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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.

The NEST Approach to Risk

Posted on August 15, 2012 by Kerry Pechter -

When U.K. officials were developing NEST, the auto-enrolled, publicly sponsored, low-cost defined contribution plan that becomes fully operational in October, they spent a lot of time and effort researching the risk-tolerance of likely NEST participants.

They discovered that much of the NEST target audience—male non-savers, under age 35, and earning about £18,000 ($30,000)—were so averse to volatility that they were inclined to quit investing entirely if their NEST account values tanked and they lost principal.

That finding has had a huge bearing on the way NEST’s investment team plans to risk-manage the 46 target date funds (and the eight institutional funds that the TDFs will be built from). They’ll be using a variety of tools to smooth the long-range savings outcomes for the millions of U.K. subjects who are currently at risk of retiring with nothing but a feeble state pension to live on.

For this second of two articles about NEST, RIJ interviewed Paul Todd, the head of investment policy at the quasi-governmental organization, about his team’s use of active and passive management, its response to the “to” versus “through” debate about TDF asset allocation, and its use of something called the Black-Litterman model.

A lot is riding on the success of NEST. The U.K. national pension system has been described as complex and confusing. The British are hoping that NEST will succeed where earlier attempts to reform the system and get working class people to save and invest have failed. The potential consequences of another failure—higher taxes to fund a richer state pension or the prospect of millions of destitute elderly on the street—are both considered politically unacceptable.

TDFs, NEST style

In some ways, NEST will work much like any big, up-to-date U.S. defined contribution plan. Each new participant will be auto-enrolled into the program and defaulted into an age-appropriate target date fund (TDF) whose mix of underlying stock, bond, and cash funds becomes more conservative as the participant ages.

“We spent a lot of time talking to people in the U.S. about target date funds. We came to the conclusion that the TDF is just a delivery vehicle. It’s flexible and efficient, but what you choose to put in it determines the success,” Todd told RIJ.

The designs of the TDFs in NEST differ in some important ways from U.S.-style TDFs. For instance, there’s a different TDF for every retirement year, not for every decade or half-decade, so there’s less chance for big disparities between long-range participant outcomes. “We wanted to reduce the dispersion of outcomes and avoid a birthday lottery effect,” he said.

“TDFs in the U.S. are five years apart and have predetermined glide paths. But the way we approach them, because we do it on a single year basis that gives us an enormous flexibility to manage the risks for that cohort. We can buy and sell different funds. We can be contrarian if we want to. We see this as a way to manage more proactively.”

Where the asset allocations of U.S. TDFs typically have continuous “glide paths,” NEST TDFs go through three distinct phases: a low-equity Foundation phase during the first five years or so when the fund seeks merely to match inflation, a long Growth phase when the fund tries to beat inflation by about 3% a year, and a Consolidation period that starts about 10 years before retirement and aims for a mix of 75% bonds and 25% cash at the retirement date.

“In the Foundation phase, which has been the victim of some misunderstanding, we still have the objective of matching inflation, and we have a sizable allocation to equities, but not as much as in the Growth phase. We have a risk target in the Foundation phase of 7% volatility, versus 11% in the Growth phase. For comparison, an all-equity allocation would have 18% volatility,” Todd said.

“At the start of the Consolidation you’ll still be in lots of equities, but by the time you get to your maturity year, you’ll be in about 75% annuity tracking assets, which includes corporate bonds and UK gilts, and 25% money market instruments. In the UK, people can take 25% of their retirement savings tax-free. There’s lots of debate about how you blur the line between working and retirement.”

The boundaries between phases may blur. NEST’s TDF managers will actively management their asset allocations during the transitions from one phase to another to avoid selling under adverse market conditions. “There’s been a debate in the U.K. about the dangers of dynamic asset allocation, about how you can make the wrong decision. But we think that whether you decide to go active or passive, you’re still making a decision,” Todd said.

NEST participants can’t inject their own behavioral risks into their accounts because they don’t have direct control over them. They can’t trade in and out of funds at the worst possible times. Like all U.K. DC participants, they generally can’t access their money until they reach retirement age: no loans, no hardship withdrawals, no rollover IRAs.

Modest growth objectives

“Our number one focus is on thinking about the amount of risk we want to take and then allocating to different assets, rather than saying here’s what we want to invest in and we’ll see what the risks are,” Todd told RIJ. “We work within risk budgets. Our investment committee talks about what the risk budget should be, and that usually means talking about volatility numbers.”

NEST is aiming for so-called absolute rather than open-ended returns. “We have some specific return objectives, but it’s really all about outperforming inflation. For a lot of our members, it’s the first time they’ll be saving for the long term and the first time they’ll be exposed to certain terms. To shoot for benchmarks doesn’t feel appropriate for our membership. We’re focusing on real incomes so that they can buy the things they need in retirement.

“We’re very public, and quite bold, in saying that we will outperform inflation by 3% a year, and do that within a risk budget. At least, that’s one of our objectives. Our aim is to achieve our objective with the least risk, and never take risks that we don’t think are necessary. We’re trying to prevent extreme losses. We don’t care only about the end result; we want as smooth a journey as possible. We know that there’s no free lunch and that you have to take a certain amount of risk, but we don’t want to do anything stupid,” he added.

Up to 90% of NEST participants are expected to invest in a TDF that matches the date they are eligible for the British state pension. But they have other options. Muslim participants can opt into a Sharia-compliant fund. Socially conscious participants can invest only in an Ethical fund. There’s also a high-growth option, a low-growth option, and a 75% bond/25% cash fund for new NEST participants who are already near retirement.

For the eight funds that underlie its TDFs (see box), NEST decided to rely on well-known asset managers, not all of whom are from the U.K. So far, the chosen managers include BlackRock, UBS, State Street Global Advisors, HSBC, F&C, and Royal London Asset Management. Four of the funds are index funds, three are actively managed funds and one, a “diversified beta” fund, is a hybrid.

The Building Blocks of NEST Target Date Funds
Global Equity Fund	Passive	FTSE All World Developed Index	UBS
UK Gilts Fund	Passive	FTSE Actuaries All Stocks Index	State Street (SSgA)
Index-Linked Gilt Fund	Passive	FTSE Actuaries Index Linked Gilts Over 5-Years Index	State Street (SSgA)
Low-Risk Liquidity Fund	Active	7-Day LIBID	BlackRock
Diversified Beta Fund	Mostly Passive	UK Risk Free Rate +2% to +4%	BlackRock
Global Ethical Equity Fund	Active	MSCI World	F&C
Sharia Compliant Global Equity Fund	Passive	Dow Jones Islamic Titans 100	HSBC
Sterling Bonds	Active	iBoxx Sterling Non-Gilt All Maturities Index	Royal London Asset Management
Source: “Developing and delivering NEST’s investment approach,” NEST Corp. 2012.

“We’re making a buy-build decision at the moment; in the future we may not always use existing pooled products. Wem ight use segregated mandates or bring them in house, but so far we’ve taken a position of not replicating what’s already out there,” Todd said.

One of the index funds that NEST chose is the BlackRock Aquila Life Market Advantage “diversified beta” fund, a concept relatively new in the U.K., The fund had lost 46% in the 2008-2009 crash, but was reengineered by BlackRock to “incorporate strategies to manage portfolio risk at market extremes,” according to the magazine Pensions Insight. In 2011, the fund returned 2.3% from February to December while the overall market lost 3.6%. The version of the fund created for NEST has an expense ratio of 25 basis points.

