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Tax changes offer advisors opportunity to contact investors

Most high net worth investors (63%) worry that their investment portfolios will be hurt by tax code changes in the wake of President Obama’s re-election, and 64% don’t believe they can offset pending tax increases, according to a new Nationwide Financial survey.

The Harris Interactive survey of 751 investors with $250,000 or more in annual household income or investable assets released found that 60% of survey respondents say they either won’t or are unsure if they will meet with a financial advisor to discuss how these changes may affect their portfolio.

More than half (56%) of survey respondents believe their individual federal taxes will increase. Nearly half (48%) expect tax rates to increase, particularly for the wealthy, and 30% believe tax rates will increase across the board. Nearly seven in ten think either that Bush-era tax cuts will be eliminated entirely (35%) or reduced for the wealthiest Americans (33%).

Despite these concerns, 61% either don’t plan to make adjustments to their portfolio or don’t know what adjustments to make. Of those who do plan to meet with a financial advisor, 26% will wait until 2013 or after tax code changes take affect.

As advisors well know, Bush-era tax cuts are set to expire at the end of 2012, raising the top four marginal brackets and eliminating the 10% bracket. The phase-out of itemized deductions for high income earners is set to return. Tax on dividend income is set to increase from 15% to ordinary income rates (up to 39.6%). Long-term capital gains rates are scheduled to rise to 20% from 15% for most taxpayers. Those with high overall income and investment earnings will face an additional 3.8% Medicare investment earnings surtax. The gift and estate tax exemption is scheduled to shrink from $5.12 million to $1 million.

Four in ten (41%) survey respondents want more education on the tax advantages of annuities and about a quarter want more education on the tax advantages of life insurance (21%) and 401(k) plans (25%). Six in ten (59%) don’t know about the changes to estate and gift tax limitations and say they do not understand very much or at all how a life insurance policy can help them take advantage of the current gift tax exemption limits (60%). Forty-three percent would like more education on that topic.

Harris Interactive conducted the tax study online between September 28 and October 5, 2012. The respondents were 751 adults ages 18+ having $250,000 or more in annual household income or investable assets. Since the survey was conducted before Nov. 6, respondents were asked to assume both potential election outcomes. The data represented here focuses on responses where respondents assumed the President would be re-elected.

© 2012 RIJ Publishing LLC. All rights reserved.

 

Fund flows favor bonds again in October: Morningstar

A net $27.7 billion flowed into long-term mutual funds in October, the 10th consecutive month of inflows, according to the November 2012 edition of the Morningstar Direct U.S. Open-end Asset Flows Update.

Bonds once again dominated the flows, though stocks retained their majority. Since October 2007, the percentage of invested assets in long-term stock mutual funds (open-ended and ETF) has dropped to 37% from 48%, and the share in taxable bond funds has doubled, to 26%.

Investors added $29.6 billion to taxable-bond funds ($33.9 billion including exchange-traded funds) and withdrew $8.3 billion from U.S.-stock funds (a $19.6 billion outflow including ETFs) in October. Intermediate-term bond, which is heavy in corporate bonds, brought in $11.4 billion, the most of any category.

Year to date, investors have added $224 billion to the taxable-bond asset class (up 10.8% from the end of 2011) and have withdrawn $85 billion from U.S.-stock funds (negative 2.7%). Since the beginning of the year, intermediate-term bond funds have gained almost $94 billion.

Large-cap stock funds remain the largest category of U.S. funds. Between them, large-blend, large growth and large value have lost a net $60 billion or so in 2012, but they are still the first ($1.14 trillion), third ($827 billion) and fourth ($604 billion) largest fund styles, respectively. Intermediate-term bond funds netted $94 billion in 2012 and ranked second.

Vanguard remained the largest fund family. Its funds netted $81 billion so far this year and grew to $1.53 trillion for a market share of almost 17%. PIMCO led all bond firms with inflows of $8.1 billion in October and $50.5 billion year-to-date.

Other highlights from the Morningstar report included:

Higher-risk segments of the bond market. Multi-sector bond, bank loan, emerging- markets bond, nontraditional bond, world bond, and high-yield bond categories each saw inflows of greater than $1 billion in October. Year to date, these six categories have taken in more than $80 billion, or 13% of beginning-period assets.

Municipal bonds. Investors also found municipal bonds attractive as $917 million flowed into high-yield muni-bond funds in October, bringing the total for the category to nearly $11 billion for the year-to-date period, or 20% of beginning-period assets. National long, intermediate, and short municipals brought in a total of $3 billion for the month and about $28 billion year to date, or 10% of beginning-period assets.

Alternatives. This category of funds has had the greatest organic growth rate of any asset class in 2012, collecting $12.4 billion year-to-date inflows. Within alternatives, investors were looking to hedge their equity exposure. The bear-market category collected $628 million, or 11.6% of assets at the beginning of the month, while long-short funds saw inflows of $628 billion, or 2.6% of beginning-month assets.

U.S. stock funds. The large blend category took in $1.4 billion, but that inflow was offset by outflows in the asset class’s other categories. Large growth, with redemptions of $4.3 billion, saw the largest outflow of any category, while large value funds had outflows of $2.0 billion.

International stock funds. While diversified emerging-markets funds saw inflows, most other international-stock categories experienced outflows. Diversified emerging-markets collected $925 million, while China region and Latin America stock funds both lost slightly more than $100 million. World stock lost $913 million.

PIMCO. Flagship PIMCO Total Return brought in $2.4 billion, more than any other fund for the month. The Gold-rated fund has returned 9.49% year to date, placing it among the top 13% of funds in its category. PIMCO Income and PIMCO Unconstrained Bond each brought in more than $1 billion.

© 2012 RIJ Publishing LLC. All rights reserved.

The Bogle Perspective

When Jack Bogle mounted the podium to speak at the National Association of Personal Financial Advisors East meeting in Baltimore two weeks ago, everybody there stood up from their lunches and applauded.

And well they should have. Because by inventing Vanguard index funds that cost only 10 to 20 basis points a year, Bogle eliminated the cost of an active fund manager and opened a niche for fee-based advisors.

Bogle, who was my employer in the late 1990s, is famous for popularizing if not inventing two slogans: “Stay the course” and “Costs matter.” Years ago, he pointed out the obvious but overlooked fact that while fees may represent a trivial fraction of an investor’s principal, they can consume a staggering proportion of his returns in the long run.

His lecture at the NAPFA conference was, as it usually is, passionate and populist. Using simple charts and graphs, Bogle demonstrated that the average investor, after adjusting his or her returns for fees, taxes, inflation, bad luck and errors, is lucky to net 2% a year from investing in stocks and bonds.

Maybe they admire him because he says—and his voice cracks into a disarming falsetto when he gets excited—what most of us can’t say, which is simply the truth. He started doing it decades ago, well before sheer longevity gave him license. Case in point: He ended his talk with a declaration that combatting climate change and controlling the proliferation of firearms are the country’s two greatest imperatives. “That has to be stopped,” he said about guns.

Whether investors agree or disagree with Bogle’s broader opinions, they have certainly endorsed his investment philosophy. As of the end of October, Vanguard was the largest mutual fund family, with over $1.5 trillion in assets (a five- or six-fold increase in 15 years) and a market share of about 17%.

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Only a few of the presentations at the NAPFA East conference focused entirely on retirement income.

Jim Otar, the Toronto engineer-turned-advisor, whose 2009 book (“Unveiling the Retirement Myth”) and retirement calculator (the $100 Retirement Optimizer) have earned a modest cult following, gave a talk called Advanced Retirement Distribution Planning. Rick Miller, the well-known Boston-area economist-turned-advisor, gave back-to-back breakout sessions on Understanding Longevity.

