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Iceland’s Tiny But Great Collective DC Plan

Posted on January 14, 2024 by -

Glaciers, geysers, active volcanoes, and the Northern Lights. Mountains, lava fields and rivers full of coldwater anadramous fish. Iceland’s freaky natural wonders— it’s the polar opposite of Hawaii—attract millions of (mostly estival) visitors every year.

The subarctic tourist-magnet has another feature, less visually striking but as notable: its retirement system. The Icelandic pension scheme was rated number one in the world by Mercer Consulting in 2021 for its integrity, adequacy and sustainability.

The scheme is an example of the workplace-based defined ambition (DA) and collective defined contribution (CDC) systems with which several countries have replaced “pay-as-you-go” plans (for example, Social Security in the US).

The system is collective in the sense that Icelanders workers put their pre-tax contributions in one of 21 diversified investment funds. Ideally, participants’ notional accounts will grow steadily and deliver a taxable life annuity at retirement.[1]

The scheme’s ambition is for full-time workers with 40 years of contributions to replace up to 72% of their average pre-retirement incomes by age 67.  Iceland’s system also has its share of complicated options and exceptions, as I’ll explain.

I visited Iceland in mid-2022 (when the volcanoes were spitting and smoking but much less than in December 2023) to interview pension experts in Reykjavik, the capital city and to fish for brown trout in the rivers near Akureyri, a harbor town on Iceland‘s north coast. I wanted to compare Iceland’s retirement policies with pension practices back home in the US.

As many pension-watchers know, the US retirement system is in transition. Social Security is on track for a funding shortfall in about 2034; multi-employer defined benefit plans need a federal bailout; life insurers intend to market individual annuities through 401(k) plans; large corporations are selling their pensions to financial giants like Athene, MetLife and Prudential.

Though Iceland is too small for direct comparisons with the US (it has fewer people than Wyoming), a review of Iceland’s highly ranked retirement system could help US firms and policymakers imagine some new possibilities for our domestic reforms.

The three-legged stool 

Since 1997, Iceland has been using the “three-legged stool” or “three-pillar” retirement system recommended by the Organization for Economic Cooperation and Development, or OECD. The three legs are:

A first-pillar basic pension. Every employer in Iceland contributes 6.35% of payroll to the social security first pillar pension. Icelanders call it the “Social.”  This contribution or tax helps finance a means-tested pension. Icelanders who have worked full-time in the country for 40 years can receive pensions of up to $3,000 per month if they have no other pension wealth. Workers who qualify typically start benefits at age 67 but can defer until as late as age 80 and take advantage of actuarial increases. Iceland’s goal is for most workers eventually to accrue a large enough benefit in their second pillar accounts (see next section) so that fewer qualify for, or need, any of the tax-financed “Social.”

A second-pillar defined ambition (DA) or collective defined contribution (CDC) pension where all risks are borne by the members. As of January 1, 2023, every Icelandic employer (including the self-employed) contributes 11.5% of workers’ pay to one of the 21 pension funds and each employee contributes 4% of pay. This contribution covers retirement benefits, disability insurance and a death benefit for families. The entire payroll is subject to the 15.5% levy; there’s no equivalent of the US taxable maximum or FICA limit of $147,000 (in 2022).[2] Funds invest in a variety of domestic and foreign securities. Benefits accrue, on average, at a rate of 1.8% of income per year. Icelanders who work for at least 40 years can expect a lifetime pension equal to 72% of their CPI-indexed average annual pre-retirement income. The monthly payout can start as early as age 62 (60 in some cases) or as late as age 70, with annual step-ups for deferral, as in the US. Savings and benefits are indexed to the cost of living, and may fluctuate with fund performance or changes in longevity.

A third-pillar, voluntary, tax-deferred non-collective DC savings program. Icelanders with a high propensity to save can contribute up to 4% of their pay on a pre-tax basis to an investment fund of their own choosing. Employers must match up to 2%. These accounts can experience losses as all risks are borne by the members. Participants own their accounts and can access them as needed after age of 60 subject to income tax.

By newly passed law, members can choose to allocate 3.5% of their mandatory 15.5% mandatory second-pillar contribution to the third-pillar. The vast majority of the third-pillar savings are managed by the pension funds. There are as well seven financial companies offering third-pillar savings. The third pillar resembles the 401(k) system in the US.

A close look at the second pillar

There were once more than 100 pension funds in Iceland. Consolidation has brought the number down to 21. Certain funds align with certain occupations, unions, industries, or even levels of education. There are specialized funds for dentists, engineers, and farmers. One fund, the Almenni Fund, caters to doctors, tour guides, technologists, architects and musicians. Other funds are open to anyone who wants to join. Workers who change jobs several times might contribute to several different funds over their careers. Every worker can track the growth of all their notional accounts funds at the Pension Portal.[3]

Teams of professional fund managers run each fund. Icelanders, in most cases, don’t pick their own second-pillar investments. They don’t trade within or between their accounts and can‘t transfer accrued savings from one fund to another when changing jobs.[4]  They can’t access their first-pillar or second-pillar entitlements before retirement.

Iceland has one of the highest ratios of pension savings to Gross Domestic Product (GDP) in the world. With a market value (in 2022) of about 7 trillion krona or $49 billion, the 21 pension funds are double Iceland’s GDP of $21.7 billion. Of that $49 billion, about 85% is in the second pillar and 15% is in the third pillar. About 35% or $17 billion of the pension funds are invested overseas; there’s a cap of 50% on foreign investment.

Who guarantees the success of the pension funds? No one. No employer, governmental body, or life insurance company backs the funds. Instead, each fund aims to be fully funded at all times. Contributions are paid into and benefits are paid out of the same risk-managed fund. There’s no transfer from a variable separate account to a general account at retirement, nor any reserve or buffer fund to smooth payments across years or across cohorts of retirees. Only the funding rules imply some smoothing and buffer mechanism.

But a smoothing element does apply to the funded ratio. “In the mandatory second pillar, benefits have to be adjusted when the difference between liabilities and assets is plus or minus 10%,” said Bjorn Z. Asgrimsson, senior risk and pension policy analyst at  the Financial Supervisory Authority of the Central Bank of Iceland. We spoke at the modernist headquarters of Sedlabank, as Icelanders call their central bank, in downtown Reykjavik.

“If the funding ratio is down 10% for a year or down 5% for five consecutive years, they have to cut benefits,” he added. Asgrimmson grabbed a marker and scribbled the formula for the funding ratio on a whiteboard in one of the Central Bank’s conference rooms: “Current assets plus future contributions divided by total liabilities.” Inflation adjustments are applied both to the notional accounts of participants and to the payments to retirees.

Some funds hire outside managers. Pension fund managers enjoy some investment freedom within investment rules set by the Central bank and enforced by risk management rules. Expenses for the funds are about 0.35% (35 basis points) of total AUM per year. Workers can claim second-pillar benefits as early as age 65 or defer up to age 80, with benefits adjusted upward for deferral. They receive income from every fund to which they contributed. After the death of a married retiree, the surviving spouse receives the deceased spouse’s first pillar and/or second pillar benefits for three years. The female labor force participation rate is high in Iceland. Between 80% and 90% of women in Iceland are said to have their own earned second-pillar benefits.

Those who study or build tontines might see similarities between Iceland’s second pillar and a tontine. A pure tontine is a centrally managed investment fund whose retired participants who are roughly the same age and who pool their “longevity risk”—their risk of living to age 90 or 100 and incurring the financial liabilities associated with such persistence.

Each year, surviving participants inherit a share of the investment gains and principal proportionate to their contributions, as well as a “survivor’s credit” that represents a share of the assets forfeited by participants who have died. A private annuity does the same, but the tontine eliminates the fees that life insurers charge for guaranteeing a fixed income stream for life.

“I would certainly say that Iceland’s pension and retirement system is infused with ‘tontine thinking,’ in which longevity risk is pooled and shared,” said Moshe Milevsky, a finance professor at York University in Toronto who has written histories of tontines and collaborated with a Canadian life insurer on the launch of a tontine in Canada. All else being equal, tontine payouts are 15% to 30% higher than annuity payouts, he said.

Iceland’s government would like to see the first pillar pension shrink to the point where few or no Icelanders still depend on it for retirement income. Iceland is the only European Economic Area member country where some retirees means-test entirely out of their country’s tax-funded first pillar, Asgrimson said. Iceland recently established minimum support for permanent residents with little or no income.[5]

Limits to rationality

Gylfi Zoega, a professor of macroeconomics at the University of Iceland and an adviser to Icelandic pension funds, has two perspectives on Iceland’s system, as a participant and as an academic. I met him at his book-filled office in the Oddi Building, a white Bauhaus-style building that houses the social science departments on the university’s Reykjavik campus.

At age 59, Zoega, who earned his doctorate in economics at Columbia University, has contributed to the mandatory second pillar and voluntary third pillar of Iceland’s retirement system for most of his career. “Altogether, I put about 25% of my pay into my pension,” he told me. At the level of income he expects his contributions to produce in his retirement, he won’t qualify for any first-pillar benefits.

Recently, he and a colleague reviewed Icelanders’ savings rates in the year after the government, employers, and labor unions agreed to raise the mandatory employer contribution for private sector workers to 11.5% of pay, from 8%. They expected to find many people reducing their voluntary savings rates accordingly.

“Our data, which included the tax returns of everybody in the country, showed no reduction in personal savings to offset the increase in the employer contribution. We conducted a follow-up survey, and found that few people even realized that the employer contribution had increased. People are not as forward-looking or as rational as economists like to think,” he said.

In a 2019 paper, Zoega and others suggested a solution to a weakness that the Icelandic pension system shares with Social Security in the US.7 Wealthier participants, such as white-collar professionals, tend to live longer than lower-income workers and therefore collect pension benefits longer; that’s true even in Iceland, where everyone has lifelong access to subsidized health care. Zoega suggested that, like participants in defined benefit pensions in the US, blue collar workers in Iceland be given the option of a lump sum payout at retirement.

‘I won’t be stranded’

Mercer gave Iceland’s retirement system its top ranking (just ahead of perennial leaders like Denmark and the Netherlands), but that’s news to the Icelanders I spoke with this summer. Their own evaluations of the system were diverse.

“Like any system, it has good and bad points,” a man in Skuggabaldur, a Reykjavik jazz bar, told me. An emigre´ from Iran who runs an Airbnb said, “I don’t know anything about it. My accountant handles all that.“ A retailer who sells Icelandic delicacies like licorice salt and freeze-dried lamb stew in a shop on Laugavegur Street, Reykjavik’s touristy pedestrian mall, told me, “It’s a disaster.”

Why a disaster? In a country as small as Iceland, there are a limited number of domestic companies to invest in, the retailer said. Conflicts can arise when, for instance, a bank that manages the domestic investments of a pension fund has overlapping domestic investments of its own.

The 2014-2018 United Silicon smelter project near the Keflavik airport is one example. While managing the Free Pension Fund (Frjálsi lífeyrissjóðurinn), Arion Bank invested both its own money and Frjálsi money in the smelter. Environmentalist groups opposed the smelter, which ultimately failed. Arion Bank assumed ownership. In 2018, an inquiry by Iceland‘s Financial Supervisory Authority “assessed that the pension fund’s investment process was not normal and healthy.”[6]

Noting “the difficulty of investing all this money in a tiny economy,” Zoega added, “You cannot invest all the money abroad because of the currency mismatch. So the pension funds own almost all listed companies, which creates problems for corporate management.”

“Almost everyone has complaints,” said Stefan Halldorsson, a project manager at the Lifeyrismal and a former president of Iceland’s stock exchange. “Some people might say, ‘I’d rather manage my own savings, or ‘This system is bound to collapse.’ But, while the system may not be ideal, in general Icelanders have a strong perception that they will not be left stranded.” Since Iceland‘s banking meltdown in 2008, he added, the pension system has been more strictly controlled, and participants are better protected.

Conflicts and trade-offs

Means-testing of first-pillar benefits remains a sore point. The higher one’s income from the second-pillar annuity, the less one receives from the first-pillar. “If you have an income of ISK670,000 per month ($4,700) or more from the second pillar, you get nothing from the first pillar,” Asgrimsson, the Sedlabank risk analyst, told me. “Iceland is only country in the OECD where some retirees get nothing from the first pillar,” he said.

