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‘Capital Arbitrage’ Helped PE-Led Insurers: Study

Posted on July 23, 2020 by -

When private equity (PE) firms like Guggenheim, Apollo, and Goldman Sachs bought struggling life/annuity businesses at bargain prices after the 2008 financial crisis, they strode into the insurance industry with a certain Wall Street swagger.

As the PE firms grabbed blocks of in-force annuities, they radiated a self-assurance that their big-city risk-wrangling skills would enable them to squeeze more yield out of general account assets than long-established life insurers ever did.

But how would they do it, exactly? Were they smarter? Did they have more chutzpah? The evidence suggests that at least one way they outperformed was by exploiting a regulatory measure, created on an emergency basis to prevent fire sales during the 2008-2009 crisis but never withdrawn, which reduced the capital requirement for one particular class of troubled securities.

In a research paper published early this month, Natasha Sarin, who teaches financial regulation at the Wharton School, and Divya Kirti of the International Monetary Fund, present the results of examining the asset purchases by new PE-led insurance companies during the period from 2009 to 2014.

In their paper, “What Private Equity Does Differently: Evidence from Life Insurance,” Sarin and Kirti show that after PE firms acquired insurance companies, they loaded up on “non-agency residential mortgage-backed securities”, or RMBS—knowing that their capital requirements had been lowered. [“Non-agency” means not issued by Fannie Mae or Freddie Mac and not guaranteed by the U.S. government.]

In November 2009, regulators at the National Association of Insurance Commissioners (NAIC) decided to help insurers who were holding lots of suddenly downgraded non-agency RMBS. They allowed the insurers to hold the RMBS on their books at a reduced value reflecting the expected loss (as estimated by PIMCO and BlackRock for the NAIC) but not at an increased risk of loss.

This regulatory change, Sarin and Kirti say, prevented beleaguered life insurers from dumping their RMBS on the market in droves, or facing the prospect of having to raise capital to support the risky assets. At the time, there were some 18,000 RMBS outstanding, all difficult to put a value on.

A PE firm, once it had acquired a life insurer (between 2009 and 2014), immediately seized on this arbitrage opportunity by investing heavily in RMBS—acquiring large amounts of them at depressed prices but without elevated capital requirements.

Natasha Sarin

The NAIC capital requirements for insurance company assets range from very low for top-rated bonds to very high for lower-rated bonds, Sarin told RIJ. The highest rating is NAIC-1. But things changed during the Great Recession when the NAIC decided to give the insurance industry some relief.

“NAIC-1 used to be just AAA-rated bonds, but that’s not true any more,” she said. “[After the rule change], if you have $100 of mortgage-backed securities with a five percent risk of default, you can hold it at a value of $95 and have the same capital requirement as a $95 AAA bond with no chance of default. You’re conflating an expected loss with guaranteed loss, and it can’t possibly be true that both should have the same capital requirements, because the underlying risks are different.”

Sarin and Kirti reached their conclusions after comparing the investment activity of PE-owned and non-PE-owned insurers. “For many PE-owned insurers in our sample, we observe that immediately after a PE firm takes over, the insurer shifts—within just a few days—to take advantage of the NAIC treatment of non-agency mortgage-backed securities,” she said. None of the PE-led life insurers are named in the paper.

Using the regulatory change—which still exists after more than 11 years, but still only for non-agency residential and commercial mortgage-backed securities—made a significant difference in capital requirements.

“On average,” the authors wrote, “PE-owned insurers’ capital charges across all bond holdings are 20% lower than they would have been absent the crisis-era regulatory change. For subsidiaries of two of the largest PE groups in our sample, capital charges are only half the level that would have been previously required.”

The research also showed that the ability to spot an arbitrage opportunity and act quickly was the main difference between PE-led and non-PE life insurers. “Beyond this capital arbitrage, we find no evidence that PE firms display any specialized investment skill in portfolio allocation, nor is there evidence that they deliver operational improvements,” the paper said.

The authors make the bold assertion that PE-led insurers may be over-rated by ratings agencies. “Were capital charges still assigned based on underlying bond risk, government intervention to address capital deficiencies could have been triggered for a quarter of PE-backed insurers,” they wrote.

“This risk appears to be missed by rating agencies: Many PE-backed insurers are rated A- to B++; ratings that fully accounted for their junk bond holdings would be several notches lower and among the lowest in the industry.”

“This is a concern for us, and we’re monitoring it closely,” an NAIC spokesperson told RIJ this week. “The original idea was that you don’t want to see a fire sale. So we said, if you write your security down to 50 cents on the dollar, the capital charge will be applied to the book value, not to the par value or purchase price. We’re concerned, but the situation is not as dire as they paint it in the paper.”

Today, the 2009 regulatory change for non-agency RMBS and CMBS (commercial mortgage-backed securities) is still on the books. The ruling doesn’t affect other asset-backed securities that PE-owned life insurers have been investing in, such as collateralized loan obligations or CLOs. These are bundles of auto loans or other consumer loans. Life insurers typically buy the higher-rated tranches.

The NAIC recently completed a study of CLO ownership by U.S. life insurers. RIJ will be reporting further on the private-equity-led life insurers and CLOs in the weeks ahead.

© 2020 RIJ Publishing LLC. All rights reserved.

Honorable Mention

Posted on July 16, 2020 by -

COVID-19 exposes vulnerable populations: Prudential

People of color, women, younger generations and small business owners have been disproportionately affected financially by the COVID-19 pandemic so, according to Prudential’s 2020 Financial Wellness Census. More than half of Americans reported damage to their financial health.

Nearly one-in-five respondents said their household income was cut by half or more in the months following the pandemic’s outbreak, with 17% losing employer contributions to a retirement plan, 14% losing health insurance and 10% losing group life insurance benefits, eliminating critical safety nets, according to the census, which was conducted in May 2020.

One-third (34%) of those with household incomes under $30,000 reported being unemployed, only 8% of those with household income over $100,000 reported being unemployed. The overall unemployment rate was 17%.

Gig workers, LGBTQ Americans and those employed in the retail industry were more likely than average to say that their household income was cut in half or more.

A Prudential survey in December 2019 showing Americans were financially on the upswing. More than half (52%) ranked themselves financially healthy by objective measures, up from 46% in Prudential’s first Financial Wellness Census conducted in October 2017.

Regardless of household income, the survey revealed nearly half of Americans (48%) are worried about their financial future, up from 38% just a few months earlier.

Census respondents said they would like to see more affordable health care, more flexible work options and more government support for small businesses. Those with lower incomes want affordable health care and universal health care coverage, better government support of small businesses and the unemployed, a higher minimum wage and more protections for workers.

Americans most often look to the federal government for financial assistance in times of crisis (32%), the data showed, followed by family and friends (28%), then state and local governments (27% and 17%, respectively).

The workplace benefits Americans most value include retirement savings plans, paid time off, and comprehensive health care and prescription drug coverage, according to the census.

Global Atlantic’s ratings unchanged by KKR deal

The financial strength and credit ratings of Global Atlantic Group remain unchanged after KKR & Co. (KKR) announced its intention to acquire a controlling interest in these companies, according to AM Best, the credit rating agency.

The group maintains its Financial Strength Rating (FSR) of A (Excellent) and the Long-Term Issuer Credit Ratings (Long-Term ICR) of “a”. The group includes:

  • Commonwealth Annuity and Life Insurance Company (Brighton, MA), and its subsidiaries
  • First Allmerica Financial Life Insurance Company (Brighton, MA)
  • Forethought Life Insurance Company (Indianapolis, IN)
  • Accordia Life and Annuity Company (Des Moines, IA), and its affiliates
  • Global Atlantic Re Limited and Global Atlantic Assurance Limited

AM Best also comments that the Long-Term ICRs of “bbb” of Global Atlantic Financial Group Limited, the ultimate parent holding company, and its wholly owned subsidiaries Global Atlantic Financial Life Limited and Global Atlantic (Fin) Company (Finco) remain unchanged.

All companies are domiciled in Bermuda unless otherwise specified. Additionally, AM Best is taking no rating action on the Long-Term Issue Credit Rating of “bbb” on the $150 million 8.625% senior unsecured notes, due 2021, initially issued by Forethought Financial Group, Inc. and assumed by Finco.

The outlook for these Credit Ratings (ratings) is stable. The ratings of Global Atlantic were affirmed on Feb. 26, 2020 (see related press release).

KKR is a leading global investment management firm that was founded in 1976 as Kohlberg, Kravis, Roberts & Co. To date, KKR has completed over 280 private equity transactions. Global Atlantic is expected to continue to operate under its existing structure as a subsidiary of KKR with the management team and all legal entities intact. AM Best expects that Global Atlantic Financial Group Limited may benefit from enhanced financial flexibility and access to new sources of capital under KKR.

Total consideration will be 100% of book value at the time of close. The acquisition is all cash and the transaction is expected to close in the first quarter of 2021, pending required regulatory approvals and the satisfaction of other customary closing conditions.

Vanguard introduces socially conscious bond ETF

Vanguard today filed a preliminary registration statement with the Securities and Exchange Commission to launch Vanguard ESG U.S. Corporate Bond ETF. The low-cost, broadly diversified ETF will be Vanguard’s first ESG-focused fixed income product for U.S. investors and complements Vanguard’s existing equity ESG ETFs and mutual funds. The fund is expected to launch in September and Vanguard’s Fixed Income Group will serve as the fund’s advisor.

ESG investing continues to gain traction around the world. U.S. investors hold more than $321 billion in assets in ESG mutual funds and ETFs and industry-wide assets for the fixed income indexed market doubled in 2019 to approximately $1.3 billion. Vanguard ESG U.S. Corporate Bond ETF will complement Vanguard’s existing $10.6 billion U.S. equity ESG product suite and offer a diverse fixed income option for investors.

