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Where’s the Infrastructure for Infrastructure Renewal?

Posted on April 22, 2021 by -

Given Fed chairman Jay Powell’s disinterest in raising interest rates, and the Biden administration’s determination to spend trillions on mending bridges, power grids, and telecom networks, it’s no wonder that investors and retirement savers are pouring money into the stock market, as Morningstar’s fund flows report shows this week.

The S&P 500 Index is up about 12% since the beginning of 2021, by about 25% from its pre-pandemic peak, and by about 50% from its March 2020 pandemic low. Stock buybacks, foreign investors, and retirement savings plans are all presumably contributing to flows into dollar-denominated securities.

What could go wrong? Obviously, more pandemic-related shutdowns would hurt. Spending on public health infrastructure will hopefully prevent that. But we always have the capacity of shooting ourselves in the foot. Several things could go wrong.

The infrastructure bill might not pass. The bill is polling well with the American public, according to news reports. Decades ago, a Democratic president might have pulled in votes from Republican legislators by offering to spend money in their districts. But since the early 1990s, Republicans have practiced solidarity in voting, opposition to tax increases, opposition to deficit spending by Democrats, and reliance on wedge issues (e.g., abortion, guns, immigration) in lieu of active public policy initiatives.

Even if Democrats introduce the infrastructure bill through “reconciliation,” the 50 Senate Republicans plus Sen. Joe Manchin (D-WV) could stop it from becoming law.

The infrastructure might pass. We have heard some public debate over the definition of “infrastructure.” (Should it include day care? Nursing homes? Homes for the homeless?) We know that wealthy people are worried that they might pay more in taxes for national infrastructure than they will get out of it. (That’s a phantom threat, in my opinion; the wealthy are making more in the stock market, thanks to Fed largesse, than they will ever pay in taxes.)

But we haven’t heard much yet about what we will decide what to spend the trillions on or how we’ll disburse it. Given the country’s fragmentation into 50 states and thousands of counties, townships, municipalities, fire departments, and police departments, etc., do we have the political and bureaucratic infrastructure necessary to execute the renewal of our infrastructure?

How will we prioritize, design, manage or trickle-irrigate these large and small projects? Will local governments apply for grants, or solicit applications for grants from private contractors? Who will review and approve those grants? Will the government merely guarantee bank loans for infrastructure spending? Will the government use tax incentives to encourage private projects? Who will set goals and make sure contractors meet them, on time and on budget? How will we prevent corruption?

Does the US have enough raw materials, expertise, or capital equipment to overhaul our energy, telecom, and transportation infrastructures? Would Asian and European construction companies have to help us? If we use only made-in-America resources, will the work cost more and take longer? What will the unions say? If engineers populated our legislatures, we might have a better chance. But they don’t.

How will we tailor tax policy to offset the infusion of infrastructure spending? The question isn’t “how will we pay for” new infrastructure. As always, Congress will instruct Treasury to write checks and the Fed will ensure that Treasury checks never bounce. But we’ll still have to offset the potential inflationary effects of spending on infrastructure with taxes and bonds sales. That might mean that other sectors, still unidentified, will have to shrink so that the infrastructure sector to grow.

There are other issues, each of which is a cultural can of worms. If infrastructure renewal aims to facilitate a transition to a post-petroleum society, or a universal health care society, or an education-for-all society, legacy industries will resist. To ensure that the benefits of infrastructure renewal are socially equitable and environmentally safe, every project will require an ethnic-impact and an environmental-impact study. We could spend tens of billions of dollars just on impact statements by consulting firms. We will need to spend billions on up-front planning.

The other pachyderm in the parlor is inequality. A rising stock market doesn’t lift the half of American who don’t own stocks and don’t even have 401(k) plans at work. Construction projects don’t need as many bodies as they did in pick-and-shovel days, let alone low-skill bodies.

We really don’t have any choice but for the public sector to act on this. On its own, the private sector will cherry-pick the most profitable work and ignore the break-even but necessary work. If we don’t improve our infrastructure, as a society we’ll drift further toward inequality, with gated islands of wealth within plastic-strewn oceans of stagnation. That kind of economy won’t feed the profit-hungry stock market or generate the tax revenues that Social Security and Medicare need. Other countries will leapfrog us. Scarcities of unity and long-term thinking will have sealed our fate, not a scarcity of money.   

© 2021 RIJ Publishing LLC. All rights reserved.

A Surprise from IRS about Inherited IRA Distributions

Posted on April 21, 2021 by -

Just in the nick of time for filing 2020 federal income tax returns, the IRS issued a revised Publication 590-B (2020), “Distributions from Individual Retirement Accounts (IRAs)” (Pub 590-B). 

In it, the IRS suggests that taxpayers who inherit IRAs and are not eligible designated beneficiaries must take a distribution for each of the 10 years following the IRA owner’s death. This would eliminate the flexibility to determine the years in which the benefit is distributed, so long as the entire amount is distributed within the 10-year period.

While Pub 590-B applies solely to IRAs, the same interpretation would also apply to tax qualified plans such as 401(k)s, as well as  403(b) plans and other plans subject to the required minimum distribution (RMD) rules of the Internal Revenue Code. 

The SECURE Act changed stretch IRAs

The SECURE Act eliminated the “stretch IRA” for all beneficiaries who inherit an IRA, other than the IRA owner’s surviving spouse and certain “eligible designated beneficiaries.” The spouse and eligible designated  beneficiaries are individuals who may “stretch” distributions over their remaining lifetimes. 

An eligible designated beneficiary includes one who is disabled, chronically ill, or is not more than 10 years younger than the decedent. An eligible designated beneficiary who is a minor (an undefined term) may stretch distributions over the period of minority, then switch to a 10-year period. Other individual beneficiaries must complete distributions from the IRA within 10 years following the death of the original IRA owner (extended from five years under prior law). Other beneficiaries who are not individuals, such as estates or trusts, remain subject to a five-year rule. 

Under prior interpretations of the five-year rule, the  beneficiary need not take distributions each year of the applicable period but could wait until the entire period ended and distribute the IRA all at once. We would expect that the newer 10-year rule to be construed in the same way as the five-year rule. The seeming difference in treatment found in Pub 590-B presents a conundrum.

Reinterpretation by IRS

The IRS’s apparent interpretation of the SECURE Act would require annual distributions over the 10-year period and is contrary to what many commentators, including The Wagner Law Group, believe to be the plain meaning of the SECURE Act. It also runs counter to the legislative history of the provision.

If the new interpretation is intended and the IRS wants distributions to be taken annually, this would be  an unusual attempt to narrow a statute through a publication, without the benefit of a regulation or other formal guidance such as an announcement, notice, FAQs (frequently asked questions) or a revenue procedure.

Regulations, to be effective, require prior notice and the opportunity to present comments in writing and at a hearing. This is a time-consuming process but is generally expected if there is to be a change from the common understanding of the law. It is more likely, however, that the changes to Pub 590-B were made in error, during the haste of publication prior to the tax filing deadline, by an already over-burdened IRS staff.

So what should a taxpayer do?

The SECURE Act changes became effective January 1, 2020, and therefore apply only to IRAs and other accounts whose owners died on or after the first of last year. Due to COVID-related relief, no RMDs were required for 2020 at all, so no corrections need be made for last year. The question is whether a distribution should be made in 2021 to those beneficiaries who are subject to the 10-year rule. 

Cautious taxpayers could certainly plan to make 2021 distributions, including considering any additional cash resources that may be needed to pay any applicable income taxes. It is likely safe, however, to wait until year end for further guidance or a correction from the IRS. We believe that some response from the IRS will be forthcoming. In the end, this may prove to be a tempest in a teapot.

© 2021 Wagner Law Group.

An Annuity’s ‘Moneyness’? There’s an App for That

Posted on April 21, 2021 by -

Life insurance companies are using predictive analysis, derived from substantial insurer historical data, as the basis for modeling variable annuity owner behavior (OB). An important metric for predicting OB is the degree to which a contract is “in the money” (ITM). 

The insurer is concerned that when the liability (present value of the future estimated owner income) is substantially greater than the account value, the owner will elect the guaranteed income and the insurer would then be on the hook for the estimated difference.  But how can contract owners or their advisers know when the contract is ITM, so that they could take advantage of this situation?

The CEO of an actuarial firm that predicts OB recently told Retirement Income Journal:

Some issuers argue that annuity owners are not actuaries or calculating machines. So, they’ll look to simpler proxies, like ‘nominal moneyness.’ Others believe that while annuity owners aren’t doing detailed calculations, they have some sense of actuarial/economic value. So, they use an actuarial moneyness measure. We spend more time talking with our clients about this issue than anything else, because it is critically important to the long-term profitability of these products.

Can owners “intuit” a contract’s ITM? As an actuary, I’m skeptical. Most VA contracts have many moving parts; Estimating the ITM would require both an excellent method and a substantial programming effort. But, as shown below, these kinds of apps are fast becoming a reality. Spurred by growing owner awareness, and recent Best Interest regulatory requirements, they’ll likely have a major impact on OB.

