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In the ‘Green Zone’ with Jim Otar

Posted on October 13, 2009 by Kerry Pechter -

Jim Otar doesn’t much care what you think. As the Canadian financial advisor likes to say in his eastern-Balkan accent, “You can’t please everyone. I’m 58 years old. I’m deep in the ‘Green Zone.’ People can think what they like.”

But if your field is retirement income, you probably will care what Otar thinks. Since he switched from engineering to finance in 1994, his articles, books, and Retirement Optimizer planning tool have become increasingly meainstream.

Or perhaps the mainstream has become increasingly Otarian.

“In the beginning, it was very lonely,” he told RIJ. “[William] Bernstein’s Retirement Calculator from Hell triggered my first questions, in 1996. I said, That is what I’m trying to tell everyone: You cannot have an assumed growth rate. That’s when I started developing my ideas, which became my first book, High Expectations and False Dreams, in 2000.”

Since then, Otar, who still practices as an advisor, has become better known. His 2002 articles in Financial Planning magazine won a CFP Board award. His website, Otar Retirement Solutions, and his $29.95 Retirement Optimizer planning tool (now $99.95) have a cult following in Canada. He contributed to Harold Evensky and Deena Katz’ 2006 book, Retirement Income Redesigned (Bloomberg).

This month, he officially published Unveiling the Retirement Myth: Advanced Retirement Planning Based on Market History (Otar & Associates, 2009), a 525-page tome that details his Zone system for building a portfolio of investments and, if necessary, income annuities. He offered an early edition for free online in August, but the number of requests for downloads overwhelmed the server.

Otar’s fans—including quite a few members of the Bogleheads discussion group—often note his mechanical engineer’s approach to retirement income planning. That includes a skepticism of straight-line projections, a scrupulous accounting of all sources of friction and a belief in establishing margins of safety that can withstand Black Swan events.

Few people in the U.S. retirement income profession claim to know much about Otar, but at least one vouched for him enthusiastically. “I have copies of Jim Otar’s earlier books and in my opinion he has done excellent work in the field,” says Bill Bengen, an El Cajon advisor who also contributed to Evensky and Katz’ book.

“Aft-casting”
Otar’s system assigns near-retirement clients to one of three zones. Those in the Green Zone can draw down their savings at a sustainable rate and still cover their living expenses. Those in the Red Zone will go broke early unless they buy annuities. Those in the Gray Zone fall somewhere in between.

Whichever zone a client happens to fall into, Otar can determine how much savings should be allocated to stocks, to bonds or, if the client’s savings can’t produce enough income any other way, a ladder of income annuities.

Personably written and replete with charts and graphs, the book details Otar’s financial philosophy. For instance, he rejects Monte Carlo analysis in favor of “aft-casting.”

“Forecasting says ‘I’m assuming an 8% percent return and three percent inflation.’ In aft-casting, each portfolio value is calculated for each year since 1900. I take all lines and put them on the same chart. It’s actually market history,” he said.

“I try to take the dividends out because right now the rate is about half what it once was. Then there are management fees. You have to include that as well. So I take the indexes and inflation rates from the past and I apply an adjustment for current dividends and portfolio costs. Then I have an outcome I call an aft-cast.”

His calculations also include a factor he calls the “time value of fluctuations,” which acknowledges that the course of finance—like the course of true love and other aspects of life—never travels as-the-crow-flies.

“The time value of fluctuations is the friction created by variations in the growth rate,” he told RIJ. “And that happens every day. Inflation goes up and down, for instance. Those variations in the growth rate crate havoc for your projections.

“You cannot use straight-line assumptions. You have to add an additional factor to the calculations to make up for the losses, which is about 50%. You need 50% more assets than the average calculations. So if you need $1.5 million instead of $1 million. Basically, that’s what time value of fluctuations is.

“To use an analogy, if you’re driving from Phoenix to Tucson there’s no fluctuations, because the highway is flat and straight. But if you drive from Flagstaff to Sedona, you’ll use three times as much gas per mile, because you’re going up and down hills.”

Istanbul to Toronto
Otar was born near Istanbul, Turkey, the son of an accountant who raised a few sheep, fruit trees and vegetables. In the forward to his new book he describes his first experiment with finance: growing cabbage as a cash crop. An early frost wiped out his entire investment in seedlings and manure.

He immigrated to Canada at 20, and earned undergraduate and graduate degrees in mechanical engineering at the University of Toronto. “In 1982, I went into a marine equipment business, and worked in it until 1994, when I went into the financial business. I started looking after my own investments. Then my friends and family wanted advice. I ended up getting my CFP in 2000.

“I also used to do technical analysis, and got my most recent designation, Chartered Market Technician. I did ‘cross over.’ I did ‘bottom out.’ We just followed the signals. Every technician has different signals.”

But he’s not one of those far-out cycle theorists who believe that pi rules the universe. “My advice is, keep it simple. You can’t please everyone. So you have to make happy the people who believe in you. That’s all. Don’t make things too complicated.

“More than 50% of everything is luck. Actually, two types of luck. The first piece of luck has to do with the timing of retirement with respect to market behavior. If you don’t retire in a bullish trend, your portfolio life can go down by half.

“The second part, which is less important, is the timing of retirement with respect to inflation. Inflation comes in waves, and if you’re in a bad wave, your purchasing power will drain away. The easiest way to minimize the luck factor is to buy insurance. We buy life annuities. If you ladder them, you can reduce the interest rate risk and the market risk.”