May 2000 – Vanguard launches its first ESG offering, Vanguard FTSE Social Index Fund (VFTAX), the largest ESG index fund in the U.S with $7.9 billion in assets.

September 2018 – Two U.S.-domiciled ESG ETFs are launched, Vanguard ESG U.S. Stock ETF (ESGV) and Vanguard ESG International Stock ETF (VSGX) with $1.6 billion and $995.5 million in assets respectively.

April 2019 – Vanguard introduces an actively managed equity ESG fund, Vanguard Global ESG Select Stock Fund (VESGX), managed by Wellington Management Company LLP with $130.9 million in assets.

Vanguard ESG U.S. Corporate Bond ETF will have an estimated expense ratio of 0.12% and seek to track the Bloomberg Barclays MSCI US Corporate SRI Select Index, a rules-based index that captures a broad cross-section of the U.S. corporate bond market and screens out the bonds of companies whose activities that do not meet specific ESG criteria.

Bloomberg L.P. and MSCI have partnered in managing bond ESG indexes for over eight years, and MSCI has managed ESG data for nearly 50 years. Importantly, there are consistent and established methods for screening corporate bonds in accordance with ESG criteria—other areas of the bond market, such as government-backed or mortgage-backed debt securities do not have such procedures in place.

  • The index methodology includes using the parent Bloomberg Barclays U.S. Corporate Index as a baseline, with Bloomberg and MSCI applying robust exclusion screens for the bonds of companies that the Index provider determines are involved in, and/or derive threshold amounts of revenue from certain activities or business segments related to: Adult entertainment
  • Alcohol
  • Gambling
  • Tobacco
  • Nuclear weapons or power
  • Controversial or conventional weapons
  • Civilian firearms
  • Genetically modified organisms
  • Thermal coal, oil, or gas

The Index also excludes the bonds of any company that, as determined by the Index provider, does not meet certain standards defined by the index provider’s ESG controversies assessment, including the United Nations Global Compact Principles, as well as companies that fail to have at least one woman on their boards or do not report board diversity.

Additionally, the ESG screens are continually assessed and applied to the investible corporate bond market to determine appropriate, diverse representation and select highly liquid bonds to promote a more liquid ETF for investors to trade in the market.

Vanguard’s Fixed Income Group, which oversees more than $1.8 trillion in global assets, will serve as the advisor for Vanguard ESG U.S. Corporate Bond ETF.

Vanguard offers 18 U.S.-domiciled fixed income ETFs with more than $228 billion in assets.5 The firm launched its first ETF in 2001 and today offers 80 ETFs to U.S. investors totaling more than $1 trillion in client assets.

© 2020 RIJ Publishing LLC. All rights reserved.

Lincoln rolls out in-plan retirement income option

Posted on July 16, 2020 by -

Taking advantage of the 2018 SECURE Act, which makes it easier for retirement plan sponsors to include income-generating annuities as plan investment options, Lincoln Financial Group has launched Lincoln PathBuilder, an in-plan guaranteed income option for plan participants.

“PathBuilder makes it possible to turn defined contribution retirement plan savings into a monthly check for life,” a Lincoln release said. The annual cost of the income option is 0.9% of the “income base” (the notional amount on which the payout rate in retirement is calculated. At age 65, the payout rate for a married couple would be 4.5% of the income base per year, according to a PathBuilder brochure.

“Among workers currently saving in their employer’s defined contribution plan, 61% would be somewhat or very likely to contribute to a guaranteed lifetime income investment option,” the release said.

With Lincoln PathBuilder, participants can protect their savings from market declines while also benefitting when the market goes up, because of the way the “income base” is calculated. When participants invest their first dollar in the Lincoln PathBuilder  investment option, their income base is set on that date. As the market goes up, the income base is reset annually once a year. If the market drops, the income base does not go down.

Plan sponsors can add the income investment option to a plan similar to the way they would add any other investment, or as part of a custom target-date portfolio. With a custom target-date portfolio, the account balances will automatically transition, over time, to an investment that can provide lifetime income. Participants can then choose to take this as a regular check that will last throughout their retirement.

Savers will always have full access to their account balance, as well as the flexibility to choose when they want to start receiving lifetime payments, with Lincoln PathBuilder. The investment is fully portable, scalable for large retirement plans, affordable, and can be embedded within a plan that leverages automatic design features, the Lincoln release said.

© 2020 RIJ Publishing LLC. All rights reserved.

Can Wall Street Remain Resilient to the COVID-19 Surge?

Posted on July 16, 2020 by -

As we move deeper into the second half of the year, we face three big questions. To what extent does the renewed surge in COVID-19 cases slow the economic recovery from the first-wave of shutdowns? How much fiscal stimulus will Congress deliver? What will the Fed do to support the recovery?

There are no easy answers to the first question. Virus numbers are surging across the south and west, but will we see a return to stay-at-home orders or more modest interventions? My instinct is that we will see a mixed strategy of wearing masks coupled with sector-specific shutdowns such as the closure of bars in Texas, capacity reductions for restaurants, and the shutting of fitness centers. With continued fiscal support, the economy could weather such a storm. To be sure, growth will be slower than desirable in the near-term, but longer-term growth requires controlling the virus.

How much would this impact Wall Street? In the category of “things that will make people unhappy,” leisure and hospitality is the icing on the cake in the economy. Even though the sector has grown in importance in recent years, it’s valued-added was only 4.2% of GDP going into the crisis. The economy can transition away from a shock to this sector.

The key is not to allow that transition to translate into cascading shocks to the financial system, as occurred after the burst of the housing bubble. That’s where fiscal and monetary policy can continue to help. Barring such a major meltdown, I suspect the rally on Wall Street can survive without keeping the bars open.

Given the deteriorating conditions in some states and resulting political impact to Republicans, my expectation is that we see a fiscal support package in excess of the $1 trillion (maximum) the White House wants but less than the $3 trillion passed by the House. A key element of any package is that some form of enhanced unemployment benefits will continue, although not with the $600 weekly add-on as before.

Treasury Secretary Steven Mnuchin said on CNBC that the White House wants to change rather than extend the enhanced unemployment provision. He did not give details on how it would want to structure aid to unemployed workers. “You can assume that it will be no more than 100%” of a worker’s usual pay, Mnuchin said.
He echoed Republicans who argue the generous insurance deters some people from resuming work because they make more at home than they otherwise would at their jobs. This is a glass half-full sort of situation.

Realistically, the full additional $600 a week wasn’t going to last forever. From a market perspective though, a continuation of benefits at 100% for many workers would be supportive. More generally though, if you believe conditions will rapidly deteriorate in (formerly?) Republican strongholds in the next two weeks, I think you should expect the final numbers on the next pandemic response bill to climb higher. Yes, I understand this has the unpleasant implication that a worsening COVID-19 situation is a market positive.

The Fed will continue to lean toward easier policy. With unemployment expected to remain high and inflation low, the Fed will be under enormous pressure to take further action. Initially, I expect that to appear in the form of enhanced forward guidance and then eventually yield curve control.

There has been some notion of late that the Fed is deliberately moving in the opposite direction by withdrawing stimulus. This idea has gained some traction because the balance sheet has contracted a bit; repo operations have fallen to zero. I don’t think you should interpret this as an intentional reduction of support by the Fed. It simply reflects better market functioning and more excess reserves such that the repo operations are no longer needed.

Three further points. First, the relationship between the Fed balance sheet and equity prices is murky at best. To the extent that the relationship appears, it is spurious. So I wouldn’t bet that a reduction in the Fed balance sheet resulted in a sustained decrease in stock prices. We already did that experiment.

Second, the Fed is already committed to sustaining the current pace of asset purchases. To support the flow of credit to households and businesses over the coming months, the Federal Reserve will increase its holdings of Treasury securities and agency residential and commercial mortgage-backed securities at least at the current pace to sustain smooth market functioning, thereby fostering effective transmission of monetary policy to broader financial conditions.

Third, realistically if market conditions deteriorate, the Fed will accelerate asset purchases if they feel necessary. Which altogether gets to the old story of “don’t fight the Fed.”

Bottom Line: If I am cautious going forward, it’s because I am worried that rising Covid-19 cases could turn market sentiment negative. I also worry that another shutdown risks cascading problems in the financial sector.

I weigh those concerns, however, against my expectation that the next round of shutdowns will be more limited to sectors that are a fairly small part of the economy, that we will thus not see the general collapse in spending as we saw in the initial phase of the crisis, that we will likely get sufficient fiscal stimulus to limp along at worst, and the Fed will continue its efforts to support the recovery.

© 2020 Tim Duy’s Fed Watch. Reprinted by permission. To read Duy’s entire blogpost, from which this is excerpted, click here.

How MMT Became Clear To Me

Posted on July 16, 2020 by -

Like countless other students of economics, I was taught that the U.S. government finances itself by taxing its citizens, borrowing from them, or stealing from them (i.e., by printing new dollars and watering down the money supply).

So I could never make much sense of the claim by proponents of Modern Monetary Theory that Uncle Sam spends before taxing or borrowing. That is, until I read a research paper about a 260-year-old scandal called the “John Robinson affair.”

The scandal involved the defalcation (embezzlement) of a fortune in paper money in pre-Revolutionary Virginia. I learned about this crime from a 2015 research paper by Farley Grubb, a colonial money expert at the University of Delaware. His paper was subsequently cited in the 2019 MMT textbook, Macroeconomics (Red Globe Press).

Gold and silver coins (specie) were scarce in colonial America, especially after the French and Indian War with France. The Virginia House of Burgesses couldn’t afford to pay for two pressing needs: a military squad (called the Rangers) and a Commissioner of Indian Affairs.

