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Fed chairman promises to do ‘whatever it takes’

Posted on April 30, 2020 by -

Noting that the Federal Reserve can lend money but not spend it, Fed chairman Jerome Powell promised that he would act “forcefully, proactively and aggressively” for long as it takes to prevent the COVID-19 pandemic from inflicting long-term damage on the U.S. economy.

Responding to questions from reporters via video streaming Wednesday afternoon, Powell acknowledged that lasting damage could occur if too many Americans remained out of work too long or if too many small companies failed.

“A wave of unnecessary insolvencies could do long-term damage to the productive capacity of the economy. That’s a risk,” he said. “There’s also the global dimension. Problems overseas could weigh on our performance.”

The Fed will continue to buy Treasury securities, U.S. agency-backed securities and mortgage-backed securities, Powell said, adding that its Primary Market Corporate Credit Facility and Secondary Market Corporate Credit Facility, which will be equipped to buy up to $750 billion in corporate bonds “will be operating soon.”

At the same time, the Fed is working on the establishment of the Main Street New Loan and Expanded Loan Facilities, which would facilitate bank or credit union loans up to a total of $600 billion to small and medium-sized businesses with up to 10,000 employees and $2.5 billion in 2019 revenues.

Under the programs, Congress also appropriated of tens of billions of dollars to absorb losses under the loan programs, because the Fed is not allowed to take on credit risk. Asked about the future, Powell emphasized that interest rates would stay low until the economy recovers, but he said the recovery timeline is uncertain.

“We’ll definitely see a sharp slowdown in the second quarter. In the next phase, let’s say in the third quarter, there will likely be less social distancing and the economy will begin to recover,” Powell said.

“We might see a large increase in output, but it’s unlikely to bring us quickly back to pre-crisis levels. The sooner we have the virus under control, the sooner people will begin to feel confident about the economy. It will take some time to get back to normal or maximum employment,” he added.

As for the Fed’s lending capacity, Powell said, “If demand for lending facilities is greater than estimated then we’ll expand them. It’s not like the Paycheck Protection Program where a certain amount is allocated and then it ends. We won’t stop lending until we exhaust the Treasury’s equity and we’re a long way from doing that.”

The Fed’s offer to buy corporate securities calmed the credit markets, he added. “So far we’ve only made short-term money market loans, and not other corporate loans. But our actions have already built confidence in the market, and many companies have been able to refinance themselves privately since we announced the facility. The announcement alone has had an effect.”

Here’s yesterday’s formal announcement by the Federal Open Market Committee:

The Federal Reserve is committed to using its full range of tools to support the U.S. economy in this challenging time, thereby promoting its maximum employment and price stability goals.

The coronavirus outbreak is causing tremendous human and economic hardship across the United States and around the world. The virus and the measures taken to protect public health are inducing sharp declines in economic activity and a surge in job losses. Weaker demand and significantly lower oil prices are holding down consumer price inflation. The disruptions to economic activity here and abroad have significantly affected financial conditions and have impaired the flow of credit to U.S. households and businesses.

The ongoing public health crisis will weigh heavily on economic activity, employment, and inflation in the near term, and poses considerable risks to the economic outlook over the medium term. In light of these developments, the Committee decided to maintain the target range for the federal funds rate at 0 to 1/4 percent. The Committee expects to maintain this target range until it is confident that the economy has weathered recent events and is on track to achieve its maximum employment and price stability goals.

The Committee will continue to monitor the implications of incoming information for the economic outlook, including information related to public health, as well as global developments and muted inflation pressures, and will use its tools and act as appropriate to support the economy. In determining the timing and size of future adjustments to the stance of monetary policy, the Committee will assess realized and expected economic conditions relative to its maximum employment objective and its symmetric 2 percent inflation objective. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments.

To support the flow of credit to households and businesses, the Federal Reserve will continue to purchase Treasury securities and agency residential and commercial mortgage-backed securities in the amounts needed to support smooth market functioning, thereby fostering effective transmission of monetary policy to broader financial conditions. In addition, the Open Market Desk will continue to offer large-scale overnight and term repurchase agreement operations. The Committee will closely monitor market conditions and is prepared to adjust its plans as appropriate.

Voting for the monetary policy action were Jerome H. Powell, Chair; John C. Williams, Vice Chair; Michelle W. Bowman; Lael Brainard; Richard H. Clarida; Patrick Harker; Robert S. Kaplan; Neel Kashkari; Loretta J. Mester; and Randal K. Quarles.

© 2020 RIJ Publishing LLC. All rights reserved.

Look Homeward, Seeker of Liquidity

Posted on April 29, 2020 by -

Reverse mortgage lines of credit (ReLOCs) can be cash lifelines for older people left jobless by the COVID-19 pandemic—providing liquidity and relieving the pressure they might feel to sell stocks at distressed prices.

Throughout the pandemic, ReLOCs are also more likely than conventional home equity lines of credit (HELOCs) to remain available. One major bank, JP Morgan Chase, recently said it would temporarily stop offering HELOCs for fear that home values might drop in a roiled economy.

A program of the U.S. Department of Housing and Urban Development (HUD), ReLOCs are not so vulnerable to passing economic storms. “In theory, the government could shut down any of its loan programs, but that would typically require an Act of Congress,” said Don Graves, who educates advisers about reverse mortgages, in an interview with RIJ this week.

Don Graves

“HELOCs can be frozen, cancelled or reduced at the banks discretion when certain economic conditions are present. But a ReLOC can’t be arbitrarily cancelled, frozen or reduced,” Graves said. He’s a principal at HECM Advisors Group and has a Retirement Income Certified Professional designation from The American College.

Under the HUD reverse mortgage program, Americans ages 62 and older with even a small amount equity in their home (depending on their age) can borrow against it in several ways. They can convert home equity to a monthly payment, borrow a lump sum, or open a line of credit and use it as needed. If they still have a conventional mortgage, they can refinance with a reverse mortgage and eliminate their monthly mortgage payment.

Reverse mortgages can even be used finance a new home, but that was not the original intent of the program, which was designed to help older people access home equity without selling their homes, thus allowing them to “age in place.”

Borrowers have the option of paying down a ReLOC, but they don’t have to. The lender will recoup any outstanding loan balance, with interest, when the house is sold (usually at the death of the borrowers). If the proceeds from the sale of the home exceed the loan balance, the excess goes to the borrower’s beneficiaries.

“Most of the calls I get are about eliminating a monthly payment,” Graves told RIJ. “That’s been my mantra [when I speak to groups of advisers]. If you’re over 62, why have a mandatory payment when you could have a voluntary payment?” He offered an example.

“Let’s say the client has a $400,000 home and a $160,000 conventional mortgage with a monthly payment of $1,000. After paying off the existing mortgage with a $160,000 ReLOC, the client still owes $160,000, but he or she doesn’t have to make payments,” he said.

“The loan balance will go down if he continues to make monthly payments, but he’s paying down a line of credit,” he added. “So he can still get the money back out. You took a nonproductive payment and restructured with a new loan that can’t be frozen, cancelled or reduced.” Graves noted that the unused balance of the line of credit  rises each year by the amount of the interest rate on the loan plus half a percent.

RIJ ran a multi-week series of articles on reverse mortgages in the spring of 2016. Click here to read the first installment in that series.

Closing costs are a common objection to opening a ReLOC. They might be $8,000 to $11,000 on a $200,000 reverse mortgage. Closing costs can be added to the loan.

A ReLOC can pay for itself during a financial crisis, Graves tells skeptics, by providing liquidity and preventing the forced sale of depressed assets. “Wade Pfau, Ph.D., has told advisers to use the ReLOC as a volatility buffer. His research shows that the benefit of avoiding the impact of just one bad year in the market makes the costs of creating the ReLOC negligible by comparison,” he said. Pfau recently published a book on reverse mortgages.

Advisers should feel a professional obligation to understand ReLOCs, Graves said. “Advisers who have retiring or retired clients and who hold themselves out to be ‘holistic,’ should reasonably be expected to say, ‘Let’s look at all of your assets, including your housing wealth.’ Most of my 21 years in this business has been spent convincing advisers how this fits into their clients’ plans. I give them a framework for using the reverse mortgage,” he told RIJ. 

Low interest rates may reduce the yields of bonds and payout rates of annuities, but they favor ReLOCs by allowing homeowners to borrow more than they could if mortgage lending rates were higher. “We’re seeing a movement that won’t go away,” Graves told RIJ. “Advisers haven’t paid attention because the hoof-beats of the bull market drowned out more conservative strategies.”

© 2020 RIJ Publishing LLC. All rights reserved.

Honorable Mention

Posted on April 23, 2020 by -

Survey: How retirement plan sponsors and providers are coping

A new survey of 21 retirement plan recordkeepers, asset managers and service providers by the Spark Institute and the Defined Contribution Institutional Association Retirement Research Center shows how plan providers are dealing with the COVID-19 pandemic and the CARES Act.

  • Recordkeepers are tracking coronavirus-related distributions (CRDs). Two-thirds are accepting self-attestations from participants that they meet the eligibility requirement. Over 80% of those surveyed have already updated their systems and procedures to accommodate the CARES Act. Another 9% should be updated within a week. The volume of distribution requests and questions is up significantly. Still, more than two-thirds of the industry is meeting their Service Level Agreements (SLAs) to clients.
  • None of the surveyed companies plans to lay off or reduce staff, but many have imposed hiring freezes on certain business units. To address shelter-in-place rules and social distancing guidelines, 98% of the industry is now working from home. This is up from 20% in January. The transition to working from home caused minimal disruption since the industry has had work from home procedures in place for more than a decade.
  • To address the increase in employees working from home, recordkeepers have responded with an increased focus on cyber-security, supplying employees with necessary technology, and online team calls.
  • About half of plan sponsors are considering reducing employer contributions until the crisis is over. To help avoid this, recordkeepers and plan sponsors are also discussing alternative tactics to address plan expense and cash flow concerns. For example, forfeiture accounts and ERISA budget accounts can be leveraged by plan sponsors to help pay some plan expenses.
  • Many plan sponsors previously considering a Request For Proposal process have decided to put that process on hold. With so many of their employees now working from home, some plan sponsors are concerned with managing paperwork and required document signatures, payroll and staffing issues, and a lack of necessary technology infrastructure.
  • Unlike in the 2009 financial crisis, most participants are not shifting their investments, but instead are looking for loans or hardship withdrawals. For those participants that are moving assets the shift is toward fixed income products.
RetireOne and Halo partner to distribute annuities and structured notes to fee-based advisers online

RetireOne, the insurance product trading platform for fee-based advisers, and Halo, a structured notes purchasing platform, have announced a partnership where RetireOne’s clients will be able to use Halo’s platform to buy structured notes and annuities.

“Clients of our RIA partners can now layer in the kinds of principal protections that have traditionally been expensive, and available only to qualified or institutional investors through brokers,” said RetireOne CEO David Stone, in a release. “Our RIA partners can choose curated structured notes, or they can design, price, and bid out custom-built solutions,”

Low interest rates are pressuring RIAs to look beyond traditional fixed income for risk-off solutions, the release said. Structured notes, a global investment product category with over $3 trillion of assets, remains relatively small in the U.S., at just over $60 billion.

HALO co-founder and CEO Biju Kulathakal said, “Halo’s technology helps analyze, customize, execute, manage and liquidate structured notes in an efficient and transparent way. This brings clients much needed access and competition to the structured note market.”

A structured note is a hybrid security that helps an investor target a level of expected returns and protection levels over a set period of time. Issued by major financial institutions, these instruments can generate returns in up, down and flat markets.

Serving over 900 RIAs and fee-based advisors since 2011, Aria Retirement Solutions’ RetireOne is an independent platform for fee-based insurance solutions. With offerings from multiple “A” rated companies, this fiduciary marketplace serves RIAs at no additional cost to them or their clients.

