grew 5% in the fourth quarter to reach $2.0 billion. However, SPIA sales declined 5% in 2012 to $7.7 billion.
© 2013 RIJ Publishing LLC. All rights reserved.

Crime writer wins $50.9 million verdict against advisor

Posted on February 21, 2013 by Editor Test -

A federal court jury in Boston unanimously found this week that accounting and business management firm Anchin, Block & Anchin LLP acted negligently and in breach of its fiduciary duties in managing the financial affairs of best-selling crime writer Patricia Cornwell (pictured above) and her partner, McLean Hospital neuroscientist Dr. Staci Gruber.

The lawsuit accused the firm of excessive and unauthorized billing, failing to put the clients’ interests ahead of its own, and gross mismanagement of Ms. Cornwell’s and Dr. Gruber’s money over four and a half years, which resulted in the loss of millions of dollars.

Cornwell charged that Anchin, Block & Anchin LLP engaged in high-risk investment strategies without her approval. According to the 2009 complaint,

“In July of 2009, after four and a half years in which Anchin controlled Ms. Cornwell’s and CEI’s business affairs and investments, including all check writing purportedly on behalf of Ms. Cornwell and CEI, Ms. Cornwell demanded information as to her net worth, and that of CEI. Notwithstanding eight figure earnings per year during that period, CEI and Ms. Cornwell learned that their net worth, while substantial, was the equivalent of only approximately one year’s net income. They also learned that Anchin had borrowed on their behalf collectively several million dollars, comprised of mortgages for real property and a loan for the purchase of a helicopter.”

“We felt we owed it to ourselves and to others who have been victimized by financial advisors to have our day in court,” Ms. Cornwell said publicly after the verdict. “A portion of the monetary verdict we receive will go to McLean Hospital for psychiatric research.”

Federal District Court Judge George A. O’Toole, Jr. presided over the seven-week trial at the John Joseph Moakley U.S. Courthouse in Boston. Under Massachusetts law, he may also award Ms. Cornwell and Dr. Gruber payment of their legal fees and multiple damages in a subsequent proceeding.

The New Yorker launches business hub

Posted on February 21, 2013 by Editor Test -

The New Yorker‘s new online hub for business coverage and commentary, The Business Pages, launches today on newyorker.com. Scotch drinkers might especially like a story about the Bruichladdich distillery in Islay, Scotland.

Weekly features on the site include:

“The Idea of the Week,” an infographic visualization of an important business or financial issue.
“The Number,” a deep dive into an economic indicator, data point, or other figure that best captures what’s happening that week.
A video series hosted by James Surowiecki, tied to his column in the magazine, The Financial Page.
“How Do They Make Money?,” a series that asks how different people make their livings—from street musicians to shoeshine men to fishermen.
The hub will also provide links to classic New Yorker stories about business.

It will feature business content from the magazine, as well as original Web content from these writers:

Malcolm Gladwell
James Surowiecki
John Cassidy
Amy Davidson
Ken Auletta
Tim Wu
And many others.

Xerox is the exclusive launch sponsor of The Business Pages.

The Bucket

Posted on February 21, 2013 by Editorial Staff -

Nationwide’s 2012 operating income survived Superstorm Sandy

Despite paying out $400 million for damages related to Superstorm Sandy in the fourth quarter of 2012 and despite “some planned risk management actions” in its variable annuity line, Nationwide reported net operating income of $741 million in 2012, up 43% from $517 million in 2011.

In a release, Nationwide reported total operating revenue for 2012 of $22.4 billion, or some $1.7 billion more than 2011. Nationwide paid over $13.7 billion in property & casualty, life insurance and other benefits to customers in 2012.

“P&C direct written premiums grew across all major product lines in 2012, particularly in our commercial lines,” said Mark Thresher, chief financial officer. “In total, property & casualty premiums rose more than 10% to $16.2 billion, including nearly $800 million in premiums from Harleysville Insurance, which was acquired on May 1, 2012.

