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Stormy Weather for Life Insurers

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

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

David Paul

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

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

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

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

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

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

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

RIJ: And where do earnings fit into that picture?

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

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

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

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

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

RIJ: But what if this financial crisis gets worse?

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

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

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

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

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

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

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

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

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

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

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

RIJ: Any other potential points of pain?

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

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

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

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

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

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

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

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

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

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

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

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

RIJ: Thank you, David

© 2020 RIJ Publishing LLC. All rights reserved.

News from RIJ subscriber firms

Corporate pension funded status rises in March: Milliman

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

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

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

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

CARES Act will help insurers: AM Best

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

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

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

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

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

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

Plan participants are curious about income options: Allianz Life

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

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

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

DPL offers two more Great American Life indexed annuities

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

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

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

MassMutual puts CARES Act into action

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

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

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

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

Principal offers relief for plan sponsors and participants

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

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

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

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

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

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

Envestnet | MoneyGuide offers new tax planning feature

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

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

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

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

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

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

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

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

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

© 2020 RIJ Publishing LLC. All rights reserved.

Life insurers hurt themselves, reader says

Dear RIJ editor:

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

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

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

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

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

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

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

David Macchia, MBA, RMA

Founder & CEO

Wealth2k, Inc.

COVID-19’s Financial Impact on Older Americans

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

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

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

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

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

Responses to a drop in cash flow

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

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

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

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

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

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

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

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

The future

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

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

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

© 2020 RIJ Publishing LLC. All rights reserved.

 

The Shape-Shifting ‘Equity Risk Premium’

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

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

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

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

ERP (Excuse me!)

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

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

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

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

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

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

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

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

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

ZIRP (Excuse me!)

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

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

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

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

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

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

Industry News

 Jackson National to offer LifeYield software to advisers

Jackson National Life Insurance Company will integrate LifeYield LLC’s cloud-based tool for tax-efficient management of investors’ portfolio into Jackson’s existing digital tool set for advisers who work the insurer, the two companies announced this week.

Financial professionals who work with Jackson will be able to use LifeYield’s powerful technology suite “to quantify the potential benefits of incorporating annuity products in client portfolios,” according to a release. Jackson is the largest issuer of annuities in the U.S., as of December 31, 2019.

LifeYield, creators of the Taxficient Score, enables financial advisors to deliver tax-smart, household-level portfolio solutions. LifeYield’s Proposal Advantage Suite provides a comprehensive, tax-aware view of a client’s entire portfolio–analyzing assets across IRAs, 401(k)s and taxable accounts.

Public companies need to be transparent about COVID-19 impact

The staff of the U.S. Securities and Exchange Commission has urged public companies to make thorough disclosures about business risks posed by the coronavirus pandemic, offering a sketch of the many ways the intensifying crisis could impact firms and shareholders, Law360: Securities reported.

The SEC Division of Corporate Finance on Wednesday offered detailed guidance on how companies should assess and communicate COVID-19 risks, encouraging firms to be proactive and revise their filings accordingly. The move accompanied a second extension of filing deadlines by the agency as it continues to adjust its rules to unprecedented times.

Agency staff encouraged timely reporting but recognized that the coronavirus, which has now infected more than 523,000 across the world and upended the global economy, poses widespread risks that are difficult to predict with precision.

The SEC put companies on notice that COVID-19 was likely to become a focal point in future disclosures when the agency first extended filing deadlines earlier this month. The new guidance elaborates on this point, laying out scores of questions companies should be asking as they assess the impact of the coronavirus on everything from liquidity to supply chains to access to credit.
Agency staff encouraged companies to think long-term about how the current economic outlook could affect their financial stability, asset values and future consumer demand for their products. But the guidance also encouraged a granular analysis of how things like remote working could impact internal controls and business continuity plans.

Laura Richman, a corporate and securities attorney at Mayer Brown LLP, told Law360 Thursday that firms should heed the new disclosure guidance and start assessing COVID-19 risk from top to bottom.
Stock markets have been on a rollercoaster ride since the coronavirus, once largely isolated to China, became a global pandemic that shook the trajectory of the global economy and dramatically altered the way hundreds of millions of people live and work. The SEC has responded by relaxing filing deadlines and offering other forms of targeted relief to public companies, shareholders and investment shops.

SEC Chairman Jay Clayton said at a Thursday meeting of the Financial Stability Oversight Council that the agency’s measures have so far helped stabilize markets despite unprecedented volatility.

AM Best sets up coronavirus web page

AM Best has launched dedicated access to its analytical updates on the COVID-19 virus outbreak. This web page (www.ambest.com/about/coronavirus.html) will be updated regularly with insurance industry-specific commentary related to the ongoing pandemic and video discussions with members of AM Best’s analytic teams about the unfolding situation.

To date, AM Best has issued 10 announcements since late January on the wide-ranging impact of the coronavirus outbreak, most with accompanying video discussions. Below are summaries of announcements released so far in March 2020. Reports and videos released before March considered potential impacts in China and Southeast Asia, as well as a look at pandemic stress testing typically undertaken by insurers.

  • Health Insurers Adjust as COVID-19 Spreads in United States (March 19, 2020): The risks to U.S. health insurers from the COVID-19 outbreak continue to expand in scope and complexity on the claims management, economic and operational fronts. See the Best’s Commentaryand related video.
  • Japanese Insurers Continue to Grapple With Global Market Volatility (March 19, 2020): Insurers in Japan remain financially stable to weather ongoing market volatility brought about by the COVID-19 virus outbreak and the sharp decline in oil prices due to their robust balance sheet fundamentals. See the Best’s Commentary.
  • AM Best to Deploy Pandemic-Related Stress Test for Rated Insurance Companies (March 18, 2020): AM Best is developing stress testing that it will conduct on its rated insurance companies’ balance sheets to gauge the impact of the COVID-19 virus fallout on their risk-adjusted capital levels, investment portfolios, reserve adequacy and other aspects of the risks borne by rated entities. See the related press releaseand related video.
  • AM Best Revises U.S. Life/Annuity Market Outlook to Negative (March 16, 2020): Due to the significant volatility and uncertainty created by the COVID-19 virus, AM Best has revised its outlook on the U.S. life/annuity segment to negative. See the Best’s Market Segment Reportand related video.
  • European Insurers Well-Positioned to Manage Potential Exposure to Pandemic Risk (March 8, 2020): The biggest impact to European insurers out of the COVID-19 outbreak likely will result from the economic fallout, as governments and markets react to the virus’ rapid spread, rather than from direct coronavirus exposures. See the Best’s Commentary.
  • S. Health Insurers Face Potential Rise in Claims Due to Coronavirus (March 6, 2020): This commentary looks at to what extent U.S. health insurers can expect increases in coronavirus-related medical claims, with costs to be driven by at-risk patients such as the elderly and those with pre-existing conditions. See the Best’s Commentaryand related video.
  • Further Global Interest Rate Cuts Anticipated as Economic Buffer for Coronavirus Impact (March 4, 2020): The initial move by the Federal Reserve to cut its federal funds rate came as a surprise. AM Best expects further accommodative monetary policy actions to continue throughout 2020. See the Best’s Commentary.
Americans are worried but calm: Allianz Life

The latest Quarterly Market Perceptions Study from Allianz Life Insurance Company of North America (Allianz Life finds Americans are worried, but trying to take a calm approach to investing for retirement.

Market crash and recession fears increased significantly from the end of 2019 when worries were at their lowest levels in over a year and half. Now, nearly two-thirds of Americans (63%) express concerns about a recession (compared with 43% in Q4 2019). In addition, 57% think that the market hasn’t bottomed out yet.

Despite increased anxiety over market swings, over half (52%) of Americans understand that it’s good time to stay neutral and not take any action because of market conditions.

Consumers have experienced many ups and downs in the market recently, and the number of people who say they are too nervous to invest reflects that, as percentages fluctuate from quarter to quarter. Currently, 41% of consumers say they are too nervous to invest in the market (compared with 35% in Q4 2019).

Interestingly, Americans still seem optimistic about their ability to recover retirement savings after a market decline. Nearly 70% believe that, even if the market continues to decline, they will have time to rebuild their retirement savings.

SIMON and Insurance Technologies team up

SIMON (SIMON Markets LLC and SIMON Annuities and Insurance Services LLC) is partnering with Insurance Technologies, LLC, a provider of sales and regulatory automation solutions for the insurance and financial services industries, according to a release.

The partnership allows SIMON to “turn manual and time intensive workflows into a simplified process, centralized in one location,” the release said. SIMON platform offers advisers an end-to-end toolset, including on-demand education, a digital marketplace, real-time analytics, and lifecycle management.

Advisers see opportunity in health care stocks: E*Trade

E*TRADE Advisor Services, a provider of integrated technology, custody, and practice management support for registered investment advisors (RIAs), released the latest iteration of its Independent Advisor Tracking study, which covers advisor views on the market, the industry, their business, and clients.

Volatility management skyrockets. More than four out of five advisors (85%) are actively managing against market volatility—shooting up 20 percentage points this quarter. More than half (55%) are managing against a recession, shifting up eight percentage points from December.

Clients aligned on volatility concerns. Clients are contacting their advisors most about volatility (53%) and the coronavirus (38%), in stark comparison to December, when clients most asked about the threat of recession (28%), and the ongoing trade tensions (21%).

Advisors see opportunity in health care investments. Health care (22%) is the number one sector where advisors see potential, moving up six percentage points since the end of the year.

Clients are increasingly trying to time the market. The top mistake advisors see their clients make is attempting to time the market (45%), ticking up seven percentage points since December.

© 2020 RIJ Publishing LLC. All rights reserved.

FYI: Legal alerts from the Wagner Law Group

The Families First Coronavirus Response Act

(Updated to Include Coronavirus Aid, Relief, and Economic Security Act Provisions) April 1, 2020

This Law Alert serves as an update to the Law Alert sent out on March 19, 2020 concerning the paid leave and group health plan provisions of The Families First Coronavirus Response Act. Effective April 1, 2020, the Emergency Paid Sick Leave Act (the “Sick Leave Act”) and the Emergency Family and Medical Leave Expansion Act (the “FMLA Expansion Act”), two of the divisions of the Families First Coronavirus Response Act (the “Families First Act”), as amended by the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”), provide paid sick leave and paid family and medical leave to employees affected by the coronavirus. They also provide tax credits for eligible employers. These provisions expire on December 31, 2020.

The Families First Act also requires, effective as of March 18, 2020, and continuing for the duration of the federal declared emergency (the “Emergency”), that group health plans and health insurance issuers offering group insurance coverage, including grandfathered health plans under the Affordable Care Act, provide coverage of testing and diagnosis for COVID-19 without any cost-sharing requirements. Also, until 2021, the CARES Act permits pre-deductible coverage of telehealth and other remote care. The CARES Act also requires, permanently, that group health plans and health insurance issuers (including grandfathered plans) cover COVID-19 vaccines (once there are any such vaccines), and permanently permits over-the-counter drugs to be reimbursed by HSAs, FSAs, HRAs, and Archer MSAs, whether or not they were prescribed by a physician.