Social Security funding levels are stable, but don’t yet reflect COVID-19 impact

The combined asset reserves of the Social Security Trust Funds (Old-Age and Survivors Insurance and Disability Insurance) are projected to be depleted in 2035, the same as projected last year, with 79% of benefits payable at that time, according to the annual report of the Social Security Board of Trustees.

The OASI Trust Fund is projected to become depleted in 2034, the same as last year’s estimate, with 76% of benefits payable at that time. The DI Trust Fund is estimated to become depleted in 2065, extended 13 years from last year’s estimate of 2052, with 92% of benefits still payable.

These estimates do not reflect the still-unknown effects of the COVID-19 pandemic on the payroll tax receipts of the programs, the trustees said.

According to the Trustees’ 2020 Annual Report to Congress:

The asset reserves of the combined OASI and DI Trust Funds increased by $2.5 billion in 2019 to a total of $2.897 trillion.

The total annual cost of the program is projected to exceed total annual income, for the first time since 1982, in 2021 and remain higher throughout the 75-year projection period. As a result, asset reserves are expected to decline during 2021. Social Security’s cost has exceeded its non-interest income since 2010.

According to the Trustees’ report:

Total income, including interest, to the combined OASI and DI Trust Funds amounted to $1.062 trillion in 2019. ($944.5 billion from net payroll tax contributions, $36.5 billion from taxation of benefits, and $81 billion in interest)

Total expenditures from the combined OASI and DI Trust Funds amounted to $1.059 trillion in 2019.

Social Security paid benefits of $1.048 trillion in calendar year 2019. There were about 64 million beneficiaries at the end of the calendar year.

The projected actuarial deficit over the 75-year long-range period is 3.21% of taxable payroll – higher than the 2.78% projected in last year’s report.

During 2019, an estimated 178 million people had earnings covered by Social Security and paid payroll taxes.

The cost of $6.4 billion to administer the Social Security program in 2019 was a very low 0.6% of total expenditures.

The combined Trust Fund asset reserves earned interest at an effective annual rate of 2.8% in 2019.

The Board of Trustees usually comprises six members. Four serve by virtue of their positions with the federal government: Steven T. Mnuchin, Secretary of the Treasury and Managing Trustee; Andrew Saul, Commissioner of Social Security; Alex M. Azar II, Secretary of Health and Human Services; and Eugene Scalia, Secretary of Labor. The two public trustee positions are currently vacant.

View the 2020 Trustees Report at www.socialsecurity.gov/OACT/TR/2020/.

View an infographic about the program’s long-term financial outlook at www.socialsecurity.gov/policy/social-security-long-term-financial-outlook.html.

© 2020 RIJ Publishing LLC. All rights reserved.

 

How $240 billion in new COVID-19 money will be spent

Posted on April 23, 2020 by -

On April 21, Congress amended the Paycheck Protection Program and Health Care Enhancement Act to nearly double—to some $670 billion—the amount of federal spending to guarantee loans to small businesses and for supplies, salaries and research to fight the nationwide COVID-19 pandemic.

The amendment, passed Tuesday and published in the Congressional Record the same day, stipulates new spending of $240.25 billion, disbursed in the following way:

$30 billion to guarantee loans made by insured depository institutions and credit unions with consolidated assets of not less than $10 billion and less than $50 billion

$30 billion to guarantee loans made by community financial institutions, insured depository institutions, and credit unions with consolidated assets of less than $10 billion

$75 billion for the Public Health and Social Services Emergency Fund to reimburse eligible health care providers for health care-related expenses or lost revenues attributable to coronavirus

$25 billion to research, develop, validate, manufacture, purchase, administer, and expand capacity for COVID–19 tests to effectively monitor and suppress COVID–19

$11 billion to states, localities, territories, tribes, tribal organizations, urban Indian health organizations, or health service providers to tribes for necessary expenses to develop, purchase, administer, process, and analyze COVID–19 tests

$2 billion shall be allocated to states, localities, and territories according to the formula that applied to the Public Health Emergency Preparedness cooperative agreement in fiscal year 2019

$4.25 billion shall be allocated to States, localities, and territories based on relative number of cases of COVID–19

$750 million shall be allocated in coordination with the Director of the Indian Health Service

$1 billion to the Centers for Disease Control and Prevention—CDC-Wide Activities and Program Support for surveillance, epidemiology, laboratory capacity expansion, contact tracing, public health data surveillance and analytics infrastructure modernization, disseminating information about testing, and workforce support necessary to expand and improve COVID–19 testing

$306 million to the National Institutes of Health—National Cancer Institute, to develop, validate, improve, and implement serological testing and associated technologies

$500 million to the National Institutes of Health—National Institute of Biomedical Imaging and Bioengineering, to accelerate research, development, and implementation of point of care and other rapid testing related to coronavirus

$1 billion to develop, validate, improve, and implement testing and associated technologies; to accelerate research, development, and implementation of point of care and other rapid testing

$1 billion to the Biomedical Advanced Research and Development Authority for necessary expenses of advanced research, development, manufacturing, production, and purchase of diagnostic, serologic, or other COVID–19 tests or related supplies

$22 million to support activities associated with diagnostic, serological, antigen, and other tests, and related administrative activities

$600 million for grants to federally qualified health centers

$225 million for COVID–19 testing and related expenses, through grants or other mechanisms, to rural health clinics, for building or construction of temporary structures, leasing of properties, and retrofitting facilities to support COVID–19 testing

$12 million to the Office of the Secretary, Office of Inspector General, for oversight of activities supported with coronavirus funds

$2.1 billion for Small Business Administration salaries and expenses

$50 billion for the Disaster Loans Program

$10 billion for Emergency Economic Injury Disaster Loan Grants

© 2020 RIJ Publishing LLC. All rights reserved.

‘This is Not Modern Monetary Theory’

Posted on April 22, 2020 by -

Modern Money Theory (MMT) has been thrust into the spotlight again, as numerous governments around the world respond to the pandemic. Unfortunately, those invoking MMT misrepresent its main tenets. For example, we are being told MMT calls for helicopter drops of cash or having the Federal Reserve finance government spending through rebooted quantitative easing.

This is not MMT, which provides an analysis of fiscal and monetary policy applicable to national governments with sovereign, nonconvertible currencies. It concludes that the sovereign currency issuer (1) does not face a “budget constraint” (as conventionally defined), (2) cannot “run out of money,” (3) meets its obligations by paying in its own currency, and (4) can set the interest rate on any obligations it issues.

Yeva Nersisyan

Current procedures adopted by the Treasury, the central bank, and private banks allow government to spend up to the budget approved by Congress and signed by the president. No change of procedures, no money printing, no helicopter drops are required. Modern governments use central banks to make and receive all payments through private banks.

When the Treasury spends, the Fed credits a bank’s reserves, and the bank credits the deposits of the recipient. Taxes reverse that, with reserves and the taxpayer’s deposit debited. This is all accomplished through keystrokes—something government cannot run out of. Both the Treasury and the Fed can sell bonds (in the new issue and open markets, respectively) to offer banks higher returns than they get on reserves.

As MMT explains, since reserves must be exchanged when purchasing government bonds, the reserves must be supplied first before bonds can be purchased. It demonstrates how the Fed provides the needed reserves even as it upholds the prohibition against “lending” to the Treasury by never buying the bonds directly. None of this is optional for the Fed. It cannot refuse to clear government checks, nor can it refuse the reserves banks need to clear payments. It is the government’s bank, after all, and is focused on the stability of the payments system.

Randall Wray

Government can make all payments as they come due. Bond vigilantes cannot force default, although their portfolio preferences could affect interest rates and exchange rates. But the central bank’s interest rate target is the most important determinant of interest rates on the entire structure of bond rates. Bond vigilantes cannot hold the nation hostage—the central bank can always overrule them. In truth, the only bond vigilante we face is the Fed. And in recent years it has demonstrated a commitment to keeping rates low. In any event, the Fed is a creature of Congress, and Congress can seize control of interest rates if it wishes to do so.

Finally, the Treasury can “afford” to make all payments on debt as they come due, no matter how high the Fed pushes rates. Affordability is not the issue. The issue will be over the desirability of making big interest payments to bondholders. If that is seen as undesirable, Congress can tax away whatever it deems excessive.

What we emphasize is that sovereign governments face resource constraints, not financial constraints. We have always argued that too much spending—whether by government or by the private sector—can cause inflation. Below full employment, government spending creates “free lunches” as it utilizes resources that would otherwise be left idle. Unemployment is evidence that the country is living below its means. Full employment means that the nation is living up to its means. A country lives beyond its means only when it goes beyond full employment, when more government spending competes for resources already in use—which could cause inflation.

MMT rejects the analogy between a sovereign government’s budget and a household’s. The difference between households and the sovereign holds true in times of crisis and also in normal times, regardless of the level of interest rates and existing levels of outstanding government bonds (i.e., national debt). The sovereign can never run out of finance—period.

MMT does not advocate policy to ramp up deficits. A budget deficit is an outcome, not a goal or policy tool to be used in recession. There is no such thing as “deficit spending” to be used in a downturn or crisis. Government uses the same procedures no matter the budgetary outcome—which will not be known until the end of the fiscal year, as it depends on the economy’s performance. The spending will have occurred before we even know the end-of-the-year budget balance.

An important lesson to learn from the COVID-19 crisis is that the government’s ability to run deficits is not limited to times of crisis. Indeed, it was a policy error to keep the economy below full employment before this crisis hit in the belief that government spending was limited by financial constraints. Ironically, the real limits faced by government before the pandemic were far less constraining than the limits faced after the virus had brought a huge part of our productive capacity to a halt.

We hope this pandemic will teach us that in normal times we must build up our supplies, our infrastructure, and our institutions to be able to deal with crises. We should not wait for the next national crisis to live up to our means.

Yeva Nersisyan is an associate professor of economics at Franklin and Marshall College. Senior Scholar L. Randall Wray is a professor of economics at Bard College. This essay was first published by the Levy Economics Institute of Bard College. 

Portfolio Rebound: How Long Should It Take?

Posted on April 22, 2020 by -

Markets operate in two different modes: random (or “normal,” in the Gaussian world) and fractal (non-normal, extreme). My work on the luck factor (i.e., a person’s sequence of returns) over 20 years has indicated that markets are random about 94% of the time and fractal for the remaining 6% (about 3% up and 3% down) of the time.

When the markets are in random mode, well-known strategies such as asset allocation, diversification, rebalancing, dollar-cost averaging, buy-and-hold, work perfectly well. But these strategies don’t help much when markets are fractally going down. You might say, why worry if it happens only 3% of the time? The answer is simple: a big drop can wipe out 10 years of retirement income.

After a fractal event, we all hope that a recovery comes quickly. Fortunately, central banks have jumped in to help. But these rescues did not come cheap. The global total debt, which was $87 trillion (U.S.) dollars in year 2000, is now an estimated $253 trillion (before accounting for the financial impact of the COVID-19 event), according to The Guardian, January 8, 2020.

Our question is this: How many months or years should it take a portfolio to recover its original value after a big drawdown (assuming that central banks keep bailing out the economy—and shifting the burden to future generations)?

In our analysis, we make projections using actual market history, which we call “aftcasting” (as opposed to “forecasting”). Within a single chart, aftcasting can display the outcomes of all historical asset values of all portfolios since 1900. That is, it offers a bird’s-eye view of all outcomes for a given client-scenario. It provides the long-term portfolio success and failure statistics with exact historical accuracy by including actual historical equity performance, inflation rates, and interest rates, as well as the actual historical sequencing/correlation of these data sets.

