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A Look at Biden’s Social Security Plan

Posted on October 10, 2020 by -

With the presidential election looming, the candidates’ views on Social Security and how to “fix it” are important to those who follow retirement policy. The president has made non-specific promises to maintain the program. Former vice president Joe Biden has specific proposals.

In a recent report, the Urban Institute, a progressive Washington think tank has reviewed the Biden plan. According to the report, an incoming Democratic administration would raise benefits for almost everybody and collect more taxes from those earning more than $400,000.

That is, someone with an income of $500,000 would pay $12,400 more in payroll taxes. Eighty-seven percent of the additional payroll taxes generated by Biden’s plan in 2065 would be paid by Americans in the top one percent of the income distribution, the report said. 

Surprisingly, the Biden plan doesn’t fully address the Social Security funding gap.“Our projections indicate that Biden’s plan would close about a quarter of Social Security’s 75-year deficit and extend the life of the trust funds by five years,” the report said. “Additional revenue sources would be needed in the future for Social Security to pay the full benefits scheduled under Biden’s plan.”

Overall, the Biden plan reflects the thinking of those, including the Social Security Administration’s own chief actuary and experts like Alicia Munnell of the Center for Retirement Research at Boston College, who have maintained for years that there’s no “crisis” in Social Security that would require radical change, such as partial privatization. 

Resistant to the neoliberal thinking that favors privatization—since the 1970s, some economists have argued that payroll taxes shrink private savings and investment—Social Security advocates have said that an increase in the payroll tax by a few percentage points or the level of income covered by it, plus a few tweaks to benefits, would enable the program to pay all promised benefits for the foreseeable future without violating existing funding rules.  

Here are the specifics of the Biden plan, according to the Urban Institute: 

  • Levy the current 12.4% payroll tax on earnings above $400,000 as well as on earnings up to $137,000 (in 2020). Income between $137,000 and $400,000 would not be taxed until, as a result of inflation-related increases, the FICA wage limit reaches $400,000. After that, all earnings up to $400,000 would be taxed. 
  • Replace Social Security’s existing minimum benefit, which is too low to help many beneficiaries, with a meaningful minimum benefit equal to 125% of the Federal Poverty Level for a single adult, or $15,950 annually in 2020.
  • Index the minimum benefit to the average national wage, which generally grows faster than inflation. Beneficiaries must have completed 30 years of covered employment to qualify for the full minimum, but beneficiaries with at least 10 years of covered employment could qualify for a prorated share of the minimum.
  • Enhance benefits by tying Social Security cost-of-living adjustments (COLAs) to changes in the consumer price index for the elderly (CPI-E) instead of changes in the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W).
  • Extend Social Security earnings credits to workers who care for children younger than age 12 and for family members with disabilities. For every month that caregivers provide at least 80 hours of care, Social Security would credit them with earnings equal to half the average national monthly wage in addition to their earnings from covered employment that month. The plan would reduce a caregiver’s credit by 50 cents for every $1 he or she earns up to the average wage, which was $50,322 in 2017.   
  • Allow widows and widowers of Social Security recipients, if they wish, to collect 75% of the total benefit received by the household before their deceased spouse died, as long as the new payment isn’t higher than the benefit that a two-earner couple with average career earnings would receive. Under current law, benefits may drop by as much as 50% when one spouse in a two-earner couple dies. 
  • Provide a bonus equal to 5% of the average benefit to beneficiaries who had collected payments for 20 years; the bonus would phase in, beginning with a 1% boost for beneficiaries who had collected for 16 years.
  • Repeal Social Security’s Windfall Elimination Provision and Government Pension Offset, which reduces Social Security benefits for workers receiving significant government pensions from jobs not covered by Social Security and their spouses and survivors.
  • Increase 2065 median annual Social Security benefits 14%, to $20,700 (in 2018 inflation-adjusted dollars)
  • Boost median benefits 27% for beneficiaries in the bottom fifth of the lifetime earnings distribution compared with only 14% for beneficiaries in the top three-fifths of the lifetime earnings distribution. Higher earners would nonetheless see the largest absolute dollar increases in their benefits.

How would these proposal affect Social Security’s finances? According to Urban Institute calculations:

  • By 2040, Social Security would collect 7% more revenue in 2021, 12% more revenue in 2040, and 16% more in 2065.
  • Biden’s plan would increase total projected federal and state income and payroll tax collections 2.4% in 2065
  • Total income and payroll taxes collected from taxpayers with incomes between $500,000 and $1 million (in 2018 inflation-adjusted dollars) would increase 4.1%.
  • Benefits scheduled under Biden’s plan would increase Social Security’s spending to 18.7% of taxable payroll in 2065, or nine percent more than scheduled under current law.

President Trump has announced no specific Social Security plan. According to the Urban institute, in an August 2020 news conference, he suggested eliminating the Social Security payroll tax and financing benefits through transfers from the federal government’s general fund. Trump did not specify how the federal government would pay for those transfers, especially given the government’s expected $3 trillion deficit this year. 

(c) 2020 RIJ Publishing LLC. All rights reserved.

Pace of portfolio construction outsourcing will slow: Cerulli

Posted on October 10, 2020 by -

As advisors seek to re-assert control over client portfolios in times of market volatility, the growing trend of advisors outsourcing portfolio construction is likely to slow in the short term, according to the latest Cerulli Edge—U.S. Advisor Edition. 

Many advisors outsource portfolio construction to scale their businesses. During the past five years, the percentage of “in-sourcers” (advisors who either construct an individual portfolio for each client or construct models at their practice and then make changes on a client-by-client basis), has fallen by an estimated seven percent.

In some channels, such as national and regional broker/dealers (B/Ds) and independent registered investment advisors (RIAs), the percentage of in-sourcers has fallen by 20% and 18%, respectively. “Outsourcing can deliver better, more consistent investment outcomes for clients of these practices,” said Matt Belnap, senior analyst at Cerulli, in a release.

But the pandemic may interrupt the shift toward outsourcing. According to Cerulli research, nearly two-thirds (62%) of respondents indicate no meaningful change in advisor discretion post-pandemic, while a significant minority (29%) report that advisors are seeking greater discretion over client accounts. Only 9% indicate that advisors were more willing to outsource a few months into the pandemic.

In times of market uncertainty, advisors seek to retain control of investment decisions. “It’s easier for the advisor to make portfolio changes, and show the client that they are doing something, than to explain why the home office or model provider is taking a ‘wait and see’ approach and that the advisor has limited ability to alter the portfolio in times of crisis,” Belnap said.

Over the long term, however, Cerulli expects outsourcing to continue, and that advisors and clients can benefit from this trend. “Constructing practice-level portfolios, or a personalized portfolio for each client, takes massive amounts of time for activities such as investment research and manager due diligence. Advisors who can move beyond portfolio construction and security selection as their main value proposition can use this time to grow and scale their practice, more efficiently servicing clients they already have, and attracting new ones,” the release said.

Product decisions will increasingly be made outside of the practice, Cerulli believes. According to the release, “In light of this trend, firms should allocate their resources and distribution focus accordingly.” 

(c) 2020 RIJ Publishing LLC. All rights reserved.

Job loss has cost millions their health insurance: EBRI

Posted on October 10, 2020 by -

As many as 7.7 million workers lost jobs with employer-sponsored insurance (ESI) during the COVID-19 pandemic, according to a new study from the Employee Benefit Research Institute (EBRI). An additional 6.9 million dependents lost insurance benefits as well. Manufacturing workers were most affected by loss of jobs with ESI.

The study, “How Many Americans Have Lost Jobs with Employer Health Coverage During the Pandemic?,” was sponsored by The W.E. Upjohn Institute for Employment Research, and The Commonwealth Fund.

In response to the COVID-19 pandemic, most states imposed lockdown orders that closed many workplaces and dramatically slowed U.S. economic activity in the spring of 2020. The result was a massive increase in unemployment, which peaked in April at 14.7%. During the 15 weeks from mid-March to the end of June, Americans filed nearly 49 million new claims for unemployment benefits.

“The strong link between employment and health insurance coverage has important implications for Americans’ insurance coverage and access to health care, as ESI is the most common form of health insurance in the United States,” EBRI said in a release. “The manufacturing sector is disproportionately impacted because more of those jobs come with ESI, compared with retail, or accommodation and food service workers.”

“Workers ages 35 to 44 and 45 to 54 bore the brunt of ESI-covered job losses, in large part because workers in these age groups were the most likely to be covering spouses and other dependents,” said Paul Fronstin, Director of EBRI’s Health Research and Education Program, in a release. “The adverse effects of the pandemic recession also fell disproportionately on women. Although women made up 47% of pre-pandemic employment, they accounted for 55% of total job losses.”

(c) 2020 RIJ Publishing LLC. All rights reserved.

Jim Otar’s Swan Song on Retirement Income

Posted on October 7, 2020 by -

Jim Otar, the Ontario-based adviser-emeritus and author, has turned his attention in retirement to writing rom-com screenplays. But he has just self-published his career capstone, “Advanced Retirement Income Planning.” It’s available for $4.99 on Amazon in a Kindle edition.

I first encountered Otar via his homepage, retirementoptimizer.com, more than 10 years ago. Here was a math-minded Canadian engineer who, dissatisfied with the existing literature on retirement planning, decided to create his own—and has become modestly famous for it within this niche.

This excerpt from one of his webpages describes his journey in his own words:

Jim and Rita Otar

“I started investing in 1977. I wrote my first book (‘Commission-Free Investing’) in 1996 about Canadian DRIPs and SPPs, to share my personal strategies and experiences about this form of low-cost investing (before the invention of ETFs). I also started writing articles regularly for a local personal financial planning magazine called Canadian MoneySaver and met many great people at their onshore and offshore conferences.

In 1999, my wife asked me a very simple question: “Do we have enough money for retirement?” I replied, “Let me check.” Nothing happened for a few weeks. That is because I could not find much about mathematics of retirement. Most experts then were recommending investing all in stocks. All have been touting the ‘miracle’ of asset allocation. So, when she asked me a second time if we have enough savings for retirement, I realized that I had to come up with an answer.

Otar soon found a career as adviser to clients and even to his peers. He has given hundreds of workshops and presentations to advisers on income planning. He has published more than 100 articles and several books, including his 525-page magnum opus, “Unveiling the Retirement Myth.” He won the CFP Board Award in 2001 and 2002 for his articles. He contributed a chapter to Harold Evensky and Deena Katz’ indispensable 2006 book, “Retirement Income Redesigned.”

We first featured Otar’s work in Retirement Income Journal in 2009. We wrote at the time that he 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.”

Of Otar’s contributions to the art and science of income planning, I have to say that his “zone theory” is my favorite. He segments clients into one of three categories: Green, Gray (or Yellow) and Red.