Speaking of market risk, Otar, like many others, doubts the sustainability of the equities rally that started in March 2009. “The more the politicians say that the depression is over-the louder their chorus gets-the more I plug up my ears. I don’t think the recovery is sustainable. If you keep printing money you might avoid a depression. But we won’t be going back to a bull market soon.”

Otar’s plans for the coming year include trying to scale his Retirement Optimizer into a tool that millions of Baby Boomers can use to convert their life savings to lifetime income. “We’re talking to a big insurance company here in Canada,” he said. “I hope it works out.”

The Abnormal Is the Norm

Posted on October 13, 2009 by Editor Test -

On an imaginary wealth spectrum, with the low end of the scale starting at HTM (hand-to-mouth) and the high end topping out at WFBW (well-fixed but worried), my friend Mark might fall into the 78th percentile.

A former engineer, Mark is now 62. He manages his own investments (bonds and dividend-paying stocks) and considers that to be his full-time occupation. I offer his story as just one example of the absurdist financial situations that some highly educated and successful Boomers now find themselves in.

From one perspective, Mark has won life’s lottery. He attended one of the nation’s best universities. He worked at a large and prestigious telecom company. He has two stellar children enrolled in elite private colleges, a supportive and capable spouse, a white clapboard Dutch Colonial and a modest defined benefit pension.

But Mark is stressed. He married late, so his kids entered expensive schools soon after his employer shrugged him off. With no group medical plan or COBRA, he pays $22,000 a year for health insurance. To offset the premiums, he plans to claim Social Security now, rather than wait for higher payments.

If you’re an advisor, what would you tell Mark? I’d bet that any financial advice based on averages, probabilities or formulas will be next to useless for Boomers like him. None of them is average. They are more likely to have been bitten by a Black Swan than to have been rescued by the AFLAC duck.

Mark and his family will undoubtedly survive—on the strength of their own wits and the help of some inherited wealth. But he’s one former Republican who hopes that the Obama health care plan includes a public option.

* * *

Like millions of other people, I’ve been a monkey-in-the-middle over the past three years or so, watching the market go back and forth over my head. But, by following the simple instincts I acquired during my years at Vanguard, I seem to have prevented the past year from becoming the apocalyptic calamity so often alluded to in the media.

In the middle of 2006, when I left Vanguard, I stopped putting new money into my Vanguard 401(k), which had a middle-of-the-road equity/bond allocation of 65:35. In my subsequent employer’s 401(k), I allocated all of my new contributions to a PIMCO intermediate bond fund. Stocks were just too expensive.

From there, I watched my Vanguard portfolio rise slowly, peak in October 2007 and go sideways until September 2008, when the Burmese tiger pit opened under our feet. I did nothing until year-end, when I rebalanced the Vanguard portfolio toward equities. Then I went back to doing nothing until recently, when I reduced my investment in two stock funds that had gained 30% since March.

Thanks to my initial inertia, a tiny bit of market timing, and (mostly) to the “quantitative easing” that fostered the mid-year rally, my portfolio balance looks acceptable to me. It hasn’t returned to its peak and, yes, I’ve forever lost the benefit of a couple of prime accumulation years. But, hey, it’s higher than my net investment. Speaking as an ordinary Boomer investor, the situation—the 401(k) situation, at least—doesn’t feel so dire.

Actually, I must confess an investment secret. I measure the incline of the rise in the Dow and when it reaches a certain pitch, I sell. My trigger-angle and the time scale of the chart are proprietary information. But I can say that by the time the Dow goes perpendicular, I’m long gone.

Retirement Planning a Challenge for Hispanic Americans

Posted on October 13, 2009 by Editor Test -

Hispanic Americans have less access to employer-sponsored retirement plans, lower levels of personal savings and inadequate financial literacy than the U.S. average, according to according to a paper, “Hispanics and Retirement: Challenges and Opportunties” prepared by the Hispanic Institute think-tank and the Americans for Secure Retirement (ASR) coalition.

Because of that, Hispanic Americans need to consider multiple retirement vehicles, such as life annuities, to supplement Social Security and to bridge the gap in access to employer plans, the paper said. The study found that:

Only 41% of Hispanic workers say they have saved for retirement.
Only 25.6% of Hispanics are covered by employer-sponsored retirement plans, compared to 42.5% of whites and 40% of African-Americans.
Of Hispanics receiving Social Security benefits, almost 80% rely on these benefits for at least 50% of their retirement earnings.
Among people 65 and older receiving Social Security, Hispanics receive about $2,124 less in earnings than non-Hispanics, on average.
Between 1979 and 1999, the number of middle-class Hispanics households increased nearly 80%. About one-third of Hispanic households nationwide earn $40,000 to $140,000 a year.
The U.S. Hispanic population is about 48 million. It is expected to increase to 132 million by 2050, accounting for nearly 30% percent of the U.S. population.

U.S. Life Settlements Activity Flat in 2008

Posted on October 13, 2009 by Editor Test -

The life settlements market was hit hard by the economic crisis and other factors in 2008, according to Conning Research and Consulting.

“The economic crisis was the major impediment to growth in the United States life settlements market in 2008, as the credit markets froze in the second half and life settlements buyers had difficulty financing new premiums,” said Scott Hawkins, analyst at Conning.