Keith and Jane

Let’s consider a hypothetical accumulation portfolio. Keith, 30, has a portfolio worth $100,000. The asset mix is 70% equities and 30% fixed income. For equities, we use S&P500 index as a proxy. We use the historical interest on 6-month CDs plus 0.5% as the net yield for the fixed income portion of his portfolio. This approximates a bond ladder with an average maturity of about five to seven years at current yields, assuming no defaults and no capital gains/losses.

Keith plans to add $4,000 each year to his portfolio. Thus his accumulation ratio is 4%, which expresses the annual addition as a percentage of the portfolio value ($4,000 / $100,000).

Then a fractal event happens. Keith’s portfolio loses 25% of its value, dropping to $75,000. Keith asks, “When will my portfolio be back at $100,000, the pre-crash value?”

Figure 1 displays the aftcast. In an aftcast, there are no assumed rates of return. Each of the gray lines represents future market performance, starting in each specific year since 1900. The blue line represents the median portfolio; half of the gray lines are above it and half below. The green line indicates the “lucky” outcome; it represents the top decile (top 10%) of all outcomes. A lucky outcome typically happens when a recovery is “V-shaped.” The red line indicates the “unlucky” outcome; it represents the bottom decile. An unlucky outcome usually signifies a multi-year bear market (like those beginning in 1929 or 2000) with several after-shocks.

Note that it took about 2.6 years for the median line to reach the original portfolio value of $100,000 (the horizontal dashed line). If this were a V-shaped recovery,  however, Keith’s portfolio would recover in about 16 months. If this were a multi-year bear market, he would not see the $100,000 mark again for 6.6 years, thanks mainly to his periodic contributions.

Our next example involves someone in the retirement stage. Jane, 65, has just retired. Her portfolio, worth $500,000, consists of 40% equities and 60% fixed income investments.

Jane needs her savings to generate an income of $15,000 each year. Her initial withdrawal rate is 3% ($15,000 / $500,000), which she can sustain indefinitely. She plans to withdraw $15,000 per year (indexed to the Consumer Price Index) or the amount of her Minimum Required Distribution from tax-deferred accounts, whichever is larger.

A fractal event happens, and Jane’s portfolio value drops 25% to $375,000. Jane asks, “When will my portfolio get back to its $500,000 pre-crash value?” Figure 2 displays the aftcast. (To simplify the illustration, the loss-percentages suffered by Jane and Keith are kept equal at 25%, even though, due to their different asset allocations, their portfolio balances would respond differently to market conditions.)

If this loss were followed by a V-shaped recovery, Jane would see her portfolio value reach the original $500,000 after about 4.5 years. The median portfolio never reaches that $500,000 mark, however.

Our question was not whether or not Jane will have lifelong income; she likely will unless she lives far beyond age 90. We asked, “When will Jane’s portfolio reach $500,000? again.” It probably won’t.

Median recovery times of different asset allocations

To complete this study, I ran a multitude of scenarios. The results are summarized in Figure 3. Let’s use an example to illustrate them further.

Jeff has a balanced portfolio of $1 million. He does not add any money to it, nor does he need any income from it. (His “accumulation rate” for these purposes is zero.) After an unfortunate market event, his portfolio is down 22%. When can Jeff expect to see his portfolio back at the $1 million mark?

In Figure 3, we draw a vertical line (the dashed line on the chart) starting at the 22% initial portfolio loss on the horizontal axis. Continue this line until it reaches 0% accumulation curve. From this point, draw a horizontal line towards the left axis. It’s about 4.4 years. Historically, this is how long it took the median portfolio to reach its pre-loss value.

You might wonder what would happen if, instead of following the median path, this loss were followed by a V-shaped recovery (lucky outcome) or a multi-year downturn (unlucky). For precise answers, you’d need to run an aftcast for each specific scenario. But there’s a rule of thumb.

To estimate the lucky outcome, divide the median by 3. To estimate the unlucky outcome, multiply the median by 2.5. In our example, the median was 4.4 years. If Jeff is lucky, his portfolio will bounce back to $1 million in 1.5 years, calculated as 4.4 / 3. If he is unlucky, the rebound may take as long as 11 years, calculated as 4.4 x 2.5. This assumes that Jeff stays invested throughout the volatility period and does not bail out.

You might ask about the impact of asset allocation. When fractal events happen, asset mix doesn’t greatly affect the recovery time. If the portfolio is heavy in equities, it loses more but recovers faster. The difference in asset mix impacts the dollar dimension much more than the time dimension. The important factor here is the client’s ability to stay-the-course during adverse market events. (In this article, I used 40/60 asset mix for all decumulation portfolios and 70/30 for all accumulation portfolios.)

Let’s drill-down on the problem of staying power, aka “behavioral risk.” Consider two investors, both in the early stages of investing. Both are 30 years old and have $100,000 in their portfolios. They each add $4,000 annually to their portfolio.

Chase and Grace

Chase is more aggressive; he believes that stocks are “for the long run.” He proudly holds a portfolio of 100% stocks. The only problem is, Chase never tested his own risk tolerance.

Grace, by contrast, is a conservative investor. She knows her risk tolerance and holds an asset mix of 40% stocks/60% fixed income. A fractal market event happens, and the equity index drops 40%. The fixed income portion stays the same. Now, Chase’s portfolio is worth only $60,000. Having never experienced a loss like this, he gets scared and changes his asset mix to 40/60. Grace’s portfolio is now worth $84k and she holds on to her investments.

Their experiences over the next 20 years are depicted in Figure 4. The lines show their median portfolio values based on market history since 1900. Because Grace had staying power, she accumulated more assets than Chase, who bailed out and reset his asset mix. That mistake cost him a lot of money and accumulation time.

Even if Grace had gotten scared and made her asset mix more conservative, she would still be ahead of Chase, because her initial losses were lower.

The best time to make an asset mix more conservative is not after a loss but before one. The best opportunities to discover your own risk tolerance are actual life experiences. No risk tolerance questionnaire will give you an accurate answer. The lesson: Stay conservative until you discover your own risk tolerance.

In this example, we looked at only a single occurrence of bailing-out behavior. In my 24 years in the investment business, I can say with confidence that if this type of misbehavior happens once, it will likely happen again. Such self-sabotage will reoccur until the lesson is learned.

Practical action steps

To summarize the lessons of this study:

  • Know thy risk tolerance. The most effective way of increasing your investment success is to look at yourself first and decide on your risk tolerance. Err on the side of less risk.
  • During the early accumulation stage, keep the portfolio at a conservative 40% equity/60% fixed income. Maintain this mix until your annual accumulation dollar amount is less than 4% of the portfolio value. Regardless of how many risk tolerance questionnaires you fill out, you won’t know how you will respond to black swan events until they actually happen. Can you hang on to your investments when large, multi-year losses happen? You won’t know that until it happens for the first time. Stay conservative until then.
  • During the mature accumulation stage, if your risk tolerance permits, you can maintain a 60/40 mix, which will provide sufficient growth with reasonable risk.
  • Ten years before retirement, move your asset mix back to 40/60. You might need a full 10 years of recovery time after a nasty black swan event. Therefore, between ages 60 and 65, reduce the risk.
  • Once you retire and switch from accumulation to decumulation, the math of loss flips on its head—dramatically so. Even if your initial withdrawal rate is a modest 3%, you may never again see the pre-loss asset value of the portfolio.
  • If the withdrawal rate in retirement (3% to 4%) is too low to cover essential expenses, consider guaranteed income products such as life annuities or segregated funds (variable annuities) with guaranteed lifetime withdrawal benefits. Why? When you’re using a safe withdrawal rate, a portfolio loss as small as 15% can reduce income noticeably.
  • If withdrawals from the portfolio are intended purely for discretionary and non-essential expenses, but preservation of capital is important, then use a variable annuity with a lifetime withdrawal benefit to protect assets, as well as to reduce behavioral risk.
  • If withdrawals from the portfolio are for discretionary and non-essential expenses only, and preservation of capital is not important, a traditional investment portfolio will work.

This study is based on the market history of the last century. It assumes that the current central bank borrowing binge can continue indefinitely. During the last century, fixed income was the “safer” side of a portfolio. Going forward, it might turn into the riskier side. We shall see. Meanwhile, enjoy this recovery.

Jim Otar is a retired financial planner and retired professional engineer. He is the founder of www.retirementoptimizer.com. His past articles won the CFP Board Article Awards in 2001 and 2002. He is the author of Unveiling the Retirement Myth, a 525-page textbook. He can be reached at [email protected]

Fed easing clobbers fixed annuities

Posted on April 22, 2020 by -

Fixed annuities of all kinds were collateral damage of the Fed’s interest-rate easing move in March, as the central bank responded to the COVID-19 related crash in prices of stocks and bonds by lowering its target overnight rate to between zero and 0.25%.

Along with a new round of Fed purchases of bonds, the easing seems to have calmed investors. A drop in the overnight rate lowers the cost of borrowing generally and helps support the prices of existing bonds, but it also reduces the yield that issuers of fixed annuities can afford to offer to new buyers.

At $29.5 billion, total fixed annuity sales were 22% lower than in first quarter 2019, according to preliminary results from the Secure Retirement Institute (SRI) U.S. Individual Annuity Sales Survey.

“At the end of 2019, we had forecasted fixed annuity sales to fall in 2020. However, the economic fallout from the coronavirus pandemic—prompting the Federal Reserve to cut interest rates to record low levels—created a challenging environment for annuity manufacturers,” said Todd Giesing, annuity research director at SRI, in a release. “All fixed products recorded double-digit declines.”

On the other hand, sales of registered index-linked annuities (RILAs), which are considered variable annuities, were $5.1 billion in the first quarter, up 44% from the prior year. It was a sales record for RILAs, which AXA (now Equitable) introduced in 2010. Overall variable annuity sales rose 16% in the first quarter, marking the fourth consecutive quarter of sales increases.

“RILAs are positioned to do well under these economic conditions,” Giesing said. “They offer the potential for growth with downside protection. We are forecasting RILAs to continue to grow in 2020.”

Within the fixed annuity category, fixed indexed annuity (FIA) sales fell for the third quarter in a row. At $15.8 billion, sales were down 12% from first quarter 2019, before President Trump succeeded in pressuring Fed chairman Jerome Powell to lower rates last summer. The spike in equity market volatility in March helped FIA sales, even as the 10-year Treasury rate dropped by 113 basis points.

Sales of fixed-rate deferred annuities fell 35% in the first quarter to $9.8 billion, compared with prior year results. However, this was 4% higher than sales results in the fourth quarter as investors sought the principal protection these products offer.

“As we saw during the Great Recession, we expect fixed-rate deferred product sales to improve in the second quarter as consumers seek to protect their investment from market volatility and losses,” the SRI release said.

Sales of single premium immediate annuities (SPIAs) fell to their lowest quarterly level in nearly seven years, as the annual payout rate for a joint-and-survivor SPIA fell to only about 5%.

At just $1.9 billion, first quarter SPIA sales were down 32% from first quarter 2019. Deferred income annuities, which don’t start paying out income until at least 13 months after purchase, totaled $530 million in the first quarter, down 16% from 2019.

Preliminary first quarter 2020 annuities industry estimates are based on monthly reporting, representing 82% of the total market. A summary of the results can be found in LIMRA’s Fact Tank.

The top 20 rankings of total, variable and fixed annuity writers for first quarter 2020 will be available around mid-May, following the last of the earnings calls for the participating carriers.

© 2020 RIJ Publishing LLC. All rights reserved.

News from RIJ Corporate Subscribers

Posted on April 16, 2020 by -

Public pensions shed $419 billion in Q1: Milliman

During Q1 2020, the overall funded ratio of the nation’s 100 largest public defined benefit pension plans suffered the single largest quarterly drop in the history of the Public Pension Funding Index (PPFI), Milliman, the creator of the index, reported this week.