Neither of these speakers strongly advocated life annuities per se, but both of them presented evidence that, in my opinion, argued implicitly in favor of them. Their numbers suggested that most healthy couples with long-lived parents who want to maximize their annual spending in retirement should probably use at least part of their money to buy a life annuity that starts sometime after age 70. 

Here’s why. Otar’s “Zone Strategy” diagrams, which depict the segmentation of clients into those who are underfunded, barely funded, and abundantly funded for retirement, illustrated his contention that the greater the percent of their savings that retirees want to spend each year, the more strongly he would advise them to buy life annuities after age 70—or ignore a high risk of running out of money before they die.

To put that another way: Regardless of how much money you start with, a life annuity can increase your freedom to spend and consume. Those in poor health, or who can afford to live on their investment yield alone, or who value a big legacy over current consumption, are the only ones who wouldn’t benefit from the payoff that comes to annuity owners—assuming that they live a long time. 

Rick Miller’s presentation showed just how long Boomer couples (particularly those who are healthy and wealthy) should expect to live, and it’s well into the life-annuity-makes-sense range. An advisor today can count on seeing up to three of every ten 65-year-old male clients and four of every ten 65-year-old female clients reach the age of 90, he said. One in eight retired men and one in five retired women will reach age 95.

Ergo, prudent advisors should assume that their healthy 65-year-old client couples will spend up to 35 years in retirement. (Cindy Levering of the Society of Actuaries assisted Miller on the presentation.)

At present, few fee-based advisors recommend life annuities—because the yields (before age 70) are low and because they’d reduce their own fee income if they did. (Annuitized assets don’t ordinarily count as AUM.) But if an advisor expects at least one member of a client couple to live beyond age 90, encouraging them to buy a joint-and-survivor life annuity might be the most fiduciary thing to do.

At the very least, a life annuity reduces overall portfolio risk and thereby allows clients to take more risk with their non-annuitized wealth. It could also spare them the anxiety and indignity of worrying about market volatility in their old age, or about running out of money before they die, or about spending the funds they had hoped to preserve for a legacy.   

© 2012 RIJ Publishing LLC. All rights reserved.     

The Four Kinds of Financial Advisors

As people in the money biz know, financial advisors come in many flavors: Brokers, RIAs, fee-only, fee-based, dually licensed, etc. They differ in the way they’re paid and in the master they ultimately serve, whether it be a bank, their clients, or themselves.

In a presentation at The Wharton School last spring, fee-only planners Paula Hogan and Rick Miller showed that it’s also useful to think of advisors or planners in terms of the professional “paradigm” that they use, consciously or not, when working with their clients.

Advisors, they posit, use one of four paradigms. There’s the Traditional, the Life Cycle, the Behavioral (which tosses psychology into the mix) and what they call the “Advisor Experience” paradigm, where the advisor dons the robe of life counselor. 

While most advisors are still Traditionals (i.e., who focus on accumulation-stage investment advice), the combined impact of the financial crisis, Boomer retirement, the advent of behavioral economics and fee compression is forcing more advisors to evolve beyond the traditional approach.

Which kind of advisor are you? Are you strictly a “numbers guy”? Or do your clients share their dreams and self-doubts with you, and rely on you to help them realize their most personal ambitions?

Below you’ll find descriptions of Miller and Hogan’s four paradigms, taken directly from the essay they presented at the conference on “The Market for Retirement Financial Advice” sponsored by the Wharton School’s Pension Research Council and Boettner Center for Pensions and Retirement Research in Philadelphia in May 2012. Maybe you’ll recognize yourself in one or two of them.

Traditional Paradigm (The advisor as technician)

  • A planner steeped in the Traditional paradigm would focus on building a large portfolio using mainly the strategies of diversification and precautionary saving.
  • Financial risk would be tailored to the client’s perceived risk tolerance.
  • The Traditional advisor believes in the long-term safety of stocks, and typically recommends that clients “stay the course” in volatile markets.
  • If the client has too little savings, the advisor might propose ramping up risk to make up for a shortfall. If the client has a surplus, a traditional advisor would also encourage the client to ramp up risk.
  • To deal with longevity risk—the risk of outliving savings—the advisor would design a sustainable portfolio withdrawal program, most likely starting with a 4% per year withdrawal rate that rises with inflation each year thereafter.
  • The withdrawal strategy could include a buffer of several years of cash reserves, smoothed withdrawal rates and/or withdrawal rates that are adjusted in response to market valuations.
  • Long-term care insurance might be suggested as a complement to portfolio wealth.

 Life Cycle Paradigm (The advisor as strategist)

  • An advisor working from the life cycle point of view would add hedging and insuring to standard portfolio strategies in order to smooth consumption over a lifetime.
  • He or she would insist on tailoring the risk of the financial portfolio to the risk in the client’s human capital in addition to the clients risk tolerance and personal goals. She would ask the client to specify the timing and cost and relative importance of various life goals.
  • The Life Cycle advisor would be aiming, especially for the most important goals, to match assets and liabilities through some combination of TIPS ladders and immediate inflation-protected annuities. More aspirational goals would be funded by riskier investments strategies.
  • The Life Cycle advisor will start showing which goals can’t be fully funded in the case of too little wealth. When there is ample wealth, the Life Cycle Advisor will show how big the client’s legacy will be, given his or her current standard of living. The Life Cycle advisor will also suggest working shorter, longer, or differently as a core strategy.

 Behavioral Paradigm (The advisor as ‘framer’)

  • The advisor coming from the behavioral point of view would want to arrange for portfolio guarantees in order to address the client’s presumed loss aversion. She would also work hard to correctly frame decisions about how much portfolio risk to take and how to view portfolio performances.
  • The behavioral advisor would focus on annuitization strategies with downside protection guarantees paired with some upside potential, after sorting through the various biases of both the client and the advisor.
  • Unless the client has a friend or relative who needed custodial care in old age, the behavioral advisor will address the client’s presumed “denial and/or implausible expectations about aging” before developing the appropriate financial strategy.
  • The behavioral advisor will echo the Life Cycle ideas of changing the level of saving, risk taking, and work duration. To improve decision-making, he will also engage the client in a discussion designed to recheck the client’s values and her way of “framing” money issues. The advisor will ask questions like, “Are you sure there isn’t enough money for your well-being?”  

 Advisor Experience Paradigm (The advisor as life-coach)

  • In the trenches of the Advisor Experience paradigm, much time would be spent at the outset agreeing upon which of the four paradigms is in play and also discovering and resetting any preconceptions the client might have about risk and return expectations and benchmarking.
  • The Advisor Experience advisor will be ready with the strategies of changing the levels of saving, spending, working, and risk taking but will start with a values discussion. The client will be urged to ask him or herself:  What do I care about and value? Where do I find meaning and purpose? What are my money values? How can I align meaning and purpose with money habits? How do I bring about the personal change that I desire?
  • Implementation of the plan will be a personally developed action plan of measured small-step progress.
  • The Advisor Experience advisor has multiple roles, including counselor, information resource, technical expert, cheerleader, accountability figure and healer.

Advisors, of course, are free to choose which paradigm they want to follow. But Hogan (left) and Miller make it clear that every client relationship involves behavioral and emotional elements, whether the advisors decide to deal with them or not. To ignore them entirely would be to risk leaving part of the job undone, or perhaps even doing it badly.

Paula HoganThe authors don’t appear to favor one paradigm over another, but they imply that as advisors grow in sophistication and experience, they’re likely to graduate from the Traditional to the Life Cycle paradigm and then, depending on their own preference or level of interpersonal skill, to the Behavioral and Advisor Experience paradigms.

