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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.

The SECURE Act Set To Pass (Finally)

Posted on December 19, 2019 by -

After years of lobbying by large firms in the retirement industry, the Setting Every American Community Up for Retirement Enhancement (SECURE) Act of 2019 appears headed for enactment as part of Congress’ $1.4 trillion appropriations bill, whose passage averts an otherwise imminent government shutdown.

On Tuesday, the House of Representatives approved a government funding bill that contains the SECURE Act by a vote of 297 to 120, according to press bulletins. The Senate was expected to pass the bill and send it to the White House for President Trump’s signature this week.

“Things look likely that SECURE will be in the year-end funding package that Congress must pass in order to keep the federal government running,” said Brian Graff, CEO of the American Retirement Association, in a statement.

Melissa Kahn

Those who have worked towards this goal for several years are elated. “This is an early Christmas present,” said Melissa Kahn, managing director of the Defined Contribution team at State Street Global Advisors (SSgA), in an interview yesterday.

Her firm, the world’s third largest asset manager, distributes its target date funds (TDFs), exchange-traded funds and other investments through large retirement plans. The aggregation of dozens or hundreds of unrelated small firms into large open MEPs (multiple employer plans) could vastly expand the market for those products.

“We’re fired up for what’s ahead,” said Troy Tisue, CEO of TAG Resources LLC in Knoxville, TN, whose firm began experimenting with and promoting the idea of open MEPs in 2004. “This is obviously a big deal for TAG as the open MEP is in our DNA. But the real winner here is the small business owner.”

Policymakers are hoping that thousands of small employers—and the millions of low-income or minority workers they employ—will join such plans and that the nation’s “coverage gap”—the fact that at any given time about half of American workers lack a tax-deferred savings plan at work—will shrink.

Elements of the Act

The SECURE Act is a retirement industry wish-list at least three years in the making. It will:

  • Allow companies—regardless of industry—to join industry-sponsored multiple-employer 401(k) plans;
  • Increase the auto-enrollment safe harbor cap on participant contributions to 15% from 10%;
  • Simplify the non-elective contribution 401(k) safe harbor by providing notice and amendment flexibility;
  • Treat certain taxable non-tuition fellowship and stipend payments as compensation for IRA purposes, thus making it easier for individuals receiving such payments to save through an IRA;
  • Repeal the maximum age (now 70½) for making traditional IRA contributions;
  • Increasing the age at which required minimum distributions (RMDs) must start from 70½ to 72;
  • Expand the types of education costs that are coverable by 529 plans; and
  • Increase the credit limit for small employer start-up costs and create a new auto-enrollment credit to defray associated start-up costs.
The significance of ‘open MEPs’

For large full-service retirement plan providers like Empower, Fidelity, Lincoln Financial, MassMutual, Principal, and T. Rowe Price (some of whom also issue annuities), for asset managers like State Street Global Advisors and BlackRock, for large plan recordkeepers, for third-party administrators, for independent fiduciaries, and for financial advisers who act as brokers for 401(k) plans, the SECURE Act should, over time, create new business opportunities.

The Act could allow these companies, for the first time, to sponsor 401(k) plans—something that in the past only an employer could do. In the past, companies could join multiple employer plans only if they had something important in common—like the same industry, the same union, or the same profession.

These new multiple employer plans will be promoted to dozens or hundreds of small to mid-sized companies whose employers have been reluctant to start or are tired of running their own 401(k)s.

The potential for ‘in-plan’ annuities

The retirement industry also sees growth opportunities emerging from the SECURE Act’s partial lifting of employers’ liability when offering “in-plan” annuities. Today, plan sponsors (i.e., individual employers) are reluctant to include any type of annuity as an allocation option within their plan’s investment lineups. They believe that, if they did so under current pension law, the bankruptcy—however unlikely—of an annuity provider (i.e., a life insurer) could expose them to steep legal and financial risks or complications.

The annuity option to be offered in retirement plans would most likely be lifetime income benefit riders attached to TDFs. These funds are the default investment option for millions of participants, and the rider could be set up as part of the default. These riders have cost about 50 basis points a year and could be added, automatically, to participants when they reach, for example, age 45 or 50. No one is mentioning the introduction of fixed multiple-premium income annuities in retirement plans, which would carry restrictions on liquidity.