So far, risk management at the NEST TDF level is being done with asset allocation, not derivatives. “In terms of fancy things, we work with BARRA to use their risk allocation tools, and we use the Black-Litterman model. We do all of that in house. We’ve done some back-testing on the financial crisis, and we think our strategy would have held up. We have no insurance policies,” he said, meaning derivatives. “We’ve looked at that and our concern with those things is that when you need them most they’re so expensive that you lose the value you’re going for.” But he doesn’t rule them out for the future.

(The “Black Litterman” model is not a term you hear very often—if ever—outside of the most esoteric discussions about investment management. Developed by Fischer Black and Robert Litterman of Goldman Sachs, this type of asset allocation model combines two main theories of modern portfolio theory, the Capital Asset Pricing Model (CAPM) and Harry Markowitz’s mean-variance optimization theory created by Harry Markowitz. According to a 2005 paper by Thomas Idzorek (now president of Morningstar’s Global Investment Management Division, then of Ibbotson Associates), portfolio managers often avoided Markowitz’ risk-and-return optimization method because it led to overly concentrated portfolios, and it was over-sensitive to assumptions about the expected returns that were plugged into it. Black and Litterman produced better performance by using a “mixed estimate of expected returns” based on a combination of historic returns and the portfolio manager’s own “subjective views” expected returns.)

Fixing market failure

Another reason for keeping NEST’s investment risks low is to counter-balance the volatility of the lives that many of the participants will lead. “My understanding from the U.S. experience is that people there see human capital as something that’s steady and stable, like a bond. If that’s your position, then the argument for putting young people in mostly equities makes a lot of sense. If you also assume that people have exposure to other assets, like home ownership and private savings, then holding a large proportion of equities in your pension pot seems reasonable.

“But if you look at the demographics of our target group, they have equity-like human capital, and they are quite linked to the U.K. economy. They’re the first people to experience redundancy [layoffs]; they may not have property [real estate] or personal savings, so there’s a lot more volatility to their human capital. That makes you think harder about what’s suitable for them. Our research showed that for people who don’t have diversification of resources, it’s not helpful to expose them to high levels of volatility right off the bat.”

Ultimately, NEST is intended to help traditional non-savers to save, and to help them end up with as much savings as possible so that they can rely on more on their own resources in retirement and less on public assistance.

“We identified a market failure on dealing with people with low incomes,” Todd told RIJ. “Private providers couldn’t serve that part of the market profitably. Charges were high. There was a need for a scheme that will take anybody, no matter what, no matter how few workers, or how small their accounts are. That’s what NEST is.”

To achieve the necessary economies of scale and to generate enough revenue to pay back its seed money to the U.K. Treasury, NEST is going to have to grow quickly. Todd quoted figures from the Pension Policy Institute that NEST will be managing “in the billions of pounds” by 2018 and perhaps £300 billion by 2050.

“The expectation from our modeling is that we will achieve high scale, and that small employers will get access to reasonable, decent products at reasonable costs,” Todd said. “A plan like this, with these 46 TDFs, and fees of only 30 basis points, with an extremely sophisticated risk allocation, has never been available for this demographic before.”

Crump Life Insurance expands relationship with AXA Network

Posted on August 11, 2012 by Editor Test -

Crump Life Insurance Services will provide enhanced technology and life brokerage sales support for the more than 5,000 financial professionals in the AXA Network, according to a Crump release.

The expansion of the firms’ existing partnership will give AXA Advisors access to “highly-rated non-proprietary products that offer a full spectrum of life-related insurance solutions for their clients, as well as disability income insurance products and variable annuities,” the release said.

Effective July 2, 2012, AXA Network’s 119 employees at its Harrisburg, Pa., location became employees of Crump, continuing to service AXA Advisors financial professionals exclusively as a national account of Crump Life Insurance Services.

“After looking at multiple options, we concluded that expanding the relationship with Crump would best meet the needs of our financial professionals and their clients, as well as the employees within AXA Network,” said Bucky Wright, chairman and chief sales officer of AXA Advisors, LLC.

“This change will allow our financial professionals to leverage Crump’s breadth and depth of expertise in brokerage to bring industry-leading capabilities in technology, sales tools, and marketing resources to help them grow their business and enhance client services.”

AXA Advisors financial professionals will access long-term care and disability insurance products exclusively through Crump, and use Crump’s “turnkey policy-review program and advanced markets expertise at the distribution level to support complex sales on a multi-carrier platform,” the insurance distribution firm said.

$17 billion flows into stock and bond funds in July

Posted on August 11, 2012 by Editor Test -

Ignoring warnings about “a bond bubble,” investors put almost $30 billion into bond funds in July, bringing the total flows for the first seven months of 2012 to almost $180 billion. That’s 50% higher than the full-year results for 2011, according to Strategic Insight.

Investors’ appetite for income and/or safety fueled demand for corporate and U.S. government bond funds, high and low credit quality funds, and Global bond strategies (in open-end and closed-end mutual funds, excluding ETFs and funds underlying variable annuities).

Those flows came at the expense of stock flows. U.S. equity funds registered net redemptions of $13 billion in July, while international equity funds benefitted from small positive inflows of $1 billion.

“Investors continue to dismiss the positive trends reflected in steady gains in the economy, employment, real estate prices, and the potential for capital appreciation through higher allocation to stock funds. Instead, investors stay very focused on capital preservation for the near term,” said Avi Nachmany, SI’s Director of Research.

“Lingering economic and political uncertainty and expectations of very low interest rates for years to come suggest that fund investors will continue to favor the near-term lower risk of bond funds during 2H’2012,” Nachmany said, “yet fund strategies offering balanced investing and exposure to wealth creation through stock allocation remain a common avenue bridging near-term concerns with long-term wealth aspiration.”

But money was in fact going into stocks via exchange traded funds, or ETFs. Strategic Insight said US ETFs enjoyed $14 billion in net inflows in July 2012, another very strong month, mostly through stock ETFs. That brought total ETF net inflows (including ETNs) to nearly $90 billion so far in 2012.

Will my clients have to pay the new Medicare surtax?

Posted on August 11, 2012 by Editor Test -

If you’re an advisor, many of your clients are likely to be subject to the 3.8% Medicare surtax that the 2010 Affordable Care Act makes effective starting in 2013. The tax is both old news and new news. In case you’ve ignored it until now, we provide the following summary.

First, a warning: your clients don’t necessarily have to be extremely high earners to encounter this tax. If their modified adjusted gross income (AGI) and their investment income combine to put them over one of the income thresholds, they will owe the tax.

For instance, an individual with only $150,000 in wages but $70,000 in investment income would owe the surtax because her combined income of $220,000 puts her $20,000 over the $200,000 threshold for a single person. She’d owe $760 (.038 x $20,000). Spouses earning $110,000 each who have an additional $50,000 in investment income would also owe the surtax on the amount that their income exceeds $250,000, or $20,000.

Now here’s the basic stuff you may or may not already know by heart:

The 3.8% surtax applies to whichever is less: a person’s net investment income (dividends, rents, interest, capital gains, passive income, royalties, net of losses) or the amount of their modified adjusted gross income (including investment income) that exceeds certain thresholds. Distributions from qualified pension plans, nonqualified deferred compensation or municipal bond interest are not subject to the surtax, according to a report from BNY Mellon.

The aforementioned thresholds are $200,000 for individual taxpayers, $250,000 for married taxpayers filing jointly, and $125,000 for married taxpayers filing separately. Total income under these amounts isn’t subject to the tax. Note that the thresholds aren’t indexed for inflation. So, as wages grow, the amount exposed to the surtax will presumably grow.

