Archives: Articles

IssueM Articles

So Few Words, So Many Implications

Posted on March 3, 2010 by Editor Test -

More than a year after suspending the Bush-era proposals for regulating investment advice in employer-sponsored retirement plans under the Pension Protection Act of 2006, the Obama Department of Labor has proposed its own regulations.

Under the new proposed regulations, “Investment Advice—Participants and Beneficiaries,” plan participants may receive investment advice only from an advisor who is compensated on a “level-fee” basis. If the adviser uses a computer model to generate advice, the model must be “certified as unbiased.”

The main difference between the Bush and Obama regulations would probably be too subtle for most laymen to detect. But it is expected to make a significant difference in determining who can furnish advice and who can’t.

The two versions agree that a fund company investment advisor, for instance, who is hired by a plan sponsor to educate 401(k) participants, must be paid the same no matter which fund options he or she recommends to the employee.

The Bush proposal, however, exempts the advisor’s manager or broker-dealer from that restriction, so that the advisor could in practice recommend one of his employer’s funds over a competitor’s without breaking the law. The Obama proposal removes that exemption.

Advertisement Without the exemption, it is expected to be more difficult for financial services companies, or their affiliates or the affiliates’ employees, to promote their products in the workplace. It could also conceivably hurt their strategic efforts to attract 401(k) rollover money to their firms when employees retire or change jobs.

The securities industry, which lobbied for the exemption during the Bush administration, has already voiced its displeasure at the prospect of losing the exemption.

“We are disappointed the Department of Labor decided to move in this direction after having withdrawn the previous final regulations and class exemption,” said Elizabeth Varley, managing director, government affairs, at the Securities Industry and Financial Markets Association, or SIFMA, on February 26.

“The proposed regulation, if approved, will do little to expand American’s access to investment advice. Americans are seeking the best paths to saving and investing for their retirement and deserve rules that allow them to do so. Today’s move by [the Department of] Labor will hurt participants and investors, not help,” she added.

Attorney Jason C. Roberts, a benefits specialist at the Los Angeles law firm of Reish & Reicher, has written about the two sets of proposals. He described a scenario where the exemption might make a big difference to a fund company.

“Let’s say you’re an XYZ fund company investment advisor getting paid a level compensation for running a participant’s data through a computer model. Under the exemption, if the computer recommends an ABC fund, you could easily venture away from the model, recommend an XYZ fund instead, and document the reason in some way,” Roberts said.

In another scenario, he said, an RIA (registered investment advisor) with a pension consulting service whose broker-dealer is owned by a specific financial services company might, under cover of the exemption, recommend plan options that would benefit the larger company without benefiting him directly.

“There was a big push for this on the lobbying front by the conflicted companies,” he told RIJ, meaning companies facing potential conflicts of interest as providers of advice for plan participants.

“Under the Bush proposal, you would have seen a whole wave of players with conflicts of interest coming into the [401(k) advice] market. Anybody could see that the original proposal would not have been sufficient to prevent that. Now we’re seeing a paring back of that.”

Democrats have opposed the exemption from the moment—the Bush administration’s last day in office—when it was proposed. “Congressman George Miller (D-CA), Chairman of the House Education and Labor Committee, and Congressman Rob Andrews (D-NJ), immediately preceding publication of the final rule, stated that they would ‘use every tool at [their] disposal to block the implementation [of the regulation],’” Roberts wrote on his blog last year.

“The issue with the broker-dealer ‘level fee’ consideration dealt with the affiliated firms of the advisor. In January of 2009, the DoL proposed that only the advisor was required to maintain a level fee arrangement, not the firms in which he/she was affiliated,” said Chad Griffeth, AIF, president of BeManaged, a plan sponsor advisor in Grand Rapids, Mi.

“The concern created was: Where would the advisor be receiving the analytics and research for delivering advice to 401(k) investors? Probably from the affiliated firms, serving as the ‘back office.

“Hence, the potential was there for broker dealers, mutual fund companies, and insurance companies to create a ‘puppeteer’ effect, holding the advisor out to deliver level-fee advice while providing support/asset allocation services that benefited the firms potentially more than the participants,” Griffeth added.

In another provision, the new proposal restricts the use of historical performance of funds within a single asset class as a basis for recommending one fund over another, because performance is “a factor that cannot confidently be expected to persist in the future,” the Department of Labor wrote. It acknowledges, however, that different asset classes may have persistent differences in returns.

The regulation contains a number of other safeguards against conflicts of interest, including:

Requiring that a plan fiduciary (independent of the investment adviser or its affiliates) select the computer model or fee leveling investment advice arrangement.
Requiring that computer models must be certified in advance as unbiased and meeting the exemption’s requirements by an independent expert.
Establishing qualifications and a selection process for the investment expert who must perform the above certification.
Clarifying that the fee-leveling requirements do not permit investment advisers (including its employees) to receive compensation from affiliates on the basis of their recommendations.
Establishing an annual audit of investment advice arrangements, including the requirement that the auditor be independent from the investment advice provider.
Requiring disclosures by advisers to plan participants.

Which Way Out?

Posted on March 3, 2010 by Virginia M. Citrano -

In 1939, near the end of the Great Depression, Virginia Lee Burton published “Mike Mulligan and His Steam Shovel.” As any well-read child can tell you, Mike could excavate a basement in just one day. But he and “Mary Anne”—the steam shovel in the storybook’s title—dug so fast that they forgot to leave themselves a way out.

For the last 18 months, Federal Reserve Chairman Ben Bernanke has been trying to dig the U.S. economy out of a hole much deeper than a basement. Now, with the worst of the Great Recession apparently over, economists and financial industry pundits are wondering what Bernanke has in mind for an exit strategy.

Is Bernanke’s new foundation solid enough for him to stop shoring up the walls and put his tools away? Does the Fed chairman know a way out?

Dropping interest rates to the floor is, of course, a classic strategy for combating a recession. While low rates may keep government borrowing costs down and the stock market humming, however, they can be deadly to retirement savers, insurance companies, pension funds and annuity providers.

On the other hand, a return to “normal” rates can pose its own dangers. The Fed has to craft an exit strategy that doesn’t trigger new problems—like falling bond prices, a new spike in unemployment, defaults on real estate loans or another serious stock market correction.

Advertisement In remarks prepared for the House Committee on Financial Services on February 10 (a hearing waylaid by snow), Bernanke described the steps the Fed has taken to prepare for an exit strategy, but indicated that the central bank was not ready to act just yet.

“The FOMC anticipates that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period,” Bernanke’s testimony reads.

Then, eight days later, on February 18, Bernanke surprised everyone by raising the rate at which the Fed lends to banks, known as the discount rate, by a quarter-point. Was this the first move toward the exit?

“It’s a start,” says Rutgers University economist Michael D. Bordo. “I was surprised that they did it so quickly, so maybe they will get it right.”

What Fed watchers say
The Fed hasn’t always done a good job with its exit strategies, write Bordo and Rutgers colleague John Landon-Lane in a recent paper for the National Bureau of Economic Research. Since 1960, the Fed has generally waited to tighten rates until unemployment peaked—after inflation had already begun to rise.

Bordo does not believe this exit will turn into a double-dip recession. But he frets that the lingering high unemployment rate could put political pressure on the Fed and cause it to repeat the multiple mistakes of the exit from the 1990-1991 recession.

Unemployment from that downturn peaked at 7.7% in July 1992, and inflation began to rise in the first quarter of 1993. But the Fed waited until early 1994 to raise rates, and then did so very rapidly. “It broke the back of inflation here, but it also led to the Latin American debt crisis,” Bordo noted.

But interest rates have to rise at some point. Otherwise they end up damaging insurers. When Japan dropped its interest rates to zero in the 1990s, for instance, it nearly killed its insurance companies, which were still legally obligated to pay 4% on whole life policies.

U.S. life insurers learned from Japan’s experience and lobbied for lower guaranteed rates in this country, said Daniel E. Winslow, a financial planner in Lake Forest, Illinois, and a former chairman of the American Council of Life Insurers’ actuarial committee. Statutorily guaranteed rates in the U.S. are now 3% or less, depending on product or state.

While those reductions help insulate U.S. insurers from the impact of today’s low interest rates, they affect only those contracts issued since the state requirements were reduced. No one knows the size of the old book of business because the information is proprietary.

“My educated belief,” Winslow said of the low interest rate environment, “is that it is bearable as long as it doesn’t last more than a few years.”

As for the prospect of rising rates, “banks should be more concerned than insurance companies because a lot of them are still in shaky condition,” he said. “They have been feasting off lending at 6% or 7% and borrowing at zero percent. When rates go back to normal it will make it that much harder for them to rebuild their balance sheets.”

Unprecedented risks
While many observers grant that Bernanke is a well-schooled student of the Great Depression, some people note that he faces risks that were not even imagined in that period. Take, for instance, the large portfolio of mortgage-backed securities that the Fed has taken on, and the assets it shouldered as the U.S. financial system melted down in 2008.

