Archives: Articles

IssueM Articles

Desperately Seeking Alpha (and Getting Caught)

Posted on May 19, 2022 by Kerry Pechter -

A major asset manager has admitted that for five years its fund advisers hid the flaws of their complex options strategies—flaws that would cost pension funds, family offices and other institutional investors an estimated $5 billion.

The Securities & Exchange Commission (SEC) has ordered Allianz Global Investors US (AGI US), a subsidiary of Munich-based Allianz SE, and three then-advisers of AGI US’s Structured Alpha funds, to “disgorge” over $100 million in bonuses that the SEC’s May 17 civil complaint called “ill-gotten.” The Structured Alpha funds held as much as $11 billion in assets, on which AGI earned some $550 million in fees, the complaint said.

No institutional investors were identified in the SEC complaint. There were 17 Structured Alpha funds, with 114 institutional investors in the US and other countries. The funds took in almost $3 billion more than their pre-established $9 billion capacity. As of December 31, 2020, AGI US managed $148.8 billion.

AGI US—which Allianz SE sold this week to Voya Investment Management (see below)—admitted that its conduct from 2016 to 2020 violated federal securities laws. It agreed to a cease-and-desist order, a censure and payment of $315.2 million in disgorgement, $34 million in prejudgment interest, and a $675 million civil penalty, a portion of which will be distributed to certain investors, the SEC release said.

In addition, the US Attorney’s Office for the Southern District of New York this week announced related criminal charges against AGI US and the three advisers: Gregoire P. Tournant, Trevor L. Taylor, and Stephen G. Bond-Nelson. AGI US, Taylor and Bond-Nelson have agreed to guilty pleas.

In an apparent response to the negative news, Allianz SE separated itself from AGI. The German firm has already arranged to sell AGI to Voya Investment Management (Voya IM). After its guilty plea, AGI US was automatically and immediately disqualified from providing advisory services to US registered investment funds for the next ten years. AGI US will transfer teams managing about $120 billion in “income and growth, fundamental equities and private placements” assets to Voya IM, whose assets under management will grow to about $370 billion. Allianz will own 24% of Voya IM. It was not immediately clear if the service ban will follow the AGI US teams or affect the disposition of their AUM after they transition to Voya IM.

In its release this week, the SEC emphasized that the crime was not victimless. “The victims of this misconduct include teachers, clergy, bus drivers, and engineers, whose pensions are invested in institutional funds to support their retirement. This case once again demonstrates that even the most sophisticated institutional investors, like pension funds, can become victims of wrongdoing,” said SEC Commissioner Gary Gensler, in a release.

The AGI advisers admitted to deceiving institutional investors about the risk management techniques in the fund and then trying to cover up its activity by lying to its customers and, later, to the SEC.

The complaint painted a picture in which low interest rates and investor demand for yield, plus high-tech financial engineering, plus immense financial incentives to hide bad news from clients, plus a black swan event in the financial markets in March 2020 (when the Structured Alpha funds suffered massive losses), provided the ingredients for a multi-level disaster.

According to the complaint, the fund advisers saved money by buying less expensive but riskier options, using less effective hedging strategies than they led their clients to believe, and accepting investor money in excess of the capacity of the fund.

“Structured Alpha was a complex options trading strategy designed to generate profits by using a portfolio of debt or equity securities as collateral to purchase and sell options, primarily on the S&P 500 Index,” the complaint said.

“Structured Alpha’s options trading strategy had three components: range-bound spreads, directional spreads, and hedging positions,” the complaint continued. “Range-bound spreads and directional spreads were designed to generate profits by collecting premiums from selling put and call options that expired out-of-the-money. Hedging positions were designed to protect against short-term market crashes.”

Judging by their bonuses, disclosed in the SEC complaint, the AGI advisers were highly incentivized to grow the Structured Alpha business, to retain clients and attract new investments, and to hide difficulties.

Over five years, Tournant and Taylor each received almost $50 million in bonuses on top of $300,000 annual base salaries. Bond-Nelson received $10.775 million in bonuses on top of a $250,000 base salary. Together, they received just under $114.66 million across the five-year period relevant to the complaint.

From 5/17/2022 SEC complaint against AGI US, p. 46.

allianz gi complaint 5-17-2022 SEC

The SEC’s investigation was conducted by Jonathan C. Shapiro and James F. Murtha, and supervised by Reid A. Muoio of the Complex Financial Instruments Unit. The litigation will be led by Timothy K. Halloran under the supervision of Melissa J. Armstrong.

Rising Use of FHL Bank System by Insurance Companies

Posted on May 19, 2022 by No Author -

Envestnet and Kestra co-launch platform for plan advisers

Posted on May 12, 2022 by Editorial Staff -

Envestnet Retirement Solutions and Kestra Financial, a wealth management platform, are partners in launching Retirement Plan Enterprise, a service for advisers who sell retirement plans and provide investment menu advice to plan sponsors.

“RPE provides a comprehensive retirement plan practice management platform through single sign-on capability within Kestra Financial’s proprietary technology platform, at no additional cost to associated financial professionals,” a Kestra release said.

The platform includes these retirement plan tools:

Plan management dashboard. Designed to help financial professionals set and manage business retention and goals, the dashboard provides aggregate views of plans, AUM and scorecards, among other key metrics. The dashboard also assists financial professionals with asset and trend monitoring by fund and record keeper.

Investment analytics, fund research and monitoring reports. The platform will enable financial professionals to analyze and compare existing funds with recommended lineups, provide access to RPE’s proprietary analytics module, scoring criteria, and weightings as well as generate self-branded reports, including market commentary, asset allocation, plan-level performance, fund monitoring, due diligence, fee benchmarking, and more.

RFP and vendor search tools. The program is built to automate, streamline, customize, and manage the proposal and search process. It can help financial professionals monitor, track, review, and compare vendor responses.

The platform is also designed to ensure that the financial professional’s recommendations are in the client’s best interest by accounting for evolving regulatory requirements and fiduciary standards, the release said.

Kestra Financial, headquartered in Austin, Texas, is a division of Kestra Holdings. It includes the Kestra-branded broker-dealer and investment advisers. The firm supports more than 1,800 independent financial professionals.

Envestnet refers to the family of operating subsidiaries of the public holding company, Envestnet, Inc. (NYSE: ENV). Its cloud-based platform supports more than 108,000 advisors and more than 6,000 companies—including 18 of the 20 largest US banks, 47 of the 50 largest wealth management and brokerage firms, over 500 of the largest RIAs, and hundreds of fintech companies.

Annuity providers report 1Q2022 performance

Posted on May 12, 2022 by Editorial Staff -

Jackson National Life, Equitable, and Brighthouse Financial recently reported their earnings for the first quarter of 2022. Excerpts from their news releases can be found below.

Jackson National Life

Jackson National Life reported $199 million in sales of Registered Index-Linked Annuities (RILAs) in the first quarter, after launching the product in the fourth quarter of 2021. RILA sales offset a 2% decline in variable annuity sales.

Jackson’s retail annuities business reported pretax adjusted operating earnings of $406 million in the first quarter of 2022 compared to $568 million in the first quarter of 2021.

Total annuity sales of $4.8 billion were up 2% from the first quarter of 2021. Jackson reported $19.3 billion in annuity considerations received for all of 2021, according to its annual statutory statement, filed in Michigan.

Jackson also reported these financial highlights:

Net income of $2,025 million, or $22.51 per diluted share, including the impact of non-economic hedging results under GAAP accounting
Adjusted operating earnings of $354 million, or $3.94 per diluted share
Total annuity account value of $242 billion increased 2% from the first quarter of 2021, primarily as a result of positive separate account performance
Returned $192 million to shareholders through $140 million of share repurchases and $52 million in dividends, in-line with full-year capital return target of $425-$525 million
Estimated Adjusted Risk Based Capital (RBC) ratio was within the target range of 500-525% at the end of the quarter
Cash and cash equivalents at the holding company of nearly $1 billion at the end of the quarter, above Jackson’s minimum liquidity buffer

“In total, annuity sales without lifetime benefit guarantees represented 33% of total annuity sales, up from 31% in the first quarter of 2021. We continue to generate fee-based sales, with current quarter advisory annuity sales of $207 million, compared to $267 million in the first quarter of 2021,” Jackson’s release said.

Equitable

Equitable reported total assets under management of $856 billion as of March 31, 2022, “a year-over-year increase of 4.1% driven by net inflows and market performance over the prior twelve months,” according to a release.

Net income attributable to holdings for the first quarter of 2022 was $573 million compared to net loss of $1.5 billion in the first quarter of 2021 driven primarily by non-economic market impacts from hedging under US GAAP accounting.

Non-GAAP operating earnings in the first quarter of 2022 was $548 million compared to $600 million in the first quarter of 2021. Excluding notable items5 of $67 million, first quarter 2022 Non-GAAP operating earnings were $615 million or $1.53 per share.

As of March 31, 2022, book value per common share, including accumulated other comprehensive income (“AOCI”), was $16.64. Book value per common share, excluding AOCI, was $21.29.

Equitable’s business segment highlights included:

Individual Retirement reported first quarter net inflows of $52 million, the highest quarter since the Equitable’s IPO and separation from AXA. The Structured Capital Strategies buffered annuity product achieved its highest month of sales ever in March and $2 billion in first-year premium for the quarter.

Group Retirement generated first quarter net inflows of $523 million primarily driven by secure income inflows associated with AB’s Lifetime Income product.

