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Off-Track Bettors

A year and a half after the collapse of the financial markets—and only days after the SEC charged Goldman Sachs with fraud—the debate about necessary “reforms” is still in its early stages, and none of the debaters seriously claims that his or her solution will in fact prevent a new crisis.

The problem is that the proposed remedies deal with superficial matters of industrial organization and regulatory procedure, while the real problems lie on a more profound level.

Banking has always been a business where the profits come over time, as the borrower pays interest on the loan and eventually repays the principal. Principal being much larger than interest, lending officers are paid to have good judgment about which applicants for loans can and will pay what they owe (and which debtors can’t or won’t)—especially on longer loans like mortgages, where one borrower who defaults eats the profits from ten or even twenty of those who pay.

The late Hyman Minsky, whose “financial stability hypothesis,” written in 1966, accurately described what happened to our banks a year and a half ago, liked to say that there was a morality to the lending officer’s work because his prosperity depended on the success of his clients.

In years past, loans were funded from the deposit base of the bank. Bank deposits are the transaction balances of the economy. Banks had the use of this money because they provided the plumbing of the payments system. Their size was determined by the needs of enterprise. Banks could not grow on their own motion; they were forbidden to borrow (except by discounting their customers’ paper) or to acquire bonded indebtedness.

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In the 1950s, the banks began to free themselves from these shackles. What was then Morgan Guaranty established a market for Fed Funds, in which banks “bought” the excess reserves of other banks overnight or for very brief periods. In the 1960s what was then National City Bank of New York began to sell “certificates of deposit” to increase the money available to the bank for lending.

In 1975, I published a book that opened with the words, “A spectre is haunting American business and government: the spectre of banking.” Once the banks could grow by tapping the money markets they controlled, the government was not well equipped—or, to be honest, well motivated—to stop them. What slowed the march of finance was the fact that the profits came at the end of the loan, which had to be financed as long as it lived.

Enter “securitization.” Instead of keeping their loans in their vaults, banks could contribute them to packages of like instruments for sale to investors. Now the money came back to the bank long before the borrower repaid his loan. Absent specific arrangements for “recourse,” the bank didn’t necessarily care whether or not the loan was repaid.

To quote George Shultz, who was an economics professor before he was Secretary of State, the bank no longer had “skin in the game.” The lending officer’s work was supplanted by machines doing complicated and often unrealistic statistical analysis of which loans were likely or unlikely to default.

Moreover, bankers saw no need to make it easier for purchasers to value these pseudo-bonds by limiting the kinds of instruments that could be agglomerated in each “collateralized debt obligation.” The Federal Deposit Insurance Corporation, when cleaning out the S&Ls in the late 1990s, developed the idea of selling “the whole bank” by combining mortgages, credit card advances and business loans in “asset-backed securities.”

Historically, any paper with such characteristics had been “overcollateralized.” That is, it had been backed by loans with total asserted valuations greater than the face value of the bond. The FDIC, working through its subsidiary, the Resolution Trust Corporation, offered another step. If some of the collateral in the initial offer went sour, the FDIC made it possible for the packager of the paper to get a second chance, substituting other assets in the RTC warehouse.

This led to the “total return swap,” and then to the infamous “credit default swap,” an insurance policy disguised as a security. It gave all the little gamblers at the big dice table the opportunity to bet on or against the solvency of some company or government, whether or not they were rolling the dice themselves.

For the participants, these “innovations” were wildly successful. Their triumph, Michael Lewis suggests in his new book, The Big Short, was that the whole world became willing to lend money to instruments—not to businesses or houses, not to land, labor or enterprise, but to artificial contracts created behind closed doors.

The share of the financial sector in the nation’s gross domestic product rose from less than three percent in the decade after World War II to more than seven percent in the first decade of the new millennium. The share of the financial sector in the profits of corporate America grew even more rapidly, to more than 40 percent. The rest of us didn’t do so well.

The labor on Wall Street now is to restore those lovely unexamined days. And Wall Street will pay Washington lavishly—indeed, has already done so—to be of assistance in this effort. We are well on our way to reproducing the disasters of 2008.

Controlling the internal operations of the giant banks is all but impossible, but we can limit their intake and thus their size. Forty years ago, Scott Pardee, then the chief foreign exchange trader for the Federal Reserve Bank of New York, suggested a Food and Drug Administration for financial instruments, with a rule that instruments could not be traded by federally insured institutions unless and until they had a certificate that they were harmless.

Harvard Law professor Elizabeth Warren, chair of the House Subcommittee supposedly policing the government’s solicitude for “troubled assets,” recently offered a similar proposal. The grounds for rejecting would be that the instrument allowed banks to increase their leverage behind the scenes or to book profits from loans the borrowers had not yet repaid.

It’s worth a try. No doubt such a program would stifle innovation, but that’s all right. Honest men can disagree about whether we can afford universal health care, wars in the Hindu Kush, or reduced carbon emissions. But after seven trillion in losses that the taxpayers of the world must find a way to finance, it should be noncontroversial that we can’t afford any more innovation on Wall Street.

Martin Mayer, a guest scholar at The Brookings Institution, is the author of 34 books, including four best sellers—Madison Avenue, USA (1958), The Schools (1961), The Lawyers (1967) and The Bankers (1975).

© 2010 RIJ Publishing. All rights reserved. 

Annuity Products That Will Sell

If a life insurance company could start with a clean whiteboard and map out the ideal annuity product mix for the future, what would that map look like? What would the products be, and what features would they have?

Timothy Pfeifer, an actuary and president of Libertyville, Illinois-based Pfeifer Advisory LLC, challenged himself to provide specific answers to those fuzzy questions in a presentation at LIMRA’s annual Retirement Industry Conference here yesterday.

For an industry that’s still dazed from the Financial Crisis and said to be sitting on a lot of underemployed cash, the topic was timely. And Pfeifer, a former Milliman and Tillinghast actuary, had clearly done a lot of homework.

To achieve reasonable profitability in the annuity business, Pfeifer said, an insurance company should have “tentacles in both the fixed and variable world, have something to sell no matter what the market environment, shouldn’t create undue litigation risk” and use their life insurance and annuity businesses to hedge each other if possible.

Tim PfeiferPfeifer defined “reasonable profitability” as about 10% a year. “If you think you can manage to 20% returns, you’ll be disappointed,” he said at LIMRA’s conference. An estimated 350 insurance professionals attended the conference.

An ideal manufacturing strategy going forward would be to put 75% of the time and effort into deferred annuities and 25% into immediate annuities, he said. The lead product on the deferred side, not surprisingly, was variable annuities with living benefits.

On the variable side
Although he conceded that owner behavior is still largely unknown, Pfeifer believed that owners of VAs with guaranteed lifetime withdrawal benefit will use the income guarantee as a safety net that allows them to buy and hold equities without fear, rather than as a market-timing tool to be triggered at the bottom of the market. If that’s true, it would allow issuers to bring prices down.

The 10-year guaranteed minimum accumulation benefit, which guarantees principal, still “resonates with some customers,” he said, while noting that the guaranteed minimum income benefit—which involves annuitization, and which was the first living benefit some 12 years ago—won’t be worth investing time in.

