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The Missing Sockdolager

Posted on January 11, 2012 by Editor Test -

Yesterday, my friend and fellow journalist Bob Powell at Marketwatch published an interview with Ward Pfau, a retirement specialist whose articles I’ve cited in RIJ. “Variable-annuity guarantees disappoint over time,” the headline read.

Perhaps you read the interview online. If you’re in PR at one of the big VA issuers, perhaps your day was spoiled. Or perhaps you felt, when you finished reading, that the content didn’t really make the headline stick.

A young Japan-based academic and CFA who has published papers in the Journal of Financial Planning, Pfau voiced criticisms that were both valid and familiar. Yes, insurance can be expensive. No, it’s not for everybody.

But the story didn’t contain the sockdolager I expected.*

On the contrary, the interviewee praised variable annuities with faint damns. At one point, he even seemed to make a persuasive case for variable annuities for the mass-affuent.

One sentence in particular stuck out: “If you have saved enough that you can meet your retirement spending goals with a low enough withdrawal rate (such as 2% or 3%), then you probably do not have any need to pay the rider fee for the GLWB,” Pfau told Powell.

True. And by that formula, a household would need $1 million after taxes to generate a mere $30,000 a year in retirement. Not very many Americans are on track to retire with a nest egg of that size.

If Pfau meant that anyone with less than $1 million in savings and no pension should consider a variable annuity with a guaranteed lifetime withdrawal benefit, that’s an endorsement, not a condemnation.

Pfau had other benign words for VAs. Asked to name the “pros” of variable annuities, he conceded that they “could help risk-averse retirees to sleep better at night and help them to stay the course with their asset allocation and not engage in panic selling after market declines. GLWBs could also be more helpful for retirees who have limited access to other guaranteed income sources, such as a corporate defined-benefit pension.”

You could find identical language in a pro-VA story.

But, as I said above, Pfau pointed out valid VA weaknesses. “The guaranteed withdrawals are not inflation-adjusted and the fee structures can be quite complicated and expensive,” he told Powell.

Point taken. To get inflation protection from a GLWB, your account value typically has to post new highs. When the contract owner is withdrawing 5% a year and the issuer is taking another 3% or more, the account value will have a hard time reaching new highs during the life of the contract, no matter how much risk the owner is allowed to take with his or her subaccounts.

In fairness to VAs, however, Pfau might also have mentioned the deferral bonuses that accompany many GLWBs, which can protect people from sequence-of-returns risk—the risk that ill-timed market losses will permanently hobble a retirement portfolio.

Whether people understand sequence risk or not, I’m convinced that they think this value proposition is compelling: Put in $100,000 today, and after 10 years you can pull out at least $10,000 for life, regardless of market performance.

Coincidentally, a friend of mine happened to call me the other night on exactly this topic.

He and his wife are considering a VA that offered such a deal. My friends are successful, fit, PhD-level, self-employed people in their mid-50s who are financially risk-averse. In today’s market, they like the sound of a product that yields a 10% payout from age 65 to whenever. From that angle, fees don’t look so important to them. (My friends are also considering a deferred income annuity; they don’t especially need the liquidity of a VA.)

In the end, Pfau was on irreproachable ground when he told Powell, “You must really decide on a personal level whether you value that protection more than the fees you must pay for that protection.” Many rational people do. Others, equally rational, do not. Go figure.

So, returning to the original question: Do variable-annuity guarantees disappoint over time? Call me in 20 years. I’ll have a definitive answer.

*Sockdolager: Something that settles a matter; a decisive blow or answer; finisher.

The Missing Sockdolager

Posted on January 11, 2012 by Editor Test -

A young academic and CFP who has published papers in the Journal of Financial Planning, Pfau voiced criticisms that were valid and familiar. Yes, insurance is expensive. No, it’s not for everybody.

But the story didn’t contain the sockdolager it seemed to promise.*

On the contrary, the interviewee praised variable annuities with faint damns. At one point, he seemed to make a case for variable annuities for the mass-affuent.

By that formula, a household would need $1 million after taxes to generate a mere $30,000 a year in retirement on top of Social Security. Not many Americans will retire that much liquid wealth.

Did Pfau mean that anyone with less than $1 million in savings and no pension should consider a variable annuity with a guaranteed lifetime withdrawal benefit? If so, that’s an endorsement, not a put-down.

That wasn’t Pfau’s only non-discouraging word. Asked to name the “pros” of variable annuities, he conceded that they “could help risk-averse retirees to sleep better at night and help them to stay the course with their asset allocation and not engage in panic selling after market declines. GLWBs could also be more helpful for retirees who have limited access to other guaranteed income sources, such as a corporate defined-benefit pension.”

You could find identical language in a pro-VA story.

But, as I said above, Pfau pointed out valid VA weaknesses. “The guaranteed withdrawals are not inflation-adjusted and the fee structures can be quite complicated and expensive,” he told Powell.

Point taken. To get inflation protection from a GLWB, your account value typically has to post new highs. When the contract owner is withdrawing 5% a year and the issuer is taking another 3%, the account value will have a hard time hitting new highs during the life of the contract, no matter how much risk the owner can take with his or her subaccounts.

In the interest of balance, however, Pfau might have referred (or the interview might have included) to the optional deferral bonuses in VAs that can legitimately protect people from sequence risk—the risk that ill-time market losses will permanently cripple a portfolio.

I’m convinced that advisors and clients love the VA value proposition that says if they put in $100,000 today, they can start pulling out $10,000 for life in 10 years. Friends of mine out West called me the other night to say they were considering a VA that offered that kind of deal. They are successful, fit, PhD-level, self-employed people in their mid-50s who are financially risk-averse. They like the sound of a product that can give them a minimum 10% payout from age 65 to whenever. With that assurance, they’re relatively unconcerned about fees. (They’re also considering a deferred income annuity.)

In the end, Pfau was perfectly right to tell Powell, “You must really decide on a personal level whether you value that protection more than the fees you must pay for that protection.” Many rational people do. Others, equally rational, do not. Go figure.

So, do variable-annuity guarantees disappoint over time? Call me in 20 years. I’ll have a definitive answer.

*Sockdolager: Something that settles a matter; a decisive blow or answer; finisher.

The ‘Safety First’ Income Planner

Posted on January 10, 2012 by Editor Test -

While growing up on a northern Alberta farm during the 1970s, Antoine Orr hated the chore of chasing stray cattle in a blizzard. So every summer he mended fences and fixed barn doors to make sure that, come wintertime, the cows couldn’t escape.

Today, as president of Plancorr, an insurance-focused planning firm in suburban Maryland, Orr urges his clients to approach their finances with the same sort of cautious foresight that he learned on his family’s Canadian farm.

Aggressively risk-averse, he views debt-reduction as a surer path to lifelong financial security than trying to win in the investing casino. He has even created a “down-and-dirty” retirement planning tool, the Plancorr Planner, predicated on his belief that, in the long run, the “tortoise” investments (i.e., fixed annuities and cash-value life insurance) eventually beat the “rabbits” (mutual funds and 401(k) accounts).

“I’m the ‘Safety First’ guy,” Orr told RIJ recently. “I tell people, ‘If you want the at-risk guys, they’re down the block. Knock yourselves out. Or cut out the middleman and go to Schwab or E*Trade. Or create a DRIP (dividend reinvestment plan) account with a few stocks.’ But that’s not what he’s about. “My job is to build a moat around your castle,” he said.

Sensitive to the potential conflicts of interest involved in selling financial products, Orr strives for transparency and simplicity. In structuring his compensation, he does charge asset-based fees. Instead, he charges fixed fees for specific planning services and takes commissions—but doesn’t bundle the two.

“Clients pay me a fee for a plan. Then they are free to take that plan to another advisor and have him or her implement it. Or they can ask me to implement, I will have them sign another document that gives me permission to purchase products and receive a commission,” he told RIJ.

“I have zero assets under management,” he said. “The reason is liability. I have difficulty with people trusting me about the market. I don’t want to get calls from people when the markets go down in the same year they retire.”

Debt reduction plan

Many of Orr’s clients in the Washington, D.C. area are late-career professionals, working in the government or the private sector, and retirement planning is naturally a central part of his practice. In the past, he has looked at several well-known retirement planning software tools, but decided that none of them fit his needs or his philosophy exactly.

“Having been in the business for 15 years, I had tried just about every kind of planning software out there. I would find one piece that I needed in one product and another piece in another product. It was, literally, a piecemeal approach. No product had everyone I wanted in one spot,” he said.

“They were also disingenuous because they never discussed the impact of fees. Some professionals still say that fees don’t matter, but I don’t share that opinion. I also couldn’t do holistic planning with most of them. A lot of them are designed to sell product. Yes, we’re all ultimately selling product. But that shouldn’t be the first consideration.

“I want to use a tool that s my belief system. To do that, the tool has to accommodate people of modest means or significant means, and it has to handle their needs transparently. I have had doctors earning $300,000 or $400,000 tell me, ‘You’re the first person to show me the impact of fees or of taxes, or what the alternatives were.”