Green clients are overfunded for retirement, red clients are underfunded, and those in the middle need to get creative—by working longer, cutting expenses or buying life annuities—or they may run out of savings too soon. Even wealthy retirees can squander their way into the Red zone, Otar observed, and even people with modest savings can figure out how to migrate up to the Green zone. It depends in part on their expenses, which he divides into essential, basic and discretionary.

More importantly perhaps, Otar developed the idea that he calls “aftcasting.” This was his alternative to more conventional methods of back-testing or stress-testing hypothetical investment portfolios and withdrawal rate assumptions against the markets’ historical performance.

“An aftcast uses the actual market history to show what would have happened in the past without any predictive claim for the future,” he writes in the new book. “An aftcast starts its calculation by picking a specific year in history, say 1900, at the current age of the client. Using the actual historical returns, it calculates the portfolio value over time. Once this is done, the calculation moves on to 1901 as the starting year. It repeats these calculations for all available years in its historic data base.”

This technique reflects the impact that actual sequences of events—phases of the business cycle, changes in securities prices and inflation—would have had on the performance of a portfolio, based on the year the portfolio was created in. It captures the feedback effects and correlations that created the environments that determined past portfolio performance.

At less than 100 pages, “Advanced Retirement Income Planning is a concise version of “Unveiling the Retirement Myth.” It contains all of Otar’s most important insights regarding such matters as the impact of luck, sequence-of-returns risk, and the signals that markets give when they are about to change direction. (He still can’t resist technical analysis.) I’ll stop the spoilers here and let you discover “Advanced Retirement Income Planning” for yourself. Otar’s books and articles are essential for any adviser who wants to improve his or her retirement income planning skills—and might even be useful for the ambitious amateur.

© 2020 RIJ Publishing LLC. All rights reserved.

The top 1%’s share of U.S income (and more)

Posted on October 7, 2020 by -

The “top 1%” receive 18% of U.S. income: CBO

There’s been a lot written in recent years about economic inequality—about the disproportionate neo-Gilded Age wealth of the “top 1%” as well as the top-heavy tax burden and the bottom-heavy government means-tested transfer payments to the poor.

This month, the Congressional Budget Office (CBO) offered a report, “The Distribution of Household Income, 2017,” based on the most recent complete data from tax returns. It showed changes in the division of income among Americans and in sources of income over the 39 years from 1979 to 2017.

The roughly 128 million households (~315 million people) in the United States received about $14.1 trillion in annual income in 2017, the CBO reported. (“Income” was defined as household income before means-tested transfers and federal taxes.) The highest-earning Americans derived their incomes primarily from business income or capital gains over that period, while the lowest-earning Americans benefited from rising transfer payments through Medicaid, SNAP and other means-tested programs.

The wealth is concentrated in the top quintile (20%), which received almost 50% of all the annual income in the U.S. The bottom half of the top quintile (the 81st to 90th percentiles) had an average income of about $165,600, or about $4.2 trillion or 30% of the total.

The average income among the 1.28 million households in the top 1% of the distribution was about $2.0 million for a total of $2.6 trillion or about 18% of all pre-tax, pre-transfer income. The average income among the approximately 11,000 households in the top 0.01 percent of the distribution was about $48.5 million.

Incomes within the top 1% varied widely: Average income before transfers and taxes among the approximately 11,000 households in the top 0.01% was $48.5 million in 2017, compared with $5.7 million among households in the 99.9th to 99.99th percentiles and $1.1 million among those in the 99th to 99.9th percentiles.

Business income and capital income (including capital gains) were, on average, a much larger percentage of income for the top 1% of the distribution than in lower income groups. Among households in the top 0.01%, capital income was an average of 66% of income before transfers and taxes in 2017.

Total billionaire wealth reached $10.2 trillion at the end of July 2020, touching a new high after the year’s V-shaped rebound in asset prices, according to a separate report by UBS and PwC (Price Waterhouse Cooper). This level surpasses the previous peak of $8.9 trillion, reached at the end of 2017. There are now 2,189 billionaires, up from 2,158 in 2017. (The report didn’t provide total world wealth, or the percentage of it represented by billionaire wealth.)

Among the poorest 25 million households, labor accounted for about 60% of all income before transfers and taxes in the quintile. With the top 20% taking home 50% of all income, the bottom 80% of American households shared the remaining 50% (about $7 trillion or $70,000 each on average).

In 2017, the average federal tax rate also varied widely by income group. Among all households it was about 21%, CBO estimates. Among households in the lowest quintile, the average rate was about 1%; in the middle quintile it was about 14%; and in the highest quintile it was about 26%. The average federal tax rate among households in the top 1 percent of the income distribution in 2017 was about 32%.

Of the five components of income before transfers and taxes, business income expanded fastest, growing more than sevenfold over the 39-year period, the report said. As a share of income among households in the top 1%, business income rose from 11% in 1979 to 23% in 2017. Meanwhile, average capital income (including capital gains) grew at a slower pace than other forms of income.

The most neglected retirement income solution

With mortgage rates extremely low and millions of under-saved retirees holding trillions of dollars in home equity, the U.S. market for “reverse mortgages” (or as the British say, “equity release” products) should be much more active than it is. A new research paper, “The Market for Reverse Mortgages among Older Americans,” by Christopher Mayer of Columbia and Stephanie Moulton of Ohio State University tries to solve this puzzle.

The two economists discovered that many retirees are in fact tapping their home equity in retirement. But they’re doing it much more often through refinancing and home equity lines of credit than by purchasing a reverse mortgage (aka Home Equity Conversion Mortgage, or HECM).

“Many seniors do, in fact utilize home equity in order to fund their retirement,” Mayer and Moulton write. “Yet they choose products that require monthly payments lasting decades into retirement and rising as a share of (declining) income as they age.”

In 2018, only 33,000 originated reverse mortgages were recorded, versus 609,000 originated equity extraction loans such as HELOCs (home equity lines of credit), cash-out refinancing, first liens not for refinance or purchase, and second liens. Another 688,000 older Americans originated a mortgage for home purchase or a refinancing. In many cases, people who were turned down for these loans could have qualified for HECMs.

The authors looked into reasons for the underutilitization of reverse mortgages and found four potential reasons: higher costs, bequest motives, product reputation, and regulatory barriers. The last two reasons, they write, play a role “in discouraging the participation of mainstream financial institutions which might be able to bring distribution efficiencies, lower costs, and retirement advice that incorporates home equity into financial plans.”

The high cost of money-back guarantees for IRAs in Germany

As defined benefit pensions disappear, experiments with creating individualized retirement income solutions are taking place all over the world. The results can provide potential solutions (or cautionary tales) for retirement policymakers in the U.S.

So it is with the German Reister plans, which are individual retirements accounts (IRAs) with tax benefits and accumulation guarantees. If, at retirement, the account value is lower than the sum of payments into the IRA, the provider—usually an insurance company—must cover the shortfall with its own equity capital.

Olivia Mitchell, director of the Pension Research Council at the Wharton School, and her German co-authors, Raimond Maurer, Vanya Horner and Daniel Liebler of Goethe University, studied Reister plans. In a recent paper, “Implications of Money-Back Guarantees for Individual Retirement Accounts: Protection Then and Now,”they write:

“these guarantees altered participant consumption, saving, and investment behavior during higher interest rate times, but their impacts are even larger in the present low-return environment.

“Importantly, we conclude that abandoning these guarantees could enhance old-age consumption for over 80% of retirees, particularly lower earners, without harming consumption during the accumulation phase.”

In 2018, 45 million German employees were entitled to contribute to tax-qualified Riester IRAs in 2018 and 16.6 million people did so. The German government pays a yearly subsidy of up to €175 plus €300 per child younger than age 25 into each worker’s IRA. To qualify for the full subsidy, the sum of employee contributions plus subsidies must equal 4% of pre-tax labor income (to a cap of €2,100).

During the decumulation phase, payouts can start at age 62, not more than 30% of accumulated assets may be withdrawn as a lump sum, and any remaining assets must be annuitized by age 85. IRA providers devote a share of savers’ IRA balances at age 67 to buy a deferred annuity paying benefits to the retiree from age 85 until death.

“Swap lines” and global financial stability

Economic history buffs, take notice. A new paper by one of America’s premier economic historians and macroeconomists, Michael Bordo of Rutgers University, explains the method (and history) behind the madness (a miracle, in a way) of the Federal Reserve’s monetary response to the financial crisis triggered by COVID-19 starting last March.

After a historical review that extends back to the classical pre-World War One gold standard, and proceeds through the collapse of the famous Bretton Wood monetary system in 1971, Bordo concludes that the Fed rescued the global economy this year in part with a safety net of “swap lines” with other countries’ central banks.

A “swap line” in this case refers to an arrangement whereby a foreign country that needs dollars—to pay for oil imports, for instance, or to service dollar-denominated debt—can trade its own currency for dollars from the Federal Reserve. The Fed accepts foreign currency as collateral for short-term loans of dollars during financial crises, when everybody is competing for dollars and dollar-denominated assets.

“In the face of a global financial crisis as in 2007-2008 and 2020, central banks have learned to effectively cooperate to prevent a liquidity panic using the swap network to pursue the well-known tenets of Bagehot’s rules,” Bordo writes. [A reference to Walter Bagehot, the British journalist who in 1873 wrote Lombard Street, the classic analysis of central banking.]

“The international swap network can be viewed as a step in the direction of a global financial safety net,” he says, “Whether it is possible to return to the world before the Great Financial Crisis of small central bank balance sheets, normalized interest rates and the policy rate as the instrument is an open question.”

© 2020 RIJ Publishing LLC. All rights reserved.

 

 

A Closer Look at CLOs (and Other U.S. Credit)

Posted on October 6, 2020 by -

The recognition that a killer flu virus was spreading quickly and silently through the U.S. population sent investors running for safety last March, igniting a financial panic and a recession that required extraordinary fiscal and monetary responses from the U.S. Congress and Federal Reserve.

By lowering the overnight lending rate to zero, and by buying corporate bonds for the first time ever, the Fed braced the falling prices of existing fixed income securities. Congress dropped trillions in “helicopter money” on businesses and individuals. Panic subsided. Stock and bond prices rose.

Amid the market crash and recovery, people who follow life insurers watched how the value of CLOs, or “collateralized loa obligations,” held up. Life insurers now own about $150 billion in investment-grade “senior tranches” of these securitized bundles of below-investment-grade “leveraged loans” to small and mid-sized companies.

Those senior tranches survived last spring’s crisis, despite a few high-profile bankruptcies among companies with leveraged loans (Neiman Marcus, J. Crew, J.C. Penney, Hertz). But their inherent risks have not gone away. The story of what happened to those loans last spring—and to America’s entire $54 trillion credit (i.e., debt) market—is told in absorbing detail by a new report, “U.S. Credit Markets: Interconnectedness and the Effects of COVID-19 Economic Shock,” from the Division of the Economic and Risk Analysis of the Securities and Exchange Commission (SEC).