The PPFI decreased from 74.9% to 66.0% between Jan 1 and March 31. Economic volatility from the COVID-19 pandemic resulted in a $419 billion loss in the market value of assets for these pensions, which in aggregate experienced investment returns of -10.81% in Q1. Individual plans in the PPFI had estimated returns ranging from -17.41% to 4.76%.

“The economic fallout from the COVID-19 pandemic has completely wiped out any public pension funding gains we saw last year,” said Becky Sielman, author of the Milliman 100 Public Pension Funding Index. But “it’s important to remember that most public pension plans use some sort of asset smoothing mechanism to dampen the impact of market gyrations,” she added.

Sorting the plans by funded ratio, four plans now remain at 90% funded or higher, down from 20 plans in the previous quarter. At the lower end of the spectrum, nine plans fell below the 60% funded mark, bringing the total number under 60% to 35, up from just 26 at Q4 2019.

The total pension liability (TPL) continues to grow and stood at an estimated $5.355 trillion at the end of Q1 2020, up from $5.313 trillion at the end of Q4 2019.

SEC awards over $27 million to whistleblower

The Securities and Exchange Commission today announced an award of more than $27 million to a whistleblower who alerted the agency to misconduct occurring, in part, overseas.  After providing the tip to the Commission, the whistleblower provided critical investigative leads that advanced the investigation and saved significant Commission resources.

“This award marks several milestones for the program,” said Jane Norberg, Chief of the SEC’s Office of the Whistleblower.  “This is the largest whistleblower award announced by the Commission this year, and the sixth largest award overall since the inception of the program.  This award also brings the total amount awarded to whistleblowers by the SEC over the $400 million mark.”

The SEC has awarded approximately $425 million to 79 individuals since issuing its first award in 2012. All payments are made out of an investor protection fund established by Congress that is financed entirely through monetary sanctions paid to the SEC by securities law violators. No money has been taken or withheld from harmed investors to pay whistleblower awards.

Whistleblowers may be eligible for an award when they voluntarily provide the SEC with original, timely, and credible information that leads to a successful enforcement action. Whistleblower awards can range from 10 percent to 30 percent of the money collected when the monetary sanctions exceed $1 million.

As set forth in the Dodd-Frank Act, the SEC protects the confidentiality of whistleblowers and does not disclose information that could reveal a whistleblower’s identity.

Silvur: A new app from Kindur, a robo-adviser

Robo-advice platform Kindur has launched a new smartphone app called Silvur, with which users can “check at any time to see where they are with their goals and get useful savings and guidance to reach,” Kindur announced this week.

According to Kindur’s release, Silvur estimates Medicare costs and Social Security benefits to illustrate Babyboomers’ retirement income and expenses. Silvur’s Marketplace feature offers “cash back” discounts on purchases at Uber Eats, Walgreens, Hulu and other retailers.

Silvur is available for download on iOS in the Apple App Store, and will be soon available on Android in the Google Play Store.

According to a Kindur-sponsored survey, 79.3% of Babyboomers say they would like a simplified process of post-retirement financial planning. In addition, Boomers’ concern that the coronavirus or other source of market instability would impact retirement funds or their ability to retire on time has risen nearly 50% since the start of the COVID-19 quarantine.

Silvur offers personalized projections based on current income, spending, assets, and account balances, the release said. Financial information can be as detailed as users choose by linking accounts or estimating assets. As someone’s income changes, the progress towards their goals will too.

Kindur is offering a free advice hotline, the release said. Anyone can schedule a free 15-minute call with a retirement advisor at Kindur or text Kindur at (800) 961-3572 with questions. Kindur has also made available a virtual calculator to estimate Social Security benefits.

Retirement isn’t what most pre-retirees expect: Allianz Life

Common perceptions about when retirement will start and what it will be like don’t match the experiences of people already in retirement, according to the new 2020 Retirement Risk Readiness Study from Allianz Life Insurance Company of North America.

While many non-retirees expect to retire when they are “financially ready” (46%) or in order to “have fun while they still can” (35%), half of survey respondents said they retired earlier than expected, often because of unanticipated job loss (34%) and healthcare issues (25%).

The Retirement Risk Readiness Study surveyed three categories of Americans to get different perspectives on retirement:

  • Pre-retirees (those 10 years or more from retirement);
  • Near-retirees (those within 10 years of retirement);
  • Those already retired.

Nearly two-thirds (65%) of non-retirees think it is likely they will work at least part time in retirement, but only 7% of retirees are currently working at least part time.

The closer people are to retirement, the less keen they are to work.

When asked if they would rather retire at age 55 and have their basic expenses covered in retirement or work until age 75 and live more extravagantly in retirement, only 23% of retirees said they would prefer to work longer (versus 33% of near-retirees and 48% of pre-retirees).

In other findings:

  • More than half (55%) of non-retirees said they are worried they won’t have enough saved for retirement and six in 10 said running out of money before they die is one of their biggest worries.
  • Forty-two percent of those within 10 years of retirement said they are currently unable to put away any money for retirement (versus 34% of pre-retirees), and almost one-third (32%) of near-retirees say they are way too far behind on retirement goals to be able to catch up in time (versus 30% of pre-retirees).
  • Asked about choices they are making or planning to make, less than a third (32%) said they want to save more in a retirement account; 12% said they are setting long-term financial goals and only 6% said they want to make a formal financial plan with a financial professional.
  • Less than one-third (30%) of non-retirees say they currently have a source of guaranteed income in their portfolio to help them meet retirement goals.
  • Nearly four in 10 (39%) say they plan to purchase a guaranteed income product in the future, only 3% view it as a top priority.

Allianz Life conducted an online survey, the 2020 Retirement Risk Readiness Study, in January 2020 with a nationally representative sample of 1,000 individuals age 25+ in the contiguous USA with an annual household income of $50k+ (single) / $75k+ (married/partnered) or investable assets of $150k.

MetLife waives certain small business service fees

Eighty-four percent of small business owners say they are concerned about the impact of the coronavirus outbreak on their business, and a majority (58%) are very concerned, according to a recent poll from MetLife and the U.S. Chamber of Commerce.

To help small businesses weather the economic fall-out and immediate challenges of COVID-19, MetLife is offering several resources to both small business owners and their employees. Effective today, MetLife is making the following available to our small business customers:

Financial Wellness. Small businesses with fewer than 100 employees can now access COVID-19-related guidance on cash flow issues, IRS taxpayer relief, government legislation, market volatility and asset allocation through MetLife’s PlanSmart Financial Wellness planners.

For 90 days, small business owners and their employees will have phone access – at no cost to them – through our alliance with Ernst & Young LLP, the U.S. firm (EY), to credentialed EY financial planners.

Overall Wellness. Overall individual health and well-being is a top priority during a crisis. To help our small business customers address these needs, MetLife is offering a dedicated COVID-19 hotline provided by LifeWorks. Through the hotline, small business owners and their employees will have access to services including immediate emotional support, research and referrals along with guidance and resources to cope with COVID-19. The hotline is available to all customers with fewer than 500 employees through September 30.

No rate increases. MetLife will not increase rates on any Group Benefits products for customers who have fewer than 500 employees for June 1, 2020, through September 1, 2020, renewals.

Additionally, MetLife is making the following available for all customers and their employees:

Financial Wellness Hub. This dynamic new financial wellness microsite is designed to guide employees at all companies and in all circumstances as they actively manage stress, navigate life choices, and manage their finances in this volatile environment. The hub, which will expand over time, helps consumers think about what they need to do now and how they can prepare for the future.

Legal document access and review. Through the end of July, MetLife Legal Plans will provide free document review and consultation to all employees, regardless of whether or not they are signed up for the service, of employers that offer MetLife Legal Plans. Employees can access our network attorneys to get answers to questions related to legal issues they may be facing and have attorneys review estate planning documents or insurance forms.

These customer offerings follow MetLife Foundation’s announcement on March 31 that it is committing $25 million to the global response to COVID-19 in support of communities impacted by the pandemic.

Securian Financial waives 401(k) COVID-19 and hardship distribution fees

Securian Financial is waiving all COVID-19 related 401(k) distribution fees for the retirement plans it serves as recordkeeper and, moving forward, will permanently make all hardship distributions fee-free to customers—regardless of the triggering event.

Securian Financial will also act as an ERISA 3(16) fiduciary for participant distributions and loans under the CARES Act, at no additional cost, for its existing full-service 401(k) employer customers. The company will also provide these customers with a suite of wellness services to make available to their employees, free-of-charge, through the end of the year.

Under the recently enacted CARES (Coronavirus Aid, Relief and Economic Security) Act, individuals younger than age 59½ can withdraw up to $100,000 from their 401(k) without paying the usual 10% penalty provided the distribution meets certain criteria. Securian Financial will not charge customers a fee for COVID-19 related 401(k) distributions, and to ensure equitable treatment, the company is permanently waiving all 401(k) hardship distribution fees.

For all full-service 401(k) employer customers who provide relief to their employees under the CARES Act, Securian Financial will assume the role of ERISA 3(16) fiduciary1 at no additional cost—reducing employers’ administrative responsibilities and lessening their fiduciary burden. Securian Financial will also waive the ordinary applicable plan amendment fee.

The wellness services Securian Financial is making available free-of-charge to its 401(k) customers through the end of the year include access to professional financial and grief counselors, self-service tools to prepare legal documents such as a will, power of attorney or health care directive, and relevant education.

Few near-retirees understand Social Security: MassMutual

“Better but still not great” is how MassMutual is characterizing the results of its latest assessment—the third since 2015—of how well near-retirees’ (ages 55 to 65) in the U.S. understand their future Social Security benefits.

This year, 33% of those surveyed failed a basic knowledge quiz about Social Security, while 19% received a D.  Only 3% got an A+ by answering all 12 true/false statements correctly. In 2015, only one person got all answers correct and 62% of those age 50+ failed and only one got an A+. In 2018, 47% failed.

Almost all Americans (94%) know that if they take benefits before full retirement, the monthly benefit will be reduced, but only 69% understood their benefits at full retirement age under current law. Only 28% knew that you don’t have to be a U.S. citizen to collect Social Security retirement benefits.

The most significant differences Those between ages 60 and 65 were more likely than those between ages 55 and 59 to correctly answer questions related to full retirement age, spousal benefits and ex-spouse benefits.

Few people were aware of their right to “voluntary suspension.” Those with a dire need for retirement income can take Social Security benefits before full retirement age and then, at full retirement age, suspend benefits and draw from other income sources for a period of time “to basically fill their Social Security credit bucket back up to become whole (or near whole) for Social Security benefits for the rest of their lifetime,” the MassMutual release said.

Free term life for front-line health workers

In other news, MassMutual launched HealthBridge, which will provide free term life insurance to frontline healthcare workers across Massachusetts and Connecticut risking their lives during the COVID-19 pandemic. MassMutual is offering local healthcare workers no-cost policies of up to $25,000.

All active employees of licensed hospitals, urgent care centers or emergency medical services providers in Massachusetts and Connecticut, the primary operational locations for many of MassMutual’s employees, whose jobs may involve occupational exposure to the virus are eligible for the 3-year term life policies. By uploading proof of employment and filling out a short application on the HealthBridge page, qualified healthcare workers will receive this free element of financial protection – completed fully online – from MassMutual.

Additionally, the company extended its free FutureSmart digital financial literacy curriculum beyond educators to families in which the parents/guardians are currently taking on secondary roles as their children’s teachers.

HealthBridge, totaling $3 billion of insurance coverage, is an extension of MassMutual’s current LifeBridge program, which has provided free life insurance for nearly two decades to income-eligible families to help children with educational expenses in the event a parent or guardian passes away.

¸© 2020 RIJ Publishing LLC. All rights reserved.