R. Michael Markham

However, the CEO’s comment above raises a useful and important distinction. This actuarial/economic value is an insurer’s liability, based on their finances; whereas, for the owner, the value would be an asset, based on their finances. These two values must be different, and so must their ITMs.

“Nominal ITM” would be a crude approximation, but it does establish the principle of a separate owner-centric ITM, one that the owner could use to optimize their income. The issuers would need to modify their OB models to account for the owners/advisers’ reactions to this or similar metrics.

So, what are the challenges in developing a more useful insurer’s OB model?

The need to jump the insurer/owner divide

To develop an OB model, insurers would first need to jump the insurer/owner divide.  That is, put themselves in the shoes of the owner/adviser, and ask how, at any point in time, they would perceive the available options.  Then they’d have to try to predict which current and future choices would maximize their ITM-ness.

The overarching principle must be that the calculations are based on the owners’ perspectives and on their attributes, not the issuers’. The owners see the world from their own financial perspectives. They’re probably not aware of how the insurer manages its finances. They care only that the policy fulfills the guarantees in the contract.

How the ITM is calculated

What are the actual (and optimal) mechanics for calculating ITM? If we assume that each future year-end has its own ITM, which one(s) would be utilized? Further, would the insurer’s actuarial ITM (I-ITM), or nominal ITM (N–ITM) determine OB, or some weighted combination of the two?

The general equation for ITM is:

ITM = (PV Future Income – Account Value)/Account Value

This equation looks simple. Far from it.

  • There are many possible future scenarios, each with numerous possible income streams.
  • There are several ways that the PV component could be calculated; from deterministic to stochastic.
  • There are many approaches for determining the benefits and how they would be discounted.

Here’s a diagram showing some possible income streams, which could also include different combinations, such as a stream of free withdrawals, followed by the election of a guaranteed income stream, followed by, in some cases, when allowed, a death benefit or a surrender.

If owners are “not actuaries or calculating machines,” how could they determine any ITMs for these complicated variable products?

How to address this challenge

There are two kinds of ITMs: the actuarial one, observed by the insurer (I-ITM), and the one observed by the owner/adviser (O-ITM). This distinction is critical. Owners will decide based on the O-ITM, not the I-ITM. 

The owner will rely on an ITM that is based on the contract’s relevant details, of course, but equally on the owner’s age, gender, risk-appetite, estimated longevity, benefit preferences, tax brackets, targets, legacy, and other goals. The O-ITM is a function of all these things.

Ask the question: what lump sum would the owner need to invest today in a no-load mutual fund portfolio, based on their risk-appetite, to self-fund the contract’s projected owner net income stream? The answer can be computed by simulating their investing in a mutual fund whose portfolio matches their risk-appetite, and by deducting the contract’s periodic income payments, with the last deduction resulting in a zero balance.

The lump sum is what their O-ITM asset would be worth to them today. This asset would then be the PV component of the numerator used in the O-ITM calculation. Discount rates used for contract income would equal the net returns of this owner-centric portfolio. In fact, this is critical for what comes next: portfolio returns make sense only in a specific economic scenario.

‘Most Frequent Gambit’

Obviously the future is mostly unknown. There are many, many possible future economic scenarios. To address this challenge, the best approach is stochastic, i.e., projecting O-ITM distributions derived from numerous calibrated, randomly generated economic scenarios.

These economic scenarios would be combined with current user-entered policyholder attributes, to help match present and future decisions based on owner goals.

The metric for evaluation is the PV of net income, and we assume that the owner aims to maximize this figure. This is a common theme in mathematical approaches. But this “goal seeking” needs to be developed and applied in a way that the adviser and owner will understand and accept.

Broadly considered, we can begin to locate the maximum by considering every possible “start year/benefit type” gambit. In each scenario, each such “gambit” produces its own O-ITM figure. But we need to sift the resulting figures to estimate the owner’s most likely choice (OB). This determines the contract’s overall O-ITM.

So, what are the steps for calculating the OB, and the contract’s overall O-ITM?

  1. Project numerous economic scenarios and determine benefits for the targeted range of years.
  2. For each scenario/targeted year, produce an O-ITM frequency distribution for the maximum gambits for each scenario.
  3. Using this distribution, identify the most frequent gambit (MFG).
  4. For each targeted year, in each scenario, use the MFG to determine the O-ITM for each year and record each year’s gambit.
  5. Starting at the evaluation year, check each scenario, and, if its MFG occurs in that year, then that gambit will be used to calculate the scenario’s unique and final O-ITM, as of the evaluation year.

Note that all income streams are discounted based on the scenario’s returns, for a shadow no-load mutual fund portfolio based on the owner’s risk-appetite.

Also note, each year’s frequency distribution is derived from the assumption that the owner is running the O-ITM app at that time, within each scenario. Due to the very large number of calculations required to do this, for each scenario and each projected target year, approximate methods will be needed.

B-I requirements spur online apps

The app described so far seems theoretical, but the demand for O-ITM apps is not. Advisers, broker-dealers, and producers will be stepping up their game for their clients when selling, replacing, or managing variable annuity contracts. They will need to comply with  new regulations that address new fiduciary responsibilities, such as the SEC’s Reg-BI, new standards from both the CFP Board and the Department of Labor and multiple states’ Best Interest requirements (e.g., New York’s Reg 187 or Arizona’s SB1557).

Several watchdogs will be looking over their shoulders; advisers will need to evaluate contracts before and after purchase, providing on-going due diligence and account-management advice. The Biden administration is likely to enforce Best Interest and strengthen the fiduciary requirements for anyone selling or managing these kinds of products. New online apps, such as SmartAsset, are help potential policyholders pick the most reliable advisers. Every adviser will need to bolster a fiduciary relationship with clients.

That’s exactly what’s happening. A method called BI-SEM, from the BI-SEM group, has been proposed. It addresses the need for a standard stochastic approach to the evaluation of variable deferred annuities and deferred annuities in general. Second, apps are now emerging to implement the method.

BI-SEM (Best Interest – Stochastic Evaluation Method)

BI-SEM is a new stochastic evaluation method that bases its O-ITM on a policyholder’s key attributes, and discounts future estimated net income based on the policyholder’s risk-appetite (see BI-SEM whitepaper). I believe the BI-SEM method, when implemented correctly, provides an excellent O-ITM model for owners/advisers.

As a stochastic method, BI-SEM employs important features from the NAIC’s Commissioners Annuity Reserve Valuation Method (CARVM) and Principles Based Reserves (PBR). In their whitepaper, the group emphasizes piggybacking on existing, well-vetted statutory valuation procedures. Any app that properly employs this method should significantly impact OB.

In addition to Age and Sex, the Method makes use of the following valuable attributes in its projections:

  • Risk Appetite
  • Health Status/Estimated Longevity
  • Goals and Strategies
  • Tax Brackets
  • Benefit Preferences
  • Retirement Age Targets
  • Legacy Wishes

In most cases these are attributes not known to the Insurer. BI-SEM emphasizes that, unlike the Insurer, an adviser can ask these personal questions. In fact, for Best Interest, they must.

When implemented properly, the method is a sound one for the owner’s interests, because it:

  • Takes advantage of important personal attributes known only to the policyholder.
  • Is generally based on current well-vetted US Statutory Valuation Methods.
  • Is stochastic – a better simulation of real life from more viewpoints.
  • Calculates a current dollar evaluation of a contract.
  • Calculates a Score for the contract
  • Provides dispersion statistics.
  • Uses standardized metrics for contract comparisons.
A BI-SEM App from InjAnnuity, Inc.

This discussion is not purely theoretical.  O-ITM apps already exist, on the internet.  The DARMA online app authored by James Kavanagh, a founder at InjAnnuity Inc., is an excellent implementation of BI-SEM. The screen shots below highlight its versatility. 

The app produced meaningful reports and charts and did an excellent job of proving its numbers with a comprehensive set of on-demand audit reports (see below).

The existence of these kinds of apps, and their easy accessibility on the internet, greatly strengthens the case for the O-ITM-centric OB model.

Getting it right

Usage of O-ITM-based apps is not widespread—yet. The approach now needed by insurers is to assume an OB Model where the owner/adviser is much more informed about O-ITM. They need to assume that they are using a sophisticated app to best the insurer.

The overarching need in the model is to base owner/adviser decision-making from their now better-informed owner-POV. For the best results, the model should be stochastic. The big challenge will be in estimating owner attributes that are not known to the insurer. They can be based on the information contained in the contract. For example, an owner’s risk-appetite might be derived from their subaccount portfolio.

Other attributes might be derived from elected riders. Targeted retirement ages and other owner goals could be derived from historical experience for policyholders in the same cohorts. This would be combined with attribute probabilities derived from the historical studies performed by suppliers like Ruark, LLC.

OB assumptions should now be updated to consider that a certain percentage of policyholders are O-ITM aware, N-ITM aware and recognize that this is a moving target as O-ITM-aware apps proliferate. Getting this right is critically important to the long-term profitability of these products.

© 2021 R. Michael Markham.

Big drop in net income for publicly traded life/annuity firms in 2020

Posted on April 15, 2021 by -

The emergence of COVID-19 added new problems for publicly traded life/annuity (L/A) insurers and led to a 31% drop in net income, to $14.3 billion in 2020, according to a new AM Best special report.