Six major segments that encompass $44 trillion of the overall U.S. credit market: short-term funding, corporate loans, leveraged loans and CLOs, municipal bonds, residential mortgages, and commercial mortgages, are covered in the SEC’s 88-page report, released Monday. Here we’ll focus on the section devoted to CLOs, because of their relevance to the current state of the life insurance industry.

CLOs are providing some of the extra juice—investment income—that’s fueling the strength of a group of relatively new life insurers that specialize in creating and managing fixed annuity liabilities. Like other securitizations, CLOs hold out the promise that their senior tranches—owners of which are the first to get paid, and have access to collateral—offer the same safety as AAA or AA corporate bonds while delivering significantly higher returns.

These new or re-organized life insurers—including Athene, Global Atlantic, Fidelity & Guaranty Life, Delaware Life, Security Benefit and now American Equity—have ties to global asset managers accustomed to dealing in asset-backed securities like CLOs, private equity, leveraged loans and other complex, illiquid instruments. Investment departments of traditional life insurers rarely have the resources to play in that space.

All of these private equity-linked life insurers have been amassing fixed indexed annuity liabilities (i.e., money that will be paid back to mom-and-pop investors after three to 10 years) by buying big blocks of in-force annuities or selling new contracts.

That money becomes raw material for the purchase of complex investments. With superior economics—higher investment returns, capital arbitrage through offshore reinsurers, lower overhead—these new or refreshed life insurers can offer superior crediting rates on the long-dated fixed indexed annuities that are sold to older investors and retirees.

The annuity industry has, as a result, undergone an historic change in the past five to 10 years. It may even have been saved. Without the arrival of deep-pocketed private equity companies, low interest rates may have forced traditional insurance companies to take extraordinary measures to keep the promises they made to annuity contract owners back when interest rates were higher.

The new SEC report describes the CLO market as more than doubling to $642 billion today from $250 billion in 2012. The largest holders of CLOs are insurance companies, with about 25% of outstanding CLOs, followed by banks and investment companies, which together hold about 25%.

“The fundamental risk in the leveraged loan and CLO markets is the financial health of leveraged borrowers, i.e., their credit risk,” the report noted. The share of loans rated B2 or lower (B or lower on the S&P scale) rose to 60% at the end of 2019 from 40% in 2016.

For the types of senior CLO tranches that insurance companies hold—and which account for small percentages of a life insurer’s assets—the risk is deemed to be low. But “the prospect of a deterioration in the risk profile of AAA CLO tranches is worthy of examination primarily because it could cause a large class of investors (e.g., investors who must hold mostly low-risk assets) to exit a market that ordinarily has low trading volumes and idiosyncratic tranches,” the report said. “Such a shift could not only disrupt the CLO market but also adversely affect the functioning of the broader leveraged loan market.”

Overall, the report provides a useful overview of the massive U.S. credit market, whose participants include individuals, institutions, endowments, mutual fund companies, and foreign governments. At $54 trillion, the U.S. credit market is more valuable than the U.S. stock market ($35.5 trillion at mid-year 2020) and much larger than the value of U.S. Treasury securities held by the public ($16.8 trillion at end of 2019).

The global bond market has a current valuation of about $128 trillion, according to the International Capital Market Association. Of that amount, government bonds represent about two-thirds and corporate bonds about one-third.

With the Fed committed to holding interest rates down until 2023. (The Fed has, significantly, changed its inflation target to an average of 2% in the future, not a ceiling of 2%.) Investors, including life insurance investment committees, will continue to “reach for yield.”

The new breed of private equity-led life insurers with strong asset management partners will probably continue to do that by purchasing the senior “AAA” tranches of CLOs, adding perhaps 20 basis points to their added annual investment yield by doing so. Those 20 basis points, a mere fifth of one percent, may be the difference between successful companies and takeover targets in the years ahead.

© 2020 RIJ Publishing LLC. All rights reserved.

Four Takeaways from the Labor Report

Posted on October 6, 2020 by -

The September employment report was almost lost in the news that President Donald Trump and a number of other high-ranking Republicans were diagnosed with Covid-19.

Jobs continue to grow at a historically rapid rate, but that rate continues to decelerate as the initial bounce back of activity fades into memory. The employment report leaves the Fed in its current holding pattern.

Although the unemployment rate continues to descend, it both remains too high to be anything approaching a hot job market.  And even if it did, it would be largely irrelevant in the absence of actual inflation at or above 2%. Four key takeaways:

Jobs growing but growing more slowly

Two narratives are developing. One is that the slowdown represents a fragile economy vulnerable to renewed setbacks. That is the narrative we heard for many years following the last recession and stems from a focus on large scale layoffs while ignoring the fact that net new hires in the private sector were still 877k in September. The other narrative is that the expansion is more likely than not still self-sustaining—even if the pace of recovery is slower than we might like prefer. I would suggest market participants focus on the latter narrative.

Aggregate hours growth, however, accelerated

Accelerating hours growth suggests that wage growth may be faster than headline job growth suggests. This would help compensate for declining fiscal support, although as of August saving rates were still 14.1%, or roughly twice pre-pandemic norms, so there is plenty of spending power still available. A key problem is that the pandemic still limits spending in a portion of the economy, which gets us to the next takeaway…

Permanent job losses continue to rise

As time passes, it has become evident that sectors of the economy most impacted by the pandemic will not recover quickly. Consequently, we should anticipate the number of permanent job losses to mount as firms that struggled through the summer collapse either continue to struggle or collapse in the fall and winter.

With cold weather already settling in, Covid-19 cases are rising in many states with colder climates, Reuters reported. Firms that were able to survive on outdoor dining this summer will be under severe pressure this winter when that no longer becomes a viable option. We won’t have a full recovery in this sector until the virus is better contained. And even at that point, recovery will be hampered by ongoing firm closures and a reallocation of labor to other resources.

Another lingering problem is that downtown areas dependent on office workers also face a restructuring. It is more likely than not that at least partial work-from-work will become the norm going forward (I had one business owner tell me their employees would flat out quit if they had to return to the office full time). Between that and more limited business travel, downtown areas are facing a very different future than that of a year ago.

Lack of child care options and online school reduces labor force participation among women

Women left the labor force in droves last month, down 617k and pushing labor force participation among that group down to 55.6%, almost 5 percentage points lower than the April 2000 high of 60.3%:

Exiting the labor force even if temporary will for many of these women have negative long term effects on their careers. For the economy has a whole, this is a negative supply side shock; we know that firms on net are adding workers at the same time conditions are forcing many out of the labor market. This will have a restraining impact on growth if, when the pandemic is under control, the child-care industry remains damaged by firm closures.

On the stimulus front, Trump’s hospitalization may accelerate passage of another fiscal support package. That said, I am wary about holding my breath as the Senate has remained the stumbling block more than Trump.

It is probably too late for a new fiscal package to have an impact on the election (I had thought goosing the economy ahead of the election was a no-brainer, but that would have been helpful in July, not now). NBC is reporting that Biden’s lead in its poll has jumped to 14 points. Trump’s performance at last week’s debate is proving disastrous for his campaign.

Bottom Line: This is a familiar place, an expansion that is self-sustaining; but the recession has left the economy in enough of a hole for people to argue that the expansion is not self-sustaining.

© 2020 Tim Duy.

Honorable Mention

Posted on October 6, 2020 by -

SEC commissioners disagree over ‘finders’ exemption

Under a Securities and Exchange Administration (SEC) proposal announced this week, “finders” who help securities issuers raise capital from sophisticated, wealthy investors in private markets would be exempt from registering with the SEC as brokers. The proposal allows finders to receive “transaction-based compensation.”

“If adopted, the proposed exemption would “permit natural persons to engage in certain limited activities involving accredited investors without registering with the Commission as brokers,” an SEC release said. The proposal is intended to assist small companies to raise capital and to provide “regulatory clarity” to investors, issuers, and finders.

The proposal would create Tier I Finders and Tier II Finders, both subject to conditions tailored to the scope of their activities. The proposed exemption would establish clear lanes for both registered broker activity and limited activity by finders that would be exempt from registration.

Tier I Finders. A Tier I Finder would be limited to providing contact information of potential investors in connection with only a single capital raising transaction by a single issuer in a 12-month period.  A Tier I Finder could not have any contact with a potential investor about the issuer.

Tier II Finders. A Tier II Finder could solicit investors on behalf of an issuer, but the solicitation-related activities would be limited to:

  • Identifying, screening, and contacting potential investors;
  • Distributing issuer offering materials to investors;
  • Discussing issuer information included in any offering materials, provided that the Tier II Finder does not provide advice as to the valuation or advisability of the investment; and
  • Arranging or participating in meetings with the issuer and investor

A dissent regarding this proposal was issued Wednesday by SEC Commissioner Caroline Crenshaw, who said in a statement that “expanding the scope of investor solicitation by unregistered and unsupervised agents in the private placement market is “particularly dangerous and ill-conceived.”

“Unlike registered broker-dealers, Finders would not be subject to periodic inspections or examinations, nor would they be required to maintain records of their activities or comply with basic broker-dealer requirements such as suitability or know your customer rules,” Crenshaw wrote. “[I]n an area of the securities markets that is already prone to fraud, the proposed approach would eliminate the important investor protections the established broker-dealer framework provides.”

New clients bring $148 billion to Fidelity in 2020

Fidelity Investments added more than $148 billion in assets from new workplace savings and company stock plan clients in 2020, the Boston-based mutual fund and retirement plan giant reported this week. Fidelity now serves 24,400 total workplace clients, 32.2 million participant accounts, and manages more than $2.5 trillion in client assets.

More than 1,200 new organizations, including Fortune 500 companies, tech start-ups, universities and nonprofits, joined Fidelity’s platform this year, where they can access investments, Health Savings Accounts, managed accounts, workplace giving programs, payroll solutions and student debt repayment programs.

New clients and assets for Fidelity’s workplace savings and company stock plans included:

Workplace savings plans. Fidelity’s defined contribution (DC) business, which includes 401(k) plans and 403(b) plans, added a record $115.5 billion in managed assets to its platform. The new business includes more than 1,000 new clients where Fidelity teams with a financial adviser to manage their plan. New 401(k) clients include the Cleveland Browns, the professional football team, and Walgreens, the drug store chain.

New clients added to Fidelity’s 403(b) platform, which experienced a record 200% growth in assets over 2019, include the Reform Pension Board, which provides clergy, professionals, educators, and other staff of Reform Movement congregations and other qualified organizations. In the higher education market, Fidelity added Indiana University, which has more than 110,000 students across seven campuses in Indiana.

Company stock plans. Fidelity’s Stock Plan Services business, which provides companies in both the U.S. and Europe with a range of equity compensation services for restricted stock plans, performance plans, stock options and employee stock purchase plans, added a record $33.1 billion in assets across 70 new clients. Clients who recently chose Fidelity include Dun & Bradstreet, a leading global provider of business data and analytics.

