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Understanding the Black Investor

Posted on April 26, 2011 by -

Beyoncé Knowles, Oprah Winfrey, Shaquille O’Neal—the wealth of these black celebrities tells us about as much about the financial lives of African Americans as the wealth of white tycoons like Warren Buffett or Eli Broad tells us about the finances of the average white person.

Not much, that is. Race-based opinion polls and academic studies don’t render a complete or vivid picture either. Surveys tend to produce averages, and averages can be misleading. But survey results, statistics and averages are sometimes the only concrete data we’ve got. 

Recently, several research studies have focused on the financial attitudes and well-being of black Americans. African Americans, these studies suggest, have relatively less money, are more oriented toward saving than investing, and are even more suspicious of financial institutions than the average American.

But the research also shows that African Americans have the same aspirations to wealth, and the anxieties about growing old without it, as everybody else. Hit even harder by the Great Recession than most Americans, they need financial guidance and financial products. They represent a potential opportunity for financial service providers who take the time to understand their values and earn their trust.       

A savings gap

Americans overall are under-saved for retirement. For African Americans, the picture is bleaker. For a variety of complex reasons—unemployment, a high incidence of single-parent households, lower average pay, higher risk-aversion—they lag the general population in ownership of investments and retirement accounts.     

For instance, a recent survey report by Prudential Research, “The African American Financial Experience,” showed, for instance, that African Americans were less likely than the general population to own individual stocks and bonds (32% vs. 43%), mutual funds (31% vs. 41%), IRAs (35% vs. 52%), or to have an estate plan, will or trust (19% vs. 26%). The results, released April 12, were based on a survey of 1,500 African Americans ages 25 to 70 with incomes of $25,000 or more.

“While African Americans are quite confident in their ability to meet their financial goals, they also tend to hold fewer financial products, invest more conservatively, lack relationships with financial professionals, and be more likely to borrow from their company retirement plans,” the Prudential report said.

That survey pretty much confirmed what others had already found. In 2009, according to Retirement Savings Behavior and Expectations of African Americans, 1998 and 2009, a report by Wilhelmina A. Leigh, Ph.D., and Anna Wheatley of the Washington-based Joint Center for Political and Economic Studies: 

• 51% of African Americans but 72% of whites report having money in savings accounts, certificates of deposit, or money market accounts

• 28% of African Americans but 47% of whites report having money invested in an Individual Retirement Account (IRA) or Keogh plan.

• 27% of African Americans but 49% of whites reported owning stocks or mutual fund shares.

• 17% of African Americans but 27% of whites reported owning bonds.

African Americans also lag in the use of 401(k) plans. While race itself is not necessarily a factor in the successful use of 401(k) plans, according to a 2009 research brief, “(401(k) Plans and Race,” issued by the Center for Retirement Research at Boston College:

“African Americans and Hispanics are still less likely to have the kinds of jobs in which participation in a 401(k) plan is possible; they are less likely to have the earnings, job tenure, and other factors that would cause them to participate in a plan; and, once in a plan, they are less likely to have the taste for saving that would result in a high contribution rate.”

When it comes to pensions, many African American households have them, but less commonly than white households do, according to Income of the Population 55 and older 2008, published in April 2010. In 2008, for instance, about 10.6 million white households but only 860,000 African American households received employer pensions.

To put that in perspective: non-Hispanic white Americans outnumber African Americans 5 to 1 but there are 12 times as many white pension recipients as black pension recipients. The median pension for both groups was $12,000, but white households were slightly more likely to have pensions of $25,000 or more a year (24.1% vs. 22.3%).

In the case of government employee pensions, 3.6 million white households and 328,000 black households receive them. The media government pension was $19,200 for whites and $18,000 for blacks. About 38% of whites’ pensions and 34.1% of black’s pensions exceed $25,000 a year. 

For many African Americans—and for many white Americans—the first step toward saving for retirement will be getting out of debt. But that’s a topic for another article.    

Less trust and smaller risk appetite  

Trust of financial services companies runs fairly shallow in America. For black Americans, it’s been said that mistrust of financial institutions and financial products is especially strong, perhaps extenings as far back as the failure of the “Freedman’s Bank”—the Freedman’s Savings and Trust Company—which cost tens of thousands of African American depositors their savings in 1874.

The trust level isn’t much higher today. “Although the majority [of African Americans] say they want financial advice, concerns about finding ‘a qualified professional they can trust and relate to’ prevent many from hiring an advisor,” said the Prudential Research report. “In fact, 58% agreed with the statement, ‘I would like advice on saving and planning for retirement, but I don’t know or can’t find a professional I can trust.’” 

Church leaders and “financial ministries” are more popular. Instead of going to financial advisors, to a wirehouse broker, or to the phone reps of a direct marketer, African Americans are much more likely to turn to institutions they trust—their churches—for financial advice and inspiration. According to Prudential, “Nearly half (47%) of African American decision makers are interested in learning about investments through a faith- based organization.”

Perhaps because they’ve been burned by financial services companies, or perhaps because they can’t afford to take risk, African Americans in general shy away from risky investments. The financial crisis has apparently made that situation worse.

“Fear of losing their jobs and homes because of the financial crisis may have exacerbated an existing tendency toward risk aversion,” said the Prudential report. “Two-thirds of African Americans surveyed revealed they do not enjoy investing and describe themselves as savers. Some revealed skepticism about the idea of investing.”

The conservativeness of African American investors, in fact, was pointed out over a decade ago in a 2000 article in Financial Services Review called, “Financial services and the African-American market: what every financial planner should know”. Business professors D. Anthony Platha and Thomas H. Stevenson of the University of North Carolina-Charlotte wrote:

 “At all income, education, and age levels, however, African-American households invest a smaller percentage of their portfolios in the form of mutual funds, brokerage accounts, and outright equity purchases than Caucasian households. In addition, Black households demonstrate a distinct preference for safety and security in their investment preferences, favoring life insurance and real estate assets over corporate debt and equity securities across all levels of household income and educational attainment.”

In 1999, the same journal published a paper by three Ohio State University professors called, “Racial differences in investor decision making.” It said:

“Black households report a lower willingness to take financial risks and have a shorter investment horizon compared to White households. A significantly higher proportion of Black households (60%) than White households (42%) report they are not willing to take any risk. Similar proportions of Black and White households are willing to take substantial financial risk… Of households reporting that they are willing to take risk, 58% own risky assets, compared to only 24% of households not willing to take risk.”

The same anxieties, only more so

As of December 2010, the official unemployment rate for whites was 8.5%, and the public was outraged. But the unemployment rate for blacks, at 15.8%, was almost double that of whites. African Americans, as much or more than other Americans, have reason to worry about their financial security, today and in retirement. 

“African Americans (45%) are more likely than whites (37%) to say they are not too confident or not at all confident that they will have enough money to live comfortably throughout retirement” and while “more than half (almost 54%) of African Americans are very or somewhat confident that they will have enough money to live comfortably throughout retirement, they were less likely than white Americans (61%) to have this level of confidence,” according to the study by Wilhelmina Leigh cited above.

Shrinkage of the public sector workforce is especially threatening to African Americans, about 20% of whom work in the public sector. Blacks are “30% more likely than the overall workforce to work… as teachers social workers, bus drivers, public health inspectors,” according to State of the Dream 2011, a study by United for a Fair Economy, a Boston-based advocacy group. As of last September, according to the U.S. Office of Personnel Management, 17.5% of the 2.06 million-member non-postal civilian federal workforce was African-American.

Any talk about ending Social Security or reducing the full retirement age is likely to make black Americans particularly nervous. While their average benefits are lower than whites’, they are more likely to rely on Social Security for all or part of their retirement income.

In African-Americans and Social Security: A Primer, a study sponsored by AARP and published last February by the Washington-based Joint Center for Political and Economic Studies, Wilhelmina Leigh found that the average monthly Social Security retirement benefit received by African American men in 2008 was $1,109.30; for African American women it was $945.50. The average monthly retirement benefit for white men was $1,333.80; for white women it was $1,014.50.

At the same time, than a third of African-Americans expect Social Security to be their main source of income in retirement and about 40% of black Americans over age 65 rely on Social Security as their only source of retirement income, according to Leigh.

Yet fewer blacks than whites live to collect Social Security. Nearly three of every four white beneficiaries (74%), but only about half of black beneficiaries (55%), receive Social Security retirement benefits. That’s partly because African Americans born in 1950 had about six fewer years of life expectancy at birth than whites, and partly because African Americans are more likely to use disability benefits or survivor benefits instead.

A plausible market?

So should a financial services company invest the time and money that it will take to understand and gain the trust of the black community? For Prudential, it was a no-brainer to sponsor The African-American Financial Experience.

As a 401(k) provider, Prudential works with plan sponsors all over the world, many of whom have large numbers of African American participants. Understanding the habits, values and needs of those participants helps plan sponsors target education programs toward certain behaviors and helps Prudential train call center personnel. Ultimately, it helps the plan retain and increase assets, helps Prudential keeps retain assets under management, and helps the participant arrive at retirement better prepared.

“We understand that there’s a need out there for a greater understanding for what’s driving participant behavior. We’ve done similar studies on Hispanics and Asians. This allows our Retirement division to put together more targeted communications. One size doesn’t fit all,” said Michael Knowling, regional vice president, Prudential Retirement.

“With this study, we learned that African Americans are tapping into their 401(k) plans more than others to pay off loans,” he added. “We also know that they’re saving very conservatively, and in some cases not saving enough. We can work on custom education materials to preserve their retirement plan assets for retirement. If our call center receives a call about a loan or withdrawal, we can guide the caller through other options. Eighty-two percent of people surveyed say it’s critical to have enough money for retirement, but only 32% say they’re confident they’ll have enough.”

© 2011 RIJ Publishing LLC. All rights reserved.

More info on New York Life’s DIA Emerges

Posted on April 20, 2011 by -

Wearing a reversed, Army-green fatigue hat, a chalk-striped suit and open-collar shirt, Dylan Huang cut an unconventional figure during his presentation at the LIMRA Retirement Industry conference in Las Vegas last week.

But the young New York Life vice president had unconventional news to share about the deferred income annuity (DIA) that his company intends to marketing in 3Q 2011, and which a few news outlets have sketchily reported.

The product is a deferred income annuity that would be purchased at a discount perhaps 10 years before retirement to fund lifetime income at retirement. Huang said the currently envisioned product would pay out about 13%—the number is presumably a projection —of the beginning premium after 10 years. That’s roughly double what an immediate income annuity pays today for a 65-year-old male.

