Archives: Articles

IssueM Articles

A Time to Laugh, or Cry

Posted on August 29, 2012 by Kerry Pechter -

As of the halfway mark of 2012, the news on variable annuities, like news about the world at large, is mixed. The good news: net new money is flowing into the business. The bad news: net flows are at their lowest level since the beginning of the living benefit era.

LIMRA released mid-2012 sales figures for the top 20 annuity issuers in the U.S. last week. This week, Morningstar followed up with its quarterly VA sales report. The numbers provide specific detail to the anecdotal reports that annuity sales have softened this year.

Sales are off 6% year-over-year for three main reasons. Supply is down as a result of the retreat or withdrawal of several once-major players. Products are also less generous than they use to be, thanks in part to the fact that low interest rates raise the cost of hedging the guarantees. In addition, the industry relies heavily on its biggest members for growth. The five largest issuers (including TIAA-CREF) account for about 58% of sales; the top 10 issuers account for 80%.

At this point, most people know about MetLife’s intended pullback from the market, evidenced by its lower (but still high) sales this year. In 2011, MetLife sold $12.65 billion worth of variable annuities in the first half of the year. In 2012, the firm’s mid-year VA sales were $9.54 billion, a decline of just over 25%. MetLife was in third place in VA sales rankings in mid-2012, after having been first in mid-2011.

In his first-quarter 2012 earnings call, MetLife CEO Steve Kandarian told analysts that the firm was targeting total annual 2012 VA sales of “$17.5 to $18.5 billion,” following its record sales of $28.44 billion in 2011. To the chagrin of investors and brokers, MetLife has reduced the generosity of its living benefit riders to help reduce risk exposure and temper its sales.

MetLife’s chief competitors, Jackson National Life (known for giving advisors maximum investment freedom) and Prudential Financial (known for its “highest daily” benefit and asset-transfer risk management mechanism), have also moderated the generosity of their riders, but without as much impact on sales. Jackson’s VA sales are actually up slightly.

Jackson’s mid-year 2012 sales were $9.64 billion, compared with $9.53 billion for the first half of 2011, putting it in second place, up from the third spot a year ago. Prudential VA sales were down about 9%, to $10.29 billion this year from $11.35 billion in the first half of 2011.

Among the rest of the top 10, sales are down moderately at Nationwide and RiverSource, up moderately at AXA Equitable and AIG, and roughly even at Lincoln Financial, AEGON/Transamerica and Allianz Life of North America. Meanwhile, there’s been some action among smaller companies. Ohio National and Guardian, for instance, have quietly slipped into Morningstar’s top 20 list after beefing up their products earlier in the year.

Guardian Life, a mutual company, saw the industry’s biggest percentage increase in sales, going from $487.5 million in the first half of 2011 to $843.4 million in the first half of 2012, an increase of more than 70%. Ohio National sales data didn’t appear on LIMRA’s Q2 2012 sales list because it doesn’t participate in the LIMRA survey, but it did appear on Morningstar’s. The Cincinnati mutual insurer, which introduced a new living benefit rider last winter that offers a 7% annual rollup for those who agree to invest in volatility-managed funds, had first-half 2012 sales of $1.377 billion, up 65% from $837 million in the first half of 2011.

In a single year, Ohio National rose from 21^st place to 13^th place on Morningstar’s VA sales ranking, which was the greatest positive change in ranking of any company during that time. Ohio National was also the fourth-highest selling VA issuer in the wirehouse channel, with $367.2 million in the first half of this year. Its two most popular contracts are the ONCore Premier and ONCore Lite II.

John Hancock may have seen the biggest decrease in VA sales, with a decline from $1.05 billion in the first half of 2011 to $514.8 million in the first half of 2012.

Sun Life Financial, the Canadian-owned company that has gotten out of the VA business in the U.S., is the only firm not on LIMRA’s top 20 list of domestic VA sellers in mid-2012 that was on it in mid-2011 (with $1.65 billion in sales). Hartford Life, which was not on the list a year ago, is back on the top 20 list this summer, with about $480 million in VA sales. The Hartford will continue to sell VA contracts until the sale of its VA business to Forethought is completed, a company spokesman said. (Hartford and John Hancock were not on Morningstar’s top 20 in the latest report; ING Group and Ohio National were there instead.)

Everything but net

Less fresh money is flowing into VAs this year. According to an analysis by product manager Frank O’Connor of Morningstar’s Annuity Research Center, only about $7.8 billion of the $73.5 billion in VA sales in the first half of 2012 was net cash flow; exchanges from one contract to another made up most of the sales volume.

“The positive flow has gotten so concentrated in the two or three biggest companies that when they hit the brakes the industry number nose dives,” O’Connor told RIJ yesterday. He rattled off the annual mid-year net flow totals (in billions) for years 2005 through 2011: $10.0, $15.2, $15.1, $14.7, $11.2, $9.8, and $11.6.

If net flow stays at the current low pace, the variable annuity industry will end 2012 with the least total net flow than it has seen in over a decade. It will be even lower than the $17 billion recorded in 2009, during the aftermath of the global financial crisis, and far below the $46 billion recorded in 2003.

Morningstar’s VA numbers were slightly different from LIMRA’s. Second quarter 2012 variable annuity new sales were up 5.5% over first quarter 2012, to $37.7 billion from $35.8 billion, but were down 4.6% from the second quarter of 2011, O’Connor’s report said. “At the midpoint of the year new sales of $73.5 billion are approximately 48% of 2011 full year new sales, indicating a strong possibility of a flat to slightly down year for VA sales absent a significant uptick in the second half. Assets were down 3.3% due to stagnant market performance,” he wrote.

The two most significant trends in VAs this year are what O’Connor called a “back to basics” movement that emphasizes the tax-deferred growth advantage of VAs (which put no limit on contributions of after-tax money) and a trend toward simplified lifetime income guarantees.

On the “back to basics” side is Jackson National’s Elite Access product, launched last March 5. The B-share has a 1.00% combined M&E and Administrative charge. It offers no death or living benefit guarantees; rather, its focus is on tax deferral and a broad array of investment options, including alternative asset classes.

Two other “back to basics” contracts are the Midland National LiveWell and Symetra Tru variable annuities. Both offer no loads and an extensive range of investment options, but the LiveWell VA offers a guaranteed death benefit and costs more (2.65% vs. 1.32%, all in). Neither product offers an income benefit.

Both Schwab and TDAmeritrade are adding low-M&E, simplified VAs with living benefits to their platforms. Schwab Retirement Income, launched on August 1 and underwritten by Pacific Life, has an optional single or joint lifetime withdrawal benefit and three fund options: Schwab Balanced, Balanced with Growth, and Growth funds. All three options are funds of exchange-traded funds (ETFs) and each costs 0.80% a year. The contract has no guaranteed death benefit. The total cost of 2.20% (2.40% for joint) also includes a 0.60% M&E/Administrative fee and 0.80% for the single lifetime withdrawal benefit (1.00% for the joint life version).

Great West launched the Smart Track contract last February 27 for TD Ameritrade’s platform. Smart Track offers an extensive fund lineup, a tiny 0.25% combined M&E and administrative charges, average total fund expenses of 1.01%, and optional single or joint lifetime income benefits for an additional 1.00% (the joint version has a lower withdrawal percentage). Only amounts allocated to the Maxim SecureFoundation Balanced L fund, with a total expense ratio of 0.94%, are covered by the guarantee, so the all-in cost for the income guarantee in Smart Track is just 2.19%, in the same territory as the new Pacific Life product on the Schwab platform.

The most popular VA share classes remain the B-share (61.4% of sales) and the L-share (21.3% of sales), but sales of the client-friendly O share, whose M&E fee drops from B-share to A-share levels at the end of the surrender period, are growing. From virtually zero sales a year ago, the O share had a 3.9% share of sales as of June 30, 2012, according to Morningstar.

The High-Voltage Plank in the GOP Platform

Posted on August 29, 2012 by Editor Test -

The 2012 GOP party platform was posted on The New York Times site yesterday. The section on Social Security pretty much reiterated the statement on the 2008 platform. (See the two below.) Both call for putting the program on a “sound fiscal basis” and “giving workers control over, and a sound return on, their investments.”

The 2012 platform stipulates, “No changes should affect any current or near-retiree.” As a Boomer, I was relieved to hear that; but why divide the country into Social Security haves and have-nots? The platform also charges, “Younger Americans have lost all faith in the Social Security system, which is understandable when they read the non-partisan actuary’s report about its future funding status.” (More about that in a moment.)

There’s no mention in the platform of tampering with the $100 billion-a-year tax expenditure for employer-sponsored savings plans, but closing unnamed tax loopholes is one of the ways that Paul Ryan has said he hopes to reduce the federal budget deficit.

Security for those who need it: Ensuring Retirement Security (2012 Republican platform)

“While no changes should affect any current or near-retiree, comprehensive reform should address our society’s remarkable advances in longevity and allow younger workers the option of creating their own investment accounts as supplements to the system. Younger Americans have lost all faith in the Social Security system, which is understandable when they read the non-partisan actuary’s reports about its future funding status. Born in an old industrial era beyond the memory of most Americans, it is long overdue for major change, not just another legislative stopgap that postpones a day of reckoning. To restore public trust in the system, Republicans are committed to setting it on a sound fiscal basis that will give workers control over, and a sound return on, their investments. The sooner we act, the sooner those close to retirement can be reassured of their benefits and younger workers can take responsibility for planning their own retirement decades from now.”

Social Security (2008 Republican platform)

“We are committed to putting Social Security on a sound fiscal basis. Our society faces a profound demographic shift over the next twenty-five years, from today’s ratio of 3.3 workers for every retiree to only 2.1 workers by 2034. Under the current system, younger workers will not be able to depend on Social Security as part of their retirement plan. We believe the solution should give workers control over, and a fair return on, their contributions. No changes in the system should adversely affect any current or near-retiree. Comprehensive reform should include the opportunity to freely choose to create your own personal investment accounts which are distinct from and supplemental to the overall Social Security system.”

I don’t understand the determination to dismantle Social Security just because of a temporary demographic bulge. If there’s a deep well of antipathy toward Social Security among Americans, I’m not hearing or seeing it. Whenever I witness a demonstration of retirement income planning software, for instance, I can’t help noticing that the red, blue, green or yellow bars of the illustrations always include inflation-adjusted Social Security income in the projections. Remove Social Security income, and we’ll have to rewrite all the software.