COVID-19 impact on long-term care insurance documented

Insure.com, an insurance information resource, recently assessed the coronavirus’ effect on long-term care insurance. Researchers evaluated changes to the application and approval process as well as pricing.

For the entire report, read: How COVID-19 is affecting long-term care insurance.

Long-term care insurance provides coverage for home care, assisted-living and/or nursing home expenses. Since COVID-19 emerged, the following changes have occurred:

  • Many insurers temporarily restricted applications for coverage and required additional steps in their application process.
  • Some insurers declined applications from people in their late 60s or older.
  • Other insurers reduced the maximum age for benefits to as low as 65.
  • Many insurers required applicants to wait 3 to 6 months after a negative COVID-19 test before applying for a policy.
  • Long-term care insurers expedited younger applicants’ applications, in some cases.
  • Some insurers are charging between 5% to 50% more for coverage and are reducing spousal discounts by as much as half.
  • Filing long-term care claims has become more complicated.

“With COVID-19 significantly impacting long-term care insurance, we caution consumers to review their coverage details before switching their care location,” suggests Michelle Megna, editorial director for Insure.com. “It is similarly wise to check your daily or monthly benefits before proposing any change to your caregiver’s schedule.”

Insure.com shares resources that can help people locate new caregivers and offers advice on when and how to appeal claim denials.

Rate drought, bull market buffet private pensions: Milliman

Corporate pension asset values dropped in September for the first time in six months, and funded ratio dipped to 84.5%, according to the results of Milliman’s latest Pension Funding Index (PFI), which analyzes the 100 largest U.S. corporate pension plans.
In September, corporate pensions experienced an investment loss of -0.74% (a $17 billion decline in asset values), marking the first time in six months that returns have not been above-average.

The monthly discount rate climbed slightly, from 2.54% at the end of August to 2.57% as of September 30, lowering pension liabilities by $9 billion for the month. As a result, the Milliman 100 PFI funded status declined by $8 billion during September, with the funded ratio dropping slightly to 84.5% from 85%.
“This was a dizzying few months for corporate pensions, with discount rates hitting historic lows while investment returns had equally noteworthy gains,” said Zorast Wadia, author of the Milliman 100 PFI, in a release. “The result was a solid third quarter for the Milliman 100 plans, with the funded ratio improving from 83.5% at the end of June to 84.5% as of September 30.”
Under an optimistic forecast with rising interest rates (reaching 2.72% by the end of 2020 and 3.32% by the end of 2021) and asset gains (10.5% annual returns), the funded ratio would climb to 88% by the end of 2020 and 103% by the end of 2021.

Under a pessimistic forecast (2.42% discount rate by the end of 2020 and 1.82% by the end of 2021 and 2.5% annual returns), the funded ratio would decline to 83% by the end of 2020 and 76% by the end of 2021.

Allianz Life enhances services for RIAs

Allianz Life of North America has launched Allianz Advisory Solutions, a suite of products and services built to help “enhance the risk management capabilities” of Registered Investment Advisors (RIAs), according to a release this week.

Allianz Advisory Solutions has three segments:

Risk Management Solutions: Allianz Life offers a growing suite of risk management strategies, including annuities, life insurance and AllianzIM Buffered Outcome ETFs.

Advanced Strategies and Planning: A new team of fintech and advanced planning strategists at Allianz Life will help RIAs deliver financial planning capabilities with software that addresses tax rules and new legislation, Social Security, and estate planning.

Technology and Platforms:  Allianz Life will provides tech support to guide them through the establishment of direct data feeds with many of the largest platforms in the industry, including Halo, LifeYield and Vestwell through the Allianz Ventures program.

The introduction of Allianz Advisory Solutions comes on the heels of the launch of AllianzIM’s Buffered Outcome ETFs. Managed by Allianz Investment Management LLC, they debuted in June.

NAIC picks Conning to provide data for calculating reserves

The National Association of Insurance Commissioners (NAIC) recently selected Conning, Inc., to provide Economic Scenario Generator (ESG) services for the NAIC, according to an announcement this weekConning will work on the ESG with the NAIC’s Life Actuarial (A) Task Force and Life Risk-Based Capital (E) Working Group to implement the ESG for regulatory purposes.

On March 4, 2020, the NAIC issued Request for Proposal #2053, soliciting proposals from vendors to:

“provide, maintain, and support an ESG that produces real-world, interest and equity scenarios to be prescribed for use in calculations of life and annuity statutory reserves according to the Valuation Manual (e.g., VM-20, VM-21) and capital under the NAIC RBC Requirements (e.g., C3 Phase 1, C3 Phase 2).”

NAIC received six proposals and selected Conning. Conning’s ESG tool uses advanced modeling and estimation technology to produce empirically validated, realistic economic behavior, and its financial models are among the industry’s most technologically advanced.

© 2020 RIJ Publishing LLC. All rights reserved.

Capitalize, a new fintech firm, wants to expedite rollovers

Posted on October 1, 2020 by -

Capitalize, a fintech start-up that aims to help Americans consolidate their 401(k) accounts, has received $2 million in a seed funding round led by Bling Capital, an early-stage San Francisco venture fund. Greycroft, RRE Ventures and Walkabout Ventures have also invested in Capitalize, according to a release.

The company appears to be pursuing the same market as Retirement Clearinghouse, which has been working on creating an electronic recordkeeper-to-recordkeeper “auto-portability” network for 401(k) rollovers for several years.

“Over time, Capitalize intends to help users manage all of their employer-sponsored and individual retirement accounts as they move throughout their career,” the release said.

The firm’s platform, according to the release, helps “Americans easily locate and roll over their legacy 401k accounts… [It] instantly locates former 401k accounts, matches users to individual retirement accounts at leading financial institutions, and initiates rollovers on their behalf.”

The service, “a streamlined alternative to the historically complicated process of rolling over retirement accounts,” will be free to plan participants. The service is intended to help people keep their retirement savings in one place and avoid cashing out of small accounts—and sometimes forgetting about them altogether.

“As fintech companies have digitized across various industries, we noticed a gap in the retirement savings market to improve how legacy accounts are transferred and managed,” said Gaurav Sharma, CEO of Capitalize. “With Capitalize, we’re empowering Americans to consolidate their 401k assets and make the most of their money as they move throughout their careers.”

Due to the lack of clarity on how to handle employer-sponsored accounts at the time of job change, many are unable to maximize their retirement benefits. Almost five million Americans cash out up to $100 billion of assets from their 401(k) accounts each year when changing jobs and millions more leave their assets behind, according to Capitalize. An additional five million Americans are estimated to have rolled over more than $500 billion of 401k assets into an IRA in 2019 through complex, manual processes.

Capitalize was founded by co-founded Sharma, who began his career in investment banking before transitioning to hedge fund Greenlight Capital. His co-founder and chief technology officer, Chris Phillips, previously served as CTO of IAC’s Applications group. Capitalize said it will use the new funding to add functionality to its rollover platform and hire operations, product, and engineering personnel.

© 2020 RIJ Publishing LLC. All rights reserved.

Another asset manager enters the ‘Bermuda Triangle’ fixed annuity business

Posted on October 1, 2020 by -

Aspida Holdings Ltd., an indirect subsidiary of Ares Management Corp., has agreed to buy all outstanding common shares in F&G Reinsurance Ltd, a Bermuda-domiciled life and annuity reinsurer with approximately $2 billion in invested assets as of June 30, 2020. Terms were not disclosed, but the consideration will be all cash.

The Company is being acquired from FGL Holdings, a subsidiary of Fidelity National Financial, Inc. Following closing, the reinsurer will operate as Aspida Re. The company expects to continue to operate as a reinsurance company under the Aspida brand (“Aspida Re”).

[See related story in today’s issue of RIJ.]

“Aspida’s three-pronged strategy includes executing new reinsurance contracts, pursuing opportunistic acquisitions of insurance companies and issuing new annuity and life insurance products,” an Ares release said.

“Ares and the AIS platform are leveraging this experience to provide asset oversight and management as well as access to infrastructure and capital to drive Aspida’s growth objectives. Aspida Re will provide customized solutions to help annuity and life carriers optimize their capital needs, improve financial results and manage the growth of their businesses,” the release said.

Ares currently manages over $16 billion for more than 100 insurance company clients.

In addition to asset management oversight, Ares and AIS also expect to provide Aspida Re with capital optimization and strategic M&A origination and advisory services.

Aspida Re will retain members of the Company’s management team and enter into a strategic flow reinsurance agreement to support F&G on certain annuity products. The acquisition of the Company is expected to close during the fourth quarter of 2020, subject to regulatory approvals and other customary closing conditions.

Lazard acted as exclusive financial advisor and DLA Piper LLP served as legal counsel to Ares and Aspida.

© 2020 RIJ Publishing LLC. All rights reserved.

Honorable Mention

Posted on October 1, 2020 by -

AllianzIM adds two new “buffered ETFs”

Allianz Investment Management LLC, a unit of Allianz Life Insurance Company of North America, has launched two new “buffered” ETFs (exchange traded funds): AllianzIM U.S. Large Cap Buffer10 Oct ETF and the AllianzIM U.S. Large Cap Buffer20 Oct ETF. They will trade on the New York Stock Exchange under the tickers AZAO and AZBO, respectively.

AllianzIM describes the products as the “lowest-cost buffered outcome ETFs on the market.” They credit investors with the returns of the S&P 500 Price Return Index up to a stated cap, while eliminating the first 10% (for AZAO) and 20% (for AZBO) of S&P 500 Price Return Index losses.

Both products carry an expense ratio of 74 basis points, with portfolio management by AllianzIM. The 12-month outcome period of the October series ETFs will be October 1, 2020 to September 30, 2021. Each Outcome Period reflects a new stated cap adjusted for prevailing market conditions. AllianzIM already has four other U.S. Large Cap Buffered Outcome ETFs on the market: AZAA, AZBA, AZAL and AZBL. AllianzIM manages over $145 billion in hedged assets.

ESG funds, now a political football, haven’t been intercepted

Despite discouragement from the Trump administration regulators, most defined contribution investment-only (DCIO) asset managers expect to keep marketing their ESG (environmental, social, and governance) funds to retirement plans, according to Cerulli Associate’s latest report: U.S. Defined Contribution Distribution 2020: Adapting to Changes in the Regulatory Environment.

According to the research, 56% of DCIO asset managers expect to increase these efforts during the next 12 months.

In June 2020, the Department of Labor (DOL) proposed new regulations requiring ERISA fiduciaries to complete more stringent evaluations of ESG investments and prohibiting the use of ESG-themed funds as a plan’s qualified default investment alternative (QDIA), or a component of a plan’s QDIA.

Nearly half (48%) of DCIO asset managers surveyed by Cerulli consider the DOL’s proposal one of the most significant barriers to adoption of ESG products in DC plans.

“For now, implementing ESG-themed products within a plan’s QDIA is not a viable option from a fiduciary standpoint. However, DC asset managers relate that some of their plan sponsor clients continue to express interest in ESG investments,” said Shawn O’Brien, senior analyst at Cerulli, in a release.