Emergency Paid Sick Leave Act

Employers with fewer than 500 employees and government employers must provide employees with paid sick leave. While the Sick Leave Act does not address the issue, the DOL has indicated that all employees of the employer are taken into account – full-time, part-time, temporary, seasonal, and union. Each separate employer entity is a separate employer for purposes of the 500-employee threshold, except that two or more employer entities may qualify as the “joint employer” of a group of employees, or all the entities in a controlled group may qualify as an “integrated employer” if the parent has de facto control over the operations of all. Employees may take paid sick leave if the employee:

  • is subject to a federal, state or local quarantine or isolation order;
  • has been advised by a healthcare provider to self-quarantine;
  • is experiencing symptoms of COVID-19 and is seeking a medical diagnosis;
  • is caring for an individual who is subject to a federal, state, or local quarantine or isolation order, or has been advised to self-quarantine by a healthcare provider;
  • is caring for a son or daughter whose school or day care has been closed or the regular child care provider is not available due to coronavirus; or
  • is experiencing any other substantially similar condition specified by the Secretary of Health and Human Services.

A big exception: healthcare providers and emergency responders are not required to provide paid sick leave to employees.

At present, employees, who are laid off before the paid sick leave requirements go into effect, will not be eligible for paid sick leave. Employees placed on furlough on or after April 1,2020, are also ineligible. If an employer closes a worksite on or after April 1, 2020, paid leave will also be unavailable.

The Department of Labor (the “DOL”) has the authority to exempt small businesses with fewer than 50 employees if the imposition of the paid sick leave requirements would jeopardize the viability of the business as a going concern.

Paid sick leave must be available to all employees of employers subject to the Sick Leave Act (those with fewer than 500 employees), regardless of their date of hire. An employer may not require, as a condition of providing sick leave, that an employee search for and find a replacement employee to cover the hours during which the employee is using the paid sick leave.

Employers who maintain a paid sick leave policy must provide the emergency paid sick leave in addition to their current paid sick leave, and may not require employees to use other forms of paid leave (e.g., vacation leave) instead of the emergency paid sick leave.

Paid sick leave must be paid at the employee’s regular rate of pay if it is used because the employee is being quarantined, has been advised by a health care provider to self-quarantine, or is experiencing symptoms of coronavirus and is seeking a medical diagnosis. Such paid sick leave shall not exceed $511 per day, or $5,110 in the aggregate, for any employee.

Employers must pay two-thirds of the employee’s regular rate of pay if the employee is on leave to care for an individual under quarantine, to care for a son or daughter whose school or day care has closed or the child care provider is unavailable due to coronavirus, or any other circumstance certified by the Secretary of HHS in consultation with the Secretary of the Treasury and the Secretary of Labor. Such paid sick leave shall not exceed $200 per day, or $2,000 in the aggregate, for any employee.

Full-time employees are entitled to 2 weeks (80 hours) of qualified paid sick leave and part-time employees are entitled to the typical number of hours that they work during a typical 2-week period. There is no carryover of this paid sick leave from one year to the next. Paid sick leave ends on the first day of the employee’s next scheduled shift immediately following the termination of the need for paid sick leave. The Sick Leave Act also contains an antiretaliation provision, and further provides that an employer who fails to comply will be treated as having committed a minimum wage violation under the Fair Labor Standards Act.

Employers that contribute to multiemployer plans may fulfill their obligations under the Sick Leave Act (if consistent with the collective bargaining agreement) by making contributions to the multiemployer plan based on the paid leave that each of its employees is entitled to receive under the collective bargaining agreement.

Employees who work under a collective bargaining agreement may secure pay from the fund, plan or program based on the hours they have worked under the collective bargaining agreement.

For employers that are required to provide the paid leave, there is a silver lining. Employers are entitled to a refundable payroll tax credit equal to 100% of qualified paid sick leave wages paid by an employer for each calendar quarter, up to specified caps:

For purposes of the tax credit, the amount of qualified paid sick leave taken into account for each employee who is under quarantine, has been advised to self-quarantine, or is experiencing symptoms and seeking a diagnosis, is capped at $511 per day.

For amounts paid to employees caring for an individual under quarantine, or for a child whose school or day care center has closed or whose child care provider is unavailable due to coronavirus, or who has experienced other circumstances certified by the Secretary of the Treasury, the credit is capped at $200 per day.

The aggregate number of days taken into account for a calendar quarter may not exceed the excess of 10 over the aggregate number of days taken into account for this purpose for all preceding quarters (e.g., if an employee had received pay sick leave for 6 days in the first quarter of the year, then only 4 days would be available in the second quarter).

However, the amount of the credit is increased by so much of the employer’s qualified health plan expenses as are properly allocable to the qualified sick leave wages for which the credit was allowed. Qualified health plan expenses means amounts paid or incurred by an employer to provide and maintain a group health plan, to the extent such amounts are excludible from gross income under the Code. Treasury is directed to issue allocation rules but, unless such rules are to the contrary, an allocation will be treated as proper if made on a pro rata basis among covered employees and pro rata based on the period of coverage.

If the tax credit exceeds the employer’s total liability for payroll taxes for all employees for any calendar quarter, the excess credit is refundable to the employer. For example, if an employer paid $100, 000 in paid sick leave and its payroll tax liability for that quarter was $50,000, it would not make any payroll tax deposit, and would request an expedited refund credit for $50,000. Employers may elect to not have the credit apply. No deduction is allowed for the amount of the tax credit, and no credit is allowed with respect to wages for which a credit is allowed under Internal Revenue Code Section 45S, which provides a tax credit for certain paid family and medical leave.

Self-Employed Individuals

There is a refundable tax credit equal to 100% of a qualified sick leave equivalent amount for eligible self-employed individuals who are under quarantine, are advised to self-quarantine, or have symptoms and are seeking a diagnosis.

For those caring for a quarantined individual, or for a son or daughter whose school or day care has been closed or whose child care provider is unavailable due to coronavirus, or who has experienced other circumstances certified by the Secretary of the Treasury, the refundable tax credit is equal to 67% of the qualified sick leave amount.

The tax credit is allowed against income taxes and is refundable. The credit is capped at $511 per day for the amount paid to self-employed individuals who are under quarantine, are advised to self-quarantine, or have symptoms and are seeking a diagnosis.

For amounts paid to employees caring for a quarantined individual, or a son or daughter whose school or day care center has closed or whose child care provider is unavailable due to coronavirus, the credit is capped at $200 per day.

The aggregate number of days in a period cannot exceed 10, reduced by the number of days previously used.

To calculate the qualified sick leave equivalent amount, an eligible self-employed individual may only take into account those days that the individual is unable to work and is eligible for emergency paid sick leave.

Self-employed individuals must maintain documentation to establish their eligibility for the tax credit.

The qualified sick leave equivalent is reduced to the extent that the qualified sick leave equivalent, plus the qualified sick leave wages from an employer, exceeds $5,110 or $2,000, as applicable (depending on the basis for the sick leave).

Emergency Family and Medical Leave Expansion Act

Employers with fewer than 500 employees, and government employers, must provide each employee who has been employed for at least 30 days with 12 weeks of mostly paid family and medical leave if he or she is unable to work or telework because the employee needs to care for his or her son or daughter, who is under the age of 18, if the child’s school or place of care has been closed, or the child-care provider is unavailable due to a coronavirus declared emergency. That is, it appears that if a parent is at home to take care of a child who is at home because of a coronavirus emergency, and the parent is able to work remotely from home, the parent will not be entitled to the leave. Note that this Act adds an additional basis for taking FMLA leave (loss of child care), but does not increase the length of FMLA leave.

Rehired employees who were laid off no earlier than March 1, 2020, can be eligible immediately if they had at least 30 calendar days of work for the employer, out of the last 60 days, prior to their layoff. In other words, if an employer has had to lay off some employees, the employer can rehire them and put them on paid leave subject to the FMLA Expansion Act without their having to work an additional thirty days.

Employees may take paid family and medical leave after they take the emergency paid sick leave described above. The first 10 days for which an employee takes leave under the FMLA Expansion Act may consist of unpaid leave, but if the employee qualifies for the emergency paid sick leave, the employee may get paid for those 10 days under the Sick Leave Act. An employee may elect to substitute any accrued vacation leave, personal leave, or medical or sick leave for unpaid leave.

Healthcare providers and emergency responders are not required to provide paid family leave to employees. Also, employers with fewer than 50 employees are exempt from the paid family and medical leave requirements if the provision of the paid family and medical leave would jeopardize the business as a going concern. Employers seeking an exemption should carefully document how paid family and medical leave would jeopardize the business. Employers who would not otherwise be employers under the FMLA are excluded from civil enforcement actions by employees.

At present, employees who are laid off before the paid family and medical leave requirements go into effect, will not be eligible for paid family and medical leave. Employees who are furloughed on or after April 1, 2020, are also ineligible for paid family and medical leave. If an employer closes its worksite on or after April 1, 2020, employees will also be ineligible for paid family medical leave.

After the first 10 days of expanded family and medical leave, employees must receive a benefit from their employers equal to two-thirds of the employee’s regular rate of pay times the number of hours the employee would otherwise be normally scheduled to work, with special rules for making this calculation for employees with a variable hourly schedule. Benefits shall not exceed $200 per day, or $10,000 in the aggregate, per employee.

Employers that contribute to multiemployer plans may fulfill their obligations under the Sick Leave Act (if consistent with the collective bargaining agreement) by making contributions to the multiemployer plan based on the paid leave that each of its employees is entitled to receive under the collective bargaining agreement. Employees who work under a collective bargaining agreement may secure pay from the fund, plan, or program based on the hours they have worked under the collective bargaining agreement.

If the credit exceeds the employer’s total liability under the employer’s portion of the social security tax for all employees for any calendar quarter, the excess credit is refundable to the employer. Employers may elect to not have the credit apply. No deduction is allowed for the amount of the tax credit. No tax credit is allowed with respect to wages for which a credit is allowed under Section 45S, which provides a tax credit for certain paid family and medical leave.

Requirements for Group Health Plans

Group health plans and insurers offering health insurance coverage must cover, may not impose any cost-sharing requirements (e.g., deductibles, copayments, and coinsurance) for, and may not impose any prior authorization or other medical management requirements on, the following items and services:

Products used to test for COVID-19 and the administration of such products, if:

  1. a test has been approved by the FDA;
  2. the developer of a test has submitted it – or intends to submit it – for FDA approval;
  3. a test has been developed in and authorized by a state that has notified the Secretary of Health and Human Services (“HHS”) that it intends to review such tests; or
  4. any other test that the Secretary of HHS determines should be covered, in appropriate guidance;
  5. Items and services furnished to an individual during visits to a health care (including telehealth), urgent care center, or emergency room that result in COVID-19 testing; and

Any “qualifying coronavirus preventive service,” that is:

  • An “evidence-based” item or service, with a rating of A or B in the recommendations of the United States  Preventive Services Task Force (the “Task Force”), or
  • An immunization recommended for the individual receiving it by the Advisory Committee on Immunization Practices of the Centers for Disease Control and Prevention (the “Committee”).