Unable to find an off-the-shelf solution to his liking, Orr spent two and a half years creating the PlanCorr Planner. He uses it with his own clients and licenses it to other advisors for $795 a year. It has the customary functions, like allocating assets, estimating expenses and identifying income sources. But it also includes a “Debt Management Summary,” a budget worksheet and a “Financial Freedom Account” that helps people save for purchases that, in the past, they would have financed with revolving credit.

For millions of middle-class pre-retirees, debt is often the elephant in the room, and Orr doesn’t let his clients pretend it’s not there. In the Plancorr software, for instance, pie charts show how much of a family’s monthly cash flow is consumed by payments on debt.

“No one talks about paying down debt,” Orr told RIJ. “I say to the client, Let’s address debt as a form of investment. We’re trying to reeducate and retrain people. Sometimes there are better things to do with the money than invest it. Let’s pay down debt. Let’s buy disability insurance,” he told RIJ.

Spend 401(k) first

Orr bucks the conventional wisdom that defined contribution plans must always be used whenever available. Some of his clients are federal employees whose Thrift Savings Plan has very low fees. But others are in micro plans with annual fees of more than 3%. The Planner can compare the likely long-term after-fee returns of contributions to a 401(k) plan with the benefits, for example, of purchasing cash-value life insurance.

“We’re not saying, ‘Don’t put money into your 401(k) plan,’ he said. “We’re saying, ‘Look and then decide.’ The presumption for the 401(k) investor is that he or she will get out more than he puts in. But what if that’s not always true? 401(k) plan fees may be greater than the employer match and employee tax deduction during the accumulation phase.”

Orr is also a maverick when it comes to retirement drawdown strategy. He recommends tapping defined contribution plans first, not last. “I say, spend down the 401(k) plan first, then the capital gains-generating account, then the Roth IRA, then the cash value life insurance. This lets you gradually reduce the risk to the portfolio and reduce your fees,” he said.

Reducing debt, risk and fees may not suit the accumulation-minded advisor, but they are important principles of decumulation, and fundamental principles for Orr. “For many people, the safety-first mentality involves a ‘paradigm shift.’ But we need to get more people back to basics,” he said. “If your credit card debt is negligible, and there’s no car payment and the house is paid for, you may not need a lot of money to live on in retirement.”

The Outer Limits of Outsourcing

Posted on January 10, 2012 by David Lindorff -

Outsourcing has gone to almost absurd extremes. Call centers in Asia are commonplace. Indian legal firms now handle boilerplate work for many American firms. Automation itself is a way of outsourcing a task—from people to software or machinery.

Financial advisors, though not always tech-savvy, were early-adopters of outsourcing. The very act of using mutual funds is a form of outsourcing, with the portfolio manager picking securities and the advisor just picking the fund.

But can you outsource too much? Should you outsource payroll and benefits? Sure. Hiring and firing? Perhaps. The creation of customized retirement income plans for key clients? Not so fast. Outsourcing may be necessary for growth; but it can turn into a necessary evil if you start outsourcing core competencies.

“You have to start by asking what your clients really value having you do personally, and what things they wouldn’t care who was doing it,” said Rick Miller, founder of Sensible Financial Planning of Waltham, Mass., a four-member firm with 200 clients and about $225 million under management.

“Most clients probably are not concerned about who enters the data about their transactions, as long as it’s done accurately. But they probably all do care that you know about it and can apply that data to their circumstances.” He advised, “As for those things you’re not good at, peel them away as fast as you can!”

Miller’s firm uses Tamarac rebalancing software. It has taken a process that used to require 20-30 minutes per client and sped it up to 20 clients or more per day, he said. He’s also automated or outsourced portfolio accounting, payables, payroll and tech support.

“Each became obvious to me. I was sort of dragged or pushed into them,” laughed Miller. “But we don’t outsource date entry for new clients. That’s sort of integral to our interview process.”

Miller is beginning to use software to automate retirement income planning using ESPlanner, the tool created by economist and author Laurence Kotlikoff of Boston University. But he stressed, “The output is not ES Planner output. We put it in our proprietary format. That’s crucial because an important part of what we do is make things clear for the client.”

Deena Katz, a professor of personal financial planning at Texas Tech University, says, “Outsourcing is the best way to enlarge your operation. But to do it, you need to figure out what your own highest and best use is. Then figure out what you can get rid of—including the sacred cows.” She adds, “In the old days it was felt that you should do everything yourself, because of course you can do it better than anybody else. But it’s not true. Most financial advisors I’ve known, for example, are not good business managers, and should hire one.”

“Start with your back office. Get rid of everything,” Katz suggested. “You don’t need all that hardware. Put everything in the cloud. There’s no reason to store information in-house anymore. And don’t worry about security. If Bank of America can’t keep its data secure, neither can you.”

“It’s all about leveraging,” she added. “If a task is too expensive for your office to handle in-house with a staff person, outsource it and standardize it. “

“A lot of outsourcing is driven by the size of the firm,” said Mark Cortazzo, senior partner at MACRO Consulting Group in Parsippany, NJ. His firm manages 40-50 model portfolios on a flat-fee basis, and specializes in the wealth distribution phase of retirement planning. “We’ve come full circle here. I started out licking every stamp myself, and ended up outsourcing a lot. Now we’re big enough to bring some things back in-house.”

He explained: “If you’re a one or two-member firm in growth mode, you’re spending a lot of your time prospecting clients. In that case, I’d have performance reporting and asset management outsourced. When you get larger, you can outsource your human resources by using employee leasing. That is, you do the hiring and firing but have an outsourced firm handle all the benefits and healthcare. As you become even larger, these things become cost-prohibitive, so you may want to bring that back in house.”

MACRO Consulting now has a staff of 23. “We have a company that does downloading and reconciliation for us, which allows us to focus on our clients,” Cortazzo said. “The one thing you can’t outsource is the client relationship management piece.”

“There’s not too much you can’t outsource,” he added. ”If I had 100 employees, I’d also outsource performance reporting. That’s not an area that wins you new clients, but it can lose you clients if you get it wrong! And asset management. We did outsource it for a while, because asset management is expensive. Now we do it in-house, but we still outsource hedge fund portfolios and asset areas we aren’t good at.”

Can outsourcing and automation be taken all the way? Could advisors outsource so much that they don’t need to be there at all?

“Things break down when financial planners don’t really understand their own automation process,” says Phil Lubinski, a partner in First Financial Strategies in Denver, a firm with eight partners and $250 million under management.

“A lot of financial planners don’t know how to match the presentation with the results they got from their automated system. And there’s no mandate or required training for understanding how the retirement income planning automation works,” he said.

“There’s the same danger with outsourcing. You should outsource, but you have to understand those things you’re outsourcing. Take asset management. I outsource all of mine, because I’m not a money manager, and if I were to try to do it, I couldn’t deal with my clients,” he added.

“ Now, there are some financial advisors who say they’re good at it, and that it’s a value-added service for their clients. But I can tell you that those advisors in the Denver area here who didn’t outsource asset management really capped their business. In recent years, managing assets has been so time-consuming for them that they couldn’t do much of anything else.”

Deena Katz agreed that the advisor must remain on top of things. “What you don’t want to do in outsourcing and automating is to lose control,” she warned. For example, “A lot of software today has built-in asset allocation,” she said. “If you don’t know how that works, you should just not use it. Because as soon as something gets out of control, and you can’t explain what happened to a client, you can get yourself in trouble.”

“Same thing with outsourcing,” she added. “Say you outsource your human resources. You’d better know what the outsource company’s standards are. For example, we have people who call us here at Texas Tech and say, ‘I need a kid.’ I tell them, ‘Don’t outsource that decision to me. You need to decide for yourself whom you want to hire.’”

Despite the limits of outsourcing, many advisors err on the side of being too hesitant to outsource—either out of fear or out of failure to recognize their own limitations. “People tend to be afraid to let go,” Katz said. “And they sometimes pretend to a level of knowledge that they simply don’t have.”

Uncle Sam publishes annual financial report

Posted on January 4, 2012 by Editor Test -

The “Fiscal Year (FY) 2011 Financial Report of the U.S. Government” was made public just before Christmas last month. On a positive note, it showed that the government’s net operating cost shrank 37% from 2010, from a negative $2.1 trillion to a negative $1.3 trillion.

The findings of the report were summarized in a 16-page Citizen’s Guide. Among the details:

The retirement of the baby boom generations over the next 25 years is projected to increase the Social Security, Medicare, and Medicaid spending shares of GDP by about 1.4 percentage points, 1.3 percentage points, and 1.0 percentage points, respectively.

It is estimated that preventing the debt-to-GDP ratio from rising over the next 75 years would require running primary surpluses over the period that average 1.1 percent of GDP. This compares with an average primary deficit of 0.7 percent of GDP under current policy.

The projections for the ratio of debt held by the public to GDP was 68 percent at the end of fiscal year 2011, and under current policy is projected to exceed 76 percent in 2022, 125 percent in 2042, and 287 percent in 2086. The continuous rise of the debt-to-GDP ratio illustrates that current policy is unsustainable.

As of September 30, 2011, the Government held about $2.7 trillion in assets, comprised mostly of net property, plant, and equipment ($852.8 billion) and a combined total of $985.2 billion in net loans receivable, mortgage-backed securities, and investments.