Further thoughts on the equity risk premium

Posted on April 16, 2020 by -

Dear editor,

In response to your April 6 article, “The Shape-Shifting Equity Premium,” I’d like to point out the following:

  1. The inflation illusion. Stocks were a tremendous buy in the 1970s when interest rates rose with inflation. You should always make clear that you are talking about the real interest rate.
  2. Risk premium versus risk.  If (real) interest rates fall and the equity risk premium stays the same, it is still likely that the risk has risen. Put another way, if the equity risk premium is 5%, and interest rates fall to 0% from 2%, then expected equity returns fall to 5%. Assuming that is below the long-term mean of 7%, the risk of holding stocks at high valuation levels is much greater since there is a likely reversion back to more normal (mean) valuations. Note the implications here for DB pension plans and pensioners.
  3. The current wealth bubble.  In my article on the Third Postwar Wealth Bubble (Journal of Business Economics) last year, I showed how we were at an all-time high in terms of net-worth-to-income. (My ratio was more like a price/earnings ratio for all assets than for the stock market by itself.) Yes, we’re below the all-time high now, but we’re still way up relative to historical precedent. This bubble and its sustainability are related to your article’s mention of the Fed “indulging the fallacy” that risks are minimal. The Fed and the related huge international investment in U.S. Treasuries and other assets can only indulge that type of fallacy for so long. Put another way, the Fed’s power (like Congress’s fiscal power) to turn the economy around is in the second derivative (e.g., the change in the change in the money supply)—which cannot forever be kept positive.

Sincerely, Eugene Steuerle

Urban Institute

© 2020 RIJ Publishing LLC. All rights reserved.

Insurance companies impacted by equity slide: AM Best

Posted on April 16, 2020 by -

The negative impact to insurance companies’ capital and surplus as a result of sharp equity market declines could top the surplus losses experienced in the 2008-2009 financial crisis, according to a new AM Best special report, “Hit to Surplus from Equity Exposures Expected.”

“The 20% decline in the Dow Jones since the end of 2019 is hurting U.S. insurers’ balance sheets,” the report said. “At the height of the financial crisis last decade, the stock market dropped 50%, which led to the property/casualty industry reporting $55 billion in unrealized losses on unaffiliated stock investments in 2008, while the life/annuity segment reported more than $23 billion and the health segment nearly $4 billion.

“These losses contributed to capital and surplus declines of 11.9% for property/casualty insurers, 5.6% for life/annuity writers and 7.8% for health insurers. Significant unrealized losses and their adverse effects on capital because of the COVID-19-led downturn and economic fallout may well be on the horizon for U.S. insurers.”

According to the report, the property/casualty segment currently has the highest exposure to unaffiliated common stock, at almost 18% of invested assets in 2018, versus 12% in 2009. The health segment’s exposure now is approximately 9%, while the life/annuity segment has maintained an exposure of approximately 1%.

Any ultimate impact on the insurance industry remains to be seen; however, the impact will be uneven. Just under 50% of property/casualty companies have unaffiliated equity holdings, while 45% of life/annuity entities and more than 75% of health companies have no exposures.

The property/casualty segment also has the greatest share of companies with an unaffiliated common stock exposure equal to more than half their capital, but that share is relatively small, at less than just 10%. These companies would see the greatest hit to capital given their larger relative exposures. Additionally, the report lists AM Best-rated entities that have unaffiliated common stock exposures greater than their capital and surplus levels, the vast majority of which are in the property/casualty segment.

© 2020 RIJ Publishing LLC. All rights reserved.

Please Don’t Raid Your Retirement Account

Posted on April 16, 2020 by -

“First chill, then stupor, then the letting go.”

The poet Emily Dickinson described death by exposure that way. She’s referring to the three stages of hypothermia. In the last stage, the body’s core heat migrates outward, creating a feverish delirium.

I felt a chill after reading that the CARES Act would allow Americans who’ve lost their jobs because of the coronavirus to withdraw up to $100,000 from 401(k) plans or IRAs without penalty. Sounds like a recipe for financial hypothermia in retirement.

It makes sense not to punish anyone for taking withdrawals from retirement accounts during the pandemic. But why encourage withdrawals (up to $100,000) that will only reduce future security? Most won’t have time to replenish their accounts before they retire. If they don’t pay back the money in three years, they’ll owe income tax on it.

The measure also seemed at odds with other federal government COVID-19 relief measures, like enhancing unemployment insurance benefits, offering forgivable payroll loans to businesses, and sending out $1,200 checks ($2,400 to couples filing jointly and $500 to minor children), all of which should help prevent raids on long-term savings.

People who work on retirement security are evidently as perplexed by the measure as I was.

“My hope and expectation is that only those individuals with no other options will tap their 401(k)/IRA balances during this crisis,” Alicia Munnell told RIJ. She’s the widely-published and widely-quoted director of the Center for Retirement Research at Boston College.

“Those who are lucky enough to keep their jobs should have no need to tap their accounts, and probably recognize that they would lock in their losses by selling at the bottom of the market. Those who lose their jobs, hopefully, would explore every other option, including unemployment insurance, the $1,200 payment, or borrowing from parents or children, to avoid tapping their 401(k),” she said.

“For those forced to tap their 401(k), I am glad that they will not have to pay a penalty.  But the size of the penalty-free amount—$100,000—is worrisome. The median 401(k)/IRA balances for households approaching retirement (55-64) is $135,000. The lower-paid, most financially hard-pressed holders of 401(k)s may think they’ve been given a green light to essentially empty their accounts. Even though the law allows re-contributing the withdrawn amounts, these vulnerable households are never going to have the financial wherewithal in the next three years to put $100,000 into a retirement plan.”

“It’s a bit of a mixed message,” said Linda K. Stone, a pension expert in Bryn Mawr, Pa., in an interview this week. “Plan sponsors have spent a lot of money on getting people to enroll in their plans and to prevent leakage.

“Now some 401(k) companies are waiving the fees they normally charge for withdrawals to make it easier for people to get their money. But the assets are depressed right now, so they’ll be selling at a low point. And most people have saved very little to begin with. You have to think of your future self. Your future self will want that money to stay in your retirement account.”

Jack Towarnicky, a former executive director of the Plan Sponsor Council of America, also regretted the new law. He’d have preferred loans or emergency lines-of-credit from retirement plans, not withdrawals.

“Unsurprisingly, we have sown the seeds of unpreparedness for the next crisis,” he told RIJ in an email. “Instead of changes that would create liquidity without triggering leakage, we enabled cash-outs for tens of thousands, perhaps millions who have not lost employment. COVID-19 in-service withdrawals will be the ‘liar loans’ of 2020.

“The CARES Act’s provisions do not limit distributions to specific needs nor require proof of economic loss, while concurrently allowing employees to self-certify that they are qualified individuals. The Bipartisan Budget Act, the SECURE Act and the CARES Act all create incentives and new options encouraging leakage for workers who have not lost employment.

“A more thoughtful approach would have created liquidity without leakage. Almost all who have a need due to separation or layoff already have full access/liquidity to their retirement savings,” he said, referring to rollovers to IRAs. In his email, Towarnicky recommended this:

Plan sponsors should consider making the following changes (all possible today):

  1. Eliminate hardship withdrawals
  2. Change the loan structure to a “line-of-credit” basis (minimum $500 or $1,000) so participants can rely on access
  3. Improve plan loan processing to 21st-century functionality by:
  • Upon initiating a loan, require participants to enter into a “commitment bond” to repay the loan, acknowledging that they are the borrower, and that the lender is their “future self.”
  • Add electronic banking so that funds can be disbursed promptly to a bank account as needed, and so loans can be repaid and initiated during furloughs, leaves of absence, layoffs, and post-separation.

Congress could facilitate this by removing arbitrary barriers to liquidity without leakage. It could index the loan limit [to inflation], which has been $50,000 since the passage of ERISA in 1974, when the average assets per defined contribution plan participant were only $6,431.

If 401(k) plans were still what they were 35 or 40 years ago—profit-sharing plans that accompanied defined benefit pensions—then dipping into them for emergencies would do little or no long-term damage. But now that millions of Americans rely on the savings in their 401(k)s and rollover IRAs (and Social Security) as their primary source of retirement income, it makes less sense. Paying for current hardship with future hardship is obviously short-sighted and potentially self-defeating.

Ironically, COVID-19 strikes the retirement industry at a time when financial wellness programs have just begun to address the need for emergency “side-car” funds in workplace retirement plans. Although heads-of-households know that they should keep several months of living expenses in cash, research by Munnell and others has shown that most Americans have little or no financial buffer.

You might object that the federal government shouldn’t tell people how to save or spend at all, and not be paternalistic. But we’re talking about tax-deferred accounts that are designed to produce retirement income. It would be smart, not paternalistic, to ease today’s financial pain without contributing to an even bigger retirement funding crisis down the road.

© 2020 RIJ Publishing LLC. All rights reserved.

The CARES Act Isn’t Careful Enough

Posted on April 16, 2020 by -

The “blitz” of World War II, when German bombs rained down on London and England’s other large industrial and commercial cities from November 1940 to May 1941, had relatively little effect on the operations of small businesses, despite the physical destruction and loss of life they wrought.

Will the COVID-19 pandemic’s effects be even more devastating to the U.S.’s small businesses and their employees than the Luftwaffe’s bombs were to English shops?

This column provides an updated summary of the Coronavirus Aid, Relief and Economic Security (CARES) Act, and then turns to the growing debate over how best to aid American small businesses—businesses with less than 500 employees—and their workers.

The CARES Act

Including its tax measures—mostly tax breaks for businesses—the CARES Act is now estimated to amount to $2.3 trillion, not $2 trillion, in stimulus measures. This does not include the measures that the Federal Reserve is taking to support credit markets. Given its massive size and impact on the federal debt, it will be important to ensure that this money is spent effectively. CARES’s main features, as described by the Committee for a Responsible Federal Budget (CRFB) are as follows:

Measures to benefit households and individuals
  • Issuance of checks or direct deposits to taxpayers of $1,200 for single filers with AGI up to $75,000 and $2,400 for joint filers with AGI up to $150,000 plus up to $500 per child ($290 billion) Rebates are phased out at a rate of $50 for every $1,000 in income above these limits.
  • Expansion of the coverage of state unemployment insurance (UI) and increase the weekly payment by a flat rate of $600 for about four months, while increasing the maximum payment period by thirteen weeks ($260 billion)
  • Expansion of the social safety net, including the SNAP and other nutritional aid ($42 billion)
Measures to support business
  • Loans and other assistance to large corporations ($510 billion), of which $454 billion will support loans to corporations, states and municipalities through a Federal Reserve facility and $29 billion will be loaned to airlines. The Federal Reserve will be providing massive support to all sectors of the economy by financing the purchase of loans, whose collateral terms will be relaxed. (For some reason, large corporations receiving aid were not required to offer paid sick leave to their furloughed employees.)
  • Loans and other assistance to small businesses ($377 billion)—also known as the Paycheck Protection Program (PPP)—as explained below. Congress has already begun to debate an expansion of this program.
  • Support to transportation providers and industries ($72 billion), including $33 billion to airlines and their contractors to avoid furloughs and pay cuts.
Other expenditure programs to support critical infrastructure and public services
  • Grants and other assistance to hospitals and other medical facilities (at least $180 billion)
  • Assistance to state and local government ($150 billion)
  • An increase in FEMA’s disaster assistance fund ($45 billion)
  • Increased education spending (at least $32 billion)
  • Other (at least $25 billion)
Tax measures
  • Corporate tax reductions (mainly increased interest and operating loss deduction allowances ($210 billion) and payroll tax reductions for businesses that retain workers at a loss (an additional $55 billion)
  • Personal tax reductions ($20 billion)

The stimulating effect of the tax relief for businesses is highly uncertain. It is unlikely to result in anything close to a dollar-for-dollar increase in investment. Its effect on decisions to retain workers is also uncertain. As noted in my March 26th column, the direct payments to taxpayers are not well targeted to those in need. No money is provided for non-filers, who are among the most vulnerable. The effect of that provision is therefore hard to predict.