Payment by the plan or insurer for diagnostic testing must be at payment rates negotiated before the Emergency was declared, if such rates have been negotiated. Otherwise, payment will be at the testing provider’s cash price as listed by the provider on a public Internet Website, or at a negotiated rate that is less than that price. There is a specific requirement for each provider of COVID-19 tests to post its cash price for the test on a public Internet Website, and a provider can be fined up to $300 for each day during the declared emergency that the requirement is violated.

The above testing provisions were effective March 18, 2020, and expire when the Secretary of HHS determines that the Emergency has ended. The requirement to cover a qualifying coronavirus preventive service is effective 15 business days after the date the recommendation is made by the task force or committee in question, and appears to be permanent.

HSAs, FSAs, HRAs, and Archer MSAs

For plan years beginning on or before December 31, 2021, telehealth and other remote care services will be able to be provided by a plan without charging a deductible, and doing so will not disqualify a person eligible for such services from making HSA contributions.

Also, certain over-the-counter items will be allowed to be paid for by HSA, FSA, HRA, and Archer MSA funds whether or not they have been prescribed. In addition, menstrual care products will be considered as medical expenses for purposes of being able to be paid by HSAs. This applies to amounts paid from HSAs and Archer MSAs after December 31, 2019; with respect to FSAs and HRAs, it applies to expenses incurred on or after December 31, 2019.

Conclusion

Paid sick leave and paid family and medical leave is available to eligible employees on April 1, 2020. Any wages required to be paid under the Sick Leave Act and the FMLA Expansion Act will not be considered wages for purposes of the employer’s portion of the social security tax. However, the tax credits described above (other than the tax credits available for self-employed individuals) are increased by the Medicare surtax on qualified sick leave wages and qualified family medical leave wages, subject to the no double benefit rule, as described above, precluding taking a tax deduction for such amount.

At present, there are a number of questions regarding these leaves and the tax credits, which hopefully will be addressed in guidance very soon.

Additional guidance regarding paid sick leave and paid family and medical leave is expected. Guidance already issued from the Department of Labor includes a notice that must be posted in a conspicuous location (e.g., with other labor law posters). Click here for a copy of the notice.

In addition to the leave requirements, employer group health plans will be required to pay for COVID-19 testing and vaccinations. For testing providers that do not have negotiated network arrangements, the plan must pay their cash rate of pay, but that rate of pay must be posted on a public Website. Also, telehealth services can be provided without cost-sharing, and without disqualifying the recipients for HSA contributions, and over-the-counter drugs and medical supplies can be paid by HSAs, FSAs, HRAs, and Archer MSAs.

Withdrawals and Loans from Defined Contribution Retirement Plans

March 30, 2020

In reaction to the current volatility in the economy due to the coronavirus pandemic, we have been receiving a large number of questions from defined contribution plan sponsors regarding ways participants can access money in their accounts. While recognizing such leakage may cause future headaches for participants in their retirement, many individuals do not have the resources to weather this storm and have no other option but to access their retirement accounts.

In-service withdrawals. Many defined contribution plans permit in-service withdrawals. Such withdrawals generally can be provided without restriction from rollover accounts, upon attainment of age 59-1/2 and in the event of a financial hardship. Although salary deferral contributions and safe harbor contributions cannot be distributed unless or until a participant attains age 59-1/2, becomes disabled or terminates employment, plans with profit sharing features can provide in-service withdrawals under other situations. For example, participants may be able to withdraw vested profit sharing amounts if they have been plan participants for at least five years or if the contributions have been in the plan for at least two years.

With respect to hardship withdrawals, not every state has been declared a national emergency for which hardship withdrawals are available under the IRS’s “safe harbor” deemed reasons, and even then an individual has to live and/or work in an affected area for which FEMA will provide individual assistance. In addition, participants could separately satisfy one or more of the deemed hardship situations in the plan – for medical care and expenses, to prevent foreclosure, to pay tuition, etc. Hardship withdrawals are generally subject to ordinary income taxes and a 10% early distribution penalty tax if taken before the participant attains age 59-1/2.

Plan sponsors also may make coronavirus-related distributions available. As noted in our explanation of the CARES Act, coronavirus-related distributions are available at any time during calendar 2020 by an individual (i) who is diagnosed with COVID-19 by a CDC-approved test, (ii) whose spouse or dependent is diagnosed with COVID-19 by a CDC-approved test, (iii) who “experiences adverse financial consequences as a result of being quarantined, being furloughed or laid off, or having work hours reduced due to” COVID-19, (iv) who is unable to work due to COVID-19 child care issues, (v) who has closed or reduced hours in a business owned or operated by the individual, due to COVID-19, or (vi) who has experienced other factors as determined by the Secretary of the Treasury. The administrator of the plan may rely on the individual’s certification that the individual qualifies for a coronavirus-related distribution under these categories.

The 10% early distribution penalty tax will not apply to such distributions up to $100,000. The amount distributed may be re-contributed to that plan or another plan within three years after the date the distribution is received, and if the individual does not re-contribute the distribution within that time period, taxes on the distribution may be spread over a 3-year period. Federal income tax withholding is not required on a coronavirus-related distribution, and a direct rollover need not be offered.

Participants whose employment is terminated usually can take a distribution of their entire vested account balance from a defined contribution plan. Also, if a partial plan termination occurs, terminated participants will have to be made fully vested in their accounts. A partial plan termination may occur if one or a series of employer-initiated employment terminations (permanent layoffs and reductions in force) affects 20% or more of the workforce; we explain the mechanics of partial plan terminations in our article “Partial Plan Terminations of Qualified Plans” (The ASPPA Journal, Winter 2010).

Loans. Many defined contributions plans permit participants to borrow against their vested plan accounts. Participants might not recognize negative implications of taking a loan from a plan, which include: initial issuance and annual fees, missing out on growth through tax-deferred earnings, selling investments at bottom of market, making repayments from after-tax amounts, and the potential taxes and penalties resulting from default or if repayments are missed.

However, a participant with an outstanding plan loan who is placed on an unpaid leave of absence may forego making loan payments during the leave of absence without triggering taxation of the loan, provided the following requirements are met:

  1. The unpaid leave of absence does not exceed one year.
  2. The loan must still be repaid by the end of the original term of the loan. Thus, the participant may make up the missed loan repayments upon returning to work, resume the original repayments with a lump sum payment of the missed repayments at the end of the term, or increase the amount of each repayment for the remainder of the repayment period upon returning to work.

Subject to the plan’s loan policy (as it may be amended), participants also may continue to make repayments from their personal accounts, provided the trustee will accept direct checks or electronic transfers. If participants are already making repayments from their personal accounts, the plan administrator can confirm whether the plan’s loan policy permits suspension of repayments, and notify affected participants accordingly.

Also note that participants who are laid off/terminated generally have until the end of the calendar quarter following the calendar quarter in which repayments are missed to cure the missed repayments. Otherwise, the participant will be taxed on the balance of the loan. However, employers may permit terminated employees to continue to make loan repayments, either from severance pay or from their personal accounts, but the plan’s loan policy must provide for the ability to make such repayments.

Plan sponsors may amend their plan documents or loan policies to provide added flexibility within limits, including, in addition to the repayment options noted above, allowing participants to take more loans than are currently offered or additional money types that might otherwise be restricted.

Plan sponsors also may modify their plan documents or loan policies to reflect changes made by the CARES Act. As noted in our explanation of the CARES Act, legal limitations on loans from qualified plans have been relaxed. For example, the limit on loans is increased from 50% of a participant’s vested account balance up to $50,000, to 100% of the participant’s vested account balance up to $100,000 for loans to “qualified individuals” made during the 180-day period from the date of enactment. A “qualified individual” is one who could meet the same coronavirus-related tests discussed above for coronavirus-related distributions.

The CARES Act also allows the plan to delay the due date for any repayment by a “qualified individual” of a participant loan that would occur from the date of enactment through December 31, 2020, for up to one year. Later repayments for such loans are adjusted to reflect the delayed due date and any interest accruing during such delay. The delay period is ignored in determining the 5-year maximum period for such loan.

The long-term prospects for the economy are uncertain, but the immediate short-term impact of the current degradation in economic growth has been significant. Employers may take steps to allow participants to access amounts in their defined contribution plan accounts. The Wagner Law Group can provide whatever assistance is needed to review and revise plan documents, draft amendments and prepare employee communications for employers wishing to expand the availability of in-service withdrawals or loans.

Retirement Plan Provisions of CARES Act

March 27, 2020

The third COVID-19 stimulus package has provisions regarding retirement plans, including expanded and penalty-free withdrawal rights, expanded loan rights, extended rights to repay loans and withdrawals, and a deferral of mandatory distributions.

Coronavirus-Related Distributions

The 10% early distribution penalty from retirement plans and IRAs under Section 72(t) of the Internal Revenue Code (the “Code”) will not apply to “coronavirus-related distributions” up to $100,000 per person from the person’s retirement plan accounts. The amount distributed may be re-contributed to the retirement plan, or to another plan, within three years after the date the distribution is received, without regard to any plan limit on contributions. If the individual does not re-contribute the distribution within that time period, taxation on the distribution may be spread over a 3-year period. Federal income tax withholding is not required on a coronavirus-related distribution, and a direct rollover need not be offered.

A coronavirus-related distribution may be taken at any time in calendar year 2020, by an individual (i) who is diagnosed with COVID-19 by a CDC-approved test, (ii) whose spouse or dependent is diagnosed with COVID-19 by a CDC-approved test, (iii) who “experiences adverse financial consequences as a result of being quarantined, being furloughed or laid off, or having work hours reduced due to” COVID-19, (iv) who is unable to work due to COVID-19 child care issues, (v) who has closed or reduced hours in a business owned or operated by the individual, due to COVID-19, or (vi) who has experienced other factors as determined by the Secretary of the Treasury. The administrator of the plan may rely on the individual’s certification that the individual qualifies for a coronavirus-related distribution under these categories.

Loans from Qualified Plans

The $50,000 loan limit, for loans from qualified plans to “qualified individuals” made during the 180-day period from the date of enactment, is increased to $100,000, and the cap of 50% of the present value of the vested benefit is increased to 100% of such present value.

The due date for any repayment by a “qualified individual” of a participant loan that would occur from the date of enactment through December 31, 2020, is delayed for up to one year. Later repayments for such loan are also adjusted “appropriately” to reflect the prior delayed due date “and any interest accruing during such delay.” The delay period is ignored in determining the 5-year maximum period for such loan.