Such a product could be purchased with a series of premiums, he said, for interest-rate diversification. A single income stream would begin at an appointed date. All of the income would be for-life, he said. The product apparently won’t be designed for bucket methods that create income for discrete time-segments during retirement.

The product is distinct from the little-used DIAs that are known as longevity insurance and which are typically purchased at retirement to provide income for life starting at age 80 or 85. MetLife and PIMCO are currently co-marketing MetLife longevity insurance to be used in conjunction with PIMCO’s 10-year and 20-year TIPS payout funds. 

In response to a question, Huang said that Income Enhancement Option on New York Life’s existing single premium immediate annuity is under review and that the company would like to make it more flexible.

The option allows an increase in the payout rate if the 10-year Constant Maturity Treasury Index in the third full week of the calendar month immediately preceding the fifth policy anniversary is at least two percentage points higher than the 10-Year CMT Index in the third full week of the calendar month immediately preceding the policy date. The higher income benefit would begin on the first scheduled payment after the fifth policy anniversary.

© 2011 RIJ Publishing LLC. All rights reserved.

The Bucket

Posted on April 20, 2011 by -

AXA Equitable launches “Virtual Consultation Calculators”

AXA Equitable Life now offers “video calculators” featuring licensed and experienced financial consultants who help guide individuals through the process of determining how long their retirement savings may last or how much life insurance coverage they may need to protect their families’ future, the company said in a release.

The video calculators, unique to AXA Equitable, provide users with an interactive experience where they receive virtual consultations. Financial consultant David Tornetto offers individuals guidance on estimating how savings may grow until retirement and how withdrawals may impact savings during retirement.

Financial consultant Char Gransta navigates users through a process to assess how much life insurance they may need to replace their income. Combined, these two financial professionals have more than 40 years of experience helping people define and work toward their financial goals.

“Our video calculators provide people with more than just a figure of how much money they might need for a particular life event,” said Andrew McMahon, president of AXA Equitable Life Insurance Company. “These calculators, featuring real financial professionals, simulate what they can expect in an initial conversation with a financial consultant.

“Planning for your retirement, assessing your family’s readiness in the event of death, even just meeting with a financial consultant for the first time – these can all be daunting tasks,” McMahon said. “The virtual consultation can help people get more comfortable, be better prepared when actually meeting with a financial professional for the first time, and hopefully get more out of the meeting in terms of deciding next steps.”

If a user has a question or needs more information about a particular term or topic, he or she simply clicks on a button and the financial consultant explains the topic and provides guidance in greater detail.

“Studies have shown that people spend more time planning for a one-week vacation than they do planning for retirement,” said Connie O’Brien, senior vice president of Internet Strategy and Design for AXA Equitable. “We recently tested this in one of our Retirement Reality Series person-on-the-street interviews and found solid evidence to support the theory. We created the video calculators to make it easier for people to take the first step toward planning for the future. With the Web technology available today, we can provide customers with a new level of resources to help them make more informed decisions at their pace and in a way that is comfortable and convenient for them.”

The video calculators and virtual consultations are available at www.axa-equitable.com.

Prudential Retirement Hits $20 billion in New Third-Party Stable Value Sales

After less than two years after entering the third-party stable value business, Prudential Retirement has surpassed $20 billion in sales, the unit of Prudential Financial said in a release.

Account values have jumped 60% since January, when the business reached more than $12.5 billion in third-party stable value assets for a variety of institutional investment-only clients.

Prudential said its entry into the third-party stable value business in the second quarter of 2009 was fueled in large part to help provide plan sponsors with new options to give plan participants the potential to protect their assets against volatility following the financial crisis of 2008-2009. 

Jeffrey Keller joins MassMutual’s retirement plan sales team

MassMutual’s Retirement Services Division, which set a division sales record in 2010, has hired Jeffrey Keller as a new managing director in its southeast region and will add three new sales support roles in the New York, New England and Michigan territories. MassMutual plans to add further to its sales team later this year, the company said in a release.

Jeffrey Keller has been appointed a managing director for MassMutual effective March 28, covering Georgia, Florida, Alabama and Puerto Rico. He joined MassMutual from New York Life where he spent 13 years in a variety of key sales and marketing leadership roles. Keller most recently served as managing director and head of New York Life’s defined contribution investment only business.

Stan Label, national sales manager for First Mercantile Trust Company (First Mercantile), has announced his plans to retire at the end of April after more than 40 years in the retirement plan business. Label also served on the MassMutual Retirement Services sales management team for 11 years.

Upon Label’s retirement at the end of this month, members of his sales team will report to the regional managers in their respective territories in alignment with the company’s local team philosophy.  

Americans are taking the longer view: Northwestern Mutual   

Americans prefer choices that deliver higher quality, long-term growth and guarantees versus options that are cheaper and faster in the short term, but may be higher risk or deliver less return over the long term, according to a poll conducted by Harris Interactive for Northwestern Mutual.  

The survey of more than 2,000 Americans asked respondents to choose their preference in a series of tradeoffs, including:

  • Trade-off for growth: When asked if an immediate one-time bonus would be preferable to a smaller raise in salary, eighty-seven percent (87%) of those polled indicated they would forgo the bonus and prefer the smaller raise that would end up being more than the bonus in the long term. Only 13% indicated they would choose a one-time bonus.
  • Trade-off for guarantees: When comparing the potential for a large reward with low odds to a smaller guaranteed reward, 83% of people would take the smaller yet guaranteed reward. Only 17% will risk the lower odds of a larger reward.
  • Trade-off for quality: According to the poll, people are prepared to pay a premium for products that hold up over the long-term (82%) versus spending less now for products that are lower quality and need to be replaced sooner (18%).

The survey was conducted online from March 30-April 11, 2011 among 2,159 American adults ages 18 and older.  

Investigation of AIG bailout urged by advocacy group

The Derivative Project, a Minnesota-based non-partisan, taxpayer advocacy organization, has asked Rep. Michelle Bachmann (R, MN) for an immediate House Oversight Committee investigation of all U.S. taxpayer payments to AIG commencing in fiscal year 2008.

The organization is requesting this investigation be completed in conjunction with Bachmann’s legislation, sponsored in January 2011, to repeal the Dodd-Frank financial reform bill.

The Derivative Project requested of Congresswoman Bachmann in this memorandum, the following investigation:

  • What legislation does The Tea Party Caucus and House Republicans propose to prevent taxpayer dollars from being used in the future to fund speculative positions by an end user, like AIG, or other financial institutions if Dodd-Frank is repealed?
  • Are there substantive issues for House Oversight Committee investigation of unequal enforcement of U.S. financial contract law, where U.S. individuals are imprisoned for breach of a financial contract and U.S. corporations and its representatives are allowed a “stupidity” defense, when there is a preponderance of evidence the corporate financial contracts are fraudulent?
  • The Tea Party Caucus and the House Republicans launch a complete House Oversight Investigation of the use of taxpayer dollars to fund collateral call payments to Goldman Sachs and other AIG counterparties during the most recent financial crisis, specifically why these financial contracts were not deemed fraudulent between AIG and Goldman Sachs and unwound in an orderly fashion.
  • The Tea Party Caucus and the House Republicans request a ruling from Attorney General Eric Holder on why the financial contracts between AIG and Goldman Sachs were not deemed fraudulent and a constitutional misuse of taxpayer dollars by the U.S. Department of Treasury headed by then Treasury Secretary Henry Paulson, who had a material conflict of interest in proposing this use of $180 billion of U.S. taxpayer dollars since he had been a partner of Goldman Sachs.  Should the U.S. Treasury Secretary have recused himself from the recommendation that U.S. taxpayers fund collateral call payments from AIG to Goldman Sachs?
  • The Tea Party Caucus and the House Republicans investigate if the $50 billion in taxpayer funds funneled to several banks for AIG collateral payments on derivative financial contract positions should be refunded by the banks to the U.S. taxpayer.

The Derivative Project is a non-partisan, Minnesota – based taxpayer advocacy organization that seeks to ensure the long-term stability of the U.S. economy through equitable enforcement, for both individuals and corporations, of financial laws and regulations.

The full text of the group’s letter to Bachmann will be made available at The Derivative Project’s website, www.thederivativeproject.com and Blog, blog.thederivativeproject.com.


Equity funds see outflows in March: Morningstar

Posted on April 20, 2011 by -

The pace of inflows into long-term mutual funds slowed slightly to $27.0 billion in March from approximately $27.9 billion in February, due largely to a reversal in U.S. stock flows, according to Morningstar, Inc.

Equities saw outflows of $934 million in March after taking in roughly $26.1 billion combined in January and February.

Inflows for U.S. ETFs rose to $7.4 billion in March after reaching $6.6 billion in February despite outflows of $3.3 billion from U.S. stock ETFs, which typically drive industry inflows.

Americans have increased their investments in passive emerging-market ETFs. Six years ago, actively managed open-end mutual funds and ETFs comprised 79% of diversified emerging-markets assets, but today make up 53%, Morningstar said.

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

  • Bank-loan funds, with inflows of $4.3 billion, drove the $18.0 billion that flowed into taxable-bond funds in March. Total category assets for bank-loan funds have reached $59.8 billion, surpassing the $41.2 billion peak reached in June 2007 by nearly 50%.
  • Among U.S. stock funds, large-cap offerings lost about $3.2 billion across the value, blend, and growth categories, while small-cap funds enjoyed modest inflows of $791 million. However, investor preference for small-cap offerings hasn’t held with international-stock funds, where large-caps acquired $3.6 billion in new assets versus just $306 million for small-caps in March.
  • Municipal-bond fund outflows slowed for a third consecutive month, with less than $2.6 billion in March redemptions. Still, roughly $40.4 billion has vacated muni-bond funds over the last five months, which represents 7.8% of beginning total assets.
  • Demand for alternative and commodity funds remained steady with $1.1 and $1.8 billion in March inflows, respectively. Money market funds saw outflows of $12.5 billion in March after inflows of $16.7 billion in February.

Additional highlights from Morningstar’s report on ETF flows:

  • Outflows from large-blend and large-growth ETFs accounted for most of the outflows from U.S. stock ETFs, as these categories lost $6.2 billion and $963 million, respectively. However, several categories in the asset class, including equity energy, natural resources, consumer discretionary, and consumer staples, saw inflows.
  • After beginning the year with two consecutive months of outflows, international-stock ETFs saw inflows of $6.7 billion in March.
  • Taxable-bond ETFs collected assets of $3.1 billion during the month, making a notable contribution to aggregate ETF inflows in March for the first time in seven months.