It’s no coincidence that this sort of self-examination is happening now in the advisor community. The financial crisis, the migration toward fee-based compensation, the arrival of the Boomer retirement phenomenon, along with need for individuals to take more responsibility for protecting themselves from health, sequence of returns, and longevity risks, are all pushing Traditional advisors toward the Life Cycle model, the two advisors told RIJ in a recent interview.

“The reason you’re seeing so much emphasis on this now is that people are living longer, and they’re more responsible for financing a longer life,” said Hogan, who is based in Milwaukee. “Their money has to last for a long time,” Hogan said.

Miller (right), whose firm, Sensible Financial, is based near Boston, agreed. “The Life Cycle model is just beginning to make in-roads in the profession. More advisors are recognizing its importance. The next wave is going to involve behavioral economics. Advisors are beginning to talk about that, but we’re not applying it in a systematic way.”

Rick MillerA retirement income-oriented advisor, almost by definition, has to adopt the Life Cycle paradigm, which emphasizes risk management, goal-setting, and asset-liability matching, as well as a greater awareness of the erosion of purchasing power by inflation over a long retirement.

“Where 10-year Treasuries have been thought of as the safe asset in Modern Portfolio Theory, the life-cycle perspective would suggest that the safe asset would be TIPS,” Miller added. “Secondly, if you think about your future retirement expenses as a liability, one way to fund that liability would be to use single premium annuity that’s indexed to inflation.”

The evolution from one paradigm to another implies an evolution in compensation models as well. Miller and Hogan don’t address that issue in their essay, but Miller commented on it during an interview. As advisors expand their services beyond product sales and even beyond asset management, they may need forms of compensation other than commissions or asset-based fees.  

“It’s useful to think of financial advice as a professional service,” he told RIJ. “So you would expect to see the compensation systems that you see in other professions, such as hourly rates or retainers, and less compensation that’s linked to transactions, and potentially even less linked to assets.” 

© 2012 RIJ Publishing LLC. All rights reserved.

Unconfirmed: Apollo nearest to acquiring Aviva U.S.

Apollo Global Management LLC is said to be in the lead to buy Aviva Plc’s U.S. life insurance and annuities unit, positioning the buyout firm to beat Philip Falcone’s Harbinger Group Inc., according to a report on Bloomberg.net. 

Apollo is bidding jointly with Guggenheim Partners LLC, Bloomberg said, quoting a source it did not identify. A sale would occur at a “substantial discount” to the unit’s book value, excluding debt, of 2.4 billion pounds or $3.8 billion, Aviva chief financial officer Pat Regan said last week.

Representatives at Aviva, Apollo, Guggenheim and Harbinger declined to comment on the deal, which is not completed and may still collapse. Aviva acquired most of its U.S. operations through the $2.9 billion purchase of Des Moines, Iowa-based AmerUs Group Co. in 2006.

Apollo, a private-equity firm run by Leon Black, last month boosted capital at its Athene Holding Ltd. annuity business by contributing assets valued at more than $800 million from a publicly traded fund it manages.

That infusion would enable Athene to acquire more annuity assets and eventually achieve enough scale to issue shares to the public, according to a presentation to investors.

Annuities are contracts issued by life insurers that offer tax deferral, guaranteed rates of return, death benefits and/or guaranteed income.

Apollo created Athene in 2009 and expanded in 2011 through the $628 million purchase of Royal Bank of Canada’s U.S. life insurance unit. Athene in July agreed to buy Presidential Life Corp. for about $415 million.

Aviva, the U.K.’s second-biggest insurer by market value, is selling or winding down almost a third of its 58 businesses, striving to get out of less profitable markets and boost capital reserves reduced by the European sovereign-debt crisis.

© 2012 Bloomberg.net.

After IPO, ING U.S. will start two-year rebranding effort

Between 2001 and 2012, ING U.S., the holding company for ING Groep’s financial services companies in the U.S., put a huge effort into building the strength of its brand, exemplified by campaigns highlighting the color orange, the Retirement Number, and the image of the Dutch royal lion.

That effort was highly successful. According to industry surveys, brand awareness for ING in the U.S. has grown dramatically, increasing from 11% in 2001 to 79% in 2012, according to a recent SEC filing.

But now that ING U.S. is separating from ING Groep—the U.S. holding company filed a registration statement last week with the SEC for an initial public offering of common stock—ING U.S. faces the task of creating a completely new brand.

ING U.S.’s future brand name hasn’t been disclosed, but the trademarked tagline will be “America’s Retirement Company,” according to the SEC registration statement. Whether it will be able to supplant entrenched retirement leaders like Fidelity and Vanguard remains to be seen. 

 “We plan to invest substantial resources to develop and build awareness of our new brand, based on our vision to be America’s Retirement Company™. We believe that strong brand recognition is the first step in reestablishing ourselves with all of our stakeholders as a standalone company,” the company said in a release last week.

According to the registration statement, ING U.S. has already developed a rebranding strategy, but doesn’t expect to “formally shift the majority of our advertising and marketing to our new brand name until 8 to 15 months” after the IPO. The rebranding process is expected to take about two years.

ING Group entered the United States life insurance market in 1975 through the acquisition of Wisconsin National Life Insurance Company, followed in 1976 with its acquisition of Midwestern United Life Insurance Company and Security Life of Denver Insurance Company in 1979. ING Group significantly expanded its presence in the United States in the late 1990s and 2000s with the acquisitions of Equitable Life Insurance Company of Iowa (1997), Furman Selz, an investment advisory company  (1997), ReliaStar Life Insurance Company (including Pilgrim Capital Corporation) (2000), Aetna Life Insurance and Annuity Company (including Aeltus Investment Management) (2000) and CitiStreet (2008).

Under the ING brand, these companies offer retail and institutional life insurance, retirement plans, mutual funds, managed accounts, alternative investments, institutional investment management, annuities, employee benefits and financial planning.

In its IPO registration statement, ING U.S. emphasized that it has taken steps to minimize the risks associated with its variable annuity closed block of business. ING was a leading seller of VAs with generous living benefits prior to the financial crisis, but de-risked as the crisis unfolded. 

“In 2009, we decided to cease sales of retail variable annuity products with substantial guarantee features (the last policies were issued in early 2010 and we placed this portfolio in run-off). Subsequently, we refined our hedging program to dynamically protect regulatory reserves and rating agency capital of the variable annuities block for adverse equity market movements. In addition, since 2010, we have increased statutory reserves considerably, added significant interest rate risk protection and have more closely aligned our policyholder behavior assumptions with experience.”  

The ING U.S. Retirement Solutions business acquired CitiStreet after the financial crisis to become, after Fidelity, the second largest provider of defined contribution retirement plans in the U.S., as measured by the number of plan sponsors and number of plan participants for which we provide recordkeeping services,” the registration statement said. “We are one of the few retirement services providers in the U.S. capable of using our industry presence and scale to efficiently support small, mid, large and mega-sized employers in the 401(k), 403(b) and 457 market segments.”

The spin-off of ING U.S. is just one of the steps that ING Groep N.V. has had to take to reimburse the Dutch government for bailing it out during the financial crisis. The Dutch insurer continues to cut costs internally. Last week, IPE.com reported that ING Groep will eliminate 1,350 jobs at its Dutch pensions insurer, Nationale Nederlanden. Jan Hommen, ING’s chairman, said the measures would save about €200m a year by the end of 2014.

© 2012 RIJ Publishing LLC. All rights reserved.

Citing capacity limits, Jackson will refuse incoming 1035 transfers for a month

Jackson National Life Insurance Company announced last week that it was “approaching the upper range for calendar year 2012 for total premium from variable annuities (VAs) that offer optional guaranteed benefits.”

