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‘Buckets of Money’ advisor Ray Lucia Sr. charged by SEC

Posted on September 13, 2012 by -

The Securities and Exchange Commission today charged an investment advisor, author, and syndicated radio personality for spreading misleading information about his “Buckets of Money” strategy at investment seminars that he and his firm hosted for prospects.

The SEC’s Division of Enforcement alleges that investment adviser Ray Lucia, Sr. claimed that the wealth management strategy he promoted at the seminars had been empirically “backtested” over actual bear market periods. Backtesting is the process of evaluating a strategy, theory, or model by applying it to historical data and calculating how it would have performed had it actually been used in a prior time period.

Lucia, who lives in the San Diego area, and his company formerly named Raymond J. Lucia Companies Inc. (RJL) allegedly presented a lengthy slideshow at the seminars indicating that extensive backtesting proved that the Buckets of Money strategy would provide inflation-adjusted income to retirees while protecting and even increasing their retirement savings. However despite the claims they made publicly, Lucia and RJL performed scant, if any, actual backtesting of the Buckets of Money strategy.

“Lucia and RJL left their seminar attendees with a false sense of comfort about the Buckets of Money strategy,” said Michele Wein Layne, Regional Director of the SEC’s Los Angeles Regional Office. “The so-called backtests weren’t really backtests, and the strategy wasn’t proven as they claimed.”

According to the SEC’s order instituting administrative proceedings against Lucia and RJL, they held the seminars highlighting their Buckets of Money strategy in an effort to obtain advisory clients who would be charged fees in return for their advisory services. They promoted the seminars on Lucia’s radio show and on Lucia’s personal and company websites.

According to the SEC’s order, a backtest must utilize actual data from the time period in order to get an accurate result. Lucia and RJL have admitted during the SEC’s investigation that the only testing they actually performed were some calculations that Lucia made in the late 1990s – copies of which no longer exist – and two 2-page spreadsheets.

According to the SEC’s order, the two cursory spreadsheets that Lucia claims were backtests used a hypothetical 3% inflation rate even though this was lower than actual historical rates. Lucia admittedly knew that using the lower hypothetical inflation rate would make the results look more favorable for the Buckets of Money strategy. These alleged backtests also failed to account for the negative effect that the deduction of advisory fees would have had on the backtesting of their investment strategy, and their “backtesting” did not even allocate in the manner called for by Lucia’s Buckets of Money strategy. The slideshow presentation that Lucia and RJL used during the seminars failed to disclose the flaws in their alleged backtests and was materially misleading.

According to the SEC’s order, Lucia and RJL also failed to maintain adequate records of the backtesting as they were required to do under an SEC rule. The pair of 2-page spreadsheets was the only documentation of their backtesting calculations, and those spreadsheets failed to duplicate their advertised investment strategy.

The SEC’s order finds that RJL violated Sections 206(1), 206(2) and 206(4) of the Investment Advisers Act of 1940 and Rule 206(4)-1(a)(5) thereunder. The order finds that Lucia willfully aided and abetted and caused RJL’s violations of Sections 206(1), 206(2) and 206(4) of the Advisers Act and Rule 206(4)-1(a)(5) thereunder. The SEC’s Division of Enforcement is seeking financial penalties and other remedial action in the proceedings.

The SEC’s investigation was conducted by Peter Del Greco of the Los Angeles Regional Office. John Bulgozdy will lead the litigation. Bryan Bennett and John Kreimeyer conducted the SEC examination that prompted the investigation.

The IRI Conference, Annuities and the American Way

Posted on September 13, 2012 by -

The Insured Retirement Institute’s 2012 meeting in San Diego was pretty good, considering the prospect of the “fiscal cliff,” the fact that variable annuities have proven not to be the salvation of the life insurance industry and the fact that the IRI, a lobbying organization, will have its hands full if Barack Obama wins in November.

Since it molted its original NAVA skin four years ago, the IRI has broadened the scope of its membership to include a wider range of annuity issuers, asset managers and distributors. The membership now includes 150,000 advisors, said outgoing IRI chair Lynne Ford; that’s almost double the level of a year ago.

The IRI now focuses on sales of all types of annuities—a product category that, according to a Cogent Research presentation, only 5% of non-annuity owners say they understand well. The conference featured panels on variable, fixed indexed and deferred income annuities, a panel on how annuity manufacturers are supporting advisors, and a panel specifically devoted to the topic of variable annuity “capacity.”

The 300 or so attendees, most of whom appeared to be senior executives or managers, also heard lots of high-level talk. There was a judiciously partisan political oration from Haley Barbour (see below), a big-picture view of the markets from David Kostin of Goldman Sachs (see today’s cover story) and a stratospheric view from Peter Diamandis, creator of the Ansari X Prize, which helped jump-start the private suborbital spaceflight industry.

*         *         *

The capacity (or shortage thereof) of variable annuity issuers to meet market demand has been widely discussed this year, but a panel of VA issuers, led by Prudential Financial’s Bruce Ferris, seemed to agree that, for them, capacity still isn’t a problem.

“Supply and demand are equal. Everybody who wants [a variable annuity] has been able to buy one,” said Randy Freitag, chief financial officer at Lincoln Financial Group, a perennial top-10 VA seller. Even at current interest rates “we can still put out a product that speaks to consumers and shareholders,” he said.

Similarly confident was Michael Reardon, CFO at Forethought Financial Group, which is in the process of taking over The Hartford’s variable annuity business. “It’s a wonderful time to get into this product,” he said.

Transamerica, which has sought to buy back some of the variable annuity contracts it sold during the mid-decade boom, “has lots of capacity at the right price and the right product design,” said Thomas Swank, president and CEO, Individual Savings & Retirement at Transamerica.

The panelists were asked what might happen if the variable annuity industry gets its wish and a large portion of the 80% of advisors who don’t currently sell variable annuities starts selling them. “We have $1.6 trillion in total assets,” the audience member said. “Can we handle $5 or $6 trillion?”

The answers, like VA income riders themselves, were hedged. “Markets will find a way to absorb that,” said Reardon. Swank suggested that would be a nice problem to have. On another topic entirely, Scott Stolz of Raymond James asked if “the deterioration of products” was over? Freitag assured him that “large-scale changes are behind us.”

Insurers can’t be blamed for wanting to hang on to VA/GLWB. By most accounts it’s a very profitable profit that’s capable of generating revenue from its insurance riders as well as from its mutual fund subaccounts.    

On the other hand, the product seems to need a bull market in equities and healthy corporate bond spreads to generate enough revenue to provide profits for shareholders, inflation protection and longevity protection for contract owners, and attractive incentives for intermediaries.

The Bush-tax-cut/Iraq-War bull market helped the industry punch all of those buttons—temporarily. Since then, the financial crisis and the low-rate environment have demonstrated how hard it is to keep all those promises: hence the smaller sales goals and departures from the industry.

Still, perennial optimists like Prudential’s Ferris (“the glass is half full”) maintain that the Boomer aging trend is still the industry’s friend, that short-term market volatility doesn’t reflect or seriously affect the affordability of the GLWB’s long-dated liabilities, and that companies who design these products right will do well selling them. 

*         *         *

Two insurance company executives, Bill Lowe of Sammons and Al Dal Porto of Security Benefit stopped to chat with RIJ during breaks between general sessions of the conference.   

Dal Porto, an actuary who came out of Ernst & Young’s retirement practice (where he worked for Chris Raham) to become senior vice president, head of Retail Retirement, at Topeka-based Security Benefit two years ago, explained the company’s strategy on variable annuities and fixed indexed annuities.

A unit of Guggenheim Partners, Security Benefit sells fixed indexed annuities through banks and broker-dealers. Its Secure Income FIA was second only to New York Life’s Lifetime Income Annuity in sales in the second quarter of 2012, according to Beacon Research. No Security Benefit product had made it into the top five sellers before. 

On the VA side, Security Benefit is selling a no-living benefit variable annuity with 200 investment options. Like Jefferson National’s product, it’s designed for advisors who want the freedom to tactically reallocate without worrying about short-term tax consequences. Security Benefits’ rating (a B++ strength rating with stable outlook from A.M. Best) effectively prevents it from competing against A-rated issuers in the market for VAs with guaranteed lifetime withdrawal benefits.

The de-risking of variable annuities and retrenchment by former leading issuers of VAs, however, has created an opening for FIAs with living benefits, and Security Benefit has an FIA with a GLWB that’s designed for that opening.

