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(Sheryl) Moore’s Law on Annuities in 2021

Posted on June 17, 2021 by -

A preliminary peek at Wink’s first-quarter 2021 Annuity Sales Report has just arrived here at Retirement Income Journal, as it does every June as part of a joint effort of RIJ and Wink to bring the annuity market into sharper focus for my readers and Wink’s clients.

We’ve been distilling the report’s 90 pages for insights. We’ve interviewed Sheryl Moore, the owner of Wink, Inc., to hear her takeaways from the report—a 3-D snapshot that assembles current and historical data about issuers, products and distributors in one place.

Traditional variable annuities (VAs) and multi-year guaranteed rate fixed annuities (MYGAs) still account for more than half of new sales ($21 billion and $13.3 billion, respectively), in the first quarter), with Jackson National dominating the VA category and New York Life MYGAs.

But the energy in annuity sales has shifted toward index-linked products. Fixed indexed annuities and registered index-linked annuities (RILAs, aka structured annuities) sold a combined $23.4 billion in the quarter ($14.4 billion and $9.1 billion, respectively.

The extended interest rate drought has driven that shift in a couple of ways. With safe bond yields chronically depressed, FIAs or RILAs try to offer competitive caps and participation rates by giving policyholders products that offer partial exposure to equities through the purchase of options on equity indices.

The shift to indexed products has also been driven by the entrance over the past ten years of new or under-new-management insurers like Athene, Fidelity & Guaranty Life, Global Atlantic and others. They are a source of illiquid assets to their asset-manager partners (Apollo, Blackstone, and KKR, respectively) who use them to buy high-yielding bundled securities.

Wink’s data showed that annuity purchasers range in age from 45 to 80, but most fall between the ages of 60 and 69. The average premium for policies ranges from about $100,000 to $200,000. As clients get older, they tend to buy more conservative annuities.

The average age for VA purchasers is 60, for structured annuities, 63, for indexed annuities, 65, and for MYGAs, age 69. Average premiums run in the opposite direction, with VAs attracting the most money ($224,700, on average) and MYGAs attracting the least ($128,800, on average). 

Overall, annuity sales totaled $58 billion in 1Q2021, according to Wink. That was 3% more than the fourth quarter of 2020 and 10% more than the first quarter of 2020. According to the Investment Company Institute, life insurers manage or administer some $2.46 trillion in annuity reserves for Americans (out of about $35.4 trillion in retirement savings). Of that amount, about $2.1 trillion is in variable annuities, whose underlying assets are mutual funds, according to Morningstar. 

The life of RILAs

RILAs have seen the greatest increases in sales in recent years ($9.05 billion in 1Q2021, 86% higher than 1Q2020). Just ten companies account for 99% of the sales in this category. The product has been a life-saver for big life insurers who needed an alternative to VAs with living benefits. The guarantees of those generous products were difficult to support at low interest rates.

Equitable (then AXA Equitable) introduced the structured annuity (a relative of a security called a structured note) in 2010. Equitable was the top issuer of RILAs in 1Q2021, with a nearly 20% market share, but Prudential’s FlexGuard contract, introduced in 2020, was the top-selling RILA for the quarter.

“The structured annuity is the golden child right now,” Moore told RIJ. “It’s relatively new, and everybody likes a bright shiny new object. Also, the current pricing is so difficult right now for fixed indexed annuities that structured annuities look much more attractive by comparison. The shift away from variable annuities with living benefits has also helped the RILAs.”

RILA sales haven’t caught up with sales of FIAs, which reached $14.4 billion in 1Q2021. The top issuer of FIAs for the quarter was Athene USA (11.6% market share), followed by AIG and Allianz Life. The top-selling contract was Allianz Life’s Allianz Benefit Control or “ABC” annuity.

Athene’s leading FIA contract is the Agility 10. “Athene has had very attractive products with attractive illustrations,” Moore said. “They distribute through multiple channels—especially banks and independent agents—and they have proprietary product offerings.” Their association with the alternative asset manager Apollo “has helped them, but it’s not the reason they’re number one. In my experience, they tend to have more attractive rates than their peers.”

Athene has benefited from its association with Annexus, the Scottsdale, Arizona company that does product development for life insurers and distributors. “Athene and Annexus are partnered together on the Athene BCA 2.0 and Velocity FIAs. In this relationship, Annexus has co-developed the product and cooperated on index selection. These FIAs are then distributed to the Annexus IDC partner firms,” Tom Haines, senior vice president, Capital Markets and Index Solutions at Annexus, in an interview.

RILAs and FIAs may look like cousins—their products extract yield from equity or hybrid indices via the purchase of options—but they are rarely found in the same place. Allianz Life is the only issuer that posts big sales in both spaces. FIAs are distributed primarily by independent insurance agents, while RILAs are SEC-registered products sold mainly by securities-licensed advisers at independent broker-dealers.

The two product-types also differ in the way they use options. RILAs offer access mainly to common equity indices like the S&P 500 for large-cap stocks, NASDAQ-100 for tech exposure, Russell 2000 for small-cap stocks, and MSCI-EAFE for international exposure.  RILA investors can also lose money if the equity markets fall past a “buffer” of minus-10% or more.

By contrast, FIAs protect investors from any loss over the term of contract. The stiffer guarantee makes their options more expensive, which pushes down the generosity of the crediting rates they can offer. They increasingly solve this problem by offering access to hybrid indices. Many of these are dynamically reallocated, as often as daily, to stay within certain volatility limits. These indices, because of their built-in hedging mechanisms, allow FIA issuers to offer more generous-looking crediting methods.

The annuity world today seems divided into fans and skeptics of hybrid indices. Moore is one of the skeptics. “All fixed indexed annuities, regardless of index or indexing method, will return approximately 1% to 2% greater interest than [traditional] fixed annuities being issued on the same day,” she said. “I and others are educating people on the realities of the situation.” 

RIAs and 401(k)s: Still elusive markets

Annuity issuers have been trying for years to convince Registered Investment Advisors (or their Investment Advisor Representatives) to sell annuities. But, even with the creation of platforms like DPL Financial Partners or SIMON, where RIAs and other fee-based advisers without insurance licenses can purchase no-commission annuities, the category cross-over hasn’t happened yet.

Wink’s 1Q2021 report showed that 5.85% of traditional VA sales involve fee-based, as opposed to commission-paying, contracts. But the report also showed that RIAs account for only 2% of sales traditional VAs and less than one percent of sales of MYGAs, RILAs, or FIAs.

“There had been an increase in fee-based sales but only by one or two percent,” Moore told RIJ. “We’re talking about building an entirely new distribution for annuities and we have to educate them and help them unlearn the negatives.

“Annuity is still a four-letter word for a lot of people in finance. The press still talks about seniors being taken advantage of by annuity salesmen, and about annuities not allowing them access to their money. RIAs are reading those stories and they are influenced by them.”

The discussion moved to the possibility that life insurers will soon be able to market annuities through 401(k) plans. Provisions in recent federal legislation, such as the SECURE Act of 2019 and the proposed “Secure 2.0,” have removed some of the obstacles to making annuities available to plan participants.

Moore believes that hurdles are still standing in the way.  “I’m excited about the development” of a push to get annuities in 401(k)s. “When the SECURE Act came out, there was finally some positive press about annuities. But don’t hold your breath. There is so much administrative groundwork that have to be done just to put a product in a retirement plan, and companies that don’t currently have ERISA products will be at a disadvantage. How do you even get in front of an HR person, or how do you know if that’s the right person to see? There are a lot of unanswered questions.

“How does a life insurer get in front of participants or provide collateral that competes with all the other options that participants see? Will there be one or more annuity per plan? What is the marketing and the messaging going to look like. How will a company support their offering?” she said. “It’s exciting, but don’t expect immediate results.”

© 2021 RIJ Publishing LLC. All rights reserved.

Feds block Aon’s bid for Willis Towers Watson

Posted on June 17, 2021 by -

The US Department of Justice (DOJ) filed a civil antitrust lawsuit this week to block Aon’s $30 billion proposed acquisition of Willis Towers Watson, which would merge two of the three biggest global insurance brokers. “The merger threatens to eliminate competition, raise prices, and reduce innovation for American businesses, employers, and unions,” said a DOJ release.

According to the release:

“Aon and Willis Towers Watson… compete head to head to… ensure businesses obtain innovative, high-quality broking services to manage their risks and provide critical health and retirement benefits to their employees at a reasonable cost. The merger would eliminate this important competition in five markets, resulting in higher costs to companies, higher costs to consumers, and decreased quality and innovation.”

As alleged in the complaint, Aon and Wills Towers Watson operate “in an oligopoly” and “will have even more [leverage] when [the] Willis deal is closed.” If permitted to merge, Aon and Willis Towers Watson could use their increased leverage to raise prices and reduce the quality of products relied on by thousands of American businesses — and their customers, employees, and retirees.

Although Aon and Willis Towers Watson have agreed to certain divestitures in connection with investigations by various international competition agencies, the complaint alleges these proposed remedies are inadequate to protect consumers in the United States. The complaint also alleges the U.S.-focused divestitures in health benefits and commercial risk broking, in particular, are wholly insufficient to resolve the department’s significant concerns.

Aon plc is incorporated in Ireland and headquartered in London. It has approximately 50,000 employees and offices in approximately 120 countries, including over 100 offices in the United States. In 2020, Aon reported revenues of more than $11 billion.

Willis Towers Watson plc is incorporated in Ireland and headquartered in London. It has approximately 45,000 employees and offices in more than 80 countries, including over 80 offices in the United States. In 2020, Willis Towers Watson reported revenues of more than $9 billion.

© 2021 RIJ Publishing LLC. All rights reserved.