The Government’s largest liabilities are: Federal debt held by the public and accrued interest, the balance of which increased from $9.1 trillion to $10.2 trillion during FY 2011, and Federal employee postemployment and veteran benefits payable, which increased slightly during FY 2011, from $5.7 trillion to $5.8 trillion. In addition to debt held by the public, the Government reports about $4.7 trillion of intra-governmental debt outstanding.

Total Government revenues increased slightly from $2.2 trillion to $2.4 trillion in FY 2011. Chart 3 shows that a $133 billion or 7.7 percent increase in personal income and payroll tax revenues during FY 2011 was partially offset by a $5 billion or 2.5 percent decrease in corporate tax revenues. Since 2007, corporate tax revenues have fallen by more than 50%, to $175 billion from $367 billion.

Federal Reserve favors more predictability on rates

Posted on January 4, 2012 by Editor Test -

In a move that recalls Alan Greenspan’s policy of telegraphing his Treasury rate hikes in the middle of the last decade, the Federal Reserve board revealed yesterday that it would be “incorporating information about participants’ projections of appropriate future monetary policy into the Summary of Economic Projections (SEP), which the FOMC releases four times each year.”

The new position was announced in the minutes of the December 13, 2011, meeting of the Federal Open Market Committee, which were released January 3, 2012.

While the step toward greater transparency seemed consistent with Fed chairman Ben Bernanke’s established policy of keeping the target range of the federal funds rate at zero to 0.25% until mid-2013—a policy that was reconfirmed in the Dec. 13 minutes—the Governors’ approval of a change in communication strategy wasn’t unanimous.

“A number of members noted their dissatisfaction with the Committee’s current approach for communicating its views regarding the appropriate path for monetary policy,” the FOMC minutes said. “Some participants expressed concern that publishing information about participants’ individual policy projections could confuse the public.”

“They saw an appreciable risk that the public could mistakenly interpret participants’ projections of the target federal funds rate as signaling the Committee’s intention to follow a specific policy path rather than as indicating members’ conditional projections for the federal funds rate given their expectations regarding future economic developments.”

In new comments on the Fed’s popularly-called “Operation Twist,” the FOMC minutes said, “The Committee directs the Desk to continue the maturity extension program it began in September to purchase, by the end of June 2012, Treasury securities with remaining maturities of approximately 6 years to 30 years with a total face value of $400 billion, and to sell Treasury securities with remaining maturities of 3 years or less with a total face value of $400 billion.”

The minutes continued, “The Committee also directs the Desk to maintain its existing policies of rolling over maturing Treasury securities into new issues and of reinvesting principal payments on all agency debt and agency mortgage-backed securities in the System Open Market Account in agency mortgage-backed securities in order to maintain the total face value of domestic securities at approximately $2.6 trillion.”

The Bucket

Posted on January 4, 2012 by Editorial Staff -

LPL to buy Fortigent

LPL Investment Holdings Inc., the parent of LPL Financial, the nation’s largest independent broker-dealer, intends to acquire Fortigent, LLC, a provider of high-net-worth solutions and consulting services to RIAs, banks, and trust companies.

The transaction is expected to close in the first quarter of 2012. Financial terms were not disclosed.

Following the transaction, Fortigent will be “solely focused on supporting sophisticated practices and those serving high-net-worth clients,” LPL said in a release. Fortigent will retain its brand, its existing management team and its Rockville, Md., headquarters. Andrew Putterman will continue to lead Fortigent, reporting directly to Robert Moore, chief financial officer of LPL Financial.

Silver Lane Advisors LLC served as financial advisor to Fortigent, with Patton Boggs LLP as legal advisor to the company. Optima Group, Inc., served as financial advisor to LPL Financial, with Skadden, Arps, Slate, Meagher & Flom LLP serving as LPL’s legal advisor.

IRI offers discounts on 2011 publications

The Insured Retirement Institute (IRI) is discounting the prices of its 2011 publications for its members until Monday, January 9. There’s a 40% discount on a package that includes the 2011 IRI Fact Book, the “Building Your Future” retirement income guide and the “Retirement Income Strategies & Products at a Glance” supplemental matrix, the IRI said in a press release this week.

There’s also a 50% discount on “Boomers and Retirement Income 2011: An Analysis of Retirement Confidence, Planning Strategies and the Opportunities for Advisors” report.

MassMutual announces executive promotions

Massachusetts Mutual Life (MassMutual) has promoted the following three people to senior vice president:

Michael R. McKenzie, Retirement Services Operations. He is responsible for all recordkeeping processes and delivery of services for MassMutual’s Retirement Services division, which offers products and services for corporate, union, nonprofit and governmental employers’ defined benefit, defined contribution and nonqualified deferred compensation plans.

McKenzie has oversight of the division’s new business implementation, ongoing account management, plan change processing, ERISA consulting services, and its Participant Information Center (PIC). He joined MassMutual in 2007.

Scott Reed, U.S. Insurance Group Business and Technology Solutions. He is responsible for the business and technology solutions team in the company’s U.S. Insurance Group, which provides and operates all technology and systems for MassMutual’s protection and accumulation products, including life insurance, disability income insurance, executive benefits, long term care insurance and annuities, and its distribution systems, broker/dealer and trust company. He has been in his current role since 2008 and joined MassMutual in 2000.

Heather Smiley, Retirement Services Marketing. She is head of Strategic Marketing for MassMutual’s Retirement Services division, which includes plan sponsor communication consulting services, advertising and public relations, web portals and tools, market research, competitive intelligence and employee communications. She joined MassMutual in 2009.

Great-West Retirement announces website upgrades

Great-West Retirement Services has enhanced its websites that serve the company’s plan sponsor clients and the advisor and third party administrator (TPA) partners who sell its retirement plan products and services, the company said in a release.

Enhancements to the plan sponsor site include:

More intuitive, tab-based navigation
Participant search capabilities on every screen
Daily balance summaries updated after each market close
Expanded plan provision data
A repository to store fee disclosure and plan documents
Access to defined benefit plan data (when applicable)
The ability to submit bank account information online
Improved file upload validation

The new partner site features include:

Easier access to the latest commission and fee-for-service payment information
Multiplan access and search capabilities for users with multiple plans
Consolidated daily balance summaries for the user’s entire block of business, including total assets updated as of the most recent market close

Both sites also include a new Resource Center – a dedicated area for the information and reference materials that plan sponsors and partners use the most. Demonstration videos outline the new design features and enhancements to help familiarize plan sponsors and partners with the new sites.

Great-West Retirement Services, a unit of Great-West Life & Annuity Insurance Company, provided 401(k), 401(a), 403(b) and 457 retirement plan services to 25,000 plans representing 4.5 million participant accounts and $142 billion in assets at Sept. 30, 2011.

Securian acquires two more insurers in financial institution market

Securian Financial Group on January 1 closed its purchase of American Modern Life Insurance Company (AMLIC) and its subsidiary, Southern Pioneer Life Insurance Company (SPLIC), from American Modern Insurance Group, Cincinnati, OH.

The acquisition increases the scale of Securian’s credit protection business by 25%. Securian will integrate the acquired business into its credit protection operations by June 30.

American Modern will provide transition services until integration is complete.

AMLIC and SPLIC’s products are similar to those offered by Securian, including credit life and disability insurance and debt protection programs provided to customers of financial institutions.

Securian is the third largest underwriter of credit life and disability insurance in the United States measured in direct written premium, according to the Consumer Credit Industry Association.

In October 2011, Securian completed the acquisition of Balboa Life Insurance Company and Balboa Life Insurance Company of New York.

Americans unresolved about financial planning: Allianz Life

Eighty percent of Americans said that they wouldn’t focus on financial planning in their resolutions for 2012, according to a recent survey from Allianz Life Insurance Company of North America.

“This lack of financial focus is at the highest level in the survey’s three-year history, exceeding the 67 percent of Americans who ignored financial planning when making resolutions in both 2009 and 2010,” Allianz Life said in a release.

Thirty-five percent of respondents said they “don’t make enough to worry about” financial planning, while 23% said that they already “have a solid financial plan” and 17% said they haven’t planned because they “don’t have an advisor/financial professional.”

When asked to rank five life focus areas —“health/wellness,” “financial stability,” “employment,” “education” and “leisure” — 45% of Americans said that “health/wellness” was their most important focus area for 2012. “Financial stability” trailed with 30%.

In a list of five economic events —“unemployment,” the “U.S. budget fiasco,” “home prices/sales,” “volatile stock market” and the “European debt crisis” — 48% of Americans ranked “unemployment” as the most worrisome of 2011. The “U.S. budget fiasco” followed with 23%, with “home prices/sales,” “volatile stock market” and “European debt crisis” drawing less attention with 15%, 10%, and 5% percent, respectively.

When asked, “Given 2011’s economic conditions and your current financial situation, are you more or less likely to seek the advice of a financial advisor/professional,” 31% said that they are “less likely” to look for help with financial planning. Only 20% indicated that they were “more likely” to seek financial advice with 49% saying they’re “unsure” about focusing on their finances.

Could “Obamacare” encourage earlier retirement?