To view the complete report, please visit http://www.global.morningstar.com/marchflows11. For more information about Morningstar Fund Flows, please visit http://global.morningstar.com/fundflows.

DTCC enhances Licenses & Appointments service

Posted on April 20, 2011 by -

The Depository Trust & Clearing Corporation (DTCC) is developing an enhancement to its Licensing & Appointments (LNA) service that will help carriers track and confirm if agents have been trained and certified to sell their specific annuity products.

These enhancements, which will help centralize the verification of completed mandated training, will roll out later this month. LNA is one of the core automation solutions from DTCC’s Insurance & Retirement Services (I&RS) business.

The changes are driven by the Suitability in Annuity Transactions Model Regulation introduced last year by the National Association of Insurance Commissioners. All agents must now take a four-hour certification course on the fundamentals of annuities, as well as complete product-specific training from carriers for which they solicit annuities.  Each state law has its own specific requirements and training deadlines, and will set its own effective date.

Twenty states adopt annuity education requirements

Eleven states/jurisdictions have adopted regulations requiring further annuity education, including California, Colorado, District of Columbia, Florida, Iowa, Ohio, Oklahoma, Oregon, Rhode Island, Texas, and Wisconsin. Nine more states have proposed regulations. Iowa was the first state to mandate regulations, beginning Jan. 1, 2011, and others are scheduled beginning second quarter, 2011.

“Customers on our Senior Advisory Board approached us with this issue late last September,” said Adam Bryan, managing director, I&RS. “The looming 2011 deadline posed a serious challenge for the industry, since carriers really had no way to centralize the verification of this producer training.

“We saw an immediate fit within LNA, our service that automates and standardizes the two-way flow of information needed to manage producer authorization information between insurance carriers and distributors. We quickly formed a customer task force, and started to work through how we could accommodate these new data requirements with a service enhancement to LNA.”

Phase I Enhancements

In Phase I of the project, which will be fast-track tested for two weeks in April, I&RS has built enhancements to LNA that can take a standardized delimited data file feed from the education vendors who provide this producer training, and translate into the industry-standard LNA format. The new data fields built into the LNA system will then be able to accommodate this training data, so carriers can quickly verify if the agents have been trained and certified.

Some distributors and carriers are using vendors to support their training efforts. The vendors are not required to become members of DTCC’s subsidiary, the National Securities Clearing Corporation (NSCC). They will also not be charged to provide training completion data, nor are required to actually build LNA.

“We wanted to eliminate any possible barriers for the vendors to engage with us,” said Lana Macumber, director, I&RS Strategy and Business Development.

In the next stage of the project, I&RS will extend these enhancements to the LNA Access Platform, the standalone online reporting tool that distributors use to enter, edit, and retrieve various sets of pre-defined required licensing and appointment data.

DTCC is currently working with seven education vendors, including Kaplan, PinPoint (partnering with LIMRA), QuestCE, RegEd (partnering with IRI), Sircon, SuccessCE (partnering with NAFA), and WebCE.

Phase II Enhancements

In the next phase of the project, targeted for early 2012, I&RS hopes to provide real time producer authorization messaging for point-of-sale and transaction processing. By leveraging ACORD XML for producer authorizations, I&RS would be able to navigate these messages to and from requestor to end carrier.

401(k) assets top $3 trillion: SPARK

Posted on April 20, 2011 by -

Assets in 401(k) plans grew by 13% and reached a record $3.075 trillion in 2010 according to the latest Marketplace Update report from the Society of Professional Asset-Managers and Record Keepers (SPARK) and The SPARK Institute.

“Strong performance across all equity sectors, especially the U.S. market over the second half of 2010, coupled with positive returns in the bond markets, helped push total retirement market assets to an estimated $16 trillion by year-end 2010,” said Bob Wuelfing, president of RG Wuelfing & Associates, Inc., which prepared the report.   

The number of 401(k) plans rose to 536,000 in 2010, covering more than 74 million workers in the U.S. in 2010, up from 510,500 plans and 73.4 million participants in 2009.

Additional statistics include:

  • Nearly 70% of participant account balances in equities at the end of 2010, including the equity portion of balanced, life cycle, risk-based asset allocation and target date funds.
  • Total assets in IRAs reached almost $4.5 trillion in 2010.
  • An estimated 20-22,000 new 401(k) plans will be formed in 2011, primarily among small companies.

The Marketplace Update includes key data on the retirement plan market, as well as commentary on industry issues. It is distributed exclusively to members of SPARK and The SPARK Institute.

SPARK was founded in 1989 as an inter-industry group of investment managers and service providers, particularly in the defined contribution retirement plan market.  Current membership includes over 250 companies representing a broad cross-section of banks, mutual funds, insurance companies, third party administrators, trade clearing firms and benefits consultants.

The SPARK Institute provides research, education, testimony and comments on pending legislative and regulatory issues to members of Congress and relevant government agency officials.  Collectively, SPARK and SPARK Institute member companies serve approximately 70 million participants in 401(k) and other defined contribution plans.

An Industry Awaits Fee Transparency Rule with Trepidation

Posted on April 20, 2011 by -

When rule 408(b)(2) goes into effect, will it achieve the Labor Department’s goal of greater fee transparency in employer-sponsored plans and higher account balances for participants?

Or will it become a ‘Tower of Babel,’ as one writer put it, creating a burden for plan sponsors and providers and perhaps scaring participants from saving?  

Whatever the consequences, a final amended version of the rule may not go into effect until the middle of next year, not long before a presidential election when the country will determine, among other things, whether it likes a reform-minded administration or wants a return to light financial regulation. 

Fred Reish (above), the ERISA legal expert, alerted his LinkedIn followers and others on April 14 that “the amendments to the 408(b)(2) regulation have been fully drafted at the Department of Labor. They are being reviewed by senior officials at the Employee Benefit Security Administration (which is the pension and welfare part of the DOL).

“It would be reasonable to expect that the amendments to the regulation would be fully reviewed and approved by the end of this month, and then sent to the Office of Management and Budget (OMB) for its review.

“It ordinarily takes the OMB 60 to 100 days to approve regulations, so it would be reasonable to assume that the amendments would be published in mid- to late July (but, of course, things always seem to go slower at the government than we would think).

“While we will not be able to see the amendments during the review process, there is a rumor that they will include an extension of time for compliance. Right now, the amendments are effective January 1, 2012.

“Since the probable purpose of the rumored extension (if true) is the late issuance of these amendments, it is reasonable to assume that the new effective date would be somewhere in the range of April 1 to July 1, 2012. But, that’s just a guess. I will do further articles like this as we hear credible information about the amendments.”

Reish did not comment on the merits of 408(b)(2), but Louis S. Harvey, president of DALBAR, Inc., called it a potential “Tower of Babel” that could backfire. His comments were published recently in Volume 16, No. 1 of DSG Dimensions, the periodical of Diversified Services Group. 

“Unlike the mountain of disclosures that exist today this new ERISA 408(b)(2) disclosure has a bite to it,” Harvey wrote. “No, this is not a warning label and is not a description of a privacy policy or showing past performance. This is about compensation and will therefore get the attention of plan sponsors.

“Exposure to the unmasked dollars and cents of a service provider’s pay is certain to raise questions in high cost plans. The new regulation applies to all fiduciaries, record keepers, brokerage services and anyone receiving indirect compensation (compensation that originated from the plan but is paid by a third party such as a record keeper or mutual fund). Compensation anticipated to be less than $1,000 is excluded.”

“The DoL estimates the total first year cost of implementing the disclosures will be $153 million with ongoing costs of $37 million per year. These estimates do not include the economic dislocation that the disclosure will cause but disruption is acknowledged by the DoL.

“The DoL explains that the disclosures will cause ‘the discouragement of harmful conflicts of interest, reduced information gaps, improved decision-making by fiduciaries about plan services, enhanced value for plan participants, and increased ability to redress abuses committed by service providers.’”

At the LIMRA Retirement Industry conference in Las Vegas last week, a John Hancock retirement executive expressed concern about 408(b)(2) possibly backfiring.

“I worry about all the noise over fee disclosure and fiduciary responsibility,” said Arthur E. Creel, executive vice presidnet, sales and marketing, John Hancock Financial Services. “They’re important, but that noise can scare people away from doing the right thing. There are lots of unintended consequences of regulatory change. You could end up with less saving rather than more.”

© 2011 RIJ Publishing LLC. All rights reserved.

Financial system a ‘con game,’ says economist

Posted on April 20, 2011 by -

The world’s financial system is tantamount to “a Ponzi scheme” and the U.S. bailouts of AIG and other entities worsened its problems according to Larry Kotlikoff, professor of economics at Boston University and former adviser to the president.

Speaking at a pension conference in Wassenaar, the Netherlands, Kolitkoff also likened the financial system to “a con game, characterised by a pervasive lack of transparency and made up of fraudulent guarantees and financial promises that cannot be kept,” IPE.com reported.

“AIG insured the uninsurable, and now the US government has taken over that role,” Kotlikoff said. “But managing the crisis by taking on promises you can’t deliver is not a fix to systemic risk. It is itself systemic risk.”

If one were to count the “unofficial” liabilities in US entitlement programs that are presently being kept out of the picture by bogus accounting, the US is actually in worse shape than Greece, he said.

“To cover all those liabilities, federal taxes would have to be raised by 64%, or expenses would have to be cut by 40% – and that is an optimistic estimate,” he said.

The financial system is inherently fraudulent, Kotlikoff said, because financial institutions insure the uninsurable and take on liabilities they cannot honor, while these institutions and their managers themselves take on only limited liability and pass the buck to the tax payer when things go wrong.

The only way to fix this sorry state of affairs is by introducing what Kotlikoff calls “limited purpose banking.”

Financial institutions should be turned into mutual funds or mutual insurance companies with unlimited liability, under supervision of an independent financial authority that would be responsible for verification, appraisal, rating and enforcing full disclosure.

A mutual fund selling shares and investing or lending out the proceeds without the use of leverage makes no promises it cannot keep, nor does it require government guarantees, Kotlikoff said.

Likewise, risks could be insured using ancient ‘tontine’-style vehicles, which mutually insure risks without any attempt to insure the aggregate – and thus uninsurable – risk.

The Dutch pensions system, too, is at risk of going under because it makes promises that cannot be kept, he said.

An ideal pensions system would cut employers out of the picture entirely because “companies have their own interest at heart”, and those interests do not include providing employees with a good income after retirement.