“We’re seeing a shift in the FIA space because of the capacity issues in the VA marketplace,” Dal Porto said, noting that broker-dealers are willing to run FIAs with GLWBs through the same suitability process that they use for VA/GLWBs: “Many allow their reps to sell the FIAs away [from the broker-dealer], but they want to do the suitability on FIA sales.” Security Benefit is also planning to introduce a single-premium income annuity sometime next year. 

*         *         *

While Security Benefit is wholly owned by Guggenheim Partners, Guggenheim Partners is one-third owned by the Sammons Financial Group, whose members include Midland National Life, North American Co. for Life and Health Insurance, Sammons Securities, Sammons Financial Network and Sammons Retirement Solutions Inc. So it’s not surprising that the sales strategy at Sammons echoes the strategy at Security Benefit.

Bill Lowe, president of Sammons Retirement Solutions, spoke with RIJ about Sammons’ LiveWell variable annuity. Instead of living benefits, this product offers hundreds of non-proprietary investment options. It is designed to compete in the same space as Jackson National Life’s Elite Access variable annuity.   

Sammons emphasizes sales of the C share contract, which pays a one percent upfront commission and a one percent trail, has no surrender charge, and has a mortality & expense ratio of 130 basis points, of which all but 30 basis points covers the intermediary compensation.

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If the IRI wanted to show where its political heart is, it could hardly have chosen a more partisan keynote speaker than Haley Barbour, the twice-elected governor of Mississippi, chairman of the Republican National Committee from 1993 to 1997 and consummate K Street lobbyist for Microsoft, RJ Reynolds and other giant firms.

In his thick-as-sorghum-syrup Gulf Coast accent, the beefy, white-haired native of Yazoo City, Miss., opened his zesty talk with a put-down of government competence in census questionnaire writing (he joked about a request for “a list of workers broken down by sex”) and closed with a solemn warning that the American way of life is at stake in the upcoming election.

“Obama wants more government in your knickers,” Barbour drawled. 

The presidential contest is too close to call, he said. Obama is the better campaigner, he conceded. But, contrary to conventional wisdom, he counted Medicare as an issue the GOP can capitalize on. “The longer the conversation about Medicare, the more people will favor the Republicans,” he suggested, because the public will recognize that only radical reform can save the 47-year-old health insurance program for retirees.

For all his evident familiarity with politics, Barbour revealed only a passing acquaintance with economics. He suggested that the “government is sucking all the money out of the economy” by “spending a net $4 billion a day” more than it takes in. The opposite policy—trying to balance the budget by spending less and reducing tax expenditures—would be more likely to “suck all the money out” of the economy.

© 2012 RIJ Publishing LLC. All rights reserved.

Why Equity Averages are So High

Posted on September 12, 2012 by -

“Stunning” was the word that Goldman Sachs equity strategist David Kostin used to describe the current incongruity in the equity market, where the S&P 500 and Dow Jones Industrials indexes have held up nicely despite a “persistent outflow” of assets from stock mutual funds.  

What’s propping up equity prices in the face of a $200 billion flow to bonds and “net zero” to equities, he said, is the fact that companies are using their huge cash reserves to buyback their stocks and pay dividends.

Kostin, a frequent guest on financial TV shows, was a keynote speaker at the Insured Retirement Institute annual conference, held in San Diego on September 9-11. About 320 executives and senior managers as well as 17 exhibitors were listed on the program. (Click here for a pdf of his slides.)

The organization, called NAVA until 2008, has broadened its original focus on variable annuities to embrace virtually the entire range of annuity manufacturers and distributors, including fund companies, insurance companies and broker dealers.

Under the direction of president Cathy Weatherford, it has also emerged as a key retirement industry lobbyist, focusing on issues like the harmonization of the fiduciary standard and the preservation of favorable tax treatment for retirement savings.    

Regarding the stock buybacks mentioned above, companies “are sitting on huge amounts of cash,” one-third of which is overseas, Kostin said, “and they’re returning cash to shareholders.” The dividend trend is strong in the tech sector, where, in only a short time, Apple Computer has gone from paying zero dividends to being a major dividend payer.  

Asked how long such a situation could be sustained, Kostin didn’t express any alarm that it might be likely to end anytime soon. This year, he said, S&P 500 firms have spent about 13% of their cash, and an estimated 22% to 24% of it has been spent on stock buybacks.

Net corporate demand for equities was $500 billion, he said. “That can offset a lot,” he said. International investors generally invest about $100 billion a year in U.S. equities. Between demand from U.S. companies and from overseas, the current trend “could persist for awhile” even if individual investors in the U.S., who directly or through mutual funds own about half of all equities, continue to sell equities, he said.

Other factors affecting the markets, Kostin added: The share of equities in defined benefit pension funds has dropped to 37% from 59% since 2002, and as people move from their 40s to their 60s, their equity allocation drops to less than 50% from 65%. On the other hand, he thinks many equity owners will bequeath stocks to heirs to take advantage of the step-up in basis, and that the heirs’ will tend to hold the equities, thus “slowing the diminution” of equities.

Where is the corporate cash coming from? Though profits have been flat since the second quarter of 2012, “net profit margins are near all time highs,” Kostin said. Productivity gains from new technology and the economies of off-shoring have been driving them. Companies aren’t hiring or making capital investments because they are uncertain about U.S. tax policy and the euro crisis, so “unemployment will remain at about 8% next year regardless of who wins the election,” he added. Though 4.6 million jobs have been created in the last four years, he said, that’s only about half the number of jobs that were lost in the financial crisis.

Financial services companies, however, are exceptions to the trend. Until 2008, they were major contributors of dividends. But since the financial crisis, when many of the firms received federal assistance, regulators have restricted their ability to pay out dividends, Kostin said.

Equity prices also do not reflect the risks posed by the so-called “fiscal cliff” that is represented by a potential increase in taxes next year if the Bush tax cuts expire, the potential drop in government spending if cuts are automatically triggered, and a potential showdown over the debt ceiling in early 2013.

Although Kostin said that the worst case scenario—a failure by Congress to resolve any of the fiscal cliff issues, resulting in a 3.5% drop in GDP—“isn’t likely to happen,” he reminded the audience that the dispute over the debt ceiling in the summer of 2011 resulted in a 17% drop in the equity indices in a single month. “The market hasn’t appreciated these risks,” and has instead focused on the probability of more quantitative easing. 

GDP and earnings growth in 2013, he added, would depend on how well Congress and the administration dealt with the nation’s thorny fiscal issues: 2.7% GDP and 10% earnings growth if the issues were handily resolved, 0.4% and -6% if they were botched, and 2.0% and 7% if the government muddles through. “My expectation is that it will be resolved in a messy way,” he said, adding that as a rule of thumb, a 1% swing in the GDP growth rate translates into a $5/share swing in corporate earnings.   

Goldman Sachs’ outlook for equity indices for 2013 ranged anywhere from a 4% gain to a 12% gain, depending on what happens politically. Kostin expects an ongoing shift from actively managed funds to indexing. Having seen the close correlations of equity class performance in 2008, investors now recognize that “alpha generation is extraordinarily difficult” and so are giving up on stock selection.

© 2012 RIJ Publishing LLC. All rights reserved.

The Real Obstacle to a Fiduciary Standard

Posted on September 9, 2012 by -

Anyone who wants to understand the legal context of the fiduciary/suitability debate should read the lucid, non-partisan papers written about it by Rutgers University law professor Arthur Laby. The most recent one was discussed at the Pension Research Council’s symposium last May and published by the PRC last month.    

Before reading them, I had not thought much about the meaning of the compound term, “broker-dealer.’ But the hyphen is apparently where all the trouble lies (though Laby’s paper doesn’t say this in so many words). Laby also traces the origins of this high-stakes turf war, which is as old as the SEC.   

As I personally have watched (off and on, I must admit) the debate over “harmonization”— i.e., the uniform application of the “fiduciary” standard to anyone who charges for financial advice, including brokers who have recently switched from commissions to asset-based fee compensation—my attention has dwelled on the question of whether the a broker operating under the suitability rule might act in his or her own interest instead of the client’s. 

After reading Laby’s paper, I felt naive for having missed what now seems obvious. Laby lasers on the question of whether a broker-dealer and its representatives can ever meet a fiduciary standard as long as the business includes proprietary trading. He reasons that when the rep is selling a product that the company deals in (or has underwritten), the rep can’t serve the client and the company equally well.

