| The Growth of Risk-Based and Target Date Funds | |||||
|---|---|---|---|---|---|
| Assets ($ Billions) | As a % of all DC Plan Assets1 | As a % of Contrib.2 | |||
| Risk Based Asset Allocation |
Target Date | Total | |||
| 2003 | $ 45 | $ 20 | $ 65 | 2.2% | 7.7% |
| 2004 | 55 | 35 | 90 | 2.7% | 9.0% |
| 2005 | 85 | 65 | 150 | 4.2% | 12.8% |
| 2006 | 120 | 120 | 240 | 6.1% | 15.7% |
| 2007 | 140 | 195 | 335 | 8.0% | 20.3% |
| 2008 | 115 | 200 | 315 | 9.3% | 21.7% |
| 2009 | 135 | 270 | 405 | 9.7% | 24.9% |
| 1 Risk-based asset allocation funds and age-based target date funds held in Corporate DC, 403(b) and 457 plans. 2 Hewitt 401(k) Index – Current allocation of participant contributions only in December of each year. Source: Retirement Research, Inc. |
|||||
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Mad About 401(k) Annuities
Scores of blunt, angry e-mails warning the government to “keep its hands off my hard-earned money” began arriving in the Department of Labor’s email box last February after the DoL issued its Request for Information (RFI) about encouraging the inclusion of annuities as distribution options in 401(k) plans.
Here’s one example from the DoL’s comment page, which might serve as a focus group for officials and executives who want to test Americans’ hunger for in-plan annuities.
“To whom it may concern: If, in fact, the goal of this plan is to convert, by forced regulation, an existing 401(k) type retirement account into some type of mandatory, government sponsored retirement plan, I am firmly AGAINST IT.
“I do not need the Federal government taking control of my money or retirement plan. I DO NOT need the federal government using my money or controlling how or where my money is invested.”
There are about 500 protest letters—a number large enough to suggest a semi-coordinated rally but probably too small to reflect an orchestrated AstroTurf campaign designed to create the appearance of a grassroots groundswell.
As Part II of this story shows, the ever-provocative Newt Gingrich may have helped ignite the protest with an op-ed piece in the financial newspaper, Investor’s Business Daily, and, six weeks later, an appearance on a Fox News television show.
“This is really a secular socialist machine that wants to take over your life,” Gingrich said on Fox News. Radio hosts Rush Limbaugh and Bob Brinker raised the possibility that, if the worst was true, a misappropriation of private wealth was afoot.
Many of the letter-writers reacted negatively to Question 13 of the RFI, which asked if 401(k) plans should offer a default lifetime income distribution option for all or part of a participant’s assets.
The general feeling is that the average citizen knows how to save, budget and invest his or her own money with much greater skill and prudence than the federal government manages, or rather mismanages, its own finances.
“Americans are SMART enough to figure out how and when to spend their hard earned cash, and DO NOT want the government telling them how they can utilize their own savings!” Lorraine Ebel wrote. lt;/span>
Others suggested that the government had squandered all of its own resources, exhausted its borrowing power, and was now eyeing the last reservoir of American wealth: private retirement savings.
Quite a few warned of a U.S. government conspiracy, modeled on the president of Argentina’s nationalization of defined contribution savings last fall, to confiscate 401(k) assets and replace them with U.S. bonds or a Treasury bond-backed life annuity.
“The U.S. government has screwed up its own finances to the point where it is the largest debtor nation on the planet and in the history of the world. Trillion dollar deficits are forecast for years. Unfunded liabilities of Medicare and Social Security dwarf the acknowledged national debt,” one Jack Spurlock wrote.
Although the federal government was often accused in the letters of having a Socialist agenda, some writers were prepared to blow the whistle on a broader conspiracy by politicians and corporations against the common man:
“DoL, Treasury, and the entire U.S. federal government, are in bed with the Financial Industry, led by Goldman Sachs et al, and all are owned by an elite group of powerful individuals and families, the primary shareholders of the privately held Federal Reserve banks.
“Treasury is especially filled with financial terrorists whose sole purpose is to consolidate wealth and power into the hands of the elites. The United States is bankrupt by design, its imminent collapse having been engineered by the elite, and no amount looting and no power on earth can reverse it or stop it.”
In Part III of this story, we’ll show that many of the responses to the RFI were well-reasoned contributions to the debate over America’s expected retirement income shortfall. They came from members of the retirement income industry, and represent the top-down response to the DoL RFI, as opposed to the bottom-up voices of individuals.
It’s impossible to tell whether or not the anger behind the RFI protest letters was limited to a vocal few, or if it represented the frustration and suspicions of a large segment of the U.S. population. But in the wake of the financial crisis and the bailout, the letters seem to confirm that many Americans don’t trust either the financial industry or the government. And a handful of letters came from people who are apparently beyond mistrust:
“You want to see anger? People will be in the streets with blood in their eyes if you try to impose this massive government seizure of private assets.”
© 2010 RIJ Publishing. All rights reserved.
Using Psychology to Sell Annuities
Is resistance to life annuities partly irrational? If given the unbiased facts, would more retirees convert some of their wealth to sensible, inflation-adjusted life annuities?
Some behavioral finance experts think so. Or, to be more precise, they believe that the application of principles of psychology could boost annuity sales.
So, apparently, does Allianz of America, which responded to the Department of Labor’s recent Request for Information on lifetime income options in 401(k) plans by presenting insights and recommendations about annuities from 10 behavioral finance experts at major universities.
UCLA’s Shlomo Benartzi (above) collected the insights at the request of Allianz of America, which includes Allianz Life and Allianz Global Investors. In addition to providing a handy 10-point checklist for evaluating retirement income strategies, Benartzi catalogued 10 ways that psychology can affect annuity purchase decisions:
Framing. Receptiveness to annuities often depends on how they’re “framed,” says Jeffrey Brown of the University of Illinois. In one experiment, people were asked to choose between a life annuity paying $650 a month until death or a $100,000 savings account paying 4% annual interest. When the annuity was presented in terms of income (“consumption framing”), 70% chose it. When the annuity was presented in terms of investment returns (“investment framing”), 21% chose it.
Vividness. People are more likely to save for the future when they come face to face with aging-especially their own aging. Daniel G. Goldstein of the London Business School and others showed that people allocate twice as much to a retirement savings account after seeing “age-morphed” images of themselves as they will look when they are old.
Loss-aversion. Older people are more averse to loss and change than younger people, says Eric Johnson of Columbia. And that makes them shun annuities. In one experiment, nearly half of the retirees said that they would refuse a coin flip that gave them $100 if they won but cost them only $10 if they lost. In other words, they feared losses 10 times more than they coveted gains. In the case of annuities, the loss of liquidity looms especially large for them. To appeal to older people, guaranteed income products must be positioned as a way to gain more control over income and spending.
Cognitive impairment. Seniors have senior moments. When asked which numbers represented the biggest risk of getting a disease, 1 in 10, 1 in 100 or 1 in 1000, 29% of adults ages 65 to 94 got the answer wrong, according to Harvard’s David Laibson. After age 60, he said, the prevalence of dementia doubles about every five years. Quality of decisions about credit begins to decline as early as age 53. These trends suggest that people should commit to guaranteed income products or systematic withdrawal plans while they can still make optimal decisions.
Bucketing systems. Bucketing may not hold water from a strictly mathematical perspective, but it apparently works for many retirees. Evidence shows that older people save more, and persist in saving, when their money goes into or comes out of accounts that are clearly earmarked for specific purposes. They tend to take less risk with the money in a “Pay the Rent” account than with the money in an account earmarked for purely discretionary purchases, says George Loewenstein of Carnegie Mellon University.
No one-size-fits-all default option. Conventional wisdom says that life annuities are a boon to people with modest savings, because mortality credits boost payout rates. But don’t be so sure, says Harvard’s Brigitte Madrian. If low-income retirement plan participants have no liquid savings other than their 401(k) accounts, maybe they shouldn’t buy life annuities. Before setting up distribution options, plan sponsors should beware of steering people toward sub-optimal default solutions. High- and low-income participants might require different default distribution options, she believes.
