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RIJ Interview: Will Fuller of Lincoln Financial

Posted on January 23, 2020 by -

In the slugfest known as the annuity market, Lincoln Financial Group punches above its weight-class. While Lincoln was the third biggest seller of retail annuities in the U.S. in the first nine months of 2019, according to LIMRA Secure Retirement Institute, it is smaller than its rivals.

Lincoln ranks only 187th in the Fortune 500, with $16.4 billion in revenues. Its close competitors—Prudential, AIG, New York Life, TIAA—either rank much higher or have big overseas parents (Jackson National, Allianz Life of North America and, until recently, AXA).

Executive vice president Wilford H. “Will” Fuller has figured prominently in Lincoln’s success. Arriving from Merrill Lynch in 2009, he now runs Lincoln’s wholesale operations, its broker-dealer and its annuity business. At 48, he’s the youngest and third-highest paid executive at Lincoln, according to wallmine.com, with responsibility for units that produce a majority of Lincoln’s revenues.

Fuller talked with RIJ late last fall at Lincoln’s Radnor, PA, headquarters. The past year has been busy: Lincoln added indexed variable annuities (IVAs) to offset softening sales of traditional variable annuities and built new bridges to registered investment advisers. Last September, the Insured Retirement Institute named Fuller its 2019 Industry Champion of Retirement Security.

Just this week, Lincoln announced its latest partnership with Capital Group, which manages American Funds, to issue a new variable annuity with Lincoln’s lifetime income rider attached to a target date fund series created by Capital Group.

RIJ: You joined Lincoln just as the financial crisis bottomed out, in early 2009. The company had recently bought Jefferson Pilot and established its headquarters in the Philadelphia suburbs. How has Lincoln’s product mix evolved over the years?

Fuller: Jefferson Pilot and Lincoln merged 13 years ago. I joined Lincoln Financial 10 years ago. When I joined we had two core product lines. Nearly 80% of our life insurance business consisted of sales of universal life. Ninety percent of our variable annuity sales were VAs with guaranteed living benefits.

After the financial crisis, we decided to become more diversified. So now you see that, within our life insurance business, we have variable, indexed, term and hybrid life, and long-term care solutions. And we sell lots of kinds of annuities. We have a fundamentally different company today. We’ve built out a more resilient and diversified franchise that relies on an all-weather product portfolio. Lincoln Financial is a far more flexible company because of that decision. It’s better than being married to one product design.

RIJ: Diversification is the first rule of risk mitigation, I imagine. For companies and individuals.

Fuller: We have a principle that, if you plan for the downside, the upside will take care of itself. We plan for down environments, as do our customers. Preferences and markets can change. So we expanded our product offerings. We went for an all-weather product portfolio.”

RIJ: When did you decide to diversify out of variable annuities?

Fuller: In 2016, we decided to participate in more segments of the annuity market. Before then, as I mentioned, we were focused on the variable annuity with guaranteed living benefits. As rates began to recover after the 2016 election, we responded with the same strategies we’d used before: We strengthened the VA benefits, and we benefited from rising sales.

Since then, we’ve brought out indexed annuities and increased our focus on traditional fixed annuities. Those products led to the expansion of shelf space with bank partners. It also led to our January 2019 partnership with Allstate, which is the first property and casualty insurer to distribute our annuities. We have also started building out customized products for new distributors. For instance, we began partnering with Market Synergy Group and Impact Partnership to distribute custom fixed index annuities.

RIJ: How’s that working out?

Fuller: Because of these new products and new channels, we’ll see more overall sales of annuities in 2019 than we did in 2016—even though we expect to sell only about as much of the traditional VA as we did then. Sales of the traditional VA have in fact been off by over $1 billion, but we more than made it up with IVA (indexed variable annuity) sales.

RIJ: The IVA, which is also called the registered indexed linked annuity (RILA) or the structured variable annuity, has been a game-changer for the annuity industry since AXA introduced the first one in 2011. [Like a fixed indexed annuity, or FIA, the IVA uses options to deliver gains or losses within a spread on the performance of a market index or a combination of market indices. An IVA typically offers more upside potential than an FIA because it doesn’t offer absolute prevention from loss.]

Fuller: Our overall variable sales got back into positive territory because of the success of the IVA. We made a commitment to return to net positive flows of variable annuities in 2018, and we achieved that goal a quarter early. But it took some time to be positive in both fixed and variable annuities. We’re positive for the VA market because we’re positive for indexed variable annuities.

RIJ: There’s a relatively new structured products sales platform called SIMON Markets. It offers a tool that helps advisers select the combination of indices in an IVA product that is most likely to maximize the product’s performance. Does Lincoln have anything like that on its IVA platform?

Fuller: With the IVA, we saw the importance of a tool that optimizes the indices. But we decided to focus our marketing on the longer-term indexed variable annuity (IVA) contracts instead. Roughly three-quarters of our IVA sales are in the six-year duration term, [where the initial cap on credited interest is valid for the entire duration of the contract, rather than subject to change every year or every three years]. We also built a calculator that allows advisers to run different scenarios comparing a portfolio with or without an IVA.

RIJ: That product seems to be built mainly for risk-reduced accumulation, not for retirement income generation. But it does seem to be resonating with a lot of people. It’s the annuity world’s version of a structured note.

Fuller: It’s extraordinary how the market for IVAs has grown. At Lincoln, nearly two-thirds of the advisers who sell our indexed variable annuity have sold more than one. We can leverage our broad access to over 90,000 advisers through Lincoln Financial Distributors. On average, they sell about twice as many indexed variable annuities as they do any other annuity category. That product is still in its early days. We launched our IVA, Lincoln Level Advantage, in May 2018 and we have a 15% market share. We launched a commission-based and a fee-based version of that product, but our distribution partners are selling mostly the commission-based product.

RIJ: Does Lincoln offer a buffer version or a floor version of the IVA? [A “floor” means the client can’t lose more than, say, 5%, 10% or 15% in a year. A “buffer” means the client is protected from the first 5%, 10% or 15% loss in a year.]

Fuller: We sell only a buffer design on the IVA. We are researching a floor design as well as additional crediting strategies. We currently sell only a one-year and a six-year term product, but we plan to offer a three-year term product in 2020.

RIJ: That product should be even more attractive with interest rates moving back down.

Fuller: The IVA holds up pretty well in a low volatility, low-interest-rate environment. It was created to withstand the pressures of low interest rates. It’s more capital-efficient and less affected by rates than the VA with a living benefit. At the same time, the IVA takes a lot of work. You must register it with the Securities and Exchange Commission. You must register the insurance subsidiary as an SEC entity. You need an augmented hedging program. And you need shelf space.

RIJ: Comparing the IVA with the fixed indexed annuity, a person might wonder why the FIA focused on zero-losses… as if it were fatal to cross into negative territory in a calendar year. I suppose the no-loss guarantee made a strong marketing story.

Fuller: The no-loss guarantee in FIAs came about because, by definition, a general account product is a principal-protected product. A separate account product can “break a buck,” but a general account product can’t. The original target market for the FIA, if you remember, was the CD [certificate of deposit] buyer. We’ve been in a declining rate environment for almost 40 years. The FIA was born in an era when CD rates were coming down. People wanted safety but they also wanted a rate greater than they could get from a CD.

RIJ: Let’s pivot to the distribution side of the annuity business, if we can. How does Lincoln approach the Registered Investment Advisor (RIA) market, which may or may not represent a growth opportunity for annuity sales?

Fuller: We divide the RIA market between pure Investment Advisor Representatives (IARs), who are associated only with an RIA, and the dually registered or hybrid RIAs, who are also registered with a broker-dealer. These hybrid advisers have their RIA business and their broker-dealer business; they can use either side. They’re a much bigger opportunity than the pure RIA market.

RIJ: What are some of the nuances of marketing to this split group?

Fuller: We approach the two markets in different ways. We can reach the hybrid advisers through their broker-dealer platforms. We call on that market through our broker-dealer wholesalers. But, since the fee-only RIAs are not registered with broker-dealers, we have a dedicated team of wholesalers and relationship managers that works directly with those advisers. We’ve also made technology integrations with Orion, eMoney, Envestnet/Tamarac and Redtail to better support the needs of RIAs. We’re making it easier for them to incorporate annuities into their clients’ planning strategies.

RIJ: Where do you see the most sales potential?

Fuller: I see our products being sold in both places—the broker-dealer and the fee-only RIA platform. The hybrid RIAs have a history of greater appreciation for and use of insurance products. The fee-only RIA platform, on the other hand, is a true frontier for new annuity and life insurance sales. Those advisers haven’t traditionally used insurance products. In fact, fee-only RIAs are skeptical of insurance products. It will require education, new product development and new technology to develop that channel. The RIA market is still small. But it’s the fastest growing adviser market, and it serves people who need annuities. The question is, can we bring those concepts together?

RIJ: Nothing stands still for very long. The brokerage side is changing too, isn’t it?

Fuller: Trying to get shelf space in an era where broker-dealers have curated their product shelf isn’t easy. It’s not like it was before the 2016 Department of Labor’s fiduciary rule, when broker-dealers felt that it was more compliant to have open-architecture for products. Now a curated shelf is considered more compliant.

RIJ: Shifting to the “macro” view, we’re all still feeling whiplash from the Fed’s recent rate reductions.

Fuller: There’s no industry more impacted by low interest rates than the insurance industry. The rates determine the expense of providing the guarantees. Our sales pulled back after the financial crisis because of the impact of rates.