The suggestion that Social Security doesn’t give people a “sound return” on their money has never made sense to me. (What is a “sound return,” exactly?) First of all, Social Security income is guaranteed. Guarantees are expensive, but worth it. Second, Social Security benefits are immune to deadly sequence-of-returns risk; it relieves the worry of retiring in the wrong year. Third, it’s inflation-adjusted. At today’s annuity prices, a new retiree would need at least $300,000 to replace a modest $1,800-a-month Social Security benefit. That’s why, as a sole proprietor, I gladly wrote a five-figure check to Mr. FICA for 2011. It’s a bargain. (Yes, Social Security crowds out the private annuity market. If that’s the motive for dumping it, then we should have a debate on that specific question.)

As an armchair economist, I still can’t figure out how the U.S. can “go broke” by taking money out of the economy via FICA taxes and immediately placing it back into the economy through the distribution of Social Security benefits—and thereby financing consumer demand, on which the health of the economy supposedly depends.

I must also question the accuracy of the GOP platform suggestion that “non-partisan actuaries” have thrown up their hands over the future of Social Security. Here’s what the American Academy of Actuaries said in 2007 (and the AAA refered to this document in a recent release):

“The problems facing Social Security, when placed in the context of the enormous US economy, are not nearly as daunting as they might seem when presented in stark dollar terms. In the 70-year history of Social Security, the tax rate has increased from 2% to 12.4% of taxable payroll; the estimated increase required to fund the current system over the next 75 years is far less. Further, the need for such tax increases can be reduced, or even eliminated, by changes in benefits and other features; and any required changes can be phased in gradually. Does this mean we can do nothing and just wait to see what develops? While waiting will not destroy the system, there are advantages to acting now.”

Why Growth Matters More Than Debt

Posted on August 29, 2012 by Editor Test -

The U.S. federal debt recently eclipsed $15 trillion, and is still climbing. That has generated headlines and raised a lot of questions. How should we behave towards China, supposedly our biggest creditor? Has the debt burden become unsustainable? How will our kids and grandkids ever pay off the debt we’ve been accumulating? The answers contain some surprises.

A total federal debt of $15 trillion means debt owners currently hold assets totaling $15 trillion in Treasury bonds, bills, and notes. Let’s examine who owns those assets.

Who owns the debt?

A pie chart is a convenient way of showing how those assets break down by owner. At the time of this writing, the latest official numbers are for December 2011. (The official numbers are updated monthly: The Treasury summarizes our debt position; the Fed estimates the magnitude of foreign holdings by country and reports its own holdings of Treasury securities.)

The United States’ two largest creditors are U.S. citizens and the U.S. government. (Yes, the U.S. government owes itself a substantial sum of its own money; for years, Uncle Sam’s social insurance fund has been using its surpluses to purchase special bonds from Uncle Sam’s general fund.)

What does the pie chart reveal? At least one fact stands out: China’s holding of the total federal debt comes in a distant fourth—behind the U.S. government, the U.S. public, and the Federal Reserve. Interestingly, China and Japan have been neck-and-neck for years as the two foreign entities most desirous of exchanging their export-derived U.S. dollars for interest-bearing U.S. Treasury securities.

How will we pay China (and Japan) back?

That is a misleading question, because every time one of their U.S. Treasury securities matures, we really do “try” to pay them back—with (non-interest-bearing) U.S. dollars. We are obligated to redeem their maturing securities with dollars; otherwise, we would be in default—a scenario that has never, and should never, happen. But the Chinese and Japanese debt holders have been turning right around and exchanging those dollars, in the open market, for brand new U.S. Treasury securities. In effect, we keep trying to pay them back, but they won’t let us; they’d rather hold interest-bearing T-bonds than non-interest-bearing dollars. It’s their choice, and they’ve been consistently rolling their maturing T-bonds over into new T-bonds.

So the proper question is not how will we pay the foreigners back but rather how do we propose to maintain China and Japan’s desire to buy low-interest Treasury securities from us? The answer: A healthy, robust, growing economy is the only way to maintain their confidence in the long run. If they ever started losing confidence in our economy’s prospects, their appetite for acquiring U.S. Treasury securities would be likely to wane, creating upward pressure on our interest rates; that in turn would not help our “debt burden”—which is explained in the section below.

Our priority should not be how to pay them back, it should be how to get our economy growing again.

How much of a burden is the debt?

Because of our large and (historically) robust economy, the worldwide demand for U.S. Treasury securities has been huge; investors view the T-bond as the world’s safe haven. Therefore, rolling the debt over (as described above)—instead of paying it down—has never been a problem. Because the debt has always been rolled over, the debt principal has not been a burden to taxpayers. The “burden” the taxpayers must bear has always been the interest on Treasury securities—not the principal.

Specifically, the debt “burden” is directly indicated by the “interest bite”: the portion of tax receipts required to cover the interest on the debt. When the interest bite is increasing, the debt is becoming less sustainable; conversely, when the interest bite is decreasing, the debt is becoming more sustainable.

What makes the interest bite grow or shrink? The debt level is just one of three primary factors. A second factor is the interest rate demanded by the buyers of T-bonds; for example, when they demand only 1 percent interest, the “burden” of any given level of debt is 80 percent smaller than it would have been had they demanded a whopping 5 percent.

The third factor affecting the interest bite is the level of tax receipts. For any given tax-rate structure, the larger the economy and the more people who are working and paying taxes, the larger the government’s tax receipts—and the lower the debt burden, i.e., the interest bite. A strong economy strengthens our ability to sustain any given debt level.

In summary, there is upward pressure on the “debt burden” when the interest rate rises, the debt level increases, or tax receipts fall. Conversely, there’s downward pressure when the interest rate falls, the debt level decreases, or tax receipts increase.

And with that, it is time to answer the question, how big is our debt burden today? The graphic below shows the answer.

In recent decades, the interest bite has been as high as 19 percent and as low as 9 percent. The chart above shows how the interest bite has tracked for the last 13 years, through December 2011. Mildly surprising is the fact that the current interest bite is no higher than it was ten years ago.

Why is today’s debt burden—as measured by the “interest bite”—lower than the headlines and political rhetoric make it sound? Because even though the debt level is currently growing at a rapid pace, the interest rate on the new debt we’ve been issuing is as close to zero as it has ever been. A near-zero interest rate results in a near-zero interest bite on any level of debt. That’s the good news, but it carries with it an ominous qualification: when the debt level is skyrocketing, as it is today, any increase in the interest rate will quickly cause the interest bite to skyrocket as well—unless it’s offset by additional tax receipts generated by a rapidly growing economy.

In short, today’s relatively low debt burden is merely indicating that we have at least some runway left before it starts challenging the recent high of 19 percent; we would be well advised to use that runway for getting the private sector economy back to robust growth rates. The intent of extraordinary fiscal and monetary interventions by the government is to stop the bleeding in the short run, but the long run depends on the private sector’s economic health.

‘It’s the economy, stupid’

Notably, everything about keeping the debt burden at an acceptable level ultimately depends on the health of our economy. Can we count on China, Japan, the United Kingdom, and OPEC to continue rolling their maturing T-bonds into new T-bonds? Can we count on continued low interest rates due to the T-bond’s reputation as a safe haven? We can if the economy gets back on track. If it does, we can expect the debt burden—the “interest bite”—to remain at an acceptable level, presumably somewhere between today’s 10 percent level and the recent high of 19 percent.

Again, all of those factors depend on the size, health, and growth rate of our economy. The bond market’s judgment as to the U.S. government’s creditworthiness depends on it, and the bond market “knows” that growing the U.S. economy is far more important than shrinking the number of outstanding U.S. Treasury securities—i.e., than “paying down” the federal debt. In short, what’s important for the sustainability of our creditworthiness is not the debt level; instead, what’s far more important is to keep the debt burden—the “interest bite”—inside the guardrails.

The 1992 Clinton campaign had it exactly right: “It’s the economy, stupid.”

Steve Conover retired recently from a 35-year career in corporate America. He has a BS in engineering, an MBA in finance, and a PhD in political economy. His website is www.optimist123.com.

Four out of five advisors continue to use VAs: Cogent Research

Posted on August 27, 2012 by Editor Test -

Advisor interest in variable annuities (VAs) remains stable despite several headwinds, including the retreat of several major annuity issuers from the market, a reduction in product benefits and an increase in fees, according to the Cogent Research Advisor Brandscape 2012 report, which was issued last week to subscribing companies.

While the latest LIMRA data shows that gross sales of variable annuities in the first half of 2012 are down about 6% from the first half of 2011 (to $75.4 billion from $80.1 billion), Cogent’s 2012 survey of 1,741 Registered Investment Advisors and registered reps showed that virtually the same number of advisors sells VAs (81%) and that virtually the same proportion of client assets are allocated to VAs (11%) as did Cogent’s 2011 survey.

But there are some signs of softening enthusiasm for VAs. More than three-quarters (77%) of advisors who currently use VAs told Cogent they expect to continue using them in the future, with 53% saying they intend to use them at the current level (up from 47% in 2011). But about a quarter (23%) expect to reduce their VA usage and the percentage who said they will rely more on VAs dropped to 24% in 2012 from 31% in 2011.

Of those who intend to reduce their investments in VAs, 40% say they will increase their use of SMAs (separately managed accounts), 34% will add more exchanged-traded funds (ETFs), and 29% will increase their use of mutual funds.

Only 11% expected to use more fixed annuities. Among those expecting to increase their use of VAs, 58% will do so at the expense of mutual funds, followed by individual securities (35%) and cash (29%).

Favorite VA issuers

In terms of showing advisor preference among VA issuers, Cogent’s Advisor Brandscape 2012 mirrors the sales figures published last week by LIMRA. As they were in 2011, Prudential, Jackson National, and MetLife are among advisors’ favorite issuers, and their first-half sales were $10.4 billion, $9.6 billion and $9.5 billion, respectively, to lead all VA issuers. According to the Cogent Research report:

Prudential and Jackson National are “pulling away from the pack.” As other providers have retreated from the VA business out of risk management and cash reserve concerns, Prudential and Jackson National stand out for their continued commitment to the business. Both firms earn “Star” distinctions in terms of brand equity, commitment, and ownership, trailing only RiverSource in terms of average revenue earned per advisor. MetLife bests Jackson National in terms of penetration among VA users, but MetLife’s recent announcement that it is reducing its VA focus is likely to reduce its consideration and market share in the future.

