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The “Evolution of the Annuity Industry”

Only a decade or so ago, variable annuities were still perceived almost exclusively as vehicles for deferring taxes on investment gains over long time horizons. Unique among tax-favored products, they could accommodate virtually unlimited after-tax contributions. While contract owners always had the right to convert the assets to lifetime income (penalty-free after age 59 1/2), very few owners took advantage of that capability.

With the advent of living benefits during the Bush bull market, the VA product itself and its marketing story changed dramatically. VAs with lots of investment choices and income riders were often described as a vehicle for risk-averse investors to stay in equities during retirement while still protecting their nest egg from ruin.

Then came the global financial crisis. It shook out the VA industry, driving some carriers out of the business entirely and forcing the rest either to “de-risk” their products, limit distribution and/or find a way to share more of the risks and costs with the customer.   

Now here we are in the fall of 2011. But where are we, exactly?

That’s the implicit question behind a new study co-sponsored by the Insured Retirement Institute (prior to October 2008, the National Association of Variable Annuities), which lobbies for the retirement industry in Washington, and Boston-based Cogent Research. (The proprietary study is available to IRI members for $7,500.)

The study, titled “The Evolution of the Annuity Industry,” was based on surveys of and conversations with 11 annuity manufacturers and broker/dealer “gatekeepers” (those who pick annuities for the b/d shelves), 359 advisors who sell (and 10 who don’t sell) annuities and 304 consumers, half of whom owned some kind of annuity and half of whom didn’t.   

Cogent and IRI have concluded, based on their research, that the annuity sales “story has changed to one that highlights guaranteed retirement income.” 

“All of the audiences we talked to brought up the idea that there’s been a paradigm shift, a change in focus from the accumulation phase to the need for retirement income,” said Cogent’s Steve Sixt, one of the report’s authors. Added co-author Marie Rice, “It used to be about accumulation. Now it’s about income.”

Yet the report’s executive summary suggests that broker/dealers, advisors and consumers continue to voice the same objections to variable annuities that they have for at least five years. The “complexity” issue, for instance, remains a dilemma.

On the one hand, the study showed that distributors still complain about “constantly changing product features” that require “additional training requirements.” Yet the study also reported that “advisors are not seeking simpler annuities that contain fewer bells and whistles; they are looking for annuities that can be easily explained and understood.”

Broker/dealers and advisors are also still apparently concerned that the annuity sales process is more cumbersome than the process of selling mutual funds—despite years of work by annuity manufacturers on what was called the “Straight Through Processing” initiative. (It might be pointed out that as long as annuities are less liquid and more closely regulated than securities, the sells process will always be relatively cumbersome.)      

(Chart source: Cogent Research and IRI.)

“The technology of the annuity sales process is behind the times,” said Sixt. “It’s true that they’re still talking about the same difficulties the industry was talking about four or five years ago. But now there are more ideas about how to deal with the barriers. There’s a lot of conversation, for instance, around standardizing the sales process among carriers.” 

The authors pointed to a couple of findings that they believe are encouraging for the retirement industry. First, advisors are now more concerned about a variable annuity’s income options and the issuer’s financial strength than about the contract’s investment options (see chart above). Advisors expect both of those issues to gain importance in the next five years. Second, younger consumers—those in the 25-44 and 45-54 age groups—are substantially more likely than older people to say they are willing to give up some control over their investments in return for guaranteed income (see chart below).


As for consumer attitudes toward annuities, the data in the summary seemed inconclusive. Only a third of annuity owners—owners of variable or fixed deferred annuities, mainly—said guaranteed income was their main reason for buying an annuity. Over a third of non-owners said they were at least somewhat likely to buy an annuity in the future. Less than half of annuity owners said they were “at least somewhat knowledgeable about the specific features and benefits” of the first annuity they purchased.

The report includes several “strategic implications,” including:

  • Broker/dealers and intermediaries should focus on the capturing the money that rolls over from 401(k) plans into IRAs.
  • Simple stories that can help sell VAs should be documented, recorded, and distributed to advisors.
  • Carriers should develop annuities whose riders can be updated without switching contracts.  

The Cogent/IRI report coincides with a frustrating period for the variable annuity industry. In 2006, the VA with a lifetime income guarantee seemed like the Ford Mustang when it first appeared in 1964 or 1965: the perfect product at the perfect time for the Baby Boomer generation. But, given the financial crisis and a low interest rate environment, the VA’s most appealing features have been increasingly expensive for insurance companies to offer. Indeed, at least three publicly held insurers reported huge charges to shore up their VA guarantees in the third quarter of this year. 

VA issuers are now scrambling to find ways to offer contracts that are simultaneously exciting (with upside exposure) and low-risk (with  downside protection).  It has been observed that, to compete for the attention of the independent advisors who sell a plurality of its contracts, VA manufacturers must dream up ever more attractive products that must also, in many cases, satisfy the demands of several other constituencies, such as customers, shareholders, regulators and accounting standards boards. But the inevitable complexity of those something-for-everyone products can itself make them harder to sell. Even in the best of times, it’s a challenging business.      

© 2011 RIJ Publishing LLC. All rights reserved.

 

 


“Carriers Settle In”

Coming off a highly active second quarter, insurers appear to have made their adjustments and shifted focus away from development to distribution, Morningstar’s latest variable annuity report shows.

 Carriers made 40 material new filings during the quarter, down from 162 in Q2 and 106 in the same quarter last year. The new filings focus heavily on new share classes and the Lifetime GMWB benefit, which currently garners about 64% of new sales flows.

Carriers continue to experiment with new benefit design. Benefit structures continue to be parsed to allow for risk control and segmentation of the target investor base. Also continuing is the trend toward releasing share classes for the fee-based market. Step ups also took a leap forward this quarter with higher fixed percentages.

Lincoln Financial

Lincoln released a new I-share contract. Priced at 65 bps, it has a Lifetime GMWB and two death benefit options: highest anniversary value and return of premium (Investment Solutions). Lincoln closed the Multi-Fund 5 contract.

Also on October 31st Lincoln released an O-share. The fee structure pulls elements from both the A-share and B-share structure. The base contract fee is 85 bps. A sales charge is spread over 7 years, ranging from 15 bps to 70 bps based on breakpoints from $50,000 to $1 million. The contract offers the unique Lincoln hybrid income guarantee, GMWB, and Lifetime GMWB. Death benefits are Return of Premium and HAV (Legacy Fusion and ChoicePlus Fusion).

Minnesota Life

Minnesota Life has created a new Lifetime GMWB. The benefit offers an age-banded withdrawal structure from 4.5% to 8.0%. The withdrawal rate is 5% for a 65 year old. The benefit base is enhanced by a 6% step up and a 200% deferred benefit base bonus. The rider costs 115 bps for the single and 165 bps for the joint life version (Ovation Lifetime Income).

Pacific Life

Pacific Life has a new bonus share. The cost is 160 bps and the surrender schedule has been extended a year to eight years. The contract offers a 4% or 5% bonus on first year payments. The contract carries a GMWB, Lifetime GMWB, GMAB and the three common death benefits (Pacific Value Select). The company closed the Pacific Value contract.

Pacific Life continues to plan for the Edward Jones market with an O-Share. The fee structure pulls elements from both the A-share and B-share structure. The base contract fee is 85 bps. A sales charge is spread over 7 years, ranging from 15 bps to 70 bps based on breakpoints from $50,000 to $1 million. The contract offers a GMWB, Lifetime GMWB and Return of Premium and HAV death benefits (Pacific Destinations O-Share).

Transamerica

Transamerica released a new I-share contract in pursuit of the RIA market. The low 45 bps fee is competitive. The contract offers a Lifetime GMWB and three types of death benefits: return of premium, highest anniversary value, and enhanced earnings (DWS Personal Pension VA).

Transamerica is offering a new Lifetime GMWB. Pricing ranges from 45 bps to 140 bps depending on investment options chosen. The rider offers an age-banded withdrawal structure ranging from 4% to 6%. The withdrawal rate is 5% for a 65-year-old (4.5% for joint life). There is a 5% simple step up as well as a highest-anniversary value feature (Retirement Income Choice 1.5).

Allianz Life

Allianz has filed but not activated a Lifetime GMWB (on hold as of 4-26-11). The rider proposes a unique guaranteed withdrawal percentage based not on age, but on the rate of the 10-year U.S. Treasury note. This ties payouts directly to market performance, removing the age factor. The fixed step up amount is 8% along with an HAV step up.

The Hartford

On October 31st Hartford released an O-share. The fee structure pulls elements from both the A-share and B-share structure. The base contract fee is 70 bps. A sales charge is spread over 7 years, ranging from 17 bps to 71 bps based on breakpoints from $50,000 to $1 million. The contract offers a GMWB, Lifetime GMWB and Return of Premium and HAV death benefits (Personal Retirement Manager).

MetLife

On October 10th MetLife decreased its step up percentage on its popular GMIB benefit. The new GMIB Max II has a step up that is either 5.5%, or the ratio of the RMD divided by the benefit base, whichever is higher. This is down from 6% previously.