Evaluability. Watch out for those “teaser rates.” Many married people opt for single life annuities at retirement merely because they provide higher monthly payments than joint-and-survivor life annuities, he believes. But if they recognized that a single life contract will short-change the surviving spouse, they might act otherwise. To make informed decisions in the presence of several distribution options, participants need complete, symmetrical information, says John Payne of Duke University.
Active decision-making. Think about it: In a study of 100,000 participants in 100 defined benefit plans, Alessandro Previtero of UCLA found that, when forced to make an active decision between a lump sum and an annuity (as opposed to an inertia-driven or default decision), about half of participants chose life annuities over lump sum distributions. Annuities aren’t as unpopular as policymakers assume they are, he thinks.
Money illusion. Most people, and especially older people, don’t fully appreciate that the bread that costs $3.50 today might cost $7 in 20 years. This type of financial myopia accounts is partly to blame for low sales of inflation-adjusted life annuities, says Princeton’s Eldar Shafir. He believes that if people knew exactly how much the real value of a nominal annuity shrinks over time, they’d buy more inflation-indexed contracts.
Fairness. Annuities are just plain misunderstood. When people understand that surviving annuity owners are the de facto beneficiaries when members of an annuity cohort die, they perceive annuities to be more “fair” than if they think-as many people do-that the insurance company keeps the undistributed assets of those who pass away, says Suzanne Shu of UCLA.
© 2010 RIJ Publishing. All rights reserved.
Jackson National Tailors GMWB for the Tax-Conscious
Jackson National Life’s latest variable annuity living benefit rider is intended for advisors and clients who expect tax rates and equity markets to rise, and whose financial appetites won’t be satisfied by one of those “lite” variable annuities with low fees and meager benefits.
It’s also for advisors and clients who aren’t afraid to digest new acronyms, like GAWA and MEWAR, and intricate new ways to calculate benefits.
Called LifeGuard Freedom 6 Net, the rider is a guaranteed lifetime income benefit that allows owners of a Jackson National Perspective II variable annuity to potentially take a two-tiered withdrawal from their contract each year during the product’s income phase.
The first tier of the withdrawal is the one usually associated with GMWB—a percentage of the guaranteed income base that Jackson National calls the GAWA or guaranteed annual withdrawal amount. Depending on the client’s age when income begins, that would mean a withdrawal of 4% to 7% of the premium, adjusted up (for to lock in market gains) or down (for excess withdrawals).
The second tier of the withdrawal is called the Earnings-Sensitive Adjustment. It equals 40% of the net gains in the account each year, if any, but not more than two-thirds of something called the Maximum Eligible Withdrawal Amount Remaining (MEWAR), which starts out as the same as the GAWA but may change over time.
For example, a person might purchase a contract with $100,000 at age 65. If a year passed and her account value had risen to $108,000, she could withdraw $5,000 (5% of the income base) plus $3,200 (40% of the $8,000 gain), for a total withdrawal of $8,200. In this case the MEWAR was two-thirds of $5,000 or $3,333.
After the $8,200 distribution, the account value would drop to $99,800 from $108,000. In the following year, the client would be eligible for another $5,000 GAWA, plus 40% of any growth of the $99,800 principal, up to the limit of two-thirds of the MEWAR.
The added withdrawals are meant to offset taxes due on the distribution, so that the contract owner’s net income is more or less consistent from year to year, said Alison Reed, Jackson National’s vice president, product management, variable annuities. The rider is available on qualified and non-qualified contracts.
“Let’s say that your contract value increases to $120,000 in the first year,” she explained. “With most available withdrawal benefits a person in the highest income tax bracket would take out five percent, or $6,000, and net about $3,600 after taxes. With Freedom Net 6, you take out $10,000″—$6,000 plus the MEWAR of two-thirds of $6,000—”and net $6,000 after taxes.”
Under the same contract, the owner can receive a 6% roll-up in the income base for each year he delays withdrawals. If he delays 10 years, the income base is automatically at least double the original premium.
There is no free lunch here. As with all variable annuity GMWBs, the payments come out of the owner’s own account. The product is not actually in the money until and unless the account value reaches zero while the owner (or the surviving spouse, in a joint account) is still living and is still eligible to receive a percentage of the income base plus the Earning-Sensitive Adjustment.
The current annual charge for the rider is 1.05% and the maximum is 2.10% (3.0% for joint contracts). The mortality and expense ratio is 1.25%. The expense ratios of the many investment options range from 0.57% to 2.41%, with a weighted average of 0.89%, Reed said.
The withdrawal percentage age-bands are 4% for those ages 45 to 64, 5% for those ages 65 to 74, 6% for those ages 75 to 80 and 7% for those age 81 or older. If other options, such as an enhanced death benefit or premium credit, were added, the all-in cost of the contract could exceed 4% per year.
“Today’s investing landscape is marked by uncertainty and complexity, which creates a need for innovative solutions that can address the challenges facing retirees,” said Clifford Jack, executive vice president and chief distribution officer for Jackson.
“At a time when many providers are focused on simplification, Jackson is committed to giving advisers the choice and flexibility to t ailor products according to the individual client’s unique needs and objectives. Our products are designed for advisers who embrace customization and view financial planning as a process, rather than a transaction.”
In a release, the company said, “Jackson offers LifeGuard Freedom 6 Net with a Joint Option to provide guaranteed lifetime income for customers and their spouses. As with many of the optional benefits available within Jackson’s variable annuities, LifeGuard Freedom 6 Net does not force asset allocation. Contract holders can also start and stop withdrawals as desired, giving them the flexibility to decide when to take income.”
“Potential tax increases are a significant concern for investors, particularly those who are on the verge of retirement,” said Steve Kluever, senior vice president of product and investment management for Jackson National Life Distributors LLC.
“Retirement products that can address these concerns and help clients streamline income planning answer an important need in the marketplace. Furthermore, by allowing clients to select and pay for only those features and benefits that they truly need, Jackson is delivering a solution that can meet a broad range of investor objectives,” he added.
© 2010 RIJ Publishing. All rights reserved.
Post-Crisis, Greeks Face Longer Work Lives
As part of the fallout from their country’s bailout by stronger European economies, Greeks will have to delay retirement by a couple of years.
To prevent Greece’s state pension system from collapse, the Greek government yesterday proposed legislation to cut benefits, introduce penalties for early retirement, raise the retirement age, and change the formula for calculation pensions, IPE.com reported.
The bill will go to the Greek parliament later this week and could be adopted into legislation by mid-June. The country’s pension gap is €4bn for 2010, while its budget deficit is 13.7% of GDP, or more than four times higher than eurozone rules allow.
The reforms raise the effective retirement age to 63½, from 61½. The statutory retirement ages in Greece are currently 65 years and 60 for women working in the public sector.
Today, the police, harbor workers, security services and journalists for the state TV and radio can retire in their 50s, because they are entitled to a pension after 35 years of social security contributions.
Starting in 2013, these privileges will be abolished. An employee will have to work at least 37 years to qualify for a full pension and there will be strong incentives to work for 40 years.
From 2018, a basic pension of €360 a month for everybody will be instituted. Pension for all retirees will drop up to 15%, in both the public and private sectors. Retirees will receive 12, not 14, payments per year, as Easter, Christmas and summer bonuses will be replaced by low flat-rate payments.
Retirees will also lose 6% of their pension for every year of early retirement they take. Final pensions will replace no more than 65% of the pensioner’s monthly salary when in working life, down from the current 70%.
Dr Jens Bastian, researcher at Hellenic Foundation for European & Foreign Policy (ELIAMEP), said Greece had too many early retirees.
“Especially in the public sector, some professions can retire only after 35 years. Many of these retirees continue to work after their retirement, and often their employment is unrecorded, so they get a generous pension and block entry to young people to the work market,” he said.
According to Bastian, the current unrest reflected a conflict between generations. “However, the government has now adopted a crystal clear policy it does not support early retirement,” he added.