“The real problem is that firms are permitted to act as both brokers and dealers,” Laby writes, explaining that “Brokers often sell securities from their own accounts to customers, and they also buy securities for their own accounts from customers, either as a market maker in particular securities or as a market participant seeking to generate trading profits. Engaging in this trading activity is the very definition of dealer in the Exchange Act [of 1934].”

Laby adds, “Resolving the issue of principal trading is one of the great difficulties in finding a way forward in achieving harmonization. On the one hand, any broker-dealer that provides advice should be required to act in the best interest of the client to whom the advice is given. On the other hand, 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.”

This sort of conflict, for instance, was at the heart of the SEC’s complaint against Goldman Sachs—a broker, a dealer and an underwriter—after the financial crisis. At the time, there was widespread consternation that Goldman Sachs advisors could be advising clients to buy collateralized debt obligations when, for another client, Goldman Sachs’ financial engineers were tailoring a high-tech credit default swap to pay off when the same CDOs plummeted in value.  

But, wait. In his paper, Laby, for some reason, didn’t distinguish between the wirehouses, which own their own broker-dealers, and what I think of as independent broker-dealers. Yet it seems hard to equate them all, because they don’t all do prop-trading. Raymond James is an independent broker-dealer that also does underwriting. It has both captive brokers and independent advisors who trade through Raymond James. LPL Financial, by contrast, doesn’t do underwriting or proprietary trading. As one LPL advisor said on his site: “LPL Financial does not engage in the business practices of investment banks or provide other alternative financial services. They do not engage in market-making activities trading out of their own inventory, which means they do not hold any securities on their balance sheet that are open to market risk.”

In light of that, it’s not surprising that statements from Raymond James suggest that it stands closer to the wirehouses on the fiduciary question than LPL Financial does. According to press reports, Raymond James chairman Dick Averitt has expressed ambiguous support for the fiduciary standard. He said he supports the “concept.” This isn’t far from what SIFMA, the Securities Industry & Financial Markets Association (whose members include the wirehouses as well as LPL Financial and Raymond James), says on its website:

“Since early 2009, SIFMA has consistently advocated for the establishment of a new uniform fiduciary standard, and not application of the Advisers Act fiduciary standard to broker-dealers… When considering the Department of Labor’s (DOL) definition of fiduciary under the Employee Retirement Income Security Act (ERISA), the consequences for a broker being deemed a fiduciary include potential prohibitions on engaging in principal transactions, as well as difficulty receiving fees or commissions. As written, SIFMA believes the proposed rule would ultimately harm investors by raising the cost of saving. SIFMA is working with the DoL through the regulatory process to avoid the harmful effects of this proposed rule.” 

In January 2011, LPL Financial chairman Mark Casady issued a statement, reprinted in Financial Planning magazine, that seemed to fully embrace a uniform fiduciary standard: “We agree with the [SEC] report’s recommendation for a uniform fiduciary standard, as we believe this is right for investors, financial advisors and the industry,” Mark Casady, LPL’s CEO and chairman, said in a written statement. “We are confident this would help drive greater consistency and evenhandedness in the supervision of the broker-dealer and advisory sides of our business.”   

So there it is. The core of the harmonization controversy isn’t about personal ethics or channel competition or commissions per se, or about raising costs for the mass affluent investor. It’s about a threat to the survival of the vertically integrated financial services firm that includes manufacturing/underwriting, prop trading, and distribution through a brokerage. What would happen to its business model if its indispensable “top producers” had to meet the fiduciary standard and start advocating on behalf of the clients whose accounts they manage?

“The dealer question is very important, and, in my mind, probably the hardest issue in the proposal to place a fiduciary duty on broker-dealers that give advice,” Laby told RIJ in an e-mail. “It is very difficult to square acting as a dealer and acting in a fiduciary capacity.”

© 2012 RIJ Publishing LLC. All rights reserved.

Looking for growth? Delay Social Security.

Posted on September 9, 2012 by -

If, like most people, your client is determined to draw Social Security before full retirement age or even before age 70, a new piece of research from scholars at Stanford and the American Enterprise Institute may help change their minds.  

The paper, “When Does It Pay to Delay Social Security? The Impact of Mortality, Interest Rates and Program Rules,” suggests that when the yield on safe assets is near zero (as it currently is), and Social Security benefits are growing by about 8% a year (as they do for people over 62 who delay taking them for up to eight years) it’s smarter to spend savings and let the Social Security benefit grow.   

The authors, John B. Shoven of Stanford and Sita N. Slavov of the AEI, make the further claim that, when interest rates are near zero, delaying Social Security becomes so advantageous that even people who don’t expect a longer-than-average lifespan can benefit from doing it. According to the paper:

“We find that when real interest rates are close to zero, singles in all groups – even those with mortality that is substantially greater than average – gain from at least some delay. Couples in all groups benefit from delaying the primary earner’s benefit, though for some groups with lower-than-average life expectancy, the couple maximizes present value when the secondary earner claims at age 62,” the paper said.

“At real interest rates that are closer to their historical average, singles with substantially lower-than-average life expectancy no longer benefit from delays. However, even in this case couples in all groups gain from delaying the primary earner’s benefit.

“These results have important implications for financing retirement in the presence of defined contribution balances. Financial planners often advise individuals to use defined contribution balances to purchase an annuity, using the annuity income to supplement Social Security benefits. That is, the two retirement resources – Social Security and defined contribution balances – are consumed in parallel.

“However, in today’s low-interest rate environment, this standard strategy is suboptimal for most retirees. The terms for delaying Social Security are more generous than the terms for purchasing a private annuity. Moreover, as Social Security payments are adjusted for cost-of-living increases, delaying Social Security buys an annuity whose payments remain constant in real terms; such annuities are virtually unavailable in the private market.

“This suggests that for individuals with defined contribution balances, accessing retirement resources in sequence – that is, using defined contribution accounts to finance a delay of Social Security – is likely to generate higher retirement income than using them in parallel.”

© 2012 RIJ Publishing LLC. All rights reserved.

A.M. Best affirms MassMutual’s “superior” rating, keeps The Hartford “under review”

Posted on September 8, 2012 by -

The financial strength, issuer credit and debt ratings of Massachusetts Mutual Life Insurance Co. and its subsidiaries remains stable since its announcement of a definitive agreement to purchase The Hartford Financial Services Group’s retirement plans business for $400 million, A.M. Best said in a release.

A.M. Best said it views the acquisition “favorably” because it brings “additional scale to MassMutual’s existing retirement business, especially in the small-to mid-sized case market.” MassMutual is rated A++ (superior) for financial strength and has an aa+ long-term issuer credit rating.

But A.M. Best said the credit ratings of The Hartford will remain “under review with developing implications.” The Hartford has a “bbb+ u” long-term issuer credit rating. The bbb+ signifies a “good” and “investment grade” credit rating. The “u” signifies “under review.”

Combined, the two retirement plans businesses will result in 3 million participants and $120 billion in retirement AUM. MassMutual is expected to finance the transaction internally. The transaction is not expected to materially impact MassMutual’s strong risk-adjusted capitalization ratios. Following some integration and infrastructure expenses, the acquired business is expected to be accretive to earnings beginning in the second year after its acquisition.

In a release, A.M. Best said, “The announced transaction remains consistent with The Hartford’s strategy to focus on its property/casualty group benefits and mutual funds businesses as outlined by management in early 2012.

“Upon the close of the announced sales of Woodbury Financial Services and its retirement plans business as well as the previously announced intention to sell its individual life business, The Hartford will have successfully executed its announced restructuring and will move forward with a strategy centered on its core strengths.

“A.M. Best believes that the basis for the under review status remains intact as the retirement plans transaction itself does not have a significant impact on The Hartford’s overall financial condition.

“A.M. Best will continue to monitor developments regarding The Hartford’s restructuring and discuss with company management its future capital plans, including any deployment of proceeds from the sales of non-core businesses, to facilitate removing its ratings from under review.

© 2012 RIJ Publishing LLC. All rights reserved.

U.S. growth rate to hit 2.8% by end of 2013: BMO Economics

Posted on September 8, 2012 by -

The North American economy should grow at a rate of two per cent in 2012 and improve during 2013, with a strong performance from residential building in the U.S. and commercial construction in Canada, according to the North American Outlook released by BMO Economics last week. The details, by country, include:

United States
The modest growth of 2% predicted for 2012 in the U.S. will pick up in 2013. Improved household finances and a strengthening housing market will help the economy accelerate to a growth rate of 2.8% by the end of next year.

“Home sales and starts have picked up from depressed levels, supported by record-low mortgage rates, pent-up demand and investor interest,” said Sal Guatieri, senior economist, BMO Capital Markets. 