As for investment choices and pricing, he suggested that issuers offer fewer subaccounts and fewer managers, with no more than 20 or 30 fund options and an emphasis on indexing.

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He described the death benefit as a “distraction,” and suggested a shift to a quasi-A share design where the M&E starts relatively large and falls over time, so that the benefits gains value for the consumer.

Regarding age bands and withdrawal rates, he suggested a withdrawal rate that rises by, for instance, 10 basis points a year rather than remains fixed. Issuers could save money, and probably not lose sales, if they limited withdrawals to once a year or once a quarter or on contract anniversary dates.

Pfeifer suggested that companies get a stand-alone living benefit (SALB) business going if they haven’t already. “The marketplace is crying out for wraps around those assets,” he said—referring to the huge amounts of unprotected savings in managed accounts and elsewhere.

“Sales today are low but they should grow,” he said. “SALBs will open up new distribution opportunities and access to new asset managers. They will be critical to our marketplace and getting started now is a good idea.” But don’t try it unless you have expertise in the necessary hedging programs, he warned.

Picks and Pans, Courtesy of Pfeifer Advisory
High-Priority Annuities Low-Priority Annuities
Variable deferred annuities with living benefits (GLWB or GMAB) Variable immediate annuities
Multi-year guaranteed rate fixed deferred annuities with a market value adjustment Longevity insurance (Advanced life deferred annuities)
Inflation-indexed single premium immediate annuities (SPIAs) Long-term care riders on annuities (unless you already sell LTC insurance)
Simple indexed deferred annuities Complex indexed deferred annuities
Equity-indexed SPIAS Conventional one-year guarantee fixed deferred annuities
One-year guarantee fixed deferred indexed to an interest rate Variable deferred annuities with guaranteed minimum income benefits
Stand-alone living benefits  
Data Source: Pfeifer Advisory LLC, 2010.

On the fixed side
The most successful design for fixed deferred annuities is likely to be the multi-year guaranteed (MYGA) product with a market value adjustment, which puts the interest rate risk associated with early withdrawals on the owner rather than the issuer. The MVA adds 10 to 25 basis points to the credited rate of MYGA products.


The MVA should be tied to the same interest index as the securities that the issuer invests in, he added, the return of premium guarantee should be dropped, and the minimum investment should be set at $25,000. He also recommended that products without a rate guarantee be indexed to interest rates. “This is a ‘Trust Me Lite’ strategy,” he said.

A SPIA was also part of the balanced product offering that Pfeifer imagined for the insurer that wants to build a durable foundation. It should include enough liquidity to satisfy the investors’ psychological need for flexibility, as well as some assurance that income would keep up with inflation. That could mean indexing the payouts to the Consumer Price Index or to the S&P 500.

SPIA “must have at least token liquidity that gives the perception of access,” he said. That might take the form of access to cash every five years or when emergencies arise. “Perception is as important as anything.” At the same time, people want some growth. “Only a minority will be satisfied with $1,000 a month,” he said. An index to the S&P500 would offer upside potential.

As for indexed annuities, Pfeifer had cautionary words. Issuers have been facing a lot of litigation, he said, from contract owners who saw “3% gains in a 40% year” in 2009. “Customers should be able to share in the home runs.” 

© 2010 RIJ Publishing. All rights reserved.

Group Urges Investigation of FINRA

The Alliance for Economic Stability (“AES”) has asked the Financial Crisis Inquiry Commission (“FCIC”), which Congress set up to investigate the causes of the financial crisis, to investigate the Financial Industry Regulatory Authority. 

AES urged the FCIC to “thoroughly investigate the responsibilities and failures of FINRA in allowing the practices that were the most direct cause of the financial crisis.”

FINRA is the securities industries’ self-regulatory body. According to the AES, a Washington, DC-based advocacy group whose directors are Allan Block, chairman of Block Communications, Daniel Rodriguez, founder of MGR Group, and Glenn Whatley, managing director of West Bay Energy LLC: 

“Most recently, FINRA has evaded scrutiny for having failed to uncover the Lehman Brothers Repo 105 program. FINRA’s most direct and specific responsibility is to supervise a firm’s compliance with capital requirements. FINRA failed not just in Lehman, but Bear Stearns and AIG as well, yet has not been the subject of any investigative action. Meanwhile FINRA executives use court-granted immunity and a lack of oversight to enrich themselves, making fortunes as what can only be described as ‘rogue cops.’ FINRA is the only private organization of its kind in the world.

The AES is urging an investigation of FINRA’s responsibilities in the financial crisis as part of the larger effort of the AES to advocate responsible economic and financial regulatory policy to ensure the safety of Americans’ savings. The letter to the FCIC and an AES report on FINRA can be accessed at the AES websites: www.eally.org or www.eallies.org.

© 2010 RIJ Publishing. All rights reserved.

MassMutual Retirement Services Offers ‘Virtual Site Visit’

MassMutual’s Retirement Services Division has introduced a new online virtual site visit that lets retirement plan advisors as well as existing and prospective plan sponsors “experience” MassMutual from the comfort of their own computer.

Intended to simulate a visit to MassMutual’s Springfield, Mass., headquarters, the virtual tour introduces viewers to the firm’s retirement plan services. The 15-minute tour originates in MassMutual’s grand rotunda and, from there, visitors can choose six different paths and learn more about MassMutual’s offerings.

“We envision our virtual site visit, which is the first of its kind in our industry, as a convenient and innovative way to introduce MassMutual to retirement plan advisors and plan sponsors, and to demonstrate the many reasons to consider MassMutual when searching for a new retirement services provider,” says E. Heather Smiley, vice president and chief marketing officer, MassMutual Retirement Services Division.

The virtual site is available at http://www.massmutualrsdemo.com/virtualvisit/.  For best results, viewers should have a processor speed of 2.4 GHz or greater and at least 2 GB of RAM.  

© 2010 RIJ Publishing. All rights reserved.

‘Graphic Illustrations’ of U.S. Spending via Heritage Foundation

The Heritage Foundation has released its 2010 Budget Chart Book, a highly visual and interactive online resource with charts illustrating the historical trends in U.S. government taxation and government spending levels.  

Visitors to heritage.org/BudgetChartBook  may download, post or e-mail any of 39 information graphics, 12 of which are new to this updated edition. Included are links to relevant Heritage research and tools for bookmarking, embedding and information sharing through Twitter, Facebook and RSS feeds.

“We’ve seen unprecedented concern and curiosity from Congress, the media and regular taxpayers about runaway federal spending and deficits,” says Nicola Moore, assistant director of Heritage’s Roe Institute for Economic Policy Studies. “The Budget Chart Book presents those issues in clear graphics and everyday terms.”

© 2010 RIJ Publishing. All rights reserved.

Hartford CEO Comments on VAs Clarified

In a news report that Retirement Income Journal reprinted last week, comments by Hartford Financial’s CEO about the company’s commitment to variable annuity sales were incomplete. In his comments during Hartford’s recent Investor Day, chairman, president & CEO Liam McGee said:

“But I do want to comment on annuities. First of all, we believe that annuities are an important part of our wealth management franchise.