© 2010 RIJ Publishing. All rights reserved.
Milliman Proposes “Simple, Obvious” In-Plan Annuity Fix
In its response to the Department of Labor’s Request for Information about adding guaranteed lifetime income options to 401(k) plans, Milliman, the global consulting firm, has offered a solution that it calls “simple, obvious and easily implemented.”
For the insurance component, Milliman recommends offering participants stand-alone guaranteed lifetime withdrawal benefits similar to those used by Prudential Retirement in its IncomeFlex in-plan product and recently introduced by Great West Life as part of its SecureFoundation institutional GLWB.
But a significant portion of the plan sponsor community will embrace such a distribution option, says Ken Mungan, leader of Milliman’s financial risk management practice, only if several highly-rated insurance companies create a trust that pools the hedging assets that back up their guarantees, collateralized on a monthly basis. If any one of the insurers in the pool defaults, he said, the trust will support the guarantees.
Plan sponsors have already told Milliman that they will not accept a lifetime guarantee from a single provider. “We’ve gone to many plan sponsors with that proposal and they’ve rejected it,” Mungan told RIJ. “If you’re a plan sponsor, this is an absolute requirement. They want a system that is going to withstand the failure of specific insurance companies, and where their obligation is collateralized and hedged.”
“We feel that those hedge assets should be dedicated to back those guarantees, in a separate account,” he added. “If there is a credit event associated with a life insurance company, there won’t be a panic because they know there’s a specific security held for the plans’ benefit. The system is so large that it far exceeds the risk bearing capacity of any single company, and spreading risk across insurance companies is also a good idea.”
This solution “will originate from the large 401(k) platforms. Each major platform will want a pool for their customers, and will want a group of insurance companies” to support the guarantees. Both the plan sponsors and insurance companies need guidance from DoL on an acceptable way to do this. There has to be clear standards. The life insurance companies have a big opportunity here. They should jump on it, because they need a source of growth, and this could be a big win,” Mungan said.
© 2010 RIJ Publishing. All rights reserved.
Prudential Financial Nets $536m in 1Q 2010
Prudential Financial’s financial services businesses reported net income of $536 million in the first quarter of 2010 ($699 million in after-tax adjusted operating income, a non-GAAP measure), up from a net loss of $5 million (or positive $427 million in after-tax adjusted operating income) for the first quarter of 2009.
Earnings highlights for the quarter included:
Individual annuity gross sales for the quarter just past were $4.9 billion (up from $2.2 billion a year ago), while net sales were $3.2 billion (up from $643 million a year ago.)
Full-service retirement gross deposits and sales were $5.6 billion, with net additions of $1.1 billion. It was the 10th consecutive quarter of net additions. A year ago, gross deposits and sales were $10.5 billion and net additions were $6.3 billion a year ago.
Individual Life annualized new business premiums of $68 million, compared to $84 million a year ago. Group Insurance annualized new business premiums of $346 million, compared to $344 million a year ago.
International Insurance constant dollar basis annualized new business premiums reach record-high $396 million, compared to $337 million a year ago.
Assets under management of $693 billion at March 31, 2010, compared to $667 billion at December 31, 2009.
Gross unrealized losses on general account fixed maturity investments of the Financial Services Businesses of $3.7 billion at March 31, 2010, compared to $4.4 billion at December 31, 2009; net unrealized gains of $2.4 billion at March 31, 2010 compared to $998 million at December 31, 2009.
GAAP book value for Financial Services Businesses, $25.7 billion or $54.63 per Common share, compared to $24.2 billion or $51.52 per Common share at December 31, 2009.
The U.S. Retirement Solutions and Investment Management division reported adjusted operating income of $514 million for the first quarter of 2010, up from $175 million in the year-ago quarter. The Individual Annuities segment reported adjusted operating income of $260 million in the current quarter, up from $17 million.
Current quarter results benefited $53 million from net reductions in reserves for guaranteed minimum death and income benefits and $21 million from a net reduction in amortization of deferred policy acquisition and other costs, reflecting an updated estimate of profitability for this business.
These benefits to results were largely driven by increases in customer account values during the current quarter. Mark-to-market of embedded derivatives and related hedge positions associated with living benefits, after amortization of deferred policy acquisition and other costs, and hedging positions implemented in mid-2009 to mitigate exposure to declines in capital from adverse financial market conditions, resulted in a net benefit of $16 million to current quarter adjusted operating income.
In addition, current quarter results include a net benefit of $25 million from refinements based on review and settlement of reinsurance contracts related to acquired business. Results for the year-ago quarter included a net charge of $327 million from adjustment of reserves and amortization to reflect an update of estimated profitability, largely driven by declines in customer account values associated with adverse financial market conditions during that quarter.
In addition, results for the year-ago quarter included a net benefit of $261 million from mark-to-market of embedded derivatives and related hedge positions associated with living benefits, primarily driven by the required adjustment of embedded derivative liabilities for living benefits to recognize market-based non-performance risk associated with our own credit standing. Excluding the effect of the foregoing items, adjusted operating income for the Individual Annuities segment increased $62 million from the year-ago quarter, primarily reflecting higher asset-based fees due to growth in variable annuity account values.
The Retirement segment reported adjusted operating income of $171 million for the current quarter, compared to $159 million in the year-ago quarter. Results for the year-ago quarter benefited $13 million from the required adjustment of liabilities for contract guarantees to recognize market-based non-performance risk. Excluding this item, adjusted operating income of the Retirement segment increased $25 million from the year-ago quarter. The increase resulted primarily from higher fees associated with growth in full service retirement account values and a greater contribution from investment results.
The Asset Management segment reported adjusted operating income of $83 million for the current quarter, compared to a loss of $1 million in the year-ago quarter. Investment results associated with proprietary investing activities contributed income of approximately $5 million in the current quarter compared to losses of approximately $40 million in the year-ago quarter. The remainder of the improvement in results came primarily from increased asset management fees and a greater contribution from performance-based fees.
© 2010 RIJ Publishing. All rights reserved.
It’s Crunch Time for Annuity Issuers: Conning Research
Now that annuity issuers have patched up their vessels from the storm of the financial crisis, they need to think about increasing sales. But, given the end of the variable annuities arms race and a decline in 1035 exchanges, fresh premium is scarce.
Growth will have to come from a new opportunity—providing income guarantees to the defined contribution market, for instance—or from capturing a larger share of the market, or from acquisitions.
That is the thrust of a new study from Conning Research & Consulting.
“The first priority for individual annuity insurers following the financial crisis has been to rebuild capital,” said Scott Hawkins, analyst at Conning Research & Consulting. “Insurers have made significant progress in repairing their capital positions.
“At the same time, premiums have actually declined, and rebuilding them will be a challenge. As insurers seek new growth, each will analyze and leverage their unique competitive advantages to position themselves for either organic or acquisitive growth,” he added.
The Conning Research study, “The Real Challenge in Rebuilding Individual Annuities: Developing Competitive Advantage in a Concentrating Market” reviews the recent history of concentration and consolidation that has altered the competitive landscape and premium growth rate.
Looking forward, the study addresses key strategies that will distinguish successful competitors in this new environment.
“Individual annuity insurers have responded to a slowing rate of growth over the past fifteen years with product development heavily focused on variable annuity benefits,” said Stephan Christiansen, director of research at Conning.
“Yet as insurers look to the future, it is unlikely that enhancing benefits alone will provide the support it has in recent years. Our analysis points to the need for insurers to refine their individual success factors, including superior product development, distribution effectiveness and new market penetration,” he said.
“The Real Challenge in Rebuilding Individual Annuities: Developing Competitive Advantage in a Concentrating Market” is available for purchase from Conning Research & Consulting by calling (888) 707-1177 or by visiting the company’s web site at www.conningresearch.com.
© 2010 RIJ Publishing. All rights reserved.
TIAA-CREF Comments on Retirement Income
TIAA-CREF, which administers some 15,000 retirement plans for some 3.6 million participants, most of them university employees and staff, has filed a 29-page response to the Department of Labor’s request for information on retirement income.