Top-Selling Annuity Contracts, First Qtr 2021

Posted on June 17, 2021 by -

The top-selling annuity contracts in their respective categories in the first quarter of 2021, according to Wink Intel, were the Jackson National Perspective II 7-year variable annuity, the Pruco Life Prudential FlexGuard Indexed VA (in the RILA category) and the Allianz Benefit Control Annuity, a fixed indexed annuity from Allianz Life. As for multi-year guaranteed rate annuities, New York Life was by far the biggest seller of MYGAs in the first quarter, but the big mutual insurer didn’t release product-level sales data. 

Perspective II from Jackson National. This contract, issued by the top seller overall of traditional variable annuities for several year, has been the most popular variable annuity for many quarters. It gives contract owners 120 investment options to choose from, and doesn’t confine the owner to certain balanced or volatility-controlled investments when they pick one of the three lifetime income riders.

A Jackson National spokesman told RIJ, “While Jackson has offered investment freedom for the longest period of time with our Perspective II VA, we cannot claim to be the only carrier. Nationwide now offers two benefits that do not have investment restrictions and Delaware Life also has a benefit that does not require investment restrictions.” The three income options are bonus, step-up, and withdrawal rate.

Allianz Benefit Control Annuity from Allianz Life. The Minneapolis company, the US branch of Allianz of Germany, is trying to fend off the invasion of the FIA space, which it once ruled, by Athene, Fidelity & Guaranty Life, and Global Atlantic, three insurers with asset managers (Apollo, Blackstone and KKR) helping them squeeze more yield from their general account investments.

Its Benefit Control Annuity seems to be a winner. It’s also complex. The contract has bonuses, income riders, and volatility-controlled hybrid indices that are likely to make it challenging for advisers, let alone investors, to navigate. But advisers, despite their protests, have always seemed to prefer complexity over simplicity as long as it translates into flexibility.

The bonuses require especially close reading. Contract owners can get a bonus to their income base (the “Protected Income Value” or PIV) of 250% of their index gain each year or, if they prefer, a bonus to their account value of 50% of their gain. So if they gain 5% from index appreciation in a year, their PIV would get a 12.5% boost or the account value would get a 2.5% boost.

In addition, there’s a bonus option that adds 150% of the index gain to the PIV and 100% of the index gain to the account value. The account value, with bonuses, is available after 10 years (which is also the length of the surrender period). How does the issuer pay for all this? In part by charging 0.95% per year on and limiting the income payout rate at age 65 to 4% of the PIV for single owners and 3.5% for joint owners.

Pruco Life Prudential FlexGuard Indexed VA. Prudential came to the structured annuity market in early 2020, 10 years after the birth of this category. But its entry product has posted about $3.5 billion in sales in its first four-quarters. Prudential claims that the fastest start for any contract in the RILA category, which Equitable (then AXA Equitable) created in 2010. This week, Prudential brought out a version of the contract with a lifetime income benefit.

FlexGuard offers three crediting strategies: A point-to-point cap rate strategy that can work like a typical FIA; a “Tiered” Participation Rate strategy; and a Step Rate Plus strategy. Only two indices were available on the original contract: the S&P 500 Index or the MSCI EAFE, which holds shares in companies in 21 developed countries outside the US and Canada.

The investor can get the index return up to a cap over a crediting period of either one year, three years or six years. As for downside protection, the investor can choose a buffer that exposes them to any loss beyond the first 10% over a one-year or three-year term, or zero loss over one year (with the S&P 500 Index only). Those who choose a three-year term can elect a downside buffer of 10% or 20%. Those who choose a six-year term can elect a 20% buffer.

The Tiered Participation Rate strategy is for people willing to commit their money for the maximum six-year term. The investor earns 100% of the index return up to a cap (20%, for example) and 130% of any gain above the cap. If the index rose 80% in six years, the investor would get 20% plus 78% (1.3 x 60%) for a total of 98% over six years. The product has a 10% buffer. In the Step-Rate strategy, available only with a one-year term, the investor earns a “step” rate (6%, for instance) if the index gain is positive but equal to or less than the step rate. If the gain exceeds the step rate, 90% of the total gain accrues to the investor.

© 2021 RIJ Publishing LLC. All rights reserved.

Investors Sought ‘Cheaper, More Cyclical’ Stocks in May: Morningstar

Posted on June 17, 2021 by -

Long-term mutual funds and ETFs collected $83 billion during May, materially less than their $156 billion haul in March and $124 billion intake in April, according to Morningstar’s US Fund Flows report for May, released this week.

Investors poured $71 billion into passively managed, index-tracking funds. ETFs—most of which are passively managed—gathered $64 billion, while open-end mutual funds pulled in about $19 billion, the report said.

US equity fund flows were quiet for the second consecutive month. After taking in a record $54 billion in March, inflows were just $211 million in May. Large-value funds picked up about $13 billion, their second-highest monthly intake in Morningstar’s database, which dates to 1993. Their top monthly inflow of $20 billion occurred just two months prior in March.

That indicates a sudden demand for cheaper, more cyclical stocks. About 97% of large-value inflows accrued to passive strategies. Vanguard Value Index VIVAX, which brought in $2.3 billion, and Vanguard Russell 1000 Value Index VRVIX, which gathered $1.0 billion.

Mid-cap value funds picked up $2.7 billion in May—their highest total since January 2004. Their 0.88% monthly organic growth rate was the highest since November 2013’s 0.91%. Actively managed mid-value funds fared better than their large-value counterparts, picking up about $950 million of the $2.7 billion total.

Fidelity and John Hancock captured the greatest shares of inflows into actively managed mid-value strategies. Small-value funds collected $2.0 billion in May, a far cry from their record $5.4 billion in March 2021 but still good for their third-largest haul over the past decade.

US equity blend and growth categories didn’t fare as well. Large-blend funds shed about $2.7 billion in May and have now bled $53 billion over the prior 12 months, after strong inflows in February and March. Large-growth funds shed $10.2 billion, the steepest outflow within the category group.

Large-growth’s outflows of $88 billion over the prior one-year period is also the most within the group. Investors have been exiting this category consistently over the past decade, potentially rebalancing to asset classes that haven’t performed as well. Small- and mid-growth funds bled about $1.5 billion and $4.0 billion, respectively, though both posted positive net flows for the year to date.

Taxable-bond funds once again saw the greatest intake among US category groups, gathering nearly $38 billion in May. Investors favored categories offering shelter from  rising inflation and interest rates. Intermediate-core bond and inflation-protected bond funds collected $7.6 billion and $6.9 billion, respectively.

Short-term bond funds, which are typically less sensitive to rising interest rates than long-term bond funds, followed closely with a $6.8 billion intake for the month. Bank-loan funds pulled in $3.7 billion, their sixth consecutive month of inflows after a long streak of outflows dating back to November 2018. Their year-to-date organic growth rate of 33% was easily the highest within the taxable-bond category group.

Bank-loan funds also provide investors protection in rising rate environments: The underlying loans in the portfolio pay floating coupons, and as rates rise, so do the coupons on the loans. While the Federal Reserve has maintained the stance that recent inflation is transitory, fund flows may suggest that investors expect inflation to remain elevated and rates to rise.

© 2021 RIJ Publishing LLC.

Vanguard publishes 2021 ‘How America Saves’

Posted on June 17, 2021 by -

Vanguard has released its 2021 How America Saves report. The report, now in its 20th annual iteration, provides the results, as of December 31, 2020, of a survey of 1,700 Vanguard defined contribution plans, sponsored by 1,400 clients, with 4.7 million participants for whom Vanguard keeps records.

Key findings in the report:

Automatic enrollment. At year-end 2020, 54% of Vanguard plans had adopted automatic enrollment, including 74% of plans with at least 1,000 participants. In 2020, 69% of participants were in plans with an automatic enrollment option. The adoption of automatic enrollment has more than tripled since year-end 2007, when the Pension Protection Act (PPA) of 2006 took effect.

Two-thirds of automatic enrollment plans automatically raise annual deferral rates. Fifty-seven percent of plans now default employees at a deferral rate of 4% or higher, up from 30% of plans in 2011. Almost all plans with automatic enrollment defaulted participants into a target-date fund.

Savings rates. The average deferral rate was 7.2% in 2020, up modestly from 6.9% in 2011. The median deferral rate was 6.0% in 2020—unchanged for as long as we have been tracking this metric. Including both employee and employer contributions, the average total participant contribution rate in 2020 was 11.1%, and the median was 10.2%. These rates have remained fairly stable for the past 15 years.

When including nonparticipants, employees hired under automatic enrollment plans saved an average of 10.7%, considering both employee and employer contributions. Employees hired under a voluntary enrollment design saved an average of 6.8%, due to lower participation.

Average and median accumulations. In 2020, the average account balance for Vanguard participants was $129,157; the median balance was $33,472. Vanguard participants’ average account balances increased by 21% since 2019, driven primarily by the 18% increase in US equity markets over the year.

Managed accounts. The rising prominence of professionally managed allocations has been essential to improvements in portfolio construction. Participants with professionally managed allocations have their entire account balance invested in a single target-date or balanced fund or in a managed account advisory service.

At year-end 2020, 62% of all Vanguard participants were solely invested in diversified, professionally managed investment portfolios—compared with 7% at the end of 2004 and 33% at year-end 2011. Fifty-four percent of all participants were invested in a single target-date fund; another 1% held one other balanced fund; and 7% used a managed account program.

Target date funds. Ninety-five percent of plans offered target-date funds at year-end 2020, up from 82% in 2011. Nearly all Vanguard participants (99%) were in plans offering target-date funds; 80% of all participants used target-date funds. Two-thirds of participants owning target-date funds invested in a single target-date fund. About 4 in 10 single target-date investors chose the funds on their own, not through default.