Jackson estimated it has approximately $1 billion in remaining capacity. As in prior years, Jackson will manage the volume of its VA business commensurate with the overall growth of its balance sheet.

To manage sales volumes, Jackson said it will no longer accept new 1035 exchange business or qualified transfers of assets for VAs that offer optional guaranteed benefits as of 4 p.m. Eastern Standard Time on Tuesday, November 13, 2012.

As of December 15, 2012, Jackson will resume accepting new 1035 exchange business and qualified transfers of assets, if premium from new sales is less than $1 billion between November 13 and then.

No limitation will be placed on new 1035 exchange business or qualified transfers of assets for Jackson’s Elite Access product, which offers alternative investment options that whose potential volatility makes them unsuitable for guaranteed living benefits.

“We are proactively communicating with our distribution partners about Jackson approaching the high end of the range for 2012 sales of our very popular VAs that offer optional guaranteed benefits,” said Clifford Jack, executive vice president and head of retail for Jackson. “Our wholesaling and service teams are well-positioned to implement the necessary actions to limit production with minimal disruptions to our partners and their clients.”

This week, Jackson National Life reported $19.6 billion of total sales and deposits during the first nine months of 2012, driven by $15.3 billion of variable annuity (VA) sales.

VA sales were up 11.3% over the $13.7 billion in VA sales recorded during the first nine months of 2011. Sales of Elite Access totaled $630.1 million during the period from launch on March 5, 2012, through September 30, 2012. Excluding Elite Access, Jackson’s overall VA sales growth during the first nine months of 2012 was 6.8% year over year.

In the first nine months of 2012, Jackson completed the $663.3 million acquisition of SRLC America Holding Corp (SRLC) and remitted a $400.0 million dividend to its parent company, while ending the period with more than $4.1 billion of regulatory adjusted capital, according to a company release.

Compared to the same period of the prior year, fixed annuity sales of $713.5 million were up 34.5%, and FIA sales of $1.2 billion were up 13.5% during the first nine months of 2012.

Curian Capital LLC, Jackson’s retail asset management subsidiary, increased assets under management to $10.4 billion as of September 30, 2012, up from $7.3 billion as of December 31, 2011.

Jackson National Life is rated A+ (superior) by A.M. Best, AA (very strong) by Standard & Poor’s, AA (very strong) by Fitch Ratings and A1 (good) by Moody’s Investors Service.

© 2012 RIJ Publishing LLC. All rights reserved.

Nationwide adds TOPS managed volatility funds to VA line-up

Nationwide Financial has added four new managed volatility funds to its core VA line-up. Additionally, the company will add three fund options, including one managed volatility fund, for its guaranteed lifetime withdrawal benefit, The Nationwide Lifetime Income Rider (Nationwide L.inc).   

New funds for Nationwide’s core VA line-up include:

  • American Funds Insurance Series® Protected Asset Allocation FundSM
  • TOPSTM Protected Balanced ETF Portfolio
  • TOPSTM Protected Moderate Growth ETF Portfolio
  • TOPSTM Protected Growth ETF Portfolio

The American Funds Insurance Series Protected Asset Allocation Fund will also be available as a Nationwide L.inc investment option. Within the VA, the Protected Asset Allocation Fund can offers an equity allocation range of 40% to 80%, depending on market conditions, with a target mix of 60% stocks and 40% bonds.    

The Nationwide VA with Nationwide L.inc offers a 7% simple interest roll-up on the original income benefit base and a 5% payout if withdrawals begin at age 65.

Nationwide Financial will also add two non-managed volatility funds back to the Nationwide L.inc investment option line-up. Both offer 60/40 equity exposure:

  • NVIT Cardinal Moderate Fund
  • NVIT Investor Destination Moderate Fund

Experts with Unrealistic Expectations

The CEOs of many of the largest U.S. financial services companies sent an open letter to President Obama and Congress on October 18, urging them to resolve the “fiscal cliff” problem quickly and rein in the nation’s deficit spending.  

“We urge you to work together to reach a bipartisan agreement to avoid the fiscal cliff and take concrete steps to restore the United States’ long-term fiscal footing,” they wrote.

Signers of the appeal, which was written on the letterhead of the Financial Services Forum, included Steven Kandarian of MetLife, John Strangfeld of Prudential, John Stumpf of Wells Fargo, Lloyd Blankfein of Goldman Sachs, Jamie Dimon of JP Morgan Chase and 10 other CEOs.

In asking Washington officials to “avoid the fiscal cliff,” the executives presumably meant avoiding the currently scheduled reversion to Clinton-era tax rates on income, capital gains and dividends, as well as an automatic $120 billion-a-year cut in discretionary spending known as “sequestration.”

In the same letter, however, the CEOs asked the president and Congress to “restore the nation’s long-term fiscal soundness by negotiating policies that will produce a stabilization and then downward trend in the ratio of federal debt to GDP over the medium term.”

But, as New York Times columnist Paul Krugman recently pointed out, those two wishes are in conflict. At best, it sounds like a recommendation to “kick the can down the road.” The Congressional Budget Office has forecast that avoiding the fiscal cliff—that is, failing to raise taxes and lower spending—would contribute to unsustainable growth in the federal debt.

The request from the CEOs resurrects supply-side economic thinking, a dead theory that says lower income taxes lead to tax revenue-enhancing growth. That thinking has been called “voodoo” and “zombie” economics. It has been disavowed by some of its original proponents. There’s no grand bargain that can simultaneously soften the impact of the cliff in 2013 and lead to smaller deficits.   

The letter exaggerates the impact of the fiscal cliff. “Sequestration” would eliminate only 3% of next year’s budget; that’s a bump in the road, not a precipice. In its latest assessment, the Congressional Budget Office said, “If all of that fiscal tightening occurs, real GDP will drop by 0.5% in 2013…  That contraction of the economy will cause employment to decline and the unemployment rate to rise to 9.1% in the fourth quarter of 2013. After next year, by the agency’s estimates, economic growth will pick up, and the labor market will strengthen…”

That’s not ideal. But it’s not catastrophic. It would be more dangerous in the long run to avoid the cliff, according to the CBO. “In years beyond 2022, rising deficits under the alternative fiscal scenario [which assumes that the Bush tax rates and other measures are maintained indefinitely] would lead to larger negative effects on GDP and GNP and to larger increases in interest rates,” the CBO report said. “Ultimately, the policies assumed in the alternative fiscal scenario would lead to unsustainable federal debt.”

It’s wishful thinking to believe that the country can have gain without pain. And it’s disingenuous for the CEOs of major financial services companies—who can easily afford the haircut they’ll take when the Bush tax rates expire—to imply that we can.   

© 2012 RIJ Publishing LLC. All rights reserved.

A Man Without a Plan

During the United States’ recent presidential election campaign, public-opinion polls consistently showed that the economy – and especially unemployment – was voters’ number one concern. The Republican challenger, Mitt Romney, sought to capitalize on the issue, asserting: “The president’s plans haven’t worked – he doesn’t have a plan to get the economy going.”

Nonetheless, Barack Obama was reelected. The outcome may reflect the economy’s slight improvement at election time (as happened when Franklin Roosevelt defeated the Republican Alf Landon in 1936, despite the continuing Great Depression). But Obama’s victory might also be a testament to most US voters’ basic sense of economic reality.

Economic theory does not provide an unambiguous prescription for policymakers. Professional opinion in macroeconomics is, as always, in disarray. Because controlled experiments to test policy prescriptions are impossible, we will never have a definitive test of macroeconomic measures.

Romney had no miracle cure, either, but he attempted to tap into voters’ wishful-thinking bias, by promising to reduce the size of the government and cut marginal tax rates. That would work if it were true that the best way to ensure economic recovery were to leave more money on the table for individuals. But the electorate did not succumb to wishful thinking.