The analysis in the Best’s Special Report, “US Life/Annuity Insurers’ Revenue Weakened in 2020,” covers a majority of the US L/A insurers that file US GAAP statements. According to the report, the segment’s operating performance was affected negatively by higher mortality, spread compression and flat sales in 2020.

Mortality rates, which remain manageable for L/A companies, peaked during the fourth quarter and the beginning of the first quarter of 2021, but the impact was less severe than that experienced by the general population. Mortality and morbidity trends are normalizing as more of the population is vaccinated, with declines in case counts and deaths. However, spread compression and interest rate assumptions will still impact profitability.

Of the 16 publicly traded companies in the analysis, nine saw a decrease in revenue. Overall revenue decreased by 4.8%, attributable to declines in net investment income (8.9%), premium revenue (3.8%) and other income (6.5%), countering the marginal increase in fees and commission revenue (0.7%).

The unfavorable revenue decline led to a 27% drop in operating income and the 31% drop in net income, with 13 of the 16 companies reporting a net income decline. A $4.7 billion realized investment loss on derivatives for Prudential Financial was the main driver of the drop in its net income, resulting in a loss of $146 million in 2020, down $4.4 billion from 2019, the largest decline of all the publicly traded companies.

The publicly traded L/A companies remain well-capitalized; capitalization has grown further due to favorable, albeit lower, earnings in 2020. Most companies showed a net increase in GAAP equity, with other comprehensive income improving due to the recovery of the financial markets after the downturn in the first quarter.

© 2021 RIJ Publishing LLC. All rights reserved.

Advisors underestimate interest in ESG investing: Cerulli

Posted on April 15, 2021 by -

Financial advisors apparently haven’t gotten the memo about environmental, social and governance investing (ESG). Advisors don’t think middle-class clients are interested in it. At least half of small investors say they are. A “disconnect” in advisor-client communications exists there,” according to the latest Cerulli Edge—U.S. Advisor Edition. 

“For ESG investing to grow in retail channels, advisors and asset managers must work to bridge these gaps and ensure that they fully understand the appetite for ESG investing among retail investors,” a Cerulli release said.

In a 2020 survey, Cerulli asked financial advisors why they weren’t adopting ESG strategies in their client portfolios. Lack of investor demand was by far the most prevalent response to a Cerulli survey; with 58% described that a “significant” and another 14% calling it a moderate reason for avoiding or neglecting ESG.

A majority of advisors believe that client demand for ESG strategies is a non-issue for them. Only a handful of clients reach out to advisors about ESG investing, Cerull said. But that’s not what the clients are telling Cerulli.

Nearly half (44%) of households would prefer to invest in an environmental or socially responsible way—far more than the “handful” of clients that advisors report proactively reaching out around the topic, according to a Cerulli survey of US retail investor households.

“Based on our research, advisors generally underestimate the demand their clients have for ESG and should not interpret lack of proactive questions as a lack of client interest,” says Matt Belnap, senior analyst.

When Trump Department of Labor dissed ESG investing last year by questioning its appropriateness for 401(k) plans—participants should invest with their wallets, not their hearts, Secretary Eugene Scalia seemed to say—the degree of blowback showed that he must underestimated the scope of public’s desire not to invest in tobacco, fossil fuel or weapons producers. 

Asset managers also misconceive

Advisors apparently share with asset managers a belief only the rich are very interested in ESG investing. Two-thirds of asset managers surveyed told Cerulli said they expect high demand from investors with more than $5 million in investable assets. Another one-quarter of asset managers expect moderate demand from HNW investors.

Retail investors feel otherwise, according to Cerulli’s research. More than half (56%) of households with investments worth $100,000 to $250,000 agree that they would rather invest in companies “that have a positive social or economic impact.”

“Asset managers and advisors are discounting the interest from a broad swath of the investing public,” Belnap said in the release. “Both asset and wealth managers should seek to make ESG investing more accessible across wealth tiers.”

An opportunity exists for wealth management home offices and asset managers to show financial advisors how to broach ESG with clients. Cerulli concluded, “If home offices can show advisors that their clients are generally open to discussing or implementing ESG solutions, and asset managers can provide them with tools and templates for successful conversations, fewer advisors will be held back by the ‘lack of client demand’ hurdle.”

© 2021 RIJ Publishing LLC. All rights reserved. 

DOL releases guidance on fiduciary investment advice

Posted on April 15, 2021 by -

The US Department of Labor’s Employee Benefits Security Administration this week issued guidance on fiduciary investment advice for retirement investors, employee benefit plans and investment advice providers. 

The guidance relates to the department’s “Improving Investment Advice for Workers & Retirees” exemption and follows its Feb. 12, 2021, announcement that that exemption would go into effect as scheduled on Feb. 16, 2021.

The department issued two documents:

Both guidance documents are limited to the application of federal retirement laws to advice concerning investments in plans covered by the Employee Retirement Income Security Act of 1974, such as 401(k) plans and the Internal Revenue Code, such as IRAs.

“The retirement investor guidance provides helpful information regarding the importance of selecting an investment advice provider who is a fiduciary and the protections that are provided to retirement investors under the “Improving Investment Advice for Workers & Retirees” exemption,” said Acting Assistant Secretary of Labor for Employee Benefits Security Ali Khawar.

“The compliance-focused frequently asked questions provide assistance to financial institutions and investment professionals as they ramp up compliance with the exemption.” The department is continuing to review issues of fact, law and policy related to the exemption, and more generally, its regulation of fiduciary investment advice.

© 2021 RIJ Publishing LLC. All rights reserved.

Life Insurers face “The Great Call”: Larry Rybka

Posted on April 15, 2021 by -

If you’re not exactly celebrating the creative destruction of the life/annuity industry over the past several years, check out the video that Larry J. Rybka, CEO of Valmark Financial Group, posted online this week.

“The Great Call” was his title for the 15-minute video. By “call,” Rybka means the signal that triggers the denouement of a poker hand. (If that title was meant to remind me of “The Big Short,” it did. The video appears to have been recorded from a wood-paneled man-cave.)

Rybka told RIJ that he was motivated to record the video op-ed piece by news of the sale of Allstate’s non-New York life and annuity business to Blackstone and its New York business to Wilton Re, as well as Constellation’s purchase of the mutual insurer Ohio National Life.

These transactions require financial disclosures, and Rybka has found that the disclosures offer  rare peeks into the financial damage that interest rate suppression has done to domestic life insurers in recent years. Like Warren Buffett, he knows that an ebb tide reveals the skinny-dippers. 

“The US life industry is facing a great call on long-term life and annuity products sold several years ago. These products had return guarantees that today’s rates don’t support. We don’t know how those blocks are doing until a sale, when companies have to show where they are on those products. That’s when we see a reconciliation of their bets.” 

In 2023, changes in FASB accounting standards will, after several delays, require all life insurers to account for the deterioration of their balance sheets in real time, not just when they are purchased or sell blocks of businesses. Currently, that deterioration becomes visible when deals go through.

In Wilton Re’s purchase of Allstate’s New York life and annuity insurance business, Rybka said, and it was reported on March 29, that Allstate had to inject $660 million into the New York subsidiary before selling it to Wilton Re for just $220 million. Allstate lost $4 billion on the sales of its life/annuity business, but the divestitures released $1.7 billion in capital that can be invested in more profitable businesses.

“Everybody says, ‘We’re fine,’  and the ratings agencies say the companies are ‘fine,” Rybka told RIJ. “So it’s only when there’s a transaction that can you see what the losses are.”

The intended audience for his video posts, he said, is made up of the insurance professionals that Valmark offers. The Valmark Financial Group consists of five companies: Executive Insurance Agency, Inc., Valmark Advisers, Inc., Valmark Securities, Inc., and Valmark Policy Management Company, LLC.

© 2021 RIJ Publishng LLC. All rights reserved.

A Chip Off the Old Rock?

Posted on April 15, 2021 by -

With ever-rising technology costs and a squeeze on their margins, US retirement plan recordkeepers have had only one refuge of profitability: Becoming big enough to achieve the necessary economies of scale. The industry has dramatically consolidated, and Prudential may be on the verge of exiting the game. 

A report on Tuesday by Bloomberg said that Prudential, the eighth largest recordkeeper by assets under management in the US, is thinking about selling its 401(k)/403(b)/457 retirement plan recordkeeping business. Sources weren’t identified and Prudential didn’t confirm the report.

“The Newark, NJ-based life insurer is working with a financial adviser to find buyers for its so-called full-service solutions business,” said Bloomberg, attributing the information to unidentified sources. “No final decision has been made and Prudential could opt to keep the business.” 

One possible reason for a change: the need for a big information technology upgrade. One plan adviser who has worked with Prudential for years, Barbara Delaney of HUB International, said that Prudential has multiple legacy systems, while competitors Empower and Vanguard have gone to faster, more agile cloud-based computing.

“This is no surprise. 401(k) margins are so small. Transactional businesses are tough to run. Prudential probably said, ‘Let’s focus on what we’re good at: life insurance and annuities,” Delaney told RIJ today. “And even Prudential employees seemed frustrated with their own systems.”

