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Tax cuts and tax expenditures hurt the economy: Concord Coalition

Posted on March 7, 2012 by Editor Test -

Reducing tax regulations that favor some taxpayers could reduce the deficit, encourage economic growth and promote fairness, the chief economist for The Concord Coalition told the Senate Budget Committee last week.

Diane Lim Rogers told lawmakers to broaden the tax base by reducing so-called tax expenditures, which she described as “upside down subsidies” for high-income taxpayers at the expense of others.

Deficit-financed tax cuts don’t pay for themselves and “are not a free lunch,” she said, adding that such cuts have generally reduced national savings and can harm long-term economic growth.

Given the progressive rate structure of the federal income tax system, she said, the current array of exemptions, deductions and preferential rates benefits high-income individuals the most.

On the question of tax cuts, Rogers pointed out that projections from the Congressional Budget Office “show economically unsustainable deficits under a business-as-usual baseline where tax cuts are repeatedly extended and deficit-financed.” Such deficits inhibit saving, she said.

She challenged the consensus among elected officials in Washington that most of the tax cuts originally approved in 2001 and 2003 should be extended and financed with additional federal borrowing, adding that the cuts have worsened the deficit and contributed to income inequality.

Advocates of extending tax cuts have suggested that government revenues of about 18% percent of GDP – the average over the last 40 years – should be adequate. But Rogers pointed out that demographic trends and rising health care costs make that untrue.

She suggested that Congress consider either letting the 2001 and 2003 tax cuts expire as scheduled or at least offsetting the cost of whatever cuts are extended.

Dissolve Solvency II’s capital requirements?

Posted on March 7, 2012 by Editor Test -

As if Europe Union’s debt crisis isn’t causing enough anxiety, much of the EU’s insurance and pension community is alarmed over the potential impact of the stringent capital requirements proposed under Solvency II, which would harmonize insurance regulations across Europe.

Under-capitalization and excessive leverage helped cause the financial crisis, but Europe’s pension funds and financial institutions say that the remedy—higher reserves—might be worse than the disease, especially if that remedy led to more conservative investing, smaller profits, and higher pension contributions. Finding a balance between risk and safety appears elusive.

Here are summaries of three reports on the issue from IPE.com over the past week:

Industry associations say Solvency II will hurt pensions

A group of eight industry associations from across Europe has called on the European Commission to reconsider plans to apply Solvency II measures to pension funds. The group emphasized that occupational pensions are often bound by collective agreements and labor laws and are therefore obliged to protect members’ benefits and interests.

In the run-up to a recent public hearing on the revised Institutions for Occupational Retirement Provision (IORP) directive in Brussels, the group warned of the impact Solvency II rules would have on the pensions industry.

The group included BUSINESSEUROPE, the European Association of Craft, Small and Medium Sized Enterprises, the European Association of Paritarian Institutions (AEIP), the European Centre of Employers and Enterprises providing Public Services, the European Federation for Retirement Provision (EFRP), the European Fund and Asset Management Association, the European Private Equity and Venture Capital Association and the European Trade Union Confederation (ETUC).

Matti Leppälä, secretary general at the EFRP, said: “More workplace pensions are needed to guarantee adequate retirement benefits for citizens across Europe. The European Commission is in a position to enable good-quality workplace pensions, [but] if it imposes capital requirements on IORPs, then it jeopardizes the future of pensions in Europe because IORPS will de-risk their assets, and employers will find it very expensive to continue funding their pension schemes.”

Adopting the quantitative Solvency II rules to workplace pensions, the group said, would produce three important adverse effects:

Risk-based capital requirements and valuation methods would force pension funds to build up higher reserves, raising the cost to employers of providing occupational pensions.
Pension funds would likely de-risk their asset allocation, making less capital available to companies to create growth and jobs.
Solvency II rules would be particularly damaging if all investors with long liabilities had to invest under the same rules, even if their structures were very different.

The group also reiterated its demand for a full impact assessment before a final version of the revised IORP directive is implemented.

“The impact of any new proposals must be measured through high-quality quantitative impact studies, including assessment of the social, financial and economic effects of any proposed rule changes, and their macroeconomic effects. A high-level political debate is also required with involvement from all the relevant stakeholders, most notably the European social partners,” the group said in a statement.

Bruno Gabellieri, secretary general at the AEIP, added, “Occupational pension schemes are in most cases compulsory as a part of the national labor law or collective labor agreements. Therefore they are not involved in any level playing field and do not compete with other providers.

“The goal of the regulation should consist in facilitating the existence of good pension schemes for European workers and citizens, and, therefore, social partners should be allowed to steer the promises they make rather than have extra capital costs imposed, which are a burden for the employers.”

Claudia Menne, confederal secretary at the ETUC, agreed.

“We have growing concerns regarding the possible plans of the EU Commission to propose a new solvency regime for occupational pensions,” she said. “The proposals will significantly change investment patterns, restricting capital flows to business, resulting in lower benefits for pensioners. Occupational pensions are part of collective agreements and are restricted by labor and social laws to a legal obligation to protect members’ benefits and interests.”

Dutch parliament “up in arms” over Solvency II

In a letter to the Dutch parliament, Social Affairs minister Henk Kamp said: “If the Solvency II accounting rules for insurers are also made applicable to pension funds, Dutch schemes will have to increase their financial buffers by 11%.

“The proposed increase of the certainty level for benefits from the current 97.5% to 99.5% will mean an unnecessary increase in contributions, further postponement of indexation and possibly additional discounts of pension rights.”

Kamp added that, for the Dutch government, it was “all hands on deck” to “turn the tide.”

The European Commission is set to hold a public consultation later today on proposals for a revised Institutions for Occupational Retirement Provision (IORP) directive.

According to Kamp, the UK, Ireland, Germany and the Netherlands – countries with similar pensions systems – have all agreed to show a united front against proposals to apply Solvency II rules to pension funds.

“Other European countries, such as France, don’t want competition for their pension insurers from Dutch pension funds because they want to keep a level playing field,” he added.

However, Kamp also said he had received a “positive response” from his French counterpart when discussing the Dutch position, adding that he planned to visit his Swedish counterpart again for support.

Almost all political parties in parliament have voiced concerns about the consequences of what they believe will be the European Commission’s proposals for the Dutch pensions system.

BNY Mellon study reflects resistance to Solvency II

A survey sponsored by BNY Mellon and conducted by the Economist Intelligence Unit, found that a majority of institutions surveyed believe that Solvency II “oversteps the mark.”

Almost three quarters of survey respondents (73%) agree that insurers will pass the cost of compliance with the new regulations on to policyholders, and that both non-financial institutions and individuals may choose to be under-insured to avoid the higher costs.

Set for implementation in January 2014, Solvency II aims to establish a revised set of EU-wide capital requirements and risk management standards that will replace the current solvency requirements.

The Economist Intelligence Unit conducted a survey of 254 EU-based companies, including insurers, other financial institutions and corporates (non-financial institutions). The research, Insurers and Society: How Regulation Affects the Insurance Industry’s Ability to Fulfill its Role – is available at www.bnymellon.com. Paul Traynor, head of Insurance, Europe, Middle East & Africa at BNY Mellon, said in a release:

“There is an understandable tendency on the part of regulators to focus more on protection than risk-sharing, but that presents the insurance industry with a challenge. The public wants insurers to fulfill three key roles for society: provide individuals with saving and pension products and to insure them against specific risks; provide corporations with an efficient mechanism to transfer risk; and to be a source of debt and equity capital to industry.

“However, the survey suggests there is a real concern that the cost of regulation may raise the cost of life cover and annuities, perhaps beyond a tipping point. It also suggests that, as currently calibrated, the regulations will inadvertently crowd out debt and equity capital for industry in favor of EU sovereign debt and unproductive cash holdings. That will make it ever more difficult for insurers to make those positive contributions to society.”

Monica Woodley, senior editor at the Economist Intelligence Unit, said: “A majority of respondents favor an overhaul of insurance regulation in the EU and recognize the importance of the sector to society. Indeed, 86% of insurers surveyed believe the industry must contribute positively to society. Our survey findings indicate that, although there is a perception that something should be done to improve the current situation and that harmonisation should bring its own benefits, the proposed regime could be seen to be overly cautious. The findings suggest that while the industry welcomes the broad thrust of the regulation, certain calibrations are wrong.”

“The demands of the new regime threaten to disrupt the key role played by insurers as investors in the capital markets, by pushing them towards ‘safer’ assets with lower capital charges, and away from the equities and non-investment grade debt on which much private industry depends for financing,” BNY Mellon said in a release.

Only 16% of respondents agreed that the proposed legislation strikes the right balance when it comes to ensuring insurers have sufficient capital to meet their guarantees. Insurers and financial institutions are more critical of Solvency II than non financial institutions, with 55% of the former but only 39% of the latter saying the directive “goes too far.” Less than one in five insurance respondents (18%) believe that most insurers are currently under-capitalized.

Over half of survey respondents (51%) believe the shift to unit-linked policies, which put the investment risk on the policyholder, will have a negative long-term affect on pension and long-term savings provision, with life insurance and annuities considered the products most likely to be negatively affected.

Other key findings were:

Insurers expect to further de-risk their asset allocations. A clear shift down the risk spectrum is anticipated by respondents. Assets expected to attract more interest include investment-grade corporate bonds, cash and short-dated debt, at the expense of non-investment-grade bonds, equities and long-dated debt.

Corporates seem less aware of the impact Solvency II will have on debt issuance. Among insurers and other financial institutions there is a strong consensus that Solvency II will make the tenor and rating of bonds from corporate issuers more significant, as insurers, driven by capital charge considerations, are increasingly pushed towards investment-grade debt.

Regulators should revisit their capital charge levels. Overall, less than a quarter of respondents (22%) believe that regulators should maintain the current capital charges.

Solvency II may create a ‘squeezed middle’ among insurers. Only 16% of respondents expect no material impact from Solvency II on the structure of smaller member-owned insurers (“friendlies”) and mutuals, and 54% believe the pressures of the new capital requirements will result in industry consolidations.

BNY Mellon has $2 trillion in insurance assets under custody and its clients include three-fourths of the top 100 life insurers and 70% of top 50 non-life insurers worldwide. The company manages over $83 billion for insurance companies.

Jackson Hits the Alt-Option Key

Posted on March 6, 2012 by Kerry Pechter -

Jackson National Life’s new deferred variable annuity contains no lifetime income benefit, no roll-up, no-step ups and few if any of the insurance features that have helped make the company’s VAs so popular with independent and regional broker-dealer reps over in recent years.