“We’ve recently introduced our new Personal Retirement Manager variable annuity, which balances guaranteed income with asset growth. The product is grounded on the principles of low cost for the customer, simplicity for the customer, and a focus on guaranteed income.

“For the reasons that I mentioned earlier, what’s happened to consumers of all types over the last couple of years, guaranteed income in our view is the emerging business opportunity in the annuity space. The product has been well received by our distribution partners.

“We’re still completing getting licensing and authorization in some states including some of the larger states. We expect to see sales traction in the subsequent few quarters.

“But to be clear about our expectations, John (Walters) and I are targeting $5 billion in total annuity sales by the year 2012. Never again will we have a concentration in any product at The Hartford, whether it be annuities or anything else, of the size the VA was.

“This will be an appropriately sized, appropriate return business that we think is going to focus on that emerging trend that I described, guaranteed retirement income. It’s going to allow us now to appeal to a broader target audience as opposed to the traditional annuity market.”

© 2010 RIJ Publishing. All rights reserved.

Insurance M&A at Lowest Level Since 2002

The U.S. saw a significant decline in the reported value of insurance industry M&A transactions in 2009, and overall global transaction values also declined further from very low 2008 levels, according to a new study by Conning Research & Consulting.

“In the U.S., the value of insurance industry transactions was the lowest we have reported since 2002, U.S. life-annuity marked its second year below $1 billion in M&A values, while the property-casualty sector dropped 78% and health insurance also dipped below $1 billion,” said Jerry Theodorou, analyst at Conning.

The Conning Research study, “Global Insurance Mergers & Acquisitions in 2009,” tracks and analyzes both U.S. and non-U.S. insurance industry M&A activity across property-casualty, life, health and distribution and services sectors.

“Non-U.S. M&A transaction values increased 58% due to significantly larger transactions in the life-annuity and health sectors, while non-U.S. property-casualty declined for the second year,” said Stephan Christiansen, director of research at Conning.

“Looking forward, we are already seeing that pent-up demand is driving increased M&A activity in most sectors of the insurance market, as economic and credit conditions improve and valuations rise again to more normal levels.”

“Global Insurance Mergers & Acquisitions in 2009” is available for purchase from Conning Research & Consulting. www.conningresearch.com

© 2010 RIJ Publishing. All rights reserved.

Annuity Issuers Slowly Enter The Digital Age

It is no secret that annuity issuers have trailed the rest of the financial services industry in terms of online account opening and management functionalities. The inefficient nature of the annuity account opening process is legendary, as is the lack of online transactional capabilities. Login security has also been a longstanding shortcoming that we’ve touched on in earlier articles.

Their past failures to swiftly adopt new technologies notwithstanding, annuity issuers have recently stepped up efforts to implement and actively market paperless document delivery services to clients. Although annuity issuers are years behind banks and brokerage firms in pushing these services, the hope here is that this trend signals a broader change in how business is conducted throughout the annuity industry.

The most progressive contribution among the companies we cover comes from AXA Equitable. In February, the firm’s annuity policyholders were mailed annual reports that, for the first time, were contained entirely on a CD-ROM in digital format. Previous annual reports were mailed exclusively in paper format.

The digital documents offer two key advantages over paper. First, clients no longer have to find space to keep the bulky, hundred-plus page annual report booklets. Documents can simply be downloaded onto the computer for easy storage. Second, a handy search feature makes it easier than ever to navigate the information-intensive documents, which can be difficult to read. 

An accompanying letter from the firm’s customer service department provides the rationale for the move to digital document delivery of annual reports. The firm estimates that digital delivery will reduce operating expenses by nearly $11.5 million annually and eliminate over 2,000 tons of paper waste a year. In short, digital documents are the more practical and Earth-friendly option.

Although AXA Equitable is currently the only annuity issuer we cover that offers digital document delivery, a number of firms have been expanding and promoting their electronic delivery services in a more aggressive manner over the past year. Most of our firms have offered electronic delivery for years; however, the additions of privacy, compliance and policy renewal documents to the service have further enhanced the user experience.

In terms of marketing, the vast majority of electronic delivery promotions target clients and focus on the environmental advantages of the service. The promotional imagery generally links to a registration page with additional information about the service in an effort to make new user enrollment as easy as possible.

AXA Equitable, Jackson National and John Hancock have been the most active firms online, posting engaging promotional imagery throughout both the public and client websites. Jackson National has been particularly impressive with its public marketing campaigns. Multiple linked images on the homepage, including the vibrant Flash image below, lead to electronic delivery information and enrollment pages.

Green Delivery is Long-Term Smart

Jackson National Public Homepage Green Delivery Promotional Image

 

Save Time. Save Paper. Save the Environment.

Jackson National Green Delivery Promotional Page

It’s encouraging to see that annuity issuers are beginning to put a greater emphasis on online services that cut costs and are eco-friendly. Hopefully, the recent advancement by AXA Equitable and the added industry-wide emphasis on paperless delivery will entice more firms to expand their online resources and services. 

 

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© 2010 Corporate Insight, Inc. All rights reserved.


Industry Views are special reports that are sponsored and independent from RIJ’s editorial content.

 

One Man’s Response to Uncle Sam’s RFI

As president of Cincinnati-based Qualified Annuity Services Inc., Joe Bellersen has helped many firms convert their defined benefit plans to group income annuities. Until recently, he also distributed Ca nada Life income annuities in the U.S.

So when the Departments of Labor and Treasury solicited public input on lifetime income solutions for 401(k) participants back in early February, Bellersen needed little prep work in order to write up his answers.

Joe knows annuities. Many responses to the DoL’s RFI have come from angry citizens, most of them warning Uncle Sam to keep his confiscatory hands off their savings. But Bellersen’s 65-page document, with charts and appendices, was informative and enlightening. (Other formal and ambitious comments have since been submitted.)

In it, he offers his explanation for how employer-based retirement plans and individual annuity products came to lose their original lifetime income focus. And he offers suggestions on how we may be able to restore that focus.

As he sees it, the inflation-breaking high interest rates in the early 1980s and the subsequent equities boom helped stimulate the rise in lump-sum payouts from defined benefit plans. And a 1994 Supreme Court decision helped recast variable annuities as accumulation tools and eclipse their annuitization feature.

Now, with the mid-decade boom over and the Boomers slouching toward retirement, Bellersen urges a return to that lost focus on guaranteed lifetime income, particularly the kind that’s funded by life insurance company general accounts and based on mortality pooling.

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Of course, he’s biased. That’s what his business is based on. On the other hand, he doesn’t pretend that putting the annuitization genie into 401(k) plans—or back into DB plans—will be easy. “Joe has some strong opinions,” said Lowell Aronoff, CEO of Cannex Financial Exchanges Ltd., which provides income annuity data to Bellersen’s company. “But he’s very knowledgeable.”