RIJ: Do falling rates affect both the in-force business and new business?

Fuller: Low rates don’t necessarily affect the in-force business. They affect the business going onto the books today. The annuity business we’re selling today is under pricing pressure. In the VA with guaranteed living benefits, low rates increase the cost of the hedging strategy. You can respond to that either by pulling back on benefits or pushing up on cost. Our competitors appear to be pulling back on benefits.

RIJ: Back on July 31, what was your personal reaction the first of the three rate cuts?

Fuller: What was my personal reaction? It was, “Damn it!” We were disappointed at how swiftly the Fed pulled back. It’s hard to see how the monetary policies of the last ten years—of quantitative easing and fiscal stimulus—haven’t resulted in more inflationary pressure. That’s what should have happened, according to current economic theory. I’m disappointed. Obviously, our value proposition is higher, and demand for our products is higher, when interest rates are higher.

RIJ: What can we expect to see from Lincoln in the coming year?

Fuller: We’re moving into 2020 with a game plan on how to manage the low rate environment for a longer period, and we’re implementing that plan.

RIJ: What will that entail?           

Fuller: We’ll provide choice. Commission-based products will always be a presence in the annuity marketplace. [Regarding the cost of a one-time annuity sales commission of 3% to 7% relative to an annual asset-based fee of 1%], I’ve always said, ‘Why is this not an easy math concept?’ People need to consider the length of the holding period when they compare the cost of the commission to the cost of the fees [which may be higher in the long-run].

RIJ: And on the product front?

Fuller: Our priority for 2020 is to put product development effort into Lincoln Level Advantage. We’re looking at the duration of the product and at the participation rates. We’re also focused on building out more shelf space for it. Beyond that, our next focus will be to develop guaranteed living benefits that are less sensitive to interest rate fluctuations.

RIJ: With the passage of the SECURE Act in December, will Lincoln try to take advantage of the safe harbor for plan sponsors choosing in-plan annuities?

Fuller: We’ve had a product available: Secured Retirement Income, which is available as either as a standalone investment, or included in the glide path of custom target-date portfolios. We’ve given it a compelling guarantee. We made sure that it’s portable. The take-up rate today is minuscule, but the SECURE Act would mean a completely new frontier for the annuity industry.

RIJ: Thank you, Will. We appreciate this opportunity.

© 2020 RIJ Publishing LLC. All rights reserved.

 

 

 

 

Sizing Up Lincoln Financial

Posted on January 23, 2020 by -

In today’s cover story, which is based on an interview with Lincoln Financial executive Will Fuller, we note that Lincoln is smaller than some of its close domestic rivals near the top of the retail annuity sales charts, like AIG or New York Life. Nor does it have a big foreign parent, as Jackson National does.

In fact, Lincoln has grown and shrunk over the past 40 years in response to trends, events and opportunities. These include the conglomerate craze that began in the 1960s, the GE/Jack Welch divestiture trend in the 1980s, the post-1986 variable annuity boom, the bull market of the 1990s and the Great Financial Crisis of 2008-2009.

To learn more about this history, we turned to actuary Jeffrey K. Dellinger, who designed Lincoln’s annuities from 1981 to 2002 and headed Lincoln’s Individual Annuities business. He pioneered the development of variable annuity (VA) living benefit riders, patented Lincoln’s uniquely flexible i4Life income rider, and wrote “Variable Income Annuities” (Wiley Finance, 2006).

Dellinger

What follows might be considered a brief history of Lincoln Financial. While it represents the view of just one person, that person was in a position to observe a lot.

Insuring NASCAR

“Before around 1980 Lincoln abided by the favored corporate strategy of the day, which was ‘be a highly diversified company,’” Dellinger told RIJ. “The Lincoln National Life Insurance Company, founded in Fort Wayne, Indiana in 1905, is and was the flagship insurance company. But it formed a holding company, Lincoln National Corporation (LNC) in 1968. LNC has at various times owned First Penn-Pacific Life, which sold fixed annuities and owned a universal life (UL) administration system; American States Insurance Company, a property/casualty insurer; and Chicago Title and Trust Co.

“Lincoln offered life insurance, individual annuities, employer-sponsored annuities, individual mortgages, mutual funds, group health, disability income insurance, reinsurance, and structured settlements. It had a full-service defined benefit pension business and a pension risk transfer business. Outside the U.S., it was in the UK and Mexico. Lincoln even owned K&K Insurance Specialties, which insured major sporting events, including automobile racing events like NASCAR.”

But the conglomerate era passed, succeeded by a downsizing era. “In the 1980s, corporate strategy in the American academic world did a 180-degree turn. The new mantras were: ‘Narrow your focus’ and ‘Only engage in businesses where you can be a market leader or at least one of the top three companies,” Dellinger said.

Lincoln sold American States Insurance Company to Safeco and Chicago Title and Trust Company to Alleghany Corp. Lincoln exited its huge group health insurance business, its disability income business, its defined benefit pension business, and its pension buyout business. It sold its huge Lincoln National Reinsurance Company to Swiss Re and sold K&K to AON. It even outsourced its travel department and IT functions.

By the early 1990s, Lincoln was down to three core business lines: Individual annuities (the largest), employer-sponsored annuities, and life insurance. There was also the closed block of annuity buyout business the company was letting run off its books rather than selling.

Annuities take center-stage

“Lincoln’s individual annuity business was the earnings engine of LNC. Three things primarily accounted for this. First, alternative tax-deferral investment vehicles mostly went by the wayside due to federal tax law changes in the 1980s, leaving deferred annuities in an advantaged position,” Dellinger said.

“Second, while Lincoln was already selling individual annuities, primarily through its career agency system, its affiliation with American Funds Distributors (AFD) helped supercharge sales growth. At the time, Lincoln’s American Legacy VA product suite was the only place where you could get American Funds’ investment adviser, Capital Research & Management Company, inside a variable annuity. That relationship gave Lincoln access to tens of thousands of brokerage advisers as well as AFD’s wholesalers.

“This growth opportunity—and the bull market of the 1990s—spawned huge individual annuity product development. With so much at stake, a lot of attention was paid to pricing and asset/liability management. The design and pricing had to be proper because Lincoln’s tremendous individual VA sales growth and assets under management would magnify the impact of mistakes. Lincoln’s annuity business was the third largest in America, behind only TIAA-CREF and Hartford Life. Think about it: A single VA product that sold $2 billion per year meant that on average $1 million in premium per hour came in every hour of every business day all year.”

Wholesale changes

One more factor that affected Lincoln’s size: After a period of divesting non-core businesses, Lincoln started buying life insurance businesses.

“Wall Street analysts would often say that Lincoln’s individual annuity business line accounted for too much of its profits,” Dellinger said. “In response, then-CEO Jon Boscia once again had Lincoln entertaining acquisitions. This time, however, it was acquisitions of life insurance companies or blocks of life insurance. This led to the Jefferson-Pilot acquisition in 2006 and the acquisition of CIGNA’s life insurance operations.”

But these acquisitions didn’t produce a full counterbalance. Rather, Lincoln’s individual annuity business continued to dominate its earnings, and grew organically rather than by acquisition, he said.

The fact that Lincoln’s flagship American Legacy VA lost its monopoly on American Funds did not help Lincoln’s growth. American Funds became available in the Hartford Leaders VAs and, later, in other insurance companies’ individual VAs. At the same time, wholesaling for American Legacy VAs shifted from American Funds Distributors to Lincoln’s new in-house wholesaling company, Lincoln Financial Distributors. That was expensive.

“It takes a lot of money to start a several-hundred-strong collection of external-internal wholesaler pairs,” Dellinger told RIJ.

Crisis and bailout

Lincoln is relatively small compared to its peers in part because of the turmoil it endured one decade ago, he added. “Lincoln had written a lot of VAs with guaranteed living benefits (VA/GLBs), particularly guaranteed lifetime withdrawal benefits (GLWBs). Due to my work on these for my 1999 GLWB patent, I had strong familiarity with their characteristics.

“It was clear that sufficient GLWB sales, if mismanaged or mis-hedged, could eventually cause solvency-threatening risk exposure for insurers. While a federal government bailout of an insurance company had not yet ever happened, I wrote two to three years before the financial crisis that it was likely to come when the next large downturn in stock values occurred.

“So due to factors including liquidity and VA/GLB issues, Lincoln needed a government bailout. To receive one, it had to turn itself into a bank holding company to qualify for the federal money. Lincoln stock dropped from $74.72 on April 30, 2007 to $4.76 on October 31, 2008. In 2010, Lincoln sold Delaware Investments, its investment department and mutual fund company, to raise cash. This shrunk the company a little.

“To its credit, Lincoln did not exit the individual variable annuity business or the individual annuity business in total. Rather, it sought external help from an actuarial consulting firm to help it understand the investment risks inherent in its product designs and ways to mitigate such risks through product design, pricing, and especially hedging.

“The company doesn’t want to make annuity acquisitions—except for some compelling strategic advantage—that would exacerbate its dependence on its individual annuity business line for earnings. As an aside, another reason Lincoln is relatively small is that a big European company hasn’t swallowed it up.”

The stock buyback era

“Share buybacks have also shrunk Lincoln in size. Like many public corporations, Lincoln has bought back shares of its own stock. It’s safer for corporations to keep dividends low and instead return money to some shareholders via buybacks. The number of shares outstanding is down. Lincoln had 319 million shares outstanding in 2010 and has about 200 million today. So more than one share in three has been retired in the last decade. This, too, keeps Lincoln smaller than it might otherwise be,” Dellinger said.