A single pensioner living alone with a complete 40-year work history would receive the tax-funded first-pillar benefit (the Social) of about ISK360,000 ($2,567), including a special supplement of about ISK75000 ($535). Members of a couple would each receive almost ISK300000 or about $2,000 each if they both had 40-year work histories.

As retirees‘ projected second-pillar income increases, their rights to the first-pillar benefit shrinks. Someone with ISK200000 ($1,426) in second-pillar monthly benefits would receive about the same amount in first-pillar benefits. Someone earning ISK400000 ($2,852) would receive only ISK100000 from the Social, for a total monthly benefit of about ISK500000 ($3,566).

This cannibalization problem is characteristic of means-tested programs everywhere.[7] Means-testing can be perceived as punishing high-income taxpayers for success rather than accepted by them as a gesture of noblesse oblige. In Iceland, retirees may not know in advance how much of their potential first pillar benefit will be crowded out by their second pillar income. Anecdotally, they are as likely to experience the means-test haircut as a loss of second-pillar benefits than as a loss of first pillar income. This strikes some as unfair.

Anecdotally, means-testing is suspected of inspiring the self-employed and others to under-report their earned income when possible—sometimes at the expense of their second-pillar accrual. “The self-employed have to divide their income into wages and profits for tax purposes,” Zoega said. “The marginal income tax rate is 47% and the capital gains tax rate is 22%, so they’re tempted to lower the wage component. But then their contributions to a pension fund are based on the calculated wages.”

A Laugavegur Street optician told me, while demonstrating a pair of blue-tinted polarized sunglasses, that he wondered why he should pay income tax (at the rate of either 31.45%, 37.95%, or 46.25%) on all of his taxable second pillar income. If his second pillar owes most of its growth to capital appreciation, shouldn‘t he pay the 22% capital gains tax instead? After exclusions, Iceland’s middle-class retirees pay income taxes equal to about 23%, Halldorsson said.

For richer or poorer

Iceland’s high tax rates and ambitious social insurance programs suggest an equitable society. Some of the data bears that out. According to figures from the Organization for Economic Cooperation and Development (OECD), Iceland has a Gini coefficient of about 30, or roughly equal to that of Denmark, Sweden or the Netherlands. The poverty rate for the elderly is listed at only 2.8%, compared with an OECD average of 14.7%.[8]

But others paint a different picture. “Most people in Iceland live hand to mouth,” Zoega told me.

Harpa Njalsdottir, an Icelandic scholar who has studied the nation’s social insurance system, sees Iceland’s shift toward DA and CDC as a shift away from a welfare society to a society where public benefits are relatively stingy.

“Seventy percent of the elderly in Iceland have incomes below subsistence standards, according to figures from the Ministry of Welfare,” Njalsdottir told the RUV in 2018. “More than 70% of those who live alone and are in poor health are women. Those who have worked in the low-wage labor market in childcare jobs for the state and the city, for example in kindergartens, elementary schools, retirement homes, home assistance for pensioners, have had low wages throughout their working lives and do not fare better when they leave the labor market. Due to low wages, their payments to the pension fund are low. Therefore, very low payments from the pension fund await them in their later years.”[9]

Rent consumes a big chunk of those low payments, Zoega said. “The main cause of old age poverty is the housing market,” he told me. “A 75-year-old who does not have any personal savings, who lives off pillar 1 or even a mixture of pillars 1 and 2, will be in poverty if most of the income goes to pay the rent—which is the case for thousands of people.”

Lessons for US?

When Iceland’s workers transfer part of their earned income to their retirement plans, they call each deferral an “idgjald.” In Iceland’s Northern Germanic language (it has also been called a Uralic language), idgjald can mean either a contribution or an insurance premium. Even though second pillar accounts are notional, irrevocable, largely illiquid and accessible only as annuity-like entitlements, Icelanders think of their accounts as assets—a feeling reinforced by their ability to track the growth of their entitlements on a virtual dashboard.

In the US, Social Security accruals are also notional, irrevocable, largely illiquid and accessible mainly as a life annuity. But since Social Security is a pay-as-you- go (PAYG) pension, and because participants perceive their contributions as direct transfers to the bank accounts of current retirees, they regard their contributions as a tax.

Polls indicate that Americans see only a tenuous guarantee that the generation of workers behind them will fund their retirement benefits. Otherwise the two systems, in their entirety, are less different than they might first appear.

Iceland’s second pillar pension combines elements of our Social Security and defined contribution systems in one program. It has the mandatory participation, universal coverage, and annuitized payouts of Social Security. It also has the individual accounts, exposure to financial markets, and professional fund management of our 401(k) system. With its first pillar, Iceland puts a floor under the incomes of poor retirees. With the third pillar, Iceland offers the rich an outlet for their higher propensity to save.

This hybrid pension system enables Iceland to solve two large retirement-related problems that the US faces: lack of access to 401(k) plans for almost half of full-time workers and a tax-funded PAYGO Social Security system that faces a revenue shortfall in the early 2030s.

Could the US convert to a DA system like Iceland’s? In 2007, the George W. Bush administration floated an idea to defer a share of the Social Security payroll tax (12.4% of earned income) into the US stock market. In 2019, Congress passed the SECURE Act, making it easier for employers to accept individual annuities as investment options or payout options in 401(k) defined contribution workplace plans. The seeds for a DA hybrid system have been planted.

The most substantive differences between the two system may be that Iceland has a) reduced costs by eliminating the need for many financial services intermediaries, b) raised contributions by subjecting 100% of earned income to the 15.5% idgjald, and c) incorporated flexibility to adjust benefits in response to demographic or economic change without political upheaval or disruptions in continuity.

© 2024 RIJ Publishing LLC. All rights reserved.

 

[1] For an evaluation of CDC plans, see Iwry, J. Mark, et al, “Collective Defined Contribution Plans,” Brookings Institution, December 2021. https://www.brookings.edu/wp-content/

uploads/2021/09/20211203_RSP_CDC-final-paper-layout.pdf

[2] FICA stands for Federal Insurance Contributions Act. The US Old Age and Survivors

Insurance tax is 12.4%, or 6.2% for both employer and employee, up to the taxable maximum.

[3] https://www.lifeyrismal.is/is/lifeyrisgattin

[4] Sigurdsson, 2020, p 60. “The returns of the pension funds are significantly higher than the investor achieves. After deducting the annual investment cost, which is 100,000 ISK annually over a 10-year period, the total return in ISK is 485,334 for the pension fund and 335,210 for the hypothetical investor. Which means that the pension funds achieve a 44.79% better return than the investor does on his own.”

[5] “A new type of payment that is intended to support the subsistence of persons 67 years and older who have permanent residency and have no or limited pension rights with the Social Security Administration will be implemented 1st of November. This additional support can amount to a maximum of ISK 231,110 [$1677] per month, which is 90% of the full old-age social security pension per month in the year 2020.  Those who live alone may in addition be entitled to up to 90% of the household supplement, which is ISK 58,400 per month [$423.70] in the year 2020.” https://www.tr.is/en/65-years/additional-support-for-the-elderly 7 Forthcoming paper.

[6] “The result of an examination of the investment process of the Free Pension Fund in Umoðiné sílikoni hf.,” the Financial Supervisory Authority, Iceland. Reykjavik, April 10, 2018.

[7] For phase out curve, see https://www.lifeyrismal.is/is/landssamtok-lifeyrissjoda/grof/5frodleikur-um-lifeyriskerfid/53-lifeyrir-sjodir-tr

[8] Oecdbetterlifeindex.org, April 28, 2023.

[9] https://www.ruv.is/frett/ekkert-norraent-velferdarkerfi-a-islandi

Of Athene, Pension Risk Transfers, and Fiduciaries

Posted on July 28, 2023 by -

While forensic accountant Tom Gober was testifying before the ERISA Advisory Council (EAC) meeting on private equity firms in the pension risk transfer (PRT) business in Washington on July 18, I was standing against the back wall of the windowless meeting room, a few feet from Bill Wheeler, vice-chair of Athene Holding Ltd.

Like all 21 guest commenters, Gober was given only 10 minutes to speak and answer questions from 15 council members. He presented slides showing how an anonymous “XYZ” insurance company had reduced its liabilities using offshore reinsurance and grown its assets with securities from its own affiliates. As Gober spoke, I watched Wheeler’s face.

He appeared to listen closely. He leaned forward in his chair and looked calmly at the floor. Wheeler, a former chief financial officer at MetLife and a Harvard Business School graduate, seemed untroubled. He may have been thankful that Gober didn’t identify XYZ life insurer as Athene Annuity and Life.

Later, after Wheeler and colleague Sean Brennan used their 10 minutes to describe Athene as “the most transparent” life insurer, I asked Gober what he thought when Wheeler said that. He told me, “I thought that was the opposite of the truth.”

To tweak or not to tweak “IB 95-1”

The topic of the July 18 hearing was dictated by the SECURE 2.0 Act, a retirement bill that Congress passed in 2022. Section 321 of the Act addresses the requirements that a defined benefit plan sponsor’s fiduciary advisor (an individual, or a consulting firm like Aon or Mercer) must meet when deciding which life/annuity company the sponsor should transfer its plan to (that is, the company from which to buy a group annuity) in the execution of a PRT deal.

Section 321 instructed the Department of Labor (DOL) to revisit those requirements—as first described in Interpretive Bulletin 95-1 (IB 95-1) 28 years ago—to see if they needed to be tweaked. The DOL’s Employee Benefit Security Administration (EBSA) sent a consultation paper on the topic to the EAC for its review and input. The EAC, in turn, solicited input from public. On July 18, the EAC heard testimony from 21 interested parties.

A key issue, for several pensioner-rights advocates represented at the meeting, is whether IB 95-1 should be amended to alert fiduciaries to the growing roles of certain large asset managers ( “private equity,” “private credit,” or “leveraged buyout” companies) in the life/annuity industry, to the complex investment and reinsurance policies of those companies, and to the potential danger of putting discretion over billions of dollars of defined benefit plan assets and responsibility to pay future benefits to millions of retirees (the “liabilities” of the insurers) in their hands.

Over the years, PRT deals have transferred $425 billion in assets and liabilities from corporate defined benefit plans to life/annuity companies, including about $250 billion since 2012 and an estimated $52 billion in 2022. Athene, MetLife and Prudential together accounted for about two-thirds of the 2022 PRT deal volume.

All three have enough surplus capital to handle huge PRT deals. Of the three, only Athene has a “private equity” label, thanks to its affiliation with the giant asset manager, Apollo, within Bermuda-based Athene Holding Ltd. Changing IB 95-1 to flag private equity companies could put Athene at a competitive disadvantage to other large life/annuity companies.

Meet the ‘Bermuda Triangle’

You may have read about the “Bermuda Triangle” phenomenon in the life/annuity business. That’s Retirement Income Journal’s short-hand for a business strategy that Athene is sometimes credited with originating and perfecting after the 2008 financial crisis. The strategy has been widely copied by other financial services firms, including MassMutual and, most recently, Fidelity Investments.

The strategy typically involves coordination between at least three related entities, often companies of the same holding company:

  • A life/annuity company sells individual or group annuities to acquire investment capital.
  • An affiliated asset manager uses some of that incoming capital to write (“originate”) long-term “leveraged loans” whose returns reflect their “illiquidity premium.”
  • An affiliated reinsurer reinsures annuity liabilities under Bermuda’s favorable accounting standards and also attracts fresh capital from foreign investors who want to invest in the U.S. life/annuity business.

The Bermuda Strategy can be complex and opaque. Few people understand exactly how it works. It appears to allow life insurers to invest in riskier, higher-yielding assets while using more flexible accounting rules in certain jurisdictions to eliminate the punitive capital requirements that would make those high-risk assets too expensive for insurers to hold under domestic accounting rules.

The strategy evidently cuts two ways. By reducing its capital requirements, an insurer can make itself more profitable (and its policyholders more secure). But, as some fear, the strategy could also bring the insurer closer to insolvency during credit crises, as in 2008 and 2020.