A “qualified individual” who could be eligible for these expanded loan limits and loan delays is one who could meet the same coronavirus-related tests as discussed above for coronavirus-related distributions.

Plan Amendments

A plan may be amended to provide for these expanded distribution and loan options. Plan amendments for both the coronavirus-related distribution and plan loan provisions need not be made until at least the last day of the first plan year beginning on or after January 1, 2022. The due date for amendments to governmental plans is two years later than such date.

Minimum Required Distributions

Minimum distributions otherwise required in 2020 from defined contribution plans need not be made. Minimum distributions with required beginning dates in calendar year 2020, which have not yet been made by January 1, 2020, and which are required from defined contribution plans, need not be made in 2020. This waiver is applicable to (i) defined contribution 401(a) qualified plans, (ii) defined contribution 403(a) and 403(b) plans, (iii) governmental defined contribution 457(b) plans, and (iv) individual retirement accounts. If this provision is treated in the same manner as the analogous 2009 relief, a plan sponsor may have discretion as to whether it should be adopted.

Plan amendments for these provisions are not required until the last day of the first plan year beginning on or after January 1, 2022 (January 1, 2024 for governmental plans).

Defined Benefit Plan Funding Requirements

Single employer defined benefit plan funding requirements for 2020, including quarterly contributions, may be deferred until January 1, 2021, at which time they must be paid with interest. In determining the application of benefit restrictions in plan years containing the 2020 calendar year, a plan sponsor may elect to apply the plan’s 2019 funded status.

© 2020 Wagner Law Group.

The Big Sick Leave: How Bad Will The Economy Get?

“Don’t let the cure be worse than the disease.”

The disease in that expression refers to the death toll from COVID-19. The cure refers to the induced coma of physical-distancing that holds much of the US economy in suspense for an unknowable length of time, threatening a recession or even depression.

As one writer put it, we face a trade-off between “lives and livelihoods.” Suppressing the disease means suppressing the economy. We can minimize the economic damage by returning to work. But if we go back to work, we infect more people and maximize the death toll.

Even with widespread self-quarantine, the disease produces more victims than hospitals can handle. COVID-19 mainly victimizes the old and immune-compromised. But the virus is just fickle enough in choosing whom to kill that even healthy people feel (justifiably) anxious and vulnerable.

Governors, mayors and the White House sense the public’s wish to put people first. But what will the economic effects be? How long could a recession last? What will it cost? Who will bear the costs? Can government and business cooperate to limit the economic pain?

Economic forecasts

Economists in the public and private sectors are working overtime—presumably from their homes—to make projections. Overall, they’re not sure whether we’ll have a V-shaped crisis that’s deep but brief, a U-shaped crisis that’s deep but longer, or an L-shaped crisis similar to Greece’s depression after 2010.

32% unemployment possible. On March 24, an economist at the St. Louis Federal Reserve estimated that the U.S. unemployment rate could swell to 32% during the second quarter of this year, with almost 53 million people out of work. He added the current number of unemployed Americans, 5.76 million, to an estimated 47 million people in high-contact jobs— sales, production, food service, barbers and hairstylists, flight attendants and others—who are likely to be laid off.

A 2% drop in consumption, bottoming out after 29 weeks. If 215 million Americans get infected and 2.2 million die, “We find that the epidemic causes a relatively mild recession,” write a team of academics at Northwestern University and the Freie Universitat Berlin in a new article. “Aggregate consumption falls by roughly 2% from peak to trough, with the latter occurring 29 weeks after the onset of the infection. In the long-run, population and real GDP decline permanently by 0.65% reflecting the death toll from the epidemic.”

A 14% drop in consumption for 50 weeks. But the same team adds that if the U.S. takes severe containment measures, prolonging a national quarantine until a vaccine or treatment appears, then “a very large, persistent recession: consumption falls by about 14% for roughly 50 weeks” might occur. On the plus side, this policy would prevent an estimated 250,000 to 600,000 deaths.

Real US GDP is likely to be flat in 2020: “The impact of social distancing on consumer spending activity and a knockdown effect on business investment, together with the oil price hit on capital investments in energy infrastructure and expanded travel bans, likely means a -1.0% reading in the first quarter and a large contraction of 6.0% for GDP growth in the second, signaling recession for the U.S.,” write analysts at S&P Global Ratings.

“For the year, we now forecast real GDP is likely to be flat in 2020 (versus our +1.9% forecast before the virus). We continue to expect a slow U-shaped recovery in the second half following a second-quarter slump,” they added, noting, “Uncertainty in our estimates of growth in 2020 is higher than usual.”

The US economy will contract by 2.8% this year, according to the Economist Intelligence Unit. The EIU also expected China’s real GDP growth to stand at only 1% in 2020, compared with 6.1% in 2019. The eurozone will post a full-year recession of 5.9%, including recessions in Germany (-6.8%), France (-5%) and Italy (-7%). In Latin America, Argentina (-6.7%), Brazil (-5.5%), and Mexico (-5.4%) are predicted to experience recessions.

An S&P target range of 1,800-2,000 by summer. The global research firm TS Lombard said in a March 31 bulletin, “We reckon investors are currently too optimistic about the post-virus recovery on the back of policymakers’ responses. Rather than a bounce in activity, we expect a slow re-opening of the economy in tandem with continued social distancing… This means valuations are unlikely to recover quickly, and means the decline after this dead cat bounce is likely to make new lows.”

How long till it’s over?

No one expects the crisis to resolve before the summer. Assuming that no effective vaccine or treatment appears suddenly, we’re probably in for a long campaign, possibly interrupted with new flare-ups in places that the initial waves of the pandemic missed.

“Even under severe social distancing scenarios, it is likely that the health system will be overwhelmed, which is indicated to happen when the portion of the U.S. population actively infected and suffering from the disease reaches 1% (about 3.3 million current cases),” writes economist Andrew Atkeson of UCLA.

“More severe mitigation efforts do push the date at which this happens back from six months from now to 12 months from now or more, perhaps allowing time to invest heavily in the resources needed to care for the sick,” he adds.

“Under almost all of the scenarios considered, at the peak of the disease progression, between 10% and 20% of the population (33 to 66 million people) suffers from an active infection at the same time. In the model simulations, this peak infection period occurs between seven and 14 months from now.”

© 2020 RIJ Publishing LLC. All rights reserved.

Protect Your Nest Egg with Options

Americans have now experienced the hazards of investing for a second time in 12 years, but unfortunately, they’ve rarely taken advantage of the protections that institutions enjoy. Investors saw as much as a third of their nest eggs disappear in 2008. This year, coronavirus has already taken a quarter of what many had accumulated.

Back in 2008, many individual investors and retirement plan participants dumped their investments only to find that, when the market came roaring back, they were not part of the rapid recovery. Instead, these investors did not reenter the market until prices had risen without them.

This habit of dumping investments in the face of a crisis and then missing the recovery is the main reason that individual investors do not earn as much as institutions. But holding on to investments in a crisis is not the only reason institutions do better. They also buy protection in the event that the market fails to recover!

The protection that institutions use is generally not offered to individuals or plan participants. No one—including most financial advisers—ever explains to them how this works or provides a simple way of obtaining it. But we’re about to show you how to do so.

How institutions protect their investments

The fund managers at institutions know that investment markets rise and fall, sometimes farther than other times. They also realize that over time the rising is more than the falling. The institutions also know that there are a large number of investors who make bets on the market activity.

Just like the football pool at the office or workshop, some people win their bets and others lose. Knowing all this, institutions place their bets on both sides. In that way, “Heads I win, tails you lose.” Not a bad way to do business, if you can do it. And yes, you can.

Protecting plan participants

The “bets” are known as options. Thousands of different options exist, some that bet on the markets to rise and others that bet on a decline. Some bet on specific stocks or commodities and others bet on the market as a whole.

For most individual investors, it is enough to buy protection against a decline, since their investments (as opposed to the options themselves) will reward them when the market rises. While individuals can buy protection against a decline in the value of their own investments, this is both difficult and unnecessary.

It is difficult because this would require a customized bet, and not all individuals have enough assets to justify the expense of a customized bet. It is unnecessary because they can buy less expensive generic bets, called index options, which pay off when the value of the market as a whole goes down.

The most widely used index options are options on movements of the S&P 500 Index. These come in two basic varieties, but individuals and plan participants need only consider the bet known as a “put,” which pays when the market declines.

You need to answer four key questions in order to protect yourself against market declines with an S&P 500 Index Put:

  • Where does one buy an S&P 500 Index Put?
  • How many of these Puts are needed?
  • What is the cost?
  • What are the risks?
Purchasing an S&P 500 Index Put

The S&P 500 Index Put is a security that can be purchased through most brokerage firms.

Index puts may be available to plan participants if their plan has a self-directed brokerage (SDBA) feature and they have a brokerage account that permits options. Outside of a plan, individuals can purchase puts through a discount brokerage account or, with their adviser’s help, through the adviser’s broker-dealer.

How much to buy?

Either way, an investor needs to buy sufficient puts to cover up to 100% of the potential losses on their investments. (As with any type of insurance, the potential loss depends on the value of the asset, the degree of coverage, and the duration of the coverage.) This coverage will be needed for as long as the market is expected to decline. Market recoveries usually occur within three months after an initial decline. To be covered all the time, investors can buy puts that expire and renew annually.

Each put has a strike price that represents the level of the bet that’s make. For cost-effective protection, use a strike price that is “at the money,” or close to the current price of the index. If the strike price is “out of the money,” or higher that the current price of the index, protection will cost more.

If the strike price is lower than the current price of the index (an “out of the money” put), the put will cost less but protection will also be less. Investors and their advisers can calculate the number of puts, expiration and strike price themselves or with any of several available online tool.

Cost of Index Puts

For the index put to be worthwhile, the cost must be far less than the potential loss. The cost of “at the money” puts ranges from 1% to 3% of the amount at risk, depending on the expiration date and the market volatility at the time. This means that the index put becomes profitable if the market declines 1% to 3% or more.

If the value of the investments falls farther than that, the profit from the put will pay for any additional market loss in the investments. If the market rises, the value of the investments increases and covers the cost of the puts.

This cost of 2% (average of 1% to 3%) lowers investment returns to a far lesser extent than using cash or bonds for protection. Historically (since 1928), a protective allocation to cash has lowered equity returns by 7.6% and to bonds has lowered equity returns by 6.1%.

Risks of Index Puts

Options are bets and therefore can be risky, depending on how they are used. The use described in this article is potentially the safest possible use of options. In fact, the risks here are less than the risks of the investments themselves.