Retreat from VAs by The Hartford and John Hancock have put them in Cogent’s “Drifters” category in 2012. Both firms have experienced declines in “unaided consideration,” “brand favorability” and “investment momentum.” John Hancock is less likely to be associated with “leader” and “financial stability” imagery this year. Both firms struggle in terms of Commitment score rankings in the VA category.

VA providers can burnish their brands by expanding product features and beefing up their wholesaling efforts. Thought leadership efforts tend to improve perceptions of integrity and honesty, while high fees and expenses hurt brand loyalty among advisors.

What Does ‘CFP’ Really Stand For?

Posted on August 27, 2012 by Editor Test -

Since reading about the rift between the Financial Planning Association and the American College over the past few days, I’ve been pondering the patchwork universe of titles, licenses, designations, professional associations, distribution channels, product preferences and compensation practices that financial intermediaries must try to navigate every day using their own moral and revenue-maximizing compasses.

In case you missed the recent articles in Investment News about the incoming CEO of the FPA or the American College’s response to some of her statements, here’s a quick recap:

On August 22, in a news article, Lauren Schadle, who will be the chief executive of the FPA after the organization meets in San Antonio at the end of September, told reporter Darla Mercado, “We’re putting together action plans that speak to the FPA’s being the professional resource and advocate for CFP (Certified Financial Planner) professionals,” she said. “We believe that one profession and one designation is the best way to build the financial planning profession.”

In suggesting that the FPA is the home of the CFP and represents financial “planners,” Schadle antagonized the leader of the American College. In a press release a few days ago, Larry Barton, CEO of the American College, which offers courses leading to the CFP and other designations, responded sharply.

“No one designation can embrace the full gamut of consumer needs. That is why we believe that consumers must have a choice of quality, reputable designations to select from, including and especially the CLU, CFP, ChFC, CPA, and CFA. While our College is one of the largest providers of courses leading to the CFP credential, I have never met any planner who believes education should be limited to one designation for all planners,” said Barton in a prepared statement.

He continued, “Financial planning shouldn’t be artificially defined as a separate profession. Instead, FPA and other organizations should encourage the process of planning to be used as broadly as possible, regardless of the designations an advisor may choose to pursue. We want planners to have choices. The CFPis an excellent one, as are such marks as CLU, ChFC or CFA, for example. As Ms. Schadle assumes the helm of the FPA, it is my hope that she will think twice about isolating the hundreds of thousands of advisors who don’t fit her criteria,” concluded Barton.

Barton then brought in the compensation issue by raising the fiduciary/suitability question, which is linked to the fee-only/commission division. He doesn’t want anyone suggesting that CFPs who follow the fiduciary standard, work for asset-based fees and belong to the FPA are the only sources of trustworthy financial advice.

Although I consider this controversy to be of the “inside baseball” variety, and while it’s not something I know much about, I have one or two minor contributions to make to the debate. Two weeks ago, coincidentally, there was a discussion about the CFP at the Retirement Income Industry Association “bootcamp” for the Retirement Management Analyst designation in Salem, Mass.

The comments I heard there seemed to echo Barton. It was suggested that it would be self-defeating for champions of the CFP designation to identify it solely with the fee-only, fiduciary-standard world. Doing so could make the CFP a “channel-specific” designation, desirable only for the Registered Investment Advisor/financial planner segment of the intermediary universe.

That might be problematic, it was said, because the RIA/planner segment, with an estimated 22,000 members nationwide, is much smaller than either the wirehouse/brokerage segment (351,000 members) or the insurance agent/suitability channel (1.2 million members), according to RIIA’s data. The sentiment I heard at the bootcamp was: Why would anyone want to shrink the market for the CFP or alienate the existing CFPs in the brokerage and insurance channels?

I can only speculate that the FPA leaders might believe that the brokerage world will continue to migrate away from commissions and suitability and toward the fiduciary standard and non-commission compensation. If so, why not be the first to seize the high ground?

The advisors I know don’t seem to get too hung up on designations. One friend who is a CFP and MBA offers advice on a fee or hourly basis only and recommends only no-load products. Another friend, a CFP and CPA, receives fees for planning and commissions (part upfront, part trail) when he sells variable annuities. Their securities or insurance licenses, not their designations, allow them to charge for advice or transactions, and their personal standards of integrity, not FINRA’s or the CFP Board’s, dictate their ethical choices.

The irony is that most clients don’t appreciate any of these distinctions. A few years ago, the Government Accountability Office established that the average person doesn’t understand the differences between the fiduciary and suitability standards or the CFP and ChFC designations or commissions and fees. To them, it’s a murky alphabet soup, and many of them don’t know whom to trust.

The confusion is probably even more acute in the realm of retirement income planning, where almost any intermediary can fashion him/herself as a specialist, where there are no codified best practices, where acceptable products range from securities to insurance to hybrids like variable annuities, and where meaningful designations are only beginning to emerge. As one advisor put it bluntly, “The public is screwed trying to dig through all the [manure] to find the pony.”

Comments? Send them to [email protected].

Economy shows “early signs of sustainable strength”: S&P

Posted on August 22, 2012 by Editor Test -

Growth for 3Q 2012 currently stands at 0.90%, considerably better than the negative 2% growth expected at the start of second quarter earnings season, according the August 17th Lookout Report from S&P Capital IQ’s Global Market Intelligence unit.

“While it may be too early to conclude that the economy has fully emerged from the second quarter ‘soft patch,’ economic conditions have not continued to deteriorate in July and early August,” an S&P release said.

These views are published in the Lookout Report for August 17, 2012. The report also features market insights and commentary on corporate earnings, leveraged loan trends, and commodity index activity.

Highlights of the August 17th Lookout Report include:

The Indian stock market is uninviting. An “anemic outlook for the national economy and a sharp decline in foreign direct investment signal potentially acute currency weakness [are] symptomatic of a prolonged period of internal economic adjustment. Such a scenario could prove discouraging for bond and stock investors alike.”

Global sales of S&P 500 companies “difficult to obtain.” In 2002, S&P Indices removed foreign companies from the S&P 500 Index, rendering Although the S&P 500 Index is a pure U.S. play (foreign companies were removed in 2002) a company classified as U.S. can be global. A company’s reports often show its globalization, but exact sales and export levels are difficult to obtain.

Refinance flood; high-yield “on fire”: In the first 17 days of August, arrangers have launched about $11.2 billion of institutional loans, versus $19.9 billion in all of July 2012 (and far ahead of the $1.4 billion in August 2011, when S&P’s Ratings Services downgraded U.S. debt). The high-yield market has been “on fire,” with $19.2 billion of deals printing in the month to date, versus $21.2 billion in all of July and $7.3 billion in August 2011.

Europe is a drag: Europe’s slowdown activity is the “main drag on the global economy,” according to recent global data releases Risk-reward profiles–as measured by average R2P scores—have deteriorated throughout the world in August ,with decreasing returns and increasing market risk. The score decline was even sharper in Europe.

A review of technology IPOs: The GMI research team examined the performance of U.S. tech IPOs with proceeds of $500 million or greater that came to the market since Google’s debut in August 2004. We found that Facebook shares have slumped by more than 42%, while Freescale Semiconductor Ltd. shares have gained more than 20%.

Energy and “backwardation” lead index gains: Middle East tensions have been a main driver of petroleum price gains in August. Agricultural prices have declined. Backward shaped futures curves have boosted commodity investor returns, adding to total returns for the index.

The Lookout Report provides cross-market and cross-asset class views of current data and forward-looking insights from S&P market specialists who focus on aggregated corporate earnings, market and credit risk evaluation, capital markets activity, index investing and proprietary data and analytics. It can be accessed on S&P.com, the S&P Global Credit Portal and Capital IQ.

The Bucket

Posted on August 22, 2012 by Editorial Staff -

Income annuities drive strong first half at New York Life

In the first six months of 2012, New York Life’s annuity sales and mutual fund sales were both up 17% over the first half of 2011,” a company release said. Income annuity sales alone were 11% higher than in the first half in 2011.

“Mutual fund sales are being driven by consistent investment performance from the company’s investment boutiques in both income oriented and capital appreciation funds, which remain in high demand from customers,” the release said. Other released statistics were:

Individual recurring premium life insurance sales through agents were up 4% through the second quarter, over the first half last year.
New York Life agents recorded an increase of 18% in sales of recurring premium whole life insurance for the same time period.
New York Life generated a 17% increase in long-term care insurance sales over the first six months of 2012.
New York Life hired 1,763 agents so far in 2012 (14% more than in the first half of 2011, and is almost halfway to its goal of 3,700 for the year.

New York Life is rated A++ in financial strength by A.M. Best, AAA by Fitch, Aaa by Moody’s Investors Service and AA+ by Standard & Poor’s (AA+).

Fidelity launches new workplace advice program, Plan for Life

Auto-enrollment and auto-escalation are high-tech ways to move the dial on overall 401(k) participation rates and account balances, but they don’t begin to provide the “high-touch” assistance that individual participants often need.

To add nuance to its advice and education services, apparently, Fidelity Investments has introduced Plan for Life, a new workplace guidance program.

“Simply asking employees to save more money from each paycheck no longer addresses many of the challenges our participants are facing in today’s economic environment,” said Julia McCarthy, Fidelity’s EVP for Workplace Marketing, Solutions and Experience, in a release. “Plan for Life will help them manage the complexities but simplify the decision making process.”

To support pre-retirees, Fidelity is offering face-to-face planning consultations at the workplace to employees approaching retirement. Fidelity is also opening these sessions to spouses or other family members of the employee as retirement decisions often impact more than just the individual. In addition, onsite education programs will utilize mobile tablets to make it easier for employees to take action and enroll in their workplace savings plans immediately.

In rolling out Plan for Life, Fidelity said it would:

Add licensed phone representatives. Fidelity grew its force of workplace guidance phone reps by 80% this year. All will hold a FINRA Series 7 license.
Offer onsite retirement planning consultations and instant enrollment using mobile tablets. Attendance at on-site guidance sessions was up 40% during the first third of 2012 over the same period last year, Fidelity said.
Introduce “Income Simulator,” a new retirement income illustration tool. This interactive tool illustrates a participant’s potential monthly income in retirement. It instantly reflects changes in contribution rates, retirement age or asset allocation. Future enhancements will allow more account types to be integrated into the tool.
Improve its participant website, NetBenefits.com. NetBenefits.com provides more than one million participants with specific guidance on various work and life events including starting at or leaving a company, having a child, retirement planning as well as steps for an annual financial check-up.