“House prices are rising, lifting household wealth and encouraging first-time buyers to take the plunge. Rising house and equity values should allow households to soon recover the rest of the $16 trillion in wealth that was lost during the Great Recession,” he said.

Residential construction is now leading the expansion, he added, noting that housing starts are about 40% below demographic needs. Because of elevated unemployment, “we now expect the Fed will delay any rate hikes until mid-2015,” said Guatieri. 

Canada

Canada’s economy should grow 2% this year, reaching 2.4% by the end of 2013. “Business investment, though moderating, continues to lead the expansion,” Guatieri said. “Commercial construction is supported by low vacancy rates, and companies are taking advantage of the strong loonie [Canada’s dollar] to buy productivity-enhancing equipment.”

Elevated commodity prices will continue to drive investment in Alberta, Saskatchewan, Newfoundland and Labrador, he added. Central Canada and the other Atlantic Provinces will face challenges because of the strong currency and weak global demand. With the exception of autos, consumer spending has moderated in the face of high household debt, tepid job growth and rising cross-border shopping.

Personal loan growth has slowed the most in two decades, and the trade deficit continues to widen due to a strong dollar and weak external demand. The Canadian dollar is expected to trade close to parity against the greenback in the year ahead, benefiting from elevated commodity prices and steady capital inflows.

Recent mortgage and credit rule changes will restrain household debt growth, leading to a further moderation in consumer spending and housing market activity and a stabilization of home prices in most regions, Guatieri said. Exceptions will be British Columbia and Toronto, where high valuations point to weaker prices ahead.

Modest growth, low inflation, a strong currency, and tighter credit rules will encourage the Bank of Canada to maintain the current low-rate policy. “Further Fed easing should encourage the Bank of Canada to hold overnight rates steady at 1% for somewhat longer than we previously thought, likely until autumn 2013,” added Guatieri.

The eurozone breakup, pending spending cuts and tax increases in the U.S., a sharp correction in the Vancouver and Toronto housing markets and the potential for a hard landing in China still pose potential risks to the North American, he cautioned.

© 2012 RIJ Publishing LLC. All rights reserved.

Envestnet adds FEG hedge fund research to its platform

Posted on September 8, 2012 by -

Envestnet, Inc., the Chicago-based wealth management platform provider for investment advisors, and Fund Evaluation Group, LLC (FEG), an institutional investment consulting firm, have formed a “Hedge Fund Research Alliance.”

The partnership will add FEG’s research on more than 40 hedge funds and hedge funds-of-funds to Envestnet’s platform, complementing the existing research on separate account managers, mutual funds, ETFs and liquid alternative investments, according to a press release.

FEG’s hedge fund due diligence includes on-site meetings, operational due diligence, third party service provider verification and multiple reference checks, the release said. FEG also provides ongoing monitoring of hedge fund managers via performance analysis, risk monitoring, position level monitoring, quarterly conference calls and face-to-face meetings.

FEG advises on a reported $33 billion in assets for institutional clients and has more than $3 billion allocated to hedge fund managers via direct investment from their clients as well as discretionary access vehicles. 

© 2012 RIJ Publishing LLC.

Allianz Life to pay $10 million to settle index annuity complaints

Posted on September 8, 2012 by -

Allianz Life Insurance Co. has agreed to take corrective action, continue a remediation plan, and pay $10 million to 23 states to settle charges that actions by agents selling its popular fixed indexed annuities (FIAs) from 2001 to 2008 led to unsuitable sales or sales based on misrepresentations, the Florida Office of Insurance Regulation has announced.

Insurance commissioners and other state officials in Florida, Iowa, Minnesota, and Missouri led the regulatory action against Allianz Life. Florida alone will receive over $1 million, according to a release.

“Some consumers who purchased annuities during these years complained to Allianz regarding the suitability of the annuities for their circumstances or representations made by Allianz or its agents during the sale of an annuity,” the release said.  “Under the remediation plan, Allianz will implement a review process addressing new and previously filed complaints by customers who purchased an eligible fixed annuity product between 2001 and 2008. A list of the eligible fixed annuity products covered in this agreement can be viewed here.”

The products named in the agreement include annuity contracts that have been and continue to be among the most popular FIAs on the market. Allianz Life was the top seller of fixed annuities in the second quarter of 2012, with about $1.4 billion in sales, and its MasterDex X fixed indexed annuity was the third best-selling fixed annuity and the second-highest selling fixed indexed annuity, according to Beacon Research.

Fixed indexed annuity, or equity-indexed annuities as they were once called, are widely agreed to be highly complex products that are difficult to understand, even for the independent insurance agents who sell them.

Essentially, they are low-risk structured products consisting of bonds with a minor investment in options on common equity indexes. They are characterized as all-weather products, because the options offer upside when stocks do well and principal is guaranteed by the insurer. Their complexity comes from the fact that many different “crediting methods” can be used to translate the equity gains into higher contract value. It is difficult if not impossible for a layperson to make meaningful comparisons between the crediting methods.

The products were aggressively marketed with rich incentives and principal bonuses through independent insurance agents, and began drawing complaints from older people or their relatives who did not understand exactly what had been purchased. A television expose helped motivate then-SEC chairman Christopher Cox to lead an ultimately unsuccessful campaign to have FIAs regulated as securities.  

The sales of FIAs have been boosted recently by the addition of lifetime income riders to the contracts. Since these bond-based products entail less downside risk to principal than variable annuities, where the underlying investments include stocks, the FIA income riders can sometimes be more generous than the variable annuity income riders, giving the FIAs a competitive advantage.   

Under the multi-state agreement, consumers can have a re-review of their complaints based on the criteria spelled out in the agreed order. A new complaint can be filed by affected consumers until March 31, 2013, either through the “Contact Us” feature on the Allianz Life website or by telephone at 866-604-7488. If a complaint is found to be justified, the consumer will be offered a retroactive cancellation of their policy and a full refund. ​

© 2012 RIJ Publishing LLC. All rights reserved.

How to Maximize Social Security Income

Posted on September 8, 2012 by -

One of the more vexing problems facing pre-retirees is when to claim their Social Security benefits. Many people cash in at the first opportunity, age 62, even though each year they wait, their benefit increases until age 70. Perhaps if they could see exactly how much potential income they were passing up, they might wait longer. 

Now there’s a software tool that can help them do that.  Impact Technology Group in Charlotte, North Carolina, has just introduced a product called Social Security Explorer (SSE) that enables advisors and pre-retirees to model up to hundreds of different Social Security claiming strategies and see how much income each one provides. (To access video, click here.)

The SSE tool requires minimum input—age, projected benefit at full retirement age, longevity expectations, investment rate of return and inflation. The computer does the heavy lifting and shows advisors how much clients would collect monthly and over the course of their presumed life expectancy, depending on which age they choose.

 “Often people take their Social Security benefits right away because they don’t know what they want or don’t understand their choices,” said David Freitag, vice-president of marketing at Impact Technology Group.

With SSE, for example, you can show that a single client (with a projected payment at full retirement age of $2,400, a longevity assumption of 85 and an inflation assumption of 2.5%) would receive only $1,800 per month and $660,623 over his or her expected lifetime by claiming at age 62. The SSE tool shows that the same person would collect $3,860 per month and $830,586 over their expected lifetime by delaying benefits until age 70.

Multiplying the options

The SSE tool is even more helpful when sorting through the 81 possible age options (nine per spouse) for married couples. It can also help married couples maximize benefits by comparing the seven different age-based strategies allowed by Social Security, which lead to a daunting 567 potential scenarios. Many of these options allow couples to receive some income while waiting until age 70 to collect maximum benefits. SSE helps advisors explore different outcomes for their clients.

For example, in a one-earner couple, with two healthy spouses, the earner, call him Jim, can elect to file for benefits at 66 (the full retirement age for those born from 1943 to 1954) but suspend collecting them.  (Full retirement age is also the age when recipients stop being taxed or penalized for earned income.) Jim’s wife Mary is the same age as Jim. As a stay-at-home mom, she never paid into the Social Security system, but she qualifies for a spousal benefit. She can apply for and collect half of Jim’s benefits, while Jim suspends his separate benefit until he turns 70 and becomes eligible for the maximum benefits on his record. 

Jim and Mary can even receive some Social Security benefits to live on while they delay receiving maximum benefits at 70. At full retirement age (66) Jim can file and suspend his benefit. Mary, at 66, can file for “restricted” benefits, or an amount equal to one-half of Jim’s benefit.  At age 70, both Jim and Mary can each start collecting their respective full benefits separately, resulting in almost a $1 million lifetime payout.