Like many of the individuals who responded to the RFI since early February, TIAA-CREF took a position against mandatory annuitization of defined contribution assets.
“Automatically placing participants in a lifetime income option has the potential to confuse, anger, and ultimately drive participants away from annuities, while having little positive impact on the overall take-up rate for annuities as an income option,” wrote Larry Chadwick, the organization’s vice president for government relations public policy.
The organization also recommended that the DoL prepare educational materials on lifetime income that plan sponsors could use without worrying about liability.
“General educational materials prepared by the DOL would help mitigate this concern, especially if the DOL would take the position that plan sponsors would not be liable for distributing materials prepared by the DOL on this subject,” the brief said. “In addition, the DOL can offer guidelines and templates for insurance companies to provide educational materials relating to lifetime income options.”
TIAA-CREF had a lot to say about complexities involved in turning defined contribution savings into a joint and survivor annuity.
“One of the disadvantages of in-plan options is that Qualified Joint Survivor and Annuity (QJSA) rules can often be cumbersome, confusing, and difficult to administer resulting, in some cases, in a delayed start to receiving annuity payments. This is one area where the Internal Revenue Service (IRS) could offer some relief by taking steps to ease this burden through regulatory action,” the brief said.
“The most critical plan qualification rule affecting a DC plan sponsor’s willingness to provide for a lifetime income option involves the qualified joint and survivor annuity (QJSA) rules under IRC §401(a)(11) and IRC §417, as well as ERISA §205 (with respect to §401(a) and §403(b) plans respectively). Certain plans are exempt from the QJSA rules provided they satisfy all three of the exemption criteria. IRC §401(a)(11)(B)(iii)(II) (and parallel ERISA section 205) provides that a plan that provides a life annuity payment option cannot be exempt from the QJSA rules.
“The extensive notice and waiver requirements that are triggered once a plan is subject to the QJSA rules provide an additional layer of administrative complexity, costs, and risk for non-compliance and associated corrections. As a result, many DC plans are designed to be exempt from the QJSA rules.
“Consequently, many plans will avoid lifetime income options solely to avoid the QJSA rules, even if such options may ultimately be beneficial for the participants. To make such options viable, the QJSA rules should be amended to provide for a means to have annuity payment options available under the plan without triggering all the QJSA rules and specified means of payment, while still protecting spousal rights and the related policy objectives.
“One approach would be to maintain the spousal beneficiary rules with respect to all forms of payment, including multiple life annuity forms, absent a waiver, and to require a spousal consent for a single life annuity form of payment that does not include a 50% spousal benefit.
“Another potential remedy is to not apply QJSA rules until a participant elects an annuity and then only if the annuity is not a QJSA. This can be accomplished with little burden to plan sponsors since insurance companies would be willing to administer these rules as part of the annuity contract.”
© 2010 RIJ Publishing. All rights reserved.
From GAO, a Primer on Retirement Income
The Government Accountability Office, which has researched retirement income several times in the past, delivered its latest report on the topic to Senator Herb Kohl (D-WI), chairman of the Senate Special Committee on Aging, on April 28.
Kohl, whose committee will hold hearings on the state of retirement income next month, had asked the GAO to examine the “options that retirees have for drawing on financial assets to replace preretirement income,” the “options retirees choose,” and “how pensions, annuities and other retirement savings vehicles are regulated.”
The GAO’s report, “Retirement Income: Challenges for Ensuring Income throughout Retirement,” surveys the landscape of retirement income thoroughly, without offering many surprises for close followers of the defined contribution and individual annuity markets. For the person who’s new to this topic, or who wants a handy compendium of facts and figures on this subject, it could be highly valuable.
The report shows, for instance, that Americans over age 65 live on income from Social Security, employer-sponsored defined benefit pensions, distributions from defined contribution plans, individual annuities, investments in stocks, bonds, and mutual funds, and earned income.
For most people, it doesn’t add up to much. After reading the report, you’re likely to be left with the impression that the median American retiree—if such a notional character exists—will start retirement with under $50,000 in guaranteed household income and perhaps $100,000 in savings.
Whether that amount can suffice will undoubtedly vary from household to household, depending on home equity, health, region and a near-infinite range of other variables. Among some policyholders, it indicates a national retirement crisis.
Social Security
Extrapolating from the GAO data, it appears that for people who earned between about $48,000 and $106,800 during their working years, Social Security benefits average about $25,000 per year.
For people who made less than that, Social Security payments will be lower but will replace a higher percentage of their former income. For people who are used to making over $100,000, Social Security payouts will level off at about $25,000 but replace a declining percentage of their former income.
As the GAO puts it, “Social Security benefits for retired workers at full retirement age (age 66) in 2010 provide 90% of the first $761 of average monthly indexed earnings, 32% of additional earnings up to $4,586, and 15% of earnings above $4,586, up to the limit on the annual base of covered earnings each year or $106,800 per year ($8,900 per month) in 2010.”
The GAO doesn’t calculate the present value of Social Security benefits for the average person. But its figures suggest that a new retiree would need about $400,000 to purchase a retail income annuity that would produce an annual income equal to the average Social Security benefit.
Even then, the annuity income wouldn’t have the inflation-adjustments that Social Security has. If you consider that the average household saves only around $100,000 by retirement, the value of Social Security to the average person looms large.
Defined benefit pensions and annuities
Many Americans are still eligible for defined benefit pensions. The ones who aren’t are not making up for it by buying income annuities. About one in three American households still had a traditional defined benefit pension plan in 2007, according to Survey of Consumer Finances data cited by the GAO. In that year, according to the IRS, the average combined taxable pension and annuity income was $19,500.
Of that amount, the portion attributable to annuity income would appear to be negligible. Few households—about 6% percent—owned individual annuities in 2007. Only 3% ($8 billion) of the total amount of annuities sold in 2008 was fixed immediate annuities, designed solely to provide lifetime income.
The GAO indicated concern about the costs of variable annuities with lifetime income guarantees, noting, “one variable annuity prospectus we reviewed indicated that maximum expenses for a $10,000 investment and a 5% annual rate of return could exceed $7,000 over a 10-year period.”
Defined contribution plans and investments
Of the people who have DC plans and taxable investments, few have balances large enough at retirement to buy an income annuity that pays as much as the average DB pension. In 2007, before the recent recession, half of the households with someone aged 55 to 64 had financial assets of $72,400 or less.
An estimated 61% of households “at or nearing typical retirement age” have a defined contribution plan account or an IRA, as of 2007. The median account value was only $98,000. At current rates, that would purchase a fixed income of less than $6,500 a year for a 65-year-old couple, GAO figures showed.
About one in five households headed by someone ages 55 to 64 holds stocks directly, with a median value of $24,000, while 14% hold pooled mutual funds, with a median value of $112,000. Only 2% held bonds directly, which had a median value of $91,000.
It might be inferred from those figures that wealthier people hold bonds, but it’s not clear. Certificates of deposit are held by 21% of near-retirement households, with a median total value of $23,000. An estimated 35% of those households had cash value life insurance, with a median value of $10,000.
© 2010 RIJ Publishing. All rights reserved.
The Hidden Risk in Target Date Funds
Choosing the appropriate target date fund (TDF) for an investor is not easy, given the large number of products in the marketplace and the lack of tools to easily compare those offerings. That choice, however, is made a lot easier if one focuses on the component of TDFs where investors are exposed to the greatest risk—what I call the “risk zone.”
The risk zone is the five to ten years before and after retirement. During this period, investors are least able to tolerate the impact of adverse market conditions, where significant dollar losses in their portfolio can be offset only by reductions in their standard of living.
The risk zone is also critical from the plan sponsor’s perspective. Older, more senior, employees are more likely to sue, or at least make their voices heard, than are younger employees with smaller account balances. Employers should fear the risk zone for both its litigation threat and its importance to employee morale. Fiduciaries need to set objectives for the risk zone, and safety first should be the order of the day.