Ricardo Reis, a professor at Columbia University, believes that the Federal Reserve System and the conduct of U.S. monetary policy have changed more in the past two years than in any period since the system was founded in 1913.

“[The Fed] made loans to a myriad of different institutions,” he wrote in a recent paper on possible exit strategies that will be published as part of a book this spring. “It started buying securities directly like a regular investor, and it found itself supporting failed companies like Bear Stearns and AIG.”

Because the Fed is now such a big player in the housing market, Reis worries, it faces new rivals. For instance, the still-powerful triumvirate of Fannie Mae, Freddie Mac and the mortgage brokerage community could make it hard for the central bank to sell its vast cache of mortgage-backed securities if they perceive the sell-off as a threat to their own finances.

“The big danger in holding all of these assets is that you can lose money on them,” Reis said in an interview. “If the Fed loses, it could lose its independence.”

The shape of the yield curve, others say, matters as much as the rates themselves. If the yield curve flattens again, as it did when the Fed raised rates in 2005, that scenario might be worse for the insurers than low rates, noted Viral V. Acharya, a professor of finance at New York University’s Stern School of Business.

“I expect the yield curve to flatten a bit to reduce the benefits to bank from borrowing short and lending long,” he added.

Acharya says the U.S. has a slightly higher risk of borrowing than it has in the past, and a reduction in the credit risk of the government should flatten the yield curve. He estimates that 40 to 50 basis points of the longer maturity U.S. borrowing rates reflect the risk that the U.S. has taken on. The unwinding of that risk should lower the cost.

The highest priority, he believes, should be to contain the over-lending and over-heating in the economy—a condition fostered by the ultra-low interest environment.

“In a low interest rate environment, the long-term yield on assets is not good,” he said. “Then everyone has to start searching for yield, and that forces people to load up on riskier assets. A rise in interest rate environment will in the long run be better for the insurance sector because it will allow them to be concentrated in lower-risk assets.”

In “Mike Mulligan”, the crowd cheered for Mike and his steam shovel to dig as fast and as deep as they could. But Fed-watchers want Chairman Bernanke to find the nearest exit ramp. “The sooner they get out [of low rates],” says Bordo, “the better.”

Photo Credit: WAYOUT Evacuation Systems Pty. Ltd

Vanguard’s Forecast of Future Returns

Posted on March 3, 2010 by Editor Test -

Recent research from The Vanguard Group suggests that over the next ten years the annualized real returns will most likely be 6% for stocks and zero to 2% for bonds.

Those estimates are based on the historical relationships between on earnings-to-price ratios (6.75 for stocks in December 2009) and the 10-year Treasury bond yield (3.6% on December 31, 2009).

But the range of possible returns is much wider. In the past, similar E/P ratios and bond yields have led to annualized 10-year stock returns of between zero and 15% and bond returns of between minus-3% and 8%.

These projections are included in a February 2010 paper from Vanguard called, “2009: A Return to Risk-Taking,” by Christopher A. Philips, CFA.

Philips makes the case that, contrary to conventional wisdom, diversification didn’t fail during the financial crisis of 2008. His data shows that even though investors who held bonds weren’t entirely protected during the crash, they suffered less than those who didn’t.

For example, somebody with an all S&P 500 Index portfolio on October 9, 2007 would still have been down about 25% on December 31, 2009. But a person with half their money in a bond fund matching the performance of the U.S. Aggregate Bond Index would have been down only about 10% at the end of 2009.

Advertisement Why the stock market rebounded
Market analysts rarely suggest that the Federal Reserve ever uses monetary policy to lift the stock market, but Philips’ paper comes close. “It can be argued,” he wrote, “in fact, that the actions of both the Fed and the U.S. Treasury were largely geared toward reviving investment in riskier assets.”

“With yields of Treasury bills hovering below 0.25% for the entire year,” Philips continued, “many investors needed little incentive to abandon the flight to quality that characterized the market crash and financial crisis of 2008 and to gravitate, instead, toward riskier assets in search of higher yields and greater potential returns. This new focus on riskier assets helped drive prices up across the board.”

The Vanguard paper also shows that U.S. investors have been more cautious in the aftermath of the 2008 equity crash than they were during the recovery from the dot-com bust earlier in the decade.

During the dot-com bust, money surged from stocks to money market funds, but then flowed back to stocks as the market rebounded in 2003. During the 2008 crash, money at first fled to cash and Treasury bonds, and then flowed more to longer-term bonds than to stocks.

Philips thinks that the dip to zero interest rates in 2009 (compared to 1% in 2003) may explain that difference. In 2009, the spread between Treasury bills and the broad stock market was 4.3% at the market bottom. In 2003, the spread was only 2.7%—giving investors little reason to be satisfied with bonds.

But by loading up on longer-term bonds, he said, investors are increasing their vulnerability to tightening by the Fed, because rising interest rates would depress the market price of existing bonds and hurt total returns.

America Speaks Out—and Against—401(k) Annuities

Posted on March 3, 2010 by Editor Test -

“Keep your hands off our 401(k)s!”

That’s how Americans are responding so far to the RIF (request for information) about lifetime income options for 401(k) plans that the Departments of Treasury and Labor published in the Federal Register at the beginning of February.

But by March 1, only 48 comments were posted at www.regulations.gov (Docket ID IRS-2010-0006) so it’s hard to say to what extent the responses were representative.

So far, no insurance companies or mutual fund providers had submitted their views. Companies that already offer in-plan annuities—MetLife, Prudential, and Genworth Financial, for instance—would be logical contributors.

Not all the comments were written in anger. Many were polite and well reasoned. Two or three even came from professionals, such as a plan sponsor and a financial advisor. But most of them seemed to reflect the latest strain of Tea Party populism.

Judging only by the first four dozen comments, many Americans apparently suspect that the Obama administration plans to confiscate 401(k) assets and somehow use the money to pay its bills, offering nothing but an unfunded promise of lifetime income in return.

Advertisement No shortage of anger
Two of the earliest comments to the RIF reflected the frustration and anger that so many Americans seem to feel these days:

“If this passes I will halt all contributions and close [my 401(k)] account with penalty. If I wanted Government bonds I’d buy them. You can thank Ben Bernanke and Tim Geithner for people not wanting the bonds.

“There’s a reason that the yield curve is steep and the short-term bonds keep going into negative yields, people don’t believe the government can fulfill its long term obligations. Cut the spending, cut the deficit and keep your hands out of our 401(k)!”

Here’s another in a similar vein:

“No, I’m not interested or willing to participate in any plan that would give the government control of my IRA, 401k, etc. in order to help offset the current administration’s deficit spending.

“I didn’t contribute funds to my retirement just to have them zapped away by the current group of profligate politicians and others on a wild spending spree, leaving me nothing for my old age… I just don’t see how anyone could support it.”

Balances not big enough
Not all of the contributors were so incensed. A more deliberate contributor pointed out that most people can’t afford a decent annuity:

“It’s disappointing to see the DoL get involved in a vendor-driven product. The last vendor-driven initiative taken up by the DoL—the target date fund—had disastrous results in rewarding millions in fees to [a] very small group of mutual fund advisors.

“The annuity initiative seems to be a way for insurance companies to take their turn at the fee trough. The DoL seems to be buying the spin fed to them by the insurance companies that participants are somehow not given the option to purchase an annuity.

“The data is clear: people do not want annuities. People have three good reasons to avoid annuities:

1. 401(k) balances averaging $30,000 provide small annuities (around $2,000 yr) not worth the trouble.

2. All annuities force single entity credit risk (think AIG).

3. Excessive hidden fees. The big gorilla in the room is too small of balances. Let’s say to provide a typical DB pension of $30,000 a year you need a 401(k) balance of nearly $400,000. With an average balance in the $30,000 range and the vast majority under $100,000 even the best-constructed annuities would fall way short.

“With high unemployment causing leakage in loans and cashing out, 401(k) balances are growing very slowly. Almost all current annuities force participants to take single entity credit risk.

“If DOL pushes this option does this imply a government guarantee making all annuity providers? Too Big to Fail? Currently there is significant credit risk in all annuity providers as indicated by bond spreads. Annuities are currently regulated by State Insurance Commissioners. Providers flock to states with the most lax regulation.

“DOL should think long and hard before pushing participants into risky products that the government may have to bail out later.”

‘First, do no harm’
But others brought a more informed perspective to the discussion. James Hardy of Tacit Knowledge, a San Francisco software company, warned about the dangers of mandatory annuitization:

“As the plan sponsor/trustee for a 401(k) plan, I think having some form of annuitization available to plan participants would be nice and would make sense for some, some of the time (as with any investment choice).

“However, and I want to make this very clear—any annuitization option should not be mandatory, and it must not be conflated with safe harbor rules on default enrollment such that people are unknowingly forced into irreversible investment options when they are potentially not paying attention.