Instead, the new Elite Access contract, announced on Monday, offers commissioned advisors an accumulation-phase opportunity to own funds (or funds of funds) that hold alternative investments, such as commodities, or use alternative investment strategies, such as tactical asset allocation.

Elite Access has average all-in costs of about 250 basis points. That includes 85 basis points for the mortality and expense risk (M&E) fee, a 15-basis point administrative fee, and fund expense ratios ranging from 0.57% to 2.45%. Jackson National pays the advisor a 5.25% immediate commission and a 40 basis point trail in years six and beyond. There’s a five-year surrender period, with a first year charge of 6.5%.

Advisors who prefer a more liquid option can eliminate the surrender period by having the client pay an annual fee of 25 basis points. In that case, the advisor would earn a 1.25% upfront commission and a 1% annual trail starting in the second contract year.

Elite Access is hardly the first variable annuity contract to offer alternative investment options. The Morningstar Annuity Research Center lists dozens of contracts from a wide range of insurers that offer one or more alternatives, often one or more RydexSGI Funds, ProFunds or, more recently, TOPS Protected Funds.

In fact, current owners of Jackson National’s own Perspective II variable annuity collectively hold $3.4 billion in a variety of alternative subaccount options, including two long/short funds—JNL/Mellon Capital Management Global Alpha and JNL/Goldman Sachs U.S. Equity Flex A.

Jefferson National’s Monument Advisor no-load, $240-a-year flat fee variable annuity offers exposure to alternatives inside a tax-deferred account, but it is designed specifically for the Registered Investment Advisor market. RIAs and other pure fee-based advisors aren’t Elite Access’ target audience.

Elite Access is aimed at advisors who are interested in offering alternative investments to their clients but don’t know much about them. The new product solves that problem by offering them ready-made funds or funds-of-funds that have the alterative product expertise of Jackson’s Curian Capital managed account firm and institutional money managers like Mellon Capital Management already built-in.

Product development

In an interview, Jackson National executive vice president Clifford Jack described the process, including nine months of research and 110 road shows at broker-dealers around the country—that led to the development and introduction of Elite Access and the belief that there’s a significant market for it.

“Coming out of the financial crisis, people realized that buy-and-hold strategies were buy-and-hope strategies,” Jack told RIJ in an interview last week. “When everything got so correlated, it was clear that the old way had to be re-evaluated. It didn’t work anymore. We studied this issue very hard. Our research asked, Which investor group, if any, did well in the midst of the crisis and coming out of it and how did they compare to those who didn’t come out well?”

Institutional investors, it turned out, weathered the financial crisis better than retail investors, thanks in part to their use of alternative investments and strategies. “We found that there was a significant performance gap and much of it was related to their use of counter-correlated or non-correlated assets, and those were alternative investments,” Jack said. “That started this initiative. We said, let’s follow those who seemed to have figured this out, and try to replicate [their strategy] and provide a better way for advisor and consumer to be more institutional-like.”

Jackson National could have packaged the alternative investments in a number of ways—as mutual funds or through managed accounts, Jack said. The company decided to offer them inside a variable annuity because it offered the benefit of tax deferral and alternative iinvestments tend to be tax-inefficient.

Funds that are generally classified as alternative investments include commodity funds that invest in metals or natural resources as well as funds that use a variety of market-neutral strategies, long-short strategies, options and futures, target allocation and other unconventional techniques designed to reduce portfolio risk by zigging when traditional securities zags and vice-versa.

Those types of actively managed funds generally involve frequent trading and rebalancing, and therefore tend to generate large amounts of short-term gains. For that reason, holding those funds in a taxable account would be counter-productive. It makes better sense to hold them inside the tax-deferred sleeve of a variable annuity.

The gains realized in a variable annuity aren’t taxed until they’re withdrawn, and withdrawals typically don’t occur until after the annuity owner retires, when he or she might be in a lower income tax bracket. (It doesn’t make sense to put alternative funds in a variable annuity with a living benefit rider, because the lack of readily-available hedges for alternatives makes an income stream based on their performance too expensive to guarantee.

“Our reason for doing this is two-fold,” Jack told RIJ. “First, [Elite Access] complements our existing portfolios for the retail advisor and client. Second, we like what it does for Jackson. It expands the pool of topics that our wholesalers can have conversations about.”

The target market includes “managed money or ETF or separate-account folks. We think advisors will migrate to a three-pronged approach. It’s not just about equity and fixed income anymore. It’s also about how much you have in alternative investments,” he added.

“We’ll go after everybody. We believe that this product will attract three types of advisors: those selling commissioned products; the hybrid advisor who does some of each, commission and fee-based; and those in the RIA channel who don’t forego the option to sell commissioned products.

“The most likely place for new assets to come from, where we expect to ‘disintermediate,’ will be load mutual funds and mutual funds sold in a wrap account. The average mutual fund wrap account costs the end client about 2.65%, assuming that the advisor charges 100 basis points for the wrap.”

The investment options

Among the offerings in Elite Access are nine Curian Guidance funds-of-funds offered by Curian Capital, Jackson National’s managed account subsidiary. “We think that the most-used of all of the investment lineup will be the Guidance portfolios,” Jack told RIJ. These include Curian Institutional Alt 65 and Curian Institutional Alt 65, which put 65% and 100% of their assets, respectively, in alternative investments.

A big part of the Elite Access value proposition is that it delivers not just exposure to alternative investments—which an advisor could get more cheaply by investing in alternative ETFs—but also support. The support includes education from Jackson’s 500 wholesalers, who have received special training and certification in alternative asset classes from The Institute of Business & Finance, and via the expertise of the fund managers at Curian Capital.

The subaccount options also include three Curian Dynamic Risk Advantage funds whose managers mitigate market risk by moving assets from equities to bonds or cash when equity prices fall and do the reverse when equity prices rise. This technique, characteristic of a risk-management process called Constant Proportion Portfolio Insurance (CPPI), is similar to the risk-management technique at the heart of the living benefit of Prudential’s Premier Retirement VA.

Jackson National, a unit of Prudential plc, was the third largest seller of VA sales in the U.S. in 2011 ($17.5 billion) and 2010 ($14.7 billion) with a 10.2% market share, according to Morningstar’s Annuity Research Center. Only Prudential Financial (no relation to Prudential plc) and MetLife sold more VAs over the past two calendar years. Jackson National had a total of $65.2 billion in VA assets under management at the end of 2011, or 4.34% of the total.

The company’s Perspective II (7-year surrender) and Perspective L-share VAs were its top sellers. Though Jackson, like other VA issuers, reduced the richness of the benefits a bit in 2011, the contracts still offered a rich deferral bonus and placed few restrictions on advisors’ choice of investments under the living benefit guarantee.

Jackson National sells most of its variable annuities in the independent broker-dealer channel and the regional broker-dealer channel, according to Morningstar. Jackson sold $2.417 billion in the independent channel in the fourth quarter of 2011, second to MetLife’s $2.5 billion. In regional firms, Jackson sold $777 million in the fourth quarter, second to MetLife’s $1.18 billion.

Elite Access is intended to add to Jackson’s VA assets and not cannibalize sales of GLWB contracts. “Our goal is to take not one dollar from our living benefit products business,” Jack said. “There’s $160 billion in annual sales in that space, and we want a portion of it. But instead of operating in a $160 billion sales pool, we also want to operate in a trillion dollar sales pool. We want to go after asset pools that we’re not working in. Elite Access is our entrée to those other markets.”

Middle-income Boomers ignorant of Medicare: Bankers Life

Posted on February 29, 2012 by Editor Test -

More than half (56%) of America’s middle-income Boomers admit to knowing little or almost nothing about the Medicare program and one in seven (13%) falsely believe Medicare is free, a study released by the Bankers Life and Casualty Company Center for a Secure Retirement has shown.

The CSR’s Retirement Healthcare for Middle-Income Americans study of 400 pre-Medicare Boomers (age 47 to 64) and 400 older adults (age 65 to 75) with income between $25,000 and $75,000, found that 72% of Boomers did not know that most Americans on Medicare pay a monthly premium, co-pays and deductibles.

Moreover, two thirds (62%) of Boomers, even those within a few years of turning 65, do not understand what their health insurance benefit will be for doctor visits and hospitalization once they are on Medicare. And more than one-quarter (27%) could not venture a guess on how much they think they will pay for healthcare once on Medicare versus what they pay today.

Although Boomers cite uncovered healthcare expenses (80%) and becoming ill (74%) as their top financial concerns about retirement, many appear to be taking a “learn as you go” approach to understanding Medicare’s coverage and costs.

According to the CSR study, most pre-Medicare age Boomers do not understand their benefits for dental care (78%), hearing care (82%) and vision care (83%), none of which are typically covered by Medicare.

In addition, 86% of Boomers under age 65 do not know if Medicare covers long-term care or overestimate its long-term care coverage. Boomers nearing Medicare eligibility (age 60 to 64) do not show a significantly greater understanding than those ages 47 to 59.

Boomers under age 65 are taking Medicare eligibility into consideration in greater numbers when determining when to retire. Nearly half (45%) of working Boomers age 47 to 64 report they are waiting to retire until they are eligible for Medicare and one-fourth (24%) are still not decided if they would retire without the safety net of Medicare’s health benefits.

The decision to wait to retire until they are eligible for Medicare may be financially sound since medical bills are one of the leading causes of bankruptcy among people age 65 and older. The CSR study reports that 12% of middle-income Americans on Medicare have medical debt.

The Bankers Life and Casualty Company Center for a Secure Retirement’s study Retirement Healthcare for Middle-Income Americans was conducted in September 2011 by the independent research firm The Blackstone Group. The complete report can be viewed at www.CenterForASecureRetirement.com.

Pacific Life launches indexed annuity

Posted on February 29, 2012 by Editor Test -

A new indexed annuity from Pacific Life offers a choice of “seven interest-earning options,” including a fixed return option, three index-linked investment options, and three crediting methods. The product’s name is Pacific Index Choice.

Contracts owners may allocate purchase payments to:

A fixed account option, which earns a guaranteed interest rate for a specific period of time.
Accounts whose returns are linked to positive movements in either the S&P 500 index or the MSCI All Country World Index (ACWI), which focuses on 45 developed and emerging markets.
A one-year, point-to-point crediting method where the interest rate is equal to the index return, subject to a cap.
A two-year, point-to-point crediting method where the interest rate is equal to the index return, subject to a cap.
An option where the interest rate is fixed and guaranteed for six, eight, or 10 years and credited at the end of each contract year.