Of course, to fully enjoy this larger benefit, Jim and Mary have to live past 85. “The wild card is longevity, Freitag told RIJ Advisor. “My parents lived into their 90s, so there’s a strong likelihood I will live to over 85. On the other hand, I have a good friend who has been type I diabetic since age 10.  His longevity assumption is age 75 or less. For him the best solution might be taking Social Security benefits at 62.”

Inflation also affects the amount that clients receive. In today’s current environment where interest rates are near zero, “the value of Social Security is magnified intensively.” added Freitag.  Not to mention that Social Security automatically includes spousal benefits and built-in inflation protection.

Most clients will have to rely on other sources of income while they delay Social Security, said Steve Sass, program director of the Financial Security Project at the Center for Retirement Research at Boston College. “The fundamental issue is where will they get income to pay their monthly bills?” It’s critical to have some pool of money or insurance set aside for medical emergencies, he said.

In a sense Social Security has become a default safety net for the variability of 401(k)s, says Sass. The baby boom generation is the first cohort that has had a substantial dependence on the 401(k).    “For the cohort that is currently retiring, you can’t get any return from bonds. And, if interest rates go up, you will have a capital loss.  The government is saying that in a 401(k) world; why not just delay Social Security.”

While people might do better in the stock market, “it will be difficult to get more income from your savings than from delaying Social Security,” Sass told RIJ Advisor.

Sass counsels advisors to make sure their clients anticipate the possibility of a long lifespan. “The risk of living too long is a difficult concept,” he said. “A lot of people think they’re going to die young and use that as an excuse to front-load the benefits.”

But many people will live into their 80s and 90s. “It’s the function of a good financial advisor to get people to understand what they want to do with their money and not to just succumb to momentary temptation,” Sass emphasized.

SSE should make it easier for advisors to show their clients how much they will benefit at different ages and using different strategies, said Freitag. Those decisions are more critical than many clients think and advisors now can show that. As Janet Reno, the vice president for income security at the National Academy of Social Security Benefits, has said: ‘The two most important decisions people make is when to stop working and when to declare Social Security.” Most people conflate the two. But choosing when and how to file for Social Security benefits could create a much more secure future.

© 2012 RIJ Publishing LLC. All rights reserved.

Modest GDP rebound likely in Q3: Prudential

Posted on September 5, 2012 by -

The latest commentary from John Praveen of Prudential International Investments Advisors offers the following data and analysis:

•  Despite the modest upward revisions, Q2 GDP remained below the Q1 pace of 2%. Looking ahead, the U.S. economy appears on track to a modest rebound with GDP growth tracking around 2.2% in Q3. Consumption spending is likely to recover to over 2% in Q3 from the anemic 1.7% pace in Q2.  July retail sales grew stronger-than-expected at 0.8% MoM (month-over-month) and core sales were up an even stronger 0.9% suggesting a good start to Q3 spending.  Business investment spending is also likely to strengthen. Industrial production was off to a strong start in Q3, rising 0.6% MoM in July driven by 3.3% jump in car production. However, business confidence is hovering around the 50 level, which suggests that lingering uncertainty will keep a lid on business investment spending. Consumer and business spending remain the main drivers of U.S. growth, supported by modest gains in income, profits, and a recovery in housing.

• However, there are potential risks to the U.S. economy in late 2012/early 2013 with the potential massive fiscal cliff of large spending cuts and tax increases in 2013 resulting from expiring tax cuts and spending cuts set to be triggered at the end of 2012. A total of $576bn (3.6% of GDP) of fiscal adjustment is set to occur in January 2013 as a result of the expiration of the Bush tax cuts ($280bn, 1.8% of GDP), expiration of the payroll tax holiday ($125bn, 0.8% of GDP) and temporary unemployment benefits ($40bn, 0.3% of GDP), and spending cuts or so called “sequestration” ($98bn, 0.6% of GDP).  

•  With U.S. elections due in November and the nation highly polarized, it appears unlikely that any agreement will be reached before the November 6 elections. However, a fiscal agreement is likely to be reached between the November election and year-end on extending at least some of the tax cuts and/or preventing the spending cuts. As a result the fiscal drag is likely to be smaller, around 1% of GDP, rather than the -3.6% drag from the full fiscal cliff.  However, the uncertainty about the fiscal cliff remains a risk for the U.S. economy and financial markets.

                                                                                     *         *          *

Data mavens may be interested in the following section of Praveen’s report:

•  U.S. Q2 GDP growth was revised up modestly to 1.7% QoQ (quarter-over-quarter) annualized rate from 1.5% in the advance estimate. The major contribution to the upward revision was trade, which swung from a -0.3% drag to a 0.3% positive contribution. However, this was offset by inventories which swung from a 0.3% contribution to a -0.2% drag. In revisions: Consumer spending was revised up (to 1.7% from 1.5%); the contraction in government spending was revised smaller (to -0.9% from -1.4%) while investment spending was revised down (3.0% from 8.5%).

•  Consumer spending was revised higher but remained soft.  Consumption grew 1.7% in Q2, revised up from 1.5%, after 2.4% in Q1, with upward revisions to both durable goods and services spending. Service spending was the largest contributor to Q2 consumer spending.  Government spending was revised to a smaller decline of -0.9% from -1.4% initially reported, after -3% with weakness in state and local spending.  Trade added 0.3% to Q2 GDP growth after 0.1% in Q1 with exports adding 0.8% and imports subtracting -0.5%. Exports grew 6%, while imports grew a more modest 2.9%.

•  Investment spending was revised down to 3.0% from earlier reported 8.5% growth. Spending on equipment and software grew 4.2%, revised down from 5.4%, after 7.5% in Q1. Residential investment grew 8.9%, revised down from 9.7% after 20.6% in Q1. Residential investment has now contributed to real GDP growth for five consecutive quarters and reflects the modest ongoing recovery in the housing market.

•  U.S. Q2 GDP growth was driven by revised contributions from consumer spending (1.1%), business investment (0.4%), net exports (0.3%) and residential investment (0.2%). Meanwhile, the largest drags came from decreased government spending (-0.2%) and shrinking inventories (-0.2%).

Japan gets younger, but still struggles with longevity risk

Posted on September 5, 2012 by -

Average lifespans in Japan have shortened to 79.44 years for men and 85.9 years for women, according to a survey by Ministry of Health, Labor and Welfare reported by IPE.com. The citizens of Hong Kong are now the world’s longest-lived. 

That’s of little interest to Japanese corporate pension funds, because they generally offer optional lump-sum retirement payouts, and have already adjusted to longevity risk by creating fixed-term pensions and adding optional extensions to the guarantee period. (See snapshot of Japan pension system.)

Nor does it relieve the anxieties of a healthy 60-year-old with a 20-year fixed-term pension who hopes and expects to live to 90 or beyond.     

The Ministry survey indicates that, among 60-year-olds, 64% of men and 82% of women will live to age 80, 23% and 48%, respectively, will reach 90, and 8% and 23%, respectively, will reach 95. One percent of men and 6% of women who reach age 60 will reach 100. Given this broad range, individuals will find it difficult to plan for retirement.

Japan’s public pension system tries to guarantee a minimum standard of living, but doesn’t always succeed. The minimum cost of living for the elderly is currently close to the model pension payment (¥238,000 or $3,032 per month for husband and wife combined).

However, this is not necessarily the case on an individual level, where daily expenditures, for example, can vary widely depending on the geographic region.

As one Japanese writer put it in IPE.com recently:

“Longevity risk cannot be overcome on an individual basis. Neither can corporations bear the risk. It is something that must be dealt with at the national level. Discussions should be separated into two parts: averages and the portion beyond the average.

“Self-efforts should aim for average levels, while the government should introduce in parallel some sort of public risk-sharing framework for the portion exceeding this. The crucial factor is sustainability. A system should not dump the risk on one party, but use a flexible approach, even if imperfect, that guards against new burdens.

“Traditionally children would inherit their parents’ longevity risk. However, family sizes are shrinking, and the economic circumstances of parents and children have reversed. The last bastion has thus disappeared. The problem needs urgently to be addressed.”

© 2012 RIJ Publishing LLC. All rights reserved.