“Making any annuitization option mandatory or making it the only safe harbor choice for default enrollment of new hires would remove choice, possibly cause loss/hardship if the funds were needed and thus potentially violate the ‘first, do no harm’ ethos a plan sponsor choosing default options should have.”

Teach financial literacy
A financial advisor who described himself only as “David” pointed out that America needs more self-reliance, supported by financial education:

“I have been in the business of advising individuals and business owners about retirement planning for 24 years… Defined contribution plan participants already have plenty of lifetime income options available, and the burden of federal regulation on plan sponsors is a significant disincentive to employers to offer a retirement plan for their employees.

“The need that is not being adequately addressed is the need to accept responsibility for one’s own financial security, rather than depending on an employer, the governme nt or the public. People need more education, beginning in elementary school, of the need to spend less and save more, and how to invest wisely for the long term… Let’s put our energy and resources into educating the public.”

A lack of inflation-protection
A contributor identified as “DM” also tried to be constructive:

“Annuities are an excellent option. They provide lifetime income and allow individuals to determine how much they need to save to achieve a desired monthly income. States also provide protection, within limits, for this type of insurance. Consequently, this may require the use of multiple insurance companies to achieve an individual’s goal and, at the same time, protect the money invested in the policy.

“The downside is the lack of reasonably-priced inflation protection. Although available, it is too expensive to be practical. If more individuals were involved in the purchasing pool and the price came down, this would make a lifetime annuity even more attractive. Once the monthly income goal is achieved, it would provide piece of mind and limit the temptation to choose a risky alternative.”

Reduce taxes
Peter Bowler, writing from Akron, Ohio, suggested that an exemption from taxes would make annuities more attractive:

“Although I could support the idea of adding annuity choices to 401(k) plans, it is not any sort of final solution to the retirement income problem. What would be more helpful would be a reduction in taxes owed on distributions of all kinds that would preserve more of the capital so hard won over the years.”

Stop the export of U.S. jobs
David Young, no address given, answered four of the 39 questions posed by the Labor and Treasury Departments, then offered some direct observations related to the macroeconomic outlook:

“Question 1: Payments must be indexed to inflation (i.e., maintain constant purchasing power over time).

“Question 2: My strongest concerns are conversion cost (i.e., converting to an annuity in a low interest rate environment), plan fees and counterparty risk. Are there steps that [federal] agencies could or should take to overcome at least some of the concerns that keep plan participants from requesting or electing lifetime income? Other than leaning on the Fed to stop holding interest rates artificially low, I can’t think of anything.

“Question 8: Plan sponsors can vet potential annuity providers before offering their products to employees. This may give employees greater confidence in a particular annuity seller and their products.

“Question 13: Should some form of lifetime income distribution option be required for defined contribution plans (in addition to money purchase pension plans)?

“Yes; however, whatever action is taken with respect to offering a lifetime income option, it must remain just that-an option. There should be no conversion requirement imposed on defined contribution plan participants.

“If so, should that option be the default distribution option, and should it apply to the entire account balance? No, it should not be the default option and it should not apply to the entire balance.

“To what extent would such a requirement encourage or discourage plan sponsorship? I think offering the option, and associated plan communications about this option to employees, would be sufficient.

“General Comments:

1) The retirement security of all workers would be enhanced if government policy did not facilitate the export of U.S. jobs. A start would be to address the mercantilist polices of our East Asia trading partners.

2) ‘Good jobs provide wages that support families, and rise with time and productivity.’ Odd; productivity has risen over past 10 to 20 years with no appreciable increase in inflation-adjusted wages. Perhaps DoL and Treasury should examine why this has occurred.

3) The Department of the Treasury could promote economic growth, stability, and economic security by stopping the direct and indirect bailouts of insolvent financial institutions.

FINRA Has “Disastrous Record”: Watchdog Group

Posted on February 25, 2010 by Editor Test -

The Project On Government Oversight (POGO) sent a letter today (February 23) to the congressional committees tasked with financial oversight urging them to stop relying on private financial self-regulators like the Financial Industry Regulatory Authority (FINRA).

FINRA oversees thousands of securities brokerage firms that do business in the U.S. It is one of the self-regulatory organizations (SROs) in the nation’s financial regulatory regime.

FINRA and other SROs have “an incestuous relationship with the industry they are tasked with regulating, and therefore should not be trusted with the important job of protecting the investing public.”

In a release, POGO said:

“Although FINRA is currently seeking to expand its authority and is defending its record in paid advertisements, the organization actually has an abysmal track record of regulating the securities industry.

“SROs such as FINRA failed to prevent virtually all of the major securities scandals dating back to the 1980s. And in recent years, under the leadership of current Securities and Exchange Commission (SEC) Chairman Mary Schapiro, FINRA failed to regulate many of the larger firms that were at the heart of the financial crisis, including Bear Stearns, Lehman Brothers, and Merrill Lynch, and also failed to detect the Ponzi schemes run by Bernie Madoff and R. Allen Stanford.

“Amidst the economic collapse of 2008 during which FINRA itself lost $568 million in its investment portfolio, and despite its failure to adequately conduct oversight of the securities industry, FINRA awarded its top 20 senior executives $30 million in salaries and bonuses.”

In its letter to Congress, POGO said, “the cozy relationship between FINRA and the securities industry has resulted in pervasive conflicts of interest, and ought to raise doubts about whether FINRA can ever be an effective regulator.”

“FINRA’s disastrous track record should be all the evidence Congress needs to conclude that self-regulators can’t be trusted with protecting investors,” said POGO Executive Director Danielle Brian.

“Our fragile economy shouldn’t be left in the hands of a regulator that’s in bed with the same industry that brought the financial system to the brink of collapse.”

Founded in 1981, POGO is an independent nonprofit that investigates and exposes corruption and other misconduct in order to achieve a more effective, accountable, open, and ethical federal government.

Don’t Tax High-Earners’ Annuity Income, Says ACLI

Posted on February 25, 2010 by Editor Test -

The American Council of Life Insurers apparently believes that President Obama’s proposed 2.9% tax on unearned income—including annuity income—would hurt annuity owners.

It would presumably also make annuity sales less attractive, at least incrementally. And it certainly flies in the face of industry efforts to protect some level of annuity income from income tax.

The tax would apply to income from interest, dividends, annuities, royalties and rent for individual taxpayers with incomes above $200,000 and couples with incomes above $250,000.

To protest the President’s proposal, which was intended to help maintain the Medicare Hospital Trust Fund, the ACLI released a letter from its president, Frank Keating. The letter, dated February 24, says in part:

“I am writing to express serious concerns about the Administration’s proposal to apply a 2.9 percent tax on annuity income to fund the Medicare Hospital Insurance (HI) trust fund as part of a series of proposed changes to the Patient Protection and Affordable Care Act.

“Currently, Americans face unprecedented difficulties securing their retirement income in an environment that has shifted longevity, savings and other retirement risks onto the individual. In such a landscape, policy-makers should not create a disincentive for annuity products that help Americans address these risks.

“As such, I would encourage you to reevaluate this proposal that increases taxes on an important retirement security tool and instead, continue to take a proactive approach to encourage individuals to take their savings in retirement as a guaranteed lifetime income payment.”

The Obama tax was described in his recent health care proposal, released February 22. In the relevant section, it said:

“The President’s Proposal adopts the Senate bill approach and adds a 2.9 percent assessment (equal to the combined employer and employee share of the existing Hospital Insurance tax) on income from interest, dividends, annuities, royalties and rents, other than such income which is derived in the ordinary course of a trade or business which is not a passive activity (e.g., income from active participation in S corporations) on taxpayers with respect to income above $200,000 for singles and $250,000 for married couples filing jointly.

“The additional revenues from the tax on earned income would be credited to the HI trust fund and the revenues from the tax on unearned income would be credited to the Supplemental Medical Insurance (SMI) trust fund.”

Variable Annuity Sales Fall 18% in 2009

Posted on February 25, 2010 by Editor Test -

After dropping 26% in the first six months of 2009, variable annuities (VA) sales finished the year down by only 18%, according to LIMRA’s U.S. Individual Annuities quarterly sales survey.

Fourth quarter VA sales were up three percent, to $32.6 billion, from the third quarter but three percent below sales in the fourth quarter of 2008. For all of 2009, VA sales totaled $127 billion.

“The last time VA sales were at this level was in 2003, at the end of the last financial crisis,” said Joe Montminy, assistant vice president and research director for LIMRA’s annuity research.

“VA sales experienced significant losses from the third quarter of 2008 through first quarter 2009 and while we are seeing VAs slowly recover, the recovery is slower than expected. We attribute this partly to a decline in 1035 exchanges.”

With so many living benefit riders “in the money” because of still-depressed account balances, contract owners have a disincentive to exchange their existing contracts for new ones. Such exchanges might also be deemed “unsuitable” by broker-dealers if reps recommended them.