Empower Retirement, Prudential Retirement and Lincoln Financial all have TDF-based 401(k) lifetime income-generating products that have been lying more or less dormant, awaiting the SECURE Act’s passage to trigger a new round of marketing to large plan sponsors.

“We’ve had a product available,” said Will Fuller, the president of Annuity Solutions at Lincoln Financial, in a recent interview. “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.” The Lincoln product, Secured Retirement Income, is available as either as a standalone investment, or included in the glide path of a custom target-date portfolio.

The impetus for change

The retirement industry not only wanted the changes included in the SECURE Act; it needed them. The industry has been consolidating since the Great Financial Crisis, and only the largest asset managers, recordkeepers, and plan administrators with the biggest economies of scale are expected to survive over the long-term.

Indeed, an analyst at Cerulli Associates wrote this week that the retirement industry is moving toward “an oligarchy” of a few large providers. Today, just 10 plan recordkeepers handle an estimated 75% of 401(k) assets today, writes Cerulli’s Anastasia Krymkowski.

But Cerulli doesn’t expect the SECURE Act to have an instant effect on the retirement market or to disrupt the industry’s current hierarchy. “This is not going to make or break the big guys,” she told RIJ. “It will be interesting to see how this plays out over the next five years.”

Size will matter for retirement services vendors that are trying to cope with a variety of headwinds. They include declining fees for investment products, rising costs of technology—ranging from artificially-intelligent chat bots to cyber-security measures—and potential competition from the state-sponsored, auto-enrolled, public-option Roth IRA savings programs for small companies that have sprung up in Oregon, California, and other states.

In addition, some observers fret that the hunger for fast growth might tempt large providers into a form of industry cannibalization, where firms try to entice existing 401(k) plans into open MEPs instead of pitching to employers with no current plan or pre-existing pool of manageable assets.

One item that the SECURE Act withholds from retirement plan providers is the ability to sponsor retirement plans and simultaneously sell its own products to the plan. The potential synergies of such an arrangement are obvious, but so are the potential conflicts of interest and opportunities for unethical self-dealing.

“Today, you can’t be the sponsor of a multiple employer plan and provide the MEP with your own products. That would be a prohibited transaction” under ERISA (Employee Retirement Income Security Act of 1974), SSgA’s Kahn told RIJ yesterday. “Even if the Department of Labor allows some exemptions to the prohibited transaction rule, there would still be a lot of restrictions on providers.”

Ben Norquist

“That could be a dangerous opening for too much conflict of interest,” said Ben Norquist, CEO of Convergent Retirement Plan Solutions LLC in Brainard, MN., in an interview. His firm serves as an intermediary between the federal government and industry, helping firms digest new developments like the SECURE Act.

“We provide education, training and content that prepares plan advisers, sponsors and vendors for either ‘reactive compliance’ or growth opportunities. We’re doing a webcast about the SECURE Act on Wednesday,” he told RIJ yesterday.

Norquist expects to field a lot of nervous questions about the effective dates of certain provisions in the bill. For instance, the Act allows retirement account owners to delay required minimum distributions until age 72 and make IRA contributions until then, but the new rule applies only to those reaching age 70½ in 2020 or later. The elimination of the “stretch IRA” and the 10-year distribution requirement applies to deaths after December 31, 2019, but not for deaths before then.

The Act will create confusion at first, but Norquist welcomes a bit of regulatory confusion. “We’ve always told the financial services industry that, even when there are  negative changes, confusion creates opportunity,” he said. “With all the money pouring into fintech (financial technology), and all the efforts to streamline plan services, the open MEP concept creates a lot of interesting possibilities.”

© 2019 RIJ Publishing LLC. All rights reserved.

What rollover IRA owners are thinking

Posted on December 12, 2019 by -

More than two-thirds of US households with traditional individual retirement accounts (IRAs) have a strategy for managing their income and assets in retirement, and two-thirds of those have taken at least three steps to develop their strategy, according to a new Investment Company Institute (ICI) survey.