In addition, the enhanced payout rate on the no lapse guarantee was reduced in the same way, now offering 5.5% (down from 6%). This provision is now available on or after the owner’s 67th birthday (down from age 70) (GMIB Max II). In addition, GMIB Max III has been filed which reduces the income amount to 5%, effective in January 2012.

Monumental Life

On October 19th Monumental Life, in partnership with Vanguard, released a new Lifetime GMWB benefit for the Vanguard I-share contract. The 95 bps benefit offers a 5% lifetime withdrawal rate for a 65 year old (4.5% joint life) and a highest-anniversary value step up (Guaranteed Lifetime Withdrawal Benefit for the Vanguard VA).

© 2011 Morningstar Inc. All rights reserved.

MetLife reorganizes in wake of Alico acquisition

MetLife, Inc. will reorganize its business from a U.S./ International structure into a structure consisting of three broad geographic regions, in order “to better reflect the company’s global reach” created by its 2010 acquisition of Alico for $16.4 billion from AIG, the company said in a release.

The three new business regions, each of which will have its own president, are the Americas, EMEA (Europe, the Middle East and Africa), and Asia.

 “To reach its full potential, MetLife needs an organizational structure that leverages the best of both MetLife and Alico,” said president, CEO and chairman-elect Steven A. Kandarian. “This structure will lay the foundation for a global company. Each of our new regions have both mature and developing markets, both of which are critical to shareholder-value creation. At the same time, we will be able to draw on strengths from across each region to drive collaboration and efficiencies.”

The Americas

MetLife will no longer have a president of the U.S. Business. Instead, William J. Wheeler has been appointed president of the Americas division and remains a member of the executive group. As MetLife’s chief financial officer since 2003, Wheeler helped guide the company’s acquisitions of Alico and Travelers Life & Annuity in 2005.

Prior to becoming CFO, Wheeler oversaw business development, product management and marketing activities for the company’s former Individual Business division. He joined MetLife in 1997 as treasurer after 10 years in investment banking. He holds an M.B.A. from Harvard Business School and an A.B., magna cum laude, from Wabash College.

EMEA

Michel Khalaf has been appointed president of the EMEA division and becomes a member of the executive group. Khalaf, who joined MetLife through the Alico acquisition, previously was executive vice president and CEO of MetLife’s Middle East, Africa and South Asia (MEASA) region.

Before that, he was deputy president and chief operating officer of Philamlife, AIG’s operating company in the Philippines. Since joining Alico’s investment department in 1989, Khalaf has held a number of leadership roles in various markets around the world, including the Caribbean, France and Italy. In 1994, he was named the first general manager of Alico’s operation in Egypt, and in 1996 he became the regional senior vice president for Alico’s life, pension and mutual fund businesses in Poland, Romania and the Baltics, as well as president and chief executive officer of Amplico Life. Khalaf earned his undergraduate degree in engineering and his M.B.A. in finance from Syracuse University.

Asia

MetLife is conducting a search for a president of the Asia division. In the meantime, the region is reporting directly to Kandarian.

With the integration of Alico close to completion and due to the reconfiguration of the company’s structure, William J. Toppeta, who served as president of the company’s International business, intends to retire. Toppeta will remain with MetLife in the newly created position of vice chair, EMEA/Asia, through May 31, 2012, reporting to Kandarian. Toppeta will serve as a mentor and consultant to the presidents of EMEA and Asia. In addition, he will serve as MetLife’s ambassador in EMEA and Asia to external constituencies on major regulatory and legislative issues that may impact the company’s business.

Global employee benefits

MetLife is also creating a new global employee benefits business unit, headed by executive vice President Maria R. Morris, who will continue as a member of the company’s executive group and report to Kandarian.

Morris has led the Alico integration and in prior roles has headed group insurance, retirement and voluntary benefit sales and service operations, and has run the group and individual disability and dental businesses. She will continue to oversee the integration of Alico until mid-2012.

The operations function formerly led by Morris now reports to executive vice president Marty Lippert, who becomes head of global technology and operations. MetLife is currently conducting a search for a new chief financial officer. The interim CFO is executive vice president Eric Steigerwalt.

Five tasks that retirement plan advisors now face

Following a national “listening tour” on which Transamerica spoke with advisors to small and mid-sized retirement plans about their most pressing business concerns, the insurer says in a release it has discovered five basic tasks that advisors are tackling:   

  1. As the April 1, 2012 deadline approaches for 408(b)(2) disclosure rules, plan advisors are expanding their efforts on fee education and transparency related to all plan services.
    The current economic environment has reinforced plan sponsors’ concerns regarding the competitiveness of their plan fees relative to the services they receive. The new regulations center on the disclosure of plan fees and the corresponding value for services. Advisors view their role as helping to educate their plan sponsor clients so that they clearly understand plan fees.
  2. Market volatility has intensified the importance of improving plan participants’ retirement readiness.
    The economic challenges of recent years continue to bring concerns about retirement readiness to the forefront, and employees’ preparedness has become a hallmark of success for many plans. Plan advisors are helping sponsors with plan design options such as auto-enrollment and auto-escalation in order to improve participation and deferral rates. Advisors are also helping sponsors develop, and in some cases implement, participant education strategies. In addition, advisors are partnering with plan providers that offer participant education campaigns which can be delivered through a variety of channels.
  3. Plan advisors and their clients are seeking greater flexibility and customized “value for service” for their retirement plans.
    Plan sponsor clients look for consultative advisors and plan providers that can provide value that is specific to the plan’s needs. For example, plan design consulting can lead to increased participation rates, while plan administrative service support or certain fiduciary services can reduce a plan sponsor’s liability. The ability to create and deliver customized, flexible services to the plan is central to demonstrating strong value to the client.
  4. Plan advisors are helping sponsors evaluate their plan’s success through annual reviews and industry benchmarks.
    Once advisors have determined how their clients define a successful plan, they can work to establish measurable goals based on the metrics that matter. Many advisors are providing their plan sponsor clients with an annual check-up on key plan metrics such as participation rates, deferral rates, average account balances, plan fees, and match, vesting and loan provisions. Annual benchmarking of these metrics can help identify strategies to improve the plan.
  5. Plan advisors may redefine their fiduciary status in advance of potential regulatory changes.
    In 2012, the U.S. Department of Labor is expected to re-propose its rule on the definition of “fiduciary” for retirement plans. Regardless of if or when this rule is formalized, advisors are currently in the process of deciding whether or not they are comfortable or allowed to acknowledge fiduciary status. The advisors who will not act as fiduciaries will most likely seek the support of a third-party fiduciary service.

 

High and low earners benefit from 401(k) plans differently

Authors of a new study from the Center for Retirement Research at Boston College take issue with the politically-charged conventional wisdom that 401(k)s and similar tax-deferred employer-sponsored retirement savings plans benefit highly-paid workers much more than lower-paid workers.

In their paper, “Do Low Income Workers Benefit from 401(k) Plans,” Karen E. Smith and Eric J. Toder, assert that every dollar that an employer contributes to a male highly-paid worker’s 401(k) account reduces that worker’s take-home pay by 90 cents, on average. But the same contribution to a male lower-paid worker’s account reduces his take-home pay by only 29 cents, on average.  Apparently the wages of lower-paid workers are less compressible. (For women, the corresponding figures are 99 cents and 11 cents.)

So, while the worker in the higher tax bracket enjoys a greater benefit from tax deferral, the worker in the lower tax bracket has relatively less of his pay replaced by employer contributions. The study assumes what most economics assume: that employer contributions are carved at least partially out of regular compensation and don’t represent an additional benefit.

The study may help solve the mystery regarding low participation rates and/or low contribution rates among lower-paid employees. First, lower-paid employees may recognize that their contributions don’t benefit as much from tax-deferral. Second, their contributions are more likely to require sacrifices in consumption.

In addition, though lower-paid workers may not realize it, the exclusion of employer contributions from the basis for payroll taxes undermines their accumulation of Social Security benefits to a greater degree than it undermines the benefits of higher-paid workers.

© 2011 RIJ Publishing LLC. All rights reserved.

The Bucket

New Principal fund uses long/short strategy against volatility

Principal Global Multi-Strategy Fund (PMSAX), a new offering from Principal Funds, will use alternative strategies to try to achieve long-term capital appreciation and positive total returns with “relatively low volatility,” Principal said in a release this week.

Principal Funds will collaborate with Cliffwater, Inc., a premier hedged-strategies consultant, on portfolio design, strategy selection and risk management. Additional subadvisors include:

  • AQR Capital Management; CNH Partners – multi-strategy
  • PIMCO – multi-strategy (fixed income)
  • Wellington Management – equity long/short (fundamental approach)
  • Los Angeles Capital – equity long/short (quantitative approach)
  • Loomis Sayles – credit long/short

A new position paper from Principal explains the potential role of alternative strategies within an asset allocation strategy. It also includes review questions for financial professionals and their clients.   