So the burgesses created money and taxes—simultaneously.

Under a new currency law, the burgesses authorized the issuance of paper money as legal tender. The bills, which essentially were IOUs of the colony, had expiration dates on them. The Acts also levied taxes that were, not coincidentally, payable with that very same paper money on the day it expired.

Between the issue date and expiration date, the paper served as circulating legal tender. The money passed from hand to hand, facilitating and catalyzing business activity. At tax time (the expiration date), people paid their taxes with it, or with specie.

If, after paying taxes, someone still held paper, he or she could redeem it for specie. After collecting the expired paper, the burgesses then burned it to make room for the next round of issuing paper—thereby preventing inflation.

Suddenly, for the first time, I had the missing link. MMT’s claims made sense to me. Money finances taxes, and taxes finance money. Yes, we earn our money from an employer or a customer. Yes, there are “frictions.” Nonetheless, the money originally comes from government spending (or from bank loans backed by reserves at the Federal Reserve) and returns to government in the form of taxes.

The implications are a bit head-spinning. If this is true, it means that the government doesn’t rely on us for money; we rely on it. Or rather, we all rely on each other. It suggests—though this stretches the imagination—that we pay Social Security taxes not to fund Social Security but to carve out room in the economy for the arrival of Social Security benefits. It means that when banks buy Treasury bonds, they are, at least sometimes, buying them with money spent into the banking system by the government.

Here’s an example of how it might work: The U.S. Treasury sends a Social Security check to a retiree. The check becomes a deposit in the retiree’s checking account. The deposit appears in the bank’s reserve account at the Fed.

When the individual writes a check, his bank’s reserves cover the check. If the banks, collectively, have more reserves than they need, they can buy Treasuries. If they need more reserves to cover more checks, the Fed can buy Treasuries from them.

In a crisis, when the banks can’t find buyers for their assets, the Fed will buy them. That gives banks the cash to cover the checks we write. The government’s checks can never bounce because the Fed will always cover them.

But doesn’t the Fed “print money”? Not really. In my new understanding—and I could be wrong—the government doesn’t sell Treasury bonds to finance deficit spending. Instead, deficit spending gives banks the wherewithal to buy Treasury bonds. Either way, the Treasury’s books look the same. The difference—and this was a key point of debate at the founding of our country—is that the central government isn’t at the financial mercy of the private sector or the states. Quite the opposite.

If you believe money is matter—gold, ideally—and that your objective is to hoard what you can—then what I’ve just told you is sophistry, heresy or even blasphemy. If you believe that the government is illegitimate, and pilfers your money from your paychecks, you won’t like it either. But if you look at money as energy—currency, literally, whose movement is its greatest virtue—then it makes sense.

In this paradigm, the Federal Reserve sits at the center of a financial power grid, ensuring that all valid checks get cashed expeditiously and that the banking system always has enough juice to keep the lights on in houses and businesses from Albuquerque to Zanesville.

In normal times, the Federal Reserve adds or subtracts liquidity from the system at the margins—mainly to push interest rates up or down. In major crises, it injects cash into the financial system by buying Treasury bonds, corporate bonds, or—for the first time in the spring of 2020—bond ETFs (exchanged traded funds).

What about the “John Robinson affair” that I mentioned earlier? Robinson served as Speaker of the Virginia House of Burgesses and the colony’s treasurer from 1738 until his death in 1766.

After he died, the burgesses discovered that instead of burning the expired paper money—the tax revenue—as the law required, he recycled it to his friends. (Perhaps he altered the expiration dates; historical evidence is incomplete.) But “the resulting scandal reverberated through Virginia politics for years.”

© 2020 RIJ Publishing LLC. All rights reserved.

 

Where Does the Fed Get Its Trillions? Ask MMT

Posted on July 16, 2020 by -

During the financial crisis of 2008, the Federal Reserve created trillions of dollars to bail out insolvent banks. At the time, politicians warned the American people, incongruously, that their nation was “broke” and on the brink of “hyperinflation.”

Many ordinary people couldn’t help wondering how the country could be so rich and so poor at the same time. The only economists who seemed able to answer our questions were the relatively obscure academics who whose work involved “Modern Monetary Theory,” or MMT.

Stephanie Kelton, an economist at Stony Brook University, was one of them. With a Ph.D. from the University of Missouri at Kansas City, she has emerged as MMT’s most visible proponent. I heard her speak at a Morningstar conference in 2016. She’s been an economic adviser to the Democrats on the Senate Budget Committee. Last month, she published “The Deficit Myth” (PublicAffairs, 2020), a layperson’s guide to MMT. On Amazon.com, it’s a best-seller in the Money and Monetary Policy category.

Stephanie Kelton

In the book, Kelton describes MMT’s foundational concepts: That wealth in the private sector increases when federal debt increases; that the country’s finances are the opposite of a household’s; and—counter-intuitively—that the federal government spends before it taxes or borrows (not after).

A few weeks ago, RIJ interviewed Kelton about her book and the controversy around MMT. Her book could not be better timed: In 2020, as in 2008, the federal government showed that it does, as predicted by MMT, have a virtually unlimited supply of dollars. If that’s true, Kelton and other MMTers might say, we should be using it more deliberately, and for better purposes.

What is MMT?

Here are three of MMT’s core principles, which Kelton presents not as theories but as facts about the world we’re living in today:

Public debt is private wealth

According to Kelton, the federal debt is a measure of how much money the government has spent into the economy and not taxed out. In other words, the $16 trillion in federal debt held by the public isn’t an economic albatross or millstone, and not a burden on our grandchildren, but a measure of assets held by the public as savings or investments.

“Government deficits are always matched—penny for penny—by a financial surplus in the non-government bucket,” Kelton writes. “At the macro (big picture) level, Uncle Sam’s red ink is always our black ink. When he spends more dollars into our bucket than he taxes away, we get to accumulate those dollars as part of our financial wealth.”

The U.S. is not a household

Most of us are experts on household finance. We know that if we borrow too much we’ll be in trouble. Our credit card bills will mount, crowding out savings and investments. We know that if companies, school districts or even state governments borrow too much, they’ll fail.

But MMT says that the federal government isn’t like a household. Unlike households, the government can levy taxes, issue legal tender, and extend its liabilities over an infinite time horizon. Ipso facto, Uncle Sam can’t go broke.

The government spends first, then taxes or borrows

We learn in economics class that the government finances itself by taxing us, by borrowing from us, or by watering the money supply (printing dollars).

The reality is precisely the reverse, MMTers say. Money has a life cycle. It is born when the government spends it into existence or banks lend it. It circulates through the banking system to the global economy, financing purchases of goods, services or investment assets. It dies when people pay taxes and repay loans.

“All government spending is paid for first,” Kelton writes. “Then, through taxing and borrowing, some of it is subtracted away.” Since only the government can issue money—barring counterfeiters—it can’t happen any other way, MMTers say. There’s no currency to tax or borrow until the government issues it.

“They’re all trying to say that the problem with MMT is that it takes advantage of the ‘printing press.’ But we’re saying that this is how the government works,” she told RIJ. “We’ve always described MMT operationally. It’s not a proposal. It’s how government finance works today.”

Criticism and praise

MMT has drawn a range of reactions, from the skeptical to the hostile to the passionately favorable. Progressive politicians like Rep. Alexandria Ocasio-Cortez (D-NY) and Sen. Bernie Sanders (D-VT) are drawn to MMT; it validates their desire to spend public money on public projects, like affordable housing, universal health care, and better schools. Mainstream economists often call MMT a recipe for inflation.

Philosophically, MMT’s polar opposite is be the “Austrian School” of economics, which is based on the work of Ludwig von Mises and Friedrich Hayek. Austrians tend to believe in holding gold. In a recent blog post about MMT, the Institute’s president, Jeff Diest, accused its advocates of promoting the seductive but illusory idea that governments can legislate prosperity.

“The promise of something for nothing will never lose its luster,” Diest wrote. “MMT should be viewed as a form of political propaganda rather than any kind of real economics or public policy. And like all propaganda, it must be fought with appeals to reality. MMT, where deficits don’t matter, is an unreal place.”

But his critique was qualified. “Kelton deserves credit for writing a book aimed at lay audiences instead of for her peers in academic economics,” Diest wrote. “Unlike most of those peers, she seems genuinely interested in helping us understand how the world works. And unlike most left progressive academics, she also seems interested in helping average people improve their lot in life.”

Gregory Mankiw, an economics thought-leader at Harvard, doesn’t much like MMT. He describes himself as a monetarist: if the money supply outgrows real economic output, inflation occurs. He’s agrees with government-led monetary policy (the Fed’s rate adjustments), but not aggressive government-led fiscal policy, which MMT favors.

But in a recent paper on MMT, he wasn’t entirely unkind. “My study of MMT led me to find some common ground with its proponents without drawing all the radical inferences they do,” he writes.

“I agree that, in a world of pervasive market power, government price setting might improve private price setting as a matter of economic theory. But that deduction does not imply that actual governments in actual economies can increase welfare by inserting themselves extensively in the price-setting process.” [That is, instead of letting the forces of supply and demand determine prices.]

But MMT also has friends in places that might surprise you. A defense of MMT was published in 2019 at at GMO.com, home of the well-known and widely respected value investor Jeremy Grantham. GMO partner James Montier wrote:

“Modern Monetary Theory (MMT) seems to provoke a visceral reaction amongst the ‘great and the good’ such as [Kenneth] Rogoff, [Paul] Krugman, and [Larry] Summers. In my experience, MMT provides a much more accurate and insightful framework for understanding the economy than the precepts of neoclassical economics.”