These households’ planning strategies include:

  • Reviewing asset allocation (72%)
  • Determining retirement expenses (67%)
  • Developing a retirement income plan (65%)
  • Setting aside emergency funds (57%)
  • Determining when to take Social Security benefits (54%)

The study, “The Role of IRAs in US Households’ Saving for Retirement, 2019,” also found that traditional IRA-owning households sought information from a variety of sources when developing their retirement income and asset management strategy. Among those households with a strategy:

  • 74% consulted a professional financial adviser
  • 24% used a website
  • 24% consulted with friends or family
  • 22% consulted a book or article in a magazine or newspaper
  • 7% used a financial software package

“Representing one-third of total US retirement market assets, IRAs are a critically important savings vehicle used by more than 46 million American households to prepare for retirement,” said Sarah Holden, ICI’s senior director of retirement and investor research. “ICI data show that traditional IRA–owning households protect their nest eggs by researching and developing strategies to effectively manage their savings and income in retirement.”

The study also found that 59% of US households with traditional IRAs in mid-2019, or 21 million US households, had accounts that included rollover assets from employer-sponsored retirement plans.

When asked about their most recent rollover, the vast majority (86%) of these households reported that they had transferred the entire retirement plan account balance into the traditional IRA, rather than withdrawing any portion of the account.

Nearly nine in 10 traditional IRA-owning households with rollovers made their most recent rollover in 2000 or later, including 63% who made their most recent rollover since 2010.

Other key findings of the report include:

  • More than one-third of US households owned IRAs in mid-2019. More than 60% of all US households had either retirement plans through work or IRAs, or both. More than eight in 10 IRA-owning households also had accumulations in employer-sponsored retirement plans.
  • More than one-quarter of US households owned traditional IRAs in mid-2019. Traditional IRAs were the most common type of IRA owned (owned by 28.1% of US households), followed by Roth IRAs (owned by 19.4%) and employer-sponsored IRAs (owned by 6.1%).
  • Traditional IRA-owning households with rollovers cite multiple reasons for rolling over their retirement plan assets into traditional IRAs. The three most common primary reasons for rolling over were “not wanting to leave assets behind at the former employer” (25%), “wanting to preserve the tax treatment of the savings” (17%), and “wanting to consolidate assets” (17%).
  • Retirees made most of the traditional IRA withdrawals in tax year 2018. Eighty-eight percent of households that made traditional IRA withdrawals were retired. Only 5% of traditional IRA-owning households headed by individuals younger than 59 took withdrawals.

“The Role of IRAs in US Households’ Saving for Retirement, 2019” includes data from ICI’s IRA Owners Survey and ICI’s Annual Mutual Fund Shareholder Tracking Survey.

© 2019 RIJ Publishing LLC. All rights reserved.

 

Mixed forecast for active ETFs: Cerulli

Posted on December 12, 2019 by -

Non-transparent exchange-traded funds (ETFs) are gaining product development mindshare, but whether they prove an attractive distribution opportunity will depend on the products that firms choose to launch and the pricing strategies they pursue.

According to a new report from Cerulli Associates, U.S. Exchange-Traded Fund Markets 2019: Expanding Beyond Passive, the majority (80%) of ETF issuers estimate that non-transparent ETFs will gather between $1 billion and $100 billion by 2025, suggesting that these products will take time to gain traction.

The U.S. ETF industry continues to expand, but its growth rate has slowed. Assets grew at a compound annual rate (CAGR) of 15% over the five years ending in December 2018, but industry revenues grew only 11% annually on average over the same period.

Intense competition, particularly amongst the most commoditized products, has made launching passive ETFs less attractive to all but the largest firms. ETF issuers polled by Cerulli in 2019 were significantly more likely to report at least moderate impact on their firm’s margins due to industry fee compression (46% report moderate impact in 2019 vs. 25% in 2018).

As a result of both fee compression and product proliferation, ETF issuers are increasingly looking to develop more active products that can earn higher fee revenues. At the same time, traditional active managers are interested in entering the ETF landscape (active mutual funds overall have suffered outflows since 2015). But equity managers who want to conceal their holdings (to maintain strategy confidentiality) are wary of the transparency of the ETF vehicle.