Participation rates. The estimated plan-weighted participation rate in 2020 was 84%, up from 77% in 2011. The participant-weighted participation rate was 78% in 2020, up from 74% in 2011. Plans with automatic enrollment had a 92% participation rate, compared with a participation rate of 62% for plans with voluntary enrollment. Between 2011 and 2020, plans with automatic enrollment have had strong participation rates. Plans with voluntary enrollment have seen participation rates deteriorate.

Roth options. At year-end 2020, the Roth feature was adopted by 74% of Vanguard plans, and 14% of participants within these plans had elected the option. All plan sponsors with automatic enrollment defaulted to traditional pre-tax savings.

Balanced portfolios. Participant portfolio construction has improved dramatically over the past 15 years, with 76% of participants having a balanced strategy in 2020, compared with 39% in 2005. Three percent of participants held no equities and 3% of participants had more than 20% allocated toward company stock in 2020. In 2005, 13% of participants had no equities and 18% of participants held a concentration in company stock.

© 2021 RIJ Publishing LLC.

 

Honorable Mention

Posted on June 17, 2021 by -

Prudential ‘FlexGuard’ RILA adds retirement income feature

Prudential Financial has added a lifetime income benefit rider to its FlexGuard structured variable annuity and created a new contract, FlexGuard Income, according a Prudential release this week. FlexGuard was the best-selling registered index-linked annuity in the first quarter of 2021, according to Wink, Inc.

Introduced in early 2020, FlexGuard was “the fastest-selling indexed variable annuity launch ever in the [annuity] industry, achieving more than $3.5 billion in sales in its first three-quarters,” the release said.

FlexGuard Income is initially available through Prudential Advisors financial professionals and will expand to additional, third-party broker dealers in fall 2021, Prudential said.

FlexGuard belongs to the class of product, invented in 2010 by AXA Equitable (now Equitable), that is variously called structured annuities, registered index-linked annuities (RILAs), or indexed variable annuities.

All three terms refer to a tax-favored structured product, issued by a life insurer, whose returns are based on the performance of brackets of options (puts and calls) on one or more equity or multi-asset indices. RILAs generally offer exposure to a wider range of gain or loss than do fixed indexed annuities, which prevent any loss of principal. 

For RIJ’s 2020 report on FlexGuard, click here.

Riskalyze and RightCapital report ‘seamless integration’

Riskalyze, which provides financial advisors with risk alignment and portfolio analytics, and RightCapital, the financial planning tool that enables advisors to create custom financial plans, have extended their integration to offer advisers easy access between them.

RightCapital gives financial advisors and their clients tools for budgeting, Social Security withdrawal optimization, and meeting student loan, Medicare and estate planning needs.

The integration gives RightCapital clients access to all of Riskalyze’s model portfolios with the company’s signature Risk Number displayed. Advisors can then import position-level account data into their RightCapital financial plans.

Riskalyze and RightCapital will be offering a joint webinar about this enhanced integration on June 29, 2021 at 11 a.m. Pacific Time. To learn more and register, go to www.riskalyze.com/events.

Americans seek more ‘holistic’ view of their finances: Franklin Templeton poll

More than half of American workers expect their financial future to differ from that of their grandparents, parents, and children, believing “that there is no single path to retirement today,” according to the inaugural edition of Franklin Templeton’s Voice of the American Worker Survey.

The survey, conducted by The Harris Poll on behalf of Franklin Templeton, is connected to Franklin Templeton’s Retirement Innovation Initiative (RII), which launched in January 2020.

Among the survey findings:

  • Most survey respondents associate their current physical, mental, and financial health with wellbeing.
  • More than half say their financial wellbeing isn’t primarily about money but includes their health and lifestyle.
  • Workers today place nearly equal importance on mental, physical, and financial health, but they feel least in control of their financial health as compared to physical and mental health.
  • Many respondents struggle to find a holistic view, with 61% indicating they need to consult many sources to get an overall picture of their finances, and 51% stating it is too complicated to integrate all of their financial info and goals into a single picture.
  • Seventy percent would like a “Fitbit-like program for their finances” to easily track everything all in one place.
  • Three out of four workers want their workplace to provide more resources to help them with their overall financial wellbeing, believing their employer should provide incentives for good financial habits and good health habits.
  • Workers are more interested in long-term support, over today’s monetary gains, with most preferring a boosted 401(k) match to a raise.
  • Nine in 10 respondents are also looking for tools to visualize their future and optimize wellbeing, with top choices being planning tools and resources.
  • Nearly three quarters of workers expect their financial management apps and programs to use what they know about them to suggest the most appropriate resources, while 68% of men and 54% of women say, “Unless I am getting personalized recommendations, I feel like financial education isn’t very helpful.” 

Americans are seeking “a holistic and consolidated view of their finances to achieve overall financial health”:

  • 73% say they wish there was a resource that combined the financial view of their entire household.
  • 73% say they wish there were more ways to get a view of their overall wellbeing.
  • 62% ay they wish they had a ‘wellbeing coach’ to help with all areas of wellness not just physical or financial.
Voya receives ESG certification from DALBAR

Voya Financial, Inc., has become the first publicly traded company to receive an Environmental, Social and Governance (ESG) Retirement Plan Certification from DALBAR, according to a release. Voya received the certification, along with a five-star rating, for the 401(k) plans offered to its own employees.

DALBAR evaluates, audits and rates business practices in the retirement industry. DALBAR’s ESG Plan Certification is an annual process to evaluate a plan’s success in actively applying ESG principles to its retirement plan.

DALBAR’s ESG Retirement Plan Certification includes a review of all ESG factors including:

  • Environmental factors such as paper suppression, automatic enrollment and online capabilities
  • Social factors like matching contributions and phone center capabilities
  • Governance factors, such as plan fees, regulation compliance and investment policy

The underlying principle of the ESG Plan Certification is the recognition of providing an incentive for continuous improvement of plans to achieve this goal, where a five-star rating is achieved by supporting environmental, social and governance characteristics. Receiving the ESG Retirement Plan Certification can benefit both employers and employees themselves, including attracting new talent to a company that offers a plan with a commitment to serving the community, the Voya release said.

According to Voya research, more than half (60%) of individuals say they would likely contribute more to an ESG-aligned retirement plan if it was certified, and the majority (83%) of working Americans find it important to apply ESG principles to workplace benefits. 

Employers interested in pursuing ESG Retirement Plan Certification can learn more at the DALBAR ESG Certification website and should contact their defined contribution plan’s recordkeeper to find out how they can work with DALBAR to begin the certification process. Voya provided assistance to DALBAR in developing this certification, but has no role in the assessment process.

Keith Burger joins Luma from AIG

Luma Financial Technologies, an independent, multi-issuer structured products and annuities platform, announced today that Keith Burger, has joined the company as National Sales Director for Annuities. He will lead Luma’s expansion across all distribution channels, a Luma release said.

Burger will “oversee the firm’s strategic initiatives to provide Luma’s scalable platform to financial professionals looking to increase the efficiency and effectiveness of transacting in the annuity marketplace,” the release said.

Previously, Burger spent more than 22 years as Senior Vice President, National Sales Manager at AIG. Earlier at AIG, he was a Divisional Vice President and External Wholesaler. He earned a Bachelor of Arts degree in Economics from the University of Colorado Boulder. He started with Luma on June 14th and is currently based in Edwards, Colorado.

Paul Garofoli joins The Standard

The Standard announced the hiring of Paul Garofoli as a regional sales director of Individual Annuities. Based in Texas, he will work with independent distributors and advisors across the country. His 38 years of insurance brokerage and distribution experience includes underwriting, product development, marketing and sales with a variety of companies.

Garofoli holds a Bachelor of Arts in political science and economics from the University of Massachusetts at Amherst. Paul is a Fellow in the Life Management Institute.

“Paul is known for his enthusiasm, communication skills and support of agencies and producers,” “Paul is a noted presenter and has trained agents in all 50 states, two U.S. Territories and several European countries,” said Rich Lane, vice president of Individual Annuity sales and marketing at The Standard, in a release.

© 2021 RIJ Publishing LLC. All rights reserved.

AM Best’s outlook for the annuity industry: Negative

Posted on June 17, 2021 by -

Despite COVID-19’s operational and sales impacts on the US individual annuity industry, the bigger issue for writers remains the low interest rate environment, according to a new AM Best report.

“The low interest rate environment continues to limit the levers insurers can pull without worsening their company risk profiles,” said AM Best in a release of the latest edition of Best’s Market Segment Report.

“Spread compression and declining investment yields have been a long-time concern as guaranteed rates on many older blocks of business remain a burden for many insurers. Increases in options, hedging costs and the net amount of assets at risk for companies writing guarantees with living benefits will further pressure operating performance.”

Net premiums written (NPW) increased just twice in the last 10 years, the ratings agency’s said. The challenging 2020 sales environment amid the COVID-19 pandemic brought additional obstacles and individual annuity NPW declined by almost $54 billion, or 27%.

Direct premiums written (DPW) did not decline as much in 2020—almost $13 billion, or 5.8%—as some companies ceded a greater portion to diminish their exposure to interest rate risk.

Variable annuities constitute the largest component of the individual annuity market, with $82.4 billion, or 56%, in NPW in 2020, despite declining by 3.6% from 2019. Indexed annuities declined by more than 54%, to $30.8 billion, the lowest premium total in the last five years after a significant increase in 2019. While NPW for fixed annuities dropped by 28% in 2020.

Some annuity markets are more competitive than others. The top 10 fixed annuity (FA) writers account for just 54% of the market, while the top 10 VA writers combine for over three quarters, and nearly two-thirds of the indexed annuity market. Sales varied in 2020 among the top writers, depending on the extent and emphasis of product de-risking.