Investment Management and Research (AllianceBernstein) reported over $11 billion in net inflows in the quarter, with fee rate expansion of 1% and annualized organic growth of 6% year-over-year.

Protection Solutions gross written premiums up 36% year-over-year driven by shift to less interested-sensitive VUL; excess mortality continues to be within COVID guidance.

Brighthouse Financial

Annuity sales decreased 3% quarter-over-quarter and 12% sequentially. Life sales decreased 13% quarter-over-quarter and 43% sequentially. Overall, sales results were impacted by the recent macroeconomic headwinds.

During the first quarter of 2022, the company repurchased $127 million of its common stock, with an additional $53 million of its common stock repurchased, on a trade date basis, through May 5, 2022.

The company reported net income available to shareholders of $613 million in the first quarter of 2022, or $7.91 per diluted share, compared with a net loss available to shareholders of $610 million in the first quarter of 2021. During the quarter, as a result of market performance, the value of our hedges increased, as expected.

Due to being accounted for as insurance liabilities as required under US GAAP accounting, certain corresponding liabilities are less sensitive to market movements and, therefore, did not fully offset the increase in the value of our hedges.

The company ended the first quarter of 2022 with common stockholders’ equity (book value) of $11.1 billion, or $146.64 per common share, and book value, excluding accumulated other comprehensive income (AOCI) of $10.8 billion, or $141.85 per common share.

For the first quarter of 2022, the company reported adjusted earnings of $294 million, or $3.79 per diluted share, compared with adjusted earnings of $385 million, or $4.36 per diluted share, in the first quarter of 2021.

Fed’s stability report assesses life insurers

Posted on May 12, 2022 by Editorial Staff -

The Federal Reserve’s Board of Governors released its annual Financial Stability Report this month. Portions of the 72-page document were devoted to statistics on the financial health of the US life insurance industry, which includes the annuity industry.

The report noted an overall increase in the liquidity of the industry’s liabilities and a trend toward holding less liquid assets—a potential cause of difficulty. Rising interest rates, the report said, could make life insurers more profitable, but also more susceptible to surrenders.

According to the report:

Leverage at life insurers remained near its highest level of the past two decades. Life insurers continued to invest heavily in corporate bonds, collateralized loan obligations (CLOs), and commercial real estate (CRE) debt, which leaves their capital positions vulnerable to sudden drops in the value of these risky assets.
Gradually rising interest rates improve the profitability outlook of life insurers, as their liabilities generally have longer effective durations than their assets, and higher interest rates may reduce life insurers’ incentives to invest in riskier assets.

However, a large and unexpected increase in interest rates could induce policyholders to surrender their contracts at a higher-than-expected rate.
If the increase in surrenders is substantial enough, it could put downward pressure on life insurers’ financial performance.
Over the past decade, the liquidity of life insurers’ assets declined and the liquidity of their liabilities increased, potentially making it more difficult for life insurers to meet a sudden rise in withdrawals and other claims.
On the asset side, life insurers increased the share of risky, illiquid assets—including CRE loans, less liquid corporate debt, and alternative investments—on their balance sheets.

Life insurers increasingly relied on nontraditional liabilities, such as funding-agreement-backed securities, Federal Home Loan Bank advances, and cash received through repurchase agreements and securities lending transactions.
These liabilities, which are generally more vulnerable to rapid withdrawals than most policyholder liabilities, have grown steadily in recent years.

Social Security’s Political Problems

Posted on May 12, 2022 by Kerry Pechter -

Social Security’s problems have always been more political than economic. We can expect Washington to make inconsistent stabs at refinancing the program, depending on the politics of the moment.

Today, even the moderates can’t get in synch.

Having praised Rep. John B. Larson’s 2019 “Social Security 2100 Act,” which raised payroll taxes on the wealthy, the non-partisan Committee for a Responsible Federal Budget (CRFB) has panned the bill’s latest iteration, which doesn’t.

“The previous version of Social Security 2100…would generate enough new revenue to restore solvency and expand benefits,” the committee said last week. “The legislation would subject earnings over $400,000 to the payroll tax while also gradually raising the payroll tax rate from 12.4% to 14.8%. In addition to closing the program’s financial shortfall, the funds would finance a stronger minimum benefit, larger cost-of-living adjustments, and reduced taxation of benefits.”

Larson (D-CT) replaced that bill last October, however, with a new bill (H.R. 5723, or “Social Security 2100, A Sacred Trust”). It disappoints the CRFB.

“The new legislation removes nearly half of the solvency-improving revenue from the original bill, while dramatically expanding new spending—but making that spending temporary to cover up the costs… The new legislation removes adjustments to the payroll tax rate—which were responsible for closing two-thirds of the solvency gap — while adding eight new benefit expansions that would further increase benefits for disabled workers, spouses, young adults, and the very old.”

In revising the bill, Rep. Larson may have wanted to replace deal-killing tax hikes with sweeteners in order to gain more support for its passage from the left and right. But the revision appears to have offended the middle, as represented by the CFRB.

Meanwhile, we get closer to Social Security’s 2034 political reckoning, whose outcome may hinge on the results of the 2028 presidential election. Which is to say, very soon.

Most of the news about Social Security tends to be characterized either by sensationalist cliff-hanging for its own sake or reductive name-calling (“Ponzi scheme”) by those who would replace our pay-as-you-go national pension with a defined contribution system.

Social Security’s actual economic situation is not so dire. Even facing demographic headwinds (rising life expectancies and falling fertility rates), 75% of all promised benefits can continue to be paid after 2034, regardless of whether the program crosses into technical “insolvency.”

Social Security doesn’t face failure. It faces the question: Do we value it enough, as the most efficient way to manage the longevity risk of the tens of millions of American elderly, to pay a bit more for it—so that we can get what we’ve already been promised?

Social Security is not a giant burden to the US economy. Every year, $1 trillion that would have gone into the bank accounts of workers goes into the bank accounts of retirees. They spend it into the economy. Workers receive incremental credits toward a guaranteed life-contingent pension.

The banking system—the economy—enjoys the same amount of reserves either way, and can lend just as much to businesses. High-income managers, professionals and business owners continue to contribute the maximum to their 401(k) accounts.

Critics of Social Security say it should be pre-funded. It has been. Starting in the late 1980s, pre-Boomers and Boomers paid trillions of dollars more in Social Security taxes than flowed out as benefits. The trust fund—still more than $2 trillion—reflects the pre-funding.

It is said that Social Security is a bum deal for high earners, because it replaces relatively less of their pre-retirement income than of low earners’ pre-retirement income. But high earners receive much larger benefits than low income earners. And because they are healthier, on average, they tend to collect longer.

A dual-income professional couple who waited to claim the maximum benefit at age 70 would receive as much as $4,200 a month each in 2022 from Social Security. That benefit is protected from market risk, inflation risk, sequence risk, and longevity risk. A comparably safe single premium immediate retail annuity would cost a man about $700,000 and a woman about $750,000, according to immediateannuities.com.

Those who recommend that we replace Social Security with a national defined contribution (DC) retirement system underestimate the difficult of switching from social insurance to investment-driven retirement savings, judging by other countries’ experience.

National DC typically calls for large mandatory contributions from employers, a centrally managed pension fund with illiquid individual accounts, a means-tested minimum benefit for those who’ve never worked, a “smoothing” mechanism so that market volatility doesn’t create winners and losers, and often a requirement for at least partial annuitization. You can’t just throw a lever and divert half of the payroll tax to target-date funds.

The politics of designing and implementing such a system in the US would be even more difficult and time-consuming than fixing Social Security, which needs only a few fiscal tweaks. It would take many years to pilot a new DC system through our contentious, erratic, lobbied and game-able legislative process.

We don’t have many years.

Who Has ‘Three Legs at Evening’? (The Elderly)

Posted on May 12, 2022 by Kerry Pechter -

The red granite Sphinx of Ramses II, all 13 tons of it, used to recline on its lion-haunches in the Egyptian gallery at the Penn Museum in Philadelphia. The Wharton School’s Pension Research Council (PRC) once punctuated its Spring Symposiums with a white tablecloth supper there.

The PRC has hosted the two-day symposium since 1994. Selected from pension academics all over the world, six or eight authors offer slide-presentations of some of their latest research to an audience of several dozen representatives of universities, policy groups, and companies in the retirement industry.

This year, for the third year in a row, the symposium happened on Zoom, on April 28 and 29. There was no elegant dinner, no live face-time with pension specialists (or, unfortunately, with a sphinx, whose lethal question, ‘What goes on four legs, then two, then three?’ refers to the stages of aging). [Penn’s sphinx has since been moved to a new gallery at the museum.]

“Real World Shocks and Retirement System Resiliency” was the theme of the 2022 Symposium. The papers looked at forces at work in the economy today—the entry of the Millennial generation into the workforce, COVID, the ever-rising costs of health care, and the growth in financial inequality—and their potential effects on retirement systems.

The conference dealt mainly with the public-policy side of retirement. On the private sector side, everyone asks: Will workers save enough? Will their investments perform well? Will they buy stocks, bonds, annuities, long-term care insurance, or reverse mortgages?

On the public-sector side of retirement, the fate of the less-affluent 50% of American retirees tends to occupy much of the discussion. Their future well-being depends largely on whether social insurance—what the private sector calls entitlements—remains funded at current levels or not.

Do the young face a tougher old age?