The Bucket

Posted on September 5, 2012 by -

The Hartford to sell retirement plans business to MassMutual

The Hartford has agreed to sell its Retirement Plans business to Massachusetts Mutual Life Insurance Company (MassMutual) for a “cash ceding commission” of $400 million, subject to adjustment at closing, according to a release yesterday. The sale, structured as a reinsurance transaction, is expected to close by the end of 2012, subject to regulatory approvals and satisfying other customary closing conditions.

The Hartford’s chairman, president and CEO Liam E. McGee, said: “The agreement marks the second of three planned business sales as we continue to make good progress executing on our strategy.” The Hartford expects the transaction to have no material impact on its GAAP financial results and to benefit net statutory capital by approximately $600 million, including the ceding commission and a reduction in required risk-based capital, on closing. 

The Hartford’s Retirement Plans business is primarily a defined contribution business with $54.9 billion in assets under management as of June 30, 2012. The business serves more than 33,000 plans with more than 1.5 million participants, and has a strong presence in the small to mid-sized corporate 401(k) and tax-exempt markets. It also provides administrative services for defined benefit programs. As a result of the agreement, The Hartford’s Retirement Plans employees will become part of MassMutual’s Retirement Services Division.

The Hartford will continue to sell new retirement plans during a transition period, and MassMutual will assume all expenses and risk for these sales through a reinsurance agreement. Between now and the close of the transaction, there are no planned changes with respect to the day-to-day interactions or processes between The Hartford and its Retirement Plans’ distribution partners, plan sponsors and customers.

The Hartford’s financial advisors for the divestiture are Greenhill & Co. and Goldman, Sachs & Co. and the company’s legal advisors are Sidley Austin LLP.

Fitch: No immediate impact on Hartford ratings

Fitch Ratings says today’s announcement regarding Hartford Financial Services Group, Inc.’s (HFSG) planned sale of its retirement plans business has no immediate impact on its ratings.

HFSG has reached an agreement to sell its retirement plans business to Massachusetts Mutual Life Insurance Company (Mass Mutual) for a cash ceding commission of approximately $400 million. The transaction is expected to close by the end of 2012, subject to regulatory approval. The sale will have essentially no impact on HFSG’s GAAP net income but will have a positive net statutory capital impact for Hartford Life Insurance Company of approximately $600 million.

Fitch views the sale as another step in HFSG’s go-forward strategy to focus on property/casualty commercial and consumer markets, group benefits, and mutual funds businesses. To date, individual annuity has been placed into run-off and the company has reached agreements to sell Woodbury Financial Services and its individual annuities’ new business capabilities consisting of the product management, distribution and marketing units, as well as the suite of products currently being sold. HFSG continues to pursue divestiture options for its individual life business. Favorably, a successful execution of the strategic plan to sell these noncore businesses should improve HFSG’s financial flexibility, with sales proceeds increasing holding company cash that could potentially be used to reduce debt.

Fitch already maintains separate Insurer Financial Strength (IFS) ratings on HFSG’s life and property/casualty companies that reflect each businesses respective stand-alone financial profiles. HFSG’s life insurance subsidiaries maintain ‘A-‘ IFS ratings, which are two notches below the property/casualty IFS ratings of ‘A+’. This approach was implemented in February 2009 during the financial crisis to reflect the divergence in operating performance and balance sheet strength between the life and property/casualty operations.

HFSG’s announcement today does not significantly change Fitch’s assessment of the life and property/casualty operating companies’ financial strength. Fitch expects that HFSG will continue to support its insurance subsidiaries and maintain insurance company capitalization that is consistent with the current ratings.

Fitch affirmed the ratings on HFSG and its property/casualty and life insurance subsidiaries on May 15, 2012.

Symetra names actuary Craig Raymond as chief strategy officer

Symetra Life Insurance Co. has appointed Craig Raymond as senior vice president and chief strategy officer, effective Sept. 17, 2012. Raymond will report to Tom Marra, president and CEO of Symetra Financial Corp.

Raymond had been chief risk officer and chief actuary at John Hancock Financial Services since 2009, where he managed and monitored strategic, insurance, liquidity, credit, market and operational risks. He previously was chief actuary at Hartford Life.

As Symetra’s chief strategy officer, Raymond will be responsible for long-term strategic planning, business portfolio analysis, and mergers and acquisitions. He will be based in the Hartford, Conn., area.

Raymond graduated from the Wharton School, University of Pennsylvania, with a bachelor’s degree in economics. He is a Fellow and past vice president of the Society of Actuaries and a Member of the American Academy of Actuaries.

ING Group to sell stake in Capital One

The Dutch financial services giant ING Group plans to sell its 9% stake in Capital One in a deal that could be worth around $3 billion, The New York Times reported today. ING acquired the stake in the American firm when Capital One bought ING Direct USA for $9 billion in February.

ING has been forced to sell assets as part of the conditions of a 10 billion euro ($12.5 billion) bailout it received from its local government in 2008. Along with the sale of ING Direct USA to Capital One, the Dutch firm sold its online bank in Canada to a local rival, Bank of Nova Scotia, last month for $3.1 billion. ING is also planning to sell its Asian insurance businesses.

The Dutch firm said late on Tuesday that it would sell 54 million shares in Capital One, and would set the price before the start of trading in New York on Wednesday. Based on the closing share price on Tuesday, ING’s stake in Capital One is worth around $3 billion. ING said it planned to complete the transaction by Monday, September 10. 

The deal for ING Direct USA transformed Capital One into the country’s fifth-largest bank by deposits. The combined business has around $200 billion in deposits, making it larger than regional powerhouses like PNC and TD Bank. Under the terms of the deal, Capital One issued $2.8 billion worth of new shares to ING, making the Dutch firm its largest shareholder.

Shares in ING rose less than 1 percent in morning trading in Amsterdam on Wednesday. Bank of America Merrill Lynch, Morgan  Stanley and Citigroup are the joint bookrunners for the deal.

MetLife announces annuity enhancements

The MetLife Income Annuity– a single premium immediate annuity – now offers an “Increasing Income Option” and an “Early Access Option.” The Increasing Income Option will allow the owner to elect to increase their income payments, compounded by an amount they choose, each year. The Early Access Option will provide access to a portion of their income payments in the event that an unexpected need arises.

The Increasing Income Option is an inflation feature that allows the annuity owner to select that their income payments be increased each year by a percentage rate they choose, generally between 2 – 4%. Under this optional feature, income payments will compound on each payment anniversary based on the pre-selected increase rate. This option is only available at issue to contracts issued to owners at least 59½ or older.

The Early Access Option allows clients to take a portion of their future income if an unexpected need arises during their liquidity period. The liquidity period will vary based on the income type elected. MetLife locks in the assumptions used to calculate the liquidity period value when the contract is issued so that clients know at purchase how much they can withdraw during the liquidity period. This feature is only available at issue to contracts issued to owners at least 59½ or older.

Marsh & McLennan gives $1.5 million to Stanford Center on Longevity

Posted on September 5, 2012 by -

Marsh & McLennan Companies, which specializes in human resources consulting, will contribute $1.5 million through 2013 to support the Stanford Center on Longevity’s studies and activities related to financial security.

According to a release, the two organizations recently collaborated on a conference where contributors from business, academia and government addressed retirement planning in the age of longevity. This fall, the Center’s Financial Security Division will expand its web resources on that issue. 

Michele Burns, former chairman and CEO of Mercer, a Marsh & McLennan company, will serve as Center Fellow and Strategic Advisor to the Stanford Center on Longevity and to its director, Laura Carstensen, PhD, and deputy director, Thomas Rando, MD, PhD. 

“The goal is to help drive the dialogue forward in order to facilitate a healthier state of long-term financial security—both for the individual and society,” Burns said in a release.

© 2012 RIJ Publishing LLC. All rights reserved.

One 401k provider girds for price pressure as disclosure kicks in

Posted on September 5, 2012 by -

Along with the symbolic end of summer, the end of August—the 30th, to be exact—also marked the deadline for starting disclosure of 401(k) fees by plan sponsors to plan participants. As of last July 1, plan sponsors were to have received a rundown of fees from their plan providers.

At this early stage of the fee-transparency game, observers still don’t know for sure whether a spike in cost-consciousness—among sponsors or participants—will follow the fee disclosure deadlines, or if a significant number of plan sponsors will want to switch plan advisors, providers or administrators in search of lower fees.

Providers are evidently concerned about a price war, and suggest that plan sponsors take care not to sacrifice quality for low price.

An executive at Security Benefit warned in a recent release that the Labor Department’s fee disclosure rules could trigger a “fee race to the bottom” unless plan providers shift the focus to the “reasonableness” of service costs rather than the costs alone.