Risks are neutralized by:

  • Diversification; achieved by buying a put on a broad-based market index.
  • Not using leverage; the options are not financed with borrowed money, but are backed by the investor’s own assets.
  • Liquidity; achieved by using the S&P500 Index, the most popular index in the world.
  • Trading convenience; the option can be purchased or sold on any trading day.
Conclusion

Use of index puts to protect individual investments is a drag on portfolio performance over the long term. But they help investors avoid the market shocks that occur periodically and cause them to act imprudently in trying to escape volatile markets. For this reason, it is highly prudent for plan sponsors and financial advisers to offer such protection to participants or clients who seek a less bumpy path to retirement income security.

Note: Over recent days, stock prices have benefited from quarter-end rebalancing strategies and a rebound from the fastest drawdown in stock prices ever. However, we believe investors should prepare for more volatility once we move through this short-term market dynamic.

As long as the U.S. remains in a health crisis, the market is unlikely to calm down in a more lasting fashion. Covid-19 cases are growing, and at an uneven pace across the country. It is also unlikely that America as a whole will return to regular activity over the next few weeks. This point alone increases the risk economic/market activity could be volatile, and unpredictable at times.

© 2020 DALBAR. Used by permission.

The ‘Fed Put’ Hurts Annuities—and Retirees

In 2018, a light flashed at the end of a long tunnel of low interest rates. By December of that year, the Fed funds rate had ticked incrementally up, to 2.4% from 1.4%. The yield on 10-year Treasury bonds reached 3.23%. The yield on AAA corporate bonds pierced the 4% barrier.

I started feeling optimistic about Boomer retirement.

If the Fed stayed the course set by chair Janet Yellen (who raised rates from 0.07% in February 2014 to 1.42% in February 2018) and maintained by her successor, Jerome Powell, bonds and annuities had increasingly attractive yields. U.S. retirees might have low-risk, inflation-beating alternatives to stocks after a long drought.

But that light at the end of the tunnel was an oncoming train—perhaps the “R” train to Whitehall Street in Manhattan’s financial district.

In 4Q2018, as the Fed funds rate tightened to 2.2%, there was an equities sell-off. The S&P500 fell 17.5% (to 2,416 from 2,929). Perceiving the swoon as a political liability, President Trump floated a trial balloon about firing Powell.

Despite the Fed’s supposed “independence,” Powell flinched. He reversed the tightening policy and lowered the Fed funds rate three times in 2019. The S&P500 would roar to 3,380 by the following February—a gain of 40% in less than 14 months. Then along came a pandemic, and the index fell 35%, inspiring a rate cut to zero.

The ‘Fed Put’

You’ve heard of the “Fed put.” It’s shorthand for Alan Greenspan’s accommodative Fed policy—a sharp drop in the Fed funds rate—in response to financial market crises starting in the late 1980s. Traders came to expect Fed to ease rates to relieve a slump in stock and bond prices. The expression isn’t necessarily complimentary. It implies an unhealthy codependency, conducive to moral hazard, between the Fed and the equity markets.

History of Fed Funds rate

The Fed’s accommodation of the Street has been terrible for annuity issuers, pension funds and aging Boomers who need safe, viable alternatives to the stock market to fund their retirements. Three times over the past two decades, falling rates have come to the aid of the markets, and subsequently rising rates have triggered crashes. This volatility is great for traders. It’s a nightmare for the rest of us.

COVID-19 will inevitably take the blame for the 2020 stock crash (and the recession or even depression that may follow). Of course that’s a big factor. But Fed accommodation helped pump the S&P500 Index up by an unwarranted 33% after December 2018. It was ripe for profit-taking when the coronavirus pandemic struck the U.S., and fell 35% in two weeks.

Now we’re back to zero rates. If we follow the roller-coaster pattern set over the last 20 years, we’ll see another rise in stocks, then a reach for yield and over-leveraging, then a cautious tightening until, Boom, the Jenga pile collapses again and we’re back to low rates. It’s getting old, and so are the Boomers.

Letter to Financial Times

Desmond Lachman, a scholar at the American Enterprise Institute (AEI), former Salomon Smith Barney economist, International Monetary Fund official, and lecturer at Georgetown and Johns Hopkins, is also fed-up with this whipsaw. In response to a March 18 op-ed piece in the Financial Times by Ben Bernanke and Janet Yellen, Lachman wrote:

The Federal Reserve’s monetary policy under their watch might have set us up for the financial market turmoil that we are experiencing today. Along with the world’s other major central banks, it did so by creating a global equity bubble and by causing the gross mispricing of credit risk as investors were encouraged to stretch for yield.

On the basis of their experience, it would have been both helpful and timely had the former Fed chairs cautioned that we should not repeat the mistake of responding to the current economic and financial market crisis as we did to the last one by putting an undue burden on monetary policy for promoting the next economic recovery.

Lachman was scheduled to participate in an AEI-sponsored panel discussion last Wednesday entitled, “Is this global credit and asset price bubble really different?” The panel’s premise was that “Many years of ultra-easy monetary policy by the world’s major central banks have boosted global debt to record levels, supported a worldwide equity market boom, and reduced interest rates to unprecedentedly low levels. This event will consider how the current credit and asset market bubble might end and how policymakers should be preparing themselves for that ending.”

Ironically, this timely panel was cancelled due to the coronavirus.

“They got the economy moving after 2008 by creating an asset bubble,” Lachman said in a phone interview with RIJ last Monday. “They encouraged people to take on a huge amount of risk and lend to borrowers in ways that didn’t compensate for the risk of default. We should have had helicopter money in 2008-2009 instead of the Fed distorting financial markets.”

By reducing rates to almost zero, and forcing investors to reach for yield by taking on more risk, the central banks have only set the US and European economies up for a bigger bust in the future. “I think were in the ‘bigger bust’ now,” Lachman said. “And we’re going to repeat the same scenario. They’ll do all sort of things to prop up assets, and that will set us up for another fall.”

Analysis of FOMC records

This month, Anna Cieslak of The Fuqua School of Business at Duke and Annette Vissing-Jorgensen of California-Berkeley’s Haas School of Business published a paper on Fed policy up to 2016 in the article, “The Economics of the Fed Put” (NBER Working Paper 26894).

The investing public is aware of the presence of a Fed put, they found, basing their conclusion on reviews of news reports and minutes or transcripts of the FOMC (Federal Open Market Committee). “We show that since the mid-1990s the Fed has engaged in a sequence of policy easing following large stock market declines in the intermeeting period. We refer to this pattern as a ‘Fed put,’ by which we mean policy accommodation following poor stock returns,” they write.

But the Fed, they believe, behaves responsibly. It lowers rates out of concern that a falling equity market will lead to a smaller “wealth effect,” reduced personal consumption, a slower economy, and weaker corporate earnings, they conclude.

“We find that negative stock returns predict target changes [Fed funds rate reductions] mostly due to their strong correlation with downgrades to the Fed growth expectations and the Fed’s assessment of current economic growth,” Cieslak and Vissing-Jorgensen write.

From internal Fed communications through 2016, they don’t find evidence that the Fed has over-reacted to stock market changes, or that the majority of governors believe that they’re encouraging moral hazard (i.e., stimulating excessive risk-taking) by traders by lowering rates.

“While the FOMC [Federal Open Market Committee, which alters the Fed funds rate by buying or selling Treasury bonds] is clearly aware of the potential moral hazard effects of loose policy, especially post-crisis, such concerns do not appear to have a major impact on actual policy choices,” the paper says.

In an interview with RIJ, however, Cieslak noted that traders perceive that a Fed put exists, and dissenting voices on the FOMC have expressed concern that this perception encourages excessive risk-taking.

“If you believe that increased leverage is one sign of excessive risk-taking, there is some evidence of this going on in the broker-dealer sector before the 2008 financial crisis,” she said. “But we don’t see it happening after the financial crisis.”

Back to zero

At the end of 2018, Fed chair Powell should have stood up to President Trump and continued on the path of tightening that Janet Yellen had set. Instead, by lowering rates, the Fed reinforced a dysfunctional pattern. It also ensured another long interest rate drought for the guaranteed retirement products industry.

In order to provide retirees with annuities that have value, life/annuity companies need interest rates that are high enough and stable enough to give their investments in superior bonds a reasonable return. In December 2018, I thought we were approaching that sweet spot. Now I doubt that we’ll get there in my lifetime.

© 2020 RIJ Publishing LLC. All rights reserved.

Investors flee to bonds: Morningstar

Investors backed away from U.S. equity funds and turned to perceived safe havens like bonds and cash in February, after the S&P 500 turned down sharply amid fears of the coronavirus pandemic’s damage to the economy, according to Morningstar’s latest report on mutual fund and exchange-traded fund (ETF) flows.

Morningstar’s report about U.S. fund flows for February 2020 is available here. Highlights from the report include:

  • In February, U.S. equity funds shed $17.5 billion amid the stock market’s turmoil, with that group’s actively managed funds suffering nearly $20.0 billion in redemptions. As evidence of investors’ lack of enthusiasm for U.S. equities, a record $27.8 billion flowed out of the SPDR S&P 500 ETF.
  • Taxable-bond funds led category groups with $23.3 billion in inflows in February. Long-government funds had their strongest inflows since early 2019 as investors hedged their equity positions and appeared willing to take interest-rate risk instead of credit risk.
  • Volatile markets also spurred investors to move into cash equivalents such as money market funds, which collected $31.4 billion in February. For the first time since October 2019, money-market funds gathered more assets than long-term funds, which saw $25.5 billion in inflows in February.
  • Among the top-10 largest U.S. fund families, Vanguard led with long-term inflows of $19.8 billion in February. On the other side, SPDR State Street Global Advisors had the worst outflows of any shop—more than $27.0 billion —owing to SPDR S&P 500 ETF’s outflows.

Morningstar estimates net flow for mutual funds by computing the change in assets not explained by the performance of the fund, and net flow for U.S. ETFs shares outstanding and reported net assets.

© 2020 RIJ Publishing LLC. All rights reserved.

Another Tough Decade for Annuities?

For millions of older Americans who bought annuities with living benefit riders over the past decade, the terrible event they were insuring themselves against—a stock market crash during their passage through the retirement ‘red zone’—actually happened over the last two weeks.

But how many of these contract owners exercise those riders and initiate guaranteed monthly payments for life? How many will lapse their policies because they need instant cash? What will their advisers tell them to do?

And will the defensive steps taken by surviving variable annuity manufacturers over the past decade—to de-risk, re-price, re-capitalize, or discontinue product lines and diversify into fixed indexed annuities—help them to weather the current crisis? Or will we see a re-run of the restructurings, benefit buy-backs, and ugly publicity that followed the 2008-2009 crisis?

Life insurers tend to be taciturn during times like these. So, to get some perspective, I called actuary Tim Paris of Ruark Consulting, Gary “The Annuity Maestro” Mettler, and Tamiko Toland, research director at CANNEX, the annuity data and analysis shop that supplies up-to-date contract prices to thousands of advisers in the U.S. and Canada.