On average, Millennials (ages 26 to 41) aren’t doing the wealth-aggregating things, like marrying and buying homes, as much as their Boomer parents (ages 57 to 75) did at the same ages, according to Richard W. Johnson and Karen E. Smith of the Urban Institute.

Since marriage and homeownership lead to (or are markers for) wealth accumulation over a lifetime, Millennials are less likely to be on track to replace at least 75% of their peak earnings in retirement as were Americans born in the early 1960s (68% on track) or the early 1940s (74%) on track.

But individual outcomes depend on lots of factors other than “generation.” On the plus side, Millennials are more likely to be college-educated, which correlates with higher earnings. Millennial women are more likely than their mothers to have jobs outside the home, and they’re more likely to keep working as they age. These are the Millennials most likely to have a secure retirement.

Those with only high school degrees and/or people of color will tend to fare less favorably, Johnson and Smith found. They have will have the most to lose if—as many of them fear—there’s no Social Security (or a Social Security with only 75% of today’s benefits) to cushion their retirements.

Less income, more illness at older ages

In their paper, “Retirement Security and Health Costs,” Glenn Follette of the Federal Reserve Board and Louise Sheiner of the Brookings Institution assemble a mountain of data to figure out the future growth of health care costs, the degree to which it will fall on the individuals of different wealth levels, the implications for federal policy and the potential impact on the national debt.

“Health care spending by the elderly is a much higher fraction of their income than it is for the population in general,” they found. That’s not surprising, given that the elderly usually don’t have earned income and have more health problems than younger people. The situation has improved, however. The poorest elderly spent an average of 45% of their income on premiums, co-pays and deductibles in 1996. By 2016, that group was paying less than 10% on average.

The data also reflects a reduction in the growth of Medicare spending. “Total Medicare spending rose at a much slower pace than anticipated before the enactment of the ACA, with lower reimbursement rates the main driver, but lower utilization rates, and much lower spending on drugs were also important… Regardless of whether expressed in nominal dollars or as a share of GDP, by 2019, Medicare spending was about 20% lower than projected in 2009. This saved the federal government roughly $1 trillion from 2010 to 2019.”

Ready (or not) for retirement

Financial “inequality” is said to have been growing in the US and around the world. Some people consider that a big mystery. But after a 40-year bull market in stocks and bonds, the world seems clearly divided into those with investments (the richest 20% owns about 80% of equities) and those without (50% of Americans own few or no securities).

Inequality inevitably affects retirement policy, because people without adequate savings will retire in poverty and rely more or less on social insurance, on local public services, and on informal care. So how is the increase in inequality affecting America’s overall “readiness” for retirement?

That turns out to be a very hard question to answer. “Two researchers with very different retirement wealth adequacy yardsticks can look at the same wealth distributions and come to very different conclusions about the number of people facing retirement shortfalls, and how large those shortfalls might be,” according to John Sabelhaus of the University of Michigan and the Brookings Institution and Alice Henriques Volz, principal economist at the Federal Reserve.

The data varies, but a young/old divide seems to exist. The Boomers and their parents, after all, enjoyed a bull market for much of their working years.

“A large majority of the growth in average comprehensive wealth between 1995 and 2016 occurred at older ages,” Sabelhaus and Volz found. “Adjusting the wealth measure for expected social security funding shortfalls makes the age differentials even larger, especially for the bottom half of the wealth distribution. In fact, average comprehensive wealth is estimated to be lower in 2019 than it was in 1995 for younger individuals in the bottom 50% of their wealth distribution.”

The young/old divide—on average—will be even more striking if younger people face weak markets and they lose Social Security. The retirement preparedness levels of the wealthiest 10% of Americans won’t change if Social Security benefits drop 25% across the board after 2034, Sabelhaus and Volz concluded. But such a cut in benefits would devastate the poorest of the Millennials.

Trillions, trillions: Size of select US asset markets

Posted on May 12, 2022 by No Author -

In the UK, private equity finds a NEST-ing ground

Posted on May 5, 2022 by Editorial Staff -

NEST, the UK “master trust” that has expanded the availability of defined contribution savings plans to millions of middle-class British workers, will add private equity to its members’ portfolios.

Schroders Capital will be NEST’s manager for the asset class, according to a report at IPE.com. A master trust in the UK is roughly comparable to a Pooled Employer Plan (PEP) in the US. PEPs were made possible by the SECURE Act of 2019.

NEST estimates it will have at least £1.5bn ($1.8bn) invested in private equity by early 2025. The master trust currently has assets of £24bn and gains more than £400m a month in new contributions.

Many observers doubted that NEST would be able to find a private equity manager to work for the low expense ratio that NEST offered. NEST has been at the forefront of UK’s auto-enrolled master trusts expansion into illiquid assets.

Fee constraints imposed by a manager charge-cap and stiff competition in the market have made it difficult for defined contribution (DC) schemes to add these more expensive strategies. But Schroders Capital was willing, and its emphasis on environmental, social and governance (ESG) companies aligned with NEST’s.

In the long run, NEST intends its centrally managed investment portfolio to allocate about 5% to private equity, on top of the 15% it already devotes to alternative assets such as real estate, private credit and infrastructure debt. NEST participates have notional accounts in the portfolio and do not manage their own assets.

Initially the private equity allocation will be for the early “foundation phase” of the NEST’s accumulation strategies which is accessed by the master trust’s youngest members as well as the subsequent “growth phase.” At age 55, as part of a glidepath toward lower volatility, NEST would transfer the private equity positions to younger participants’ accounts.

The ‘Retirement Income Consortium’ is Born

Posted on May 5, 2022 by Kerry Pechter -

A group of life insurers and asset managers has created a new industry group: the Retirement Income Consortium (RIC). The founding members are AllianceBernstein, Allianz, BlackRock, Income America, Nationwide, Principal Financial Group, Prudential Financial and TIAA-Nuveen.

RIC’s overall goal is to “accelerate adoption of guaranteed income solutions in retirement plans,” according to a release this week. More specifically, it plans to “develop a vetted due diligence framework for retirement income solution selection and monitoring.”

Broadridge, a fintech firm would provide some of the infrastructure for 401(k) income options, provided a platform for RIC-related information on its website. Cannex, fi360 (a Broadridge company), Endeavor Retirement LLC (Lake Oswego, OR), and Michelle Richter, founder of Fiduciary Insurance Services LLC, are facilitators of the consortium. Richter is also executive director of IRIC, the Institutional Retirement Income Council.

The American Retirement Association, which encompasses the National Association of Plan Advisors (NAPA) and the Plan Sponsor Council of America (PSCA), has also joined the Consortium. It has “an independent initiative to create a curriculum for a new retirement income certification program,” the release said.

Those who want to hear about RICs plans can join a 30-minute webinar on May 19, 2022 at 1 pm Eastern, titled “Introducing the Retirement Income Consortium.” Registration is free and open to the public. Register for the webinar here.

Nouns and verbs

A clear process by which defined contribution plan participants can convert all or part of their tax-deferred savings into a guaranteed revenue stream at retirement has long been a feature in non-profit 403(b) plans; TIAA pioneered it. But Department of Labor-regulated 401(k) plans, sponsored by for-profit companies, rarely offer them to active participants prior to retirement.

That’s partly because a clear legal and business process by which employers can evaluate, select, design and monitor so-called “in-plan” annuities for their participants hasn’t existed. While the SECURE Act of 2019 helped clarify the applicable labor law around annuities in 401(k) plans, it didn’t create a specific guide to conducting due diligence on income tools and providers.

RIC’s goal is to formalize such a process. It will educate plan sponsors about income tools while remaining agnostic to the various types of tools and annuity products that its member-companies want to distribute to participants through retirement plans.

Richter told RIJ that there’s an implicit barrier to retrofitting 401(k)s for income. On the one hand, plan sponsors are used to hiring financial professionals to give them advice on creating an investment menu for participants.

But there is no training for financial professionals who can give plan sponsors advice on annuities, she said. And while the Alliance for Lifetime Income promotes income solutions to individuals, no one is advocating income solutions to plan sponsors.

“There’s been no centralized advocacy group for the income solution providers,” she said. “They’ve been on their own in wholesaling to the plan sponsor community. The Retirement Income Consortium will level the playing field for those of us who believe that we can deliver insurance in a way that supports fiduciaries. ERISA says you must have a prudent, well-documented process or you could be sued.”

One of the barriers to annuities in 401(k) plans involves cost. Plan sponsors are sensitive about adding new fees to their plans; they’ve fought many lawsuits over the level of fees that their retirement plan providers charge participants. A new insurance product such as an annuity would add a potentially expensive new option to 401(k) plans.

Michelle Richter

Plan sponsors need a framework for reconciling the expense of an annuity with the best interests of plan participants, said Richter. Her firm, Fiduciary Insurance Services LLC, is a provider of services that would be available within such a framework.

Today, “Insurance products are still perceived as expensive assets and not as efficient providers of liability management,” Richter said. We live in a regulatory regime where investment advisory services are “verbs” and insurance products are “nouns,” she explained. “There is a framework of verb sales to the left [asset] side of an individual’s persona balance sheet, but no framework of verb sales to the right [liability] side of the balance sheet.”

This type of framework is a necessary but not sufficient condition for the distribution of annuities through 401(k) plans. Even if a framework for comparing income products is standardized, plan sponsors would find no standardized income solution.

They will still face a bewildering landscape of variable, fixed, indexed, deferred, and immediate annuities—and possibly even tontines. These products are difficult to compare. They entail certain trade-offs that can’t easily be resolved by giving plan sponsors more information.