Athene’s vice-chair speaks

The three most important speakers, for me, were Wheeler, who moved from MetLife in 2016 to become Athene’s president; David Eichhorn, president of NISA, the pension fund bond manager; and Tom Gober, a forensic accountant who studies the assets, liabilities, and reinsurance practices of life/annuity companies.

Along with Wheeler, Athene Holding sent four or five people to the hearing. It was the only life/annuity company offering public comment Tuesday. “We’re the bad guys,” Wheeler said jokingly to me during a break in the EAC meeting. Athene Holding Ltd. encompasses New York-based Apollo Global Management, a publicly-traded company; Athene, a retirement business (including Iowa-based Athene Annuity and Life Company); Apollo Asset Management; and Bermuda-based Athene Life Re, a reinsurer.

Athene has become a lightning rod because it has been the leader in disrupting, reinventing, and (depending on your point of view) either plundering or rescuing a weakened U.S. life/annuity business during the long low-interest-rate period after 2008. During Athene’s 10 minutes of testimony, Wheeler defended his firm, its investment and reinsurance practices, and private-equity firms generally. He rejected the “private equity” label, however. “Let me set the record straight. Yes, we own assets that Apollo originates. That’s eating your own cooking. We’d rather have Apollo assets than assets from some third party,” he said.

“It’s not true that we’re ‘private-equity’ backed,” he added. “We look a lot like Prudential, or MassMutual, or MetLife. [Some people] don’t want you to know that.” He seemed to be distinguishing between firm directly financed by private equity investors and companies like Athene, that have partners who lead private equity investments. He praised private equity firms, saying, “Forty percent of all new capital in the life/annuity industry has come from private equity firms. Traditional life insurers have raised no capital on their own in a decade.” For Athene’s complete letter to the EAC, click here.

Wheeler was preceded at the commenter’s table by Eichhorn and Gober. Eichhorn co-founded NISA Investment Advisors, which manages over $400 billion in bonds for institutional asset managers. His data showed that, for professional bond buyers like himself, a certain type of debt (Funding Agreement Backed Notes, or FABNs) is considered significantly riskier when issued by Athene than when issued by its competitors or peers in the life/annuity industry. [See NISA chart below.]

Indeed,  Eichhorn said he trusts the market prices of FABNs more than the ratings by credit ratings agencies. The NISA website said, “We believe our market-based measure of credit risk conclusively demonstrates an exceptionally wide range of default risk of the various PRT providers. …Any reasonable reading of the ‘safest annuity available’ standard in IB 95-1 would require narrowing the universe of potential PRT providers.”

Gober, in his presentation, focused on the conflicts of interest inherent in certain life/annuity companies’ purchase of assets from sibling firms in the same holding company (“affiliated assets”). As for offshore reinsurance, he called it a “sleight of hand” tactic for reducing the amount of surplus capital supporting pension liabilities.

Tom Gober

Under Bermuda’s accounting rules, pension liabilities (estimates of what the annuity issuer will have to pay out to pensioners in the future) are smaller. Nor does Bermuda impose U.S.-style “risk-based capital” penalties. These penalties raise the owners’ capital requirements when U.S. insurers hold riskier investments.

Bermuda, in effect, doesn’t necessarily require a U.S. life/annuity company’s owners to post as much of its own capital (on top of the savings it manages for the pension plan participants or annuity contract owners) as the U.S. does, given the same pension liabilities. Bermuda-based operations are also not as transparent to the general public as U.S. operations, Gober said.

Potential impact on 401(k) annuity market

After getting feedback from the EAC, the DOL faces a December 29, 2023 deadline for giving Congress its recommendations on amending IB 95-1. “That’s a pretty quick turnaround,” one of last Tuesday’s commenters told me. A member of the EAC told me that the consultation on IB 95-1 was “different than others” and “not part of [the EAC’s] perennial process.”

Last week’s meeting added, in a sense, a new chapter to ongoing discussions between the annuity industry and EBSA over tightening or easing regulations that govern the marketing of annuities to 401(k) plan participants or IRA owners. The state insurance commissions regulate annuities, but the DOL regulates such plans and accounts. There’s potential friction wherever the state and federal regulatory agencies overlap.

In 2016, the Obama DOL singled out marketers of fixed indexed annuities and variable annuities to owners of IRAs to act only in their clients’ “best interests.” (The industry appealed the new regulation in 2018 and a federal appeals judge voided it.) In 2020, the Trump DOL successfully amended a 1975 DOL regulation to say that advisors are committing a “fiduciary act” when they advise clients to roll over 401(k) savings into an annuity. That is, advisors can’t recommend a rollover out of their own self-interest.

Now the Biden DOL is mulling an amendment of IB 95-1 that could tighten the oversight of PRT transactions involving life/annuity companies that are affiliated with major “private equity” or “private credit” companies, such as Athene, that invest in riskier assets, and that buy reinsurance from their own affiliates.

That may be difficult, given the establishment of Athene’s already-large footprint in the PRT market and individual annuity market, and given the steady blurring of the lines between the business practices of Athene and its competitors in the life/annuity industry.

Whatever the DOL recommends to Congress regarding revisions to IB 95-1, it could affect the life/annuity companies that are competing to distribute annuities through 401(k) plans to plan participants. As in the PRT debate, defined contribution plan fiduciary advisors must follow specific rules when recommending an annuity provider. If any factor disparages, hinders or disqualifies a certain type of life/annuity company from the PRT market, the same factor might hinder its competitiveness in the much broader 401(k) market.

© 2023 RIJ Publishing LLC. All rights reserved.

RIJ’s Next Phase

Posted on June 30, 2022 by -

After 650 editions over 13 years, Retirement Income Journal is about to evolve. As of tomorrow, we will change our editorial model and our business model. 

Instead of publishing a weekly e-newsletter, we’ll turn this platform into a library for information on retirement income.

Before that happens, however, I hope to revise Annuities for Dummies for John Wiley & Sons. A lot has changed in the annuity space since 2008, when the first edition appeared.  

The look and feel of the next RIJ platform remains TBD. But, at the very least, we’ll take the best of my archives—original articles, research, interviews, evergreen data, webcasts—and make them easily accessible. For the first time, consumers/investors will be part of the target audience.

Near retirees need this information as much today as they did in April 2009, when RIJ started. Common-sense, impartial, practical, customer-centric information exists. It has always existed. But, in an ocean of information, misinformation, disinformation, special pleading, legalese, and jargon, people need help locating it.  

Some things never change. The life/annuity industry and the federal government, imho, aren’t any closer to solving the nation’s retirement challenges than they were 15 years ago. The Boomer opportunity appears to be slipping past the struggling life/annuity industry. And any hope that Congress might agree on a fix for Social Security seems naive. 

It has been my pleasure and privilege to study and write about the global retirement crisis. I have been a lurker of silos and subcultures. Mostly by phone and email, but often in person, I’ve been welcomed into start-ups, corporations, ivory towers and government agencies. I have met brilliant thinkers, writers, and entrepreneurs in several countries. I am lucky to have known so many. 

The broader, younger population may regard annuities, pensions and retirement as a snooze. But eventually they wake up to its eternal urgency. Annuities are about life, death, money and taxes. You can’t get much more urgent, or more eternal, than that.  

© 2022 RIJ Publishing LLC. All rights reserved.

Why Annuity Issuers Use Bermuda Reinsurance

Posted on June 30, 2022 by -

Of the three legs of the Bermuda Triangle strategy, reinsurance might be the most opaque and arcane. That’s saying a lot, because the other two parts—fixed indexed annuities (FIAs) and collateralized loan obligations (CLOs)—are mysteries of their own.

True, big reinsurance deals between unrelated insurers are regularly reported. But when one holding company owns both a life insurer and a “captive” reinsurer, or the deal happens offshore, or involves a certain type of reinsurance—all typical of the Bermuda Triangle strategy—it can be hard for an outsider to know how substantive the deal actually is, or if its just an accounting maneuver.

Certain data is available. In each FIA issuer’s 2021 statutory filing, lengthy documents, you can see its gross annuity sales, the amount of premium reinsured, the annuity products that were reinsured, the type of reinsurance used, the reinsurance partner, and the partner’s headquarters.

In our June 23 issue, RIJ shared some of that data, with a focus on FIA issuers with ties to a big private equity firm. For this week’s story, we interviewed insiders about the purpose of reinsurance within the Bermuda Triangle strategy. Some sources spoke on the record; most asked for anonymity. 

Cross-border, captive reinsurance capitalizes on differences in accounting standards between the US and Bermuda, enabling what some have called regulatory arbitrage. The transfer of risk from annuity issuer to reinsurer can reduce the insurer’s liabilities, release surplus capital, and lower risk-based capital requirements. The reinsurer can reimburse the issuer’s distribution expenses (e.g., FIA commissions) and, through special purpose vehicles, sell its own risks to third-party investors. 

“The move to ‘capital light’ is based on reinsurance,” one annuity issuer executive told RIJ, referring to the life insurance industry’s ongoing drive to become annuity retailers while outsourcing risk to reinsurers and investment chores to global asset managers—often, but not always, within the same holding company. “It’s a wholesale change in the structure of the life insurance industry.”

Not your grandpa’s reinsurance 

With conventional reinsurance, a life insurer sells a block of asset-intensive insurance business—in-force variable annuity contracts with living benefits, say—to an unrelated life insurer or reinsurer. The block includes assets and the risk that the assets will not perform well enough to cover the liabilities (in this case, deferred annuity principal and gains accrued per the contract).

Reinsurance in the Bermuda Triangle works differently. A US-domiciled annuity issuer “co-insures” a block of old (or new) annuity business with an affiliated reinsurer in a different jurisdiction, like Bermuda or Vermont. “Modified” coinsurance (modco) or  “funds withheld” coinsurance may be used. 

With modco, the first insurer (the “ceding” company) transfers the risk on a block of business while keeping the assets and reserves (liabilities) on its own balance sheet. In a “funds withheld” arrangement, the ceding insurer transfers reserves (liabilities) and specified risk to the reinsurer, but maintains control of the assets. 

The amount of risk ceded, the amount of capital the reinsurer (or its investors) puts up, the riskiness of the investments backing the guarantees—these all vary from one deal to another Wherever the money is, or whatever an asset manager—maybe the owner of the insurer and reinsurer, maybe a strategic partner—manages it for a fee and sometimes part of the profit. 

‘Regulatory arbitrage’

Different jurisdictions use different accounting standards, which translate into different ways of calculating an insurer’s liabilities, assessing the riskiness of its assets, and determining the amount of excess assets (surplus) it needs to hold as a buffer against either a spike in liabilities or a crash in the value of its assets. 

In the US, state regulators require domestic life insurers to use Statutory Account Principles. In certain states or countries (Arizona, Vermont, Bermuda, Cayman), reinsurers can use Generally Accepted Accounting Principles. Publicly traded life insurers use SAP with state regulators and GAAP with the Securities & Exchange Commission. [See box from Insurance Information Institute.]

“The reason to be in Bermuda is to take advantage of regulatory arbitrage,” a global insurance consultant told RIJ. “Bermuda is not going to require the same level of capital, simply because their models are different. But it’s hard to make blanket statements about how the regulatory arbitrage is done. The exact processes are pretty well guarded.”

Just as it can be cheaper to manufacture offshore, it can be cheaper to insure annuity liabilities in a state or country where GAAP can be used to price liabilities instead of SAP. SAP is more conservative, requiring high, “statutory” reserves—enough to weather a financial crisis. GAAP requires only “economic” reserves—enough for the most likely business environment. 

“If you sell $1 worth of annuities, the current regulations might say that premiums will only cover 90 cents of the liabilities, and the regulators ask you to post 10 cents of capital to back all the claims,” a post-doc in finance at an Ivy League business school told RIJ. 

“But you might believe that the risk is really just five cents. So you find loopholes in the code and manage to post five cents. Regardless of how you arranged to guarantee the contract—through swap arrangements or whatever—you’ve still posted just five cents of capital instead of 10 cents,” he added.