Weiss Ratings names its favorite VAs

Posted on February 29, 2012 by Gavin Magor -

Every year we release our selection of the best variable annuities looking for contracts with low fees, no front-end loads, no surrender charges and a solid investment portfolio. This year they’ve been harder than ever to find. TIAA-CREF dominates the list with the insurance giant offering four of the nine best annuities.

At a time of low interest rates, variable annuity (VA) sales were up during 2011 according to LIMRA’s (Life Insurance and Market Research Association) fourth quarter 2011 U.S. Individual Annuities Sales survey. That is no surprise as investors would typically not want the low rates available on fixed-rate annuities. The surprise is, however, that sales dropped during the third and fourth quarter.

Insurer	Variable annuity contract
AXA Equitable Life	Retirement Cornerstone Series ADV
Fidelity Investments Life	Fidelity Personal Retirement Annuity
Nationwide Life	America’s marketFLEX Advisor Annuity
Pacific Life	Pacific Odyssey
Teachers Insurance and Annuity Assoc. of America	TIAA Access 1
Teachers Insurance and Annuity Assoc. of America	TIAA Access 2
Teachers Insurance and Annuity Assoc. of America	TIAA Access 3
TIAA-CREF Life	Intelligent Variable Annuity
Western Reserve Life Assurance Co. of Ohio	WRL Freedom Advisor
Data sources: Weiss Ratings, Beacon Research, Morningstar Inc.

Joseph Montminy, LIMRA assistant vice president, annuity research said “In this economic environment, VA companies are carefully managing the risks associated with their guaranteed living benefit riders, which has had an impact on overall sales trends.”

One interpretation of the trend is that although a variable annuity is probably the better route for the majority of folks out there, an insurer would much rather steer you to a fixed annuity, where it can control the risk so much better in this economic environment and lock buyers in at the low rates.

Not surprisingly, fixed annuity sales are lower than during the market collapse, when guarantees were like gold dust assuming that the insurer survived. Now the market sees little short-term movement, and the investor would like to at least share in any potential upside. This means that the investor is much more likely to want a variable annuity.

According to Beacon Research data, 76.5% of variable annuities incur surrender charges. Nearly 5% of those lock you in for as much as nine years, as with some Prudential Financial (NYSE: PRU) contracts and up to twelve years with one MetLife (NYSE: MET) annuity. Clearly there are advantages for a company to be certain of the money that it will be controlling and for a publically traded company there are outside pressures that are not faced by some privately held or mutual insurers.

Unfortunately it is the consumer who is so often required to pay the price for wanting to receive the potentially higher returns of a VA. The consumer should carefully examine all charges and fees before selecting an annuity, and flexibility of moving should be high on the list.

Our full list of best variable annuities for consideration offers the consumer that alternative. The choice of investment funds is extensive, averaging nearly 67 for each annuity. This should allow investors sufficient opportunity to find a place for their money, with a company that they feel comfortable with, and the knowledge that there will be no up-front fees or surrender charges.

Gavin Magor, senior financial analyst at Weiss Ratings, leads the firm’s insurance ratings division and developed the methodology for Weiss’ Sovereign Debt Ratings.

What Are Sales Trends Telling VA Issuers?

Posted on February 29, 2012 by Editor Test -

Although variable annuity sales fell 4.6% in the fourth quarter of 2011, they managed to finish the year at $153.4 billion, up 12.3% from the $136.6 billion at year-end 2010. But that was well below the 2007 high-water mark of $179.5 billion, according to year-end sales data from Morningstar’s Annuity Research Center.

As in the past, most of the new sales transactions were simply exchanges of existing contracts for new contracts. Net new cash flow for the year was just 18% of total sales, or $27.7 billion. That was up from only $21.7 billion in 2010 but well below the high of $46 billion back in 2003.

MetLife repeated as the quarter’s top seller, with $7.23 billion and a 21.7% share of individual annuity sales (19.7% of all variable annuity sales, including group sales). “MetLife has stated their objective to drive to greater balance across product lines, however, so their market share will likely drop in 2012,” said Frank O’Connor, Product Manager at Morningstar’s Annuity Research Center, in a release.

Prudential Financial (the 2010 sales leader) came in second, followed by Jackson National Life, TIAA-CREF (a group annuity specialist) and Lincoln Financial Group. These five companies accounted for more than 55% of total sales. (A table of the top ten VA sellers for Q4 and all of 2011 is below.)

Variable annuity issuer	Q4 2011 sales ($bn)	2011 sales ($bn)
MetLife	7.23	28.44
Prudential Financial	4.41	20.24
Jackson National Life	3.76	17.49
TIAA-CREF	3.41	13.54
Lincoln National	2.17	9.32
Nationwide	2.07	7.38
SunAmerica/VALIC	2.02	7.98
AXA Equitable	1.74	6.87
Ameriprise	1.56	6.40
AEGON/Transamerica	1.38	5.25
Source: Annuity Research Center, Morningstar, Inc.

The VA industry continues to consolidate, mainly because the product demands the kind of sophisticated hedging programs, robust wholesale forces, brand strength, financial strength, and economies of scale that only a few companies have achieved.

Just a few major companies saw sales increases in 4Q 2011. Nationwide’s sales rose more than 20%, to $2.07 billion. That raised its sales rank to sixth from ninth. TIAA-CREF, AXA Equitable, AEGON/Transamerica, Ohio National, Northwestern Mutual, Guardian and MassMutual also added modestly to sales.

VAs remain something of a puzzle. Despite the fact that Americans are getting older and more risk-averse, there’s still no clear indication that Boomers are gaining an appetite for variable annuities—a product that actuaries and marketers have spent over a decade custom-tailoring for precisely their situation. Variable annuities are surviving, but the VA market should be much bigger than it is.

The perennial objection to VAs is that they are expensive. Part of that expense stems from their primary method of distribution. According to Morningstar’s report, insurers rely on commissioned brokers for 98% of VA sales. It takes generous incentives and product features to win that business, but those factors add cost to the product. Simpler, cheaper contracts are available—contracts built to appeal to fee-based advisors or to the direct-sold market—but they aren’t getting much traction.

If marketers are trying to position VAs as all-season products, the message doesn’t seem to be getting through. VA sales are still correlated with equity market performance. If investors perceived VAs as a form of protection, then VA sales should have gone up in the fall, after the big volatility storm in August spooked investors. Instead, sales went down, which suggests that the public still doesn’t understand or appreciate the risk-mitigating aspect of the product. VA sales are also correlated with the generosity of the product features, such as payout rates and deferral bonuses, but the financial crisis and recent volatility have forced insurers to make products more austere.

In his quarterly commentary, Morningstar’s O’Connor was hopeful that less-expensive, more client-friendly variable annuities might finally break through in 2012. “An area to watch this year is the development of new low-cost, advisor-sold products offering living benefits, such as Transamerica’s Income Elite product, which offers both single and joint lifetime withdrawal benefits for a 1.25% annual fee on top of a base product cost of 0.45% for an all-in insurance cost of 1.70% per annum as compared with the industry average of 2.75%,” he wrote.

O’Connor pointed out that “Historically, advisor-sold products have captured around 2% of the overall VA market, with most such ‘simplified’ annuities failing to generate significant sales; will it be ‘different this time,’ to use a financial markets aphorism? If investor demand grows, perhaps fueled by the combination of longevity, return, tax, and inflation expectations, we may finally see the market develop for these products. But for now the broker-sold, fully-commissionable product is getting 98% of the business.”

Assets under management in variable annuities were essentially unchanged in 2011 relative to 2010, closing out the year at $1,502.3 billion vs. year-end 2010 assets of $1,504.4 billion. These assets have gradually become concentrated in fewer hands over the past decade.

Eight of the 37 firms that reported their sales results to Morningstar accounted for 75.4% of the individual VA assets in 2011, compared to the 12 of 44 firms sharing 73.8% of the individual market in 2001. The top five firms by individual product assets were MetLife (13.4%), Prudential (10.5%), Lincoln Financial (7.8%), and Hartford (6.6%), according to Morningstar.

More than 60% of variable annuities continue to be sold either through independent broker-dealers or captive agents. Banks, wirehouses, and regional broker-dealers contribute about 10% each to overall sales. In the fourth quarter of 2011, MetLife was the sales leader in banks/credit unions, independent broker/dealers, regional broker/dealers, and wirehouses. It was second to TIAA-CREF in captive agency sales.

The Income Expert

Posted on February 29, 2012 by Kerry Pechter -

Affluent fret over, but do little about, future health expenses: Merrill

Posted on February 28, 2012 by Editor Test -

Three out of four Americans with at least $250,000 in investable assets would manage their money differently if they knew they would live to age 100, according to the latest Merrill Lynch Affluent Insights Survey. Specifically:

39% would continue to work at least part-time during retirement.
37% would work with their financial advisor to reevaluate their savings and investment strategies.
32% would invest in a lifetime income product, such as an annuity.
32% would contribute more to a 401(k), IRA or other retirement savings vehicle.
29% would purchase long-term care insurance.
25% would retire closer to age 85 than 65.

In light of longer life expectancies, 59% of respondents also believed in raising the age of eligibility for claiming Social Security.

Braun Research conducted the survey of 1,000 affluent (investable assets > $250,000) Americans over age 18 by phone in December 2011 on behalf of Merrill Lynch Global Wealth Management.

Two factors most likely to lead Americans over age 50 to retire include “feeling confident that their assets will grant them the lifestyle they want throughout their remaining years” (25%), and “a possible health condition” (18%) of their own or within their family. More than half (55%) were concerned about affording their desired lifestyle in retirement.

Affluent prefer delayed retirement to austerity

If given the choice, 51% of affluent Americans not yet retired would rather retire later than accept a more austere lifestyle. However, 81% would, if necessary:

Trim day-to-day expenses (38%).
Purchase fewer personal luxuries (35%).
Limit budgets for vacations (32%).
Keep the same car longer (27%).
Leave less of an inheritance (25%).
Downsize their home (24%).

Among those preparing to retire in the next five years, 39% are saving more, 36% are developing a plan for monthly expenses and other financial needs once retired, 20% are consolidating assets with fewer financial institutions, 19% are clipping more coupons, and 15% are providing less financial support to adult-age children.

Only 24% defined retirement as never working again, while 73% of those not yet retired viewed retirement as “a second act” during which they would work at least part-time.

Health costs are top concern

For the third year in a row, rising health care costs was the top financial concern (79%) expressed by those surveyed. One-third of respondents said they are more concerned about the financial strain associated with a chronic illness or disability than its effect on their quality of life. Despite these concerns, 62% of respondents over age 50 have not yet estimated what their health care costs will be in retirement.