Fidelity Investments has assets under administration of $3.7 trillion, including managed assets of $1.6 trillion, as of July 31, 2012.

Vanguard publishes four white papers on ETFs

Billions of dollars continue to flow into exchange-traded funds, which offer the appealing combination of low costs, the risk-diversification of index funds, and the intra-day tradability of individual stocks. Vanguard, whose 64 ETFs and $215 billion in ETF assets make it the third largest U.S. ETF provider, has issued a series of white papers and articles on ETF and index construction, with commentary on the risks, returns, costs and tax implications of owning and trading ETFs. Summaries of those publications can be found below.

Evaluating dollar-weighted returns of ETFs versus traditional fund returns

Over specific time periods, a mutual fund’s dollar-weighted returns (that is, its internal rates of return—IRRs) often trail the fund’s reported returns (that is, it’s time-weighted returns—TWRs). In recent years it has been claimed that dollar-weighted returns in exchange-traded funds (ETFs) fare even worse than those in conventional mutual funds, owing to the intraday trading flexibility of ETFs. The authors of this new Vanguard research paper demonstrate that such claims, on their own, are problematic and commonly ignore important factors affecting the outcomes. In addition, similar to the IRRs of conventional mutual funds, the return differences for ETFs are highly time-period dependent.
https://advisors.vanguard.com/VGApp/iip/site/advisor/researchcommentary/research/article/IWE_InvResEvalInvestors

ETFs: For the better or bettor?

Do exchange-traded funds encourage their owners to trade more actively? Or are active traders more likely to owners ETFs?

Vanguard put these questions to the test recently by analyzing over 3.2 million transactions by self-directed investors in more than 500,000 positions held in traditional and ETF versions of four Vanguard index funds from 2007 through 2011.

Yes, trading in ETFs was more active than trading in traditional index funds, but 40% of the trading activity differences between ETFs and funds could be explained by investor and account characteristics.

Foresight is only 50:50

ETFs and target benchmarks have proliferated side by side. As of March 31, 2012, more than $1.2 trillion was invested in about 1,400 U.S.-listed ETFs, according to Strategic Insight’s Simfund. At the same time, U.S.-listed ETFs track more than 1,000 different indexes, according to Vanguard’s review of Bloomberg data.

More than half of the indexes use back-tested performance data (i.e., data based on retroactively applying the index methodology to historical data) in lieu of or in addition to live performance data (i.e., real-time performance data after index-live date).

Among the indexes being created for use in ETFs, more than half include back-filled data before the index inception date, and investors can’t always tell which data are hypothetical and which are live. Vanguard researchers found that while 87% of the indexes outperformed the broad U.S. stock market for the time in which back-tested data were used, only 51% did so after the index was launched.

Replicating equal-weighted indexing with traditional indexes

Tracking equal-weighted indexes—where the smallest company in the index has as much weight or importance as the largest company in the index—is a popular strategy among Alternative index funds and ETFs often track “equal-weighted” indices, where all companies have equal weight regardless of size.

Some critics have suggested that investors should abandon market-cap-weighted indexes in favor of alternative equity benchmarks that weight stocks equally, or according to dividends, company fundamentals, or statistical properties. Vanguard researchers say that market-cap-weighted portfolios focused on smaller-cap and value stocks represent a more cost-effective, more transparent, and statistically equivalent strategy.

Are ETFs still a bargain?

Cash flow has poured into ETFs due to the investment vehicles’ low-cost structure but the market’s average ETF expense ratio increased from 0.39% to 0.56% from December 31, 2005, to March 31, 2012. The increase in cost averages is due to the proliferation increase of narrowly focused, niche ETFs launched. Vanguard suggests investors to look more closely at asset-weighted average expense ratios instead, which show where the money is flowing. The asset-weighted average expense ratio for ETFs is only 0.32% which shows that investors are choosing lower-cost ETFs.

Sales at NPH Inc. increase 9% in 2Q 2012

The National Planning Holdings, Inc. (NPH) network of independent broker-dealers booked record revenue of nearly $412 million in the first half of 2012, a 7.5% increase over the previous six months, and a 1.6% increase over the same period in 2011.

The four firms in the network generated more than $8.2 billion in gross product sales for the first half of 2012, up 3% over the last half of 2011. The NPH firms are INVEST Financial Corporation, Investment Centers of America, Inc., National Planning Corporation, and SII Investments, Inc.

NPH achieved revenue of nearly $215 million on gross product sales of more than $4 billion during the second quarter of 2012. Second quarter revenue was up nearly 9% over the first quarter of the year. NPH also continued to grow its representative count during the first half of 2012, compared to the prior year period, ending the half with a total of 3,651 reps.

National Planning Holdings Half-Year 2012 Results
	1H 2012	2H 2011	% ∆	Q2 2012	Q1 2012	% ∆
Sales $m	8,243.89	7,999.15	3.0	4,028.24	4,214.65	(4.4%)
Revenue $m	411.54	382.80	7.5	214.55	196.99	8.9
No. of Reps	3,651	3,636	0.4	3,651	3,652	0.0
Source: National Planning Holdings, Inc. Includes sales and revenue of INVEST Financial Corp., Investment Centers of America, Inc., National Planning Corporation, and SII Investments, Inc.

Fixed indexed annuity sales rise in 2Q 2012: AnnuitySpecs.com

Posted on August 22, 2012 by Editor Test -

Forty-five fixed indexed annuity carriers reported sales of $8.7 billion in the second quarter of 2012, up more than 8% from the previous quarter and 6% from the same period in 2011, according to the 60^th edition of AnnuitySpecs.com’s Indexed Sales and Market Report.

“This quarter’s sales were only 0.60% lower than third quarter 2010’s record-setting indexed annuity sales levels,” said Sheryl J. Moore, president and CEO of Moore Market Intelligence, owner of AnnuitySpecs.com. “That being said, second quarter was a period of flux for indexed annuities; nine different companies made changes to their products on 14 different occasions during this quarter.”

Allianz Life maintained its lead position with a 16% market share. Aviva again was second, and American Equity, Security Benefit Life, and Great American (GAFRI) rounded-out the top five.

After less than one year in the FIA market, Security Benefit Life had the top-selling indexed annuity for the quarter, the Secure Income Annuity. Despite declining fixed interest rates and a transition to income sales, Guaranteed Lifetime Withdrawal Benefit (GLWB) elections dropped this quarter to 53% of total indexed annuity sales. The riders are increasingly being utilized to guarantee income; however, the bulk of the changes to annuity products in the second quarter reduced the relative competitiveness of these annuity benefits.

Prudential Launches HD Lifetime Income 2.0

Posted on August 22, 2012 by Editor Test -

Prudential Annuities, the U.S. annuity arm of Prudential Financial, Inc., has launched the latest iteration of its Highest Daily Lifetime Income rider. The new version, Highest Daily Lifetime Income 2.0, includes the introduction of a Highest Daily death benefit, according to a Prudential release.

Highest Daily Lifetime Income 2.0 retains the five percent annual compounded growth rate of the Highest Daily Lifetime Income product suite, while adding the new death benefit. Fees, age eligibility, payout bands and an investment fund choice have been adjusted for the new offering.

The August 20, 2012 “2.0” contract appears to supercede the prospectus filed on April 30, 2012, which described the Highest Daily Lifetime Income and Spousal Highest Daily Lifetime Income benefits. The prices are slightly higher on the new version of the popular rider and the age bands have shifted. The minimum age for 5% payouts, for instance, has moved up to 65 from 59 1/2.

Prudential’s optional Highest Daily income rider allows investors to reset the value of their lifetime income benefit base to the high water mark of their account value regardless of what day the high water mark occurs on. The account value itself fluctuates, however, and does not necessarily post a new high water mark every day on which the overall market shows a gain. The account’s asset allocation is subject to change by Prudential’s automatic risk management mechanism, depending on market conditions.

Many competing living benefit riders allow resets only if the high water mark occurs on a quarterly or annual contract anniversary. As noted above, the HD 2.0 benefits retains the previously-available 5% annual compounded “rollup” until an investor begins lifetime withdrawals, and a minimum 200% rollup of the income base (if withdrawals are deferred for 12 years).

Specific details of the contract are outlined below:

Fees: 1.0 percent single life (up from 95 basis points), 1.10 percent for spousal (up from 95 basis points) and 1.50 percent for single with Lifetime Income Accelerator (LIA) (up from 130 basis points.
Minimum issue age: Age 50 for the full suite of living benefits (compared with no minimum issue age in the April 30, 2012 prospectus).
Age-banded payouts: New age banded payouts include:

– Ages 50-54: 3% (changed from 45-54)

– Ages 55-64: 4% (changed from 55-59 1/2)

– Ages 65-84: 5% (changed from 59 1/2 to 84)

– Age 85+: 6% (unchanged)

(Spousal versions are 50 basis points lower for all age bands.)

Investment platform: Within the lineup of asset allocation portfolios, the AST Horizon Growth Asset Allocation portfolio will become the AST J.P. Morgan Global Thematic Portfolio.
Enhanced death benefit: Highest Daily Lifetime Income 2.0 and Spousal Highest Daily Lifetime Income 2.0 introduce a new optional integrated death benefit that locks in account highs daily. This benefit replaces the Combination five percent roll-up and highest anniversary value death benefits. The combined fee for the enhanced death benefit and income guarantee is 1.50% for single and 1.60% for spousal.

Launched in 2006, the Highest Daily suite of living benefits offers other features, including:

Real-time “stacking,” i.e., the ability to apply the guaranteed growth rate on top of the Highest Daily step-up on a real-time basis.
Nineteen actively managed asset allocation portfolios.

Post-withdrawal step-ups: After lifetime withdrawals begin, Highest Daily Lifetime Income 2.0 and Spousal Highest Daily Lifetime Income 2.0 provide annual opportunities for increased income based on the account’s highest daily value.

Overall election rates for Prudential Annuities’ variable annuity optional living benefits grew to 92% during the second quarter of 2012, the company said.