Posted on January 4, 2012 by Editor Test -

People who are eligible for employer-subsidized health benefits in retirement tend to retire earlier than people whose retirement health benefits (i.e., Medicare) don’t start until age 65, according to a new paper by economic researchers from Harvard, Towers Watson and elsewhere.

The research was undertaken to help policymakers predict the possible impact of the Patient Protection and Affordable Care Act of 2010 on labor market participation by older, pre-Medicare workers. The PPACA allows Americans under age 65 to buy group health insurance at below-market rates.

The findings suggested that the PPACA might encourage or facilitate earlier retirement. Using data on employees at 64 Towers Watson client firms, the researchers found that the probably of retirement at age 62 rose by 3.7 percentage points (an increase of 21.2%) at age 62 and by 5.1 percentage points (an increase of 32.2%) at age 63 when employers contributed toward health insurance premiums.

The effect was more pronounced if the employer paid half or more of the cost of insurance. Turnover rates rose by one to three percentage points at ages 56-61, by 5.9 percentage points (a 33.7% increase) at age 62, and by 6.9 percentage points (a 43.7% increase) at age 63.

“Overall, an employer contribution of 50% or more reduces the total number of person-years worked between ages 56 and 64 by 9.6% relative to no coverage,” wrote Stephen Nyce and Sylvester Schieber of Towers Watson, John B. Shoven of Stanford, Sita Slavov of Occidental College and David A. Wise of Harvard and the National Bureau of Economic Research (NBER).

Only 28% of firms with 200 or more employees and three percent of smaller firms offer employee health coverage that also extend benefits to retirees, according to a 2010 Kaiser Family Foundation report. The Consolidated Omnibus Budget Reconciliation Act (COBRA) of 1985 enables workers to retire at 63½ and stay on their employers’ health plans for 18 months at their own expense.

Consumer Reports rates 13 brokerage services

Posted on January 4, 2012 by Editor Test -

A Consumer Reports survey of its readers, published in the February issue of the magazine and posted on its website, showed those readers to be “very satisfied” with 10 of 13 major brokerage organizations.

The brokerage arm of USAA, a members-owned insurance company that mainly serves current and former servicemen and women, led in overall satisfaction. Scottrade, an online broker, and Vanguard, tied for second place.

The broker satisfaction ratings were based on a 2011 Consumer Reports National Research Center online survey of 7,327 ConsumerReports.org subscribers reporting on their experiences with brokerage firms between October 2010 and October 2011.

Consumer Reports Ratings for Brokerage Services
*Discount/Online Brokerages*	Score*
USAA Brokerage	93
Scottrade	89
Vanguard Brokerage	89
Charles Schwab	84
TD Ameritrade	83
E*Trade	82
Fidelity Brokerage	81
WellsTrade (Wells Fargo)	74
Merrill Edge (Bank of America)	72
*Full-Service Brokerages*
Edward Jones	83
Raymond James	82
Ameriprise	80
Morgan Stanley Smith Barney	71
Based on overall satisfaction with quality of customer service, financial advice, phone service and website usability. Source: Consumer Reports*, Feb. 2012, p. 26. Based on a 2011 survey of 7,327 CR subscribers.

Besides surveying its online subscribers about their experiences with their brokers, the organization sent staff members into brokerage offices in New York and Washington State to experience how clients seeking advice were served. And the organization asked major financial-services companies to prepare investment plans based on the profiles of five of those staff members.

Two independent financial planners and their teams evaluated the appropriateness of the advice in the companies’ plans. They analyzed 20 investment plans created for the Consumer Reports staffers by Citibank, Fidelity, Schwab, and T. Rowe Price, and judged them about equally good. Citi and T. Rowe Price earned somewhat higher marks for the appropriateness of investment recommendations. Citibank’s approach toward planning was deemed more comprehensive than the others’ approach.

But Consumer Reports’ financial advice judges found “inappropriate advice in several plans. They also found most of the documents to be filled with boilerplate language and short on real, actionable advice,” according to a press release.

In a Consumer Reports field test, participants encountered some questionable sales tactics, the company said. “One CR staff member was shown a chart on a portfolio’s performance that omitted the significant impact of fees. Another tester was pitched a complicated annuity product though the adviser knew little about her,” the release said.

Canada’s Annuity Issuers Protect their Turf

Posted on January 4, 2012 by Editor Test -

In a win for Canadian insurers, the finance minister of Canada last month ordered the Bank of Montreal to stop selling issued an annuity-like retirement income product called BMO Lifetime Cash Flow, the subject of an article in Retirement Income Journal one year ago.

“The decision is a win for the country’s life insurers and a blow to Bank of Montreal,” the Toronto Globe and Mail reported on December 16. BMO Lifetime Cash Flow, not an insurance product, resembled and competed with variable annuities with guaranteed lifetime withdrawal benefits, such as the Sun Life Elite Plus contract.

The Bank of Montreal’s Lifetime Income Cash Flow product, when purchased with after-tax money, provided annual income payments of 6% of principal for life beginning after a 10-year deferral period. The first 15 years of payments were tax-free. The assets (C$5,000 minimum) were invested in target-date type mutual funds. The all-in fee was 2.75% of the account value.

A press release issued by the Canadian government in mid-December read in part:

“The Honorable Jim Flaherty, Minister of Finance, today announced the Harper Government will introduce legislation to prevent banks from offering financial products that function like life annuities.

“Since taking office, this Government has taken steps to clarify the separation of banking and insurance activities,” said Minister Flaherty. “This will ensure the business of insurance continues to be subject to the appropriate rules and regulations.”

Annuities “are subject to the regulatory framework for insurance companies. As well, current federal legislation prohibits banks from promoting or selling life annuities, which are considered insurance products.”

“However, in recent years, some banks have introduced products that perform the same or similar functions as life annuities. These products are not subject to the same regulatory standards as those sold by insurance companies.

“The Minister said legislative amendments, which will be proposed as soon as possible, would allow the grandfathering of existing products, subject to contract terms and conditions.

According to the Globe and Mail:

“The issue was highly contentious within the financial industry. As the baby boomers age, many of them are expected to use products such as annuities to provide steady retirement income. So financial institutions are putting all of their muscle into ensuring that they have the right products for that demographic group.”

“The life insurers took this issue to the regulator, the Office of the Superintendent of Financial Institutions, complaining that if banks got into the business of annuities, they would have an advantage because they are not required to adhere to the same capital rules as insurers. The insurers also feared that BMO’s move would represent the ‘thin edge of the wedge,’ as banks become increasingly bold about pushing into the insurance arena in any way they can.”

“Royal Bank of Canada, for instance, in recent years began building insurance offices right next to its bank branches, a strategy that other banks and credit unions have since adopted to sidestep rules preventing them from selling insurance in their branches.”

Searching for the Right Decumulation Tool

Posted on January 4, 2012 by Editor Test -

No matter how sophisticated it might be, no retirement income planning software program can replace the instincts, intellect and mental intangibles of a good financial advisor. This much we know.

But that’s not to say that software can’t help brighten advisors’ presentations, or streamline their methodology, or add new capabilities to their repertoire. So the search for a useful decumulation tool goes on.

Last fall, in an email, an advisor asked us if we knew of any good income planning tools for independent advisors. He was a relative newcomer to the world of decumulation, and he wanted a few suggestions on selecting the right technology.

We felt his pain; there are no easy answers to that question. He also inspired us to devote much of this month’s editorial space to an informal review of the available software. Today’s cover story, by Joel Bruckenstein, CFP, looks at a few tools you may never have heard of.

You might have avoided software until now—because of the expense, or the initial learning curve, or even because you’re computer-phobic—but there are good reasons for incorporating it into your practice. Offhand, I can easily think of three:

Your clients may learn better with their eyes than with their ears. A multi-hued chart that enables clients to visualize the elements of their income plan is a basic requirement (not sufficient, but necessary) of any good retirement software program. Obviously, a well-designed visual aid can educate and impress clients and cement their buy-in. An income planning tool needs to be part illustration/sales tool, part algorithmic tool, and part heuristic tool (because there are no “right” answers).

To serve mass-affluent clients cost-effectively, you need automation. Every retiree’s finances are unique, but most Boomers won’t be able to afford a time-intensive, fully customized income plans. Therefore you need a scalable system, whether it be DIY or off-the-shelf, that automates and accelerates the more routine parts of the process so that you can serve more people in less time. A tool that demands a lot of your time will simply go unused.

You may be new to the decumulation process and don’t have a preferred planning method. Many advisors who read RIJ are already experts at creating retirement income. Some of you have even created and marketed your own software. But for other advisors, especially those still wired for risk (as opposed to risk-mitigation), decumulation may represent a strange new landscape. They may need a structure—a financial GPS, so to speak—in order to orient themselves in it.

Researching, evaluating, and ultimately choosing an income-planning tool can be, by most accounts, a trial-and-error process. One software specialist warned us that trying to compare tools is a bit of a fool’s errand, since they’re “all over the map” in terms of price and capabilities. “To make it more difficult, every producer you talk to likes his or her software best,” he said.