Life insurers, he suggested, may regard SAP as too conservative, especially with respect to a low-risk product like fixed indexed annuities, and get around it with GAAP reinsurance in Bermuda. “After 2008, the regulators wanted more liabilities. They said, ‘If the reserves are $1, the liability is $2.’ Now the insurers are finding ways to deflate the liabilities. They will tell you that they are just deflating them down them to what they should be. They say, ‘Let’s find a way to normalize the liabilities and use the capital surplus we generate for share repurchases.’”

Capital release

Release of surplus capital is perhaps the most important benefit of reinsurance. In a multi-billion dollar reinsurance deal, it can, virtually overnight, unencumber hundreds of millions of dollars and turn it into shareholders equity. 

Nonetheless, the mechanics can be gnarly. “If [the reinsurer] is a Bermuda-domiciled captive, the captive might hold a lower reserve than the reserve credit taken [by the ceding company]. Sometimes they would set up an asset for the difference, instead of stating that they’re holding a lower reserve. But they were effectively holding a lower reserve,” a former chief actuary at a state insurance commission told RIJ.

“Typically on funds withheld, the ceding company will end up replacing the reserve liability with the funds withheld,” he added. That difference, between the statutory reserve and the economic reserve, will be capital released to the ceding company. Their rationale in doing these transactions—they want the surplus release of course. They’re trying to get rid of redundancies from their surplus. Their thinking is that economic reserves with margins are adequate.”

When US companies reinsure in Bermuda or Cayman Islands, they may have no choice but to use “modco” or “funds withheld” reinsurance in order to get the capital release they’re looking for.

An actuary at S&P Global Markets Intelligence, publishing on LinkedIn, wrote, “Why would you want to use mod-co? Suppose the reinsurer is not admitted in your jurisdiction. You can’t take credit for those reserves. You don’t want to have to worry about that, so you just don’t give the reserves up.

“Most ceding companies prefer to control and invest their own assets,” he explained. “They don’t want to give money away to the reinsurer. With modified co-insurance, you give the experience on the assets which is the transfer of risk. You don’t give the actual assets. It’s the same with co-insurance funds withheld. I may keep my stocks and bonds and just hand an IOU to the reinsurer. It’s no different financially, but I still get to control my own stocks and bonds.”

But the fairness and reasonableness of such an arrangement is unclear when the reinsurer is in Bermuda (where disclosure is limited) and the insurer and reinsurer are within the same holding company, said Tom Gober, a forensic accountant and certified fraud examiner, in an interview.

“If it’s an opaque, affiliated transaction, all we can see is that they’re just moving money from one pocket to another” for the sake of capturing Bermuda’s accounting advantages, he said.

Lower ‘RBC’

Bermuda differs from most US states not just in the quantity of capital it requires in support of a block of annuity business, but also in the quality of the investments purchased with that capital.

Some years ago, state regulators created a yardstick for the riskiness of a carrier’s investment portfolio. They use it to calculate a minimum capital requirement (the RBC) for the carrier. If the ratio of a carrier’s total capital to its RBC falls too low, regulators have grounds to investigate.      

As US insurers reach for yield by investing in riskier assets, they risk a penalty that adds to their capital requirement. Bermuda’s RBC formula differs from that of the US states, and may not add the same penalty, thus making Bermuda an attractive place for an insurer to put risker assets.

“That affords a bit more room to earn more yield on investment assets without onerous regulatory capital penalties,” said an Ernst & Young actuary who asked not to be identified by name. 

Modified co-insurance “allows insurers to transfer all the RBC components— if the assuming company is willing to take all of that risk. That’s why the ceding company doesn’t need as much surplus,” Gober told RIJ. He considers nearly all modco deals with offshore affiliates to be transferring risk in appearance only, leaving fewer and inferior assets backing American’s annuity contracts. 

Here’s how an article on the subject described Bermuda’s advantage:

“Private equity firms are drawn to Bermuda partly because asset-backed securities, such as collateralized loan obligations (CLOs), are treated more favorably [there] than in the US and Europe,” financial reporter Will Hadfield wrote at Risk.net. “The Bermuda Solvency Capital Requirement (BSCR) requires insurers to hold similar levels of capital against both corporate bonds and CLOs, even though some CLO tranches have a larger downside risk than bonds with the same credit rating. 

“The Bermuda Monetary Authority (BMA), which sets the BSCR, also allows insurers to use the excess spread of CLOs to reduce their liabilities, which are typically discounted using corporate bond yields. This in turn lowers reserve requirements and increases available capital.  That accounting trick is prohibited in the US where insurers can only book the relative outperformance after it is realized. Says a senior risk manager at a large US life insurer, “It’s a big advantage to be able to go to Bermuda and get the extra spread.”

Just as some actuaries believe that SAP is too conservative, more than one suggested that the RBC rules in the US may be out of date. 

“RBC is kind of ‘antiquated,’” the Ernst & Young actuary said. “Bermuda capital requirements allow for better recognition of cash-flow matching and long-term value accrual with alternative assets. Using a different jurisdiction does not necessarily mean that policyholders are less protected or the insurer is less-well capitalized.”  

Other benefits

Bermuda reinsurance offers another potential advantage to affiliated US annuity issuers: It helps them get faster recovery of their acquisition costs, which include the commissions they pay to agents and brokers to sell annuities. FIA commissions average about 6.5%, according to Wink, Inc., data.  

“In the first year [after an annuity sale], the commission expense is heavy, and then it drops gradually,” said Gober. “SAP accounting says that [the money spent on commissions] is gone. But under GAAP, the issuer can amortize it. That’s one reason why there’s a higher surplus (relative to the liability) under GAAP.”

Reinsurance may also create more sales capacity for the ceding insurer. “Technically, reinsurance does allow insurers to write more business because they are getting additional capital from the reinsurer,” said Dennis Ho, CEO of Martello Re, a Bermuda reinsurer part-owned by MassMutual. 

“However, reinsurance doesn’t enable insurers to hold more risky assets or reduce the amount of capital supporting the liabilities because the cedant typically requires the reinsurer to invest according to certain guidelines and hold sufficient capital to manage the risk. So total risk and capital in the system shouldn’t change due to reinsurance,” he told RIJ. But, like the S&P Global source quoted above, he appears to be referring to a conventional transaction between unrelated, independent companies, not offshore affiliates.

Yet an accounting consultant told RIJ that Bermuda isn’t the shrouded venue that it once was. “Ten years ago, Bermuda wouldn’t have required much information, and there could have been regulatory arbitrage. But now Bermuda has Solvency II. They’re not just dumping liabilities in the ocean,” he said. 

An insurance broker told RIJ, regarding Bermuda as a regulatory haven, “Bermuda is tougher to deal with than certain US states. You’re not necessarily holding riskier and fewer assets in Bermuda. Each US jurisdiction also has its own asset guidelines, and they also cut deals with individual companies on the percentage of risk-based capital they must hold or the ability to move away from the RBC guidelines in some cases.”

Some asset managers appear to be using affiliated Bermuda reinsurers as a special purpose vehicle for attracting third-party institutional investors with opportunities to invest in the reinsurer as a business, buy the asset manager’s bespoke assets, or invest in the publicly traded annuity issuer. This is another variation on the “capital-light” strategy mentioned above. Such structures are beyond the scope of this article, however.

Is there a free lunch here? Does the regulatory arbitrage create value? We asked one consultant whether it was all a wash—Did a reinsurer have to replace all the capital that the ceding insurer was “releasing” and would their parent holding company gain nothing from the transaction? The answer was no, “It doesn’t all even out,” he said. That made sense. Otherwise, why bother setting up a Bermuda Triangle structure? 

But if the holding company saves money by outsourcing its annuity risk to a reinsurer in Bermuda, what does that mean for the annuity contract owner? Fans of the Bermuda Triangle strategy claim that the savings from a lighter capital load helps enrich the annuity payouts. Skeptics like Tom Gober insist, however, that modco reinsurance may be returning capital to the shareholders without necessarily reducing risk, leaving the liabilities to contract owners underfunded.  

© 2022 RIJ Publishing LLC. All rights reserved.

 

A Recession’s Threat to Retirees and Near Retirees

Posted on June 30, 2022 by -

Inflation is running at close to 9%, its highest annual rate in four decades, and the Federal Reserve has increased its short-term lending rate by 0.75 basis points, the largest hike in two decades. This has already led to increases in long-term rates, like rates on mortgages. 

GDP growth and the labor market remain strong, but the Fed’s efforts to dampen inflation may precipitate a recession, possibly even  a severe one, with a drop in GDP and an increase in unemployment.

These developments and uncertainty over the conflict in Ukraine may have serious implications for both retirees and households near retirement. That uncertainty and fears that the Fed would indeed raise interest rates contributed to the severe decline in the stock market in the first half of 2022.

Impact on households) approaching retirement

Most households preparing for retirement, with heads in the 55 to 65 age range, still rely on income from work. A severe recession could cost them their jobs at a time when households should be building up their retirement nest egg.

Wage and salary earners who had lost their jobs after age 62 might feel compelled to draw on Social Security earlier than would otherwise be ideal, particularly if another job is not found. Doing so would leave them less well prepared for retirement, particularly if they were counting on Social Security for most of their retirement income. They might also be compelled to take on additional debt. 

A home equity loan, for instance, might make sense. However, declines in house prices, which are quite likely given the increase in mortgage interest rates, could reduce the collateral value of a house. In any case, increases in debt would eat into retirement savings. Unemployed people who manage to find another job might suffer a cut in pay and a loss of fringe benefits.

Households with secure jobs could nonetheless be hurt by declines in stock and housing prices, particularly if they were relying on the sale of a house or stock to finance current or future expenditure.

The uncertain economic and financial environment would lead many households, even those with secure jobs, to rein in their expenditure on discretionary items like dining out or entertainment. This cautionary approach to spending would aggravate the recession and would 

reduce employment in sectors of the economy that have not fully recovered from the effects of the pandemic.

Impact on retired households

Retired households rely for their income on a blend of Social Security, income from old-fashioned defined benefit pensions (which public sector workers are most likely to have), and 401(k) plans and other savings. Most retired households do not own significant quantities of stock, nor do they rely on the labor market for income. 

However, most of them do own a home. Declines in house prices could conceivably affect their ability to pay for current expenditure, but also to afford a place on an assisted living facility, a continuing care retirement community (CCRC) or a private nursing home. The impact of a decline in house prices would hurt older retirees who can’t age in place and who need services provided in assisted living facilities or nursing homes.

One of the curious effects of high inflation is that it can reduce the purchasing power even of an indexed benefit. Social Security, for example, is adjusted once a year, based on the increase in consumer prices over a period ending a few months before the adjustment. 

However, the price of groceries and those of other goods and services increase continuously through the year. Consequently, the adjustment of Social Security is always trying to catch up. For example, if a load of groceries costs $100 at the beginning of the year, it will cost about $109 at the end of the year at the current rate of inflation. By June it will cost $104, but the Social Security benefit will not yet have been adjusted. Consequently, its purchasing power will have declined during the year, dragging on the economy. 

Retired households who do hold substantial amounts of stock might find their ability to finance current expenditure impaired if they were planning to finance this expenditure by capital decumulation. Similarly, stock market declines would impair a move to an assisted living facility or a CCRC. They would also find their ability to pay off student debt compromised, and likewise their ability to make inter vivos transfers to support younger family members who had been thrown out of work.

Conclusions

The effect of the recent surge in inflation on retirees and near-retirees will depend largely on the Federal Reserve’s success in curbing inflation without inducing a severe recession. Among households who are in the run-up to retirement, the most severely affected will be those who lose their jobs. They will be forced to deplete their savings rather than build them up, possibly reducing their standard of living in retirement. The more protracted any recession, the greater the likelihood of job loss and hardship for the affected households.

Retired households who are particularly vulnerable are those relying on the sale of securities to finance current expenditures, as well as older retirees who were hoping to use the equity in their homes to help pay for long-term care or accommodations at an assisted living facility or a CCRC. It bears noting that a high share of retired households will require some long-term care at the end of their lives. A protracted decline in financial markets could have grave consequences for them.

In general, most retirees can afford routine and foreseeable expenses like groceries and mortgage or rental payments. Many will be less prepared for high out-of-pocket health care expenditure or the cost of long-term care.