The Principal Global Multi-Strategy Fund is the third in a series of funds designed to provide outcome-oriented solutions for financial professionals and their clients. The two previous funds were Principal Global Diversified Income Fund (PGBAX) and Principal Diversified Real Estate Fund.


Liberty Life to partner with iPipeline   

iPipeline, which provides marketing and processing solutions for insurance carriers, distributors and producers, today announced a relationship with Liberty Life Insurance Company, the retail annuity subsidiary of Athene Holding Ltd..

Liberty Life will use a variety of iPipeline applications to automate and streamline business processes for independent insurance agents selling Liberty Life annuities. iPipeline will be providing access to the integrated solution via a customized agent portal built for Liberty Life’s agents.

 

Allianz Life appoints new CIO   

Allianz Life Insurance Company of North America has today named Carsten Quitter as its new chief investment officer and head of Allianz Investment Management-U.S. His predecessor, Axel Zehren, will join the parent company Allianz SE in Munich.

In this role as head of AIM-U.S., Quitter is responsible for investment management, liquidity planning, hedging and trading the insurance assets for Allianz Life, Allianz Fireman’s Fund, Allianz Global Corporate and Specialties (AGCS) and Allianz Mexico.

Quitter had been chief investment manager and head of risk management for Allianz in Switzerland, responsible for assets under management of more than 20 billion Swiss francs. He joined Allianz Switzerland in 2005 as head of asset liability management. Quitter spent eight years with Swiss Re, including stints as managing director and chief operating officer of new markets. He was also a partner with Zimmermann & Partner, a consulting firm for the re-insurance industry. Quitter holds a Master’s degree in Computer Science and Mathematics from the University of Dortmund in Germany.

 

MassMutual selected as provider for $23+ million Taft-Hartley retirement plan

MassMutual’s Retirement Services Division has been selected as the new provider for the Labor Unions 401(k) Plan, based in Southern California. The Taft-Hartley plan has more than $23 million in assets under management and serves over 3,500 union members who work in the hotel, food service, gaming, textile, laundry, manufacturing, and distribution industries.


MassMutual Retirement Services launches online video series

MassMutual Retirement Services recently launched RetireSmart TV, a new series of short online videos on topics such as the importance of good credit, affording healthcare, ways to save for college, and how to prepare for retirement, the company said.

The first 10 two-minute educational videos feature Farnoosh Torabi, independent Generation Y money coach, author and personal finance journalist, talking with “everyday Americans” about being RetireSmart with their individual strategies surrounding:

  • Keeping tabs on credit
  • Staying on track to reach their retirement goal
  • Assessing their current retirement strategy
  • Getting an early start to saving for retirement
  • Ways to pay for college
  • Envisioning their retirement future and important lifestyle considerations
  • Getting help with retirement planning
  • Affording healthcare
  • Reaching their retirement goal
  • Understanding mutual funds

“People today are reading less and watching more online video and webisodes, with Americans spending nearly three and a half hours a week watching online video,” says Kris Gates, assistant vice president of participant and interactive marketing for MassMutual’s Retirement Services Division.  

The videos can be accessed at www.retiresmart.com, www.facebook.com/retiresmart, www.massmutual.com/financetips, or  www.youtube.com/user/MassMutual.

Signature of the Times

In 2005, John Hancock Life was riding the pre-Crisis boom in variable annuity sales. In U.S. banks alone, it sold $1 billion worth of its Venture variable annuity with the Principal Plus for Life living benefit rider, doubling its 2004 bank sales. Over the next six years, the company would amass more than $56 billion in total VA assets.

But the Global Financial Crisis spoiled the party for John Hancock, as it did for many VA issuers. In 2009, the firm initially shifted its focus to a new, simplified VA contract called AnnuityNote, which had less exposure to market risk. AnnuityNote flopped however; it didn’t have the flashy features that independent advisors craved and it was pulled from the market last March.

By last May, journalists in Canada, the home of Manulife Financial Corp., John Hancock’s parent company, were starting to scoff:     

Once viewed as the boldest foreign acquisition in Canadian financial services history, Hancock has become Manulife’s albatross, sucking up resources to such an extent that some analysts think it might be time for the company to sell it and flee the U.S. for the promise of Asia.

Manulife took a $1 billion write-off last year because of diminished prospects for its U.S. business; John Hancock takes up almost half of Manulife’s equity capital, but, as National Bank Financial analyst Peter Routledge has noted, produces only one-third of its earnings.

The company’s large variable annuity business in the U.S. became a major problem during the financial crisis because of the massive amount of exposure to stock markets that it built up. With the rebound in equities, that is no longer the problem that it once was.

 But [Manulife CEO Donald] Guloien has nevertheless pledged to remake the company’s business – to put more emphasis on fee-based products like mutual funds, to wring better earnings out of its insurance business, and to take less risk so that it will better withstand the next market meltdown.

The stock market slippage and the announcement of more Federal Reserve loosening last August just made things worse for everyone, including John Hancock. Market losses overwhelmed the company’s VA hedging program, and in early November Manulife reported a $900 million charge against earnings to fill the hole.

Annuity sales also took a big hit. John Hancock’s VA sales in the third quarter were down 32% from the same period in 2010, to $412 million. Thanks to the low interest rate environment, which hit all fixed annuity issuers, its FA sales also declined. Sales fell 48% from a year earlier, to $176 million.

Given all that bad news, it couldn’t have surprised many people last week when word leaked out that John Hancock had decided to lay off or transfer some of its annuity people and to stop distributing its annuities except through “key partners.” That includes the independent advisors in John Hancock Financial Network and Edward Jones. Edward Jones sells a front-loaded John Hancock variable annuity, which means that sales don’t increase the insurer’s exposure to problems recouping deferred acquisition costs.

In response to an inquiry, a John Hancock spokesperson explained in an e-mail that three JH Venture variable annuities (7 Series, 4 Series, and Frontier), three market value-adjusted fixed annuities (JH Signature, JH Choice and Inflation Guard), and the JH Essential Income immediate annuity would be withdrawn from general distribution.

The e-mail included the following statement:

Due to volatile equity markets and the historically low interest rate environment that is expected to continue for an extended period of time, John Hancock is restructuring it annuity business.  Going forward, our annuities will be sold only through a narrow group of key partners such as John Hancock Financial Network.  John Hancock will continue its award-winning service to its annuity clients, who will see no change in how their accounts are handled.  

Partners such as John Hancock Financial Network sell many John Hancock products.  This will allow them to continue offering a full complement of products to their clients.  We continually evaluate our products, but at this time will not be making any modifications to the annuity products we offer. Many of our annuity employees, including most of those in the sales area, have been transferred to our growing mutual funds and 401k businesses.  There were some staff reductions.

We looked at our wholesaling capabilities in mutual funds and VA where we had a variety of distribution coverage arrangements, and have merged our VA wholesaling team into our mutual funds distribution team. Prior to our restructuring we had 20 wholesalers covering channels for both mutual funds and VA, and 30 wholesalers who focused on VA.  We now have 14 wholesalers who support both VA and mutual funds and their focus will be on firms where we distribute both products. As a result of restructuring our annuities business, 36 wholesaling positions were eliminated.

Three people close to the retirement industry shared their thoughts about John Hancock’s move with RIJ this week. One suggested—and this is pure hearsay—that the firm preferred to shift its focus to the nascent but potentially huge in-plan annuity market. John Hancock, with Prudential, recently founded IRIC (Institutional Retirement Income Council) to promote in-plan annuities.

Another observer noted that John Hancock was a merely a victim of persistent “below 2% 10-year Treasury rates”, plain and simple. A third observer, showing a trace of schadenfreude, believed that John Hancock was paying the inevitable price for the pre-Crisis hubris of its once-rich VA riders. Back then, he said, wirehouse brokers would sometimes irk other carriers’ wholesalers by asking them, “Why can’t you be more like John Hancock?”

© 2011 RIJ Publishing LLC. All rights reserved.  

Put Your Money Where Your Neurons Are

Economics is at the start of a revolution that is traceable to an unexpected source: medical schools and their research facilities. Neuroscience – the science of how the brain, that physical organ inside one’s head, really works – is beginning to change the way we think about how people make decisions. These findings will inevitably change the way we think about how economies function. In short, we are at the dawn of “neuroeconomics.”

Efforts to link neuroscience to economics have occurred mostly in just the last few years, and the growth of neuroeconomics is still in its early stages. But its nascence follows a pattern: revolutions in science tend to come from completely unexpected places. A field of science can turn barren if no fundamentally new approaches to research are on the horizon. Scholars can become so trapped in their methods – in the language and assumptions of the accepted approach to their discipline – that their research becomes repetitive or trivial.

Then something exciting comes along from someone who was never involved with these methods – some new idea that attracts young scholars and a few iconoclastic old scholars, who are willing to learn a different science and its different research methods. At a certain moment in this process, a scientific revolution is born.