“In addition, the major life expectancy underwriters revised their methodologies, calling into question the accuracy and valuation of existing portfolios. While there were fewer active buyers in the market, our $11.7 billion estimate of 2008 settled policies did increase our estimate of cumulative in-force life settlements face values.”

The Conning study, “Life Settlements: A Buyers’ Market for Now” presents Conning’s estimates of current market size and growth rate, as well as a long-term forecast and analysis of market conditions.

“The life settlements market must shake off profitability concerns and general market concerns about life insurer solvency before it will return to growth,” said Stephan Christiansen, director of research at Conning. “The buyers’ market of late 2008 and 2009 should help buyers re-establish profitability in their portfolios. More policyholders want to sell, and more agents now understand life settlements-the near term challenge is all about buyers’ and investors’ capacity.”

A Third of DC Plans Have Auto-Enrollment—Mercer

Posted on October 13, 2009 by Editor Test -

One-third of employers globally offer at least one automatic feature in their defined-contribution plans, according to a Mercer survey of 1,500 employers representing $440 billion in defined-contribution pension plan assets, Pensions & Investments reported.

One third said they offered auto-enrollment in DC plans, one third offered automatic escalation, and about 20% offered automatic rebalancing. Among employers offering a default investment option, 67% use lifecycle funds, the June 2009 survey found.

Also, 90% of employers considering adding or changing a default option are looking at lifecycle funds. Seventy-two percent of employers surveyed have 15 or fewer investment options in their defined-contribution pension plans.

Only one-third of employers plan to change their fund lineups over the next two years. Of those, most plan to increase their options or introduce a lifecycle fund. Also, while 74% of employers have a targeted employee participation rate of 80% to 100% percent, only half of them have achieved that goal.

Cash-strapped Firms Hope to Delay Pension Funding Mandates

Posted on October 13, 2009 by Editor Test -

Pension funding requirements that mandated by the Pension Protection Act of 2006 could threaten job creation and investment by diverting cash into pension plans rather than into operations, a Fortune 500 CEO told Congress earlier this month.

Bill Nuti, chairman and CEO of NCR, appeared before the House Ways and Means Committee to argue for relief from the pension obligations instituted by the PPA, which responded to airline and steel company pension defaults by tightening defined benefit funding rules and requiring companies to meet 100% of their obligations by 2015.

Experts from Mercer and Watson Wyatt Worldwide told legislators that defined-benefit pension plans have lost substantial value over the past year and many face significantly higher contributions in 2010. NCR’s pension fell from 110% funded to 75% funded during 2008.

Rep. Earl Pomeroy (D-ND) has drafted legislation that would give companies more time to fund their pension plans. The House Education and Labor Committee approved a similar bill. House Minority Leader John Boehner (R-OH) has introduced another.

All three measures would allow companies to make interest-only payments for two years on their 2008 losses and then give them seven years to amortize pension shortfalls. The Pomeroy and Boehner bills also implement 24-month smoothing of assets within 20% of their fair market value. The House labor panel bill limits smoothing to 10%.

“While giving companies additional breathing room to meet their pension obligations may make sense on the surface, we must also recognize that too much latitude could erode the likelihood of workers receiving the full benefits they were promised and could further expose taxpayers to the costs of bailing out the PBGC,” said Rep. Dave Camp (R-MI) and the ranking member of the Ways and Means Committee.

In the U.K., Are Pensions a Retention Tool, or Just a Compliance Chore?

Posted on October 13, 2009 by Editor Test -

For most small and medium sized firms in the United Kingdom, pensions are seen as a compliance point and not part of a rewards package. But a majority of large U.K. firms still think of pensions as a way to attract and retain staff, despite the shift towards portable defined contribution (DC) plans.

These were among the findings of “The Business Case for Pensions,” a survey sponsored by Blackrock, the asset management firm, and the Chartered Institute of Personnel and Development. The report also noted that upcoming regulatory changes in 2012 might restrict innovation in employer-sponsored retirement plans rather than stimulate it.

Only 55% of working Britons participate in a company pension “scheme” or plan, the survey showed. To encourage greater participation, Steve Rumbles, head of UK DC pensions at BlackRock, suggested allowing plan participants to borrow from their workplace defined contribution plans, as Americans can.

“You might think in 2008 most people took advantage of the loan system in the US. But only 1.2% of members actually used it. It gives you piece of mind, even if it is not used,” he said.

The report warned that the introduction of auto-enrollment in 2012, and the minimum contribution requirement of 8% of qualifying earnings could lead to a “follow the herd mentality,” particularly among smaller employers who will look upon the 8% as a maximum rather than a minimum.

“We deal with predominately larger companies and in talking to those with both DB and DC schemes, there is little indication of them leveling down [to the 8% minimum],” Rumbles said. “But that’s because of their recognition of pensions as a retention tool. The herd mentality is likely to be at the smaller end, who will think 8% will be it, and will stay at that level forever unless the government changes it.”

New White Paper Describes New Normal

Posted on October 13, 2009 by Editor Test -

More Americans are abandoning the old formula for retirement and focusing on protecting principal and generating “income for life,” according to a new white paper from Allianz Life and LIMRA entitled “How the New Economy is Changing the Way Americans Save.”

By 2020 almost one-third of Americans will be nearing or in retirement, but most don’t have financial plans, the white paper says. The old formula for retirement was one-third Social Security, one-third corporate pension, and one-third investments, such as 401(k) plans. Today many pensions have disappeared, the future of social security is unclear, and stock market investments aren’t considered as reliable as once thought.