Non-transparent ETF structures provide a solution for firms that want to offer active strategies in the ETF wrapper but not divulge holdings. According to Cerulli’s research, almost half of issuers state that they are currently developing (20%) or planning to develop (27%) non-transparent active ETF products. That would mean a momentous shift in a market where only about 2% of assets are currently actively managed.

Some of the largest asset managers are either signing non-transparent structure licensing agreements or launching their own. “Nontransparent active ETFs are a logical progression as the existing ETF market moves beyond passive exposures,” said Daniil Shapiro, associate director of product development at Cerulli Associates, in a release this week.

“It’s likely that more active products will provide a more lucrative battleground for ETF sponsors, with the average issuer reporting that they expect to earn a greater share of fees from more active offerings in several years,” he added.

Cerulli believes that non-transparent ETFs will gain traction, but that their adoption will be highly nuanced. Product choice and pricing will be the most significant challenges for asset managers to overcome. “Assuming that the non-transparent structures and associated infrastructure [support] their strategies, asset managers will have to decide whether their newly launched products should be clones, differentiated versions, or entirely different products when compared to their existing offerings,” according to Shapiro.

Concerns about over-saturating distribution partners and the cannibalization of existing products will affect their decisions. “Asset managers will find it difficult to offer their best products at an attractive price,” he said. “Low costs are a key success tenet for ETFs, so managers risk creating a self-fulfilling prophecy where launched products are slow to gain traction.”

© 2019 Cerulli Associates. Used by permission.

YTD annuity sales up 7.5% over 2018: IRI

Posted on December 12, 2019 by -

Combined sales of fixed and variable annuities sales fell 8.4% in the third quarter of 2019, to $55.7 billion from $60.8 billion in the second quarter of 2019, according to the Insured Retirement Institute (IRI), which used data reported by Beacon Annuity Solutions and Morningstar, Inc.

Sales were on par with year-ago levels, down 0.4% from total annuity sales of $55.9 billion in the third quarter of 2018. Annuity sales for the first three quarters of 2019 totaled $174.3 billion, up 7.5% from $162.2 billion for the same period in 2018.

Fixed annuity sales highlights
  • $30.1 billion – 2019 third quarter fixed annuity sales
  • 16% decrease from second quarter sales of $35.8 billion
  • 5% lower than 2018 third quarter sales of $31.8 billion
  • $101.8 billion – fixed annuity sales in the year-to-date period ending September 30, 2019
  • 1% increase over sales of $89.2 billion in the year-to-date period ending September 30, 2019
Variable annuity sales
  • $25.6 billion – 2019 third quarter variable annuity sales
  • Up 2.4% versus 2019 second quarter sales of $25.0 billion
  • 2% higher than 2018 third quarter VA sales of $24.1 billion
  • $72.5 billion – variable annuity sales in the first three quarters of 2019
  • Down 0.7% from 2018 sales of $73.0 billion in the first three quarters of 2018

According to Beacon Annuity Solutions, fixed annuity sales are off recent highs, but fixed indexed and market value-adjusted annuities are higher than in the same period last year. In other highlights:

  • $18.2 billion – fixed indexed annuity sales fell 9% from second quarter 2019 sales of $20.0 billion but rose slightly from 2018 third quarter sales of $18.0 billion
  • $4.1 billion – Book value annuity sales fell 43.3% from $7.2 billion in the second quarter of 2019 and were 41.0% lower than 2018 third quarter sales of $7.0 billion
  • $5.0 billion – Market value adjusted (MVA) annuity sales were down 3.8% from 2019 second quarter sales of $5.2 billion but up 22% from third quarter 2018 sales of $4.1 billion
  • $2.7 billion – Income annuity sales fell 18.1% from second quarter sales of $3.3 billion and were flat compared with third quarter 2018 sales of $2.7 billion

For the entire fixed annuity market, there were approximately $17.4 billion in qualified sales and $12.7 billion in non-qualified sales during the third quarter of 2019.

“The inverted yield curve, along with declining corporate bond yields, continued to apply downward pressure on overall third quarter fixed annuity sales,” said Beacon Annuity Solutions CEO Jeremy Alexander.