“I recall Lincoln having a market value of around $7.5 billion perhaps 20 years ago. Its current market value is around $11.64 billion. Its growth rate—about 2.3% per year—is the combined result of earnings made, earnings reinvested in the company, earnings paid out as dividends, and earnings spent on stock buybacks. The point is that the size of the company hasn’t grown at much of a clip. In sum, there are many reasons why Lincoln is the size it is.”

© 2020 RIJ Publishing LLC. All rights reserved.

Honorable Mention

Posted on January 17, 2020 by -

Nag Odekar moves to HealthView from Great-West Financial

Odekar

Entrepreneur and composer Nag-Bushan Odekar has joined HealthView Services and HealthyCapital as chief strategy and marketing officer.

Odekar was previously vice president and head of marketing for Great-West Financial’s Individual Markets business, where he led strategy, product marketing, customer experience and digital solutions. He also led a team responsible for go-to-market strategies, campaigns, brand management, advertising, industry conferences and promotions.

In 2012 Odekar co-founded and was chief operating and marketing officer for Forevercar.com, a website portal seeking to revolutionize the purchase of car repair services. He oversaw the design and development of the e-commerce website, SEO, SEM, customer experience, as well as digital and email marketing, until its sale to a private equity company in 2014.

Odekar previously held leadership roles in marketing, product innovation, communications and brand strategy at Athene, Northwestern Mutual, The Hartford, and Fidelity Investments.

A Juilliard-trained composer and conductor, he has been a regular speaker at technology, digital marketing and financial services conferences.

HealthView Services (www.hvsfinancial.com) provides software for retirement healthcare costs, Social Security optimization, Medicare, and long-term care retirement planning tools for the financial services industry. HealthyCapital provides tools for using condition-management data to incentivize improved health and retirement healthcare savings.

Which default investment is the stickiest?

Managed accounts are the stickiest default option in qualified defined contribution workplace savings plans, followed by target-date funds and then balanced funds, according to a new research paper from David Blanchett, director of retirement research at Morningstar, Inc.

“The increased personalization” associated with managed accounts may explain the greater “stickiness” of these accounts, but the exact reason is still unknown, the paper said, noting that it will be important to continue researching this topic as they become more popular as “opt-in” and “opt-out” arrangements in DC plans.

The popularity of managed accounts—a service that Morningstar sells—calls into question the historical emphasis on fees, performance and “fit” with plan participants when plan sponsors evaluate default investments, Blanchett concluded.

“While we believe the above criteria are important, we also believe it is important to consider the likelihood of participants’ continued usage of the default investment solution,” the paper said.

Blanchett noted that participant acceptance of a default was meaningfully influenced by the type of default offered and participant demographics.

“Participants who are more likely to accept/use the default are not the ‘average’ participant, which has important implications when designing or selecting a default investment for a plan,” the paper said.

Bhalla to be CEO of American Equity Investment Life

Bhalla

Equity Investment Life Holding Company, effective March 1, 2020. He succeeds John M. Matovina, who is retiring on that date, the company’s board announced this week.

Bhalla will also succeed Matovina as president and will join American Equity’s Board on January 27, 2020. Mantovina will remain on the Board as non-executive Chairman.

From 2016 to 2019, Bhalla served as executive vice president and CFO of Brighthouse Financial, the publicly traded spin-off of MetLife’s U.S. individual life and annuity business. He joined MetLife in 2014 as CFO of retail business.

Bhalla co-led the creation of Brighthouse in 2016. During his tenure at Brighthouse he guided its migration from legacy variable annuity products into newer fixed index and structured annuity products and market segments.

Prior to MetLife, he served at AIG, Lincoln National, Ameriprise Financial and other Fortune 500 companies in senior roles including chief risk officer and treasurer. Since last spring, Bhalla has been a partner of Bhalla Capital Partners. He earned a bachelor degree at Madras University, India and an MBA from S.P. Jain Institute of Management and Research, India.

Matovina became CEO and president of American Equity in June 2012, and succeed the firm’s founder, David J. Noble, as chairman in April 2017. He joined the board in June 2000 and began his employment with the company in June 2003 as vice chairman. He served as CFO and treasurer from January 2009 to June 2012.

As CEO, Matovina oversaw substantial growth in the company’s business and market capitalization and the diversification of its distribution network into banks and broker-dealers. During his tenure, the Company’s market capitalization increased 328% and its book value per share excluding accumulated other comprehensive income increased 67%. Its operating income excluding unlocking more than tripled and its investment spread more than doubled.

Great American joins SIMON structured products platform

It’s official: Great American Life is the second insurance carrier to offer products on the new annuities platform for wealth managers created by SIMON Markets LLC, which also offers structured notes. RIJ reported this event in its December 5, 2019, issue.

SIMON’s platform is accessible to more than 30,000 financial professionals managing more than $3 trillion in assets. Great American offers fixed indexed annuities and structured variable annuities. Joe Maringer, Great American Life’s National Sales Vice President, played an integral role in the development of the new partnership.

© 2020 RIJ Publishing LLC. All rights reserved.

 

What the Debate over ‘Wealth Taxes’ Misses

Posted on January 17, 2020 by -

The current debate over wealth taxes mostly focuses on whether the very rich are under-taxed, but gives little attention to the most efficient and fairest ways to tax them and capital income more generally. Here are three specific questions that any well-designed effort aimed at raising taxes on the wealthy should answer:

  • How do the changes address double taxation?
  • Is there any reason why gains unrealized by time of death should be subject to income tax, as under current law, only for heirs of decedents who die with money in retirement accounts?
  • When is the best time to tax wealth and/or returns from capital?
Double tax issues

The wealthy already may be taxed through corporate income taxes, individual income taxes, and estate taxes. Few believe these taxes combine efficiently to raise revenue or that the burdens are distributed fairly. Some individuals are subject to all of these taxes on their capital income, some none. These double tax issues could become magnified should a new wealth tax simply be grafted onto the existing tax structure.

 

Consider how the corporate tax can combine with the individual income tax (both statutory income tax rates and a “net investment income tax”) to create a double tax. For now, I’m ignoring the estate tax. A new wealth tax can create a triple tax for the stock owner of a corporation that recognizes its income currently and then pays the remaining income (after corporate income tax) out as dividends.

Suppose the return on capital is 6%. Then a 2% percent wealth tax is roughly equivalent to a 33% income tax rate on that capital income. However, that wealth tax can combine with a 21% corporate income tax rate and a potential individual income tax rate of 23.8% (the 20% tax on qualified dividends plus the 3.8% net investment income tax).

After taking into account interactions, the total tax rate on that return is still over 70%, well above the current nearly 40% potential combined corporate and individual income tax rates.

By contrast, the partnership owner of real estate who uses interest and other costs to completely offset rent revenues, while earning a 6 percent net return entirely in the form of capital gains on the property, owes no corporate or individual income tax currently, and simply pays the 2 percent wealth tax, for a combined tax rate of 33 percent on the income generated by this property.

Double taxes (or triple taxes) aren’t new by any means. What to do about them depends upon the purpose of those taxes. But at very high levels of assessment, where the effective income tax rate can approach or exceed 100%, this issue becomes a lot more important. And, as far as I can tell, almost none of the proponents of a wealth tax have dealt with or even discussed it.

Taxation of gains accrued at death

Among the issues that arise in assessing higher taxes on the wealthy is whether Congress should continue to forgive income taxes on gains accrued but not yet taxed by time of death because the underlying assets have not been sold.

Both the holder of a regular IRA account and the owner of corporate stock with accrued capital gains have income earned during their lifetime but not yet taxed by time of death. Yet only the latter gets permanent forgiveness of the tax, because the heir’s basis in the asset is “stepped up” to the value at the time of the original owner’s death.

In contrast, heirs of an IRA or other retirement account must over their lifetimes pay tax on all gains accrued by their deceased benefactors. (In fact, Congress just passed a new law requiring heirs to recognize income and pay income tax over ten years on inherited retirement accounts.)

Now I recognize that the two cases are not exactly equivalent. IRA owners get an extra tax break by deferral of taxes on their wages (because the contribution to a traditional IRA is deductible). But I suggest that the same holds for many wealthy taxpayers for whom the returns to wealth often derive from returns to labor and entrepreneurship for which tax was also deferred. Why not create greater parity between households with IRAs and more wealthy households who accrue their untaxed capital income outside of retirement accounts?

Timing of taxation on returns from wealth

Regardless of the level of tax assessed on the wealthy, when to tax them raises very important efficiency issues. See my earlier two-part discussion here and here. Among the concerns that carry over to wealth taxation, successful entrepreneurs become wealthy mainly by earning a very high rate of return on their business assets and human capital, then saving most of those returns within the business.

Because the societal returns to most great entrepreneurial ideas dissipate as the new idea ages, and the skills of the entrepreneurs often don’t pass onto their children, rich heirs tend to generate lower rates of return for society, not just themselves, than their entrepreneurial forebears.

Thus, it may be better for society to collect tax on the accumulated unrealized gains at death rather than taxing them during life and reducing the entrepreneur’s wealth accumulation. As Winston Churchill once stated, “The process of creation of new wealth is beneficial to the whole community. The process of squatting on old wealth though valuable is a far less lively agent.”

Answering the three questions raised at the beginning of this post can help channel efforts to raise—or for that matter, lower—taxes on the wealthy more efficiently and equitably.