The idea that Obama lacks a plan is right in a sense: nothing he has proposed has been big enough to boost the US economy’s painfully slow recovery from the 2007-9 recession, nor to insulate it from shocks coming from Europe and from weakening growth in the rest of the world.

What Obama does have is a history of bringing in capable economic advisers. Is there anything more, really, that one can ask of a president?

And yet US presidential campaigns generally neglect discussion of advisers or intellectual influences. Although a president’s advisers may change, one would think that candidates would acknowledge them, if only to suggest where their own ideas come from; after all, realistically what they are selling is their ability to judge and manage expertise, not their own ability as economists. This time, too, however, there was no mention by name of any deep economic thinker, or of any specific economic model.

Obama originally had a wonder team of economic advisers, including Lawrence Summers, Christina Romer, Austan Goolsbee, and Cass Sunstein. But they are gone now.

Today, the most powerful economic adviser remaining in the White House is Gene Sperling, head of the National Economic Council, the agency created by President Bill Clinton in 1993 to serve as his main source of economic policy (somewhat shunting aside the Council of Economic Advisers). Because this position does not require Congressional approval, the president may appoint whomever he wants, without having his choice raked over the coals in the US Senate. That is why Obama could appoint the highly talented but politically unpopular Summers, the former president of Harvard University.

Sperling is not nearly so well known as Summers. But his record of influence in government is striking; indeed, he has been at the pinnacle of economic-policymaking power in the US for almost a decade. He was the NEC’s deputy director from its beginning in 1993 until 1996, and its director from 1996 to 2000. Obama reappointed him as head of the NEC in January 2011.

His 2005 book, The Pro-Growth Progressive, contains many ideas about how to make the economy perform better. None is grandiose, but together they might help substantially. Some of these ideas found their way into the American Jobs Act, which might have had some real impact had Congress passed it in 2011.

The AJA embodied some of what Sperling describes in his book: subsidies for hiring, wage insurance, and job training, as well as support for education and early learning. Moreover, the AJA would have offered some balanced-budget stimulus – the kind of stimulus that would boost the level of economic activity without increasing the volume of government debt.

But the public, despite its concern about unemployment, is not very interested in the details of concrete plans to create more jobs. Sperling is just not very visible to the public. His book was not a best seller: in commercial terms, it might be better described as a dud.

Sperling is fundamentally different from the typical academic economist, who tends to concentrate on advancing economic theory and statistics. He concentrates on legislation – that is, practical things that might be accomplished to lift the economy. He listens to academic economists, but is focused differently.

At one point in his book, Sperling jokes that maybe the US needs a third political party, called the “Humility Party.” Its members would admit that there are no miraculous solutions to America’s economic problems, and they would focus on the “practical options” that are actually available to make things a little better.

In fact, Americans do not need a new political party: with Obama’s reelection, voters have endorsed precisely that credo of pragmatic idealism.

© 2012 Project Syndicate.

Traitor VIX

Is the variable annuity industry coming or going? Will life insurers, after taking losses in the financial crisis, retreat into the comfort zone of the law of large numbers? Or have they learned enough about derivatives to stay at the Wall Street gaming tables?

One of the best places to look for straight answers to those questions, I’ve found, is the Equity-Based Insurance Guarantees conference hosted each fall by Toronto options expert K. (Ravi) Ravindran and the Society of Actuaries. The eighth annual EBIG meeting, held this week in Chicago, drew 195 actuaries and quants, up from 110 in 2005.

These perennial meetings help bring insurance company actuaries up to speed on derivatives and give banks and consulting firms a chance to tout their options expertise. Goldman Sachs, Deutsche Bank, Barclays, BNP Paribas and Credit Suisse represented Wall Street. Consultants included Milliman, Tower Watson and Aon Benfield. Actuaries and IT folks from Transamerica and Pacific Life shared front-line war stories. 

The experts’ answers to all three questions posed at the top of this story were “Yes.” Some insurers are staying in the game; they’re now hearing that the safest way forward is to put investors in volatility-controlled funds. Many have left the game; they’re learning that the risks buried in their existing blocks of business might still come back to haunt them.

While listening to the presentations—most of whose content, including terms like contango and backwardization, sailed far over my head—a couple of questions nagged at me. First, the design and maintenance of VA products is getting more complex and more expensive; is that a smart idea? Second, could the industry be gearing up to “fight the last war”? In a world ruled by Dodd-Frank and Solvency II, will market volatility be the biggest danger?

At this juncture, life insurers face a greed-fear quandary vis-à-vis VAs. The Fed’s open-ended financial repression policy argues in favor of hunkering down. But the presence of a huge and hungry market for guaranteed income products argues in favor of forging ahead.    

Indeed, opportunity continues to knock. “There’s a disconnect in the marketplace,” said Matt Zimmerman, who sells Milliman’s volatility-control hedge program. “VA providers are pulling back, but financial advisors and investors are clamoring for guaranteed income riders. One of the wirehouses, for instance, has massive demand coming on, and they want to add certain insurers to their shelf, but those insurers don’t have the capacity to take on that business.”    

How to proceed—safely

Companies that plan to keep selling variable annuities with guaranteed income riders will most likely require contract owners to invest some or all of their premia in volatility-controlled funds. That was a major takeaway from the conference.     

“The whole mantra is volatility-controlled funds and managed volatility funds,” said Ravindran in his opening comments on Monday. “It’s been of interest for a few years, but more writers are focusing on that, and you’ll be hearing a lot about that here.”

Those volatility-controlled funds, such as the TOPS funds that are now used by several insurers to manage the risks of variable insurance products, shift risk from the insurer to the investor. In the past, when an insurer hedged a VA, it held the options on its own balance sheet. That design led to losses during the financial crisis. In new “low-vol” funds, the funds themselves—i.e., the contract owners—hold the derivatives.    

“It’s a two component approach—volatility management and capital protection,” said Milliman’s Zimmerman, whose firm designed the dynamic hedging strategy in the TOPS funds.

“The volatility component involves buying inverse exchange-traded futures contracts, based on a major index, such as the FTSE, NASDAQ or Nikkei, and targeting about 10% volatility,” Zimmerman said. The capital protection strategy involves buying a five-year rolling equity put for each subaccount, which replicates a five-year rolling maturity put option on the portfolio. (See RIJ’s December 2011 story on “Airbag-Equipped Annuities.”)

“That strategy would be too expensive on its own, but it isn’t as expensive when you couple it with volatility management,” he added. “There’s a little over $1 billion in those funds now, and that will increase with launches next May. We think that employing protected accounts will become the norm for this market.” It remains to be seen, however, whether those low-vol funds are able to capture enough upside to keep advisors and clients happy.

How to stop the bleeding

What about the life insurers that are retreating from VAs? If they have a large legacy block of contracts with generous riders, their worries aren’t over. They still face market risk, longevity risk, and policyholder behavior risk on their guarantees.

Longevity risk is a major wild card, said Tim Paris of Ruark Insurance Advisors. He recommended that companies look into reinsurance for the longevity risk in their legacy blocks. While reinsurers have largely left the VA market, he said, coverage for the longevity risk component is available. 

“Variable annuity mortality doesn’t follow the standard mortality tables,” Paris said. “People who elected the death benefit ratchet had 20% higher than average mortality, but people who elected a rich living benefit had 20% lower mortality. Those selection effects were magnified by policy size. A policy of $250,000 or more tended to be the smart money; the smaller policies were not quite as savvy.”

The month-to-month fluctuations in mortality among VA owners can be significant—and ill timed, Paris said. “We looked at monthly mortality as a percentage of Ruark’s [proprietary] mortality tables over 84 months and found them to be as low as 50% of average and as high as 170% of average. We saw similar numbers across eight or nine insurance companies. That’s a lot of volatility.