Quote of the Week

Posted on August 22, 2012 by Editor Test -

What Happened to the ‘Auto-IRA’?

Posted on August 22, 2012 by Kerry Pechter -

Over the past decade, while the British were creating the National Employment Savings Trust, a “public option” workplace retirement plan that takes full effect this October, a small group in the U.S. was trying to promulgate a somewhat similar program here.

Called the “Automatic IRA,” the program would urge employers who don’t sponsor defined contribution plans to let their employees be auto-enrolled into a tax-deferred individual retirement account (IRA) and to let employees use the company payroll system to make automatic deferrals into it.

The policy goal in the U.S. was the same as the policy goal in the U.K.: To enable the millions of people who aren’t covered by DC plans to start saving in earnest, so that they would have more money in retirement and have less need to rely on public assistance.

But while the British pension wonks, after years of laborious trial, error, negotiation and legislation, made NEST a reality, their counterparts in America, despite early bipartisan support, have seen the Auto-IRA get mired in the “swamp”—as George W. Bush recently characterized it—of contemporary American politics.

At the height of its popularity, during the 2008 presidential campaign, the Auto-IRA appeared to have friends and champions in both political parties. But some political bloggers demonized it as a “retirement wealth and power grab” by the Obama administration, and the controversy over the Affordable Care Act soon upstaged it.

To be sure, the Auto-IRA still has a pulse. “There’s a bill in Congress right now,” said Mark Iwry, the Treasury official who, with David John of the Heritage Foundation, conceived the Auto-IRA about six years ago. But the Auto-IRA’s future is dim; its fate may well depend on the outcome of this fall’s elections.

The seed: ‘negative election’

The roots of the Auto-IRA concept, as Iwry tells the story, can be traced to the mid- 1990s. While working in the Clinton Treasury Department, Iwry learned about a technique involving passive enrollment of employees into defined contribution plans. It was called “negative election,” and he began exploring its potential for ramping up participation rates.

“We had heard of this notion of ‘negative election,’” he told RIJ. “It was not widespread but the idea had cropped up. [In collecting feedback], we were asked, Is this legal? Or is it a violation [of IRS or ERISA code]? We decided that it was legal. But, more importantly, we wanted to make it legal, and we wanted to use it to encourage more participation in the plans.”

Iwry doesn’t claim to have invented auto-enrollment, but he’s at least one of its authors and promoters. “We refined it and improved it and in 1998 Treasury and IRS issued a revenue ruling that described something we named ‘auto-enrollment in a 401(k) plan.’ So we made a high profile announcement and tried to tell the market, Here’s an idea that you could try out.”

[The “negative option” was a common feature of direct marketing during the 1980s and perhaps before then. If you didn’t actively reject a junk mail solicitation, for instance, you might soon start receiving a classical music CD-of-the-month, accompanied by an invoice.]

“It was a little lonely promoting [auto-enrollment] in 1999,” Iwry said. “When introducing it to businesses and consulting firms, we talked about why some employers were interested and not others, and how the participation rates of minorities and low income people tended to go up the most with auto-enrollment. It started to catch on.”

Six years later, during the George W. Bush administration, a provision of the Pension Protection Act of 2006 provided retirement plan sponsors who were still uncertain about the legal implications of auto-enrollment with the explicit clarification they needed to adopt it.

By then, Iwry was temporarily out of government and working at the Brookings Institution, the liberal-leaning Washington think tank. While there, he and David John (below, right) of the Heritage Foundation, the conservative Washington think tank, began working on a way to apply the auto-enrollment concept beyond the 401(k) plan.

Designing the Auto-IRA

“We started with this simple notion: ‘Can we extend auto-enrollment to the rest of population even though they don’t have plans?’” Iwry told RIJ. “The next question was, ‘What can we auto enroll them into?” The solution that naturally suggested itself was to have the employer create a payroll deduction savings plan. That’s the key to the 401(k)—the savings comes out painlessly, and people don’t have to write a check the way you traditionally have to do with an IRA. So we thought, how about if we ask employers to auto-enroll people into tax-favored savings accounts without having to sponsor a formal 401(k) plan?”

Like the creators of NEST in the U.K., Iwry and John did not want their program to compete with or crowd out 401(k) plans, but rather create a starter-kit that might lead to 401(k) sponsorship. Unlike the creators of NEST, they ruled out the idea of trying to convince government policymakers to make sponsorship of a full-sized retirement plan or contributions to an Auto-IRA mandatory for employers.

“We didn’t want to try to require them to do this. We didn’t want to cross the line into forcing them to offer plans. So we said, we’ll leave small businesses with no obligations. But we’ll ask them to allow employees to get direct-deposit part of their paychecks into an IRA, just as they automatically make a mortgage or car payment,” Iwry said.

“When we developed the Auto-Ira, we realized that making employer contributions mandatory was a no-go,” David John told RIJ in a recent interview. “In fact, we used the IRA as vehicle because employer contribution aren’t allowed.”

The whole project, of course, needed buy-in from the private sector, and Iwry and John were careful not to alienate or antagonize the private sector. “We chose not to ask employers to make a contribution because we wanted position the proposal as pro-employer—and one that didn’t compete with 401(k). We didn’t want the new initiative to have any whiff of competition with or crowding out of 401(k) plans,” Iwry said. Since the contribution limits on IRAs were so much lower than those on 401(k) plans, the Auto-IRA would be weak competition at best.

“It was designed to pick up where the 401(k) left off,” he added. “We all felt that anything we could do to nudge more employers toward sponsoring [formal 401(k)] plans would be positive. We also thought employers might want to step up to the 401(k) after they saw how much employees appreciated the benefit.”

In the U.K., distributions from tax-deferred accounts are generally not allowed before retirement, but Iwry and John also saw that barring access would be non-starter in the U.S. “We thought about banning leakage, but our view was that there’s too big a connection between the participants’ willingness to contribute and their ability to get their money out if they desperately need it,” Iwry said.

“We thought briefly about starting with a clean slate and creating the ideal anti-leakage policy for the Auto-IRA, but we were trying to keep it simple. The IRA itself already strikes a balance [in that respect]. It’s not totally leaky or totally sticky. An IRA is an IRA; everyone knows what it is. We said, ‘The Fidelitys and the Vanguards already know how to run IRAs, so let’s use what’s already there.’ We also felt that once we got the plumbing in place, we could go back and tweak it,” he added.

One part of the Auto-IRA design that remained vague was the designation of investment options. “Regarding the default investment, we haven’t tried to design that part of it. We thought we should go with the general weight of investment opinion. We looked to the QDIAs [qualified default investment alternatives, such as target-date funds]. This was a saving agenda, for people who are not saving now,” Iwry said.

“We weren’t trying to make people into sophisticated investors,” he added. “We wanted to limit [the investment options] to perhaps three choices, with one of them being the default and the others being something that was already commonplace in the 401(k) world. The employers who started this would get a tax credit, but it would be a small one because there would be hardly any cost to setting one up.”

Support appears, and so do hostile bloggers

“David John and I formulated this and rolled it out in 2006. We wrote a paper, presented it at Heritage Foundation, had an event to roll the idea out. We got immediate interest and support from a variety of groups. We created the Retirement Security Project under the aegis of the Brookings Institute with funding from the Pew Charitable Trust.

“That was when things started to happen. The Hill contacted us. Gordon Smith and Jeff Bingaman sponsored Auto-IRA legislation in the Senate. Representatives Phil English and Richard Neal introduced it in the House.

“The New York Times endorsed it, saying it was the ‘best pension idea’ around. The Washington Times endorsed it. And in the 2008 campaign, candidate Obama endorsed it and put it in his campaign materials as his first retirement initiative. John McCain also endorsed it. AARP endorsed it. Laura Tyson, Martin Feldstein of Harvard, and ASPPA [the American Society of Pension Professional and Actuaries]—we got all their support. ASPPA like it because they saw that, while this was not an employer plan, just an IRA, it might encourage more employers to eventually sponsor plans.”

“It was endorsed by Obama and McCain in the campaign,” David John said. Whoever won the 2008 election, “we expected to be able to move ahead in 2009.” After the Democrats won, Iwry joined the Obama administration as a Deputy Assistant Secretary for Retirement and Health Policy.

And they did move ahead. But the bipartisan support may have encouraged them to expand the program in ways that would provide anti-Obama administration bloggers with an opportunity to demonize it.

In mid-2009, Iwry met at the Treasury Department with a delegation of journalists from the National Press Foundation, and in a meeting at which RIJ was present, explained that the Auto-IRA contained several ambitious elements that would fill in some of its holes.

The improved Auto-IRA would enhance an existing tax break, the Saver’s Credit, and make it refundable so that it would serve in lieu of an employer match. The initial contributions would go into a new government security, called R-bonds.

As RIJ reported in June 2009, “Managed by the government, the R–bond program would relieve private investment firms of the task of managing unprofitably small accounts. ‘The money would be in the R bonds until the account gets big enough for the money to go to the private sector,’ Iwry said.”

When President Obama introduced the Auto-IRA in his 2010 budget, however, and when Auto-IRA legislation included a mandate that all but the smallest employers enroll employees into an Auto-IRA unless they opted out, the hitherto feel-good, bipartisan Auto-IRA suddenly became a lightning rod for conspiracy theories in the blogosphere and online publications in the U.S. and abroad.

Stories and even lurid political cartoons began to appear widely on the web. The Auto-IRA and the R-bonds were compared to Argentina’s recent nationalization of defined contribution accounts. The American Lantern Press in South Carolina described “The Obama Administration’s Secret Plan to Hijack Your 401(k)s and IRAs.”

A headline on a blog at ohiomm.com asked, “Will the Government Nationalize Your Retirement Funds?” The EU Times website said, “US Said Preparing New Laws to Seize Americans Retirement Accounts,” and a column by Ron Holland at lewrockwell.com was titled, “The New Auto-IRA is Just Highway Robbery.”

Introduced at the same time and in the same budget at the Affordable Care Act, the Auto-IRA proposal became conflated with the health care proposal, and opponents of so-called “Obamacare” and its mandates became opponents of the Auto-IRA and its mandate.