Mr. Mackenzie is a past editor of the Journal of Retirement and a former economist in the Fiscal Affairs Department of the International Monetary Fund.

© 2022 George A. (Sandy) Mackenzie. 

Pension experts assess ‘OregonSaves’

Posted on June 23, 2022 by -

With only about half of the US private-sector workforce currently covered by an employer-sponsored retirement plan, public policymakers and academics have been looking at the causes of this gap and at the success of measures taken to close it.

A team of prominent pension experts recently analyzed the records of the OregonSaves, a state-sponsored, employer-based, payroll-linked, auto-enrolled Roth IRA for workers whose employers didn’t actively sponsor a tax-deferred retirement savings plan for them. 

For their paper, “Auto-Enrollment Retirement Plans for the People: Choices and Outcomes in OregonSaves,” John Chalmers, Olivia S. Mitchell, Jonathan Reuter and Mingli Zhong assessed the success of the program by analyzing participation choices, account balances, and inflow/outflow data using administrative records between August 2018 and April 2020.

Their findings:

“Within the small to mid-sized firms served by OregonSaves, estimated average after-tax earnings are low ($2,365 per month) and turnover rates are high (38.2% per year). We find that younger employees and employees in larger firms are less likely to opt out, but that participation rates fall over time. 

“The most common reason given for opting out is “I can’t afford to save at this time,” but the second most common is “I have my own retirement plan.” At the end of April 2020, 67,731 accounts had positive account balances, holding $51.1 million in total assets. 

The average balance is $754, but there is considerable dispersion, with younger workers accumulating the fewest assets due to higher rates of job turnover.

“Overall, we conclude that OregonSaves has meaningfully increased employee savings by reducing search costs. The 34.3% of workers with positive account balances in April 2020 is comparable to the marginal increase in participation at larger firms in the private sector. 

“Nevertheless, there are significant constraints to the savings that auto-enrollment savings plans can achieve when provided to workers in industries and firms with low wages, volatile wages, and high turnover. Our evidence suggests that employees who are opting out of OregonSaves are often doing so for rational reasons.”

© 2022 RIJ Publishing LLC. 

Breaking News

Posted on June 23, 2022 by -

Income Lab launches ‘Life Hub’

Income Laboratory, Inc., a retirement income planning software provider, has introduced Life Hub, an interactive tool for that allows clients of financial advisers to “visualize their financial lives on one page, at any level of detail, and at any point in time.” 

Life Hub is the only tool that seamlessly integrates dynamic retirement income plans and tax-smart distribution strategies. More than 200 advisors have been beta testing Life Hub for the past six months and the tool has just gone live, an Income Lab release said. 

Financial advisors use Income Lab’s advanced technology to build and monitor dynamic retirement income plans that help retirees adjust for evolving economic and market conditions and make tax-smart distribution decisions. Income Lab’s software monitors retirement plans monthly to see whether circumstances have changed sufficiently to warrant modifications and then notifies advisors, who can discuss any adjustments with clients.

Life Hub is currently included as part of the Income Lab retirement planning software available to advisors at rates ranging from $159 per month for a single advisor to $139 per month for large teams of advisors.

Ubiquity and Paycor announce 401(k) partnership

Ubiquity, one of the first fintech firms to set up retirement plans for small businesses for a flat fee, is partnering with Paycor HCM, Inc., a provider of human capital management (HCM) software, to expand its market reach.

Paycor will refer small business owners and startups to Ubiquity to provide retirement benefit solutions with less of the usual administrative burden of starting a 401(k) plan.

Ubiquity also plans to rollout a suite of IRA solutions this year to meet the needs of companies where a 401(k) may offer more savings than is needed, and to satisfy state retirement plan mandates. Additionally, a Pooled Employer Plan (PEP) solution will be available.

Amber Williams to lead Lincoln ESG initiatives

Lincoln Financial Group has appointed Amber Williams, CFA, as senior vice president and head of Client Investment Strategies. She will serve as  Chief Sustainability Officer, the Philadelphia-based life/annuity company has announced.

Williams will oversee Lincoln’s Environmental, Social and Governance (ESG) efforts and disclosures, “guiding the continuous improvement of the environmental impact of company operations, advocating for and supporting the integration of ESG priorities across business areas and encouraging a sustainability mindset across the enterprise,” a Lincoln release said.

At Lincoln since 2019, Williams developed the Client Investment Strategies team. Prior to Lincoln, she worked in a variety of investment product management and investment consulting roles at Nationwide Investment Management Group. Most recently, she served as Head of Product Management.

Williams holds a BA in Accounting from the University of Phoenix, is a member of the CFA Society of Philadelphia, and holds her Series 6, Series 7 and Series 24 securities licenses.

© 2022 RIJ Publishing LLC. All rights reserved.

Demographics and interest rate policy favor annuities: LIMRA

Posted on June 23, 2022 by -

Heartened by first quarter 2022 US annuity sales, which rose 4% to $63.3 billion, LIMRA said this week that it expects the current momentum to continue for several years. LIMRA is the life insurance industry’s marketing and research arm.

“The outlook for rising interest rates and fairly level equity markets will have investors continuing to look for the balance between protection, growth, and guaranteed income, creating a strong potential for individual annuity sales to break the all-time record levels of sales experienced in 2008,” said Todd Giesing, assistant vice president, LIMRA Annuity Research, in a new release.

Rising interest rates will allow manufacturers the ability to add more value to their solutions, leading to higher sales, according to Giesing. “We see steady growth in both fixed and deferred annuity sales with the potential for seeing over $300 billion in sales in just two short years,” he said. 

A growing market
The US population aged 65 or over is expected to grow by more than 8.5 million by 2026, LIMRA said, citing data from Oxford Economics. LIMRA data show individual annuity product sales clustering around the traditional retirement age of 65. In addition, the COVID pandemic accelerated the decision to retire.

“We saw a massive amount of unemployment in the US due to COVID-19 events, resulting in a portion of Americans near retirement altering their initial plans and retiring earlier than anticipated,” Giesing said.

The traditional variable annuity (VA) market rebounded in 2021, with sales increasing 16% from the prior year. Sales of products without income riders (guaranteed living benefits, or GLBs) grew 28% and sales of structured variable annuities—also known as Registered Index-Linked Annuities or RILAs—rose 62% during the year.

“By 2023, traditional VA sales will flatten out as economic conditions continue to improve. There will be continued pressure not only on investment-focused traditional VAs, but also on traditional VAs with guaranteed living benefits from carriers that have shifted their focus to registered index-linked annuities, or RILAs,” Giesing said.

He expects an increase in RILA product offerings with guaranteed living benefits.

“After the challenges faced during the height of the pandemic, the indexed annuity market rebounded with 2021 sales increasing 15%,” the release said. Similar to the traditional VA market, sales of products without guaranteed living benefits grew at a faster clip as investors were looking for the balance of principal protection and growth.”

© 2022 RIJ Publishing LLC.

How Annuity Risks Get Passed to the Bermuda Triangle

Posted on June 23, 2022 by -

To assess the role of reinsurance in the today’s annuity industry, RIJ recently obtained and analyzed key pages from the most recent state statutory filings of the ten life insurance companies or financial groups that sold the most fixed indexed annuities (FIAs) in 2021. 

FIAs, if you’re unfamiliar with them, are structured products inside insurance wrappers. Using options strategies to bet on equity or blended indexes, they’re built to capture part of the gains when equity markets rise over specified periods; they return zero when equity markets fall. 

Invented only about 25 years ago, FIAs are now a bread-and-butter product for certain life insurers, with $63 billion in 2021 sales. They flourished after the Great Financial Crisis, thanks in part to their safety. They pose little risk either to the life insurers that issue them or the older investors who typically buy them. 

A decade ago, giants in the private equity (PE) and private credit businesses began investing in or partnering with life insurers that issue FIAs. FIAs provide deposits for what RIJ calls the “Bermuda Triangle” strategy, which also involves reinsurance and the creation of private credit.

This week, we look at the 2021 data regarding the reinsurance leg of the triangle. The data comes from the annual statutory filing that life insurers are required to file in the state in which they are legally domiciled. 

The numbers here show that leading private equity-linked FIA issuers ceded the risk (the liability) of 95% of their 2021 annuity sales off their own balance sheets and onto the balance sheets of affiliated or co-owned reinsurers located mainly in Bermuda.

At the same time, using a special form of reinsurance, the annuity issuers retained ownership of 61% of the assets backing those liabilities; the affiliated or co-owned Bermuda reinsurers (and their third-party investors) make up the difference. In most cases, the same private equity/private credit firm manages all or a large portion of the assets of both the annuity issuer and the reinsurer. These relationships form the Bermuda Triangle. 

Private equity firms dominate FIA sales

The first column of Table 1 shows the largest FIA issuers: The total amount of annuity premium it gathered in 2021, including all types of annuities; the total amount of annuity premium it moved off its balance sheet to a reinsurer; and (in the last three columns) the amounts of annuity premium it reported. 

In the first column, the top issuers of FIAs are listed. The results from Sammons Financial Group  includes sales of two companies—Midland National and North American. The results from American Equity Investment Life also include two companies—American Equity and Eagle Life. Most of these insurance companies work closely with asset managers, who either started or purchased them, are part owners, or have investment agreements with them.  

Asset manager-led life insurers now dominate the FIA industry. Apollo Global Management owns Athene and its reinsurers. Blackstone works closely with Fidelity & Guaranty Life. Eldridge Industries (led by former Guggenheim Partners president Todd Boehly) owns Security Benefit. 

Sammons is a significant but minority owner of Guggenheim Partners. Brookfield Re owns 16% of American Equity, according to the Des Moines Register. KKR owns Global Atlantic, which owns Forethought (formerly part of The Hartford). Blackstone has a minority stake in AIG, and will be a part owner of Corebridge, which will be the trade name of AIG’s retirement business after an initial public offering planned for this year.

Only three FIA leaders here without prominent PE ties appear on the top-10 list: Allianz Life (a subsidiary of Allianz of Germany), Nationwide (the household-name multi-line insurer), and SILAC (created in 2015 by former Conseco CEO Steve Hilbert out of Sterling Investors Life).

Reinsurance reduces reported premium

In the next three columns on Table 1, to the right of the company names, note their total annuity sales (of all contract types), the level of “reinsurance ceded” (which is deducted from gross sales on Schedule T of the statutory filings) and the level of total annuity sales net of reinsurance ceded. This is the amount of annuity premium that the issuer “ceded” to its reinsurer(s), another life insurance company or specialized reinsurer. The reinsurance ceded, in effect, changes the amount of premium that reaches the carrier’s balance sheet.  

The PE-affiliated companies ceded the most. Athene ceded $18.78 billion of its $22.43 billion in premium; American Equity ceded $10.13 billion; Fidelity & Guaranty Life ceded $6.67 billion; Security Benefit Life ceded $4.98 billion; Midland National (Sammons) ceded $3.46 billion; and Forethought ceded $3.33 billion. American Equity and Fidelity & Guaranty Life ceded so much that they ended up reporting negative premium for the year. 

The last two columns in Table 2 show the new FIA premium that each life insurer reported on its statutory filing for 2021 and the 2021 FIA sales it reported to Wink, Inc., which gathers and syndicates annuity sales data and other information. A side-by-side comparison of the two columns shows a correlation between the PE-affiliation, the use of reinsurance, and large differences between the FIA premium reported to the state regulators and to Wink. It’s not clear yet what this correlation might mean.   

By contrast, Allianz Life ceded only $600 million and Nationwide ceded only about $90 million. American General itself acted as a reinsurer in 2021, assuming over $2.2 billion in premium from three British insurers. The differences between the FIA premium on their statutory filings and the figures reported to Wink were smaller for these three life insurers than for the other FIA issuers, but the significance of that difference isn’t immediately clear.

Together, the companies in Table 1 reported total annuity sales (group and individual) of $87.3 billion and ceded $52.1 billion, or just over 60%, to reinsurers. The seven PE-linked companies reported total annuity sales of $51.87 billion in 2021 and reported ceding $49.67 billion in 2021. In other words, they ceded the equivalent of 95% their new annuity business to reinsurers.