The ‘R.U.B’: Rider Utilization Behavior

Since the Great Financial Crisis, Ruark Consulting has analyzed data from life insurers to identify utilization behavior patterns among owners of deferred variable and fixed indexed annuities with guaranteed lifetime withdrawal benefits (GLWBs) or guaranteed minimum income benefits (GMIBs).

Many factors determine policyholder behavior. But having studied such data for more than 10 years, he’s learned that policyholders are most likely to activate their income riders when the contracts are “in the money” and the contracts no longer benefit from further deferral bonuses. (In this case, a contract is “in the money” when the value of the guaranteed benefit base, which determines monthly income amounts, exceeds the contract’s cash value. This is most likely to happen during an equity market crash.)

“If I were 60-something and I’d been paying rider fees for 10 years and had deliberately delayed taking income in order to get the full bonus, I would think about doing it now,” Paris told RIJ. You’d think that this was fundamental to the offering. Presumably, advisers are telling clients to that.”

Enough time has passed since the peak in sales of deferred variable annuities (VAs) with GLWBs and GMIBs for Ruark to see such a pattern appear. “In the last few years the data has started to go out beyond the 10-year mark,” he said. “We’re now in the 11th and 12th policy years. A lot of contracts have riders that incentivize the owner to defer income for 10 years.

“What we find is that after year 10, once the incentives kick in, that people are five to six times more likely to commence income. Commencement is highly sensitive to the end of the deferral period. I would not be at all surprised that when the market is down 30%, folks will recognize that the product was fundamentally built for this purpose, and say, ‘I’ll take the income now.’”

I asked Paris if VA issuers were likely to suffer as much as they did during the 2010s. “I wouldn’t be too surprised if we had a similar experience this time,” he told me. “It won’t be exactly the same, because carriers are more educated now than they were last time. After the shock of the last crisis, issuers found out how expensive the riders were. That led companies to think along different lines.”

If the Fed keeps interest rates close to zero, however, he added, it will be difficult for carriers to issue attractive products. “With zero rates, I get a ‘shrinking iceberg’ feeling,” he said.

“It will be hard to offer a lifetime income guarantee. There are more levers the carriers could tinker with. The guaranteed floors could go lower, the income payout rates could go down. But you can’t escape the reality that these are the rates and these are the costs and you’re forced to bake them into the product. As a result, the products will won’t look as good.”

At CANNEX, Toland is seeing distributors pulling annuity products off their shelves. New products are not attractive at the prices that life insurers are able to offer right now, and today’s products will look even worse if rates rise and better products eclipse them.

“We’re seeing suspensions of sales of annuities across all product categories, including immediate and deferred income annuities,” Toland told RIJ. “We anticipate more of the same.”

On the other hand, she added, “There’s still an argument to buy an annuity. If someone has to retire now, and needs a guaranteed income, and is worried about sequence of returns risk, there’s still an argument to buy. So there’s going to be a demand regardless of what happens to rates.”

Mettler, an insurance agent who recommends income annuities to his clients, believes that life insurers may be able to bring annuities to market, but they may not be products that agents will want to sell.

“There will still be an annuity market, but the carriers that remain will be overwhelmed by demand,” he said. “They might say that their budget for annuities will be only so much in a given year. And they might hit that mark in the first three months of the year.

“Some might partially withdraw from the market, or they’ll stay in the market with pricing that’s even more terrible than it is now. They might stop issuing contracts to people under 50. There might be no ‘period certains’ longer than 10 years, or no cash refunds. The carriers will find a way to survive. But who will be available to sell the products?”

© 2020 RIJ Publishing LLC. All rights reserved.

Can employers contribute less to their retirement plans?

In reaction to the current volatility in the economy due to COVID-19, we have been receiving a large number of questions from retirement plan sponsors regarding whether it is permissible to suspend or reduce required safe-harbor contributions during the plan year.

Many companies have to reduce their expenses and improve cash flow. In recent years many of these companies adopted safe harbor designs for their defined contribution retirement plans in order to satisfy required nondiscrimination and top heavy testing, but these designs impose on the sponsoring company the cost of making required employer safe harbor nonelective contributions or safe harbor matching contributions.

An employer can reduce or suspend its safe harbor contributions during a plan year, but only if certain conditions are met:

  • The employer must either: (a) have included in the required annual safe harbor notice a statement that the plan could be amended during the plan year to reduce or suspend safe harbor contributions, or (b) be operating at an economic loss as described in Section 412(c)(2)(A) of the Code, which generally requires that the employer and related employers in the same controlled group would likely need to show that its expenses exceed income for the year using generally accepted accounting principles.
  • The plan sponsor must send a supplemental notice informing participants that the plan will be amended with an explanation of the reduction or suspension of the safe harbor contribution. The suspension or reduction cannot be effective until 30 days after the later of: (a) the date the supplemental notice is distributed to participants, or (b) the effective date of the plan amendment. Participants must have a reasonable opportunity prior to the suspension or reduction of the safe harbor contribution to change their deferral elections, and this opportunity also must be described in the supplemental notice.
  • The plan document must be amended to reduce or suspend the safe harbor contribution and to add the required nondiscrimination testing provisions for the plan year: the “actual deferral percentage” (“ADP”) test for 401(k) plans and the “actual contribution percentage” (“ACP”) test for plans with matching contributions, both of which must use the current-year testing method. The plan also cannot rely on the top-heavy exemption available to safe harbor plans for the plan year in which the safe harbor contributions are suspended or reduced, which means the employer may be required to make a top heavy minimum contribution at the end of the plan year that could potentially exceed the cost of the safe harbor contributions.
  • An employer that suspends or reduces its safe harbor contribution mid-year must pay the safe harbor contribution amount from the beginning of the plan year until the effective date of the change. The annual compensation limit used to calculate the amount of the safe harbor contribution is prorated through the date of suspension.

A few additional considerations also should be kept in mind:

  • If the employer wishes to reinstate the safe harbor provision, another plan amendment and an annual notice may be required before the start of the applicable plan year (see additional comment regarding the SECURE Act below).
  • A plan could lose its tax-qualified status if safe harbor contributions are suspended during a plan year and the IRS determines that all requirements were not met. The employer may further be at risk of being found to have engaged in a prohibited transaction or fiduciary breach by not making its required contributions.
  • Given the current circumstances, the Internal Revenue Service may issue further guidance in this regard.

Additional comment regarding SECURE Act changes to safe harbor nonelective contribution requirements.

The SECURE Act made changes to the safe harbor rules that allow an employer to amend a plan during the plan year or even after the end of a plan year to add safe harbor nonelective contributions without having to provide notice to plan participants before the start of that plan year. It is not clear how the new rules under the SECURE Act will affect an employer that suspends its safe harbor contributions during a plan year and wishes to amend its plan later that same plan year to resume making those contributions and make up the amount owed for the suspension period. The IRS will need to provide guidance to clarify the interplay of these rules.

The long-term prospects for the economy are uncertain, but the immediate short-term impact of the current degradation in economic growth has been significant. Employers must take steps to remain in business, which means reducing expenses, including their contributions to their qualified retirement plans.

The Wagner Law Group can provide whatever assistance is needed to review and revise plan documents, draft amendments and prepare employee communications for employers wishing to suspend or reduce their safe harbor contributions, or to amend their non-safe harbor plans to make mandatory employer contributions discretionary.

© 2020 Wagner Law Group.

‘Dull’ Investments Shine in a Crisis

During bull markets, products like whole life insurance, annuities, and inflation-protected government bonds look too conservative for most investors to bother with. But during bear markets, guaranteed products (and those who recommend them) start to make sense.

RIJ spoke recently with three champions of ultra-safe products. Antoine Orr and Michael Seibert are insurance-licensed representatives of RIAs (Registered Investment Advisors). Zvi Bodie is an emeritus professor of management, pension fund expert and author.

Spoiler alert: You won’t read much here about profiting from the current volatility. Rather, you’ll read about products your clients might wish they bought a year ago, or that they might want to buy after the current crisis passes and before the next one begins.

No risk-free risk premium

Zvi Bodie, a retired pension expert who has taught at Harvard, MIT, and Boston University, and a prolific author of textbooks and popular books on safe investing (Risk Less & Prosper, Wiley, 2011), admits that when the stock market started its multi-decade ascent in the 1980s, he was an avid buyer of equities.

Zvi Bodie

But Bodie got out of the market when the price/earnings (P/E) ratio reached 40 in the late 1990s. Since then, he has invested mainly in equity-indexed certificates of deposit (CDs).

He’s now enthusiastic about I-Bonds, which are tax-deferred, liquid, inflation-protected Treasury savings bonds whose yield tracks inflation. They cannot lose value (though there are small penalties for withdrawals in the first five years), are exempt from state and local taxes, and yield a small fixed interest rate plus the rate of inflation. The current “composite yield” is 2.22%.

“I-Bonds are better than Treasury Inflation-Protected Securities (TIPS),” he said. “They’re perfect for an emergency fund. The only ‘drawback’ is that you can’t buy more than $10,000 worth per year.”

Bodie has also contested the validity of the gospel that stocks always “pay off in the long run.” If stocks (or baskets of stocks, called indices) were safer the longer you hold them, he has pointed out, then investment banks would happily sell long-dated shortfall put options on them. But no one writes such options; they’d be too expensive. “How can there be a risk premium if there’s no risk?” he often asks.

The source of the confusion, he explained over the phone this week, is what he calls the “Bodie Paradox.” Over any specific time period, “the probability increases that stocks will beat the risk-free rate,” he said, referring to the rate on risk-free Treasury bonds whose maturities match the designated time period.

But, paradoxically, the potential magnitude of an extreme equity market loss grows over time—because unforeseen black-swan events like the COVID-19 pandemic happen from time to time. “Two things determine risk: the likelihood of a bad thing, and the severity of a bad thing,” he said. “When there is a shortfall, it’s really terrible. And you have to take that into account.”

‘Sadly, he’s all in stocks’

Michael Seibert and I met at a modish restaurant near Allentown, PA, called Grille3501. Once a Pennsylvania Dutch eatery called “Trinkle’s,” Grille3501 reflects this small East Coast city’s evolution from Amish-flavored mill town to satellite of New York.

Michael Seibert

Seibert was under some time pressure. The S&P500 Index was falling. Later that afternoon, he would call a nervous new client—a 62-year-old man whose existing wealth consisted of ownership of a successful business, the cash value of a large whole life policy, and a 401(k) account holding $700,000 in equities.

“Sadly, he’s in all stocks,” Seibert told me. “He’s not retiring for four or five more years, so he’s holding on tight. When stocks rebound, whenever that may be, we’ll move some of the money to a fixed income annuity (FIA).”

During crises, he said, “Retirees have four volatility buffers: Cash, the cash value of life insurance—either spending it or borrowing against it—a reverse mortgage line of credit, or taking Social Security earlier than planned.”