In interviews, Iwry and John spoke only generally about the Auto-IRA being upstaged by the Affordable Care Act and falling victim to polarized Washington politics. “We went to draft the bill, and the same people were working on both health care and retirement, and health care became the first priority. After that, we lost a lot of momentum,” John said. “Also, people have assumed that the mandates in the health care law are paralleled in the Auto-IRA. One employer said, ‘Damn it, you just put in a bunch of new requirements for health care and now you want to stick on more with retirement.’ But this was a rare situation where the longer you discussed it, the more support built. We ended up with 75% support.”

“We have gone through a very turbulent period,” Iwry told RIJ. “We had the financial crisis and health reform, and all the Congressional dynamics around that. With the way things have gone the past few years, in an atmosphere that is more partisan than both of the [2008] presidential candidates had hoped, it’s been harder to get this through.

“With the financial crisis, the revenue issues have become more acute,” he added. “The situation with the national debt has made it harder to get new ideas enacted unless they have really broad support. But the Auto-IRA doesn’t cost much, so the deficit issue shouldn’t be a showstopper for this. The cost is estimated to be only about 1% of the amount we spend as a tax expenditure on retirement plans, which is somewhere above $100 billion. A mere 1% increase [in the expenditure] would increase [retirement plan] coverage by a dramatic percentage.”

Fading prospects

The Auto-IRA was again included in the Obama administration’s budget for 2012, and a bill was re-introduced earlier this year by Rep. Richard Neal (D-Mass). It contains the much-vilified employer mandate to auto-enroll employees. For that reason, its prospects for passage are considered dim. At a conference last May, a reporter asked Dallas Salisbury, the president and CEO of the Employee Benefits Research Institute, whose members include many of the largest 401(k) plan providers and financial services firms in the country, what he thought its chances might be.

“As an observation, what we know is that mandates are not currently something that seems to be popular with policymakers or with the public,” Salisbury said. “It is the mandate in the Affordable Care Act that is at the center of the Supreme Court challenge currently taking place. And the auto-IRA proposal puts a mandate on small employers. Members of Congress in both parties have said that the inclusion of the mandate makes that [auto-IRA proposal] a difficult policy to adopt. And many interest groups have said they would oppose that because of the mandate. So setting aside the merits of auto-IRA per se, as a practical matter, the current debate about mandates affects very much what the likely outcome in that area is.

“It makes it quite unlikely, in the near term, that you would see that proposal enacted,” he added. “That is not a statement on whether they think more retirement savings is needed, it is a statement on current attitudes toward mandating that individuals or employers do things as opposed to having free choice.”

The future of the Auto-IRA may well depend not only on the outcome of the presidential contest this year, but also the contest to control the House and Senate. Either way, the problem that the Auto-IRA intended to address—the lack of retirement plan coverage by about half of America’s private-sector workers and a low savings rate among middle- and low-income Americans—remains. The consequences of not addressing that problem won’t disappear.

“People really don’t understand how little they’ll be getting from Social Security,” David John told RIJ. “Years ago, [New York Senator] Patrick Moynihan feared that people would think they’ll be getting more from Social Security than they actually would, and wouldn’t make other provisions [to save]. If we don’t have a retirement savings system for everyone, there will be demand for more government services and benefits, funded by a tax on business.”

A Flock of Black Swans

Posted on August 22, 2012 by Jeffrey Frankel -

Throughout history, major political and economic shocks have often occurred in August, when leaders have gone on vacation believing that world affairs are quiet. Consider World War I’s outbreak in 1914, the Nazi-Soviet pact in 1939, the Sputnik launch in 1957, the Berlin Wall in 1961, and the failed coup in Moscow of 1991. Then there was the Nixon shock of 1971 (when the American president took the dollar off the gold standard and imposed wage, price, and trade controls), the 1982 international debt crisis in Mexico, the 1992 crisis in the European Exchange Rate Mechanism, and the 2007 subprime mortgage crisis in the United States.

Many of these shocks constituted events that had previously been considered unthinkable. They were not even on the radar screen. Such developments have been called “black swans” – events of inconceivably tiny probability.

But, in my view, “black swan” should refer to something else: an event that is considered virtually impossible by those whose frame of reference is limited in time and geographical area, but not by those who consider other countries and other decades or centuries.

The origin of the black swan metaphor was the belief that all swans are white, a conclusion that a nineteenth-century Englishman might have reached based on a lifetime of personal observation and David Hume’s principle of induction. But ornithologists already knew that black swans existed in Australia, having discovered them in 1697. They should not have been viewed as “unthinkable.”

Before September 11, 2001, some experts warned that foreign terrorists might try to blow up American office buildings. Those in power did not take these warnings seriously. After all, “it had never happened before.” Many Americans did not know the history of terrorist events in other countries and other decades.

Likewise, until 2006, most Americans based their economic behavior on the assumption that nominal housing prices, even if they slowed, would not fall, because they had not done so before – within living memory in the US. They may not have been aware that housing prices had often fallen in other countries, and in the US before the 1940’s. Needless to say, many indebted homeowners and leveraged bank executives would have made very different decisions had they thought that there was a non-negligible chance of an outright decline in prices.

From 2004 to 2006, financial markets perceived market risk as very low. This was most apparent in the implicit volatilities in options prices such as the VIX. But it was also manifest in junk-bond spreads, sovereign spreads, and many other financial prices. One reason for this historic mispricing of risk is that traders’ models went back only a few years, or at most a few decades (the period of the late “Great Moderation”). Traders should have gone back much further – or better yet, formed judgments based on a more comprehensive assessment of what risks might confront the world economy.

Starting in August 2007, supposedly singular black swans begin to multiply quickly. “Big banks don’t fail?” No comment. “Governments of advanced countries don’t default?” Enough said.

Debt troubles in Greece, especially, should not have surprised anyone, least of all northern Europeans. But, even when the Greek crisis erupted, leaders in Brussels and Frankfurt failed to recognize it as a close cousin of the Argentine crisis of 2001-2002, the Mexican crisis of 1994, and many others in history, including among European countries.

Nowadays, a eurozone breakup has become one of the most widely discussed possible shocks. Considered unthinkable just a short time ago, the probability that one or more euro members will drop out is now well above 50%. A hard landing in China and other emerging markets is another possibility.

An oil crisis in the Mideast is the classic black-swan event. Each one catches us by surprise: 1956, 1973, 1979, 1990. Oil prices can rise for many other reasons, as they have in recent years. But the most likely crisis scenarios currently stem from either military conflict with Iran or instability in some Arab country. The threat of a supply shock typically fuels a sharp increase in demand for oil inventories – and thus in prices.

The most worrisome financial threat is that currently over-priced bond markets will crash. In theory, inflation (particularly commodity-induced inflation, as in 1973 or 1979) could precipitate a collapse. But this seems unlikely. Default in some euro countries or political dysfunction in the US is a much more likely trigger.

Evidence of extreme dysfunction in US politics is already plain to see, reaching a low in 2011 during the debt-ceiling showdown (also in August), which cost America its AAA sovereign rating from Standard & Poor’s. In theory, as the “fiscal cliff” set for January 1, 2013, approaches, fearful investors should start dumping bonds now. But investors still believe that politicians, aware of the dire consequences of going over the cliff, will again find a last-minute way to avoid it.

Perhaps observers believe that a clear result in November’s elections, one way or the other, would help to settle things. A true black swan – low probability, but high enough to think about – would be a repeat of the disputed 2000 presidential election. There has been no reform since then to ensure that people’s votes will be counted or that a disputed outcome will not be resolved by political appointees.

Scariest on the black-swan list is a terrorist attack with weapons of mass destruction. There is a long-standing gap between terrorism experts’ perception of the probability of a nuclear event and the probability as perceived by the public. (Admittedly, the risk is lower now that Osama bin Laden is dead.)

Last on the list is an unprecedented climate disaster. Environmentalists sometimes underestimate the benefits of technological and economic progress when they reason that a finite supply of resources must imply their eventual exhaustion. But it is equally mistaken to believe that a true climate disaster cannot happen simply because one has not already occurred.

Have a nice vacation.

Jeffrey Frankel, a professor at Harvard University’s Kennedy School of Government, previously served as a member of President Bill Clinton’s Council of Economic Advisers.

RIIA’s Retirement ‘Bootcamp’

Posted on August 22, 2012 by Editor Test -

Wearing shorts, a cotton polo shirt, New Balance sneakers and a 24-hour stubble, Mike Hardin was carefully jotting down notes in a classroom at the Bertelon School of Business at Salem State University in Massachusetts last week.

Hardin is no schoolboy—he’s a tall, 40-something broker and advisor at First Tennessee Brokerage in Johnson City, Tenn. But he had traveled all the way from there to Salem, Mass., to study for and take an exam that he hoped would give him an edge over his fellow advisors in their competition for Baby Boomer clients.

“If you don’t know this,” Hardin told me, “you’ll be left behind.”

By “this,” Hardin was referring in general to the ability to build efficient, reliable retirement income portfolios and in particular to the curriculum of the Retirement Income Industry Association’s RMA (Retirement Management Analyst) designation, a credential whose exam Hardin hoped to pass in a few days.

In June, RIJ wrote about retirement income credentials, including RIIA’s RMA, the American College’s Retirement Income Certified Professional (RICP) designation and InFRE’s Certified Retirement Counselor designation, among others.

These sponsoring organizations provide concentrated instruction—videos, textbooks, live lectures, continuing ed—in how to evolve from an accumulation-minded to a decumulation-minded advisor. They bestow suitable-for-framing diplomas that may or may not carry weight with advice-hungry Boomers. And they are more or less rivals in a quiet but urgent hunt for enrollees, corporate grants, endorsements and prestige—as this week’s endorsement of the RICP by the Insured Retirement Institute implied.

To get a closer look at one of these courses, I drove up to Boston last week to spend a few days at the RIIA’s RMA “bootcamp.” As an inductee, I slept in a dorm room at Salem State. For several days I woke up to bagels, coffee and a presentation by one of the academic retirement gurus who are informally or formally affiliated with RIIA.

Wade Pfau, the Tokyo-based Princeton Ph.D. and blogger who is the RMA curriculum director, was there, along with Larry Kotlikoff, the Boston University author, economist, creator of the ESPlanner income planning software, and Zvi Bodie, the Boston University author, economist and pension finance expert. In addition, there was Dana Anspach, a Phoenix-based advisor who writes the About.com column, “Money Over 55”, and Alain Valles, a Wharton-trained reverse-mortgage broker from Boston. RIIA’s founder and chairman, Francois Gadenne, and RIIA’s chief operating officer, former Fidelity and Merrill Lynch executive Steve Mitchell, also taught segments.