“In addition, fixed indexed annuities suffered from higher hedging costs due to market volatility. We anticipate next quarter sales to be flat with an upward bias given the steepening yield curve, as well as rising corporate bond rates and lower market volatility.”

According to Morningstar, variable annuity net assets fell in the third quarter on lower investment returns and negative net asset flows. Highlights included:

  • $1.95 trillion – Variable annuity assets fell 0.5% from $1.96 trillion in the second quarter of 2019.
  • Allocation funds held $796.8 billion in VA assets, or 40.9% of the total, falling below the $800 million mark.
  • Equity funds held $597.0 billion, or 30.7% of total VA assets.
  • Fixed accounts held $351.2 billion, or 18.0% of VA assets.

Net asset flows in variable annuities were a negative $21.4 billion in the third quarter, worse than negative $20.4 in the second quarter but better than outflows of $24.8 billion in the first quarter. Within the variable annuity market, there were $16.7 billion in qualified sales and $8.9 billion in non-qualified sales during the third quarter of 2019.

“Structured annuities continued to gain market share in the VA space,” said Michael Manetta, Senior Quantitative Analyst at Morningstar. “More than a decade after a significant stock market correction, this growth likely reflects investor interest in products that offer downside protection to the account value.”

© 2019 RIJ Publishing LLC. All rights reserved.

A Few of Our Best Income Strategies

Posted on December 12, 2019 by -

Bill Sharpe, the Nobel Prize-winning economist, once described retirement income planning as the most complicated financial problem he’s ever faced. There are “up to 100, 200 parameters that you’ve got to nail down before you can find an optimum strategy,” he said in a 2014 interview.

At Retirement Income Journal, we report on many of the different strategies that advisers can use to tackle this Rubik-ian challenge. We’re receptive to any approach, but we favor techniques that blend guaranteed sources of income and risky investments in the same retirement portfolio.

For today’s issue of RIJ, we’ve retrieved several of the best income-planning articles from our archives. (Synopses and links can be found below.) In each case, the adviser goes beyond the “safe withdrawal” method to design a customized, outcome-driven solution for the client.

Income plan for two well-funded therapists

“Andrew” and “Laura,” married psychotherapists in their early 60s with a combined annual income of $300,000, hoped to retire in a few years with an income of about $140,000, consisting of their Social Security benefits, Laura’s pension, and about $77,000 a year in withdrawals from their $1.24 million portfolio.

Their adviser, Bill Lonier of Osprey, FL, believed that such a high drawdown rate (6.2%) could exhaust their savings in only 18 years. He recommended that they build a 30-year ladder of Treasury Inflation Protected Securities for essential income and re-characterize $30,000 of their spending needs as “discretionary” (contingent on favorable markets) instead of “essential.”

To reduce Andrew and Laura’s “longevity risk,” Lonier advised them to buy a joint-life qualified longevity annuity contract (QLAC) with 10% of their investable assets. To give them an alternative source of cash during future market downturns, he also advised them to open (but not tap) a home equity line-of-credit.

Jim Otar’s Advice for ‘Andrew’ and ‘Laura’

When assessing new clients, Jim Otar, the creator of the Retirement Optimizer, categorizes them either as “green zone,” “yellow zone,” or “red zone” retirees. Green-zone retirees have enough assets to cover their expenses throughout retirement, come good markets or bad. Red-zone retirees will most likely run out of money unless they purchase income-generating annuities. Yellow-zone retirees require creativity on the part of their advisers if they hope to realize their goals and avoid misfortune.

Otar quickly identified Andrew and Laura as Green zoners, so he recommended no annuities or bond ladders for them. Instead, he took note of the fact that they owned two homes worth a combined $1.8 million (bringing their current net worth to more than $3 million). He suggested that they cover their expenses by spending $50,000 a year from their $1.24 million investment portfolio and their combined $72,000 in Social Security benefits (at age 70).

If equity markets performed badly and the couple appeared likely to live into their 90s, Otar, a Canadian who is now retired, suggested that they make up any shortage of liquidity by, for instance, selling one of their homes and moving into the other. In the meantime, he suggested that they put 58% of their investable assets into equities, 39% into bonds and 3% into cash.