All the more reason for us to try to shed some well-deserved light on the subject. There’s really no alternative. The Boomers are streaming into retirement, and they’ll need effective, affordable and mass-customized guidance from independent advisors.

Four Income Planning Tools

Posted on January 4, 2012 by Joel Bruckenstein -

Building good retirement income software is challenging. The field of retirement income planning itself is still evolving, and the software supporting those efforts is evolving along with it. Numerous approaches to generating a retirement income plan are currently available.

We’ve profiled a handful of lesser-known yet valuable applications, each designed to create meaningful retirement income planning results with minimal data entry. These thumbnail sketches of the products should serve as a starting point for anyone in the market for a targeted retirement income software solution. (Photo, Joel Bruckenstein.)

Firm: Torrid Technologies

Product: Retirement Savings Planner–Professional Edition

URL: http://www.torrid-tech.com/rp_main_pro.html

If you want something quick, simple to use, and easy for clients to understand, Retirement Savings Planner–Professional Edition, from Torrid Technologies, Inc. is worth a look. It addresses the pre- and post-retirement planning periods.

After you enter the client’s assets, liabilities and projected cash flows, an interactive graph illustrates his or her projected income, outflows and potential shortfall, if any, on a yearly basis. As you change assumptions (about rates of return, life expectancies, etc.), the graph immediately reflects the changes. A spreadsheet view provides a more granular depiction of each year’s cash flows.

Unfortunately, the planning options of the RSP are limited, as is its methodology. All calculations are on a fixed, straight-line basis. As a result, this tool is probably best suited as a first-line diagnostic tool for mid-market clients as opposed to a planning tool for more sophisticated clients.

Firm: Impact Technologies Group, Inc.

Product: Retirement Road Map

URL: http://www.impact-tech.com/products/retirement-road-map/

According to Impact Technologies Group, Inc., its Retirement Road Map is “a sales system that helps advisors chart retirement courses for baby boomers.” Retirement Road Map is a good example of the “bucket” approach to retirement income planning. Some in the industry believe that clients understand retirement income planning better when the process is broken down into smaller pieces.

Retirement Road Map divides the retirement years into four phases, and creates a separate sub-plan for each phase. Its illustrations also include a pre-retirement phase for those who have not yet retired. The pre-retirement phase allows pre-retirees to make changes to their plan, such as saving more or delaying Social Security benefits, before they retire.

Each retirement phase has a different set of assumptions. For example, in the early phase of retirement, it might be assumed that the clients require 90% of pre-retirement income for monthly expenses. Since the early retirement phase will start in five years, the application might recommend a conservative portfolio (assumed growth rate of 3%) or a very conservative portfolio (2% rate) to preserve capital. For the survivorship portfolio, which begins perhaps 20 or 25 years out, the application might suggest a portfolio that is initially aggressive, but then becomes more conservative over time so that the capital will be available when needed.

As in the Torrid Technologies product, all numbers are computed on a yearly basis and the default calculation uses a straight-line methodology. Retirement Road Map does, however, allow the user to include a “what-if” scenario. For example, you can illustrate the impact on a plan if an illness necessitated spending an additional $5,000 per month for five years, as well as the impact of that spending on the overall plan. You can also illustrate the impact of adding an annuity to the mix.

Firm: OMYEN

Product: Sustainable Retirement Income Planner (SRIP)

URL: https://www.omyen.com/

OMYEN offers a number of innovative products for planners and individuals. The Personal Financial Index (PFI module) is essentially an interactive client questionnaire with some basic calculation capabilities built in. It calculates a score designed to be a single numerical estimate of the client or prospect’s overall financial health, in much the same way that a FICO score is meant to represent a person’s creditworthiness. The SRIP leverages the information collected when compiling the PFI score to arrive at a Retirement Income Schedule.

After the advisor and client enter the necessary data, the tool generates a report. At the top of this report are graphs indicating the portfolio balance drawdown over time, the net income or cash flow withdrawn over time, and a chart showing discretionary, non-discretionary and total expenses over time along with the net income over time.

Below the graphs, the application provides a chart of the expected cash flow on a yearly basis. This chart includes the age of the client(s), estimated distribution; the portfolio(s) from which the withdrawal comes from, the beginning and ending estimated portfolio values, estimated taxes, Required Minimum Distributions and more. All of these calculations assume a constant rate of return and a constant inflation adjusted withdrawal rate throughout retirement, although advisors have the option of running Monte Carlo simulations as well.

The program automatically sets aside money to cover specified legacies. It can also set aside funds to cover longevity risk if the client’s health profile indicates a necessity to do so.

Firm: Fiducioso Advisors

Product: Income Discovery

URL: http://www.incomediscovery.com/

According to the folks at Fiducioso Advisors, the “efficient frontier” used by investment professionals isn’t suited for retirement income planning because it doesn’t adequately deal with the risks that concern retirees.

To better address retirement income planning risks, they developed Income Discovery, a web-based application that addresses the interplay between four factors: Level of sustainable income, plan failure rates, the potential lifespan of a portfolio in a “bad case” scenario, and the portfolio’s average terminal value.

Suppose, for example, that the application calculates a 15% chance that a given portfolio will expire before the clients do. That may be unacceptable to the client, who insists on at least a 90% probability of success. With the click of a mouse, the advisor can constrain the scenario to a failure rate of 10% or less.

The program will then recalculate the other factors to arrive at a solution. The revised result might be a lower monthly income, a different asset mix, or a combination of both. The client can immediately see the impact of a change in portfolio failure probability on the other factors. The client and advisor can then work through multiple scenarios and trade-offs to arrive at a solution that is acceptable to the client.

Perhaps the client encounters a conflict between achieving a desired level of income and leaving a certain legacy to heirs. The application can, by modeling the purchase of an immediate annuity with a portion of the portfolio, precisely quantify the trade-off between generating a certain monthly income and leaving a certain legacy. Armed with this information, clients can make more informed decisions about allocating their wealth.

The program can also model tradeoffs between three retirement income strategies: a systematic withdrawal plan from a diversified portfolio of stocks, bonds, and cash; a joint and survivor annuity (the default choice is one that pays 100% of the benefit when both spouses are alive and then pays 75% of the benefit after the death of the first spouse); and a maturity matched portfolio (MMP).

A maturity-matched portfolio works like a bond ladder, with the exception that you don’t roll over the principal. With a MMP, the interest (if any) and the principal supply a cash flow for a stated period of time. For example, if you wanted to provide income for each of the next five years, you could buy zero coupon bonds with maturities of 1, 2, 3, 4, and 5 years. At the end of the five years all principal and interest from the portfolio would be depleted.

MMPs help insure against the risk of a bad sequence of returns by ensuring the required cash flow for the desired period of time. Admittedly, MMPs aren’t the only way to provide stable cash flows. You could, for example, hold the required funds in cash. With very short-term rates near zero, MMPs may be preferable.

The application’s ability to illustrate a portfolio composed partially of MMPs is appealing. Even more appealing is its ability to illustrate the “cost” of extending the MMP period. You can run a scenario that extends the MMP period from three to six years and see the impact of such a change on the asset mix and the cash flow.

As you can see, retirement income software applications can vary widely in their methodologies and still get the job done. Retirement Planning Software and Sustainable Retirement Income Planner, though very different, are both easy to use. Income Discovery’s approach is more sophisticated than that of Retirement Road Map, yet both should work equally well with clients. No single product suits the needs of all advisors, but the marketplace offers enough choices to satisfy most buyers.

incomeforlifemodelad

Posted on January 4, 2012 by Editor Test -

White succeeds Bhojwani as president and CEO of Allianz Life

Posted on December 21, 2011 by Editor Test -

Walter White will succeed Gary C. Bhojwani as president and CEO of Allianz Life Insurance Co. of North America, effective January 1, 2012. Bhojwani will remain in Minneapolis as chairman of Allianz Life, with responsibility for the U.S. insurance operations of Allianz on the board of management of Allianz SE, Munich.

White (pictured at left) joined Allianz Life in 2009 as chief administrative officer responsible for compliance, information technology, operations, and suitability. A new CAO for Allianz Life will be named.

Prior to joining Allianz Life, White was president of Woodbury Financial Services (Hartford Life’s independent broker/dealer). He led the formation of Woodbury Financial after Hartford Life purchased Fortis Financial Group in 2001.

At Fortis, White held senior leadership positions in operations, finance, marketing, and sales. Before joining Fortis, White was also president of MONY Brokerage, the MONY Group’s life insurance brokerage subsidiary.

White holds a Bachelor of Arts degree from Yale University and an MBA from The Wharton School at the University of Pennsylvania. He holds a Chartered Life Underwriter (CLU) designation.

The Bucket

Posted on December 21, 2011 by Editorial Staff -

Euro-crisis triggers “review with negative implications” for AXA

The financial strength rating (A+, Superior) and issuer credit ratings (aa-) of AXA Equitable Life Insurance Co. have been placed under review with negative implications by A.M. Best Co. The ratings agency also instituted a similar review of the ICR (a-) of AXA Financial and the debt ratings of AXA Financial and AXA Equitable.

The actions stem from exposure of the companies’ French parent, AXA S.A., to the ongoing eurozone financial crisis, which A.M. Best described as “the continued deterioration of the sovereign creditworthiness of several eurozone countries and the negative economic outlook for the region.”