This column first appeared on TaxVox on January 8, 2020

Next-gen funds will be active/passive hybrids: Cerulli

Posted on January 17, 2020 by -

With active-passive hybrid mutual funds likely to dominate the future, the historical debate over active versus passive funds is destined to become a thing of the past, according to the latest issue of The Cerulli Edge—Global Edition.

“An investment model—structured around service provision and its high level of value rather than sales of yet another active equity fund—looks set to provide an alternative to active management fees,” said Justina Deveikyte, associate director, European institutional research at Cerulli Associates.

Demand is up for strategies that perform like actively managed funds but with lower fees, such as smart beta and “active” exchange-traded funds (ETFs). In the fixed income arena, such ETFs offer investors access to funds with higher or lower allocations to certain issuers.

“The market for “ETFs offering hand-picked, then packaged-up, basket exposure to broad themes such as robotics, climate, or rapid urbanization, is set to thrive,” said Deveikyte.

When Britain’s state-sponsored defined contribution plan, the National Employment Savings Trust (NEST), sought external private credit managers for its investment mandates, it chose managers who could provide innovative “evergreen, scalable” fund structures. Such structures were deemed better able to meet the liquidity and legal needs of NEST participants better than closed-end funds with limited lives.

As retirement plans migrate from a focus on fees and price to value and outcomes, more asset managers will offer a mix of self-advisory mandates that provide portfolio-allocation tools or risk-and-performance tools.

Alternatively, instead of creating a wide array of products themselves, asset managers may increasingly source strategies from expert boutique fund managers in a more consumer-centric business model.

“Straightforward active equity will continue to face strong headwinds, yet the distinction between active and passive is starting to soften. The trend for thematic exposure, and the industry’s shift to services rather than products, promises new avenues for growth,” said Deveikyte.

Other findings from Cerulli

Liberalization of the financial market in China is giving rise to potential new opportunities for foreign managers in the country, including retail funds, retirement assets, institutional investors, high-net-worth individuals, and foreign investments. Cerulli believes that global managers with good track records in certain specialized areas have an advantage.

© 2020 RIJ Publishing LLC. All rights reserved.

Applying Actuarial Science to Income Planning

Posted on January 17, 2020 by -

While impartial experts have repeatedly shown that income annuities can supercharge a retirement portfolio, relatively few people—not retirees or advisers or even the actuaries who build annuities—buy them, let alone use them to maximum advantage.

Shemtob

At the Society of Actuaries’ “Living to 100 Symposium” this week, actuary and Certified Financial Planner (CFP) Mark Shemtob became the latest in a long line—from Menahem Yaari to Wade Pfau—to make the case for adding a single premium immediate annuity (SPIA) to a retirement income plan.

Because of his actuarial background, Shemtob’s approach is unusual. “Actuaries typically work in institutional settings,” he told RIJ. “I introduce actuarial science into individual retirement planning.”

Shemtob has also a developed an information platform (REST or Retirement Education and Strategy Tool) and a basic calculator for analyzing and comparing strategies. Not least, he claims success in persuading many of his wealthy clients to embrace annuities.

At the symposium, Shemtob presented his method. The steps involve estimates of life expectancy, returns, balances, and income gains for every year between retirement and anticipated age of death, based on 10,000 randomizations. His methodology can be found in the chart below; I’ll cut to his case study.

A path to steady income and high final wealth

A healthy 62-year-old woman wants to retire immediately. She has $1 million saved, a mortgage-free home, and a buyout offer from her employer of $5,000 a month for three years. She expects $2,500 a month from Social Security at age 66½. Her income goal is $6,000 a month, growing at 2% per year to offset inflation.

Based on her health and gender, this client has a life expectancy of 90 and a 16% chance of reaching 100. Shemtob assumes annual growth rates of about 3% for fixed income and about 7% for equities (with standard deviations of 4.4% and 15.6%, respectively), a 2.6% inflation rate and a retail SPIA payout rate of $5,880 per year per $100,000 in premium.

Using the method in the chart, Shemtob compares three strategies for their relative ability to maximize reliable income or maximize final wealth. For simplicity, he ignores taxes, home equity and long-term care costs.

  • Strategy A. Taking Social Security at age 62, using a 60/40 stock/bond investment portfolio, and not buying a fixed income annuity.
  • Strategy B. Taking Social Security at age 66, using a 70/30 portfolio and buying a $250,000 fixed income annuity.
  • Strategy C. Taking Social Security at age 62, using an 80/20 portfolio and buying a $500,000 fixed income annuity.

In each year, the hypothetical client withdrew enough from her investments to meet her income goal, dipping into principal only if the previous year’s earnings plus guaranteed sources of income didn’t satisfy the amount projected under the plan.

If you’re new to this type of analysis, you might be surprised that Strategy C produced the most reliable income and the highest final wealth. Strategy A showed steady income and modest wealth growth to age 85, but only 70% of desired income at age 100. Strategy B showed 90% of desired income even at age 100, and steady legacy growth, but not as rich as Strategy C.

What’s the catch? The annuity buyer has to accept a big drop in liquidity at the start of retirement in the belief that her riskier asset allocation—made possible by $29,400 in safe annual annuity income—will pay off in higher returns in the long run.

“People avoid annuities because they’re afraid it will hurt their kids [by reducing their inheritances]. But if you live long enough, the purchase of an annuity actually helps your kids,’ Shemtob said.

So why don’t more retirees supplement Social Security and investment gains with annuities? Most people get their retirement advice from investment advisers who aren’t familiar at all with annuities, or whose business model doesn’t accommodate commission-paying annuities, or from insurance agents accustomed to selling only packaged products.

What RIJ calls “ambidextrous advisers”—professionals who are adept at blending insurance products and investments for maximum income and maximum safety in retirement—still represent only a tiny percentage of the hundreds of thousands of financial intermediaries in the U.S.

The market for SPIAs is limited for several reasons. Independent agents and advisers historically earn lower commissions by selling SPIAs than by selling deferred fixed indexed annuities (FIAs) or deferred variable annuities (VAs), so many potential clients never hear about SPIAs. It’s also likely that many retirees regard Social Security as the only annuity they need.

Life insurers hope that demand grows for no-commission FIAs or VAs among clients of registered investment advisers (RIAs), and that an appetite for guaranteed lifetime withdrawal benefits develops among participants who own target date funds in 401(k)s. The scenario that Shemtob described remains more the academic ideal than the marketplace reality.

© 2020 RIJ Publishing LLC. All rights reserved.

Extreme Longevity? He Lives It

Posted on January 17, 2020 by -

Relaxing on a patio in the mild Florida air after lecturing at the Society of Actuaries’ “Living to 100 Symposium,” 98-year-old demographer Jacob S. Siegel was living proof that human beings can be mobile and productive well into their tenth decades.

Just two years ago, Siegel, who goes by Jay, published a 719-page textbook, “Demographic and Socioeconomic Basis of Ethnolinguistics,” which synthesizes topics that have intrigued him since he entered the University of Pennsylvania 80 years ago.

“Clinically, I’m in good shape,” said Siegel (below), wearing a sky-blue sweater over a white shirt, khakis and soft leather shoes. “For the first 10 yards, I can walk as fast as anybody. But at this age, I’m a mass of symptoms.”

Siegel

Siegel gave a slide presentation on the “Demography of Retirement in the U.S” to a roomful of actuaries and others on the first morning of the symposium—the seventh in a series that since 2002 has showcased contributions to global aging research. The SOA hosts it every three years in Orlando.

As superbugs are to epidemiologists and warming seas are to climatologists, so is global aging to actuaries and demographers. All of these professions employ statistics and calculus to extrapolate from current trends so that governments, insurers and individuals can anticipate and prepare for the risks of the future.

Our DNA ‘clocks’ tick at different speeds

On Monday, a prominent researcher in a relatively new field of epigenetics—the study of chemical modifications of genes—presented his work on aging and DNA methylation rates. These are the rates at which methyl compounds (–CH3) attach to or detach from the 28 million cytosine sites in human DNA. Cytosine, guanine, adenine and thymine are the four main bases of DNA.

The rate of this mysterious but essential process is now used to measure biological age, as opposed to chronological age. For instance, DNA methylation has shown with precision that the body’s tissues age at different rates. The cerebellum, the neuron-rich region where the brain meets the spinal cord, ages most slowly.

Horvath

“DNA is not just the carrier of genetic information,” said researcher Steve Horvath, a Harvard-trained professor of biostatistics at UCLA. “It’s one gigantic aging clock that measures aging in all of the cells that contain DNA. It’s the ‘Grim Reaper’s’ hourglass.”

Tip-of-the-chromosome compounds called telomeres were once considered the body’s most accurate timepiece. But DNA methylation looks more promising, Horvath told RIJ. It can be used to make insurance underwriting and pricing more accurate or to measure the efficacy of anti-aging drugs. It has already been used to identify behaviors—like exercise or vitamin E intake—that retard aging.

Impossible savings goals

How much money would American workers need to save in a retirement plan (defined benefit or a defined contribution) over a lifetime of work to save enough to replace 40% of their final pay each year for a 35-year retirement—from age 65 to age 100?

Jonathan B. Forman, who teaches tax and pension law at the University of Oklahoma law school, addressed those questions in a presentation at the symposium. His grim calculations showed that it would take nearly ideal conditions—steady employment, savings, raises, and capital gains over a 40-year career and low annuity prices—to reach adequate savings.

Forman

To simplify his calculations, Forman started with round-number assumptions. He posited that, based on final salary replacement requirement of 70%, people finishing their careers with $100,000 incomes would need $40,000 a year from savings, plus Social Security benefits, to meet their annual spending needs in retirement.