Rescuing small businesses and their employees—the United States contrasted with Europe

In the U.S., small businesses are being offered loans through the banking system and the Small Business Administration (SBA). The loans will be converted to grants if the recipients keep all of their employees on the payroll for at least eight weeks, even if they are not working. Funds may also be used to cover rental payments and other operating costs.

Small businesses will need assistance along the lines of the PPP to cover the wages and salaries of their employees, if these are not to be laid off, and to pay for their employees’ health insurance. Unemployment insurance will help support workers who have been laid off, particularly the low-paid, but will not pay health insurance premiums. Small businesses will also need help with rental and mortgage payments, property tax, and certain other expenditures.

Some prominent American economists and economic journalists have criticized this approach as being too indirect, and unlikely to prevent the permanent closure of many businesses. They contrast it with the approaches of the United Kingdom and Denmark, where the central government directly supports firms that retain their workers by paying a very high share of their wages, while also providing money to make rental and mortgage payments for other obligations.

In the United Kingdom, private sector workers will receive 80% of their pay, and in Denmark 75%. Canada has also just approved legislation that will provide funds to businesses to pay up to 75% of their employees’ salaries to keep them on the payroll.

The success of the U.S. approach will depend on how quickly and efficiently the program can be implemented. Similarly, relief to laid-off workers, including the self-employed who are now without work, will depend on how speedily their states can handle the huge increase in UI claims. Many or most of those workers who do not remain at least nominally attached to their employer will lose their health insurance, although furloughed workers are an exception.

It would be grim indeed if large numbers of small businesses proprietors were forced into bankruptcy. Unlike London during the blitz, however, the pandemic will not destroy physical premises. Their businesses can in principle be reopened, possibly by new owners. That said, they might well be shuttered for some time even after the pandemic has done its worst. Large-scale bankruptcies obviously have to be avoided, and the economic and social consequences of the associated unemployment would be dire.

The United Kingdom and Denmark have important advantages in implementing their approach. In particular, they are both highly centralized. The U.K., the devolution of some governmental responsibilities to Scotland and Wales notwithstanding, is a highly centralized country. It has only one UI administration, as does Denmark, which has the added advantage of being very small. Its labor market is about one-thirtieth the size of the U.S. labor market.

In addition, in neither country does unemployment spell the end of health insurance. Canada’s federal system is in some respects like that of its giant neighbor, but UI is centralized, which is easier because of Canada’s much smaller population. The more flexible character of the U.S. labor market may have one notable advantage over Europe: workers can more easily move to those few sectors where labor demand is growing, like delivery services and health.

The U.S. cannot remake its institutions into a European model overnight, even if there were sufficient public support for so great a political and constitutional sea change. It must work with the institutions it has. Every effort has to be made to make the loans program work.

News reports speak of banks’ being swamped by requests, and processing only applications from established customers. Banks themselves are also reported as needing more guidance. The states differ in their ability and perhaps their eagerness to process UI claims, and news reports suggest that some states are definitely behind the curve.

Federal legislation may be needed to prevent the loss of health insurance by the unemployed. There is no good reason for the exemptions of large corporations from offering paid sick leave. On the plus side, the direct payments to households from the IRS have started to flow.

The pandemic will inflict staggering losses in life unless the stay-at-home rule is rigorously enforced for a sufficient time. That said, a prolonged absence of workers from the workplace, necessary as it is, is bound to have a heavy cost in purely economic terms and in personal misery.

The writer, a naturalized citizen born in Nova Scotia, believes that the pandemic has made clearer than ever the inequities and inefficiencies of his adopted country’s social safety net and health insurance system. If this period of agonizing trial can lead to genuine reform, perhaps we may say that the blood, sweat and tears (to borrow Winston Churchill’s famous words in 1940) of our most vulnerable citizens will have not been entirely in vain.

The author was founding editor of the Journal of Retirement and a former International Monetary Fund official. He would like to thank Dallas Salisbury, Allison Schrager and Elaine Weiss for valuable comments. He alone is responsible for any remaining errors of fact or interpretation.

© 2020 RIJ Publishing LLC. All rights reserved.

Stormy Weather for Life Insurers

Posted on April 9, 2020 by -

Despite the impacts of lower equity prices, the Fed’s zero interest rate policy, business disruptions and a hefty amount of triple-B bonds on their balance sheets, life insurance companies are bearing up fairly well during the coronavirus pandemic.

That’s the opinion of David Paul, a principal at ALIRT, an insurance research firm that evaluates the credit strength of U.S. life, property & casualty and health insurers for a client base that include insurance product distributors, insurers, asset managers, and risk managers.

David Paul

Paul spoke at length with RIJ earlier this week. What he calls the U.S. life industry’s “decent surplus position” and the Federal Reserve’s willingness to support the bond market should help companies weather the current storm even as low interest rates potentially weaken the future profitability or availability of their products.

Below is an edited transcript of the conversation between RIJ editor Kerry Pechter and ALIRT’s David Paul:

RIJ: David, you’re used to reviewing the balance sheets of life insurers for strengths and weaknesses. What do you see right now?

Paul: As concerns their balance sheets, the more asset leverage a company has—which is an expression of surplus to general account invested assets—the greater the stress that can occur in a downturn like this. Overall, the U.S. life industry has asset leverage of just south of 12%. So it’s fairly leveraged. But that’s one of the best ratios in 20 years. And, given the long-term nature of their liabilities, this type of leverage is normal.

RIJ: These surpluses—are they related to a company’s reserves?

Paul: I heard a recent news report that the industry has plenty of “reserves.” But when one talks about reserves, in our world this is really a liability term. Surplus is different. As the difference between assets and liabilities, surplus is the financial cushion that’s available to offset investment losses or strengthen existing reserves, if needed.

Let’s say an insurance company sold variable annuities with rich lifetime income guarantees. It may have to put up more reserves if those guarantees go “into the money.” Or, if mortality trends and/or projected investment returns weaken, reserves would have to be strengthened for the products sold. The surpluses, which are hopefully being constantly bolstered by operating earnings, are there to provide any needed strengthening of existing reserves.

RIJ: And where do earnings fit into that picture?

Paul: Imagine a situation where the reserves are fine [i.e., sufficient] and the investments are fine [i.e., not impaired]. In that case, the earnings will become extra funds that go into surplus. The U.S. life insurance industry today is generally profitable. It has had a nice run. It’s in a relatively good balance sheet position. And, as a result, its surplus has been built up.

RIJ: Life insurers, like other investors, have been searching for yield by taking more risk and buying more BBB-rated bonds, which are the lowest-rated investment-grade fixed income instruments, than they traditionally have. In a credit crisis, will those holdings come back to haunt them?

Paul: The aggregate amount of BBB-rated bonds held by U.S.-based life insurers has exploded over the past few years. But, as I mentioned, the industry’s surplus has also grown nicely over the last decade. So the industry’s leverage to these bonds is not out of whack. For instance, the 10-year average ratio of BBB bonds to industry surplus is 195%; at year-end 2019 it was 199%.

Outside of all bonds, the industry’s second largest investment class would be commercial mortgage loans, which were roughly 13% of the industry’s invested assets at the end of 2019. In both cases, the industry is entering into this type of environment in a better position leverage-wise than during the last crisis.

What’s unique about this crisis, in terms of potentially mitigating impacts to the asset side of the life insurance industry’s balance sheet, is that the government has pledged to build, rapidly, what we call a “liquidity bridge” over the crisis. Massive government monetary and fiscal intervention will hopefully help to minimize economic damage from the current crisis, which could otherwise produce sizeable investment losses. We hope that this economic crisis will be temporary, whatever that means.

RIJ: But what if this financial crisis gets worse?

Paul: If those bonds are downgraded to below investment grade, the amount of risk-based capital that insurance companies are required to hold against those securities will ramp up quickly. If the ratings go to double-B or triple-C, the capital requirements jump. That’s a reality that insurers may have to deal with. We call those bonds “fallen angels.” The reported value of bonds under statutory accounting does not change with interest rate movements, because companies don’t have to mark them to market as they do under GAAP [General Accepted Accounting Principles]. If they hold the downgraded bond to maturity, and it doesn’t default, then it won’t affect the balance sheet. You certainly wish in the current stressed environment that the insurance carriers weren’t so loaded up with triple-Bs, but they needed more investment spread over the past decade as portfolio yields came under pressure. Otherwise their products would have been much less attractive.

RIJ: On the plus side, some bonds must be bargains right now.

Paul: When we think of low rates, we’re used to thinking of the 10-year Treasury, now with a yield of 0.6%, as a proxy for overall bond yields. But the relative credit spread on corporate fixed income and other non-government debt has actually expanded recently. People were fearful and sold off bonds. We’ve heard life executives say that their portfolio yield will actually improve if they can buy these bonds at depressed prices. Ironically, if you’re willing to buy triple-Bs now, and you think you minimize excessive exposure to credit losses, you can get more yield and potentially make your products more attractive.

RIJ: OK, we’ve touched on the asset side of the balance sheet. What’s happening on the liability side?

Paul: On the liability side of the balance sheet, it’s possible that reserve liabilities will need to be strengthened during a financial crisis. The math is simple: If liabilities go up, the surplus goes down. If you’re looking at where liabilities might be hit, here’s an example. When companies are pricing products, whether it’s life insurance, disability, or long-term care insurance—any of these long-tail products—they base that pricing in part on what they think their investment returns will be over time.

As the yields on all types of investments decline, the carriers have to recalibrate how much investment income they think they’ll earn in the future. If that number goes down, they may have to build up existing reserves to reflect that. And this will pressure surplus. Or when the lifetime income guarantees on variable annuities go “into the money,” the liabilities may go up. That also puts pressure on surplus positions.

RIJ: So, if I understand it correctly, the surplus can be threatened if, for whatever reason, the assets lose value or the liabilities get bigger.

Paul: Yes, both sides of the balance sheet can be hit. That’s where the pressure comes from. The problems are traditionally more on the asset side. But the Federal Reserve is throwing its full weight at that current problem, and companies that might otherwise quickly get caught in a liquidity crunch will hopefully not be. Afterwards, if the equity markets or investment yields improve, we’ll see existing reserves potentially “taken down,” which will help surplus positions.

RIJ: We’re also seeing a sales drop in annuity products. That has to hurt too.

Paul: We’ll definitely see a revenue hit. With social distancing, it’s tough to distribute products when you can’t physically get in front of people. It’s also more challenging to sell products to people in an environment where they’re pulling in their horns and husbanding cash. Two weeks ago, even Treasuries were being sold.

On the other hand, a good annuity or life insurance salesman will tell clients, ‘This crisis is an example of why you need guarantees.” Whole life insurance has no equity market risk, it pays a dividend, and it builds up cash value that you can use at times like this. People are getting the message. One distributor said that people who were jumping out of variable annuity contracts a couple of weeks ago are now telling their advisers that they want to get back into them. That’s the kind of behavior you see in a panic.

RIJ: Any other potential points of pain?

Paul: There will be losses. Disability claims will tick up; people who lose their jobs will decide to claim disability benefits. Companies are generally still paying their salaries; they don’t want to lose talent, so revenue is down but expenses remain. So you’ll see lower income or operating losses. Operating losses, all things equal, will depress surplus positions. This crisis wasn’t driven by a recession, so if we can get through the current health crisis in a relatively rapid manner—a big if—it doesn’t have to create long-term economic havoc.

RIJ: Even though equity indexes have rebounded from their recent lows, life insurance holding company stocks are still far below their recent peaks. Is that a source of concern for you or your clients?