Survey respondents believe that future health care costs (26%) and life expectancy (25%) are the most difficult unknowns in retirement planning.

Women out-worry men

Perhaps because they live longer than men, 66% of affluent women (but only 54% of men) worry about outliving their savings. Women are more concerned (76%) about the future of Social Security benefits than men (59%), and about the cost of caring for an aging parent (37% of women, 25% of men).

Client to Financial Advisor: How do I live well longer?

Nearly half (47%) of affluent Americans said that conversations with their advisor now include retirement as well as general investing. Topics clients would like to discuss more often with their financial advisor include:

Planning for the possibility of reaching age 100 (30%).
Managing cash flow and liquidity in retirement (29%).
Balancing near- and long-term financial demands (26%).
How they hope to live during retirement (25%).
The impact of rising health care costs (25%).
Making lifestyle choices today that will improve their long-term financial security (21%).

The Bucket

Posted on February 28, 2012 by Editorial Staff -

LPL Financial names new EVP of Independent Advisor Services

LPL Financial, the independent broker-dealer unit of LPL Investment Holdings Inc. has appointed Mimi Bock executive vice president of Independent Advisor Services (“IAS”). Based in San Diego, she will report to Derek Bruton, managing director and IAS national sales manager at LPL Financial.

Bock will oversee some 4,500 LPL Financial advisor branch offices and lead LPL’s Business Consulting, Relationship Management, and Education & Consulting teams.

Previously, Bock was a managing director in the global wealth management division of Morgan Stanley Smith Barney. Earlier, she worked in institutional sales for Furman Selz and as a registered sales assistant for Laidlaw Adams and Peck & Bear Stearns in New York City.

Bock earned a B.A. in economics and sociology from Denison University in Ohio and is FINRA Series 3, 7, 9, 10, 24, 63, and 66 registered.

McCamish Systems announces new strategic business unit

McCamish Systems LLC, an Infosys BPO company specializing in insurance and retirement business process solutions, has established a strategic business unit (SBU) to focus on increasing market demand for Producer Services offerings.

McCamish’s Producer Management and Compensation System (PMACS), which is deployed both in McCamish’s Life and Annuity BPO and as a licensed product for three of the ten largest life carriers in the United States, will be the featured platform of the SBU.

McCamish’s Producer Management and Compensation System (PMACS) is a single flexible, multi-tiered and browser-based platform providing distribution management capabilities. Information can be retrieved from the relational database using the available user interface or a variety of electronic data interface (EDI) options.

Sales force management tools include producer maintenance, licensing, compensation, statements, and disbursement processing and reporting. The September, 2011 release 8.1 included the following increased capabilities:

Improved Mass Change Functionality
Enhanced Accounting Journal Entry Functionality
Improved Performance
Regulatory Changes through Fall 2011

For 2012 the following key features will be added/enhanced as part of significant Infosys investment in PMACS:

Standalone Agent Portal (with agent on-boarding)
Incentive/Bonus Calculation engine
Production Credit Calculation engine
Interfaces with NIPR
Upgrade of batch processing framework

Allianz Life reports 2011 financial results

Largely because of the popularity of annuities with income riders, Minneapolis-based Allianz Life Insurance Co. of North America reported total premium (new sales and recurring premiums) of $10.8 billion for 2011, which was unchanged from the prior year.

Fixed annuity sales declined 8% to $6.5 billion in 2011 compared to $7.1 billion of premium in 2010. Variable sales increased 19% to $3.8 billion of premium. As a result, assets under management increased 9% to $95.3 billion at year-end.

The company also posted operating profit of $428 million for its 2011 financial year, a decline of 9% from $472 million in 2010. Allianz Life also improved its capital position, reporting regulatory risked-based capital ratio growth, to 361% from 294% in 2010.

In January 2012, Standard & Poor’s affirmed Allianz Life’s rating as AA (very strong); this is the third highest out of 21 possible ratings. Standard & Poor’s affirmed the financial strength rating of Allianz SE of “AA” and added a “negative outlook” which applies to Allianz SE and other entities, including Allianz Life Insurance Company of North America.

Fidelity reports growth in small-to-mid-sized 401(k) market penetration

Fidelity Investments reported 40% year-over-year growth in defined contribution sales commitments in the small-mid market in 2011, with promised assets of $6.6 billion. The number of plans sold with $50 million in retirement assets or less reached more than 1,400, a 57% jump over the same period last year. Fidelity services approximately 11.6 million 401(k) participants in 20,000 plans working with both plan sponsors and nearly 3,000 financial advisors.

For instance, Burke & Herbert Bank of Northern Virginia, a 401(k) client with nearly 400 participants, worked closely with Fidelity in 2011 to build a workplace retirement plan that incorporates a mix of Fidelity and non-Fidelity funds. Advisors like Bjork Asset Management, a Chicago-based advisory firm, also said their plan sponsor clients are increasingly choosing Fidelity for their workplace retirement needs.

McLaren joins Lincoln Financial as stable value business leader

Bill McLaren has been joined Lincoln Financial Group’s Retirement Plan Services Product and Solutions Management team as Stable Value business leader, reporting to Eric Levy, senior vice president and head of Retirement Plan Product and Solutions Management.

McLaren had been an independent defined contribution stable value consultant in the 401(k), 457, 403(b) and defined benefit markets. He also held stable value-related positions with Prudential Retirement, most recently as vice president of sales with expertise in Guaranteed Interest Contracts (GICs), Institutional Book Value Wraps and Investment Only businesses. McLaren holds FINRA series 7 and 63 designations, is life insurance licensed in all 50 states and holds bachelor’s and master’s degrees from Rider University.

Ebix adds e-signature capability to insurance and annuity processing

Ebix, Inc., a supplier of on-demand software and e-commerce services to the insurance and financial industries, will partner with Communication Intelligence Corporation, a provider of electronic signature solutions, including biometric signature verification.

Ebix also announced the impending integration of CIC’s SignatureOne Cloud-based electronic signature service into EbixExchange’s AnnuityNet, AMP, LifeSpeed and SmartOffice platforms.

The companies said they are in the execution phase with a number of EbixExchange’s largest U.S. insurance customers to expedite straight-through-processing by incorporating electronic signatures into EbixExchange’s market leading platforms, thus eliminating their last remaining non-digital process.

“We will be providing an end-to-end solution including EbixCRM, illustrations, product research, electronic applications for life insurance, compliance, suitability, electronic policy delivery and electronic servicing of insurance policies—all with the capability of capturing and verifying both the customer and agent signatures through CIC technology,” said Dan Delity, Ebix’s senior vice president in charge of EbixExchange..

“This will also shorten the cycle for payment of brokerage commissions for all types of insurance sales,” said William Keiper, CIC’s president.

Mutual of Omaha fills retirement sales leadership positions

Mutual of Omaha Retirement Plans Division has appointed Seth Friedman as its 401(k) national sales director. The company has also expanded its reach in the Midwest adding two new retirement plan wholesalers, Mark Jewett and Dan Runser.

Friedman had been national sales director of Mutual of Omaha’s registered retirement products. Prior to that, he held positions at Nationwide Financial Services, Jackson National Life, Allstate Financial and Essex Corporation. He received his bachelor’s degree from the University of Massachusetts.

Jewett has focused on the pension marketplace since joining Mutual of Omaha in 1978. He most recently supported the company’s agency distribution as a 401(k) agency channel manager. He received his bachelor’s degree from Drake University.

Runser has more than 15 years experience selling 401(k), 457 and defined benefit plans. Prior to Mutual of Omaha, he was a pension wholesaler at AXA Equitable and Smith Barney Plan Services. Runser was also an agent/broker for Prudential prior to becoming a wholesaler. He received his bachelor’s degree from Wittenberg University and his MBA from DePaul University. He is a Chartered Life Underwriter and Chartered Financial Consultant.

Indexed Annuities, Unbundled

Posted on February 28, 2012 by Jack Marrion -

As bond yields began to collapse in 2010, indexed annuity carriers reacted by cutting sales commissions, premium bonuses, and minimum interest rate guarantees. However, by autumn 2011 bond yields had sunk to a point where there was little left to cut.

As a strategic response, agile carriers are unbundling the various features—such as GLWBs and death benefits—and letting annuity buyers decide which ones they want to pay for. Greater transparency and greater flexibility—which are both good for customers, carriers, and the annuity industry—have been the results.

Beyond the mortality expense, administrative expense and minimum guarantee return, contracts have several costs. The most visable examples are higher sales commissions and premium bonuses that must be repaid from future annuity earnings.

More subtle is the cost of offering an initial interest rate or interest cap that can’t be supported by carrier earnings—although it is not disclosed as such. It has to be recaptured by lowering the contract’s renewal rates.

Other costs are even subtler. Most products include a waiver of surrender charges if the annuity owner is confined to a nursing home; some contracts extend this waiver to cover a terminal illness, and a few are triggered by unemployment. Anecdotal evidence suggests that these features are almost never used, but they nonetheless impose a cost on the annuity.

Many of these costs have been offset by adjusting the renewal rate credited to the annuity owner in subsequent contract years. The reality of the lowest bond yield environment in over 50 years is that there is no longer enough spread to recapture all of these costs from the renewal rates. This is forcing carriers to unbundle the features, specify their costs, and allow the annuity buyer to choose which ones to buy.

Redefining the annuity promise

The first unbundling occurred before rates dropped and involved guaranteed lifetime withdrawal benefits. The first two carriers to offer GLWBs, American National and Aviva, charged specific fees for this income benefit. Almost every other carrier followed their lead in treating GLWBs as an optional feature. About a year later, Aviva became the first carrier to charge an annuity owner an explicit fee* for guaranteeing a minimum death benefit.

But it wasn’t until autumn 2011, as bond yields continued to fall, that more carriers began to consider charging annuity owners fees for features that had heretofore been regarded as standard equipment. Wariness about breaking the sanctity of the annuity promise was the reason for the delay, in my opinion.

A defining element of the fixed annuity value proposition has always been the promise that you can’t lose the money you already have. The industry has claimed that no matter what amount your account balance shows at the end of one year, at least that amount will be there the next year, most likely with an increase.

But this promise had already been broken. Most GLWBs were charging a fee that could cause – and in an indexed annuity context would almost certainly cause at some point – the subsequent year’s account balance to be less than the previous year’s.

Although the first contract to offer a GLWB, an American National product, explicitly stated that the charge would never be more than the interest credited, the second entrant, Aviva, made no such guarantee and almost every carrier has followed Aviva’s example. With the advent of GLWBs, most fixed annuities offering this feature could no longer promise that the account balance would never fall.