“What matters even more is the interaction of this pattern with the net amount at risk at any given time,” he added. “If you hit 50% of expected mortality when the excess benefit was $1 billion, you’d make money. But if you hit 170% when the amount at risk was $1 billion, you’d have lost even more.”

Policyholder behavior is even less predictable than mortality rates. So far, no clear pattern has emerged in the utilization rate of the income guarantees. “Over the next couple of years, we’ll see a lot of GMIBs (guaranteed minimum income benefits) reaching the end of the accumulation period,” Paris said. “We’ll learn a lot about policyholder behavior then.”

Addressing another legacy block issue, executives from Transamerica—which has offered to buy back in-the-money riders from contract owners as a way of trimming excess risk from its VA block—described the difficulty of building and maintaining a system that can accurately assess the risks in a large block of VA contracts with living benefit riders.

“A barebones variable annuity is a complicated set of derivatives. Just to price one policy you’re talking about hundreds of variables,” said an IT executive at Transamerica, which has about 700,000 VA policies worth $55 billion. “As I dug into the products, I was shocked at the various forms of risk.”  

Aside from modeling risks, those systems also have to generate reports that senior executives can readily interpret and act on. That’s a significant task in itself. “Having information systems that funnel information upward and consolidate data in a decision-friendly way is increasingly important, because C-suite managers are more involved [in the VA business segment] at this point,” said Cornelia Spiegel of Deutsche Bank.

‘The only game in town’

“Should we de-risk or focus on growth? That’s the big question,” said Spiegel, in an overview of the cross-currents in the VA market. “On the one hand, you have 10,000 boomers turning 65 each day, and a generation of 107 million coming in after them.  Seventy percent of their assets are in retirement related products.

“On the other hand, we have capacity constraints,” she added. “The product is still complex. Reserving is expensive. Interest rates are low. What is a comfortable level of sales? It’s a challenging balance. In the long run the industry outlook is positive, especially as we roll out new products, and as long as we can insulate ourselves from the risks in the legacy books.” Asked if optimism about the VA market was truly justified, she said, “No other product gives you principal protection and lifetime income. It’s the only game in town.”

© 2012 RIJ Publishing LLC. All rights reserved.

ABB ordered to post $50m bond due to 401(k) violations

In the latest order involving Fidelity Investments and ABB’s conduct in the ABB 401(k) Plan, U.S. District Court Judge Nanette Laughrey ordered ABB to post a $50 million bond to protect ABB employees and retirees, the plaintiff’s attorney said in a press release. According to the release:

The company was ordered to post the bond within ten (10) days while it appeals a $50 million judgment against it and Fidelity Investments, which was previously entered.  This judgment found ABB and Fidelity to have used employees’ retirement assets for their own benefit, in violation of the Federal law which protects the safety of 401(k) retirement assets.

Jerome Schlichter, of the St. Louis law firm of Schlichter, Bogard, & Denton, LLP, said in a statement:

“The Court required a $50 million bond to protect the retirement assets of ABB employees and retirees after Fidelity and ABB were ruled to have used them for their own corporate interests. These were assets of the employees and did not belong to Fidelity or ABB. The Court also made clear that Fidelity and ABB are liable for additional damages if they continue to use ABB employees’ retirement assets for their own benefit.”

ABB was also ordered previously to reform the 401(k) plan and to put out a request for proposals to replace Fidelity Investments as recordkeeper of the 401(k) plan; to monitor recordkeeping costs and negotiate for reasonable costs; to stop using Fidelity to provide its corporate services while using Fidelity as the employees’ 401(k) plan recordkeeper; to choose investments with low expenses; and to manage the 401(k) plans solely for the benefit of employees and retirees, not for its own benefit. The Court also ordered Fidelity to avoid taking income earned by the employees’ and retirees’ assets for its own purposes.

The Court also stated that is “does not believe ABB is likely to succeed on appeal” and that any additional damages to the employees and retirees from violations “can be remedied with a monetary award and additional attorney’s fees.”

 

Lack of Social Security savvy will be costly: BMO

Many American retirees risk losing a significant amount of retirement income because they poorly understand their Social Security benefits, according to a new report from the BMO Retirement Institute.

The report, “Retirees Not Maximizing Social Security Retirement Benefits,” showed that many retirees are taking their benefits too early and aren’t aware of options and strategies that may raise their benefits.

While 91% of respondents to a BMO survey understood that waiting longer increases the monthly amount they will receive, almost half admitted they are currently collecting or planning to collect before full retirement age, the report said. Couples are particularly vulnerable since a claim impacts both for their combined lifespan and can significantly affect spousal and widow benefits.

The report also revealed several factors that influence when people begin taking Social Security:

Too many decisions: Since so many decisions take place at retirement it appears that too many options can result in confusion and paralysis, pushing many people to take Social Security early by default.
Lack of knowledge: Half of Americans (52%) are not knowledgeable about general strategies to maximize Social Security benefits and 62% have not actively looked for information. Sixty percent have not discussed their Social Security decision with anyone.
Doubts about Social Security: More than 80% of Americans doubt Social Security’s viability, even though the program is solvent well into the 2030s. 

Spousal benefit: Almost half (49%) of those surveyed say they lack knowledge about spousal benefits and 56% are uninformed about widow benefits. Under Social Security rules, a person can receive up to 50% of a spouse’s benefit and a widow can receive 100% of a deceased spouse’s benefit.

To view a copy of the full report, please visit: www.harrisbank.com/retirementinstitute.

© 2012 RIJ Publishing LLC. All rights reserved.

Retirement insecurity rose from 2007 to 2010, academics say

The National Retirement Risk Index (NRRI) rose to 53% in 2010 from 44% in 2007, according to the Center for Retirement Research (CRR) at Boston College. The ongoing tracking of the NRRI by the CRR is sponsored by Prudential Financial.

The Index calculates the percentage of U.S. households at risk of falling short of maintaining their pre-retirement standard of living in retirement, based on their projected replacement rates (their retirement income as a percentage of pre-retirement income).

As of 2010, the latest report shows, more than half of today’s households will fail that test, even if they work to age 65 and annuitize all of their financial assets, including the receipts from a reverse mortgage on their homes.  

The financial crisis contributed to an already difficult situation for many pre-retirees, the CRR study shows, through “the combined effect of poor investment returns, lower interest rates, and the continuing rise in Social Security’s Full Retirement Age.” The report also showed that:

  • The length of retirement is increasing [because] the average retirement age hovers at 63 and life expectancy continues to rise.
  • Median 401(k)/ IRA balances for households approaching retirement were only $120,000 in 2010, according to the Survey of Consumer Finances.
  • Asset returns in general, and bond yields in particular, have declined over the past two decades so a given accumulation of retirement assets will yield less income.
  • The decline in interest rates through its impact on annuity prices worsens the NRRI. A retiree with $100,000 will receive $492 per month from an inflation-indexed annuity when the real interest rate is 3% compared to $413 per month when it is 1.5%. (The NRRI assumes that retirees will annuitize financial assets, 401(k) balances, and home equity.)

© 2012 RIJ Publishing LLC. All rights reserved.

Celent: Stop gaming the system

A new report from Celent, the global research firm, uses unusually blunt language in calling for more probity in financial services, saying that “the global economy is not set up simply for the financial industry to benefit from, and if necessary, sacrifice.”