Income plan for a couple with $750,000

Jerry Golden, CEO of Golden Retirement, a Manhattan-based advisory firm, was asked to create an income plan for the “M.T. Knestors,” a couple with $755,000 in savings. At 66, the husband intended to work for four more years and then claim Social Security benefits of $3,000 a month. His spouse, 60, was already retired.

In the first rough draft of a plan for the Knestors, Golden suggested that they receive retirement income from a combination of dividend stocks, annuities and systematic withdrawals from investments. He used $132,500 (the sum of 25% of each spouse’s IRA savings) to buy a QLAC that would provide income when each reaches age 85.

In addition, he recommended investing about $400,000 in a 50% stocks/50% bond portfolio to provide systematic withdrawal income for 15 years, until the QLAC income starts. For additional monthly income, he recommended putting about $170,000 of after-tax savings in dividend-bearing stocks. He allocated the remaining $56,000 in after-tax savings to an inflation-adjusted, joint-life, single premium immediate annuity (SPIA).

Safety First or Safety Last?

Are guaranteed monthly checks more important to retirees at the beginning of retirement, when systematic withdrawals and market volatility can combine to raise a client’s “sequence of returns” risk (the risk that a retiree will need to liquidate depressed assets for income)?

Or is guaranteed income more important at the end of retirement, when a history of good health habits can make a client vulnerable to longevity risk (the risk of outliving assets)?

In this hypothetical case, the clients, a 65-year-old married couple with $1 million in savings, only want to commit 25% of their savings to an income annuity. They’d also like to receive the income either early in retirement, when they plan to travel, or late in retirement, as a hedge against the risk of living longer than expected.

Their adviser points out that they could fund the first decade of retirement a 10-year bond ladder (or a 10-year period-certain SPIA) costing $250,000 and paying out about $28,000 a year, while spending up to $30,000 a year from their remaining savings of $750,000. Or they could use $250,000 to buy a deferred income annuity that pays $40,000 a year starting when they reach age 80, while taking withdrawals from their $750,000 in savings over the intervening 15 years.

In a presentation at the Investments & Wealth Institute Conference for retirement income specialists in 2018, advisers Dana Anspach, of Sensible Money, and Asset Dedication’s Brent Burns and Stephen Huxley, recommended using a bond ladder for essential income in the first 10 years of retirement and investing other money in an asset class with a history of benefiting from a 10-year time horizon, such as small-cap value funds. The choice of strategy might depend most on the client, and which gives him or her more peace of mind: protection from investment risk or protection from longevity risk.

Bill Sharpe’s ‘Lockbox Strategy’

In his proprietary ‘Lockbox’ software, Nobel laureate Bill Sharpe divides retirement into two periods. During the first period, starting at the retirement date, a retired couple takes withdrawals from an investment portfolio. In one of his examples, the first period lasts 19 years and consumes 64% of savings. In the second period, if the retirees are still living, they buy an income annuity with the remaining 36%. Each year of the systematic withdrawal period is represented by a “lockbox.”

Each lockbox contains a certain portion of Treasury Inflation-Protected Securities (TIPS) and a share in an investment portfolio consisting of ultra-low-cost total market stock and bond index funds.

“The idea is to provide the discipline to say to yourself, ‘I will only cash the number of shares in this year’s lockbox,’ he said in an interview. “Obviously, the lockboxes aren’t really locked. If you have an emergency, you can take money out. You still have the key.” The asset allocation depends on the client’s appetite or capacity for risk.

“For implementation, you’d buy a certain number of TIPS, and a certain number of mutual fund shares,” Sharpe told RIJ. “You build a spreadsheet with one column for the initial amount in TIPS and another column for the amount in a risky portfolio. Then you would multiply the number of TIPS and shares for each lockbox by their current values and figure out what they’re worth in each period. Once a year, you would sell off that year’s portions of the two at their current price. It’s an accounting/spreadsheet task.”

In the 20th year of retirement—i.e., at age 85, which roughly corresponds to the average life expectancy of an affluent 65-year-old American—the couple, if living, buys a joint-and-survivor fixed life annuity. For the sake of liquidity, flexibility, and cost-reduction, they might prefer to make the annuity purchase an option, rather than buying an immediate or deferred annuity at retirement.