Overall individual annuity sales fell 2% in the fourth quarter, as compared the prior quarter, to $53.3 billion. This was a 22% decline from the fourth quarter of 2008. Total individual annuity sales declined 11% in 2009, to b$234.9 billion.

In fourth quarter of 2009, fixed annuity sales were down 10% from the third quarter and down 40% from the fourth quarter of 2008. Fixed annuity sales totaled $20.7 billion in the fourth quarter and $107.9 billion for the year, down one percent from 2008.

LIMRA predicts fixed annuity sales will remain depressed, relative to sales of certificates of deposit, while interest rates remain at current levels.

In 2009, indexed annuities rose to a record $29.4 billion, up 9% from 2008. Indexed annuities performed very well throughout the year, with a record-high in the second quarter. Fourth quarter sales were down 5% from the third quarter, at $6.9 billion.

For the third consecutive quarter, sales of book value fixed annuities were down 10% from the third quarter and 43% from the fourth quarter of 2008. For all of 2009, sales of book value annuities were up 2%, thanks to strong first quarter sales.

Fourth quarter sales of market value-adjusted fixed annuities were down 35% from the third quarter and 80% from the fourth quarter of 2008. For 2009, MVA sales were down 20% from the prior year.

“Face-Off” at the IRI Marketing Conference

Posted on February 25, 2010 by Kerry Pechter -

With the U.S. and Canadian Olympic hockey teams facing off in Vancouver, B.C., last Sunday night, a hockey metaphor seemed to pervade the Insured Retirement Institute’s annual marketing conference, held in New York early this week.

That was apt, given that much of the annual meeting could be characterized as a friendly face-off between annuity manufacturers and their third-party distributors. But in this case, of course, the product manufacturers don’t want to beat the distributors. They want to supply them.

Easier said than done. This year’s marketing conference, which drew some 530 or so registered guests and 22 listed exhibitors, wasn’t as crisis-stricken as last year’s meeting. But the basic marketing challenge facing annuity manufacturers hasn’t changed much in twelve months.

Manufacturers are still trying to convince brokers and advisors in every distribution channel from wirehouses to banks to independent broker/dealers to fee-based advisory practices that annuities are the financial products that aging Boomers need and—with proper education—will want.

But many intermediaries still regard insurance products as alien to their DNA. Because of complexities related to compensation, regulation, cultural differences and general unfamiliarity, annuities still trigger the equivalent of a negative immune response from the non-insurance world.

Advertisement Annuities, to continue the biological analogy, are still perceived as antigens—rather than, say, vitamins, life-saving drugs or legal stimulants—by much of the financial products distribution system. That’s why some observers think that the unbundled income guarantee, or “stand-alone living benefit,” applied to managed accounts, could turn out to be the dominant income “app.”

But it’s too early to tell who the winners and losers will be. There are so many uncertainties and so many strategies afoot in financial services today that it’s hard to see anything clearly through the fog of war. Or through the scrum of stick-waving hockey players, you might say.

The distributors’ perspective
Executives from big distributors like Wells Fargo, Morgan Stanley Smith Barney, UBS, and Edward Jones, were present in force at the conference. They made it clear that the retirement market is huge for them. But whether they will champion annuities was not as apparent.

Morgan Stanley Smith Barney, which was born when Morgan Stanley bought Smith Barney from a strapped Citigroup in January 2009, came across as especially receptive to annuities. With 20,400 advisors at a thousand brokerage locations, the combined firm has a big distribution footprint.

In a panel discussion called, “Retirement Income, Service or Product?” Mike Stern, a national sales manager at MSSB, said that his firm had established a Retirement Standard last September, which included a 10-point checklist for evaluating a client’s future income needs.

Over 1,000 advisors signed up to receive support materials and resources for the program, Stern said. The firm also adopted a time-segmented, “bucket” approach to income planning after the start of this year. These efforts have produced “significant wins” in rollovers, attracting $250 million in new money so far, he said.

Certainly, wirehouse customers have an enhanced appetite for safety. “We’re hearing that the proposition of a guarantee is impactful,” Stern said, adding that he wants to integrate insurance solutions into income plans. “We’re working toward introducing an insured retirement solutions the same way as we introduce a large cap fund.”

Among registered reps, however, annuities are still new. If he questions a rep about a given mutual fund, Stern said, the rep can rattle off every detail of the prospectus. If he asks about a guaranteed lifetime withdrawal benefit, “I get a blank stare.” Going forward, he thinks a rising tax environment will lift variable annuities. “Tax efficiency will be big in 2011,” he said.

UBS Financial Services’ Wealth Management division has about 8,000 financial advisors in the U.S. and its over-55 clients account for 75% of its assets, so it is another object of courtship by annuity manufacturers. Like MSSB’s Stern, UBS managing director Ed O’Connor sounded receptive.

Internal surveys show that retirement income is one of his clients’ top three concerns, O’Connor said. Clients are telling UBS they would prefer a 5% guaranteed income to an uninsured systematic withdrawal income of 4.5% to 5%, he said.

Not every distributor sounded convinced about annuities, however. Bernie Gacona, director of annuities at Wells Fargo Company, said that annuities aren’t getting much traction among his force of some 16,000 reps nationwide.

“We have not added any of those products,” he said in reference to some of the new variable annuity contracts that have appeared since last summer. Participating in a panel called “Simple Annuity and Other New Products Designs,” Gacona said that the commissions on simplified contracts are too low while the expenses on the more elaborate contracts are still too high.

“The low compensation product doesn’t sell in a commission environment,” he said. “If your commission is in the 2% range and other products pay 5% or 6%, how will your products get sold?” L-shares of variable annuities, which have no up-front charges but higher trailing fees, are not getting traction either.

The manufacturers’ perspective
While Gacona was talking, his fellow panelist, John Egbert, national sales manager in the wire/bank channel for John Hancock Annuities, was visibly stressed. Last summer, his company introduced a simplified A-share variable annuity with a three-percent commission and total annual expenses of only 1.74%. Distributors don’t seem to want it.

Called AnnuityNote, the product has no death benefit, no credits for delaying withdrawals, and involves passive investments. It pays out 5% of the original investment or the contract value on the fifth anniversary, if greater. Income starts five years after issue.

Though simplicity seemed to be just what the post-crisis world wanted, AnnuityNote has not sold well. Egbert and his team are still trying to figure out why. “We were either early or we were wrong,” he said. “But we’re not stopping.” The product is the right thing for the 80% of producers who don’t currently sell annuities and for mass-market investors, Hancock still believes.

Hancock’s approach was just one of many. Executives from New York Life, The Phoenix Companies, Genworth Financial, Hartford Financial, ING Annuities, Nationwide, Lincoln Financial, and AXA Equitable also took part in panel discussions and described their approaches to the market.

ING, like John Hancock, has gone the simplified, low-cost var iable annuity design route. Michael Katz, head of variable annuity product development at ING Financial Services, described ING’s rational from reducing client expenses on its VAs from 314 basis points before the crisis to 225 basis points after.

“The equity markets are stabilizing, and the chirping over costs will start as markets recover,” he said. Advisors won’t like a product that pays out 5% a year in income but costs 3.50% a year, he said, and clients won’t like accumulating 30% less over 20 years because they owned a high-cost contract.

Hartford and AXA Equitable, represented at the conference by Peter Stahl and Steven Mabry, respectively, have gone another route entirely.

They’ve decided to “decouple” the investment and income segments or “sleeves” of their products into a bucket dedicated to accumulation and a bucket dedicated to income. The manufacturer only takes on the risk of insuring the assets that the owner allocates to the much-tamer income bucket.

Robert Grubka, vice president, Retirement Solutions Products at Lincoln Financial Group, said that his company tries to exploit parts of the market that other companies neglect. “If everybody goes to the same spot on the ice,” he said, using a hockey metaphor, “it gets very crowded and you get jostled around.”

Lincoln will go its own way, he said, perhaps by putting its weight behind a long-term care annuity hybrid product. Such products, which were blocked by regulatory barriers until January 1, 2010, enable annuity owners to, in effect, use their annuity assets or guaranteed income streams to buy low-cost, high-deductible long-term care insurance.

Chris Blunt, the head of the Retirement Income Security at New York Life, the largest mutual life insurer, came at the market from still another angle. “We want to take immediate annuities into the world of broker-dealers,” he said.

So far there have been “operational” obstacles to doing that in a big way, he said, but eventually New York Life would like to see “guaranteed income treated as an asset class alongside mutual funds.” Demographics will drive the market his way, Blunt added: “Our target clients are in their mid-60s to 70s, so we’re still five years from seeing a tsunami of interest” from Boomers.

Stand-alone living benefits
Although there was no panel discussion devoted purely to stand-only living benefits (SALBs), several panels touched on them. Genworth Financial, the Phoenix Companies, Nationwide and Prudential have already launched group or individual forms of these income guarantees. Although their progress was slowed by the financial crisis, they have by no means disappeared.