To buy an annuity producing $40,000 a year, they would need at least $400,000 in savings by age 65, he assumed—erring generously on the low side to start with. To accumulate $400,000, they would have to save at least 7.27% of their income each year for 40 years, earn 5% a year, experience an annual inflation rate of 2.5%, enjoy 3.5% annual salary growth, and vest immediately in their savings plans or pensions.

But Forman demonstrated that the average person would have a difficult time hitting even those low numbers. Americans routinely experience career interruptions, including layoffs in their 50s that deprive them of critical savings years. Many people retire at 62 and dip into their savings immediately.

At the same time, $400,000 isn’t likely to produce an inflation-adjusted $40,000 a year. Today, according to immediateannuities.com, a fixed $3,300 per month joint life annuity costs about $750,000. As possible solutions to the savings dilemma, Forman listed a fully funded Social Security program, Social Security add-on accounts, and mandatory defined contribution plans with auto-enrollment and auto-portability.

Life insurers fall short

On the last day of the symposium, a reinsurance expert and inventor of the Vita mortality bond, Ronald Klein, gave a wide-ranging talk entitled, “The Insurance Industry’s Response to the Worldwide Aging Crisis.” He told the actuaries, “The response has not been very good.”

Klein enumerated the life insurance industry’s mistakes, including:

  • Few people understand what the word annuity means.
  • Life insurers are pitching annuities as investments when they’re insurance.
  • Life insurers are chasing digital distribution when consumers need personal handholding
  • A lower percentage of the public (23%) has a favorable view of the insurance industry. That’s worse than their view of banks or drug makers.

Klein

“Annuity issuers should be calling people when they reach age 59½ to ask if they’ve thought about turning tax-deferred savings into income,” he said. “But they don’t. I’m 59½, and nobody’s calling me.”

As for software that tries to scare young people into saving more by showing them how they’ll look in old age, he said, “This is a great idea. I love it. But it works for only one person at a time. It’s not going to move the needle on annuity sales.”

Self-reliance

Before the symposium ended, Jay Siegel talked a bit more about his almost century-long life. Asked if living for a century had been a specific goal of his, he dismissed that thought with a sharp wave of his hand. “Not at all,” he said. “When I was 25 I thought I might live to 35.”

Siegel’s father fled pre-revolution Russian pogroms in what is now Latvia and recorded those events, along with poems, in a diary that Siegel still has. Arriving in Boston and migrating to Philadelphia, his father opened a grocery there. His mother kept what Siegel called a “filo-centric” household; she fussed lovingly over her children’s health and happiness.

Reaching age 98 wasn’t easy: Good fortune and grief struck Siegel in roughly equal measure. Among his early successes: while at Philadelphia’s selective Central High School, he won a full scholarship to Penn by acing a city-wide test.

Siegel has worked at the U.S. Census Bureau, written textbooks, and taught at, among other schools, Cornell, Georgetown, and the University of California at Irvine, as well as abroad. He co-authored “the bible” for his discipline (“The Methods and Materials of Demography”) in 1971. At age 90, he published “The Demography and Epidemiology of Human Health and Aging.” He is currently revising his 2001 book, “Applied Demography.”

As a demographer, he observed that “individual lives are often like miniatures of vast social movements.” His personal motto has been, “Don’t dwell on what you can’t do. Instead, think about what you can do.” He recommends self-reliance; whenever the need arose, “I became my own lawyer, psychiatrist, and stockbroker. Never let other people do for you what you can do for yourself.”

© 2020 RIJ Publishing LLC. All rights reserved.

Honorable Mention

Posted on January 9, 2020 by -

Seeking scale, Nationwide adopts two BNY Mellon funds

Nationwide’s Investment Management Group business has adopted two mutual funds from the BNY Mellon Family of Funds: BNY Mellon Disciplined Stock

Fund (reorganized as Nationwide Mellon Disciplined Value Fund) and BNY Mellon Growth and Income Fund (reorganized into the existing Nationwide Dynamic U.S. Growth Fund), effective December 16, 2019.

“The fund adoptions expand Nationwide’s lineup of investment offerings and could provide potential asset growth opportunities that, if realized, may result in more efficient portfolio management and economies of scale,” Nationwide said in a release.

The Nationwide Mellon Disciplined Value Fund seeks total return by investing primarily in common stocks. John Bailer, Brian Ferguson and David Intoppa of Mellon will manage the Fund.

The Nationwide Dynamic U.S. Growth Fund seeks long-term capital growth. Mellon Portfolio Managers Vassilis Dagioglu, James H. Stavena and Joseph Miletich, began managing the fund in July of 2018 and will continue to do so.

Symetra’s new asset management unit helps parent invest in U.S.

The first task of Symetra Financial Corporation’s new standalone investment subsidiary, Symetra Investment Management Company (SIM), will be to help Sumitomo Life Insurance Company, Symetra’s parent, invest in U.S.-based assets, Symetra announced recently.

The initiative allows Symetra to expand its investment capabilities and assets under management, the company said in a release from Margaret Meister, president and chief executive officer, Symetra Financial. Sumitomo completed its first investment of $500 million through a corporate bond fund in December 2019.

Mark E. Hunt, president of SIM, which manages almost $40 billion in assets, will remain executive vice president and chief investment officer for Symetra Financial. SIM’s operations include a fixed income team in Farmington, Connecticut, and a commercial mortgage loans team in Bellevue, Washington.

The SIM team also includes Colin Elder, senior managing director and head of commercial mortgage loans; Nicholas Mocciolo, senior managing director and head of structured bonds and derivatives; and Evan Moskovit, senior managing director and head of corporate fixed income.

Small and smaller: Vanguard ETF and fund fees dip slightly

Nine Vanguard stock and bond ETFs reported lower expense ratios in annual reports published December 24, 2019, including the $24.3 billion Vanguard Total International Bond ETF, the $17.3 billion Vanguard Total International Stock ETF, and the $63.2 billion Vanguard Emerging Markets Stock ETF, the largest in its category.

Vanguard also reported lower expenses on two actively managed mutual funds, Vanguard Global Minimum Volatility Fund and Vanguard International Value Fund.

In aggregate, these changes represent $27.7 million in savings returned to investors, bringing the total 2019 client savings to $69 million. A hypothetical $50 billion fund with a 10 basis point annual expense ratio would generate $50 million in gross management fee revenue.

The table below shows a list of expense ratio changes by fund. Last week, Vanguard announced expense ratio reductions on three international income-oriented funds and four externally managed active equity funds.

Index industry veteran joins Morningstar

Morningstar, Inc. has appointed Ron Bundy to lead its global Morningstar Indexes business. Bundy joined the firm in December as managing director, Morningstar Indexes.

The move “reflects Morningstar’s continued investment in a fast-growing indexes business that continues to elicit global demand amid the trend toward low-cost investing,” Morningstar said in a release. Morningstar’s Open Indexes Project supports the trend.

Bundy was most recently CEO of North America benchmarks and head of strategic accounts for global index provider FTSE Russell. Prior to Russell’s 2014 acquisition, Bundy served as CEO of the Russell Index Group, where he grew a U.S.-centric business 20-fold into a global operation.

Also joining Morningstar is Pat Fay, managing director of Morningstar Indexes. Fay was formerly head of research and consulting for EQDerivatives and, before that, global head of derivatives for FTSE Russell. During his eight years with CBOE, Fay led the launch of VIX derivatives.

Since its inception in 2002, Morningstar Indexes has grown asset value linked to Morningstar Indexes to $64 billion (as of Sept. 30, 2019), launched hundreds of beta and strategic beta indexes, embedded Morningstar’s independent research into differentiated offerings—such as the Morningstar Wide-Moat Focus Index Family and Morningstar Women’s Empowerment Index—that have underpinned a number of prominent ETF launches.

For pensions, falling yields undercut rising asset prices

In 2019, U.S. corporate pension funding ended down $30 billion for the year, with the funding ratio dropping from 89.4% at the end of 2018 to 89.0% as of December 31, 2019, according to the year-end results of Milliman Inc.’s latest Pension Funding Index, which analyzes the 100 largest U.S. corporate pensions.

Plan assets outperformed expectations, posting an annual return of 15.66% and a gain of $174 billion, Milliman said in a release. But record-low discount rates resulted in plan liabilities increasing as well, by $204 billion during 2019.

As of December 31, the Milliman 100 discount rate had fallen 99 basis points, from 4.19% at the end of 2018 to 3.20% a year later. This marks the lowest year-end discount rate that has been recorded in the 19-year history of the Milliman 100 Pension Funding Index (PFI).

“For corporate pensions during 2019, the funded status environment was like trying to fill a bucket full of holes with water,” said Zorast Wadia, author of the Milliman 100 PFI. “Funding levels would rise given superb asset gains but then quickly recede given offsetting liability movements attributable to ever-falling discount rates. Many plan sponsors can expect to have a rise in pension expense in 2020 given the funded status losses suffered by plans during 2019.”

Under an optimistic forecast (with rising interest rates of 3.80% by the end of 2020 and 4.40% by the end of 2021) and asset gains (10.6% annual returns), the funded ratio would climb to 104% by the end of 2020 and 121% by the end of 2021.

Under a pessimistic forecast (a 2.60% discount rate at the end of 2020 and 2.00% by the end of 2021 and 2.6% annual returns), the funded ratio would decline to 82% by the end of 2020 and 76% by the end of 2021.