To illustrate the need for up-to-date technology, Delaney pointed to the passage of the CARES Act in 2020, which suddenly allowed retirement plan participants to take more money out of their accounts. Recordkeepers had to adapt within the space of hours, and all recordkeeping  systems were overtaxed. 

Prudential may also be underwater on the stable value funds offered in its retirement plans. As interest rates have gone down, stable value fund providers in some cases aren’t earning enough on their general account investments to cover the minimum yields contractually promised to plan sponsors. 

The plan recordkeeping business in the US has been consolidating for years. In the past year alone, MassMutual and Wells Fargo sold their retirement plan businesses to Great-West Lifeco, the second largest recordkeeper by AUM, and Principal, the fifth largest, respectively.

“This was not unpredictable. Prudential recently pulled out of the retail GLWB business, and the trend is toward of recordkeeper consolidation,” said Michelle Richter of Fiduciary Advisory Services. Another life/annuity industry insider told RIJ yesterday,  “My understanding is that [a Prudential deal] would be similar to the MassMutual sale. Retirement business very much a scale play.”

Scale is measured in fees on assets under management, or AUM. Fidelity leads in recordkeeping AUM with more than $2 trillion. Empower is a distant second, with almost $500 billion, followed by Vanguard, Alight, Voya, Principal and T. Rowe Price. (Alight is the new name for Aon Hewitt’s benefits business, now owned by the asset manager Blackstone. Empower is a unit of Great-West Lifeco.) Prudential was eighth in 2020 with about $180 billion (all AUM data come from Plan Sponsor magazine).

Stable value funds, with their modest but reliable yields, used to be the primary default investment for 401(k) plan participants who didn’t choose their own investments. The Pension Protection Act of 2006 allowed target-date funds and managed accounts to be default alternatives. These defaults included equities, and so offered much more higher upside than stable value funds. The Great Financial Crisis also ushered in the Fed’s ultra-accommodative interest policy, whose low rates reduced the returns on stable value funds. 

While the rates on many stable value funds were re-set every year, some retirement plans included stable value funds with long-term minimum guaranteed rates as high as 3% or more. Those promised rates, which helped providers win business, are now the source of losses, in some cases. Delaney said she does not believe that underwater stable value guarantees would cause Prudential to leave recordkeeping, however.

Prudential’s 10-K filing with the SEC on February 19, 2021, page 63, shows that $28.1 billion of the company’s $62 billion in contracts promising guaranteed minimum returns have a floor return of between 3% and 4%. An addition $900 million worth have contracts with guarantees of greater than 4%. In total, 47% of those contracts have minimum guarantees greater than 3% at a time when the ten-year Treasury is earning 1.56%. “The funds need to earn 3% to cover contractual minimums and the insurer’s cost of capital,” a person familiar with stable value funds told RIJ.

Prudential had considered growing its recordkeeping business through acquisition, but now has apparently decided to go the other way. A person familiar with Prudential Retirement estimated that the recordkeeping business accounts for about 10% of Prudential Financial’s earnings and 7% to 8% of its employees. 

Prudential has been an innovator in the in-plan annuity market. It began offering IncomeFlex, a guaranteed lifetime withdrawal benefit that could be wrapped around a plan participant’s Prudential target-date fund for an additional fee. That product—introduced a decade before the SECURE Act reduced barriers to annuities in plans—never reached critical mass, despite a big push from Prudential. 

In the retail retirement space, Prudential had $171.4 billion in variable annuity assets under management at the end of 2020, according to Morningstar. That was more than any other firm expect Jackson National ($229.1 billion) and TIAA ($527.4 billion). TIAA’s VAs are primarily group annuities in 403(b) plans. 

© 2021 RIJ Publishing LLC. All rights reserved.

ALI announces new research chair, ties with CANNEX

Posted on April 8, 2021 by -

The Alliance for Lifetime Income announced this week that economist Jason Fichtner, a former Social Security official and academic, would become a Senior Fellow and lead the organization’s Retirement Income Institute (RII). He succeeds Seth Harris, who was recently named deputy assistant for labor and economy to President Biden.  

In another announcement this week, the Alliance, a non-profit that educates consumers about annuities, and CANNEX, the annuity pricing, data and research firm, said they are joining forces “to conduct new research on protected income planning and annuities,” according to a release.

Fichtner, a senior lecturer at Johns Hopkins University’s Paul H. Nitze School of Advanced International Studies, helped found the RII in 20xx. In its first year, the Retirement Income Institute published 24 Insights papers and assembled some 200 retirement experts, academics and industry executives at the Alliance’s inaugural series of dialogues. 

In his new position, Fichtner will join a leadership team of RII co-chairs: 

  • Jon Forman, a law professor at the University of Oklahoma College of Law  
  • Leora Friedberg, a professor of economics and public policy at the University of Virginia and its Frank Batten School of Leadership and Public Policy  
  • Barry Stowe, former CEO of Jackson National Life Insurance and member of the board at Zurich Insurance Group

The Alliance’s research partnership combines CANNEX’s industry expertise in supporting the pricing and research needs of financial professionals and financial institutions with the Alliance’s deep knowledge and understanding of consumer behavior and sentiment related to annuities and retirement income planning. The topics this new research will explore include:

• Retirement and protected income planning behaviors and trends

• Perceptions, understanding, and use of annuities in retirement planning

• Importance and value of protection within modern retirement portfolios

• Shifts in retirement planning due to changes in the industry, the pandemic and other recent events

Both organizations have compiled retirement research in the past, including the Alliance’s Protected Lifetime Income study and the CANNEX/Greenwald Guaranteed Lifetime Income study.

Fichtner joined the Johns Hopkins University faculty in 2011 as an adjunct professor. Previously, he was a senior research fellow at the Mercatus Center at George Mason University. He has also taught at Georgetown University and Virginia Tech. In government, he served as senior economist with the Joint Economic Committee of Congress, and an Acting Deputy Commissioner of Social Security, among other roles.

© 2021 RIJ Publishing LLC. All rights reserved.

Falling discount rates hurt DB pensions at insurers: AM Best

Posted on April 8, 2021 by -

Defined benefit plans at insurance companies have been declining for more than four decades, a long-term trend that has been reinforced in recent years, according to a new AM Best Special Report, “Low Interest Rates Leading To Sharp Decline in Insurer Defined Benefit Plans.”

Only 184 companies rated by AM Best had defined benefit plans at year-end 2019, compared with 257 in 2016, according to the report. “In most cases, the decline can be attributed to companies terminating their plan, though in some instances, the benefit obligations were moved off the insurance entity balance sheet and are at the holding company level,” said AM Best in a release this week.

In 2013, new statutory accounting rules began requiring all insurers with defined benefit plans to recognize unfunded benefits on the balance sheet. Companies could either recognize the unfunded benefit obligations up front, or amortize them for a period no longer than 10 years.

Unfunded obligations can vary significantly each year, as economic conditions change and dictate new assumptions, which measure obligations and impact asset performance. Aggregated insurance company unfunded pension benefits have dropped to $13.9 billion in 2019 from $19.4 billion five years ago.

Pension obligations and assets have exhibited more volatility over this period, while other post-retirement benefit obligations and assets have been stable at around $16.5 billion. Few assets are held for post-retirement obligations, as they tend to vest much closer to retirement age.

An initial review of year-end 2020 statement filings indicates that benefit obligations will rise sharply as the Federal Reserve kept rates very low to stem the effects of the COVID-19 pandemic, the release said.

While interest rates started to rise late in 2020, the baseline discount rate to determine plan obligations will average between 2.50% and 2.60%, a drop of 80 to 90 basis points from 2019 levels. This is partially offset by strong returns on the equity assets backing the obligations.

The number of defined benefit plans on insurers’ balance sheets will continue to decline, AM Best predicts, either through plan termination or movement of the exposure elsewhere in the organization. As the accounting transition from 2013 winds down, these unfunded obligations will be fully recognized on statutory balance sheets.

To access the full copy of this special report, please visit http://www3.ambest.com/bestweek/purchase.asp?record_code=307416.

© 2021 RIJ Publishing LLC. All rights reserved.

Why bonds fit awkwardly in the separate account space

Posted on April 8, 2021 by -

Despite its importance as an asset class in the separate account space, fixed income represents less than 5% of model-delivered accounts, according to the latest Cerulli Edge—U.S. Managed Accounts Edition. Given how bonds are traded, asset managers struggle to deliver a bond portfolio to a broker/dealer (B/D) in a model format.

“Low-grade corporate, emerging market, and municipal issues trade infrequently, whereas the average daily trading volume of many stocks numbers in the tens of millions of dollars,” says Tom O’Shea, a Cerulli director.

When asset managers send sets of equity tickers to an overlay portfolio manager (OPM) at a large B/D, the B/D can usually send the trade straight to the market because there’s enough liquidity in equity trading, O’Shea said.

But if the asset manager were to send CUSIPs for a municipal bond to the B/D, the OPM would have to enter the bond market and post bid or ask prices for the bond and wait for a buyer or seller to emerge.

Additionally, fixed-income trading still depends on human networks. Stocks are usually traded through electronic networks that execute trades in seconds. Bonds are traded through buyers and sellers with long-established relationships that facilitate negotiation.