“The ‘new normal’ for retirement balances liquidity, volatility and rate of return,” said Allianz Life President and CEO Gary C. Bhojwani. “Today, Americans are looking more closely at guarantees and principal protection as important components of a solid retirement plan.”

The paper outlines how dramatic changes to the economic landscape is changing behavior, and gives an overview of fixed annuities, the only financial instruments that offer both lifetime income and principal protection. Survey data from MSF Financial Management, Allianz American Legacies Study and Gallup illustrates the points regarding retirement options, concerns and income options. The paper also explains how age plays a role in financial decision-making, also known as planning from a life-stage context.

“For many years, people followed the advice that a mix of stocks and bonds reduces risk, provides upside potential, and helps achieve financial objectives,” said Bob Kerzner, CEO of LIMRA. “The latest downturn shows that asset allocation alone is not enough. Consumers must consider a variety of financial options.”

J.P. Morgan Adopts FundQuest’s Advisor Gateway™ Platform

Posted on October 13, 2009 by Editor Test -

J.P. Morgan’s Broker Dealer Services business will begin using a new managed account program from FundQuest Incorporated, FundQuest announced. The program, Advisor Gateway, uses FundQuest’s reporting, portfolio modeling, fund selection, and rebalancing technology. Other services include due diligence, training, back-office services and wholesaling support.

The managed account offerings on Advisor Gateway include unified managed accounts, mutual fund portfolios, income portfolios, and separately managed accounts. The new program also offers Advisor Choice, an advisor/client constructed portfolio using FundQuest asset allocation and performance reporting tools.

“Financial advisors who use J.P. Morgan Clearing Corporation’s clearing and custodial capabilities will now have access to FundQuest’s web-based proposal generation, portfolio diagnostics, performance reporting, and open architecture investment research capabilities,” said FundQuest chairman and CEO James L. Fox.

Boston-based FundQuest, a provider of outsourced managed account solutions, has 180 advisory firms as clients and $40 billion in assets under management in its combined US and European operations.

Sun Life VA Sales Up 35% At Mid-Year

Posted on October 13, 2009 by Editor Test -

The U.S. division of Sun Life Financial Inc. said its first-half 2009 variable annuity (VA) sales rose 35%, versus the first half of 2008, while VA industry’s overall sales fell 25.4% for that period, according to Morningstar/VARDS.

Sun Life was the fifteenth largest seller of variable annuities in the U.S. in the first half of 2009, with $1.4 billion in sales and a 2.3% share of the VA market, according to LIMRA International. Sun Life’s parent company has a Standard & Poor strength rating of AA2, a Moody’s rating of Aa3, and a Fitch rating of A+3, as of June 30, 2009.

The firm’s year-over-year gains occurred in all three major financial distribution channels. The company’s assets rose 10.7%, more than double the industry’s 5.1% gain. The Wellesley, Mass.-based insurer also almost doubled its market share in VA sales since the end of 2008, and 91% of its new VA sales for the first half of the year included at least one optional living benefit.

Sun Life VA sales increased against the industry average in all three financial distribution channels. Its wirehouse sales roles 82.6%, to $596.7 million in the first half of 2009 versus the first half of 2008, independent channel sales rose 46.6%, to $536.3 million, and bank sales rose 6.3%, to $226.2 million. The industry’s overall sales fell 28%, 23.2%, and 43.4% in those channels, respectively.

AIG and ING Sell Units to Raise Cash

Posted on October 13, 2009 by Editor Test -

American International Group, the recipient of a $100 billion-plus U.S. government bailout last year, has agreed to sell its Taiwan life insurance unit, Nan Shan, to a Hong Kong investor group for $2.15 billion, the New York Times reported.

The sale is AIG’s largest divestiture so far since September 2008, when it nearly failed because of losses on credit default insurance it wrote on mortgage-backed securities. Nan Shan, one of Taiwan’s largest life insurance, has assets of over $46 billion and 7.9 million in-force policies held by about four million policyholders.

Nan Shan’s buyer is Primus Financial Holdings, which was co-founded in early 2009 by Robert Morse, a former senior Citigroup banker, China Strategic Holdings, an investment firm.

AIG previously raised $500 million from the sale of its Pacific Century Group asset management business to a Hong Kong investment firm, $1.9 billion from the sale of its energy and infrastructure investment assets, and $1.9 billion from the sale of 21st Century Insurance Group, an auto insurer.

Founded in Shanghai in 1919, AIG also hopes to raise cash through initial public offerings for two life insurance units—American International Assurance, or AIA, and American Life Insurance Co., known as Alico—in Asia and New York, respectively.

Like AIG, ING is also using divestitures to raise cash after a huge government bailout.

ING Groep, the Dutch parent of the U.S. insurer, has agreed to sell its Swiss private banking unit to Zurich-based wealth manager Julius Baer for 520 million Swiss francs, or $505 million, as part of a planned disposal of assets after receiving a 10 billion euro government bailout a year ago.

The all-cash transaction is expected to close in early 2010. ING sold its Australian joint venture to ANZ, and may sell units in Asia and possibly North America.