Glide paths of TDFs differ markedly as they approach the risk zone, and this divergence creates a hidden risk for investors. Without understanding the implications of an excessively risky glide path in the risk zone, investors may face painful choices in their retirement. I have created a simple metric, which I explain below, that can help advisors and investors choose the right TDF.
We need to be especially diligent and protective during the risk zone, but how do we measure and evaluate safety in this critical period? As shown in the graph on the right, TDFs have a wide range of equity exposures in the risk zone; they disagree about the appropriate level of risk. The range of equity allocations widens as retirement approaches.
The Safe Landing Glide PathTM (SLGP) is also shown in the graph. The SLGPTM is designed to achieve two common sense objectives:
- Build a portfolio that, at retirement, delivers to each participant at a minimum his or her accumulated contributions plus inflation.
- Grow assets as much as possible without jeopardizing the first objective.
The safety-first objective necessitates an end point where the fund is invested mostly in safe inflation-protected assets, such as TIPS and T-bills.
Let’s consider the risk and reward trade-offs for varying equity exposures in the risk zone. Since investors should be concerned with lifestyle risk, I define risk as a dollar loss rather than percentage loss. Losing 10% of a one-dollar portfolio is significantly less painful than losing 10% of a million-dollar savings account.
Lifestyle in retirement depends on money, not percentages. Accordingly, I have measured ending wealth and risk for all 40-year glide paths from 1926 through 2009. There are 44 such 40-year paths ending in calendar years. I assumed that the investor contributes $1,000 initially and increases this $1,000 by 3% per year, roughly equal to the historical inflation rate. I measured risk as the dollar-weighted downside deviation, and “reward” as the dollar growth. I also analyzed just the last 10 years of the glide path to focus on the risk zone. There are 74 such 10-year periods.
I compared the reward (dollar growth) and risk (of dollar loss) of the SLGPTM target date fund to that of the average TDF, shown as the middle line in the graph above. The glide path of the SLGPTM ends almost entirely in safe assets, whereas the typical TDF ends with 40% in equities because it is a “through” fund designed to continue beyond the retirement date, so it is substantially riskier in the risk zone. The results for the ratio of reward (ending wealth) to risk (dollar-weighted downside deviation) are as follows:
The SLGPTM unsurprisingly delivers superior reward-to-risk in the last 10 years before retirement. Somewhat surprisingly, however, the reward-to-risk ratios are about the same for the entire 40 years prior to retirement, primarily because the glide paths of the two approaches are similar for the first 25 of those 40 years. When viewed over the continuum of their lives, TDFs look deceptively similar; their hidden risk is revealed only when one examines the risk zone.
Enlightened advisors should focus on the risk zone in their TDF selection. Most TDFs provide similar asset allocations prior to the risk zone, and then diverge widely in their equity exposures as the target date nears. Most TDFs view the target date as a speed bump on the highway of life, ignoring the risk zone altogether. During this critical period TDFs demonstrate their mettle, by protecting or not.
“Safety first” is the right choice as the target date nears because lifestyles are at stake. Advisors can help protect their clients from lifestyle risk by choosing the right TDF.
For an entertaining and informative description of the risk zone, and an explanation of why spending is harder than saving, please see the video of Prof. Moshe Milevski, York University, at Return sequence risk.
Ron Surz is president of Target Date Solutions.
© 2010 RIJ Publishing. All rights reserved.
Top 10 Bank Holding Companies in Annuity Fee Income
| Top 10 Bank Holding Companies in Annuity Fee Income (Millions) | |||
|---|---|---|---|
| |
2009 |
2008 |
Change |
| Wells Fargo & Co. | $678.00 | $118.00 | 474.6%* |
| JPMorgan Chase & Co. | 328.00 | 363.00 | -9.6% |
| Morgan Stanley | 253.00 | N/A | N/A |
| Bank of America Corp. | 251.83 | 145.89 | 72.6% |
| PNC Financial Services | 121.28 | 69.50 | 74.5% |
| Regions Financial Corp. | 93.53 | 109.50 | -14.6% |
| SunTrust Bank Inc. | 80.46 | 123.84 | -35.0% |
| US Bancorp | 66.00 | 100.00 | -34.0% |
| KeyCorp | 60.73 | 56.42 | 7.6% |
| BB&T Corp. | 46.07 | 45.94 | 0.39% |
| Source: Michael White-ABIA Bank Annuity Fee Income Report *Reflects acquisition of Wachovia Bank. |
|||
US Mutual Fund Inflows On Record Pace
US mutual fund investors have put nearly $200 billion into stock and bond mutual funds so far in 2010, making it likely that full-year net inflows would top $450 billion. That would make 2010 a record year, according to Strategic Insight.
The previous record was set last year, when just over $400 billion went into long-term funds, according to Strategic Insight’s Simfund database. These figures include open- and closed-end mutual funds and funds underlying variable annuities, but exclude ETFs.
Inflows have been this high this early in only one previous year—in 2007, when net inflows to stock and bond funds totaled more than $210 billion.
“Lately we are observing the early signs of thawing of investors’ reluctance to get back on the stock market train,” said Avi Nachmany, SI’s Director of Research. “Assuming further economic and employment improvements in the coming months, more such investors should inch higher in their risk curve. But turmoil in Europe and the fragility of the US recovery are just a few of the many concerns still on investors’ minds.”
For all of 2010, Strategic Insight projects that US stock and bond fund new sales are on track to rise 20% (or more) from their 2009 pace. Net inflows are new sales minus investors’ redemptions out of funds.
Worldwide, mutual fund investors have added nearly $1.4 trillion of net flows to bond and stock funds since March 2009’s market bottom, according to Strategic Insight’s Simfund databases, which track more than $20 trillion of fund assets globally. About half of these gains occurred in the US. This year through early May, global inflows to stock and bond funds are nearing $400 billion.
© 2010 RIJ Publishing. All rights reserved.
ING Responds to Income RFI
ING Insurance U.S. announced today that it has filed suggestions and comments in response to the Department of Labor and the Department of Treasury (the Agencies) joint request for information on lifetime income options for participants and beneficiaries in retirement plans.
Through its filing, ING supports a number of key positions with respect to lifetime income products, while recognizing certain items need to be addressed in order for these products to be more widely embraced by employees who save in a workplace plan. These include the following:
1. ING broadly supports investing in guaranteed lifetime income options within a retirement plan. Retail products, such as individual IRAs or guaranteed income annuities, are also important vehicles for consumers to plan for and manage retirement assets.
2. Regulations must be simplified and clarified in order to address employer fiduciary and administrative concerns. Employers and plan fiduciaries should be given a streamlined fiduciary standard with more objective criteria than exists under current ERISA regulations. Some of the administrative burdens that come with carrying annuities need to be eased in order to attract more employers to offer these types of products.
3. The workplace is the best time to reach participants with materials, resources and communications that can increase their financial literacy and positively influence their behavior.
4. Offering and investing in guaranteed lifetime income options should be encouraged but not mandated. Plan sponsors and participants indicates a prefer choice and control when it comes to plan design and benefit distribution matters.
5. A desirable strategy for many workers would include investing a portion of one’s retirement assets in a lifetime income product. Plans that offer lifetime income distribution strategies tend to present this option to employees as an “all or nothing” decision with respect to their account balance. ING favors steps that would encourage individuals to complete a financial plan and then commit only an appropriate portion of their account balance to a guaranteed income stream, while retaining control of the uncommitted balance.
© 2010 RIJ Publishing. All rights reserved.
Lincoln Financial Group Profitable So Far in 2010
Lincoln Financial Group net income for the first quarter of 2010 of $283 million, including net realized losses of $27 million, compared to a net loss in the first quarter of 2009 of $579 million, which included net realized losses of $136 million.
The current quarter included income from discontinued operations of $28 million, including a gain on the disposition of Lincoln UK and Delaware Investments. The first quarter of 2009 included a non-cash charge of $600 million, after tax, for the impairment of goodwill in the annuity business.