How we got to where we are
Bellersen points to a contradiction that’s lying in plain sight but that hardly anyone ever mentions. Even as we discuss annuities for defined contribution plan participants, most people with defined benefit plan coverage don’t take annuities when they separate or retire. If they have a lump sum option, they usually take it.

[As Vanguard retirement researchers Gary Mottola and Stephen Utkus pointed out in a 2007 paper, “Lump Sum or Annuity? An Analysis of Choice in DB Pension Payouts,” only 27% of lump sum eligible employees in a traditional defined benefit plan took lifetime income at retirement or separation and only 17% of people in a cash balance DB plan did so. Less than 20% of those ages 55 to 60 took an annuity.)

The spike in interest rates in the 1980s, and the long bull market that followed, helped foster the trend toward lump sum payouts from DB plans, Bellersen says. High interest rates reduced the present value of annuities, so that sponsors could save money by paying lump sums. For participants, the rising stock market made lump sums look like a better bet.

“The broader use of LSDs [lump sum distributions] was due to the very high interest rates available for discounting distributions on plan terminations,” he told RIJ. “It gathered steam as plans realized that offering a lump sum as an ‘optional form of an annuity’ allowed the liability to be removed from the sponsor’s balance sheet at a discount.

“The participant will grab the lump sum regardless of whether it’s the right thing to do. You can talk to them till you’re blue and they wont choose a pension. They’ll choose instant gratification. There’s a complete disconnect,” Bellersen added.

He finds it ironic that the government wants 401(k) participants to do what DB plan participants have stopped doing. In his comments to the Labor Department, he writes, “We must pause to ask these questions: 1) Why have DB plans been permitted to become cash bonus plans? 2) If DB plans are cash bonus plans, then why expend efforts on making DC plans income replacement plans?

“There seems to be inherent contradiction with regard to the retirement income policy. This is a paradox.” If we’re going to talk about lifetime income for 401(k) plans, he says, we should also think about restoring lifetime income to DB plans.

Fateful Supreme Court decision
Bellersen points to another inflection point in the saga of the decline of lifetime income over the past 30 years. A single court decision, he said, catalyzed the metamorphosis of variable annuities into tax-deferred investments from retirement income tools.

“In 1994 the Supreme Court held in NationsBank of North Carolina, N.A. et al. v. Variable Annuity Life Insurance Co. et al., that the Comptroller of the Currency was allowed to conduct annuity transactions. The Supreme Court granted rights for banks to sell annuities on the premise that conducting such sales were ‘incidental’ to ‘the business of banking.’”

In the process, variable annuities turned into tax-deferred mutual fund portfolios. “The court went on to cite: ‘The Court further defers to the Comptroller’s determination that annuities are properly classified as investments, not ‘insurance’ within §92’s meaning.’ This decision cleared the hurdles and was a watershed event allowing the sale of annuities by banks and imposing a product-driven mentality.”

If that’s true, it’s easy to see how the Supreme Court decision may have unintentionally enabled the subsequent spate of alleged “unsuitable” variable annuity sales. “This decision eliminated the theory of insurance since it focused solely on the tax deferral aspects of annuity contracts and was supported by professional opinions that ‘no one ever annuitizes.’ Such a bold categorical declaration permitted deferred annuities to be sold on the basis that ‘one size fits all.’ Nothing could be further from the truth,” Bellersen wrote.

Yet another smoking gun in the demise of defined benefit plans was the 50% reversion tax on pension surpluses that was enacted in the early 1990s. As many have pointed, this tax led to underfunding and plan terminations. In response, the sponsors decided that “rather than add contributions and invest in the same way as before, we’ll put in less and take more risk,” he told RIJ.

Recommendations
Introducing a guaranteed lifetime income to employer-sponsored plans will require several reforms, Bellersen concluded. Among them would be the provision of participant education to help people understand the full value of guaranteed lifetime income and the reason why annuities cost more than investments, the resolution of gender differences in payout rates, and the tailoring of income solutions to individuals, so that people with ample defined benefit income, for instance, don’t necessarily annuitize their defined contribution savings.

© 2010 RIJ Publishing. All rights reserved.

How Big Is the Gap in Public Pensions?

The financial crisis of 2008 will continue to hurt state and local government pension funds for at least several years, and a rebound in both the stock market and the economy may be required to restore them to health.

That is the assessment described in a new research brief from the Center for Retirement Research at Boston College, entitled The Funding of State and Local Pension Funds, 2009-2013, by Alicia H. Munnell, Jean-Pierre Aubrey and Laura Quinby.

Funding ratios for public pensions could drop to 72% by 2013, from 78% in 2009, or as low as 66% under a “pessimistic scenario,” the authors said. At 72%, the funding shortfall could rise (in constant dollars) from $728 billion to about $1.2 trillion.

The study was based on 126 state and local plans representing about 90% of the universe of state and local plans. State and local pension plans currently have about $2.7 trillion in assets-enough to cover pension outlays for about 15 years on average even with no investment growth.

A Snapshot of Public Pensions

Roughly three-quarters of state and local government employees take part in an employer-provided pension plan. Around 80% of public employees have only a defined-benefit pension, 14% have only a defined-contribution pension, and 6% have both. Government employees typically receive benefits equal to around 2% of final earnings per year of employment. Some public sector employees take part in Social Security, while others are not covered by Social Security and receive their principal retirement income from their employer’s program.

The average state employer contribution rate as of 2006 was 9.9 percent of employee salary, while the average employee contribution rate was 5.7 percent. As of 2006, around 60% of public-pension assets were held in domestic or foreign equities and slightly over 25% in bonds, with smaller allocations in real estate, cash, alternate investments such as private equity, or other asset classes.

Public sector pensions tend to allocate around 10 percentage points more of their assets to equities than do private sector pensions. The share of public sector assets held in equities has risen from around 4% in 1990 to around 70% as of 2006. State pensions on average project future nominal returns of 8%; the lowest projected return for a state pension is 7% and the highest is 8.5%. Rates of return on plan assets are either projected by plan managers or established in statute. -Andrew Biggs

“So there’s no immediate cash crisis,” said Munnell, the Center’s director. But she added that in some states public pensions could run short in as little as six or seven years.

“State and local governments are facing a perfect storm: the decline in funding has occurred just as the recession has cut into state and local tax revenues and increased the demand for government services. Finding additional funds to make up for market losses will be extremely difficult,” the brief says.

Nationwide, the funding shortfall will require states, on average, increase their annual pension fund contributions by about $400 per covered employee. Because of the shortfall, contributions for 2009 will be about 8% of state budgets, up from a historical average of 6%.

Others say the problem is much more serious, given the volatility of future market returns and the inability of states to modify their pension obligations. For instance, the American Enterprise Institute (AEI) estimated this month that the size of the state employee pension shortfall alone is more like $3 trillion.

That figure uses the 10-year Treasury rate as the discount rate for the obligations and adds the hypothetical cost of guaranteeing the obligations with put options in the financial markets.

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Because governments may need to raise taxes to cover future pension obligations, the problem has become increasingly political, often characterized by resentment toward teachers and other state, county or city workers with public pensions.