As interest rates reached historic lows, many insurers started to deemphasize fixed annuity sales, reinsure FA blocks of business, and reprice products. In some cases, companies have withdrawn interest-sensitive products from the market altogether, and in other cases, companies have increased pricing to the point of reducing new business volume to a trickle.

While most US annuity companies have maintained solid balance sheets, owing largely to healthy risk-adjusted capitalization, adequate liquidity and prudent investment policies, AM Best’s market segment outlook for the industry remains negative. The negative market segment outlook is due to the persistent low interest rate environment, operating margin pressure and organic growth challenges.

To obtain a full copy of this AM Best market segment report, click here.  

© 2021 RIJ Publishing LLC.

Honorable Mention

Posted on June 10, 2021 by -

Nationwide annuities join SIMON’s shelf 

Several of Nationwide’s annuities will be distributed through the SIMON structured products platform, according to an announcement from SIMON Annuities and Insurance Services LLC this week. Nationwide is the latest life insurer to offer its products through the SIMON platform. SIMON Markets was created in 2018 as a spin-off from Goldman Sachs structured notes desk.   

The platform offers structured  notes as well as commission and fee-based annuities to financial advisers, wealth managers. The head of Insurance Solutions at SIMON is Scott Stolz, formerly head of Insurance Solutions at Raymond James. 

The SIMON Marketplace gives advisers “powerful allocation analysis tools and product-specific educational resources to better serve the retirement and legacy goals of clients,” according to a release. The platform serves more than 85,000 financial professionals managing $3 trillion in assets.

The platform provides “on-demand education, an intuitive marketplace, real-time analytics, and lifecycle management” while providing access to structured investment, annuity, and defined outcome ETF solutions to investment professionals, centralized within one unique ecosystem,” the release said.

2021 starts better for life/annuity industry than 2020 did: AM Best

The US life/annuity (L/A) industry saw its net income jump to $13.3 billion in the first quarter of 2021, compared with a $23.2 billion loss in the same period in 2020, according to a new Best’s Special Report, “First Look: Three-Month 2021 Life/Annuity Financial Results.”

The data is derived from companies’ three-month 2021 interim statutory statements that were received as of June 1, representing an estimated 99% of the total L/A industry’s net premiums written.

In the first three months of 2021, US L/A total income declined by 9% from the prior-year period. An increase in commissions and expense allowances was offset by declines in premiums and annuity considerations, as well as in net investment and other income.

The large 33% reduction in expenses resulted in a pre-tax net operating gain of $27.1 billion, up from a loss of $46.7 billion in first-quarter 2020. A $10.9 billion increase in tax obligations and $26.5 billion decrease in net realized capital gains contributed to the industry’s net income for the first three months of 2021.

Capital and surplus increased slightly from the end of 2020, to $446.8 billion, as $15.6 of net income and contributed capital nearly was negated completely by a $4.7 billion change in unrealized losses, a $3.6 billion change in asset valuation reserves and $6.5 billion of stockholder dividends.

“Extended care” requires as much planning as “long-term care”: Thrivent

Despite the COVID-19 pandemic, a significant percentage of Americans have not planned for the possibility that they will need someday need “non-medical care” involving assistance with basic daily activities due to a physical or cognitive impairment,” according to a survey by Thrivent.

The survey was conducted in partnership with data intelligence company Morning Consult and polled 2,200 adults across the country between March 11-15.

Although the pandemic magnified the impact of long-term care on individuals and their caregivers’ daily lives, more than half of survey respondents (51%) said COVID-19 “did not change their approach to extended care planning at all,” according to Thrivent’s 20221 Extended Care Planning Survey, 70% of Americans have not documented their plans for extended care. 

Only 18% of respondents said COVID-19 made them realize having a plan is more important than ever, the survey showed. Only 12% said the pandemic led them to have a conversation with their spouse and or/immediate family about extended care for themselves or a loved one.

Modern Woodmen in reinsurance deal with RGA

Reinsurance Group of America, Inc., a leading global life, annuity, and health reinsurer, has completed an annuity reinsurance transaction with Modern Woodmen of America, a member-owned fraternal financial services organization.

The Willis Re Life Solutions Group served as the broker for the transaction. The transaction closed on June 3, 2021, with an effective date of April 1, 2021. Additional terms of the transaction are not being disclosed.

Under the agreement, an RGA subsidiary will reinsure a seasoned block of US annuity business. Modern Woodmen will continue to service and administer the contracts.

“We were able to tailor a mutually beneficial transaction that meets Modern Woodmen’s specific capital and risk management objectives,” said Larry Carson, Executive Vice President, Global Financial Solutions, RGA. “This transaction continues RGA’s successful strategy to grow our asset-intensive business.”

Cryptocurrencies available in ForUsAll retirement plans

Posted on June 10, 2021 by -

ForUsAll, a San Francisco-based fintech firm specializing in retirement plans for small businesses and alternative investment options, has extended its product offering with Alt 401(k), which allows employers to provide cryptocurrencies and other alternatives within 401(k) plans.

The platform is the first of its kind, according to a release. It will initially offer access to cryptocurrencies through Coinbase Institutional.

ForUsAll was founded in 2012 by the same team that helped build Financial Engines, the largest registered investment advisor in the country. ForUsAll currently has over $1.7 billion in assets under management and serves over 70,000 employees, the release said.

“By introducing the Alt 401(k), we are democratizing access to what drives wealth for the wealthy – alternative investment options, combined with our original core offering of low-cost index funds, and personalized help,” said Jeff Schulte, ForUsAll’s CEO, in a release.

“Alternative investments, including small allocations to cryptocurrency can help improve portfolio diversification and expected returns. However, the volatility and the complexity of these asset classes make prudent education and advice for employees essential,” said David Ramirez, co-founder and Chief Investment Officer of ForUsAll.

Alt 401(k)’s features include:

  • A full turn-key automated 401(k) for employers, with both traditional and alternative investment options
  • Employees can transfer up to 5% of their balances into a secure account that has exposure to certain cryptocurrencies
  • Employees will be able to buy, hold, and sell over 50 different cryptocurrencies
  • Employees will get ongoing portfolio monitoring and education

Employers who adopt Alt 401(k) will be able to offer access to cryptocurrency via a self-directed alt window inside the 401(k) alongside their investment lineup. From there, participants can transfer up to 5% of their portfolio into a cryptocurrency window where they can invest in over 50 cryptocurrencies. ForUsAll alerts employees when their allocation exceeds 5%, so that they can rebalance into traditional mutual funds.

© 2021 RIJ Publishing LLC. All rights reserved.

Examining the Indices in Index-Linked Annuities

Posted on June 10, 2021 by -

Relatively speaking, an indexed annuity was once as simple as a Schwinn bicycle with fat tires and a three-speed gear shift. The early contracts gave policyholders partial exposure to the growth of just three or four common indices: the S&P 500, the NASDAQ and the Russell 2000 or MSCI-EAFE.

Today’s indexed annuities are more like 21-speed mountain bikes. Some contracts offer a dozen index options, including hybrid indices, factor-driven indices, and (especially) volatility-controlled indices whose algorithms dynamically reallocate assets in response to market signals that only computers can hear.

Over the past six or seven years, the number of indices available to buyers of fixed indexed and registered index-linked annuities (FIAs and RILAs, respectively) has mushroomed to more than 140, according to a list compiled by The Index Standard, a fintech startup that analyzes the indexes in annuities for advisers and clients. (*See list disclaimer at end of this article.)

More choice is presumably better. Access to 21 gears can smooth a mountain biker’s path over rocks and through arroyos. A deferred indexed annuity with lots of indices can theoretically smooth an investor’s path across three to ten years of unpredictable and unforgiving markets.

But choice adds complexity. Annuity issuers have not yet shown advisers how to optimize the use of the new indices, one observer told RIJ. While 40% of the money that flowed into FIAs in 2020 went into hybrid indices, over half still went into the S&P 500 Index, according to Wink Intel.

In this second week of RIJ’s annual four-week focus on FIAs and RILAs, we provide capsule summaries of just five indices in indexed annuities. These are offered as examples, not as recommendations. They reveal a few of the mechanisms that provide diversification and volatility management that indexes use.

The mechanisms range from simple averaging across sub-indexes, or periodic rebalancing according to changes in the performance of certain sectors or factors. Some indexes use short sales to manage volatility. Given the tools available to actuaries and quants, the possibilities are unlimited.

JPMorgan Mosaic II

This momentum-seeking index, created in 2016, offers exposure to equities, bonds, and commodities and aims for 4.2% volatility. From a universe of 15 assets consisting of global equity futures, bond futures and commodities, the managers pick the nine assets with the highest returns over the last six months. They allocate to these assets using risk parity, and then use a dynamic volatility control mechanism on the risk parity portfolio and notional cash to hit the volatility target. It uses leverage of up to 300% on the components.

“Overall this is a well constructed index,” according to The Index Standard. But a period of flat results has made it into a cautionary tale of a volatility-controlled index that isn’t nimble. “When a stressful market begins to recover, such as in the end of 2018 and March 2020, the index can be slow to move back into risky assets and may lag in subsequent bull markets,” The Index Standard analysis said.

Performance Blend-Weighted Average

This index, a throwback to an earlier stage of FIA product development, is noteworthy for being the only hybrid index offered in the top-selling contract from Athene, the top-seller of FIAs in 2020, according to Wink Intel. The return of this index is calculated based on the relative performance of the S&P 500, Russell 2000, and MSCI EAFE indices, according to product literature.

Half of the interest credited to the contract owner for a given crediting period is based on the index with the best performance (i.e., the one with the largest positive or least negative change during the period). Thirty percent of the interest is based on the index with the next best performance. Twenty percent is based on performance of the weakest-performing index.