By most accounts, plan sponsors won’t import annuities into their plans unless the products are “liquid.” That implies a variable or fixed indexed annuity with a “guaranteed lifetime withdrawal benefit” rider.

But those products are typically fee-heavy, complex, or both. At the same time, annuity issuers are striving to have their products bundled into QDIAs (Qualified Default Investment Alternatives) so that participants can be defaulted into them. Managed accounts and target-date funds are the prevalent QDIAs.

Without more demand from participants for income solutions, plan sponsors might hesitate to climb a daunting new learning curve. Demand for in-plan communities comes mainly from companies like the RIC members, who are looking for ways to capture 401(k) assets that will otherwise be rolled over to brokerage IRAs and lost to them.

Most plan advisers are investment advisers, and they share a conviction that risk can be efficiently managed on the investment side alone, either through diversification of risky assets or by allocating more or less of a client’s portfolio to cash equivalents or TIPS.

The idea that an investor or plan participant should pay an insurance company to haul away their risk, like asking 1-800-Got-Junk to empty their basement, is foreign to them. RIC will try to teach plan advisors and sponsors that removing longevity risk and market risk by purchasing an annuity or a guaranteed lifetime withdrawal rider should be a participant’s first step toward putting his or her retirement house in order.

Jack Towarnicky, former executive director of the PSCA, remains skeptical of the demand or the need for in-plan income solutions.

“In my past plan sponsor roles, I did not encounter any financial organization that provided an in-plan guaranteed income solution which would appeal to more than a minimal number of my plan participants—if only because of tenure trends, where only a small minority of my plan participants actually retired upon leaving my firm,” Towarnicky told RIJ in an email.

“Perhaps the consortium can focus on demonstrating why/how an in plan guaranteed income option would be superior to a choice of individual marketplace products so as to overcome the cost to implement/administer and the fiduciary risk in selection and monitoring.”

In the coming months, the Consortium will present a free educational webinar series covering the essentials of in-plan retirement income, starting with “Retirement Income: Why Now?” Registration is free and continuing education credits are available. Registration and replays will be available through the Consortium website.

Why RIJ Obsesses over the ‘Bermuda Triangle’

Posted on May 5, 2022 by Kerry Pechter -

As an RIJ reader, you might have wondered why we spend so much editorial space on the ‘Bermuda Triangle’ phenomenon. There are three main reasons.

First, the obvious. The annuity business is our wheelhouse. Annuities (and life insurance, to a lesser extent) are an essential ingredient of the Bermuda Triangle strategy.

Second, if the insurance business is a black box, the Bermuda Triangle is a black box within a black box. Outsiders—competitors, regulators, investors—want to know what’s happening inside of it.

Third, the Bermuda Triangle strategy contains echoes of the home mortgage crisis of 2008. It just may contain the seeds of another financial disaster.

Private equity is no longer a sideshow in the annuity industry. Its involvement is now the main event. But we know too little about its growing role in this space.

Let’s unpack those points of interest one by one. [Newcomers can find a definition of the Bermuda Triangle strategy in the last section of this article.]

A problematic foundation

Yield-hungry individual investors bought some $63 billion worth of fixed indexed annuities (FIAs) and $53 billion worth of fixed-rate annuities in 2021. FIAs are complex and opaque products, but people typically buy them (often without understanding them) because they yield more than bonds—and because selling agents are highly incentivized and aggressive. But those factors are not new.

What’s new is that there’s more supply than ever: Life insurers that once ignored FIAs now sell them because they’re less capital-intensive than other types of annuities. What’s also new is the degree to which sales are driven by the requirements of the private equity companies that manage an increasing share of life insurer general account assets.

Private equity firms love FIA premiums because they’re a source of long-dated and illiquid deposits (“sticky”or “permanent” capital, in industry jargon) that the firms can lend at relatively high rates of interest to high-risk borrowers. They bundle the loans, securitize them, create tranches of varied risk levels, and sell the tranches to life insurers and other yield-starved investors worldwide.

Does this dynamic encourage suitable sales of commission-driven FIAs? Is the commission-driven FIA the right product on which to build the future of the life/annuity business? My impression is that buyers of long-dated FIAs are over-paying for the protection and/or upside potential they get—too much in terms of opportunity costs, if not in fees—without knowing it.

Too much privacy, too little transparency

Transparency is a sine qua non of trust, and not much about the Bermuda Triangle strategy is transparent. Private assets exist outside the public markets. The newest custom indexes that drive the returns of FIAs are hard to understand.

When one holding company controls all three partners in a Bermuda Triangle strategy—the annuity issuer, the reinsurer and the asset manager—no one can see whether or not transactions between affiliates are as fairly priced as they would be between unrelated counter-parties.

Ratings agencies say they can see the assets held by reinsurers in Bermuda, but the exact nature of those assets are not available for public review. The “modified coinsurance” and “funds withheld” forms of reinsurance that characterize most Bermuda Triangle reinsurance transactions are not widely understood, and have been described by academics as “shadow insurance.” Financial shadows call for sunlight.

Participants in the Bermuda Triangle strategy tell me that the current regulatory and legislative regimes governing their business are adequate. But regulators don’t necessarily agree. The NAIC has convened new task forces to address questions about the Bermuda Triangle strategy (without using that moniker).

The Senate Banking Committee chairman has asked for a formal briefing from the NAIC and the Federal Insurance Office on private equity involvement in the life/annuity business. There are many unanswered questions.

Seeds of crisis

Before the home mortgage crisis of 2008, houses were considered the safest of investments. Investors in mortgage-backed securities took comfort in the idea that there had never been a meltdown in housing prices. You hear the same about the life/annuity industry: It has a history of stability.

But in the housing crisis, banks lost their incentive not to lend to high-risk borrowers. They were writing mortgages and selling them to FannieMae and FreddieMac. Something similar may be happening in annuities. Issuers increasingly send the liabilities to reinsurers and the assets to asset managers. The asset managers repackage the investment risk and sell it to third-party investors. The issuers bear less risk and require less capital.

A so-called “capital light” fee-based business may be more profitable, but it also has less skin in the game. Is it even still an insurance company, let alone one that people will entrust with their retirement savings for periods of up to 30 years? Or has it become a mere storefront for annuity sales?

An annuity-fueled crisis wouldn’t necessarily start with the large firms that pioneered the Bermuda Triangle strategy. It could start with the failure of small or hastily assembled copycats of the pioneers’ business models. In classical fashion, it could start after the insurers and asset managers have accepted in-flows far in excess of the availability of worthwhile investment targets. We’ve seen that movie before.

A bit of background

What RIJ calls “the Bermuda Triangle” is a synergistic, much-varied business model involving a kind of triple accounting play between:

A US domiciled life insurer that issues fixed-rate or fixed indexed annuities
An asset manager with global reach and expertise in alternative assets and origination of high-yield loans
A reinsurer in a jurisdiction (e.g., Bermuda, Cayman Islands, Vermont) that permits the valuation of annuity liabilities according to Generally Accepted Accounting Principles (GAAP) along with or instead of the more conservative Statutory Accounting Principles required of all US life insurers

In the Bermuda Triangle’s purest form, all three players belong to the same holding company. They may also have some overlapping ownership, or may be strategic partners. Life insurers who employ all or part of the Bermuda Triangle strategy include leading FA and/or FIA sellers like Athene Annuity & Life, Global Atlantic, AIG, MassMutual, and others. Together, Bermuda Triangle companies accounted for about half of the $116.8 billion in 2021 fixed-rate/fixed indexed annuity sales reported by LIMRA’s Secure Retirement Institute.

USAA inked a pair of reinsurance deals in 2021

Posted on May 4, 2022 by Editorial Staff -

USAA Life Insurance Company entered into two reinsurance arrangements in 2021, with a combined value of about $6 billion, according the Texas-domiciled mutual insurer’s 2021 Annual Statement, filed with the Texas Department of Insurance on February 10, 2022.

USAA “entered into a coinsurance arrangement with Commonwealth Annuity and Life Insurance Company (CALIC) to reinsure its closed block of fixed rate annuity business representing approximately $3 billion in ceded annuity reserves,” the statement said. The deal with effective July 1, 2021.

USAA also “entered into a coinsurance agreement with Fortitude Re to reinsure 100% of its legacy annuity closed block of business on a funds withheld basis. This reinsurance agreement represents approximately about $3 billion in ceded reserves.” The deal was effective October 1, 2021.

USAA is a “reciprocal” insurance company, which is similar to a mutual insurance company. In July 2019, Charles Schwab announced that it would acquire the assets of USAA’s Investment Management Co., including brokerage and managed portfolio accounts, for $1.8 billion in cash. The companies agreed to a long-term referral agreement, effective at closing of the acquisition, that would make Schwab the exclusive wealth management and brokerage provider for USAA members.

For 2021, USAA, which is headquartered in San Antonio, reported $2.72 billion in new annuity premiums, $743 million in individual life insurance premium, and $1.11 billion in net investment income. USAA markets insurance products and services primarily to current and former members of the US military and their families.

Because of “reinsurance ceded” of $7.6 billion, however, the company reported a negative $3.7 billion in life and annuity premium and a $4.9 billion reduction in aggregate reserves. USAA reported about $26.4 billion in assets, $23.6 billion in liabilities, and a surplus of about $2.8 billion (10.6% of assets), according to the annual statement.