The surtax applies to trusts and estates as well as to individuals. The annual surtax payable by a trust or estate is 3.8% of whichever is less: the undistributed net investment income or the excess of adjusted gross income over the amount at which the top income tax bracket for trusts and estates begins. The top bracket started at $11,200 for 2010, but will be indexed for inflation.

The Medicare surtax is not to be confused with next year’s hike in the individual portion of the Medicare payroll tax. That tax, coincidentally, will also rise to 3.8% next year. It is currently 2.9% (with employer and employee each paying 1.45%). Starting in 2013, an additional 0.9% (for a total of 2.35%) will be levied on the portion of wages that exceeds $200,000 for single earners and $250,000 for couples.

Note: Moving assets into a tax-deferred annuity today can reduce or eliminate the surtax in future years by shielding investment income from taxes until after retirement, when your client’s AGI may be far below the Medicare surtax threshold, says Robert Keebler, of Keebler Associates in Green Bay, Wis. “Some people are critical of that strategy because of the fees [associated with deferred annuities],” he said, but noted that fees needn’t be prohibitive if you use a top-ranked insurer with competitive rates.

Two JFP articles you shouldn’t miss

Posted on August 11, 2012 by Editor Test -

The August 2012 issue of the Journal of Financial Planning contains a couple of highly useful articles on retirement income planning. One article involves using a line of credit associated with a reverse mortgage. The other describes a framework for comparing distribution strategies in retirement.

In the reverse mortgage article, entitled “Standby Reverse Mortgages: A Risk Management Tool for Retirement Distributions,” authors John Salter, Shaun Pfeiffer and Harold Evensky describe the advantages of leveraging the Home Equity Conversion Mortgage (HECM) Saver.

Under the strategy they suggest, homeowners age 62 and older with small or paid-off mortgages can open a standby home equity line of credit, but borrow from it only during bear markets in order to avoid selling assets at depreciated prices. When the assets recover, the retiree can sell them, pay off the line of credit, and recapture the equity in their home.

The line of credit would, in effect, eliminate or reduce the need to maintain a large and unproductive cash reserve—e.g., the first “bucket” in a bucketing strategy—as a buffer for meeting immediate needs during a downturn. Using the HECM Saver line of credit also offers certain advantages over a standard reverse mortgage as a source of cash or using a conventional home equity line of credit.

The tough question is, how do you optimize the timing of this strategy with regard to market behavior? Much of the article is devoted to providing answers, based on the results of simulations that try to help identify the “trigger for borrowing rebalancing, and paying back the HECM Saver line of credit.”

The second article is “A Framework for Finding an Appropriate Retirement Income Strategy.” It acknowledges the existence of a wide range of decumulation strategies beyond the traditional systematic withdrawal program (SWP), and tackles the challenge of making apples-to-apples comparisons between them.

The author, Manish Malhotra, has a stake in all this: his company, Income Discovery, makes a software tool that runs simulations that allow advisors to see how different distribution strategies would perform under a variety of hypothetical future scenarios.

Except perhaps for advisors whose clients are deep in what advisor Jim Otar calls the “green zone”—with a very high resources-to-expenses ratio—few will argue with the author when he points out that “The art of building an income plan lies in finding the right balance between SWP and fixed sources of cash flow that provide acceptable confidence and reasonable protection in unfavorable markets with a potential to leave a legacy (if so desired) in favorable markets.”

The article appears to break new ground in the breadth of risk factors, capital market assumptions, and types of financial tools and resources—including fixed immediate annuities, variable deferred annuities with living benefits, TIPS ladders, and Social Security—that it embraces in its comparisons.

Decumulation, it is often said, is much more complicated than accumulation—partly because there are no second chances and partly because there are so many different ways to do it. As more boomers retire, and turn to advisors for help with income planning, tools that allow them to test the viability of competing strategies in advance should come in handy.

What Retirement Advisors Most Want to Know

Posted on August 11, 2012 by Editor Test -

Most advisors are well schooled in managing the pre-retirement, accumulation stage of the human life cycle. But when it comes to the post-retirement decumulation stage, advisors tend to have more questions than answers.

What are their most common questions about decumulation, and what are the answers? That’s what the Retirement Income Industry Association (RIIA) is in the process of finding out. The Boston-based organization intends to survey large numbers of advisors on their methods for handling decumulation. The survey answers, whatever they might be, will help RIIA put together what RIIA’s Steve Mitchell called “a collection of knowledge” that would reflect existing methodologies and perhaps yield a treasury of best practices.

At a recent webinar hosted by RIIA and attended by some 70 to 80 people—of whom about 40% were advisors—Mitchell asked attendees to suggest questions that RIIA might include in that large-scale survey of advisors. Here are 17 of the questions I jotted down while tuned in to the webinar:

Q. What kinds of planning software do you use for decumulation?

Q. Do you establish a minimal acceptable return for the client’s entire portfolio when making allocations between investments and insurance products?

Q. How do you “address human capital leading up to retirement”?

Q. How do you deal with the impact of taxes in retirement planning?

Q. Do you use a different kind of compensation system for clients who are in retirement?

Q. What kinds of support do you expect from insurance product wholesalers and the firms they represent?

Q. What models or strategies do you use? Systematic withdrawal? Bucket methods? A combination of products, some of which create “floor income” and some of which generate “upside”?

Q. Do decumulation strategies create more or less work for you?

Q. What functions do you outsource, either to specialists or to software solutions?

Q. How do protect clients from the impact of inflation when using annuities?

Q. How do you draw income from bonds or equities during down markets?

Q. Do you use the Social Security Administration’s calculators to help clients choose the best time to claim their benefits?

Q. Do you have alternatives for the phrase, “retirement income”?

Q. Do you provide advice about Medicare and health care planning in general?

Q. Which money managers do you use or recommend?

Q. If the expression, “Build a floor, and then seek upside” doesn’t resonate with clients or seem self-evident, what other kinds of analogies or explanations do you use to convey the same principle?

Q. Other than earn a retirement-specific professional designation, how do you differentiate yourself from accumulation-oriented advisors?

None of the webinar attendees, I noticed, suggested questions related to longevity risk. I would have expected a question like, ‘Do you assume average longevity for planning purposes?’ Or, ‘How do you handle the topic of death when advising retirees?’ Likewise, there was no mention of widowhood or widower-hood, even though every retired couple will need to prepare for it.

No questions were asked about the use of home equity in retirement planning either, even though reverse mortgages or lines of credit can be useful even to affluent households. And there was no mention of legacy planning, even though a retiree’s desire to make a bequest often sets the boundaries for other parts of the income planning process.

I suppose that only goes to show how many “unknown unknowns” are associated with decumulation planning. Retirement itself entails too many different kinds of risks, and lifetime income strategies have too many moving parts, to bring to light in a single one-hour brainstorming session.

Is There an Annuity-Life Insurance Arb Opportunity?

Posted on August 10, 2012 by Kerry Pechter -

Taxes on the affluent are almost certain to rise, so many advisors are looking for ways to trim their clients’ tax exposure. By funding a life insurance policy with the income from a life annuity, they can sometimes turn a highly taxed asset into a tax-free bequest.

Not long ago, for instance, a woman came to Teckmeyer Financial, in Omaha, Nebraska, with a deferred variable annuity. According to Joseph Hearn, one of Teckmeyer’s advisors, her contract had an account value of $85,000, a lifetime income rider with a benefit base of $128,000, and a death benefit worth $104,000. Her purchase premium had been $70,000.

Were she to liquidate the annuity, she would get the $85,000 account value and pay ordinary income taxes on the $15,000 gains. Were she to die with the contract in force, her son would owe ordinary income tax on the difference between the original cost basis and the death benefit. For someone in the 28% tax bracket, the tax would be about $9,500.