Applicable to after-tax managed accounts or to qualified money, SALBs provide advisors and investors with the income guarantee of a variable annuity without the restricted fund selection, fund expenses, or marketing costs associated with one. Their sales potential is unknown, but could extend far beyond the traditional market for variable annuities.

The only conference panelist specifically representing SALBs was Philip Polkinghorn, president, Life & Annuity, at The Phoenix Companies. Phoenix, whose financial strength rating slipped out of the A range in the financial crisis, created the first SALB with Lockwood Asset Management, a Philadelphia-area managed account provider, in late 2007.

“The vast amount of retirement money is not in variable annuities,” Polkinghorn said, referring to the managed account market, which is $1.5 trillion and growing, as well as 401(k) and 403(b) accounts that will eventually roll over to IRAs. SALBs will appeal to that market than variable annuities, he thinks.

“[SALBs] focus entirely on longevity risk—the tail risk,” he said. They are contingent on both the owner’s life and the exhaustion of the covered portfolio. Deferred income annuities, aka longevity insurance, also cover that risk, but have no cash value. “We’re putting a liquidity feature in longevity insurance.”

Best of all, perhaps, SALBs are not perceived as annuities.

Fixed Annuity Sales Fall Overall in 2009

Posted on February 23, 2010 by Editor Test -

Performing inversely to the equity markets, overall fixed annuity sales weakened over the course of 2009 and in the fourth quarter sales were down more than 40% from the same quarter a year earlier.

After a record-setting first quarter 2009, when overall fixed annuity sales reached $34.8 billion, sales fell to $27.8 billion, $22.1 billion, and $20.4 billion in the last three quarters of the year. Sales for the fourth quarter were $20.4 billion, down slightly from $22.1 billion in the previous quarter, representing an 8% decline.

Most of the decline in sales across the year could be attributed to weakening sales of book value and market value adjusted fixed annuities. They sold a combined $25.7 billion in the first quarter of 2009 but were only $10.8 billion in the last quarter, a decline of almost 60%.

Quarterly U.S. Fixed Annuity Sales, By Product Type
Quarter Ended	12/09	9/09	6/09	3/09	12/08
Total Sales ($millions)	20,360	22,140	27,810	34,760	34,110
Book Value	8,994	9,940	13,862	19,194	17,120
Market Vale Adjusted	1,855	2,907	3,563	6,549	7,445
Indexed	7,588	7,349	8,215	7,076	7,179
Income	1,915	1,942	2,167	1,941	2,362
Source: Beacon Research

By contrast, sales of fixed indexed annuities, which are structured notes whose returns fluctuate with equity markets, and sales of immediate annuities, were relatively stable throughout the year.

In a way, the sales decline was a return to normalcy, after the panicky flight from equities in last quarter of 2008 and the first quarter of 2009. Year-to-year sales were down marginally, from a record $106.7 billion in 2008 to $105.1 billion in 2009, posting a 1.5% decline.

“Fixed annuity sales in 2009 were second only to the record-setting prior year,” said Jeremy Alexander, CEO of Beacon Research, which compiled the data and released it in partnership with the Insured Retirement Institute. “Due to strong demand for secure retirement savings and income alternatives, 2009 results were achieved despite financial pressures on consumers and other challenges.”

Quarterly Market Share By Product Type (As a percent of total sales) 12/31/09
Book Value	44.2%
Market Value Adjusted	9.1
Indexed	37.3
Immediate	9.4
Source: Beacon Research

Fixed indexed annuity sales climb at the end of the year, with fourth quarter sales totaling $7.6 billion, up 3.2% from the previous quarter. Total fixed index annuity sales for 2009 were $30.2 billion, posting a year-to-year increase of $3.5 billion.

Total fixed annuity sales were $105.1 billion in 2009, just 2% less than the record high in 2008. During the last quarter of 2009, fixed indexed annuity sales represented 37.3% of all fixed annuity sales, compared to only 21% in the last quarter of 2008.

Beacon Research, based in Evanston, Ill., is an independent research firm and application service provider that tracks fixed and variable annuity features, rates and sales. Beacon also licenses information to Insurance Technologies’ VisibleChoice annuity sales platform, Ebix, Lipper, and Ibbotson Associates.

Record Sales for Indexed Annuities in 2009

Posted on February 23, 2010 by Editor Test -

Forty-four indexed annuity carriers representing 99% of indexed annuity (IA) production reported combined fourth quarter 2009 sales of $7.0 billion, down 2.7% from the same period last year, according to the 50th edition of AnnuitySpecs.com’s Indexed Sales & Market Report (formerly the Advantage Index Sales & Market Report).

But “The big story this quarter is that sales of IAs exceeded $30 billion in 2009, setting an all-time record. That tops our previous 2007 annual sales record by more than 10%,” said Sheryl J. Moore, President and CEO of AnnuitySpecs.com.

Sales were down 6.7% from the prior quarter. “The past two quarters’ sales have been the strongest the IA industry has ever seen. It is natural to rebound to a normal sales level after such record highs,” Moore added.

Allianz Life remained the top-selling carrier in the quarter and for 2009. Aviva regained its position as the second-ranked company, while American Equity, Jackson National and ING rounded out the top five, in that order.

Allianz Life’s MasterDex X was the top-selling IA for the third consecutive quarter. Jackson National Life dominated sales of IAs in the bank and wirehouse distributions for the quarter.

For indexed life sales, 33 carriers in the market participated in the AnnuitySpecs.com’s Indexed Sales & Market Report, representing 100% of production.

Fourth quarter sales were $151.3 million, an increase of nearly 16% from the previous quarter and a reduction of 4.0% from the same period in 2008.

“A third of the companies in the indexed life market experienced greater than 50% growth since this period last year,” said Moore. “The IUL market is going to become increasingly competitive now that so many of these new entrants’ distributions are comfortable with the product.”

Aviva held its top position in indexed life, with a 22% market share. Pacific Life, National Life Group, Minnesota Life, and American General Companies completed the top five.

Pacific Life’s Indexed Accumulator III remained the best-selling indexed life product for the fifth consecutive quarter. Nearly 77% of sales utilized an annual point-to-point crediting method, and the average target premium paid was $7,596.

‘Saving More’ Trumps ‘Working Longer’

Posted on February 23, 2010 by Editor Test -

“I’ll postpone retirement” is the first thought that many people have when their retirement accounts drop in value. But emergency financial counseling can persuade them to decide to increase their saving rate instead.

That is one of the conclusions of a survey conducted by a team at the Center for Retirement Research at Boston College last summer. The finding was important, say the designer of the survey, because it shows that well-timed advice can produce more positive financial outcomes for many people.

Why is saving more preferable to retiring later? Because few people can or do work as long as they’d like, according to the paper that describes the survey, “Workers’ Response to the Crash: Save More, Work More?”

“The intent to work longer is potentially a powerful response to the loss of retirement wealth. But many workers retire earlier than planned. Increased saving is a more certain and immediate response to a large negative wealth shock,” researchers Steven A. Sass, Courtney Monk and Kelly Haverstick wrote.

This team asked people ages 45 to 59 about the impact of the financial crisis on their finances. Two-thirds had retirement accounts that lost value. Each expressed their way of coping with the loss. Later the researchers (in the guise of a “finance professor”) told some of the people: You could offset your loss by saving 11% more each year, retiring one year later, or living on 8% less in retirement.

Advertisement After this minor intervention, there was a definite shift away from inertia, as well as a shift from working longer to saving more.

The percentage who said they would do nothing to recover their investment losses fell (to 24% from 41%) while the percentage who said they would work longer fell (to 28% from 36%).

The segment who said they would save more and work longer rose (to 30% from 13%) and the percentage of those who said they would save more rose (to 18% from 10%). In sum, 48% said they would save more, either with or without working longer.

The study supports the argument that retirement plan participants should receive counseling after a market crash so that they do not a) fail to respond at all to the crisis and b) that they do not simply delay pain or sacrifice into the future by making hard-to-keep resolutions to work longer.

Counseling worked best on those who had succumbed to inertia. “A striking 60% reconsider[ed] their decision, with 24% saying they would increase their retirement age, 20% saying they would increase their savings, and 16% saying they would do both. This outcome suggests that credible information can substantially change both retirement and savings behavior.”

Not surprisingly, individual responses to the survey reflected personal circumstances to at least some extent. People who were more dependant on their investments for retirement security (as opposed to those with good pensions), those closer to retirement, and those with higher degrees of anxiety about their losses tended to respond more actively to the impact of the crisis on their finances.

The survey also showed:

A widespread rise in the expected age of retirement. About 40% expect to retire later than they had before the downturn with most of those who intend to work longer delaying retirement by four or more years.

Relatively little change in retirement saving. Two-thirds of respondents reported no change in how much they save for retirement in 401(k)s, IRAs, or other accounts.

A decline in spending. However, nearly 60% reported that they are spending less (which is equivalent to saving more if income is unchanged).

Some reallocation of retirement savings. About 30% reported changing the allocation of assets in their accounts or contributions to these accounts, with 81% reallocating away from stocks.