“In our financial services business, sales topped $18 billion for the year, down modestly from last year due to some planned risk management actions taken during 2012 in our variable annuity product line.”

Despite Superstorm Sandy, Nationwide reported a net operating income of $18 million in the fourth quarter, down from $142 million during the same period in 2011.

MetLife sheds bank holding company status

MetLife has received the required approvals to deregister as a bank holding company from the Federal Deposit Insurance Corporation and the Federal Reserve. MetLife sold its MetLife Bank’s depository business to General Electric Capital on January 11.

Northwestern Mutual hosts webcast for plan participants

On March 5 at noon Central Standard Time, Northwestern Mutual will host a webcast for plan participants called, “Make Your Money Last: Shattering the Top 5 Retirement Planning Myths.”

Northwestern Mutual’s vice president-market strategy, Rebekah Barsch, will discuss longevity risk, income planning and healthcare costs. The webcast is the second in the mutual insurer’s “Planning for Success” series.

Jefferson National VA to offer tactically-managed portfolios from CMG Capital Management

Jefferson National, whose flat-fee Monument Advisor variable annuity offers hundreds of investment options to Registered Investment Advisors and fee-based advisors for tax-deferred investing, has launched three new tactically managed model portfolios with CMG Capital Management Group.

Models available to the RIAs and fee-based advisors working with Jefferson National include CMG System Research Treasury Bond Program, CMG Opportunistic All Asset Strategy and CMG Scotia Partners Growth S&P Plus Program.

These tactical strategies employ what CMG refers to as “enhanced modern portfolio theory,” using “quantitative rules-based trading strategies, incorporating various technical, fundamental and mathematical indicators, with a clearly defined buy and sell discipline,” according to a Jefferson National release.

The high-turnover typical of tactically managed portfolios can produce short-term capital gains, and generate taxes that can reduce returns. Morningstar estimates that over the 74-year period ending in 2010, failure to defer those taxes could have reduced some investors’ returns by as much 100 to 200 basis points a year, the release said.

AIG Life and Retirement gets an A+ from Fitch

Posted on February 21, 2013 by Editor Test -

Fitch Ratings has upgraded the IFS (Insurer Financial Strength) ratings of American International Group’s U.S. life insurance unit, led by AGC Life, to ‘A+’ from ‘A’, according to a Fitch release.

At the same time, Fitch affirmed the ‘A’ IFS ratings of AIG’s rated property/casualty insurance subsidiaries, as well as AIG’s Issuer Default Rating (IDR) of ‘BBB+’ and senior debt rating of ‘BBB’. The rating outlook is “stable.”

In upgrading the IFS of AIG’s Life & Retirement units, Fitch cited “continued improvement in statutory capital position, recovery of investment values over time and return to stronger operating profits and earnings stability.”

The company has largely recovered from the financial crisis and can generate about $4 billion of annual run-rate operating earnings, Fitch said.

“Surrender activity has stabilized and is currently at or below historical levels and is now reflective of the low interest rate environment rather than AIG-specific issues,” the release said. “Net investment spreads have improved as a result of an increase in base yields due to the reinvestment of cash and short-term investments in 2011 combined with lower interest credited.”

But Fitch cautioned: “These positive factors are offset somewhat by concerns as to the effect of continued very low interest rates on product performance and future profitability.”

AIG has repaid its government borrowings and other support; the remaining 15.9% U.S. Department of the Treasury ownership in AIG’s common stock was sold in December 2012, Fitch said. “The organization more closely represents a traditional insurance holding company with an operating focus on global property/casualty insurance and domestic life insurance and retirement products.”

The pending sale of 90% of AIG’s ownership of aircraft leasing firm International Lease Finance Corporation (ILFC) which is expected to close by midyear 2013, will also help, Fitch noted.