Seibert is a representative of 1847Financial, and a national trainer with Wealth Building Cornerstones. He said that his business has blossomed since he positioned himself a few years ago as a retirement income specialist. Recently, he earned his Retirement Income Certified Professional (RICP) designation from The American College and started following the teachings of the College’s Wade Pfau—who recently wrote a paper on the potential synergies between life insurance and annuities in retirement.

He’s trying to deliver those synergies to his new 62-year-old client. As the client approaches retirement, Seibert may recommend that he follow a “covered assets” strategy.

This move involves taking advantage of a client’s whole life policy to buy a single or joint-and-survivor income annuity with other savings—but only if the client is healthy and has a substantial life-expectancy. The purchase premium of the annuity and the death benefit of the life policy are roughly equal, so that the client and his family are equally and simultaneously protected from mortality risk and longevity risk.

‘C’ stands for control

Antoine Orr’s clients are likely to be middle-class people who need to get out of debt and save before they invest. Perhaps lacking enough investable assets to attract asset-based advisers, or perhaps very conservative, they’re part of the vast market traditionally served by commission-based, insurance-driven advisers.

Antoine Orr

Orr is president of Plancorr Wealth Management in Nottingham, Maryland and West Palm Beach, Florida. He’s both an insurance agent and an IAR (Investment Advisor Representative), as well as author of the 2009 book, “Inside the Huddle,” and creator of the IVEST LLC marketing system.

“LLC” stands for Liquidity, Leverage and Control. “First, there’s liquidity. When you’re liquid, you can jump on any opportunity or need that arises without going into debt,” Orr told RIJ. “Second, we want to find out if you can borrow against an asset without interrupting its growth. The last issue is control: Do you control the outcome, the fees, the preservation of the asset, and taxes on the back end? Most people don’t have liquidity or leverage or control.”

Orr said that his clients often “feel powerless on the way to prosperity.” They’re contributing to 401(k) accounts, making extra mortgage payments, and paying down credit card debt.

But they’re also paying fees and interest and accumulating a future tax liability. “People feel like they’re held hostage by their finances, and I’m there to help them negotiate their way out of that. I say, ‘Only put money in to stocks after you’ve paid down your non-mortgage debt, strengthened your free cash flow, are highly liquid, and have leverage and control over your assets.’ Once we’ve taken care of the foundation, then we can talk about stocks and P/E ratios. Even if they don’t make money there, they’ll be OK.”

Right-size the lifeboats

If you’ve never sold insurance or you consider Treasury bonds too stingy with yield, or if you don’t like “products” and never accept commissions from life insurers, then the strategies described above probably won’t make much sense to you. They may seem too safe or, in the case of insurance, too self-serving.

Indeed, carrying a lot of whole life insurance or inflation-protected bonds may also seem absurd—like sailing on a ship with lifeboats bigger than the ship itself. But none of the three experts cited here suggests that safe assets should constitute the bulk of every portfolio.

My big takeaway from talking to these three retirement specialists is that most people, particularly younger workers and pre-retirees, should make sure they have a foundation of safe assets before they start taking risks. As many people learn the hard way, it’s much easier to establish a safe foundation before a crisis than after a crisis begins.

© 2020 RIJ Publishing LLC. All rights reserved.

An Imperfect Demand Stimulus

What is happening today may be likened to a hurricane or a tornado, but one that affects every city, town and county in the country, as well as the rest of the world, at the same time. Because so many workers simply cannot report to work, the economy’s effective capacity will shrink drastically for a time, in the same way that the ability of a small island’s economy to produce is devastated temporarily by a hurricane.

Unlike a small island economy, however, there can be no prospect of external aid. Even if the textbook Keynesian response would work in more normal times, it cannot offset this decline.

However, aggregate demand could still fall well short even of the economy’s reduced capacity. Laid-off workers, especially those living paycheck to paycheck, will have to cut back drastically on their spending on those goods and services that the economy is still capable of producing. Declines in income will be particularly severe for gig workers, and workers in the hospitality and retail sectors. Even households that are spared lay-offs and are not (or have stopped) hoarding will be trying to economize, or will be cutting expenditure on what is no longer available, like a drink at their local bar. The increased efforts to save by many households will not automatically be offset by an increase in business investment, except perhaps for some involuntary inventory accumulation, which will be reversed as inventories mount.

Many workers, especially teachers and other civil servants in government and education, will continue to receive a paycheck even if they are unable to work from home. Some of the households that are financially strapped may benefit from transfers from their parents and grandparents, which will partly mitigate their plight. Households that remain in a comfortable position may also increase their charitable contributions. Nonetheless, millions and millions of workers will find themselves virtually without resources unless the government steps in.

This truly grim economic outlook has led some commentators to argue that the economic suffering entailed by concerted and strong action to control the virus may outweigh the pain and suffering of those who end up sick or who die. Comparisons with the Great Depression, which lasted for a decade, are made, but are surely exaggerated. This writer believes that if strong public action can stop the spread of COVID-19 before many months have passed, even a huge increase in unemployment can be reversed.

What should be done?

In this writer’s view, economic policy should be geared to preventing a further fall in aggregate demand below the economy’s reduced capacity level, and to helping those households with the lowest and least secure incomes, including one-person households. In addition to assisting hospitals and medical workers obtain the supplies they so desperately need, assistance from the federal, state and local governments to businesses and to households is urgently needed, in the form of loans, grants and transfers.

The news media report that the Senate has agreed on a $2 trillion dollar package. The components of this package (which fall short of $2 trillion) are reported to be:

  • $130 billion to hospitals
  • $250 billion for direct payments to households and individuals, apparently in the form of direct mail-outs
  • $250 billion in increased unemployment insurance benefits accompanied by a broadening of its application
  • $350 billion in loans to small businesses
  • $150 billion for state and local governments, which are starting to run short of tax revenue to pay their furloughed employees
  • $500 billion for distressed corporations and municipalities, with requirements to ensure that these payments will go to support their workforce

As of today, the bill has left the Senate and gone to the House, where it must be approved before going to the White House for the President’s signature.

In the writer’s view, the package that is ultimately passed should be judged by three criteria: (1) how well targeted it is; (2) how quickly it acts; and (3) its administrative feasibility. On those counts, how does the latest version stack up?

  • Loans to business, even when the lender enjoys a guarantee, are not well targeted. Their impact on employment is indirect and uncertain, unless there is a way of requiring recipients to keep their workers on the payroll. They may also take some time to implement. Direct investment and loans by the government, which are probably feasible only for large corporations, may be better targeted, but only if they are accompanied by an effective employment requirement. This is probably not feasible for hundreds and thousands of small businesses. That said, if such a policy can be made to work for them, all the better.
  • Enhanced unemployment insurance (increased by $600 per week for four months) is well targeted, although its decentralized administration at the state level makes it more complex. Nonetheless, the infrastructure is established—it doesn’t have to be started up from scratch.
  • A direct mail-out of checks to households is quick and easy to do. The Senate bill makes the mail-out decline with income and be phased out when adjusted gross income (AGI) reported to the IRS in 2018 reaches $99,000 for singles and $198,000 for couples. The maximum benefit for singles is $1,200, payable if their AGI is $75,000 or less and $2,400 for couples with an AGI of $150,000 or less. An additional $500 is paid for each child (also subject to a phase-out). A mail-out is undoubtedly appealing politically. Making payments decline with income is desirable, but the policy does not distinguish between households with secure and those with insecure incomes. Many payments will be going to households that do not really need them, because many households have reasonably secure incomes, and a lower cut-off point could finance larger payments to low-income households.
  • Enforcing a moratorium on evictions of tenants and foreclosures of households behind in their mortgage payments, as some commentators have proposed, might also help. Ideally, it should be should be targeted at low-income households. The feasibility of this is uncertain. Outright forgiveness of student debt is poorly targeted, especially if it is a permanent policy. A temporary moratorium on loan servicing makes more sense, although even this measure will benefit a large number of students and their families who are not in desperate need.

An emphasis on payments to persons, not business entities, is the best policy, and an increase in unemployment insurance with a concomitant relaxation of its terms is probably the best single policy of this sort. Loans with guarantees in place for the lender, direct loans by the federal government, and ownership positions in very large employers could be justified provided their terms make them effective in preventing large-scale lay-offs. Of course, assistance to hospitals is vital.

The writer is not in a position to put a number on the size of the total package, but it should be large. The initial package may have to be followed up by another, given the uncertain duration of the drop in the economy’s ability to supply the normal amount of goods and services and the possibility that demand falls even below that level. Any stimulus package will take some time to implement.

Conceivably, and unbelievable though it might seem, a very large package or series of packages might actually push demand beyond what the economy can now supply. In the writer’s opinion, the resulting increase in the price level and in the rate of inflation would not be a large price to pay to prevent a true calamity. Inflation is very low now, and the price level is in fact likely to drop—i.e. the rate of inflation will probably become negative for a time, given the inevitable drop in demand before any stimulus takes hold. We are not on the verge of hyperinflation.

© 2020 RIJ Publishing LLC. All rights reserved.

Dividend futures signal long slowdown: U. of Chicago

Analyzing data from the aggregate equity market and dividend futures, two professors at the University of Chicago’s Booth School this week quantified investors’ expectations about economic growth  in light of the coronavirus outbreak and potential policy responses to it.

“As of March 18, our forecast of annual growth in dividends is down 28% in the US and 25% in the EU, and our forecast of GDP growth is down by 2.6% both in the US and in the EU,” they write in a new research paper.

“The lower bound on the change in expected dividends is -43% in the US and -50% in the EU on the 3-year horizon. The lower bound is model free and completely forward looking. There are signs of catch-up growth from year 4 to year 10.”

According to the paper, “news about economic relief programs on March 13 appear to have increased stock prices by lowering risk aversion and lift long-term growth expectations, but did little to improve expectations about short-term growth.

“The events on March 16 and March 18 reflect a deterioration of expected growth in the US and predict a deepening of the economic downturn. We also show how data on dividend futures can be used to understand why stock markets fell so sharply, well beyond changes in growth expectations.

“Dividend futures, which are claims to dividends on the aggregate stock market in a particular year, can be used to directly compute a lower bound on growth expectations across maturities or to estimate expected growth using a simple forecasting model. We show how the actual forecast and the bound evolve over time.”

© 2020 RIJ Publishing LLC. All rights reserved.

For annuities, 2019 was great. 2020 is TBD

Total fourth quarter sales for all deferred annuity sales were $53.3 billion, a decline of 3.3% from the previous quarter. Total 2019 deferred annuity sales were $221.8 billion, according to the 90th edition of Wink’s Sales & Market Report for 4th quarter, 2019.

Sixty-two indexed annuity providers, 50 fixed annuity providers, 68 multi-year guaranteed annuity (MYGA) providers, 11 structured annuity providers, and 47 variable annuity providers participated.