CALIC is a Massachusetts-based subsidiary of Global Atlantic Financial Group, which is a Bermuda-based, US-focused annuity life insurance and reinsurance company owned by KKR, the global asset manager, and by Goldman Sachs. CALIC executed a coinsurance deal with USAA.

In a coinsurance deal, “the ceding insurer transfers a proportionate share of all the policy risks and cash flows. The reinsurer receives its share of premiums, pays its share of benefits, sets up its share of reserves, and pays an allowance to the ceding insurer to cover its share of the costs of administering the policy,” according to the American Council of Life Insurers.

Fortitude Re and USAA have a “funds withheld” reinsurance deal. USAA received a reserve credit from Fortitude Re of $2.84 billion for business ceded to Fortitude Re. USAA included that $2.84 billion among its liabilities as “funds withheld.”

Like many other life insurers, USAA used funds-withheld reinsurance to transfer away the risk associated with certain contracts while keeping the corresponding assets under its own management.

Fortitude Re is a Bermuda-based multi-line reinsurance company “specializing in transactional solutions for legacy life, annuity and property and casualty line of business.” The Carlyle Group and other investors created and financed Fortitude Re over a period of several years after 2018 to acquire or reinsure AIG annuity contracts.

Annuity sales on pace for another $250bn year

Posted on May 4, 2022 by Editorial Staff -

Total US annuity sales increased to $63.6 billion in the first quarter of 2022, up 4% from the first quarter of 2021, according to preliminary results from the LIMRA Secure Retirement Institute (SRI) US Individual Annuity Sales Survey.

At their current quarterly sales pace, annuities would post 2022 full-year sales of $254.4 billion, or just shy of the all-time record sales of $254.6 billion in 2021.

“First quarter annuity sales tend to be a bit slower,” said Todd Giesing, assistant vice president, SRI Annuity Research. “While sales in the first two months of 2022 were a bit sluggish, annuity sales in March were at record-high levels. Rising interest rates and increased market volatility shifted the product mix this quarter with fixed annuity products driving the overall growth.” SRI has tracked monthly annuity sales since 2014.

Total fixed annuity sales were $35.2 billion in 1Q2022, up 14% over first quarter 2021. Double-digit growth for fixed indexed annuities and fixed-rate deferred annuities returned the overall fixed annuity sales to pre-pandemic levels.

$ in billions. Source: Secure Retirement Institute, May 3, 2022.

Fixed indexed annuity (FIA) sales were $16.3 billion, 21% higher than in prior year quarter but down 2% from 4Q2021. Fixed-rate deferred annuity sales increased 10% in the first quarter, year-over-year to $16 billion. They were up 45% from 4Q2022.

“Both FIAs and fixed-rate deferred products benefited from the significant interest rate increases in the first quarter,” said Giesing. “Coupled with a nearly 5% equity market decline, investors sought out principal protection and steady growth, which these products offer.”

Sales of fixed-rate annuities and FIAs were $32.3 billion in 1Q2022, compared to $28.4 billion for all variable annuities. Combined sales of indexed products—FIAs and registered index-linked annuities, or RILAs—were $25.6 billion.

Index-linked annuities are, from that perspective, the single best-selling class of annuity products. The two occupy very different niches: FIAs are distributed through insurance marketing organizations and require an insurance license to sell, while RILAs are distributed through broker-dealers and require a securities license to sell.

Both are distinct from all other annuities, however, in that they are structured products. That is, their performance is tied to the performance of options on equity market indexes or hybrid indexes.

FAs and FIAs, especially those with longer contract terms, are the products favored by life/annuity companies that have close partnerships with alternative asset managers. The annuity companies are stoking their profitability by reducing exposure to capital intensive products like variable annuities with living benefits, investing in higher-yield private assets, and making strategic use of reinsurance in havens like Bermuda.

Traditional variable annuity (VA) sales were $19.1 billion in the first quarter, down 8% year-over-year. Registered index-linked annuity (RILA) sales were $9.3 billion. While this is 2% higher than first quarter 2021, it reflects a 10% drop from the fourth quarter of 2021.

“Market conditions in the first quarter have made FIAs more attractive than RILAs. As a result, the remarkable growth RILAs experienced over the past three years has leveled off,” Giesing said in a release.

Immediate income annuity sales were $1.5 billion in the first quarter, level with first quarter 2021. Deferred income annuity sales fell 18% to $300 million in the first quarter.

“We finally are beginning to see payout rate increases for income annuities as interest rates improve,” said Giesing. “However, because the Fed has signaled additional rate hikes later this year, we expect investors to wait to lock in rates so sales will likely remain muted in the second and third quarters.”

Preliminary first quarter 2022 annuity industry estimates are based on monthly reporting, representing 85% of the total market. A summary of the results can be found in LIMRA’s Fact Tank.

The 2021 top 20 rankings of total, variable and fixed annuity writers will be available in May, following the last of the earnings calls for the participating carriers.

Contribution to Inflation by CPI Component

Posted on May 4, 2022 by No Author -

New York’s ‘shot-across-the-bow’ to PE firms

Posted on April 29, 2022 by Kerry Pechter -

In a message that may have been inspired by Blackstone’s 2021 purchase of a 9.9% equity stake in AIG Life & Retirement, the New York Department of Financial Services issued Insurance Circular Letter No. 5 (2022) on April 19.

“People are paying attention to this,” Tim Zawacki of S&P Global Intelligence told RIJ this week. “It appears the NY superintendent intends to exercise wide latitude to determine what constitutes a ‘change in control’ of a life insurance company. My reading of letter is that the superintendent can subjectively determine whether even so little as a board appointment constitutes a change in control.”

Zawacki called the letter a possible “shot across the bow” to PE firms that are forming strategic relationships with life/annuity companies. “I think that’s a fair characterization in light of this statement in the letter: ‘The Department wishes to remind industry participants of the requirements of the Insurance Law and the Department’s expectations given the apparent misconception in the marketplace and the recent increase in insurance company transactions,'” he said.

A change in control would subject a transaction to “filing and approval requirements imposed under New York Insurance Law (“Insurance Law”) §1506,” the circular said.

Besides Blackstone’s equity stake, its deal with AIG included an agreement that Blackstone would manage $50 billion of AIG Life & Retirement’s assets immediately and the right to manage up to $92.5 billion for the company over the next six years. In addition, Blackstone president and chief operating officer Jon Gray joined the AIG Life & Retirement board. AIG intends to spin off its Life & Retirement business as an independent company later this year.

Here’s the text of the circular:

STATUTORY REFERENCES: N.Y. Insurance Law §§ 1501, 1505, 1506 and 1510

The New York State Department of Financial Services (“Department”) has become aware that several potential investors in New York domestic insurers have structured their investments as an acquisition of less than 10% of the insurers’ voting securities, at least in part, based on the expectation that an investment below that level would avoid filing and approval requirements imposed under New York Insurance Law (“Insurance Law”) § 1506.

Similarly, transactions have been structured to limit an investor’s board representation to a single board seat, which, by itself, does not create a presumption of control. As discussed below, an acquiror of less than 10% of an insurer’s voting securities, or with the right to appoint a single board member, may still be deemed to control the insurer based on all the facts and circumstances, including the terms and conditions of the proposed transaction.

The Department wishes to remind industry participants of the requirements of the Insurance Law and the Department’s expectations given the apparent misconception in the marketplace and the recent increase in insurance company transactions.

A determination of “control” under Insurance Law § 1501(a)(2) depends on all the facts and circumstances. Control is presumed under § 1501(a)(2) if a person, directly or indirectly, owns, controls, or holds with the power to vote, 10% or more of an insurer’s voting securities. However, this presumption does not create a safe harbor for acquisitions below the 10% threshold, which may still result in a control determination. In addition, while § 1501(a)(2) makes clear that any director of an insurer, or any person with the right to appoint such a director, is not presumed to control the insurer, these facts may, in combination with other factors, lead to a control determination.

The statute makes clear that a control relationship can arise from a contract or other factors, in the absence of any ownership of voting securities of an insurer. Section 1501(a)(2) defines “control” in relevant part as “the possession direct or indirect of the power to direct or cause the direction of the management and policies of a person, whether through the ownership of voting securities, by contract (except a commercial contract for goods or non-management services) or otherwise…”. Furthermore, § 1501(b) provides that the Superintendent of Financial Services (the “Superintendent”) may find a controlling relationship if a person “exercises directly or indirectly either alone or pursuant to an agreement with one or more other persons such a controlling influence over the management or policies of an authorized insurer as to make it necessary or appropriate in the public interest or for the protection of the insurer’s policyholders or shareholders that the person be deemed to control the insurer.”

The Department urges parties contemplating a transaction that raises potential control issues (including, but not limited to, transactions involving the acquisition of an insurer’s voting securities by, the grant of a board seat to, or a new contractual relationship with, a transaction counterparty, or any combination of these factors) to engage with the Department as early in the transaction structuring process as practicable, even if the parties believe that such transaction will not give rise to a control relationship, to give the Department a reasonable opportunity to review the transaction and the parties’ position. The Department encourages this informal engagement to avoid delay and other adverse consequences (including penalties under Insurance Law § 1510(a)) should the Superintendent reach a different conclusion. If, notwithstanding the parties’ position, the Superintendent determines that the transaction would result in a change of control, the parties must either submit an application under § 1506 or request a determination of non-control pursuant to § 1501(c).

Please direct questions regarding this circular letter to [email protected].