The client had two goals: to get a little more money to live on, and to pass on the remainder to her son as tax efficiently as possible.

If she annuitized the contract, she could collect an income stream for life based on the larger $128,000 income base. That would bring in $764 a month or $9,168 per year, but it would also negate the death benefit.

With help from her advisor she found a permanent, universal life insurance policy with a $100,000 death benefit for only $366 a month. Over time, this would replace the annuity death benefit and come with the added advantage of being tax-free to her son. Meanwhile she could keep the remaining $398 to cover taxes on the annuity distributions and add to her income.

“It was a win-win-win,” Hearn told RIJ. “It’s not going to work for everybody, but she had an annuity already with a high income benefit, a high death benefit and a low contract value.”

The same goal can be accomplished using an annuity/life insurance arbitrage, says Glenn Daily, a fee-only advisor in New York City. The advisor should shop for the highest-paying life annuity from one insurer and then hunt for life insurance with low premiums from another insurer.

“People who are in poor health can buy a substandard annuity that usually has bigger payouts,” said Daily. (With a “substandard,” impaired,” or “medically-underwritten annuity,” as they are variously called, someone with compromised health can receive the payout rate of someone with a higher age.)

Daily admits that most of the time when he runs the numbers, this arbitrage doesn’t work and advisors have to really dig into the details of the life insurance policy. It is most likely to work if there’s a favorable disparity in underwriting between the life annuity and the life insurance policy. If the client buys a no-lapse life policy, he’ll have guaranteed benefits on both the annuity and life insurance. But “good insurance policies with low premiums are harder to find these days because of greater reserve requirements,” Daily noted.

One trap to be wary of when buying a non-guaranteed universal life policy: If an insurance agent says he can credit the life insurance account at 5%. “That means they’re still getting the benefit of older bonds in their portfolio,” said Daily. “In this interest rate environment, that’s bound to change, so if the advisor is running the numbers, he or she should be using a value closer to 3%.” He warns that insurance agents will often simplify the tradeoffs to make the sale.

To make sure the evaluation is done right, advisors should look to see that three different amounts of after-tax annuity payments are going into the life insurance policy in sequence, said Daily. These would reflect the payments that are partly taxed under the exclusion ratio, the payments that are fully taxed after the cost basis has been recovered, and payments that are made during the period of up to one-year between the two.

“You should see three numbers on the analysis if it’s done properly,” he said. If the advisor doesn’t do this level of analysis, his proposal may be “just a sales pitch thrown together to get the client to buy something.” If the money is coming from a qualified plan, of course, this analysis is irrelevant.

Bob Keebler, a partner at Keebler & Co. in Green Bay, Wisconsin also uses this annuity/insurance combination as an added component of an estate tax reduction strategy for high net worth clients. fter he’s finished moving qualified assets out of a client’s taxable estate He moves IRA assets, for instance, to an irrevocable living trust (ILIT), thus reducing the estate, then buys life insurance with the assets to create the tax-free legacy.

“I had a lady who had $6 million in an IRA and $10 million in other property,” he explained. “She annuitized $4 million from the IRA and used the income stream to buy a whole life insurance contract in an ILIT.” While she would still have to pay estate taxes on assets above $5 million, “this was a step in the right direction,” Keebler said.

Few clients have enough wealth to need an ILIT for tax purposes, given today’s $5 million estate tax exemption ($10 million for couples), but no one knows how the exemption will change next year when the Bush tax cuts expire, he pointed out.

San Diego-based CPA Leonard Wright recommends ILITs even for the merely affluent, because it’s a way to protect assets that they want to bequeath from potential lawsuits. “I’m a strong proponent of ILITs because unexpected things happen like divorces and car crashes,” he said. “If the money is in an ILIT, it’s protected by the trust and attorneys can’t get their hands on it.”

The annuity/life insurance arbitrage, as it were, does have drawbacks. The client loses flexibility on both the annuity sides and the life insurance side, says Keebler. “Once you give up control over your money and turn it into a stream of income payments, you’ve locked yourself in and may get nothing back from the life insurance policy if you change your mind. If you let the payments lapse you may have nothing but an annuity.”

Furthermore, Wright said that now is a particularly bad time to buy a life annuity. “I would never recommend it since interest rates are at historic lows,” he said. Instead he believes that a well-diversified portfolio will provide better rates of return to fund permanent life insurance. He is skeptical about using the arbitrage strategy. “Using an annuity to fund an ILIT is such a sales-y thing to me,” he says. “I’m not really big on this because I see two commissions there. The client is going to pay 3% or 4% on that.”

Nonetheless he would consider funding life insurance if the client already has an annuity or craves the security of a steady income stream. “There’s the emotional aspect where consumers are shell-shocked because of the capital markets and are gravitating toward some kind of certainty,” Wright said.

“That appeals to the emotional instinct in all of us—having the certainty of a fixed income annuity and a life insurance policy where the payments can’t rise,” he added. “I personally don’t like it except where it’s in the best interest of a client who wants that peace of mind, and where it makes sense in the context of their financial plan.”

The Bucket

Posted on August 8, 2012 by Editorial Staff -

Insurance Technologies launches VisibleChoice 3.0

Insurance Technologies, LLC, a provider of sales and regulatory automation solutions to the insurance and financial services industry, announced today the launch of VisibleChoice® 3.0.

The latest version of Insurance Technologies’ annuity sales and suitability solution for broker-dealers and advisors includes new features aimed at simplifing and streamlining the annuity sales process.

VisibleChoice 3.0 new features include:

Annuity Sales and Suitability Capabilities: Delivers annuity data access for the entire industry and integrated suitability modules that broker-dealers and advisors can use to reduce compliance risk and increase sales suitability and productivity. It also includes enhanced management reporting, which provides broker-dealer home offices with valuable sales and comparison intelligence such as product usage and business replacement percentages.
- Provides broker-dealers and advisors with the ability to perform direct comparisons for all annuity types, filtering important criteria such as rating, class, and risk tolerance so advisors can recommend the most suitable annuity option for each client. With easy to understand Annuity Summary Reports, advisors can quickly and effectively communicate complex product information to clients, which increases transparency and understanding for the customer.
- Helps advisors meet the home office suitability forms process requirements in an automated manner through VisibleChoice Suitability®, a rules based suitability forms platform. VisibleChoice Suitability provides broker-dealer home offices with a flexible platform that can be integrated into existing business processes and systems to assist advisors in managing compliance with FINRA rules 2090 “Know Your Customer” and 2111 “Suitability”.
Mobile Access: Now advisors can access VisibleChoice 3.0 from multiple devices, which helps them to make their practices more portable. Version 3.0 enables e-signatures and paperless suitability reviews and allows firms to create an electronic audit trail on their annuity product comparisons and recommendations. Bringing key functions such as annuity product reviews, completion of the suitability process and electronic signing of documents to a remote format allows advisors to meet with more clients and close business on the spot. This leads to stronger client relationships, more efficient bookkeeping and better management of compliance requirements.

Protective reports second quarter 2012 results

Protective Life Corporation has reported results for the second quarter of 2012. Highlights include:

Net income of $76 million, or $0.91 per share
Operating earnings of $71 million, or $0.85 per share
Year-to-date operating earnings up 23% to $170 million
46% of year-to-date earnings returned to shareowners in dividends and share repurchase

Net income available to PLC’s common shareowners for the second quarter of 2012 was $76.2 million or $0.91 per average diluted share, compared to $87.6 million or $1.00 per average diluted share in the second quarter of 2011.After-tax operating income was $70.9 million or $0.85 per average diluted share, compared to $75.4 million or $0.86 per average diluted share in the second quarter of 2011.