The October 31 report, Malpractice in Capital Markets: Changing the Organizational Blueprint, by Celent’s Anshuman Jaswal, adds that, “If anything, it is the industry that is set up for the economy to meet its requirements and goals. The service-centered focus of the financial markets has to be restored. This is something that has been lost in the last few decades.”
The report found that:

  • “The events leading to the financial crisis were not outlying occurrences.” It was believed that the global financial crisis was caused in part by the repeal of the Glass-Steagall Act and the resulting tendency on part of large financial conglomerates to engage in high levels of speculation using complex derivatives. But the Libor-rigging case and similar instances show that there have been ongoing instances of market manipulation in the last couple of decades and the events leading to the financial crisis were not outlying occurrences.
  • “The systemic occurrence of market manipulation have negated the earlier idea that… corruption was only at the large corporate level and did not affect the layperson as much.” The recent case filed in New York by a group of US homeowners against the Libor-fixing banks possibly illustrates how the systemic corruption actually affected people in all parts of the society and was not confined to just one part of the economy or one country.
  • “A siloed approach for encouraging ethical employee behavior” may be to blame. If firms want to incentivize ethical behavior, they have to make it an essential part of employee induction and training and also remunerative practices. Trading firms should create proper safeguards to ensure employees know what the limits of risk-taking are.
  • Organizational malpractices shouldn’t “compromise the very economies firms are a part of.” Financial market participants have been making efforts in this area, but these have focused on fire-fighting and preparing for upcoming regulatory requirements.
  • The argument for a zero tolerance policy has its roots in the grassroots support for action against financial institutions in the leading global economies, especially in the US and Europe. The Occupy movement in the US and the Spanish Indignants movement show the general public’s displeasure at the way the financial crisis came about and was dealt with.
  • “The global repercussions have been severe.” Even though the crisis unfolded in a select band of developed nations, 5% and 10% of the population of some developing countries may have gone back into poverty due to the economic effect of the crisis in those countries. Growth rates for China and India have still not recovered and are following a lower trajectory.
  • The crisis undid the good work of the previous two decades in a number of the poorer countries around the world and made the situation more difficult for citizens of the US and the nations in the European Union.
  • Further changes have been recommended, including looking at the size of financial institutions worldwide. Accountability and transparency can suffer when an institution is very large. If banks and other large financial institutions were smaller, regulators could monitor them more efficiently. But this is not a simple trade-off and requires further research.
  • “The financial industry needs to change its psychological blueprint,” and prevent overwhelming domination by certain groups of individuals, perhaps by hiring different types of individuals and reviewing the places or institutions they are hired from.
  • Firms have to put checks and balances in place to encourage and incentivize healthy practices. Self-regulation by organizations must go beyond normal risk mitigation. The industry needs to understand the impact that malpractice and corruption have on not-so-obvious stakeholders and society at large.

© 2012 RIJ Publishing LLC. All rights reserved.

SEC: VA closures, buybacks send wrong message

In late 2011, when word first trickled out that some life insurers might try to de-risk their books of variable annuity business by encouraging owners of contracts with rich riders to exchange them for less risky new ones, observers wondered how the SEC might react.

Similar concerns arose last summer after the decision by several of the largest VA writers to block new contributions to contracts that were purchased a few years ago, when living benefits were rich.

The carriers involved in the closures included Allianz, AXA, John Hancock, MetLife, Prudential and Transamerica, according to Morningstar’s third-quarter variable annuity update.

[Last week, the Associated Press reported that Hartford Financial Services Group has offered some of its annuity clients cash for their contracts. “We are making this offer because high market volatility, declines in the equity markets and the low interest rate environment make continuing to provide the Lifetime Income Builder II rider costly to us,” Hartford said in a Securities and Exchange Commission filing last Thursday. CEO Liam McGee said during a conference call on Friday that the offer will be made to annuity holders that make up almost 45% of the net amount at risk on the contracts.]

The SEC has since taken notice of the situation, according to an attorney who is a consultant to life insurers. One of its responses has been to approach the major insurers and ask them to answer eight questions about the prospectuses of the contracts that were closed to subsequent contributions, or sub-pays, and whether they had properly disclosed their right to shut off contributions. The SEC delivered the questions orally, but asked for written answers, the attorney said.

Both of these issues—the exchanges and the closures—were addressed by Norm Champ (below right), the director of the SEC’s Division of Investment Management, in a speech at the ALI CLE (American Law Institute-Continuing Legal Education) 2012 Conference on Life Insurance Company Products in Washington, D.C. on November 1.

In prepared remarks, Champ articulated the same concerns that a few VA distributors voiced months ago. He urged life insurers to prevent the current situation in the future by risk-testing their products more thoroughly before marketing them to the public.    

Norm Champ“The [SEC] staff has noted that several recent filings announced companies’ decisions to stop accepting additional purchase payments on outstanding contracts,” Champ said. “In most cases, the affected contracts were those with a living or death benefit that appears to have been too generous for the issuing insurer to maintain in a sustained environment of low interest rates and volatile equity markets.

“These actions may have surprised some investors who had hoped to fund their retirement income over time through ongoing purchase payments, including established automatic purchase plans.

“Regardless of whether any or all of the companies had effectively reserved the right to suspend payments, one has to question the message this course of action sends to investors in these products generally. I fear the message might read something like this: ‘Here is the deal we are offering you, unless we find out later that we miscalculated, in which case you may have to go elsewhere to build annuity value and possibly pay a surrender charge on your investment with us on your way out.’ ”

On the question of life insurers offering to exchange new contracts for existing contracts with rich benefits, Champ said:

“Several issuers of variable annuities, again generally those with generous living benefits, have recently made exchange offers for newer contracts that do not feature those benefits. Some insurers have also offered inducements, such as cash bonuses, to contract owners who surrender their contracts or terminate living benefit riders.

“These actions raise questions about the suitability of both the original transaction and the exchange, where the original transaction was perhaps premised on the value and importance of the living benefits and the exchange removes or reduces those same benefits.

“A careful consideration of the risks associated with the design of any product could assist in avoiding the scenarios playing out now. Going forward, the Division urges you to keep in mind steps you may have to take in the future to limit your risk, think through how this affects your customers, and consider how you can make your customers aware of the risks they may face with the product you are selling them.”

The eight questions that the SEC sent to variable annuity issuers asked them to identify the contracts that were being closed to new payments and to identify the specific prospectus language that supported the closure, and whether the decision to block new contributions had been vetted by an attorney. The questions also sought to identify the exact dates when the products were sold and the dates when prospectus language was added.  

Asked what might occur if the prospectus didn’t support the closures, the attorney said, “The SEC could bring an action against the company that had no contractual right to do it. There could be fines, and if the prospectus was false and misleading, and if the SEC can show that it was willful, the fines can go up.”

In other comments, Champ noted that the Investor Advisory Committee, created by the Dodd-Frank Act, had recently published its first recommendations on the general solicitation in Rule 506 of Regulations D offerings. This year’s JOBS Act requires the SEC to lift the ban on general solicitation and advertising in Rule 506 private placements. The ban had confined hedge funds and private equity firms to promoting securities only to “accredited investors,” such as wealthy investors and institutions.

The Insured Retirement Institute issued a press release Monday praising Champ for a part of his speech where he favored the development of a summary prospectus for variable annuities. Champ noted that a recent financial literacy study showed that investors liked the mutual fund summary prospectus.

In a release Monday, IRI President and CEO Cathy Weatherford said, “We are encouraged by Director Champ’s remarks and agree with his optimism that a variable annuity summary prospective would benefit investors by providing better information. “There remains a strong demand by investors for clear and concise variable annuity information. IRI research shows that 95% of investors prefer a shorter paper summary prospectus. As it stands today, the length of the full prospectus—in and of itself—is a barrier to investor education and informed decision making.