Within just the last two months, two carriers have taken unbundling to the next level. Midland National’s MNL RetireVantage series offers an optional package that includes a higher bonus, higher penalty-free withdrawals, annuitization bonus and return of premium for an annual cost of 60 basis points (0.60%). Allianz’s new 365i offers an annuity rider that, at present, raises an index cap by 2% in return for a 1% rider charge.

These examples of unbundling all stem from very low bond yields—an environment that will continue to challenge carriers for at least the next few years. I view it as a positive development. It brings greater transparency to the fixed annuity world and it permits each consumer to decide whether a specific feature is worth the cost. While I believe that bond yields will eventually rise and that carrier spreads will widen, greater transparency is here to stay.

Jack Marrion is president of Advantage Compendium, Ltd., a St. Louis based research-consultancy.

* Index annuities may involve an “asset fee” that reduces index-linked interest credited. But this isn’t actually a fee because it can never reduce the interest earned to less than zero. An index annuity asset fee is, in effect, simply an adjustment of the participation rate.

The Bucket

Posted on February 21, 2012 by Editorial Staff -

Hartford is first to adopt DST middleware for ‘in-plan’ annuity

DST Systems, Inc., a provider of information processing solutions to the asset management, insurance, retirement, brokerage, and healthcare industries, today officially announced a technology that can make it easier for DC plans to offer so-called “in plan” annuities.

The new solution, Retirement Income Clearing Calculator (“RICC”), is a “middleware” solution, said to be the first of its kind, designed specifically to support guaranteed retirement income products through traditional recordkeeping platforms.

The Hartford is DST’s charter client for RICC. Hartford recently launched Hartford Lifetime Income option; a patented income solution available through 401(k) plans to provide retirees with guaranteed income for Life.

“These new guaranteed income products are essentially the convergence of investment and insurance benefits into a single product,” said Larry Kiefer, Systems Officer for DST Systems. “Current recordkeeping solutions simply aren’t suited to handle the attributes of these new offerings. RICC is specifically designed to meet these new demands.”

Before RICC, an insurance carrier had no industry alternative to offer guaranteed income products in 401(k) plans except through its own policy administration system. DST’s new recordkeeping platform will enable insurers broader distribution of their income products, make it easier to bring new solutions to market and allow for greater portability of income products.

New tools for advisors from LPL Financial Retirement Partners

LPL Financial Retirement Partners, the retirement plan-focused division of LPL Financial LLC, the nation’s largest independent broker/dealer, announces the additions of Plan Health Check and Fee Comparison & Analysis Evaluation tools to bolster the Retirement Partners tool suite for advisors.

The LPL Financial Retirement Partners tool suite offers a comprehensive collection of retirement plan tools designed to help advisors grow and maintain their book of business in an automated and scalable fashion.

LPL Financial Retirement Partners has partnered with Fiduciary Benchmarks, Inc. to provide peer level data for comparison purposes in both new offerings:

The Plan Health Check tool allows retirement plan advisors to track and report on a plan’s value and success attributes such as plan participation, deferral rates and average account balance.
The Fee Comparison & Analysis Evaluation tool quickly and legitimately compares plan fees and design against an appropriate peer group, producing an easy-to-read report for plan sponsors.

Pfau to direct curriculum for RIIA’s retirement designation program

Wade D. Pfau, PhD, CFA, associate professor at the National Graduate Institute for Policy Studies in Tokyo, Japan, has been appointed curriculum director for the Retirement Management Analyst Designation Program, said Francois Gadenne, executive director and chairman of the Retirement Income Industry Association (RIIA).

The RMA designation is the only scientifically-based, rigorous retirement planning education and certification serving the financial services industry including defined contribution and retail distribution organizations, financial advisors, broker dealers, banks and insurance companies.

As curriculum director, Pfau will oversee and review the academic direction of the evolving RMA curriculum as well as edit and review submissions of annual updates to the RMA textbook and Retirement Income Body of Knowledge which are the foundation of the RMA program of study.

Pfau holds a doctorate in economics from Princeton University. He is a blogger on retirement research (wpfau.blogspot.com), a columnist for Advisor Perspectives, an online newsletter for financial advisors, and has published in a wide range of academic and professional journals.

MassMutual Retirement Services promotes one, hires one

MassMutual’s Retirement Services Division announced the promotion of John Budd and the hiring Brian Mezey in its sales and client management organization, which is led by Hugh O’Toole, senior vice president.

Budd will be national practice leader, a newly created role that covers the division’s institutional retirement products. He will lead MassMutual’s distribution strategy for its stable value investment only and defined benefit businesses.

For the past 24 years, he was a managing director in MassMutual Retirement Services. Budd reports to Jonathan Shuman, vice president and head of business development for the Retirement Services Division.

Mezey will assume Budd’s previous duties. He will work with retirement plan advisors in the mid- and large-markets and partner with Andy Hanlon in the eastern New England region.

He joins MassMutual from E&M Consulting of Raymond James & Associates, Inc., where he was a top retirement plan advisor and a member of MassMutual’s Advisor Partners Council. Mezey reports to Scott Buffington, national sales manager for the Retirement Services Division.

U.S. consumer debt reaches $2.48 trillion, a 10-year high

Consumer borrowing surged in November 2011 almost 10% or $20.4 billion, raising the consumer debt total to $2.48 trillion, according to Federal Reserve figures cited by Consolidated Credit Counseling Services Inc.

Revolving debt showed an 8.5% increase. Credit card debt accounts for almost all of revolving debt, which rose by $5.6 billion to $798.3 billion. This was the largest percentage jump since March 2008.

Non-revolving debt, which includes auto loans and student loans as well as loans for mobile homes, boats and trailers, rose 10.7% to $1.68 trillion.

Michael Hall joins Lincoln Financial Distributors

Michael Hall has joined Lincoln Financial Distributors as National Sales Manager for Institutional Retirement Solutions Distribution (IRSD). IRSD focuses on Lincoln’s full service retirement plan services offerings for corporate and nonprofit/tax exempt plan sponsors.

Reporting to John Morabito, head of IRSD, Hall will be responsible for retirement plan services distribution strategy and tactical execution. He will be based in Chicago.

Prior to joining Lincoln, Hall served as vice president of Institutional Sales for Prudential. Throughout his career he held other sales leadership positions at Northern Trust Company, Kidder, Peabody & Co., and Hewitt Associates.

He earned a B.S. in finance from Northern Illinois University. Hall is licensed in life and health, and holds FINRA Series 7, 24, and 63.

Mutual of Omaha names John Corrieri as VP of 401(k)

Mutual of Omaha has appointed John Corrieri as vice president of the company’s 401(k) product and distribution.

In his new role, Corrieri will further differentiate Mutual of Omaha’s retirement product offerings as the preferred choice of 401(k) advisors and plan sponsors in the small to mid size markets.

Corrieri most recently served as the Institutional Retirement Group Marketing Leader for Genworth Financial in Richmond, Va. His diverse Financial Services career includes varied leadership positions in call center management, service strategy, education and enrollment, and defined contribution strategic marketing at both Fidelity Investments and Prudential Financial.

Corrieri earned his bachelor’s degree from the University of Massachusetts and his Master’s in Business Administration from Babson College – F.W. Olin Graduate School of Business. He holds Series 7, 24 and 63 designations.

New CMO at Lincoln Financial Distributors

Richard Aneser has been hired to the newly created position of chief marketing officer of Lincoln Financial Distributors (LFD), the wholesale distribution unit of Lincoln Financial Group. He will report to LFD President and CEO Will Fuller.

Aneser has more than 20 years of experience creating campaigns for the wealth management and retirement markets. He joins Lincoln from UBS, where he served as head of Advisory and Solutions Marketing for UBS Wealth Management, focusing on campaigns aimed at the individual advisor level.

Prior to UBS, Aneser held senior marketing positions with Merrill Lynch and Fidelity Investments. Earlier in his career, he served at Hill, Holliday Advertising, Seigel & Gale, Wells Rich Greene BDDP and AC&R Advertising. He earned a bachelor of arts in philosophy from St. Michael’s College in Vermont, and holds FINRA Series 7, 24 and 66 licenses.

Money managers doubtful on equities: Towers Watson

Posted on February 21, 2012 by Editor Test -

Institutional fund managers responsible for some $8trn (€5.6trn) expect lower equity returns this year than last across all major markets, according to 114 respondents to a recent Towers Watson survey.

The US was viewed as the best equity market to invest in, with predicted returns down two percentage points to 8%.
Chinese prospects declined from 10.5% to 7.8%.
Australian stocks were expected to see the third-highest returns – despite also witnessing the sharpest fall in predicted returns, from 10% in 2011 to just 7% this year.
Compared with 2011, equities within the European single currency were only expected to return one percentage point less, down from 7%.
Expected Japanese returns saw a comparative drop to 5%.
Equity volatility of 15% to 25% was expected in most markets, with the most stable year-on-year returns predicted for the euro-zone and Japan.

The Western world’s rising debt burden and lower growth prospects (thanks to structural reform and austerity measures) were cited as reasons for pessimism. The economic recovery remained “as elusive and fragile as ever,” said Towers Watson global investment committee chairman Robert Brown.

Fund managers identified the growing involvement of politics in the financial world as their biggest concern. They did not expect problems in Greece and Portugal, including possible defaults, to spread to other countries.

Towers Watson warned investors not to let the recent rally give them a false sense of confidence. “The move into positive territory for many markets this year is helpful, but largely reflects central bank liquidity and may not prove sufficiently sustainable to justify a strategic move back into risk assets or indicate a cyclical recovery,” Brown said.

Save capitalism with “long-termism”: Gore and Blood

Posted on February 21, 2012 by Editor Test -

Generation Investment Management, an Anglo-American company whose chairman is former U.S. vice president Al Gore and whose senior partner is David Blood, have published five recommendations that will expedite a transition to what they call “sustainable capitalism.”

In a new white paper, GIM suggests these actions:

Identify and incorporate risks from stranded assets
Mandate integrated reporting
End the default practice of issuing quarterly earnings guidance
Align compensation structures with long-term sustainable performance
Encourage long-term investing with loyalty-driven securities

The paper calls for businesses and investors to incorporate the risks of “stranded assets” – those with a value that would change dramatically under certain scenarios, such as a reasonable price on carbon or water, or improved regulation of labor standards in emerging economies.

It argues that:

Businesses should integrate both their financial and ESG (Environmental, Social and Governance) performance into one report, and move from issuing quarterly earnings guidance towards only issuing guidance as deemed appropriate by the company.
Compensation structures in both financial and non-financial businesses should pay out over the period during which results are realized, and be linked to fundamental drivers of long-term value, employing rolling multi-year milestones for performance evaluation, the paper suggests.
Long-term investing should be encouraged by the issuance of loyalty-driven securities, which offer investors financial rewards for holding a company’s shares for a certain number of years.