The neuroeconomic revolution has passed some key milestones quite recently, notably the publication last year of neuroscientist Paul Glimcher’s book Foundations of Neuroeconomic Analysis – a pointed variation on the title of Paul Samuelson’s 1947 classic work, Foundations of Economic Analysis, which helped to launch an earlier revolution in economic theory. And Glimcher himself now holds an appointment at New York University’s economics department (he also works at NYU’s Center for Neural Science).

To most economists, however, Glimcher might as well have come from outer space. After all, his doctorate is from the University of Pennsylvania School of Medicine’s neuroscience department. Moreover, neuroeconomists like him conduct research that is well beyond their conventional colleagues’ intellectual comfort zone, for they seek to advance some of the core concepts of economics by linking them to specific brain structures.

Much of modern economic and financial theory is based on the assumption that people are rational, and thus that they systematically maximize their own happiness, or as economists call it, their “utility.” When Samuelson took on the subject in his 1947 book, he did not look into the brain, but relied instead on “revealed preference.” People’s objectives are revealed only by observing their economic activities. Under Samuelson’s guidance, generations of economists have based their research not on any physical structure underlying thought and behavior, but only on the assumption of rationality.

As a result, Glimcher is skeptical of prevailing economic theory, and is seeking a physical basis for it in the brain. He wants to transform “soft” utility theory into “hard” utility theory by discovering the brain mechanisms that underlie it.

In particular, Glimcher wants to identify brain structures that process key elements of utility theory when people face uncertainty: “(1) subjective value, (2) probability, (3) the product of subjective value and probability (expected subjective value), and (4) a neuro-computational mechanism that selects the element from the choice set that has the highest ‘expected subjective value’…”

While Glimcher and his colleagues have uncovered tantalizing evidence, they have yet to find most of the fundamental brain structures. Maybe that is because such structures simply do not exist, and the whole utility-maximization theory is wrong, or at least in need of fundamental revision. If so, that finding alone would shake economics to its foundations.

Another direction that excites neuroscientists is how the brain deals with ambiguous situations, when probabilities are not known, and when other highly relevant information is not available. It has already been discovered that the brain regions used to deal with problems when probabilities are clear are different from those used when probabilities are unknown. This research might help us to understand how people handle uncertainty and risk in, say, financial markets at a time of crisis.

John Maynard Keynes thought that most economic decision-making occurs in ambiguous situations in which probabilities are not known. He concluded that much of our business cycle is driven by fluctuations in “animal spirits,” something in the mind – and not understood by economists.

Of course, the problem with economics is that there are often as many interpretations of any crisis as there are economists. An economy is a remarkably complex structure, and fathoming it depends on understanding its laws, regulations, business practices and customs, and balance sheets, among many other details.

Yet it is likely that one day we will know much more about how economies work – or fail to work – by understanding better the physical structures that underlie brain functioning. Those structures – networks of neurons that communicate with each other via axons and dendrites – underlie the familiar analogy of the brain to a computer – networks of transistors that communicate with each other via electric wires. The economy is the next analogy: a network of people who communicate with each other via electronic and other connections.

The brain, the computer, and the economy: all three are devices whose purpose is to solve fundamental information problems in coordinating the activities of individual units – the neurons, the transistors, or individual people. As we improve our understanding of the problems that any one of these devices solves – and how it overcomes obstacles in doing so – we learn something valuable about all three.

© 2011 Project Syndicate.

Airbag-Equipped Annuities

When Ohio National Life introduces a new version of its ONCore variable annuity early next year, the contract will sport a rich living benefit. Its GLWB will offer an 8% annual deferral bonus and a single-life payout of 5.25% at age 65, according to the prospectus. The initial rider fee is 110 basis points a year.

How can the Cincinnati-based insurer afford to offer this alluring value proposition? Because it requires contract owners to allocate much of their money to three volatility-managed portfolios from TOPS, an ETF portfolio manager.

And if the strategy pays off for Ohio National, this type of product design could become the template for the VA industry going forward.

The portfolios, called TOPS Protected ETF Portfolios (Balanced, Moderate Growth and Growth), all contain, besides a foundation of ETFs, a futures-based hedging strategy that aims to cut off extreme performance, especially on the downside.    

“Our goal is to get 75% up-capture and 25% down-capture over time,” said Michael McClary, TOPS’ chief investment officer. “If the market goes dead straight up, we won’t get 100% of it. But when it goes down we won’t go down as much.”

The hedging strategy inside those funds isn’t TOPS’ work, however. It’s the work of actuaries at the fund subadvisor, Milliman. It involves buying short equity index futures when the market goes up and selling them when the market goes down.  

As Milliman’s Kamilla Svajgl said in a presentation at the Society of Actuaries conference on Equity-Based Insurance Guarantees Conference last week in Chicago, “It’s like having an airbag in your car. You have protection.”

A relatively new idea

Equity market volatility is Topic A these days. (On Monday, the DJIA dropped 2.11%.) Whether or not volatility is historically high, or simply feels high, or seems more dramatic because the market averages are inflated, or is aggravated by high frequency trading, it’s hard to say.

But, real or perceived, volatility scares clients. It can presage market collapses and, when it does, it can create mayhem for VA issuers by raising reserve requirements. Prudential alone took a $435 million charge in third quarter 2011 to strengthen its reserves due to the negative impact of falling equity prices on its living benefit guarantees and deferred acquisition costs (DAC).

Some insurers have decided that VAs are more trouble than they’re worth. John Hancock, a unit of Canada’s Manulife, last week said it would limit distribution of its fixed and variable annuities, after Manulife reported a $900 million charge related to annuity-related losses in the third quarter. MassMutual, Genworth Financial and ING have abandoned new variable annuity sales.

To stay in the game, other VA issuers have reduced their risk exposure through some combination of stingier benefits, higher prices, or risk-mitigating product designs that either change the client’s asset allocation automatically, or link fees to changes in the VIX or Treasury rates, or embed derivatives in the subaccounts themselves.

The Milliman strategy of adding a futures program to the ETFs in the TOPS portfolios is one of the latest ideas to be adopted by major insurers. (Milliman began promoting it over a year ago. See “Plugging Leaks in VA Guarantees,” RIJ, June 23, 2010.) .

So far, McClary says three insurance companies are using the TOPS Protected ETF portfolios. The first was Jefferson National for its flat-fee 300 investment-option VA. Then came Ohio National and Prudential (in variable life products). About $70 million has flowed into portfolios in just two months. Five more clients will launch products using the TOPS Protected portfolios within the next six months, he told RIJ, declining to name them. 

How it works

For issuers of VAs with lifetime income guarantees, the beauty part of the Milliman index futures strategy is that it puts a low-cost risk management mechanism inside the subaccount investment.

To elaborate on Milliman’s automotive analogy: Under the old VA design, the insurer gave the contract owner a high-speed investment vehicle and then assumed the costs of building strong highway guardrails and buying collision coverage.

Under the new design, the vehicle is equipped with airbags and an automatic braking system whose costs are built into the price of the vehicle. “Accidents” are less likely and less violent.

“It’s like Driver’s Ed, where the passenger has a brake,” said McClary. The insurer’s risk and costs go down as a result. It can use the savings to pump up the product benefits, reduce the price, and/or fatten its bottom line.

As Milliman’s Kamilla Svajgl explained, this “sustainable model” requires five to 10% of the fund assets to be set aside as collateral for futures contracts. When the market goes up, Milliman enters into short equity futures contracts. If the market goes down, it will close out the short futures at a profit and add to the portfolio’s long position in ETFs.   

It turns out that it’s better for the insurer to have the fund hedge itself by entering futures contracts than for the insurer to hedge by buying options and carrying them as volatile assets on its own balance sheet. (Cynics have said that the strategy shifts the cost of hedging onto the contract owner. But if the carrier returns the costs savings to the client in the form of richer benefits or lower expense ratios, the contract owner could benefit in the long run.)  

Cheaper and safer

The cost savings can be game changing. “Before the financial crisis, a company might charge 65 bps for a GLWB rider and spend about 40 bps of that on hedging costs,” Svajgl said. “Since the financial crisis, a policyholder could pay 105 bps for the rider and it might cost 90 to over 105 bps to hedge it.

“But all of our vega [volatility] and most of our delta [changes in equity prices] is being done in the subaccounts. That reduces the overall hedge costs to manage the living benefits. So, if you charge 105 bps for the rider, only 50 to 60 bps will be spend on raw vega hedging or residual delta hedging.”

“If you bought put options,” McClary told RIJ, “you’d have to pay an option premium. But we’re using futures. You’re entering a position instead of paying a premium.”

In theory, this model can provide as much downside protection as the modified form of Constant Proportion Portfolio Insurance (CPPI) that Prudential uses in its popular Highest Daily variable annuities while being more nimble than CPPI at capturing the upside opportunity that often appears after a sharp market dip.

Prudential uses an algorithm that automatically moves assets from equities to investment grade bonds when equity prices fall and moves money back into equities as prices go back up.  In contrast, because Milliman hedges the effects of a potential fall in equity prices by holding short equity futures,  TOPS managers can reduce their funds’ equity risk exposure without actually selling depressed ETFs.