On April 26, lawyers at the firm of Locke Lord offered the following opinion:

Under NY Ins. Code § 1501, “control” is defined as “the possession direct or indirect of the power to direct or cause the direction of the management and policies of a person, whether through the ownership of voting securities, by contract…or otherwise; but no person shall be deemed to control another person solely by reason of his being an officer or director of such person…control shall be presumed to exist if any person directly or indirectly owns, controls or holds with the power to vote ten percent or more of the voting securities of any other person.” NY Ins. Code § 1501(a)(2). Under NY Ins. Code § 1506, no person “other than an authorized insurer, shall acquire control of any domestic insurer, whether by purchase of its securities or otherwise, unless: it receives the superintendent’s prior approval.” NY Ins. Code § 1506(a)(2).

The Letter addresses what the NY DFS views as a recent trend of investors seeking to avoid such filing and approval requirements by acquiring less than 10% of an insurer’s voting securities. The Letter emphasizes that “‘control’ under Insurance Law § 1506(a)(2) depends on all the facts and circumstances” and that there is no “safe harbor for acquisitions below the 10% threshold, which may still result in a control determination.” The Letter further cautions that “a control relationship can arise from a contract or other factors, in the absence of any ownership of voting securities of an insurer.”

The Letter urges parties contemplating investments or other transactions which might result in control of a New York insurer to informally engage with the NY DFS as early in the process as possible so that the NY DFS can review the transaction and the parties’ position. If the NY DFS determines that a change in control has occurred, the parties must either submit an application to the NY DFS for approval or attempt to disclaim control pursuant to NY Ins. Code § 1501(c). The NY DFS advises a lack of engagement could result in delays, and even adverse consequences, if the NY DFS determines that the parties have not complied with the requirements of Article 15 of the NY Ins. Code.

Private Equity in the Life/Annuity Biz

Posted on April 29, 2022 by Kerry Pechter -

Private equity (PE) firms or “alt-asset managers,” in the opinions of many, have bestowed heavenly manna on the life/annuity industry during the past decade’s yield-famine.

In addition to buying several large and small life insurers outright, PE firms have relieved other life companies of capital-intensive blocks of annuity and life business, “released” surplus capital through reinsurance, used their loan origination skills to boost general account yields, and perked up crediting rates of indexed annuity contracts.

But the PE disruption of the staid life/annuity industry has also raised the interest of regulators, legislators, life/annuity executives and actuaries—enough so that LIMRA, the life/annuity industry’s market research arm, included a break-out session on “Private Equity and the Life Insurance Industry” at its 2022 Life Insurance Conference in Tampa this week.

Expert panelists included Tim Zawacki, research analyst at S&P Global Market Intelligence; Rosemarie Mirabella, a director at ratings agency AM Best, and Jason Kehrberg, an actuary at PolySystems Actuarial Software and Services and chair of the American Academy of Actuary’s Asset Modeling and Risk Task Force.

My takeaway: Few observers believe that PE-owned life insurers (or the life insurers that hire PE firms to run their money) are putting themselves or their policyholders at risk; on the contrary, most of those companies sport “A” ratings from AM Best. Most close observers also believe that current regulatory frameworks—though fragmented and playing catch-up with a fast-changing industry sector—are working.

But private investments now account for some $800 billion of life company general account assets —10% of the industry total—and are rising, AM Best shows. Private assets like CLOs (collateralized loan obligations) tend to be opaque, complex and hard to price.

PE-led reinsurance arrangements use complicated “modified coinsurance” or “funds withheld” structures. Fixed indexed annuities, the raw material of private assets, are hard to understand. Transactions between subsidiaries of the same holding company can lack transparency or the equipoise that unrelated counterparties can bring to transactions.

Regulators and legislators (most recently New York’s Department of Financial Services and Sen. Sherrod Brown, D-OH) have joined the National Association of Insurance Commissioners in looking closely and asking questions about PE penetration of the life/annuity business. PE firms, after all, are now handling almost a trillion dollars worth of annuities, much of which represents the retirement savings of middle-class Americans.

US-domiciled insurers with the highest book value of private equity investments in their general accounts.

‘Surprising’ risk-based capital levels

Mirabella

In her presentation, Rosemarie Mirabella of AM Best showed the acceleration of PE’s presence in insurance. “PE companies controlled only 1.2% of industry assets in 2011, now its up to $800 billion or about 10% of the life/annuity industry’s assets,” Mirabella said.

Why do investment companies like insurance assets so much? “They like the [fixed] annuity space because the embedded guarantees are modest relative to what they can earn on the asset management side,” Mirabella added. “Private equity is a duration asset class [with specific initiation dates and ending dates]. That gives companies ability to match liability to assets.”

“These companies have other advantages besides investment skills. They don’t have the pressure of legacy systems. They’re good on the digital side. They understand what it takes to leverage their business model. They have a lot of capability to support good returns.”

PE company purchases of insurance assets started slowly after the Great Financial Crisis, and then accelerated. “In the early years, from 2011 to 2016, we saw the ramping up and re-engineering of the investment portfolio by the PE firms,” she said. Yields and profits didn’t show much change until 2016. Then they started to climb—above the life industry, above the individual annuity composite, above stock companies overall.”

Mirabella said she first expected life insurers under PE control to run minimal RBC ratios (Risk-based capital). Instead, she watched their ratios climb and, by 2017, exceed the overall industry’s. “That was a surprise to me,” she confessed. “A lot of [PE] companies were coming in and buying capital-impaired insurers. I expected it to take them awhile to reengineer the business and increase the capital base.”

Source: AM Best.

‘Little choice but to optimize balance sheets’

In his slides, Tim Zawacki of S&P Global Intelligence also tracked the growth of PE firms in life insurance. Mergers and acquisitions involving US and Bermuda-based life-sector firms were close to $30 billion in 2021, the highest level in 16-years.

PE-linked entities accounted for 64% of the reserve credits taken for reinsurance in 2020 and 56% in 2021. The 2021 figure didn’t count Global Atlantic’s deal with Ameriprise, in the which the KKR subsidiary reinsured $8 billion in Ameriprise. The deal allowed Ameriprise to release $700 million in excess capital.

Zawacki cited these supply and demand factors in driving PE/annuity reinsurance activity in 2021 and 2022:

A continued push by traditional carriers to reinsure their legacy liabilities
An interest in acquiring or reinsuring variable annuities and universal life with secondary guarantees, in addition to fixed/indexed annuity business
Organic growth from primary business [i.e., new fixed/fixed-indexed annuity sales] and flow reinsurance [instant reinsurance of newly issued annuity contracts]
Demand from traditional life/annuity reinsurers for new business
Demand among private equity-affiliated investment funds for a source of permanent capital

Zawacki

In an interview, Zawacki explained the growing demand for reinsurance. “From a competitive standpoint, for public companies to achieve the kinds of returns that equity investors expect, they have little choice but to optimize their balance sheets by engaging in these [reinsurance] structures.”

But today’s “modco” or “funds withheld” reinsurance arrangements, where an Iowa-domiciled life insurer might get credit for reinsuring annuities in Bermuda without giving up control of the assets, can be obscure. “If you have funds withheld, the deals become more difficult to analyze. It’s impossible for an outside observer to distinguish what is in a ‘funds withheld’ account and what is part of the general account investments. That’s one challenge with that structure.”

Are ASOPs up to the task?

Reinsurance isn’t the only complex piece of the PE/insurance phenomenon. The high-yield private equity and private credit assets that PE firms originate, including securitized bundles of leveraged loans, are difficult for actuaries to analyze and evaluate.

Jason Kehrberg, of PolySystems, said that members of the NAIC’s Life Actuarial Task Force have “potential concerns,” as described in the slide below.

Actuaries do have tools for analyzing high-yield products, such as the Actuarial Standards of Practice (ASOPs). Kehrberg shared a deep-in-the-weeds review of the ASOPs that might apply to actuaries’ analyses of CLOs and other complex investments. Whether those practices are sufficient for the challenge presented by today’s bespoke assets remains to be seen.

Kehrberg

The NAIC’s Life Actuarial Task Force has proposed a new Actuarial Guideline for Asset Adequacy Testing, he said. If adopted, this guideline would apply to “reserves reported this year-end to life insurers with general account actuarial reserves [i.e., liabilities] of $500 million or more and at least 5% of supporting assets composed of projected high net yield assets.”

Kehrberg defined a projected high net yield asset as a “fixed income asset whose spread over a comparable Treasury is greater than a prescribed BBB spread less a prescribed BBB- default rate” or “equity-like assets in the category of common stock for purposes of risk-based capital C-1 reporting.”

Lots of runway left

Driven by the almost universal demand for higher yields, higher fee revenue, and higher profits, the convergence of insurance and investments will likely continue, analysts say. Mergers, acquisitions and strategic partnerships between life/annuity companies and alt-asset managers will likely continue to be formed—though perhaps at a slower pace if US and world economy goes into an anti-inflation, post-stimulus recession.

Would a rise in prevailing interest rates slow down this trend, perhaps causing a shift by investors from indexed annuities to bonds or bond funds? Barring a steep economic downturn in 2022 or 2023, Mirabella didn’t think so.

“The PE-owned companies have been positioning themselves for years to take advantage of the eventual uptick in interest rates,” she said.“This trend will continue unless there are major, fundamental economic shocks that change the risk profile of private equity.”

Zawacki told RIJ that he looks forward to seeing the Federal Insurance Office’s (FIO) response to Sen. Sherrod Brown’s March 16 request for more information on PE ventures in insurance, to be delivered by May 31. There are many different aspects to those ventures, and the future of regulation in this area may depend on which aspect the FIO focuses its energy and attention on, he noted.