Addressing pension funds specifically, Gore said:

“Pension funds have a fiduciary obligation to maximize the long-term performance of their assets to the long-term maturation of their long-term liabilities.

“If pension funds turn to managers of their assets and compensate them with a structure that gives an incentive to maximize performance on an annual basis, they shouldn’t be surprised that that is, in fact, what their managers end up doing. We would like market participants to do what is in their own best interests to do in any case.”

“A large proportion of investors, including pension funds, were allocating capital in a way that was at odds with their real needs and with the needs of a healthy economy, and that the balance between the short term and long term had become skewed.”

Generation Investment Management, based in New York, was established in 2004 and is dedicated to long-term investing and integrated sustainability research.

Potential Hartford split raises uncertainties: Fitch Ratings

Posted on February 21, 2012 by Editor Test -

Recent public discussions surrounding a possible split of the Hartford Financial Services Group, Inc. into separate life and property/casualty (p/c) companies has raised questions regarding the potential rating implications of such a breakup, Fitch Ratings said in release.

“While we do not speculate on the likelihood of a split occurring, Fitch would review any announced transaction for its impact on the credit quality and financial strength of the resulting company structure,” the release said.

Fitch currently maintains separate insurer financial strength (IFS) ratings on HFSG’s stand-alone life and p/c companies. HFSG’s life insurance subsidiaries maintain ‘A-‘ IFS ratings, which are two notches below the p/c IFS ratings of ‘A+’. (This approach was implemented in February 2009 during the financial crisis to reflect the divergence in operating performance and balance sheet strength between the life and p/c operations.)

Some investors have reportedly voiced strong opinions regarding profitability and are pushing for a split.

“Our analysis would particularly focus on any new entities’ debt service capabilities and financial flexibility, as cash to service debt is dependent on dividends from the operating company subsidiaries. In recent years, dividend capacity has only been provided by the p/c operations, as the life companies’ earnings have been challenged by lower margins and increased hedging costs in its competitive annuity and life insurance businesses,” Fitch said.

Any analysis of a proposed split would consider the allocation of holding company debt between the life and p/c companies and the capitalization and leverage metrics of the individual stand-alone entities.

In addition, the p/c companies served as a source of capital to the life operations during the financial crisis. The p/c companies continue to have the ability to provide such support. This could serve as a particularly valuable source of financial flexibility should the life operations require an additional capital boost.

Summary of proposals in Obama budget

Posted on February 21, 2012 by Editor Test -

Earlier this month, President Obama proposed his federal budget plan for fiscal year 2013, which rescinds the Bush-era tax cuts. A newly-released report from CCH, a Wolters Kluwer business, analyzes the proposals. In this article, RIJ republishes the proposals (with CCH commentary) affecting the financial, insurance, and retirement industries.

The analysis pointed out that the proposals hinge on this year’s presidential election. “Most likely, the lame duck Congress that returns to work after the November elections will take up the fate of the Bush-era tax cuts,” the analysis said. “The outcome of the November elections will also most likely determine whether many of the other items in President Obama’s FY 2013 budget proposals will either fade into history or become strong contenders for tax legislation at the end of 2012 and into 2013.

“President Obama’s FY 2013 budget is proposed in an environment unlike others in the recent past. The Budget Control Act of 2011 reduces the federal deficit by at least $2.1 trillion over the FY 2012 – FY 2021 period. Absent Congressional amendment, an automatic spending reduction process is scheduled to begin in January 2013. The automatic reduction would be divided evenly between defense and non-defense spending.”

Below are some of the items in the summary that may interest RIJ readers:

RETIREMENT MEASURES

In February 2012, Treasury and the IRS issued a guidance package intended to encourage employers to offer more flexibility to workers in retirement savings vehicles. The administration launched a similar initiative in 2009. President Obama’s FY 2013 budget reflects these developments.

Saver’s Credit. The retirement savings contribution credit – also known as the saver’s credit – is available to lower and moderate income taxpayers and offsets a portion of the first $2,000 individuals contribute to IRAs, 401(k)s and other retirement savings vehicles. President Obama has proposed to make the saver’s credit refundable and make other modifications to encourage individuals to contribute to retirement funds.

COMMENT: For 2012, the AGI limit for the saver’s credit is $57,500 for married couples filing joint returns; $43,125 for heads of households; and $28,750 for married taxpayers filing separately and single taxpayers.

FINANCIAL AND INSURANCE INDUSTRIES

President Obama has proposed a number of tax-related proposals affecting the financial and insurance industries.

Financial Crisis Responsibility Fee. The President would impose a fee on covered liabilities of U.S. bank holding companies, thrift holding companies, certain broker-dealers and insured depository institutions with assets in excess of $50 billion. The rate of the fee would be 17 basis points, discounted by 50 percent for more stable sources of funding, such as long-term liabilities.

IMPACT: The fee would be effective beginning January 1, 2014 and is intended to re-coup the costs of the Troubled Asset Relief Program (TARP) and to discourage excessive risk-taking by major financial firms.

Sale of Corporate Stock. A corporation does not recognize gain on the issuance or forward sale of its own stock, but does recognize interest income on a current sale of its stock for a deferred payment. The President’s proposal would require the corporation to treat a portion of the payment from a forward sale of stock as a payment of interest, includible in income.

Dealers. Dealers of certain property (commodities, commodities derivatives, securities, and options) treat 60 percent of the income from day-to-day dealer activities as capital gains. President Obama would require these dealers to treat the income as ordinary, not capital. The proposal would apply to individuals and partnerships.

IMPACT: Dealers of other types of property treat income from their day-to-day dealer activities as ordinary income. There is no reason for different treatment, according to the administration.

Definition of “Control.” If a corporation purchases a debt instrument convertible into its stock or into stock of a controlled or controlling corporation, the tax code limits the deduction for any premium paid to repurchase the instrument. The President’s budget would expand the definition of “control” to encompass indirect relationships (a parent and a second-tier subsidiary) as well as direct relationships (a parent and its first-tier subsidiary). The proposal would be effective on the date of enactment.

Life Insurance. President Obama has proposed requiring a purchaser of a policy with a death benefit of at least $500,000 to report the purchase. The insurance company would have to report the payment of any policy benefits to the buyer. The proposal would also modify transfer-for-value rules to ensure that buyers are properly taxed when they collect on the policies.

IMPACT: Recent years have seen a significant increase in transactions where individuals sell their previously-issued life insurance contracts to investors. The administration is concerned that investors are not reporting payments they receive, and may be inappropriately escaping taxes on the profit when the insured person dies.

Proration Rules. Under current law, a life insurance company must prorate its investment income between the company’s share and the share allocated to policyholders. The proration is used to limit the company’s funding of (deductible) reserves with tax-advantaged income, such as dividends and tax-exempt interest. President Obama has proposed a simpler regime, a flat proration percentage of 15% that is applied to non-life insurance companies regarding the dividends-received deduction, tax-exempt interest, and certain policy cash values.

COLI. President Obama would expand the pro rata interest expense disallowance regime that applies to corporate-owned life insurance (COLI). The current disallowance regime is designed to prevent the deduction of interest expense that is allocable to a life-insurance policy’s inside buildup that is not taxed. The proposal would eliminate an exception to the regime for contracts that cover the lives of officers, directors, and employees. The proposal would not repeal the exception for 20-percent owners.

IMPACT: Retaining the exception for 20-percent owners would benefit small businesses and other taxpayers that depend heavily on the services of a 20-percent owner.

IRS BUDGET

The IRS’ budget was cut by $305 million for FY 2012. President Obama has proposed to increase the IRS’ FY 2013 budget by $944.5 million (an 8% increase from FY 2012 levels). More than $400 million would be devoted to new enforcement activities, which the IRS projected would raise $1.48 billion in revenue annually at full performance, once newly hired employees are fully trained and develop broader experience by FY 2015.

COMMENT: President Obama also proposed a multi-year program integrity cap adjustment for IRS tax enforcement to fund $350 million in new revenue-producing initiatives above current levels of enforcement and compliance activities.

INDIVIDUALS

President Obama’s FY 2013 budget proposals for individuals are a mix of old and new ideas.

Payroll Tax Cut. The Temporary Payroll Tax Cut Continuation Act of 2011 extended the employee-side payroll tax cut through the end of February 2012. President Obama’s budget proposed to extend the employee-side payroll tax cut for all of calendar year 2012. Congress approved that extension on February 17, as part of the Middle Class Tax Relief and Job Creation Act of 2012. No proposal to extend this OASDI rate reduction for a third year, into 2013, has yet been made.

Income Tax Rates. As expected, the President would reinstate the 36% and 39.6% tax rate brackets for higher income taxpayers. When the tax rate brackets provided under Bush-era legislation and extended by the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (2010 Tax Relief Act) expire after 2012, the President would extend the tax rate brackets of 10, 15, 25, and 28 percent, eliminate the 33% and 35% tax rate brackets, and reinstate the prior law tax rate brackets of 36% percent and 39.6%. The rate increases, the President explained, would apply to single individuals with incomes over $200,000 and to married taxpayers filing joint returns with incomes over $250,000 levels. These income levels are 2009 amounts, indexed to inflation in subsequent years.

IMPACT: After 2012, additional Medicare taxes impacting higher income taxpayers are scheduled to take effect. The Patient Protection and Affordable Care Act imposes both a 3.8% Medicare tax on the lesser of an individual’s net investment income for the tax year or modified AGI in excess of $200,000 ($250,000 in the case of joint filers) as well as an additional 0.9% increase in the Hospital Insurance (HI) portion of the FICA tax for individuals falling into that same income range.

Personal Exemption Phaseout/Limitation on Itemized Deductions. The Bush era tax cuts, as extended by the 2010 Tax Relief Act, gradually phased out and then removed–but only through 2012—two long-standing cutbacks in the amount of personal exemptions and certain itemized deductions otherwise taken by higher-income taxpayers.

Under these limitations, the deduction for personal exemptions of taxpayers and their dependents phased out for taxpayers with adjusted gross income in excess of certain thresholds. Additionally, the amount of otherwise allowable itemized deductions (other than medical expenses, investment interest, theft and casualty losses, and wagering losses) were reduced by three percent of adjusted gross income in excess of certain threshold amounts but not by more than 80 percent. Starting in 2013, these limitations are scheduled to return to pre-2001 levels unless Congress acts.