Seated in the classroom and absorbing each session’s smart-board presentations were, at various times, Danny Francisco, retirement income consultant at John Hancock Financial Network—who also presented on John Hancock’s success using Moshe Milevsky’s “Retirement Sustainability Quotient” calculator as a sales tool—Susan Yates, owner of a continuing ed company who came down from Toronto, and Grant Rondeau of Symetra, who came in from the Seattle area.

In addition, there was a Salem-area advisor, Kathy Mealey, a local lawyer named Andy Stone who wanted to learn how to fund his own impending retirement, as well as Bob Powell, editor of RIIA’s Retirement Management Journal, Mike Hardin, and myself. It was a small group; just two or three were actually studying for the course. The RMA designation is only about two years old, has had only a couple of prior bootcamps at Texas Tech University and Boston University, and is still finding its feet. So far there are about 60 RMA designees.

There’s not enough room in this column to summarize the content of all of the presentations, but there are three things about RIIA you should know: Its decumulation philosophy is “build a floor and then seek upside;” it values process and open architecture solutions over product solutions; and it not only tolerates but fosters a diversity of economic and political opinions that it calls “the view across the silos.”

Certainly, the bootcamp presenters were coming from very different places. Larry Kotlikoff insisted on the exclusive legitimacy of “consumption-smoothing” over one’s entire lifetime. Wade Pfau proved mathematically the long-held heuristic that you should buy a life annuity big enough to cover basic expenses and invest the rest of your money in stocks and bonds. Offering the brokerage perspective, Danny Francisco talked about how to make annuity product sales a slam-dunk. Offering the planner perspective, Dana Anspach, in the course of describing her own odyssey from aerobics trainer to high-visibility advisor, talked about creating holistic strategies and long-term relationships. Brokers and planners appear to be equally welcome under RIIA’s big tent.

Exposing investment myths and challenging conventional wisdom are standard activities at RIIA events, and at the bootcamp it was even more so. In his booming voice, for instance, Zvi Bodie assailed the idea that long holding periods neutralize the volatility of stocks. Like a lot of people, I had been told that if you held stocks for more than 10 years, you’ll probably end up with an average annualized return of 5% to 10%. But the idea that past averages give any hint at all about the potential range of returns in the future, Bodie argued, is pure nonsense.

“That is a fallacy. It has no validity, and it’s bordering on fraud,” Bodie, who was wearing a Hawaiian-style shirt, insisted. “If I were the SEC I would outlaw this. Time diversification is a fallacy.”

The bootcamp wasn’t an all-work-no-play affair. From Salem State University, where the RIIA bootcamp was held, it is only a short drive to Marblehead, Mass., a picturesque thumb of land that sticks out into the Atlantic Ocean. Many of Boston’s business tycoons, including Peter Lynch, the former Fidelity fund manager who was to investing what Red Sox great Ted Williams was to hitting a baseball, own palatial oceanfront or harborfront homes there.

Most days after the RMA presentations were done, the bootcamp attendees piled into cars and convoyed out to a cove on the west side of Marblehead for wine or gin-and-tonics on the veranda of the Corinthian Yacht Club, with its relaxed and privileged view of hundreds of tiny pleasure boats at anchor. From that perspective, financial success certainly looked worth studying for.

Six VA issuers that advisors love

Posted on August 16, 2012 by Editor Test -

Earlier this summer, some insiders in the variable annuity business were remarking on the mismatch between the rising demand for income guarantees and the waning supply, created by annuity manufacturers withdrawing from the market.

Now Cogent Research has data that sheds some light on that mismatch—and the opportunity it creates. It also names the annuity issuers that advisors like best.

“The demand for variable annuity products is expected to remain strong, and advisors’ interest in these vehicles shows no sign of waning despite recent volatility in the variable annuity market,” according to the Cogent Research Advisor Brandscape 2012 report.

“The contrast between providers pulling back from the VA business and advisors looking to VAs to meet their clients’ objectives creates an opportunity for the remaining providers to step up, ride out the risk, and potentially gain a strong hold on the market,” said Meredith Lloyd Rice, Senior Project Director and co-author of the report, an annual survey of over 1,700 financial advisors across all channels with at least $5 million in assets under management.

Overall, 77% of advisors expect to continue selling variable annuities and allocate 11% of their AUM towards these products, the report says. Of the 15 leading VA providers, Prudential and Jackson have increased their penetration among VA sellers by 7% and 12% respectively, and both firms lead in Advisor Investment Momentum (AIM) which measures advisors’ intent to increase or decrease usage of existing providers in the coming year.

Prudential, Jackson National, MetLife, Aegon/Transamerica, and RiverSource have managed to increase their penetration among VA users over the past year. In particular, Prudential appears to be making inroads among advisors in the Regional channel, the report says.

Meanwhile, RiverSource has improved its penetration among Independent advisors driven in part by an uptick in cross-selling among Ameriprise financial advisors. Lastly, Jackson National has experienced a significant increase in usage among advisors in the National wirehouse channel. In the AIM ranking, Prudential and Jackson National tie for first place, followed by Lincoln National, MetLife, RiverSource, and Aegon/Transamerica. All six firms earn above average AIM scores among the top providers.

The Bucket

Posted on August 16, 2012 by Editorial Staff -

Nationwide names new leaders for retirement plans and P&C Direct

The leaders of Nationwide’s retirement plans business and its property & casualty direct channel will be switching roles, the company announced this week. Larry Hilsheimer will lead Nationwide Retirement Plans and Anne Arvia will lead Nationwide Direct, Affinity and Growth Solutions. The changes are effective immediately.

Larry Hilsheimer has been named President and Chief Operating Officer of Nationwide Retirement Plans. He will retain oversight of Nationwide Bank. He joined Nationwide as executive vice president and chief financial officer in 2007 coming from Deloitte & Touche USA, LLP where he served as partner, vice chairman and regional managing partner.

Anne Arvia has been named President and Chief Operating Officer of Nationwide Direct, Affinity and Growth Solutions (NDAGS). Arvia currently serves as the leader for Nationwide Retirement Plans. NDAGS includes Nationwide’s direct property & casualty sales channel, specialty insurance, affinity partnerships, and Veterinary Pet Insurance. Arvia joined Nationwide in 2006 as president of Nationwide Bank prior to assuming her role as leader of Retirement Plans in 2009. Previously, Arvia spent 15 years at ShoreBank in Chicago.

Additionally, Mark Berven has been named Executive Vice President and Chief Strategy and Product Management Officer. He will oversee strategy for the Nationwide enterprise and the product organization for property & casualty business lines. He joined Nationwide in 1994 and has served as a regional vice president and most recently as senior vice president of product and pricing for all P&C operations.

Hilsheimer will report to Kirt Walker, President and Chief Operating Officer of Nationwide Financial Services. Arvia will report to Mark Pizzi, President and Chief Operating Officer of Nationwide Insurance. Berven will report to CEO Steve Rasmussen.

Stout joins MassMutual Retirement Services as southeast sales director

Christopher Stout joined MassMutual’s Retirement Services Division on August 1 as sales director to support the Southeast region. He reports to Shefali Desai, emerging market sales manager for MassMutual’s Retirement Services Division.

Based in Canton, Ga., Stout is responsible for business development and sales support of MassMutual’s third-party and dedicated distribution channels focusing on retirement plans in the small-plan market. He will partner with MassMutual’s managing director, Jeffrey Keller, covering Ga. and Ala.

Previously, Stout was regional vice president of retirement plan sales with Guardian Insurance Company of America. He holds a BA from Stockton State College.

Transamerica Retirement Services website gets top DALBAR rating

Transamerica Retirement Services’ plan participant and plan sponsor websites have been rated “Excellent” in DALBAR’s first quarter Defined Contribution WebMonitor program. Transamerica outperformed more than 40 other retirement plan provider websites rated in the study, according to a company release.

Transamerica’s plan participant website earned a score of 93.35 out of a possible 100, an increase of 3.33 points since 4Q 2011, surpassing its own record WebMonitor score achieved by a plan participant website in the study’s history. This is the second consecutive calendar quarter that Transamerica’s plan participant website has set a record score for the DALBAR report.

Transamerica’s plan sponsor website also earned an “Excellent” designation – the only site to do so among 42 peers – and ranked in top position in DALBAR’s analysis of provider websites for retirement plan sponsors. Transamerica’s plan sponsor website has won this recognition for 10 consecutive calendar quarters.

Transamerica’s plan sponsor and plan participant websites have also been awarded DALBAR’s Seal of Excellence for eight consecutive years.

Each quarter, DALBAR identifies industry websites that attain a top-10 ranking based on scoring in five categories: functionality, usability, behavior centric attributes, content currency and consistency.

The worst of the global slowdown will soon be over: BNY Mellon

Posted on August 16, 2012 by Editor Test -

There will be a moderate strengthening of global economic indicators in late 2012 and 2013, according BNY Mellon chief economist Richard Hoey’s August 2012 Economic Update. He expects global GDP of 3% and a “growth recession” for 2012, as the worst of the global slowdown passes.

European policymakers will support the integrity of the euro rather than face the severe losses that would follow its dissolution, according to BNY Mellon. “For that reason, we do expect the euro to survive,” Hoey said in a release. “The euro should continue to include most of its current members.”

Hoey believes the rescue of the euro to come too late to stop a European recession, but foresees no financial apocalypse there.

“We believe that Europe is currently in the worst phase of the European recession and the stronger countries can exit recession in late 2012 or early 2013,” Hoey added. “We disagree with the disaster scenarios for Europe. However, even after the current European recession ends, we expect a multiyear period of sluggish economic activity, given unfavorable demographics, competitiveness challenges and legacy debt issues.”

Too many fund choices can spoil the portfolio, researchers say

Posted on August 16, 2012 by Editor Test -

Because ordinary investors tend to be overwhelmed by too many retirement fund options, they often adapt by choosing simple, intuitive diversification strategies that don’t necessarily reduce their overall portfolio risk.

That conclusion was reached by a team of researchers from Rutgers, the University of Pittsburgh, the University of Texas, and Boston College and reported in the August issue of the Journal of Marketing Research.