Public pensions

Milliman’s 2019 Public Pension Funding Study (PPFS), which analyzes funding levels of the nation’s 100 largest public pension plans, included an independent assessment on the expected real return of each plan’s investments.

For Milliman’s 2019 PPFS, the estimated aggregate funded ratio of the nation’s largest public pension plans is 73.4% as of June 30, 2019, with the estimated combined investment return at 7.34% in Q1 2019 and 2.66% in Q2, and aggregate plan assets reaching $3.84 trillion as of June 30. Total Pension Liabilities (TPL) for these plans crossed the $5 trillion mark for the first time, and as of June 30, 2019 Milliman estimates the PPFS aggregate TPL to be $5.23 trillion.

“Plan assets continue to keep pace with liability growth, buoying public pension funding,” said Becky Sielman, author of Milliman’s Public Pension Funding Study. But plan sponsors are making low interest rate assumptions. “While interest rate assumptions of 8.00% were once the norm, 85 of the public pensions in our study now have assumptions of 7.50% or below,” she said.

See the full Milliman 100 Public Pension Funding Study at http://www.milliman.com/ppfs/. The complete Pension Funding Index can be found at https://us.milliman.com/en/periodicals/corporate-pension-funding-index. To see the 2019 Milliman Pension Funding Study, go to https://us.milliman.com/en/Insight/2019-Corporate-Pension-Funding-Study.

© 2020 RIJ Publishing LLC. All rights reserved.

TD Ameritrade offers two Pacific Life annuities for RIAs

Posted on January 9, 2020 by -

Will registered investment advisers (RIAs) start recommending annuities to their older clients, now that they can easily access no-commission annuities through online platforms?

The question arises whenever another RIA platform adds another no-commission annuity to its product shelf. Case in point: Pacific Life and TD Ameritrade just announced that two fee-based Pacific Life annuities are available for purchase through TD Ameritrade Institutional, which about 7,000 RIAs currently use as an asset custodian. Those contracts are:

  • Pacific Odyssey, a no-commission variable annuity (VA) with a lifetime retirement income rider and a guaranteed death benefit. A VA is typically a portfolio of stock and bond mutual funds with insurance and sometimes volatility-control features.
  • Pacific Index Advisory, a no-commission fixed indexed annuity (FIA). FIAs are structured products whose returns are linked to the performance of options on an equity or hybrid index. Owners of FIAs are guaranteed not to suffer market losses.

Some RIAs, especially those who were or still are registered with broker-dealers, might already be familiar with annuities, and may sell a few each year. But there’s a large cohort of RIAs who aren’t registered with a brokerage, aren’t licensed to sell insurance products, and have never sold an annuity.

The Pacific Life annuities, along with annuities from other carriers, will be available through The Insurance Agency of TD Ameritrade, LLC. Clients of RIAs will be able to buy them through TD Ameritrade’s insurance agents. RIAs are expected to apply their asset-based fee to the account value of the annuity contract.

In the press release, Pacific Life said that the rates and caps for Pacific Index Advisory will not change throughout the entire length of the initial guaranteed period. That should reassure advisers who worry that FIA issuers often reserve the right to change crediting rates from year to year, in response to changing market conditions.

Doug Mantelli, vice president of RIA strategy for Pacific Life’s Retirement Solutions Division, and Matt Sadowsky, director of Retirement and Annuities at TD Ameritrade, announced the deal in a January 7, 2020, press release.

TD Ameritrade Institutional offered no-commission annuities to RIAs as far back as 2012, but 2019 saw a surge in the distribution of no-commission annuities to fee-based advisors through online platforms such as Envestnet, DPL Financial Partners, Orion, RetireOne and others. Charles Schwab acquired TD Ameritrade in November 2019.

© 2019 RIJ Publishing LLC. All rights reserved.

‘Don’t overlook us,’ a boutique ETF issuer tells advisers

Posted on January 9, 2020 by -

Advisers are now more than twice as likely to say they’re seeking safety than seeking “alpha” for their clients, according to a new white paper from Cerulli Associates and Rafferty Asset Management, LLC, the adviser to Direxion ETFs.

But that sense of caution, inspired by an over-valued stock market, low bond yields, and liquidity concerns, can cause advisers to over-rely on the biggest exchange-traded funds (ETFs) providers and overlook boutique ETF issuers (like Direxion), the white paper said.

“The uncertain regulatory environment coupled with tightened internal compliance have made advisors refrain from bold tactical shifts in favor of strategic allocation,” a Cerulli release said. “Two-thirds of advisors use strategic allocations when building portfolios and seek downside protection and portfolio diversification (57% and 55%, respectively) over alpha generation (22%).”

As advisers try to build portfolios to withstand volatility, “they could be building portfolios that are too conservative to meet their clients’ objectives,” said Ed Louis, Cerulli senior analyst, in the release. “Issuers need to explain how their product is a strategic fit for advisors’ client bases instead of pure alpha generation.”

Many advisors are using multifactor ETF products to gain exposure to strategic asset allocations or making small factor tilts as recommended by asset managers they know and trust, the release said.

“Within the strategic asset allocation component, advisors are expressing their views by adding and subtracting sector exposure risk, selecting asset classes to overweight, or choosing to use passive products. At the earliest stages of portfolio construction, selecting and implementing a strategic asset allocation consists of active decisions,” according to Daniil Shapiro, associate director at Cerulli.

These factors, along with the search for lower expenses, are good for the ETF industry overall. In the first half of 2019, ETFs gathered 50% more flows than their mutual fund counterparts. But, to the chagrin of asset managers like Rafferty, the major ETF issuers are receiving all but a trickle of the flows.

The top-three largest ETF sponsors have 82% of ETF assets; market share jumps to 90% when expanded to the top five, according to Cerulli. Advisers evidently gravitate toward well-known brands, and tend to evaluate them on the basis of performance, liquidity of underlying holdings, and expense ratio.

But the assumption that brands are “proxies for quality and liquidity” and reliance on the top providers “can result in use of products that are not optimized to these advisors’ specific needs,” Shapiro said. Offerings from other providers may allow them to express specific views in a more targeted manner.

© 2020 RIJ Publishing LLC. All rights reserved.

Seeking ‘Ambidextrous Advisers’

Posted on January 9, 2020 by -

If you’re new to Retirement Income Journal, I’d like to tell you where we’ve come from, what we’re trying to accomplish today, and what we’re planning for the future.

The elevator version of our story: We want to serve our original audience of annuity product professionals (and actuaries, attorneys and academics in the broad “retirement industry”) while growing our readership among “ambidextrous” financial advisers.

By ambidextrous, we mean advisers who want to differentiate themselves and become more successful by combining investments (on the one hand) and income-generating annuities (on the other) in synergistic ways to provide affluent and mass-affluent Boomer clients with maximum income at minimal (or tolerable) levels of risk.

Most advisers today have both feet planted (to shift metaphors) in either the investment or the insurance world. But we believe that advisers should have a firm footing in both worlds, except perhaps when working with very rich or poor clients.

Being ambidextrous—understanding all types of retirement income strategies—becomes indispensable, we believe, in a regulatory environment where advisers are expected to act in the best interest of their clients. A one-dimensional approach to retirement will mean compliance problems and professional obsolescence.

A brief history

How did we acquire this philosophy? Before starting RIJ in April 2009 (one month after the bottom of the financial crisis), I worked for nine years at Vanguard and three years at Annuity Market News.

At Vanguard, I wrote marketing and educational materials about retirement and annuities. The late Jack Bogle didn’t see much need for annuities, but Vanguard at that time still sold variable annuities for customers seeking tax deferred growth on large amounts of savings, as well as fixed and variable single-premium immediate annuities (SPIAs).

In website articles and mailings to Vanguard shareholders, we posited that retirees in danger of outliving their money should put enough savings into annuities so that the annuity income plus Social Security would cover their essential expenses for life. In articles for advisers, we also suggested that annuities would free their clients to take more risk with their Vanguard mutual funds.

Those were slogans, certainly, but they embodied principles that RIJ still holds.

At Annuity Market News, I wrote for an audience of annuity professionals at life insurance companies. I learned about their products and their view of the world, leveraging my own experience in a large financial institution. On the side, I wrote Annuities for Dummies (Wiley, 2008). After Annuity Market News folded in March 2009, its audience was deprived of a valuable service. So I started RIJ.

Today and tomorrow

Since then we’ve tried to diversify our audience to include both advisers and annuity professionals, as well as actuaries, academics, attorneys, software entrepreneurs and others in the U.S. and abroad whose work is linked to retirement security. This means offering content that will interest members of each of these groups.

While we can’t be all things to all readers, we believe that many of you will continue to be interested in information that enhances your understanding of the larger retirement landscape. So we’ll continue to publish on an eclectic variety of topics, including international pensions, executive interviews, recent research, regulatory developments and more.

At the same time, every issue will include useful items for readers in the advisory world and useful items for readers in the annuity product world. We believe that our knowledge of both worlds helps us serve both worlds better. In short, we’ll try to be “ambidextrous” in our coverage of the two. If you think certain topics deserve more coverage, please reach out and let us know.

© 2020 RIJ Publishing LLC. All rights reserved.

A Look Back at (and Beyond) the ‘Stretch’ IRA

Posted on January 9, 2020 by -

The “stretch IRA” was a time-honored tactic in tax-efficient estate planning. It allowed children or grandchildren who inherited large traditional or Roth IRAs to spread the distributions—and their income tax liabilities—over the entire remainder of their lives.