The President has proposed to reinstate the personal exemption phase-out and the limitation on itemized deductions for single individuals with incomes over $200,000 and married taxpayers filing joint returns with incomes over $250,000, effective for tax years beginning after December 31, 2012.

COMMENT: President Obama also has proposed to reduce the value to 28% of specified exclusions and deductions that would otherwise reduce taxable income in the 36% and 39.6% income tax rate brackets. A similar limitation would apply under the AMT.

AMT. The President’s budget envisions repeal of the AMT and its replacement with the so-called Buffett Rule (discussed below). Until (and if) repeal is accomplished, the President proposed to extend the AMT “patch.” The patch provides increased exemption amounts.

IMPACT: For 2011, the AMT exemption amounts were $48,450 for single individuals, $74,450 for married couples filing joint returns and surviving spouses, and $37,225 for married couples filing separate returns. Absent action by Congress, the AMT exemption amounts for 2012 are $33,750 for single individuals, $45,000 for married couples filing joint returns and surviving spouses, and $22,500 for married couples filing separate returns. Most everyone in Congress agrees that the AMT needs to be fixed, but a permanent solution has been avoided so far because of the significant offsetting revenues that would be needed. One possible scenario is for another one-year AMT “patch” to be enacted for 2012, followed by rolling a solution into an overall consideration of comprehensive tax reform for years after 2012.

Buffett Rule. The President’s FY 2013 budget does not include a specific Buffett Rule but keeps it alive as a future goal. President Obama has asked Congress to pass measures that ensure individuals making over $1 million a year pay a minimum effective tax rate of at least 30%.

COMMENT: President Obama first proposed the Buffett Rule in 2011 and repeated the proposal in his 2012 State of the Union address. Sen. Sheldon Whitehouse, D-RI, has introduced legislation based on the President’s proposals. Taxpayers earning over $2 million would be subject to a 30% minimum federal tax rate. The tax would be phased in for incomes between $1 million and $2 million, with those taxpayers paying a portion of the extra tax required to get them to a 30% effective tax rate.

Capital Gains/Dividends. Under the President’s proposal, reduced tax rates on qualified capital gains and dividends enacted during the Bush-era and extended by the 2010 Tax Relief Act would expire after 2012 for higher income taxpayers.

The President would increase the tax rate on qualified capital gains to 20% for single individuals with incomes over $200,000 and married taxpayers filing a joint return with incomes over $250,000, effective for tax years beginning after December 31, 2012.

In a controversial move, however, the President proposes that the current reduced capital gain tax rates on dividends would expire at the end of 2012 for those taxpayers above the $200,000/$250,000 level and would be replaced by taxing them as ordinary income.

IMPACT: Decoupling capital gains and dividends caught many administration observers by surprise. The tax rates on qualified capital gains and qualified dividends have been linked for nearly 10 years. A Treasury official told reporters that “long-term capital gains often have had a preferential rate for the entire history of the income tax from 1913 until now.” Utility companies and other industries that traditionally rely on rewarding investors through regular dividends rather than dramatic share appreciation are obviously expressing concern over this proposal. A decoupling of capital gains and dividends would also resurrect certain universal techniques and issues inherent in corporate tax planning for taxable distributions.

‘Field Research’ in Behavioral Finance

Posted on February 21, 2012 by Editor Test -

Late last month, feeling flush after shaving $500 from the cost of a future business trip, I tempted myself by taking a long-cut on my way to the Port Authority Bus Terminal through the red light district of conservative men’s fashion in Manhattan.

I mean those sleek storefronts near Grand Central Station where Brooks Brothers, Paul Stuart, Charles Tyrwhitt, Allen Edmonds, and JoS A. Bank wait to prey on well-heeled males walking from the Harvard and Cornell Clubs (or from Citibank and Bank of America) to the Metro-North trains.

“SALE,” read the big red letters in JoS A. Bank’s window at the corner of 46^th St. and Madison Ave. Inside, a matter-of-fact salesman (a Wall Street trader until 9/11) made this offer: Buy a sports coat at the “regular” price and receive two casual shirts, two dress slacks, and two sweaters free.

* * *

JoS A. Bank isn’t Barney’s or Brooks Brothers. But then, neither am I. After estimating the average weighted price per garment in my head, and selecting my clothes, and finally standing on a carpeted platform while a tailor chalked my pant cuffs, I took the trade.

Later I reflected on my own behavior. Or rather, my participation in an act of behavioral finance. And I began to remember similar moments, involving myself or others. Check out these anecdotes and decide whether they count as evidence of anything:

Buyers’ club beware. As new homeowners, my spouse and I were once seduced by an “exclusive” direct-mail invitation to join a “buyers’ club” whose members enjoy discounts of 10% or more on a “vast” selection of wholesale furniture, carpets, kitchen cabinets, etc. We drove to the address on the invitation–a warehouse in a desolate industrial park.

Once inside, we were more less committed to watching a time-share-style video and an equally vapid live presentation. Then we and other couples were led, one pair at a time like creatures boarding Noah’s Ark, to a desk in a cubicle where a carefully scripted but otherwise clueless salesperson finally made the pitch.

We were offered the golden opportunity to pay $5,000 up-front to join the “club” and—for a single year—save 10% on purchases of big-ticket items from certain selected catalogues. We were not allowed to inspect the catalogs before joining.

Invoking my junior-high math, I calculated the minimum amount ($50,000) we would have to spend in a year simply to recoup our annual “membership fee.” Before I could start ridiculing the salesperson in a loud voice, my spouse hooked my arm and hustled me out.

Target-date mirage. A relation of mine, a very trusting single person of about 50, recently started a new job. Her 401(k) plan sponsor, an omnipresent Internet retailer whose name you can easily guess, defaulted her into a target-date fund whose target date indicated that she would retire in 15 years. When visiting us for dinner one Sunday, she marveled at her new employer’s confidence that she could afford to retire in 15 years.

For some reason her naiveté reminded me of the time I and my young daughters saw a man in a cowboy hat buying lottery tickets from a cashier in a mini-market. Always ready to torment them with a teaching moment, I asked the girls, then ages 7 and 10, to guess that person’s chance of winning the lottery in the next day’s drawing. “Fifty-fifty,” said my oldest. How so? “Simple,” she said. “He wins or he doesn’t win.”

‘Unfair’ subsidies. People don’t necessarily appreciate a subsidized price if someone else gets a free pass on the same item. I’ve observed this twice.

In the first instance, a friend of mine complained that, while he paid full tuition for his child at the state university (about $16,000), one of his children’s single-parent friends was able to go tuition-free as a hardship case. Now, my friend could afford the $16,000 (plus $9,400 for room and board, $3,000 for fees and $1,400 for books). But the unfairness of it bothered him.

For argument’s sake, I reminded him that he was the beneficiary of an in-state discount (non-resident tuition is $28,000) and an implicit discount for choosing a taxpayer-supported university over a private one, where the typical all-in sticker price is now $54,000. It was “all relative,” I told him. But he didn’t buy my argument.

In the second instance, a money manager for a family office firm in New York told me about indigent people living in her building on the Upper East Side who paid only $150 a month for spacious two-bedroom apartments, while she paid $4,000 a month for a similar apartment on the other side of the building. I was vaguely familiar with New York’s rent control laws, but this particular wrinkle was new to me.

The money manager herself also enjoyed a subsidy: She paid $1,000 below-market because her landlord participated in a city-sponsored housing program that allowed a few of her neighbors to live there for next to nothing. But that didn’t change the way she felt. What really annoyed her was that the City of New York apparently provided a car and a driver to chauffer any two people in the program anywhere in town on a day’s notice—for free. I wondered if Mayor Bloomberg knew about that.

Herding. One of the couples in my neighborhood recently held a garage sale to get rid of a lot of bric-a-brac before moving to Florida to retire. They called it an “estate sale” to try to attract a crowd with deeper pockets than the usual flea market mob. Curious, I wandered over to gawk. Strange cars were parked up and down the lane.

Inside the house, an antique blanket chest caught my eye. A dozen other shoppers ahead of me had walked right by it. The tag said $125. I offered $100. The agent of the company that managed the sale swiped my credit card through an attachment to her smartphone and marked the chest “Sold.” I rationalized the purchase as a memento of my soon-to-be-former neighbors.

An hour later, when I came back with a van to collect my little white elephant, the agent said, “As soon as you took the chest, a half-dozen people asked me about it. That’s how it always works. Once one person gets interested in a piece, suddenly everyone wants it. I had lots of offers for it after you left. You could have tripled your money.”

* * *

But let me finish explaining the significance of my visit to JoS A. Bank.

As I said, I didn’t agree to their deal immediately. First I had to see if any of their sportcoats appealed to me. Generally, the selection of jackets or suits in my size on any retail rack is meager at best. In fact, I order my suits from a reliable Tsim Sha Tsui tailor who has kept my vital statistics in a handwritten ledger since 1994.

As it turned out, I found a versatile tweed jacket that fit perfectly. At $500, it cost more than I generally pay, but the price included (as mentioned above) two slacks (tagged $165 each), two shirts (up to $90 each) and two sweaters (up to $100 each). Several round-trips to the changing room later, I had chosen all seven items.

Now, exactly what was I thinking, financially? Not for a moment did I pretend that I was getting $1,200 worth of clothes (which might have cost as little as $10 to manufacture in South Asia) for $500. But I was satisfied to think that I was paying about $250 for the jacket and getting the rest for $250. (And how much, really, was my $500 “worth”? These days I have a habit of dividing prices by 10 to see what they would have been before August 1971, when Nixon took the U.S. off gold to get re-elected.) So I bought the clothes.

Ultimately, money wasn’t the issue. What mattered was whether the clothes were stylish enough and durable enough to serve me long enough to make the cost basis irrelevant. Clothes are not like stocks or bonds. I didn’t need to sell them for a profit to realize their value. I just needed to wear them long enough. Indeed, given my age and their quality, the clothes and I might reach the ends of our lives simultaneously.

In that sense, the clothes were comparable to an income annuity. Will the income from the annuity meet your needs? Will it last? Will it make you feel more comfortable and secure? These are the most important considerations. When you are 91 years old and you continue to receive monthly checks from an insurance company, you’ll probably have forgotten what you paid for the contract back in 2000-something.

Patently Controversial

Posted on February 21, 2012 by Editor Test -

A new patent, or rather a continuation of an earlier patent, was issued to Lincoln National Life by the U.S. Patent Office last January 10, raising questions about whether Lincoln will use it to revive its intellectual property rights challenges against other issuers of variable annuities with lifetime income guarantees.