Net income available to PLC’s common shareowners for the six months ended June 30, 2012 was $175.2 million or $2.10 per average diluted share, compared to $146.5 million or $1.67 per average diluted share for the six months ended June 30, 2011. After-tax operating income was $170.0 million or $2.04 per average diluted share, compared to $137.9 million or $1.57 per average diluted share for the six months ended June 30, 2011.

New investment options for Securian retirement plan participants

Securian will begin offering 21 new investment options to retirement plan clients, the company said in a release.

The net operating expenses for most the new Securian options are 0.2% or less. All revenue sharing funds from investment companies are passed on to plan participants on a daily basis using a 20-year-old process called Securian’s Actual Allocation Method.

Advisors can find more detail about the new options on the “Financial Professionals” page at SecurianRetirementCenter.com.

Prudential Retirement selected as recordkeeper for MGM Resorts 401(k) plan

Prudential Retirement, a unit of Prudential Financial, Inc., will serve as recordkeeper for Las Vegas-based MGM Resorts International’s 401(k) plan, the company said in a release. The plan has roughly 24,500 participants and approximately $858 million in assets, which were transferred to Prudential in the second quarter of 2012.

Advantage Financial Group joins LPL Financial

LPL Financial announced that Advantage Financial Group and its 63 affiliated independent advisors are transitioning their securities registrations from their current broker-dealer to LPL Financial, bringing client assets of approximately $2 billion.

Based in Cedar Rapids, Iowa, AFG provides professional services to its independent financial advisor members in the Midwest, Great Lakes and Southeast regions. Structured as a professional partnership, AFG is owned by its advisor members, who share an equity interest in AFG as a separately managed professional services firm. AFG generated trailing 12 month revenues of $11.2 million.

AFG will affiliate with LPL Financial under its current producer group structure, and continue to grow under its own existing brands and organization. Also as part of this transition, the LPL Financial RIA Platform will become the primary custodian for AFG’s sister company and Registered Investment Advisory (RIA) firm, Advantage Investment Management (AIM), which will continue to provide fee-based solutions to the advisor members of the AFG producer group.

Falling rates drove up pension liabilities in July: BNY Mellon

Posted on August 8, 2012 by Editor Test -

The funded status of the typical U.S. corporate pension plan in July fell 2.9 percentage points to 68.7%, according to BNY Mellon, It was the lowest level since the company began tracking pension funded status in December 2007.

“A 34 basis-point drop in the Aa corporate discount rate, to 3.64%, led to a 5.5% increase in pension liabilities,” the bank said in a release.

The rise in liabilities overwhelmed a 1.2 gain in assets at the typical corporate plan, according to the BNY Mellon Pension Summary Report for July 2012. The funded status of the typical plan has now fallen 3.7 percentage points during 2012.

Assets in the typical plan benefited from a one percent gain in U.S. equity markets and a 1.1% increase in international developed markets, according to BNY Mellon.

“The continuing uncertainty regarding the euro zone and lack of a coordinated response to the debt issues in Europe continue to send investors into bonds that are perceived to be a safe haven,” said Jeffrey B. Saef, managing director, BNY Mellon Asset Management. “As long this uncertainty remains, we expect to see very low interest rates, which will continue to pressure plan sponsors.”

Saef also noted that portfolios for plan sponsors have performed well, with assets rising more than seven percent during the first seven months of the year for the typical U.S. corporate plan. However, he added, “Hitting a return target isn’t enough these days if you’re not keeping up with the growth in liabilities.”

Washington freeze chills the whole economy

Posted on August 8, 2012 by Editor Test -

The pervasive sense that manufacturers are not investing or hiring this summer because of uncertainty—about the presidential election, the automatic spending reductions associated with the impending “fiscal cliff,” and the potential end of the Bush-era tax cuts in January—was documented in an article Monday in the New York Times.

The Times interviewed several executives who confirmed that industry is waiting for clear signals from Washington before placing any bets on the future.

“We’re in economic purgatory,” said Alexander M. Cutler, the chief executive of Eaton, a big Ohio maker of industrial equipment like drive trains and electrical and hydraulic systems. “In the nondefense, nongovernment sectors, that’s where the caution is creeping in. We’re seeing it when we talk to dealers, distributors and users.”

At Siemens, CFO Joe Kaeser said the German industrial giant has been slow to fill openings among its 60,000-member work force in the United States, while delaying some new investments and capital expenditures. “We would expect volatility till after the election and the fiscal cliff is sorted out,” he said.

“The fiscal cliff is the primary driver of uncertainty, and a person in my position is going to make a decision to postpone hiring and investments,” Timothy H. Powers, CEO of Connecticut-based electrical products maker Hubbell Inc., told the Times. “We can see it in our order patterns, and customers are delaying. We don’t have to get to the edge of the cliff before the damage is done.”

The Times cited data that reflect the slowdown. The annual rate of economic growth in the second quarter fell to 1.5% from 2% in the first quarter, and 4.1% in the last quarter of 2011, it reported. Labor market data showed job creation still falling short of the level needed to bring down the unemployment rate. On Thursday, the Commerce Department reported that factory orders unexpectedly fell 0.5% in June from the previous month.

A survey by Morgan Stanley in July showed that more than 40% of companies polled cited the fiscal cliff as a major reason for their spending restraint, according to Vincent Reinhart, chief U.S. economist at the bank. “Economists generally overstate the effects of uncertainty on spending, but in this case it does seem to be significant,” he told the Times. “It’s at the macro- and microeconomic levels.”

Unless Congress acts to extend the tax provisions and agrees on a budget that averts the planned reductions in spending on military and other programs, taxes will rise by $399 billion while federal government spending will fall by more than $100 billion, according to the Congressional Budget Office.

The fiscal cliff’s total impact equals slightly more than $600 billion, or 4% of GDP. The Congressional Budget Office projects that, if no action is taken, the economy will shrink by 1.3% in the first half of 2013 as a result.

Last week, Congressional agreed tentatively to keep the government financed through next March, extending a deadline that had been set to expire Oct. 1, but that deal did not address the extension of the tax cuts or spending reductions.

Bond guru to Wall St.: “You didn’t build that”

Posted on August 8, 2012 by Editor Test -

William Gross, chief investment officer of PIMCO, and the undisputed king of active bond fund management in the U.S., used his latest column to assert that the equity market gains of the last several decades simply cannibalized other sectors of the economy and didn’t create new wealth.

Asserting that there’s no other way to explain how average stock returns could be double the average growth of the economy for the past several decades, Gross argued that equities have outpaced GNP mainly because of falling tax rates and declining real wages.

“Economists will confirm that not only the return differentials within capital itself (bonds versus stocks to keep it simple) but the division of GDP between capital, labor and government can significantly advantage one sector versus the other… [R]eal wage gains for labor have been declining as a percentage of GDP since the early 1970s, a 40-year stretch which has yielded the majority of the past century’s real return advantage to stocks,” Gross wrote.

“Labor gaveth, capital tooketh away in part due to the significant shift to globalization and the utilization of cheaper emerging market labor. In addition, government has conceded a piece of their GDP share via lower taxes over the same time period. “Corporate tax rates are now at 30-year lows as a percentage of GDP and it is therefore not too surprising that those 6.6% historical real returns [of equities] were 3% higher than actual wealth creation for such a long period.”

Are boomers doomed to live in trailers, clip coupons and eat dandelion leaves?