Affiliated reinsurers

But not to independent reinsurers. The data in the first three columns of Table 2 includes the leading FIA issuers, their home states, their reinsurers (in red, if affiliated), and the amount of annuity business that they reinsured (“reinsurance ceded,” as reported in Table 1). The table shows that PE-linked life insurers ceded their annuity business mainly to affiliated reinsurers.  

Athene moved business onto the balance sheet of two affiliated insurers within Athene Holding, whose parent is Apollo. American General, a subsidiary of AIG, ceded business to Fortitude Re, which had been AIG’s own reinsurance division until its sales to a group of investors led by the Carlyle Group in 2020. Fortitude Re is domiciled in Bermuda.

Sammons created SFG Bermuda in 2021 in order to establish its own Bermuda Triangle synergies. American Equity used Brookfield Re, which owns part of American Equity. American Equity affiliate Eagle Life used American Equity as its reinsurer. Forethought and Security Benefit each used its parent’s reinsurer, Global Atlantic and SkyRidge, respectively.  

Bermuda-based reinsurers

Most of the reinsurers listed here—Athene Re, Brookfield Re, Fortitude Re, SkyRidge, SFG Bermuda, Kubera, Aspida Life Re, and Global Atlantic—are based in Bermuda. The exceptions are Talcott Resolution Life (which was The Hartford until 2018), and Heritage Life, a Arizona-domiciled life insurer created to serve annuity issuers in need of a specialized type of reinsurance. Bermuda, Arizona, and Vermont are among the jurisdictions where insurers and reinsurers can use different or more flexible accounting standards.

“Modco” reinsurance

A specific type of once-rare type of reinsurance is used in these transactions. “Modco” reinsurance allows FIA issuers to shift liabilities from its own balance sheet to reinsurers while keeping the premium (or assets purchased with the premium) backing the liabilities. These “withheld” funds are still owned by the “ceding company”—the company that sold the annuities in the first place—and are listed as a liability on the ceding company’s balance sheet. (Ownership of the withheld funds may vary from one reinsurance deal to another.)

In more conventional reinsurance negotiations—between unrelated companies—an independent reinsurer wouldn’t accept the risks (investment risk, lapse risk, longevity risk, mortality risk, or interest rate risk, for example) of ceded business without simultaneously receiving enough cash or assets to offset the risks (i.e., to pay the policyholders’ claims and generate a reasonable profit for itself). We’ll describe the purpose of less-than-arm’s-length modco reinsurance between members of the same holding company in a forthcoming article.

What it means, why it matters

None of this would be important if not for two facts about FIAs. They are now the bread-and-butter product for many life insurers. And they have become a sought-after source of funds for private equity and private credit firms like Apollo for lending to high-risk borrowers. Asset managers bundle the loans, slice them into risk-ranked tranches, and sell the tranches to investors who want higher fixed-income yields than public-market bonds with comparable risk profiles offer.

Along with the asset managers and annuity issuers, the Bermuda reinsurers represent the third leg of the Bermuda Triangle strategy—serving as a device for processing US insurance liabilities (annuities, in this case) into high-yield assets for global distribution. Financial firms that control all three corners of the triangle have come to dominate the FIA business. 

But why do companies cobble together these legally and financially complex cross-border arrangements? Next week, RIJ will examine the benefits and potential hazards of the reinsurance leg of the Bermuda Triangle. 

© 2022 RIJ Publishing LLC. All rights reserved.

You Can’t Eat Your Own Head

Posted on June 23, 2022 by -

Every so often the Penn Wharton Budget Model sends out a depressing new report about the un-sustainability of US government finances. The PWBM often depicts the federal government (though not in so many words) as up to its neck in ink that’s as red as Uncle Sam’s trouser stripes.

Based in Philadelphia, PWBM is a non-partisan econometrics group that analyzes proposed federal legislation and estimates the impact of new fiscal initiatives on the nation’s long-term budget. Its latest release describes US finances as not sustainable. PWBM’s economists wrote: 

“We estimate that, under current law, the US federal government faces a permanent present-value fiscal imbalance of $244.8 trillion, or 10.2% of all future GDP… A positive permanent fiscal imbalance implies that federal debt payments continue to increase indefinitely relative to the size of the economy, which is not fiscally sustainable.”

Those numbers come from a projection to perpetuity. The present value of the imbalance projected over just the next 75 years is a more manageable $104.3 trillion. That includes $27.5 trillion in US Treasury debt, $36.3 trillion in payouts in excess of tax receipts by Social Security, and [federal purchases of public goods and services] of $77.5 trillion. The total is reduced by the $37 trillion the government owes itself (intra-governmental debt).

“That [$104 trillion] is the extra resources that, if available today, would permit maintenance of current receipt and expenditure laws for the next 75 years (2021-95),” the new report said.

To solve this shortfall, the PWBM economists say:

“The government would save this money at the long-term borrowing rate, like a very large trust fund, and spend it down over time as needed, reaching full depletion by the 75th year.”

These numbers make the US government look like a household with lousy credit, or a private business not productive enough to earn its way out of its hole. That outlook is depressing—it implies that the US might need to sell its public lands, for instance, and put the money aside somewhere.

Fortunately, this analysis isn’t the only way to describe our situation.

Yes, the US would probably appear fiscally healthier if as a nation we manufactured more domestically, imported less, and financed more public expenditures with tax revenue than debt.  

But PWBM’s bleak portrait of America’s financial future—despite the scholarly chops of the authors, the undoubted precision of the calculations and the internal logic of the underlying model—just doesn’t ring true. 

History doesn’t validate it.

Over the past 15 years, we’ve seen repeated financial crises where the Federal Reserve and Treasury bailed out the private sector (and not the other way around). For more than 40 years, we’ve heard many predictions that our national “Don’t Tread on Me” snake is eating its own financial tail (and will eventually reach the head). 

But the head never gets around to eating itself. Why?

Those who hold Treasury debt consider it wealth, not a burden. Lending to the government doesn’t make individuals or banks poorer. Just because the federal government spends all the money it borrows, and doesn’t “save” money, that doesn’t mean that it can ever be “broke.” (State and local governments are a different story.) 

That’s a clue to the way our monetary system works. US money is borrowed into existence—by citizens, businesses and the federal government—from the banking system, which creates it through the act of lending. Money goes out of existence when loans are repaid or when federal taxes are paid. During the weeks, years or decades between its birth and disappearance, money passes (digitally, for the most part) from hand to hand and catalyzes essential activity. 

To avoid an excessive build-up of demand, the federal government taxes some of the money it spent into the economy back out of the economy. So it’s easy to frame the government as a destroyer of precious liquidity. 

That accusation can be made persuasive—but only by obscuring the roles of federal borrowing and taxing in the larger monetary cycle.

The US government could stop spending, lower taxes, pay down its debt, balance its budget, and fund only a military. But the deflation associated with such a deleveraging would devastate us all. It would make the US economy—not just the government—small enough to drown in the fiscal hawks’ proverbial bathtub. 

© 2022 RIJ Publishing LLC. All rights reserved.

Bermuda ‘confident’ in regulating reinsurers

Posted on June 16, 2022 by -

Bermuda’s premier told a Risk.net reporter this week that the Bermuda Monetary Authority (BMA) had addressed the concerns of Sen. Sherrod Brown (D-OH) and investigated the activities of insurers and reinsurers owned by private equity (PE) firms on the island.

The investigation turned up nothing. “We have examined these particular issues,” Bermuda’s premier David Burt said. “We are confident that we are regulating these companies appropriately.”

David Burt

But Burt did not provide any documentation of an investigation by the BMA, which regulates $707 billion of life insurance assets reinsured on the island, according to Risk.net.

It was not clear why Bermuda authorities responded to a query that Brown sent in March to the National Association of Insurance Commissioners (NAIC) and the Federal Insurance Office.

Brown, the chairman of the Senate Banking, Housing and Urban Affairs Committee, inquired about the growing role of private equity firms in the life/annuity industry. The NAIC responded on May 31 to Brown’s request, and described the state-based oversight of private equity firms in the US insurance industry as adequate and effective.  

Regarding Bermuda, “Insurers reinsured an additional $163 billion of pension and annuity assets on the island in 2020, the biggest annual influx of new business in a decade, according to the BMA’s latest annual report published on June 13. For the first time, life insurance assets reinsured on the island overtook assets under management held against property and casualty policies. In another first, capital held against pension and annuity business climbed above $100 billion,” according to Risk.net.

Much of that growth has come from private equity owned insurers. Apollo Global Management was the first to spot Bermuda’s potential. It set up Athene Life Re, the reinsurance arm of its in-house insurer Athene, in 2009.

© 2022 RIJ Publishing LLC.  

Robo-advice settlement costs Schwab $185 million

Posted on June 15, 2022 by -

The Securities and Exchange Commission (SEC) this week charged three Charles Schwab investment adviser subsidiaries for not disclosing that they were allocating client funds in a manner that their own internal analyses showed would be less profitable for their clients under most market conditions. The subsidiaries agreed to pay $187 million to harmed clients to settle the charges.

Without admitting or denying the SEC’s findings, Charles Schwab & Co., Inc., Charles Schwab Investment Advisory, Inc., and Schwab Wealth Investment Advisory, Inc., agreed to a cease-and-desist order prohibiting them from violating the antifraud provisions of the Investment Advisers Act of 1940, censuring them, and requiring them to pay approximately $52 million in disgorgement and prejudgment interest, and a $135 million civil penalty. 

The subsidiaries also agreed to retain an independent consultant to review their policies and procedures relating to their robo-adviser’s disclosures, advertising, and marketing, and to ensure that they are effectively following those policies and procedures.

According to the SEC’s order, from March 2015 through November 2018, Schwab’s mandated disclosures for its robo-adviser product, Schwab Intelligent Portfolios, stated that the amount of cash in the robo-adviser portfolios was determined through a “disciplined portfolio construction methodology,” and that the robo-adviser would seek “optimal return[s].” 

In reality, Schwab’s own data showed that under most market conditions, the cash in the portfolios would cause clients to make less money even while taking on the same amount of risk. Schwab advertised the robo-adviser as having neither advisory nor hidden fees, but didn’t tell clients about this cash drag on their investment.

Schwab swept money from the cash allocations in the robo-adviser portfolios to its affiliate bank, loaned it out, and then kept the difference between the interest it earned on the loans and what it paid in interest to the robo-adviser clients, the SEC said.

“Schwab claimed that the amount of cash in its robo-adviser portfolios was decided by sophisticated economic algorithms meant to optimize its clients’ returns when in reality it was decided by how much money the company wanted to make,” said Gurbir S. Grewal, Director of the SEC’s Division of Enforcement.  

According to a release from Schwab:

The Charles Schwab Corporation reached a settlement with the US Securities and Exchange Commission to resolve an investigation into historical disclosures related to the Schwab Intelligent Portfolios (SIP) advisory solution, according to a release this week.

Under the terms of the settlement, Schwab will deposit $186.5 million into a Fair Fund account for distribution to affected investors. Schwab will also retain an Independent Compliance Consultant to review its current supervisory, compliance, and other policies and procedures concerning SIP-related disclosures, advertising, and marketing communications with clients or potential clients.

As disclosed in a Form 8-K filing dated July 1, 2021, Schwab’s second quarter 2021 financial results included a liability and related non-deductible charge of $200 million in connection with the settlement.

Excerpts from the company’s official statement include:

Schwab has resolved a matter with the SEC regarding certain historic disclosures and advertising related to Schwab Intelligent Portfolios between 2015-2018, and we are pleased to put this behind us. The SEC Order acknowledges that Schwab addressed these matters years ago.

In entering the settlement, Schwab neither admits nor denies the allegations in the SEC’s Order. SIP was designed to provide clients competitive returns across different market environments, and the ability to help weather volatility or challenging market conditions over time. The service recommends a diversified portfolio based on a client’s goals, time horizon and risk profile, and keeps the allocation consistent through automated rebalancing as markets.

We are proud to have built a product that allows investors to elect not to pay an advisory fee in return for allowing us to hold a portion of the proceeds in cash, and we do not hide the fact that our firm generates revenue for the services we provide. We believe that cash is a key component of any sound investment strategy through different market cycles.