The review will remain in effect while A.M. Best examines the organization’s exposure to a prolonged adverse economic environment within the eurozone and the potential impact on its U.S. life insurance operations.

“Downward rating pressure may occur if there were a worsening of the AXA Group or AXA Financial life insurance subsidiaries’ risk-adjusted capitalization tied to investment losses, a deterioration of the operating environment in key territories of the parent or a perceived lessening of support for the U.S. insurance operations,” A.M. Best said in a release.

Besides AXA Equitable Life, the review affects MONY Life Insurance Co. and MONY Life Insurance Co. of America. In addition, the A (Excellent) and “a+” issuer credit ratings of AXA Equitable Life and Annuity Co. and U.S. Financial Life Insurance Co. are under review with negative implications. The “a” debt ratings on $350 million in 7% senior unsecured debentures, due 2028, issued by AXA Financial Inc. and $200 million on 7.7% surplus notes, due 2015, issued by AXA Equitable Life Insurance Co. were also under review with negative implications.

Prudential to sponsor National Retirement Risk Index

Prudential Financial will be the exclusive sponsor of the Center for Retirement Research (CRR) at Boston College’s National Retirement Risk Index, Prudential said in a release.

The Index measures the percentage of working-age Americans at risk of failing to maintain their standard of living in retirement. As its sponsor, Prudential will underwrite a number of studies conducted by the CRR related to the Index.

The National Retirement Risk Index reflects the changing retirement landscape. According to the Index, the percentage of households at risk of not being able to maintain their standard of living in retirement rose to 51% in 2009 from 30% in 1989. The next update of the Index is scheduled for the spring of 2012.

“Retirement needs are increasing due to longer life spans and rising health care costs, while retirement resources are shrinking due to declining Social Security replacement rates and insufficient savings in 401(k)s,” said Alicia Munnell, director of the Center for Retirement Research.

MassMutual launches new retirement plan investment option

MassMutual’s Retirement Services Division has launched MassMutual Barings Dynamic Allocation Fund, with management by MassMutual-affiliate Baring International Investment Limited. The fund is offered to MassMutual’s plan sponsor clients and their advisors.

The new Fund relies on Barings’ dynamic multi-asset strategy, which has been in operation since 2002, to combine investment types from across the risk/return spectrum. The portfolio includes stock and bond investments from developed and emerging economies as well as real estate, commodities, and other investment vehicles.

Barings portfolio managers have discretion to increase exposure to investments with growth potential when they anticipate growth markets and hold more defensive alternatives when they anticipate weaker markets.

Barclays Wealth hires five to serve HNW clients in New York

Barclays Wealth has appointed five Investment Representatives to its New York office, bringing the total number of new advisors hired in the Americas this year to 50.

Jack Broderick and Bill Belleville, CFA, join as managing directors from Credit Suisse Private Banking. Broderick and Belleville have more than 40 years of combined experience in wealth management, trading and solutions development for high net worth individuals and family offices.

Broderick spent 15 years at Credit Suisse, initially running the Monetization Services Group, an equities trading desk. In 2000, he moved to London to develop a similar platform for European clients. He returned to New York three years later as a relationship manager in Private Banking. Prior to Credit Suisse, Broderick managed the Execution Services Desk at Lehman Brothers for seven years. He holds a B.A. in mathematics and economics from Bucknell and an M.B.A. from Fordham.

Belleville, CFA, joined Credit Suisse Private Banking in 2001 to design customized solutions for high net worth clients. Prior to Credit Suisse, he specialized in fixed-income derivatives and structured products in roles at Merrill Lynch, Cantor Fitzgerald Securities, and First Continental Trading. A CFA charterholder, Belleville holds a B.S. in economics from Cornell, an M.B.A. from the Wharton School, and an M.A. in International Studies from the School of Arts and Sciences at University of Pennsylvania. He sits on the Board of Trustees of The Albany Academy.

Barclays Wealth also hired Michael Gordon, Scott Madison and Jonathan Sopher as advisors in New York. Gordon and Madison join as Directors from Credit Suisse Private Banking, where for the past three years they specialized in serving high net worth clients. Previously, Gordon worked for six years in the Private Client Group of Jefferies & Co. He holds a B.S. in Business and an M.B.A from the University of Chicago.

Prior to Credit Suisse, Mr. Madison worked in the Markets Coverage Group in Goldman Sachs’s Private Bank and in Jefferies’s Private Client Group. He holds a B.S. in Accounting from Indiana University.

Jonathan Sopher joins as a Director and brings 17 years of wealth management experience to his new role at Barclays Wealth. Previous roles included serving as a financial advisor at Jefferies & Co., Wachovia Securities and Prudential Securities. He holds a B.A. in Business Communications from California State Northridge.

The five new New York-based Investment Representatives report to Mark Stevenson, regional manager for New York.

New kit to help plan sponsors comply with fee disclosure regs

To help plan sponsors comply with Department of Labor rules for fee disclosure in 2012, 401k Pro Advisor, a division of Wealth & Pension Services Group, Inc., is providing needed fiduciary reviews and cost analysis to assist 401k plans in evaluating the new information.

Under the new rules, known as 408(b) and 404(a), retirement plans will receive fee disclosures from their service providers that are intended to allow plan sponsors to tell whether vendor fees are reasonable and to reveal hidden compensation and conflicts of interest.

Compensation is defined to include “both direct and indirect and applies to the service provider, its affiliates or subcontractors.” Service providers must disclose if they are acting in the capacity of a fiduciary to the plan. In many instances, this will be a “no,” which will be a surprise to many plan sponsors.

“As a fiduciary, the plan sponsor is duty-bound to understand, review and monitor this newly disclosed information,” says William Kring, chief investment officer of Wealth & Pension Services Group, Inc. and founder of 401k ProAdvisor.

Plan sponsors may find it difficult to evaluate this new information against a standard of “reasonableness” as required by ERISA, according to Kring. Also, participants will raise alarms as they realize they pay for most plan expenses. A recent survey by AARP showed that 74% of participants do not know they pay for plan expenses.

ERISA requires that plan sponsors hire prudent experts to help them with determinations of reasonableness. 401k ProAdvisor’s 408b2 Rules Kit and consulting services “will take the burden off plan sponsors to evaluate the disclosure information that will be forthcoming,” the company said in a release.

“Further, 401k ProAdvisor will identify fiduciary breaches, conflicts, cost control issues, and highlight areas that need additional fiduciary follow-up. If necessary, 401k Pro Advisor can negotiate fees across service providers to meet the test of reasonable compensation,” the release said.

About those Embedded Derivatives

Posted on December 21, 2011 by Kerry Pechter -

The final week of 2011 seems like a suitable moment to ask if the life insurance industry’s romance with variable annuities with lifetime income riders has been, on the whole, a net positive or a net negative experience.

The industry’s lobbyists insist that VAs currently enjoy the best of times. Indeed, sales rebounded in 2011, as more Boomers entered the so-called retirement red zone and sought what VA riders advertise: downside protection with upside potential.

But so many VA issuers either exited the business in 2011, or curtailed distribution, or announced charges against earnings, or failed to recover enough of their acquisition costs (“DAC unlocking”) or reduced their benefits, that it might be described as the worst of times.

It seems reasonable to ask if the GLWB concept was a regrettable experiment in financial engineering, a good idea overzealously sold, a transitional product paving the way for something more sustainable—or perhaps a great idea that fell victim to a Black Swan market?

Those questions lead to more questions: Will companies that left the VA space return to it when markets normalize? Will CEOs shrug off this year’s charges against earnings as nothing but margin calls—or will they lose their appetite for VAs?

Will the industry consolidate so much that the survivors can’t satisfy Boomer demand? Will issuers de-risk the payout rates and the investment options so much that the product loses its sizzle?

In short, what lies ahead for the variable annuity with a guaranteed lifetime withdrawal (or minimum income benefit), as a solution to the Boomer retirement dilemma?

Embedded derivatives

Answering these questions is difficult, and not just because the future remains so uncertain. It’s difficult in part because the industry’s many players—issuers, intermediaries, and customers—are affected so differently.

Among the issuers alone, there are publicly-held companies and mutual companies, domestic and foreign-domiciled companies, companies with huge blocks of business and others with small ones, etc. Some companies have bigger balance sheets, more diversification and more sophisticated hedging operations than others.

For those who have the skills to read and interpret them, financial statements are good places to seek answers to certain questions—like how badly companies were hurt by market turmoil in 3Q 2011.

Mutual companies do not file SEC documents, of course, but public companies do. They have to report the value of their “embedded derivatives,” which is an accounting term for the long-dated options that VA marketers call lifetime withdrawal benefits.

“The guarantee is in effect a put option to the policy holder,” an insurance specialist at a major accounting firm explained to RIJ recently. “For accounting purposes, it gets classified as a derivative. It’s essentially similar to the annuitant going out and buying an option on the market. And it has to be ‘fair valued.’ During times of economic stress, when the account value starts going down, the guarantee becomes more and more valuable.”