Posted on August 8, 2012 by Editor Test -

More than one-third (34%) of defined contribution plan participants either “guessed” or “made up” estimates for the income they will need in retirement and only 30% said they consulted an advisor about retirement income planning, according to a survey of 3,370 participants by Diversified, a retirement plan administrator.

Almost 70% said their employer-sponsored DC plan was their only or primary retirement account. More than half (54%) said they had less than $100,000 saved for retirement, even though more than half were age 46 or older and earned at least $75,000. About one-third (37%) had less than $50,000 saved.

Only three percent said they saved $1 million or more. In other survey findings:

61% said they were saving 10% a year or less of their annual salary
25% said they were saving 5% a year or less.
19% said they were saving more than 15% annually.
38% said they had increased their savings rate.
11% said they took a loan against their DC plan over the past year.
3% said they took a hardship withdrawal.

The survey was conducted via email by Diversified in the first quarter of 2012 among 3,370 defined contribution plan participants in plans administered by a wide variety of organizations.

Like some other recent surveys of plan participants, however, the news release about the survey didn’t say how many of the participants have working spouses who might have their own defined contribution savings accounts and their own Social Security.
Diversified provides customized retirement plan administration, participant communication and open architecture investment solutions for mid- to large-sized organizations.

“Quote” of the Week

Posted on August 8, 2012 by Editor Test -

An Annuity Fee Record with an Asterisk

Posted on August 8, 2012 by Editor Test -

Fee income from annuity sales at banks rose 4.5% to a quarterly record high of $781.7 million in the first quarter of 2012, compared with $748.2 million in the first quarter of 2011, according to the Michael White-ABIA Bank Annuity Fee Income Report.

But all of the increase, and then some, came from the $61.0 million and 15.6 million in fees reported for the first time by Raymond James Financial, Inc., and from thrift holding companies, respectively. Without their contributions, the fee total would have been almost 10% lower.

Wells Fargo & Company (CA), Morgan Stanley (NY), JPMorgan Chase & Co. (NY), Raymond James Financial, Inc. (FL), and Bank of America Corporation (NC) led all bank and thrift holding companies in annuity commission income in first quarter 2012. Institutions with $10 billion or more in assets earned over 90% of annuity sales fees. Morgan Stanley experienced a 48% increase in annuity fee income in the quarter. The report did not explain the reason for that anomalous jump.

Compiled by Michael White Associates (MWA) and sponsored by American Bankers Insurance Association (ABIA), the report is based on data from all 7,307 commercial banks, FDIC-supervised banks and savings associations (thrifts), and 1,074 large top-tier BHCs and THCs operating on March 31, 2012.

Thrifts and THCs began reporting annuity fee income for the first time in first quarter 2012. Several THCs and a BHC that are historically and traditionally insurance underwriting operations have been excluded from the report.

Far fewer top-tier bank and thrift holding companies achieved double-digit growth in annuity fee in 1Q 2012 and than in 1Q 2011. “Of 412 large top-tier BHCs and THCs reporting annuity fee income in first quarter 2012, 178 (43.2%) were on track to earn at least $250,000 this year,” said Kevin McKechnie, executive director of the ABIA.

“Of those 178 BHCs, 71 (39.9%) achieved double-digit growth in annuity fee income for the quarter. That’s nearly a 22-point decline from first quarter 2011, when 116 institutions or 63.4% of 183 of those on track to earn at least $250,000 in annuity fee income achieved double-digit growth. Those findings are troublesome, particularly since they follow the significant slide in fourth quarter 2011 annuity income we previously reported.”

Of 1,078 BHCs and THCs, 412 (38.4%) participated in annuity sales activities during first quarter 2012. Their $781.7 million in annuity commissions and fees constituted 14.0% of their total mutual fund and annuity income of $5.6 billion and 30.1% of total BHC and THC insurance sales volume (i.e., the sum of annuity and insurance brokerage income) of $2.60 billion.

Of 7,307 banks and thrifts, 873 or 12.0% participated in first-quarter annuity sales activities. Those participating banks and thrifts earned $180.5 million in annuity commissions or 23.1% of the banking industry’s total annuity fee income. The annuity production of banks and thrifts was down 11.6% from $204.2 million in first quarter 2011.

Sixty-seven percent (67.1%) of BHCs and THCs with over $10 billion in assets earned first-quarter annuity commissions of $736.9 million, constituting 94.3% of total annuity commissions reported by the banking industry. Aided by the contribution of new BHC Raymond James Financial, Inc. (FL), this total was an increase of 4.0% from $708.3 million in annuity fee income in first quarter 2011. Among this asset class of largest BHCs, annuity commissions made up 14.9% of their total mutual fund and annuity income of $4.96 billion and 31.8% of their total insurance sales revenue of $2.32 billion in first quarter 2012.

BHCs with assets between $1 billion and $10 billion recorded an increase of 8.9% in annuity fee income, growing from $33.8 million in first quarter 2011 to $36.9 million in first quarter 2012 and accounting for 17.5% of their total insurance sales income of $210.8 million. BHCs with $500 million to $1 billion in assets generated $7.84 million in annuity commissions in first quarter 2012, up 28.1% from $6.12 million in first quarter 2011. Only 27.8% of BHCs this size engaged in annuity sales activities, which was the lowest participation rate among all BHC asset classes. Among these BHCs, annuity commissions constituted the smallest proportion (11.4%) of total insurance sales volume of $68.6 million.

Among BHCs and THCs with assets between $1 billion and $10 billion, leaders included Stifel Financial Corp. (MO), SWS Group, Inc. (TX), National Penn Bancshares (PA), Old National Bancorp (IN), and First Citizens Bancorporation, Inc. (SC). Among BHCs and THCs with assets between $500 million and $1 billion, leaders were First Command Financial Services, Inc. (TX), Liberty Shares, Inc. (GA), Nodaway Valley Bancshares, Inc. (MO), Nutmeg Financial MHC (CT), and Banctenn Corp. (TN).

The smallest banks and thrifts, those with assets less than $500 million, were used as “proxies” for the smallest BHCs and THCs, which are not required to report annuity fee income. Leaders among bank proxies for small BHCs were Essex Savings Bank (CT), Seneca Federal Savings and Loan Association (NY), FNB Bank, N.A. (PA), The Hardin County Bank (TN), and The Bennington State Bank (KS).

Among the top 50 BHCs nationally in annuity concentration (i.e., annuity fee income as a percent of noninterest income), the median Annuity Concentration Ratio was 7.2% in first quarter 2012. Among the top 50 small banks and thrifts in annuity concentration that are serving as proxies for small BHCs and THCs, the median Annuity Concentration Ratio was 16.0% of noninterest income.

A New NEST for British Nest-Eggs

Posted on August 8, 2012 by Kerry Pechter -

The fact that 45% of American workers have no access to an employer-sponsored retirement plan has troubled U.S. policy wonks for years. But proposed solutions to the problem, such as the so-called automatic-IRA, have run into government gridlock.

In Britain, where even a smaller percentage of workers have DC plans at work, the story has played out differently.

Since before the turn of the millennium, as British employers abandoned DB plans, the government has tried to broaden DC plan coverage. In 2001, a voluntary plan, called the Stakeholders Pension, was a flop. In 2002, a national commission was formed and spent almost 10 years crafting a national auto-enrolled DC policy and legislation that ultimately yielded the National Employment Savings Trust, or NEST, a DC “public option.” The legislation also requires all qualified plan sponsors to use auto-enrollment.

NEST was introduced on a voluntary basis to employers and workers in July 2011. Starting in October 2012, the new policies go into full effect. All qualified DC plans in the U.K. will start practicing auto-enrollment. Workers who have no private plan option will be auto-enrolled into NEST.