The researchers’ experiments showed that increasing the fund assortment size does two things: it increases the number of funds that people invest in and increases their tendency to spread the dollars evenly among those funds. As a result, people may be under-diversified and more vulnerable to market swings.

“People get overwhelmed by choice,” said J. Jeffrey Inman, a marketing professor and associate dean for research and faculty at the University of Pittsburgh. “It is one thing to be faced with a big assortment of mustards at the grocery store, where the stakes are low. The order of magnitude is greater with mutual funds, where you feel less informed.”

The study, “Investing for Retirement: The Moderating Effect of Fund Assortment Size of the 1/N Heuristic,” was co-written by Inman, with Maureen Morrin of the Rutgers University School of Business; Susan M. Broniarczyk of the University of Texas-Austin McCombs School of Business; and Gergana Nenkov and Jonathan Reuter of the Boston College Carroll School of Management.

IRA contributions increase nearly 15% since 2007: Fidelity

Posted on August 16, 2012 by Editor Test -

The average contribution to Fidelity IRAs was $3,930 for tax year 2011, up nearly 15% percent from $3,420 for tax year 2007, according to a five-year analysis by the giant Boston-based no-load fund company.

All age groups showed double digit percent contribution increases. Roth IRA conversion activity in 2012 continues to be double the level seen in 2009, the year before income limits were removed.

The analysis from Fidelity, which according to Cerulli Associates has nearly $700 billion in assets under administration in IRAs, shows positive contribution trends across all age groups:

Age Range	Average 2011 Tax Year Contribution	Average 2007 Tax Year Contribution	% Increase
20-29	$3,210	$2,840	12.9
30-39	$3,350	$2,970	12.7
40-49	$3,610	$3,160	14.1
50-59	$4,480	$3,970	12.8
60-69	$4,690	$4,140	13.4
70+	$4,650	$4,030	15.3

The analysis also examined usage trends of Roth and Traditional IRAs, highlighting the various benefits of each account. Findings from the analysis include:

On average, annual contributions to Roth IRAs have surpassed those made to traditional IRAs by 62.7% per year since tax year 2007.
For the past five years, investors in their 60s have had the highest Roth and traditional IRA contribution rates. For tax year 2011, these investors contributed an average of $4,930 to Roth IRAs and $4,790 to traditional IRAs.
For the past three tax years, an average of 41.6% of the contributions by investors in their 50s were made to traditional IRAs.
84% percent of all contributions made by investors in their 20s for tax year 2011 were to Roth IRAs.
85% of all contributions made by investors aged 70 and older were to Roth IRAs.

For the first half of 2012, Fidelity conducted more than 45,000 Roth IRA conversions with investors. This was a slight increase over the number of conversions conducted in the first half of 2011, and more than double (109%) the number conducted within the same timeframe in 2009, before income limits were removed.

How Will the LIBOR Scandal Affect Bank Shares?

Posted on August 16, 2012 by Gene Kirsch -

Note: This article first appeared at Weiss Ratings, and the original, including charts that the story below references, can be found there.

The LIBOR rate-rigging scandal threatens to engulf some of the major banks in the world including JPMorgan Chase and Citigroup in the U.S. and, of course Barclays, plc in the United Kingdom.

LIBOR is an acronym for London Interbank Offered Rate. It’s a benchmark interest rate that affects how consumers and companies borrow money across the world. The LIBOR rate is set each week by the British Bankers’ Association (BBA) an industry group in London. Each weekday, leading banks around the world submit a rate estimate for borrowing funds from other banks. The BBA throws out the highest and lowest 25% of submissions and averages the remaining rates. This establishes the LIBOR which is then calculated for 10 different currencies and 15 borrowing periods or terms such as for one-month, three-months or one-year rates.

LIBOR is the benchmark used to set interest rates for an estimated $350 trillion financial instruments globally, including derivative swap transactions, futures contracts, home mortgages and even some credit cards. Lenders use the LIBOR as a base and add additional interest to cover anticipated borrower credit risk. They may also add additional interest to reach the bank’s own profit targets. Many variable mortgage and credit card interest rate adjustments are triggered and set based on changes in the LIBOR rate. When the LIBOR goes up, rates and payments on loans tied to it, rise too.

A majority of variable-rate commercial loans are tied to the LIBOR. In fact, about 45% of prime mortgages and 80% of subprime adjustable rate mortgages in the United States have interest rates based on the LIBOR. And, about half the variable-rate private student loans are tied to the LIBOR.

While it is not clear exactly what caused regulators to investigate Barclays Bank, plc now, there have been suspicions for some time that banks were submitting false rates to increase their own profits. In fact, regulators may have known as far back as 2008, but it has taken this long for them to close in on what was going on.

What Barclays did was have its trading unit convince employees responsible for submitting LIBOR rates to alter the bank’s rates based on their derivative trading positions. Traders even coordinated with other banks to lower rates as well. During the height of the financial crises, Barclays submitted artificially low rates to give the impression that the bank could borrow money more cheaply and was healthier than it was. The three-month Libor was set at or above 5.25% during the crises, but might have been higher in reality. The current three-month LIBOR is at 0.47%, as of July 18, 2012.

Barclays was investigated, and in June the bank was found guilty and fined over $450 million for manipulating the LIBOR as far back as 2005. The Barclays settlement does not include potential civil litigation by investors and others that may occur as the result of the fraud.

While there has been no official mention of the banks suspected to be involved in the scandal or being investigated for possible wrong doing, it is clear Barclays did not act alone. So, other banks are likely to face regulatory scrutiny for similar price collusion and rate manipulation. Looking at the table above, you can see the banks that might have more exposure based on the number of currency panels they sit on. For example, Barclays, Deutsche Bank, HSBC and Lloyds Banking Group sit on all 10 currency panels and may have a higher risk of investigation and also a higher probability or incentive to manipulate the LIBOR rate.

For those banks that may have the most exposure, let’s look at the potential hit to earnings based on regulatory fines and potential civil litigation. The earnings-per-share (EPS) hit could translate to a drop in stock price if the institution is implicated in the scandal.

For banks with fewer shares outstanding, the impact of fines and civil litigation on earnings per share (EPS) might be more severe. For example, Barclays, with more than 12.2 billion shares outstanding, would take an $0.11 per share hit on earnings (U.S. dollars) compared to the $2.42 per share hit on earnings for Deutsche Bank with only 929.5 million shares outstanding.

Barclays incurred price depreciation in the vicinity of 19% since the scandal was announced on June 28. If other banks are implicated, you may expect similar stock price depreciation for those institutions with the highest risk. The table above estimates what the resulting lowest stock price would be after depreciating 19% from its June 28 price, then compares it to the closing price on July 20 to project how much further the price could fall on a percentage basis.

There may be more damage from the fallout than from the rate manipulation itself. Once again, we see that there is little backstop to keep banks from acting in their own self-interest, often at the expense of their own clients. The very foundation of our faith in the integrity of the financial system and regulatory oversight has been badly shaken — yet again. And the financial impact of fines and penalties loom large for the banks and investors in the financial sector.

This scandal, even if it remains primarily outside the United States and the Federal Reserve’s control, will undoubtedly produce a major overhaul in the process to calculate the LIBOR rate. While it may take some time to overhaul the process, today’s sophisticated technology should make it possible to calculate the LIBOR based on actual bank data from existing contracts while tapping a broader base of banks to be in on the process than the 23 that are currently involved. This should make it more difficult for banks to skew results going forward. We also hope there have been many lessons learned by regulators that will translate to a more even playing field for banks, customers and investors.

Gene Kirsch, senior banking analyst at Weiss Ratings, leads the firm’s bank and thrift ratings division and developed the methodology for Weiss’ credit union and global bank ratings.

Strategic Insight is Bullish on ‘In-Plan’ Annuities

Posted on August 16, 2012 by Editor Test -

The widening use of target-date funds as qualified default investments and the advent of technical solutions to portability issues should make defined contribution plan sponsors more receptive to offering so-called “in plan” annuities, according to In-Plan Guarantees, a new report that Strategic Insight is currently marketing.

“Many of the challenges have been addressed,” said Tamiko Toland, managing director of Retirement Income Consulting at Strategic Insight and primary author of the report. “This market is still in its early stages, but it is more mature than many people realize.”

Marketers of in-plan guarantees that are covered in the report include Alliance Berstein, ING, AXA Equitable, John Hancock, BlackRock, Diversified/Transamerica, The Hartford, Genworth, Lincoln, MetLife, Great-West, Prudential and Mutual of Omaha.

Insurance companies are eager to market their lifetime income guarantees, especially living benefit riders, to defined contribution plan participants. Prudential has succeeded in that arena with its IncomeFlex program, and United Technologies seemed to set a precedent not long ago when it began offering Alliance Bernstein’s annuity program, which uses guarantees from three insurers.

Annuities are also a way to retain participant assets. Asset managers who sell institutional target-date funds can keep participants invested in their funds even after they retire if they sell them an insurance wrapper before they leave the plan. Otherwise, participants who retire often roll their money over to an IRA and buy new funds from a rival asset manager.

But many plan sponsors are still wary about in-plan annuities. Despite a nascent sense that they may have a fiduciary duty to provide exit strategies to retiring participants, they have been reluctant to offer them. Some fear liability for a future insurance company failure. Others worry that it will be hard to switch insurance providers once all the plumbing and wiring between the plan and the insurer has been installed.

According to a Strategic Insight release, In-Plan Guarantees: Identifying Trends and Opportunities in an Evolving Marketplace sheds light on this area. Some of the report’s observations and areas of interest include:

Products based on target date funds dominate the market – 70% of lifecycle in-plan products are target date
Many 401(k) platforms view guaranteed income options as a competitive differentiator
Regulatory clarity will come after more plan sponsors, especially “jumbo” sponsors, adopt guaranteed income solutions

The report provides descriptions of 14 different in-plan guarantees as well as key information on the marketplace. Sections detailing challenges, areas of progress and opportunities provide a comprehensive understanding of the environment for in-plan guarantees.

Income annuities drive strong first half at New York Life

Fidelity launches new workplace advice program, Plan for Life

Vanguard publishes four white papers on ETFs

Sales at NPH Inc. increase 9% in 2Q 2012

Nationwide names new leaders for retirement plans and P&C Direct

Stout joins MassMutual Retirement Services as southeast sales director

Transamerica Retirement Services website gets top DALBAR rating

Data Connection

Lists*