BlackRock iBLD Claria

This index was one of several available in 2020’s top-selling FIA contract, the Allianz Benefit Control Annuity. In addition to three common indexes (the S&P 500, NASDAQ-100, and MSCI-EAFE), this contract offers access to three dynamically re-allocated indexes of ETFs: BlackRock iBLD Claria Index, Bloomberg US Dynamic Balance Index II, and PIMCO Tactical Balanced Index.

An index of indices, the BlackRock iBLD Claria reallocates daily to an equity component (consisting of iShares ETFs tracking the Russell 2000, S&P 500, MSCI EAFE, and MSCI Emerging Markets) and a bond component (iShares ETFs tracking 1-3 year, 3-7 year, and 7-10 year Treasury Bonds) based on historical realized volatility (i.e., the past annualized standard deviation of returns).

This contract also allows the owner to lock in an index value on any of individual indexed interest allocation(s) one time at any point during the crediting period. The beginning index value for the next crediting period will be the index value at the end of the previous crediting period (not the locked-in value). 

Shiller Barclays CAPE US Sector Risk Controlled 10% USD Excess Return Index

This index of indices is a volatility-controlled version of the Shiller Barclays CAPE US Sector TR USD Index (CAPE stands for Cyclically Adjusted Price Earnings ratio). It was created in 2014 by Nobel Prize-winning economist, Yale professor and author Robert Shiller.

This index uses derivatives (options or futures) to get “notional long exposure to the top four US equity sectors that appear to be relatively undervalued, as defined by a modified version of the CAPE Ratio and that possess relatively strong price momentum over the prior twelve months.”

Each month, that index ranks the pre-defined, fixed universe of exchange-traded funds— Select Sectors SPDR Funds specializing in Energy, Materials, Industrial, Consumer Discretionary, Consumer Staples, Health Care, Financial, Utilities, Technology, Real Estate and Communications Services—and removes the six most overvalued sectors (as measured by their Relative CAPE Indicators).

Of the remaining five sectors, the sector with the lowest twelve-month price momentum is removed. The underlying index then allocates equally to the four remaining index components for the relevant month. In addition, the Index targets a 10% volatility level by reducing exposure to any of the sector indexes where volatility is rising. 

NYSE Zebra Edge Index

Created by the eminent Roger Ibbotson, past professor at Yale and the University of Chicago, and founder of Ibbotson Associates (now part of Morningstar, Inc.) and Zebra Capital Management, this index looks for “the most popular equities” in terms of trading activity and risk, among the 500 largest US public companies.

Every quarter (February, May, August and November) it filters out the stocks most frequently traded over the preceding two years and with the highest three-month and one-year volatility. That process reveals about 200 less-popular and less-risky equities. These are weighted equally.

At the end of 2020, this process resulted in the following sector allocations (approximately):  Industrials (22%), Financials (19%), Consumer Goods (13%), Utilities (11%), Technology (10%), Health Care (10%), Consumer Services (9%), Basic Materials (4%), Telecommunication (2%), and Oil & Gas, (0%).

Managing expectations

Anyone comparing indices inside an annuity needs to keep in mind that, while the index might offer the sector or the factor exposure that he or she takes an interest in, the annuity owner doesn’t necessarily receive all of the index gain or incur all of the index loss over a contract year or crediting term.

The contract owner’s gain (or loss, in the case of a RILA) depends entirely on a set of options on the index. When someone buys a FIA, for example, the issuer might apply about 2% of the purchase premium to the purchase of options on the selected indices. This “options budget” might be increased by using the dividend yield from the stocks in the index.  A RILA’s option budget will typically be larger than an FIA’s, because the a RILA only insures about 10% of a contract owner’s money against potential loss, while an FIA insures 100%.

“The buffered payoff in a RILA is a cheaper hedge compared to an option’s hedge with a FIA,” said Tom Haines, senior vice president, Capital Markets and Index Solutions at Annexus, in an interview. “The hedge budgets on buffered annuities have been and could be lower but this can change if the carrier wants to be competitive.”

Sometimes the contract offers a crediting method with no cap on the gains. In that case, all of the index gain might accrue to the owner, even though he or she isn’t invested directly in the index. In such cases, the index will usually contain volatility controls that, in addition to limiting the potential for loss, also limit the potential for gain. There’s an inherent trade-off.

For more on the hybrid indexes in FIAs and RILAs, see the accompanying article in today’s issue of RIJ.

*Past performance is not indicative of future performance. The Index Standard® is not a registered investment advisor, and nothing in The Index Standard®‘s reports is intended, and it should not be construed, to be investment advice. This material has been prepared by The Index Standard® on the basis of publicly available information internally developed and other third-party resources believed to be reliable. The Index Standard® did not attempt to verify the information independently. No representation is made as to the accuracy of the assumptions made within, or completeness of any opinion, report, rating, or scenarios. No representation is made that any omissions or error in any of its opinion, report, rating, or scenarios will be corrected. The Index Standard is not obliged to inform the recipients of this website, or communication of any change to any opinion, report, rating, or scenarios. All opinions, reports, ratings, and scenarios of The Index Standard® are subject to change.

© 2021 RIJ Publishing LLC. All rights reserved.

Ten Rules-of-Thumb for Choosing Indices in Annuities

Posted on June 10, 2021 by -

Once an adviser and client decide to buy a specific index-linked annuity contract, they need to allocate the client’s premium to one or more of the indices on whose performance their returns will depend. 

The client, on his or her own, will have no idea how to make that decision. When it comes to the newer hybrid, factor-driven, sector-driven or volatility-controlled indices, most advisers may be out of their depth as well.

That’s understandable. Index-linked annuities are the screwballs of the financial product world. Once they leave the pitcher’s hand, so to speak, their flight toward the catcher’s mitt is largely unpredictable. They may flutter, wobble or sink en route to the strike zone—or outside it.

All investments are wagers on an unknown future, of course. But it’s especially hard to forecast the yield of even the plain-vanilla indices in annuities because their performance is refracted by the lens of a crediting formula—i.e., the caps, spreads, and participation rates—which in turn are determined by the variable cost of the options on the index.

But allocations must be made. The folks who build these products shared some advice with RIJ about choosing indices inside FIAs and RILAs. We’ve summarized their wisdom below. 

Diversify, diversity. Rather than try to guess which index will perform best over a one-year crediting period or the multi-year term of the contract, the experts recommend dividing your money up evenly among all of them. The conventional wisdom is that if you choose five different indices, one of them is bound to perform well enough so that the overall contract produces an average annual gain of 5%.

That said, it’s important to avoid choosing indices that are highly overlapping or correlated and don’t help diversify the contract. Considering that many indices are indices of indices, and that they shift their sub-allocations in response to quarterly, monthly or even daily market signals, you’ll never know the effect, if any, of your addition to an already extensive diversification process.

Price index versus total return index. When choosing an index, determine whether the index tracks only the change in the market price of the underlying assets or if it tracks the total return, which will include dividends. Often, the issuer will use the price-only index because the options on it are cheaper, which allows the issuer to buy more upside with its options budget. 

“Uncapped” rates: Too good to be true? The open secret of the FIA business is that advisers and clients look at the crediting rates first, rather than the index, and will opt for crediting rates that are “uncapped.” In other words, the client will get 100% of the return of the index. But what if 100% of that index is doomed, by dint of its own internal governors and mufflers, never to exceed 75% of the S&P 500 Index? I’m told that you should go for the uncapped strategy so that you won’t miss out on a rare Golden Goose (the opposite of a Black Swan).

“Anyone can build a good back test, and there is data mining going on. But if you do it the right way, certain factors or markets will outperform going forward. It’s a bet that—based on sound merits and economic research and an analysis of long-term expected returns—warrants greater return. That possibility exists,” said Tom Haines, senior vice president, Capital Markets and Index Solutions at Annexus, in an interview. 

Be alert to the trade-off between volatility targets and caps. The higher the volatility target of a volatility-controlled balanced index, the higher the equity component will be and the lower the performance cap will be, and vice-versa. But how does one choose between an index with a 10% target and a 5% cap, and one with a 5% target and a 10% cap?

“A volatility managed index is inherently cheaper to write an option on,” said Adam Schenck, head of the Portfolio Management Group at Milliman, the actuarial consulting firm, in an interview. “That allows the issuer to increase the upside for the customer. So if you have a cap of 3% on an S&P 500 Index without volatility controls, you might have a cap of 10% on the same index with volatility controls.”

Beware OD-ing on vol-control. Sometimes the volatility control mechanism in an index will be too effective. Instead of smoothing out volatility en route to a safe 5% return, it drugs the poor index into a stupor. In that case, the index may be slow to wake up to the fact that markets have recovered. To mix metaphors, you want an anti-lock braking system rather than brakes that might lock up.

“Some indexes may not be good at detecting when markets will be calm, and they lock you out of the returns,” Schenck told RIJ. “There’s too much risk management in place. The volatility forecast misses too high, and the index thinks that markets are more volatile than they really are, and it under allocates to equities.”

What “ER” stands for. This doesn’t stand for Emergency Room. It stands for Excess Return. You may see two indices that appear identical, but one will have the capital letter ER at the end of its name and the other won’t. An in-depth explanation is beyond the scope of this article, but ER indicates that the return is based on changes in the prices of index futures rather than changes in the price of the index. “The excess return (ER) indexes use an excess return methodology by tracking the price of futures, which mitigates the impact of short-term interest rates,” an Allianz spokesperson told us.

Academically gifted? Some observers have a special predilection for indices created by well-known academics and based on their original research. Two examples would be Robert Shiller, the Nobel Prize-winning economist, or Roger Ibbotson, the Yale professor and entrepreneur who created Ibbotson Associates and sold it to Morningstar before starting Zebra Capital Management.

Stagger your purchases. Two people can buy the same annuity and choose the same indices in the same proportions yet experience very different returns. That can happen because one person bought the contract three months before the other, for instance, and so timed the market differently. Some advisers practice time-diversification by breaking up a client’s premium into multiple contracts, purchased at three- or six-month intervals.