“Fixed-income asset managers typically have deep sell-side relationships, developed over years, that allow them to buy and sell bonds at institutional-level pricing that is unavailable to an investor buying through a retail overlay portfolio manager,” he added. 

The few asset managers that offer model-delivered bond portfolios do so through only the largest B/Ds, whose trading desks typically have the same deep relationships with counterparties that large fixed-income asset managers do. These model portfolios are also limited to high-grade, highly liquid fixed-income securities.

Fixed-income models will remain difficult to deliver in a model format, Cerulli believes. “The bond market is structured around the trading habits of large institutions,” said O’Shea. “With rare exceptions, fixed-income separately managed accounts are likely to continue to be manager-traded.”

© 2021 RIJ Publishing LLC. All rights reserved.

Raising Revenue–and Consciousness

Posted on April 8, 2021 by -

The Biden administration unveiled its plan for generating more revenue from US corporations yesterday. The plan would raise the statutory tax rate on corporate profits to 28% from 21%. That’s about halfway back to 35%, its level before the Tax Cut and Jobs Act (TJCA) in 2017.

Treasury Secretary Janet Yellen released a 19-page summary, “The Made in America Tax Plan” on Wednesday. The tax reforms described in the plan are intended to help offset his eight-year, $2 trillion project to renew the nation’s infrastructure and tilt from fossil fuels to green energy.

President Biden

The tax measures described in the white paper would do more than simply raise money to replace rusty bridges and subsidy solar panels. The administration would explicitly use the tax code to correct what it characterizes as long-standing ethical injustices, such as wealth inequality.

The paper reflects the stark change in Oval Office philosophy that occurred last January 20—an about-face as abrupt as any since 1932. President Biden might be counting on broad public support for his initiatives—evidenced by polls—to overcome his skinny majorities in Congress. He must know, however, that tax increases are the “third rail” of Republican politics: Raise them and you die. 

Since the measures in this latest segment of Biden’s tax plans apply mainly to multinational enterprises, rather than to taxes that directly hit citizens’ wallets, they might be difficult for anyone outside of the tax department of a multinational corporation tax department to tell what their exact impact might be. But here they are.

‘GILTI’ or not guilty

Much of the summary focuses on the alleged practice by US multinational corporations of minimizing taxes by reporting profits in tax havens overseas instead of at hone. In a reversal from the previous administration, the Biden plan accuses Corporate America of underpaying its taxes, not paying punitively high taxes. It distinguishes between tax rates and what corporations actually pay. In a sense, it charges companies with doing too good a job of reducing their US tax burdens.   

“The effective tax rate on US profits of US multinationals—the share of profits that they actually pay in federal income taxes—was just 7.8%,” the report said. “And although U.S companies are the most profitable in the world, the US collects less in corporate tax revenues as a share of GDP (gross domestic product) than almost any advanced economy in the Organization for Economic Co-operation and Development (OECD).”

The Biden plan would eliminate incentives in the TCJA that it claims encourage the “offshoring of assets.” The TCJA “created new offshoring incentives through two provisions, the Global Intangible Low-Tax Income (GILTI) provision and the foreign-derived intangible income (FDII) deduction.” The administration would work with other nations to set a uniform minimum corporate tax rate that would discourage regulatory arbitrage. 

Labor and Corporate Share of Federal Tax Revenue (1950-2019)

The Made in America Tax Plan would end the tax exemption for the first 10% return on foreign assets, would calculate the GILTI minimum tax on a per-country basis (raising an estimated $500 billion over a decade, and increase the GILTI minimum tax to 21% (three-quarters of the proposed 28% corporate tax rate, instead of the current one-half ratio).

“In addition to these reforms to GILTI, the plan would disallow deductions for the offshoring of production and put in place strong guardrails against corporate inversions. Overall, the stronger minimum tax regime would substantially reduce the current tax law’s preferences for foreign relative to domestic profits, creating a more level playing field between domestic and foreign activity,” the report said.

Paying at the pump, or not

The Biden plan also proposes deep changes in the taxation of energy, with an eye toward removing implicit and explicit subsidies for fossil fuel producers and creating incentives for developing sources of renewable energy. These changes are intended to slow the catastrophic warming of the earth under a shroud of heat-trapping gasses—a phenomenon that many Republicans still claim to disbelieve, despite well-documented evidence.

“Eliminating the subsidies for fossil fuel companies would increase government tax receipts by over $35 billion in the coming decade,” the report said, citing figures from the Treasury’s Office of Tax Analysis. The main impact would be on oil and gas company profits, not gas or energy prices, the report predicted.

For instance, the production tax credit and investment tax credit for clean energy generation and storage would be extended for ten years. There would be a new tax incentive for long-distance transmission lines and expansion of incentives for electricity storage projects.

The proposal would remove so-called allowances that shield corporations from federal taxes, such as the use of separate “book” and “tax” reporting. “Corporations are simultaneously able to signal large profits to shareholders and reward executives with these returns, while claiming to the IRS that income is at such a low level that they should be freed from any federal tax obligation,” the report said.

Instead, there would be a minimum tax of 15% on book income (the profit firms generally report to the investors). Firms would pay the IRS for the excess, up to 15%, on their book income over their regular tax liability. A firm with zero federal income tax liability computed based on its taxable income would still face a minimum tax of 15% on book income.

Easing labor’s pains

The Biden administration has previously announced its desire to reduce disproportionate wealth and income inequality in the US. His tax proposal would address that problem. “The labor share of national income has been declining for years, representing a worrying trend for workers and a contribution to rising income inequality,” the report said.

Inequality is “is exacerbated by a worldwide trend of governments shifting relative tax burdens away from corporations and capital and onto workers by reducing tax rates on capital gains, dividends, and corporate income while increasing tax burdens on sales and wages.” Consequently, the share of federal revenue raised by the corporate tax has fallen to under 10%, while the share of revenue raised by taxing labor has grown to over 80%.“In 2019, the top 5% of the income distribution earned just 26% of labor income, but 71% of capital income,” the report said.

© 2021 RIJ Publishing LLC. All rights reserved.

What’s Cooking at ‘Income Lab’?

Posted on April 8, 2021 by -

True story: Around midnight, a sleepless retiree speed-dials her adviser. Their last meeting had ended on what the adviser thought was a positive note: a Monte Carlo simulation showed that the client’s portfolio had a 94% likelihood of success through age 90.

But now the client was bedeviled by bankruptcy goblins. “Was 94% safe enough?’ she wanted to know. ‘Shouldn’t they reach for 96% or 97%?” 

Anxiety attacks like those are what Johnny Poulsen and Justin Fitzpatrick, two former Jackson National Life executives turned entrepreneurs, see their software curing. Their product, beta-launched a year ago and now available to advisers, is called Income Lab. The name sounds scientific—like the AgeLab at MIT.

Denver-based Income Lab is designed to help quell the fearful client question: Will I run out of money? and emphasize the more common question, How much can I spend in retirement? The goal is to maximize annual income during retirement rather than maximize gains or final wealth. 

“Most people begin retirement with a lot of upside, relatively speaking,” said Fitzpatrick, who earned a Ph.D. in linguistics at MIT. “There’s more upside to their situations than downside. But other software doesn’t capture that at all. There’s no way to tell the hopeful story. We have a system that shows people the upside, and encourages them to ‘live a little.’”

With a financial planning software market that’s both crowded and concentrated in just a couple of firms, one has to wonder if there’s room for one more. Poulsen and Fitzpatrick believe that none of the existing tools do a very good job with income planning. “We worked with 20 different finance professors when we were developing this, and nobody disagreed that there’s a need for a massive upgrade,” Poulsen told RIJ.

Grabby screenshot

The grabbiest screenshot in Income Lab, of what I saw, is a chart that resembles a scenery artist’s grey and blue silhouette of a distant urban skyline. This is Income Lab’s “Economic Context” tool. (For a video, click here.) Each of the tightly packed vertical bars on the chart represents a month in market performance history, and the height of each bar indicates the maximum amount a particular client could have safely spent from his or her portfolio in such a month.

Three colored lines run horizontally across the width of the chart. A purple line represents the retiree’s minimum spending need; a higher green line represents the retiree’s desired spending, and an even higher blue line represents the advisers proposed spending level. The blue line shows a spending level that’s in-the-money—affordable, that is—for almost every month in history, going back to the 19th century. (See below.)

Exactly how Income Lab generates those numbers, I don’t know. But I suspected that a client would find this chart soothing to look at before and during retirement. In practice, an adviser would get an automatic ping from Income Lab’s software every year, recommending that clients should tweak their incomes up or down a notch.

“We call it ‘guardrail-based retirement income planning,’” Fitzpatrick told RIJ. “Any time you have dynamic income planning, you need triggers. That’s the framework that a lot of advisers would like to use but, given the software that they’re using, it’s a square peg in a round hole.”

Under-applied research

Poulsen emigrated to the US from Denmark in the late 1990s. He joined Jackson National at its Denver office, eventually becoming senior vice president for distribution. Fitzpatrick had been a linguistics professor before arriving at Jackson. When he met Poulsen, Fitzpatrick was leading a team of  CFPs and CPAs who were studying research on advanced financial planning.