Will it focus, for instance, on the adequacy of the existing state-based regulatory framework? On the perceived arbitrage with offshore domiciles? Or at the pension risk transfer business? “There are a number of different ways this could go,” Zawacki said. “We would like to see them update the regulatory framework to the realities of the market.”

‘Bermuda Triangle’ news

Posted on April 29, 2022 by Editorial Staff -

FNF ‘dividends’ 15% of F&G Annuities & Life stock to shareholders

Fidelity National Financial, Inc., a provider of title insurance and transaction services to the real estate and mortgage industries, said last month that it will “dividend” to FNF shareholders, on a pro rata basis, 15% of the common stock of its F&G Annuities & Life, Inc., its annuity and life insurance subsidiary.

FNF, which will retain control of F&G through an 85% ownership stake, said it “remains committed to F&G’s growth and long-term success.”

In a statement, FNF chairman William P. Foley II, said, ”F&G has exceeded all of our expectations having grown assets under management by 38% to $36.5 billion since our acquisition in June of 2020 and proving our strategic rationale for the deal. FNF’s balance sheet allowed a credit ratings upgrade of F&G and accelerated its growth by entering new distribution channels.

“While this has played out much better than we had expected, the market has not recognized the value creation that has taken place at F&G. We believe that the best way to unlock this value is to publicly list F&G through a dividend to our shareholders.”

The distribution was approved by FNF’s Board of Directors on March 14, 2022. The Board of Directors believes that the public listing of F&G shares through a dividend to FNF shareholders will unlock the value of both industry leading businesses, a release said. The separation is intended to be structured as a taxable dividend to FNF shareholders and is targeted to be completed in the third quarter of 2022.

FNF will convert its $400 million intercompany loan to F&G into F&G equity prior to the distribution. FNF will maintain 85% of F&G’s common stock, continuing to hold control and primary ownership. FNF intends to distribute 15% of F&G’s common stock to FNF shareholders in order to reinforce the standalone value of F&G, as well as to allow investors to invest directly in F&G.

Chris Blunt, President and Chief Executive Officer of F&G, will remain in his role leading F&G. No change is expected to FNF or F&G’s strategy, operations or management teams. F&G said it will continue to benefit from FNF’s majority ownership, expect sales growth to remain robust through the expansion into new distribution channels, and have access to public markets over time, as needed.

Blunt said in a statement, “We’ve gone from a $4 billion annual sales retail annuity carrier offering one product through one channel, to a more than $10 billion annual sales insurer offering life, annuities, and institutional solutions across five different channels. This transition to being a publicly traded company is a vote of confidence for our business.”

Ares Management announces $40 billion in lending commitments

Ares Management, the private equity firm that, with life insurance subsidiary Aspida Financial and Bermuda-based reinsurer Aspida Re, gathers annuity liabilities, reinsurers them, and manages the associated assets, announced about $5.0 billion in US direct lending commitments across 54 transactions during the first quarter of 2022 and about $35 billion in direct lending commitments across 287 transactions in the last twelve-month period ended March 31, 2022.

The lending figures improve on the $3.6 billion in commitments that Ares closed on 45 transactions during the 1Q2021 and approximately $14.5 billion in commitments for 168 transactions in the twelve-month period ended March 31, 2021. Below are descriptions of selected transactions and expansions that Ares supported and closed during the first quarter of 2022:

3E / New Mountain Capital. New Mountain Capital acquired 3E, a global provider of data-driven intelligent compliance solutions in the Environmental, Health, Safety & Sustainability space.

AirX Climate Solutions / Catterton Partners. AirX Climate Solutions (ACS). ACS provides cooling and ventilation solutions in the telecommunications, data centers, educational, residential and industrial and commercial markets.

Community Brands / Insight Partners. Insight Partner has growth plans for Community Brands, a provider of cloud-based software and payment solutions for association, education, and non-profit organizations.

Convera / The Baupost Group & Goldfinch Partners. The Baupost Group and Goldfinch Partners acquired Convera, a large non-bank provider of cross-border business payment and foreign exchange solutions processing.

Covaris / New Mountain Capital. New Mountain Capital acquired Covaris, a provider of instruments, consumables and reagents associated with the pre-analytical sample preparation process.

Cranial Technologies / Eurazeo. Euraze acquired Cranial Technologies (CT), a provider of custom helmet orthotics for patients diagnosed with plagiocephaly or brachycephaly.

High Street Insurance Partners / ABRY Partners. Ares supported the growth of High Street Insurance Partners, a full-service independent insurance brokerage firm providing business insurance & risk management, employee benefits & human capital management, financial & retirement services and personal insurance solutions.

The Mather Group / The Vistria Group. The Vistria Group acquired The Mather Group (TMG), an independent wealth management firm serving high net worth individuals, families, corporate retirement plans and other institutions.

New Era Cap / ACON Investments. Ares served as the joint lead arranger and joint bookrunner for a senior secured credit facility in New Era Cap, a portfolio company of ACON Investments. New Era is a large authentic licensed headwear and lifestyle brand in the US and globally.

SageSure. Ares served as the administrative agent for a senior secured credit facility to support SageSure’s strategic growth initiatives. SageSure is a managing general underwriter and insurance technology innovator specializing in coastal residential property markets.

As of March 31, 2022, Ares Management Corporation’s global platform had approximately $325 billion of assets under management, with approximately 2,100 employees operating across North America, Europe, Asia Pacific and the Middle East.

Athene gets ‘Excellent’ strength rating from AM Best

AM Best has affirmed the Financial Strength Rating (FSR) of A (Excellent) and the Long-Term Issuer Credit Ratings (Long-Term ICRs) of “a+” (Excellent) of the members of Athene Group (Athene).

Athene, which is focused on the pension group annuity, funding agreement, fixed indexed and fixed annuity market segments, is the consolidation of the organization’s US operating companies, along with its affiliated reinsurance companies domiciled in Bermuda.

Additionally, AM Best has affirmed the Long-Term ICR of “bbb+” (Good), the existing Long-Term Issue Credit Ratings (Long-Term IRs) and the indicative Long-Term IRs of Athene Holding Ltd. (Bermuda). Athene Holding Ltd. operates as the holding company for the U.S. and Bermuda operations. The outlook of these Credit Ratings (ratings) is stable. (See below for a detailed listing of the companies and ratings.)

Concurrently, AM Best has assigned an FSR of A (Excellent) and the Long-Term ICR of “a+” (Excellent) to Athene Annuity Re Ltd. (Bermuda). The outlook assigned to this rating is stable.

The ratings reflect Athene’s balance sheet strength, which AM Best assesses as very strong, as well as its strong operating performance, favorable business profile and appropriate enterprise risk management.

AM Best views Athene’s consolidated risk-adjusted capitalization as strongest, as measured by Best’s Capital Adequacy Ratio (BCAR), and supported by favorable financial flexibility. Athene has demonstrated its ability to access capital markets and maintains additional access to capital and liquidity through a revolving credit facility, Federal Home Loan Bank borrowing capacity, and a shelf registration statement, as well as uncalled capital commitments from Athene Co-Invest Reinsurance Affiliates (ACRA) investors. The completed merger with Apollo Global Management, Inc. is expected to increase Athene’s financial flexibility.

Financial leverage metrics have improved in the past year as capital growth has outstripped debt issuances. However, AM Best notes that Athene holds elevated allocations to more complex and less-liquid investments, which could be impacted materially under adverse market conditions.

Athene has a track record of strong earnings driven by favorable earning spreads and operating profitability, despite the challenges related to the persistent low interest rate environment and high competitive pressures.

Athene’s favorable business profile reflects continued enhancements through additional distribution channels in its retail markets, and expansion of its pension risk transfer business in the United States and United Kingdom, its increased issuances of funding agreements and of its flow reinsurance channel in Japan in recent years. Furthermore, ACRA and the recent fixed annuity reinsurance agreement with Jackson National Life Insurance Company have been accretive to earnings.

KKR closes ‘over-subscribed’ $19 billion private equity fund

KKR, the asset manager that owns Global Atlantic, today announced the final closing of KKR North America Fund XIII, an over-subscribed $19 billion fund focused on pursuing opportunistic private equity investments in North America. KKR will be investing $2.0 billion of capital in the fund alongside investors through the firm’s balance sheet, affiliates, and employee commitments. A KKR release said:

Over the past decade and across NAX3’s two predecessor funds, KKR North America Fund XI and KKR Americas XII Fund, KKR has delivered an average gross IRR of 30.1% (25.1% net) and a gross multiple on invested capital of 2.6x (2.2x net). In comparison to the S&P 500, this has resulted in net outperformance of more than 850bps, against the backdrop of near-unprecedented performance of the index over that decade.

KKR Americas XII Fund, which began investing in 2017, is now fully deployed. It has generated a gross IRR of 50.1% (41.9% net), with a gross multiple of 2.6x (net 2.2x), as of December 31, 2021. With the closing of NAX3, KKR’s Americas Private Equity platform has more than $90 billion in assets under management across flagship, growth and core investment vehicles.

NAX3 received strong support from a diverse group of both new and existing investors globally, including public and private pension plans, sovereign wealth funds, insurance companies, endowments and foundations, private wealth platforms, family offices, high-net-worth individual investors and other institutional investors.