After prices have fallen, Milliman applies a capital protection strategy to help TOPS take advantage of bargains. A bit like a mountain climber who has driven pitons into the rock to limit the distance he can fall, Milliman sells appreciated short futures whenever the market drops more than 10% and uses the profits to provide cash for ETF purchases to shore up the funds’ equity allocation.

This futures-based rebalancing strategy demonstrated its value during the August 8 collapse in equity prices, when the S&P 500 Index dropped 6.65% and the equity exposure of the TOPS Protected portfolios had dropped to just 30% at one point.  

“But our system then can reset the capital protection, reinvesting the cash profits from hedges into long ETFs, so that we don’t stay at 30% long forever and miss the opportunity for market growth,” McClary said.  “Some strategies that include a hedge can effectively become very expensive money market accounts. It is our goal to avoid that.” The Protected portfolios returns for August 8 ranged from -0.81% to a positive 1.52%.

No free lunch

Of course, none of this financial engineering tames or beats the market, but merely shaves off the tail risk from an aggressive portfolio. According to Milliman’s analysis of “1,000 stochastically generated real world scenarios based on 30 years of daily returns for indices and interest rates,” a portfolio equipped with its protection method had half the average annualized volatility of an unprotected fund while lagging in average return by just 95 basis points, 7.66% to 8.51%.

Interestingly, the data shows that the protection works better during portfolio decumulation than during the accumulation stage. The average annual internal rate of return of an aggressive portfolio decumulating over 30 years was 6.86% for the protected portfolio and only 6.06% for the unprotected portfolio. Hedging appears to pay for itself and more by buffering the effects of sequence risk during retirement drawdown, when selling depressed assets can accelerate portfolio ruin. 

“We are solving a sequence of return problem,” Svajgl told RIJ. She envisioned a time when every mutual fund or separate account portfolio has a built-in hedging strategy.

“I think we’re in a transitional period,” she said. “It used to be that Volvo was the only car company that talked about safety.  Nobody else wanted to talk about safety because it reminded people of the danger of driving. But in the ‘new normal,’ it’s OK to talk about safety. I think we’ll reach a point where, just as people wouldn’t imagine getting into a car without air bags, they won’t imagine getting into a fund without a protection mechanism.”

© 2011 RIJ Publishing LLC. All rights reserved.

The Hartford adds enhanced death benefit to Future6 GLWB

An enhanced death benefit s now available as an optional rider on The Hartford’s Personal Retirement Manager (PRM) variable annuities with the Future6 guaranteed lifetime withdrawal benefit,

The Future6 Death Benefit allows for income withdrawals that do not reduce the death benefit, unlike most VA death benefits, according to Steve Kluever, vice president of product and marketing for Global Annuities at The Hartford.

 “Many people have found it difficult to accomplish the opposing financial objectives of generating a lifetime income and leaving a legacy through a variable annuity,” said Kluever. The new option is designed to “allow consumers to achieve both living and giving goals, without detracting from either.”

The value of the death benefit is based on the greater of premiums invested or the contract value at the time income payments start, providing the annual withdrawals (5% of the benefit base) do not exceed predetermined limits. For the new death benefit to apply, the final account value must be equal to at least the value of one income payment.

Investors who elect the Future6 GMWB are required to put their money in The Hartford’s volatility-managed Personal Protection Portfolios. As part of the enhancements, The Hartford said it is also reducing certain expenses associated with PRM.

The new enhanced death benefit rider costs 85 basis points and the Future6 GLWB costs 85 basis points. Hartford reduced the contract’s surrender period to seven years from eight years and reduced the mortality and expense ratio of the B share contract to 115 basis points from 125 basis points, a spokesman for The Hartford said.

The Future6 Death Benefit is available when the optional Future6 Guaranteed Minimum Withdrawal Benefit (GMWB) is also elected. Future6 provides guaranteed growth of a future lifetime income stream through the greater of a 6% annual deferral bonus or market appreciation step-up. The bonus lasts for up to 10 years while investors delay taking income payments. Performance step-ups are available until age 90, even while taking income.

© 2011 RIJ Publishing LLC. All rights reserved.

A.M. Best reports on impact of low rates

U.S. life/annuity insurers’ earnings are being pressured by the prolonged low interest rate environment. In the near term, writers of single-premium deferred annuity and flexible-premium deferred annuity products are not expected to be significantly impacted, except perhaps structured settlement annuity writers.

Insurers actively hedging interest rate risk across product portfolios are expected to experience less of an impact, although most hedging programs have been more narrowly focused on variable annuity product lines.

Companies that have diversified their earnings by maintaining larger percentages of less interest-rate sensitive business lines—group retirement, supplemental health lines, traditional life, fixed indexed annuities—are likely to fare better from a capital and earnings perspective.

While interest rates remain a key concern, the risk has been partially offset by lower levels of credit impairments, higher levels of capital and overall stability in credit spreads.

Nevertheless, the negative impact of interest rates on statutory capital requirements may be longer term because many insurers’ cash flow testing assumptions include reversion to the mean in their interest rate and equity market scenarios, which may deviate substantially from actual results.

Although the capital impact has been partially mitigated by substantial capital raising in recent years, additional capital requirements are likely to emerge if low interest rates persist.

In the near term, A.M. Best expects the earnings’ impact to be significant, although manageable. The ability to weather prolonged low interest rates partially depends on an insurer’s growth strategy. An important consideration will be the growth of higher margin business that can offset embedded low-margin products.

AARP launches Social Security benefits calculator

As part of AARP’s Ready for Retirement? campaign, a ten-step approach to retirement planning, the organization has also introduced an online Social Security benefits calculator

More than half of those claiming retired worker benefits in 2009 elected to receive benefits as soon as they became eligible at age 62. But that decision comes at a cost of lower monthly benefits, potentially decreasing one’s lifetime retirement income by a significant amount – as much as 8 percent lower for every year that someone claims before reaching full eligibility age.

The AARP Social Security Benefits Calculator walks users through a simple, question-and-answer format and provides estimates for both monthly and lifetime benefits across a range of ages. Users can also calculate spousal benefits, account for the impact of receiving earned income while collecting benefits, compare estimated monthly benefits to expected expenses in retirement, and print a personalized summary report. 

Despite equity bounce in October, investors flee to bond funds

Combined U.S.-stock and international-stock outflows of $21.1 billion roughly mirrored inflows of $23.7 billion to taxable- and municipal-bond funds, as net long-term mutual fund inflows to reached only $745 million in October, according to Morningstar Inc.

Additional highlights from Morningstar’s report on mutual fund flows:

  • Investors redeemed $18.2 billion from U.S.-stock funds in October, the greatest monthly outflow for the asset class since $22.7 billion in July.
  • Overall, U.S.-stock outflows reached $53.5 billion for the year to date. Outflows for the asset class are on pace to match or exceed 2010’s redemptions of $63.6 billion and 2008’s record outflow of $77.4 billion, especially given that outflows from the asset class have picked up in the second half of the year for the last five calendar years.
  • Inflows of $2.1 billion to diversified emerging-markets equity funds prevented international-stock funds, which sustained outflows of $2.9 billion in October, from losing even more.  Emerging-markets equity funds have seen strong monthly inflows in 2011 despite the fact that these funds are significantly underperforming U.S.-stock funds.
  • Taxable-bond funds, with inflows of $21.7 billion, had their strongest month since September 2010. Intermediate-term and high-yield funds dominated the asset class, taking in a combined $18.6 billion during the month. High-yield bond funds had a record month for inflows, collecting $8.8 billion in new assets.

In addition to Morningstar’s data, the following summary of mutual fund flows in October 2011 was issued by Strategic Insight. Data differed in some respects.

Thanks to demand for taxable bond funds, US stock and bond mutual funds saw net inflows of $1.1 billion in October 2011 (in open-end and closed-end mutual funds, excluding ETFs and funds underlying variable annuities). October marked the second consecutive month of net inflows to long-term funds, after net inflows of $1.9 billion in September

Investors poured $19 billion into taxable bond funds in October, more than $16 billion of which went into high-yield bond funds and intermediate-term bond funds. Bond fund investors seemed to be either creeping out on the yield curve from short-term bonds or plunging into riskier high-yield bonds in search of higher income. October’s net inflows were the biggest monthly flows for taxable bond funds since they drew $20 billion in May.

Muni bond funds, meanwhile, saw net inflows of $1.9 billion – up a bit from September’s $1.7 billion and evidence that investors are no longer worrying about widespread muni bond defaults.

“With low interest rates set to continue and investors feeling risk-averse, we expect the search for income and safety to persist into 2012,” said Avi Nachmany, director of research for Strategic Insight. “This should mean continued demand for select bond funds.” 

Equity mutual funds saw net outflows of $20 billion, with $18 billion of net redemptions coming out of domestic equity funds. Although the S&P 500 index returned +10.9% in October, including sharp increases early in the month, investor behavior seemed more a reaction to the losses suffered in August and September.