Furthermore, many asset managers tout performance-related benefits to incorporating ESG criteria into their investment analysis, even within non-ESG-branded funds.

“Many asset managers stand behind the financial merits of ESG. Some asset managers tell us they employ ESG screening processes or incorporate ESG factors into their investment analysis across all of their funds,” O’Brien said.

Three-quarters (75%) of asset managers cite mitigating risk as a top reason for incorporating ESG criteria into their investment analysis and more than two-thirds (68%) indicate incorporating ESG criteria leads to improved alpha opportunities.

On top of these regulatory headwinds, retirement plan providers suggest confusion related to ESG investing has also contributed to a lack of adoption by DC plans.

In the absence of universally accepted definitions and terminology, providers should consider taking a step back to address the fundamentals of ESG investing in order to facilitate more nuanced discussions with their DC clients.

“There seems to be a lingering confusion among plan sponsors and participants about how ESG investing works. Managers should seek to educate DC plan sponsors and intermediaries on the various methods of ESG investing and illustrate how their firm’s product fits within the broader ESG landscape,” said O’Brien.

“Moreover, helping plan sponsors articulate and document investment decisions related to ESG products—and ensuring those decisions are consistent with the plan’s IPS—will be particularly important given the current regulatory environment and the litigious nature of the DC market,” he concludes.

FIDx and Halo partner on annuity/structured product service for advisors

FIDx, the product-agnostic platform that integrates insurance solutions with wealth management platforms, will partner with Halo Investing to make annuities available to users of the Halo platform, which connects investors to protective (structured) investment products, according to a release this week.

The partnership will directly serve financial advisors, wealth managers, and Registered Investment Advisors (RIAs), the release said. “Annuities naturally align with structured products and this [move makes] these collective strategies available to a wider audience of firms, advisors, and their respective clients,” said Rich Romano, CEO of FIDx, in the release.

FIDx offers commission-based and fee-based annuities from AIG Life & Retirement, Allianz Life, Brighthouse Financial, Global Atlantic Financial Group, Jackson National Life Insurance, Nationwide, Prudential Financial, and Transamerica.

Halo describes itself as the only independent marketplace for structured products, which use options to produce investment returns within specific ranges. FIDx provides access to commission-based and fee-based annuities from industry leading insurance carriers. Using Halo and FIDx, advisors will be able to “plan, research, propose, execute and manage annuities alongside structured products” through Halo’s platform.

“Advisors [will] have one holistic protective investing experience rather than managing them through separate doors. It really is the future.” said Jason Barsema, President & Co-Founder at Halo.

“Building on FIDx technology, advisors using Halo can incorporate income, protection and growth options through annuities into client portfolios. This technology partnership will dramatically cut time and costs typically associated with the manual, outdated process of executing annuities,” the release said.

Schwab-TD Ameritrade integration to take 18 to 36 months

The Charles Schwab Corp. today announced that the Board of Governors of the Federal Reserve System approved The Toronto-Dominion Bank to acquire a minority, non-controlling interest in Schwab in connection with Schwab’s proposed acquisition of TD Ameritrade.

The approval and related actions from the Federal Reserve follow the June 4, 2020 announcement that the Antitrust Division of the United States Department of Justice closed its investigation of the proposed acquisition as well as approvals from the stockholders of both companies and regulators in international markets where Schwab is active.

Schwab expects to close the transaction on October 6, subject to the customary closing conditions set forth in the merger agreement.

The integration of TD Ameritrade into Schwab is expected to take 18 to 36 months to complete following the close of the transaction. Until then, Schwab and TD Ameritrade will continue to operate as separate broker-dealers, and clients of the two firms can continue to do business with their respective companies. More information will be made available to Schwab and TD Ameritrade clients once the transaction closes.

Empower in retirement plan deal with Fifth Third Bank

Empower Retirement, the nation’s second-largest retirement services provider,  has agreed to provide recordkeeping and administrative services to 476 retirement plans previously administered by Fifth Third Bank, N.A., according to a release this week. Fifth Third will “continue to serve in a plan-level investment advisory capacity for most of the plans with a continued focus on providing independent fiduciary advisory services,” the release said.

Fifth Third’s retirement plan business for its institutional clients will now focus on providing independent fiduciary advisory services and comprehensive investment solutions to the plans. It will also continue to deliver advice and client solutions.

“The extended relationship will capitalize on both firms’ expertise to the benefit of retirement plan participants and their employers. Empower currently provides recordkeeping services for Fifth Third’s retirement business through its private-label retirement plan unit, Empower Institutional. Because of this existing relationship, the Fifth Third plans will not require conversions,” the release said.

Empower administers $667 billion in assets on behalf of 9.7 million American workers and retirees through approximately 41,000 workplace savings plans. In August, Empower announced it had completed the acquisition of Personal Capital, a registered investment adviser and wealth manager. On Sept. 8, 2020, Empower announced that it had agreed to acquire the MassMutual retirement plan business.

Pandemic raises pressure on insurers’ $1.4T in private placements

Insurers have significantly ramped up their private placement bond holdings over the last decade—to $1.4 trillion at year-end 2019. But, given the effect of the COVID-19 pandemic, an increase in covenant waivers is expected as a means to avoid defaults on these bonds, according to AM Best.

A new Best’s Special Report, “Private Placement Assets Double in Decade, Now Face Pandemic Pressure,” states that the life/annuity (L/A) segment maintains the largest share, about $1.2 trillion (84%) of total insurance industry holdings.

The growth rate of private placement holdings held by insurers has increased annually by an average 8.4% over the last five years. In the face of the prolonged historically low interest rate environment, insurers have looked to purchase private placements to earn higher returns than with publicly traded securities, but the spread has converged to within less than one percentage point since 2012.

The continued purchases of private placements have exceeded publicly traded bonds in each segment, increasing the share of private placement bonds as a percentage of total bonds. Since 2009, private placement bonds have seen their share of the bond portfolio increase to 35.5% from 24.9% in the L/A segment, the largest allocation of the three segments.

However, the P/C and health segments have dramatically increased their holdings over the last decade, with the P/C segment increasing to 16.3% from 5.1%, and the health segment to15.2% from 3.4%. While AM Best expects insurers to continue to seek private placement bonds, growth rates may slow to some extent as some companies may view giving up the liquidity as less worthwhile.

AM Best expects that many covenant waivers will be approved by insurers to avoid default, aiming instead to achieve better recovery rates. But if investors believe the issuing company’s financial woes result from bad decisions and mismanagement, term negotiation will prove more difficult.

The increasing allocations of private placements have not had a substantial effect on liquidity ratios nor on companies’ abilities to meet their policyholder obligations. Companies with large exposures have strong credit shops to perform the necessary underlying analysis.

As part of an organization’s overall risk management practices, investments should be diversified and there should be no significant concentrations, whether by sector, investment strategy or issuer.

JPMorgan Chase to pay almost $1 billion in ‘spoofing’ fraud

The Securities and Exchange Commission has announced charges against J.P. Morgan Securities LLC, a broker-dealer unit of JPMorgan Chase & Co., for fraudulent, manipulative trading of U.S. Treasury securities.

J.P. Morgan Securities admitted the findings in the SEC’s order, and agreed to pay disgorgement of $10 million and a civil penalty of $25 million to settle the action.

The U.S. Department of Justice and the U.S. Commodity Futures Trading Commission also announced parallel actions against JPMorgan Chase & Co. and certain of its affiliates for engaging in manipulative trading in the precious metals and U.S. Treasuries futures and cash markets.

A total of more than $920 million, including amounts for criminal restitution, forfeiture, disgorgement, penalties, and fines, is to be paid across the three actions. The DOJ entered into a three-year deferred prosecution agreement with JPMorgan Chase & Co., and the CFTC announced settlements with J.P. Morgan Chase & Co., JPMorgan Chase Bank, N.A., and J.P. Morgan Securities.

According to the SEC’s order, between April 2015 and January 2016, certain traders on J.P. Morgan Securities’ Treasuries trading desk placed bona fide orders to buy or sell a particular Treasury security, while nearly simultaneously placing orders, which the traders did not intend to execute, for the same series of Treasury security on the opposite side of the market.

The order finds that the non-bona fide orders were intended to create a false appearance of buy or sell interest, which would induce other market participants to trade against the bona fide orders at prices that were more favorable to J.P. Morgan Securities than J.P. Morgan Securities otherwise would have been able to obtain. According to the order, after the traders secured beneficially priced executions for the bona fide orders, they promptly cancelled the non-bona fide orders. This practice is known as a type of “spoofing.”

“J.P. Morgan Securities undermined the integrity of our markets with this scheme,” said Stephanie Avakian, Director of the SEC’s Division of Enforcement. “Their manipulative trading of Treasury cash securities created a false appearance of activity in the market and induced other market participants to trade at more favorable prices than J.P. Morgan Securities would have otherwise been able to obtain.”

J.P. Morgan Securities agreed to the entry of an order in which it admitted to the SEC’s factual findings and that its conduct violated Section 17(a)(3) of the Securities Act of 1933. J.P. Morgan Securities was further ordered to cease and desist from future violations of Section 17(a), was censured, and was ordered to pay disgorgement of $10 million and a civil penalty of $25 million.  The civil penalty ordered will be offset by amounts paid by JPMorgan Chase & Co. and its affiliates in the parallel proceedings announced by the DOJ and the CFTC.

The SEC’s investigation was conducted by Jessica T. Quinn and Thomas P. Smith, Jr., and supervised by Sanjay Wadhwa, all of the New York Regional Office. The SEC appreciates the assistance of the DOJ and the CFTC.

© 2020 RIJ Publishing LLC. All rights reserved.

Why American Equity’s Share Price Spiked Today

Posted on October 1, 2020 by -

It’s now clear what American Equity intended when it hired Anant Bhalla, a former Brighthouse/MetLife financial star, as its new CEO last January. He was brought in to guide the publicly-held fixed indexed annuity (FIA) issuer into what RIJ calls the “Bermuda Triangle.”

[Editor’s note: As we were publishing this article last week, the news about Athene and MassMutual’s takeover of American Equity broke in the Wall Street Journal. So our claim to explain the reason for the explosion in AEL share prices was completely wrong–but not really. The information in this article may offer some context for the acquisition, and may even help explain why this deal went through when previous flirtations between AEL and acquirers did not.]

Bhalla appears to be replicating the three-part business formula—including life insurer, private-placement debt shop, and Bermuda-based captive reinsurer—that Athene Holdings, Fidelity & Guaranty Life and others have been using to climb the FIA sales chart in recent years. American Equity dropped out of the top 10 sellers of FIAs in 1Q2020, after two decades as a regular top-five finisher (top three in the independent-agent channel).