“That got me thinking about the state of the art of financial planning,” Fitzpatrick told RIJ recently. “Retirement planning is such a difficult problem. It’s attracted the heavy hitters in the financial world, like Robert Merton and Bill Sharpe. So there’s been a lot of great research.” But advisers and clients weren’t applying much of it, he thought.

Fitzpatrick (l) and Poulsen of Income Lab

By 2018, a time when Jackson National was starting to change course—it vacated its Denver office for Nashville and began separating from its long-time owner, Asia-focused Prudential plc, in 2020—the two men and a distribution colleague, Gregg Mahalich, decided to put what they’d learned (and their own savings) to work by starting Income Lab.

“Johnny and I were part of a team looking at technology,” said Mahalich, who is chief revenue officer at Income Lab. “Justin was researching retirement planning. We found a lot of high quality research that we thought could greatly improve the process of retirement planning.”

They had three implicit goals: To make the software dynamic, so that a retiree’s income would adapt to market conditions; to help retirees avoid unnecessary worry (an affliction common even among the well-off); and to help retirees avoid under-spending.

“I have a 59-year-old neighbor who invests with a national broker-dealer. He got a plan from his adviser with a 90% success probability,” Fitzpatrick said. “His wife is 49. She’ll probably outlive him by at least 10 years. He assumed she’ll face a 10% risk of portfolio failure. We showed him that their worst-case scenario would involve an 8% decrease in spending. Would that be inconvenient for them? Maybe. Would it mean ‘failure’? No.”

Top-heavy field

Fitzpatrick, Poulsen and company are now taking their product to market. They have added a tax module to the original software, so that advisers can help clients spend tax-efficiently from their various taxable, tax-deferred and Roth IRA accounts. So far they’ve been working with a few firms in the XY Planning Network, the group of independent planners created in part by advisory guru Michael Kitces.

Gregg Mahalich

“We launched a beta version in April 2020, and we stayed under the radar for a while to get product feedback. We started in earnest in the fourth quarter of last year, and launched the tax module this year. We see ourselves at the intersection of academics, technology, and practice,” Fitzpatrick said.

Pricing is volume based. A single adviser would pay $159 a month to use the software, with a 10% discount for annual payment. Teams up to nine people would pay $149 per month and teams of ten or more would pay $139 per month. Again, the 10% discount for annual payment is available.

They’re trying to penetrate a market dominated by a handful of big players. According to Bob Veres and Joel Bruckenstein’s 2020 survey of advisers on their choices of financial planning software, two providers accounted for 50% of the market. MoneyGuidePro, which Envestnet owns, had a 28% share. Fidelity’s eMoney Advisor had a 21.5% share. Right Capital was a distant third at 5.5%. MoneyTree and Advicent/Naviplan filled out the top five. 

Of course, it seems as if all planning software makers claim to provide dynamic modeling, retirement income projections, side-by-side plan comparisons, risk assessment, a holistic, all-encompassing approach and the ability to integrate annuities into the plan.

But they arguably tend to emphasize investment management and optimal accumulation. That may reflect the fact that most advisers have those priorities. It may also signify that many affluent people over age 65 don’t think of themselves as retirees but as full-time investors. 

Fitzpatrick sees it differently. “People ask us, ‘Why has no else one done this before?’” he said. “Because it’s really hard. It’s much easier to run a static plan. The plans that people create on Income Lab are fully dynamic. Many other planning platforms will tell you that they’re dynamic. But while they may be able to update account balances through integration, their plans are static. We recognize that things change. People adjust their spending as their circumstances change.”

© 2021 RIJ Publishing LLC. All rights reserved.

Security Benefit Life’s Secret Sauce

Posted on April 1, 2021 by -

There’s a belt-and-suspenders aspect to pegging the performance of a fixed indexed annuity (FIA)—a product that can’t lose money unless “surrendered” prematurely—to the movement of an index designed to move less than the market. 

From a marketing perspective, however, it makes perfect sense to use a managed-volatility index inside an FIA. It allows the issuers to offer attractively high participation rates or caps on returns—or even “uncapped” returns. You don’t need to cap the returns if the cap is baked into the index.

This week, Security Benefit Life, the eighth largest seller of FIAs in the US in 2020 ($2.88 billion), according to LIMRA, added two new managed-vol index options to its Strategic Growth Series FIAs.

The two new options are the S&P500 Factor Rotator RC2 7% Index and the S&P Multi-Asset Risk Control (MARC) 5% Index. Both rebalance daily among several asset classes as they pursue 7% and 5% volatility levels, respectively. Both indexes were launched in March 2017, but they’ve been hypothetically back-tested to 2011. 

A dozen years ago, people thought FIAs were “complex,” with their bewildering variety of crediting methods. Today, FIAs are even more complex. They use bespoke indexes designed by rocket scientists. Recommending the “right” index to a client (especially if you’re subject to a “best interest” advisory standard) won’t be easy. 

Security Benefit Life is a highly rated (A-) life insurer with assets of about $40 billion, as of the end of 2019. Like Athene, Global Atlantic and F&GL, it is one of FIA issuers acquired by big investment firms or holding companies since the Great Financial Crisis, and which now collectively dominate the FIA market.

Factor Rotator

The Factor Rotator index includes a mechanism that shifts money between the five factors: Quality, Value, Momentum, Low Volatility, and High Dividend. “The index varies allocations between the equity factor components, the Treasury Note Futures Index, and cash, depending on market performance on a daily basis,” according to an S&P fact sheet.

Here are the steps that the Factor Rotator Index follows:

1. Calculate historic risk-adjusted momentum based on short, medium, and long-term return horizons for the five eligible factor indices.

2. Select the two factors with the highest composite risk-adjusted momentum scores.

3. Weight 75% of the account value to the highest-ranking index, 25% to the index with the next-highest rank.

In addition, there’s a Risk Control 2.0 (RC2) overlay that tries to maintain portfolio volatility at 7% by adjusting the portfolio allocation between the underlying index and the S&P 20Year US Treasury Note Futures Index liquid bond index.

In effect, a kind of CPPI (Constant Proportion Portfolio Insurance) mechanism is built into the index. CPPI ensures that a dynamically rebalanced portfolio will always contain at least enough safe assets to cover the guarantee. It was CPPI that protected Prudential’s Highest Daily variable annuity liabilities from getting underwater during the Great Financial Crisis. 

MARC

The S&P 500 Multi-Asset Risk Control 5% Index reaches for yield by using leverage (up to 150%) and keeps volatility down to 5% by rebalancing every day between three underlying indexes: the S&P 500 Excess Returns Index, the S&P GSCI Gold Index, and the S&P 10-Year US Treasury Note Futures Excess Returns Index. Its methodology:

The underlying commodities and fixed income indices are calculated and published by S&P Dow Jones Indices on a daily basis as excess return indices. [In this case, the equity component is an “excess return,” i.e., levered, version of the S&P 500, derived from the S&P 500 Total Return Index.] The indices are calculated using a risk-weighted approach that utilizes a maximum leverage of 150% and a 5% volatility target.

As the index brochure says, “In low-volatility environments, the S&P MARC 5% Index risk control mechanism increases market exposure to riskier assets by increasing the allocation to the Index (up to a leveraged position of 150%).”

Powered by former Guggenheim president

Joe Wittrock

In an interview with RIJ, Security Benefit chief investment officer Joseph Wittrock said, “With the Rotator, we researched the factors that produce outperformance. Everybody knows that there are certain factors driving long-term returns. But some do better in some environments than others. We asked, ‘How do we create an evergreen strategy that gives the benefits of factor outperformance all the time?’”

Guggenheim Partners bought Security Benefit in 2010 and spun off the life insurer to one of its senior executives, Todd Boehly, when he left Guggenheim in 2015. Wittrock noted that the investment skills that Guggenheim brought to Security Benefit had paid off. “When you look at track record, it speaks to consistent returns. We have the highest earn rates in industry, and that enables us to offer higher [FIA crediting] rates.”

For example, Security Benefit has, like several of its peers in the FIA business, been able to lift its general account returns by investing in CLOs, or Collateralized Loan Obligations. These are securitized bundles of the type of “leveraged loans” often made to equipment leasing, cellphone tower, or music-royalty companies with strong cash flow but weak credit. Life insurers can buy the senior or investment-grade “tranches” of these bundles, which offer higher yields than similarly rated corporate bonds.

Security Benefit’s FIA-issuing peers include Athene, Global Atlantic, F&GL, Great American, American Equity, EquiTrust, and Delaware Life. Many of these companies are owned by or affiliated with powerful asset managers or holding companies like Eldridge, Apollo, KKR, Blackstone, Guggenheim, Group1001 and others. (Great American was acquired last year by MassMutual.) Together, they accounted for 42% of all FIA sales in 2020, according to LIMRA. Their close competitors in the FIA market—AIG, Sammons, Allianz Life, and Nationwide— have quite different business models. 

Daily allocations of the MARC Index (pre-March 2017 backtesting data is hypothetical.)