 “After the ups and downs of recent months, investors seem to be suffering from volatility fatigue,” said Ari Nachmany of Strategic Insight. “It may take several months of consecutive gains to generate sustained enthusiasm for US equity funds. In the meantime, we expect investors to look for ways to reduce portfolio volatility.”

 “Alternative” or less-correlated asset classes did well in October. Commodities mutual funds, managed futures mutual funds, and long/short mutual funds all saw positive net flows during the month (and global tactical allocation funds also saw modest net inflows).

Despite positive flows into emerging markets funds, international equity mutual funds saw net outflows of $2 billion in October. Equity funds have seen $1.4 billion in net outflows in the first 10 months of the year.

Money-market funds saw net outflows of $21 billion in October, as institutional money funds in particular continued to experience net redemptions. In the first 10 months of 2011, money funds experienced total net outflows of $215 billion, as institutional investors shunned their near-zero yields.

US exchange-traded funds (ETFs) in October experienced $19 billion in net inflows. Leading the way in net inflows were diversified emerging markets ETFs ($4.6 billion in inflows) and high yield ETFs ($2 billion).

Through the first 10 months of 2011, ETFs (including ETNs) saw net inflows of $94 billion, a pace that could produce the fifth straight year of $100 billion or more in inflows to ETFs. At the end of October 2011, US ETF assets stood at $1.08 trillion (rising from $970 billion at the end of September).

Security Benefit introduces multi-premium fixed annuity for 403(b) plan participants

Security Benefit Corp. has launched the Total Interest Annuity, the firm’s first fixed annuity product designed to receive multiple premiums. Security Benefit Life will issue the product.

Built for the 403(b) market, the Total Interest Annuity can be funded with contributions up to $16,500 annually or with IRA contributions or rollovers. The initial guaranteed crediting rate will be reset at the end of each contract year. A 2% bonus on all contributions or transfers in the first contract year is intended to incentive clients to save.

The new product offers plan advisors a solution to help them with their clients’ concerns about market risk and volatility,” says Jim Mullery, President of Security Distributors, Inc., Security Benefit’s distribution company.  

Security Benefit provides retirement plan services for more than 200,000 accounts throughout the nation, primarily in the K-12 education market. The Kansas City, KS-based firm manages $38 billion (as of 12/31/2010) and partners with 27,000 financial planners and representatives through 700 broker/dealers.  

Last year, Security Benefit was purchased by a group of investors led by Guggenheim Partners, a privately held global financial services firm with more than $125 billion in assets under supervision. According to Mr. Mullery, the new Total Interest Annuity will benefit from Guggenheim’s well-regarded general account management capabilities.

© 2011 RIJ Publishing LLC. All rights reserved.

The kids are not alright… as prospective heirs

A significant minority of rich Americans (23%) don’t trust their children or stepchildren to safeguard their inheritance, according to a new report from Barclays Capital. Among wealthy individuals worldwide, the figure was over one-third (35%).   

The report, The Transfer of Trust: Wealth and Succession in a Changing World, is based on a survey of some 2,000 high net worth individuals in 20 countries. It examines wealthy investors’ attitudes towards wealth transfer and succession planning.

The study reinforced some common perceptions: that families tend to quarrel over money inheritances and that people experience more satisfaction from earning wealth than having it handed to them. 

Thirty-six percent of wealthy Americans surveyed told Barclays that they have personally experienced family disputes caused by wealth and 21% believe that wealth places an unnecessary burden on the next generation.

About two-thirds of U.S. respondents said their values were very similar to their parents and 82% said they were more likely to allocate assets to children whose values are most similar to their own.

Apprehension about passing considerable wealth is a common rationale for establishing a trust to manage distributions, while still allowing a child access to substantial inheritance. Wealthy individuals may even consider incorporating an “incentive clause” into a trust structure.

Virtually all (97%) of U.S. respondents to the study were nonetheless committed to passing their money to their children. But 68% of American respondents say that they require a great deal of professional advice when deciding on an inheritance plan for their children/stepchildren.

Prenuptial agreements are more talked about than actually used. Over three-quarters (76%) of wealthy Americans think that a prenuptial agreement is important for the protection it affords, but only 11% actually have one in place. An alternative to a “prenup” is a “lifetime trust” that segregates the legacy wealth from the newlyweds’ marital assets. 

Nearly all (94%) wealthy Americans currently have a will in place. Half (50%) of U.S. respondents have revised their wills at least once and over one-third (35%) has revised them three or more times. In the U.S., the primary trigger for a will revision is tax efficiency/planning (23%). Abroad, the primary trigger is an increase in wealth (19%).

The “inherited dollar” seems to be treated differently than the “earned dollar.” Although it varies by family, high net worth individuals often prefer to preserve inheritance money and often keep their inheritance separate from wealth they earned themselves. Inheritances are sometimes seen as an embodiment of the character of the deceased, and the money is perceived as having “personality.” 

© 2011 RIJ Publishing LLC. All rights reserved.

 

Our Half-Full, Half-Empty Retirement Glass

The Achilles heel of the defined contribution system in the U.S. is that too few workers enjoy its coverage. At any given time, almost half of America’s private-sector workforce lacks access to an employer-sponsored retirement savings plan.

The half-empty status of our private pension system looks like this: Only 54% of full-time workers ages 21 to 64 have retirement plans at work; Hispanic workers, younger workers and people who work for small companies are less likely than average to have access to a plan, according to the EBRI, Employee Benefit Research Institute.  

In part because of this shortfall, the U.S. received a ‘C’ in the 2011 Mercer-Melbourne Global Pension Index. “In the private sector, the coverage of the American system isn’t as broad or as comprehensive as elsewhere,” David Knox, a Mercer partner and author of the index report told RIJ. “Many people in the workforce have no provision other than Social Security.” 

That’s a problem that we can’t really afford to ignore or (in the all-purpose catch phrase) “kick down the road.” It’s a problem not only for the millions who might retire on little more than $1,000 a month from Social Security. It’s also  a problem for anybody who may have to help support (as a family members or a taxpayer) larger numbers of elderly poor.

More to the point, it’s a problem for the huge defined contribution industry and the millions who make their living in it. Unless the 401(k) system becomes more equitable and more universal, the tax preferences that, in effect, help finance the whole system will be subject to attack from both liberals and deficit hawks. It will also be increasingly vulnerable to competition from alternative solutions that could eat at its assets under management, or AUM.

Several of those solutions are already on the table. For instance, the National Commission on Fiscal Responsibility and Reform to cap tax-favored contributions at 20% of pay up to $20,000, down from the current 100% of pay up to $49,000. William Gale of the Brookings Institution has urged the government to replace tax deferral that drives the 401(k) system with a flat-rate tax credit worth 18% of a participant’s contributions. Mark Iwry, a Treasury Department official, has been promoting “automatic IRAs” for small company employees without retirement coverage.  

More recently—and this is the topic of today’s cover story in RIJ—there have been some surprising proposals to open up state employee pension plans to participation by people whose private or non-profit employers don’t sponsor retirement savings plans.

That may seem like an odd idea. Considering all the criticism that state plans have received for over-promising benefits and using unrealistic discount rates to measure their funding status, relying on an expansion of state plans to provide coverage for private sector or non-profit workers might seem unlikely.

Yet the proposals are out there and people are working on them. According to pension experts who spoke with RIJ, theses plans, frankly, aren’t considered likely to come to fruition. Anecdotally, they inspire a lot of opposition from private industry. That’s not surprising. A worker who doesn’t have access to a plan today is still a potential participant in a defined contribution plan in some future job.

The inequities of the pension industry resemble the inequities of the health care industry. Many people go uninsured, but public sector initiatives to make health care coverage universal meet with a lot of opposition. Both issues are related to ancient problems regarding free enterprise and the role of the state, which themselves tend to be paradoxical and may be insolvable.

If Republicans take the White House in 2012, some of those currently pushing for reform of the retirement system from within the government may lose positions and influence. We may hear less criticism of the status quo. On the other hand, conservative deficit hawks may scrutinize the cost of tax deferral more skeptically than ever.

If there is a silver lining here—we don’t hear a lot these days about silver linings, do we?—it is that outside challenges are forcing the 401(k) system itself to become more efficient, more transparent, and more responsive to the ultimate goal of providing lifelong retirement income.

© 2011 RIJ Publishing LLC. All rights reserved.

Changing Money

SHANGHAI – The dollar isn’t so almighty in China these days. 

I recently visited Shanghai after an absence of 15 years and was shocked by the magnitude of change. Phalanxes of new cars and a modern subway grid that outshines the Paris Metro have replaced the slow river of bicycles I remembered. A Maglev train floats people to and from the airport at a smooth, silent 275 mph. 

More surprising was the fact that nobody seemed to want my U.S. dollars. When I first lived and worked in Shanghai in 1991 as a Mandarin-fluent Fulbright Professor of Journalism, the Chinese wanted American cash so badly that I was accosted everywhere I went by people asking to exchange renminbi for dollars at black market discounts.