Much better to have the government introduce mandatory savings of about 8% of wages, to be invested collectively in a globally diversified index fund at virtually zero cost, he said.

“The government could then guarantee that people would get what they put in adjusted for inflation, and people could turn to tontine funds to take out additional insurance,” he added.

Kotlikoff also said he hoped his views would resonate in the Netherlands and inspire measures to overhaul the financial system.

“Don’t expect the US to take the lead in this. We are the ones who created this mess in the first place,” he said. But unless the US gets its fiscal house in order, fiscal problems could well trigger a second, and far worse, financial crisis, Kotlikoff warned.

“Once people figure out the government can’t actually deliver what it has promised, other than by printing huge amounts of money, this may trigger a bank run,” he said. “PIMCO has already said it will buy no more US Treasuries, which is not a good sign.”

Kotlikoff, a former senior economist on the presidents Council of Economic Advisers, has proposed a radical overhaul of the financial system in his book Jimmy Stewart is Dead – Ending the World’s Ongoing Financial Plague with Limited Purpose Banking, which was endorsed by Mervyn King, governor of the Bank of England.

Aspen Institute to host retirement discussion

Posted on April 13, 2011 by -

A roundtable conversation hosted by The Aspen Institute Initiative on Financial Security (Aspen IFS) will hold a roundtable discussion entitled “Savings to Last a Lifetime: The Changing Needs of Retirees” on Friday April 15 from noon to 1:30 p.m. at 1333 New Hampshire Avenue, NW, 10th Floor, Washington Room, Washington D.C.

Participants will include Mark Iwry, Deputy Assistant Secretary for Retirement and Health Policy, U.S. Treasury, Michael Davis, Deputy Assistant Secretary, U.S. Department of Labor Employee Benefits Security Administration, and Lisa Mensah, executive director, Aspen Institute Initiative on Financial Security.

The topic is the transition from defined benefit (DB) to defined contribution (DC) plans and the resulting opportunities and challenges to improve retirement security in today’s changing landscape.  The event is hosted in conjunction with the National Retirement Planning Week.

The Aspen Institute Initiative on Financial Security   (Aspen IFS) is a leading policy program dedicated to helping bring about the policies and financial products that enable all Americans to save, invest, and own.   For more information about Aspen IFS and its work, please visit www.aspenifs.org.

The Aspen Institute mission is twofold: to foster values-based leadership, encouraging individuals to reflect on the ideals and ideas that define a good society, and to provide a neutral and balanced venue for discussing and acting on critical issues. The Aspen Institute does this primarily in four ways: seminars, young-leader fellowships around the globe, policy programs, and public conferences and events. The Institute is based in Washington, D.C.; Aspen, Colorado; and on the Wye River on Maryland’s Eastern Shore. It also has an international network of partners. For more information, visit www.aspeninstitute.org.

America Isn’t a Corporation

Posted on April 11, 2011 by -

Wisconsin congressman Paul Ryan, in his “Path to Prosperity” polemic, was correct to point out that the United States is on an unsustainable financial course.  No one seriously disagrees with that conclusion. The projections are scary.  

And his proposals made sense if you’re inclined to think of the government as a corporation. If taxpayers were like shareholders, if those who pay the most taxes were the biggest shareholders, and if the rest were like employees with fat benefit packages, then it would be perfectly reasonable to act like a corporation and start cutting fast, from the bottom.

Similarly, his proposals about health care made sense if you believe, as some people do, that Medicare and Medicaid payments should be counted as income for the people who receive treatment under those programs.

But framing is everything. If you frame things differently his ideas don’t make as much sense. First, the country isn’t a corporation. Corporations aren’t societies. They aren’t democracies. They aren’t perpetual. The country is all three. Second, entitlement payments aren’t income for the masses. Since 1965, they’ve been a font of income—a moral hazard, a “blank check,” a boondoggle—for the very profitable medical industry.

We have to find a way to deliver good health care to everybody at lower cost, rather than deliver perfect health care to some people at very high cost.

Charlie Baker, a Harvard and Kellogg School graduate, son of a Mayo clinic surgeon, former CEO of Harvard Pilgrim Health Care in Boston, and recent unsuccessful Republican candidate for governor of Massachusetts, was asked at the recent RIIA conference in Chicago how he would reform the medical system if he were its “czar.”

Baker, like Ryan, said that the government should give older people a “basket of money” and let them choose their own insurance plans. The amount in the basket would get bigger as they aged.” But in calling for medical teamwork and a change in Medicare that would reward “cognitive” care rather than encourage costly procedures, he also targeted the costly fragmentation and duplication in the medical care delivery system.

Arnold Relman, the 88-year-old nephrologist and former editor of the New England Journal of Medicine, has argued in print and in speeches for 30 years that the country could afford comprehensive high-quality health care for everyone if medicine were a not-for-profit business, with highly-paid salaried doctors working in groups and no investor-owned hospital chains.

“Health care should not be a playground for investors,” Relman told RIJ last week. “The single payer is the first step. But you have to reform the delivery system, by saying to the medical system, ‘This is what we can afford, this is all we can pay you and you’ve got to do the best you can.’ Some say that will lead to rationing. That’s nonsense. There’s more than enough money in the system. It’s just not being spent on health care. It’s being spent on administration and duplication and fraud.”

Every human being is a million-dollar medical bill waiting to happen, and if nobody stops the growth in health care spending, then BabyBoomers will spend all of their savings on nothing else. But the solution isn’t to shift rising costs away from taxpayers and onto older people. The solution is to reduce costs by taking the profit motive (and the profiteering) out of medicine.

In that regard, Baker was pessimistic. At 18% of GDP, he said, the medical system is too big to let anyone to dictate to it. He believed that health care might account for 30% of the economy by 2035. Relman was more optimistic. He noted that some 200,000 doctors now work in salaried groups like the Mayo Clinic, where costs are lower and outcomes are better. Doctors themselves, he said, can change the system, he said.

Relman thinks the Ryan Medicare proposal is just plain wrong. “It’s a sham. It’s mean-spirited. It’s a reversion to the old ‘devil-take-the-hindmost’ philosophy,” he said.  “It guarantees that people would have to pay more and more out of pocket to insurance companies. Doctors would continue to practice fee-for-service. Costs wouldn’t be controlled at all.”

© 2011 RIJ Publishing LLC. All rights reserved.

The Bankers Who Control the World

Posted on April 11, 2011 by -

“A towering citadel housing what is essentially a sovereign state known as the Bank for International Settlements is located in Basel, Switzerland. The bank now controls the financial affairs of planet Earth”—from Crisis by Design: The Untold Story of the Global Financial Coup, John Truman Wolfe (Roberts Ross, 2010).

For many decades the central bank for central bankers, the Bank of International Settlements has been accused of engineering the recent financial crisis in order to weaken the dollar. In the early 1980s, reporter Edward Jay Epstein visited the BIS and wrote about it for Harper’s magazine. Updated for RIJ, his first-hand account remains one of the few independent profiles of the BIS.

Ten times a year—once a mouth except in August and October—a small elite of well-dressed men arrives in Basel, Switzerland. Carrying overnight bags and attaché cases, they discreetly check into the Euler Hotel, across from the railroad station.

They come to this sleepy city from places as disparate as Tokyo, London, and Washington, D.C., for the regular meeting of the most exclusive, secretive, and powerful supranational club in the world. While here, they are fully serviced by chauffeurs, chefs, guards, messengers, translators, stenographers, secretaries, and researchers. For their relaxation, there is a secluded nearby country club with tennis courts and a swimming pool.

The membership of this club is restricted to a handful of powerful men who determine daily the interest rate, the availability of credit, and the money supply of the banks in their own countries. They include the governors of the U.S. Federal Reserve, the Bank of England, the Bank of   Japan, the Swiss National Bank, and the German Bundesbank.

The unabashed purpose of this elite society is to make decisions that aim to influence and, if possible, to control all monetary activities in the industrialized world. The place where this club meets in Basel is a unique financial institution called the Bank for International Settlements—or more simply, the BIS (pronounced “biz” in German).

Origins of the BIS

The BIS was established in May 1930 by a small elite of central bankers to collect and settle Germany’s massive World War I reparation payments (hence its name). These lords of finance organized it as a commercial bank with publicly held shares. Their power was such that an international treaty, signed in The Hague in 1930, guaranteed the bank’s immunity from government interference, and even taxation, in both peace and war.  

Its depositors, the world’s central banks, also stored much of their gold there. As the central banks provided it with a profit on every transaction, it required no subsidy from any state, making it truly a supra-government of finance. Congress officially refused to allow the U.S. Federal Reserve to participate in the BIS, or to accept shares in it (which instead were held in trust by the First National City Bank). But the chairman of the Fed quietly slipped over to Basel for important meetings to deal with the financial panics that flared up in Austria, Hungary, Yugoslavia, and Germany in the 1930s, and to prevent the collapse of the global financial system.

These central bankers had to coordinate their rescue efforts in secret, and the meeting spot that provided them with the necessary cover was the BIS, where they   regularly went anyway to arrange gold swaps and war-damage settlements. World monetary policy was evidently too important to leave to national politicians. Even during World War II, when the nations, if not their central banks, were belligerents, the BIS continued operating in Basel. The monthly meetings were temporarily suspended in 1944, following Czech accusations that the BIS was laundering gold that the Nazis had stolen from occupied Europe.  

After the war, the American government backed a resolution calling for the liquidation of the BIS. The naive idea was that the new International Monetary Fund could take over the BIS’ settlement and monetary-clearing functions. What could not be replaced, however, was what existed behind the mask of an international clearing house: a supranational organization for setting and implementing global monetary strategy, which could not be accomplished by a democratic, United Nations-like international agency.

The central bankers, not about to allow anyone to take their club from them, quietly snuffed out the American resolution. Indeed, the BIS grew stronger, and proved particularly useful to the United States in the Cold War years.

When the dollar came under attack in the 1960s, massive swaps of money and gold were arranged at the BIS for the defense of the American currency. It was undeniably ironic that, as the president of the BIS observed, “the United States, which had wanted to kill the BIS, suddenly finds it indispensable.”

Up until the late 1970s, the central bankers sought such complete anonymity for their activities that they maintained their headquarters in an abandoned six-story hotel, the Grand et Savoy Hotel Universe, with an annex above the adjacent Frey’s Chocolate Shop. Since there purposely was no sign over the door to identify the BIS, visiting central bankers and gold dealers used Frey’s, which is across the street from the railroad station, as a convenient landmark.