Paul: ALIRT doesn’t react to the stock prices of holding companies. As we remind our clients, insureds are not legally exposed to the holding company but rather to the legal entity that actually underwrites their policies. And these legal-entity insurers are closely regulated by state insurance departments. In this stressed environment, state regulators will make sure that life insurers aren’t paying out excessive amounts of money to holding companies, as their primary concern is the solvency of these insurers.

But when the holding companies are impacted and they’re putting out fires, they can become distracted. The idea of pulling in horns becomes likelier. If the parent feels that the investment community doesn’t like the risks it is underwriting, its life insurer subsidiaries might become more conservative in the types of policies they issue.

RIJ: Publicly traded companies in this industry have bought back billions of dollars worth of their own shares in recent years. That might make Wall Street analysts and shareholders happy, but it worries some consumer advocates. Some of the money for buybacks comes out of the life insurance subsidiaries, I would guess.

Paul: We watch the amount of dividends paid out by insurance companies, especially to publicly traded parents. If holding companies become more leveraged over time—that is, they take on more debt—their life insurer subsidiaries may be called on to pay more dividends to the parent to support that debt. This can serve to constrain an insurer’s surplus position, potentially making it more leveraged versus its peers.

Certain life insurers have also been paying out money to their publicly traded parents—not because those parent necessarily needs money to service debt payments, but because they’re buying back their stock and/or paying out dividends to shareholders. Whatever the reason, surplus funds that are up-streamed to parent organizations can cause an insurer to become more leveraged and therefore potentially more financially constrained.

RIJ: Excuse my naïveté, but are you saying that the parents might be issuing debt even as the life insurance subsidiary is buying debt?

Paul: For a company to ramp up a new product, it has to hire actuarial talent and managerial talent, pay commissions to producers, and pay for the infrastructure required to produce and service the product. And if you’re a CEO, and you have a lot of stock options, and you feel a fiduciary duty to your shareholders, you’ll want to help the stock price. It’s in the nature of a public company to do that.

RIJ: Even though large life insurance companies rarely go bankrupt, consumers who buy their annuities and other long-dated products often worry about that happening. If we go into a sustained recession, will the potential for failure increase?

Paul: It’s really hard to put a life company out of business because it’s hard for them to experience a “run on the bank.” There’s a real stickiness to life insurance products. Life and disability and long-term care products tend to be held for a long time. Even with shorter-tail annuity products you have surrender charges that serve to protect the insurer.

To have an It’s a Wonderful Life-style run on the an insurance company, a lot of individuals would have to decide to get out of products at the same time, which is unrealistic. So, to answer your question, we don’t look at this crisis as provoking a liquidity crunch that turns into a balance sheet issue. At this point, it’s really an income statement/cash flow issue. Insurance companies may have several quarters of operating losses, but this should not necessarily threaten their balance sheets. If this crisis is short term, it shouldn’t turn into that at all.

RIJ: Thank you, David

© 2020 RIJ Publishing LLC. All rights reserved.

News from RIJ subscriber firms

Posted on April 9, 2020 by -

Corporate pension funded status rises in March: Milliman

The funded status of the 100 largest corporate defined benefit pension plans rose by $93 billion during March as measured by the Milliman 100 Pension Funding Index (PFI).

The funded status deficit improved to $255 billion at the end of March
2020 due to a record increase in the benchmark corporate bond interest rates used to value pension liabilities. This funded status gain was partially offset by the precipitous decline in investment returns during March. As the decline in pension liabilities outweighed the decline in pension assets, the March 31 funded ratio increased to 85.6%, up from 82.1% at the end of February.

The market value of assets fell by $85 billion as a result of March’s sharp market decline. The Milliman 100 PFI asset value decreased to $1.516 trillion from $1.601 trillion at the end of February based on a monthly return of -5.08%. Only five other months in the last two decades have posted more severe investment losses, the last occurring in October of 2008 during the Great Recession. By comparison, the 2019 Milliman Pension Funding Study reported that the monthly median expected investment return during 2018 was 0.53% (6.6% annualized). The expected rate of return for 2019 will be updated in the 2020 Milliman Pension Funding Study, due out later this month.

The projected benefit obligation (PBO), or pension liabilities, decreased to $1.771 trillion at the end of March. The change resulted from an increase of 70 basis points in the monthly discount rate, to 3.39% for March from 2.69% for February 2020.

CARES Act will help insurers: AM Best

The recently passed Coronavirus Aid, Relief, and Economic Security (CARES) Act will provide U.S. insurance companies tax relief in the event of operating losses due to the COVID-19 pandemic outbreak, according to an estimate from AM Best, the ratings agency.

A new Best’s Commentary, “COVID-19 Stimulus Package to Benefit Insurers,” notes that the $2 trillion CARES Act provides a special rule applicable for all companies’ net operating losses in 2018 to year-end 2020, allowing these to be carried back to each of the five tax years prior to the year of loss, which could help all insurance segments.

The Tax Cut and Jobs Act (TCJA), passed in late 2017, had repealed all net operating loss carrybacks for life companies, while preserving the net operating loss provisions for property/casualty companies. Allowing insurers to carry net operating losses to years prior to the effective date of the TCJA gives them the ability to use the 35% tax rate that was in effect then, thereby increasing tax credits.

The removal of carryback provisions in the TCJA also had forced life/annuity writers to reduce the amount of admitted deferred tax assets. With the modified carryback provisions, net admitted assets may increase at least over the period up to year-end 2020.

The CARES Act also allows companies to file for accelerated alternate minimum tax (AMT) credits, which could be a backstop in the event of a surge in health claims during the pandemic. A number of non-profit Blue Cross Blue Shield companies enjoyed significant windfalls from the TCJA due to the elimination of the AMT. This combined with the reduced tax rate resulted in significant surplus increases in 2017 and 2018.

These companies are in a very strong capital position owing to the AMT credits, but decisions to file for accelerated credits will depend on tax strategies employed as the pandemic evolves.

Plan participants are curious about income options: Allianz Life

More than three-quarters (77%) of current participants in employer-sponsored plans would consider adding a guaranteed lifetime income option to their plans, and 59% would consider adding an annuity, according to new research from Allianz Life.

About six in 10 (61%) of respondents to an Allianz Life survey say they want more information on how annuities can be part of their plan. At the same time, 60% of those surveyed are not sure of the benefits of having an annuity in their plan.

“The next step will be to provide [participants] with relevant information so that they are able to make an informed decision as to which potential options are a fit for their given situation. Ongoing volatility will only serve to increase the urgency surrounding this need,” said Matt Gray, assistant vice president of Worksite Solutions, Allianz Life, in a release.

DPL offers two more Great American Life indexed annuities

DPL Financial Partners (“DPL”), a platform where registered investment advisors (“RIAs”) can access insurance products, will add two more commission-free annuity contracts from Great American Life Insurance Company to RIA member firms.

Great American’s Index Protector 4 and Index Protector 5 MVA (market value adjustment) fixed-indexed annuities are available now at DPL. They feature shorter surrender periods than the Index Protector 7, which DPL already offers.

The addition of Great American’s Index Protector 4 and Index Protector 5 MVA fixed-indexed annuities brings the number of commission-free annuity and life products available to DPL members to well over 30 products.

MassMutual puts CARES Act into action

Massachusetts Mutual Life Insurance Company (MassMutual) will begin implementing new provisions available under the Coronavirus Aid, Relief, and Economic Security (CARES) Act this week, the company announced.

To start, MassMutual is offering several new provisions enabled by the CARES Act for its 32,000 retirement plan sponsors to offer employees enrolled in a MassMutual retirement plan, which reflects 3 million participants. Plan sponsors can ‘opt-in’ to offer:

  • A suspension of required minimum distributions for 2020
  • A temporary increase of up to $100,000 for loans and an extension of up to one year for loan repayment
  • A penalty-free COVID-19-related distribution capped at $100,000 with no mandatory tax withholding requirements and the ability to repay distributions

MassMutual is also waiving fees associated with eligible retirement plan hardship distributions, loan initiations, and withdrawals under the CARES Act until further notice. MassMutual will also continue to pay third-party administrators’ portions of these fees.

Principal offers relief for plan sponsors and participants

In accord with the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), Principal and Wells Fargo Institutional Retirement & Trust (IRT) said they will waive participant-paid distribution and loan origination fees for participants taking tax-favored withdrawals, hardship withdrawals, or loans from their employer-sponsored retirement accounts.

Additionally, retirement plan sponsors will have fees waived for plan amendment changes to allow participants to access these programs, or who need to reduce or remove their employer contributions1.

To help Principal insurance policyholders—individuals and employers—prevent a lapse in coverage, grace periods for premium payments have been extended. For employers who hold group benefits coverage the company is temporarily halting any rate increases.

This measure is for employers with fewer than 500 employees with policy renewal dates coming due between May 1 and August 15 of this year. Policyholders and others can visit the dedicated Principal COVID-19 resource page for more information related to insurance coverage.

Principal is also leveraging recent investments in digital services to continue meeting customer needs during this time of disruption. When underwriting life and disability policies, the company is using digital health data and records where possible, instead of requiring physicians’ statements and labs.

For dental insurance customers, Principal will cover expenses related to teledentistry (exam fees were already covered) and ensure they will not count towards annual frequency limits.

Envestnet | MoneyGuide offers new tax planning feature

Envestnet | MoneyGuide has launched a new Tax Planning feature that will enable advisors to have deeper conversations with clients regarding different strategies and show via interactive graphics and illustrations the potential impact of each across personalized retirement plans. Since the SECURE Act recently became law, advisors say clients have more questions than ever about rules related to required minimum distributions (RMDs) for certain retirement accounts and how the new law could impact their own financial plan.

Advisors are also finding that clients have some common misconceptions about paying taxes in retirement, as pre-retirees often assume they will automatically pay less to Uncle Sam during their golden years. However, today the opposite is more likely.

The new Tax Planning feature quantifies the expected savings and illustrates the potential impact of implementing different strategies in the plan, thereby helping reduce a client’s tax burden during retirement.

Based on the client’s goal, advisors can calculate a Roth Conversion, Qualified Charitable Distributions (QCDs) and Qualified Distributions, to test the strategies, and see the impact on the client’s probability of success and overall tax savings.

Some examples of what this new feature can help advisors show clients:

Roth Conversion: Show how converting a Traditional IRA or an Employer Retirement Plan to Roth Assets impacts your tax burden and the assets left to heirs. Based on the clients’ projected taxable income during retirement, auto-calculate the amount to convert that maximizes the use of a selected tax bracket.

Qualified Charitable Distribution (QCDs): Show the impact on lifetime tax savings of gifting up to $100,000 of Qualified Retirement Assets directly to charities. Establish the amount to gift based on the client’s projected Required Minimum Distribution.

Qualified Distribution: Show the impact of taking distributions from Traditional IRA or an Employer Retirement Plan early in retirement rather than waiting until RMDs begin. Based on the clients’ projected taxable income during retirement, instantly determine the amount that maximizes the distribution in years where there is lower taxable income.

These strategies are available in MoneyGuidePro as Goal Strategies on the What If Worksheet. Interactive visual models to demonstrate these strategies in the plan are available in MoneyGuideElite, according to the release.

© 2020 RIJ Publishing LLC. All rights reserved.

Life insurers hurt themselves, reader says

Posted on April 8, 2020 by -

Dear RIJ editor:

Thank you for your excellent April 2 article, “The ‘Fed Put’ Hurts Annuities—and Retirees”) While I understand that it may be tempting to blame Trump, and perhaps Powell caved, in reality the plight of life insurers is due more to what’s been a decades-long inability or unwillingness on the part of that industry to communicate its inherent (and unmatchable) advantages.

It’s hard to imagine a multi-trillion dollar industry that has done more to neuter its own influence over national economic policy.

Early in my career, insurers largely controlled the business of pensions. But what happened? The insurers ceded that business and much of their influence to the asset managers, an industry that was infinitely better at “selling” its story.