The architecture of the new strategy was revealed this week, when Des Moines-based American Equity (American Equity Investment Life Holding Company; AEL), with $53 billion in policyholder assets, announced that it has teamed with Värde Partners and Agam Capital Management in a move to vastly improve AEL’s investment game—and, ideally, make its FIA crediting rates more competitive.

American Equity Holding’s first quarter FIA sales (including units American Equity and Eagle Life) were $739.6 million, eleventh highest in the industry. In 2Q2020, after a cut in interest rates hit all life insurers, the company’s sales dropped to $559 million. Average investment yield fell to 4.12% from 4.36%.

The firm’s share price spiked today, rising from $22.01 at close yesterday to $33.99 at 9:30 a.m. this morning, before falling back to just under $31 at midday. (Most investors evidently found out about the deal from mass media today, missing the press release on Monday.) The price was $33.52 last February 14. Before that, its previous peak was more than $37 in August 2018, when the Fed’s downward push on interest rates began hurting life insurers’ investment returns.

Värde Partners, Inc., specializes in “corporate and traded credit, real estate and mortgages, private equity and direct lending.” Agam Capital Management, a New Jersey-based asset manager, describes itself as a “one-stop operating platform to price, value and risk-manage the entire gamut of life and retirement businesses globally.”

Under the terms of the agreement:

  • Värde will establish a Bermuda reinsurance company that would reinsure $5 billion of American Equity fixed index annuity liabilities. The deal will reduce capital requirements for the block by 7%, releasing $350 million to AEL.
  • American Equity and Värde will also jointly establish an asset management entity to provide insurance asset management services to the reinsurance company.
  • American Equity is intended to have a significant minority interest in the new reinsurer and a 35% interest in the newly formed asset manager.

Bhalla, American Equity’s CEO, came from Brighthouse Financial, where he was CFO of the U.S. retail business and co-led its spin-off from MetLife. In 2012, his Bhalla Capital Management firm specialized in aggregating and refinancing annuity blocks. Before that, he worked at American Express, Ameriprise and Lincoln Financial.

Chak Raghunathan, president and COO of Agam, was chief risk officer at Apollo Global Management when Apollo established the three-part strategy, from 2008 to 2014.

Värde (Swedish for “value”) was founded in 1993 by three Minnesota alternative investment pioneers, George Hicks, Marcia Page and Greg MacMillan. The firm specializes in several of the same relatively high-yield asset categories and strategies that Bermuda Triangle life insurers now look for: commercial real estate, private placement, opportunistic credit and capital structure arbitrage.

This week, AEL also announced the hiring of Equitable Holdings veteran Graham Day to run Eagle Life, the AEL holding company subsidiary that markets FIAs in the broker-dealer channel. Kirby Wood, American Equity’s chief distribution officer, left the firm after 15 years in June 2020.

The Bermuda Triangle model has, in a sense, rescued the annuity industry from ruin by chronic low interest rates after the Great Financial Crisis (GFC). Low yields on traditional investments, such as high quality corporate bonds, threatened their ability to earn enough to service their large blocks of fixed annuity liabilities. Relatively tiny investment teams at traditional life insurers didn’t have the resources to hunt down higher-yielding yet still-suitable investments.

Private equity (PE) firms, by comparison, have armies of credit analysts who can do that. Firms like Apollo, Guggenheim Partners, Blackstone, Goldman Sachs and others saw opportunities to acquire blocks of in-force fixed annuity business and then reinvest the underlying assets to, ideally, greater effect. In some cases, the asset managers bought life insurers and began selling new fixed annuities. (See today’s story on Aspida.)

The asset managers used their more sophisticated, algorithm-driven, labor-intensive “loan origination skills” to lend to cash-hungry private companies when bank lending to them dried up (a result of post-GFC regulations). They also bundled and securitized these loans. PE-led firms were able to generate returns great enough to service old blocks and issue competitive new contracts.

According to a senior executive at one of the new breed of fixed annuity issuers, the “liability origination skills”—the ability to create and place customized private equity loans—of the practitioners of this model can give them a decisive 20-basis point average investment yield advantage.

The triangle model also includes a captive offshore reinsurance company in a jurisdiction with less stringent reserve requirements for backing insurance liabilities such as in-force blocks of FIAs. Life insurers can sell blocks of FIA assets and liabilities to a Bermuda-based reinsurer, which then credits excess capital back to the life insurer. In this case, the process yielded $350 million to American Equity’s holding company.

In the second-quarter of 2020, Athene used the model to unseat long-time leader Allianz Life as the top seller of fixed annuities in the U.S. Allianz Life was second, followed by Fidelity & Guaranty Life (a historic leader in indexed annuity sales which now collaborates with Blackstone on the three-way model), AIG, and Sammons.

(In August, RIJ asked Allianz Life if it uses the Athene model, with a captive offshore reinsurer. A spokesperson for the life insurer said it does not. We asked the same question of Great American Insurance Group, another major FIA issuer, but no one was available to comment.)

In reporting its 2Q2020 financial results, American Equity said, “Policyholder funds under management at June 30, 2020 were $53.1 billion, a $203 million, or 0.4% decrease from March 31, 2020. Second quarter gross and net sales were $559 million and $553 million, respectively, representing decreases of 63% and 61% from second quarter 2019 sales. On a sequential basis, gross and net sales decreased 21% and 20%, respectively. Compared to the first quarter of 2020, gross sales at American Equity Life and Eagle Life declined 18% and 34%, respectively.”

In late June, American Equity Life launched the Destinations 9 & 10 fixed index annuity, which includes the Destinations index the life insurer co-developed and co-branded with Bank of America, to the independent agent channel, according to a news release. This index uses a rules-based, multi-asset sector strategy that combines investing in low volatility S&P500 equities, 10-year US treasury bonds and gold. The products haven’t changed much, but it’s a whole new game for American Equity.

© 2020 RIJ Publishing LLC. All rights reserved.

She’s Got Advice for Life Insurers

Posted on October 1, 2020 by -

What is the nature of insurance advice—in the context of annuities and retirement? Does it mean reading prospectuses? Does it mean recommending an indexed annuity over a bond fund? Can an insurance agent charge for giving investment advice? Can a financial adviser charge for giving insurance advice?

Questions like these, which have specific financial and legal implications, have occupied Michelle Richter for much of her 20-year career in financial services. She contended with them while helping bring insurance products to market at New York Life. More recently, she dealt with them while counseling annuity industry clients at Milliman, the actuarial consulting firm.

Such questions have become more pressing, and more specific, as the worlds of insurance and investment increasingly overlap, and as life insurers try to normalize the use of their products by the fee-based advisers who serve as the gatekeepers to individual retirees and participants in 401(k) plans.

Life/annuity companies, she believes, have trapped themselves, lobster-like, in growth-inhibiting exoskeletons called products. To evolve, they need to think more in terms of producing investment/insurance hybrids. Recognizing that life insurers need help with this existential challenge, and believing that her real-world experience—and her MBA from Columbia—qualifies her to provide it, Richter recently set up her own consulting firm, Fiduciary Insurance Services, LLC, and begun working with corporate clients.

Michelle Richter

“What made me start this business,” Richter told RIJ, “was the realization that there can be no such thing as a valuable product in insurance” because insurance products are too expensive to manufacture and distribute, and too easy to copy. “That’s why we have seen few new ideas in insurance in decades,” she blogged recently.

“My long-term vision is to keep the industry relevant by changing the focus from products to solutions. I want to help those advisers who are not insurance experts, and those insurance experts who are not investment product experts, to develop programmatic intellectual frameworks that intelligently weave together products for systematic solutions to common consumer challenges,” Richter wrote.

Cannex, the premier annuity rate provider, has collaborated with Richter and supports her mission. “Michelle’s understanding of the practical challenges of implementing systems is invaluable; it’s one thing to devise a new product, but making sure that it is functional and fits within a firm’s compliance framework is another,” Cannex’s Tamiko Toland told RIJ. “She pushes back against the standard perception that this is an industry of followers by devising and facilitating forward-thinking concepts.”

Plenty of ideas

Abstract questions aside, what “systematic solutions” does Richter envision? It turns out that industry participants or academics have floated most of them over the past two decades. But they haven’t been implemented yet, which is where she sees opportunity. Here are examples of the programs she’d like to see finally brought to fruition:

A tontine for qualified plans. It could be structured as an Open MEP (Multiple Employer Plan) offered by a PPP (Pooled Plan Provider) under the 2019 SECURE Act, with a single Form 5500 for all companies in the plan. The program could be modeled on the tontine developed by Nuova Longevita founder Richard Fullmer, a former target date fund manager at T. Rowe Price.

A QLAC-and-SWP combo for qualified plans. (Institutional market) A qualified longevity annuity contract would be purchased and held in a defined contribution managed account (or part of a model portfolio) that also generates income through systematic withdrawals from investments. A portion of the employer’s matching contribution could be applied to the purchase of a multi-premium QLAC that would start producing income anytime after age 72 but by age 85.

Embedding life insurance into personal financial plans. Life insurance agents with securities licenses, especially those who hope to become fee-based registered investment advisers (RIAs) when they have enough assets under management, could use applied software to evaluate the ideal timing and amount of life insurance for a retail non-qualified client.

Registered index-linked annuities (RILA) with long-term care insurance for individuals. This program would apply the Cannex Adaptive Withdrawal Strategy, which calculates mortality-based withdrawals from an investment portfolio, this program would apply withdrawals from RILAs (aka structured annuities) in excess of need automatically to the purchase of long-term care insurance.

An income bridge to Social Security for retirees from qualified plans. In this program, a plan recordkeeper and an RIA could help participants create a “bridge” that would give separated employees an income from their plan assets that would support them while they delay claiming Social Security. This would help them optimize the income from their Social Security “annuities.”

Déjà vu all over again

Readers with good memories might recognize some of these programs. In 2008, MetLife and then-Barclays Global Investors teamed up to create SponsorMatch, which applied portions of 401(k) plan contributions to the gradual purchase of a deferred income annuity. During the same period, Financial Engines created “Income Plus,” a managed account program that originally included an optional out-of-plan deferred income annuity.

Tontines have been described in detail by Moshe Milevsky, Jonathan Forman and Fullmer. Over a decade ago, MassMutual created the Retirement Management Account, which used an algorithm to produce a blended income from investments and income annuities for retirees. Before the Great Financial Crisis, actuaries were working on fixed annuities that funded high-deductible long-term care insurance. Academics proposed Social Security bridges over 10 years ago.

Not all of the hybrid insurance/investment ideas have failed. In the 401(k) plan at United Technology Corporation, three life insurers bid to sell lifetime income benefits that participants can wrap around their target date fund savings. DPL Financial, RetireOne, and FIDx have helped RIAs integrate annuities and insurance into their clients’ portfolios, and manage both through a single “portal.”