In the wood-paneled rooms above the shop and hotel, decisions were reached to devalue or defend currencies, to fix the price of gold, to regulate offshore banking, and to raise or lower short-term interest rates. And though the bank shaped a new world order, the public, even in Basel, remained almost totally unaware of its activities.

A rare guided tour

The BIS had relaxed some this passion for secrecy and, against the better judgment of some of its members, moved to a more efficient eighteen-story cylindrical skyscraper, when I was invited to its headquarters in 1983 by Karl Otto Pohl, who, as president of the German central bank, belonged to the inner club of the BIS. Earlier, I had interviewed Pohl for Institutional Investor magazine, and he had complained to me, over a bratwurst-and-beer lunch on the top floor of the Bundesbank in Frankfurt, about the repetitiousness of the meetings he had to attend at the BIS.

“First, there is the meeting on the Gold Pool, then, after lunch, the same faces show up at the G-10. The next day there is the board which excludes the U.S., Japan, and Canada, and then the European Community meeting, which excludes Sweden and   Switzerland. But these meetings are not where the real business gets done,” he said. That was done at the “inner club” that included Pohl. Since Pohl was telling me about his power, at the end of our leisurely lunch I asked him if he could arrange a visit for me.  “Why not,” he answered, “You can interview its President Fritz Leutwiler.”

When I arrived in Basel the following week, there was no mistaking the BIS’ headquarters. Known as the “Tower of Basel” it rose over the medieval city like some misplaced nuclear reactor. I was immediately taken to Dr. Leutwiler’s office, which, despite his power, was modest in size. He began the interview by apologizing for the prominence of the bank’s new venue: “That was the last thing we wanted. If it had been up to me, it never would have been built.”

Despite its irksome visibility, the building has some practical advantages over its   predecessor over a chocolate shop, he conceded. For one thing, it is completely air-conditioned and self-contained, with its own nuclear-bomb shelter in the sub-basement, a triply redundant fire-extinguishing system (so outside firemen never have to be called in), a private hospital, and some twenty miles of subterranean archives.

While we talked, his eyes never left the Reuters screen in his office, which signaled   currency fluctuations around the globe. He then provided me with a tour of the building. Gunther Schleiminger, the general manager, escorted me around the different levels, and provided a revealing commentary about the layout of one of the financial world’s most secretive institutions.

The top floor, with a panoramic view of three countries, Germany, France, and Switzerland, contained a deluxe restaurant, used only to serve the members a buffet dinner on Sunday evenings when they arrive to begin the “Basel weekends.”

Aside from those ten occasions, this floor remained ghostly empty. The next three floors down were the suites of offices reserved for the central bankers. On the next floor was the BIS computer, which, for 1983, was state of the art.  It was directly linked to the computers of the member central banks and provided instantaneous access to data about the global monetary situation. 

The gold room

On the floor beneath it was the actual bank, where 18 traders, mainly from England and Switzerland, were busy rolling over short-term loans on the Eurodollar markets.  They spoke mainly English. Finally, on the lowest floor, gold was being hectically traded.

Traders were constantly on the telephone arranging loans of the bank’s gold to international arbitragers, thus allowing central banks to earn interest on gold deposits. Indeed, the BIS is prohibited by its statutes from making anything but   short-term loans. So almost all the gold-backed trades were for 30 days.

To back their trades, these traders had roughly one-tenth of the world’s gold supply. According to Dr. Leutwiler, the profits the BIS received on this trading had amounted to $162 million the previous year.

But why were the central banks using the BIS to trade their gold? The German Bundesbank, for example, has a superb international trading department and 15,000 employees—at least 20 times as many as the BIS staff.  The answer was, of course, secrecy.

By commingling part of their reserves in what amounts to a gigantic mutual fund of short-term investments, the central banks created a convenient screen behind which they can hide their own deposits and withdrawals in financial centers around the world. And the central banks are apparently willing to pay a modest fee to use the cloak of the BIS. They also provided it with a large enough profit to support the other services it provided them.

On paper, the BIS was a small, technical organization with just 86 of its 298 employees ranked as professional staff in 1983. But artfully concealed within this outer shell, like a series of Chinese boxes one inside another, were the operations that truly required the support of the world’s central bankers.

The first box inside the bank is the board of directors, drawn from the eight European central banks (England, Switzerland, Germany, Italy, France, Belgium, Sweden, and the Netherlands), which meets on the Tuesday morning of each “Basel weekend.”

The board also meets twice a year in Basel with the central banks of other nations. It provides a formal apparatus for dealing with European governments and international bureaucracies like the IMF or the European Economic Community. The board defines the rules and territories of the central banks with the goal of preventing governments from meddling in their purview, including setting the ratio of bank reserves to loans.

To deal with the world at large, there is another Chinese box dealing with the “G-10.” This powerful group, which controls most of the   transferable money in the world, meets for long sessions on the Monday afternoon of the “Basel weekend.”

It is here that broader policy issues, such as interest rates, money-supply growth, economic   stimulation (or suppression), and currency rates are discussed.

Directly under the G-10, and catering to all its special needs, is a small unit called the “Monetary and Economic Development Department,” which serves in effect, as its private think tank. This unit produces the occasional blue-bound “economic papers” that provide central bankers from Singapore to Rio de Janeiro, even though they are not BIS members, with a convenient party line.

‘No use for politicians’

Finally, there is the inner club, made up of the half dozen or so powerful central bankers. Even when the BIS is not holding a meeting, they are in constant contact with each other by phone. And they all speak the same language when it comes to governments, having shared similar experiences. “Some of us are very old friends,” Pohl said, and share the same set of well articulated values about money.

One such value is the firm belief that central banks should act independently of their home governments. A second shared value, according to Pohl, is that politicians should not be trusted to decide the fate of the international monetary system. When Leutwiler became president of the BIS in 1982, he insisted that no government official be allowed to visit during a “Basel weekend.” “To be frank,” he said, “I have no use for politicians. They lack the judgment of central bankers.”

This effectively sums up the common antipathy of the inner club toward “government muddling,” as Pohl termed it at our Bundesbank lunch.  The other value shared by the inner club is the conviction that when  the bell tolls for any single central bank, it tolls for them all.  “We are constantly engaged in a balancing act without a safety net,” Leutwiler explained.

When Mexico faced bankruptcy in the early 1980s, the issue for the inner club was not the welfare of that country but the stability of the entire banking system. It was clearly an emergency for the inner club. Even though the IMF was prepared to step in, it would require months of paperwork to get approval for the loan, and Mexico needed an immediate $1.85 billion.

After speaking to Miguel Mancera, director of the Banco de Mexico, then-Fed Chairman Paul Volcker called Leutwiler, who was vacationing in the Swiss mountain village of Grison. Leutwiler realized that the entire system was confronted by a financial time bomb. In less than 48 hours, Leutwiler had called the members of the inner club and arranged the temporary bridging loan.

While the loan appeared in the financial press to have come from the BIS, virtually all the funds came from the central banks in the inner club. The BIS merely provided a convenient cloak for the central bankers; Volcker and other members would have to take the political heat individually for what appeared to be the rescue of an underdeveloped country.

The BIS has not changed that much since my visit 28 years ago. Although Russia, China and other new players now send observers to meetings in Basel, the inner club still runs it. And that club still remains true to its mission of rescuing the banking system from politicians.   

New York Life plans deferred income annuity for July

Posted on April 11, 2011 by -

New York Life Insurance Co. expects to release its first longevity insurance product this July,  Investment News reported and a New York Life spokesman confirmed this week.

Longevity insurance is a deferred income annuity. A 65-year-old retiree, for instance, might buy such a product to provide life-contingent income from age 85 onward. Since the product would have 20 years to appreciate and, depending on the product design, would only pay out if the owner lived past age 85, it could be purchased at a steep discount. The product can help eliminate the tendency among retirees to hoard their savings against the possibility that they might live five, ten or even 15 years past the average life expectancy. 

Recently, PIMCO and MetLife announced a co-marketing plan that coupled PIMCO’s TIPS payout fund, which provides income for a fixed 10 or 20-year period, with a MetLife deferred income annuity that would provide income when the TIPS fund payments expire.

As an insurance product, deferred income annuities have never sold well and have not even been vigorously marketed, for a number of reasons. In its cheapest form, it has no cash value. When purchased with qualified money, it may also conflict with current laws pertaining to required minimum distributions from IRAs and employer-sponsored retirement plans at age 70 1/2.  Recently, low interest rates have made it more expensive than it had been only a few years ago.

 

Polish president signs new pension laws

Posted on April 11, 2011 by -

The hotly debated overhaul of the 12-year-old “second pillar” of Poland’s state pensions system was signed into law by president Bronislaw Komorowski April 7,  IPE.com reported.

Starting May 1, contributions to open pension funds (OFEs)—mandatory defined contribution accounts—will fall to 2.3% of gross wages from 7.3%. The difference will be transferred to individual accounts managed by the Social Insurance Institution (ZUS), with a return indexed to the average of the previous five years’ nominal GDP growth (not counting falls in GDP). After two years, the OFE portion will rise gradually to 3.5% by 2017.

Over the next two years, growth of pension funds will slow markedly. In the first three months of 2011, contributions alone amounted to PLN6.4bn (€1.6bn), bringing the total net assets of the 15 million-participant plan to some €58bn ($83.8 bn).

The new law also raised the equity limits from 40% to 42.5% in 2011 and 62% by 2020, but it maintained the unpopular 5% cap on foreign investments, which prime minister Donald Tusk described as essential for maintaining the stability and security of the system.

The law introduces a new voluntary savings vehicle, the Individual Pension Insurance Account (IKZE), into which savers can contribute an additional 4% of gross wages tax-free.

Savers can either add these to their existing OFE account or have them managed by banks, insurance companies, brokerages or investment companies.

The new law also bans, as of May, transfer fees levied on savers switching between OFEs and, as of 2012, the use of sales agents by pension companies.

Poland’s deteriorating public finances back in late 2010 drove the changes. The budget deficit is estimated at 7.9% of GDP for 2010. The government – a coalition between the centre-right Civic Platform (PO) and the agrarian Polish Peasants Party (PSL) – wants it down to the 3% level for euro adoption by 2013.

The deficit, in turn, increased the country’s public debt, which in 2010 was approaching the constitutional limit of 55% of GDP, above which the government is legally obliged to institute pension freezes and other public sector cuts.

Since OFE contributions counted as public spending, the second-pillar system was an easy target for deficit reduction, as has been the case in the Baltic states and, at its most extreme, in Hungary, which effectively nationalised its second pillar system last year.