Aside from the fact that, decades ago, workers weren’t given a balanced explanation of the trade-offs between traditional pensions and 401(k) plans, how else can one explain the mass-transfer of risk from insurers’ balance sheets to retirees’ personal balance sheets?

How did we go from a retirement security paradigm that featured quantifiable, guaranteed retirement income to one that guarantees no retirement income at all?

Blame the insurance industry itself for losing its preeminence. Blame its many years of pushing opaque and overly complicated products. Blame the annuity compensation structures that gave rise to and then institutionalized low agent productivity. Blame ineffective client-facing communications. Blame many years of insurer management teams looking the other way in the face of distributors’ poor market conduct.

This is how you give rise to a Ken Fisher who absurdly proclaims, “I Hate Annuities and You should Too!” Not for a moment, I’d wager, would Fisher let his home(s) go uninsured. Nor drive to work without insuring his car. Yet he proudly condemns what virtually no retiree should fail to secure: income insurance. Blame not Fisher—or Trump. Blame an industry that never learned how to communicate its value.

David Macchia, MBA, RMA

Founder & CEO

Wealth2k, Inc.

COVID-19’s Financial Impact on Older Americans

Posted on April 8, 2020 by -

The COVID-19 pandemic is affecting the finances of older Americans in a variety of ways. The effect depends partly on whether they are retired, working, or recently unemployed. It also depends on the sector of the economy they work in, the level of unemployment insurance (UI) benefits they receive, and the speed with which the benefits are disbursed by their state.

On the plus side, older workers will be less hard hit than the young. Older Americans are more likely to hold public service jobs, and this sector will probably be less badly affected. Workers in the leisure and hospitality industries (restaurants, bars, etc.) have been especially hard hit. The median age in this sector is only 32 years compared with the economy-wide average of 42 years. Gig workers in general tend to be young, and they are suffering more than most.

Whatever their age, low-paid workers will see a higher share of their income replaced by UI benefits, which the Coronavirus Aid, Relief, and Economic Security (CARES) Act—the 2.3 trillion-dollar stimulus law signed last week by the President—has increased by $600 per week for 13 weeks.

Nonetheless, American households headed by those near retirement (aged 55-64 year old) still depend for almost all of their income on the labor market. Their labor force participation rate is high and their unemployment rate low in normal times, but even in normal times the loss of a job for this age group usually leads to a long period of unemployment. A subsequent job is often paid less, and comes without health benefits.

A question that arises is whether a long period of extraordinarily low economic activity in the wake of the pandemic will lead to a permanent exit of older workers from the labor market. If so, the hardship they experience would be considerable. The debt burden of this age group is already substantially higher than it was in the early 1990s, although declines in interest rates may have at least partially offset the burden of servicing that debt.

Responses to a drop in cash flow

Social Security. Americans who have reached age 62 can claim Social Security retirement benefits, but this means that they will forego the substantial increase in the benefit that results from delaying a claim to their normal retirement age or even later. Those who can keep working and delay claiming Social Security probably should.

Dividend stocks. Most American households, even older households, do not hold a substantial share of their assets in stocks or bonds. According to the Federal Reserve’s Survey of Consumer Finances, even the top 10% of households by income with a head aged 55 to 64 held on average just nine percent of their total assets—which include a household’s principal residence and other real property—in directly and indirectly held stocks in 2016. For the 65-74 age group, the share in stocks was twelve percent.

However, the clients of financial advisors who subscribe to the RIJ are undoubtedly well up in the top 10% of income, and the share of stocks in their total assets would be much higher. Many have already suffered a substantial decline in the value of their assets, and they face some difficult decisions.

For older Americans still enjoying a steady income, the undoubtedly strong temptation to liquidate the share of their portfolio in stocks or stock mutual funds should probably be resisted, although the decision to do so obviously depends on the individual circumstances of the households affected. The key question investors need to ask is whether they could survive financially if the stock market did not recover strongly.

To judge from the experience of the Great Recession, the stock market will eventually recover. That said, we are living in extraordinarily uncertain times, and the often seismic day-to-day swings in the market are unnerving. Shifting stock holdings from growth stocks to stocks emphasizing income might be worth considering to avoid the need to sell stocks to finance current expenditure.

Retirement plan savings. For older Americans who have lost their jobs, emergency withdrawals from their 401(k), IRAs and other retirement accounts will probably be necessary, but these need to be kept to a minimum. For those households that have managed to accumulate at least a moderate balance in their retirement plans and are nearing retirement age, withdrawals can be seen as a bridging strategy until the Social Security benefit kicks in.

Some employer-provided 401(k) plans offer plan participants either phased withdrawals or annuities in addition to lump-sum withdrawals. Choosing between a lump-sum withdrawal and an annuity is never an easy decision. Human beings, being human, tend to underestimate the value of a future income stream relative to a lump sum paid today, and this tendency is probably exacerbated in uncertain times. The decision to take a lump sum over a future stream of income is probably best made with the help of a financial advisor.

Reverse mortgages. Taking out a conventional mortgage is another strategy for homeowners with sufficient equity in their properties. A reverse mortgage (RM), or a reverse-mortgage line of credit, are other possibilities, since they do not have to be paid back until the death of the mortgagor or the sale of the property. RMs have not proved popular, but these strategies may be relevant for some of the clients of RIJ subscribers.

The future

Even if labor market participation rates recover, a long period of unemployment could seriously jeopardize this group’s retirement prospects, quite apart from the impact of the pandemic on the value of their assets. The years from 55 to 64 should normally be the ones where retirement assets are being built up. Mortgages are being paid down, and other financial obligations, like financing the education of dependents, should be declining. (That said, older households have recently been incurring substantial direct debt to finance their children’s education.)

Looking to what we must hope will be a brighter future, Americans households of all ages need at least to begin to save more. The strategy of living for paycheck to paycheck has now been revealed as fatally unwise and short-sighted. No one could have self-insured against the pandemic, but many households could have been better prepared to weather its effects.

We must pray that we are never again assailed by a time as trying to the soul as this one, but pandemics and financial crises have occurred and reoccurred throughout history. Think of the biblical account of Ancient Egypt, and the cycle of lean and fat years. That story has never really gone out of date.

© 2020 RIJ Publishing LLC. All rights reserved.

 

The Shape-Shifting ‘Equity Risk Premium’

Posted on April 8, 2020 by -

We’re all familiar with a “premium” grade of gasoline. It’s supposed to contain more of a type of octane (C8H18) than lower grades of gas. That’s why it costs about a third more than “regular.” But does premium gas contain enough extra octane to justify its price? Hard to say.

Assigning a value to the “equity risk premium” is even harder. If you stopped ten people on the street—if it were hygienic to do that today—it’s unlikely that more than one of them, and possibly none, could tell you what that term means.

Yet millions of people who participate in employer-sponsored retirement plans regularly buy stocks (via mutual funds) without knowing which they’re doing: paying a premium for risking their money in stocks or receiving a premium for taking that risk.

It’s a timely question. Over the month of March 2020, the stock market’s equity risk premium grew and shrank dramatically. Before deciding how to respond, savers, investors, and speculators need to refresh their acquaintance with this financial market term of art.

ERP (Excuse me!)

Let’s unpack the phrase “equity risk premium,” word by word. “Equity” refers to common stocks. Most people know that. But how many understand what risk means, or how to measure it? If they’ve read “Against the Gods,” Peter Bernstein’s famous book on risk, they might.

The website of John Wiley & Sons, the publisher of financial books, defines the equity risk premium (or ERP) as the “extra return (over the expected yield on risk-free 10-year Treasury bonds) that investors expect to receive” in the long run by investing in a diversified basket of U.S. stocks—perhaps by buying shares in an S&P500 Index Fund.

On average, since the Great Depression, stocks have delivered an attractive average risk premium. That’s why people buy them and hold them for a long time, even though stocks are riskier (more prone to price fluctuations in the short run) than bonds.

But how big is your ERP? Over the past 100 years or so, the average ERP has been about 5%. But averages mean nothing to individuals. At any given time or for any given investor, the ERP depends on many factors: On whether stocks are cheap or expensive today (relative to corporate earnings); on the dividend that stocks yield; on the difference between what you paid for the stocks and their price today; on the inflation rate; on the current 10-year Treasury yield; on whether you’re talking about the performance of one stock or of 30 stocks or all the stocks in the equity universe, or some quantity in between.

In short, the ERP fluctuates—from time to time, investment to investment, and investor to investor. Somewhat counter-intuitively, it shrinks when stock prices rise (because their future growth potential shrinks) and grows when stock prices fall (when stocks are “on sale”). It shrinks when 10-year Treasury bond yields are high (because then you can get a pretty good return without taking any long-term risk at all) and grows when the Fed (the Federal Open Market Committee, to be exact) lowers the risk-free rate, which can lower the 10-year Treasury rate (as it did in March).

You can’t take the ERP for granted. Yet that’s what most investors do. “It is widely believed that while stocks are risky in the short run, in the long run they are sure to outperform risk-free investments like government bonds,” pension expert Zvi Bodie of Boston University wrote recently. “This is a dangerous fallacy… It leads to the illusion that one can earn an equity risk premium without bearing risk.”

The Federal Reserve sometimes indulges that fallacy. It’s been shown that investors will pay more and more for stocks if they believe that, even if stock prices go too high (run out of ERP), the Federal Reserve Board will come to the rescue. The Fed does this by lowering rates when stocks fall, which restores ERP by expanding it from the bottom. That makes bonds less competitive, which stimulates demand for stocks, which drives up prices, which starts to cancel out the new ERP.

That’s what happened when the S&P500 Index dropped by 17.5% in the fourth quarter of 2018. Taking note, the Fed halted its policy (at the time) of slowly raising the Fed funds rate. Then, in the second half of 2019, the Fed lowered the rate three times. Welcoming the fresh injection of ERP, investors started buying stocks again. Over the 14-month period that ended in March 2020, they drove the S&P500 Index up by 33%.

As two business school professors described this chain of events in a recent article, “Mean-reversion in stock returns is driven by a reduction in the equity risk premium [i.e., a rise in stock prices] via the Fed’s promise of accommodation should the economy deteriorate.”

ZIRP (Excuse me!)

Then came the COVID-19 pandemic. Investors sold stocks in the fear that a recession would soon arrive and reduce corporate profits. The S&P500 Index was down 35% at one point in March. Paradoxically, the collapse of stock prices put a ton of ERP back into stocks, making them more attractive. The Fed added even more ERP by lowering the Fed funds rate twice, to zero, in March. Investors cautiously returned to the market, and stocks rebounded a bit.

But now the Fed is employing “ZIRP,” aka Zero Interest Rate Policy. The Fed can’t lower interest rates any further. For that reason, you’ll hear TV pundits say that the Fed is “out of ammunition.” (The Fed can still affect rates by buying bonds, but that’s another story.) Stocks may have to drop even farther before the ERP rises enough to inspire broad and consistent demand for stocks again.

What should the average investor do now? You should think seriously about buying stocks. They’re on sale. (A mutual fund executive once said, “If you liked a stock at $100, you should love it at $85.”) But your own unique circumstances should drive your decision.

Let’s assume that the U.S. government’s multi-trillion dollar stimulus bills will prevent a full-blown depression and that average stock prices won’t fall any farther than they already have.

If you’re under 45, you should put most of your new savings into stock mutual funds. If you’re middle-aged, you might take a more conservative approach: Consider selling enough bonds and buying enough stocks to “rebalance” your portfolio back to your pre-crash stock-to-bond ratio.

If you’re near or in retirement, don’t sell depressed stocks if you can avoid it. If you don’t already have a pension, consider creating a personal pension by selling your bonds and buying an income annuity that provides a guaranteed monthly income for life. That’ll put gas in your tank.