Life insurers have launched no-load “adviser” versions of their variable and fixed indexed annuities. Software like MoneyGuidePro and eMoney can model annuities. The curricula of certification programs like the Retirement Income Certified Professional at The American College, and the Investment & Wealth Institute’s Retirement Management Advisor both add expertise and professionalism to hybrid insurance/investment advice. Wade Pfau, Ph.D., of The American College, has established an “efficient frontier” for investment/annuity allocations.

So where is the devil-of-a-problem that Richter wants to help solve? It’s still there, in the details. And, despite the successes of the programs described above, they’ve only begun to bridge the chasm between investment and insurance or solve the Boomers’ need for custom retirement income plans.

Lots of unanswered questions remain. What should RIAs charge clients for managing income annuities? How can an RIA know if a new client’s old variable annuity is worth keeping? Will 401(k) annuities be in-plan or out-of-plan, and must they be QDIAs (qualified default investment alternatives) in order to be viable? Have the SEC and Department of Labor resolved what it means to be a “fiduciary”? How does an asset manager retrain an investment adviser to sell annuities? How does a mutual insurance company retrain a career agent to sell investments? How does an RIA justify the choice of a specific fixed indexed annuity contract?

Some of these questions may be unanswerable until there’s a federal insurance authority that mirrors the SEC. As long as “agents” represent companies and “advisers” represent clients, attempts to merge the two roles may create more confusion than clarity (as it does today). But there is pressure to answer these questions soon.

The SECURE Act has created new opportunities for adding optional annuities to 401(k) plans, but it’s not a sure thing. On the negative side, the low interest rate environment threatens the life insurers’ ability to offer guarantees at all. The products they can afford to offer may not be the products that plan participants want.

It’s a truism that most insurance companies are conservative, preferring to be “fast followers” rather than innovators. Today, however, following could be fatal. Richter told RIJ, “Insurance carriers can remain wedded to product sales, which are becoming commoditized in a future that trends toward financial advice, or they can leave their comfort zones and try to move the industry needle toward holistic integrations. I’m betting my career on the second one.”

© 2020 RIJ Publishing LLC. All rights reserved.

Searching for Yield? Here’s Where to Look

Posted on September 24, 2020 by -

These are swell times for levering up, but sad times for lending. If you’re buying a house, you’re in luck. If you’re a retiree searching for safe yield, or an insurance company trying to fund long-term liabilities, luck is hard to find.

Few strategists know the bond market as well as Anne Mathias, senior strategist, fixed income, at Vanguard, and Rick Rieder, chief investment officer of global fixed income at BlackRock. Both participated in a discussion of interest rates, inflation, and other macro trends at the Morningstar Investment Conference last week.

In a webcast, “The Search for Yield in an Ultra-Low Interest Rate World,” they spoke with Morningstar’s Sarah Bush. [This was the first virtual version of the annual Morningstar conference. It was viewable by computer screen and through an Oculus VR headset and GatheringVR technology from Mesmerise, a UK firm.]

My takeaways:

  • An actively managed “barbell” strategy may work best for bonds, with cash at one end and risky stuff at the other
  • In the U.S., inflation is more a goal than a threat
  • A weak service sector and hot tech stocks explain the perceived disconnect between a slow economy and strong financial markets
  • Monetary policy is limited; fiscal stimulus and higher employment levels are essential for economic recovery
‘Security selection matters’

Today’s rate environment, Rieder said, calls for a “very different bond strategy from a year ago,” when the 10-year Treasury rate was 1.7% and the average yield on 10-year high quality corporate bonds was almost 2.9%. Even then, he noted, the “whole world was dialing for yield.” Today, that’s even more the case.

Rick Rieder

He recommends a barbell-shaped bond allocation. “Cash is one part of the barbell,” he said. “I’d rather be in cash than wasting beta in places that are currently too rich [like high-grade bond indexes]. There are some opportunities overseas, such as China. The European central bank intends to keep the euro zone’s rates low, but parts of the high-yield market there are interesting.”

Securitized debt (a favorite of private-equity led life insurers) can offer opportunity for the sophisticated investor. “In the last three months, a lot of return has been coming from bespoke opportunities,” Rieder said. “There’s mezzanine funding for big real estate transactions.” Average junk bond yields can be misleading because of concentration at the extremes of creditworthiness, he noted.

“Owning some TIPS makes sense, and some gold is a good idea. If you think the dollar is going to be under pressure, then you have to be 30% in gold. I’m not there, personally.” Getting income from large, stable dividend-paying companies makes sense. “It’s all about doing the research,” he said. “You have to be very precise in choosing securities.”

Vanguard’s Mathias agreed. “What matters now is security selection,” she said. “It’s time to search for true alpha. We know that rates will stay low, and that the Fed won’t shut off the recovery. So it’s a matter of doing the work and looking carefully for opportunities.”

Opportunities exist in the lower investment grade bonds and in the “lower- to middle-quality high-yield sector,” she said. She recommended some TIPS as a hedge. With inflation still well below where the Fed would like it to go, TIPS are a low-cost insurance policy for inflation,” she said.

Emerging market bonds—if you can find an issuing country with good governance and robust trade activity—represent another opportunity. “Emerging markets should benefit from our rate policy, Mathias said. “With rates near zero here, and no chance of moving up, and with the dollar stable-to-weakening—that’s all positive for emerging markets. You want to go to less energy-sensitive countries, and to those who are oriented to trade. Don’t go bottom-fishing. You want countries with responsible governance.”

Will low rates cause inflation?

Neither analyst expected inflation to be a near-term threat from low rates; the Fed, on the contrary, is trying to push the inflation rate higher. Rising wages are one traditional contributor to inflation, and Rieder said that wages aren’t necessarily headed higher.

“I don’t think that growing the monetary base by a lot creates inflation. In some areas, like energy and apparel, prices have already come down. We’re seeing companies bringing their costs structures down. They want to do everything they used to do, but at a lower price point. That’s a big headwind for inflation.”

Anne Mathias

“Structural factors still exist that will push inflation down,” said Mathias. “With COVID-19, companies are finding that they can do more with less—fewer people and a smaller footprint. That’s deflationary in itself. We also face this demographic issue of aging. The labor force is smaller relative to the overall population. We may end up with a higher structural level of unemployment.”

The historical dynamic—where unemployment falls, workers ask for higher wages, prices go up, and the Fed raise rates to cool down inflation—may no longer apply the way it used to.

Why stocks seem immune to downturn

Many people have wondered why equity prices are so high when certain segments of the economy are still so depressed. Rieder explained that service businesses constitute a third of the U.S. economy, but only a small percentage of the stock market’s valuation. So, a depression in services shouldn’t necessarily affect the markets.

He thinks many U.S. jobs, both in services or manufacturing, may be gone forever. “Trends in artificial intelligence, cloud technology, and virtual shopping accelerated to hyper-speed because of the pandemic,” he said, echoing a widely held assessment. “Manufacturers are learning how to work with smaller workforces. It will be hard to bring some of those jobs back.”

While he believes the Fed will make more asset purchases, Rieder believes the overall economy needs another injection of fiscal spending. “The Fed’s tools are blunt at this point. [Fed chairman Jay] Powell said that ‘fiscal has to take the ball from here.’ Whoever is president next year, we’re going to get another stimulus. And the system can take on more debt,” he said.

Asked about the potential impact of larger and larger federal deficits, Rieder said, “My opinion on deficits has evolved,” he said. “I recently read The Deficit Myth [by Modern Monetary Theory economist Stephanie Kelton]. It’s phenomenally good. The system is structured for the Fed to be a lender. As long as the U.S. has the world’s reserve currency, and as long as the dollar doesn’t come under tremendous downward pressure, there’s room for the debt to grow.

A virtual reality view of inner space at the Morningstar Investment Conference.

“There’s a limit to the amount you can issue, but I think the system can withstand more debt than the 1980s-1990s academic literature would suggest. The Fed has to buy more Treasuries and reduce the amount of mortgages they’re buying. It has to monetize the debt. But the main thing is getting more people back to work,” Rieder added.

“The fiscal piece is important,” Mathias said. The support has to continue or we’ll see a fall-off. So far, we’ve mostly seen income replacement. The government has been dumping ‘helicopter money’ on the population. People have been spending. But activity in services has been very slow to move up at all.”

Rates will stay low for years

“We can’t underplay the importance of what the Fed did in changing policy,” said Mathias, who expects that even if the U.S. economy approaches full employment, even if inflation surpasses the Fed’s target, and even if low rates fosters an asset bubble, the Fed’s recent language indicates that a rate hike is nowhere in the forecast.

“In its new statement on longer-run goals, the Fed said its decisions would be informed by its assessment of ‘shortfalls’ of employment from its maximum level,” Mathias said. “The previous version had referred to ‘deviations’ from its maximum level. The Fed is basically taking the Phillips Curve Framework off the table in terms of an input to inflation estimates and monetary policy. The Fed will no longer view the momentum of employment gains as an inflation risk. If unemployment is very low in the future, the Fed will not take it as a signal of coming inflation (as they have in the past) and will not act preemptively.

“This policy creates an environment where it’s harder for the market to predict when the Fed will start raising rates,” she added. “Nominal interest rates are effectively capped. The five to 10-year yields are effectively capped. Even in an inflationary environment, rates will stay below where they would normally be. The Fed is saying that it won’t feel pressured to raise rates for a very, very, very long time.”

© 2020 RIJ Publishing LLC. All rights reserved.

Honorable Mention

Posted on September 24, 2020 by -

Mercer enhances U.S. Pension Buyout Index

Mercer, the employee benefits unit of Marsh & McLennan, has found that the costs associated with annuity buyouts are “increasingly attractive.” According to a Mercer release, “The data indicates that a hypothetical retiree buy-out transaction may cost 97.7% of the plan’s accounting obligations.”

The data comes from Mercer’s U.S. Pension Buyout Index (the “Index”). Launched in 2013, the Index tracks the relationship between the accounting liability for retirees of a defined benefit pension plan and two cost measures: The estimated cost of transferring the pension liabilities to an insurance company (i.e., a buyout) and the approximate total economic cost of retaining the pension obligations on the balance sheet.

The Index is a useful tool for Plan sponsors and other pension plan stakeholders can use the tool to evaluate cost-effective ways to “de-risk pension obligations and plan for end-game scenarios,” the release said.

The enhancements to the Index were made following Mercer research, which revealed several changes to market conditions:

  • Competition – The number of insurers who compete for annuity and buyout transactions has doubled since 2012
  • Investments – Insurer pricing is generally driven by the ability of insurers to source higher yielding, less liquid assets such as private credit and commercial mortgages. These investments are not typically held by pension sponsors but are a natural fit to back illiquid annuity buy-out liabilities held on the insurer’s balance sheet
  • Mortality – Insurers have evolved their mortality underwriting techniques to better assess mortality risk at the individual participant level. This may often lead to lower pricing especially for transactions with smaller benefits and/or where benefit accruals have been frozen for many years.