The Individual Annuities segment reported operating income of $119 million in the first quarter of 2010, up from $74 million a year ago, reflecting a 34% increase in average annuity account values. The first quarter of 2010 included a net positive after-tax impact of approximately $21 million, primarily from DAC unlocking.
Gross annuity deposits were $2.3 billion and net flows were $575 million, up 4% and 34%, respectively, versus the prior year.
Income from Defined Contribution operations was $36 million, up from $30 million a year ago, reflecting a 26% increase in the average account values.
Gross deposits of $1.3 billion were down 16% versus the prior year quarter. Total net flows in the current quarter were $109 million, down from $657 million in the 2009 quarter. The year-over-year declines are primarily attributable to the timing of the placement of a few large cases.
The first quarter income from operations was $276 million, up from $163 million in the first quarter of 2009. Income from operations in the current quarter reflected growth in average variable account values driven by positive net flows and improvement in equity markets, favorable unlocking of deferred acquisition costs (“DAC”) in the annuity business and unfavorable mortality in the individual and group life businesses.
© 2010 RIJ Publishing. All rights reserved.
Genworth Financial Announces 1Q 2010 Results
Genworth Financial is much healthier than it was a year ago.
The Richmond-based company reported net income of $212 million in the first quarter of 2010 (before provision for non-controlling interests), compared to a loss of $469 million in the first quarter of 2009. Net operating income was $147 million, up from $14 million a year ago.
Genworth’s results in the quarter included net operating income of $122 million from the Retirement and Protection segment and $91 million from the International segment. This was partially offset by lower net operating losses of $36 million in the U.S. Mortgage Insurance (U.S. MI) segment and a loss of $63 million in Corporate and Other. The impact of foreign exchange on net operating income in the first quarter of 2010 was a favorable $19 million.
Net income in the quarter included a $106 million tax benefit related to separation from the company’s former parent recorded in the first quarter of 2010.
The company spun off ownership of 42.5% of Genworth MI Canada last fall with an initial public offering (IPO) transaction, raising net income available to common stockholders to $178 million the first quarter of 2010. On the same basis, net operating income available to common stockholders for the first quarter of 2010 was $114 million.
Net investment losses, net of tax and other adjustments, decreased to $42 million from $483 million in the first quarter of 2009, and decreased on a sequential basis from $54 million in the fourth quarter of 2009. Net unrealized investment losses, net of tax and other adjustments, declined to $900 million from $4.1 billion in the prior year quarter.
Retirement and Protection earned $122 million compared to $38 million a year ago. Consolidated U.S. life insurance companies ended the quarter with an estimated RBC ratio of approximately 385%.
Retirement income fee-based earnings increased to $17 million from a $27 million loss in the prior year. Results in the prior year were significantly impacted by declines in the equity markets, which accelerated deferred acquisition cost (DAC) amortization and reduced variable annuity income. Earnings in the current quarter reflected equity market growth, lower death related claims and an $8 million favorable DAC amortization adjustment. Total variable annuity sales increased to $205 million compared to $143 million in the prior year from improved equity market conditions.
The retirement income spread-based business had net operating income of $17 million compared to a loss of $20 million in the prior year from improved investment income. Earnings in the prior year included a $39 million loss from lower valuation of limited partnership (LP) investments. Total spread-based AUM remained flat sequentially ending at $18.9 billion reflecting the company’s targeted annuity strategy and favorable persistency.
Life insurance earnings decreased to $37 million from $38 million a year ago as improved investment income and lower taxes were more than offset by less favorable mortality, lower persistency on policies coming out of the post level term period and a $5 million unfavorable correction related to the calculation of ceded reinsurance premiums.
Total life sales reflected a mix shift to the new more capital efficient product suite as well as lower universal life (UL) excess deposits associated with the low interest rate environment. Sales from the combination of term life insurance and the new Colony Term UL product grew 26% versus the prior year and 9% sequentially. The more capital efficient Colony Term UL product, in late 2009, demonstrated strong producer adoption.
LTC earnings declined $1 million to $40 million, as higher net investment income was more than offset by higher claims on old generation policies and a return to lower levels of policy terminations experienced historically. Individual LTC sales increased $7 million year over year, primarily reflecting growth in overall industry sales. Group LTC sales increased to $8 million in the quarter from $1 million a year ago, while linked benefit sales grew to $11 million from $5 million a year ago.
Wealth management earnings increased from $6 million to $11 million primarily from increased revenue associated with a 41% increase in assets under management (AUM) and also included a $2 million favorable tax item. Net flows were $504 million, representing the fourth consecutive quarter of positive net flows. This, combined with favorable market performance, resulted in a $1.2 billion sequential increase in AUM to $20.0 billion.
© 2010 RIJ Publishing. All rights reserved.
The Savings Sweepstakes
Eighty-six-year-old Billie June Smith of tiny Lake, Michigan, was beaming last February 4 as she stepped forward to accept a check for $100,000 from Steve Winninger, CEO of the NuUnion Credit Union.
At the ceremony in Lansing, the state capital, she held a cardboard mock-up of her sweepstakes check. Measuring about 4′ by 2′, the check was nearly as wide as she was tall.
Luck and thrift had brought Ms. Smith to Lansing. She was one of more than 11,600 Michiganders who deposited over $8.6 million in accounts at one of eight credit unions around the state in 2009. Each depositor was eligible for small monthly cash drawings and an annual grand prize of $100,000.
And her ticket number was drawn for the big one.
A lottery? At a credit union? Bingo! No, this wasn’t some maverick banker’s update on 1950s toaster giveaways. It’s part of a grassroots campaign based on the research of Peter Tufano of the Harvard Business School and a Boston-based nonprofit he chairs, the Doorways to Dreams Fund (D2D).
Life-altering prizes
As millions of Americans reel toward retirement without adequate savings, policymakers and 401(k) plan providers have conjured up lots of different strategies to encourage low- and middle-income people to start saving more.
This effort has produced carrot or stick solutions like auto-enrollment in retirement plans, the proposed Saver’s Credit, tax breaks on saving for health care, college tuition, retirement and long-term care, and research into framing and choice architecture. Yet many Americans still lack the means, motive or opportunity to save adequately.
But they do buy lottery tickets, to the tune of about $60 billion a year in 42 states. So Tufano urges policymakers to channel that compulsion into thrift by linking savings accounts to irresistible, “life-altering” cash prizes.
Instead of buying chances to win, people get tickets for savings. The more money they sock away, the more tickets they get. The yields on savings are small, just like the chances of winning the grand prize. But to many people, the size of the prizes, psychologically, seems to make up for it in both cases. In prize-linked savings programs, participants at least get return of principal.
“Fifty percent of Americans say they can’t lay their hands on $2,000 in 30 days—not from savings, from a bank loan, or from friends or family,” said Tufano, who presented a paper on prize-linked savings programs at the Pension Research Council’s conference on financial literacy, held last week at the University of Pennsylvania’ Wharton School of Business.
“But in 2008, Americans spent an average of more than $540 per household nationwide on state lotteries,” said Tufano, who co-authored the paper, “Making Savers Winners,” with Erick Hurst, Melissa S. Kearney and Jonathan Guryan. “In Massachusetts, people spent an average of $725 per person on lotteries. In the same year, American households spent $430 on all dairy products and $444 on alcohol. We buy more lottery tickets than milk or beer.”
“You have to go where the people are,” he said, rather than try to persuade them to come to where you are.
Unfortunately, prize-linked savings programs are illegal in the United States—except in credit unions. That’s where Doorways to Dreams has directed much of its effort, by organizing pilot prize-linked savings programs at credit unions in Michigan and elsewhere.
It’s not too surprising that prize-linked savings programs are illegal, and not just because they’d break the monopoly on lotteries that state governments currently enjoy. Even if the programs help the masses save, does it make sense to enrich a tiny fraction of them with jackpots while depriving the rest of decent compound interest? And they can hardly be said to make people more financially literate.
But that may not matter. One of America’s leading experts on financial literacy, Dartmouth’s Annamaria Lusardi, is a fan of Tufano’s work.