“There is no reason public-sector employees should receive retirement benefits that are either larger or more secure than those received by private-sector workers,” wrote Andrew Biggs of the AEI. He recommends that new public sector employees be offered defined contribution plans instead of traditional pensions.

Munnell said that up until about 50 years ago, state and local governments did little in the way of formal funding of their employee pension plans. But after the Baby Boom created a surge in demand for public school teachers in the 1960s, and a big increase in pension commitments, the funding issue got more attention.

According to CRR, it was said in the mid-1970s: “In the vast majority of public employee pension systems, plan participants, plan sponsors, and the general public are kept in the dark with regard to a realistic assessment of true pension costs. The high degree of pension cost blindness is due to the lack of actuarial valuations, the use of unrealistic actuarial assumptions, and the general absence of actuarial standards.”

In the 1990s, with the creation of a Governmental Accounting Standards Board, benchmarks were established. The funding ratio continued to improve until the financial crisis of 2008. The CRR researchers noted that states and municipalities don’t have many options to respond to the pension dilemma. For various reasons, they can’t raise employee contributions or earned benefits. Because of the recession, tax revenues are down and demand for services are up.

“One small step… would be for states and localities to at least pay their full Annual Required Contribution,” which the Governmental Accounting Standards Board defines as the an amount needed to cover the cost of benefits accruing in the current year and a payment to amortize the plan’s unfunded actuarial liability. “Otherwise, the only option is to wait for the market and the economy to recover.”

The future health of state and local pensions “depends increasingly on the future performance of the stock market. Under the most likely scenario, the funding ratio will continue to decline as the strong stock market experienced in 2005, 2006, 2007, and much of 2008 is slowly phased out of the calculation.”

The AEI’s Biggs made the following recommendations for public pensions:

  • Pensions must disclose greater detail regarding investment risk. These details should include the volatility of their investments and the co-variances of returns between different elements of their portfolios.
  • Actuarial firms contracted by pensions should calculate the probability that plan assets will be sufficient to meet obligations, such as is currently done for Social Security by the plan’s actuaries and by the Congressional Budget Office.
  • Second, pension plans should reform their accounting methods to include the market value of plan liabilities.
  • Employee contribution rates should be increased and eligibility for retirement delayed. Where possible, the rate at which future benefits are accrued should be reduced. For instance, most plans currently pay 2% of final salary per year of service; while accrued benefits should be honored, future benefits could be earned at a lower rate.
  • States should no longer put off their own pension contributions. Each state must do the maximum to restore its plans to solvency. For newly hired employees, public sector pensions should shift to a defined contribution basis to make them more comparable to plans offered in the private sector.

© 2010 RIJ Publishing. All rights reserved.

 

1Q 2010 Equity Performance: An Unconventional Evaluation

Although the first quarter of 2010 started badly, with US stocks losing more than 3% in January, the market recovered most of those losses in February, setting the stage for 6%+ returns in March. All of the first quarter return was earned in March.

As the chart below shows, every US style posted a positive return for the first quarter of 2010, continuing the recovery that began in March of last year. This quarter’s 5.7% market return brings the 13-month return from March-to-March to 66%.

Style Returns for Q1/2010Smaller companies fared best, while all three styles—Value, Core, and Growth—fared about the same in aggregate. Value, Core, and Growth stock groupings within each size category are defined by our proprietary aggressiveness measure, a proprietary measure that combines dividend yield and price/earnings ratio.

We designate the top 40% (by count) of stocks in aggressiveness as “Growth.” The bottom 40% are called “Value,” with the 20% in the middle falling into what we choose to call “Core.”

Sector Returns for Q1/2010Performance by sector
On the sector front, Finance came roaring back with a 12% return, followed closely by Consumer Discretionary and Industrial stocks. Other sectors earned mid-to-low single-digit returns, except Telephones & Utilities, which lost 2% in the quarter.

Although it’s not shown in the chart, cross-sectional volatility was highest in Consumer Staples, indicating a wide performance spread across individual stocks in that sector. Financial held that distinction for most of 2009.

Country ReturnsNow let’s look outside the US. While 2009 market performance far exceeded domestic returns, the first quarter of 2010 was a different story. Foreign markets earned 6.7% in local currencies but only 2.9% in US dollars, about half the US market return, as the dollar strengthened against other currencies.

Japan led the quarter with an 8.5% USD return. Europe ex-UK was the only region that lost money, declining 1.8% in the quarter. EAFE and ADRs lagged because of their larger company orientation. Large companies (not shown in the exhibit) earned 1.8% in the quarter while mid- and small-caps returned 5.5% and 6.3% respectively. Unlike the US, where core was in favor, growth stocks fared best outside the US.

How did your portfolio perform?
Traditional peer groups are poor barometers of success or failure, but advisors still believe that there are no better choices. Not so. As a benchmark, we use Portfolio Opportunity Distributions (PODs), our proprietary method that represents the range in performance of all of the possible portfolios that managers could have held when selecting stocks from a specific market.

S&P 500 PODsFor S&P 500-based portfolios, for instance, we provide the following PODs. Use this table and graphic in the meantime to evaluate your investment managers. (Performance numbers for periods ending 3/31/10 are available now, but most peer groups won’t be released for a month.)

We believe that this chart will help you compare your equity portfolio’s performance with all possible performances-not just its peer group’s. Note, for example, that a return of 40% for the year ending March, which would appear to be good on its surface, is in fact bottom quartile. But extend the timeframe out two years or more, and a mere 1% return is a top quartile winner.

© 2010 RIJ Publishing. All rights reserved.

 

 

 

P. Kennedy Proposes Savings Accounts for Children

Under the Aspire Act of 2010, H.R. 4682, introduced by Rep. Patrick Kennedy (D-R.I.), the U.S. government would jump-start the savings habits of every American under 18 with a Social Security number.

H.R. 4682 would create an account with $500 for all children at birth. Children in families below the national median income would be eligible for up to an additional $500 at birth and matching funds up to $500 each year for additional funds put into the account.

Account holders could withdraw funds at 18 to pay higher-education expenses; at age 25, the funds could go toward homeownership or into a retirement plan. Account holders could also add up to $2,000 per year to their accounts by contributing tax refunds or payroll deductions. For tax purposes, the accounts would be treated the same as Roth IRAs.

Secretary of the Treasury would transfer $500 each year (with an inflation adjustment every five years) for every American under age 18, starting when they are issued a Social Security Number, to a Lifetime Savings Account.

The Lifetime Savings Accounts would be invested in Aspire Fund, default investment program run by the Aspire Fund Board and managed “in a manner similar to a lifecycle investment program” and “allocated to investment funds in the Aspire Fund based on the amount of time before the account holder attains the age of 18.” 

© 2010 RIJ Publishing. All rights reserved.

Americans To Spend Their Mad Money Sanely

With economic uncertainty still lingering, many Americans plan to use their tax refunds in a fiscally conservative fashion, according to a survey released by Bankrate, Inc., “How Americans will spend their tax refund.”