The patent document itself is lengthy, highly technical in nature and illustrated with flow charts. All but a few phrases have been published before, but according to several people familiar with it, those new phrases repair a flaw that caused a federal appellate court in July 2010 to nullify Lincoln’s victory in February 2009 against Transamerica over patent rights.

“The language in the new patent addressed the points that Transamerica brought up,” said an insurance executive familiar with the history of the legal dispute. “This brings up the question, why did Lincoln do this and what will they do with it?”

A Lincoln spokesperson would not comment on the matter when contacted last week by RIJ. Lincoln had also sued Jackson National Life Insurance Co., a unit of Britain’s Prudential plc. That case is still active. At the end of the third quarter of 2011, Lincoln was the fifth biggest seller of variable annuity contracts in the U.S., with a 6% market share and $7.15 billion in premia collected in the first nine months of the year.

Billions of dollars in royalties may be at stake. If Lincoln were to resume legal action against other issuers of GLWB contracts, and if those actions succeeded, those companies might have to pay royalties on at least some of the assets under GLWB riders. (It’s not clear which sales would be affected.) In February 2009, a jury decided that Transamerica should pay Lincoln royalties of 11 basis points, or $13 million. That judgment was nullified.

The pertinent language in the new patent, which protects a business process rather than a product, reads: “payments made thereafter may be made with or without a computer.” The clause refers to the calculation of the income payments that GLWB contract owners receive if and when their account balances are exhausted while they are living.

Lincoln lost its dispute with Transamerica because, under the previous versions of the patent, the payments in question had to be made with a computer. Transamerica could hypothetically calculate the ongoing payments without a computer, however. (In point of fact, Transamerica’s GLWB contracts were so new that none had yet reached the stage where such payments needed to be calculated.)

Michael C. Gilchrist, a Des Moines patent attorney who has written about the case on his blog, told RIJ, “Lincoln had a pretty bad result with their first Transamerica case. They won at the trial level, but their claim required that all of the steps in the process had to be done by a computer. On appeal, the judge said nothing showed that Transamerica had used a computer. None of Transamerica’s accounts had ever gotten to the guarantee phase.”

On his blog, Gilchrist wrote, “It remains to be seen whether Lincoln will aggressively pursue enforcement of this new patent. Lincoln may be reluctant to sign on for additional litigation after going through the time and expense of the first litigation only to come away empty handed.”

Actuary Tom Bakos of Ridgway, Colorado, who has written analyses of the Lincoln patent to help other insurers defend themselves against infringement actions, said the new patent could allow Lincoln to defend its patent anew.

“If Transamerica is still issuing and processing their GMWB the same way they were when Lincoln initially sued them for infringement, then this new ‘398′ patent gives Lincoln new ammunition to assert infringement again – but only for issues dating from June 2, 2011 – should Lincoln choose to pursue this either by lawsuit or settlement,” Bakos told RIJ in an email.

To a lay person, it might seem counterintuitive that Lincoln could amend an earlier patent and, in essence, patch holes that became visible when competitors appeared to copy what Lincoln believed was its intellectual property. But under the patent laws such strategies are possible and legal.

“This exemplifies the value of having patent applications pending,” Bakos told RIJ. “As long as Lincoln has pending applications they can file new applications (as they did in this case) to address issues they forgot or overlooked with respect to enforcing their applications. If Lincoln had no pending applications, they would not have been able to file a new application to correct the problem pointed out by the litigation in their [earlier] patent.”

Gilchrist agrees with that view. “The new patent was the result of a ‘continuation application.’ A continuation application is a patent application that uses the same disclosure as an earlier application, but has different claims. Any continuation applications must be filed while the earlier application is still pending,” he wrote on his blog.

“However, there is no limit to the number of continuations that can be daisy-chained together,” he added. “Therefore, it can be a valuable strategy to file a continuation application with amended claims each time the issue fee is paid for an allowed application. Keeping a continuation application alive gives the patent owner the ability to address any weaknesses in the original patent that may be identified during litigation.”

“Lincoln is hoping to get a monopoly in this area,” Gilchrist said. “What happens to all the business that has been written? Courts would generally say that the patent owner is entitled to an injunction, but it also has to consider public interest. It’s highly unlikely they would prevent the companies from servicing existing clients.” He noted too that a competing insurance company might avoid infringement simply by farming out annuity calculations to a computer in Canada, for instance, because other countries don’t recognize patents on business processes per se.

The executive who is familiar from the dispute worried that a renewed IP dispute could hurt the variable annuity industry. “If other companies have to pay [Lincoln], who is it hurting?” he told RIJ. “It’s a cost to the manufacturer that will get passed on to the consumer.” At this point, the likelihood of that happening is difficult to gauge.

Low Hanging Life Insurers

Posted on February 20, 2012 by Stan Luxenberg -

The prices of all types of financial stocks sank in 2011, but the share values of life insurers suffered ear-popping losses in altitude.

Shares of MetLife (NYSE: MET) fell to $29 in December from around $46 in January. Hartford Financial (NYSE: HIG) dropped to $15 from $26. In recent weeks, life insurance company stocks have rebounded, but analysts say that the shares are bargains at their current levels.

“The stocks are trading for much less than their book values, and the shares are significantly undervalued,” says Gavin Magor, senior financial analyst for Weiss Research.

The stocks are depressed largely because of fears that low interest rates are hurting profits. When rates decline, bonds produce lower long-term returns. Life insurers hold 76% of their assets in bonds, according to Moody’s. With interest rates on 10-year Treasuries having dipped below 2%, some insurers have already reported minor damage to profits. The problem becomes acute when bonds mature and companies must reinvest the principal at lower rates.

Along with low rates, stock market volatility also punished insurers last year. Volatility drives up the cost of hedging variable annuity income guarantees. Sales of variable annuities suffer when the equity mutual funds appear unattractive. As a double-whammy, asset-based fee revenue also falls when assets under management decline in value. That makes it hard for variable annuity issuers to recover the commissions—deferred acquisition costs, or DAC—that they paid intermediaries.

Despite these 80-knot headwinds, analysts say that the companies (MetLife is 144 years old, Prudential 137) can survive the current period of low rates—even if the Federal Reserve keeps its promise to hold rates near zero until 2014.

Weiss Research points out that balance sheets have been improving since the financial crisis. For the industry, surplus capital—the assets in excess of liabilities—increased from $266 billion in 2007 to $313 billion in the third quarter of last year, according to Weiss. “The insurers are in pretty good shape overall,” said Magor.

In a recent report, A.M. Best agreed that the industry has gotten financially stronger. At the end of 2010, the credit rater gave stable ratings to three-fourths of the life/health companies that it covers. By the end of 2011, the proportion had increased to more than 90%.

But a long yield-drought could hurt the industry, Moody’s cautions. If returns on 10-year Treasuries stay at 2% for a decade, the rating agency estimates, investment spreads would compress and accounting rules would require companies to increase reserves. In that event, most companies would be downgraded. Such conditions have prevailed in Japan.

Still, the U.S. is not likely to trod Japan’s flat path, Moody’s said. A sluggish recovery is more likely. It should gradually nudge interest rates higher, boosting the profits of life insurers in the process. A spike in prevailing interest rates, on the other hand, would hurt the prices of bonds that insurers have in inventory and create paper losses—at least temporarily. But analysts expect any rate spikes to be short-lived.

While acknowledging all the difficulties that plague life insurers, analysts seem to agree that markets have oversold them. “The stock market is not valuing earnings as much as it has in the past,” says Steven Schwartz, a Raymond James analyst in Chicago.

The price-earnings ratio of insurers has typically ranged from 60% to 80% of the figure for the S&P 500, he told RIJ. In 2008, the insurance multiple climbed as high as 140%. Then as markets collapsed, insurance stocks cratered, and the ratio dipped below 30% in the first quarter of 2009. In the rally of recent weeks, the multiple has reached 63%. Schwartz expects more upward progress. “As the economy improves, earnings will increase,” he said.

Yields on BBB-rated corporate bonds stabilized in the fourth quarter and began rising a bit in recent weeks, Schwartz noted. The climbing rates have already helped boost insurance company share prices, he says. More rises are likely. “As the economy picks up, corporate yields could move higher,” he says.

Among life insurance stocks, Schwartz recommends Lincoln National (NYSE: LNC). He figures that the shares could rise to $31 from the current $23 over the coming year. At $31, the stock would still trade at a multiple of just 8.3 times 2012 estimated earnings. The S&P 500 currently trades at 12.6 times estimated earnings. He had been recommending MetLife, but he recently lowered his rating to “market performer” because the stock had appreciated.

Principal Financial (NYSE: PFG) is also on Schwartz’ buy list. The Des Moines-based company’s strong sales force and brand equity should enable it to benefit from an improving economy, he said. Principal is expanding into emerging markets, where demand for financial products is brewing.

Insurance stocks have been unduly punished compared with financial stocks overall, argues Eric Berg, an insurance analyst for RBC Capital Markets. As markets grew harsher in the past decade, returns on equity for financials declined to a feeble 7.8%, a 58% drop. It wasn’t quite as bad for insurers, whose RoE dropped to 10.9%, a decline of 28%. Yet, despite the relative resilience of insurers, their price-book ratios fell 61%, about the same as the decline for financials.

Insurers’ price-book ratios indicate just how cheap the sector has become, some analysts say. MetLife shares now sell for 64% of book value, while Hartford’ shares trade for only 37% of book. “All the traditional life insurers are trading below book value,” said Drew Woodbury, an insurance analyst for Morningstar. “According to our estimates, the fair values for the stocks are right around the book values.”

Corporate management teams evidently agree that their stocks are cheap; they have been buying back shares. And those repurchases help boost share prices. “Instead of sitting around with cash—which earns nothing—the smart thing to do is to deploy the capital by raising dividends or buying back shares,” said Berg.

Prudential Financial (NYSE: PRU) and Principal Financial are Berg’s picks. Principal has already announced that it will buy back $100 million worth of shares, and Prudential intends to buy back a hefty $1.5 billion by this June.

Overall, macro trends should be friendly to the insurance industry. Many companies are expanding globally again, demand for life insurance remains steady if not spectacular at home, and aging Boomers are excellent candidates for annuities, which only life insurers can issue. As Morningstar’s Drew Woodbury put it, “Now that a lot of people have seen their 401(k) balances bounce up and down, they are looking for guaranteed income.”

It’s Conference Season

Posted on February 15, 2012 by Editor Test -

Here are some of the important conference dates for the next two months, beginning with next week’s annual Morningstar Ibbotson gathering and continuing through the always informative LIMRA/LOMA/Society of Actuaries Retirement Industry Conference (which immediately follows the Life Insurance Conference at the same location).