The company’s financial leverage as measured by the ratio of financial debt and preferred securities to total capital (excluding operating and ILFC debt and the impact of FAS 115) declined from 31% at year-end 2010 to approximately 22% currently.

Fitch’s Total Financial Commitment (TFC) ratio for AIG, while still high compared to most insurance peers, has improved from 2.5x at year-end 2010 to a current level of 1.3x. Elimination of ILFC debt and airline purchase commitments will further reduce financial leverage and TFC. AIG has also created an adequate liquidity position and has demonstrated access to capital markets through execution of several recent financing transactions.

AIG reported significantly improved profitability in the first nine months of 2012, with net income of $7.6 billion relative to a modest net loss in the prior year period. Life & Retirement’s pre-tax income rose 22% in the same period, year over year. Core operating subsidiary interest coverage on financial debt was 4.9x in the first three quarters of 2012.

Hyper about hyperinflation? Read this.

Posted on February 19, 2013 by Editor Test -

A reality check on unnecessary anxiety about the threat of “hyperinflation” in America is overdue. Luckily, an essay recently posted on Jeremy Grantham’s homepage provides one. Written by James Montier, a member of the Asset Allocation team at GMO, the $106 billion global management firm that Grantham and colleagues founded in 1977, the essay explains that it takes more than a few rounds of quantitative easing in response to a credit crisis to trigger hyperinflation. Below you’ll find a brief abstract of the essay. Click here for the complete version.

“To say that the printing of money by central banks to finance government deficits creates hyperinflations is far too simplistic (bordering on the simple-minded). Hyperinflation is not purely a monetary phenomenon. To claim that is to miss the root causes that underlie these extraordinary periods. It takes something much worse than simply printing money. To create the situations that give rise to hyperinflations, history teaches us that a massive supply shock, often coupled with external debts denominated in a foreign currency, is required, and that social unrest and distributive conflict help to transmit the shock more broadly.

“On the basis of these preconditions, I would argue that those forecasting hyperinflation in nations such as the US, the UK, or Japan are suffering from hyperinflation hysteria. If one were to worry about hyperinflation anywhere, I believe it would have to be with respect to the break-up of the eurozone. Such an event could create the preconditions for hyperinflation (an outcome often ignored by those discussing the costs of a break-up). Indeed, the past warns of this potential outcome: the collapse of the Austro-Hungarian Empire, Yugoslavia, and the Soviet Union all led to the emergence of hyperinflation!”

The Unloved Dollar Standard

Posted on February 19, 2013 by Editor Test -

Since World War II’s end, the US dollar has been used to invoice most global trade, serving as the intermediary currency for clearing international payments among banks and dominating official foreign-exchange reserves. This arrangement has often been criticized, but is there any viable alternative?

The problem for post-WWII Europe, mired in depression and inflation, was that it lacked foreign reserves, which meant that trade carried a high opportunity cost. To facilitate trade without requiring payment after each transaction, the Organization for European Economic Cooperation created the European Payments Union in 1950.

Supported by a dollar-denominated line of credit, the EPU’s 15 Western European member states established exact dollar exchange-rate parities as a prelude to anchoring their domestic price levels and removing all currency restrictions on intra-European trade. This formed the keystone of the hugely successful European Recovery Program (the Marshall Plan), through which the US helped to rebuild Europe’s economies.

Today, most developing economies, with the exception of a few Eastern European countries, still choose to anchor their domestic macroeconomic arrangements by stabilizing their exchange rates against the dollar, at least intermittently. Meanwhile, to avoid exchange-rate conflict, the US Federal Reserve typically stays out of the currency markets.

But the dollar’s role as international anchor is beginning to falter, as emerging markets everywhere grow increasingly frustrated by the Fed’s near-zero interest-rate policy, which has caused a flood of “hot” capital inflows from the US. That, in turn, has fueled sharp exchange-rate appreciation and a loss of international competitiveness – unless the affected central banks intervene to buy dollars.