As of June 30, 2020, the new Index value was 97.7%, indicating that a hypothetical retiree buy-out transaction may cost 97.7% of the plan’s accounting obligations. Additionally, the Index estimates the long-term costs of maintaining these pension liabilities to be 105.2%, which reflects costs not included in accounting liabilities such as PBGC premiums, investment management and administration fees, and the risk associated with fixed income defaults and downgrades.

This demonstrates potential economic savings from a buyout of 7.5% compared to holding liabilities for the long term. The revised methodology is more in line with the experience of the majority of Mercer clients who have executed retiree buy-outs and achieved a transaction price near or often below the accounting liability.

“Over the past several years, pension plan sponsors have shown a strong appetite for purchasing buyout annuities to reduce their liabilities, with transaction volumes growing more than 700% since 2013,” said Jay Dinunzio, principal, Mercer’s U.S. Financial Strategy Group.

“As the COVID-19 pandemic has led many organizations to prioritize cost savings during this time of economic instability, we are confident that this trend will continue into the future. While conventional thinking is that these annuities are expensive and involve a higher premium over accounting costs, our data and client experience show that there can be significant cost savings when executed properly.”

CUNA offers new MYGA fixed annuity, ‘MaxProtect’

CUNA Mutual Group has launched the MaxProtect fixed annuity, a multi-year guaranteed (MYGA) annuity with a guaranteed rate of return over interest rate periods of three, five or seven years, with a market value adjustment and book value versions, according to a CUNA release this week.

CUNA had fourteen mentions in Barron’s 2020 Top 100 Annuities list, according to a release this week from Dave Hanzlik, Vice President of Annuity and Retirement Solutions, CUNA Mutual Group.

Currently available in 44 states, MaxProtect is underwritten by CMFG Life Insurance Company, a subsidiary of CUNA Mutual Group.

WINK unveils sales data portal

Wink, Inc., the insurance industry’s resource for annuity and life insurance sales data since 1997, has launched an enhanced web portal and dynamic sales data query tool for subscribers of Wink’s Sales & Market Report.

“We are now providing the ability to access our reports with greater ease, as well as the opportunity to slice and dice our life insurance and annuity data,” said Sheryl J. Moore, president and CEO of Wink, Inc., in a release.

The new portal enables subscribers to locate provides an easily specific pdf or Excel editions of sales reports at the industry, company, or product level for both life insurance and annuity data. Supplemental reports can be quickly identified in a like manner.

The enhanced Sales Data Query delivers html or Excel results, based upon every query option mentioned above. In addition, subscribers can search sales data by distribution channel, company ratings, specific product features, or select rider features.

“If you ever wondered about the sales for a specific quarter, or of variable annuities with bonuses, or offered by A-rated companies, we’ll give you that result in just a couple of clicks. Our Platinum subscribers now have 23 years of data included as a part of their subscription,” Moore said.

Future enhancements of Wink’s Sales & Market Report will provide subscribers with data on every data point reported by Wink, for each participating peer, on a quid pro quo basis. Also, subscribers using both Wink’s Sales & Market Report, in conjunction with the AnnuitySpecs and/or LifeSpecs Tools, will soon have the ability to see sales rankings and market share data.

The Sales Reports and Sales Data Query are available for subscribers of Wink’s Sales & Market Report.

© 2020 RIJ Publishing LLC. All rights reserved.

Low uptake of HSAs still a mystery: Cerulli

Posted on September 24, 2020 by -

While contributions to health savings accounts (HSAs), along with total balances, are still negligible compared with 401(k) plans or individual retirement accounts (IRAs), the industry is expected to evolve during the next several years in response to trends emphasizing holistic planning and financial wellness, according to the latest Cerulli Edge—U.S. Retirement Edition.

HSAs have been available to members of high-deductible health plans (HDHPs) for more than 15 years, but they remain underutilized—and less widely understood—in comparison with qualified retirement plans, according to Cerulli.

Cerulli’s most recent 401(k) participant survey showed that, despite their flexibility and tax advantages, HSAs ranked last out of about a dozen options when participants are asked how they would allocate an additional $1,000. respondents rank HSAs last out of about a dozen options.

“Retirement advisors and financial planners generally acknowledge the triple tax-advantaged nature of these accounts, making them an attractive vehicle for long-term savings, but many investors are in the dark,” said Anastasia Krymkowski, associate director at Cerulli, in a release.

Given the eventual likelihood of a medical emergency or costly procedure, investors should plan ahead and cover these expenses with tax-advantaged dollars whenever possible, Cerulli recommended. “After contributing enough in the 401(k) to earn the full employer match, a participant’s ‘next dollar’ is likely best directed to an HSA, if available,” she said.

While a slight majority of participants with investable assets exceeding $2 million treat their HSA as a retirement savings vehicle, only one-third of respondents with $500,000 to $2 million (i.e., solidly “mass affluent”) do the same. Cerulli suggests that more participants in this demographic could benefit from conversations about taking a long-term view of health savings.

Employers and financial services providers should discuss HSAs in the context of emergency savings and retirement planning, not just healthcare elections during annual enrollment.

“The most effective campaigns will adapt to meet plan members at each stage of the process—whether recognizing the value of an HSA and opening an account, funding to meet the deductible, accumulating assets, or investing for the long term,” Krymkowski said.

Employers’ focus on financial wellness and the increased involvement of retirement providers (recordkeepers, advisors, consultants, etc.) is expanding awareness of these benefits and framing HSAs in a longer-term, more holistic context.

More than 40% of defined contribution plan recordkeepers participated in the HSA market as of 2019, up from 21% just two years prior, and Cerulli believes this trend of increased HSA involvement will continue.

© 2020 RIJ Publishing LLC. All rights reserved.

‘Cacophony’ from the Fed: Duy

Posted on September 24, 2020 by -

Here is a trick learned from many years in the backcountry: When you lose your trail, stop and backtrack to the last place you know where you were. Then start over. In this case, the starting point is the Fed guidance that operationalizes the update strategy:

“The Committee decided to keep the target range for the federal funds rate at 0 to 0.25% and expects it will be appropriate to maintain this target range until labor market conditions have reached levels consistent with the Committee’s assessments of maximum employment and inflation has risen to 2% and is on track to moderately exceed 2% for some time.”

There are three conditions for a rate hike: Maximum employment, inflation at 2%, and the expectation that inflation will exceed 2% for some an undefined period. There is a lot of guidance there, but a lot that is left unsaid.

We don’t know what [level of] inflation would be “moderately” in excess of 2%. We don’t know how long the Fed expects inflation to exceed 2%. We don’t know even what the Fed will eventually conclude is maximum employment, even if we believe that it is somewhere below 4% unemployment.

It’s not just that we don’t know these details. FOMC participants don’t know these details.

They have different views of the appropriate interpretation of the guidance. Chicago Federal Reserve President Charles Evans, for example, admits that his willingness to tolerate 2.5% [inflation] is a minority view of the implementation. They also have different views of when these conditions will be met. Boston Federal Reserve President Eric Rosengren acknowledges that he is particularly pessimistic, saying we would be lucky to reach 2% inflation in four years.

All of that is interesting but really only an intellectual exercise. They are false trails. The Fed doesn’t believe it needs to lock down any details on an “exit strategy” because the forecasts of FOMC participants indicate that rates will remain at near-zero levels through at least 2023. And that is assuming we get the additional fiscal stimulus that they are pleading for.

Vice Chair Richard Clarida tried to clarify the Fed’s position, telling Bloomberg that the Fed would need to see months of observed inflation at 2% before the Fed would even think about raising interest rates. I would pay attention to Clarida and not get tied up in the forecasts of Fed presidents.

Take the FOMC statement at face value; it’s where you go back to when you are lost. The rate story doesn’t get interesting until inflation is 2% on a year-over-year basis and looks to be sustainable for an extended period. I have said this before, but it is worth repeating: The risk is not that the Fed decides to hike rates before inflation hits 2%, the risk is that the economy surprises on the upside and brings that outcome sooner than anticipated.

In hindsight, I guess we should have all seen this confusion coming. Federal Reserve Chair Powell had said that the Fed isn’t even thinking about thinking about thinking about raising interest rates. The updated forward guidance gives guidelines about the timing of a rate hike, so they must be thinking of when to raise rates. The Fed thus inadvertently changed the focus of the conversation.

Changing the focus of the conversation toward rate hike is one communications problem. They still have another problem. They left open the question of the pace of asset purchases. Presumably, they could reduce the pace of asset purchases before inflation hits 2%.

Moreover, the Fed made explicit that asset purchases were not just about smooth market functioning, but also providing accommodative financial conditions. The implication is that the Fed has retained the option to reduce financial accommodation before inflation hits 2%, but that reduction comes via a slower pace of asset purchases rather than a rate hike.

See the problem there? I don’t know that market participants have fully absorbed that implication.

The focus instead has been on the unwillingness of the Fed to commit to additional asset purchases given that its own forecasts reveal we should expect a long period below target inflation. Oddly, Evans makes the case that additional asset purchases are unwarranted until the economy improves. Via Reuters:

“Ramping up the Fed’s bond purchases from its current monthly pace of $120 billion (or otherwise beefing up asset purchases) would be premature until the economy gets into better shape,” Evans told reporters on a call. That could include unemployment closer to 6% than the 8.4% it is now, and more consumers feeling comfortable spending their money outside of the home.

“When that happens, ‘we would have a better idea of the right amount of accommodation and the way to deliver it,” Evans told reporters. “At the moment everybody understands that we are accommodative.”

That sounds like a “pushing on a string” argument, i.e., that [rate] policy is no longer effective but could accelerate the recovery when the economy gains some self-sustaining momentum. Personally, I have trouble imagining that Fed will actually boost the size of asset purchases if the unemployment rate falls to 6% and looks to be heading lower, but I guess that is just another academic exercise at this point.

The question for the Fed is: Has it given itself too much leeway on asset purchases and even interest rates at this point to avoid having to tighten up the guidance with yield curve control or push out asset purchases along the yield curve. I don’t think they are ready for that yet. I am looking for upward pressure on bond yields [i.e., falling bond prices] that appears unwarranted as something that could push the Fed into a more accommodative stance. That, or fading inflation expectations. With that in mind, we should be watching an old favorite:

Bottom Line: The Fed is committed to a near-zero rate policy until inflation reaches 2% and anticipates it will remain at or above 2% on a sustainable basis. That is so far off in the future that we shouldn’t get too deep in the weeds before it happens, but now that the Fed has brought up the issue of rate hikes, they are stuck with a new communications problem.

Realistically, every time some Fed president puts some conditionality in the Fed’s commitment, someone like Vice Chair Clarida will have to come out and lock down expectations again. If they can’t keep expectations locked down with verbal guidance, they are going to have to resort to yield curve control or asset purchases.

Yield curve control is the easy route, but the Fed has dismissed it as an option for now. The real risk for rates is not the Fed’s commitment, but the Fed’s pessimism. If the economy continues to surprise on the upside, Fed forecasts will follow.

© Tim Duy. Used by permission.