But “The Deficit Myth” has attracted a lot of positive attention, Kelton told RIJ. She’s been interviewed by journalists from Vox, the Financial Times, Bloomberg, The Nation, and many other publications. “My days and nights are filled with exchanges, and the vast majority are positive and enthusiastic,” she told RIJ. “I’m getting invitations from all over the world to speak at conventions of world leaders and heads of industries.”

‘Radical’ implications

MMT draws criticism in part because it is not as politically neutral as Kelton makes it sound. Mankiw called it “radical,” and it is. MMT turns the conventional economic worldview upside down when it implies that federal debt isn’t necessarily bad or that America pays its taxes and buys Treasury bonds with money that government has already spent. And when it justifies aggressive government spending on health care, jobs, and a “Green New Deal,” MMT inevitably invites comparisons to socialism.

“I trust in the democratic process,” she said in a recent email. “Congress should work to deliver a budget that best reflects the will of the people. And if people want a border wall instead of more hospitals and schools, that is what we’ll get. The goal is to bring the public into the conversation.”

MMT can’t answer the political questions that its economic ideas raise. Even if the government spends much more money, legislators and policymakers will still fight over what to spend it on. Even if higher taxes are better for fighting inflation than high interest rates, people will still fight over whom to tax and by how much.

But no other school of economics answers those questions either. No other economists have ever been able to answer all of the serious questions raised by the 2008 and 2020 financial crises and the subsequent Fed rescues. MMT has come closer than most.

When House Speaker John Boehner in 2009 said that the government had to tighten its belt because households had to tighten their belts, or when George Bush and Barack Obama later said that the government was “broke,” all of them were wrong. Only MMT could explain why. The same has been true in the current crisis. Traditional economics has no recommendations for our worst-of-both-worlds situation, where we’re spending fortunes without investing in the future.

MMT and Social Security

Given its applicability in financial crises, MMT has generated a lot of media attention relative to its size. All of its leading figures—Warren Mosler, Randall Wray, Bill Mitchell, Stephanie Kelton, Pavlina Tcherneva, and Scott Fullwiler—could fit around a large dinner table.

And while they don’t lack for important academic predecessors—Keynes, certainly, Wynne Godley and Hyman Minsky, whose “financial instability hypothesis” was rediscovered in the Great Recession and gave impetus to MMT—the nation’s most influential economics departments have not been hospitable to economists specializing in MMT.

You won’t find MMT economists on the faculties of the biggest and most prestigious universities. They teach at fine schools like Bard College, the University of Missouri at Kansas City, the State University of New York, but not at the University of Chicago, Harvard, or MIT, whose graduates will someday set policy in Washington and on Wall Street.

Social Security, which will technically run short of money between now and 2034, might turn out to be a test case for MMT. In the conventional view, Social Security is a zero-sum game between America’s tax-paying workers and the rising number of retirees their payroll taxes support. It’s assumed that unless payroll taxes go up or benefits go down, the system will fail to fulfill its promises.

On the topic of retirement income, I asked Kelton for her thoughts on the Social Security funding dilemma. She doesn’t see it as a crisis. If Congress can’t agree to lift the cap on the earnings subject to FICA taxes, she told me, it could cover the impending Social Security funding shortfall with an appropriation from general funds—the way it currently pays for most of the costs of Medicare Part D. Social Security doesn’t face an actual funding crisis, she said, “but if everybody agrees to keep up that fiction, I don’t know who will win.”

© 2020 RIJ Publishing LLC. All rights reserved.

DOL’s Perplexing ‘Best Interest’ Proposal

Posted on July 9, 2020 by -

Does anyone understand the Department of Labor’s final proposed  fiduciary rule for retirement plan advisers, which was issued last week with an invitation for comment? Even the experts seem hesitant about its implications.

For instance, the American Retirement Association’s chief content officer, Nevin Adams, a lawyer and former editor of PlanSponsor magazine, knows this subject as well as anyone.

When he wrote recently that the proposal is “a mixed bag and has a certain ‘back to the future’ feel,” he seemed almost as nonplussed by it as I am.

I scanned the rule, but I didn’t find what I was looking for: Examples or scenarios of exactly how it might affect the ability of plan providers either to “cross-sell” products (like health savings accounts, student loan refinancing tools or life insurance) to 401(k) plan participants, or to influence “rollover” decisions when people are ready to move their money from the plan to a brokerage IRA.

Regulators and lobbyists worry over each letter of a statute—knowing that the letter of the law is what matters, especially on appeal. (No one ever seems to pay attention to the “spirit” of a law. That’s apparently for people who believe in ghosts.) Often, the whole idea is to create a kind of Trojan horse—to lull us to sleep and then catch us napping. I tried and failed to read between the lines of this rule.

If the purpose of the DOL’s “principles-based” approach is to allow plan providers (and the advisers they employ) to decide on their own where to draw the line between advice and sales, it would be refreshing to hear.

One particularly confusing section of the proposal involves the so-called “Deseret Opinion.” That’s a 2005 DOL opinion that the provision of a rollover recommendation doesn’t make the adviser a fiduciary. (The rollover decision is one of the pucks you need to follow in this sport; it often determines whether the current recordkeeper retains or loses custody of the participant’s investments.)

The Trump DOL evidently rejected the Deseret Letter, suggesting that rollover advice is sacred work. But that position seems incompatible with the administration’s apparent inclination to relax the regulation of advice about rollovers. If you understand this, please drop me an email about it.

“Thus recordkeepers—who weren’t fiduciaries to the plan but provide recommendations regarding rollovers, and drew comfort from the shield previously offered by the Deseret letter—now find that shield removed by the Labor Department’s proposal,” wrote Adams.

That’s confusing.

We spoke with an ERISA lawyer about the rule. “The question is what level of protection will you provide to the participants,” said Barry Slavin, an attorney at the Wagner Law Group in Boston, in an interview with RIJ. With respect to rollovers, protection is important because the stakes are high. “People are likely to be in an IRA longer than they’ve been in any plan,” he told me.

Another question: Why is the Trump DOL so determined to align its Best Interest standard with the SEC’s Regulation Best Interest? It claims that such an alignment will be more efficient. Yes, but for the plan providers, not the participants.

There’s a reason why qualified money, which the DOL supervises, has been regulated more closely than non-qualified money, over which the SEC and FINRA reign. Qualified money is different. In a sense, it has a higher purpose (essential consumption in old age) than non-qualified money (discretionary spending).

The Obama DOL seemed to understand that. It may indeed have overstepped its authority in its Best Interest rule by suggesting class action lawsuits against violators; it lost in court because of that. The Trump DOL seems to under-step its responsibility to participants when it tries to equate the ethical standards for advisers in retirement plans with the SEC’s standards for advisers in brokerages.

My position is that tax-subsidized defined contribution savings deserves more protection than brokerage money. That distinction seems to go unacknowledged and unappreciated in the current DOL “best interest” proposal.

Even if (in the few brief months before the November election) the Trump DOL succeeds in lightening the fiduciary standard as it pertains to compensation for advisers to plan participants, the retirement industry may have already raised the standard on its own.

Slavin pointed out that larger plan providers seem willing to embrace a “best interest” principle, as long as the regulations don’t (as the Obama DOL rule did) expose them to massive lawsuits.

“Four years ago, plan providers were prepared to implement the Obama rule,” Slavin told RIJ. “Before the Fifth Circuit [Court of Appeals] struck the rule down, those companies were well on their way to complying. I don’t know if we’ll necessarily see them cut back.”

© 2020 RIJ Publishing. All rights reserved.

Romancing the Fixed Annuity: KKR Buys Global Atlantic

Posted on July 9, 2020 by -

KKR & Co., the private equity firm, said this week that it would acquire Global Atlantic Financial Group Ltd., the fourth largest originator of fixed annuity contracts in the U.S. in 2019, in a deal that will raise KKR’s assets under management by about a third, to $279 billion, according to press reports.

Under the terms of the agreement, KKR will pay Global Atlantic shareholders an amount equal to Global Atlantic’s book value as of the date of closing, subject to an equity roll-over for certain existing shareholders.

As of March 31, Global Atlantic’s book value was approximately $4.4 billion. Global Atlantic reported $602 million in operating earnings in 2019 on $90 billion in assets, up from $377 million in operating earnings on $50 billion in assets in 2016, according to KKR. [hartford kept… mark pulley.

KKR, formerly Kohlberg, Kravis, Roberts & Co., expects to fund the acquisition, net of equity roll-over participation, from a combination of cash on hand, proceeds from potential minority co-investors and the issuance of new debt and/or equity. The investment in Global Atlantic will be held on KKR’s balance sheet and through a proprietary vehicle established for others to invest alongside KKR’s balance sheet, not in any client funds.

After closing, Global Atlantic will continue to operate as a separate business with its existing brands and management team, led by Allan Levine, Global Atlantic’s chairman and CEO.

The transaction, which is expected to close in early 2021, is subject to required regulatory approvals and certain other customary closing conditions.

The impact of low interest rates

The deal appears to be a continuation of the trend that began in the wake of the 2008 financial crisis, when private equity or investment companies like Apollo, Guggenheim Partners, Goldman Sachs and others started buying annuity companies or re-insuring existing annuity blocks at bargain prices from companies that needed capital or just wanted out of the U.S. annuity business.

Starting in 2010, for instance, Guggenheim bought Security Benefit Life, Equitrust Life, and Sun Life (now Delaware Life). Global Atlantic, which grew out of Goldman Sachs’ reinsurance group in 2004, eventually bought the U.S. life insurance business of Aviva plc (from Athene) and Forethought Financial Group, which owned The Hartford’s former annuity businesses.

That trend is very much alive today. In recent weeks, Athene, which was first financed by Apollo, bought a $27 billion annuity block from Jackson National. Recently, Nassau Financial (which was funded in 2015 by Golden Gate Capital) concluded its purchase of the International Order of Foresters’ annuity businesses.