The settlement with the SEC involves Schwab Wealth Investment Advisory, Inc., Charles Schwab Investment Advisory, Inc. and Charles Schwab & Co., Inc.

The Charles Schwab Corporation (NYSE: SCHW) provides 33.8 million active brokerage accounts, 2.3 million corporate retirement plan participants, 1.7 million banking accounts, and approximately $7.28 trillion in client assets. Its operating subsidiaries provide wealth management, securities brokerage, banking, asset management, custody, and financial advisory services to individual investors and independent investment advisors. 

© 2022 RIJ Publishing LLC. 

Breaking News

Posted on June 15, 2022 by -

Fed hikes benchmark rate to 1.65%  

The Federal Reserve announced its decision to implement the monetary policy stance announced by the Federal Open Market Committee in its statement yesterday, June 15, 2022. The Fed’s Board of Governors of the Federal Reserve System voted unanimously to raise the interest rate paid on reserve balances to 1.65%, effective June 16, 2022. A summary of the Fed’s economic projections can be found here.

[The price that banks pay each other for reserves at the Fed—reserves that they need in order to cover checks written by their depositors (including borrowers)—has just gone up. The increase in the cost of money will ripple through the economy, not only raising borrowing costs, but also reducing the market value of existing bonds and sending panic through leveraged investors in the equity markets. It also means that innocent people will lose their jobs—for the sake of reducing inflation. Inflation lowers the real yield on investments, which many Americans don’t own.]

As part of its policy decision, the Federal Open Market Committee voted to authorize and direct the Open Market Desk at the Federal Reserve Bank of New York, until instructed otherwise, to execute transactions in the System Open Market Account in accordance with the following domestic policy directive:

The Board of Governors of the Federal Reserve System voted unanimously Wednesday to approve a 3/4 percentage point increase in the primary credit rate to 1.75%, effective June 16, 2022, according to Wednesday’s statement from the Fed. In taking this action, the Board approved the request to establish that rate submitted by the Board of Directors of the Federal Reserve Bank of Minneapolis. Effective June 16, 2022, the Federal Open Market Committee directs the Desk to:

  • Undertake open market operations as necessary to maintain the federal funds rate in a target range of 1.5% to 1.75%.
  • Conduct overnight repurchase agreement operations with a minimum bid rate of 1.75% and with an aggregate operation limit of $500 billion; the aggregate operation limit can be temporarily increased at the discretion of the Chair.
  • Conduct overnight reverse repurchase agreement operations at an offering rate of 1.55% and with a per-counterparty limit of $160 billion per day; the per-counterparty limit can be temporarily increased at the discretion of the Chair.
  • Roll over at auction the amount of principal payments from the Federal Reserve’s holdings of Treasury securities maturing in the calendar months of June and July that exceeds a cap of $30 billion per month. Redeem Treasury coupon securities up to this monthly cap and Treasury bills to the extent that coupon principal payments are less than the monthly cap.
  • Reinvest into agency mortgage-backed securities (MBS) the amount of principal payments from the Federal Reserve’s holdings of agency debt and agency MBS received in the calendar months of June and July that exceeds a cap of $17.5 billion per month.
  • Allow modest deviations from stated amounts for reinvestments, if needed for operational reasons.
  • Engage in dollar roll and coupon swap transactions as necessary to facilitate settlement of the Federal Reserve’s agency MBS transactions.

The New York Times reported,”Officials predicted that the unemployment rate would increase to 3.7% this year and to 4.1% by 2024 and that growth would slow notably as policymakers push borrowing costs sharply higher and choke off economic demand.

“The Fed’s policy rate is now set in a range between 1.50 to 1.75 and policymakers suggested more rate increases to come. The Fed, in a fresh set of economic projections, penciled in interest rates hitting 3.4 percent by the end of 2022. That would be the highest level since 2008 and officials saw their policy rate peaking at 3.8 percent at the end of 2023. Those figures are significantly higher than previous estimates, which showed rates topping out at 2.8 percent next year.

“Fed officials also newly indicated that they expected to cut rates in 2024, which could be a sign that they think the economy will weaken so much that they will need to reorient their policy approach.”

NWL and Achaean Financial introduce SPIA with upside 

National Western Life Insurance Company (NWL) and Achaean Financial Holdings have launched what they call launch “a new and innovative single premium immediate annuity” or SPIA. RIJ reported on an earlier Achaean income product in September 2021.

Introduced as NWL Income+, the new product, to come onto the market in the third quarter of 2022, will provide lifetime income that delivers on two key features advisors and their clients are looking for in an income product: a highly competitive initial annual payment, and an innovative growth component that presents an opportunity for increasing income to help policyholders keep pace with inflation. 

The NWL Income+ is planned to be marketed as a stand-alone product to secure an immediate income stream today, and may be offered as an option on select deferred annuity products in the future.

National Western Life Group, Inc. is the parent organization of National Western Life Insurance Company, which is the parent organization of Ozark National Life Insurance Company, both stock life insurance companies in aggregate offering a broad portfolio of individual universal life, whole life and term insurance plans, as well as annuity products. 

As of March 31, 2022, the Company maintained consolidated total assets of $13.8 billion, consolidated stockholders’ equity of $2.3 billion, and combined life insurance inforce of $20.6 billion.Achaean Financial is a business-to-business licensing and marketing organization with an objective to address the multiple dislocations within US retirement market, using innovative proprietary products, software and marketing expertise.

Protective Life and Michael Finke in retirement education co-venture 

Protective Life Corporation, a US subsidiary of Dai-ichi Life Holdings, Inc., announced today the launch of a new goals-based income planning program with Michael Finke of The American College of Financial Services.

The program will supply financial professionals with the strategies needed to evaluate clients’ income needs, better understand key income risks and develop specialized strategies that will help protect their clients’ goals in retirement.

To learn more about the growing need for guaranteed income in retirement and gain additional insights and tools visit finpro.protective.com/retirement.

Michael Finke, Ph.D. is a professor of wealth management and Frank M. Engle Distinguished Chair in Economic Security at The American College of Financial Services. 

He received a doctorate in consumer economics from The Ohio State University in 1998 and in finance from the University of Missouri in 2011. He leads the O. Alfred Granum Center for Financial Security at The American College of Financial Services and is a Research Fellow at the Retirement Income Institute, and a member of the Defined Contribution Institutional Investment Association Academic Advisory Council.

Edelman expands its ‘Income Beyond Retirement’ program for 401(k)s

Edelman Financial Engines, the independent wealth planning and investment advisory firm, has launched Income Beyond Retirement (IBR), a retirement income solution designed for 401(k) plan participants in or near retirement.

“IBR combines portfolio management and technology-enabled analysis with financial advisor support to create highly personalized, flexible retirement income plans and investing strategies to match the individual needs of employees,” Edelman said in a release. 

IBR is currently offered by Boeing, Lenovo, Equifax, Milliken and Prime Therapeutics and many of the FORTUNE 500. Edelman Financial Engines said it is working with its 401(k) provider partners to make IBR available to plan sponsors. Currently, the solution is live with its direct provider partners and will be available across all partners soon.

Near-retirees aged 55 and older are offered a complimentary Retirement Checkup with an advisor, and together they develop a plan that manages to the employees’ anticipated needs while planning for the unexpected. IBR focuses on critical decisions, such as claiming Social Security and evaluating income and growth preferences.

Nationwide enhances RILA’s beneficiary features  

Nationwide has added two new complimentary, automatic death benefit features to its registered index-linked annuity (RILA), the Nationwide Defined Protection Annuity (DPA). The product was co-developed by Nationwide and Annexus, the indexed annuity designer.

  • Under the Return of Premium (ROP) death benefit feature, beneficiaries will receive no less than the original premium invested in the annuity. It is automatically added if the annuitant and co-annuitant are both 75 or younger on the application sign date. 
  • The Spousal Protection feature protects both spouses and provides a death benefit on both of their lives, even on qualified contracts. 

Nationwide DPA also provides three defined protection levels which limit negative performance. Clients can select how much of their investment—90%, 95% or 100%—will be protected from market losses and helps determine their performance opportunities. DPA also features a variety of index strategies whose performance determines the owner’s gains or losses.  

Under the Return of Premium Death Benefit, the Death Benefit is equal to the greater of the Contract Accumulation Value, or the purchase payment amount adjusted proportionately for any withdrawals, the Nationwide release said. 

Upon the first spouse’s death, the Contract Accumulation Value will be set equal to the purchase payment amount (adjusted for withdrawals), if greater. Upon the surviving spouse’s death, the Death Benefit (including the ROP if applicable) will be paid to the beneficiaries.

Under the Spousal Protection feature, a surviving spouse may continue the contract and name new beneficiaries. From that point on, any withdrawals will be treated as Preferred Withdrawals, and will receive full gains/losses and will not be subject to surrender penalty or market value adjustment. 

New three-year FIA from Midland National

Midland National Life Insurance Company and Midland Retirement Distributors have launched Summit Focus 3, a new three-year fixed index annuity, the two member companies of Sammons Financial Group announced this week.  

The Summit Focus 3 fixed index annuity offers:

  • A term length of only three years
  • Crediting rates that are guaranteed for the three-year term
  • Protection against losses during a market downturn
  • Growth potential based on the performance of quality index options
  • No taxes until a withdrawal is taken

“The contract period is designed for clients who need a short-term solution during a time of transition, or who may be looking for more upside potential than a traditional fixed-rate product can offer. The product is aimed at clients with concerns about the potential for annually declining rates in subsequent years of a longer-term contract,” the companies said in a release.

A subsidiary of Sammons Enterprises, Inc., Sammons Financial Group is privately owned. Its  member companies include Midland National Life Insurance Company (including Sammons Corporate Markets); North American Company for Life and Health Insurance; Sammons Institutional Group (including Midland Retirement Distributors and  Sammons Retirement Solutions), and Beacon Capital Management, Inc. 

© 2022 RIJ Publishing LLC.

The Bear That Ate My Grandfather

Posted on June 15, 2022 by -

One fine evening in 1957, after stock prices collapsed and my grandfather’s railroad shares cratered, he took a rope down to the basement of his house in the Oxford Circle section of northeast Philadelphia–a basement smelling of scorched cotton from the mangle that my grandmother ironed sheets with–knotted the rope around an overhead pipe and hanged himself.

According to family lore, he had just told my grandmother, nonsensically, that “There’s enough for one but not for two.” “He did it, he did it,” my grandmother screamed at her sons through the mouthpiece of her black rotary phone.

The market bounced back quickly but not the family. When my grandfather died, I lost an intimate. I had sat on his lap and watched him smoke a cigar and read the Evening Bulletin, licking his thumb to turn the page. I lost a champion. He paraded me down Castor Avenue, introducing me to every shop keeper as the world’s single most remarkable grandchild. The deli owners paid tribute to the dauphin with a slice of salami handed over the counter, a pickle from the fragrant barrel, a delicacy from a wire nest of cookies. My grandfather took me to the broker’s too, to sit and watch the flickering marquee lights of the “ticker.”

Life was good, then it wasn’t. Most photographs of my grandfather, with his deceptive grin and his ‘big lunch’ ties, disappeared. From then on, the only words I heard my grandmother say about her late husband, whom she married in 1913 and outlived by 35 years, was, “Money, money, money. That was all the man talked about.” Of course, the dress shop on Kensington Avenue never yielded much, and my grandmother’s younger brothers were clerking for judges and moving to Scarsdale, but that’s another story. When I read ‘Death of a Salesman’ in high school, the characters were, spookily, people I’d known.

There’s a point to this sad tale. When I saw on Bloomberg yesterday that the stock market had fallen into “bear market territory,” I paid a little attention, but not much. I know the worst that a crash can do, and it’s not about money. A bear had eaten my grandfather. I also know, grimly but with no doubt, that despair over the stock market is never justified. Markets recover faster than families, and most families do too, eventually.

© 2022 RIJ Publishing LLC. All rights reserved.

Why ‘Offshoring’ Annuity Risk Is Wrong

Posted on June 15, 2022 by -

Any investor or adviser who relies on the products or services of the life insurance/annuity industry today should be aware that assessing the financial integrity of a company in that industry is more difficult now than in the past.