ING has said it wants to sell assets to raise between 6 billion euros and 8 billion euros as it attempts to repay the Dutch state for the emergency funds that propped up its Tier One capital during the financial crisis. The sale of ING’s 51% stake in its Australian joint venture brought in 1.1 billion euros. The Dutch bank and insurer has clients in more than 40 countries, and employs about 110,000 people worldwide.

Highlights of Principal Financial Survey

Posted on October 7, 2009 by Editor Test -

Highlights of Principal Financial Survey
50% of workers unsure when they will retire 12% have delayed their planned retirement date 40% may delay retirement by six years or more 83% do not have a plan for converting savings to income 43% of those who have a plan have an “actual written plan” 44% of retirees began planning for retirement 10 years before retirement 73% of retirees say they should have started planning earlier
Source: The Principal Financial Well-Being Index, Third Quarter 2009

Guardian Expands Sales Team for Retirement Solutions

Posted on October 7, 2009 by Editor Test -

The Guardian Life Insurance Company of America is expanding its Retirement Solutions national sales force to offer a suite of specialized retirement products to small and mid-sized businesses across the nation.

So far, 13 new Regional Vice Presidents (RVPs) have been hired alongside an internal sales support team of seven. The RVPs are responsible for sales and support of Guardian’s group retirement products across all distribution channels. The sales team will report to Dale Magner, vice president, Retirement Product Sales.

“We are expanding our sales team to accommodate the enormous demand for retirement products that meet the unserved needs of thousands of small and medium-sized businesses,” said Margaret W. Skinner, executive vice president of Guardian’s Individual Products Distribution organization.

“Our retirement products, The Guardian Choice and The Guardian Advantage, are both designed to offer the features normally available only to large plan sponsors to this growing market segment,” she added.

The Retirement Solutions sales team has an average of 13 years direct group retirement sales experience. In their roles, the RVPs will assist financial advisors with prospecting leads, sales and ongoing client support. The sales team will also work with Guardian’s Retirement Center of Excellence, a knowledge center that provides pre-sales support with customized plan illustrations, product recommendations and regulatory compliance assistance to financial professionals.

Guardian Retirement Solutions also includes 370 professionals who provide product design and client service to financial advisors and their clients. Guardian is now a strategic partner for LPL Financial’s new Retirement Plus Program, which provides retirement products and support for retirement plan-focused independent financial advisors.

Accountants Split on Financial Reforms

Posted on October 7, 2009 by Editor Test -

Accountants are divided in their opinions of the impact of President Obama’s proposal to overhaul the financial regulatory system and increase protections for consumers and individual investors, according to a survey of 350 financial professionals by Ajilon Finance in conjunction with the Institute of Management Accountants.

The survey revealed that almost half (48%) of respondents believe that President Obama’s plan will have a “very positive” or “somewhat positive” effect. But 40% of accountants say the plan will have a “barely positive” or “negative” effect.

Among those opposed, 29% believes the plan will be too difficult to implement and enforce, 11% say the country will find itself in a similar mess in a few years, 5% called the plan “too little, too late” and three percent said the plan doesn’t go far enough to prevent excessive risk-taking and protect the public.

What If Employees Are ‘Too Poor To Retire’?

Posted on October 7, 2009 by Editor Test -

A new report prepared by CFO Research Services and Prudential shows that “although there has been some improvement in capital markets since the beginning of the year, many employees’ near-term plans to retire are in jeopardy.”

Senior finance executives at large companies are concerned that if older employees can’t afford to exit the workforce and thereby make room for younger workers, “workforce productivity and overall employee morale can suffer and companies can find it difficult to retain rising stars when paths to promotion are effectively closed.”

The results of the survey, “Managing Retirement Benefits Amid Capital Market Disruption,” was based on responses last spring by 140 senior finance executives (primarily chief financial officers, controllers, and directors of finance) at companies with $500 million or more in annual revenues. Almost half of the companies had $1 billion to $5 billion in revenues.

Among the findings:

Almost two-thirds of respondents (63%) say they are more concerned now than they were a year ago that employees who become financially unable to retire might “retire on the job” and be unproductive. About the same percentage said that they are now more concerned about a shortage of growth opportunities for younger staff.

More than two-thirds of respondents answered “yes” to the question, “Would it be beneficial to make your company’s DC plan more closely resemble a DB plan by enabling the plan to provide guaranteed income during retirement and by further automating the plan?”

Seventeen percent of respondents rate employees’ investment allocation decisions as poor, and 17% say employees make poor decisions about their contribution amounts.

More than one-fourth of respondents (27%) rate employees’ retirement planning as poor. Many employees don’t recognize the need to adjust or revisit their asset allocations, contribution amounts, and risk appetite as they approach retirement.

Forty-two percent of respondents say they are very likely to limit high-risk investments for their DC plans.

Companies are very likely to add investment products that defend against market declines (44%) to their DC plans, as well as more conservative target-date funds (38%).

Forty-two percent of respondents said their companies are very likely to increase automatic enrollment and contribution-escalation efforts. Respondents are less likely to say they will increase funding for DC plan education in the next two years.

Risks of Retirement Poorly Managed

Posted on October 7, 2009 by Editor Test -

Nobody likes to retire after a losing year. Just ask Brett Favre.

Older employees appear to postponing retirement until an economic recovery begins and employers are delaying major changes to their retirement plans until business-as-usual returns, according to Aon Consulting, the human resources consulting arm of Aon Corp.