Be careful when using bonds for risk-mitigation. “If the index uses bonds for risk control, make sure the re-allocation to bonds is tactical, so that you’re participating in bonds differently,” said Haines. “But you need access to all of the risk mitigation strategies—to global indexes, tactical bond indexes, short strategies. Combine them all. Don’t think that all you need for risk control are an S&P 500 Index and a bond fund.” 

Managing expectations. Index-linked annuities should be viewed as alternatives to bonds, we were told by several people. Regardless of the caps or participation rates, investors should expect the products to provide them with the kinds of returns—and level of safety—that they used to expect from bonds. By chance, they’ll deliver double-digit returns in one specific contract year. But, by design, they’ll attempt to use options on equity indices or hybrid indices to achieve an average annual return of 1.5% to 2% above the yield on highly rated corporate bonds, while eliminating or buffering the risk of loss. 

Why not DIY? You might wonder, “Why couldn’t my clients just buy the options that an annuity issuer would buy, and get the same potential reward? Why do they have to hand over $100,000 to an insurer so that it can spend $2,500 of their $100,000 on options?”

One answer we got was that private investor can’t access the options markets, or get exposure to sophisticated indices, to the extent that the annuity issuer can. The second answer was brief: the annuity offers tax deferral. The short-term capital gains from trading options could easily be eaten up by taxes.

© 2021 RIJ Publishing LLC. All rights reserved.

Diversification and Insurance: Which Should Come First?

Posted on June 8, 2021 by -

To see the complete text of this article, click here. To visit the ‘Retirement Investing’ page at EDHEC-Risk Institute, click here. The authors are Nicole Beevers, Hannes Du Plessis, Lionel Martellini, and Vincent Milhau.  

MODERN PORTFOLIO THEORY suggests that the complex problem of investor welfare maximization subject to various constraints is best handled by jointly using three forms of risk management. First, diversification aims to harvest risk premia across and within asset classes with the lowest possible amount of risk and leads to the construction of well diversified performance-seeking portfolios (PSPs). Second, hedging aims to immunize a portfolio against certain risk factors and leads to hedging portfolios, including liability-hedging portfolios in asset-liability management, and goal-hedging portfolios in goal-based investing. It completes diversification in that it takes care of systematic risk factors, the exposures to which cannot be neutralized by diversifying a portfolio, while idiosyncratic risk is eliminated by diversification. Finally, insurance is captured via a dynamic allocation between a PSP and a hedging portfolio designed to secure an essential goal that can be the protection of a minimum amount of wealth or, more generally, the protection of a minimum amount of wealth relative to a benchmark.

Fund separation theorems from dynamic portfolio theory (see, eg, the seminal paper by Merton [1973] and Martellini and Milhau [2012] for the incorporation of minimum funding requirements) show that the investment strategy that maximizes an investor’s welfare uses all three techniques.

This discussion raises the following question: if diversification and insurance (ie, dynamic hedging) are not mutually exclusive techniques, is there an optimal order for them to be performed? Put differently, is it better to diversify a portfolio of insured payoffs or to insure a diversified portfolio? Since insurance has an opportunity cost, which takes the form of a limited participation in the upside of the PSP in favorable scenarios, compensating for the downside protection in unfavorable scenarios, and since diversification has no cost, intuition suggests that it should be more efficient to costlessly diversify away unrewarded risk before insuring the resulting portfolio at a cost. This lower opportunity cost is reflected in the lower price of the put option that protects against downside risk if the volatility of the underlying asset has been reduced first by diversification.

Several theoretical optimality results show that under certain assumptions, diversification should indeed come before insurance. El Karoui, Jeanblanc and Lacoste (2005) show that an investor who maximizes expected utility from future wealth with constant risk aversion and imposes a minimum wealth constraint should implement an extended form of option-based portfolio insurance (OBPI), where the underlying asset of the option is the portfolio that would be optimal in the absence of the constraint.

The latter portfolio is diversified because the expected utility criterion favors returns but penalizes risk, but it involves the expected returns and covariances of constituents and the risk aversion parameter (Merton [1973]). When the objective is to maximize the probability of reaching a target wealth level while respecting a floor, Föllmer and Leukert (1999) and Deguest et al (2015) establish that it is optimal to hold a knockout option that pays either the floor or the target, whose underlying asset is the ‘growth-optimal portfolio,’ that is the portfolio that maximizes the expected logarithmic return.

These theorems are obtained in a stylized framework where continuous trading, leverage and short sales are allowed, all risk and return parameters are perfectly known and the criterion is expected utility or the success probability. In practice, it can be argued that since crashes and recoveries in risky assets are not perfectly synchronized, it might be worthwhile to have an asset-by-asset control of the amount of risk-free asset to be invested in – and this would be done by applying insurance first.

In this context, this paper considers whether the question of which should come first, diversification or insurance, subsists in a context closer to real-world investment conditions than the theoretical environment in which the theoretical results are derived. We consider various diversification methods often used in practice, which avoid the estimation of expected returns and risk aversion. These are equal weighting, variance minimisation, risk parity (Maillard, Roncalli and Teiletche [2010]) and maximum diversification (Choueifaty and Coignard [2008]).

As far as insurance strategies are concerned, we test both constant proportion portfolio insurance (CPPI) and option-based portfolio insurance (OBPI), and we report several standard performance and risk metrics to compare the properties of the ‘diversification first’ and ‘insurance first’ approaches. A non-trivial methodological issue that arises in our study is how to construct a diversified portfolio of insured payoffs, given that the usual diversification methods require a covariance matrix estimate. We propose two estimators, both of which are consistent with the returns on the original securities, and one of which takes into account the composition of the insured portfolio.

Our results show that it matters whether insurance or diversification comes first. The big picture is that diversification before insurance tends to perform better than insurance before diversification in the long run, thereby confirming the aforementioned intuition about reducing the opportunity cost, but there are exceptions to this finding, since an equally weighted portfolio of CPPI-like payoffs outperforms a CPPI portfolio based on an equally weighted portfolio. Ultimately it seems that no one approach unambiguously prevails over the other, with respect to whether diversification or insurance should come first.

Nicole Beevers and Hannes Du Plessis are Quantitative Strategists, Rand Merchant Bank, a division of FirstRand Bank Ltd; Lionel Martellini is Professor of Finance, EDHEC Business School and Director, EDHEC-Risk Institute; Vincent Milhau is Research Director, EDHEC-Risk Institute.

Honorable Mention

Posted on June 4, 2021 by -

Annuity sales will rebound in 2021: Secure Retirement Institute 

The Secure Retirement Institute (SRI) is forecasting all individual annuity product lines except traditional variable annuities and fixed-rate deferred annuities to rebound in 2021. Overall individual annuity sales could see a slight increase in 2021, as the US and the insurance industry slowly transition from the global pandemic.

Longer term, SRI expects the total annuity market to benefit from improving economic conditions, shifts in demographic, as well as technology implementations. By 2025, SRI is forecasting the annuity market to grow as much as 30%.

There are several factors that will likely drive the annuity market:

  • While economic conditions are forecasted to improve, historic low interest rates will continue to be a headwind.
  • Products with protection features will continue to be in high demand.
  • Demand for guaranteed income is expected to grow.

“The most significant factors that drive annuity sales are the economic and regulatory environment,” noted Todd Giesing, assistant vice president of SRI Annuity Research. “How, and how quickly, manufacturers and distributors respond to external factors will dictate the ultimate impact of these changes. The rate of change and adoption of solutions to the challenges created by the 2020 global pandemic were accelerated, as companies looked for ways to adapt and show resilience amidst massive disruption.”

A look at the individual products:

Traditional Variable Annuities (VA): SRI is projecting traditional VA sales to decline slightly in 2021. By 2022, traditional VA sales will flatten out as economic conditions improve. Slow growth will come back to the traditional VA market in 2023 through 2025. Improving interest rates will help carriers with pricing efficiencies in products with guaranteed living benefits, and smooth equity markets will aid in the slow growth of investment-focused traditional variable annuities.  

Registered Index-Linked Annuities (RILA): The RILA market has experienced remarkable growth over the past few years and this trend is expected to continue through 2025. New manufacturers continue to enter the market and SRI expects some to introduce guaranteed lifetime benefits riders to broaden the appeal of these products to investors. By 2025, RILA sales are expected to be double what they are today.

Fixed Indexed Annuities (FIA): The indexed annuity market faced an extremely challenging environment in 2020, and as a result saw sales decrease by nearly $20 billion in 2020. Looking ahead, as interest rates improve, indexed annuities should slowly return to growth mode in 2021, but will face challenges as RILA’s continued success will likely take a portion of flows away from FIA sales, particularly in the independent BD and bank channel. SRI does expect FIA sales to enjoy slow and steady growth through 2025, and to reach or exceed 2019 record sales levels.

Fixed-Rate Deferred Annuities (FRD): Record market volatility and highly competitive crediting rates drove 2020 FRD sales to their highest annual level since 2009, as consumers sought investment protection and guaranteed growth. Despite improving interest rates and market stability — which would normally drive investors toward other products with greater growth potential — FRD sales will be bolstered by the nearly $150 billion invested in short-term fixed-rate deferred products over the past three years that will be coming out of their surrender periods. Given the current market conditions, we expect many investors will likely reinvest in fixed-rate deferred annuity products due to the rising rates, driving sales to close to $50 billion over the next few years.

Income Annuities: Despite improving economic conditions, low interest rates will continue to challenge the value proposition of income annuities through 2025. In addition, more flexible income solutions, such as guaranteed living benefits, will continue to capture a majority of the flows for investors seeking income guarantees in their retirement portfolio. While the growing aging population will benefit these products, the challenges of limited liquidity and the inability for insurers to provide robust pricing to attract individuals to income annuities will limit income annuity sales growth.