The trend is tied to the Federal Reserve’s interest rate policy. The benchmark overnight rate for Fed funds plunged to nearly zero in 2008 as part of the government’s rescue of the financial system. Those rates edged back up to almost 3% by the end of 2018; that’s when the tightening stopped. Rates dropped twice in the second half of 2019 and then went to near zero in March.

Cuts in rates help the stock market recover from swoons and support the prices of existing bonds. But they hurt the ability of life insurance companies to earn enough interest to support their existing liabilities when they have to reinvest the proceeds of maturing bonds into new bonds at lower rates.

Fixed-rate and fixed indexed annuity blocks can be highly desirable to nimble, asset-hungry firms. The blocks are sources of stable assets, while the liabilities (payouts) may not come due for five to 10 years. The private equity-led firms have—or claim to have—sharper asset management skills, access to niche opportunities and higher-yielding assets, and a self-professed ability to exploit the tax and capital advantages of captive Bermuda-based reinsurance partners.

These traits are said to make them better than larger, older life insurers at managing acquired as well as self-originated annuity blocks more profitably. Blocks of variable annuities, by contrast, are much less attractive to private equity firms. Most variable annuity assets are in separate accounts and not under the insurer’s control. In addition, variable annuities’ optional lifetime income guarantees make potential liabilities hard to predict.

About the partners

Goldman Sachs formed Global Atlantic in 2004 and converted it into an independent company in 2013. Headquartered in Bermuda, Global Atlantic acquired Allmerica Life in 2005 and Forethought Life Insurance Company (owner of The Hartford’s fixed annuity business) in 2013. Also in 2013, Global Atlantic acquired the U.S. annuity arm of Aviva PLC, converting it into Accordia Life and Annuity.

KKR was founded in 1976. In 1992, the firm helped buy American Re Corp. out from Aetna Inc. KKR made a big investment in Willis, which is now part of Willis Towers Watson, in 1998. In 2017, Aflac Inc. tapped KKR in an effort to use private equity investments to increase returns on its $120 billion investment portfolio.

© 2020 RIJ Publishing LLC. All rights reserved.

Honorable Mention

Posted on July 9, 2020 by -

SIMON platform to offer Allianz Life fixed indexed annuities

Allianz Life Insurance Company of North America, the top seller of fixed indexed annuities (FIAs) in the U.S. for well over a decade, has added its products to the SIMON Annuities and Insurance Services annuities platform and digital marketplace for Raymond James wealth managers.

“Expanding SIMON’s Marketplace with the on-boarding of Allianz Life delivers not only a broader selection of annuities products to Raymond James advisors [who use] SIMON’s platform, but also the depth of analytics they seek to effectively serve the wealth management and retirement needs of their clients,” a SIMON release said.

Within SIMON’s interactive platform, Raymond James advisors can evaluate Allianz Life’s annuity products and features, run allocation and income analytics within these products, and access product-specific marketing literature.

Scott Stolz, president of Raymond James Insurance Group, who facilitated ties between SIMON Annuities and Raymond James advisors earlier this year said in a statement, “SIMON greatly simplifies all required annuity education by combining it together into a single, easy to use platform that resides on each of our advisors’ desktop.”

SIMON, an independent spin-off from Goldman Sachs’ structured product department, serves more than 30,000 financial professionals managing more than $3 trillion in assets.

Previous RIJ stories about SIMON’s annuity business appeared in our issues of October 2019 and December 2019.

Janus risk-managed index available in Global Atlantic FIA

Janus Henderson Investors has licensed its Janus SG Global Trends Index to Global Atlantic Financial Group, which is in the process of being acquired by KKR, the private equity firm.

The index will be available in a new FIA crediting method called the Enhanced Accumulation Strategy, or EAS, which is available in Global Atlantic’s Choice Accumulation Edge product. The Janus SG Global Trends Index uses dynamic risk management tools to diversify among global stocks, bonds and commodities.

“Traditional tools have typically relied on the assumption that stocks are always higher risk, while bonds are relatively safe, which does not always hold true. Such asset allocation approaches can over-allocate to bonds in rising interest rate environments, and may not consider the changing return potential of different asset classes over time,” a Janus release said.

The Index was co-developed with Société Générale who acts as the index sponsor and licensor. Global Atlantic will have exclusive usage rights to the index within their fixed index annuity (FIA) offering.

Janus Henderson Indices has been providing quantitative index strategies since 2012, and these strategies are now the basis for $3.5 billion in investment products with major financial partners including FIAs, variable annuities, and exchange traded funds (ETFs). The Janus SG Global Trends Index uses market signals to manage these challenges dynamically, adapting to changes in risk profiles between bonds, stocks and commodities.

Morningstar completes purchase of Sustainalytics

Morningstar, Inc., has completed its previously announced acquisition of Sustainalytics, which provides security-level ESG Risk Ratings on the environmental, social, and governance (ESG) factors of tens of thousands of companies worldwide, Morningstar said in a release.

Institutional asset managers, pension funds and investors use Sustainalytics’ risk ratings when integrating ESG factors into their investment processes and decision-making. They underpin Morningstar Indexes and Morningstar’s Sustainability Rating for funds.

More than 650 members of Sustainalytics global workforce, including its CEO, Michael Jantzi, and his executive team, have joined Morningstar.

Morningstar will support Sustainalytics’ existing offerings and integrate ESG data and insights across the firm’s research and solutions for individual investors, advisors, private equity firms, asset managers and owners, plan sponsors, and credit issuers.

Morningstar marked the acquisition by publishing a primer on sustainable investing, “Sharpening the Tools of the ESG Investor: Why ESG Factors Are Important, How Investors Use ESG Data, and What Policies Promote (or Impede) Effective ESG Investing?”

MetLife joins sustainability initiative

MetLife, Inc. has become the first U.S.-based life insurer to join the United Nations Global Compact, the world’s largest corporate sustainability initiative. The compact calls for companies to honor 10 universal principles in the areas of human rights, labor, the environment, and anti-corruption.

The 10 principles of the Global Compact are:

On human rights

Businesses should support and respect the protection of internationally proclaimed human rights and make sure that they are not complicit in human rights abuses.

On labor

Businesses should uphold: the freedom of association and the effective recognition of the right to collective bargaining; the elimination of all forms of forced and compulsory labor; the effective abolition of child labor; the elimination of discrimination in respect of employment and occupation.

On the environment

Businesses should support a precautionary approach to environmental challenges; undertake initiatives to promote greater environmental responsibility; encourage the development and diffusion of environmentally friendly technologies.

On anti-corruption

Businesses should work against corruption in all its forms, including extortion and bribery.

Last week, MetLife issued its annual Sustainability Report, which aligns with the U.N. Sustainable Development Goals and details the ways MetLife and MetLife Foundation deliver for their stakeholders.

In 2019, MetLife became the first insurance company to join the U.N. Women Global Innovation Coalition for Change, and in February 2020, the company became the first U.S.-based insurer to sign the U.N. Women’s Empowerment Principles.

Life insurers’ real estate assets bear watching: AM Best

U.S. life/annuity (L/A) insurance companies continued to increase their exposures to commercial mortgage loans in 2019 and now hold more than $522 billion, up significantly from $382 billion in 2015, according to a new AM Best special report.

The Best’s Special Report, titled, “Commercial Mortgage Loans Increasing, Credit Quality Decreasing,” notes that U.S. economic fundamentals were mostly favorable throughout 2019, with continued GDP growth, low unemployment and rising retail sales. All of these factors led to stable commercial real estate rents and stable vacancy rates. However, more recent trends for commercial mortgage loans (CML) properties show decreases in office and retail properties and increases in apartment properties.

COVID-19-related developments may lead to further percentage declines in these holdings. Holdings in hotel and motel properties, which make up roughly 4% of L/A insurers’ CML investments, also likely will come under pressure until economies reopen more fully.

Despite the increased holdings, including an 8% year-over-year increase in 2019, the percentage of investment-grade loans with the highest rating, designated as CM-1, has declined steadily, while the percentage of loans designated as CM-2 has grown. The shift to CM-2 loans appears to be due to insurers’ efforts to increase yield, rather than to deteriorating conditions leading to downgrades.

AM Best’s recent COVID-19 stress testing on its rated companies assumed declines in several asset categories, including a 10% drop in the statement values of CMLs, with such declines reducing surplus, adjusted for taxes.

CML valuation declines will impact Best’s Capital Adequacy Ratio (BCAR) results, particularly for property types affected the most by the COVID-19 shutdowns. Hotel properties in particular are experiencing unprecedented vacancy rates.

Retail and office property also are experiencing significant drops in revenue, which can lead to deterioration in quality and declines in valuations. This will also affect the performance of other mortgage-backed assets, such as commercial mortgage-backed securities. A prolonged impact of COVID-19 could have a significant effect on the loan values and operating income of most property types as well.

As the pandemic leads to loan forbearance, along with remote work forces and travel restrictions, the potential for deterioration in credit quality grows. However, L/A insurers’ low exposure to hotels will help minimize the impact. Instead, insurers will feel the impact of longer-term pandemic conditions through accelerated loss recognition, leading to pressure on GAAP earnings. AM Best said it will closely monitor insurers with higher CML exposures relative to total statutory surplus.

Asset management consolidation to continue: Cerulli

Secular trends in the asset management market that made the environment ripe for consolidation during the past five years—namely, fee compression, outflows from higher-cost active strategies, and product rationalization—are still active despite the COVID-19 pandemic, to the latest Cerulli Edge—U.S. Asset and Wealth Management Edition.