More than eight in 10 polled (84%) said they would use the refund to pay down debt, save or invest, or spend on everyday necessities. The poll, conducted by Princeton Survey Research Associates International, also showed: 

Among the findings:

  • 55% of Americans polled expect to get, or have received, a tax refund this year while 24 percent expect to owe.
  • Only 7% planned to use their money on “fun” activities like shopping or taking a vacation.
  • Among the 84% fiscally conservative respondents, 30% percent intended to pay down debt, 28% said they will save or invest, and 26% anticipate spending their refund on food or utility bills.
  • Only 3% of those getting a refund took a refund anticipation loan; of those with incomes under $30,000, the rate was 6%.   
  • 19 percent of Americans plan to adjust their tax withholding rate to avoid a big refund next year while 71% plan on keeping their withholding the same;
  • Among those who anticipate owing money, 63% plan on paying their taxes straight from their bank accounts; 6% anticipate borrowing money to pay off their tax bill.
  • Of those who owe money, 17% plan on setting up an installment plan with the IRS.   

This national random-digit-dialed phone study of 1,002 adults 18 or older was conducted for Bankrate by Princeton Survey Research Associates International. The sample was weighted by demographic factors including age, gender, race, education and census region to ensure reliable and accurate representation of adults in U.S. households. The overall margin of error for the survey is +/- 4 percentage points based on the total sample.

© 2010 RIJ Publishing. All rights reserved.

Czech It Out: Pension Pains are Global

The U.S. is far from the only country that faces a growing fiscal burden as the result of an aging population. The same trend threatens the Czech Republic.

Unless the Czech Republic creates new policies for dealing with healthcare and retirement benefits for the aged, the country’s “long-term fiscal sustainability remains a serious challenge,” according to a report by the Organization for Economic Cooperation and Development (OECD).  

As reported by IPE.com (Investment & Pensions Europe), the Czech Republic’s own Ministry of Finance estimated that rapid population aging would increase age-related spending by 6.4 percentage points over the next 50 years.

Without reform, that demographic trend would push the country’s public debt past 60% by 2040 and to more than 250% of GDP by 2060. The OECD said raising the retirement age by two years won’t be enough. 

“Recent legislation extending the increase in the retirement age will do much to fend of the threat of looming increases in pension spending” said the OECD, “but on current projections pension expenditure is still set to rise from around 7.8% of GDP in 2007 to roughly 11% by 2060.”

“Tackling this challenge without imposing large—and possibly unsustainable—increases in social security contributions or other taxes is likely to require a combination of both further parametric adjustments to the system and structural changes,” the report added.

The Czech finance ministry has predicted that projected spending will fall by 1% of GDP by 2060 following a recent move in 2008 to increase the retirement age by two years. However, age-related spending in the Czech Republic will be 23.4% of GDP by 2060, according to data gathered by the European Commission.

The country should consider phasing out the differentiation between men’s and women’s retirement ages and introducing partial indexation of benefits to life expectancy, the authors of the OECD report recommended.

It claimed the earlier Czech government’s aim to create a voluntary but fully-funded, defined contribution plan or “second pillar pensions regime” might help the country’s pension problems. On the other hand, diverting assets from the state defined benefit pension to fund a new DC pension “could undermine financial sustainability too.”

A “DC carve-out” of existing pension assets would lead to a “transitional deficit” as revenue into the DB plan or “first pillar pensions regime” fell, so how much impact it would have at retirement would have to be carefully determined at the carve-out stage.

Either way, said the OECD, a simple carve-out of assets would need to be topped up with further reforms to ensure Czech workers have enough retirement income.

Instead, the OECD has proposed the Czech Republic introduce mandatory or “soft compulsion” to pensions by requiring individuals to “opt out” of a new DC plan rather than “opt into” one. In other words, the OECD recommended something similar to the “Auto-IRA” that the Obama administration is considering.

Though market turmoil may have created a sense in the public’s mind that a Social Security-type pay-as-you-go plan is safer than a market-based 401(k)-type plan, the OECD pointed out, a poor economy also hurts both types of plans.

“The crisis has reduced the rates of return on contributions to the PAYGO pillar as well, even if the decline has been less visible,” said the OECD. In that case, it might be better for Czechs to have both types of plans or “pillars,” the OECD report suggested.

© 2010 RIJ Publishing. All rights reserved.

Hartford CEO to VAs: “Never Again”

Hartford Financial Services Group Inc. chief executive officer Liam McGee, who repaid a $3.4 billion government bailout last week, said he’ll avoid focusing on variable annuity sales that contributed to two straight annual losses, according to a Bloomberg report.

“We learned our lessons from the last two years,” McGee told analysts and investors today at a presentation in New York. “Never again will we have a concentration in any product, whether it be annuities or anything else, of the size that VA was.”

McGee, hired in October, is repositioning Hartford after losses under his predecessor forced the firm into the U.S. rescue. The stock market’s recovery helped Hartford return to profitability in the fourth quarter and aided McGee as he sold stock and debt to repay the U.S. Treasury Department. McGee, 55, said when he was hired that he would reduce risk and conduct “an intense review” of the 199-year-old insurer’s businesses and strategy.

“De-risking general parts of the business is a focus,” said Randy Binner, an analyst with FBR Capital Markets, in an interview before the Hartford presentation. “Their risk profile is more market-sensitive than other life insurers.”

The insurer expects total annuity sales of $5 billion in 2012, the company said today. It didn’t give a comparable figure for 2009 in a slide presentation available on its Web site. Limra, the trade group, said Hartford’s individual annuity sales were $4.3 billion last year and $10.7 billion in 2008.

Hartford swung to a profit in the final three months of 2009 with net income of $557 million. The company posted more than $4 billion of losses during the 15 months before McGee was hired. 

© 2010 RIJ Publishing. All rights reserved.

HSAs No Panacea for Retiree Medical Costs: EBRI

Health care savings accounts (HSAs) are not likely to cure the medico-financial ills that millions of Boomers will face in retirement, says the Employee Benefit Research Institute.

Not at their current low contribution limits, that is.

Contribution limits and prevailing low interest rates will likely prevent retirees from accumulating enough money in the accounts to cover all of their health insurance premiums and out-of-pocket health care costs in retirement, the EBRI said.

Based on current interest rates, if a 55-year-old contributed $3,000 to his or her HSA in 2009 and also contributed the $1,000 catch-up contribution each year for 10 years, the account would equal $48,300 after 10 years, assuming a 2% interest rate. Assuming a 5% rate, the amount would be $55,100.

But a man age 55 in 2009 would need between $144,000-$290,000 by the time he reached age 65 in 2019 (depending upon his use of prescription drugs in retirement) merely to have a 50% chance of covering all premiums and out-of-pocket expenses for Medigap and Medicare Part D. 

Women, who live longer than men on average, would need more.  “The savings needed for retiree health care far exceed the savings potential of an HSA,” said Paul Fronstin of EBRI, author of the report.

The present value of lifetime benefits from Medicare for a husband and wife turning age 65 in 2010 has been estimated at about $376,000. Since Medicare on average covers a little more than one-half of health care costs for beneficiaries, the average husband and wife will need a little less than $376,000 in savings to cover what is not covered by Medicare. 