‘Income-oriented’ models are a growth category: Cerulli

The latest issue of The Cerulli Edge—U.S. Monthly Product Trends includes an analysis of mutual fund and exchange-traded fund (ETF) product trends as of April 2021, explores asset managers’ desire to expand their product offerings, and discusses why outcome-oriented solutions may serve as an entry point for registered investment advisors (RIAs) into model portfolios. 

Highlights from this research:

  • In April, mutual fund assets rose 3.7% to more than $19.6 trillion. Net flows were positive in April ($50.0 billion), although at a lesser scale than experienced in March ($61.0 billion) and February ($57.1 billion). ETF assets surged past $6 trillion during April, climbing 5.0% during the month to end at $6.2 trillion. In addition to April’s equity market performance, net flows continue to propel the vehicle’s assets, having added $75.3 billion during the month.     
  • Over the last decade, financial advisors have become far more confident in implementing ETFs in client portfolios. This greater comfort, along with greater model use and fee compression, has spurred many large asset managers, including former mutual-fund-only stalwarts, to expand their product offerings to include ETFs. Cerulli anticipates vehicle diversification will continue in coming years, as asset managers hoping to gain size and scope will need to give their clients the ability to access their investment capital in the vehicle that best suits their needs.
  • Model providers may be better served providing targeted goals-oriented solutions that RIA practices can use to address specific needs than trying to contend with the sea of options competing for a limited market of true RIA outsourcers. Cerulli believes that income-oriented completion models are a meaningful growth opportunity for asset managers and model providers. The independent RIA channel may offer an ideal arena for establishing a foothold with its lower barriers to entry, especially for those with proven investment expertise that are launching new strategies.
Equitable and Venerable close transaction

Equitable Holdings, Inc. announced this week that it has successfully closed its transaction to reinsure legacy variable annuity policies sold between 2006 and 2008 with Venerable Holdings, Inc. and that AllianceBernstein will serve as the preferred investment manager for the transferred general account assets.

As part of the transaction, the Company also announced that its in-force variable annuity reinsurance entity, Corporate Solutions Life Re, has been acquired by Venerable. With the close of this transaction, Venerable’s pro forma assets under management and reinsurance increase to approximately $70 billion.

On a pro forma basis, Venerable has more than doubled its general account assets from $9 billion to $19 billion, in addition to over $51 billion in separate account reinsured. The transaction includes reinsurance of a legacy variable annuity block from Equitable Financial Life Insurance Company with the combined deal representing $36.5 billion of underlying account value and general account assets. Venerable has also reinsured its existing business into CS Life Re, enabling operating efficiencies and optimizing liquidity for its collective book of business.

In accordance with the terms of the agreement, Equitable Holdings has acquired a 9.09% equity stake in Venerable’s parent holding company, VA Capital Company LLC. In connection with such investment, the Company will have the right to designate a member of the Board of Managers of VA Capital Company LLC.

Equitable Holdings, Inc., is a financial services holding company comprised of Equitable and AllianceBernstein. It has about 12,000 employees and financial professionals, $822 billion in assets under management (as of 3/31/2021) and more than 5 million client relationships globally.

© 2021 RIJ Publishing LLC. All rights reserved.

Seeking ‘An Index that Moves’

Posted on June 4, 2021 by -

Bryan Anderson owns Annuity Straight Talk in northwest Montana. He’s a licensed insurance agent who sells fixed annuities to people all over the US. Lately he’s been podcasting and training other advisers in how to communicate the indexed annuity value proposition to their clients. He manages the indexes in fixed indexed annuities (FIAs) much the same way that he might manage direct investments in index funds or exchange-traded funds (ETFs). 

His clients are just looking for safe, modest returns. “The people who buy FIAs are people who haven’t been able to time the market well. They’re not happy. They don’t have the emotional fortitude to deal with a 20% downward bump in the equity market, and they’re perfectly happy with an average return of 4.5%. I want to get them there.” Anderson told RIJ in a recent interview.

“I didn’t like the blended or hybrid indexes at first because I thought they were too complex. I had every skepticism that anybody could come up with. But over the past few years I’ve changed my mind. My clients tend to look at the participation rates. They like the idea of getting all of the returns.”

Clients are naturally drawn to a crediting method that will give them 100% of the index gain, even if they know that it’s 100% of performance that is more or less restrained by a volatility control mechanism. Such a mechanism might automatically reallocate the index holdings to safe assets when market volatility exceeds a 5%, 6% or 7% target, depending on the contract. 

Volatility control at the index level can also prevent an unexpected change in pricing, he said.  “The life insurers explained to us that they can better project pricing with a volatility-controlled contract. They don’t get stuck in the position of  suddenly having to reduce a 6% cap down to 3.5%,” he said. 

Like many advisers, Anderson welcomes lots of choices in an annuity, even if it adds complexity to the contract. “I like to see 15 different indexes. I know that at least one of them is going to grow. It’s just a matter of figuring out which one it will be,” he said. “Most of all I like to see an index that moves.” That is, he doesn’t want to use an index so volatility-controlled that it becomes inert. If it doesn’t respond to trends, he can’t get a feel for how it might behave in the future. 

How do clients generally divide their money among multiple indexes? “If there are six indexes, some people won’t want to over-think the decision. So they split their money among all six. Others will chase one or two,” he said. “We might be optimistic about one index in particular and put 60% of the money in that and then put 10% into four different ones. The worst situation is to not be in an index and then realize that you’d have gotten a much bigger gain there.” He also likes the flexibility of newer contracts. “In the old contracts you might be stuck with three index options. There was no way to go elsewhere until the contract was free of the surrender penalty.”

Some clients invest all of their money in a contract at once. Others split up their money across contracts. It depends in part on how much money they want to invest. “Some people go all in at one time. I’ve had people who bought a single contract for $500,000. Another who bought eight contracts that totaled $800,000,” he said.

To diversify across time, “I like to sell half at a time, to offset the crediting dates,” Anderson said. In one case, where we used the Bloomberg US Dynamic Balance Index, I put half of the money in a one-year contract and half in a two-year contract. That index had a second-year return of 15%.” He tries to deliver an average annual return of 5% to his clients, and keeps looking for it. “I know that there’s a 5% gain somewhere in there,” he said. 

Sometimes Anderson chooses the index, and sometimes his clients do. “A client might say to me, ‘You know best,’ or ‘We did OK last year, just keep it the same.’ But some people really get into it. One of my clients spends an hour a day after work looking at the charts. Then he tells me, ‘I want 20% of the money here and 40% there.’ He’s an intelligent guy who enjoys it. I like to see him having fun. It takes pressure off me; I’d say that about 25% of my clients are like that,” he said.

Anderson sees real value for the client, and not just the appearance of value, in the higher crediting rates that come with volatility control. For him, even those indexes have the potential to deliver the best of both worlds—higher returns than bonds with less risk. 

“Yes, there’s value there,” he said. But he knows better than to tell clients to expect the upper limits on returns. “It’s a matter of adjusting your sales tactics. If I know that a product could do 10%, then I know I have an opportunity to do 5%. I want a product that has the upside potential, but I won’t pitch them on it. I sell them on a 3.5% gain and tell them to look at the rest as gravy.”

© 2021 RIJ Publishing LLC. All rights reserved.

‘Sometimes the Market Swings Your Way’

Posted on June 4, 2021 by -

Don Dady and Ron Shurts started Annexus in 2005. Lack of discipline in the distribution of index annuities, which led to lawsuits and prosecutions over high-pressure sales practices, was threatening to kill that business.

“Independent distribution was broken. The IMOs [insurance marketing organizations] had no control over the insurance agents. Insurers had no control over the agents. Nobody was supervising them. We saw that we could increase the value proposition of wholesale distribution if we handpicked a select group of distributors and gave them something different to offer,” Dady told RIJ recently.

“We built a virtual insurance company. Annexus performs all the functions of a life insurer except administration and investments. We’ll come up with annuity concepts, we’ll price them out, and take them to the insurer, work on the marketing story. We vet different indices and help choose the portfolio of indices that we think will work in a particular product. We ‘do it all’ without the baggage and overhead of a life company.”

Dady welcomes hybrid indexes into the indexed annuity business. “In my opinion, a lot of advisers aren’t comfortable with hybrid indexes because they’re not sure how they work. So they’re just going to sell the S&P 500 Index. It will be a safe approach. The options will be cheaper [because of the ample supply] but the volatility of the index and the participation rates will be lower.”

Before volatility controls were applied to the indexes in indexed annuities, they were used to dampen the volatility of the investments of variable annuities with lifetime income guarantees. “The control method was ‘just get out’ [of equities and into bonds or cash],” he said. “Now you have hybrid smart beta indices,  which are designed to drive growth using the same algorithms that asset managers use. ‘Value’ and ‘momentum’ are techniques that we can incorporate into the index, with dynamic allocation among the asset classes. There has been a learning curve for advisers and insurers. The insurers get it. The advisers still have work to do.”

Like Lau, Dady likes the value proposition of registered index-linked annuities, or RILA. “What’s driving the sales of RILAs is the distribution,” he said. “There are a lot more securities-licensed producers than insurance producers, and registration creates more credibility. The buffer enhances your option budget in a low-rate environment. The beauty of the products is that they insulate you from some but not all of the market volatility. If somebody is willing to be insulated from only the first 10% loss, that fuels our option budget.”

More so than Lau, Dady believes that owners of index annuities can expect to enjoy an occasional year of outperformance. “We shouldn’t set the consumer up to expect phenomenal returns from such a low-risk product. On average, there will be no double-digit returns,” he told RIJ. “But once in a while there will be. We have definitely seen some phenomenal returns with vol-controlled indexes. Sometimes the market swings in your favor.”