Numerous subscale managers have joined forces In order to combat fee compression, shrinking shelf space, and the rising cost of compliance due to stricter regulations. These subscale deals are aimed at strategic expansion into broader markets around the globe and consolidation/rationalization of product lineups to focus on top-performing strategies.

“In theory, these M&A deals make sense on paper,” said Cerulli managing director Bing Waldert. “But they can also exemplify the difficulties of melding operations within different firms with varying cultures. They typically lead to at least some level of reorganization and staffing reductions.”

A clearer path to success may reside in another type of M&A deal, said Cerulli senior editor David Fletcher said. “We have observed an increasing amount of M&A deals that primarily focus on the opportunistic acquisition by larger firms of smaller firms with strong brands and reputations for specific capabilities in a given sector—e.g., alternative investments and environmental, social, and governance (ESG) offerings.

Alternative investment capabilities are an attractive M&A target for many asset managers given investors’ increasing interest in uncorrelated, risk-adjusted allocations and these products’ relatively attractive revenue potential.

Alongside the 74% of firms polled by Cerulli in 2020 citing the potential for increasing revenues as motivation for developing alternative investment capabilities, 59% point to business diversification as a chief driver. In addition to the alternatives space, an increasing number of managers are expanding via acquisitions in the ESG-related product universe.

Nearly one-quarter of firms polled are in the process of developing ESG capabilities during the next two years. For some firms, there will be significant cost to building these processes and staffing them.

Therefore, as asset owners continue to place increased scrutiny on asset managers’ business practices and processes, Cerulli expects that more M&A activity related to ESG/responsible investing will occur in the near term.

© 2020 RIJ Publishing LLC. All rights reserved.

Nassau Financial creates Apple app to sell fixed-rate annuities

Posted on July 9, 2020 by -

Nassau Financial Group has launched a fixed-rate multi-year guaranteed annuity with virtual distribution through an iOS mobile application.

The contract, called “Simple Annuity,” and the app of the same name will support the sale of the annuity by independent, commissioned insurance agents and by Nassau’s own licensed, salaried representatives. The app is intended to “redesign the sales and consumer experience for annuities, empowering agents with digital tools to support sales,” a Nassau release said.

The Simple Annuity is a fixed rate, multi-year guaranteed annuity with four-year and six-year terms. As of June 1, the guaranteed annual returns are:

  • 4-year, 2.45%
  • 6-year, 2.75%

“The future of annuity distribution will be a digitally-enabled agent,” said Paul Tyler, chief marketing officer of Nassau Financial, in an interview. “We also get a lot of good intelligence when we offer this product directly to consumers.” The single-premium product has a minimum investment of $5,000 in non-qualified money. The yield on the contract is the same whether sold by a commissioned agent or salaried representative.

With the app and phone support, a sale can be closed in as little as “six minutes,” Tyler told RIJ. “The clients take a picture of their driver’s license, you verify their identity, you do an EFT [electronic funds transfer]. It’s a great way for agents to reach people who have no time for paperwork or an appointment. If we can sell direct, it will be groundbreaking.”

Nassau was founded in 2015 with capital provided by Golden Gate Capital, a private investment firm with over $15 billion of committed capital. Aiming to “build a franchise across the insurance value chain,” the firm bought Phoenix Life and related companies, Saybrus Partners, a distribution firm, Constitution Life and CorAmerica. It also formed Nassau Re Cayman, and Nassau Corporate Credit.

Nassau Financial Group currently has combined assets of about $22.6 billion and capital of about $1.3 billion. It has four business segments: insurance, reinsurance, distribution and asset management through various affiliates.

In a deal announced in October 2019 and completed this year, Nassau Financial Group acquired two New York-domiciled firms, Foresters Financial Holding Company, Inc. and Foresters Life Insurance and Annuity Company (FLIAC) from the International Order of Foresters. Founded in 1962, FLIAC has 112,000 life insurance and annuity policyholders in the U.S. and $2.5 billion in assets.

Foresters Financial Holding Company, Inc., includes a registered broker-dealer, two investment advisers, a life insurance company and a transfer agent. Foresters Life Insurance and Annuity Company maintains an “A” (Excellent) rating by A.M. Best.

Phil Gass is a co-founder of Nassau Re and serves as chairman and chief executive officer. Gass previously served as chairman and director of Fidelity & Guaranty Life (2011 through 2015) and managing director of investments at HRG Group, Inc.

From 2004 to 2008, he served as vice president of GE Capital. Before then, he held positions at Dresdner Kleinwort Wasserstein and the Sumitomo Bank.

Symetra Life Insurance Company announced this week that it is partnering with the Nassau Re/Imagine insurtech incubator based in Hartford, Connecticut, in order to tap the region’s deep insurance industry talent pipeline.

Nassau Re/Imagine currently supports 19 startups focused on solving pressing problems for the life, annuity, reinsurance, and property & casualty sectors. Symetra’s Harry Monti, executive vice president, Benefits Division, will join the Nassau Re/Imagine advisory board.

“Our Enfield, Connecticut-based employees [will have] greater access to Hartford’s vibrant innovation network, multiple brainstorming events and the kind of collaborative environment that can fuel viable business ideas,” Monti said in a release.

Through parent company Sumitomo Life, Symetra is already a participant in the Plug and Play Tech Center in Sunnyvale, California.

The Nassau Re/Imagine program, launched in early 2019, supports individuals and teams committed to fostering an insurtech ecosystem in Greater Hartford. The program provides entrepreneurs with operational resources, access to potential customers, support for product commercialization, and introductions to investors. The support network includes Hartford-area insurance carriers, technology companies, academic institutions and professional service firms.

© 2020 RIJ Publishing LLC. All rights reserved.

Odds Favor Yield Curve Control

Posted on July 9, 2020 by -

I staked out a position on yield curve control in Bloomberg Opinion:

The Federal Reserve might not be ready to explicitly target yields on U.S. Treasury securities to keep them from rising and hindering the economic recovery, but that doesn’t mean it won’t happen. If you believe the Fed will be under continued pressure to do more to support the economy, it’s tough to bet against the eventual adoption of so-called yield-curve control.

Recall that last week, the Fed signaled doubts about yield curve control. My expectation is that those doubts will eventually fade.

How do I arrive at such a conclusion despite the Fed’s reticence? My position assumes continued economic weakness, inflation persistently below target, and an eventual unwillingness on the part of the Fed to continuously ramp up the scale of asset purchases.

With a new wave of Covid-19 cases sweeping some states, particularly in the South and West, it is becoming increasingly evident that we will not experience anything like a V-shaped recovery. We are in this for the long haul; consumers are already starting to step back:

From a July 8, 2020 Tweet by Julie Coronado, Ph.D.

We have to assume that even in the case of a miracle vaccine, full recovery remains years away. If the last recovery is any example, inflation will remain persistently below the Fed’s 2% target. With that being the case, the Fed will be under constant pressure to DO MORE.

What does “doing more” entail? First up will be enhanced forward guidance. They will tie policy to economic conditions, likely weighted more toward realized inflation. Beyond that, they will want to move onto a tool they can escalate. They could escalate quantitative easing, but that commits them to a path of expanding the balance sheet at an increasing pace. Doing more with quantitative easing means $45 billion becomes $60 billion becomes $75 billion, etc. You get the idea. I think the Fed would eventually become concerned about the optics.

Alternatively, you could instead move toward yield curve control. The Australian experience is that once you establish credibility on the policy, you don’t need to actually buy any bonds. Plus, you don’t have to jump straight to three years out. You start at one year, then two years, then three years. That’s like a full year of “doing more” without escalating the pace of asset purchases.

You can argue whether this actually accomplishes anything. That’s fine, you don’t think the signaling alone has much value. Others think it does. Either way, you have an investment position. Note also that a turn toward yield curve control doesn’t necessarily preclude the Fed from doing more quantitative easing. I expect they would use the tools in tandem, yield curve control to lock down the front end and enhance forward guidance and asset purchases to reduce term premiums and force investors into less safe assets.

Of course, a surprisingly quick recovery or an outbreak of inflation would eliminate the need for additional policy. For example, Congress could in theory pump enough money into the economy to accelerate the return to full employment. It’s not my expectation, but it could happen and shift the path of Fed policy.

Bottom Line: Yield curve curve control seems too obvious a choice to easily dismiss.

© 2020 Tim Duy. Used by permission. This column first appeared on his blog.

In robo deal, Empower pays $1 billion for Personal Capital

Posted on July 2, 2020 by -

Empower Retirement, second only to Fidelity as a U.S. retirement plan provider, has acquired Personal Capital, the hybrid human-and-digital investment advice platform.

Empower will pay “up to $1 billion in enterprise value, composed of $825 million on closing and up to $175 million for planned growth,” according to a release this week.

In Personal Capital, Empower acquires an advice platform that has “added over 2.5 million users on its platform, tracking over $771 billion of household assets” since its founding in 2009, the release said.

“There are few modern wealth management platforms that can deliver personalization at scale direct to the consumer,” Personal Capital co-founder Rob Foregger told RIJ this week. “They’re hard to build and hard from an execution standpoint. And it’s not easy to do the marketing and to build a national brand.

“Personal Capital brings together all the pieces,” he added. “There’s a scarcity of pure-play platforms that can drive this technology. That’s one reason why Empower made this acquisition, and why these types of acquisitions will continue.”

The COVID-19 pandemic will accelerate the digitization of professional services, bringing it to maturity about five years sooner than the financial services industry expected, Foregger said. “Changes in the financial industry that were underway but still 10 years from taking full effect, are now on top of us.”

NextCapital, a sibling company to Personal Capital, remains independent, Foregger said. NextCapital is an advice platform that enterprises can provide to their clients under their own brand, in a “white-label” relationship. Such enterprises include 401(k) plans, broker-dealers, Registered Investment Advisors, and other retail financial businesses.