A substantial minority did nothing. Forty-three percent did not intend to change their planned retirement age or savings rate. These households may have suffered little or no loss of retirement savings; may plan to only decrease consumption; may be too overwhelmed to take an active role in rectifying their financial situation; or may just be unaware of their options.

401(k) Balances Bounced Back in 2009: Fidelity

Posted on February 23, 2010 by Editor Test -

A new study by Fidelity Investments finds that the average balances of 401(k) retirement plans rebounded in 2009, recovering much of the value they lost in 2008, National Underwriter reported.

Average 401(k) account balances ended 2009 at $64,200, up 5.7% from the end of the third quarter and up 28% for the year, according to Boston-based Fidelity. Standard & Poor’s 500 index showed a total return of 26%. The average balances include employer and employee contributions as well as market appreciation.

The average deferral rate remained relatively flat for the year at about 8.2%, but the fourth quarter saw the continuation of a trend of more participants electing to increase their deferral rates than to decrease them, Fidelity said.

The company’s analysis of employed participants who had a Fidelity 401(k) account from 1999 to 2009 showed their account balance increased nearly 150% in the period, to $163,900 at the end of 2009 from $65,800 at the end of 1999.

The increase in balance was due to continued participant and employer contributions, dollar cost averaging and market returns, Fidelity says. These continuous participants had a median age of 51 years with a deferral rate of 10.4%, the analysis found.

In 2000, Fidelity found participants on average directed over 80% of their new contribution dollars into equities. By contrast, participants were contributing less than 70% to equities by the end of 2009. At the same time, the proportion of participants contributing 100% to equities dropped to 19% in 2009 from 47% percent in 2000.

Brokers Are More Than “Blackjack Dealers,” PA Regulators Say

Posted on February 23, 2010 by Editor Test -

The commissioners of the Pennsylvania Securities Commission (PSC) today warned that failure to require a higher “fiduciary standard” for stockbrokers would be a blow to investor confidence and slow down economic recovery.

“If Wall Street wants the freedom to engage in the development of new financial products it should shoulder the responsibility to protect investors from inappropriate risks and the best way to do that is to impose on brokers the same fiduciary standards we require of investment advisers,” the commissioners said. “Otherwise, we may as well treat brokers as croupiers and Blackjack dealers.”

PSC Chairman Bob Lam and Commissioners Steve Irwin and Tom Michlovic made the prediction in a letter to Pennsylvania’s two U.S. Senators in response to media reports that the Senate Banking Committee was backing off on efforts to hold stockbrokers to the same ethical standards set for investment advisers.

“What’s at stake here is consumer and investor confidence,” the commissioners said in their letter to Sen. Arlen Specter and Sen. Bob Casey Jr. “Congress acted quickly and effectively through the Troubled Asset Relief Program (TARP) and the American Recovery and Reinvestment Act (ARRA) to prevent the total collapse of t he nation’s economic systems. Rebuilding our economy—especially the retirement and investment portfolios of ordinary Americans—will require much more and it begins with appropriate and effective measures to protect individuals.”

The commissioners noted that other members of the North American Securities Administrators Association (NASAA), representing regional securities administrators in the United States, Canada and Mexico, shared their views.

In UK, BMW Is “Ultimate Pension Machine”

Posted on February 23, 2010 by Editor Test -

The largest longevity insurance deal seen yet by a pension fund has been completed by the UK pension fund of BMW, the German automaker, with Deutsche Bank unit Abbey Life and Paternoster, IPE.com reported.

BMW confirmed it has agreed to a customized longevity swap that will provide the BMW (UK) Operations Pension Scheme with a hedge for life expectancy risks. The sum protects nearly £3bn (€3.4bn, $4.6bn) of pension scheme liabilities related to approximately 60,000 pensioners and contingent benefits such as spouse’s pensions.

The announcement came a week after Hymans Robertson estimated the longevity swap market could reach £10bn (€11.3bn) in 2010. (See earlier IPE article: Longevity swap market to hit £10bn in 2010)

Abbey Life will insure the longevity risk of the scheme for the whole of life (until the last pensioner or their spouse dies) but has already reinsured part of the risk with a consortium of reinsurers including Hannover Re, Pacific Life Re and Partner Re. Abbey Life has also used the structuring expertise and longevity modeling techniques of Paternoster, which is also partly-owned by Deutsche Bank.

BMW was revealed to be considering its options for a longevity deal earlier this month, as part of a risk reduction strategy, and “chose to insure this risk in order to protect the sponsor against a financial risk in its UK pension scheme”. Latest figures from the 2007 actuarial valuation of the scheme showed the pension fund at that time had a deficit of £584m and a funding ratio of 87%.

Martin Bird, principal and head of longevity & risk solutions at Hewitt Associates, the consultancy which advised scheme trustees on the transaction, said:

“Entering into a bespoke longevity hedge to mitigate against continued improvements in member life expectancy is a natural extension to the scheme’s current liability-matching investment strategy and is designed to enhance further the security of members’ benefit.”

The policy is a named life policy, which means rather than being referenced against an index, the transaction actually covers the longevity exposure of the members in the BMW scheme, so it is bespoke and customized in a manner similar to the Babcock longevity deals. The transaction is also fully collaterized, despite being written as an insurance-regulated policy.

Bird said the hedge has also been constructed to provide flexibility, which “has not been done before”, so the hedge can be realigned over time to adjust the specific benefit structure and better match the longevity risk of the scheme.

Nardeep Sangha, CEO of Abbey Life said: “In bringing this leading solution to BMW and its UK pension scheme, we have demonstrated our ability to combine our balance sheet strength and internal expertise with the specialist pensions and longevity know-how at Paternoster to bring about a landmark transaction. As this market develops, we are committed to providing innovative solutions to UK pension schemes.”

Prudential Financial Reports Turnaround in 2009

Posted on February 23, 2010 by Editor Test -

Prudential Financial, Inc. reported net income of its Financial Services Businesses of $3.411 billion ($7.63 per common share) for the year ended December 31, 2009, compared to a net loss of $1.140 billion ($2.53 per common share) for 2008.

After-tax adjusted operating income for the Financial Services Businesses was $2.481 billion ($5.58 per common share) for 2009, compared to $1.087 billion ($2.62 per Common share) for 2008.

Pre-tax adjusted operating income for Financial Services Businesses reached $3.3 billion for year 2009, more than double the level of 2008. GAAP book value for Financial Services Businesses reaches $24.2 billion or $51.52 per common share, compared to $14.3 billion or $33.69 per common share a year earlier.

For the fourth quarter of 2009, net income for the Financial Services Businesses attributable to Prudential Financial, Inc. amounted to $1.788 billion ($3.79 per common share) compared to a net loss of $1.656 billion ($3.89 per common share) for the fourth quarter of 2008.

After-tax adjusted operating income for the fourth quarter of 2009 for the Financial Services Businesses amounted to $495 million ($1.07 per common share), compared to a loss, based on after-tax adjusted operating income, of $879 million ($2.04 per common share) for the fourth quarter of 2008.

“We completed over $4 billion of long-term debt and equity issues during the year, significantly adding to our financial strength and flexibility,” said Prudential chairman and CEO John Strangfeld.

“In December, we sold our stake in the Wachovia Securities joint venture for $4.5 billion of cash proceeds. With this transaction we realized a substantial return on our investment, which had an initial book value of $1.0 billion in 2003,” he added.

The Individual Annuities segment reported adjusted operating income of $88 million in the current quarter, compared to a loss of $1.04 billion in the year-ago quarter. Individual annuity gross sales for the fourth quarter were $4.8 billion, up from $2.2 billion a year ago; net sales were $3.2 billion, up from $434 million a year ago.

For the year, individual annuity gross sales were $16 billion, Full Service Retirement gross deposits and sales were $23 billion, International Insurance annualized new business premiums $1.4 billion, each at record-high levels.

The fourth quarter showed net pre-tax benefit of $30 million in Individual Annuities from reserve releases for guaranteed death and income benefits, reduced amortization of deferred policy acquisition and other costs, and mark-to-market of hedging positions and embedded derivatives.

The U.S. Retirement Solutions and Investment Management division reported adjusted operating income of $215 million for the fourth quarter of 2009, compared to a loss of $975 million in the year-ago quarter.

Full Service Retirement gross deposits and sales of $4.0 billion and net additions of $903 million, compared to gross deposits and sales of $6.5 billion and net additions of $2.7 billion a year ago. Individual Life annualized new business premiums of $91 million, compared to $86 million a year ago.

Current quarter results benefited $47 million from net reductions in reserves for guaranteed minimum death and income benefits and $32 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.

White House Tweaks Senate Health Care Bill

Posted on February 23, 2010 by Editor Test -

The Obama Administration added its own recommendations for health care legislation this week. The new proposal “reflects policies from the House-passed bill and the President’s priorities” and includes “a targeted set of changes” to the Senate-passed Patient Protection and Affordable Care Act, according to a White House release.