Aon surveyed 1,313 employers nationwide for its 2009 Benefits & Talent Survey. More than 90% said they are not changing their retirement programs quite yet and 87% said employees are delaying retirement due to economic conditions.

A third of employers polled said fewer than 70% of their employees are enrolled in their defined contribution (DC) plans, with two-thirds saying they believed workers are not participating because they don’t believe they can afford to.

Meanwhile, 38% of these employers believe employees have little knowledge of the funds they needed to invest in for retirement and 52% said employees have an accumulation target. Just 8% believe their employees have a strong understanding of how much money they’ll need in retirement.

Workers wanting to learn more about retirement savings have turned to their employers for additional information. In fact, 64% of responding employers said there was an increase in investment-related questions in 2008 vs. 2007, but only about a third of these organizations increased their communications around the importance of saving for retirement last year, while 62% said their communication remained unchanged from the previous year.

“The ‘wait-and-see’ attitude is not surprising,” said Amol Mhatre, senior vice president responsible for retirement innovation with Aon Consulting. “We may continue to see dramatic economic swings, as interdependencies grow in the global economy, and retirement programs and savings can’t stop with every downturn.”

In addition to not changing their retirement communications strategy, 92% of organizations are not changing their pension/defined benefit (DB) programs in the near future, citing the high cost of company-required contributions (71%), volatility (47%) and administrative costs (35%) as the main reasons. Employers also are not changing the risk profile of their pension plans, as two-thirds of these organizations have not made changes to their pension investments during the past two years and do not intend to do so in the next two years.

Regarding defined benefit plans, the survey showed that only 45% of employers offer a DB plan to their employees. Forty-one percent of employers have frozen their pension plans to new entrants, 25% have frozen their plans entirely and do not have a strategy regarding plan termination, and 20% have frozen their plans and intend to terminate the plan once funding allows.

As for defined contribution plans, 56% of respondents said they offer matching contributions on DC plans. Of those, approximately half provide a match greater than three percent. In addition, 41% of employers have an automatic enrollment plan, with 53% implementing a default contribution from employees of 3%.

Proposal Would Require Ratings Agencies To Share Liability

Posted on October 7, 2009 by Editor Test -

Legislation that would hold the major credit rating agencies responsible for each other’s strength assessments has been drafted by the chairman of a House Financial Services subcommittee.

Rep. Paul Kanjorski (D-PA)’s bill could help resolve the conflicts of interest that arise when agencies receive fees from the companies whose bonds and financial strengths they rate. He contends that establishing collective liability could spur the powerful rating agencies—Moody’s Investors Service, Standard & Poor’s and Fitch Rating—“to police one another and release reliable, high-quality ratings.”

But Moody’s chairman and CEO Raymond McDaniel testified that imposing collective liability could stimulate lawsuits against the agencies and create an unpredictable business environment.

The SEC recently proposed rules designed to address the inherent conflicts of interest in the current system. One SEC proposal would discourage “shopping” for favorable ratings by requiring issuers to disclose whether they had received preliminary ratings from other agencies.

A lot rides on those ratings. The agencies issue ratings on the creditworthiness of public companies, thereby determining their borrowing costs. The ratings also offer an opinion about the creditworthiness of securities, which can determine their prices.

After giving positive ratings to exotic mortgage-backed securities a few years ago, the rating agencies downgraded many of them last year as home-loan delinquencies soared. The securities plummeted in value and became the untradeable “toxic” assets whose illiquidity created a credit crisis and resulted in hundreds of billions of losses for investment banks and their investors.

Presidential’s New Campaign

Posted on October 7, 2009 by Editor Test -

In a year when low interest rates are making single premium immediate annuities more expensive, tiny Presidential Life, which was born 44 years ago in a Nyack, NY storefront, has found a way to enhance a SPIA’s payout.

The $240 million NASDAQ-listed company, 40% of whose sales are income annuities, has engineered a joint and survivor contract where the first annuitant receives benefits for life but the survivor receives income for a period certain or for life, whichever is less.

Contract owners can adjust their payments up or down by shortening or lengthening the period certain, from as few as five to as many as 20 years. Because the second income stream is life-contingent, the survivor receives an added dividend from mortality pooling.

“Normally, adding a second annuitant can reduce the monthly payment,” the company said in a release. “But in [our] new contract, the second annuitant receives the full payment for a fixed, pre-elected period of five to 20 years or until death, if sooner. If the second annuitant predeceases the first annuitant, the first annuitant continues to receive a lifetime annuity at the same payment rate.”

According to Presidential’s Gary Mettler, this arrangement would be appropriate for intergenerational transfers from an 80-something parent to a 60-something child, perhaps as an alterative to a single life annuity with a premium refund feature.

“We take the beneficiary of a period certain income annuity and make that person a second annuitant,” Mettler, Presidential vice president, told RIJ. “By making the contract a temporary life, we give ourselves some wiggle room to raise payouts.”

“We generally make sure that the payment period is long enough to refund the premium. If there’s a $100,000 premium, for instance, we might issue a contract with full life and 13 years period certain,” whichever is shorter.

“The Achilles heel of a life with period certain contract is that the beneficiary may receive little or nothing,” Mettler said. To avoid that problem, agents and consumers sometimes choose contracts with long certain periods or refund provisions. But that strategy punishes the annuitants with lower incomes, without guaranteeing a legacy.