The government estimates that, by 2020, the reforms will have reduced Poland’s debt obligations by PLN190bn (€48bn).

The Bucket

Posted on April 11, 2011 by -

Three new fixed income funds from Prudential Investments

Prudential Investments, the mutual fund family of Prudential Financial, has launched three new fixed income funds: the Prudential Floating Rate Income Fund, the Prudential Absolute Return Bond Fund, and the Prudential Emerging Markets Debt Local Currency Fund.

 “Today’s historically low interest rates have many investors concerned that if rates start rising, it could have a negative impact on their bond investments,” said Judy Rice, president of Prudential Investments. “Two of our new funds help protect against changing market conditions and may reduce interest rate risk, while the third fund focuses on helping investors take advantage of growing opportunities in developing markets.”

  • The Prudential Absolute Return Bond Fund seeks to generate positive returns over time regardless of market conditions by investing across a broad range of sectors and securities. Its flexible strategy uses a variety of investment techniques, which may include managing duration and credit quality, yield curve positioning, and currency exposure.
  • The Prudential Floating Rate Income Fund invests primarily in floating rate loans and other floating rate debt securities. Floating rates loans have historically offered attractive yield and stability in times of rising interest rates.
  • The Prudential Emerging Markets Debt Local Currency Fund invests primarily in currencies and fixed income securities denominated in the local currencies of emerging market countries. Many of these countries are growing faster, have less debt, and maintain lower national budget deficits than their counterparts in developed countries.

The portfolio managers for all three funds are part of Prudential Fixed Income, which has about $270 billion in assets under management as of December 31, 2010.   

 

Putnam Investments named year’s ‘Retirement Leader’

Putnam Investments was named the inaugural recipient of the “Retirement Leader of the Year” award at recent the 18th annual Mutual Fund Industry Awards in New York.

The Annual Mutual Fund Industry Awards, presented by Fund Directions and Fund Action recognize the funds, fund leaders, marketers, trustees and independent counsel who stood out for their successes, achievements and contributions in 2010.  

 “Putnam was recognized for its leadership initiatives and innovative solutions in the workplace savings arena, including its efforts to sharpen the focus on retirement income and encourage the industry and policy makers to further strengthen the workplace savings system,” the company said in a release.

“We are honored to be the first-ever recipient of this award,” said Robert L. Reynolds, president and chief executive officer of Putnam Investments. “There is an increasing need across the retirement savings industry – for plan sponsors, 401(k) participants, advisors and consultants, as well as policy makers, and importantly, plan providers – to define ways to help working Americans prepare financially for a dignified and sustainable high-quality retirement.”

Since Reynolds joined Putnam from Fidelity in July 2008, Putnam has announced a series of actions designed to have positive, long-term impact on the retirement market. Most recently, Putnam shared plans to offer a unique suite of income-oriented mutual funds that shift the focus from asset accumulation to asset distribution, to address changing financial needs throughout an individual’s retirement.

The funds, working in tandem with a retirement income planning tool, will aim to help advisors guide their clients, who are in or near retirement, in developing strategies for monthly income flows, based on varying levels of risk tolerance.

Putnam’s RetirementReady Funds, a suite of 10 target-date/lifecycle retirement funds, which were the industry’s first lifecycle funds to integrate absolute return strategies. Putnam’s Absolute Return Funds seek positive returns of 1%, 3%, 5%, or 7% above inflation over a period of three years with less volatility than has been associated with traditional asset classes that have earned similar rates of return.   


New York Life announces record earnings, surplus for 2010

New York Life Insurance Company, the nation’s largest mutual insurance company, announced record 2010 operating earnings and added $1.8 billion to surplus for the year, increasing the company’s reserves to $16.8 billion, an all time high. The company also set records in sales of insurance and investment products, operating revenue and assets under management.

The company reported the following performance highlights:

  • Surplus and Asset Valuation Reserve increased by $1.8 billion, or 12%, to a record high of $16.8 billion.
  • Operating earnings of $1.4 billion increased 21% from 2009, exceeding the record result set in 2008.
  • Operating revenue grew by $1.1 billion, or 7.7% over 2009, to a record high $15.5 billion.
  • Total insurance sales surpassed $3 billion, an increase of 15% over 2009, setting a new record, with U.S. Life Insurance leading the way with a 26% increase.
  • Total investment sales exceeded $35 billion, a rise of 6.7% over 2009 and a new record.
  • Assets under management reached a record of $316 billion, a 10.2% increase from 2009.

Retirement Income Security (RIS), New York Life’s retirement division, manufacturers and markets income annuities, investment annuities, MainStay mutual funds, and long-term care insurance.

In 2010, RIS achieved new sales records in income annuities and new sales records for MainStay mutual funds. The long-term care operation generated a double digit increase in sales.   

Ted Mathas, chairman and CEO, said, “The company’s operations continued to generate strong growth in 2010. Our U.S. Life Insurance operations, the core of the New York Life franchise for 166 years, produced life sales growth of 26% at a time when the industry struggled for a modest single-digit increase.

“In fact, over the past four years our insurance sales have grown at a compound annual rate of 13%. Contributing to this strong sales growth has been outstanding growth in our career agency system. Since 2005 the ranks of New York Life active agents have grown 32%, while the number of agents industry wide is declining.”

 

PulteGroup unit targets Boomers who are relocating, downsizing their homes

The nation’s leading 55+ community builder has launched a comprehensive set of online tools to help people make better informed decisions about their retirement or their next stage in life, which increasingly includes home downsizing, a geographic move and some level of work activity.

“A pre-retiree can compare the tax laws of where they are currently living with laws in states where they are considering moving to. This definitely helps ease the unknown, which is so important in facilitating a move.”

The resource at DelWebb.com/value includes a cost of living calculator and information on home appreciation, taxes by state and even job opportunities for Boomers. It also includes an updated news stream of articles relevant to optimizing an active adult lifestyle. Key components of the data are provided through partnerships with Bestplaces.net and the Retirement Living Information Center, Inc.  

Among its retirement planning tools, DelWebb.com/value uses Sperling’s cost of living calculator—a top Google destination providing information on property taxes, income tax, utilities, etc.

Del Webb’s most recent Baby Boomer Survey revealed optimism in the 55+ market with 33% of the respondents saying they are likely to buy a home within the next four years. The likelihood of buying skyrockets to nearly 66% of Baby Boomers purchasing a home in the next two years if economic and financial barriers were removed, said Deborah Meyer, Chief Marketing Officer for Del Webb parent company, PulteGroup.

“The Boomer survey told us that people want more comprehensive information to make smart retirement decisions,” Meyer said. “We created this one-stop shop web tool to help people who want to take that next step in making a life change. Understanding that information seems to be the key to removing what often are only perceived barriers.”

The percentage of Baby Boomers planning to use equity from their current home to help finance retirement has not changed in the past 15 years, according Del Webb Baby Boomer Surveys polled in 1996 and 2010. In both surveys 23% said they plan to use their home equity for retirement.

“With more than 78 million people aged 55 or older by 2014, their interest level and likelihood to purchase a home in the next several years may be a key component in leading the housing industry toward recovery. Many economists and new builders expect people 55+ to capture at least 25% of the total housing market,” Meyer said.

Del Webb consumer research also found that people thinking about a move wanted to hear from “real people” about their experiences, Meyer said. The DelWebb.com/value resource includes testimonials from active adults talking about the home they sold, why they moved and describing the emotional side of a move, she said.

Economy improving amid anxiety about end of QE2: TrimTabs

Posted on April 11, 2011 by -

Income and employment are increasing at much stronger rates than the Bureau of Economic Analysis (BEA) and the Bureau of Labor Statistics (BLS) are reporting, according to TrimTabs Investment Research.

In a research note, TrimTabs’ real-time and near real-time indicators point to a rapid acceleration in economic growth:

  • The TrimTabs’ real-time measure of wages and salaries posted a huge year-ago increase of 8.6% in March, up markedly from 4.7% in February and the largest increase since 2006. TrimTabs’ data for the first six days in April show the strong growth trend is continuing. Meanwhile the BEA just released their data for February documenting an increase in wages and salaries of 4.1% year-over-year. Data for March will not be available until April 29.
  • The TrimTabs tax-based employment model shows that the U.S. economy added 293,000 jobs in March, 36% higher than the BLS estimate of 216,000 new jobs.
  • The TrimTabs Online Job Postings Index is up 11.9% in 2011.
  • The four-week average of new claims for unemployment insurance sits at 394,250, just above the lowest level since July 2008.

“Our real-time data already shows that wage and salary growth accelerated sharply in March,” said Madeline Schnapp, Director of Macroeconomic Research at TrimTabs. “Meanwhile it took the BEA until last week to release an estimate for February while we are already analyzing growth trends for early April.”

While TrimTabs’ research points to healthy economic growth, the company is concerned about the health of the U.S. economy as government stimulus measures begin to wane in the second half of the year.

“We are happy to finally see stronger economic growth in the wake of trillions of dollars in fiscal and monetary stimulus,” Schnapp noted. “Our biggest fear concerns how the economy will perform after the Feds quit QE2 cold turkey in June. We are far from convinced that the recent surge in economic growth is sustainable.”

Schnapp says that TrimTabs’ real-time analysis of daily tax deposits provides a more reliable measure of income and employment because it is a real-time measure of income from all salaried U.S. employees. Meanwhile the BEA and BLS initial estimates rely on either historical data or surveys and are subject to frequent and at times sizeable revisions. 

Additionally, TrimTabs estimates are available immediately after the end of the reporting period, while estimates from the BEA and the BLS are released in lagged fashion. Government statistics reflect critical economic changes only after the fact, not in real time.

After 2010, nowhere to go but up for fixed annuities

Posted on April 11, 2011 by -

The Fed’s loose interest rate policy helps the government finance its bailouts and helps banks recover from the financial crisis, but it has next to pure pain for fixed income investors—and for marketers of fixed annuities.

 

Estimated fixed annuity sales by banks and other depository institutions were $3.17 billion in fourth quarter 2010, down 48% from fourth quarter 2009, according to the American Bankers Insurance Association.

Quarter-to-quarter sales declined 20%.  Sales in calendar year 2010 fell 53% to an about $15.53 billion. Falling sales of fixed rate annuities without market-value adjustments (MVAs) drove overall results relative to all three periods, according to data from the Beacon Research Fixed Annuity Premium Study.

 

“The current interest rate environment suggests that fixed annuity sales in banks will gradually increase in 2011,” said Jeremy Alexander, president and CEO of Beacon Research.  “However, fixed annuities may not do as well as expected if banks raise certificate of deposit rates aggressively to attract deposits as the economy improves. Consumers’ inflationary expectations may also limit sales.”