Key changes to the Senate health care bill include:

Eliminating the Nebraska FMAP (Federal Medical Assistance Percentage) provision and providing significant additional Federal financing to all States for the expansion of Medicaid. The Nebraska provision gave special financial assistance to Nebraska, and was widely seen as a quid pro quo for Nebraska Sen. Ben Nelson’s vote in favor of the Senate bill.
Closing the Medicare prescription drug “donut hole” coverage gap. The so-called donut hole was a provision in the Bush drug plan that reduced the overall cost of the plan but dramatically increased the cost of prescriptions for people with drug expenses within a certain dollar range.
Strengthening the Senate bill’s provisions that make insurance affordable for individuals and families. These provisions would provide public subsidies for the purchase of private health insurance coverage and are intended to reduce the numbers of uninsured Americans, estimated at 31 million people.
Strengthening the provisions to fight fraud, waste, and abuse in Medicare and Medicaid. An estimated $60 billion of the $470 billion spent on Medicare last year was lost to waste, fraud or abuse.
Increasing the threshold for the excise tax on the premiums of the most expensive health plans from $23,000 for a family plan to $27,500 and starting it in 2018 for all plans. This is the “Cadillac plan” tax, a 40% assessment on high cost insurance plans.
Improving insurance protections for consumers and creating a new Health Insurance Rate Authority to provide Federal assistance and oversight to States in conducting reviews of unreasonable rate increases and other unfair practices of insurance plans.

Like the existing House bill, the White House said its proposal would:

Set up a new competitive health insurance market giving tens of millions of Americans the same insurance choices that members of Congress will have.
End discrimination against Americans with pre-existing conditions.
Reduce the federal budget deficit by $100 billion over the next ten years—and about $1 trillion over the second decade—by cutting government overspending and reining in waste, fraud and abuse.

A Regulatory Nudge Is Needed

Posted on February 23, 2010 by Martin Hutchinson -

Paul Volcker’s proposal that proprietary trading should be spun off from deposit-taking banks is a worthwhile step in the direction of stabilizing the financial services business.

However, when you consider that business in detail, it becomes clear that further breakups are necessary in order to remove the excessive risks from the U.S. economic system.

There are three problems with the current setup on Wall Street: systemic risk, rent seeking and conflicts of interest. The Volcker proposal addresses the systemic risk problem to a great extent, but does not do much about the other two. For a complete solution, we thus need to go further.

Systemic risk

When Treasury Secretary Larry Summers and former Senator Phil Gramm (R-Texas), among others, pushed through repeal of the Glass-Steagall Act in 1999, they didn’t give proper thought to the dangers of institutions funding a traders’ casino with guaranteed deposits.

The introduction of Glass-Steagall in 1934 had been highly damaging to the economy, because it decapitalized the investment banks, killing off the capital markets for the remainder of the 1930s and playing a major role in prolonging the Great Depression.

Advertisement However, by 1999, the investment banks were more than adequately capitalized (provided they followed sound principles of risk management and leverage, which of course they increasingly didn’t). Thus, the rationale for allowing commercial banking and investment banking to be combined was shaky at best.

It should have caused further doubt that the trigger for Glass-Steagall repeal was the acquisition of the investment bank Salomon Brothers by Citigroup, itself a quagmire of conflicts of interest that had been bailed out from bankruptcy only eight years before.

However, restoring Glass-Steagall as it was would achieve nothing. After all, the two most serious failures of risk management in the 2008 crash were collateralized debt obligations, involving a mortgage bond market in which commercial banks’ securitization operations have always been active, and credit default swaps, a product in which commercial banks were intimately involved from the first.

Conventional underwriting of corporate debt and equity securities, the activity prohibited to commercial banks by Glass-Steagall, was not the problem, as it might have been had the crash occurred with the bursting of the 1999 dot-com bubble. The principal risks involved in finance today are those incurred by traders, but those proliferate in both types of banking.

It’s not clear how Volcker’s ban on proprietary trading in banks benefiting from deposit insurance would work. Every bank foreign exchange desk and money desk trades on the bank’s own account in almost every transaction it makes (relatively few transactions are pure brokerage between two counterparties.)

Thus, however simple the bank’s operations, it cannot avoid “proprietary trading.” Of course you can ban separate “prop trading” desks, but in a naughty world that would drive the proprietary traders to integrate themselves into the operations of the various products concerned, thus negating the effect of the legislation.

The other problem with the Volcker proposal is that even without separate proprietary trading operations, the banks are undertaking risks which they don’t manage properly. Wall Street risk management systems are based on assumptions of Gaussian randomness in markets that are demonstrably far from realistic.

In particular, Wall Street risk management systems understate the risk of several highly risky products such as collateralized debt obligations and credit default swaps. This understatement is in the interest of bank management, which benefits from state bailouts when it all goes wrong. It is even more in the interest of traders, who by and large make the most money from trading the riskiest instruments, and hence welcome artificially large position limits for those instruments.

Since current Wall Street risk management methods are in the interest of those who work on Wall Street, they will not be changed except by regulatory means. Before their alteration they will, even without proprietary trading, leave the Wall Street behemoths in continual danger of explosion.

Rent-seeking

Rent-seeking is another current problem of Wall Street, not addressed by Volcker. This takes many forms, and has resulted from computerization and from the endless proliferation of derivative instruments.

Basically, Wall Street houses, by their substantial market share in trading businesses, acquire insider information about money flows, and then profit by trading on this information. Traders have always done this, of course, and there is no sensible way of making it illegal.

In addition, genuine “crony capitalism” insider information about future finances and future government actions is as available as it always has been, but with larger trading volumes and fewer inhibitions is more usable without technically contravening insider treading legislation.

Thus insider trading, almost all of it technically legal, has acquired an enormously magnified profit potential. This is the principal reason for Wall Street’s greater share of the economy; the genuine value added to third parties from “hedging” or “liquidity” is only a tiny fraction of the rents Wall Street can extract from these markets.

There is no complete solution to this problem, but the best palliative is a “Tobin tax,” a modest ad valorem transaction tax on each trade. By this means, the profitability of “high speed trading” would be eliminated and many of the other insider trading strategies would be reduced in scope and profitability, particularly if the tax were levied on the nominal principal amount of a derivative and not on its theoretical value.

This would in turn swing the power base within Wall Street away from traders and back towards bankers and corporate financiers, whose approach to life is more conducive to maximizing those houses’ genuine economic value added.

Conflicts of interest

The final problem in the Wall Street behemoths, that of conflicts of interest, requires no legislative solution, at least as far as the corporate customers are concerned, but only that the financing business remain adequately competitive.

With behemoths doing corporate financing transactions, any of their customers is faced with huge conflicts in dealing with them. Wall Street pretends to operate internal “Chinese walls” through which sensitive information does not penetrate, but to rely on those is to put yourself entirely under the protection of Wall Street’s ethical integrity, a security currently trading at a very substantial discount.

The solution to these conflicts of interest is “single capacity,” the system under which the City of London acted until the passage of the Financial Services Act of 1986, surely among the most misguided legislation in human history.

Under this system brokers, who sold securities, were kept separate from jobbers, who made markets in them. Both were separate from merchant bankers who arranged financings and carried out mergers and acquisition transactions. When an underwriting took place, the merchant bank arranged the transaction and the brokers sold the underwriting to insurance companies and other large investment institutions, who earned additional income by backstopping deals in this way.

“Proprietary trading” was undertaken by investment trusts, pools of money whose business was to maximize income for their investors, in a similar way to a U.S. hedge fund. As for banking, that was done by the merchant banks if complicated, but the high volume simple transactions were carried out by the clearing banks, home of the nation’s retail deposits but not known for their intellectual heavy lifting.

It worked beautifully, just as well as the modern system, indeed better. It cost far less, in terms of the wealth it extracted from the economy. It was much less risky. And there were few conflicts of interest; each participant in the business, having only one function and capability, was devoted to its own interest rather than torn between the interests of several participants in every transaction.

This system is to some extent returning anyway, with the increasing market share of “boutique” investment banks such as Greenhill & Co. and Evercore Partners, which at least have fewer conflicts of interest than the behemoths. However, a regulatory “nudge” or two would be no bad thing.

As I said, Volcker had a good idea, but he did not go nearly far enough.

The Exploitation of Sherry Pratt

Posted on February 17, 2010 by Editor Test -

Sherry Lynn Pratt, a quadriplegic 38-year-old African-American woman, was a bed-ridden patient in a Chicago nursing home when, in December 2007, her forsaken life became the only thing standing between a group of “investors” and some $9.1 million in annuity death benefits.

Pratt died destitute in February 2008 of complications from neglected decubitus ulcers, or bedsores. But not before she served as the unwitting pawn in what her family’s lawyers describe as a multi-state conspiracy that also targeted at least six of the nation’s largest insurers.