“The problem with a normal joint and survivor for a parent and child is that it drags the payment down,” Mettler said. “By limiting the duration of the unreduced payments to the second annuitant, we have more premium dollars to fund higher monthly payments to the first Annuitant, contract owner.”

This structure also protects the family in other ways, Mettler said. If there’s a Medicaid lien against the first annuitant, for instance, the state would be able to claim assets ahead of a beneficiary but not ahead of a second annuitant. “Life contingent payments and their legacies become consumer defensive financial arrangements without peer,” the company said in a release.

While interest rates are low, interest in SPIAs among the elderly is high. “As a result of the economic debacle, we’re getting more life-contingent SPIAs at high ages. Our biggest age group is 75 to 85. Many are life only. If the bank is only paying one percent on CDs, and the clients find themselves invading other money to live on, this produces a lot more income,” Mettler said.

Aside from its small size and slim marketing budget, Presidential Life’s weakness is its B+ (Good) rating for financial strength from A.M. Best. Last April, the ratings firm noted the insurer’s vulnerability to low interest rates because of its concentration in SPIAs, but praised it for paying down its debt. The company lost $10.2 million in the first half of 2009, compared with net income of $22.4 in the first half of 2008.

One annuity industry observer calls Presidential Life “The Mouse that Roared”-referring to Leonard Wibberley’s 1955 comic novel after a tiny European country whose archers conquer Manhattan. “For such a small company, they’ve shown the greatest leadership in terms of product development and marketing of income annuities,” said Garth Bernard, CEO of Sharper Financial LLC.

“My hat is off to them,” he said. “More carriers should take a page out of their book. The industry would not be in the precarious position it is in today if they had followed the leadership of Presidential Life (at least for putting some of their eggs in the income annuity basket instead of entirely in the VA basket).”

“We do more things with SPIAs than anyone else,” Mettler said. “In the last year, for instance, almost everyone has dropped out of enhanced annuities because it’s a capital intensive tool. So now only we and Mutual of Omaha issue them. We’re picking up business from other carriers, and because the carrier pool has dropped, we can price accordingly.”

Presidential Life has a slim marketing budget-it relies on fixed annuity giant New York Life to generate buzz for SPIAs-but its SPIA commissions are competitive. “We pay [insurance marketing organizations] 4.5%, and they will usually reel out 3.5 points to the agents. We don’t adjust commissions for age, and we issue to age 100, “ he said.

But winning over insurance agents isn’t easy. “If you had 100 agents in the room and asked them if they had ever sold a SPIA, you might find five who would raise their hands. And if they actually sold one, it was probably a period certain, and usually sold in the context of selling a split annuity-a deferred annuity and an immediate annuity,” Mettler said.

“Why don’t agents like them? It’s a single transaction, and a one-time fee,” he added. “With a variable annuity, they can exchange it for a more advanced product when the surrender period expires and receive a new commission. So a lot of agents buy a deferred, then another deferred. They haven’t been trained to annuitize. They’re trained to transfer.”

Let’s Look at Your Telomeres

Posted on October 7, 2009 by Editor Test -

Will homo sapiens discover a way to live significantly longer? Perhaps. Elizabeth H. Blackman, Carol W. Greider, and Jack W. Szostak won the Nobel Prize in medicine this week for their work on telomeres, the tiny protective bumpers at each end of our chromosomes that wear away after our cells divide about 50 times.

If science can find a way to keep telomeres from eroding, our cells may replicate in a normal way indefinitely, keeping us forever young. On the down side, cells that never lose their telomeres can turn cancerous.

The limits of human longevity were, not surprisingly, a key topic of discussion at the Longevity 5 conference in New York in late September, where experts such as Joseph Coughlin of the MIT Aging Lab and John Iacovino of Fasano Associates, a Washington, D.C., underwriting firm, spoke at length. (See ‘Old People with Attitude and Expectations’.)

The two men painted a complex picture. Most of the gains in longevity in the last 40 years, for instance, have come from improvements in the treatment of cardiovascular diseases. The beneficial effect of those advances may have peaked—at least among people who have followed the recommended dietary, exercise and drug regimens. The eradication of cancer might extend the average American’s life by six years—a tremendous boon, perhaps, but not immortality.

Looking backward, of course, the gains have been impressive. In 1950, a 65-year-old American male could expect to live 13.9 years and a 75-year-old man could expect to live an average of 10.9 years. By 2000, a 65-year-old man could expect to live 18 years and a 75-year-old could expect to live 11.4 years.

It’s a truism that women outlive men, but on average it’s becoming less so. Among 65-year-olds, an estimated three out of four men and four out of five women will reach age 75. The average 65-year-old couple can expect to live a combined 38.4 person years. But they will only spend 13.5 years of those years together, on average—even without taking separate vacations. Elderly women still spend more time alone than men. Married women on average spend 6.8 years as widows. Men spend 4.5 years as widowers. Women have a 57% chance of outliving their husbands.

Just as there are income disparities in the U.S., there are also longevity disparities. There’s a widening gap between the lifespans of the more affluent 50% of the U.S. population and the less affluent 50%. Obesity raises the mortality rate of a growing segment of American society. As a result, Americans are not as long-lived as, say, the Japanese or Norwegians. From roughly the late 1970s to 2000, the obesity rate in the U.S. more than doubled, to 31% from 15%.

But even as some people have extended their lives and others shortened theirs, the end game has become increasingly expensive. Many Americans spend their final months, weeks, days or hours in cost-intensive care settings. To some extent, that’s probably to be expected. But it distorts the use of resources, in that 80% of the nation’s health care expenditures go to people during their final two years.