© 2019 RIJ Publishing LLC. All rights reserved.

In Defense of ‘Buffered’ Annuities

Posted on December 12, 2019 by -

As the annuity industry celebrated record sales of structured, or “buffered,” index annuities last week ($12.5 billion in the first three-quarters of 2019, according to the LIMRA Secure Retirement Institute), the Wall Street Journal published a tepid review about the whole category of registered index-linked annuities.

The December 6 article, which called structured annuities “An Imperfect Solution to a Calamity,” was, like the low interest rate environment of the past decade, a bit unfair to annuity issuers. The two are related. (On the web, the article was titled, “What Nervous Investors are Buying to Feel Brave”.)

By reducing the fed funds rate to nearly zero in the Great Financial Crisis, the Fed pinched the annuity industry’s oxygen hose. That decision made sense at the time. Low rates helped support the prices of existing bonds, flooded banks with liquidity, and financed a stock market rebound.

But it occurred just as the market for guaranteed income products was blossoming and it greatly reduced the yields that life insurers use to make the benefits of those products attractive to retirees and near-retirees. In 2009, I asked the largest writer of single premium income annuities how long he thought the life insurers could endure such conditions. “Five years,” he said.

Don’t get me wrong. A rising stock market and easy credit helps the entire economy. And life insurers have found ways to survive the interest-rate drought. They’ve invested in BBB bonds and mortgage-backed securities. More to the point, they’ve relied increasingly on products that get their juice indirectly from the equities markets. As variable annuity subaccounts have grown (to $1.95 trillion), they’ve generated more asset-based fees. As stock indices have risen, index-linked annuities have enjoyed rising sales.

But this strategy plays to the strengths of asset managers, not to the strengths of annuity issuers. It also encourages journalists to frame annuities as over-priced investments or as inadequate protection. Which brings us back to the Journal’s article.

The column begins, “One of Wall Street’s hottest investments lets you participate in most of the gains on stocks while sidestepping some of the losses.” From this statement on, structured products are at a disadvantage.

First, Wall Street may create the structured annuity’s derivative strategies, but index-linked annuities are more likely to come from Des Moines, Minneapolis, Cincinnati, Philadelphia and Columbus. Second, structured annuities aren’t investments. They’re insurance products. Investments convey risk to people. Insurance products transfer risk to insurance companies. It’s burritos and hoagies. No comparison.

Third, the article says that structured annuities “encourage gun-shy investors to keep some money in the stock market.” Owners of structured annuities don’t have money in the stock market. They buy options on equity indices, and the options expire at the end of each term.

Further down in the story, we arrive at a more vital issue. Zweig notices something strange about the downside “buffer” that so many structured annuities offer. He’s right. It’s counter-intuitive. When this product type was first introduced eight years ago, the SEC, too, thought it strange (before approving it). In a structured annuity with a buffer (as opposed to a “floor”), the insurance company absorbs the initial 10% or 20% of losses while the contract owner absorbs the net loss beyond that. Yes, it exposes the owner, not the life insurer, to the tail risk.

This dour, man-bites-dog observation drives the headline of the story. (It also inspired the illustration that accompanies the story: A large man, standing waist-deep in the ocean, is wearing an inadequate, child-size life vest while a version of “The Great Wave” looms behind him.) The implied lesson for Journal readers is that structured annuities are the worst of both worlds—weak growth potential and weak protection—rather than the best of both worlds, as annuity issuers try hard to frame them.

But the article should have explained that there are versions of these products that offer “floors,” which resemble traditional insurance deductibles. A floor stops a contract owner’s losses at five, 10 or 20 percent. It might also have mentioned the reason why life insurers sell more buffered structured annuities than floor versions. (I could not find data on sales of the two.)

A buffer is cheaper to buy than a floor, which means that buffered annuities can afford higher caps than floor annuities. Investors like higher caps.  The last time I compared the caps on floor-based structured annuities with the caps on buffer-based structured annuities, the buffer caps were about 2.5 percentage points higher for each of the indices.