Like the widely-reported lawsuits filed against attorney Joseph Caramadre and others in Providence, RI, by Western Reserve Life and Transamerica Life, the lawsuits that are filed or about to be filed in Illinois on behalf of Sherry Pratt’s family also involve “stranger-originated annuity transactions,” or STATs.

Advertisement Interviews with or documents provided by the Pratt family’s attorneys, Robert Auler of Urbana, Ill., and Peter C. King of Columbus, Ind., claim that, through offers of what amounted to small finder’s fees, representatives of a Daniel Zeidman of Long Island, NY, and the Esther Zeidman estate, procured Sherry Pratt’s signature on several annuity contracts during the winter of 2007-2008.

Pratt was the named the contracts’ annuitant, on whose life expectancy future annuity payments would be calculated and on whose death, if prior to annuitization, a death benefit would be paid to a designated beneficiary.

Others acting for Zeidman were said to be Menachem (Mark) Berger of Patient Financial Services, Abraham Gottesman and Akiva Greenfield. They allegedly approached a Chicago woman named Debra Flowers in October 2007 and enlisted her help, for compensation, in finding terminally ill nursing home patients.

Through a relative of Ms. Pratt, Ms. Flowers obtained Ms. Pratt’s signature, Social Security number, and other personal information, and sent it to people and companies identified as Richard Horowitz and Mark Firestone of Management Brokers Insurance Company, Beverly Hills, Calif., as well as to Global Risk Management LLC, CZ Planning Group, U.S. Planning Group, AM Consulting Inc., Marc Cohen, Abraham Gottesman, Asher Greenfield and Akiva Greenfield.

In due course, Daniel Zeidman and the Esther Zeidman estate of Boca Raton, Fl., purchased a number of variable annuity contracts using what was purported to be Sherry Pratt’s signature.

According to attorneys Auler and King, Zeidman invested $975,000 in a MetLife annuity, $950,000 in a New York Life annuity, $2.95 million in an ING USA annuity, $1.9 million in a Sun Life annuity, $1.875 million in a Genworth Life annuity, and $494,000 in an annuity issued by The Hartford.

[Given deadline pressures, RIJ was unable to seek or obtain confirmation from those six companies or from the other parties named here but instead relied on documentation from attorneys Auler and King. As a rule, companies do not comment on pending litigation. Attempts by telephone and e-mail to contact Daniel Zeidman and his attorney were unsuccessful.]

In late 2009, relatives of Sherry Pratt became aware of the contracts and contacted the insurance companies involved. In January 2009, MetLife filed a lawsuit in U.S. District Court, Eastern District of New York, indicating that it rescinded Zeidman’s contract and asking the court to decide whether it should return the $975,000 premium to Sherry Pratt’s family or to Daniel Zeidman.

On behalf of the Pratt survivors, Auler has sued the Southshore Nursing and Rehabilitation Center of Chicago for neglect in the death of Ms. Pratt. He told RIJ that he believes that she “was allowed to die” prematurely of horrific and untreated bedsores for reasons not unconnected with the annuity contracts purchased in her name.

According to Auler, Pratt told a relative, “These people are trying to kill me,” in reference to the failure by nursing home staff to treat her skin ulcers.

Under a little-used Illinois statute protecting individuals from the improper exploitation of their identify, Auler and King say they intend to ask the courts to turn the $9.1 million in annuity premiums over to Sherry Pratt’s survivors, as recompense for the misuse of her identity, and not to return it to Daniel Zeidman.

“Because Sherry Lynn Pratt or her estate is the only innocent or blameless party who has had no benefit whatsoever, and in equity, instead of refunding the money to any of the other parties, equity should direct it to the estate of Sherry Lynn Pratt,” wrote attorney Auler, “not only because she deserved it for the use of her last remaining thing of value, her name and persona, but to discourage this type of transaction in the future, in that perpetrators would stand to lose the funds they cynically ‘invested’ in harvesting the rapidly vanishing lives of dying and innocent patients.”

In late February 2009, the Zeidman Trust’s attorney, Gary Guzzi of the Florida law firm of Akkerman Senterfitt, filed a response to MetLife’s suit, asking that the $975,000 be returned to the Zeidmans.

Plan Sponsor Barriers to In-Plan Annuities

Posted on February 17, 2010 by Editor Test -

Plan Sponsor Barriers to In-Plan Annuities
48% >>No barriers; not interested now 45% >>Wait to see how industry develops 28% >>Concern over fiduciary exposure 24% >>Employee usage too small to justify 23% >>Communication hurdles 17% >>Difficulty in selecting provider 14% >>Cost to set up and maintain 10% >>Potential operational difficulties 7 % >>Accumulation focus, not income Source: “Hot Topics in Retirement 2010,” Hewitt Associates. Based on survey of 160 employers.

Stellar 2008 Makes for Dismal 2009 in Bank Annuity Sales

Posted on February 17, 2010 by Editor Test -

In November, total annuity sales at banks dropped below the $3 billion mark for the first time since February 2007 and remained there through December, according to the Kehrer-LIMRA Monthly Bank Annuity Sales Survey.

“There have been only two times in the last five years where we have seen bank channel total annuity sales this low,” said Janet Cappelletti, associate research director at Kehrer-LIMRA.

Financial institutions sold $2.7 billion of fixed and variable annuities in November, a reduction of 23% month-to-month, and 37% year-over-year. In December, banks sold just slightly more—$2.8 billion—or about half of the $5.4 billion in sales recorded in December of 2008.

Total annuity sales were pulled lower by faltering fixed annuity sales, which trended downward nearly every month of 2009.

The Kehrer-LIMRA survey is based on a national sample of banks that have a minimum of $4 billion in assets. The participating institutions account for about one-third of all bank annuity sales.

Fixed Annuity Sales

Sales of fixed annuities through financial institutions fell below $2 billion in November 2009 for the first time since January of 2008. Banks sold $1.7 billion of fixed annuities in November, a 32% erosion from October and a 47% collapse from the previous November.

Fixed annuity sales through banks in November 2009 were 51% below where they started the year at $3.5 billion. In December, fixed annuity sales slipped an additional 6%, ending the year at $1.6 billion, 63% below the record high of $4.3 billion set in December of the previous year.

“Since the all-time high in December 2008, fixed annuity sales have declined consistently through 2009, and variable annuity sales have not stepped up to take their place as they normally would” said Scott Stathis, managing director of Kehrer-LIMRA. “Instead mutual funds sales, which are less profitable to banks, have ramped up.”

“Fixed annuities have been rate-challenged, and variable annuities have increased in cost while the value of their benefits has decreased. This makes for a very challenging annuity sales environment,” he added.

Fixed annuities continue to lose their appeal as providers pull back on interest rates. The average effective rate on five-year fixed annuities eroded by 45% since December of 2008, but five-year CD rates slipped comparatively less-34% in the same period.

According to the Kehrer-LIMRA Bank Fixed Annuity RateWatch, the spread between the yield on five-year CDs and the average effective yield offered by fixed annuities guaranteed for five years dropped from 111 basis points in December 2008 to 24 basis points in December 2009.

“Fixed annuity sales accounted for only about a quarter of packaged product sales at financial institutions in November 2009 compared to more than half the sales mix a year ago,” Cappelletti said. “The vanishing spread on the five year products between the effective yield on fixed annuities and CD rates represents diminished opportunities for bank investment programs.”

Variable Annuity Sales

Bank-sold variable annuities continued to tread water at $1.0 billion in November, just short of the $1.1 billion level they were flat for most of the year. After bottoming out in the beginning of the year at $0.7 billion, variable annuity sales had been running at $1.1 billion a month from March through September.

In December, however, variable annuity production shot up 20% to $1.2 billion, back to the levels last seen in October of 2008. Compared to January 2009’s record low sales, December was up 71% for the year, but improved only 9% from December of the previous year.

Banks sold $1.70 in fixed annuities for every dollar of variable annuities in November, and the ratio sunk to $1.33 to one in December. These ratios are considerably lower than the January 2009 high of $5.00 to one, and much closer to figures from March of 2008 when the ratio was at $1.55 to one, after which fixed annuity sales began to pick up steam.

Mutual Fund Sales

Since August of 2009 mutual funds have consistently accounted for more than half of the bank sales mix. This had not been the case since June of 2008. Sales of mutual funds have more than doubled since January of 2009.

Bank mutual fund sales in November cooled after several increases in 2009, backing down 14% from a robust October. In November, banks sold $4.4 billion in mutual funds, making a significant recovery from the prior November when mutual fund sales hit their low point at $2 billion.

In December, bank mutual fund sales rallied 15% to $5.1 billion to match October’s banner productivity. Mutual fund sales at financial institutions closed the year 143% higher than the $2.1 billion they began at in January.

Mutual fund recovery outpaced variable annuities and accounted for 62% and 64% of packaged product sales at banks in November and December, respectively. Mutual fund sales mix had not been that high since June of 2007.

Data Connection

Lists*