After the close of the transaction, Personal Capital will be branded as “Personal Capital, an Empower Company.” It will continue to provide its financial tools and investment solutions to clients. Personal Capital CEO Jay Shah will serve as president of Personal Capital, the release said.

Shah will report to Empower CEO Edmund F. Murphy III, and join Empower’s executive team. A joint team from both enterprises will work together to integrate the Personal Capital and Empower offerings. The transaction is expected to close in the second half of 2020.

Sullivan & Cromwell LLP served as legal counsel and Morgan Stanley & Co. LLC and Rockefeller Capital Management advised Empower. Willkie Farr & Gallagher LLP served as legal counsel and Moelis & Company LLC served as financial advisor to Personal Capital.

© 2020 RIJ Publishing LLC. All rights reserved.

Fresh from Midland National and DPL, AllianzIM

Posted on July 1, 2020 by -

A versatile fee-based FIA from Midland National, on the DPL platform

DPL Financial Partners and Midland National Life Insurance Company are introducing a new commission-free fixed index annuity (FIA) with a “health-activated income multiplier” feature.

The contract is called Midland National Capital Income. Contract owners can receive double income payments for up to five years “to help prepare for increased personal care costs.” Capital Income will be available exclusively to DPL’s RIA member firms by the end of July 2020.

Policy-owners who can’t perform two or more of the six basic activities of daily living (bathing, continence, dressing, eating, toileting, and transferring in and out of beds and chairs) can turn the rider on. It is not intended to replace long-term care insurance.

The multiplier is a feature of the product’s guaranteed lifetime income rider, available for a rider fee of 1% per year; it can be dropped after seven years. There’s a seven-year surrender period with a 6% first-year penalty for withdrawals of more than 10% of the account value.

A waiting period and an elimination period are among the conditions and limitations on the benefit, the companies said in a release. There’s a three-year waiting period after the purchase of the contract, and a three-month waiting period after switching on income.

The older you are when you buy the contract, and the longer you wait after buying the product to start income, the higher the annual annual payout percentage. According to the product brochure, for example, a 65-year-old single contract owner could take lifetime income of 5% per year. The rate would go up to 5.75% if he or she delayed income until age 70. Payouts for couples are a bit less.

According to the product rate sheet, the contract currently offers a fixed-rate account paying a guaranteed 2.75% per year. There’s a market-value adjustment for excess withdrawals. The minimum investment is $20,000.

There are two annual point-to-point crediting strategies offering exposure to the S&P500 Index (without dividends). One has a 5.25% cap, the other has a 35% participation rate and an “index margin” of 2%.

There’s also uncapped annual point-to-point exposure to the Fidelity Multifactor Yield Index 5% ER, “a multi-asset index, offering exposure to companies with attractive valuations, high quality profiles, positive momentum signals, lower volatility and higher dividend yield than the broader market, as well as U.S. Treasuries, which may reduce volatility over time.”

New rates for Allianz buffered ETFs

Allianz Investment Management LLC (AllianzIM) has announced new caps and buffers on the structured exchange-traded funds that it introduced in June and which trade on the New York Stock Exchange, an Allianz news release said. The new rates are valid from July 1, 2020 to June 30, 2021.

There are two versions of the ETF: the “U.S. Large Cap Buffer10 Jul ETF” (NYSE Arca: AZAL) and the “U.S. Large Cap Buffer20 Jul ETF” (NYSE Arca: AZBL). Both have begun trading on the New York Stock Exchange.

AZAL has a gross 10% buffer and a gross upside cap of 16.1%. AZBL has a gross 20% buffer and a gross upside cap of 8.8%. The net buffers and caps are 0.74% lower than the gross, reflecting the 0.74% annual expense ratio.

The net return will also reflect brokerage commissions, trading fees, taxes and non-routine or extraordinary expenses. The cap and buffer experienced by investors may be different than the stated numbers, the release said. The funds’ website, at www.allianzIM.com, provides additional fund information and information relating to the potential outcomes of an investment in the funds on a daily basis.

Accessible to retail investors via the New York Stock Exchange, AllianzIM Buffered Outcome ETFs are also available to advisers through Halo Investing, Inc.’s (Halo) global technology platform.

© 2020 RIJ Publishing LLC. All rights reserved.

Should Nursing Homes Be Closed?

Posted on June 30, 2020 by -

Many senior-living executives advanced in the industry by qualifying as Nursing Home Administrators. That has tilted the industry toward caring for the frail more than celebrating the capable. There are different kinds of nursing homes, ranging from small board and care homes, to proprietary nursing homes specializing in Medicaid, to the care facilities in Continuing Care Retirement Communities (CCRCs).

Life in a SNF

CCRC residents are sometimes seen as embarked on a life journey that ends with confinement in the Care Center, as CCRC nursing facilities are often termed. That is no longer seen as a desirable place to spend one’s final days. Sharing a room and a bathroom with a total stranger, who may have annoying habits, is not an outcome that anyone would want.

The COVID-19 pandemic has led to a media focus on Skilled Nursing Facilities (SNFs) as disease-prone concentrations of vulnerable people. Estimates have suggested that as many as one-third of all COVID-19 deaths may occur in SNFs. This, of course, ignores the death rates in hospitals. As one wise person said, “Have you ever thought about what a privilege it is that your residents have chosen to die in your community?” The recent negative publicity may be unfair, but it is a new public awareness reality with which senior living operators must cope.

Some of what media reports present as “excessive” deaths may be no more than hospice patients, for instance, choosing to forego treatment. Thus, many of the SNF deaths may be among people who were likely to die soon in any event, but for whom COVID-19 has merely accelerated the inevitable.

Who’s to Blame?

LeadingAge’s Katie Smith Sloan recently courageously pointed to the failure of our national leaders to give priority to shielding nursing home workers with adequate Personal Protective Equipment (PPE). The nursing home industry has not been as effective as have hospitals in making their plight known. One reason may be the artificial distinctions that prevent the trade associations – LeadingAge, American Senior Housing Association, and Argentum – from speaking with a shared voice. A secondary reason may be that their voice is less compelling due to the absence of residents and their family members in trade association policy councils. AARP has demonstrated that true grassroots support weighs heavily in Washington.

Nevertheless, as the National Institutes of Health’s respected spokesman, Dr. Tony Fauci, said recently, now is not the time to be assigning blame. Now is the time to address the common foe with all our strength, with all our will, and with all our capacity. That the media have chosen to single out nursing homes and then to assign blame to their proprietors has not been helpful. Moreover, it shows a journalistic superficiality that is unworthy of those who are given authority to shape public opinion in a democracy. Still, unjust publicity is not the only challenge confronting nursing homes. They face financial challenges as well.

Do We Need SNFs?

Financially, licensed SNFs are eligible for short term Medicare reimbursement benefits. Downward pressure on reimbursement rates makes it increasingly difficult to cover the cost of quality care. Thus, it’s not surprising that, even before COVID-19, many CCRCs were delicensing their SNFs and converting them into more homelike high-acuity assisted living. Most needs calling for a SNF license can be provided in that more inviting setting if there is competently licensed staff.

Without a skilled nursing facility, senior living operators won’t need to have a licensed Nursing Home Administrator. The focus can shift to ensuring that what seems like an attractive home for life remains just that.

Trend Away from SNFs

A trend away from skilled nursing began before COVID-19. A 2018 CBRE (Coldwell Banker Richard Ellis) study concluded: “Telemedicine and other technological advances in the delivery of health care are keeping seniors with significant health-care needs in non- nursing care environments longer.” COVID-19 has accelerated the adoption of telemedicine, so it is likely that the decline of licensed SNFs will continue.

A two-stage assisted living approach can allow CCRCs to provide a more integrated care response. Generally, skilled nursing staff are not allowed to respond to independent and assisted living residents if an emergency develops, say, in the middle of the night. That can lead to expensive and unnecessary transports to emergency rooms. Effective telemedicine, however, can connect remotely with emergency room physicians, who can determine whether transport is needed or not.

What Happened?

Criticism of nursing homes is not new. During the 1980s, there was a move toward privatization, which spurred the expansion of proprietary skilled nursing homes. A 1986 study titled “For-Profit Enterprise in Health Care” from the Institute of Medicine decried the prospect of substandard care. Some proprietary SNFs have been characterized as greed-motivated, suggesting that profit takes precedence over patient welfare. That unsavory perspective may now have tainted the entire industry.

The COVID-19 crisis is accelerating many business trends. The time may be now when senior living operators need to decide whether it is wise to continue. It’s hard to make a case for continuing a care model that can result in losses, especially when serving needy Medicaid patients. Now that financial challenge is exacerbated as nursing homes are seen as hazardous for the welfare of those served. It’s possible that hospitals will offer SNF-type services in separate facilities on their campuses, or that specialized operators may be able to scale SNFs to be viable. If so, those who no longer provide SNF services as part of their portfolio can contract with others to meet those needs.

© 2020 SeniorLivingForesight (seniorlivingforesight.net). This article first appeared here. Reprinted by permission.

 

Why Is Income Planning So Hard?

Posted on June 30, 2020 by -

Bill Sharpe, who won a Nobel Prize for co-creating the capital asset pricing model, called retirement income planning the hardest financial problem he has ever tackled. It’s clearly different from other types of financial puzzles.

On a personal level, the pre-retirement “accumulation stage” might actually be more stressful. Financially, it involves earning, saving and investing; borrowing and re-paying; buying all kinds of insurance. Plus parenting. That entails a lot of stress. People are least happy at mid-life, research shows.

Then comes retirement. It’s not all that bad. Medicare and Social Security benefits begin. Mortgages, loans, and credit card debt have melted away, ideally. Paydays end but deferred income or pensions may begin. Many people dread retirement until they dive in. When they do, the water feels surprisingly good.