The bank channel, where Western National Life was the sales leader, was an isolated bright spot. One-third of the bank channel carriers tracked by Beacon’s study reported improved fourth quarter sales, and about 22% did better quarter-to-quarter.

 

Two fixed annuity issuers dropped out of the top ten from third to fourth quarter 2010, and were replaced by Midland National and Genworth.  Fourth quarter 2010 bank channel results for the ten leading companies were as follows:

 

Fixed annuity issuer 

  Bank sales (000)

Western National Life           

$1,055,552

New York Life                          

     453,393

Great American Financial Resources Inc.

     235,476

Lincoln Financial Group Distributors

     219,337

W&S Financial Group Distributors

     128,577

American National

     121,206

Protective Life                          

       97,213

Midland National                                  

       96,502

Pacific Life                                   

       90,853

Genworth                                          

       66,374
   

 

 

 

 

 

 

 

 

 

 

 

The New York Life Preferred Fixed Annuity moved up one place to become fourth quarter’s bestselling fixed annuity in banks.  Like eight of the top ten, it is a fixed rate non-MVA product. Lincoln Financial Group’s Lincoln New Directions remained the only indexed annuity among the top ten sellers. 

The New York Life Income Annuity continued as the bank channel’s only top-selling income annuity, moving up two notches to come in seventh.  Once again, half of the quarter’s bank bestsellers were fixed rate non-MVA products issued by Western National. Fourth quarter’s leading bank-sold annuities were as follows:                                        

Company

Product

Product type

New York Life

NYL Preferred Fixed Annuity

Fixed Rate Non-MVA

Lincoln Financial Group

Lincoln New Directions

Indexed

Western National Life

Flex 7

Fixed Rate Non-MVA

Western National Life

Flex 5

Fixed Rate Non-MVA

Great American Financial

AssurancePlus 7

Fixed Rate Non-MVA

Western National Life

Proprietary Bank Product A

Fixed Rate Non-MVA

New York Life

NYL Lifetime Income Annuity

Income

Western National Life

Proprietary Bank Product F

Fixed Rate Non-MVA

Western & Southern Life

MultiRate Annuity

Fixed Rate Non-MVA

Western National Life

Proprietary Bank Product B

Fixed Rate Non-MVA

 

 

 

 

 

 

 

 

 

 

The American Bankers Insurance Association (ABIA) is the separately chartered insurance affiliate of the American Bankers Association (ABA) and is the only Washington, D.C.-based full service association for bank insurance interests. Additional information on the ABIA can be found on the Internet at www.theabia.com.

Beacon Research is an independent research company and application service provider founded in 1997 and based in Evanston, IL. Beacon tracks fixed and variable annuity features, rates and sales. Financial institutions use its systems at www.annuitynexus.com for compliance review of 1035 exchanges, sales support, conservation and product research.

 

What Advisors Say About Wholesalers, Etc.

Posted on April 10, 2011 by -

Financial advisors will make many of the decisions that determine how Boomer retirees and pre-retirees invest hundreds of billions of dollars in savings. So they’ve always been a critical market for fund companies and variable annuity manufacturers. But what does this market want? 

Well, listen for yourself.

Besides collecting survey data on advisor sentiment every year (see this week’s cover story), Howard Schneider of GDC Research and Dennis Gallant of Practical Perspectives have also gleaned candid, anonymous comments from hundreds of advisors—comments that annuity wholesalers might find useful.   

“Advisors don’t think about retirement income in the same way that the retirement industry does,” Schneider told RIJ. “For advisors, retirement isn’t only about generating income. Clients come into the office and say they want to retire and play golf or visit the grandchildren. The advisor asks, ‘And what will you do with the other 10 months?’ Or the client comes in an asks, ‘Do I have enough money?’ ‘To do what,’ says the advisor? It’s like being asked, is there enough gas in my car? To do what? Drive to the 7-11? Yes. Drive to Florida? No. An advisor has to touch on all of these issues.”

With regard to the economy, advisors “are very concerned about interest rates,” Schneider said. “Their big challenge in building portfolios is deal with risking. They’re looking over their shoulders and wondering when the other economic shoe will drop. They’re saying,  There still seems to be a lot of risk. How do I manage that, especially when fixed income investments have  nowhere to go but down in value and don’t provide enough income to live on. That’s why variable annuities with income riders are something they say they’ll use more of.”

Schneider continued, “Advisors say one of their biggest problems is managing expectations. One manager created a portfolio that could deliver an income of $4,000 a month, but the client said he needed $6,000. The manager said, but your money will probably only last 15 years that way. The client said, ‘You’ll figure something out.’ Advisors say that one of the differences between first-stage Boomers and the Silent Generation is that the Silent Generation was willing to live more conservatively in retirement. Boomers don’t want to make any sacrifices.”

Below are some of the direct comments from advisors that Schneider and Gallant compiled during their most recent survey, Trends in Retirement Income Delivery: Advisor Portfolio Construction, Product Usage and Sales Support:

  • “Annuity dealers are not always right in suggesting an annuity for every account or occasion—it seems they forget the annuities are only as good as the worth of the company behind them as we saw with AIG—they seem to be the only ones really looking and asking for retirement business.”
  • “Income from short term liquid assets is very challenging. CD and money market rates are horrible.”
  • “Wholesalers should keep the golf balls, umbrellas, coffee mugs, etc., and provide as much info, training and current ideas as possible. The wholesalers who get Moshe Milevsky and Nick Murray in front of me will get a large part of my attention and the attention of my clients.”
  • “Our broker back-office doesn’t understand annuities and they are making it impossible to do business. They don’t know how to handle annuities and the annuity companies are being bullied by them into handling annuities in ways good for firm but not for client!!!! Very scary.”
  • “Nothing is guaranteed, therefore [I] can never use that word with clients.”
  • “I am more interested in receiving information and training than in getting meaningless designations.”
  • “Challenging at best, client expectations are far too high; [we] need to do away with 401(k)s and go back to a form of pensions.”
  • “Crucial topic. Very underserved.”
  • “Most of my clients are already retired and I provide risk management and manage the portfolios to provide low volatility and a better than average gain by active management techniques.”
  • “Less concern of suppliers on competitive edge and MORE consistency in support of the available products.”
  • “We have to continue to re-evaluate.”
  • “I view retirement income as simply one very important component of the overall financial planning process.”
  • “Conservative or risk-mitigating retirement income related investment products continue to lag in innovation and flexibility and higher yield possibilities, overall.”
  • “A comprehensive web site that compares all annuity companies and products would be helpful.”

How To Market to Advisors

Posted on April 10, 2011 by -

Are we there yet?

The years have been slipping by, the oldest Boomers are edging into retirement, and manufacturers of income products are still waiting for the so-called tipping point when they feel the tug of serious demand for their wares from retirees and their advisors.

Howard Schneider of GDC Research sees evidence that we’ve reached that point. While most advisors are still fence-sitting with regard to retirement income, he told RIJ, the inexorable aging of their clients is pushing more of them to act.

“It’s here,” Schneider said. “We’re in the early stages of a marketplace that will see tremendous growth. It’s not well developed yet, but retirement income is becoming part of the base of all advisors. Advisors say it’s real.”

Schneider and colleague Dennis Gallant of Practical Perspectives have periodically surveyed advisors in recent years on their attitudes toward retirement income planning. Their latest report, “Trends in Retirement Income Delivery: Advisor Portfolio Construction, Product Usage and Sales Support,” is just out.

One big takeaway: when marketing to advisors, don’t focus entirely on whether they’re in the wirehouse, independent, RIA or bank channel. Focus instead on the number of retired clients they have, which of the three major types of retirement income strategies they practice, and whether they’ve just begun to think about income planning as distinct from accumulation-stage planning.

For instance, one way that Schneider and Gallant segment advisors is by their “Retirement Income Client Quotient,” a ratio they’ve invented that refers to the percentage of an advisor’s clients who are within three years of retirement or retired. There are five levels of RICQ:

  • Fledgling, with a RICQ of 20% or less.      
  • Emergent, with a RICQ of 21% to 40%. 
  • Transitional, with a RICQ of 41% to 60%.
  • Committed, with a RICQ of 60% to 80%.
  • Elite, with a RICQ over 80%. 

Schneider noted that the Fledging group has shrunk to 7% from 15% of the advisor universe in one year, while the Committed group (include Elites) has grown to 20% from 18% in a year. While the Elite group, which Schneider estimates at about 5,000 advisors across all channels, is already receptive to retirement income messages, the bigger opportunity for product marketers may lie with the transitional and emergent groups, which include some 68% of advisors.

Schneider and Gallant also divide advisors by the retirement income philosophy they follow. Advisors tend to use one of three core approaches:

  • Risk-adjusted total return approach, with a focus on optimizing total return of the client portfolio. Also known as the systematic withdrawal method. 
  • Pooled or bucket approach, with an emphasis on managing assets across duration- based short, intermediate and long-term pools.
  • Hybrid or income floor approach, with a goal of providing assured income for client needs while managing risky assets for ongoing growth. It often combines risky and insured products.

“[Retirement] is unlike the accumulation phase, where all the advisors do some version of Modern Portfolio Theory,” Schneider said. “For retirement income, 40% to 45% of advisors do the risk-adjusted total return method. They’ll use income vehicles for diversification. not income. About a quarter of the market uses either the pool or bucket approach. And about 30% use the income floor or hybrid approach, which combines the other two.”

How does a marketer find out which strategy an advisor uses? “You have to know the advisor and how the advisor provides income for their client. You’ve got to say, “If you’re trying to manage a portfolio this way, here’s how you can use our solution.’”

A third way that the researchers segment advisors is by their stage of evolution toward the retirement opportunity. “If you could know only one thing about an advisor, you want to know what their management philosophy is. But you also need to know the stage they’re in,” Schneider said.

He and Gallant identify four stages of familiarity:

  • Unbelievers. This group, which includes many older advisors, doesn’t recognize retirement income planning as a distinct discipline.
  • Uneducated. This group, which includes many younger advisors with younger clients, understands the retirement income challenge but isn’t engaged with it.
  • Aware. This group includes “advisors who understand the potential of the market and are in various stages of transitioning a practice to retirement income.”
  • Best Practice. Members of this group have been serving the retirement income market for many years, and have developed a “deep, well-honed” process that they aren’t going to change.