A stretch strategy could be executed with trusts, annual withdrawals over a beneficiary’s IRS life expectancy, or life annuities. An IRA owner might buy a joint-life single premium immediate annuity (SPIA) and name a child as co-annuitant, or a child could buy a life annuity with the inherited assets.

As of January 1, 2020, however, the stretch has been outlawed. With the passage of the SECURE Act in December, only spouses and a few other “exempt” beneficiaries can distribute inherited traditional or Roth IRAs over their lifetimes. Others must empty them—and pay income tax on the distributions—within 10 years of receiving them.

The change was expected, but its suddenness—the ban on stretch IRAs became effective just 12 days after the SECURE Act passed on December 19—triggered a wave of webinars, articles, and LinkedIn conversations over the past weeks. (Kitces.com will host a webinar by accounting guru Jeffery Levine today, Thursday January 9, at 4 p.m.)

Simulating the stretch

Advisers who feel robbed by the SECURE Act must now consider simulating the tax benefits of stretch IRAs through other means. The main options for replacing the lost tax benefits (for non-exempt IRA beneficiaries) include:

Spend down traditional IRA faster. If the original IRA owner wants to minimize the tax burden on non-spouse beneficiaries, he or she can always take distributions, pay the tax, and gift the after-tax amount to anyone immediately.

Convert to a Roth IRA. If the IRA owner (original or surviving spouse) wants to keep distributions (net of income taxes) growing tax-deferred for up to 10 years after his/her death, they can gradually transfer them to a Roth IRA.

Name grandchildren rather than adult children as the beneficiaries of the IRA. The grandchildren will still have to distribute the IRA assets over 10 years, but they’re likely to be in lower income tax brackets than their parents.

Buy life insurance. IRA owners who are young enough and healthy enough can try to offset the anticipated tax burden of IRA distributions on beneficiaries by purchasing life insurance, which will render a tax-free inheritance. The owner will have to pay taxes on any IRA withdrawals used to buy the life insurance, and the cost of insurance premiums could be prohibitive. One source recommends buying a hybrid life/long-term care policy to take advantage of potential tax deductions for the premiums.

Buy a life annuity with a period certain or a cash refund. The IRA owner would receive income until he or she died, at which time the beneficiary would receive a refund of any unpaid premium. This strategy would not provide tax benefits for the beneficiary, however. (Check with the carrier to determine the length of the period certain duration they will permit.)

Name a charitable remainder annuity trust (CRAT) or unitrust (CRUT) as the beneficiary of the IRA; and name children or grandchildren as trust beneficiaries. Charity-minded IRA owners can arrange to bequeath their IRAs to irrevocable charitable remainder trusts. A charity receives a tax-exempt contribution, the estate of the IRA owner receives a tax deduction, and the beneficiaries receive taxable income from the trust for a specific period or until they die. A CRAT distributes a fixed annual annuity and does not allow additional contributions; a CRUT distributes a fixed percentage of the initial assets and allows additional contributions.

The $400,000 difference

These strategies, even more than the techniques they replace, are complex and labor-intensive. Predicting their eventual value is impossible, unless you knew exactly how long your clients will live, what their tax brackets will be each year, and what their beneficiaries’ ages, financial needs and tax brackets are. You would also need to know what the beneficiaries will earn on their subsequent investments.

As a rule, the wealthier the client and the greater his or her bequest motives, the more valuable such strategies obviously become. How valuable? In a recent article at the Financial Advisor website, James Blase, a St. Louis tax attorney, estimated the growth of $1 million IRA inherited by a hypothetical 60-year-old and held till he reached age 85.

If distributed within 10 years and reinvested at 5%, the IRA assets would grow to $1.85 million or $1.76 million after 25 years, depending on whether the IRA was emptied over the first 10 years or at the end of 10 years, he calculated. Under the old stretch IRA formula, the $1 million would have grown to $2.2 million, assuming that the beneficiary took only required minimum distributions (according to IRS unified life tables).

The martyred ‘stretch’

Killing off the stretch IRA will raise federal tax revenues by $15.7 billion over the next 10 years, according to a study published last April by the Congressional Budget Office (CBO). The new revenue offsets the estimated $16.3 billion that other provisions of the SECURE Act will cost the government.

Moving the starting age for required minimum distributions from IRAs to 72 from 70½ will cost $8.9 billion, according to the CBO. The SECURE Acts’ legalization of open multiple employer plan (“Open MEPs”) will cost an additional $3.4 billion, because it will likely increase participation in (and tax-deferred contributions to) retirement plans. The removal of penalties of Roth IRA distributions for births and adoptions will cost an estimated $1.2 billion.

Some observers have cheered this trade-off. Ben Norquist, the CEO of Convergent Retirement Solutions, which educates sellers of IRAs and small retirement plans, noted on LinkedIn this week that the stretch IRA itself did nothing to promote retirement income security.

“I’m already on record as being understanding/supportive of the basic premise of reallocating the tax revenue resources historically foregone (delayed) due to second generation stretch strategies to areas that can more directly move the needle on retirement plan coverage and retirement security,” Norquist wrote.

Chief mourner

Gary Mettler

But Gary Mettler, a Florida-based immediate annuity specialist and author, was disappointed by end of the stretch IRA. On January 3, he posted an article on LinkedIn with the headline, “How the SECURE Act WRECKED the SPIA/DIA and Pension Business.” SPIAs are single-premium immediate annuities. DIAs are deferred income annuities.

Mettler, an insurance agent and former executive at Presidential Life (now part of Athene) has long recommended SPIAs because their design—they use mortality pooling and are illiquid—allows them to offer retirees significantly more immediate monthly income per dollar of investment than a deferred annuity with a guaranteed lifetime withdrawal benefit (GLWB) or the 4% “safe withdrawal” method can.

He believes that the life insurance industry, which lobbied for the SECURE Act, was willing to trade away the stretch IRA to get two provisions that it wanted more: Open MEPs and a “safe harbor” clause that could make 401(k) plan sponsors much more willing to allow their participants to contribute to annuities.

While the SECURE Act will in theory ease the introduction of any type of annuity into 401(k) plans, in reality life insurers are more inclined to sell deferred annuities with GLWBs (or GLWBs as riders on target date funds) than to try to sell SPIA to plan participants.

That’s no secret. Demand for SPIAs is small, but the potential market for portable, liquid annuities with GLWBs as lifetime income options in 401(k) plans is potentially huge.

With the SECURE Act, “I think the life insurers wanted to put themselves in a better position to offer deferred annuities with guaranteed lifetime withdrawal benefits in retirement plans,” Mettler said in an interview. “They won’t use mortality-pooling products [such as SPIAs]. I think they even intended to put a pall over the SPIA product design.” As a SPIA aficionado, Mettler can’t help but regret that.

© 2020 RIJ Publishing LLC. All rights reserved.

Schwab adds hybrid robo income distribution service

Posted on December 19, 2019 by -

Charles Schwab, fresh from announcing its acquisition of TD Ameritrade, will in January 2020 launch Schwab Intelligent Income, a hybrid digital advice service “for people who want a simple, modern way to pay themselves in retirement, or any other time, from their investment portfolios,” according to a release Wednesday.

Schwab’s Intelligent Income will help customers “generate a predictable paycheck” from their portfolios without “high costs, lack of flexibility and long-term commitments,” said Schwab senior executive vice president and head of Investor Services Jonathan Craig. There was no indication that the services would include access to an annuity purchasing platform, in addition to providing “smart” systematic withdrawal plans.

According to the release, the Schwab service will help clients decide:

How much money to withdraw from retirement and taxable accounts

How to invest based on individual goals and time horizon

How to withdraw tax-efficiently from taxable, non-taxable, and Roth accounts

At press time, it was undetermined whether or how this new service might compete with digital advice services at Vanguard, Fidelity, Guided Choice, or Financial Engines, all of which serve either individual clients, retirement plan participants or both.

“More than half of our existing digital advice clients are over the age of 50, and Schwab Intelligent Income aims to solve the retirement income concerns common for this population – from the difficulty of managing multiple income sources to the fear of running out of money,” said Tobin McDaniel, senior vice president of digital advice and innovation.

Enrollees in Schwab Intelligent Income must answer a short set of questions that assess their financial situation, time horizon and risk tolerance. The tool will then recommend an appropriate strategy across their taxable and retirement accounts. The portfolios are comprised of low-cost exchange-traded funds (ETFs) from Schwab and third-party providers including Vanguard, iShares and Invesco.

Schwab Intelligent Portfolios has a $5,000 minimum and charges no advisory fee. Schwab Intelligent Portfolios Premium has a $25,000 minimum and charges an initial one-time $300 fee for planning and a $30 monthly subscription ($90 billed quarterly). Clients can get unlimited guidance from a Certified Financial Planner with the premium version of the firm’s digital advisory service.

Clients in Schwab Intelligent Portfolios and Schwab Intelligent Portfolios Premium pay the operating expenses on the ETFs in the portfolio, which includes Schwab ETFs and funds from third party providers. Based on a client’s risk profile, a portion of the portfolio is placed in FDIC-insured deposit accounts at Schwab Bank. Some cash alternatives outside of the program pay a higher yield.

Schwab Intelligent Portfolios Premium also features a satisfaction guarantee, which states that if a client is not completely satisfied for any reason, Schwab will refund any related fee or commission and “work with the client to make things right.”

© 2019 RIJ Publishing LLC. All rights reserved.

Size matters, Cerulli tells plan providers

Posted on December 19, 2019 by -

To stay profitable and satisfy the demands of plan sponsors and participants for cheaper, faster and more comprehensive services, retirement plan providers must achieve new economies of scale and upgrade their technology, according to The Cerulli Report – U.S. Retirement Markets 2019.