Wittrock said that Security Benefit allocates about 40% of its general account to CLOs, and that most of that 40% is in tranches rated BBB. “If you look at our asset allocation, and look at the other companies, you’ll notice that we look very different. That’s intentional. If we look like everybody else, you’ll get the same outcome,” he told RIJ.

Some of his firm’s competitors enhance their earnings by moving part of their liabilities to captive reinsurers in offshore regulatory havens like Bermuda, Wittrock said, but only about one percent of his company’s assets are reinsured, and those are reinsured in Vermont. [Vermont, along with South Carolina and Delaware, is a domestic insurance regulatory haven.]

What’s striking about Security Benefit and at least some of the other life insurers named above, is the integrated business model they’ve created, which Fed economists described in a research paper a year ago. In this model, a life insurer accumulates (by purchase or new issue) blocks of long-dated liabilities, such as FIAs.

An affiliated asset manager (or strategic partner providing investment expertise) originates loans to companies with good cash flow but poor credit, bundles those loans into CLO securities, and then carves out made-to-order tranches suitable for purchase by the FIA issuer for its general account.  In such cases, the FIAs are sold to provide stable assets for the purchasing and holding the tranches of the CLOs. 

Within a single holding company, there might be an investment firm specializing in loan origination, an affiliated reinsurance company, an annuity issuer, and perhaps a Registered Investment Advisor or insurance marketing organization, that are vertically integrated. Security Benefit is a property of the Eldridge Industries, which is led by former Guggenheim president billionaire Todd Boehly. 

Along with the investment skills and properties (including Security Benefit) that Boehly brought with him from Guggenheim in 2015, Eldridge owns or controls Maranon Capital, a private equity firm, CBAM Partners, an alternative investment management firm, SE2, a life insurance and annuity web platform, as well as a variety of media properties that earn the types of streams of royalties that can finance CLOs.

As a Bloomberg reporter wrote in 2019, Eldridge “incorporates some elements of both Warren Buffett’s Berkshire Hathaway and Athene Holding. Like Berkshire, Eldridge is a holding company that uses premium revenue from a captive insurer — the so-called float — to fund investments. Like Athene, the insurer whose assets are managed by Apollo Global Management, it issues annuities to create that float.”

© 2021 RIJ Publishing LLC. All rights reserved.

Updates from Allianz Life, Athene and Investors Heritage

Posted on April 1, 2021 by -

New caps on AllianzIM Buffered Outcome ETFs

Allianz Investment Management LLC announced new upside caps for the April series of its Buffered Outcome ETFs suite: the AllianzIM US Large Cap Buffer10 Apr ETF and the AllianzIM US Large Cap Buffer20 Apr ETF.

Introduced in June 2020, the AllianzIM Buffered Outcome ETFs offer exposure to the S&P 500 Price Return Index up to a stated cap, while aiming to buffer investors from losses on the downside. AllianzIM currently offers two strategies on the S&P 500 Index: a 10% buffer and 20% buffer, each with quarterly offerings and 12-month outcome periods.

“The funds are the lowest cost defined outcome ETFs on the market today and consistently trade with some of the tightest spreads among peers in the category,” an Allianz Life release said.. AllianzIM manages its ETF line-up on a proprietary in-house hedging platform with over $150 billion in hedged assets.

Investors Heritage Life offers climate-friendly index on new FIA

Investors Heritage Life Insurance Company has launched Heritage Income Advantage, a single-premium fixed indexed annuity. The product offers a Guaranteed Lifetime Withdrawal Benefit (GLWB) Rider, which guarantees income for life, and an Enhanced Income Benefit Rider, which can double income for up to 60 months when certain unexpected health situations occur.

“The Enhanced Income Benefit can be used for five years non-consecutively. A client and spouse can use it for hospital or home-healthcare costs,” said John F. Frye, president of Investors Heritage. HIA allows policyholders to realize upside potential based on three index options: the S&P 500, the S&P MARC 5% (Multi-Asset Risk Control) Index, and SG Entelligent Agile 6% VT Index

Société Générale partnered with Entelligent to launch the SG Entelligent Agile 6% VT Index. The index uses Entelligent’s Smart Climate model to score companies in the S&P 500 based on the potential impact from new environmental-focused regulation and technology as well as forecasted energy costs. The index provides exposure to the 250 companies in the S&P 500 with the highest scores. 

AccuMax is launched by Athene

Athene Annuity and Life Company, a unit of Athene USA, has launched AccuMax, a fixed indexed annuity (FIA) that the company describes as designed for “patient money set aside for retirement or other long-term savings goals.” 

AccuMax makes available multi-year indexed interest crediting strategies, multi-asset indexes, and crediting rates that are guaranteed for the annuity’s withdrawal (surrender) charge period. All fixed and indexed strategy crediting rates are guaranteed for the duration of the Withdrawal Charge period. Additional product features include:

  • Multi-year and annual crediting terms provide growth potential and liquidity.
  • Features new AI Powered Multi-Asset Index (AiMAX1) and Shiller Barclays CAPE Allocator 6 Index (BXIISC6E1).
  • Innovative Annual Interval Sum crediting strategy tied to the S&P 500® combines the benefit of higher rates through a multi-year strategy with the ability to measure index performance in annual steps.
Prudential adds Invesco and BlackRock ETFs to its FlexGuard RILA

Prudential Financial, Inc., has added the Invesco QQQ ETF, which tracks the Nasdaq-100 Index, and the BlackRock iShares Russell 2000 ETF as options within the crediting strategies of Prudential’s FlexGuard indexed variable annuity.

FlexGuard has achieved close to $2 billion in sales within less than a year of launching, according to annuity sales data from the Secure Retirement Institute. Indexed variable annuities are also RILAs (registered index-linked annuities). Sales of RILAs, introduced in 2011 by AXA Equitable, grew more than 30% in calendar 2020.

“FlexGuard’s index strategies allow customers to select strategies providing the potential to accelerate gains above and beyond the index return when certain targets are met. Importantly, FlexGuard is designed to adapt with consumers’ needs, allowing periodic changes to investment length, protection level and growth strategies, as the markets shift, and individual financial goals evolve,” a Prudential release said.

  • © 2021 RIJ Publishing LLC. All rights reserved.

Honorable Mention

Posted on March 31, 2021 by -

Edward Jones to pay $34 million, agrees to improve treatment of minority advisors

Edward Jones, the broker-dealer and 16,000-adviser financial products distribution network, has agreed to pay $34 million to settle a racial discrimination lawsuit filed in 2018 on behalf of current and former African American financial advisers, according to news reports this week. Edward Jones also agreed to change its hiring, training, promotional practices and policies to better support financial advisers of color.

“The settlement includes measures Edward Jones is taking to report diversity progress to its leadership team, create a financial advisor council with diverse representation and reduce training cost obligations,” the brokerage said in a release.

Wayne Bland, a Black financial adviser who worked at Edward Jones from 2014 to 2016 filed the class action suit in 2018. The Chicago law firm of Stowell & Friedman, which negotiated class-action settlements on similar claims against Merrill Lynch and Wells Fargo, represented the class.

Bland’s suit alleged that management at Edward Jones repeated passed over Bland and other Black advisers in favor of equally or less-qualified white advisers when granting or assigning the most desirable assignments, clients, training programs, mentorships, and promotions, all of which reduced the ability of the Black advisors to get ahead at the firm. to young advisers.

The class includes Black financial advisers employed by Edward Jones at any time between May 24, 2014, and Dec. 31, 2020, according to settlement documents filed with the federal court in Chicago.

According to the 2018 complaint, African American hires at Edward Jones were “disproportionately” from the “Legacy” and “Goodknight” training programs, where new advisers received office space, administrative support, and mentoring from an established FA. The suit claims that these programs disproportionately went to white advisers. The best territory assignments and the opportunity to inherit clients from retiring advisers also went mainly to white advisers, the suit said.

“The Firm disproportionately relegates African American FAs to territories and offices in less lucrative locations with less investable income and that are less productive for the FA. The Firm also reserves territories with greater investment opportunities for non-African American FAs in order to race-match its FAs to the neighborhood demographics,” according to the complaint.

Bland and co-plaintiffs said that, in 2015, only 6% of Edward Jones advisers were Asian, African American or Latino, compared with 21% of financial advisers nationally.

J.P. Morgan to diversify advisor hiring by 2025

J.P. Morgan Wealth Management unveiled plans this week to serve more Black and Latinx clients and increase diverse advisor hiring by 2025. The firm said it had made a “$30 billion commitment to advance racial equality.”

The plans will include partnerships with Historically Black Colleges and Universities (HBCUs), initiatives to promote internal mobility, resources to allow diverse employees to grow their career over time and a goal of hiring 300 additional Black and Latinx advisors by 2025.

Over the next five years, J.P. Morgan Wealth Management will partner with various HBCUs to offer students resources and information about careers in wealth management, and to provide scholarships, training and licenses. The initiative will create 185 full time positions specifically for this program by 2025.

The Advisor Development Program is a 24-36 month training that is providing about 270 candidates with the investments knowledge, mentorship and coaching needed to become a successful financial advisor. Nearly 80% of the participants are women or minorities.