“We went live in July of last year, and we have over 100 employers working with us now,” said Helen Dean, a NEST managing director in London, in an interview with RIJ. “NEST is very simple to use. All people need to know is the date they want to retire. We compare it to driving a car. You can drive a car without understanding what’s going on under the bonnet.”

In the first of two articles on NEST, RIJ takes a look at how NEST works, and how it resembles and differs from American-style defined contribution plans. While some of NEST’s features might be transferable to the U.S., others—like mandatory employer contributions—would likely face stiff opposition. Next week, in the second installment, we’ll look at how NEST evolved and how it manages participants’ money.

How the U.K. does retirement

To understand how NEST works, you have to understand a little about the British retirement system. As in the U.S., there’s been a hodgepodge of legacy defined benefit plans, privately provided defined contribution plans and annuities, and government-sponsored attempts to provide IRA-like vehicles to workers who have no other plan.

To sponsor a qualified (tax-deferred) plan under auto-enrollment, the employer must contribute at least 3% of pay per year and each participant must contribute at least 4% of pay, with another 1% coming in tax relief from the government. Unlike in the U.S., British DC providers can choose to enroll some employees but can turn away others. Hence, many employees remain uncovered even when the employer offers a plan.

In retirement, the U.K. government regulates the drawdown of assets, requiring everyone to buy a life annuity by age 75 with their remaining tax-deferred assets (they can cash out up to 25% tax-free at retirement) unless they can demonstrate income of at least £20,000 a year (about $35,000)—from other sources. The U.K. state pension is less robust than Social Security, involves means-testing, and may soon convert to a flat $800-a-month stipend.

NEST is aimed at the 50% or so of U.K. workers who are not currently offered a defined contribution. The NEST target audience includes young people and minorities who save little and in many cases don’t understand the basics of investing or finance. Starting in October, unless their employer offers them a qualified plan, they will be auto-enrolled into NEST and, unless they choose another option, defaulted into a target-date fund.

“Every employer has to offer a pension plan,” Dean (at right) told RIJ. “The employer could use NEST or a private plan,” she said. “It’s up to the employer to decide what to use NEST for. We will not turn any employer away who wants to use us. We don’t intend to compete with private plans but to complement them.

“What’s happening is that smaller employers are choosing to just use NEST, while the bigger employers are using a combination of NEST and a private plan. In companies where there’s a high level of turnover and people don’t stay a long time, employers might think it’s better to use NEST” because of its portability from one employer to another, she added.

“Anybody who has a qualifying plan—if the employee is contributing at least 5% of pay and the employer is contributing 3%—can keep their plan,” Dean said. “But every employer in the U.K. will be making a choice between using their own scheme, NEST, or a combination of the two—with different ones for different segments of the workforce.”

How NEST differs from 401(k)

NEST would probably not fly in the U.S., except perhaps among U.S. government employees, since it was modeled in part on the federal Thrift Savings Plan. It includes a number of restrictions that are not unusual for Britain but which American employers and employees alike would probably find restrictive and paternalistic.

But the British, many of whom had defined benefit pensions until relatively recently, don’t seem to mind DC with DB-like guardrails. More importantly, the British government is said to be serious about getting people to save more, partly because the state pension alone is deemed inadequate.

Here are a few of the ways NEST differs from U.S.-style DC plans:

Persistent auto-enrollment. Starting in October, British workers will start being auto-enrolled in whatever defined contribution plan, including private plans and NEST, that their employer offers. They can unenroll from the plan but they will be automatically re-enrolled every three years.

Mandatory contributions. NEST, like all qualified plans in the U.K., will involve mandatory contributions from both employers and participants. For private plans, the current minimum contributions, as mentioned above, are 3% for employers and 4% for participants. The government kicks in another 1% for the tax savings on the contributions. To ease the transition to auto-enrollment starting in October, contributions will start low (2% for employers and 1% for employees) and rise to the full 8% over time. This low starter rate applies to new private DC plan auto-enrollees as well as to NEST auto-enrollees.

No withdrawals. Unlike Americans, the Brits can’t borrow from their DC plans and can’t take withdrawals for special needs such as education expenses, a down payment on a home or medical bills. When they change jobs, they can’t take a lump sum withdrawal, pay the tax (and penalty, in some cases), and spend it, as Americans can. There’s no U.K. counterpart to a rollover IRA. The earliest age at which British participants can access their money is age 55, but most don’t take distributions until they qualify for a state pension, which occurs at age 65 but will eventually climb to 68.

Centralized investment management. NEST participants have personal accounts, but they don’t manage them directly. The default investment is a target date fund made up of five or six underlying funds. NEST hired Tata Consultancy Services, the India-based global IT firm, to administer the plan. State Street Global Advisors has a 10-year contract to administer the investment funds. The managers of the underlying funds are State Street, BlackRock, UBS, HSBC, F&C Investments, and Royal London Asset Management.

Target date funds with big differences. There are 45 different target date funds in NEST, one for each year that participants will retire. (In the U.S., of course, target-date funds are dated in five-year intervals.) The organizers of NEST intend to manage the funds very conservatively. Unlike target date funds in the U.S., where the equity allocation tends to be very high in the early years and to remain substantial even after retirement, NEST TDFs owned by 20-somethings will be highly conservative at the beginning, and will hold zero equities at the retirement date. Each account will go through three phases: a cash-preservation Foundation phase that lasts for up to five years, a long Growth phase, and then a Consolidation phase that starts about 10 years before retirement. The lines between phases may blur, because fund managers will actively manage asset allocations to avoid adverse timing.

Ultra-low fees. The ongoing all-in investment and administration fee load for NEST participants is only 30 basis points. For the first few years, participants will pay a 1.8% front-end load to help reimburse the British Treasury for lending NEST its startup funds.

A different audience. The typical NEST participant is expected to be under age 35 and earning the equivalent of about $27,000 a year. Members of ethnic minorities will represent a large percentage. Most have little knowledge of saving or investing and NEST’s own surveys show that 37% are risk-averse. Many are excluded from participating in their employer’s private DC plan. In the U.S., 401(k) anti-discrimination regulations require plan sponsors to ensure that coverage is universal and participation is broad-based. The U.K. has no anti-discrimination laws that apply to DC plans. The NEST target audience has a counterpart in the U.S., however: the millions of American workers who have no access to an employer-sponsored retirement plan.

Next week: How NEST came to be, how it invests participants’ money, and why corresponding efforts in the U.S. haven’t made much progress.

The Mid-Point of a Trying Year

Posted on August 8, 2012 by Editor Test -

Second quarter earnings reports came out last week, and, in their annuity businesses, the major publicly-held U.S. life insurers appear to be in scrape-the-rust and repair mode rather than a go-go marketing mode. Although their share prices picked up a bit in the last 10 days, they are way off their highs for the year, posted last March.

MetLife’s variable annuity sales were down 34% in the second quarter, year-over year, but lower sales and less risk exposure were exactly what MetLife, the 2011 market leader, awanted this year. Prudential has spent $1.5 billion over the past year repurchasing its own shares.

The ever-steady Lincoln Financial, with the unusual i4Life variable income annuity option on its deferred variable annuity , has seen increases in variable annuity sales versus 2012, but it and Allianz Life of North America have both taken big hits on fixed and fixed indexed annuity sales, respectively. The Hartford, still in recovery mode and no longer manufacturing individual annuities, is unwinding its massive 2008 loan from Allianz SE.