Growth—organic or via mergers/acquisitions—and technology that protects against cyber attacks, makes operations more efficient, and streamlines client engagement “will be “essential to maintain a competitive edge,” said Anastasia Krymkowski, associate director of retirement at Cerulli Associates, in a release.

‘Oligarchy’ ahead

With estimates that the 10-largest recordkeepers will represent more than 75% of recordkept 401(k) assets by year-end 2019, current market dynamics point to an “oligarchy” of retirement plan providers, the release said. Consolidation may include strategic partnerships as well as acquisitions.

M&A activity has continued in the recordkeeping space, with asset managers, consultant intermediaries, and third-party administrators all looking to widen profit margins by spreading costs across a larger book of business.

“Whether through acquisitions or strategic partnerships, retirement-focused firms that are lacking the capabilities to provide comprehensive financial guidance should consider their role in supporting plan sponsors and participants. They should also evaluate the potential to expand their purview into more holistic and higher-margin lines of business such as fiduciary services and managed accounts,” said Krymkowski in the release.

Spend to save

Innovation—in cybersecurity, payroll and recordkeeping infrastructure, customer-facing platforms, or data-driven portfolio management and financial advice—can also create efficiencies, reduce long-term costs, and give plan providers a competitive edge despite its expense, Cerulli believes.

Digital solutions, like robo-advice platforms, can standardize recommendations, combat human biases, and alleviate some of the more time-intensive, computational aspects of portfolio management and financial planning—even if humans still interpret, communicate, and implement the resulting advice.

“Ultimately, firms that can deliver personalized and user-friendly solutions are well positioned for long-term success” in both the institutional and individual wealth management spaces,” Krymkowski added.

“Providers should partner with plan sponsors to understand employees’ financial circumstances and identify the most appropriate products and strategies—keeping in mind that defined contribution investments represent just one piece of the puzzle.”

© 2019 RIJ Publishing LLC. All rights reserved.

New annuity ‘best interest’ rule from NAIC

Posted on December 19, 2019 by -

The National Association of Insurance Commissioners (NAIC) is finalizing a model regulation on the sales and recommendations of annuity products by insurance producers. The NAIC’s Life Insurance and Annuity (A) Committee adopted the current exposure draft of the Suitability in Annuity Transactions Model Regulation at the NAIC’s recent Fall National Meeting in Austin.

The adoption is subject to the incorporation of certain technical amendments, which are not intended to be substantive changes to the model and are expected to be completed by the end of 2019.

The model would impose a best interest standard on sales and recommendations of annuity products by insurance producers, which is a higher standard than the currently applicable suitability requirements but not rising to the level of a fiduciary duty.

National Association of Insurance Commissioners is finalizing a model regulation of the sales and recommendations of annuity products by insurance producers.

The Life Insurance and Annuity (A) Committee (the “Committee”) of the National Association of Insurance Commissioners (“NAIC”) adopted the current exposure draft of the Suitability in Annuity Transactions Model Regulation (the “Model”) at the NAIC’s Fall National Meeting in Austin, Texas this past weekend.

The adoption is subject to the incorporation of certain technical amendments which are not intended to be substantive changes to the Model and which are expected to be completed by the end of this year.

The Model would impose a best interest standard on sales and recommendations by insurance producers of annuity products, which is a higher standard than the currently applicable suitability requirements although it does not rise to the level of a fiduciary duty.

A producer would be deemed to have acted in the best interest of a consumer if the producer met obligations of care, disclosure, conflict of interest and documentation, which are detailed in the Model.

The Model would also prohibit an insurer from issuing an annuity product to a consumer unless the insurer had a reasonable basis to believe that the annuity would effectively address the consumer’s insurance needs and financial objectives.

Insurers would be required to establish and maintain a system of supervision over producer recommendations which would be designed to achieve the insurer’s and producer’s compliance with the requirements of the Model, including, inter alia, by providing education and training to producers with respect to the requirements of the Model and its annuity products and by reviewing producer recommendations prior to issuance.

The Model provides for various exemptions from its requirements, such as exemptions for certain group annuities. The Model also provides a safe harbor for sales and recommendations made in compliance with “comparable standards” — e.g., in compliance with applicable securities (SEC and FINRA) requirements in the case of a broker-dealer.

© 2019 RIJ Publishing LLC. All rights reserved.

An HNW Adviser’s Personal Income Plan

Posted on December 19, 2019 by -

Meet Alex Powers, a 62-year-old institutional bond manager and former private banker and portfolio manager. Not quite retired, he shuttles seasonally with his wife between a house in suburban New Jersey and a cottage on Cape Cod. Their two Millennial-age children are educated and self-supporting.

Eight years ago, at 54, Powers started facing his retirement planning chores. His longevity risk was hard to gauge; his mother’s family was short-lived, but his father is 97 years old and an aunt had lived to 96. His wife’s folks are 88 and 87. So the couple needed to prepare for long lives and potentially large long-term care costs.

He turned to a relatively recent annuity concept: deferred income annuities, or DIAs. For those unfamiliar with DIAs, they are income annuities that are typically purchased early in retirement for a lump sum and start paying out a fixed monthly income at age 75 or later.

“I liked the deferred income annuity concept,” he said. “As an investor, you want to diversify your risks. Buying a certain amount of stable income seemed like a good idea for a portion of our assets. Annuities also seemed to represent a good deal relative to bonds.” He believes individuals should start to consider DIAs five to 10 years before retirement to get the most out of the mortality risk pooling effect (which distributes the assets of annuity owners who die to those who live on.)

In 2011, he purchased what he described as a small joint-life DIA, from The Hartford (later Global Atlantic), that will start paying an income when he and/or his spouse reach age 84. Given the 30-year deferral period, the late income start date, and his choice not to add a cash refund feature (which would pay their beneficiaries a death benefit if the they didn’t live long enough to recoup any or all of their original investment), he was able to buy the future income stream at a steep discount.

Two more DIA purchases followed. At age 58, Powers bought a New York Life contract that starts paying out a fixed income when the couple reaches age 76. That same year, he bought a Northwestern Mutual Life DIA contract that starts paying a variable income when they reach age 79. The income is variable because the contract earns the life insurer’s dividend each year during the deferral period. This type of contract promises less guaranteed future income than a fixed DIA but a chance for much higher income.

Overall, Powers said he applied 6% to 7% of his savings to DIAs, creating a ladder of income that increases as each of his sources of guaranteed income kicks in. Social Security benefits for him and his wife will start at age 70, to be supplemented by additional layers of guaranteed income at age 76, age 79 and age 84. He also has a defined benefit pension that he can start taking anytime between the ages of 65 and 70½.

“I look at the DIAs as ‘longevity insurance,’ he told me recently. “My wife worries about nursing home expenses. To us, this is better than long-term care insurance. You get the money no matter what. And the further out you buy it, the less it costs. I’m not a big believer in the 4% rule.”

“We’ll eventually be getting a bit less than 40% of our income from guaranteed sources. We don’t spend a ton of money relative to our means. The DIAs will cover most of our basic income needs as long as inflation stays under 3% to 3.5%. I figure that if inflation runs no more than 3%, the proportion I get from guaranteed income will eventually go up to 60%.

“Other than mortality risk pooling, asset diversification is the only free lunch in the investment world. The more ways you can diversify the better off you’ll be. The way to do that is to have investments that are uncorrelated.”

Besides income annuities, he holds a sprinkling of real estate investment trusts (REITs), along with long-duration bonds, junk bonds, closed-end funds, gold, and index funds. He describes his portfolio as 40% bonds, 30% stocks, 10% closed end funds (mainly fixed income) six percent REITs and five percent gold.

“My dad thinks I’m nuts to own gold, but I think of it as an inflation hedge, a deflation hedge and a political-upheaval hedge,” Powers said. “I could probably go with more in stocks, but I believe this allocation improves my safe withdrawal rate.”

What about the rest of the Powers’ “household balance sheet”? With so much back-loaded guaranteed lifetime income, they probably won’t need their personal real estate as a buffer against longevity risk. Plans for their two paid-off homes are still unspecified, he added: “If we need additional money for long-term care, then we can sell one of our homes. At this point we don’t think the kids will be interested in them.”

As for tax planning, “We use a professional tax return guy who I can bounce ideas off of,” he said. “Just this year I started doing a limited conversion to a Roth IRA.

“The conversion was intentionally limited because I don’t want to bump up my tax bracket much. I should do more research on Roth conversions as a hedge against future tax law changes.” Regarding the DIAs, “we haven’t worked out the tax effects as much as we could.” As for bequests, “We have done some estate planning in case we both meet an accidental death. But nothing more significant.”

Having been both an adviser of ultra high-net-worth investors and an institutional trader/portfolio manager, he learned a few lessons. Wealth managers are too quick to try to sell single securities and structured notes to wealthy clients, he said. He also discovered that a firm’s best investment managers are more likely to be running the firm’s own money or its proprietary funds than advising clients. Yet he doesn’t think most people should try beat the market on their own. “Investing in index funds is a good thing,” he said.

“People who are used to selling stocks and bonds for a living tend to discourage you from buying annuities. The people who sell annuities want you to put a lot of your portfolio in them. The proper solution—the truth—is somewhere in the middle,” Powers said. “By far the most important thing that advisers do is to help people through the down periods so they don’t get scared out of the market.”

© 2019 RIJ Publishing LLC. All rights reserved.