There are three reasons why: 

  • Certain annuity issuers are investing high percentages of their surplus in high-risk, affiliated or opaque assets. 
  • Certain life/annuity companies are reducing the costs of new business and the riskiness of new assets—or appearing to reduce them—by moving new assets and liabilities off their balance sheets through “reinsurance” with their own affiliates. 
  • The types of reinsurance practiced by certain life/annuity companies— especially “modified coinsurance”—are not like yesterday’s arm’s length reinsurance between unaffiliated, independently capitalized reinsurers. These new types of reinsurance make the balance sheets of life/annuity companies less transparent.

Tom Gober

These trends are making it harder for agents, advisers, and investors to evaluate the financial strength and the trustworthiness of the life/annuity companies whose products they use.

That’s why I and my colleague developed the Transparency, Surplus and Risky-assets Ratio, or TSR Ratio. It establishes a new, easy-to-interpret benchmark that shows the relationship of a company’s higher-risk and off-balance sheet assets to its surplus. 

Let me explain.

We need to measure each life/annuity company’s holdings of high-risk, affiliated or opaque assets by its percentage of its surplus; not its total assets 

The National Association of Insurance Commissioners concedes that life/annuity companies hold more risky, illiquid investments today than they once did. But regulators tried to minimize the threat of higher risk investments. Using CLOs as an example, the NAIC said CLOs were 2.6% of life/annuity industry’s total assets. 

That figure offers false comfort. It obscures the fact that risky or illiquid investments are concentrated at a handful of private equity-led annuity issuers. More important, it obscures the fact that risky assets often constitute a dangerously high percentage of those companies’ surplus.  

The NAIC also downplays the increasing amount of affiliated assets that some companies are holding. When a life insurer buys an asset from (invests in) an asset management subsidiary of its own holding company, it’s difficult for outside analysts to evaluate the value or riskiness of the asset. Its price or risk hasn’t been determined in the public marketplace, but by sister firms.

 In 2021, for instance, Athene Annuity and Life of Iowa, the top seller of fixed indexed annuities, held $10.36 billion in stock and IOUs from affiliated companies—sister companies in the same holding company. In my opinion as a forensic accountant and certified fraud examiner, that amount of affiliated paper should be compared with Athene’s surplus of only $1.28 billion. 

If just 12% of their reported affiliated paper became un-collectable in an economic downturn, Athene’s surplus—its buffer against insolvency—would vanish. If one of Athene Annuity and Life’s affiliates were to come under financial stress and not be able to pay Athene back, the negative impact on the other affiliates could be similar to a general national market downturn. 

I don’t take issue with moderate risk-taking in an insurer’s investment portfolio. But if all of a company’s high-risk and affiliated and off-balance sheet reinsurance were compared to its surplus, its true financial strength would be more readily seen.  

Reinsurance ceded to affiliates within Athene Holding. Source: Tom Gober, June 15, 2022.

 

Certain companies are moving large portions of their new business “off-balance sheet” through reinsurance. This allows them to write more new business and invest in riskier assets than if the new business and risky assets stayed on their own balance sheets. 

If a life insurance company sold $4 billion in new annuities in one year with a surplus of only $250 million to support it, state insurance regulators would be concerned that the company might be taking on more new business than its balance sheet could safely support. 

But regulators are less likely to be alarmed if that company moves most of those sales off its balance sheet; the volume of new business suddenly looks more manageable. I call this “lulling” the regulators.

The US companies can dramatically reduce the surplus required for new liabilities (i.e., sales) and eliminate the penalties for holding riskier assets in its general account, by sending the new business to an affiliated reinsurer in a favorable jurisdiction. If they sent the business to an independent reinsurer, that reinsurer would demand top dollar for assuming the liabilities, and the transaction wouldn’t yield any great savings for the original issuer. Absent fraud, most transactions with independent reinsurers are generally arms-length or fair and reasonable.

So, many for-profit US companies do not use independent reinsurers. They use a friendlier affiliated or captive reinsurer in a jurisdiction like Bermuda, the Cayman Islands, Vermont, or Arizona. In these locations, because of differences in accounting standards, the required surplus and/or the risk-based penalties appear lower. In addition, the affiliated reinsurer might be less choosy when accepting risky assets in support of the liabilities, because they are all under common control and the savings all accrue to the same holding company.

Reinsurance in affiliated, unauthorized or offshore reinsurers is reducing the financial transparency of life/annuity companies, making it difficult for the public to determine the financial strength of annuity issuers.   

Leading issuers of FIAs today are using unorthodox types of  reinsurance to increase their ability to hold risky or affiliated assets and to increase their sales capacity without increasing their capital requirements. Virtually all the larger for-profit annuity carriers are engaged in medium to high levels of affiliated and offshore reinsurance; most of which I consider to be more for financial engineering than bona fide risk transfer. 

Reinsurance, done properly, can assist insurers in long-term planning and help avoid spikes in claims. In traditional reinsurance, the carrier “cedes” blocks of business liabilities (death claims, annuity payouts) to another independent company. That assuming company takes on current and future claims liabilities and stands ready to pay to the ceding company all claims made on those blocks of business. 

Unfortunately, some insurance executives have found ways to game the already complex and arcane reinsurance process. I consider these transactions of offloading liabilities (future death claims or annuity payouts) to be a greater risk to annuitants because of the complex, arcane and opaque nature of captive or offshore affiliated reinsurance. The magnitude of such opaque deals is troubling.  

Some carriers create domestic, affiliated captive reinsurers in jurisdictions such as Vermont or Arizona where their financial information is statutorily made confidential. This lets them fund their liabilities with far less assets than the ceding carrier itself would need to fund the same liabilities in their own state. Some cede or offload large amounts of liabilities to affiliate reinsurers in  “secrecy jurisdictions” like Bermuda, Barbados, the Cayman Islands, or even Malta. 

Typically, this strategy allows a form of regulatory or accounting arbitrage. A life insurer knows that if it can reinsure annuity business under Generally Accepted Accounting Principles in Bermuda, for example, instead of Statutory Accounting Principles (SAP) in Iowa or New York, it will enjoy certain advantages. Its required reserves for new liabilities might be smaller, penalties for holding risky assets might be lower, and the recognition of certain large expenses (such as commissions) might be spread over many years instead of in the current year actually paid.  

The TSR

Matt Zagula

To convert all of these factors into a metric that advisers and policyholders can use to distinguish low-risk, transparent annuity issuers from higher-risk, opaque annuity issuers,  I and a colleague, Matt Zagula of Smart Advisor Network, have turned the relationship between risky assets, offshore reinsurance, and surplus, to a single ratio: the TSR.

TSR stands for Transparency, Surplus and Riskier Assets. To calculate this metric, we add a company’s dollar amount of higher-risk, less-transparent investments plus its  dollar amount of higher-risk, less transparent ceded reinsurance and divide the sum by the surplus reported on the insurer’s annual statutory filing. The lower the ratio, the lower the exposure to excessive risks. We’ve seen TSR scores ranging from the lowest at 25% to the highest of 8,300%. 

With a TSR of 25, a company could write off the entire amount of higher risks and it would still have 75% of its surplus. But with a TSR of 8,300%, if only 1.6% of the higher risks had to be written down, the surplus would go to zero. 

Annuity carriers have seen their total assets skyrocket in recent years; so, too, have their liabilities. This has left them with even thinner surplus. The TSR ratio puts both asset and reinsurance risks in perspective by comparing them with surplus. The work necessary to arrive at the final TSR is complex and requires peeling back many layers of numbers, but our single ratio makes it easier for agents, advisers and investors to assess risks relative to surplus.

Tom Gober is a forensic accountant and certified fraud examiner based in Virginia.

© 2022 RIJ Publishing LLC.  

Nationwide is 13th life insurer nabbed by New York

Posted on June 9, 2022 by -

Nationwide has agreed to pay $5.64 million to settle charges brought against it by the New York regulators for selling new income annuities to people who could have annuitized their existing deferred annuities, possibly at higher income rates than the new annuities paid.

On May 20, Superintendent of Financial Services Adrienne A. Harris announced today that the Department of Financial Services (DFS) entered into a consent order with Nationwide Life Insurance Company for violations of New York Insurance regulations with respect to deferred to immediate annuity replacement transactions. 

Nationwide will pay approximately $3.4 million in restitution to New York State consumers as a result of the settlement in addition to $2.24 million in penalties. Impacted consumers will also receive higher monthly payouts for the remainder of their contract terms. 

Nationwide said in a statement:

Nationwide remains committed to protecting people, businesses and futures with extraordinary care. We continue to urge the NYDFS to focus on promoting clearly articulated regulatory expectations for all industry participants in a manner that protects consumers while concurrently protecting their access to affordable and innovative product offerings. We will continue to work with NYDFS to further develop and maintain clearly defined standards as it relates to transactions that may involve the replacement of an existing annuity. We are pleased to put this matter behind us.

The settlement is the latest result in DFS’s industry-wide investigation into deferred to immediate annuity replacement practices in New York State. To date, the industry-wide investigation has resulted in settlements with thirteen life insurance companies, totaling approximately $29 million in restitution and penalties.  

DFS’s investigation found that Nationwide failed to properly disclose to consumers income comparisons and suitability information, causing consumers to exchange more financially favorable deferred annuities with immediate annuities. Hundreds of New York consumers—primarily elderly individuals—received incomplete information regarding the replacement annuities, resulting in less income for identical or substantially similar payout options.  

A former life insurance company executive told RIJ this week that his then-employer was fined by New York a decade ago for the same reason. “[Our company] was guilty of replacing deferred annuity contracts with our ‘new issue’ immediate annuity contracts after our agents claimed our immediate rates were better than the deferred annuity settlement rate on the official NY Reg 60 replacement documents (required in NY),” he said. 

“Because our annuity new issue department didn’t verify the agents’ written claims of our immediate annuity rate superiority, our penalty, leveled by NY State at the time, was to make up the entire payment differential between what our SPIAs paid versus what was guaranteed by the existing but replaced contracts for the life of the payment duration,” he added. 

“We had to manually adjust our SPIA administration system and post additional dollar reserves to force/support higher payments. In a further company embarrassment, we were also required to contract each contract holder (owner) and explain why we were giving them higher payments and apologize for our lack of oversight,” he told RIJ.  

“But many other carriers were guilty of the same practices. In reality this goes on in all states, not just New York.  It’s terrible to say, but I believe there may be an unwritten carrier conspiracy to perhaps ‘indirectly’ cheat consumers out of their guaranteed income rights.”

Annuities are contracts between life insurance companies and consumers that provide guaranteed payments for the remainder of an individual’s lifetime or for a specified period. Immediate annuities provide periodic income payments that begin within thirteen months after the annuity is issued, while deferred annuities allow consumers to earn interest on their premium before receiving payments at a future date. 

Recommending that consumers replace existing deferred annuities with immediate annuities without proper disclosures may cost consumers substantial lifetime income.

Nationwide has also agreed to take corrective actions, including revising its disclosure statements to include side-by-side monthly income comparison information, and revising its disclosure, suitability, and training procedures to comply with New York regulations.

© 2022 RIJ Publishing LLC. 

A New Kind of RIJ is on the Way

Posted on June 9, 2022 by -

Retirement Income Journal is changing its business model. 

After more than 13 years (and almost 650 issues) as a subscription-based weekly publication, the RIJ website will become a free-standing online library and information resource, effective July 1. That’s just three weeks from now.

Over the next few months, I plan to redesign the site. My goal will be to make the material that I’ve written and collected since April 2009 more accessible to visitors. The focus will still be on retirement income and annuities.

Beyond that, I will continue to write about annuities and retirement financing. I’ll make new articles or books available on the site. Access to the new material will be limited for a certain period to RIJ’s current and recent paid subscribers. 

Many of the details of the redesign are still to-be-determined. The upshot is that I’m taking a break from the pressure of a weekly news cycle. 

Dozens of readers, subscribers, contributors, sources, advertisers, family members and friends helped RIJ survive and thrive. It’s premature to start thanking people, however; the show will still go on, but with a different format. 

© 2022 RIJ Publishing LLC. All rights reserved.