The Fund intends to implement KKR’s broad-based employee ownership program at majority-owned companies in which it invests. Since 2011, KKR has focused on employee ownership and engagement as a key driver in building stronger companies and driving greater financial inclusion.

The firm is committed to deploying the model in all control investments across its entire Americas Private Equity platform. To date, KKR has awarded billions of total equity value to over 45,000 non-senior employees across over 25 companies.

Earlier this month, KKR joined more than 60 organizations in becoming a founding partner of Ownership Works, a nonprofit created to support public and private companies transitioning to shared ownership models.

Finke report touts benefits of ‘contingent deferred annuities’

Posted on April 29, 2022 by Editorial Staff -

A new report, written by retirement researcher Michael Finke and sponsored by RetireOne, the retirement income solutions platform, assesses the potential the benefits of a “a novel, pure insurance solution” for the retirement drawdown challenge, RetireOne said in a release.

Finke’s research paper, entitled, “Portfolio Income Insurance: Understanding the Benefits of a Contingent Deferred Annuity,” focuses on the Contingent Deferred Annuity or CDA (sometimes known as a SALB or stand-alone living benefit). SALBs allow Registered Investment Advisors (RIAs) to wrap an income benefit around a client’s investment portfolio.

“It is possible for an institution to guarantee that a retiree will always be able to spend a fixed amount in retirement no matter what happens in financial markets,” wrote Finke, an authority on retirement income at The American College of Financial Services. “Portfolio insurance through a CDA provides the freedom to spend within one’s financial planning boundaries, without the fear of running out of money due to events out of one’s control.”

A CDA “unbundles” the two main components of a variable annuity. The first component is a portfolio of mutual fund-like variable subaccounts offered by a life insurance company. The second is an insurance rider that guarantees the contract owner a floor income for life (with upside potential) while allowing the investor to tap the portfolio for liquidity (at the cost of proportionately reducing the income rate).

Finke’s research showed that “the certainty of lifetime income provided by a CDA may give individual investors the assurance to not only spend confidently, but to continue to invest in equities without the fear that a market downturn will force them to spend much less than planned in retirement,” the RetireOne release said.

“If stocks outperform bonds, the retiree will accumulate a larger nest egg over time,” wrote Finke. “Greater retirement wealth can result in higher spending or a more substantial legacy as a reward for accepting investment risk. However, if investments underperform early in retirement, a retiree can continue to spend the same guaranteed amount despite a much higher risk of outliving savings.”

With Midland National Life Insurance Company, RetireOne recently launched a Contingent Deferred Annuity called Constance. Constance costs a flat certificate fee instead of an expense ratio, allows the policyholder to begin taking income at any time, hold a portfolio with up to 75% equities, and cancel the contract at any time.

“Portfolio Income Insurance: Understanding the Benefits of a Contingent Deferred Annuity” is a free download on RetireOne’s website. Advisors who would like to learn more about Constance can schedule a meeting or call their RetireOne Relationship Manager at (877) 575-2742. For additional information, please visit retireone.com.

Holy satoshi! Fidelity blesses bitcoin for 401(k)s

Posted on April 29, 2022 by Editorial Staff -

Though the ~$39,000 price of a single bitcoin is almost double the annual limit on individual, under-age-50 contributions to 401(k) plans, Fidelity Investments will soon enable its thousands of plan sponsors to offer the crypto-currency to their participants.

The Boston-based privately held retirement giant said Tuesday that, through its “Digital Assets Accounts” (DAAs), participants will be able—if sponsors allow it—to allocate part of their retirement savings to bitcoin through the core 401(k) plan investment lineup.

The service will start later this year, apparently despite warnings from the Department of Labor about the speculative nature of bitcoin (see below). Bitcoin’s smallest unit is the satoshi, which represents one hundred millionths of a Bitcoin or 0.00000001 BTC.

In 2020, Fidelity launched a private bitcoin fund, currently available to accredited investors. In 2018, the company introduced Fidelity Digital Assets, which offers custody and trade execution for digital assets to institutional investors. Fidelity manages employee benefits for almost 23,000 businesses with more than 32 million participants.

Fidelity appears to be acceding to popular demand. Americans have “an appetite to incorporate cryptocurrencies into their long-term investment strategies,” said Dave Gray, head of Workplace Retirement Offerings and Platforms at Fidelity, in a release.

Thirty percent of US institutional investors surveyed would prefer to buy an investment product containing digital assets, according to the Fidelity Digital Assets 2021 Institutional Investor Digital Assets Study. Roughly 80 million US individual investors currently own or have invested in digital currencies, Fidelity said.

But when the Plan Sponsor Council of America recently asked its members if they are or are considering adding crypto to their menu of investment choices, only about 2% said yes. “Plan sponsors are overwhelmingly not considering, and will not consider, cryptocurrency a prudent investment option in a retirement plan,” the organization said.

The Department of Labor, which is still awaiting the confirmation of Lisa Gomez as chief of the Employee Benefit Security Administration, frowns on the move. “We have grave concerns with what Fidelity has done,” Ali Khawar, acting assistant secretary of EBSA, told The Wall Street Journal.

How ‘Workplace Digital Assets Accounts’ will work

The DAA is a custom plan account that holds bitcoin and short-term money market investments to provide the liquidity needed for the account to facilitate daily transactions on behalf of the investor, Fidelity said. Bitcoin in the DAA will be held on the Fidelity Digital Assets custody platform, which has “institutional-grade security.”

Plan sponsors that offer the DAA will establish their own employee contribution and exchange limits into the account. Employees will benefit from a fully integrated retirement plan, digital experience and education to help them make informed decisions.

“Fidelity’s move comes a month after the Labor Department expressed concerns about including cryptocurrencies in retirement plans. It is also an uneasy time for the stock market, with the S&P 500 down almost 10% this year in part due to rising interest rates. Bitcoin is notoriously volatile and has lost more than 40% of its value since its November high,” the Wall Street Journal reported this week.

Under the plan, the Journal said, Fidelity would let savers allocate as much as 20% of their nest eggs to bitcoin, though that threshold could be lowered by plan sponsors. Mr. Gray said it would be limited to bitcoin initially, but he expects other digital assets to be made available in the future.

News reports did not mention any possibility of cryptocurrency mutual funds in 401(k) plans. According to a recent report at Motleyfool.com, there is one cryptocurrency mutual fund available to US investors. Bitcoin Strategy ProFund (NASDAQMUTFUND:BTCF.X) was launched in July 2021 to follow the results of Bitcoin (CRYPTO:BTC). The fund, which invests in Bitcoin futures contracts, requires a minimum investment of $1,000 and charges a 1.15% annual expense ratio.

Regulatory headwind?

On March 10, the DOL’s Employee Benefits Security Administration (EBSA) published Compliance Assistance Release No. 2022-01, which said, “EBSA expects to conduct an investigative program aimed at plans that offer participant investments in cryptocurrencies and related products, and to take appropriate action to protect the interests of plan participants and beneficiaries with respect to these investments.

“The plan fiduciaries responsible for overseeing such investment options or allowing such investments through brokerage windows should expect to be questioned about how they can square their actions with their duties of prudence and loyalty in light of the risks described above.”

Under US tax law, bitcoin is classified as property, not currency. Distribution of the proceeds of the sale of bitcoin held in 401(k) accounts (or rollover IRAs) would be taxable as ordinary income when withdrawn, typically during retirement. Federal income taxes would be payable in dollars, not bitcoin.

MicroStrategy, a major bitcoin buyer, said it plans to be the first employer to offer Fidelity DAA in its own retirement plan. According to the crypto trade publication Coindesk, MicroStrategy is known in the “cryptosphere” for its aggressive bitcoin acquisition strategy. Earlier this month, it purchased 4,157 BTC for about $190.5 million, bringing its holdings to 129,218 bitcoins, or $5.1 billion.

A small player in the 401(k) provider universe — ForUsAll — said it will be launching a cryptocurrency investment option for clients in the second quarter of this year.

According to an April 1 report by CNN, ForUsAll, which primarily services small-to-mid size employers, said that over 120 of its 400 clients have signed up for the new option, which participants can access through a self-directed account on Coinbase.

ForUSAll participants may only invest 5% of their current 401(k) balance and 5% of their contributions going forward (as well as 5% of their employer matches) to their crypto account. Participants will get automatic notices whenever the value of their crypto investments exceeds 5% of their total 401(k) portfolio. But it will be up to them to decide whether to reallocate.

Before opening an account, participants must go through ForUsAll’s educational materials about crypto investing and take an interactive quiz to demonstrate that they understand its risks and the importance of not taking excessive bets on crypto with their retirement savings, ForUsAll Chief Investment Officer David Ramirez said in an interview.

Select Alternative Asset Manager-Linked Life/Annuity Reinsurers

Posted on April 29, 2022 by No Author -

Jackson National Life

Equitable

Brighthouse Financial

Do the young face a tougher old age?

Less income, more illness at older ages

Ready (or not) for retirement

A problematic foundation

Too much privacy, too little transparency

Seeds of crisis

‘Surprising’ risk-based capital levels

‘Little choice but to optimize balance sheets’

Are ASOPs up to the task?

Lots of runway left

FNF ‘dividends’ 15% of F&G Annuities & Life stock to shareholders

Ares Management announces $40 billion in lending commitments

Athene gets ‘Excellent’ strength rating from AM Best

KKR closes ‘over-subscribed’ $19 billion private equity fund

How ‘Workplace Digital Assets Accounts’ will work

Regulatory headwind?

Data Connection

Lists*