Simply pursuing the lowest cost is a risk for small plan providers, which account for 90% of the nation’s 401(k) plans, said Kevin Watt, senior vice president of Security Benefit’s defined contribution group.

 “The ability to easily see costs will prove invaluable to plan participants,” he said. “But reasonableness means a lot more than cheap.” If service quality decays, plan participants could be hurt more than helped by the new rule, he said.

“It’s absolutely critical that before the RFPs [requests for proposals] start going out, participants need to know what they give up for stripped-down, low-cost plans,” Watts added.  

The first round of the DOL’s fee disclosure rules, which became effective on July, requires service providers to disclose the compensation they receive to plan sponsors. Sponsors will be able to compare service prices among providers more easily, stoking price competition among providers.

As of August 30, the new rules require plan sponsors to begin disclosing the fees of the investment options in their plans to participants. Watt said disclosures will give good advisors an opportunity to stress the link between the cost of advice and investment outcomes.    

Security Benefit partners with licensed financial planners to provide advice to employer-sponsored retirement plans. The firm’s recently-launched Security Benefit SecurePoint Retirement  401(k) product includes the services of Mesirow Financial as an ERISA 3(38) fiduciary.

Plan sponsors are not compelled by their fiduciary responsibility or by the new regulations to determine that fees are low, only that the fees are “reasonable.” Their perception of reasonableness may depend on whether they get complaints about fees—or perhaps legal action—from plan participants.

Fidelity Investments, the largest 401(k) provider, has released fee data to participants and not received much feedback, but that was no surprise because Fidelity’s fees already reflect vast economies of scale. It may take longer to see how participants at tens of thousands of small, higher-cost plans will react as they learn more about their fees.

“Participants will be surprised by the size of these fees,” predicts business and tax attorney Christopher Ezold, a Philadelphia-based attorney specializing in business, employment and health care law. (According to a research group, New York City-based Demos, the total fees paid on 401(k) plans reduce accumulation in retirement accounts by 30% on average over a lifetime of saving.)

“In fact, many will be startled to see that they are paying investment management fees at all. The new rules will likely strengthen a trend to reduce fees on all 401(k) plans as long as participants learn what action they should take,” Ezold said. But he warned that the mere availability of fee information will not necessarily lead to lower fees. 

“Now that the proverbial curtain has been pulled away, the heightened focus on fees will empower the participants to demand a better return on their investment,” said Ezold. “However, participants need to do their homework and take action. These new quarterly reports need to be examined and compared if the plan participants expect to see change.”

© 2012 RIJ Publishing LLC. All rights reserved.

“America the Undertaxed”

Posted on September 5, 2012 by -

At a little past midnight in the old-fashioned clubroom of an Ivy League university a few months ago, two men settled deeper into leather chairs and swirled the ice in their last cocktails of the night. The topic of U.S. tax policy came up.   

It’s not healthy, one said, when as many as half of all Americans pay virtually no federal income taxes, leaving the rest with a huge burden. If the poorer people paid more, they might better appreciate the true cost of what society gives them and relinquish their sense of entitlement.   

Personally, I would prefer to owe more taxes. That’s not because I think it could make me a better citizen, but because I’ve noticed that bigger tax bills tend to correlate with higher standards of living. In any case, I’m not sure whether I’m taxed fairly or unfairly, relative to the services and benefits I get.

In the home stretch of a presidential race where the tax question is front and center, an MIT political science professor makes the counter-intuitive claim in the latest issue of Foreign Affairs that the U.S. is a low-tax haven compared with other advanced countries.

In an article called “America the Undertaxed,” Andrea L. Campbell claims that the overall tax burden has been shrinking in the U.S. for decades, on both rich and poor, and that the decline has led not to general prosperity but merely to a concentration of wealth in fewer hands. 

Campbell gathered a wide range of data that enable her to make comparisons between the U.S. of several decades ago and today and also between the U.S. and some 30 other countries in the Organization for Economic Cooperation and Development, or OECD.

In terms of historical data, she claims that the effective federal income tax rate for a family of four with a median income was was just 5.6% in 2011, down from 12% in 1980. Overall, the individual income tax was equal to 10.4% of Gross Domestic Product in 1980 but had fallen to 8.8% in 2005.

Wealthy families have evidently gotten about as much relief as the median family. “The top one percent of taxpayers paid an average federal income tax rate of 23% in 2008, about one-third less than they paid in 1980, despite the fact that their incomes are now much higher in both real and relative terms,” Campbell writes.

Taxes on US corporations, as a percent of all federal revenues, have fallen to 10% today from 30% in the 1950s, her data shows. And while the U.S. has a statutory corporate tax rate of 39%, tax credits made the effective corporate tax rate between 2000 and 2005 only 13%, according to a Treasury Department report cited by Campbell.

Compared with 33 other industrialized nations, total tax revenues in the U.S. were the third lowest as a percent of GDP in 2009, the article said. The highest percentage was 48.1% in Denmark. The percentages in the U.K. and Canada were 34.3% and 32.0%, respectively, and the percentage in the U.S. was 24.1%. Only Chile and Mexico, at 18.4% and 17.4%, respectively, ranked lower than the U.S. on that scale.

Looking only at personal income taxes at all levels of government as a percentage of GDP, the U.S. doesn’t differ much from other countries, on average. Our personal income taxes equal about 9.2% of our GDP, while the OECD average is 10.1%. But European countries have a value-added tax or VAT, which accounts for their higher total tax revenues, as a percent of GDP.

The VAT is a tax on the value added to goods and services at every stage in the production of a given product. On average, other OECD countries get the equivalent of 6.7% of GDP from VAT every year. The VAT is a regressive tax, meaning that it eats up a larger percentage of the income of the poor than of the rich, but the VAT is generally used to finance universal social services, which tend to have relatively more value to the poor than the rich. 

Since taxes in the U.S. are already low, according to Campbell’s analysis, she sees little point in proposals by Rep. Paul Ryan (R-Wis.), the Republican vice presidential nominee, to reduce the tax burden by cutting federal spending to 16% of GDP by 2050 from 24% of GDP today. “Ryan’s plan would give those with incomes over $1 million a tax cut of $265,000” on top of the Bush tax cuts already in place, while raising taxes on low-income households by cutting the Earned Income Tax Credit, she writes.

But, as one of the two men in the clubroom argued, wouldn’t cutting entitlements and raising taxes on low- or moderate income households give that demographic a stronger sense of responsibility? Doesn’t social insurance spoil people and encourage moral hazard?

That idea does have a certain self-serving appeal, but it’s difficult to see how someone with even an average income could afford higher taxes. A person with a gross income of $42,000, for instance, currently takes home about $2,500 a month after withholding for income and payroll taxes and deductions for health insurance and a modest 401(k) deferral. That doesn’t leave much room for higher taxes.

If our taxes have in fact been shrinking for decades, then why do we feel so hounded by the taxman? I don’t know. Maybe it’s because there are so many different taxes and fees, or because the tax code is so complex. Maybe we fail to factor in the value of the available tax credits and deductions, or don’t acknowledge the value of what our taxes buy. Perhaps higher tax rates are just an inevitable (though nonetheless unwelcome) covariant of success.

Or it may be that declines in tax revenues, such as we’ve seen as a result of the financial crisis, can’t help but translate into higher levies on those who are still able to pay. For them, it must feel like persecution.

© 2012 RIJ Publishing LLC. All right reserved.

Life annuities are more popular than retail sales suggest: AARP

Posted on September 5, 2012 by -

Sales of individual life annuities have always been relatively modest, prompting perennial explanations of the “annuity puzzle,” as well as speculation that, despite the Boomer retirement tsunami, Americans may never really warm up to the idea of insuring against longevity risk.

But a new study from the AARP Public Policy Institute shows that, when offered the choice between a lump sum and an annuity in an employer-sponsored retirement plan, Americans choose the lifetime payout surprisingly often—more often, that is, than retail sales data suggest.

That means there may be “more potential in the annuity market than many observers have assumed,” according to the authors of “Older Americans’ Ambivalence toward Annuities: Results of an AARP Survey of Pension Plan and IRA Distribution Choices,” which was published last spring.  

“People who have defined benefit plans, and who have a choice in the matter, are likely to elect an annuity,” said Sandy Mackenzie, who co-wrote the report with Carlos Figueiredo. “Even among members of defined contribution plans, one in three say they would be willing to choose an annuity.”