All of these companies, at the least the ones that are U.S.-domiciled, experienced a run-up in share prices early last spring. But those prices, like the overall economy, lost steam over the summer and are now back where they were late last fall. at bargain levels, assuming that interest rates will eventually rise. MetLife has a P/E ratio of 6.53, Hartford of 7.57, Prudential of 8.78, and Lincoln Financial of 6.9.

Here’s a summary of earnings reports from the companies mentioned above:

MetLife variable annuity sales down 34%

MetLife, Inc., today reported second quarter 2012 operating earnings of $1.4 billion on net income of $2.3 billion. Operating earnings were up 18% from 1.19 billion in the second quarter of 2011. The net income included $1.4 billion in after-tax derivative gains that do not have an economic effect on the company, a MetLife release said.

Variable annuity sales were $4.6 billion in the quarter, down 34% from the second quarter of 2011, and reflected MetLife’s decision to rein in its variable annuity exposure after setting records in 2011.

Operating earnings for MetLife’s retail businesses, which includes U.S. retail life insurance and annuities, were $380 million, up 14%, on premiums, fees and other revenues of $2.4 billion, up 3% from a year ago. The increase was attributed to favorable investment margins, higher fees and lower expenses. Higher annuity fees were partially offset by lower income annuity and life sales.

MetLife’s stock closed at $33.20 last week, down from a 52-week peak of about $39.50 set in mid-March 2012.

Prudential buys back shares

Prudential Financial saw higher gross and net individual annuity sales in the first quarter of 2012 compared with the prior quarter, but operating income for the individual annuities segment fell by almost half.

Net income for the firm’s Financial Services Businesses was $2.203 billion for the second quarter of 2012. That figure included $1.9 billion in pre-tax gains from changes in the value of currency derivatives. Those gains were “largely offset by adjustments to comprehensive income which are not reflected in net income or loss,” the company said in a release.

In the second quarter of 2011, net income was $779 million. In the first quarter, the company reported a net loss of $988 million, thanks to a $1.5 billion charge for currency derivatives losses.

After-tax adjusted operating income for the Financial Services Businesses was $627 million for the second quarter of 2012, down from $773 million for the year-ago quarter and down from $741 million in the first quarter of 2012.

The Individual Annuities segment reported adjusted operating income of $107 million in the current quarter, down from $207 million in the year-ago quarter. Individual annuity account values were $124.1 billion at June 30, 2012, up 7% from a year earlier. Gross sales for the quarter were $5.4 billion and net sales were $3.7 billion, up from $5.0 billion and $3.2 billion, respectively, in the first quarter of 2012.

Retirement account values were $244.8 billion at June 30, up 11% from a year earlier. Total Retirement gross deposits and sales were $12.8 billion and net additions were $6.3 billion for the quarter. Asset Management segment assets under management were $650.2 billion at mid-year, up 11% from mid-2011.

The Retirement segment reported adjusted operating income of $147 million for the current quarter, compared to $171 million in the year-ago quarter. Overall, operating income for the entire U.S. Retirement Solutions and Investment Management division was $302 million for the second quarter of 2012, compared with $605 million in the year-ago quarter.

During the second quarter of 2012, Prudential repurchased 4.8 million shares of its common stock for $250 million, at an average price of about $52 per share. From July 2011 through June 30, 2012, Prudential bought back 28.6 million shares of its common stock for $1.5 billion.

Prudential’s share price, which peaked last March at over $68, faded to about $45 in late July before catching the latest rally and rising to $52 last week. Prudential is also still digesting its circa-$30 billion acquisition of General Motors pension obligations.

The Hartford pays down debt to Allianz SE and takes loss

Hartford Financial Group incurred a second quarter 2012 net loss of $678 million compared with a net loss of $151 million in the second quarter of 2011. The net loss in the second quarter of 2012 included a $587 million after-tax loss from reducing its debt to Allianz SE by $1.75 billion. Hartford borrowed the money during the October 2008 market meltdown.

“We are making progress executing on our strategy to focus The Hartford on its historical strength in insurance underwriting. We announced the definitive agreement to sell Woodbury Financial Services yesterday and the sales process for Individual Life and Retirement Plans is proceeding as expected,” said CEO Liam E. McGee in a release.

Hartford, which has withdrawn from writing new annuities, saw a 15% decline in the account values of its U.S. annuity book, to $77.8 billion from $91.3 billion, largely as a result of surrenders and withdrawals.

Hartford Financial Group’s share price has fallen from almost $22 last March to $16.16 on August 2, before bouncing to just over $17 two days ago.

Lincoln Financial’s net income rises by 7% in 2Q 2012, year-over-year

Lincoln Financial Group, which prides itself on sales consistency, saw net growth in variable annuity deposits in the second quarter of 2012. But, thanks to the ongoing impact of low interest rates, its fixed annuities department suffered net outflows.

Variable annuity deposits of $2.4 billion were up 3% from the second quarter of 2011 and up 11% from the first quarter of 2012. Variable annuity net flows were $0.7 billion compared to $0.6 billion in the prior-year quarter. In 2Q 2012, the company “introduced a family of risk-managed Protected Funds that provide an attractive value proposition to clients and lower the risk profile to the company,” according to a release.

Fixed annuity deposits of $445 million were down 22% from the second quarter of last year, as low interest rates continued to discourage sales. Fixed annuity net outflows were $32 million compared to net inflows of $134 million in the prior-year quarter.

Overall, the annuities segment reported a combined income from operations of $158 million in the second quarter of 2012, including a positive DAC adjustment of $5 million, compared to $145 million in the prior-year quarter.

As a company, Lincoln Financial reported net income for the second quarter of 2012 of $324 million, up about 7% from $304 million in the second quarter of 2011. Income from operations was $322 million for the period, down slightly from $326 million in the second quarter of 2011.

Share prices of Lincoln National Corp., the parent of Lincoln Financial, hit a 2012 peak of $27.10 last March but recently closed at about $22.43, surging 15% from $19.29 on July 26. It has benefited from an overall equities rally over the past two weeks, which saw the Dow Jones Industrial Average rise about 500 points and the S&P 500 rise about 60 points.

Allianz Life operating profits up 21% in first half of 2012

Allianz Life of North America, which dominates the fixed indexed annuity market in the U.S., saw a 15% drop in FIA premium in the first half of 2012, to $2.9 billion, compared with the first half of 2011. Variable annuity premium of $2.0 billion was virtually unchanged over the same period.

The release did not include Allianz Life’s quarterly results.

Overall, Allianz Life saw a 21% increase in operating profit in the half of this year, as profits rose to $381 million from $315 million in the same period in 2011. Total assets under management grew 9% in the first half of 2012, to $99.6 billion, compared with the first half of 2011. The Minneapolis-based firm is a unit of Allianz SE, the German financial conglomerate.

“Sustained customer balances coupled with positive investment returns generated this growth,” the company said in a release. New product offerings helped cement the company’s position as the top fixed index annuity provider in the U.S., according to AnnuitySpecs.com.

The low interest environment kept a lid on new annuity sales, and total annuity premiums fell to $5.2 billion in the first half of 2012 compared with $5.6 billion the first half of 2011. Fixed annuity premium of $2.9 billion was down 15% year-to-date compared to 2011 and variable annuity premium of $2.0 billion was flat. Sales of life insurance more than doubled, to $31 million, for the first half, year-over-year.

Insurance Technologies launches VisibleChoice 3.0

Protective reports second quarter 2012 results

New investment options for Securian retirement plan participants

Prudential Retirement selected as recordkeeper for MGM Resorts 401(k) plan

Advantage Financial Group joins LPL Financial

Data Connection

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