An increase in the HSA limits would, however, reduce tax receipts for the U.S. Treasury, and the reduction might have to be made up elsewhere. Most of the benefits of HSAs accrue to people with high incomes, who are most able to fund them and have the most to gain from their tax advantages.   

The full report is online at http://www.ebri.org/pdf/notespdf/EBRI_Notes_04-Apr10.HSAs-TaxExpends1.pdf.

© 2010 RIJ Publishing. All rights reserved.

Percent of U.S. Tax Units With No Income Tax Liability, 2009

Percent of U.S. Tax Units
With No Income Tax Liability, 2009
Income* Single Jt.
Filers
Elderly w/
Chdrn
All
Units
<$10K 99.9 100 100 99.9 99.8
$10-20K 74.3 99.9 89.5 99.8 83.6
$20-30K 36.7 90.2 76.5 98.9 61.8
$30-40K 16 79.8 61.4 89.3 47.5
$40-50K 7.4 71.7 48.2 68.3 35.7
$50-75K 5 34.2 22.5 40.9 21.5
$75-100K 3.6 11.3 8.1 15.1 9.2
$100-200K 4 3.4 4.9 4 4.5
$200-500K 3 1.8 3.9 1.6 2
$500K-1M 2.6 1.8 1.6 2.1 2
>$1MM 2 1.5 1.1 1.3 1.5
All 46.7 38.1 55.3 54.1 46.9
*Cash income is Adjusted Gross Income minus taxable state and local tax refunds, plus total deductions from AGI.
Source: Urban-Brookings Tax Policy Center, 2009

Two Trends in One: CTFs and TDFs

It’s too soon to say if, when or how it will affect the way Americans save for retirement, but the trend is undeniable: asset managers are creating target-date collective trust funds at a rapid rate and pitching them to 401(k) plan sponsors.

“They still have issues, but they’re gaining traction,” said one 401(k) platform provider who asked not to be identified. His firm offers a range of exchange-traded funds, CTFs, and mutual funds to plan sponsors.

Of the 159 collective trust funds (CTFs) that were launched in 2009, 115 (72%) were formed as vehicles for lifecycle or target date investing strategies. From 2007 to 2009, 439 CTFs were formed, of which 241 (55%) were target date CTFs.

Both collective trusts and target date funds—especially TDFs—were handed a ready-made market when they were approved as QDIAs (qualified default investment alternatives) for 401(k) plans by the Pension Protection Act of 2006.

Top-20 US Collective Trust Fund Managers
and Total Assets, 2Q 2009
($ billions)
Rank Firm 2Q 2009 Assets Q 2009 Marketshare
1 BlackRock1 $388.2 37.8%
2 State Street Global Advisors Ltd. $123.4 12.0%
3 Northern Trust Global Investment Services $118.9 11.6%
4 BNY Mellon $110.6 10.8%
5 Fidelity Investments $65.0 6.3%
6 Invesco National Trust Co. $40.8 4.0%
7 Old Mutual Asset Management Trust Co. $26.2 2.5%
8 Galliard Capital Management Inc. $17.8 1.7%
9 The Vanguard Group, Inc. $13.1 1.3%
10 UBS Realty Investors LLC $10.3 1.0%
11 Capital Guardian Trust Company $10.0 1.0%
12 Ameriprise Trust Company $9.5 0.9%
13 Wilmington Trust RISC $6.3 0.6%
14 Schroders Investment Mgt North America $5.6 0.5%
15 Amalgamated Bank $4.8 0.5%
16 Fortis Investments USA, Inc. $4.4 0.4%
17 Genesis Asset Managers, LLP $4.4 0.4%
18 Morley Financial $4.0 0.4%
19 Prudential Private Placement Investor, L.P. $3.5 0.3%
20 AFL-CIO Housing Investment Trust $3.6 0.3%
Total CTF market $1,027.7
1Formerly Barclays Global Investors NA
Sources: Morningstar Direct, Cerulli Associates

Leading the charge
The largest CTF provider is BlackRock, which has a 38% market share, according to Cerulli Associates. Just four firms, BlackRock (formerly Barclays Global Investors), State Street Global Advisors, Northern Trust, and BNY Mellon, account for 72% of the $1 trillion-plus CTF business in the U.S.

“It’s my understanding that the bigger firms are leading the charge into target-date CTFs,” said Jake Hartnett, senior analyst, Institutional Asset Management, at Cerulli Associates. “Pyramis, Fidelity’s institutional money manager, has come out with them. BlackRock also has a TDF-CTF product.”

“We have cloned a Freedom Fund collective trust,” said Beth McHugh, a Fidelity vice president, referring to Fidelity’s proprietary line of target date funds. “They’re fairly recent and they’re not available to everyone. We also have other multi-fund collective trusts.”

“The trend has been shared among various providers,” said Steve Deutsch, who tracks CTFs for Morningstar, Inc. “BlackRock, Putnam and Nuveen are there, but also smaller firms like Avatar Associates and Manning & Napier. Since CTFs are unregistered, you’ll see a mix of established firms as well as boutiques and smaller firms that can’t afford to go through the cost and time of registration.”

According to Cerulli, CTF assets peaked at $1.43 trillion in 2007 after five years of steady growth. The “flight to quality” in 2008 and 2009 cut their assets to $1.07 trillion in 2008 and $1.03 trillion last year. Of that trillion, about 28% is in DC plans and 72% in DB plans. Morningstar estimates the CTF total at about $1.6 trillion, with about half in DB and half in DC.

That’s still only a fraction of the $13.4 trillion that Americans hold in retirement accounts, in the form of mutual funds, exchange traded funds, variable annuity separate accounts, and individual stocks, as well as CTFs.

Made for each other
Because CTFs are marketed only to institutions, and not to the public as mutual funds are, they do not need to submit a prospectus to the Securities and Exchange Commission for approval and provide one to every potential investor. They are supervised by banking regulators rather than by the SEC.

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But TDF-CTFs aren’t merely wholesale, bank-regulated versions of target-date mutual funds.

“We have compared target date mutual funds and TDF-CTFs from same firm,” Deutsch said. “While they may have the same name and the same target date in their objective or strategy, you’ll get completely different money managers running them, different investment decision processes, different allocations and different return streams. They’re not just low-cost clones of mutual funds.”

Cerulli’s Hartnett thinks the CTF structure will actually enhance the target date strategy, because it will make it easier than ever for target date fund managers to hold alternative assets as they seek more sophisticated, institutional-style diversification.

“The target date format and the CTF structure are made for each other,” he said. “Part of the TDF solution, which even in the mutual fund format includes getting exposure to non-correlated assets, is to bring a more institutional level of management to DC plans.”

Presenting the target-date investment strategy in a CTF wrapper will also relieve some of the fiduciary burden from plan sponsors, Hartnett said. By statute, the trustees of CTFs have fiduciary responsibilities that mutual fund managers do not. They can relieve that burden from plan sponsors, or at least share it.