The world according to AARP

Even if you exclude Social Security, the study showed, annuities themselves aren’t rare in America. “Among retirees [ages 59 to 75], no less than 74% were receiving (or expecting to receive) income from an annuity of some kind, and 63% were receiving income from a life annuity,” the study found.

Among older workers [ages 50 to 75] whose most important plan was a traditional DB pension that offered a lump sum distribution option, 63% told the AARP researchers that they intended not to take a lump sum distribution. Of current retirees who had had a lump sum option, 87% had not taken the lump sum. Only about one in ten older workers and retirees with a lump sum option expected to choose or had already chosen the option of taking a full lump sum balance.

The tendency to choose an annuity was weaker among workers and retirees covered by 401(k) plans, and weaker still among those whose most important plan was an IRA. But even in those cases, the annuity was a surprisingly common choice.

In 401(k) plans that offered options other than lump sums, 31% of current older workers and 25% of retirees planned to elect or had already elected a life annuity. Another 24% of workers and 18% of retirees planned to elect or had elected a series of regularly scheduled payments in lieu of a lump sum. Only 11% of workers but 30% of retirees planned to elect or had elected a lump sum. One in four workers was still undecided decision.

The survey showed how stark a difference there is between current retirees and near-retirees in terms of the type of retirement plan coverage. In the survey, 61% of retirees said they had a traditional DB or cash balance plan, compared with only 33% of those who were 50 and over but still working.

Squaring the facts 

Mackenzie and Figueiredo can only speculate, however, why people are more amenable to the life annuity concept when it’s an exit strategy from an employer-sponsored retirement plan than when it’s a retail option.

“There may be a problem with the marketing of retail annuities or the way they’re perceived,” said Mackenzie, a former International Monetary Fund official and author of Annuity Markets and Pension Reform (Cambridge, 2006) and The Decline of the Traditional Pension (Cambridge, 2010).

“Maybe the participants feel that the in-plan annuity comes from a more trusted source. The lack of previous association with an insurance company might explain low retail sales. Our message is simply that, based on our data, the market for immediate annuities shouldn’t be so vanishingly small,” he said.

“There might be self-selection bias affecting the results [i.e., that people who like annuities choose companies that offer defined benefit plans], or because people may choose the annuity just because it’s the default,” Mackenzie added. “I don’t want to overplay the results, but if you observe that the demand for life annuities as such is pretty small, then how do you square that with the fact that, even among members of defined contribution plans, one in three say they would be willing to choose an annuity?”

The AARP study joins the relatively slim body of literature on annuitization rates in retirement plans. A 2007 study by Steve Utkus and Gary Mottola of participants in two Vanguard-administered Fortune 500 plans, a traditional DB plan and a cash balance plan, found that “annuitization was popular among a small though meaningful group: 27% of older participants in the traditional plan and 17% in the cash balance plan elected an annuity.” The older the participant at the time of the distribution—which didn’t necessarily occur at the moment of retirement—the more likely he or she was to take an annuity over a lump sum.

The data for “Older Americans’ Ambivalence toward Annuities” was collected in the spring of 2010. Some 1,750 older workers, aged 50–75, and 670 retired people aged 59–75 were interviewed. Each had to be a member of at least one pension plan or have an individual retirement account (IRA). Older workers had to have a pension plan or retirement saving account. Retirees had to have begun drawing or receiving payments from their most important retirement plan/account in the last three years.

© 2012 RIJ Publishing LLC. All rights reserved.

Bernanke, Equities and the November Election

Posted on September 4, 2012 by -

If Mitt Romney’s and Paul Ryan’s punches have failed to KO a vulnerable president, the reason may be no farther than your Bloomberg terminal, where you can see that the S&P 500 has more than doubled since the earliest days of the Obama administration.

Credit for the rally—or blame, if you’re an angry bear—arguably goes to Fed chairman Ben Bernanke, who as arbiter of U.S. central bank policy has suppressed prevailing interest rates and somehow—despite a strong undertow of risk aversion among mass investors—managed to buoy up stock prices.   

Last Friday, at the annual symposium sponsored by the Kansas City Fed at the foot of the Grand Tetons—the Olympus of the banking gods—Bernanke reiterated his commitment to keep rates low for as long as another two years; by mid-afternoon on August 31, the S&P hit 1409, up from 680 on March 9, 2009.

In the course of his address, whose meaning was as usual camouflaged in Fed-jargon and stippled with acronyms, Bernanke more or less assured the markets that his motto remains, “Easy does it.” Hence the equities outlook, as well as Obama’s, is pretty good, at least for the moment.

It could be worse

Regarding the stock market, Bernanke specifically said, “It is probably not a coincidence that the sustained recovery in U.S. equity prices began in March 2009, shortly after the FOMC’s decision to greatly expand securities purchases. This effect is potentially important because stock values affect both consumption and investment decisions.”

The first stage of the Fed’s asset-buying policy also put a floor under prices of mortgage-backed securities and lowered retail mortgage rates, he said. Lower mortgage rates helped people refinance, if they qualified, and support higher home prices.  

Once the forces of deflation were muzzled, in Bernanke’s view, the economy could begin to recover, and did. “As of 2012, the first two rounds of LSAPs [large-scale asset purchases] may have raised the level of output by almost 3 percent and increased private payroll employment by more than 2 million jobs, relative to what otherwise would have occurred,” Bernanke said in his speech.

“As of July,” he added, “the unemployment rate had fallen to 8.3% from its cyclical peak of 10% and payrolls had risen by 4 million jobs from their low point… Inflation (except for temporary deviations caused primarily by swings in commodity prices) has remained near the [Federal Open Market] Committee’s 2% objective and inflation expectations have remained stable.” Manufacturing, housing, and international trade have strengthened, and investment in equipment and software has rebounded, he said.

Four dangers

Four things could still go wrong, Bernanke conceded. First, the Fed’s policy could backfire if it buys too many U.S. government agency and Treasury bonds, reduces the liquidity of the market for U.S. debt, and compels private buyers to demand higher yields in return. Second, the Fed could eventually own so many assets that, when the economy revives, it couldn’t sell them fast enough to suck excess cash out of the economy and prevent inflation. Third, the Fed’s rate-suppression policy could compel investors to take bigger risks in hopes of higher yields, and thereby de-stabilize the financial system again. Finally, a sudden spike in rates could cause the assets on the Fed’s balance sheet to fall in value and the Fed might lose hundreds of billions of dollars. But the potential dangers of his policies, the central banker said, were outweighed by their positive effects.   

A number of “headwinds” are preventing the economy from recovering faster than it has, Bernanke added. He cited the facts that new construction remains at low levels, that hiring and purchasing by governmental entities is down because of depressed tax receipts, that uncertainty and anxiety persists regarding the so-called “fiscal cliff” at the end of 2012, that many homeowners and small businesses still find it difficult to borrow, and that uncertainty about the Eurozone economy is weighing on Americans.

Rates will stay low

In conclusion, Bernanke was fairly clear that interest rates aren’t going up soon, at least not if the Fed can help it. “A number of considerations,” he said, “…argue for planning to keep rates low for a longer time than implied by policy rules developed during more normal periods.”

© 2012 RIJ Publishing LLC. All rights reserved.

Letter to the Editor

Posted on August 29, 2012 by -

Dear editor:

I noticed the opening sentence of “Weighing the Value of a Variable Annuity” (July 31, 2012 RIJ) mentions that Steinorth and Mitchell indicate that a VA lifetime withdrawal benefit—especially one with a ‘ratchet’—can provide upside potential and downside protection many Baby Boomers want in retirement.

Attached is a short PDF I sent to you previously, containing selected language from the 1998 GMWB & GLWB patent filing.  Anticipating such a desire for a ratchet, I included it in the patent filing and even gave a numerical example of how this would work. (See page 3 of the attached PDF.)

Another reason a VA-writing life insurer might want to offer a “ratchet” GLWB is for persistency purposes.  Suppose the VA account value goes up substantially after the GLWB election in a product with a standard, non-ratcheting GLWB.  In the current product, a consumer’s GLWB withdrawal level is fixed at the original level.  If the consumer performs an exchange to a new VA and elects a new GLWB still of the standard, non-ratcheting form, then he or she establishes a higher GLWB withdrawal level.

If the original VA-writing life insurer had offered a “ratchet” design, such loss of business on the books could have been avoided, resulting in higher assets under management and the commensurately higher M&E&A revenue.

So while a ratcheting GLWB may offer additional value (for an additional price) to the consumer, the insurer’s self-interest can also play a role in the offering of such a design.

Best wishes,

Jeffrey Dellinger