Annexus is currently partnering with The Index Standard, a fintech startup whose founder, Laurence Black, has developed an index evaluation tool for Dady’s distribution partners. “With The Index Standard, somebody for first time is pulling the curtains back and explaining the mechanics of the indexes.

“Some of the indices have been reverse engineered to look good in the past, but not necessarily to perform in the future. All of the 10-year look-backs look good. We vet the indexes to see how well-positioned they are on a forecasting basis. Black is asking questions like, ‘What drove the past performance of the index?’ and ‘Does the index have survivor bias? and ‘What percent of the index returns came from capital gains on bonds?’ We know that the likelihood that interest rates will fall by 300 basis points in the future is very low.

“With The Index Standard, we’ll be able to caution advisers about those things. We also want to make sure the contracts allow the adviser to create buckets, where they can diversify across non-correlated indexes. We remind advisers that the product is not designed to outperform equities. In the end, the FIA is a fixed income product. Using an equity index is a way to create a fixed income ‘alt.’

“We do not believe that the carriers have done that work for the adviser, We see indices that have been put in products that have not been vetted. Advisers need better tools to evaluate them. Three or four years from now, the industry will have better processes. They’ll build a framework to help advisers select indices.

“The low interest rates are definitely a challenge. But it’s all relative. We’re competing against fixed income. Now that the larger world is waking up to the risks of retirement, that’s really opening up our world. We have a major initiative with Nationwide for September in the in-plan space. We reinvented the annuity to make it look like a security. It’s a target date fund that generates a 6% income, designed to kick off income starting at age 65.”

© 2021 RIJ Publishing LLC. All rights reserved.

Too Much ‘Hocus Pocus’

Posted on June 4, 2021 by -

David Lau has been marketing fee-based annuities to Registered Investment Advisor (RIA) firms and their Investment Advisor Representatives for years. He helped start Jefferson National Life, which pioneered the sale of low-cost variable annuities to RIAs; the firm was later sold to Nationwide.

A serial entrepreneur, he then launched DPL Financial Partners, a web platform where advisers without insurance licenses can learn about, purchase, and bill on a variety of no-commission insurance products. He likes indexed annuities as bond alternatives. But the FIAs and RILAs offered on the DPL platform do not contain volatility-controlled indexes.

“I generally don’t like the custom indexes that are in the market. I think there’s a lot of hocus-pocus going on,” he told RIJ. “They’re built to illustrate well and show well when you present to a clients. These products have been built to be sold, not built to be used.

“I don’t have a problem with volatility controls. That’s part of risk mitigation. If volatility control prevents the investor from moving to cash in a downturn, then it makes sense.” But he finds that some index designers deliberately set low volatility targets (restricting the range of returns) because the options on the index will cost less and their option budget will buy more potential upside.

“When you see popular indexes with target volatilities of only 4% or 5%, you know that they’re doing it to get more money to buy options and to get higher caps. If it sounds too good to be true, it probably is.” Lau told RIJ. 

“For instance, an issuer might offer the S&P 500 Index with a 4% cap in an FIA. If you put volatility controls on that index, suddenly you can afford to offer a 10% cap. That illustrates well to the client. It makes them feels like they could get 10% every year. The product will look good but it has very little chance of actually performing in that well.”

A RILA, or registered index-linked annuity, which also uses options on indexes to generate yield, can advertise even higher caps and participation rates than FIAs. But those higher rates are not illusory, he pointed out because the investor has increased his options budget by selling off part of the downside protection that an FIA offers. Instead a floor of zero returns, the RILA might have a downside “buffer” of 10%, which means that the investor is responsible for all losses beyond 10%. For instance, if the index goes down 14%, the client loses only 4%.

That makes sense to him and to his customers. “Clients love RILAs. They provide excellent risk protection and a strong return. Who doesn’t like the notion that you might get as much as 15% in a year and also have 10% protection on the downside?” he said.

Anyone who believes that an annuity issuer can take a tiny fraction of a contract owner’s annuity assets and turn it into a big gain doesn’t understand the math, Lau explained. That’s doubly true because many of the indexes used in annuities track the index price without including the yield.

“The carrier has an options budget. You can see what it is by what they’re paying in the fixed account. They might have 3% of the client’s money to buy options on the index. I don’t think you can generate multiples of that return by buying options on an index. It’s not going to happen. The index also has a lot of expenses that the fixed account doesn’t have. Roger Ibbotson once looked at 90 years of index returns and concluded index annuities should outperform bonds by only about 10%.” 

That said, Lau thinks the no-commission index annuities have great value for advisers and clients near retirement. Low interest rates and high correlations of asset performance are the reasons. “In the RIA world, these products are underused,” he said. “We’ve seen a lot more correlation of assets in the last ten years. As a result, diversification alone isn’t enough.

“You also have to look at the purpose of the product. It replaces fixed income. You’re looking for predictable return because that’s what you’re replacing. As an adviser, I might allocate 50% of a client’s assets to the fixed account, which might pay 2.5% to 3.1%. For the other 50% I’ll look for some upside from an index, perhaps the Russell 2000 or MSCI.

“At DPL, we’re trying to create insurance products, or bring products to market, that are built to be used by an advisor in a portfolio and not to be sold by a salesman,” he added. “So we go with the basic indexes like the Russell 2000 and S&P 500. We will be offering a custom index ourselves later this year. It’s going to include dividends. It will be built to provide consistent, real performance.”

© 2021 RIJ Publishing LLC. All rights reserved.

The Point of Indexing (in Annuities)

Posted on June 4, 2021 by -

When Jack Bogle introduced indexing to the investing public in the 1970s, competitors mocked him. Investors won’t settle for “average” returns, they said. But they were wrong. By 2020, index funds (including exchange-traded funds or ETFs) were worth over $11 trillion worldwide.

Indexing has even saved the annuity industry. Using the equivalent of about 2.5% of a client’s premium to buy options on an equity index, life insurers can offer fixed and variable indexed annuities that can outperform bonds at times (like now) when bond yields are down and equity returns are up.  

Today, a single indexed annuity contract might include as many as 15 different index choices. About 48% of all fixed indexed annuity (FIA) sales are still allocated to the S&P 500 Index, according to Wink. But almost 40% now gets applied to “hybrid” indexes that blend the performance of stocks and bonds or dynamically allocate between asset classes in response to market volatility.

Every June, RIJ focuses on indexed annuities. Last year, we took a deep dive into the use of options in variable index-linked annuities. This year we want to find out what the proliferation of indexes—especially hybrid and volatility-controlled indexes—means for advisers and clients.

For instance, if an FIA contract offers multiple indexes, how does the adviser help the client decide which ones to use, and in what proportions? How do volatility-controlled indexes work, and by what financial alchemy can they offer such generous performance limits? For answers, we went to the people who work with these indexes every day.

For answers, we turned to agent Bryan Anderson of Annuity Straight Talk in Whitefish, Montana, to Don Dady, co-founder at Annexus, an annuity product designer and distributor in Scottsdale, AZ, and to David Lau, founder of the DPL Financial Partners annuity platform and a pioneer in marketing fee-based annuities to Registered Investment Advisors. These experts gave us three nuanced perspectives.

Our three specialists agreed on one thing: That indexed annuities offer people who are nearing retirement a source of higher yields (on average) than bonds provide in today’s low interest rate environment, while also insulating their principal from volatility during early retirement.

With respect to the hybrid or volatility-controlled indexes in indexed products, however, they hold different views. Lau regards them with skepticism; he believes they can be manipulated to give investors unrealistic expectations of potential gains.

Anderson welcomes the flexibility that a large selection of indexes gives him. He finds real value—not the illusion of a free lunch—in the higher caps and participation rates that volatility-controlled indexes are able to offer. Dady is working with Laurence Black of The Index Standard to create a tool that, he believes, can forecast the performance of the indexes well enough to enable advisers to make an optimum selection among them. 

For their comments, see the stories on today’s home page.

© 2021 RIJ Publishing LLC. All rights reserved.

A close look at ‘collective defined contribution’ plans

Posted on May 27, 2021 by -

The economies of “pooling” are non-trivial. Whether it’s car-pooling with co-workers, buying life annuities, or joining an old-fashioned community “swim club,” the efficiencies that come from sharing an expense, a chore or a risk can deliver significant individual savings.

But pooling brings frictions and complexities as well. That’s why many people choose to install their own backyard swimming pools, avoid illiquid annuities, and commute solo to work every day.  

Which brings us to the concept of “collective defined contribution” or CDC plans. A timely new white paper from the Center for Retirement Initiatives at Georgetown University makes a case for these retirement plans, which try to blend elements of defined benefit pensions and of defined contribution plans in a best-of-both-worlds hybrid.

“A CDC plan is similar to a DB plan, but does not provide a guaranty from the employer,” write Charles E. F. Millard, David Pitt-Watson, and CRI executive director Angela M. Antonelli in “Securing a Reliable Income in Retirement.” They contribute to the ongoing debate over how best to help DC plan participants turn their tax-deferred savings into reliable income.

Like a DB plan, a CDC plan is overseen by a professional investment management team with the goal of paying participants an annual retirement income equal to a percentage of their final or average pay. The white paper describes the potential benefits and avoidable pitfalls of using CDC, and highlights lessons learned from CDC experiments in the Netherlands and the United Kingdom.

Ultimately, the authors favor CDC. “Recent studies suggest that a CDC plan will generate a retirement income at least 30% higher than a typical DC plan,” they write. “Recent reforms in the United States offer a potential new opportunity for the greater adoption of pooling, the introduction of CDC plans, and other future plan design considerations for policymakers.”

© 2021 RIJ Publishing LLC. All rights reserved.