Frequency of Data Calculations and Reporting to Institutional Clients, 2009“Because [CTFs] are bank-registered products, you have an external fiduciary joining the plan sponsor,” he added. “Plan sponsors like that. If the asset manager is using a ‘40 Act’ [i.e., Securities Act of 1940] mutual fund format, there’s no co-fiduciary. From what we’ve heard, that makes the CTF an easier sell. We’ve also heard that Taft-Hartley plans [multi- employer union-sponsored DC plans] are more comfortable with CTFs.”

The percentage of defined contribution plans offering mutual funds declined to 54% from 65% over the six-year period from 2003 to 2008, according to Morningstar. Meanwhile, a higher percentage of plans are using institutional mutual funds (to 80% of plans from 72%), of collective trusts (to 45% from 32%) and separate accounts (to 29% from 24%).

Ironically, CTFs were the investment structure of choice in defined contribution plans during the early days of the 401(k) phenomenon—a holdover from DB practices.

But as the mutual fund business grew, mutual funds supplanted CTFs in DC plans. Mutual funds, which were built for the retail market, have traditionally been more transparent than CTFs in terms of offering prospectuses and daily valuations. But they are more expensive.

Back to the future
Now the pendulum has swung the other way. Precisely because they don’t market to the general public and don’t have to meet a heavy regulatory burden, CTFs operate more cheaply than mutual funds—especially actively managed funds.

In response to consumer and government pressure to cut plan costs, plan sponsors have become increasingly receptive to a variety of low-cost alternatives, including index funds, institutional mutual funds, exchange traded funds, separate accounts, and CTFs.

“Collective trusts, separately managed accounts and institutionally priced mutual funds all have advantages,” said David Wray, president of the Profit Sharing Council of America, an organization of large 401(k) plan sponsors. “There is no single right answer.”

The positioning of target date funds in collective trusts won’t necessarily resolve certain problematic aspects of target-date funds, however. The problems, which were reviewed in Senate hearings last year, include the wide variation in TDF design and the difficulty that investors have in benchmarking TDF performance.

The hearings also revealed that many investors believed that by investing in target date funds, they would reach retirement with adequate savings and that the volatility of their savings would taper off by retirement.

In fact, until they experienced steep losses in 2008, many TDF investors had no idea that so much of their money was at risk. The very fact that TDFs were dated created a false impression that they would protect investors from the market risk associated with an ill-timed retirement.

When packaged inside CTFs, which are less transparent than mutual funds, TDFs are not likely to be any more understandable to the average plan participant than they were before. Whether there’s the seed of a crisis in the wedding of these two strategies remains to be seen.

© 2010 RIJ Publishing. All rights reserved.

My Life as a ‘Dangerous Woman’

When I tell people at parties that I’m a professor of economics who specializes in pension policy, I get a lot of yawns and sidelong glances. I don’t mind—retirement policy is important, but it does tend to be complex. 

So imagine my surprise when I saw a Google Alert linking these two word strings: “Teresa Ghilarducci” and “the most dangerous woman in America.” (Not, for instance, Angelina Jolie?)

How did I gain such notoriety?  When the banks were bailed out in 2008, I testified before Congress, calling for government to help regular people, not just banks. Absorb the collapsing 401(k) assets on a volunteer basis, I recommended, and replace the assets with safe ones. 

Maybe I should have stopped there. But I didn’t. I said 401(k)s were failures and that tax breaks for saving money should go only to the people who need them most, with the government guaranteeing a safe return on savings. 

But despite what I thought was a modest proposal, some people heard me—or deliberately misinterpreted me—saying that I wanted the government to take over 401(k)s.  And these people weren’t just casual listeners. They were active conservatives, including the Big Enchilada himself—Rush Limbaugh. 

Oh, well. No publicity is bad publicity, right?

Wrong. Limbaugh attacked me three times, calling me “communist babe,” among other endearments. Lots of people listen to Rush, it turns out. The exaggerated story soon went viral, to Fox News, the Wall Street Journal editorial page, and to a dizzying array of right-wing bloggers, some of them very angry. You’d be surprised how many there are. I sure was. 

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The story even reached John McCain, who in the last weeks of the Presidential campaign accused Democrats of wanting to confiscate 401(k)s.  If I were a horse, a friend told me, I’d have won the trifecta. 

Of course, they shoot horses, don’t they?

Things got pretty scary for a time.  My employer, the New School, became alarmed at the screaming voicemail death threats and ominous threatening emails.  The university’s security chief gave me his cell phone number. I won’t reveal his last name, but Steve is big and alert. He made me feel secure.

But then support poured in. Justin Fox of Time magazine said the attacks on me were unfair. I wasn’t killing 401(k) plans, he wrote; Wall Street was doing a perfectly good job of that on its own.  The New York Times Magazine called my suggestion one of the best ideas of 2008. US News and World report ran a nice article about me. (My glossy photo was soft-focused, with a flower in the background.) 

Parade Magazine, which has tens of millions of readers, wrote favorably about my plan in its Intelligence Report section. And the Annenberg Center’s Political Fact Check debunked the false accusations about my alleged “socialist” and “theft” motives.  (It’s still on the web if you care to see it.)

So what’s it like to be ‘the most dangerous woman in America?’ I’m working hard on my Rockefeller Foundation grant to promote real pension reform. And I’m still promoting my message—as recently as a few weeks ago, on Larry Kudlow’s CNBC show. Because we still need secure pensions for all Americans.

Citations (Because I’m an academic.)

Ghilarducci, Teresa. “Saving Retirement in the Face of America’s Credit Crises: Short Term and Long Term Solutions,” Committee on Education and Labor, The Impact of the Financial Crisis on Workers’ Retirement Security 1:00, 2181 Rayburn House Office Building. Oral Testimony. Tuesday October 7, 2008.
<http://edlabor.house.gov/testimony/2008-10-07-TeresaGhilarducci.pdf>

Limbaugh, Rush. “Biden: CEO Pensions “Go First” (And Your 401(k) Will Go Next),” Rush 24/7, aired on October 24, 2008.
<http://www.rushlimbaugh.com/home/daily/site_102408/content/01125109.guest.html>

Fox, Justin. “Should the 401k Be Killed?” Time Magazine. Dec. 04, 2008.
<http://www.time.com/time/business/article/0,8599,1864139,00.html>

Mihm, Stephen. “8th Annual Year In Ideas: The Guaranteed Retirement Account,” The New York Times. December 12, 2008.
<http://www.nytimes.com/2008/12/14/magazine/14Ideas-Section2-C-t-001.html>

Brandon, Emily.  “Teresa Ghilarducci: The 401(k) Retirement System Has Failed,” U.S. News & World Report. January 30, 2009.
<http://www.usnews.com/money/blogs/planning-to-retire/2009/01/30/teresa-ghilarducci-the-401k-retirement-system-has-failed>

Winik, Lyric Wallwork. “Rethinking Retirement,” Parade Magazine. April 26, 2009.
<http://www.parade.com/news/intelligence-report/archive/rethinking-retirement.html>

FactCheck.Org. November 19, 2008.
<http://www.factcheck.org/askfactcheck/are_congressional_democrats_talking_about
_confiscating_ira.html
>

 

© 2010 RIJ Publishing. All rights reserved.