“I’m not so sure that’s sustainable long-term,” Dr. Iacovino said.

‘Old People with Attitude and Expectations’

Posted on October 7, 2009 by Kerry Pechter -

Overweight Baby Boomers are digging their graves with their spoons. Skinny Boomers are obsessed with exercise and antioxidants. These counter-trends make life confusing for the experts who just want to know exactly when the average retiree will die.

On Sept. 25 and 26, a bunch of those experts convened on the 50th floor of the JP Morgan Building, where brilliant silk-screens of zoo animals by Andy Warhol adorn the interior walls and the glass outer walls reveal a 360-degree sky-view of New York City.

Fifty or so economists, actuaries, bankers, insurance executives and aging experts had traveled from as far as Taiwan and Germany to attend Longevity 5, the fifth in a series of international meetings, and to hash out responses to the global aging trend.

For many of them, global aging is as big a threat as global warming. Instead of rising sea levels and desertification, they foresee a tide of longevity risk that could bankrupt the social insurance programs, pension funds and annuity issuers whose obligations are linked to the length of people’s lives.

“Economists have not really understood this risk. Policymakers are not yet engaged,” said David Blake of the Pension Institute at the Cass Business School in London and the chairman of the conference. “This is a real, underestimated, slow-burning risk.”

Or, as Joseph Coughlin, the bow-tied director of the MIT Age Lab put it, “There are going to be a lot of old people with attitudes and expectations.

On the other side of the bet, financiers in suits are circling. JP Morgan Chase and Goldman Sachs have built longevity indices. A few pension funds have used swaps to off-load longevity risk. Life settlement companies are buying up life insurance policies and selling “death bonds.” But, relatively speaking, the response to the aging problem is in its infancy.

The case for longevity bonds
The dilemma boils down to this: who will bear the financial risk that billions of people might live too long?

In Finland and Germany, governments are pushing some of the longevity risk of their social insurance programs back onto individual participants by adjusting benefit levels to fit changing mortality rates and market performance.

Alternately, pension funds are looking to share their risks with investment banks. Last July, the Devonport Royal Dockyard pension fund became the first UK pension fund to enter into a longevity swap, in a deal with Credit Suisse.

Investment banks may buy the risk, securitize it, and sell it in the capital markets to investors who are looking for an asset class uncorrelated with stocks or bonds. Or a government could issue ultra-long-dated “longevity bonds” and spread the risk across generations.

A majority of those at the Longevity 5 conference seemed to favor the idea of the U.S. government issuing 50-year longevity bonds, pegged to a longevity index, that would mitigate longevity risk the way Treasury Inflation-Protected Securities mitigate inflation risk.

Guy Coughlan, managing director and global head of JP Morgan’s LifeMetrics and Pension Solutions business, said the U.S. government has a “responsibility” to issue longevity bonds because it encouraged the transition from defined benefit to defined contribution retirement plans and dumped longevity risk on the plans and participants.

“There’s a social need to pick up the risk borne by corporations,” Coughlan said. Longevity bonds “would help create an orderly market for annuities.” Peter Blake agreed, saying the “U.S. government has obligated companies to honor their pension liabilities, and now it says it has nothing to do with the government.”

The U.S. wouldn’t have to issue enough longevity bonds to pick up all of the risk, said Tom Boardman of Prudential plc, which issues about one-eighth of all individual income annuities in the world. “Private industry can handle 85% of the risk,” he said. “We’re just looking for protection of the tail.”

Coal mine canaries
The British are apparently the canaries in the longevity coal mine. Under recent pension reforms, those in the U.K. have to annuitize their tax-deferred savings by age 75, and millions buy life annuities at retirement. The British now buy about half of all life annuities in the world each year, making themselves a test case for coping with longevity risk.

The pipeline into annuities in Britain will get even bigger in 2012, when workers who don’t now have workplace pensions will be auto-enrolled in a defined contribution program to which they, their employers, and the government (through tax breaks) will contribute. That could eventually double the demand for annuities, to £30 billion a year.

“For a small country, those are significant numbers,” said Boardman. “Insurance companies don’t have the capacity to take on that kind of risk. But the capital markets do.”

The same capacity problem could occur in the U.S.-if large numbers of Americans were inclined to buy life annuities with their trillions of dollars in defined contribution savings. Theory dictates that that should happen-but it isn’t, said James Poterba, the MIT economics and president of the National Bureau of Economic Research.

“Our models tell us that people will see a role for annuities,” Poterba said. “But there’s very little activity in the annuity markets. That’s the so-called annuity puzzle, which has attracted a large percentage of the research community.”

Insurance companies might be able to offer more attractively priced annuities to U.S. retirees if they could lay off their longevity risk in the capital markets, he suggested. But he believes that, even with better pricing, selling individual annuities will “still be an uphill battle.” The existence of a public annuity-Social Security-probably crowds out some of the demand for private annuities, he said.

It all adds up to a gloomy picture-almost as gloomy as global warming. If there’s a silver lining, Poterba told some of the world’s top pension wonks, it’s that at least the 2008-2009 financial crisis gave us a warning to reform our retirement systems before it’s too late. By 2025, he said, much more savings will be at stake, and a similar crash would make last year’s $500 billion drop in retirement fund assets look mild.

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