The greatest opportunity for manufacturers lies among the Aware advisors, Schneider said. “Someone in the aware group may be more receptive [to wholesalers] than someone who is already got things in place, and knows what he or she is doing.  The best- practice group won’t be as receptive to new solutions. They’ve already figured out the puzzle and built a business around it.”

How do manufacturers figure out which segments an advisor falls into? “It requires a lot of pick and shovel work to do that,” Schneider said.

In emphasizing these other forms of advisor market segmentation, it would probably be a mistake to say that channel doesn’t matter for retirement income marketers. The Trends in Retirement Income Delivery study show clear differences between channels in adoption of or interest in annuities.

For instance, 12% of advisors at regional broker-dealers and 11% of bank/insurance channel advisors are big users of variable annuities, while RIAs—the fastest-growing category—rarely use them. Only about 7% of wirehouse and independent advisors are frequent users of variable annuities.

Francois Gadenne, executive director of the Retirement Income Industry Association, which has been promoting its retirement management designation, the RMA, to advisors, said he was encouraged to see Schneider’s estimate of 5,000 to 6,000 adherents to the retirement paradigm among advisors. “If you think of it as a plant, the growth does not take place on the old wood,” he said. “The question is, where are the green tips of growth?”

The way to find retirement-oriented advisors, he said, is to look for those with “constrained” older clients who have considerable savings but not quite enough to cover all their needs and wants.  “This isn’t a top-down movement. What drives the advisors are the clients. So you want to look for advisors with a book of business that is tilted to older clients, and to older clients who are constrained rather than overfunded,” he said.

At independent broker-dealer LPL, “We’re definitely hearing more from advisors in the field that they would like help in developing retirement income solutions,” said Stephen Langlois, LPL’s executive vice president for strategic planning. “It’s mostly anecdotal at this point. They’re not looking for a product, they’re looking for guidance in putting all the pieces together.”

Kevin Seibert, CFP, director of InFre, which provides retirement income planning education and a related certification, says, “I’m having more conversations with advisors who have been proactively seeking information on retirement income management. With the economy turning around, the first Boomers turning 65 and clients becoming better informed and asking the right questions—partly because of all the TV commercials they’re seeing related to retirement—all of a sudden there’s been a renewed positive interest that enables us to tell our story to more advisors.”

© 2011 RIJ Publishing LLC. All rights reserved.

“The Ultimate Ponzi Scheme”

Posted on April 10, 2011 by -

The following excerpt from “Guaranteed to Fail” is reprinted with permission from Princeton University Press and from the authors, Viral Acharya, Matthew Richardson, Stijn van Nieuwerburgh and Lawrence J. White, all of the New York University Stern School of Business. 

In a November 3, 2009, report “An Overview of Federal Support for Housing”, the Congressional Budget Office (CBO) estimated that the federal government provided approximately $300 billion in subsidies to housing and mortgage markets in 2009.

As a comparison, the much maligned farm subsidies and support for energy initiatives each receive approximately $20 billion per year. The degree of support for home ownership is staggering.

In the U.S., home ownership in particular is stimulated by four main government policies: the home-mortgage interest rate and property tax deductibility, the tax exemption of rental income enjoyed implicitly from homeownership, the exemption from income tax of capital gains on the sale of owner-occupied houses, and the lower interest rates that are enjoyed thanks to government support of the GSEs. In addition, there is a myriad of other programs. 

“Too much is never enough” is a reasonable summary of this array of housing policies.

As the CBO report outlined, these programs are expensive: The current home mortgage interest rate deductibility, for example, will cost $105 billion in lost federal tax revenue in fiscal year 2011. Property tax exemption, exclusion of rental income, and exclusion of capital gains taxes upon sale of the house will cost an additional $92 billion in 2011.

These programs come at a cost that is overlooked in the public debate: They make housing relatively cheaper and other goods relatively more expensive. This, in turn, leads to more consumption of housing, more investment in housing and construction, but less business investment and less consumption of non-housing goods and services.

The consensus among economists is that investment in residential real estate is substantially less productive (at the margin) than is capital investment by businesses outside the real estate sector (e.g., plant, equipment, inventories), investment in social infrastructure capital (e.g., highways, bridges, airports, water and sewage systems), or human capital (e.g., more and better education and training).

In other words, every additional dollar that is spent on residential construction instead of on business or other investment reduces economic growth. Careful research has found that all of the incentives for more house has led to a housing stock that is 30% (!) larger than would be the case if all of the incentives were absent, and that U.S. GDP is 10% smaller than it could be.  The U.S. simply has too much house!

Many politicians on the left and on the right equate reducing these housing subsidies to political suicide. After all, many believe that these policies are at the heart of the social contract with America and that they are therefore untouchable. Conventional wisdom has it that home ownership confers such benefits as good citizens, stable neighborhoods, strong communities, and – of course — personal wealth accumulation.

This “conventional wisdom” has met not only with a massive destruction of home equity in recent years, but also with mixed reviews in academic research. Nevertheless, housing subsidies have been and still are the policy tool of choice for combating income inequality, which has been on the rise in the United States since the 1970s.

However, research has shown that these policies predominantly benefit middle- to upper-income groups rather than the low-income group. One recent research paper specifically on the GSE subsidy by Jeske, Krueger, and Mitman (2010) finds that their effect is a loss in overall welfare and an increase in inequality.

Their model indicates that low-income households would be willing to pay 0.3% of lifetime consumption to live in a world without the GSE subsidy. The wealthy, instead, benefit from the subsidy.

In earlier research, academics have reached a similar conclusion regarding the home mortgage interest deduction. It too is regressive, benefiting high-income, high-asset households the most.

Upper-income households are more likely to itemize on their income tax returns and to have higher marginal tax rates (which is what makes the mortgage interest and property tax deductions more valuable), and they are more likely to buy higher priced houses (which would involve larger mortgages and hence more benefits).

Gervais (2001) calculates that abolishing the deduction would benefit the bottom 20% nearly 6 times more than the top 20% of the income distribution. Abolishing the tax advantage from owning would benefit everyone somewhat (in the long-run) because it would lead to a larger business capital stock (and possibly more social infrastructure and more human capital) and a smaller housing capital stock, which would positively affect economic growth.

More recent work by Poterba and Sinai (2008) estimates that the benefits from the home mortgage interest deduction for the average home-owning household that earns between $40,000 and $75,000 are one-tenth of the benefits that accrue to the average home-owning household earning more than $250,000.

The current policies do not discriminate between first-time home purchasers and households simply wanting to buy larger houses or (for the GSE subsidies) even second homes. Rather, the policies promote larger home purchases. Census data show that the square footage of new houses grew by about 50% between the mid 1970s and the mid 2000s. Although some of this increase surely reflected growing household incomes, some of the increase also surely reflected the growing value of the subsidy advantages for buying larger houses.

Finally, the deduction encourages people to borrow as much as possible. Encouraging household leverage does not strike us as the best possible policy. Thus, ironically, although one of the motives for encouraging home ownership was to provide households with a means of building wealth, the process of making borrowing cheap and easy encouraged these households to borrow excessively, and then to borrow again if interest rates declined and/or their house value increased.

In the process, they reduce the amount of net equity that they might otherwise build in their home. The metaphor of the refinancing household’s using their home as an ATM to finance consumption was a strong one in the mid 2000s.

And, of course, the excessive leverage and the cashing out of equity meant that the declines in housing prices after mid 2006 caused more houses to be “underwater”, where the value of the house was less than the outstanding principal on the enlarged mortgages. And, in turn, this meant more instances where households defaulted on their mortgages.

There is no social purpose that is served by such “more house” investments – a fifth bedroom rather than four, a fourth bathroom rather than three, a half acre of land rather than a third of an acre – and no social purpose that is served by excessive leverage.

Clearly, the housing policy of the past is misguided, and there is an urgent need to think of more effective ways to halt the increase in income inequality.

It should be clear, however, what purpose is served by the household leverage that is provided in the form of off-budget guarantees through Fannie and Freddie. This is what so far allowed successive presidential administrations to encourage ever-larger short-term consumption and spending during their tenures.

It might seem odd that in a game between two political parties to get to the seat, both would agree on a strategy to promote housing finance at successively higher levels over time. The game, however, is not between the two parties, but between each current administration and the future ones (and ultimately current and future taxpayers).

No President would want to shut down or bring onto the federal budget Fannie and Freddie’s debt or guarantees – until they have to be honored. Doing so would seriously alter the shape of that administration’s fiscal budget and force them to make hard choices that would produce long-term gains that would accrue only to future administrations. Instead, as long as possible, it would be better to let households spend more on housing, passing on the problem of dealing with housing guarantees to the next government, and so on.

And while each presidential administration is working its way through its term, aided by Fannie and Freddie’s balance sheets and off-balance sheet guarantees, the competitive landscape of the financial sector is altered as they enter more mortgage markets, contributing to a downward spiral of lending standards, excess leverage, and an unsustainable bubble in housing prices and construction.

In many ways, this is the ultimate Ponzi scheme of all.  

© 2011 Princeton University Press.

Republican budget manifesto released

Posted on April 6, 2011 by -

Congressman Paul Ryan, chairman of the House Committee on the Budget, released a Fiscal Year 2012 Budget Resolution entitled, “Path to Prosperity: Restoring America’s Promise,” at his website yesterday.

The resolution, much of which is based on the “supply-side” economics principle that lower taxes will lead to economic expansion, outlines a plan to cut federal spending by $6.2 trillion relative to the Obama administration projections over the next decade. 

Under the proposal, the top individual and corporate tax rate would drop to 25% from 35%. The proposal also repeatedly calls for repeal of the Affordable Health Care Act passed by Democrats on a near-party line vote in 2010.   

The resolution, a polemic that characterizes Democratic policies as “reckless”  but blames both parties for helping to create the country’s huge debts and fiscal imbalances, also calls on the government to:

  • Reduce the federal workforce by 10% over the next three years attrition, coupled with a pay freeze for the next five years and reforms to government workers’ benefit packages.
  • Reduce inefficient spending by $178 billion, following guidance from Defense Secretary Robert Gates. Reinvest $100 billion of these savings into key combat capabilities, and put the rest toward deficit reduction.
  • Privatize the business of government-owned housing giants, Fannie Mae and Freddie Mac, so that they no longer expose taxpayers to trillions of dollars’ worth of risk.
  • Convert the federal share of Medicaid spending into a block grant tailored to meet each state’s needs, indexed for inflation and population growth.
  • Provide younger workers, when they reach eligibility, with a Medicare payment and a list of guaranteed coverage options from which they can choose a plan that best suits their needs.