Overall sales leaders

Jackson National Life ranked as the top carrier overall for deferred annuity sales, with a market share of 9.8%. Its Perspective II Flexible Premium Variable & Fixed Deferred Annuity, a variable annuity, was the top-selling deferred annuity, for all channels combined in overall sales for the fourth consecutive quarter. Lincoln National Life, AIG, Equitable Financial, and Allianz Life followed.

from Secure Retirement Institute.

All fixed annuities

Total fourth quarter non-variable deferred annuity sales were $26.9 billion, down 7.6% from the previous quarter and down 17.8% from the same period last year. Total 2019 non-variable deferred annuity sales were $122.8 billion. Non-variable deferred annuities include indexed annuities, traditional fixed annuities, and MYGA products.

AIG ranked as the top carrier overall for non-variable deferred annuity sales, with a market share of 8.5%. Allianz Life, Jackson National, Global Atlantic Financial Group and Nationwide followed. Allianz Life’s Allianz 222 Annuity, an indexed annuity, was the top-selling non-variable deferred annuity, for all channels combined, in overall sales for the fifteenth consecutive quarter.

All variable products (structured and conventional)

Total fourth quarter variable deferred annuity sales were $26.3 billion, up 1.3% from the previous quarter. Total 2019 variable deferred annuity sales were $99.0 billion. Variable deferred annuities include the structured annuity and variable annuity product lines.

“A steadily-rising market and continued rate reductions for fixed annuities lent to increased sales of structured and variable annuities this quarter,” said Sheryl J. Moore, president and CEO of Moore Market Intelligence and Wink, Inc.

Jackson National Life ranked as the top seller overall of variable deferred annuities, with a market share of 13.9%. Equitable Financial, Lincoln National Life, Prudential and Brighthouse Financial followed.

Conventional variable

Variable annuity sales in the fourth quarter were $21.4 billion, an increase of 1.0% as compared to the previous quarter. Total 2019 variable annuity sales were $81.6 billion. Variable annuities have no floor, and potential for gains/losses that are determined by the performance of the subaccounts that may be invested in an external index, stocks, bonds, commodities, or other investments.

Jackson National Life held its ranking as the top seller of variable annuities, with a market share of 17.2%. Lincoln National, Prudential, Equitable Financial, and Nationwide followed. Jackson National’s Perspective II Flexible Premium Variable & Fixed Deferred Annuity was the top-selling variable annuity for the fourth consecutive quarter, for all channels combined.

Structured variable (Registered index-linked annuities)

Structured annuity sales in the fourth quarter were $4.9 billion; up 2.7% from the previous quarter, and up 39.3% from the previous year. Total 2019 structured annuity sales were $17.3 billion. Structured annuities have a limited negative floor and limited excess interest that is determined by the performance of an external index or subaccounts. “Structured annuity sales are still setting records. It will be interesting to see how low fixed interest rates, coupled with market volatility, will affect this immature product line, in terms of sales,” Moore said.

Equitable Financial (formerly AXA) was the top seller of structured annuities, with a market share of 28.9%. Its Structured Capital Strategies Plus was the best-selling structured annuity for the quarter, for all channels combined.

Fixed indexed

Indexed annuity sales for the fourth quarter were $17.1 billion, down 8.1% from the previous quarter, and down 10.6% from the same period last year. Total 2019 indexed annuity sales were $73.2 billion. Indexed annuities have a floor of no less than zero percent and limited excess interest that is determined by the performance of an external index, such as Standard and Poor’s 500.

FIA sales by Qtr, from WinkIntel

“This was another record year for indexed annuity sales,” Moore said in a release. “Given the recent volatility in the markets, coupled with even lower fixed interest rates, I suggest we are going to have a repeat in 2020.”

Allianz Life retained its top ranking in indexed annuities, with a market share of 9.8%. AIG, Nationwide, Jackson National Life, and Athene USA followed. Allianz Life’s Allianz 222 Annuity was the top-selling indexed annuity, for all channels combined, for the twenty-second consecutive quarter.

Traditional fixed

Traditional fixed annuity sales in the fourth quarter were $764.7 million, down 2.6% from the previous quarter, and down 26.5% when compared with the same period last year. Total 2019 fixed annuity sales were $3.6 billion. Traditional fixed annuities have a fixed rate that is guaranteed for one year only.

Great American Insurance Group ranked as the top seller in fixed annuities, with a market share of 10.9%. Modern Woodmen of America, Global Atlantic Financial Group, Jackson National Life, and OneAmerica followed. Forethought Life ForeCare Fixed Annuity was the top-selling fixed annuity for the third consecutive quarter, for all channels combined.

MYGA

Multi-year guaranteed annuity (MYGA) sales in the fourth quarter were $9.0 billion, down 7.0% from the previous quarter and down 28.0% from the same period last year. Total 2019 MYGA sales were $45.8 billion. MYGAs have a fixed rate that is guaranteed for more than one year.

Massachusetts Mutual Life Companies ranked as the top carrier, with a market share of 13.2%. New York Life, Symetra Financial, AIG, and Global Atlantic Financial Group followed. Massachusetts Mutual Life’s Stable Voyage 3-Year was the top-selling multi-year guaranteed annuity for the quarter, for all channels combined.

Report from Secure Retirement Institute

Total annuity sales reached a 12-year high in 2019, surpassing 2018 sales by three percent to reach $241.7 billion. The top three issuers held a combined 22% market share, down from 25% in 2014, the Secure Retirement Institute reported this week.

from Secure Retirement Institute.

Total variable annuity (VA) sales were $101.9 billion in 2019, up 2% from 2018. VA sales grew for the second year in a row. Jackson led the sales in the VA market in 2019 for the seventh straight year. The top three VA sellers represented 36% of the total VA market in 2019, up slightly from 35% in 2014.

Registered index-linked annuities (RILAs) drove the growth in the VA market. In 2019, RILA sales were $17.4 billion, up 55% from 201x. RILA sales held a 17% share of the total VA market. Equitable Financial was the top seller of RILAs in 2019, with 29% of sales.

Fixed annuity sales set a new sales record in 2019. Total fixed sales were $139.8 billion in 2019, up 5% from prior year. AIG was the top seller of total fixed annuities for the second consecutive year. The top three fixed annuity manufacturers represent 23% of the U.S. fixed annuity market, down from 28% from 2014.

For the second year in a row, fixed indexed annuities (FIAs) broke annual sales records. FIA sales were $73.5 billion in 2019, up 6% from 2018. For the 11th consecutive year, Allianz Life gathered the most FIA premium in the U.S. In 2019, the top three FIA sellers represented 28% of the market, down from 43% in 2014.

“In 2019, Jackson focused on growing its fixed annuity market share, which propelled its overall growth in 2019,” said Todd Giesing, SRI senior annuity research director. “Its FIA sales jumped 1,293% in 2019, while its fixed-rate deferred annuity sales climbed 169%.”

SRI’s U.S. annuity sales survey represents 94% of the U.S. annuity market.

© 2020 RIJ Publishing LLC. All rights reserved.

IPO reflects ongoing shift at Jackson National

Seeking outside capital to fuel Jackson National Life’s aggressive retirement product diversification strategy, the U.S. life insurer’s British parent has decided to sell a minority position in its flagship subsidiary via an initial public offering (IPO) in the U.S.

Prudential plc, which earned $525 million from Jackson in 2019, said in a March 11 release that it sees a “substantial opportunity for Jackson’s products” in the U.S., “the world’s largest retirement savings market and the continuing transition of millions of Americans into retirement.”

“In order to diversify at pace, Jackson will need access to additional investment, which we believe would best be provided by third parties,” Prudential plc’s release said. “We are today announcing that the Board has determined that the preferred route to achieve this is a minority Initial Public Offering (IPO) of Jackson.”

Prudential plc appears to have acted under shareholder pressure. The Financial Times reported February 24 that Dan Loeb, leader of Third Point, the $14 billion US hedge fund with a stake of almost $2 billion in Prudential, had urged the insurer’s board to separate Prudential’s US and Asian businesses and eliminate its figurehead UK office. Prudential no longer has any operations in the UK, but it remains the largest insurer listed on the London market, with a value of £37bn.

Jackson National emerged as the U.S. variable annuity sales leader about seven years ago—especially after Prudential Financial (no relation to Prudential plc) and MetLife throttled down their sales pace. More recently, Jackson, AIG and other life insurers have diversified their product offerings for greater stability.

“In 2019, Jackson diversified its annuity sales to focus on growing its fixed annuity market share, which propelled its overall growth in 2019,” said Todd Giesing, senior annuity research director at the Secure Retirement Institute, in a release this week. “Jackson’s fixed indexed annuity sales jumped a staggering 1,293% in 2019, while their fixed-rate deferred annuity sales climbed 169%.”

According to Prudential plc:

“US adjusted operating profit increased by 20% to $3.07 billion, reflecting the impact of lower market-related amortisation of deferred acquisition costs. Higher equity markets also led to US separate account assets increasing by 19% to $195.1 billion.

US APE (Annual premium equivalent) sales increased by 8%, driven by fixed income and fixed index annuities, in line with our diversification strategy. New business profit declined by 28%, reflecting lower interest rates and changes in product mix.”

Prudential plc bought Michigan-based Jackson for $610 million in 1986. The business, which has four million U.S. customers, accounts for half of the group’s operating profit.

Jackson today announced its full-year financial results, generating $3 billion in IFRS pre-tax operating income in 2019, an increase of 22% over 2018 and the highest in company history. Jackson also reported $22.2 billion in total sales and deposits, noting significant growth in fixed and fixed index annuity sales.

The British insurer acknowledged the potential impact of the pandemic and financial crisis on its industry:

“We continue to monitor closely the development of the coronavirus outbreak and are focused on the health and well-being of our customers and staff. The outbreak has slowed economic activity and dampened our sales momentum in Hong Kong and China,” the firm said in a release, adding, “lower levels of new sales activity in affected markets are to be expected with a consequential effect on new business profit. Our in-force business is proving robust.”

“The U.S. is the world’s largest retirement market, with trillions of dollars expected to move from savings into retirement income products over the next decade,” said Michael Falcon, CEO of Jackson Holdings LLC. “Jackson’s ambition is to play the fullest role possible in this through a strategy of diversifying its product range and distribution network. Over time, this is expected to lead to a more balanced mix of policyholder liabilities and enhance statutory capital and cash generation.”

Strong equity markets drove the company’s 2019 results, Falcon said. Variable annuity separate account assets, which generate asset-based fees, totaled a record $195.1 billion in 2019.

“As Jackson works to achieve commercial diversification, we are continuing our efforts to balance our business,” said Falcon. “By offering the right mix of products through the right distribution channels, we have strengthened our leadership position in the U.S. retirement market. Our deliberate approach has enabled us to deepen our presence in the advisory space and capture new opportunities as we move into the next phase of our growth.”

© 2020 RIJ Publishing LLC. All rights reserved.