Others have described similar experiences. One friend of mine, a young American working in China as an English teacher, told me in 1993 that he was once biking into the city, and was on a street packed solid with cyclists when a bus suddenly crowded the whole pack against the curb.   

My friend’s bike collided with a neighboring cyclist’s and his handlebar gashed the man’s wrist, which bled profusely. My friend, who spoke Chinese, apologized equally profusely, and was dismounting his bike to offer help when the man, blood gushing from his arm, begged, “Change money? Change money?”

Today, it’s dollars that go begging. Nobody wants greenbacks, which are viewed here the way Americans have (until recently) viewed Canadian bills. The Chinese now are driving hard bargains for their “hard” currency with any Americans trying to unload dollars. 

Even big money earns little respect. The controller of the local unit of a French-based company told me he can’t break ground on a new factory in Shanghai because he can’t exchange the $70 million his parent company sent him for renminbi, and the local construction companies won’t accept payment in dollars, because they keep losing value.

Now for the most humbling part. The day before our flight home to Philadelphia I had to change $6,000 worth of RMB into bucks (I knew it would be a costly hassle to do this back in the U.S., where most banks don’t even change money.)

Frankly, I expected sub-par service at the bank. When I was last in China, a visit to any bank at 3 p.m., an hour before closing, meant having to wake up one of the sleeping tellers by knocking on the security glass.

Eventually someone would raise her or his head, look in annoyance at the intruder, then at the clock on the wall, groan, and finally trudge to the counter, acting as though the customer was crazy to expect service so close to closing time.

This time it was different. At 3:30 p.m., bustling tellers at a branch of the Chinese Construction Bank zipped through their transactions with clients, who on entering the lobby received numbers and were directed to a seating area to watch a video of Charlie Chaplin’s “Little Tramp” while awaiting their turn at the window. When my turn came, the teller could hardly count out $100 bills for my wad of 380 100-RMB notes fast enough.

Neither Shanghai nor the almighty dollar is what it used to be.

© 2011 RIJ Publishing LLC. All rights reserved.

 

Unlikely Rescuer

Concerned that only about half of all full-time workers in the U.S. are covered by an employer-sponsored retirement savings plan at any given time, a number of pension advocates, economists and public officials have hatched ideas for expanding coverage.

So far this fall, in separate initiatives, the National Conference on Public Employee Retirement Systems (NCPERS), economist and 401(k) critic Teresa Ghilarducci of The New School, and Massachusetts state representatives have proposed plans that would give more people access to state pension plans.

In a kind of pension version of the medical “public option,” these proposals suggest that a state could leverage its existing pension infrastructure and expertise, and either administer a professionally-run defined contributions for private sector workers without plans, or else allow such workers to contribute to a separate sleeve of a state’s public retirement fund.    

This approach has been under discussion in state pension circles for some time. A similar idea was developed for Washington State in the mid-2000s, according to Boston University pension expert Zvi Bodie. But it was reportedly opposed by private plan providers and was dropped before it came to fruition.

In an interview, Professor Bodie was sympathetic but skeptical regarding the likelihood of expanding access to public pensions. “This is yet another proposal to do something that makes sense,” he told RIJ about the NCPERS plan (described below.) “But why should it have any better chance of success than the others?”

Some might question whether state pension plans are the right vehicle for solving the country’s retirement savings shortage. After all, many of which emerged from the 2008 financial crisis badly underfunded. But with gridlock at the national level, state governments are seen by some as better able than Congress to take action.      

Like the push to broaden health insurance coverage by introducing a public insurance option or state insurance exchanges, any push to broaden retirement plan coverage by opening up state plans is likely to be controversial. Nonetheless, the need exist and the proposals are out there. Here are summaries of three of them.

The Massachusetts plan

Two weeks ago, the Massachusetts House of Representatives voted 143 to 7 to approve H. 3754, which authorized the state treasurer to “sponsor a qualified defined contribution retirement plan… that may be adopted by not-for-profit employers for their employees,” in compliance with IRS rules and the Employee Retirement Income Security Act, or ERISA.  

Like most bills, it is short on operational specifics. Participants might invest in a privately run, state-supervised qualified trust or in the existing state employees plan. Under the proposal, the treasurer could contract, after a competitive bidding process, with plan advisors, administrators or investment managers in the private sector to create and manage a qualified trust for non-for-profit employers and employees.

Participants could be permitted to contribute to the “same investment products as provided through a deferred compensation plan for employees of the commonwealth administered by the treasurer.” The assets in the new plan would be segregated from the state employee assets, however.

The bill, a revival of a proposal made in 2009, was approved without debate and sent to the Massachusetts Senate for consideration. Not-for-profits employ14% of the state’s workers, and less than one in five workers in not-for-profits has access to an employer-sponsored retirement plan, according to an October 27 Boston newspaper report.

Massachusetts has a $5 billion deferred compensation plan for about 300,000 state employees. According to a 2011 report by the Pew Center on the States, Massachusetts’ long-term pension liability for current and future retirees of $61.1 billion for fiscal 2009 was only 68% funded. The state made 66% of its actuarially recommended contribution (ARC) of $1.97 billion in fiscal 2009.

Ghilarducci’s plan

Not long after the Massachusetts legislators acted, economist and 401(k) critic Teresa Ghilarducci of the Schwartz Center for Economic Policy Analysis at The New School in Manhattan recommended that similar plans be adopted throughout the U.S. and be offered to all workers, not just employees of not-for-profits.

In a recent article, “How Policymakers and State Pension Funds Can Help Prevent the Coming Retirement Crisis,” Ghilarducci and co-authors Lauren Schmitz and Robert Hiltonsmith described the plan this way:

“The best policy would be an individual account that would be portable between employers in which workers and employers would contribute at least 5% of pay into an account with guaranteed to earn at least 3 percent above inflation. At retirement, workers would have option of converting their savings into an annuity, a guaranteed stream of income for life.”   

Ghilarducci, whom Rush Limbaugh once called “the most dangerous woman in America” for arguing that the 401(k) system fails most Americans, had previously advocated “Guaranteed Retirement Accounts,” a national defined contribution plan with a 5% employer/employee contribution, a $600-a-year tax credit and a 3% guaranteed real return.

“In effect,” the report continued, “the state pension funds could “open a window”, much like a bank would for a new customer, for private sector workers who want their retirement savings managed by professionals and, at retirement, have the option of a stable annuity.”

Gridlock in Washington prompted her to change her strategy. “Due to the current political climate, the federal government may not be able to act, so states should step up and help their own citizens save for retirement.  State legislatures could create such accounts and then take advantage of the already existing public pension infrastructure to invest the funds,” the SCEPA report said.

Secure Choice Pension

Yet another proposal for opening up state employee pension plans came in September from the National Conference on Public Employee Retirement Systems, or NCPERS, which represents more than 500 public plans in the U.S. and Canada. Its plan is called the Secure Choice Pension, or SCP.

Each state could create a SCP, setting it up as a multi-employer plan. SCPs would be modeled on cash balance plans, where employers contribute to professionally managed funds on behalf of employees. In a SCP, every participant would have a virtual account that would grow by 6% of covered earnings each year, plus an annual credit of the 10-year Treasury rate plus 2%. A guaranteed minimum accumulation rate of 3% a year would take effect if an employer withdrew from the plan and a funding shortfall occurred.

“This plan would establish statewide pension plans for all the employees in the private sector of that state,” said Hank Kim, the director of NCPERS. “Under the ideal situation it would be funded by a joint contribution from employer and employee. An administrative board composed of plan sponsors, employer and employee representatives and a board of trustees would run it.”

As for investment management, “We envision a co-investing of assets [with state pension assets] as the new plans start up, but the money would be in two completely separate trusts. It could be contracted out to insurance companies or 401(k) providers,” Kim told RIJ.

 “[NCPERS] would provide a model plan document, but each state can tweak it,” Kim added. “Under our concept it would lead to an annuity. We would strongly discourage if not prohibit lump sum distribution. This would not be a plan for those who already have a pension plan or other coverage. This is a pension for those who don’t have one. We don’t think it will compete with the mutual fund or the 401(k) business. The penetration of 401(k)s into the small market, which is the one we’re looking at, hardly exists.”

A person entering such a plan at age 25 and staying in it for 40 years would ultimately receive an annuity replacing about 29% of his or her pre-retirement income, which would supplement Social Security’s replacement rate of 30%, NCPERS estimates. Someone entering an SCP at 35 would be able to replace 21% of income after 30 years and someone entering at age 45 would replace 13%. 

Kim said he envisioned 25% to 30% of SCP assets invested in risky investments and about 70% to be invested in Treasury Inflation-Protected Securities, or TIPS. The strategy for dealing with funding shortfalls would apparently be left up to each state that sponsors an SCP. The liability could fall on the employer, or on a reserve created by the state, or by a pool funded by contributions from employers.