“Only 17% of investors reported reading any part of the full prospectus in 2012. And even among those that have, they are only reading a small fraction of the full prospectus, which often times can be between 150 to 300 pages long. The research is clear that now is the time for a summary prospectus to facilitate more informed decision-making.”

© 2012 RIJ Publishing LLC. All rights reserved.

Sampling the Breakfast Buffett at NAPFA

It’s safe to say that most if not all of the advisors attending the NAPFA East conference in Baltimore admire Warren Buffett, the “Oracle of Omaha.” So when Buffett biographer Alice Schroeder rose to give the first keynote address Wednesday morning, the Hilton ballroom grew hushed.

Schroeder shared her insights into Buffett’s investing style, and I’ll relate those comments in a moment. First, let me pass along Schroeder’s investment tips.

“The great growth industry of the 21st century will involve risk management and risk mitigation,” she said. “I don’t mean derivatives. I mean insurance. I mean esoteric businesses like staffing companies—businesses that take the risk of having employees off of other companies’ balance sheets. Risks are going to grow, but the sophistication of handling risks will grow even faster.

“The second big trend, and one that’s underrated by economists, is what’s happening in the digital scientific world. If you hang with West Coast venture capitalists, you will find out that all of us will soon have 3-D printers that will let us do things like design our own shoes and make them at home. Someone has already designed an artificial intelligence doctor that diagnoses more accurately than a human doctor.

“You should be short ‘stuff,’ she said. “Be short on the people who make Hummel china, and the stores that retail that kind of stuff. The generation behind us, those who are 35 and under, they don’t want stuff. They don’t want antiques or art. Younger people have digital collections, like photographs, apps, games, and they want disposable furniture and clothes. Just as our 19th century robber barons hauled old stuff back from Europe, people in Shanghai will be carting home old stuff from the U.S. Your grandmother’s good china will be going to China.”

‘Warren likes cash’

Getting back to Buffett: I haven’t read Schroeder’s bestseller about the great investor, “The Snowball: Warren Buffet and the Business of Life” (Bantam, 2008). So I can’t say if it improved on Roger Lowenstein’s masterpiece, “Buffett: The Making of an American Capitalist,” (Random House, 1995) which revealed how Buffett had a huge cash hoard when the DJIA dropped to 577 at the end of 1974, and took full advantage of what turned out to be historic bargains.

But Buffett clearly allowed Schroeder almost unlimited access for this authorized biography, so she had ample opportunity to observe him up close. She described his ability to shut out distractions, his brown-on-brown corner office like the “inside of a cuckoo clock,” his belief that “valuation is the ultimate protection against risk” and that “you don’t have to worry about the future if you don’t overpay for an asset.”  

What impressed Schroeder most was Buffett’s attitude toward cash. Her conclusions were consistent with Lowenstein’s.

“Most money managers are under pressure not to hold cash, because it doesn’t earn anything. But Warren likes cash. He likes having it around him. He would bathe in cash. He thinks of cash as a call option on every asset class, with no strike price and no expiration date. The premium for the option might be high or low, depending on the interest rate, but that doesn’t matter to him.

“Berkshire Hathaway currently has $47 billion in cash, and Warren feels like he has a huge cash option on whatever happens in the economy. Everyone wants to know where the economy is headed. But an investor’s real goal, he thinks, is to exempt yourself from it and make it not matter. He wants to be in a position to take advantage of any economy. He never wants to feel like he’s corralled. He’s the only person I ever knew who has thought about cash in quite that way.”

Election hangover

Schroeder’s upbeat attitude was just the tonic that NAPFA advisors seemed to need Wednesday morning. Judging by a random sampling of opinions, few of them were celebrating the Obama victory. The people I spoke to would rather have watched the bubble economy deflate than see it kept afloat with stimulus and bailouts that, they bleakly suspect, will lead to higher taxes, inflation and slower growth.

And then, of course, there’s the buzz-killing fiscal cliff, “sequestration” and the expiration of the Bush tax cuts.  

One advisor was thumbing through the e-mail on his smartphone screen and sipping his first coffee of the day. I asked him to tell me the most pressing issue on his mind, investment-wise, given that the Democrats had retained the presidency and the Republicans still dominated the House.

His biggest challenge, he said, will be to protect his clients from the impact of the coming inflation. The trillion-plus dollars sitting in excess bank reserves at the Fed will eventually be loaned out, he believes, and inflation will follow.  

What about bonds, I wanted to know. When bondholders start demanding better returns on government debt, he said, the prices of existing bonds will fall. Boomers’ savings will evaporate just as the cost of living soars. And prices will inevitably soar, he said, because the Chinese will soon be paying their workers much more and passing the costs on to us.

For inflation protection, he has adopted what he calls a “Depression era strategy.” He’s begun recommending utilities to his clients. More specifically: he likes those trendy master limited partnerships that own gas transmission lines.  

But wait. If the Great Depression was characterized by deflation, I asked, why use a Depression strategy against inflation? “Do you remember the ’70s?” he asked rhetorically. He expects a return of stagflation, that limbo of rising energy costs and falling corporate profits that made the 1970s a dead zone for equity investors.

The most, or I should say, the only positive note that I heard about the election outcome was sounded by an advisor from Rochester, N.Y., who seemed to be glad that the Affordable Care Act won’t be repealed. It will make it easier for some of her clients to retire before age 65, she said, because the universal mandate will make individual health insurance policies cheaper.

Of course, we may never know just how painful it would have been to let the financial crisis run its course, and to let the zombie banks and inefficient automakers die a more or less natural death. I imagine that the Oracle of Omaha, with his $47 billion war chest, would have emerged from the wreckage that much richer.

© 2012 RIJ Publishing LLC. All rights reserved.

Fees will soon rise on several VA contracts: Morningstar

Variable annuity carriers filed 106 annuity product changes in the third quarter of 2012, making for an active period according to Morningstar’s third-quarter annuity product update. This compares to 168 new filings during the second quarter of 2012 and 40 in Q3 of last year.

Morningstar took notice of the fact that some VA carriers are eliminating add-on payments, also known as subsequent payments or “sub-pays.” The carriers who recently limited additional investment dollars into existing contracts and benefits include Allianz, AXA, MetLife, John Hancock, Prudential and Transamerica.

New York Life re-entered the individual VA market after a long hiatus, Morningstar said, referring to the firm’s Income Plus product. The product was issued as a variable annuity with an optional guaranteed minimum income benefit rider and as a deferred income annuity.  

Product changes that Morningstar said were in the “pipeline” included:

  • In October Allianz is raising the fixed percentage step up to 6% from 5% on the Income Protector GLWB. The simple interest is credited quarterly before the first withdrawal (or age 91). The change applies to new sales.
  • Fees will increase on six different Genworth benefits to 1.25% on December 3rd.
  • Jackson National is dropping 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.
  • John Hancock is closing 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, purchase payment restrictions were added to multiple JH Venture contracts on October 15th.
  • Lincoln 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) or 85 bps to 100 bps (joint). In addition the withdrawal percentages for Lifetime Income Advantage 2.0 will change, though new age bands were not specified. The changes are effective in December 2012.
  • Nationwide is launching a new I-share contract (Destination Income) on November 15th. The fee is 70 bps and it carries a lifetime withdrawal benefit (100 bps).
  • Protective is increasing the fee for Protective Income Manager to 1.20% (1.30% under the RighTime option) effective December 10th. SecurePay R72 is closing, to be replaced by a new SecurePay benefit with a different roll-up percentage that was not specified in the supplemental filing.
  • On October 1st Pacific Life will increase fees on multiple versions of its CoreIncome Advantage benefits. Fees increases ranged from 10 to 20 bps.
  • The RiverSource Accumulation Protector Benefit (multiple versions attached to different contracts) fee increases to 1.75% on October 20th.

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