There’s other contextual information that the article might have provided. It might have compared structured annuities favorably with structured notes, their after-tax, non-insurance, derivative-driven cousins. It might have mentioned that structured annuities offer much more upside potential than fixed indexed annuities, which promise zero loss of principal if held to term.

The Journal article closed with an aside that we in the annuity industry hear a lot. “Insurance companies and financial advisers make a lot of money selling these products,” it said. Yes, they make money. That’s why they’re in business. But they surely don’t make as much as the equity industry has made over the last decade, thanks largely to the same low interest rate environment that makes life tough for annuities.

© 2019 RIJ Publishing LLC. All rights reserved.

Prudential Joins the SIMON Platform

Posted on December 5, 2019 by -

Prudential is a late-comer to the fixed indexed annuity (FIA) party that’s been in progress for the past several years, but—perhaps for that reason—the carrier’s PruSecure FIA recently became the first FIA contract offered on the SIMON structured products platform.

Prudential is also an investor in SIMON, a virtual wholesaling platform for structured notes and index-linked annuities. The other investors include (since December 2018) leading structured notes manufacturers like Goldman Sachs, Barclays, Credit Suisse NEXT, HSBC, J.P. Morgan and Wells Fargo.

SIMON’s owners hope that wealth managers and investment advisers at participating broker-dealers (Raymond James is already on board) can use its platform to learn about, compare, back-test, select, and manage their purchases of index-linked products. The product manufacturers, who also sit on SIMON’s board, pay SIMON a fee based on sales flow.

Kathy Leckey

RIJ spoke recently with Kathy Leckey, vice president and head of Strategic Distribution, Individual Solutions Group, at Prudential Financial, about the timing of Prudential’s decision to join SIMON. [See the feature story on SIMON in today’s issue of RIJ.]

Just when SIMON came along, her company was in the process of reducing its reliance on its long-time cash cow, variable deferred annuities.

“We had 95% of our assets in variable annuities a few years ago, and we were happy to be focused on that business. But we want to diversify our mix. Our peers are doing the same thing. SIMON approached us to see if we had an interest. We had a lot of interest.

“We got into the FIA business before we started working with SIMON, but it became one more reason for us to diversify our product mix,” she said. “SIMON will help us distribute our fixed indexed annuity, and maybe eventually a structured annuity.”

“Our challenge is, ‘How do we make this complex product simpler? How do we get new producers [advisers] who wouldn’t have sold an annuity in the past?’ We decided that we needed to use technology to help tell the FIA story in a different way.”

SIMON appears to be one answer. “The people at SIMON found a way to make complex products simpler for advisers who haven’t sold indexed annuities before or for retail clients who are unfamiliar with them,” Leckey said. “They’ve created a platform that lets advisers customize their investment and gives them best-in-class education and training.”

Life insurers are still struggling to tell the annuity story to investment advisers, and they’re turning to digital platforms. “I call these platforms, ‘technology distribution,’” she said. “Others call it ‘non-traditional channels.’ Advisers don’t necessarily have time to read brochures. And you’re not sending paper anymore.

“We’re trying to get annuities to resonate with more advisers. Especially with the SEC Best Interest rule coming down, advisers need to have more holistic conversations about retirement income. But how do we tell our story in a more cohesive way? How do we explain not only the product but also the process. The process itself has to be better if it’s going to help sell our product.”

Of the capabilities on the SIMON platform, Leckey singled out its post-sale services for praise. As one feature available for structured notes and being built out for annuities, SIMON reminds advisers to revisit an in-force contract to determine if owning it is still in the client’s best interest.

“The client might be holding the product for up to seven or eight years,” she said. “He or she may not even remember why they bought it. There may be no tangible results to show them yet, but there still needs to be a conversation along the way. You want to have a more transparent process.”

In a sense, SIMON serves as a wholesaler that’s always present but never intrusive. “If the financial adviser has SIMON, he or she can turn on SIMON. The adviser may already be using SIMON on the structured notes side of the house. It’s different from a wholesaler coming and giving the adviser a pitch. Then, when a wholesaler and an adviser do meet, they won’t be coming cold to their meeting. They can have a different kind of conversation.”

© 2019 RIJ Publishing LLC. All rights reserved.