“What Peter is doing is combining what people like to do into a financial instrument,” said Lusardi, who co-organized last week’s conference with Pension Research Council director Olivia Mitchell. “If low-income people think they only way to become rich is to play the lottery, why don’t we offer an instrument that allows them to save and to play the lottery? I do not find anything paternalistic about it. Quite the opposite. The return may be low, but the objective is to make people save.”
Mentioned by Jethro Tull
Prize-linked savings programs do seem to have a productive track record. As Tufano’s research shows, these schemes been used in various parts of the world since the 17th century. In Britain, a government agency called the National Savings & Investments has been marketing Premium Savings Bonds for over 50 years.
First sold in England in 1956 to encouraged savings after World War II, Premium Bonds are now owned by 26 million Britons with £26 billion ($39.4 billion) invested. Each month’s prize fund—the top prize is £1 million ($1.5 million)—equals a month’s interest (currently 1.5%) on the principal. The minimum single purchase is £100, which buys 100 chances to win. The maximum account balance is £30,000.
(Tufano’s research shows that the premium bond has even appeared in the lyrics to a classic rock song. A line from Thick as a Brick, the title track of the 1972 Jethro Tull album, reads: “… how’s your granny and good old Ernie: he coughed up a tenner on a premium bond win.”)
The first recorded prize-linked savings program was the “Million Adventure” in the UK in 1694. Intended to help pay off debt from the Nine Years’ War (1689-97), the British government sold 100,000 tickets at £10 each. Lower-income people brought fractions of tickets through syndicates. As a savings program, it paid out £1 per year, and each year 2,500 of the tickets would win prizes of up to £1,000.
Premium bonds became popular all over Europe at the end of the 19th century. Today, they’re offered in 20 countries from Brazil to Germany to Sri Lanka. Prizes include gold bars, DVDs, apartments, cars and motorcycles, encyclopedias and, of course, large and small cash prizes. In early 2009, JP Morgan Chase ran a no-purchase-necessary, “Double Your Deposit” sweepstakes that paid up to $10,000 to savers.
The unlikelihood that prize-linked savings will ever become a huge phenomenon in the U.S. has apparently not stopped Tufano and the Doorways to Dreams Fund from continuing to pursue programs at credit unions or from pursuing fundamental research into the psychology of non-saving.
D2D has partnered with Olson Zaltman Associates, a Pittsburgh-based consulting firm that uses the ZMET, or Zaltman Metaphor Elicitation Technique. It requires individuals who are not highly verbal to describe their feelings or attitudes with a collage of digitized visual images.
In the process, they claim to be “probing the minds of lower income consumers in order to bring innovation to the marketing of savings.” D2D says it “hopes to dramatically strengthen the storehouse of consumer data and insight from which financial service vendors, policymakers and non-profit providers may draw.”
© 2010 RIJ Publishing. All rights reserved.
AIG Mending, But Still Dependent, GAO Says
The Government Accounting Office (GAO) has issued an 89-page report, “Trouble Asset Relief Program: Update of Government Assistance Provided to AIG,” that offers a portrait of the global insurance giant’s financial health two years after its near-fatal losses in the subprime mortgage crisis.
While AIG is healthier than it was 18 months ago, as indicated by the price of credit default swaps on its debt, its share price, and reductions in its debt to the Federal Reserve, the GAO says the company has mainly exchanged government debt for equity, turning U.S. taxpayers from creditors to shareholders, and it is not ready to function without outside assistance.
The report says in part:
AIG’s commercial paper programs, which reflect the amount of commercial paper AIG has issued to third parties, have steadily decreased from a high of about $13 billion in December 2007. Due to the general breakdown of the U.S. commercial paper market and reluctance from market participants to purchase or roll over AIG’s commercial paper, by September 30, 2008, the balance had dropped to $5.6 billion.
As of December 31, 2009, AIG had no outstanding commercial paper held by third parties. According to AIG, this is because all of AIG’s third party commercial paper had matured and, currently, AIG’s subsidiaries do not have access to third party commercial paper funding. This funding source had been replaced by commercial paper purchased by FRBNY’s CPFF, which was utilized by AIG until the facility expired on February 1, 2010.
As a result of the facility closing, AIG’s CPFF amount outstanding had decreased to $4.7 billion from a high of $15 billion one year earlier. However, given AIG’s ongoing reliance on federal assistance, it remains unclear when support provided by CPFF will be replaced with funds from AIG’s own operations. Unlike many of the other large institutions that received government support as a result of the financial crisis, AIG has not yet been able to tap traditional sources of short-term capital, including commercial paper or other debt markets until recently.
In particular, International Lease Finance Corp. (ILFC) and American General Finance (AGF) recently have been able to access the capital markets. In March 2010, ILFC sold $4.05 billion of secured debt and unsecured debt, and in April 2010, AGFS Funding Company-a wholly- owned indirect subsidiary of AGF-entered into and fully drew down a $3 billion, 5-year term loan.
In closing, the report says:
Federal assistance provided to AIG has gradually shifted from debt to equity, with a reduction in the authorized amount of the FRBNY Revolving Credit Facility and an increase in the amount of preferred equity interests held in AIG and various special purpose vehicles for the government. Consequently, the government’s, and thus taxpayer’s, exposure to AIG is increasingly tied to the success of AIG, its restructuring efforts, and its ongoing performance.
However, the sustainability of any positive trends in AIG’s operations depends on how well it manages its business in this current economic environment. Similarly, the government’s ability to fully recoup the federal assistance will be determined by the long-term health of AIG, the company’s success in selling businesses as it restructures, and other market factors such as the performance of the insurance sectors and the credit derivatives markets that are beyond the control of AIG or the government.
© 2010 RIJ Publishing. All rights reserved.
U.S. Retirement Assets
| U.S. Retirement Assets | ||||
|---|---|---|---|---|
| 1994 | 2007 | 2008 | 2009 | |
| Private DC | $1.16T | $3.73T | $2.67T | $3.34T |
| 403(b), 457 | $0.24T | $0.81T | $0.72T | $0.78T |
| IRA/KEO | $1.06T | $4.78T | $3.58T | $4.28T |
| Private DB | $1.28T | $2.67T | $1.93T | $2.12T |
| State&Local | $1.11T | $3.30T | $2.33T | $2.67T |
| Federal | $0.51T | $1.20T | $1.22T | $1.32T |
| Annuities | $0.52T | $1.60T | $1.40T | $1.53T |
| Total | $5.91T | $18.09T | $13.85T | $16.04T |
| Source: Retirement Income Industry Association, Federal Reserve and Profit Sharing Council of America | ||||
Great-West Enters the In-Plan Income Space
The fourth largest retirement plan recordkeeper in the U.S. has begun offering an in-plan group variable annuity option that allows defined contribution plan participants to add a guaranteed lifetime withdrawal benefit (GLWB) option to their target-date fund assets.
Great West Retirement Services, a unit of Power Corporation of Canada, announced the option, called SecureFoundation, last February and began accepting assets on April 1, according to Sara Richman, FSA, a vice president of product development at the Denver area company.
“We’re doing presentations to companies that have recordkeeping relationships with us. One sponsor has taken it already and we have a list of companies that will be adding it in the coming months,” Richman said. She declined to name specific clients.
“They’ve embraced what we’re doing. They understand the value of the income protection,” she added. “They’re saying, ‘This is exactly what we need and we’re going forward with it.’ Others are still asking questions like, ‘How do I know if this is priced right?’ ‘How do I know if you’ll be around in 30 years?’ ‘Is it the right product for us?’”
As of the end of 2009, Great-West Retirement Services’ FASCore recordkeeping division served 23,000 defined contribution in the corporate, government, healthcare/non-profit and institutional markets, representing 4.2 million participants with $123 billion in assets, according to the company.
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SecureFoundation is just one part of Reality Investing Lifetime Solutions program, Richman said. It offers different levels of guidance for different participants—those who want someone to manage their accounts for them, who want help with their accounts, or who intend to manage their accounts on their own.