Indeed, since late 2003, when the Fed first cut interest rates to 1%, triggering the US housing bubble, dollar reserves in emerging markets have increased six-fold, reaching $7 trillion by 2011. The resulting expansion in emerging markets’ monetary base has led to much higher inflation in these countries than in the US, and to global commodity-price bubbles, particularly for oil and staple foods.

But the US is also unhappy with the way the dollar standard is functioning. Whereas other countries can choose to intervene in order to stabilize their exchange rates with the world’s principal reserve currency, the US, in order to maintain consistency in rate setting, does not have the option to intervene, and lacks its own exchange-rate policy.

Moreover, the US protests other countries’ exchange-rate policies. Two decades ago, the US pressed the Japanese to allow the yen to strengthen against the dollar, claiming that Japan’s unfair exchange-rate policies were responsible for America’s ballooning bilateral trade deficit. Likewise, today’s “China-bashing” in the US – which has intensified as China’s contribution to America’s trade deficit has soared – is intended to force the Chinese authorities to allow faster renminbi appreciation.

Herein lies the great paradox. Although no one likes the dollar standard, governments and private market participants still consider it the best option.

In fact, US trade deficits are primarily the result of insufficient, mainly government, saving – not a misaligned exchange rate, as economists have led policymakers to believe. Large US budget deficits during Ronald Reagan’s presidency generated the famous twin fiscal and trade deficits of the 1980’s. This, not an undervalued yen, caused the bilateral deficit with Japan to widen in the 1980’s and 1990’s.

The much larger US fiscal deficits of the new millennium, courtesy of Presidents George W. Bush and Barack Obama, portend large – and indefinite – trade deficits. But American policymakers continue to blame China, claiming that the renminbi has been undervalued for the last decade.

The claim that exchange-rate appreciation will reduce a country’s trade surplus is false, because, in globally integrated economies, domestic investment falls when the exchange rate appreciates. So the ill will that China-bashing is generating is for nothing. Worse, it detracts political attention from America’s huge fiscal deficit – $1.2 trillion (7.7% of GDP in 2012 – and thus impedes any serious effort to rein in future spending for entitlements, such as health care and pensions.

Some contend that large fiscal deficits do not matter if the US can exploit its central position under the dollar standard – that is, if it finances its deficits by selling Treasury bonds to foreign central banks at near-zero interest rates. But America’s ongoing trade deficits with highly industrialized countries, particularly in Asia, are accelerating de-industrialization in the US, while providing fodder for American protectionists.

Indeed, America’s trade deficit in manufactures is roughly equal to its current-account deficit (the amount by which domestic investment exceeds domestic saving). So those concerned with job losses in US manufacturing should join the chorus lobbying for a much smaller fiscal deficit.

Can large US fiscal deficits and near-zero interest rates be justified because they help to revive domestic economic growth and job creation? Five years after the credit crunch of 2007-2008, it seems that they cannot. And, without even that justification, the latest wave of criticism of the US dollar standard appears set to rise further – and to stimulate the search for a “new” arrangement.

But the best new arrangement – and possibly the only feasible one – would follow an old formula: As in the 1950’s and 1960’s, the US would set moderately positive and stable interest rates, with sufficient domestic saving to generate a (small) trade surplus. The cooperation of China, now the world’s largest exporter and US creditor, is essential for easing and encouraging the transition to this nirvana. Apart from the ongoing euro crisis, a stable renminbi/dollar exchange rate is the key to renewed (dollar) exchange-rate stability throughout Asia and Latin America – as envisaged in the original 1944 Bretton Woods Agreement.

Nationwide’s 2012 operating income survived Superstorm Sandy

MetLife sheds bank holding company status

Northwestern Mutual hosts webcast for plan participants

Jefferson National VA to offer tactically-managed portfolios from CMG Capital Management

Data Connection

Lists*