Considering the criticism that states have received for contributing too little to their plans, using unrealistic discount rates to value their obligations, and allowing benefits to get too generous, why should state pension plans be used as a model or a framework for a new breed of retirement plan, Kim was asked.

“Data shows that the criticism is really unwarranted,” he told RIJ. “There have been a few high profile instances of plans with funding challenges, but that’s because some plan sponsors, the states, have essentially taken holidays from their fiduciary contributions. Public plans have been around for over 100 years. We think we are a model, and shame on us to hold back on what might be a possible solution just because we’ve been criticized.”

© 2011 RIJ Publishing LLC. All rights reserved.

The Bucket

Strong VA sales drive Jackson National growth   

Jackson National Life Insurance Co. generated $17.9 billion in total sales and deposits during the first nine months of 2011, up 25% over the same period in 2010, the company said in a release. Variable annuity sales rose 31% over the first nine months of 2010, to $13.7 billion.

Jackson, an indirect wholly owned subsidiary of the United Kingdom’s Prudential plc, generated total sales and deposits of more than $5.7 billion during the third quarter of 2011, compared to $4.9 billion during the third quarter of 2010 and $6.4 billion during the second quarter of 2011.

VA sales were $4.2 billion during the third quarter of 2011, up 15 percent over the same quarter in 2010 and down 15 percent from the second quarter of 2011, as market volatility reduced customer demand for equity-based products.

During the first nine months of 2011, Jackson generated $1.1 billion in fixed index annuity sales, compared to $1.3 billion during the same period of the prior year. Traditional deferred fixed annuity sales totaled $531 million during the first nine months of 2011, compared to $1.0 billion during the same period in 2010. Jackson restrained fixed and fixed index annuity sales during the first nine months of 2011, as the company continued to direct available capital to support higher-margin product sales.

Curian Capital, Jackson’s registered investment adviser that provides fee-based managed accounts and investment products, attracted $2.1 billion in deposits during the first nine months of 2011, up 41% over the prior year period. As of September 30, 2011, Curian’s assets under management totaled $6.7 billion (including more than $300 million of assets managed on third-party platforms), compared to $5.4 billion at the end of 2010.

During the first half of 2011 (latest industry data available), Jackson ranked:

  • Third in total annuity sales with a market share of 8.6%
  • First in VA net flows
  • Third in VA sales with a market share of 12.2% 
  • Ninth in fixed index annuity sales with a market share of 4.4%  
  • 12th in traditional deferred fixed annuity sales with a market share of 1.9%   

 

Janus selects Fidelity as its plan provider

Janus Capital Group has chosen Fidelity Investments to provide it with a defined contribution plan (DC), a non-qualified retirement savings plan and stock plan services, the companies announced.

Fidelity began delivering certain Janus participants with 401(k) and non-qualified retirement savings plans on July 1, and began providing eligible participants with stock plan services on October 17. Upon final implementation of all three savings programs, Fidelity will service approximately 1,100 Janus participants with an estimated $250 million in assets under administration.

Under FINRA Rule 350 and the Dodd-Frank Wall Street Reform and Consumer Protection Act, Janus must monitor the securities trading activities of its employees. Fidelity’s Employee Compliance Reporting platform will give Janus a daily electronic snapshot of participant trading accounts and positions.   

 

David Goldstein appointed general counsel at Symetra

Symetra Financial Corp. has named David Goldstein as senior vice president and general counsel, reporting to Tom Marra, president and CEO. Goldstein replaces George Pagos, who retired on Sept. 30.

Goldstein will advise Symetra senior management on strategic and operational issues and oversee the company’s legal and compliance departments, including corporate governance, securities compliance, contracts, and statutory and regulatory affairs.

Before joining Symetra, Goldstein was a partner at Sutherland Asbill & Brennan LLP in the firm’s Washington, D.C.-based Financial Services Practice Group, which serves financial institutions, including insurance companies, investment advisors, broker-dealers and employee benefit plan service providers.

Goldstein previously served on the staff of the U.S. Securities and Exchange Commission in the Division of Investment Management. Earlier in his career, he was an assistant vice president and assistant general counsel at the Variable Annuity Life Insurance Company (VALIC).

“David has built an outstanding track record of success at one of the nation’s top private law firms. He is a strong leader, known for his proactive and collaborative approach,” said Marra. “With his deep experience in insurance and securities matters, David will be a valuable contributor as we pursue Symetra’s ‘Grow and Diversify’ strategies.”

Goldstein earned a bachelor’s degree at Hampshire College in Amherst, Mass., and a law degree at Boston University School of Law.

 

The Principal gets early start on fee disclosure to plan sponsors

In advance of the April 1, 2012 deadline set by the Department of Labor for such action, The Principal, a major retirement plan provider, said it has begun disclosing fees to its plan sponsors.     

“Beginning this week, plan sponsor clients and their financial professionals have access to all the revamped disclosures required by the new DOL regulation— including a redesigned fee summary,” The Principal said in a release.   

The Principal began delivering a redesigned summary of fees to new clients in July and started unveiling it to existing clients beginning November 1, 2011. The new summary displays the most important information on the first two pages, as requested by financial professionals and plan sponsors.

The Principal also launched a new online disclosure landing page where sponsors can find required information on investments, fees, fiduciary status and services in one place.   The company said it expects to offer an online participant disclosure resource center in mid-November.
The DOL has also issued a regulation changing how plan sponsors communicate fees and investments to participants. While the first compliance date for most sponsors is in May of 2012, The Principal has already made a number of changes to make it easier for plan sponsors to comply and will unveil a new online participant disclosure resource center in mid-November.

 

DST announces partnership, acquisitions 

DST Retirement Solutions, a provider of Application Service Provider (ASP) and Business Process Outsourcing (BPO) defined contribution solutions, has announced an alliance with Wealth Management Systems Inc (WMSI), a leading provider of rollover services, to “provide expanded rollover service options to DST clients,” DST said in a release.

WMSI offers a web-based rollover application for retirement plan participants, call center technology for rollovers, a network for targeting rollover services to select participants and a program for administering force-out provisions and plan terminations.

On August 5, 2011, DST’s IOS (Innovative Output Solutions) subsidiary acquired Lateral, a $80 million U.K. company engaged in integrated, data driven, multi-channel marketing, for $41.7 million.

“The acquisition allows IOS to extend and develop its service/product offerings by further integrating communications through print, data and e-solutions and by providing additional solutions such as data insight and online marketing to the IOS client base,” DST said in a release. 

On July 1, 2011, DST acquired the assets of IntelliSource Healthcare Solutions, whose principal product is CareConnect, an automated care management system.  The addition bolsters DST Health Solutions’ medical claims processing product offering for integrated care management.  

On October 31, 2011, DST completed the previously announced acquisition of ALPS Holdings, Inc., a provider of a comprehensive suite of asset servicing and asset gathering solutions to open-end mutual funds, closed-end funds, exchange-traded funds, and alternative investment funds.  


Primerica to market Lincoln Financial indexed annuities   

Lincoln Financial Distributors (LFD), the wholesale distribution subsidiary of Lincoln Financial Group, and Primerica, Inc., the multi-level marketing company that sells financial products to and through middle-income Americans, have announced that 82,000 of Primerica’s 92,000 licensed representatives would add Lincoln’s fixed indexed annuity to their product offerings.   

Starting in November, certain Primerica representatives will begin offering Lincoln’s Lincoln New Directions and OptiChoice (7-year surrender only) to their target middle market—families with annual incomes between $30,000 and $100,000.  

Lincoln will establish a dedicated team to coordinate Primerica’s efforts with Lincoln’s back office, field wholesalers and internal sales support. John Chidwick, Lincoln’s national sales manager, will oversee the new distribution channel, reporting to   John Kennedy,head of Lincoln’s Retirement Solutions Distribution.

Since 2007, Chidwick has served as a divisional sales manager for Lincoln. He previously held leadership positions for The Hartford and AIG.

 

Putnam introduces ‘Short Duration Income Fund’ 

Putnam Investments has launched the Putnam Short Duration Income Fund, which  seeks to combine characteristics of money market funds and ultra-short bond funds, including a check-writing feature.

The new Fund will “strive for a higher rate of current income than is typical of  money market funds and a have a greater focus on capital preservation than  is usually associated with ultra short bond funds, with the goal of  maintaining liquidity,” Putnam said in a release.

The fund will invest in a diversified portfolio of fixed-income securities composed of short duration, investment-grade money market, and other fixed income securities. Its primary benchmark will be the BofA Merrill Lynch U.S.  Treasury Bill Index. The fund will hold certificates of deposits, commercial paper, time deposits, repurchase agreements and U.S. government securities, including Treasury Bonds and other fixed income instruments. 

The fund will also invest in asset-backed securities, investment-grade corporate bonds, sovereign debt, and will use derivatives to manage risk. The fund will make daily accruals and pay distributions monthly.

The new fund will be managed by a team led by Michael V. Salm, co-head of fixed-income at Putnam.