So what makes retirement income planning so difficult—for adviser and client? Well, it’s different from the accumulation stage. The risks are different, for one thing. Longevity risk (living too long) replaces mortality risk (dying too soon). “Sequence risk” (selling depressed assets for income) looms larger than market risk (volatility). Those “deferred” income taxes start to come due. Risk capacity supersedes risk tolerance or risk appetite.

For many people, these changes demand a new approach to money management. Your clients probably won’t know that the rules of the game have changed. They’ll rely on you to guide them through an unfamiliar financial landscape. To maximize your value to them, you may need to make a few mental adjustments yourself. For instance, creating plans that involve investments and insurance can be challenging if you’re not used to it.

Blending investments and insurance

At RIJ, we believe that a combination of the two can create financial synergies for the client. But most advisers, by personal and professional history, are grounded in either the investment or the insurance world. Investment specialists may find it awkward to “frame” the role of insurance products in their own minds, and when communicating their pros and cons to a client.

The awkwardness is understandable. For retirees, insurance (annuities, life insurance, Medigap or Medicare Advantage policies, long-term care insurance, reverse mortgages) can be looked at as expensive investments, as sunk costs, as income-generating assets, or as tax-deferral or tax-reduction vehicles. The role of deferred annuities with “income riders” can be especially difficult to frame or position in the portfolio, because they contain several of those elements.

There’s a fundamental difference between investments and insurance. When people invest, they buy risk in the form of securities. They also buy asset management services. When they insure, they do the opposite. They sell (or transfer) risk to an insurance company by signing contracts. That is, they buy risk protection or risk management services. When annuities serve as both investments and insurance, their value can be hard to value or communicate.

One important benefit of insurance products often goes unarticulated, I think. Insurance creates opportunities. To transfer one risk, like market risk or longevity risk, to an insurance company is to create “risk budget” for a different kind of investment or expenditure.

Insurance lets people do things that would otherwise be too financially risky. Like spending money today instead of hoarding it for an uncertain or even unlikely calamity in the future. Identifying or measuring those things won’t be easy. Every client’s opportunity will be unique. Only the client can name it. But helping retirees name their own opportunities might produce the most satisfying moments you have with them.

Topics for the future

There are other challenges to retirement income planning. You’re probably familiar with them. There are, of course, the obvious uncertainties related to health and length of life. Then there is the sheer multiplicity of methods for generating income from existing assets. Not least, income planning often involves difficult trade-offs or sacrifices. Spouses may not agree on how to resolve them. Hesitation over an unpalatable trade-off can stall the execution of a plan forever.

Your business model may also present a significant challenge, if not an obstacle. If you earn fees only by charging a percentage of assets-under-management, how can you obtain compensation for providing advice on insurance or home equity? Advisers who are multi-licensed might not have difficulty handling this challenge, but others will.

There’s also the challenge of broaching personal topics with clients. Mortality is an unavoidable presence at the table. Any discussion of annuities, especially for couples, will involve mortality. Many clients will avoid talking about death. Retirement income planning encompasses almost everything that happens within a household. Not all clients or advisers will be equally eager or capable of “going there.” But we believe that the satisfactions make the effort worthwhile.

© 2020 RIJ Publishing LLC. All rights reserved.

Tontine Savings Accounts

Posted on June 30, 2020 by -

A tontine is a financial vehicle that allows people to pool their assets and their mortality risk and thereby enhance their savings. We envision tontine savings accounts (TSAs) as taxable or tax-deferred retirement accounts, with investors free to select their investments and payout method. Payouts could be 10% to 15% higher than those of commercial life annuities.

Unlike a regular savings account (but like a life annuity), an investor in a TSA can’t directly access her contributions or earnings. Instead, the investor would receive payouts only according to the payout method she elected.

A typical investor in a TSA might elect to receive relatively level monthly payments starting at her planned retirement age (if she is alive then) until her death. Alternatively, she might elect inflation-adjusted payouts that would start out lower than level payments but end up much higher. TSA payouts would be higher than payouts from regular savings accounts—precisely because surviving pool participants inherit the assets of those who die. These enhancements are known as “mortality gains” or “mortality credits.”

Payouts from a TSA are based on:

  • The investment returns on the investment portfolio that the investor elects
  • The mortality experience of her tontine pool
  • The payout method elected

While mimicking the high payouts of an actuarially fair variable life annuity, TSAs would cost significantly less than commercial life annuities. Tontine sponsors don’t insure investors against market risk or longevity risk, so they don’t need to set aside reserves to back up any guarantees. For a relatively trivial fee, they would merely invest and custody passively-managed funds, keep track of when investors die, reallocate forfeited assets to surviving investor accounts, and deliver payouts.

Sally, a 35-year-old investor

Consider Sally, a hypothetical 35-year-old investor who contributes $1,000 to a TSA at ABC Co., which could be an insurance or investment company. Sally and ABC agree that: 1) her contribution will be invested in a Standard & Poor’s 500 (S&P 500) stock index fund, 2) Sally will get an appropriate lump-sum payout at, say, age 70 if she is alive then, but 3) if she dies before age 70, her contribution will be forfeited (for the benefit of the other investors in ABC’s TSA portfolio).

Richard Fullmer

ABC does not guarantee the amount Sally would receive at age 70. When Sally first invests, neither she nor ABC knows how large her lump-sum payout will be in 35 years. But ABC offers Sally a “fair deal” [see explanation below] based on its transparent estimates of her probability of surviving to age 70 and the probable size of the lump-sum payout she would get.

For instance, ABC might tell Sally that a 35-year-old investor like her has an 80% chance of surviving to age 70 (from an appropriate life expectancy table) and that her investment in the S&P 500 index fund will earn an average annual rate of return of around 7% (from a capital markets forecast).

Given these two assumptions, ABC can tell Sally that if she survives until age 70, she should expect to collect a lump-sum payout of about $13,350 then. Here’s the math:

First, if the S&P 500 index fund grows at exactly 7% every year for the next 35 years, then Sally’s $1,000 investment will grow (ignoring expenses) to around $10,700 in 35 years ($10,676.58 = $1,000 × 1.0735). Second, if exactly 20% of the 35-year-old investors in the TSA pool die before reaching age 70, then (if she survives until then) her payout will be around $13,350 ($13,345.73 = $10,676.58/0.80). If she doesn’t survive, she will have already forfeited her investment.

In other words, if Sally invests $1,000 in an S&P 500 index fund, she (or her heirs or estate) should get around $10,700 in 35 years. But if she instead invests $1,000 in a TSA, she should get around $13,350 if she survives until then. She would have an extra $2,670 to live on in retirement ($2,669.15 = $13,345.73 – $10,676.58). Depending on her bequest motives and other preferences, she could split her investment between a TSA and a regular account, for which she would designate beneficiaries.

‘Fair’ tontines

In a fair tontine, each investor receives a “fair” bet in the probabilistic sense, meaning that the expected value of mortality gains (while living) will equal the expected value of the account forfeiture (at death). Satisfying this “fairness constraint” requires that the forfeited assets of dying investors be transferred to the surviving investors in an actuarially fair (unbiased) way, based on each investor’s relative stake in the tontine pool and probability of dying.

Jonathan Forman

All in all, a fair tontine can be designed to offer fair bets to all investors even if they are of different ages and genders, invest different amounts at different times, use different investment portfolios, and elect different types of payouts.

Like traditional savings accounts and brokerage offerings, TSAs would be perpetually open-ended. New investors could open new accounts at any time, and current investors could make additional investments at any time. The individuals who make up any given financial institution’s tontine pool would change over time, and, eventually, newer generations of investors would completely replace older generations.

All fees for TSAs would be plainly and transparently disclosed. The use of index funds as investments would make the all-in costs to investors very low. For example, a TSA might invest entirely in index funds. Many discount brokerages charge 0.15% or less per year to administer such funds. If TSA management and record-keeping functions could be performed for about 0.25% of investments per year, a TSA’s annual expense ratio could be as low as 0.40%.

TSAs in practice

Besides IRAs or standard taxable accounts, accounts in 401(k) and other defined contribution plans could also serve as vehicles for TSAs. An employer could invest its matching contributions into TSAs for its employees and allow them to direct some, or all, of their own contributions into their TSAs.

During the accumulation stage, investors could also elect from a wide variety of investment options including stock, bond, and target-date strategies. Investors could be allowed to reallocate their assets (i.e., trade within their accounts) periodically.

When an investor contributes to her TSA, she would choose among payout options. These would include not only the lump-sum payout option chosen by Sally in the example above but also a variety of periodic and lifetime payout options. Lifetime payout options could be designed to mimic:

  • Immediate, level-payment annuities
  • Immediate, inflation-adjusted annuities
  • Deferred annuities (i.e., longevity insurance)
  • Joint-and-survivor annuities

Life insurance companies are well positioned to offer TSAs since they already deal with mortality data and trends. State insurance commissioners already know how to regulate pooled annuities, if not tontines. However, mutual fund or investment brokerage companies might also wish to offer TSAs since TSAs do not offer guarantees and thus are technically not contracts of insurance in the traditional sense of risk transfer.

No doubt, there will be some regulatory hurdles for TSAs, but we are confident that those hurdles can be overcome—as with any new financial product. All in all, we believe that TSAs can provide investors with a new and more valuable source of lifetime income, and we look forward to their inception.

Jonathan Barry Forman, J.D., M.A. (Economics), M.A. (Psychology), is the Kenneth E. McAfee Centennial Chair in Law at the University of Oklahoma College of Law. He can be contacted at [email protected].

Richard K. Fullmer, CFA, M.Sc. (Finance, Management), is the founder of Nuova Longevità Research. He can be contacted at [email protected].