HUB launches bundled retirement plan for small to mid-sized employers

The introduction of HUB Retirement Select, a bundled retirement plan solution for small to mid-sized businesses “looking for amenities traditionally afforded to large organizations,” was announced this week by HUB Retirement and Private Wealth, a unit of Hub international Ltd.

HUB Retirement Select is designed for owner-only organizations to those with hundreds of employees, providing “advanced technology and analytics, leading retirement benefits specialists and compliance support at an affordable cost,” according to a news release.  HUB Retirement Select’s managed account service offer investment guidance to participants.

HUB Retirement Select is being positioned as “a highly competitive alternative option to state-mandated and voluntary retirement plans for employers.” California, Illinois, Oregon,  Washington, New York, Vermont, Connecticut, New Jersey, Massachusetts, Maryland, and Seattle have enacted mandated and voluntary retirement programs.

HUB RPW provides investment advisory services on more than $93 billion in assets through its SEC-registered RIAs. It offers institutional and retirement services to for-profit and not-for-profit organizations and customized private wealth management services to individuals and families. Joe DeNoyior is National President of HUB RPW.

Insurance services are offered through HUB International, an affiliate. Global Retirement Partners, LLC, Silverstone Asset Management, LLC, Hub International Investment Advisory Services, Inc., and Sheridan Road Advisors, LLC are SEC-registered investment advisors and wholly owned subsidiaries of HUB International. 
Headquartered in Chicago, Illinois, HUB International Ltd is a full-service global insurance broker with more than 13,000 employees. It provides risk management, insurance, employee benefits, retirement and wealth management products and services.

Allstate Corp. concludes exit from life/annuity business

Wilton Re will pay $220 million to acquire Allstate Life Insurance Company of New York (ALNY) from the Allstate Corporation, according to a release this week. The transaction is expected to close in the second half of 2021, subject to regulatory approval and other closing conditions.

With this transaction, and its announced agreement to sell Allstate Life Insurance Company (ALIC) and certain affiliates to entities managed by Blackstone, Allstate has exited the life and annuity businesses. Allstate agents and advisers will offer life insurance and retirement products of third-party providers. The agreement includes termination of an ALIC stop-loss reinsurance treaty.

Allstate has agreed to contribute $660 million of capital into ALNY, then receive a payment of $220 million from Wilton Re. The transaction will reduce GAAP reserves and invested assets by $5 billion and $6 billion respectively.  The combined divestitures will result in an estimated GAAP net loss of approximately $4 billion, which will be recorded in the first quarter of 2021, and generate approximately $1.7 billion of deployable capital.

J.P. Morgan Securities LLC and Ardea Partners LP acted as financial advisers, and Willkie Farr & Gallagher LLP was the legal adviser to Allstate.

Prudential adds Invesco and BlackRock ETFs as options on its FlexGuard RILA

Prudential Financial, Inc., has added the Invesco QQQ ETF, which tracks the Nasdaq-100 Index, and the BlackRock iShares Russell 2000 ETF as options within the crediting strategies of Prudential’s FlexGuard indexed variable annuity.

FlexGuard has achieved close to $2 billion in sales within less than a year of launching, according to annuity sales data from the Secure Retirement Institute. Indexed variable annuities are also RILAs (registered index-linked annuities). Sales of RILAs, introduced in 2011 by AXA Equitable, grew more than 30% in calendar 2020.

“FlexGuard’s index strategies allow customers to select strategies providing the potential to accelerate gains above and beyond the index return when certain targets are met. Importantly, FlexGuard is designed to adapt with consumers’ needs, allowing periodic changes to investment length, protection level and growth strategies, as the markets shift, and individual financial goals evolve,” a Prudential release said.

© 2021 RIJ Publishing LLC. All rights reserved.

VAs suffer record outflows, but enjoy record assets

Posted on March 31, 2021 by -

The registered index-linked annuity, or RILA, has perhaps the least self-descriptive name in the entire annuity industry, and that’s saying something. A few distributors flat-out hate the acronym for this hybrid product—which combines features of a variable annuity, a fixed indexed annuity, and a structured note.  

But no one can argues with the sales numbers that RILAs are putting up. As Morningstar’s VA quarterly sales analysis for 4Q2020 shows, sales of these cap-and-buffer contracts were up 70% in the fourth quarter of 2020, versus 4Q2019, and LIMRA had them growing almost 40% in 2020, to $24 billion.

The RILA market is still much smaller than either the traditional VA market ($74.9 billion sales in 2020), where Jackson National dominates ($16.6 billion), or fixed indexed annuities ($55.7 billion) in 2020, where the private equity firms have muscled in. But both of those categories saw overall falling sales in 2020.

That makes sense. RILAs don’t seem to carry the annuity stigma, and they give nervous investors a Goldilocks alternative to high-priced stocks or bonds. Not that the average investor would understand how RILAs work. To structure them, insurers buy upside calls and sell downside puts on domestic or international equity indexes. The call options buy gains up to a cap, and the puts buy buffers against the first five to 35 percentage points of loss over a given term. The S&P 500, Russell 2000 and MSCI are among the indexes commonly used.

With their fixed income assets yielding so little in today’s low interest rate environment, life insurers have for a decade had to tap into the robust equity market, either by wrapping guarantees around mutual funds (in a traditional VA) or buying options on an equity index. Equitable (then owned by AXA) brought the first RILA to market in 2011; others have followed.

Five of the 10 best-selling VA contracts in 4Q2020 were RILAs: Prudential Flexguard B (2), Equitable’s Structured Capital Strategies (3), Lincoln’s Level Advantage (4), Allianz Life Index Advantage Income (6) and Allianz Life Index Advantage (10). The top seller, with a whopping 14.3% market share, was Jackson’s Perspective II.

Flexguard was the top-selling rider in the fourth quarter of last year, but, as a newcomer to the market, was only fifth in sales for the year. Lincoln’s Level Advantage B-share was the top seller for 2020, with $4.18 billion in sales. Allianz’s Index Advantage Income moved into the list of top 10 best-selling VAs jumping 14 places compared to Q4 2019. RILAs accounted for almost 24% of all VA sales in the fourth quarter, up from 14% a year ago.

VA assets top $2 trillion

Sales of traditional variable annuities, with and without lifetime income guarantees, have taken a huge hit from the low interest rate environment of the past decade. While a rising stock market would be expected to favor VAs—which consist of tax-deferred mutual funds—low interest rates makes it expensive to hedge them. Costs have gone up and benefits have gotten less generous.

Sales of VAs have stabilized at between $87 billion to $91 billion a year for the last three or four years, after peaking at $125 billion in 2011. But the real damage shows up in the net flow statistics. The category has suffered increasingly large negative net flows. In 2020, for the first time, net outflows of money from VAs (-$94.9 billion) surpassed new sales ($87.1 billion). 

Don’t cry for VA issuers, however. They are still huge fee generators for the companies that issue them. The market value of assets held in VAs surpassed $2 trillion for the first time in 2020. Since VAs generate both insurance and investment fees (as high as 4%, in contracts with income benefits), those assets could easily produce more than $50 billion in fees for annuity issuers and asset managers. Of that $2 trillion, more than 25% is at TIAA, where it is held mainly in group annuities at the firm’s network of 403(b) plans. The top 10 VA issuers account for about 80% of VA assets.

VAs with GLWBs

The sale of non-RILA VAs offering guaranteed lifetime withdrawal benefits (GLWBs) fell 12% y/y but grew 12% over the previous quarter—signaling a slow recovery for the segment. Jackson’s Perspective II, AIG’s Polaris Platinum III B, and Ameriprise’s RVS RAVA5 Advantage all showed significant sales movement, according to Morningstar.

The Perspective II retained its top position and saw sales jump by 7% to $3.4 billion in the fourth quarter. Its living benefit offers an average fixed percentage increase (FPI) of 6% and its withdrawal rates lie near the 75th percentile of the industry. AIG’s Polaris Platinum grew 8% y/y in sales; its GLWBs offer better-than-average benefit fees and withdrawal rates.

Sales of Ameriprise’s RVS RAVA5 Advantage dropped 34% y/y and the contract fell out of the top 10 sellers. While its living benefits offer a relatively high FPI of 6%, the withdrawal rates of its GLWBs dropped by 20 to 50 basis points year-on-year. Benefit fees increased by 15 to 55 basis points in the same period.

Though Perspective II and RVS RAVA5 have comparable FPIs, withdrawal rates and benefit fees, The discrepancy in quarterly sales between Perspective II and RVS RAVA5 may reflect the role of distribution channels and surrender schedules. The Perspective II is distributed primarily through independent agents; that channel rebounded after restrictions on businesses were lifted in the third quarter.

RVS RAVA5 is distributed through captive agencies, which continue to record negative quarter-on-quarter sales growth. Moreover, interest rates increased in the fourth quarter, which may have led investors to favor more liquid products. RVS RAVA5 has a 10-year surrender schedule, whereas Perspective II has a relatively short 7-year schedule. 

Four new VA contracts were introduced and five closed down in 4Q2020, as new product activity remained sluggish. Seven new living benefits appeared while twelve closed, perhaps because high market volatility drove up the cost of hedging.

© 2021 RIJ Publishing LLC. All rights reserved.