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Searching for a product that will help it capture rollovers from 401(k) plans and give its plan sponsors an income option for participants, Prudential Retirement has wedded its existing in-plan income guarantee, IncomeFlex, to its new line of EasyPath target-date funds (TDFs).

The new offering, a group variable annuity called IncomeFlex Target or IFX Target, is designed to be fully automatic. If not exactly a “cradle-to-grave” plan for qualified plan participants, it’s potentially a “first-job-to-grave” plan.

Here’s how it works: A participant in a Prudential-managed 401(k) plan could enroll—voluntarily or by default—into one of nine new EasyPath TDFs with retirement year targets ranging from 2015 to 2055. Like other TDFs, the EasyPath funds grow more conservative over time, but will always have at least 60% in equities.

Ten years before the participant’s TDF maturity date, the IncomeFlex lifetime income rider would automatically switch on, locking in a minimum income base at an annual cost of one percent of assets. The rider puts a floor under the income base,  protecting participants from sequence-of-returns risk—the risk that a bear market will occur shortly before they retire. 

“The migration of the [lifetime income guarantee] to the qualified plan environment is the future,” said Mark Foley, vice president of the Innovative Simplicity program at Prudential Retirement.

For insurance companies, $10 trillion-plus in qualified retirement plans represents a much larger market for the GLWB rider than the $1 trillion-plus variable annuity niche will ever be. Qualified plans are the massive glaciers from which rivers of rollover money will flow.

“The vendors want to find ways to continue to service those employees once they retire, whether it be through rollovers or an annuity stream,” noted Trischa Brambley, president of Resources for Retirement in Newtown, PA. “If participants like their plan and are familiar with the vendor’s name, then the opportunity to sell them something into retirement is something most vendors would like to pursue.”

For plan sponsors, the question is more complicated. They feel an obligation to offer in-plan income options, but they don’t want lifelong responsibility for former employees. So they’re proceeding with caution, if at all, in choosing income options.

“The plan sponsor community is still coming to grips with what happens when people leave the program,” said David Wray, president of the Profit-Sharing Council of America, a trade group composed of plan sponsors.

“Small companies are overwhelmed,” he added. “They don’t have the expertise or scale to get best practices, and they’re concerned that employers who take the next step take responsibility. When you choose an insurer to provide an income stream, you’ve made a decades-long commitment. That’s not something you do lightly.”

TDFs—the controversial QDIA
Prudential Retirement manages about $156 billion for some 3.6 million plan participants. Of that, about $150 million has been invested in the the original IncomeFlex program across 120 or so plans. The carrier plans to roll out IFX Target to Prudential-managed plans and also license it to other plan providers. As of late April, plan providers Mercer and Hewitt Associates were already signed up.

Prudential hopes IFX Target will ride the coattails of the popular target date funds, which the Pension Protection Act of 2006 blessed as a qualified default investment alternative (QDIA) for automatic enrollment of plan participants. In 2007, TDFs attracted $58 billion in new deposits—more than all other fund categories combined.

“The TDF has become the most popular QDIA,” added Foley. “We know TDFs are challenged, but rather than ask, are they good or bad, we asked, How can we make them better? How can we make them do what they’re intended to do?”

By “challenged,” Foley referred to the ongoing debate over the adequacy of TDFs as retirement savings vehicles. Many fund companies offer them, but there’s no industry standard. Funds with identical target dates may have different asset allocations, different risk levels, and earn different rates of return.

Indeed, Prudential cited research by Ernst & Young showing that retirees who rely solely on TDFs for retirement income have a one-in-three chance of running out of money if they tap savings at an inflation-adjusted rate of five percent. IFX Target is intended to make sure TDF investors don’t run out of money.

The Easy Path TDFs are predominantly index funds with a REIT as an alternative investment. ““The glide path is a little different from [our] other TDFs. You start out at 90% equities and glide down. But as you move into the retirement phase, you keep a higher equity and alternative allocation, which never goes below 60%,” Foley said.

In addition to the 100 basis-point annual fee for the lifetime income guarantee. The guarantee provides a five percent annual lifetime payout at age 65 (4.5% for joint coverage). Income can start as early as age 55 with a 4.25% annual lifetime payout, or after 70 with a 5.75% payout. The annual expense ratio for all of Prudential’s 2015 to 2055 EasyPath TDFs will be 59 bps.

Under the guarantee, the income base would step up to the account value, if higher, on the investor’s birthday. “We reserve the right to increase the fee at the step up,” Foley said. “But there’s never a withdrawal charge or penalty for taking money out. Operationally, this works and feels like any other investment option. You have the flexibility to walk away at any time.”

Portability is a big hurdle for in-plan income options, according to Wray. As people move from job to job, and income guarantees become more common, participants could accumulate a hodge-podge of small accounts that might be inconvenient for them and unprofitable for providers.

Foley said IFX Target is portable at the participant level and at the plan sponsor level. If participants leave their employers or their plan sponsor changes providers, their money can stay with Prudential. But the participant would lose the guarantee if he or she moved the insured assets into another company’s products.

So far there’s little or no consensus among qualified plan experts on the merits of the handful of participant income options that have been launched so far—such as IncomeFlex, the MetLife/Barclays SponsorMatch program, the Genworth ClearCourse plan or the Hueler’s online single premium immediate annuity (SPIA) platform.