These valuations are buried in the 10-Q statements that VA issuers filed. Sometimes they’re dismembered and the parts are buried in several locations, the accountant said. That can makes it difficult to assess the damage.

At The Hartford, for instance, which still has $66.7 billion in VA assets under management but added only a cautiously meager $194 million in sales in the third quarter of 2011, the losses on its book of VA business seemed significant—but it’s hard to tell.

Under the Fair Market Measurements on The Hartford’s 3Q 2011 10-Q, the company’s VA hedging derivatives and macro hedge program was valued at $1.7 billion and the amount reinsurance recoverable on its living benefits was listed at $3.0 billion. In the liability section of the same table, a negative value of $5.9 billion was reported for living benefits.

A later page in the 10-Q said that, “As of September 30, 2011, 63% of all unreinsured U.S GMWB ‘in-force’ contracts were ‘in the money’ … the ultimate amount to be paid by [Hartford], if any, is uncertain and could be significantly more or less than $3.2 billion.”

That sounded like a lot, but subsequent language made the immediate pain sound milder, though significant: “In the third quarter, Hartford reported a $118 million net pre-tax realized loss on its U.S. GMWB liabilities (net of dynamic and macro hedging programs) and a $247 million charge resulting from a loss on GMWB-related derivatives.”

The 10-Qs of other major VA issuers were just as intriguing—and just as hard for a layperson to interpret or evaluate.

At MetLife, the latest 10-Q seemed to show that hedges had protected the company against the rising in-the-moneyness of its guaranteed minimum income benefit, which is an option to annuitize a protected amount.

“The favorable change in net derivative gains of $2.9 billion” over the previous year “was driven by a favorable change in freestanding derivatives of $4.4 billion which was partially offset by an unfavorable change in embedded derivatives of $1.5 billion primarily associated with variable annuity minimum benefit guarantees,” the MetLife 10-Q said. It looked like MetLife’s risk management strategy was working.

The 10-Q filed by Prudential, which traded places with MetLife as the top seller of VAs in 2011, also showed a positive balance on its hedging and embedded derivatives positions, but mainly because of NPR, or non-performance risk—a factor related to Prudential’s overall financial strength and ability to pay its bills.

“As of September 30, 2011, the fair value of the embedded derivatives in a liability position was $8.9 billion,” the quarterly report said (p156). “The cumulative adjustment for NPR was $5.7 billion, which decreased these embedded derivative liabilities to a net liability of $3.2 billion as of September 30, 2011.”

In a table on the same page, however, the change in the fair value of the embedded derivatives was [negative] $8.1 billion and the change in the fair value of the hedge positions was a positive $4.9 billion. But because of NPR, it ended up, all told, $1.295 billion to the good.

Despite those positive numbers, Prudential’s “adjusted operating income for the third quarter of 2011 included $435 million of charges from adjustments to the reserves for the GMDB and GMIB features of our variable annuity products and to amortization of DAC and other costs, compared to $412 million of benefits included in the third quarter of 2010,” the 10-Q said. (p. 147).

The accountant quoted above told RIJ that these numbers (or “valuations”) would probably change in the long run but that they could cause pain in the short run.

“As markets improve, [these losses] could reverse themselves, and hopefully they will,” said the accountant quoted above,” he said. “In theory, if they got number crunching right, they should come out ahead, but at any given point in between, they are asked to measure liability as though it could all be invoked today.

“There’s no way to prove otherwise, so the you book the liability based on current best estimate,” he added. “It’s an ‘accounting blip’ only if you believe the market will reverse itself. In the meantime, it potentially puts them in a position where they may have to bolster their capital or cut back on sales because they don’t want any more of that liability.”

Share prices

Compared to the forest of numbers in the SEC filings, the share prices of life insurance companies are much easier to interpret. Those prices have trended steeply downward this year—more steeply than the overall market averages.

Indeed, life insurers have experienced an angry bear market in 2011. Losses in market capitalization have been massive at MetLife (-32%) and Lincoln Financial (-36%), and merely serious at Prudential Financial (-16%).

But what role does VA in-the-moneyness play in those low valuations, either as cause or effect? Not nearly as much as macroeconomic conditions overall, says Steven Schwartz, a Chicago-based life insurance analyst for Raymond James in Chicago.

“Even the life insurers that don’t sell variable annuities have low share prices,” Schwartz told RIJ. “It’s macro stuff that’s driving the valuations. By that I mean the low interest rates, which are driven by a flight to quality, by Europe’s problems, and by Operation Twist. Low rates aren’t going to kill anybody, but it will certainly slow down earnings growth.”

Variable annuities, whose guarantees are collateralized by equity values and whose hedging programs cost more when interest rates go up just happen to be one of the products most adversely affected by current market conditions, Schwartz added. Other products in that category are secondary guarantee universal life and long-term care insurance.

“Lincoln Financial is probably the best example of that,” he said. “It is a major player in variable annuities and secondary guarantee universal life. But all the life insurers are all down, and that reflects investor fears that rates will stay where they are for a long time.”

Sharing the life insurance industry’s own view, Schwartz believes that demographics and risk aversion still favor the variable annuity issuers.

“The demand for variable annuities remains very strong. The cost of riders has gone up and the guarantees are less attractive than they were, yet there is such a high amount of risk aversion in populace that sales will remain strong and most sales still include the income riders,” he said.

“At some point the numbers could work out that the product is just not that compelling,” Schwartz conceded. “But people have to do something with their money, and a five-year CD isn’t compelling, a fixed annuity isn’t compelling, the stock market isn’t compelling and 10-year Treasuries at 1.8% aren’t compelling. Nothing is historically compelling.”

The future of VAs

Going forward, VA watchers expect certain things. They expect companies that have dismantled their variable annuity wholesaling networks to have difficulty re-starting them at some future date. They expect the industry to continue to consolidate. They expect contracts to promise less and shift risk onto the contract owner. Some expect the retrenchment of the VA to create opportunities for non-annuity solutions.

For VAs specifically, the big trend is risk reduction. To use an automotive comparison, the VA will be less like a big-finned, fuel-guzzling 1959 Cadillac Eldorado and more like a 2012 Subaru with front, side and rear airbags and a five-star crash rating. This trend is well underway.

VA issuers “are all trying to reduce some the risk that comes from volatility, either through constant volatility funds or CPPI [constant proportion portfolio insurance],” said Ryan Hinchey, an actuary who recently launched NoBullAnnuities.com. “We’re rounding that corner and there’s no way companies can stick around without taking those risk management measures.

“To protect themselves from the DAC [deferred acquisition cost] issue”—that is, the danger of advancing generous incentives to brokers and advisors—“companies have gotten away from the B share product. There’s also been some innovation aimed at managing that risk by having the consumer pay premium-based rather than account-based fees,” he added.

In writing put options on the securities markets, insurers revealed a bit of naiveté, Hinchey acknowledged. “Companies underestimated certain risks. They placed guarantees on mutual funds, for instance, when they knew that they could only use hedge instruments that mimic index funds,” he said. “When companies were running their own Doomsday models, they weren’t taking that into account. But it’s still a young product, and over time companies have figured out how to better manage the risks.

“Certainly the product will be a lot tamer in the future, especially with the constant volatility funds. There will also be a heavier focus on index funds that are easier to hedge, and companies won’t get too crazy with the roll-ups. Low interest rates will certainly make it a lot tougher to offer roll-ups,” he predicted.

“Fringe players will continue to disappear. But going forward, I think some of the bigger issuers feel confident that they’ve finally gotten it right. Sometimes you need the experience of getting hit hard and having to figure out how to get it right the next time.”

VA sales might fall in the near future, he said, but not dramatically. “I don’t think sales will drop to half of the current $150 billion a year,” he said. “But the products will be different and more conservative. I expect to see a reshuffling of the top few players. I expect MetLife and Prudential to scale back,” he added.

In the long run, will the product be a mainstay for retired Boomers, or will it play a niche role in generating lifetime income? Perhaps the GLWB’s appeal was built primarily on claims and promises—of liquidity, guaranteed lifetime income, rising payouts, a legacy for one’s heirs, generous commissions for advisors and big profits for shareholders—that are unrealistic in any environment other than a raging bull market?

In other words, was the product, in its past incarnations at least, a failure, and will it fail to be the ‘killer app’ for Boomer retirement?

To couch the GLWB in such terms is to create a straw man, countered Tamiko Toland, who covers variable annuities as managing director for Retirement Income Consulting at Strategic Insight. She sees the VAs’ difficulties as part an evolution in retirement income solutions rather than as a defeat.

“The GLWB never was a ‘killer app,’ though it may have looked like one under certain market circumstances,” Toland told RIJ. “I think the GLWB is just one of an emerging suite of product solutions that will meet consumers’ needs in different ways. The companies that intend to stick with this market are the ones that have a vision of a future that is not defined by GLWBs—or at least not by the products as they look today.

“Retirement income protection is still a very valuable service to provide, but a boom lulled people into thinking that they could have their cake and eat it too. That was never true of GLWBs, even in the best of times, though it wasn’t evident to everybody. Maybe this is a bit of a reality check.”

Low Growth, High Inflation? It Could Happen.