Like Prudential’s IncomeFlex
Because target date funds and in-plan GLWBs are a qualified default investment alternative under the Pension Protection Act of 2006, participants in plans that offer auto-enrollment can now be defaulted into programs like SecureFoundation and passively ride such a product for the rest of their lives. If participants change jobs, they can maintain the same investment and benefit in a rollover IRA.
“What we’re really trying to do with our SecureFoundation retirement income product is put back in play some of the attributes of a defined benefit plan into the defined contribution market,” said Great-West Retirement Services president Charles P. Nelson in a published interview. “We’re defining that up front, leveraging the portability functionality that has been developed in the defined contribution market through self-directed brokerage-type options.”
SecureFoundation resembles Prudential Financial’s IncomeFlex program, an in-plan GLWB that was introduced in 2007. Both options allow participants to add a certain level of protection against investment risk, timing risk and longevity risk in retirement. Both are potential game-changers in the employer-sponsored retirement plan industry.
“SecureFoundation is similar to IncomeFlex or Nationwide’s SALB (stand alone living benefit), in the sense that they are all income guarantees applied on traditional investment vehicles. SecureFoundation is more similar to IncomeFlex, because both are engineered to DC accounts. Nationwide’s SALB is for a brokerage managed account program.”
| Maxim Target Date Fund Starting Asset Allocations | ||
|---|---|---|
| Maxim SecureFoundation Lifetime Portfolio | Equity Fund Allocation | Fixed Income Fund Allocation |
| 2015 Portfolio | 50-70% | 30-50% |
| 2025 Portfolio | 60-80% | 20-40% |
| 2035 Portfolio | 70-95% | 5-30% |
| 2045 Portfolio | 75-95% | 5-25% |
| 2055 Portfolio | 75-98% | 2-25% |
As of the end of 2009, Prudential’s IncomeFlex product was offered in 170 retirement plans, where 5,000 participants were using it and had invested $261.5 million.
The “all-in” cost of SecureFoundation is 160 basis points per year, including 90 bps for the insurance rider and 70 bps for the eligible funds, which include five Maxim SecureFoundation target date funds (2015, 2025, 2035, 2045 and 2055) or Balanced Portfolio.
Typically, the contract owner would begin paying the 90 bps for the rider at a “trigger date” ten years before their target retirement date. Unless they decided to turn it off, they would continue paying it for the rest of their lives. Under the current contract, Great West could increase the annual rider fee to a maximum of 150 bps.
Glide-paths by Ibbotson
GW Capital Management LLC, a Great West unit doing business as Maxim Capital Management, manages the funds. The “glide-paths” for the target date funds were created by Ibbotson Associates, a unit of Morningstar, Inc. Putnam Investments, which Power Corporation purchased in 2007, is not involved.
Like all GLWBs, SecureFoundation guarantees, in effect, that if the contract owner’s account goes to zero during his or her life-either because of market depreciation, permitted distributions and/or fee attrition-the contract owner will still receive a specific percentage of the protected benefit base (the initial premium or higher) every year until he or she dies.
In theory, a 65-year-old could obtain somewhat similar protection by purchasing an advanced life deferred annuity (also known as longevity insurance) that would provide life-contingent income at, say, age 83. But that would require the kind of irrevocable, lump sum payment that most consumers resist. GLWBs offer longevity insurance on the installment plan.
“It’s a very intriguing approach,” said Joe Bellersen, president of Qualified Annuity Services, a group annuity specialist. “The fact that you’re paying for the tail coverage out of the returns is a convenient way to overcome the resistance to paying for longevity insurance. You’re essential paying for it in installments and paying for it out of the return. I can see that as an appealing approach to someone getting ready to retire from a plan.”
This type of option has been extremely popular as an individual variable annuity rider, with almost all recent purchasers of variable annuities electing it. Prudential and Great West are the first to offer it to the $3.34 trillion private defined contribution plan market. Under the Pension Protection Act of 2006, both target date funds and GLWB riders on target date funds are blessed as QDIAs—qualified default investment alternatives.
Retirement plan consultant and ERISA attorney Fred Reish of Los Angeles is familiar with the in-plan GLWB concept and believes that it will become more prevalent. “I think it has legs. This product has a lot of appeal from a 401(k) perspective. Ultimately the marketplace will decide who the winners and losers will be. But there’s a clear-cut need for guaranteed income, particularly among people will end up with account balances of $200,000 to $500,000,” he said.
“The fact that the premiums [in SecureFoundation] begin at age 55 is very good, since that’s when people will have larger account balances and the guarantee will be worth the most,” he added. “I like the idea that the protection is built-in, but that people also have the freedom to get out if they want to. I like the institutional pricing. This costs 1.5% or 1.75%, while even a reasonably priced retail product might cost 2.5% or 3%. There are just a lot of advantages to an in-plan solution.”
Sleep-easy blanket
By all accounts, annuity manufacturers don’t tout the rider as a source of guaranteed income, but rather as a layer of sleep-easy investment insurance that enables retirees to tolerate a relatively high level of equity exposure in retirement, knowing that, if the market slumps, they’ll get a minimum payout per year. The rider doesn’t guarantee the account balance or the investment performance, only the “benefit base.”
In a roundtable discussion sponsored by Great West, Ibbotson president Peng Chen commented on the difference between the Maxim target date funds in Secure Foundation and the funds Great West offers without a GLWB.
“We made a couple of tweaks compared with the standard Maxim Lifetime Asset Allocation Series offered by Great-West,” he said. “Unlike the typical glide path that assumes you’ll continue to de-risk as you get into retirement, this actually stays relatively flat because, since you have this protection, to some degree, you can afford to invest a little bit more aggressively and enjoy the long-term upside of the equity market.”
“The second thing we did was look at the underlying investment options inside the fund, and we worked with Great-West to implement this asset-allocation glide path using index-type products, which significantly reduced the cost of that protection,” Chen added.
| Age Bands and Payout Rates under SecureFoundation | |
|---|---|
| Single Coverage | Joint Coverage (Based on age of younger spouse) |
| 4.0% for life at ages 55-64 | 3.25% for life at ages 55-64 |
| 5.0% for life at ages 65-69 | 4.25% for life at ages 65-69 |
| 6.0% for life at ages 70-79 | 5.25% for life at ages 70-79 |
| 7.0% for life at ages 80+ | 6.25% for life at ages 80+ |
The rate at which contract owners can withdraw each year depends on their age, and in this respect SecureFoundation adds an interesting twist to traditional GLWB designs. People who take income at 55, 65, 70 or 80 and receive 4%, 5% 6%, or 7% of their benefit base, respectively, aren’t necessarily locked into that percentage for life. (For joint coverage based on the age of the younger spouse, the withdrawal rates are 75 basis points lower for each age band.)
For instance, a person might retire at age 65 and begin taking the guaranteed 5% of the benefit base per year. When that person reaches age 70, he or she could opt to change the payout rate to 6% of the current account value. This would make sense only if the new payment turned out to be higher, which would depend on how far the account value had dropped from the benefit base as a result of market performance, distributions and fees.
Although the potential market for an in-plan income option like qualified retirement plan market is huge, some have wondered whether sales might be limited by the insurers’ underwriting capacity. Ibbotson’s Chen believes, however, that if demand is great enough for in-plan GLWBs, insurers will create capacity.
“There’s no question that these guarantees require insurance companies to manage their balance sheets effectively,” he said. “I think if you take a static view, then, you can figure out how much ‘capacity’ there is. And if you calculate the potential amount of dollars that might come under the guarantee, then there is potentially a capacity issue. Right now, there isn’t really an issue-at least not a big issue). You may have a few firms pulling back from offering VA guarantees, but there is plenty of supply right now.
“The financial market is also quite dynamic, and there are many ways that a company can manage that “capacity” issue, i.e., expand it,” he added. “For example, there are discussions about rolling out “longevity swaps” to help securitize longevity risk in the market. Another point is that, if the demand does come, I would expect more capacity to be created.”
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