“This new offering is representative of the innovation that has been constant and ongoing in the 401(k) system since it came into being,” said Wray. “There is clearly interest in finding new ways to deliver some kind of guarantee in 401(k) plans.” His group doesn’t evaluate or comment on specific products.

Brambley noted, however, that “anything that has the words ‘guarantee’ or ‘preservation of capital’ in it will sell.”

© 2009 RIJ Publishing. All rights reserved.

On a sultry afternoon in Washington, D.C. in early May, the U.S. Capitol looked stark, lonely, and forbidding. The famous white dome, broad steps and balustered porticos glowed like the Taj Mahal but appeared deserted except for two or three black-clad sentries cradling automatic rifles.

Eighty-some members of the National Association for Fixed Annuities (NAFA) were undaunted and undeterred, however. In groups of four or five they had cabbed to the Hill from the gilded luxury of the Renaissance Mayflower Hotel and were bound for appointments with their legislators—or at least with their legislator’s legislative aides.

The purpose of the meetings—a “March to the Hill” orchestrated for NAFA by the lobbying arm of the Washington law firm Blank Rome—was to educate senators and congressmen or their aides about indexed annuities and SEC Rule 151A, which made equity-indexed annuities subject to SEC regulation.

Most of all, the purpose was to urge legislators from both major parties to co-sponsor a bill that would reverse 151A, which reclassified index annuities as securities rather than insurance products. The rule was approved by the SEC last December but doesn’t take effect until 2011.

The new bill, which apparently has not yet been submitted or given a number, would nullify 151A and “clarify” the Securities and Exchange Act of 1933 to ensure that EIAs are exempt from federal securities regulation. The original co-sponsors of the bill are Gregory W. Meeks (D-NY) and Tom Price (R-GA). There is no companion bill in the Senate yet.

Rep. Meeks’ legislative director, Tre Riddle, explained the Queens, New York congressman’s interest in the bill: “We have a number  of constituents who hold annuities who have expressed concern about this issue, as have independent insurance agents who live or work in our district and insurance companies based in New York.

“As a member of the House Financial Services committee, we’re acutely aware of the financial markets, globally, nationally, and in New York. We’re also sponsoring the bill because we disagree with the SEC interjecting itself in a traditionally state-regulated matter.”

The Meeks-Price bill is part of NAFA’s “two-pronged assault” on 151A, which includes a lawsuit filed against the SEC by indexed annuity manufacturers and wholesalers, including American Equity Life, National Western Life, Midland National Life, OM Financial Life, BHC Marketing and others.

The lawsuit argues that indexed annuities are annuities, with guarantees that shift risk from the consumer to the insurer, and therefore should be regulated as other insurance products are—by the states, not by the SEC. It rejected the SEC’s claim that indexed annuities are risky assets because their upside is variable, even though they guarantee principal.

If successful, the lawsuit and the legislation would eliminate the ambiguity of EIAs’ regulatory status forever. “Litigation locks the door and legislation throws away the key,” said Danette Kennedy, NAFA’s government affairs director.

Rule 151A has roiled the world of EIAs, which are a type of structured product in which most of the assets are invested in bonds and a small portion is used to buy options, typically on the performance of the S&P 500. The bonds offer principal protection (less costs) and the derivatives allow the contract owner to participate in S&P gains, if any.

Such products—especially those issued by Allianz Life—sold extremely well after the 2001 dot-com crash, when many investors felt paralyzed by a fear of buying stocks and the absence of attractive returns in fixed income investments. EIAs might be expected to shine in the current environment—a murky outlook for equities and low interest rates—but uncertainty about the outcome of the fight over 151A has caused far more EIA manufacturers to pull products off the market than introduce new ones.

Privately, many in the EIA industry claim that the SEC created Rule 151A to divert lucrative EIA transactions from insurance agents and IMOs to broker-dealers and their registered reps. Kim O’Brien, the executive director of NAFA, said that, while NAFA is fighting 151A on legal grounds, the stakes are ultimately economic. “Clearly, [the broker-dealers] are desperate for money,” she told RIJ.

Others have said that then-SEC chairman Chris Cox, a Bush administration appointee, was moved to regulate indexed annuities after watching a Dateline NBC news episode in the spring of 2008 that depicted alleged mis-selling of EIAs to senior citizens for whom the products were inappropriate.

If 151A takes effect in January 2011, as scheduled, only those with securities licenses will be able to sell EIAs, and all EIA sales will have to be cleared through broker-dealers. To avoid seeing their EIA business diverted to broker-dealers, insurance agents will have to get securities licenses and IMOs must consider becoming broker-dealers—at no small cost.

That’s what one large IMO, Financial Independence Group of Cornelius, NC, is doing, according to Brian K. Williams, its chief operating officer. “We want to be prepared for whatever comes along,” he told RIJ at the NAFA annual meeting.

Before the NAFA members dispersed in taxis from the Renaissance Mayflower Hotel to their various meetings at the Capitol and the Dirksen, Hart, Longworth, Russell, Cannon and Rayburn office buildings, they received some inside tips on how to lobby Congress.

“Most folks in Congress want to do the right thing,” Rep. Price said. “But when it comes to insurance, they don’t know what the right thing is. You know much more than they do about fixed annuities, so you have to educate them. Above all, be passionate, or your representatives won’t feel compelled to act. Show passion for their constituents, not for your pocketbooks. And don’t be discouraged if you don’t get to meet your representative. The legislative aides are the key people here in Washington. They’re the ones you need to impress.”

© 2009 RIJ Publishing. All rights reserved.