Posted on December 19, 2011 by Editor Test -

Economics really is a dismal failure. It started out as a neat mental set of images that helped people understand the world. You were never really expected to find evidence for these mental pictures let alone start to run countries on the basis of it. In many respects, things were fine for economics while the facts were, by and large, hidden. The collection of data on a wholesale basis was for a very long time blissfully difficult to do. Testing economic theory against what actually happened remained a minority activity.

A case in point is the so-called Phillips Curve, which, plainly put, says that, as unemployment increases, so inflation decreases. The idea is logical – a reduction in demand because of increasing unemployment causes producers to reduce prices to bring the system back into equilibrium, and the fillip to the economy helps kick-start the cycle all over again. It’s a nice sensible picture. The trouble is, it doesn’t work.

Take, for instance, the Phillips Curve for the US. It looks more like someone has taken a shotgun to a barn door. You could get a computer program to draw a straight line or polynomial curve through it, but it would be a fanciful argument that led you to positing any kind of deterministic relationship. Data collection has debunked a rather nice idea.

But this is too harsh. Interestingly, the relationship varies from nation to nation and on what length of time of data you include. For instance, Japan shows a startling coincidence between theory and practice over the long term. The question arises as to why it is not universally applicable at all times and in all circumstances and to all nations.

The key seems to be, ‘the larger your deficit with the rest of the world, the more chaotic your Phillips Curve.’ In other words, the more you have an external deficit (as much as to say a dependency on other people’s money), the more your currency will flip around. In turn, this means your domestic inflation rate becomes more chaotic and less related to your correcting unemployment rate as the Phillips Curve would dictate.

Japan has a very strong external balance and a strong Phillips relationship. The UK and US have large external deficits and terrible Phillips Curves. Europe once had a large positive balance with the rest of the world and a Phillips Curve that was respectable. Lately, the region has slumped into deficit, explaining why, even with unemployment of 9% across the European region, inflation remains at 3% when it “should” be less than 1%.

The consequence of deficit reduction, the new mantra of the West, will be low growth and high unemployment. Believers in the Phillips Curve are expecting inflation to fall rapidly and even deflation to set in. But since we are now systematically in deficit and at the sway of the currency markets, this is not a foregone conclusion. In fact, the opposite may happen as our currencies decline. At the very least, inflation will stay much higher than policymakers are expecting or markets are currently anticipating given the level of unemployment.

For instance, over the next 10 years, US inflation is (according to the markets) expected to average just 2%. In the UK, the figure is 2.6%. These numbers are ridiculously low if we have lost control of our own domestic inflation rate. The combined effects of chronic external dependencies (both in terms of deficit funding and trade), the fragility of our currencies and the ability of emerging nations to buy the basic stuff of life from underneath us because they have money in the form of reserves could send inflation materially higher or keep it at the levels we are experiencing today. In anything other than the magical realism of some financial commentators, investors should be compensated for this with higher nominal yields and higher implied inflation rates from the markets. Neither of these things is happening at this time. The lack of compensation is just not something that can go on forever.

From our point of view, there are things we can do about this. Buying inflation-linked bonds in the US and UK are the obvious outlets, but, should ‘real’ yields rise, just buying inflation-linked bonds won’t be enough to create a positive return. Any rise in yields will cause index-linked bond prices to decline because even an index-linked bond possesses a duration – the rise and fall of prices as yields fall and rise.

Instead, we want access to the inflation aspect without the duration effect. To do this, we have been buying inflation-linked bonds and selling government bond futures against them. This way, as inflation expectations rise, the combined pair of a long and short makes money in an environment that is normally hostile to bonds. Conversely, if inflation expectations fall, the pair will experience a loss.

So far, this strategy appears to be working – in the US at least, where inflation expectations are rising. We suspect we will be doing more of this trade in the future, but there’s plenty time yet.

Stewart Cowley is head of fixed income at Old Mutual Asset Managers.

See you in the new year!

Posted on December 19, 2011 by Editor Test -

Fitch calls U.S. life industry “stable,” but notes concerns

Posted on December 19, 2011 by Editor Test -

In a new bulletin, “2012 Outlook: U.S. Life Insurance,” Fitch Ratings calls industry “stable,” but says it expects the “positive trends in industry earnings performance and investment results reported in 2011 to be pressured in 2012 due to the low interest rate environment, increased hedging costs, and ongoing market volatility.”

Among other things, the bulletin said:

Fitch expects that the industry’s large in-force book of variable annuity business will continue to be a drag on profitability over the near term. It could also cause a material hit to industry earnings and capital in an unexpected but still plausible severe stress scenario.
Near-term impacts due to low interest rates include reduced interest margins and increased statutory reserving associated with asset adequacy testing which could reduce statutory capital level by up to 5% in the fourth quarter of 2011. Insurers with defined benefit pension plans for their employees will face increased pension funding expenses in 2012.
Fitch remains concerned about the risk profile of the variable annuity (VA) business. Through the sale of VA products with secondary guarantees, insurers effectively have a short embedded-equity put exposure, the value of which is sensitive to interest rates and volatility.
Leading up to the 2008–2009 financial crisis, a key concern was the effectiveness of the industry’s variable annuity hedging programs. While the hedging programs that were in place were generally effective in mitigating losses from VA embedded guarantees, the industry was clearly under-hedged, relative to certain risks, and did experience a degree of hedge ineffectiveness.
Fitch believes that the industry has strengthened and expanded the scope of the VA hedging programs following the financial crisis. However, the industry’s hedging programs continue to be challenged by policyholder behavior risk, hedging costs, sensitivity to tail risk, and the long dated nature of the liability.
Policyholder behavior risk relates to pricing assumptions on lapsation, living benefit utilization, and mortality. Emerging experience is indicating that the industry’s assumptions may have been too aggressive, as a number of insurers have increased reserves in 2011 to reflect emerging experience. Fitch expects this trend to continue.

Andrew Davidson, CFA, one of the Fitch analysts who wrote the report, shared his views with RIJ about the charges against earnings and other adjustments that some life insurance companies reported at the end of the third quarter of 2011, as a result of changing market conditions and emerging trends in policyholder behavior.

“The products’ benefit features often have delayed benefit options, and the policyholders are just beginning to make decisions about them. The companies priced certain assumptions about utilization of benefits, and they’re in the process of getting more data points about it, and of adjusting their assumptions to match their experience,” he said.

“That’s what’s going on right now. If they made accurate assumptions, they don’t need to make reserve changes. It’s a company-by-company issue. A Prudential or a MetLife has more diversification of business outside of variable annuities than some other companies.

“Some companies will target hedging to reduce volatility in income, others to protect statutory capital, others to protect economic value of their book of business, so it’s difficult to make comparisons between companies. If the charge is not outsized in comparison to the book of business, ratings would not likely be affected. The companies can also make adjustments to their books of business.

“When you add to reserves it comes out of capital, so from a financial perspective you’ve got less capital. So the higher reserve and the lower capital are more representative of the true economics. The hedges offset some of the need for reserves; if hedging is not effective you have to reserve more.”

TD Bank predicts 2% growth, 8.8% unemployment in 2012

Posted on December 19, 2011 by Editor Test -

Despite signs of progress over the last few months—the economy grew at an annualized rate of 2% in July and September—the U.S. recovery remains vulnerable, according to a report released by TD Economics, an affiliate of TD Bank.

Although TD Economics projects 3.2% growth in the closing months of 2011—“economy’s best quarterly performance since mid-2010”—it expects growth of only about 1.9% during 2012 and 2.3% in 2013. The unemployment rate is expected to remain elevated at 8.8% by the end of next year, and 8.4% by 2013.

The main headwinds, according to the report, are “financial market volatility, Europe’s dual banking and fiscal crises, and a highly polarized U.S. Congress,” as well as “overzealous fiscal restraint in Washington.”

A “disconnect” exists between positive economic performance and persistent economic pessimism among businesses and households, which seems to discount modest improvements in commercial bank lending, employment, credit quality, and credit delinquency rates since the financial crisis.

TD Economics forecasts the eurozone economy to contract 1.2% in 2012. “Though the U.S. banking system has relatively small exposure to the debt of the most troubled periphery nations, a failure on the part of European policymakers to contain the crisis could lead to financial contagion migrating West,” the report said. “The eurozone’s governing structure was not built to take on the kind of extraordinary decisions at the kind of extraordinary pace the situation requires.”

The failure of the Congressional “supercommittee” to reach consensus on deficit reduction may lead to steep spending cuts by 2013, and “partisan jockeying” on the payroll tax cut and emergency unemployment benefits could reduce economic growth by 0.7% next year, the report added. 234 – tasked with drawing up plans to bring the country’s deficit trajectory under control – failed to reach a consensus. As a result, steep spending cuts are slated to come into place by 2013. Partisan jockeying has left Congress at an impasse over whether to extend this year’s payroll tax cut and emergency unemployment benefits into 2012. Failure to do so could result in as much as a 0.7 percentage point drag on economic growth next year.

Euro-crisis triggers “review with negative implications” for AXA

Prudential to sponsor National Retirement Risk Index

MassMutual launches new retirement plan investment option

Barclays Wealth hires five to serve HNW clients in New York

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